By: Penny A. Showalter
An edited version of this article was originally published in the October 2012 issue of Servicing Management (Page 8-9)
The First Commandment of Loan Servicing
If there were Ten Commandments for the Loan Servicing business, Commandment #1 would be
Thou shalt contain costs while controlling delinquency, or thou shalt go broke
and sooner rather than later
Commandments #2-10 would be “See Commandment #1.”
This principle does not require a divinely inspired epiphany; eighth grade arithmetic, in fact, is sufficient.
Depending on the type of loan and the advancing requirements, servicers charge 25 to 50 basis points (bps) for each loan serviced. The servicer takes its fee from each payment collected, so if a payment is delinquent, no fee is collected until the delinquency is cured. So in a cruel twist, the most expensive loans to service generate the least collected revenue.
The servicing fee is the primary funding source for the tasks required for servicing a loan: sending statements, following-up on lagging payments, managing loss mitigation (modifications, short sales, deed-in-lieu, etc.), processing foreclosures and subsequent REO acquisitions and sales of the properties.
Setting aside accrual accounting timing difference, the servicing fees collected minus the servicing costs paid equals the profit – before other business costs and taxes.
Now, the reason this is eighth grade arithmetic rather than third grade arithmetic is that solving this equation sometimes involves an understanding of negative numbers. National Mortgage News reports, for example, that it costs servicers 75 bps (.75 percent) or more to service a high-touch loan (e.g., a defaulted loan). Subtracting costs of 75 bps from the collected servicing fee gives a profit on delinquent loan of -75 bps aka a loss of 75 bps.
“The positive profit on current loans must be sufficient to cover the full cost of servicing the delinquent loans”, says Michael Trickey, Managing Director of consulting firm Berkshire Advisors, LLC. So the concept is supremely valid: turning a profit in the loan servicing business is dependent on keeping the costs of providing those services to a minimum.
Of course, simply bidding low on purchasing of servicing rights is not the solution. This route has led to methodologies such as robo-signing, sewer service and pushing for the “rocket-docket” in Florida. These tactics have caused problems that in turn have led to the servicing shops now facing costly new regulatory compliance requirements from CFPB, rendering containment of costs more difficult than ever before.
On January 4, 2012, the Federal Reserve sent a White Paper on “The U.S. Housing Market: Current Conditions and Policy Considerations” to the Committee on Financial Services. That paper noted that:
Other data show, for instance, that less than half of lenders are currently offering mortgages to borrowers with a FICO score above 620 and a down payment of 10 percent – even though these loans are within GSE parameters. This hesitancy on the part of lenders is due in part to concerns about the high cost of servicing in the event of loan delinquency and fear that the GSEs could force the lender to repurchase the loan if the borrower defaults in the future.
The Fed goes on to say that concerns about the high cost of mortgage servicing stem from:
- the realization of how expensive it is to resolve a nonperforming loan,
- uncertainty about what it will cost to comply with new mortgage servicing-related regulations and
- the potential change in the way Mortgage Servicing Rights (MSRs) are treated for capital requirements under Basel III (new international banking regulations).
The servicing fee must cover a variety of costs, many of which vary widely in sporadic and unpredictable ways. Servicing costs vary based on size and efficiency of the servicer and on level of delinquency. Also based on whether the loans are in securities and what the advance requirements are.
On a performing loan, servicing costs are low—especially for large servicers with highly efficient, automated systems. For these loans, the servicing fee significantly exceeds the servicing costs incurred.
For nonperforming loans, however, the direct costs associated with collections, loss mitigation, foreclosure, and the maintenance and disposition of REO properties are unpredictable and can quickly become substantial, substantially exceeding the servicing fee. Add on top of that the interest costs of advancing principal and interest to investors and taxes and insurance to counties and vendors, and the earnings drag becomes even worse.
The Consumer Finance Protection Bureau (CFPB) has proposed a policy change that would dramatically change the current regulations of the Real Estate Settlements Procedures Act (RESPA) and Truth in Lending Act (TILA). On August 9, 2012 CFPB Director Cordray announced the impending release of proposed national servicing standards to protect consumers, especially those experiencing difficulty making their monthly mortgage payments.
“The major failures in this industry demonstrate that all servicers need to meet basic standards of good customer service,” CFPB Director Richard Cordray said in a call with reporters. The proposal, he said, reflected “two basic, common-sense standards — no surprises and no runarounds.”
The core of the proposal comprises nine major points affecting the implementation of Dodd-Frank Act provisions, ranging from providing options for avoiding force-placed insurance to reviewing a loan modification within 30 days of receiving it.
Small servicers, already operating on razor-thin margins, would be subject to many of the same requirements as the industry giants (Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and Ally Financial) that struck the $25 billion mortgage settlement early this year with regulators.
“As these incremental mandated costs continue to add up, it will impact costs to borrowers” says Michael Trickey. “Servicers can only absorb so much before fees will have to be increased somehow.”
The nine major points of the proposal are as follows:
- Periodic billing statements (TILA proposal): Servicers would be required to provide clear billing statements including information on the loan, amount due, and application of past payments.
- Adjustable-rate mortgage interest-rate adjustment notices (TILA proposal): Servicers would be required to provide consumers with a new notice 6 to 7 months before the first rate adjustment, as well as earlier and improved notices before rate adjustments causing an increase in a consumer’s mortgage payments.
- Prompt payment crediting and payoff payments (TILA proposal): Payments must be applied as of the day they are received, and the handling of partial payments is clarified.
- Force-placed insurance (RESPA proposal): Servicers can only charge borrowers for buying insurance on the property when they have a reasonable basis to believe that the borrowers have let their own insurance lapse and have given borrowers two notices estimating the cost of the “force-placed insurance.”
- Error resolution and information requests (RESPA proposal): Mistakes happen, but they need to get fixed. Servicers must address borrower concerns about possible errors within certain timeframes and provide the information they request.
- Information management policies and procedures (RESPA proposal): Servicers must have reasonable policies to ensure that when borrowers provide documents and information the servicers can find and use them.
- Early intervention with delinquent borrowers (RESPA proposal): Servicers must work with delinquent borrowers with early intervention and information about options available.
- Continuity of contact with delinquent borrowers (RESPA proposal): Servicers will insure delinquent borrowers will be able to contact the right people to get information and take steps to avoid foreclosure.
- Loss mitigation procedures (RESPA proposal): Servicers would be required to appropriately review borrower applications for loan modifications or other options to avoid foreclosure.
In addition, mortgage servicing companies would be required to provide clear monthly billing statements, warn borrowers before interest rate hikes and actively help them avoid foreclosure. The rules also require companies to credit people’s payments promptly, quickly correct errors and keep better internal records.
The CFPB plans to finalize the rules by January 2013.
Consider the costs involved if a property does end up in a foreclosure proceeding. The servicer is required to provide all of the documentation of the default to the law firm preparing the foreclosure documents. This would of course include all of the payment records and accounting, but may also require that the servicer copy all of the communications between the borrower and the account reps and collectors that worked the loan.
Depending upon the state, the foreclosure process may require from one to ten months’ time if all goes well. Borrowers have been made very aware of the robo-signing issues and are using that knowledge to delay or in some cases derail the foreclosure process. The servicer is incurring costs to keep that loan on the books every day, and every action by the borrower has the potential to create a need for a reaction from the servicer to respond to a request for more data information. Everything, from a telephone call to an e-mail adds cost to the servicer. When you’re operating on 25 basis points, it does not take much to turn the potential profit into a hard loss.
Once the lender is successful in completing the foreclosure, the servicer’s duties are still not done. Many states have a redemption period, wherein the borrower can remedy the loan default.
Redemption is a period after your home has already been sold at a foreclosure sale when you can still reclaim your home. During that period the servicer pays the outstanding mortgage balance and all costs incurred during the foreclosure process.
Many states have some type of redemption period. The redemption period and availability is often determined by whether the foreclosure is judicial or non-judicial. And, timelines and procedures can vary greatly from state to state.
Given the soft real estate market, a foreclosed property is more than likely going to remain on the lender’s books for months. During that time, the REO property will need to be inspected, secured, and maintained. The lender may be paying the bills, but the servicer is still providing the accounting and reporting, and incurring the daily cost of having that loan on the books.
Cost increases, other than compliance expenses, will include increased capital requirements, increased cost of funds and recourse losses.
Sticking with the first commandment of servicing is becoming ever more challenging. As public policy grows ever more vigilant for consumer protections, costs will continue to be pushed upward. The associated costs are unstoppable, but must be controlled to the best of the servicer’s ability.