Distressed servicing costs normalizing after two-year reprieve

The expenses associated with nonperforming loans have returned to pre-pandemic levels, according to the latest numbers the Mortgage Bankers Association released at its annual servicing conference.

Distressed servicing costs in the first half of 2022 rose to $1,994 per loan from $1,487 in full-year 2021 and $1,226 in 2020. 

NPL expenses haven't been this high since 2019. That year, mortgage companies paid $1,960 to service the average distressed loan, according to the data from the MBA's Servicing Operations Study and Forum.

The cost to service an NPL was artificially constrained by pandemic-related relief and rate stimulus in 2020 and 2021, but that changed as these were rolled back and servicers began operating in a more normalized market.

While loss mitigation was one of the top three contributors to overall servicing costs at 13% in 2022 (the other two being systems, 18%, and customer service, 17%), delinquency rates haven't risen far from their recent historic lows so the expense affects a small number of loans.

So the bulk of the mortgages in the market remain performing, but the per-loan cost to service these tends to be far lower because they are less work-intensive. 

Performing loan costs actually inched down a little in the first six months of last year to $160 from $171 in full-year 2021. The 1H22 number was similar to full-year 2020's $161, but up from 2019's $147. 

With pandemic-related stimulus largely phased out and consumers strained by higher costs in the market that have outpaced wages, distressed servicing is slowly becoming more prevalent – in line with signs that a mild recession is in the offing.

"We're not seeing a lot of stress in the mortgage system right now" in terms of delinquencies but there are some early indications that they are rising, Mike Fratantoni, chief economist and senior vice president at the MBA, said at the conference in Orlando, Florida.

Short-term delinquencies are up, and the number of loans with payments late by 90 days or more will likely rise. The MBA doesn't typically issue a specific numerical forecast, but CoreLogic estimates long-term late payments, including foreclosures, will rise from 1.2% to around 2% by year-end 2023. 

CoreLogic's delinquency numbers tend to be lower than the MBA's because they exclude bankruptcies.

Meanwhile, as stress builds on the economy, reperformance rates after workouts have and could continue to fall slightly, but recidivism levels will be nowhere near those seen in the Great Recession, said Marina Walsh, the MBA's vice president of industry analysis.

New options for distressed borrowers to avoid foreclosure have helped keep redefault rates low overall, but they have had their limits in terms of overcoming obstacles faced by certain pockets of the market.

Many borrowers have high levels of equity. However, some of the most recent purchasers don't have as much of a buffer because they bought at the top of the housing market, which is softening now. While their performance has remained relatively strong so far, it's being watched.

Also, distressed consumers who have particularly low borrowing costs because they got loans when these were bottoming out might find it difficult to engage in a modification of loan terms that makes their loans affordable given today's relatively higher interest rates.

Looking forward
If the economy weakens a little as forecast, the prevailing interest rate could come down, with the MBA predicting it'll end 2023 at 5.3%. That will help some borrowers who got loans at higher rates last year, but won't be enough to help distressed borrowers who got loans when rates were at record lows during the pandemic.

While originations could be on the rise again by 2024, forecasts generally suggest any declines in interest rates that may lie ahead this year also won't be enough to prevent further declines in production in 2023.

As a result, job losses in production could continue. The MBA estimates there will be a total 25% to 30% decline in mortgage employment from the market's, and that the industry is roughly halfway done shedding the jobs it will need to rightsize.

However, the natural but imperfect hedge that servicing is for originations has been working as it did in the third quarter of last year, when it made a big difference in the share of mortgage companies that could generate a profit. (Some fourth-quarter metrics aren't yet available.)

Mortgage companies with lending operations have been able to use their mortgage servicing rights to raise cash through sales. The share retaining servicing has fallen since topping out at 39% in first-quarter 2020. It was 23% in the third quarter of last year.

Also, household formation remains high and continues to fuel demand for homeownership, which is a plus for servicers that lend.

"You've got a lot of individuals who should be demanding their first home," said Molly Boesel, principal economist at CoreLogic.

Because the mortgage market has saving graces such as this, it's "going to survive this really hard time," Walsh said.