Regulators' mortgage servicing consent orders require big banks to conduct a thorough review of their foreclosures. On Friday they were told what "thorough" means.
In a four-hour meeting with bank representatives, officials from the Office of the Comptroller of the Currency (OCC) prescribed a more extensive process than the review of a few hundred loans that the bankers originally hoped for.
"Just pulling a high-level sample isn't going to cut it," Joe Evers, the OCC's deputy comptroller for large banks, told American Banker before the meeting. "Some of the early thinking we've heard of isn't acceptable. … If anyone thinks there are going to be shortcuts here, it's not going to happen."
Regardless of what the independent reviews find, there's little risk that the audits will air banks' dirty laundry. The findings will be sealed, a detail that has some industry critics howling.
The scale of the reviews will mean that Bank of America Corp. and Wells Fargo & Co. will each have auditors review several thousand foreclosure files from January 2009 through December 2010.
For all servicers, auditors will look at a larger number of files from the six states with the highest number of foreclosures, participants at the meeting said.
According to the OCC, any foreclosure mistakes will result in a broader review, potentially covering the whole portfolio.
"Even a single error in the sample population is going to require a deeper dive," Evers said. "It's up to the independent consultant to determine whether there was financial harm."
Along with the sampling, the OCC has mandated that the big banks design and publicize a consumer complaint review process through which borrowers who lost their homes to foreclosure can complain to the independent auditor.
Considering the thousands of foreclosure-related lawsuits already under way, such a program could potentially generate a huge number of complaints.
The OCC has urged banks to build out the channel immediately. "There's no time like the present to have a process like this get started," Evers said.
While borrowers would be guaranteed a response from the independent auditor, they wouldn't necessarily know who adjudicated: The OCC will not require that the identities of the companies reviewing the complaints be made public. Mortgage investors, who might have lost money because of such errors, also will not be informed of the reviews' findings.
The private nature of the reviews has caused consternation among both borrower advocates and a fellow regulator.
"[W]e have heard concerns regarding the thoroughness and transparency of these reviews, and we continue to press for a comprehensive approach to this 'look back,'" Federal Deposit Insurance Corp. chairman Sheila Bair told the Senate Banking Committee on May 12, arguing that only credible and public reviews would allow the industry to move forward.
Other critics attacked the OCC's role directly.
"Unless they make that review process public, who is to believe it?" said Kathleen Day, a spokeswoman for the Center for Responsible Lending. "We're supposed to take the banks' and the OCC's word on this?"
Law firms will review foreclosures to see if servicers had proper legal standing, but the OCC will not allow them to audit fees and penalties assessed. That work will go to some of the consulting firms such as PricewaterhouseCoopers (PwC), Navigant Consulting and Promontory Financial Group.
Some of the consultants were involved in banks' mortgage servicing operations at the same time the massive compliance failures identified by the OCC took place. PwC, for example, has offered audit, compliance and review services for years.
Francine McKenna, a forensic accountant and frequent critic of the big-four firms, said she questioned whether such accounting giants could be credibly independent, given that they have signed off on mortgage servicers' financials.
"The external auditors were supposed to ask whether the banks had adequate compliance and risk management in house to monitor themselves," McKenna said.
A spokesman for PwC did not comment by press time.
Another issue that has emerged as a sticking point between regulators and servicers is how deep the foreclosure reviews will be.
For example, if a servicer misidentified the property address in a foreclosure but still notified the defaulted borrower, would that be considered a technical or a material flaw and would it require remuneration to the borrower? Likewise, what if a borrower quit making payments on a modified loan after a bank improperly notified her of its intent to foreclose?
Though only regulators will know the results, the reviews will try to answer the nagging question of how many borrowers were improperly foreclosed upon because servicers primarily outsourced the legal processing of foreclosures, resulting in end-runs around requirements in the law, including the "robo-signing" of documents.
"Were there significant numbers of people who were subjected to foreclosures where they shouldn't have been? We don't know the answer to that," said David Dunn, a partner at the law firm Hogan Lovells.
A key requirement of the legal review of foreclosure documents will involve assurances that the proper entity had standing to foreclose.
Auditors also must complete an accounting review to determine that all fees and penalties assessed as part of the foreclosure process were customary and reasonable and if not, to calculate the financial injury to the borrower.
Reviewers also will determine if borrowers were offered loan modifications and if servicers' denials of loan modifications were done properly.
Only material errors will be eligible for redress, though the OCC has not yet determined how it would define such a benchmark. The agency does, however, say that the review should not be limited to whether a bank's own accounts showed the borrower was in default at the time of foreclosure.
The OCC has pledged that the auditors will report their findings directly to regulators and not to the banks.
But given the opacity of the process and skepticism of the OCC's prior servicer oversight, consumer advocates are still casting doubts on the integrity of the process.
Tom Borgers, a managing director at Mesirow Financial Consulting, suggested the scale of the review must be determined by what it uncovers.
Borgers, a former investigator for the Financial Crisis Inquiry Commission and FDIC who would be interested in performing work as part of the review, said the process should continue until auditors "understand what the numbers mean and who is responsible for potential fraud or gross negligence."