A new avenue of attack may be opening up for investors seeking to force big banks to buy back billions of dollars in mortgages: drag the trustees into the fight.
Last month, the Knights of Columbus sued Bank of New York Mellon Corp., the trustee for two mortgage-backed securities that the Catholic fraternal group invested in. The plaintiffs' real target was not named as a defendant: Bank of America Corp., whose mortgage unit, the former Countrywide Home Loans, issued the securities. The Knights are demanding that BNY Mellon account for unauthorized fees that Bank of America, the servicer of the pools, has allegedly been charging to the investor trusts.
Despite widespread reports of improper practices in the securitization and servicing of mortgages, investors have had a hard time proving that their own securities were affected by such malfeasance. One reason is a refusal by trustees, which are supposed to be looking out for investors' interests, to prod servicers to provide loan documents. In this case, the Knights of Columbus are using the threat of liability to scare BNY into acting.
"It is the most novel and sensible of the litigation strategies that we have seen," says Josh Rosner, managing director of Graham Fisher & Co., an investment consultancy, of the Knights of Columbus suit. "It doesn't threaten to blow up the trusts, but it does in fact create a wedge with which investors should start being able to get the information they need to pursue rep and warranty violations."
Many attempted put-backs flamed out after investor coalitions failed to get the 25% of bondholder votes that pooling and servicing agreements require for a trustee to be forced to take action against a mortgage servicer. But investors don't need to meet such a threshold to sue the trustees for failing to meet their obligations.
The role of trustees in the mortgage securitization process also faces new scrutiny. Attorney Generals Eric Schneiderman of New York and Joseph Biden III of Delaware are examining whether BNY Mellon and Deutsche Bank fulfilled their obligation to ensure loan files placed into the securities were complete. Neither Deutsche nor BNY Mellon would discuss the attorney generals' inquiry.
Research by Amherst Securities Group indicates that trustees may routinely have failed to fulfill their obligations to investors. For example, trustees only loosely enforced early payment default provisions, which should have been a slam-dunk for mortgage put-backs. According to Amherst, in instances where borrowers never made a payment, only 37% of mortgages were put back to securitizers, with much smaller amounts for loans making only one to six payments.
Although trustees on securitization deals are supposed to represent investors' interests, there are various disincentives for them to take action against a servicer or a securitizer. Compensation is based on volume and trustees have do not earn extra money for going after servicers over violations of representations and warranties. If a trustee did in fact establish that a servicer was guilty of rep and warranty violations, it would have little recourse other than to tell investors who could then take legal action themselves. Trustees generally cannot fire servicers except for specific reasons such as a failure to remit payments when a servicer becomes insolvent. In addition, in the event of a servicer default, the trust could find itself liable for the expense of making advances on the bonds to investors.
"Trustees are paid very little because their duties are ministerial prior to a default," says Cris Naser, senior counsel for the American Bankers Association's Center for Securities, Trust and Investments. "They are not paid like the underwriters or attorneys and if they are going to undertake action, it is going to cost them a lot of money."
Further, there is the risk of alienating a trustee's best customers. Research by Adam Levitin, a law professor at Georgetown University, and Tara Twomey, of counsel at the National Consumer Law Center, shows that four mortgage trustees accounted for about two-thirds of all the residential mortgage-backed security trustee business from 2003 to 2009. During the same period, according to the paper, almost two thirds of Bank of New York Mellon's residential mortgage bond trustee business was on Countrywide or Bank of America deals. In many instances, the mortgage servicer is obligated to pick up the legal expenses of Bank of New York Mellon in investor suits.
"What you are seeing with the Knights of Columbus case is the investors holding the servicer responsible for doing its job," Twomey said in an interview. "There are lots of reasons set forth in the complaint showing that the trustee should have been aware of the problems and should have done something about it."
The Knights of Columbus lawsuit, filed in a county-level New York supreme court, describes a litany of alleged mortgage servicing abuses, which it states are grounds for Bank of New York to take action against Bank of America. It notes that federal agencies have taken the bank to task for failing to follow legal procedures in the foreclosure crisis. It also points out that the trust has been the target of lawsuits over the dilapidated state of foreclosed properties that the Knights claim is due to poor care by Bank of America. And the complaint cites a Federal Trade Commission complaint and reports in the media (including American Banker) about inflated default servicing fees which the plaintiff alleges that Bank of America is passing along to the trust.
"The complaint does not assert any claims against Bank of New York Mellon or seek damages," says Kevin Heine, a BNY Mellon spokesman. "It merely seeks an accounting." B of A didn't return a request for comment.
Rosner says that the Knights of Columbus case and the New York and Delaware attorneys general inquiry raise troubling questions about the relationship between the trustees and the big banks.
"The conflict is very real," he says. "If the trustee's interest are supposed to be serving the interest of the note holder, then given how much of their business is coming from the banks, you do wonder what was their real interest."