The Cost of Trust

“Our distrust is very expensive” said Ralph Waldo Emerson. I love the quote above. It may define our times. But it raises the question; what is the cost of trust lost? Merrill Lynch Credit Corporation, a mortgage lender to Merrill Lynch clients won the Malcolm Baldridge Award in 1997. It was the first financial services company to win the award. Since that time, it has been common to hear total quality management or six sigma, be emphasized at financial services firms (although GE Capital subsidiaries had been working with it from the early 1990’s). While new and connected technology was being introduced by just about every financial services firm, the decade before the mortgage crisis was characterized by process improvement in time and cost. Leveraging the new technologies by efficient processes was paramount to competitive advantage. Better, faster, cheaper was on every leaders mind. Those efforts were paying off. In 2000 the cost to originate a mortgage loan was 141 bp’s, in 2003 it was down to 93 bp’s per the Mortgage Bankers Association Cost Study for those years. In cash to the bottom line that was $265. I use 2000 and 2003 because they are not too close to the financial crisis and may be more balanced as a benchmark than the years closer to the crisis when volumes were way up. It was a low interest rate environment where industry experts knew that most home owners, enjoying steady appreciation could be counted on to refinance possibly twice in a decade, if you provided good service. A focus on key performance indicators by a management team could improve customer satisfaction, speed to approvals and closings and lower costs, improving profitability or price competitiveness. Management sciences was at work (along with technology and very often driven by technology) in the mortgage industry. This was a great time to be in the business. Loans per production employee improved from 41 to 62, for the same period per the same study. Yes a 50% improvement. Ok, channel management might help that one a bit, but not 50%. What’s more, personnel cost per loan went from 70bp’s to 48bp’s for the same period. A very positive trend was developing. Let’s skip the crisis in this discussion and acknowledge you need to be managing production much tighter today than in 2003. Investor put-backs are requiring better quality controls are in place. But with the crisis, trust was lost. Government and investors (same stakeholder really) reaction to the industry’s performance to the crisis was lots of new rules because there is little trust that the industry participants will operate looking out for consumer or investor interest. That lost trust is costing quite a bit as every compliance officer knows. How much is that lost trust costing? Well the MBA released some cost numbers in December for the third quarter of last year. The total loan production expense was 2.13%. The loans per production employee were 16 (annualized). This is just over $3,000 more costly per loan than the 2003 value of 93 bp’s. That’s a lot of compliance. Fortunately for lenders, in the 2012 study secondary and marketing income was 271 bp’s, compared to 94 bp’s in 2003. That kind of spread can mask a lot of issues. But is that spread sustainable? The government has stated in many different ways they want to retreat from their current share of the secondary markets and have private investors come back to the market. The government insuring or buying over 90% of the loans originated is unsustainable. Private investors will want a lot more of that spread than the government has been taking. That brings us back to the cost to originate. The operational risk of sustaining a profitable business model is on the lenders shoulders. Maintaining access to capital markets is too important than cutting any corners to save on costs. Running at the current efficiencies is just as unsustainable as the governments participation rate in the secondary markets. Now that the rules are being defined and implemented, automation will help drive down some costs, but not all of it. The human process that originates a loan will need to be managed better than ever before. The management of that process had better be able to inspire trust, or it will not be competitive or sustainable. That is where leadership, not just management will be the differentiator. Those abilities beyond just control and coordinate are needed. Firms will need the key performance indicators of the loan origination process along with the metrics that evidence an aligned and engaged work force, with a strong values driven culture and clear responsible empowered decision makers ensuring compliance beyond anything programmable or the limits of policy memos. Are you ensuring that for your business? Can you evidence it when someone like a regulator or investor asks to see it? You will not be able to rely on trust, it has been lost. They know you can do, they just don’t trust you will do it. The cost of trust lost is usually handled in a very macroeconomic fashion like the cost to society or to generations or market access or liquidity. But sometimes you can calculate it on what you do every day. So the answer to the question; what is the cost of trust lost? If you’re a lender today; about $3,000 per loan originated.

Using Compliance to Rebild Trust

“Our distrust is very expensive” said Ralph Waldo Emerson. He had no idea. The Chicago Booth/Kellogg School Financial Trust Index (for the second quarter of 2012) found that only 21 percent of Americans trust the financial system, the lowest point on record since March 2009. This decrease was largely driven by a drop in trust of national banks. Late last summer Innoveta Strategies conducted a survey of financial services executives and found a strong majority (86%) working on restoring public trust for themselves and the industry. Optimistically 83% felt that public trust in financial services industry can be restored. In his book The Speed of Trust, Stephen M.R. Covey introduces and defends the idea that trust in business and in life is built on competence and character. A lot of pages have been written in the last few weeks on the industry reaction to the CFPB issuance of the Qualified Mortgages\Ability to Repay rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules are far from perfect, but they are specific and will become the starting point in how the federal government regulates the mortgage industry going forward. Incorporating these rules into the human and technological processes used to originate mortgages is now a tactical imperative of industry participants. The mortgage loan origination process has never been more expensive according to the MBA Cost Study. Codifying these rules efficiently provides the opportunity to reduce this cost. Attitude is a significant driver of performance. A bad attitude can derail the best calculated plans. Embracing any task makes its execution more efficient. To ensure efficient execution and demonstrate the competence that helps build trust, it is every leader’s duty to embrace the task before him or her. This might be difficult this time around because in the same Innoveta Strategies Survey, 76% of respondents disagreed that the government understood the challenges to the housing market and 53% disagreed that the government had the best interest of the consumer in mind. The competence with which the industry displays in this stage of a major market overhaul will be a significant contribution to the rebuilding of public trust. Demonstrating a commitment to compliance might even demonstrate a little bit of character.

Addressing Mistrust

“Mistrust doubles the cost of doing business” John Whitney, Columbia Business School The cost to originate a residential mortgage has ballooned from 93 bp’s in 2003 to 231 bp’s in the third quarter of 2012. Almost all of that are new procedures and reporting of additional data required by investors and regulators. There are several ways to reduce this cost in the near future. Recently, the final issuance of guidelines will allow technology and policy and procedures, guidelines to standardize the new requirements, thus bringing down the cost somewhat. But there is still a large premium in that number for the mistrust lingers with the mortgage industry today. The rigor with which a successful total quality management or continuous improvement process style of management takes, requires using a lot of facts in a continuous and organized fashion. The tool kit includes reports, scorecards and dashboards to generate the information we need to digest in order to determine the quality and efficiency of our groups’ processes. We answer the question- are we meeting our goals or stretch goals for our process and production? The information positions us to make the many small decisions that can often have a big impact on our production or quality goals. The mortgage industry has well known quality and process metrics; speed to approval or closing, error rates and related reworking, effectiveness of turning inquiries into applications, applications into approvals and approvals into closed loans. Less pursued and often more impactful in managing these key performance indicators is the information we rarely turn to regularly because we don’t turn it into data. If we did, this information can also be used to make small decisions that can have a big impact on results. They are things like- is management’s vision for the business and future known and understood by those doing the work (alignment of the workforce), is our organization’s culture supportive of what we are asking of employees and want to deliver to customers and other stakeholders, are employees engaged and do they have what they need to make decisions in the course of normal and not so normal circumstances? The first reaction to these questions by leaders is usually -that’s why we invest in training and technology and aggressively document our expectations in policy, procedures and guidelines. All of that is good, and in the rigor of continuous improvement, one can never be let up. But the key quality and process indicators are results and don’t directly measure the questions in the previous paragraph. Those measurements have to be derived by asking the questions to the parties involved, collecting the results and measuring performance against a goal. The goal setting and asking part are very often not ever bothered with when a company is focusing on big issues around growth and process improvement. That is as big a mistake as not asking customers if they are satisfied. Best practices needs to include performing regular assessments similar to the questions posed above, as well as other questions measuring a variety of issues around the attitudes pervasive in your organization, capturing the results and tracking their movement over time in a report, scorecard or dashboard, similar to other key indicator measurement tools. These tools have the ability to reflect when an organization’s culture supports decisions in the absence of technical or policy, that are knowledgeable and consistent with all stakeholder interests. It may seem like a “nice to have” and not a “have to have”, except a careful reading of the Consumer Financial Protection Bureau Examination Manual reveals that they are going to look at a firm’s culture specific to the law. What metrics will you show them to affirm your supportive culture? Managing and leading in the world going forward requires a larger tool kit. Assessments that solicit feedback on attitudes and values will be as important to decision making as the quality and process key performance indicators used today. And as you chip away at mistrust, you will move costs down, enhancing profitability and sustainability.