Wednesday, Dec. 31, 2008
If you think subprime lenders are the loan sharks of real estate, then loan servicers--the outfits that collect mortgage money and run the books--are the enforcers. Their job is to keep the dough coming, no matter what. Yet Ocwen, one of the nation's largest servicers of subprime loans, has rewritten its role as the heavy and may have an approach to modifying delinquent loans that could slow the wave of foreclosures undermining the economy.
Last year, nearly a million houses were lost to foreclosure. That number could easily rise by millions over the next few years, promising more economic pain. The big problem is that no one has figured out a systematic way to stop the rot. Federal agencies and private lenders have rolled out one loan-modification program after another--scattershot and largely timid attempts to make existing mortgages more affordable and keep neighborhoods intact. (See the top 10 financial collapses of 2008.)
Then there is Ocwen, which has already revised 16% of its 340,000 mortgages, in many cases cutting monthly payments 20% to 40%. Based in West Palm Beach, Fla., the company handles some of the worst loans Wall Street kicked up during the housing boom and isn't about to win any popularity contests among consumers--in the past, it's been the target of complaints about unresponsiveness and excessive fees. Nevertheless, good ideas can come from unlikely places, and as more borrowers--including a growing number with prime loans--fall behind on payments, there are lessons to be learned from the firm that has done more than almost anyone else to keep struggling homeowners in their houses.
Executives at Ocwen used to think, as those at any mortgage servicer would, that the solution to a delinquent loan was to create a plan for homeowners to catch up on past payments. When house prices were rising and refinancing was easy, that generally worked, even though it often meant higher monthly payments. But in early 2007, as housing values plateaued, then plummeted, Ocwen saw the percentage of homeowners defaulting a second time climb from 25% to 36%. "We realized we were going to have to make some adjustments," says Ocwen president Ron Faris.
So the company reprogrammed its computer models, which determine how to extract the most value from each loan, to allow much more substantial changes--lowering a mortgage's interest rate, docking its principal balance, converting an adjustable rate to a fixed one, stretching out the life of a loan. With many mortgages "upside down" (when the loan is larger than the home's current value) and the economy sagging, changes often have to be drastic to make the math work, but Ocwen has largely found a way, devising an affordable payment plan 90% of the time.
What really sets Ocwen apart, though, is its vigor. From doing just a couple of hundred modifications a month in the first half of 2007, Ocwen was up to 4,000 a month by the beginning of 2008, with 77% involving a reduction of the interest rate and 20% including a permanent write-down of the principal balance. Is it working? Six months after receiving an Ocwen modification, 21% of homeowners have again fallen behind on their payments by 60 days or more. That compares with a 37% redefault rate nationally, according to data from federal regulators--a figure that also includes much more stable prime loans.
Principal write-downs are practically unheard of elsewhere--even though they might very well be the best long-term solution for people who owe more than their mortgage is worth, and they help the broader picture too. "That debt overhang is a big drag on the economy," says Alan White, a Valparaiso University professor who studies loan modifications.
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The motivation for modification isn't so much social responsibility as the pursuit of profit; when loans go delinquent, the servicer makes less money. Most of Ocwen's business is in collecting on subprime loans, so its portfolio has been hit hard. Nearly a quarter of the loans it services were behind in November, up from just 8% at the end of 2006. And while Ocwen doesn't own those loans, it still loses out when people don't pay on time, since the company has to temporarily front money to investors to make up for the shortfall. "Despite the fact that they're doing it in their own interest, you can't dismiss it," says Rod Dubitsky, head of asset-backed-securities research at Credit Suisse, whose assessments show that aggressive modifications keep people in their homes longer.
Ocwen has also answered a key question for other would-be modifiers: whether it's possible to pass major losses to investors without getting sued. Paul Koches, Ocwen's general counsel, holds that the company is not only permitted to take such steps but obligated to--if that's what it takes to squeeze the most money out of a loan for the long term. That's the case executives make when angry investors call--and they do call, especially when a principal reduction chokes off cash flow in a particular month.
Make no mistake: Ocwen has a nearly messianic focus on the goal of maximizing returns for investors. "In most cases, that means keeping people in their homes and getting them to pay their mortgages," says Ocwen CEO Bill Erbey. In foreclosure, investors typically recoup only 60¢ on the dollar.
In a way, Ocwen was uniquely situated to jump ahead on modifications. Erbey, who used to run General Electric's mortgage-insurance operation, started buying nonperforming loans with his partners in the early 1990s. Ever since, Ocwen has been refining its computer models--we're talking sophisticated stuff, like vectors and artificial intelligence--to better whip delinquent loans into shape. When the housing slump hit and defaults started to rise, Ocwen wasn't some afterthought unit of a mortgage originator caught with its pants down; it was in its element, in a position to immediately scale up.
That's why, unlike a lot of loan-modification programs, such as those rolled out by Citigroup and IndyMac Bank, Ocwen's doesn't use broad guidelines--for instance, assuming that homeowners should be able to contribute 38% of their income to paying their mortgage. When Ocwen rewrites a loan, it starts from scratch, with an agent at one of its four call centers--two in Florida, two in India--following an adaptive script to reconstruct a borrower's financial data. (The script changes, based on not only what a borrower says but also how he says it; since hiring a director of consumer psychology last summer, Ocwen has been handling embarrassed callers differently than, say, angry ones.)
"I had to show why I was making less money," says John Archon, a manager at a roofing company in Florida, whose paycheck took a major hit in the housing bust. He and his wife now share a car, are energy conscious and "eat a whole lot more hamburgers than steak." Ocwen knocked the interest rate on their 30-year fixed-rate mortgage from 9.3% to about 6.9%, saving the couple $500 a month. Getting those new terms was a stressful process, says Archon, but he "took the standpoint that they were weeding out the people who were not that serious."
Ocwen also breaks ranks with industry practice by modifying loans for people who bought houses as investments. Again, that's in Ocwen's self-interest: those loans account for 17% of its portfolio. In bucking the general disdain for bailing out investment properties, Ocwen realizes that cash is cash, whether it comes from an owner-occupied mortgage payment or one fed by rent, and that a foreclosure displaces a family and blights a neighborhood whether the occupants are owners or tenants.
Which just goes to show that moneymaking and good economic policy aren't necessarily incongruous. As much as capitalism--especially in the mortgage industry--has gotten a bad rap of late, it might just prove useful yet.
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