Opportunities Exist to Enhance the Board’s Oversight of Future Complex Enforcement Actions

Introduction

Objectives

The Office of Inspector General (OIG) conducted an evaluation of the Board of Governors of the Federal Reserve System's (Board) oversight of the Independent Foreclosure Review (IFR) payment agreement.¹ In January 2013, the Board and the Office of the Comptroller of the Currency (OCC)² agreed to the payment agreement with certain mortgage servicers to provide approximately $3.67 billion in payments to approximately 4.2 million borrowers based on possible harm.³ The payment agreement replaced requirements in consent orders that the Board, the OCC, and the Office of Thrift Supervision (OTS) issued in 2011 and 2012 to address deficient mortgage loan servicing and foreclosure processing practices.⁴ Those consent orders had established the Independent Foreclosure Review (IFR)--a prior effort to identify and remediate actual harm to borrowers.

In February 2013, the Board and the OCC issued amended consent orders. Under the amended orders, servicers slotted borrowers into various categories of possible harm established by Board and OCC staff. After the servicers subject to the amended orders placed borrowers in the various categories, the Board and the OCC published payment amounts for each category ranging from $300 to $125,000. The servicers selected Rust Consulting, Inc. (Rust) as the paying agent to administer the payment agreement and distribute checks to borrowers, and the Board and the OCC did not object to this selection. Our objectives for this evaluation were to (1) evaluate the Board's overall approach to oversight of the amended consent orders issued in February 2013, (2) determine the effectiveness of the Board's oversight of the slotting process, and (3) determine the effectiveness of the Board's oversight of the servicers' paying agent, Rust. For additional information regarding our scope and methodology, see appendix A.

Background

In 2010, reports of widespread irregularities and potential violations of law in the documentation and processing of foreclosures prompted some mortgage servicers to temporarily suspend certain foreclosures in process. Congress held hearings to examine these issues. During the fourth quarter of 2010, the Federal Reserve System, the OCC, OTS, and the Federal Deposit Insurance Corporation initiated a horizontal review to assess the potential impact of the foreclosure processing issues of certain mortgage servicers.

Horizontal Review of Mortgage Servicer Foreclosure Practices Resulted in Enforcement Actions

The interagency horizontal review sought to evaluate the adequacy of controls and governance over servicers' foreclosure processes and to assess servicers' authority to foreclose. The Board assembled a team from its Division of Banking Supervision and Regulation (BS&R), Division of Consumer and Community Affairs (DCCA), and Legal Division to oversee the horizontal review, with the assistance of staff from certain Reserve Banks.

In April 2011, the Federal Reserve System, the OCC, and OTS published a report describing the results of the horizontal review.⁵ The report outlined deficiencies and weaknesses in foreclosure processing, including inadequate monitoring and control of foreclosure activities and weak quality control and internal audit procedures. The report also identified that individuals employed by the servicers signed foreclosure-related affidavits filed in state courts, but they often did not personally check the documents for accuracy or possess the level of knowledge of the information they attested to in those affidavits.

On April 13, 2011, the Board, the OCC, and OTS issued consent orders to the following 14 mortgage servicers and their subsidiaries to address the issues identified during the horizontal review:

1. Ally Financial, Inc.; Ally Bank; Residential Capital, LLC; and GMAC Mortgage, LLC (hereafter, GMAC)
2. Aurora Bank FSB (hereafter, Aurora)
3. Bank of America Corporation and Bank of America (hereafter, Bank of America)
4. Citigroup Inc.; Citibank; CitiMortgage, Inc.; and CitiFinancial Credit Co. (hereafter, Citibank)
5. EverBank Financial Corp. and EverBank (hereafter, EverBank)
6. HSBC North America Holdings, Inc.; HSBC Bank USA; and HSBC Finance Corporation (hereafter, HSBC)
7. IMB HoldCo LLC and OneWest Bank, FSB (hereafter, OneWest)
8. JPMorgan Chase & Co., JPMorgan Chase Bank, and EMC Mortgage (hereafter, JPMorgan Chase)
9. MetLife, Inc., and MetLife Bank (hereafter, MetLife Bank)
10. PNC Financial Services Group, Inc.; PNC Bank; and PNC Mortgage (hereafter, PNC)
11. Sovereign Bank (hereafter, Sovereign)⁶
12. SunTrust Banks, Inc.; SunTrust Bank; and SunTrust Mortgage, Inc. (hereafter, SunTrust)
13. U.S. Bancorp, U.S. Bank, U.S. Bank Home Mortgage, and U.S. Bank Consumer Finance (hereafter, U.S. Bank)
14. Wells Fargo & Company and Wells Fargo Bank (hereafter, Wells Fargo)

Of these 14 servicers, 4 had mortgage servicing subsidiaries supervised by specific Reserve Banks under delegated authority from the Board--GMAC, HSBC, SunTrust, and JPMorgan Chase.⁷ Additionally, in September 2011 and April 2012, the Board issued similar consent orders to Goldman Sachs and Morgan Stanley.⁸ Issuing these enforcement actions raised the total number of mortgage servicers subject to foreclosure consent orders to 16. These consent orders included provisions that required servicers to retain independent consultants to review foreclosure activity to identify whether mortgage borrowers with loans serviced by the respective institutions whose home was in the foreclosure process during 2009 or 2010 suffered financial injury due to servicer errors or deficiencies. The term IFR refers to the file review process combined with an outreach process designed to make borrowers aware of the opportunity for a file review. Board staff worked with dedicated teams from the Reserve Banks of Atlanta, Chicago, and New York to monitor compliance with the consent orders for servicers supervised by the Board.

Independent Foreclosure Review

The consent orders that established the IFR alleged that the servicers used unsafe and unsound practices to process mortgage foreclosures. Specifically, the orders alleged that servicers (1) filed or caused to be filed in state courts affidavits asserting that the affiant had personal knowledge of the facts contained, when in many cases he or she did not; (2) failed to sufficiently respond in a timely manner to the increase in foreclosures by increasing staffing and managerial resources; and (3) failed to have adequate internal controls, policies and procedures, compliance risk management, and training.

To address these issues, the consent orders required the servicers subject to the orders to make extensive changes in servicing and foreclosure processes. In addition, the orders required servicers to retain independent consultants to conduct a comprehensive foreclosure file review of each servicer's foreclosure activity in 2009 and 2010 to identify financial harm to individual borrowers that resulted from deficient foreclosure practices and to provide compensation or other remedy for that harm.

One official explained that as a result of the horizontal review, Board officials knew that some borrowers may have been harmed, but they did not know the extent of the harm. The IFR process allowed borrowers who felt they were harmed by these servicing practices to submit a request for review. In response, the independent consultants would review the borrower's mortgage file to determine whether any harm occurred and to assess the extent of the potential injuries. In addition, the IFR consent orders required the independent consultants to perform look-back reviews to identify harmed borrowers who may not have submitted a request for review.

The IFR covered more than 4.4 million borrowers who had a mortgage on their primary residence in any stage of the foreclosure process in 2009 or 2010 that was serviced by one of the 16 financial institutions subject to the consent orders.⁹ The six mortgage servicing subsidiaries supervised by Reserve Banks serviced approximately 16 percent of the 4.4 million mortgage loans.

In June 2012, the Board and the OCC published a financial remediation framework to guide remediation for the IFR.¹⁰ The framework listed various categories of harm and suggested remedies, such as suspending foreclosures in process, correcting credit reports, and paying borrowers for the financial injury. Lump sum payments suggested in the IFR financial remediation framework ranged from $500 to more than $125,000.

Under the IFR, the Board and the OCC attempted to implement the corrective action and remediate harm at an individual-borrower level through a file review process for more than 4.4 million borrowers across multiple financial institutions. Board staff characterized the IFR as a "highly unusual undertaking," unlike anything the Board had previously undertaken, as enforcement actions typically address weaknesses and deficiencies in a financial institution's internal controls and risk management practices. Further, oversight of the IFR involved a shift from the Board's standard practice for overseeing a consent order. Board staff explained that typically, day-to-day oversight of compliance with consent orders is delegated to the Reserve Bank responsible for supervising the relevant institution. For the IFR, however, Board staff provided ongoing guidance to the oversight process, with staff at the three Reserve Banks interacting with the relevant servicers and their independent consultants on a regular basis.

As the supervisory process progressed from the interagency horizontal review to the IFR, the Board preserved the continuity of the team overseeing the project. The project team that supervised the horizontal review became responsible for overseeing the IFR and the work performed by the independent consultants.

By November 2012, the IFR had been ongoing for about 18 months, but no money had been provided to any of the borrowers. As of December 2012, the independent consultants for the IFR file reviews had billed about $1.8 billion to the respective servicers.

The IFR process received intense scrutiny from Congress and the U.S. Government Accountability Office (GAO). For example, one congressional hearing questioned the independence of the consultants hired to conduct the IFR. Additionally, members of Congress questioned the transparency surrounding the effort and sent various letters to the Board seeking additional information concerning the IFR. During our interviews, Board officials responsible for supervising the IFR explained that reviewing mortgage files was complex because of all the variables involved. A GAO report indicated that according to independent consultants, a mortgage file could comprise as many as 50 separate documents and consist of 2,000 pages or more to be reviewed.¹¹

Payment Agreement

In light of the delays associated with the IFR, Board and OCC staff began negotiating an agreement to end the IFR with the servicers subject to the IFR in late 2012. The agencies transitioned to the payment agreement to provide remediation to borrowers in a timelier manner than would have occurred under the IFR process. According to a GAO report, an OCC official estimated that the file reviews may have taken an additional two years to complete. Based on OCC data, the Board estimated that the servicers may have had to pay the independent consultants an additional $2.0 billion to complete the file reviews. In our opinion, the IFR's lack of success in distributing remediation to borrowers resulted in a heightened sense of urgency to provide remediation to borrowers under the payment agreement.

Beginning on January 7, 2013, the Board and the OCC signed the payment agreement term sheets with 13 of the servicers.¹² The term sheets replaced the IFR mortgage file review requirements with an agreement to provide approximately $3.67 billion in cash payments to borrowers.¹³ The deadlines contained in the term sheets between the Board and the OCC and the relevant servicers evidenced this urgency to act quickly. Under the terms of the payment agreement, the Board provided a 30-day deadline for the servicers to complete their validations and an additional 15 days for the Reserve Bank dedicated team reviews to be completed--that is, by February 21, 2013, for servicers that signed payment agreement term sheets in January 2013.

As the Board transitioned from the IFR to the payment agreement, the same Board staff who managed the interagency horizontal review and the IFR process became responsible for managing the payment agreement, including overseeing the remaining IFR consent order requirements, the check issuance process, and the paying agent. Board officials preserved the continuity of the oversight team due to the steep learning curve associated with this unique project. According to Board staff, the Board has not undertaken enforcement actions of the size of the payment agreement. Also, similar to the IFR, the Board retained responsibility for overseeing compliance with the amended consent orders in addition to the oversight responsibilities typically delegated to the Reserve Banks.

Payment Agreement Borrower Slotting Process

The Board and the OCC issued the guidance defining the waterfall categories on January 8, 2013, and clarified that guidance 10 days later, on January 18, 2013. The guidance to the servicers defined 11 categories of potential borrower harm, known as the IFR waterfall. Definitions for the categories are in table 1.

Table 1: IFR Payment Agreement Categories

Number	Category description
1a	Servicemembers Civil Relief Act (SCRA)a sections 533 and 521
1b	SCRA section 527 interest rate protection
2	Borrower not in default
3	Foreclosure while in bankruptcy
6	Performing forbearance plan
4	Failure to convert trial plan
5	Performing trial period plan
10	Modification approvals
7	Denied modification
8	No decision
9	No loss mitigation engagement
11	Other

Source: OIG analysis of Board and OCC documents.

Note: The categories listed are not in numerical order. For the slotting, borrowers were to flow down through the waterfall in the order in which the categories appear in this table. Board staff explained that the Board and the OCC decided that all borrowers denied a modification would be slotted into category 7. Thus, the Board and the OCC combined two subcategories that had previously been listed separately in a draft of the IFR waterfall. For more information on the categories, see appendix B.

^aThe SCRA provides relief to active duty servicemembers so that members of the Armed Forces can focus their full attention on their military responsibilities. Some of the relief provided under the SCRA includes reducing the rate of interest for debts incurred before entering active duty to six percent and protecting servicemembers against default judgments, evictions, mortgage foreclosures, and repossessions of property.

The categories in the IFR waterfall were similar to those in the June 2012 financial remediation framework. The IFR waterfall guidance differentiated potential harm to borrowers by the stage of foreclosure (in progress, complete, or rescinded) and by whether the borrower had requested a review of his or her loan file under the IFR.

One Board official explained that for the payment agreement, the Board transitioned to a process that required no action to receive a check by most borrowers, unlike the IFR, which may have required a borrower to submit a request for review or be part of the look-back population to obtain remediation. Under the terms of the payment agreement, once the servicers submitted completed waterfalls that were validated by the servicer's internal audit or compliance function and reviewed by the Reserve Bank, the borrower's placement was deemed final and could not be appealed. The payment agreement prohibited servicers from requiring borrowers to waive any legal claims they may have against their servicer as a condition of accepting a payment.

After finalizing the terms of the payment agreement, the Board and the OCC published amended consent orders in February 2013, which replaced the IFR file review requirements in the origina consent orders issued in 2011 and 2012. Table 2 shows the dates the Board, the OCC, and other agencies issued the IFR consent orders to the servicers and when the servicers agreed to the payment agreement.

Table 2: IFR and IFR Payment Agreement Participating Servicers

Banking institutions	Date the IFR consent orders were issued by the Board, the OCC, and other agencies	Month and year the servicer agreed to the payment agreement with the Board and the OCC
1. Aurora	April 13, 2011	January 2013
2. Bank of America	April 13, 2011	January 2013
3. Citibank	April 13, 2011	January 2013
4. EverBank	April 13, 2011	August 2013
5. GMAC	April 13, 2011	June 2013
6. Goldman Sachs	September 1, 2011	January 2013
7. HSBC	April 13, 2011	January 2013
8. JPMorgan Chase	April 13, 2011	January 2013
9. MetLife Bank	April 13, 2011	January 2013
10. Morgan Stanley	April 2, 2012	January 2013
11.OneWest	April 13, 2011	Did not participate in the payment agreement
12. PNC	April 13, 2011	January 2013
13. Sovereign	April 13, 2011	January 2013
14. SunTrust	April 13, 2011	January 2013
15. U.S. Bank	April 13, 2011	January 2013
16. Wells Fargo	April 13, 2011	January 2013

Source: OIG analysis of Board and OCC documents. 

Note: Bolded institutions have a mortgage servicer subsidiary supervised by the Board, and shaded rows indicate the five servicers whose slotting process was within the scope of this OIG evaluation. HSBC and JPMorgan Chase also had separate mortgage servicing operations supervised by the OCC.

Of the 13 servicers that agreed to the payment agreement in January 2013, 5 were supervised by Reserve Banks--Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, and SunTrust. As required by the terms of the payment agreement, these servicers began slotting borrowers into the waterfall categories, the servicers' internal audit functions validated the slotting, and the responsible Reserve Bank dedicated teams reviewed the validation.

The Reserve Bank dedicated teams prepared, and the Board' s team overseeing the initiative approved, guidance to the Reserve Bank teams called the Complex Servicers Mortgage Foreclosure Supervisory Expectations (Supervisory Expectations). This guidance addressed monitoring the implementation of the payment agreement term sheets and sought to ensure, to the extent possible, consistency of the slotting review. The slotting, validation, and review processes were iterative and involved multiple meetings of the Board, the OCC, the Reserve Bank dedicated teams, the servicers, and the servicers' internal audit functions. Throughout this process, the Board had conference calls and meetings with Reserve Bank staff to ensure consistent results.

Under the terms of the payment agreement, servicers had the option to use their IFR independent consultants to conduct mortgage file reviews to determine harm to borrowers who fit into categories 1a, 1b, and 2. Category 1 pertained to violations of the Servicemembers Civil Relief Act (SCRA), such as foreclosing on an active duty servicemember, and included a subcategory (category 1b) related to charging a servicemember interest rates above SCRA caps. Category 2 pertained to borrowers who were not in default at the time of the foreclosure actions.¹⁴ Servicers could slot borrowers into categories 1a and 2 using automatic system queries, or they could elect to have their independent consultant complete file reviews to slot borrowers into categories 1a or 2. If the independent consultant' s file review determined that the borrower had not suffered harm as defined by categories 1a or 2, those borrowers were placed into the next highest applicable waterfall category.¹⁵ As one Board officer explained, the Board allowed the file review to continue for these categories because these situations involved some of the more egregious types of harm to borrowers. According to this Board official, IFR independent consultants reported that they had made significant progress reviewing files to determine these types of harm during the IFR file review process.

The payment agreement term sheets imposed an aggressive deadline for completing the slotting, validation, and review process. Under the payment agreement, the term sheets provided a 30-day deadline for the servicers to complete their validations and 15 additional days for the Reserve Bank dedicated team reviews to be completed--that is, by February 21, 2013, for servicers that signed payment agreement term sheets in January 2013. During this time frame, servicers requested more time to complete their waterfall submissions. Based on the documentation we reviewed, the Board-supervised servicers submitted their final waterfalls to the Board during the March 11, 2013-April 3, 2013, time frame.

On April 9, 2013, after servicers had finalized their waterfalls, the Board and the OCC published a payment distribution plan for 11 of the 13 servicers.¹⁶ Payment amounts ranged from $300 to $125,000, and a few borrowers were eligible for additional variable payments--reimbursement for equity plus interest. Payments received under the payment agreement did not preclude borrowers from pursuing any legal actions against the servicer. Appendix B depicts the waterfall categories, the payment amounts, and the results of the servicers slotting exercises, with the total number of borrowers slotted into each category, for all 13 participating servicers that agreed to the payment agreement in January 2013, including the servicers supervised by the OCC.

Oversight of the Payment Agreement Check Issuance Process 

The servicers selected Rust as the paying agent to administer the payment agreement, and the Board and the OCC did not object to the selection. The payment agreement term sheets and the amended consent orders identified Rust as the paying agent. Board staff based their nonobjection on Rust's prior knowledge of and possession of data regarding the borrower population and its familiarity with the servicers' systems given its role in serving as the administrator for the original IFR. 

Board staff did not object to the statements of work (SOWs)¹⁷ between Rust and the Board-regulated servicers. Board and OCC staff provided the oversight for Rust's activities despite the fact that neither the Board nor the OCC were parties to those contracts. While the Board was not a party to the SOWs, the contracts described many tasks that Rust would conduct under the oversight and at the direction of the Board and the OCC. As required by the SOWs, Rust provided periodic reports to the Board and the OCC. Also, Rust submitted invoices to the servicers for payment, as the amended consent orders required the servicers to pay for the administrative costs associated with the payment agreement.

Rust functioned as the paying agent administering the payment agreement. To print and mail the checks, Rust hired a subcontractor, Quad/Graphics, Inc. (Quad/Graphics), and Rust selected The Huntington National Bank to manage the payment agreement Qualified Settlement Fund (QSF) accounts and clear the checks. Rust and the other third parties' activities in support of the payment agreement have included, among other activities, the following: 

1. The Huntington National Bank maintained QSF accounts in which the servicers deposited funds, as required by the payment agreement' s terms.
2. The servicers provided borrower data to Rust, such as borrower name, address, and waterfall categorization.
3. Rust sent the borrower data to Quad/Graphics.
4. Quad/Graphics printed the checks and accompanying documentation, such as cover letters, envelopes, and tax reporting forms, as required. 
5. Quad/Graphics delivered the checks and accompanying documentation to the U.S. Postal Service to be mailed. 
6. Quad/Graphics monitored the check delivery process and provided related data to Rust. 
7. Rust received and processed mail returned by the Postal Service as undeliverable.
8. The Huntington National Bank cleared the checks that borrowers cashed or deposited with various financial institutions and check cashing establishments. 
9. Rust managed a call center to respond to borrower inquiries. 

Beginning in March 2013, Rust mailed postcards to approximately 4.2 million borrowers alerting them that a payment agreement had been reached and that checks would be mailed. Rust mailed the checks in separate batches, and all checks had a 90-day expiration date. The vendor mailed the first batch of approximately 1.4 million checks on April 12, 2013. Rust sent most of the approximately 223,000 checks to Morgan Stanley and Goldman Sachs borrowers on May 3, 2013. For the initial 13 servicers, borrowers had cashed or deposited checks worth approximately $3.15 billion, as of August 15, 2014.