Countrywide’s $8.4B Settlement: Must Holders of Its Securitizations Foot the Bill?

Written by J. Bruce Boisture

Managing Partner

Grais & Ellsworth LLP

 

To settle allegations of predatory lending made by the Attorneys General of California, Illinois, and nine other states, Countrywide Financial Corporation proposes to modify the mortgage loans of some 400,000 borrowers, a proposal estimated to be worth some $8.4 billion to those borrowers. But even though it is Countrywide’s own conduct (or misconduct) and the resulting liabilities that make it prudent to offer so large a  settlement, Countrywide plans to pay not a cent of its own (or, rather, of its parent Bank of America) toward the $8.4 billion. Instead, it plans to impose the cost of its settlement on the trusts into which the to-be-modified loans were securitized, and thereby onto holders of certificates in those trusts. In our view, Countrywide’s plan will violate the agreements that govern those trusts.

 

Only a hopeless conflict of interest enables Countrywide even to think of passing the cost of its settlement to certificate holders. Wearing one hat, Countrywide originated predatory loans and sold them to securitization trusts. Wearing another, Countrywide services the loans in the trusts on behalf of the trustees and certificate holders. Countrywide as servicer now plans to modify 50,000+ loans so as to extinguish the liabilities of Countrywide as predatory lender. Countrywide as servicer says these modifications will increase revenue into the trusts by avoiding the expense of foreclosure, etc. This assertion is laughable, for two reasons. First, if it were true, then Countrywide as servicer would be modifying those loans anyway, and the settlement between the Attorneys General and Countrywide as predatory lender would convey no incremental value at all to borrowers in distress. Second, Countrywide as servicer could say nothing else without betraying the plan of Countrywide as predatory lender to shift the cost of its misconduct to certificate holders.

 

Securitizations are governed by pooling and servicing agreements, and the PSAs that govern Countrywide’s many securitizations are all very similar. Three provisions of those PSAs are pertinent.

 

First, Countrywide as lender represents and warrants that “[e]ach Mortgage Loan …complied in all material respects with applicable local, state, and federal laws, including, but not limited to, all predatory and abusive lending laws.” (Emphasis added.) [§ 2.03(b)(68).†] The proposed settlement makes clear that Countrywide breached this representation and warranty wholesale. Countrywide must repurchase from the trusts each loan that was not made in compliance with “all predatory and abusive lending laws,” and must pay the trusts 100% of unpaid principal and interest, plus “any costs, expenses and damages incurred by the Trust Fund resulting from any violation of any predatory or abusive lending law in connection with [the] Mortgage Loan [being repurchased].” [§§ 2.03(g); 1.01 (definition of “Purchase Price”).]

 

Second, Countrywide as servicer must “service and administer the Mortgage Loans in accordance with customary and usual standards of practice of prudent mortgage loan lenders.” [§ 3.01.] Prudent lenders do not make predatory loans or spend their money to discharge the liabilities of others. In servicing and administering the loans, Countrywide “shall take no action that is inconsistent with or prejudices the interests of the Trustee or the Certificateholders.” [§3.01.] Thus, Countrywide as servicer must act in the interests of the certificate holders, not in the interests of Countrywide as predatory lender.

 

Third, Countrywide as servicer may modify mortgage loans, but only five percent of them by principal amount and, more important, only if Countrywide as lender then repurchases each modified loan from the trust. [§ 3.12(a).] Countrywide as lender would argue that the unpaid principal and interest that it must pay for each loan are the reduced amounts after the modification.  But no matter.  As noted above, Countrywide as lender must also pay “any costs, expenses and damages incurred by the Trust Fund resulting from any violation of any predatory or abusive lending law in connection with [the] Mortgage Loan [being repurchased].” [§ 1.01 (definition of “Purchase Price”).]  Those “costs, expenses and damages” are precisely the difference between what Countrywide as lender pays each trust for a modified loan and the unpaid principal and interest on the loan unmodified. Those “costs, expenses and damages”, according to B of A, will be at least $8.4 billion.

 

Countrywide’s PSAs try to make it difficult for certificate holders to enforce their rights.

 

Countrywide and B of A must be assuming that the $8.4 billion will be spread over enough certificate holders that none will think it worth the trouble to protest. By working together for their mutual protection, certificate holders can disabuse Countrywide and B of A of this unfortunate assumption.

 

† Citations are to the sections of a typical PSA, dated September 1, 2006, and available at

http://tinyurl.com/4kpb5k.

 

The opinions expressed in this article are not necessarily those of BVR Legal or Business Valuation Resources LLC.

 

EVENT ALERT: Financial Crisis in the Banking Industry Conference – Litigating For & Against the FDIC will be held January 15-16 at the Westin Grand in Washington, DC.   Watch www.bvrlegal.com’s “Live Conferences” section for details.

 

 

DLA Piper Among Large Firms ‘Publishing’ Frequent News, Views on Financial Tsunami

Law firms are increasingly going straight to the Web with their own brand of updates and perspectives, creating a motherlode of free legal insights.  The urgency of the credit markets crisis has put many firms into high gear with fresh content going up daily.  DLA Piper is no exception.  Below are some recent observations provided by the firm.  More info at www.dlapiper.com.

 

September 21, 2008, Implications of the Global Credit Crisis and the US Government’s Response

1.    “Participants in the global financial services industry have witnessed developments this past week unprecedented since the late 1920’s: within the span of several days, a major investment bank (Lehman Brothers) was forced to file bankruptcy, one of the premier retail and institutional broker/dealers in the United States (Merrill Lynch) was induced to be sold to Bank of America amid concerns of its own solvency and survival, and a major insurance conglomerate (American International Group (AIG)) was rescued by a direct loan and guarantee program that effectively provides for this entity to be owned and operated by the United States government.  These developments occurred within weeks of the federal rescue of two crucial government sponsored enterprises (Fannie Mae and Freddie Mac), and only months after the near collapse and government-guaranteed acquisition by JP Morgan of another prominent investment bank (Bear Sterns).”

 

2.   “The Treasury has been encouraging its counterpart agencies overseas to develop and implement comparable asset purchase programs.  The ability to extend the availability of the US purchase program to additional foreign entities having a significant presence in the US may, in turn, depend on the extent to which comparable programs are established overseas.”

 

3.   “In light of the broad ranging and dramatic nature of the proposals promulgated by the regulators and contemplated for passage by the Congress, the impact on individual businesses and their counterparties will be significant…”

 

4.   “By allowing hedge funds or other investors to hold amounts greater than 25 percent of the total contributions to the capital of a banking entity, without becoming subject to regulation as a bank holding company, banking regulators may create the potential of opening a significant amount of new sources of capital for investment in the banking industry.”

September 22, 2008, SEC Attacks Short Selling on Regulatory and Enforcement Front

1.    “With the issuance of a formal order of investigation, the Enforcement Division now has the power to subpoena documents and testimony relevant to its investigation into manipulative and ‘abusive’ short selling practices and illegal ‘rumor mongering.’”

 

2.   “According to the SEC’s press release, hedge fund managers, broker-dealers and institutional investors with significant trading activity in certain financial issuers or positions in credit default swaps will be required to disclose these positions, under oath, to the Commission.”

September 24, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.   “Today the financial markets received the welcome news that investor Warren Buffett, acting through Berkshire Hathaway, Inc., is planning to invest $5 billion in Goldman Sachs.  The proposal, coupled with an additional capital raise by Goldman Sachs announced today, is being seen as a favorable indication of faith in the viability of the country’s financial system.”

 

2.   “This CDS [credit default swaps] market has been the fastest growing derivatives market worldwide in the last two years.  The sellers of CDS protection are often Insurance companies, and the risk of loss to sellers (in the event reference indebtedness is not repaid in accordance with its terms) increases exponentially.  This arguably increases systemic risk to the financial markets.”

September 29, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.    “…concerns of Main Street bankers in smaller communities who are expressing anxiety at recent market turmoil, and communicating to their legislative representatives the fear that the Wall Street upheaval may result in contagion by smaller market participants in communities and industries throughout the US.  Indeed, legitimate fears exist, given European market developments, that such systemic breakdowns will accelerate beyond the shores of America to Europe and Asia, as well.”

 

2.   “Only one certainty remains: both the regulatory and the market landscape will be a radically different one in the months to come.  While once-hallowed institutions meet their demise by restructuring, liquidation, acquisition or bankruptcy, governmental authorities across the globe are calling for a new system of financial regulation amidst frank acknowledgements….that the old regulatory regimes are obsolete.”

October 1, 1008, The Global Credit Crisis and the Global Response

1.    “In the regulatory area, the Securities and Exchange Commission announced additional guidance on market-to-market accounting standards, in an effort to address concerns about the implementation of this regime and its impact on the financial services industry.  It is expected that this topic will be one of extended debate in weeks to come, as the goals advanced by such accounting treatment, providing for greater clarity and transparency in the valuation of assets, are outweighed by the difficulties of determining accurate values at times when market prices for such assets may be impossible to obtain in a deteriorating market.”