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Th e M Rep o RT | 17 Feature R egulatory pressures continue to grow for mortgage lenders and, logically, so do the costs to originate mortgages. Increased back-office compliance overhead is a primary factor impacting lenders' profitability. At this point in time, the industry does not have a good handle on the additional costs re- sulting from Dodd-Frank reforms. However, we do know that for all types of financial institutions, the cumulative effect of regulatory requirements has led institutions to add staff throughout the past few years. We also know that community banks, independent mortgage bankers, and mortgage subsidiaries of chartered banks spend a higher percentage of their operating costs on compliance than mega-banks. The old problem in mortgage origination was efficiency in mortgage production. The new problem is efficiency in compli- ance. The high cost of compli- ance is not going away, and it is a discussion we must continue to have with regulators, policymak- ers, mortgage lenders, and third- party service providers. What We Know About the Cost of Mortgage Reforms I n October 2012, the Consumer Finance Protection Bureau (CFPB) announced plans to study compliance costs. About a year later, the CFPB released a 176-page report, but the subject of the report was the costs associated with compliance for deposit regulations not mortgage transactions, which are at the core of the cost issue. To date, the CFPB has not released a report on the costs for mortgage regulatory reform. The CFPB may take a similar approach with mortgage compliance costs analysis. If it does, the cost study will most likely focus on the ongoing and recurring operating costs of the regulations; it will probably not address the costs for litigation or the opportunity costs of the regulations. As required by law, the CFPB accepted comments after it an- nounced plans to study compli- ance costs. One responder was from a $350-million bank, and he knew that his compliance expenses for staffing, training, and reference resources increased $150,000 per year and profits fell approximately 10 percent. He also stated that some of the bank's products would be discontinued because of the risk of noncom- pliance. Another community banker echoed a similar concern, stating that increased regulatory costs caused some products to be unprofitable and therefore eliminated. While regulations can have many benefits for consum- ers, these benefits can come at a cost, according to the CFPB's Dan Sokolov. In 2005, the Center for Responsible Lending (CRL) released an issue paper address- ing the direct cost of compliance. The paper was written at the time most lenders began employ- ing automated compliance tools to comply with state anti-preda- tory lending laws. CRL used the Mortgage Bankers Association (MBA) 2004 data, which estimat- ed the cost of manual compliance reviews to be about $43 per loan. With automation, however, MBA's data showed the cost of compliance reviews was reduced to $16 per loan. According to CRL's paper, the 2003 MBA Cost Study estimated $1,505 for total loan production costs, on average, for all lenders. Fast forward 10 years and MBA's data for the first quarter of 2014 showed total production costs were $8,025. This survey is based on costs reported by independent mortgage banks and mortgage subsidiaries of chartered banks, and while this is not totally an apples-to-apples comparison because the 2003 study averaged the costs of all lenders, it demonstrates the sig- nificant cost increase to originate a mortgage. Perhaps a better comparison is "net cost to originate," which includes all production operat- ing expenses and commissions, minus fee income, excluding secondary marketing gains, capitalized servicing, servicing re- leased premiums, and warehouse interest spread. In the first quarter of 2010, the net cost to originate a mortgage loan for independent mortgage bankers and bank subsidiaries, on average, was $2,945. Four years later for this same class of lenders, the net cost to originate averaged $6,253. The industry doesn't have the data to say how much of that $3,308 increase is from the significant increase in compliance costs. However, it is a likely primary driver in the soaring cost of origination. (Source: MBA) It is also important to note that in comparing the first quar- ter of 2010 to the first quarter of 2014 in MBA's Cost Study, the average quarterly production volume per company increased from $158 million to $274 mil- lion. Generally, when production volume goes up, the average cost per loan is expected to decline as a result of the increasing econo- mies of scale. When we look at these snapshots in time—before and after Dodd-Frank regula- tions were in place—we find an alarming impact on profitability. Independent mortgage bankers and bank subsidiaries, on aver- age, had a loss of $194 per loan in the first quarter of this year, compared to an average profit of $606 per loan four years earlier. (Source: MBA) How to Build Mortgage Compliance Efficiencies M ortgage lenders accept the fact that the costs associated with regulatory compliance have increased over the last five years, but this doesn't mean that costs must continue to escalate and erode profitability to a loss on each loan. Many of the new regulations are designed to bring greater transparency to the mortgage process, which should result in more commoditization in product and pricing. The effect of commoditizing mortgage processes should result in higher degrees of efficiencies for lenders and the ability for lenders to focus on improving consumers' borrowing experiences and expanding market share. Financial institutions tend to respond to increased regula- tions by adding people rather than leveraging technology and improving processes. Technology spending needs to go beyond monitoring compliance to improving the performance of By Judy Wheatley, SVP of Compliance, Indecomm Global Services