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Viewpoint: Lender-Borrower Disconnect Harms Both

By Tyrone Canaday and Frank T. Pallotta  |  American Banker  |  Thursday, January 18, 2011
This article appeared in the January 18 issue of American Banker in the Viewpoint column.

Everyone knows of the mounting frustration shared by homeowners over mortgage relief. Many underwater homeowners are enduring an arduous loan modification process fraught with problems that include missing documentation, misrouted calls and months of little or no communication with their servicers.

This process can drag on for months before reaching any type of conclusion.

A number of factors contribute to this inefficiency, such as operational burden, confusion, or just plain bureaucracy.

One underappreciated aspect of the inefficiency lies in the inability to contact the homeowners, which as a result can spiral into billions of dollars of losses a year for banks and other owners of mortgage risk.

This problem further underscores the need for a reliable connection to homeowners that can help influence borrower behavior long before costly foreclosures ensue.

Mortgage delinquency rates have grown dramatically in the past five years. We have reached a record of 3 million households in foreclosure and unprecedented levels of strategic default.

Additionally, nearly one in four mortgages in the U.S. is underwater. Data shows that 20% of all mortgage defaults are strategic, where homeowners have the money to pay but refuse.

High levels of unemployment coupled with a slow housing market recovery will undoubtedly increase the number of defaults and foreclosures for the foreseeable future.

Looking to preserve any part of this revenue stream should be a primary concern of the holder of residential mortgage risk on portfolios where strategic default probabilities are high.

While operational challenges for banks and servicers vary, there exist some common themes:

  • Loss-mitigation efforts to address strategic default are largely reactive or nonexistent.
  • Efforts are focused primarily on loans that have already hit the 30-plus-day delinquent stage.
  • High incidence of bad contact data and weak homeowner outreach strategies diminish the overall success of any loss-mitigation efforts.

Despite the fact that most of the future losses on mortgage portfolios will derive from current loans with a high combined loan-to-value ratio, many financial institutions' strategies address only loans that fall into delinquency. Still, many others have no plan to address high-risk current loans.

Since there is little focus on risk mitigation for current loans, as these homeowners typically pay and thus the servicer sees "no need" to contact them, the associated contact data gets stale and the direct connection to the homeowner is lost. Consequently, when a subset of "noncontactable" homeowners become delinquent there is no immediate way to reach the borrower to offer an alternative loss-mitigation strategy.

Today, servicers are handling a multitude of new strategies as well as having to execute government-mandated programs such as the Home Affordable Modification Program to address the crisis. Systems that sufficed 10 years ago are now obsolete and overwhelmed, along with associated customer contact methodologies and tools. Take a closer look into the servicers' ability to connect with the homeowner and you'll see bad contact data is a growing problem. Inaccurate data or "noncontactable" homeowners can be as high (15-32%) in certain mortgage portfolios. Mapping back to actual loans revealed that they were located in regions where default rates are high.

Hypothetically, if a large percentage of these loans fall into delinquency, the servicer would be at a major disadvantage in terms of quickly applying another loss-mitigation strategy or recouping arrearages.

Additionally, without this connectivity and ways to track effective channels to contact the borrower, the timetable to reach homeowners gets longer, causing loans to fall further into delinquency. Thus, even more losses are realized over time.

The most successful banks and owners of residential mortgage risk will offer a positive experience that the homeowner will embrace especially during this time of personal hardship. The visionaries will also address the volume challenges they face by rolling out proactive strategies that hedge expected losses, especially around loan portfolios that are at the highest risk of strategic default.

Additionally, this can be done quickly, in scale, and be used to influence positive, future payment behavior.

In today's environment, it is not good enough for servicers to have only a monthly paper statement or an occasional call to solicit the homeowner for a loan modification or refinance. Increased saliency and connectivity, and an ongoing positive connection with the homeowner will provide those banks a tremendous competitive advantage over the others. No longer can financial institutions afford to sit on the sideline waiting for a solution.

The stakes are too high. In these times there needs to be a realization that a proactive series of solutions is the only way to bring about a housing recovery. As with any true recovery, clear vision, strong leadership and an unwavering commitment to innovation will always prevail.

Tyrone Canaday is CIO and vice president and Frank T. Pallotta is an executive vice president and a managing partner of Loan Value Group LLC, a Rumson, N.J., firm that helps lenders and servicers identify borrowers likely to engage in strategic default and devise financial incentives to keep them current on payments.