The author discussed issues of timing in buying and selling mortgage-servicing portfolios in an article on Wednesday. This article examines performance and indemnity.
A purchaser typically protects itself against poor performance of an acquired portfolio of servicing rights by not paying for loans that become more than 60 days delinquent between the sale date of the transaction and the transfer date of the servicing.
But is this provision enough? A seller may embrace such a clause to be rid of costly foreclosures. Perhaps a better protection for the buyer is to require the seller to buy out a level of delinquencies from the pools before the transfer. This may require some agency approvals.
A comprehensive due-diligence review provides the greatest assurance of quality. No contractual protection that comes after the fact can adequately rectify the problems that a servicing operation can encounter if it assumes a troubled portfolio.
The best protection is to establish an experienced staff of independent-minded employees who will put in the effort to determine whether the portfolio has the characteristics represented by the seller and does not have hidden pitfalls.
If you do not have such people on your staff, you should hire an outside service. Too often, due diligence gets short shrift, with devastating results.
Contractually, due diligence often will be covered in the bid letter and not in the servicing sale agreement. It is important to have competent counsel on board at the beginning of negotiations so that the bid letter provides sufficient opportunity for due diligence and makes it easy for a purchaser to walk away from a deal that is not what it was supported to be
Sellers Eager to Close
The purchaser should try to get due-diligence provisions into the servicing sale agreement, but the seller will fight to make certain that the deal does not remain open right up to the transfer date.
Performance issues pervade servicing transactions because the buyer and seller do not separate at the sale date or even the transfer date.
Yearend tax filings, payment of real estate taxes, payments mailed but not received before the transfer date, the execution and recording of final documents, and the certification of agency pools all require the cooperation of the seller.
In many ways, a servicing transaction, especially the transfer of Ginnie Mae servicing, has the characteristics of a short-term marriage. Key people on each of the parties' staff must get to know each other and be willing and able to cooperate. Lingering issues can extend well beyond a year.
Small Stake Retained
Contractual provisions cannot ensure cooperation but can facilitate a willingness on both sides. One method is the use of performance holdbacks. The seller retains a small percentage of the purchase price, or a dollar amount per loan transferred, or an agreed-upon flat dollar amount to ensure that it cooperates and all of the post-transfer documents are executed, recorded, and returned.
Depending on the nature of the transaction (for example, conventional servicing against Ginnie Mae servicing) and the relative bargaining position of the parties, this holdback can be retained in a lump sum or returned over time on a per-file basis, can be held by the buyer or an escrow agent, and may or may not bear interest.
The purchaser must focus the seller and his employees on the need to expedite the paperwork surrounding the sale. The nature of the servicing and the viability of the seller must be taken into consideration by the purchaser when negotiating the holdback provisions.
Indemnification Is a Must
A document holdback or performance holdback should not be confused with indemnity issues. A purchaser should insist on indemnification for substantive monetary issues such as losses on VA "no bids" in Ginnie Mae servicing and losses caused by origination errors. The indemnity should be coupled with a purchase-price holdback or escrow.
With a large Ginnie Mae portfolio, the handling of losses relating to VA no-bids should be considered a purchase price issue. A purchaser could pay a lower price for Ginnie Mae servicing and assume all the losses from normal Ginnie Mae forclosures and VA no-bids, but only if it has a strong due-diligence department that can weed out difficult portfolios.