Funny what a difference a few days makes. Late last week, we discussed how banks were unhappy about the fact that Benjamin Lawsky, New York State’s Department of Financial Services, had the temerity to take his duties as a regulator seriously and launch probes into currency manipulation and evidence of incompetent-to-abusive mortgage servicing at Ocwen. Lawsky is blocking the transfer of mortgage servicing rights to $39 billion from Wells Fargo to Ocwen, questioning Ocwen’s ability to do the job properly. Ocwen is already subject to two orders from Lawsky’s office, one in 2011 and one in 2012. The December 2012 order is based on a limited exam earlier that year that uncovered a number of deficiencies.
Of course, industry incumbents sniffed that Lawsky was overreaching and seeking to garner headlines. But the fact is that the mortgage industry servicing model is broken. Servicing fees don’t compensate them enough to service defaulted mortgages properly, while they do pay them to foreclose. So what do you think they do when a borrower starts to get into arrears? And banks have chosen to ignore, skirt, or claim strained interpretations of requirements in mortgage settlements to end some of the worst practices (the banks are admittedly aided and abetted by weak supervision and provisions in the 49 state/Federal settlement that permit astonishingly large rates of error, as in non-compliance).
Lawsky blocking the Ocwen transfer has bigger implications: the banks were hoping to dump their servicing headache on smaller non-banks who supposedly could do a better job. But as we’ve written repeatedly, mortgage servicing does not scale, and really large servicers tend to be good only at taking and crediting payments and remitting money to investors, and then not even very good at that (previous exams of Ocwen found it often failed to verify the accuracy of information before “boarding” the loans onto its system).
It turns out big investors, including Pimco and Blackrock, also have serious reservations about Ocwen’s performance, to the point of possibly taking the unusual step of suing them. From the Financial Times:
Investors including Pimco and BlackRock are considering legal action against Ocwen Financial, in a sign of unease at the growing clout of non-bank mortgage-servicing companies which are responsible for collecting payments on millions of US mortgages.
The investors’ concerns centre on mortgage servicing practices and loan modifications that they claim may have hurt the performance of securities bought by investors, said people familiar with the discussions…
Ocwen’s servicing portfolio has grown more than 300 per cent since 2012, according to Fitch Ratings, making it the biggest non-bank mortgage servicer in the US managing about $430bn worth of unpaid principal balances on home loans…
Ocwen’s mortgage servicing standards have been under increased scrutiny after it reached a $2.1bn settlement in December with the Consumer Financial Protection Bureau, which had accused the company of a litany of administrative errors and deceptive practices that pushed borrowers into foreclosure…
Non-bank mortgage servicers have expanded rapidly in recent years as banks have sold their rights to service mortgages because of new rules that force them to hold more capital against the assets.
The rapid growth has spurred criticisms that the servicers have been skimping on services as they handle more loans and make aggressive acquisitions of new servicing rights.
So this possible suit reveals a much bigger policy failure: regulators assumed that moving servicing over to hungrier, smaller players would fix the problem. But with no change in the payment structure or the existing agreements, there was no basis for this rosy belief. Indeed, the Ocwen case shows that if anything, this change has made an already bad situation worse. Investors have refused to mobilize to go after rampant servicing abuses (the padded costs, servicer-induced foreclosures and failure to maintain properties ultimately come out of investors’ hides), largely because the investors had incentive problems of their own. They aren’t “investors” in the sense that they are putting their own funds at risk; they are in the other people’s money business. They don’t have incentives to sue and generally can’t be bothered.
The interesting part here is that what appeared to have changed the dynamic is that Ocwen’s performance is apparently notably bad and investors aren’t putting other business at risk (remember, they execute transactions through major banks and think they need their market intelligence and research, so they are loath to sue them). So what was otherwise a misguided regulatory move may have an itty bitty upside in that by locating servicing in non-TBTF, not-otherwise important firms, regulators and investors may, finally, start cracking down on them in a meaningful way. But even if this happens, it’s likely only the worst conduct will be targeted. But even that would be progress.