CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

It was clear from a Tuesday afternoon panel that the waves of civil litigation in the RMBS industry will continue to crash on the shores of every major financial institution.  Did you actually think that the statute of limitations would prevent plaintiffs from pursuing claims?  Unfortunately, in an effort to prove that the government can perform any task better than private actors, President Obama announced at his State of the Union address (televised on the last night of the Conference) that he was forming a new financial crimes unit to pursue mortgage securities fraud during the financial crisis.  Wells notices are flying out of D.C. at a rate only surpassed by the dollars coming off the printing presses at the U.S. Mint.  It’s ironic that this new focus of investigation is kicking off at the same time that a $25 billion agreement was reached with five large mortgage banks to settle federal and state investigations in 49 states into alleged foreclosure abuses.  (Oklahoma reached its own settlement with the banks on Thursday.)  Note also that the “settlement” doesn’t prevent individual borrowers from continuing to bring claims.  Some of my litigation partners and I plan to host a seminar in our NY office this spring to offer our clients and friends much more detail on all of these developments - I’ll inform you of the particulars of that event in a subsequent blog. 

But the other big topic that continues to garner a lot of attention is how to effectively manage the liquidation of the huge inventory of foreclosed homes on the balance sheets of the banks and the GSEs.  Analysts estimate that there are 500,000 REOs on the balance sheets of the GSEs and private lenders, and the number is obviously expected to increase as foreclosures continue at a high rate.  How then do banks liquidate these properties without having to sell them at fire sale prices and without putting downward pressure on a housing market that is desperately trying to plateau and inch upward in many markets?  With demand for rentals rising in many markets, there is a lot of buzz among private equity investors with the idea of buying up bundles of REO, renting them out for 1-5 years, and then flipping those properties when home values recover.  And the lenders sitting on a huge inventory should welcome this new investment strategy as such investors should drive up the bids for REO.  But the key to all of this happening is on what terms can investors get financing for the bundle of REOs they intend to buy up.  I think this discussion will dominate the residential market for the next year and may well be the key to a meaningful economic recovery.  Stay tuned for more information on a Dechert sponsored webinar on this topic.

By: Ralph Mazzeo

An issuer has strict liability for misstatements and omissions in a public deal. So what’s really added here?  An issuer can now be liable for bad disclosure about the nature of its diligence process or if its diligence failed to provide “reasonable assurance” that the disclosures were “correct”.  Now that’s new and different!  I don’t know what “reasonable assurance” means, but I suspect if we round up the usual suspects at the trial bar, they will tell us it means something, by God!  One more count in every complaint!

This only applies to registered deals and in the CMBS space registered deals are beginning to look like the dodo.  But the SEC staff mused in the preamble to the Rule that a similar regulatory regime for the 144A market might be appropriate and they’re a fixin’ to think about it.  Joy. 

Also one should not discount the argument that, as the SEC has concluded that this information needs to be provided to meet its standards for adequate disclosure, mischief could be concocted by our usual suspects right now.  If this disclosure is appropriate in 2012, why not now?

Another new rule, Rule 15Ga-1 (release here (pdf)), is more straightforwardly and more immediately problematic.  Rule 15Ga-1 requires an issuer to disclose, in a very complex and burdensome way, its past history of demands for the repurchase of assets -- successful, unsuccessful or otherwise -- for breaches of representations and warranties on pool assets.  The SEC is also requiring, in Rule 17g-7 (released with Rule 15Ga-1 above), that rating agencies include in their reports a description of the issuer's reps, the enforcement mechanisms to address breaches and how each differs from such provisions in "similar securities".

All this kicks in by the first quarter of 2012 as well, and it applies to all securitizations, public and private. SIFMA, in its comment letters on these rules (available here and here) stressed how burdensome this was, how little actual probative information it would deliver to investors, by giving investors data about unrelated asset classes and unsuccessful or even unpursued claims, and how, at least in CMBS, put-backs were really extraordinarily rare in any event.  And what in the world do rating agencies do with a "similar securities" standard?

All for naught.  We’re now going to have to learn to live with this.  Note how extraordinary it is that issuers of private 144A deals will now have to make public filings.  If that doesn’t blur the distinction between the public and private markets (which I sort of think is what the SEC has in mind), what does?

While Rule 15Ga-1 doesn’t kick in for a year, this will cause issuers a very substantial amount of work, starting now, to get ready for next year.  Below the Rule's headlines, a lot of detailed compliance and mechanics questions will need to be answered in the process.  How comforting that the Rule contains an analysis by the SEC of its expectations of the cost of compliance.  And here’s the headline: the compliance costs won’t be bad at all!  It makes risible reading.

Beyond the additional costs, extra work and potential liability imposed by these Rules, which are bad enough, this first batch of Dodd-Frank regulations tells us that complying with the fullness of Dodd-Frank is going to be a lot worse.  In a significant way, Dodd-Frank was built on the basis of unsupported conjecture, received wisdom and ideological certitudes.  Dodd-Frank booted much, if not most, of the actual sausage-making to the reconciliation and launched dozens of regulatory processes. 

The regulatory handcuffs will magnify the underlying subtext of Dodd-Frank - that we have insufficient regulatory restraints on the behavior of market participants and we need more to avoid a return to the edge of apocalypse.  Regulators will regulate.  Close calls and unclear, skeletal legislative direction will be settled in favor of more, not less. 

Consequently, the industry faces a daunting rear guard action in the 112th Congress to try to mediate what will likely be excessively burdensome and intrusive rules.  No matter how well this goes, capital formation will get harder and more expensive.  Will all of this really help investors and prevent irrational exuberance and excess?  

At least in CMBS, I think not. It’ll make some trial lawyers happy, though.

By Rick Jones.