Tight Margins and Reg Changes Prompt New Interest in Outsourcing
As mortgage lending volumes decline and regulatory costs climb, potential cost savings are tempting lenders and servicers to outsource more of their operations.
Lenders remain reluctant to outsource for control and liability reasons. But with volumes down and compliance expenditures up, more have, particularly among midsized firms with limited resources.
"Midtier players are willing to look at anything that might save them money right now. This cycle is one of the worst. Companies are looking at it out of necessity. If it means keeping the door open, they will do it more than ever," says Brian Koss, EVP at Mortgage Network, a retail lender that outsources post-close quality control.
The trend marks a shift in lenders' motivation to use business process outsourcing. Traditionally, lenders farmed out overflow work during busy periods, such as refinancing booms.
"The mortgage industry compared to other industries has been rather slow to embrace outsourcing. However, there is now a growing trend toward lenders looking for ways to cut costs," says Judy Wheatley, SVP, compliance, Indecomm Global Services.
Now, lenders are contracting out different functions to save money, even as they bring back in-house certain work previously handed off for capacity reasons.
"It really has changed in terms of why people do it. Over the past couple of years, and historically, we've seen people expand outsourcing based on how much business they can do. It was a lever point," says Jeff McGuiness, CEO of the Lenders One mortgage cooperative, a group which has a fulfillment services arm. "However, most recently it really has been done to make sure all compliance components are administered as efficiently as possible to control cost variables."
Outsourced compliance systems lenders can use on a per-transaction basis have become particularly crucial for the midtier market, says John Robbins, who is one of the executives working on launching Mortgage Collaborative, a separate mortgage cooperative that lacks an outsourcing affiliate.
Use of outsourcers' compliance systems may fall short of offering overall costs savings, but they will prevent what might otherwise be an unmanageable increase in costs related to new regulations and associated repurchase risks, Robbins says.
Lenders "can't afford to save money by cutting the compliance side," he says, noting that the volume of information involved simply is too large to handle manually, and the midtier's loan origination systems alone generally lack the compliance functions to handle new rules, except through integrations with third-party compliance software.
Exceptions may be companies like loanDepot that have enough of their own technology to handle today's operational demands efficiently. "We're trying to create a conveyor belt so services can flow through faster," says Anthony Hsieh, CEO of loanDepot, and a mortgage industry veteran with a lot of experience with online lending.
"We really don't see a ton of cost savings yet [from outsourcing]. Maybe we're just blinded, but we'd rather have the control," he says.
Outsourcing is "not right for everybody, but it makes sense for companies that are trying to decrease their fixed costs in a down market. I've never seen the mortgage industry more inefficient than how I see it now," says Hsieh, noting that full-time employee efficiency is "the worst I've ever seen it, particularly when it comes to underwriting."
One particularly costly task that some lenders are considering outsourcing is underwriting. But given underwriting's close ties to revenue, lenders that can afford to keep it in-house tend to refrain from outsourcing underwriting for control and liability reasons, says Koss, who works for a retail-only lender.
"As desperate as everyone is to save money, sales come first," he says.
Other types of loan reviews are increasingly being outsourced, though, particularly in third-party channels where companies buy correspondent loans or fund wholesale ones. Some lenders have grown more interested in developing these channels as volumes have waned.
"Everybody's out there scrambling for a larger market share," says Wheatley, noting that this is driving an increased lender interest in outsourcing certain correspondent functions.
Third-party origination channel reviews are easier to outsource because they are "more an audit function than an underwriting function," and they are noncustomer facing, says Stan Middleman, CEO of Freedom Mortgage, Mt. Laurel, N.J., a national lender that operates direct lending retail, correspondent purchase and wholesale channels.
Freedom outsources some of its functions like file review for loans it purchases through its correspondent channel, but it also has begun providing its own outsource services along the value chain "from origination to servicing" for external clients.
The tasks that get outsourced vary between lenders, but generally reflects a lot of change in one direction or another, he says. Some midsized lenders are seeking to move away from servicing because of increased regulation in this area. But others, including Freedom's first outsourcing client, continue to service their own loans and contract out the origination process from funding to closing, for customer retention reasons.
"We see a lot of folks pulling things like underwriting back in-house, but anything that is…a commodity is outsourced," says Deb Aydelotte, president of Lenders One affiliate Altisource Fulfillment Operations (parent company Altisource Portfolio Solutions also owns Lenders One).
Lenders are often finding outsourcers have the automation or offshore staff to handle certain processes more efficiently than they can, but there is a limit to what is effective to outsource. Koss finds it helpful to have a third party handle its post-closing quality control on a checklist basis, but prefers to keep all decision-making roles in-house.
The processes that can save lenders money via outsourcing vary depending on the company. "I can't say it's underwriting or quality control, it depends on the client and function," Aydelotte says.
"There are those that would say underwriting is your highest expense and it generally is the highest paid in an operation, but that cookie-cutter response just doesn't work for everyone," adds McGuiness.
Other recent hot spots for outsourcing have been quality control functions where regulatory and/or secondary market scrutiny is intensifying, such as sampling designed to fulfill new Fannie Mae QC requirements, and fair lending and Home Mortgage Disclosure Act QC, says Aydelotte.
While there are common areas of focus, a lender's decision about which tasks to outsource typically result of a review of its processes where the outsourcer and lender identify the functions that can result in the greatest cost savings if contracted out. This generally results in more third-party involvement throughout the lending process.
"I don't think outsourcing is the right answer for every lender, and it needs to be strategic and very specific by lender. But the larger the scale and the more volume you can commit in aggregate, the better efficiency," says McGuiness.
"With a long-term engagement, you are able to affect a much deeper benefit," says Bob Krasney, senior practice manager of mortgage BPO at Wipro Technologies.
The deepening of mortgage companies' outsourced relationships, combined with post-downturn regulatory reform that clearly holds them responsible for anything their contractors might do on their behalf, raises the question of whether outsourcing liability and risks are increasing as well.
"On the compliance side, there is more of a deeper review and requirement for due diligence of us as vendors and we endorse that," says Aydelotte, noting that she encourages clients to thoroughly investigate her company's operations and make site visits.
One question lenders need to weigh in considering outsourcing is whether the savings are worth the "opportunity cost" of having to set aside time to make those site visits and perform due diligence, Koss says.
As outsourcers become more deeply ingrained in lenders' processes, it becomes more difficult to extricate them from operations. The complexity of a specific task affects how easily a lender can wind down an outsource relationship to either switch providers or bring the function back in-house, Aydelotte says.
A correspondent loan channel platform that has been almost entirely outsourcing would be "tough to bring in-house," but a smaller process is less of a concern, she says.
An outsourcer might need 60 to 90 days to get such an operation up and running, but it would probably take more like "90, maybe 120 days" to bring it back in-house, Aydelotte adds.
With volumes shrinking, there is consolidation risk when it comes to vendors as well as lenders to consider, she says.
Outsourcers even more so than the lenders they serve need to keep their costs under control, given increased regulation and competition for talent in overseas markets.
"Is the labor arbitrage still there? I would say yes," says McGuiness.
Mortgage companies should monitor inflation rates and perform cost-benefit analyses to manage this risk, Wheatley suggests.
Lenders who choose to outsource through offshore providers can still receive significant savings as high as 30% over time, but before the competition for talent heated up the efficiencies were closer to 10-20% higher, Krasney and other mortgage industry outsourcing providers generally say.
There has been some shifting to other overseas markets that might have less staffing competition and lower costs, but much of the offshore mortgage industry expertise so far remains in India, says Wheatley. Servicers also have been working with some customer service and collections contractors in the Philippines, says Krasney.
"The labor rates are going up in the offshore countries. In India and the Philippines, the labor arbitrage has been reduced. All the more reason why vendors, more than labor arbitrage, are focused on providing efficiencies through, automation, best practices, re-engineered workflow, by leveraging data analytics, and by reducing cycle times," says Krasney.
Some lenders also are concerned about data security and U.S. privacy law in offshore outsourcing, but providers generally obtain certification showing that they meet certain international auditing standards that alleviates this concern, he says.
The best way to mitigate any outsourcing concern is to make sure lenders and vendors are on the same page, and that lines of communication are open and very clear, suggests Aydelotte.
"Look for folks at a vendor who have actually been in your shoes. They will understand the risks, they will understand the costs, and they will understand how to best help you with what you need," she says.
"There should be a phased, controlled approach to outsourcing and frequent feedback crucial in the early stage," so that outsourced procedures can be tested and modified over time, McGuiness suggests.