AND THE PAIN KEEPS ON COMING – WELLS and JPMORGAN REDUCE VALUE OF MSRs

In another acknowledgement that servicing residential mortgage loans isn’t all that it is cracked up to be, Wells Fargo announced that it is reducing the value of its mortgage servicing rights (MSRs) by $214 million in the first quarter based upon higher projected costs for loss-mitigation and foreclosure. Following the Consent Order that the major servicers, including Wells, signed last week with their federal regulator (either the OCC or the OTS together with the Federal Reserve) JPMorgan also acknowledgement that the cost of the Consent Order it signed will haircut its MSR valuation by $1.2 billion in the first quarter. Interestingly, Citigroup announced at the beginning of this week that the Consent Order it signed with the OCC will only cost the bank between $25 million and $30 million annually. Maybe they got a better deal?

Whatever the costs associated with the new regulatory requirements to be instituted, it is clear that there aren’t going to be blue skies ahead for the servicers. Beyond the Consent Orders, there is still the brewing of the 50 (now 49, since Oklahoma broke from the pack) Attorneys General action against the servicers, as well as the FDIC’s new insurance/risk balancing act. Defaults are not slowing down,  REO assets are stockpiling, and the governments newest attempt to move REO inventory by allowing IRA moneys to be used to purchase foreclosure homes is not a very strong solution to the problem. And as the pack leader, Goldman’s announcement that it is looking to sell its mortgage servicing company, Litton Loan Servicing, indicates that there isn’t any meat left on this bone.

So, what is a servicer to do? Well, back in the day, the servicer was part of the origination platform. Because of that, the economics of the servicing were different, since the originator would then retain the residual pieces of the deal. With “gain-on-sale” and the use of “creative accounting” on the prepayment assumptions, servicing looked like a winner, since money out of one pocket (the servicer)  came back into the other pocket (at least for accounting purposes) on the residual certificate. Once the connection between origination and servicing was broken, and residuals were sold into NIM structures, the plight of the servicer was sealed. Now, it is a matter of marginalizing costs, meaning the cheaper the better. This is why HAMP didn’t work (modifications are really just re-underwriting the loan, which has a significant cost) and why there is a need to foreclose (cost containment and reimbursement of advances).

The entire industry has to be reworked, as well as re-adjusting the fees paid to make it economically feasible for servicers to manage the cash-flow from a less “squeezed” position. But, unfortunately, the servicers are operating under agreements (the Pooling and Servicing Agreement) that never contemplated this level of stress. And investors will never allow the servicers to change the terms, for it will only be a detriment to the investors. So, the deals are going to have to run out before the servicing shops will be able to find some relief. That, or servicers  will have to “game” the system (robo-signing, “rocket-docket” and the like) to maintain profitability.

So, let the games begin (or continue). But now it appears that the referees are at least trying to keep the playing field level (until, like Washington and state regulators have done in the past, elections are over, people get bored/tired with hearing about the problems  and certain men with certain bags of money appear and the rules get forgotten).

THE COST OF DOING (SERVICING) BUSINESS – LITTON ON THE ROPES

From a report today in HousingWire, Goldman Sachs acknowledged a $220M expense in the first quarter of 2011 relating mostly to its operations of its mortgage servicing arm, Litton Loan Services. Such a huge wallop to earnings means that the attempt by Goldman to manage cash-flow of securitization structures through the servicing of the loans has not played out as well as expected. Remember, Goldman got into servicing back in 2007 when it purchased Litton from C-BASS.

In the game of servicing, it is all about cost containment. Generally, servicers are allowed to make 25bps on each loan it services for the securitization trust, where a majority of the loans are actually owned. From this fee, servicers are expected to send statements, follow-up on lagging payments and manage the loss mitigation (modifications, short sales, deed-in-lieu, etc.), foreclosure and subsequent REO acquisition and sale. In certain situations, that fee can be extending to include up to 50 bps for “special servicing.”  But in either case, the ability to make money in the servicing game is solely based upon keeping the costs associated with these services to the securitization trust at a minimum. This is why the servicing shops ran into the problem with robo-signing, sewer service and pushing for the “rocket-docket” in Florida.

Now, the servicing shops are facing new, costly, regulatory compliance requirements. The OCC and OTS, with the backing of the Federal Reserve, have gotten the major mortgage servicers to executed Consent Orders this past week, requiring that they clean up their foreclosure practices. This will add another layer of cost to an already thinly stretched bottom line to servicers.  Fortunately for Goldman and Litton, they were not part of this regulatory round-up. However, there is still the 50 state Attorneys General action that has still yet to be flushed out, which will probably cover Litton’s practices.

Add to this the ever looming requirement that servicers advance delinquent payments of interest and principal to securitization investors and you can see why Goldman is looking to pull its chute and bail from the mortgage servicing business.

What is interesting to see is the players expressing interest in the Litton servicing portfolio. Ocwen Financial, which recently just digested HomEq Servicing, has expressed interest. Homeq was originally the servicing platform for The Money Store and started its independent life following the acquisition of The Money Store by First Union/Wachoiva. Wachovia subsequently sold HomEq to Barclays, which then sold it to Ocwen. The other player presumably expressing interest in the platform or its servicing rights is Carrington Mortgage Services, which is made up of mostly ex-Fremont Investment & Loan servicing employees, especially in senior management.

So, with Goldman looking to say “adieu” to residential mortgage servicing, clearly it is time to rethink what  is the benefit to collecting payments in an industry overwhelmed with problems. Because, as the preeminent negotiators on Wall Street, Goldman always does what is best for Goldman. All that otherwise can be said is  “Caveat Emptor”!

AND THE FEDERAL GOVERNMENT STEPS UP TO THE PLATE WITH THE BIG BAT FOR SERVICERS

The Office of Comptroller of the Currency and the Federal Reserve got the largest of residential mortgage servicer to sign “Stipulation and Consent to Issuance of a Consent Order” today, forcing the servicers to take a look at their prior practices that allowed for robo-signing and improper foreclosure practices and to make changes to those processes in pretty quick order.

Of those servicers hit with the Order include Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, Ally Financial, HSBC North America Holdings, PNC Financial Services, U.S. Bancorp, MetLife  and SunTrust Banks.

The Order appears to basically address the “robo-signing” issues that have plagued the servicing industry since last year. Claims by the OCC were that the servicers:

·         Filed affidavits in state and federal court in which the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such personal knowledge or review of the relevant books and records ;

·         Filed numerous affidavits or other mortgage-related documents that were not properly notarized, specifically that were not signed or affirmed in the presence of a notary;

·         Litigated foreclosure and bankruptcy proceedings and initiated non-judicial foreclosure proceedings without always ensuring that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party at the appropriate time;

·         Failed to devote sufficient financial, staffing and managerial resources to ensure proper administration of its foreclosure processes;

·         Failed to devote to its foreclosure processes adequate oversight, internal controls, policies, and procedures, compliance risk management, internal audit, third party management, and training; and

·         Failed sufficiently to oversee outside counsel and other third-party providers handling foreclosure-related services.

In light of these findings, servicers are now being required to:

·         Develop Oversight Committees within 5 days to monitor and coordinate compliance with the Order;

·         Provide the Board of Directors of the Servicer with a Compliance Tracking Report within 90 days (and every 30 days thereafter), showing the progress in complying with the Order, for which the Board will then, within 10 days, have to enter such report and their findings into the corporate records.

·         Build appropriate Compliance Programs within 60 days to ensure that all servicing and foreclosure actions company with all applicable legal requirements. This Compliance Program will then need to be implemented within 120 days.

·         Provide the Regional Director of the OCC within 60 days

o   an acceptable plan (the “Action Plan”) to achieve full compliance with the Order.

§  to include effective mortgage servicing, foreclosure and loss mitigation actions, as well as associated risk management, compliance, quality control, audit, training and staffing.

o   policies and procedures for outsourcing foreclosure and related functions, with implementation with 120 days;

o   a plan to ensure appropriate controls and oversight with respect to MERS and its rules;

o   a management information system for foreclosure and loss mitigation;

o   an acceptable plan, along with a timeline, for ensuring effective coordination of communications with borrowers, both oral and written, related to Loss Mitigation or loan modification and foreclosure activities;

·         Provide within 45 days for an OCC approved independent consultant to conduct reviews of foreclosure actions

o   The OCC shall review the terms and methodology to be used by the independent consultant.  

What does all this mean? Well, in the first place, the cost to service loans will now become much more expensive, as these policies and procedures will require significant more man-hours. Anytime you build more policies and procedures with specific reporting requirements, costs go up. At 25 bps, servicers are going to be squeezed, at least in the short term, until efficiencies can be found to comply with these new requirements. This will be similar to the implementation for SOX, except that the servicers have limited revenue generation, which is now going to be scrutinized by the government.

Secondly, this can turn out to be another boon-doggle for the plaintiffs’ bar, like the first round of MERS litigation. Until the courts get their heads around what is going on, slick plaintiff’s attorneys will use these new requirements to forestall the foreclosure of their delinquent borrower clients even more. Which also mean higher costs to servicers and slower repayment of servicing advances as servicers are dragged into slower foreclosures.

Lastly, investors will be left waiting for their money even longer, if they get any at all, as the time to foreclosure and resell the home, as well as the cost of foreclosure (which may now include the policies and procedure costs), will be passed along into the securitization trusts. More government intervention always means less money to the investor.

So, while there was clearly a need to fix the broken foreclosure process following the over-greased skids that were in place, the OCC’s efforts to right the ship may have sent the boat over the other way. Let us hope that if that is the case, like in the last “Pirates of the Caribbean” movie, turning the ship upside-down actually gets us out of this “Davy Jones’ locker” of mortgage servicing. But then again, that was Hollywood and Disney.

THE HARDEST HIT FUND – TAXPAYER CASH FOR PRINCIPAL WRITE-DOWNS

In its efforts to stop the proverbial plane from nose-diving into the ocean, the Obama administration back in February of last year put forth the Hardest Hit Fund (“HHF”), a $1.5 billion taxpayer backed initiative to allow state housing authorities to come up with “innovative measures” to help homeowners in the most hardest hit states. First in line were California, Florida, Arizona, Michigan and Nevada.

 Now it appears that Wells Fargo is looking to help out Arizona underwater homeowners by using some of the HHF money to provide for principal reductions. In an announcement that it is in talks with the Arizona Department of Housing to join a program of principal reduction, Wells Fargo now joins the ranks of Bank of America in providing principal reductions to delinquent homeowners in Arizona.

This is good news for investors! Simply put, if it is structured in a way that allows the HHF money to off-set the principal reduction, the investor is made whole for the write-down. HOWEVER, if the servicer looks to capture some of that money for expenses and deferred costs, the investors will be getting less than their full reimbursement. It is up to the state housing authorities to hold the line for investors, and not the servicers.



At stake as well is the reimbursement for advances that the servicers most probably will attempt to recoup from the HHF moneys. Now, while the servicers should be entitled to any reimbursement of advances that are specifically tied to principal advances, it is questionable if reimbursement of interest advances should be permitted. The counter-argument, however, is that any interest advances not reimbursed would then most likely be added to principal (either as a straight addition or as a deferred balloon payment) and would then constitute principal as well. Either way, the servicer would be left out in the cold for a while as it attempts to get back its advances.

 So, as the property values in Arizona remain as stagnant as the hot summer air in the desert, let’s hope that this program provides a bit of cooling to the burn that homeowners have been suffering. And although this may be more of a spray of water than a jump into a pool, for those of us that have been in Scottsdale in August know, even the mist makes a difference when you are otherwise baking in that Arizona sun.