*New Servicing Standards: Obstacle or Opportunity*
**By Barbara Perino and Rebecca Walzak**
***Everyone knows what “standards” are. In fact, we have all grown up with standards. There are standards for when you can begin attending school and when you are able to graduate from school. There are standards for getting your driver’s license and voting. Even as kids there were standards for how tall you must be to ride the fun rides and get into certain movies. So, when the CFPB presented their long-awaited servicing standards there was concern about what they included but no one seemed overly worried about implementing them into their organization.
****Standards have never really been a popular concept in the industry. Mortgage lenders were always part of the banking world and as such were always concerned that standards would unnecessarily expose us to various types of litigation risk. In addition, being able to say we really don’t have any industry standards amounted to a safe harbor if issues of non-compliance to guidelines and regulatory requirements should arise. In other words, if there is no standard how can you say I’m doing it wrong?
****That approach has now gone by the wayside as the regulators and investors have announced their new requirements and monitoring methods for all of us. But what does having standards mean? Are these arbitrary measurements that are in place to punish those who don’t meet them or are they goals to strive for? How will they be measured and will each entity have the ability to determine how that measurement will be conducted?
****The good news is that while we have not had “standards” we have had measurements that were used frequently. The primary one has always been delinquency rate. We have used these numbers to determine everything from quality of origination to the basis of risk-based pricing. Costs were always important as well. Information about the cost of each activity is collected by various companies and offered for sale. Information on various other measures were also collected and distributed. Unfortunately, these measurements were always designed by the owner of the data without understanding how each participant collected the information. There was never any implied uniformity between various issuers of this information and most mortgage bankers were satisfied that they could reconcile their results to one of these options.
****Now however, things are changing. These new standards can mean the difference between success and failure; profitability and loss and that means we need to get the implementation of these standards correct.
****Historically the measurements we used were either the result of something that was already available, delinquency rates for example, or something we implemented over time, the three-day disclosure rule. These new standards are not quite as easy. They require a methodology to implement them correctly and a common way of calculating the results in order to provide the ability to measure effectiveness. After all if the height line changed for every child that wanted to ride the “big” roller coaster, everyone could ride. So how are standards implemented to get the desired results? The most efficient and effective way to implement any type of standard is to incorporate the elements that comprise operational risk; people, process and technology.
****The methodology for implementing standards is consistent with how you measure the risks associated with failing to meet the expectations of those standards. Each element: people, process and technology are involved in one way or another. But in order to make sure it is done correctly these steps are recommended.
****The first step is to define the process. To do that, ask yourself:
****>> What process is involved; loan boarding, collections, payment processing, escrows?
****>> What output is expected of this process and how is success determined? What is the measurement to be used? It is a number, a percentage or some other quantifiable result?
****>> Is it a matter of changing the expected output of the process; changing the entire process or adding a step or a measurement? For example, if today I rely on the student’s grade to determine if they have learned what I expected them to learn but now I must show that they meet a quantified standard, what must I do differently? Do I need to change the education process or simply add a measurement step at the end?
****>> Once that has been determined, establish what new activities have to be added or what existing activities have to be changed. Using the example above, we would have to determine what other activities could measure the results for us, or as in our case, we may be told what to use.
****>> These new activities may involve creating a coding system to track the types of complaints received so that we have an objective way to count them.
****>> Once we determine what the process will be it needs to be documented and added to the policies and procedures manuals as part of the implementation plan.
****Next, we need to determine how they are going to be implemented.
****>> Are they going to be done manually by the staff or will there be a technology fix?
****>> Maybe there is already a way to collect the data using the technology that we have used.
****>> Next we have to engage the people involved in this activity. Is this an additional step that must be taken as part of their function or is it already taking place? Will it be change from the current process that makes it easier for them to do their job or is it more difficult? If it is decided that rather than adding notes to the “note screen,” a code is used to identify the type of complaint received from a borrower, the change may in fact make the job easier to perform and more consistent in the results. Always assuming that changes create complexity, look for the easy and efficient way to accomplish the task.
****>> Once the technology changes, (if required) are in place the personnel involved in the activities must be trained. This process should be formalized rather than “on-the job” training. Making sure the staff is involved and that they understand why the work has to be done and what is expected of them. They will then be more accepting of the change.
****The last step is developing the measurement and monitoring process.
****>> Understanding what the expected output is doesn’t necessarily mean the changes will automatically produce the desired result. Making sure you know what to measure is critical to your success. Furthermore, don’t expect to immediately see exceptional results. The implementation of the change takes times. What you will most likely see is a gradual improving process.
****>> Some of these measurement standards will require consistency across the industry if they are to be meaningful. If every servicer decides what is to be measured and how it will be measured, there will be no meaningful standard. Fortunately, most of the standards involve uniform processes and data, which lend them easily to measurement and reporting.
****>> Once you have determined what the measurement method for this standard is you will need to begin collecting the data. Who collects this data can be determined by the organization, but it should be an entity that can conduct a thorough analysis of the results. While some of the settlement agreements call for a specialized “internal review group (IRG)” others may wish to rely on their servicing quality control function. While this approach is more cost effective, the organization may have to deal with questions from agencies that dictate current QC requirements. Another issue that may have to be addressed is a lack of analytic ability within the QC staff.
****>> Part of the measurement process is to develop an on-going monitoring program. This involves ensuring that the measurement results are communicated to senior management as well as the process manager. These measurements must be incorporated into a continuous monitoring program in order to evaluate the effectiveness of the changes that were implemented. This will allow management to determine what level of risk is involved with the process and determine if it is acceptable.
****>> One mistake that many management teams make is expecting perfection. This is not going to happen. Operational risk studies show that more a process involves humans the greater the likelihood of error. Most frequently these errors occur randomly; humans sometimes make mistakes. Spending time trying to eliminate random errors is a waste of both time and money.
****>> Instead management must understand the level of random errors that will most likely occur in the process. What is the expected error rate? Once this is known, each measurement result can be compared to that level to determine if the process is working normally or if there are improvements or problems.
****>> While this works internally, it does not address how well the company is performing against the standard set by regulators. In order to get accomplishment, these results must be set against the performance expectations of the regulators. If the rate of variation between the regulatory standard is equal to or lower then the company has no regulatory risk. However, if it is greater on a continuous basis, then management needs to investigate why this is occurring and change the process to achieve better performance.
****Is this approach to achieving the regulatory goals of Dodd-Frank, the CFPB and the State Attorney Generals effective? Compare this to the approach that many states have taken to improve their educational systems. They have developed standards for achievement in various levels throughout the educational process and measure them through a testing process. These results are then used to determine what schools are successful in meeting the educational expectations and which are not. And since school funding is typically based on these results, management of the school systems are focused on those that don’t do well. In fact the results of each school is compared to all other schools to inform parents which schools are best and let them decide where they want to send their children.
****Unfortunately our industry does not have the ability to conduct such a comparison, only the regulators have that data and ability. This problem has the potential to cause significant risk to servicers without them even being aware of it or giving them the opportunity to mitigate the risk. It is not impossible to imagine a CFPB servicing review in which the servicer can demonstrate that they have met the standards on a consistent basis and yet have the regulators tell them that they have a problem because the majority of other servicers have better results. Or suppose that one servicer informs rating agencies and investors that they have exceeded all the regulatory standards. It is possible that they will be able to garner more value for their servicing operation than others.
****The only way to prevent these problems from occurring is to develop an industry database that is available to all servicers. It has to be independent of all servicers, sub-servicers and related technology platforms if it is be accepted by everyone. Such a database would allow every member to evaluate the results of their standards against the industry as a whole, determine if their results are acceptable or contain regulatory or competitive risk. If desired, they can identify what level of expense would be needed to improve those areas with which they unsatisfied and proactively begin to improve. Fortunately for servicers the development of such a database is underway and being beta tested. For those with the foresight to recognize the tremendous benefits that can be achieved through the use of such a tool, the opportunities are unlimited.
****While the forced placement of standards on servicers is seen by many as a punishment for the consumer-based problems that we recently experienced, they may turn out to be a blessing in disguise. Servicers now have a way to differentiate themselves from the crowd and turn their efforts into greater rewards. All it takes is a few standards.