Servicing's next phase: the servicing business is moving into a new phase where outsourcing becomes central and business process management is key. Pulling together all the disaggregated functions into a functioning enterprise will be a major management challenge.

DRAMATIC CHANGE IS OCCURRING IN THE SERVICING WORLD. It's enabled by technology, but it's based on management's need to reduce costs, streamline operations and improve flexibility. This is forcing the nation's servicing companies to redefine what they do and make decisions about how they treat the information that flows through their companies. [??] As technology becomes more standardized across the industry, these decisions will be the sole basis for competitive advantage. Firms that hope to thrive in the days ahead must carefully consider their options today. [??] It wasn't that long ago that most mortgage loans were serviced by a single company, usually from a single geographic location. A bank of telephones and a database allowed a company to track its borrowers as their mortgage liabilities were slowly satisfied. The subprime lending industry was in its infancy, so the vast majority of loans were easy to service. Exceptions were rare. [??] As the best of these companies grew, they opened more call centers across the country to more easily service different time zones. Simple data routers and dedicated telephone lines kept all company employees on the same page, regardless of their location. Borrower information was generally centralized, allowing the same managers to oversee the growing organization.

But by the time the industry rolled into the most recent refi boom, the servicing function had changed significantly. The proliferation of loan types created complex servicing challenges. The transformation of the subprime niche into a major market segment further intensified those challenges.

With trillions of dollars of new mortgages to board and intense portfolio runoff to manage, servicers could only survive with the help of subservicing partners. Outsourcing was not just convenient--it was essential.

However, as outsourcing businesses continued to add new clients, they realized that working within each client's servicing system limited their ability to be efficient across their entire customer base. In order to create the scale and system utilization they required to grow and become more profitable, many of these third-party providers began creating or commissioning proprietary solutions.

For a little while, these unique solutions gave some servicers a competitive advantage. Certain integration issues (including the security issue) had to be addressed when these companies connected their systems to their clients' primary platforms--and technology innovations helped overcome those issues.

In today's environment, we see servicers outsourcing to subservicers who, in turn, outsource pieces of their operations to additional third parties. The job of servicing a mortgage loan is no longer a simple process, and vendors have targeted elements of that process to create highly niched specializations.

Decisions to make

But as origination volumes drop and capacity is freed up in servicing assets, servicers have important choices to make.

First, servicers must decide to either use existing technology to bring all the servicing functions back under one roof, or use that technology to take advantage of outsourcing opportunities.

The industry's top loan servicing technology platforms provide all the required functionality to service any loan product in the portfolio and bring economies of scale to the servicing enterprise. The question is, what is the best way to leverage that technology?

Over the past few years, some third-party service providers in the mortgage servicing industry have developed excellent value propositions for their clients by focusing on discreet parts of the business. In fact, this increasing specialization offers the servicing industry one of the most attractive opportunities it has ever had.

The concept of business process outsourcing (BPO)--where specific functions are outsourced--has not only taken hold in the mortgage industry, but technology is allowing it to expand at a rapid pace.

As a result, outsourcing in the mortgage industry can take many forms: private-label subservicing, subservicing and outsourcing of functional and business projects. Add in the outsource-support resources located near shore and offshore, and the possibilities--and the challenges--become exponential.

The lure of outsourcing

There are many reasons servicers find the outsourcing solution attractive, not the least of which is proven success. A classic example is the use of outsourcing for property inspections.

Servicers have been outsourcing property inspections for defaulted properties for decades. Rather than sending their own personnel to determine the condition of properties in their portfolio, servicers often outsource that work to a third party already in the area. Today, with digital cameras attached to cellular phones, a servicer can literally be on the scene via its technologically advanced outsourcing partners.

In most cases, the servicer uses the Internet via e-mail or a transactional Web site to place an order for a property report with its inspection partner. The local inspection firm accepts the order, sending back an automatic acceptance notification. On-site inspection professionals use form-filling software to complete their report on location, attach digital photographs of the property, then send the data back in an extensible markup language (XML) stream directly to the servicer's database.

Outsourcing has gained acceptance in the mortgage industry, largely because of high-profile successes in other industries. The following are some notable examples:

* The health-care and insurance industries have found it expedient to outsource a number of processes within the document-management function. Medical transcriptionists, working from locations all over the world, use technology to receive their assignments, transcribe medical records from digital voice files and electronically return the completed transcribed records to the physicians.

* In the U.S. automotive industry, primary manufacturers put their brand names on vehicles--but everything from fabrication of parts to vehicle assembly, and even management of plant waste, is outsourced to tier-one suppliers who, in turn, often outsource to other third parties.

* Computer software development projects are now being accomplished using programming talent that resides around the country, or in near-shore and offshore locations. Corporations use technology and vendor management solutions to send various parts of major projects to third-party service providers for completion, then "assemble" the programmed elements into the final product.

In the mortgage industry, there are many successful precedents for outsourcing. Servicers have outsourced data processing to firms such as Fidelity National Financial (FNF) for decades. Processes related to default servicing, including bankruptcy and foreclosure processes, are now regularly outsourced. As technology and data standards have evolved, it has become safer and easier to send sensitive customer data outside of the enterprise and across the Internet.

Information management, tax and insurance administration, and escrow management are other proven mortgage industry examples. Servicers are finding better economics, less risk and faster service when they outsource many of these functions to niche providers. Even customer service, considered a core competency by many in the financial services world, is being outsourced to third parties. Scalability and access to lower costs are powerful motivators for doing so.

The ease of scaling volume requirements up and down and the avoidance of costly investments in offices, staffing and technology make outsourcing solutions attractive. And since outsourced partners are niche specialists, they usually track, measure and analyze reams of data related to their specialty. As a result, servicers often can get much better information about processes and functions by outsourcing them. Outsource partners often bring better management, control and knowledge of the risks involved in their specialty.

In the drive toward constantly improving efficiency and cost containment, subservicers are starting to analyze their businesses much like a general contractor does in the construction trades. While the general contractor may handle many of the processes involved in a project, many others are managed through outside companies. In some unique cases, subservicers are taking responsibility for the servicing and then farming some of the work back to the company that gave them the contract in the first place.

The technology for the job

Loan servicing technology was admittedly simple in the beginning. All that was really required was a dependable database and the ability to easily post payments to an account. But as the industry grew, the platforms grew with it, eventually adding all of the functionality required by the modern servicing shop.

In the domestic loan servicing business, the market has been dominated by a couple of large technology players. The platforms offered by the industry leaders have evolved over time, not only as in-house strategists anticipated or reacted to marketplace trends, but also as a result of partnering with customers to develop custom applications.

Eventually these custom features became standard functionality in today's servicing systems, and included comprehensive subservicing and private-label servicing capabilities for those providing outsourced solutions to others in the industry. Yet despite this progress--or perhaps because of it--it's becoming increasingly clear that technology, by itself, will not constitute the strongest competitive advantage in the mortgage industry of the future. Success will depend more on how companies use technology, rather than how quickly or affordably they can create new software to solve old problems.

The credit card industry learned this lesson some time ago. Companies operating in that space are typically working on a single platform, differentiating their companies by the unique ways they use their system. The mortgage servicing industry will eventually follow suit.

This is a shift from industry thinking of just a few years ago, when the "secret sauce" of a proprietary technology was attractive to a servicer in search of its primary platform, or even from its strategic subservicing partners. However, that sort of highly customized development work is not the most efficient or economical way to operate.

Top industry players are now suggesting that technology should allow business partners to share information, while remaining flexible enough that it can be tailored to a firm's individual methods. Reinventing the wheel is old-school thinking.

At the same time, the mortgage industry is not static. As different parts of today's distributed servicing architecture change, new integrations are necessary to keep systems working properly. According to one industry chief information officer, the way to reduce technology maintenance costs is to create simpler systems without using so many proprietary software elements.

"With Web services, workflow and business rules now readily available, the day is soon coming when powerful, simple systems using the latest technology will be assumed as the entry-level standard," says this CIO. "I believe that in the foreseeable future, the number of platforms will shrink to just a few. Servicers will compete on the basis of their unique service strategies instead of technology differentiation."

Servicers should start looking now for a technology partner that can not only deliver current, cutting-edge technology, but can also work to accommodate their own differentiated approach to doing things. These technology providers realize that their systems exist to serve the business strategy, which varies from one servicer to the next.

Today, no servicing platform offers all of the functionality that will enable servicers to fully capitalize on the trend of business process outsourcing.

As servicing platforms expand, bringing functionality that was formerly "surroundware" into the main offering, servicers can expect a modular approach, rather than a big-bang approach to system enhancements.

The concept of the virtual servicer

As servicing technology gets better at enabling the outsourcing of discreet processes, the question becomes: How far can we take it? The right technology could conceivably make it possible for a servicer or subservicer to outsource every process and function required to service a mortgage loan. By doing so, the company would be able to take advantage of the most effective niche players, easily outsourcing business processes and then streaming the completed work back into the main database.

Some servicers will take it further, getting the paper out of their processes first and perhaps giving up their office buildings, too. In the future, some servicers will use their platforms to automatically route work to a distributed work force--wherever they may be around the world.

That will change the whole management dynamic in the servicing business, presenting fundamental challenges along with the benefits. However, in many cases, the economic benefits will far outweigh those challenges, especially as technology helps bridge management gaps.

Eventually, the servicing platform will be able to handle all of the work necessary to service the loan, using business rules to automatically outsource each function to the most cost-efficient, service-capable alternative, whether internally or externally, domestic or offshore. This entire system can then be duplicated for as many institutions with which the mortgage loan servicer or subservicer plans to contract.

Of course, from the borrower's perspective, all this activity must be invisible. In fact, the servicing platform should make it easier for customers to be served through any channel they choose, without the slightest indication that the channel is operated by a party other than their banking institution.

A borrower visiting a local bank branch to follow up on a collection call received about his or her mortgage will expect to find the branch employee completely up to speed on the conversation they had just an hour ago.

Likewise, a borrower should be able to send in a request for loan account information through any channel and expect the request to be routed to the proper party for a prompt response. While that kind of seamless performance doesn't often happen in today's servicing world, it won't be long before customers demand it and servicers are able to provide it.

To facilitate the rise of a virtual servicing company, the servicing platform must be capable of supporting both the disaggregation of functions so that they can be sent to workers outside the enterprise--and then the re-aggregation of data when it comes back to the servicer.

However, as the servicing function is disaggregated, the project becomes more complicated and the chances of systemic failure rise. The customer cannot be expected to understand that in a virtual servicing world, the customer service function might be broken up into 12 discrete areas that might be managed by companies around the country or the world.

The challenges to outsourcing

The first important difference between managing a contemporary servicing business and a virtual servicing company involves the shift from managing people to managing processes. Most supervisors have been trained to watch people, counting hours, sick days and vacation time. The people working in a virtual servicing concern will generally not be working in the same location as the people managing the business, so a new paradigm must be adopted.

Managers will find their responsibilities shifting from personnel to process. Instead of managing a staff, they will oversee a discreet portion of the overall servicing business, dealing with vendors and distributed work groups that could reside anywhere in the world.

It will require managers to learn new skills and measure against new metrics. For instance, when companies outsource, they often find that their work is being performed on new systems (often proprietary systems developed by the outsourcer) or in conjunction with new technology (e.g., mail is digitally scanned instead of being managed by hand). As a result, department managers--used to managing people under their direct supervision performing a process that they are intimately familiar with--find themselves managing a third-party company, generally not physically close to their location and performing work (the details of which) the manager may not be familiar with. As a result, new metrics often need to be developed to provide the company that outsourced the work with meaningful feedback about the quality and performance of its outsourcer.

It will favor those who view other cultures with respect and understand what it means to cooperate in every sense of the word. It will focus management's attention on specific data and create new priorities for the aggregation, sharing, storing and protection of that data.

Instead of managing a portfolio of loans, top management will be engaged in managing a portfolio of partners, each of which plays an integral role in the completion of the company's work.

What new technologies and business models will not do is change the importance that top companies now place on choosing the right outsourcers. The due diligence required to pick a good business partner today will be no less rigorous in the future. In fact, with more of a servicer's work being placed in the hands of its third-party service providers, choosing the right partners will become more important than ever. It will constitute a key competitive differentiation between companies.

Similarly, protecting that ongoing relationship with appropriate management controls will remain very important. While some argue that the underlying data from the mortgage transaction is the most valuable part of the servicing asset, others say it's the relationship with the customer. Carefully managing the relationships a servicer maintains with its outsourcers is an important part of protecting these assets. The closer the servicer gets to a virtual operation, the more complicated and risky this becomes.

To take full advantage of the cost-saving benefits of the virtual servicing company, firms may send employees home, or to some other appropriate location to work. When that happens, one of the more difficult challenges companies will face is managing employees they can't see. While the platform, with its automated workflow capabilities, will automatically route work from queue to queue, keeping remote employees properly motivated and challenged will be more difficult than some imagine.

American business in general, and the mortgage servicing business specifically, doesn't have enough information yet to determine how employees will hold up in virtual "confinement." Teamwork and even one-to-one interaction has become such a part of our work culture that we're not sure yet whether workers will benefit from this new environment or languish in it. While the virtual model will certainly help companies cut direct costs, human resource managers will be called upon to create new communication strategies to help simulate the in-person relationships and team dynamics these employees will miss.

Likewise, cross-training and utilization can become more difficult as the virtual operation pigeonholes employees into areas of specialization that may limit their future opportunities--and the company's ability to use them for overflow work in other areas. The company will have to use work-balancing technology to smooth production across remote employees, and maintain enough resources and vendor relationships to make cross-utilization of employees less necessary.

Competitive advantage in the future of servicing

The future of servicing is not in technology, but it will be powered by new technologies that enable de-aggregation of servicing functions and re-aggregation once the resulting work is complete. The most successful companies, will be those that make best use of the technologies available for the value proposition they're trying to provide.

Outsourcing discreet functions will be taken further than anyone expects, especially as servicers get better at managing their processes. This will result in the rise of virtual servicing models, with some firms handling almost none of the functions commonly associated with servicing. Instead, servicers will become master logistics experts, maximizing relationships with subservicers, private-label servicing providers and other third parties.

As mentioned earlier, the technology that will make the virtual servicing company possible is not available today, but it is currently under development. We will see it rolling out incrementally over the next few years. Servicers that want to remain competitive will learn about these new tools and be prepared to adopt them.

The servicing industry has been intensely focused on technology, and rightly so, for it accounts for much of our recent progress. But servicing companies must now shift from a paradigm of differentiation based on the bells and whistles of their technology platform to competitive advantage created through technology-enabled strategies. How companies choose to use the exciting tools available to them will determine how the industry evolves and, ultimately, which servicing organizations survive.

Steve Gozdan is senior vice president and chief operating officer of Cenlar FSB, Edison, New Jersey. He can be reached at [e-mail].