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FHFA Sues UBS to Recover GSE Mortgage Losses

by devteam July 28th, 2011 | Share

UBS Americas Inc., several of itsrnsubsidiaries, and four former executive officers were sued Wednesday morning inrnU.S. District court for the Southern District of New York.  The Federal Housing Finance Agency (FHFA)rnbrought suit charging violations of securities laws in the sale of privaternlabel residential mortgage-backed securities (MBS) to government sponsoredrnenterprises (GSEs) Freddie Mac and Fannie Mae. rnFHFA sued as conservator of the GSEs and seeks a jury trial in anrnattempt to recover losses and damages on behalf of the GSEs that occurred as arnresult of their investment in the UBS securities.</p

In addition to UBS America therndefendants are UBS Real Estate Securities, Inc; UBS Securities, LLC; MortgagernAsset Securitization Transactions, Inc., and former UBS employees David Martin,rnPer Dyrvick, Hugh Corcoran, and Peter Slagowitz. </p

The lawsuit seeks specifically tornrecover damages from the GSEs investment in 16 separate pools of MBS sold byrnUBS between 2005 and 2007.  FHFA isrnclaiming that the GSE’s had a total investment of $4.5 billion in thernsecurities sold by UBS.</p

The suitrnalleges that the underwriters of the underlying mortgages systematicallyrndisregarded their respective underwriting guidelines in order to increasernproduction and profits and that the Defendants failed to conduct adequate duerndiligence on the mortgage loan files and mortgaged properties prior to orrnduring the securitization process.  Arnnumber of banks and mortgage companies originated the loans in questionrnincluding Fremont Mortgage, Wells Fargo Bank, Countrywide Home Loans, IndyMac,rnand Provident Funding Associates.</p

A forensicrnreview of a sample of 966 randomly selected loans from two of the pools atrnissue found that approximately 78 percent were not underwritten in conformancernwith guidelines. The underwriting guidelines that were violated were thoserndesigned to assess the likelihood that loans would be repaid.  The forensic review revealed the followingrntypes of breaches:</p<ol

  • Failurernto test the reasonableness of the borrowers’ stated income relative to theirrnline of work, leading to material misrepresentation of income.  The forensic review found multiple instancesrnin which income appeared unreasonable yet there was no indication thernoriginator attempted to confirm that income.</li
  • Failurernto investigate multiple submissions from the same borrower of applications showingrnincreasing stated incomes.  In eachrninstance the stated income on the original application did not meetrnunderwriting guidelines, but subsequent applications at higher income levelsrndid.  Forensic review confirmed that thernlater applications misrepresented that income and that underwriters did notrninvestigate the discrepancies.</li
  • Failurernto confirm the intended owner occupancy of the property despite indicationsrnthat the property was intended as an investment.  In some cases the loans were underwritten asrnowner-occupied properties even though the borrower stated they intended thernproperty to be as second home or investment. rnAdditionally, the Prospectus Supplements materially understated the proportionsrnof the loans that were not owner occupied.</li
  • Failurernto properly calculate the borrower’s outstanding debt, resulting in a debt-to-incomern(DTI) ratio that exceeded underwriting guidelines.  When properly calculated, 32 percent of thern996 loans in the random sample for forensic review contained DTI ratios thatrnexceeded applicable guidelines.</li
  • Failurernto investigate credit report information that indicated potential misrepresentationrnof borrower debt.  The forensic reviewrnrevealed numerous instances where multiple credit inquiries on borrower creditrnreports should have put underwriters on notice for potential misrepresentationsrnof debt obligations, but underwriters did not investigate</li</ol

    FHFArnalleges that while securitization Prospectus Supplements state that there mayrnbe compensating factors to warrant exceptions to applicable underwriting guidelines,rnnone of the 966 loan files reviewed evidenced compensating factors that wouldrnsupport such exceptions.  “A 78 percentrnbreach rate, in any event, could not possibly be explained by the proper allocationrnof any such exemptions.”</p

    Inrnaddition to the forensic review, a review of loan level data was conducted tornevaluate the accuracy of information provided in the ProspectusrnSupplements.  At least 1000 loans were sampledrnin each securitization and a review confirmed that much of the informationrncontained in the Supplements regarding owner occupancy and loan-to-value wasrnmaterially false.  </p

    The suitrncontains a table (see page 91 of 102) showing the ratings by various agencies (S&P, Fitch, Moody’s)rnat the time of issuance and the ratings as of May 3, 2011.  Without exception every Tranche had a ratingrnof at least Aaa at issuance.  Most arerncurrently rated CCC or even D.</p

    FHFA is asking for an award against allrnDefendants for all damages sustained as a result of their wrongdoing in an amountrnto include rescission and recovery of the consideration paid for the GSErnCertificates with interest; the GSEs’ monetary losses including lost principal andrninterest payments’ attorneys’ fees and costs, pre-judgment interest and otherrnrelief as deemed proper by the Court.</p

    ActingrnFHFA Director Edward J. DeMarco said of the suit, “FHFA is taking this actionrnconsistent with our responsibilities as conservator of each Enterprise. Fromrnthe issuance of 64 subpoenas last year to the filing of this lawsuit andrnfurther actions to come, we continue to seek redress for the losses suffered byrnthe Enterprises.”

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    • About the Author

    devteam

    Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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