Rethinking the Default Landscape: The Industry Has Endured Waves of Defaults before. but This Time, Things Are a Bit Different. Consumer Attitudes, Loan Products and Market Dynamics Have All Changed
Lang, Cheryl, Mortgage Banking
The default servicing industry has witnessed tremendous change over the last two decades. Twenty years ago, the life span of a delinquent loan was much shorter than it is today. In those days, delinquent loans went into foreclosure, and, if they were sold to an investor, there was scant chance of any loss mitigation or loan workout. * The mortage industry's rigid default-servicing processes were routinely applied against a consumer-behavior model that was well understood and relatively consistent. Today's consumer and market circumstances represent a quantum shift from traditional risk-management and loss-mitigation approaches. * Many lending practices of the recent past were overly risky, and some products were excessively complex, resulting in widespread consumer and market misconceptions regarding loan terms. The billions of dollars of mortgage and real estate losses that have resulted represent just a fraction of the total market impacts and cross-industry mark-to-market write-downs that are the byproduct of the current default crisis. * Consumers also began behaving contrary to prior risk models. Consumer behavior shifted from having a strong sense of pride in ownership and fighting off foreclosure to the bitter end, compared to now, where borrowers are more frequently abandoning the property when the loan terms become unmanageable.
Property became increasingly viewed as "disposable" or transitory, much like an automobile, a flat-screen television or even a vacation. Consumers in many overheated markets speculated on real estate, much like they did in 1999 on the stock market--and with similar results. As markets turned and sentiment soured, consumers began struggling to pay "upside-down" loans. When adjustable-rate resets started kicking in and home prices plummeted, an increasing number of consumers are opting to return the house keys to their lenders via mail, otherwise known as "jingle mail."
Well, how did we get here?
According to Mark P. Dangelo, managing principal of Grafton, Ohio-based Innovative Relevance [R], the mortgage industry was not prepared for the "reverse supply chain" inherent within the end-to-end cycle of the creative loan products and services that were deployed.
"While automobile manufacturers clearly understand the disposal characteristics of every part within their products, mortgage markets failed to appreciate and prepare for downstream consequences of their 'originate-and-securitize' business models," says Dangelo. "By failing to adopt a manufacturing discipline for the products created, the industry was ill-prepared for the unwinding both in terms of volume and investor/market sentiment."
"Some lenders were out there telling brokers, 'We'll pay you $ 1,000 for an option ARM [adjustable-rate mortgage] and $700 for a fixed-rate loan,'" says Joe Dombrowski, executive consultant for Brookfield, Wisconsin-based Fiserv Financial Institutions Group.
"Brokers were thinking they could make an extra $200 to $300, and these lenders [seemed unconcerned] since they were making money generating larger portfolios and could sell them off quickly. As such, lenders were not worried about no-doc loans. They were focused on making sales instead of looking at the potential impact down the road if market conditions changed," says Dombrowski.
With such intense focus on the loan origination side of the business, there were subsequently negligible technology investments made on the loan servicing side to expand, build and grow solutions in preparation for a default wave of significant proportions.
The flowering of loss mitigation
Loss mitigation is a relatively new construct that began with private investors and portfolio lenders about 10 years ago. Fannie Mae and Freddie Mac started, in earnest, over the last decade to establish loss-mitigation programs, including repayment agreements, loan-modification options and even non-retention options such as short sales and deed in lieu of foreclosure. …