As the United States battles simultaneous public-health and economic crises, COVID-19 has presented some unprecedented challenges — many are familiar to borrowers, regulators, servicers and investors who recall the financial crisis in 2008.
In this time of “certain uncertainty,” several recent trends that were seen in 2008 point to imminent financial losses and increasing complexity of existing systems, at a rate that is testing the industry’s resiliency once again. Some of the trends that point to the added complexity that requires businesses to adapt to the ‘new normal’ include:
- Aggressive but uncoordinated response from federal, state, and local agencies, resulting in a confusing web of new regulations and moratoriums posing a challenge for the servicing industry and creating unique risks for borrowers, investors and servicers.
- The need for remote workforces to service clients, which results in additional costs for communication and management tools to be effective.
- Call center volumes, which have spiked past the capacity to respond to incoming calls.
In addition, a number of factors point to a state of political and economic instability that analysts are comparing to the 2008 market crash – unprecedented unemployment rates, decreasing home prices, a high bankruptcy rate among small and medium businesses, high rates of forbearance and urgent government measures intended to save entire sectors from collapsing (aircraft and travel, manufacture, food and hospitality, etc.).
In a time of crisis, communication between borrowers, servicers, regulators and investors is critical. Servicers can play a pivotal role across these stakeholders to flag inconsistent and conflicting regulatory guidance, identify reputational and financial risks for investors, and work through the complicated loss-mitigation process with borrowers. To do this effectively, servicers will need to communicate with all stakeholders early, often, and clearly.
Our perspective is drawn from more than a decade of fieldwork on high-stakes investor/servicer and master servicer/subservicer litigation disputes, regulatory enforcement actions, and significant settlements in mortgage history including the Independent Foreclosure Review, National Mortgage Settlement, and Residential Mortgage Backed Securities Settlements.
Serious losses and litigation are potentially on the horizon
In the aftermath of the previous financial crisis, the industry experienced massive losses and litigation that continue today.
- Settlements of credit crisis-related litigation between 2007 and October 2013 totaling more than $32 billion.
- Settlements related to mortgage repurchase claims by Fannie Mae and Freddie Mac exceeding $18 billion to date.
- The U.S. government has recovered more than $34 billion in settlements of its claims against various banks in relation to allegations of improper foreclosure proceedings and other consumer finance issues such as fairness in mortgage lending.
We believe that data from regulatory bodies and analysts points to a serious, credible risk that the industry may experience challenges like those witnessed during the financial crisis of 2008. The abundance of conflicting, ambiguous, and rapidly evolving regulations coming from multiple, often uncoordinated sources may present challenges like past financial crises.
HUD alone has issued 14 mortgagee letters since March 18 in response to the COVID-19 crisis, a volume and velocity of regulatory change that is similar to the financial crisis — but has still not answered many of the central questions that servicers face today.
For example, HUD has not opined on extension requests, or whether they will be more forgiving to delays directly or indirectly caused by COVID-19’s impact. And while HUD has provided temporary relief on the so-called First Legal and Reasonable Diligence Milestones, significant ambiguity exists in the interpretation of the guidelines.
Additionally, HUD has been silent on the 30-day Conveyance deadline. Foreclosure moratoriums and reduced property preservation capacity will put properties at risk of deteriorating conditions and put strain on servicers trying to meet conveyance requirements. Shelter-in-place and other work restrictions will affect property preservation work, and likely result in delayed timelines and increased holding costs. Yet HUD has offered no guidance for servicers facing these COVID-related delays.
HUD is also facing the same challenges as other entities, managing remote contractors who are working at less than 100% capacity. This may only exacerbate the timeliness and consistency of requests for common activities such as extensions, clarifications, approvals, and over-allowables.
Meanwhile, state regulators are issuing their own regulations, which often contain additional ambiguities.
For example, in New York, the governor is implementing a new executive order, effective for 60 days starting in late June, that suspends eviction for borrowers who can demonstrate either that they are eligible for unemployment insurance or benefits, or that they are facing financial hardship because of COVID-19.
This executive order is narrower than the current pandemic eviction moratorium, which barred all residential and commercial evictions, but that only heightens the potential risks for servicers, who will need to determine exactly what documentation New York expects for demonstrating the borrower’s hardship, implement procedures to comply with these new documentation standards, and communicate the state policy to agencies, insurers, and investors when seeking relief from foreclosure milestones and timelines.
All of these inconsistencies and ambiguities create substantial risk for all stakeholders involved. A servicer acting on their “best interpretation” of these regulations is squeezed between foreclosing too quickly, hurting borrowers and subjecting the servicer to significant regulatory exposure, and foreclosing too slowly, jeopardizing any guarantees or insurance on the loan creating a different type of regulatory exposure.
As we saw in the financial crisis, these risks are heightened by the likelihood that the servicers’ decisions may be questioned years later —when the crisis is a distant memory, but the financial losses are a present reality.
What can servicers do?
Right now, servicers, investors, regulators, and borrowers can likely all agree that some “crisis-response” changes are needed — though these may need to evolve once the crisis is over. Building consensus about how to handle the crisis now, and memorializing any agreements reached, will help keep stakeholders satisfied while resolving disagreements that could arise later.
During the crisis response, the focus remains on protecting borrowers and keeping them in their homes. As the industry starts to emerge from the crisis and losses are realized, the focus will shift from customer care to accounting for losses incurred on the balance sheet. The financial crisis from a decade earlier has demonstrated that the guidance to keep borrowers in their homes will become a distant memory when the hard reality of potential claims — and losses — come due. Default servicing processes, agency timeliness, and penalties will be front-and-center again.
Thus, it is imperative that servicers be transparent and proactive today, with communications that identify the challenges and explain the response plans, which they regularly send to regulators, investors, master servicers, and borrowers.
For example, they should proactively communicate with regulators when gaps and inconsistencies are identified, and document any responses. These communications can guide subsequent conversations with investors, master servicers, and vendors, about plans for providing borrower relief, suspending foreclosures, delaying repairs, and other crisis-response plans as they are being implemented. All parties will need to understand that any service-level agreements in place may need modification for the current crisis (indeed, many may be impossible to adhere to under current state regulations), but documenting precisely what changes are expected will help avoid challenges in the future.
Servicers play a pivotal role in the mortgage industry. They are responsible for implementing regulatory obligations, managing investor requirements, navigating borrowers through the processes, and coordinating with title companies, insurance agencies, property vendors, and virtually all other participants in the process. They can use effective crisis communication to identify where opportunities exist, and where breakdowns occur, in a way that other stakeholders cannot. By effectively communicating these issues and building consensus around a response, they may help to avoid some of the worst difficulties from the previous financial crisis.