Heads are rolling at some of the biggest financial firms – most recently at Citigroup and Merrill Lynch, where defaults on the subprime mortgages in which they invested are leading to billions of dollars in losses. Furthermore, it is unclear whether costs and careers will be the only worries for these firms and their current or former executives.
Consider the Sarbanes-Oxley (SOX) mandate for real-time, accurate reporting of a public company's business state and any recognized risks. In the wake of widely reset forecasts on their losses, publicly traded firms – Bear Stearns, Citigroup, Merrill Lynch and many others -undoubtedly will face scrutiny as to whether they complied with the reporting processes legally required by SOX.
In the best case, these investigations will be a distraction from running the business. In the worst case, if any violations are found, large fines and even jail time for responsible executives will be in the future.
Consequently, with funds and careers at stake, investors are beginning to realize they need to work much more closely with mortgage servicers.
Although servicers may now feel that they, their decisions and their actions are under a microscope, there is an opportunity for servicers to proactively manage investor relationships in order to gain the best financial outcome for all parties. Doing so will require some significant improvements in processes and, most likely, investments in technology to implement those improvements.
For years, the relationship between investors and the mortgage servicing industry has operated differently from the rest of the business world. Investment firms that closely watched other sectors, sometimes tracking them on weekly or daily basis, have been comparatively hands-off with servicers.
Scrutiny of loan pools seemed unnecessary when the accepted wisdom was that home values would continue to rise and that a troubled borrower could always refinance. The relatively small percentage of loans that went into default had minimal impact on the overall pool performance.
Moreover, in a seller's market, even in a short-sale situation, there was confidence that the buyer would wait – and little to compel investors to act quickly.
With comparatively few demands from investors and low numbers of defaulted and at-risk loans, many mortgage servicing operations maintained their size or even shrank over the last several years. While other industry sectors invested in technology to improve their efficiency and gain real-time business insight, such expenditures were few among mortgage servicers, where the status quo seemed to be working.
However, the mortgage industry and those who invested in it learned the hard way that the home loan business carries as much or more risk than other industries – and that it can be wildly dynamic, requiring timely insight and the ability to act immediately.
Whether mortgage servicers operate as independent businesses or part of a larger mortgage firm or investment house, the time to start managing the investor relationship differently is now.
In many cases, investors have lacked a timely, deep understanding of market factors, leading them to underestimate the impact of the mortgage fallout.
Among some mortgage servicers, the process of generating a report on the loan pool can take up to two weeks, as people manually review spreadsheets of data. Information is already old by the time it reaches the investors' hands – reducing the value of any resulting analysis and prediction.
Then there is the SOX mandate, which demands real-time reporting of any factors that could significantly affect a publicly traded company's financial performance. Generally accepted guidelines are that the report must occur within 48 hours of the event to be considered real-time.
Minimally, servicers need to implement processes in which reports on the current condition of the loan pool can be generated in under two days. That timeline covers the legal demands.
But to be truly effective, servicers need to implement software that can generate reports in minutes, not days. There should be automatic alerts when certain thresholds are reached – such as when home prices drop by 5% or the average days on the market for real estate owned (REO) homes increases another two days.
For a complete picture, reports should be able to incorporate a range of data on the borrower, the loan conditions, the condition of the property, and the rate of home sale/pricing down to the ZIP-code level.
With this degree of information, servicers can address the investors' need to have a clear understanding of the mortgage portfolio status and demonstrate that awareness to top management. More importantly, doing so will also lay the groundwork for servicers to make fact-based cases for investors to approve more effective actions in resolving loan issues.
Pure data has limited value: It needs context that can only be gained by analysis. Manually reviewing data may have worked in the past, but the vast number of factors to consider and demands to act quickly mean mortgage servicers need to invest in analytical software.
Servicers should expect to have at their fingertips, for example, the ability to see the extent to which a certain neighborhood is being hit by the mortgage crisis.
They should be able to predict how long a defaulted property is likely to sit on the market, as well as what kind of price it can command. In addition, the software should allow servicers to roll up those numbers to show a larger, highly accurate picture of the areas of greatest risk.
Ideally, the software will provide an on-screen dashboard that visually represents trends to make them more easily recognizable. Imagine viewing an image of a geographic region with pulsating hot spots where defaults are rising above a set threshold – and then next to it, a chart comparing the rates of default for different neighborhoods.
By using data analysis to provide context, mortgage servicers can give investors the insight they need for their business reporting and projections. Servicers also arm themselves with the market understanding required to make the right decisions for getting the best performance out of individual loans and the loan pools.
Too often, mortgage servicers have been hamstrung from implementing certain loss mitigation tactics that would best serve investors.
These difficulties are particularly common when the servicer's recommended tactics fall outside the realm of those allowed by the servicing contract terms or mortgage-backed securities pool terms – leading to a decision process among investors that can take weeks.
Mortgage servicers can speed the investors' decisions by building on their reporting and analysis and providing predictive models for the various outcomes of different actions, such as an REO sale versus a short sale versus a modified loan.
For example, predictive modeling could demonstrate how modifying a loan to a lower interest rate – resulting in a lower return but preserving the principal balance – would provide a better overall return than moving into a short sale or foreclosure that would result in a large and immediate principal loss of 10% to 20%.
With a well-documented and compelling case for taking corrective action, an investor can streamline the process on its end for approving a servicer's recommendation.
Just as reporting, analysis and decision-making need to be automated, so too do communications and processes if mortgage servicers and their investors are to work quickly and efficiently to stay ahead of mortgage market dynamics.
It already is standard operating procedure for many businesses – healthcare, insurance, manufacturing and banking, to name a few – to share information electronically and even work together in real time on the same electronic document or file.
Such online collaboration occurs not just internally but across all the partners and suppliers with whom these customers work. Eliminating faxes and other paper trails has enabled companies to reduce time, costs and errors. For each of these industries, there are business-specific applications that incorporate workflow software to enable this collaboration.
Increasingly, there are default management solutions that incorporate rules-based workflow technology along with analytics and reporting.
Such software, for instance, can enable servicers and investors to review the default status, market conditions and predictive models in a common online workspace. The servicer can talk through recommendations and address the investor's questions right there.
By electronically sharing the predictive model, all relevant statistics and electronic copies of supporting documents, the servicer makes it easier and faster for the investor to complete the due diligence required to approve an action.
There is no one solution that will address all servicers' needs for managing their investor relationships. Mortgage servicing divisions within larger organizations may be able to take advantage of existing software with the help of the internal technology group or specialized technical consultants with years of experience serving the mortgage industry. General-purpose reporting, analysis and workflow software packages are available.
However, in most cases, mortgage servicers can benefit from applications for such processes as default management, REO and asset management, which incorporate these functions.
One important lesson mortgage servicers can take from other industries is to plan strategically and then build incrementally in order to gain early success.
In this case, automated reporting is probably the single most important function mortgage servicers can put in place to more effectively manage their investor relationships. From this cornerstone, servicers can build a solid foundation for long-time investor collaboration.
Rebecca Hurst is a freelance writer, information technology analyst and communications consultant. She can be reached at (650) 679-9282.