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Countrywide Loses Investor Loan Modification Lawsuit

Source: New York Times

Posted on 21 Aug 2009

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A New York federal judge ruled against mortgage company Countrywide Financial, now a unit of Bank of America, which was attempting to secure certain protections from investor lawsuits under new laws that are intended to encourage home loan modifications.

Countrywide had argued that the legislation automatically voided its pledges to buy back loans from investors if those loans were modified for troubled borrowers.

The ruling is a win for holders of mortgage-backed securities who sued Countrywide in December after the company, now a unit of Bank of America, agreed to modify thousands of loans in a settlement with state attorneys general.

The case against Countrywide is being closely watched by pension funds, insurance companies and other investors in mortgage securities who contend that loan servicing companies that agree to change the terms of mortgages are breaching contractual obligations to owners of those loans.

Investors who own mortgage securities receive interest and principal payments from borrowers over the life of the loans. When servicing companies modify those loans, investor payments are typically reduced.

“I view this as an opening salvo and a demonstration that investors do have contractual rights, even when it is politically unpopular,” said William A. Frey, one of the investors who brought the lawsuit. “This is ultimately going to be one of many legal battles over who should pay the hundreds of billions of dollars in losses on mortgages.”

Bank of America, which took over servicing of the investors’ loans when it bought Countrywide in 2008, is defending the case. It argued that the matter belonged in federal court and that any contractual obligations to repurchase modified loans were trumped by the Helping Families Save Their Homes Act of 2009. Under that law, servicing companies that agree to modify loans receive some protection from liability arising from the loan changes.

Judge Richard L. Holwell ruled that the immunity granted under the legislation did not prevent Countrywide’s investors from trying to enforce their rights under the mortgage securities contracts. The investors must prove that Countrywide’s pooling and servicing agreement covering their loans does indeed require it to repurchase mortgages the bank modifies, the judge said, ruling that the case belongs in state court.

Shirley Norton, a spokeswoman for Bank of America, said it was reviewing the order and considering its options. “The court did not rule that the safe harbor is inapplicable,” Norton said, merely that it did not fall under federal jurisdiction.

Investors’ lawyers hailed the decision.

“This is a first step in a decision by a federal judge that says even after the servicers’ safe harbor was enacted and even after all the wrangling in Congress, we are still going to allow people to enforce their contract rights when it is appropriate,” said Owen L. Cyrulnik, counsel at Grais & Ellsworth in New York, which is representing investors in the suit against Countrywide.

The lawsuit was filed in December after Bank of America struck a predatory lending settlement with attorneys general in 11 states. In that deal, the bank agreed to modify thousands of mortgages written by Countrywide, providing $8.4 billion in loan aid to an estimated 400,000 Countrywide borrowers.

Under the terms of the settlement, Countrywide said it would cut principal balances on some loans and reduce interest rates on others. Rates could decline to 2.5 percent, depending upon a borrower’s ability to pay, and remain at that level for five years.

But it turned out that Bank of America owned only a small portion of the mortgages it had agreed to modify. Investors who owned the largest share of the loans had not agreed to the settlement and would bear the brunt of the reduced payments.

Two investment funds holding Countrywide mortgages sued Bank of America, contending that the regulatory deal ran afoul of promises Countrywide had made when it issued the mortgage securities.

The funds, Greenwich Financial Services Distressed Mortgage Fund and QED L.L.C., are owned by Mr. Frey, who contended that the mortgage securities contained pledges by Countrywide to repurchase from investors any loans it agreed to modify. On later mortgage securities, Countrywide changed the agreements, eliminating the language about buying back modified loans.

According to the lawsuit, which is asking for a declaration from the court to make Countrywide live up to its contracts, some 374 mortgage pools issued by Countrywide contain language pledging to buy back modified loans from investors.

The case highlights the potential for conflicts of interest in the loan servicing business. Loan servicers have a duty to investors not to do anything that jeopardizes the income stream to holders of the securities.

But servicers are often units of large banks that also make home loans. Investors in mortgage securities are increasingly concerned that the companies may put their own interests ahead of those of their servicing customers when they modify loans.

As the mortgage crisis has deepened, servicers have also come under immense pressure from the government to modify loans. The goal is to keep borrowers in their homes and curb the flood of foreclosures, but changes to loan terms can put servicers at odds with the investors they have a duty to serve.