High-Risk Regulation

The Consumer Financial Protection Bureau (“CFPB”) poses a major risk for companies that hold mortgage-servicing rights (“MSRs”). This adversarial relationship stems from an inherent conflict of interest between MSR holders and CFPB regulators. Looking out for bondholders is MSR holders' fiduciary obligation, while protecting borrowers is CFPB regulators' official duty.

Private roles vs. official duties

Dealing with delinquent borrowers is one of a servicer's professional roles. CFPB regulations impose severe limitations on the way servicers may contact delinquent borrowers and servicers must comply under penalty of law. Assisting delinquent borrowers via loan modification programs designed to reduce monthly payments on a temporary or permanent basis is another major loan servicer duty.

Recently, the federal government has been putting massive pressure on servicers to implement such loan modification programs. This official coercion creates conflicts of interest between servicers and the bondholders that are entitled to the servicers' first allegiance. Such conflict develops when initial loan modifications that frequently serve a bondholder's best interests work to the bondholder's detriment in the event of subsequent re-default.

When this occurs, it lengthens the foreclosure process significantly. Such delays are very undesirable for bondholders in any economic climate. It is even more so the case in declining realty markets, however.

Uncle Sam ties loan servicers' hands

Recent CFPB regulations have also prohibited "dual tracking." Dual tracking was a widespread practice within the mortgage industry whereby servicers would pursue both foreclosure and loan modification at the same time. Endemic loan modification failure was the main motivation for dual tracking, because it expedited the foreclosure process if the modified loan subsequently became delinquent. This is precisely why the CFPB has banned the practice, however.

New CFPB regulations have also restricted “force-placed” insurance plans whereby loan servicers could purchase property hazard coverage and then charge borrowers for the cost of premiums if the servicer suspected that the borrower's own policy had lapsed. Furthermore, CFPB has imposed time limits for contacting delinquent borrowers and deadlines for responding to modification requests, among many others.

Bottom line

The sum total of these changes is increased loan servicing costs. In turn, these cost increases induce corresponding decreases in marginal MSR values.