The recent credit crunch showed the importance of financial strength in mortgage servicing.
Many originators' funds dried up overnight, making it difficult to fund loans already committed and originate new loans. Servicers quickly noticed that their portfolios where deteriorating and they did not have the financial strength to stop the bleeding.
A costly mistake that originators make is to use undercapitalized mortgage servicers. In the subprime market, portfolio quality can quickly deteriorate if the servicer does not have access to adequate capital, technology, and experience.
To take the risk out of subprime servicing and ensure that portfolio quality is maintained-no matter what state the economy is in-the following guidelines should help mortgage originators select a servicer with financial strength.
Make sure the servicer can fund advances required for scheduled remittances on securitized loans. Because of the higher delinquency ratios inherent in the subprime business, the servicer may have to use more of its own capital to meet remittance requirements of securitized transactions.
In the event that a servicer must borrow funds for this, it is unlikely that a lender would readily finance the scheduled remittances, since there is no tangible collateral to secure the note. When a loan is made to a servicer for this cash need, the decision is usually based on the servicer's overall financial strength rather than its ability to recuperate its funds from any collateral.
Make sure the servicer can fund loan payoff expenses. Compensating interest upon loan payoffs is paid entirely by the servicer, and this could result in significant cash constraints for a servicer with a weak financial position. Yet the funding of this expense is an unavoidable obligation of the servicer, and essential for the investor market.
Ensure that the servicer can maintain the high level of staffing necessary for a quality operation. The staffing requirements for subprime servicing are significantly greater than for the conforming market. More personnel are needed for this labor-intensive operation, which means more space and higher overhead expenses.
Look for a servicer that invests in technology. Technology is critical for minimizing risk and maintaining portfolio quality. Required servicing technologies include, at a minimum, predictive dialers, automated voice response units, and data analysis tools.
Make sure the servicer can fund taxes and insurance premiums on non- escrowed loans. In the subprime environment, non-escrowed loans are common. To protect loan collateral, the servicer often must come up with the delinquent taxes and/or insurance premiums, and then collect from the borrowers.
Look for a servicer that can finance loan default and foreclosure expenses. Attorney fees, property maintenance, and loss mitigation expenses can be substantial.
In cases of total default, the servicer may be forced to wait several months before it can recover these funds, making it critical to have long- term financing available.
Look for a subservicer with subprime experience. The servicing demands of B and C product are different from those ofconforming mortgage loans.
Most subprime borrowers have had credit problems, and servicers must have a firm and persistent manner to keep accounts from going into default. Detailed policies and procedures must be enforced. Security and confidentiality of borrower and broker lists are needed.