The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Mortgages

  • From Vol. 7 No.11 (Mar. 21, 2014)

    Second Circuit Appeal May Alter the Regulatory Landscape for Hedge Funds and Other Investors in Residential Mortgage-Backed Securities

    In an appeal highlighting conflicting federal district court decisions from the Southern District of New York, the United States Court of Appeals for the Second Circuit will have to determine whether the Trust Indenture Act of 1939 (TIA) – which commentator Thomas Hazen has called the “forgotten” securities statute – applies to the scores of securitization deals that are governed by pooling and servicing agreements.  If the panel finds that it does, then the opportunities and challenges for securitization trustees and investors may alter the structured finance landscape significantly.  If the Court of Appeals finds that it does not, then the status quo in the securitization market will be preserved, albeit with rather shaky analytical underpinnings.  In a guest article, Edmund M. O’Toole, a litigation partner with Venable LLP and head of the firm’s New York office, provides a brief background on the TIA, a summary of the conflicting district court opinions and the significant market and policy issues that are implicated in this appeal.

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  • From Vol. 6 No.18 (May 2, 2013)

    When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?

    A federal district court recently considered whether claims brought by investors in a bankrupt hedge fund against a lender for allegedly aiding and abetting the fund manager’s breach of fiduciary duty and fraud against the hedge fund should be permitted to proceed.  The fundamental question at issue was whether the investors’ claims were direct claims that should be permitted to proceed or derivative claims that should have been brought by the hedge fund and therefore should be dismissed.  For another discussion of derivative suits in the hedge fund context, see “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  This article summarizes the factual and procedural background of the case as well as the court’s legal analysis and decision.

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  • From Vol. 5 No.37 (Sep. 27, 2012)

    Baupost Group Hedge Funds Seek to Force Bear Stearns Unit to Repurchase 1,100 Mortgages Sold in a 2007 Securitization

    In a February 2007 mortgage securitization, defendant EMC Mortgage LLC (EMC) sold over 2,000 mortgages to the Bear Stearns Mortgage Funding Trust 2007-AR2 (Trust).  In an action commenced in the Delaware Court of Chancery (Chancery Court), the Trust is seeking to force EMC to repurchase more than half of those mortgages.  It alleges that EMC breached numerous representations and warranties relating to the underwriting of the mortgages in question and showed “callous disregard for prudent [loan] origination protocol.”  It also claims that, with respect to the few dozen mortgages that EMC has agreed to repurchase, EMC has miscalculated amounts it owes to the Trust.  This article summarizes the Trust’s allegations.  See also “For Hedge Funds, Ownership of Commercial Mortgage-Backed Securities Servicers Offers a Growing, Uncorrelated Stream of Fee Income and Advantageous Access to Distressed Mortgages, But Not Without Legal and Business Risk,” The Hedge Fund Law Report, Vol. 2, No. 38 (Sep. 4, 2009).

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  • From Vol. 3 No.42 (Oct. 29, 2010)

    New York State Court Dismisses Suit to Force Buy-Back of Reduced Mortgages, Finding that Plaintiffs Failed to Follow “No-Action Clause” Procedures

    A New York State Court has dismissed a lawsuit brought by hedge funds and other investors seeking to force Countrywide Financial Corp. and two of its subsidiaries to buy back the full balance of mortgages that had been sold to investor trusts, but had been subsequently reduced pursuant to a settlement agreement.  In throwing out the Complaint, New York State Supreme Court Justice Barbara Kapnick ruled that the Plaintiffs, Greenwich Financial Services Distressed Mortgage Fund LLC, et al., failed to meet the required procedural preconditions for bringing a suit under the trusts’ pooling and service agreements, including the support of 25 percent of certificateholders.  This article details the key facts and the court’s legal analysis in a case that provides important insight into and background for the growing trend of mortgage “put-back” litigation.

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Prospectus for Suspended Ellington Financial IPO Details Mechanics of a Hedge Fund Permanent Capital Vehicle

    Only days after Ellington Financial LLC (Ellington), run by Michael Vranos’ hedge-fund firm, Ellington Management Group, LLC (Manager), filed a prospectus with the SEC announcing a planned initial public offering (IPO) to raise cash in order to purchase mortgage-backed bonds, Ellington suspended the IPO due to “market conditions.”  The IPO was premised on the idea that investors would be willing to purchase Ellington shares at a premium, an average of $26 per share, 6.1 percent more than the value of its net assets, or 1.06 times Ellington’s shareholder equity, so that Ellington could invest in potentially underrated home loans in the recovering United States housing market.  While the IPO has ceased, its mechanics and the risk factors discussed in the Ellington prospectus remain particularly interesting for hedge fund managers contemplating a similar issuance of shares to obtain so-called “permanent capital” for the purpose of investing in designated assets.  This article summarizes the material terms and provisions of the Ellington prospectus and the suspended IPO.

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  • From Vol. 2 No.38 (Sep. 24, 2009)

    For Hedge Funds, Ownership of Commercial Mortgage-Backed Securities Servicers Offers a Growing, Uncorrelated Stream of Fee Income and Advantageous Access to Distressed Mortgages, But Not Without Legal and Business Risk

    Servicers of commercial mortgage-backed securities (CMBS) collect mortgage payments, remit distributions to investors and facilitate interactions among borrowers, lenders, investors and rating agencies.  Just as certain hedge funds have acquired residential mortgage servicers, see “Hedge Funds are Purchasing or Launching Mortgage Servicers to Take Advantage of Increased Opportunities in Distressed Residential Mortgages,” The Hedge Fund Law Report, Vol. 2, No. 35 (Sep. 2, 2009), some hedge funds are evaluating the purchase of CMBS servicers, but for different reasons.  In the residential context, a primary reason for a hedge fund manager to own a servicer is the ability to modify residential mortgages owned by its hedge funds.  In the commercial context, by contrast, the primary reasons for owning a servicer include a steady, likely growing (in the short and medium term) and uncorrelated revenue stream and advantageous access to defaulted loans in the CMBS serviced by the owned servicer.  However, modification of loans in a CMBS by a servicer is significantly more difficult (for various regulatory and practical reasons, explained more fully below) than modification of whole residential loans by a residential servicer.  In other words, the purchase of a CMBS servicer is more of an investment in itself, as opposed to an adjunct to a separate investment.  This article defines CMBS and describes the securitization process; defines the master servicer and the special servicer and the different roles played by each; the rights and obligations of CMBS servicers; pooling and servicing agreements; Real Estate Mortgage Investment Conduit rules; the legal and contractual standards to which CMBS servicers are held; commercial real estate market dynamics; the benefits to hedge funds of owning CMBS servicers; the concerns raised by CMBS servicer ownership; the reasons why the interests of holders of junior and senior tranches of CMBS bonds often diverge, and how servicers can perform in light of such divergent interests.

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  • From Vol. 2 No.35 (Sep. 2, 2009)

    Hedge Funds are Purchasing or Launching Mortgage Servicers to Take Advantage of Increased Opportunities in Distressed Residential Mortgages

    Despite accounting rules that generally permit banks to carry residential mortgages at cost and thus serve as a disincentive to sell, banks have begun unloading residential mortgages for two primary reasons: pressure from regulators (especially the Federal Deposit Insurance Corporation (FDIC)) and improvements in other operating or investment areas that can offset loan losses.  Hedge funds have been buyers, to a degree, but hedge funds’ appetite for whole residential mortgages (as opposed to mortgage-backed securities) is limited by a dearth of servicers who are willing or able to modify mortgages in a manner that will serve the hedge funds’ investment goals.  Since a significant amount of value in mortgage investing may be captured via modification, the limited field and ability of existing servicers has constrained purchases by hedge funds from banks of residential mortgages.  In response, various hedge fund managers are launching or buying servicers.  As noted by Paul Watterson, a Partner at Schulte Roth & Zabel LLP: “Some institutional investors feel like they are not getting enough attention from these mortgage servicers, particularly for scratch and dent loans, and so they are launching or buying servicers so the loans get the attention they seemingly deserve.”  (“Scratch and dent loans” generally refers to non-performing, or sub-performing mortgages.  The phrase can also apply to re-performing mortgages – mortgages that have been modified so they are performing again but still may fall back into default.)  Owning a servicer offers the opportunity to create value in mortgages, but it also can expose a hedge fund manager to liability for, to name just a few items, predatory lending claims or misrepresentation, to the extent the manager is involved in or controls modification decisions.  At worst, the manager may be exposed to a buy back obligation.  However, hedge funds that purchase or start servicers can structure transactions to mitigate liability concerns.  As a practical matter, managers contemplating ownership of servicers also face a “buy or build” question, and have to contend with various barriers to entry (practical and regulatory) into a non-core business.  We analyze these and other issues involved in ownership by hedge fund managers of mortgage servicers.

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  • From Vol. 2 No.21 (May 27, 2009)

    New Disclosure Obligation Imposed on Assignees of Residential Mortgage Loans

    Purchasers (including hedge funds and other investment funds) of residential mortgage loans will have affirmative disclosure obligations to consumers under The Helping Families Save Their Homes Act of 2009 (Act), which Congress passed last week and sent to President Obama for his signature.  While most have focused attention on the Act’s “safe harbor” for servicers and amendments to the FHA Hope for Homeowners Program, this new statutory obligation will subject purchasers of mortgage loans to civil liability if they fail to make the required disclosures.  This provision does not require regulations first to be promulgated and is effective upon the President’s signature.  In a guest article, Laurence E. Platt and Kerri M. Smith, Partner and Associate, respectively, at K&L Gates LLP, discuss this underappreciated provision in the Act – which can have a powerful impact on the returns (and reputations) of hedge funds involved in buying and selling residential mortgage loans.

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  • From Vol. 2 No.18 (May 7, 2009)

    Consequences of the Mortgage Loan Servicer Safe Harbor for Hedge Funds Invested in Securities Backed by Primary Mortgages

    One of the primary reasons why troubled loans do not receive meaningful modifications is that the loan servicers fear lawsuits from the investors who own securities backed by the loans.  As a result, the government effort so far to address the problem of troubled mortgages has focused on creating incentives to get loan servicers to begin workouts.  President Obama gained their favor in his housing rescue plan by promising up to $9 billion in TARP funds to cover the fees associated with modification and proposing as part of the comprehensive Housing Act a legal “safe harbor” from litigation that might arise in reworking a deal.  The bill is intended to give loan servicers, including big banks like Bank of America and Citi, breathing room to modify loans more easily without having to worry about investor lawsuits.  But recent reports, including one by the Amherst Security Group, found that many of the supposed loan modifications are simple repayment plans that actually increase the balance of the mortgage and result in bigger fees payable to the loan servicers.  Now, there is another major stumbling block as investors holding mortgage-backed securities realize just how big a threat a servicer safe harbor poses to them.  We provide a comprehensive discussion of the legislative background, the mechanics of the proposed servicer safe harbor, a discussion of the necessity of such a safe harbor and a summary of the Amherst Security Group report.

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