Better REO solutions: a host of new solutions to support REO disposition couldn't have...

There are many techniques for predicting the future of credit losses in the residential real estate market: You can read tea leaves, scatter chicken bones or squeeze some new meaning out of Nostradamus' quatrains--which, at best, are no more obscure than some announcements from the Fed and

arguably just as reliable for predicting the future. [??] But when it comes to prognosticating on the body count of a declining real estate market, there is perhaps no better indicator than the increasing demand for improved software to manage the mounting inventory of real estate-owned (REO). That demand can be seen as a proxy for the level of foreclosed property, particularly in the subprime sector. [??] While experts disagree on the reasons for and magnitude of the present distressed real estate environment, servicers of subprime residential mortgages--with their eyes locked on increasing defaults--offer a first-hand perspective on the immediacy of the challenges. One asset manager for a top-10 subprime servicer recently likened the inadequacy of traditional remedies (i.e., adding resources and hiring multiple outsourcers) to "herding cats." [??] When home appreciation was skyrocketing, troubled borrowers could merely refinance out of default, and in many cases did, with enough cash removed from the transaction for a flat-screen TV and a summer vacation. Now, however, what had been a rapidly rising tide of real estate values that raised everyone's "house-boat" is shifting into a deadly undertow. Exotic loan products, questionable credit profiles and a tick-up in interest rates have left many homeowners with dwindling options.

Bubble or balloon?

Former Federal Reserve Chairman Alan Greenspan once said, "You can't tell if there was a bubble until it bursts."

The bubble metaphor serves both economists and soothsayers well. But in the subprime sector, the best imagery may be that of a balloon.

According to a July 1, 2007, article by Louis Uchitelle in The New York Times, subprime adjustable rates are rising and balloon payments are coming due even as home prices are dropping. Uchitelle goes on to state that "the stake that families have in their homes fell faster in the 12 months through March [2007] than at any time since the early 1990s," with the nation's homeowners owning, free of debt, only 52.7 percent of their dwellings.

A study conducted by First American CoreLogic Inc., Santa Ana, California, predicts that 1.1 million loans out of a group of 8.37 million adjustable-rate mortgages (ARMs) will be in foreclosure over a six- to seven-year period, representing 13 percent of the ARMs originated through purchase or refinance from 2004 to 2006. After foreclosure and resale, investors and insurers of these loans stand to lose approximately $112 billion on the total debt of $326 billion.

According to the same study, the impact of reset-based foreclosure will focus on subprime mortgages and teaser-rate loans with low initial interest rates, interest-only or negative amortization features originated within the past three years.

The effects of this rise in foreclosures have already begun to surface in the REO sector, according to Todd Mobraten, national marketing director for US Real Estate Services Inc. (USRES), Lake Forest, California. Mobraten estimates that there are currently 520,000 active non-government-sponsored-enterprise (non-GSE) REOs, up from 190,000 last year.

This nearly 300 percent increase in current REO inventory levels has led investors to put the pressure on servicers to provide efficient, cost-effective REO-management processes immediately. In turn, servicers' own asset managers are facing equal pressure to manage these skyrocketing portfolios more effectively, thereby decreasing credit losses without increasing staff levels. How can this be achieved? Servicers have turned to new REO technology in hopes that it will help save the day.

Given the declining credit market, investment in REO technology is not only timely but imperative. A survey of available technology reveals a market saturated with products ranging from do-it-yourself Web solutions to servicing platforms boasting fully integrated REO modules. Despite their glossy promises, many of these products simply compound ineffective processes with newer, more complicated technology.

While the right technology solution can help shorten timetables and increase profitability, given the sheer enormity of the rise in foreclosures, REO managers who hope to weather this storm must perform a 360-degree re-evaluation of their own internal processes. Then they must determine what results they hope to achieve through this new technology, and seek out the appropriate solution to complement their needs.

Metrics for success

REO technology can only be as effective as the asset managers who use it. In order to measure the potential return on investment (ROI) of these products, you must examine traditional REO metrics.

Loss severity, or the average loss at REO sale as a percentage of the total balance, is the clearest measure for scoring asset managers' performance. As factors of loss severity, you must closely examine holding timetables, monthly carrying costs and unexpected or incidental expenses incurred.

According to Mobraten, average REO loss severity is 43 percent for prime loans and 51 percent for subprime loans. If asset managers are to lower loss severity while handling rapidly increasing REO volumes, it is clear they must shorten timetables (within the limits allowed by state regulations), along with the associated monthly carrying costs. They must also take the proper preventative measures to avoid incurring unnecessary expenses.

Lights. Camera. Action!

It's no secret that the entire default-loan process is a complicated maze of guidelines and regulations, with myriad key players involved. The REO process, however, can often make earlier stages of loss mitigation seem like a walk in the park.

REO disposition incorporates all the complexities of foreclosure while introducing its own regulatory nuances. A larger forum of individuals and disparate parties are more heavily involved in the process, and they must work together to check tasks off of a convoluted, ever-expanding to-do list.

Mobraten likens the process to that of a movie production:

* The investor acts as the producer, because it owns the REO. The investor is in the key position due to its ultimate financial influence over the REO.

* The servicer fills the role of director, arranging for servicing of the REO. A "loss-and-turn" servicer must get rid of the REO while minimizing losses to lessen loss severity. Sometimes a servicer uses a subservicer for REO, and the subservicer will either service the REO for the servicer/investor or outsource the defaulted property to an asset manager.

* The asset manager fits the description of a production assistant, and is given responsibilities to carry out the servicer's (director's) responsibilities to the investor. The asset manager provides property valuation services--such as broker price opinions (BPOs), appraisals and limited reconciliation reports--usually on a national basis. More and more asset managers utilize a technology platform to interface directly with listing agents, title companies, property-preservation vendors, closing attorneys and other players in the default asset-disposition process.

* Real estate agents facilitate REO tasks established by the asset managers who are acting on behalf of servicers and subservicers' guidelines. So it can be said that agents are the primary actors ultimately directed by the servicers/investors.

* Other third-party vendors also report to the asset manager. Their role is to submit bids and fulfill tasks sent to them by agents, such as property winterization, lawn care, trash removal and so forth.

Broker-direct vs. outsourcing

Even at the simplest level, the REO process is an absolute migraine for servicers. Before they can begin to compare the different technology solutions available, servicers must determine the most cost-effective approach to selling and marketing REO. Choosing whether to deal with brokers directly or to outsource the process greatly impacts how different technologies can be applied to meet their needs.

In the broker-direct model, the servicer hires and maintains an in-house asset-management staff. This internal department works directly with real estate agents and third-party vendors, and is responsible for the disposition of REO from foreclosure through closing.

Working directly with third parties requires servicers to either re-key data constantly, leaving them susceptible to lost productivity and declining data integrity; or to configure multiple interfaces among their system of record, workflow tools and individual vendor systems. While the servicer ultimately retains control over the process, this option can cost the servicer valuable time and money, compounding already steep losses.

In the outsourcing model, a national asset-management firm is engaged to provide all management and marketing functions. The management company retains power of attorney as the seller, and incurs daily operational costs on behalf of the servicer.

Because the management company will likely interface with all required third-party systems, only one connection is required between the servicer's system of record and the management company's REO platform. This solution can be more cost-effective, but the servicer is at the mercy of the management firm and has little control over the process.

The current nightmare

The broker-direct model was popular while REO levels were still manageable. As REO inventories grew, servicers augmented their own systems in an attempt to handle the increased volume. However, as REO inventories kept climbing with no end in sight, we saw the emergence of a combination broker-direct and outsource model. In this combination model, servicers' asset-management departments handled most REO internally, while the overflow was outsourced to national management companies.

While this model allows the servicer to maintain control over its portfolio, and at the same time handle rising REO inventories, the combination model poses a new set of technological challenges. Investors are forced to access reports from multiple systems, which is inefficient and fraught with inaccuracies. Workflow cannot be efficiently managed across the numerous systems. Data integrity suffers. This all translates into increased credit losses for investors and higher costs for servicers.

The solution

Among all of the products in the REO technology sector, servicers must seek out a comprehensive solution--not simply a collection of products each designed to meet one specific REO need. For example, many companies allow users to go online and order BPOs electronically; some even facilitate batch orders. Others go so far as to offer delivery of the orders in a format that can be imported into the main servicing system "with ease."

While that sounds appealing at first, what about all the other tasks on the REO checklist? Even if you find a company that can offer electronic delivery of products across the board, employees will be screen-hopping to order the services and spending valuable time updating tasks in workflow-management systems, all the while missing important deadlines and eliminating productivity gains supposedly achieved by the new products.

Servicers' REO needs are copious and complex, and it's unlikely that purchasing a variety of individual products or services will work any better than trying to fix a sinking boat with duct tape. Servicers should instead turn their attention to solutions that merge asset-management services with a unified REO servicing platform.

There are innovative approaches to these problems. By using a commercial software solution for in-house REO processing as well as outsourced processing, servicers gain greater visibility. This allows them to retain control over certain properties, outsource others and monitor action on their entire portfolio. Providers using this methodology must deal with REO disposition throughout the nation. The solution should also offer asset managers and agents streamlined servicing software to manage and distribute tasks associated with REO portfolios from the point of foreclosure to closing. The ideal solution should have extensive tracking screens that support workflow by acting as a checklist and communication hub for asset managers and agents--all in real-time.

Communications between agents and asset managers can be overseen by the servicer through direct access to the network. The ideal system should also provide a convenient ordering system for third parties to implement property preservation, order titles and valuations, update property data, submit expenses and volley buyers' bids through an online system to manage offers.

Having data-exchange capabilities with all major servicing platforms is also a must. But servicers should be aware of the sometimes egregious charges imposed by service bureaus for extracting and importing into a wraparound system and posting back transactions in real-time (Web services) to the service bureau because it is the system of record.

Additionally, agent involvement in a technology platform provides a link to sure and steady business. Outsourcing asset-management companies rely on agents to be their eyes and ears throughout the process, and as a result, relationships are built with agents who are reliable, responsible and dependable.

Because the servicer, asset manager, real estate agent and third-party vendors are integrated into one REO platform, servicers only need to configure one data exchange between the REO platform and their system of record.

Though the point is beyond the scope of this article, linking REO functionality to the default servicing system would go a long way in bridging a disjointed process that must withstand mounting pressure to do more with less in the coming years. Because the entire default process is essentially a continuous flow of interrelated processes, removing barriers among loss-mitigation, foreclosure and REO departments promotes more effective collaboration, saves time and minimizes losses for the servicer.

A unified platform that is capable of processing a loan from its initial delinquency through REO disposition provides managers with the benefit of a complete borrower profile, including all previously ordered inspections, valuations, credit reports, etc. All of these attributes will help asset managers make better decisions from the day a property becomes REO.

Whatever approach a servicer pursues, the REO technology it purchases should include the following components and capabilities:

* Centralized communication among all relevant participants;

* Administrative function allowing users to input investor guidelines, timelines and cost parameters;

* Dynamic tasking and role-based access for all involved parties;

* Progress ticklers;

* Workflow orchestration and tracking;

* Offer routing/management (from bid to approval);

* Marketing tools;

* Custom decisioning engines;

* Complete integration with third-party vendors;

* Vendor invoice payment;

* Gain/loss transaction analysis; and

* Automated approval and signoffs.

Ultimately, the technology should give asset managers the ability to assume larger REO caseloads without adding additional employees. Asset managers must determine their current capabilities, and set reasonable expectations for their staff following implementation. According to Denis Brosnan, partner with EAG Consultants LLC, Columbia, South Carolina, asset managers utilizing a solution that automates workflow and activities, such as the one described earlier, could increase caseloads from an average of 77 per full-time equivalent (FTE) to somewhere between 250 and 300 per FTE.

Final thoughts

In addition to management efficiency, effective marketing of REO properties is crucial to their timely and efficient disposition. In a market brimming with REO, asset managers will need to target potential buyers through innovative and sometimes unconventional methods.

Online marketing tools such as RealtyTrac.com and Buy-BankHomes.com can be connected to the rest of the REO process, exposing the properties to a much larger audience. According to Realtythoughts.com, a Web site that tracks and analyzes real estate traffic online, RealtyTrac.com sees roughly 2.7 million unique visitors monthly. Additionally, removal of the buyer's real estate agent can save 1 percent to 2 percent on commissions.

The ongoing fallout from the subprime market decline is coming as surely as the pig moves through the python. The rapidly improving market for REO software solutions, combined with creative services and products, will help transform the asset manager from the oracle of doom to a welcome part of the solution.

Camillo T. Melchiorre III is chief operating officer of Baltimore-based MSTD Inc. for Richmond. Virginia-based LandAmerica Financial Group. He can be reached at cam.melchiorre@landam.com.