Few industries have gone through as much change and turmoil since the global financial crisis as the U.S. residential mortgage industry, and probably no part of that business has changed as much as the market for nonperforming mortgage loans (NPLs) and real estate owned properties (REOs). Understanding these changes and their implications is critical to succeeding in this evolving marketplace.
The most obvious difference is that the market for distressed assets isn’t nearly as big as it used to be, as the number of home foreclosures has receded to historical levels. But as the market has declined in size, investor demands and expectations have grown.
Ten years ago, in the wake of the housing bust and the Great Recession, the REO market grew as banks and other lenders unloaded bad loans they originated as they tried to cut their losses. It was relatively easy for investors to make money in buying these assets, which were often being sold at a discount from fair market value, as speed of sale took precedence over best execution. Today, however, with fewer NPLs and REOs for sale and at tighter margins, investors must be more opportunistic in their approach to buying while looking for more creative ways to maximize their returns.
This change puts greater demands on the servicers that manage these loans and the properties underlying them.
Servicing NPLs can be labor-intensive
Given the higher bar on loan performance, servicing NPLs today is far more involved and labor-intensive than it used to be. Although there is still a premium on timeliness, it is only to the extent that it improves the net present value of each trade. Investors are far more interested in servicers spending more time on the front end of the process, making sure each asset is valued properly and that due diligence is done assiduously if that additional time and effort ultimately results in higher net execution.
Previously, investors were much more time sensitive and willing to significantly reduce a list price, for example, in order to get deals done. Timeliness is still highly important today, but there are cases when it is economically beneficial to spend a few extra days to make absolutely certain that each property has been accurately evaluated and valued – a practice that pays dividends in maximizing the return to the investor.
At the same time, servicing must be customized to the specific investor based on its individual expectations and goals. Investors that buy NPLs and REO assets are a varied lot, and each has a preference for how it wants its holdings managed. There is no cookie-cutter, one-size-fits-all approach to servicing NPLs.
Today’s NPL investors are very involved in the process. And that certainly helps the servicer do its job, as a hands-on investor provides more insight into the best strategy that can be applied to each investor’s portfolio based on its outlook – whether it’s short- or long-term, buy-and-hold, or buy-and-sell. Servicing systems, therefore, need to be interactive and include an approval mechanism by which deal scenarios can be presented to clients so they can see what the best economic outcome would be, whether it’s to sell the property as is, repair it, rent it out, include it in a bulk sale or put it up for auction. The servicer can then execute the best approach for the client.
Boots on the ground
What is clear in this new market order is that technology has not usurped the human element. Although our company is certainly a technology-driven company as much as it is a loan servicer and asset manager because technology enables us to do our jobs better to maximize our clients’ returns, boots-on-the-ground intel is important when it comes to certain aspects of REO asset management and property valuation.
Prior to the housing market meltdown, many lenders sought out the cheapest and quickest ways to value properties, often relying too much on technology. Although automated valuation models (AVMs) can often provide a reasonably accurate price estimate and can be a great starting point in the process, it is dangerous to rely exclusively on them. That’s as true now as it was 10 years ago, when many lenders saw fit to replace on-site valuations with automated valuations. In many cases, the short-term savings in obtaining an AVM product was far outweighed by long-term losses resulting from poor initial valuation.
Although AVMs play a significant role in the industry, there are gaps that AVMs cannot address. For example, an AVM can’t tell you the condition of the house next door or walk down the street to determine what kind of neighborhood it is located in; only a trained professional can do that. Having eyes and ears on location is therefore critically important, especially in today’s REO business. Many investors buy a pool of NPLs but have never seen the properties in person, so they rely on the servicer to do that for them.
Servicers, therefore, need to have somebody local to provide information about the asset and deliver an opinion of value. When we receive a file from a client, we immediately hire a local real estate agent from our network to provide an occupancy check and an opinion of value within 24 hours. We also obtain a second opinion from another local agent. That information is transmitted to the asset manager, who then begins to evaluate the property to decide what kind of preservation or repair work – if any – needs to be done.
If rehab work is required, we begin the process of obtaining bids from both local and national vendors and undergo a thorough line-itemized review of those bids. Once a reconciled repair figure is determined, that data point is included in our net present value (NPV) model for a repaired versus an as-is scenario. The NPV result provides the asset manager with the best economic outcome for that asset. Additional desktop analysis is completed, and a recommendation is presented to the client for approval.
Without the inclusion of local intel from a thoroughly vetted real estate agent, the NPV result will only tell a partial story. If, for example, the NPV recommends repairing the property but our local agents tell us that crime is on the rise on that block, that may be the deciding factor in whether we take the risk of expending additional capital for the potential of a greater return.
Technology creates transparency and empowers investors
Technology plays a big role in helping servicers add value and maximize client returns. Investors and clients always have a need for live, real-time information on the assets they own. That’s why it’s critical to be able to automate loan status reporting. As an example of how this can be addressed, our firm offers an analytics engine that provides investor clients with a unique window into the performance of each of their loans. This enables our representatives and investor clients to examine empirical data on every loan in their portfolios and have a fact-based conversation about how their loans are being serviced, as well as identify and resolve any issues with loans before they become problems. In addition, our REO disposition system has a client interface that allows our asset management team to submit approval requests and repair recommendations directly to the client. Likewise, all documents, property notes, BPOs/valuations, marketing strategies and title reports are available to the client for review at any time.
Clearly, the role of the distressed-asset servicer has changed, just as the market itself has changed. In order to be successful, servicers must judiciously apply automation while incorporating human decisioning at critical points in the loan servicing lifecycle. At the same time, investor clients require real-time visibility into loan status and performance, combined with economic scenarios, to seek the best outcome in a tightening market.
Brian Sindell is vice president at BSI Financial Services, which offers mortgage servicing, quality control, due diligence, loss mitigation and REO management services. He can be reached at firstname.lastname@example.org.