“Third parties are an extension of the engaging organization and, in some cases, perform very critical functions for them. Therefore, it is vital to ensure that third party ecosystems, supply chains and other external partnerships are as resilient as the engaging organization.”
—Business continuity consultant, RSA Archer
After a year like last, no one would question the need for disaster preparedness or for the wisdom of conducting regular and thorough risk assessments of vendor operations. Except when it comes to Tax Services.
Mortgage servicers, as a rule, have redundant providers for most critical services: credit, valuations, telephone, internet and more (in fact, their regulators insist on this.) Yet most servicers still work with a single tax service provider and often don’t require diversification or back-up planning for tax service vendors.
This article will discuss the various risks that this practice can expose servicers and their clients to and drill down into what it takes to implement an effective tax service disaster recovery plan.
Geographic Risk & Redundancy
Let’s start with something that is still fresh in everyone’s mind: The Texas ice storms in 2021. Without warning, almost an entire state lost internet, power and even access to natural gas. Fast moving, often unforeseen events—like the ice storms—underscore the need for operational resiliency and redundancy. For example, what would the impact have been on servicers if the storms had occurred in December at the height of the tax season instead of February?
To prepare for such eventualities, servicers need to conduct due diligence on their tax service providers to determine the resiliency of their operations.
Do they have separate [U.S./domestic?] locations, where all processes can be performed? What about subject matter experts and specialty departments, like reverse mortgage, manufactured housing, commercial or oil and gas? Does this expertise reside in one location? Or is it redundant and easily transferrable?
What about offshore operation centers? On one hand, offshoring can reduce risk, but on the other it can create additional challenges, as we have seen this year with COVID-19 spikes in India and Brazil.
In addition to geographic separation, ideally volume distribution comes into play so there isn’t an over- concentration at any one location. Best practices suggest that no more than 40% of total volume should be handled by any one partner.
How quickly can your tax service vendor switch from facility centric to remote work? Prior to 2020, this would have been a purely hypothetical question. But last year, in a matter of weeks, it became the way the world worked. The good news is now most companies have solutions for this enormous challenge. Hopefully these lessons have been institutionalized. And in the future, employees will have immediate access to the Wi-Fi, computers and applications they need for remote work in a secure, compliant manner—if the need arises again.
Switching Vendors vs. Service in House
Regulators, including the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC) and the Consumer Financial Protection Bureau (CFPB), have made it clear that an institution’s board of directors and senior management are ultimately responsible for managing activities conducted through third-party relationships and identifying and controlling the risks arising from such relationships. The CFPB and OCC consider escrow servicing and payments a critical servicing function that, if disrupted, could negatively impact borrowers. Undoubtably the best way to be truly resilient and cover all risks is to diversify tax service providers.
OCC also states in bulletin 2013-29 they expect “more comprehensive and rigorous oversight and management of third-party relationships that involve critical activities” and critical activities are defined as having significant customer impact (not paying taxes on time) and/or “causes a bank to face significant risk if the third party fails to meet expectations” (tax liens are superior to mortgage liens). Put simply, putting all your eggs in one basket for tax service creates an enormous risk and liability for a financial organization that is not commensurate with the degree of care needed for this critical function.
Obviously, tax service diversification needs to be done proactively, given the time required to implement such a critical vendor. Contract negotiations will vary by client, however, considering certain factors: organizational structure, amount of time it takes to have contracts approved, conducted due diligence, getting vendor management and the risk & compliance sign off. It is also important to remember budgeting in time for technical connectivity to third-party loan servicing systems and developing business rules specific to your servicing needs. Why does this work need to be done upfront? So you can effectively call upon an alternate tax service vendor during an emergency.
The servicer has a legal obligation to continue to provide tax services and pay the taxes during this disruption; there is no grace period for the inconvenient timing of a tax vendor conversion. If there is an interruption, and no tested back-up plan is in place, this means that a servicer may be forced to take tax service in house until they are able to set up the alternate provider.
Is your organization even prepared to do this? Are there established resources? Can your current team handle their existing job functions plus tax? Assessing the capacity and skillset proactively is essential because tax service has thousands of nuances. Attention to detail is key to minimize borrower impact.
What about your infrastructure? For example, does your loan servicing system support tax payment facilitation? What are the accounting functions or policies and procedures that need to be documented for disbursements? Are temps need? Is there a formal training and QA management team established? Will there be liquidity concerns?
Keep in mind: the longer the business interruption, the higher likelihood of some taxes not being paid on time. This will not only create anxiety for borrowers but may well draw the attention of consumer advocacy groups, public media and regulatory agencies such as the CFPB.
Our Recommendation – Diversify Proactively
Long before the next emergency, here are some fool-proof recommendations to take charge and hedge your risk with tax service.
- Create a plan and split the portfolio across the tax vendors and platforms. Different business models have different needs, a split that is 50/50 or 60/40 divided across a balanced mix of states can provide immediate relief and transfer when needed. Consider options for the best approach to splitting tax service. Does it make sense to divide portfolios by state, by clients or by business line? Does the size of the portfolio determine the strategy?
- Complete the vendor management and contracting process with a second tax vendor as soon as possible. This will dramatically reduce the ramp up time during a crisis.
- Work with both vendors to establish SLAs or KPIs that are comparably similar; this way you can measure the performance against each other and have an even comparison. This takes some investment in the beginning, but the rewards will pay dividends. This sparks inherent competition between the two vendors and a byproduct should be better service from both.
- Ensure the portfolio is loaded to the secondary or back-up tax vendor. Just having another contract is of little help if the portfolio still needs to be boarded. This often gets overlooked and the impact is particularly painful for borrowers who are in the middle of a tax cycle when a transition occurs. Having the portfolio pre-loaded with the second tax vendor allows the vendor to include properties in tax bill procurement requests immediately, which can dramatically reduce payment delays.
- Establish financial processes and accounting controls so that if a switch over is needed, tax payments can be funded and disbursed immediately. For example, make sure banking relationships are set up to support the payment process end to end, custodial accounts are established and that check signatures and wire functionalities are set up.
- Test interfaces and loan servicing system connectivity ahead of time. For example, make sure that tax payments flow through the loan servicing system, that open item files are connected and that remote check printing is up and functioning.
Switching tax vendors in the middle of a disruption or bringing servicing in house is unlikely to be smooth or practical for risk management. When given the opportunity, it is best to plan accordingly for the worse-case scenario.