Blackrock, Pimco, Fannie Target Banks Using Texas Lawyer's Clearing House

After he bought his Dallas home last year, attorney Talcott Franklin found a novel way to eliminate a musty odor emanating from a basement well installed as part of a previous owner’s air-raid shelter: He used boat hatches to seal it.

This year, the former partner at lobbying firm Patton Boggs LLP also found a unique solution to an even bigger housing problem: getting money back for investors in residential mortgage-backed securities that went bad. Franklin created a clearing house where investors can pool claims and potentially create the necessary legal clout to force mortgage lenders to buy back improperly made loans at the heart of the securities.

Before Franklin’s innovation, investors in such securities had no way of knowing who other investors were. Franklin’s approach may cost banks such as Bank of America Corp. billions of dollars. Lenders can be required to buy back securitized mortgages if they misrepresented their quality.

“If we’re going to have a mortgage system in this country that’s not government controlled, this effort or an effort like it will have to succeed,” says Bill Frey, head of Greenwich, Connecticut-based securities firm Greenwich Financial Services LLC. If the investors “don’t act together, the deals are going to continue to take huge losses.”

In July, Franklin, 45, sent a letter to trustees for some non-government backed securities. He said institutional clients that hold about a third of the $1.5 trillion market for mortgage-backed securities are in his database.

Clearing House Members

Participants in his clearing house include BlackRock Inc., Pacific Investment Management Co., Fortress Investment Group LLC, Fannie Mae and Federal Home Loan Banks, according to people familiar with the matter. Many members also hired separate lawyers, said the people, who declined to be identified because members don’t want to be named.

Lauren Trengrove, a spokeswoman for New York-based BlackRock, Janis Smith, a spokeswoman for Washington-based Fannie Mae, and Gordon Runte, a spokesman for New York-based Fortress, declined to comment, as did Mark Porterfield, a spokesman for Newport Beach, California-based Pimco.

Mortgage securities have been among the largest sources of the $1.8 trillion of writedowns and credit losses suffered by the world’s biggest financial companies since the start of 2007, according to data compiled by Bloomberg.

Repurchasing Costs

Mortgage repurchases have cost the four biggest U.S. lenders -- Bank of America, JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. -- $9.8 billion, according to Credit Suisse Group AG. The total, which so far includes few costs tied to bad mortgages packaged into bonds, could exceed $179 billion for 11 of the largest banks, according to Chris Gamaitoni of Compass Point Research and Trading LLC, a Washington-based investment bank.

Repurchase requests for mortgages in bonds without government backing will be about $24 billion or, in a “worst- case scenario,” $51 billion, FBR Capital Markets Corp. said Sept. 20.

Franklin’s RMBS Investor Clearing House -- “RMBS” stands for “residential mortgage-backed securities” -- is a “brave new venture” that confronts the issue of having “these very diverse, and even diffuse, interests even within a particular securitization structure,” said Jeff Nielsen, of Chicago-based Navigant Consulting Inc., who analyzes MBS litigation.

Clearing House Advantage

Because of the attorney-client privilege, the clearing house allows investors to pool holdings in a database without disclosing their portfolios to each other.

In his July letter to bond trustees, Franklin said he’d signed up investors holding more than 25 percent of the “voting rights” in about 2,300 private-label RMBS deals; 50 percent of the voting rights in more than 900 deals; and more than 66 percent of the voting rights in more than 450 trusts.

Those levels exceed thresholds laid out in most deals to allow RMBS investors to force trustee actions such as declaring loan servicers to be in default of their contracts, requiring them to share loan files, forcing changes to deal terms and replacing trustees.

Mortgage-bond trustees are responsible for passing payments collected from mortgage holders to investors, handling suggested amendments to transaction terms and overseeing loan servicers, which manage the underlying loans.

U.S. Bancorp, Deutsche Bank AG and Bank of New York Mellon Corp. signed on as trustees for the most new U.S. securitized debt in 2005 and 2006 as sales of home-loan securities without government-backed guarantees hit $1.2 trillion each year, according to newsletters Asset-Backed Alert and Inside Mortgage Finance.

Analytic Methods

Frey, who has sued Bank of America’s Countrywide unit over its servicing practices, advises Franklin as a member of the clearing house’s administrative committee. He’s developed analytic methods to determine defaults in the deals without having to get the loan files, Franklin said.

More investors have signed on since he sent his letter to trustees, Franklin said. He declined to say how many or to name any. The members of the clearing house are “anyone who has fixed-income investments,” such as hedge funds, asset managers, insurance companies and government entities, he said.

David Grais, a New York lawyer who is suing banks including Charlotte, North Carolina-based Bank of America and New York- based JPMorgan to try to force underwriters to buy back whole securities on behalf of the Federal Home Loan Banks of San Francisco and Seattle, said Franklin’s is the only effort he’s aware of to organize investors in mortgage-backed securities.

‘It’s Complicated’

“It’s complicated when you have so many people involved,” Grais said. “They have, not surprisingly, many different priorities.”

Some investors will join forces to replace loan servicers, some to force “put-backs” and some to do both, Grais said.

The idea for the clearing house grew out of a lobbying campaign Micah Green of Washington-based Patton Boggs led last year to oppose legislation that shields servicers from litigation against them by RMBS investors when they modify mortgages in certain ways, Franklin said. Franklin wrote a 40- page paper arguing that the measure would undercut efforts to fix the securitization market and would retroactively grant immunity for lender fraud.

During that effort, some investors told Franklin that, while lobbying was important, they needed to find out who other certificate holders were so they could band together, he said.

Hire Me

“I thought about it for awhile and I said, hey, look, if every investor in the world would just hire me as their lawyer for the purpose of determining what their collective-action rights are for each deal, I’d have to know what their deals are, and if I knew what their deals were, with their consent, I could match them to each other,” Franklin said.

He brought the idea to Patton Boggs and after considering it they decided a separate law firm would be required to avoid conflicts with clients whose interests might be opposed to the clearing house, such as investors in the banks, Franklin said. He has an arrangement with the law firm to use its offices for meetings. Green didn’t return phone calls seeking comment.

When he started his firm, Franklin said he thought he’d sign up 25 percent of investors in about 200 deals.

Surprise Sign-Ups

“I didn’t think that we’d have a third of the market,” he said.

Franklin’s firm makes money through the legal work it does in pursuing claims. One of his primary foes is loan servicers -- companies that collect homeowners’ payments on their mortgages. They are often affiliated with the loan originators, if they aren’t also the originator, he said. Investors view such dual roles as a conflict of interest, he said.

Loan servicers appear to be requiring too few home loans to be repurchased by lenders in part because their companies would be taking back the debt, according to the letter Franklin wrote.

“The loans have already been originated,” he said. “What’s done is done. The question is how to fix it. And one way to fix it is better servicing. There are a thousand ways to work out loans. The problem is they’re not doing it.”

The four biggest U.S. lenders are also the biggest U.S. home-mortgage servicers, managing almost 70 percent of outstanding loans, according to newsletter National Mortgage News.

Mortgage Servicers

By taking mortgage payments, the servicers are most likely to know about problems with the origination of loans, such as faulty appraisals, inflated borrower incomes and missing documentation that could lead to a forced buyback of the loan, Franklin said.

Bank of America has provided loan-modification assistance to more than 680,000 homeowners since January 2008, the company said in a Sept. 21 statement. JPMorgan has offered more than 900,000 mortgage modifications since the beginning of last year, said Thomas Kelly, a spokesman.

Melissa Key, a spokeswoman for the Mortgage Bankers Association, and Mark Rodgers, a spokesman for New York-based Citigroup, had no immediate comment.

Tom Goyda, spokesman for San Francisco-based Wells Fargo, said the bank was verifying that Franklin represents the investors and is unable to comment until it does.

While at Patton Boggs, Franklin -- co-author of “Mortgage and Asset Backed Securities Litigation Handbook,” represented loan originators and sellers, as well as investors. He was lead counsel for subprime mortgage loan sellers MortgageIT Holdings’ MortgageIT Inc. and Fremont General Corp.’s Fremont Investment & Loan in repurchase lawsuits.

Previous Clients

He represented Texas Capital Bancshares Inc. when it was sued by Lehman Brothers Holdings Inc. in March 2009 for not buying back or indemnifying the now-bankrupt firm on eight loans Texas Capital sold it. The parties settled this year.

“Now I’ve really gone pure investors,” Franklin said.

Born in Oakland, California, Franklin, who grew up in Salem, Oregon, has long held an interest in quantitative analysis. He has a master’s degree in sociology from the University of Washington in Seattle, where he specialized in quantitative-research methodology, and once thought he’d become an actuary, he said.

He earned his law degree in 1995 from Washington & Lee School of Law in Lexington, Virginia, where he was editor in chief of the law review.

He joined Patton Boggs in 2003 and became deputy chair of its litigation department. Before that, he did stints at law firms including Hunton & Williams LLP in Charlotte, North Carolina, and Susman Godfrey LLP and Akin Gump Strauss Hauer & Feld LLP in Dallas, in addition to being intellectual-property counsel at American Airlines Inc.

Talcott Franklin PC is a “virtual” law firm -- he mainly works out of his home, where he lives with his wife and three daughters. He said he has hired four senior-level attorneys with experience in finance, securitizations and loan workouts who also work remotely.

“They’re taking a leap of faith to do this with me,” he says.

To contact the reporters on this story: Thom Weidlich in Brooklyn, New York, federal court at tweidlich@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net.

To contact the editor responsible for this story: David E. Rovella at drovella@bloomberg.net.

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