Return on Quality

Mustaches are top of mind in Movember for those hirsute men who wish to do some good with their facial hair.  But there are those who go beyond just letting it grow once a year; these are men who have turned the mustache into a cause. 

The American Mustache Institute and a noted tax professor have lobbied the IRS and Congress for a tax incentive for Mustached Americans called The STACHE Act Proposal (Stimulus To Allow Critical Hair Expenses).  The rationale?  “We’ve learned from studies that mustached Americans are earning about 4.3% more on average than the clean-shaven American,” says that noted tax professor, Dr. John Yeutter. 

He goes on to say: “Given the clear link between the growing and maintenance of mustaches and incremental income, it appears clear that mustache maintenance costs qualify for and should be considered as a deductible expense related to the production of income under Internal Revenue Code Section 212.”  Specifically, the STACHE Act offers incentives for people of Mustached American heritage in the form of a $250 deduction for expenditures for mustache grooming supplies in the determination of Adjusted Gross Income.

Brilliant!  To date, our favorite example to illustrate the fallacy of equating correlation with causation has been that of the almost perfect synchronicity between drowning deaths in the US and the consumption of ice cream.  While the two march in lockstep, ice cream consumption does not cause drowning nor vice versa.  But the American Mustache Institute may have sprouted an even better example.  Clearly, the task is now to advise all ambitious men of this newfound competitive advantage.  But what of the women?

Posted by Kaan Etem

Cogent has won Mortgage Technology magazine’s 2011 Lasting Impact Award.  The Lasting Impact Award acknowledges an individual, group or company responsible for a technology initiative or development proven to have an enduring influence that has transformed mortgage finance. 

In presenting the award, the judges cited Cogent’s “fundamental innovation as adapting quality improvement principles from manufacturing industries to the mortgage industry.”  For more information, see the links below.

See Mortgage Technology award citation here (PDF)

See how Cogent QC Systems has made a Lasting Impact.

This is a welcome validation of everything Cogent has been doing since 1991 to help lenders across the industry to improve origination and servicing quality .  Many thanks to the judges at MT magazine.

For the second time, Cogent QC Systems has been selected as a finalist for Mortgage Technology magazine’s Lasting Impact Award.  The Lasting Impact Award “acknowledges an individual, group or company responsible for a technology initiative or development proven to have an enduring influence that’s transformed mortgage finance.”

Cogent has been recognized by Mortgage Technology five times in the past decade, receiving the Fix-It Award in 2003, Top 100 Vendors in 2005, Top 25 Vendors in 2006, runner-up in the Lasting Impact Award in 2009, and finalist for the Lasting Impact Award in 2011.

Cogent’s commitment to continuous improvement, in partnership with our clients, is an integral part of our corporate culture.  For more information on why Cogent QC Systems lead the industry, check here.

Posted by Kaan Etem

That red symbol at the heart of Cogent’s logo is the Greek letter sigma, which is the mathematical symbol for the statistical concept of “standard deviation”.   This is a reminder that statistical methods are central to Cogent QC Systems’ approach to improving the quality control process. In a nutshell, these methods enable quality control professionals to more efficiently identify and correct significant defects in loan production and servicing processes.
 
Statistical methods have been used in quality control since the 1920’s. In fact, one of the most powerful reports available in Cogent QC Systems, the control chart, was invented by Walter Shewhart, an engineer at Bell Laboratories, in 1924.  Statistical methods were also emphasized by W. Edwards Deming and Joseph Juran, the fathers of modern quality control, who (separately) took these methods to Japan in the 1950’s, contributing to the “Japanese miracle” of manufacturing quality and economic growth in the 1960’s and beyond.
 
Here’s brief timeline of the history of statistical quality control (and its acronyms): SPC >> TQM >> 6 Sigma
 
1920’s:  Walter Shewhart (Bell Labs) invents statistical control charts, pioneers methods of SPC (statistical process control)

1950’s:  Deming and Juran bring statistical QC to Japan; Deming coins the acronyms TQM (total quality management) and PDCA (plan-do-check-act)

1960’s-70’s:  Japan’s major corporations implement statistical QC, leading to the “Japanese Miracle”

1981:  Motorola incorporates statistical QC into a new quality management program called 6 Sigma; coins the acronym DMAIC (define-measure-analyze-improve-control)

1980’s-present:  “Quality Revolution” brings statistical QC methods to U.S. manufacturing, health care, and financial services
 
Since the mid-1990’s, when Cogent pioneered the use of statistical sampling and reporting methods in mortgage quality control, the use of statistics has become recognized as key to efficient and effective process improvement.  And yet, widespread understanding and adoption of robust statistical methods is not complete.  Cogent’s goal is to facilitate this adoption and to design systems that make the job as easy as possible. 

Image by Tessa Hunkin 

Fannie Mae’s new Loan Quality Initiative adds a number of new quality control requirements for originators that must be in place by July 1, 2010.  Perhaps the biggest change is the new requirement for all originators to perform pre-funding quality control reviews, in addition to the existing requirements for post-funding and early payment default (EPD) reviews.  For mortgage quality control professionals, this is another step toward what we at Cogent call “Enterprise QC” — an integrated, end-to-end approach that promotes continuous QC monitoring of all loan origination and servicing processes.

Until now, most lenders have had a disjointed and incomplete approach to quality control across the enterprise. Even among lenders that have been doing some form of pre-funding review, the results are often not available to post-funding reviewers, because there is not a common database for sharing the information.  Although many lenders have begun using automated compliance engines (ACE’s), such as those provided by Mavent and ComplianceEase, the loans that are flagged by the ACE for potential compliance errors are not automatically targeted for post-funding reviews. And QC auditors doing reviews of EPD’s, Repurchases and Claim Denials often do not have access to the data from the pre- and post-funding reviews. On the servicing side, many lenders still do not have a formal quality control process in place, and those that do often do not have access to data from other servicing department audits, let alone audits of originations.

We believe the keys to successful Enterprise QC are: (1) the ability to easily access and manipulate the production and servicing data that are needed to accurately define the populations and select the loans that qualify for each quality control audit, (2) continuous communication between quality control managers and the managers of the processes being audited to ensure that audit checklists always reflect the most current policies and procedures; (3) closed loops for reporting, feedback and response, to ensure that adverse findings are responded to and corrective actions are implemented and documented; and (4) sharing of all quality control data across the enterprise, to maximize the returns from the risk information generated from each QC process.

It’s been no surprise to see a flood of books aiming to unravel the causes of the financial crisis of 2007-2009.  By many accounts, Gregory Zuckerman’s “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History” is the best of the bunch.

Now Michael Lewis, one of our favorite financial authors, has thrown his hat into the ring and released “The Big Short: Inside the Doomsday Machine.”  Lewis is one of the most engaging writerss working today, with a particular flair for apt analogies and clear phrasing (”A credit-default swap was confusing mainly because it wasn’t really a swap at all.  It was an insurance policy…”)

By weaving compelling characters into his narrative, he manages to entertain while informing.  No mean feat.   

For a taste of Lewis’ latest, check out the long excerpt in Vanity Fair.  You’ll see that it reads like a thriller and crystallizes a lot of the thinking that’s surrounded this epic debacle.

(By the way, note the interesting phenomenon on Amazon’s customer reviews of the Michael Lewis book.  Almost every one-star rating bemoans the lack of a Kindle version of the book, not the actual content of the book.)

The recent MBA Mortgage Servicing Conference in San Diego, at which the talk of loan modifications was front and center, reminded us of an article published in the November 2009 issue of Mortgage Banking magazine titled “Servicers as Originators“ [requires subscription]. That article described the most significant recent development in the world of mortgage servicing: the need for mortgage servicers to act like mortgage originators as they re-underwrite loans under various loan modification programs such as HAMP.

While loan modifications are not new, the sheer scale of pending loan modifications has overwhelmed servicers and drastically extended processing times.  At the same time, critical scrutiny of the process and pressure to accelerate the pace of completed modifications, has created fertile conditions for a new loan quality disaster. 

Image by Matthieu

This represents a vastly more complicated “servicing” process than traditional servicers are used to.  Indeed, the modification process is arguably more complex than the origination of a new loan, requiring a re-underwriting of the loan, complete with credit reports, appraisals and verifications (income, asset and employment).  All this in addition to program-specific documentation requirements, which in the case of HAMP, are onerous.

Recognizing this requirement for a different skill set, servicers have been hiring servicing reps with origination experience.  Thus, much of the production staff of now defunct mortgage lenders have new gigs as servicing staff, no doubt helping unemployment numbers in subprime epicenters such as Irvine, CA. 

In addition to massive new hiring, servicers are deploying new or modified software systems to automate what they can; outsourcing various sub-processes where they can; and trying to stay in compliance as program guidelines change.  Which they do, frequently.

As servicers struggle to meet these challenges, it falls on auditing and quality control professionals to ensure that the latest processes and compliance requirements are adhered to.  Unfortunately, this is not an area where software vendors have invested much time or effort.  Except Cogent, as it happens.

Cogent’s ServicingQC system was introduced more than a decade ago and has evolved into the most sophisticated quality control system available for servicing operations.  Moreover, with the release of the CogentQC.NET platform, virtually all of the functionality of Cogent’s ProductionQC system - designed to monitor origination quality - can now be embedded into a ServicingQC system.  Result?  A ready-made platform for servicing quality professionals to monitor their new “servicing” process: loan origination.

Ocwen Financial Corporation, which does residential and commercial loan servicing, special servicing and asset management, is reporting significantly better results in its HAMP modifications than the rest of the industry.  And they attribute it to superior technology. 

In congressional testimony, Ocwen’s President Ronald Faris claimed:

• that Ocwen is converting trial modifications to permanent modifications at a rate that is 10 to 20 times greater than industry average;
• a 3-month re-default rate of less than 5% for Ocwen, versus 18.7% to 33.7% for the industry; and
• a total of 100,000 successful modifications since the beginning of the mortgage crisis.

These impressive numbers could use a little clarification.  So could the statement that Ocwen has spent “$100 million in R&D to build loans servicing technology that incorporates behavioral science for effective customer communication and is also scalable for high volumes.”  But Ocwen is an industry leader and when they report these kinds of results, it’s worth listening.

Image by sgrace

Likewise, their recommendations for improving the HAMP program carry weight.  Among those:

• Lower the borrower debt-to-income (DTI) ratio for modifications to below 31%; in other words, allow for lower monthly payments on modifications  
• Allow for principal reductions on modified loans  
• Make additional funding available for housing counseling groups
• Require underperforming servicers in HAMP to outsource to servicers that perform 

Also worthy of note: Mr. Faris is one of the few industry voices who believes that HAMP is a “well designed response to the mortgage crisis”.  Maybe he’s on to something.

It’s good news that in some quarters, quality control is beginning to matter. But here’s the Economist to remind us that the job of risk manager “is said to have the risk profile of a short option position with unlimited downside and limited upside — something every good risk manager should avoid.”

Small wonder that talent is staying away in droves.  In sales-driven cultures - like mortgage banking - it’s frowned on to discourage transactions, without which money can’t be made.  The bias is to get the deal done.  So risk managers are always swimming against the current. 

However, risk is currently the busiest area for financial recruiters, which means there is a lot of activity.  Chief risk officers are being appointed, risk committees and departments are being formed, and new regulations are announced with frequency. 

But business practices adapt to new structures and find their way around them. (Like fraud, in some ways.)  Once the spotlight is off regulation and compliance, experience suggests that a new innovation will make it seem like “it’s different this time”.  And the Cassandras in risk management will be ignored anew.

So how does a risk manager survive the next bull market?  Hope that new incentives will be put in place to encourage the right behavior.  And show the ROI of risk management - or in the case of mortgage quality control professionals, show the return on quality (ROQ).  In future posts, we’ll try to help formulate that ROQ.

Apparently, in early 2007 - at the peak of the real estate bubble - the Mortgage Bankers Association (MBA) came to the “inescapable conclusion that owning [their]own building was the smartest long-term investment for the association.”  So with $75 million in financing, they purchased a new headquarters building.  Then on February 5, 2010, they announced that they had sold it for a little over $41 million.  Oops.

This is the sort of fiasco that the mortgage industry can dine out on for years.  But it’s just the latest irony that we’ve witnessed recently.  Remember the advocates of unbridled capitalism on Wall St. asking for government assistance so that they could continue to do ”God’s work“?  Then paying out billions in bonuses with taxpayer money?  Irony verging on outrage.

But more ironic to mortgage quality professionals, and likely to have a larger impact, is another major story these days: the recall of millions of cars by Toyota due to quality issues. 

Toyota?  Poor quality?  How could the company that virtually invented the quality revolution in manufacturing over the past 50 years be in this position? 

As one article points out, it was a combination of things: the goal to be Number One in the world driving rapid expansion; increasingly complex products with multiple potential points of risk/failure; uninterrupted success leading to arrogance; a culture that discouraged bad news; and managerial sclerosis. (One might almost be talking about Wall Street).

It might seem like the compeuppance of a world leader in the quality movement would negate the value of a quality culture.  Yet this story may unfold to include other car manufacturers, too.  Everyone is trying to sell as many complex ‘world cars’ as they can, and each car shares components with other cars in manufacturers’ product lines. Will Toyota’s brand be the only one tarnished?  Probably not.  But Toyota will recover, while others may not.  And Toyota at least will re-learn a basic lesson: don’t rest on your laurels.