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Mortgage New regulations

Staying in Business with New Regulations

Unless efficiencies are built into lenders' business processes, the cost of complying with new mortgage rules will ultimately erode all profitability.

Regulatory pressures continue to grow for mortgage lenders and, logically, so do the costs to originate mortgages. Increased back-office compliance overhead is a primary factor impacting lenders' profitability.

At this point in time, the industry does not have a good handle on the additional costs resulting from Dodd-Frank reforms. However, we do know that for all types of financial institutions, the cumulative effect of regulatory requirements has led institutions to add staff throughout the past few years. We also know that community banks, independent mortgage bankers, and mortgage subsidiaries of chartered banks spend a higher percentage of their operating costs on compliance than megabanks.

The old problem in mortgage origination was efficiency in mortgage production. The new problem is efficiency in compliance. The high cost of compliance is not going away, and it is a discussion we must continue to have with regulators, policymakers, mortgage lenders, and third-party service providers.

What We Know About the Cost of Mortgage Reforms

In October 2012, the Consumer Finance Protection Bureau (CFPB) announced plans to study compliance costs. About a year later, the CFPB released a 176-page report, but the subject of the report was the costs associated with compliance for deposit regulations not mortgage transactions, which are at the core of the cost issue. To date, the CFPB has not released a report on the costs for mortgage regulatory reform. The CFPB may take a similar approach with mortgage compliance costs analysis. If it does, the cost study will most likely focus on the ongoing and recurring operating costs of the regulations; it will probably not address the costs for litigation or the opportunity costs of the regulations.

As required by law, the CFPB accepted comments after it announced plans to study compliance costs. One responder was from a $350 million bank, and he knew that his compliance expenses for staffing, training, and reference resources increased $150,000 per year and profits fell approximately 10 percent. He also stated that some of the bank's products would be discontinued because of the risk of noncompliance. Another community banker echoed a similar concern, stating that increased regulatory costs caused some products to be unprofitable and therefore eliminated. While regulations can have many benefits for consumers, these benefits can come at a cost, according to the CFPB's Dan Sokolov.

In 2005, the Center for Responsible Lending (CRL) released an issue paper addressing the direct cost of compliance. The paper was written at the time most lenders began employing automated compliance tools to comply with state anti-predatory lending laws. CRL used the Mortgage Bankers Association (MBA) 2004 data, which estimated the cost of manual compliance reviews to be about $43 per loan. With automation, however, MBA's data showed the cost of compliance reviews was reduced to $16 per loan. According to CRL's paper, the 2003 MBA Cost Study estimated $1,505 for total loan production costs, on average, for all lenders.

Fast forward 10 years and MBA's data for the first quarter of 2014 showed total production costs were $8,025. This survey is based on costs reported by independent mortgage banks and mortgage subsidiaries of chartered banks, and while this is not totally an apples-to-apples comparison because the 2003 study averaged the costs of all lenders, it demonstrates the significant cost increase to originate a mortgage.

Perhaps a better comparison is "net cost to originate," which includes all production operating expenses and commissions, minus fee income, excluding secondary marketing gains, capitalized servicing, servicing released premiums, and warehouse interest spread.

In the first quarter of 2010, the net cost to originate a mortgage loan for independent mortgage bankers and bank subsidiaries, on average, was $2,945. Four years later for this same class of lenders, the net cost to originate averaged $6,253. The industry doesn't have the data to say how much of that $3,308 increase is from the significant increase in compliance costs. However, it is a likely primary driver in the soaring cost of origination.

It is also important to note that in comparing the first quarter of 2010 to the first quarter of 2014 in MBA's Cost Study, the average quarterly production volume per company increased from $158 million to $274 million. Generally, when production volume goes up, the average cost per loan is expected to decline as a result of the increasing economies of scale. When we look at these snapshots in time—before and after Dodd-Frank regulations were in place—we find an alarming impact on profitability. Independent mortgage bankers and bank subsidiaries, on average, had a loss of $194 per loan in the first quarter of this year, compared to an average profit of $606 per loan four years earlier.

How to Build Mortgage Compliance Efficiencies

Mortgage lenders accept the fact that the costs associated with regulatory compliance have increased over the last five years, but this doesn't mean that costs must continue to escalate and erode profitability to a loss on each loan. Many of the new regulations are designed to bring greater transparency to the mortgage process, which should result in more commoditization in product and pricing. The effect of commoditizing mortgage processes should result in higher degrees of efficiencies for lenders and the ability for lenders to focus on improving consumers' borrowing experiences and expanding market share.

Financial institutions tend to respond to increased regulations by adding people rather than leveraging technology and improving processes. Technology spending needs to go beyond monitoring compliance to improving the performance of compliance management, according to a recent Deloitte Center for Banking Solutions study. A holistic approach to compliance management is needed to build compliance efficiencies. This approach requires action steps, which include the following:

  • Reduce duplication of activities across mortgage processes and production channels.
  • Integrate oversight and controls across these channels.
  • Maximize the use of qualified third-party service providers to move fixed costs to variable costs.
  • Perform cost-benefit analyses to justify expenditures.
  • Effectively plan for future compliance regulations.
  • Demonstrate compliance risks are under control.

These action steps apply to all types and sizes of mortgage lenders, but we must realize that the impact of compliance is not equal across all types and sizes of mortgage lenders. Megabanks have an advantage over community banks because they are able to leverage their scale to better absorb the compliance burden. Depository institutions have an advantage over independent mortgage bankers and mortgage subsidiaries of chartered banks because they are not subject to the same SAFE Act licensing requirements.

An efficient compliance management program starts with having the resources and the tools to understand the regulations, as well as knowing how to practically and compliantly apply them to an institution's business process. This is where qualified compliance consultants and mortgage training companies can play a key role, especially for smaller institutions that can't leverage the economies of scale that megabanks have.

When selecting a service provider for compliance consulting and training services, it is ideal to have the same company perform both services. Also, be sure to exercise due diligence in your evaluation of the service provider. Ensure it has sufficient experience with your type and size of financial institution and with the mortgage products and services your company offers. Make sure it can effectively identify your current business processes and has the expertise to recommend process improvements that can be achieved through the implementation of new compliance regulations and the ongoing monitoring of existing rules.

Training

Mortgage compliance training should be delivered in a cost-effective manner. eLearning has come a long way in the past few years, and most mortgage lenders have realized the many benefits of interactive eLearning courses for their employees. However, not all eLearning compliance courses and training providers are equal.

If you used a compliance consultant to help your institution improve compliance process efficiencies and the consultant provides mortgage compliance training, then you should insist on compliance course content that is tied to your business process. For example, if the regulation deals with caps on fees and charges, not only should the regulation be explained, but with eLearning, the employee can practice entering data into a simulated loan origination system (LOS). The simulation should be identical to what the employee would experience in a live environment.

Mortgage training will not be cost-effective or deliver the desired results without adequate learning governance. The objective of learning governance is to make training work better for the entire organization. In order to do this, learning must be managed as a strategic business process linked to the company's strategic objectives. Many financial institutions use a learning management system (LMS) application to aid them in the governance process. Large financial institutions generally have their own LMS, but medium and smaller companies can also take advantage of the benefits of technology through a mortgage learning service provider with a robust LMS.

Policies and Procedures

Comprehensive policies and procedures are required by regulators, but more importantly, managers are required to implement a compliance program for their institution and employees. Effective policies and procedures serve as a compliance road map. Policies must reflect your institution's position related to the regulations.

Policies should not be a restatement of the rules, and they must be written in non-legalese language. Procedures express how the company's policies are to be carried out to ensure that effective compliance risk management controls are in place. Policies and procedures must be living documents that allow for timely updates in an easy and orderly manner.

Loan Origination Systems

One of the emerging techniques is to embed policies and procedures with job aids into lenders' loan origination systems (LOSs). LOS business processes and data entry that are impacted by regulatory compliance can have links built into the LOS that reference the institution's policies and procedures. This gives mortgage professionals quick access to information, which helps mitigate compliance risk.

Technology applications that minimize the duplication of activities across business processes and production channels are a cost-effective way to ensure adequate compliance. Information processes should enable a one-and-done intelligent movement of information between legacy systems. If a mortgage operation has one LOS for its retail lending channel and a different LOS for its third-party origination channel, it should consider merging them into one comprehensive system or maintaining a data warehouse that pulls data from multiple LOSs and is the system of record.

Nearly all mortgage lenders today have a technology application for automated compliance testing. These applications need to be integrated into the LOS to eliminate duplication of data entry, minimize errors, enhance controls, and reduce costs. Automated triggers within the LOS are also critical to ensure compliance, but lenders need to take care that the right risk thresholds are set or excessive alerts will occur, hindering productivity and reducing efficiencies.

Compliance Audits

Automated and integrated compliance testing applications do not eliminate the need for lenders to perform compliance audits on a representative sample of transactions. Some lenders separate their loan-level compliance audits from their required credit and collateral quality control (QC) audits. An effective QC program should integrate compliance with credit and collateral in random and discretionary audits. This is especially important as loans are reviewed for qualified mortgage (QM) and ability-to-repay compliance.

If a lender has multiple production channels, senior management needs to see executive summary reports that cover all business channels to help identify enterprise risks. Targeted compliance audits are appropriate when new regulations are implemented or for high compliance alert areas. This ensures that effective compliance risk management tools are in place and corrective action steps for technology fixes are working properly.

SAFE Act

Another area where compliance costs have significantly increased over the past few years is SAFE Act compliance for non-banks. Loan originators working for independent mortgage bankers were not required to be licensed or tested in most states until 2008. Today, non-bankers incur the costs of mandatory pre-licensing and continuing education requirements, as well as extensive criminal and financial background checks by state agencies. Loan officers employed by banks must only register with the Nationwide Mortgage Licensing System (NMLS) and undergo criminal and financial background reviews conducted by their employer. There is a movement within the mortgage industry to standardize the SAFE Act requirements for banks and non-banks, and to build consensus among the states regarding their licensing requirements, which often vary from state to state.

Mortgage bankers retain in-house licensing specialists to keep their company in compliance with the SAFE Act and the multitude of state licensing requirements. The work effort to obtain and maintain corporate and individual mortgage loan originator (MLO) licenses can be daunting for many lenders, especially during the peak periods for annual corporate filing deadlines and MLO renewals. The industry has qualified third-party service providers that can perform licensing services for non-banks on an outsourced basis. Lenders should perform a cost-benefit analysis to determine if outsourcing their licensing functions will reduce overall costs and move fixed staffing costs to variable costs.

Non-banks that originate in a large regional area or across the country should also look at the cost-benefit of operating in all of the states where they are currently licensed or are considering licensing. For example, if your company operates a direct-to-consumer retail channel and only originated a handful of loans in the state of North Dakota last year, does it make financial sense to renew those corporate and MLO licenses?

Staying in Business Requires a Focus on Compliance Efficiencies

Even though it may be difficult for lenders to fully quantify the costs of new mortgage regulations, we do know that the flood of regulations has impacted loan profitability. This has resulted in a reduction in products and services offered by many lenders. Many smaller financial institutions are also consolidating to stay in business by achieving greater economies of scale.

The impact of new mortgage regulations will ultimately be felt by consumers. Therefore, it is critical for regulators to work closely with financial institutions to establish the right balance between regulations designed to protect consumers and the unintended consequences of higher costs and limited access to credit for consumers.

As financial institutions continue to adapt to increasing regulations, there must be a focus on finding the most efficient approaches to plan for new regulations, implement them, establish controls, and monitor for compliance. By building cost-effective efficiencies, lenders can minimize the duplication of activities through smart technology applications and maximize the use of qualified third-party service providers to move fixed costs to variable costs. At the same time, performing cost-benefit analyses when considering new products and services, new business channels, or the expansion of geographical service areas is more important than ever in the new regulatory environment.

Judy Wheatley, CMB, SVP of compliance at Indecomm Global Services, is a recognized expert in consulting and fulfillment services to residential mortgage lending clients. She has actively served the mortgage banking industry as a governor on several Mortgage Bankers Association boards. Wheatley received her designation of Certified Mortgage Banker (CMB) in 2003 and the designation of Accredited Residential Underwriter (ARU) in 1993 from the Mortgage Bankers Association of America. She has a master's degree in sociology from Johns Hopkins University and a bachelor's degree in history from Bethany College.

About Author: blakestepan

CMB, SVP of compliance at Indecomm Global Services, is a recognized expert in consulting and fulfillment services to residential mortgage lending clients. She has actively served the mortgage banking industry as a governor on several Mortgage Bankers Association boards. Wheatley received her designation of Certified Mortgage Banker (CMB) in 2003 and the designation of Accredited Residential Underwriter (ARU) in 1993 from the Mortgage Bankers Association of America. She has a master’s degree in sociology from Johns Hopkins University and a bachelor’s degree in history from Bethany College.
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