Bankruptcy

Vulture Mentality of Piling On Fees or Countercyclical Diversification Strategy

By Katie Porter

In the recent hearing on mortgage servicing, the Senators probed Countrywide's chief executive for loan administration, Steve Bailey, on exactly how mortgage servicers (distinct from the owners of the mortgage) make their profits. Mr. Bailey confirmed the description in my article of the three ways that servicers earn revenue: a fee that is a percentage of the mortgage, float income from interest on temporarily-held funds, and retained fees such as late charges and other fees that are paid by borrowers.  Senator Schumer described the imposition of these default costs as "piling on" and expressed a fear that a "vulture mentality" was developing among servicers as defaults rise. Mr. Bailey tried to diffuse these concerns, but Senator Schumer called him to task in attempting to deny that servicers can and do generate profit from delinquent homeowners, even when borrowers and loan holders might benefit if the family retained its home, rather than struggle to pay an avalanche of default costs. The Senator quoted from a Countrywide earnings' call that characterized the "piling on" practice as a "counter-cyclical diversification strategy."

David Sambol, president of Countrywide, said in an earnings call for 2007 that when "asked what the impact on our servicing costs and earnings will be from increased delinquencies and lost mitigation efforts, and what happens to costs . . .  we point out that increased operating expenses in times like this tend to be fully offset by increases in ancillary income in our servicing operation, greater fee income from items like late charges, and importantly from in-sourced vendor functions that represent part of our diversification strategy, a counter-cyclical diversification strategy such as our businesses involved in foreclosure trustee and default title services and property inspection services."

Mr. Sambol is saying that, for the 75-88% of loans that Countrywide services but does not hold any loss position, the servicer's additional expenses when a loan defaults are paid by the borrower. Defaults do not cut into a servicer's profits. Indeed, the reference to ancillary income tending to "fully offset" increased operating expenses suggests that in at least some cases, a servicer will make money when a loan is non-performing, particularly if that loan is repeatedly non-performing but ultimately the borrower pays (Gee, that sounds a lot like the situation before bankruptcy, doesn't it?)

I think the most damning part of this statement is the reference to "in-sourced vendor functions." Allegations are swirling around that servicers, and their agents such as MERS, bloat their actual costs of collection or default and build in a profit margin. This is illegal, in part, because most mortgages only permit the recovery of "costs," which most courts read to mean actual costs incurred, not some amount chosen to "offset" the costs of servicing delinquent loans. Judge Elizabeth Magner has a recent opinion that addresses the propriety of this practice. She writes in the Memorandum Opinion in In re Stewart (07-11113, Bankr. E.D. La. April 10, 2008) that "Wells Fargo's national counsel has represented to this Court that only $50.00 of each invoice represents the actual cost incurred by Wells Fargo fro a BPO. The remaining amounts, approximately $880.00 in total, were added to the actual costs by Wells Fargo. The Court concludes that these additional charges are an undisclosed fee, disguised as a third party vendor cost, and illegally imposed by Wells Fargo." Her opinion, combined with the statement in Countrywide's earnings statement, suggest that Senator Schumer may be too generous in calling servicers' practices "piling on."  If this practice is widespread, the more apt term may be "ripping off" struggling homeowners.

Full post as published by Credit Slips on May 16, 2008 (boomark / email).