Controlling Expenses In The New Environment
By James Hennessy
One year ago, we were marveling at the amazing rate at which investors were throwing money at dot-com companies, almost as much as we were marveling at how rapidly those companies were throwing that money away. We spent much of a very exciting Super Bowl trying figure out who these advertisers were, and wondered why they didn't tell us something about themselves in their $2 million, 30-second spots.
The whole dot-com thing was so bewildering as a business experience, trying to get one's arms around the whole thing and really understand it was, well, like herding cats. Twelve months later, we are becoming set in a more comfortable, more readily understood reality, both in terms of business in general and lending in particular.
The inexplicable excesses of the dot-coms in establishing brand did not work in the real world, after all. And lenders are looking at who and what they are in the face of a new set of rules. Is a mortgage lender now a company which performs all of its operations in-house, completely integrated and self-sufficient? Not hardly. If you go back far enough, you'll find institutions that were truly self-sufficient, going so far as to conduct their own title searches, credit research and appraisals. Purist firms like these saw the wisdom of outsourcing those tasks decades ago.
Why, then, are most companies insistent on keeping complete processes in-house in an era when GSE-influenced commoditization has made most of the processes generic - standardized to the point where automation is taking over more and more of them? One answer is that lenders need to be reminded of what they really are: financial intermediaries specializing in managing risk - not processes.
Processes are the "heavy lifting" of the mortgage business. Aside from those which identify and help mitigate risk, most processes conducted within lending institutions are repetitive tasks related to document gathering, filing, transmittal and reporting. They have little to do with bringing business in, manufacturing the product or selling the finished goods on the secondary market.
The important parts of those activities are contractual or relationship-oriented, not process-oriented. In "manufacturing" a loan, for example, the important work is verifying that risk parameters are met and conformed to and moving paper or imaged documents from one basket to another. Yet those mundane tasks tie up the lion's share of the business' revenue by virtue of the sheer numbers of people required to perform them.
In the New Reality, resources are slim, thanks to the thin margins available in the bread and butter mortgage space. And since the GSEs have expanded to become involved in a far wider variety of loans than ever before, these additional market segments are on the way to being commoditized like the mainstream conforming loan channel. As this trend continues, margins will be compressed on product lines that historically have enjoyed greater profitability.
And that means more pressure on the bottom line, challenging executives to look at different organizational and operational models in order to stay profitable. There is a good chance those models will include outsourcing some or all of the company's mortgage processes as a tactic to swap fixed expenses for variable costs. Size, not numbers of employees, matters when it comes to capital resources, origination capabilities and servicing portfolios.
The march of progress
When processes can be automated to individual lenders' specifications, the results can include dramatic improvements in cost structures, overall size, new focus on core competencies - and improved financial performance.
The modern mortgage lender must be very good at collecting and evaluating B2C and B2B
applications, with automated decisioning and locking capabilities that take minutes, not hours. Internal processes must be as paperless as possible, with imaging and workflow technology in place to reduce paper chases, time delays, and redundant FTEs.
Secondary marketing systems need to provide real-time pipeline management, which means that loans committed today are in the pipeline immediately, not at the speed of a live body filling in a paper-based report that sits in someone else's in-basket before being input onto the system.
The necessities of speed, accuracy and multiple internal system capabilities have raised the bar on lending technology to heights that are difficult for many companies to maintain - at least without betting the farm on the cost of admission.
Add in the requirements of keeping up with "best in class" technology on the Internet, and the complexity of the overall picture blurs focus away from managing risk and toward information technology specialization. At that point, the mortgage lender is less in the business of lending and more in the business of computing.
It happened to other companies long before it happened to lending. Back in the days when he had more hair available for bad haircuts and less money to pay for them, Ross Perot invented the IT outsourcing business. His company, which he named Electronic Data Systems, did precisely what its name entailed: it enabled information-intensive firms to stem the tide that threatened to drown their companies in the demanding, perilous, and very expensive waters of information technology.
These days, IT is just part of the picture - the most inherently complex part, of course, but still just a part. Processes account for a huge part of the mortgage banker's payroll, and with new methods of origination upon us in earnest, the Internet most eminent among them, new processes mean new skill sets, further complicating the human element.
Progress marches on, and keeping pace with the music requires doing things differently and frequently more expensively from the ways they have been done in the past.
The new reality is the e-reality
The early critics of the Internet as a loan origination channel are pretty much quiet by now. True, in the beginning there was far more smoke than fire, but technology and hard lessons have changed all that. While many people still want a live person to handle their loans, a great many others - $37 billion worth in 2000 and $56 billion in 2001 - are just fine originating their mortgage loans on the Internet.
Internet departments within lending companies seemed to spring out of nowhere. Literally, nowhere, since there was no precedent within the lending industry for this type of experience. So departments were created either around executives with an e-commerce background but no lending experience, or with lending backgrounds and no e-commerce experience; there were no executive level people with both and no benchmarks to guide them.
As a rule, these executives were expected to work miracles, or at least to indulge the CEO's desire to go "E," then fail and be dismissed as a noble experiment, never to be repeated. Sure, that happened in some places, but like any good "killer app," Internet loan origination was too good a notion to go quietly.
The departments created by those new-breed execs turned to outsources to provide technology, to design interfaces, to synthesize content and to provide the functional back offices to make their e-lending initiatives successful.
Along the way, many of them discovered that a parallel organization strategy was preferable to feeding e-loans into the traditional channels. Hence the concept of outsourcing the back-office processes, so that one production channel would not be favored over another. E-lending is not "brochureware" any longer, intending to drive customers into branches or call centers, though those were the best practices of the first generation of online lenders.
Today's second generation requires more sophistication and functional capabilities to gain traction with customers, as well as more security and greater privacy measures. The application process has to be quicker and easier than filling out a 1003 by hand. Automated decisioning and locking capabilities are more expected than ever before, as are user-friendly, intuitive, graphic, "learning" interfaces that make the process educational, not odious.
Sites like HomeAdvisor.com have set the bar at very high levels of technical sophistication, with the reward of being accepted by consumers very rapidly. Within a matter of weeks, HomeAdvisor zoomed to the top all-around rating among online lenders at Gomez.com.
Becoming a success on the Internet requires significant investment, commitment and risk, if you are going to build it yourself. And if, once you have built it, they don't come? The less risky path is outsourcing many of the more difficult (and expensive) aspects of the process. Automated sites, complete with sophisticated decisioning engines and real-time rate-locking capabilities can be implemented through outsourcing and generally paid for through unit charges.
This lets the power of a company's brand still work for them, driving customers into the Web site, without requiring that the company become a technology business in the process. Once qualified and approved, the company then has the latitude to either process in-house or outsource the back office as well, keeping the e-lending effort unit-based and separate from the mainstream shop. Loan servicing has been outsourced for a long time and is especially popular for specialized product types like subprime.
New reality alternatives
Choice is a good thing, particularly when there is so much from which to chooses. Outsourcing for mortgage lenders can be soup-to-nuts, or anything in between these days, and can include the normal channels of production just as readily as the Internet ones. The reason outsourcing works as a New Reality alternative is precisely because it offers so many options; as with the menu in a good family restaurant, there are items that will appeal to just about everyone's tastes.
A company introducing an unproved product line may not want to staff up for the experiment, thereby limiting the costs associated with it. Or, it may want to partner with someone experienced and private-label their brand to a process they know works well - like a private-label Visa or MasterCard program - but still be able to call the shots by specifying the program's parameters and rules.
Or a company may want to become a serious Internet player, but is reluctant to step up to the budgetary plate to create and own the necessary technology. Or a company that is working well, but is facing margin compression and is looking for alternatives that may include outsourcing several steps of the process in order to enhance profitability. All these examples are good candidates for outsourcing, along with just about any other company that is re-evaluating its business model.
Depending on the result desired, finding a good outsource is as easy as looking around the industry at firms that are working well. Who among the big boys is doing it internally, and who is using an outsource? Some outsources are specialized and boutique-like, sticking to aspects like site design and Web hosting.
Others are highly adept at loan servicing and loss mitigation. A select few, including Wendover Financial Services, are well regarded in the "soup-to-nuts" category, particularly for automated e-lending, back-office process outsourcing and subservicing, as well as for parent EDS's signature IT outsourcing.
Building a superiority complex
Complex problems require complex solutions. Seeking to find those solutions internally can cost a big company a hundred million dollars for, say, a new front-end loan origination system or perhaps to unify a half-dozen legacy systems acquired over the last few years' merger and acquisition activity.
Perhaps this is why, as a former chief information officer for a mega-mortgage banker remarked recently, the average shelf life of a chief information officer is around 18 months before someone up the ladder loses the stomach for the cost of a new, internally grown system. Technology is expensive, so why not use somebody else's?
Processes are also expensive, not only because they require a lot of trained, expensive people, but also because they require that expensive technology to go about their jobs. Depending on the lending niche, many of the repetitive functions can be outsourced to highly professional providers who can use economies of scale to accomplish several things most lenders cannot.
Among these are the abilities to drive down unit costs, to afford "best-in-class" processes and equipment, and to offer a wide variety of alternatives on a private-label basis so that all of the outsourcing is transparent to customers and third-party originators.
So what is a modern mortgage lender in The New Reality? Is it a company which performs all of its operations in-house, completely integrated, self-sufficient and state-of-the-art? Very few of those come to mind when taking the roll.
Lenders today need not be information technology companies, need not be dot-com innovators, and need not be process-heavy behemoths with acres of desks in regional centers around the globe. Just as in the days when mortgage banks started outsourcing their loan origination overhead to independent brokers, the day has come when outsourcing many aspects of the internal operations makes tremendous sense.
Lenders are in the business of managing credit risk, managing interest rate risk and managing relationships with their customers, their investors, their partners and the capital markets. And these days, those critical tasks represent a very, very full plate.
James Hennessy is director, solutions consulting, for the Credit and Real Estate Services unit of EDS (Electronic Data Systems), Plano, Texas. Previously a senior national production executive with several major mortgage banking firms, Hennessy specializes in consulting to lenders on e-commerce, business process reengineering and technology applications. Based in San Diego, he can be reached at (858) 793-0950; jim.hennessy@eds.com.
This article was previously published in the December 2000 Issue of Secondary Marketing Executive.
