More Notes on eNotes

eNotes in the News
The use of eNotes continues to expand across the mortgage industry. In May, MERS® reported that 44,170 eNotes were registered on the MERS eRegistry (as of the end of April 2021). There have now been over 1,155,052 eNotes registered since the inception of the MERS® eRegistry. MERS is also reporting an 83% year-over-year increase in the number of companies transacting on the MERS® eRegistry, (as of April 2021). The use of eNotes had already started to increase before the pandemic, but public health measures initiated as a response to COVID-19 surely accelerated the use of eNotes. This acceleration will likely continue as the mortgage market shifts away from refinances and pivots towards more purchase transactions as rates increase and the demand for housing remains strong.

The use of eNotes is also starting to gain some traction in the world of Housing Finance Authorities (HFAs). As we noted in an earlier blog entry, in March, the Colorado Housing and Finance Authority (CHFA) announced that they had become the first HFA to accept, purchase, and deliver an eNote to the secondary market. This was a culmination of an initiative that was launched in 2020 by CHFA to provide greater efficiency to its mortgage process.

“Accepting eNotes aligns CHFA with the trajectory of the mortgage industry, leading to improved efficiencies and faster funding of loans delivered to CHFA by our participating lenders. Ultimately, it allows CHFA to meet its mission and help more low- to moderate-income households achieve homeownership,” said Cris White, CHFA executive director and CEO. “We are thankful to all who contributed to this achievement.”

Currently, CHFA is conducting a pilot program for eNotes with Fairway Independent Mortgage Corporation for conventional, first-lien loans for delivery to Fannie Mae and Freddie Mac®. CHFA anticipates expanding offering its eNotes capabilities to other qualifying lenders later in 2021. In addition, CHFA is exploring accepting eNotes for FHA-insured first-lien loans and CHFA down payment assistance second mortgages.[1]

Considering this exciting news about the acceleration of the use of eNotes, it might be helpful to take a step back and review and refresh our knowledge on some of the basics about eNotes. These basic principles help us understand the importance of the unique features of eNotes and the systems that support them.

eNote Refresher
The eNotes utilized in the mortgage industry are electronic promissory notes. A promissory note is a unique kind of agreement, they are defined as “an unconditional written promise, signed by the maker, to pay absolutely and in any event, a certain sum of money either to, or to the order of, the bearer or a designated person.”[2] It is important to understand that a promissory note is a special kind of agreement to pay a sum of money. Unlike a normal contract where payment may be conditioned upon the performance of another party, payment of a note is unconditional, meaning that it is not conditioned upon the occurrence of any event, it is simply an unconditional obligation to pay.

Another unique feature of promissory notes is that they are classified as negotiable instruments. A negotiable instrument is defined as “A written instrument that (1) is signed by the maker or drawer, (2) includes an unconditional promise or order to pay a specified sum of money, (3) is payable on demand or at a definite time, and (4) is payable to order or to bearer.” UCC § 30104(a). The key to this concept is that the negotiable instrument is payable to order or to bearer. This means that the instrument can be enforced by the person that is in possession of the instrument and that the instrument can be transferred, negotiated or passed to another party that has an unconditional right to enforce the promise to pay against the debtor.

To restate these concepts, the promissory note is in and of itself an unconditional obligation. This means that whoever lawfully holds the actual promissory note is entitled to payment from the debtor. A copy of the promissory note is not sufficient to enforce the obligation, the holder must have the actual note. These promissory notes are also often negotiated or transferred from one person to another, as the note is transferred so is the right to collect. This function is critical to the mortgage industry as notes are transferred from one party to another and eventually securitized. For eNotes to work they must be able to perform the same functions as paper promissory notes. This means the actual electronic version of the note must be possessed or held electronically by the party entitled to payment. Also, these electronic notes must be able to be negotiated or transferred from one party to another as eNotes are moved through the lending process toward securitization.

An eNote is an electronic promissory note. This means it has all the same information that is generally included in a paper promissory note, but is created, executed, and managed electronically. The MISMO SMART Doc is the industry standard for eNotes. The SMART Doc format links the visual representation or text of the note along with data included in the note and the signature. They can be viewed using a variety of technologies, most commonly PDF, and they are electronically sealed to prevent tampering. This format ensures that what a borrower signs on their computer screen is the exact document that will be stored. Once an eNote is signed, it is transferred to an electronic vault or eVault where the original file is securely stored and where it can be transferred to another eVault as needed.

The MERS eRegistry is an important part of the eNote ecosystem. It is the authorized registry that identifies the current Controller (the electronic holder) and the Location (the electronic custodian) of the Authoritative Copy (original) eNote. The Controller of an eNote has all the rights and privileges as the holder of a paper promissory note. The MERS eRegistry does not actually store eNotes, they are stored in eVaults, the registry interfaces with eVaults and tracks the Controller and Location of eNotes so they can be easily identified and located. Fannie Mae and Freddie Mac (GSEs) require the use of the MERS eRegistry for eNotes that they purchase, and GSE buyers require the use of MERS for eDelivery.

MERS recently added a Secured Party field to the eRegistry. A Secured Party is a person who has been sold, pledged, assigned, or granted a security interest in an eNote by a Controller. This field allows specific entities to be designated as a Secured Party on eNotes instead of being designed as a Controller. This provides a Secured Party with the ability to review and approve a transfer prior to the performance of the transfer by the eRegistry. The Secured Party can also perform a transfer of control to themselves if needed.

This Secured Party functionality has been key to the Federal Home Loan Banks' work to accept eNotes as pledged collateral. As we noted in an earlier blog entry, MERS reported that in February Together Credit Union became the first member to use this new functionality by designating FHLB Des Moines as a secured party and identifying the location of the authoritative copy of the eNote to be FHLB Des Moines eVault. It is exciting to watch as the framework to utilize eNotes continues to solidify and support the acceleration of eNotes throughout different segments of the mortgage business.

To learn how you can digitize more of your mortgage workflow and incorporate eNotes into your eClosing process, request a demo below and we’ll show you how to get started.

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[1] https://www.chfainfo.com/news/Pages/03122021-enotes.aspx
[2] Black’s Law Dictionary (11th ed. 2019)