Building downturn readiness in US mortgage servicing

July 22, 2020US mortgage-servicing businesses are experiencing significant industry-wide challenges as a result of the COVID-19 crisis, driven by surging unemployment, an exponential increase in customer forbearance requests, and an impending surge in delinquencies and losses. As a result, servicers need to rapidly build and operationalize their readiness plans for the next 6 to 12 months to support a significant number of distressed borrowers and ensure operational readiness for a vastly different landscape. In this article, we briefly discuss the expected magnitude of the borrower and industry impact based on our recent customer insights and industry roundtable, and discuss the dimensions of a holistic readiness plan for servicers.

1. An unprecedented wave of customer distress on the horizon

The significant macroeconomic stresses exerted by COVID-19—for example, peak unemployment rates exceeding the 10 percent levels observed in 2009 (Exhibit 1)—are expected to result in a significant surge in delinquencies and losses in 2020-2021 and beyond. Results from our weekly consumer pulse check survey and responses from mortgage-servicing executives during our recent roundtable indicate that about 10 to 12 percent of mortgages may end up in forbearance, with 20 percent or more of these potentially progressing to default and requiring assistance (Exhibit 2). This means that more than one million customers may need assistance over the next 12 to 36 months. As a point of comparison, currently the industry processes about 45,000 loan modifications per quarter. The sheer magnitude of the resulting customer assistance needs requires immediate and swift action by servicers to build readiness before expiry of the forbearance period.

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2. A “rinse and repeat” of the 2008 toolkit will not be effective

There are several lessons to take from the impact of the 2008 financial crisis, and servicers can use capabilities developed in response to that crisis to bolster their downturn readiness in the current environment. However, a “rinse and repeat” of the 2008 toolkit is unlikely to be effective, given that the triggers and nature of this crisis are unique and distinct from 2008. These include:

• Temporary shutdowns, with geographically diverse impact as well as response
• More adverse unemployment, in some cases concentrated in specific sectors
• Uncertainty about potential second shocks and associated duration of economic contractions
• Likely materially higher delinquency inflow
• Significant evolution in customer behavior (e.g., greater digital savviness)
• Disruption to status quo operating models and shift to remote/work-from-home arrangements

While servicers developed capabilities in the previous downturn that can be leveraged today (e.g., HAMP, HAFA, SPOC), an expanded set of capabilities are now available to help customers in distress, such as sophisticated risk analytics (e.g., using external data, artificial intelligence and machine-learning models) and digital tools (e.g., self-service, robotics, outreach through digital channels).

Finally, there is significant evolution in regulatory perception, with financial institutions playing a central role in current recovery efforts.

3. The time to act is now: Go-forward priorities

Servicers must work with customers to get ahead of the potential losses stemming from distress due to the crisis and slow the surge of distressed loans in the future. Simultaneously, servicers must also rapidly build operational readiness in preparation for the significant surge in delinquencies expected in the coming months.

Doing this right will require an end-to-end approach across the default management value chain, and targeted action in five areas: digital and self-serve, streamlining loss-mitigation operations, addressing capacity shortfalls, portfolio risk segmentation and analytics, and the development of a robust centralized “nerve center” program management capability. Servicers will need to consider dependencies across these areas, and can pursue selective partnerships to accelerate impact (e.g., for capacity, digital and analytics).

While servicers have focused their crisis response over the last three months on capacity shortfall, liquidity concerns (especially for non-banks), and gearing up collections/loss-mitigation operations, there are five major priorities that will require critical focus going forward (Exhibit 3).

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1. Digital: While deploying digital self-serve and document intake was the biggest future priority among our roundtable attendees (80 percent), for many participants efforts to date appear to be focused on scaling up IVR self-serve in the phone channel, and launching online forbearance applications (e.g., 30 to 50 percent or higher adoption of online app). Servicers need to quickly pivot to downstream digital use cases, especially document intake, customer asset/income auto verification, and digital outreach and “nudges” to reach affected customers.
2. Loss mitigation and customer complaint operations: A surge in volumes from forbearances rolling into default that far outweigh current levels of 45,000 loan modifications per quarter will exert significant strain on loss-mitigation operations. Significant opportunities exist in most servicing organizations to streamline and automate loan modification and loss-mitigation operations (e.g., end-to-end process flows, handoffs, roles/responsibilities, capability building, automating QA/QC, and digitizing loan modification processes). Additionally, scaling up customer complaint capabilities will be critical, as demonstrated during the financial crisis.
3. Capacity: Several institutions have reported significant progress here, as well as plans to increase headcount by 30 to 40 percent or more in the near term. More will be needed, especially as forbearance expirations intensify in the coming months. Thoughtful exploration of options such as BPO/subservicing/specialty servicing partners across customer risk segments should be considered, focused around capacity stress points in the current operating model.
4. Portfolio analytics: Forty percent of roundtable respondents said they consider analytics to be a critical priority going forward. A number of participants highlighted capacity planning as a key use case for analytics. We believe that additional opportunities exist to assess customer risk and likely delinquency inflow using existing credit models, with overlays from known customer data (direct deposit trends, employment sector, zip+4 local conditions) and leading indicators such as active COVID-19 cases, customer hardships tracked granularly to inform portfolio risk monitoring by segments. Servicers must use these models to project demand under various economic scenarios, and identify early-warning triggers that can guide their operational response.
5. Nerve center: Finally, servicers must establish a central cross-functional program management capability, focusing on program oversight, progress tracking, vendor management, talent, compliance, daily/weekly MIS reporting, and real-time identification of stress points across the process.

4. “Monday morning actions”

Time is of the essence. Mortgage servicing executives can use a set of key questions to help them shape their near-term action plan and ensure readiness to support significantly higher numbers of borrowers in their time of need:

• Can we accurately estimate the magnitude of the challenge we face, based on the volume of forbearances and profile of customers (e.g., credit profile, employment industry, direct-deposit data)?
• How does the expected inflow compare with the operational capacity available across various scenarios? What options should we consider to scale up operational capacity to meet the spike in customer needs?
• How ready are we across all components of the default value chain—collections, loss mitigation, foreclosures, bankruptcy, vendor dependencies (e.g., BPO, digital, analytics)?
• What opportunities exist for streamlining and automating operational processes to prepare for increased inflow?
• How can portfolio risk indicators be deployed to better guide operational decisions?
• How can we ensure process readiness for customer complaints and escalation?
• Which major initiatives do we need to launch over the next three to four weeks to build readiness?