In some respects, 2016 was a “year of healing” for the mortgage servicing industry. For example, this past summer, the Consumer Financial Protection Bureau (CFPB) released its final mortgage servicing rule, which provided much-needed clarity – as per servicer feedback – on the original set of rules that took effect in January 2014. Although compliance will no doubt continue to create headaches for servicers in 2017, most people in the industry agree that the final rule has greatly helped servicers better understand the “rules of the road.”
It was also a huge year in terms of mortgage servicers upgrading their technology and systems to better meet compliance – and, perhaps just as important, to realize new efficiencies and cost savings through automation. Servicers made great strides in terms of meeting compliance mandates through technology upgrades – and, moving forward, they will no doubt continue to heed warnings that they can no longer hide behind antiquated servicing technology.
In addition, delinquencies and defaults – which have become even more expensive to service under the new regulatory framework – have dropped to pre-crisis levels, thus helping servicers further reduce their operational costs and worry less about potential fines and lawsuits. Add in the rising interest rates that came in the fourth quarter, which will help servicers realize better profits through increased earnings on their positions, and things actually start looking pretty good for the mortgage servicing industry in 2017.
To get a clearer view of factors that significantly changed the industry in 2016 – and which factors will likely bring about further change in 2017 – Servicing Management recently interviewed a diverse swath of executives, including Gagan Sharma, CEO of BSI Financial Services; Ed Fay, president and CEO of Fay Servicing; Michael Schreck, senior vice president of default software solutions provider Equator; Kevin Kanouff, president and CEO of Statebridge Co.; and Lee Smith, chief operating officer for Flagstar Bank.
SM: What do you think were the most significant or disruptive factors impacting the mortgage servicing industry in 2016?
Sharma: One of the most disruptive factors impacting servicing last year was the rise in loan payoffs due to the unexpected reduction in mortgage rates, especially post Brexit. Servicers had to scale up their payoff functions in order to meet the surge.
Fay: Compliance was again the dominant factor on the mortgage servicing landscape. Servicers of all sizes are working to enhance their processes and procedures to further comply with the changing regulatory environment.
Schreck: Servicers have to do more with less to remain profitable, as the costs to service performing and delinquent loans remain extremely high – over four times what they cost in 2010. Meanwhile, delinquency has dropped below 5% for the first time since 2008. With budgets shrinking and regulatory risk elevated, technology and advanced analytics need to bridge this gap. Expect an inflow of new disruptive mortgage tech to address this need.
Kanouff: The most disruptive factor in 2016 was the increase in regulation and enforcement from states and the CFPB on servicers. From a special servicing perspective, the sea of change from the CFPB that essentially forestalls foreclosure movement during loss mitigation acted as a countercurrent to reduced foreclosure timelines. Historically, borrowers tended to get serious about loss mitigation deals when the foreclosure clock started ticking. Now, the incentive for borrowers to act is less, and the opportunity to shorten foreclosure timelines has been lessened. Of course, these longer timelines result in reduced neighborhood home values and lower tax revenues. Obviously, the change in administration should reduce the number of new regulations on us.
Smith: In 2016, compliance was a major emphasis – in particular, the cost of compliance. That has been a big thing for the industry. And then, the mortgage servicing rights (MSR) market softened a little bit in 2016 because of the low interest rate environment. So, the number of buyers in the MSR market decreased, and the value of MSRs came down. But, at the end of the year, and as of the beginning of this year, as interest rates moved up quickly and significantly, we saw a number of potential buyers of MSRs coming back into the market, as well as new buyers entering the market. So, we’re now seeing a lot more activity in terms of people wanting to buy MSR assets, and that’s mainly a function of the increase in interest rates that came following the election.
SM: What do you think will be the most significant challenges facing mortgage servicing in 2017?
Sharma: This year will be a time to adapt to higher demands. Servicers will continue their investment in technology for data accuracy and servicing transfers. Servicers must also be able to meet the change in borrower expectations for a digital/online transaction experience.
Fay: Compliance will, once again, be the dominant factor in the mortgage servicing landscape. Servicers of all sizes are working to enhance their processes and procedures in order to further comply with the changing regulatory environment.
Schreck: The unknowns with the new administration may be the single biggest challenge for the mortgage servicing ecosystem. How will regulation change? How will underwriting change? How will the agencies’ statuses change? Without clarity on these and related issues, it is more challenging to know where to place long-term bets. Nevertheless, the core issue of servicing costs and inefficiencies will persist and will require a reinvention of process and technology automation to bring those back in line.
Kanouff: For special servicers such as Statebridge, the biggest challenge is scaling into more performing paper as the number of delinquent mortgages declines.
Smith: In 2017, I think compliance will continue to be very important – servicers are still going to be very focused on doing a good job from a compliance point of view, particularly for the seriously delinquent loans, because the cost of servicing a loan increases significantly once it goes past 60 days delinquency. So, that will still be a major focus.
SM: What impact might a rising rate environment have on servicers in 2017?
Sharma: Higher rates in 2017 would mean reduced payoff rates, which would be a good thing, as that will allow servicers to focus on investing in borrower retention for a longer period, as opposed to loans paying off very quickly. But the unknown is whether mortgage originators will retain servicing in a rising rate environment or sell loans servicing-released.
Fay: The impact of rising rates depends on an organization’s business model. Servicers that derive a great deal of revenue from refinancing their books into better loans for customers will experience some financial headwinds. In contrast, organizations that are primarily focused on servicing should see more stability in their books, with prepay speeds dropping rapidly and MSR valuations rising in kind. However, this makes the assumption that the macroeconomics of rising rates won’t cause a rise in delinquency.
Schreck: I think the consensus is that there will be refinance volume, and perhaps it will trigger some last-minute purchase volume that was on the sideline in the short term. With the Fed likely to continue pushing up rates through 2017, it is signaling a confidence in the economy for the first time since the Great Recession. Ultimately, this is all good news for servicers. The more provocative question may be, when will the yields be high enough for private money to meaningfully enter the mortgage market again? Although that may not happen at scale in the next year, it is another likely impact of a continued rising rate environment.
Kanouff: We own our own MSRs, and we also subservice for others. Rising rates lift boats in both of these areas. For MSR holdings, obviously, rising rates reduce our prepayment speeds, which make our MSRs more profitable and valuable. On the subservicing side, rising rates can similarly help our bottom line, as we have less runoff in our portfolio. Also, we rely on Treasury float for a portion of our income, so rising rates lead to more income for us.
Smith: If interest rates stay in the same ZIP code where they are today, I think we’re going to see a lot more activity as it relates to MSRs – people trading and buying MSRs – and that creates opportunities for those companies that want to subservice and grow their servicing platforms. We feel that we’re well positioned to do that because we’re the only full-service bank in the top 20 servicers, nationally, for which this is part of our core strategy. We also offer a lot of ancillary services to the people who buy MSRs from us; it’s not just subservicing – we can provide MSR lending, we can provide servicing advance lending, and we can provide recapture services because of our direct-to-consumer origination business. So, we see ourselves as having a very attractive offering to people who either buy MSRs from us or buy MSRs from others and want to put them on a servicing platform that they have a lot of confidence in. In addition, a higher interest rate environment reduces prepay speeds – so, fewer loans are prepaying off. That obviously creates a greater balance of loans for servicers to subservice.
SM: Any other factors you see reshaping servicing in 2017?
Sharma: I think there will be continued growth in non-qualified mortgage originations, which will make that asset class larger. As a result, the industry will develop more experience in servicing that product. Although we have seen some securitizations, the industry will look to a revival of the public securitization market.
Fay: From a macroeconomic perspective, rates are rising with improvement in the economy, and that should have a positive effect on housing. However, the risk with rising rates is rising payments on homes, which could cause a stagnation or drop in home prices. Average household income, according to the Fed, is $56,515, while the average home value is $193,800. A 1% increase in interest rates would mean more than $1,500 in additional annual interest – equal to more than 2.5% of the average household income. This is a big chunk of a family’s resources and could have a significant impact on home prices and delinquency rates, especially with adjustable-rate mortgages. The aggregate effect could be another increase in delinquency, which would require servicing organizations to evaluate their staffing models to make sure they are compliant with regulations and agency requirements and are providing an engaged and high-touch customer experience to avoid delinquencies.
Schreck: Although millennials have held off purchasing homes longer than previous generations, their impact on the mortgage market is coming quickly. In particular, their use of social media and smartphones will reshape which mortgage brands thrive in the future. Traditional financial brands do not resonate much with this generation, and whichever company reinvents its technology/processes to match to their preferences will be the big winner. How poorly Wal-Mart competed with Amazon online despite its supply-chain brilliance and purchasing expertise is a metaphor for how a new entrant has a chance to win with this new generation.
Kanouff: Yes, what will Trump do with the CFPB? You now see most of the leaders of large banks saying, somewhat magnanimously, that they think Dodd-Frank and the CFPB as constructed should stay. These guys are not stupid; they know that the current regulatory structure vastly favors them over smaller competitors. They have the scale to comply with the structure, and they know that it creates a heavy headwind for companies without that scale. Dodd-Frank and, by extension, the CFPB cr
Smith: Obviously, we’re all guessing, and I don’t like to guess, but we don’t know what this new political environment will bring. We obviously have built a very robust risk and compliance infrastructure, and I think we feel confident that whatever it is we need to do, we will be in a position to deal with it. Any time there is change, you have to react to it. And I feel confident in our ability to react to it. But anytime you have to make changes, it creates at least some disruption.
But it affects some more than others – and, because some of the statements that have been made about potential regulatory rollback are so broad, it’s hard to say for sure what it really means. It’s all just sort of guesswork at this point. We’ve built a model and a platform where we know where every loan is. We’ve invested a lot in technology and processes and in analytics and management information systems, and we’ve invested a lot in our risk and compliance infrastructure. I believe that gives us a huge competitive advantage, and it gives a lot of confidence for the people we’re subservicing for – and that’s not something that we’re going to want to give up.
On the performing servicing side, the other theme is, it’s all about scale. You really have to have scale on the performing side. And I think something the industry has found is that you probably need at least 175,000-plus loans, on the performing side, to really start to make that work.