Efficient management of a mortgage book and understanding the risks within it will help lenders deal more effectively with arrears. So will linking cost cutting and risk management, says Exact’s Alan Cleary
If it ain’t broke, don’t fix it. Not a bad maxim. But I’ve been thinking about it a bit recently. There’s one problem with it as a principle. How do you define “broke”? Particularly in an economy where the banks, which by all rights should be well and truly broken, have been propped up with state finance - and now seem to be ticking along just fine thank you very much.
For the most part, the building society model is working perfectly well – look at the success of Nationwide. It’s playing to its traditional strengths in its recent ad campaign - 'Solid. Stable. Dependable. Exciting, aren't we?’ And it’s working. Last year Nationwide opened around 5,000 new savings accounts every day. And in its last financial year, around £1 in every £5 deposited in the
But is there some distance between perception and reality? After all, building societies are under the same financial strains as the rest of the banking sector in the
House prices are still falling.
The vast sums of money societies are having to fork out to reimburse savers hit by Bradford & Bingley’s collapse and the implosion of Icelandic banks via the Financial Services Compensation Scheme are also taking their toll on building society profits. The historic failure of the
What’s more, investment in whole loans originated by specialist lenders and other banks has put strain on the mutual sector. One of the criticisms levelled at the
With government controlled banks under so much pressure to offer competitive mortgage and savings rates to consumers - and with the Bank Base Rate at a paltry 0.5 per cent - building society margins are being squeezed to the point of non-existence.
So it’s no small wonder that I’ve heard so many people in the industry suggest the circumstances point to just one outcome – job cuts across the mutual sector. Clearly, building societies can’t afford not to be commercial and while I think there may be some scope for trimming a bit of fat, the thing about building societies is they’re community-based. Traditionally, they do not put profit over welfare. In my view that should continue. They may not need profits to siphon off to shareholders, but they do need profits if they want to pay off FSCS bills and recapitalise balance sheets to ensure their long-term survival – particularly in lieu of Moody’s downgrades.
Cost cutting
So the question is – how do building societies go about boosting profits? In a downturn the only way to do this is by cutting costs.
The solution is risk management. That might sound counter-intuitive. But linking cost cutting and risk management comes back to my opening mantra - though the building society model might not be broken, the landscape in which they operate is now so different from the ones they’ve operated in for the last 250 years that some modification might not go amiss. Against this background, improving risk management can be viewed as “tightening the ship”. All lenders know they have to tighten new lending criteria to control costs. And they realise they have to streamline operations so they don’t have money falling through the net when it doesn’t have to. But few lenders have yet got on to the larger problem of managing their back books efficiently. These loans already exist – loss severity is already predicted. Case closed?
Managing existing loans
On the contrary – it’s the efficient management of these loans which will sort the wheat from the chaff in this recession. Lenders and building societies which fail to predict (and subsequently manage) both their operational and credit risk are not long for this world. It’s happened too many times now for any mutual to think it’s immune.
The first step is to understand the risk on a mortgage book. All lenders have loans on their books which date back to the pre-credit crunch era – those mortgages were written in a benign economic environment and the truth is, no matter how efficient the underwriting at that stage, things have changed.
Reassessing existing mortgage accounts offers the kind of transparency lenders have with new mortgages. It’s important to understand more than just whether the account is current with its payments – knowing what a borrower’s unsecured debt is, what their outgoings are each month can offer insight into their propensity to pay. Similarly, understanding the severity of losses on specific mortgage accounts allows more efficient risk management.
For example, negative equity is a theoretical loss for the lender as long as the borrower continues to pay each month. If a mortgage is three years old, there is every chance the lender doesn’t know how much the property has fallen in value – a city-centre new-build in Leeds two years ago is not going to be worth the same as a detached house in the a leafy Southern suburb – even if they were both £500,000 three years ago. Say borrower Smith lives in the urban bachelor pad, and three years ago took out an interest-only 110 per cent loan-to-value (LTV) mortgage. If Mr Smith unexpectedly loses his job and can’t afford the mortgage payments, what appeared to be a performing account and of little concern turns overnight into the potential for considerable loss.
Arrears and possessions
Arrears and possessions are rising fast. Statistics released in February this year from the Council of Mortgage Lenders revealed that 2008 saw 40,000 repossessions in the year – the equivalent of one in 290 mortgages. The same analysis also showed one in 64 mortgages was in arrears of 2.5 per cent or more. The CML is forecasting a whopping rise in repossessions to 75,000 for 2009. Unemployment is already over two million and we haven’t heard the last swing of that axe.
Understanding your mortgage book and how to maximise the returns seen from collections departments is key to surviving this recession and emerging stable at the other end. Cash flow is king, and making every penny work – even if it’s simply a matter of managing suppliers more tightly - is what sets the successes apart from the failures in this environment.
Lenders are under growing pressure from the Financial Services Authority to treat customers fairly, and with the introduction of various government schemes to protect homeowners, including Mortgage Pre-Action Protocol and the Homeowner Mortgage Support Scheme, the management of arrears and possessions is becoming a minefield. So lenders need to maximise recovery in collections while treating customers fairly in the process. One solution satisfies those two requirements. As long as you treat borrowers as individuals, you maximise the likelihood of recovering some of their arrears because you have understood their financial situation properly, thereby adhering to the principles of TCF.
Collection strategies
Assessing the best collection strategies for borrowers in arrears can be costly and time-consuming for businesses without specific experience. How much have mutuals needed to know about the make up of their mortgage book in a benign economic environment? Most mutuals remained conservative lenders throughout the late nineties and early noughties boom time. LTVs in excess of 100 per cent were virtually the exclusive domain of the banks. But even the most conservative of lending practices doesn’t insulate mutuals from the threat of arrears burgeoning because customers are being made redundant. Even prime arrears are rising surprisingly fast. The need to understand exactly how those assets are performing in today’s economic environment is crucial - not only for risk management and
This is when the use of credit assessment and analytics comes into its own. Traditionally, collections has been a matter of calling and sending letters to borrowers who have gone into arrears. It was a volume churn business – and in the benign economy, it minimised losses to the extent that anyone cared. But with such a rapid increase in arrears, it’s become more important that lenders manage credit collections efficiently. Understanding borrowers’ propensity to default before accounts go into arrears allows lenders to manage risk far more efficiently and cost effectively than arrears management on a reactive basis.
With collections departments growing exponentially, there is an opportunity for building societies to improve their operational efficiency. The large number of people requiring help and advice about their arrears is only going to keep rising – building societies as well as banks must be ready to meet this new demand from their customers. The CML recommends that “against this backdrop of regulation and enforcement, staff training is essential for your business”.
Options
There are several choices. Mutuals could retrain their existing staff in collections and field counselling – effectively reallocating resources to the areas of the business which demand it. Alternatively, they could continue business with the arrears and possessions management team they already have in place - and outsource overflow to a third party special servicer. Or outsource this part of the business completely to a third party with the resource to manage collections professionally and cost effectively.
It’s not always easy to see where improvements should come from inside the business, but companies like Exact are now offering internal audits covering aspects of the business such as risk management, operational resource, training, IT, MI infrastructure, systems and business strategy. A view from outside could offer mutuals the perspective needed to realign business practices to recover value which exists in the current model but is slipping through the net. Building societies must cut costs if they are to survive. But there are ways other than job cuts to achieve efficiency. And they’re mutually beneficial.
Alan Cleary is managing director of Exact Mortgage Experts
Date: 2nd, June, 2009
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