of the by-products of the current mortgage market is the explosive[/b] growth in advances that servicers are now carrying. High delinquency rates, increased foreclosure timelines and, in some cases, the implementation of moratoriums, as well as increased listing times for real estate owned (REO) properties, are requiring servicers to fund significant expenses related to taxes and insurance, property preservation, legal fees, and principal and interest (P&I) advances. To further compound the issue, servicers have seen a marked decline in service fees as a result of increased delinquency rates. The result is that many servicers are facing serious liquidity challenges and are incurring significant costs to fund these advances. While advances will remain a challenge in the coming year, there are some practical and immediate strategies that servicers can implement to help manage and perhaps even reduce advances. The first step in managing advances is being able to measure and forecast them. Simply put, you cannot manage what you cannot measure. As such, developing robust advance forecasting models is critical for servicers. Forecasting models need to take into consideration items such as delinquency rates, tax disbursement dates, average escrow advances, foreclosure timelines, REO listing timelines, cure rates and historical advance recovery percentages. These are all critical inputs into an advance forecasting model. Through the use of forecasting, servicers can better understand and project liquidity needs and be in a position to develop proactive strategies, rather than taking a reactive approach to cash shortages – a method that typically results in premium funding costs. [b][i]What's in your PSA?[/i][/b] Equally important as forecasting is the ability to track and manage existing advance balances. Servicers should be monitoring the aging of advances and address those that are aged and outside of normal collection parameters. A key part of this is understanding what advances are truly recoverable from an investor. To accomplish this, servicers should perform a detailed review of pooling and servicing agreements (PSAs), and at an investor level, identify which advances are recoverable and when. A best practice in this area is to have a data warehouse for PSAs that summarizes the key terms, including remittance dates, non-business remittance treatment, allowable advances and service-fee payment criteria. This information should then be fed to the default and investor accounting areas to ensure that the appropriate claims are made in a timely manner. Too many servicers do not have a good understanding of PSA requirements, and this impacts the ability to successfully manage advances and increases the risk of penalties associated with claiming ineligible advances. In addition to the above forecasting and reporting strategies, there are several operational strategies that servicers can pursue to minimize advances. Escrow represents one of the largest advances for servicers, and escrow advances are a result of both delinquent loans and shortages in escrow collection. To minimize escrow advances, servicers should consider the following: [list]Setting escrow analysis schedules based on "optimal analysis month" versus workload balancing. Through the use of models, servicers can model out which analysis month will result in the highest average balance on a loan. A common belief is that the optimal month is always the one following the largest tax disbursement; however, this is not always the case. The frequency of disbursements is also a key driver. *Holding allowable cushion in escrow accounts. While a basic strategy, acquired loans are often an area where escrow cushion may not be optimized. *Applying for property reassessment on high-value delinquent properties. Given the steep decline in home prices, there may be an opportunity to have the assessed value lowered, thereby reducing the advance requirements. *Core balance assessment. It is also imperative for servicers to understand the core escrow balance they hold. In other words, the core balance is the level below which escrow monies never decline throughout the year. The optimization of the core balance is achieved through the above strategies; however, understanding the core balance is an integral part of cash forecasting and should be part of any liquidity strategy.[/list] [i][b]Stop-loss analysis[/b][/i] Outside of escrow, there are other opportunities to reduce advance requirements. One of these is around P&I advances. The duration of P&I advances is typically governed by the PSA and can range from when a loan goes 90 days delinquent through REO liquidation. However, many PSAs allow the servicer to stop advancing when it can be demonstrated that the loan is in a loss position. Therefore, it is important for servicers to have the ability to perform detailed stop-loss analysis on their loans to be in a position to request relief from P&I advances. Servicers should ensure overly delinquent loans are appropriately flagged in the servicing system so that advances do not continue after the decision to halt them has been made. In the majority of PSAs, most reasonable expenses incurred while performing default-related activities – such as escrow advances and property preservation costs – will be reimbursed. As a result of the high-default environment, the American Securitization Forum (ASF) now considers expenses incurred while performing counseling activities to be part of normal advancing expenses that can be reimbursed. These counseling activities include those performed while the loan is in default or is about to default, as well as any activities that aid in loss mitigation efforts. Per the ASF, servicers have not traditionally sought reimbursement. But as loss mitigation efforts continue to increase, it will be beneficial. To seek recovery of these expenses, it is imperative that servicers have processes in place to track these activities and related costs. There are also other operational areas where servicers should ensure they are maximizing cashflows and reducing advances. An operational diagnostic of key processes should be performed on those areas impacting cash advances to identify where practices can be improved to reduce cash advances and/or improve collectability, including the following: [list]property and preservation costs, *loan payoff and liquidation practices, *fee waivers and collections, * investor advance practices, *corporate advance recoveries, * loan modifications and loss mitigation, *loss analysis and claims management, and *review of policies and procedures related to corporate advances to reduce the amount of rejected claims caused by administrative errors and omissions.[/list] If the burden of advances is too great, then servicers may wish to seek financing options for their advances. Opportunities exist to both pledge advances for financing and securitized servicing advances in exchange for funds. Both of these are subject to "factor" rates based on the anticipated recovery rates of advances. Therefore, for servicers who are considering these options, being able to demonstrate sound controls, strategies and reporting over advances will be of benefit. Servicing advances will remain one of the key issues and challenges facing the industry. However, while advances are a fact of the business, the level at which they are made and recovered can be influenced. Through the implementation of advance forecasting, tracking and advance management strategies, servicers can begin to manage a process that some have deemed to be very challenging. [i]Martin Touhey is a senior manager in the consumer finance practice of PricewaterhouseCoopers. He can be reached at (206)-790-8751 or martin.e.touhey@us.pwc.c
