With the impact of foreclosures and defaults reverberating throughout the mortgage industry, a little-known but important battle is brewing that has major implications for lenders facing repurchases. Sub-prime loan servicing agents are being criticized inside large investors for their inability to conduct impartial and effective loss mitigation to stem the tide of losses flowing from the glut of bad loans hitting the market. The failure of servicers to do their job well when it comes to defaults is having a significant impact on repurchase demands plaguing lenders today.
Servicers, the initial and most direct link to borrowers, are failing to take immediate, effective steps to control losses before they spiral out of control. Lenders are then facing repurchase demands where significant time has passed after a default, with little or no steps taken to control losses. Investors are then forced to look at their lender clients as an insurance policy rather than a partner in loss mitigation, as the lender-investor has traditionally been viewed and as anticipated in most Purchase and Sale Agreements. Furthermore, the failure of servicers to act properly, or in concert with their investor clients, sometimes means that foreclosures occur before a notice of defect or default is even given to a lender.
It is not unusual these days for an investor to send a repurchase demand over a year or more after a default has occurred, and months after a foreclosure sale, merely seeking a make whole amount. The consequences are enormous as a lender then has no opportunity to investigate the alleged defect that caused the default, has no opportunity to conduct its own loss mitigation and control its losses, and has no chance to examine and challenge the investor's actions to assure that they were completed within the good faith and fair dealing covenants inherent in the Purchase and Sale Agreement.
As those who specialize in loss mitigation in our industry are aware, timeliness is the key to loss control. Engaging in immediate and constant communication with brokers, borrowers, insurers, title underwriters, and others involved in the loan process is important because it normally provides sufficient time to either correct loan defects, recover losses, or control the property to the extent that it can be sold or refinanced to satisfy the existing lien and resolve a repurchase scenario. With servicers controlling access to the borrowers, they are the first to learn of defaults, servicing errors that occur when payments are misapplied, as well as other important details about a property. They are speaking to the borrower constantly; servicing notes are usually full of nuggets of important clues about a property and a borrower that, if interpreted properly and addressed quickly, could result in better loss management for investors, and ultimately lenders as well.
Lenders would be interested to know that typical servicing agreements executed by investors contain extremely detailed schedules of servicing tasks and time frames within which they are to be performed. These include timely reporting of consumer servicing problems and disputes, defaults, escrow problems, insurance issues (such as cancellation), property issues (such as abandonment and damage), property valuation, foreclosure, REO acquisition, and the details of post foreclosure property listing and sales.
Left to their own devices, without proper reporting (or investor inquiry), some servicers are ignoring early warnings of borrower issues, failing to manage and control abandoned properties, failing to properly conduct market valuations to determine post REO sales, and most important to lenders, failing to provide timely notice to defaults so that loss mitigation can be conducted in a global manner, involving not only the servicer, but the investor and the lender as well. Some investors have also claimed that servicers are literally stealing from them, failing to forward insurance proceeds, rents, and even post-default payments, all of which works to offset losses to the investor, and ultimately to the lender as well.
I have previously written about the necessity for a new "Wall Street-Main Street" partnership in loss mitigation. This involves the tacit recognition by lenders and investors that only by working together, utilizing resources from the street, where the loans were originated, to the board rooms of the Wall Street giants, can the industry really get its arms around effective loss mitigation arising from the sub-prime meltdown. Now it is clear another important link in the mortgage loan chain must also be on board: the servicers. Investors, servicers and lenders all have a common interest in the defective mortgage loan. All have benefited from loan origination, all have potential losses from loan defaults, and all have a stake in a coordinated effort to resolve loan problems to their mutual benefit.
For lenders, the immediate lesson is this: beware of repurchases that may be the result of the failure of your investor's servicing agents to do their job effectively. You have the right under your purchase and sale agreements to expect good faith and fair dealing in the investor-lender relationship. When a servicer is negligent, that negligence should not, in good faith, be the basis for a lender's demand that you insure for their failed contractual relationships.