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The Recent Woes of Non-Bank Mortgage Servicers

Before the financial crisis, servicing of loans was a relatively straight forward process. Loan modifications and foreclosures were relatively rarer. However, in the wake of the crisis, entire mortgage portfolios went delinquent. Mortgage Servicing Rights (MSR) prices dropped by up to 70%.

Soon thereafter, lenders recognized the need for low-cost non-bank servicers. This trend was mainly because handling a large volume of distressed loans required increased borrower interaction, either for modifications or foreclosures. Traditional banks neither had the manpower nor the infrastructure. The financial crisis also brought the banks in the cross-hairs of the regulators, not to mention the general public.

 

Non-bank Servicers – Recent Troubles

Non-bank servicers welcomed this growth with open arms. They raised the bar through more effective operations, by migrating certain processes to lower cost economies, and better loss mitigation.

However, detractors also claim that non-bank servicers have been quick to foreclose on their borrowers and have been operating on shoe-string capacity. Regulators have sat up and taken notice. The following concerns have been raised:

Aggressive foreclosures over loan modifications: Regulators believe that non-bank servicers make more money by going for foreclosures rather than carrying out loan modifications. This is because of the poor incentive compensation which servicers get in a successful loan modification. Even the cash incentives to modify the loans through HAMP (the Obama Administration’s foreclosure mitigation program) have not outstripped servicers’ compensation incentives in the foreclosure process.

Illicit benefits due to Business Affiliations: Non-bank servicers have business affiliations with other entities including providers of loan originations, securitizers, or foreclosure management firms. It is often believed by regulators that these affiliations incentivize the servicers to act in ways that are in the interest of allied companies. The servicers, however, claim that these business alignments help to increase efficiencies for customers and investors.

Recent increase in loans per employee: In late 2010, bank staffing levels declined as distressed loans were resolved but the nonbank staffing levels increased due to rapid expansion of their portfolios. While the number of loans per employee decreased significantly for banks from 800 to 500 by 2012, it was noted that this number remained constant at 275 for non-bank servicers.The same ratio, however, grew in 2013 to 400 amidst regulators' fears of decreasing servicing quality.

Lower-quality and delayed loan modifications: The quality of loan modifications carried out by non-bank servicers has been questioned. It's not just a matter of re-default rates; the non-bank servicers initiate the mod trial at a later stage than their banking counterparts.

 

What should Non-bank servicers do to sustain their growth?

While non-bank servicers have taken the flak for compromising the borrower’s interest more than traditional large-bank servicers, this picture may already be outdated. The gap between loan-modification rates of bank and non-bank servicers bridged significantly in 2013. The complaint rates also decreased over this period of time.

However, given the generally poor quality of the portfolios that non-bank servicers handle, and their already-significant role in the mortgage industry, the regulatory pressure on non-bank servicers is here to stay.

We feel that servicers would do well to heed the following:

Enhancing Operational Effectiveness, Esp. Loss Mitigation: Since the portfolio of non-bank servicers consists largely of distressed loans, they need to be fundamentally better at loss mitigation than their bank counterparts. Part of the solution lies in better capacity planning to do enough workouts each month, but the other part will be to invest in superior loss mitigation infrastructure.

Managing Financial and Operational Risks: The financial risks discussed earlier have become a much more crucial piece in the current macroeconomic environment. These risks need to be mitigated through better MSR pricing and robust cash flow management.

Increasing Process Transparency towards the Regulator: There is no doubt that the non-bank servicers needs to strictly adhere to the standards set by CFPB by providing clear monthly billing statements, warning borrowers well in advance about interest rates hike, crediting people’s payments promptly, swiftly correcting errors and keeping better records.

While meeting these requirements, the servicers should aim to bring in more transparency in their communications to the regulators than there has been in the past. This is difficult but not without its benefits. Latest advances in data aggregation and visualization will help servicers convince their regulators that they are knowledgeable of the issues, and are working to minimize them.

Aligning the goals of Servicers and Regulatory Bodies: Finally, and most critically, we believe that servicing efficiencies and borrower centrism can improve only when both regulators and servicers are aligned in their goals.

The servicers should look to make their servicing practices as borrower centric as possible rather than merely adhering to the guidelines set by the regulatory bodies. The regulatory bodies on the other hand need to consider the development of regulations that improve the safety and soundness of this channel, rather than those that eventually become a bottleneck to growth. Ultimately the question regulators need to address is: how to best encourage all servicers to perform optimally for borrowers, investors, and lenders, as well as for shareholders.

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Tags: BFSI, Finance, Loans

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