Point of View: Unleashing the Power Of Servicing
Mortgage servicing, like Thomas Jefferson - who famously counseled never to use two words when one will do - prizes efficiency. Indeed, even though financial markets are often more complex than an 18th century tract, the business of servicing loans still boils down to a few basics.
The value of servicing should not be overlooked by industry participants. Servicing is what allows mortgage providers to maximize cash flows to mortgage investors through strong connections and relations with the customers. Quality customer care, customer retention and cross-selling are all significant benefits of servicing.
The numbers prove servicing matters. The U.S. residential mortgage servicing business topped the $11 trillion mark in unpaid principal balance, or UPB, as of the third quarter of 2007. While thousands of servicers perform daily servicing operations for the residential mortgage market, the exposure based on outstanding UPB is still concentrated among a handful of top-tier players.
Despite the relevancy of servicing and the size of the market, challenges abound. One key risk is whether servicers will remain in business given the recent liquidity crisis. Should they fail, the transfer of servicing responsibilities from one lender to another is an arduous process.
Another concern is operational risk, such as the lack of adequate staffing to handle drastic increases in delinquency, default, loss mitigation, repurchase, real-estate owned assets and bankruptcy activity. Unprecedented levels of borrower delinquencies and defaults in high-risk assets, such as subprime loans, have exacerbated the current crisis and can wreak a heavy toll on any servicing organization.
And while servicing is indeed a revenue generator, it's also a volume game. This fact, along with the risks cited above, argues for making servicing a more efficient and responsive function.
Mortgage servicing faces an era of unprecedented increases in delinquencies, defaults, foreclosures, REO and bankruptcies. Though many servicing organizations may have excess capacity overall due to lower origination volumes, areas within each organization may be overwhelmed by the drastic increase in borrower delinquencies and defaults.
The recent focus on loan modification efforts to help keep at-risk borrowers in their homes is critical to success. Servicers may assess payment shock, loan-to-value, FICO drift, and behavioral patterns such as payment histories to identify at-risk borrowers. Pre-emptive loan modifications are keeping mortgage servicers busy and will improve financial performance to investors while simultaneously satisfying the needs of customers. Given the current market dynamics, strong relationships with and oversight of servicing operations is critical to maximizing financial performance.
Leading organizations monitor their servicing operations and third-party servicing providers through a structured risk assessment framework. Generally the monitoring framework includes three components.
The first is governance, or the development of an organizational structure and reporting requirements with policies and procedures, delegations of authority and decision processes. Second is the risk identification and evaluation of the inherent and residual risks posed by the servicers. Generally, an oversight framework takes into account all types of risks such as financial, operational, market, information technology, human capital and company-specific risks. The final component is the establishment of an ongoing monitoring approach, which may include a questionnaire to gather and monitor updated servicer information, and onsite reviews for servicers.
In tandem with establishing an oversight framework, organizations are typically in a solid position to evaluate servicer performance. Servicers should consider the following factors when evaluating improvement opportunities:
* Loan Administration: Effective mortgage servicers are finding ways to identify and hold accountable key functions such as payoffs, escrow, taxes, insurance and records management. Questions to ask include how many points of customer contact exist within the process and whether employees at all these points have the information and skills they need to work with troubled customers.
* Servicing Operations: Moving information between departments often results in significant inefficiencies as employees spend time getting acquainted with a loan file. Additionally, processes such as the new loan setup, escrow management, loan transfer quality control, servicing release loans and contract management further complicate the issue. Servicers need to look at how to streamline these functional hand-offs.
* Default Management: A lot of effort in default management is spent on contacting customers to collect payments that should have been preempted before delinquencies and defaults occur. Servicers can use performance measures throughout the process to ensure the quality of a defaulted borrower's file. Remember, the idea is to drive value for investors. * Account Management: In some servicing organizations, account management may include the managing of high-risk assets such as second liens as well processing charge-offs, monitoring recoveries, and reporting and monitoring loss severities. Servicers should determine how points of contact with investors, third-party subservicers, and vendors exist within the process.
* Investor Accounting and Reporting: Many mortgage servicers have developed sound financial performance statistics at both the organization and departmental level to track the cost of servicing a loan. But those processes don't provide any helpful information on how and where to look within the process to improve performance. Servicers also need to see whether the proper remittances and cash flow movements are occurring and review their key performance indicators.
The risk of not having the proper servicer oversight functions in place is too great. Deploying a risk-based approach to managing servicer risk, on the other hand, is cost-effective and essential. Such an approach considers all information that is available or should be made available to relevant stakeholders. It allows for reliance on the internal controls of the servicing organization coupled with required regulatory reviews and reporting, rating agency and auditor reports.
Monahan and Binh Hua are partner and senior manager, respectively, in Ernst & Young's risk advisory services practice. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/