By Tom Adams, securitization professional for over 20 years and partner at Paykin, Krieg & Adams, LLP
Rather than listen to thousands of borrower complaints, housing advocates, foreclosure attorneys, market experts and, well…, us, the Obama Administration tried to paper over the many problems in the mortgage servicing market by creating the foreclosure settlement (officially the National Mortgage Settlementof 2012), as well as the earlier OCC enforcement actions against big mortgage servicers.
Now we have the disaster of Ocwen, the fifth largest servicer in the country, imploding as a result of the settlement charade. Sean Donovan, the Treasury and the Attorneys General were all told repeatedly that the servicing problems were serious and needed to be addressed. Instead, they listened to the banks and mortgage servicers themselves, who earnestly swore that they had seen the light and mended their ways.
It was widely acknowledged back in 2009 that the mortgage servicing industry business was a mess as borrower defaults and foreclosures swamped servicer capacity. In his recent memoir, former Treasury Secretary Tim Geithner acknowledged that the Administration was aware that the large mortgage servicers were unprepared for the housing crisis, lacked resource capacity, were terrible at managing loan modifications and borrower relief and were, generally, incompetent at managing distressed borrowers. When the problems of the foreclosure crisis began to bubble over in 2010, the Administration finally took action, both indirectly, through the Attorneys General settlement, and directly, through actions of the HUD.
Yet despite efforts to convince the mortgage investors, borrowers and consumer activists that real servicing reform efforts were being made, the Administration permitted the orders and settlements to be watered down and generally without meaningful change, as was documented extensively here at Naked Capitalism. Presumably, the Administration’s theory was that the banks with large servicing portfolios or the housing market (or both) were too delicate to actually withstand real regulatory reform of servicing.
Was the Administration active in encouraging banks to move the troubled servicing portfolios out to third party servicers like Ocwen? It’s possible. The liability and negative headlines that came with servicing so many distressed borrowers, which seemed justified considerably the poor job the banks were doing with the servicing, was not helping the reputation of the banks or the Administration’s efforts to shore up the banking industry and the financial economy. If so, it is shame that more thought wasn’t put into the consequences of shipping the files off and wiping their hands of responsibility.
Recent reports indicate that Ocwen had a servicing portfolio of approximately $430 billion. The massive growth in Ocwen’s portfolio was a direct result of the foreclosure settlement. After the national pact in 2012, big bank servicers were eager to exit the servicing of non-agency loans (that is, loans that were not backed by Fannie, Freddie, the FHA or the VA) and distressed loans.
In quick succession, Ocwen acquired servicing portfolios of Goldman Sachs and Morgan Stanley entities, as well as the portfolio of Rescap (a former unit of Ally Bank, formerly known as GMAC) and assorted other pools from Bank of America and Barclays. As a result of these and several other smaller acquisitions, in 2012 Ocwen’s servicing portfolio nearly tripled in size.. This worked out well for the sellers of the servicing portfolios, who were now free of the headaches of the distressed loans but, not surprisingly, it didn’t work out so well for the mortgage backed securites investors and borrowers who now had Ocwen as a servicer.
Even as Ocwen was acquiring these portfolios, it was under regulatory scrutiny for many of the same issues that would surface in 2014 to the company’s detriment. In 2011, Ocwen disclosed that the FTC was looking into its servicing practices. In 2012 the New York Department of Financial Services established a consent order with Ocwen and installed a monitor of its servicing practices. In addition, Ocwen had regulatory scrapes in the past that included the loss of its bank charter, also as a result of its servicing practices.
While Ocwen was in the process of ramping up its servicing portfolio, it was also entering into a consent decree with the CFPB and the Multistate Mortgage Committee (an aggregation of regulators from 49 states) over charges of “systemic misconduct at every stage of the mortgage servicing process”. So, even as a much smaller company, Ocwen had numerous struggles with managing its servicing portfolio and numerous prior allegations that it harmed the interests of borrowers and MBS investors. The writing was on the wall – why would it be a surprise that Ocwen would encounter even more problems after it tripled in size?
In addition, the business of servicing distressed borrowers has always had issues. The rapid growth and subsequent problems managing the basic elements of the business that Ocwen has experienced mirror what happened back in the early 2000s. In 2003, long before the financial crisis, the Federal Trade Commission took on the then-largest servicer of distressed loans, known at the time as Fairbanks Capital. I got to witness the ugly implosion close up because Fairbanks was the servicer on a significant portion of the loans in my then-employer’s portfolio (for which I had some responsibility). It feels like déjà vu putting up the list of the FTC’s complaints against Fairbanks:
The FTC alleged that, in servicing loans, Fairbanks frequently:
• failed to post consumers’ mortgage payments in a timely and proper manner, and then charged consumers late fees or additional interest for failing to make their payments “on time”;
• charged consumers for placing casualty insurance on their loans when insurance was already in place;
• assessed and collected improper or unwarranted fees, such as late fees, delinquency fees, attorneys’ fees, and other fees; and
• misrepresented the amounts consumers owed.
falsely represented the character, amount, or legal status of consumers’ debts; communicated or threatened to communicate credit information which was known or which should have been known to be false, including the failure to communicate that a debt was disputed; used false representations or deceptive means to collect or attempt to collect a debt, or to obtain information concerning a consumer; collected amounts not authorized by the agreement or permitted by law; and failed to validate debts.
As a result of the negative publicity regarding their servicing practices and various actions by the FTC, Fairbanks was severely crippled, its CEO resigned, and, ultimately, its investors sold off the company.
As the Fairbanks case illustrates, distressed mortgage servicing has a history of being a problematic business. For one thing, servicing distressed borrowers is far more labor intensive than managing a portfolio of performing borrowers. Servicing distressed borrowers involves, in varying degrees, numerous phone calls, correspondence, regulatory checks and balances, outside attorney, appraiser and broker management, real estate market assessments and liquidity management relating to servicing advances. Servicing for performing borrowers is basically payment processing. Because of the strict terms and cashflow structures of mortgage servicing contracts, however, servicers are paid the same fixed fee (0.25%-0.50% of the outstanding loan balance) for both performing and distressed borrowers (some special servicing agreements paid distressed servicers a form of incentive fee, though such fees must still fit under the servicing fee cap of the servicing agreements. In addition, the government’s HAMP program provided incentive fees for modifications and related borrower enhancements, which Ocwen aggressively pursued.
One might reasonably ask why someone would want to be in an expensive, labor-intensive business subject to capped fees? According to Ocwen, they were able to make the business work because of the extensive experience, low cost structure (which included overseas business units), efficient use of technology and artificial intelligence and effective loss mitigation strategies. However, based on numerous allegations leveled against the company, Ocwen cut corners, extracted (questionable) fees and expenses, including through above-market rate affiliates, and generally, steam-rolled the process for their own benefit and to the detriment of borrowers and MBS investors, who were actually paying for the various hidden costs of Ocwen’s servicing.
Despite its claims, Ocwen hadn’t really found a way to make servicing of distressed loans profitable as much as they had found a way to cut costs and extract fees without anyone noticing (for a while, at least). After our experience with Fairbanks, I and many other MBS investors concluded that mortgage servicing didn’t really work as a standalone business – such companies needed other sources of income to offset the high costs of servicing distressed borrowers, such as loan origination or investment in the residual interest in the mortgage assets. Without this buffer, distressed servicers would likely face conflicts and misaligned incentives when managing their portfolios of other peoples loans. Of course, the foreclosure crisis revealed that even servicers that have origination arms, owned residual interests or have other sources of income can still be overwhelmed by the costs, complexity and complications of a distressed portfolio of mortgages. Unfortunately, 7 years after the onset of the financial crisis, the mortgage market still has not resolved the many issues relating to servicers, conflicts of interest and adverse incentives. It is reasonable to assume that some of the reluctance for private capital to return to the non-agency mortgage market is due to ongoing concern about these unresolved issues in the mortgage servicing market.
Today, Ocwen is facing regulatory scrutiny from various state regulators (including New York and California most prominently), its CEO and founder, William Erby has resigned, investors are making the case that Ocwen has breached various servicing termination triggers in its servicing agreements, equity investors have lost confidence in its once high-flying stock to the tune of about a 90% decline in the past 12 months and the company is scrambling to re-structure, including by selling off portions of the portfolio it worked so hard to build. Based on my prior experience with sericers like Fairbanks, this is what it looks like when a servicer is blowing up.
Ocwen announced that it will be selling off a significant portion of its Fannie Mae and Freddie Mac servicing portfolio. This is a bit odd, since agency mortgages generally have low defaults and, therefore are easier and cheaper to service and, presumably are more profitable than seasoned distressed mortgages which make up a substantial portion of Ocwen’s remaining portfolio. It is unclear if Ocwen has begun to sell these servicing rights yet, and there is the possibility that other servicers may be somewhat reluctant to acquire loans previously serviced by Ocwen, out of concern for hidden legacy issues related to Ocwen’s problems. Nonetheless, the market for servicing rights on agency loans is relatively deep and liquid, so Ocwen should eventually be able to find buyers for this portion of the portfolio at some price.
Of greater concern to Ocwen investors, as well as MBS investors and consumers, the mortgage market is tolling a bell for the servicer. A hedge fund has sent a notice of default to an Ocwen affiliate regarding its advancing facility and notified the MBS trustees on many Ocwen serviced deals that Ocwen may be in default under those agreements. While Ocwen disputes these charges (and blames “the shorts” for trying to harm the company), hedge funds aren’t the only ones that are raising alarms about Ocwen. Fitch warned that Ocwen-serviced MBS deals face ratings downgrades due to Ocwen’s servicing problems. Also, to the extent that Ocwen has rating triggers as one of its servicing termination provisions as many MBS deals do, recent servicer rating downgrades by Fitch, Moody’s and S&P could be triggered.
Fitch notes that one of its concerns with Ocwen is that its portfolio is so large, and troubled, and there may not be anyone interested or able to step in and take over servicing for them. That’s when things will start to get ugly. It is likely that more MBS investors will raise alarms. It is also likely that Ocwen will try to fight its termination as servicer. As the battle develops, troubled borrowers will likely get neglected, which will likely lead to higher delinquencies and messy servicing files. If a successor servicer is brought in, the odds are very high that the transition to a new servicing platform will be bumpy, at best. Borrower defaults could increase and losses to MBS investors could increase, as well. Given the large size of Ocwen’s portfolio and the delicate state of so many borrowers in the portfolio, the transfer of some or all of Ocwen’s servicing portfolio will cause disruptions throughout the housing market.
As an aside, the stock prices of several other mortgage servicing companies have also been hit hard, in sympathy with Ocwen. Perhaps investors in those companies are concerned that Ocwen’s servicing was not that unique. If regulators and MBS investors (or hedge funds) are stepping up the scrutiny on distressed mortgage servicing, other servicers employing similar tactics may also be at risk. Of course, if other distressed servicers are also experiencing regulatory issues, that would make the transfer of Ocwen’s servicing portfolio that much more challenging.
Back in 2011, I asked how likely it was that “predatory servicing” would come back sometime soon if the Administration proceeded with a weak foreclosure settlement. Now, we know the answer: very likely, and in about 3 years.
The attorney generals, the OCC, HUD and the Treasury Department had the opportunity to create a meaningful reform to the problems in the servicing market and they declined to do so. The current Ocwen problems are clearly a result of the failure to act in 2012. Solutions to the problems in the mortgage servicing market have been offered from a variety of sources. Certainly, effective enforcement of existing laws in a timely manner – such as the opportunity offered by the Foreclosure Settlement of 2012 – would have been a big help. As the passage of time since the crisis suggests, the mortgage market hasn’t been able to fix itself yet.
When it comes to the housing markets, this Administration seems unable or unwilling to take the right steps to truly help it recover. In the coming months, borrowers and MBS investors in the fifth largest servicer in the country are likely to be the ones paying the price for the missteps.