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Cheat Sheet: How the State AGs Want to Revamp Mortgage Servicing

WASHINGTON — The 27-page term sheet handed to the five largest mortgage servicers last week is a detailed, dense list of requirements that, if implemented as proposed, would fundamentally change the relationship between servicers, investors and borrowers.

The term sheet, obtained by American Banker and available here, is just the opening bid in an ongoing negotiating process between the servicers and various state and federal agencies attempting to punish them for significant issues uncovered in the foreclosure process. While some of the details of the term sheet have been made public already, the sheer breadth and depth of the proposed requirements were not clear until now.

The term sheet covers virtually every detail of how servicers operate, laying out new requirements for mortgage documentation, interaction with borrowers, relationships with active military personnel, loan modifications, principal reductions, bankruptcy proceedings, short sales and technology systems.

It even includes a proposed requirement that servicers enter into a contract with retailers such as Wal-Mart Stores Inc. or FedEx's Kinko's to enable borrowers to fax modification documents to banks free of charge, in addition to ordering servicers to create Web sites to allow borrowers to upload documents directly.

Speaking to reporters on Monday, Tom Miller, the Iowa attorney general in charge of negotiations on behalf of the 50 state AGs, said the proposed settlement had to be tough to enact real change in the industry.

"What we are really trying to do is change a dysfunctional system," he said. "We really want to change all that, that's our goal. It's a significant difficult goal. We've had discussions with banks. We are hopeful we can reach an agreement good for banks and good for homeowners."

Following are highlights of the term sheet and its most critical requirements:

Loan Modifications
Overall, the term sheet is designed to pressure servicers to offer some kind of loss mitigation, preferably principal reduction, for delinquent loans.

Under the term sheet, servicers must offer a modification when it will result in a greater net present value than foreclosure. If a borrower requests a modification and the servicer believes that a pooling and servicing agreement prevents one, the servicer must still perform a net present value test and, when positive, present that to trustees or other authorized parties in order to obtain consent for a modification.

The servicers must present their models for determining a net present value to the Consumer Financial Protection Bureau upon request.

Servicers are pushed to consider principal reduction as a first option when possible, although the term sheet makes it clear that the subject has also been "reserved for further discussion." Servicers must evaluate certain delinquent loans with a loan to value ratio of greater than 100%, and offer principal reduction if that would result in a better net present value than a standard modification.

Instead of forbearing on principal, the draft agreement says servicers shall begin "conditional forgiveness of principal" if a loan modification performs well.

"Standard shall be that one-third of forborne amount is forgiven for each successive year that the borrower complies with loan modification terms over a three year period," according to the term sheet.

The state AGs and other federal enforcement agencies are also pushing for the reduction of mortgage debt in the bankruptcy process.

"Servicer shall consider implementation of a special loan modification process for bankruptcy cases where the borrower (a) is considered for voluntary principal reduction to fair market value of property while other unsecured debt is discharged; or (b) as part of a Chapter 13 plan, the interest on the borrower's first lien is reduced to zero for five years and then reamortized at a market rate for 25 years at the conclusion of the five year payment plan," the term sheet says.

The term sheet also touches on second liens, requiring that for all loan modifications, including principal reductions, second loans must be modified proportionately to the first lien or extinguished at the time the modification is offered.

Borrower Interaction and Documentation
Under the term sheet, servicers would have to stop "dual tracking" modifications at the same time they move forward with a foreclosure. Regulators have spoken out against the process, arguing it is confusing for struggling borrowers.

Servicers must also provide borrowers with a single point of contact for all loss mitigation. Many borrowers said they had been lost in the shuffle, unsure of who they should be talking to when trying to get a loan modification.

Under fire for losing records vital to a foreclosure, the term sheet would require servicer employees handling an affidavit to give a sworn statement that they have personal knowledge of its contents. Servicers must create standards for qualifications, training and supervision for employees who prepare or execute affidavits and sworn statements. Servicers should also maintain procedures to ensure accurate and timely documentation of a borrower's account information, including posting of payments and imposition of fees. Further, servicers' record keeping systems must be audited by an independent auditor with the results available to the state AGs and the CFPB.