Mortgage Servicing Operations kpmg.com

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1 ADVISORY Mortgage Servicing Operations kpmg.com

2 b Section or Brochure name Contents Tested Methodologies and Services for Turbulent Times 1 Process Control Review Needs 4 Developing the Right Approach 6 KPMG at Work 7 KPMG s Mortgage and Consumer Lending Services Practice 8

3 Mortgage Servicing Operations 1 Tested Methodologies and Services for Turbulent Times Today s mortgage servicing and default management industry is under tremendous pressure to enhance its business practices. Companies are being directed by supervisors and investors to contain costs, improve service levels, capture new markets, and increase profitability all while addressing a growing range of regulatory requirements. The cost per loan serviced is rising dramatically, and this trend is not expected to change in the foreseeable future. Many markets remain soft, putting a strain on business growth. The regulatory environment in particular has created significant challenges. Basel II, Basel III, and the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) have raised capital reserve requirements for banks and holding requirements. The regulatory mandate for a Single Point of Contact for loans in the loss mitigation and default management process is driving additional financial pressures in terms of operational deleveraging. Other mortgage-related standards and regulations include Regulation AB; the Uniform Single Audit Program (USAP); Mortgage Servicer Consent Orders from the Office of the Controller of the Currency (OCC) and the Federal Reserve Board; National Mortgage Settlement; the Servicer Alignment Initiative (SAI); and guidance provided by the Consumer Financial Protection Bureau (CFPB). Additionally, mortgage institutions continue to feel pressure from state and other prudential regulators to meet standards that continue to develop. These institutions must be aware of these regulations and be prepared to comply with them. Adapting to the new regulatory environment will require companies to rethink their servicing processes and make dynamic changes, especially as increased regulation creates additional challenges around cost structure. New accounting rules will change original terms and accounting treatments, requiring systems to balance their large volume processing capabilities with new dynamic flexibilities. And on the other hand, manual processes will require automation and standardization to protect data integrity and ensure completeness. Additionally, consumer protection efforts will drive increased consumer reporting and once routine operations like servicing transfers may see more regulatory hurdles and disclosure requirements. Generally, companies servicing payments and escrow advances will require new management practices to incorporate additional notifications and more real-time investor reporting integration. Servicing companies will need to continuously evaluate their compliance to new regulations, costs associated with new processes, potential new liabilities, and risk of loss. Whether it is a matter of updating reporting systems, mining and analyzing existing data, or rethinking and reengineering an entire process layout, how you prepare for and react to these challenges will define how your company competes in the future, and KPMG is ready to help you achieve a competitive advantage.

4 2 Mortgage Servicing Operations A Typical Control Environment Framework Servicing Activities and Default Management Process Flow Servicing Loan Boarding Customer Service Custodial Accounting Investor Reporting Escrow Analysis Portfolio Retention Collections Promise to Pay Payment Plans Loss Mitigation Loan Mods Short Sale/Deed-in-lieu Forbearance Layered Risk Management Control Processes Business Unit Controls Global Controls Servicing QC Collections QC Loss Mit QC Servicing QA Default Management QA IT Risk Selfassess Compliance KRIs Internal Audit External Audit External Review Preforeclosure Prereferral Foreclosure Referral and Document Preparation Presale Foreclosure QC Legend: Process Controls Postforeclosure Foreclosure Sale Postforeclosure Sale Review First Layer (Preventative) Second Layer (Detective) Third Layer (D) REO/Asset Disposition REO QC In addition, as new accounting rules and capital requirements are unveiled, quantifying servicing operations in terms of earnings and capital will become more complex. These new regulations will lead to loss of available Tier I capital from mortgage servicing rights as well as the requirements to retain a portion of credit risk for certain mortgage products. In light of these developments, we are seeing a changing competitive landscape where ill-equipped traditionally active mortgage businesses must exit or reduce exposure. Both winners and losers will emerge from these trying circumstances. We believe that the ability and willingness of some industry participants to adapt to the new environment will create significant opportunity to provide servicing, purchase servicing or subservice. Accordingly, supervisors, investors, mortgage insurance companies, and sellers of servicing will require accurate, timely information to help ensure that servicing is being performed properly. In choosing reviewers to supply this information, companies should consider a number of key criteria, including the capability and credibility of the reviewer, the frequency of reviews, and compliance with standards. A control environment framework can help support the processes and controls needed for effective mortgage servicing and default management. KPMG s mortgage specialists use a tested control environment framework that can be easily adapted to the specific needs of individual clients. Particular attention is given to the foreclosure process. Due to complex and changing regulations, this is one of the biggest challenges that companies face today. The right framework can help all parties address related issues and mitigate risk. Key Regulations and Programs Many governing requirements that affect mortgage services are based on the following regulations and programs: Regulation AB: Issued by the Securities and Exchange Commission (SEC), Regulation AB is designed to address the registration, disclosure, and reporting requirements for assetbacked securities.

5 Mortgage Servicing Operations 3 Mortgage Servicer Consent Orders: Issued by the Office of the Controller of the Currency (OCC) and the Federal Reserve Board, these consent orders require the strengthening of processes and procedures for the foreclosure practices supported by the major mortgage servicers. Servicer Alignment Initiative (SAI): The Federal Housing Finance Agency (FHFA) has directed Fannie Mae and Freddie Mac to align their guidelines for servicing delinquent mortgages they own or guarantee. The updated framework will establish uniform servicing requirements as well as monetary incentives for servicers that perform well and penalties for those that do not. National Mortgage Settlement: 49 State Attorney Generals (AGs) and the federal government have reached an agreement with the country s five largest loan servicers. This agreement provides immediate aid to borrowers who need loan modifications, whose mortgages currently exceed their homes values, and to those who lost their homes to foreclosure. In addition, the agreement provides direct help to states to create new consumer protections and foreclosure protection initiatives. The agreement requires national banks to report on compliance with the agreement and provides penalties for noncompliance. Finally, the settlement agreement provides nationwide de facto servicing standards. Consumer Financial Protection Bureau (CFPB): This federal bureau was created by the Dodd-Frank Act and charged with authority to supervise the offering of consumer financial products and services under the Federal consumer financial protection laws. The CFPB is further charged with ensuring that consumers have access to financial products and services in a fair, transparent, and competitive marketplace. The CFPB expects every regulated entity under its supervision, which includes large banks and certain nonbanks, and their service providers, to have effective compliance management systems. The CFPB Supervision and Examination Procedures contain a separate section specifically focusing on Mortgage Servicing, and it accepts consumer complaints on all aspects of mortgage lending including origination, servicing, and modification/foreclosure processing. The CFPB will promulgate any final rules for Qualifying Mortgages required under the Dodd- Frank Act, which will work with the Section 941 risk-retention requirements discussed below, and may contain servicing standards as part of the qualifying criteria. Section 941, Dodd-Frank Act: Section 941 of Dodd-Frank mandates that securitizers of asset-backed securities, including all mortgage-backed securities, be required to retain a portion of credit risk in a securitization vehicle, with the only exception provided for qualified residential mortgage products (QRM). QRM requirements are being refined and the rule is still in the comment period. However, these factors point toward a different costs and profitability model than what exists today. Impacted banks will need to assess and quickly adapt their operational practices. Basel III: As international capital requirements are finalized and unveiled, Congress and/or regulators may choose to adopt these requirements partially, in their entirety, or not at all. As a result, banks and companies impacted will need to be able to update their operations to evaluate their capital structures and asset portfolios for various regulatory scenarios and sensitivities. They will need to ensure that they have the appropriate amount of capital held against their risk-weighted assets and be able to report on capital fluctuations. Uniform Single Audit Program (USAP): Developed by the Mortgage Bankers Association, USAP has the goal of providing investors in residential mortgages with assurance relating to a servicing entity s compliance with minimum servicing standards. USAP was the predecessor to many new standards as derived from the Consent Order, Servicer Alignment Initiative, and others.

6 4 Mortgage Servicing Operations Process Control Review Needs Servicing and default management require specific process controls to address compliance issues for today s regulations and programs. In the following charts, note that a single set of process controls can address multiple regulations (i.e., Reg AB and USAP as well as Mortgage Servicer Consent Orders and SAI). SERVICING MANAGEMENT MANAGEMENT REPORTING REQUIREMENTS Third-party policies and procedures instituted to monitor third-party servicing activities and compliance Back-up servicer requirements Proper coverage maintained Proper payment management and allocation Proper collateral/security management Timely management of disbursements, advances, interest, and fees Proper management of accounts Escrow accounts analyzed in accordance with loan documents Proper management of interest on escrow accounts Disclosure of compliance with servicing criteria and CPA firm attestation in Form 10-K report Reports are maintained in accordance with transaction agreements USAP report sent to users (90 days) detailing performance of USAP Statement of compliance with servicing criteria Statement that CPA firm-issued attestation report on assessment of compliance Investor reports agree to investor records Amounts remitted to investors agree with support Submit to FRB plan for: Third-party management of servicing MIS for servicing Risk assessment and management Enhancement of Internal Audit program Submit progress reports to Federal Reserve Board/FDIC detailing actions taken for compliance Standards and time lines for Call Center activities Uniform compensation for borrower response package established Increased standards for borrower communication to ensure communications are timely and effective Required to develop/ implement process for reviewing and responding to borrower complaints Provide servicing in fair, nondeceptive, and nonabusive manner Expected to bring a legal enforcement based consumer protection focus Jurisdiction scope extends beyond those banks typically supervised by the OCC or Fed Expected to be expanded to additional banks over time Noncompliance severity high, including significant per occurrence fines and threat of public disclosure Increased standards for borrower communication to ensure communications are timely and effective Key Regulations and Programs The main governing requirements that affect mortgage services are based on the following regulations and programs: Regulation AB: Issued by the Securities Exchange Commission (SEC), Regulation AB is designed to address the registration, disclosure, and reporting requirements for asset-backed securities. Uniform Single Audit Program (USAP): Developed by the Mortgage Bankers Association, USAP has the goal of providing investors in residential mortgages with assurance relating to a servicing entity s compliance with minimum servicing standards. Mortgage Servicer Consent Orders: Issued by the Office of the Controller of the Currency (OCC) and the Federal Reserve Board these consent orders require the strengthening of processes and procedures for the foreclosure practices supported by the major mortgage servicers. Servicer Alignment Initiative (SAI): The Federal Housing Finance Agency (FHFA) has directed Fannie Mae and Freddie Mac to align their guidelines for servicing delinquent mortgages they own or guarantee.

7 Mortgage Servicing Operations 5 MANAGEMENT DEFAULT MANAGEMENT REPORTING REQUIREMENTS Policies/procedures instituted to monitor performance or other triggers of default Changes to terms/status of loan made, reviewed, and approved by authorized personnel Collection effort records maintained during default period Mortgage loan records agree with mortgagor records Adjustments with interest rates/arm based on mortgage note Loss mitigation/recovery actions initiated, conducted, and concluded meet agreement Requirements delinquencies, charge-offs, and uncollectable accounts are recognized and recorded Collection effort records maintained during default period Mortgage loan records agree with mortgagor records Submit to FRB plan for: Third-party review of loss mitigation Policies/procedures for third-party management of loss mitigation Training for loss mitigation Risk assessment and management Consistent timeline/requirements for managing delinquent loans Consistent loan modification hierarchy and process Strengthen Foreclosure prevention solicitation communication with Benchmarks established for default mgmt. borrower regarding status of mortgage Communicate and Work with Borrowers During Default Period Expected to bring a legal enforcement based consumer protection focus Jurisdiction scope extends beyond those banks typically supervised by the OCC or Fed Compensation program to encourage proper default management Submit to FRB plan for: Third-party review of mortgage foreclosure actions Policies/procedures for third-party management of loss mitigation/foreclosure functions Training for loss mitigation and foreclosure actions Risk assessment and management Uniform time lines/requirements for foreclosure process Standardize exceptions to foreclosure timeline Compensation program to encourage proper foreclosure management Execute foreclosure process in fair, nondeceptive, and nonabusive manner Strengthen communication with borrower regarding foreclosure process/status Expected to be expanded to additional banks over time Noncompliance severity high, including significant per occurrence fines and threat of public disclosure The updated framework will establish uniform servicing requirements as well as monetary incentives for servicers that perform well and penalties for those that do not. Consumer Financial Protection Bureau (CFPB): This federal bureau was created by the Dodd-Frank Act with the purpose of ensuring that consumers have access to financial products and services in a fair, transparent, and competitive marketplace. The CFPB expects every regulated entity under its supervision to have effective compliance management systems. The CFPB Examination Procedures contain a separate section specifically focusing on Mortgage Servicing. National Mortgage Settlement: In addition to providing immediate aid to impacted borrowers, this agreement driven by the federal government and state AGs helps address consumer harm created by improper foreclosures and other related default management activities. It also requires national banks to report on compliance with the agreement and imposes penalties and implied public disclosure for noncompliance. The settlement agreement provides a nationwide de facto servicing standards.

8 6 Mortgage Servicing Operations Developing the Right Approach KPMG employs a comprehensive, risk-based review methodology comprised of the following four phases, which can be customized to meet an organization s specific needs: 1 Objectives Engagement kickoff Interview key stakeholders Prioritize objectives of servicing or default management operations, such as: Performance metrics Target state planning Payment and asset management Regulatory implementation Contract compliance 2 Scoping Review risks for payment/asset management processes and practices: Establish a risk-based approach predicated on understanding core processes Identify key controls and evaluate control design Structure review plan to test operating effectiveness of key controls Determine business units, locations, and resources Assemble a multidisciplinary (as-needed team, including data analysts, contract compliance, regulatory compliance, and other advisory professionals) Specific scope considerations based on contract terms, nature of the operations, and specific risks identified 3 4 Perform Fieldwork Identify relevant data and information (e.g., vendor sites to review, orders contracts, key personnel, etc.): Perform procedures to control and stratify population Select confidence intervals and sampling methodology. Update process flows and operational walk-throughs Perform control testing steps as well as transactional testing Aggregate preliminary results Determine propriety and representativeness of results Expand sampling/procedures to validate or explain outlier data and unexpected results: Deploy proprietary, database-driven workflow tool to help create an efficient, effective, and transparent engagement environmentrecommendation of solutions to those cause Findings and Results Final report detailing: Potential control and/or process deficiencies Summary of compliance with contract Regulatory deficiencies and reporting needs Gaps and process improvement opportunities Root cause analysis Recommendation of solutions to those cause Key capabilities include: maintaining flexibility and the ability to establish the framework based on your operations; and the ability to deploy programs in a tailored manner, with a risked-based focus on specific attributes, to improve both the value to the organization and return on investment. KPMG deploys active project management on each engagement to foster real-time communication of activities, progress, and roadblocks. This helps avoid surprises and mitigate issues before they become significant. Our timely reporting provides a periodic update to process owners and project sponsors to promote continuing alignment with corporate objectives. For each servicer operation or default management process identified for review, our team will coordinate with the internal stakeholders and business process owners to understand the nature of the servicer or default management operation and the financial and operational transactions associated with the operation. We recognize that relationships are important to every business, and that reputation for treating business partners with integrity and respect is critical to the ongoing health of the relationship. Accordingly, our project management approach provides proactive management and communication.

9 Mortgage Servicing Operations 7 KPMG at Work Case Study Default Management and REO Process Review Rapid growth in REO and loan defaults led a large entity in the mortgage industry to reach out to KPMG over concerns about their REO liquidation process and the controls required develop a REO least-cost resolution option. KPMG s professionals assisted the client in improving its default management operations for mortgage loans and Real Estate Owned (REO) property liquidation. KPMG assisted in the design and implementation of proper foreclosure and other loss mitigation initiatives. Also, KPMG s professionals managed 30 contracts for loan and property portfolios in distressed areas of the country. They conducted a thorough analysis of all material documentation and performed a comprehensive on-site risk assessment of the bank s default management and REO business operations. KPMG successfully identified potential financial harm resulting from failure to follow the least-cost resolution option, as well as several recommendations for improvements (especially around REO property disposition) to help reach the least-cost option. Cash Escrow Management A large banking client was concerned about filing the proper proof of claim for the escrow shortages on bankruptcy loans as a result of the high risk of legal action due to improperly filing claims. In addition, the client was concerned about potential supervisory audits. KPMG conducted a thorough analysis of all documentation covering the process being reviewed. This included policy and procedures, contracts, training and job aides, existing process flows, existing reports, and data management processes. In addition, we recalculated the escrow shortage for a sample population in order to validate calculations. To evaluate data accuracy, KPMG validated data by coordinating directly with third-party data providers and reviewing the client s escrow database structure, controls, and reports. We successfully assisted the client in identifying process deficiencies and worked with the client to remediate the issues before they became potential liabilities. KPMG developed recommendations for operational improvement and created additional process documentation for the client s process. Regulation AB Services Issuers and servicers are required to comply with the SEC s Regulation AB requirements. From interpreting applicable Regulation AB guidance to process control analysis, we have assisted our issuer and servicer clients in treasury, servicing, and trustee functions to assess readiness for Regulation AB compliance. KPMG s professionals have provided advisory and internal audit assistance to issuer and servicer clients for Regulation AB. Advisory assistance involves Servicer Report tie-out to transaction documents, such as pooling and servicing documents, indenture and trust agreements. Also along with static pool disclosures, KPMG s professionals have supported general servicing considerations such as the review and testing of policies and procedures instituted for structural monitoring of the pools. Activities include walk-throughs and documentation of securitization and servicing processes; gap analyses; remediation recommendations; and assistance with test plans and testing. KPMG reviewed transaction documents to ensure completeness and timeliness, including: Cash collections and administration Investor remittance and reporting Pool asset administration. We successfully assisted our clients in updating procedures and meeting annual Regulation AB requirements, providing recommendations for process improvements and additional control strengthening. Regulatory Risk Management Consumer Protection and Fair Lending Our clients have hired us to identify potential risks to consumers and analyze their fair-lending processes. For several of our banking and servicing clients, under the Consumer Financial Protection Bureau (CFPB), yesterday s business

10 8 Mortgage Servicing Operations models and compliance programs have needed to be revamped to answer new challenges and measure up to customers and regulators expectations. For the purposes of the risk assessment, the CFPB has explicitly defined risk to consumer as the potential for consumers to suffer economic loss or other legally cognizable injury as a result of a violation of Federal consumer financial law. The focus on consumer and compliance risks is the prevailing regulatory paradigm in consumer financial products. For clients ranging from large banks with servicing operations to pure servicers, KPMG developed a consumer protection framework and a practical methodology to help our clients diagnose their level of consumer risks and identify enhancements to their business models and operations to mitigate those risks. Our framework and methodology incorporate a Consumer Risk Diagnostic Tool built around the key requirements outlined by the CFPB, which can be applied at various levels enterprise, line of business, functional, and/or product level and tailored based on applicable regulatory requirements and expectations. Additionally, KPMG has conducted multiple fair-lending servicing analyses over the last few years for a variety of clients. Broadly, the fair-lending servicing framework includes both key metrics that need to be analyzed for potential fair-lending risk at relevant segmentations and analysis on frequency, drill-down triggers, and additional follow-up. We successfully assisted our clients in inventorying and quantifying their various consumer risks and develop processes and recommendations for future improvement. In addition, we have assisted clients in developing key metrics and analyses for potential fair-lending risk. KPMG s Mortgage and Consumer Lending Services Practice KPMG mortgage servicing and default management specialists are backed by the full resources of our Mortgage and Consumer Lending (MCL) services practice. The MCL practice group includes over 200 KPMG professionals who focus specifically on mortgage and consumer lending. They provide a broad array of advisory services to the majority of financial institutions, government agencies, and specialty finance companies, including: Five of the top 10 global financial institutions Five of the top 8 U.S. banks Four of the top 10 FORTUNE 1000 commercial banks Seventy percent of the top 15 mortgage and consumer lending companies Our service offerings support business process improvement and redesign, compliance assistance with new regulations, and financial assistance at the portfolio and loan level. We use credit analytics, financial analysis, and other tools and methodologies to support informed decision making. We can also monitor loan performance, forecast borrower behavior, estimate credit losses, and help mitigate credit and lease residual risks. KPMG member firms are well-positioned to help organizations gain market share and stay competitive in the mortgage and consumer lending marketplace. We also possess the advantage of access to additional advisory, tax, and audit resources, enabling them to examine and address issues from a variety of business perspectives.

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12 For more information To learn more about our services and capabilities, please contact one of the following KPMG professionals: Kimberly Davis-Riffe Partner T: E: Anthony Sepci Partner T: E: Jeffrey P. Hulett Managing Director T: E: Edmund Green Managing Director T: E: kpmg.com 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International NSS The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.