Big Isn't Always Best When Servicing Commercial Mortgages

Commercial and multifamily mortgage debt outstanding has touched $2.29 trillion at the end of 2004, representing a major opportunity for commercial servicers. One major competitive factor that has been cited in servicers obtaining and maintaining market share is economies of scale. So what exactly goes into the economics of loan servicing? A case study of four different servicers by Roy Owen, a principal with Amsterdam Advisors, and Diana Reid, managing partner, Beekman Advisors, delves into this topic (the study was presented in a recent Mortgage Bankers Association teleconference).

The companies they studied are a portfolio lender (a primary servicer with 12 full-time employees and a $8 billion portfolio of 1,000 loans), a GSE mortgage banker (a primary servicer with 14 full-time employees and a $6 billion portfolio of 650 loans), a regional mortgage banker (a primary and subservicer with five full-time employees and a $2 billion portfolio of 500 loans) and a large national servicer (a master, primary and special servicer with 500 full-time employees and a $105 billion portfolio of 15,000 loans).

The information provided about the servicers has been disguised a bit so as not to reveal their true identities. As for how representative they are of the larger commercial servicer world, these are all established servicers who have been in business for a while, according to Ms. Reid. As a backdrop to the study, the presenters noted that the servicing business has become increasingly complex, especially in the commercial mortgage-backed securities world. "It is not just clipping coupons anymore," Ms. Reid noted. At the same time, fees paid to third-party servicers have gone down over the same period.

The study found that the cost per loan was lowest in the case of the regional mortgage banker at $1,000, with the large national servicer next at $2,000, followed by the GSE mortgage banker at $3,000 and the portfolio lender at $5,500. The regional mortgage banker's personnel cost accounted for the highest component of their cost structure at 66%, followed by occupancy costs at 16%, other overhead at 12% and vendors at 4%. This servicer's outsourcing costs accounted for a mere 2% of their total cost and they did not have technology-related costs.

In comparison, the large national servicer's personnel costs accounted for 47% of total cost, followed by technology at 18%, occupancy costs at 6%, other overhead at 16% and vendors at 4%. Outsourced services accounted for 9% of their total cost.

Technology is the highest component of cost in the case of the large national servicer and this servicer is trying to use technology to make up for a lack of borrower focus since they are less strong on borrower focus than the other three. This large national servicer is in a state of mind that there is zero scope for error.

As for the GSE mortgage banker, their personnel costs accounted for 72% of the cost, with occupancy next at 11% and other overhead at 8%. The portfolio lender's outsourced services accounted for 84% of their cost.

What makes for such differing cost structures among these servicers? The portfolio lender runs its servicing operation as a cost center, includes asset management in its servicing operation, is low on technology, outsources most services, has up to 25% additional capacity that can be realized with its existing setup, and is extremely borrower focused. The other servicers all run their operations as profit centers and the large national servicer benefits the most from the large scale of its operations.

As for each servicer's biggest challenge, the portfolio lender believes that "it's all manageable"; the GSE mortgage banker cites "increasingly complex loans," staff retention, the need to improve their technology and "become scalable"; for the regional mortgage banker it's "seasonal peaks," and finding and training staff; and the large national servicer wrestles with "cash management for large, complex loans" and "monitoring triggers on complex loans."

There is a potential for each of these servicers to cut down on costs. Re-engineering their processes, investing in technology and outsourcing some select functions could help in the case of the GSE mortgage banker; outsourcing some functions during seasonal peaks could reduce costs for the regional mortgage banker; the large national servicer could outsource some functions during peak times and offshore some select functions.

One noteworthy factor is that all these servicers mentioned that they don't know their current costs, which creates a barrier to re-engineering their processes. As well, quality control issues and need for borrower contact are other concerns that might prevent them from outsourcing, offshoring or going in for more technology.

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