FDIC Chair Addresses Robo-Signings and Poor Servicer Incentives

Federal Deposit InsurancernCorporation Chairperson Sheila Bair told an audience in Washington on Tuesdayrnthat the current “robo-signing” situation underscores how wrongrnthings went in the financial crisis and that there is still a lot of work torndo.  </p

Robo-signing refers to recentrnreports that servicers are relying on shoddy documentation and skirting legalrnprocedures in some states, foreclosing on properties without sufficientrnauthority or even reading the relevant documents.  These reports have led three large money center banks torntemporarily halt foreclosures and the sale of owned real estate as thernattorneys generals of the majority of states have called for a nationwide moratorium.</p

Bair told the Urban LandrnInstitute that the robo-signing issue also points to the poorly alignedrnincentives that have existed in the mortgage servicing business.  Pricing of mortgage securitization deals havernresulted in inadequate funding and staffing of servicers, making it difficultrnfor them to address problems.  Inrnaddition, the frequent practice of requiring servicers to advance principal andrninterest payments to the securitization trusts for nonperforming loans while theyrnquickly reimbursing them for their foreclosure costs has had the effect ofrnaccelerating foreclosures while discouraging modifications.  Foreclosure is a costly, unpleasant,rnand emotional process, she said.   It hurts communities and families alike andrnshould be a last resort; loan modifications should be considered wheneverrnpossible. “Foreclosure should only come after careful thought, thoroughrnanalysis, and good documentation.”</p

 In response to these systemic problems, Bairrnsaid that the FDIC has recently adopted a new rule on securitizations whichrnrequires that the issue of servicer incentives be addressed in order to obtainrnsafe-harbor status.  New agreements mustrnprovide servicers with the authority to act to mitigate losses in a timelyrnmanner and modify loans in order to address reasonably foreseeablerndefaults.  “The agreements,”rnshe said, “must require the servicer to act for the benefit of allrninvestors, not for any particular class of investors.   The newrnrule also strictly limits the number of advances the servicer must make tornthree months unless there is a way to promptly repay the servicer short ofrnforeclosing and selling the home.</p

FDIC’s authority is limited tornimposing this rule on banks, but Bair said that the Dodd-Frank financial reformrnlaw provides an opportunity to improve incentives across the market.   “Dodd-Frank requires regulationsrngoverning the risk retained by a securitizer. rnThose regulations may reduce the standard 5 percent risk-retention wherernthe loan poses a reduced risk of default.”</p

While an initial review indicatesrnthat FDIC supervised non-member state banks did not engage in robo-signing andrnhave limited exposure to the current situation, Bair said her agency continues tornclosely monitor the problem and is working with other regulators through itsrnbackup examination capacity where the FDIC is not the primary federalrnregulator.  FDIC is also requestingrncertifications from loss share participants in failed bank transactions thatrntheir foreclosure activity complies with all legal requirements.  </p

Bair said that servicing plays anrnimportant role in mitigating the incidence of default and that new regulationsrnshould addressed the need for servicer reform. rn”We want the securitization market to come back,” she said,rn”but in a sustainable manner.  Itsrnreturn should be characterized by strong disclosure requirements, high-qualityrnloans, accurate documentation, better oversight of servicers, and incentives tornassure that servicers act to maximize value for all investors.</p

Bair also spokernto the audience about challenges in commercial real estate where, she said,rnaverage prices are down by 30 to 40 percent from peak levels of 2007 and rentsrncontinue to drop.  Credit availabilityrnhas been limited as lenders have tightened standards, the commercialrnmortgage-backed securities market has virtually disappeared, and the creditrnstanding of many borrowers has declined. rnShe said that FDIC holds about half of the $4.5 trillion in CRE loans currentlyrnoutstanding so her agency has been focusing on this market for a long time.  </p

Federalrnregulatory agencies issued guidance last fall on how banks should confront the choicesrnthey have to make when some loans with significantly reduced collateral valuesrncome up for renewal. This, she said was an important step to reduce uncertaintyrnas to how restructuring efforts would be viewed and reported for regulatoryrnpurposes.  Some have criticized thesernloan workouts as a policy of “extend and pretend,” she said, butrn”the restructuring of commercial real estate loans around today’s cashrnflows and today’s low interest rates may be preferable to the alternative ofrnforeclosure and the forced sale of a distressed property. And going forward, asrnis the case with residential mortgage lending, we need better risk managementrnand stronger lending standards for bank and nonbank originators to help preventrna recurrence of problems in commercial real estate finance.”</p

Bair said that she believes that,rnfor now, continued federal involvement in mortgage lending is neededrnto keep credit flowing on reasonable terms to the housing market as the economyrnand the financial system recover. But going forward, there needs to be arnbroader debate about the future role of government in mortgage finance and thernhousing sector.</p

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