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March 8, 2011

Joshua Rosner
646/652-6207
jrosner@graham-fisher.com

Initial Analysis of Attorney General Miller’s “Term Sheet”

While the term sheet may be an effort by Attorney General Miller to deliver a headline
settlement worthy of an appointment as permanent head of the CFPB, given the vagaries
and lack of clarity, it should be seen as little more than a statement of purpose. In current
form, it will be difficult to move this plan forward other than as an agreement on servicer
best practices.

It is hard to believe that banks and servicers could feel it adequately identifies or ring-
fences their potential liabilities. Similarly, it appears that it will be difficult to find
overwhelming support from borrower groups, investors or even state AG’s in those states
with the greatest number of harmed parties or the greatest powers to prosecute.

This “term sheet” may well tie the hands of states from bringing actions against prior
improper servicing and back-end/foreclosure practices AS WELL AS improper front-end
or assignment practices. If state AG’s do not pursue cases and win those in actions
regarding such violations then the ability of borrowers and investors to pursue private
rights of action will be significantly weakened by a lack of precedent in court. Moreover,
the document fails to address appropriate enforcement mechanisms for the proposed
actions and does not spell out remedies for such failures.

The document demonstrates an intent of regulators and government enforcement to settle


with servicers without first assessing the damages. Neither the states nor the OCC has
carried out any meaningful investigation of the accuracy or completeness of mortgage
loan files nor have they earnestly investigated servicer related pyramiding practices.

If a private-sector lawyer, representing any harmed party, settled for damages without an
investigation of actual damages they would likely be exposing themselves to malpractice,
why would that not be the case here?

It is unclear if this is merely a series of best practices or if this is an actual settlement that,
if adhered to, would preclude legal actions by state or federal bodies. If it were the latter,
this agreement would be one of the greatest abdications of governmental responsibilities
to both borrowers and investors in modern history.

While the document does send the right message on principal reductions, requiring
second liens to be written down proportionally with the first mortgages, it is unclear what
legal authority states have to enforce this requirement. Moreover, rather than just
accepting a negatively amortizing open-end second lien loan that is making minimum
payments to be classified as current, were federal regulators to require accurate

Please refer to important disclosures at the end of this report.


The Weekly Spew March 2011

consideration of the likelihood of full repayment of such an open-end second lien in


which the borrower had negative equity in the first lien then the proportional write-down
would not be necessary. After all, with the proper write-down of such seconds the
servicer would have little incentive to avoid an NPV positive write-down of a first-lien.

Also, even if the industry is expected to pay around $25 billion towards principal write-
downs, that amount of money is clearly inadequate to cover the necessary principal
reductions where will the other monies come from? There is nothing in the document that
precludes inappropriate costs, which should be borne by the sell-side, from coming from
the pockets of investors in the same manner that Countrywide settled its actions against
state AG’s with investor funds.

The document does not prevent investors from being assessed the costs of bringing
servicers into compliance with practices that should already exist.

Section analysis:

Foreclosure and bankruptcy information and documentation:

Section I A – Standards for affidavits’ and sworn statements in foreclosure and


bankruptcy proceedings: Merely a statement of servicing practices that should already
be followed. It is not requiring anything of servicers not already required by law or
contract. All incremental costs of compliance with these practices that should already
exist would likely be passed on to investors rather than be borne by servicers.

Section I B – Requirements for accuracy and verification of borrower’s account


information: Requires proper allocation of payments first to interest and principal and
only thereafter to escrow, late fees and junk charges. This too is already required in the
mortgage contract, TILA, FTC and Fair Credit Reporting. There has been no
investigation by federal or state authorities to find out which servicers violated the law
(pyramiding) and therefore there is no way to monitor remediation of their systems and
future compliance. We have seen Fairbanks, Bear/EMC and Countrywide pyramid
payments in the past. This diverted monies that should have first gone to note holder’s to
servicers and junk fees thus allowing servicers to predatorily and falsely create
delinquencies and defaults that were not actually the result of non-payment of principal
and interest but were instead attributable to diversion, by servicers, to their own income
ahead of the investor’s. Given that servicer’s advance funds to the pool to make up for
these diverted streams of cash, when a borrower defaults, the servicer jumps to the top of
the waterfall to claim monies illicitly advanced to the pool and further harms note
holder’s. It does not seek to determine the degree to which the industry, which
ubiquitously employs LPS’ servicing systems, has violated the laws nor does it seek to
penalize them for having done so. See Fairbanks, Bear/EMC and Countrywide below:
http://www.ftc.gov/opa/2010/06/countrywide.shtm

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http://www.ftc.gov/opa/2008/09/emc.shtm
http://www.ftc.gov/opa/2003/11/fairbanks.shtm

Section I C – Documentation of note, holder status and chain of assignment: This


section appears to give the servicers, originators and Trustees cover for problems not
actually related to the back end but rather to the front end, or pooling and assignment of
mortgages and notes. This suggests that the settlement would, once signed onto by states,
preclude the ability of AG’s to take actions for improper assignments, fraud in the
creation of trusts and other front-end problems. Thus, the scope of this settlement would
be more far-reaching than just a back end, or foreclosure settlement. As a result it would
negatively impact investor’s private rights of action.
As example subpoint 4, which prohibits servicers from intentionally destroying or
disposing of original notes or like documents appears to ignore any prior such actions and
proposed no punitive damages or remedies for such past actions.
Section I D – MERS: Ignores all issues relating to MERS.
Section I E – Quality assurance systems: If servicers followed the requirements of
section A and B then this would not be necessary and would be redundant.

Loss Mitigation Requirements

Section II A – Loss mitigation duty: Which requires consideration of appropriate loss


mitigation is already required by the FHA and the GSEs and, by agreement, HAMP and
Help for Homeowners. Consideration of NPV positive modifications is already allowed
or required by nearly all pooling and servicing agreements. All incremental costs of
compliance with these practices that should already exist would likely be passed on to
investors rather than be borne by servicers.

Section II B – Dual tracking prohibited: This states what should be considered best
practices but fails to address conflicts with private contracts (pooling and servicing
agreements).

Section II C – Single point of contact: Requires a single point of contact for borrowers
and government oversight. This is not particularly novel and also reflects practices that
should already exist. All incremental costs of compliance with these practices that should
already exist would likely be passed on to investors rather than be borne by servicers.

Section II D – The loss mitigation communication requirements with borrowers:


Seems to intentionally allow servicers to pass their basic responsibilities on to investors
and requires them to inform borrowers of the name of a particular investor that opposes a
modification for any reason, valid or invalid. This will act to undermine investor’s ability
to assert their rights for fear of valid or invalid public criticism.

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Section II E – Protections for military personnel: This is also a restatement of existing


law. All incremental costs of compliance with these practices that should already exist
would likely be passed on to investors rather than be borne by servicers.

Section II F – Development of comprehensive loan portals: This section appears to,


without first listing deficiencies in loan servicing tracking platforms (particularly LPS),
direct servicers to create a better and more comprehensive and publicly transparent
servicing tracking system. There is no discussion of the timeframe this would require or
the feasibility of such a platform. All incremental costs of compliance with these
practices that should already exist would likely be passed on to investors rather than be
borne by servicers.

Section II G – Loss mitigation Timelines: This section creates a timeline for actions
that should already exist in best practice.

Section II H – Loss mitigation denials: This section would serve to allow borrowers to
request a process for review. While this is appropriate, current servicing contracts would
seem to allow such incremental costs to be passed on to investors rather than be borne by
servicers.

Section II I – Support of state based foreclosure prevention hotlines: Again, while a


worthy goal there is nothing that would preclude the incremental costs of such initiatives,
which should have long existed, from being passed on to investors.

Section II J – Consideration of FHA Short Refi: Such consideration should already


exist.

Section II K – General loss mitigation requirements: All incremental costs of


compliance with practices that should already exist would likely be passed on to investors
rather than be borne by servicers.

Section II L – Proprietary loan modifications: This section requires basic disclosures of


policies and basic fairness in rates and terms.

Section II M – Principal loan modifications: This section, while appearing appropriate,


are highlighted by underlined text which reads “Note: the provisions in this subsection
are in addition to the loan modification initiative that is referenced in Section VI and
reserved for further discussion”.

Section II N – Second lien relief: This section which includes only one sub-point
requires, at the time of a permanent modification of a first lien, seconds to be written
down proportionately. While this is laudable and probably acceptable to most investors, it
is worth noting that where a first has substantial negative equity the second should, in
most cases, be assumed to be worthless.

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Section II O – Initiatives to assist borrowers in submission of documents: This section


suggests servicers partner with Kinko’s, Staples, Office Depot and Wal-Mart to allow
borrowers to copy, fax, mail or email documents to servicers free of charges. Again, All
incremental costs of compliance would likely be passed on to investors rather than be
borne by servicers.

Section II P – Consideration of borrower’s ability to pay and sustainability: This is


another example of requirements already existing in best practices and in prior joint
federal guidance.

Section II Q – Short sales: Again, this represents expected best practices.

Section II R – Other loss mitigation-related relief:


R1- Special servicing: It does not require any particular change in timeframe or
requirement of such transfer.
R2 – Transfer of default servicing: This subsection merely suggests
consideration of a pilot program to transfer servicing on a 60 plus days delinquent to an
independent, performance-based special servicer or subservicer.
R3 – Investors’ access to loss mitigation information: This section requires
little more than compliance with existing contracts and offers no new enforcement
remedies.
R4 – Servicer conflict of interest in residual interest in MBS trust: Merely
requires servicers to inform investors of any related parties investment position in
certificates, notes or bonds issued by the trust.

Restrictions on servicing fees:

Section III A – General requirements: Requires fees levied on borrowers be fair and
reasonable and not marked up inappropriately. There are no protections for investors.

Section III B – Specific fee provisions: Again, this section is merely a restatement of
practices that already exist in multiple laws and best practice.

Section III C – Third party fees:


C1 – (BPO): Property and inspection fees should not be imposed until servicer
has a reasonable belief the property is vacant. Servicers shall be limited to imposing a
BPO only once every 12 months unless requested by federal regulators or borrowers.
C2 – Servicers shall ensure attorneys and foreclosure trustees are permitted to
integrate their systems with any outsourcing companies and third-party vendors utilized
by the servicer without any cost to the attorneys, trustees or borrowers. All incremental
costs of compliance with these practices would likely be passed on to investors rather
than be borne by servicers.

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The Weekly Spew March 2011

C3 – Subsidiaries and affiliates of the servicer shall be prevented from collecting


third-party fees.
C4 – Fee splitting, kickbacks and referral fees shall be prohibited.

Force-Placed insurance

Section IV A – General requirements:


A1 – Servicer shall be prohibiting from placing insurance on the property when
they have reason to know that a policy is in place that meets the minimum requirements
of the loan documents.
A2 – If the servicer places such insurance on a borrower they must clearly inform
the borrower and provide the borrower the ability to demonstrate they already have
required levels of coverage. Once demonstrated the servicer must terminate the force-
placed coverage and refund any premiums and fees.
A3 – Limits the value to coverage to replacements costs.
A5- force-placed coverage may not be placed with an affiliated carrier and may
not split-fees, receive referral fees.

Section IV B – No force-placed insurance where borrower’s policy can be


maintained: Servicers will be required to re-establish or maintain an existing
homeowner’s policy where there is a lapse in payment. Servicers should advance
premium fees if there is no escrow or insufficient escrow. If a policy cannot be
maintained the servicer shall purchase force-placed insurance at a commercially
reasonable price. All incremental costs of compliance with these practices that should
already exist would likely be passed on to investors rather than be borne by servicers.

General servicer duties and prohibitions

Section V:

V A – Duties to borrowers: Servicers shall act in good faith.


V B- Duties to communities: Servicers have a responsibility to prevent vacant,
abandoned or REO properties do not become blighted. All incremental costs of
compliance with these practices that should already exist would likely be passed on to
investors rather than be borne by servicers.

Monetary relief:

Section VI: This section is vague and states (reserved for further discussion). Beyond
that is states servicers shall provide monetary relief as compensation or penalties for
unlawful conduct, to settle claims owed to the government, and/or to fund programs to
help homeowners avoid foreclosure, including support of non-profit housing counseling,

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The Weekly Spew March 2011

legal aid assistance, hotlines, web portal access, borrower education and outreach,
mediation, post-foreclosure relocation assistance and similar efforts. Servicers shall also
establish a fund to compensate victims of servicer misconduct. It also states that a
substantial portion of the funds will support and enhanced program of loan modifications.
There is no consideration of harm to investors resulting from illegal or poor servicing
practices nor does it address the likely costs that will be passed on to investors.

Compliance review and monitoring:

Section VII - This section requires undefined reports be presented to AG’s and the CFPB.
It does not define enforcement or penalties for non-compliance. It also fails to address the
risk of an insufficiently funded CFPB.

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