NEW YORK (
) -- New rules by the California State Legislature and municipalities in San Bernardino County could greatly increase the cost of mortgage loans over the long term for the Golden State.
Two new mortgage servicing bills passed by California lawmakers and a possible radical use of eminent domain to force loan modifications signal a painful new round of challenges for mortgage lenders, loan servicers and investors.
California governor Jerry Brown is expected soon to sign into law two bills passed on Monday by California's Senate and Assembly, which will make permanent key protection rules for mortgage loan borrowers that were set to expire after three years, under the $25 billion settlement between federal regulators, 49 states' attorneys general, and the largest loan servicers -- including
Bank of America
California Governor Edmund G. Brown, Jr.
The two bills will permanently require most lenders or loan servicers "to establish a single point of contact and provide the borrower with one or more direct means of communication with the single point of contact," while also prohibit "dual tracking," which is the practice of continuing to pursue foreclosure while simultaneously negotiating new terms with a residential loan borrower.
While Bank of America and JPMorgan Chase declined to comment on the new California rules, Vickee Adams -- the Vice President for external communications for Wells Fargo Home Mortgage -- says that the lender has been complying with both rules for some time.
Adams says that Wells Fargo's "1:1 Model" was initiated in June 2010 "to assign one point of contact within the organization to handle their loan all the way through modification and resolution to avoid foreclosure," adding that "we are almost 3-4% lower in our foreclosure rates than our competitors so we believe our modification order has been very successful."
The single point of contact for borrowers facing foreclosure became the industry standard for the largest mortgage servicers in April 2011, when the Office of the Comptroller of the Currency, ordered eight national servicers -- including subsidiaries of the "big four" U.S. banks listed above, as well as subsidiaries of
PNC Financial Services Group
-- to cure various servicing deficiencies. The April 2011 OCC order also prohibits servicers from continuing foreclosure proceedings "once a mortgage has been approved for modification."
Regarding dual tracking, Adams says that before the rules changed "some investors required the foreclosure proceeding to continue during the modification negotiation."
Adams adds that Wells Fargo Home Mortgage has "made a commitment to avoid referring a loan to foreclosure or to advance an existing foreclosure process" if the bank has received a complete modification package from the borrower, unless the modification has been denied and a 20-day appeal process has concluded. The foreclosure process also stops if the borrower has been approved for a modification or forbearance plan and is complying with the new terms, or if a short sale or a deed-in-lieu of foreclosure has been approved by all parties, with financing provided.
The new California laws will become effective in January, setting up conflicts with the national mortgage settlement, which itself conflicts in some ways with the OCC's order, as well as possible conflicts with new national mortgage loan servicing rules expected to be handed down by the Consumer Financial Protection Bureau late this year or early in 2013.
Frank Mayer -- a partner in the Financial Services Practice Group of Pepper Hamilton LLP, in the firm's Philadelphia office -- says that rather than focusing on the mechanics of the foreclosure process, "it would be nice to see the policy makers focus on how to deal with the negative equity issue, because there are rational decisions being made by homeowners" who decide whether or not to walk away from homes with mortgage loan balances greatly exceeding their market value.
Mayer worries "about unintended consequences," because in California non-judicial foreclosures are quite common, but the new laws -- which include serious penalties for violations of the rules requiring a single point of contact for the borrower facing foreclosure and the rules preventing "dual tracking -- could lead to an increase in more expensive judicial foreclosures.
In California, the property title remains in trust until the mortgage loan is fully paid off. During a non-judicial foreclosure, the trustee can sell the property, greatly facilitating the process for the lender or the holder of the mortgage, and "they just write off the deficiency," according to Mayer.
If the mortgage holder opts for the traditional judicial foreclosure, "it is a very difficult process for a consumer to redeem their property," according to Mayer, who adds that "what will potentially happen is that these cases will go through court, and then the borrower may also be sued personally for attorney fees and costs," on top of a potential deficiency judgment.
Mayer also says the new rules are "unique and different" from the previous regulatory orders against the six banks," because they "give the consumer a right to an injunction to stop the foreclosure process, which can lead to attorney fees and fines against the banks."
So not only do the new laws potentially lead to mortgage holders opting for the more expensive -- and potentially more painful for the borrower -- judicial foreclosure, the increased costs for all parties could raise borrowing costs or stifle credit availability for the consumers the legislators are seeking to help.
Dustin Hobbs, a spokesman for the California Mortgage Bankers Association says that if the California legislation "results in a slew of new frivolous lawsuits and lengthens the foreclosure process, investors will put more of a premium on California loans, which of course will push some borrowers out of the market."
A Blunt Instrument
Another California development that could make it easier for thousands of "underwater" borrowers to stay in their homes, while setting a very painful precedent for lenders and investors in mortgage-backed securities is the possible use of eminent domain to force loan modifications.
San Bernardino County, along with the cities of Fontana and Ontario, have set up the Joint Powers Authority, which is considering what County spokesman David Wirt calls the "intriguing idea" of using eminent domain to take control over mortgage loans with principal balances greatly exceeding property values. Under the proposed program, which would be funded by
Mortgage Resolution Partners
, a new refinanced loan balance amount that could be supported by the current fair value of the property would be determined, and the investor holding the mortgage would be paid off for that amount.
The borrower would be offered a refinancing, with possible assistance from the Federal Housing Administration, meaning that the borrower might only need 2.5% equity in the home, so that the refinanced balance could be more than the amount that the investor was paid.
Mortgage Resolution Partners is a private firm led by Graham Williams, a former director of residential lending at Bank of America. The company did not respond to a request for comment.
Wirt says that San Bernardino County "has not determined whether or not it would be a good idea" to move forward with the novel use of eminent domain being explored by the Joint Powers Authority, but also says "our economy is in crisis mode and the sooner we can do something to help people, the better, as lot of people trapped in underwater mortgages could eventually face foreclosure."
Mayer says that in order for this new use of eminent domain to pass muster, the cities and the county "have to show that the eminent domain proceeding is benefiting the public as a whole, rather than just individual property holders. Absent that, it will be deemed unconstitutional."
Hobbs calls the specter of mortgage modifications foisted upon MBS investors through the use of eminent domain "disturbing, to say the least," and while the California Mortgage Bankers Association is "not exactly sure what the program is going to look like," the program "could chill investor activity in certain territories."
Mark Dowling, CEO of the Inland Valleys Association of Realtors says his organization is also "against the use of eminent domain to modify mortgages." Regarding the benefits to the public at large from keeping homes from becoming vacant and potentially run down, he says the municipalities "have code enforcement policies in place that would already oversee the maintenance."
in California usually involves two owners, the homeowner and the deed-in-trust holder," Dowling says, adding "our board does not feel it is appropriate to deny one of the owner's rights while protecting the other owners' rights and interests."
Chris Katopis -- the executive director for the Association of Mortgage Investors -- says "our members are strongly opposed" to the use of eminent domain to force mortgage loan modifications, and that "we're looking at something of a land grab by a very small group of investors."
Wirt says that the first public meeting of the Joint Powers Authority will "occur this month, possibly next week," although no specific date has been set.
Written by Philip van Doorn in Jupiter, Fla.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.