The alleged scandals involving Enterprise Mortgage Acceptance Co. (EMAC) intensified recently as Teachers Insurance Annuity Association (TIAA) filed a lawsuit against the company and several of its principals to recoup nearly $50 million in losses suffered from investments in EMAC's deteriorating securitizations.
The lawsuit names EMAC's parent company Koch Industries and several former senior officers of EMAC, including Ken Saverin, Jeffrey Knyal, Charlene Chai, Sean Stalfort and Jeffrey Thompson (of Koch Capital Servicers, who replaced Saverin as CEO in late 2000). Officials at EMAC could not be reached for comment. As of press time, media relations officials at Koch did not return phone calls.
In a prepared statement, TIAA comments, "[We] contend that the credit quality of the investment was presented as being much stronger than it actually was, with many of the borrowers having no experience in the businesses for which they received loans from EMAC, leading to quick defaults."
TIAA was a major investor in the subclasses of privately placed EMAC Owner Trust 1999-1, taking the D-class (A3/A-) and E-class (Baa2/BBB) almost entirely. TIAA made similar purchases on EMAC Owner Trust 2000-1, taking 50% of the C-class (A2/A), and 100% of the E-class (Ba2/BB).
In the complaint filed by law firm Bernstein Litowitz Berger & Grossman in the U.S. District Court Southern District of New York, TIAA alleges that EMAC was propping its securitizations by financing the debt service on outstanding loans to borrowers that would have otherwise been delinquent, a probability previously reported in ASR (see ASR 7/23/01).
TIAA alleges that such loans, called working capital loans, were made to EMAC's largest borrower, Convenience USA, which accounted for approximately 18% of the 1999-1 pools and 6.6% of the 2000-1 pools. Convenience USA specialized in the convenience store and gas station franchise segment (C&G). According to the complaint, these concentrations were not disclosed in the offering documents, and instead were masked over by a failure to connect certain companies to its ultimate parent (Convenience USA). Convenience USA filed for bankruptcy protection shortly after EMAC stopped originating loans last winter.
Cited from the lawsuit: "[A former employee at EMAC] states that both EMAC and Convenience USA knew that EMAC's loans to Convenience USA were not designed to be self-sustaining from their inception. Although EMAC represented in the Prospectus that its borrowers would pay their debt from the cash flow generated by the stores collateralizing the loans extended by EMAC, it was never made possible for Convenience USA to do so... In November 1999, EMAC began making undisclosed prop up' loans to Convenience USA, which Convenience USA used to make its payments on the loans that were already part of the 1999 Pool and on loans that would become part of the 2000 Pool."
According to the complaint, the operating cash loans to Convenience USA, which were never securitized, amounted to about $7.5 million as of April 19, 2001.
As previously reported in ASR, shortly after EMAC ceased originating loans in late March 2001, defaults spiked considerably. For example, the 1999-1 pool was showing just 2.7% in delinquencies in January 2001, 1.7% in February, rising to 10% in March, 10.5% in April, and 30.5% in May.
TIAA also alleges that EMAC was lending in a reckless manner, often to borrowers who either had little or no experience in the convenience and gas station industry, or who were personally affiliated with the underwriters or other employees at EMAC (the Convenience USA loans also fall into this category). Such practices are in conflict with EMAC's representation to investors in its offering prospectuses, and in subsequent discussions with TIAA prior to the purchase of the bonds, the insurance company alleges.
Other questionable lending activities include borrowers Northwest C&G, Vista Stores, Micro Energy, Union Oil Markets and Trico SE Petroleum, the suit alleges.
Interestingly, in its report on methodology changes issued last fall, Fitch Ratings raised data reliability as an issue in some of the problem franchise deals.
In total, EMAC securitized three times, bringing roughly $1.1 billion in franchise ABS to market. Morgan Stanley Dean Witter was underwriter on all three deals.
Third party advisors...
a questionable development
Meanwhile, since the franchise fallout began about two years ago, several third-party workout specialists have found a lucrative niche representing borrowers, arguably to the dismay of the servicer and the detriment of the deals, sources said. Convenience USA is said to have recently hired a workout specialist.
These sources contend that the third-party advisors will restructure the workouts on the borrowers' behalf using bankruptcy as a threat. Because the problematic franchise deals were generally backed by loans without real estate collateral, the threat of bankruptcy is fairly potent. In the worst of these allegations, certain advisors are supposedly approaching non-problem borrowers and persuading them to restructure.
"[The restructuring] can involve the forgiveness of some portion of the principal," a source said. "It has the potential to increase losses."
Of course, the third-party workout specialists take issue with these assessments.
"[Because] most of these franchise mortgages are egregiously under-secured in terms of a hard collateral liquidation perspective, the typical servicer role of, Pay me or I'm going to take my asset back' doesn't work," said Kevin Burke, of Trinity Capital, which was involved in a par amount of $1.1 billion in loan restructurings last year. "Another issue is that some servicers have used workout professionals who think their mission is to punish wayward borrowers and not optimize the recovery of the asset."
As to persuading non-problem borrowers to restructure, Burke argues that this is a out-and-out fallacy: "It's unethical to disrupt a lender/borrower relationship with promises of Christmas time for borrowers, who fail to understand that perhaps the biggest component to paying a loan back is honor."
Burke, who was an executive in securitization at Franchise Mortgage Acceptance Co. throughout the 1990s, added that Trinity has seldom represented borrowers, and currently has just one active borrower client out of 30 transactions.