The unspoken value of technology in the MMR
Paul Hunt, managing director of Phoebus Software, has expressed disappointment that the Mortgage Market Review has been silent on the importance of technology, particularly the updating of back office systems
Perhaps the most poisoned chalice in the world of mortgages must have been that taken up by those within the Financial Services Authority who put together the latest mammoth edition of the Mortgage Market Review.
Since the document was released, it has been criticised for a both a lack of ambition and described as the potential cause of the next house price crash.
It reminds me of a quote from a judge on how to strike a balance between the anger of the victim and the magnitude of the offender’s crime when sentencing: “Three years must have been about right because I managed to upset everyone.” Just like the judge’s courtroom dilemma, the regulator knows those looking for heavy handed restrictions will dismiss sensible changes as bland common-sense and others will suggest any addition to the regulatory burden will crush an already deflated market.
The mortgage industry’s reaction to the MMR has been to criticise it as simultaneously too lenient and too severe. Nick Hopkinson, of PPR Estates, reacted to the MMR saying the FSA’s lenience was akin to slamming shut the barn door once the horse has bolted. The regulator’s credibility, he said, was ‘in tatters’. Any proposed further regulation, he said, ‘will simply cause more red-tape and reduce the availability of much needed credit through higher costs’.
On the other hand, Bill Warren of Bill Warren Compliance LLP took the view that in dealing with the rapidly expanding bridging market, the FSA was too eager to be risk averse rather than accepting the industry’s record.
It’s nothing new to criticise the FSA for being either too harsh or too permissive in its attempts to prevent another avalanche of credit from crushing the UK’s economy. The arguments are well rehearsed and while they are vitally important, they incorporate a degree of inevitable uncertainty.
But in my view, the MMR’s implementation of common sense assessment practices is beyond reproach. After all, what can be the purpose of a regulator if not to set out the minima at which practitioners are required to operate? So long as there are more horses in the stable, bolting the door is eminently sensible.
As for the severity of the new regulatory agenda, any post-recession commentator who suggests that industries with relatively unblemished records should be treated with kid-gloves because they have not fallen into crisis is, sadly, living in dreamland.
Lending volumes
Unfortunately for the FSA, despite the intense industry scrutiny of its proposals, only time will tell whether it has done enough – or sufficiently little – to protect the mortgage and property markets from another implosion. But the data so far looks positive.
The lesson of 2011 appears to be that while lenders have broadly adopted the three key changes the FSA has made to affordability assessments for house price change, interest rate fluctuations and interest-only mortgages, this has not sent volumes off the cliff.
According to the CML, in the year to October 2011, gross mortgage lending grew on an annual basis for three consecutive months for the first time since 2007, despite the growing liquidity fears of lenders facing the now almost inevitable financial earthquake that a default in the eurozone would cause in the UK.
Moreover, lending to first-time buyers has actually increased as a proportion of total lending since the recession. This is a result of an impressive willingness among lenders to drive forward the property market at the lower end.
Lenders have taken on board the fact that today’s first-time buyers are tomorrow’s higher-value purchasers and a failure to push forward this section of the lending market will, in the long run cause instability in property prices and greater uncertainty for lenders and borrowers.
Last year showed lenders are prepared to find a way to increase volumes regardless of ongoing economic uncertainty and the industry’s post recession performance is an empirical indication that lending in line with the MMR’s proposals does provide scope for volume growth and access for those trying to get a foot on the ladder.
This cannot have escaped the attention of the regulator. The ability of lenders to increase their activity – along with the rapidity of the growth in niche sectors like bridging – serves as an indicator that the industry is capable of adapting to new regulatory schemes so long as they are based on sound business practice rather than lock and key caution. But given that this seems to be the clear message provided in the MMR, the failure of the report to address the use of technology by the mortgage industry is remarkable.
Arrears
Any increase in the size of the regulatory burden must ultimately be met with intelligent and capable use of technology to assist lenders in reducing costs and improving the accuracy of their activities. This is best illustrated by lender forbearance in 2011.
The CML’s arrears figures show that from Q3 2010 to Q3 2011, the average outstanding balance on mortgage properties in arrears rose slightly from 4.76 per cent to 4.8 per cent. In the same period, the number of properties taken into possession fell by almost 10 per cent from 39,300 to 35,500. While the level of arrears was almost static in the year to Q3 2011, lenders still managed to find a way to cut possessions dramatically.
The reduction is the result of a change of policy and practice rather than any improvement in the finances of mortgage borrowers struggling to keep up their repayments. This shows the power not only of political and social pressure on lenders, but also of technology and improving management of borrowers’ finances.
Repossessions
The political reasons behind the pressure on lenders to forbear aren’t necessarily bad news for lenders. Especially in a market where real property prices are tumbling, it’s a good idea to try to find ways of assisting borrowers to ward off repossession. In the halcyon days of the mid-2000s, the greatest barrier to the wider implementation of this approach was its ability to eat away at margins, requiring as it does greater expenditure on servicing functions. Lenders in the last year have rightly made it clear that this is worth paying for.
This change owes as much to falling house prices as it does to the regulator’s greater willingness to wave the stick of treating customers fairly (TCF) at lenders who have not done enough to prevent possession occurring. The question now is whether this ongoing forbearance is sustainable?
In his response to the MMR, Mark Blackwell, of xit2 made it clear he doesn’t think so. He points out a rise in the base rate or a return to recession ‘could swiftly bring the problem of arrears back to the surface’. Blackwell has good company.
The Bank of England has criticised the degree to which TCF has extended forbearance, stating the current situation is unlikely to continue and ultimately a spike in repossessions is almost inevitable. This may well be true, but the failure of the MMR to address the potential value of technology in the industry is indicative of a wider failure in the industry to fully explore what is possible through the use of modern, up to date systems.
There will always be borrowers who fall on hard times and simply cannot keep up their payments. But the original cause of the latest mortgage crisis was not an excess of borrowers failing to fund their borrowing. It was excessive optimism about their ability to service whatever debt they took on. An inability to comprehensively scrutinise the financial positions of individual borrowers and to consider fully the level of risk they posed was the root cause of the write-downs of securitised mortgage assets that brought the British financial system into crisis.
My point is the same as that which underlies the recommendations of the MMR – taking the time to look in carefully at the positions of individual borrowers is the best way of preventing another crisis.
Investment in technology
But cost sceptics would say that this is impossible without choking off the supply of credit which has so far prevented a property price crash through soaring lending costs. The MMR missed an important opportunity to counter this argument.
Mortgage lenders, understandably, have for the last few decades prioritised fee-earning parts of their business over investment in technological infrastructure. This decision was based on the argument that excessive internal spending would have a damaging impact on lending volumes.
But in a new regulatory and financial environment, such investment is now crucial. Lenders stuck with unwieldy and idiosyncratic legacy systems now not only deny themselves the cost savings of more modern technology – especially that provided by the Cloud – but they also prevent themselves from accessing technology which can significantly reduce the cost of applying TCF for the purposes of not only compliance, but sustainable and prudent lending.
A number of big lenders have had a tough time following acquisitions in trying to rationalise the legacy systems those mergers brought under their umbrellas. It’s not an overtly lax attitude to customer service that has caused high-profile problems, but rather the immense challenge these organisations face to make their technology work efficiently and effectively. Anyone working around the servicing industry should sympathise with this situation.
But beyond suffering in the personal finance press, having an unwieldy system prevents lenders from maximising the possibilities offered by technology to make TCF work for them.
A major investment now not only places a lender in the best possible position to grow coherently, but by putting in place systems which make it possible to distinguish rather than agglomerate borrower risk, technological modernisation is the best way to ensure regulatory compliance and that borrowing is sustainable in what will eventually become a growing market.
Legacy systems
The industry’s approach to technology has to change. In the mid-2000s, the primary investment focus on systems was for state of the art origination platforms, which left servicing functions by the wayside. As the figures on forbearance imply, this balance has begun to be redressed, but with the top five lenders accounting for 80 per cent of the market, it’s very hard to assess precisely how many people are still exposed to legacy systems.
When you’re running an older system, problems occur when data is not accessible. When this happens, you’ve got to revert to manual processes, pulling files out of drawers to work out who’s in arrears and by how much. So if you’ve got 100 people working in the collections arena, 50 are spending their time putting information together while the rest are on the phone.
Improving servicing functions means ensuring as many functions are automated as possible, leaving human beings to start hitting the phones to talk to borrowers.
The thing about having a good automated process is that you know the position of borrowers possibly going into arrears so you can do risk management and initiate the dialogue. You’re already speaking to them before you have to do the laborious investigation – and all the information is readily available on the screen.
There’s no substitute for direct and informed contact in servicing functions and this type of communication gives the lender the best possible chance to work out an alternative repayment structure that staves off default and does exactly what TCF was designed to achieve.
MMR overlooked technology
My greatest disappointment with the MMR is that it is silent on the importance of updating back office systems. Technology is the most effective way in which the regulator can have its cake and eat it.
Those who claim the FSA’s expectations of greater compliance functions are no more than expensive utopian whimsy have had fuel added to their fire by the MMR’s arcane overlooking of technology in all of its 700 pages. Technology is core to change in the industry and the best answer to those who question the cost of regulatory growth.
Perhaps the FSA feels advocating systems updates is too paternalistic, delving further than is comfortable into internal functions. But in an industry where legacy systems serve as an ongoing brake on servicing functionality, any regulator hoping to provide solutions rather than just problems must place systems technology high on its agenda.
