Why would a commercial lender outsource its servicing and technology?
One important factor is fluctuating loan servicing volumes--the shrinkage and growth of servicing portfolios in response to dynamic market conditions. Other drivers include the addition of new lending products with different servicing and investor reporting requirements; changing business models; and changing regulatory, compliance and risk management requirements.
However, the primary consideration in any decision to outsource is economic--re-ducing expenses, increasing profitability by improving operating efficiency and converting fixed overhead into variable costs.
Corporate pressures to grow revenues, and reduce expenses and head count are causing lenders and servicers to evaluate a variety of operational alternatives to a completely in-house servicing and asset management operation.
Maintaining an in-house servicing staff and technology platform to manage a limited number of loans is a challenge, and the ability to realize significant operational efficiencies is limited without major structural changes. Outsourcing provides the ability to utilize advanced servicing technology that offers increased servicing efficiency, flexible capacity and improved risk management.
Many lenders are exploring outsourcing, subservicing and subcontracting alternatives to respond to dynamic market conditions affecting the commercial real estate finance industry since the Great Recession.
The commercial loan servicing industry has changed dramatically over the past two decades as commercial mortgage-backed securities (CMBS) became a major component of the commercial real estate debt market. CMBS origination and issuance volume created a demand for third-party servicing and technology to support the burgeoning business.
The dramatic growth of the CMBS market resulted in the emergence of very large servicing operations that were designed to efficiently service high volumes of loans to a standardized construct. Servicing technology developed to support CMBS servicers' high processing volumes and short monthly time frames for payment processing, remittance and reporting.
The development of high-volume CMBS servicing operations and the technology to support these operations created significant economies of scale and reduced servicing cost per loan for the megaservicers.
CMBS offers borrowers attractive and inexpensive permanent commercial real estate debt; however, one of the major trade-offs is in servicing quality. Borrowers typically do not have a personal relationship with their CMBS master servicer, and there is some likelihood of being exiled to an unresponsive "special" servicer to deal with credit issues even for seemingly routine requests.
Portfolio lenders such as life insurance companies and multifamily agency seller/servicers offer their borrowers a higher quality of customer service and responsiveness. They have significantly more flexibility in addressing the types of issues that manifest with owning and managing income-producing commercial real estate properties. Can these lenders get the economic and operational benefits of the large-scale servicing platforms while still maintaining their comparative advantages with borrowers?
For insurance companies or multifamily agency seller/servicers, maintaining direct borrower relationship management, credit analysis and decision making is a critical factor in any decision to outsource or subservice.
Servicing technology has developed to facilitate the bifurcation of borrower-facing customer service and asset management activities from the highly scalable activities, like payment processing; loan accounting; tax, insurance and reserve administration; remittances; and investor reporting. Advanced servicing systems permit the outsource provider and lender/servicer to operate in real time on a shared platform with all loan, borrower, collateral and asset status information available to both parties in real time.
Integrated digital document imaging and indexing further enhances the shared servicing relationship and increases collaboration and operating efficiency. Additionally, the shared technology platform facilitates the efficient use of third-party vendors or subcontractors for servicing activities such as tax, insurance and Uniform Commercial Code (UCC) administration; mortgage release processing and recordation; site inspections; and the data input and analysis of property operating statements, rent rolls and borrower financial statements. Many servicers subcontract these activities to third parties on a variable cost basis to reduce overhead and improve operating efficiency.
The composition and complexity of commercial and multifamily servicing portfolios have changed as lenders add new credit products. Insurance companies and multifamily mortgage bankers are expanding their origination activities to include new commercial real estate debt offerings. Such offerings include CMBS conduit, bridge, mezzanine and construction/permanent lending, which have different servicing, asset management, investor reporting and remittance requirements.
Some lenders are originating loans with complex structures, multiple tranches of debt and equity, and multiple investors or participants. These loans require active asset management and engagement between the borrower and servicer. Additionally, servicers are supporting much more intensive credit risk management regimes.
All of these activities put burdens on legacy servicing operations and systems.
Evolving servicing and investor reporting requirements are causing portfolio servicers to look at technology and outsourcing alternatives to address their needs.
The newly implemented National Association of Insurance Commissioners (NAIC) risk-based capital requirements for insurance companies require significantly more property operating information to support annual valuations and credit metrics. These requirements are similar to the credit surveillance and collateral financial analysis activities performed by CMBS master servicers. The mechanics of collecting and analyzing property operating statements, rent rolls and borrower financial statements and the servicing systems to support these activities are well developed. Outsourcing can be a very effective alternative to managing these changing servicing operational requirements.
Multifamily seller/servicers are adapting to changing servicing and investor reporting requirements as they originate and service Freddie Mac Capital Markets Execution (CME) securitization product and address changing Department of Housing and Urban Development (HUD) Federal Housing Administration (FHA) servicing and asset management activities.
There is uncertainty as to how and when the Fannie Mae and Freddie Mac multifamily lending programs will evolve with future regulatory and structural changes. Multifamily agency seller/servicers will have to adapt their business models in response and will look for more flexibility in their servicing operations and infrastructure.
Outsourced servicing and technology provide opportunities to address the challenges associated with maintaining servicing and asset management personnel resources. The single largest expense for a servicing operation is personnel and their associated costs (benefits and overhead).
While personnel costs are a variable expense, these costs are somewhat inelastic and difficult to manage as portfolios shrink, and capacity is sometimes difficult to add. Many servicers are facing the aging and retirement of their most experienced servicing managers and staff; training replacements takes time and expense. Technology can improve operating efficiency and productivity, increasing the number of loans serviced per employee, thereby mitigating some of the personnel resource needs.
Outsourcing the high-volume processing activities allows the retained servicing and asset management personnel to focus on higher value-added activities. This provides career development opportunities and better employee engagement, which may result in lower turnover associated with clerical and administrative staff.
The decision to select a specific servicing technology platform is a major longterm commitment. The time, expense and disruption associated with changing servicing systems are significant. Advanced servicing technology has been proven to improve operational efficiency through process improvements, workflow automation, and digital document imaging and indexing. Internet-accessible, real-time investor reporting and borrower portals improve the availability of information and reduce the need for manual support. The integration of payment processing, loan servicing and administration, asset management, borrower customer service, investor reporting and remittance on a single platform has significantly improved servicing productivity and capacity. A number of large servicers that have outsourced their servicing technology have reported realizing operating efficiency gains averaging 30 percent as measured by loans per servicing employee two to four years after conversion.
Reducing the number of side systems improves data integrity and reduces technology support costs. Hosted technology applications provide a comprehensive technology solution, including system access, data storage, business continuity and disaster recovery on a monthly fee per loan variable cost basis.
The decision to outsource servicing activities or technology requires a significant commitment of time and management attention. To achieve the optimal results, servicing operations and processes should be re-engineered to take full advantage of the capabilities of the outsource provider and technology.
An outsourcing relationship is a longterm commitment, and requires trust and confidence among the parties to achieve the established objectives and ongoing success. The experience, capabilities and financial stability of the outsource provider are paramount to building this trust and confidence. Outsourced servicing and technology will be an increasingly important consideration for portfolio lenders and multifamily seller/servicers.
Outsourcing provides the ability to utilize advanced servicing technology that offers increased servicing efficiency, flexible capacity and improved risk management.
Stacey M. Berger is an executive vice president of Midland Loan Services, a PNC Real Estate business. Midland is a leading provider of loan servicing, asset management and technology for the commercial real estate finance industry. He can be reached at email@example.com. NOTE: The views expressed by the author are his own, and this column was prepared for general informational purposes only and does not Durport to be comprehensive. The information and views in this publication do not constitute legal, tax financial or accounting advice or recommendations to engage in any transaction. The views expressed in this column are subject to change due to market conditions and other factors.
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|Comment:||Why would a commercial lender outsource its servicing and technology?(SERVICING)|
|Author:||Berger, Stacey M.|
|Date:||Jan 1, 2014|
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