U.S. consumer bureau’s mortgage servicing rules are in the right direction despite shortcomings
By Bora Yagiz
NEW YORK, Aug. 31 (Thomson Reuters Accelus) – The Consumer Finance Protection Bureau’s proposed rules earlier this month on mortgage servicing are a step in the right direction in its efforts to uproot the malpractices that were once prevalent in the subprime mortgage market. The proposals suffer from a few shortcomings, however, not the least because the Bureau, with its “one-size-fits-all” approach, seems to have ignored the nuances between the different players within the servicing industry.
On the face of it, mortgage servicing is an administrative and routine business with little scope for profits, aside from the indirect business opportunities through cross-selling, where the lender can offer other products to the same customer.
It is about collecting from and making payments on behalf of mortgage borrowers, including payments for taxes and insurance from escrow accounts, calculating the variable interest rates for the adjustable rate loans, and providing other types of customer service such as negotiating modification of loan terms under hardship or handling the foreclosure process, for which the average annual fee collected is about 0.25% of the loan’s total value.
The neglect of the servicing area, with sloppy recordkeeping and lost loan files first, then outright abuse and fraudulence such as the “robo-signing” scandal and the reinsurance kickback schemes that surfaced in the last few years, constitute another hallmark of the crisis in mortgage lending, along with the misalignment of interests in the originate-to-distribute model of securitization and the perverse compensation linked to sheer mortgage-loan generation with little regard for underwriting.
Transparency and standardization
The guidelines proposed through the amendments to the Truth in Lending Act and the Real Estate Settlement Procedures Act under sections 1418, 1420 and 1463 of the Dodd-Frank Act offer a much desired transparency and standardization to avoid a repeat of such abusive practices.
For instance, the Bureau has developed, after comprehensive design and testing with a third-party vendor, model mortgage servicing disclosures where the information is provided in an understandable and useful manner to the borrower.
It is true that some of the rules had already been adopted by the industry as “good customer practices,” – especially for the servicing of Government Sponsored Enterprise (GSE) backed loans. Sending statements with a breakdown of payments by principal, interest fees and escrow, and the amount of and due date for the next payment is one example. The proposed rules, however, not only codify these practices through standardized statement formats and extend them beyond the GSE backed loans, but also improve them, for instance by now requiring the inclusion of a warning about fees.
Among other “common-sense requirements” within the proposed rules, the servicers will also have to be vigilant with regards to possible error notifications from borrowers, and conduct investigations in a timely manner and correct them. Prompt crediting of a borrower’s account by applying the amount towards the earliest delinquent payment is another requirement. This would, in effect, prevent servicers applying a payment to most-recent payment period then charging delinquency fees for older unmet payments still on the books.
Perhaps most positively, borrowers will now receive two notices (45 days and again 15 days prior to being charged for insurance) from servicers with cost estimates for “force-placed insurance,” a policy purchased by the servicer on behalf of a customer who fails to carry adequate hazard coverage. Additionally, if the borrower provides proof of insurance policy, the servicer will have to cancel and refund expenses related to any force-placed insurance policy it had purchased on behalf of its client.
This differs fundamentally from the previous practice in which the servicer would choose a policy on its own with little regard for cost, at rates almost invariably higher than the market rate, as the premium charges would be taken out of the customer’s escrow account. This has pushed borrowers who were struggling financially into foreclosure. The proposed rules clearly rule out any such bad surprises.
One size fits all
Yet, they seem to have a few shortcomings.
First, the Bureau seems to treat all types of servicers as if they form a uniform group. Community banks, for example, which typically are deeply involved in their local communities and provide all mortgage-related services to their customers, may find unbearable certain costs related to red tape and possible upgrades in their systems. Yet, spinning off their mortgage servicing activities may not be easy either.
“These banks, unlike their bigger counterparts, cannot support massive systems upgrades and changes on the small volumes of mortgage loans they produce for portfolio. As such many small community banks may simply exit the business which would make it harder to find mortgage financing in many small towns and rural communities,” says Ron Haynie, Executive Vice-President at Independent Community Bankers of America.
True, the CFPB intends to provide certain exemptions for small servicers that handle fewer than 1000 mortgage loans and service only those that they originate or own, such as the exemption related to periodic mortgage statements. However, this threshold may be too low.
It is not only the small banks that may feel the squeeze. Bank of America, one of the nation’s largest mortgage servicers and originators has been scaling back its mortgage servicing operations since last year, and in June 2012 it sold a further $10.4 billion worth of its mortgage-servicing rights to Nationstar Mortgage Holdings Inc., a non-bank financial institution. Nationstar similarly acquired even bigger chunks of mortgage servicing rights from other bank holding subsidiaries such as Aurora Bank and Residential Capital LLC earlier in 2012. Goldman Sachs also sold its home loan processor Litton Loan Servicing LP to Ocwen Financial Group in 2011, another non-bank specialized servicer company.
Indeed, the regulatory burden under the proposed rules is just another reason for the banks’ eagerness in exiting the business. This burden is compounded by the onerous capital requirements under Basel III, which force banks to hold more capital against mortgage servicing rights that exceed 10 percent of Tier I capital.
Another area of concern is the earlier of the two required notices regarding the interest rate adjustment for adjustable-rate mortgages, which is intended — naively perhaps — to alert the borrower on upcoming changes in their monthly payments. Such notice, however, has to be sent by the servicers seven to eight months in advance.
“This is only going to confuse the borrower. The rate that the bank is required to estimate under the rule is likely to be an inaccurate one given the length of the period between when the statement that has to be provided and the date when the actual rate will be set,” says Robert Cook, a partner with Hudson Cook, LLP.
“The servicers are not in the business of interest rate forecasting for their customers” concurs Isaac Boltansky, a Policy Analyst at Compass Point Research & Trading.
Most significantly, the ambiguity of some of the terms used by the Bureau in its proposed rules cannot be said to be conducive to clear-cut communication. One of the proposed rules stipulates that servicers make a “good faith effort” in contacting delinquent borrowers and informing them of their options in avoiding foreclosures, but does it does not clarify what steps would constitute such effort.
Similarly, the proposed rule on force-placed insurance requires the servicer to have “reasonable basis” to believe that the borrower does not have hazard insurance before charging him/her for force-placed insurance coverage, but offers no parameters specifying “reasonable basis.”
With input to be received during the comment period, the Bureau will hopefully make the necessary clarifications to overcome any semantic impediment that could potentially hamper the effective enforcement of its mortgage servicing rules.
(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. <a href=”http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)