Title: Top 5 in '05
1The Top Five in 05
MBA Servicing ConferenceFebruary 21, 2005
2Speakers
- Tony Ebers IndyMac Bank
- Martin Touhey PricewaterhouseCoopers
- Matthew Cosman - PricewaterhouseCoopers
3The Top 5 in 05
- Cost and Capacity Management
- Cash Flow Management
- Maximizing Customer Value
- Operational Risk Management Sarbanes-Oxley 404
Basel II - Repurchase Risk Management
4Industry Conditions Where Have We Come From?
- Interest rates dropped to historical lows before
increasing to levels that remain below historical
averages - Unprecedented refinance volumes came to an end
- Refinance market that favored TPOs and
originators gave way to a greater focus on
servicing portfolios - Operational risk became a greater compliance risk
with the introduction of Sarbanes-Oxley
5Industry Conditions The Present
- Servicing will be the major driver of revenues
float, ancillary income, cross-sell, etc. - Relatively stable servicing portfolios given most
customers have refinanced at low interest rates - Interest rates relatively stable although
continued upward bias - Focus on purchase market
- Focus on cost management
6Industry Conditions The Present
- Development of new products ARMs, Treasury
Index, Interest-Only Loans, introducing
additional servicing complexities - Increased focus on home equity and sub-prime
markets - Customers will use home equity products in order
to avoid losing low interest rates on first
mortgages - Sub-prime customers fully leveraged
- Highly leveraged customers and properties require
robust portfolio management in order to monitor
risk - Local housing bubbles and over concentration
- Monitoring of CLTV and FICO scores
7- Cost and Capacity Management
8Effective Cost and Capacity Management
- Why is it important?
- Servicing is a low margin business
- Excess or over capacity can adversely impact
profitability and customer retention - Some servicing initiatives that focus on cost
improvement and/or customer service could in fact
be damaging the cash flow economics to the
business - Ability to understand cost components fixed vs.
variable, and marginal costs is required in order
to make sound strategic decisions
9Strategies to Manage Capacity
- What is your capacity?
- Cost of excess capacity
- Impact of over capacity
- Outsourcing / Insourcing
- When does it make sense?
- Non-core process typically back-office
functions - Non-preferred customers
- Strategies to mitigate risk
- Rigorous vendor management process and controls
- 404 compliance issues
- Sub-servicing
- When is it advantageous to outsource servicing
10Economics of Sub-Servicing
- Failure to understand the true economics can
adversely impact the business
11Strategies to Manage Capacity
- Consider combining HE and first mortgage
servicing - Cost and service advantages to doing so
- Have a capacity plan in place
- Linked to a robust forecast model
- Segmentation of portfolio is critical varying
service levels
12Managing Costs Effectively
- Avoid blanket cost reductions slash and burn
is detrimental in the long run - Understand your cost drivers imperative to
making correct decisions - Identify value added vs. non-value added
activities and target the high cost / low value
activities for reengineering - Understand channel costs and correctly align
customers with appropriate channels (requires
segmentation)
13Opportunity Matrix - Cost vs. Value-Added
14Managing Costs Effectively
- Measure and understand the costs of excess
capacity and allocate appropriately - Recognize the difference between cost development
and cost transfer - Understand the difference between fixed and
variable cost components to determine the true
savings of any planned initiatives - Understand and measure marginal costs
15 16Cash Flow Management Performance Measurement
- Historic Industry Practices
- Business line priorities are often not aligned
with maximizing cash flows - Capital Markets functions that value the MSR
asset are run distinctly from the Servicing
operations that generate the cash flows intrinsic
in those asset values - Customer related initiatives often do not include
a genuine understanding of the real cash value to
the servicer (e.g., payment campaigns such as
bi-saver) but are instead focused on marginal
cost reductions and customer service values that
are not quantified - Little understanding of actual cash flow
performance
17Cash Flow Management Performance Measurement
- THE SERVICERS WHO WILL PERFORM THE BEST IN THE
COMING YEARS ARE THOSE WHO CAN RECOGNIZE WHEN A
COST MANAGEMENT INITIATIVE WILL BE A DETRIMENT TO
OPERATIONAL CASH FLOWS, THIS REQUIRES - Detailed understanding of costs
- Detailed understanding of operational cash flows
such as float, corporate advances, fee income,
etc. - Performance measures that are balanced between
cost management and revenue maximization
18Cash Flow Management Effective Performance
Measurement
- Building the Right Framework
- Track actual cash flows at a loan level
- Align servicing performance measures with actual
cash flow performance of the MSR asset - Vendor performance measurement includes cash flow
targets and significant controls over cash flow
component - Actual cash flow performance data linked to
pricing models - Actual cash flow data linked to TPO scorecards
19Cash Flow Management Effective Performance
Measurement
- A detailed knowledge of the cash economics of
mortgage servicing is imperative to performing
effective process improvement analysis - Real dollar operational benefits arise as a
result of measuring actual cash flows against
projected and investigating variances and making
operational changes - Not only will it help deliver value to the
company, it will also help meet investor, state,
federal and other requirements for servicing
customer mortgages - Excessive focus on cost ignores the fact that
float revenues often far outstrip costs to service
20Improving Cash Flows Best Practices
- Escrow
- PI Float
- Payoffs and Lien Releases
- Interest Lost on Payoffs
- Ancillary Income
- Service Fees
- Corporate Advances
- Cost to Service
21- Maximizing Customer Value
22Customer Value Industry Conditions
- Industry Conditions
- General move from looking at the business as a
transaction / loan based business to more of a
customer based business - Servicing portfolios are more stable presenting
greater cross sell opportunities - Many servicers have implemented streamline
refinance products to reduce expensive
acquisition costs - Home equity loans are a key area of focus
- Increased focus on up-front data capture to
support retention and marketing efforts
23Customer Value Lifecycle Approach
- It is important to understand the needs of your
many different customers What are the
attributes of your most profitable customers?
24Understanding Customer Value
- Transaction / Loan view
- Minimal customer level data
- Inability to track multiple products
- Little understanding of profitability
- Customer level view
- Customer data collected but not integrated across
all platforms - Ability to track multiple products
- Basic understanding of customer profitability
- Customer retention programs in place
- Customer centric view
- Customer data collected and integrated across all
platforms - Complete customer / product level view
- Detailed understanding of customer profitability
- Segment / customer level service and pricing
25Benefits of Understanding Customer Value
- The goal of understanding customer value is to
measure the total profitability of your
relationship with customers across all products
as well as customers loan level profitability.
This will help you determine campaigns, pricing
incentives, refinance channel direction, and loan
servicing fee waivers. - Benefits
- Reduced hedging costs on CRM campaigns
- Marketing campaigns to profile of profitable
customers - Modification vs. Refinance offers based on
profitability - Fair and consistent fee waiver policy
- Pricing incentives based on total profitability
- Provides customer benefit for an increased number
of relationships
26Strategies to Harvesting Customer Value
- Have a market strategy
- Which part of the pie do you want to eat?
- If not defined you will be left with bottom of
the barrel - Understand your customer base
- Requires ability to segment your portfolio
- Assess customer / segment level profitability
- Develop your customer strategies
- Targeted retention campaigns
- Targeted offers for home equity, deposits, credit
cards, etc. - Service levels channel and customer based
27Strategies to Harvesting Customer Value
- Use customer level data to drive cash flow
results - ACH Targeting Do not convert a customer who
consistently pays on business day 2 to ACH on
business day 7 - MLS listings for proactive retention
- Recognize unprofitable customers
- Target for channel migration
- Sell segments viewed as non-profitable or not
fitting with companys overall strategy
28- Operational Risk Management Sarbanes-Oxley 404
Basel II
29Operational Risk Management Sarbanes-Oxley 404
and Basel II What Are They?
- Sarbanes-Oxley 404 requires management of a
Corporation to state that it is their
responsibility for establishing and maintaining
an adequate internal control structure and
procedures for financial reporting. Management
must also document assertions for what procedures
have been followed and the effectiveness of
these procedures in ensuring accurate financial
reporting as well as compliance with certain FDIC
laws and regulations. - Basel II establishes new standards by which
regulatory capital requirements will be
determined and spans credit, market and
operational risk. In addition, Basel II
introduces new supervisory procedures and the
effective use of disclosure. Management must
understand that Basel II focuses primarily on
risk as opposed to return.
30Operational Risk Management Sarbanes-Oxley 404
and Basel II Does It Impact You?
- For many organizations the value of servicing is
a material asset to the company - As servicing managers you are responsible for
- Protecting the value of the servicing asset
through escrow reviews, default management, etc. - Collecting millions or billions of dollars in
payments and processing them timely and
accurately - Disbursing millions or billions of dollars to
investors in a timely and accurate manner - Mitigating and managing losses as a result of
repurchase or default - Managing large cash flow streams related to
float, fees, advance costs
31Operational Risk Management Sarbanes-Oxley 404
and Basel II Compliance
- Key Risks and Potential Impact
- Financial losses
- Regulator sanctions
- Legal exposure
- Investor sanctions
- Fraud losses
- Repurchases
- Key Servicing Areas Affected
- Default
- Investor Reporting
- Investor Accounting
- Cash Management
- Loss Mitigation and Collections
-
32Operational Risk Management Sarbanes-Oxley 404
and Basel II Compliance
- The need to work with various constituents to
accommodate all internal 404 and Basel II
programs - Work done upfront to identify all significant
risks and controls can lead to stronger controls
and a better understanding of processes which can
translate to redesign to effect more efficient
processes - Policies and procedures will be up-to-date and
will pass regulatory and audit standards - Establish performance benchmarks to measure all
areas of the company (e.g., 404 and Basel II
compliance) - It is important to implement strong controls to
mitigate fraud risks
33- Repurchase Risk Management
34Repurchase Risk Management Reducing Repurchase
Levels
- Strong Front-End Controls - (Get it right upfront
and avoid the headaches this is the greatest
potential for savings) - Rigorous due diligence of third party originators
(TPOs) - Broker and correspondent performance scorecards
that are monitored - Strong system controls in place
- Imaging system in place to store critical loan
documents - Action on root cause analysis
REPURCHASE CONTINUUM
Pre - Origination
Post-Origination Repurchase Request
Loan Repurchased
FRONT END CONTROLS Moderate Cost / High Savings
35Repurchase Best Practices
- Not always going to get it right so, if wrong,
how can you mitigate your losses? - Approval
- Approval levels for all repurchases and
indemnifications - System edits block approval amounts greater than
staff threshold - Repurchase Committee performs monitoring of
repurchase levels assumptions, policies, and
collections
36Repurchase Best Practices
- Centralized Database
- Reduces reliance on Excel and Access databases
- Interface directly to other systems (i.e.,
Servicing, Accounting) - Tracks investor requests and correspondence with
brokers and MI companies to ensure that requests
are processed on time
REPURCHASE CONTINUUM
Pre - Origination
Post-Origination Repurchase Request
Loan Repurchased
MITIGATING CONTROLS Moderate Cost / Moderate
Savings
37Repurchase Best Practices
- Recourse
- Track loans with recourse within the servicing
system - Monitor the accuracy and completeness of recourse
flags - Due diligence of all originated and purchased
loans
38Repurchase Best Practices
- Repurchase Reserves
- Reserve assumptions for loss frequency rates
reflect recent historical experience - Management assumptions for loss amounts are
independently reviewed - Accounting reserve analysis should include
pending repurchases, make-wholes,
indemnifications and feedback loans
REPURCHASE CONTINUUM
Pre - Origination
Post-Origination Repurchase Request
Loan Repurchased
MITIGATING CONTROLS Moderate Cost / Moderate
Savings
39Repurchase Best Practices
- Ensure that proper steps are taken after the loan
is repurchased to reduce costs and future
occurrences - Cure the loan and resell into the secondary
market - Validate that collections are made in full for
all loans with recourse - Implement quality control function to determine
biggest areas of improvement
REPURCHASE CONTINUUM
Pre - Origination
Post-Origination Repurchase Request
Loan Repurchased
BACK END CONTROLS High Cost / Minimal Savings
40Repurchase Best Practices Management Reporting
- Key metrics can include
- Collection rates
- Aging analysis (files, advances)
- of successful appeals
- Overall loss amounts
- Delinquency analysis of indemnification and
feedback loans - Repurchase and make-whole losses by year of
origination and reason for repurchase - Actual vs. modeled assumption analysis
41 42Can you answer the following?
- What are your target markets and customer groups?
- What is the actual cash flow performance of your
portfolio? - What effective controls are in place to manage
repurchase risk? - How do you manage your capacity? What is the
cost of your excess capacity? - What are your cost drivers and how can you
influence them? - Can you measure your fixed vs. variable costs?
- Can you measure customer profitability? How do
you use this information in your service, pricing
and targeting decisions? - Do you measure vendors on cash flow performance
as well as operational performance? - What controls do you have in place to monitor
vendors and / or sub-servicers?
43Summary and Conclusions
- There is a lot to do in 2005!
- Reduce costs the right way
- Increase actual cash flow understanding and
reporting - Re-evaluate customer relationships and
profitability - Comply with Sarbanes-Oxley and Basel II
- Implement front end controls to reduce repurchase
levels in the future
44