A Florida real estate broker was current on his mortgage for years until the recession cut his commissions in half.
After falling behind on several payments, he called his bank to renegotiate his loan. After reviewing the terms and an updated real estate appraisal, the bank decided to modify the loan by reducing his monthly payments.
Four months later the borrower redefaulted, forcing the bank to foreclose on his home.
Where did the bank go wrong? In addition to overlooking recent income pressures and the struggling local economy, the bank failed to consider the borrower's multiple credit cards with large balances and an extensive home equity loan. Under those circumstances, the bank's monthly payment-adjustment could never have been sufficient to keep the customer current.
This hypothetical situation is playing out every day across the country with borrowers who are both eligible and ineligible for the government's Homeowner Affordability and Stability Plan. According to federal regulators, more than half of borrowers whose mortgages are modified fall behind on payments again within six months. Government efforts to head off millions of foreclosures have become an epic test of the industry's ability to identify troubled borrowers, modify their loans and keep them out of redefault and foreclosure on a massive scale.
The industry could be navigating these waters far more effectively with a clear and current view of their customers' financial situations, better tools for managing information, more advanced analytics and a better-skilled work force.
Most servicers today are just not equipped to support an effort of this magnitude. Their challenge is nothing less than transforming a relatively small collections department into a large loan portfolio management operation.
In analyzing this market, we see five imperatives for transforming loan portfolio management and modification.
Reskill the work force for a new mission. Thousands of U.S. banking jobs were lost in the first quarter, yet servicers sorely lack the manpower and skills to modify loans on the scale called for in the current environment. Loan modification processes are very different from collection processes, and most servicing professionals do not share the mind-set of "salesmen" trained at persuading borrowers to convert to new products.
Banks and servicers need to reorient their work forces by choosing the right people for the job and providing them with the specialized skills and training to modify loans effectively en masse. There is no shortage of talent in the banking industry. The challenge is rapidly reskilling large work forces and, in some cases, deploying onshore outsourcing to scale up quickly.
Raise the bar on data quality and integrity. Current information about the borrower's full financial situation (income, assets and liabilities), real estate values, local economies, industry employment trends and other factors can make the difference between a good modification decision and a costly one.
Servicers often fail to account for all the borrower's debt obligations and other financial and economic circumstances. The use of stale origination data, such as dated property valuations, is widespread, and significant fraud has permeated the system, particularly regarding income. But powerful new data sources and integration tools have come online recently to help banks make better modification decisions. The industry's high performers are beginning to make profitable use of them, but so far it has been largely ad hoc.
Embrace new analytics to isolate troubled loans. High-quality, real-time data will not help if servicers cannot extract what they need from it easily. For example, most firms have the data but lack the analytics to identify the minimum modifications and costs (term adjustment, principal reduction, rate adjustment) necessary to keep borrowers out of redefault or foreclosure. This lack of analytics means too many servicers are spending precious time and resources on borrowers who are beyond help.
On the other hand, some industry leaders are starting to break this mold, applying analytic tools like advanced risk scoring to create targeted customer outreach campaigns and prioritize agents' work queues.
Focus on performing loans, too. New technologies combined with quality data make it possible to head off future defaults with a high degree of accuracy. However, few servicers have the intervention processes, tools and skills to identify borrowers whose loans are currently performing but heading for default.
Reorienting the loan modification operation to focus on both performing and nonperforming loans is, for some, a major paradigm adjustment. Those institutions are struggling to implement new government programs that emphasize performing borrowers. The firms with the ability to identify and modify at-risk performing loans will stop defaults and foreclosures before they start and emerge from this crisis with a strong competitive advantage.
Get a bird's eye view of the loan portfolio. Instead of managing portfolios manually and reporting on a monthly or quarterly basis, the industry's high performers are using "dashboards" that automate loan portfolio management and provide a view of daily macro- and micro-level changes.
This approach helps to refine workout programs and deliver insight to investors on why and how decisions are being made. Such robust reporting also gives servicers the ability to track geographical trends and redirect their most skilled loan modification specialists to higher-risk areas.
The government's loan modification program provides a scripted response for many troubled borrowers. But millions more are ineligible for the program and at risk of foreclosure. To handle both types of borrowers, the leading servicers are industrializing their loan management processes by getting access to borrowers' complete debt picture and updated property values, using more advanced analytics to improve their predictive abilities and adopting better reporting tools to monitor portfolios.
Those advantages give institutions the opportunity not only to persevere through a rising tide of defaults and foreclosures, but also to secure a better future for their businesses.