Bank Lawyer's Blog

Big Bad BofA Muzzling Mortgagors?

CBS Interactive's Alain Sherter took off Friday on a bombing mission over the land that America loves to blast--Bank of America Territory--and dropped a cluster of verbal whoop-a** on the countryside.

As a condition for offering mortgage relief to Arizona homeowners, Bank of America (BAC) is allegedly requiring them to refrain from criticizing the company, according to Bloomberg BusinessWeek. That includes making borrowers delete any negative comments they may have made about the banking giant online.

Alain cites reports first published Thursday that the Arizona Attorney General is asking a judge to tell borrowers who have signed non-disparagement provisions contained in loan modification agreements that they don't have to comply with such provisions. The AG claims that such restrictions are impeding the AG's investigation into potential wrongdoing by BofA in connection with its servicing practices, including potential violations of a 2009 settlement agreement over charges that Countrywide (purchased by Bank of America) defrauded borrowers.

If these allegations are true, B of A's intent is clear: It wants to muzzle borrowers, especially those who are unaware that no court in the land would respect what amounts to a legally unenforceable -- and outrageous -- gag order.

I haven't researched the legal issues in a residential loan context, so I don't have Sherter's confidence that the confidentiality and non-disparagement provisions are prima facie unenforceable, nor, to me. "outrageous." In my personal experience, they're not uncommon in commercial loan modifications, especially in cases where the allegations by the borrower have been "intemperate" and/or the negotiations "contentious." A representative of the Arizona AG's office obviously thinks they present a legal problem for the borrowers, because she alleges that "[t]he settlement agreement purposefully makes it impossible, legally and practically, for a consumer signing it to come forward, voluntarily and promptly, to provide evidence in this case." If the agreements are obviously unenforceable, how can they make it "legally impossible" for a borrower to speak?

In this situation, the provisions are allegedly impeding a state attorney general's investigation. Therefore, there may be valid public policy arguments that the provisions should be held to be unenforceable. We'll see what the judge rules. That said, I don't think that BofA intended them specifically to hinder the Arizona AG's investigation. According to the Bloomberg article cited above, other banks are using them.

Wells Fargo & Co., the biggest U.S. bank by market value and the largest mortgage lender, has a similar practice, said James Hines, a spokesman for the San Francisco-based bank.

“Each case is unique and for a variety of reasons we may elect to include a confidentiality and/or a non-disparagement agreement as part of the settlement,” Hines said in an e-mail. He said he didn’t know how many settlements had been reached.

To me, this is one more ham-handed practice by a bank that has proved that it's tone deaf when it comes to playing a sweet public relations refrain. You have to wonder about a couple of things: first, is anyone home at BofA headquarters who can consider the reputational risk of such provisions in settlement agreements with consumers in the current climate in this country? Second, is the crowd that consistently screams that we need to "break up the too-big-to-fail banks" wasting its collective breath? Those banks seem to be doing an excellent job of destroying their own reputations without any outside assistance.

One final thought: how long before the CFPB finds confidentiality and non-disparagement provisions in loan modification agreements to be "unfair or abusive"?

A Word To The Unwise

For all the snark slung about on the pages of this blog, it might be difficult to comprehend that my approach to life is something other than "scorched earth". However, I recently had an opportunity to discuss the very real downside of bank management and directors taking a personally hostile stance toward banking regulators who criticize them. In this case, it involved some folks with strong business and banking track records, high IQs, and healthy egos, who bristled when bank examiners and supervisory personnel do what they do: criticized management performance and board supervision. It's called "regulating." The offended senior officers and directors fired back consistently with adversarial barrages and plenty of attitude. As a result, the regulators have been, shall we say, less than charitable.

The banking business does not afford banks an opportunity to file a Chapter 11 petition and "reorganize" when the business model is transformed by an economic recession from brilliant to stupid. Instead, federal law requires that as a bank's financial condition deteriorates, the regulators must place restrictions on the bank's activities that almost ensure that it will never emerge from the death spiral and will, rather, augur into the ground from 40,000 feet up at 32 feet-per-second squared. While that unpleasant result is unfolding, the regulators will be focusing on the prospect that if the bank fails, the FDIC's Inspector General's post mortem will inevitably conclude that a primary cause of the failure was the limp-wristed, somnolent, borderline incompetent supervision of the bank in the years leading up to its demise. The IG will opine, with the perfect 20/20 hindsight usually displayed only by field examiners (sorry, snark suppression is only good for one or two paragraphs), that if only the bank examination and supervisory staff had, much earlier in the game when only Nostradamus could have foreseen the outcome, lowered the boom on the miscreants running the bank, all this unpleasantness could have been avoided or, if not completely avoided, mitigated to a large extent. Therefore, the management and directors of banks in financial distress are going to be criticized by the bank's regulators, who want to show that they're as tough as Mike Tyson on a bad acid trip. It goes with the territory.

There are a number of ways of responding to such criticism, but I never advocate the spit-in-your-face, kick-you-in-the-groin, question-your-mother's-lineage approach. Setting aside the issues of basic human dignity, manners, and civility (in an era in which Fox News versus MSNBC spit-spewing typifies much of our "civil discourse"), regulators are human beings (contrary to popular opinion), but human beings who wield a tremendous amount of power, power that is entitled, in most cases, to judicial deference as long as the regualtors can make a case that their actions were not arbitrary and capricious without collapsing in hysterical laughter. You might as well walk up to a sleeping Bengal tiger and poke it in the eye with a stick. You can disagree with them, even sue them, in so many different ways that don't involve provoking bitter personal animosity. There is simply no upside in that approach and so much downside.

I always advise taking the high road, even in those cases where what you want to take is a baseball bat, a running start, and a swing for the fences.

Another Nero

I have no choice but to direct my energies toward the acquisition of fame and fortune. Frankly, I have no taste for either poverty or honest labor, so writing is the only recourse left me.
---Hunter S. Thompson

Thompson could have substituted "politics" for "writing" and he'd have been equally spot-on.

Massachusetts Attorney General Martha Coakley (who pulled defeat out of the jaws of victory by blowing a Senate election to Scott Brown) made a big splash last week when she sued the five largest loan servicers over the robo-signing kerfuffle. She promised that whatever fine she collected from the miscreants, "it would be a lot." The next day, one of the Gang of Five, GMAC, told Ms. Coakley, and the citizens of Massachusetts, that they could all perform a physical act that is extremely difficult, if not impossible, to perform upon not only themselves, but upon The Mayflowers they all sailed to the Bay State on. GMAC said it was pulling out of Massachusetts.

The immediate reaction of the Big Five to the lawsuit should have telegraphed that this was coming quickly. Trying to reconcile the positions of the posturing prairie ponies among the state regulatory group that sometimes seems more concerned with getting face time before the television cameras than with coming to what private parties concerned only with actual dollars and cents might consider "the bottom line," has been like trying to nail Jello to the wall.

The banks issued press statements immediately following the filing of the suit "expressing frustration with the splintering AGs." "Splintering" is a more polite way of saying publicity-seeking Eliot Mess wannabes, too busy applying makup and blow-drying their 'dos in preparation for the next press conference to pay attention to the fact the banks they're trying to pummel also need to get the punishment applied, lick their wounds, and get this behind them for the same reason the taxpayers bailed them out instead (as would have been dictated by an innate sense of "justice") putting bullets in their heads. The economy needs the banks in order not only to prosper, but to survive. The AGs need to quit trying to prove which one of them has the biggest appendage (let's just all agree it's Coakley) and get the litigation settled in a way that makes the point, punishes the banks, and deters future bad acts, but--and here's the rub--doesn't destroy them while your at it.

Everyone blames Washington, D.C. for being the epicenter of dysfunctional partisan gridlock that prevents the political system from moving effectively to put our Humpty Dumpty economy back together again. However, the Bozo Factor permeates all levels of government. State attorneys general are not immune. These clowns need to rise above the need to make political points with the bank-hating voters and focus on the fact that while most of us don't like the biggest banks, we're stuck with them until the brain trust at HuffPo, The New York Times, and The Washington Post lay out the Occupy My Nether Regions Master Plan For Peace and Prosperity Without Working.

It's the economy, stupid. Everything else is a sideshow. Get over it and get on with it.

El Jefe

One of the other topics I talked about ast week was how directors of community banks that today are doing well, can learn from their less fortunate brethren whose banks have gone to the elephant graveyard where all too-small-to-save banks go when their chickens come home to roost and their capital runs out. One of the lessons I tried to convey I called "El Jefe is a great name for the leader of a gang of banditos, but a lousy name for the CEO of a bank."

I'm not talking about the the kind of CEO who rides off the reservation in the dead of night and rampages around the Hill Country, killing and scalping the settlers, burning the homesteads, stealing horses, and generally "Going All Rogue Like" out of sight of the rest of the tribe, who remain blissfully unaware of the CEO's illegalities until Col. Chivington and the Colorado Cavalry come riding into the reservation at the break of dawn, killing men, women and children and screaming "Nits Makes Lice!" That kind of criminal is not as common as the Occupy Wall Street crowd would have you believe.

No, I'm talking about a guy who's a Master of the Universe, a Man In Full, The Pro From Dover, the kind of guy whose ego wouldn't fit inside Cowboy Stadium (aka "The Death Star") without the application of a very large shoe horn. He's the kind of CEO who knows more about what the bank ought to be doing than any ten lesser men or women (which means "anyone else") and who not only doesn't accept criticism well, but doesn't respond to questions with anything less than a blowtorch set high enough to melt diamonds. Directors who "raise issues" at board meetings are either condescended to, generate utter silence and a cold stare, or are met with a variation of Tony Montana's "Say Hello To My Little Friend!"

These guys seem to be surrounded by one of two types of henchmen. One is the guy who makes only one of two comments to anything uttered at a board meeting by El Jefe: "Cool" or "Way Cool." He's relatively harmless, in that he's usually too busily honed in on the boss 24/7/365 to befoul other people's nests. The other is the "Junior G-Man" type, who wants to be like the Big Boss but hasn't quite got the right stuff, so he barks like a Doberman at his subordinates and imitates the body, face, and vocal gestures of his role model, but every one laughs at him the minute his back is turned. In the "fear and loathing" department, he mans the "loathing" desk while his boss mans the "fear" desk.

Federal and state bank regulators expect directors, especially outside directors, to be independent watchdogs on management. It's extremely difficult to be an effective watchdog when every time you open your jaws to bark, you're kicked in the teeth by The Big Dog. In fact, it's practically impossible.

If you're unfortunate enough to be a director of a bank where the CEO is an El Jefe, and you can't put him on a leash because the rest of the pack is cowed, I'm not suggesting that you walk away from the position. No, instead, I'm recommending that you run...RUN ....Run for your life and don't look back!

You'll thank me later. Trust me on this one.

State Bank Regulators Speaking Up

In February of this year, we noted that state bank regulators were starting to come out of their shells of political correctness that usually hamper their desire to bash their federal counterparts. The trend has not abated.

Newly appointed director of New Mexico's Financial Institutions Division recently came out of her corner swinging haymakers at Dodd-Frank (free trial subscription required).

Cynthia Richards, who was appointed in July, finds many of the provisions of new federal banking reform laws, known as Dodd-Frank, to be “onerous” and says their effect is largely to protect banks that are too big to fail. It’s a category that none of the state-chartered banks and credit unions she oversees falls into.

“When we see this act fully implemented we’re going to see across the nation the effect on competitiveness and the profound effect on the economy, and not for the good,” Richards said.

The major problem she sees with new federal laws is that they are designed for Goldman Sachs and not for the small, rural banks that constitute many of the 37 state-chartered banks the state Financial Institutions Division is responsible for regulating.

Some regulations are going to be difficult to implement, costly and confusing, Richards said. Others will cost banks some revenue.

“I get numerous phone calls from bankers just wanting to talk about it,” Richards said. “I’m overwhelmed with the concern smaller banks have with this act.”

"Concern" is too mild a word. "Angst" would be more appropriate.

In neighboring Colorado, Banking and Securities Commissioner Fred Joseph refused to sign off on a request to put a Colorado community bank into an FDIC receivership (paid subscription required), so the Federal Reserve was forced to use a rarely (if ever) used provision of federal law and do the dirty work. Joseph disagreed with the FDIC's judgment that squelching a deal that the bank had cut with another bank to sell less than all of its branches was a worse deal for the FDIC than taking the bank down and selling the whole kit-and-kaboodle to the same bank with a loss-sharing agreement. The branch sale had been approved not only by Joseph's office, but by the same Federal Reserve that turned around and put the bank into an FDIC receivership. Who says there's no honor among thieves?

"I believe what was best for the bank was the sale of the branches," Joseph said Sunday. "We looked at the bank and thought it was best for the consumers and the state of Colorado to let the deal go through."

The failure was not only historic — in that the Fed instead of the state regulator played the role of executioner — but it also revealed a rare instance of state and federal regulators disagreeing over when to the pull the plug.

Joseph called the case of Greenwood-based Community Banks "a very unique situation."

Community Banks had agreed to sell 16 of its 40 branches to Boston company NBH Holdings Corp. (The Kansas City institution, MidWest Bank, that ultimately bought Community's operations from the FDIC is also owned by NBH.)

Joseph said the branch sale would have increased the bank's status to "adequately capitalized", making its condition less dire, and given it more time to deal with its losses. A heavy dose of construction loans had left the bank with a high amount of assets in nonaccrual status. At June 30, its leverage ratio was a meager 1.92%.

"They still would have to retain the poor assets that they had and had to work through them, but they would have more capital and more time to do it," Joseph said.

But federal regulators blocked the branch sale. Joseph said the FDIC, which becomes involved whenever a bank is "critically undercapitalized", objected to the deal because it would not meet the so-called "least cost" resolution test. The FDIC is bound by law to pursue resolution options for failing or failed institutions that result in the least cost to the Deposit Insurance Fund.

"They did the least cost analysis and they don't explain to anybody how they do it," Joseph said.

Why would the FDIC reveal the cost analysis and subject itself to scads of laughing children who would gleefully point out that the emperor is naked? This way, the FDIC can justify its "least cost" analysis the old fashioned way: "Because I said so!" Hey, it worked for your mother, didn't it?

The last time around this broken horn, back in the late 1980s and early 1990s, I don't recall these types of disagreements between state and federal regulators hitting the newspapers. Then again, in those days, we had twice the number of banks we have today. An industry whose very existence is imperilled tends to garner support from every stakeholder, much of it vocal. That includes state regulators who see their constituency being whittled away, one too-small-to-save community bank at a time.

UPDATE 11.03.11: An article in today's American Banker (paid subscription required) states that the Fed never approved the branch sale by Community Banks to MidWest Bank, but that the acquirer's primary federal regulator, the OCC, did approve it. The article also alleges that "the FDIC was apparently very involved in supervisory discussions in the bank's final days, and helped reject the bank branch deal that would have at least delayed the institution's failure." Whether the Fed agreed with the FDIC about the substance of the transaction and then changed its mind, or whether it agreed with the FDIC all along that the branch sale was not a good deal, the fact remains that there was a basic disagreement about the benefits of the transaction among the federal and state regulators, and rather than opt for preserving a charter, the regulators with the ultimate power of life and death decided to eliminate it. It's also clear that the FDIC, once again, played an important role in culling the herd.

Choke Hold

I'm not certain how many readers are aware of it, but two Colorado community bankers sat before a congressional subcommittee last Thursday and gave voice to a proposition that many of their brethren also believe but are reluctant to bring to the public's attention: regulators are killing off the commercial lending business.

Jay Davidson, founder and chief executive of First American State Bank in Greenwood Village, said regulators have become so risk-averse that community banks that make loans to small businesses have almost quit making them.

As a result, said Davidson, banks are "not fulfilling their obligations to assist in the economic recovery, and therefore small-business transactions, expansions and investments are not occurring."

[...]

"Life does not exist without risk," Davidson said. "Bankers don't like risk. But you can't make a system totally without risk. Now we run our banks to regulatory standards. We'd like to run it to business standards."

Davidson and David Brown, president of Southeast Denver Centennial Bank in Centennial, Colorado, made the following allegations:

• regulators are requiring higher capital levels, which reduces the amount of money available to lend (because community banks are having trouble raising capital in the current environment).
• the increased regulatory burdens of Dodd-Frank and the CFPB are increasing compliance costs and, as a result, banks are cutting costs elsewhere, including downsizing.

Brown complained that "he receives so many e-mails explaining the regulations that he could spend two hours a day trying to comprehend them." I guess I'd better cut down on those gratuitous e-mails.

Davidson and Brown (sounds like the name of a law firm, doesn't it?) showed some moxie, whether or not you agree with them (I expect that their primary regulators would take issue). Unfortunately for Mr. Davidson, as the video embedded below reveals, last Friday evening while leaving his favorite water hole "O'Neills" with his SBA lending crew, they were set upon out of the gloom by the bank's primary federal regulator's chief examiner, who took exception to Mr. Davidson's testimony with extreme prejudice. Notwithstanding Mr. Davidson's final words of bravado ("I'm glad it was you"), we feel fairly certain he was anything but glad that it was him.

You'll notice that, as is the case in many instances where bankers speak truth to power and pay the price, other bankers look down upon their cooling carcasses and thank their lucky stars that it was the other guy who spoke up. Well, as Jay so aptly put it, "Life doesn't exist without risk."

Sticking A Bank Charter Where The Moon Don't Shine

In what some call a portent and others an aberration, a Texas banker whose bank was making decent money but was being criticized by the FDIC, its primary federal regulator, for making too many loans to small businesses that actually repaid them and not enough loans to other types of borrowers who might not repay them, told the FDIC to take the bank and shove it (paid subscription required). He's in the process of having the bank surrender its charter and, with the backing of investors like Microsoft co-founder Paul Allen, is about to embark on a business in which second-guessing by Hobbits and Elves will not be an impediment to making money.

Not coincidentally, the bank's owner is a Texan. They tend to have a low threshold of tolerance for BS shoveled by anyone other than themselves. I make this observation on the basis that "it takes one to know one."

I represented a large Texas financial institution that was successfully executing a lucrative business plan that had been approved by the institution's primary federal regulator until, about six years following its approval, the regulator's local head of supervision claimed that he no longer understood the business plan, which hadn't changed an iota over the years. After several months of incredulous discussions with the primary federal regulator and other state and federal regulatory agencies, the owner at first seriously explored converting to another form of charter and he was given some encouragement by other regulatory agencies to do so, but I think he eventually came to the conclusion that he was putting his investment, which at that time equalled hundreds of millions of dollars, at risk that at some future date, another regulator would also suffer an attack of amnesia and a precipitous drop in IQ points. He decided to bid the regulators adieu, voluntarily liquidated the institution and surrendered its charter, and upstreamed hundreds of millions of dollars that were put to uses he decided were appropriate without the input of treadmill-churning hamsters. By doing that, hundreds of employees were sent packing and the nation had one less successful financial institution to provide credit, liquidity, and (in this case), some nice deposit rates to consumers.

Such cases have been rare up to this point. Yet, based on discussions I've had over the past year with some investors, many of them former bankers, I think the unregulated arena is looking more and more attractive as a place to play. For more entrepreneurial operators, the funding advantage provided by FDIC-insured deposits is increasingly not a sufficient enough attraction to offset the brain damage inflicted by regulation that often seems intentionally designed to choke off the flow of credit at precisely the worst possible time for the economy.

I think that the FDIC (and a number of the more brain dead commenters to the linked article) seem to think that the exit of banks like this one from the system is a good trend. For FDIC personnel, one less bank means one less potential subject for criticism that can endanger the race to retirement. For some of the members of the general public who love the thought of there being only a few banks in this country that are essentially run as public utilities by the federal government, Texas bankers are a roadblock that ought to be removed.

What seems to be an anomoly might become a movement.

Colorado AG Miraculously Punishes Evil Doer Without Liz Warren's Assistance

I don't believe that every homeowner who took out a loan in the last decade that he or she was later not able to repay "had a bunch of junk done to them." On the other hand, I'm convinced that a large number of them did, in fact, have a bunch of junk done to them. Yet another good (or bad, actually) example of a junk dispenser was just jacked, sliced, diced, and julienned in Colorado last week by the Attorney General of that state.

A Denver District Court judge has barred a Centennial mortgage broker from issuing loans in Colorado and fined him and his companies almost $1 million in civil penalties.

Leo Shifrin, and his companies Mortgage Planning & Lending Specialists, Ltd., Jupiter Lending, Mile High Mortgage, Shifrin Inc. and Wholesale Mortgage Lending, had engaged in deceptive advertising and fraudulent loan-origination practices, according to a news release from Colorado Attorney General John Suthers' office.

[...]

Suthers’ office reached a consent decree with Jerry Johnson, who was also involved with the business, shortly before trial that also forced him to pay $1 million in fines and stops him from issuing loans.

The complaint, filed in February of 2008, alleged the men defrauded customers from 2004 to 2007 by not telling them about important details during the loan-origination process. Through the use of what the complaint said were deceptive ads, the men steered the customers to risky “option-adjusted rate mortgage” loans “which are considerably riskier than traditional adjustable rate mortgages,” according to a news release from Suthers’ office.

“The court found that defendants lured borrowers into their offices with hundreds of advertisements printed in The Denver Post and The Rocky Mountain News that featured low teaser rates,” the release states. “The court found that defendants misrepresented and failed to disclose that these low teaser rates only lasted for a few months and then would quickly escalate upwards thereafter.”

Whitney also ordered the men to pay fees and court costs the AG incurred prosecuting the case.

Interestingly for proponents of the provisions of Dodd-Frank that created that soon-to-be juggernaut of national imperial power, the CFPB, in Colorado, malfeasors in the consumer loan business seem perfectly capable of being reigned in and spanked by existing state laws enforced by existing state law enforcement authorities. Then again, as Rahm Emmanuel once cackled, you never let a good crisis go to waste in adding another rung to the federal nanny state ladder andf continuing to render the Tenth Amendment to the dust bin of history. Plus, Liz Warren will get to test out her academic theories, concocted in the laboratory of her very own cerebrum, operating in the practical vacuum of a university law professor's cranium, on real banks and other financial providers in the real world. That opportunity to have fun and wreak havoc, alone, will be worth any cost the country ultimately might pay in unintended consequences that seem to frequently flow from the efforts of the federal government to fine-tune the intersection between private enterprise and social justice.

From a purely narrow, selfish perspective, we can't wait to see the well-intended results. From a broader perspective, we could wait indefinitely and never lose a night's sleep.

Onboard A Ship Of Fools

There's no telling what, in the myriad of items you read each day, is going to strike your funny bone. Take, for instance, the 27-page settlement term sheet that was recently circulated by the attorneys general of all 50 states and the federal banking regulators. Within that document, of all the items that are laugh worthy, I got an initial chuckle out of the requirement on page 9 that loan servicers provide the formula they use to calculate the net present value of loan modifications and foreclosure alternatives on a loan to the CFPB upon request. I can see Liz Warren arm wrestling with the CFO of Wells Fargo over the appropriate discount rate to use in NPV calculations. You get the sense that there's no crevice into which an eminently unqualified bureaucrat won't be poking his or her nose if such settlement terms are agreed to by the servicers. It won't be long before the size of paper clips used to attach portions of loan modification documents will be specified by the CFPB and/or the AGs.

I also like the requirement on page 19 that servicers "consider partnering with national chain retailers such as FedEx Kinko's, Staples, Office Depot, and Wal-Mart, or through use of bank branches affiliated with Servicer, to allow borrowers to copy, fax, scan and mail or email documents to Servicer free of charge with national chain retailers." As you plow through weeds this thick, AGs, you might ask yourself what this type of procedural minutiae has got to do with enforcing the law, as opposed to...you know...social engineering.

According to Housing Wire, these folks, who propose to regulate the mortgage servicing industry with laser-like precision and in minute detail, have apparently failed to understand the basic fact that before you make a settlement proposal to the other side, you need to get your own side on the same settlement page.

...[I]t appears there is some negotiation left to complete between the AGs themselves.

"We haven't even begun face-to-face discussions with the banks yet," a spokesman in Miller's office told HousingWire Monday. "We'll begin the negotiations and hammer out an agreement."

The spokesman at Miller's office said the proposal was transmitted to all 50 state AGs before it was sent to the banks. But a spokesman in Utah Attorney General Mark Shurtleff's office said he hasn't seen it.

"We'd love to comment on it (the settlement), but we wouldn't know what we were talking about," the spokesman said.

Other AGs have openly criticized the settlement. Oklahoma AG Scott Pruit opposes the settlement, saying that a principal write down requirement would force servicers to violate their contractual obligations to mortgage investors. Virginia AG Kenneth Cuccinelli told Bloomberg at least a dozen states, including his own, don't back the proposal.

It takes extra special effort to make yourself look more inept than large loan servicers, but it's obvious that the state AGs have what it takes.

 

Forced-Placed Kerfuffle

A little over four months ago, I linked to an article by Jeff Horwitz in the American Banker that discussed the "scandal-in-the-making" over force-placed insurance by loan servicers. At that time, I expected that we'd be hearing a lot more about it. Since then, it hasn't become exactly front-page news (which is understandable, given the more pressing issues of Charlie Sheen and Lindsay Lohan). On the other hand, Jeff is still on the case and, it's evident, so are the attorneys general of the states.

In an article in Friday's American Banker, Jeff referred to the 27-page proposed settlement that we discussed in our last post and stated that few restrictions in that document "are as absolute as the prohibition of profiting from force-placed insurance."

Under the settlement's terms, banks and other mortgage servicers are forbidden from placing policies with an affiliate or accepting "commissions," "referral fees," "kickbacks" or "anything of value" in relation to force-placed policies. Moreover, it would require servicers to attempt to maintain delinquent borrowers' existing policies, rather than replacing them with more expensive ones.

Servicers are not speaking to the press (yet) on this aspect of the settlement. Maybe they're hoping that no one will notice and, if they just ignore it, it will go away. However, other interested observers, including consumer advocates, think that the large loan servicers will eventually come out swinging and will keep on swinging until this aspect of the proposed settlement is knocked down for the count. I think that those observers are correct. As Jeff reveals with a little digging and the application of logic, there are a lot of dollars at stake.

Even the scant data available on the sector's finances is sufficient to show how much banks and other servicers may have at stake.

Last year, a leading force-placed insurer, Assurant Inc., collected roughly $2.7 billion of premiums through its specialty insurance division, which is overwhelmingly devoted to force-placed insurance. Of that it paid out claims equaling 36% of its take — though in the company's other lines of business, a 70% claims-to-premiums ratio is the norm. (The company has said that low recent hurricane losses explain the difference, though even in bad years claims have remained far below the levels seen in other businesses.)

But while high premiums and low losses consistently make force-placed insurance the company's most profitable segment, the company doesn't get to keep all of the extra money. According to the company's SEC filings, 40% of the division's revenue is eaten up by "general expenses," a category that includes commissions to the banks. In other lines of insurance, overhead and expenses are usually a fraction of policyholder claims.

Assurant does not provide a breakdown of its expenses, but analysts say that referral fees, commissions and other payments to bank affiliates explain why the overhead is higher — implying paydays for servicers amounting to hundreds of millions of dollars a year. Other insurers operate similarly, borrower advocates and analysts say; they just disclose less than Assurant in their financial statements. While servicers that partner with force-placed insurers customarily perform little of the work in monitoring their portfolios for lapses and writing policies, payments to them are simply a cost of doing force-placed business.

For those who are unfamiliar with the concept of force-placed insurance (for example, those who escrow for insurance as part of their monthly mortgage payment or otherwise actually honor their obligation to keep hazard insurance in place on their home), Jeff gives a brief explanation of what it is and why it has become controversial.

Banks purchase force-placed policies when mortgage borrowers don't live up to their obligation to maintain insurance on their property. Homeowners then must pay back the servicer for the premiums it advanced the insurer, often at multiples of what a voluntarily purchased policy would run.

Though part of the extra expense can be explained by the higher risks associated with insuring the homes of delinquent borrowers, force-placed policies generate profit margins unheard of elsewhere in the insurance industry — even after accounting for the generous commissions and other payments that servicers demand. Force-placed policies are reviled by consumer advocates for pushing already-struggling borrowers toward foreclosure, and their costs have also drawn criticism from mortgage investors who end up paying for them when borrowers default.

Defenders of the loan servicers claim that there's nothing wrong with the payment of these commissions and fees by the insurers to the financial institutions. The attorneys general of all fifty states disagree. They think that the large loan servicers and insurers are in cahoots in a scheme that incentivizes servicers to implement forced-place insurance at the first available opportunity because of the huge fees that will be generated by the sky-high premiums, rather than working with borrowers to reinstate existing policies or find much cheaper alternatives. As Jeff discusses, the proposed settlement would impose not only a requirement of a "commercially reasonable price" for force placed insurance premiums, but a requirement that the servicer attempt to pay the premiums on the borrowers' existing insurance (at a much lower cost to the borrowers) before resorting to much more expensive force-placed insurance. Some analysts state that the latter requirement could cause an administrative nightmare for servicers and insurers.

As I've indicated in other posts, I'm no fan of many of the practices of the loan servicers. However, as is the case with loan modifications, the root cause of this particular problem becoming a problem in the first place is the fact that borrowers don't comply with the loan terms they've negotiated. They are in default of the covenant in their mortgages to keep in place homeowners insurance that protects not only themselves, but the lender. The failure to keep such insurance in place gives the lender the contractual right to obtain the force-placed insurance or, for that matter, to declare the loan in default and foreclose. You don't want the servicer ordering expensive force-placed insurance? Pay your insurance premiums.

As far as investors are concerned, I think they may have a right to balk, since the cost comes out of their pockets. On the other hand, force-palced insurance has been around for years (decades, in fact), although it has only been with the default tsunami of recent years that the exhorbitant cost impact has been felt to a degree that investors have started howling. I question, though, whether this issue might be better handled by changes to pooling and servicing agreements than by a settlement agreement administered in part by the attorneys general of fifty states. Personally, I wouldn't trust many of those politically posturing Spitzer wanna-be's to tote up my bar bill, much less determine what's a "commercially reasonable" premium for a force-placed insurance policy. Perhaps that task is delegated to the CFPB and the fair and balanced judgment of people like Elizabeth Warren.

I admit that micro-managing loan servicing processes and procedures is a lot less dangerous than fighting organized crime or gangs like Los Zetas, but when most citizens think about the primary purpose they elect a state attorney general to fulfill, stopping force-placed insurance "abuse" is not what leaps first to mind.