Servicers Short on Modifications

“Given the flexibility provided in most PSAs [pooling and servicing agreements],” Sheila S. Bair testified at a Jan. 31 hearing before the Senate Banking, Housing and Urban Affairs Committee, “it seems unlikely that a servicer engaging in loan modifications to avoid greater losses through foreclosure will be legally liable to investors.”

In fact, warned Bair, whose background includes a law degree, the opposite could be the case, according to a transcript of her prepared testimony provided by the Mortgage Bankers Association.

Servicers who do nothing to deal with upcoming mortgage rate resets that would be unaffordable to borrowers, and instead follow traditional processes that lead to foreclosures, she pointed out, “probably run a greater risk of legal liability to investors for their failure to take steps to limit losses to the loan pool as a whole.

“Based on existing industry standards and the flexibility provided in servicing agreements,” she explained, “we believe that sufficient legal authority exists to protect servicers from liability for engaging in loan modification activity.”

But if Congress determines that statutory affirmation of this authority is desirable, then Congress should pass legislation that establishes a clear statutory standard regarding servicers’ fiduciary obligations, Bair suggested. The standard, she said, could allow a loan modification if the loan is in default or expected to default and anticipated recovery under the loan modification or workout plan exceeds the anticipated recovery through foreclosure “on a net present value basis.”

Such a standard would be consistent with most existing contracts and would be a confirmation of existing law, and would not change servicers’ normal contract obligations, according to Bair. By not taking away, altering or overriding existing contractual rights of the parties, such legislation would avoid any potential constitutional problems.

“The FDIC stands ready to assist Congress if it considers such legislative action necessary,” she vowed.

Bair stressed that the need for action by servicers is only increasing.

“The problems in the subprime mortgage markets are only going to increase in coming months and servicers need to be much more aggressive in utilizing the tools available to them to address these issues,” she said.

“The peak of monthly payment resets on subprime hybrid ARMs is still approaching,” she warned, pointing out that this peak will involve more than 350,000 loans in this year’s third quarter, compared with about 270,000 loans in the first quarter. “We also should anticipate additional credit distress from payment resets on other nontraditional mortgages, such as interest-only or payment-option loans, as we move forward in time and as market conditions remain relatively weak.”

She said the FDIC estimates that almost 1.3 million hybrid loans are scheduled to undergo their first rate reset during 2008 and an additional 433,000 subprime hybrid loans are scheduled to reset in 2009, “which means these problems will not end anytime soon.”

Decrying that with foreclosures continuing at “an unacceptably high level while true loan modifications are lagging,” she stressed, “It is important that servicers demonstrate and document real progress soon or they invite regulatory and legislative action to supplement the industry’s actions.”

Jerry DeMuth is an award winning journalist who has been reporting for four decades.

e-mail Jerry at demuth933@earthlink.net