States Said to Alter Mortgage Accord as Banks, Republicans Balk at Terms

U.S. states probing foreclosure practices revised a nationwide settlement proposal after banks and eight Republican attorneys general objected to mortgage loan principal cuts, two people familiar with the talks said.

The provision of the original 27-page term-sheet submitted by the states and Justice Department would encourage defaults, the banks and eight attorneys general said. Revisions of the proposal reflect earlier talks with the banks, one of the people said, without disclosing terms of the new accord. The new terms were sent last week to lenders including Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM)

Republican attorneys general met today in Atlanta to discuss the issue, said Adam Temple of the Republican State Leadership Committee. A representative of the American Bankers Association, which represents the banking industry, told them that principal reductions don’t work.

The seven-month probe by all 50 states was triggered by claims of faulty foreclosure practices after the housing collapse, which state officials said may violate their laws. In addition to Bank of America and JPMorgan, Wells Fargo & Co. (WFC), Citigroup Inc. (C) and Ally Financial Inc. are involved in talks with the states. The five banks control more than half of the mortgage servicing market, Iowa Attorney General Tom Miller, who leads the state probe, has said.

Miller, a Democrat, didn’t return a call seeking comment on the new proposal. Jumana Bauwens, a spokeswoman for Bank of America and Thomas Kelly, a spokesman for New York-based JPMorgan, declined to comment.

Lenders Object

During a recent call between states officials and the banks, some lenders said they opposed any settlement term that would reduce loan balances, according to one of the people familiar with the talks. The banks argued a principal writedown plan would encourage homeowners to default, a notion some attorneys general on the call disputed, the person said.

Representatives of banks said they were open to other types of loan modifications, including changing interest payments, said the person.

While the original term-sheet required “a substantial portion of monetary relief” go toward loan modifications including principal reductions, one of the people said the states may seek money to pay restitution to homeowners who were wrongly subjected to foreclosure.

Principal Reductions

At today’s meeting in Atlanta, Bob Davis, an executive vice president with the American Bankers Association, said in an interview that he told the group that principal reductions don’t work. Loan balances must be reduced so much for borrowers struggling to make payments that it is a better deal for lenders to foreclose instead, he said.

“Principal reductions don’t substantially improve the cash flow problem,” Davis said. “You can’t lower principal enough to make it an attractive tool.”

In talks over the initial proposal, the states agreed on some terms while failing to reach an accord on how much lenders would pay to fund principal reductions, a third person familiar with the talks said in April. As of yesterday, the states had yet to give the banks a proposed dollar amount, one of the people familiar with the revised proposal said.

Federal Settlement

Earlier this year, mortgage servicers agreed with U.S. banking regulators to a series of reforms, including conducting a review of loans that went into foreclosure in 2009 and 2010 and improving procedures for modifying loans and seizing homes.

The proposals for a nationwide settlement by the states and federal government seek to set requirements for how banks service loans and conduct home foreclosures.

Any state agreement with banks on principal reductions will depend on the size of the writedowns and the incentives provided servicers, the third person said.

A final agreement could take as long as four months to reach, a fourth person involved in the talks has said. All four declined to be identified because the matter is confidential.

Oklahoma Attorney General Scott Pruitt, a Republican, said last month he may negotiate an alternative accord with the banks if the national settlement turns out to be “inconsistent with our conviction.”

Pruitt said in a letter to Miller in March that forcing lenders to reduce mortgage balances would take away incentives for banks to loan money and “destroy an already devastated housing market.”

Targeting States

Besides Oklahoma, state attorneys general who have criticized the proposal to reduce principal balances are Florida, Texas, South Carolina, Virginia, Alabama, Nebraska and Georgia. Attorneys general for Florida, Georgia and Alabama were among the officials meeting in Atlanta today, Temple said.

The modified settlement proposal comes after government officials revealed that at least one bank has been targeting individual states for talks related to the foreclosure settlement.

Charlotte, North Carolina-based Bank of America was accused on a conference call by a top official at Miller’s office of engaging in a divide-and-conquer strategy by undermining support for a settlement of the state probe, a person on the call said.

The bank tried to get attorneys general to break away from those supporting the original deal, Iowa Assistant Attorney General Patrick Madigan said during the recent call, according to the person. Another person familiar with the settlement talks said the bank sought to sow dissent among the states. Both asked not to be identified because the talks are private.

‘Shared Research’

Lauren Kane, a spokeswoman for Georgia Attorney General Sam Olens, has said a bank, which she declined to identify, discussed with her office the federal regulator settlement. Adam Piper, a spokesman for South Carolina Attorney General Alan Wilson, said last month two banking representatives “shared research” with his office and “pointed out some concerns with certain provisions.”

Jennifer Meale, a spokeswoman for Florida Attorney General Pam Bondi, said last month that her office has “had general discussions with banks about how the matter might be resolved.”

Diane Clay, a spokeswoman for Oklahoma’s Pruitt, has said several “industry representatives” have been in contact with her office. It’s unclear whether Pruitt’s proposal of a new settlement agreement is related to the modified plan under consideration by the states and banks.

Clay didn’t return a call seeking comment on the new plan.

To contact the reporter on this story: David McLaughlin in New York at dmclaughlin9@bloomberg.net and; Karen Freifeld in New York at kfreifeld@bloomberg.net.

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net

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