Required Actions to Address Mortgage Loan Servicing Crisis

By simply reading the front page of any newspaper, one cannot help but notice the extraordinary emphasis being placed on mortgage servicing by regulators, Congress, the press, consumer advocates and others. While most of the attention has focused on alleged abuses by servicers – with the press eager to highlight frequently exaggerated examples of servicing errors – the regulators, and increasingly plaintiffs’ counsel, are focusing on the obligations and the deep pockets belonging to banks, thrifts, credit unions and others who are the holders of the loans and who have outsourced loan servicing duties. In fact, one of the federal banking agencies, the Office of Thrift Supervision (OTS), has already issued a formal letter instructing financial institutions under its jurisdiction to ascertain whether their and their servicers’ procedures are in compliance with local courts’ foreclosure procedural rules, bankruptcy law, safety and soundness requirements and various state and federal consumer protections. Another regulator, the Office of the Comptroller of the Currency, has instructed banks under its supervision to undertake internal assessments of their foreclosure management processes to ensure banks do not fall victim to the delayed foreclosures, court-imposed sanctions and other foreclosure problems now plaguing lenders. All federal and state banking regulatory bodies share these worries. The regulators, like their regulated banking organizations, are especially concerned with reputation risk.

The OTS instructed institutions to immediately undertake a review of their servicing operations to ensure that any servicers which are retained are in compliance with and sensitive to these obligations. This affirmative obligation requires financial institutions to examine not only their internal operations, but also the operations and procedures of their outsourced contractors servicing the loans belonging to the financial institutions. These need not only be loans that are serviced on a long-term basis, but also include short-term servicing, for example, servicing of new loans pending resale into the secondary market. The OCC makes clear that examination of foreclosure counsel procedures also falls within a banking institution’s due diligence and quality control obligations. This latter requirement is particularly curious, given that servicers and their clients rely on the legal advice of their foreclosure counsel to help guide them through the often complex state and local foreclosure rules. Nevertheless, with the continued press and public attention on bungled foreclosures, servicers and banks may find themselves in the unenviable position of having to hire separate counsel to watch the foreclosure counsel.

Furthermore, banking institutions ought not to forget the longstanding requirement that they undertake due diligence on any party with which the financial institution undertakes a contracting or subcontracting relationship. Certainly, this applies to the servicing of residential mortgage loans on the books and records of the bank, thrift or credit union. Examiners expect management to, among other things:

  • Ensure each outsourcing relationship supports the bank’s overall requirements and strategic plans;
  • Make certain the bank has sufficient expertise to oversee and manage the relationship;
  • Evaluate prospective third parties based on the scope and critical nature of service(s) to be outsourced;
  • Tailor their third-party monitoring program based on initial and ongoing risk assessments of the outsourced services; and
  • Notify their primary regulators of the outsourced relationships.

Foreclosure or sale does not end management’s due diligence duties. Lenders need to assess the compliance status of loans pending foreclosure, REO and even REO having been sold.

To fulfill these obligations properly, the institution must determine whether its policies and procedures and those of its sub/contractors comply with the various laws and obligations relating to debt collection and loan servicing, and that servicing comports with FannieMae and FreddieMac guidelines to ensure the loans remain eligible for sale into the secondary market. Procedures also need to be sensitive to the various enforcement actions taken by the banking regulators, Federal Trade Commission, state attorneys general and other enforcement bodies over recent years. (The Fairbanks, EMC, Countrywide and similar cases come to mind.) Doing so enables the bank to identify the procedures or lack of procedures that have triggered lender and/or servicer liability. These procedures range from Fair Debt Collection Practices Act disclosure and consumer communication restrictions, e.g., telephone contact prohibitions; Fair Credit Reporting Act mandates, e.g., credit report error correction; state debt collection rules; to compliance with the panoply of servicing-specific state and federal laws, e.g., Real Estate Settlement Procedures Act escrow account and “qualified written request” requirements.

And if that were not enough, we cannot fail but notice the rush to legislation that is being discussed in Washington and various state capitals to impose new and substantially expanded servicing obligations on lenders and their servicers in response to the myriad horror stories we have been reading in the general press.

What to Do Now?

Financial institutions must review and update their policies and procedures. The various disclosure and procedural obligations discussed above and those mandated by the recently enacted Dodd-Frank legislation must be incorporated into these policies and procedures. Lenders must ensure that any organizations to which servicing has been subcontracted and foreclosures assigned do the same. Loan file sampling, interviewing key personnel (especially personnel in direct communication with consumers), review of consumer communications, e.g., collection letters, are obvious starting points. Complaint and litigation file reviews are another step in this process. Analyses of servicing contract representations, warranties and indemnifications, as well as insurance coverages of both the banking institution and its contractors should be undertaken not only to appease examiners, but also to mitigate bank exposure. Creative insurance products are increasingly coming to market. Consideration of such coverages needs to be part of the full range of risk mitigation strategies that need to be adopted.

Stevens & Lee has advised and undertaken due diligence and quality control examinations of mortgage loan servicers and foreclosure counsel. We represent mortgage loan servicers and their client lenders in both regulatory compliance and litigation defense. We have extensive experience in negotiating sub/servicing agreements and the sale of servicing rights. Our team is very familiar with the myriad obligations, pitfalls, plaintiffs’ attorneys’ strategies, and examiner concerns.

For More Information

If we can assist you with these increasingly burdensome obligations, please contact Paul H. Schieber at 610.205.6040 or the Stevens & Lee attorney with whom you usually work.

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.