The debate over where and how regulators should establish national servicing standards came to a head on Wednesday, with Federal Deposit Insurance Corp. (FDIC) Chairman Sheila Bair pushing to include them in a pending risk retention proposal, while Acting Comptroller of the Currency (OCC) John Walsh warned such a move would be inappropriate.
Both agencies also gave clues to how they would write such standards, a further indication that the agencies — one way or another — will establish national servicing rules.
While much of the financial services industry is backing the OCC, it's unclear which agency will prevail, with the Federal Reserve Board appearing open to the FDIC's plan, albeit with reservations, while also drafting its own proposal.
"Sheila really wants to get it done and I think that it's clear she is trying to build public pressure to use the" risk retention proposal, said Jaret Seiberg, a financial services policy analyst at MF Global's Washington Research Group, who said Bair is likely to succeed. "It's a very technical argument to explain why you don't want to do it there, so when you are having a rhetorical fight it's easier to be for something than against it."
While regulators have mostly clashed behind the scenes over the issue, Bair reiterated at a speech to the Mortgage Bankers Association that the agencies should not wait to write separate servicing standards, but must include them in the risk retention proposal.
"Because effective servicing of problem loans is so important to preserving value for investors and preventing systemic instability, it is imperative that the Dodd-Frank risk-retention rules also create financial incentives that promote effective loan servicing," Bair said.
The Financial Stability Oversight Council (FSOC) "agencies writing the risk-retention rule have been charged with establishing securitization standards that will align incentives in the securitization process. This task cannot be considered complete unless they have addressed the misaligned incentives in servicing that created the present foreclosure crisis."
At issue is a rule that regulators are required to promulgate that would force lenders to retain 5% of the risk of a mortgage when they sell it into the secondary market. The Dodd-Frank Act exempts, however, "qualified residential mortgages" (QRM), a category regulators are still trying to develop.
Bair argues that as part of the QRM test, regulators should mandate certain servicing standards governing how servicers treat borrowers and disclosure of potential conflicts of interest.
But speaking to reporters after a speech at the Exchequer Club, Walsh argued regulators do not have the legal authority to include such standards in the risk retention regulation.
"We believe legally it just doesn't fit within the QRM," Walsh said. "Even if there was something we decide to do there, we would like to see a broader set of standards that can be applied across the system, that will be enforceable by the regulators and we would like to pursue a broader effort."
Walsh emphasized that he supported the creation of servicing standards, but said they needed to be done as a separate rulemaking. He said the OCC has drafted a proposal that it is circulating to the other regulators about what such a plan might look like.
"We've put out an outline of thoughts on what might be included for a broader set of standards and we really think that's the way to go," Walsh said.
He said their outline reflected the results of a joint regulatory examination of the servicers, the details of which have yet to be made public.
"We want to make sure we get this problem solved and we have a solution that is comprehensive," Walsh said. "We think there is full authority for the regulators to develop the set of regulations that would be fully enforceable that we would be able to get in placed and get it across the system."
The OCC's plan would call for the creation of procedures for borrower payments, such as requiring payments to be applied first to principal and interest before fees, and also for improved disclosures to borrowers on their accounts and payment records, including any communications in connection with delinquencies, loss mitigation and foreclosure.
The OCC plan would also require servicers to make prompt responses to borrower inquiries and complaints; establish protocals for servicing delinquent loans; and set up procedures for the foreclosure process to ensure compliance with legal and documentation requirements.
The Fed, meanwhile, has its own plan which it has circulated to the other agencies. Although details are unclear, the plan is a response to a request by the Senate Banking Committee to draft suggested standards after Fed Gov. Dan Tarullo first publicly called for the creation of national servicing rules.
The Fed appears open to including servicing standards as part of the QRM test, but is concerned they may not be enforceable against servicers unrelated to securitizers and would not protect all consumers.
Bair, meanwhile, offered a glimpse of the FDIC's plan during her speech to the MBA. Specifically, she said servicers should be required to take actions that maximize the value of an entire mortgage pool rather than just the claims of any one asset class of investor. Bair is also seeking disclosure in cases where the servicer manages both the first and second lien of a mortgage and the establishment of a pre-defined process to address conflicts from second-liens.
Additionally, Bair said regulators should require an independent master servicer to provide oversight and resolve disputes on servicer actions, cap servicer principal and interest advances and provide a means other than a foreclosure for a servicer to be repaid.
But Walsh said an independent master servicer is impractical.
"I'd would be hard pressed to see how that would work but I have not looked at the proposal," he said.
Bair recommended rights for borrowers such as a right to appeal any adverse denial of a loan modification request to an independent party. She also argued for standards to change second lien contracts that can deter loss mitigation actions.
"While big banks and big investors can handle themselves, the uncertainty around the treatment of second liens has reduced opportunities for effective foreclosure prevention," Bair said. "As part of any resolution of claims regarding large servicers, a fixed formula should be established to govern the treatment of first and second mortgages when the servicer or its affiliate owns the second lien. At a minimum, this formula should require that the subordinate lien be reduced pro-rata to any change in the first mortgage."
Other regulators, meanwhile, are also pressing for some kind of action but do not appear to be taking sides.
"The most important thing is we get the standards right, that we as collectively as possible try to set standards with as many regulators so that they are easily understood by industries that service mortgages," Federal Housing Administration Commissioner Dave Stevens said at the MBA conference. "As to the vehicle how that gets implemented, I think there are a variety of options there. The FDIC has put forth some ideas that could be included in the QRM language. There are other avenues that could also get us there."
But many in the industry are hoping regulators do not establish such standards, arguing they aren't needed yet.
"Why do we need it now?" said Tom Deutsch, deputy executive director of the American Securitization Forum. "In 2011, I expect we may see 3 to 4 million private label mortgage transactions total maybe in the billion dollar range. That's not even a drop in the bucket so I think it's much more important for us to get it right than for us to try to get out ahead of an issue that clearly won't ripen until 2012."
John Courson, chief executive of the Mortgage Bankers Association, said the risk retention proposal is too narrow for servicing standards.
"We think it's two really different issues," Courson said. "The QRM, the qualified residential mortgage, is really a key component of the Dodd-Frank bill in terms of providing housing and loans for consumers. The foreclosure piece just doesn't fit."
Some lenders even took issue with the premise of regulatory arguments, disagreeing that servicer standards were misaligned.
"I really don't agree with the premise that servicers are not aligned with the investor," said David Motley, the president of Colonial National Mortgage, citing a servicers' incentive to maintain its servicing rights. "There's a lot of headlines about how bad servicing is…. The issue may not be as bad as we're making it out to be."