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Tuesday, November 06, 2007

GM Watch, Again: Foreclosures and Fees

by Tanta on 11/06/2007 11:10:00 AM

I know how disappointed everyone would be if I passed on an opportunity to publically describe Gretchen Morgenson as a tendentious writer with only a marginal grasp of her subject matter and what appears to be an insatiable desire to make uncontroversial facts sound sinister. So here we go again.

Obligatory declamation: I hate sloppy mortgage servicers, I think fee gouging is criminal, and nothing would make me happier than to see bankruptcy judges slapping some servicers around a little. Morgenson's article, "Borrowers Face Dubious Charges in Foreclosures," brings up one particular thing, payoff fees, that I have been bitching about for fifteen years and that I'd be happy to see outlawed. (News flash: those fees are charged by servicers to everyone who requests a payoff quote, including everyone who has ever refinanced a mortgage. This isn't just something that happens in bankruptcy or foreclosure. If there is a more normal course of business process than calculating what one is owed, which should therefore be a matter of general servicing fee compensation, I can't think of one. Total Ick.)

As usual, though, Morgenson's valid points are drowning in a sea of sensational swill:

Because there is little oversight of foreclosure practices and the fees that are charged, bankruptcy specialists fear that some consumers may be losing their homes unnecessarily or that mortgage servicers, who collect loan payments, are profiting from foreclosures.
The article presents exactly zero evidence, anecdotal or otherwise, that any of the foreclosures or bankruptcies in question were "unnecessary." There is certainly the implication here that servicers profit more from a foreclosure than from simply servicing a performing loan. That idea could use some evidence. It may be true that once a loan defaults, the servicer loses less by foreclosing (where its costs are reimbursed by the noteholder out of the liquidation proceeds) than by working the loan out; this is a big problem with the modification thing, in which servicers generally have to absorb the costs of the modification. But if the accusation here is that servicers drive borrowers into default in order to foreclose, I'd like to see some evidence for that. (Really, I would. That would be a serious indictment of the servicing industry.)
Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.
Perhaps our attorney friends will tell me how it is that servicers have to prove that they are noteholders in a bankruptcy. I suspect that's news to all investors in mortgage bonds, who think they are the noteholders. Are we talking about sloppy filings, in which the servicer failed to include a copy of the note? Or are we really talking about servicers who cannot cough up an assignment of mortgage or deed of trust to show standing to foreclose? Is this predation by servicers who don't even have the right to collect on the debt, trying to worm their way into BK court, or botched paperwork?
In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.
These are not impressive examples of servicer competence, and I don't object to public humiliation of any servicer who can make errors like that. But does anyone seriously think that these were attempts to "raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered"? (Keep reading to get to the details of the Wells Fargo case, and notice that the inappropriate charges were overwhelmingly fees or charges that would not be payable to Wells as servicer but would be passed through to the investor or someone else.)

But that's the thing: once again, Morgenson displays her profound ignorance of the industry she spends so much time writing about:
Loan servicing is extremely lucrative. Servicers, which collect payments from borrowers and pass them on to investors who own the loans, generally receive a percentage of income from a loan, often 0.25 percent on a prime mortgage and 0.50 percent on a subprime loan. Servicers typically generate profit margins of about 20 percent.
I have no idea where the 20 percent "profit margin" comes from or what it means in this context. I also do not know what "extremely lucrative" means in the context of a 25 bps servicing fee. But here's the kicker:
Now that big lenders are originating fewer mortgages, servicing revenues make up a greater percentage of earnings. Because servicers typically keep late fees and certain other charges assessed on delinquent or defaulted loans, “a borrower’s default can present a servicer with an opportunity for additional profit,” Ms. Porter said.

The amounts can be significant. Late fees accounted for 11.5 percent of servicing revenues in 2006 at Ocwen Financial, a big servicing company. At Countrywide, $285 million came from late fees last year, up 20 percent from 2005. Late fees accounted for 7.5 percent of Countrywide’s servicing revenue last year.

But these are not the only charges borrowers face. Others include $145 in something called “demand fees,” $137 in overnight delivery fees, fax fees of $50 and payoff statement charges of $60. Property inspection fees can be levied every month or so, and fees can be imposed every two months to cover assessments of a home’s worth.
When other sources of revenue go down, servicing revenue does, in fact, make up a larger percentage of total revenue even if servicing revenues are unchanged. Remember that you get that lordly 0.25-0.50% in servicing fees only as long as you have a loan to service. No new originations, no new servicing fees.

But of course, we are talking revenue here. For instance, those late fees are revenue: they aren't "income" until you back out the expenses of collecting on late loans and the carrying costs of the payments servicers have to advance to the noteholders on time regardless of whether they're collected or not. Do servicers actually make a profit, at the end of the day, on late fees? I suspect most do. Is it less than 100% of revenue? Yes. How much less? Pity Morgenson didn't ask.

You get no argument from me that junk fees like payoff fees, fax fees, demand fees, and unnecessary overnight charges are a horror. I am less convinced that doing away with periodic property inspections for a home in the foreclosure or bankruptcy process is such a great idea: you need to know that the home is still occupied and that it hasn't been vandalized. There's surely a reasonable argument that inspection costs should come out of general servicing revenue, not pass-through fees to the borrower. If you did that, of course, I'd guess that servicing fees would probably go up, so you'd pay it anyway. However, unless the servicer owns the inspection company and makes a big markup (which is possible, although no evidence is presented here), then it's "revenue" with a matched expense. Mortgage servicers can be amazingly dumb at times, but if they're beefing up income with that strategy, you can rest assured it won't last long.

Here's the part of the article based on actual data from a researcher:
In 96 percent of the claims Ms. Porter studied, the borrower and the lender disagreed on the amount of the mortgage debt. In about a quarter of the cases, borrowers thought they owed more than the creditors claimed, but in about 70 percent, the creditors asserted that the debt owed was greater than the amounts specified by borrowers.

The median difference between the amounts the creditor and the borrower submitted was $1,366; the average was $3,533, Ms. Porter said. In 30 percent of the cases in which creditors’ claims were higher, the discrepancy was greater than 5 percent of the homeowners’ figure.

Based on the study, mortgage creditors in the 1,733 cases put in claims for almost $6 million more than the loan debts listed by borrowers in the bankruptcy filings. The discrepancies are too big, Ms. Porter said, to be simple record-keeping errors.
Well, we don't know what the total amount of the loan debts listed is. Let's assume an average loan debt of $200,000. That gives us $346,600,000 in debts. A $6 million discrepancy is 1.7%. You have to assume that at least some of these are "discrepancies" because the borrowers simply have no idea how much back interest they owe (like all those folks who thought the accrual rate on their OA was 1.00%). There certainly seem to be some big outliers there, given a median of $1,366 and a mean of $3,533. I'm guessing that the one loan of $60,000 with a servicer balance of $1MM is probably throwing that off. End of the day, the discrepancy due to intentional servicer padding of fees has to be less than 1.0%.

Is that an impressive track record for the servicing industry? No. Are we relieved that bankruptcy judges are challenging these charges? Yes, we are: $1,366 might be small beer for a trillion-dollar servicer, but it's money no one needs to squeeze out of a bankrupt consumer. Does it support the contention that servicers are making up for a drop in origination income by loading up on inflated revenues that have no offsetting expenses? Not as far as I can see.

I realize that this will hurt the feelings of the conspiracy-minded, but I do believe that high rates of foreclosure and bankruptcy are money-losers for mortgage servicers, not profit centers. This is not a plea for sympathy for the servicing industry: I have wasted eleventy-jillion of your pixels on the subject of how the industry created this mess with ridiculous lending standards and dereliction of risk management duty. No one is happier than I am to see the little punks take it in the bottom line, and my enthusiasm for things like cram-downs and workouts--the cost of which is borne by the parties who got us into this mess--is an example of that.

It strikes me as quite plausible that some servicers are trying to make some lemonade by charging every fee they can think of. In a foreclosure of an upside down loan, of course, those fees come out of the investor's or insurer's pockets, not the consumer's. In a Chapter 13, these are fees borrowers are expected to repay, and with the cram-down prohibition, there's little incentive for servicers to control costs. So cram the damned things down.

The sad fact of the matter is that there are many businesses and industries that "profit off misfortune." There's money to be made in divorce lawyering, funeral parloring, and broken bone-setting, as well as default mortgage servicing. When profiting becomes profiteering, then yes, that should be punished to the fullest extent of the law. I suggest it also helps to create legal and regulatory structures that remove as many incentives for profiteering as possible in the first place. In order to do that, we have to understand how the business works. Nerdiness matters.

Are we to believe that payoff quote fees were OK until now? That late fees have never until the bust been a money-maker for servicers? That favorable bankruptcy treatment for mortage lenders was fine until 2007? That sloppy business practices have nothing to do with outsourcing, temping, mass layoffs, misguided technology projects, and any of the other myriad forces that corporate America has unleashed in its endless quest to enrich CEOs and keep you on hold for ten hours as you struggle to understand all that crap on your phone bill or locate your lost luggage? Mortgage servicing isn't any better or any worse than the rest of corporate America when it comes to half-assed business practices. It is, however, beginning to suffer the consequences of a huge boom, and I for one predict that we will get to see just how poorly managed a lot of these operations really were: there will be more than a few lost copies of promissory notes and misapplied payments. I'm sure it's too much to hope that everyone who bought shares of these outfits based on their impressive "cost management" will have to pay for it all.

Until justice does finally arrive, I guess we'll have to remember these words of wisdom:
No one likes to face ugly realities like financially ailing borrowers who are so strapped that nothing can save them. Not the lenders, not the Wall Street firms that sell the securities, not even the holders. But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market.