November 9, 2016

Federal Reserve Bank of New York

Residential Mortgage Note

Repository/Revisions to UCC 1, 3, 9

Commercial Law Discussion

Proposed National (Residential) Mortgage Note Repository Act

• Addresses residential mortgage notes in paper or electronic form,

deposited into proposed new mortgage note repository

• Deposit destroys or makes ineffective the original paper or electronic

record and replaces it with an electronic mortgage note (EMN) in the

system

• Only applies to residential mortgage notes. Does not apply to

commercial mortgage notes or to debts not secured by residential real

property

• Repository Act and accompanying proposed revisions to UCC Articles

1,3 and 9 are still being drafted and still under consideration

Brief Overview of Key Commercial Law Principles Related to

Residential Mortgage Notes

• Who is the person entitled to enforce an EMN and, correspondingly, to

whom is the obligation to pay the note owed?

• How can the owner of an EMN effectively transfer ownership of that

note to another person or effectively use that note as collateral for an

obligation?

• Does a secured party with a security interest in an EMN (a) need to be

listed as a registrant in order to perfect its security interest; (b) obtain

other benefits by being the registrant; or (c) gain sufficient protection

by filing a financing statement and being designated as authorized

transferor?

• What are the duties/obligations/liabilities of a registrant or an

authorized transferor?

Rights and Responsibilities of Registrant (Page 1 of 2)

• Must have relationship with gateway

• Identified on records of repository as registrant; identity available to borrower and

others

• Makes deposit warranties (See Draft Act 8(d)(4))

• Has rights of holder of negotiable instrument (except no HDC status if underlying

instrument non-negotiable) (See Draft Act 9(b))

• Has authority to direct payments (See Draft Act 9(b)(2))

• Deemed to be in possession (See Draft Act 9(c))

• Pays fine to repository operator for delay in submitting loan modifications to

repository (See Draft Act 10(a))

• Has liability for harm to borrower for delay in submitting loan modifications to

repository (See Draft Act 10(a))

• Represents and warrants that has submitted all modifications to repository

system (See Draft Act 10(d))

Rights and Responsibilities of Registrant (Page 1 of 2)

• Must give notice of discharge to borrower and repository operator (See Draft Act

11(a))

• Can only transfer entire obligation (but may transfer payment rights outside

registry) (See Draft Act 12)

• Makes UCC Article 3 transfer warranties (but may be permitted by rule to give

only limited warranties)

• Has access to information about its EMN on the system; may authorize another

person to access that information with warranty to borrower that information will

remain confidential

• Must provide borrower disclosures and borrower information changes (such as

contact information) to system operator (See Draft Act 17(b))

Overview of Approach to Key Commercial Law Issues, including

Discussion of How Proposal Applies to Paradigm Transactions

• Deposit of instrument results in instrument being treated as destroyed

or ineffective.

• Person named in registry as registrant is person entitled to enforce

(PETE).

• Person named in registry is in possession and, per UCC Article 9, is

perfected by possession with heightened priority under certain

circumstances.

• Mortgage follows the note.

• Ownership not expressly addressed.

• Person named in registry as authorized transferor (AT) has the right to

change registrant. Open question as to whether AT has special UCC

benefits in terms of deemed possession and/or ability to achieve

heightened priority. Open question as to whether AT can block other

changes.

Whole Loan Sale (Single Loan)

Party

A

Party

B

Mortgage Note

$

Whole Loan Sale (Single Loan) – Commercial Law Principles

• Negotiable Instrument (Today): Sale agreement and transfer of possession with

blank or special endorsement. Buyer = holder = PETE. May be HDC.

• Non-negotiable Instrument (Today): Sale agreement with or without transfer of

possession. Buyer = owner. Cannot be HDC.

• Negotiable EMN: Instrument destroyed or ineffective, buyer’s interest noted in

registry. Buyer = registrant = PETE. May be HDC.

• Non-negotiable EMN: Instrument destroyed or ineffective, buyer’s interest noted

in registry. Buyer = registrant = PETE. Cannot be HDC.

Whole Loan Sale (Single Loan) – Additional Issues

• Timing of purchase price and deposit into registry must be coordinated

• Each market participant’s role in the registry must be considered: holder/owner,

servicer, traditional custodian, pledgee. There can only be one registrant and

one authorized transferor. Partial interests/joint registrants are not contemplated

(although there is an ability to transfer payment rights outside the system, so

participation structures may still work)

Portfolio Sale

Party

A

Party

B

1,000 notes

$

Portfolio Sale – Commercial Law Principles

• Negotiable Instrument (Today): Sale agreement and transfer of possession with

blank or special endorsement. Buyer = holder = PETE. May be HDC.

• Non-negotiable Instrument (Today): Sale agreement with or without transfer of

possession. Buyer = owner. Cannot be HDC.

• Negotiable EMN: Instrument destroyed or ineffective, buyer’s interest noted in

registry. Buyer = registrant = PETE. May be HDC.

• Non-negotiable EMN: Instrument destroyed or ineffective, buyer’s interest noted

in registry. Buyer = registrant = PETE. Cannot be HDC.

Portfolio Sale – Electronic Notes/Transferable Records

• What changes if portfolio

consists of electronic

notes/transferable records

stored in a control system?

– Registrant becomes PETE

– Status as transferable record

and strength of control

system impact HDC status

Party

AParty

B

1,000 notes

$

Portfolio Pledge (Warehouse Line or Secured Financing)

Pledgor

Secured

Party

Pledges

1,000 notes

$ (must be

repaid)

Portfolio Pledge – Commercial Law Principles

• Pledge (Today): Written security agreement or possession to attach security

interest; UCC financing statement or possession to perfect security interest.

Possession gives higher priority.

• Pledge (with registry, Secured Party or its agent as registrant): If Secured Party

or its agent becomes registrant, possession deemed through registry; sufficient to

perfect pledge and receive higher priority. However, this would make Secured

Party or its agent the PETE and the publicly disclosed registrant, which may not

be desirable and may result in the Secured Party or its agent facing additional

responsibilities/risks.

• Pledge (with registry, pledgor remains registrant): If Secured Party is not named

in registry, pledgor remains the PETE. Pledgor is deemed to be in possession of

the note. Secured Party can only perfect its security interest by filing a financing

statement. Secured Party can become AT in order to provide practical ability to

foreclose, but Secured Party would be at risk of the Pledgor registering the note

in favor of someone else. Secured Party would need to search UCC records and

ensure no prior security interest that could not be trumped by filing. Secured

Party/AT can only enforce its security interest as an adverse claim under the Act.

Portfolio Pledge – Additional Issues

• Same as above, but wet funding with security interest attaching at closing of pre-

deposit EMN. If security interest is an “adverse claim”, mortgage note cannot be

deposited into registry.

• Where financing party becomes Registrant/PETE (directly or through agent), on

enforcement of underlying EMN, financing party enforces in its own name or

transfers back (unperfects).

• Risks of becoming registrant would be removed if AT status also constituted

possession, but this could complicate UCC priority rules if it resulted in more than

one person being deemed to possess, and/or more than one person with

superpriority, at the same time.

Portfolio Pledge – Electronic Notes/Transferable Records

• What changes if portfolio

consists of electronic

notes/transferable records

stored in a control system?

– Registrant becomes PETE

– Status as transferable record

and strength of control

system impact HDC status

Pledgor

Secured

Party

Pledges

1,000 notes

$ (must be

repaid)

AGGREGATOR STRUCTURE

Aggregator Financing or

SecuritizationEMNs

$

Seller 1

Seller 2

Seller 3

Seller 4

AGGREGATOR STRUCTURE

• Aggregator: EMNs purchased from small mortgage lenders by an aggregator

who then finances/sells/securitizers. As sales of promissory notes, the sales are

automatically perfected. However, depending on the terms of the sale they could

be deemed to be pledges to secure an obligation requiring perfection by filing or,

if available, possession. And, sale even if automatically perfected may not purge

prior security interests.

• Option A: Aggregator searches and files against individual dealers to ensure first

priority. Likely too cumbersome.

• Option B: Aggregator becomes registrant/PETE. Perfected and with

superpriority as if in possession.

• [Option C: Aggregator becomes Authorized Transferor to protect its practical

ability to transfer. ]

Warehousing/Repo Transaction

Originator Financing

Party/Repo

Buyer

Sells notes in repo

$

•Transaction reversed at end of repo term

Warehousing/Repo Transaction – Commercial Law Principles

• Negotiable Instrument (Today): Repurchase agreement and transfer of possession (likely to

custodian) with blank or special endorsement. Buyer = holder = PETE. Backup security

interest perfected by possession. UCC filings/searches not customary or practical.

• Non-negotiable Instrument (Today): Repurchase agreement with or without transfer of

possession. Buyer = owner. Backup security interest perfected by possession. UCC

filings/searches not customary or practical.

• Negotiable EMN: If buyer is willing and transaction is of sufficient term, buyer becomes

registrant. Buyer = PETE and deemed in possession to perfect backup security interest.

However, if buyer is unwilling to be named registrant, buyer would be required to search/file

UCC financing statements, which may not be customary or consistent with timing.

• Non-negotiable EMN: If buyer is willing and transaction is of sufficient term, buyer becomes

registrant. Buyer = PETE and deemed in possession to perfect backup security interest.

However, if buyer is unwilling to be named registrant, buyer would be required to search/file

UCC financing statements, which may not be customary or consistent with timing.

Warehousing/Repo – Additional Issues

• For short term repos, not clear if repo buyer could become either the registrant or

the authorized transferor in a timely fashion. Repo buyer would have trouble

perfecting its backup security interest or enforcing its interest.

• Where repo buyer becomes registrant, repo buyer takes on responsibilities of

registrant. May not be consistent with expectations for transaction. Repo seller

may not be able to adequately compensate/indemnify repo buyer for this

risk/responsibility.

• Where repo buyer becomes authorized transferor, enforcement limited to

adverse claim rules prior to making itself registrant. As currently drafted,

authorized transferor status would not perfect backup security interest.

Short-Form/Simplified

Term Securitization

Originator Indenture

Trustee

Depositor

Sells notes Sells notes

$ $

Statutory

Trust

May pledge

notes

May issue

certificates

Investors

$

Term Securitization – Commercial Law Principles

• For Sales: See Portfolio Sale – Commercial Law Principles

• For Pledges: See Portfolio Pledge – Commercial Law Principles

• Topics for Discussion: In pledge structure, would Indenture Trustee or Delaware

Trustee be willing to be registrant? If not, will they be comfortable as AT with

practical control benefit but not perfection/priority benefit? How will servicer's

interest be recorded in the registry?

Term Securitization – Additional Issues

• For multistep transaction, how many steps are recorded in the registry – just the

sale or the sale plus pledge? Would this impact true sale/nonconsolidation

analysis?

• Will registry identify spv entities separately from originator or report on a

consolidated basis?

• From a consumer perspective, what additional information if any is available in

the registry – ability to amend, identities of trustees plus servicers, etc.?

• What risk threshold will rating agencies be unable to bear re: competing liens,

etc.?

Contact Information

• These materials have been prepared for discussion purposes only based on

available drafts of repository materials and proposed changes to the UCC. All

information in this presentation is preliminary and subject to change. Questions

or comments regarding the information in this presentation can be sent to:

• Edwin E. Smith, Morgan, Lewis & Bockius LLP

• One Federal Street, Boston, MA 02110-1726 and 101 Park Avenue , New York, NY 10178-0060

• Phone: (617) 951-8615 or (212) 309-6825 Email: edwin.smith@morganlewis.com

• Professor Steven L. Harris, Chicago-Kent College of Law

• 565 W. Adams St., Chicago, Illinois 60661

• Phone: (312) 906-5218 Email: sharris@kentlaw.iit.edu

• Teresa Wilton Harmon, Sidley Austin LLP

• One South Dearborn Street, Chicago, IL 60603

• Phone: (312) 853-7863 Email: tharmon@sidley.com