The 27-page proposed settlement between state attorneys general and mortgage servicers leaked last week will, in its current form, negatively impact servicers and investors, one credit rating agency said Monday. The draft settlement, also known as "the term paper," will hike up the operational cost of servicing, extend foreclosure timelines and decrease competition in the marketplace, according to Moody's Investors Service (MCO). "Implementation of the proposed terms will be painful and costly for servicers," Moody's analyst report in the Weekly Credit Outlook. "Our initial opinion is servicers and investors will be taking it on the chin." There are approximately 16 points mortgage servicers must follow with regard to foreclosure affidavits. Robo-signed documents need to be reviewed, with proof required that proper processes were taken. There are a further 12 points for requiring the accuracy and verification of the borrower's account information. All of these provisions would be at the expense of the servicer. There are also additional reporting requirements to agencies and third-party audit programs, as well as updates to controls and audit protocols "all of which will be labor intensive for servicers and require additional resources," Moody's said. Whereas large banks can absorb the extra costs updates and changes will require, small banks and lenders "may be priced out." Currently, the servicing industry is highly concentrated with the top four firms accounting for 58% of market share. "The pain will be less at highly efficient or large servicers that are able to distribute the increased fixed costs over a larger earning asset base," commented Moody's. "As a result, there could be further consolidation in the industry." Moody's believes the increased cost surrounding the industry will fall on investors in the residential mortgage-backed securities market. RMBS investors should expect less in principal recoveries as servicers will be required to waive deficiencies from short sales and consider principal forgiveness more heavily, the rating agency said. Although one piece of the proposed settlement aims to condense servicing timelines, Moody's believes this will have the adverse effect. Pending loss mitigation and foreclosures will be put on hold while servicers implement the required operational changes, and foreclosures will take longer in the absence of duel-track loss mitigation. The settlement says if a borrower is enrolled in a trial period plan under the Home Affordable Modification Program and makes all required trial period payments, but gets denied a permanent mod, the servicer must suspend all foreclosure-related activity. This too will increase servicing timelines, "causing severities to increase and investors to wait longer for liquidation cashflows," Moody's said. Republicans agree that this settlement could disrupt the functioning of the mortgage market. Last week, lawmakers sent a letter to Treasury Secretary Tim Geithner alerting him of their concerns. But some think the settlement doesn't go far enough. An alliance of consumer groups, including PICO and National People's Action, believe the settlement is a good first step, but that ultimately the proposal leaves too much "wiggle room" for big banks. The consumer advocates are pushing for stricter rules. "We’ve learned that there’s only one way to deal with the big banks," the alliance wrote in a March 10 letter. "You have to lay out all the rules, with no wiggle-room and then watch them like a hawk every step of the way." The group suggested making principal reductions mandatory and widely acceptable, having banks pay criminal penalties, returning homes to "the millions of people who are currently in the midst of foreclosure and dealing with the abusive servicing system," and strict enforcement of the settlement. Steve Horne, chief executive officer and president of Wingspan Portfolio Advisors, sees both sides of the coin. On one hand he believes it's completely reasonable to expect mortgage servicers to comply with foreclosure laws and produce accurate and verified paperwork. However, some aspects he doesn't agree with. "It's unreasonable to get rid of dual track mitigation," Horne commented. "Not every borrower can be saved and removing the foreclosure option will encourage bad borrower behavior." One suggestion he had to limit the potential cost to servicers coming out of this settlement was a gradual shift into the special servicing space. As it stands now, Horne said, the servicing cost structure is unsupportable because of the way servicers are compensated. And that filters into the competition side of business, he added. "We need to change the way servicers should be compensated," Horne said. "If you move to a special servicing servicer whose compensation is based on their success rate on an outcome other than foreclosure … many more loans are saved and investors end up with more money in their pockets." Write to Christine Ricciardi. Follow her on Twitter @HWnewbieCR.