Ellie Mae is growing so quickly that the loan origination system vendor ran out of room at its San Francisco Bay Area headquarters and had to cram software engineers into its gym.
Technology companies such as Ellie Mae, which almost doubled its employees to 700 this year as its shares hit a record high on Oct. 28, are seizing an opportunity to
"It's becoming more cost-efficient for lenders to outsource compliance than interpret every regulatory change and update their software," said Richard Hill, an associate vice president at the Mortgage Bankers Association in Washington. "Lenders don’t want to be tech companies."
Shares of Ellie Mae soared 44% this year to $38.49. That compares with a gain of 7.3% for the Standard & Poor’s 500 Index. Pleasanton, Calif.-based Ellie Mae, which reported earnings on Oct. 30, more than doubled its profit to $7.1 million in the third quarter, according to the average of five analyst estimates in a Bloomberg poll.
Today, parts of the lending process, such as transferring documents and verifying compliance, remain low-tech and laborious. Many lenders still email forms to borrowers for them to print and sign by hand.
"People have to take out their iPhones and search for a place that still has a fax machine," said Scott Sambucci, vice president at Blend Labs, a San Francisco mortgage software startup backed by Peter Thiel, a co-founder of PayPal. "If you think generationally, some of the younger borrowers probably have never even used one. The old way of doing business can’t keep up with the ever-changing rules."
Companies such as Ellie Mae and Fidelity National Financial Inc., the largest mortgage software firm, sell access to cloud platforms that handle every part of loan-making within a network that includes brokers, appraisers, insurers and credit companies.
Lenders exchange documents with applicants and store records electronically so they are easily retrieved by regulators and the investors who eventually buy the loans. The software also evaluates applicants for risk, checks documents for compliance with qualified mortgage and other rules as they are adopted, and lets borrowers sign forms electronically.
During the housing boom, lenders mostly did a terrible job making sure borrowers were creditworthy, said Julia Gordon, director of housing finance and policy at the Washington-based Center for American Progress, which has ties to the Democratic Party. Between 2004 and 2007, lenders provided about $2 trillion in subprime loans, many to unqualified borrowers who defaulted. So-called liar loans didn't require borrowers to provide pay stubs or tax returns to document earnings.
After the housing collapse, regulators cracked down on reckless lending. The Consumer Financial Protection Bureau has issued dozens of rules and clarifications in the last three years governing everything from appraisals to broker compensation. In January, it began implementing the qualified mortgage rule mandating that lenders must take detailed steps to prove that borrowers have the ability to repay their loans.
Six regulators including the Federal Reserve jointly issued a 553-page document earlier this month detailing when lenders must retain a stake in mortgages they package for sale to investors. And the industry is now bracing for rules taking effect in August that will make it difficult for lenders to do business without giving borrowers the ability to sign some documents electronically.
"Most lenders are using some level of technology, but not enough to deal with a regulatory tsunami," said Jonathan Corr, president of Ellie Mae. "What we've seen so far is nothing compared to the new rules that are going into effect in 2015."
Lenders will spend about $500 per loan on adopting technology, according to Stratmor Group, a mortgage banking consultant firm. With lenders on track to make 1 million loans in 2014, total spending may reach $5 billion.
Lenders have paid tens of billions of dollars in settlements stemming from compliance missteps while securitizing loans during the housing boom. In November, JPMorgan agreed to a $13 billion mortgage settlement to resolve probes by the Department of Justice. In August, Bank of America Corp. said it would pay $16.7 billion to end federal and state probes into mortgage bond sales. In addition, investors have forced lenders to buy back more than $81 billion of soured home loans because of faulty underwriting.
Lenders are buying cloud technology because it’s more efficient and less costly than maintaining a staff to update proprietary software, said Rich Smith, chief marketing officer for Ditech Mortgage Corp., the fifth-largest nonbank lender. The Fort Washington, Pa.-based company switched from using its own software to Ellie Mae earlier this year.
"We'd rather use someone who is thinking day and night about compliance so we have the freedom to focus on what we do best — serving customers," said Smith. "This industry is extremely competitive, and anything we can do to be more efficient gives us an edge."
Hiring experts to keep abreast of new regulations doesn’t let lenders off the hook, said Hill of MBA.
"Lenders can't outsource responsibility," he said. "You can't say, 'My vendor says it’s compliant, so I don't have to worry about it.' You still need some oversight, to ensure the programs are working the way they should."
Lenders in March saw the risks of using cloud technology operated by another company. Ellie Mae's platform went offline for more than a day, putting hundreds of U.S. loans on hold. Homebuyers had moving vans full of furniture and nowhere to put it because of delays in closing their purchases.
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Since mortgage technology firms store an abundance of sensitive personal data — tax returns, social security numbers and information on assets — hackers also pose a risk to borrowers.
"The stakes are a lot higher with a mortgage file because of the volume of information," said Timothy Ryan, a managing director with Kroll Inc. in New York and a former FBI agent who investigated cybercrimes. "A credit card, you can just replace, but having this data compromised is a lot more complicated."
In July, a federal grand jury indicted three men on charges they hacked into Xerox's computer servers and stole financial information from about 4,200 mortgage applicants. According to the FBI, the men were part of a Tijuana, Mexico-based conspiracy that used the borrowers' data to obtain credit cards and wire as much as $30,000 from brokerage accounts. Two defendants plead not guilty and are being held in a federal prison.
"Xerox cooperated with authorities throughout their investigation and took action to further safeguard confidential information and prevent a reoccurrence of a similar incident," said Kevin Lightfoot, a Xerox spokesman.
A Xerox survey of lenders earlier this year said that 71% of them are increasing investment in technology in response to regulations. Lenders' biggest investment is for electronic-signing software, said Jamie Williamson, the vice president of Xerox's mortgage group.
Rules taking effect in 2015 will require lenders, at the beginning of the application process, to send borrowers documents outlining mortgage costs to be signed and returned within three days. The drill must be repeated three days before a mortgage closes.
"If you are doing things the old way — printing out forms, then sending them by FedEx or by fax — you’re going to be pushing back closings," Williamson said. "E-signing is the hottest part of the market, because of the rules that go into effect next year."
Borrowers using the software click on a button to confirm their intent to sign the document. Then they click on the various places in the document that require a signature.
"It's going to be easier for consumers, but it means the lending industry is going to have to make fundamental changes in the way it does things," said Ellie Mae's Corr, who next month will begin moving his staff into a larger building about a mile away from the company's current headquarters.
