Several recent high-profile, £multi-billion lender collapses have thrown the need for back-up servicing into sharp focus. Investors providing the capital for lenders’ loans need to know that the assets they’re funding are protected, and that a standby servicer is in place to secure the portfolio if anything happens to the lender.
Usually, the standby servicer is appointed as part of the financing structure: it’s a prerequisite for the funding to go through. Almost every non-Residential Mortgage-Backed Securitisation (RMBS) outside of the bank’s own trade will have a standby arrangement.
However, there’s a worrying trend in credit markets of contracts being signed with a Back-Up Servicer Facilitator to protect a portfolio, rather than an actual servicer. Back-Up Servicer Facilitators can be seen in perhaps 90% of RMBS portfolio transactions.
I can see why the idea of a facilitator (essentially a low-cost middleman) might be attractive. Originators may seek to save some costs by appointing a facilitator, while third parties involved in transactions see an opportunity to up-sell, despite them not having the technology, skills, experience or regulatory permissions to service loans themselves should it become necessary.
But in the real world, where standby servicers are increasingly being invoked at short notice to protect securities, the role of the facilitator simply does not work.
One need only look at the wording of the contracts. The facilitator is contractually appointed to “use best efforts” to “identify” a “possible” replacement servicer in the event it should be required, and to “procure” within 30 days. Should an invocation due to fraudulent activities become necessary, this simply isn’t fast enough.
Granted, if there is a significant lead-up time to a transfer of servicing, then I can see the appeal. But in light of recent collapses, we can see that the luxury of time is far from a given.
Even if the facilitator immediately finds a suitable servicer, that servicer would still require further precious days for due diligence and contractual negotiations before invocation. This creates not only an unsustainable time pressure, but a commercial risk: negotiating with a servicer when a crisis is already live and the clock is ticking is hardly a favourable position for a portfolio holder.
Next there is the issue of the cold start. The only way to ensure that back-up servicing provision is ready to go is to have a servicer on a standby contract, where ideally invocation testing – a kind of dress rehearsal for potential scenarios – has also taken place. This ensures the servicer is already familiar with the portfolio, technology platform, risk profile, and no less importantly the regulatory requirements.
The mantra of “too big to fail” has been exposed in recent years, with multiple examples of major lenders collapsing and hitting the headlines around the world. Stenn Technologies left a trade finance book of over $1bn exposed; US auto finance brand Tricolor collapsed suddenly with a book almost as large, while even bigger cases include First Brands with its reported $2.3 to $2.7bn in falsified accounts, and the recent MFS insolvency leaving a portfolio of £1.3bn.
Naturally, this has caused nervousness among investors, who are increasingly looking for greater assurance that their portfolios have robust protection in place. For lenders, therefore, back-up servicing should be viewed as more than a box-ticking exercise or contractual requirement.
Being able to demonstrate that a credible, experienced servicer is already engaged, familiar with the portfolio and has rehearsed the process of taking it on gives investors tangible reassurance that their capital remains protected if circumstances change. In an increasingly risk-conscious lending market, that assurance can be a genuine commercial differentiator – helping lenders build trust and ultimately secure funding.
