U.K. loan servicers have never been more under scrutiny, given the current state of the economy and with increasing numbers of loan defaults and limited options for refinance. Although some structured finance investors might believe the current situation for loan servicing is overwhelmingly negative, servicers themselves claim that the picture is mixed.
To address investors' increased interest in the role of servicers in this difficult market, Standard & Poor's Ratings Services recently hosted a conference featuring a servicer discussion panel. The event gave investors in CMBS and RMBS the opportunity to question servicers on the strategies they employ to manage securitized loan portfolios, including in critical functions such as collecting payments from borrowers and foreclosing properties when a borrower defaults.Depending on the effectiveness of such strategies, servicers can influence the number and severity of losses in the portfolio and hence the amount of cash the securitization vehicle can use to repay investors.
The panel suggested that the picture is not as bleak as investors might think. The panel cited as an example that some loans are actually benefiting from an upturn in property prices, although this is highly dependent on the type and quality of the property. However, it was clear that commercial servicers are having a harder time of it than residential servicers.
Certain Areas Of The Property Market Starting To Improve
The general consensus of the panel was that the current market is patchy for both residential and commercial properties. Although there are areas where it is hard to shift property at any price, others areas of the market appear to be fairly buoyant.
Indeed, in the residential market, the relative lack of available housing inventory means that laws of supply and demand have kicked in. Servicers are taking advantage of this and over the past six months have experienced an upturn in the turnover rate for repossession stock-that is, the speed at which a servicer resells a foreclosed home. Steve Staid, chief operating officer at Capstone Mortgage Services, told the conference that over the past six months his company's sales have almost returned to pre-crisis levels, with property prices bottoming out and in some cases even increasing a point or two. Steve Haggerty, group CEO, Crown Westfalen Bank, explained that turnover is "bearable": "We're seeing some slowdown in the time it takes from repossession to actual sale but not significantly. It's far from a bloodbath out there. The repossession stock is moving pretty well."
It may not be all doom and gloom for the commercial property market either. The panelists commented that they are observing an upturn in relation to prime assets, with prices improving on the best kind of stock. John Smith, director of special servicing at CB Richard Ellis Loan Servicing(CBRE), said that certain parts of the property market have come back quite strongly, so if investors are looking at prime assets with long, secure income streams, then they could currently realize an almost full price on the property.
Unfortunately, as Smith pointed out, a lot of CMBS pools don't incorporate too many of those prime assets. Servicers are still finding it difficult to get finance on poorer quality stock with short leases and vacancy issues. Ian Grimsley, head of portfolio management for CMBS loan servicing at The Royal Bank of Scotland (RBS), agreed that for lower quality assets things are still difficult. He also expressed concern about the current scarcity of refinancing options for commercial loans.
Changed Landscape Leads Servicers To Use A Wider Variety Of Tools To Cope With Delinquencies
In essence, a servicer's job is to minimize losses, manage increasing arrears, and maximize collections. Over the past two years the toolkit that servicers use to achieve these objectives has changed dramatically. Crown Westfalen said that many of its clients are investors who bought heavily discounted nonperforming loans and want to liquidate the assets quickly and take a return. Haggerty said, "Things like assisted sales, short sales, forbearance, all of that comes into it now. To be honest, three or four years ago...no way would you use some of these tools. Today it's a question of needs must."
Staid also noted a dramatic shift in market conditions. Capstone's loss severities two years ago ran at 6%-8%, he noted, so there was less focus on default frequency. With house price appreciation and a lot of liquidity in the market, it wasn't necessary. Now, loss severities - measuring the amount lost following the sale of a repossessed property - are 20%-25% on average, signaling a huge shift in portfolio dynamics. Staid noted that this has necessarily placed an emphasis on servicing strategies to work with borrowers with debt problems and negative equity as Capstone and other servicers have little possibility of recovering the outstanding loans given the fall in property prices.
One tool that servicers use is loan modification, such as payment holidays and changes to mortgage repayment plans. Haggerty explained that within six months of a loan modification, an average of just 10% to 12% of their borrowers go into arrears again, which they view as a pretty good success rate. Staid said that Capstone has a one-year re-default rate for loans that have had modifications of about 25%, which he views as pretty strong. Both speakers pointed out that they carry out borrower evaluations before agreeing to any loan modification.
In a worst-case scenario, foreclosure is sometimes the best option, rather than waiting to see if defaulting borrowers will start repaying again. Indeed, the panel agreed that the art of a special servicer-one who manages delinquent or defaulted loans-is to be able to judge correctly when it is best to foreclose on a loan. Mr. Smith stressed that at CBRE, they look at every case on its merits rather than deciding formulaically. As their objective is to maximize recoveries, Mr. Smith said that CBRE evaluates a range of options before deciding on foreclosure.
So What Does The Future Hold For U.K. Servicing?
Clearly the outlook for residential and commercial servicers is different, with both groups facing problems particular to their market.
For commercial loans, the future still looks tough, the panel agreed. A large number of loans are due for refinance in the next three years and servicers are concerned that if current conditions continue, it will be increasingly difficult to refinance, especially for poorer quality properties in the secondary market. Smith said that CBRE is focusing strongly on a borrower's ability to maximize the value of its property, but for most assets Grimsley pointed out that it is hard to say where the refinancing is going to come from. "This is not a pretty picture. We've got increasing operational risks, valuations are falling, and we're not seeing all the rent money come in." He added that RBS has loans that require refinancing over the next four years and, particularly in the next two to three years, will have to hold tight until things improve, hopefully in five or six years' time.
Haggerty said that residential servicers need to position themselves for when bank lenders come back to market, even if that may be a way off. Staid thought that as long as interest rates stay low, he would be happy. However, he was worried about affordability if interest rates increase. A lot of Capstone's borrowers are now earning sometimes as little as half the figure they did two years ago and any interest rate rise would likely affect their ability to repay their loans.
It is clear that an important focus for panel members over the next couple of years is to identify loan trends well before they cause additional portfolio losses. In our view, this can be achieved in part by maintaining close borrower contact and by working with borrowers cooperatively wherever possible.
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