An enforcement action against a bank is almost always bad news for the institution involved.
But a federal bank regulators' order released Wednesday against the top 14 mortgage servicers was likely to help, not hurt, the banks, providing them with added leverage as they attempt to negotiate a separate settlement with the 50 state attorneys general and several federal agencies.
While the order requires the servicers to overhaul their operations, it also bolsters a key bank defense — namely, that the significant problems uncovered in the process have not led to improper foreclosures. It also allows banks to argue that the banking agencies have already addressed many of the issues that the state AGs would like to see resolved.
"It will work in the banks' favor," said Paul Miller, managing director of FBR Capital Markets Corp. "It's a good way to say to the attorneys general, 'The federal banking agencies have it handled.' "
The order was quickly seized on by both sides, with lawmakers who want to see tougher actions calling it weak and ineffective, while banking industry representatives said it appropriately dealt with problems.
The state AGs and Obama administration officials, meanwhile, praised the order but insisted their negotiations were not undercut by it.
"We don't agree with that," said Tom Perrelli, an associate attorney general at the Justice Department, in a conference call with reporters.
Perrelli emphasized that the agencies have yet to assess monetary penalties — although even bank regulators have said they are necessary — and said certain areas, including federal trade and bankruptcy provisions, were not covered by the order released Wednesday.
"We are negotiating directly with servicers" so "that those action plans fully satisfy the state AGs as well as the other federal enforcers," Perrelli said. "We're working with the servicers on how they will address the subset of issues in the federal orders as well as a broader set of issues."
Although a monetary penalty was not included in the order, the Federal Reserve Board and other federal officials made it clear one is in the offing.
"We have capacity to levy substantial fines which could be used for a variety" of measures, said Helen Kanovsky, the general counsel of the Department of Housing and Urban Development, on the conference call.
But several Democratic lawmakers were hardly satisfied with the enforcement action, accusing regulators of being too soft on the banks in an attempt to help them with negotiations with the state AGs.
"The consent orders released today fail to hold servicers accountable for the egregious, and often illegal, actions taken against American homeowners during the worst economic crisis since the Great Depression," Rep. Maxine Waters, D-Calif., said in a press release. "I fear that these consent orders are merely an attempt to do an end run around our state attorneys general, and replicate the failed policy of preemption that exacerbated our subprime crisis and brought us to this point."
On a conference call with reporters, acting Comptroller of the Currency John Walsh defended the enforcement order, arguing it addressed significant issues.
"They require substantial corrective actions," Walsh said. "We consider them tough orders covering the whole range of issues we examined. The banks are going to have to do substantial work to fix the problems we identified. … I just don't accept the proposition that this is not a hard-hitting and complete approach."
The order requires servicers to improve loss mitigation efforts and foreclosure proceedings and create a single point of contact for troubled borrowers. Regulators also will force servicers to upgrade technology systems for record keeping, payments and fees, ban so-called dual tracking of mitigation efforts and foreclosure procedures, force enhanced oversight of third parties and mandate third-party consultants to review recent foreclosure activities.
Under the order, banks are required to reimburse any borrower who has been harmed by the institutions' actions. Servicers must hire an independent consultant to review all foreclosure actions from Jan. 1, 2009, to Dec. 31, 2010, to determine if mistakes were made.
Industry representatives said the order was commensurate with the problems uncovered by regulators' investigation into foreclosure practices. "It addresses not only the robo-signing allegations but also the greater criticisms that have came out from the crisis that the loss mitigation wasn't adequate, the compliance programs weren't adequate, the outside supervision wasn't adequate," said Stephen Ornstein, a partner at SNR Denton. "It at least tries to address the system problems for servicers since the crisis began."
But Mark Calabria, director of financial regulations studies at the Cato Institute, said the order would undercut state AGs as they negotiate separate deals with the banks. "This really undermines [Iowa Attorney General Tom] Miller and the rest of the AGs because it shows a split between them and the other regulators," he said. "It will also undermine any efforts to put together class actions. It does create a burden for anyone who wants to put together a class action on this because the bank regulators are saying there is no systemic issue here."
Still, analysts said it was clear the battle is not over. The state AGs are likely to continue to push for principal reductions.
"This settlement sidesteps the broader fight of whether banks should engage in principal reduction but it doesn't end that fight," said Jaret Seiberg, an analyst for MF Global's Washington Research Group. "We fully expect the state attorneys general to continue to press for principal reduction for any deal. And that's the threat that is going to hang over the banks for the next several months."
But Seiberg also agreed the banks now have a stronger hand.
"The state attorneys general lost leverage today because the bank regulators had the power to impose remedies without the need for litigation," he said. "With the federal regulators out of the picture, the states have less leverage."
A key to that is bank regulators' contention that no borrowers were improperly foreclosed on as a result of the mistakes in the process. "The loan-file reviews showed that borrowers subject to foreclosure in the review files were seriously delinquent on their loans. … The reviews also showed that servicers possessed original notes and mortgages, and therefore, had sufficient documentation available to demonstrate authority to foreclosure," regulators said in an 18-page report on their investigation of servicer practices.
Robert Davis, executive vice president of government relations for the American Bankers Association, said this backs up the bankers' arguments. "This will settle the argument about what the banks did wrong and the identifiable consumer harm," Davis said. "There is information now that is public that is not easy to refute and I think this narrows the scope of the negotiations to have a final resolution."
But consumer groups continued to argue regulators were just wrong. "The implications that everything that's happened to date are pretty proper … is really insensitive and missing the point of what the problem has been of people getting loans that are unsustainable," said John Taylor, the president of the National Community Reinvestment Coalition.
Josh Rosner, managing director of the research firm Graham Fischer & Co., also said it's clear from court filings that some borrowers have been hurt as a result of servicer mistakes. "It flies in opposition of court cases that we've seen finding specific examples where borrowers were improperly foreclosed upon and the banks and their third party contractors were engaged in problematic pervasive practices," Rosner said.