Mortgage Servicers Face Washington Hammer

NEW YORK (TheStreet) -- Mortgage loan servicers are becoming the new regulatory pin cushion.

In the aftermath of the credit crisis, it became pretty clear that the largest U.S. banks were having plenty of difficulty handing various aspects of servicing distressed mortgage loan portfolios, resulting in numerous regulator actions and a landmark $25 billion foreclosure settlement with regulators, which included plenty of relief for suffering borrowers.

Loan servicing specialists began purchasing the rights to service large pools of mortgage loans, with key players such as Ocwen Financial (OCN) growing by leaps and bounds. Ocwen grew its pro forma portfolio of serviced loans to $473 billion in November from $204 billion at the end of 2012, according to the company's Jan. 28 presentation to lenders.

But that $473 billion pro forma figure has here been adjusted down from $512 billion, because Ocwen on Feb. 6 said it had it had agreed "to put an indefinite hold" on its deal to purchase the serving rights for a pool of 184,000 mortgage loans with an unpaid balance of roughly $39 billion from Wells Fargo Bank, NA, the main subsidiary of Wells Fargo (WFC).

Ocwen put a hold on the Wells Fargo deal at the request of the New York Department of Financial Services Superintenden Benjamin Lawsky, who expressed concern over Ocwen's ability to handle its rapid growth, according to media reports.

In comments at the New York Bankers Association annual meeting in New York on Feb. 12, Lawsky didn't mention Ocwen by name, but he called the growth of non-bank mortgage servicers "a troubling trend." Of the top 10 U.S. mortgage loan servicers, four are non-banks, according to Lawsky, servicing "more than a trillion dollars of loans -- 10 percent of the residential mortgage market, and climbing."

Lawsky also pointed out that "the loans that those non-bank companies service are disproportionately distressed. And behind each distressed loan is a homeowner or family struggling to make ends meet."

It seems reasonable at this stage of the economic recovery, with banks trying to cut their loan servicing costs, for the loans being sold to non-banks to be "disproportionately distressed," since those are the serving burdens the banks want to get rid of.

One of the reasons the big banks want to focus less on servicing loans is their increased regulatory burden and capital requirements. Non-bank servicers for the most part don't hold the loans being serviced, which is one of the reasons they have a lower regulatory burden.

"Non-bank servicers see a tremendous business opportunity in this regulatory arbitrage, and are moving quickly to gobble up distressed MSRs," or mortgage servicing rights, Lawsky said.

In comments that must have been aimed at Ocwen, Lawsky said a recent SEC filing by "one of these non-bank servicers" made for "startling" reading. "In the space of about a single year, that company had nearly quadrupled in size, and now services more than $400 billion in loans... In the next 2-3 years alone, that company said it sees opportunities for as much as a trillion dollars in additional servicing growth," he said.

Lawsky went on to say the New York DFS "closer look" at non-bank loan servicers has identified "corners being cut."

Shares of Ocwen have dropped 53% this year through Wednesday's close at $36.28, nearly following a gain of 60% during 2012.

In addition to Lawsky's action against Ocwen, there has been plenty of recent coverage of consumer complaints against non-bank mortgage loan servicers, and the industry is facing much greater pressure in Washington.

Consumer Financial Protection Bureau deputy director Steven Antonakes during a Mortgage Bankers Association (MBA) conference in Orlando, Fla., on Wednesday described his agency's new rules for mortgage servicers, which include a monthly statement to show the borrower how their payments are applied, along with balances for principal and escrow accounts.

An example of areas of concern for the CFPB is the process of transferring of servicing from one company to another. When loan servicing rights are sold, borrowers sometimes have difficulty communicating with the new servicer and errors can be made between servicers, causing great stress for borrowers. Antonakes said to MBA members, "We expect you to pay exceptionally close attention to servicing transfers and understand we will as well."

Antonakes also said servicers have had "more than a year to work on implementation" of new rules. Here's his detailed description of the CFPB's new rules for the foreclosure process:

For consumers in trouble, getting the runaround is not just frustrating, it can be disastrous. So our rules require mortgage servicers to let consumers know about available options to save a home or to work out a problem in making payments. We are also restricting "dual tracking" by barring servicers from starting foreclosure proceedings until the borrower has been delinquent for more than 120 days. If the borrower timely submits a complete application for loss mitigation more than 37 days before a scheduled foreclosure sale, no foreclosure sale can occur until all other options available through the owner of the loan have been considered, such as loan modifications, short sales, and deeds-in-lieu of foreclosure. And servicers cannot foreclose on a property once a loss mitigation agreement has been reached, unless the borrower fails to perform under that agreement. We expect these simple protections to help prevent needless foreclosures, which is best for borrowers, lenders, and our entire economy.

Antonakes went on to say that the CFPB had already "ordered the return of more than $1 billion to consumers and mandated another $2 billion in foreclosure relief."

So what will the increased scrutiny of mortgage servicers by the CFPB and other regulators mean for the formerly high-flying mortgage servicing sector?

FBR analyst Paul Miller, who is generally upbeat about mortgage servicers as investments, wrote in a client note on Thursday, "We continue to believe that specialty servicers are much better prepared to meet the servicing goals outlined and should continue to benefit from servicing transfers. However, the increased scrutiny, especially on transfers, could certainly become a speed bump."

Miller wrote that Antonakes' speech was "notable in its aggressive tone, which was outside the norm for speeches by CFPB officials and in stark contrast to recent speeches by CFPB officials promising leniency for originators adopting to new mortgage origination rules."

Looking ahead, the analyst still feels the trend will be for more large transfers of servicing rights to be made, to the benefit of the non-bank servicers, but that the transfers will take much longer.

And there's another dark regulatory shadow on the horizon. Fannie Mae and Freddie Mac, which together purchase the great majority of newly originated mortgage loans in the United States, pay an annual servicing fee of a quarter point to loan servicers. Federal Housing Finance Agency Director Mel Watt is considering lowering the servicing fees paid by Fannie and Freddie. That would instantly lower the value of mortgage servicing rights for banks and non-bank servicers alike, and also "could make it harder for smaller servicers to have the economy of scale to service loans," according to Miller.

As part of the regulatory pile-on against the banks, Rep. Maxine Waters (D., Calif.) -- the ranking member of the House Financial Services Committee -- has "added her voice to the debate in a letter to regulators asking for a review of servicing transfers to non-banks," according to Miller.

Shares of Ocwen were down 3.8% in late morning trading, to $34.91.

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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.

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