Rationale

S&P Global Ratings has affirmed its ABOVE AVERAGE rankings on Pepper (UK) Ltd. as a primary and special servicer of residential mortgages in the U.K. At the same time, we have affirmed our AVERAGE rankings on Pepper (UK) as a primary and special servicer of commercial mortgages in the U.K. We revised to stable from positive the outlook on our ranking as a primary servicer of residential mortgages. The outlook is stable for the other three rankings.

Our rankings reflect:

• The leadership team's broad experience within the servicing sector. The new CEO and COO were appointed through internal promotions in 2018 and 2019, respectively, as a result of intra-group movements. Moreover, the Pepper Group created an overarching European servicing management layer to share knowledge across European jurisdictions and pursue synergies, supporting Pepper (UK);
• Elevated turnover rates across the organization in 2018;
• The high number of induction and ongoing training hours relative to peers;
• The company's frequently updated and effective integrated servicing platform, which supports the servicing of residential and commercial mortgages. Nonetheless, we have observed some peers exploring and deploying wider use of technology innovations such as robotic process automation;
• The residential mortgage portfolio's high single-client concentration of about 70%, despite the servicer experiencing sustained business growth. The residential mortgages portfolio includes less diverse product types, compared to peers, notwithstanding the planned expansion into second-charge mortgages later in 2019;
• Pepper (UK)'s continued adequate servicing activity over a relatively small-scale commercial mortgage portfolio; and
• Well-developed workflows and case management strategies, supporting the management of residential and commercial mortgages.

Since our previous review, (see "Servicer Evaluation: Pepper (UK) Ltd.," published on Oct. 5, 2017), Pepper (UK) reported the following key changes:

• Pepper (UK)'s residential mortgages portfolio increased to £13.268 billion at year-end 2018, of which 94% is performing, from £10.265 billion at year-end 2017.
• While the lending business is now a separate group entity, Pepper Money Ltd., Pepper (UK) continues servicing its portfolios.
• Several executive moves, including the CEO, COO, and chief information officer (CIO), took place following the separation of the lending business and the creation of the Group's pan-European servicing business line.
• The company enhanced its second line of defense following the implementation of a new risk appetite framework and cross-functional risk champions program.
• The servicer has invested in IT security in line with market trends, including increased system and server monitoring, and business continuity.
• Similar to peers, Pepper (UK) launched a customer portal in 2019 for its non-white-label customers, including functionality to make payments and upload documents, and introduced other servicing enhancements such as letter reviews.

We have revised our outlook to stable from positive on our ranking on Pepper (UK) as a primary servicer of residential mortgages. While the residential primary servicing portfolio has increased and there is a busy pipeline, the company promoted the former head of residential primary servicing to COO, who oversees the residential primary servicing function ad interim. Additionally, the function's turnover rate increased. Finally, the servicer maintains high single-client concentration compared to peers.

The outlook is stable as a special servicer of residential mortgages in the U.K. The servicer has well-structured servicing operations, working on a decreasing special servicing portfolio.

The outlook is stable as primary and special servicer of commercial mortgages in the U.K. The commercial mortgage servicing operations are supported by adequate policies and procedures for the size of the portfolio under management and the same servicing platform as residential mortgages. We will continue monitoring the servicer's ability to manage an expanded primary servicing portfolio, comprising additional product types such as bridge and development loans.

In addition to conducting an on-site meeting with servicing management, our review includes current and historical servicer evaluation analytical methodology data through Dec. 31, 2018, unless otherwise noted, as well as other supporting documentation provided by the company.

Profile

Originally established in 2003 as Oakwood Global Finance LLP, Pepper (UK) has been a subsidiary of Pepper Group (Group) since 2013. The Group provides lending, advisory, loan servicing, and asset management services. The Group operates in several jurisdictions including the U.K., Ireland, Spain, Portugal, South Korea, China, Australia, New Zealand, Cyprus, and Greece, and has a total servicing portfolio of over $48 billion. In December 2017, KKR Credit Advisors (US) LLC (KKR) acquired Pepper Group and delisted it from the Australian stock exchange. The change in company ownership has not resulted in major changes in the servicing operations, as KKR provides strategic development guidance to the Group.

In 2018, Pepper Group established an overarching pan-European servicing business line that aims to align practices across the regional servicing branches and leverage synergies.

Pepper (UK) is an asset management company in the U.K. and shares several synergies with the Group. Pepper (UK) manages performing and nonperforming loans on behalf of investors and lenders. The company services a range of assets, including residential home loans through the Engage Credit trading name, commercial loans through the Engage Commercial trading name, and consumer finance. Pepper (UK) receives support from its parent company but retains some independence regarding its business strategy and operational management.

At the end of 2018, Pepper (UK) separated its lending division, now called Pepper Money Ltd. (Pepper Money). Pepper Money is a standalone business, originating residential and buy-to-let mortgages, that Pepper (UK) services. In 2018, Pepper Money acquired a U.K. second-charge mortgages lender, Optimum Credit. As a result, Pepper (UK) will begin to service the associated new originations flow and a back-book of about £550 million later in 2019.

Table 1

Our rankings are limited to Pepper (UK)'s activity as a primary and special servicer of residential and commercial mortgages in the U.K.

Pepper (UK)'s overall portfolio under assessment has been growing continuously over the last four years, primarily driven by the expansion of the residential primary servicing portfolio. In 2018, performing loans represented 94% and 70% of the residential and commercial servicing activity, respectively. The residential and commercial mortgage special servicing portfolios have decreased over the last two years.

Table 2

Over 2017 and 2018, Pepper (UK) achieved servicing revenue broadly in line with its targets. In 2018, Pepper (UK) set up a servicing-specific marketing team, focusing on clients who actively originate mortgages in the U.K., which it expects to bring along further business opportunities. The servicer reported a busy pipeline, especially in relation to residential mortgages.

Pepper (UK) has a clear business plan drafting and approval process in place. The department heads draft financial forecast targets annually that project over the following five years, while the executive team reviews the business plan prior to sending it to the Group in Australia.

Management And Organization

The management and organization subrankings are ABOVE AVERAGE for primary and special servicing of residential and commercial mortgages.

Organizational structure, staff, and turnover

Pepper (UK) has a well-designed organization and corporate governance model supported by an experienced management team, in our view.

As of December 2018, Pepper (UK) employed 362 staff based in London--where the head office is--as well as Skipton. Over the same period, almost 50% of these employees worked in residential and commercial mortgage servicing (115 and 32, respectively), and the remainder comprised internal controls, support functions, and the lending business line. Eighty-two employees, part of the lending business division, Pepper Money, were transferred to a new entity under a transfer of undertakings in early 2019 as a result of the separation of the lending business. After the transfer of the Pepper Money employees, Pepper (UK)'s staff count was 278 as of March 2019.

Several Pepper (UK) executives took over new responsibilities following the creation of the European leadership team as well as the separation of the lending business. Most of the executives were replaced through internal promotions. This demonstrates the company's ability to foster leadership and retain talent. Key changes include:

• In early 2018, the CEO undertook a CEO/chairman pan-European role, coordinating the servicing businesses across Europe, while the previous head of residential servicing became Pepper (UK)'s CEO.
• Pepper (UK) appointed a new CFO and CIO in March and April 2018, respectively, as the previous ones moved to the lending business.
• In March 2019, the previous Pepper (UK) COO also undertook a pan-European role leading the project management office, which reviews potential synergies and efficiencies across servicing operations. Consequently, the previous head of residential primary servicing became Pepper (UK)'s COO, while still overseeing the residential primary servicing area in the interim.
• The previous head of commercial loan servicing was assigned to set up and lead the Cyprus business, and a member of the commercial mortgage servicing team was promoted as team head.

The servicer applies a functional structure, and all lines of business report to the company CEO.

The company has a robust governance model that includes several governance and operational committees. This allows for a sufficient level of control and an independent internal control system.

Pepper (UK) registered an increase in the overall company turnover rate at 37% in 2018 from 28% in 2017. This can be partially explained by the fact that 14 contractors were hired in 2018 to support the separation of the servicing and lending businesses. Moreover, several members of the new lending executive team were originally hired as contractors within Pepper (UK) and consequently transferred to Pepper Money. The company does not perceive the increased turnover rate as an issue and is confident with the stability of its leadership team. Nevertheless, the residential mortgages primary servicing team turnover rate accounted for 30%, and the commercial mortgages special servicing turnover rate accounted for 39% in 2018. We believe this is on the high end compared to peers' turnover rates.

Table 3

Pepper (UK) reported higher staff experience rates relative to peers'. The residential mortgages middle management's average experience decreased in 2018 due to several staff promotions. Moreover, the commercial mortgages senior management experience rate fell due to a change in the senior management team. Pepper (UK)'s senior and middle management tenure rates are lower than peers, in line with the increased turnover rate.

Table 4

Training

A team of 11 full-time equivalent employees make up Pepper (UK)'s HR department. While Pepper (UK) does not have an intranet to streamline people management, like other companies of similar size, the company has an appropriate HR function that manages recruitment, induction, ongoing training, communication, and staff appraisals. Highlights and controls of the training process include:

• All new starters are subject to a comprehensive induction program, which includes a mix of classes and on-the-job activities. The HR team, supported by quality assurance and compliance, regularly reviews and monitors the program.
• The servicer has developed and expanded the breadth of its nine-month apprentice induction program, as Pepper (UK) continues to bring in junior talent.
• The HR function, together with senior management, prepares an annual training plan. Pepper (UK) offers continuous annual training in three main areas: regulatory training, core skills (defined by each role's required skills), and general further development. The company supports professional qualifications such as master degrees and other specialized accreditations.
• Following the latest annual internal employee survey results, Pepper (UK) has introduced the "Unicorn" program, which comprises one-day training with an external advisor, focusing on staff morale and personal contribution.
• In 2018, the servicer launched the Pepper success learning management system to complement the existing training offering supporting ongoing self-development.
• In line with the market's focus on cybersecurity, Pepper (UK) introduced Wombat, an online platform that provides cybersecurity training.
• The company also has a succession plan in place and conducts a periodic review of its staff to identify talent gaps and outstanding talent and to support their development.

Table 5

Pepper (UK) applies a well-documented appraisal system that tracks progress against objectives, development actions, and training requirements, which are measured monthly by specific quality assurance (QA) and productivity metrics.

In addition, the servicer holds regular town halls and other employee events such as lunch with the CEO, and delivers regular newsletter updates in order to keep employees informed.

Pepper (UK) has a robust HR function. We will continue monitoring its ability to nurture staff retention.

Systems and technology

There are 26 employees in the Pepper (UK) IT department split across the following teams: infrastructure and IT support, testing and development, and reporting. Since our previous review, the servicer brought together the technical and project delivery teams within the change management department, which now has 16 employees.

While IT infrastructure remains separate for each of the Group's subsidiaries, there is a global IT governance committee chaired by the Group's CIO to share best practices.

The servicer has a reliable and well-tested IT platform that has a comprehensive embedded workflow. Three interconnected applications (communications between applications occur every 15 minutes) make up the Pepper (UK) servicing platform:

• Phoebus is its loan management system, which other servicers and lenders in the U.K. use. It is primarily an account ledger that contains customer data and supports single-case management. It is used for all payments to the Bankers' Automated Clearing Services interface. A plug-in to Phoebus is used to automatically calculate interest and installments.
• Proflow is the workflow management system, built in-house, that allocates work across the business and interacts with Phoebus. The tool shows users the tasks under their responsibility and indicates daily priorities. Users can drill down to a single task. The system flags actions close to service-level agreement (SLA) targets in yellow and any items past target in red.
• CaseMan is the proprietary customer relationship management system that primarily supports the call center agents and offers a greater overview of a single case, supporting arrears management. Clients can access a limited amount of read-only information through a lighter version of CaseMan.

Similar to peers, the servicer does not have a power dialer as it does not deem that the type of assets and services it provides justify it. Pepper (UK) applies interactive voice response (IVR) technology to allow a debtor to pay automatically over the phone and which redirects inbound calls. If the debtor needs to talk to an agent, calls are automatically recorded via OAK and saved to CaseMan. The servicer uses a real-time contact center management system, allowing managers to coach and manage agents.

Each system has a specific database that feeds into and interacts with a unique data warehouse (DWH). The DWH is also updated with external data sources and is used to produce key performance indicators (KPIs), reports, and other data mining information.

Pepper (UK) has continued investing in its IT security and resiliency, including increased system and server monitoring, compliant card payment functionality, and the deployment of automatic failovers within their telephony system. Additional 2019 IT initiatives include the introduction of a web chat functionality and further Power BI business intelligence dashboards.

Disaster recovery/business continuity

A third-party provider, Daisy, provides Pepper (UK) with business continuity (BC) and disaster recovery (DR) sites. Since our previous review, the servicer made a considerable investment to upgrade all elements of its BC management framework.

The primary DR site is in Wapping, 33 miles away from the company's main offices, and has 100 seats available. The company also has access to other Daisy sites across the U.K. and can request that Daisy provide replicated servers on-site, in case they do not want to vacate their offices. In addition, about 80 employee can work from home.

The servicer last updated its BC and DR plans in June 2018, which is when the latest DR test took place. It took four hours to switch over to the recovery site, and the test did not result in any major findings.

Cybersecurity

In our view, the company has appropriate cybersecurity controls, such as:

• The servicer now performs a monthly external penetration test, when at the time of our previous review it did so annually, demonstrating its focus on cybersecurity. The company appointed an external consultant to perform an audit of its information security.
• Pepper (UK) performs phishing campaigns every two months, complemented by cybersecurity training for staff. In addition, the servicer uses software that screens for phishing emails and spam.

Internal controls

In our view, Pepper (UK) has an appropriate internal controls system, incorporating three lines of defense controls, in line with peers. There is a sound governance structure in place, and the internal controls functions report to the company's board and senior management.

Policies and procedures

The directors of each department, as risk and control owners, are responsible for policies and procedures definition and application. This is the first line of defense. Pepper (UK) reviews policies annually, and the policy committee approves any new or updated policies. The servicer reviews and updates procedures periodically, as needed, in line with business needs.

Compliance and quality control

The risk and compliance function is the second line of defense. Highlights and controls of the compliance process include:

• The compliance team of five works closely with risk and internal audit and uses a risk-based approach to draft the annual compliance monitoring program, that includes monthly monitoring and ad hoc reviews.
• The compliance team is in charge of monitoring for financial crime activities including screening and suspicious activity report processing.
• Similar to peers, Pepper (UK) implemented the General Data Protection Regulation (GDPR) controls since our previous review and appointed Grant Thornton to validate the process.

The three QA team members report directly into the head of operational services to ensure independence from the servicing operations. Highlights and controls of the process include:

• Servicing managers perform three monthly call monitoring observations per agent on average, following a specific procedure that aims to raise the case managers' awareness of the customer's experience. The second line of defense QA team oversees the call monitoring process.
• If a customer experiences a detrimental event, the QA team investigates the root cause and the appropriate solution.
• The second line of defense QA team also performs monthly "end-to-end" reviews covering both residential and commercial servicing, for instance, focusing on all aspects of case management from the start of the latest arrears cycle until the present day. In our view, this adds an additional layer of assurance for borrower communication.
• QA reviews focus on adherence to internal documented processes and procedures, complementing the compliance monitoring activity.
• The QA team reports its findings to senior management within the monthly compliance monitoring report. We reviewed a sample of a 2018 quarterly QA report, which reported several findings that management follows through to completion. Staff receive feedback in the monthly one-to-one sessions or during the annual appraisal meeting.

Risk management

Three staff members comprise the risk management function. Pepper (UK) has reviewed and enhanced its risk management approach since our previous review, including an updated risk appetite framework and cross-functional risk champions program.

The servicer prepares an annual plan and implements a "top-down" and "bottom-up" approach to risk management in order to provide clarity on material risks affecting the company strategy and risk appetite. There are several board level committees that govern risk management such as conduct risk, executive, overall risk management, and audit.

The risk function maintains independent oversight and challenges risks and respective controls within the business units. The risk function nominates risk owners, currently 14, among operations managers and monitors their activity within a risk register. In turn, risk owners can appoint risk champions within their teams. Risk champions meet regularly with staff to discuss issues/risks and provide feedback to the risk owner.

Finally, each employee needs to log issues in the incident register. Each log appears immediately on the risk function's task list so they can analyze causes and supervise any required remedy actions.

Internal and external audits

Internal audit, composed of two team members, is the third line of defense. The team recently introduced a co-source arrangement with PricewaterhouseCoopers, whereby it undertakes specialist internal audit reviews, as and when required.

The internal audit team reports to the board via the audit committee. Internal audit drafts the annual audit plan using a risk-based approach, which the audit committee subsequently approves.

In 2018, Pepper (UK) completed 19 audit reviews, resulting in 66 total company audit findings, eight of which related to residential servicing and 26 related to commercial servicing. The company raised 17 overall high risk findings, one of which remains open. At the end of 2018, Pepper (UK) reported seven audit actions that were raised in 2017 and still remain open, and one audit action raised in 2016 also remains open.

The servicer performs periodic follow-ups on the reviews with control owners and tracks open audit findings in an internal audit database. We will continue monitoring the timeliness of the audit findings resolution.

Complaint management

A team of six employees, which reports to the director of operational services, looks after complaints. As of year-end 2018, the servicer reported 2,085 complaints related to residential mortgages and 70 complaints related to commercial mortgages. Depending on the contractual agreement, Pepper (UK) provides clients with monthly complaints reports.

Vendor management

Pepper (UK) performs robust vendor network monitoring. Highlights and controls of the process include:

• The company works with selected panels of third-party providers including two field agent companies, two asset managers, and six law firms. The servicer manages repossessed assets in conjunction with external insolvency professionals.
• Senior managers appoint third-party providers, subject to specific SLAs.
• Pepper (UK)'s relationship managers undertake semiannual reviews of all solicitors' performance via conference calls during which SLA issues are discussed. In addition, the company conducts annual on-site visits of solicitors, complemented by monthly reporting activity.
• The property services team monitors the performance of asset managers via monthly reports on marketing activity and sales, quarterly reviews, and annual audit.
• Case managers instruct third-party providers on cases they transfer to them through email sent via CaseMan for full audit trails. Nevertheless, external providers do not have access to the servicing system, and case managers have to duly record incoming communication from vendors.
• Each service provider has to accept the case transferred to them within a specific amount of time.
• The case manager is notified via email to download the message, which also automatically links it to the relevant account. If an employee does not download the data, an automatic reminder is sent.

Insurance and legal proceedings

Pepper (UK) has represented that its directors and officers as well as its errors and omissions insurance coverage is in line with the requirements of its portfolio size. In August 2019, the management reported there were no material servicing-related pending litigation items.

Loan Administration

The loan administration subrankings are ABOVE AVERAGE as primary and special servicer of residential mortgages and AVERAGE as primary and special servicer of commercial mortgages.

Chart 1

Chart 2

New loan set-up

Since our previous review, Pepper (UK) exclusively boarded newly originated loans with no new closed portfolios. In 2018, the servicer boarded 15,280 residential mortgages accounting for almost £4.33 billion and 1,166 commercial mortgages accounting for £0.540 billion. The servicer also secured three new originating clients over the same period.

A team of eight manages the boarding process. Pepper (UK) involves the primary and special servicing team to board larger closed portfolios during the bidding phase to support due diligence. After the engagement, Pepper appoints a project manager to lead the project team, which includes representatives from each area such as legal, compliance, finance, and servicing, and including subject matter experts from the business units depending on the stage of the loans. The servicer defines the timeline of the migration plan, typically around 90 days, and required actions on a case-by-case basis described in each SLA.

The company has a robust boarding process that has been widely tested on newly originated loans since our previous review. Highlights and controls of the process include:

• The completion portal undertakes automated data validation checks of the incoming flows.
• Originators send files via the application programming interface every night or via file upload. An IT member uploads them to the system to ensure automated data checks are properly followed.
• For new clients, Pepper (UK) runs parallel manual checks on the data until it is comfortable with the quality of the automation.
• During boarding, the company maps the client's data, loan documents, and customer communication. The mapping also foresees integrity checks and extensive analysis of all available data, including reconciliation testing, review of loans' terms and conditions, segmentation, and technical readiness.
• As part of the operational readiness, Pepper (UK) also checks details on specialist segments such as complaints and vulnerable customers who are in arrears.

Pepper (UK) sends out welcome letters typically within three days after boarding. Similarly, subject matter experts and IT ensure that the reminders on CaseMan have been properly set up.

In most cases, the servicer receives documents from lenders or servicers working with the same archive provider, Iron Mountain, which serves most of the mortgage market. Consequently, documentation transfers are usually simple as they do not require physical transfer of the original documents. IT checks a sample of document images for completion to identify information gaps. The post room team scans inbound paper documents, which are indexed manually and uploaded to Proflow.

Payment processing

In our view, Pepper (UK) has a sound process in place to allow for timely reconciliation of balances and detailed reviews of any exceptions. Highlights and controls of the process include:

• There is a clear separation of duties and appropriate controls regarding the movement of funds and the production of reports. A dual sign-off procedure is in place to approve outbound cash, finance reports, invoices, and direct debits.
• A team of 15 takes care of payment processing for residential and commercial mortgages and performs bank account management, direct debit collection, bank reconciliation, supplier payments, and cash reporting.
• Pepper (UK) processes over 90,000 payments monthly. All payments take place electronically. The servicer accepts debit card payments over IVR as well as card payments over the phone.
• The servicer uses Proflow to prioritize its activities and a proprietary system (BRT) to reconcile cash transactions associated to bank entries with mortgage account entries daily. BRT does the bulk of this reconciliation automatically, and it is reviewed by the cash management specialists.
• The cash management specialists classify any unreconciled entries at the end of each day and include them in daily reporting. Proflow keeps track of any outstanding items.
• Over 99% of the cases are accurately posted and nearly all suspense items are reconciled in less than two days on average. The servicer performs finance QA checks, such as a monthly suspense items review.
• Pepper (UK) reviews any exception that falls beyond an SLA on a monthly basis and traces the roots of any issue as well as checks accuracy of postings.
• The loan management system automatically generates daily direct debit files. Pepper (UK) sends text messages to borrowers whose direct debit has failed.
• Finance set up direct debits associated with repayment plans.

Client management and investor reporting

Pepper (UK)'s CEO leads the business development activity while the servicing teams manage the relationship with existing clients. Typically, there is a monthly client meeting with operations staff and a quarterly senior-level meeting.

Each servicing agreement defines the reporting requirements. Four staff members currently work on residential and commercial mortgage reporting. The servicer extracts loan information from the DWH daily and stores it in a portal where clients can access and download it. Pepper (UK) also produces monthly servicing reporting packs, within five to 10 working days from month end.

The IT team leverages the DWH to produce reports available on internal repositories for authorized members. Pepper (UK) uses Power BI for internal reporting. We have observed other servicers making greater use of business intelligence tools for client reporting. Nevertheless, the company reported that its clients prefer more traditional report formats such as Excel files sent via secure file transfer protocol and receipt of raw data.

Primary servicing (residential mortgages)

As of March 2019, the residential mortgages primary servicing team was split in the following teams:

• Five client specific operations teams providing white-label services;
• Two teams managing Pepper Money portfolios;
• A development team; and
• One reporting specialist.

The servicer has a business improvement team that sits within the project management office, focused on driving continuous servicing improvement. Pepper (UK) was able to reduce the team size to 40 as of March 2019 from 56 as of year-end 2018 despite portfolio growth due to system enhancements, and other operational efficiencies. For example, in 2018, the servicer finalized a project that streamlined borrower letter templates embedded in the system. The company also completed various portfolio-specific improvements such as introducing paperless direct debits, allowing time efficiencies. Similarly, the servicer introduced a customer portal for non-white-label clients in 2019 that includes functionality to make debit card payments, upload documents, and complete income and expenditure forms. This has reduced inbound borrower calls.

The servicer applies a portfolio and case ownership model, whereby each of the portfolios under management are managed by dedicated teams. Each client-specific team typically has five to 10 crossed-trained specialists including the team leader. Pepper (UK) applies a proactive daily resource management planning strategy. The team leaders oversee the task queues in Proflow to ensure timely completion and share the daily plan with the team.

There is no dedicated team for inbound calls since there are not many in relation to the portfolio's size, so each specialist takes calls. If the specialists are not on a call, they are processing tasks reported in Proflow following their manager's instruction for prioritizing. Specialists can open CaseMan automatically from Proflow.

The primary servicing staff work on Phoebus, CaseMan, and Proflow in their daily work. The systems support a variety of functions, including interest calculations, general ledger functions, and other loan administration tasks.

The specialist can retrieve all relevant data including documentation and track service-level commitments on each case from CaseMan. Every time a case manager needs the support of another team, he or she creates an activity within CaseMan that appears in the receiver's Proflow to-do list. In addition, Proflow facilitates the following activities:

• It is linked to a short text message service, allowing it to send reminders to clients on specific days before payments are due.
• Proflow scans information on inbound emails through automatic identification of account numbers in the body or subject line.
• Proflow tracks SLA compliance in real time while the company's DWH generates internal and client SLA reports. Pepper (UK) reported being in line with its SLAs in 2018.
• Every morning, each staff member can access a summary of their individual KPIs as well as team KPIs to foster greater transparency.

Pepper (UK) has a proactive customer contact program to make frequent contact with borrowers who have interest-only mortgages or mortgages that may have a balance at term. There are also impairment indicators such as returned direct debits and bankruptcy orders, which generate case-specific reminders to case managers, even if the account is up to date. Case managers will then review each specific case.

In our view, Pepper (UK) has an efficient servicing model to manage an increasing portfolio of performing residential mortgages and an extensive workflow embedded in the system that supports the case managers' activity. Nevertheless, the largest single client represents about 70% of its primary servicing portfolio by gross book value, which is higher than that of peers. We will continue monitoring the servicer's single client concentration to determine how it could affect overall operations.

Special servicing (residential mortgages)

Table 6

The residential mortgages special servicing team comprises 53 staff members as of March 2019, split in the following teams:

• Five arrears and litigation teams, that case manage accounts from one month in arrears up until repossession, applying the same workflow;
• A litigation management team, managing more complex cases as well as the relationship with external solicitors and field agents;
• An arrears administration team dealing with administrative tasks; and
• A property services team that handles the sale of repossessed residential and commercial properties.

Pepper (UK) applies a well-established end-to-end workflow, but allows for deviation if more bespoke workout strategies such as loan modifications and assisted sales could result in a higher return. The case manager can decide between options using relevant information and a comparison of each collection strategy through the system. Pepper (UK) has created a robust process and controls that facilitate decision making. The special servicing staff uses Phoebus tools to apply generic and targeted collections strategies. The workflow system has permission-based access to ensure appropriate separation controls are in place between different clients' portfolios and the teams managing them.

Upon boarding a nonperforming loan portfolio, the special servicing team analyzes the portfolio composition and proposes a strategy to the client, which the team then delivers. The current progress is reviewed in client governance meetings, where the strategy can be amended. The special servicing teams work on regulated and unregulated loans in different jurisdictions (England, Wales, Scotland, and Northern Ireland).

Pepper (UK) applies a strategy for arrears: as soon as a payment arrangement is missed it sends it back to the arrears queue and calls or sends an automatically generated letter to the customer. The servicer regularly assesses borrowers' ability to pay through the completion of an income and expenditure assessment.

Pepper (UK) makes the first phone contact attempt one day following a missed payment. In 2018, the servicer registered a 3.76% abandonment rate for inbound calls related to accounts in arrears.

Pepper (UK) has a monthly loan management committee (LMC) to review loan performance. A portfolio review committee, an LMC sub-committee, takes place monthly to review and apply different strategies on the individual loan cases.

Over 2017 and 2018, Pepper (UK) sold 351 and 295 repossessed residential real estate assets, respectively. The servicer achieved 98% of average marketing price for repossessed properties in 2018. It took 112 days on average to complete asset sales in 2018, which is better than peers, compared to 109 days in 2017.

The servicer reported that it measures the success of the special servicing business, tracking gross book value and number of loans by months in arrears. Pepper (UK) demonstrated the evolution of arrears on a sample of seven client portfolios that contain 87% of all loans in arrears under management. On average, the gross book value and number of loans in arrears have decreased over the last three years.

Commercial mortgage servicing operations

Pepper (UK)'s commercial servicing activity comprises portfolios managed on behalf of five clients. In late 2017, the servicer boarded a new originating client in the bridge and development loans, and buy-to-let space. Pepper (UK) expects 31% (predominantly comprising bridge and development loans) of the current portfolio to mature in 2019 and 5% in 2020. A small portion of these loans typically transition onto a buy-to-let product offered by the same client and Pepper (UK) retains the servicing.

In line with the residential mortgages operating model, Pepper (UK) applies a case-ownership model across the primary and special servicing teams, supported by the same suite of technology tools--Phoebus, Proflow, and CaseMan. As of March 2019, 19 staff composed the commercial servicing department, which has the following structure:

• Four commercial primary servicing employees;
• 14 commercial special servicing specialists; and
• One senior reporting analyst.

Commercial mortgage servicing specialists are experienced in dealing with facility documentation and credit procedures and the majority have an origination and/or recoveries background.

Primary servicing (commercial mortgages)

Pepper (UK) offers a white-label service so borrowers are typically contacted in the lender's name. They collect and allocate all payments (usually via direct debit) and become the first point of contact for every borrower. They undertake all day-to-day loan administration including building insurance, know-your-customer (KYC), and covenant management.

The reduction of the commercial primary servicing team to four as of March 2019 from seven in 2018 and 36 in 2016 is due to changes in the portfolio composition, which since December 2017 includes a portion of bridge and development loans that largely require no payment processing on accounts with direct debit or include retained/rolled interest. Pepper (UK) also achieved some procedural efficiencies such as completion of the KYC project.

Highlights and controls of the process include:

• In 2018, Pepper (UK) performed around 1,000 property inspections on performing and nonperforming loans, with the support of third-party asset managers and advisors.
• The servicer reviews every new tenant lease with client approval or via power of attorney, and it takes five days on average to approve new leases.
• Pepper (UK) obtains and reviews borrowers' financial statements in line with facility documentation and covenants. The servicer tracks financial statements collection via an automated module of CaseMan that creates Proflow reminders. The system also monitors loan expiries, triggering appropriate alerts.
• Clients typically have block insurance policies, and Pepper (UK) requests copies of insurance schedules for all performing loans. The servicing system monitors renewal dates for each property.
• Pepper (UK) performs automated covenant monitoring, accompanied by certain manual checks.
• The servicer resolves borrower requests within 48 hours while more complex ones may take up to five days.

Special servicing (commercial mortgages)

The team reviews loan documentation and proposes strategic solutions at the facility, asset, and portfolio levels. The commercial special servicing team increased in 2017 due to the boarding of a complex nonperforming loan portfolio in the prior year. It has decreased since our previous review in line with the reduction in the nonperforming portfolio. The servicer has not replenished its special servicing portfolio as a result of the current economic conditions. Highlights and controls of the process include:

• The commercial primary servicing team provides daily updates for the loans they believe may require special servicing in the near future. If a loan is transferred to special servicing, the primary servicing team remains in charge of some tasks such as payments, borrower financial statements, and complaints.
• The special servicing team reviews borrower proposals and performs borrower analysis. Similarly, it undertakes valuation and property analysis.
• Where appropriate, they segment the portfolio to ensure a consistent approach and to maximize returns for each cluster.
• The special servicing manager meets with borrowers and undertakes site visits to ensure the best resolution for the lender.
• The team produces a detailed credit recommendation in the form of a resolution strategy to assist the decision-making process. Once approved at an internal committee, the strategy is forwarded to the client for their approval.
• The resolution strategy may take various forms depending on factors such as cash flows and liquidity, and borrowers' willingness to cooperate.
• Pepper (UK) maintains relationships with market-leading professionals at real estate, legal, and advisory firms, (including insolvency practitioners) across the U.K. in order to leverage their knowledge and expertise. Decisions on property sales and sale prices are retained in-house.

The special servicing team works closely with the internal real estate team to assess the best solution to maximize the underlying security's value. Highlights of the process include:

• Over 2017 and 2018, Pepper (UK) performed 1,664 and 648 commercial real estate sales, respectively. The higher number of sold real estate assets in 2017 was primarily due to improving market conditions and the shift from hold to sale strategies.
• In 2018, assets were sold within 128 days on the market.
• Pepper (UK) achieved 89% of marketing price in 2018 due to bulk sales of blocks of flats, resulting in a price discount.

The servicer reported increasing collections as a percentage of assets under management over the last two years.

Financial Position

The financial position is SUFFICIENT.

Related Research

• Pepper (UK) Rankings Affirmed As A Primary And Special Servicer Of Residential And Commercial Mortgages In The U.K., July 31, 2019
• Select Servicer List, June 25, 2019
• EMEA Servicer Evaluation Industry Report 2018, Jan. 30, 2019
• Analytical Approach: Global Servicer Evaluations Rankings, Jan. 7, 2019
• Servicer Evaluation: Pepper (UK) Ltd., Oct. 5, 2017