Outsourcing: A Prescription for Continuity and Risk Management in Mortgage Banking
The economic justification for outsourcing in mortgage originations is generally thought of in terms of the historic cyclicality of the underlying mortgage business. The source of this historical variation in mortgage originations emanates from the seasonality in the home purchase market and interest rate moves in the refinancing market. But the business has experienced radical changes in the last decade and the historic behavior of the market has been overwhelmed by periods of paucity and demand from the financial crisis and the responses to it. As we absorb ongoing industry changes such as HARP 2.0, and its impending demise, to the risks inherent in pending qualified residential mortgage (QRM) rules, the horizon is full of unforeseeable shocks in mortgage origination demand. With these changes in the market have come new demands on market participants. Economic and policy shocks have brought the role of outsourcing to a new and distinct level.
An ongoing outsourcing partnership can help a company with regulatory surveillance and risk management, as well as strategic business initiatives. These capabilities provide companies with the flexibility to manage the changes that are inevitable in the mortgage industry.
Outsourcing evolves to an innovative business tool
Over the years, outsourcing of business segments such as human resources, accounting and information technology has made significant inroads with U.S. corporations because it can help reduce costs and improve profitability. As of December 2011, the top 200 global outsourcing companies employed four million people and a fully one-third of their employees are located in the United States.1
Today, outsourcing is considered a standard business model as well as a nuanced business tool that can be used in new ways. The expansion of different sourcing arrangements is a growing trend made possible by advances in technology, especially from cloud computing and socio-economic pressures. For example, domestic outsourcing is gaining momentum. As a result, outsourcing companies may have U.S. as well as overseas operation centers. In some cases, U.S. federal and state governments are encouraging the development of domestic centers in economically depressed areas. This gives governments a regional economic boost. Outsource providers are creating new jobs that leverage work-from-home concepts, expanding the scope of local labor markets.
Collaboration and innovation is also contributing to new outsourcing solutions. One result is the bundling of multiple business processes being outsourced to one supplier. At the same time, many companies are limiting their number of service providers and setting up “champion-challenger” roles between their suppliers. For example, multiple large mortgage lenders outsource a portion of their loan fulfillment functions including processing, conventional underwriting, closing, and pre-funding audit to one or a few outsourcing companies. The service providers often compete against each other for the “champion” position. With competition, the lender enjoys quick turn-times and high quality from the processes being performed.
Hybrid delivery models offer choice
HfS Research and PwC recently conducted a survey on the “Future of Global Business Services.” The purpose of their survey was to learn how organizations maximize their outsourcing strategies. In the financial services industry HfS and PwC found that approximately 75 percent of respondents use a hybrid or shared services delivery framework.2 In the mortgage industry, the typical shared service model is one where the mortgage lender staffs their mortgage operations such as underwriting, processing and closing at a base production level and then outsources functions above the base level.
A fee-for-service pricing model is often ideal because it transforms fixed costs to variable costs. Mortgage lenders can maximize their flexibility and respond to the cyclical changes in required capacity and it does not demand that organizations add to their permanent human or physical capital.
Providing customers with choices of where the services are to be performed can impact the success of the project. Outsource services may be conducted exclusively in the U.S., or entirely from operations centers outside of the U.S., or a combination of both. Regardless of which delivery model is deployed, the key is transparency for the mortgage lender. In a successful outsourcing partnership, the supplier must be in sync with their clients’ culture and maintain outsource solutions, including delivery models that embrace their clients’ business strategies and corporate philosophy.
Outsourcing changes with industry and regulatory transformation
The high rate of unemployment and the need to create jobs is on the minds of most Americans today. Mortgage company owners and shareholders are no different, but face profitability constraints. To help improve profitability, successful mortgage lenders are increasingly outsourcing a wider range of functions that they used to do in-house, freeing up their employees to focus on existing customers and developing new business.
In addition to profitability, the transformation of the industry and the fallout from the financial crisis are a focus of senior managers. Change is an opportunity as well as a risk. Regulatory reforms are shifting the structure of the industry. For example, the new Basel III requirements are causing some banks to downsize their mortgage business, which includes eliminating some of their production channels. At the same time, non-banks are growing and actively acquiring servicing rights and expanding their production channels. This industry flux brings human resources challenges which can be addressed with flexible outsourcing solutions.
And they will be needed as new regulations come into play. Will a third version of the Home Affordable Refinance Program (HARP) pass the Senate and House of Representatives? What additional monetary policy changes will the Federal Reserve make to try and spur economic growth? Will there be changes to the tax code that makes homeownership less favorable? How will policy makers address the future of the secondary mortgage market after Fannie Mae and Freddie Mac? Will the powers of the Consumer Financial Protection Bureau (CFPB) be diminished over time? These are all important questions that we don’t have answers for at this time. Perhaps after the upcoming presidential election there will be a better sense of direction, but one thing is guaranteed—the rate of change is accelerating.
What we do know is the mortgage market has been jolted by past legislative shocks. The Dodd-Frank Act in 2010 gave birth to the CFPB. The CFPB is well on its way in developing, implementing and enforcing new consumer protection regulations. Qualified residential mortgage (QRM) requirements, national servicing standards, integrated mortgage disclosures, mortgage originator standards and loan officer (LO) compensation are just a few that will profoundly impact the industry. Organizations most likely to succeed in this environment must be flexible, nimble and prepared to effectively address market dynamics.
As mortgage industry executives grapple with the impact of many policy issues, they must set a course for their companies with business objectives that successfully manage change and ensure regulatory compliance. Some specialized outsourcing providers are proficient at collaborating with their clients to plan, develop and implement solutions that accelerate the adoption of new or revised business processes as well as comply with regulatory and investor changes. A successful outsourcing partnership will ensure loan quality and mitigate compliance risk while increasing productivity and customer satisfaction.
Outsourcing and the future of mortgage banking
Mortgage companies today want more than just cost reductions from their outsourcing partnerships. Increasing risk management, scalability and flexibility are also essential to outsourcing partnerships. This demands that mortgage lenders and their service providers meet adequate performance management and governance standards. Their regulators will require this.
The CFPB expects mortgage lenders to have adequate service provider oversight to protect consumers. The CFPB requires institutions to conduct due diligence to verify their providers understand and are capable of complying with federal consumer financial law. Due diligence includes reviewing providers’ policies, procedures, internal controls and training materials. Statements of work must provide clear expectations regarding compliance, as well as enforcement consequences for non-compliance. In addition mortgage bankers must have an effective governance program that monitors performance and takes prompt and decisive action when performance expectations are not met.3
The environment today is real-time. Outsource providers must continually monitor and measure their performance and engage in on-going communication with their client partners. Production and quality control (QC) reports need to be a shared product. Providers must be proactive in addressing detected weaknesses and implement performance improvement plans. Outsource providers must also be up-to-date with the knowledge of new and pending regulatory and industry changes, and implementing training programs to ensure compliance.
The futures of mortgage banking and outsourcing are intertwined. The growing complexity of mortgage banking will be reflected in the work being asked of outsourcing partners. In addition, outsource service providers are being asked to bear more business and regulatory risk. Limitation of liability, pre-defined direct damages, termination rights and service levels can often be challenging in contract negotiations.
One of the reasons for service providers to assume more risk comes from the regulatory oversight requirements, but another important reason is that progressive lenders are demanding stronger partnerships with their providers. And for the mortgage industry and the outsourcing business, partnership these days increasingly means partnership in risk as well as partnership in return.
Judy Wheatley is senior vice president at Indecomm Global Services, a business process outsourcing company. With 30 years of experience in the mortgage industry, Judy is a recognized expert in consulting and fulfillment services to residential mortgage lending clients. She received her Certified Mortgage Banker (CMB) designation in 2003 and her Accredited Residential Underwriter designation in 1993. She may be reached by e-mail at email@example.com.
1—“International Association of Outsourcing Professionals’ 2011 Trends Forecast Shows Industry Redefined,” the Web site of IAOP, Dec. 23, 2011, page 1.
2—“The Future of Global Business Services”, HfS Research Ltd. and PwC, June 2012, slide 13.
3—CFPB Bulletin 2012-13, Consumer Financial Protection Bureau, April 13, 2012, pages 2-3.
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