U.S. Lending Industry Meets Mortgage Process As a Service

U.S. Lending Industry Meets Mortgage Process as a Service

Executive Summary plan to wind down the GSEs and support the private The U.S. subprime mortgage crisis ended a sector’s efforts to become the dominant provider prolonged period of growth and prosperity within of mortgage credit is a positive sign. the housing industry. Rapidly increasing home prices and residential mortgage backed securi- In addition to the government’s proposed role, ties (RMBS) increased home lending. The housing it is clear that private investment will rely bubble burst, and with it, many private investors heavily upon improved risk management and and originators exited the housing finance market. clearer visibility and understanding of the risks Government-sponsored enterprises (GSEs), oper- within an investment pool prior to ramping up ating as government conservatorships, increased private investment efforts. their position within the housing finance market in an effort to stabilize the housing industry. The shift to a primarily private investor-driven market with clearer management and under- The GSEs have become the dominant players standing of risk is one of three primary factors in the mortgage market in the absence of pri- affecting the revitalization of the housing finance vate investment. Investors have been waiting for market. The role of government regulation in the direction from the U.S. Department of the Trea- housing market is the second factor affecting the sury regarding the future of the GSEs. In Febru- revitalization of the housing finance market. The ary 2011, a report to Congress from the Treasury February Treasury report provided insights into Department was released, which discussed a plan the gradual change within the GSEs. Moreover, to “responsibly reduce the role of the Federal The Dodd-Frank Wall Street Reform and Con- National Mortgage Association (“Fannie Mae”) sumer Protection Act has given broad directives and the Federal Home Loan Mortgage Corpora- regarding what constitutes a qualified residential tion (“Freddie Mac”) in the mortgage market and, mortgage, reasonable lending practices and risk ultimately, wind down both institutions.”1 retention requirements for loan originators and mortgage securitizers. A lender’s and/or inves- Industry players speculate that the gradual tor’s ability to effectively and efficiently address and measured reduction of the GSEs’ mar- and manage regulatory change is a critical ket dominance will provide opportunities for component to successful growth within the new private investors to re-enter the housing finance RMBS space. market. Although the Treasury’s plan lacks the specific details that would draw a clear- incen The stabilization of the housing market is the tive for private investors to re-enter the market final factor. There are emerging signs that the during ongoing challenging economic times, the housing market is beginning to stabilize, including

cognizant reports | september 2011 a decline in foreclosures, increasing household increased. In most cases, subprime originators formations, increasing corporate profits, increas- provided a guarantee to investors (private-label ing consumer confidence and home affordability. mortgage securitizers) to repurchase a loan if These factors point to a gradual positive turn in it went into early default or if there was a mis- the mortgage industry. Mortgage banks will need representation in the terms of the loan when it to gear up proactively in order to capitalize on was purchased. market opportunities as they begin to emerge. Subprime mortgage originators became insolvent The emerging suite of services referred to as due to improper forecasting of defaults and were “mortgage process as a service” (MPaaS) offers unable to repurchase their mortgage loans. Many several solutions to revitalize the housing finance of the subprime lenders went bankrupt or closed market. Ensuring loan quality and providing data lending operations. Heavily leveraged private- transparency will help reduce risk and increase label mortgage securitizing companies suffered private investment. Loan origination data will be large losses and exited the secondary mortgage collected, verified and presented in a standard- market, defaulted on RMBS payments to their ized manner, which will improve credit under- investors or filed for bankruptcy. This led to a dra- writing decisions for the originator and deliver matic decline of private investment in the housing improved due diligence services to private inves- finance market. tors. Enhanced loan information quality will result in fewer mortgage repurchases and poten- The decline of the housing finance market caused tially reduce early loan default rates by provid- many to question existing regulatory oversight. ing deeper, more accurate and more meaningful Banking regulators reassessed the secondary information during the loan origination process. mortgage market and housing finance to deter- mine what oversight and rules could be imple- By removing the cost of ownership of technol- mented to avoid the mistakes of the past. Con- ogy infrastructure, applications, platforms and gress and other regulators (Federal Housing people, as well as adopting a pay-per-use model, Finance Agency, Office of the Comptroller of the MPaaS enables banks to save money. They can Currency, etc.) have provided guidance and regula- then focus on increasing market share, while rely- tory requirements to banks and private investors. ing on their MPaaS partners to streamline processes, manage and extend systems capabilities A major directive came from the Dodd-Frank Act, and provide meaningful loan information to help whose extensive consumer banking provisions them make better business decisions that comply added stringency to existing lending requirements with government regulations. (e.g., defining a qualified residential mortgage), detailed acceptable lending practices and man- How We Got Here dated 5% credit risk retention requirements for There are many opinions as to whom and what is originators and mortgage securitizers. The intent responsible for the exit of private investors from of the legislation is to promote a safer housing the secondary mortgage and housing finance finance market by spreading the share of risk in markets. Key contributors include the easing of securities for originators and mortgage securitiz- lending standards (such as Fair Isaac Corporation ers and improving lending standards and practices. (FICO) scores, loan-to-value (LTV) ratios, debt-to- income (DTI) ratios, etc.); exotic mortgages (such As banks and private investors work to implement as adjustable rate mortgages, interest-only loans, and comply with these new regulations, change is stated income loans, etc.); the government’s occurring within another department of the U.S. desire to increase home ownership; shareholder government. The exit of many private investors in pressure on companies to stay competitive and the RMBS issuance business resulted in the GSEs increase revenue; heightened speculation in the emerging as dominant players in the secondary housing market; appraisal fraud; broker fraud; mortgage market. The U.S. Treasury directed the and borrower fraud. GSEs to stabilize the housing market by providing liquidity. Private investment has remained As delinquencies spiked due to borrower defaults, on the sidelines, waiting for business conditions demands for mortgage repurchases from to improve. investors (mortgage securitizers) to originators

cognizant reports 2 The February Treasury report to Congress pro- Private investors anticipating a return to the sec- vides the Treasury’s plans to significantly reduce ondary mortgage market are interpreting this the GSE’s presence in the mortgage market. It is release as a positive signal for developing plans evident that the reduction in the GSEs’ market to re-enter the market. As the conditions of the share will be gradual and measured. The report housing market begin to improve, private invest- states, “Our plan presents several proposals for ment will increase (see Figure 1). structuring the government’s long-term role in a housing finance system in which the private sector is the dominant provider of mortgage credit.”

Forces Driving the U.S. Mortgage Industry

Area Drivers Impact Implication Unemployment rate estimated Increased demand for housing to stabilize at 5% after 2013

Household formation to Increased demand for housing average 1.2 million/year over the next decade Early signs of Improving credit scores, deleveraging, Improving credit quality of gradual revival Economic declining delinquencies borrowers for housing Environment Declining price-to-income ratio Increased affordability and mortgage borrowing Low mortgage interest rate scenario Increased affordability

Rising rental incomes Improved attactiveness of ownership Slow rise in consumer confidence Improved willingness to borrow Industry Lower net interest margins Lower profitability levels Drivers scenario Declining foreclosure filings Demand and prices for homes will stabilize Revival of lending and Increase in all-cash deals Traction in housing market RMBS Jumbo deals activity in Revival of investor risk appetite business RMBS market

Uptick in ABX index Improving prospects of secondary RMBS market Regulations Prospect of significant reduction of Revival of private players' interest the role of GSEs

Heightened regulatory oversight Increased compliance and reporting Increase in cost Risk retention norm Capital adequacy implications and of compliance enhanced safety for RMBS investors Enhanced consumer protection Creation of a safer market measures

Technology Siloed structure of banking Challenges on the compliance front IT systems

Regulation-induced need to reinvent Increase in IT spending IT systems and processes IT challenges and opportunities Competition-induced need to build Opportunity to marry competitive- new competencies ness goals with compliance-driven investments into systems

Source: Cognizant Research Center

Figure 1

cognizant reports 3 Market Conditions in 2010 (see Figure 2). Loan originations peaked at The U.S. mortgage market is navigating its way $3.8 trillion in originations in 2003. This year, the out of the subprime crisis. Home sales fell from U.S. mortgage industry forecasts approximately 7.53 million units in 2006 to 5.23 million units $1 trillion in originations (see Figure 3).

Home Sales in Units 9 8.36 7.98 8 7.53 7.26

7 6.43

6 5.40 5.33 5.36 5.23 5.10 Millions 5

3 2003 2004 2005 2006 2007 2008 2009 2010 2011* 2012*

Sources: Fannie Mae Annual Reports, Federal Reserve Board, Bureau of Census, HUD, National Association of Realtors, Mortgage Bankers Association and FHFA * Forecasts for 2011 and 2012 are from National Association of Realtors, July 2011 Figure 2

Mortgage Origination Estimates One- to four-family homes

4,000 2,532 Purchase Refinance 3,500

3,000 1,514 1,757 1,463 1,326 2,500 1,283 1,166 2,000 1,331

$ Billions 1,500 777 1,099 1,512 1,399 1,309 234 1,280 1,000 1,097 1,140 697 905 960 400 731 664 500 531 473 412 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011* 2012*

Source: Mortgage Bankers Association * Estimates Figure 3

RMBS issuance, which rose to around $724 billion 2005, to their peak in 2010 of over 3.82 million (see in 2005–2006, has dropped to $39 million in 2010 Figure 5, next page). As a result of the downturn (see Figure 4, next page). The steep fall in home in the economy, studies indicate that consumers prices and rising job losses pushed foreclosures became more averse to debt and began saving higher. Foreclosures went from less than 1 million in more (see Figure 6, next page).

cognizant reports 4 RMBS Issuance 800

700

600

500

400

$ Billions 300

200

100

0 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Federal Reserve Figure 4

Foreclosure Trends 4.5

4.0 3.75 3.83

3.5 3.16 3.0

2.5 2.20 2.0 Millions 1.5 1.26 1.17 1.0 0.89

0.5

0.0 2005 2006 2007 2008 2009 2010 2011*

Source: Realty Trac * Foreclosure filings for 2011 are for the first six months only. Figure 5

Post Crisis: Higher Savings, Lower Debt

14% 140%

130% 12% 120% 10% 110%

8% 100%

6% 90% 80% 4% 70% 2% 60%

0% 50% 60 65 70 75 80 85 90 95 00 05 10

Personal saving rate (left scale) Household debt/disposable income (right scale)

Source: Federal Reserve Bank of San Francisco Figure 6

cognizant reports 5 There are emerging signs of a market revival. Corporate profits, a key determinant of business Mortgage servicers are working through their growth prospects, point to the likelihood of job defaulting loan portfolios, and housing prices are creation. The St. Louis Federal Reserve’s research nearing a bottom. Low interest rates, reduced indicates that corporate profits as a percentage home prices, increasing credit availability, improv- of GDP hit a low of 5% in 2008 and rose to 8% ing job prospects, rising consumer confidence and in 2010 (see Figure 7). The industry considers this the opportunity for buyers to rent out properties favorable employment scenario as a strong influ- at profitable rates are among the key factors that encer that increases borrower confidence in buy- could stimulate the demand for mortgage loans ing homes. The Wall Street Journal reports that and, in turn, increase the supply of loans to RMBS household formations, which declined to 578,000 investors. The historical data representing these in 2008, rose to 950,000 in 2010.2 This figure is factors and their estimated trends point to a slow expected to rise gradually, which is expected to and steady revival. increase housing demand.

Corporate Profits

Percent of GDP 14

0 ‘86 ‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11

Profits (before tax) Profits (after tax) U.S. recessions Source: Federal Reserve Bank of St. Louis Figure 7

The unemployment rate, presently around A slow but steady drop in the unemployment 9%, is expected to gradually decline and rate should improve upon already increasing settle at around 5% after 2013 (see Figure 8). consumer confidence numbers. Additionally,

Unemployment Rate (Q4) Percent 11

3 2005 2006 2007 2008 2009 2010 2011* 2012* 2013*Long Run* Source: Federal Reserve Bank of St. Loius * Projections Figure 8

cognizant reports 6 the Conference Board notes that the Con- February 2009, the lowest since its inception sumer Confidence Index has risen from 25 in in 1967, to 45.4 in September 2011 (see Figure 9).

Consumer Confidence Index

75 70 65 60 55 50 45 40 35 30 25 20 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Source: Conference Board Figure 9

Delinquencies and foreclosures that surged in article provides some insight into what the next the aftermath of the subprime crisis peaked in five years might look like: “Once the foreclosure Q2 2010 at 11.59% and are now on a declining mess begins to clear up, say housing economists, path (see Figure 10). Estimates of foreclosure the traditional drivers of the housing market filings for 2011 are one-fourth of the filings of — demographics, affordability, loan availability, 2010. All these factors signal a positive turn for employment and psychology — should take over.” the mortgage industry. The Wall Street Journal

Delinquency Rate On Loans Secured By Real Estate Top 100 Banks Ranked By Assets 12 11 10 9 8 7 t

en 6 5 rc Pe 4 3 2 1 0 March '05 March '06 March '07 March '08 March '09 March '10 March '11

Source: Federal Reserve Bank of St. Louis Figure 10

The Economist concurs that “the best news of all stingy with credit, but households are better may be the ongoing improvement in credit con- positioned than they were to take advantage of ditions. Delinquencies have trended downward cheaper homes.”3 There has also been a marked since late 2009. Consumer-debt payments rela- shift in originations, from a low LTV scenario, tive to incomes are at a 17-year low, and house- to rapidly rising LTV since 2007 (see Figure 11, hold credit scores are rising. Banks are still being next page).

cognizant reports 7 Shift in Originations From Low LTV to High LTV

50%

45%

40%

35%

cupied Originations cupied 30%

25%

20% l Owner Oc ta 15%

To ge of ta 10% en 5% rc Pe 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

75% to 80% Originations 95% to 100% LTV Originations

Source: CoreLogic Figure 11

The present conditions in the U.S. housing market buying property. The scenario has already led have significantly improved home affordability. to considerable growth in all-cash deals, with The price-to-income ratio (an indicator of afford- bargain-seeking investors attempting to cash ability) fell from 2.7 in 2007 to 1.8 in 2010 (see in on low property values. The Mortgage Bank- Figure 12). The Freddie Mac 30-year fixed-rate ers Association (MBA) estimates that purchase mortgage at 4.27% in August 2011 is the lowest originations for one- to four-family homes may in the last 50 years. Additionally, the oversupply decrease by 12.71% in 2011, to $412 billion, and rise of homes and rising rental incomes (see Figure 13, by 29% in 2012, to $531 billion. next page) should increase the attractiveness of

Homes are More Affordable Now Price-to-income ratio, national average 3.0

2.5

2.0

1.5

1.0 '90 '95 '00 '05 '10 15-year average 15-year average 4Q 1995 – 4Q 2010 1Q 1989 – 4Q 2003

Source: Fiserve Inc.; Federal Housing Finance Agency; Moody's Analytics Figure 12

cognizant reports 8 Rent Changes in Realtors' Local Area, Year-Over-Year

50% 48% 46% 44% 45% 42% 40% 39%

35%

30%

25%

20%

15%

10%

0% Dec 2010 Jan 2011 Feb 2011 March 2011 April 2011

Increase Constant Decrease

Source: National Association of Realtors Figure 13

The market for RMBS, which nearly evaporated, is The Wall Street Journal reports that “subprime beginning to show signs of a likely revival. There and other residential mortgage bonds are back have been two private-label RMBSs offered in in vogue with long-term investors, in the latest the last two years: Redwood Trust 2010 and Red- sign that American credit markets are healing wood Trust 2011 ($290 million issue). The securi- after the worst downturn in a generation.”4 This ties comprise loans with high unpaid principal is reflected in the substantial improvement in the balances (average under $1 million), high credit ABX index from 30 in 2009, to around 60 in 2011 scores (average 775) and low LTVs (average 63%). (see Figure 14). Private market players are taking proactive steps to set up conduits in anticipation of the reduction in GSE loan-buying limits in October 2011.

Growing Attraction The ABX index, which tracks prices of subprime mortgage bonds, has recovered since the crisis.

100

60 e

Pric 40

0 2008 2009 2010 2011

Source: The Wall Street Journal Note: ABX.HE.AAA.06-2 sub-index Figure 14

cognizant reports 9 Gearing up for a New Mortgage Industry Given the present state of the banking landscape The prospect of increasing regulatory oversight and the prospect of a gradual recovery for the makes compliance key to the survival of mort- mortgage banking industry, originators would be gage banks and securitizers. There are many wise to take proactive steps to position their busi- signs pointing to the emergence of a different nesses for success in the new mortgage industry. mortgage industry, including the increased focus on customer protection, the creation of credit The banking industry’s business processes and IT risk retention requirements for mortgage origi- systems need to undergo considerable change in nators and securitizers, the curbing of predatory order to meet the unfolding regulatory require- lending practices, the rise of the spend-thrift and ments, as well as build new competencies to be debt-averse customer, and the increased capital successful. These investment decisions pose sig- adequacy demands. nificant challenges to banks that are presently operating in a business environment of weaken- ing demand, declining spreads (see Figure 15) and intensifying competition.

U.S. Banks: Falling Net Interest Margins

4.10 4.08 4.00 3.90 3.84 3.80 3.77 3.77 3.69 3.70

atio 3.60 3.54 R 3.57 3.50 3.46 3.40 3.34 3.31 3.30 3.25 3.20 3.10 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Federal Reserve Bank of St. Louis Figure 15

Increasing regulatory focus on banking is driving of originating a loan rose approximately 375% up the cost of compliance (see Figure 16), while in 2011 from 2003, 53% in 2011 from 2008, and spreads are falling. The net interest margin of going forward it is likely to increase significantly U.S. banks began falling at the end of the first (see Figure 17, next page). quarter of 2010. MBA research indicates the cost

Rising Cost of Compliance IT spending by financial services firms on governance, operational risk and compliance 1.8 1.72 1.7 1.68 1.60 1.6

1.5 1.41 1.40 1.4 1.35

$ Billions 1.3

1.2

1.1

1.0 2006 2007 2008 2009 2010 2011* Source: Celent * Estimate Figure 16

cognizant reports 10 Increasing Net Cost to Originate

$3,500

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$0 2003 2004 2005 2006 2007 2008 2009 4Q 2010 2Q 2011

Source: Mortgage Bankers Association Note: The "net cost to originate" includes all production operating expenses and commissions, minus all fee income, but excludes secondary marketing gains, capitalized servicing, servicing released premiums and warehouse interest spread. Figure 17

The profitability of the industry is driven by vol- The conditions and challenges that lenders face umes, spread and efficiency of operations. Indus- require a significant end-to-end process overhaul. try origination volumes and interest margins are With unfolding regulatory changes, investor scru- generally driven by the market. Mortgage banks tiny and a heightened focus on loan quality, lend- will need to leverage their operational efficiencies ers will be required to move quickly and deploy to increase profits and differentiate themselves more flexible business and technology solutions. from the competition. MPaaS providers can be a critical ally during sig- Many banks are challenged by the existence of nificant times of change. Their pointed emphasis silos within their organizational structure. Tra- on mortgage services and ability to readily adapt ditionally, compliance and business needs are to changing business needs can help banks get separately addressed, a gulf that has widened more bang from limited IT budgets — by shift- over time as systems have evolved. Legacy sys- ing Cap-Ex to Op-Ex, through pay-per-use or tems are traditionally inflexible and incapable of outcomes-based models — while accessing new adjusting to rapid changes within the banking and more automated service capabilities. Cou- industry. These older, hard-coded systems rely on pled with a lender’s ability to manage business manual intervention to provide workarounds and processes via MPaaS, banks have a tremendous overcome process limitations. opportunity to manage the challenges in the new landscape more effectively.

Enter Mortgage Process as a Service Traditional mortgage business process outsourc- The emerging business processes as a service ing (BPO) services providers already provide skilled (BPaaS) delivery model offers a viable option to domain resources and a scalable organization mortgage banks in need of a technology refresh with appropriate infrastructure to manage criti- and process makeover. This approach enables cal mortgage functions, such as loan processing. banks to rely on service providers with expertise in In this existing model, lenders essentially leverage mortgage processing services to shoulder the cost a service provider’s resources and infrastructure of ownership of technologies, infrastructure and capabilities, while retaining their own technology people. One flavor of BPaaS — mortgage process and defined processes. The perceived value of this as a service (MPaaS) — provides banks with the arrangement is cost, timeliness and quality. talent and systems wherewithal to handle essen- tial lending services, enabling them to solely focus Today’s mortgage market requires significant on rebuilding their businesses to the needs of the change in this value proposition. As such, BPO changing industry and capture market share. services companies must transform into MPaaS providers. Beyond cost, timeliness and quality,

cognizant reports 11 the MPaaS provider will need to offer pointed solu- than more strategic aspects, such as accuracy, tions to the lender’s and investor’s business objec- loss severity, repurchase risk, compliance, down- tives, risks and processes. The expectation can no stream efficiencies and customer experience, to longer be focused on executing a lender’s inter- name a few. nal process while leveraging the lender’s tools. The value proposition and expectations need to To evolve, the mortgage BPO provider must offer be extended to align the service output with the solutions rather than capable bodies. The solutions goals and objectives of the lender and investor. must address the critical aspects of the business. Loan processing solutions, for instance, need to Consider loan processing, for example. The admin- provide outputs that provide clear visibility into istrative aspects of loan processing have been loan data at a document and field level, in addition outsourced to third-party specialists for many to deeper analysis that will enable effective and years. In many cases, the BPO process is a reflec- compliant decisions. Critical loan origination values tion of the process requirements of the lender such as “Total Monthly Income” need to be encap- rather than the business and risk objectives of the sulated with the specific documents, document lender and investor. While some may contend that areas, document meta data (values extracted from there should be no difference between the two the document) and calculations utilized to arrive at (lender processes should address business and the critical value. The information collected should risk objectives), the flood of repurchase requests be compared with other available information and should point to the likelihood that a majority of analytics to provide a more trusted understanding loan origination processes do not provide the of the accuracy of the information. process output that meets or exceeds the risks or objectives of the business. In the loan processing example, the provider must move beyond the checklist-prepared file to the In short, many lenders’ processes lack the needed risk-and-objective-prepared file that clearly and depth of analysis, trust, accuracy and credibility methodically provides trust and transparency, with respect to investor requirements. Thus, the in addition to analysis that allows downstream traditional mortgage BPO provider is measured consumers of the service to extract more value on how well it executes a lender’s process rather (see Figure 18).

Future Dimensions of Mortgage BPO: Driving The Solution Needs

Traditional Dimensions of Mortgage BPO Mortgage Market Needs • Focused on labor cost savings and staff • Need for great scrutiny and due diligence during augmentation for scale and capacity. loan origination. • Provide increased visibility into potential loan risk. Market Drivers • Reduce overall origination, processing and servicing • Increased focus on portfolio and repurchase risk. costs while increasing process quality. • Need for greater process transparency, improved • Increased process control and consistency to increase data integrity and increased loan due diligence. loan quality and reduce repurchase risk.

Traditional Dimensions of Mortgage BPO Market Drivers

• Labor Cost • Rising origination costs • Capacity/Timeliness • Increased regulatory and • Domain investor requirements • Quality • Significant repurchase risk • Significant default risk

Future Dimensions of Mortgage BPO

Mortgage Process Process Process/Solution Traditional as a Service Risk Mitigation Consistency Benefit Dimensions (Sourced as (Data accuracy and Control (Cost benefit of (Capacity, domain utilities on & intelligence) (Process accuracy solution vs. and quality) pay-per-use basis) & intelligence) pure labor cost)

Source: Cognizant Figure 18

cognizant reports 12 A New Strategic Services Era The absence of transparency and data integrity The time for more strategic services has arrived. was one of several root causes of the industry’s Mortgage processes need to be retooled to problems that led to increases in repurchase address the need for enhanced regulatory scru- claims (see Figure 19). tiny, process transparency and risk mitigation.

Residential Mortgage Loans

Reserves for Repurchase Claims (in millions) Year BoA JP Morgan Chase Wells Fargo Citigroup Total 2008 2,271 1,093 620 75 4,059 2009 3,507 1,705 1,033 482 6,727 2010 5,438 3,285 1,289 969 10,981 2011 Q1 6,220 3,474 1,207 944 11,845 2011 Q2 17,780 3,631 1,188 1,001 23,600 Total 35,216 13,188 5,337 3,471 57,212

Source: Company Annual Reports and Natoma Partners Figure 19

Several factors undermined the quality of mort- produce a stronger mortgage market and increase gage loans, including the origination of exotic borrower and investor confidence in the housing mortgage types, predatory lending practices, eas- finance market. ing of underwriting guidelines, increasing property prices and the ability of financial interme- The rise of software as a service (SaaS), platform diaries to leverage their relationships to bypass as a service (PaaS), virtualization and cloud- underwriting guidelines. Ensuring data quality based sourcing of servers, storage, desktops and during the loan application and credit underwrit- data centers have created an environment that ing process would have removed some of the risk is conducive for innovations such as MPaaS that associated with purchasing mortgages. optimize efficiencies by reorganizing the industry services chain. Under MPaaS, vendors provide all The importance of data quality is also evident four key elements: people (BPO/KPO), applica- in Fannie Mae and Freddie Mac’s joint effort in tions, platforms and cloud-sourced infrastructure, the Uniform Mortgage Data Program (UMDP) which can be used like utilities on a pay-per-use as part of their Loan Quality Initiative (LQI). basis, obviating the need for banks to lock in their The UMDP establishes uniform requirements capital in these four areas. and file formats for appraisal and loan delivery data. Improved data quality throughout the loan By variabilizing fixed costs, MPaaS offers a com- application and underwriting process will help pelling case for significantly enhancing capabili- revive the housing finance market. Increased ties at a time when banks are facing significant loan transparency provided by MPaaS solutions transformational challenges. Banks and financial will enhance the quality of loan originations and services industry players are already ahead of reduce repurchase risk. Higher quality loan infor- other industries in embracing cloud computing mation and originations will result in increased (see Figure 20, next page). This places them in an mortgage performance. This will gradually advantageous position to embrace MPaaS.

cognizant reports 13 Financial Services a Leader in Cloud Adoption

60 53% 50

41% 40 37% 35% t 32% 32% en 30 29%

rc Pe 24%

20 19%

0 Technology Financial Legal/ Retail Healthcare Manufac- Education Energy Government Services Professional turing Services Source: Mimecast Base: 565 respondents Figure 20

Originators’ systems need to handle high volumes also help originators present quality information of originations and defaults. Even during the pro- about their loans to mortgage purchasers. longed period of prosperity that preceded the U.S. financial downturn, banks did not prioritize The MPaaS partner will be able to offer and pack- the need to invest in rebuilding their systems and age information that is specific to the vintage of processes to reap sustainable efficiencies. the loans, the demographics, the overall credit quality, etc. The infomediaries will ensure trans- The case for sustainable efficiencies is now stron- parency in loan sales by offering flexible platforms ger, coupled with the need to invest in systems to that will maintain compliance with underwriting gear banks for greater levels of regulatory scru- criteria, as requested by the user. The information tiny. An MPaaS partner can lend consulting ser- available to the user will foster trust and build vices that will provide guidance and solutions to sustainable business foundations. The mortgage regulatory challenges and opportunities. A part- purchasers will have greater knowledge regard- ner with the resources and capacity to assist in ing the pools of loans that they are buying, which navigating regulatory hurdles can make perceived will remove the mortgage purchase risk that was barriers to market re-entry less challenging. prevalent in the past. Better loan information will lead to better loan originations, informed loan purchases, increased loan performance, reduced Moving Forward risk, reduced repurchases and a stronger housing The mortgage BPO industry, which is projected finance market. to reach $3.56 billion in 2013, is embracing MPaaS because it enables mortgage bankers to The reformed mortgage market places huge access applications and processes built to serve demands on employee and IT resources that the demands of the emerging industry order. By are tied up in attempting to comply with current leveraging an MPaaS partner, mortgage banks rules and regulations. Lenders are hard-pressed will be better positioned with critical information to focus on product innovation and future busi- to make better loan decisions. ness planning. The MPaaS partner can help banks be more flexible and respond to regulatory MPaaS providers can act as infomediaries to pro- change. Banks and other lenders can leverage the vide independent and unbiased information about strength of partnerships with MPaaS providers the mortgage transaction to enable originators that double as infomediaries. In addition, working to make sound lending decisions and underwrite with MPaaS solutions providers (see sidebar) can quality loans. In addition, such information will help them gain market share and reduce risk in origination and purchase decisions.

cognizant reports 14 What to Look for in Your MPaaS Partner

The emergence of MPaaS is accompanied by the rise of potential partners that can enable loan originators of all types to better navigate the unfolding industry transformation. We believe they should seek the following in a partner to ensure they are on the right course:

• Capable of rolling out utilities in the MPaaS model, providing variabilization of fixed costs.

• Offers consulting services and possesses strong domain expertise rather than acting as a pure- play provider that lacks the ability to offer business advice or consulting in the transition to global sourcing.

• Provides best-of-breed workflows, data products, analytics and process controls that are aligned to the needs of a changing mortgage business.

• Delivers a solution that can process mortgage application documentation and critical underwriting data that empowers the originator and loan purchaser to make better investment decisions.

Footnotes

1 “Reforming America’s Housing Finance Market: A Report to Congress,” The U.S. Department of the Treasury and U.S. Department of Housing and Urban Development, February 2011, http://portal.hud.gov/hudportal/documents/ huddoc?id=housingfinmarketreform.pdf

2 Ruth Simon and Jessica Silver-Greenberg, “Why It's Time To Buy,” The Wall Street Journal, June 4, 2011, http://online.wsj.com/article/SB10001424052702304563104576361522020024248.html#printMode

3 “Delinquency Rate On Loans Secured By Real Estate, Top 100 Banks Ranked By Assets,” Federal Reserve Bank of St. Louis, 2011, http://research.stlouisfed.org/fred2/graph/?id=DRSRET100S

4 Matt Wirz and Serena Ng, “Subprime Bonds Are Back,” The Wall Street Journal, April 1, 2011, http://online.wsj.com/ article/SB10001424052748704530204576235010413833114.html

References

Federal Register, Vol. 76, No. 83, April 29, 2011, http://edocket.access.gpo.gov/2011/pdf/2011-8364.pdf

“Implications of Dodd-Frank for U.S. Banking and Financial Services Industry,” Reflections Journal, Cognizant Technology Solutions, May 2011, http://www.cognizant.com/InsightsWhitepapers/Reflections- May-2011.pdf

“Table 1193, Mortgage Originations and Delinquency and Foreclosure Rates: 1990 to 2009,” U.S. Census Bureau, 2011, http://www.census.gov/compendia/statab/2011/tables/11s1193.pdf

“MBA Sees Growth in Purchase Originations, Drop in Refinancing, and Weak Overall Economic Growth in 2011,” Mortgage Bankers Association, October 2010, http://www.mbaa.org/NewsandMedia/Press Center/74457.htm

“Profiles of GSE Mortgage Purchases,” U.S. Department of Housing and Urban Development, July 2011, http://www.huduser.org/portal/datasets/gse/profiles.html

“Report to the Congress on Risk Retention,” The Federal Reserve Board, 2010, http://www.federalre- serve.gov/BoardDocs/RptCongress/securitization/risk_d_links.html

cognizant reports 15 “U.S. Foreclosure Activity Increases 7 Percent in August, Defaults Surge 33 Percent,” Realty Trac, Sept. 13, 2011, http://www.realtytrac.com/content/foreclosure-market-report

“The Gender Wage Gap,” National Economic Trends, Federal Reserve Bank of St. Louis, July 2011, http://research.stlouisfed.org/publications/net/20110701/net_20110725.pdf

“U.S. Economic Outlook September 2011,” National Association of Realtors, July 2011, http://www.realtor. org/research/research/reportsstatistics

John McCrank, “U.S. Housing Market Attracting Bargain-Hunters,” Reuters, April 4, 2011, http://www.reuters.com/article/2011/04/04/us-wealthmanager-ushousing-idUSTRE72U6YW20110404

“U.S. Housing and Mortgage Trends,” CoreLogic, February 2011, http://cl.cvic.com/assets/CoreLogic_US_ Housing_Mortgage_Trends.pdf

“United States Consumer Confidence,” Trading Economics, July 2011, http://www.tradingeconomics. com/united-states/consumer-confidence

John Gittelsohn, “Cash-Paying Vultures Pick Bones of U.S. Housing Market as Mortgages Dry Up,” Bloomberg, March 29, 2011, http://www.bloomberg.com/news/2011-03-29/cash-paying-vultures-feast-on- u-s-housing-as-mortgages-dry-up.html

“Redwood Files for Second Jumbo MBS Deal in 10 Months,” American Banker, February 2011, http://www. americanbanker.com/issues/176_32/redwood-mortgage-backed-security-1033085-1.html

Tim Cave, “Broker-Dealers Count the Cost of Compliance,” Financial News, November 22, 2010, http://www.efinancialnews.com/story/2010-11-22/broker-dealers-count-cost-of-compliance

“Net Interest Margin for all U.S. Banks,” Federal Reserve Bank of St. Louis, July 2011, http://research. stlouisfed.org/fred2/series/USNIM

Prashant Gopal and Jody Shenn, “Banks May Soften Blow of Jumbo Loan Limits,” Bloomberg, June 28, 2011, http://www.bloomberg.com/news/2011-06-28/banks-appetite-for-jumbos-may-soften-blow-of-new- loan-limits.html

“Goldman Sprints Ahead with Conduit Plans,” Asset-Backed Alert, May 20, 2011, http://www.abalert. com/headlines.php?hid=151643

“Orchestrating Mortgage Lending Using Business Process Management,” PricewaterhouseCoopers LLP, November 2010, http://www.pwc.com/us/en/financial-services/publications/viewpoints/viewpoint-business-process-management.jhtml

Lawrence Yun, “Housing Market and Economic Outlook: July 2011,” National Association of Real- tors, July 21, 2011, http://www.realtor.org/wps/wcm/connect/2753558047abfcff9436d593a9f011da/ Chicago_Chase_Event_July+2011.ppt?MOD=AJPERES&CACHEID=2753558047abfcff9436d593a9f011da

cognizant reports 16 Authors Analyst Rajeshwer Chigullapalli Svetlana Malu Cognizant Research Center Cognizant Research Center

Aala Santhosh Reddy Cognizant Research Center

Nathan Longfellow Director, Cognizant Banking and Financial Services Consulting Practice

John Geertsema Manager, Cognizant Banking and Financial Services Consulting Practice

About Cognizant

Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out- sourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and over 118,000 employees as of June 30, 2011, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top-performing and fastest growing companies in the world.

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