(Editor’s note: This select print feature originally appeared in the November 2016 issue of MReport)
Over the past decade, the mortgage industry has become increasingly more aware of the need for sound and prudent residential loan servicing practices to help better manage risks, maximize cash flows, and minimize defaults. Investors, banks, issuers, sponsors, GSEs, rating agencies, and other regulatory bodies, and pertinent third-parties all recognize the critical role loan servicing plays in helping maintain and improve loan performance. As such, a great deal of emphasis now exists across the industry toward having a strong servicing surveillance/oversight function that can play the role of “watch dog’’ over loan servicers in order to safeguard consumers from inappropriate and unsuitable practices. Effective surveillance has been shown to foster greater compliance and lead to improved portfolio performance through more active management and mitigation of risks. The end result: An overall reduction in loss severities.
One prominent industry leader, now a senior executive at a major U.S. rating agency, makes his sentiments very clear: “Proper surveillance of mortgage servicers is an absolute necessity—end of story! Had a more extensive [servicing] oversight function been in place across the industry back at the height of the collapse, many improper actions taken [by servicers] against consumers, such as robo-signing and dual tracking, would [most likely] have been detected early-on, and would not have prevailed, and overwhelmed the industry. There would have been less havoc wreaked on critical processes like foreclosure and loss mitigation, and in all likelihood, fewer loan losses may have resulted, thereby positioning many servicers to better weather the storm.”
Investors who have incurred losses now look to the role residential mortgage loan servicers play in helping manage loans and curtail/minimize defaults. Prior to this decade, investors seeking recourse for damages they incurred focused primarily on loan origination and underwriting malfeasance in order to identify fraud or representation and warranty breaches related to defaulted loans. Over the past several years, however, the emphasis associated with loan origination fraud and underwriting malfeasance has shifted, with greater focus now being placed on loan servicing and the corrective measures servicers can take to address shortfalls and ultimately reduce loss severities.
Sound and prudent business practices advance the need for increased servicer vigilance across a wide range of key servicing functions. Best practices for servicing surveillance start with a proactive program to monitor servicer performance. Investors and other third parties want to ensure a formal servicing surveillance function exits, with a primary goal of maximizing cash flows, mitigating loss severities, and ensuring proper liquidity is maintained over servicing assets.
Catering to the Industry Watch Dog
A servicer’s overall compliance with regulatory standards is critical. The prominent industry leader quoted above goes on to say that “many of the protections outlined by the Consumer Financial Protection Bureau (CFPB) relate to common sense practices that sound servicing oversight functions should include.” Clearly, compliance with guidelines established by the Fair Credit Reporting Act, the Real Estate Settlement Procedures Act, the Truth-In-Lending Act, and the Fair Debt Collection Practices Act—to name only a few—is essential; failure to do so potentially inhibits the borrower’s ability to pay, thereby creating processing challenges for the servicer that, if not effectively dealt with, may adversely impact a servicer’s reputation (as well as its bottom line due to the potential imposition of fines and penalties).
Recently issued standards from the CFBP touch on a variety of key servicing functions, including but not limited to, areas such as: foreclosure processing, billing/payment processing, collections, proper/timely handling of borrower complaints and disputes, escrow administration, early intervention with delinquent borrowers, loss mitigation practices, bankruptcy administration, and force-placed insurance. CFPB’s goal in issuing these guidelines was to prevent borrowers from receiving unwelcome surprises, to put the “service” back into mortgage servicing, essentially. More important, the guidelines were written to assist borrowers with maintaining home ownership, preserving their ability to pay, and ultimately averting losses. Limiting losses is “near-and-dear” to an investor’s heart; therefore, establishing and executing a sound loan surveillance function that incorporates CFPB compliance is critical. Investors view issuers and sponsors that have formalized loan servicing surveillance functions in a highly favorable manner; this places them at a competitive advantage for winning new business and retaining it.
Servicer Surveillance Strategies
The most effective strategies for optimizing servicer performance incorporate collaborative interactions between investors and servicers, including on-site audit reviews and ongoing performance feedback. By applying a consistent set of performance-based metrics to a portfolio, opportunities can be identified and recommendations made that enable servicers to keep pace with the market while still improving performance. Reviewing and analyzing servicing data on a consistent basis allows for the identification of performance patterns, underlying gaps in procedural requirements, and overall process effectiveness.
Servicing surveillance professionals can provide assistance to servicers in achieving optimal performance by:
- Emphasizing the importance of maintaining a consistent and simple process.
- Ensuring a robust control and compliance environment exits.
- Maintaining maximum borrower transparency.
- Ensuring proper staffing is in place and robust training is provided.
- Focusing on asset performance and key processing metrics to drive continuous process improvements.
- Tailoring an approach to meet the individual needs of each servicer.
Consistent management of a servicer in accordance with this criterion should result in material improvements in collateral performance, strengthen investor confidence, maximize cash-flow velocities, and reduce delinquencies and resultant loss severities.
Staffing is critical to the success of a servicing surveillance organization. Experienced professional staff having exposure to a variety of servicers and industry best practices is recommended. Generally, the experience level of professional staff encompasses two main areas: (i) default management (i.e. debt collection, loss mitigation, foreclosure processing, bankruptcy, and REO administration), and (ii) servicing operations (i.e. loan boarding, servicing transfers, cash applications, investor reporting, escrow administration, mortgage insurance processing, customer service, and dispute management). According to one senior executive at a mid-sized residential mortgage loan servicer in Texas, “Having an effective servicing surveillance organization staffed with a diverse group of experienced professionals is the cornerstone behind ensuring that servicers and sub-servicers alike adhere to procedures aimed at maximizing performance.”
Because both default management and servicing operations house functions critical to driving successful asset performance, they represent the foundation of a successful servicing surveillance function. Absent such a structure, the surveillance function may not perform optimally. In addition, the most effective servicing surveillance organization operates best when it can draw upon past experiences and best practices followed by other servicers; this allows surveillance personnel to expediently identify problems, recommend potential areas for improvement, and provide appropriate remedies to servicers in order to optimize collateral performance. Independence is also critical so that servicer surveillance personnel maintain an “arms-length” standing at all times and are not influenced by investors, issuers, sponsors, rating agencies, asset managers, or others.
In Real Life
From an audit perspective, on-site field reviews of servicers should be done on a rotating basis, generally every 12 to 15 months. These reviews are usually initiated with a formal request for information to obtain data on items such as delinquencies, volumes, cash flow, foreclosure timelines, key performance indicators, organizational structure, staffing, turnover statistics, senior management biographies, and critical policies and procedures.
Surveillance professionals should also request recent reports written by internal and external audit teams, regulatory agencies, and other critical third-parties (including investors) with corrective action plans as appropriate. When issues are identified, more frequent field audit reviews may be warranted. The results of these evaluations should be shared and discussed with servicing management. This in-depth field audit approach is critical in order to get a “hands-on” feeling for the servicing organization, its staff and culture, and the servicer’s ability to work with borrowers to preserve home ownership.
Surveillance professionals that are knowledgeable in different sub-specialties within both default management and servicing operations should perform these reviews. External vendors with specific subject-matter-expertise in certain defined areas (such as property valuations or property inspections) may be utilized as necessary to supplement staff knowledge and experience levels.
Since most asset performance problems begin up-front with incomplete or incorrect loan boarding (either from new originations or from servicing transfers), boarding should be a major area of focus. As such, servicing surveillance organizations should have resources intimately familiar with and knowledgeable about the process. Specific areas of focus should include timing and completeness of data received and entered into the underlying servicing system (such as borrower contact telephone numbers). Loan boarding is often overlooked when analyzing the cause behind loan delinquencies; however, gathering information correctly at the beginning of the process is critical in helping minimize collection and loss mitigation problems that may occur at a later date.
Something of Substance
In addition to this in-depth approach, metrics are a useful tool in helping drive more positive servicer performance. If a servicer has not developed a robust set of metrics and key performance indicators (KPIs), it becomes challenging for them to control, manage, and improve the business consistently and effectively.
Default management and other key operational data should be collected monthly, and reviewed regularly to identify emerging trends so that appropriate proactive corrective measures can be initiated to help improve performance. It is critical that surveillance professionals periodically validate the metrics and information being provided. In some cases, surveillance professionals will need to partner with servicers to develop and expand key metrics.
While actual field audit reviews provide a solid “point-in-time” assessment of performance, ongoing review, and analysis of metrics and KPIs offers a consistent view into how well a servicer is performing on an ongoing basis. Leading indicators designed to identify process improvement opportunities should comprise many of the metrics utilized. Critical trends—such as delinquency roll-rates, cash flow velocities, foreclosure timelines, loan modification volumes and timelines, corresponding recidivism rates, and REO disposition timelines—should be highlighted so that corrective measures can be taken proactively in order to curtail delinquencies and reduce losses. In addition, identification of certain adverse trends should be studied in order to identify the root causes of performance breakdowns. For example, excessive customer service inquiries, customer disputes, and aged payment applications may mask a true underlying problem (like untimely follow-up relating to loan modification processing and other loss mitigation activities, borrower confusion over payment transmittals caused by servicing transfer issues, etc.).
Setting the Standard
Surveillance professionals should be well versed in a variety of servicing best practices. Such standards should be openly shared with servicers so that processing routines can be enhanced, with the end-goal being to optimize asset performance. These practices should identify the most effective processes and strategies across the industry and should be continually updated and revised, so they remain state-of-the-art.
Best practices should cover a wide variety of key servicing functions, including (but not limited) to:
- Loan boarding
- Customer service
- Billing and payment processing
- Investor reporting
- Collections and default management
- Loss mitigation
- Property inspections
- Foreclosure timelines
- Bankruptcy processing
- Escrow administration
- REO processing
The preceding list touches on just a handful of areas that should be covered by best practices in order to enable servicers to continually improve their operations, and aid in the reduction of loss severities. Adherence to, and adoption of best practices increases the likelihood that servicers can identify and eliminate process redundancies, thereby resulting in more streamlined operations and cost savings.
Effective servicer surveillance has been and will continue to be a critical ingredient in the mix of elements necessary to achieve compliance with CFPB and other regulatory guidelines, while at the same time maximizing asset performance. In today’s marketplace, more than ever, it is essential for servicers to adhere to the highest levels of servicing standards.
Servicing surveillance is essential and should be integrally woven into the fabric of any successful firm, whether it is an investor, bank, monoline/private mortgage insurer, sponsor, servicer, GSE, rating agency, other regulatory body, or pertinent third-party. When implemented properly, surveillance can ensure residential mortgage servicing organizations run more efficiently and effectively, thereby yielding greater compliance, improved performance, enhanced borrower satisfaction, increased mitigation of risks, and an overall reduction in loss severities.