The macroeconomic problems of job losses, wage cuts, the lack of new[/i][/b] lending, adjustable/hybrid rate resets and high interest rates have created the tidal wave of defaulted loans that has every loan servicer – as well as members of the federal government – scratching their heads. I recently read a report detailing the struggle of a headhunting firm that was searching for skilled loss mitigators to work at a special servicing shop. The report noted that special servicers are in demand, because they supposedly do a better job of managing a defaulted loan than a traditional loan servicer does. The already particular skill set of a special servicer has been refined even further for "re-performers," or individuals who specialize in creating the best value possible and who are more proficient than mainstream and special loan servicers. This breed of servicers has changed the mantra of default management from "Fix if you can, but if not, then foreclose quickly" to "Manage the loan to the best possible outcome." That is the design of the "new" default management. Each asset has a value and a set of variables that must be determined by an individual asset manager. Depending on the variables, the asset value goes up or down, its measure a product of cashflow and net present value versus the expected return at origination (or purchase) and the liquidation alternatives. The individual asset manager is responsible for, at minimum, figuring out the following: [list]figuring out the cause of delinquency; *an accurate accounting of a borrower's current monthly budget; * a time frame for borrower recovery; * the likelihood of borrower recovery and the degree to which the borrower can perform; * the market value of an asset in both "as is" condition and repaired condition; * a liquidation time frame for "as is" condition versus repaired; * if possible, the best mitigation approach to keep the borrower in the property; * if necessary, the best mitigation approach to keep the property value up; * if necessary, the best mitigation approach to liquidate as quickly as possible; * when to start and stop the foreclosure; * how to negotiate the best possible outcome in a bankruptcy; * tenant-friendly options that maintain cashflow; and * settlements.[/list] The responsibilities are many, but a little historical perspective illustrates how an asset manager need not be a default superstar but simply a person who applies work rules, systems and common sense in a logical manner. Historically, the term "default management" meant the loan servicing group running collections, foreclosures, loss mitigation, bankruptcy and REO (i.e., all the functional areas involved when a loan stopped paying as agreed). Lately, most of the discussion has centered on loss mitigation and modifications. The government has even come out with its own proposed program that looks like it may help some borrowers, but everyone is awaiting more detail on the actual procedures before performing any modifications under the program's guidelines. The rest of the default management group, as traditionally defined, continues to work its processes and make adjustments as required by investors or the government (e.g., foreclosure moratoria). This silo approach to business tasks has proven, in many industries, to be part of the evolution of the assembly-line mentality. We can hire the least-skilled people, teach them the minimum requirements needed to perform the job and line up the jobs sequentially, so they each do their part and mindlessly produce the final widget. This mentality was dropped in most manufacturing processes two decades ago and has evolved through work teams to total-quality and just-in-time inventory, etc. Mortgage servicing, however, remains an exception. Instead, many companies have even taken the skilled position of loss mitigator and broken it into three positions: prospector, analyst and negotiator/closer. Why? Costs, time to train and a lack of experienced loss mitigators has driven these changes in traditional servicing and special servicing operations. The logic of the assembly-line approach only makes sense if workouts are going to be performed the same way they have always been. But what if a shop wants to do better? What if the goal is to minimize redefault rates and maximize returns to investors? [b][i]The new approach[/i][/b] The more modern approach to default management takes on processes from a different standpoint. Instead of the historical sequential processes, the default goes through a clearing process up front. All the main effort is directed at determining the reason for the delinquency at the earliest possible stage and addressing the identified type of delinquency with the appropriate remedy. That does not mean that the person who is working the defaulted loan file identifies "job loss" as the reason for delinquency on day 20, waits 45 days to start loss mitigation, and on day 90, starts foreclosure. Early-stage intervention means that loss mitigation has begun by day 20. In fact, in cases where the reason for delinquency is unknown or unidentifiable, the new form of default management dictates that loss mitigation begins on the 16th day. Critics of this approach argue that it is too expensive or unrealistic, given the volume of accounts. Many will question how this style of servicing is impacted by "slow pays," or if it is vulnerable to exploitation. Let's look into these statements further. [b][i]Cost-effective?[/i][/b] The expense issue, on the surface, looks like it might be indisputable: An employee who can actually work with a borrower to find out the root cause of delinquency and who is able to begin resolving in a manner reminiscent of a true loss mitigator should be paid more money than a collector who is making a base pay of $15 per hour. But if that type of employee can work on resolving a loan at an early stage, then the company saves two months of the collector making, at minimum, one call per week, and with the account still winding up with a loss mitigator. Instead of costing more, the new approach actually costs less. [b][i]Too many loans?[/i][/b] Even if you save money on each individual borrower, costs will still increase because of the high number of specialists needed, critics argue. This is true to an extent: Compared to the number of current collectors found in most servicing operations, the number of specialists that would need to be hired would be greater. However, the deployment of more specialists in early-stage operations would be offset by the significantly smaller portion of specialists working in aged loss mitigation. Furthermore, fewer collectors would be needed. This all goes back to one overarching theme: Do it right the first time. [b][i]What about slow pays?[/i][/b] Slow pays are those borrowers who, based upon historical behavior patterns, can reasonably be expected to pay late. If a trend is established and observed by the loss mit specialist, a slow-pay cutoff can be established; if a missed payment goes beyond that cutoff date, then the issue should be addressed as a serious one (particularly in this economic environment). With new accounts that miss a payment, a collector makes an early-stage phone call – a function of customer service – to find out the borrower's status. Once it is established that, for example, the borrower routinely pays after the first of the month, a cutoff date can be set. If the cutoff point has come and gone and no payment has been received, then further investigation (borrower contact) is again required. [b][i]Open to abuse?[/i][/b] People will only take advantage of servicers if the servicer lets them. If income is verified, the budget is reviewed for reasonable expenses and a "budget triage" is performed with the borrower, then the servicers and their policies will not be abused. Most of the abuse that occurs in the current process happens to investors, when a loan servicer receives a budget and accepts it at face value without questioning a $800 monthly grocery allowance for a family of three. Then again, most budgets used by today's loan servicers and special servicers are consolidated categories that do not lead to a comprehensive understanding of where the money is going. The move to consolidate was done to ease input, not gather better information. The best budget form available is the one-page form offered by the U.S. Department of Housing & Urban Development (HUD), which captures all monthly expenses and shows total expenses, total income and surplus income. HUD's form is, by far, the best way to review the reasonability of a budget and determine which items are leading to a change in the borrower's behavior. An important and valid question is, where do servicers find staff that can be trained to be re-performers? In short, customer-centric people make the best re-performers. These individuals listen and provide empathy to the borrower and will establish a relationship with the borrower that allows for a constructive workout. The alternative is a person who instructs a borrower on a course of action and shows no compassion. Re-performers can be trained in much the same way that underwriters used to be trained: Assemble a group of trainees around a knowledgeable lead and let them make recommendations on how to resolve complicated default matters. The lead reviews the trainees' recommendations and works with them until they have a high enough pass rate to fly on their own. This is a quick and effective way of developing loss mitigators. By working in partnership with the borrower, servicers can have a direct conversation about what the borrower qualifies for, which option they are choosing and whether the borrower can truly afford to keep the home. In today's world, loss mitigators tell the borrower the option and the requirements. In the new default management arena, the "re-performer" leads the borrower to the right decision. There is one main measure of success and a single leading indicator of success for the new default administration: net profitability of the loan pool over time creating return on investment, especially upside recovery beyond the expected return. The leading indicator is the redefault rate. When modifications are done properly, the corresponding redefault rate of a portfolio should be under 5%. This may sound very difficult, given the industry norms of 50% redefault rates and Citi's recently announced 25% redefault rate. Such a low redefault rate can be achieved, however, when servicers work with borrowers and try to understand their situations rather than demand payments (i.e., collections) and simply tell them the solution (i.e., loss mitigation). [i]Joseph C. Smith II is president and CEO of Default Mitigation Management LLC. He can be reached at (800) 481-10
