Skin in the Game

Posted by kevin on August 5, 2016 under Foreclosure Blog | Be the First to Comment

I read an article in Bloomberg about new waves of regulations on mortgage backed securitizations in the EU. One recent proposal requires that the sponsor of a securitized trust must retain up to 20% of the offering. My experts have uncovered some offerings in the US from 2006-2007 where the sponsor is holding a much smaller precentage- known as the residual tranche.

So, what does this mean? In Europe, it appears that the regulators believe that if the sponsor has “skin in the game”, there is less chance that it will try to foist unduly risky investments onto the public. But the article set me to thinking. Looking at retaining an interest in the securitization from a litigation standpoint, such a regulation may open up new defenses for the borrower.

The object of most mortgaged backed securities (MBS) offering is that the trustee is buying the pool of mortgage loans from the sponsor through the depositor. On closing day, the sponsor through the depositor is selling the notes and mortgages to the trustee. The note, they claim and the courts have agreed, is a negotiable instrument. As the buyer of the note, the trustee can become a holder under Article 3 of the Uniform Commercial Code (UCC). A holder is the first step to becoming a holder in due course (HDC). The trustee wants to be an HDC because you take the note free and clear of most defenses to the note. It is like laundering the transaction.

So, if you had a subprime loan for 450K on income of 30K given to a person who did not speak or read or write English with a 500 FICO , you probably have a good case under predatory lending and consumer fraud. However, if the originator of that loan sold it to a securitized trust, the foreclosing trustee could argue that it is an HDC. The borrower may be able sue the originator, but vis-a-vis the trustee (who is foreclosing on the house), the borrower is usually SOL.. Not good for the borrower.

But, perhaps an argument could be made that the transaction is not a sale because the originator is keeping a portion of the loans. It is more akin to a security interest under Article 9 of the UCC. If Article 9 controls, the there can be no HDC and the trustee takes subject to all the bad things that the originator may have done.

NJ has take the approach, for the most part, that a borrower lacks standing to argue that the note is not in the securitized trust because it was not transferred in accordance with the terms of the Pooling and Servicing Agreement. I disagree with these holdings, and so does the Supreme Court of California and courts in other states. But so far, my argument plus $23 gets me a parking space at Citi Field.

Perhaps the argument that may get some traction is that because of the residual tranche, the transaction is not a sale of notes and mortgages but a secured transaction covered by Article 9. If that argument prevails, we might see more case law in NJ where the banksters get tagged for treble damanges and attorneys fees under the Consumer Fraud Act.

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