Will Servicers Be the Next Victim of the Housing Crunch?

Reuters’ Al Yoon hits it out of the park today on the trouble that likely lies ahead for many of the nation’s servicing shops, both large and small:

“If they are not careful, servicers may be the next in line” to follow dozens of failed mortgage lenders, said Rick Smith, chief executive officer of Marix Servicing LLC in Phoenix, Arizona. “They are not getting more loans, but need twice as many people. How long can you operate at a negative cost of service?” Servicers of subprime loans, such as Ocwen Financial Corp., are in the worst predicament since the companies must send payments to investors of mortgage-backed bonds created out of pools of home loans even if homeowners are delinquent, analysts said.

Ocwen, for the record, has a much-coveted servicing contract from the VA; and, of course, it’s not just Ocwen that’s having to provide advances — every servicer faces this problem. And that should provide some pause to a part of the mortgage industry that operates on pretty thin margins to begin with; doubly so when we hear broad public commitments to increasing loss mitigation from six of the nation’s largest financial institutions. Each of the big six has a sizeable servicing portfolio of its own. But while all servicers will face this new sort of crunch, it is particularly firms like Ocwen — stand-alone servicing shops that aren’t married to a deep-pocketed bank — that are most likely to be sent reeling by a flood of troubled borrowers. While servicers are likely to eventually recoup most of their advances, the time horizon on collecting those repayments is increasing exponentially as REO inventory continues to pile up and goes unsold for months on end. Which leads us to what could end up being the single largest inflection point in the servicing industry’s history. This is an industry — particularly in default management — that has long operated under cost mandates moreso than any sort of real value proposition:

“There are a lot of actions (by servicers) that are cost-minimizing and not performance-maximizing,” Rod Dubitsky, a managing director at Credit Suisse, said on an American Securitization Forum panel, the nation’s biggest bond lobbying group, in Las Vegas last week.

Reuters cites Marix in particular, a new-entrant into the servicing space, as a servicer looking to differentiate by paying the bucks needed to bulk up loss mitigation. The company is putting a focus on loss mit specialists instead of bulking up call center staff as part of a way to win servicing contracts from frustrated investors, according to Reuters. But it’s not just loss mitigation that’s being put under the microscope now that the number of distressed borrowers is rising; foreclosure and REO management also face similar strains, as many servicers outsourced these two areas during the housing boom in an effort to keep costs as low as possible. As the volume of defaults have continued to rise dramatically, servicers are now finding themselves increasingly reliant on an often unregulated and patchwork network of vendors to ensure that foreclosures are properly processed, evictions are managed properly, and so forth. Some servicing executives I’ve spoken to recently have said they’re having to rethink their operating strategy. “We can’t be held hostage by fact that one of our vendors is the weakest link,” said one executive, who asked not to be named. Reuters quotes Bear Stearns’ Tom Marano as saying that “servicing is going to be the focus…of how we get out of all this,” and I agree. But, as the Reuters story highlights, I’d suspect that more than a few servicers will be rethinking the rules of the game needed to get there.

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