There is a by Adam Levitin at Credit Slips which discusses the implications of the fact that a recent court decision in stated that Countrywide had not transferred the note (the borrower IOU) to the Bank of New York, trustee for the securitization trust. Perhaps more important, the ruling also noted that a Countrywide employee stated that it was Countrywide’s practice not to transfer the note, which is contrary to the stipulations of the pooling and servicing agreement.
Levitin’s post discusses the implications of Kemp v. Countrywide and also gives an overview of the problems with securitization, with the legal arguments recapped in a way that is accessible to laypeople yet also serves to
eviscerate address the usual industry defenses. I suggest you read it in full, but for the time pressed, I’ve extracted the juiciest bits:
This opinion could turn out to be incredibly important. It provides a critical evidence for the argument that many securitization transactions simply failed to be effective because non-compliance with the terms of the transaction: failure to properly transfer the mortgage meant that the mortgages were never actually securitized…..
So the critical issue here is whether the notes and mortgages were properly transferred to the securitization trusts….
A. The American Securitization Forum’s Argument
The American Securitization Forum (ASF) has a recent white paper that purports to explain how notes and mortgages are transferred in a securitization transaction. The white paper explains that there are two methods for transfer and that either can suffice, although typically both are used. Those methods are a negotiation of the notes per Article 3 of the Uniform Commercial Code (UCC) and a sale of the notes per Article 9 of the UCC (take a look at the definitions of security interest, debtor, and secured party to understand how UCC 9-203 functions to effect a sale). (The ASF argues that the mortgage follows the note, meaning that a transfer of the mortgage effects a transfer of the note. I’ve got my doubts on this too, but that’s for another time.)
B. Trust Law and the UCC Permit Parties to Contract for a More Rigorous Method
The ASF white paper is correct to the extent that is explaining how notes could be transferred from, say, me to you or from Citi to Chase. But that’s not what happens with a securitization. A securitization involves a transfer to a trust, and that complicates things.
It’s axiomatic that a trust’s powers are limited to those set forth in the documents that create the trust. In the case of RMBS, that document is the Pooling and Servicing Agreement (PSA). Most PSAs are governed by NY law, which provides that a transaction beyond the authority of the trust documents is void, meaning it is ineffective.
PSAs typically set forth a very specific method of transferring the notes (and mortgages) that goes beyond what is required by Articles 3 or 9. This is perfectly fine under the UCC, which permits parties to deviate from its default rules by agreement (UCC 1-203), which can be inferred from the parties’ conduct, including the PSA itself. So what this means is that if a securitization transaction did not meet the requirements of the PSA, it is void, regardless of whether it complied with the transfer requirements of Article 3 or Article 9. The private law of the PSA, not Article 3 or Article 9, is the relevant law governing the final transfer in a securitization transaction…
So to tie this all back to Kemp: the note in Kemp lacked the endorsements required in the PSA. That means, as the Bankruptcy Court concluded, that the note was never transferred to the trust at the time the bankruptcy claim was filed. The Bankruptcy Court did not need to opine beyond that point, but it is a small step to recognizing that if the loan wasn’t transferred to the trust in the first place, it cannot be transferred now. PSAs contain numerous timeliness provisions about loan transfers, often related to ensuring favorable tax status for the trust. PSAs also require the transferred loans be performing (not in default). That means that for the securitization trust, the Kemp note is like caffeine in 7-up: never had it, never will. The securitization of the Kemp note failed.
Now here’s the real kicker: there’s no reason to think that the Kemp note was a unique, one-off problem. All evidence from actual foreclosure cases points to the lack of a chain of endorsements on the Kemp note being not the exception, but the rule, and not just for Countrywide, but industry-wide. Certainly on the non-delivery point (separate from the non-endorsement problem), Countrywide admitted that non-delivery was “customary.” If either of these issues, non-delivery or non-endorsement is widespread, then I think we’ve got a massive problem in our financial system.
Please do read the post in full .
Legal authorities and the facts are lining up with the pattern we have outlined on this blog since August: that there was a widespread, perhaps endemic, failure to conform with the requirements of the pooling and servicing agreement regarding the conveyance of mortgage notes, that there is no easy fix, and that this creates serious problems for RMBS investors, and enormous liability for securitization sponsors, trustees and servicers.