Bank Lawyer's Blog

FDIC Says "Nyet" To NetBank

No sooner does the OTS hint that it's ready to supervise previously unregulated mortgage brokers and bankers than it announces that NetBank has bitten the dust while under the watchful eye of the OTS. While the press release was terse, mainstream media reports shed more light on the downfall of one of the first "pure" Internet banks.

Federal regulators closed NetBank Inc.(NTBK), a $2.5 billion thrift based in Alpharetta, Ga., on Friday partly due to significant mortgage-related losses the company sustained in 2006 and 2007.

NetBank marked the largest bank to fail since since the early 1990s, which marked the end of the savings and loan crisis. The Office of Thrift Supervision closed NetBank at 3 p.m. EDT, the federal regulator said, and the company was immediately taken into receivership by the Federal Deposit Insurance Corp.

The OTS said weak underwriting standards, failed business strategies, and a lack of proper controls forced NetBank to suffer significant losses starting in 2006.

"They had significant problems with respect to loan underwriting, poor documentation, and a high amount of early payment defaults," OTS spokesman Kevin Petrasic said. "All of those factors led to fairly significant losses that increased substantially in 2007."

NetBank's woes have been evident for some time, and when, a couple of weeks ago, its sale to another (much more solvent and much less troubled) Internet bank, EverBank, fell through, many observers figured that NetBank's days were numbered. On the bright side, EverBank ended up with $700 million of NetBank's mortgages (it closed in July on the mortgage loan servicing portfolio of NetBank), and ING assumed $1.5 billion of NetBank's insured deposits in return for a 1% deposit premium and purchased another $720 million of NetBank's assets. The FDIC will retain $1.1 billion in assets for "later disposition" (at fire sale prices, we presume). Depositors owed $109 million in uninsured deposits will likely get a valuable lesson in why the average depositor should never, ever, keep deposits in a bank in excess of FDIC insurance limits. The heartless and the free market disciples call this "enforcing market discipline."

Will Chuck Schumer, Chris Dodd and Barney Frank be front and center with a bailout plan for the uninsured depositors? Stay tuned.

Banking crank consultant Bert Ely was once again front and center with his standard Monday morning (actually, Saturday morning) arm-chair quarterbacking.

Bert Ely, a banking consultant based in Alexandria, Va., said NetBank was in "deep trouble" before the subprime mortgage market's woes accelerated this year. Regulators, he said, "should have closed it a long time ago."

Easy for him to say.

Ely was right on the button with this comment: "While some Internet-only banks are successful, he said, operating one without retail branches can be a difficult strategy to maintain."

It's been evident since before the dot.com bust that the banking regulators were, to put it mildly, less than enamored of the "Internet-only" banking model. Running what amounts to a money desk is a tough way to go, especially where you rely on a cyclical income generator like residential mortgage lending. When you don't have a stable base of core deposits to stabilize your cost of funding, you can, like NetBank, get whipsawed. As I noted in June, the "monoline model" is a no-go (and all you Countrywide folks who wrote and razzed me over that previous post, you've since proved my point. I love ya', but your recent  troubles are proof of the risks.).

In his speech of September 19, 2007, OTS Director Reich observed that liquidity and competition for deposits were matters on which the OTS was focusing.

For some of our lenders, the current concern is liquidity. Institutions selling loans to Fannie Mae and Freddie Mac are not greatly affected by current market conditions. However, as I mentioned earlier, the market for non-conforming loan products has weakened significantly, if not totally evaporated, the last several weeks. A number of institutions are re-evaluating their business strategies and OTS examiners are being vigilant to evaluate any changes.

The last area I want to mention is competition for deposits, which is strong in most large retail markets. Large organizations with effective marketing campaigns for deposits may cause other institutions to turn to more volatile—and potentially risky—funding sources. In this environment, contingency planning is essential. Thrifts must prepare for potential shifts in the markets. As a regulator, the OTS must ensure that the preparation is adequate. As recent events in the capital markets have illustrated, a solid foundation of deposits can provide stability during rocky times. Despite robust competition, the stability provided by deposits remains a positive force in the thrift industry, which has relied on customer deposits for liquidity since the first savings association was established in 1831.

Core deposits: Good. Money desk: Bad.

Brick'n'mortar branches: Good. Internet-only: Bad.

Buy'n'sell mortgage banking model: Bad (unless it's conforming product sold to Fannie Mae or Freddie Mac). Buy'n'hold: Good.

At least, that's the likely to be the company line until the next change in economic conditions.

OTS Grabs For The Brass Ring

I like John Reich, Director of the Office of Thrift Supervision. While I don't know him personally, the former community banker seems like a straight shooter and a man whose intentions are honorable. Yet, operating as he does in the land of confusion and corruption, where power vacuums are abhorred and no good deed goes unpunished, one always has to be ever vigilant for signs that another once-good man or woman has succumbed to the Dark Side of the Force.

In pursuit of this thankless task, Bank Lawyer’s Blog, employing an electron proctoscope,  was parsing the nuances of Mr. Reich’s speech last week to the Exchequer Club in D.C., and we thought we caught a whiff of something more akin to sardines than jasmine, if you catch our drift. In fact, we detected a definite drift by Mr. Reich’s boat into waters where one finds usually finds only corsairs manned by the likes of Julie Williams of the OCC or everyone’s favorite political pirate, the FDIC’s Sheila Bair, ever on the prowl to plunder the political oceans, increase their agency's power, and smite their enemies in the never-ending blood feud known as “bureaucratic turf tussle.”

John had some interesting things to say about the problem of transparency, and the role that its absence played in the recent subprime mortgage market turmoil that has spread into other areas of financing. He also telegraphed some positions that scream “Danger, Will Robinson! Danger!” to any thrift that is regulated by the OTS and that has engaged heavily in residential mortgage lending (more about that in a future post). Then, toward the end of his remarks, John got down to brass tacks.

    I have heard comments from executives at federally regulated financial institutions that a level playing field does not currently exist and I have to agree with them. Many of the abuses in home lending have come from a side of the mortgage market that is outside the reach of federal regulators, and in many cases also outside the reach of the states. Current supervisory structure provides minimal accountability—and represents a continuing force for tipping the competitive balance in the home mortgage marketplace in favor of entities that play by less stringent sets of rules.

    The activities of mortgage brokers and nonbank lenders have filled stories in the press and caught the attention of lawmakers in recent months. As noted in a recent Time magazine article on the mortgage industry, "the farther away from the prying eyes of federal bank examiners a transaction occurs, the more likely it is to cause trouble."

Oh, oh! What about state bank examiners, John? Don't they have "prying eyes"?

    We have suggested to Capitol Hill that the time has come for a more structured regulatory regime to apply to these corners of the home mortgage market. We must find a way to provide that level playing field and to eliminate or significantly reduce competitive pressures to engage in practices that are misleading and otherwise not consumer friendly. CSBS is a strong advocate of uniform licensing standards and national registration of mortgage brokers and loan originators. We support CSBS’s efforts in conjunction with the American Association of Residential Mortgage Regulators to establish a national licensing system for mortgage brokers and originators.

Nice. A quick head nod to the states. But, he gets back to the only real power that can save the states, individually and collectively, from the scourge of "opacity."

    The OTS and other federal regulators currently have tenuous authority to provide meaningful nationwide protection for mortgage originations conducted outside the entities that we regulate. Our ability to regulate activities of brokers and others in the mortgage origination process is constrained by the scope of our jurisdiction. However, Congress has the power to act to curtail abuses by requiring national registration and oversight of mortgage brokers and loan originators that operate outside of existing federal oversight and supervision.

    The other area of concern has been the funding of mortgages that were poorly underwritten and/or that had predatory pricing and lending terms. Again, Congress has the ability to address funding abuses by imposing much needed oversight and accountability for mortgage banks. The OTS has extensive expertise in the oversight and supervision of mortgage banking operations that I believe would benefit the currently unregulated mortgage banking market. As I have said in the past, the OTS is not asking for expanded regulatory authority, but if Congress determined that our agency could provide the best solution, we would rise to the challenge.

You have to love the "we don't want the power, but if you deem us worthy, well, shucks, I guess we'll do our duty, step up to the plate, and take a swing." There's just no way around it: John's power grabbing in a most blatant manner. He couldn't sound more desperate than if he'd screamed, "We have less than a thousand federal thrifts left! Either expand our role or just shoot us!"

The thing is, he's right about the OTS being the best federal agency to regulate mortgage lenders. The federal thrift is supposed to be a residential mortgage lender, and its lending authority and asset holding requirements ensure that a lion's share of its assets will be related to residential real estate. As a result, its an agency with a lot of experience in the risks and rewards of residential lending and mortgage banking. Some might prefer HUD, and it occasionally kicks some keister when it discovers blatant violations of the anti-kickback provisions of RESPA, but ever since the thrift regulators got religion in the early 1990s, they've been running a tight ship. Unfortunately for the OTS, that ship was once a heavy battle cruiser but is now a coal barge that's taking on water.

Of course, the nut that needs to be cracked at the outset is whether there's a need for a federal regulator with that kind of oversight authority. It's a discussion that ought to keep the CSBS actively engaged in presenting counterarguments that a national licensing system and more vigorous oversight of previously unregulated (or poorly regulated) mortgage lenders and brokers can be implemented without the need to reanimate a failing federal agency and create a flesh-eating zombie that will gobble up, through federal preemption (if you think the OCC is a preemption junkie, read OTS preemption opinions), what little power the states retain in this area.

Thanks for throwing your hat in the ring, though, John. On one level, I admire you for making the play. You can't fault a jockey for trying to prop up a faltering horse and keep it in the race. On the other hand, can't you just hear folks who hate the idea of the OTS stepping into this area shouting, "If you liked what the savings and loan regulators did for the thrift industry in the twentieth century, you're gonna' just LOVE what they'll do for mortgage banking in the twenty-first."

D.C. Lowers The Boom On Payday Lenders

Sure, it's old news, but it's never too late to gloat about bad things happening to predators. 

Notwithstanding fierce lobbying efforts by payday lending mouthpieces, payday lenders took another one right on the chin last week, this time in Washington, D.C. The D.C. Council passed, by a 12 to 1 vote, the Payday Loan Consumer Protection Act of 2007, which caps the annual percentage rate on payday loans at 24%. The American Banker (paid subscription required) reported that such an APR translates to $0.90 per $100 of loans repaid, versus the "going rate" of most payday lenders of about $15.00 per per $100 of loans repaid. As the bill's sponsor, Mary Cheh, observed, less than 1% of the payday loan borrowers are able to pay off such loans, plus the "vig," in the usual two-week loan period, requiring payday borrowers to repeatedly roll-over and add to the unpaid balance of such loans, which, in turn, means, as Ms. Cheh puts it, payday lenders "steal futures."

That's a bit melodramatic, but then, Ms. Cheh's a politician playing to a constituency. Obviously, Cheh hasn't listened to the arguments of some payday lending shills to the effect that using an annual percentage rate to discuss the cost of a payday loan is "ridiculous" because payday loans pay off in two weeks.  It's amazing the inane things some lawyers will spout when a client pays them to sell their brain as well as their soul.

Interestingly, the lone dissent came from Councilman, and former Mayor, Marion Barry, who also happened to be a former co-sponsor of the bill.  He claimed he turned around on the bill because it would force 90% of the payday lenders to leave the District and that borrowers would be forced to go to (gasp) Virginia to obtain these loans (apparently because Maryland has also enacted legislation that caps these loans at 24%). Pardon us if we don't weep bitter tears over that prospect, Marion.

With the dust starting to settle, it was nice to see that Marion Barry can still draw out some lingering snark from critics. The Cleveland Leader's blog had this question for Barry:

Did the lobbyists make him an offer he couldn't refuse?

That take-off on a line from The Godfather is certainly apropos. With so many payday lenders shutting down, this makes a great time for the Gambino Family to step in and take up the slack.

As for Barry, you have to remember that this is a man who not only was caught on videotape and subsequently convicted of smoking crack cocaine (with a prostitute...fitting for a politician, eh?), but uttered this immortal line of defense to the FBI: "Bitch set me up." He more recently plead guilty to income tax evasion and received probation. None of these misdeeds has hurt his political career, apparently. Then again, D.C. is home to the biggest collection of professional politicians in the country, so none of this should come as a surprise.

Given his personal history, how a reporter could suspect Barry of being in the pocket of payday lenders is beyond me.

TJX Settles

It's not that we're stuck on class action litigation; it just appears that way.

Our latest adventure in litigation news takes us to the land of TJ Maxx, which we've visited a number of times, most recently last month. Last Friday, TJ Maxx's parent, TJX Companies, issued a press release that reported that the company had entered into a settlement agreement "with respect to the customer class actions in the United States, Canada and Puerto Rico relating to customer claims arising from the criminal intrusion(s) into TJX's computer system." The cost of the settlement has been included in the $107 million previously estimated, and reserved, by TJX to cover losses as a result of the security intrusions.

Depending upon what data was stolen, customers of TJX will get up to three years of credit report monitoring and identity theft insurance coverage and, for those whose drivers license numbers were taken, reimbursement for the cost of securing replacement licenses "and, if their drivers’ license or other ID numbers were the same as their social security number, for certain losses from identity theft".
Customers "who show they shopped at TJX stores located in the U.S., Canada and Puerto Rico (excluding Bob’s Stores) during the relevant periods and incurred certain costs as a result of the intrusion, will be offered vouchers [up to two, $30.00 vouchers] for use in these TJX stores in the country in which they reside." Whether or not you were an affected customer, everybody gets the benefit of a three-day sale with prices reduced by 15%.

Although nowhere in the press release or on the information page at TJX's website that details the terms of the settlement, was set forth what the class action plaintiffs' attorneys are receiving as their "just due" for squeezing this settlement out of TJX, that information is in section 7 of the Settlement Agreement that is attached as an Exhibit to TJX's latest 8-K. Co-lead counsel gets a cool $6.5 million in fees and $150,00 for expenses. We assume that they'll not be paid in $30.00 vouchers. We also doubt that they'll be taking advantage of the 15%-off, 3-day sale. Our guess is that after their payout, the sharks will be swimming at Neiman Marcus.

Not that there's anything wrong with that, of course.

Help! My Settlement Lender Just Imploded!

Anyone know a good lender? One with money to burn? Have we got a hot deal for you!

Responding to my posting (a rant, actually) of last week concerning class action litigation against subprime mortgage lenders, a bemused reader pointed me to this proposed class action settlement. According to the class action information web site, the class action is against Finance America and concerns purported violations by Finance America of the Fair Credit Reporting Act arising out of what were (or were not ) "firm offers of credit" made (or not made) by Finance America. The proposed settlement involves "Settlement Loans" to be made by BNC Mortgage to members of the class who are "qualified borrowers at a favorable interest rate and with a single fully disclosed fee to be paid to and retained by the lender."

There's a "hitch in the giddy-up," however.

Like other mortgage lenders, BNC Mortgage is closing. The parties are in the process of trying to work out a solution to the closure of BNC that would allow the settlement loans to be made on at least as favorable terms as before. Once that process is finished, both the settlement website and information on the toll free phone line will be updated. In the meantime, you may still register for settlement loans. Registered class members will be contacted by their preferred means of contact with updated information about the case.

According to our favorite "Implode-O-Meter," BNC isn't "closing," it's "closed." See number 136 on the list  of "Imploded Lenders." That must make the "process of trying to work out a solution" very challenging, indeed. There's a hearing scheduled for October 22, 2207, so I'm sure that folks are scrambling to find a lender to step in and make loans to the class "at a favorable interest rate."

That should be relatively easy. It's not like there's a liquidity crisis in the residential mortgage market.

Cell Phone Karma

My travel schedule makes it impossible (ok, inconvenient) to attempt to make a substantive post for the start of the week. Instead, I present for your inspection evidence that there is a God.

The Fun Is Only Starting

We all knew that this stuff was coming , didn't we? Pick any large mortgage lender, preferably one solvent and well-run, and paint a bulls-eye on its back. The war cry bellows forth: "They done a bunch of junk to me."

A lawsuit filed against Wachovia Corp.undefined mortgage unit and World Savings Bank alleges the bank was less than honest in explaining its option-adjustable-rate mortgages to consumers.

That "campaign of deceptive conduct and concealment" led customers to lose their homes through foreclosure, contends the suit, which is seeking class-action status. It was filed Aug. 30 in federal court in California.

Dolores Mandrigues of Milpitas, Calif., filed the suit on behalf of herself and any other consumers who have taken out option-ARM loans from the bank over the past four years. She is seeking unspecified damages.

The suit claims the bank did not disclose the actual interest rate on its loans, which were often raised "immediately and significantly" after closing. It also says if borrowers made payments at the teaser rate, the principal on the loan would actually increase, which is called negative amortization.

[...]

The suit claims Mandrigues was told her option-ARM loan would have an interest rate between 1% and 3% that would be fixed for the first three to five years of the loan.

She contends she was also told that if she made payments at that rate, the principal on the loan would not increase through negative amortization. She says the product was "aggressively marketed" as a fixed-rate, low-interest home loan to increase loan volume for the bank and maximize profits.

Instead, the loan had a low fixed payment but not a fixed interest rate, her suit alleges, and the low teaser rate stayed in place for only a month.

As a result, the loan negatively amortized, and Mandrigues lost equity in her home, she says, a prospect she claims the bank did not adequately disclose.

Wachovia is reviewing the suit and hasn't yet filed a response.

"We are confident that World Savings has clear and accurate loan disclosures for all of its mortgage products," says bank spokeswoman Christy Phillips-Brown.

After a few years of struggling along, the war of attrition will settle and the main beneficiaries will be the class action plaintiffs' attorneys. Not that it's a racket or anything.

Purely by coincidence comes this news:

William Lerach, the nation’s best known class action shareholder litigator and prominent San Diego attorney, pleaded guilty to a single count of criminal conspiracy that will result in his serving one to the two years in prison, and paying other monetary penalties, said the U.S. attorney’s office Sept. 18.                                                  

In the plea agreement, which comes after a seven-year investigation into his former law firm, Milberg Weiss LLP, Lerach, 61, acknowledges that he paid named plaintiffs in class action lawsuits filed against corporations. The plaintiffs were generally promised 10 percent of the attorneys’ fees collected in settlements, the usual way many companies dealt with the suits.

Good news also came to light concerning Learch's former firm.

On Wednesday, Weiss' firm, Milberg Weiss in New York, said that it expected to be indicted anew in the kickback case and that Weiss would be indicted too. Milberg Weiss already faces conspiracy, mail fraud and money laundering charges leveled in a 2006 indictment that alleges the firm ran a criminal kickback operation, paying people to sign on as lead plaintiffs in more than 150 lawsuits.

Another former partner of Lerach's, Steven Schulman, has agreed to plead guilty, the Los Angeles Daily Journal reported Wednesday. The guilty pleas have piled up, amounting to five so far -- with Lerach's the most recent.

I'm certain that these folks are either victims of a government witch hunt or merely a few bad apples in an otherwise pristine bushel of class action plaintiffs' lawyers.

It's tough to feel good about these indictments. It's like putting a 2,000 pound laser guided bomb down the smoke hole of some jihadists' abode in Baquba. 15 down, an infinite number to go.

Dick Durbin Does Bad Bankruptcy Bill

Another great idea is about spew forth from the bowels halls of Congress.

There's been "buzz" for the past couple of months about Illinois Senator Dick Turban's Durbin's plan to introduce legislation that will radically "re-reform" the Bankruptcy Reform Act of 2005. In a recent article in UMKC Law Professor Patrick Randolph's daily e-mail newsletter/discussion group "BROKERDIRT" (you can subscribe through Listserv by clicking here), Pepperdine University law professor Mark S. Scarberry and American Bankruptcy Institute Scholar in Residence Robert M. Zinman provide a preliminary peek at what is currently entitled the "Helping Families Save Their Homes Act of 2007." The professors warn that since the legislation has not yet been introduced, it's subject to change; however, what they've reviewed thus far should be sufficient to scare the pants off of banks and other lenders to consumers.

Here's what the professors had to say. The editorial comments are mine, not the professors':

• The bill would provide debtors aged 55 or older with a minimum $75,000 homestead exemption in any equity they might have in their homes. It also would provide for a mortgage to be forfeited—eliminated both as a personal liability of the debtor and as a lien on the home—if the holder of the mortgage failed to comply with any of several sections of the Truth in Lending Act or "any provision of applicable State constitution, law, or regulation that was in force at the time at which such debt was incurred." [Ed.: Ouch! No parking violations, lenders, ya' hear!]
• The bill would make substantive changes in treatment of mortgages in chapter 13. It would eliminate the special protection against modification of home mortgages now found in §1322(b)(2). It would allow the lien of a home mortgage to be stripped down to the value of the home in a chapter 13 case, and would allow the chapter 13 debtor to pay the stripped-down mortgage over thirty years at a court-determined interest rate. It would limit—to claims secured solely by personal property—the requirement that equal monthly payments be made on secured claims in chapter 13, thus making clear that a chapter 13 plan may provide for a balloon payment of a mortgage at the end of the plan pursuant to an anticipated refinancing. It also would limit the fees that could be added to a home mortgage due to occurrences during the chapter 13 case; only fees approved by  the bankruptcy court could be added, and then only to the extent that the mortgagee was oversecured. [Ed.: Yikes! Cram down comes to Chapter 13. A perfect idea if you're Linda Lovelace Savings Bank, but most residential mortgage lenders are going to gag on this one.]
• In chapter 7 cases, the bill would expand the §722 redemption provision to include the debtor’s principal residence. The home could be redeemed by a lump sum payment of the lesser of the secured claim or the home’s liquidation value (net of costs of sale, according to the draft section-by-section summary). That may allow some debtors to redeem by refinancing. [Ed.: Potentially painful! Potentially beneficial! In the words of actress Rebecca De Mornay in the film Risky Business, "Yes. No. Maybe."]
• In chapter 11 cases in which the debtor holds consumer credit claims, the bill would ensure that transfers of those claims pursuant to a chapter 11 plan or a court order accompanying the plan would not cut off consumers' claims or defenses to any greater extent than would a sale under nonbankruptcy law. This will provide consumers the same protection when such transfers take place that they already are provided, under §363(o), when consumer credit claims are sold under §363. [Ed.: Curses! Another loophole closed!]
• The draft bill also includes several provisions not limited to mortgages or to any  particular chapter of the Code. With respect to consumer debtor cases, arbitration agreements would be unenforceable in civil proceedings arising under the Code or arising in or related to the bankruptcy case. Failure to schedule a claim held by the debtor as an asset of the estate would not result in dismissal of an action later brought by the debtor on that claim; instead, the trustee could request to be joined or to substituted as the real party in interest, absent which the debtor could proceed as the real party in interest. The debtor’s certification that a mortgagee has initiated a judicial or nonjudicial foreclosure on the debtor’s principal residence would trigger a waiver of the §109(h) credit counseling requirement, so that the debtor could seek bankruptcy relief without delay. [Ed.: What? While we're at it, let's just remove all statutes of limitation on all consumer claims against lenders, so that my descendants in 2213 can sue whatever successor to Citibank then exists (First National Bank of the Jihad?) over claims that I possess today but was not conscious of and that were discovered by my great grandson, also long deceased, but passed down by oral tradition.]

I know most of my clients will have a smile on their face and a happy greeting for Senator Durbin when this piece of junk legislation is introduced.

Are these clowns basically trying to kill home mortgage lending in this country? Just asking.

Have Litigators, Will Travel

Beal Bank, headquartered in the Dallas suburb of Plano, and owned by Texas legend Andy Beal (profiled by attorney Tom Kirkendall's blog "Houston's Clear Thinkers" two years ago), has a business plan that includes activities that made Mr. Beal a "good living" inside and outside of the banking business: making silk purses out of sows' ears. Among other banking activities, Beal Bank buys "distressed debt" and "works it out." Obviously, this takes a keen eye for appraising distressed assets, and the bank has an admirable track record in this respect. As also might be expected in such a line of business, litigation can't scare you. Sure, you must manage it wisely and unemotionally, but when the stakes are high, you sometimes need to be willing to adopt the Toby Keith method of litigation tactics: put a boot up your opponent's backside (after all, it's the American way). On occasion, this entails taking things all the way to the highest appellate court.

In 2005, we recounted the critical Massachusetts Supreme Court decision in Beal Bank v. Eurich, in which  the Supreme  Court overturned a potentially disastrous decision by that state's Appeals Court, and held that loan purchasers can use their own business records to establish the amount of the debt owed by a borrower, and do not have to produce evidence of the originating bank's (and those of any intervening owner's) business records. That decision was accompanied by a sigh of relief heard from loan servicers and purchasers from throughout this great land that we here at Bank Lawyer's Blog are fond of referring to as "The United States of America."

Well, Beal Bank has done it again, this time clear across the country in yet another "Blue State" where you'd think a bank with solid "Red State" roots might not get a favorable reception.

Beal Bank bought from U.S. Bank two promissory notes that were secured, respectively, by a second and a third deed of trust on a condominium unit located in Washington state. When the holder of the first lien note foreclosed its prior deed of trust in a nonjudicial foreclosure, Beal Bank did not bid in the trustee's sale. When Beal Bank later sued to enforce the promissory notes, the borrowers filed a motion for summary judgment on the grounds that the nonjudicial foreclosure of the first deed of trust extinguished not only the liens of the junior deeds of trust, but also the debt secured by the junior deeds of trust. The trial court granted the motion and dismissed the claims of Beal Bank.

Beal bank appealed the trial court's order, and succeeded in having the appeal transferred from the intermediate appellate court to the Washington Supreme Court. In a decision captioned Beal bank, SSB v. Sarich et. al., rendered last week, the Washington Supreme Court overruled the trial court and decided, based upon the plain wording of the relevant statutory provision (RCW, 61.24.100(1)), that the foreclosure of a senior deed of trust does not extinguish the debt/obligation of any junior lienholder or otherwise preclude an action to recover that debt. That statute provides:

Except to the extent permitted in this section for deeds of trust securing commercial loans, a deficiency judgment shall not be obtained on the obligations secured by a deed of trust against any borrower, grantor, or guarantor after a trustee's sale under that deed of trust.

While it might seem that the phrase "under that [emphasis added] deed of trust" should have made a decision in Beal Bank's favor an easy one for the trial court, the trial court relied upon the 1990 case of Washington Mutual Savings Bank v. United States, 115 Wn.2d 52, 793 P.2d 969, 800 P.2d 1124 (1990). In that case, the Supreme Court had ruled that the IRS, as a junior lienor that was provided a right of redemption under federal law (Washington law did not provide junior lienors with such a right), was required to pay the combined debt (junior and senior notes) to a junior lender that had purchased the property securing senior and junior loans at a trustee's sale in connection with the foreclosure of the senior deed of trust.  However, in that decision the Supreme Court also certified to the U.S. Ninth Circuit Court of Appeals (a court whose very name makes Bank Lawyer's Blog recoil in horror) that a nonforeclosing junior lienor who purchased at a foreclosure sale of a prior deed of trust could not seek a deficiency. Thus, we understand the trial court's confusion, as well as the borrowers' counsels' decision to grab that pony of confusion and ride it until it dropped. Well, Beal Bank dropped it with a well-placed shot right between the eyes.

Justice Sanders, in a concurring opinion, recognizes the problem with the Washington Mutual decision.

There we held a nonforeclosing junior lienor could not seek a deficiency judgment.  This holding was contrary to the plain meaning of Washington's deeds of trust act, chapter 61.24 RCW, as well as our prior case law. More importantly, it frustrates the goals of the deeds of trust act and might dissuade would-be lenders from financing home loans by unnecessarily prohibiting the lenders from seeking a deficiency judgment.

Although this case did not present an opportunity to expressly overrule the Washington Mutual decision, Justice Sanders urges the court to be vigilant and seize the first opportunity that presents itself to overrule a bad decision. That bodes well for the future with respect to junior lienholders in Washington, although it doesn't entirely eliminate the risk.

So, once again, Gus McCrae-like, Beal Bank rides into a hostile town, blazes away at the bad guys, and when the dust settles and the smoke clears, the bank is the last man standing. Other lenders can offer their thanks for Beal Bank blazing the legal trail and ride their slow-moving buckboards into a now-safe state on the coattails of a bank that makes "good law" (for bankers, at least) while it makes money for itself.

This case is also an interesting example of how Beal Bank takes yet another asset that other, less imaginative banks (and businesses generally) not only discount, but actively loath -trial lawyers - and makes it an asset that adds value to the bank's core business. 

Banks Bail Out (On Borrowers)

A couple of weeks ago, the general counsel of one of my clients told me about a large acquisition that his company had in the works, but with the liquidity squeeze, the substantial increase in the cost of financing, and the uncertainties in the stock market, the investment bankers backing the deal could no longer make the kind of returns on their investment that justified the risk. A deal that looked good two months ago now looks "not so good." They passed.

According to today's The Wall Street Journal's Deal Journal, nervous bankers are pulling the plug on a number of deals.

Bankers giveth, and bankers taketh away.

It is the latest in a series of debt commitments for M&A deals that banks are trying to back out of. Mortgage lender PHH said today that J.P. Morgan Chase and Lehman Brothers Holdings signaled they will back out of their commitment to fund Blackstone Group and General Electric’s purchase of PHH. The move may leave the buyers $750 million short of debt financing they need to complete the $1.8 billion deal. (Read more about it in an early Bloomberg take.)

Banks are pulling any levers they can to get out of lending commitments that have suddenly become unprofitable as credit markets sour. As we discussed Friday, a similar dynamic is playing out with Morgan Stanley’s financing of GSO’s $1.1 billion purchase of Reddy Ice. Finish Line’s leveraged purchase of athletic-shoe retailer Genesco, financed by UBS, smells the same.   

All these deals are relatively small ones. Things will get really interesting if and when the banks try to back out of their commitments on the really big deals, the ones like TXU (at $32 billion) and Alltel ($27.5 billion). Then the fireworks would really begin.

Bankers giveth, and bankers taketh away." Friggin' bankers!

As a commenter points out in the Deal Journal's combox, there's this nasty concept called "material adverse change" that's incorporated into any competently drafted acquisition, merger or financing agreement.  It's there for a reason, and unfortunately, mortgage lender PHH is taking a hit unless someone pulls a cash-laden rabbit out of a hat.

Those of us who don't fly in the rarefied air where The WSJ soars get a kick out of $1.8 billion and $1.1 billion deals being referred to as "small," whether or not that description is "relative." PHH is not a considered a small fry in mortgage lending circles. So, in addition to being stiffed by the bankers, PHH gets "dissed" by the Deal Journal's Dana Cimilluca. All-in-all, a bad day.