Some investors are wary about the $8.5 billion Bank of America agreed to pay in the MBS-related settlement it worked out with 22 large money managers, but if approved the bank will be giving up more than a one-time cash payout. The settlement imposes requirements on the servicer that appear likely to portend long-term and much broader benefits for investors.
"What's come out of this settlement could potentially set the groundwork for the regulation that's eventually going to come out for regulating all servicers," said Barbara Chell, a principal at C&A Consulting and formerly chief operating officer for the residential mortgage groups at Credit Suisse and Donaldson, Lufkin & Jenrette.
The provision that is likely to have the greatest impact requires servicers to outsource high-risk loans to specialty servicers upon request by investors. The settlement also pushes the BofA servicer to follow best practices, requiring it to relinquish part of its servicing fee if it fails to meet industry norms, and to alert the trustee about missing documents in the loan files so the trustee can post that information on its Web site for all to see.
A court hearing scheduled for Nov. 17 may end up invalidating the settlement, given concerns that only a limited group of investors hammered it out with the trustee and it may push delinquent borrowers out of their homes more quickly. Reacting to those concerns, the New York attorney general has asked the 22 institutional investors involved in the settlement for more information, and at least one other investor, Walnut Place, has officially objected to the settlement for what it views as the trustee's conflicts of interest.
An approval, however, would give the settlement's servicing provisions an official stamp that could broaden their impact.
"To the extent the settlement does get approved, it could provide a test-case scenario, so that if [the Bank of America servicer does] succeed in adhering to these standards other industry members will become hard-pressed to say they can't do it," said Leah Campbell, an associate in structured finance at Katten Muchin Rosenman. "It potentially creates a new benchmark for servicing that investors will want to see when the market comes back."
Investors' concerns so far center on the settlement's payment amount. The provisions imposing requirements on the servicer, however, could ultimately be worth a lot more to investors by engendering more responsive and capable servicers, and by extension greater monetary rewards.
BofA, for example, still holds at least $200 billion in private-label, first-lien RMBS issued by Countrywide, which the bank acquired in 2008. If the settlement's new servicer requirements improve collections by 5%, investors save an additional $10 billion. If the settlement becomes a model for future RMBS offerings, then additional savings - although difficult to measure - would accrue from loans that avoided default because of better servicing.
Sue Allon, CEO of Allonhill, which provides RMBS-related due diligence and risk-management services, said that improving collections significantly for any large servicer such as BofA would be a challenge, given that much of these portfolios are severely delinquent and so will be hard to salvage. But since the provisions are part of a settlement with the nation's biggest mortgage lender and servicer, they reflect the direction the industry is headed and the desire for a more direct relationship between servicer fees and performance.
"Even if the settlement isn't completed, it's a major statement that says the servicer needs to be performing at a higher standard and it means that investors are going to hold servicers to that standard," Allon said.
And if servicers aren't meeting that higher standard, investors are going to want to push at least the high-risk loans to specialty servicers - a provision in the BofA settlement. Allon noted that specialty shops, such as Wingspan Portfolio Advisors, Residential Credit Solutions, Acqura Loan Services, and Marix Servicing, devote more manpower on a per-loan basis, leading to solutions that benefit borrowers and investors alike. Their specialized focus is particularly effective in non-routine defaults, she said.
"Outsourcing the servicing is a way to get loans into the hands of a servicer who specializes in getting those loans to best net-present-value resolution quickly. And that's something investors are very focused on," said Tom Hiner, a partner at Hunton & Williams.
Allon said that introducing the outsourcing provision raises other kinds of issues. For example, the Office of the Comptroller of the Currency (OCC) announced enforcement actions against eight of the largest servicers, including BofA, Wells Fargo, JPMorgan Chase and Citibank, that require them to establish a single point of contact for borrowers throughout the loan modification and foreclosure processes. Allon said that the OCC's actions indicate the regulator views that a single contact is critical to servicing, "but by introducing the specialty servicing model, you may be undoing some of that good."
In addition, she said, "Even some specialty servicers are under water at this point. The new players are very good, but they don't have enough capacity."
Debash Chatterjee, who heads up Moody's Investors Service RMBS Monitoring team, said empowering investors to choose new and hopefully more effective servicers is "something the larger servicers have been looking to do for some time." He added that the only two private-label offerings over the last two years - both by Redwood Trust -contained language enabling RMBS investors to review delinquent loans and refer them to binding arbitration if they suspect infractions of the securities' representations and warranties.
"This is not a new concept, but the settlement gives wider rights to the investors that can bring about change," Chatterjee said. "It could be a model for future RMBS transactions because it aligns the interests within the transaction, since specialty servicers have new equity interest in it and are just interested in loss mitigation."
Chatterjee noted that in many RMBS offerings, the originator, securitization sponsor and servicer were one and the same. Another provision aims to lessen the conflicts of interest arising from one bank holding multiple roles by requiring the BofA servicer to meet industry practice norms or return part of their servicing fee to investors.
Campbell said the provision represents another instance of better aligning interests in the deal by putting the servicing burden squarely on the servicer. However, industry norms aren't always clear-cut, she said, so while the provision prompts BofA to strive for those norms, it may not carry much legal weight.
Nevertheless, by introducing a mechanism to reduce the servicer's fee, it highlights a likely move by the industry toward developing different compensation structures for servicers handling high-risk loans. The BofA settlement requires the servicer to pay the additional costs for loans outsourced to specialty servicers, presumably out of its aggregate servicing compensation, and it includes provisions that can reduce servicing compensation depending on how actual performance compares to benchmarks.
The big servicers have typically received a flat servicing fee - typically between 50 and 75 basis points - that covers processing costs but not the high-touch services necessary to rescue a problem loan. The threats of returning a part of its servicing fee and losing the loan to a specialty servicer should provide incentive to the BofA servicer to take more proactive steps to hold on to loans which performance is slipping.
"The servicer might do a better job in the early stages of default, when there's the highest chance of getting a loan back on its feet," Allon said, adding that two missed payments can often be "fatal" for a loan, while three typically means the loan is beyond recovery.
Hiner said that future servicing agreements may have variations of incentive based servicing fee arrangements, perhaps involving different fee percentages for performing loans and distressed loans. He added that they may also use sliding scales to increase or decrease servicing compensation based on performance that is measured against industry benchmarks, such as results for investors and timeliness of resolution. Hiner said the provisions of the settlement that would have the servicer forgo reimbursement of servicer advances are not likely to be adopted by third-party servicers, because they typically assign their reimbursement rights for servicing advances to funding facilities.
Chell said the multi-faceted settlement, including the servicing requirements, "clearly highlighted what the regulators are looking for." She pointed to the overlapping language in consent orders the OCC sent to 14 large banks in mid-April, such as outsourcing foreclosure or related functions. Although it's unclear now which of several government agencies with jurisdiction will issue rules related to mortgage loss mitigation -and more than one set of rules could cause significant headaches for banks - the BofA settlement likely provides an accurate template for what those rules will look like.
"The focus of the settlement was loss mitigation and the foreclosure process, and it highlighted what the regulators are looking for," Chell said. "It clearly sets a standard for other servicers to say, 'The regulators will eventually come to all of us, so let's make sure we don't have those issues.'"