The Importance of Good Loan Servicing

A significant portion of Redwood’s clients manage mortgage pool funds. When working with these clients, some of whom have large portfolios of loans, we have seen a variety of loan servicing strategies and capabilities. Those managers who have a clear strategy and strong capabilities in loan servicing are able to more effectively manage their loan portfolios, are able to receive and distribute financials and investment returns to their investors, and more tightly control the performance of their loan portfolios.

There are two primary options when considering how your Fund should service its loans: in-house or outsourcing. Whether you are going to service your own loans or outsource that responsibility, there is a significant amount of detail about each loan which must be captured and reported on, including:

  • Interest Charged: At what point will interest be charged? Will the borrower pay any interim interest up front?
  • Payment Frequency: Will the borrower be paying interest monthly or at maturity? Will interest carries be involved?
  • Modifications: Is a forbearance agreement in place or has a full modification occurred? What unpaid interest or fees are being considered, and what additional fees will be charged?
  • Foreclosures and Bankruptcy: Will the asset need to be impaired post-foreclosure? Are there any lien positions that need to be considered?

Experienced private lenders or those with the right internal infrastructure may be able to effectively service their own loans. Some considerations fund managers may have when making a decision about whether to outsource or not: cost of outsourcing and the impact that will have on fund returns; ability to generate an additional source of revenue to managers; internal capabilities and ability to effectively source and retain talent; and whether to focus on core capabilities and allow others to provide loan servicing.

I would offer a word of caution to first-time servicers: you may run a higher risk of not being able to support a rapidly growing portfolio as compared to an outsourced servicer’s established infrastructure and ability to scale, and poor loan servicing can create a great deal of issues down the line for you, your borrowers and your investors.

Through Redwood’s activities as a third-party Fund Administrator, I have a great appreciation for the complexity of loan servicing and I urge all potential and current clients to not underestimate the potential impact of loan servicing on their financial statements.

From Redwood’s perspective as a Fund Administrator, in order to produce those financial statements, we need to determine out how much money will eventually end up in the investors’ pockets. The process is not as simple as the concept; the life of the loan must be translated from a cash basis to an accrual basis, under Generally Accepted Accounting Principles, which requires forecasting and then adjusting accounting journal entries. In our experience in working with a number of both in-house and outsourced loan servicers, we see a wide variance in loan-servicing capabilities. Invariably, those with solid loan servicing allow us to produce investment returns and financial statements in a fraction of the time than those with poor loan servicing.

 

Nate Ashley

Redwood’s Senior Fund Accountant Nate Ashley works with a number of clients who both service their own loans and who outsource their servicing to a third-party. Feel free to reach out to Nate at nate.ashley@redwoodrea.com should you have any questions or are in need of recommendations for a servicer.

 

 

Nothing in this blog is intended to be or should be construed to be legal, accounting, or other professional advice that requires a license to provide. Anyone acting on the information contained in this blog should consult with independent professional advisors.  

Understanding How to Handle Loan Impairment in a Changing Market

Many Fund Managers spend a significant time evaluating both borrowers and market conditions for loan collectability. Changing economic and market conditions make these evaluations even more difficult and despite the best due diligence, some loan repayments fall short. Fund Managers must consider how these losses will impact the investors coming in and out of their offering. Redwood’s sound knowledge of accounting standards in both theory and application provides expertise and guidance in navigating these conditions.

Some key considerations for Fund Managers include:

  • Loan Loss Allowance or Reserve
  • Foreseeable Loan Losses
  • Impairment Valuation

Loan Loss Allowances/Reserves: Fund Managers should set a provision for loan losses that enables them to build a reserve on their balance sheet, which is similar to write-offs for bad debts or other similar events. Exactly how losses are determined and at what point they should be recognized differs, depending on whether the portfolio is being collectively evaluated or if a single loan has a foreseeable loss.

In the case of pooled mortgage loans with similar underwriting and smaller principal balances, Financial Accounting Standard (FAS) 5 guidance provides for a reserve or allowance to represent a small portion of the overall portfolio. While no one loan may have a foreseeable loss, economic and market conditions justify keeping the small allowance. However, when a loan does have a foreseeable loss a different accounting standard applies.

Foreseeable loan losses: As a result of periodically evaluating your portfolio of active loans, you may determine that one loan has become impaired. In this situation, accounting standard FAS 114 applies. Once a loan is determined to be impaired, a separate loss allowance can be calculated, in line with any loss that can be reasonably estimated.

Impairment Valuation: While accounting standards suggest several measurements of impairment, using the fair value of collateral may be most relevant to the SBRE community. If the fair value of the loan is less than the outstanding receivables to be collected, a separate allowance should be created along with a corresponding current period Expense to loan losses related to the impaired loan.

As always, you should consult with your duly licensed CPA to ensure that you are applying these rules appropriately for your fund. Although Redwood is not a CPA, we can help you understand how these issues may be treated, as well as exactly what issues you should raise with your CPA. Don’t hesitate to reach out to us if you have questions.

 

Nate Ashley

Redwood’s Senior Fund Accountant Nate Ashley provides expert guidance to his clients based on the accounting standards to make sound business decisions in the face of varied economic conditions. Feel free to reach out to Nate at nate.ashley@redwoodrea.com.

 

 

Neither Redwood nor any of its affiliated entities offer or provide any legal, accounting, or other advice that requires a professional license. None of the materials in this post or any related materials are intended to be or should be considered legal, accounting, or similar advice. No one receiving these materials may rely on them as a substitute for appropriate professional advice. Redwood strongly encourages and advises anyone receiving these materials to consult with their own independent attorneys, CPAs, and other professionals in order to ensure that any actions taken in connection with the materials complies fully with all applicable laws, rules, and regulations.