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There must be a better way.

The small branch production-mode could soon be ancient history. The inefficiencies, poor service and snail-like pace of this way of delivering mortgages make it destined for extinction, as technology breeds a new species of competitor.

For decades, the backbone of residential mortgage marketing has been the retail branch structure--relatively small, local offices with the complete responsibility for soliciting, processing and closing mortgage loans. It has remained the principal source of production through several boom-bust cycles, through the virtual elimination of an entire competitive force (thrifts), through times of drastic cutbacks and frenzied expansions and the emergence and legitimization of the mortgage broker community.

Increasingly, however, it is becoming very clear that the self-contained branch distribution network can't deliver what is needed--on a consistent basis.

Some of the flaws that have been the legacy of relying primarily on the branch distribution system are now painfully obvious in a new customer service environment where the ground rules for winning are changing dramatically.

One stark example of this is that our customer service reputation is just plain not good--on a consistent basis. We simply don't serve our customers well. Even in nonrefinance boom periods, we have cultivated a reputation for poor service. The only saving grace to date has been that service has been consistently poor across almost all competitors, so good service has not yet become a real competitive weapon.

Another example of the weakness inherent in the branch delivery system is that the operating dynamics of a typical branch are simply not healthy. An organizational behaviorist would shudder at the operational dynamics that exist within the typical branch. The typical branch is usually small, with six to fifteen people, bringing in volume too modest to easily adjust staff to when production levels change.

The mortgage transaction, on its own, is complex to handle and deliver with consistently good service. But with product rules changing frequently (with changes regularly issued by investors), it becomes doubly difficult to stay current on various products. The core service and productivity elements that basically determine whether service levels will be good and productivity will be maximized are the processors employed by the branches. This is a critical consideration, particularly when one considers who these key staff people generally are. They tend to be early career people with modest training at best. Furthermore, the typical branch offers no career path for processors, and that, when added to other factors, results in high turnover among these critical employees.

The point person for ensuring that branch business is being conducted efficiently and that good service is consistently provided is the branch manager. And, typically, branch managers are far more sales-oriented than management-oriented. The net result is a very unstable environment for producing either high productivity or high service levels.

Another fatal flaw in this traditional reliance on the branch delivery system is the fact that originators still "own" the clients, not the mortgage company. Because mortgage companies have not been able to develop enough value in what they can bring to the table to benefit the mortgage consumer or the business referral source, Realtors or builders do business with a particular mortgage company almost solely because of relationships established with a particular loan officer. As a result, loan officers can freely move those relationships with them from mortgage company to mortgage company, with the company itself having very little control over the business. Furthermore, seasoned loan officers with good, established contacts are increasingly hanging out their own shingles and becoming mortgage brokers. It is no accident that a survey of brokers estimated that 40-plus percent of all production is now done through mortgage brokers. Loan officers are simply responding to the more attractive economics (and absence of constraints) of working for themselves.

Add to the litany of weaknesses built into the branch delivery system the fact that the washout rate of new originators probably exceeds 80 percent to 90 percent annually. A clear tip-off that the old methodology is not working is the inability of new loan representatives to enter and succeed in the business. Something is fundamentally wrong with the structure of the business when only 10 percent to 20 percent of those entering the business can make a go of it.

Finally, the bottom-line economics of branch systems for most firms are simply not acceptable. Most businesses are able to improve efficiency with time. However, per-unit, branch-based production costs have increased steadily during the past two decades, despite healthy increases in average loan balances. The crux of the problem is that even with good technology, it is very difficult to improve materially individual branch economics, because the operating expense-base of an individual branch is relatively small and difficult to change appreciably.

Clearly, there are individual branches that provide wonderful service, maintain a stable operating environment and produce at an attractive cost. But, there are very few entire networks that can do so. This is not because people don't want to perform well, but because the basic structure within which they operate makes it extremely difficult to perform consistently well.

Service--the necessary center of attention

Long-term success in any business necessarily starts with service--giving the customer what he or she is willing to pay for--and doing so efficiently, pleasantly and with the overriding attitude that the customer truly is king.

A painful, yet pointed example of the difficulty we create for customers (lack of service) in mortgage lending is illustrated by the comparison of the process of buying an $80,000 Mercedes with the purchase of a home. A customer can walk into a Mercedes showroom at lunch time and drive out with the car, financed and titled, in an hour. Yet, it takes this same person 30 to 60 days and tons of documentation to finance a house. But which is the riskier credit--the Mercedes, which is on wheels and depreciates, or the house?

As an industry we have developed an incredible mania for documentation that translates into unjustifiable poor service, unmanageable operating demands within production branches, and that almost guarantees poor service and high cost.

We have become an industry focused almost entirely on the investor, not the consumer. Responding to the (sometimes irrational) pressures of the investor, the typical branch has become a paper factory where, when in doubt, you ask for more documentation.

Several mortgage companies advertise customer service and/or create catchy internal campaigns for good service. The truth is, however, that as an industry we only give lip service to the issue. The acid test is, if you don't measure your performance on service, then you aren't managing it. You can't manage what you don't measure, and very few mortgage companies measure effectively and consistently their performance on customer service.

Is it really that important?

We'd all like to provide better service, of course, but is it a core strategic issue? Should it drive our planning and investment? If lessons from other industries are relevant, service levels should be a key strategic issue. When the gap between current practice and what is possible is as large as it is in mortgage banking, service becomes the crucial variable around which the entire competitive environment is reshaped.

Charles Schwab, the king of discount brokerage, almost single-handedly refined the securities brokerage business based upon dramatic improvements in service, speed and consistency and reasonable prices. Fred Smith (Federal Express Corporation) completely redefined the air shipment business based upon a single factor--it was indeed possible to provide consistent, reliable, overnight air shipment service at a reasonable cost, if one took the time to fundamentally rethink how air shipment service could work. Sam Walton and WAL-MART Stores, Inc., redefined the discount merchandising business, even after people like Kmart Corporation had already defined it once. In 20 years, WAL-MART has surpassed every other merchandiser in sales and profitability in the country, starting from almost nothing.

Someone will seize the day

The message is simple. When an existing delivery system proves inadequate to satisfy reasonable consumer desires, someone will ultimately step forward, redefine the business and usually cause fundamental restructuring of the industry. Such change would trigger major shifts determining who survives and who loses. Branch-based mortgage banking gives all the signs of a business ripe for fundamental restructuring.

The weaknesses of branch-based operations are not recent discoveries. Most mortgage bankers have recognized the problems, and several have pursued solutions. But in most cases, these solutions have only skirted the problem.

Several firms have gone to centralized processing, hoping to realize productivity, quality and managerial-cost gains from having more of a critical mass of operation in one place. Unfortunately, all too often this solution only replaces one problem with another. The gains in control and productivity are offset by increased bureaucracy and a further diminution of customer service.

Others have begun to rely on technology to solve the problem, providing processing automation to improve information and processor efficiency. Unfortunately, merely automating traditional processing does little for either lowering costs or speeding up the process.

Several firms have abandoned retail production in part or entirely, relying instead on wholesale production as a way to control costs and simplify their managerial challenge. Unfortunately, this approach merely adds yet another layer of cost onto the consumer. Internal studies done by one large wholesaler have indicated that consumers can pay on average 0.75 percent more in total fees through the broker wholesale delivery chain than through a traditional retail operation. So, while wholesale may seem to serve the mortgage banker, it's not at all clear that it serves the customer better.

Finally, some firms view marketing that is not face-to-face, or a combination of direct mail and telemarketing, as a way out. But while direct marketing is a clear and growing niche, it isn't a viable alternative to quality retail branch production in most cases.

The solutions tried address only parts of the performance problems faced in retail production. The problems are complex and require complex solutions--nothing less than fundamental reengineering.

What's the solution?

The ultimate solution to the myriad problems created by traditional branch operations is not simple--on the contrary, it's exceedingly complex. It seems to require dealing effectively with organizational, geographic, technological, workflow and human capital management issues simultaneously. Consider what we are attempting to do. Simultaneously, we want to:

* speed up processing dramatically;

* drive down costs;

* reduce loan officers' control over the clients;

* increase workplace stability;

* improve the quality of service we provide.

The general solution seems apparent. How difficult it is to implement successfully is not yet known, although several firms have taken steps toward this end. Several larger mortgage companies and, seemingly, most of the larger commercial bank-based mortgage lenders have moved or are moving to a regional or central processing structure. Almost all major firms are making large investments in enabling technology, including artificial intelligence. Few yet, however, seem to be attacking directly the documentation issue.

While individual firms' solutions will vary, the following are the principal parts of a new retail delivery system that offers the opportunity to improve both customer service and operational economics greatly.

* Organization

Reorganization is a central part of reengineering retail production and includes several parts. The first step is moving the processing, underwriting and closing functions together into centers (the number of which depends on several factors), instead of having centralized underwriting separated from dispersed branch-based processing. This is in direct conflict with the trend toward totally centralized underwriting in most companies, but the move to large "bullpens" of underwriters has generally damaged branch-underwriting relations and further reduced customer service.

Next, team-based processing units need to be put in place and take full responsibility for the origination, underwriting and closing of every loan. Functional organizational lines need to be broken down in favor of interdisciplinary, self-managed teams consisting of loan officers, processors, underwriters and closers. This produces ownership of the loan and, if rewarded with proper incentives, a much greater focus toward serving the customer.

Originators are left in executive suite-type offices close to the customer and Realtor. The combination of the centers and localized production offices forms a hub- and-spoke-type delivery system.

The organization that's envisioned is flat, with no departmentalization and few managers. The manager of the hub- and-spoke network becomes a real business manager, managing a particular market and all parts of the business necessary to serve the customer. Strong producers, rather than being promoted to branch managers and forced to play to what is typically their weakness, are positioned to maximize their real talent--marketing.

* Process redesign

Over the years, we have allowed the lack of efficient technology to fundamentally invert the way the origination process should and must work. Now, loan officers typically take a scratch application (in every sense of the word) and hand off the application to processing, which then begins the real work. Credit application evaluation is postponed until the end of the process (when all documentation is in and supposedly correct).

Two fundamental changes must take place. First, loan officers must take complete applications on a personal computer and perform most of the critical credit evaluation upfront at the initial interview. A merged in-file credit report is ordered and received electronically at the interview table, and potential credit issues reviewed and resolved immediately. Good Faith and Truth-in-Lending documents are generated then, as are any verification forms required. For those believers in computer-based underwriting, an artificial intelligence (AI)-based credit underwriting can be performed at the interview table or sent by modem out to the underwriting center for analysis. In either event, a preliminary credit approval is given, and a very specific, minimum documentation-oriented needs list is generated. Finally, the loan officer sends an appraisal request electronically to the selected appraiser, immediately triggering the appraisal process.

The second major change embedded in this scenario is underwriting all loans immediately, either using AI models embedded within the origination software, or by human underwriters at the center, as soon as the loan application is electronically transmitted there. "Upfront" underwriting, while seemingly demanding more underwriting resources, actually reduces the total underwriting demands by virtually eliminating time-consuming multiple handling of underwriting submissions. It also permits the mortgage company to define upfront for the customer precisely what documents will be needed to approve the loan. The "hassle factor" is reduced significantly.

With the loan officer doing the necessary upfront processing, and with the team approach to processing/underwriting, the processor job becomes more focused on underwriting than grunt-work processing. In fact, the whole flavor of the center's work is underwriting, not processing, thereby improving the focus on underwriting, not diminishing it.

* Technology

Much of what makes the organizational and process-flow changes effective is the support of highly user-friendly, intelligent technology. This is not just an automated data-capture, reporting system, but software that truly helps loan officers, underwriters and processors, as well as management, to look and act smart.

Technology permits the loan officer to be physically separated from his or her processor and the files and, yet have full, finger-tip information available. Technology allows loan officers to do their job, take full applications and resolve as many credit issues as possible without becoming overburdened and diminishing their sales effectiveness.

The proper software also helps all parties in the process, but particularly the center management, to become proactive in managing customer relations. The time that loans are in processing can be monitored and managed proactively, as can any potential loan approval issues. Daily work schedules can be set up electronically, based on customers' needs, rather than relying on crisis management. In short, management can gain the necessary vantage point over processing to produce consistent quality service.

* Economics

The economics of the entire retail distribution system will change substantially if the process is reengineered successfully. The (sparse) evidence is that overall unit costs for production could decline 30 percent to 50 percent, particularly if the redesign is combined with a dedicated use of alternative documentation programs and a redesigned loan officer compensation program based upon greater volume potential for the same effort. Centralized processing shops show much lower unit-processing costs, although it is not clear that customer service and organizational teamwork have not suffered as a result. The few mortgage companies that have employed a hub-and-spoke-type office structure, within a specific market, seem to be realizing both superior economics and service.

If volume is easier to generate, so that individual originators can realize greater volume with the same effort, there is the opportunity to lower or refocus per-loan commissions, particularly since much of the greater volume would be due to corporate efforts to improve the overall delivery system.

Costs are also more stabilized because of the greater ability of the system to adjust to volume shifts, and due to the likelihood of lower staff turnover. Turnover would likely decline for several reasons: greater career flexibility within a larger processing center, better hands-on management and an opportunity to share in the improved economics.

It's likely that employee morale would be improved, possibly dramatically, because an environment would be created harboring less contention (processor-originator-underwriter), greater control over one's ability to perform and a greater attachment to the customer (if proper incentives are provided). Morale should also be boosted by the opportunity to share in the improved economics of the business.

In short, the whole traditional, retail branch operations methodology is reengineered organizationally, technologically and by workflow to produce service levels and economics more in line with what is possible.

Ultimate goal--Creating a customer-focused business

The complex reengineering just described redefines the basic operations of a retail production organization. It provides the capability for sustained, improved customer service. But what standards of service should be set for this improved capability? How will the winners set themselves apart from the rest?

Customer service will be measured primarily in two ways--speed of approval and the absence of unnecessary documentation. Speed, particularly, will be a differentiating factor. The reengineered retail operation, like a supercharged race car without someone to put it through its paces, becomes only something to look at and talk about. Speed is what it's all about.

The future winners will use their redesigned operations to effectively segment the market, developing aggressive standards for approval times for each segment. The smart competitors will concentrate first on the cream of the market--the low loan-to-value, owner-occupied, conventional market. They will "cherry-pick" first the most susceptible part of the market, the easiest to address, and the segment where the gulf between the current service level and what's possible is the greatest.

For this market segment--conventional loans with LTVs of 80 percent or less--it is possible, given today's technology and investor requirements, to routinely provide credit approval at the interview table, and full approval within three days, with appropriate control over appraisal resources.

Absurd? No, not at all. In fact, at least one major competitor has already established a three-day approval operation. (The refinance boom, however, has made three-day appraisals impossible, but the key point is, once the market returns to normal, three-day approvals will become an operational reality.)

What's wrong with 30 days?

Why concern ourselves with a three-day, or even ten-day, approval cycle? Who really cares? Realtors and home-buyers are conditioned to 30- to 60-day closing cycles. Why not just work to this standard?

The answer is threefold. First, the Realtor, in particular, really does care how long it takes to obtain an approval. The closing date may not change, but the Realtor will readily route his or her business toward the lender that provides the fastest service with the least hassle. And by its very nature, three-day approvals imply very hassle-free processing--no last-minute requests for documents, no need for status updates, no extended managing of the Realtor's client while the processing proceeds. Significantly, the Realtor doesn't receive his or her commission until the loan closes. Therefore, as Realtors learn they can rely on quick approvals, they will begin to set earlier closing dates.

The second reason for wanting very quick approvals is the tremendous positive impact on the efficiency and cost of the mortgage lender's operation. The shorter the time a loan stays in processing, the less it is handled and the lower the cost of processing. The ability of the processor to anticipate deadlines or late documents rather than simply react to broker calls greatly improves. The total number of files handled at any one time drops significantly, but the total loans processed per month or year increases dramatically.

The third reason for wanting rapid approvals is to build institutional value for the mortgage bank with its client-Realtors and builders, thereby lessening the loan officer's control over the company's client base. This is a necessary step in gaining long-term competitive stability and a corresponding lessening of price pressure.

Perhaps a final reason for targeting quick approvals is that few firms will be able to accomplish it consistently, thereby providing a sustainable long-term advantage for those who can. This type of advantage can be translated into greater market share and profitability for those who can consistently deliver.

Competitive momentum

It is difficult, at best, to think about draining the swamp while fighting off alligators. For most mortgage bankers, it's almost impossible to even think about reengineering their retail operations, given the pressure currently created by refinances at every stage of their operations. Yet postponing serious action until after the refinance boom subsides is risky for several reasons: There is a desperate need to provide the branches and underwriters with help now. Once the refinance activity has subsided, so will profitability and the willingness to invest. But perhaps most important, the lead time needed to complete reengineering, for any sizable firm, is so long that waiting until later risks losing competitive position, at a time (post-refi boom) when firms will be able to least afford it.

Several major firms are already aggressively pursuing development of the proper technology, which is the building block of the new structure requiring the longest lead time. They will be in position during the next 12 months to begin reorganizing around their new systems capabilities and will begin to benefit from quicker approvals soon thereafter. By 1994, it is not unlikely that significant differences in levels of service will begin to appear among mortgage lenders. Speed will begin to emerge as a real competitive weapon. It will accelerate an inevitable post-refinance shakeout.

As with the evolution of mortgage brokers following the 1987 to 1989 shakeout, the competitive landscape will be redefined. This will leave a number of firms wondering what happened to their business. Product innovations are quickly initiated and rarely become a source of competitive advantage. Pricing, as we regularly reconfirm to ourselves, is never a source of long-term advantage, however. Superior delivery systems that focus on speed and service are real sustainable sources of advantage.

While speed and service leads can be replicated by competitors, they rarely are, because it requires difficult managerial and cultural shifts to translate superior delivery systems into realizable differences in service. The sooner a company starts the transition and the more intensively it works at it, the faster it gets through the inevitable rough spots. The smart competitors are already well into their learning curve. The rest of the competition may well be left behind in the next 18 months.

However long it takes to restructure retail delivery operations, at this point it seems relatively clear that, for most markets and competitors, the small branch-based style of production will ultimately decline as the most effective delivery system. What will take its place are delivery systems that are more economically and behaviorally stable. The road may seem rocky getting there, but the resulting superior cost and customer service should make it worth the trip.

Fred Portner is a consultant for Symmetrix, Inc., Boston.
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.

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Title Annotation:retail branch structure of mortgage banking
Author:Portner, Fred
Publication:Mortgage Banking
Date:Nov 1, 1992
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