Servicing scratch-and-dent loans presents special challenges.

In the optimism business, there are two phrases familiar to just about everybody. One has to do with measuring the contents of a glass (it's half-full, of course), and the other with that yellow-skinned fruit guaranteed to pucker your lips. We're talking here about turning the proverbial "lemons into lemonade."

Just what does this have to do with mortgages--or with the servicing of home loans?

The answer is particularly apparent these days in the subprime world, where a battered and shrinking market is strewn with the wounded, weary and washed-away.

Dozens of lenders have gone under, vast numbers of homeowners are faced with foreclosure and the government is racing to write new laws to ensure these problems never happen again.

But, as always, where there's change (and, if a market ever was changing, this is it) there's opportunity.

While some originators, servicers and securitizers simply vanish, others are stepping in and ramping up. In servicing, one contingent has developed a strong appetite for so-called scratch-and-dent (S/D) loans, of which there seems to be an increasing number.

This year's subprime "saga," "implosion" or "meltdown" (depending on the nom du jour), has put scratch-and-dent servicers in the spotlight.

In normal times, lenders would keep such "dinged" loans and extend a short-term warehouse line to fund them. However, as those loans are now becoming backed-up, such extensions tie up cash--so they are selling at huge discounts to the new scratch-and-dent guys willing to fix them. And the new guys need a new system that can help them make their lemonade.

Outside the customary buckets

Scratch-and-dent loans fall outside the customary A, alternative-A or subprime originator guidelines and performance expectations. While the majority are performing, a sizable number may be reperforming, nonperforming or subperforming.

The loans are purchased from various institutions and brokers on a bulk or flow basis, by competitive bid or through a pre-negotiated agreement. Portfolios may include second liens, real estate-owned (REO) and, on a limited basis, nonresidential properties. Servicers may work on a delinquent loan(s) for a client firm or be involved in a workout partnership with another player. The possibilities are endless. Hedge funds are even getting involved.

These new buyers are discovering that, as much as speed, accuracy and flexibility are important when handling unblemished loans, those attributes are even more critical with troubled accounts.

The problems may involve undocumented loans that can't be sold due to unmatched underwriting conditions, incorrect borrower information and possibly fraudulent information. Also important is the servicer's ability to collect on mortgage loans, prevent defaults from occurring or work out loans through modification and forbearance agreements, while efficiently managing the liquidation process.

With nonperforming loans--those 60 days late on payment--investors are pushing back on the originators to keep those loans or take them back. In turn, originators are trying to get rid of them any way they can--so they are selling them to the S/D people at 30 and 40 cents on the dollar. But the buyers want to keep them and reform the loan, if possible.

In such instances, they also manage the REO. This takes inventive thinking to save formerly lost causes, and that is driving an evolution in servicing system usage. Two years ago, if a borrower couldn't make a loan payment, he or she lost the house. End of story. Today, the situation is different; few, if any, lenders want the keys.

Lenders have come up with solutions such as shared equity with the borrower--a novel concept that actually allows the homeowner to keep his or her shirt. Or you offer the delinquent borrower a long-term rental contract with buy-back options. More new ideas keep coming along each day.

All this agile thinking requires a flexible system. The use of a servicing system as a hub enables integration with sophisticated default tools.

We have been working with the scratch-and-dent servicers to provide a servicing system that can interface real-time with accounting systems, collection management/calling services and document services. Real-time is the big deal here, because overnight batching doesn't work in the financial and collections world.

Hosted in a complete package

LoanQuest[TM] Servicing's Microsoft[R] .NET[TM] platform makes it happen for them. Scratch-and-dent servicers want a vendor that can coordinate all the interfaces and make them work together, then host it all in a complete package. Very few vendors can deliver this--or even want to try.

MortgageFlex developed LoanQuest Servicing in .NET technology, with ease of integration and Web capabilities in mind. Last year, we also began converting the rest of our LoanQuest products to Microsoft's new .NET 3.0 framework.

It took MortgageFlex five years to develop LoanQuest Servicing properly because the technology needed to stabilize and, because honestly, it took a while for that technology to catch up with the mortgage market requirements.

The development of this new .NET 3.0 product platform was accomplished without losing any of the functionality or familiarity of the product our customers depend on. At the same time, we introduced many new features that our customers will be able to take advantage of over time (read customization and flexibility).

The .NET 3.0 version features a reengineered database and an implementation of the Microsoft workflow engine that is more event-driven, reflecting a task-specific workflow.

The use of .NET technology in MortgageFlex's LoanQuest[TM] Servicing system earned recognition from Mortgage Technology magazine last year, which named the company a finalist in the competition for products that helped solve an industry problem. So today, as the industry's problems persist and even proliferate, innovative products and problem-solving--as seen in the scratch-and-dent sector--have become more important than ever.

James Dowell is executive vice president and chief operating officer of MortgageFlex Systems Inc., Jacksonville, Florida. He can be reached at [e-mail].