Every now and then I get ambitious and try to cook a dish that is well over my head. It is usually for a dinner with friends which means there is no Plan B. It is fun but there is always some sticker shock and high anxiety. Not only are the ingredients not run-of-the-mill but the process requires some sort of kitchen implement that I do not own. I often find out after I have committed that what I don’t have is expensive. For that one time I cooked Coq au Vin I wish I could have bought the ingredients in quantities more in line with my needs and I could have just rented that giant skillet. Truths: My culinary skills are “untested” and the margin of error for the recipes I pick is small. As exhilarating as my kitchen adventures are I still wish I could convert my costs from fixed to variable and assure flawless execution!
Yes, there are similarities between making Coq au Vin and a loan servicing operation…especially those of mortgage banking firms and debt funds. Usually a firm that is excellent at originating great loans also needs a robust servicing platform to service them effectively but they find the costs of doing what is required (and doing it well) are more than expected. Having the on-site expertise to process payments and remit and report investor funds and monitor insurance, property taxes and UCCs and assist the client in new loan closings and manage impounds and monitor the condition of the collateral and manage the disruption of scheduled operating statement analysis and handle borrower requests and monitor loan covenants is expensive. The risk of losing money on the servicing end is real. Costs can slowly outpace the income stream with a smaller servicing portfolio or overwhelm staff allocated on a part-time basis. Add in the rising costs of retail banking and staff turnover and the best intentions fall short.
Staffing, the key ingredient to a successful servicing platform, can be particularly daunting. Finding people who flourish in the multi-tasking environment of smaller shops is a tall order. The best real estate analysts end up on the originations side. Your in-house property tax expert is not as strong in the other areas of their job. The longtime MVP of the servicing operation retires requiring two new hires. These are common occurrences and they contribute to your servicing operation having high fixed costs when what you need are variable costs in strict lockstep with the servicing fee income stream.
The transactional nature of loan originations is inherently a variable cost arrangement: Loans are closed and you receive a one-time fee. The best mortgage bankers flourish in that commission-based performance environment. However, servicing fees are paid on a somewhat more variable basis: The fee is based on the unpaid principal balance which declines over time. Unfortunately, the greatest cost of loan servicing is staff which is more or less fixed. Managing this reality is a balancing act. Which is worse? Costly excess capacity or a shortage of people which contributes to poor performance and turnover.
The solution? Convert your servicing costs from fixed to variable by outsourcing all or some of your loan servicing functions to a skilled sub-servicer. The firm you select must simultaneously treat your borrowers like you would while handling each loan as if they were the investor. This trusted partner must be good at executing all duties and have experience working with a wide variety of lenders. They must have a large enough servicing platform to absorb the same fixed costs you wish to avoid. Finally, their fee must be less than what you are paid by your client…hey, that steady stream of net servicing fee income going to your bottom line is good stuff!
Your investor relationships probably began because of your expertise in placing money. The next expectation of your client is that the servicing will go without a hitch regardless of your fixed costs. Why not pass the risk of fixed costs on to the sub-servicer and deploy your resources on doing what you do best: delivering a great portfolio of loans while overseeing the work of a strong sub-servicer?
Essex Financial Services has assets under management in excess of $5 billion, services loans owned by 40 institutional investors and sub-services for some of the most successful regional mortgage banking operations in the US. Take a closer look at what you are paying to operate your servicing platform then give me a call at 678-770-5551. We can help.