“Double Dipping Docket” is Just a Dumb Idea

DUMMY

I saw the article’s headline pop up here and there online just last week… a few homeowners even emailed me a link to it, as if to say “See…” The headline read: “The Embarrassing Double Dipping Docket: Bank Foreclosure Complaints Conceal That the PSA Trusts Pay Defaulted Mortgages.”

My first thought was that perhaps for the author, English was a second language. I mean… a “PSA Trust?” I know what a PSA is and what kind of trust the author is referring to, but “PSA” and “trust,” just aren’t words that should be placed right next to each other.

The article was written by a lawyer, Susan Chana Lask, and her bio says she is “New York’s High Profile Attorney,” and that she has appeared before the U.S. Supreme Court… and that she was responsible for suing and shutting down a notorious foreclosure mill.”

I have no reason to doubt anything Susan is saying about her background. And it would seem that based on that background, she has to be an experienced lawyer… but she what she says in this article is NOT CORRECT. And actually, it’s pretty basic stuff, so I don’t know why she doesn’t know.

Beyond the awkward grammar, the headline bothered me for all sorts of other reasons. “Double dipping,” and foreclosure complaints “concealing” that PSA trusts are paying something? It’s all like nails on a chalkboard to me. Complaints conceal something? How so? And PSA trusts paying something? That’s just not possible since there’s no such thing as a PSA trust.

The PSA stands for Pooling & Servicing Agreement and it’s the 500+ page contract between the trust, which holds the loans, and the servicer who collects payments and deposits them into the trust, pursuant to the PSA. When a borrower defaults, the servicer notifies the trustee and the trust initiates the foreclosure.

No reason to dwell on a headline though, so I started to read the article…

“Foreclosure complaints routinely allege that because homeowners fail to pay their mortgage then the bank must take the home to recover its losses. However, the banks are never at a loss according to the Pooling and Servicing Agreement (“PSA”) trusts terms. Notably, banks never inform the courts of the PSA terms in their foreclosure complaints.”

“The PSA is the insurance existing specifically to protect the banks from homeowner’s default, which by its terms always pays any defaulting mortgage and other fees, including real estate taxes. Logically, if the bank is paid then there is no default or damage to the bank. How can a loan be in default if the servicer advanced every payment to cover any alleged default?”

OKAY, STOP. Every sentence in BOTH paragraphs is BADLY STATED or just plain WRONG.

Okay, let’s start with this… first of all, we’re talking about securitized loans, so the “bank” doesn’t own the loan… a “trust” owns the loan.

The loan is part of a pool of loans that has been securitized, meaning that the pool has been divided into “tranches” or slices… and are now held in a REMIC trust. (REMIC stands for Real Estate Mortgage Investment Conduit.) Investors buy “Pass-through certificates that entitle them to a percentage of the payment streams that flow into the trust as people make their mortgage payments.

The trust contracts with a mortgage servicer, which can be a bank-owned servicing company, or a non-bank servicer. The servicer does not own the loans, it merely services them for a monthly fee of between 0.25% and 1.25%, depending on whether the loan is prime or sub-prime, current or in default.

The contract between the servicer and the trust is called the Pooling & Servicing Agreement or PSA. When a homeowner fails to pay his or her mortgage payments, the servicer is ultimately required to foreclose on the property and liquidate the REO… also per the terms found in the PSA.

NEXT IT SAYS: “However, the banks are never at a loss according to the PSA trusts terms.”

NO, that is also NOT CORRECT.

First of all, to say that “banks are never at a loss according to the PSA trusts terms,” besides being incorrectly stated… is also ridiculous. I don’t think there’s anything in the world of business and investing that can never lose… and common sense will tell you that if you think about it.

If no banks ever lost money, then why have we had a few thousand banks go under since 2008? Did they go under because they had no losses? That doesn’t make any sense, does it?

The WHY and HOW of Servicer Advances…

What the author of the article is trying to describe are “servicer advances.”

Almost all PSAs today, contain clauses that require servicers to advance payments to cover principal & interest (“P&I”) and separately, taxes & insurance “T&I”) to the trust when a borrower goes delinquent.

The primary reason that the issuers of Residential Mortgage-backed Securities (“RMBS”) require servicers to advance funds to cover borrower delinquencies is that it makes it much easier to sell the bottom tranches to investors. To the investors in triple A and top tranches, such advances aren’t all that meaningful, but without these advances, monthly payment amounts paid to investors in bottom tranches would fluctuate and be less desirable as a result.

Servicer advances add liquidity to a transaction, but they do not serve as credit support. As advances, they are loans that trusts repay without interest, and therefore they have no net affect on trust accounting.

Generally speaking, servicers are obligated to advance payments and expenses as long as the servicer believes that those advances are recoverable from an ultimate liquidation of the loan. Once that’s not the case, and a servicer deems the amount of the advances exceed the expected liquidation proceeds would be on that loan, the servicer is no longer required to continue advancing payments to the trust.

With that in mind, the servicer is making an “advance,” meaning the servicer is “advancing” funds to the trust. The advance is NOT A PAYMENT MADE ON BEHALF OF THE BORROWER, it is merely a contracted advance to the trust or bondholder in the amount of the unpaid monthly payment. And the purpose of these advances to the trust are to ensure the trust maintains the steady cash flow needed to make regular payments to investors.

Then, maybe the borrower who didn’t make his or her payment last month… caught up next month. Or perhaps, that borrower doesn’t and ends up in default… and eventually the home is sold at trustee sale as an REO. When EITHER happens, the servicer is reimbursed.

Again… in effect… the payment advanced to the trust by a servicer when a borrower fails to make his or her mortgage payment is simply a loan made pursuant to the contract between the servicer and the trust. The trust is only borrowing funds not received from borrowers… and ultimately the amounts are repaid in full.

So, the advances made by servicers HAVE NOTHING to do with BORROWERS… they don’t impact how much borrowers owe or whether borrowers are considered to be in default.

If the property does not ultimately sell for enough money to repay the servicer’s advance then the servicer will be reimbursed from the proceeds of other payments that come into the trust, so again… in all cases, the loans are ultimately always repaid in full.

Nothing I’m explaining here is the least bit debatable, and I’d encourage anyone who doesn’t think I’m right about what I’m saying to do their own research… check with three or four different sources of information. Try Googling, “servicer advances,” or ask a couple of different lawyers.

The repayment provisions of the note are found in the waterfall language of how the servicer distributes the proceeds. Usually that section of the PSA is titled… “Withdrawals from the Collection Account”.

The argument made by the author is as silly as arguing that…

If you were NOT paid by your employer…
And you HAD to get a loan from your bank to pay your bills…
That you can’t recover your paycheck from work because you already got the money from your bank?
NO. The bank DID NOT agree to pay you on behalf of your employer.
And in the event that your employer NEVER PAYS YOU AGAIN… you’ll still be expected to repay the loan you got from your bank.

Get it? Advances made to the trust by the servicer are only loans that are repaid by the trust at specified times AND HAVE NOTHING TO DO WITH YOUR MORTGAGE PAYMENTS.

If you’re not making your mortgage payments, maybe your servicer is advancing those amounts or maybe not. Once the servicer believes that the amount of the advances exceeds the amount that can be expected to be received by liquidating the property… then the advances stop, and subsequently are always repaid.

Now, before posting this piece I spoke with several who I saw had commented on this article favorably. Both talked about UCC 3-602, which talks about payments on negotiable instruments. The problem with their theory is that it’s based on the idea that servicers are required to make the borrower’s PAYMENT when the borrower doesn’t… but this is NOT what the PSA says or requires.

The PSA only talks about servicer “advances” being made to the trust… advances are “loans,” not payments, and the PSA is a contract between the trust and the servicer, so the servicer advance is simply a contractual advance and repayment provision between two parties… and the borrower is not one of them.

To put this issue to bed, I contacted Kathleen Tillwitz, who is the Senior Vice President, ABS/RMBS, Operational Risk, U.S. Structured Finance at DBRS in New York. (DBRS has offices in Toronto, Chicago, New York and London.)

DBRS was formed in 1976. As described on the company’s Website, the firm is a “globally recognized provider of timely credit rating opinions that offer insight and transparency across a broad range of financial institutions, corporate entities, government bodies and various structured finance product groups in North America, Europe, Australasia and South America.”

Kathleen, a nationally recognized expert in all aspects of mortgage-backed securities, explained why servicer advances have nothing to do with a borrower’s obligation to make payments on their loan: “The borrower’s loan was sold into a security. The security is separate from the loan.”

Kathleen also sent me an email on servicer advances that explained them in detail…

In most U.S. Residential Mortgage-Backed Securities (RMBS), the servicer is required to advance delinquent principal and interest (P&I) to the trustee to the extent it is deemed recoverable. The servicer is also expected to make escrow advances for delinquent taxes and insurance (T&I) in addition to corporate advances for reasonable “out-of-pocket” expenses incurred by the servicer in the performance of its servicing obligations in connection with a default, delinquency, or other unanticipated event, including but not limited to, foreclosure proceedings and fees associated with the management and liquidation of any REO property (including legal fees).

PSAs also specify when and how servicers get repaid for advances to the trust. When the repayments come from general collections on the pool of mortgages, it’s called “pool-level recovery.” When the advances are reimbursed after the loan has been liquidated (or when it reinstates), it’s called “loan-level recovery.” For the most part, principal and interest advances are done at the pool-level, while taxes and insurance are handled at the loan-level.

Also, most PSAs specify that when a loan is modified, any outstanding advances are repaid.

Servicers are repaid for advances “at the top of the trust payment waterfall,” which means they get repaid first, and how fast they get paid just depends upon the type of advance (P&I or T&I), and the how long the foreclosure takes. And as you might expect, repayment of advances made on loans in judicial states takes somewhat longer than those made on loans in non-judicial states, and of course, pool level P&I advances get repaid much sooner than loan level, which come from liquidation proceeds.

The truth is that I didn’t really want to write this article… not one bit. I truly don’t understand why Susan Lask wrote it… I’m assuming she simply doesn’t know that what she’s saying won’t work. I mean, even the people I spoke with who liked her article admitted that the approach she suggests isn’t one that’s ever gotten anyone anywhere… except evicted from their foreclosed home.

So, I didn’t want to leave Susan’s article unchallenged because I know some poor homeowner will come along and follow the advice as it’s stated and lose his or her home as a result.

I’ve said it before and I’ll say it again now… defending a foreclosure in court, or bringing an action in court against your lender or servicer involves making highly technical and fact specific pleadings. I’m not saying you can’t bring any you certainly aren’t going to prevail by claiming that your servicer made your payments so now you don’t have to.

Mandelman out.