What makes a successful loan workout? That's a question being asked by many in the servicing industry nowadays, and one that Steven Horne, founder and president of Wingspan Portfolio Advisors LLC, hopes to help answer. A lawyer who has served as both a former director of servicing risk strategy with Fannie Mae and a former director of default servicing for Ocwen Financial, Horne has long been involved with the process of turning nonperforming loans into re-performing assets.
With that experience in mind, he decided this year to launch Wingspan, which uses a borrower-focused servicing methodology to work out loans. Wingspan's modus operandi takes into consideration a borrower's psychology in addition to the collateral value that's tied to a loan. This week, MortgageOrb asked Horne to give his perspective on current workout activity.
Q: As governmental pressure encourages more home retention strategies and fewer foreclosures, what do you see as the greatest challenges facing servicers?
Horne: Even with the ever-increasing focus on reducing foreclosures, I think the greatest challenge facing servicers is still overcoming the slippery slope toward foreclosure. Advocacy groups and disgruntled borrowers sometimes accuse servicers of profiting from taking back houses.
That is virtually never the case – especially where the credit risk is held by someone other than the servicer. It is true, however, that as servicers legitimately seek to control their servicing costs, foreclosure can easily become the path of least resistance. Not only is most of the work performed by third parties, but the majority of the servicer's costs are typically reimbursed once the loan goes to REO.
To overcome this subtle temptation to do less, more work needs to be done to incorporate law firms into the loan resolution process and to better align their incentives with the goal of home retention. So much emphasis has been placed on foreclosure timelines in the last few years that the industry seems to have lost sight of the fact that we don't want the REO in the first place – even if it is on time.
Q: Countrywide and the FDIC say they will use systematic approaches, where appropriate, for modifying nonperforming Bank of America and IndyMac loans, respectively. Can a one-size-fits-all modification approach work, or will some party (e.g., investors, servicers, borrowers) inevitably lose out?
Horne: It would be helpful if the courts or the government were able to provide some clear guidance regarding compliance with pooling and servicing agreement restrictions on workouts and also servicer liability for "wrongful workouts."
Regarding pooling and servicing agreements, there are inevitable conflicts between senior and subordinate bond holders. Senior bond holders have tended to favor foreclosure sooner [rather] than later, before home-price depreciation completely wipes out the subordinate tranches and exposes them to loss. Subordinate holders have been more favorably disposed to repayment alternatives because it keeps them alive a little longer.
From my perspective, it seems that public policy and a pragmatic consideration of exponentially increasing credit losses weigh in favor of an equitable interpretation of any restrictions that encourage more workouts. Nonetheless, there is a wide array of views in the industry, and it is not unreasonable to expect clearer guidance before wholeheartedly embracing any particular approach.
Similarly, we are starting to see creative plaintiff attorneys raising claims of wrongful workouts, where servicers have allegedly slammed borrowers into workout agreements that did not fit their circumstances. I have little sympathy for this trend and would like to see some protection for servicers trying to do the right thing.
That being said, the mass mailing of modification agreements appears to be an inevitable compromise with or without the guidance requested above. Nonetheless, it will certainly exacerbate the growing tendency of some borrowers to believe that they no longer need to pay their mortgage because the government will take care of them.
Moreover, bulk solutions tend to eliminate the possibility that other stakeholders such as mortgage insurance companies can contribute to the resolution of the loan through claim advances or other strategies.
Finally, because modifications are actually fairly powerful legal agreements, I have historically preferred to offer them only after a borrower has proved their ability to maintain a payment plan for some months and only in cases where they actually requested the modification.
In my perfect world, I would prefer to see more sales of nonperforming loans into the private sector. Investors who purchase these loans at a discount have the financial incentive to invest the patience and effort required to work with the borrower individually and coordinate the efforts of all stakeholders to maximize the value of each loan.
Q: Do you find some resolution options are underutilized while others are leveraged too often?
Horne: Servicers are under intense pressure to control their servicing costs while attempting to limit the credit losses of others. These pressures tend to bias servicers in favor of "one call and done" workout solutions or a "silver bullet" strategy that will resolve the bulk of their nonperforming loans. As someone who has spent the last 20 years resolving nonperforming loans for profit, I feel that neither approach works.
What works best to restore value to the greatest number of nonperforming loans is an intense sequencing of many strategies over time by highly skilled professionals. The limiting factor to this approach, however, from a cost-to-service perspective, is that it is not cheap. Thus, it is not a viable approach for traditional third-party servicers who do not own the risk.
Where one owns the risk, however, the returns from investor-centered strategies such as those utilized by Wingspan are clearly demonstrable, and an investor's net economic experience will be much better.
Q: Character, capacity, capital and collateral are viewed as the pillars of origination, but it seems they may be well applied to the modification process, too. Do you believe the four C's are typically given equal consideration? Should they be weighted equally?
Horne: I find it odd that the four C's are frequently given more weight in the modification approval process than they were in the origination process. For loan resolution, I am in favor of the "fifth C": chance. Where a borrower's intentions and circumstances present a deep commitment to stay in their home – a characteristic we call "psychological equity" – I think the borrower should be provided a second chance even if one might conclude that the odds are not overwhelmingly in their favor.
Not only have I found that borrowers succeed more often than not, but in the cases where they do re-default, they are often much easier to work with if they feel they have been treated fairly.
For those [who are] worried about HPA declines, I would argue that the credit losses, litigation and protracted evictions avoided through a more patient and generous approach to workout qualification more than offset the risk of collateral depreciation for those loans that do subsequently go to foreclosure.
Q: Does the currently frenzied business environment necessitate a change in attitude as it relates to loss mitigation practices?
Horne: Although I am sympathetic to the cost constraints limiting traditional servicers, the continuing stories of inbound calls from borrowers going unanswered is very troubling. It is amazing to me that, for all the effort spent on reaching a borrower, when a borrower actually calls in, servicers frequently can't seem to answer the phone.
There is really only one reason a borrower calls in – because they care about the loan. One way or another, when a borrower cares about the loan, there is almost always a better outcome available than foreclosure.
The calls that do occur with borrowers are too few and too short, and the gathering of information to understand better the borrower's circumstances is not sufficient. Over the years, we have clearly seen that very high call volume negatively correlates with loan resolution success.
The loan resolution staff must be allowed the time and the information necessary to succeed. Moreover, loan resolution staff that aren't leaping for the phone the moment it rings are symptomatic of deeply misaligned incentives in the loan resolution process.
The fact that servicers may not have the time, information or incentives to respond to willing borrowers contributes to a sense of helplessness on the part of many loan resolution employees. This sense of helplessness sometimes transforms into a generally negative attitude toward borrowers. It may be easier to rationalize one's inability to respond into a belief that the borrowers either didn't want help or there were no available alternatives anyway.