WASHINGTON — House Financial Services Committee Chairman Barney Frank is moving forward on legislation designed to encourage servicers to renegotiate more mortgages by shielding them from investor lawsuits.
A draft bill by the Massachusetts Democrat, which was obtained by American Banker, aims to protect servicers that provide modifications to borrowers who are delinquent or on the verge of it when doing so would be more profitable to the collective group of investors than foreclosure.
The approach generally clarifies that servicers of pooled mortgages are responsible to the interest of the collective group of investors as a whole, and it would credit servicers as respecting that obligation — thus protecting them from liability — under certain conditions.
Specifically, the draft bill would protect a servicer that "accepts a short payment for the property, agrees to a short sale of the property, or agrees to or implements a modification or workout plan for residential mortgage loans, if the servicer reasonably believes it will realize a net present value greater than it would realize through foreclosure."
Though other permissible loan solutions would also be protected, the draft bill gives deference to workouts with particular features by establishing a safe harbor.
The clear liability protection would apply to loan modifications or workout plans that remain in place for at least five years, or until the borrower sells or refinances the property; avoid negative amortization; and do not require the borrower to pay additional points and fees.
The concept of providing liability protection for loan restructurings to spur industry-driven foreclosure prevention efforts was first raised last fall by Rep. Mike Castle during a committee vote on mortgage reform legislation.
The Delaware Republican later offered a separate bill, which was considered at a committee hearing in December. Federal regulators said then that such protection was unnecessary and could even set a dangerous precedent by breaking contracts, though Federal Deposit Insurance Corp. Chairman Sheila Bair said Congress could codify servicing agreements to provide peace of mind to investors.
Industry representatives also gave the original bill mixed reviews, acknowledging servicers are wary of investor lawsuits but cautioning that providing the safe harbor also could destabilize an already shaky securitization market.
"While we appreciate and support the need for clarity and legal certainty for servicers in effecting loan modifications, we have concerns" about the bill "as introduced," George Miller, the executive director of American Securitization Forum, said in written testimony at the time.
"As a general matter," Mr. Miller wrote, "we have concerns with any legislation that would abrogate or interfere with previously established, private contractual obligations. … Changing this standard would alter the commercial expectations of investors and could undermine the confidence of investors in the sanctity of agreements which are central to the process of securitization."
But Rep. Frank said in an interview last month that servicers continued to complain that the potential for legal risk was a hurdle to voluntary loan modification efforts such as those initiated by the Hope Now alliance, and he directed his staff to improve upon Rep. Castle's bill.
The bills have roughly the same framework but place different time frames on the protection for modifications. Rep. Frank's approach would apply liability protection to workouts initiated before January 2011. The Castle bill would cover loans originated since January 2004, with a sunset on the provision six months after enactment. Rep. Frank's version also provides the safe harbor for workouts in more general terms; the Castle bill is tied the protection to workouts that hit certain interest rate ranges.
Rep. Frank's bill could be swept into a broader housing rescue package he plans to introduce before Congress adjourns for its Easter vacation.
That package is expected to call for $15 billion of government assistance to refinance distressed mortgages through the Federal Housing Administration and $20 billion to provide assistance to states and localities to repurchase foreclosed properties.
