End-of-Draw HELOCs: Using Data-Enhanced Consumer Outreach to Mitigate Mortgage Portfolio Risk

1PROTIVITI • END-OF-DRAW HELOCs

IntroductionNearly a decade after the collapse of the financial markets, triggered by massive subprime mortgage defaults and plummeting values of securities tied to real estate prices, another major aftershock of the crisis has the potential to impact a significant segment of homeowners. The original crisis created a ~$700B negative equity gap in the financial markets, wiping out many financial institutions and exposing operational shortcomings in the servicing infrastructure of many more, as well as leaving millions of Americans with homes worth less than what they paid originally. In response, the U.S. Treasury initiated unprecedented regulatory reform to stabilize, correct and attempt to prevent an event like this from occurring again. Despite these measures, the next five years may test the financial markets’ resolve and once again threaten the housing market with a new wave of loan defaults.

During the period of 2005-2011, tens of millions of home equity lines of credit (HELOCs) totaling US$2.39 trillion were originated. A large portion of these HELOCs—those with minimum, interest-only payments—are nearing their “end-of-draw” period (typically five to 15 years), after which most of these HELOC contracts will require higher payments to amortize the outstanding debt. This will undoubtedly cause payment shock to certain homeowners as their minimum payments triple and quadruple in size. A significant majority of these HELOCs were originated in the immediate run-up to the crisis, between 2005 and 2007, when the lending, underwriting and credit quality standards were lenient and demand for home equity loans was at its peak. (See Figure 1.) Similar to the subprime meltdown, the primary risk in the loan products is due to a change in payment terms, going from a low, interest-only payment to a higher, fully amortizing or balloon payment. A sluggish economic recovery and the threat of rising interest rates combine with these factors to spell disaster for owners of mortgage risk. Evidence of this can be found in the fact that over-90-day delinquency rates for adjusting HELOCs originated around the peak are as high as 20-25 percent, resulting in billions of dollars in losses each month.

2PROTIVITI • END-OF-DRAW HELOCs

Figure 1. Second-lien originations (U.S. dollars, billions)

20

0

CES

1999

Q2

1999

Q4

2000

Q2

2000

Q4

2001

Q4

2001

Q2

2002

Q2

2002

Q4

2003

Q2

2003

Q4

2004

Q2

2004

Q4

2005

Q2

2005

Q4

2006

Q2

2006

Q4

2007

Q2

2007

Q4

2008

Q2

2008

Q4

2009

Q2

2009

Q4

2010

Q2

2010

Q4

2011

Q2

2011

Q4

40

60

80

100

120

140

160

180

200

HELOC

Figure 2. Over-90-day delinquency rates for HELOC originations, after first-lien originations, based on year of origination

0%

5%

15%

20%

25%

10%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

0 quarters 1-4 quarters 5-8 quarters 9+ quarters

Source: “A New Look at Second Liens,” Federal Reserve Bank of New York, Staff Report #569, www.newyorkfed.org/research/staff_reports/sr569.html.

3PROTIVITI • END-OF-DRAW HELOCs

Adjusting HELOCs are top-of-mind for both business and risk executives at institutions that hold these loans, and some organizations are proactively preparing to mitigate the risks by trying to place impacted consumers into different products or alternative payment options, based on the borrower’s situation.

In addition to concerns about credit default risk, banks also need to comply with new mandates and requirements brought on by changing regulation aimed at ensuring that proper notifications and disclosures are sent to consumers, appropriate data is reported to government entities, and homeowners are handled correctly throughout the life of their loans. Specifically with regard to HELOCs, federal and state regulators recently published “Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods.” Protiviti has issued a Flash Report providing strategies for institutions in complying with this Guidance.1

The 2008 credit crisis also exposed the shortcomings of some financial institutions’ internal operational infrastructures. One of the most apparent flaws is the fact that processes and systems simply were not nimble enough to keep up with new government mandates and the deluge of modifications that flooded the marketplace following the collapse. Legacy systems up to this point were not built to handle the volume of new loan modification applications, and the processes that existed were insufficient to provide an effective customer experience. Additionally, a fully integrated view of customer risk was not available to the business in order to quantify and manage risk. It became quite apparent during and after the crisis that the processes and their supporting technology are in dire need of a makeover if they are to support the mortgage banking of the future. Consequently, banks are taking a long, hard look at the underlying technology supporting their operations, from origination through back-end processing, and considering an overhaul of their core systems.

At this pivotal time of reinvestment into core systems, a key question is whether a more strategic and unique approach is needed to craft the lending and servicing infrastructure for the future. Innovative and best practices used in other industries are now being considered as ways to produce game-changing results. These practices leverage big data analytics, social media and mobile computing to address regulatory mandates, establish better connections with homeowners and create the necessary agility to turn the tide on a historically reactive industry. If implemented correctly, these changes can be used proactively to develop new ways to cultivate and preserve market share. One aspect of this new approach that can specifically address the HELOC problem and therefore deserves a deeper look is data-enhanced consumer outreach.

DATA-ENHANCED CONSUMER OUTREACH IN MITIGATING LOAN DEFAULTS

The ability to cultivate, manage and analyze consumer data is at the crux of building a data-enhanced consumer outreach strategy. Data governance and aggregation of information making up consumer profiles for mortgage servicing outreach are in the infancy stage of maturity and have been historically fragmented or built around stale information. For example, the rate of bad phone contact information on representative current portfolios is as high as 25-35 percent mainly because this information is rarely refreshed. The benefits from having updated contact information are significant not just for loss mitigation, but also for cross-selling and marketing, all of which are extremely important for a lender.

The ability of banks today to detect early warning signs of delinquency and to reach consumers quickly in response to market conditions, regulatory mandates and borrower defaults is a quantum leap from where banks were even five years ago. In the case of mitigating the risk of readjusting HELOCs, the benefits of reaching borrowers pre-emptively and cross-selling them into a different product are clear. Logically, some banks may ask, how do we use data-enhanced consumer outreach to be even more proactive? By reviewing the core systems architecture that makes up the mortgage lending process, we begin to see the type of homeowner data inputs from these systems that can be collected and managed, from initial customer contact throughout loan servicing.

1 “Financial Services Flash Report: Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods,”Protiviti, August 2014, www.protiviti.com/en-US/Documents/Regulatory-Reports/Financial-Reporting/Financial-Services-Flash-Re-port-Interagency-HELOC-Guidance-081214-Protiviti.pdf.

4PROTIVITI • END-OF-DRAW HELOCs

This information includes:

•Updated contact information (e.g., phone numbers, address, email)

•Credit history

•Income

•Property value

•Loan-to-value ratio

•Debt-to-income ratio

•Product type

•Payment string

•Metropolitan Statistical Area (MSA) population concentrations

•FICO score

•Deposit account balances

•Social/behavioral information

Based on this information, an enhanced profile of the consumer is built and maintained throughout the life of the loan. A data governance program focused on actively managing these consumer profiles creates new capabilities, such as detailed customer segmentation for tailored/targeted outreach campaigns, ongoing data collection for predictive analysis to address risk, data-enhanced outreach for compliance purposes, and cross-sell opportunities, among others. Clear lines of responsibility within organizations and proactive “scoring” of data quality throughout the lifecycle of the loan provide the necessary maintenance controls on data to ensure reliable inputs.

The future of mortgage banking and quality of mortgage bonds will rely heavily on capturing, storing and mining consumer data to analyze payment trends and proactively manage behaviors to influence them positively throughout the life of the loan. By aggregating the information across all core systems from origination through servicing into a data warehouse, a base for intelligence on the borrower can be created. This forms the backbone for an event-driven architecture that can monitor, detect and pre-emptively alert bank personnel to perform specific targeted outreaches.

Figure 3. A high-level overview for an event-driven architecture that connects consumer data with core mortgage systems

CRM LoanOrigination

CoreServicing

Data Append Property Value Credit Score

Geographic Concentration

Risk

AccountInformation

Social/Behavioral

TriggerEvents forOutreach

Event-DrivenArchitecture

Data Warehouse

Core Systems

Augmentable DataSources

5PROTIVITI • END-OF-DRAW HELOCs

In the context of the HELOC problem, it is easy to see how by monitoring thresholds on key data elements (e.g., decreasing values, increasing rates, etc.) one can create a proactive “radar” for potential risks. Augmenting the data “warehouse” with other external data sources, such as updated geographic concentration risk values, credit information or refreshed property values, can reveal early risks in a profile that can trigger either a loss mitigation or a marketing effort. Pulling in social or behavioral data sources can offer additional insights about a consumer’s buying patterns, which can identify new opportunities. For example, a consumer who has an existing mortgage loan at a bank and who has good credit/payment characteristics may be searching online for bathroom fixtures and remodeling. Here, a targeted marketing event could be triggered to offer this particular homeowner a HELOC for home improvements at a favorable rate.

CONCLUSION

Over the next few years, the foundation for the future housing finance industry will be set. The road for a number of banks and servicers is clear: they must redefine and reshape their relationships with customers in a way that benefits all constituents, from the investors down to the homeowner.

From a governance perspective, organizations must be able to understand better their existing data assets, control the quality of these assets and exert positive controls to maintain the data assets over time. The use of data analytics, data governance and event-driven architecture will position risk owners to influence positive change dramatically at the grassroots level. By creating a complete customer experience starting with incentivizing behavior at origination and continuing through liquidation, banks can improve payment performance, increase information on the homeowner, reduce reaction time on loss mitigation and generate billions of dollars of market share as a result. This new relationship with the customer is the future of mortgage servicing, and data-enhanced consumer outreach has the potential to spearhead this change.

The approaching HELOC end-of-draw wave presents a unique opportunity for CIOs, COOs and CROs to initiate a renaissance in how banks think about, re-architect and modernize their servicing infrastructure. New government regulations and the pervasive volatility in the financial markets render it unwise to sit idle and expect status quo processes and systems to be enough to stem the pending risks and losses. The worst housing crisis in recent memory created the worst mortgage performance in the past 20 years, and the market is still struggling to recover. Innovative approaches utilizing data to mitigate risks, drive new market share and con-nect with customers are needed and likely will become the new norm in mortgage banking in the 21st century.

How Protiviti Can HelpThrough numerous interactions with our clients over the years, Protiviti has gained unique perspectives on residential mortgage credit risk, regulatory pressures and compliance challenges faced by financial services institutions. Combining these perspectives with subject-matter expertise in the technology space, we can help business and IT executives focus not only on the immediate HELOC problem but to understand more broadly the enterprise risk and compliance considerations needed to satisfy regulatory requirements. Our Risk & Compliance team can help your organization design and implement compliance, IT and data governance best practices that enhance business value.

6PROTIVITI • END-OF-DRAW HELOCs

ABOUT PROTIVITI

Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit, and has served more than 40 percent of FORTUNE 1000® and FORTUNE Global 500® companies. Protiviti and its independently owned Member Firms serve clients through a network of more than 70 locations in over 20 countries. The firm also works with smaller, growing companies, including those looking to go public, as well as with government agencies.

Protiviti is a wholly owned subsidiary of Robert Half (NYSE: RHI). Founded in 1948, Robert Half is a member of the S&P 500 index.

ContactsEd Page Matt McGivern+1.312.476.6093 +1.404.926.4346ed.page@protiviti.com matt.mcgivern@protiviti.com

Michael Brauneis Tyrone Canaday+1.312.476.6327 +1.212.603.5435michael.brauneis@protiviti.com tyrone.canaday@protiviti.com

©2014 Protiviti Inc. An Equal Opportunity Employer M/F/D/V. PRO-PKIC-0914-164 Protiviti is not licensed or registered as a public accounting firm and does not issue opinions on financial statements or offer attestation services.

ASIA-PACIFIC

AUSTRALIA BrisbaneCanberraMelbournePerthSydney

CHINA BeijingHong KongShanghaiShenzhen

INDIA* BangaloreMumbaiNew Delhi

INDONESIA** Jakarta

JAPAN Osaka Tokyo

SINGAPORE Singapore

SOUTH KOREASeoul

* Protiviti Member Firm ** Protiviti Alliance Member

THE AMERICAS

UNITED STATESAlexandriaAtlantaBaltimoreBostonCharlotteChicagoCincinnatiClevelandDallasDenverFort LauderdaleHouston

Kansas City Los Angeles Milwaukee Minneapolis New York Orlando Philadelphia Phoenix Pittsburgh Portland Richmond Sacramento

Salt Lake City San Francisco San Jose Seattle Stamford St. Louis Tampa Washington, D.C. WinchesterWoodbridge

ARGENTINA*Buenos Aires

BRAZIL*Rio de Janeiro São Paulo

CANADAKitchener-WaterlooToronto

CHILE*Santiago

MEXICO* Mexico City Monterrey

PERU* Lima

VENEZUELA* Caracas SOUTH AFRICA*

Johannesburg

EUROPE/MIDDLE EAST/AFRICA

FRANCE Paris

GERMANY Frankfurt Munich

ITALY Milan Rome Turin

THE NETHERLANDSAmsterdam

UNITED KINGDOMLondon

BAHRAIN* Manama

KUWAIT* Kuwait City

OMAN* Muscat

QATAR*Doha

UNITED ARAB EMIRATES* Abu DhabiDubai