Will Servicers Embrace the Too Big to Fail Creed?

Millions of delinquent or foreclosure loans in need of default management assistance have created demand far and beyond the capacity of existing specialty servicers that in return is fostering the creation of mega servicer shops.

Some insiders worry that servicing market changes of the recent past will lead to the birth of large specialty servicers and the too-big-to-fail mentality that eventually brought some of the nation’s largest banks so close to bankruptcy that they were bailed out of failure by federal funds.

It will all depend on how the mortgage industry reacts to these changes.

It is a turning point, says president and CEO of DepotPoint Inc., Joe Filoseta, and the real question is whether the industry is at a tipping point where it transforms into a set of large specialty operations that can do things better than the traditional servicer, or not.

Currently for banks the alternatives appear to be: Either the gradual creation of a new breed of mega specialty servicers or millions of risky bad loans that cannot be properly managed.

And in order for more efficient loss mitigation firms to exist, Filoseta says, some financial service providers within the mortgage industry have to be willing to make investments that bring about “effective changes in the infrastructure,” hire the right people and offer adequate training.

To state the obvious, adds Jay Loeb, vice president of strategic business development of National Creditors Connection Inc., the industry is dealing with very, very large numbers of loans. But in addition to that challenge there are “some inherent” contractual issues.

“It's easily said in theory, take those loans and give them to the specialty servicer. But there's a lot of contracts, written by a lot of attorneys, that have a lot of language,” and possible implications, he argues, including actual dollar figures both about paying off contracts or servicing contracts.

In one example where his firm started negotiations with a small investor of about 150,000 loans to discuss the transfer of servicing responsibilities from one of the mega-servicers to a specialty servicer. It would cost $140 million to do, he recalled, so they declined.

“A lot of things are good in theory, when you look at some of the contractual obligation, it's not as easily said and done to the investment community. We talked to secure advisors too, but they only owned a strip of that security. They don't have the legal interest to do it. There's some difficulty just doing it.”

Loeb sees the solution in industry wide cooperation where collectively the mortgage industry participants work together to find out how they can “help the specialty servicing side, …identify the pain points, and work together with the mega servicers to get it done.”  There are cases where that level of cooperation between third party service providers and mega banks is successful. In other cases it is not possible. There also are cases where two investment REIT specialty servicers need to join forces to provide needed services. It is a collective effort, he adds, “more than say just give them all to a specialty servicer.”

Ed Gerding, senior fraud consultant with CoreLogic agrees that since at the end of the day there are contractual issues and loss risks associated with bad paper performance-based valuations can help. He told this publication that there is precedent for such “performance-based moves” and the need for counseling programs.

He recalled the early Helping Hand Programs designed a decade ago by Freddie Mac as an illustration of how to manage performance quality. They were specifically put together to ensure the mortgage servicing operations of some of the largest banks would not underperform. Freddie required these banks use third-party specialty firms for loss mitigation, or for designated counsel purposes, or for foreclosure actions. “It can be done, and it should be done.”

President of the MOS Group, Greg Hebner argues that it is impossible for any single, or even a few large specialty servicers to handle 1.4 million loans. The best solution is “to build a cadre of very, very high performing specialty servicers” that are rated by results-based and service-quality-based standards.

“If you're servicing a loan, it shouldn't take an hour to pick up the phone. You ought to be able to work things out in a reasonable amount of time. You ought to be able to meet benchmark results. And if you do, you ought to be able to continue to grow and build your book.”

Hebner notes however that “there's theoretical limits” pertaining to the size of operations. Once a specialty servicer’s shop reaches “a certain size” it will also run into some of the same limitations the primary lender-servicer had to face. “There's a right size where you can deliver great service,” he says. So while “some upstanding servicer out there” may be doing really well, the theoretical limit to how much volume they can process without sacrificing service quality remains. 

And improving the quality of mortgage servicing standards is a goal most in the industry, including Loeb, would support. Investors and taxpayers also would agree on holding pretty high standards on the $5 trillion that has been pledged as a response to the crisis, he adds. “Put benchmarks up, and hold people's feet to the fire to deliver.”

In Gerding’s view the complexity of the situation requires complex solutions. “Hiring tens of thousands of people and putting them into the same culture without the requisite DNA and certainly without the right technology is not the answer.”