Moody's Investors Service said yesterday that the "intense spotlight" that was placed on mortgage servicers following the disclosure of irregularities in foreclosure documentation will persist into next year.

In its 2011 US Mortgage Servicer Quality Outlook report, the rating agency said that the scope of irregularities should be better known in the next few months. However, the scrutiny might lead to fresh controversies regarding the additional servicing practices.

The rating agency expects that more clarity will be forthcoming as servicers finish their extensive loan-level reviews of defaulted portfolios and internal procedures later next year. The irregularities' legal consequences will also emerge as more courts respond to them.

"In 2011, it will become evident how seriously courts will view violations of court rules on foreclosure procedures" said Gene Berman, a Moody"s assistant vice president and analyst. "Since judicial foreclosure laws vary as greatly from state to state as judicial foreclosures do from judge to judge, we could see a wide range of judicial opinions on the legality of the foreclosure processes and actions taken to remedy each situation."

Moody's thinks that the foreclosure flaws will lead to a three-month or more extension in the foreclosure timeline. Foreclosure practices irregularities led Moody's to place the servicing quality ratings of 12 servicers (such as the five biggest U.S. residential mortgage servicers) on review for downgrade earlier in the year.

The rating agency said that both internal and external audit programs will be broadened so that servicing practices are sound, particularly in terms of default management. These will also ensure that proper controls are in place to identify risk areas for investors. External scrutiny will remain from government entities and investors. State attorneys general will continue their investigations into servicing practices.

The collective scrutiny, according to Moody's, might result in new controversies. An area that might be questioned is the different practices servicers have in making advances to investors. The method can change cash flows to the advantage of some classes of investors over others, the rating agency said.

An added area of exposure might be the denial or curtailment of mortgage insurance and trust claims that are due to servicing errors and how these might cause losses for investors, the agency stated in the report.

Moody's will continue to investigate the servicers' cash management and investor reporting practices into the next year, following some commingling cash practices that surfaced in mid 2010, according to the rating agency.

The other issues the servicers will be dealing with in 2011 include enhanced government programs to help borrowers and delinquency rates that are still much higher compared with what they have historically been.

The rating agency expects that the government will enhance its mortgage modification programs probably so that it can address the problem of borrowers with negative home equity. The government is probably going to seek a broader use of principal forgiveness.

As for delinquencies, Moody's reported that the rate at which delinquencies have been increasing slowed this year. They remain, however, at elevated levels, thus raising costs to servicers.

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