(Update 2: adds updated discussion of effect on outsourcers, clarifies indirect versus direct outsourcing) In a seller and servicer bulletin released Thursday morning, Freddie Mac announced some very big changes to how it expects its servicers to manage their foreclosure and bankruptcy referrals to eligible legal counsel in key U.S. states. The changes represent the first time that a GSE has exerted direct influence over servicing practices in what is typically a widely unregulated area of mortgage banking.

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In particular, Freddie Mac said that servicers must retain more than one law firm or trustee in high-volume foreclosure states, and that servicers will be required to have formal contingency plans in place for managing file referrals in the event that a law firm or trustee cannot accept new bankruptcy or foreclosure referrals. Many attorneys have simply been overwhelmed with the volume of work that is now being pushed through the pipeline as the mortgage wreck has progressed, and it’s clear that Freddie Mac wants to make sure that servicers are limiting its losses on those loans that do progress to foreclosure. Changing the playing field? The new requirements could potentially also mean a sea change in how foreclosure outsourcing will be accomplished — Freddie indicated in its bulletin that servicers looking to comply with the GSE’s diversity requirements could either ensure that foreclosure and bankruptcy referrals on only Freddie Mac mortgages were split between two firms, or that servicers could ensure that their entire servicing portfolio was split between at least two law firms or trustees for foreclosure and bankruptcy referrals in higher-volume states (without special distinction for Freddie Mac files). Some sources suggested the reason for the latter distinction was that many large servicers have outsourced much of their default operations, especially management of foreclosure and bankruptcy referrals, to vendors that include subsidiaries of Fidelity National Information Services (FIS) and The First American Corporation (FAF), among others. Both companies, however, said that the new directives targeted what they called “direct outsourcing,” and that the diversity requirement would only apply in situation where a servicer had contracted directly with a law firm in a particular state. Executives at both companies, which they say practice “indirect outsourcing,” told HW that their platforms can and already do meet the requirements set for by Freddie Mac regarding risk management in foreclosure and bankruptcy referrals. It’s unclear if liability and responsibility for managing and oversight of the new diversity requirement would sit with the outsourcer, or with the servicer, for one thing. But sources suggest to HW that servicers are likely to take a more active role in managing the foreclosure and bankruptcy referral process — the question is how they choose to tackle the diversity requirement. Regardless, sources say, the new regulations will likely shift at least some of the caseload around to other firms in high-volume states. How much shifting depends on the servicer, we’re told. Beyond requirements for diversification, Freddie Mac also said it has amended its servicing guidelines to require that servicers “consider a law firm’s reputation” when selecting which counsel to refer files to. The bulletin said servicers would need to consider “whether the firm or its attorneys, principals or managers are, or have been, subject to disciplinary action, court-imposed sanctions, or other legal action related to single-family loan level foreclosure, bankruptcy, eviction, or property closing activities” in determining its default management practices. The new foreclosure and bankruptcy referral regulations will go into effect June 1, the GSE said. For more information, visit http://www.freddiemac.com.

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