Expert AnalysisMay/June 2023 Edition

Lender Defaults Ahead, Are You Prepared?

After 20 years in the mortgage servicing and default management world, I’ve seen a thing or two that might surprise you. Today, as Managing Director and Partner of Servicing at BlackFin, I am always looking to share best practices for default servicing. Especially now as there is a notable shift afoot in default servicing. Make note that defaults are ahead and there is an impending need to start preparing your organization.

Just yesterday, in Yahoo News it was noted that in May 2023 lenders repossessed 4,020 properties through completed foreclosures (REO’s). That’s up 38% from April and 41% from this same time last year. And folks, we are just getting started.

With that said, even as lenders and mortgage servicers focus on squeezing out what they can on the origination side, it’s incumbent on them to start, once again, to prepare by reallocating resources for the support of those pending defaults on the horizon. Or at the very least, make sure your default management infrastructure is scalable in relation to compliance, process, procedures, and ready for audit.

As they say, the numbers don’t lie. Between increased defaults, originations continuing to slow, limited housing inventory, reduced credit availability, and increased cost of money, lenders need to begin to reallocate resources to prepare their default servicing teams.

So, where to start, you ask? Let’s begin by highlighting the most impactful variables that must first be considered in the current state, and then start narrowing down to the practical steps for preparing your organization.

The Current State Assessment

Experience tells us there is sometimes a difficult transition to a renewed attention on default. Many assume this current shift will not happen as quickly or be as drastic as in 2008. However, everyone will need to be cognizant of some of the primary responsibilities that will exist. It will be important to ensure that proper policies and procedures are in place. What are the lender’s current tools for loss mitigation and delinquency resolution? Are processes related to borrower contact regulatory compliant and documented? Do business units maintain dedicated internal or outsourced compliance personnel? If a loan goes to foreclosure how are companies managing collateral analysis, bidding processes and legal outsourcing oversite? Is there proper oversite to ensure they are appropriately maintained and current to industry best practices?

Regulatory Environment

Mortgage servicing has become increasingly stringent, emphasizing the importance of compliance and consumer protection. Regulatory agencies have implemented measures to safeguard homeowners, such as the Consumer Financial Protection Bureau’s (CFPB) mortgage servicing rules. These regulations require mortgage servicers to follow specific guidelines during default scenarios, including loss mitigation efforts and foreclosure procedures. As a result, mortgage servicers are compelled to strengthen their default servicing operations to ensure compliance and mitigate potential penalties or legal repercussions.

The other issue is reporting. How does one manage and document their reporting. If a lender is currently or thinking of becoming Freddie or Fannie approved the reporting requirements for default, specifically borrower interaction, is extensive. There will be multiple requirements for reoccurring and ad-hoc reporting for these relationships and these are very specific and time consuming.

Changing Market Dynamics

The mortgage servicing industry has witnessed a shift in market dynamics in recent years. While origination volumes tend to fluctuate with the state of the economy, default servicing remains a constant need. Economic downturns, such as the 2008 financial crisis, have highlighted the importance of robust default servicing capabilities. Lenders and mortgage servicers have recognized the need to enhance their default servicing operations to effectively manage delinquent loans, foreclosure proceedings, loss mitigation, and asset disposition.

Many servicers and/or lenders are reallocating personnel resources. Potentially redistributing and retraining people can be expensive. There are those who are currently holding job fairs for loss mitigation however the prospect of hiring and training new employees can be expensive as well. In either scenario business units may not have the expertise to perform the required gap review to properly review processes for possible risk and potential efficiency improvement opportunities. 

Evolution of Loss Mitigation Strategies

The focus on default servicing is also driven by the evolution of loss mitigation strategies. Mortgage servicers are proactively working with borrowers facing financial hardship to explore alternatives to foreclosure, such as loan modifications, repayment plans, short sales, and deed-in-lieu of foreclosure arrangements. These loss mitigation efforts require specialized knowledge, resources, and processes to navigate complex borrower situations effectively. How do lenders scale all these activities from a resource allocation perspective to ensure minimization of costs and maintaining prosperous margins? Would it be more cost beneficial to outsource some of these activities.  If so, how do companies manage quality control for their outsourced vendors. It does however allow the opportunity to cost effectively maintain more scalability to manage the fluctuation in loan volume levels.

Investor Requirements and Risk Management

Mortgage servicers often act as intermediaries between borrowers and investors who hold mortgage-backed securities. Investors, including government-sponsored entities (GSEs) such as Fannie Mae and Freddie Mac, impose strict requirements on mortgage servicers to manage default scenarios efficiently. Servicers must adhere to specific timelines, reporting obligations, and quality control measures to meet investor guidelines. By focusing on default servicing, mortgage servicers can ensure compliance with investor requirements, reduce credit risk exposure, and protect the interests of all stakeholders involved.

Operational Efficiency and Cost Optimization

The transitioned focus to default servicing offers mortgage servicers the opportunity to enhance operational efficiency and optimize costs. While origination processes require substantial resources and personnel, default servicing can benefit from advanced technologies, automation, and streamlined workflows. By investing in innovative solutions, such as loan servicing platforms, digital document management systems, and analytics tools, mortgage servicers can streamline default servicing operations, reduce manual efforts, and achieve cost savings.

In conclusion, the mortgage servicing industry is starting to experience a significant shift in focus, moving away from origination and towards default servicing. Evolving market dynamics, regulatory changes, loss mitigation strategies, investor requirements, and operational efficiencies are driving this transition. Mortgage servicers will recognize the need to enhance their default servicing capabilities to effectively manage delinquent loans, foreclosure proceedings, compliance requirements, and risk mitigation. By embracing this transitioned focus, mortgage servicers can better serve borrowers, investors, and regulatory expectations while positioning themselves for long-term success in an evolving industry landscape.

In the end, the question is how you will look at your existing infrastructure and will you be prepared for these changing needs.