THE ONE CAUTIONARY PHRASE THAT KEEPS COMING UP IN THE WAKE OF the huge influx of new servicing during the past two years is: "wake-up call." [??] Not the kind that deep-sleeping hotel guests rely on to rise early, but the kind that smart-thinking mortgage companies heed when there is trouble all around them. [??] Two years after the nonprime servicing company Fairbanks Capital Corporation, Salt Lake City, ran afoul of the Federal Trade Commission (FTC) for certain servicing practices, and a year after Ocwen Federal Bank, West Palm Beach, Florida, also was cited for transgressions by the Office of Thrift Supervision (OTS), vigilance has spread widely [??] "The industry, as a whole, has definitely taken this as a true wake-up call, which is a good thing," says Diane Pendley, managing director, operational risk, structured finance, at Fitch Ratings, New York. [??] Fitch, along with Standard & Poor's (S & P) and Moody's Investors Service, both based in New York, are the top three credit-rating agencies in the domestic and international fixed-income securities markets; as such, they have come to play increasingly important roles in regulatory affairs. [??] These, and other, analysts repeatedly insist that the Fairbanks and Ocwen cases were not intended to put other nonprime--or any--servicing companies on notice, yet more than a few have come to view these rulings as "fenceposts," clearly delineating what may (not) be done. [??] In some respects, that is a healthy result. [??] "Every servicer is best served by carefully reviewing these cases," Pendley advises," and establishing controls to avoid similar situations." At base, she says, "servicers should look at their practices and ask themselves: How would regulators look at what we're doing?"
Fitch and others with stakes in the game want servicers to keep the pressure on their processes and staff, according to Pendley, "so that good results continue for both the consumer and the investors. There's no reason to believe it won't," she adds optimistically.
Blind faith aside, the servicing of nonprime loans may have gotten a little easier, if evolving performance statistics are any indication. Last fall, according to the Mortgage Bankers Association's (MBA's) National Delinquency Survey, year-over-year delinquency rates dropped 135 basis points for nonprime loans--a rough patch last summer drove rates up 35 basis points in the quarter.
Foreclosure rates, meanwhile, decreased 32 basis points for nonprime loans in 2004, but also spiked in the third quarter by some 18 basis points. On a year-over-year basis, the foreclosure inventory percentage decreased 167 basis points for nonprime loans, according to MBA's NDS.
Of course, predicting nonprime loan performance is like forecasting the weather--ineluctably uncertain. While technology and past experience do improve accuracy, surprises still happen, especially with the increase in adjustable-rate mortgage (ARM) originations last year, estimated to be running at 40 percent of all originations.
S & P, in particular, is concerned about the potentially adverse impact that interest-only loan (IOL) programs could have in the nonprime sector.
In a special report issued last December, S & P calculated that nonprime deals over the past few months have included up to 20 percent to 40 percent of IOL collateral. These loans have an interest-only period of two to five years and are typically hybrid ARM loans, according to S & P, with a fixed rate for a predetermined length of time, adjusted semiannually thereafter.
"The unique features of the IOLs," the agency worries, "leave the borrower vulnerable to a monthly mortgage payment that is not only overwhelming, but unmanageable--especially if the end of the interest-only period coincides with the reset date of the ARM. This combination has even more of a negative effect in a rising interest rate environment."
No wonder nonprime servicers feel pressed like a pancake between the proverbial rock and a hard place, at once searching for profits yet forced to watch warily for increasingly combative regulators.
"There is an emerging sense that certain national standards must be followed, despite the fact that they may not necessarily be based on law or statute," says Joseph T. Lynyak III, a partner in the Los Angeles law firm of Reed Smith LLP, the firm that negotiated the Ocwen settlement with the government nearly a year ago.
An example of this "unwritten law," says Lynyak, is the avoidance of charging for default letters and attorney letters, which notify a borrower that he or she is in default. Once a source of income, such charges are now a no-no.
Short of standards carved in regulatory stone, Lynyak says servicers may have to make do with industry-adopted best practices in the aftermath of the Fairbanks and Ocwen cases.