There are many ways servicers might describe the developments of 2009, but dull isn't one of them. We know. We asked.
As the year winds down, the editorial staff at SM reflected on some of the game-changing events that took place in 2009 and opened the floor to a select group of industry participants, asking them for their observations on how the industry has metamorphosed in the last year. We also picked their brains on what to expect for 2010, as the federal government shows no signs of slowing its involvement in servicing, option-ARM resets appear ready to trigger another wave of foreclosures, and the pressure to modify only increases.
Answering our inquiries on the state of the industry were:
- David J. Miller Jr., senior vice president of business development, Cenlar FSB, Ewing, N.J.;
- Kevin Kanouff, president, Statebridge Co., Denver;
- William LeRoy, president and CEO, American Legal & Financial Network, St. Louis;
- Gerald B. Alt, president, LOGS Network and HEART Financial Services LLC, Northbrook, Ill.;
- Edward Pinto, former Fannie Mae chief credit officer and CEO of Courtesy Settlement Services LLC, Sarasota, Fla.;
- Rick Smith, CEO, Marix Servicing, Phoenix;
- Â Richard Cimino, CEO, iServe Servicing, Irving, Texas; and
- Nigel Brazier, president, Acqura Loan Services, Plano, Texas.
Q: When all is said and done, how will 2009 be viewed in terms of its impact on the servicing industry?
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Richard Cimino: Prior to this year, most borrowers and investors alike were unaware the same entity collecting and remitting cash payments – the servicer – would be playing a significant role in their mutual survival. 2009 ushered the back office to the front of investors', regulators' and borrowers' minds. Servicing has long been the first and only line of defense for investors in difficult economic environments, but these unprecedented times have highlighted the frailties and vulnerabilities of a system solely configured for efficiency and rising home values. Securitizations have commoditized the servicing function to the point that we've handcuffed those responsible for managing risk.
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The servicing industry of tomorrow will reflect the origination market of today. Servicers are scrambling to build the personnel and technology necessary to understand, decision and mitigate a variety of credit/collateral risks. Performance is the new cost-per-loan in an environment where price appreciation is no longer your favorite loss mitigator.
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David Miller Jr.: 2009 will be viewed as the year of servicers focusing on developing and delivering best-practices models that emphasize the default, loss mitigation and foreclosure procedures and processes. It has also required them to review internal capacity models and better utilization of technology to maintain efficiency as a result of the impact on default while assuring compliance in an evolving market.
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Kevin Kanouff: It will be seen as the year in which servicing stopped being viewed as something that can be provided in a quality way without investment and loan-level attention. Going forward, investors and regulators will treat servicing not as a commodity in the mortgage machine, but as an integral piece of the puzzle of loan-pool performance. I think there will be a fundamental shift in the way investors compensate servicers as the process moves more towards aligning the economic interests of the two.
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Edward Pinto: 2009 will go down as a year of ramping up to meet the loan modification demands of the federal government and attempting to avoid getting blamed for the failures that the federal government will attempt to pin on private-sector servicers.
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Gerald B. Alt: I'm a glass-half-full kind of guy, but 2009 may end up being viewed as only the first of several really bad years in housing finance and servicing – mostly because the economy isn't in good shape – and it will take some time, measured in years, for the housing market to rebuild. All of this has to take place in the face of an enormous option-ARM-reset issue coming up next year and continuing, by some estimates, until possibly 2013.
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Nigel Brazier: 2009 was the year when more people than ever began to understand the importance of the servicing component of the mortgage market. Unfortunately, most came to a fairly negative view of the industry's readiness and capabilities – a view driven by the industry's lack of capacity to deal with millions of delinquent borrowers on a case-by-case basis.
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Because government awareness was largely focused on origination issues – New Century, Countrywide, IndyMac – its awareness of servicing has been focused on one-off issues, such as subprime servicing practices earlier in the decade. Now, there is an all-out attempt to focus awareness on the largest servicers' ability to convert delinquent borrowers to a government-designed modification program as measured by the U.S. Treasury Department on a monthly basis.
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William LeRoy: 2009 was the first icy blast of a climate change whose effects are far from being fully realized. Our "earth" is moving from a climate of self-regulation to one of intense, focused and granular exterior regulation and legislation. Like any large ship in a tumultuous sea, the turning radius of our industry is a very large one. The singularly most important question of all of us is, "Can we respond in time?" I believe we can, but in order to do so, we must fundamentally change the way we look at ourselves and each other.
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Virtually all of our familiar industry business models are based upon fragmentation and the inevitable competition that results. But the tide is turning. Industry groups are beginning to talk to one another. Former competitors are finding ways to work together. The walls that used to separate us are being replaced with partnerships and strategic alliances.
I believe this new wave of cooperation is being driven by an emerging realization that there is an antidote for the fragmentation, wasted efforts and the disjointed approaches that we have all struggled with.
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Rick Smith: The internal structure for service organizations is changing to place a greater emphasis on the high-touch approach to mortgage servicing. I believe 2009 will be seen as a year of transition of the servicing industry toward this new model, which could ultimately result in change to the historic fundamentals of the business – how it is staffed, what products are delivered and how servicers are compensated.
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Q: Uncle Sam's footprint in servicing is larger than ever, but there is great debate over whether that's a positive or a negative trend. Is the private sector unable to modify a suitable number of mortgages on its own, or is government intervention, as it is playing out today, a necessity?
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Kevin Kanouff: I think that our problem is more fundamental than an ability to modify a suitable number of mortgages. The real problem, I think, is the notion that loan modifications are the answer to whatever problems the industry has. The reality is that not everyone will qualify for a modification, nor should they.
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The sooner that observers, particularly those in government, realize that loss mitigation and default management go well beyond loan modifications, the better off the real estate market will be. A very encouraging sign on this front was the recent Treasury announcement regarding short sales. By all appearance, the administration is acknowledging that a good number of homeowners should either be in a more modest home or renting.
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David Miller Jr.: The answer here is largely dependent on the type of portfolio being serviced. Portfolio lenders generally do a good job of modifying balance-sheet products and will continue to modify loans in their portfolios to minimize risk and reduce losses. For loans that are sold into the secondary market, government intervention is necessary because of the inherent conflict between the servicer and investor. Without this intervention, loans would not be able to be modified out of pools and would impact the end customer.
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Richard Cimino: Specialty servicers working for private investors with whole-loan portfolios have generally been more successful at loan modification efforts, because they have more flexibility and the time to dedicate to real workouts on a case-by-case basis, and are incentivized to get the highest [net present value] on the loans possible. The government needed to insert itself in relation to the large-scale servicers, because their business model was collapsing.Â
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In particular, the servicing firms performing work for securitizations needed the government's blessing, dollars and cover to perform work that the [pooling and servicing agreements (PSAs)] would either not allow them to do or not pay them to perform. Because the servicer, performing under a PSA with different stakeholders having divergent interests, could not, without getting pulled into litigation from one of the stakeholders, perform the modification work that was necessary, the government plans gave the servicers a "get out of jail free" card to perform the necessary modification work to help homeowners.
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Nigel Brazier: Ultimately, the U.S. government's involvement is not a bad thing, and I would not characterize it as a trend – positive or negative. The U.S. government, and its various tools, is here, and here to stay. 2009 was a year of discovery for many elements of the government, and I think 2010 and beyond will provide a real opportunity for some positive government involvement.
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The best way for government intervention to be meaningful would be to adopt a more robust view – standards – on specific servicing protocols that should be associated with a mortgage loan as it travels on each of the potential paths of loan performance. Unfortunately, most servicing guidelines in existence today are merely just that – guidelines. [They are] not specific protocols that are driven by the borrower's behavior and specific circumstances, coupled with the nature of the underlying collateral on a real-time basis.
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William LeRoy: The short answer is that there is much more work to do, and the legislators need to give our industry the time to do it. The unrelenting criticism, vilifying, almost daily new game-changing legislative efforts and political rhetoric have created an atmosphere where success is not being looked for, much less being recognized.
The negative, poorly researched reports are being hailed as the truth, and the facts are being pushed aside. The fact is that our industry is responding to the challenges and that our heroes are largely unrecognized. My message would be, give us a reasonable amount of time, and we will meet or exceed all expectations.
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Gerald B. Alt: The private markets could stabilize, but only at a tremendous cost in lost homes and resultant credit losses to investors. The federal government's effort to provide a uniform method of loan modification will, for those who qualify, provide a pool of well-underwritten loans that can be securitized themselves.
The downside is that the Home Affordable Modification Program (HAMP) requirements and limitations exclude many consumers with valid hardships. The difficult balance is whether we accept an 80/20 mentality or encourage the federal government to start "bailing out" individual homeowners in what could be perceived as a form of socialism.
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Rick Smith: The political, economic and media climates have made borrowers more aware of modifications, and focused investors and servicers on getting them done. That focus has led to more help requests from borrowers, spurred development of industry best practices, and assured investors that modifications are in their interest. While more modifications have been done as a result of this awareness and focus, federal government involvement in the actual process has yet to contribute substantially to that success.
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Only time will tell if federal involvement can help resolve the so far intractable inconsistency between what is presently expected of mortgage servicers and how those businesses have historically been built and compensated. In the meantime, state and local governments are working against Uncle Sam, making it harder for servicers to operate. Time and resources that might help borrowers stay in their homes is defensively spent to study evolving state and local compliance rules and building external reporting processes.
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Edward Pinto: The goal of the government is to keep borrowers in homes, regardless of the likelihood of eventual success, and as a result, it slows down appropriate foreclosures that are needed to help the market clear. Also, it relies on interest reductions for the heavy lifting, which means it needs to keep interest rates low in order to reduce appropriated funds, but in the process, it is greatly distorting the economy. Principal reductions, along with appropriate provisions necessary to reduce moral hazard, are needed for many of these modifications to be successful.
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Many private portfolio lenders are doing this. The government – Fannie Mae, Freddie Mac and the Federal Housing Administration – is not.
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Q: There is ample reason to believe another foreclosure wave is coming: Some $134 billion in ARM loans are scheduled to recast over the next two years. Although FHA's market share has mushroomed, its underlying loan quality appears to be deteriorating. And there is tremendous skepticism surrounding HAMP – specifically the closing of trial modifications and the ultimate sustainability of those mods that do close. Do you anticipate another foreclosure wave? If so, when will it happen, and on what scale?  Â
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Edward Pinto: Yes, on all counts. But add a "job loss" recovery.Â
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The federal government created the housing bubble, and we are now living with the consequences of its bursting. The problem is massive. My most recent estimate is that there will be 7 million to 8.5 million foreclosures over the next four years, with the vast majority resulting from the 25 million outstanding subprime and Alt-A loans. Fully two-thirds of these were acquired or guaranteed by government agencies or required by government regulations.
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Kevin Kanouff: We absolutely expect another wave of foreclosures. I think we can expect this second surge to begin in the first quarter of 2010. More than that, we will not even be close to working through the current wave of foreclosures due to various moratoriums and the like, which will lead to an incredibly large backlog to work through.
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David Miller Jr.: It is still too early to determine the success of HAMP, because the first groups of loans are just reaching their final modification periods. But as they proceed further, we believe that a determinant in the future success will be the unemployment rate. If the interest-rate environment stays the same as it is today, we should not see a large impact because of the favorable rates.
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Richard Cimino: Certainly, the next 24 months will see the default of those five-year option-ARMs of 2005 and 2006. The very structure delays the inevitable. Borrowing from tomorrow's appreciation to pay for today's principal payment only works in an environment where appreciation is as pervasive as stated-income underwriting.
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Arguably, moratoria have dammed the natural flow of foreclosures, creating a bubble that cannot be deferred much longer. Cumulatively, the pending ARM defaults and bubble of unresolved delinquency will create a foreclosure wave of unparalleled proportions.
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The government – via government-sponsored enterprise (GSE) conservatorship, the Troubled Asset Relief Program, the Public-Private Investment Program and HAMP – has set up the infrastructure to meter out the future flow of foreclosures. Absolute success of these programs appears to be an objective subordinated to the more relevant goal of controlling the timing and flow of housing supply.
Whether or not HAMP modifications ultimately succeed, the process and second chance at homeownership will provide a supply respite long enough for legislatures and investors alike to provide solutions geared toward stimulating demand – albeit, sensible demand.
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Nigel Brazier: I fully expect foreclosures to increase over the next 24 months before decreasing, for all the reasons noted. Size is difficult to project – much is dependent on HAMP performance, the ability to execute short sales and other pre-foreclosure sales, the near-term performance of the noted option-ARM resets and the recent FHA volumes.
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William LeRoy: Everyone agrees that we are yet not out of the residential foreclosure woods. The economy is the new player in this game. We have a 10% unemployment rate. It's simple: Jobs equal paychecks, which equal mortgage loan payments, good credit, loan refinance [and] sustainable loan modifications. Also, the commercial mortgage market is in chaos. That collapse is unfolding now, and its ramifications will be sweeping and deadly for the remaining financial institutions. 2009 and 2010 will keep the FDIC very busy.
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Gerald B. Alt: From the standpoint of a person whose business consists of dealing with consumers on a daily basis, I agree that there is an even larger potential foreclosure crisis on the horizon. Until and unless the economy recovers, there isn't any way for many unemployed or underemployed individuals to make the payments necessary to keep their homes – even under a HAMP modification. Forbearance agreements will naturally expire, and the onslaught of option-ARM resets will find the same problems in the marketplace: less access to credit to refinance and a diminished value of the collateral that won't support a refinance.
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Rick Smith: The timing and magnitude of the next wave of foreclosures will depend on if and how much the general economy has improved and, more significantly, how much real estate values recover, ultimately dictating whether modifications are successful or if an ARM adjustment is too much to bear for a homeowner. Borrowers with no or negative equity are much more likely to give up when faced when financial difficulty.
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While in the past this meant walking away, today it often means strategically "squatting" during a lengthy foreclosure process. A borrower who perceives equity will fight through temporary problems and ARM recasts and do what it takes to stay in their home. Continual value deterioration will have borrowers regularly reassessing their commitment to the property. HAMP trial periods are an effective way to determine ability and willingness to perform, but only for today. The borrower's perception of equity, or the potential for equity, will be a major driver of future foreclosure volume.
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Q: Several servicers have reported success in modifying loans held in portfolio. Securitized loans, however, are another story altogether. As we're seeing in the case of Countrywide v. Greenwich Financial Services Fund, pooling and servicing agreements present many hurdles. What's in store for servicer-investor relationships in the coming year? More litigation? More cooperation?
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Kevin Kanouff: More cooperation. One would expect the tranche warfare to subside, because the losses have really moved up the structure.
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David Miller Jr.: The servicer-investor relationships in the coming year will most likely be involved in more litigation, as ultimate losses are felt by the different participants in the securitization market. As servicers report success in modifying loans held in their portfolio, we may see more modifications prompted by the government.
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William LeRoy: In a nutshell, the sad truth is that litigation will drive the changes necessary for more situational, astute, comprehensive PSAs and cooperation among the necessary parties. It would be my hope that the plaintiff's bar would recognize that the need for a robust securitization marketplace far outweighs the opportunity to make headlines.
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Richard Cimino: Litigation rarely serves to benefit anyone. It does, however, serve to cut to the heart of the matter – redrawing and redefining the fiduciary expectations between servicers and investors. Going forward, the servicing handbook dictating operational procedures – the PSA – will be rewritten collaboratively. Investors need servicers, and servicers need investors' loans. Collaboration between servicers and investors will remedy the incentive misalignment, improve investor reporting and serve to recalibrate the expectations of stakeholders.
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Nigel Brazier: More cooperation – either forced or voluntary. Stay tuned to government intervention for [asset-backed securities and private-label securities] deals.
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Gerald B. Alt: Unfortunately, the intrinsic inability of servicers to get approval for loan mods from pools may fuel Washington's efforts to introduce cramdown legislation to allow certain borrowers to use the bankruptcy process to force a revaluation of the collateral. Despite the safe-harbor provisions, servicers know that if they voluntarily take a loss on a loan – even if it makes sense given the circumstances – they stand to have the investor pull all their servicing and place it elsewhere. With servicing income margins so thin, it's not worth the business risk.
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Rick Smith: I hope that the Countrywide-Greenwich case doesn't have a chilling effect on modifications. That case does have some unique aspects that differentiate it from normal investor-servicer relationships. The real issue in the case, and with respect to modification of all privately securitized loans, is economics.
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If investors are convinced loan modifications deliver value for them, as supplemented by government incentives in some cases, servicers and investors will have consonant interests. If investors remain unconvinced of the value of loan modifications, or don't even consider the issue, servicers will remain stuck between their contractual obligations to investors and increasing public pressure to modify loans. Unfortunately, if this dilemma is not resolved, investors and consumers could both come out on the short end of the stick.
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Q: Also on the topic of litigation: Ohio's Richard Cordray recently became the first state attorney general to sue a servicer for unfair practices since the foreclosure crisis began. Do you believe Cordray's suit is only the tip of the iceberg?
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Gerald B. Alt: Yes, in response to political pressure from their state constituents – especially in hard-hit economic regions like Ohio and Michigan – I would expect to see more and higher-visibility efforts made by state regulators, legislators and the executive branches to attack servicing practices. Expect to see this, in particular, with the rash of coming option-ARM resets.
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Rick Smith: Similar suits are certainly a possibility in the future. However, these suits seem, at best, not well thought out, and at worst, politically motivated. The government officials bringing such actions are focusing exclusively on consumer impact and ignoring the economic reality that typical servicers are neither compensated nor staffed to deal with the large number of delinquencies they are faced with.
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Therefore, while garnering headlines and making consumers feel better for a moment, such lawsuits are not addressing the core problems in the industry. If servicers are truly incompetent, as is alleged in this case, then such lawsuits may have merit. But if the servicer is just not set up or compensated to do what the government would like it to do – and what the servicer probably would like to do as well – those are fundamental issues that can't be resolved with litigation.
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Nigel Brazier: Servicers have been sued before, and they will be sued again. This iceberg has been there for a long time, and servicers have, for the most part, cleaned up their acts.
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The industry has policed itself fairly well, given the fallout from prior government lawsuits surrounding subprime servicers earlier in the decade, with rating agency, GSE, and third-party oversight directly involved in regulatory compliance. The bigger problems are 1) the capacity to provide borrower-specific service beyond the sound design of a servicer's process, and 2) decoupling origination issues from servicing issues. Many lawsuits seem to lump these problems together with allegations of unfair servicing practices.
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David Miller Jr.: Yes, Cordray's suit is only the tip of the iceberg. As the servicing industry is under the microscope and the topic of litigation is apparent, we will see more changing of servicing practices.
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Richard Cimino: A confluence of events has ended an extended period of rising home prices, lax credit requirements and increasingly exotic mortgages. The resultant flow of delinquencies and defaults has inundated a system built for efficiency, and legacy servicers have struggled to receive, process and adjudicate increasingly complex default remediation scenarios�. Complex structured agreements designed to make predicting the level/timing of cashflow to bondholders have handcuffed servicers and limited flexibility and creativity.
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While it's improbable, litigation of this sort will have much more of an impact in the coming years. If servicers cannot read the handwriting on the wall, they could face a worse fate: over-regulation.
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William LeRoy: It certainly will not be the last attempt by a politician trying to make a name for himself or herself. The proposed Preserving Homes and Communities Act of 2009, S.1731, is a classic example of this. There are sections in the newly proposed bill that would take this tactic in a very dangerous direction. This all underscores the hysterical and prejudicial climate and critical need for the members of our community to get out wherever and whenever we can in front of all of the lawmakers and make certain that our story is heard.
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Q: How do you predict the servicing industry will look at the end of 2010?
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Edward Pinto: Beaten up. It will be blamed for the failure of HAMP.
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David Miller Jr.: We would predict that the servicing industry will continue to change and evolve, as will the shape of the servicing industry, due to the unprecedented number of regulatory matters at both the federal and state levels. Litigation challenges will emerge out of these changes, as well.
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Richard Cimino: Going forward, investors will demand transparency, alignment of interests and performance-based fees over legalism and efficiency. Servicer reporting and technology will need to improve to meet the needs of more involved investors. Risk holders will consolidate, and that will require servicers to put more skin in the game. In the last 18 months, there has been a surge of new captive servicers. The move by investors to jettison tradition and opt instead for more controlled, high-touch and responsive servicing should serve as a harbinger for old-line servicers.
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Investors will demand increasing transparency and the technology to support a wider range of solutions. Reporting that clearly conveys pool performance in investor-relevant terms (e.g., yield, roll, velocity, severity, forecasted cumulative loss) will supersede operational measures of servicer performance, such as call-center metrics.
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Servicers must reorganize their workflow and authority to efficiently receive, document, evaluate and decision borrower scenarios. Improved analytics and integrated technology must provide connectivity across functions and throughout the servicer-investor relationship. Servicers that combine the basics of availability to the borrower with decision-supported framework will, time and again – in this environment or otherwise – produce more and better results for the borrower and investor alike.
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Nigel Brazier: I would expect the industry to be a little more coordinated and cohesive. I expect the larger industry players to identify their strengths and more honestly accept their weaknesses. In this process, I expect servicers to leverage the specific skills available to them to address their weaknesses and focus on their strengths to provide borrowers with a more satisfying experience. In most cases, this makes economic sense, too. Larger players with 90% of the loans in their portfolios currently performing are less inclined to build efficient organizations to meet the needs of the 10% that are not performing or that require specialized attention.
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Gerald B. Alt: Proactive loss mitigation efforts will become an ingrained part of the servicing process earlier than is currently the case. Included in this will be an opportunity to do data analysis of performing loans to target those that can be saved from future foreclosure and the attendant credit loss.
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Rick Smith: More and more specialty servicers are popping up to assist with the unprecedented volume of high-touch work being required of the larger servicers. A number of smaller companies have started to specialize in areas of concern – short sales, modifications, etc. Will the larger companies utilize this type of industry assistance or develop internally to manage the process is the million-dollar question – the answer to which will bear on how our industry will look at this time in 2010.
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Kevin Kanouff: I think that we will see more loans move from the large servicers to workout specialists. Also, there should be some consolidation in the special servicing industry.
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William LeRoy: The industry will continue to compress, and bank failures will continue, fueled by the loan defaults in the commercial mortgage sector. If we cannot get a handle on the rising unemployment rate, then residential property values will continue to fall, and as a result, residential mortgage default rates will increase along with the resulting foreclosures. The private-equity-funded special servicers will grow both in size and number.
Hopefully, the FDIC will become more nimble with its asset-distribution process, and we can get the failed loan pools out into the hands of the folks who can move the assets. If someone at a policy level finally realizes that the old [Resolution Trust Corp.] approach would have worked better when this mess all started, then we will be a lot farther along on the road to recovery this time next year than we would be otherwise. I pray that Fannie Mae and Freddie Mac continue unscathed and remain in swing, but that will be up to our D.C. friends.
The investor side of the house will need to make the back-office loan servicing side of the house the front-office operations and fund the transition accordingly. The Fed will need to resolve the mark-to-market issues, and our lawmakers will need to lighten up on our industry if we are to see the credit markets loosen up and our present stormy skies change from gray to shades of blue. I am the eternal optimist, so I hope for the best. But to be honest, I have yet to see that spark of "I actually get this" anywhere in Washington, and until that happens in a fairly significant way, a lot of this is still a Las Vegas-style crapshoot.
– John Clapp, editor, Servicing Management
