rethinking loan servicing

Re-ThinkingLoan ServicingPrime Alliance Loan Servicing April 2010

Lori J. Pinto, CMB, SVP Cenlar FSBExecutive Director, Prime Alliance Loan Servicing

Nizar HashlamonVice President Prime Alliance, Executive Director, Prime Alliance Loan Servicing

Dan GreenExecutive Vice President, Strategy, Prime Alliance

Re-thinking Loan Servicing

Prime Alliance Loan ServicingApril 2010

Lori J. Pinto, CMBSVP, Cenlar FSBExecutive Director, Prime Alliance Loan Servicing

Nizar HashlamonVice President, Prime Alliance Executive Director, Prime Alliance Loan Servicing

Dan GreenExecutive Vice President, StrategyPrime Alliance

Table of Contents

...................................................................I. Executive Summary! 3

..............................II. The Changing Role of Mortgage Servicing! 4

......................................................III. Servicing as Risk Mitigator! 6

....IV. Servicing as Member Retention and Relationship Builder! 8

.....V. Opportunities in Credit Union Mortgage Loan Servicing! 12

..............................VI. Why Aggregate Credit Union Servicing?! 18

............................................................................VII. Conclusion! 25

© 2010 Prime Alliance Loan Servicing. All Rights Reserved. Page 2 of 25

I. Executive Summary

The mortgage lending landscape has changed drastically over the past several years from virtually every perspective. Rapidly rising home prices, over-easy financing and exotic loan products, so prevalent through 2007, are now things of the past. Mortgage brokers, once responsible for more than 30% of annual originations, haven’t disappeared, yet their role has diminished in favor of big banks, community banks and credit unions. That would be enough in any three-year period, yet the bubble that burst in late 2007 imperiled homeowners and lenders alike. Low interest rates—the lowest in four decades—round out the environmental picture. The effects are far reaching, yet the impact on obtaining new loans continues to get more attention than how older, existing loans are managed and serviced. Mortgage loan servicers have had to expand their infrastructures and their capabilities in order to meet new and increasing regulatory requirements as well as consumer demand for assistance with modification, pre-foreclosure assistance, and, when it can’t be avoided, foreclosure itself.

The implications of these changes, but especially those related to loan servicing, are or should be of interest to credit unions. Servicing in all its forms has been largely ignored over the history of credit union mortgage lending, yet last decade’s cataclysm brings into sharp focus the full benefit of well-managed servicing operations.


II. The Changing Role of Mortgage Servicing

We are a numbers industry. Looking at credit union first mortgage lending performance over the past five years shows the fundamental shift in the nature of credit union lending. From 2% market annual share beginning in 2005 through 2009’s growth to 4.5%, the push is on for housing finance as a core strategy, as opposed to a mere accommodation, as it had been during its first 30 years as a credit union service. Graph I illustrates the industry’s growth.

Graph IThe Growth in Credit Union Mortgage Lending Market Share

Source: Callahan and Associates

This growth in terms of dollars and market penetration is impressive. Yet like the market’s abundant changes of the past three years, even more change has taken place in the credit union industry. Credit unions sold more loans last year than at any time in their history as mortgage lenders. As Graph II depicts, credit unions sold 2.6 times more loans during 2009 than at any other time in the past. Loans were sold both servicing released as a means to generate additional cash and servicing retained as a member relationship building and retention strategy.


$100

$75

$50

$25

$0

5.0%

3.8%

2.5%

1.3%

0%

60.3054.4060.50 70.30 95.00

200720062005 2008 2009

2.0% 1.9%

2.6%

4.0%

4.5%

Graph IIHistorical Mortgage Loan Sales by Credit Unions

Source: Callahan & Associates

Credit union mortgage origination practices matured concurrently with market share, volume and secondary market sales growth. The industry honestly claims some of the best in borrower experiences among all lenders, large and small, bank and non-bank. With processing under control, it’s important that the industry turn its attention to loan servicing.

The growth in real estate portfolios fairly demands it. The static view of loan servicing as a back-office, payment processing operation must evolve to be seen from at least two additional perspectives, first as a risk management tool, second as an important avenue to build and retain member relationships.

60

45

30

15 0

20072006 2008 2009

16.5 16.219.5

51.4

2005

20.6


III. Servicing as Risk Mitigator Real estate lending is fast becoming the credit union industry’s principal financing activity. More than 35% of loans are now concentrated in first mortgages, as shown in Graph III. Total real estate loans now comprise 53.50% of all credit union lending portfolios.

Graph IIICredit Union Loan Distribution

Sec Mort8.3%

Unsec10.4%

Used Auto17.2%

New Auto13.1%

Other5.7%Home Equity

7.7%

1st Mort Adj11.9%

1st Mort25.6%

Jan 2010 Loans = $583.6 Billion Jan 2009 Loans = $582.3 Billion

Sec Mort9.5%

Unsec10.1%

Used Auto16.6%

New Auto14.3%

Other5.6%Home Equity

7.3%

1st Mort Adj12.0%

1st Mort24.5%

Source: CUNA & Affiliates

With mortgage portfolios becoming such large, profitable assets, it is time greater emphasis is placed on aligning them with each credit union’s asset/liability policy and risk management standards to ensure consistent long-term performance as well as safety and soundness.

Risk management has always been a variable in the mortgage loan servicing equation, though its importance, at least in the credit union industry, was not given its due until the housing bust and the latest recession. Consequently, servicing departments must harness and master their data so that the health of every loan and the collateral securing those loans and the borrower’s status is readily available.

Real estate risk awareness itself is reward enough and is an abundantly good reason to strengthen these practices now. Regulatory focus is another reason. Mortgage loans are a significant area of inquiry in most annual examinations. While most attention in the past was focused on origination practices, equal or more time is given to the longer-term


Portfolio AssessmentCredit unions need the ability to assess portfolio risks. State and federal regulators are placing more emphasis on real estate lending, generally, and portfolio risk assessment and management, specifically. Assessing portfolio risk, until now, meant a great deal of manual effort as well as expensive tools typically available to only the largest of lenders.

Prime Alliance Solutions, Inc., in partnership with Prime Valuation Service and its relationship with First American Core Logic, and Prime Alliance Loan Servicing have created an affordable, turnkey solution that enables credit unions to evaluate both borrower and collateral, presenting a multi-dimensional risk assessment. Aggregation answers yet again. Credit unions, through these collaborative efforts, now have access to the same tools used by the nation’s largest lenders.

PALS clients automatically receive this service as part of regularly recurring portfolio management reports. This is a stand-alone service available to non-PALS clients at a very affordable price.

management of these assets. The introduction of government programs such as the Home Affordable Modification Program (HAMP) and Homeowner Affordability and Stability Plan (HASP), both pro-active loss mitigation activities, are additional reasons NCUA and State Regulators are paying extra attention to real estate servicing practices. NCUA Examiners are expanding their attention to the effectiveness of overall mortgage servicing compliance programs. Specifically, compliance with Fair Lending Review, Fair Debt Collections Practices Act (FDCPA) and Service Members Civil Relief Act (SCRA), to name a few, receive attention during examinations.

The industry’s focus on loan modifications, driven by government attempts to fix the housing market, will result in ever more regulations. The following are some of the requirements servicers have to comply with under the current HASP program:

• Providing appropriate documentation to borrowers about the modification process;• Complying with all fair lending requirements (ECOA and FHA);• Maintaining appropriate processes to address member inquiries and complaints;• Monitoring data collections and reporting;• Testing completeness and accuracy of data; and• Having the necessary processes to ensure compliance on a quarterly basis.

Complying with modification requirements, while new, is not the only compliance issue servicers have to manage. In general, the servicing system and processes, functions and calculations performed have to be in compliance with published regulations. These published regulations require a level and range of scrutiny across the entire servicing function, such as ARM adjustments, escrow analysis, and payoff processes. This function becomes unduly complicated for credit unions that service loans in multiple municipalities, counties and states, since many jurisdictions have their own regulatory requirements in addition to those required by the federal government.

In addition to compliance risk, credit risk is another main area of managing loan portfolios. Default management, including collections and loss mitigation, is more important than ever. More of an observation than a criticism, credit unions don’t necessarily have the resources to do both in today’s real estate environment largely because the industry’s mortgage loans historically and consistently performed so well. Today’s unique servicing environment plus increased regulatory scrutiny demands that collection policies, practices and programs be revisited and staff become current on the latest industry practices.

Concentration in two main areas defines collection success. First, all collection activities have to be built on the philosophy that it takes a partnership between the member and the credit union to resolve the issue. If the delinquency cannot be resolved, both parties lose. The second is beginning member communication early and ensuring it happens often. This helps identify the reason for the default and allows the credit union to craft an appropriate solution.

Section VI discusses mortgage lending collections in detail.


IV. Servicing as Member Retention and Relationship Builder

Mortgage servicing, when viewed from a marketing perspective and from the perspective of lending competitors, is much more than payment processing and investor reporting. It can and should be used to retain members and to build member relationships. Unchartered territory for most credit unions, this is one of the important, new frontiers in housing finance.

The Three Member Relationship Pillars of Loan Servicing

Pillar I: The Member Experience

Credit unions are cooperatives. Cooperative principles dictate owners of the cooperative, the members, should expect and receive the best financial services from their credit union. Best in terms of financial services means many things and different things to different audiences. Credit unions typically deliver competitively, though most realize competing on price alone is a losing proposition. In the past decade an increasing number of these financial cooperatives began focusing on the member experience: how the member interacts with their credit union and the credit union with them. Here, truly competitive advantage can be had as well as sustained. The industry achieves high marks for the experience it delivers when it comes to share account services. Credit unions have also done a commendable job meeting members’ consumer loan demands. However, lack of loan servicing resources and infrastructure has hindered the industry’s ability to provide the same experience when it comes to financing homes. Few credit unions, if any, are providing members with post-closing services considered standard in housing finance. These include multiple options for loan payment, online access, 24/7 access to interactive voice response systems, automated notifications of loan status and problem resolution to name a few.

Credit unions, on the other hand, have done a good job enhancing the mortgage loan origination and closing experiences. Prime Alliance Solutions, Inc., has enabled credit unions to provide a WOW member experience from the moment they begin their application to the day they close their loan electronically. Members apply online, in person or over the phone in a paperless environment. They follow the progress of their loan, too, accessing their loan from any internet-connected PC. Could this WOW member experience be duplicated during the loan servicing stage? We believe it can.

Real estate borrowers are the key to future growth, provided they are satisfied with their origination and servicing experiences. Mortgage members are the most valuable candidates for future loans, housing and consumer; the respect and service level they receive today translates to additional services tomorrow. To provide superior service, loan servicing departments must meet and exceed member needs and preferences. Prime Alliance Loan Servicing (PALS) was founded on the idea of creating a WOW servicing experience and has built its offering with this in mind. Following are a few options available to PALS clients:


Paperless and Electronic Lending

Prime Alliance credit unions have all the technology and tools necessary for completely paperless, fully electronic mortgage lending. To learn more about the benefits to both the member and the credit union, download Prime Alliance’s White Paper, 2010: A Homeownership Odyssey, from their website at www.primealliancesolutions.com.

http://www.primealliancesolutions.com

http://www.primealliancesolutions.com

• Anytime account access via the internet, through the credit union’s on-line banking system, or through a toll-free automated voice response calling system (IVR);

• Knowledgeable, friendly member service representatives that are available over the phone or by email;

• Convenient payment options that are available at branch offices, through the web, and other electronic options;

• Flexible monthly statement options that match each member’s preference, be it traditional paper, email, or on-line;

• Readily available loss mitigation services ready when the member needs them or provided in anticipation of member need. This is one of the most important features a servicer can provide to members who find themselves in difficulty. Helping members achieve the dream of homeownership isn’t much good in the long run if every possible step is not taken to keep them in their home. This could be achieved through providing ongoing counseling to members online, via the phone and in person to introduce alternatives that meet their individual situation.

Every credit union should be asking itself: Are we providing superior member service? Are we doing everything we can to keep members in their homes? And, of course, are we able to offer this high level of service while achieving maximum profitability and meeting business requirements? If not, an outside, credit union-focused resource such as Prime Alliance Loan Servicing may be the answer.

Pillar II: Member Retention

Mortgage loans have an historical duration of between 5 and 10 years, making them the longest and perhaps most important relationship building opportunity a lender has, yet credit unions still do not take full advantage of this remarkable chance to build true kinship with members. The credit union industry is beginning to learn what mortgage bankers have understood for years: It takes a different type of marketing effort to keep real estate customers than it does to gain new borrowers.

The fact remains: It is easier to get new customers to try new services or to buy products the first time than it is to get them to come back again and again, yet we know anecdotally and paradoxically new customer acquisition is much more expensive than proactive customer retention. It makes sense, then, to dedicate more resources to member retention. It further stands to reason that real estate borrowers, as a subset of all members, are the most creditworthy borrower segment and will have the greatest long-term needs for all manners of financial services.

These two arguments for proactive member retention are powerful. Done correctly, credit unions more than retain members; they build long-term member loyalty. Building loyalty begins with a memorable mortgage origination experience that continues throughout the life of the loan. Just like originating a loan, the servicing is a differentiator. According to a J.D. Power 2007 study, overall consumer satisfaction with mortgage loan servicers slipped in 2006 and again in 2007. In fact, also according to the firm, just 10% of borrowers are satisfied with their servicer.1 The reason servicing is so bad, according to The Mortgage Professor’s Website,2 is simple. Borrowers don’t select their servicer, don’t pay them and, most significantly of all, cannot fire them, unless, of course, they refinance their loan. There is, therefore, no incentive for most servicers to provide anything other


1 To read the full article, follow this link: http://www.thetruthaboutmortgage.com/jd-power-loan-servicing-satisfaction-falls-bbt-is-best/

2 To read the full article, follow this link: http://www.mtgprofessor.com/a%20-%20servicing/why_is_servicing_so_bad.htm

http://www.thetruthaboutmortgage.com/jd-power-loan-servicing-satisfaction-falls-bbt-is-best/

http://www.thetruthaboutmortgage.com/jd-power-loan-servicing-satisfaction-falls-bbt-is-best/

http://www.mtgprofessor.com/a%20-%20servicing/why_is_servicing_so_bad.htm

http://www.mtgprofessor.com/a%20-%20servicing/why_is_servicing_so_bad.htm

than mediocre customer service. In fact there is a significant disincentive: Increasing service levels reduces already thin profit margins. Knowing this it is easy for credit unions to create a niche. Our industry has every incentive to provide WOW experiences in every aspect of the member relationship. Clearly there is a need for mortgage servicing to be done well.

But how to do it? Put yourself in the borrower’s shoes, realizing your advantage. Your credit union has the choice of servicer, pays the servicer and has the option of firing the servicer. If your members are not satisfied, neither is your credit union. What stronger signal could there be?

Prime Alliance Loan Servicing helps its credit unions focus on retention and has helped them gain ground in the fight to retain members by:

• Meeting and exceeding member service standards other lenders have established, providing a personal touch with each member transaction, similar to the teller line experience. This should be done through each channel members choose to conduct their business: online, on the phone and in person.

• Employing event driven processes based on prepayment analytics to anticipate member needs, then marketing into those needs. It is possible, with a great degree of certainty, to predict when members will refinance or purchase a new home. Contacting them before they seek financing does not assure retention, yet it does provide a distinct advantage.

• Ensuring your credit union’s ability to respond to members who are having problems by implementing a better problem resolution process. Servicing problems occur rarely, yet when issues arise they tend to be sizable for borrower and lender alike. For example, large penalties assessed on the borrower by local jurisdictions if tax payments are not made.

• Measuring perceived value versus members’ satisfaction. Most lenders routinely survey their customer base to determine satisfaction levels. What most institutions don't do is survey the perceived value of their service. This type of analysis will provide insight as to why members who are satisfied with credit union service tend to defect to other institutions.

More can be done, however, by following the example set by the largest lenders in the industry. They know retention is one very important key to profitability. They practice it employing models that accurately predict customer behavior: Who is most likely to refinance and when? Who is most likely to be shopping for a home and when? Anticipating needs such as these drives their marketing strategies and tactics. This is one reason it can be so hard to lure members away from their current lenders, even if their loan servicing experience is abysmal.

Two can play this game, and it is time credit unions got into the contest. One way is to utilize Prime Possibilities. This service pinpoints those members who are shopping for a new mortgage or are about to refinance an existing home using leading edge marketing technology and business intelligence. Combined with proven, direct-mail campaigns, this is targeted marketing at its best. There are at least two ways to use it. The first is the retention use. Running these analytics against the servicing portfolio on a regular basis enables the type of proactive marketing that keeps members with their credit union. The second applies these tools to the credit union’s entire home-owning membership base. This is the market share growth use. In addition to predicting when members will purchase or refinance, this tool also shows your credit union where members financed their homes, what products they used and current interest rates as well as the original term of the loan. Not only does Prime Possibilities enable the practice of highly targeted marketing, it provides valuable information on member behavior vis-a-vis their housing finance habits. It ought to be every


credit union’s first step when designing or re-designing strategy. Prime Possibilities is offered through Prime Alliance’s partnership with MGIC, the nation’s leading mortgage insurer.

Life-event triggered marketing also ought to play a role in every credit union’s mortgage strategy. While what is known about each of us may feel intrusive bordering on invasive, the truth is everyone’s life is now an open book. Keeping tabs on life events, then marketing into them, is another strategy successfully used by the largest lenders, and central to their success in doing so is their servicing portfolios. Sustaining and growing mortgage market share requires credit unions to avail themselves of these resources.

Pillar III: Cross-selling

Several researchers have proven borrowers are more likely to return to their current servicer for future home financing if they had a positive experience. Furthermore, members who have their mortgage with their credit union are likely to use four to six additional financial services if they were presented with the opportunity.

Currently challenging economic circumstances provide credit unions a unique opportunity to grow their mortgage program and meet more of their members’ needs for home financing. While the low interest rate environment provided an added incentive for a large number of members to refinance their loans, credit unions are in a good position to build on their success and increase their share of the purchase-money market. J.D. Power’s 2009 Home Mortgage Servicing Satisfaction Study concluded that mortgage servicers who perform well on the key fundamentals of loan servicing have higher levels of loyalty and retention. These practices include:

• Keeping problems and complaints to a minimum• Improving speed and effectiveness of problem resolution• Offering customers choices in billing and payment options• Providing adequate information on statements

Cross-selling is discussed in detail in the Section V.


V. Opportunities in Credit Union Mortgage Loan Servicing

Mortgage loan servicing plays an important role in loss mitigation. It is also an important strategy for building member relationships, as the previous section discusses. Two other considerations are important as well. Should credit unions sell or retain servicing rights? Should credit unions service in-house or have their loans serviced by a third party? These considerations are discussed in this section. Insights from the PALS experience are presented here as well and are used as a model for loan servicing as it evolves into one of this decade’s five most important mortgage lending strategies.3

The Economics of Servicing Rights

Closing a mortgage creates two assets, the loan and the servicing right, commonly referred to as mortgage servicing rights or MSRs, making mortgage loans one of the most interesting and versatile debt instruments in a lender’s portfolio. The loan is familiar; it behaves like most other debt though it amortizes differently than consumer loans. The fundamentals are the same. Servicing rights, on the other hand, are unusual assets. Servicers (lenders/credit unions if servicing rights are retained) are paid4 by investors (often Fannie Mae and/or Freddie Mac) to service (collect payments, amortize the debt, manage escrow and impounds, collect delinquencies, foreclose if necessary) the debt. If the credit union retains both the loan and the servicing, income is earned on both assets over their lives. Yet retaining both is just one option. On the other end of the spectrum is selling both, realizing cash immediately, if not gain from their sale. Along the continuum is retention of the loan asset and the servicing with servicing outsourced, as is retention of the loan with the servicing right sold. Though practiced infrequently, especially among credit unions, another choice is selling the loan while retaining the servicing.

Loan sale economics are not the subject of this paper, though servicing rights valuation is, if only at a high level. How servicing rights are valued is determined by the one doing the valuing, yet regardless of one’s role in the transaction, the simple starting point is multiplying the servicing fee paid by the investor by some multiple which represents the expected life of the servicing asset. If a buyer believes, for instance, that the life of the servicing asset (the underlying mortgage has the same life) is five years, then five becomes the multiple by which the servicing fee of 25 basis points is multiplied. The servicing release premium or SRP in this example, therefore, is worth 125 basis points.

Yet it’s not that simple. The previous discussion takes into account base servicing fees only. Illustration I provides a more complete look at the servicing value calculation:


3 Look for Prime Alliance’s forthcoming white paper, Five Strategic Frontiers, later this year.

4 Servicing fees paid by investors to servicers are typically 25 basis points for conventional conforming fixed rate mortgage (FRM) loans, 37.5 basis

points for conventional conforming ARMs and 44 basis points for FHA and VA loans.

Illustration IMortgage Servicing Rights Valuation

Servicing value is the sum ofthe present values of allfuture cash-flows generatedby servicing rights.

Additional factors are oftentaken into considerationwhen servicing rights arevalued. Geographicconcentration, propertytypes, maturity and averageweighted mortgage rate areall considered when valuingBase Servicing.

Retention Income

Cross-Sell Value

Late Fee &Ancillary Income

Escrow Float

Pre-Payment Float

P&I Float

Base Servicing

Retention Income

Cross-Sell Value

Late Fee &Ancillary IncomeAncillary Income

Escrow Float

Pre-Payment Float

P&I Float

Base Servicing

Atw

Notice that retention income and cross-sell value take their places as top variables in the equation, reinforcing the preceding discussion. And, as the illustration suggests, other factors are considered too, such as geographic distribution, property types, loan maturities and note rates. Valuing servicing is as much alchemical as it is mathematical.

How does a credit union decide whether to sell servicing for a servicing released premium or retain servicing rights? Service in-house or out-source to a subservicer? Both decisions are as much subjective as they are objective. Dealing first with the objective question of sell or retain, it is helpful to consider the question from three perspectives. For the purposes of this discussion assume the servicing rights in question were created in the last 12 months, during the period when interest rates hit four-decade lows. Borrowers flocked to their lenders to lock in sub-5% mortgages as they believed they would never see such a phenomenon again.

• Perspective One: The Servicing Buyer. Mortgage assets, beginning in late 2007 and continuing through 2009, were not the darlings of the investment community due to the total loss of confidence in their ability to perform, even though better than 90% of borrowers continued to pay on time. Considering this, and despite the fact that mortgage loans originated in 2009 are likely to have some of the longest durations of any loans made over the long history of housing finance, servicing buyers were and are paying deeply discounted prices for servicing rights. Where the simple arithmetic of servicing fee times expected duration should yield 125 to 175 basis points, buyers were and are paying in the neighborhood of 80 to 100 basis points, a substantial discount. Investors are buying cheap because confidence in these assets remains low. Why sell an asset for 100 basis points when logic dictates it may be worth as much as 25 to 75 basis points more?

• Perspective Two: The Servicing Retainer. In this context the servicing retainer is the credit union. Given that servicing buyers are paying so little, it may make more sense to keep servicing as an asset. Financial accounting standards, however, prohibit valuing the investment at anything greater than market value. Sold or retained, the book value recognized, therefore, is 80 to 100 basis points.


• Perspective Three: The Cash View. While the one who retains servicing is no further ahead than the lender selling the servicing from a book perspective, cash is cash. So, looking at this question from a purely cash perspective, why sell servicing today for as low as 80 basis points when, over the life of the loan, the servicing retainer will more than likely recognize 125 to 175 basis points in cash? This is what the servicing buyer in Perspective One is counting on.

On a purely cash basis, assuming cash is not needed for current operations, selling servicing today is a bad bet. The question then becomes service in-house or out-source servicing?

When dealing purely in objective criteria, this equation, too, is rather simple. Servicing in-house costs the typical lender $153 per loan per year according to the Mortgage Bankers Association’s 2008 Annual Mortgage Bankers Performance Report. Compare this benchmark average with your credit union’s cost., versus the cost of outsourcing which is typically less than $75 per loan per year. Table I provides a quick summary of the financial benefit of outsourcing:

Table IFinancial Benefits of Outsourcing Servicing5

OutsourceServicing

Annual Servicing Income, Per Loan $500 $500

Less: Annual Servicing Income, Per Loan $153 $75

Equals: Annual Servicing Income, Per Loan $347 $425

Advantage to Outsourced Servicing $78

$

ServiceIn-House

The Servicing Retention Opportunity

While investor-paid servicing revenue may seem insignificant at 25 basis points per year, it does provide welcome fee income, especially as servicing portfolios grow. Yet the more compelling reason to retain servicing is the opportunity servicing rights create for member relationship building and retention. Cross-selling begins, or should begin, as the member’s loan is originated and should never stop. Indeed, the residential mortgage is considered by many mortgage bankers as the key to relationship banking. Sell servicing rights, and these opportunities are lost.

The second best time to provide members information about the credit union’s other services is when their mortgage is closed. The third best time is while the loan is being serviced by the credit union. These members are prime candidates for the use of all the credit union’s services. How is this done effectively? Competitors frequently use the following tactics:

• Train your mortgage loan officers about the credit union’s other services, deposit accounts and home-equity loans, for example, and allow them to sell products appropriate to the member’s life stage. Or, build a process where loan officers can introduce the members to a


5 Income calculation assumes a loan amount of $200,000.

member service representative or provide them with a discount for other services as part of the real estate loan closing.

• Utilize member service representatives and tellers as salespeople. For many lenders, holding on to existing customers means rethinking the role front-end staff plays. Pitching new products to existing members during regular interactions can be a very effective cross-selling tool.

• Target current mortgage borrowers with direct mail or with advertisements included in their monthly statements. Many credit unions have moved from coupon books to mailed monthly statements to take advantage of the marketing opportunity.

• Use relationship pricing to sell other services. Home equity lines of credit are the logical step after the first mortgage but not the only one. Promoting deposit products and credit cards to mortgage customers could work very well.

• Offer an exclusive packaged account just for members with a mortgage loan. This could include a discount on other loans offered by the credit union or higher interest on deposit accounts and CDs.

• Offer refinancing opportunities or modification to borrowers who are paying interest above the current market rate or have an adjustable rate loan that will reset at a higher rate as part of a mortgage retention campaign.

Regardless of the tactic, one essential component is to present the service at the right time and invest in systems and resources.

Service In-house or Outsource?

As discussed throughout this paper, increased credit union participation in mortgage lending over the past four years has substantially increased the need for greater servicing capabilities.

Advancement in origination technologies has resulted in significant growth of credit union mortgage portfolios as mortgage loans become easier to originate. It follows that mortgage servicing automation should support this growth, which has had a significant impact on real estate portfolio management, secondary marketing and on meeting regulatory requirements. Members’ service expectations are also higher. In short, the dynamics of the last five years highlight the need for a credit union system servicing and sub-servicing solution. It’s a market niche no credit union entity is filling at the desired scope or scale, save Prime Alliance Loan Servicing.

Two solutions have been available for credit unions to help manage the challenges of servicing these growing portfolios:

In-house Servicing

Most credit unions built their servicing operations utilizing inadequate processing systems that in most cases fail to accurately support essential functions as well as support today’s robust mortgage product offerings. Moreover, inexperienced staff, pulled from other areas of the credit union, has been tasked with managing the servicing operation, including regulatory compliance. This situation results in limiting servicing operations to the basic loan administration functions, failing to provide members with enhanced service, or providing members with mortgage loans that do not meet their needs. All in all, these operational limitations keep credit unions from maximizing the benefits of servicing retention. It is worth noting that most credit unions chose in-house servicing solutions


based on the subjective assumption that the members want to stay with the credit union and no other entity can serve the members as well. PALS’ customers have proven this hypothesis incorrect. It is also evident in the wide credit card portfolio servicing enjoys among credit unions. Furthermore, most of these credit unions failed to utilize the value of retaining the servicing since very few have successfully implemented any cross-sell or retention program.

Subservicing Subservicing is a contractual agreement where a credit union outsources their loan servicing functions (loan administration) to a third-party for a fixed, per-loan subservicing fee.

With the tremendous recent growth in mortgage lending, many lenders and credit unions are turning to subservicing to reduce the added cost and manage the risk while improving customer relationships. By using an outsourced solution, credit unions can chose between either private-label servicing, where all member contact and correspondence is done in the credit union’s name, or generic servicing, where the servicing is done in the subservicer's or a generic name.

While the benefits of subservicing are many, there remains an industry-wide bias against this economical solution. Some of the common reasons cited for keeping servicing in-house do not hold up under close scrutiny. Reasons most cited against subservicing include:

• We can do it cheaper. A Mortgage Bankers Association (MBA) servicing cost-study estimates the per-loan cost of servicing falls between $150 and $290 annually, depending on the size of the portfolio. While credit union in-house servicing costs might be lower without having dedicated staff or related overhead expenses, the costs quickly exceed the expense of using a subservicer when you factor in elements such as collections, compliance and reporting (see Table I).

• No one serves our members as well as we do. With dedicated resources and state-of-the-art technology, subservicing providers have the tools to provide the quality service that matches or exceeds the levels credit unions can provide on their own. With subservicing, members generally receive higher levels of service while you retain the relationships.

• Our loan volume is too low for subservicing. This is generally not true of all third-party subservicers, especially those dedicated to serving credit unions. Many have low or no volume limits. PALS, for example, provides the same services for the same price, regardless of the credit union portfolio size.

• We don’t have the resources to dedicate to the conversion. While any conversion presents challenges, in the case of outsourcing mortgage servicing, the subservicer should do the bulk of work. Taking the time to make the switch now, rather than later, positions you to better compete for members’ business.

Today, many credit unions are looking beyond the reasons to avoid outsourcing and welcoming the significant benefits such an option provides. Working with a reliable, credit union-specific subservicer not only positively impacts the bottom line, it expands and enhances mortgage-lending programs. Ultimately, members win.


Comparing the Costs of In-house versus Outsourced Servicing

When evaluating servicing costs, it is important to consider all expense components to ensure an accurate comparison. Costs to consider include:

1. Occupancy. 2. Data Processing.3. Personnel. Personnel costs should include those staff directly involved with loan servicing as

well as those that support the function, including accounting, personnel, legal and administrative employees.

4. Notification Costs. These include coupon books, statements, mailing costs and the costs of other notifications, such as the annual escrow/impound analysis.

5. Collections and Foreclosure.6. Regulatory Compliance.

PALS has created a servicing cost analysis that it uses with its customers and potential customers to help them understand servicing economics.


VI. Why Aggregate Credit Union Servicing?Loan servicing is a commodity proposition, one that is dependent on portfolio size. All lenders, credit unions included, need sizable portfolios to justify the in-house cost of providing members with state of the art service. This service, to a large extent, is limited to the resources (system and staff) dedicated to these important activities. Simply put, by joining PALS, credit unions will be able to tap into the significant resources of Cenlar, Prime Alliance Loan Servicing’s partner and provider.

The mortgage industry has traditionally turned to subservicing to lower costs, reduce risk, gain access to the latest technology and enhance customer service. Traditionally, smaller credit unions have relied on subservicing due to resource limitations that prohibit in-house creation of a robust servicing department. That has changed. With the growth in compliance requirements, secondary market activities, the need for better portfolio management and the increased demand from members for better service, larger credit unions are looking to subservicing for help managing the growing complexity of loan servicing while lowering their costs. In short, the dynamic environment of the past five years highlights the need for a scalable, robust servicing solution that supports continuing growth.

Just as mortgage origination has changed, so has mortgage subservicing. This is another reason many credit unions are evaluating subservicing as a component of their overall real estate lending strategy to achieve higher levels of efficiency in meeting members’ needs as well as support their lending activities. Credit unions are acknowledging outsourced servicing operations are a better strategy than building needed expertise and infrastructure in-house. Doing so allows for intense focus on mortgage origination and meeting member needs for home financing. It also enables more attention to be paid to managing the relationship with the member, rather than getting weighed down by the operational mechanics of loan administration. Additionally, because of their size and capabilities, subservicers can and frequently do a more effective job at cross-selling additional products and services, thereby strengthening the relationship with the member household.

However, the fact remains that many credit unions have been uncomfortable turning over the management of a member relationship to another entity, but having a CUSO committed to the industry that shares the credit union member service philosophy and that utilizes the power of aggregation to provide needed resources has made this decision easier.

Aggregated Subservicing and PALS

Many CUSOs have successfully used aggregation to increase credit union buying power and achieve higher levels of efficiency. Prime Alliance Solutions demonstrates this with origination and the services required to close mortgage loans. PA clients have access to best of breed technologies at an affordable price, which has reduced the cost of loan origination. This is only possible through the collaborative power of aggregation. As a group, these credit unions enjoy buying power equal to that of the top 10 lenders in the country. Documents, flood, title, credit and valuation are all lower in cost as a result.

Another successful aggregation model is PSCU Financial Services in the credit and debit card area. By servicing more than 14 million cardholders, PSCU is able to offer credit unions access to one of the largest credit card processing systems at an affordable price. Individual credit unions could not afford the technology, processes, systems and talents necessary to deliver these services in a competitive manner. Together, however, it is possible, and the results have been notable. Mortgage servicing is now at the same stage, volume is increasing, servicing is becoming highly complicated and very costly to keep in-house.


Prime Alliance Loan Servicing (PALS) was formed to provide credit unions with an aggregated subservicing solution that is exclusively focused on industry needs. A partnership between several credit unions and Cenlar, the largest subservicer in the country, PALS is the framework that enables credit unions to aggregate their servicing portfolios to achieve scale and access to capabilities traditionally reserved for very large institutions. While the PALS portfolio is 74,000 loans, Cenlar services in excess of 500,000. Being part of this aggregation model allows credit unions to avoid costly investments in offices, staffing and technology. It also provides the tools and technologies needed to track, measure and analyze data related to their portfolio performance and aids management, control and knowledge of the risks inherent in the servicing portfolio.

In addition to these subjective reasons, there are a number of objective considerations, cost savings being the first. Previous sections of this Paper discuss servicing costs. In-house servicing, according to MBA’s performance data, typically costs lenders between $150 and $290 per loan per year, depending on portfolio size. Outsourced servicing through PALS reduces this cost by more than half, typically costing as little as $75 per loan per year for a full-featured solution. Members still make payments at their local branch offices and access their mortgage account on-line through the credit union’s home banking portal. Member service representatives are available by phone and interactive voice response is available 24 hours per day, all at a fraction of the cost of providing this same level of access using in-house resources.

Private-labeling is the second objective consideration. Building and reinforcing the credit union brand through the subservicing transaction is not only possible, it’s essential. The PALS program showcases the credit union’s brand in all member communications, including mail, phone and internet interaction. Prime Alliance Loan Servicing offers the best private-label experience in the industry, all at no added cost. Credit unions can expect the brand recognition they’ve worked to build with members over the years will continue to be delivered. Features of PALS’ Private Label Program include:

• A dedicated toll-free number that greets members in the credit union’s name;• Payments are made payable to the credit union, reinforcing name recognition;• Payments can be processed at the credit union’s branches;• All reporting to investors will be done in the credit union’s name;• Monthly credit bureau reporting is done in the credit union’s name;• Live call transfers to the credit union for sales or refinance opportunities;• Custom website with Single Sign-On capabilities will reflect the credit union’s name and

brand;• Ancillary income opportunities are available; and• User-friendly internet access to loan data.

PALS’ private-labeling also helps credit unions maintain brand recognition. The following steps ensure members strongly identify with their credit union:

• Credit union’s name and logo are on all outbound correspondence and printed materials such as coupon books, notices, 1098s, escrow analysis, ARM notifications and letters;

• Outbound calls are identified as calls from the credit union;• Payments and correspondence are addressed to the credit union;• Customized welcome letters are sent to new members in the credit union’s name;• Members have access to a dedicated toll-free number, which is always answered in the

credit union’s name;• Members always receive communications, written or verbal, identified as coming from their

credit union; • Direct call transfer capability to the retail centers will give members the opportunity to

research sale or refinance opportunities directly with the credit union;


• Members drafting from checking or savings accounts will be done in the name of the credit union, or member may make their payments at the credit union’s branches;

• Member payments are made payable to the credit union;• E-Pay for member payments;• Tracking of fire losses and payouts to members and contractors in the credit union’s name;• Notice of unpaid taxes and unpaid insurance are sent to members in the credit union’s

name;• ARM loan change letters are sent in credit union’s name;• Partial release, assumption and liability release verbal and written correspondence are sent

in the credit union’s name;• Modifications are completed in the credit union’s name;• Laser check writing, reporting package to support remittance types are all handled in the

credit union’s name;• Electronic reporting to the GSEs under the credit union’s seller/servicer number;• Remittance reporting in the credit union’s name;• Regulatory/compliance reporting in the credit union’s name;• Loss mitigation verbal and written correspondence in the credit union’s name; and• HELOCs - member checks are sent in the credit union’s name.

Collection and loss mitigation is a third consideration. Creating a customized solution for collection campaigns is typical for most credit unions. PALS begins with a standard timeline as illustrated by Table II and uses it to create a program that meets each credit union’s needs:

Table IISample Collections Time Line

CallingCampaign

LetterCampaign

Day 2 LoansScored usingEarly Indicator

Day 16 Day 30 Day 45 Day 65 Day 70 Day 90 Day 95-105

Day 17 + Autodial Calls Based on Scoring

P198 Late ChargeNotice

P199 MonthEnd

Delinquency Notice

Breach Letter

2nd Loss MitSolicitation

Letter

3rd Loss MitSolicitation

Letter

Foreclosure Reviewand

Recommendation

- PMI Delinquency Reporting- Loss Mit Solicitation Letter- Order Property Inspection

Day 45 + Loss Mitigation Solicitation Calls

Collections

PALS’ approach to collections is based on early member contact to identify the cause of the delinquency and the best possible resolution in as short a time as possible. To achieve this the collections team is divided into two groups: those who deal with conventional/conforming and government loans (prime loans) and those who manage more aggressive collection campaigns (similar to sub-prime delinquencies). All delinquent loans are directed to the collection agents by the predictive auto-dialer based on specified calling campaigns. Within the prime team, standard work rules are applied according to investor guidelines. The non-conventional/conforming team makes collection attempts based on a variety of non-prime work rules based on client directives.

The following tools aid the staff in maximizing their collection efforts in an attempt to make right party contact and ultimately reduce delinquency:


• Melita Predictive / Preview Auto-dialer; • Inbound / Outbound Call blending;• Early Indicator scoring model;• Western Union Quick Collect;• Phone Pay / IVR Pay / Web Pay;• Inbound Contact Capture;• Online Promise-to-Pay / VRU Promise-to-Pay;• PLANET Code® Postal Tracking;• Delinquency Interview;• Skip tracing; and• Witness Call Recording.

Conventional/Conforming Collection Team

Delinquent loans in this group follow standard servicing guidelines in accordance with investor requirements. Customized calling campaigns and activities can be added as needed.

Dedicated collection staff members are responsible for daily management and reporting as it pertains to all collection call campaigns and their results. Standard campaigns are scored and built based on Freddie Mac’s Early Indicator scoring model. Using the predictive auto-dialer, collection campaigns are designed to reach delinquent members based on the risk score. Two to three collection attempts per week will be made until right contact is made and/or a resolution has been reached.

Collection calls continue throughout the duration of the delinquency until the loan is reinstated, placed on a repayment plan, or approved for foreclosure. Calls are made to the member inclusive of all available phone numbers at various times of the day.

A delinquency notice is mailed to the member at approximately the 17th day of the delinquency. This notice reflects the payment and applicable late charge that is due. Other collection letters may be generated on an individual basis depending upon the type of contact, or lack of contact, with the member. Prior to the end of the first month of delinquency, an additional final notice is also sent to the member. When the right person is contacted, reasons for delinquency are identified and the applicable workout resolution will be offered to ultimately bring the loan current. Payment plans have a maximum duration of six months. Longer repayment plans may be considered through loss mitigation efforts.

Demand/breach letters are mailed to members during the third month of delinquency along with any letters required to meet existing state laws. Loans continuing to be delinquent will be reviewed for foreclosure, depending on loan type, between the fourth and fifth month of delinquency.

Non-Conventional/Conforming Collection Team

This team’s objective is to ensure more assertive collection efforts. Non-prime loans or loans identified as requiring a more aggressive collections approach normally fall under this category.

PALS utilizes Freddie Mac’s Accelerated Early Indicator scoring model calling for earlier collection attempts. The non-prime calendar is an accelerated version of the prime calendar.

Collection calls are performed day and night, seven days a week based on credit union directives. Partial payments are accepted (taking one payment when two or more are due) to prevent the loan


from rolling to a higher delinquency bucket. Payment plans follow standard work rules but may be adjusted based on credit union preferences. Promise-to-Pays are not permitted to cross over month-end.

All broken Promises-to-Pays are called within 24 hours of the broken promise. If contact is made the collector will determine the reason for the broken promise and attempt to collect the promised payment immediately. PALS is typically in a stronger negotiation position with the member as they have broken a promise.

A new Promise-to-Pay for a date in the future must be carefully considered before being accepted as the member has already broken at least one promise. The member will be counseled to determine if the reason for the broken promise was beyond their control and what the next steps are to resolve the delinquency. All phone numbers are verified and additional contact information is requested. All information is documented on the system of record. If contact is not made, a broken promise-to-pay letter to the member is generated through the servicing system. Collection calls continue through the normal collection campaigns. Urgency for payment is stressed on all right party contacts.

Additionally, when bad phone numbers are identified, skip tracing is performed to obtain additional contact information using various vendor websites.

Delinquency visits are ordered based on client directives in an attempt to make face-to-face contact with hard to reach members.

Unattended dialing campaigns are utilized on a periodic basis. Campaigns leave messages requesting members return phone calls during normal business hours. Campaigns are run in an attempt to stress to the member the urgency of the situation and to increase inbound call volumes.

PLANET Code® (postal code tracking) is utilized through the US Post Office to assist in strategic dialer campaigns. Postal code tracking identifies and notifies the collection staff as to when a payment has been placed in the mail. This notification removes the identified loan from the daily campaign therefore avoiding unnecessary collection attempts.

Collection staff are reviewed and monitored daily to enhance existing collection attempts and to promote collector development. Approximately 10 calls per month, per collector are monitored and reviewed. A quality control representative performs a loan level review with the agent as well as provides a score based on the call effectiveness.

All loans with a non-sufficient funds (NSF) check are called within 24 hours of the NSF check being processed. If contact is made the collector must determine the reason for the NSF and attempt to collect the scheduled payment immediately. Quick Collect is the preferable means of obtaining these payments. If it is determined that this is an isolated case, the payment can be taken in other fashions. After the initial call, collection calls continue through the normal campaigns if no contact has been made.

Loss Mitigation

Cenlar, PALS’ servicing provider, recently achieved and was named a recipient of the U.S. Department of Housing and Urban Development (HUD) Tier One (1) Ranking Score (TRS) for its "superior performance and dedication to providing Loss Mitigation to FHA borrowers." The same Tier One (1) ranking was bestowed upon Cenlar by Freddie Mac in 2009.


PALS’ collections and loss mitigation staffs are aligned to maximize loss mitigation referrals and to identify loss mitigation opportunities. Understanding the practices of the credit union and the flexibility they are willing to apply to each loan modification or workout plan is important in developing a member strategy. Additionally, PALS works very closely with its credit union customers on a loan-by-loan basis to ensure they are cognizant of the total debt held by the credit union and the approach that the credit union wants to take with each member.

Contact will be attempted both via letters and telephone calls from the loss mitigation solicitors to make arrangements with the borrower/member. The solicitors start making solicitation calls at the 45th day of delinquency through the foreclosure sale date, based on the early indicator loss mitigation score. Loss mitigation opportunities are considered whether the member is delinquent or can provide proof of imminent default. This is carried forward to the foreclosure area where parallel processes are managed to maintain timeline performance while continuing to work loss mitigation opportunities up to the date of a pending foreclosure sale. Both Process Management and New Invoice have been implemented. They are products that are designed to improve communications and coordination with PALS’ nationwide attorney network.

Loss mitigation is handled through the loss mitigation workstation on the servicing system. The loss mitigation unit consists of two functional teams: underwriting and processing. The goal is to obtain a complete workout package consisting of a completed financial statement, last two pay stubs and bank statements, last two years’ federal tax returns and a credit bureau report. The underwriter will review the package to determine the feasibility of a workout and then make their recommendation according to investor guidelines and hierarchies. They will take into consideration all factors surrounding each case, including whether or not the situation is a short- or long-term hardship, the financial ability to pay, and will tailor each decision individually.

The processor will then work to complete the underwriter’s recommendation. All communication with borrowers/members, investors, PMI companies, representing third parties and title companies will stem from this group. Processors are also responsible for the monitoring of all forbearance and repayment plans as well as removing and restarting foreclosures if applicable. In addition, all short sales and Deed in Lieu requests are handled within this area and are handled by specialists in those areas as no underwriting will be needed. They will present investors with recommendations after the highest and best offers have been negotiated and obtained.

The introduction of the Home Affordability Modification Program (HAMP) in March of 2009 and the adaptation of that program by Fannie Mae, Freddie Mac and recently FHA has become another focal point for loss mitigation efforts. The internal infrastructure needed to perform the waterfall to meet GSE guidelines for this program has been implemented, and although the program continues to evolve, the core items have been put into place. Loans are underwritten according to the GSE’s current hierarchy and put on three-month trial modifications. Those plans are closely monitored to ensure they are compliant with all regulations surrounding the program including document viability, payment dates, and required signatures. During the trial period more current financial information is obtained so PALS can generate the final modification and put the borrower/member in a more permanent workout option.

Loss Mitigation

Loss Mitigation continues throughout the foreclosure process. It is important to hold with the idea a borrower's home may be saved. Circumstances could change such that the member may keep their home.

PALS works very closely with the GSEs and the insuring agencies including HUD, to be certain their guidelines are followed. However, on credit union portfolio loans, PALS works directly with its credit


unions to coordinate the foreclosure process so that the correct decisions are made as they relate to each individual member and their relationship with the credit union.

To stay compliant with local municipalities and county and state guidelines, PALS outsources the foreclosure process to a third party that uses a national attorney network with a proven track record of exemplary performance processing foreclosure and bankruptcy work. All client/borrower facing tasks and communication remain with PALS. If the credit union has a preferred attorney of choice, then PALS will integrate them into the process. PALS' default compliance department maintains the responsibility to monitor all loans to ensure they are approved for foreclosure according to established timelines and to ensure every effort has been made to cure the default before foreclosure is approved. PALS has created foreclosure workstation tracking templates to monitor the foreclosure timeline by state, investor, agency and insurer guidelines. Timeline tracking reports are utilized to identify loans approaching the established timelines and loans that have exceeded the timelines, and the reasons for the exceptions are documented.

Additionally, the foreclosure department utilizes various exception reports to monitor the performance of a loan through the foreclosure process. These reports monitor steps such as timely filing of the first legal (referral to first legal), timeframe between foreclosure steps, and timeframes from foreclosure referral to sale. Contested foreclosures and foreclosure delays (e.g., court delays, title problems) are closely monitored to ensure timely and prudent resolution. Advance activity related to property maintenance, utilities, taxes, insurance, security, and repairs are tracked through the corporate advance workstation.


VII. Conclusion There has never been an opportunity like the present for the credit union industry to take its rightful place in the housing finance market. In order for our industry to serve the nation's members, we must use innovative new ways to bring solutions utilizing the tried and proven concept of aggregation. This couldn’t be truer than aggregating credit union loan portfolios to achieve the scale needed to access the technology and the expertise essential to achieve this objective. While this Paper discussed in detail our views of successful servicing strategies, the fact remains that servicing at its core is a self-liquidating asset. As older loans amortize, servicing revenues decrease while costs per loan remain unchanged. Maximizing the investment made in servicing rights is a matter of leveraging retention and cross-sell opportunities while managing risk and minimizing loss. Credit unions must also consistently increase origination volume to maintain the size of the servicing portfolio. Aggregation is a certain means of maximizing the return on servicing rights. This strategy ensures the scale essential to lower servicing costs and to allow the industry to access best of breed solutions. For aggregation to succeed, first and foremost, the industry has to evolve its view of loan servicing and its role in three main areas:

I. Service as a cornerstone for member retentionMost members lost to a competitor are lost for pricing and/or service reasons. While in most cases credit unions cannot compete on price alone, we can compete on service as we do with most other financial services. II. Cross selling Servicing is clearly a high transaction/low profit margin business. The Mortgage Bankers Association, in its Quarterly Performance Report, showed the average mortgage servicer net income is $214 per loan per year. This $214 included $53 ancillary income. Servicers that are able to cross-sell additional products to the borrowers have a decided economical advantage. III. Risk Management As credit unions’ real estate portfolios grow, so do associated risks. We would go as far as to say managing risk will be instrumental to the survival of credit unions. Managing risk requires access to systems and analytics. These systems and solutions are costly and only available to large scale servicers. In this case aggregation becomes a prerequisite to access these solutions at an affordable price.

As Charles Darwin said, ”It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.”


Notes:

rethinking loan servicing

Documents

mortgage loan servicers

prime alliancere

exotic loan products

credit unions

nature of credit union

mortgage brokers

mortgage lending performance

new loans