Editor’s note: This feature originally appeared in the February issue of DS News
During the 2010s, our industry saw foreclosures fall to record lows as the economy experienced a full decade without a recession. At the same time, however, residential properties were negatively impacted by a host of natural disasters with a scope and frequency not seen before. As we now transition from one decade to another, servicers are sensing the inevitable impact of a future economic correction paired with a predicted continuation of severe weather events nationwide and are working to proactively evaluate the potential impact on loan portfolios.
The reality today is that servicers face significant risk in expeditiously managing the liquidation of distressed properties due to a number of different types of claims, each with its own unique, strict requirements—all adding to the complexity of the filing process. Those with FHA loans in their portfolio are impacted most as FHA home retention (incentive) claims and home disposition (foreclosure) claims are among the most scrutinized investor claims. Of these, approximately six out of 10 claims filings are deficient due to either inappropriate depletion of escrow funds or claiming inappropriate expenditures, resulting in the assessment of monetary penalties by the Department of Housing and Urban Development (HUD).
The result is almost $9,000 on average in loan-level losses per file due to FHA claim filing errors—errors that HUD often converts into fines since submitting inaccurate claims for reimbursement can be viewed by HUD as fraud. In instances such as these, the loss is then multiplied by the number of non-performing loans within the servicer’s portfolio.
In many cases, these errors, fines, and inefficiencies are largely avoidable. The majority of loan-level losses stem from the failure of either internal staff or outsourced claims service providers to perform effective due diligence of the circumstances of the case file. Losses can also occur from the filer’s lack of knowledge of reimbursable items, mistakes in proper identification of the appropriate automatic interest extensions (i.e., an interrupted foreclosure sale due to bankruptcy or loss mitigation actions) or the servicer failing to utilize HUD-approved extensions where applicable.
To counter this threat, many servicers are leveraging a mortgage loss analysis strategy to support final review of case files from default through final disposition of investor claims. In mortgage servicing, “loss analysis” generally describes the final review of the case file from default through final disposition, performed to ensure that all available funds have been recouped. The process includes an evaluation of accrued interest and whether FHA timeframes were met; identifies gaps in upstream processes, vendors that may consistently cause losses, and/or any opportunities to recover additional funds. In many cases, missed reimbursable items can be recouped through supplemental claim filings or by tapping into available indemnities of service providers.
This ensures that all available funds have been recouped from either the guarantor (GSE) or the insurer (FHA or MI carrier), as it relates to the claim itself. Doing so positions servicers to recoup any reimbursable expenses that were missed during the initial claim filing, as well as provides a feedback loop to servicing managers to improve their internal processes and the provisioning of third-party services on non-performing loans.
Perhaps more importantly from a strategic planning perspective, data analytics enables servicers to better identify problematic patterns that once remedied, can prevent costly future error duplication in claims filing and within the default loan servicing process. Success, of course, lies in appropriate training, technology and quality control processes and procedures. Too often, those filing loan claims (whether on staff or outsourced) are unaware of generating recurring errors or, alternatively, if motivated by production, tend to be less interested in recuperating the maximum allowable reimbursements than in simply completing the largest number of claims.
There are some proven steps that servicers can take to improve their claim recovery efforts, including:
- Having appropriate documentation—Often, the root cause of a loss lies within the billback process, which makes proper documentation and tracking crucially important. There is no small amount of documentation required, as every block and expenditure reflected on the claim must be supported. Loss analysis reviews usually expose deficiencies in a servicer’s documentation, enabling supplemental claims for these items and pinpointing areas in technology, training, or processes that require improvement.
- Understand the rules on reimbursable items—Due to the complexity of the FHA claims process, servicers or their claims service providers often either neglect to claim reimbursable items or fail to claim the appropriate amounts. This demands a proper review of not only unclaimed items, but also ensuring that reimbursable items were properly documented and billed. Servicers and investors need a full breakdown of the total interest loss (note rate vs. debenture rate), itemized corporate and escrow disbursement losses, reasons for each loss, and potential vendor bill back opportunities. Common non-reimbursable items can include: occupied property inspections without supporting documentation or where there was contact with the borrower; escrow disbursement for hazard insurance when the declaration pages did not support the period coverage or the correct amount of the policy; and/or over-allowable property preservation expenses claimed without the appropriate HUD approval.
- Adherence to HUD’s timeframe for filing claims—This seems simple, but servicers often underestimate how rigorous the claims guidelines are. Staying within HUD’s timeframe for filing claims is crucial for servicers looking to avoid curtailments of interest and expenses. Servicers must also determine whether a missed timeframe deadline indicates a lack of knowledge by claims filing staff or simply a processing mistake, and then takes steps to address it.
A well-executed mortgage loss analysis provides access to loan-level data that is often buried within multiple levels of service transfers and documents usually housed within different systems. That claim data is then carefully evaluated to determine if each line item was paid in full or curtailed. If curtailed, the expressed reasoning (whether interest calculations, recoverable expenses, non-recoverable/over-the-allowable expenses, etc.) must then be verified against FHA guidelines and regulations. Finally, reconciliation file documentation is required on confirmed losses and follow-up actions to recoup additional funds through supplemental claims or indemnity requests. All of this must be appropriately constructed for audit purposes later.
According to the FHA’s Single-Family Loan Performance Trend Report, it takes servicing companies an average of 12 months to convey a foreclosed property to the FHA, yet nearly 80% of FHA claims filed received an interest curtailment penalty because of a missed timeframe. Given the opportunity for extensive loan-level losses from incorrect FHA claims filings and the prospects of penalties for fraudulent claims, servicers are correctly concerned about the issue. While mortgage loss analysis can be a complex process to execute properly, there is value in servicers gaining a detailed look into each loan, finding gaps in upstream processes, recognizing vendors that consistently cause losses, and identifying opportunities to recover additional funds. Doing so positions servicers to maximize recouped expenses and avoid the costly, systemic errors that generate penalties repeatedly over time.