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.