S&P: State regulations squeeze mortgage servicing profits

But compensation rates aren’t changing

With fighting blight a top of the priority for the government, mortgage servicers are tasked with making sure they stay up-to-date with the changing regulation or face the pricey consequences.

S&P Global outlined the challenges facing mortgage servicers in a recent report, stating, “The state regulatory environment for the preservation of foreclosed properties is continuing to evolve, which has precipitated additional cost and resource allocation from servicers.”

“We believe the industry will continue to encounter new and different regulations and approaches by state legislatures to protect their communities,” it stated. “We also expect servicing costs to continue increasing, which may cause servicers to adjust their operations.”

A great example of this is the recent “sweeping” regulations on zombie foreclosures in New York City.

While the U.S. Senate could soon consider new rules governing the maintenance of foreclosed homes and the glut of “zombie homes”, New York decided to take the matter into its own hands back in June and announced legislation to reform the state’s foreclosure process and address the state’s issues with zombie homes.

“For each zombie home that we cure and for each that we prevent with this legislation, we are saving entire neighborhoods from the corrosive effect of blight and neglect,” said New York Gov. Andrew Cuomo. “I thank my colleagues in the Assembly and Senate for seeing a crisis and helping to turn it into an opportunity for people to realize the great American Dream of homeownership.”

The S&P report uses New York as an example of what potential changes mortgage servicers could expect to see.

A zombie foreclosure, the report explained, generally refers to a servicer initiating foreclosure on a vacant property but never actually taking title.

According to the report, New York’s laws addressed several items, including enhanced mandatory settlement conferences, a consumer bill of rights to assist homeowners in knowing their rights when their home is in foreclosure, and an expedited foreclosure process for vacant or abandoned homes.

These changes create new costs for servicers. S&P spotlights two specifically in its report.  

1. Pre-foreclosure maintenance

Under the new rules, the report explained that servicers must properly maintain vacant or abandoned properties pre-foreclosure rather than the prior practice of performing this function later in the foreclosure process.

What it means for servicers:

This obligation becomes effective when the servicer "becomes or should have become aware" of the vacancy. Depending on how the respective court interprets when the servicer should have become aware, servicers could incur substantial fines for not maintaining the abandoned premises. The law may impose civil penalties up to $500 per violation, per property, per day.

2. Property must be reoccupied within 180 days

The report also stated that the New York law requires servicers to take action to ensure that the property is reoccupied within 180 days of taking title.

This poses several complexities, the report explained, “Even in the current improved economy, properties sell based on various factors such as condition, neighborhood, price, and others.”

In the situation that the property is not occupied and is approaching the 180-day mark, the report noted that it's not clear whether the law requires the selling party to rent out the property (so it is reoccupied) or substantially reduce the asking price to sell the property in order to comply.

What it means for servicers:

In our view, either option adds operational difficulty for servicers because they may not be equipped to manage rental properties or they may face significant financial strain due to losses on properties. Also, we are unsure if the property could be sold to an investor who might seek to repair the property and subsequently rent or sell.

These two cost issues lead back to S&P’s belief that servicing costs will continue increasing, which may cause servicers to adjust their operations.

However, as it stands, servicer compensation for non-performing loans is non-existent.

Laurie Goodman, codirector of the Housing Finance Policy Center with the Urban Institute, recently highlighted the gigantic problem surrounding servicer compensation, especially for non-performing loans.      

Currently, the mortgage servicer is generally required to retain a minimum servicing fee of 25 basis points for Fannie Mae and Freddie Mac.

Goodman noted that this 25 bps fee has been used since the mid-1980s, ignoring the fact that the average loan size has gone up from $70,200 to $215,000 in that period.

Doing the math, Goodman calculated that servicing a performing loan costs $181/year in 2015, and servicing a non-performing loan costs $2,386/per in 2015. 

However, gross revenue from servicing the average loan size of $215,000 is $538/year in 2015.

“It costs way too much to service non-performing loans, and way too little to service performing loans,” Goodman said.

The issue is quickly coming to the forefront of industry talk, which is why Goodman was speaking on the issue at a recent industry event hosted by the Urban Institute and CoreLogic.

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