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

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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.

Servicers must also adopt policies to oversee third parties that provide foreclosure assistance. The regulators deferred action on the Mortgage Electronic Registration Systems that hold the documentation of the ownership of most mortgages. Instead, regulators said issues related to MERs would be held for further discussion.

Military Personnel
Under the term sheet, servicers must use a consultant to review whether they improperly foreclosed on any active duty members of the military.

Military personnel are protected by the Servicemembers Civil Relief Act, which prohibits foreclosures on active-duty military personnel and limits interest rates on their pre-existing consumer debt to 6%. JPMorgan Chase & Co. was recently forced to offer significant concessions to military customers amid acknowledgements that it violated the law. The bank strongly suggested that it was not alone in doing so, signaling that other large servicers likely had similar problems.

The draft agreement would require servicers to inform the U.S. attorney general of the results of the SCRA review, and designate employees familiar with the law to be a point of contact for borrowers.

If a servicer believes a home in question is owned by a servicemember, he or she must inform the borrower they may enjoy special treatment under the SCRA, and also refer the servicemember to approved advocacy organizations.

"Comprehensive Loan Portals"
The draft agreement calls for servicers to significantly improve their technological capabilities.

Servicers must develop their own portal system - or engage a third-party vendor in doing so - for borrowers, which utilizes "loan servicing technology to enhance tracking of, and to provide a direct borrower link to, loss mitigation information."

The portal must be real-time, allow electronic document submission, provide information on eligibility for proprietary loss mitigation solutions and be free for borrowers.

In addition to a loan portal for borrowers, servicers must also cooperate in the establishment of one for housing counselors. The portal would be neutral and nationwide, and meant to "enhance communications with housing counselors."

Loss Mitigation Timelines
The draft agreement also specifies certain timelines in the loss mitigation process. For example, within 10 days, servicers must acknowledge in writing that they have received documentation from a borrower regarding an application for a loan modification. Servicers have 30 days from when they receive documentation to make an initial loan modification decision.

For the purposes of a modification, a borrower's financial information is valid for at least 120 days "unless there is a material change in circumstance."

If a borrower is denied for a modification through the government's Home Affordable Modification Program, servicers then have 15 days to determine if the borrower is eligible for a proprietary modification. If a borrower is denied a request for loss mitigation, the servicer must notify the borrower within 10 days of the decision.

Short Sales
The draft agreement says servicers will consider "appropriate monetary incentives" to troubled borrowers to support short selling.

Servicers will have just 30 days after receiving required information for a short sale to make a decision about the sale and provide written notice. "If the short sale request is denied, servicer shall provide reasons for the denial in the written notice," the term sheet says.

Servicing Fees
The term paper includes extensive restrictions on servicing fees. Any fee assessed on a borrower for a default or foreclosure-related action must be "bona fide," and properly disclosed, according to the draft agreement. During a trial modification, or while a modification is under consideration, no such fees shall be assessed.

Servicers are required to make available on its Web site and to the borrower a detailed schedule of fees.

Servicers can only collect fees that are "for reasonable and necessary services actually rendered." Generally speaking, fees should be allowed by law and disclosed in a loan instrument.

The agreement also limits late fees, including that no late fee may be imposed during a trial modification, even if the payments during the trial period are less than full payment amounts would have been.

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