After months of stalemate, the state attorneys general have proposed new terms to the top five mortgage servicers that drop some controversial provisions of their first attempt at a settlement, including a push to force banks to reduce principal on thousands of mortgages.

The new offer, which was expected to be discussed at a meeting between the two sides on Tuesday, moves them closer to a final agreement, but does not detail how much state AGs are seeking in penalties for servicing issues uncovered by federal and state regulators.

Banks have privately said that they will not agree to a fine above $10 billion — far below a discredited $20 billion figure floated in the press two months ago — arguing that regulators have not provided evidence that servicing problems led to wrongful foreclosures.

The AGs are considering using whatever money they receive from banks to start a "cash for keys" program to help troubled borrowers move out of their homes and speed the foreclosure process by providing them cash incentives to leave. The funds are also expected to be used to promote mortgage counseling and offer some forbearance to troubled homeowners.

While banks have not agreed to the new terms, they do appear much more beneficial than an offer made in February, which demanded sweeping changes across the servicing industry, including principal reductions. By dropping that requirement, banks have already scored a key victory, observers said.

"It makes sense for principal reduction to be off the table because it creates a tremendous number of legal and logistical obstacles that in the context of a complex settlement are obviously difficult and distracting," said David Dunn, a partner at Hogan Lovells law firm. "It makes sense for that to come off the table for the parties to reach agreement on issues that are less difficult and controversial."

But the term sheet would still require the servicers to enact substantial changes to their practices, and could potentially raise issues in new areas.

Under the new terms, according to several sources, servicers would be required to allow borrowers that received a trial Treasury Home Affordable Mortgage Program modification — but which were denied a permanent mod — to reapply for the program.

The state AGs are also continuing to insist that servicers stop pursuing loan modifications and foreclosures at the same time, a process known as dual tracking that has drawn complaints from confused consumers.

The revised term sheet raised some new issues, including a proposed requirement for more documentation concerning the basis of knowledge for a foreclosure and notes and assignments.
The state AGs are seeking to require documentation on the appropriate transfer and delivery of endorsed notes and deeds of trust at the formation of an MBS. Essentially, servicers would have to document that they not only have positions with the MBS but document that the securitization was formed properly.

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