Will servicers be able to better control costs in the next downturn?

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Distressed mortgage servicing costs, while remaining high, continued their fall during last year, and one of the underlying reasons for that may bode well for the industry's ability to handle another recession.

There's been a "decent change" in the cost to service nonperforming loans, Marina Walsh, vice president of industry analysis at the Mortgage Bankers Association, noted at the group's national servicing conference in Orlando, Fla.

NPL servicing costs dropped to $1,645 per loan in the first half of 2019, compared to $1,969 in 2018. This appears to continue a trend that started the previous year. In 2017, the average cost to service outstanding, single-family loans over 30 days delinquent was $2,135, according to the MBA.

An increase in the share of distressed loans with shorter-term, curable delinquencies along with a strong housing market and increased stability in the regulatory landscape are the primary drivers of this decline, according to Walsh. But it also likely reflects some improved efficiencies in the servicing business.

A notably weak economy could reverse many of these conditions, but key operational improvements developed in the wake of the financial crisis will still help exert some downward pressure on the cost to service NPLs even if distressed loans multiply.

"We wouldn't expect that cost to rise as drastically as in the past even if [NPL] volumes do go up," said Shelley Leonard, an executive vice president at Black Knight.

But that's assuming post-crisis efficiencies keep staffing needs during a future downturn in line with the experienced talent that might still be available.

"Defaults have shrunk in this environment, and what's happened is a lot of knowledge from experienced people has left because of this," said Laura McIntyre, CEO of Dimont, a provider of hazard and investor claims services. "To make sure you have the right bench strength and that it’s competitive, I would work with vendors in this area, or ask them to do things like stage a champion challenge against your internal expert. That way you make sure they will be there when you need them."

Another risk that could drive distressed servicing costs higher in the next recession even with those new efficiencies in place is regulatory risk. While there has been an increase in stability in this area, it is something that could re-emerge, particularly given that this is an election year.

"An agency like the Consumer Financial Protection Bureau could become enormously active again," said John Walsh, CEO of Lereta, a national provider of property tax and flood hazard data.

The kind of downturn that would significantly increase distressed loan volumes does not appear to be in the offing this year, but it is a risk, according to Joel Kan, the group's associate vice president of economic and industry forecasting.

The MBA expects the economy to remain strong with "a slightly weaker growth path for 2020," he told attendees at the conference. That means mortgage rates could remain lower for longer than previously anticipated. In conjunction with only a slight weakening in a generally strong economy, that could help sustain origination volumes and loan performance. Both are expected to remain stable this year.

But economic outlook has been and continues to be somewhat uncertain, Kan warned, citing the unexpected volatility that surfaced the capital markets this week as one example.

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