REQUIRED READING: The recent foreclosure mess has exposed the overdue need for changes and improvements in the U.S. residential mortgage servicing industry, to the ultimate benefit of investors. There will be very strong pressure on mortgage servicers to clean up their act and improve documentation procedures.
What is required is nothing less than a thorough updating of industry servicing systems. That, combined with better loan underwriting and more loans being handled by smaller and specialty servicers, will be needed to improve overall loan quality and give investors greater confidence in buying residential mortgage loans once again.
Problems within the servicing industry were apparent even before the recent robo-signing and documentation scandals. Mortgage servicing systems at many large companies have not been updated in 30 to 40 years – something you'd be hard-pressed to find in many other industries.
In addition, many systems are not equipped to handle new government and secondary market requirements, such as mortgage modifications and stricter housing agency guidelines. The modern, large mortgage servicing system was designed to automate collections and payments to enable the servicing of millions of loans. But its designers did not contemplate the meltdown we have witnessed over the past few years, particularly in regard to the hundreds of thousands of defaults that required considerable human intervention.
The pressure on servicers will only intensify, as additional paperwork is required by the Dodd-Frank Act. Servicers will be required to provide more comprehensive tracking of loans they have boarded – in particular, the home appraisal piece.
All of these systemic changes will require that servicers change their systems significantly -Â minor upgrades will not cut it. However, investors can expect cleaner loans and better loan servicing going forward, which will translate into fewer defaults and, therefore, greater profits for all.
Recent Federal Reserve Board proclamations expressed hope that the efforts by state attorneys general to fix robo-signing problems will lead to structural reforms in the servicing industry. Any improvements will redound to the benefit of investors.
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One of the changes that will take root is a return of smaller originators will go back to retaining the servicing of their loans, and specialty services will take on a greater role. Since the start of the recession and the torrent of defaulted mortgage loans, there has been a noticeable rejuvenation of smaller and specialty servicers stepping into the void as the mega servicers have reduced their market share.
There will be a disaggregation, with a trend back to smaller servicers. Smaller lenders – those who originate $200 million to $1 billion a year – are now getting back into retaining their own servicing – more than they have in years. In addition, credit unions and community banks will have an increasing interest in originating loans because of their large cash reserves and the great margins on mortgage underwriting today, and they will be more interested in retaining the servicing on those loans.
At the same time, the financial incentives for smaller originators to retain servicing are better now than they have been in a long time. Loan underwriting is much improved – loans underwritten in the past two or three years will be much less likely to default than those originated prior to 2007.
This trend toward smaller servicers is also being encouraged by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. They want a greater distribution of loans among a larger number of servicers and for smaller lenders to do their own servicing. Smaller lenders and correspondents are now selling their loans directly to Fannie and Freddie and bypassing the likes of Bank of America and Wells Fargo and retaining the servicing on those loans. But for this trend to be encouraged, new servicing systems need to be constructed that will allow smaller players to be able to retain servicing in a cost-effective way.
Furthermore, there will also be an increased demand for specialty servicers. The need for specialty servicers has grown in tandem over the past few years with the number of distressed homeowners, and foreclosure moratoria can be expected to lead to even more business going to specialty servicing operations.
Specialty servicers spend more time with borrowers and offer more flexibility on loan workouts – a better solution for investors. Unlike the large servicers, specialty servicers are directly compensated to avoid foreclosures.
There is also the evolving role of investors in ensuring the quality of the loans they hold. Many investors are trying to piece together assignments from the institutions from which they purchased loans. While some believe the seller of the loan should do the assignment, common sense dictates that the buyer needs to take control.
Since the buyer is the new beneficiary of the loan, it is important to take the necessary steps to protect his or her investment. It is critical to establish contact with the proper authority and execute assignments before doing the lost assignment process. In the past, investors assumed that previous assignments were done properly. Now, they're taking a more cautious approach and looking at the title chain ahead of time to make sure the seller is on record.
Despite the obvious failure of the old GSE model, which has already cost U.S. taxpayers hundreds of billions of dollars and may cost billions more, there is definitely a role for a GSE-type entity in the mortgage industry going forward. Most market participants do not want a mortgage market without the GSEs – a completely private-sector industry leads to too much consolidation, and everyone knows the results of that scenario. The GSEs do provide an important backstop and a counterbalance to the rest of the industry.
How exactly the future will look is anyone's guess – after all, the market is still evolving, and the Dodd-Frank Act requirements are only now taking shape. Hopefully, investors, originators and servicers can see the dim glow of a light at the end of the tunnel – and not be afraid that it belongs to an oncoming train!Â
Gagan Sharma is president and CEO of BSI Financial Services, based in Irving, Texas. He can be reached at (972) 746-2037. Mike Wileman is president and CEO of Orion Financial Group, based in Southlake, Texas. He can be reached at (888) 316-7466.
