Countrywide's Mortgage Document Errors May Doom Bank of AmericaTestimony in a New Jersey foreclosure case decided last week may spell big trouble for Bank of America (BAC). If what one bank employee said on the stand proves to be accurate, paperwork problems it acquired when it purchased the failing mortgage provider Countrywide in 2008 could leave BofA on the hook for billions of dollars.

As first reported by Kate Berry for American Banker, Linda DiMartini, a supervisor and operational team leader for the Litigation Management Department of BAC Home Loans Servicing, testified in the foreclosure case of John T. Kemp that it was "customary for Countrywide to maintain possession of the original note and related documents."

If that's true, then Bank of America may discover that it has millions of loans on its books that it thought it had transferred to trusts that issued mortgage backed securities, because 96% of Countrywide loans were ostensibly securitized. As the Congressional Oversight Panel explained, that outcome alone could cause massive damage to a bank's balance sheet. And as bad as that would be, it isn't the only problem that could result from Countrywide hanging on to the notes.

If the mortgage-backed securities aren't in fact "mortgage-backed," investors who bought them could be able to force BofA to buy the securities back. A significant number of buybacks could on its own destroy BofA's balance sheet. Nor could BofA stave off either outcome retroactively by delivering those notes today. First, the contracts that created the trusts would typically forbid transferring the loans into the trusts now. Second, even if somehow that could happen, such a transfer would destroy the special tax status the mortgage backed securities enjoy and give the investors a different reason to put back the securities or sue over them.

Retaining Documents While Servicing the Loans


At oral argument, BofA's attorney conceded that DiMartini's testimony was accurate and that as a result, BofA had failed to deliver the note at issue in that case to the trust under the contract or otherwise applicable law:
"[A]lthough Your Honor is right and the UCC and the Master Servicing Agreement apparently requires [physical delivery of the note to the trustee], procedure seems to indicate that they don't physically move documents from place to place because of the fear of loss and the trouble involved and the people handling them. They basically execute the necessary documents and retain them as long as servicing's retained. The documents only leave when servicing is released."
The judge ominously replied: "They take their chances."

Bank of America, via its spokesman Larry Platt, who is a partner at K&L Gates in Washington, told DailyFinance:
"Countrywide's policy and practice has been and remains to fully comply with the pooling and servicing agreements, including forwarding any necessary documents to the trustee. The associate whose testimony was cited in the ruling was asked about a process outside her normal scope of responsibilities and in an entirely different department from where she worked. A review of her testimony shows she later clarified that she was not comfortable testifying about the circumstances under which original loan documents would move, or whether and to what extent they ever are moved. This would include the initial delivery of original loan documents to the trustee."
Bruce Levitt, the attorney representing Kemp commented:
"DeMartini was flown to New Jersey from California to testify as the document custodian, the person BofA chose to get the note and other documents admitted as evidence. She was refreshingly unrehearsed; she testified with confidence and candor. She wanted the judge to understand that BofA was very careful with the notes."
Moreover, if Platt is right and Countrywide always delivered the notes, why did BofA's attorney in the Kemp case make the admission to the contrary quoted above?

If Countrywide didn't deliver the notes, how many loans are at issue? Well the loan in question in the specific court case -- Kemp v. Countrywide Home Loans -- was supposedly securitized in June 2006. So securitizations involving Countrywide loans for at least some time before that date and certainly thereafter are affected. And this case begs the wider question: Is it really possible that it was only Countrywide that followed the practice of not physically delivering the documents of securitized mortgages?

"There's been talk on the street for years that banks didn't send the notes up the line when they did securitizations," explained Max Gardner, a consumer bankruptcy attorney not affiliated with this case but who has litigated foreclosures based on bad bank documents for years. "But this is the first time I've seen someone under oath admit there was a policy not to deliver the notes. I had to read it twice to make sure that's really what she said, but she did: It was customary."

The Kemp Case

Bank of America made at least three attempts to fix its note problem in the context of the Kemp bankruptcy case. To prove it had the right to foreclose on Kemp's house, BofA needed to show that Bank of New York, the trustee for the 2006 securitization, had the right to foreclose. If BoNY had the right to foreclose, BofA could foreclose on its behalf. But for BoNY to have that right, the trust had to have the note and mortgage, which is why Countrywide's hanging on to the notes was a problem.

One effort BofA made was to file an assignment of mortgage and note to BoNY from March 2007. But under the contracts for securitizations in general -- those under New York law, which is most of them -- that assignment would have been too late, and thus void. The judge didn't address that issue, simply noting that the note wasn't delivered, so the assignment didn't cure BofA's problem.

DiMartini also admitted that another document -- an "allonge" -- that BofA submitted to try to solve its note problem hadn't been created in 2006, as BofA was implicitly suggesting by giving it to the court, but had been created only a few weeks before, specifically for the Kemp trial. And created sloppily at that: It referred to the trust as "6006-8" instead of "2006-8." Again, the judge didn't address all the problems that flowed from the timing of the document's creation because the note was not delivered, which meant that BofA's problem remained.

BofA made at least one additional attempt to solve its note problem: At one point, it filed a "lost note affidavit" claiming the original note had been lost. Given DiMartini's testimony and the bank's later "discovery" of the note, BofA's attorney asked the judge to disregard that filing.

Clouded Title Means No Foreclosure

For Kemp, the upshot of all these document problems is that the claim of Bank of New York via BofA to get paid under Kemp's mortgage was disallowed by the bankruptcy judge.

Assuming the case follows the normal course going forward, that will mean that neither bank will be able to foreclose on Kemp's house, and his mortgage debt will become unsecured debt -- the banks will have to stand in line with the credit card issuers and get paid only a portion of the principal.

If it's true the securitization trusts routinely didn't get notes delivered from Countrywide, then all those properties -- millions of properties -- could have clouded titles. That hurts many people outside of the bank, because clouded title makes selling those properties much harder, and leaves the current owners in a kind of legal limbo. As the Congressional Oversight Panel warned:
Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse. ... If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions.
So much for the banks' claims that these paperwork problems are technicalities that will be quickly resolved.


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