U.S. Regulators Chastise Banks on Loan Modifications; Political Tide May Be Turning on Home Loan Servicers

On August 13, U.S regulators issued a joint statement to residential mortgage servicers warning them that “[a] servicer’s decision to modify the first lien mortgage should not be influenced by the potential impact of the modification on the subordinate loan and vice versa.” The statement was issued by the Federal Financial Institutions Council, an interagency group that includes the Fed, the FDIC and the Office of the Comptroller of the Currency, among others. The regulators further noted that entities servicing both first and second loans on the same property “may be faced with potential conflicts of interest when making loan modification decisions,” and that the failure to modify loans in cases that would produce a greater anticipated recovery for owners and investors, “may be a breach of the servicers‘ obligation to those owners/investors.”

Until recently, it appeared that residential mortgage servicers–often the very same banks that had issued the loans that borrowers are now unable to afford–were the favored sons of this nation’s regulators. First, Bank of America/Countrywide was allowed by state Attorneys General to saddle investors with the lion’s share of an $8.4 billion settlement stemming from its irresponsible lending practices. Then, servicers were given a Safe Harbor and cash incentives to clean up their problematic loans when Congress passed the Helping Families Save Their Homes Act back in May of this year.

However, a letter issued by congressmen Christopher Dodd and Barney Frank on July 10 signaled a shift in the way regulators viewed home loan servicers. This letter, which was sent to the Fed, the FDIC and the Office of the Comptroller of the Currency, among others, was the first acknowledgment from Congress that servicers may have been resisting performing the loan workouts needed to stem the foreclosure crisis because they were the foxes guarding the henhouse. Though industry experts and commentators have recognized servicers‘ conflict of interest stemming from their own holdings for months, this letter may have been the first to alert the Federal Financial Institutions Council that servicers were acting in their own interests, not those of the borrowers or bondholders servicers were contractually obligated to further.

Also contributing to this shift in momentum was the release by the Treasury Department of its first monthly progress report on its plan to aid homeowners through loan modifications. This report found that just 9% of eligible homeowners have received trial modifications. The Treasury also released a breakdown on modifications by home loan servicers, which showed that none of the Big Four servicers (Wells Fargo, Citibank, BofA and Chase) had modified more than 20% of the loans eligible.

Officials from the Obama administration already met with mortgage servicers last month to encourage these companies to double the number of borrowers receiving aid. However, as this was before the Treasury released its numbers, I expect the frequency and intensity of such meetings to increase over the coming weeks. As those who have followed this blog are aware, I believe it is high time to acknowledge the role that banks (and now servicers) have played in fomenting the current financial crisis, and force those entities to pay their fair share to help clean up this mess.