The BoA MBS Settlement
The $8.5B dollar figure of the Bank of America settlement with a cohort of MBS investors has gotten all the attention, but I think there's a bunch of more interesting things going on than the price tag. Still, it's hard not to talk about the price tag, so let's get that out of the way. Then we can get into servicing, documentation, and the question of whether anyone can/will object to the settlement.
I have no way of knowing. On the one hand, putback claims are really hard to pursue. They are slow slogs, and there are questions of loss causation under other litigation theories (not that any suit has actually been brought). On the other hand, BoA looks like a dog in any court, and recent rulings in putback or rep/warranty cases have been holding that they can be done by sampling, rather than by "onesies and twosies" as Judge Crotty of the SDNY memorably put it. And if BoA is willing to pay out $8.5B when the investors haven't even gotten to the loan files, they must be hiding something pretty bad.
Frankly, it's just hard to know how to price this. If I were an MBS investor, however, I'd hesitate to take the offer. The investors would be probably able to get to the loan files one way or another, even if it takes some time, and that would give them far better information for pricing a settlement.
OK, enough on the price tag. Now for the more interesting tidbits.
2. The Settlement is really a PSA addendum.
The settlement agreement really gets interesting to me with parts 5 and 6. Part 5 deals with servicing, and part 6 with documentation and putbacks. I think the best way to understand it is that it is a correction/clarification via settlement of all sorts of terms that should be in pooling and servicing agreements (PSAs), but aren't. For example, PSAs require trustees to compile an exceptions report for documentation problems. And they do. But there is nothing in PSAs that requires trustees to ensure that all of the exceptions actually get fixed.
There's widespread consensus that PSAs are going to have to be drafted differently (and servicing will have to work differently) going forward, and this settlement might be part of that blueprint. I don't think investors are going to go for "trust and have no ability to verify and lousy remedies."
3. The Servicing Provisions of the Settlement Are a Vote of No Confidence in BAC
On the servicing side, I think this settlement is a real embarrassment for both BAC and the OCC and Fed. BAC has basically consented to outsource the servicing on all of its delinquent loans in these pools. That's a pretty clear sign that no one has confidence in BoA's servicing operation. It'll be interesting to see who gets brought in; while some servicing shops are better than others, none of them is exactly a dreamboat.
4. The Servicing Provisions Show Just How Weak the OCC/Fed Consent Orders Are
For the OCC and Fed, this should also be an embarrassment. The OCC and Fed had significantly greater leverage over the servicers than the investor coalition does, yet they were only able to extract generic operational reform promises. This settlement has some very precise operational reforms mandated and a much more serious verification mechanism, including a requirement that audits of the servicers be done by firms that do not have significant other dealings with them. This settlement shows what a slap on the wrist the OCC/FRB consent orders were.
5. Documentation Is a Suprisingly Detailed Focus but Doesn't Cover Endorsements
I've been ranting since last fall about documentation problems, and on several occasions I've been told that I must be wrong since big law firms did all the work and they never screw up. (I take careful note of these individuals as likely investors in my future Florida swampland real estate venture.) Well, a bunch of investors (who happen to hire those very law firms for their securitization deals) seem to be awfully concerned about documentation. They want exceptions reports to know what's wrong and they want them on a regular basis.
Curiously, though, they don't want to know about endorsements in the exceptions reports. The particular exceptions they want to know about in paragraph 6(a)(i) aren't the ones that I'd be particularly concerned about. Sure, "document missing" or "photocopy" could be real pains, but title insurance issues? That's not where the action is. So why nothing about missing or incomplete endorsements? Well, for starters, those problems aren't correctable. The only remedy would be a putback. The issue seems to have been pushed off to paragraph 6(c), which says that if the trust can't foreclose because of any documentation issue, then the servicer (BAC) has to make the trust whole. Which is actually a pretty good smart settlement for BAC and the investors. To the extent that documentation issues don't get in the way of foreclosure, the investors will eat the loses, but if there are documentation problems, then it's on BAC. What would concern me, as an investor, however, is how the trustee will determine whether the trust's inability to foreclose was because of a documentation issue or not. It's not as if the trustee is looking at the court filings to figure this out. I would want a better verification system, such as an audit of all cases where foreclosure actions failed.
6. The scope of the release.
The release is very broad. I was struck, however, by how careful it is to include the "delivery" of notes to the trust and to cover
the documentation of the Mortgage Loans held by theCovered Trusts (including the documents and instruments covered in Sections 2.01(“Conveyance of Mortgage Loans”) and 2.02 (“Acceptance by the Trustee of the MortgageLoans”) of the Governing Agreements and the Mortgage Files) including with respect to alleged defective, incomplete, or non-existent documentation, as well as issues arising out of or relatingto recordation, title, assignment, or any other matter relating to legal enforceability of a Mortgage or Mortgage Note
Clearly BAC thinks there's something here for which it is worthwhile getting a release. What does that tell you?
7. Will There Be a Squeakly Wheel (and Some Tips for How One Might Contest the Settlement)
I'm very curious to see if there'll be a squeaky wheel with this settlement. If I were a hedge fund manager, I'd try to buy some MBS in these pools just to extract some holdup value. BONY, the trustee, has petitioned the NY State Supreme Court to sign off on the settlement. I'm not sure that they technically need to do so, but trustees are cautious types who like comfort orders. And that opens the door for someone to come in an object to get a holdup payment.
On what basis would one object? Well, there are any number of substantive terms within the settlement, but I don't think an objector will get particularly far with those. Maybe an objector could try to pare back the scope of the release, such that if there was not actual delivery to the trusts, the deal would be off.
But I think there's a better argument to be made, namely that BONY has not established its authority to settle claims on behalf of the trust. BONY is only the trustee if there is an express trust. An express trust requires, among other things, a trust res and delivery of the res to the trust. If there isn't proper delivery, there might be a constructive trust, but then BONY's authority is quite different. Put differently, don't we have to peak behind the curtain and see if the notes (the trust res) were actually delivered to the trust in order to know whether the trustee is in fact a trustee and can settle the trust's claims? That's not a particularly burdensome inquiry--produce a random sample of notes for examination. And doing so will help resolve the initial question about the pricing. There are a few months before this settlement will get heard, I think, so that's plenty of time for holdouts to flex their muscles.
I've linked BONY's petition to the NY Supreme Court and their memorandum of law in support of the petition. I love the reference in the memo of law to the unnamed financial advisors and unnamed leading contract law professor. Who is this international wo/man of mystery? And why isn't BONY naming who these parties are? I would think that would be a key part of establishing the credibility of their position.
9. Bottom line
The biggest thing about this settlement might be what it doesn't do. It doesn't settle things for every CW deal out there; there are plenty that aren't covered. If anything, the settlement's an invitation to other investors to come and get their share of the action. We haven't seen the end of putback litigation, and Subprime Shakeout has some astute commentary (here and here) explaining why we'll see more.
The settlement doesn't settle things in any of the homeowner class actions that are facing BAC. And it doesn't solve their problems vis-a-vis the attorneys general.
Speaking of which, I'd be curious to see if the NY AG weighs in on this settlement. The NY AG is the supervisor of NY trusts, which would make it appropriate. Afterall, it's not every day that NY trusts enter into an $8.5B settlement. This might present an opportunity for the NY AG to squeeze BAC for any and everything else it wants on servicing reform.