“Third parties are an extension of the engaging organization and, in some cases, perform very critical functions for them. Therefore, it is vital to ensure that third party ecosystems, supply chains and other external partnerships are as resilient as the engaging organization.”
—Business continuity consultant, RSA Archer
After a year like 2020, no one would question the need for disaster preparedness, nor would any business question the importance of conducting regular and thorough risk assessments of vendor operations. Mortgage servicers have redundant providers for most critical functions: credit, valuations, telephone, internet and more, regulators strongly encourage this type of disaster recovery planning. Yet most servicers still work with a single tax service provider and often don’t require diversification or back-up planning for tax service vendors.
A single tax service provider poses many dangers for servicers and their clients. This article will break down what’s at risk and drill down into what it takes to implement an effective tax service disaster recovery plan.
Geographic Risk & Redundancy
The Texas ice storms in February of 2021 complicated an already fragile balance of working conditions in the middle of a pandemic. Without warning, almost an entire state lost internet, power and even access to natural gas. Fast moving, often unforeseen events, like the ice storms, underscore the need for operational resiliency and redundancy. From a tax service perspective, the Texas ice storms occurred in a relatively low workload month. If these storms occurred in December, during the busiest peak cycles for the entire industry, the impact of unpaid tax bills for our clients and their borrowers might have been catastrophic due to the business interruption it caused.
To prepare for the unexpected, servicers need to conduct due diligence on their tax service providers to determine the resiliency of their operations and diversify where appropriate.
Here are some questions to consider when conducting the due diligence.
- Are there separate domestic locations where all processes can be performed?
- Are subject matter experts and specialty departments isolated in one location?
- Are processes redundant and easily transferrable?
- What is the reliance on offshore vendors, and is there stability and diversification amongst them?
In addition to considering geographic separation, volume distribution also comes into play. It is important not to over saturate any one location so that the business’ ability to lift and switch in the event of an emergency is not crippled by volume and concentration. Best practices suggest that no more than 40%-60% of total volume should be handled by any one partner.
Equally important to geographic separation is the ability to switch from facility centric to a secure remote work environment. Prior to the covid-19 pandemic, a work from home concept was not a critical need. Last year the world had to create a remote work infrastructure to survive within a matter of weeks. Most companies now have secure solutions for this enormous challenge, and the agility of switching to a secured and efficient remote working environment needs to be maintained as part of a regular disaster recovery plan.
Switching Vendors vs. Service in House
Regulators, including the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC) and the Consumer Financial Protection Bureau (CFPB), have made it clear that an institution’s board of directors and senior management are ultimately responsible for managing activities conducted through third-party relationships and identifying and controlling the risks arising from such relationships. The CFPB and OCC consider escrow servicing and payments a critical servicing function that, if disrupted, could negatively impact borrowers.
One of the best ways to be resilient and mitigate risks is to diversify tax service providers. The OCC also states in bulletin 2013-29 they expect “more comprehensive and rigorous oversight and management of third-party relationships that involve critical activities” and critical activities are defined as having significant customer impact (not paying taxes on time) and/or “causes a bank to face significant risk if the third party fails to meet expectations” (note, tax liens are superior to mortgage liens). Relying on a single vendor for all tax service creates an enormous risk and liability for a financial organization.
Tax service diversification needs to be done proactively; given the time required to implement such a critical vendor and the level of detail involved in the scope of work this is not something that should be done at an emergency hour. Contract negotiations will vary by client and may be materially impacted by certain key factors such as: organizational structure, amount of time needed to approve contracts, the due diligence process, and obtaining vendor management & compliance sign off. It is also important to budget time for technical connectivity to third-party loan servicing systems and developing business rules specific to your servicing needs.
The servicer has a legal obligation to continue to provide tax services and pay the taxes during this disruption; there is no grace period for the inconvenient timing of a tax vendor conversion. If there is an interruption, and no tested back-up plan is in place, this means that a servicer may be forced to take tax service in house until they are able to set up the alternate provider.
On the contrary, for servicers that opt to bring tax service in house for a disaster recovery response, rather than call upon a diversification plan, there are serious risks to consider due to the complexity of property taxes and escrow management. For example: Are there resources available that are cross trained in property taxes, and do these resources have the capacity to handle their current job functions plus tax?
Assessing the capacity and skillset proactively is essential because tax service has thousands of nuances. Attention to detail is key to minimizing borrower impact and financial loss.
Additionally, consider the impact of your infrastructure if tax service is brought in house. For example, does your loan servicing system support tax payment facilitation? What are the accounting functions or policies and procedures that need to be documented for disbursements? Is additional staffing needed? Are there formal training and QA management teams established? Will there be liquidity concerns?
The longer the business interruption, the higher likelihood of some taxes not being paid on time. This will not only create anxiety for borrowers but may well draw the attention of consumer advocacy groups, public media, and regulatory agencies such as the CFPB.
Our Recommendation – Diversify Proactively
Long before the next emergency, here are some fool-proof recommendations to hedge your risk with tax service.
- Create a plan and split the portfolio across the tax vendors and platforms. Different business models have different needs, a split that is 50/50 or 60/40 divided across a balanced mix of states can provide immediate relief and transfer when needed. Consider options for the best approach to splitting tax service. Does it make sense to divide portfolios by state, by clients or by business line?
- Complete the vendor management and contracting process with a second tax vendor as soon as possible. This will dramatically reduce the ramp up time during a crisis.
- Work with both vendors to establish SLAs or KPIs that are comparably similar; this way you can measure the performance against each other and have an even comparison. This takes some investment in the beginning, but the rewards will pay dividends. This sparks inherent competition between the two vendors and a byproduct should be better service from both.
- Ensure the portfolio is loaded to the secondary or back-up tax vendor. Just having another contract is of little help if the portfolio still needs to be boarded. This often gets overlooked and the impact is particularly painful for borrowers who are in the middle of a tax cycle when a transition occurs. Having the portfolio pre-loaded with the second tax vendor allows the vendor to include properties in tax bill procurement requests immediately, which can dramatically reduce payment delays.
- Establish financial processes and accounting controls so that if a switch over is needed, tax payments can be funded and disbursed immediately. For example, make sure banking relationships are set up to support the payment process end to end, custodial accounts are established and that check signatures and wire functionalities are set up.
- Test interfaces and loan servicing system connectivity ahead of time. For example, make sure that tax payments flow through the loan servicing system, that open item files are connected and that remote check printing is up and functioning.
The risks are clear, it’s important to design and implement a tax service diversification plan today. When and if your organization is faced with a material service disruption you will move gracefully to your back up plan and greatly minimize borrower and business impacts.
Jim Micali is Chief Operating Officer at LERETA. Since 1986, LERETA has provided the mortgage and insurance industries the fastest, most accurate and complete access to property tax data and flood hazard status information across the U.S. LERETA is committed to giving customers extraordinary service and cost-effective property tax and flood solutions. LERETA’s services are designed to increase efficiency, reduce penalties and liabilities and improve processes for mortgage originators and servicers. LERETA’s dedicated teams of real estate tax and flood professionals along with LERETA’s experienced management team allow the company to lead the industry in service and technology.