[Editor's Note: On March 28, HousingWire published a blog titled: Christopher Whalen: So what is today's nonbank business model? This post is Whalen's reaction to the negative comments concerning that blogpost.]
Over the past week, I have been subject to personal attacks by consumer advocates such as Tom Cox and Adam Levitin, both in HousingWire and elsewhere.
These supposed consumer advocates don’t want to discuss the facts, but they love to call people names.
Consumer advocates assume that mortgage servicers are not agents to administer legal contracts, but fiduciaries bound to protect some implied non-payment entitlement of delinquent borrowers. They seem to assume that lenders are credit-providing principals in these loan contracts, when in fact most banks and non-banks are almost always acting as agents for an investor.
In fact, loan servicers are agents that are almost always acting on behalf of a third party. In the majority of these cases, the note holder is the US taxpayer. Consumer advocates conveniently forget that in the vast majority of cases, the "victims" of foreclosure abuses, real or imagine, have defaulted on their promise to repay the mortgage.They borrowed money to buy a home and now they are reneging on that solemn promise to repay the debt. Indeed, not content with their clients defaulting on the mortgage, consumer advocates want to further injure the note holder by allowing their clients to live in the house for free, sometimes for years.
And again, nine times out of ten, the note holder is an agency of the US government. That is, the US taxpayer.
Now consumer advocates like Cox and Levitin are correct when they note that the “too big to fail” commercial banks as well as some of the pre-crisis non-banks are irrational when it comes to foreclosure. The pre-2007 mortgage market was designed to move money around, not to care properly for consumers or service distressed mortgages. The big bank servicing operations were built on the assumption of zero defaults.
As a result, the big banks are losing billions of dollars per year on mortgage servicing, one reason they are so desperate to sell these loans. But the systems and loan documentation defects at the big banks are so serious and insoluble, that in many cases the legacy loans on the books of the TBTF banks will never be sold.
When you think about non-bank financial firms that have grown up since 2007, however, a different model applies. First and foremost, many of these non-bank firms came from the world of distressed servicing, so unlike the big banks they know how to deal with a defaulted mortgage. The non-bank firms are also paid on performance, which means that efficiency in terms of loan resolution is an important benchmark for measuring their operations. And third, the non-banks are also agents, often working for private investors such as mutual funds, pension funds and other institutional investors who fund strategies such as purchasing non-performing loans or mortgage servicing rights.
While we can all agree that a large bank may not act rationally when it comes to a distressed loans, there are a number of reasons why a rational loan servicer such as a nonbank wants to choose loan modification as opposed to a foreclosure.
Let's list a few of them:
1. The first issue is time.
Modification of a mortgage is relatively quick compared to a foreclosure process. In the Northeast, for example, it can take more than three years to move a defaulted borrower out of a house through foreclosure. During this time, the servicer is NOT being paid any fees. Also, if the house is abandoned, the value of the asset will be impaired, reducing the eventual recovery on the mortgage note. So a loan modification is always the rational choice. This is not to say that the big banks don't make irrational choices and attempt foreclosures when they should instead be focused on a modification, but a rational servicer will always attempt a loan modification as the first resolution path. Indeed, doing so is now the law.
2. The second related issue is cash flow.
Loan modification not only helps the borrower to repair their credit standing, but helps to preserve or restore the cash flow coming to the servicer and the note holder. When the borrower defaults, the servicer is required to pay the property taxes, insurance and in some cases the interest and principal due to the note holder. So a loan modification is always a superior choice vs. a foreclosure. The cost of financing "advances" of taxes, insurance, interest and principal can be very onerous for a servicer, especially a non-bank that must pay market rates for funding from commercial banks. In the case of GNMA advances, a non-bank servicer must finance the advances with cash because banks generally will not finance GNMA advances. Also, if a GNMA loan defaults and goes to foreclosure, the servicer will only recover part of the principal and advances, thus the risk exposure with GNMA loans is quite high and requires special care by the servicer to avoid a catastrophic loss.
3. The third reason why loan modification is the preferred route is the possibility of getting the loan to reperform.
Let's say you are a servicer with a defaulted GNMA loan. It is three months in arrears and you have advanced principal and interest to the note holder and paid the insurance and property taxes to protect the asset. The logical step for you is to buy the loan out of the RMBS pool, contact the borrower and fix the loan via a modification. This is a classic example where a loan modification is the best choice. Let's say your get the borrower to agree to a modification, you notify GNMA of your intention to forebear, and then you complete the modification. You can then sell that modified loan back into a new pool and recover part of the principal required to repurchase the defaulted asset. You then also start to receive principal and interest from the borrower.
4. Let's take another example of a default loan owned by a bank.
Let's say you are a non-bank servicer and purchase that non-performing loan (NPL) for say 60% of the unpaid principal balance and assume the related advances of principal, interest, insurance and property taxes. You buy the NPL on behalf of a private investor, let's say a large state pension fund. You contact the borrower and attempt a modification, but the borrower is not able to qualify. The next rational step is to assist the defaulted borrower to move out of the house and into a less expensive rental property as quickly as possible, via a deed in lieu, cash for keys or similar process.
In this case, making a substantial cash payment to the defaulted borrower helps to 1) accelerate the process and 2) preserve the home and thereby the value of the asset, which helps the note holder. You avoid a foreclosure and are still able to provide a very attractive return to the note holder when the house is sold. The servicer recovers the advances of taxes, insurance, principal and interest when then asset is finally liquidated. So even if you spend 10% or more of the UPB helping the borrower make the transition, it is a win/win for all concerned. The consumer is in a new situation that makes sense, the NPL holder gets paid and the servicer recovers the unpaid fees and advances.
Again, it needs to be said that there are many times when a large bank does not act rationally. There is no excuse for such stupidity, but the fact is that the operational chaos inside large lenders often leads to some really strange outcomes. But if a servicer is acting rationally and, most important, as a fiduciary for the note holder, then it is very clear that helping the borrower is always the best choice when measured against the new present value of the mortgage note.
The basic rules of buying and servicing NPLs are three: 1) keep the borrower in the house if possible via loan modification, 2) preserve the condition of the asset by moving quickly, 3) preserve the cash flow to the servicer and the note holder. If you cannot modify the loan, then the next rational step is to help the borrower move to a new situation and thereby accelerate the resolution process. At the end of the day, moving quickly is always better for the debtor and the note holder.
Sadly, consumer advocates and many people in the regulatory community think that the many acts of stupidity committed by the TBTF banks are the rule for the entire mortgage industry. If people like Tom Cox and Adam Levitin actually took the time to understand how a compliant special servicer behaves in today’s mortgage market, they might change their tune – but I doubt it. Nobody in the US has been a more consistent critic of the big banks than this writer, but we cannot allow the particular acts of idiocy committed against consumers by the big banks to allow us to overlook the other wrongs being committed against investors in the name of “consumer protection.”
The sad fact is that the consumer advocates, trial lawyers and regulators make a living by perpetuating the notion that all lenders and loan servicers are evil and stupid, and that all consumers are victims. This is simply not the case. There is a whole class of victims – namely the shareholders of banks, investors in private mortgage securities and the US taxpayer — who are being damaged each and every day because of the unfair and self-serving representations made by consumer advocates.
Consumer advocates, let us remember, make a living by exaggerating the misery faced by millions of Americans who have defaulted on their mortgages and face the loss of their homes. Let me repeat: most of the victims of consumer abuse by the big dumb banks have in fact defaulted on their mortgages. Nothing that Tom Cox, Adam Levitin or the other consumer advocates can say will change that basic fact, but that does not prevent them from trying to damage note holders even more by seeking to delay or even prevent lawful foreclosures. And just remember, that 9 times out of 10, the ultimate note holder is the US taxpayer, represented by a federally insured bank or non-bank servicer.
