This lengthy post covers different ways in which mortgage servicers can get ahead.
Interpreting the PSAs
Private label non-agency RMBS have pooling and servicing agreements (PSAs) that govern how the servicer gets paid and what the servicer can/cannot do. RMBS vary in the terms of the PSAs. For example, some of them do not allow for any loan modifications. In general:
- Servicers are incentivized to perform loan modifications. If a home ends up in foreclosure, the servicer no longer gets paid its servicing fee, which is a percentage of the UPB (unpaid principal balance) since the home is no longer in the mortgage pool. On top of that, the servicer has to eat the cost of financing advances on the delinquent mortgage. It has to effectively lend money to the mortgage investors at 0% interest for certain unpaid principal+interest payments (that the borrower would have otherwise paid if they weren’t delinquent) and foreclosure costs. The servicer will also have non-reimbursable expenses associated with foreclosures. Reimbursable expenses vary from PSA to PSA.
- Servicers are incentivized to avoid short sales if the borrower is current. If the borrower continues to pay the mortgage, the servicer will continue to collect its servicing fee. A short sale would eliminate the servicer’s servicing fees.
- Servicers are incentivized to be low cost and to provide minimal customer service.
- Servicers are incentivized to spend as little money as possible repairing REOs and to sell them as quickly as possible.
- The servicer can exploit the PSA to drive business towards affiliated adjacent businesses.
To my knowledge, the most egregious example of a servicer pushing the limits was when Nationstar tried to sell non-performing loans (allegedly at fire sale prices) on auction.com. This benefits Nationstar because it gets to recoup its advances quickly. The plaintiff argued that the sale was a clear breach of contract under the PSA (complaint). The lawsuit was later settled out of court and Nationstar reversed its sale of NPLs.
If the borrower does not pay insurance via escrow and does not pay for sufficient insurance, the servicer may purchase insurance on the borrower’s behalf. The servicer can make the borrower pay for overpriced insurance. In return, the servicer can take kickbacks from the insurance company. That may be in the form of:
- Insurance commissions. (The excuse is that consumers normally pay commissions on insurance they purchase.)
- Profit sharing agreements.
- Reinsurance deals.
- Free or discounted services. Specifically, the insurer (or an entity/middleman working for it) may do the work of figuring out which mortgages require force-placed insurance. The givers and takers of kickbacks has an incentive to increase the number of force-placed insurance policies so they will find excuses to force-place insurance. For example, flood zone changes can cause situations where a homeowner’s existing insurance is technically insufficient according to the mortgage contract.
- Fees to access the servicer’s records.
- Fees for services provided by the servicer or the servicer’s affiliate. Benjamin Lawsky’s letter to Ocwen talks about this. He suggests that SWBC paid kickbacks through paying fees to access to Ocwen’s loan files and fees to Altisource for loss draft services.
Ocwen and Altisource have provided very little disclosure on its force-placed insurance practices. 8-K/A filings for Beltline Road Insurance Agency (one of Homeward’s fee-based businesses) mentions “insurance commissions”. An obscure 8-K filing associated with the Homeq acquisition states:
Certain amounts in the historical statement of operations of HomEq Servicing have been reclassified to conform to Ocwen’s presentation. Insurance commissions revenue has been reclassified to Servicing and subservicing fees.
That’s all I could find about Ocwen receiving fees that could be construed as kickbacks on force-placed insurance. In my opinion neither Ocwen or Altisource did a good job in disclosing the risks associated with force placed insurance practices or the revenues from such practices.
Nationstar (NSM) groups its “insurance commissions” as Other fee income for its Servicing segment. Its 10-K states (emphasis mine):
Other fee income was $238.1 million for the year ended December 31, 2013 compared to $35.1 million for the year ended December 31, 2012, an increase of $203.0 million, or 578.3% due to higher commissions earned on lender placed insurance and higher REO sales commissions. Solutionstar contributed $185 million of the 2013 fee amounts.
Both Nationstar and Walter’s 10-K contain substantially more disclosure about lender/force placed insurance than Altisource and Ocwen. Both Nationstar and Walter mention the change in GSE rules that effectively banned the practice after June 2014.
The big banks have paid settlements over force-placed insurance. See my post on force-placed insurance.
On November 12, 2014, Altisource closed its force placed insurance brokerage business “given the uncertainties with industry-wide litigation and the regulatory environment” (here is one of my posts on the news). Presumably Altisource and Ocwen will not be engaged in risky practices in the future.
Both Nationstar and Green Tree / Walter have not renounced insurance commissions or other revenue streams related to force-placed insurance.
Fees paid to adjacent businesses
Mortgage contracts allow the servicer to purchase certain services if the loan defaults. The cost of these services is added onto the mortgage. For examples of such fees, look at a copy of a mortgage servicer’s fee schedule (e.g. Wells Fargo; scroll down to Default Costs). Servicers can buy default-related services from affiliates (or themselves) at high prices, thus steering profits towards their affiliates (or themselves).
There is usually some uncertainty as to what market rates for fees are, especially when the quality of different service providers vary. Market prices usually exist over a range. The idea is to charge on the high side of market prices. If borrowers or mortgage investors were to sue, it may be difficult to prove that the fees are unreasonably high. As far as I know, borrowers and mortgage investors have not been able to successfully sue servicers over such practices. Fannie Mae tries to protect itself from abuse by establishing pre-determined fees that servicers can be reimbursed for (e.g. foreclosure attorney costs, $80 for an exterior BPO, $105 for an interior BPO).
In general, Altisource has higher margins on mortgage services (especially default-related services) than it does for its technology services. This is a little unusual given that a software company with scale should achieve high margins while labour-intensive mortgage services would likely yield lower margins. Page 30 of the ASPS 10-K provides information on the relative margins between Altisource’s segments:
- In 2011, technology services had Income from operations/service revenue of 26% versus mortgage services with 42%.
- In 2012, technology services had Income from operations/service revenue of 14% versus mortgage services with 40%.
- In 2013, technology services had Income from operations/service revenue of 7% versus mortgage services with 36%.
Altisource’s investor presentation (here’s the slide) suggests that Altisource can have 40% margins on mortgage services and 10% margins on technology for Ocwen’s non-GSE portfolio. Through this pricing scheme, money is transferred from mortgage investors and borrowers to Ocwen and Altisource because the mortgage investors are getting slightly gouged on mortgage services.
There is a chance that this game may change… at least in New York. Ocwen’s consent order with the NY DFS states that Fannie Mae’s maximum rates cannot be presumed to be the market rate. It also states that if market rates are not available, the rates should be “reasonably related to actual expenses incurred by the related party”. While the former is similar to the rules set out by Ocwen’s CFPB consent order, the latter doesn’t seem to be.
53. With respect to mortgage loans serviced by Ocwen, Ocwen will conduct semi-annual benchmarking studies of pricing and performance standards with respect to all fees or expenses charged to New York borrowers or to investors on New York property by any related party, to determine whether the terms offered by the related party are commensurate with market rates or, if market rates are not available, are reasonably related to actual expenses incurred by the related party. Maximum rates for services that are established by government-sponsored enterprises or other investors may not be presumed to be the market rate and may not substitute for actual assessment of market rates.
The NY DFS seems to be specifically going after high-cost services imposed onto borrowers and mortgage investors. However, Altisource indicated on its Jan 2015 conference call that it does not believe that NY DFS settlement and regulatory woes will affect the company’s pricing (transcript).
A recent analyst report has generated a lot of confusion on this topic and whether Altisource will need to reduce its pricing to Ocwen. Let me start by saying that we strive to provide services to Ocwen at rates comparable to the market and we firmly believe we charge Ocwen market rates for those services. Altisource has a long-term agreement with Ocwen that runs through 2025. The agreement provides that both Altisource and Ocwen have the ability to renegotiate pricing based on prevailing market conditions. Further, Ocwen’s recent settlement with the DFS requires Ocwen to conduct market studies on the services Altisource provides. We welcome this requirement, agree that our pricing should be in line with market and firmly believe that it is.
An example- BPOs
For interior BPOs, Altisource seems to pay $39 to the contractor that performs the BPO (source: forum posters on agentsonline.net). Apparently in the past contractors could be expect to be paid $60 for similar work. On top of the $39 Altisource has various expenses (technology, direct deposit, staff to QC BPOs, overhead, support, soliciting agents/contractors, etc.). Fannie Mae’s maximum fee for a BPO is $105 (source: Fannie Mae PDF). Somewhere in there is the opportunity to make fairly high margins.
*I don’t know what Altisource charges for its BPOs and did not save a copy of Ocwen’s fee schedule (which is now behind a login-wall on ocwencustomers.com).
REO sales commissions
The mortgage servicer is tasked with selling homes after they have been foreclosed on. The servicer can drive fees to affiliated real estate brokerages that help sell the home.
RMBS/mortgage investors should ask themselves whether or not they are getting value for what they are paying. Altisource often uses an out-of-state agent to list properties onto local MLS systems. The NY DFS criticized this practice in its press release on Ocwen’s settlement:
Moreover, Ocwen engages Altisource Portfolio subsidiary REALHome Services and Solutions, Inc. as its default real estate agency for short sales and investor-owned properties, even though this agency principally employs out-of-state agents who do not perform the onsite work that local agents perform, at the same cost to borrowers and investors.
Altisource uses local contractors to perform the work that a traditional real estate agent would. Altisource generally takes a low-cost approach to REO management. Its approach can sometimes cause problems. There seems to be some cases where Altisource does not realize that its contractors have performed shoddy work or no work at all. Because it does not have somebody on the ground that is intimately familiar with the property, it may be slow to spot problems with its properties (e.g. somebody is living inside the house, the house has not be trashed out, house not secured, etc. etc.).
Online auction sites
Online auction sites are another way to partake in fees associated with the REO sales process.
In some cases these sites can create value. One of the problems with traditional real estate agents is that they are more incentivized to close deals than to get the highest price for their client. Because of this, online auction sites can sometimes lead to better price discovery. For short sales, mortgage investors do not want to be defrauded by borrowers who sell their home to their relatives or buddies at below market prices. Nationstar and Ocwen regularly force short sales to be listed on these companies’ affiliated auction sites to see if the home can fetch a better price.
Shill bidding is a sleazy aspect of some auction sites. Both Nationstar’s HomeSearch.com and Altisource’s Hubzo.com (formerly GoHoming.com) are regularly accused of shill bidding.
- The FAQ on Hubzu’s website states that the company does not do shill bidding. Unfortunately I have not figured out how to independently verify this.
- HomeSearch.com’s Event Agreement does seem to allow for shill bidding (here is a blog post that explains it).
Profitability of REO sales commissions
Overall, REO sales commissions seem to be a major profit center for Altisource and Nationstar with extremely high margins. My guess is that the pre-tax profit margins are well above the average ~40% margin on Altisource’s and Nationstar’s mortgage services businesses.
I don’t know if RMBS investors are getting value out of the REO sales commissions that they are forced to pay to mortgage servicer’s affiliates. HSBC has contracted Altisource for its REO management so presumably HSBC sees some value in what Altisource offers.
Getting into adjacent businesses creates some efficiency for servicers because the adjacent businesses do not have to spend money attracting clients. The servicing rights ensure captive customers.
Offshoring labour can reduce costs. Some of the problems with offshore employees is that:
- They do not speak with American accents so they may be difficult to understand.
- They may have a poor understanding of US mortgages and US mortgage laws.
- Churn is typically much higher with offshore employees. This makes it difficult to retain experienced employees.
- Time zone differences. If the offshore employees are to work weird hours to sync with American time zones, the employees will need transport to their workplace if public transportation does not run.
- Data security. It is normal for BPO employees to have their cell phones taken away and not have Internet access.
Altisource is the most extreme when it comes to offshoring. It uses offshore employees for high-skilled jobs in computer programming, IT, and in title/closing services. I believe that the lower-quality labour force can sometimes cause a lot of problems and not work out well in practice (e.g. title & closing services).
For some statistics on how much each servicer uses offshore labour, see How much offshore staff do the top mortgage servicers use?.
Remote contractor workforce
Altisource has many businesses where it solicits contractors remotely (over the Internet, phone, etc.) and issues work orders electronically. By doing so, it does not have to maintain offices in 50 States. Work orders for Altisource BPOs are issued on a first-come first-serve basis. The contractor that accepts a posted job first gets the job. (Some real estate agents use auto-accept software to grab BPO orders for their vicinity.) This competitive labour situation allows Altisource to greatly reduce its labour costs.
For more complicated services, this may not work as well. Whereas the quality of a BPO can be verified remotely, verifying the quality of repair work requires a visit to the home. In the past, the US Government Accountability Office heavily criticized Ocwen for its poor work on Ocwen’s VA contract (link). On the other hand, Ocwen managed to win a contract with Freddie Mac for similar services (link).
Software programs allow mortgage servicers to automate various tasks.
Altisource pays its contractors via direct deposit. This saves a very small amount of money versus mailing a cheque. The way Altisource hires its contractors allows it to drive down its labour and office costs.
Online auction platforms can create efficiencies in selling a home and ensure better price discovery for the seller.
Altisource hires psychologists to try to apply behavioural science to improve outcomes. It tries to generate value by trying to convince borrowers to agree to a loan modification over a strategic default. It tries to convince a borrower to accept a cash payment for deed-in-lieu-of-foreclosure.
Altisource has a dynamic script that tries to standardize what its offshore call center employees say to borrowers. I believe Altisource is working on technology that allows it to easily perform split testing between two different scripts. This will allow the company to figure out which behavioural science techniques work the best. Altisource’s investor presentation (unfortunately the transcript is not available online) suggests that the impact of some behavioural science techniques is very small given that they are difficult to measure.
Third party marketing
Ocwen and the publicly-traded company Intersections (INTX) have teamed up to market a silly product (identity theft protection) to Ocwen customers. Both companies were sued over this. Strangely enough, they won this class action lawsuit.
Cross Country sells appliance insurance. The company lists both Ocwen and Green Tree (Walter) as clients. Lately, Cross Country has engaged in very deceptive marketing as it sends Ocwen customers a cheque. Ocwen customers may cash the cheque thinking that it is a payment from Ocwen. Unknown to them, cashing the cheque signs them up for Cross Country’s insurance service. This amount is added to the customer’s mortgage bill. Sometimes customers do not read their bill carefully and figure out why their mortgage bill has gone up.
Nationstar may be involved with Cross Country. Their YE2013 10-K states: “Some of our subsidiaries earn commissions as licensed insurance agencies from the sale of lender-placed insurance on our portfolios and from the sale of optional insurance products“.
I don’t know if the profits from third party marketing results in meaningful revenue for mortgage servicers. For whatever reason, these sleazy practices have not received much attention in the press or from regulators.
Clean up call rights
See my post on RMBS arbitrage. Nationstar was the first company to do this.
Servicers can try to increase their returns on capital by using yield-oriented vehicles to finance their MSRs. Currently the opportunity exists because investors tend to overpay for dividend-paying stocks with dividends that appear to be stable. Both Ocwen and Nationstar do this.
Ocwen and Altisource have very low effective tax rates due to the use of tax havens (Luxembourg and US Virgin Islands). I believe that the use of the US Virgin Islands is not that risky because those tax breaks have the blessing of the US government (it is effectively a subsidy on growing the US Virgin Islands’ economy). The downside to these tax breaks is that executives at Ocwen and Altisource have to live outside the US. For the US Virgin Islands, executives have to physically be in the Virgin Islands for at least half the year.
Practices that mortgage servicers have been accused of
Intentionally generating late fees
A servicer can try to make a borrower late by:
- Delaying when payments are posted.
- Applying payments to past late fees first before applying the payment to principal and interest.
I don’t think servicers engaged in nefarious schemes to generate late fees. In any case, these practices are banned for servicers with CFPB consent orders.
Avoiding regulation by selling MSRs to nonbank servicers
The big banks are regulated by the CFPB when they signed the National Mortgage Settlement. Since then, the big banks have sold MSRs to Ocwen and Walter. Ocwen and Walter have agreed to be regulated by CFPB monitors. In those cases, the big banks did not somehow circumvent the CFPB regulations by selling their servicing rights to companies not subject to those regulations.
Nationstar did buy MSRs from big banks. It does not have a CFPB monitor.
Pushing homes into foreclosure because foreclosures are more profitable than current mortgages
The theory is that foreclosures allow the servicer to generate lots and lots of fees. Servicers supposedly make more profit from a foreclosure than on mortgages that are paid on time. I do not believe that there is any merit to these arguments. PSAs generally punish the servicer for foreclosures and delinquent mortgages.
My thoughts on the big picture
When I first researched Altisource, I did not realize how much money could be made from using MSRs to force mortgage investors to purchase from adjacent businesses. For whatever reason, only Ocwen/Altisource and Nationstar seem to be successful in making very high returns from that strategy.
I could be wrong but I see these opportunities going away because very few subprime MSRs are being created. Eventually, mortgage servicers will have to compete based on efficiency and value creation. I think that Ocwen and Altisource are the leaders in that department. Walter strikes me as the least efficient (e.g. no/little offshoring).
Nationstar strikes me as the most ruthless. Their HomeSearch.com fees are a little higher than Hubzu’s. The site seems to explicitly allow shill bidding. They have been semi-successfully sued by RMBS investors. In the long run however, I think it is better to be efficient than to be ruthless.
*Disclosure: Long OCN and ASPS. No position in NSM or WAC or big banks.