It’s Not Easy Being Small

Smaller mortgage firms find it tougher to retain servicing, especially in recent times when prepayments have been rampant. For those that have found a profitable niche, a customer-centric approach is key.

While mortgage servicers in general haven’t been winning high marks for customer satisfaction (for example, a recent survey by J.D. Power and Associates, Westlake Village, California, found 90 percent of borrowers dissatisfied with the servicing of their home mortgage), the smaller and midsized servicers may have an edge here. This is particularly true if they emphasize the personal touch with a customer-friendly approach and are the original lenders on the loan.

John Williamson, vice president of mortgage servicing for Johnson Bank, Racine, Wisconsin, holds to that view. “I think the small to midsized servicers generally treat their customers with more care than the larger servicers. If I lose 10 mortgages, I feel that much more so than a Countrywide [Financial Corporation], for instance, with a million loans. So I’m going to be much more customer-service-oriented,” he says.

Johnson Bank, which services only conventional loans—mostly fixed-rate and conforming—with a $2.2 billion portfolio, is one of those servicers that keep it local. The company does all its loan servicing in Racine, with a staff of 17 servicing more than 1,100 loans apiece. “Our customers appreciate the fact that when we do business with them, they know we’re not going to sell off their loan to a third party in another state,” says Williamson.

The philosophy has paid off for Johnson in terms of investor recognition. Freddie Mac, which deals with almost 1,500 loan servicers in the United States, gave Johnson Bank and only four other servicers its Tier One Platinum performance ranking—which means it got a perfect, error-free score of 100—for its management of performing loans during two or more quarters in 2005.

Johnson’s success in this regard suggests that when the servicer and the borrower belong to the same community and have a face-to-face relationship the odds are better that the homebuyer won’t have one of these situations arise: the servicer sells the loan to a buyer that compressed the borrower’s grace period or jacked up the late fee; appends late charges months after an overdue payment is settled; pays the wrong amount of taxes or is tardy with payment; duplicates the owner’s insurance with a new policy and tacks the premium onto the loan balance; or sends statements that don’t show loan balances.

It’s good that smaller servicers have that close-to-home characteristic going for them, because in other respects (e.g., their best employees leaving for much higher pay) they’re being squeezed by the competition from the mega players in the servicing industry. With the housing boom already starting to cool and the prospect of more delinquencies looming, profitability—or even survival—becomes a concern for some smaller companies.

Brad Northcraft, for one, sees a moderate rise in delinquency happening this year. “The watershed year for new loan originations was 2003, and that vintage is entering its prime default years,” says Northcraft, director of retail loan services for Associated Bank, Depere, Wisconsin.

Associated Bank has a servicing portfolio of $11.4 billion in outstanding principal balances on 122,146 loans, virtually all of them prime conventional product, which cost about $60 apiece to service. “I think the outlook for servicing in 2006 anticipates accelerated consolidation through bulk-loan sales and companies exiting the business,” Northcraft says.

Indeed, data released last month by Boca Raton, Florida-based Foreclosure.com had a foreboding cast to it: Total foreclosure inventory ballooned 12.7 percent in December, to 91,905, while new foreclosures shot up 7.7 percent, to 24,124. Those figures represented the highest month-to-month increases in both categories since March 2005. While it’s not unusual to see some rise in foreclosures at the end of a year, this jump was “higher than in recent years,” noted Foreclosure.com President Bruce Geisen.

"If factors such as waning investor confidence in the housing market, high interest rates and a weakening sellers’ market continue, it is very likely that foreclosure inventory will remain high in the early months of 2006, “ predicted Geisen.

It’s not just competition from larger servicers that is making life harder for many small to midsized loan servicers, says Scott Lehrer, senior vice president and manager of loan administration at First Mortgage Corporation, Diamond Bar, California. It’s also today’s more rapid prepayment patterns, where the more sophisticated borrower today routinely refinances online, via broker or through other means when rates make the slightest change. “The impact this has had is on companies such as ours, which are less inclined to retain or acquire loans,” says Lehrer. First Mortgage has a $700-million-plus servicing portfolio containing roughly 5,900 loans, including conventional, government, adjustable-rate and fixed-rate.

Lehrer adds, “When you keep the loans, you expect them to be on your books for three to four years, when in fact they may be off your books in six months. So why pay for that premium?”

The fact of life is that smaller servicers often can’t afford to retain the servicing on loans they originate, and instead sell them service-released to large aggregators. “It’s far more economical for us to sell the servicing as we originate the loan,” concedes Maurice Wilhelm, executive vice president of Birmingham, Alabama-based Mortgage America Inc., which services a $600-million portfolio of 6,321 loans, most of them conforming or government.

When Astoria Financial Corporation, Lake Success, New York, announced last August that it was outsourcing its loan servicing to Dovenmeuhle Mortgage, Inc., of Schaumberg, Illinois. George Engelke, Jr., the company’s chairman, president and chief executive officer, indicated that its servicing loan volume and servicing operating efficiency had fallen off despite fewer delinquencies than ever before and growing individual loan balances.

Not only does selling servicing at origination undermine the close customer relationships by cutting them off, it also puts at risk the goodwill the smaller companies build up with their borrowers over time. “The response we have from customers when we do have to service-release a loan to a Countrywide or a Washington Mutual is that they complain very loudly before they even go there, from prior experience,” says Wilhelm.

So why—and how—can smaller companies stay in the servicing business, short or long term?

Resorting to boutique or niche product servicing is one way to do it. For First Mortgage Corporation, that means servicing loans for specialized customers like the California State Teachers’ Retirement System and the California Housing Finance, Sacramento, California. “The larger servicers may not want to delve into these kinds of loans because you have to jump through more hoops,” explains Lehrer. “We’ve found that we can continue to be successful by handling those sorts of portfolios.” Servicers in other states may also do business with credit unions and housing finance agencies in their markets, where available.

For others, servicing is a means to an end. “It’s just a piece of our business, so whether we service or not will not dictate our survival,” says Wilhelm. “We like to service because it affords us options in the execution of our trades for the sale of the loans. We like that flexibility, and consequently we probably will remain in the servicing business.” Even so, Wilhelm said that Mortgage America will sell all its servicing on a flow basis this year.

Consolidation of a different sort can actually benefit smaller mortgage servicers, according to Northcraft. “They can achieve greater economies of scale by consolidating the servicing of other retail loan products, such as equity lines and consumer [loans], into a single department,” he says.

Northcraft sees the market helping smaller servicers over time, too, as interest rates go up. “The value of servicing will increase as long as long-term rates rise,” he maintains. “In addition, the revenue stream from servicing will partially offset the decline in mortgage origination fees.”

Whatever the reasons, the smaller companies that continue servicing loans can take certain steps to create a customized experience for their borrowers. Johnson Bank invests heavily in the training of its employees, and encourages them to take advantage of courses offered by organizations such as Freddie Mac and the Mortgage Bankers Association (MBA). “We have Freddie Mac-certified investor-accounting servicers, if you like,” says Williamson.

Moreover, Johnson Bank and other servicers make a conscious decision not to use voice-response units (VRUs) to field customer calls. While some of this is budget-related, since these firms don’t have the financial resources of their bigger brethren, it also fits in with their customer-service emphasis.

“We’re able to handle calls individually without having to go through an automated phone attendant,” says Lehrer. “Being the size we are, all of our folks here can handle any type of call on a one-on-one basis.”

The proliferation of new mortgage products in recent years—interest-only loans and the like—also helps smaller servicers, which can incorporate them into their business to meet customer demand. “Small servicers have to have the system support, that back-end support to handle these changes and these new offerings,” points out Steve Nasman, vice president of mortgage lending at Kinecta Federal Credit Union, Manhattan Beach, California.

Kinecta services 11,000 loans—a first-mortgage servicing portfolio of $1.4 billion and a home-equity loan servicing portfolio of $377 million— at a cost of $125 per loan or less. Kinecta’s portfolio is split about 40-60 percent, fixed-rate to adjustable-rate, with the fixed-rate segment split about 85 percent conforming and 15 percent jumbo.

But this opportunity also comes with another hurdle for smaller servicers to negotiate. “Those products—say, the option ARMs [adjustable-rate mortgages], interest-only and piggyback—require a different level of risk management, and risk-management resources are more limited at small-to-midsized mortgage servicing companies,” says Bill O’Brien, Kinecta’s senior vice president of lending. For its part, Kinecta heavily buttressed its own risk-management processes for that purpose.

Small-to-midsized lenders can also score servicing points with borrowers on a touchy subject for both of them—tardy payments and late fees. While the state of the economy and secondary-market guidelines will limit how much slack servicers can cut customers, they can extend some leeway and then move to collect in a dignified manner that recognizes a good-faith relationship with people in arrears—even when default looms.

“Nobody benefits when the homeowner loses their house through foreclosure,” points out Williamson. “So we work very hard with them to try to create modification programs, and in other ways—such as extending terms of their loans—to mitigate their losses so they can stay in their houses.”

Kinecta looks for as quick a solution as possible on delinquencies, so that the credit union members involved can stay in their homes. “At a very large national bank, a $1-million loan that goes 60 days past due is a number on a report,” says O’Brien. “Here, it’s an event.”

Even if they’re not inclined to do it, giant servicers can financially weather longer waits for late payments from borrowers. Their smaller counterparts are going to be more sensitive to cash-flow requirements and will need to accrue income where they can, including post-grace-period penalty fees. But their customer-centric style of business may make them “flexible in terms of forbearance,” as Lehrer puts it.

“If a customer calls me and says, ‘Look, my payment just got lost,’ I look at the history and—a lot of us will do this—we’ll say, ‘OK, we’ll go ahead and waive it.’ We don’t have to go through formal channels to do that.”

Do customers complain about small servicers as much as they do large ones? Most smaller companies say no, but they can even exploit their customer-service edge here. Credit unions like Kinecta, being member-focused by design (the members own the credit union, after all) don’t want gripes to fester. The institution has a defined escalation process where a special board will resolve things, if necessary. “At the latest, we try to get a resolution completed in 24 hours,” states Nasman.

Rule-making actions last year by the Securities and Exchange Commission (SEC), as well as Fannie Mae and Freddie Mac, may negatively impact mortgage servicing operations to varying degrees.

The SEC’s Regulation AB, effective Jan. 1 of this year, imposes major new data-reporting requirements upon issuers of asset-backed securities (ABS). The concern for smaller servicers is the static pool section that compels the disclosure of historical information on like asset performance when a prospectus is issued. Vicki Vidal, senior director for the Mortgage Bankers Association, cautions that even if they’re simply selling loans service-released, these servicers could find themselves pressed to provide issuers with loan-performance data after they’ve sold loans.

The larger concern, though, is what Fannie Mae did Dec. 15, 2005, when it announced it was reducing its minimum servicing fee for ARMs to 25 basis points, with the option to negotiate it down to 12 1/2 basis points. Driving down this fee to reduce rates appeals to the larger servicers that want to put more loans into higher-priced coupons and cash out on the sale of the loans into the secondary market. But smaller companies could find it tougher to compete if the lower servicing costs result in reduced interest rates. Mortgage America generally doesn’t look to Fannie Mae or Freddie Mac ARM products for its loans, but Wilhelm allows that the servicing fee reduction “might possibly make them attractive—particularly if it’s done through a reduction in the guarantee fee that we pay when we retain the servicing on loans. If that happens, those products might be more attractive to our borrowers.”

Lehrer is dead-set against Fannie Mae’s action, since his firm can’t match the big servicers on overall cost per loan. “Fannie Mae is going against their mission statement, because they’re supposed to be in partnership with companies like ourselves, regardless of size, so we can stay in the business and offer loans. Reducing that servicing fee down to 12 1/2 basis points can put many more small companies out of business,” he says.

Is the servicing future for smaller companies a glass half-full or a glass half-empty? That might depend on how many smaller servicers agree with this parting conclusion from Northcraft: “We will remain in the servicing business so long as we can maintain per-loan expense at or below the cost of outsourcing.” MB