Now that the Mortgage origination settlements are winding down, Mortgage Servicers and MSR owners become the next target of enforcement and legal action

Mortgage Servicers are finally attracting enforcement and legal attention for what they did after they underwrote and securitized mortgages. Until recently regulators have focused on the origination of faulty mortgages for regulatory action. Now they are starting to go after improper mortgage servicing after the loan closed. Banks may be in for a bumpy ride.

The new player in the regulatory landscape is the Consumer Finance Protection Bureau (CFPB) created by the Dodd-Frank Act. On July 21, 2011 administration and enforcement for the Fair Debt Collection Practices Act (FDCPA), the Real Estate Settlement Procedures Act (RESPA) also known as Regulation X and the Truth In Lending Act (TILA) also known as Regulation Z were transferred to the CFPB. On January 10, 2014 a major revision and extension of RESPA rules will take effect. Here is a link to CFPB issued PDFs and Videos describing all of the new rules they are responsible for and ready to enforce.

The CFPB is a powerful new enforcer immune to the influences of Congress and its Lobbyists

The major banks use a servicing platform to generate invoices, allocate vendor charges, receive and allocate payments, pay vendors and assess penalty fees. These platforms were designed during a time when the vast majority of people were able to pay their mortgages. The underlying technology is old and cannot radially be modified to become more flexible to incorporate complex rule structures. As long as default rates stay at their normal low level, this is not a problem.  The housing boom and large numbers of improperly underwritten mortgages that borrowers soon couldn’t make payments on quickly stressed bank servicing operations.

Previously, the very few borrowers that couldn’t pay their mortgages had their file manually reviewed and calculated by specialists in Bankruptcy and default servicing. Court imposed payment plans were examined so each payment could be allocated properly. As the volume of default servicing was low, it was not a problem keeping this as a manual process.

Unfortunately, these legacy platforms are fundamentally incapable of correctly servicing loans where the homeowner is in Bankruptcy and with recent platform ad-ins only marginally better when there is a simple default.

When the crisis hit, the servicers relied on their servicing platforms to correctly allocate payments to principal, interest, escrow and fees for borrowers who were in and out of bankruptcy at various points. As it is, the laws governing payment treatments change depending on the bankruptcy status of the homeowner. These legacy servicing platforms cannot apply these laws to the court level detail which is necessary. Some Bankruptcy Districts are pay all, some just pay Court determined amount inside of the Bankruptcy plan, some treat escrow separately. In short, the legacy servicing platforms have no idea. One misapplied payment and the servicer is out of compliance with the Bankruptcy Court. And so the snowball of errors begin.

The major banks violated bankruptcy law when they collected money they were not entitled to. Every bank who filed an inaccurate proof of claim is criminally liable. There are moves within agencies to go after these servicers and the fines contemplated are huge.

Here's just one example from the library of 30 causes of harm to homeowners in Bankruptcy which can be found here. It's called the 21 day rule and is harm #5 in the library template. When a borrower is in Chapter 13 Bankruptcy, the court requires 21 days notice if a payment is to be increased. The reason does not matter, it can be an interest rate reset, an increase in escrow, forced placed insurance, an inspection fee, anything.

If notice is not given, the servicer is not entitled to that increase and will not then or in the future be entitled to the increase. Under FDCPA there is also a $1,000 per month fine, plus legal fees, for collecting or attempting to collect money where the Bankruptcy Court was not electronically notified by a 21 day rule filing.

Several of the SIFI banks did not file any 21 day rule notices for YEARS. This is a fact and is electronically discoverable on the the Federal Bankruptcy Court website.

The widely known National Mortgage Settlement of 2013 was preceded consent decree originally signed by five of the largest mortgage originators Wells Fargo, Citibank, Bank of America, JP Morgan Chase and Ally Financial. These decrees from the OCC and the Federal Reserve ordered the banks to hire outside auditors referred to as the Independent Consultants (IC). The ICs were to uncover inappropriate charges collected from homeowners and return the money to the borrowers. These consultants spent a year and hundreds of millions of dollars to demonstrate to the OCC that the banks had done little wrong.

How is this possible? The focus of the IC inquiries was Robo Signing. As it turns out, the engagement contracts between the banks and the ICs that were approved by the OCC specifically excluded bankruptcy process legal errors and many of the arcane but sizable causes of harm to homeowners that occurred during the default phase of a mortgage. It was argued the servicing platforms were automated therefore incapable of error. So, the manual review of mortgage files found few problems. An industry list of 30 servicing errors that harm borrowers was not reviewed or remediated.

Before this nonsensical conclusion could be written into neatly bound spiral binders, the OCC shut the IC work down. The OCC declared victory and announced that harmed homeowners would receive a compensation amount determined by formula depending upon their classification. Homeowner compensation for the harm caused beyond Robo Signing has not yet been addressed. This has yet to play out in the courts and CFPB enforcement. I'm told here I have the sequence of events and the players slightly mangled. I will update this section shortly.

In the last year the major banks have been shrinking their mortgage operations by selling off mortgage servicing rights MSR of home loans to specialty servicers. These servicers which include Nationstar Mortgage Holdings, Ocwen Financial, Walter Investment Management, and others. Under the new Basel III capital requirements, banks will see a capital charge for owning servicing rights as MSRs as an asset will no longer be considered Tier I Capital. Servicers are not governed by Basel III so they will not have a capital charge for holding MSRs. The old adage holds true, assets always flow to the entity with the lowest capital charge.

MSRs are a hot commodity. For operating a call center and payment facility a servicer can earn a nice annuity. In a zero interest rate environment the returns are good and long term. Unfortunately, analysts of MSRs have not taken into account the Operational Risk of managing a regulated asset with potential embedded legal liabilities. Some MSRs purchased from the large banks have payment amounts that are in violation of the 21 day rule. How many I will leave up to the reader to investigate.

MSR servicers acquiring rights from an originating bank are now responsible to bill the correct amount under the 21 day rule for every invoice going forward. This is true even if the error of missing the 21 day notice occurred two years ago before they owned the servicing rights. How is a servicer to know? MSR purchase due diligence should include an audit of all loans where the homeowner had been in Bankruptcy at any point during the life of the loan. Then, check for electronic 21 day rule filings for all payment changes. If any are missing, return the MSR to the seller.

The 21 day rule is just one of the 30 areas of harm in the library. Each must be checked in order to ensure a buyer has an MSR free of embedded Operational Risk.  The value of the MSR portfolio can be severely compromised very quickly with just a few distressed loans that were improperly serviced buy the seller. If a buyer doesn't discover these problems during the put back window, it's the buyers' problem.  Caveat Emptor

Richard Ellis PMP PRM CSM PMI-ACP