Hung By Their Own PSA

(Via The Big Picture)

Barry points out another case where (wonder of wonders) a securitization trust is permanently barred from foreclosing on a house because they didn't obey the rules of their own Pooling and Servicing Agreement.

Brief explanation (as far as I understand it)

In order to turn a home loan into an investment (to securitize it), a number of things must happen:

1. The loan must stop being owned by orginating bank
2. The loan must start being owned by a trust, a Special Purpose Vehicle or other legal construct
3. There must be a written record of the transfer of ownership of the loan
4. The record of title transfer must meet the exacting specifications contained in a document called a Pooling and Servicing Agreement, typically they require that all the documents establishing transfer of the mortage note be completed within 60-90 days.

Why all this rigamarole?
Two big reasons are who owns the loan and taxes.

In order for an investor to invest in a security, they want to know that the thing the are investing in is truly theirs. In theory, if the home loan goes bad - they want to know that at least they will get the property in a foreclosure. If an investor knows that there are other entities that could claim to own the home loan - then their back up plan of foreclosure is now worth less, (and may be impossible). If the bank who made the original loan doesn't provide documentation that it no longer has any right to a home loan - there is a chance that that bank could show up and demand a share of the the loan's value (or of the resulting foreclosure).

Now taxes:
The SPV allows ownership of the loan by a trust without subjecting its payments or distributions to investors to taxation. This is a big deal because if the money passing through an SPV was taxed - it would make mortgage backed securites much less attractive as investments because investors would see their money taxed twice. Once as the money flows through the SPV and then again as the investors get paid. This is an intentional loophole, as the SPV is just a pass-through legal construct, it takes no profits - it just passes along the payments it gets.

The price of getting this nice loophole is complying with a very strict agreement called a Pooling and Servicing Agreement. If you don't comply with the PSA bad things can happen. Like, the tax rate on money going through the SPV goes from 0% to 100%

Investors will hate that with the heat of a nova.

And when home loans go bad - and the SPV moves to foreclose they had better have a chain of ownership that shows that they own the loan in question.

Otherwise something like this Alabama ruling will happen - Phyllis Horace vs. LaSalle Bank National Association et. el.:

Following hearing and review of all submissions from the parties the Court has come to two conclusions necessary for the disposition of this case:

First, the Court is surprised to the point of astonishment that the defendant trust (LaSalle Bank National Association) did not comply with the terms of its own Pooling and Servicing Agreement and further did not comply with New York Law in attempting to obtain assignment of plaintiff Horace's note and mortgage.

Second, plaintiff Horace is a third party beneficiary of the Pooling and Servicing Agreement created by the defendant trust (LaSalle Bank National Association). Indeed without such Pooling and Servicing Agreements, plaintiff Horace and other mortgagors similarly situated would never have been able to obtain financing.

Consequently, plaintiff's motion for summary judgement is granted to the extent that defendant trust (LaSalle Bank National Association) is permanently enjoined from foreclosing on the property...
...Further, the Court is of the opinion there is no reason for further delay as to the entry of final judgment concerning the issue of foreclosure by the trust (LaSalle Bank National Association).

That notice shall issue to the parties.
DONE this the 25th day of March, 2011.

ALBERT L. JOHNSON, CIRCUIT JUDGE

Counsel for the investors...start your engines! You will be suing the bejeezus out of LaSalle Bank National Association et. el., because the secured loans you invested in are unsecured because the trust can't prove they own the loans.

Also, your client's pass-through tax exemption is at risk. Huzzah!

LaSalle says they will appeal - although they'd better confine it to the bit about the plaintiff being ruled a third party beneficiary of the PSA, because they look seriously owned on any argument that they met their PSA obligations.

If you believe Barry and the crew, there are many, many loans out there in the same condition as this one just waiting for an enterprising attorney to detonate them.

I'll quote Barry from an earlier post of his:

Understand this precisely: This was not a case of slipshod handling, of sloppy paperwork, or bad management. This was a willful decision to break the law in order to save expenses and be more profitable.

The bank's PR machine can play whack-a-mole, but these cases are going to bubble out all over the place. They can't appeal all of them, and by rights they should lose most of them.

When does this mess reach critical mass?