Two years ago when the housing market looked bleak, it was thought that the road to riches in mortgage banking could be found in creating a firm that specialized in servicing (or subservicing) problem loans. The logic was simple: with $2 trillion in home mortgages expected to go south someone would have to service all that junk.
"Big box" servicers the likes of Bank of America and Wells Fargo & Co. had built their platforms on the concept of economies-of-scale, which rewarded them in profitability for funneling as many performing loans as possible through their processing factories.
But neither of those mega banks had engineered their workflow to handle a deluge of delinquent prime, subprime, and home equity loans, which meant they and other large scale servicers would turn to specialty firms to handle the worst-of-the-worst. Not only that, but hedge funds and other investors speculating in the nonperforming loan market would gladly outsource the grunt work on managing problems loans — including cures and defaults — to both existing and new specialists.
It all looked good on paper. But then reality set in. "Right now, I think there's an excess of capacity among subservicers," said Phil Leggio who runs the risk management group at Waterfall Investments in New York, an investor in problem mortgages. "A lot of firms were created to take advantage of the boom in problem loans but now they're all running around trying to find business."
Leggio said he is frequently contacted by subservicing firms, in particular companies that were launched over the past two years, that want his business. And Waterfall isn't all that big. It currently manages roughly $350 million in loans. "We have a small portfolio and they're constantly calling us, looking for business," he said.
To date just one 'newbie' subservicing firm, Prodovis Mortgage of Arlington, Texas, has closed its doors but rumors persist that others may follow if they cannot pick up more clients soon.
"The platforms that were formed to handle all these loans have just not seen the volume they were expecting," said Tom Piercy, managing member of Interactive Mortgage Advisors, Denver, which, among other things, brokers the sale of servicing portfolios. "It's very competitive out there."
One thing some of the upstarts may not have seen is that existing subservicers that were already in the nonconforming space, even partially, have snatched up new contracts. Ocwen Loan Servicing, West Palm Beach, and Nationstar Mortgage, Lewisville, Texas, for example, grew their subprime subservicing contracts by 164% and 27%, respectively, according to figures compiled by National Mortgage News and the Quarterly Data Report.
It's hard to get a handle on exactly how well — or how poorly — some nonprime subservicers are doing because many, even though their parent companies are publicly traded, don't usually release their contract figures.
According to Leggio, one of the biggest problems for the upstart firms is the lack of problem loans changing hands. With dozens of investment banking firms and mega lenders taking huge charges on their delinquent loans, it was believed that these institutions would sell their problem assets in the secondary market, but to date most of the largest sales of nonperformers have been by the Federal Deposit Insurance Corp.
Even banks that are selling their NPLs are loathe to discuss them, especially with the media. Most of the NPLs deals that get reported on in this newspaper, for example, tend to be sales of $100 million or less.
One Chicago-based investment banker who plays in the NPL space believes that over the next six months some of the younger subservicing firms might be forced to sell their businesses. Requesting his name not be used, he noted that a huge new headache for subservicers is the issue of state regulation. "Everyone knows that you need to be licensed to originate loans but we're hearing more and more about states requiring licenses to service," he said. "The fear of future regulation might just force them to get out of this niche."
