How surging escrow balances are changing servicing

A lot of low-coupon mortgage servicing in the current market has almost no prepayment risk, but it does have exposure to another rate-related concern that's grown, speakers at a recent industry meeting warned.

"If you look at the field of mortgage bankers that are here, you might say, why would I ever hedge that? Well, you're not hedging prepayment risk, you are hedging the value of the cash flows, that is, the escrow balances," said Austin Tilghman, CEO of United Capital Markets.

Property taxes have soared in many areas as have homeowner insurance costs, and that's boosted interest rate risk associated with escrowed funds, speakers on servicing challenges at the Mortgage Bankers Association's Secondary and Capital Markets Conference noted.

Escrowed funds held to pay obligations on behalf of borrowers, including T&I, are in designated depository accounts. Balances in these accounts grow and get paid down, producing earnings that vary by jurisdiction and come in different forms, such as warehouse-line rate buydowns.

Those earnings also are correlated with the fed funds rate, so they've grown amid tighter monetary policy. That followed a long period in which the fed funds rate was low, so there's still a tendency to overlook or deprioritize this risk amid low profitability and high hedging costs.

"For years, we had overnight funds at zero and escrow balances were not part of the cash flows. Well, now they're a big part of the cash flows," he reminded attendees at the conference.

Compounding that concern has been the more recent growth in escrows, which not only has led to there being more at stake when it comes to how they're affected by interest rates, but also other risks around them, another panelist noted.

Consumers have been confused in some cases when they've seen their payments adjusted to account for higher homeowners insurance premiums, property taxes or both and it's evident in complaint customers log, said Seth Sprague, director of consulting services at Richey May.

"That payment shock is real and it's confusing. It causes servicers and subservicers a lot of pain and agony," Sprague said, noting that he sees a lot of related complaints on the Consumer Financial Protection Bureau's website.

An examination of complaints on that site at deadline found several questioning escrowed amounts, such as one that reads in part, "There is no way they can have me behind this much on my escrow and also jump my payment up this much."

The CFPB logs a "timely response" from most companies to recent complaints. In this case, the complaint was "closed with explanation" and the servicer stating that it "believes that it acted appropriately as authorized by contract or law."

The escrow issue the bureau appears to be tracking most closely based on its more recent Supervisory Highlights is any "failure to make timely disbursements."

Servicers need to be prepared for their next escrow analysis period and make sure they have the cash to cover advances on payments, said Sprague, noting this is another risk associated with higher T&I some companies have been overlooking.

"Those advances on insurance today are astronomical," he warned.