Thursday, April 24, 2008

Death to the servicers!

(Naked Capitalism) As the housing/mortgage crisis has progressed, homeowner advocates and legislator have to get mortgage servicers to offer more loan modifications to struggling borrowers. Even though this housing recession has a far higher proportion of borrowers seriously underwater than past downturns, the logic of loss mitigation is still valid. It's still better for the bank to keep the homeowner in place, even at a reduced payment, than foreclose (although in some communities where home valued have plummeted, the banks seem content for the moment not to take action against defaulting debtors).

Some observers have taken the view that it's impractical for banks to negotiate on a case-by-case basis (gee, that's how they used to make loans and do workouts before they decided to go for efficiency at the expense of quality). And that may be a valid objection: serivcers are factories. Even by some affordable housing experts report that they are unable to do one-offs.

Another impediment is that securitized transactions often limit the ability of the servicer to do loan modifications (although no one seems to have good estimates on how often that is operative).

Last year's Treasury sponsored Hope Now Alliance was a cosmetic rescue program to address those issue, offering a "one-size-fits-few" template that was anticipated to offer servicers a legally defensible ground for making mods. However, few have happened.

Now legislators are considering another approach: require servicers to attempt loss mitigation before foreclosing. From Credit Slips:
n my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).

The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.

In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.

Mind you, I skimmed the text only quickly, but several thing stood out. This bill is clearly thought out, and is tough. Not only do the servicers have reporting obligations as discussed, but there are explicit requirements regarding communication with the borrower. For instance:
`(2) INCOME USED IN DETERMINING AFFORDABILITY- In making a determination of affordability for purposes of this subsection, a mortgagee or servicer shall use the income information furnished by the borrower at the time of loan origination, except that the borrower or mortgagor may elect to provide the mortgagee or servicer with current information and, if so provided, such current income information shall be used for purposes of determining affordability. The mortgagee or servicer shall advise the borrower or mortgagor of any right under this paragraph to provide current income information. If current income information is used, all sources of income shall be verified by tax returns, payroll receipts, bank records, or other third-party verification; the best and most appropriate documentation shall be used....

`(4) WRITTEN NOTIFICATION OF AFFORDABILITY CALCULATION- The mortgagee or servicer shall notify the borrower or mortgagor in writing of the results of the determination of affordability under this subsection and the income on which the determination was based. Such written notice shall be provided by mail not later than 7 business days after such action is taken or as part of the written notice required under subsection (c)(1), whichever is earlier.

The bill also permits servicers to recover "reasonable fees" (although they are subject to review) and applies to any "federally related mortgage loan that is secured by a lien on the principal residence of the borrower or mortgagor" that defaults after the bill is enacted.

My initial reaction is schadenfreude: the industry has brought this sort upon themselves. If it can't figure out a way to do mods despite the mounting pressure to do so (and in cases where a mod might be possible, lose/lose to borrower and investor for failure to do so), it will be imposed on them, and as this bill delineates, in a way that offers them little wriggle room. My second is that it won't be passed; there appears to be no Senate version of this bill. My third is that that's a shame, the credible threat of the passage of a measure like this would light a fire under servicers (although that might only be to mobilize lobbying against it).

But to the more serious question: is this bill a good idea? Given the track record so far, it may be that servicers need something this confining to force them to act, and to give them cover with their investors to do so. Mods, however, typically favor certain tranches over others, so this might produce some sharp repricings.

Moreover, even if the team at the servicer has the best of intentions, it has to start with the mit plan from the income records at the time of the loan. With no docs, low docs, and generally lousy standards, that information is generally terrible. And while the debtor can provide current information, it isn't clear they will be forthcoming. Servicers aren't particularly well liked or trusted in borrower land.

But as much as I have little sympathy for companies that made a lot of money during the gravy days of the housing bubble and now plead poverty as an excuse for inaction, this bill would an industry under stress to the wall. It will have to incur the costs of notification and reporting for all defaulting borrowers, but will be able to collect fees only out of continuing cash flow from the borrower or a foreclosure sale. Most of these activities (setting up a call center, creating methods, forms, and supporting systems for borrower communication and regulatory reporting) have high fixed and low variable costs. It will be hard to determine the right fee levels up front (and you can't readily go back if you got it wrong). And its quite possible the fees will look disproportionate, even if they are costed properly.

Plus there's a big cash flow problem: the costs are incurred up front, the fees recovered over time. And servicers are already having big time cash flow problems. I have been told that servicers, which in most cases are part of large banks, are hemorrhaging cash. Notes from a conversation with informed parties:
The servicer has guaranteed to pay whatever interest is promised to the investors for at least 90 days after default. Some agreements also require them to pay principal during that period. Even after the 90 days, the servicer has to continue to pay real estate taxes and insurance. The servicer can use any late payment or other penalties from the borrower to offset these costs.

The idea was that if you were good at collecting and efficient at serciving, the overcollateralization would give you enough of a cushion. But they assumed 5% loss rates, not 20%.

And the cash flow drain is worse in prime or mixed pools than in subprime pools. The defaults relative to assumptions are far worse there.

As we noted, the banks will probably dodge this bullet. But a measure like this is an indicator of how sentiment about regulation is changing, Expect to see more tough-minded proposals, some of which will stick.

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