Andy Pollock is chief revenue officer for Clayton Holdings, a provider of loan due diligence, surveillance, real estate owned management, consulting, valuation, title and settlement services to the mortgage industry. The firm conducts more than 50 due diligence reviews for servicing operations per year and also provides advanced technology that is used for tracking the performance of loan portfolios.
Servicing Management recently interviewed Pollock to get his views on how potential deregulation under the Trump administration might impact the servicing industry moving forward, as well as the other trends he expects to see in 2017.
SM: This is an interesting time to be in the mortgage servicing industry, especially considering the potential for regulatory rollback under the Trump administration. Where do you think things are headed for the industry over the next 12 months?
Pollock: You’re right; it is going to be interesting. It’s a situation in which nobody really knows for sure what is going to happen. I know that President Donald Trump would lead you to believe what he wants you to believe – but just because he wants it doesn’t mean it’s going to happen, as was shown with the recent effort to roll back Obamacare. He can’t even convince the Republicans to do what he wants them to do.
With regard to the potential for regulatory rollback, I’ll say this much: There’s still 250-plus rules that have not been rolled out yet under Dodd-Frank, and I think if they just stopped right there – and re-evaluated with heavy scrutiny whether those rules should ever be implemented – without rolling out anything new, it would still be a win for the industry because I think at this point, although there’s more cost with the rules that have been implemented, there’s certainty. And that’s because they’ve already been adopted, for the most part. Servicers now have the processes and procedures – and hopefully the technology – in place to support the implementation of all of these new rules.
Technology has certainly been very helpful in making things better. But at this point, I really feel it would be best if the implementation of new regulations just stopped.
SM: Is it safe to say that most servicers have come to embrace the new regulations? Would you say that most are appreciative of what these rules have done for customer service – and in terms of improving borrower relationships?
Pollock: I would argue that most of what has been done so far are things that servicers should have been doing all along, no matter what the regulations are.
It’s a little bit like garbage in, garbage out. A lot of these servicers previously were not getting the information they needed when loans were getting transferred – particularly with regard to where the borrower was in the loss mitigation process. It wasn’t a clean hand-off. So, you ended up having to start all over, which was frustrating not only for the borrower, but also for the servicer because if the servicer was able to just pick up where the last guy left off, it would have been a much better hand-off, and the borrower would’ve been happier.
SM: Then, on top of that, there has been a lot of investment made in technology and in revamping processes – all of the training. So, would you say some servicers are concerned that if there’s significant regulatory rollback, they’ve made a lot of unnecessary investment in knobs and dials, so to speak, that they really don’t need?
Pollock: That’s right.
SM: So which do you see as being the main concern for the industry, should regulation get rolled back?
Pollock: I think the real danger is that, as time goes on and margins get compressed and pricing wars erupt with the competition, without enforcement, you could see some of the industry roll back to where it was in the pre-crisis years, which would be really unfortunate for the borrowers.
The other danger is this: It really takes two to tango. The company getting the servicing may want to do all of the right things. It might ask for all of the right information. But you have to figure that the servicer losing the servicing is losing some revenue stream – plus, it’s costly to comply with all of these regulations. So, it’s not so much that the servicers that are picking up the servicing don’t want to do the right thing – it could be that the servicers that are losing that servicing don’t want to spend the money or take the time to make sure that things are done right. I see that as a big risk going forward, should the Consumer Financial Protection Bureau (CFPB) lose some or all of its teeth.
SM: Isn’t it also true that if the CFPB loses its teeth, lenders will likely start making riskier loans – and that will likely impact servicers, as some of those loans are bound to default? I mean, Fannie and Freddie are working on finding new ways to loosen or modify their credit requirements.
Pollock: You’re absolutely right. As we go through 2017, I think non-qualified mortgage (non-QM) loans, even though they are still very pristine, still represent a loosening of credit. That’s even though it is nowhere near the subprime loans that were being done back in the heyday. So, we are going to start seeing more defaults, naturally, as a consequence – also, the proliferation of government lending will lead to greater defaults.
People also sometimes forget that Federal Housing Administration (FHA) borrowers are more of a risk. You just naturally have a larger default rate on those loans. So, as those proliferate in the market, it will also potentially put pressure on things.
SM: What about the effect of regulatory uncertainty on the mortgage market? Do you think that could lead to problems?
Pollock: There’s a thousand ways I can answer that question, but I’ll say this much: I think as refis go away, it’s going to open up opportunities for non-QM, which over the last couple of years could not get off the ground because of the rules for how loan officers are compensated, as the fact that it might have been a higher coupon didn’t matter. But in the heyday of subprime, you couldn’t get people to focus on the agency product because, quite honestly, they get paid a lot more by doing subprime. Call it non-QM today, but it’s the same point, right? When refis were out there, and they were low-hanging fruit, it was easy for lenders to originate – there was no need for them to go talk to an investor to find out what they wanted, from a non-QM perspective, and whether they could find borrowers to fit those underwriting guidelines.
But now, there’s going to be more focus on products like non-QM because lenders are going to be desperate for volume.
You’re also going to have, I think, a lot more mergers and acquisitions activity this year – we’ve already had quite a bit. I also think you’re going to see a lot more subservicer growth – and you’re going to see more servicing sales. And those sales may end up leading to more subservicing with the original owner of that servicing. If you look at the transactions lately, such as PHH Mortgage’s recent sale of mortgage servicing rights (MSRs) and some of these big deals that have been done, most of them are selling the servicing rights, but they’re allowing the subservicing to be retained by the original owner of the servicing. That happens for a lot of reasons – it’s usually capital constraints and regulatory constraints, but it can also be about the unknown of future regulatory constraints.
If you take all of that into account, it’s going to be an interesting market in 2017.
SM: I see that there has been significant growth in the subservicing sector – I heard it has grown about 20% in the past two years and is now about a $2 trillion market, which is amazing when you consider that the whole market is about $3.8 trillion. What’s driving that?
Pollock: For one thing, you’ve got the four mega banks dumping servicing like we’ve never seen. That’s because of the Basel III concerns, and it’s because the cost of servicing doesn’t make sense with the regulatory requirements.
SM: Yeah, and I hear that the master-rights holders are now potentially at risk of stricter regulation, too.
Pollock: It’s interesting that you mention that because, in theory, the owner of the servicing is accountable for anything that happens during the servicing. But in reality, I don’t know that we’ve ever seen that enforced. And if the CFPB loses its teeth, that’s even less likely to occur. I think the entities that own the servicing and are allowing it to be subserviced – and that aren’t doing a lot of due diligence – are going to get away with some things.
With regard to going after the rights holders, I think whomever the CFPB goes after would likely be the ones with the deep pockets. If it’s a small hedge fund or advisory firm that has the rights, it obviously might not be worth it for the CFPB to go after it. But a larger servicer, with deeper pockets, that is having its loans subserviced – or it is subservicing itself – maybe it would be held accountable. But I can tell you that, so far, that has not been the case.
Also, I can tell you that, from a consulting perspective, from all of the clients we go to – and we must review upwards of 50 reviews of servicers per year, mostly for investors and warehouse providers offering funding for MSRs – quite honestly, the oversight is pretty minimal. They go in there and kick the tires – they do an operational review, but they’re not doing the quality control that they should; they’re not testing at the loan level to be sure that things are really being done right. And, of course, it’s a cost issue. Their margins are such that it’s not likely they would consider outsourcing it.
SM: What about the effect of the rising rate environment on servicing? Most people say this will be a positive thing for servicers in 2017, but I guess it really depends, right?
Pollock: I agree that, in general, it should be a positive. So many of these companies that have owned servicing and thought rates were going up for the last three years really got crushed through valuations because rates went up a little bit – like, maybe a quarter point – and then they went back down, and all of a sudden, you’re getting a refi wave that you did not expect. And a lot of these servicing shops were not set up to recapture that run-off.
So, generally speaking, although there’s going to be a lot less done in terms of originations in 2017, with the rising rate environment, I do think you’ll see servicing books grow for those that want them to grow.
That’s going to happen not only because we’re going to see prepay rates continue to slow, but also because you have borrowers who are going to do anything to keep those first-lien rates right where they are. Borrowers today are way more likely to go with a home equity line of credit or some sort of home equity product rather than refinance that first-lien mortgage. So, I do think you have some extension of those servicing rights that maybe we’ve never seen before, should rates continue to go up. At the same time, servicers are going to be harder-pressed to find the volumes.
I think the subservicing group has done a great job of capturing a lot of the independent mortgage banker market – and that’s also why this segment has grown so fast. You had a lot of independents that were originating and wanted to start retaining some servicing, but they weren’t really at the volume levels to justify retaining it internally, so they subserviced it. And you have the mega banks getting rid of a lot of servicing, and the people who are buying that tend to use subservicing, as well. Both of these factors have helped the segment grow considerably.
SM: What about MSR transaction velocity in 2017? How crazy do you see that getting, and is there any chance of the big banks wanting to get back in?
Pollock: If the banks could, they would love to hold onto MSRs. I think the return for them, given their low cost of capital, is something that gives them a competitive advantage, in terms of being able to hold onto MSRs. Unfortunately, I think the capital restrictions from Basel III are going to make that a major challenge for them. And I think the non-banks are going to continue to be aggressive. They see an opportunity, particularly with that extension that I mentioned – they see the possibility of seven-plus-year servicing.
SM: In light of the potential for regulatory rollback, do you think servicers will continue to invest heavily in technology this year, as has been forecast?
Pollock: One of the problems I see with the mortgage servicing software market is that you have 60% of the market on one core system. And – I’ve been in the industry for 27 years – it’s still the most antiquated software out there. Yes, they’ve done things to make it work better, and they’ve added workflow – and it’s night and day in terms of a default perspective – but it’s still bad.
As far as technology goes, servicing is still the redheaded stepchild of the industry. People had to put money into it due to the crisis, but people still approach it like it’s a manufacturing process. People still just throw bodies at it. The technology was implemented in order to comply with the regulations, but there is very little automation – or, there could be a lot more of it. You still don’t really have portals where borrowers can self-service their loans. But I think some of these fintechs and new start-ups are thinking about it in a new way, and they will start to push the edge. But I think as long as a borrower has no say as to who services his or her loan, we’ll never see the same level of technology investment that we see on the front end.
Look at Rocket Mortgage. Nothing even close to that exists on the back end.
SM: During the Mortgage Bankers Association’s servicing show, there was one session during which they discussed the possibility of there being a Rocket Mortgage equivalent for loan modifications.
Pollock: Yes, I heard, and I think you absolutely could do that. I think the one thing that might slow that down and prevent it from happening sooner rather than later is the lack of defaults. Look at how pristine the performance has been. But as credit starts to loosen and defaults start to rise again, you might see people starting to invest in that type of technology for servicing.
SM: What, in your opinion, is the biggest problem with the CFPB’s final servicing rules?
Pollock: I think there’s still a lack of clarity around how the rules are supposed to be implemented – and what the CFPB is asking servicers to do. Without that guidance, and without that specificity, servicers are in a nebulous, gray area in terms of how to proceed, and that’s a very dangerous thing. Some of the rules are very straightforward and black and white – and they’ve given good examples. But upwards of 50% of them are still not fully defined. I expect to see further revisions to this rule. It’s just like the TILA-RESPA Integrated Disclosures Rule.
SM: What about new initiatives as they relate to investor reporting, etc.? How do you see those evolving from here?
Pollock : Unfortunately, I don’t think the investor community really understands what it should be asking for in a lot of cases. They get the basic monthly reports on balance and delinquencies and what the fees were and things like that, but they don’t seem to have a really firm grasp on the advances they’ve made or what the aging of those advances has been, and they don’t have a good grasp as to what stage of loss mitigation the loans are in. They don’t have a lot of transparency into it – unless they have someone who is doing a really good job of looking at things at the loan level. But I find that not to be the case, most of the time.
This is an area where the fintechs say they want to help because they think it will help them raise capital from investors by giving them that transparency – by providing a clearer snapshot of what’s going on with every single loan. But I think it’s a long way off. And it’s not an easy thing to do. It’s not that the data is not there – it’s how do you put it into a format that’s easily understandable for all of the different processes that you’re doing?
The other thing about investors is that I don’t think they really understand government servicing at all. I think they understand conventional servicing, but when it comes to the FHA and Veterans Affairs and all of the rules and what you have to make advances on – I think they’re just paying the servicer whatever advance money the servicer asks for, but they’re not really understanding why, nor do they understand when they’re getting it back. They understand that when they liquidate the property, they’ll get the money back – or when they make the claim – but they don’t really know what that means. It’s a little frightening, when looking at the amount of government servicing that’s out there. Even the servicers themselves still struggle with government servicing.