The Federal Reserve System, the Office of the Comptroller of the Currency and the Office of Thrift Supervision (the “agencies”) recently released a joint report summarizing their findings from on-site reviews of 14 federally regulated mortgage servicers, resulting in consent orders being signed by the mortgage servicers and respective parent holding companies agreeing to remedial actions. The report, entitled “Interagency Review of Foreclosure Policies and Practices,” comes in light of increased mortgage foreclosures and claims against lenders alleging fraud in foreclosure practices. See “Multidistrict Court Dismisses Mortgage Foreclosure Class Actions,” Financial Services Litigation Newswire (December 2010). Lenders and servicers need to take instruction from this report as to the foreclosure procedures these agencies deem unacceptable.  

Risks Associated With Weak Foreclosure Processes and Controls

The report provides a comprehensive background of mortgage servicing and the risks associated with weak foreclosure processes and controls. The report notes the importance of mortgage servicers because they act as the intermediary between lenders and borrowers in collecting payments, reporting to investors, and foreclosing when loans are in default. The 14 mortgage servicers examined by the agencies make up over two-thirds of the mortgage servicing industry (or nearly 36.7 million mortgages). The report noted that “a necessary consequence of the growth in foreclosures since 2007 is increased demands on servicers’ foreclosure processes.” Thus, the agencies expressed concern that deficiencies in foreclosure processing among the major servicers may adversely impact the housing market and borrowers.  

The report described the potential impact of shoddy foreclosure practices on borrowers, the mortgage industry and its investors, the judicial process, the mortgage market and communities. In particular, the report observed that the risks to borrowers “presented by weaknesses in foreclosure processes are more acute when those processes are aimed at speed and quantity instead of quality and accuracy.” Further, the risks to the financial services industry and investors include the financial costs of remedying errors and refiling documents, legal costs related to disputes over authority to foreclose, allegations of procedural violations and claims by investors due to delays or other damages, general uncertainty amongst investors of securitized mortgages, and reputational risks. The report also stated that courts may lose confidence in the reliability of foreclosure documentation by servicers. Moreover, the impact on the mortgage market and communities has already been demonstrated by the suspension or slowing of foreclosures by several servicers in late 2010. When delays in foreclosure processing increase, the clearing of excess inventory of foreclosed properties slows which leads to extended periods of depressed home prices. This, in turn, may affect local property values if foreclosed homes remain vacant and ill-maintained. Therefore, proper foreclosure processes influence the stability of the entire housing market.  

The Agencies’ Findings

The agencies found a variety of issues in the current processing of mortgage foreclosures across all 14 servicers, including weaknesses in foreclosure governance processes, foreclosure document preparation processes, and oversight and monitoring of outside law firms and vendors. Specifically, the major problems related to staff, affidavits and their notarization, documentation, and audit practices. Generally, servicers had an insufficient level of staff and had inadequately trained their current staff. The examiners found numerous affidavits and other documents to be inaccurate because of the staffing issue and servicers’ affidavit signing protocols that expedited the affidavit process. These signing protocols resulted in individuals attesting to information without personally reviewing the foreclosure documents. In addition, a majority of servicers had improper notary practices that did not comply with state legal requirements. For example, individuals failed to sign documents in the presence of a notary. Furthermore, “some foreclosure documents indicated they were executed under oath when no oath was administered.” As a result, some affidavits inaccurately stated amounts owed by borrowers, stating that borrowers owed more than their file actually reflected (although typically the amount was less than $500). Regarding documentation practices, the examiners determined, although “servicers generally had possession and control over critical loan documents such as promissory notes and mortgages,” there were instances where proof of authority to foreclose required reference to additional information outside of a foreclosure file.

The report then summarized issues with outside law firms and vendors. Servicers often use outside law firms to prepare legal documents, file pleadings in court, and litigate foreclosure proceedings. Arrangements with law firms created problems for several reasons: the relationship typically lacked a formal contract; the servicers provided inadequate oversight; servicers relied on firms to retain foreclosure documents, rather than having a central location for foreclosure files; and there was an absence of formal guidance or procedures governing law firms, including instances where law firms signed documents on behalf of servicers without authority or changed the content of affidavits without the servicers’ knowledge. The examiners observed related issues with Default Management Service Providers (DMSPs), in particular Lender Processing Services, Inc., which provide services to support mortgage servicing and foreclosure processing. Generally, servicers had inadequate contracts with DMSPs and provided inadequate oversight, resulting in cases where DMSP employees signed affidavits without reviewing the foreclosure information.  

Similarly, the report discussed problems found in the agencies’ review of Mortgage Electronic Registration Systems, Inc. (“MERS”), which had relationships with all examined servicers. MERS assists servicers by streamlining the mortgage recording and assignment process through a computer database of mortgages that tracks the servicing rights and beneficial ownership of mortgage notes and by serving in a nominee capacity as the mortgagee of record in pubic land records. The examiners found that servicers failed to assess internal control processes at MERS; failed to ensure accuracy of servicing transfers; failed to ensure that servicers’ records matched MERS’ records; and had inadequate quality control, demonstrated by a lack of independent audits; and a need for more frequent and complete reconciliation between the MERS’ registry and the servicers’ systems.

Finally, the report described general ineffective quality control and internal auditing procedures at all servicers. Servicers did not meet a satisfactory level of ensuring accurate foreclosure documentation, incorporating mortgage-servicing activities into servicers’ loan-level monitoring, evaluating compliance with applicable law and regulations, and ensuring proper controls to prevent foreclosures when intervening events occurred.  

Supervisory Response: Enforcement Actions

As a result of the agencies’ findings, the agencies took formal enforcement action against each of the 14 servicers, the servicers’ respective parent holding companies, as well as Lender Processing Services, Inc. and MERS, resulting in the execution of consent orders. The report stated “the deficiencies and weaknesses identified by examiners during their reviews involved unsafe or unsound practices and violations of law, which have had an adverse impact on the functioning of the mortgage markets.” Accordingly, the consent orders require servicers to establish a compliance program; conduct a foreclosure review by an independent firm of residential foreclosure actions from January 1, 2009 through December 31, 2010; dedicate a single point of contact to ensure timely and appropriate communication with borrowers; establish policies and procedures to manage third-parties’ functions in the foreclosure process; improve management information systems; and conduct a comprehensive risk assessment by an independent firm. The agencies will monitor the actions taken by servicers to comply with the consent orders.

Conclusion

The report issued by the agencies indicates that lenders and servicers need to be conscientious at all stages of the foreclosure process, and should establish standard practices and procedures that address the agencies’ concerns. A significant finding in the report, however, is that servicers generally had control of promissory notes and mortgages, and thus the authority to foreclose. This finding essentially refutes an argument made in much of the foreclosure litigation that servicers do not have authority (or standing) to foreclose on behalf of the lenders. Thus, while lenders and servicers must tighten controls on the foreclosure process, the mortgage industry’s legal right to foreclose is likely not in jeopardy based on this report.