Bigger is Better in Offshoring

A recent Deloitte Consulting LLP report outlined questions and alternatives for mortgage providers considering offshoring capabilities. The report was based on interviews with senior mortgage banking, executives, extensive secondary research and a detailed survey of 10 prominent offshore service providers.

While about half of the top 40 mortgage lenders currently offshore some business processes, many are expected to offshore to some extent within five years, according to the report, Business Process Offshoring in the Mortgage Industry: A Tale of Two Opportunities.

The $462 million mortgage lenders offshored in loan origination and servicing processes in 2005 will increase at a compound annual growth rate of 21 percent through the end of the decade, according to previous research.

“The large firms already immersed in offshoring are looking past cost savings to other business drivers and benefits,” Deloitte stated in the current report. “The challenge on their horizon is the shift toward longer-term, strategic integration of offshoring into overall operations.

“The many mortgage lenders who have yet to make any offshoring moves at all have a window of opportunity now to get out ahead of the competition to begin to achieve cost considerations so they can then move on to enjoy the full range of offshore benefits.”

The focus of those already embracing offshoring will be in managing offshoring units to facilitate continued benefits, moving other processes and functions offshore and incorporating divisions into overall business operations. The non-offshoring group has “by far the most to gain” because it can benefit from a mature, more sophisticated offshoring service sector.

Lenders expect savings in the range of 35 percent to 45 percent when moving processes offshore. Even though cost savings is, and will continue to be, one of the drivers and key benefits of offshoring, Deloitte warned that companies basing their decision to offshore solely on the basis of cost may lose other potential benefits, “increasing risk and trading a long-term gain for a short-term cost fix.”

Contributing to offshoring’ rapid expansion are technology innovation, improved offshore vendor capabilities, changing business and economic dynamics, and lack of available skilled resources in the United States, according to the analysis.

One way vendors are improving their capabilities is through substantial investments of time and resources in education and training of their employees, going as far as securing appropriate certifications and relevant exposure to the United States for employees. Furthermore, the performance of some has improved “to such a degree that the financial services organizations they serve see process improvements first in their offshore facilities, and then adopt them back home,” Deloitte reported.

“The widespread adoption of offshoring can have significant implications for mortgage lenders of all sizes — from how loan applications are processed to the increased array of viable higher-risk products due to more-favorable cost structures.”

According to the study, one mortgage provider attributed its three-year move into the top 10 from being in the top 20 to its effective leveraging of offshoring. The lender outsourced tech and back-office functions at cost savings of between 40 percent and 60 percent. Offshoring supported loan application data entry, loan processing, post-clearing, customer service, loan collections and enhanced services such as 24-hour service and faster turnaround.

To determine which processes should be offshored, companies should analyze whether the process is a core or noncore process, the level of possible cost reduction, the ability to provide quality enhancement, the operational complexity and the customer impact offshoring a process will have, Deloitte suggested.

Processes ideal for offshoring that should also be strongly considered for any initial efforts include capturing borrower information, processing incoming applications, creating loan documents and providing some types of customer service and investor relations. More complex processes that should be considered after gaining some experience in managing initial offshoring processes are processing applications, setting up loan files, reviewing and signing loan documents, and loan servicing. Processes generally not considered good prospects for offshoring include managing broker relationships, obtaining leads from other business channels, doing post-funding audits and most aspects of secondary marketing.

In choosing an appropriate offshoring model, lenders should consider the size and scope of their business, the magnitude and complexity of processes they plan to offshore, and the number of resources available and committed to launching offshoring.

Amongst the top 40 lenders, Deloitte found that 37 percent preferred the captive model, which a firm builds offshore and manages internally, an equal 37 percent relied on contracting with third-party vendors and 26 used a hybrid structure through a third-party partnership and/or joint venture or used other models.

Large players are the most suitable for captive models due to the initial investment — generally $10 million or more versus less than $1 million for third-party offshoring – time, and level of experience necessary to effectively launch a captive unit. This model may generate the most cost savings over time, provide more control and security, and provides easier integration of the unit into the organization.

The third-party model is likely to be selected by mid-sized and smaller lenders that are not currently offshoring, have a limited need for it, and are primarily interested in cost reduction. The start-up time and costs for this model can be minimal, and the extent of previous experience with offshoring is much less than with captive model, according to the study.

The hybrid model reportedly best suits companies that view offshoring as a key part of their business strategy, but due either to size or available resources are not able to develop a full-scale captive model. The hybrid approach combines the most effective elements of in-house and third-party capabilities.

The responses of the 10 prominent vendors reportedly showed that the criteria mortgage lenders consider most important when choosing a vendor are data security, followed by mortgage experience and service quality.

“Demonstrating a high level of data security is viewed by the vendors as a baseline requirement,”and, “over the past three years, vendors have significantly improved their security apparatus and the quality of their overall service offerings, closing much of the quality gap between captive and third-party models,” Deloitte wrote.

Lenders are also looking at vendors’ capability for knowledge process offshoring — which includes business processes that require specific knowledge of a given topic. KPO is growing among analytical services and processes that require domain and industry knowledge, such as loan document indexing, data validation for loan delivery to investors, and loan pricing. Vendors indicated that KPO constitutes almost one-tenth of their business process revenues and that many plan to add these processes within the next 12 months, according to the report.

“Like a storm feeding on itself, vendor abilities are encouraging more mortgage lenders to join the fray and increased offshore business can help vendors to further improve,” Deloitte wrote. “Our analysis tells us that offshoring is no longer a matter of if, but of when.”

However, because vendors are improving their capabilities, vendors are moving away from per-hour rates for employees in favor of transaction based-pricing or a risk/reward performance-based model, according to the report.

While half of the vendors surveyed believed cost savings from offshoring will continue at the same pace over the next three to five years, the other half believed the percentages saved will decline over time, Deloitte reported. Nonetheless, all the vendors believed offshoring will offer major cost savings when compared to on-shore options.

Furthermore, “as more and more mortgage lenders turn to offshoring to help cut costs, improve service and increase functionality, those who don’t take the initiative may find they are not well-positioned in a tight or volatile market,” Deloitte said. “An effective offshoring strategy could mean the difference between profit or loss, achieving or not achieving specific objectives, and independence or acquisition.”

Deloitte further noted that “offshore operations that aggressively expand both scope and scale typically deliver higher returns and sustain those benefits over time,” while “institutions that make a halfhearted attempt at offshoring often fail, leaving offshore operations marooned and rudderless.”

Lenders that offshore must stay vigilant and committed, periodically rotating key managers and staff to maintain a constant mix of experience, skill and enthusiasm, the firm recommended. Otherwise, they can suffer “offshoring fatigue,” which occurs after initial cost savings pass — generally after three years — and the attention to offshoring declines to the level of “business as usual” and falls short of its true potential.

“We believe the market is at an interesting and significant point in time — mortgage lenders should be critically and strategically evaluating their business processes and goals to determine when, where and how to make the jump offshore,” Deloitte reported.