Mandatory loan modifications and a fund to help reduce the principal on underwater loans are part of the price the nation's state attorneys general are seeking from mortgage servicers for settling the robo-signing controversy.

A proposed 27-page settlement, published in The American Banker, lays out a detailed code of conduct for lenders to follow in servicing mortgages, working with financially distressed homeowners, considering loan modifications and pursuing foreclosures when other remedies are not available.

Among the key elements: lenders would be required to offer distressed homeowners a loan modification if doing so could be shown to yield a greater net value than could be obtained through foreclosure. Lenders would also have to contribute to a fund to support enhanced loan modifications and principal reductions for financially pressed homeowners.

A spokesman for Attorney General Miller has described the proposal as a draft agreement, subject to ongoing negotiation. Several sections of the document, including the one dealing with the size of any financial settlement, are marked as subject matter for further discussions.

For his part, Miller told a press conference on Monday that he hopes an agreement can be reached in the next couple of months.He was speaking at a conference of the nation's state attorney generals, who are meeting in Washington, D.C. this week.

Loan modifications could be required

Under the proposal, mortgage servicers would be required to evaluate delinquent borrowers for a loan modification before any foreclosure proceedings could begin. Borrowers who met certain criteria would have to be offered loan modifications, a change from current policy, where modifications are generally at the discretion of the servicer.

One of the obstacles that homeowners sometimes face in seeking a loan modification is that it may be more profitable for their mortgage servicer foreclose rather than do a loan modification that would bring in more money over the long term. That's because banks that service mortgages usually don't own the mortgages themselves, but merely manage them on behalf of investors.

The way their compensation is structured, servicers can often earn more in fees by foreclosing than modifying the loan, even when the latter would be more beneficial to their investor clients. By establishing guidelines for when a loan must be modified, the proposal seeks to change this.

Fund for principal writedowns

The proposal also seeks to have lenders establish a fund to compensate homeowners who were harmed by mortgage servicer improprieties during the robo-signing scandal, and to provide for a program of enhanced loan modifications featuring reductions in mortgage principal for underwater borrowers. No figure is discussed in the document, but previous reports have suggested a figure of $20 billion is being sought.

Other parts of the proposal would specifically prohibit practices that gave rise to the robo-signing scandal, including a requirement that staff preparing affidavits and sworn statements for use in foreclosure proceedings must have personal knowledge of the facts contained, and a prohibition on incentives that might encourage staff or third-party agents to use robo-signing methods or undue haste in preparing foreclosure claims.

The robo-signing scandal arose last fall when it was reported that some of the nation's largest banks had been taking legal shortcuts in preparing foreclosure claims in order to deal with a flood of cases, in particular having representatives routinely sign off on sworn statements without verifying them.

The settlement being offered would apparently be in exchange for the state attorney generals and federal agencies agreeing not to pursue charges or fines against the lenders for violations or damages related to the robo-signing scandal.

No lenders were specifically named, but it is believed about14 mortgage servicers are involved. Last fall, several large mortgage servicers, including Bank of America, JP Morgan Chase and Ally Financial (GMAC) temporarily suspended foreclosure actions to investigate reports of foreclosure documentation issues.