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Residential Department: BackSpace: October 2012

 

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Are mortgage-repurchase demands a case of revisionist history?

More than four years ago, it became obvious that the U.S. housing and residential mortgage markets were imploding. It also soon became clear why they were imploding — because many large financial institutions and the government-sponsored enterprises (GSEs) had devoted considerable time, energy and money over the past several years to acquiring, and then selling or securitizing, large volumes of high-risk, loosely documented loans.

Those loans were both high-risk and loosely documented for almost exactly the same reason. They were being made to borrowers ill-suited for the creative loan products into which these institutions steered them. But the predictable onslaught of defaults and foreclosures that followed did not inspire shame on the parts of these big loan aggregators. Instead, it sparked some remarkable revisionist history.

These aggregators now would have you believe that they were duped — as to loans originated under their own loan program guidelines and underwritten pursuant to their own lax requirements (or lack thereof). The supposed wrongdoers are the third-party correspondent lenders and originators who were supposed to abide by those lax requirements, and forbidden to exceed them if they wanted to sell to the aggregators the particular types of loans that the aggregators wanted to purchase.

The aggregators revised the historical record even further by claiming something never indicated in their public statements or securities filings in the relevant time period: Somehow, all risk of loss on these high-risk, low- documentation loans was not on the huge institutions that created the loan products and loan programs, but instead on the much smaller businesses that had been told to limit their data-verification activities in the underwriting process, so as to comply with the large banks’ institutional instructions.

"Numerous legal and equitable issues are implicated in these situations. These include the possibility of fraud, bad faith, the failure to mitigate any losses they may have incurred and the increasing possibility as time passes that the claim is barred by the applicable statute of limitations."

For those smaller businesses that originated and sold the loans, this is far from an academic debate about whether history is being recounted accurately. They now face an ever-increasing barrage of repurchase and indemnification demands from the big banks, despite the fact that it is not even clear whether or not the banks hold anything that can — much less should — be repurchased.

Many of these demands relate to loans originated under high-risk loan programs like stated income, SISA (stated income and assets, without third-party verification), and NINA (no third-party verification of a borrower’s income or assets). The aggregators touted these programs to mortgage originators as being novel products that would increase sales volume because of the relaxed underwriting requirements. The originators dutifully followed the underwriting guidelines for these reduced-documentation programs, including the guideline requirement that the originator not verify the income or assets of the borrower when originating a loan under these reduced-doc programs.

In late 2006, residential mortgage originators and correspondent lenders saw an unprecedented uptick in the number of demands they were receiving from the aggregators to whom they sold mortgage loans. These demands were asserted on the basis of a claimed breach of the applicable purchase agreements between the parties (typically, that a representation and warranty in the agreement was not true or correct). In some cases, the originators wanted to fight these repurchase claims, but they were reliant on their ongoing business relationships with the aggregators (fewer of which remained after several notable bank failures and rescues). In other cases, originators simply did not recognize they had viable defenses to repurchase demands. In many instances, they even had claims and counterclaims that they could assert against the aggregators.

The aggregators and GSEs often assert that a repurchase claim is justified based solely on their statement that a breach of a representation or warranty occurred. Some believe, however, that a repurchase claim is nothing more than a claim of breach of contract. Accordingly, to prevail on a repurchase claim, an aggregator has to establish all of the basic elements required to support its claim, such as the right (“standing”) to bring the claim in court, and that it incurred an actual out-of-pocket loss. It also must show that it acted promptly to bring the potential breach to the originator’s attention, and that the alleged breach was material and actually caused the alleged loss.

Far too often, originators pay aggregators millions of dollars to resolve repurchase claims, based solely on alleged “loan-level” breaches, without considering the large array of contractual hurdles that the aggregator would have to overcome to prevail on the claim — including whether the alleged breach even occurred in the first place.

Originators must be provided with satisfactory evidence that the claim meets all of the relevant contractual elements that the aggregator would have to demonstrate to a judge and/or jury. For example, aggregators typically provide originators with internally prepared statements showing their losses, but often these statements indicate that the losses are estimated.

When an aggregator is asked to demonstrate (by canceled check, wire-transfer advice or other objective evidence) that it has incurred an actual loss, this request often is met with extreme resistance. Who seeks reimbursement from another party, such as an employer or a business partner, but is unwilling to document the payments for which they are seeking reimbursement? Moreover, many aggregators already have settled claims with investors on highly favorable terms, and some have simply refused to pay their investors on pending repurchase demands. What future losses are they nevertheless “estimating”?

Many aggregators are so brazen in their demands that they do not hide the fact that they have not repurchased — or made “make-whole” payments on — the loans that they are demanding that the originator repurchase from them. So let’s get this straight: The aggregator acquired the loan from the originator and then re-sold it for a profit.

It likely also made servicing-related fees on the loan after selling it. If it has not ever bought back the loan, how exactly has it suffered a loss? If it has not suffered a loss, then it is whole, so why should an originator ever make a “make-whole” payment in that situation? The aggregators appear intent on creating new profit centers for themselves via unjustified repurchase demands on originators.

Similarly, the aggregator must have standing to make the demand in the first place. In other words, it must be the proper party to pursue the claim. If the loan that is the subject of the repurchase demand still is viable, the aggregator must be able to concurrently deliver to the originator the original note and mortgage. Standing to bring the action for repurchase is equally relevant in “make-whole” claims. For example, if after foreclosure of a loan the mortgaged property has not been sold to a third party, then aggregators should demonstrate that they hold the title to such property before the originator makes a payment.

In addition, some claims pursued by the aggregators are incredibly stale. There have been recent demands related to loans that were sold to the aggregators as early as 2003. Aggregators also have asserted claims in 2012 that the GSEs long ago abandoned against those same aggregators — so the aggregator has not suffered, and will not suffer, any damage. Originators always should assess whether claims asserted today could have been raised years earlier. Numerous legal and equitable issues are implicated in these situations. These include the possibility of fraud, bad faith, the failure to mitigate any losses they may have incurred and the increasing possibility as time passes that the claim is barred by the applicable statute of limitations.

Repurchase demands cause third-party originators a lot of consternation. Knowing, and properly using, the many sound defenses available to combat such demands can eliminate a lot of the angst.

Disclaimer: The above is for informational purposes only and does not constitute legal advice. Any opinions expressed in this article are solely those of the authors, and are not necessarily the opinions of Scotsman Guide or its management.


 

Robert M. Siegel and Philip R. Stein are partners at the Miami-based law firm of Bilzin Sumberg Baena Price & Axelrod LLP. Siegel practices in the firm’s Corporate & Securities Group and Stein practices in its Litigation Group. Both attorneys are active in the mortgage repurchasing crisis that has followed the subprime meltdown of 2008. Reach them at rsiegel@bilzin.com and pstein@bilzin.com, respectively.

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