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Crossing the rubicon.

Crossing the rubicon

KPMG Peat Marwick's 1990 servicing performance study shows participants passed the $100-per-loan threshold on core cost. Here's the rest of the story behind this milestone.

The $94 core servicing cost reported in KPMG Peat Marwick's 1989 Mortgage Servicing Performance Study (MSPS) reflected a decrease in the cost of customer service, an increase in the cost of collection and foreclosure and a subsequent decrease in total servicing cost. The results suggested that the 1990 core servicing cost could go either way. The challenge for the 1990s was on.

"...Ancient history has it that it

was considered an act of treason to

enter Italy proper with an army

over the Rubicon River. Of course,

Julius Caesar did just that in 49

B.C. Since then, crossing the

Rubicon is associated with making a

statement...and dealing with the


unknown undergraduate,

final exam, History 103

The 1990 Mortgage Servicing Performance Study (MSPS) produced a weighted-average core cost of nearly $109 per loan. Participants in this year's study crossed the mythical servicing-cost Rubicon, reporting a 15 percent increase in core cost and a 17 percent increase in total cost (excluding amortization). The core-cost increase reflected the volume of difficulties in the industry; the total-cost increase was clearly a result of the cost of carrying these difficulties.

Notably, crossing the $100-per-loan-threshold was done amidst significant efforts to keep costs down. Noticeable changes in organizational structure, increased use of outsourcing, enhanced preservicing acquisition scrutiny and planning and investment in voice-response units, autodialers, imaging and other technology were but a few of the projects aimed at managing servicing core costs. There were noticeable differences between those functional areas where core costs benefit from increases in volume and those functional areas where core costs rise with added volume.

The KPMG Peat Marwick fifth annual MSPS covered more than 3 million loans with a dollar volume of $204 billion serviced. The average portfolio serviced per participant was more than 196,000 loans with an average balance of close to $70,000 per loan.

Data collection was focused on personnel (salaries, benefits, incentives and the like), operating (outsourced and non-reimbursed) expenses and other operating (occupancy, utilities and so forth) costs. Full-time equivalent (FTE) management and staffing were measured for productivity purposes. Noncore costs, performance and profitability results were derived from balance-sheet and income-statement information.

Portfolio characteristics were gathered to reflect industry trends and the impact of previous results on core cost. The increasing number of repeat participants coupled with participants new to the study provided a wealth of data for the fifth and most unique analyses.

The big picture

The weighted-average core cost, or the direct cost of servicing a residential mortgage loan across this database of 3 million loans was $108.68, or $109 per loan. The $15 or 16 percent increase over the average core cost finding under the 1989 study occurred also entirely within the collections and foreclosure function ($12, or 46 percent more than 1989) and ancillary functions ($4, or 15 percent over 1989). A 4 percent reduction in the cost of customer service was nearly offset by a 3 percent rise in the cost of investor services.

In 1990, ancillary functions, which include general administration, data processing and the like, displaced customer service as the second-largest component of core cost. A comparison of the 1989 and 1990 core cost functional breakdown is presented in Chart 1.

The problems of delinquent loans were clearly reflected in total costs. The total servicing cost, which includes the core cost, loan losses, interest expense on advances plus indirect overhead, was $174 per loan, excluding amortization. This represents a $30, or 21 percent increase over 1989 results. In addition to the $15 increase in core cost, participants experienced a $10-per-loan increase in interest expense (a rise of 145 percent) over 1989, plus a $6-per-loan increase in loan losses. Indirect overhead allocation decreased compared to 1989. The relative distribution of 1989 and 1990 total servicing costs is shown in Chart 2.

Cost: at the crossroads

1990 core cost, as a percentage of total servicing costs, decreased over 1989's findings in that regard, suggesting that participants were better able to manage their direct costs. Inflation appeared to have minimal impact on 1990 core costs. Both personnel and other operating costs decreased as a percentage of core cost compared to 1989, as shown in Chart 3.

Personnel costs per loan increased $5 per loan over 1989. This finding was a reflection of participant geography, rather than inflation or additional staffing. Personnel cost per FTE had a significant impact on overall core costs and was a relatively good predictor of core cost.

The increase in operating costs as a percentage of core cost (from 30 percent to 39 percent) suggested that the 1990 participants used more outside services in 1990. The $14-per-loan increase was supported by added costs in the foreclosure and real-estate owned (REO) functional areas, which experienced the most significant increases in operating costs.

Participants did an admirable job of controlling their other operating costs. Occupancy, telephone, postage and the like, experienced a $4-per-loan decrease.

Analysis of the 19 functional areas show that some trends isolated in past surveys are continuing, while the most recent results also show some new issues have emerged.

Five functional areas--foreclosure, data processing, REO, customer inquiry and general administration--accounted for 58 percent of core cost. In 1989, data processing, REO, general administration, customer inquiry and collections accounted for 51 percent of the core servicing cost.

For the third consecutive year, the cost of customer service dropped, both as a percentage of core cost and in absolute dollars. The insurance function experienced the largest cost decline compared to 1989, followed by decreases in the tax, payoff and assumption functional areas.

The cost of servicing acquisition and special loans (including ARM adjustments) more than doubled over 1989 costs. Bankruptcy costs increased 40 percent compared to 1989 levels, although there was no relationship between bankruptcy ratios (the ratio of bankruptcies to total loans in the portfolio) and bankruptcy core cost.

Performance measures took a decided turn downward in the 1990 survey findings. For the fifth year, the average monthly number of loans serviced per FTE was a good predictor of core cost. However, the 1990 monthly average number of loans serviced per FTE of 630 reflects a decrease of 5 percent over 1989's average.

Surprisingly, the increase in collection and foreclosure costs was not reflected in increased staffing levels. For the third consecutive year, collection and foreclosure staffing levels declined as a percentage of total FTEs.

Turnover averaged 34 percent, an increase over 1989's ratio of 31 percent. Total turnover, as well as turnover by functional area, was not a predictor of core cost in the 1990 study.

There was no apparent trend between span of control (staff to management ratios) and overall core costs.

In 1990, lower cost meant less

In the 1990 study, some of the most significant differences among servicing costs occurred between participant groupings of "low-," "mid-" and "high-" cost servicers, as calculated by their deviation from the weighted-average cost.

One of the most revealing facts was that the low-cost servicers had lower costs in each of the five largest functional areas: foreclosure, data processing, REO, customer inquiry and collections; however, the same servicers were not lower cost across all 19 functional areas. Conversely, the high-cost servicers were not the higher cost finishers across all functional areas, although they were the higher cost servicers for the five largest functional areas.

Some other characteristics that distinguished low-cost servicers from high-cost servicers included:

* Collections and foreclosure expenses accounted for 29 percent of core costs for the low-cost servicers. High-cost servicers, on the other hand, had 42 percent of their core costs coming from the collections and foreclosure area. Low-cost servicers had lower average delinquency, foreclosure and REO rates than high-cost servicers. * Nearly 68 percent of foreclosure costs for the mid- and high-cost servicers were associated with outsourcing--the use of an outside provider of a particular service. The low-cost servicers incurred only 27 percent of their foreclosure costs with outside vendors. This suggests that low-cost servicers are doing more of the foreclosure processing themselves and managing their outside relationships more closely. Productivity results support this observation as foreclosures per FTE were about the same for low-, mid- and high-cost servicers. * Although bankruptcy core costs were linear, bankruptcy ratios did not mirror bankruptcy core costs. It might seem reasonable that as costs rise there would be a corresponding rise in bankruptcies, but the 1990 MSPS did not find that to be true. Again, it appears that lower-cost servicers are performing more of the processing themselves and managing outside vendors, such as attorneys, more closely. * REO costs clearly distinguished low-cost servicers from high-cost servicers. The low-cost servicers generally had REO rates significantly below average and thus also had lower costs in this area. Furthermore, many participants, low-, mid- and high-cost alike, became property managers with an average of almost 40 percent of REO costs allocated to property maintenance (net of reimbursements). * Productivity followed the low-mid-high core cost relationship for the customer service and ancillary functions (the largest and third-largest FTE areas). This finding suggests that customer service and ancillary function core costs are affected more heavily by productivity than areas such as collections and foreclosure, where costs are driven by factors such as portfolio age and mix.

Another possible factor contributing to this theory is that the low- and mid- cost services had their most experienced management in the customer service and ancillary functions areas, coupled with the least experienced staff. Higher cost servicers had their most-experienced management and least-experienced staff in the collections and foreclosure area. They also had 45 percent of their total personnel dedicated to this area. * Consistent with 1989, low-cost servicers experienced growth in their portfolios, while higher cost servicers experienced net decreases in portfolio size.

Is bigger always better?

Participants were arbitrarily divided by 1990 average portfolio size into "larger" (more than 200,000 loans), "mid-sized" (between 125,000 and 200,000 loans) and "smaller" (less than 125,000 loans) servicing portfolios. Overall core cost ranged from $106 to $117 when moving from larger to smaller portfolios, representing a linear pattern.

However, the core cost for each of the four functional groupings (customer service, investor services, collections and foreclosure and ancillary functions) was hardly linear, suggesting that economies of scale exist within some of these functional groupings but not others. For example, the larger servicers had higher per-loan collection and foreclosure costs than either the mid-sized or the smaller servicers. However, the reverse was true for ancillary functions, where the larger servicers had lower per-loan costs than the mid-sized or smaller servicers.

The 1990 results also indicated that mid-sized servicers experienced a per-loan cost advantage in investor services while experiencing a per-loan cost disadvantage in customer services. This supports our theory that growth is felt unevenly across the key functional areas.

The ultimate challenge: profitability

There appeared to be several key factors in determining profitability for this year's study participants. Net portfolio change proved a good predictor for overall servicing profitability. Participants who experienced portfolio growth in 1990 were able to earn more income per loan than those who experienced portfolio shrinkage. The participants with the lowest net-servicing-income figures experienced portfolio shrinkage--the portfolios shrunk from a drop of 2,000 to upwards of 23,000 loans. Conversely, the highest servicing income participants experienced portfolio growth ranging from 13,000 to 36,000 loans.

Participants with high profit margins tended to have a larger number of loans originated in the previous two years (1989 and 1990). Consequently, these participants had a higher average principal balance outstanding than participants with portfolios dominated by older loans.

Gross servicing fees accounted for 84 percent of total revenues, which gave a profitability edge to those participants with higher average principal balances outstanding. Ancillary income followed gross servicing fees, accounting for 10 percent of total revenues. Of the ancillary income accounted for in the 1990 study, 67 percent came from late charges collected, up 10 percent from 1989. This corresponded to the overall increase in delinquency rates (from 4.32 percent to 4.68 percent).

The study basics

Participants provided data in two forms. On a preformatted diskette, key cost accounting, productivity, operating, some balance sheet and profitability information was provided. Submitted in February, this data underwent several iterations of stringent review and validation, including preliminary graphical interpretation among participants. Nearly 3,000 cost, productivity, performance and profitability relationships were examined before selecting key results for presentation.

In written form, participants responded to profile, or qualitative, inquiries concerning servicing initiatives and projects, productivity and quality measures employed, capital and equipment investments, incentive programs and so forth. These profile results were summarized in table and matrix formats by participant and by functional area to provide a reference between the cost results and qualitative approach of the individual participants. For example, the data-processing cost results are followed by a complete matrix of data-processing systems, peripherals and the like, by participant.

Results of the data and profile analyses were provided to participants in mid-April. Participants also received an analysis depicting themselves against the average of each functional area in cost, salary, productivity and turnover. Specific functional areas were highlighted to signify how cost reduction in a given area would contribute to overall core-cost reduction. In addition, nearly all participants were visited during the data-collection or validation phases of the study to provide both participants and validators a better understanding of each participant's unique set of circumstances. Senior executives of participating firms met in early May to further analyze the results and to discuss how current trends are affecting their 1991 costs.

As the story goes, crossing the Rubicon was not the end of the line for Julius Caesar. History has it that he did well for a number of years after his crossing. The same is likely to be true for the mortgage servicing industry. While the $100 servicing-core-cost threshold has been crossed this year, 1990 remained a positioning year for the MSPS participants. Certainly, many are poised for lower servicing costs during 1991--hopefully they will slip back across the critical line. [Chart 1 to 4 Omitted]

Linda C. Simmons is a principal in KPMG Peat Marwick's Washington, D.C. office, and Michele M. Long is a senior manager in the Washington, D.C. office. Both Dr. Simmons and Ms. Long are active participants in the firm's national mortgage banking practice.
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Article Details
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Title Annotation:core servicing cost of mortgage services
Author:Simmons, Linda C.; Long, Michelle M.
Publication:Mortgage Banking
Date:Aug 1, 1991
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