There is no question that mortgage originators have faced difficulties the past few weeks when it comes to moving to remote work, handling the high levels of applications and requests for refinances and much more. But these issues are also carrying over to mortgage servicers.
No one could have predicted what would happen to the mortgage industry after COVID-19 began to spread. The mortgage application volume increased a full 55% in one week, and was up 479% from the year before as rates tumbled.
The Federal Reserve cut rates, and then cut rates again before even making it to the Federal Open Markets Committee’s March meeting. These rare inter-meeting cuts came after the worst stock market retreats since 2008, with the federal funds rate dropping to 0%.
But for servicers, the situation is much more dire as they face problems on multiple fronts caused by the virus, along with the increase in demand.
Early payoffs threaten profits
The surge in refinance and origination volume is drastically increasing the number of early payoffs for servicers.
“It was the greatest nightmare, ever,” Logan Mohtashami, a columnist for HousingWire and a senior loan manager at AMC Lending Group, said when describing the week after the Fed made its first emergency cut.
Monhtashami explained that interest rates were actually held higher than they should be because servicers were keeping them elevated due to early payoffs.
“I understand the capacity constraints that the lenders are talking about, but this was all an early payout issue,” he said. “There are going to be too many losses taken, which is why you saw a unilateral increase in rates.”
“Monday morning there was red tape on everything in terms of how much pay off risk – it got painful,” Mahtoshami said. “And then rates just kept on going higher and higher faster.”
Servicers have the potential to mitigate some of this risk if they have an origination arm that can recapture the refinance business within its portfolio, or if subservicers funnel leads back to them. But not all servicers have these options available.
“There is usually very little that servicers can do to deal with these types of situations,” Fitch Ratings Managing Director Roelof Slump said. “Certainly cases where the servicer has an origination arm they are naturally hedged because they have origination and new servicing coming in with current coupons that are much lower than the existing books.”
“That ultimately helps significantly to maintain servicing portfolios,” Slump said. “And if the servicer’s origination arm is able to recapture or keep the existing customers, that’s even better.”
But before the full force of the refinance surge hit, Black Knight data shows that in the fourth quarter of 2019, only one in five borrowers remained with their servicer after they refinanced.
A shift in delinquency levels
Even if lenders and servicers are able to protect against portfolio runoff, that’s not the only challenge they’re facing. Mortgage default rates are expected to increase for the first time in more than a decade.
The latest data from Black Knight shows mortgage delinquencies are at all-time lows. For the first time since 2005, the beginning of this year started with less than 2 million non-current loans, which is anything 30 days or more past due, including those in active foreclosure.
This 15-year low isn’t going to last through the year though since, for the first time in several years, servicers expect mortgage default rates to increase.
“There’s going to be an increase in borrowers reaching out to their servicers for help for consideration as they experience short term disruptions of income,” Slump said. “I think that’s probably something that’s happening today as we speak. There’s been more of an influx of calls coming into the servicers.”
One expert explained that the refinance boom, while stronger than normal, will not be the greatest obstacle servicers face. The Money Source President Ali Vafai explained that the mortgage industry sees a refinance boom about every three years. Comparatively, the industry only sees an increase in mortgage delinquencies once every 10 to 15 years. And now, the industry is seeing both, at the same time.
Exactly how many delinquencies should we expect? According to Vafai, there could be quite a few.
“We should be prepared for 2008 delinquency levels,” he said.
The U.S. is already bracing for the impact as Fannie Mae, Freddie Mac and the U.S. Department of Housing and Urban Development announced a suspension of foreclosures and evictions for at least the next 60 days.
Federal regulations state that servicers need to send payoff quotes out within seven business days of receiving the request, driving servicers to ramp up operations.
“We’ve had to reallocate our team just to keep up with those turn times,” Vafai said.
He explained that while TMS’ system is highly automated, the company also informs its subservicers when it receives payoff requests so they know when the consumer is out shopping for mortgages.
But the coronavirus is making this step more difficult than it would normally be since the majority of workers are remote right now.
Servicing is making major advancements in the technology field through use of artificial intelligence and machine learning, however, progress is slow, and many servicers are missing the technology they need for their workforce to function remotely.
“Servicers need, from a staffing perspective, to have the capabilities to manage more delinquencies,” Vafai said. “And pair that up with the coronavirus where you have to now potentially work remote. If you lose half or 25% of your workforce because they can’t work remote, and you had to go double your staff – you can do the math. That’s a big problem for most servicers, but fortunately not for us.”
Servicers now also have to prepare for the potential of higher operating costs.
“Servicers may not be able to balance their higher cost of operation as delinquencies increase,” Slump said. “And it may just be a temporary spike right now, but borrowers will likely be calling and asking for guidance. And as more borrowers call in and ask for help, you need more staff.”
“It could be a double-edged sword where, in addition to faster prepays of the existing book you have higher costs, and that can lead a servicer, especially an independent servicer, to need or want to consider strategic alternatives,” he said.
Learning from current events to better prepare for the future, there are several clear factors that, if they had been utilized, could have created faster turn times and higher profit margins during a tumultuous period.
One example, mentioned above, is that servicers should have the capability to work remotely in order to continue operations through a vast array of scenarios. But there are other technology areas that could significantly help servicers during times of crisis in the future.
“Servicers have dealt with technology limitations by building ancillary systems and build around to deal with the limitations in order to meet regulatory requirements and to meet program guidelines that the institutions offer,” Slump said. “I think they’ve been able to do that reasonably well, and it hasn’t contributed to significant problems for them other than it is all costly. So legacy systems, to the extent they’re not able to adequately deal with 2020-type expectations and requirements, need to be modified and to be enhanced.”
But for now, servicers are preparing for a hit to their liquidity as their ability to borrow diminishes due to lower rates and early payoffs.
“As the value of servicers mortgage servicing rights drop, whether just because they’re marked to market and when the interest rates go down, the prepayment expectations go up, and therefore the asset value drops, or they’re real, meaning the loan actually paid off, of course, the mortgage servicing rate goes to zero when the loan has paid off,” Mortgage Bankers Association President and CEO Bob Broeksmit said in a podcast with HousingWire CEO Clayton Collins. “That limits their ability to borrow against the value of those mortgage servicing rights. So that’s a liquidity hit.”