The Association of Institutional Investors, whose members include the largest money managers, have asked the U.S. Congress to create an “unambiguous fiduciary standard” for trustees of mortgage-backed bonds without government backing at the same time that a Senate committee considers a bill that would overhaul the $9.4 trillion home-loan market by replacing the U.S. controlled Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).

The Association of Institutional Investors wants Congress to step in as they did with the corporate bond market in 1939 when the Trust Indenture Act created new duties and responsibilities for trustee banks in order to protect bondholders and provide them the confidence to extend credit following the stock market crash of 1929. Money managers want mortgage-backed bonds protected in a similar way. Such bonds suffered about $450 billion of losses through 2012.

Mortgage bond investors are banding together to push trustees into action to receive compensation from banks for loans that were riskier than promised and to create changes to allegedly poor management by mortgage servicers. Money managers are saying “You have representatives of trillions of dollars of capital refusing to buy new private-label residential mortgage-backed securities because this problem of no one looking out for investors’ interest isn’t solved.”

One of the roles of the trustee in mortgage-backed financings is the collection of cash and data from mortgage servicers and passing them on to investors.

The American Bankers Association opposes a fiduciary role for trustees which generally perform “only ministerial duties” that are “commensurate with the minimal fees paid,” according to a letter to lawmakers sent on April 17, 2014.1

Background

In 2010, the American Bankers Association’s Corporate Trust Committee wrote a position paper entitled “The Trustee’s Role in Asset-Backed Securities.” This position paper was an update to a White Paper written by the Committee in 2003 on the role of the trustee in asset-backed securities transactions. Asset-backed securities (ABS) were defined to include residential and commercial mortgage-backed securities, collateralized debt and loan obligations as well as other types.

The 2010 position paper was a response to the then current assertions that the obligations of trustees in ABS financings were greater than the duties contractually undertaken by those trustees. “These assertions, which have been made by participants in the ABS market by investors, investment advisors, rating agencies and others, fail to recognize the legal limitations on the duties of ABS trustees and have been made in response to both disappointing ABS investment performance and market issues arising from the current economic crisis.”

The 12 page position paper described in depth the roles played by the many parties to an ABS financing as set forth in the legal transaction documents.

The conclusions reached in the position paper were:

trustees provide important services to the ABS marketplace under the terms of the applicable transaction documents the duties are ministerial in nature and scope which is consistent with the limited information given to trustees and the level of compensation paid to trustees for those services. parties in the ABS marketplace generally have accepted the scope of the trustee’s role since the enactment of the Trust Indenture Act in 1939, as evidenced by consistent terms in the relevant agreements since that time. the limited contractual role of the trustee was not a contributing factor to either the disappointing ABS investment performance or a contributing factor in the current financial crisis.2

Present Status

It is important to note that there is also much thought that more duties should be imposed on the mortgage servicer rather than the trustee.3

The American Bankers Association “strongly opposes” the efforts to legislate a fiduciary duty for trustees of mortgage-backed securities, James C. Ballentine, Executive Vice President wrote in an April 17, 2014 letter to the Senate Banking Committee members. Mr. Ballentine stated that the issues vexing investors were created by the “woefully inadequate” legal language in mortgage-bond contracts which would be improved by new rules that the Securities and Exchange Commission has proposed.

“If corporate trustees were subject to a fiduciary duty and the attendant level of liability, they would have to demand a significant increase in their fees, which would ultimately be borne by investors and homeowners,” he said.4

Romano I. Peluso