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From Banking and Finance Law Daily, April 29, 2014

Missing and limited data plagued mortgage foreclosure review payout determinations, says GAO report

By Colleen M. Svelnis, J.D.

Missing and very limited data kept the Office of the Comptroller of the Currency and the Federal Reserve Board from accurately negotiating a payout for borrowers harmed due to deficiencies in foreclosure processing, concluded a GAO report. The report, entitled “Foreclosure Review: Regulators Could Strengthen Oversight and Improve Transparency of the Process,” examines the process the federal banking regulators went through to determine a payout amount after termination of the Independent Foreclosure Review (IFR) in 2013. The federal banking agencies paid out $3.9 billion in cash payments to about 4.4 million borrowers and $6 billion in foreclosure prevention actions, such as loan modifications, which the report concluded was an overpayment that could have been prevented by more careful analysis on the part of the Fed and the OCC.

Congressional reaction. Congresswoman Maxine Waters (D-Calif), Ranking Member of the House Financial Services Committee, has monitored the IFR since the program began in early 2011, and has raised numerous questions about the design and fairness of the process. Waters released a statement in response to the GAO report:

“I’m troubled by the recent GAO report, which shows that just as the Department of Justice deliberately overstated its investigation and prosecution of mortgage fraud cases, regulators claimed six billion dollars of settlement payments that never truly occurred. According to the report, regulators used a nonsensical crediting system for the largest portion of the settlement, meant to provide additional foreclosure relief activities to victims of unscrupulous practices. And the report found that banks were able to meet the requirements of the settlement without making any changes to their existing foreclosure activities.”

“I’m concerned with these findings by GAO, which also show that the settlement was reached without adequate investigation into the harms committed by the servicers,” she said. “Many of the files did not contain complete data, making it impossible to know whether borrowers were disqualified from the possibility of the greatest cash payouts. Only a thorough review of poorly maintained or incomplete servicer files could have verified whether payments were commensurate with the harms committed.”

Waters objected to the blanket settlement issued in 2013, and had sent a letter to the Fed Chair and the OCC head requesting greater transparency in the process. In addition, Waters has requested a Financial Services Committee hearing on the termination of the IFR process, which has not yet been held. She stated that “[t]he information from the Independent Foreclosure Review is critical to reforming the mortgage servicing industry, which has been allowed to operate without adequate controls for protecting borrowers since the peak of the foreclosure crisis. Regulators must act immediately to disclose data from the review, reform broken practices at the servicers, and ensure that borrowers receive the information they need to right these wrongs.”

Background on foreclosure review. The report describes how, after allegations surfaced that several mortgage servicers’ documents in support of judicial foreclosure may have been inappropriately signed or notarized, the federal banking regulators undertook a review of 14 mortgages servicers “to evaluate the adequacy of servicers’ controls over foreclosure processes and to assess servicers’ policies and procedures for compliance with applicable federal and state laws.” The agencies found critical issues in servicers’ foreclosure governance processes; foreclosure documentation preparation processes; and oversight and monitoring of third-party vendors, including foreclosure attorneys.

The Fed issued consent orders and civil money penalties against some of the servicers. The consent orders also required each servicer to retain an independent consultant to review certain foreclosure actions. So in 2011 and 2012, the OCC required 16 mortgage servicers to undertake an Independent Foreclosure Review.

Consultants were hired to review loan files to identify any borrowers who had suffered financial harm due to errors, misrepresentations, or other deficiencies in foreclosure processing.

The consultants were to review the following areas, determining whether:

  • the servicer had proper documentation of ownership of the loan;

  • the foreclosure was in accordance with applicable state and federal laws;

  • a foreclosure sale occurred while a loan modification was under consideration;

  • nonjudicial foreclosures followed the terms of the loan and state law requirements;

  • fees charged to the borrower were permissible, reasonable, and customary;

  • loss-mitigation activities were handled in accordance with program requirements and policies; and

  • any errors, misrepresentations, or other deficiencies resulted in financial injury to the borrower.

Payments. By 2013, these reviews had not been completed and the agencies discontinued the reviews of 15 mortgage servicers, according to the report. At this point, according to the report, the agencies and the mortgages servicers moved away from identifying the types and extent of harm an individual borrower may have experienced and focused on issuing payments to all eligible borrowers based on identifiable characteristics.

The agencies then paid out $3.9 billion in cash payments to about 4.4 million borrowers and $6 billion in foreclosure prevention actions, such as loan modifications. The remaining servicer is still in the process of completing the examinations process, which the report says should be finished in 2014.

The report outlines the limited data that was available to the regulators because the reviews were incomplete. According to Fed staff, OCC led the data analysis used for negotiations, and the Fed relied on aspects of this work. The GAO report concluded that the regulators did not test the major assumptions used to inform negotiations. The GAO compared the final negotiated cash payment amount to estimates obtained by varying the key assumptions used in regulators’ analysis. The final payout of $3.9 billion exceeded the two separate cost estimates of $2.9 billion and $1.2 billion that the OCC generated during the negotiations.

According to the GAO’s research, the OCC and the Fed relied on cost projections from consultants which estimated that the remaining expected fees for consultants to complete the reviews would be at least $2 billion. The consultants also reported cost projections based on time frames ranging from 4-13 months to complete the evaluations after November 2012. The report states that using the aggregate financial harm error rate of 6.5 percent, the OCC estimated the potential payout to borrowers would be $1.2 billion. The Fed did not rely on OCC’s financial harm error rate analysis, but instead relied on cost projections and remediation reserves.

The Fed and OCC staff considered the error rate for proposed cash payment amounts during negotiation. The report states that the agencies estimated that the actual error rate from completed reviews would have had to exceed nearly 26 percent before remediation payments under the reviews would exceed the negotiated cash payment amount. The negotiated amount was determined to be more than sufficient to cover the total amount that servicers would have to pay to harmed borrowers under the IFR.

GAO review finds issues with regulators’ analysis. In its review, the GAO “tested assumptions related to projected costs, error rate, and borrower categorization.” In order to assess the reasonableness of the final payout amount, the GAO compared the final negotiated cash payment amount to the amounts calculated when key assumptions were varied. The report concluded that the payout amount was higher—at the highest reported servicer error rate, the GAO calculated a payment of $3.7 billion. The GAO analysis generated a range of estimated remediation payouts “between 71 percent below and almost 206 percent above the amount generated by OCC’s analysis using the average error rate of 6.5 percent.”

The report concluded that the banking regulators did not establish specific objectives for foreclosure prevention actions, but instead negotiated the amount without any specific objectives or informed by any data or analysis. “Although regulators stated they considered other similar settlements, they did not collect or analyze relevant data to inform the amount or structure of the foreclosure prevention component of the amended consent orders.”

The report acknowledged the atypical nature of the negotiations and payment, but stated that some data collection and analysis “would have been feasible and useful to inform the amount and structure of the foreclosure prevention component.” The GAO noted that useful data was available from the servicers and other agency programs.

Although the early termination of the foreclosure review process provided payments to harmed borrowers more quickly than would have otherwise occurred, the report noted that one of the goals that motivated the original file review process was a desire to restore public confidence in the mortgage market. Without making information about the processes used to categorize borrowers available to the public, such as through forthcoming public reports, regulators may miss a final opportunity to address questions and concerns about the categorization process and increase confidence in the results.

Recommendations. The GAO report recommended that the OCC and the Fed define testing activities to oversee foreclosure prevention principles and include information on processes in public documents. The report recommended better transparency on the processes used to determine cash payment amounts such as the criteria servicers use to place borrowers in various payment categories.

Agency responses. The Fed agreed with the recommendations in the report and the OCC did not explicitly agree or disagree. In addition, the OCC included the requirement on assessing servicer implementation of foreclosure prevention principles in its examination plans and will be used as considerations when assessing the effectiveness of servicer actions. The Fed plans to conduct its assessments in 2014 and stated that its examination teams will use testing.

The OCC stated that it will consider including additional detail about the categorization of borrowers in its public reports to increase transparency of the process. Both the OCC and the Fed noted that they had made information about the foreclosure review and amended consent order processes available on their websites to communicate information to the public.

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