Ammunition For Loan Buyback Plaintiffs

A couple of years ago, I related a conversation I had with a banker whose bank was being sued by FNMA to force repurchase of loans that, FNMA alleged, breached the representations and warranties the bank made when it sold the loans to FNMA. The bank was opposing the buyback requests, in part, on the argument that the alleged breaches of warranties were not connected to the reasons that the loans defaulted and, therefore, did not cause the losses that FNMA alleged that it suffered. I told him at the time, that FNMA didn't care about connecting the dots of causation. It's position was (and presumably still is) "if you break, you must retake."

A blurb on Housing Wire's site today alerted us to a recent Southern District of New York court decision that supports the position of FNMA (although the lawsuit does not involve FNMA). Housing Wire linked to an article posted online by law firm O'Melveny & Myers that discusses the decision and its implications. Following are the opening and concluding paragraphs of that article.

On June 19, the Southern District of New York ruled that a residential mortgage originator that securitized those mortgages into mortgage-backed securities (“MBS” or “notes”) could be liable for alleged breaches of representations and warranties it made, to the insurance company that insured principal and interest payments to investors in the MBS, and could be forced to repurchase non-conforming mortgages even if (a) the breaches did not cause the underlying mortgages to default and (b) the underlying mortgages have not yet defaulted.

[...]

Currently there are many dozens -- if not hundreds -- of lawsuits against mortgage originators, seeking hundreds of billions of dollars due to alleged misrepresentations about the quality of mortgages sold into securitizations. Such suits can be brought by various parties, including, among others, an investor who purchased the MBS, the insurance company that insured the underlying mortgages and/or principal and interest payments on the MBS, the guarantor of the MBS, the servicer of the underlying mortgages, and the trustee of the mortgage pool. All of the above categories of plaintiffs will undoubtedly argue that the Syncora decision should apply equally in those cases. Defendants will counter by pointing out that with its emphasis on insurance principles, Syncora, on its face, makes clear that these different plaintiffs should not be conflated as their legal rights may vary. The case also demonstrates that the language used in the related documents can be determinative, as the court specifically relies on the terms in the operative agreements and observes that the parties could have included different language in their contract that could have provided for other rights and remedies.

Institutions facing such lawsuits may wish to re-evaluate their exposure, and possibly adjust reserves set aside to cover such risks, based on the type of plaintiff and the specific language in the securitization agreements at issue.

While I haven't yet read more than the synopsis provided by O'Melveny and Myers, it seems to me that FNMA's status as the guarantor of mortgage-backed securities secured by the loans that it buys, as well as the broad wording of FNMA's Sellers and Servicers Guides regarding the breadth of the warranties and representations that loan sellers and servicers make to FNMA, will make this decision an important arrow in FNMA's legal quiver. Moreover, the law firm's admonition to potential (and current) defendants to "re-evaluate their exposure" is wise. If the defendants don't "re-evaluate," their outside auditors are likely to do it for them.