Return on Quality

The recent MBA Mortgage Servicing Conference in San Diego, at which the talk of loan modifications was front and center, reminded us of an article published in the November 2009 issue of Mortgage Banking magazine titled “Servicers as Originators“ [requires subscription]. That article described the most significant recent development in the world of mortgage servicing: the need for mortgage servicers to act like mortgage originators as they re-underwrite loans under various loan modification programs such as HAMP.

While loan modifications are not new, the sheer scale of pending loan modifications has overwhelmed servicers and drastically extended processing times.  At the same time, critical scrutiny of the process and pressure to accelerate the pace of completed modifications, has created fertile conditions for a new loan quality disaster. 

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This represents a vastly more complicated “servicing” process than traditional servicers are used to.  Indeed, the modification process is arguably more complex than the origination of a new loan, requiring a re-underwriting of the loan, complete with credit reports, appraisals and verifications (income, asset and employment).  All this in addition to program-specific documentation requirements, which in the case of HAMP, are onerous.

Recognizing this requirement for a different skill set, servicers have been hiring servicing reps with origination experience.  Thus, much of the production staff of now defunct mortgage lenders have new gigs as servicing staff, no doubt helping unemployment numbers in subprime epicenters such as Irvine, CA. 

In addition to massive new hiring, servicers are deploying new or modified software systems to automate what they can; outsourcing various sub-processes where they can; and trying to stay in compliance as program guidelines change.  Which they do, frequently.

As servicers struggle to meet these challenges, it falls on auditing and quality control professionals to ensure that the latest processes and compliance requirements are adhered to.  Unfortunately, this is not an area where software vendors have invested much time or effort.  Except Cogent, as it happens.

Cogent’s ServicingQC system was introduced more than a decade ago and has evolved into the most sophisticated quality control system available for servicing operations.  Moreover, with the release of the CogentQC.NET platform, virtually all of the functionality of Cogent’s ProductionQC system - designed to monitor origination quality - can now be embedded into a ServicingQC system.  Result?  A ready-made platform for servicing quality professionals to monitor their new “servicing” process: loan origination.

Ocwen Financial Corporation, which does residential and commercial loan servicing, special servicing and asset management, is reporting significantly better results in its HAMP modifications than the rest of the industry.  And they attribute it to superior technology. 

In congressional testimony, Ocwen’s President Ronald Faris claimed:

• that Ocwen is converting trial modifications to permanent modifications at a rate that is 10 to 20 times greater than industry average;
• a 3-month re-default rate of less than 5% for Ocwen, versus 18.7% to 33.7% for the industry; and
• a total of 100,000 successful modifications since the beginning of the mortgage crisis.

These impressive numbers could use a little clarification.  So could the statement that Ocwen has spent “$100 million in R&D to build loans servicing technology that incorporates behavioral science for effective customer communication and is also scalable for high volumes.”  But Ocwen is an industry leader and when they report these kinds of results, it’s worth listening.

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Likewise, their recommendations for improving the HAMP program carry weight.  Among those:

• Lower the borrower debt-to-income (DTI) ratio for modifications to below 31%; in other words, allow for lower monthly payments on modifications  
• Allow for principal reductions on modified loans  
• Make additional funding available for housing counseling groups
• Require underperforming servicers in HAMP to outsource to servicers that perform 

Also worthy of note: Mr. Faris is one of the few industry voices who believes that HAMP is a “well designed response to the mortgage crisis”.  Maybe he’s on to something.

Mortgage servicers have no choice but to open their kimonos to Freddie Mac’s MHA Compliance (MHA-C) division.  So when MHA-C offers to share its insights, as they did at the Mortgage Bankers Association’s National Servicing Conference last week in San Diego, there’s a rapt audience of servicers, most of whom are struggling to comply with HAMP programs.

Servicing Management magazine was there to capture the main points.  The presenters were quick to acknowledge the difficulty of setting up and complying with the program.  However, citing Sarbanes-Oxley as an appropriate benchmark for packaging HAMP modifications, the panel suggested that a lot of the loan packages they see seemed devoid of any due diligence or quality control. 

So how do you deal with a constantly changing program that is known to be difficult to comply with but that has high documentation standards?

“The biggest takeaway I’d have for a servicer is to really understand the program, which is why I recommend having somebody in the organization who is the ‘internal expert,” says Vic O’Laughlen, vice president of servicer oversight for the division.  This becomes more important as the programs morph and spin off programs are introduced (like Home Affordable Foreclosure Alternatives (HAFA).) 

As we all know, MHA is a work in progress.  The question is, will it ultimately be a successful work?

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For a clear, concise perspective on which parts of HAMP are and aren’t working, and why, take a look at this interview in HousingWire with Gagan Sharma, president and CEO of BSI Financial, “an outsourcing provider specializing in mortgage subservicing, default management, loss mitigation, due diligence, REO and quality control services to over 240 lenders and investors.” 

Among the insights:

• Loan modifications will only work for a subset of distressed borrowers, as the Treasury Department admits.  Of the 7 million or so eligible, only 1.5 million are real candidates and with fewer than 800,000 trials in place, it’s doubtful that we will see 1.5 million permanent modifications.
• Even modified loans are in danger of re-default, for two main reasons: 1) many if not most HAMP borrowers are underwater and 2) unemployment will remain high for some time.
• The willingness to reduce principal may be the single biggest determinant of modification success. But owners of mortgages have different incentives in that regard.   Banks must recognize the loss immediately, which is not appealing.  Investors who bought loans at 40-to-50 cents on the dollar may be more willing.
• Short sales and deeds-in-lieu of foreclosure are good alternatives to HAMP (and non-HAMP) modifications.  Generally faster to process, these alternatives give borrowers an incentive to maintain the property and leave mortgage owners with better collateral.

If we’re going to solve the problems that HAMP was designed to solve - stabilizing the housing market and keeping borrowers in their homes - we need to look at the incentives built into the program.  The reality is that for most servicers, HAMP is not a money-making proposition.  It costs them more to set up and maintain a HAMP infrastructure (people, systems, processes) than the payback they can expect from the program.  There must be a better way.

At the launch of HAMP (Housing Affordable Modification Program), the Treasury Department and the Department of Housing and Urban Development (HUD) set as their goal the modification of 3m to 4m mortgages.  Through December 2009, approximately 850,000 borrowers had been placed into trial modification programs and 66,000 had been placed into permanent modifications.  Hardly a blistering pace.

We outlined some of the issues with the structure and deployment of the program in our HAMP Best Practices article published in the December 2009 issue  of Servicing Management magazine.  Mentioned in that article were the documentation requirements of the program, which slowed the process down.  In recognition of this, Treasury and HUD have released new requirements for upfront documents and guidance on permanent modification conversion.

Effective for all trial period plans with effective dates on or after June 1, 2010, a servicer can only evaluate a borrower for HAMP after receiving an initial package that includes a request for modification and affidavit (RMA) form; the Internal Revenue Service (IRS) 4506T-EZ form, which gives servicers the ability to pull the borrower’s tax return; and two pay stubs from the borrower for proof of income.

Said Herb Allison, the assistant secretary for the Treasury: ““We’re making it as easy as possible for homeowners to provide the documents. A lot of the problem of converting the trial mods to permanent mods has been time delay between the verbal communication about their eligibility to actually getting the documents and sending them in.”

Every little bit helps.