Servicing Rules Could Force Institutions Out of the Business

The Consumer Financial Protection Bureau's new mortgage servicing rules may force some servicers to exit the business altogether or simply outsource servicing of defaulted loans to third-parties, experts said Thursday.

In many ways, the sweeping rules were as industry players expected, cracking down on everything from how servicers communicate with delinquent borrowers to when they can initiate a foreclosure proceeding.

But some servicers said the rules, which were released Thursday and go into effect in a year, might still upend the current business model, with many lenders deciding the cost to comply with the regulations is too prohibitive.

"Servicing has become a very expensive endeavor and I suspect some servicers are looking at offloading some servicing," said Jeff Hulett, an advisory managing director at KPMG's mortgage and consumer lending practice. "CFOs are looking very hard at cost per loan and that has gone up dramatically. This may encourage movement (of mortgage servicing rights) between banks and non-bank servicers."

That is particularly true for non-bank mortgage servicers that were not subject to the national consent orders by the Office of the Comptroller of the Currency or the national mortgage settlement with the top five bank servicers. Much of the new rules were based on those settlements, CFPB officials said.

Servicing practices also differ widely. The servicing regulations are so detailed, and more changes are on their way, that some servicers may have a problem changing processes or updating their technology. Training employees also will require added time and expense.

"You can't just turn on a lightswitch and expect this to run like clockwork," said Suzanne Garwood, an attorney at Venable. "The regulations are so detailed that it takes a while to get these processes in place. Some banks may sell servicing rights or exit servicing altogether. The biggest fear is if the servicers can really get everything together to be compliance in a year."

Still, not everyone saw the potential exodus from the business as a bad thing, saying the new rules could effectively create a better system.

"It creates an interesting opportunity for a change in the way servicing is done," said Steven Horne, president and chief executive of Wingspan Portfolio Advisors, a Dallas special servicer. "If servicers are incentivized to produce positive outcomes, it cleans up the inherent misalignment in the servicing model."

Others said the new rules may not have the large impact expected by the agency. They pointed to one of the toughest new requirements — that a servicer cannot start a foreclosure until a borrower has missed four mortgage payments — noting it may be mostly moot because foreclosure timelines are already so backlogged they stretch longer than 120 days.

Moreover, the CFPB's final rules mandate that servicers only "assign personnel" to delinquent borrowers. The agency did not make a change from its proposed rules that called for servicers to maintain "continuity of contact," with a borrower.

"The single point of contact is a different business model, it's more costly," said Hulett. "Typical servicing systems hadn't been set up to manage the business model that way."

Still, he and other industry experts said the industry is up to its eyeballs dealing with a slew of new regulations including the CFPB's qualified mortgage rule issued last week that will determine the strategy banks and servicers will take going forward.

The largest mortgage servicers, including Wells Fargo (WFC) and JPMorgan Chase (JPM), declined to comment on the new rules.

In a field hearing on Atlanta designed to tout the new rules, CFPB Director Richard Cordray said large changes were necessary because the basic structure of the servicing market makes it hard for borrowers. Loans often are transferred from one servicer to another and servicers are paid by investors, including government agencies like Fannie Mae and Freddie Mac, and not by the borrowers themselves.

"Normal market forces do not work well for consumers," Cordray said.

The CFPB has fielded more than 47,000 complaints about mortgages in the second half of 2012, and more than half were related to problems borrowers had when they were unable to make a mortgage payment. The CFPB said as many as 10 million borrowers are at risk of foreclosure.

The hearing served to highlight the problems the CFPB was attempting to address. Packed with distressed homeowners and their lawyers, they detailed cases in which servicers failed to correct errors promptly, resulting in excessive fees charged to borrowers and even defaults. One Atlanta Legal Aid lawyer described a 70-year-old borrower whose home has been scheduled for a foreclosure sale eight times — yet the borrower still remains in the home trying to get a loan modification.

"The biggest mess here is the tracking of all the documents going back and forth between the borrower and the servicer," said John Beggins, president and chief executive of Specialize Loan Servicing, a Denver third-party servicer, who spoke on a panel at the field hearing. "There is significant expense and operational changes that need to be done."

But a key challenge for Cordray and the CFPB remains enforcement. The agency's enforcement authority includes the ability to enact civil penalties of banks and non-banks alike, including requiring restitution to consumers based on the severity of the problem, a senior CFPB official said.

The CFPB also plans to issue requirements next month on how servicers properly transfer loans to other servicers, which can wreak havoc on borrowers in the process of getting a loan modification.

Joe Lynyak, a partner at Pillsbury Winthrop Shaw Pittman LLP, said servicers are concerned about penalties if they miss certain deadlines. For example, under the final rules servicers must review and respond within 30 days to any completed loss mitigation application that is received 37 days before a foreclosure sale.

"The failure to meet these precise deadlines will become more problematic as we in the courts work through what the penalties mean and how to apply it," he says, adding that penalties likely are going to be "next year's problem.

"This year's problems are going to be capital outlays and personnel and IT considerations," he said.