Mortgage Settlement Raises Ire Over Credit for Short Sales

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A prominent consumer group is bothered that the top five mortgage servicers are stressing short sales under the $25 billion national mortgage settlement when the goal of the program is to keep borrowers in their homes.

In particular the California Reinvestment Coalition questioned why servicers should receive credit for principal forgiveness on short sales in states where they already are barred from pursuing borrowers for the unpaid debt.

In 12 non-recourse states, including California and Arizona, borrowers cannot be personally held liable for the loss in a short sales when a home sells for less than the value of the mortgage. In those states, banks would have to absorb the losses anyway, so borrowers are not getting any added relief from the settlement, says Kevin Stein, the associate director of the California group.

"If servicers are getting credit for something that has no value, that's a problem," Stein says. "The success of the agreement depends on benefits to consumers they would not have received without the settlement. If the agreement is going to be characterized by short sales that wipe out debt that was not collectible even without the settlement, then that's not moving the ball forward."

Of the $10.6 billion in consumer relief given to borrowers in the March-to-June period, $8.7 billion came from short sales completed for 75,000 borrowers, the settlement's independent monitor, Joseph A. Smith, said last week in a preliminary report.

Servicers completed $5 billion in short sales in non-recourse states during the four-month period. The preliminary report included raw numbers that were not verified for their accuracy.

The settlement was designed to incentivize servicers by giving them credits depending on the type of consumer relief. Each dollar forgiven in a short sale, for example, results in a credit of 45 cents if the bank owns the loan and 20 cents if it is held by investors. Servicers get full dollar-for-dollar credit for principal forgiveness.

Still, the gross dollar amounts in the preliminary report do not reflect what will ultimately be credited to the servicers.

Laura Brewer, a spokeswoman for the Office of Mortgage Settlement Oversight, said the settlement made no distinction between recourse states, where borrowers can be pursued for unpaid debts, and non-recourse states, where they are not held liable for any legal action, or deficiency judgment, to collect the remaining debt.

"It's something we're going to continue to look at," Brewer says.

The independent monitor was appointed to oversee compliance with the terms of the settlement reached earlier this year with Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC), Citigroup (NYSE:C) and Ally Financial, formerly GMAC.

Short sales made up 80% of the total consumer relief offered in the initial four-month period beginning March 1, primarily because many short sales were already in process before the settlement was even announced.

Still, the California Reinvestment Coalition's Stein called the report "disappointing."

"You can't ignore how large the short sale numbers were and the agreement hopefully will not be remembered for promoting large numbers of short sales," he says. "We hope that changes."

In comparison with the $8.7 billion in short sales completed, servicers provided just $749.4 million in principal forgiveness of first liens to roughly 7,000 borrowers nationwide, and $231.4 million by forgiving or extinguishing second liens for 4,200 borrowers in the same four-month period.

Several state regulators and attorneys general had a more muted response to the preliminary report.

Illinois Attorney General Lisa Madigan said in a statement she is "cautiously encouraged by the initial progress reported by the independent monitor," and that she will continue "to hold banks and other financial institutions accountable for the destruction they've caused our communities."

Tennessee Attorney General Bob Cooper praised the use of short sales, saying in a statement that they were helping stabilize home prices.

"One aspect of the settlement that could sustain that momentum is the provisions requiring the servicers to make timely decisions regarding short sales," Cooper said. In Tennessee, servicers have approved 437 short sales at a benefit of over $22 million in the four-month period, according to the report.

Mark Kaufman, Maryland's commissioner of financial regulation and a member of the monitoring committee overseeing the settlement, said servicers are "in the early innings of this effort."

"We remain diligent in pushing the servicers to comply with the terms of the agreement and in ensuring fairness in the treatment of homeowners," Kaufman said in a statement.

To be sure, banks have said they are on track to give the principal reductions they have promised under the settlement.

Some of the principal reductions did not show up in the preliminary report because borrowers typically are put into 90-day trial loan modifications that include principal reductions to prove they can repay the mortgage at a reduced amount. Three months' of payments must be completed before credit is given to the servicer.

For example, though Bank of America failed to complete any principal reductions or refinancings in the initial four-month period, the Charlotte, N.C. bank had completed $596.2 million in first-lien principal reductions through Aug. 21, says B of A spokesman Dan Frahm. Nearly 16,000 borrowers are in trial modifications that include $2.5 billion in principal reductions and roughly 23,000 borrowers have been approved to receive another $3.6 billion in principal reductions through Aug. 21, Frahm says.

B of A completed $4.8 billion in short sales to nearly 40,000 borrowers, nearly half of all consumer relief tracked in the preliminary report.

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Comments (3)
What would be interesting to see is how many, if any, of the borrowers approved for short sale were denied modifications or told that they would not qualify for one without having had a fulsome review of the mod request. There is no comparative denial process in servicing arena as there is in the origination space. Nor is the HMDA data reported in the servicing decisions..or even captured for that matter in most cases at the initial boarding of the loan in the servicing system. Given the changes in the Loss Mitigation area of Defaul Servicing over the past 3 years, the modification requests are being truly underwritten, ratios, documentation, tax returns and all. Why isn't the transparency required? I keep asking. Haven't yet received a satisfactory response.
Posted by Ingrid Beckles | Tuesday, September 04 2012 at 12:30AM ET
Ingrid, great questions, but the settlement itself was inherently unfair by offering special financial benefits only to a small number of people with moral hazard as an incentive. Transparency won't facilitate fairness, it would only highlight the fundamental problems with the remedial provisions of the settlement. That is something that its authors (both the banks and the AG's) would prefer everyone to ignore.
Posted by Brian L. | Tuesday, September 04 2012 at 9:40AM ET
For each Loan Servicer, a "Multi-dimensional Loan Modification Process Flow Diagram", with identified Key Control Points and Supporting Procedures, which reflect the minimum legal requirements should be compared with each Loan Servicer's "Processing of Each Borrower's Loan Modification Application Process." The Modification Denial Process' Investigation should begin with "Each Borrower who was Denied the 'Best' Loan Modification Available". Many Loan Servicers intentionally built time into the process to ensure borrowers would be exhausted both emotionally and financially when the time arrived to cut the new deal. Servicers ensured borrowers would accept any deal, even if they knew how bad the deal was. They collected their money and moved on. Now, Loan Servicers continue to pretend as if none of this ever happened.
Posted by sjnewport | Thursday, September 06 2012 at 6:29PM ET
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