Although the impact of hurricanes Harvey and Irma on the national mortgage default rate has yet to be fully realized, unforeseen events such as these can result in a wave of defaults that can challenge a servicing shop. That’s especially the case if a servicer’s portfolios are geographically concentrated in the disaster areas. In essence, the recent hurricanes will serve as tests of the new processes and technology that servicers now have in place, much of it driven by regulation.
Many people would argue that servicers should, in theory, be ready for any size wave of defaults, given the regulatory framework now in place and the lessons learned from the 2008-2009 housing crisis. Since then, servicers have made significant investments in technology, automation and process improvement, much of it in response to new regulations such as the Consumer Financial Protection Bureau’s (CFPB) recently finalized mortgage servicing rules. However, just because a servicer has successfully automated most of its functions in default doesn’t necessarily mean the servicer is ready for an onslaught like we saw in 2008.
Technology alone can’t manage a massive spike in defaults. It takes skill, experience, a complete understanding of default servicing and the ability to scale rapidly to tackle the challenge. It also requires a full understanding of the loan lifecycle, a keen understanding of current regulations, and the capacity to maintain compliance in a highly automated, technology-driven environment. In other words, “default as a core competency” doesn’t mean the same thing today that it did a decade ago.
The risk of complacency
For now, though, servicers have nothing to worry about, right? Americans are feeling good about the economy. Delinquencies and defaults have been decreasing steadily for the past four years and are now near pre-crisis lows. Home prices continue to rise, the job market is improving, and the stock market has seen a stellar rally during the past several quarters.
In fact, as of the end of July, the national delinquency rate for all mortgages stood at about 3.9%, which is down by more than 13% from a year ago, according to Black Knight. Meanwhile, the national default rate for first mortgages at the end of July stood at about 0.62%, down from 0.66% in July 2016 and significantly lower than the mid-2009 peak of about 5.5%, according to the S&P/Experian Consumer Credit Default Indices.
With delinquencies and defaults near pre-crisis lows, and with so much automation now in place to “capture” borrowers before they go into default, is it possible that some servicers are still unprepared for the next inevitable wave of defaults?
We’re about to find out. According to a Sept. 8 report from Black Knight, Hurricane Harvey put approximately 1.18 million mortgaged properties at risk for default, which is more than twice the number of properties affected by Hurricane Katrina in 2005. It has been estimated Harvey could result in 300,000 new mortgage delinquencies, with 160,000 borrowers becoming seriously past due as they struggle to repair their lives after devastating floods.
That may not even be close to the effects of Hurricane Irma, which could potentially impact more than 3.1 million mortgaged properties throughout Florida. That would be nearly three times as many properties as Harvey and seven times more than Katrina. The properties located in the Irma disaster area alone represent nearly $517 billion in unpaid principal balance.
It won’t be until December or January that we begin to learn what the full impact of the storms will be on the default rate. It should be noted that Fannie Mae and Freddie Mac are offering foreclosure relief for borrowers in FEMA-declared disaster areas, provided they are eligible for FEMA Individual Assistance. There are, however, concerns that many delinquencies will go past the grace periods for forbearance the GSEs have offered.
Other factors could contribute to a “mini wave” of defaults. If interest rates rise over the next couple of years in response to the Fed’s balance sheet reductions, an additional several hundred thousand borrowers may end up defaulting on their home equity lines of credit.
Adding to this troublesome brew are stubborn pockets across the country where home values have failed to return to pre-2008 norms. According to a recent report from real estate firm Trulia, only about 35% of U.S. homes have seen their values surpass 2007 levels. And most of those homes are located in the major technology hubs such as Denver; San Francisco; and Portland, Ore. – markets that otherwise have strong job, population and income growth.
Greater complexity and expectations
New regulations have added significant complexity to default servicing, boosting operating costs and opening servicers up to additional compliance risk. Since the 2008-2009 housing crisis, most servicing shops have put technology and automation in place to handle potential spikes in default volume. These tools enable servicers to communicate with troubled borrowers faster and provide alternatives to foreclosure more efficiently.
While technology and tools improve processes, default servicing needs to be high-touch in order to be effective, and only so much of it can be automated. The rollout of new technology and automation must be accompanied by efforts to improve the borrower’s understanding of the process.
The default servicing process requires constant communication, and a special servicing market has emerged to help traditional servicers with borrower communication. But that doesn’t mean special servicers don’t rely on technology and automation. Some, but not all, have made significant investment in new systems to ensure continuous borrower outreach, as well as in tools to manage compliance and exchange documents.
In addition to the constant challenge of helping borrowers understand how the default servicing process works, servicers have faced a slew of new operational challenges for both performing and nonperforming loans that did not exist before 2008. Topping the list are the CFPB’s new servicing rules, which require timely borrower outreach and communications, full transparency of all back-office functions, and seamless hand-off of MSRs when a loan is in loss mitigation.
Then there is the not-so-small matter of property management, which is one of the biggest operational costs a servicer faces when experiencing heavy default volume. While this is often an outsourced function, the servicer or special servicer is responsible for tracking and managing property management costs in a compliant manner. What’s more, new vendor oversight rules make it critical for servicers to closely monitor all property preservation activities, adding yet another layer of complexity to servicer operations and increasing risk.
Despite these challenges, mortgage servicers have greatly improved their operations in recent years and should be much better prepared for another wave of defaults. Many of these improvements come not just as a result of new regulations, but also as a result of lessons learned during the crisis. Let’s take a look at some of these improvements – and how servicers could be doing even better.
Improved servicing through technology
Most of the core servicing systems today are highly flexible and can readily accommodate regulatory and guideline changes. In addition, most servicers have revamped their back-office operations to gain alignment with new processes. The best servicers, however, have completely rebuilt their back offices from the ground up and have done so with a customer-centric approach in mind.
Recent regulations have compelled servicers to think of the borrower first, not the business. Before the housing crisis, it was the other way around. But, making this switch involves new ways of exchanging information between servicers and borrowers.
Servicers communicate better than they used to, especially once a borrower has become delinquent. As servicers learned in the downturn, it is critical to contact borrowers immediately after they become delinquent – and afterward, as frequently as possible. This is an area where investment in technology and automation has really paid off. Through automation and open channels of communication, borrowers can quickly gain information and determine what their servicer is doing.
This improved borrower communication also presents opportunities to address the challenge of explaining the default process to borrowers. Servicers’ systems now alert borrowers in loss mitigation when certain steps need to be taken and explain why those steps need to be taken. Also, the content that accompanies a process can be delivered in a standard, uniform, unbiased and compliant manner.
In addition to opening the channels of communication, advancements in system integration mean that data hand-off between servicing systems are now much more accurate and reliable. That’s critical when transferring customer data from a core servicing system to a default servicing system or when transferring MSRs between systems.
This seamless hand-off of data is also important for compliance, as there can be no disruption of the loss mitigation process due to servicing transfers. If a borrower submits a complaint to the CFPB’s Consumer Complaint Database as a result of a transfer glitch, the servicer could face an audit and significant fines. That being said, servicers and their technology partners have made huge strides in perfecting these data hand-offs, making them seamless all the way down to the loan level.
So, are servicers – and, just as importantly, their special servicer partners – ready for the next wave of defaults? Considering the level of investment made in new processes, technology and automation in recent years, plus all of the new regulations put in place and the lessons learned from the Great Recession, they certainly should be. The best-prepared servicers, however, are those that achieve greater back-office transparency, improved borrower communication, and solid policies and procedures in place for meeting compliance.
While no one is sure when the next wave of mortgage defaults will arrive, servicers that invest in new processes and systems will be the most prepared for any event when it comes – whether it’s a devastating storm or a sudden economic downturn.
Sandy Jarish is president of Planet Home Lending, a GNMA issuer and approved subservicer, as well as a Fannie Mae- and Freddie Mac-approved seller/servicer, with a $12+ billion servicing portfolio. The company also maintains a separate operating platform for the special servicing of non-agency and small-balance commercial product. Jarish can be reached at firstname.lastname@example.org.