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Apples to apples.

Is your competition really servicing 1,000 loans per person at a cost of $80 per loan? Probably not, but it's often difficult to know because you are comparing your apples to someone else's oranges. KPMG Peat Marwick's annual servicing study tries to keep it strictly apples to apples.

Keeping up with competition is always a serious challenge. In today's economic environment losing a competitive edge can have disastrous effects. While mortgage servicing operations constantly face many challenges, today's primary goal is how to improve performance. Or more specifically, servicers are looking for ways to minimize bankruptcy and foreclosure losses, cut costs while maintaining quality service, increase revenues on the existing servicing portfolio and profit from the current increase in refinancings.

Through KPMG Peat Marwick's Mortgage Servicing Performance Study (MSPS), and through other services including due diligence reviews, acquisition efforts and diagnostic analyses, clients can get information and advice on key issues, such as ways to respond to economic pressures and approaches that will balance quantitative performance with quality service. This increased emphasis on quality has caused many servicing managers to question conventional performance standards, which historically measure only financial performance. Such measurements as servicing cost per loan and various productivity standards often are not comparable among organizations, and reliable information often is simply not available. For these reasons, Peat Marwick's sixth annual MSPS collected, validated and analyzed quantitative and qualitative data to provide each participant with reliable "apples-to-apples" benchmarking standards against which to measure their operation.

This year's MSPS covered 2.7 million loans totalling approximately $200 billion in principal balance. The collection, validation and analysis of cost data focused on three cost areas--personnel (salaries, benefits, bonuses and so forth), direct operating expenses (outside services, bank fees, REO assessment and similar items) and other operating costs (occupancy, utilities and other related expenditures). Additionally, the data were stratified and analyzed by 19 specific functional areas. Although some cost and productivity trends were similar to those that appeared in the results from the prior five studies, there were a number of notable differences from past trends owing to the economic environment in 1991.

On the cost side, the study results indicated a fully loaded, direct cost of servicing, per loan of $114, up only 5 percent from 1990. Of the four functional areas that comprise direct costs--customer service, investor services, collections and foreclosures and ancillary functions--participants reported the greatest increase in spending in ancillary functions, which includes general administration, data processing, record retention and loan setup. The collections and foreclosures area remains the largest cost area in the study, with REO management and loss mitigation being the single highest cost component.

Overall, the total cost of servicing increased 14 percent in 1991, compared with a 15 percent rise in 1990. This represents the fifth annual cost increase in the six years that the study has been performed. Indirect costs, including loan losses, contributed significantly to the percentage increase from the prior year. The greatest dollar increase resulted from loan losses and prepayment interest. In this way, the 1991 economic environment clearly affected the cost of loan servicing.

The economy: How it affected servicing cost

The most obvious and drastic effect of the current economic environment has been the dramatic rise in prepayments. There is a strong relationship between interest rates and prepayments--as interest rates continued to drop throughout 1991, hitting a low by year-end, payoff rates rose in response. Surprisingly, although the prepayment rate increased 50 percent over the 1990 level, the related cost per loan remained flat. This trend may indicate a combination of previous excess capacity in the payoff area and participants' ability to achieve economies of scale as payoff volume increases. In the payoff area, although costs appeared to be volume-driven in prior years, the opposite was true in 1991. There seemed to be a threshold of activity in this area above which the variable portion of payoff costs dropped and certain economies of scale were recognized.

The direct costs associated with collections and foreclosures--excluding actual foreclosure losses--again represented the largest portion of overall direct cost. In 1991, these costs represented 34 percent of total servicing costs. Participants who successfully controlled collection and foreclosure costs generally had low overall direct cost. Over the past three years, though, the composition of costs within the collections and foreclosures area, with the exception of bankruptcy, has changed considerably. Bankruptcy costs have remained level at approximately 5 percent of total collection and foreclosure costs. REO direct costs increased 36 percent, which represents the greatest change. The increase in real estate-owned was a logical progression, as the foreclosures that occurred in 1990 moved into REO status. This corresponds closely with the typical life cycle of a loan in foreclosure--costs were consistently moving from the foreclosure area into the category of REO. A decrease in foreclosure direct costs, however, is notable, especially considering that foreclosure rates were higher than in the prior year. On average, study participants experienced a net increase in 1991 foreclosure rates of almost 60 percent. Reduced costs in this area are likely the result of improved cost control, greater experience and clearer corporate policies in the foreclosure arena, as well as some realized economies of scale.

Collection costs increased, reflecting the sharp rise in delinquencies, beginning in the third quarter of 1990, continuing through 1991 and steadily climbing through the fourth quarter of 1991. In general, participants with low overall servicing costs spent a larger portion of their dollars upfront in collections and experienced lower than average delinquency rates, while higher-cost services typically spent more dollars and staff hours in the foreclosure and REO areas.

Productivity: A step toward profitability

Not surprisingly, productivity was a major concern for all participants this year. In the face of rising costs and increasing foreclosure losses, all servicers were looking for creative ways to increase productivity and get more for the money they spend. In this year's study, the average number of loans serviced per full-time equivalent (FTE) equaled 570. It should be noted that this figure represents a fully loaded staffing level including servicing area FTEs in data processing, general administration, accounting and finance and so forth. As expected, the lower-cost servicers were the most productive, while the higher-cost servicers were the least productive.

One unusual finding was that participants with a below-average portfolio size had above-average productivity, while participants with an above-average portfolio size had below-average productivity. Overall productivity was significantly affected by the type of servicing system, how effectively the servicing system was used, other technological advances and investments in the servicing area and the use of out-sourcing. Some of the other specific productivity measures that were analyzed included payoffs processed by payoff FTE, delinquent loans per collections FTE and incoming calls per customer inquiry operator.

Productivity issues were most evident in the customer service area and, to a lesser extent, in collections and foreclosures. In the customer service area, personnel costs represented two-thirds of the total direct cost of this function. Overall customer service productivity, as measured by loans per customer service FTE, paralleled customer service direct-cost performance. The collections and foreclosures area, although not as labor-intensive as customer service, also placed a strong emphasis on productivity. Productivity standards included average delinquency per collector, collections FTE per workstation, bankruptcies per bankruptcy FTE and average monthly REOs per FTE.

Technology: A boost to productivity

For many participants, the increased use of technology is the answer to the question of how to increase productivity in the midst of unusually high volumes for most servicing areas, but especially customer service, which consists of assumptions, prepayments, escrow analysis and customer inquiry. In regard to evaluating their current servicing system, participants were asked: Is your system a true mortgage banking system? Are you effectively using the system? Do you have enough terminals for maximum productivity? As expected, there was an inverse relationship between the number of FTEs per PC or terminal and productivity in the servicing operation, suggesting that more automation and technology in servicing is directly related to greater productivity. In addition, the majority of this year's participants--particularly those with above-average productivity--had a voice response unit (VRU) integrated into their phone systems. Most updated their VRU menu on a regular basis to ensure that seasonal questions were promptly answered and waiting periods were minimized.

Automation was also a focus in the tracking and transmission of payoff information, the disbursement of tax payments and the centralization of customer inquiries. In all of these cases, the investment in automation and improved technology was made in order to improve productivity while maintaining a high level of customer service. Other technological investments that the study participants considered included imaging and digital storage, bar-coding in the record-retention area and the use of a robot mail attendant. Productivity can be further enhanced when systems are fully integrated. Automation is the only solution to balancing the quantity versus quality dilemma.

Profitability: On the revenue side

In this year's study, top participants in terms of net income shared a number of characteristics related to the revenue side of the income equation. More profitable participants experienced net growth in their portfolios, while their less profitable counterparts experienced shrinkage or stagnation in their portfolios. In addition, top services characteristically had higher than average loan balances, thus yielding higher gross servicing fees per loan. This was expected because gross servicing fees accounted for more than three-fourths of total servicing revenue. Strong ancillary income was also a common trait of the more profitable participants, accounting for at least 10 percent of total servicing revenue. Late charges accounted for the majority of ancillary income and showed an increase from 1990 that corresponded with the overall increase in delinquency rates. Insurance revenue was the second largest contributor to ancillary income.

Profitability in the cash management area was also a key to overall profitability. Most participants used available float dollars to: buy down rates on warehouse lines of credit; as compensating balances against bank charges, such as lockbox fees, custodial bank charges, wire charges, and the like; and/or to indirectly invest excess dollars in short-term interest-bearing securities. In general, as the average loan balance increased, the float benefit from principal, interest, taxes and insurance (PITI) payments also increased. Also, study participants with larger portions of government loans in their servicing portfolios recognized larger-than-average escrow float benefits. It should be noted, however, that the amount of benefit that the servicer recognized and the specific use of available float dollars was in part dependent on the type of organization and that entity's relationship with a parent or affiliate company. Generally, the participants who were better cash managers performed regular cash management analyses and were able to answer routine questions, such as: What are the available float dollars? What dollar benefit is received from the current investment strategy? What are the other options and their potential returns?

Benchmarking: How do I compare?

Looking back on 1991, the economic environment magnified the many challenges faced by mortgage servicing operations. Continuous, objective revenue and cost analysis appear to be critical to an organization that is striving to improve profitability during recessionary times. The ability to access comparable, uniform statistics is crucial to being able to successfully analyze an operation, assess strengths and weaknesses, identify potential areas for improvement and develop a strategy for change that will improve overall profitability. Benchmarking--the comparison of operating results against industry averages or standards--helps an organization to effectively accomplish these goals. Peat Marwick's MSPS is one such tool for providing a base of benchmarking information. The resulting benefits for participants in MSPS is a better understanding of their operation, an objective look at the leaders in the industry, a forum of peers for the exchange of ideas and suggestions and a comprehensive analysis of trends and issues in the industry.

Currently, some of the recessionary trends that were experienced in 1991 have already begun to improve; others are lagging behind. Refinancings, which have made a significant reappearance during the second and third quarters of 1992, are continuing to heavily impact mortgage servicing operations. High payoff volumes create both challenges and opportunities to these organizations. Many servicing operations have found that, although 1991 was an especially challenging year owing to recessionary economic factors, the servicers that learned to improve profitability during these difficult economic times will undoubtedly excel during more normal growth periods.

Few, if any, of the servicers operating today are achieving productivity levels of 1,000 loans serviced per person at a fully loaded cost of $80 per loan. Even in nonrecessionary periods, few servicers have been able to crack this level of productivity and cost efficiency. However, a comprehensive benchmarking process will help management better understand servicing operations, begin to develop better work flows and identify the technological investments necessary to break through today's productivity and efficiency barriers.

Geoffrey Oliver is a partner with KPMG Peat Marwick's National Mortgage Banking Practice, headquartered in Washington, D.C. Regina Reed is the lead manager for KPMG Peat Marwick's Mortgage Servicing Performance Study and Mortgage Origination Performance Study.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:Servicing; per person costs in mortgage servicing operations
Author:Oliver, Geoffrey; Reed, Regina
Publication:Mortgage Banking
Date:Sep 1, 1992
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