Weathering the subprime storm

'Meltdown' in the subprime mortgage space means servicers need to mitigate the financial damage. Kurt Brenneman reports

As default rates rise, US financial institutions that service subprime mortgages are using default management technology to weather the storm. Some experts argue that the US mortgage boom of the last eight years was built on subprime mortgages, or home loans to borrowers with dubious credit histories. To shoehorn them into these mortgages, lenders structured the loans in 'exotic' ways. For example, a borrower's first few years of repayments would be at a low 'teaser' interest rate. At a certain point, the interest rate then adjusts upward, increasing the borrower's monthly payment. Some of these borrowers are not meeting these higher payments, while other borrowers who planned to sell their homes before the upward adjustment are thwarted by declining property values in a slow real estate market. As a result, subprime servicers, particularly non-banks, are awash in troubled mortgages. LoanPerformance, a vendor of mortgage analytics, announced that 12.4 per cent of all subprime mortgage borrowers were at least 60 days late on their payments in February, a record high.

This 'meltdown' puts pressure on subprime servicers to utilise technology to mitigate the financial damage. Thus, mortgage default management systems are becoming crucial to successful, profitable mortgage servicing. Mortgage servicers rely on mortgage servicing systems -- the 'core' systems -- as the systems of record for the mortgage business. Leading systems include Fidelity National Information Services' MSP, Fiserv's Loan Servicing Platform, and ISGN Technologies' LSAMS. Some major servicers, such as Countryside Financial corporation of Calabasas, California, and Ocwen Financial Corporation of West Palm Beach, Florida, use bespoke technology developed in-house, wanting complete control over servicing platforms in order to adapt to an expanding panoply of mortgage loans. These systems include basic functionality for managing defaulted mortgages.

But subprime mortgage servicers face higher default rates even during boom times because of the high risk associated with their customers, and present a strong market for default management systems. Subprime servicers are progressive in this area, perhaps even more so than their prime servicing counterparts. As Duke Olrich, president of DRI Management Systems (DRI) of Newport Beach, California, observes, 'Everyone is embracing it and realising that automation is the only saving grace.' He adds that customer service representatives in the servicing area handle 800-1000 issues at a time. But staffers in the default management area only support 200-300 issues. 'Productivity just stalls.' The only solution is automation.

And, since mortgage servicers are rated for soundness by Moody's, Standard & Poor's, and Fitch Ratings, servicers face further pressure to automate default management. Olrich notes that some servicers that installed DRI's Default Solution have seen their ratings increase as a result. Olrich says, 'Our software increases productivity and that increases their ratings.'

There are three approaches to automating default management. This first is deploying a standalone system that receives the defaulted loan information from the mortgage servicing system. The second is the use of the tools built into the mortgage servicing system. Thirdly, vendors are strengthening ASP services.

The two leading standalone systems are Fortracs from ISGN Technologies of India and the Default Solution from DRI. Olrich notes that its system has been at home among subprime servicers, 'because [subprime servicers] are more entrepreneurial when looking for solutions'. For example, one major customer is Chase Home Finance, of Columbus, Ohio, the second largest servicer of subprime mortgages according to National Mortgage News.

Default management systems have two crucial functions: loss mitigation and foreclosure management. The latter encompasses the old guard processes -- tracking the foreclosure process, managing bankruptcies associated with the mortgage, and managing any subsequent real-estate owned (REO). The system also manages communication with the variety of third parties -- lawyers, contractors, brokers, and other vendors -- who the bank must work with at some point in the process.

However, with the ongoing subprime crisis, the emphasis is on the former, newer area -- loss mitigation. Vendors are strengthening loss mitigation functionality as fast as possible. After a buyer stops making payments, the servicer will work with the borrower to mitigate, or reduce, the financial loss while still keeping the borrower in the home and preventing foreclosure. A servicer will gladly take some loss upfront rather than lose money and have a customer dealing with a foreclosed home. With the loss mitigation tools found in the default management system, a servicer's customer service representatives can do a better and a more efficient job.

DRI's Olrich concurs that loss mitigation is the focus. 'There are servicers out there that have taken very entrepreneurial approaches towards getting in front of the borrower and saying "we can help you". There can be a high success rate. The average loss (when a subprime mortgage defaults) is about $50,000. The servicers are very motivated to do loss mitigation.'

Olrich describes one of the tools that comes with the Default Solution, the Loss Mitigation Decision Model. The Model includes a scripted interview the loss mitigator uses to determine the delinquent borrower's intentions and ability to pay. It merges the borrower's credit report with the mortgage information and other analytic data. 'Based on what the data and what the borrower's intentions are, the Model can run that through an economic model and generate a temporary payment plan or a forbearance plan where the borrower pays something that is less than a full payment.'

The Model can also propose a loan modification, where mortgage terms such as the interest rate are changed to arrive at a new payment plan that the borrower can meet while remaining in the home. The Model could instead propose a 'short sale' if appropriate. The Model can analyse the situation to determine if the loss can be reduced by selling the property immediately rather than going through the lengthy costly foreclosure process. If the property can be sold immediately, the borrower's mortgage will be labelled 'paid off'. The borrower's credit standing will not be impaired.

The use of the Model maintains consistency across loss mitigation, an important advance, says Olrich. 'In the old days, a borrower would talk with one loss mitigator. If he or she did not like what that loss mitigator said, he or she would call again in a couple days, speak with someone else, and maybe like that plan better.' The Model also speeds up resolution. 'You can march through an interview in 15-20 minutes. Very quickly, [the servicer and the borrower] have come to a conclusion as to the best way to handle the process.'

While Dave Demster, president of the Mortgage Products Division of ISGN, also acknowledges that loss mitigation functionality is most important in the market today, he asserts that the fundamentals of default management are still important and in need of improvement at many servicers. 'All the basic tools a default management team require related to foreclosure, bankruptcy, and REO management are still critically important. Servicers still have to streamline these processes, because there are a lot of loans that are there regardless [of earlier loss mitigation efforts].' Unlike Olrich, Demster feels that loss mitigation fits better with the mortgage servicing system. Since the predictors for default are numerous and will-known, the earlier the servicer can contact the borrower, the greater the chance for loss mitigation success. This means that loss mitigation should occur long before the mortgage ever hits the default management system, and that servicers will push loss mitigation closer and closer to the point of origination.

ISGN is a new entrant in this market, but with a well-established product. ISGN acquired Fortracs when it bought the mortgage software line of Fair Isaac Corporation, based in Minneapolis, Minnesota. This product line also included the popular LSAMS mortgage servicing system, the Diamond mortgage origination system, and the TCL construction lending system. It also includes the communications network LenStar. Demster says, 'We have the electronic communications to handle the referrals from the servicer to their attorneys when they have to handle these foreclosures and bankruptcies. We handle all the communications in a network and Fortracs ties it all together.' ISGN will merge this software line with its MortgageHub division, which offers online portals to mortgage originators.

Fortracs was introduced by Advanced Mortgage Technology in February 1997, but he product line was acquired later that year by CheckFree Corporation. From the start, Fortracs was built on Microsoft Windows technology and defined the core functionality set of default management systems: foreclosure tracking, loss mitigation, bankruptcy processing, and REO management. Less than a year later, UK-based London Bridge Software Holding bought CheckFree's entire mortgage software product line, including Fortracs. Fair Isaac then acquired London Bridge in 2004.

When asked about ISGN's plans for Fortracs and its other mortgage solutions, Demster, replies, 'The plans are not fully in place. We are looking at each product individually. The basic plan is to grow all of these products. We have some very modern products that are very fully featured. We have products that are a little more mature with great client bases, but there are things we want to look at regarding refreshing the technology to ensure that we can take them into the future.'

Regarding the client base for Fortracs, Demster adds, 'It ran the gamut. We have the ability to handle the needs of the very largest servicers, as well as the middle tier, very, very easily.' Like Olrich, Demster believes that default management automation is pervasive in the subprime sector. 'There is no such thing as a servicer that has not invested in default technology. It cannot be managed manually.'

Demster describes how loss mitigation functionality is incorporated into the LSAMS mortgage servicing system as servicers start implementing loss mitigation long before the default management process. 'One of the strengths of LSAMS, and something we are developing even further, is its predictive capabilities. A servicer can analyse its portfolio. It may have some adjustable rate mortgages that are adjusting upwards. A servicer is at risk automatically for those mortgages going into default. Now servicers are getting smart and analysing those portfolios early in the process. For example, they may pull a credit report on these borrowers. Even if they are paying fine now, late payments on credit cards and consumer loans are predictors of mortgage default.' In the future, Demster sees more deployment of such predictive tools throughout the mortgage servicing and default management processes.

Fortracs can be integrated not just with LSAMS, but with other leading mortgage servicing systems. Demster explains, 'We have full integration, because we are in the best-of-breed category for default management. That is a critical part of any default management system working properly. A lot of servicers overlook that. They build a freestanding foreclosure system and loss mitigation system and suddenly realise that they have to manually re-enter all this data both going out and coming into the servicing system because, at the end of the day, that is your system of record.'

While ISGN incorporates Fortracs into its business in 2007, DRI will be rolling out new functionality for its Default Solution, including modules for management of litigation, property preservation, and pre-foreclosure tasks. Olrich says, 'The objective is to increase productivity. Litigation has become a bigger issue because of concern about predatory lending. We built the Litigation Module for the legal department for anything that happens in servicing in general. It is not necessarily default-oriented, though most legal cases are default oriented. It is another way to manage that process and have it in one place, so as not to have silos of information all over. The big move in servicing in general as well as in default management is to do away with silos of information. We have one client that we are converting now. It has 20 Microsoft Access databases that it is using just to manage and monitor the default management department. We are consolidating those into some of our existing modules and some new ones we may build for them. By adding the additional modules, a servicer is able to share the information among all the various departments. It adds much more efficiency.'

The vendors of the two leading mortgage servicing systems, Fidelity National Information Services and Fiserv Lending Solutions; are moving ahead in default management as well. In February, Fidelity launched FIS Desktop, a suite of ASP services for default management. FIS Desktop consists of three components, explains Greg Whitworth, president of Fidelity National Information Services' Loan Portfolio Solutions division. 'We have 13 of the top 20 subprime servicers using our application today. We estimate about 40 percent of all the defaults in America are processed on our FIS Desktop solution.'

Whitworth explains, 'FIS Desktop is a service bureau wrap application. We use it in conjunction with the MSP system and also Fiserv's Loan Servicing Platform, along with other clients that have home-grown applications.'

The Process Management components is the workflow piece. Whitworth notes, 'It allows all the vendors -- attorneys, property preservation companies, tax companies, title companies, appraisal companies – to work in a single, online thin-client, collaborative environment, so they all have their own independent queues and steps that they manage, as well as a way to communicate with the servicer.' The second component is Desktop Image Management for default related document management. The third is an integrated expense and invoice management platform, which includes electronic presentment of invoices from third parties. According to Whitworth, 'No other application talks to its invoice management or document management solution, so a servicer is deploying two or three applications, instead of just one solution from one provider. This is where Fidelity is leading the market.' About 90 per cent of FIS Desktop customers use all three components.

Fidelity developed this 'wrap application' in response to the inherent nature of mortgage servicing systems. As Whitworth notes, mortgage servicing systems, like retail banking systems, are often huge, legacy applications that, while stable and robust, are difficult to customise as the mortgage industry changes and subprime mortgages mushroom. An easier solution is to 'wrap' a web-based service around the servicing system. Whitworth says, 'By having these dynamic, robust wrap applications, we unlock the mortgage servicing system and allow its assets to be deployed to the people doing the work day-to-day.'

For example, 'If a defaulted loan goes to sale, a servicer may want to track the property, which company is going to sell it, what the amounts are things like that. You cannot go in and add 40 data elements to MSP. With FIS Desktop you have the ability to do that. Then you can create workflows that drive off those data elements to a business rule engine. Then, we backfill into MSP and add critical events into MSP. It creates a lot of flexibility to use the two together.'

Whitworth, like Demster, feels that default management will begin earlier when mortgages still reside on the servicing system. Anticipating this, Fidelity plans to integrate the three components of FIS Desktop into one 'enterprise' product by the end of 2007. The enterprise version of FIS Desktop can be used to work with all the loans on the servicing system, not just those loans that have already dropped into default management. 'FIS Desktop is not just a default management solution. It is a workflow solution that happens to have a lot of defaulted loans in it.'

In addition, expect more analytics. Whitworth explains that analytics in FIS Desktop can measure the performance of third parties who are working on defaulted mortgages and foreclosed properties. Finally, a loss mitigation tool will be integrated with FIS Desktop by the end of 2007, responding to what Whitworth feels is a weakness in the loss mitigation environment among some subprime servicers. 'There are some servicers that are phenomenal, but others are struggling for the right kind of loss mitigation tool.'

For Fiserv, the solution was to build a default management module right into its Loan Servicing Platform. Interestingly, this platform is evolving into a universal loan servicing platform, so versatile that it can service many different types of consumer loans, not just mortgages. This will drive the expansion of default management functionality into other types of consumer loans. Likewise, DRI now offers a Consumer Debt Module for handling defaulted automobile loans and even unsecured debts, such as credit card debt. For many lenders, particularly those handling less than ideal debt, the delicate interaction of loss mitigation, and with that the retention of the customer relationship, may replace the hammer of collections.

Finally, at least two vendors market ASP services that can work with different servicing systems, while helping a servicer avoid the cost and complexity of setting up a standalone solution. For example, MSTD Inc., based in Baltimore and acquired by LandAmerica Financial Group in 2006, offers BackInTheBlack, a complete default management offering via the web, with all the standard functionality. Computer Sciences Corporation's EarlyResolution, which the company acquired from Freddie Mac in 2004, is a similar web-based default management 'front-end' for a servicing system.

Olrich feels that, once the current subprime disaster dissipates, subprime mortgage servicers will be stronger. 'We are talking now to companies that are buying a lot of subprime loans [being sold by troubled servicers]. They know that technology is a big part of the answer.' Many of the companies that are buying subprime portfolios from bankrupt servicers such as New Century Financial Corporation of Irvine, California, are Wall Street investment banks. 'Wall Street has gotten into subprime mortgages servicing very heavily, creating their own servicing departments. The ones I have seen are sophisticated and well-run.' And, notes Olrich, investing in default management technology. Luckily, today, subprime servicers can evaluate and purchase 'prime' technology. Whereas default management systems barely existed only ten years ago, they are now available in many shapes and with strong functionality.