The need for national loan servicing standards has been recognized by regulators as well as securitization and servicing market participants.
Recently there has been a clamor from industry players to adopt nationwide servicing standards together with the risk retention rules under the Dodd-Frank Act.
Under the Dodd-Frank Act, the Financial Stability Oversight Council (FSOC) has been told to write rules that would require lenders to retain at least a 5% stake on loans sold to the secondary market, unless they meet a test for a "qualified residential mortgage."
Although regulators were given until April to finalize risk retention rules, the regulatory agencies have thus far postponed coming up with a proposal.
"The rules under the Dodd-Frank Act relating to disclosure and risk retention for securitizations, which apply to all market participants are the place to start," said the group of 51 academics, financial analysts, as well as former regulators who wrote an open letter to six U.S. regulators that included the Federal Deposit Insurance Corp. (FDIC), the Securities and Exchange Commission (SEC) and the U.S. Treasury. "We suggest, therefore, that the agencies concerned, led by FDIC and SEC, undertake a coordinated rule making effort now to start the process and then also report to Congress." The letter was dated Dec. 21.
In the letter, the group noted that recent discussion among regulators in terms of the need for new legislation to address the servicing issue are misplaced. "We cannot wait for uncertain future legislation to accomplish something that is clearly appropriate under the Section 941 risk retention rules of Dodd-Frank and current law, namely a national standard for loan servicing," the letter said.
The group added that the agencies that are now involved in developing the standards for residential mortgages have a chance to address this issue, noting that responsible servicing standards they had described in the said letter can be applied to all securitization issuers. These standards, the group also wrote, will prevent from happening the problems seen today in the secondary market for mortgage loans.
Among the standards proposed in the letter are the creation of incentivized compensation structures that are tied to the effectiveness in managing the long-run performance risk of the assets in a securitized transaction. The group also proposed to lessen the losses on residential mortgages by taking appropriate action to maximize the mortage's net present value to benefit all investors in a securitization instead of just a particular class of buyers.
Meanwhile, officials from the FDIC agreed that the risk retention rules is good venue to write these nationwide servicing standards.
In an interview with ASR sister publication American Banker, Michael Krimminger, acting general counsel at the FDIC, said that regulators should not wait for legislation to come up with national servicing standards.
Krimminger noted in the American Banker interview that, via the Dodd-Frank Act, Congress instructed regulators to apply the risk retention rules to make sure that high-quality risk management practices are implemented. He added that servicing standards are critical to achieve this goal, noting that the Congress wanting to adopt further servicer standards might be a good thing, but that there is a rule in Dodd-Frank that applies across the board.
In the same interview, Krimminger said that there are mixed views on how to best approach implementing these servicing standards among regulators, noting that the FDIC's view is that there is a "statutory vehicle" to accomplish this now. He added that servicing standards are critical to making sure that the risk retention rules can accomplish Congress' goals under the Dodd-Frank Act. He also disagrees with separate rules from each regulator because this would create an opportunity for regulatory arbitrage.
The ABS Perspective
However, securitization experts said that there is a lot of focus on servicing and its role in foreclosures, but not enough on the various conflicts involved in servicing a securitized loan. For instance, a mortgage being serviced can have a second lien on the same property. There might also be pressure from different classes in the securitization, as in the case where a servicing bank might hold a residual in the transaction.
Under the Dodd Frank Act, there is an amendment to the Truth in Lending Act section that specifically deals with mortgage servicing, which provides for regulation of practices related to residential mortgages. Enforcement of the Truth in Lending Act was assigned to the Bureau of Consumer Financial Protection (BCFP).
"It may be logical that the BCFP focuses on mortgage servicing," said Jerry Marlatt, senior of counsel at Morrison and Foerster. "The problem with that, however, is that the BCFP is not charged with balancing the interests that different parties might have in a securitization. The focus of the BCFP is the regulation of consumer financial products or services. Thus, the more likely result is that the mortgage servicing rules drafted by the BCFP will address only homeowner or borrower concerns, while there will be a different set of servicing guidelines that are focused on securitizations."
Marlatt said that regulation of servicing is a somewhat complex question that cannot be addressed very quickly. Thus far, he said, there's been little regulatory focus on mortgage servicing and to date there has been no proposed rules that have been published.
Given the time frame of the process of for agencies coming up with new rules, it might take time before actual servicing standards can be achieved. Generally, Marlatt said, the way it works is that the agencies come up with a conceptual release and await public commentary, after which more specific rules are proposed.
He added that the Truth and Lending Act and the creation of the BCFP do not specifically address the problems with servicing that came after the Dodd-Frank Act was adopted.
"The servicing problems related to foreclosure happened since then and therefore Dodd-Frank doesn't address the specific types of servicing problems that arose," he said.
He acknowledges, however, that servicing is a retained interest. This is why it makes some sense to develop national servicing rules in conjunction with regulations on retained interests for securitized transactions. However, he said, there is no reason for the development of servicing rules to delay the adoption of the retained interest rules required by Dodd-Frank.
"The fundamental thing to remember is that servicing rules, although they affect the borrower, they also need to protect investors and others who have an interest in mortgage loans," Marlatt said. "That's why it is likely that there will be more than one set of rules regulating mortgage servicing."