Regulatory Settlement of Fraudulent Robo-Signing by Mortgage Servicing Companies

Posted September 30, 2011 by   · Print This Post Print This Post

Like a well-designed software package, BPO services offer the advantages of process uniformity and standardization, scalability, speed to completion, predictability and transparency.  When BPO is abused, the advantages can quickly turn into disadvantages of equally grand scale.  Such is the tale of “robo-signing” of affidavits of compliance with banking regulations that were based on common practice of non-compliance.  This article addresses the settlement by Goldman Sachs with the New York State Department of Financial Services and New York Banking Department in early September 2011.  For more click here.

The Business Services of Mortgage Loan Origination Management. The origination of mortgage loans is the first step in the syndication of bundles of mortgage loans for sales to investors, or for retention in a bank’s own loan portfolio of assets.  Whether a loan is bundled into a package of collateralized debt obligations (“CDO’s”) or retained as a portfolio asset, the origination process must comply with applicable laws governing Truth in Lending and eligibility for loan guarantees.  Such laws include full disclosure of applicable financing terms, consumer protection, due diligence and verification of due execution of the borrower’s promissory note, the mortgage securing the loan, title documents confirming the underlying assets are owned of record in the name of the borrower.

Robo-Signing. The phrase “robo-signing” arose in 2008-2009 when regulators discovered that many BPO service providers in loan origination services falsely provided affidavits of compliance with statutory requirements for bank lending.

The Sub-Prime Debt Crisis. Affidavits of compliance with loan origination requirements are an essential element of any loan origination program for a bank.  In the 2000’s, many U.S. banks outsourced the compliance function to service companies.  In the U.S. sub-prime mortgage crisis that began in 2008 and continues through at least 2011, the failure of the outsourcing companies to meet a service level of 100% compliance has triggered a tsunami of legal woes:

  • Borrowers have alleged in court that they were defrauded (and therefore cannot be foreclosed).
  • Investors have sued to rescind their investments in CDO’s because the underlying collateral was fraudulently obtained.
  • The CDO market has become unsettled, impairing the free trade and circulation of CDO’s as a source of liquidity in the housing market (and thus a source of sustainability of higher prices).
  • Housing prices have collapsed by 30% in many locations.
  • Banks are not only prudent to ensure 100% compliance with loan origination laws, but they have been reluctant to lend to qualifying buyers, thereby depressing     the housing market and increasing the immobility of homeowners seeking jobs elsewhere.
  • Delinquent borrowers have been subjected to loan servicing fees that make it more difficult to repay the loan.
  • Non-delinquent borrowers might have an escape from repayment obligations under principles of fraud and rescission, but they cannot escape due to the collapse of “normal” lending markets for residential real estate since 2007.
  • Regulators have conducted investigations and sought penalties against banks using robo-signing practices.

Litton Loan Servicing: Goldman Sachs’ Alleged Robo-Signers. In September 2011, the New York State Department of Financial Services and New York Banking Department reached a settlement with Goldman Sachs, as owner of Litton Loan Servicing, as a condition of allowing Goldman to sell Litton to another mortgage servicing company, Ocwen Financial Corp.   On September 2, 2011, Ocwen described the deal in its SEC filing:

On September 1, 2011, Ocwen Financial Corporation (“Ocwen”) completed its acquisition of (i) all the outstanding partnership interests of Litton Loan Servicing LP (“Litton”), a subsidiary of The Goldman Sachs Group, Inc. (“Seller”) and provider of servicing and subservicing of primarily non-prime residential mortgage loans (the “Business”), and (ii) certain interest-only servicing strips previously owned by Goldman Sachs & Co., also a subsidiary of Seller. These transactions and related transactions (herein referred to as the “Transaction”) were contemplated by a Purchase Agreement (the “Agreement”) between Ocwen and Seller dated June 5, 2011 which was described in, and filed with, Ocwen’s Current Report on Form 8-K dated June 6, 2011. The Transaction resulted in the acquisition by Ocwen of a servicing portfolio of approximately $38.6 billion in unpaid principal balance of primarily non-prime residential mortgage loans (“UPB”) as of August 23, 2011 and the servicing platform of the Business.

The purchase price for the Transaction was $247.2 million, which was paid in cash by Ocwen at closing. In addition, Ocwen paid $296.4 million to retire a portion of the outstanding debt on an advance facility previously provided by an affiliate of Seller to Litton. To finance the Transaction, Ocwen received a senior secured term loan facility of $575 million with Barclays Capital as lead arranger and also entered into a new facility with the Seller to borrow approximately $2.1 billion against the servicing advances associated with the Business.

The actual purchase price differed from the estimated base purchase price of $263.7 million disclosed in the current report on Form 8-K filed by Ocwen on June 6, 2011 as a result of certain adjustments specified in the Agreement for changes in Litton’s estimated closing date net worth, servicing portfolio UPB and advance balances, among others. The purchase price may be further adjusted as these estimated closing-date measurements are finalized after the closing date.

In connection with the Transactions, Ocwen, Goldman Sachs Bank USA, Litton and the New York State Banking Department have entered into an agreement (the “NY Agreement”) that sets forth certain loan servicing practices and operational requirements. No fines, penalties or other payments were assessed against Ocwen or Litton under the terms of the NY Agreement. We believe the NY Agreement will not have a material impact on our financial statements.

Settlement Terms. The “Agreement on Mortgage Servicing Practices” was consented to by Goldman, Ocwen and Litton.  Goldman, which is exiting the mortgage servicing business with the sale of Litton, agreed to adopt these servicing practices if it should ever reenter the servicing industry.

According to the Banking Department, the settlement makes “important changes in the mortgage servicing industry which, as a whole, has been plagued by troublesome and unlawful practices. Those practices include: ‘Robo-signing,’ referring to affidavits in foreclosure proceedings that were falsely executed by servicer staff without personal review of the borrower’s loan documents and were not notarized in accordance with state law; weak internal controls and oversight that compromised the accuracy of foreclosure documents; unfair and improper practices in connection with eligible borrowers’ attempts to obtain modifications of their mortgages or other loss mitigation, including improper denials of loan modifications; and imposition of improper fees by servicers.”

“The Agreement makes the following changes:

  1. Ends Robo-signing and imposes staffing and training requirements that will prevent Robo-signing.
  2. Requires servicers to withdraw any pending foreclosure actions in which filed affidavits were Robo-signed or otherwise not accurate.
  3. Requires servicers to provide a dedicated Single Point of Contact representative for all borrowers seeking loss mitigation or in foreclosure, preventing borrowers from getting the runaround by being passed from one person to another. It also restricts referral of borrowers to foreclosure when they are engaged in pursuing loan modifications or loss mitigation.
  4. Requires servicers to ensure that any force-placed insurance be reasonably priced in relation to claims incurred, and prohibits force-placing insurance with an affiliated insurer.
  5. Imposes more rigorous pleading requirements in foreclosure actions to ensure that only parties and entities possessing the legal right to foreclose can sue borrowers.
  6. For borrowers found to have been wrongfully foreclosed, requires servicers to ensure that their equity in the property is returned, or, if the property was sold, compensate the borrower.
  7. Imposes new standards on servicers for application of borrowers’ mortgage payments to prevent layering of late fees and other servicer fees and use of suspense accounts in ways that compounded borrower delinquencies and defaults.
  8. Requires servicers to strengthen oversight of foreclosure counsel and other third party vendors, and imposes new obligations on servicers to conduct regular reviews of foreclosure documents prepared by counsel and to terminate foreclosure attorneys whose document practices are problematic or who are sanctioned by a court.

Notably, the adoption of new “best practices” does not release Litton from future claims or from being investigated in the future.

Lessons Learned. While Goldman might have been negligent in supervising its mortgage loan origination subsidiary, it learned the lesson by divesting the BPO service provider to a larger, more stable BPO service provider.   The services provided by Litton had helped feed Goldman’s role as an originator and underwriter of CDO securities that it then packaged and sold into financial markets.  The sale of Litton represents an unwinding of this financial chain and should improved the credibility, marketability and liquidity of the CDO markets.

On a broader level, the New York banking settlement underscores the importance of a BPO service provider’s “getting it right the first time.”   This means that service supporting regulated businesses should anticipate that their functions will be supervised by regulators even if their function is only a slice of a regulated function.  As a result, the risk profile for service providers can be expected to increase where the enterprise customer or the service provider fails to ensure 100% compliance with regulations.   Master Services Agreements should be structured to ensure appropriate allocation of liability, together with risk management practices to limit the enterprise customer’s exposure to regulatory investigation and penalties.

Surprisingly, there were no regulatory penalties for Goldman.  This may be attributable to good lawyering as well as the fact the “settlement” arose solely in the context of a divestiture, where the purchaser willing purchased a troubled asset.

To learn more about robo-signing click here.

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