Banks Protest as Servicing Rules Are Set by Regulatory Fiat
WASHINGTON — Federal agencies are set to establish sweeping new servicing standards not by legislation or regulatory process, but by a major action against the top five mortgage servicers.
The state attorneys general and several federal government agencies sent a 27-page term sheet last week to the servicers outlining their demands, including pressuring them to offer principal reductions while revamping foreclosure proceedings, borrower records and technology processes.
While the term sheet amounts to an opening salvo in negotiations, bankers were already protesting the creation of de facto servicing standards through a punitive action, arguing that in some cases regulators are asking for changes that had little to do with faults uncovered at the companies.
"I have always had a visceral dislike of regulating through enforcement, because the settlement will affect these major parties but won't affect others and therefore creates an unlevel playing field," said Ernest Patrikis, a partner at White & Case LLP and a former counsel at the Federal Reserve bank of New York. "That's not the way things should be done. They should be done through comment from regulations. When you are dealing with enforcement matters, you are not really negotiating. One guy has a gun to your head."
But it is unclear whether bankers have much leverage to fight back. While some industry sources are hoping for support from Republican lawmakers that may share their concerns, winning the debate is an uphill battle.
"I don't know if they have the right to do it," said Paul Miller, managing director of FBR Capital Markets Corp. "The government is suddenly inventing new regulation without congressional approval. The banks have a legit complaint. They are going to have to fight it. They may not have a lot of leverage."
Rep. Patrick McHenry, R-N.C., said in a statement he was already concerned. "It does seem that the administration is looking at this settlement to revamp their failed foreclosure mitigation programs, which I find very troubling," he said.
So far, the settlement with federal banking regulators, 50 state attorneys general and other government agencies are running on different tracts. The bank regulators sent 14 servicers draft cease-and-desist orders three weeks ago outlining steps they want servicers to take. Last week's term sheet, delivered Thursday to only the top five, is from the attorneys general, Consumer Financial Protection Bureau, the Department of Justice and the Department of Housing and Urban Development.
Both regulators and enforcement officials are hoping to finalize both in a single global settlement. While the details of each have to be worked out, however, the other open question is how much money the servicers will have to pay. Regulators still disagree on that issue, and have yet to bring the issue to servicers.
Some bankers say the entire process is unfair. Regulators are working on multiple tracks asking them to agree to a series of reforms without also simultaneously negotiating on a civil money penalty. They argue everything should be hashed out at the same time.
Others complained that the term sheet does not say exactly what servicers are alleged to have done wrong, making it difficult to know how to respond.
Some industry representatives are quietly urging bankers to push back, pointing to court precedents where judges have said federal agencies went too far by trying to establish standards in an enforcement action.
"I think it makes a mockery of the legislative and rulemaking process that permits significant public input," said Laurence Platt, a partner at K&L Gates. "It somewhat defies explanation why the administration isn't using more traditional methods to create policy of such material magnitude. … What's so fascinating here is the concept of national servicing standards is an area where reasonable people can differ and it raises fair-lending issues, investor issues, Fannie, Freddie issues. The notion the political process is not being used to develop that either through rulemaking or legislation to me is very bad public policy."
But Patrikis questions whether the banks will challenge the deal, even if it is far-reaching.
"Do the banks have the stomach to do that in this environment, with all the hostility toward the banking industry?" he said.
Gil Schwartz, a partner at Schwartz & Ballen, said new standards should not be written this way.
"It's inconsistent with due process to require institutions to do things without having opportunity to provide notice and opportunity for comment," Schwartz said. "The argument can be it's enforcement, but it's really setting down for all what they would like the behavior to be. It's part of the trend toward substantive regulation rather than establishing some general principles and implementing it how you think is appropriate for an institution."
Regulators have taken such steps in the past. In 2008, then-New York Attorney General Andrew Cuomo reached a settlement with Fannie Mae and Freddie Mac to set new appraisal standards. Agreed to by the Federal Housing Finance Agency, the standards were a significant change that was not handled through legislation or regulation.
Consumer groups cited other precedents for this type of action.
"There is precedent for new standards in the marketplace through the work of attorneys general and others," said David Berenbaum, the National Community Reinvestment Coalition's chief program officer. "For example, when we were looking at fee-based subprime services … ultimately it was the role attorneys general and the Federal Trade Commission that ultimately changed these practices. In the absence of a national servicing standard or a strong agency enforcing strong consumer protection laws, state attorneys general can use their role to protect their jurisdiction's interests and that's what's happening."
The term sheet delivered last week appears to be an aggressive starting point for negotiations and would significantly reshape the servicing business if implemented in its current form.
Under the term sheet, the CFPB would gain an even stronger hand in dealing with servicers — four months before the agency officially assumes much of its authority. Servicers would have to provide details to the CFPB for how they determine the net present value of a home — a crucial metric that allows the banks to figure out if it is cheaper to foreclose or offer borrowers' some kind of workout. The bureau would review and monitor those calculations. Under the term sheet, servicers would have to offer some kind of loss mitigation if the net present value of a modification would be more than its value in foreclosure.
The term sheet also lays out new timetables for documentations, audits and appeal procedures, which are likely to lengthen the foreclosure process. For example, any documentation referred to in an affidavit would have to be attached to the affidavit. Servicers have been heavily criticized for missing essential paperwork as part of the foreclosure process.
The term sheet calls for new restrictions on servicer fees and force-placed insurance. Nominally purchased to protect the owners of mortgage-backed securities, such insurance products on a borrower's home can be 10 times as costly as regular policies, raising struggling homeowners' debt loads, pushing them toward foreclosure.
Banks are also concerned because the term sheet says any violation of the new requirements would be considered an unfair and deceptive trade practice, a designation that would create a private right of action for consumers and open the bank up to more penalties.
Regulators are also proposing new conditions designed to improve the Obama administration's Home Affordable Modification Program. The term sheet would set new conditions to convert a trial modification into a permanent one under the program. Currently a borrower has to make three consecutive payments on a trial modifications before it is considered permanent. But many borrowers have had problems meeting that test. According to the last Hamp report, there were 740,240 trial modifications that have been canceled, outpacing the number of permanent modifications, which were at 539,493 at the end of January.
On Monday, Iowa Attorney General Tom Miller, who is leading the states' efforts, will speak about the foreclosure settlement at the National Association of Attorneys General conference in Washington.
The settlement is in response to numerous reports last year of foreclosure problems, including robo-signing, which prompted a large-scale investigation by the state AGs and several federal agencies. As a result of the investigation, the bank regulators have issued a draft cease-and-desist order to 14 of the largest servicers, which would force them to improve their processes. Regulators are hoping to issue both the cease-and-desist and the final term sheet at the same time as part of a global settlement.