[Senate Hearing 112-139]
[From the U.S. Government Publishing Office]
S. Hrg. 112-139
THE NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS
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HEARING
before the
SUBCOMMITTEE ON
HOUSING, TRANSPORTATION, AND COMMUNITY DEVELOPMENT
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING THE IMPORTANT NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS
__________
MAY 12, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
_____
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70-857 PDF WASHINGTON : 2011
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Dawn Ratliff, Chief Clerk
Brett Hewitt, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Housing, Transportation, and Community Development
ROBERT MENENDEZ, New Jersey, Chairman
JIM DeMINT, South Carolina, Ranking Republican Member
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii PATRICK J. TOOMEY, Pennsylvania
SHERROD BROWN, Ohio MARK KIRK, Illinois
JON TESTER, Montana JERRY MORAN, Kansas
HERB KOHL, Wisconsin ROGER F. WICKER, Mississippi
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Michael Passante, Subcommittee Staff Director
(ii)
C O N T E N T S
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THURSDAY, MAY 12, 2011
Page
Opening statement of Chairman Menendez........................... 1
WITNESSES
A. Nicole Clowers, Acting Director, Financial Markets and
Community Investment, Government Accountability Office......... 2
Prepared statement........................................... 26
Diane E. Thompson, of Counsel, National Consumer Law Center...... 6
Prepared statement........................................... 42
Responses to written questions of:
Chairman Menendez........................................ 185
Laurie F. Goodman, Senior Managing Director, Amherst Securities.. 8
Prepared statement........................................... 122
Responses to written questions of:
Chairman Menendez........................................ 186
David H. Stevens, President and Chief Executive Officer, Mortgage
Bankers Association............................................ 10
Prepared statement........................................... 129
Responses to written questions of:
Chairman Menendez........................................ 187
Anthony B. Sanders, Professor of Finance, George Mason University
School of Management........................................... 14
Prepared statement........................................... 172
Responses to written questions of:
Chairman Menendez........................................ 188
Richard A. Harpootlian, Attorney, Richard A. Harpootlian P.A..... 15
Prepared statement........................................... 175
(iii)
THE NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS
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THURSDAY, MAY 12, 2011
U.S. Senate,
Subcommittee on Housing, Transportation, and
Community Development,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 2:12 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Robert Menendez, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN ROBERT MENENDEZ
Chairman Menendez. Good afternoon. This hearing will come
to order, the hearing of the Banking Subcommittee on Housing,
Transportation, and Community Development. This is the first
Subcommittee hearing that I have called as Chairman in the
112th Congress, and for this hearing I have chosen to focus on
the need for national mortgage servicing standards, which
speaks to just how important I believe this subject is not only
for homeowners and mortgage investors, but for the entire
lending industry.
It is of particular concern to the countless New Jersey
homeowners who have contacted my office, almost all with
terrible stories about their experience going through
foreclosure, and many with stories of being either mistreated
or neglected by mortgage servicers. The typical problems they
encounter are servicers losing their paperwork, not
understanding what already happened the last time they called
since they get a different person each time they call, asking
them to reapply for modifications numerous times with new
documentation each time, a lack of transparency as to whether
their modification requests are being calculated properly,
ineffective appeals, excessive delays in coming to decisions,
and a general reluctance by servicers to modify loans in ways
that would be sustainable in the long run. And we are going to
hear from some witnesses as to why that might very well be the
case. Overall, the current process is both emotionally draining
and ineffective in keeping people in their homes.
Closely related to homeowner concerns are mortgage investor
concerns about the conflicts of interest that many mortgage
servicers face when deciding whether to foreclose or modify a
loan. In response to all of these concerns, numerous
commentators have suggested that national mortgage servicing
standards may be a way to provide consistency, accountability,
and better homeowner and mortgage investor protections.
There seems to be an increasing consensus that at least
some kind of national mortgage servicing standards are
warranted, and I believe that if they are done in the right
way, they can actually make mortgage servicers' jobs easier as
well.
This is also a timely topic because Federal banking
regulators, including the OCC, the Federal Reserve, FDIC, and
OTS, recently issued consent orders as enforcement actions
against some of the largest banks to require changes in their
mortgage servicing practices. These actions take a step in the
direction of developing national mortgage servicing standards,
but they are also too little and too late.
The independent Government Accountability Office, the GAO,
has also released a report recently that speaks to the need for
national servicing standards related to foreclosures. There
have also been numerous bills introduced in Congress requiring
various kinds of national mortgage servicing standards. So I
have convened this hearing to solicit the views of various
experts and market participants. I have asked them to comment
on whether they believe national mortgage servicing standards
are needed and what exactly should be in those standards, and I
want to thank all of the witnesses in advance for their
testimony here today.
I want to apologize. We were a few minutes late in starting
because we have a vote that is taking place on the floor. I
know Senator Merkley, who is very involved in these issues, has
voted and is on his way here, and so if he wishes to, when he
gets here I will recognize him. But in the interest of moving
our process ahead here, let me start off with our first witness
on this first panel, Nicole Clowers. She is the Acting Director
of Financial Markets and Community Investment, Government
Accountability Office. She has testified here before, and she
is the lead author of a GAO study that Senator Franken and I
requested and that just came out last week on the Federal
banking regulators' response to the so-called robo-signing,
which is the illegal rubber-stamping of foreclosures by
mortgage servicers in court documents.
So, Ms. Clowers, thank you for your work. Thank you for
being here for testimony. I would ask you to summarize your
testimony in about 5 minutes or so. We are going to include
your full testimony in the record, and with that, I would like
to recognize you to start off.
STATEMENT OF A. NICOLE CLOWERS, ACTING DIRECTOR, FINANCIAL
MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY
OFFICE
Ms. Clowers. Thank you, Chairman. Thank you for having me
here today to talk about our recent work on mortgage servicing
issues.
As you know, last fall a number of servicers announced that
they were halting or reviewing their foreclosure practices
after allegations that foreclosure documents may have been
improperly signed or notarized. While the servicers resumed
their foreclosure activities after completing their reviews,
concerns about servicing practices and the impact of reported
problems remain. In light of these concerns, you and several
others asked us to review Federal oversight of the servicing
industry.
We issued our report last week and concluded that the
documentation problems revealed the need for ongoing oversight
of servicers. Although Federal regulators have taken steps in
recent months to increase their focus on servicing issues, the
resulting delays in completing foreclosures and increased
exposure to litigation highlight how the failure to oversee
whether institutions follow sound practices can heighten the
risk these entities present to the financial system and create
problems for the communities in which foreclosures occur.
As a result, we recommended that the banking regulators
take various actions, including: one, developing and
coordinating plans for ongoing oversight of the servicing
industry; two, ensuring that foreclosure practices are included
as part of any national servicing standards that are developed.
In my comments today, I will discuss each of these
recommendations in more detail.
First, we recommended that the banking regulators and the
new Bureau of Consumer Financial Protection work together to
develop and coordinate oversight plans. Until the problems
regarding foreclosure documentation came to light, Federal
oversight of the servicing industry had been limited, in part
because regulators viewed such activities as low risk to safety
and soundness. Furthermore, past Federal oversight was
fragmented and not all servicers were overseen by Federal
banking regulators.
In response to reported foreclosure documentation problems,
banking regulators conducted a review of foreclosure processes
at 14 servicers. This review found that servicers had generally
failed to properly prepare documentation and lacked effective
supervision and controls over their foreclosure processes.
Examiners also identified a limited number of cases in which
foreclosures should not have proceeded, even though the
homeowner was seriously delinquent, including cases where
foreclosures proceeded against military servicemembers on
active duty in violation of the Servicemembers Civil Relief
Act.
Banking regulators plan to follow up with servicers to
better ensure that they implement agreed-upon corrective
actions, and the new Bureau also plans to conduct oversight of
servicing activities. However, the extent to which the
regulators will conduct ongoing supervision of servicing
activities in the future as well as the goals for the
supervision and the roles that each regulator will play have
not been fully determined. Until these plans are developed, the
potential for continuing fragmentation and gaps in oversight
remain.
Second, we recommended that the banking regulators and the
Bureau of Consumer Financial Protection take steps to include
foreclosure practices in any national servicing standards that
are developed. To help address the identified problems and
concerns with servicing activities, various market
participants, as you noted, Chairman, have begun calling for
the creation of national servicing standards, and most of the
regulators have stated that national servicing standards could
be beneficial. Regulators and others cite a number of potential
benefits of implementing standards, including creating clear
expectations for all servicers, establishing consistency across
the servicing industry, increasing transparency of servicing
practices, and promoting accountability in dealing with
consumers. Regulators have established an interagency process
to consider these issues in developing national servicing
standards.
While servicing standards could cover a wide range of
activities, it is unclear the extent to which they would
address the identified weaknesses and lack of consistency among
servicer foreclosure practices and how the standards would be
implemented. If national servicing standards are developed,
ensuring that they provide clear expectations for servicers to
follow as part of the foreclosure process could be a way to
improve consistency in the servicing industry. Consistent
expectations for the foreclosure process could also help
address the limited oversight of the servicing industry that we
have seen in the past.
In conclusion, regulators have recently increased their
oversight of the servicing industry, but additional actions are
warranted. We made several recommendations to the regulators to
help strengthen the oversight of this industry. The regulators
generally agreed with our recommendations, and some are taking
steps to implement them. We look forward to working with the
regulators and this Subcommittee to ensure these
recommendations are fully implemented.
Mr. Chairman, this concludes my prepared statement. I would
be happy to answer any questions you may have.
Chairman Menendez. Well, thank you very much, and you are
so effective. You had 5 seconds left.
[Laughter.]
Chairman Menendez. Let me ask you just a couple of
questions. One is you reported that past Federal oversight was
limited and fragmented. So if we were to have national
servicing standards, would that help address this problem?
Ms. Clowers. It could help address the limited and
fragmented oversight that we saw. In terms of addressing the
fragmentation, the servicing standards could help increase
consistency in both the treatment of the borrower as well as
increase consistency in regulator oversight of the servicers.
It could also increase the attention that the regulators give
to the servicing process and the servicing industry and,
therefore, help address the limited oversight that we saw.
Chairman Menendez. And if we were to have national
servicing standards, what should be included in them?
Ms. Clowers. The servicing standards could cover a wide
range of activities, from loss mitigation to the compensation
model for servicers. We did not evaluate all the potential
elements. Rather we found that if servicing standards were
developed, the foreclosure process should be included. OCC has
developed a set of potential standards that I think could be
used as a starting point in considering what type of
foreclosure processes to include. The enforcement orders that
were recently issued by the regulators also contained elements
such as a single point of contract that could be another
starting point as the stakeholders work to develop the
standards.
I would also note that in 2009 we issued a report outlining
principles for financial regulatory reform, and I think these
principles could be useful in the context of developing
servicing standards as they relate to the foreclosure process,
including making sure that the goals that we set are clear and
not conflicting, making sure that all parties are treated
consistently, considering the regulatory burden placed on the
industry versus increasing oversight, as well as ensuring that
they are flexible and forward looking so that we are not
necessarily fighting the last fight.
Chairman Menendez. Finally, the banking regulators just
recently issued a report themselves with reference to their
review of servicers' practices, and I wonder if you have had an
opportunity to review that and some of their findings.
Ms. Clowers. I have. The regulators found significant
weaknesses in the foreclosure practices of the 14 servicers
they reviewed. The weaknesses fall into three general
categories.
There were weaknesses with the documentation process, which
would include such things as the person signing the affidavit
not having the personal knowledge of the facts and
circumstances of the loan as required by law.
There were also weaknesses with regard to vendor management
in that the servicers were not providing sufficient oversight
and due diligence in their oversight of the vendors that they
use, such as the law firms.
And, finally, there were a number of weaknesses in what
would be categorized as governance issues, and this ranged from
a lack of documented written policies, lack of staffing
capacity, lack of training, and a lack of controls and quality
checks to make sure that documentation errors did not occur.
Chairman Menendez. Good. Let me thank you for your work and
your testimony. We may have colleagues who are going to ask
questions in writing in the next couple days, so we appreciate
your responses to those.
Ms. Clowers. Absolutely.
Chairman Menendez. And thank you for coming before the
Committee.
Ms. Clowers. Thank you.
Chairman Menendez. Let me introduce the second panel as we
excuse Ms. Clowers and ask them to come up and we will dictate
the order here as we introduce them.
Diane Thompson is Of Counsel at the National Consumer Law
Center and has represented low-income homeowners since 1994,
and she has testified here before on foreclosure-related
issues, so welcome back. Diane, please come on up.
Laurie Goodman is a senior managing director at Amherst
Securities where she is responsible for research and business
development. Before joining Amherst, she was the head of global
fixed income research and manager of U.S. Securitized Products
Research at UBS, and she is one of the most well respected
mortgage investor analysts in the country, so we welcome her.
David Stevens is president and CEO of the Mortgage Bankers
Association, and he just assumed that role. I think this may be
his first hearing, so, David, welcome. Members of the Committee
may recognize Mr. Stevens from his previous role only a few
months ago as the head of the Federal Housing Administration at
HUD. He has had a long and distinguished career in the public
and private sectors.
Anthony Sanders is a professor of finance at George Mason
University School of Management. He has written extensively
about real estate finance and securitization. Thank you,
Professor. And I am told he is from Rumson, New Jersey, so you
can have all the time you want.
[Laughter.]
Chairman Menendez. All politics is local. Welcome.
And Richard Harpootlian is a distinguished attorney who has
tried cases in South Carolina for over three decades, and he
currently represents thousands of military members, many of
whom were illegally foreclosed on or overcharged in a class
action lawsuit, and so we welcome you and your insights in that
respect as well.
So thank you all for coming before the Committee. We would
ask you to limit your oral testimony to about 5 minutes. Your
entire written testimony will be included in the record, and
this way we will have some opportunities for some Q&A with you.
With that, Ms. Thompson, would you begin?
STATEMENT OF DIANE E. THOMPSON, OF COUNSEL, NATIONAL CONSUMER
LAW CENTER
Ms. Thompson. Thank you, Chairman Menendez.
Chairman Menendez. You want to put your microphone on.
Ms. Thompson. Thank you.
Chairman Menendez. We want to hear you.
Ms. Thompson. Thank you for inviting me to testify today. I
am an attorney, currently of counsel to the National Consumer
Law Center. In my work at NCLC, I provide training and support
to hundreds of attorneys representing homeowners from all
across the country. For nearly 13 years before that, I
represented low-income homeowners East St. Louis, Illinois. I
testify here today on behalf of the National Consumer Law
Center's low-income clients and the National Association of
Consumer Advocates.
The time for national mortgage servicing standards has
come. We have tried reliance on servicers' good faith and
competent execution. Servicers' good-faith efforts 4 years into
this Nation's most devastating foreclosure crisis have failed
to produce results. Serious delinquencies continue to outpace
modifications by nearly five to one. Homeowners wait on average
14 months for approval of a permanent HAMP modification and
often face wrongful foreclosure even after entering into a
permanent modification. The loan modification process is
dysfunctional in the extreme.
For example, high-level Bank of America employees recently
promised a California homeowner that they would honor a
modification they had granted the homeowner and cancel a
pending sale. And yet the foreclosure sale went forward.
Despite repeated orders from a New York State court judge
tolling interest on the loan for over 14 months percentage
Chase's participation in court-supervised mediation, Chase has
still not complied with its undertakings in that process.
Litton denied a North Carolina homeowner for failure to
provide documentation, after sending all requests for
additional documentation to an address that corresponded to
neither the homeowner's nor her attorney's.
Chase foreclosed on a Washington State homeowner who was
making payments and, then when she called after receiving the
eviction notice in connection with the foreclosure, denied that
it had foreclosed. That woman and her family are now living in
an apartment and are no longer homeowners.
Loan modifications make economic sense, but servicers
nonetheless deny modifications because they, the servicers, can
do better financially by foreclosing than providing permanent
sustainable modifications and because there are no consequences
to servicers for failing to provide the modifications.
The lack of restraint on servicer abuses has created a
moral hazard juggernaut that at best prolongs and deepens the
current foreclosure crisis and at worst threatens our global
economic security. State regulators have attempted to rein in
these abuses, but servicers have often sought protective
shelter in the preemption rulings issued by the Office of the
Comptroller of the Currency. Recent consent orders announced by
the Federal banking agencies are of limited reach and threaten
to undermine the combined and unprecedented efforts of the
Department of Justice and the Attorneys General of all 50
States.
The GSEs--Fannie Mae and Freddie Mac--and their oversight
agency, the Federal Housing Finance Authority--have failed to
prioritize loan modifications over foreclosure. Even new
guidance from the FHFA fails to end dual track--the practice of
proceeding with a foreclosure and a loan modification at the
same time.
The dual-track process must be ended. Key to any national
servicing standards is the evaluation of a homeowner for a loan
modification prior to the initiation of a foreclosure.
Homeowners must be evaluated for and, when appropriate, offered
a loan modification before a foreclosure. Once a foreclosure is
started, it takes on a life of its own. Fees mount up and legal
deadlines must be met. A modification becomes increasingly out
of reach and accidents happen. Initiating foreclosure before
completing the loan modification review guarantees wrongful
foreclosures.
Failing to stop an existing foreclosure proceeding while a
modification review is underway has the same costs, the same
risks, and the same results--families turned out on the street
while awaiting a review on their application or even while
making payments on a modification.
In order to prevent wrongful foreclosures, reduce costs for
both homeowners and investors, and encourage the timely
evaluation of loan modification applications, the dual-track
system must be stopped, and stopped absolutely. Recent bills
introduced by Senator Reed, Senator Brown of Ohio, and today's
bill introduced by Senator Merkley take this and other
important steps.
To promote responsible servicing that serves the interests
of both homeowners and investors, principal reductions must be
mandated, fees limited, transparency provided throughout the
modification process, including the calculation of the net
present value. Servicers should be prevented from foreclosing
if they have not complied with these baseline servicing
standards.
We are at a watershed moment. To date, we have imposed no
restraints on servicers' excesses. The existing proposals for
servicing reform from the banking agencies and the FHFA would
leave the existing dysfunctional system intact. We can do
better. In my written testimony, I detail the reforms needed.
We must hold mortgage servicers accountable to the
stakeholders, homeowners, investors, and the American public.
I thank you for the opportunity to testify today, and I am
happy to answer any questions you may have.
Chairman Menendez. Thank you, Ms. Thompson.
I want to interrupt the panel for a moment and ask my
colleague--I know he is under time constraints--whether he
wishes to make any statement or let the rest of the witnesses
go, and I would be happy to yield to you first for questioning.
It depends on your time constraints.
Senator Merkley. I simply deeply appreciate the folks who
have come to testify on such an important issue to the health
of our families and the health of our economy, and I would like
to have them continue. Thank you.
Chairman Menendez. Thank you.
Ms. Goodman.
STATEMENT OF LAURIE F. GOODMAN, SENIOR MANAGING DIRECTOR,
AMHERST SECURITIES
Ms. Goodman. Mr. Chairman and Members of the Subcommittee,
I am honored to testify today. My name is Laurie Goodman, and I
am a senior managing director at Amherst Securities Group, a
leading broker/dealer specializing in the trading of
residential mortgage-backed securities. I am in charge of the
strategy and business development efforts for the firm.
The purpose of my testimony is to discuss conflicts of
interest facing mortgage servicers that may stop them from
acting in the best interests of mortgage investors and
homeowners. Let me begin by pointing out that the interests of
mortgage investors and homeowners are largely aligned for two
reasons.
First, the mortgage market is reliant on investors to
continue to extend credit, allowing borrowers to achieve
competitive mortgage rates.
Second, foreclosure is, without question, the worst outcome
for both investors and borrowers. It is a long and drawn-out
process in which a borrower is forced from his home, and an
investor typically suffers a loss on his investment of between
50 and 80 percent of the loan amount.
Here are the five inherent conflicts that we see.
Conflict number one, large first-lien servicers have
significant ownership interests in second liens and often have
no ownership interest in the corresponding first lien. The four
largest banks--Bank of America, Wells Fargo, JPMorgan Chase,
and Citigroup--collectively service 54 percent of the 1-4
family servicing in the United States. They own approximately
40 percent of the second liens and home equity lines of credit
outstanding. This is a conflict because the servicer has a
financial incentive to service the first lien to the benefit of
the second lien holder. Some examples:
Short sales and deeds in lieu are less likely to be
approved. If the servicer accepts a short sale offer, the
second lien, which is held on the balance sheet of the
financial institution, must be written off immediately. As a
result, the servicer may be more inclined to reject the short
sale offer, even if the offer makes sense for the investor and
borrower. In addition, loan modification efforts are
suboptimal. Principal reduction is used far less often than it
should be. National servicing standards should require
servicers to perform the modification to maximize the net
present value of the loss mitigation options.
Conflict two, the servicer often owns a share in companies
that provide ancillary services during the foreclosure process
and charges above market rates. These services included force-
placed insurance and property preservation. Even when a
servicer is not affiliated with the company providing the
service, they often mark up the fees considerably. These fees
are added to the delinquent amount of the loan, making it much
harder for a borrower to become current. Moreover, when a loan
is liquidated, the severity on the loan will be much higher, to
the detriment of investors.
National servicing standards can be used to require
servicers to keep existing homeowners insurance policies in
place as long as possible. There should be a prohibition on
marking up third-party fees. Moreover, following the lead of
the proposed Attorney General settlement, national servicing
standards should prohibit a servicer from owning an interest in
an entity that provides foreclosure-related services.
Conflict three, conflicts of interest in the enforcement of
representations and warranties are becoming an increasing issue
for the market, as indicated by recent litigation. Once a ``rep
and warrant'' violation is discovered, the trustee is charged
with the enforcement. However, the trustee does not have the
information to detect the violations as they do not have direct
access to the loan files. Servicers who do have the information
to identify ``rep and warrant'' violations often have a
financial disincentive to do so as they would be putting the
loan back to an affiliated entity.
It is critical to have an independent third party that is
incented to enforce reps and warrants and has both access to
the information and enforcement authority. This must be
achieved through the deal documents. National servicing
standards should, however, direct servicers to make sure that
there is an adequate enforcement mechanism for reps and
warrants.
Conflict four, the servicing fee structure is unsuitable to
this environment. There are many situations in which
transferring the servicing of a loan on which the borrower is
delinquent to a servicer that specializes in loss mitigation
would be the best outcome for both borrowers and investors. A
number of special servicers have had considerable experience
tailoring modifications to the needs of individual borrowers
and tend to provide more hand holding to the borrower post
modification than what a major servicer can offer. Servicing
transfer issues are made very difficult as servicers are
compensated too highly for servicing current loans, not highly
enough for servicing delinquent loans. If fees for servicing
current loans were lowered while fees for servicing delinquent
loans were raised, it would allow the special servicer to be
adequately compensated for his high-touch efforts. This, in
turn, would make it much easier to transfer delinquent loans to
servicers who would do a better job of loss mitigation.
Conflict number five, transparency for investors is
woefully inadequate. In a private label securitization, there
is often a large difference between the monthly cash payment
the investor expected to receive and what is actually received.
Moreover, an investor is unable to delve into the cash-flow
information further as transparency on the action of the
servicer that would be necessary to reconcile the cash-flows is
not available. When I receive the statement from my bank each
month, I balance my checkbook, reconciling the differences.
Investors want to be able to do exactly this with the cash-
flows from the securitizations in which they have an interest.
They are unable to. We believe the remittance reports for
future securitizations should contain loan-by-loan information,
and that loan-by-loan information should be rolled up into a
plain English reconciliation. National servicing standards
should encourage this transparency.
In conclusion, national servicing standards can go a long
way toward dealing with the conflicts of interest between
servicers on the one hand and borrowers and investors on the
other.
We appreciate the opportunity to testify on this important
set of issues. Thank you.
Chairman Menendez. Thank you.
Mr. Stevens.
STATEMENT OF DAVID H. STEVENS, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, MORTGAGE BANKERS ASSOCIATION
Mr. Stevens. Thank you, Mr. Chairman, for the opportunity
to testify here on the need for national mortgage servicing
standards. On May 1st, I began my tenure as president and CEO
of the Mortgage Bankers Association, and most recently I served
as Assistant Secretary for Housing and the Federal Housing
Commissioner. I have also been actively involved in this
industry for three decades.
In 2008, we faced the perfect storm. As the global economy
collapsed, the subprime market imploded. Many Americans lost
their jobs. Millions of Americans defaulted on their mortgages,
putting extraordinary strains on the existing servicing system.
It is clear that our industry was unprepared to handle these
unprecedented events and that we made mistakes. Acknowledging
our mistakes is the first step to rebuild trust in industry and
our actions. Without trust, the industry is nothing, and by
trust, I mean the ability of policy makers, thought leaders,
borrowers, and the industry at large to have faith in the
products and services that we provide, and we absolutely have
to do better moving forward.
I can assure you that the mortgage finance industry and
servicers in particular have not stood still in addressing the
mistakes. Many have put in place training, internal controls,
independent third-party auditors, adding thousands of people
and improved technology needed to move forward. Presently,
servicers face a growing number of checks and balances ranging
from Federal laws and regulations, RESPA and TILA, to 50 State
laws, regulations that vary, local ordinances, as well as court
rulings, FHA, VA, Rural Housing Service requirements, et
cetera. These requirements are in addition to Fannie Mae
standards, Freddie Mac standards, and other contractual
obligations. In short, servicers are faced with complex, often
contradictory rules and regulations, many of which are
emergent.
So what is the answer? A consolidated servicing standard
could drive these reforms. Creating a servicing standard would
streamline and eliminate many of the overlapping requirements,
provide clarity and certainty for borrowers, lenders, and
investors alike. It is critical that all of the Federal
regulators involved act in a coordinated manner to establish
one national consolidated servicing standard that applies to
the entire industry rather than piling on requirement after
requirement. A national standard should start with a complete
analysis of existing servicer requirements and State laws
governing foreclosures. Developments should include an open
dialog with stakeholders in the servicing arena, all of whom
must ultimately implement and comply with the national
standard.
The MBA has initiated this process by convening a blue
ribbon Council on Residential Mortgage Servicing. The council
examined the entire servicing model and is forming
recommendations to improve the system for all stakeholders.
I am pleased to announce that today we actually rolled out
a white paper, which I believe is the first white paper on the
subject, and ask that it be included as part of my testimony.
In the white paper, the council aims to examine the
current servicing model, address public misconceptions relating
to servicing practices and incentives, and educate the public
on the role and compensation of servicers. I believe this white
paper will provide useful information to you and other policy
makers that are currently debating the national servicing
standards, and I encourage the Subcommittee to use the MBA and
its Council on Residential Mortgage Servicing as a resource
going forward.
In conclusion, as we develop servicing standards, I will
urge you to pay careful attention to the interdependence of
servicing and the impact that change to the servicing system
will have on the economics of mortgage servicing, tax and
accounting rules and regulations, and effects of the new
requirements on Basel capital requirements and on the TBA
market. Servicing does not exist in a vacuum. Instead, it is
part of a broader ecosystem which involves all the varied
elements of the mortgage industry. The housing market remains
very fragile and, therefore, when considering changes to the
current model, policy makers we ask be mindful of unforeseen
and unintended consequences that could ultimately result in
higher housing costs for consumers and reduced access to
credit.
As I mentioned at the beginning of my remarks, I have spent
more than three decades in this industry. Despite what we have
just lived through and the challenges we continue to face, I am
optimistic we can successfully address the challenges of the
mortgage servicing system going forward. And, Mr. Chairman, MBA
supports reasonable, rational national servicing standards that
apply best practices to the process to better serve the needs
of borrowers, servicers, and investors alike. We want to be
part of the solution and look forward to working with you and
other policy makers toward that end.
Thank you.
Chairman Menendez. Well, thank you, Mr. Stevens. Thank you
for the spirit in which the association comes here.
I want to accommodate Senator Merkley, who has been very
involved in these issues, so to our final two witnesses, if you
would just forbear with us a moment or a few minutes and
recognize Senator Merkley, who has some questions of the panel
at this time.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you for holding this hearing, because I think this issue of the
complexity of the mortgage markets and the role servicers play
within the set of parties is an extremely important one to
figure out.
And, Mr. Stevens, thank you for your work at the FHA. I
appreciate the spirit that you bring to trying to address some
of these key complexities.
Ms. Goodman, I wanted to ask you one question about the
conflicts of interest, and that is you put forward--one of your
concepts was to increase the fees for dysfunctional mortgages
and decrease the fees for servicing current mortgages, and one
concern I have had about that is it creates perhaps--well, let
me explain that I have had many Oregonians tell me that the
first time they missed a payment was after they had talked to
their servicer about the change in their financial
circumstances and the servicer said to them, well, what you do
is you are eligible for a mortgage modification, and so--but
first, you have to--you cannot be current, so you need to miss
three payments or make half-payments for 3 months.
One of the issues that has come up as to whether there was
kind of a perverse incentive in the servicer structure in which
they were getting paid more for loans that were not current
versus loans that were current, and to put salt into the wound,
the same families then report that after they missed those
payments, they were often told, because you are not current,
you are not a good credit risk for a mortgage modification.
This is kind of a hellish nightmare position to be in, and your
recommendation about accentuating the difference between those
fees, could that make this problem worse?
Ms. Goodman. I would be very careful about how I would do
it. I agree that that is definitely a moral hazard issue, and
what I actually suggested in my written testimony is there is a
very simple solution to this. Give the GSEs or private label
investors the ability to move the servicing when the higher
fees are scheduled to take effect.
So what that does is I am servicing a current loan. That
loan goes delinquent. If I do not make that proactive phone
call to keep that loan from going delinquent, I stand a chance
of losing that servicing when the higher fee takes effect. You
have to have something like that in there in order to eliminate
the moral hazard.
Senator Merkley. Yes, eliminate that conflict of interest.
Thank you. That is helpful.
And, Mr. Stevens, one of the ideas that Ms. Goodman put
forward was to try to reduce or eliminate the conflict of
interest, where the servicer who may have originated the loan
still holds the second mortgage, but no longer the first
because the first has been sold. It creates distinctions
between operating on behalf of the trust that holds the first
mortgage and the interest of the second mortgage. Do you have
any particular insights on the concepts that she put forward to
address that?
Mr. Stevens. These are all subjects I would love to engage
in a longer discussion with you, Senator, as we have in the
past on these issues. We have struggled as we work through
these foreclosure processes over the past several years with
incentives in the process, incentives on first mortgage
modifications or principal write-down or foreclosure
resolution, incentives on seconds, loans held, loans sold.
The one thing I am challenged by is does the mere act of
having someone else service the second in any way change the
outcome as to what could ultimately be write-down on the
second, and just to articulate that, whether the first lien
gets modified or protected in any way--in some form, whether
that second is held on the first lien holder's--on the same
servicer's balance sheet or another servicer's balance sheet,
both of those can cause challenges ultimately to having
anything happen to the second lien. It will ultimately depend
on how that second lien is valued.
I think, fundamentally, the thing that is absolutely clear
is when the loan goes to foreclosure, the second lien gets
wiped out in its entirety and the bank loses. So fundamentally,
there should be an incentive to have that loan perform and to
engage in some sort of modification.
I think we have communication challenges. Seconds are often
held on bank balance sheets. First mortgages are held on the
mortgage side balance sheet. But I am not certain that having
two sets of servicers in any way resolves the complexity around
the incentive structure and the ultimate resolution of that
foreclosure.
Senator Merkley. And to add to this dilemma, the servicer
of the second, even if the servicer is separate, may find the
second is fully performing when the first is not, in part
because there is a line of credit. The family may have chosen
to say, I need to keep this line of credit valid because it is
the only way to rescue myself from difficult financial bumps I
might encounter.
Mr. Stevens. That is right.
Senator Merkley. So then you are asking the servicer of the
second to essentially engage in a process in which the loan
that is current is--yes, it is messy and difficult----
Mr. Stevens. Well, and----
Senator Merkley. ----and I am glad to have you all working
on it.
Mr. Stevens. And, Senator, the only thing I would just add
as a follow-up to that, it needs to be a consideration, is many
of these second loans were set up as home equity lines of
credit, as you know. You know this very well. And many small
businesses in America basically use that as their funding
resource to operate a small business in this country. That is
just one example.
So these are solutions that, as I said in the outset, we
fully realize the mistakes and lack of preparedness that our
industry did not have at the time and the mistakes we made, but
working through these resolutions is critically important, as
well, because we need to make certain that we are not
disrupting, again, small business access or the kind of
incentive misalignment that you just referred to in terms of
the performing versus the nonperforming first.
Senator Merkley. Well, thank you all. I am sorry I have to
leave, but I think just this short conversation shows how
important this set of issues is in order to taking and
restoring a healthy mortgage market, which is essential to
working families being successful in home ownership and
rebuilding their wealth. Thank you.
Chairman Menendez. Thank you, Senator.
Dr. Sanders.
STATEMENT OF ANTHONY B. SANDERS, PROFESSOR OF FINANCE, GEORGE
MASON UNIVERSITY SCHOOL OF MANAGEMENT
Mr. Sanders. Chairman Menendez, Ranking Member DeMint, and
distinguished Members of the Subcommittee, thank you for
inviting me to testify today. I have been asked to opine on the
need for national mortgage servicing standards.
The recent crash of the housing market and the rise of
unemployment led to a historic surge in serious delinquencies
and requests for loan modifications, short sales, and related
transactions. As a result, the residential mortgage servicing
industry was overwhelmed. Going forward, it is helpful to
recommend changes to both servicing and securitization
industries so they can avoid problems going forward as we
attempt to revive the securitization market.
In December, Christopher Whalen, Nouriel Roubini, Josh
Rosner, and others, including myself, wrote a letter to the
U.S. financial regulators regarding national loan servicing
standards. Again, I am one of the signors of the letter, but
not because I wanted to have necessarily a national loan
servicing standard created by the Government. Rather, I wanted
to facilitate consideration for servicing companies on how to
proceed forward.
Many of the items that were discussed in our letter were
plausible recommendations, with a few exceptions. And one thing
I want to point out is that Fannie Mae and Freddie Mac have
their own servicing standards, which are, again, quite good and
have been the industry standard for a long time. Since Fannie
and Freddie can actually mandate servicing standards, that is a
good place to begin.
You have just heard Dave Stevens for the Mortgage Bankers
Association talking about the Blue Ribbon Committee to modify
the standards that Freddie and Fannie use for the private label
market and general mortgage servicing in general, and while it
is very tempting to have the Federal Government regulate loan
servicing, I would argue that, in fact, since Fannie, Freddie,
and the FHA basically occupy 95 percent of the space now, they
are, in fact, regulating the market for national loan servicing
anyway.
But one recommendation that the Whalen letter had that I
disagree with was risk retention by securitizers, where Dodd-
Frank requires that securitizers retain at least 5 percent of
the risk of the loans or they do not qualify as QRMs, or
qualified residential mortgages sold in the securitization
market. In theory, that retention would lead securitizers to be
more careful in loan origination, underwriting, and even
servicing process since many of the services are actually
captured by the banks. To be sure, 5 percent risk retention
would be the simplest approach to implement to improve all
these things. However, risk retention also appears to be the
least useful approach.
Once again, housing prices in Las Vegas fell 56 percent
from peak to trough. Five percent risk retention would have
been knocked out of the box within months. Therefore, that also
complicates and exaggerates, or exasperates--makes it worse.
[Laughter.]
Mr. Sanders. Sorry. My coffee machine broke this morning.
Fannie Mae and Freddie Mac along with the FHA do control a
large segment of the market, but even they have had to file
repurchase claims on some of the loans sold to them in regards
to servicing. Therefore, one thing I recommend that bypasses
both the 5 percent risk retention and also addresses what Ms.
Goodman talks about is transparency to investors and
regulators. Greater transparency would permit more accurate
pricing, better loan servicing, and reduce the asymmetric
information between securitizers, investors, regulators, and
homeowners.
There has already been a movement, as witnessed by what the
Mortgage Bankers Association is doing. But again, we have
relied heavily on the reps and warranties which served very
well to kind of back up the claims on securitized issues. But
again, just that simple tsunami of requests of loan buy-backs
and defaults, et cetera, by consumers has made that market a
little bit tough to deal with.
Therefore, I recommend in addition to greater transparency
such as loan level files and also whatever the servicing
standards are, and I think some of Ms. Goodman's ideas are very
good, I would also like to propose a securitization
certificate, which is a little change to the model, but what
that does is the certificate at origination which follows the
loan from hand to hand, including all of the relevant
information, chain of title, but would also include the
servicing guidelines so everyone is clear that purchases the
loan exactly what those guidelines are. And again, following
Freddie and Fannie, I think this would actually be a very
simple thing to do.
Thank you very much.
Chairman Menendez. Thank you, Doctor.
Mr. Harpootlian.
STATEMENT OF RICHARD A. HARPOOTLIAN, ATTORNEY, RICHARD A.
HARPOOTLIAN P.A.
Mr. Harpootlian. Mr. Chairman, thank you for allowing me to
be here today. I want to tell you, it is my honor to represent
over 6,000 service men and women who were wrongfully
overcharged or foreclosed on by Chase Bank. We resolved this
case by settlement last week and they are going to receive
payment of about $56. And Chase has stepped up to the plate and
is going to do a number of things that are going to benefit
these 6,000 service men and women and other service men and
women.
But what I think is important for this body to know is that
prior to being caught, if you will, there was no effort on the
part of Chase--and we can find seeing other financial
institutions--to monitor the accounts of these service men and
women.
Now, the Servicemen's Civil Relief Act goes back to the
1940s. The concept is fairly simple. If you are deployed and
fighting in a foxhole in Afghanistan, you should not have to
worry about the bank taking your house because you cannot keep
up with the financial affairs at home. Likewise, the Act
requires that the mortgage interest rate be no more than 6
percent during that period of time to alleviate some of the
financial burden on these men and women in uniform.
What we find is, again, a dysfunctional system. There is no
way, no method by which the Pentagon or any of the Department
of Defense informs banks when someone is deployed. There is no
method other than going to a Web site for the bank to know
before they foreclose that someone is deployed. Everything is
put on that servicemember to send their orders to the bank, and
we found in most instances those got lost somewhere.
The most important thing to understand is this process
affects the quality of defense, the quality of effort we get
from our men and women in the field. I talked to hundreds of
service men and women, some of whom had SCRA protection, many
of whom did not, that are worried about the financial welfare
of their family while they ought to be worrying about bullets
coming in and shells coming in. And this is a national
disgrace. It is a national disgrace because these men and women
are putting their lives on the line for us. Even the ones that
are not deployed are performing a valuable defense effort and
function.
So in my prepared remarks, I have outlined a couple of
things I think that are important that ought to be enacted. A
much more streamlined way of financial institutions knowing who
is deployed, who is not deployed. But more importantly, the
military itself ought to have resources available. JAG officers
do a great job, but they are not tasked, if you will, with
ensuring that the men and women in uniform understand what
their rights are under the SCRA and they are protected against
harassment and, I mean, the main plaintiff in this case got
100--his wife and he got 140 collection phone calls from the
bank while he was deployed while she was 8 months pregnant and
while he is flying an airplane in combat. That is wrong and we
need to stop that.
The last thing I would say, which may have applicability to
what the other speakers said here, is things have gotten so bad
in South Carolina that our Chief Justice has enjoined mortgage
foreclosures--all mortgage foreclosures--and I put in my
remarks, unless and until a financial institution certifies
certain things, and all of those things are--I will briefly
summarize them. One, that the mortgagor has been served with
notice of the mortgagor's right to foreclosure intervention by
means of loan modification or other means of loss mitigation;
that the mortgagor has been given an opportunity to do that;
that they have had a full and fair opportunity to submit
information or data to the mortgagee; that after completion of
foreclosure intervention process, the mortgagor does not
qualify and why; and that the notice of the denial of loan
modification or other means of loss mitigation has been served
on the mortgagor by mailing and there has been a 30-day period
after that mailing before they can begin foreclosure.
This is not a model, but it certainly shows that, at least
on a State level, our Chief Justice has said this thing is a
mess and too many people are not being given the opportunity to
try to modify their loans.
Most of the people I talk to in uniform could work some
sort of modification out if the financial institutions allowed
them to do so. What we have heard here today about beginning
this process, being told, well, you should miss--you know, we
cannot help you unless you miss two or three payments, I heard
that over and over again.
Thank you for the opportunity to be here today.
Senator Merkley. Thank you. Thank you all.
Mr. Stevens, without objection, your white paper is
included in the record as part of your testimony.
Let me ask all of you, do all the witnesses here agree that
some national mortgage servicing standards would be helpful?
Ms. Thompson. Yes.
Ms. Goodman. Yes.
Mr. Sanders. Yes.
Mr. Stevens. Yes.
Chairman Menendez. OK. Now, in that respect, I want to ask
you, if you had to name just three specific national mortgage
servicing standards that you believe would be most helpful in
your area of expertise, what would those be and exactly how
would they be helpful? Ms. Thompson?
Ms. Thompson. End dual track, both for loans that are in
foreclosure and for loans that are not yet in foreclosure. Dual
track must be ended, absolutely.
The other large recommendation that has many sort of
subparts is that you have got to create transparency in the
entire process, so that includes dealing with tracking systems.
It includes making available publicly the net present value
test and holding servicers to account to actually make the net
present value test.
And the third critical point is that you have to have
enforceability of all these--of everything you do, there has to
be enforceability, and one of the things that that means is
that homeowners have got to be able to raise violations of the
servicing standards as a defense to foreclosure, because if
homeowners cannot raise violations as a defense to foreclosure,
there is really, in the end, not much to stop servicers from
conducting business as usual.
Chairman Menendez. Ms. Goodman.
Ms. Goodman. My number one is that national servicing
standards should require servicers to perform the modification
to maximize the net present value of the lost mitigation
options, and regardless of the conflicts of interest that
entails for the servicers.
Second would be addressing the fact that the servicer also
provides ancillary services during the foreclosure period and
prohibiting a servicer from owning an interest in an entity
that provides foreclosure-related services.
And my third would be better disclosure. That is, better
transparency in terms of what is happening on the modification
side, what the cash-flows are on these loans. Again, those are
my three.
Chairman Menendez. Mr. Stevens, if you have some. I do not
want to force people to have some. If you have some.
Mr. Stevens. I think, generally speaking, getting uniform
foreclosure time lines, uniform time lines for modification,
uniform foreclosure requirements nationally versus all the
State variations would help. I think there is an opportunity,
Senator, to have some discussions about both dual track and
single point of contact, which I think are the two most
commonly vetted items to support better foreclosure processes
by servicers.
And I would also suggest that there is an opportunity to
have a further dialog around minimum servicing compensation, as
I think all of these things have potential unintended
consequences that we should talk through. I would love to talk
through and engage with you or your staff as you work through
these processes. But clearly, aside from what the two previous
comments were is that the difficulty of all the various rules
and regulations State by State, I think, add a level of
confusion that is unnecessary to the overall process.
Chairman Menendez. Doctor, do you have any?
Mr. Sanders. Chairman, first of all, I would recommend that
the industry move toward more standardization of pooling and
servicing agreements. Those are the PSAs. Whether it is
regulated or the industry moves toward it, I am sure as Mr.
Stevens's MBA is working on, that would be very helpful in
reducing problems in the future.
Second, transparency. Not only transparency of the process
to the consumer, but again, and I want to say this, had we had
loan-level details about the private label market in the first
place, we might not have seen the problems that we saw, and
therefore we might not be sitting here today. But again,
whether it is loan-level transparency or servicer transparency,
I think that is an excellent idea.
And in addition, the one thing that has been left off the
table, and there is nothing we can do about it, is that, in
part, the huge housing bubble that blew up and collapsed so
many consumers and caused us grief and heartache was
attributable to the Federal Reserve keeping interest rates so
low for so long and creating a huge asset bubble. There is
nothing we can do about that, but I just wish we could throw
that into a servicing standard. Please stop printing money. But
thank you very much.
Mr. Harpootlian. I have nothing really to add. Thank you.
Chairman Menendez. Ms. Thompson, what are the views of
homeowner advocates on the draft consent orders that were
recently promulgated by several of the banking regulators, such
as OCC, the Fed, and FDIC? And let us try to split this, if I
can, your answer into three parts. What did they get right
about mortgaging service standards? What did they get wrong,
from your perspective? And what do they not address that they
should have addressed?
Ms. Thompson. Thank you, Chairman. I will start with what
did they get right. What they got right was that there are
problems that are endemic throughout the servicing industry,
that the servicing industry has failed to document virtually
everything and has gross inadequacies in its foreclosure
process. That is part of the review, I think, that supports the
allegations that have been widespread for many years about
servicer abuses and loss mitigation.
Beyond that, the orders are not very helpful and are
potentially harmful in some ways. The orders are vague. They do
not set out clear standards. They lack any meaningful
enforcement action. At best, they suggest that the agencies may
come back and do some enforcement action. These are agencies
that, unfortunately, do not have a good track record of
enforcement actions.
They only look at loans for a very limited timeframe. It is
2009 and 2010. So we provide no protection for loans going
forward, no remedies for homeowners who were wrongfully
foreclosed on before then, even if remedies to homeowners are
provided. I think we could safely say that we are disappointed.
Chairman Menendez. Any other comments from any other
members of the panel on those consent orders?
Ms. Goodman. They are relatively teethless. I agree with
Diane 100 percent.
Chairman Menendez. All right. Let me ask, Ms. Goodman, you
outlined a series of the conflicts. What do you think is the
most important of those conflicts of interest from a mortgage
investor's perspective?
Ms. Goodman. I actually think the first lien-second lien
issue, and more broadly the fact that first lien servicers
oftentimes do not own the first lien. In a GSEs loan, the GSEs
have the first loss position in the first lien. Servicers do,
however, own the second lien. In addition, they also own credit
card debt and auto debt of the borrower.
You will notice that in a modification, the only thing that
is really affected is mortgage debt. There is no restructuring
of the borrower's entire debt. There are two reasons why
modifications fail. The first is that the borrower has
substantial negative equity. The second is that he has a back-
end debt-to-income ratio, that is, a total debt burden that is
unsustainable. And for more successful modifications, you
really have to address the borrower's overall debt situation.
There has been an extreme reluctance to do that. And even in
terms of more successful modifications, respecting lien
priority and writing off the second completely, or at least a
greater than proportionate write-down on the second lien versus
the first lien would help a great deal in eliminating negative
equity.
So my first order of business would be looking at the
conflicts of interest between the servicers who own the second
lien and other borrower debts and do not own the first lien.
Chairman Menendez. Mm-hmm. And I just want to just stay
with this conflict of interest question. Flesh out for me a
little bit more how, number 1, how it is a conflict of interest
for the mortgage servicer for the primary mortgage on a
property to also own the secondary mortgage, and how do we best
address that conflict of interest, from your perspective?
Ms. Goodman. There are a couple of different ways to
address that. The reason it is a conflict of interest is
because you own the second lien, you can make decisions, or
there is an incentive to make decisions that basically help the
second lien holder at the expense of the first lien holder. So,
for example, if a borrower gets a short sale opportunity, the
servicer may reject that even though it is in the best interest
of both the investor and the borrower because it essentially
requires them to wipe out the second lien.
How do you address it? I think, as Dave mentioned, it is an
extraordinarily difficult, difficult problem. You can--one way
is basically to say----
Chairman Menendez. That is why we get paid the big bucks
here.
Ms. Goodman. One way--basically, the easiest way to address
it is to say if you own the second lien, you cannot also
service that first lien, or alternatively saying if you service
that first lien, you cannot own the second lien.
Let me also mention that in the modification process, the
first and second liens are oftentimes treated pari passu. So if
I am making a first lien mortgage going forward, the costs of
that may well be higher if this becomes institutionalized. So
you really have to consider how to make it clear to investors
that lien priority is, in fact, lien priority. I think that is
just a critical point.
There are a variety of ways to do that. We seem to be
unwilling to address the second lien situation on any level. We
have gone to great lengths to put out QRM standards, which I
have some real issues with, but basically, there is nothing
that prohibits that borrower from going out, taking out a
second lien tomorrow and essentially negating the whole purpose
of those standards. So I think you have to basically put some
up-front restrictions on second liens, as well, in order to
have better mortgages going forward. But certainly, you have to
respect lien priority.
Chairman Menendez. Mr. Stevens, do you have any views of
that? I sort of like heard----
Mr. Stevens. I do, and actually----
Chairman Menendez. I thought you might, so----
[Laughter.]
Mr. Stevens. Ninety-nine percent of the time, I agree with
everything Laurie says. I think the challenge here is that I am
not at all certain that by having someone else service the
second lien, it is going to change the outcome. I think----
Chairman Menendez. I heard that in response to a separate
question.
Mr. Stevens. And I think, actually, one of the things we
ought to test for and we ought to think about--``test'' sounds
a little too clinical--is whether, if it is two different
servicers, is there perhaps even less incentive? Again, as I
said earlier, when the first lien ultimately goes to
foreclosure, if the investor owns a second, as well, they are
completely wiped out on the second.
So I am not sure that is necessarily the case when--and I
will just take this to an extreme--many of the loans originated
during this boom period in this low-interest rate market when
stated income loans were created, et cetera, so were not very
sustainable loans on the first lien basis. So a stated income,
negatively amortizing ARM on the first lien that some PLS
investor was ready and willing and able to buy, you know, that
fundamentally could be part of the challenge of why the
borrower ultimately went into default. So I understand why the
investors would like the second liens expunged and have the
first lien written down, because they hold the--their whole
interest is in that first lien, just as in the second lien
holder, their objective is to keep whole on their second lien.
I spent a couple of years in my last position talking to
everybody who would come in and talk about their interests, and
it clearly reflected the businesses they were in. You know, in
the end of the day, it is a very complicated subject----
Chairman Menendez. Let me ask you two questions.
Mr. Stevens. Yes.
Chairman Menendez. First of all, the mere fact that you are
a second lien holder basically says, yes, you have certain
legal rights, but you have inferior rights to the first lien
holder.
Mr. Stevens. Absolutely.
Chairman Menendez. So as such, you know that you are taking
another level of risk, right?
Mr. Stevens. Correct.
Chairman Menendez. Second, I understand your view that
maybe not having different servicers is the answer, but by the
same token, if I am the servicer and owner of the second lien
and not the owner of the first, I truly have a, if not an
actual conflict, a potential conflict in ensuring that,
somehow, my legal interests and my economic interests are
preserved. And so I am more reticent to find a way to either do
a mortgage adjustment or, you know, some principal pay-down or
reduction because I will be wiped out. I mean, that is, to me,
pretty obvious. Now----
Mr. Stevens. Yes, and Senator, I am going to tell you, I do
not have the answer to this as some others may feel they do. My
view on this is I do not think it ultimately ends up being that
simple, because the one thing for certain, having been a banker
for most of my career, is if I do not keep that first
performing, I am going to get wiped out completely if I hold
both. And I am not so certain if you separate those interests
that second lien holder is going to have any additional
incentive whatsoever to write down the second when they have
absolutely no interest in the performing of the first due to an
obligation as the servicer.
So, again, I am not arguing necessarily that one solution
is better than the other. I just think we ought to be very
thoughtful to make sure that is really the answer to this
thing, because I can see challenges with the outcomes if we
said we separate them. That can even make it more
dysfunctional.
Chairman Menendez. Ms. Goodman, let me hear your response.
Ms. Goodman. My response is twofold. First, the fact that
you have got the same guy servicing the first and owning the
second actually does produce some distortions in terms of the
type of loan modifications you get. You end up with a lot of
sub-optimal loan modifications.
So, for example, if you do a first lien proprietary
modification, you do not have to touch the second. That may not
be necessarily the best modification for the borrower, but it
is sure as hell the best modification for the servicer, and it
is certainly not the best modification for the investor,
either, because the borrower and investor are fairly well
aligned there.
Another instance is the reluctance to approve a short sale
because you wipe out the second. It may well be the best
interests of the borrower and the investor, but it is not the
best interest of the servicer. So I think you get sub-optimal
loss mitigation because of the conflicts of interest in terms
of the liens.
Chairman Menendez. Doctor, did you have an opinion on this?
I saw you raise your hand.
Mr. Sanders. Yes. What I wanted to comment on is the
commercial mortgage, or CMBS market, went through these
gyrations years before we had the big housing bubble burst, and
I actually have a study on adverse selection and mortgage
servicing in the commercial sector, and what we found is that
the difference between what we call same servicer and different
servicer was negligible. So I would agree that it is a very
complicated problem, and in defense of Ms. Goodman, it could be
a little different for the residential market, but I agree with
Mr. Stevens that this is going to be such a--you know, there
are so many competing problems in this industry, I would just
say that would not be the focal point. I would go to, again,
examining or total debt as something we really had to consider.
And bear in mind that many of the PSAs, the servicing
agreements, were all written back in the day when we were not
thinking about second mortgages or the big HELOC problem, and I
think those definitely should be amended going forward.
Chairman Menendez. Let me ask you just one or two more
questions and then I will let you go. Principal deductions--
they are not typically offered very often today to borrowers,
even though we know the borrowers are more likely to simply
walk away from their homes and decide it is not worth it to
stay if they are deeply underwater. Why are servicers not doing
more about principal reductions? Ms. Thompson?
Ms. Thompson. Principal reductions are the one kind of
modification that servicers will unequivocally absolutely lose
money on by doing. Servicers' largest source of income is the
monthly servicing fee, which is based on the outstanding
principal. So if they reduce the principal, they are
guaranteeing themselves a loss of future income.
Ms. Goodman. Let me also mention that while banks are--
while servicers are not doing principal reductions for others,
they are doing it for their own portfolio loans. According to
the OCC OTS Mortgage Metrics Report from the fourth quarter of
2010, overall, principal reduction was done on 2.7 percent of
modifications. Seventeen-point-eight percent of portfolio
loans, however, received principal reduction as part of the
modification package, 1.8 percent for private investors, and 0
percent for Fannie, Freddie, and Government-guaranteed loans. I
realize there are some institutional constraints on Fannie,
Freddie, and Government-guaranteed loans, but there are
basically no--there are very few institutional constraints in
terms of why private investor loans do not receive principal
reduction in the same proportion as banks' own portfolio loans.
Chairman Menendez. Mm-hmm.
Mr. Stevens. I would just add, having been the architect
for the FHA Short Refi program, which was designed around
principal write-down, one of the big resistance points is that
the--for Freddie Mac and Fannie Mae, FHFA put out a letter that
they will not participate in the principal write-down. That is
why, I think, one of the reasons why the percentage is point-
zero-one, or whatever it is----
Ms. Goodman. Yes. Yes.
Mr. Stevens. ----and it is such a large part of the market.
It is also, unfortunately, and I hate to make it all sound
like--I think there are solutions if we work deliberately at
it, but in the PLS market with trustees in the middle of the
ultimate investor, getting ultimate authority to do the
principal write-down with no real safe harbor that would likely
stand up in the courts becomes a problem for the servicers.
But without question, as Laurie points out, and I was going
to say the same, you do see a lot of principal write-down
mostly where it is occurring on whole loans held by the
servicers on their own balance sheet, the banks, where clearly
there are no impediments to them doing the write-down because
they own the asset themselves. You could also say it is in
their best interest to do so, potentially, but there are
clearly restrictions from the secondary market to be able to
allow the servicer to simply do a principal write-down.
Ms. Goodman. Can I just say one other thing, and that is I
would argue that there actually is a safe harbor for doing
principal reductions on private investor loans and that safe
harbor comes through the principal reduction alternative of the
HAMP program. I would like to see that become mandatory if it
is the highest NPV.
Ms. Thompson. Senator----
Chairman Menendez. Net present value.
Ms. Goodman. Net present value, yes, thank you.
Chairman Menendez. Just for the record for everybody who
does not have the acronyms down, so yes?
Ms. Thompson. Yes. Indeed, I think the HAMP principal
reduction alternative should be mandatory. It should be
encouraged. It has been radically underused. There is no reason
not to use it. That produces modifications that are more
sustainable, better return for everybody, really.
On the FHFA point, that underscores the need for national
servicing standards. The fact that Fannie and Freddie have
stood in the way of principal reductions, there is no need to
allow that to continue. They are in a conservatorship. It
should be possible for Congress to indicate strongly to them
that they should step out of the way and allow principal
reductions to happen. Their failure to allow principal
reductions to happen, I believe, is ultimately costing the
American taxpayers money.
Chairman Menendez. That is a concern that I have of my own.
Mr. Sanders. Well, again----
Chairman Menendez. I will let you go in a minute, Doctor.
The largest owner is the Federal Government. At the end of the
day, it seems to me that there are two interests of the Federal
Government, and therefore the Federal taxpayer, which is, one,
whatever we can do to have property values rise, and two,
whatever we can do to mitigate that loss. But when we fail to
do principal reduction when it is fitting and appropriate, we
are not mitigating the loss. We are taking, in my view, a much
larger loss. And we have the displacement of individual
families from their homes and we have the consequential fact of
property values being diminished, which ultimately means that
ratable bases are diminished, and when ratable bases are
diminished, mayors have just one of two choices. Either they
cut services or they raise taxes. It is all a bad scenario.
Doctor?
Mr. Sanders. Yes. Let us not take this one too lightly,
because I gave a presentation at Treasury when the Obama
administration first came in and I said that, really, the only
solution to this, the negative equity states, will be massive
principal reductions. Otherwise, we probably are not going to
have any resolution.
On the flip side, the moral hazard problem of putting up
the sign saying, we will do principal reductions or short
sales, could cause a kind of a massive entrance into doing loan
modifications with everybody. I would like to have a principal
write-down, but again, you do not apply for it. Again, it is
just one of those touchy issues that--I think Mr. Stevens
probably has looked into this, I think, quite intensively, but
that is----
Chairman Menendez. I think there are a lot of moral hazards
that crossed when we gave out mortgages to individuals who
should never have been enticed into a mortgage for which they
did not have the wherewithal to live up to, and there was a lot
of moral hazard crossed there. There was a lot of moral hazard
when, because of systemic risk to this entire country's
economy, we had to go in and resolve for every American
taxpayer the consequences of institutions that would have
collapsed but would have created a consequence to every
American.
So I agree with you. There is a lot of moral hazard here.
At some point, though, my concern at this point in time, having
seen many of those moral hazards already crossed, is the
question of how do we mitigate the consequences to the Federal
taxpayer at this point for that which has already been
determined. And we have, by virtue of Fannie and Freddie, the
largest single portfolio of that, and that means that the
Federal taxpayer has the largest single risk. And so in my mind
is how do we mitigate that so that we walk out as best as we
can under the circumstances.
Mr. Harpootlian, I want to close on a note. I appreciate
the service that you rendered to the men and women in uniform.
You know, it is pretty incredible that we find ourselves at a
time in which we have two wars raging abroad, largely unpaid
for but nevertheless raging abroad, that the men and women in
uniform would have to worry about their homes being lost where
their wives or husbands and children are. It is not how a
grateful Nation says thank you, and it is not how institutions
who are benefiting from the investments of those individuals in
their companies should act.
So I read your greater testimony with interest. I know you
recommended greater legal support for servicemembers to
understand and enforce their rights and more cooperation with
the Department of Defense and financial institutions, and I
wholeheartedly agree. With reference to your recommendation
that we should incentivize mortgage modifications and
discourage foreclosures when it comes to service people, that
is what some of our current mortgage modification programs are
trying to do more broadly, not as successful as we would like.
Do you have any ideas of how that would be tailored to service
people?
Mr. Harpootlian. Well, I think that, again, our men and
women in uniform are sacrificing--I mean, I have heard story
after story of folks that were in the Reserves that were making
a pretty good salary ending up in Afghanistan or Iraq. Salaries
come down dramatically. They cannot make their house payments
anymore. It just seems to me that at the front end, before--
when they are deployed, somebody in the military ought to sit
down and do some sort of financial analysis of what their
situation is.
There is a Lieutenant Colonel from California who was a
Reservist in military intelligence. Her husband was making
about a half-a-million dollars a year and she was making about
$125,000 a year. She got deployed. His business, RV business,
shut down. She went from making $125,000 to about $30,000 or
$40,000. And all that--nobody there to help them, nobody to
talk to the financial institutions, and they foreclosed on her
and she is one of our class members.
But that is an extreme case. I think the Department of
Defense ought to work something out with the financial
institutions so when folks, both deployed and not deployed,
have issues, that there is somebody advocating for them,
because they are distracted. They are distracted in some
instances by incoming. In other instances, if they are
maintaining a jet at Shaw Air Force Base in South Carolina, I
want them focused on maintaining that jet, not worrying about
their financial issues. And I think, again, the pay is not
good, the life is pretty hard, and we ought to do something in
addition to all this that you are talking about in terms of
servicing standards, we ought to do something in addition for
our men and women in uniform.
Chairman Menendez. All right. Thank you very much.
Well, I do know this much, and you all have been very
helpful in beginning, and I underline ``beginning,'' to help us
understand some of the challenges here. The present system as
it is is not acceptable and not working, so there has to be
change. And those who are involved, I hope, will come forth in
the spirit of embracing the change and helping us structure it
in a way that both meets the desire to have people obviously
live up to their obligations, but also be able to stay in their
homes.
In the absence of having those who are in the industry come
forth and embrace the necessary changes, then I think that
there will be changes forthcoming that they might not very well
appreciate when they have an opportunity to engage. So I hope
this hearing starts the highlighting of what some of these
critical issues are and we have to think through as to how we
best resolve them and have the pendulum strike in the right
balance. But just the belief that we can tough it out is the
wrong belief.
With that, I want to thank all the witnesses for sharing
their expertise today. I hope, as I said, that we can come
together to try to improve this process pretty dramatically.
The record will remain open for 7 days to give everybody an
opportunity to answer questions in writing. I still have some,
but I did not want to keep you here longer. And we would
appreciate your answers as expeditiously as possible.
So with the thanks of the Committee and with no other
Senator present, this hearing is adjourned.
[Whereupon, at 3:33 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF A. NICOLE CLOWERS
Acting Director, Financial Markets and Community Investment, Government
Accountability Office
May 12, 2011
PREPARED STATEMENT OF LAURIE F. GOODMAN
Senior Managing Director, Amherst Securities
May 12, 2011
I am honored to testify today. My name is Laurie Goodman and I am a
Senior Managing Director at Amherst Securities Group, a leading broker/
dealer specializing in the trading of residential mortgage-backed
securities. I am in charge of the strategy and business development
efforts for the firm. We perform extensive, data-intensive research as
part of our efforts to keep ourselves and customers abreast of trends
in the residential mortgage-backed securities market. I would like to
share some of our thoughts with you today.
A few quick numbers will serve as background. There is $10.6
trillion worth of 1-4 family mortgages outstanding in the United
States. Of those, one half, or $5.4 trillion, is in Agency MBS
(mortgage-backed securities), $3.0 trillion consists of first lien
mortgages in bank, thrift and credit union portfolios plus the
unsecuritized loans on Freddie Mac and Fannie Mae's balance sheet, and
$1.2 trillion is in private label MBS. Second liens, which are mostly
held on bank balance sheets, total just under $1 trillion. It is
important to note that while private label securitizations represent
only 12.8 percent of the first lien market, they represent 40 percent
of the loans that are currently 60+ days delinquent.
Servicers play a critical role in the housing finance market. They
are the cash flow managers for the mortgage system. If the borrower is
making his payments, the servicer collects and processes those
payments, forwarding the proceeds to the investor in a securitization.
If there is an escrow account, the servicer is charged with making the
tax and insurance payments. If the loan goes delinquent, the servicer
is responsible for running the loss mitigation efforts, an endeavor
that many servicers, especially so-called ``prime'' mortgage servicers,
had little experience at prior to the crisis. It was never contemplated
that these servicing platforms would be used to perform default
management on the current scale. As a result, they have never built up
a loss mitigation infrastructure. A set of national servicing
standards, addressing minimum infrastructure requirements to handle the
servicing of delinquent borrowers within a servicing platform is the
best way to address this issue, and I am pleased to have input on this
important topic.
The servicer is generally paid a fixed percentage of the
outstanding loan balance for servicing a mortgage. This fee is
generally too large for servicing loans that are not delinquent, and
too small to cover the costs of servicing loans which have gone bad.
There are other sources of income as well. The borrower often makes his
payment early in the month, and the monies are not required to be
remitted until mid-month, giving the servicer the right to invest these
proceeds in the meantime (float). When the borrower goes delinquent,
servicers charge late fees. There are a number of ancillary fees that
are charged during the loss mitigation process. Finally, servicing a
loan allows a firm to cross-sell other financial products to the
borrower, including auto loans, credit cards, and home equity lines of
credit. As a result, the servicer often interacts with the borrowers
across a number of different products, some of which may be in the
investment portfolio of a related entity. There are some costs as
well--the servicer will generally advance tax and insurance payments,
and in private label securitizations are usually obligated to advance
principal and interest to the extent deemed recoverable.
The purpose of my testimony is to discuss conflicts of interest
facing mortgage servicers that may stop them from acting in the best
interests of mortgage investors and homeowners, and to discuss which of
these conflicts can be addressed through national mortgage servicing
standards. Let me begin by pointing out that the interests of mortgage
investors and homeowners are largely aligned for 2 reasons. First, the
mortgage market is reliant on investors to continue to extend credit,
thereby providing the necessary capacity to encourage competitive rates
for borrowers in pursuit of home financing. Second, foreclosure is,
without question, the worst outcome for both investors and borrowers.
It is a long and drawn-out process in which a borrower is forced from
his home, and an investor typically suffers a loss on his investment in
the mortgage loans of between 50-80 percent of the balance of the loan
amount after the home is sold and the various costs are deducted.
The interests of both the borrowers and investors can be
marginalized when the loan is serviced by a conflicted party. Here are
the inherent conflicts we see.
CONFLICT #1: Large first lien servicers have significant ownership
interests in 2nd liens and often have no ownership interest in
the corresponding first lien mortgage loans that are made to
the same borrower and secured by the same property.
In such cases, the first liens are typically held in private label
securitizations, the second lien and the servicing rights are owned by
the same party, often a large bank. The 4 largest banks (Bank of
America, Wells Fargo, JPMorgan Chase, Citigroup) collectively service
54 percent of all 1-4 family servicing in the United States. They own
approximately 40 percent ($408 billion out of $949 billion) of second
liens and home equity lines of credit outstanding. The securitized
second lien market is very small. Thus when a first lien in a private
label securitization is on a property that also has a second lien, that
second lien is very likely to be held in a bank portfolio, and if it is
inside a bank portfolio it is often in one of the big 4 banks.
This is a conflict because the servicer has a financial incentive
to service the first lien to the benefit of the second lien holder.
Many time this incentive conflicts with the financial interest of the
investor or borrower. We outline some of the consequences of this
conflict.
Consequence: Short Sales and Deeds-in-Lieu Are Less Likely To Be
Approved. An example makes this more intuitive. Assume that a borrower
has a $200,000 first lien and a $30,000 second lien ($230,000 lien
total) on a home that suffered a valuation reduction down to only
$160,000. The borrower is paying on his second lien, but not on the
first lien. The borrower receives a short sale offer at the market
value of the property, and asks the servicer (a large financial
institution) to consider it. If the servicer accepts the offer, the
second lien (held on the balance sheet of the financial institution)
must be written off immediately. If the servicer is also the second
lien holder, he may be more inclined to reject the short sale offer. In
this case, accepting the short sale offer was clearly in the best
interests of both borrower and first lien investor. Similarly, a
servicer will be less likely to accept a deed-in-lieu of foreclosure.
We believe that national servicing standards should explicitly address
this issue.
Consequence: Loan Modification Efforts Are Sub-Optimal. Loan
modification programs have two issues: they do not address the
borrower's total debt burden, and they do not address a borrower's
negative equity position. As a result, the redefault rate has been
enormous. We believe that both of these shortcomings share, at their
core, one common trait: conflicted servicers. We look at each in turn.
Modifications Fail To Address the Borrower's Total Debt Burden. In
a loan modification, only the mortgage debt is affected. That is, most
modification programs, including HAMP, the Government's Home Affordable
Modification Program, look at the payments on a borrower's first
mortgage plus taxes and insurance, and compare that to the borrower's
income. This is called the front-end debt-to-income ratio, and an
attempt is made to reduce the payments to a preset percentage of the
borrower's income. Consider a bank who services a borrower's first
lien, second lien, credit card and auto loan. The first lien is in a
private label securitization, all other debts are on a bank's balance
sheet. The bank is obligated to modify only the mortgage debt, leaving
the credit card and auto debt intact. Moreover, the second lien
mortgage debt is generally treated pari passu with the first lien.
There are situations in which only the first lien is modified, and the
second lien is kept intact, making even less impact on the borrower's
total debt burden.
Since there is no sense of an overall debt restructuring, the
borrower is often left with a mortgage payment that is affordable, but
a total debt burden that is not. For example, the Treasury HAMP report
shows that the borrowers who received permanent modifications under the
Home Affordable Modification Program had their front-end debt-to-income
ratio reduced from 45.3 percent to an affordable 31.0 percent, while
the median back-end debt-to-income ratio (or total debt burden as a
percent of income) was reduced from 79.3 percent before the
modification to a still unsustainable 62.5 percent afterwards. The
result: a high redefault rate on modifications. For a successful
modification, a borrower's total debt burden needs to be completely
restructured.
Modifications Fail Because They Do Not Address a Borrower's
Negative Equity Situation. Consider the 2MP program, the HAMP program
which applies to second liens. Essentially this program treats the
first and second lien holders pari passu when the borrower's first lien
is modified. If there is a rate reduction on the first lien, there is
also a rate reduction on the second lien; if there is a principal
write-down on the first lien, the second lien also receives a principal
write-down. This makes no sense, as the junior lien is by definition
subordinate to the first lien, and as such should be written off before
the first lien suffers any loss. And if a modification is done outside
of HAMP (and there are more non-HAMP or proprietary modifications than
there are HAMP modifications) the servicer is not compelled to address
second liens at all.
The negative equity position of many borrowers would be
dramatically improved if the second lien was eliminated or reduced more
in line with the seniority of the lien. Indeed, loan modification
programs would be markedly more successful if principal reduction were
used on the first mortgage and the second lien were eliminated
completely. Our research has shown that a principal reduction
modification has the highest likelihood of successfully rehabilitating
a borrower, and will ultimately result in the lowest redefault rate.
Principal Reductions Are Used in Loan Modifications Less Frequently
Than They Should Be, Due to Conflicted Servicers. Even with the current
pari passu treatment on first and second liens, we believe there are
fewer principal reduction modifications on loans owned by private
investors than there would be if a related entity of the servicer did
not own the second lien. That is, we believe banks are reluctant to
take a write-down on a second lien that is paying and current; as a
result, they do a first lien modification which is less effective, to
the detriment of the borrower/homeowner as well as to the private
investors who own the first lien loan. In addition we believe
conflicted servicers are counseling borrowers to remain current on
their second liens, thereby allowing them to postpone the write down on
the second lien, and increasing the likelihood of a pari passu
modification.
Principal Reductions Are Also Used Less Frequently Due to
Distortions in the Compensation Structure. Servicing fees are based on
the outstanding principal balance. Thus, when a principal reduction is
done, the servicing fee is reduced, as it is based on a lower principal
amount. Since it costs more to service delinquent loans than the
servicer is receiving in fees, and this is exacerbated by the write
down, it adds to the reluctance to do the principal write down.
With servicers trying to minimize the write off of second lien
holdings and maintain servicing fees, it is no surprise that we see
distorted outcomes for borrowers and investors in loans that banks
service for private investors.
Here is some evidence of the distortion. We can see a marked
difference in servicing behavior for first liens owned by banks and
those where the first lien is NOT owned by a bank portfolio. According
to the OCC/OTS Mortgage Metrics report of Q4 2010, banks did a
principal reduction on 17.8 percent of their first lien portfolio
loans. These were loans in which they own the first lien, generally own
the second lien (if there is one), and modified the first lien to
achieve the highest net present value. By contrast, those same
financial institutions did a principal reduction on only 1.8 percent of
loans owned by private investors and 0 percent of Fannie Mae, Freddie
Mac, and Government-guaranteed loans. While there are major obstacles
to principal reduction in the case of GSE (Government Sponsored
Enterprise) loans or Government-guaranteed loans, there are few
obstacles to doing principal reduction on private investor loans. Only
a few PSAs (Pooling and Servicing Agreements) prohibit such behavior.
And the OCC/OTS Mortgage Metric Report numbers for Q4 2010 were not a
fluke; in the immediately preceding calendar quarter Q3 2010, banks did
principal reductions on 25.1 percent of their own loans, but on only
0.2 percent of loans owner by private investors.
Solution: To Increase the Use of Principal Reductions as a Loan
Modification Tool. National servicing standards should require that
servicers perform the modification with the highest net present value,
which will usually be a principal reduction. Under HAMP, the servicer
is required to test the borrower for a modification using both the
original HAMP waterfall, as well as the Principal Reduction
Alternative, which moves principal reduction to the top of the
waterfall. If the Principal Reduction Alternative has the highest net
present value, servicers are not obligated to use it. Use of the
Principal Reduction Alternative is voluntary, at the discretion of the
servicer. HAMP should be amended to require the use of the Principal
Reduction Alternative, if it has the highest net present value of the
alternatives tested.
Consequence of Pari Passu Treatment of First and Second Liens:
Higher First Lien Borrowing Costs. We believe a large error was made in
opting to treat the first and second liens pari passu for modification
purposes. The consequence of this is that first mortgages will become
more expensive, as investors realize they are less well protected than
their lien priority would indicate. It is very important to realize
that under present law and practices, a second mortgage can be added
after the fact, without the first lien investor even knowing it. But
addition of a second lien significantly increases the probability of
default on the first mortgage. However, as presently constructed, if a
borrower gets into trouble, the first and second mortgages are treated
similarly for modification purposes. Since that raises the risk for the
first lien investor, it should also increase the cost of debt for the
first lien borrower. (We haven't seen this reflected in pricing yet, as
few mortgages have been originated for securitization; most mortgages
issued since the pari passu decision were insured either by the GSEs or
the U.S. Government.)
Solutions To Maintain Lien Priority
What can be done about conflicts of interest inherent in an entity
servicing a pool of loans and owning the second lien (while the first
lien is owned by an outside investor)? There are at least 3 alternative
solutions for newly originated mortgages. The first two require
congressional consent, while the third would require actions by the
bank regulatory authorities. These solutions to the reordering of lien
priorities are beyond the scope of national servicing standards.
Alternative 1. This solution would contractually require first lien
investors to approve any second lien (or alternatively, approve any
second lien with a CLTV [(combined loan-to-value, the ratio of the sum
of all the liens on the property to the mortgage amount) exceeding a
preset level, such as 80 percent]. If the first lien holder does not
approve it, yet the borrower still takes out a second lien, the first
lien must be paid off immediately (the ``due on sale'' clause is
invoked). This may sound harsh, but it really is not. Currently, if a
borrower wants to refinance his first lien, the second lien must
explicitly agree to resubordinate his lien. The infrastructure to
arrange these transactions exists and works smoothly. Prohibition of
excessive indebtedness is common in corporate finance. This is done
through loan covenants that limit the amount of junior debt that can be
issued without the consent of the senior note holders. This alternative
may be required to restart the private mortgage markets and would
require an amendment to the Garn-St. Germain Depository Institutions
Act of 1982. That act prohibits the senior lien holder from invoking
the due-on-sale clause if the borrower opts to place a second lien on
the property.
Alternative 2. Place an outright prohibition on second mortgages
where the combined CTLV exceeds a designated level, such as 80 percent,
at the time of origination of the second lien.
Alternative 3. Establish a rule that a lender cannot service both
the first and second liens while owning only the second lien.
CONFLICT #2: Affiliate Relationships With Providers of Foreclosure
Services.
The servicer often owns a share in companies that provides
ancillary services during the foreclosure process, and charges above-
market rates on such. Entities that provide services during the
foreclosure process that are possibly owned by servicers include force-
placed insurance providers and property preservation companies. (These
companies provide maintenance services as well as property inspection
services.) Even when a servicer is not affiliated with the company
providing the service, they often mark up the fees considerably.
What is the consequence of affiliates of the servicer charging
above market fees? Such fees are added to the delinquent amount of the
loan, making it much harder for a borrower to become current. Moreover,
when a loan is liquidated, the severity on the loan (the percentage of
the current loan amount lost in the foreclosure/liquidation process)
will be much higher, to the detriment of the investor(s) in that
mortgage. It also tends to make servicers less inclined to resolve the
loan through a short sale, as fee income that will be earned in the
interim (as the loan winds its way through a lengthy foreclosure
process) is quite attractive.
Problem: Distortion in the Servicing Fee Schedules. We have heard
assertions that, since servicers are inadequately paid for servicing
delinquent loans, the related fees are a way to make up the difference.
It is absolutely the case that servicers are definitely underpaid for
servicing delinquent loans. However, they are overpaid for servicing
performing loans. Moreover, ex ante (at the inception of the loan), the
servicer had agreed to service the loans at the agreed-upon price. It's
just that ex post (at the present time), given the amount of delinquent
loans that accumulated versus original expectations, their original
agreement has turned out to be a bad deal. But in the real world, a
deal is a deal! For instance, my own firm Amherst Securities Group
can't agree to a consulting contract at a fixed price, then come back
and renegotiate because it is more work than we thought it would be.
Problem: No Disclosure of Fees. Servicers will tell you that the
services they provide are essential, and they would be provided at
similar prices by any third party. By owning or having an interest in a
wider array of services, the servicers also have more control over the
timing and can more closely monitor the quality of the servicers
provided. However, neither borrowers nor investors have any way to
confirm this. The ancillary fees are not broken out in a form that is
transparent to anyone outside.
Partial Solution: Make Better Fee Disclosure a Part of National
Servicing Standards. The New York State Banking Department, in their
Regulations for Servicing Loans (part 419), requires that servicers
must maintain a schedule of common fees on its Web site, and must
include a ``plain English'' explanation of the fee, and any calculation
details. In addition, the servicer should only collect a fee if the
amount of that fee is reasonable, and fees should be charged only for
services actually rendered and permitted by the loan instruments and
applicable law. Attorneys fees charged in connection with a foreclosure
action shall not exceed ``reasonable and customary'' fees for that
work. At the minimum, this type of language should be adopted for
national servicing standards.
Force-Placed Insurance Highlights the Conflicts of Interest. The
servicer, or an affiliate of the servicer often own a share of a force-
placed insurer. This insurance is used to protect the home when the
borrower is no longer maintaining his existing policies. Given the
conflicts, it is unrealistic to expect a servicer to make an unbiased
decision on when to buy this insurance (there is a tendency to buy it
without trying to retain the homeowner's policy that was already in
place) as well as how to price it (there is a tendency to price too
high).
There have already been several attempts to address this issue. The
New York State requirements explicitly address force-placed insurance
(hazard, homeowner's, or flood insurance), and details situations in
which it should not be used. A servicer is prohibited from (1) placing
insurance on the mortgaged property when the insurer knows or has
reason to know the borrower has an effective policy for the insurance;
(2) failing to provide written notice to a borrower when taking action
to place insurance; and (3) requiring a borrower to maintain insurance
exceeding the replacement cost of improvements on the mortgage
property.
The State Attorneys' General proposed settlement (circulated in
March of this year but not yet approved) contains similar provisions
governing the placement of force-placed insurance. The servicer must
make reasonable efforts to continue or reestablish the existing
homeowner's policy if there is a lapse in payment. The servicer must
advance the premium if there is no escrow or insufficient escrow. If
the servicer cannot maintain the borrower's existing policy, it shall
purchase force-placed insurance for a commercially reasonable price.
However, the Attorneys' General proposed settlement went one step
further than the New York State requirements--it suggested the
elimination of the conflict of interest by prohibiting these servicers
from placing insurance with a subsidiary or affiliated company or any
other company in which the servicer has an ownership interest.
Solution: Force-Placed Insurance Conflicts. National Servicing
Standards can be used to require servicers to keep existing homeowner's
policies in place as long as possible, as both the New York State
requirements and the proposed Attorneys' General settlement do. If it
is not possible to reestablish the existing homeowner's policy,
measures must be included to make sure the pricing of the purchase is
reasonable. Moreover, following the lead of the Attorneys' General
settlement, national servicing standards should prohibit the placement
of force-placed insurance with a subsidiary, affiliated company, or any
other company in which the servicer has an ownership interest.
Solution: Dealing With Other Ancillary Fees. Under the Attorneys'
General proposed settlement, the servicer cannot impose its own mark-
ups on any third party fees. Subsidiaries of the servicer (or other
entities where the servicer or related entity has an interest in such a
third party) are prohibited from collecting third party fees. Moreover,
servicers are prohibited from splitting fees, giving or accepting
kickbacks or referral fees, or accepting anything of value in relation
to third party default or foreclosure-related services. We at Amherst
Securities Group agree with these recommendations. These ideas should
become a part of a meaningful set of national servicing standards.
CONFLICT #3: Conflicts of Interest in the Governance of a
Securitization, Including Enforcement of ``Representations and
Warranties''.
While the enforcement of ``rep and warrants'' (representations and
warranties) does not directly affect borrowers, we believe it is a very
important topic for investor, and serves to highlight the conflicts
between servicers and investors.
Violations involving reps and warrants are becoming increasingly
common as seen in recent litigation. That is, loans in a securitization
often do not conform to the representations made about the
characteristics of these loans. For example, a loan may have been
represented as an owner-occupied property when in fact it is not; or a
borrower lied about income to a degree that should have been picked up
in the origination process; etc. Once a rep and warrant violation is
discovered, at present the trustee is charged with enforcement [the
remedy is generally that the sponsor or originator repurchases that
particular loan out of the pool at par (an amount equal to the original
balance on the loan less any paid down principal)]. However, the
trustee does not have the information to detect the violations, they do
not have direct access to the loan files. Moreover, as they have little
incentive to detect rep and warrant violations, since the trustee is
not compensated for detecting violations and the benefits of doing so
actually accrue elsewhere (to the investors).
Servicers (who do have the information to identify rep and warrant
violations) often have a financial disincentive to do so, as they would
be putting the loan back to an affiliated entity. For example, the
largest banks often serve as originators, deal sponsors (underwriters)
and servicers on securitizations. There is nothing wrong with this, as
long as there is a mechanism to allow for enforcement of the reps and
warrants.
Solution: Properly Enforcing Reps and Warrants. It is critical to
have a party that is incented to enforce them, and has both access to
the information and enforcement authority. This can best be achieved
through an independent third party charged with protecting investor
rights, who is paid on an incentive basis. Some current deals nominally
have a third party charged with protecting investor rights, but that
party is not empowered, does not have access to necessary information
(the loan files), and is not paid on an incentive basis. This set of
conflicts should be addressed the PSAs (purchase and sale agreements)
for new securitizations. National Servicing Standards should direct
servicers to make sure that there is an adequate enforcement mechanism
for reps and warrants.
CONFLICT #4: The Servicing Fee Structure Is Unsuitable to This
Environment.
There are many situations in which transferring the servicing of a
loan on which the borrower is delinquent to a servicer that specializes
in loss mitigation would be the best outcome for both borrowers and
investors. A number of special servicers have had considerable
experience tailoring modifications to the needs of individual borrowers
and tend to provide more hand holding to the borrower post-modification
than what a major servicer is staffed to provide. Consequently, the
redefault rates on modified loans are much lower with specialized
servicers who focus on loss mitigation.
Servicing transfer issues are made very difficult, as many deals do
not provide for adequate servicing fees to encourage such a transfer.
We made the point earlier that servicers are compensated too highly for
servicing current loans, not highly enough for servicing delinquent
loans. If compensation is inadequate, it will be very difficult to
convince a special servicer to service the loan.
Solution: Revamp the Servicing Fee Structure. There has been a
considerable amount of discussion about revamping the structure of
servicing fees, to allow for lower fees for performing loans and higher
fees for nonperforming loans. The FHFA has organized a number of
meetings to discuss these issues, and has outlined the alternatives. If
fees were to be altered such that fees for servicing current loans were
lowered while fees for servicing delinquent loans were raised, it would
allow the special servicer to be adequately compensated for his high-
touch efforts. This, in turn, would make it much easier to transfer
delinquent loans to servicers who would do a better job at loss
mitigation.
There has been some concern about the incentive issues that would
arise. Given higher servicing fees for servicing nonperforming loans,
will servicers be dis-incented to make a proactive phone call when a
borrower misses one payment? Will the originator/affiliate be less
concerned about the quality of loans they originate? We think there is
a very simple solution to this--give the GSEs or private label
investors the ability to move the servicing when the higher fees are
scheduled to take effect.
CONFLICT #5: Transparency for Investors Is Woefully Inadequate.
Many of the conflicts are obscured by servicers as a result of the
poor reporting they provide on a monthly basis. We believe that with
more transparency, many of these conflicts would be more visible and
servicers will be less inclined to act against the interests of first
lien borrowers and investors. In a private label securitization there
is often a large difference between the monthly cash payment the
investor expected to receive and what is actually received. Moreover,
an investor is unable to delve into the cash flow information further,
as he lacks the information on the actions of the servicer that would
be necessary to reconcile the cash flows. When I receive the statement
from my bank each month, I balance my checkbook, reconciling the
differences. Investors want to be able to do exactly this with the cash
flows from the securitizations in which they have an interest. There
are several culprits:
Insufficient transparency on liquidations. When a loan is
liquidated, investors often receive only one number--the
recovered amount. Servicers provide no transparency on what the
home has been sold for, what advances were made on the loan,
what taxes and insurance were, what property maintenance fees
were, nor what the costs of getting the borrower out of the
house were. A breakdown of these costs/fees would help
investors understand severity numbers that were different
(often much higher!) than anticipated. It would also allow
investors to better compare behavior across servicers, allowing
for identification of the most efficient servicers, and
exposing the underperformers.
Insufficient transparency on servicer advances. A servicer
usually advances principal and interest payments on delinquent
loans, allowing for a payment to the investor even if the
borrower is not paying. These advances are required to be made
as long as the servicer deems them to be recoverable. There is
often little information on which loans are being advanced on,
which makes it very difficult for investors to figure out how
much cash they should expect.
Insufficient transparency on modifications. Similarly, when
a loan is modified, investors often can't tell how that loan
has been modified. Has there been an interest rate reduction, a
term extension, a principal forbearance, or principal
forgiveness? How long will any reduced interest rate be in
effect, and how will it reset? Were any delinquent payments
forgiven? While some servicers are better than others at
reporting this information, investors are often forced to infer
(guess!) it from the payments.
Insufficient transparency on principal and interest
recaptures. When a servicer modifies a loan, the servicer is
entitled to recapture the outstanding principal and interest
advances. Those amounts, payable to the servicer, have the
first claim rights on cash flows of the securitization.
Investors often receive less money than anticipated due to
these recaptures. There is certainly nothing wrong with
servicers recapturing funds they advanced, but investors want
to know how much has been recaptured and from which loans.
[NOTE: As an aside, we have often heard assertions that servicers have
an incentive to speedily move a borrower along in the foreclosure
process, as they can recover their advances. That charge has never made
any sense to us. By modifying a loan, servicers can recover advances.
Moreover, by modifying, the servicer receives bonuses from the U.S.
Government from using the Home Affordable Modification Program (HAMP).
Finally, the longer the process, the more ancillary fee income is
generated for the servicer.]
The result of the lack of transparency is that investors can't
reconcile the cash flows on the securitization they have invested in.
They don't know how much is being advanced, what are the terms of the
modifications on the modified loans, and how much of the principal and
interest advances the servicer is recapturing when doing the
modification.
Solution: Transparency. We believe the remittance reports for
future securitizations should contain loan-by-loan information, and
that loan-by-loan information should be rolled up into a plain English
reconciliation. National servicing standards should encourage this
transparency.
Conclusion
In summary, we have discussed five conflicts of interest between
servicers and borrowers/investors. They involve the following:
1. Servicers often own junior interests in deals they service, but
in which they do not own the first liens
2. The servicer often owns a share in companies which can be billed
for ancillary services during the foreclosure process, and
charges above market rates on these services
3. There are conflicts of interest in the governance of the
securitization, including the enforcement of rep and warrant
issues
4. Servicing transfers can be problematic due to a misaligned
servicer compensation structure
5. transparency for investors is missing
______
PREPARED STATEMENT OF DAVID H. STEVENS
President and Chief Executive Officer, Mortgage Bankers Association
May 12, 2011
Introduction
Chairman Menendez, Ranking Member DeMint, and Members of the
Subcommittee, thank you for the opportunity to testify on behalf of the
Mortgage Bankers Association (MBA). \1\ My name is David Stevens, and I
am President and CEO of MBA. Immediately prior to assuming this
position, I served as Assistant Secretary for Housing at the United
States Department of Housing and Urban Development (HUD), and Federal
Housing Administration (FHA) Commissioner.
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\1\ The Mortgage Bankers Association (MBA) is the national
association representing the real estate finance industry, an industry
that employs more than 280,000 people in virtually every community in
the country. Headquartered in Washington, DC, the association works to
ensure the continued strength of the Nation's residential and
commercial real estate markets; to expand homeownership and extend
access to affordable housing to all Americans. MBA promotes fair and
ethical lending practices and fosters professional excellence among
real estate finance employees through a wide range of educational
programs and a variety of publications. Its membership of over 2,200
companies includes all elements of real estate finance: mortgage
companies, mortgage brokers, commercial banks, thrifts, Wall Street
conduits, life insurance companies and others in the mortgage lending
field. For additional information, visit MBA's Web site:
www.mortgagebankers.org.
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My background prior to joining FHA includes experience as a senior
executive in finance, sales, mortgage acquisitions and investments,
risk management, and regulatory oversight. I started my professional
career with 16 years at World Savings Bank. I later served as Senior
Vice President at Freddie Mac and as Executive Vice President at Wells
Fargo. Prior to my confirmation as Commissioner of the FHA, I was
President and Chief Operating Officer of Long and Foster Companies, the
Nation's largest, privately held real estate firm.
Thank you for holding this hearing on the important subject of the
creation of national servicing standards. I would first like to provide
some background information as a preface to my remarks, express support
for the need for national standards, highlight what MBA has done so far
in examining that need, recommend steps for the process of developing
comprehensive servicing standards, and suggest principles for those
standards.
Background
As the housing crisis evolved, industry and policy maker responses
evolved along with it. An understanding of these developments and their
context is crucial to a full appreciation of the challenges facing the
mortgage industry as it works to help borrowers avoid foreclosure and
in identifying viable long-term solutions.
The ``Great Recession'' was the most severe economic downturn that
the U.S. experienced since the Great Depression of the 1930s. It led to
the failure or consolidation of many of the country's leading financial
institutions, and from January 2008 to February 2010, the U.S. economy
lost almost 8.8 million jobs. Government reacted with unprecedented
policy initiatives, both in terms of fiscal stimulus and other
Government interventions, and monetary stimulus in the form of near
zero interest rates and massive purchases of mortgage-backed securities
and other assets.
The housing and mortgage markets both contributed to and suffered
from this crisis. Although not an exclusive list, several factors were
at play: excessive housing inventory, lax lending standards that
favored nontraditional mortgage products and reduced documentation, the
easing of underwriting standards on the part of Fannie Mae and Freddie
Mac, passive rating agencies and regulation, homebuyers chasing rapid
home price increases, undercapitalized financial institutions, monetary
policy that kept interest rates too low for too long, and massive
capital flows into the U.S. from countries that refused to allow their
currencies to appreciate.
According to the Federal Housing Finance Agency (FHFA), home prices
nationally decreased a cumulative 11.5 percent during the past 5 years,
with much larger cumulative declines of 40 to 50 percent in the States
of Arizona, California, Nevada, and Florida, known throughout the
crisis as the ``Sand States.'' Household formation rates fell sharply
in response to the downturn, with many families combining households
and household expenses to save money. And consumers cut spending across
the board, as they tried to rebuild savings after the shocks to their
wage income and the declines in the stock market and housing values.
The residual effects continue today: even though construction of new
homes remains near 50-year lows, inventories of unsold homes on the
market remain high, with nearly 4 million properties currently listed,
and homebuyer demand remains weak.
Regardless of which factors caused the recession, we do know that
the nature of the crisis changed over time. Initially, rising rates
from the Federal Reserve and suddenly tighter regulatory requirements
regarding subprime and nontraditional loan products stranded borrowers
who had counted on being able to refinance loans in late 2006 and into
2007.
As a result, serious delinquency rates on subprime ARM loans (loans
90 days past due) increased by 50 percent in 2006 and then more than
doubled through 2007. \2\ Even before their first interest rate reset,
these loans failed at unprecedented rates. Subprime ARMs originated
from 2005-2007 have performed far worse than any others in recorded
data.
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\2\ MBA's National Delinquency Survey.
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Without access to credit for new buyers, home prices in the Sand
States markets began to fall dramatically. With investors increasingly
questioning loan performance, the private-label MBS market froze in
August 2007 and has remained essentially paralyzed ever since.
Compounding the problem, lending to prime, jumbo mortgage borrowers
effectively stopped. As liquidity fled the system, fewer potential
buyers could access credit, and home prices declined further. According
to the National Bureau of Economic Research (NBER), the economy
officially fell into recession in December 2007.
The unemployment rate in January 2008 was 5 percent. Eighteen
months later, it would be nearly twice as high, following the near
collapse of the financial sector in the fall of 2008. From that point
forward, joblessness and loss of income began to drive mortgage
delinquencies and foreclosures. Serious delinquency rates on prime
fixed-rate loans were at 1.1 percent in the beginning of 2008. By the
end of 2009, they approached 5 percent. These loans were traditionally
underwritten and well-documented with no structural features that
impacted performance. Many borrowers simply could not afford their
mortgage payments as they did not have jobs.
Important policy initiatives were launched during this time period.
Servicers began large-scale efforts to modify subprime and
nontraditional loans. Initially, individual servicers and the GSEs
undertook these efforts voluntarily, but Government and industry
efforts led to standardization of processes through the Home Affordable
Modification Program (HAMP). HAMP also benefited proprietary
modification programs, which could leverage these standardized
processes. Importantly, the HOPE NOW Alliance \3\ estimates that, as of
March 2011, almost 3.8 million homeowners have received proprietary
modifications since mid-2007. Another 7.2 million borrowers received
other home retention workouts, including partial claims and forbearance
plans, a key tool supported by the Administration to assist borrowers
who are unemployed. \4\ The Treasury Department and HUD also report
that borrowers received an additional 670,186 permanent HAMP
modifications. \5\ More than 11 million home retention workout options
have been provided to consumers in 4 years. This is a significant
accomplishment that took significant manpower and coordination in the
face of unprecedented turmoil in the mortgage servicing industry and
servicers should be recognized for what they have accomplished despite
the industry's problems.
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\3\ Established in 2007, HOPE NOW is a voluntary, private sector,
industry-led alliance of mortgage servicers, nonprofit HUD-approved
housing counselors and other mortgage market participants focused on
finding viable alternatives to foreclosure. HOPE NOW's primary focus is
a nationwide outreach program that includes (1) over five million
letters to noncontact borrowers, (2) regional home ownership
preservation outreach events offering struggling homeowners face to
face meetings with their mortgage servicer or a counselor, (3) support
for the national Homeowner's HOPETM Hotline, 888-995-
HOPETM, (4) Directing homeowners to free resources through
our Web site at www.HOPENOW.com and (5) Directing borrowers to free
resources such as HOPE LoanPortTM, the new web-based portal
for submitting loan modification applications.
\4\ HOPE NOW, Data Report (March 2011).
\5\ March 2011, Making Home Affordable Program Report.
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However, other public policy efforts, such as those designed to
delay the foreclosure process, have typically not been effective over
the longer term. Frequently, there can be a tradeoff between late-stage
delinquencies and foreclosure starts, as new regulatory or statutory
requirements delay foreclosure starts one quarter, resulting in a
temporary increase in the delinquency ``bucket.'' In most cases,
though, foreclosure starts rebounded in subsequent quarters as backlogs
were drawn down.
In summary, the worst recession in living memory has led to the
worst mortgage performance in our lifetime. Servicers have been
overwhelmed by national delinquency rates running four to five times
higher than what had been typical during the prior 40 years for which
MBA has data. In spite of these market circumstances, servicers have
worked to help borrowers avoid foreclosure whenever possible.
MBA Supports the Concept of National Servicing Standards
Presently, servicers face an overwhelming multitude of servicing
standards and rules, from Federal laws, such as the Real Estate
Settlement Procedures Act, Truth in Lending Act, and the Dodd-Frank Act
(just to name a few), to 50 State laws (plus DC), local ordinances,
Federal regulations, State regulations, court rulings or requirements,
enforcement actions, FHA requirements, Veteran Affair's (VA)
requirements, Rural Housing Service (RHS) requirements, Fannie Mae
standards, Freddie Mac standards, and contractual obligations, such as
the pooling and servicing agreement (PSA). Almost every aspect of the
servicer's business is regulated in some fashion, but the rules are not
always clear, placing servicers in a position of having to guess as to
the requirements. Also, the evolutionary nature of the housing crisis
caused significant, near constant changes in these rules. Since the
introduction of HAMP, a substantial number of major changes and
additions have been made to the program. Many recent judicial
challenges to the well-settled law of ownership rights to notes and
mortgages have placed the very basis of secured lending at risk by
disrupting note holder's and investor's ability to enforce their
security interests.
Adding to the complexity is the fact that no two servicing
standards are alike. Fannie Mae, Freddie Mac, and FHA guidelines may
cover the same subjects, but the requirements differ for each. Each of
the guidelines addresses foreclosure processes, outlining penalties for
not performing specified collection and foreclosure procedures in
particular stages of delinquency, foreclosure, or bankruptcy. This
results in the need for servicers to create specialized teams for each
investor. FHFA has undertaken a project to align certain portions of
Fannie Mae's and Freddie Mac's servicing guidelines and create uniform
requirements. This is a very positive step and we applaud the effort.
State laws also play into the complexity of servicing regulation.
Each of the 50 States and the District of Columbia has its own laws
governing the foreclosure process and other servicing activities. Some
States require judicial foreclosure proceedings while others are
nonjudicial foreclosure States. Thus, the servicer must manage the
nuances of the laws in the various States through its servicing systems
and work processes. MBA supports uniformity among judicial foreclosure
laws and nonjudicial foreclosure laws, which have historically been
within the domain of the States.
As a result of the unprecedented volumes of nonperforming loans
during the current cycle, servicers have experienced difficulties in
their ability to adjust systems and work processes quickly to meet the
ever-changing regulatory environment, including changes to loan
modification programs, and the time required to hire and train
employees for these new processes. We believe a national servicing
standard would be beneficial to streamline and eliminate overlapping
requirements. However, a national servicing standard must be truly
national in scope and not simply another standard layered atop the
already overwhelming number of servicer requirements.
In developing servicing standards, we must also pay careful
attention to the interdependence of servicing and the impact that
changes to the system will have on the economics of mortgage servicing,
tax and accounting rules and regulations, and the effect of the new
requirements on Basel capital requirements and on the To Be Announced
(TBA) market. Servicing does not operate in a vacuum; instead it is
part of the broader ecosystem of the mortgage industry. When making
changes to the current model we need to be mindful of unforeseen and
unintended consequences that could result ultimately in higher costs
for consumers and reduced access to credit.
MBA's Servicing Initiatives
On December 8, 2010, MBA announced the creation of a task force of
key industry members to examine and make recommendations for the future
of residential mortgage servicing. The Council on Residential Mortgage
Servicing for the 21st Century (Council) is being led by MBA's Vice
Chairman, Debra W. Still, CMB, the President and Chief Executive
Officer of Pulte Mortgage LLC. In announcing the formation of the
Council, MBA Chairman Michael Berman, CMB, stated, ``The residential
mortgage servicing sector has been operating in a time of unprecedented
challenges, presenting us with a unique opportunity to explore
potential improvements to business practices, regulations and laws
affecting the servicing sector and consumers. As the national trade
association representing the real estate finance industry, we will
bring together industry experts to take a comprehensive look at the
current state and ongoing evolution of residential mortgage servicing
and make recommendations for the future.''
The Council convened a 1-day public session on January 19, 2011, in
Washington, DC, titled, ``MBA's Summit on Residential Mortgage
Servicing for the 21st Century.'' This Summit brought together industry
leaders, consumer advocates, economists, academics and policy makers
who took a detailed look at the issues that have challenged the
industry and started the process of identifying the essential building
blocks for the future of servicing.
Keynote speakers and panelists at the Summit discussed problems and
perceptions from their respective vantage points. Many speakers
identified the need for a national servicing standard, the need to
change the compensation structure to better incent servicers in the
area of dealing with nonperforming loans, and the need for potential
changes in laws and regulations related to foreclosures and other
facets of servicing.
In analyzing the issues that surfaced during the Summit, the
Council identified three major areas for further study and development
of policy recommendations:
Review of existing servicing standards and practices
especially in the areas of large volumes of nonperforming
loans, foreclosure practices, and loss mitigation practices,
including loan modifications. The Council formed a working
group to study and make policy recommendations related to a
national servicing standard.
Evaluation of the legal issues related to the foreclosure
process, chain of title and other issues. The Council formed a
working group to study and make policy recommendations related
to legal issues surfaced during the Summit and any additional
statutory or regulatory changes deemed appropriate for
servicing in the 21st Century.
Analysis of proposed changes in servicer compensation
proposed by the FHFA, Ginnie Mae, Fannie Mae, and Freddie Mac.
The Council formed a working group to analyze the proposed
compensation structure from the vantage of various stakeholders
including large and small servicers, depository and
nondepository servicers, and portfolio lender/servicers and MBS
issuer/servicers.
While MBA will continue to release several documents to the public
during the next several weeks, today we issued a white paper that will
act as an educational tool and provide background information and an
environmental scan of the events leading up to the current crisis. The
white paper provides information on what a servicer does, how a
servicer is compensated, and the perspectives of consumers, regulators,
and the legal community with regard to servicer performance in the
current crisis and their policy recommendations. It also contains an
industry analysis of the criticisms against servicers in order to
separate real problems from ``urban myths.'' The last chapter
highlights the Council's next steps to set the course for the future of
servicing in the 21st century.
The ``urban myths'' document summarizes several issues and
misperceptions raised by regulators and consumer groups that have crept
into the public consciousness during the servicing debate and dialogue.
For example, the document dispels beliefs that a servicer's
compensation structure is misaligned whereby servicers have higher
incentives to foreclose on a delinquent borrower rather than to modify
a loan.
The final document in the initial wave will be the Council's
preliminary views on the four fee proposals currently under
consideration by FHFA, Fannie Mae, Freddie Mac, and Ginnie Mae. Since
servicers come in different sizes, ownership structures, specialties,
etc., each servicer has its own unique motivations or ``hot buttons''
for owning servicing.
The Council's analysis will contrast specific attributes of each of
the four fee structures against the current fee structure.
MBA expects to have a preliminary recommendation with respect to
national servicing standards later this year. The Council plans to
release in the coming months its preliminary recommendations related to
foreclosure laws, chain of title issues, and other legal and regulatory
obstacles to the servicer doing its job in dealing effectively with
borrowers in default.
Additional Industry Efforts
In addition to implementing the various loss mitigations programs,
including HAMP, the industry has supported many other proconsumer
efforts:
Free Borrower Counseling: \6\ Many servicers and investors
pay HUD-approved counselors to counsel borrowers on options to
avoid foreclosure. Housing counseling is also supported through
NeighborWorks America and HUD grantees. These counselors are
instrumental in helping to educate borrowers about specific
program details and to collect documents necessary to complete
loss mitigation evaluations. Counseling is free to borrowers.
HOPE NOW, of which MBA is a member, supports the Homeowner's
HOPETM Hotline, 888-995-HOPETM, which is
managed by the nonprofit Homeownership Preservation Foundation,
and operates 24 hours a day, 7 days a week in several
languages. The hotline connects homeowners to counselors at
reputable HUD-certified nonprofit agencies around the country.
As of March 2011, there have been more than 5 million consumer
calls into the hotline since inception, and it serves as the
Nation's ``go-to'' hotline for homeowners at risk. The U.S.
Government uses this hotline for their Making Home Affordable
program and noted in its December 2010 report that 1.8 million
calls have been fielded by the hotline to date, and more than
one million borrowers have received housing counseling
assistance.
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\6\ MBA's Research Institute for Housing America recently released
a study, ``Homeownership Education and Counseling: Do We Know What
Works?'' which examined the benefits of prepurchase and postpurchase
counseling. http://www.housingamerica.org/Publications/
HomeownershipEducationandCounseling:DoWeKnowWhatWorks.htm
HOPE LoanPortTM (HLP): HLP is an independent
nonprofit created by HOPE NOW and its members as a data intake
facility to improve efficiency and effectiveness of
communications among borrowers, counselors, investors and
mortgage servicers. HLP was created to help address the
frustration among borrowers, policy makers, counselors, and
servicers in the document submission process. HOPE
LoanPortTM's web-based system allows a uniform
intake of an application for a loss mitigation solution though
HAMP, all Federal programs and proprietary home retention
programs. It allows for all stakeholders to see the same
information, in a secure manner, and delivers a completed loan
package to the servicer for action. This web-based portal
increases accountability, stability and security for submitted
information and increases borrower confidence that that their
information will be reviewed and will not be lost. Servicer and
counselor steering teams, working together have made the
decisions on how best to create and improve the HOPE
LoanPortTM system. This portal was designed by a
core group of nonprofits including NeighborWorks'
America and HomeFree-USA, and six industry servicers who shared
in this unique and important mission.
Recommended Steps in Developing National Servicing Standards
Several regulators have recently specified their own distinct
standards regarding mortgage servicing, a trend that concerns MBA
deeply. The State of New York implemented standards late last year for
loans serviced in the State of New York. The Office of the Comptroller
of the Currency (OCC) released proposed standards, and has separately
issued consent orders to specific banks that impose servicing standards
through enforcement action as opposed to the normal Federal rulemaking
process. The Federal Reserve and the Office of Thrift Supervision (OTS)
have likewise issued consent orders to banks and thrifts that they
regulate, which contain prescriptive servicing requirements. Several
State attorneys general have proposed a settlement with some larger
servicers that would impose restrictive standards as an alternative to
civil litigation.
Additionally, the SEC and the Bank Regulators are currently
attempting to impose servicing standards in the proposed origination
rules related to a qualified residential mortgage (QRM) under the Dodd-
Frank Act. In order to be considered a QRM and exempt from risk
retention requirements, the proposal would require compliance with
certain servicing standards. Specifically, the QRM's ``transaction
documents'' must obligate the creditor to have servicing policies and
procedures to mitigate the risk of default and to take loss mitigation
action, such as engaging in loan modifications, when loss mitigation is
``net present value positive.'' The creditor must disclose its default
mitigation policies and procedures to the borrower at or prior to
closing. Creditors also would be prohibited from transferring QRM
servicing unless the transferee abides by ``the same kind of default
mitigation as the creditor.''
MBA is extremely concerned with the inclusion of servicing
standards in a QRM definition. The QRM exemption was very clearly
intended under the Dodd-Frank Act to comprise a set of loan origination
standards only. The specific language of the Act directs regulators to
define the QRM by taking into consideration ``underwriting and product
features that historical loan performance data indicate lower the risk
of default.'' Servicing standards are neither ``underwriting'' nor
``product features,'' and while they may bear on the incidence of
foreclosure, they have little, if any, bearing on default. Combining
origination standards that terminate at loan closing and servicing
standards that commence at closing and continue for decades in a single
QRM regulation is problematic, as the regulation must address two
distinct functions and time frames. Accordingly, MBA strongly believes
they have no place in this proposal.
Embedding servicing standards within the proposed QRM regulations
will have unintended consequences that could actually harm borrowers.
Specifying a servicing standard as part of QRM is directly contrary to
achieving a national standard, as QRM as proposed would only represent
a small share of the market. The proposal requires loss mitigation
policies and procedures to be included in transaction documents and
disclosed to borrowers prior to closing. Such a requirement codifies
the servicer's loss mitigation responsibilities for up to 30 years at
the time of origination. While servicers today have loss mitigation
policies to address financially distressed borrowers, these policies
continue to evolve as regulator's concerns, borrower's needs, loan
products, technology, and economic conditions evolve. One need only
look at the variety of recent efforts that have emerged during the
housing crisis such as HAMP, the Home Affordable Foreclosure
Alternatives, FHA HAMP, VA HAMP, and proprietary modifications. A
further example is the different set of loss mitigation efforts
necessitated by Hurricane Katrina. In both situations, inflexible loss
mitigation standards would not have been in the best interest of the
public or investors.
The QRM proposal is also likely to make servicing illiquid by
combining ``static'' loss mitigation provisions in legal contracts and
borrower disclosures with the inability to transfer servicing unless
the transferee abides by those provisions, even if more borrower-
friendly servicing options become available.
The proposal also calls for servicers to disclose to investors
prior to sale of the MBS the policies and procedures for modifying a
QRM first mortgage when the same servicer holds the second mortgage on
the property. This adds another level of complexity to the concerns
raised above, notwithstanding the irrelevance of these provisions to
underwriting, origination, and statutory intent.
MBA believes that national servicing standards should start with a
full analysis of existing servicer requirements and State laws on
foreclosure. The new standards should be promulgated in a process that
includes open dialogue with all stakeholders, including Federal
regulators, State regulators, consumer advocates, servicers, and
investors in mortgages and MBS. MBA welcomes the opportunity to
participate and play a constructive role in such a process.
Principles for National Servicing Standards
MBA believes that one consistent set of standards would be
beneficial for servicers and consumers. In developing a national
servicing standard, specific principles should to guide decision
making. We suggest, at a minimum, the following principles:
a. National Servicing Standards Must Be Truly ``National''
Of paramount importance to the industry is that any national
servicing standard be truly national and not yet another requirement on
top of the myriad existing obligations. Servicers would not have the
burden of looking to varying standards created by different entities
(e.g., Federal regulators, State laws, Government agencies, etc.).
Servicers could reduce staff and third-party experts currently needed
to follow, track and comprehend varying standards. Errors would be
reduced. Consumers would benefit by reduced complexity and, ideally,
easy-to-understand requirements.
b. Process Must Be Transparent and Involve Key Stakeholders
The process to create national servicing standards must include
servicers and investors as these parties must ultimately implement the
new standards and the standards will potentially restrict servicing
activities and impose additional costs. Although it is likely that the
newly authorized Bureau of Consumer Financial Protection (CFPB) will
finalize the standards, given its expansive role in consumer
protection, industry input must be a crucial part of the process for
the standards to be workable.
c. Process Must Recognize Existing Requirements
As previously indicated, servicers are subject to a multitude of
laws, regulations, and requirements. In many cases, remedies already
exist for a majority of the perceived problems. In setting national
standards, regulators must recognize existing rules and adopt them
without change when they have been fully vetted through the rulemaking
process.
d. Rules Should Allow Flexibility To Deal With Market Changes
Rather than prescribe the exact methodology in which servicers must
conduct their day-to-day operation, a national servicing standard
should describe the ultimate result the Government wishes to achieve.
Servicers and investors would be allowed to devise the means to achieve
the objective that best suits their business model and capital
structure. Moreover, flexibility would allow servicers to address
different market conditions and consumer needs. The best example to
illustrate the importance of flexibility is by comparing today's
borrower's needs, whereby modifications are critical, to borrowers
affected by Hurricane Katrina, whereby forbearances were paramount as
borrowers awaited hazard insurance and Road Home funds.
e. Standards Should Create Uniform and Streamlined Processes
Processes that servicers must follow need to be simple and uniform.
Markets operate best with certainty, and servicers need straightforward
processes that do not differ by product, investor, regulator or State.
As stated above, one set of standards will limit errors and litigation
risk, and promote customer satisfaction. Simple processes will yield
the best results for all consumers and servicers.
f. Standards Must Treat Borrowers Fairly/Recognize Borrower Duties
MBA strongly believes that borrowers should be treated fairly and
with compassion. Customers should obtain respectful service, should
have access to the opportunities to retain home ownership for which
they qualify, and should understand their options. We also believe that
borrowers have duties. These include responding to servicer offers of
assistance, contacting the servicer early in the delinquency, and
diligence in providing required documents and other fulfillment
requirements of loan modification programs. These principles, for both
the servicer and the borrower, must be recognized in the development of
national servicing standards.
g. Standards Must Treat Servicers Fairly
National servicing standards should ensure the fair treatment of
servicers and recognize the economic realities of the servicing
business. Standards must recognize the costs of delinquency and
foreclosure, including late fees and other compensatory fees necessary
to offset the cost of delinquency. Many of the suggested standards
question these charges, yet these fees are necessary to ensure quality
customer service, to enable advance payments to bondholders as
required, and to provide the loss mitigation products borrowers seek.
We urge policy makers, therefore, to balance the needs of borrowers and
servicers.
Potential Components of National Servicing Standards
Regulators, congressional leaders, consumer advocates, and academia
have proposed various servicing standards to address perceived problems
as well as borrower complaints. These proposals differ significantly,
but the goals appear clear: to improve the customer's experience while
in the loss mitigation process, to avoid confusion, and to ensure that
borrowers are treated fairly and given access to loss mitigation. We
agree with these goals.
We would like to address several concepts currently under
consideration as part of the dialogue concerning various proposed
national standards.
a. Single Point of Contact
Some regulators and consumer advocates are promoting a single point
of contact to simplify communications with servicers during the loss
mitigation process. MBA supports clear and helpful communication with
the borrower. However, a single-point of contact may have unintended
consequences, potentially leaving consumers more frustrated and with
greater delays. There is no unified definition of ``single point of
contact.'' A plain English definition would imply that a single person
would be assigned to each borrower and that the borrower would
communicate only with this person. This is not feasible in the current
environment and would create numerous problems as servicer call volumes
fluctuate significantly throughout the day, week, and month.
First, a single point of contact eliminates the specialty training
necessary to deliver accurate and timely assistance to borrowers, as
borrower assistance may range from questions regarding their payment
history or escrow processes to complicated modifications such as HAMP
or short sales. A single person cannot be expert in each of these
highly complex and regulated areas. The result will be delays,
miscommunication, and/or errors.
Second, given the current environment, it will be impossible to
appropriately staff to meet demands as they fluctuate widely. By the
sheer reality of the situation, borrowers may be subject to significant
delays and response times if limited to one individual. Even if a
borrower were able to talk to other knowledgeable servicing team
members, we are concerned that said borrower could decline and request
a return phone call from the single point of contact. As a result, the
borrower will suffer delays and frustration with regard to his or her
issues and concerns.
Third, a single point of contact raises concerns regarding staff
departures, work schedules, business travel, vacations, illness, etc.
The reality is a single point of contact can never be truly a single
person. In its purest sense, a single point of contact disrupts a
servicer's efforts to provide the best service in a specific area of
expertise. Borrowers must be willing to communicate with other staff
familiar with the borrower's account, and servicers must have the
flexibility to structure staff the best way to achieve the principle of
superior customer service.
b. Dual Track
Policy makers and consumer advocates continue to call for the
elimination of so-called ``dual tracking.'' Dual tracking occurs when
the servicer continues intermediate foreclosure processes while loss
mitigation activity is underway. Interim foreclosure processes, such as
notices, rights to hearings, and the like are required by State law or
the courts and would continue during preliminary loss mitigation
efforts to ensure the borrower received due process and to avoid
unnecessarily delaying foreclosure should the borrower not qualify. It
is important to realize, however, that servicers will not go to
foreclosure sale (e.g., the borrower will not lose the house) if the
borrower has provided a complete loss mitigation package sufficient to
evaluate the borrower for loss mitigation and has provided such
information in a reasonable time before the foreclosure sale date.
Successful loss mitigation, however, requires diligence and
priority on the part of the borrower. Borrowers should submit full
application packages as soon as possible and prior to initiation of
foreclosure. Servicers should not be expected to stop foreclosure
processes, or even a foreclosure sale, if the borrower waits until the
last minute to request assistance. Moreover, some courts do not allow a
foreclosure sale to be canceled within 7-10 days of the scheduled sale
date.
The halting of the foreclosure process is difficult due to investor
requirements. As noted above, Fannie Mae, Freddie Mac, and FHA all
require servicers to meet various foreclosure timelines. Failure to
meet these timelines, without a waiver, results in penalties to the
servicer. For example, FHA requires that the servicer start foreclosure
within 6 months of the date of default. Failure to meet this strict
deadline by even one day, without a waiver, means the servicer does not
get reimbursed for almost all of its interest costs (e.g., the
accumulating arrearage).
Moreover, State law often provides that various steps must occur at
specific times or costly steps, such as newspaper publication, must be
repeated at significant cost to the servicer, foreclosing attorney,
Government agencies, and, ultimately, taxpayers with regard to
Government programs.
Delays have significant monetary impact on the investor and
servicer. Delays extend the period of necessary advances a servicer
must pay to investors, increase costs to Government agencies due to
larger claim filings, result in the loss of equity in the property if
market values decline, and allow more time for the property to
deteriorate. In addition to merely delaying foreclosure, a pause can
result in real hard dollar costs, which today are not fully reimbursed
to the servicer or the foreclosing attorneys who incur them. This is
not a sustainable model and can result in millions of dollars of
unreimbursed costs. A national standard must consider these ``cost''
issues.
c. Mandatory Principal Write-Down
The issue of mandatory principal write-down continues to be
suggested as a means to achieve affordability. While there is no doubt
principal write-down promotes affordability, there are other means to
achieve the same affordability without the disparate impact on
servicers or noteholders. Such options include rate and/or term
modifications and principal forbearances. A principal forbearance takes
a portion of the principal and sets it aside in calculating a reduced
monthly mortgage payment. It is similar to a principal write-down, but
appropriately gives a portfolio lender or investor the right to recoup
the set aside principal at a later time, such as when the house is
sold. FHA, HAMP, and FHA partial claims are principal forbearance
programs, and we believe they are effective tools.
The concept of mandatory principal write-down--as opposed to
principal forbearance--is extremely problematic in secured credit
transactions for the many reasons MBA has expressed in previous policy
debates regarding Chapter 13 bankruptcies. The same issues surface if
servicers are required to accept principal reductions over interest
rate or term modifications or principal forbearances in the loss
mitigation waterfall:
First, the servicer is a mere contractor in the
securitization function and thus cannot obligate the note
holder or investor to take a permanent loss on the loan. Fannie
Mae and Freddie Mac do not accept principal write-downs and FHA
and Ginnie Mae do not reimburse for voluntary or mandatory
principal write-downs. Servicers, therefore, cannot impose it.
Second, with regard to private label securities, the
securitization documents must specifically provide for this
option or the servicer risks litigation. Most securitization
transaction documents do not provide for principal write-downs,
and some specifically prohibit principal write-downs. We
understand there are differences in views from the various MBS
tranche holders. Principal write-downs would benefit senior
security holders to the detriment of subordinate holders.
However, it is inappropriate to forcibly reallocate winners and
losers in contradiction to the contract created to protect
against these very default scenarios.
Third, note holders and investors must be able to rely on
the contractual terms of their mortgage agreements given the
secured nature of a mortgage transaction. It is inequitable to
mandate that secured note holders or investors to write down
principal.
Fourth, without statutory changes, mandatory principal
write-downs by the servicer could eliminate Government mortgage
insurance \7\ and private mortgage insurance \8\ that currently
protect servicers/investors against losses. If mandatory
principal write-downs were required without a change to agency
guidelines/statutes, servicers--not the investors--would be
required to absorb the principal loss. This is an inappropriate
role of a servicer, who never priced their compensation to
accept first dollar loss. However, servicers have been
voluntarily writing down principal balances of loans when
appropriate and more often on loans they own and will continue
to do so.
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\7\ Today, FHA insurance and VA guarantees protect the servicer
against principal loss due to foreclosure. However, FHA and VA cannot
pay the servicer a claim for principal reductions. Authorizing statutes
do not permit it. Conversely, if the loan went to foreclosure, the
servicer would have the benefit of the insurance/guarantees and not
suffer a principal loss.
\8\ Private mortgage insurance is comparable to Government
insurance in that it protects lien holders from principal loss in the
event of foreclosure. Private mortgage insurance protections will be
lost in the amount of the lien strip.
In sum, MBA opposes involuntary principal write-down and believes
it will inhibit the housing market's recovery.
d. Misalignment of Servicer and Investor Incentives
Another common theme is that servicer incentives are misaligned
with the interests of investors. While servicing compensation may not
appropriately compensate the servicer for the multitude of additional
requirements imposed on them during this crisis, \9\ we do believe that
there are significant incentives within the existing fee structure that
encourage appropriate loss mitigation. Fannie Mae, Freddie Mac, and
Ginnie Mae ultimately designed their programs and concluded that
servicers should not be paid their servicing fee while the loan is
delinquent. The theory is that if the servicer is not paid for managing
the very expensive default process, they will expend resources to cure
the delinquency or otherwise ensure cash flow--ultimately the goal of
the investor. This incentive is real for the servicer.
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\9\ Fannie Mae, Freddie Mac, and FHA recognized over a decade ago
that servicers could reduce their losses by performing
``extraordinary'' servicing, which involved very complex loss
mitigation options. MBA was involved in those discussions, which
ultimately resulted in the incentive payments for successful loss
mitigation efforts. Unfortunately loss mitigation has become even more
complex, with the agencies requiring more and more from servicers and
foreclosure attorneys without compensation. This is not appropriate
and, thus, we agree that some additional compensation is required.
Investor contracts should not impose unlimited cost burdens on
servicers.
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The greatest financial incentive supporting modifications over
foreclosures for servicers is the reinstatement of servicing income and
the servicing asset. A modification immediately reinstates the
servicing fee income and retains the servicing asset. Assuming a
borrower remains current under the modified terms, the servicer will
continue to receive its base monthly servicing fee income (25 basis
points for GSE servicing and approximately 44 basis points for Ginnie
Mae servicing) over the life of the loan. In contrast, such income
ceases during the period of delinquency. In the case of GSE and FHA
programs, the servicer never gets reimbursed the servicing fee if the
loan goes to foreclosure. In private label securitizations, the
servicing fee ultimately is reimbursed to the servicer when the Real
Estate Owned (REO) is sold, but the reimbursement is without interest.
In summary, foreclosures result in an early termination or, in the case
of private label securities, deferment of servicing fee income.
Modifications, on the other hand, result in the immediate reinstatement
and continuation of such servicing income. Also, the continuation of
servicing fee income through a loan modification or other cure provides
retention of the servicing asset that is otherwise written off upon
foreclosure.
Modifications also stop costly advances of principal, interest,
tax, insurance and other expenses, such as property preservation costs,
and provide for quick reimbursement of these outstanding advances. In
the case of private label securities, servicers generally must advance
principal and interest from the due date of the first unpaid
installment until the property is liquidated through the sale of REO.
According to LPS's Mortgage Monitor Report, ``as of February 2011, the
average length of time a loan in foreclosure is delinquent was nearly
537 days.'' The average number of days a property remains in REO is in
the range of 116-176 days, according to Clear Capital and the Five Star
Institute. In many cases, the servicer does not receive full
reimbursement for those advances. For example, FHA curtails 60 days of
interest advanced and one-third of foreclosure attorney's fees on all
foreclosure claims. The GSEs also curtail property preservation
expenses and attorney's fees when foreclosure steps must be repeated
due to a foreclosure pause. In sum, servicers are incented to modify
the loan to reduce the interest costs and capital allocation associated
with carrying advances.
Conclusion
MBA supports reasonable national servicing standards that apply
fair practices for borrowers, servicers, and investors alike and that
seek to eliminate the patchwork of varying Federal, State, local and
investor requirements. However, national servicing standards must be
truly national. Creating different State and local requirements would
only compound the complexities servicers already face within current
market conditions.
Servicers must also be included as stakeholders in the development
of the standards. It is important to understand why processes are in
place to avoid unintended consequences. Existing standards should be
given careful consideration before being replaced. Servicer's use and
development of successful loss mitigation efforts to date should also
be recognized.
We recognize that our industry can and must do better. Given the
overwhelming nature of the crisis and the ever-changing requirements,
servicers have tried to meet competing obligations in a rapidly
changing environment, and we believe that national servicing standards
can help us accomplish the goal of preventing foreclosures whenever
possible.
At the same time, in moving toward national servicing standards,
policy makers must fully recognize the economics of mortgage servicing
and balance laudable public policy goals against business and market
realities. Our industry stands ready to play a constructive role in the
dialogue about how best to achieve this balance.
PREPARED STATEMENT OF ANTHONY B. SANDERS
Professor of Finance, George Mason University School of Management
May 12, 2011
Chairman Menendez, Ranking Member DeMint, and distinguished Members
of the Subcommittee, thank you for inviting me to testify today. I have
been asked to offer opinions on ``The Need for National Mortgage
Servicing Standards''.
The recent crash of the housing market and the rise of unemployment
led to a historic surge in serious delinquencies and requests for loan
modifications, short sales, and related transactions. As a result, the
residential mortgage servicing industry was overwhelmed. Going forward,
it is helpful to recommend changes to both servicing and securitization
industries so that they can avoid problems going forward as we attempt
to revive the securitization market.
Servicing Standards
During a December 1, 2010, hearing, Federal Reserve Board Governor
Daniel Tarullo stated that ``it seems reasonable at least to consider
whether a national set of standards for mortgage servicers may be
warranted.'' Although the Government Accounting Office (GAO) has
released a report to Congress recommending creation of servicing
standards, \1\ I agree with the sentiment but disagree with the
process.
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\1\ Government Accountability Office, ``Mortgage Foreclosures:
Documentation Problems Reveal Need for Ongoing Regulatory Oversight'',
GAO-11-433, May 2011.
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Pooling and Servicing Agreements
There already exists pooling and servicing agreements (PSAs). The
PSA is a legal document that contains the responsibilities and rights
of the servicer, the trustee, and other parties concerning a pool of
securitized mortgage loans. If the securitization is public, the
documents must be filed with the Securities and Exchange Commission.
It has been suggested that PSAs be uniform and I would agree that
greater uniformity among PSAs would reduce investor uncertainty.
However, rather than having it regulated by the Federal Government,
uniformity of PSAs would seem to be a natural evolution demanded by
investors in the marketplace.
Broader Servicing Guidelines and Standards
In December, Christopher Whalen, Nouriel Roubini and others wrote a
letter to U.S. financial regulators regarding national loan servicing
standards. \2\ I am one of the signers of the letter, but not because I
wanted to have national loan servicing standards created by the Federal
government. Rather, I wanted to open a discussion for consideration by
servicing companies. Many of the items that were discussed were
plausible recommendations.
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\2\ ``Open Letter to U.S. Regulators Regarding National Loan
Servicing Standards'', Christopher Whalen, et al., December 21, 2010,
http://www.rcwhalen.com/pdf/
SecuritizationStandardsLetter_final_122110.pdf.
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The private sector is able to adopt guidelines and standards for
loan servicing. For example, the Mortgage Bankers Association (MBA)
created a task force of key MBA members to examine and issue
recommendations for the future of residential mortgage servicing. While
it is tempting to have the Federal Government regulate loan servicing,
it will be more effective to have an industry group such as MBA provide
guidance.
One of the items recommended in the Whalen letter to regulators
was:
As part of your duties under Section 941 of the Dodd-Frank Act,
your agencies must develop new standards for the secondary
market in mortgage loans. These standards must promote a
sustainable securitization market and, in particular, maintain
additional ``skin in the game'' for sellers of loans so the
excesses and abuses of the past are not repeated. As part of
this effort, you will be defining the criteria for the highest
quality residential mortgages, those which do not need risk
retention. This new definition for what constitutes a qualified
residential mortgage should be the gold standard in all areas
of mortgage origination, securitization packaging and
servicing, and disclosure. \3\
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\3\ Ibid.
While I agree with the signers that standards could be advantageous
to investors and consumers, we need to be careful about the
implementation of standards and rules, such as risk retention, which is
also an important part of addressing this issue. Ultimately, servicing
inadequacies are part of the problem of origination risk, which I
address below.
Risk Retention and Servicing
Dodd-Frank requires that securitizers retain at least 5 percent of
the risk in all loans that do not qualify as a Qualified Residential
Mortgage (QRM) \4\ and are sold into the securitization market. In
theory, 5 percent risk retention would lead securitizers to be more
careful in the loan origination, underwriting, and servicing process.
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\4\ A qualified residential mortgage (QRM) is one with a 80% loan
to value, full documentation, and more traditional underwriting
standards. Generally includes the 30 year fixed-rate mortgage and
excludes exotic mortgages such as interest-only mortgages.
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To be sure, 5 percent risk retention would be the simplest approach
to implement in order to encourage improved loan origination,
underwriting, and servicing. Unfortunately, risk retention also appears
to be the least useful approach.
First, the house price collapse resulted in house price declines
that far exceeded 5 percent; for example, Las Vegas fell 56 percent
from peak to trough [see, Figure 1 for the collapse of housing prices].
\5\
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\5\ Free exchange, ``Recovery Comes to Las Vegas'', The Economist,
January 26, 2010, http://www.economist.com/blogs/freeexchange/2010/01/
recovery_comes_las_vegas.
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Second, risk retention does not directly address origination risk
or servicing risk. \6\ Representations and warrants (reps and
warranties) that are found in Mortgage Loan Purchase Agreements (MLPA)
and related documents are supposed to directly address origination
risk. The avalanche of loan repurchase requests in the aftermath of the
housing collapse makes reps and warranties less viable for nonagency
mortgage-backed securities.
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\6\ Origination risk refers to the risk of breaches of
underwriting standards, misrepresentations, fraud, poor data quality,
and legal breaches.
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Third, the Federal Housing Administration (FHA), Fannie Mae, and
Freddie Mac are exempt from risk retention rules. Exempting these
players in the mortgage market defeats the spirit of risk retention
since a loan originator will be tempted to sell to or be insured by
Fannie Mae, Freddie Mac, and the FHA rather than keep the retained
risk. All financial entities should be subject to risk retention or
none at all.
Fourth, given Reg AB (Dodd-Frank 942) and the anticipated
transparency of the asset-backed securities markets, the retention rule
implies that Qualified Institutional Buyers (QIBs) are not
sophisticated enough to understand origination risks and need to be
protected beyond greater transparency. QIBs (or ``sophisticated
investors'') such as Fannie Mae, Freddie Mac, PIMCO and others do not
require the additional security of 5 percent risk retention since they
perform substantial due diligence and analysis before purchasing
securities. Furthermore, they would have been expected to understand
the servicing process and PSAs.
Moreover, it is unclear how risk retention will be implemented
(e.g., vertical versus horizontal versus ``L'' cuts) and if it is even
effective in reducing origination risk.
There are more effective alternatives to risk retention:
transparency and improved reps and warranties via an origination
certificate.
Greater Transparency
One solution to origination risk is to provide greater transparency
to investors. Greater transparency would permit more accurate pricing.
Greater transparency potentially reduces the asymmetric information
between securitizers and investors.
There has already been a movement in the industry toward greater
transparency. Prospectuses and Prospectus Supplements for both agency
and nonagency mortgage-backed securities provide detailed breakdowns of
the underlying loans in terms of critical risk measures such as loan-
to-value ratio, loan type, credit score, etc. In 2006, Freddie Mac took
loan transparency to a new level by providing a file of loan level
information. \7\ The nonagency market (as well as the FHA) could
provide similar loan level disclosure.
---------------------------------------------------------------------------
\7\ See data reports provided by Freddie Mac and available at:
http://www.freddiemac.com/mbs/html/data_files_5bd.html.
---------------------------------------------------------------------------
I would prefer that the securitizers provide transparency
themselves rather than be forced through regulation. Some investors may
prefer having less information disclosed which should result in a
higher expected yield compared to fully disclosed loan information.
Investors should retain the right to choose how much information that
they want disclosed by securitizers.
But additional loan disclosure is just one prong to providing a
better alternative to retained risk. The other is to enact an
``origination certificate'' approach to reducing securitization risk.
Origination Certificate
Even though securitizers could release great loan-level
information, the market would still be concerned that the information
is inaccurate. Furthermore, transparency doesn't address servicing
problems. There should be mechanisms to insure that the disclosed
information is actually correct and that proper servicing is followed.
Andrew Davidson and I proposed a ``securitization certificate'' in our
paper ``Securitization After the Fall.'' \8\ In the paper, we write:
---------------------------------------------------------------------------
\8\ Andrew Davidson and Anthony B. Sanders, ``Securitization After
the Fall'', Second Annual UCI Mid-Winter Symposium on Urban Research,
``Housing After the Fall: Reassessing the Future of the American
Dream'', February 2009, http://merage.uci.edu/ResearchAndCenters/CRE/
Resources/Documents/Davidson-Sanders.pdf.
We propose a ``securitization certificate'' which would travel
with the loan and would be accompanied by appropriate
assurances of financial responsibility. The certificate would
replace representations and warranties, which travel through
the chain of buyers and sellers and are often unenforced or
weakened by the successive loan transfers. The certificate
would also serve to protect borrowers from fraudulent
---------------------------------------------------------------------------
origination practices.
The securitization or origination certificate approach has the
potential to be effective because it directly addresses origination
risk and contains a fraud penalty. \9\ The origination certificate
would travel with the loan and would verify that the loan was
originated in accordance with law, that the underwriting data was
accurate, and that the loan met all required underwriting requirements.
This certificate would be backed by a guarantee from the originating
firm or other financially responsible firm and would travel with the
loan over its life. The seller must provide a means of demonstrating
financial responsibility, either via capital or insurance, for the
loans to be put into a securitization. There should be a penalty for
violations of reps and warrants beyond repurchase obligations and
tracking of violations of reps and warrants available to all investors.
Furthermore, there could a penalty for violations of the servicing
standard adopted by the securitizer.
---------------------------------------------------------------------------
\9\ Andrew Davidson and Eknath Belbase, ``Origination Risk in the
Mortgage Securitization Process: An Analysis of Alternate Policies'',
The Pipeline, Andrew Davidson & Co., 2010.
---------------------------------------------------------------------------
It is my opinion that risk retention is ineffective at best in
solving underwriting and servicing issues. Increased transparency and
loan specific origination certification is a more effective way of
preventing future problems. And they are best designed and implemented
by the private sector and not the Federal Government.
Thank you again for the opportunity to testify. I look forward to
your questions.
PREPARED STATEMENT OF RICHARD A. HARPOOTLIAN
Attorney, Richard A. Harpootlian P.A.
May 12, 2011
Mr. Chairman and Members of the Committee, I thank you for the
invitation to speak on behalf of my clients--Captain Jonathon Rowles of
the United States Marine Corps and Sergeant George Holloway of the
United States Army Reserve. I represent these fine men and women in
uniform along with my cocounsel, William Harvey and Graham Newman.
As the Committee is aware, our law firms have filed a class action
complaint against subsidiaries of JPMorgan Chase alleging systematic
violations of rights guaranteed to our men and women in uniform under
the Servicemembers Civil Relief Act as it pertains to the financing of
real estate. I am pleased to report that after intense negotiations we
have reached a settlement with JPMorgan Chase and are currently
undertaking the process of informing approximately 6,000 men and women
in uniform of their entitlement under the settlement. With this case
and settlement serving as a backdrop, I would like to discuss three
topics: first, the facts and circumstances leading to the JPMorgan
Chase litigation and the pending settlement; second, broader problems
in the home finance industry revealed by the litigation; and third,
suggestions as to how Congress might address these problems.
I. Jonathon Rowles and George Holloway vs. Chase Home Finance, LLC
As I noted earlier, the litigation in which I and my cocounsel are
representing Captain Rowles, Sergeant Holloway, and approximately 6,000
military men and women stems from violations of the Servicemembers
Civil Relief Act pertaining to home finance. The opening words of the
Servicemembers Civil Relief Act establish that the purpose of the law
is ``to provide for, strengthen, and expedite the national defense
through protection extended by this Act to servicemembers of the United
States to enable such persons to devote their entire energy to the
defense needs of the Nation.'' The venerable nature of these goals is
undeniable. But to truly grasp the importance of the Act to our Nation
as a whole, one must examine the history of the legislation through the
last two centuries.
a. History of the Servicemembers Civil Relief Act
The roots of the Servicemembers Civil Relief Act lie in the
Constitution itself. Article I, Section 8 of the Constitution expressly
grants to Congress the authority to build and maintain our Armed Forces
in order to guarantee the security of this Nation. With this in mind,
as early as the Civil War Congress recognized the need to enact
legislation placing certain restrictions on civil actions that would
hinder the abilities of an individual soldier or sailor to dedicate all
of his efforts to defending this country. In 1917, as the United States
became embroiled in World War I, our Government employed the services
of Major John Wigmore--then Dean of the Northwestern University Law
School and author of the famous treatise Wigmore on Evidence--to draft
the first modern version of the SCRA, then known as the ``Soldiers' and
Sailors' Civil Relief Act.'' This Act instituted many of the
regulations that are central features of the modern law, including a
stay of civil actions and a prohibition of foreclosures upon the homes
of those on active duty.
Major Wigmore's Soldiers' and Sailors' Civil Relief Act expired 6
months after the end of World War I due to a sunset provision included
in the law. Thus, in 1940, as conflicts throughout the globe again
escalated into World War, Congress reenacted Major Wigmore's bill with
some amendments. At the time, Congressman Overton Brooks of Louisiana
reiterated the vital role the Act played in preserving the Nation's
defense and recognized the concerns the Act was intended to address.
This bill springs from the desire of the people of the United
States to make sure as far as possible that men in service are
not placed at a civil disadvantage during their absence. It
springs from the inability of men who are in service to
properly manage their normal business affairs while away. It
likewise arises from the differences in pay which a soldier
receives and what the same man normally earns in civil life.
The Soldiers' and Sailors' Civil Relief Act has been in effect
since it was reenacted by Congressman Brooks and others in 1940.
In April of 2003, as Operation Enduring Freedom in Afghanistan
progressed, the 108th Congress styled a complete restatement of the
Act. The bill received broad bipartisan support in the House Committee
on Veterans' Affairs, boasting as its sponsors then-Chairman
Christopher Smith of New Jersey and Ranking Member Lane Evans of
Illinois. In its Report to the House, the Committee expressly noted the
following:
Congress has long recognized that the men and women of our
military services should have civil legal protections so they
can ``devote their entire energy to the defense needs of the
Nation.'' With hundreds of thousands of servicemembers fighting
in the war on terrorism and the war in Iraq, many of them
mobilized from the reserve components, the Committee believes
the Soldiers' and Sailors' Civil Relief Act (SSCRA) should be
restated and strengthened to ensure that its protections meet
their needs in the 21st century.
Among the protections recognized as necessary in modern society
were three rights directly implicated in the pending litigation
involving my clients: (1) a 6 percent cap of interest chargeable on
debts incurred prior to military service; (2) a prohibition of
derogatory reports to credit agencies due to eligibility of SCRA
protection; and (3) limitations upon the ability to foreclose upon
servicemembers' homes.
Once favorably reported to the House, the bill gained thirty-nine
(39) cosponsors from both parties and was passed by the full House by
425-0. The Senate passed similar legislation with the leadership of
Senator Lindsey Graham from my home State of South Carolina and the
differences between the two bills were negotiated without need of a
conference committee. On December 19, 2003, President George W. Bush
signed into law the now-restyled ``Servicemembers Civil Relief Act.''
b. Experiences of Captain Rowles and Sergeant Holloway
The litigation in which we are involved began after Jonathon Rowles
and his wife, Julia, endured several years of frustration regarding
their home mortgage with Chase Home Finance, LLC. Our law firms filed
this lawsuit on behalf of Captain Rowles in July of 2011. Over the past
several months, we have been contacted by numerous military personnel
who have experienced similar denials of SCRA protection from Chase's
subsidiaries. Last month, we filed an amended complaint, adding
allegations on behalf of Sergeant Holloway.
Our research revealed what we believed to be systematic failures in
the maintenance of SCRA protections pertaining to three classes of
military men and women: (1) those denied the 6 percent maximum interest
rate on debts incurred prior to military service; (2) those who
received a blighted credit report as the result of their invocation of
SCRA protection; and (3) those whose homes were foreclosed upon despite
SCRA protection.
A review of the basic facts pertaining to each plaintiff is helpful
in explaining how these violations came about.
In February of 2004, the Jonathon and Julia Rowles entered into a
purchase money mortgage with BNC Mortgage, Inc. In May of 2004, Chase
Manhattan Mortgage Corporation purchased this loan and, from that point
in time, the Rowleses made all payments to Chase. After a year of
making payments on this mortgage, Jonathon Rowles executed a United
States Marine Corps Reserve contract on August 16, 2005, and received
Assignment to Active Duty Orders which became effective on January 22,
2006. Shortly thereafter, Rowles requested in writing that Chase reduce
the interest rate on the loan to 6 percent pursuant to the SCRA. In
this letter, Rowles specified January 22, 2006, as the date he entered
active duty and produced two sets of orders to verify his current
status. Again on May 2, 2006, Rowles wrote to Chase to request the 6
percent rate protection under the SCRA. This letter also specified
Rowles' active duty date and included additional copies of his orders
and a copy of his previous letter.
On May 8, 2006, in response to this series of correspondence, Chase
requested that Rowles provide ``orders and/or an enlistment agreement
showing the date of original call to duty.'' Again Rowles sent faxes to
Chase customer service representatives that included handwritten cover
sheets explaining his active duty orders as well as copies of his
letters of April 14 and May 2. In a letter dated July 27, 2006--seven
months after Rowles received his active duty orders--Chase informed
Rowles that because he had qualified for the protection of the SCRA,
the company had adjusted the interest rate on the loan to 6 percent
effective with his May 1, 2006, payment. However, Chase failed to apply
the statutory interest rate to the loan until August 17, 2006, which
was the date of the first statement received by Rowles that reflected
the 6 percent rate.
The July 27 letter also informed Rowles that his ``loan is
protected against late fees, adverse credit reporting, and default
activities. These protections will remain in effect for 90 days
following your return from active duty.''
Though Rowles' SCRA protection had been in place for less than 4
months, Chase mailed Rowles a letter on December 1, 2007, which it
characterized as a ``required quarterly verification.'' The letter
included a form which Rowles was instructed to complete and sign in
order to continue to receive the protection of the SCRA. Rowles duly
completed the form and returned the letter to Chase. Chase sent
additional verification letters on December 17, 2008, March 25, June
22, and December 29 of 2009, and March 22, 2010. In addition to the
periodic verification letters, no fewer than four times per year since
July of 2006, Rowles has had to call various Chase customer service
representatives after being verbally informed or receiving
documentation indicating that the interest rate on the loan was going
to be adjusted above 6 percent if he failed to do so. In March of 2008,
Rowles was forced to request that his commanding officer at Training
Squadron Eighty-Six in Pensacola, Florida, write to Chase on his behalf
in order to confirm that he was in fact an active duty Marine.
In a letter dated January 16, 2007, Chase again informed Rowles
that he had qualified for the protection of the SCRA and that the
company had accordingly extended the adjustment on the 6 percent
interest rate effective February 1, 2007. On April 2, 2008, Chase
informed Rowles in writing that the company was ``in receipt'' of his
``request for relief'' under the SCRA and that he should allow three to
four weeks for review of the request. A subsequent letter dated April
25, 2008, again informed him that his rate adjustment would be extended
effective October 1, 2008.
From the time that Chase applied the 6 percent interest rate to the
loan until April 2009, Chase would send loan statements to the Rowles
family indicating the interest rate charged on their loan was, in fact,
substantially above 6 percent. On information and belief, during this
time Chase would use various formulas and accounting methods to
reconcile the higher stated interest rates while effectively only
charging Rowles at 6 percent.
This pattern of conduct by Chase caused Rowles to spend
considerable time communicating with Chase via telephone, e-mail, and
written correspondence. This time included leave from his unit which
was spent traveling to meet with Chase representatives in an effort to
preserve his 6 percent interest rate under the SCRA and to prevent
Chase from taking threatened actions which are unlawful under the SCRA.
Finally, in June of 2010, Chase denied Rowles electronic access to his
account. Thereafter Rowles brought this suit.
The circumstances giving rise to Sergeant Holloway's allegations
are much more brief, but gave rise to an injury perhaps worse than that
of Captain Rowles and his family. On March 30, 2000, Holloway purchased
a house located in Fountain Inn, South Carolina. At the time of the
purchase, Plaintiff Holloway was not on active duty. The purchase was
financed by NVR Mortgage Finance, but the loan was thereafter
transferred to Chase for servicing. In 2008, Chase initiated
foreclosure proceedings against Holloway's home which resulted in a
foreclosure sale on May 4, 2009. Holloway was serving on active duty at
the time of the sale. Today Sergeant Holloway is serving with the Army
Reserve in the Afghanistan theater. His mail is addressed to his
parents' home.
c. Details of the Proposed JPMorgan Chase Settlement
After Captain Rowles brought to light the potential systematic
failure of internal SCRA procedures at JPMorgan Chase, Chase began an
extensive internal review to determine the extent of the mistakes made.
That review, combined with the efforts of Captain Rowles and Sergeant
Holloway, has resulted in a settlement that was reached after several
months of intense negotiations that were supervised by a retired
Federal judge.
While this settlement is awaiting final approval of the District
Court--the hearing of which has been scheduled for November 15, 2011--
the details of the proposal have been made public. In sum, Captain
Rowles, Sergeant Holloway, and Chase have agreed to a benefits package
amounting to $48 million of relief to the military men and women who
were denied SCRA benefits. This figure amounts to an estimated six
times the actual damages suffered by the class members, including
refunds of overcharges, full remediation of damage to credit, and
remediation of all foreclosure actions.
To its credit, JPMorgan Chase has begun instituting many of these
reforms even prior to the final approval of the settlement. Chase has
also asked Captain Rowles to serve as an informal advisor to several of
its senior officers, providing the company with a ``boots on the
ground'' perspective of how its policies affect our men and women in
the military.
II. Systematic Problems Revealed by the Rowles Litigation
The immediate effect of SCRA violations on our military men and
women are obvious. Unlawful foreclosures force families from their
homes. Derogatory reports to credit agencies damage the ability of our
soldiers and sailors to enter into future financial agreement.
Excessive charges of interest demand monies which are not owed.
Perhaps more damaging than these immediate effects, however, is the
financial stress endured by military families while their loved ones
serve on active duty. As the stories of Captain Rowles and Sergeant
Holloway show, the spouses, parents, and children of our military men
and women are those that inevitably bear the brunt of SCRA violations.
While her husband was deployed to Korea, Julia Rowles was forced to
negotiate with Chase representatives while caring for a small child and
pregnant with another. While he was serving in a war zone, George
Holloway was powerless to protect his home as foreclosure crept closer.
I began this written testimony by referring to the stated policy of
the SCRA: ``to enable [servicemembers] to devote their entire energy to
the defense needs of the Nation.'' Violations such as those suffered by
our clients directly defeat this purpose. While on active duty, our
soldiers have limited time to so much as contact their families. Sadly,
it appears that over the past few years several thousand men and women
like Captain Rowles and Sergeant Holloway were forced to spend what
personal time they did have on the phone with banking officials seeking
an explanation why their families were being overcharged interest or
why their home was being foreclosed.
Obviously companies like JPMorgan Chase need to do more to ensure
that their internal procedures are refined to ensure that all
servicemembers entitled to SCRA protection enjoy those rights. As Chase
has shown with the settlement terms now pending in Federal court, it
has made the affirmative decision to lead the way in the financial
industry in crafting more reliable SCRA policies and procedures. But
based on my experience in this case over the past year, I believe there
are measures that Congress can take to produce an atmosphere in which
SCRA violations are greatly reduced. Below are three problem areas that
can be addressed.
a. Lack of reliable information regarding servicemember status
As Captain Rowles' situation demonstrates, one of the primary
problems with SCRA protection is that it can be difficult for the
financial companies to determine when the ``active duty'' status of
servicemen ends. As a result, account managers resort to calling the
families of men and women in the military to obtain some sort of
verification as to whether the borrower in question is, or is not,
still ``active duty.'' This repeated contact, however, violates the
very spirit of the SCRA.
b. Lack of JAG manpower sufficient to protect civil rights
Many of the SCRA-protected individuals with whom I have spoken have
emphasized two things: first, the staff at their bases or posts do an
excellent job of educating them on their SCRA rights; but second, once
a problem arose with their home mortgages, insufficient staff existed
to help these servicemen negotiate resolutions with the various home
finance companies.
Our clients and those servicemen I have spoken to all speak very
highly of the JAG services that they receive. However, these attorneys
are often heavily burdened with other tasks associated with their duty
and do not have the ability to dedicate sufficient time to SCRA
problems.
c. Lack of incentives to adjust mortgages that can be saved
After my testimony before the House Veterans' Affairs Committee in
February, I received phone calls from hundreds of service men and women
about problems they were experiencing with their mortgage. Some of
these folks were entitled to SCRA benefits and some were not. But
during my many conversations I noticed a disturbing trend of borrowers
who had become no more than a handful of months delinquent on their
loans only to be threatened with foreclosure.
There appears to be an atmosphere within the home finance market
that incentivizes foreclosures and discourages modifications. Numerous
servicemen I spoke with offered to increase their payments over a
period of 6 months or less to become current on their loans. As a
matter of routine, however, the financial institutions replied that
these men and women immediately pay the balance of the loan--an option
that is impossible for almost every American--or face accelerated
collections or even foreclosure.
Within the State of South Carolina, this problem has reached
epidemic proportions. In fact, on May 9, 2011, our State Supreme Court
Chief Justice entered an administrative order dramatically altering the
means by which foreclosures are litigated in this State. Now, before
any foreclosure proceedings can proceed, a financial institution must
certify:
(a) that the Mortgagor has been served with a notice of the
Mortgagor's right to foreclosure intervention for the purpose
of seeking a resolution of the foreclosure action by loan
modification or other means of loss mitigation;
(b) that the Mortgagee, or its designated agent, has received
and examined all documents and records required to be submitted
by the Mortgagor to evaluate eligibility for foreclosure
intervention;
(c) that the Mortgagor has been afforded a full and fair
opportunity to submit any other information or data pertaining
to the Mortgagor's loan or personal circumstances for
consideration by the Mortgagee;
(d) that after completion of the foreclosure intervention
process, the Mortgagor does not qualify for loan modification
or other means of loss mitigation, in accordance with any
standards, rules or guidelines applicable to the mortgage loan,
and the parties have been unable to reach any other agreement
concerning the foreclosure process; and
(e) that notice of the denial of loan modification or other
means of loss mitigation has been served on the Mortgagor by
mailing such notice to all known addresses of the Mortgagor;
provided, that such notice shall also state that the Mortgagor
has 30 days from the date of mailing of notice of denial of
relief to file and serve an answer or other response to the
Mortgagee's summons and complaint.
A copy of this order has been attached to my testimony for your
review (See, Exhibit A).
III. Suggestions for More Diligent Enforcement of SCRA
The systematic failure of SCRA protections in the Rowles litigation
is evidence that the enforcement provisions of the SCRA deserve
reconsideration. In our review of the law and its application over the
last 6 months, we believe that there are three areas Congress may
improve to strengthen the SCRA in hopes of preventing such failures in
the future.
a. Cooperation between the Department of Defense and financial
institutions
As noted above, much of the strain suffered by Jonathon and Julia
Rowles was the result of continuous contact from JPMorgan Chase
officials seeking written verification that Captain Rowles was still on
active duty and thus entitled to SCRA protection. There is no provision
of the SCRA that permits a financial institution to demand such
verification and the Rowles believe that Chase was overly aggressive in
pursuing it. At the same time, however, JPMorgan Chase and other
financial institutions undoubtedly wish to protect themselves from the
potential of fraud, namely a servicemember continuing to receive SCRA
benefits long after he or she has been deactivated.
A solution for this quandary could be found in the creation of a
liaison office within the Department of Defense designed to work with
financial institutions to certify when servicemembers are--or are not--
on active duty. Such an office would provide the financial institutions
with the information needed to determine whether to apply SCRA
protections while relieving the servicemembers and their families from
the burden of continuously updating their status.
b. Stronger emphasis on legal support for servicemembers
Every single class member with whom I have spoken has noted his or
her gratitude for the assistance they have received from JAG officers.
However, it appears that JAG is often unable to render remedial SCRA
support to servicemen that experience problems with their home loans.
This could be due to several reasons. Obviously lack of manpower
hinders any ability to respond to this type of situation. But also, JAG
officers may not be licensed to practice in the civilian courts in
which their fellow soldiers are experiencing difficulty. For example, a
JAG officer assigned to Fort Jackson, South Carolina may receive an
SCRA question from a solider about to lose his home to foreclosure in
California. It would be highly unusual for that South Carolina-based
officer to be licensed to appear on behalf of the soldier in the State
of California to contest the foreclosure. Even if the officer was
licensed to do so, transporting him or her across the country for this
one event may not be practical.
In my opinion, Congress should examine two possibilities that may
alleviate this situation. First, determine whether JAG possesses
sufficient manpower to adequately address remedial needs of servicemen
who need to assert their SCRA protections. Second, examine partnership
efforts that can be formulated between JAG and State bar associations
who would be, I am sure, willing to offer pro bono services to the
military in order to help enforce SCRA rights.
c. Incentivize mortgage modification and discourage foreclosure
Congress should reexamine the incentives in place that either
encourage, or discourage, loan modifications. As I noted above, many
servicemen have offered to accelerate their loan payments over a series
of months in order to become current on their obligations to the
various financial institutions. Yet they report what seems to be a
disturbing trend of preferring foreclosure and/or collections to
preserving the terms of a loan.
Federal insurance of mortgages may contribute to this reverse
incentive. While the specifics of mortgage finance are not my
professional specialty, it appears that the guaranteed payment
financial institutions receive from entities such as FHA may be
encouraging foreclosure rather than loan modification. While I in no
way suggest that such programs be terminated, I do think that
considering modifications to these programs that would incentivize loan
modification could alleviate many of the problems that servicemembers
are now facing with their mortgages. Consideration of several
prerequisites to foreclosure as instituted by the South Carolina Chief
Justice (see, Exhibit A) may serve as a useful starting point.
Conclusion
I would again like to thank the Committee for the opportunity to
speak on behalf of our clients and on behalf of the thousands of
servicemen and servicewomen who have fallen victim to SCRA violations
in the last several years. As the SCRA recognizes, its protections are
essential to our national defense. It is my hope that Congress will
take all steps necessary to ensure the continuing vitality of this law.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN
MENENDEZ FROM DIANE E. THOMPSON
Q.1. In your testimony, you provide a stunning array of
specific examples of homeowners who have had terrible
experiences with mortgage servicers' actions, most of them
illegal. In your experience, how widespread are each of the
homeowner abuses you describe?
A.1. The abuses I catalogued in my May 12, 2011, testimony are
widespread. Every day, I hear examples of similar abuses.
Attorneys representing homeowners anywhere in the country have
similar experiences to relate.
Last December, in an attempt to quantify the scale of
servicer abuses, the National Association of Consumer
Advocates, in conjunction with NCLC, conducted a survey of
attorneys representing homeowners in foreclosure. That survey
found that almost 99 percent of the respondents were
representing a homeowner who had been placed into foreclosure
while awaiting a loan modification, almost 90 percent of the
attorneys surveyed were representing a homeowner who had been
placed into foreclosure despite making payments as agreed, 87
percent of the attorneys were representing clients who had been
placed into foreclosure due to a servicer's improper failure to
accept payments, over 50 percent reported representing
homeowners who had been placed into foreclosure as a result of
forceplaced insurance alone, with similar figures reported for
the impact of illegal fees and the misapplication of payments.
These figures suggest that all of these abuses are common.
My testimony provides illustrative examples of several
different kinds of abuses: the improper solicitation of a
waiver of some or all of a homeowner's legal rights; servicers'
failure to honor their agreements with homeowners, whether
permanent or temporary modifications or short-term payment
plans; the failure to timely convert a loan modification to a
permanent modification; foreclosing on homeowners who are
either awaiting a loan modification review or are in a
temporary or permanent loan modification; misapplication of
payments, improper assessment of fees, and abuse of suspense
accounts; and a failure to offer homeowners a loan modification
that would have benefited the investor. In my experience, all
of these abuses are so commonplace as to be unremarkable were
they not so appalling.
Q.2. Ms. Goodman, Senior Managing Director of Amherst
Securities, stated in her testimony that mortgage servicers
should be required to offer borrowers the loan modification
that has the highest net present value for the investor, not
just any modification that has a higher net present value than
foreclosure. Do you agree with that?
A.2. We agree with Ms. Goodman's proposal that servicers be
required to offer a loan modification with a principal
reduction where a loan modification with a principal reduction
offers a greater return to investors than a modification
without a principal reduction. The failure to make the HAMP
Principal Reduction Alternative mandatory where the principal
reduction offers a greater net present value to investors than
a conventional HAMP modification is illogical and harms both
borrowers and investors.
We would oppose any requirement that the servicer be
required to offer borrowers only the loan modification that has
the highest net present value for investors in all
circumstances. There are many circumstances in which the loan
modification that is most responsive to the homeowners' needs
may not be the one that returns the highest NPV to investors.
Indeed, such a rule might impede settlement of litigation and
interfere with judicial oversight of foreclosure mediation.
Moreover, we are not sure that such a rule would in all
cases serve the interests of investors. We are unsure the
extent to which the NPV test accurately measures the value of
an increase in the sustainability of a loan modification.
Recent data from the OCC-OTS Mortgage Metrics Report supports
our experience that providing deep payment cuts, reducing
principal significantly, and otherwise structuring loan
modifications to ensure long term affordability results in
improved outcomes and lowered redefault rates. Unless the
redefault rate used in the NPV test dynamically takes into
account the offered terms of the loan modification, the NPV
test will likely understate the positive return to investors
from a loan modification that provides for greater
sustainability.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN
MENENDEZ FROM LAURIE F. GOODMAN
Q.1. Can you suggest any methods of doing principal reductions
for homeowners that would avoid moral hazard? Please explain
how moral hazard would be avoided.
A.1. We have to stop thinking of borrowers making moral
choices, and start thinking of borrowers as making economic
choices. Once we recognize that they are making an economic
choice, we can design an incentive structure where borrowers
who need the principal reduction to stay in their home are able
to obtain it, while those that don't need the principal
reduction are not envious of those who received it.
Here are a few possibilities:
Make it clear that if the borrower accepts a
principal write-down, there is a well established set
of costs. These costs could include either (1) a shared
appreciation feature, in which the borrower shares any
future appreciation with the lender; or (2) a Federal
tax levy of 50 percent on any future appreciation on
the property. The tax levy is the conceptual equivalent
of a shared appreciation mortgage, except the borrower
share the upside with the Government. We believe a tax
would be easier to implement on a broad scale than a
shared appreciation feature.
If the borrower accepts a modification, there is an
appropriate ``ding'' to one's credit rating.
To discourage ``economic defaulters'' who can
easily afford their home, lenders will pursue
deficiency judgments to the extent possible.
Let's look at the impact of these actions. A borrower at a
150 percent loan-to-value ratio would have been apt to default.
By giving the borrower a principal reduction to say, 115
percent LTV, the borrower is able to stay in his home. A shared
appreciation mortgage would be acceptable to the borrower, as
that is the only way he can afford to continue to own and live
in the home.
A borrower with a 120 percent LTV, who is paying his
mortgage, wonders if he, too, should go delinquent in order to
obtain a principal reduction. By making the costs of the
principal reduction explicit (a shared appreciation mortgage, a
ding to a borrower's credit rating), the borrower at 120 LTV
would make the rationale decision not too default. He would
look at the deal his neighbor received, and decide that he
wouldn't take a principal reduction on these terms. That is, in
order to receive a principal reduction from 120 LTV to 115 LTV,
the borrower would have to share his appreciation with either
the lender or the Government--too large a cost for the limited
benefit.
Again, the best way to combat the moral hazard issue is to
think about a set of economic frictions designed such that the
borrower who can afford to pay continues to do so, and the
underwater borrower who cannot afford to pay his mortgage is
entitled to a principal reduction (assuming the modification is
NPV positive).
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN
MENENDEZ FROM DAVID H. STEVENS
Q.1. Ms. Goodman, Senior Managing Director of Amherst
Securities, stated in her testimony that mortgage servicers
should be required to offer borrowers the loan modification
that has the highest net present value for the investor, not
just any modification that has a higher net present value than
foreclosure. Do you agree with that?
A.1. Ms. Goodman indicated in her testimony that servicers
should be required to perform principal write-downs on HAMP
modifications if they present the highest net present value
[NPV]. She suggested this would mandate principal write-downs
over other loss mitigation options. MBA does not support
mandatory principal write-downs.
The proposal would require bondholders and lien
holders, not merely servicers, to accept principal
write-downs. As evidenced by the lack of significant
principal reductions by portfolio lenders and
Government agencies, there is not a uniform view that
principal write-downs are the most economical response
for lien holders.
Rate and term modifications and principal
forbearance modifications offer the borrower the same
affordability during his or her period of hardship, as
a principal reduction, but without the permanent
impairment to the mortgage asset for the lien holder.
As a result, a borrower who ``must'' receive a
principal reduction to remain in the home in addition
to the same affordable payment through other means
(such a principal forbearance) is a strategic
defaulter. Strategic defaults should be discouraged,
not encouraged.
The NPV does not test whether a policy, such as
principal reduction, will result in greater numbers of
defaults, thus greater overall losses to lien holders.
If there is a high level of debt forgiveness created by
this standard, it is going to increase default
frequency associated with high LTV loans. This in turn
impacts the NPV assumption, predicting a higher default
rate on high LTV loans, thus perpetuating (or self-
fulfilling) the appearance that principal reductions
are the necessary and best outcome. MBA along with many
others believe that principal write-downs will cause
more delinquencies and ultimately increase the severity
of losses.
The proposal does not offer indemnification from
risk for a servicer who performs a principal reduction
on behalf of a trust. HAMP safe harbor may not be
sufficient protection to alleviate such risk. A mandate
to write down would be a taking and could subject the
servicer to litigation risk.
Some PSAs prohibit principal reduction. We do not
believe Ms. Goodman's proposal should or will change
the ultimate authority of the transaction documents
over HAMP.
In general, efforts could be made to discourage
strategic defaults by reversing the exemption to the
discharge of indebtedness tax rules for principal
residences created by the Mortgage Forgiveness Debt
Relief Act of 2007. Prior to this Act, an individual
would be subject to ordinary income taxes on the amount
of mortgage debt discharged or written down, unless the
person was insolvent. With the current exemption to
this rule for principal residences, borrowers benefit
even more from a principal reduction than a principal
forbearance--despite the forbearance achieving an
``affordable payment'' for the borrower.
This greater the incentive of a principal write-down, the
greater the impact on default rates--a critical factor
that drives the outcome of the NPV calculation. As
previously stated, if Congress wishes to discourage
strategic defaults, it could reinstate the discharge of
indebtedness rules for principal residences.
Individuals would be taxed on the amount of discharged
debt to the extent he or she was solvent. The change
would start to equalize the incentives between
principal write-downs and principal forbearances by
reducing the strategic default incentive.
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN
MENENDEZ FROM ANTHONY B. SANDERS
Q.1. Ms. Goodman, Senior Managing Director of Amherst
Securities, stated in her testimony that mortgage servicers
should be required to offer borrowers the loan modification
that has the highest net present value for the investor, not
just any modification that has a higher net present value than
foreclosure. Do you agree with that?
A.1. No Response provided.