Mortgage Servicing in US: In-house or Outsource?
Sutherland Banking Insights
Mortgage Servicing in US: In-house or Outsource?
October 2013Page 1
Mortgage Servicing in US: In-house or Outsource? Overview US residential mortgage industry is going through one of the worst financial crises in decades. The industry is battered with record volumes of delinquencies and foreclosures, intense regulatory scrutiny and legal issues. The role of a mortgage servicer is to look at mortgage installment payments on behalf of actual investors in the mortgage. The role primarily includes managing billing and collection of monthly payments, loan review, escrow accounts and also looking after the foreclosure process in case a mortgage turns bad. New guidelines issued by the Consumer Financial Protection Bureau (CFPB) increases challenges for mortgage servicers, especially big banks, which are already overwhelmed with delinquent loans. Moreover, the banks are also facing pending regulations related to Basel III, which limits the amount of capital that the banks can risk on servicing rights. According to the Basel III norms, maximum amount of mortgage servicing right value (MSR) that a bank should keep is limited to 10% of Tier I capital. As a result, holding a higher MSR is becoming expensive for banks, as a result of which banks are selling their MSRs.
“There’s a finite amount of capacity in the servicing enterprise today, and the system by design was never set up to withstand these rates of delinquency, these high rates of foreclosure for an extended and protracted period of time which is where we’re at right now.” – Edward Delgado COO, Wingspan Portfolio Advisors
Given all new regulatory and capital obstacles, servicing loans has become a big headache for financial institutions, giving them enough reason to outsource the work. Banks, credit unions and community banks all are selling out their mortgage servicing rights to specialty servicer or outsourcing the day-to-day operations of mortgage servicing on a fee-perloan basis under multiple-year contracts termed as sub-servicing. The banks also outsource their mortgage servicing process to BPO companies. Mortgage Processing Services
Impending regulatory challenges and capitalization risk of Basel III have stirred a number of banks to sell MSRs. Total MSR for the top 5 servicers has declined to USD4.0 Tn in the second quarter of 2013 from USD4.7 Tn in the fourth quarter of 2011. Moreover, the cost of servicing mortgage loan is also increasing mainly due to the compliance burden by CFPB, thus compounding the economic challenges faced by the mortgage servicing industry.
Mortgage Servicing in US: In-house or Outsource?
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Mortgage Servicing: In-house The changing regulatory landscape and high cost of servicing are forcing financial institutions to outsource their mortgage servicing operations. However, few banks and credit unions want to keep servicing operations inhouse, as in-house servicing helps them stay connected with their customers and provide personalized customer services. To manage servicing operations efficiently, banks are taking various initiatives such as updating their software to comply with the leading regulatory reforms, recruiting compliance officers, training and updating staff with the mortgage servicing requirements. For instance, Envoy Mortgage, a Texas-based (US) full-service retail and correspondent mortgage banking firm has appointed Financial Industry Computer Systems, Inc.’s Mortgage Servicer platform to manage its loan servicing department. In an another example, Simplicity Bancorp, Inc., a community bank based in Covina, California started servicing its mortgages in-house due to increase in non-performing assets. Earlier, the majority of the bank’s mortgage was serviced by third parties. Simplicity Bancorp’s management team noticed an increase in nonperforming loans, from 1.8% in 2009 to 3.3% in 2011. Poor payment collection by third parties forced Simplicity to bring mortgage servicing operations in-house. The bank paid fair market value of servicing mortgage to the third parties and obtained the servicing rights. After obtaining the servicing rights, Simplicity quickly moved to tackle credit issues and contacted borrowers to collect overdue payments or make alternative arrangements. The in-house servicing operations helped Simplicity improve its asset quality. Moreover, the delinquency rate also improved from 2.5% in June 2012 to 1.4% in June 2013.
Mortgage Servicing in US: In-house or Outsource?
Mortgage Servicing: Outsourcing through Thirdparty Service Provider Independent third-party mortgage service providers provide specialty servicing and subservicing to banks. Specialty servicers are those who buy mortgage servicing rights from banks and collect the principal and interest due from mortgage borrowers and handle foreclosures when a borrower default. Independent third-party servicers employ a number of dedicated and experienced individuals to implement all new federal and state regulations. They subscribe to multiple services that provide regulatory updates and information on how to roll out these updates, execute quality control efforts and monitor transaction and portfolio-level performance. Specialty servicing is a growing trend as big banks sell their MSR rights to independent servicers like Nationstar, Ocwen, and Walter Investment Management. For instance, recently (2013) Bank of America has signed an agreement with Nationstar to sell USD215 Bn in residential mortgage servicing rights. The bank wants to remove its "noncore" assets such as loans to people with whom the bank does not have an extensive relationship. The deal also helps Bank of America move toward its capitalization goals under the Basel III norms. A mortgage sub-servicer collects mortgage payment each month and holds escrow account for tax and insurance payments on behalf of the bank. For example, in July 2013, Flagstar, a community bank decided to outsource its noncore default servicing business, which represents less than 4% of its overall servicing business, to a third-party servicer. By outsourcing the default servicing business, Flagstar expects to realize significant cost savings and focus on core, performing mortgages.
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"Improving company-wide efficiency and carefully managing expenses is consistent with our plan to build long-term shareholder value. By focusing our mortgage servicing business on core, performing mortgages, we seek to enhance Flagstar's profitability and be even better positioned to serve our clients and capitalize on value-enhancing opportunities. Further, this action will better position our servicing department for long-term growth. We remain deeply committed to our community banking in Michigan and our mortgage origination and servicing, and look forward to continuing to meet and exceed the needs of our clients and communities." – Sandro DiNello, President and CEO, Flagstar
Mortgage Servicing: Outsourcing through BPO Apart from outsourcing to sub-servicers, many US banks have opted to outsource their mortgage servicing business to BPO companies. Outsourcing of the mortgage process to BPO providers not only helps banks reduce operating cost but also relieves them from impending regulatory framework and constant training to bank employees. It also help banks in offloading some of the administrative burden associated with compliance to the BPO providers. The role of BPO compared to sub-servicers is limited as most banks do not use overseas BPO organizations to approve foreclosures on loans. The role of BPO is mainly to ensure that documents are in order before the banks sign off. For instance, Citibank’s major mortgage servicing is still done in the US, but it has also partnered with an Indian outsourcing company, which provides support on servicing to Similarly, in 2011, Cognizant bought Core Logic's India operations to strengthen its mortgage service capabilities including loan origination, escrow, title and closing services through Similarly, in 2011, Cognizant bought Core Logic's Similarly, in 2011, Cognizant bought Core Logic's
Mortgage Servicing in US: In-house or Outsource?
Citibank’s US business. In mortgage servicing operations, BPO handles various complex processes such as default management, income verification, loan boarding, investor reporting, escrow services, special loan review, etc. According to a report by HfS Research, Indian IT/BPO companies are expected to almost double their revenues from mortgage process outsourcing from USD158 Mn in 2009 to USD316 Mn by 2013. At present, most of the US banks are outsourcing only a portion of their loan serving operations. But with the introduction of tougher regulations for home loans by the government, banks are expected to outsource a growing number of back-office functions. The trend to move mortgage BPO offshore is mainly driven by the need to reduce costs aggressively and also to shift liability, and thus risk, to the BPOs. The Indian mortgage BPO landscape is majorly dominated by players like Accenture, Cognizant, Infosys, Tata Consultancy Services (TCS), Wipro, etc. During 2010-12, TCS has witnessed about 40% increase in its mortgage business revenue. TCS has also seen an increase in its mortgage related employee base from 7,000 to 9,000 during the same period. Indian BPO players like Accenture, Cognizant and Wipro are following the inorganic route to fasten their go-to market strategy in mortgage outsourcing. For instance, Accenture acquired Zenta (a provider of mortgage processing services) in 2011; and Mortgage Cadence (a provider of loan origination software and electronic document management service) in 2013 to enhance its mortgage capabilities. Accenture Credit Services offers a full suite of services for mortgage originations, servicing, and closure. India operations to strengthen its mortgage service capabilities including loan origination, escrow, title and closing services through secondary markets, loan administration and default management.
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Key Benefits of Outsourcing
Reduce fixed costs by moving to a variable cost model – potentially performance linked
Access technology, systems and people who are fully focused on meeting your customers’ needs
Outsource excess capacity and manage product areas that are overly demanding on limited resources
Protect your exposure to the cost and risk associated with legislative and regulatory change
Conclusion The rising regulatory challenges, capital risk related to Basel III and increasing cost of mortgage servicing are forcing banks to decide on whether to keep mortgage servicing in-house or outsource it to third-party or BPO service providers. On one hand, in-house servicing helps banks provide better customer service and connect with their customers or sell MSRs to independent service providers to avoid the complexity of servicing the mortgage asset. Whereas, on the other hand, by outsourcing servicing operations to third-party providers or BPOs banks can further reduce cost of servicing and hence increase their margins. Both options have their pros and cons, hence depending on their priorities banks need to decide which option is viable.
Mortgage Servicing in US: In-house or Outsource?
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