WASHINGTON — The Treasury Department has swapped the carrot for the stick for three of the largest participants in the administration's foreclosure prevention program.

After nearly a year of complaints about the program's lack of effectiveness, Treasury said Thursday it has begun to withhold incentive payments from Wells Fargo, Bank of America and JPMorgan Chase until they improve their performance the Making Home Affordable Program.

Industry observers said the long-awaited move to impose financial penalties may be a sign of building pressure from regulators and state attorneys general who are trying to negotiate a foreclosure settlement with the top five servicers.

"It is another direction from which the regulators are indicating their concerns about mortgage servicing," said Andrew Sandler, a partner with Buckley Sandler LP.

The banks were found to be in need of substantial improvement, according to a Treasury report released Thursday. The assessment was based on compliance reviews and program performance results from the first quarter of 2011.

It was also the first time Treasury has released detailed information on the performance of the program's largest participants. The new disclosures, which will be included in future quarterly reports, are intended to provide greater transparency about servicer performance, and prompt firms to fix their mistakes, Tim Massad, the acting Treasury Assistant Secretary for Financial Stability, said on a call with reporters.

"The assessments are intended to be another tool to promote servicers to correct identified deficiencies so that they more effectively assist struggling homeowners," Massad said.

Participants in the program — which aims to reduce monthly mortgage payments for struggling borrowers — receive incentive payments for each mortgage they permanently modify. Wells, JPMorgan and Bank of America collected roughly $24 million in payments last month, but Treasury is still calculating what the payment would have been for this month.

David Berenbaum, a chief program officer for the National Community Reinvestment Coalition, said the report vindicates what borrowers have long known: that the program is plagued by servicer mistakes.

"I think it speaks to some of the recommendations being made by the attorney generals right now," Berenbaum said. "We need to be thinking outside of the box right now. If the systems are not working, there are proposals on the table …that would restore trust to the martketplace."

In a statement Thursday, Wells said it plans to formally dispute the findings.

"It paints an unfairly negative picture of our modification efforts and contradicts previous written assessments shared with us by the Treasury," the statement said. "The report reviews activities that date back a year or more and in no way reflects the improvements Wells Fargo has made in our processes and the work we have done to help homeowners."

JPMorgan Chase also responded to the report, saying it "respectfully disagrees with the assessment. We have made significant improvements since the modifications that Treasury reviewed and continue to work hard to keep improving our processes and controls."

Bank of America, which appeared to be the worst performer, took a different tack and said it is working to improve its performance.

"We acknowledge improvements must be made in key areas, particularly those affecting the customer experience," it said. "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. We believe future reviews will confirm that progress."

Since the program began, Treasury has used regular and ongoing compliance actions to require servicers to improve their performance. But this is the first time servicers have been subject to financial penalties.

Participants were judged on three categories of program implementation: identifying and contacting homeowners; homeowner evaluation and assistance; and program reporting, management and governance.

According to the new assessments, the three banks whose payments will be withheld appeared to make significant mistakes determining eligibility for the program, communicating effectively with potentially eligible borrowers and calculating the incentives they are owed.

Bank of America appears to be the worst performer, meeting the benchmarks for only one of seven performance metrics, and receiving the lowest rating — 1 out of three stars — in four of the categories.

According to the report, the bank was unable to provide enough evidence to back up their determination of eligibility for nearly 18.8% of all loans, nearly twice the benchmark set by Treasury. It also made significant errors calculating a borrower's income — an important tool used to establish eligibility and determine a modified payment amount — on 22% of all loans. And it miscalculated incentive payments by an average of 11.5%, compared with what the Hamp system record reflected.

Wells Fargo also received a single star in three of the seven performance categories. It made significant errors calculating income for 27% of borrowers, and also miscalculated its incentive payments by an average of 11%, according to the report.

JPMorgan Chase received a single star rating for only one category, but failed to meet the established benchmarks in five out of seven categories. According to the report, it made significant errors calculating borrower income on 31% of loans.

Ocwen Loan Servicing was also found to be in need of substantial improvement, but will not face financial penalties because the results were negatively affected by the acquisition of a large servicing portfolio during the first quarter, according to a Treasury official.

The remaining six largest servicers were found to be in need of moderate improvement, and could face financial withholding in the future if their performance does not improve.