How Not to Make a Mortgage Servicing Settlement: Lessons from '08

In October 2008, 11 state attorneys general settled a lawsuit with Bank of America Corp. that was supposed to provide relief for up to 400,000 homeowners.

Two of the states hardest hit by the foreclosure crisis, Nevada and Arizona, are suing B of A, alleging that the bank is not performing the loan modifications required by the settlement, which the two states (along with 31 others) ultimately joined. The company has denied the allegations in both suits and said it will fight them in court.

For the 50 state attorneys general now seeking redress — and a lot more of it — from the entire servicing industry, enforcement is crucial if the servicers are to be kept from succumbing to the myriad conflicts of interest inherent in the foreclosure process.

"For the past three years we have had all manner of policies designed to promote better, more responsible mortgage servicer behavior, and the main reason that it hasn't happened is that there hasn't been better enforcement," said Kevin Stein, associate director of the California Reinvestment Coalition, an advocacy group for low-income communities. "You can require performance — that sounds great, but if there is no enforcement, it doesn't mean anything."

Many attorneys general might not be set up to do enforcement, said Alan White, a professor at Valparaiso University Law School. "Part of the problem with these attorneys general settlements is that they don't have the staff or the will to really do ongoing monitoring and enforcement," White said. "Their agenda is to move on to the next abuse."

The 2008 settlement was intended to resolve alleged violations of state consumer protection laws against B of A's Countrywide subsidiary, then newly acquired. It contrasted with earlier ones that resulted in monetary damages for alleged predatory lending; it was supposed to save hundreds of thousands of homeowners from foreclosure through mass loan modifications.

Although an $8.4 billion figure made it into attorney general press releases and newspaper articles, it was only an estimate by B of A and not a requirement of the settlement, which mandated that the bank modify loans for 50,000 borrowers, not 400,000 — another estimate from press releases.

To comply with the settlement, B of A set up the National Homeownership Retention Program, which prefigured the federal Home Affordable Modification Program.

The separate lawsuits of the Arizona and Nevada attorneys general against B of A echo today's growing chorus of consumer complaints against the mortgage servicing industry as a whole.

The lawsuits claim that B of A misled customers covered by the settlement with false assurances that their homes would not be foreclosed on while their requests for modifications were pending. They also say that B of A engaged in bait-and-switch tactics with different terms of mortgage modification offers to borrowers. In addition, the AGs charge that B of A denied modifications to homeowners using inaccurate and deceptive reasons.

According to White, a major problem with the 2008 Countrywide settlement and with current loan mod efforts is that they fail to address servicer conflicts of interest.

One of the most notable such conflicts, according to White, is the enormous second-lien loan portfolios on the balance sheets of large servicers. "The whole dilemma is that you need to wipe out second mortgages completely," White said. "It should be something on the order of 10 cents on the dollar."

The Countrywide settlement covered first-lien loans that B of A serviced, but it did not cover the second-lien loan portfolio that B of A inherited from Countrywide. And although B of A has the largest portfolio of second liens in the country, it owned only 12% of the first-lien loans covered by the Countrywide settlement.

According to the Nevada suit, B of A has financial disincentives that stand in the way of its commitment under the Countrywide settlement to modify loans. "Bank of America earns substantial late fees and other default-related fees, which operate as disincentives to modify mortgages so that borrowers can afford to remain current on their obligations," the suit states. "The fact that Bank of America and other servicers hold second-lien loans on many of these mortgages may explain their reluctance to pursue certain modifications involving principal forgiveness, which would require them to recognize losses on these second liens."

Despite the various alleged conflicts of interest that B of A had in servicing the loans covered by the National Homeownership Retention Program, the Countrywide settlement left the administration of the program largely up to the bank.

For example, according to the settlement, a loan mod offer made by B of A in its role as servicer could be turned down if the investor or group of investors that actually owned the mortgage failed to approve the modification. But B of A was in charge of securing investor approval for the loan modifications.

Investor disapproval turned out to be one of the major reasons B of A gave when denying modifications to homeowners eligible for the National Homeownership Retention Program, according to the Arizona and Nevada suits. (Investor disapproval also has been a common reason that servicers have given for denying loan mods under Hamp.) But, according to the Nevada and Arizona AGs, while B of A refused to approve loan mod requests on the grounds that investors would not approve them, the bank, in fact, had in some instances received the delegated authority to make such decisions.

In other instances, B of A failed to make best efforts to get investor approval for mods as required by the settlement, the attorneys general said.

Shirley Norton, a B of A spokeswoman, said the company is "the only servicer that voluntarily initiated a 50-state foreclosure moratorium to review our procedures, and ensure that our processes are accurate and fair. We have modified 725,000 home loans nationwide, and approximately 30,000 of these were in Arizona."

One investor in mortgage securities covered by the Countrywide settlement said that B of A never went through the procedures for obtaining approval or disapproval on loan modifications on the mortgages in the securities he owned.

"I know of absolutely no attempt by Bank of America to reach out to investors either through formal or informal channels," said William Frey, the CEO of Greenwich Financial Services, a money management company.

According to Frey, many of the pooling and servicing agreements governing the securitizations already allow for a certain amount of loan modifications, and for those that do not, there are procedures for changing them to allow for mods.

Frey said he would welcome sustainable loan modifications for borrowers who could afford them. However, he said a misunderstanding of the mortgage servicing business is getting in the way of a workable solution. "It is in the interest of the servicer to drag it [default servicing] on forever," he said, "because they get late fees, and they bill a lot of the costs to the loan."

There are indications that with the new proposal by the 50 attorneys general, some of the fallout from the original Countrywide settlement is being addressed. Talcott Franklin, an attorney who has represented investors in loan put-back cases against the banks, said that he and a group of investors made a PowerPoint presentation to the AGs offering ways to reform the mortgage servicing industry.

Franklin said some of the suggestions from the presentation made it into the proposal of the state attorneys general, albeit in weakened form. Other suggestions did not make it in, such as an independent mediator who could arrange a voluntary pre-bankruptcy cramdown for overleveraged borrowers.

For any future settlement to work, Franklin said, it is essential to get the servicing decisions out of the control of the big banks. "If you have the same old people doing the same old things, you can pretty much expect a bad outcome," he said. "What makes the AGs think that they can trust these guys any more than they could last time?"