At its core, the Obama administration's foreclosure prevention program makes mortgage servicing the lynchpin of a new process that looks to modify and refinance millions of delinquent and underwater mortgage loans. The administration is attempting to incentivize servicers to be both proactive in soliciting modifications and to collect sufficient verifiable information to reunderwrite a borrower's credit in order to modify the existing loan. The plan provides for an annual incentive payment to the mortgage servicer provided the modified loan remains current.
The plan is consistent with an urgent need to transform the existing servicing loan model from one that is high-volume, requiring minimal contact with the borrower-where the principal metrics of efficiency include loans serviced per employee and average monthly cost to service- to a new model in which a significant portion of the loans are serviced in a diametrically different manner.
In this new servicing model, the servicer obtains sensitive financial information from borrowers and resolves complex modification terms and conditions. These borrowers had been previously dealt with under servicing arrangements that sought in-person borrower contact only in the event of delinquency and gave servicers virtually no leeway to modify loan terms based on a change in borrower financial condition. In the new model, the servicer/customer interface will push credit judgment to a trained servicing representative, who works in close contact with the customer to get an economically meaningful modification done, using new electronic tools.
In order to support this kind of new credit management, a servicer will need desktop access to tools/models that enable rational modification of a borrower's loan terms and legal documentation regarding revised loan terms. Alternatively, in certain instances, per these new tools/models and documentation sources, a servicing representative could agree to a short sale or a deed in lieu of foreclosure if a modification is not a feasible outcome.
Providing the analytical tools to support credit decisions, assigning accountability to individual servicing representatives and incentivizing these hands-on representatives and their teams while continuing frequent contact with the borrower-both before and after modification-are the new model steps to maximize recoveries. Technology will continue to be useful, but it must be applied to automate documentation, accelerate reunderwriting of the borrower and provide economic analysis to support loan modifications or alternative borrower settlements.
Certain servicers have already moved rapidly in this direction, developing large loss-mitigation teams within their special servicing units to engage delinquent borrowers, both on an inbound and outbound basis. This has required new training, around-the-clock and weekend scheduling, new documentation and loan recording protocols and incentives to servicing personnel that are markedly different than in the past. Assigning a dedicated individual servicing representative to a specific loan seems effective in achieving modifications, which have resulted in refinancings or lower rates of delinquency recidivism.
Certain servicers have adopted a strategy to create dedicated servicing cells where team members are assigned to work exclusively with a particular investor's loans, and they can work closely with the investor using the criteria for loan modifications and carry out targeted campaigns prescribed by the investor. We expect to see further permutations of the new servicing model.
For example, there are small servicing shops to which servicing of highly delinquent loan portfolios have been transferred in which the investor and the servicer have agreed to a value for each loan that has transferred. The servicer and the investor have contractually agreed to share the incremental value of any improvement in loan value upon modification and/or subsequent refinancing. Loan values are based on prices in the secondary market for distressed residential loans and generally reflect high funding, scarcity and supply/demand imbalance. Recoveries through modifications and refinancings can result in significant compensation to the servicing joint-venture partner. This, of course, argues for incentive compensation to be shared at all levels of the servicer and certainly challenges the notion that scale is the dominant metric to evaluate servicing.
Unfortunately, in comparison to the scale of the problem, the creation of sufficient loss-mitigation capacity is inadequate. Servicers for the most part still operate under a mandate that requires the original loan balance to be collected at par. Accordingly, even use of a cell-based triage process has led to unrealistic and often unaffordable modifications in which insufficient economic relief is given to the borrower. Renewed delinquency occurs frequently in this context, and foreclosure is often the result.
The administration's plan intends to modify the economics behind now-punitive servicing mandates. It calls for an annual payment of $1,000 if a modified loan remains current and provides funding to buy down the monthly mortgage and escrow payment to 31 percent of income. This is a strong incentive, but to work well, the plan needs to clearly support sharing both the government incentive and higher recovery values with all levels of servicing, especially with the loss-mitigation professionals. Incentive compensation arrangements-which reward departments, teams, supervisors and servicing representatives-are critical. Fortunately, given that most of these kinds of troubled mortgages have high loan balances, the recovery differential achieved by a servicing representative working with a borrower, compared with a foreclosure outcome, is sufficiently high enough that the Obama plan, if properly implemented and generously supporting all necessary servicing incentives, may work to mitigate delinquency levels meaningfully.
With properly focused, federally supported incentives, servicers could be even more proactive in contacting borrowers because the vast majority of foreclosures involve borrowers who have never had discussions with their loan servicer. In many instances, the property is vacant and the servicer's only alternative is pursuing a time-consuming and expensive foreclosure process. In our view, using third-party doorknockers to visit a property in the evening and on weekends and contacting neighbors is an effective way to reach a reluctant borrower or, in some cases, will lead to owners who have left the property but are willing to enter into a deed in lieu of foreclosure in exchange for a release of a deficiency or a modest payment. Servicers are sometimes reluctant to engage doorknockers because of cost, but deploying some of the federal incentive funds to back this outreach, in our view, could prove to be highly cost-effective and can result in a larger number of loan resolutions.
Borrowers, particularly those that overstated their assets and income when a loan was originated, must be confident that they can negotiate with a servicer that is responsive and can quickly reach a resolution fairly, as there is little benefit to either party in driving a foreclosure. Achieving this common ground is the key to the new servicing model, and the Obama plan is a good first step in ensuring that the new model is broadly and effectively implemented.