NEW YORK (CNNMoney) -- Three top mortgage servicers are finally being taken to the woodshed by the Obama administration.
Federal officials say these banks are doing such a bad job at foreclosure prevention that the government will stop paying them for modifying delinquent loans.
The Treasury Department announced on Thursday that it will withhold incentive payments to Bank of America (Fortune 500), J.P. Morgan Chase ( , Fortune 500) and Wells Fargo ( , Fortune 500) until they substantially improve their performance in the federal Home Affordable Modification Program, known as HAMP.,
Ocwen Loan Servicing () was also cited but will continue receiving payments. Its results were affected because it started servicing a large pool of mortgages while under review.
The banks needed to boost their performance in several areas, including correctly evaluating whether a homeowner meets the HAMP income requirements.
Though the administration has talked tough in the past, this is the first time it is wielding the most powerful weapon in its HAMP arsenal -- the withholding of payments. Servicers are eligible for up to $4,500 over three years if they put borrowers into sustainable modified mortgages.
Until now, officials had hoped that compliance reviews and publication of each servicer's performance would be enough to get the banks to improve their handling of troubled borrowers. They stressed the withholding of payments is the "next step" in the process.
"While we continue to get tens of thousands of new homeowners into mortgage modifications each month, we need servicers to step up their performance to meet the needs of those still struggling," said Tim Massad, a Treasury official.
So far, the administration has paid $1.3 billion in incentive payments -- paid for with funds from the 2008 TARP law -- to 84 servicers. It has used about $2 billion of the $46 billion in TARP funds dedicated to homeowner help.
Banks react: The cited banks had varying responses to the Treasury's action, with Wells Fargo saying it would formally dispute the findings.
The San Francisco-based bank said Treasury is using data from last year and that it has cut its error rate to 4.5%, down from the 27% cited in the report.
"We realize that continued improvements are needed, but this report does not fairly reflect our leading role in making loan modifications," the bank said in a statement. "It paints an unfairly negative picture of our modification efforts and contradicts previous written assessments shared with us by the Treasury."
Chase said it "respectfully disagrees" with the assessment, while Ocwen said it was surprised that it was dinged for problems with the modifications made by servicers whose portfolios it took over.
Bank of America said it acknowledges it must make improvements, particularly in areas affecting homeowners.
"We have made great progress in several key performance areas and, in the first quarter, Bank of America was responsible for one of every four modifications completed under HAMP," said Dan Frahm, a senior vice president at the nation's largest servicer.
Pressure building: The Obama administration has been under fire for not getting the banks to do more to help homeowners practically since the HAMP program began in the spring of 2009. Officials have been repeatedly pressed to hold the banks accountable for their poor results in the administration's signature foreclosure prevention program, which has performed far below expectations.
Through April, nearly 700,000 homeowners have received permanent modifications through the HAMP program, which the administration said would help up to 4 million people.
Servicers have also started 25,500 second lien modifications through a separate Obama administration program and have helped nearly 15,000 people get out of their homes through short sales or other foreclosure alternatives.
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