Although entirely unrelated to the current crisis in the mortgage lending sector, one litigation in which Loeb attorneys have acted as lead counsel since 2003 puts front and center the issues regarding the valuation of mortgage-backed securities that are at the core of the litigations that are being commenced now on a virtually daily basis. This monograph summarizes the valuable lessons that we have learned in the course of this engagement — lessons applicable to the cutting edge issues presented by the mortgage credit crisis.

Over the past decade, members of Loeb & Loeb’s Mortgage Industry Service Team (MIST) have been involved in the full panoply of residential mortgage-related litigation and government investigations. Our members have litigated those issues in Federal Court, State Court, and administrative tribunals. Although many of the cases have involved fair lending issues, all of them require an understanding and appreciation for the entire lending process, including the finance issues.

We have, in the course of these engagements, been exposed to, and we believe have understood and integrated, information relevant not only to every aspect of residential mortgage lending, but to the very issues that are being litigated every day in the current mortgage credit crisis. Some of the vocabulary might be different, as you move from lender to lender, financier to financier, underwriter to underwriter, but the concepts are uniform as is the knowledge base. In all modesty, we feel that we have moved well up the learning curve.

Background
In 2003, our client, Delta Financial Corporation, and its directors were sued for $110 million in New York Supreme Court.¹ The case involved a theory of liability built around projections Delta had included in a prospectus that it had issued in 2001 in connection with an exchange offer. Delta had projected cash flow for the excess cashflow certificates or residuals (the first-loss or equity piece of an MBS securitization) of $150 million. The plaintiff, claiming to use assumptions extant at the time of the exchange, alleged that an accurate projection would have been $40 million and sued for the difference.

The Issues in the Delta Case Mirror
Today’s Issues
The claims in the Delta lawsuit seem torn from current headlines, and the salient issues in the case permeate current litigation. Thus, among other things, we have learned about:

• Cash flow projections;
• Cash flow waterfall through the various tranches;
• Promulgation of pertinent assumptions – prepayment, default, deficiency, loss, discount rate;
• Delinquency, default and loss indicators, such as FICO scores;
• Net Interest Margin Securitization (NIMS);
• Gain on sale modeling;
• Loss and delinquency triggers;
• Servicing;
• Securitization of servicing advances;
• Warehouse lending;
• Clean-up calls;
• Market disruptions in 1999 – 2001;
• Loss severity; Hold-to-maturity valuation;
• Liquidation valuation.

We Have Dealt with the Experts in the Field
We have worked with, and against, noted experts in the field. Our experts included Pentalpha Capital Group of Greenwich, Connecticut and Navigant.² Our adversaries used Boston Portfolio of Ft. Lauderdale, Florida; Chartered Capital Advisors, Inc. (Ronald Quintero); and Hayden Consulting (Luke Hayden of GMAC). KPMG, the auditors for Delta and for the plaintiff, was named in a parallel lawsuit, which was joined with ours for discovery. Virtually every member of the audit team, and many additional personnel, were deposed by our adversary.

We Broke New Ground in E-Discovery Litigation
It took literally years to get through document discovery. The principal calling the shots for the plaintiff happened to be a litigation support and bankruptcy work-out specialist. He was very well versed in e-discovery, and it became apparent from the outset that e-discovery was going to become very much a surrogate battlefield. As a result, we resisted, successfully, repeated efforts to capture and review data located on 72 different servers. We also were successful in convincing the Court to shift the costs of a costly, but ultimately valueless, fishing expedition that our adversaries insisted on – until they realized that they would have to pay the freight. The decision is unique and one of the more frequently cited and commented upon decisions in New York jurisprudence on e-discovery.

We Experienced Soup-to-Nuts Discovery
Deposition discovery lasted more than a year. Every member of Delta’s finance department was deposed, and Delta’s gain-on-sale models, which covered literally hundreds of pages of Excel spreadsheets, were projected onto screens and combed over in minute detail. Every KPMG auditor who touched the file was deposed, and some of the depositions covered up to four days.

Outcome
Regrettably, just prior to the time we were to provide expert reports and make dispositive motions, Delta, caught in the credit crisis that permeates the marketplace, filed for bankruptcy protection. The case is now stayed. Since Delta’s directors are also named as defendants, whether the case proceeds or not will depend on further litigation in the Bankruptcy Court and in the NY Supreme Court.

We Have a Team of Experienced Counsel
Loeb & Loeb’s Mortgage Industry Service Team is an interdisciplinary group of lawyers established to advise our clients with respect to the myriad legal, economic and practical issues which have arisen as a result of the dislocations and upheavals in the subprime mortgage market. The team works with our clients as a coordinated group to analyze the challenges and opportunities, prepare for possible eventualities, and respond promptly and effectively to the risks and legal liabilities presented.

1. In late 1998 and early 1999, Delta faced an investigation of allegations of predatory lending by the New York AG’s Office, summary suspension proceedings by the Banking Department, and a massive class action in the Eastern District of New York. Loeb & Loeb began representing Delta in 2005, when the case came to us through the addition of Eugene Licker. Eugene initially handled the government investigation and later the class action. Since then, we have provided significant and ongoing advice, counseling and representation to Delta, as well as other lenders and other participants in the residential mortgage marketplace. Most of those cases involved the entire process of mortgage lending as well as the full lattice of federal and state fair lending legislation: TILA, HOEPA, RESPA, UDAP, and ECOA.

2. As noted below, the Delta case came to an abrupt halt with Delta’s filing of a voluntary petition in bankruptcy. At the time of the filing, Delta had not identified its testifying experts (and, of course, had not identified consulting experts). As a result, we are not at liberty here to set forth a complete list of the experts with whom we have worked on the case.