Outsourcing some or all of your mortgage administration has been an option for lenders for 20 years and specialist lenders have been a big part of the story. Paul Fenn looks at TPA
2008 marks the twentieth anniversary of third party mortgage administration (TPA) in its present form in the UK. How far we have come since those early tentative days – not just in outsourcing, but also in the mortgage industry as a whole and in the wider world.
In our sector, 1988 is probably most memorable as the year Chancellor Nigel Lawson abolished multiple tax relief on mortgage interest, unleashing a surge of house price inflation as first time buyers scrambled to buy a property in joint names and beat his August deadline.
Further afield, the summer Olympics were held in Seoul in South Korea, Michael Dukakis (whatever happened to him?) was beaten by vice-president George H.W. Bush to be 43rd president of the US, and Prozac was introduced. The Soviet Union was alive and kicking (just about) and the Berlin Wall separated the German Democratic Republic from West Germany. And by the way, the average mortgage rate at the end of 1988 was 12.75 per cent, Bank rate 12.88 per cent and 3 month Libor 13.25 per cent. Eye watering compared with today’s levels – and they were set to rise further over the following two years.
Over those 20 years, we have seen massive growth in the mortgage market, the birth and coming of age of non-conforming, sub-prime, self cert and buy-to-let. Back in the late eighties, the main choice a mortgage borrower had to make was – repayment or endowment? Of course, the endowment mortgage came and went, even though many borrowers continue to rely on their policies either as a means of repaying part or all of their loan or as an additional savings vehicle.
Since then, there has been an explosion both in the number of mortgage providers and in the range of products available to choose from. The mortgage rationing of the early eighties, when it was a privilege to receive a home loan, and when you had to prove you deserved a mortgage and wait for months on end, has (thankfully) faded into the mists of history.
Specialist lenders
The mortgage revolution that has occurred over the two decades was achieved on the back of a large number of new entrants that funded themselves via the wholesale markets rather than from retail deposits. They were quicker and nimbler than many of the existing players, and saw that they could distribute their wares through intermediaries rather than needing to build and maintain costly networks of branches. They identified new categories of ‘non-conforming’ customer – those who were unable to raise a mortgage because of impaired credit, named ‘sub-prime’; the self-employed who needed to ‘self certify’ their income; and the growing breed of investors taking ‘buy-to-let’ loans.
The new specialist lenders whose business models were based on wholesale funding and a direct distribution strategy needed an infrastructure that achieved low costs at launch (when volumes would inevitably be low) but was scaleable to handle growth as the business achieved success over time. Most of the successful start-ups used an outsourced servicing model in some shape or form, and over the past 20 years TPA providers have grown, as their clients have grown, delivering an increasingly sophisticated range of services to meet the evolving needs of those lenders and their customers.
Variable costs
This variable cost model has proved a major benefit to these firms as they cope with growing levels of business – but it also helps them benefit from lower costs at times of contracting volumes. In an industry that has become increasingly ‘best buy’ driven (particularly true with business generated through the intermediary sector), an individual lender’s volumes can fluctuate wildly as the tap is turned on, turned off, and then turned on again.
The current market, with most lenders experiencing a significant downturn in mortgage activity since September 2007, provides ample proof of the benefit of the variable cost model, and those lenders that chose to outsource core business functions will be glad they did so. They are enjoying the advantage of lower costs based on lower volumes, and in many cases have seen less of an impact in terms of needing to rationalise their own operations through unpalatable staff cuts and other cost savings.
Even lenders who service in-house have the possibility of looking at an outsourced option, and indeed in the current environment with a significant degree of uncertainty as to what 2008 may bring, it seems only sensible that any lender that services in-house should at least consider the range of outsourced options available to them.
The capabilities of today’s third party servicers are such that they can offer a flexible and tailored solution to clients and can implement the launch or boarding of assets quickly and with a minimum of fuss. In one recent example, assets were transferred for a lender in under 21 days, reflecting the experience and expertise of the twenty-first century servicer.
Investment in technology
The key for success as a third party servicer is continual investment in technology and people, and ensuring that the servicing offering leads the market rather than lags it. There is no scope for complacency in an industry that is as fast moving and dynamic as ours, and we believe that investment in the latest systems and promoting best practice is vital to our success.
We sometimes say ‘it’s about collecting the cash, stupid’ (with apologies to Bill Clinton) but a highly professional servicer needs to have centres of excellence covering all key servicing functions. Cash collections and arrears management are the most critical, yes, but there is also core administration, securities management, customer service, processing new lending, supporting securitisations (with all the reporting that entails), facilitating whole loan sales, to name but a few.
Menu
In simple terms, an outsourced servicer really adds value when it has the expertise and experience to handle the full range of functions that a lender may require. That does not necessarily mean that a lender must take the full ‘cradle to grave’ service – although of course many do. In some cases, a lender will select from certain parts of the servicer’s ‘menu’. Just as in a restaurant you may choose to skip the starter and have just main course and coffee, so lenders can choose an ‘à la carte’ solution comprising whichever elements of the outsourced solution meet their specific business needs and play to their strengths.
They handle origination themselves, perhaps controlling the pre completion activity in its entirety and contract out their post completion servicing. Maybe arrears will be handled by the TPA servicer, or alternatively the lender may wish to handle the plus 90 day cases themselves in-house. In other situations, a lender may service in-house the assets it generates itself, but will use an external servicer to look after portfolios of loans it buys in the secondary market. It is a highly flexible and tailored solution. With secondary market assets, servicers can help enhance liquidity by enabling pools of mortgages to be transferred quickly and efficiently with minimum delay, cost and inconvenience.
The successful TPA servicer does, however, need to offer optimal service in all parts of the process, and the key elements for this are experience and investment. In order to be able to devote the appropriate level of resource to all parts of the service, the outsourced provider needs to build critical mass.
Quality of service
Size does not always equate to top notch service, but providing the highest quality of service does necessitate constant investment in both technology and training. In our experience, it is essential in our industry to continually invest in market-leading technology and process development. In addition, it is also vital to hire good quality staff and give them thorough training – for example, we run in-house academies for our personnel (many of whom come to us from other sectors) in each of our four geographic locations in different parts of the country.
This level of investment is impossible to achieve without a wide cross section of clients and, of course, a sufficiently large asset base. Over the years we have seen a number of servicers spring up who handle the assets of one, often related, lender and try to win business from others. This model gives them little potential to achieve the economies of scale and critical mass that are key to offering the best price, best quality and best risk management to their existing and prospective clients.
Succeeding in this market is a matter of continuously reviewing the offering and where appropriate re-engineering business processes to make sure they are best in class and indeed setting, rather than following, the market trend. This enables the servicer to respond quickly and efficiently to meet a specific need – for example, what we like to call the ‘bed and breakfast’, where assets can be switched very quickly, for example within the three week timeframe we mentioned above and serviced while the lender builds a portfolio either to sell on or keep on balance sheet and securitise later.
The future
So what can we say about 2008 and the future for the world economy, the mortgage industry and, closer to home, outsourced servicers?
Much remains uncertain. The US will choose a new president in 2008 and, by the end of the year, the American president elect, not to mention the British prime minister, could find themselves facing a much less rosy economic backdrop than either George W. Bush or Tony Blair found in either 2001 or 2005. Even with the work of US treasury secretary Henry Paulson to help struggling homeowners, it looks as if the sub-prime problem in the US will last a bit longer, not least as it looks as if the ‘payment shock’ in 2008 on sub-prime borrowers who took a two year fixed rate in 2006 could potentially be worse than those who took one in 2005.
So far, the sub-prime problem over here has been largely one of sentiment, with little statistical evidence either way as to whether mortgage credit quality has deteriorated to any significant extent. In terms of confidence, however, the industry can do a lot to mitigate the risks and reassure lenders and investors.
Arrears and possessions
In times of rising possessions and arrears, underwriting practices and collection management naturally take on a significantly higher level of importance. It must be remembered that many specialist lenders were only created since the last significant downturn in the housing and mortgage markets, and therefore can benefit substantially from working with a servicer that has been in existence for a long time and can boast the accumulated experience of a strong team of credible individuals with many years in mortgage lending.
As we all know, the origins of the UK ‘credit crunch’ lay in the virtual closure of the securitisation and wholesale funding markets following the problems that arose with the credit quality of US sub-prime loans. The key to the sustained long-term recovery of the UK mortgage market will be a realisation that our lending continues to enjoy a low risk credit profile, thereby reassuring investors that mortgage pools that have been securitised or passed on as whole loan sales remain of good credit quality, and that future ones will be too.
It’s in the more difficult times that servicers really earn their crust. In recent years, with the intense competition for secondary market assets, there was pressure on servicers to cut costs – something that we as a company have resisted, sensitive to the need to provide the best possible risk mitigation service. It was right to resist this. Our industry has an important role to play in promoting high standards in credit management and collections, ensuring that non-performing loans remain low, and helping to restore much needed confidence in the securitisation and whole loan markets.
As the UK outsourced mortgage servicing industry prepares to celebrate its twentieth anniversary, the role our industry fulfils is as important now as it has ever been. Not exclusively the preserve of smaller, start-up or specialist lender, TPA can offer a value-added service to lenders of all sizes and profiles. Whatever happens in the wider world, 2008 will prove a year of renewed opportunity for outsourced mortgage servicers.
Paul Fenn is development director at Homeloan Management Limited
Date: 5th, December, 2007
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