The mortgage industry is finally becoming standardized.We have toyed with ideas like E-Mortgages and MERS, but they have not moved the industry in ways that maybe they could have.FHFA was explicit in their Strategic Plan Freddie Mac and Fannie Mae that standards will be created dictating how others will do business with the Enterprises and in the industry going forward.What is happening now, and what is on the horizon may be truly revolutionary.As defined by Merriam Webster, a standard is something established by authority, custom, or general consent as a model or example.When thinking of the word standard, I quickly think about terms such as rigid, inflexible, and boring.I believe in this case the new standards have the potential to make the industry truly dynamic.
Laying the Groundwork
In April the GSEs started a new era when they accepted information from their customers using the standard data sets defined under the Uniform Mortgage Data Program.It may cause risk and control issues in the short run and could result in bad data if bugs exist in the system.At some point soon thereafter, however, everything will run smoothly as it did for decades using the old, proprietary data sets required by Fannie and Freddie.But something else will happen that will benefit all companies who sell to the GSEs.They will be able to do business with both entities without having to change their internal systems and processes.For years most small companies were beholden to one or the other GSE, but not both.The costs of having two very different processes and system interfaces were prohibitive.This will no longer be the case.In fact there is no reason why there can’t be more GSEs in the future.Even better would be a world where FHA and GNMA get involved, and I know that the dialogues have started.
What won’t change in the short run are the existence of Desktop Underwriter, Loan Prospector, and the FHA Total Scorecard.The investor/insurers will still need to maintain their proprietary decision engines and pricing mechanisms on a go forward basis unless a radical change is mandated through GSE reform.
Moving to the Next Phase - Servicing
During 2011 many things were announced related to the Servicing Alignment Initiative (SAI), and new guide language was set in place.Now doing business with Fannie Mae and Freddie Mac in the servicing space will be the same, or at least on a track towards what is occurring on the purchase side.What the industry needs are standard data sets for the industry based on MISMO that will be adopted in a similar manner as what occurred for loan delivery.Given the chaos in the default space, it may not happen on my timeline, but it will be here before long.
Related to decisioning and edits on the servicing side, there is a unique opportunity for someone to emerge with a tool that will store all of the edits and rules required by SAI.For years the model has been one where the primary servicer performs their work on a proprietary system or using a major service provider such as LPS.In either case the servicer would send information to the GSE and wait for messages back that validate whether it was accepted or rejected, how much is owed, and so forth.With SAI, the rules are all public information and standard across both entities.It seems logical that servicers should be able to ensure that their information is complete, timely, and accurate prior to submitting to the GSEs.With a standard data set across the industry and a standard validated set of rules, it should be simple to streamline the processes.This type of process flow and architecture will save time and money for both the servicer and GSEs.Unlike underwriting, there is no inherent benefit to the GSEs or the industry to keep the decisions in a black box.In fact, it is quite the opposite.A standard set of data and rules for servicing would become the industry standard on a go forward basis.Perhaps MISMO could tackle this as well.
On January 11, 2012 the CFTC approved the final regulations for the Protection of Cleared Swaps Customer Contracts and Collateral Conforming Amendments to the Commodity Broker Bankruptcy Provisions.
In the Cleared OTC derivatives trading framework, derivatives counterparties have to post collateral for trades with their FCM.In its final rule pertaining to cleared swaps collateral treatment by the FCM and DCO, the CFTC adopted the LSOC Model (Legally Segregated Operationally Commingled Model). Position and collateral treatment pre-FCM- and post-FCM- bankruptcy under the LSOC Model is as follows:
Pre-Bankruptcy of FCM:
FCM and DCO must segregate customers’ collateral of cleared swaps from their own obligations and from the obligations of customers with non-cleared swaps.Additionally, FCM and DCO can commingle the collateral of all its cleared swaps customers in one account.
Post-Bankruptcy of FCM:
FCM bankruptcy resulting from operational or investment risk - FCM Customer positions and collateral can be ported or delivered to the trustee after their pro-rata share in the shortfall is deducted ( per US Bankruptcy Code)
Additionally, FCM bankruptcy resulting from customer account shortfall (“double default”): 1.) DCO will have access only to the defaulting cleared swap customer collateral to cure a FCM bankruptcy 2.) Collateral of non-defaulting cleared swaps customers can be ported and 3.) DCO may liquidate positions of both defaulting and non-defaulting customers
The rule specifies that investing of customer collateral has to follow CFTC Regulation 1.25 as amended periodically (which specifies the securities, minimum ratings, concentration limits, liquidity, etc) but allows the FCM and DCO to denote the type of collateral they would accept.
Actualize View
(I) The LSOC Model offers protection for instances of “fellow customer” risk where the FCM defaults because it cannot meet its defaulting customer’s obligations. But the LSOC Model does not protect against FCM bankruptcies akin to MF Global’s which are due to the FCM investing and/or transferring customer funds to meet margin calls of its trading counterparties.
(II) Parties to cleared swaps contracts need to be aware that because the Dodd Frank Act specified that cleared swaps be treated as “commodity contracts”, they will not be subject to the protections afforded to uncleared swaps under the US Bankruptcy Code.
(III) Cross-product netting between commodity contracts and other contracts (uncleared swaps) held at the defaulting FCM needs to be addressed.
Swap participants - keep records throughout swap existence and up to five years following swap termination. The speed of retention following termination varies depending on the band categorization of the swap participant (e.g. Swap Dealer(SD)/Major Swap Participant (MSP) vs. non SD/MSP).SDRs must keep records throughout the existence of the swap and for fifteen years following swap termination
2. Reporting to Swap Data Repository (SDR)
Responsibility for reporting swap data to SDRs will vary on a number of factors including:
·Whether the swap is cleared through a CCP
·The categorization of the swap participant
·It the swap has just been executed (Creation Data), or if the terms are being amended (Continuation Data)
·Reporting entities will need to code and include: Unique Swap Identifiers, Legal Entity Identifiers, and Unique Product Identifiers
3. Third Party Providers may be used to manage reporting to SDRs
Compliance Date
Tiered depending on the asset class and categorization of swap participant with initial compliance date is the later of one of the following: 1.) July 16, 2012 or 2.) 60 days after CFTC finalization of rule definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant” (expected in Q2).
Firms project likely compliance dates based on their analysis of asset classes and projected band of swap participation and Firms determine if they want to manage reporting themselves, vs. assess and contract with third party vendors.
On January 11, 2012 the CFTC approved the final regulations which establish the registration process for swap dealers and major swap participants.The commission has delegated to the National Futures Association the responsibility for the administration of swap entity registration.Because the rules that define the terms swap dealer (SD) and major swap participant (MSP) and the term swap have not yet been finalized, the registration requirement will not be mandatory until those rules are finalized.According to the CFTC’s schedule of expected rulemaking, these rules will be finalized by April 2012.In the meantime, entities that believe they are swap dealers or major swap participants can register provisionally with the CFTC
A SD/MSP becomes ‘provisionally registered’ once they: 1) file form “7-R” 2)file form “8-R” and a fingerprint card for each principal in the SD/MSP and 3)submit any documentation required under the section 4s regulations (the specific documentation that is required is not discussed in the rule). Section 4s is a new section the Dodd-Frank Act has added to the Commodity Exchange Act.It requires registered SDs/MSPs to meet specific requirements in the areas of capital and margin requirements, reporting and recordkeeping requirements, daily trading record requirements, business conduct standards, documentation standards, trading duties, designation of a chief compliance officer, and segregation of customer funds associated with uncleared swaps. Section 4s enumerates the areas for which requirements are needed but does not actually provide requirements; they are to be detailed in separate rulemakings.
A SD/MSP becomes fully registered once the NFA confirms that the registrant has demonstrated initial compliance with section 4s regulations and full compliance with all other registration requirements.
Persons associated with swap entities (aside from principals) are not required to register.However a swap entity is prohibited from permitting an associate person to effect or to be involved in effecting swaps on the swap entity’s behalf if that person is subject to a “statutory disqualification” under sections 8a(2) and (3) of the Commodity Exchange Act.In other words, associated persons involved in swap dealing do not have to register but they must meet the standards of someone who could register successfully.
The proposed registration rule requested comment on the application of the swap entity registration requirements to those entities based outside of the United States.The final rule specifically declined to address this issue.As per the CFTC’s schedule of expected rulemaking, extraterritorial issues will be discussed in a proposal to be released after March 2012.
Actualize View:
At this point it is advisable to wait to register.This recommendation is based on the following factors:
·A registration deadline has not yet been defined
·The section 4S requirements are not complete and any registration would need to be updated as these requirements become complete
·Filing early does not provide an advantage because the actual registration process is simple and does not require much preparatory work, and because registration is valid as soon as the required documentation is filed
In recent years the competition within the financial services industry has intensified due to a severe and prolonged economic downturn, tight credit markets, legislative and regulatory pressures, and a consolidation of many of the top players.Profits have taken a massive hit and IT budgets have been slashed.In order to survive in this challenging and unprecedented environment, firms need to take advantage of technology advances, improve customer dedication, and reduce their time to market with innovative, new services.Unbelievably, many financial services firms are not utilizing an organized approach to addressing these challenges.They indiscriminately throw dollars at a myriad of ad-hoc solutions, hoping for favorable results.
Instead of this scattershot approach to deploying limited resources for business and IT initiatives, a structured mechanism called Project Portfolio Management (PPM) can be used to drastically increase a firm’s chances for differentiating themselves from their competition.By implementing PPM processes, a financial services firm can align the allocation of resources with agreed upon corporate objectives.
PPM is a method for analyzing, prioritizing, selecting and collectively managing a group of current or proposed projects based on numerous investment criteria. The fundamental objective of PPM is for management to identify the optimal mix, sequencing, and resourcing of proposed projects to best achieve the organization’s overall goals while taking into consideration internal (budgetary, resource, management, infrastructure) and external (market factors,regulatory, legislative) constraints.
A governance team comprised of Business and IT executives selects the optimal portfolio using tools agreed upon by the group.Once the approved portfolio is selected, the projects are monitored and the portfolio is adjusted, when necessary.Portfolio monitoring and governance mechanisms are put in place to constantly evaluate individual projects as well as the entire portfolio.Once a project is delivered, an evaluation is conducted to quantify business benefits and to identify project and portfolio lessons learned.
In order to adjust to ongoing financial industry market shifts (stricter oversight, lower credit growth, and changes in customer preferences), technology must be seen as the great facilitator, the mechanism to build a positive relationship with the customer.Successful companies will fund the business and technology projects that will offer services that will expedite success.By implementing a PPM structure financial services firms can better navigate the ever-changing market landscape and achieve significant benefits: 1) selecting the right projects, 2) reducing cost per project, and 3) increasing financial return.
PPM is a great start towards focusing on the right service and technology offerings, but implementation requires commitment from Business and IT management.Each group must independently buy-in to the value of establishing PPM processes and then be equal participants in the ongoing management and monitoring of the project portfolio.Without this collaboration, PPM will fail.
The successful implementation of PPM requires organizational and procedural planning.Do not skip this step.If your firm lacks the necessary PPM expertise to develop and implement a PPM plan, there are external resources that can assist with both the preparation and implementation of PPM.Once the optimal organizational structure and initial processes are established, there are a myriad of software tools to assist with the management and monitoring of your project portfolio.
The most severe economic recession since the great depression dramatically impacted all sectors of the financial markets. The effect on the mortgage market and on loan servicers specifically, forced a paradigm shift in the business model. Large volumes of non-performing loans, multiple and complex loan modification programs, increased scrutiny and regulation and a heightened awareness by customers and the general public are the new reality.
A thorough review and assessment of loan servicer business operations is imperative and must address compensation, staffing and training, data management, compliance and reporting, default servicing improvement, technology infrastructure and effective application of software solutions.
Current State
Servicers are not the root cause of current problems, but they are an important part of the solution. The deluge of delinquencies and high volumes of foreclosure were unanticipated and unforeseen consequences of a housing bubble. Servicers weren’t expecting it and their operating models weren’t designed to handle it. The results are higher costs and lower productivity over the last 5 years.
Loan servicing is essentially two distinct business processes:transactional and administrative.
·Transactional processes: routine, standardized and generally referred to as reporting and remittance
·Requiring decisioning and ‘hands-on’ interaction.
·Have been more limited in automation and are not easily scalable
Since 2007, revenues are down and expenses are up. The Private Label RMBS market is essentially frozen. Hard costs are up. Delinquency rates are at four-to-five times historical levels. Fewer loans are being originated. Loan balances on the new loans tend to be lower. Demand for specialty servicers is at an all time high.
Servicing fees can range from 25bps to 50bpsdirect servicing costs can range from 15bps to 20 bps. Corporate allocations add 2-4 bps. Higher rates of servicer errors, Increased unreimbursed foreclosure and REO expenses, property inspection and preservation costs, and advances due to higher delinquency rates and longer foreclosure time lines put pressure on profitability.
Future State
Increased reliance on technology will require higher levels of expenditure. Future state will include national servicing standards, increased legal and legislative involvement, and changes to servicer compensation. Investors and rating agencies will stipulate more stringent requirements. Regulators will mandate compliance. Issuers and guarantors will implement performance metrics and fees and penalties for poor servicer performance.
Regulation will increase: Dodd-Frank and the Consumer Financial Protection Board regulations, FHFA Servicing Alignment Initiative (SAI) and GSE revised servicer performance metrics (STARS for FNMA and SSP for FHLMC).Changes include specific performance measures and monetary penalties for non-compliance, increased repurchase demands and limiting or in some cases terminating servicers.
Business Process Assessment
Costs and efficiencies will be achieved through refined and/or redesigned business processes. Servicers will employ new technology to leverage personnel and increase productivity. Emphasis will be on capability, capacity and cost. Individual recommendations should be documented and a formal implementation roadmap prepared and executed. An effective assessment supports recommendations to refine and redesign policies, processes and procedures, effectively manage staffing needs, enhance automation and leverage technology.
Servicers need to conduct a thorough business process and technology assessment:
·Identify areas of improvement to existing processes and systems
·Encompass all loan servicing functions
·Include all internal and external service providers and consumers
·Technology assessments should include software, hardware and personnel
·Focus on current high cost/high visibility issues for performing and non-performing loans
The business assessment process should constitute:
·Discovery- reviews existing policies and procedures
·Current State Assessment- a holistic view of all departments, systems and personnel
·Risk Assessment-specific risks are identified relative to each process
·Gap Analyses- differences or deficiencies between the desired state and current state
The entire mortgage industry is at a cross roads.As we traverse through the chaos caused by the housing industry collapse companies are faced with huge inventories of defaulted loans, new mandates from Dodd-Frank, and real pressure to reduce costs.This combined with multiple mergers and acquisitions has resulted in fragmented data and software platforms that can’t keep up with the changes and demands in this new world order.Throughout all this the Mortgage Industry Standards Maintenance Organization (MISMO) has been working to provide key data standards for the entire mortgage process.Moving to a MISMO-based infrastructure may require an up front investment today, but in the intermediate and long run will result in the ability to be more agile and manage costs more effectively.
MISMO is an all-volunteer organization, organized as groups working committees of industry experts from across the country that promotes data consistency and transparency through standardization across the single family, commercial, and multifamily sectors.
As beneficial as MISMO can be for many companies, there has been little reason historically to convert.Converting to MISMO requires an upfront investment that can be fairly small for community and regional lenders to millions of dollars for national lenders.With all of the pressures to reduce spending it has been a tough business case to make, especially when business is down and defaults are up.Even with the market turmoil and political and regulatory uncertainty, now is the best time to consider an investment in moving to a MISMO-oriented architecture.
It is inevitable that everyone doing business with Freddie Mac or Fannie Mae will need to create MISMO-compliant interfaces to these entities just to do business.FHFA has orchestrated cooperation among the players that is resulting in standardized data sets and formats for appraisal and delivery.The Uniform Mortgage Data Program (UMDP) is here to stay.Due to the standardization of data sets across the industry the major service and information providers like LPS, Core Logic, First American, Trepp and others will be forced to move to these new standards in order to remain competitive.Certainly they will offer backwards compatibility for a time, but eventually it will become a cost burden to maintain the legacy standards.This is also true of software firms offering loan origination, underwriting, servicing, secondary, and other tools.
Expect to see additional data sets announced as a result of the Servicer Alignment Initiative and other coordinated efforts.
For small companies who are in a spreadsheet environment or who use a combination of end user and off the shelf packages a MISMO oriented approach will allow for rapid change coupled with standardization required for controls.Nearly all off the shelf packages will move to a MISMO compliant or MISMO “friendly” standard which means that you don’t need to be bound to one software or another due to high switching costs.Creating spreadsheets, uploads, and reports based on MISMO will allow for the use of new packages or multiple packages without the need to constantly create your end user applications from scratch.
For larger companies with large databases, warehouses, and proprietary models the move to MISMO may be quite expensive.It will require a concerted effort, time, and money to create a MISMO-oriented architecture, but the payoffs can be huge.
Companies have, for the most part ignored the need to integrate purchase and servicing platforms as a result of mergers and acquisition activities.In some instances it is virtually impossible to integrate the data fast enough to provide executive level information on a timely manner.Making incorrect business or operational decisions due to poor data quality can be devastating from both a cost and controls perspective.
Utilizing MISMO - a standards-based, industry-proven enterprise data model for mortgage processing - as the backbone of an integration effort means that these companies can eliminate the high-dollar and time cost of defining their own proprietary data models, data models that will likely be inferior because they replicate existing shortcomings or short-sighted address a subset (the in-focus hot-spots) of what’s needed. Additionally, a MISMO-based approach will position these companies for easier integration of commercially-available tools and platforms, as these platforms themselves will be moving to MISMO. Similarly, a MISMO-based approach will provide for seamless interfacing across the mortgage processing chain - servicers to interface seamlessly with originators, sub-servicers, data providers, and the secondary market.
Ultimately the move to MISMO will become a competitive advantage.The companies that move to MISMO first will have a huge head start on the competition.Having a nimble data set will allow the rapid launch of new products and will provide the agility to react to regulatory changes and mandates.Companies with a flexible data set will quickly be able to make changes to interfaces, models, and reports.Companies with fragile infrastructure will need to react under pressure by throwing bodies at the problem and may run the risk of non-compliance at the very least, but ultimately they will be passed by their competitors.The mortgage market will rebound at some point over the next several years and those with a competitive advantage will thrive.
In summary, the real question is why wouldn’t a company move to MISMO. Those companies who move to a MISMO oriented architecture will be able to compete in the future. Those who stay in their current environment may become less relevant.
