US Retail Mortgage Origination Challenges

Transcription

1 White Paper US Retail Mortgage Origination Challenges The retail mortgage business in the US has gone through a phase of tremendous flux. Retail mortgage lenders are currently in the process of consolidating their operations necessitated by large write-offs, regulatory pressures and changed market conditions. This white paper looks at key challenges that US retail mortgage lenders face in revamping their origination operations, and initiatives that would help overcome these challenges.

2 About the Authors Eswaran Swaminathan Eswaran Swaminathan is a Chartered Accountant by qualification and heads the Lending (Retail, Mortgages and Commercial) Sub- Practice within the Banking & Financial Services (BFS) Industry Practice at Tata Consultancy Services (TCS). He has previously worked in the areas of commercial lending and investment banking with a bank and is now a banking domain consultant with TCS. Narayanan Seshadri Narayanan Seshadri is a graduate in commerce, a Certified Associate of the Indian Institute of Bankers and a qualified Six Sigma Black Belt. He is a senior consultant within the TCS BFS Industry Practice and specialises in mortgage lending. He has extensive experience in the areas of retail lending, retail liabilities, cards and channels having worked with different banks and is currently a banking domain consultant with TCS. Lakshmipriya Das Lakshmipriya Das, a post graduate diploma holder in Business Administration, specialising in Finance, is a subject matter expert in mortgage business in the TCS BFS Industry Practice. She has built her expertise in the US retail mortgage market and worked with a mortgage servicing organization prior to taking on her current role. 2

3 Table of Contents 1. Introduction - What ails the retail mortgage industry? 4 2. Challenges banks face in retail mortgage origination 4 3. Transformation opportunities for banks 6 4. An approach to address Compliance Challenges 9 5. Conclusion 10 3

4 Introduction US Retail Mortgage Origination Challenges What ails the retail mortgage industry? The state of the US residential mortgages business is a continuing reminder of the financial crisis. Inefficiencies such as slack appraisals, perfunctory checks, inefficient controls and unrealistic valuations, in the origination process have contributed to the existing state of affairs. have contributed to the downfall of the retail mortgage market, and diminished customer confidence. The challenge before mortgage lenders is to eliminate these inefficiencies and revive the industry. The state of the retail mortgage business is a key indicator of the vibrancy of an economy. An upswing in the house price index will be an indicator of improvement in economic conditions. While regulators and government strive to revive the economy, banks will have to contribute to the revival of the dormant residential mortgage business by improving operational efficiency of mortgage origination processes. For this, it is essential to understand the challenges that banks face in their origination business and how they can leverage technology to improve operational efficiencies and controls. Challenges banks face in retail mortgage origination The key challenges that confront banks today in the mortgage origination space are: Decrease in mortgage purchase loan volumes; Change in the sourcing model; and Regulatory compliance issues. These challenges are a consequence of macro-economic conditions, and cannot be remedied by the banks independently. However, banks need to put in place systems and processes to manage what has become the 'new normal' for the industry. This paper discusses the context and implications of these challenges and the measures that banks could initiate to address them. Decrease in Mortgage Purchase Loan Volumes After years of consistent growth, mortgage purchase loan (loans for new purchases) originations have registered consistent negative growth since Fig 1 shows that new purchase loan volumes fell by 73% to US$ 404 billion in 2011 from US$ 1512 billion in Loans for new purchases increased on the back of historically low interest rates and government policy support to slightly more than US $ 500 billion during However, this was still only about one-third of the peak volumes achieved earlier. The revival was also limited to a few key financial institutions and not the entire banking sector. 4

5 Purchase Volumes (USD Billions) 1,600 1,400 1,200 1, Retail Mortgage New Business Volumes 1,512 1,399 1,280 1,309 1,097 1, Year Fig 1: Retail Mortgage New Business Volumes Source: Census.gov and MBAA Fig 2 indicates that origination volumes for refinance mortgage loans have however been declining at a lower rate. Refinance loan volumes declined by 39% between 2005 and While refinance loans constituted 48% of total loans disbursed in 2005, they rose to 68% of total loans disbursed in Effectively, this means that though new business volumes have been coming down affecting income levels, because of heightened refinance activity and other requirements relating to loan modification, banks have not been able to bring down their operational overheads, which has adversely affected profitability. Banks have been complaining about not being able to handle additional business volumes, and efficiently process refinance requests, which has become a key focus area. Refinance Volumes (USD Billions) 3,000 2,500 2,000 1,500 1, Refinance Loan Volumes 2,532 1,757 1,463 1,397 1,326 1,331 1,166 1, Year Fig 2: Refinance Loan Volumes Source: Census.gov and MBAA For years, mortgage business has been a key contributor to retail banking profits. Coupled with the profits on packaging and reselling these new loans, mortgage business has also been a key contributor to the overall profits of banks. 5

6 Mortgage business is unlikely to revive without a change in economic fundamentals and an upswing in home prices. Notwithstanding this, banks' need to focus on two factors: Transform existing mortgage operations by improving operating efficiencies thereby reducing overheads, and putting in place better controls; and Try to garner a greater share of the refinance market, staying ahead even in a falling market. Transformation opportunities for banks Today, a large number of banks operate on legacy origination platforms. It is our experience that significant opportunities exist for: Increasing straight through processing; Using enterprise mobile applications for lead generation, origination and vendor interaction Making document handling more efficient; Providing consistent experience for retail customers through common loan origination platforms; Automating interfaces to vendors; Enabling pipeline view and balance workload; Enabling data analytics; Enforcing appraisal standards and controls and flagging exceptions. The opportunities for achieving operational efficiencies could be many and it is essential that banks carry out a comprehensive evaluation of their existing operating model and processes before they embark on a transformation initiative. Change in Sourcing Model A significant fallout of the financial crisis has been the shift by banks from wholesale (broker) origination channels. Table 1 shows the volume of loans originated through broker channels by select banks between 2007 and The proportion of these loans to total mortgage loans disbursed is given in brackets. Bank 2007 Amount (%) 2008 Amount (%) 2009 Amount (%) 2010 Amount (%) Table 1: Mortgage Originations through Wholesale Channel Source: MortgageStats.Com 2011 Amount (%) Wells Fargo 42 ( 15% ) 28 ( 12% ) 45 ( 11% ) 33 ( 8% ) 18 ( 5% ) BOFA 30 ( 16% ) 7 ( 4% ) 22 ( 6% ) 15 ( 5% ) 0 ( 0% ) Chase 52 ( 25% ) 31 ( 17% ) 4 ( 3% ) 1 ( 1% ) 1 ( 1% ) Citi 54 ( 27% ) 23 ( 20% ) 7 ( 9% ) 9 ( 13% ) 6 ( 9% ) US Bank 9 ( 33% ) 13 ( 38% ) 18 ( 32% ) 7 ( 13% ) 7 ( 13% ) 6

7 The volume of loans disbursed through broker channel and proportion of such loans to total loans originated has been coming down consistently for all five banks. This shift can be attributed to the following reasons: Lacunae in risk assessment in the indirect mortgage origination channels; and Need to manage regulatory risk and comply with stringent quality control norms imposed by multiple regulations, including those under the Dodd Frank Act. With the number of quality borrowers shrinking post the financial crisis, more banks are competing for the same borrower's business. An increase in the number of originations from direct channels provides banks an opportunity to differentiate themselves in terms of 'customer experience', and expand their share in the available business. Managing the changed sourcing model The proportion of originations through alternate direct channels such as internet banking and mobile banking has been negligible till now. Banks need to invest in robust internet and mobile banking solutions for mortgage origination (and servicing). These channels have already gained popularity for delivery of services including account enquiries, status alerts, payments and cheque deposit capture, and it is time to replicate this in the mortgage space as well. Enabling mortgage consultant tools, electronic origination and electronic submission of documents to enable e-mortgages will also reduce the need for manual intervention and facilitate straight through processing. Some of the key services that could be enabled through electronic channels include: Easy to use mortgage consultant tool to advise the customer on eligibility, product options available, affordability and refinance options Location based pricing services Scan and search facility for property listing details Pre-qualification Application submission and receipt of good faith estimate (GFE) Notifications and alerts for submission of documents Facility for scanning and submission of documents Status information, to do lists, closing calendar, contact details etc. The mobile channel for originating business, in addition to helping reaching out to a larger customer base, would also greatly help enhance customer experience and improve operational efficiency. However, banks need to ensure integration between the different channels to provide a seamless experience to customers switching between channels while conducting a transaction. 7

8 Regulatory Compliance Post the implementation of the Dodd Frank legislation, banks are required to comply with a number of regulations during the mortgage loan origination process. Brief details of these regulations are given below: Sl. No Name of Regulation Impact on origination Current Status 1 Qualified Mortgages Ability to Repay 2 Mortgage Loan Originator (MLO) Compensation (Duty of Care) 3 Originator Compensation and Prohibition on Steering Incentives 4 Mortgage Examination Procedures Lays down factors to be checked for determining customer's ability to repay Specifies licensing / registration requirements, norms and compensation guidelines for originators Defines checks to ensure that the loan product proposed best suits the consumer's needs. Stipulates new audit / review criteria to be followed by the Consumer Financial Protection Bureau (CFPB) examiners Effective from Jan. 10, 2014 Effective from Jun 1, 2013 (partly) and Jan. 10, Effective from Jan Effective from Jan 11, Home Affordable Refinance Program 2.0 (HARP 2.0) 6 Uniform Loan Delivery Dataset (ULDD) 7 Uniform Appraisal Dataset (UAD) and Uniform Collateral Data Portal (UCDP) Lays down new refinancing guidelines for underwater loans Effective from Nov. 15, 2011 Specifies data standards and file formats for submission of Effective from July 23, 2012 loan data to government sponsored enterprises for sale of (Phase 1) and Aug. 25, 2014 loans. (Phase 2). Standardizes collateral appraisal data elements to ensure Effective from June 1, 2013 quality and consistency. (UAD) & March 19, 2012 Makes electronic submission of appraisal report mandatory (UCDP) 8 Dodd Frank Preemption Rule 9 Home Mortgage Disclosure Act (HMDA) Amendments 10 Additional Disclosure Requirements for Mortgages under Dodd-Frank Act Makes compliance with state level laws mandatory for state incorporated subsidiaries of Federal Chartered Banks Stipulates additional disclosure requirements for regulatory reports. Lays down additional disclosures to be made to the customer at the time of closing Effective from Jul 21, 2011 Effective from Jul 21, 2011 Effective from Jan. 10,

9 Sl. No Name of Regulation Impact on origination Current Status 11 Amendments to the Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act 12 Integrated Disclosures - Consolidation of disclosures under Real Estate Settlement Procedures Act (RESPA) and Truth In Lending Act (TILA) Specifies additional disclosures to be made to the customer on rejection of loan requests or for charging a higher rate of interest than the prime rate. New disclosure requirements as part of good faith estimates (GFE), integrating existing disclosure requirements under RESPA & TILA Effective from Jul 21, 2011 Draft regulations. Effective date not yet announced These regulations seek to enforce greater transparency and establish fair lending practices and disclosure standards. Given the rapid frequency of these regulations and their granular impact on origination processes, banks face multiple challenges of timely response, escalating compliance costs, cascading awareness of compliance requirements down the organisation and compliance monitoring. An approach to address Compliance Challenges Until now, regulations like KYC norms, Anti Money Laundering and Capital Adequacy involved additional internal controls and analysis of transactions / portfolios, and post facto reporting, without impacting operational models or operational processes. Compliance management was largely a fragmented effort at the Line of Business (LoB) level. However, provisions of the Dodd Frank Act have taken compliance requirements to a much more granular level, such as product development and management, fair lending practices, customer disclosures, responsiveness to complaints / problems, post-sale monitoring, and safeguarding customer interests. As a result, banks need to transform their compliance management functions. Regulatory compliance is evolving into an enterprise function, requiring a holistic approach to compliance tracking, impact assessment, implementation, and monitoring, similar to risk management after the implementation of Basel regulations. The Chief Compliance Officer needs to: Put in place tools and processes for tracking regulations, conducting collaborative impact analysis, checking implementation status and compliance monitoring dashboards. Identify geographical regulatory overlaps in the case of banks operating in multiple geographies to ensure a common approach for adoption of overlapping regulations. Identify common elements of compliance requirements, examine whether these can be converted into repeatable, rule based processes, and adopt a suitable functional and technical architecture. Establish processes for disseminating information about regulations down the organisation. 9

10 Conclusion The financial crisis and the state of the home mortgage business portfolio continue to place a huge strain on the operations of banks. As a result, the financial viability of several banks is under threat. Revival of interest in new mortgages, and home owners' confidence is a much needed catalyst for the US economy coming out of stagflation pressures. It would also help banks eliminate bad loans and investments from their balance sheets. Hence banks need to be innovative & enterprising in transforming their mortgage origination business. Technology can be a great enabler in overcoming the existing challenges in the origination process and help achieve growth in the retail mortgage segment. References [1] US Dept. of Commerce, US Census Bureau, Retail Mortgage Business Volumes, [2] US Dept. of Commerce, US Census Bureau, Refinance Loan Volume, [3] Mortgage Bankers Association of America, MBA Mortgage Originations Estimates, May 2009 [4] Mortgage Originations through Wholesale Channel, 10

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