A Tale of Two Loan Modifications, As Investors Sue Countrywide
A predatory-lending settlement that will see Countrywide modify as many as 400,000 loans, reducing payments due on mortgages it services by as much as $8.4 billion, has led a group of investors to sue Bank of America Corp. (BAC) and Countrywide. In a complaint filed Monday morning by the New York-based law firm of Grais & Ellsworth LLP, investors say the language in their contracts require the Calabasas, Calif.-based servicer to purchase all modified loans out of affected securitization trusts. Countrywide has said it does not believe it is required to do so. The case highlights the investor pushback often involved in implementing massive loan modifications, as well as the surprisingly vague language that was used in some critical contracts that guide the management of hundreds of billions of dollars' worth of mortgages sent through the securitization process and into the capital markets. Countrywide first announced the loan modification program on Oct. 6, as part of a settlement with 15 different state Attorneys General that had sued the lender over predatory lending charges. Officials at Countrywide have insisted for months that their pooling and servicing agreements allow for loan modifications without repurchase obligations, when such modifications are done to prevent a borrower default. Only recently, however, have investor prospectus' added language making that right explicit. Two reasons to modify, but vague contract terms At issue here is a distinction between "retention modifications" and "distressed modifications" -- something that HousingWire's sources said has only become clear as the number of troubled borrowers has grown. Most of Countrywide's pooling and servicing agreements that govern loans it securitized through early 2007 specify that any loan modifications it wishes to perform require it to purchase the loan from the trust fund at par value, plus accrued and unpaid interest. Every one of the PSAs tied to various issuances named in the lawsuit -- 371 of them in all -- contains similar repurchase language, which suggest any and all modifications entail Countrywide's purchasing the loan out of the relevant securitization trust. And the reason for this language is simple: prior to the housing mess, so-called "retention mods" were commonplace, with borrowers actively refinancing their loans to obtain a lower interest rate. The language was innocuous enough: anytime a loan was prepaid because a borrower refinanced, the terms of the buyout were specified in the contract, whether the borrower refinanced through another lender or whether the servicer actively encouraged the borrower to modify the loan directly in order to retain the servicing income stream. From the investor's viewpoint, the repurchase language meant that the source of prepayment on an existing loan -- whether servicer-initiated or via another third-party -- was irrelevant. The investor would receive par plus accrued interest. Not exactly rocket science. The problem is that the language used in the various PSAs in question, until very recently, never spelled out how to handle so-called "distressed mods" -- modifications to loans for borrowers who cannot afford their mortgages. Back in 2005, that wasn't a problem. It is now, of course. Greenwich Financial alleges in its complaint that the language of the contracts on key Countrywide securitizations specified exactly how all modifications should be handled, while Countrywide is taking the tack that the purchase clause in its PSAs applies only to "retention mods," and that the intent of its initial contracts always allowed it to modify loans to prevent borrower defaults without triggering the purchase clause. Officials at BofA and Countrywide said that the case "represents an unlawful effort to assert the rights of the trusts" and that the company was "disappointed in this attack on a program intended to keep as many as 400,000 at-risk families in their homes." That said, Countrywide's actions last year suggest there was at least some level of concern with previous contractual terms governing its securitizations. Early last year, Countrywide began adding explicit language to its PSAs that explicitly spell out its rights involving distressed mortgage modifications. "The master servicer may agree to modifications of a mortgage loan, including reductions in the related mortgage rate, if, among other things, it would be consistent with the customary and usual standards of practice of prudent mortgage loan servicers. Such modifications may occur in connection with workouts involving delinquent mortgage loans. Countrywide Home Loans is not obligated to purchase any such modified mortgage loans," a clause in a more recent Countrywide-led securitization, CWABS 2007-8, reads. The clause does not appear in earlier prospectus statements from the firm covering earlier deals. In August of last year, Countrywide officials told the New York Times that the change in language was made "to clarify the original intent of the agreements." The question, of course, is whether the court will buy the unspecified and disputed "intent" of previous PSAs, or what was actually written and committed to record. Harm to investors The lawsuit seeks putative class action status, but the lead plaintiff at this point is Connecticut--based Greenwich Financial Services; CEO William Frey has been a vocal opponent of mass loan modifications that he says violate the contractual terms he and other investors originally agreed to. He made headlines in late October by voicing a dissent to the mass loan modification programs being rolled out by key lenders, including Countrywide -- a move that drew sharp criticism from lawmakers, including House Financial Services Committee chair Barney Frank (D-MA) for impacting the ability of servicers to funnel loans into the recently-enacted Hope for Homeowners refinancing program. "We were outraged to read that two hedge funds, Greenwich Financial Services and Braddock Financial Corporation, are instructing the servicers of their mortgages to defy this national program and to insist on further socially and economically damaging foreclosures,” said Frank in a hearing last month. “We believe the law clearly allows for modification where such changes would involve a lesser loss than foreclosure, and the benefits to the whole economy of such an approach are obvious.” Despite admonishment from legislators, Frey and other investors clearly believe the law rests on their side. Sources suggest the lawsuit is designed to more generally test the sanctity of contractual terms and clarify what are currently vague contractual rights assigned to investors. While the lawsuit names 371 different securitizations, Frey's fund holds certificates in only one: CWALT 2005-36. The other securities named in the lawsuit, however, contain similarly vague language surrounding the rights of investors in distressed loan modification scenarios. The complaint acknowledges that a question of law and a "justiciable controversy" exists over investors' rights in Countrywide loan modifications, and seeks a declatory judgment from the court specifying that the lender/servicer must purchase all loans that it modifies at par. "The resolution of this controversy by a declatory judgment will materially affect the value of certificates owned by plaintiffs and members of the class on whose behalf plaintiffs bring this action," the complaint reads. Legal experts said the case will prove to be a strong litmus test for investors and for contractual rights in general. "It's really amazing to think that Countrywide left this sort of 'hanging chad' in its PSAs," said one legal expert, who asked not to be named in this story. "It's really going to be interesting to see how this plays out." Read the full complaint. Write to Paul Jackson at email@example.com. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.