Regulator wants better incentives to modify mortgages

WASHINGTON — The regulator for government-controlled mortgage refinance giants Fannie Mae and Freddie Mac said last week it was looking at different compensation models for mortgage servicers that would help make it easier to modify mortgages for troubled borrowers.

The current compensation structure doesn't give servicers many incentives to modify a mortgage for troubled homeowners.

"As the recent problems in managing mortgage delinquencies suggest, the current servicing-compensation model was not designed for current market conditions," according to Edward DeMarco, the Federal Housing Finance Agency's (FHFA) acting director.

The FHFA is conducting the examination with the Department of Housing and Urban Development. They expect that the effort will lead to a proposal for a new mortgage-servicing-compensation model.

"The goal of this joint initiative is to explore alternative models for single-family mortgage-servicing compensation that better address the needs of borrowers, servicers, originators, investors and guarantors," DeMarco said.

The top four U.S. mortgage securitizers are Bank of America, Wells Fargo, JPMorgan Chase & Co. and Citigroup, according to Inside Mortgage Finance.

They also own the largest servicers, which collect a fee for administrating all aspects of a loan, including sending monthly payments to mortgage investors, maintaining records and collecting and paying taxes and insurance.

Alys Cohen, staff attorney at the National Consumer Law Center, said that when someone is delinquent or in default — either 30 or 60 days behind on their payments — the servicer has to cover the borrowers' payments to the investors. If the servicer wants to recoup those costs, the servicer can do so more quickly when there is a foreclosure than when there is a modification.

Cohen points out that if there is a foreclosure, the servicer can typically recover the costs they put up in advance because they collect it from other loans in the pool of securities packaged with the foreclosed loan. If the loan is modified, they receive a lower fee, she said, and the servicer must cover their costs over time.

"They are incentivized to foreclose rather than modify the loan because the servicer makes its money back right away if there is a foreclosure, and they only make it back over time with a modification," Cohen said.

Treasury Secretary Timothy Geithner and Housing and Urban Development Secretary Shaun Donovan said the compensation model is "broken and should be fixed."

"The current model has not motivated mortgage servicers to invest the time, effort and resources needed to fully explore all options to help delinquent borrowers avoid foreclosure," Geithner and Donovan wrote in a letter to DeMarco.

In many cases, servicers are reluctant to modify primary mortgages owned by bondholders, even if those mortgage investors want to alter the loan to help troubled borrowers, because they are under pressure from their parent bank not to modify the second mortgages the large institution owns.

Separately on Tuesday, the Treasury released a long-awaited study examining a provision in a sweeping bank-reform statute that requires banks to have "skin in the game" by retaining some of the risk of loans they package and sell into securities.

The study examined a piece of the measure that requires regulators to consider a provision exempting certain mortgages from the risk-retention rule if their loans met certain high underwriting standards.

Regulatory observers had expected the Treasury to state a position on whether the loans approved under the exemption should have down payments, and if so, how much money down would be necessary.

However, the study did not make such a recommendation. It did argue that regulators could choose whether to have a specific set of high standards for exempted mortgages or could set up a flexible approach.

With a flexible approach, a borrower's lower credit history could be offset with an increased down payment and lower loan-to-value ratio.

The study also said regulators could look at a static specific amount of risk retention — requiring banks to hold 5 percent of the risk of a package of mortgage securities, for example — or whether variations could be permitted.

"Thus, the amount of risk retention could be a function of time and/or a function of asset characteristics," the report stated.

Bank regulators must jointly write rules to implement rules on risk retention by April.

The study also warned that having overly restrictive risk-retention rules could adversely impact economic growth.