REQUIRED READING: Federal regulators and law enforcement agencies have begun reviewing fair-lending practices in the context of mortgage servicing – a fairly recent trend that some legal experts and industry consultants predict could turn into a difficult endeavor. While agencies may well have trouble analyzing and interpreting data, servicers may end up having an equally tough time defending against allegations.
Fair-lending violations in mortgage lending are relatively unambiguous: A high-priced loan or unfair loan denial is clear-cut in nature and can be determined with ease. The same cannot be said for servicing, where the positive or negative effects of a loss mitigation outcome for a particular borrower are less easily discernible.
Nonetheless, servicers must prepare their shops for such inquiries from regulators, said panelists at the Mortgage Bankers Association's recent National Mortgage Servicing Conference & Expo in Dallas. The U.S. Department of Justice's civil rights division has started analyzing loan-level data from the Home Affordable Modification Program (HAMP), and Fannie Mae has indicated that it will use HAMP data to hone its investigative attention. The Federal Reserve is also in the process of reviewing HAMP and non-HAMP modification data.
"Fair-lending scrutiny of loan servicing is here – it's here now, and it's here to stay," said Anand S. Raman, a partner in the Washington, D.C., office of Skadden, Arps, Slate, Meagher & Flom LLP. "It's not going to go awayâ�¦until the foreclosure crisis abates, at a bare minimum."
Raman, along with Charles River Associates' Marsha Courchane, published an article on the topic of fair lending in servicing last year. In the article, Raman and Courchane wrote that even some of the seemingly simple aspects of fair-lending analysis, such as defining "good" and "bad" outcomes, are hard to clarify in default servicing.
Issues that arise in the fair-lending examination of origination practices, such as whether to focus on discretionary decisions and how to analyze data from multiple geographies, are "equally or more difficult in the default servicing context," they wrote. Regulators are looking at investor guidelines for loss mitigation, the origin of data that servicers use, how automated servicers' processes are, as well as whether servicers are internally reviewing fair-lending protocols, said Lynn Gottschalk, an economist with the Federal Reserve Board who is familiar with the fair-lending tests.
With loan modifications top of mind for the examiners who are conducting these tests, the makeup and distribution of modifications are key details. Of course, variables such as investor allowances for principal reductions must be considered.
Another aspect that is unique to default servicing fair-lending testing is that borrowers' situations need to be reviewed at multiple points in time, including before and after a loss mitigation solution is presented. Major factors, such as home values and debt-to-income ratios, can change drastically over the course of a loss mitigation event.
When the Fed does find differences in the way servicers treat borrowers, it is unclear what those differences actually mean, Gottschalk said. For example, one of the elements that the Fed reviews is the length of time it takes servicers to approve or deny loss mitigation. In some instances, drawn-out timelines can indicate exhaustive efforts by the servicer to review every possible workout scenario. In other cases, long timelines could suggest a poor effort to communicate with borrowers.
Furthermore, regulators cannot necessarily rule out that a timely foreclosure, for example, is less beneficial to a borrower than is a modification that ultimately redefaults.
What's a servicer to do?
With so little certainty regarding what, exactly, constitutes reasonable metrics for fair-lending violations in the realm of default servicing, it may appear that servicers have few options for defense. To get an idea of where shops should gear up, Raman suggested looking to origination practices. In loan pricing and underwriting, the risk of fair-lending violations is greater in processes where individuals have discretion, he said.
For servicing, that discretion may take the form of loss mitigators' going off script to produce different workout options or in interpreting hardship reasons. "There are a number of areas where discretion comes into play, and those are the areas where one does have control," Raman said.
Careful documentation provides another layer of protection for servicers. By the time agencies review files for fair lending, it is typically years removed from the actual date that a loss mitigation action was approved or denied. Real-time documentation that details policies, procedures and thought processes behind loan-level decisions can help servicers support their actions, Raman noted.
Greg Imm, Fifth Third Bank's director of community affairs and fair and responsible lending, has learned firsthand the priorities of regulators. While working at IndyMac successor OneWest Bank, Imm gained the perspective of the Federal Deposit Insurance Corp. (FDIC) and the Office of Thrift Supervision (OTS) officials when it comes to fair-lending matters in default servicing.
Among the top issues for the regulators at the time was the distribution of complaints and resolutions. Imm recommended segmenting complaints by product and personnel, if possible, and checking to see who benefits from the outcome of complaints – the bank or the borrower.
Escrow administration and late charges are two other important areas. Escrow, while often an automated process, can hold risks in terms of year-end overages and underages, Imm added, saying it is valuable to look for patterns. Linking late charges to specific product types can also be a significant indicator of where changes might be warranted.
"If there are certain products that are generating a huge amount of late charges in proportion to your portfolio, you have to wonder whether or not those products are really suitable for the community," Imm said.
He further stated that the FDIC and OTS were interested in customer contact policies regarding late payments and the methodology behind determining contact hierarchies. In this respect, servicers may want to revisit call-center metrics.
Because borrowers who are not native English speakers may be perceived as difficult to communicate with – and because call-center employees are sometimes compensated based on the number of calls made – ESL borrowers may end up falling to the bottom of a call list, Imm explained. In turn, outreach to those borrowers may be unnecessarily delayed by days, which would certainly paint a negative picture for regulators.
Imm additionally cautioned servicers to examine the default-management responsibilities that rest with vendors. A separate analysis of in-house versus outsourced processes is helpful. Because servicers ultimately have less control over their vendors, outsourced work should sit atop the list of processes to be reviewed.
