REQUIRED READING: Moving Forward, Servicers Reassess Fee And Advance Structuring

Written by John Clapp
on April 17, 2009 No Comments
Categories : Required Reading

menting on dried-up foreclosure sales and mounting delinquencies in[/b] [b][i]Servicing Management[/i][/b]'s February 2007 cover story, Litton Loan Servicing President Larry B. Litton Jr. observed, ‘It's the inevitable end of a cycle.’ Indeed, the approaching storm of foreclosures was in sight, and Litton and others were already on their way to establishing strategies for how to adjust to a post-housing-boom era of servicing. What few people could have predicted then was not that the feel-good days of thin but reliable profit margins and problem-free collections were ending, but rather that the uptick in foreclosures would reach such scary heights. The consequences, well documented and well known, have left no part of the economy untouched, especially servicing operations. While a return to normalcy is perhaps far more difficult to pinpoint than was the industry's initial turn for the worse, once it does happen – this year, next year or in 2011 – those banks and servicing shops still doing business will undoubtedly and remorsefully consider where they went astray. "About every mistake that could've been made over the last 20 months – we as an industry made that mistake," Litton reflected a during panel session held at the Mortgage Bankers Association's National Mortgage Servicing Conference in Tampa. "There's a great many lessons for us to learn in terms of how to run a servicing business." Chief among the lessons is that responsible, diligent servicing has significant value and, as such, is deserving of greater fees than what most shops charged when times were good. Although preventing a similar meltdown from happening again is a goal shared by all parties, the possibility of such an occurrence is, from many people's perspectives, not unrealistic. Executing large-scale modifications is a capability that comes with investment, both in technology and human resources. "Those come at a cost, and there's got to be a way to be able to cover those costs with some different type of structures," Litton told attendees. [b][i]Advance costs explode[/i][/b] Of course, inadequate servicing fees are not the only force tugging at shops' purse strings nowadays. The alarming expense of escrow advances has caused major liquidity problems at all but the most conservative community-level operations. In February, when it was reported that Wilbur Ross' American Home Mortgage Servicing Inc. (AHMSI) paid Citi Residential Lending $1.5 billion for servicing rights on 185,000 loans, AHMSI CEO David Friedman later clarified that the "vast portion" of the amount was related to outstanding advances. Litton said his company, which is positioned in the subprime/Alt-A arena, services a portfolio worth about $70 billion. Its advance book is approximately $2.5 billion. "We all talk about managing advances, but if you're not careful, they'll manage you," added Gene Ross, president of subservicer LoanCare Servicing Center LLC. Foreclosure moratoria imposed at the state level as early as last year, combined with those implemented while the Obama administration drafted its foreclosure prevention plan, have had the unintended effect of lumping remittance payments into a short and costly time frame, Ross pointed out. "What it has done is, rather than spread out reimbursements or repurchases for loans that are in a security, it's now pushed them all into a particular month in which you have a bubble of liquidity and a need for advances," Ross said. "Right now, there's nothing more important to me and my organization," he added, in regard to cashflow management. LoanCare Servicing examines cashflow on an almost daily basis, but Ross concedes that a weekly schedule may be sufficient for simpler portfolios that feature fewer delinquent loans. Financing options are limited, but cashflow forecasting models provide at least some guidance on the best management strategies. Martin E. Touhey, a senior manager with PricewaterhouseCoopers, has observed, on a limited basis, instances of servicers asking counties to reassess properties, resulting in lower property taxes. But he admitted he does not know if such an approach is scalable. Litton suggested that once the subprime and Alt-A markets reemerge, residential mortgage servicers might want to take a page out of their commercial counterparts' playbook and start demanding interest paid on advances. Just as cashflow analysis has become a daily routine, so too has investor reporting. Investors are no longer satisfied with weekly reports, let alone monthly reports. They are also increasingly asking for loan-level data, if not outright access to servicing platforms. For a company like LoanCare Servicing – which, as a subservicer, has 90 clients, all with different contracts and expectations – reporting represents only one investor-related challenge. Maintaining compliance for such a wide and diversified swathe of contractual obligations has its own set of difficulties that, if overlooked, can prove costly. "One of the big things that keeps me up at night is risk – compliance risk," Ross said. "If you make a mistake as a subservicer, you have to step up to your indemnifications, and you have to resolve the mistake monetarily, if you can't fix it nonmonetarily." His company's book has landed only four loans because of noncompliance, but that number could spiral out of control for a shop that does not efficiently communicate guidelines throughout the entire organization – an immense undertaking that stretches from customer service through loss mitigation. [b][i]Vendor management[/i][/b] With its array of clients, LoanCare Servicing must also be mindful of the way it manages vendor relationships, Ross added. Picking best-in-class vendors is ideal from a servicer's perspective, but investors have their own preferences for how to outsource certain functions. To contend with this demand, LoanCare Servicing retains several vendors in all of its outsource categories. Inserting more precision in the contracts than was previously the industry norm is required, Ross advised. "It takes proper [service-level agreements], termination clauses, indemnifications and a little bit more care and legal work than the past," he said. "Going forward, it's important to perform due diligence on vendors." This might involve on-site visits or implementing a vendor audit program that could be housed within a functional area of a servicing shop (e.g., quality control, accounting, internal audit). Having these safeguards in place helps ensure, among other things, that overbilling does not occur. Efforts to create staffing and capacity models have been strong, PricewaterhouseCooper's Touhey observed, and those practices must continue as the industry maneuvers its way through the currently brutal business environment. "People really need to understand what are their exact capabilities," he said. "When does it make sense to go to a subservicer? Where does it make sense to keep things in-house? [You should] understand what are the breaking points in your cost structure as you ramp up." Touhey's colleague and PricewaterhouseCoopers manager, Roberto Hernandez, who served as the panel's moderator, added that most servicers do a decent job of analyzing costs at the aggregate level but struggle to do so at the loan level. He additionally cautioned attendees to not forget about borrowers who have the largest long-term potential. As servicers make greater investments in mitigating the losses associated with delinquent loans, being mindful of customer retention remains critical. For shops not already doing so, Hernandez suggested investing in data collection that allows a firm to review its customer relationships across all product

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