FDIC Calls for Risk Management Improvements

This week, the Federal Deposit Insurance Corporation (”FDIC”) released a special edition of its Supervisory Insights publication focusing on the recent foreclosure crisis in mortgage banking. In the report, the FDIC provides additional perspective on the deficiencies in internal processes, staffing and control that resulted in a foreclosure moratorium by several of the largest mortgage servicing institutions in late 2010. The FDIC worked with the lead regulatory agencies of the fourteen largest mortgage servicers in the United States to conduct extensive reviews of current foreclosure practices.

The reviews uncovered many common issues among the mortgage servicers. The FDIC noted the following, “concerns included lax foreclosure documentation, ineffective controls over foreclosure procedures, and deficient loss mitigation procedures and controls. Many institutions failed to commit resources sufficient to manage responsibly the rapidly growing volume of mortgage loans in default or at risk of default. Weak governance and controls increased legal, reputational, operational, and financial risks while creating unnecessary confusion for borrowers.”

While the report focuses specifically on the foreclosure shortcomings, it can also serve as a reminder of the value of strong internal controls and risk management practices. As our business processes grow to be more complex and interconnected, the risks inherent in the processes grow exponentially. Unchecked, these risks can quickly propel a business into a full-blown crisis.

Is This Just the Tip of the Iceberg?

The Congressional Oversight Panel released its November report today and it focused on the continued foreclosure crisis. The panel is calling for additional investigation by regulators and is also requesting that the U.S. Treasury provide additional evidence of their claim that the crisis has been averted.  Below is an excerpt from their report as well as video commentary from the chairman of the panel, Senator Ted Kaufman.

At this point the ultimate implications remain unclear. It is possible, however, that “robo-signing” may have concealed much deeper problems in the mortgage market that could potentially threaten financial stability and undermine the government‟s efforts to mitigate the foreclosure crisis. Although it is not yet possible to determine whether such threats will materialize, the Panel urges Treasury and bank regulators to take immediate steps to understand and prepare for the potential risks.

In the best-case scenario, concerns about mortgage documentation irregularities may prove overblown. In this view, which has been embraced by the financial industry, a handful of employees failed to follow procedures in signing foreclosure-related affidavits, but the facts underlying the affidavits are demonstrably accurate. Foreclosures could proceed as soon as the invalid affidavits are replaced with properly executed paperwork.

The worst-case scenario is considerably grimmer. In this view, which has been articulated by academics and homeowner advocates, the “robo-signing” of affidavits served to cover up the fact that loan servicers cannot demonstrate the facts required to conduct a lawful foreclosure. In essence, banks may be unable to prove that they own the mortgage loans they claim to own.

Only time will tell whether the foreclosure issues are merely the tip of the iceberg.  However, if the issues are real, then the financial institutions and other involved parties will be best served to proactively address the problem now rather than hoping it goes away on its own.

SEC Seeks to Shed Light on Foreclosure Crisis

The U.S. Securities & Exchange Commission ("SEC") has entered the foreclosure fray by requiring publicly traded financial services companies to disclose their estimated risk of foreclosure related losses. Here's what Bloomberg Business Week reported on the recent SEC actions.

Lenders must disclose circumstances that they “reasonably expect” to have an “unfavorable impact” on financial results, the SEC said in a letter posted on the agency’s website today. The letter was sent because of “concerns about potential risks and costs associated with mortgage and foreclosure-related activities,” the SEC said. Federal regulators and attorneys general from all 50 states are investigating whether loan-servicing companies used improper procedures during foreclosure proceedings, including so-called robo-signers who didn’t check documentation. Investors such as Pacific Investment Management Co. have demanded that banks buy back faulty loans that were bundled into bonds.

These forced disclosures will shed more light on the potential dollar impact of an operational risk that was neither fully anticipated nor proactively managed.

Lessons Learned from the Foreclosure Crisis

The recent foreclosure crisis is just another chapter in the financial meltdown that began in 2007.  As a result of the frenzy to securitize mortgage loans back in the middle of the decade, the required paperwork to foreclose on a property is difficult, if not impossible, to retrieve. Now, financial institutions are finding that the outsourced foreclosure work is faulty at best and fraudulent in many cases. Here's what the Wall Street Journal reported today.

In recent days, some lenders named in the foreclosure inquiries have said they would no longer use the services of some of these law firms for new foreclosures. Ally Financial Inc.'s GMAC Mortgage has pulled business and dispatched executives and a new team of lawyers to Florida to ensure foreclosure cases are being handled correctly, according to a person familiar with the situation.

The law firms and a Lender Processing unit, Docx LLC, which did work at a suburban Atlanta office, handled the nitty-gritty paperwork necessary to verify key document batches, including ownership transfer of a loan, known as an assignment, and the amount owed by a borrower losing his home. That paperwork processing at the law firms and lenders allegedly didn't review all information needed, such as who owned the loan or borrower financial information, the Florida attorney general claims. The Florida attorney general's office is looking at possible use of "fabricated documents" used in foreclosure actions in court, according to the attorney general.

This situation provides a few lessons in risk management. First, it demonstrates the lingering effects of poor controls when dealing with massive amounts of transactions complicated by a highly complex securitization process. Second, it also shows that the operational risks to a given company extend well beyond its walls to its outsourcing partners' ability to properly control its business.  Finally, with the crisis today clearly rooted in the actions of the past, it demonstrates the need for more forward-looking risk management programs.