Agencies Clash Over How to Create Federal Servicing Standards

WASHINGTON — If the Federal Deposit Insurance Corp. has its way, federal regulators would not wait for Congress to create national servicing standards, but instead write such rules as part of risk retention guidelines set to be released soon.

The agency's idea has divided the banking agencies, with the Federal Reserve Board and Office of the Comptroller of the Currency arguing risk retention is not the place for new servicing standards. But FDIC officials said that with all the problems in the servicing industry, regulators must act now.

"We shouldn't wait for legislation," said Michael Krimminger, FDIC acting general counsel, in an interview. "In Dodd-Frank, Congress instructed us to apply the risk retention rules to help ensure high quality risk management practices, and servicing standards are critical to achieve this. If Congress wishes to adopt further servicer standards that may be a good thing, but we have a rule in Dodd-Frank that applies across the board."

Regulators largely agree on the need for new servicing standards, but disagree on how and when to create them. Fed Gov. Dan Tarullo first called for such standards at a Dec. 1 hearing, and the concept has been endorsed since then by Treasury Secretary Tim Geithner and lawmakers such as Rep. Barney Frank, D-Mass.

FDIC officials argue the risk retention rules are the perfect opportunity to write servicing standards.

The Dodd-Frank Act orders the Financial Stability Oversight Council to write rules that would require lenders to retain at least a 5% stake in any loan they sell to the secondary market, unless the loan meets a test for "qualified residential mortgages." Regulators have until April to finalize risk retention rules, but the agencies have so far delayed releasing a proposal.

"There are mixed views on how best to approach this among regulators," Krimminger said. "Our concern is we have the statutory vehicle to do it now, and it is critical to ensuring that risk retention can accomplish the goals set by Congress. We shouldn't do it by separate rules adopted regulator by regulator because that creates opportunity for arbitrage."

For example, the FDIC said regulators could create standards to realign compensation incentives for true loss mitigation and limit monthly payment advances by servicers unless there is a process other than foreclosure to repay the servicer for the advances. The FDIC is also seeking to require servicers to conduct their business for the benefit of all investors, rather than a particular class or tranche.

Although OCC and Fed officials declined to comment for this article, sources said that they question the legality of using risk retention to write new servicing standards. They would prefer to use another rule to craft such standards or leave the issue to Congress.

But other regulators may be leaning toward the FDIC's view. Sources said the Securities and Exchange Commission and Treasury are both favorable to the FDIC's plan.

Lawmakers are also weighing in. Rep. Brad Miller, D-N.C., a member of the House Financial Services Committee, is circulating a letter to colleagues that urges regulators to add servicing standards to the risk retention rule.

"The rules adopted pursuant to section 941 must, of course, require rigorous underwriting standards for 'qualified residential mortgages' or any other mortgages excepted from the risk retention requirement, but underwriting requirements are not enough," the letter says. "The rules must also address the servicing of securitized mortgages."

In an interview, Miller said he expects outgoing Financial Services Committee Chairman Barney Frank, among others, to sign the letter. He said it is clear servicing standards are linked to risk retention.

"It is hard to imagine that there would be effective regulation of securitization that does not address servicing issues," he said.

The banking industry, meanwhile, says putting servicing standards with risk retention rules is a mistake.

"Generally we are supportive of servicing standards but there is so much to do on risk retention that adding servicing standards is premature," said Paul Leonard, vice president of government affairs for the Housing Policy Council.

The American Securitization Forum "would not be supportive of including national servicing standards in the risk retention rules proposal," said Tom Deutsch, executive director of the American Securitization Forum. "That seems to be mixing apples and oranges. The legislative intention of the risk retention was really to create and better align the incentives between the issuer and investor. It was not intended... indicating that they were looking at it or approaching it for national servicing standards."

Pete Mills, a principal at Mortgage Banking Initiatives, Inc., said regulators are reaching if they attempt to combine the two ideas.

"There's no statutory framework for servicing reforms in the risk retention provisions of Dodd-Frank," he said. "So the agencies would essentially be writing new rules out of whole cloth. It just feels like it's a real bootstrap to me... For the regulators to move on this issue on their own, without any guidance from Congress, would be a real power grab. I also think it delays the risk retention rule unnecessarily."

Laurence Platt, a partner at K&L Gates, agreed.

"The statutory purpose of the [risk retention] rule is to encourage quality underwriting, which has nothing to do with quality servicing," Platt said. "There is nothing in the statute or the legislative history that supports the view that loan servicing and risk retention should be tied together."

But Miller said lawmakers intended to tie risk retention with servicing standards.

"This is all one in the same," he said. "The biggest problems in the foreclosure crisis and all the turmoil it has created in the housing market with homeowners, with the investors in mortgage backed securities, has been not just the poorly underwritten mortgages but the manner in which they were serviced."

The FDIC is gaining support for its plan among other industry players.

A group of 51 academics, financial analysts, and former regulators sent a joint letter to regulators supporting the FDIC plan.

"New securitization standards should be adopted now," the letter says. "The rules under the Dodd-Frank Act relating to disclosure and risk retention for securitizations, which apply to all market participants, are the place to start."

Josh Rosner, managing director of the research firm Graham Fisher & Co., signed the letter and said it was logical to combine risk retention with servicing standards.

"If the qualified residential mortgage rule and risk retention are intended to be the gold standard and Congress created the Dodd Frank Act for that purpose and left it to the regulators to define the right rules, this is entirely the right place to do it," Rosner said. "To do it here will create an industry standard securitized or otherwise. It creates the standard and they are not going to run two different sets of servicing platforms."

Ellen Harnick, senior policy counsel for the Center for Responsible Lending, said several problems could be addressed immediately, including conflicts of interests between servicers and various investors, different interests among the classes of investors, and confusion of servicer authority to modify loans.

"It's pretty urgent to get this in place and this is a logical vehicle to put it in place," she said. "Dodd-Frank does direct the regulators to consider mortgage attributes that either increase or decrease default risk and there is little question servicing problems increase default risk or increase the losses associated with defaults."

But Karen Shaw Petrou, managing director of Federal Financial Analytics, said risk retention rules wouldn't cover all mortgages.

"Not all mortgages are securitized and servicing is a significant issue," she said. "I thought their goal was to do a broader set of national servicing standards whether securitized or not and do that through other provisions of Dodd-Frank."

She said that regulators could pursue servicing standards in other rulemakings, including proposals governing systemically risky activity or settlement and clearing activities.

Jeffrey Naimon, a lawyer at BuckleySandler LLP, said there are a number of other ways servicing standards could be done but called risk retention the "single worst one." He said the new Consumer Financial Protection Bureau could write new servicing rules, for example.

"I don't understand why they would want to rush through this," he said. "It's actually really complicated and trying to get the compensation structures right for the business purposes and other purposes is going to take some work. Trying to do it along with risk retention is going to be a mistake and for a lot of what they want to do there is this new agency, the CFPB."

Industry representatives also warn that attempting to add risk retention and servicing standards together would delay the risk retention rule.

"I think any kind of national servicing standards would take a significant amount of time for discussion and the risk retention rules are required by Dodd-Frank to be finalized by April 15," said Deutsch. "That's just going to be too short of a period of time for there to be a robust discussion among regulators as to what standards would be appropriate, particularly since there is and intersection between federal law here as well as state laws."

Steve O'Connor, senior vice president of public policy and industry relations for the Mortgage Bankers Association, said the risk retention rule will be hard enough as it is.

"It would seem to me the QRM is sufficiently complex on its own that we don't need to layer on another massive new issue like national servicing standards," he said.

But Rosner and others said the servicing standards don't need to slow down risk retention.

"This part of the rule can be phased in over time so I think that argument is disingenuous and speaks to an unwillingness by the industry to move towards rational servicing standards," Rosner said.