CORRECT: Mass. Court Rules Against US Bancorp, Wells Fargo

A court in Massachusetts raised questions about the mortgage foreclosure process when it ruled against U.S. Bancorp (USB) and Wells Fargo & Co. (WFC) Friday in two mortgage foreclosure cases. The ruling affirmed a lower court decision that the banks, acting on behalf of investors in trusts of securitized mortgages, failed to show they held the mortgages at the time of the foreclosure.

The Massachusetts ruling involves just one of many litigations winding their way through courts across the country. In another case in nearby Maine, the Supreme Judicial Court ruled Thursday in favor of the bank, J.P. Morgan Chase & Co. (JPM), in a foreclosure dispute that also involved documentation issues.

In the stock market Friday, uncertainty was a negative. Investors worried the Massachusetts ruling suggests trouble for banks in foreclosing on mortgages that had been packaged into asset-backed securities. Many questions remained, but with bank stocks up sharply since the end of November, investors reacted to the ruling with concern.

Bank stock investors decided to "sell first and ask questions later," said Peter McCorry, a senior trader at Keefe, Bruyette & Woods Inc., which specializes in financial stocks.

Wells Fargo and U.S. Bancorp said they had not originated the mortgages, nor serviced them. The investors who bought the mortgage-backed securities own the foreclosed properties. As such, "this judgment has no financial impact on U.S. Bancorp," a spokesman said. "Our role in this case is solely as trustee."

Wells Fargo said it "expects the entities who service these loans to abide by all applicable state laws, including those laws that govern foreclosure sales." In the Massachusetts cases, those mortgages were serviced by Option One Mortgage Corp., then unit of H&R Block Inc. (HRB).

American Home Mortgage Servicing Inc., the independent servicing company that services the mortgages now, said Friday's ruling "confirms that the securitization processes...are sound" and the "decision is of limited applicability because it is based on law that is unique and specific to Massachusetts."

Paul Miller, a bank stock analyst at FBR Capital Markets, said the court's decision cast uncertainty on how lingering foreclosure issues will affect banks. Miller had previously estimated an industry cost of $10 billion related just to the resolution of the robo-signing issue raised last fall. The Massachusetts court decision may encourage other homeowners to contest their foreclosures, raising the overall potential litigation costs to the industry. There are many other such cases pending in other states, Miller added. "This is really the first high profile case where the foreclosure process is coming under scrutiny," Miller said in an interview.

In the Massachusetts decision, the judges pointed out the long-standing rules involving procedures for lenders to follow in a state in which the courts are not required to sign off on foreclosures. The banks failed to follow the rules, they said. One justice criticized the "utter carelessness with which the plaintiffs documented the titles to their assets."

Stuart Rossman, the director of litigation at the National Consumer Law Center, which filed a friend of the court brief in the Massachusetts case, said it's not simple quibbling over whether banks dotted the i's and crossed the t's. Lack of attention to details "throws the legitimacy of the entire process into question," he said. "It's like being a little pregnant."

In contrast, the court in Maine was willing to overlook a procedural problem in a foreclosure. The Maine court agreed that J.P. Morgan improperly filed a foreclosure complaint on the homeowner in 2009 a month before it was assigned the loan, but since it fixed that deficiency before moving for summary judgment in 2010, and the homeowner didn't object, it could move forward.

Some analysts said the Massachusetts ruling wouldn't set a precedent. Betsy Graseck, an analyst with Morgan Stanley, wrote Friday, "this is a procedural judgment, not a systemic judgment... This judgment is not saying the foreclosure process is flawed." As such, investors overreacted, she wrote.

The ruling by The Supreme Judicial Court in Boston affirmed a lower court ruling. The banks, acting as trustees on behalf of the investors in mortgage-backed securities, had sought to clarify that the two foreclosures were proper to obtain title insurance.

In the ruling, the court said, "We agree with the judge that the plaintiffs, who were not the original mortgagees, failed to make the required showing that they were the holders of the mortgages at the time of foreclosure."

-By Matthias Rieker and Liz Moyer, Dow Jones Newswires; 212-416-2471; [e-mail]

--Corrie Driebusch in New York contributed to this article.