An Accountant’s Perspective On The Mortgage Industry July 2011
Improving The Mortgage Lender’s Bottom Line
The predictions seem to be holding true (well, the ones about mortgage volumes anyway): mortgage volumes were down dramatically for the first quarter of 2011. At the same time, expenses continue to increase thanks to continually more complex regulations, changing compensation rules and general inflation. So, since the world didn’t end, the independent mortgage banker is left with the task of managing the bottom line to stay afloat. One method I’ve found to be successful for improving net profit, is when management sits down with their balance sheet and income statement (with detailed revenue and expense data) and reviews, line by line, each item, considering opportunities for savings. Often assets can be redeployed, revenue producing products can be fine-tuned and expenses can be renegotiated. Some potential discussion items are highlighted below to help you get started.
REVENUES FIRST. If I heard any good news in the first quarter, there were some reports of higher per loan yields in the secondary market, chalk it up to good old supply and demand. If you’re still operating on a best efforts model, now might be the time to research other secondary marketing options. While volumes are down, management teams can put some time and effort into researching and implementing a more sophisticated and (hopefully) lucrative platform to bulk sale loans. If internal staff feel overwhelmed by this option there are several third-party providers in the market place that can make this task far less daunting. If the Company is already trading in these markets, the third party providers are also available to review your internal secondary marketing efforts, possibly identifying dollars left on the table which the Company may not be taking advantage of.
MAKE YOUR MONEY WORK FOR YOU. Increasing liquidity requirements from HUD and warehouse lenders are forcing independent mortgage banks to keep more liquid assets on hand than ever before. Generally, liquid assets are cash and investments with an original maturity of three months or less. If you find that you don’t require all this cash for your operations, consider purchasing three-month investment products that can offer some return (albeit, a very small return). What can I say, I’m an accountant; I count every penny!
DIRECT EXPENSES. There’s no way around paying direct expenses, however if you haven’t evaluated what you’re paying for some of these costs recently, it’s time to revisit this. I’ve seen some nicely negotiated volume pricing on many different products. Other lenders are realizing savings through involvement with mortgage-focused co-ops. It’s also a good time to review operational procedures to ensure that unnecessary costs are not being incurred, for example, incurring credit or appraisal fees too early on loans that don’t materialize. Finally, avoid the warehouse non-use fee! Volumes may stay lower for a while so negotiate your terms with the bank. If they won’t bend on terms, adjusting available credit may help manage these fees. The warehouse lending market is not as tight as it was over the past few years; I expect that lenders will be willing to discuss reasonable amendments to terms or fees.
INDIRECT EXPENSES. This is where the line by line review can really pay off. To compete for your business, most service providers are happy to evaluate your Company’s needs and provide a free quote. Let them! Providers to contact include insurance salespersons, office equipment lessors, office product suppliers and landlords. This can be a little taxing on your internal resources as you need to provide information and evaluate options (don’t do the whole income statement at the same time) but the reward can be significant.
When was the last time the Company completely re-evaluated employee benefits? Improvements here can save the Company money and may also make for happier employees. You may find that you’re able to offer better options or pass some savings on to the employees. Health insurance is a very large expense to every employee and company. Are you offering your employees the best options for the price? Have you explored high deductible or self insurance options? Do you offer employees pre-tax options for health and dependent care costs that come at very little cost to the Company? And remember, health insurance isn’t the only insurance product that should be reevaluated; don’t forget the liability, key man and fidelity policies.
If your office lease is up for renewal (and maybe even if it isn’t) take advantage of the plethora of commercial property available for lease. Do some research and then let your landlord know that there are a lot of options out there that could save you money. Do the same with office equipment leases or purchases, office supplies and even printing costs for direct mail advertising.
In summary, leave no stone unturned. In today’s economy every business has an obligation to manage costs. More importantly to you, nearly every business recognizes the need to compete for business, leaving the door wide open for negotiation on terms, prices and so forth. Look at where you spend your money and then explore options that would allow you to spend less of it. A word of caution however, sometimes you really do get what you pay for. Make sure you’re not sacrificing too much quality to save a few dollars. For example, the name brand of your office paper may not matter to you (save money here), but a poor health insurance provider, who denies claims or makes life difficult for your employees, can be detrimental to employee morale (be more careful when trying to save money here). Always end every decision making process on expenses with a risk / reward analysis to help management focus in on the best overall solution for the Company.
HUD Audit Guide Chapter 1 Newly Revised
In early May, HUD released the long-anticipated revision of Chapter 1 of its Audit Guide. The following are some of the major changes related to audits of mortgage lenders. These changes are effective for fiscal year ends ending on or after September 30, 2011.
MAJOR PROGRAM DETERMINATION MATERIALITY LEVEL: HUD has raised the materiality level to determine if a lender’s FHA lending activities meet the requirements of a major program. The raised materiality amount is now $2 million. The old materiality level was $300,000. Major program auditees are subject to substantial audit testing of their compliance with the laws and regulations of the lender’s FHA lending activities. Nonmajor program auditees are subject to reduced testing of their compliance requirements, and the auditor does not issue an audit opinion on their compliance with FHA regulations. The raised level of materiality could have an impact on small lenders who originate very small amounts of FHA-insured loans. Overall, lenders could save money on audit fees if they fall under the new materiality level for major programs.
FRAUD HOTLINE: HUD now requires auditors to call the HUD Office of the Inspector General when he/she becomes aware of illegal acts and/or fraud that has occurred or is likely to occur. The auditor would discuss their findings with HUD, who would then determine what reporting and/or documentation is needed. This communication has to occur immediately upon the auditor becoming aware of any such acts as outlined above.
ADDITIONAL INFORMATION IN ENGAGEMENT LETTERS: HUD has outlined certain mandatory information that needs to be included in auditors’ engagement letters to their clients. Such information includes the delivery date of the auditors’ report, documentation of the fraud reporting responsibility as outlined earlier, and a list of information that the client needs to provide the auditor with requested delivery dates of such items.
HUD plans on releasing revisions of additional chapters of their Audit Guide in the upcoming months (including Chapter 2 later this Summer 2011). As these revisions are released, auditors and their clients must work together to evaluate the impact of these changes to their yearly audits.
LinkedIn Poll Results
Which of the following performance indicators do you believe to be more important currently?
Loan Turnover 38%
Profit By Loan 25%
Pull Through Percentage 38%
Our Next LinkedIn Poll Questions
How did you find the greatest expense savings in reviewing your Company’s operations?
a. Management initiative to review expense line items
b. Approached by a service provider regarding their services
c. Suggestion from an employee
d. Other – please tell us about it
Join in on the conversation and participate in our next LinkedIn Poll Question by visiting https://linkd.in/qMkfZ7 and see the poll results in our next issue.
Bend The Trendline With Unique Self Insurance Solution
Historically, small and midsized employers have been risk adverse when it came to self insuring their group health insurance program. Fears stemmed from the belief that if a catastrophic claim was to occur— the group was not large enough to absorb this potential hit. However, Health Care Reform legislation passed in March 2010 has placed increased pressure on the health insurers and employers to be more collaborative and proactive to control health insurance costs—and self insurance has become a very viable option.
Some insurers have reacted to this pressure by developing unique self insurance programs which are gaining in popularity for small and midsized employers. Employers that are currently fully insured are considering self-funding as an alternative due to increasing frustration over not receiving health insurance renewals in a timely manner and not receiving their groups detailed claims experience from the insurers.
One unique option that is becoming increasingly popular for employers, which also comes with tax advantages, is a product called Level Funding. Level Funding is designed to allow employers to benefit from positive claims years while being protected from catastrophic claims. Employers continue to offer plans similar to what they offer now— but what changes is how the program is funded. Depending on the size of the company— the employer will be required to answer a series of underwriting questions to assess the overall health of the group. The groups’ previous claims experience will also be considered. Once this information is submitted to the insurer— a set monthly premium amount will be determined.
An employer that is in a self-funded program has the ability to truly affect their claims utilization more so than when fully insured. When a group is fully insured, the employer does have the comfort of being part of a larger pool of companies, but there is not much that the employer can do to financially benefit from their own wellness activities or health initiatives. Now, due to Health Care Reform, the increased pressure placed on the insurers has created an environment where the insurance carriers are playing a larger role in helping companies to reduce their claims with disease management and wellness services. When combining these health programs with a self-funded plan, companies can benefit immediately from positive claims years.
Here’s how it works. Every month the employer will pay the same pre-set amount. Then, at the end of the year, the company can realize significant savings if actual claims experience was better than what was projected when the insurer trues up the year’s actual claims against those projected.
For employers who are accustomed to being fully insured, this product allows the employer to continue to pay a pre-set monthly premium. Unlike being fully insured, there is an opportunity for savings when claims run well. If, however, the claims experience is worse than what was projected— nothing additional is owed, which allows the company to budget the program in advance.
This type of self insured program is helping clients to bend their trendline. For instance, some small companies who are self-funded are able to keep costs consistent year over year, without changing employee’s deductibles or costs for insurance coverage. CFO’s are now more effective in budgeting for health insurance premiums, and the employer is not subject to state health insurance premium taxes which are generally 2-3 percent of the premium’s dollar value. These tax savings can save small businesses thousands of dollars annually.
Full transparency in claims reporting is available throughout the year, which allows the company to constantly assess the program, including at the time of the policy renewal. At that time the employer can decide to remain in the program or go back to a fully insured program if they wish. This Level Funding product is an example of one of the new self-funded plan alternatives available in the market.
For more information on how to structure a self insured health insurance plan, please feel free to contact:
About Our Expert
Greg Sandler is Vice President of Employee Benefits at Meeker Sharkey Associates, a WithumSmith+Brown Partner. He helps businesses reach their corporate goals by implementing a wide variety of health insurance products and strategies, human resources services, and the execution of long range strategic plans. He has become an expert on the changes resulting from Health Care Reform and is focused on designing insurance programs that sustainably control health insurance costs while incorporating wellness, disease management, care coordination, and HR technology strategies.
HUD Quality Control Loan File Reviews
Although HUD mandates quality control “QC” reviews, it is a process which provides originators useful information that might otherwise not be obtained. Originators should view QC reviews as a positive requirement. QC reviews identify potential systemic problems, create improved procedures, and force management to quickly identify solutions as opposed to sweeping problems “under the rug.”
HUD mandates that all FHA loan originators maintain and follow a QC plan (allowing for certain individual specifications depending upon a mortgagee’s needs) and perform QC reviews in accordance with HUD guidelines. Depending upon the volume of FHA loan origination, the frequency of reviews can differ.
Mortgagees are allowed to utilize either internal or external QC review. A cost-benefit analysis, in addition to qualitative factors, should be reviewed. If internal reviewer is used, they must be independent of the loan originating and servicing processes or “day-to-day operations”. If QC review is outsourced, the mortgagee is responsible for the quality and compliance of their external reviewer. Originators should perform due diligence prior to hiring an external QC firm and periodically assess the quality of the services being provided.
Given current economic and industry conditions, if volumes are down, management should reconsider its review frequency requirement and determine whether reviews can be reduced from monthly to quarterly, and the cost-benefit of external vs. internal QC.
As we continue to recover from the financial and housing market crisis, it is even more important to perform QC reviews in accordance with HUD guidelines, not only as a shield from HUD scrutiny, but for awareness and best practice from a business position. Recently the Federal Government sued Deutsche Bank for “reckless lending.” The lawsuit cited Deutsche’s failure to implement and follow QC standards, in addition to lying about their compliance. Though using an external QC reviewer, according to the lawsuit, the reviews were never read by management, and therefore, no management responses could have been produced.
This is just one example which reiterates the importance of performing QC reviews in accordance with the regulations and to document the performance of the reviews. It facilitates the detection of errors, potential fraud and ensures that management takes timely appropriate action to correct any deficiencies. Management can also assess loan quality and whether loans are not holding up to company standards. Additionally, non-compliance with QC review results in an external audit finding, which is submitted to HUD, and can result in penalties and license suspension. In conclusion, it is in a lender’s best interest to perform timely and proper quality control reviews.
SUMMARY OF CERTAIN REQUIREMENTS:
Timeliness: Review of a specific mortgage should be completed within 90 days from the end of the month in which the loan has closed.
Frequency:
Close > 15 loans monthly 4 monthly reviews required and should address one month’s activity.
Close < 15 loans monthly 4 quarterly reviews are required.
Sample size:
Originations 3,500 4 10% of originations or a statistical sample providing a 95% confidence level with 2% precision.
Documentation: Sample selection and size must be documented as to how it was determined, in addition to management responses and the date review was performed. Without documentation, HUD could penalize an originator and conclude that no review was performed.
An Accountant’s Perspective on the Mortgage Industry is published by WithumSmith+Brown, PC, Certified Public Accountants and Consultants. The information contained in this publication is for informational purposes and should not be acted upon without professional advice. To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. Please contact a member of the Mortgage Banking Services Group with your inquiries.
