Commentary on Transfers of Mortgage Loans to RMBS
Securitization Trusts
October 18, 2010
There is a tremendous amount of public
commentary these days about possible defects
in foreclosure proceedings commenced by loan servicers.
Much of this discussion concerns procedural matters, such as
whether the appropriate steps are being taken to verify the
accuracy of statements made in affidavits executed in
connection with these proceedings. These issues are very fact
specific and it may take some time to ascertain what effect, if
any, they may have on any given loan.
Within this overall dialogue, however, more
fundamental issues have been raised challenging both the validity
of the procedures used to convey mortgage loans into securitization
trusts and the qualification of the securitization trusts as a real
estate mortgage investment conduit (“REMIC”) at the time those
trusts were formed. These statements are false and
misguided.
The reasoning behind these statements appears
to be as follows: (i) in order to satisfy procedural
requirements in connection with foreclosure, certain steps may need
to be taken in order to document the ownership of a mortgage loan
by the securitization trust, and (ii) since not all of these steps
were taken at the time of the securitization, the securitization
trust must not own the mortgage loan. This reasoning is
faulty, because some of the steps that may be required under
applicable state law in order to bring a foreclosure action are not
required to transfer ownership of the mortgage
loan.
The purpose of this article is to refute these
challenges to the efficacy of mortgage loan transfers to
securitization trusts. Simply stated, the industry standard
procedures used for decades in transferring mortgage loans to
securitization vehicles comply with the well-settled principles of
law governing the transfer of mortgage loans, and therefore are
effective to transfer ownership of the mortgage loans.
Standard procedures for transferring a mortgage
loan
A mortgage loan can be thought of as a bundle
of rights, including (i) a borrower's obligation to repay
debt, evidenced by a note, and (ii) a lien on real
property collateral securing this obligation to repay the debt,
which is created by a mortgage or a deed of trust. (As
used in this article, “mortgage” includes a deed of trust.)
Transfers of notes are governed by applicable state contract law
including the Uniform Commercial Code (UCC).
Transfers of a mortgage or deed of trust are generally governed by
state real property law. While these laws do not conflict,
they do have the result of transfers of mortgage loans being
legally complex. There is no single legally prescribed format
for transferring mortgage loans, such as the certificate of title
rules for motor vehicles. In addition, ownership of a
mortgage loan does not require the owner to have recorded an
assignment of the mortgage in the real property records.
There are decades of custom and practice in
the transfer of mortgage loans as between the originator and
successive purchasers or into a securitization. The practices used
in conveying mortgage loans to private label securitization
trusts are consistent with the practices used in
transferring mortgage loans to Fannie and Freddie. In
addition, these practices are the same practices used in sales of
mortgage loans ("whole loan sales") in transactions prior to or not
involving a securitization, as between the originator and
successive purchasers in these whole loan sales.
These standard transfer procedures are
essentially designed to meet three objectives: 1) document
the parties’ intent to effect a sale of the mortgage loans and
memorialize all terms and conditions of that sale, 2) evidence the
transfer of ownership by delivering the physical notes with
endorsements consistent with UCC provisions, which protects the
purchaser from being subject to adverse third party claims in the
mortgage loans, and 3) enable the purchaser to become the mortgagee
of record as needed for foreclosure proceedings or other
purposes.
General custom and practice in the sale of
mortgage loans involves three key steps from a documentary
perspective:
- Contract. In mortgage loan sale
transactions, there is almost always a contractual agreement as
between seller and purchaser which: clearly establishes the parties
intent to sell the mortgage loans to the purchaser; identifies the
specific mortgage loans being sold by use of a loan level schedule;
contains granting language which states that it conveys ownership
of the mortgage loans; identifies the time of sale; and specifies
the governing law for the sale transaction (frequently, the laws of
the State of New York are designated by the parties as the
governing law). These contractual agreements typically also
contain representations and warranties made by the seller. An
agreement of this type is essential to establish the parties’
intent to sell the loan, to actually convey the loan to the
purchaser and to articulate the terms and conditions of the
sale. (Delivery of the note and an assignment of mortgage,
while important for the reasons discussed below, do not in and of
themselves establish the parties intent and articulate the terms
and conditions of the sale.)
In a private label RMBS
transaction, the relevant contractual agreement is typically a
pooling and servicing agreement, which conveys the mortgage loans
from the depositor to the trustee on behalf of the securitization
trust. Another relevant document could include a separate
mortgage loan purchase agreement, under which the mortgage loans
are sold by the sponsor to the depositor immediately prior to the
sale from the depositor to the trust, with representations and
warranties that are assigned to the trustee. These documents
contain clear granting language that conveys ownership of all of
the seller's "right, title and interest in and to" the mortgage
loans to the trustee on behalf of the securitization trust.
There is a schedule or exhibit to these documents that specificly
identifies each loan sold under the agreement.
- Delivery of Note. Physical
delivery of the mortgage note to the purchaser or its agent,
together with an endorsement of the note by the seller in blank,
are also key components in the sale of mortgage loans for several
reasons. First, because mortgage notes are generally
“instruments” under the UCC, possession of the mortgage note by the
purchaser in a valid sale is generally sufficient to establish that
the purchaser's ownership rights are superior to the rights of any
other person in the mortgage loan. Second, as an
“instrument”, the note can be transferred and the purchaser will be
recognized as the holder in accordance with applicable UCC
provisions, upon physical delivery of the note to the purchaser
with an endorsement (which may be in blank). (The question of
whether a mortgage note is a negotiable instrument is fact
specific, and the standard transfer procedures are designed to be
effective irrespective of whether it is a negotiable
instrument.) Third, since there is generally only one
physical note per mortgage loan, delivery by the seller to the
purchaser effectively prevents the seller from engaging in any
mistaken, improper or fraudulent sale or pledge of the mortgage
loans to multiple parties. Fourth, possession of
the mortgage note may be needed for enforcement of the note in the
event of default, including by foreclosure.
Notes may be delivered to the
purchaser with an endorsement in blank. It is common for a
mortgage note for a mortgage loan that has been sold to have
stamped on it an endorsement to the effect of "Pay to the order of
_____________, without recourse", signed by the originator or a
subsequent purchaser. Such an endorsement has the effect that
any subsequent transfer of the note presumptively only requires
physical delivery (i.e., with no additional endorsement).
Therefore, where there are successive purchasers to a note, the
endorsement in blank by any prior holder is a sufficient
endorsement for purposes of the most recent purchaser. For
this reason, a mortgage note that has been transferred numerous
times typically will only show one endorsement, which remains in
blank. Importantly, for all purposes for which an endorsement of a
mortgage note may be necessary or desirable in connection with a
sale of the mortgage note, an endorsement in blank is sufficient
and is equally effective as an endorsement where the name is filled
in.
In private label RMBS
transactions, the prevailing and nearly universally-followed
practice has been for the endorsed notes to be physically delivered
to the trustee, or to a custodian as the trustee's agent, at the
closing of the securitization. Typical procedures
include a requirement that the trustee or custodian provide an
initial certification at closing and a final certification a
specified number of days thereafter in order to confirm the
delivery of each mortgage note. Any exceptions noted in these
certifications result in a repurchase obligation of the seller
within a specific period of time. Significantly, these
procedures require a specific verification by the trustee or
custodian that it has in fact received the physical notes for each
loan listed on the mortgage loan schedule. These procedures
make it highly unlikely that there has been any widespread failure
to deliver the mortgage notes that simply went undetected.
- Assignment of Mortgage. The final key step in
transferring ownership of a mortgage loan is to provide an
assignment of mortgage in recordable form to the purchaser.
Typically, the assignment is in blank so the name of the assignee
can be filled in later prior to recordation. Because the
mortgage “follows the note”, it secures the debt for the benefit of
the noteholder, and as between seller and purchaser it is not
necessary to record the assignment in the name of the purchaser in
order to convey rights under the mortgage to the purchaser.
However, in order to exercise its rights under the mortgage against
the borrower following default, it may be necessary, under certain
states’ law, that the purchaser become the mortgagee of
record. Delivery of an assignment of mortgage in recordable
form in blank is intended to enable the purchaser to become the
mortgagee of record by completing the assignment in its name and
submitting it for recording. Because every recording of an
assignment of mortgage involves a filing fee and other expenses, it
is not unusual for these assignments to remain unrecorded until
such time as is needed in connection with a foreclosure of a
specific defaulted loan.
In a private label RMBS
transaction, the prevailing practice has been to deliver an
original signed assignment of mortgage in recordable form in
blank. In many cases, the securitization governing documents
have not required that the assignments of mortgage be recorded in
favor of the trust as a general matter. Certification of
receipt by the trustee or custodian of the assignments of mortgage
has been required under the same procedures as for the mortgage
notes.
Variations from the above procedures
In our experience, we are not aware of
material deviations from the general practice of delivering the
physical mortgage notes to the trustee or its custodian. In
some programs, delivery of the notes was permitted to occur within
a specified period of time after issuance, but subject to the
overall procedures for checking in the notes and providing a
certification of receipt by the trustee or custodian with
repurchase required for any delivery failures as described
above.
In some cases, at the time of the
securitization it is known that the seller will be unable to
produce the physical note because it had been previously lost or
destroyed. In that case, a lost note affidavit executed by
the seller would be delivered to the trustee which affidavit would
confirm that the seller (i) had owned the loan, (ii) had possession
of the original note, and (iii) had attached a true and complete
copy of the original note to the affidavit, and also that the
original note had been lost or destroyed. The securitization
governing documents by their terms would still nevertheless convey
ownership of those mortgage loans to the trustee, although the lack
of the original note might in some states give rise to additional
requirements that the lender must comply with in connection with a
foreclosure (e.g., posting a bond).
With respect to mortgage loans where, as of
the time of the securitization, the mortgage was held through the
MERS system, instead of delivering an assignment of mortgage, the
seller would transfer its beneficial interest in the mortgage to
the trustee through MERS. In jurisdictions where the
noteholder must be named as the mortgagee of record in order to
complete a foreclosure, relatively simple steps can be taken to
accomplish this, thereby permitting foreclosure if necessary
(although delays may occur).
Validity of original transfer procedures
For the reasons described above, these
standard procedures are sufficient to validly transfer ownership of
the mortgage loans to the securitization trusts, consistent with
the clear and unambiguous intent of all parties to the transactions
(including the investors) at the time. Specifically, use of
an endorsement in blank on the mortgage note is fully consistent
with a sale. Recordation of an assignment of mortgage to the
securitization trust is not necessary to evidence ownership of the
mortgage loan by the trust, and the delivery of an assignment of
mortgage in blank in recordable form is sufficient to enable the
trust to become the mortgagee of record if needed for
foreclosure.
There may be additional steps required at the
time of foreclosure in order to comply with procedural or
documentary requirements. For example, an assignment of the
mortgage may need to be recorded to the securitization trust.
Any such additional steps would not convey any new or additional
ownership rights to the securitization trust and would not negate
the sufficiency of the transfer procedures described above to
convey ownership of the mortgage loans to the securitization trust
at the time of issuance.
It should not be surprising that additional
steps may be needed at the time of foreclosure. The standard
transfer procedures described above are used in the context of
transactions between sophisticated financial institutions and
institutional investors, who clearly mutually intend for the
transactions to be sales. As commercial transactions, the
steps taken are certainly sufficient to legally convey ownership
and protect the rights of the purchaser, but do not include
additional steps not required to convey ownership that would
involve additional time or expense. In contrast, the
foreclosure process is adversarial and in that context it is
understandable that extra requirements could be imposed over and
above those necessary to convey ownership of the loan itself.
Is there a REMIC qualification issue?
A few commentators have added to the parade of
horribles a concern that the REMIC would lose its qualification
because it did not own the mortgage loans. The underlying
premise to this argument is that the actions taken to convey
ownership of the loans at issuance were ineffective and that any
subsequent step taken to supposedly “cure” such deficiency (such as
recordation of an assignment of mortgage) would have the effect of
transferring the mortgage loan to the REMIC after the 90 day period
following the issuance date during which transfers to the REMIC are
permitted, causing a prohibited transaction tax. The simple
response to this argument is that the mortgage loans have been
legally conveyed to the securitization trust at the time of
issuance, which satisfies the requirements of the Internal Revenue
Code and the related Treasury Regulations governing REMIC
qualification. Under basic principles of tax law in which
substance is controlling over form, there is no question that the
REMIC at the time of issuance was the owner of the mortgage loans
for tax purposes.
Conclusion
We believe that the recent allegations of
possible wholesale failures to convey ownership of mortgage loans
to private label RMBS trusts are baseless and unfounded. All
parties to these transactions, including issuers, underwriters,
trustees and investors, clearly intended that the transactions
convey ownership of the loans to the trusts, and appropriate steps
were taken to effect such conveyance in accordance with
well-settled legal principles governing transfers of mortgage
loans. Any attempts to assert otherwise today are inaccurate
and uninformed, and, if left to stand unchallenged, could cause
substantial and unwarranted harm to the economy.
If you have any questions or would like
further information concerning the subject matter of this
Client
Alert, please contact Stephen Kudenholdt,
Co-Chair of our Capital Markets Practice Group (+1 212 768 6847 or
steve.kudenholdt@snrdenton.com),
or Stephen F.J. Ornstein (+1 202 408 9122 or stephen.ornstein@snrdenton.com).
The following SNR Denton partners also
contributed to this article: within our Capital Markets group,
Andrea N. Mandell, Michael C. McGrath, Robert B. Olin, and Richard D. Simonds; and within our Real
Estate group, Peter J.
Mignone and Mitchell G.
Williams.