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 that those with poor loan servicing.
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 firstname.lastname@example.org 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 consulting with independent professional advisors.