Why Paperwork Matters: Consider This Mortgage Mess

Judge Shelley C. Chapman, of the U.S. Bankruptcy Court for the Southern District of New York, has ordered HSBC and Litton Loan Servicing (a Goldman Sachs subsidiary) to send officers with some juice -- and not low-level types -- to her Manhattan courtroom on Feb. 10 to explain themselves. More specifically, to explain their failure to provide adequate documentation about a mortgage they claim to own and service. Judge Chapman also ordered the Texas attorney who signed the documents to show up.

At issue is the fact that HSBC (HBC) hasn't come close to proving it owns the loan, and the documents it has submitted look funny. It also doesn't appear to have been acting in good faith when it comes to trying to modify the loan (also known as "loss mitigation"). So, the judge wants to talk to people who actually know things and can make decisions.

How Did HSBC Get the Note?

Here's the story:

In 2004, Miguelito and Jacqueline Garcia bought a property in New York City's borough of the Bronx, using a mortgage from Fremont Investment & Loan. Shortly afterward, that mortgage was apparently securitized, and HSBC became the trustee for securitized trust. HSBC hired Goldman Sachs's (GS) Litton Loan Servicing to service the trust loans.

Last summer, the Garcias declared bankruptcy, and Litton Loans told the court the Garcias owed HSBC some $3,600 in missed principal, interest and fees. (This isn't a foreclosure case, at least not yet.) To back up its claim, Litton gave the court the note -- stamped "Duplicate Original" (starting on page 3 of the linked document) -- and the accompanying mortgage (starting on page 10).

But the Garcias' lawyer, consumer bankruptcy attorney David Shaev, pointed out in a letter to Litton that the note was made out to Fremont Investment & Loan, and the mortgage was made out to MERS -- the Mortgage Electronic Registration Systems -- as nominee for Fremont. Litton didn't give the court any evidence that either document was transferred to the trust HSBC represented. In the first place, Fremont hadn't endorsed the note to anyone, and second, HSBC hadn't submitted an assignment of the mortgage to anyone.

Two Different Notes

Shaev didn't get a meaningful reply from Litton, so he formally objected to HSBC's claim. When Litton replied, it submitted a new note that was endorsed. But Litton's filing didn't address the fact that the first note it submitted wasn't endorsed, while it now it offered one that was. Nor did Litton mention several other oddities, such as the initialing by the borrowers on the new note is in a different order and position on each of the first two pages. Even the signatures on page 3 of the note look different -- for example, look at the "J," "a" and "q" in Jacqueline.

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I'm not a handwriting expert, so I make no claim that someone forged the names and initials. Maybe Fremont had the Garcias initial multiple copies of the note when the deal was done, and they didn't initial each identically. Perhaps the Garcias signed two copies of the note at closing. The signatures on the two notes aren't wildly different from each other. The bottom line, however, is the notes aren't photocopies of each other.

So, unless the Garcias took out two identical mortgages, having two signed notes is a problem. Each is separate and complete proof of a debt.

For a moment, let's forget that the securitized trust exists and just imagine that Fremont endorsed one note to HSBC and one to, say, Wells Fargo (or any other bank). If either wanted to foreclose, each HSBC and Wells would have employees sign for MERS and assign it the mortgage. The Garcias would face two apparently legitimate foreclosure actions. That possibility is why the signature page of the note itself says "Sign Original Only."

Bad Endorsement

So one problem with the documents is that two "original" notes appear to exist. Another problem is that only one of these originals is endorsed to HSBC. And a third problem is that the endorsement, such as it is, doesn't make sense.

In seeming violation of the securitization contracts, the endorsement went straight from Fremont Investment & Loan to HSBC. That's a problem because in a securitization deal, the notes go from the loan originator (or a later owner) to the "depositor" to the trust. -- and the depositor is always in the loop. Since Fremont Mortgage Securities Corp. was the depositor in this case, the note should have been endorsed to it, and then to HSBC.

Beyond the two-note-and-endorsement problem, the assignment of mortgage is another question. Despite the fact that HSBC's right to the mortgage debt has been an issue for months, it still hasn't submitted an assignment of mortgage. And, as a credibility side note, Litton's attorney stressed in the opening paragraph of the firm's reply that he is relying solely on the documents provided by Litton, regarding the truth of the claims Litton is making.

That statement means the attorney couldn't try to foreclose on the mortgage right now if Litton asked him to. New York requires attorneys in foreclosure actions to actually talk to someone at the bank and affirmatively try to make sure the documents are accurate. The problematic documents in this case are a good indicator of the wisdom of that rule.

Not a Vintage Year?

One final cheery note: This mortgage and trust is from 2004, not the peak bubble years of 2006 and 2007. I want to believe the document mess in this case isn't typical of that year's vintage and that the document chaos was a bubble-frenzy phenomenon. But to be honest, I think that's as likely as the wishes I make on shooting stars ever coming true.

So, how far back in time need one go to find a securitization deal done carefully, such that its documents are in order and available to the trust's attorneys? How many mortgages is that?

Judge Chapman says she'll cancel the Feb. 10 hearing if the parties come to agreement in "loss mitigation," meaning they've agreed on a mortgage modification. An agreement would take a real change in attitude on HSBC's part, however. The bank's most recent offer, according to Shaev, involved a balloon payment at the end that wasn't defined. When he asked how much it was, he was told it would be however much the Garcias hadn't yet paid. That is, it would be a number HSBC could fill in later, after everything was signed. That's not a serious modification offer.

If the hearing does happen, I hope the judge finds out just how both original notes came to be -- why HSBC submitted one and then, without acknowledging the change, it submitted the other.

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