Last week, the world of mortgage servicing got an unpleasant surprise. Cenlar FSB, the nation’s largest subservicer of residential mortgages, was hit with a consent order by the Office of the Comptroller of the Currency alleging “unsafe and unsound” banking practices.

“The order requires the bank to take comprehensive corrective actions to address identified deficiencies and implement internal controls and risk management practices that are appropriate to the bank’s risk profile and the size of its mortgage subservicing operations,” notes the OCC.

Cenlar’s subservicing book has grown rapidly in the past several years, including the boarding of the loans owned by the CitiMortgage unit of Citigroup. Cenlar was consistently rated positively as a servicer by the major credit rating agencies. S&P rated Cenlar “strong” in February of this year. Fitch Ratings, in 2020 rated Cenlar ‘RPS2.’ Fitch said that the rating “reflects Cenlar’s continued investments in its servicing operation, experienced management team and staff, highly developed growth strategy, effective enterprise risk management controls, and the financial strength and support of its parent, Cenlar Capital Corporation.”

The OCC order suggests that significant weakness exists in the bank’s internal systems and controls. Keep in mind that OCC found no consumer harm and levied no monetary fine on Cenlar. Yet, by accepting the OCC’s findings without a fight, Cenlar recognized a long list of operational deficiencies that must be corrected before the thrift holding company is allowed to board new servicing.

The Cenlar case is unusual for a number of reasons. First, Cenlar is a tiny bank, chartered over a century ago as Centennial Savings. In Q2 2021, the thrift had just $1.1 billion in total assets, about $300 million in mostly non-interest revenue, and $8.2 million in net income. The bank lacks a diversified banking business and deposit base, holds virtually no escrow deposits or mortgage servicing rights, and instead is entirely focused on mortgage subservicing.

Cenlar FSB is actually a very small bank that is now being regulated as a large bank by the OCC, the most prescriptive and problematic federal bank regulator. Why? Because Cenlar subservices three million of loans with over $750 billion in unpaid principal balance as of June 30, 2020. More than a commercial bank, Cenlar FSB looks an awful lot like many large non-bank servicers.

The OCC consent order limits “excessive growth” and prioritizes remediation by requiring the bank to receive no supervisory objection from the OCC before adding new subservicing clients and prior to declaring or paying dividends to shareholders while the order is effective. Yet to understand the actions of the OCC, we need a little context.

Federal bank regulators have long made clear to regulated institutions their distaste for reputational risk. Regulators are also not thrilled about monoline business models focused on residential mortgage loans, again because of the reputational risk. Facing consumers in the world of servicing 1-4 family mortgage loans is a chief source of reputational risk, thus the OCC and other regulators have steadily raised the bar for institutions that specialize in consumer finance in an effort to avoid such risk.

Another data point comes from the recent travails of Wells Fargo & Co., which has been in regulatory purgatory for years due to a breakdown in internal systems and controls in several areas of the bank. Wells has been under regulatory sanctions for almost a decade to correct deficiencies in its loss mitigation activities. But the giant bank’s board and senior management so far has failed to make progress in addressing these areas.

As a result, the OCC just imposed a $250 million fine on Wells based on the bank’s “unsafe or unsound” practices related to deficiencies in its home lending loss mitigation program and violations of the 2018 Compliance Consent Order. The bank was told to fix problems, failed to do so, and is now facing additional fines and monetary sanctions.

“Wells Fargo has not met the requirements of the OCC’s 2018 action against the bank. This is unacceptable,” said Acting Comptroller of the Currency Michael J. Hsu. “In addition to the $250 million civil money penalty that we are assessing against Wells Fargo, today’s action puts limits on the bank’s future activities until existing problems in mortgage servicing are adequately addressed.”

Hsu continued: “The OCC will continue to use all the tools at our disposal, including business restrictions, to ensure that national banks address problems in a timely manner, treat customers fairly, and operate in a safe and sound manner.” Translated into plain language, fix the problems at Wells Fargo or we will compel you to downsize and eventually break up the bank.

Likewise, with Cenlar, the bank reportedly was told to make improvements in many areas of its systems and controls. Cenlar had been making progress and added several senior executives to its management team. These changes did not occur in a timely fashion, at least as measured by the OCC, so now Cenlar faces a draconian consent order that limits the bank’s ability to do business and places limits on corporate actions. Ironically, the OCC action has damaged Cenlar’s reputation and also carries a potential threat for non-bank servicers as well.

The consent order from the OCC for Cenlar contains a laundry list of issues many banks and mortgage servicers have seen in the past. That said, this action is the most stringent order applicable to a bank from OCC in a decade. Again, while there was no fine or finding of consumer harm in the order, the Consumer Finance Protection Bureau and state agencies may decide to impose similar standards on independent mortgage banks.

The OCC action against Cenlar FSB may be considered a preventative action to avoid future errors, consumer harm and fines as and when credit loss levels return to normal. The lesson to be taken from the cases of Wells and Cenlar FSB is clear: address operational issues identified by regulators or face public shaming via an enforcement action and the attendant reputational damage.

Many chief executives in the mortgage finance industry may take comfort from the fact that they are not depositories. But that is a mistake. Again, Cenlar looks a great deal more like an IMB such as sub-servicing giant Dovenmuehle or private servicer Lakeview than it looks like Wells Fargo, JPMorgan, Flagstar Bancorp, a large subservicer that is also among the largest warehouse lenders in the industry.

The OCC’s focus on operational risks at Cenlar, even before any consumer harm has occurred, should be a wakeup call to all IMB’s with significant servicing or subservicing books.

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