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Refinancing Boom and Bust One would think financial institutions are faced with a consistent demand for home equity lines of credit. After all, what homeowner doesn t want to make improvements or needed repairs? Half of home equity loans are used for that purpose according to recent findings from Synergistics Research Corporation. Other purposes for borrowing against one s home value include emergency expenses, debt consolidation and vehicle purchases. Clearly needs exist, but this particular form of lending is very sensitive to fluctuations in interest rates. In times of low interest rates, borrowers flock to take out home equity lines of credit. When rates rise, refinancing loan volumes fall. The cyclical nature of refinancing loan volumes contrasted against interest rates is depicted in the following graphic from Freddie Mac taken from their 2013 Second Quarter Refinancing Report. Refi Booms End Quickly As Rates Come Off Lows Refinance Share of Applications (Percent) 30-Year FRM Rate (Percent) 90 12 80 11 70 10 60 9 50 8 40 7 30 6 20 5 10 4 0 3 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Freddie Mac s Primary Mortgage Market Survey Financial institutions face revenue challenges and certainly home equity lending can raise both interest and non-interest income. The challenge becomes how to maximize revenue while managing variable personnel costs. The average compensation per full-time employee continues to rise, but the industry s compensation efficiency ratio has not improved. This overall decline in the banking industry s compensation effectiveness is shown in the following graphic. 2013 FIS and/or its subsidiaries. All Rights Reserved. 2
$100.0 $90.0 $80.0 $70.0 $60.0 $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 $60.4 $63.5 $64.4 $68.2 24.6% 25.3% 25.6% 26.2% Compensation Efficiency Effectiveness Ratio Source: FDIC June 2013 Average Compensation per FTE Employee $71.7 26.5% $77.1 $74.0 $78.1 27.5% 26.8% 25.0% Compensation Efficiency Ratio $82.3 25.8% $86.9 27.6% $90.8 $92.5 28.1% 28.7% 2002 1 2003 2 2004 3 2005 4 2006 5 2007 6 2008 7 2009 8 2010 9 2011 10 2012 11 2013 12 June 30.0% 29.0% 28.0% 27.0% 26.0% 25.0% 24.0% 23.0% 22.0% Additionally, today s headlines concerning the bank mortgage and refinancing market indicate anything but easily predictable market dynamics. In today s mortgage and refinancing lending world, uncertainty reigns. Here is a sampling of recent article headlines: How Community Banks Are Adapting to Refi Slowdown, American Banker, Aug. 2, 2013 B of A Said to Cut 2,100 Jobs, Shut 16 Mortgage Offices, Bloomberg News, Sept. 9, 2013 Term-Shortening Trend Continues with Low Mortgage Rates, Office of Chief Economist, Freddie Mac Home-refinancing applications plunge 62% since May, Mortgage Bankers Association, Aug. 21, 2013 Proceeding with Caution Even given the above uncertainty, community and mid-tier banks find that expanding their refinancing lending is attractive because they can replace fee income lost from other sources. According to Curt Gabardi, CEO of Metropolitan BancGroup, in a June 25 American Banker interview, Mortgage banking is consistently 30 40% of our monthly net profits. Given this bullish attitude, community and regional banks need to ask themselves how they can succeed in the face of market uncertainty and how can they manage profits in such a cyclical climate. 2013 FIS and/or its subsidiaries. All Rights Reserved. 3
A Partner Mitigates Risk and Uncertainty Managing risk in a business where cyclical models apply presents unique challenges. Banks in the mortgage refinancing business must seek strategic partners who can help them widen the gap between revenue and expenses regardless of the economic climate and interest rate fluctuations. These partners must apply innovation and best practices to help bankers cope with mortgage market dynamics. They also should be able to cover both the origination and servicing sides of the business. If a bank has a partner offering to provide complete home equity origination and loan servicing, then unexpected volume fluctuations in refinancing lending can be easily managed. Hiring and firing risks can be borne by the outsourcer. Their labor resources can more easily adjust resources as industry conditions shift. Plus, this partner should be a large enough player to deploy resources into other areas if the entire refinancing industry enters a deep funk. This frees individual banks from the resource-intensive cycle of hire, train, manage and fire in order to address fluctuating demand. Partner Selection Criteria When looking at such a partner as an outsourcer, the three most important criteria revolve around domain expertise, according to a STRATMOR Consulting Group Survey. Bank buyers rank mortgage process, industry and technology expertise more important to them than the cost of outsourcing. Importance of Various Criteria in Choosing an Outsourcing Partner Mortgage process expertise 15 Boards, 14 1,955 13 Skill levels and mortgage industry expertise Technology expertise Cost of outsourcing 12 Contract reps and warrants 11 Vendor financial stability 10 Ability to customize solutions9 Ability to demonstrate SLA performance8 Potential to leverage process innovations7 6 Twitter, 8,128 Ability to deliver technically complex solutions Potential for competitive differentiation5 Contract terms flexibility4 Ability to process in multiple site locations3 Ability to offshore some or all of the processes2 5% Other 1 5% 88% 12% 86% 14% 79% 21% 79% 21% 76% 24% 71% 29% 62% 38% 50% 43% 48% 45% 40% 50% 31% 60% 29% 71% 17% 40% 14% 2% Extremely Important Somewhat Important Source: STRATMOR Consulting Group Survey This expertise with mortgage refinancing business and technology is important because activities/functions in mortgages are extremely domain intensive. They require the outsourcing company s employees to understand the mortgage ecosystem, implications of operational errors, importance of compliance, and focus on customer service and timeliness. 2013 FIS and/or its subsidiaries. All Rights Reserved. 4
Expertise in processes such as end-to-end loan originations processing, mortgage underwriting, repurchase management, foreclosure and bankruptcy management enable service providers to take on work that has been traditionally a high-cost activity for lenders. The variably priced resources of outsourcers allow community banks expenses to ebb and flow with mortgage market fluctuations. Plus, the domain expertise of some outsourcers provides for extremely quick entry into (and exit from) new sourcing arrangements. Cloud Computing Can Extend Domain Expertise An outsourcer s expertise can also be delivered virtually, with cloud computing services that offer business process outsourcing solutions leveraged by either onshore or offshore resources. The TowerGroup depicts this solution set in the following graphic. Service Trends: Hiding Product and Process in the Solution and the Cloud Creeps in Financial Institution Engage with client at business level. Capture functional needs that solve business problems. Identify and select the right technologies. Integrate and deliver. Business Engagement Technology Engagement Proprietary Platform BPO Core Systems F&A Platforms CRM and Business Intelligence HR Platforms SAP and Other ERP Systems Microsoft Solutions Cloud Services Source: CEB TowerGroup The cloud computing solution can provide variably priced, pay-as-you-go processing for the main components of a comprehensive refinancing solution. A robust partner will provide, own and understand as many of these components as possible, which include: Loan origination Document imaging Any third-party services such as credit approvals Loan servicing 2013 FIS and/or its subsidiaries. All Rights Reserved. 5
Mortgage process expertise should be provided within all of the above components, which can be considered as four legs of a chair of a comprehensive mortgage solution. Comprehensive Mortgage Solution Origination Imaging Third party- Services Servicing The greater the service coverage, the greater the flexibility provided for the mortgage banker in terms of breadth of offering and elasticity of price. Everest Research defines the integrated approach of combining cloud computing with business process outsourcing (BPO) as business process as a service (BPaaS). They contend that the banking and financial services industry will place a high emphasis on leveraging BPaaS well into the future. Questions to Ask When Selecting a Sourcing Partner As bankers start the evaluation process to review potential sourcing partners, they should ask themselves the following questions when beginning their search: Who is driving my bank s sourcing strategy? Is this the appropriate team for the business decisions at hand? How will we determine whether or not the BPO partner has the right skill sets to address our current and future mortgage origination and servicing needs? What types of handoffs will I require between my BPO partner and internal resources? How will they be managed? What are the risks associated with our current approach to mortgage origination and servicing? What are the opportunities for revenue creation, expenses reduction and risk mitigation with an outsourcing partner? 2013 FIS and/or its subsidiaries. All Rights Reserved. 6
Summary As the refinancing market retains attractiveness for financial institutions looking to expand their revenues, consider outsourcing solutions that combine cloud computing of mortgage processing with labor resources skilled in both the cloud technology and banking practices. Contact Us For information about FIS Consulting Services, call 800.822.6758 or visit www.fisglobal.com. 2013 FIS and/or its subsidiaries. All Rights Reserved. 7