Preparing your organization for increased mortgage defaults

Not every borrower makes timely payments, payments in full or even payments at all. In these cases, servicing entities are typically required to “advance” the P&I, known as principal and interest advances, and T&I, known as escrow advances. Entities may also incur recoverable corporate advances, which are expenses the servicer paid that are recoverable from the borrower, such as bankruptcy fees, forced placed insurance and other expenses.

Further, entities may incur nonrecoverable corporate advances, or the fees that the servicer determined in its good faith business assessment will not be recovered. Many of these corporate advances (also known as foreclosure advances) are tied to the preservation and, if necessary, the liquidation of the mortgaged properties.

Complexities in servicing advances

Advances are recovered from borrowers when payments are ultimately made by the borrowers, liquidation of the property or by filing claims with the various agencies or companies that insure the loans. During the collection process, servicers incur costs associated with trying to collect the payments, the foreclosure process and ultimate sale of property in liquidation scenarios. The expenses incurred (advanced) by the servicer are due back to the servicer, which may be repaid by the borrower, investor or through liquidation.

Servicers should have controls around the appropriateness and collectability of advances and compliance with regulatory, investor and insurer guidelines. In addition to the investor and insurer guidelines, many states and counties have guidelines around what can be assessed to the borrower and minimal entitlements that the borrowers are allowed. For example, many state "and counties" have criteria “supporting what” lien release fees can be charged to the borrowers and “every state” has guidelines around foreclosure, while "some" states require minimum interest that is due on borrower escrow funds. Costs associated with bankruptcy liquidation are also complex since it’s guided by complex jurisdictional guidelines.

Forbearance and rising interest rates

With the onset of COVID-19, many governmental bodies adopted the Coronavirus Aid, Relief and Economic Stability (CARES) Act and various other programs to provide temporary relief — primarily through forbearance — to defer the need to liquidate property and to keep borrowers in their homes. Under the CARES Act, lenders and servicers were prohibited from starting a judicial or nonjudicial foreclosure judgment until March 31, 2021, which was later extended to July 31, 2021. Borrowers could request a mortgage forbearance up to 180 days and request a secondary extension of 180 days so long as the borrower experienced a financial hardship due to COVID-19. This was later extended to permit a total forbearance period of 18 months.

With the completion of the CARES Act — combined with the recent increase in interest rates — the industry could see a jump in delinquencies. Moreover, a certain percentage of borrowers never successfully completed the CARES forbearance programs. With an upturn in delinquencies and residual CARES Act forbearances, servicing advances have been identified as a heightened risk for operators holding these advances. To complicate matters, due to rising interest rates, refinancing and modification programs have been constrained affecting the ability to recover principal and interest advances and creating potential constraints. This has caused many organizations to focus on the advance recovery processes to limit operational losses and minimize liquidity impacts of advancing obligations.

Due to the complexities and manual nature of servicing, it is often challenging to identify the areas influencing ultimate collectability, creating the potential for additional losses. These hidden losses and the long time frame until collection makes the implementation and management of reserve methodologies even more challenging. Those charged with financial governance also need to evaluate whether losses on advances are related to credit issues or operational losses and the related accounting associated with this.

This article is part of a series of servicing articles that Baker Tilly will be releasing in the coming months. Stay tuned for the next installment discussing what happens in the servicing process when a loan becomes delinquent.

Baker Tilly’s Mortgage Center of Excellence offers assistance with servicing, regulatory compliance, quality control and risk management — all in one place. Our mortgage specialists can help servicers traverse the ever-changing mortgage landscape. Discuss the state of the industry with our team and how we can help you prepare for the future, today.

Co-author Matt Petrick, CPA is a senior finance and accounting executive specializing in the financial services industry, with a focus on mortgage and servicing entities. Matt has experience with REITs, financial institutions, business development companies and other funds. The discussions throughout the article should not be implied to represent the position, processes, or procedures of professional affiliations, current or former employers, or employer relationships. 

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought.