Last year was a record year for UK mortgage lenders, with gross advances exceeding £160bn ‘ a 35% rise on the previous year. This booming market, much of which represents business generated through the intermediary sector, was driven by a buoyant housing market. It was also helped along by low and falling interest rates and a plethora of attractive mortgage deals offering consumers a choice of fixed rate, capped, discounted and cashback deals, to name but a few.
Far from living off the fat of the land in a booming market, lenders found themselves in an extremely competitive market, with margins coming under increasing pressure. With high levels of churn in existing books and remortgaging reaching record proportions, it has become increasingly difficult for lenders to make any positive return on mortgage business.
Not only were the established high street lenders competing for business, but they had been joined by low-cost, virtual and specialised lenders. These lenders have been encouraged to enter the market over the past few years thanks to the success of the first wave of new players in the mid to late 1990s and the reduced barriers to entry that exist in today’s market.
Turning up the heat
These new entrants target specific niche lending sectors with a business model based on a substantially lower-cost of originating and manufacturing of mortgages. By delivering products more cheaply than established branch-based lenders, new entrants have had the effect of intensifying price competition throughout the market.
So how do these new lenders succeed in achieving lower costs in processing mortgages so they can undercut traditional lenders? First, they are centralised and specialised, thereby avoiding the costs of maintaining an expensive branch network or of delivering a whole range of financial products.
Second, new entrants tend to outsource the manufacturing of their mortgage business, entrusting it to specialised servicers under third-party administration (TPA) contracts. This avoids needing a fixed cost processing function in a start-up situation where business volumes are inevitably uncertain and fluctuating. They are able to benefit from variable costs at the outset and get to market faster than they could on their own.
Finding another route
Faced with steadily increasing competition from low-cost providers, more established lenders have started to look seriously at the outsourcing route. This combination of factors has provided a long-awaited boost to the outsourcing industry ‘ both in terms of the participants and the business they handle.
The initial concept arrived from the US almost 20 years ago in the early 1980s with the birth of Mortgage Systems, which was subsequently acquired by Homeloan Management.
The past two years have seen several new players enter the market. In the main, these lenders have North American parentage and are usually based on a joint venture arrangement with an existing lender. At the same time, assets under administration have grown sharply ‘ an estimated £200bn by the end of 2001.
So what is the big attraction? Is the growth of the TPA business set to continue, particularly in an environment of increasing regulation?
TPA servicers enable lenders to take some of the cost out of their business models, and concentrate more fully on the value-added functions of delivering new products, of winning and retaining customers, and indeed offering attractive pricing. The cost and hassle of building infrastructure ‘ including a burgeoning IT spend ‘ falls not to the lender but to the contracted servicer. The latter typically operates out of unified facilities located sensibly in low-cost locations. More importantly, because the genuine servicer handles the business of a number of lenders with much larger asset values, it benefits from economies of scale that individual lenders could not achieve alone.
With impending new regulation, the ability of the TPA servicer to develop solutions to the issues faced by lenders, their customers and intermediaries becomes even more critical. As each lender faces many of the same issues ‘ even if the detailed specifications differ ‘ an outsourced solution is able to deliver the systems, training, compliance and other requirements in a more cost-effective way.
For example, our industry is currently busy working on upgrading IT systems. The aim is to enable lenders to meet the forthcoming regulatory regime and to offer state-of-the-art solutions covering issues such as online mortgage applications and tracking for advisers, customer service modules and other key benefits. This does not come cheap, but because TPAs can amortise this spending over a lot of lenders, the burden is not as great as it would be for those lenders alone. Ultimately, keeping ahead of the latest developments is the only way forward.
So is it just a cost-cutting story? Does it mean service quality will be sacrificed for economy? Surely the TPA servicer will not have the same degree of commitment to the customer as the lender’s own back office ‘ which in the case of a small or medium-sized building society may be located geographically close to the customer?
The answer is that TPAs are judged on the quality of what they deliver and with the competition in our industry, if any fail to meet customer expectations they will not stay in business for long.
A major advantage of TPA contracts is that they are eminently more scaleable than a lender’s in-house processing function. Most intermediaries have come across examples of lenders offering attractive product deals to borrowers, then falling down on the time they take to process the application and issue the offer letter.
A TPA servicer generally has the resources to devote to peak demand levels and ensures there is no delay in handling applications. The new technology the industry is rolling out, including initiatives such as web-enablement, will help smooth this process further. We anticipate that within a couple of years more than half of all mortgage applications received from IFAs will be internet-generated.
In addition, TPA servicers have become skilled at providing the right training environment, so their staff are truly focused on meeting the customer service objectives of each lender. At their best TPA arrangements work as a true partnership between lender and servicer, where the business objectives of both parties are effectively interlinked.
Outsourcing does not mean loss of control for the lender over its business, or the crucial customer relationship. A servicer is no more than an extension of the lender, with fully branded delivery. This extends to answering telephone calls, emails and correspondence in the lender’s name, and issuing communications and other notices to advisers and customers using branded stationery. This allows lenders to retain both independence and individuality.
Of course, there are as many different outsourcing agreements as there are relationships between the lender and TPA servicers. It is not about one size fitting all ‘ the beauty is that the industry has the willingness and skills to design a tailored solution to meet each lender’s requirements. TPAs work with lenders entering or leaving the market, launching specialist or niche products, buying or selling assets, or simply looking to reorganise their processes.
There are many options ‘ for example, at one end of the spectrum, the full cradle-to-grave service from initial enquiry through to shortfall debt recovery. Other lenders may prefer to retain greater involvement in the client interface, or just to cover peak requirements arising from seasonal fluctuations, new product launches or other temporary surges. In some cases lenders that otherwise have a full internal processing function entrust administration of certain portfolios to servicers because their systems do not have the functionality to handle a particular type of product.
Outsourcing can also be used as a means by which a lender can securitise portfolios of mortgages ‘ the TPA with the technical skills and reputation demanded by the rating agencies to ensure the structure is awarded the appropriate rating to allow funds to be raised in a cost-effective fashion.
The outsourcing industry is totally focused on adding value to lenders’ clients, helping them to streamline their operations, offer new and innovative products, and deliver to their customers the best service at the most attractive price. With a continually growing need for IT enhancement and an ever more complicated regulatory environment, the future of outsourcing seems assured.
The TPA servicer makes a significant contribution to the efficient operation of the mortgage industry ‘ and that must spell good news for borrowers and advisers alike.
Steve Haggerty is managing director of Homeloan Management
Increased competition from new players has led more lenders to outsource administration to TPA servicers.
TPAs can help lenders to meet growing costs related to regulation, such as IT systems, training and compliance.
TPAs can help cut lenders’ administration costs, meaning savings can be passed onto borrowers.