During our reviews of different companies, we ask operators what their process is for managing Loss Mitigation. Generally, the term, Loss Mitigation, is used to explain the process of negotiating terms between a lender and borrower when a loan is delinquent or in default. If done correctly, terms, such as loan modifications, are negotiated to help borrowers make payments and avoid foreclosure.
Our focus on Loss Mitigation is the process mortgage bankers have developed to manage issues such as early payment defaults (EPDs), repurchase requests, and losses resulting from borrower misrepresentation. Purchase agreements between investors and mortgage bankers have specific language detailing the outcome when loans have EPDs or fraud. Essentially, losses resulting from these issues are the responsibility of the mortgage banker and must be attended to in a timely manner.
During 2005 through 2006, mortgage bankers who sold subprime and Alt-A loans to Wall Street firms and other large investors started to see an increase in EPD activity. These EPDs were the early warning signals of the mortgage meltdown. Mortgage bankers were making boatloads of money selling bulk deals to Wall Street desks and rarely had to deal with EPDs in the past. When mortgage bankers started to get letters from investors requesting loans be repurchased under the EPD clause in their agreements, owner operators began to “bury their heads in the sand”, thinking these issues would just go away somehow.
I remember one firm who was getting an average of 10 repurchase requests a month and just filing the letters away in a drawer in his desk. Before he agreed to work with us in putting together a process to manage his Loss Mitigation, he had over 50 EPDs from 6 different investors. Losses resulting from the second mortgage (100% piggy back loans) alone were 400% of his net worth.
The moral of the story: Put a Loss Mitigation Process in place before an investor is forced to grab all your net worth and put you out of business. The process should be sequential: validate claim, review for fraud, obtain appraisal to peg potential loss, and communicate often with investors. Most investors will negotiate with mortgage bankers and settlements are common today.
