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Building an RTC portfolio.

Learning the ABCs of RTC servicing purchases has been the challenge for of San Diego-based bank that boasts a return of more than 20 percent on its four RTC-acquired packages.

Working with the Resolution Trust Corporation (RTC) to buy mortgage servicing packages is like riding a bronco at the rodeo. The ride can be bumpy but rewarding if you stay on top of it.

So goes the wisdom from experience at First National Bank, a San Diego-based commercial bank with a mortgage banking division that currently holds a $4.4 billion servicing portfolio and originates approximately $80 million per year, servicing released.

To date, First National has completed four acquisitions of mortgage servicing portfolios from the RTC. The deals have progressed as follows: a $300 million package in July 1990; a $1.2 billion package in August 1990; a $300 million package in July 1991; and another for $400 million in October 1991. Their secret?

"Plan ahead," says managing director of the bank's mortgage banking group Andrew Gissinger III. "You've got to make a competitive bid that takes into consideration the potential pitfalls and extra work involved. Thorough due diligence is essential, and your people have to ride the problem areas immediately and without let-up."

Adds Gissinger, "In the mortgage banking business, and especially in the case of RTC product, there is just no substitute for competent, experienced personnel." Bank officials say that competency must also be found in every division of the RTC institution as well, where no one employee is more important than another, and employees must be flexible and able to work in many different areas.

The RTC acquisitions team

Upon its inception, the RTC held a screening process to select brokers to market servicing portfolios from RTC-controlled institutions across the nation. On average, the mortgage banking division at First National Bank receives offering information on a total of 10 packages per week from RTC and non-RTC brokers.

Package offerings are reviewed by First National's acquisitions team according to the bank's parameters. The team compares the price of the package to the income that First National can generate from the portfolio. The bank's acquisitions team has four main players.

Servicing Acquisitions Manager Linda Harvey heads up the due diligence team and decides what documents are needed, depending on what type of portfolio the team is reviewing. She decides what kind of files need to be pulled, and after the due diligence process, sits down with the seller in an exit interview to discuss what was found and to put together the contract and orchestrate the transfer internally. Harvey ensures that all internal personnel follow up with the terms of the contract.

Julie Giacalone, acquisition coordinator, is responsible for reviewing the loan files and other details prior to the visit to the RTC institution. After the transfer occurs, she coordinates the delivery of the seller's magnetic tape from its data processing center to First National's servicing bureau and follows up with each department involved with the transfer.

Another member of the team is Default Manager Judy Conditt, who handles the audit of the collection and foreclosure files. When the acquisition has transferred, she follows up on any problem that is found in the due diligence audit, such as the filing of foreclosure documents.

Investor Accounting Manager Bobbie Vogt makes up a fourth leg of the acquisitions team. Vogt is responsible for investor accounting activities in relation to balancing, and she must note any overages, underages or discrepancies in the account. After the transfer, she reports on the status of the accounts and the status of discrepancies that remain unresolved.

RTC acquisitions: the process

RTC packages typically trade at lower prices than non-RTC servicing portfolios. Thus, rewards can be greater for RTC product if a servicer is experienced and not afraid of hard work. Sometimes hard work is created because after the RTC takes over an institution, many key staff members may leave the institution, and other employees often struggle to take up the slack. Servicing Acquisition Manager Harvey says, in one case, the RTC had moved production personnel into servicing slots, such as investor accounting, just to keep up with daily requirements.

Factors examined by First National in considering RTC servicing packages include the type of loans involved (whether fixed or ARM); high or low loan balances and geographic area; interest rates (for example, relatively high interest rates can trigger higher percentages of refinances and early payoffs among borrowers); the average age of the loans; impound accounts; delinquencies; service fees; and auxiliary income potential.

First National prefers GNMA, Fannie Mae and Freddie Mac packages but realizes that with RTC portfolios, they can expect a mix of products. Harvey says that they generally have more interest in new, fixed-rate loans with high loan balances seasoned three years or less. Although First National prefers portfolios consistent with national average delinquencies, the bank is aware that RTC packages will have higher ratios; therefore, its due diligence in the default area is critical to the success and performance of the portfolio. If it turns out that there has been no staff available to send out mortgage default notices or collect on accounts, then the bank realizes that delinquency rate may be lowered substantially once First National takes over.

First National also looks closely at the geographic location of the loans. Regions with a higher likelihood of foreclosures and bankruptcies draw away from the earnings of the servicer. Although the bank prefers national packages, most loans in the servicing packages the bank has purchased have been Texas loans that are three years or newer. The bank has also increased its mix of Midwest loans and has grown its total portfolio size from $2 billion to $4.4 billion in the last two years. According to Harvey, First National believes these newer Texas loans should have a good chance of staying current, because that region has already been through its recession and is on its way up. The delinquency and foreclosure rates have been a big factor--and the newer loans in Texas have a good showing in that area. The only drawback is that the loan balances are lower.

Another factor in any potential bid by First National is the servicing capability of the selling institution. A thrift that has failed may nevertheless have an excellent servicing record. In many cases, the thrift institution may have suffered from poor management and bad loans, while its mortgage company remained profitable. Knowing the servicing capability of the seller (generally known by word-of-mouth) and the nature of the seller's loan product allows First National to choose those packages that can be assimilated most easily into its existing servicing portfolio.

Calculating bids

When an offering meets First National's parameters as outlined earlier, it is run through a loan servicing computer model. The modeling software used by First National is widely used in the industry. The model allows the potential bidder to consider the loan balances, the interest rates, the potential income, the delinquency and payoff rates during the next 7 to 10 years, and so forth, and arrive at a portfolio value. The acquisitions team then bases its bid for the servicing on a percentage of the figure supplied by the model.

For example, in the RTC acquisition that took place last October, the size of the portfolio was 4,066 loans and totaled $208,415,970. The average balance of the loans was $51,258, with a mix of GNMA, Fannie Mae and Freddie Mac loans. This mostly midwestern package was made up of loans from Ohio (2,903 loans), Pennsylvania (878 loans), Michigan (133 loans) Indiana (110 loans) and Florida (42). The model evaluated this information along with any other unusual characteristics, which, in this case, was the fact that it was an RTC portfolio. The model's calculated value was 1.55 percent--First National's winning bid was then calculated as .85 percent, a percentage of the model's servicing portfolio value.

After the bid is calculated, a bid letter is prepared and sent to the broker. It specifies that the bid will lapse if it is not accepted by a certain deadline--usually within 24 hours.

The servicing broker who was assigned to sell the particular package takes the bids to the RTC and one of its two servicing sales advisors for review. Smith, Barney, Harris, Upham & Company, Inc. was selected as a servicing sales advisor to the RTC for large mortgage servicing portfolios, while Hamilton, Carter, Smith and Company was selected as servicing advisor for smaller RTC-owned packages.

The highest bid is not necessarily the one that is selected by the advisor. The perceived financial ability of the bidders to finance the acquisition is taken into consideration by the RTC, along with the offering price, in selecting the final purchaser. The mortgage banking group at First National, with the financial strength of the bank behind it, was deemed a reliable purchasing party in the deals concluded with RTC to date.

The time allowed for the bid to be accepted by the RTC is set by First National. Generally, the bank gives RTC a deadline date and time of noon the following day after the bid is submitted. The bid is only good up until that time. However, First National follows up with the broker even if the bid lapses. This way, the bank learns what the winning bid was and uses that information to remain competitive in the future. Although the winning bid may not be revealed immediately, if an institution calls and requests it, RTC eventually discloses the information after the final contract is executed, usually 30 to 45 days after acceptance. First National then keeps records of the packages and the winning bids and tracks this data to help it to structure its future bids more precisely. The bank bids on an average of two packages per week. The full range of time it takes for the acquisition is 60 to 90 days--from the time the bank bids on the package to the time the acquisition team does due diligence, gets investor approval and transfers it.

"We're not known for being the highest bidders," says Harvey. "But we can move fairly quickly, back up our bids with the necessary financing, and we are prepared to assist the selling institution with the transfer."

Winning the bid: the due diligence process

If the bid is accepted, a conference call is set up with the broker, the institution for whom the RTC is selling the servicing--known as the "RTC shop"--and First National. Details of how the transaction will be handled are discussed. For instance, First National tells the sellers what they can expect between the time of the bid acceptance and the audit; with whom they should meet; what kind of documents to have ready and how far back in the records they will want to go; and what employees should be present during the due diligence and at the exit interview.

Also at this time, First National informs the RTC shop that a lengthy questionnaire will soon be sent along with a list of reports and trial balances it will be expected to run. These must be completed and returned prior to the scheduled on-site due diligence audit. The questionnaire is a key step in First National's strategy to ensure that its RTC acquisitions are successful. This detailed questionnaire was developed by the bank to ferret out important, yet not always obvious, information--information that, when faced ahead of time, could end up saving First National a considerable amount of time on its due diligence and also, money, further down the line.

The questionnaire covers such topics as customer service, investor accounting, loan collateral, loan types and geographic locations, loans both current and in default under bankruptcy plans, originations and the data processing capabilities of the current servicer. The comprehensive questionnaire helps uncover potential expenses to First National. Their due diligence process has proven so successful that First National has been able to market its due diligence services to other institutions making servicing acquisitions.

Another key part of the due diligence process is the up-front audit reports requested from the RTC shop. These reports are required prior to the first day of the on-site audit. Reports detail trial balances, delinquencies, insurance issues, bankruptcies and foreclosures, tax information and intricate software codes used by the RTC shop.

The controller and the managers of the acquisition, investor accounting and foreclosure departments meet to discuss the completed questionnaire and target potential problem areas for further investigation at the time of the visit. If any one of these key managers is unable to make the trip, the others know the full plan and are able to fill in.

The on-site audit

Within two weeks of the bid being accepted, First National's team travels to the RTC shop. Depending on the size of the loan package, the number of investors and the condition of the servicing package, the audit may last from two to five days.

Introductions are made, audit reports are reviewed and representatives from the selling institution direct First National staff to information sources. The on-site audit team examines systems and goes from department to department talking to shop employees. They look at accounts over a two-year period, identifying trends. For example, in the delinquency area, they track delinquency numbers on a monthly basis, by product type and geographic area to determine the average cost of foreclosures, VA no-bids, etc. The staff looks for out-of-balance investor reporting conditions and checks to see if they are being cleared up, as well as look for the dollar volume of penalties for taxes. They also choose a percentage of loan files to verify the underwriting, PMI and the like.

Depending on the composition of the portfolio, the team spends an average of two days at the custodian bank reviewing original documents. For each loan, they ensure that promissory notes are valid, assignments are accurate, loan guaranty certifications/mortgage insurance certifications (LGC/MIC) are valid, the deed of trust/mortgage has been properly recorded and the title policy is present. A review of all GNMA pools is performed to verify the validity of final certifications in addition to trust documents held for other investors.

The exit interview

At the end of the audit, the team from First National, along with Managing Director Gissinger, share their findings with the RTC shop. This exit interview is another key step of First National's operating procedure in RTC servicing acquisitions. It's the time when variances between the original offer and the findings are detailed, and the potential effects on First National are outlined.

"We have to be sure that we're getting what we bargained for before we sign the contract," says Harvey, an eight-year veteran of servicing acquisition deals. "Depending on the severity of the problem found in the due diligence, we try to address this at the exit interview, and we try to determine how the exceptions found should be addressed contractually; whether it should be excluded from the portfolio; whether the seller should be expected to clear up the problem, or if the buyer will be compensated for the discrepancy."

Thus, after the due diligence, First National must decide whether it wants the portfolio. The discrepancies are discussed to determine how they will affect the bid, and the terms of the deal are examined to decide the most effective way of handling bidding. The bid may include an offer by First National to do the cleanup for a price; or it may be constructed so that the RTC shop must handle the cleanup itself. The RTC shop is given the option to fix discrepancies or to compensate First National for fixing them.

Land mines and pitfalls

Assumptions, taxes and insurance problems and foreclosures are common pitfalls for the unwary acquirer. For example, Harvey says, "In the area of taxes, we have seen individual taxes that may either be unpaid for several years, or they could have been paid on the wrong parcel, due to an erroneous legal description. In the area of insurance, we have found vacant properties that don't have the proper vacancy clause coverage, and accounts where the property has been demolished."

Defaults are another potential headache--especially if the bank finds that notices have not been generated. "If that hasn't happened, then we can't foreclose, and it means that we have to generate notices under agency guidelines before foreclosure can take place," says Harvey. Also, she notes, if a borrower is in bankruptcy and has defaulted, and the release on the bankruptcy has not been filed, then the foreclosure can't go through.

Troubles with ARMs or government subsidy loans are common. If adjustments are improper, or if there has been an incorrect calculation on government subsidy loans such that they are improperly certified, the bank may find that money may be due to the government or that the borrower may be overpaying.

"So much depends on the condition of the institution, its staff and the experience of the managing agent," notes Harvey. "It is not uncommon for a portfolio to quickly deteriorate."

With RTC packages, the offering broker, depending upon his or her level of experience in these matters, can recommend adjustments to the purchase price during the exit interview. Some brokers prefer to take First National's findings as to the condition of the portfolio to RTC's servicing advisor and return with a counter-offer or recommendations.

Both sides continue to negotiate until an acceptable deal can be struck. The RTC requires that acquiring servicers sign its standard purchase and sale contract. This contract has normal reps and warranties for a given length of time, either five or seven years, whereas in non-RTC deals, the bank can build the contract around the individual package and can include the bank's own reps and warranties to protect against certain conditions for the life of the portfolio.

The transfer

Within 60 days of the signing of the contract, the process of transferring the loans from the RTC shop to First National begins. First National has developed clear transfer procedures that leave no question as to which party is responsible for completing tasks and how the work is to be done.

First National requires from the seller a computer tape containing all the loan information. First National sends tapes to its service bureau, Computer Power, Inc., (CPI) Jacksonville, Florida, which develops the conversion definitions and sends back edit reports and trial balances. The tape and resulting reports allow First National's investor accounting team to balance the accounts and send welcome letters and payment coupons to borrowers. This also enables the bank to detect problem data, such as accounts that should be transferring that aren't located on the tape; loans that are misidentified on the tape; or any incorrect definition that was given to CPI prior to conversion to the First National system.

Difficulties arise when the test tape is not sent on time, when it doesn't contain the right data or trial balances of the same investor cutoff date or when the proper record layouts are not sent. Record layouts define the computer codes and fields used by the seller; they're essential for development of the conversion definitions for the new servicer's software system.

The acquisitions staff decides who should fix errors in the data, whether it be the seller or First National, and a timeline is set up for corrections to be made prior to the final conversion.

Once the portfolio arrives at First National, all files and other documentation described in the transfer procedures are immediately inventoried against the trial balance produced from the buyer's servicing system. The sooner an exception list is compiled, the better First National's chances of receiving the missing documents from the RTC institution. This time element is especially important with RTC portfolios, because the longer it has been since the RTC took over, the less likely it is that key RTC-shop employees, who can assist in finding documents, will still be there to help. In the worst-case scenario, there are a lot of instances where the documents and files never show up. In cases where trust documents are missing, the bank will apply for a Lost Instrument Bond that replaces each note that is missing. For missing collateral documents, First National will notify the appropriate investor prior to signing a contract and ask for an indemnification or solution.

As discussed earlier, when these types of additional measures must be taken, the matter is discussed at the exit interview to decide how First National will be contractually compensated. "Once," says Harvey, "we had a Midwest portfolio in which, at due diligence, it was discovered there were complete missing collateral packages. Six months after the RTC transfer, we were still looking for the custodian documents. There were very few employees left--they didn't even know where the documents were kept."

To complete the transfer process, First National sends out welcome letters and payment coupons to the new borrowers two to three weeks prior to the transfer. Finally, the loans are loaded onto the books at First National Bank.

After the transfer

Delinquency ratios at RTC institutions are normally about 2 percent higher than at other institutions because the accounts haven't been worked. Thus, experienced, hardworking personnel are essential when it comes to jumping onto the foreclosure and collection activities immediately upon transfer of the loans.

Foreclosures and collections are the biggest problem areas within the RTC portfolio. RTC institutions typically consist of skeleton staffs and, therefore, don't have experienced collectors working for them, especially late in the conservatorship.

First National makes sure that borrowers on all newly delinquent loans and potentially delinquent loans receive a telephone call as soon as possible after the transfer. Toward that end, First National recently installed a new power dialer system, thereby increasing its efficiency in making these important contacts. The power dialer enables collection department staff to make an average of up to 400 contacts a day.

The dialer selects a borrower according to preset parameters and dials the person's phone number. If the line is busy or no one answers, the system will redial the number up to six times throughout the day. When the system connects with the borrower, the call is transferred to a collector within the department. The borrower's account, along with pertinent collection information, appears on the computer terminal of the collector taking the call so the borrower can be asked for by name. The delinquencies for the RTC portfolio are worked along with the bank's regular servicing portfolio of delinquent loans.

Another critical function after the transfer is that of recourse. First National's Recourse Analyst July Correll's primary responsibility is to bill the RTC for losses that First National deems reimbursable according to the contract.

This is not a job for the timid. Correl deals with scores of RTC attorneys from RTC regional offices in her efforts to gain reimbursements. The attorney is often not located anywhere close to the RTC shop and tends to be trained in corporate law rather than real estate law. While the contract allows for billing by the new servicer, it is a difficult and labor intensive process. Non-RTC portfolio contracts use holdbacks rather than the billing process.

Worthwhile ventures

"Not all RTC transactions are difficult," Gissinger stated. "As a matter of fact, our smoothest transfer ever came from an RTC shop in Texas. You have to be prepared, however. The lower prices for RTC product can make it a lucrative investment if you know what you're doing--every step of the way."

"It boils down to two important matters: how thoroughly you can get in and out of the shop during the due diligence and, second, making sure that the portfolio is serviced properly to correct the problems."

First National Bank expects at least a 20 percent return on the packages they have purchased; thus far they've experienced more than their expected return. In terms of future purchases, Harvey says that the bank anticipates purchasing about $1.5 billion in total servicing in 1992, with the same rate of RTC purchases continuing as in 1991. First National also entered the subservicing market in 1991, and to date, subservicing approximates $700 million. One factor that will enhance the bank's ability to grow is its plans to go public with its mortgage banking division, notes Harvey.

Even though there is much hard work and due diligence involved, bank officials are quick to note that such things are a fact of life with any servicing acquisition--not just RTC packages. Once a competent acquisitions team is assembled and portfolio problems are identified upfront, then the question of bidding becomes more refined with experience--and the returns can be well worth the effort.

Barbara Nicholson is the facilities manager for First National Bank, headquartered in San Diego. Linda Harvey is vice president of servicing acquisitions and Leslie Bruce is marketing representative for First National Bank.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:First National Bank of San Diego's acquisition of mortgage packages from Resolution Trust Corp.
Author:Nicholson, Barbara; Harvey, Linda; Bruce, Leslie
Publication:Mortgage Banking
Date:Feb 1, 1992
Words:4151
Previous Article:Battling the bankruptcy boom.
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