The Proposed Servicing Settlement, Through Servicers' Eyes

Privately, mortgage servicers are fuming.

The proposed settlement agreement with state attorneys general and federal regulators, the companies will tell you, is unfair and impracticable. It’s hard to see them convincing government officials of the former argument, given public outrage over the robo-signing scandals and the many other revelations of incompetence and conflicts of interest in this once-obscure corner of financial services. But the industry’s latter objection could make this story a little more interesting.

To be fair, we’ll present the no-fair position. Servicers are chafing at the idea of paying out billions in a settlement with regulators because they claim very few borrowers have been wrongly foreclosed upon or were harmed by last year’s robo-signing scandal. Servicers delayed tens of thousands of foreclosures in the 23 states where the process is handled in court. They argue that the vast majority of borrowers in these cases had stopped paying their mortgages, were in default on their loan and had been living in the home for free during the foreclosure process. While servicers have admitted there was procedural misconduct in the shoddy paperwork submitted to courts, they claim the proposed penalty of upwards of $20 billion is disproportionate to the alleged crime.

Wishful thinking? Perhaps. The industry’s complaints get more nuanced and harder to dismiss out of hand when it comes to how the regulators’ proposal would be put into practice.

Lawyers for the servicers maintain that the proposal does not distinguish between loans a bank services for itself and a loan it services for others. And servicers insist they don't have the authority under the pooling and servicing agreements governing securitizations to do a great deal of what the proposal calls for them to do.

The servicers say they are not authorized by PSAs to make principal reductions on loans held in private-label securities, as the draft settlement calls for them to do, so the companies argue it is unclear if a proposed government settlement would override such contracts.

Industry lawyers are saying the AGs are "shooting the messenger." But the industry has been pinning the blame for the glacial pace of loan mods on the alleged straightjacket of the PSA for several years now. And when pressed, officials quietly acknowledge that no one at a servicer ever goes back to the investors asking for authority. (It's also worth noting that the regulators' term sheet does try to address the issue. If a borrower requests a modification and the servicer believes the PSA prevents one, the servicer must still perform a net present value test and, when that test indicates a mod would be less costly than foreclosure, present that result to trustees or other authorized parties to obtain consent for a modification.)  

Principal reductions have been a bone of contention for a long time because banks, servicers and investors do not want to take the losses. Moreover, servicers say that many borrowers who signed up for loan modifications either did not qualify or refused to provide documentation. Lawyers say that unless there is an inquiry into which borrowers were victims of unscrupulous origination practices by lenders, there is no way to determine which borrowers should get principal reductions.

Careful what you wish for?