REQUIRED READING: The calls for servicing standards are intensifying, but finding consensus on how to establish such a code nationwide, let alone on what the actual standards should be, appears to be a tall task.
One school of thought holds that the federal financial regulators, responsible for implementing Dodd-Frank Act changes to the secondary market, should consider servicing reform as they craft the Qualified Residential Mortgage (QRM) definition. Elsewhere, the push is for a more market-driven solution, such as improvements to pooling and servicing agreements (PSAs) that address a structurally flawed compensation model and shaky guidance on default management.
A product of last year's financial reform legislation, the QRM label is intended to denote conservatively underwritten mortgages – products that will be exempt from credit-risk-retention mandates imposed upon lenders. One of the chief negotiators in the inter-agency QRM rulemaking process, FDIC Chairwoman Sheila Bair, has said she considers the process "a unique opportunity" to align incentives among stakeholders, bake loan modifications into servicing agreements and wipe out conflicts of interest. She told the Senate Banking Committee in December that the QRM rules could help to eliminate tranche warfare and create a predefined process for treating subordinate liens when the servicer has an interest, either as owner or administrator, in the junior-lien loan.
In December, dozens of industry analysts, researchers and consultants wrote to federal regulators in support of wrapping servicing standards into the QRM process. "This new definition for what constitutes a qualified residential mortgage should be the gold standard for all areas of mortgage origination, securitization packaging and servicing, and disclosure," the letter states. Later, the letter cites congressional testimony from Federal Reserve Board Governor Daniel Tarullo in which he suggested servicing standards may be warranted.
The letter was a conversation-starter about servicing reform, says Anthony Sanders, a finance professor at George Mason University and a cosigner. Any mandated standards should be targeted, he cautions. Servicer disclosures of second-lien interest (when visible) and an industry-wide revamping of documentation transmission speak to concerns about transparency. However, requiring special-servicing carve-outs for severely delinquent loans and payment- and principal-reducing loan modifications where economically feasible – two standards proposed in the letter – could kill the possibility of private capital returning to the market, Sanders warns.
"If you want to dry up lending and servicing in this country, mandate that principal has to be written down to market levels," he says. "Who's going to bear that risk?" Regulators are slated to deliver their risk-retention rules this April, which seems to indicate a truncated opportunity for dialogue with industry stakeholders, should servicing rules be included.
In a letter last month, the Mortgage Bankers Association recommended that regulators not use the QRM to correct servicing, suggesting that the commingling of origination and servicing issues would be too much for regulators to handle at once. Add in recent memories of regulatory failures throughout the bubble and burst, and confidence in the QRM approach weakens, says Sanders.
"My worst fear is we become overly dependent on regulatory solutions, and then the regulators drop the ball again," he says.
There is also disagreement over the logic of trying to achieve industry reform through the QRM, which, by design, sets standards for securitized loans. Given that so many junior-lien loans are held in bank portfolios, the ability for the QRM to envelope servicing standards for subordinate loans seems limited. At most, the proposals for a QRM-servicing overlap speak in general terms of up-front agreements about second-lien resolutions.
"You have to have something that encompasses the industry overall, and if you use the qualified residential mortgage approach for that, you're immediately segmenting out a certain portion of that industry that [the QRM] is not going to apply to, because not everybody's involved with securitization activities," says Dave Worrall, national servicing manager for RoundPoint Mortgage Servicing.
The Center for Responsible Lending (CRL), an ardent supporter of servicing reform, advocates use of the QRM mechanism because securitized loans are generally harder to modify, explains Ellen Harnick, senior policy counsel with the CRL. Including servicing standards in the QRM would not preclude regulators or legislators from establishing across-the-board servicing regulations, she says.
"I think there is an added layer of complication when it comes to servicing securitized mortgages," Harnick says, citing servicer fear that modifications en masse could lead to investor lawsuits.
As stakeholders contemplate national standards for servicing, some are left to wonder what future PSAs will look like if and when the securitization market rebounds. Historically, PSAs have downplayed the complexity of mortgage servicing. Often developed with an emphasis on the capital-markets piece, legacy PSAs are fairly boilerplate in regard to servicing protocol. Servicers anticipate future PSAs will deal with default management responsibilities in much greater detail.
"I think, in retrospect, [PSAs] probably didn't define as much of the servicing activity as they needed to," says ISGN Senior Vice President Bill Garland, who was involved in writing subprime- loan PSAs in the early 1990s. "My personal feeling is, a lot of discretion of how to service loans was left up to the servicer. That's probably one of the contributors to the disconnect that we've experienced in this asset class."
PSAs have typically been devoid of specific guidance to servicers about when loss mitigation efforts should begin and end, Garland says. Although contracts have always included delinquency triggers, Worrall adds, the treatment of how a delinquency progresses in a structured transaction will become better defined going forward. Roll rates and delinquency migration will become vernacular, he says. "Clear and effective guidelines" for when loans go bad would benefit all parties, he explains.
"Servicers want that too, because one of the biggest conundrums of servicing loans today is, you don't know when you've done enough," Worrall says. "You don't know at what point you can safely move forward with foreclosure."
Garland agrees, saying servicers would embrace a clear disclosure of investor expectations. "Good fences make good neighbors," he says. "The more definition we can get, the better."
Another reason for the immense confusion over foreclosures – the lack of uniformity among state foreclosure statutes – ultimately falls outside the realm of regulatory reform or investor contracts.
Although he is in favor of a single, national foreclosure code, Worrall acknowledges that the discussion broaches the ever-contentious states' rights debate. Considering many servicing shops' national footprints, a more streamlined process would provide obvious relief from a compliance standpoint. Garland similarly points to the inconsistency of foreclosure laws as a main obstacle for servicers.
"I think the most relevant area of that topic is in some nationalization of how a foreclosure is processed," says Garland. "Today, that is almost all at the local level, and I think the complexity of those various rules and regulations and laws has really complicated the foreclosure/default process and has contributed to some of the process failures we've seen in the industry."
