The mortgage industry saw significant changes since 2007, including new regulatory measures, increasing default volumes, increasing service calls and reduced O&O. Most originators and servicers have implemented cost improvement programs to survive.
In 2012, our perspective is that the pain is not over for the industry. While savings have been achieved, the sluggish recovery in profits forces originators and servicers to go beyond typical cost improvement measures. Our thoughts on what is possible include exploring “nontraditional” areas of the cost base and implementing radical measures.
These new approaches could fundamentally change how mortgage companies view their cost curve, introduce a more profitable operating structure and allow managerial flexibility.
The financial crisis in 2007-2008 clearly had a major impact on the mortgage industry. More defaults, coupled with falling housing prices, caused a severe decline in originations as underwriting standards tightened. Originations declined 50%, from over $3 trillion in 2005 to $1.5 trillion in 2008. Many originators went out of business, reducing the total to 51,900 versus 144,000 in 2006. Survivors faced significant operational challenges as they coped with a high level of defaults.
We view savings opportunities at originators/servicers across three levels:
Level 1: Initial savings achieved in the early phases of the financial crisis, e.g., staff reductions, internal focus on cost improvement.
Level 2: Incremental savings (beyond Level 1) via cost transformation programs that apply traditional, standardized levers, e.g., vendor cost reduction, process improvement, reorganization, automation.
Level 3: Incremental savings (beyond Level 2) potentially achieved through nontraditional set of measures, e.g., large shifts in delivery model, such as substantial outsourcing/offshoring servicing, applying straight-through processing for standardized, low-risk mortgages.
2009-2011 saw a wave of major adjustments including new regulatory measures, increasing default volumes, increasing service calls, and reduced outsourcing and offshoring. Most players made changes in product offerings and reduced costs.
A.T. Kearney has worked with major mortgage originators and servicers and analyzed their cost base to identify additional savings opportunities.
The levers typically applied during a traditional cost reduction program include:
a. Sourcing/Procurement: retender, renegotiate external work
b. Outsourcing and Offshoring: move internal work to external provider
c. Demand Management: reduce overall workload
d. Process Redesign: change how work is performed
e. Re-organization: change how people/facilities are organized around work
f. IT Enablement: automate steps, improve information quality
g. Professionalization: improving leaders’ skill sets and the leadership culture
For a major mortgage originator and servicer, savings opportunities identified through traditional cost reduction programs reduced the addressed cost base by 8% to 13%.
Today, cost and productivity improvement continue to be critical in the mortgage process. Some savings have been achieved from traditional cost reduction programs, but mortgage originators must continue to increase their efficiency levels. The largest mortgage servicers, such as Bank of America and Wells Fargo, are trying to compensate for weak revenue growth by reducing expenses.
Cost reduction is complicated by a recent surge in refinancing volume, mainly driven by HARP 2.0. The majority of the recent revenue increase has come from refinancing rather than originations and primarily benefited the largest players. As servicers struggle to keep up with high refinancing demand, many banks have resorted to staffing up mortgage operations or retraining employees from other areas, such as credit card collections, to process refinancing requests. This could leave the revenue-strapped banks with a longer-term problem. If the refinancing revenue drops off, banks may be left with higher expenses than before HARP 2.0.
Large banks have also agreed to overhaul critical parts of their mortgage servicing operations, due to a national settlement with federal and state officials. This $25 billion settlement requires the banks to evaluate foreclosures, improve paperwork processes, and ensure adequate staffing, which complicate cost cutting.
Due to these challenges, mortgage originators and servicers must go beyond typical cost improvement measures, explore nontraditional areas of the cost base and implement radical measures to reduce fixed-cost base (Level 3 Savings). We see several ways that this can be done:
1. Change the operating/delivery model
- Wholesale move to offshore locations, e.g., move majority of servicing or other core operations offshore.
- Wholesale move to onshore provider if scale and investment offshore is an issue.
- In-source processes from market/competitors to further leverage fixed costs (if at scale).
- Expand shared services to maximum number of processes across the bank, e.g., direct marketing, payments.
2. Innovate on automation and product offerings
- Reduce turnaround times of the approval process on certain mortgage sizes in order to provide on-the-spot approvals.
- Bundle income protection and life insurance with mortgage products in order to reduce default risk and improve profitability per customer.
3. Expand the scope of efficiency programs
- Cost reduction in atypical areas, such as any remaining IT or middle-office functions (finance, HR, legal) by applying levers like automation, span of control, consolidation and benchmarking the number of FTEs in these areas.
- Reduce complexity to reduce costs via simplification of policies, processes and product portfolio.
4. Reduce fixed cost base for enhanced flexibility
- Sell owned facilities and rent/lease back to reduce fixed cost base (including branches, servicing and operations centers, call centers and office space).
These new approaches could fundamentally change business models and how mortgage companies view their cost curve. It can also help position mortgage providers for success in the long-term by introducing a more profitable operating structure as well as managerial flexibility.