A recent decision by a New York Appellate Court in regards to MBIA’s reps and warranties litigation against Countrywide Home Loan is credit positive for both residential mortgage-backed securities and commercial mortgage-backed securities trusts, Moody’s Investors Service said in its latest credit outlook.
A panel of New York’s Appellate Division, First Department, ruled that a residential mortgage-backed securities loan does not have to be in default to trigger a bank’s obligation to repurchase it from an RMBS trust if the loan breaches reps and warranties given by the bank.
The issue at hand was the contractual language, which required Countrywide to repurchase a loan if it violated reps and warrants that “materially and adversely affect the interest of the certificateholders… in the mortgage loan.”
However, Countrywide argued that only a defaulted loan triggers the repurchase obligation, and that the words ‘adverse affect’ means the representation breach must cause harm to the loan not just an expectation of harm — as in an increased loss of risk.
MBIA (MBI) disputed that the repurchase obligation is triggered if the originator inaccurately represents the credit quality of the loans, regardless if the loan actually defaulted.
If the loan had a higher risk of loss than as originally released, then the interests of the certificateholders were materially adversely affected, MBIA claimed.
The intermediate appellate court ruled in favor of MBIA, stating “had these very sophisticated parties desired to have an event of default or nonperformance trigger the repurchase agreement, they certainly could have included such language in the contracts. They did not do so, and this court will not do so now.”
CMBS transactions’ pooling and servicing agreements have language that supports MBIA’s position even more clearly than RMBS, generally providing that the originator much repurchase a loan if an reps and warrants violation “materially and adversely affects either the value of the loan or the interest of the certificateholders,” Moody’s states,
“This double-barreled approach more easily leads to the conclusion that increased risk of loss on the loan alone triggers the buyback remedy,” the report explained.
Overall, last week’s court ruling makes clear that whatever the buyback formula used in pooling and servicing agreements, the hands of RMBS and CMBS trusts are strengthened in cases within this particular jurisdiction.