Breaking Down the LIBOR Acronyms
We recently conducted a (sold out!) webinar on the LIBOR Transition, driven by the NY DFS sending a letter to over 1,000 companies that they regulate Board of Directors, with a response due on March 23, 2020.
The first question we received in response to the webinar was “you guys use a lot of acronyms, can you explain what it means, please?” And it’s true, we do use a lot of terms, so we put together a LIBOR transition cheat sheet (a Glossary) to explain not only what each acronym means, but why it is important in a LIBOR transition context.
Some facts about LIBOR:
- LIBOR has been in use since the 1970’s and is well understood by the markets and regulators.
- Many loans use LIBOR as an index rate, especially mortgages and student loans.
- However, dollar volume of LIBOR based contracts, futures, options, or other types of derivatives is far greater than its use in loans.
- Although people talk about it as if it were a single number, it actually has its own “Term Structure” (see our glossary) with 7 different rates and its own yield curve. Having a Term Structure is a great attribute for a Reference Rate to have, and most Alternative Replacement Rates do not have that, at least not yet.
- The Financial Conduct Authority (FCA, below) that oversees the publication of LIBOR decided in 2017 to not compel any bank to contribute to the LIBOR process after December 31, 2021. This means it is very unlikely that banks will participate after this date, and LIBOR will cease to be credible if it exists at all.
- Liquid markets require many participants. Therefore, regulators and associations are issuing Replacement Guidance to move participants to a new market. In the US, the ARRC (below) is guiding markets towards SOFR (below).
Here are the first four LIBOR-related acronyms you’ll hear us mention when we talk about the transformation. The full list of terms can be found here. It will be updated on a regular basis.
The new URLA is coming. But the status report, for July 2019, is decidedly Red.
Warning signs regarding the immensity of the forthcoming changes have been out for well over a year, yet it seems some lenders are just starting to realize the size and implications of the coming changes related to the new loan application – the Uniform Residential Loan Application (URLA, aka 1003 or form 66). This is the first of a short series of blogs exploring the benefits and challenges that lie ahead.
The URLA is undergoing a total redesign for the first time in 30 years and that is driving major changes in four areas:
- The application itself – its form, data elements, organization and fundamental operation
- Its corresponding data file, the Uniform Loan Application Dataset (ULAD)
- The agencies’ automated underwriting systems (DU, Fannie Mae’s Desktop Underwriter and LP, Freddie Mac’s Loan Prospector) submission, interfaces and files
- The retirement (at least not keeping current) of the Fannie Mae DU3.2 file, which has long been the industry de facto standard for transferring data.
The optional date is coming soon – July 1, 2019 – and the required date is February 1, 2020 – not very far away for a truly major change.
When the subject of the new ULRA came up at the recent National Advocacy Conference, a gentleman sitting at my table said, “My vendor is taking care of it.” When he didn’t smile and the rest of us figured out that he was serious, the branch manager and the lawyer at my table both asked him “You mean your vendor sets your policy for how to fill out the language preference and whether you let the MLO do that instead of the borrower?”
I saw two other issues myself, including “Which vendor?” and “Are all your counterparties ready? Does your entire process work end-to-end?”
On the issue of leaving things to your vendor, even small lenders are likely to be dealing with two or more vendors who not only have to be ready, their systems have to be tested together to make sure that your process works.
Below is a simplified snippet taken from CC Pace’s Reference Architecture, showing internal interfaces that are affected by the new URLA:
That’s a lot of moving parts undergoing substantial change that need to continue to work together. Let’s look at things from the perspective of relatively common test cases. It seems reasonable to expect that a POS submission to DU and an LOS submission to DU will both work. But in an equally common, but decidedly more complex scenario, when you take the application on the POS, transfer the loan to the LOS, where you rerun DU and then request a set of documents from your doc vendor, it’s not hard to imagine that initially something will break down, simply based off of different assumptions that were made.
On the issue of counterparty readiness, the reference architecture reveals even more counterparties and vendors that have to be ready and that you will have to test your process with:
But wait, there’s more! As far as the industry is concerned, not only do you and your counterparties have to be ready, but the entire ecosystem has to be ready, end-to-end. And the status for that is decidedly red.
Take the previous difficult test case and now extend it to a common industry chain. A broker starts the application, it closes with a mortgage banker who then sells it to a correspondent investor, who now runs Early Check or LQA on it, purchases it from the mortgage bank and then delivers it to Fannie or Freddie. It is known that this will not all work in July 2019.
Here is what I gleaned from the MBA ResTech call from May 16th, 2019:
- Many individual vendors appear to be ready – but what that means is that they are ready to be tested in conjunction with other counterparties in the ecosystem
- Not all components necessary for an agency correspondent transaction are ready
- Correspondent Purchasers are starting to issue guidance that they will not purchase loans on the new URLA until 2020
It is CC Pace’s recommendation that every organization be extremely active monitoring the status of the new URLA both within and outside of their company; it is impossible that “our vendor is taking care of it all” is the right answer. This July through February represents a significant and much needed test period, not just for the systems and your process, but also for your compliance and training.
Some Correspondent Purchasers are issuing their own guidance on the matter. Have you?
CC Pace recently completed an interesting project for a mortgage lender who had just done an acquisition. The project questioned a fundamental assumption of loan pricing and whether the existing approach was compliant or not. One entity had “branch” pricing (as do many lenders), where the price quoted to the borrower is based on the branch rate sheet of the loan officer that the borrower works with. The second entity, however, had pricing based on where the property was located (also a common practice). Compliance recognized that these two different methodologies could result in disparate pricing to the consumer, potentially leading to fair lending violations.
Having been in the industry for a long time, the notation of pricing based on the loan officer’s rate sheet didn’t seem unusual to me. We have implemented this model many times, going back to the 1980’s. It was so ingrained that I had never really thought about it. But this project challenged my assumptions and changed my way of thinking—for the better.
In retrospect, under the “right” (wrong?) use cases the lender could have faced fair lending penalties even before the acquisition. For example, if a borrower was looking for loan for a second home and had gotten quotes from both their local branch and from the branch in the property’s geography, those quotes could easily have been different.
Our client’s Compliance group recommended moving everyone to the geographic model – pricing based on where the property is located, not based on where the loan officer is located. And pricing should include “junk” fees, which were determined by the Sales organization, whereas Secondary determined rates & points. CC Pace’s role was to lead this transition, a major shift for a lender who hadn’t re-thought their pricing in many years.
Redesigning processes that were deeply ingrained in the organization and systems made for an interesting project. How do you define the geographies? Zip code level is too small to be compliant; MSA is better. But using every MSA in your footprint may be too many geographies to maintain. How do you align the “junk” fees with the geography and with the organization? Who actually sets the branch rates? What updates do you need to make to your rate sheet? What new training do you need to do?
Much of the elapsed time for the project was spent in the conceptual design and getting it approved by the stakeholders and Compliance. However, the bulk of the man-hours were spent updating and testing the pricing engine and loan origination system for both pricing and fees, and then testing the systems across all the different use cases (retail, call center, digital). There was also a need for some organizational realignment of responsibilities. Surprisingly, however, the re-training of loan officers turned out not to be very difficult.
I came away from this experience realizing that this was an important project that many lenders may need to consider, even if they are not doing an acquisition.
How does your organization price loans?
“There I was on assignment for a month in the Sahara Desert of Northern Africa during a time of the year that was supposed to be fairly mild. Unfortunately, there was a heat wave during most of that month, which drove temperatures into the mid 120’s. With little to no shade, relentless flying and crawling insects, and sparse meals that caused me to lose 20 pounds, I continued to work toward getting that ‘perfect shot’, at the perfect time. This assignment proved to be the most physically demanding I ever endured. Nonetheless, I’d choose that job every day over an unstimulating project.”
So goes the story of a high school friend and renowned photographer, Don Holtz, whose impressive work includes the likes of Tom Hanks, Morgan Freeman, Steven Spielberg, Time Magazine and chronicling the Foo Fighters. Yet despite his amazing success, Don humbly shared with me (when asked) that there is no perfect time for taking the perfect shot. Instead, he explained, it is by the continued effort of working ‘toward’ perfection that he is able to achieve the highest level of success.
Similar to Don’s challenges in Africa, mortgage bankers continue to maneuver stringent regulations, weak GDP growth, and persistently low interest rates that limit their ability to help grow the local or national economy. As a result, most lenders are content to maintain a conservative approach to lending while instructing their IT departments to tweak or revamp old and disparate technologies in order to keep management, maintenance and overall IT project costs down rather than pursue innovation and rethink how business could be done better. Basically, most are waiting for the ‘perfect time’ to rebuild, reengineer and transform their business.
Conversely though, there are nearly 80 million millennials (18 to 34 years old) in the US who are actively shifting from renting to home buying as their family’s needs grow. In a recent study by the National Association of Realtors (NAR), millennials were the largest share of home buyers in 2015, at 31%. All evidence points to this trend actually increasing throughout 2016.
Just consider that the millennial generation, who has maximized the use of Snapchat, Facebook, Facetime and texting to such an extent they do not know of any other way to live, communicate or do business, is now the greatest force driving home buying. This should put pressure directly on the backs of mortgage bankers to re-think and rebuild century-old banking and lending practices in order to successfully support this new generation of borrowers. Millennials are first and foremost a tech-savvy generation of borrowers who are fiercely brand loyal (think Apple) and seeking to do business with firms that speak their language of fast, easy and friendly, supported by best-in-class technology platforms.
Over the last thirty-six years, CC Pace has helped implement scores of mortgage banking technology platforms supporting strategic initiatives and business transformation projects, but never have we seen a greater need than exists today for business transformation in mortgage banking. Business transformation is desperately needed that will successfully help to attract and support the new generation of home buyers. Such projects require lenders to challenge their organization’s own institutionalized thinking in order to evaluate all aspects of the firm’s strategy, its lending process, its technology and equally importantly, how they provide the service levels this generation requires. Business transformation is needed not just to entice the millennial generation, but to earn their loyalty for return business as well.
Certainly embarking on new large-scale business transformation projects is stressful and risky (which is why firms hire CC Pace). But the alternative of risking alienation of the millennial borrower generation by failing to meet their needs and expectations will prove to be devastating to lenders who choose to continue a conservative approach to facing the future of mortgage lending.
When I asked Don what he thinks it means when people indicate they are waiting for the perfect time to take the perfect shot, he said, ”The idea of perfection is more dependent on a state of mind than on external conditions that we can’t always control.” He went on to highlight how he takes responsibility for how he will respond to changing conditions, spending his energy planning, as best he can, to arrive at a shoot prepared to adapt his game plan for both the existing and changing conditions to ensure the best possible outcome. As Don put it, “There is no perfect time, but that doesn’t mean you don’t continue to work ‘toward’ perfection.” This is as true for mortgage bankers as it is for world-class photographers. If you aren’t working toward transforming to meet the demands of the market, you will never achieve greater success. So as lenders continue to expect mild temperatures, they may soon find themselves in the middle of a heat wave. There is no perfect time; there is no perfect shot. Success can only be achieved by actively working toward the goal of perfection.
Don Holtz is the owner of Don Holtz photography services. If you are interested in Don’s services he can be reached at here.
While TRID didn’t necessarily result in a ‘housing apocalypse’ as I jested it might in a blog piece posted in the fall of 2015, it does in fact continue to wreak havoc on mortgage bankers nationwide―havoc that won’t end any time soon.
Mortgage bankers have worked vigorously to cobble their people, process and technology together to ensure the forms and data would be correct in order to meet regulatory scrutiny. While there is room for error (as lenders only need to demonstrate a concerted effort to comply), the struggle continues. Lenders are challenged to overcome the operational impacts and impairments that have resulted in dramatically increased cost to produce.
CC Pace conducted a survey of a wide variety of lenders recently, and found that 2 out of 3 are struggling ‘significantly’ with meeting the new TRID regulation. Lenders indicated they have had to ‘throw bodies at it’, temporarily re-structuring processes and other facets of their organization to keep up with the workload. They’ve had to hammer their technology providers for immediate enhancements and implement additional manual steps and work arounds to ensure compliance. Yet despite these proactive steps, some lenders continue to conduct emergency meetings daily to put out the fires at hand in an effort to remain out of hot water with the CFPB while moving loans to close. Cost to produce has sky rocketed due to staff increases in closing and significantly increased tolerance cures, and customer service has been impacted, often with numerous days added to the closing process, negatively impacting lenders’ efficiency, productivity, profitability and reputation. As a result, recent headlines show several top banks and mortgage lenders are either getting out of the lending business or significantly reducing their appetite for production. This should be a clear and distinct message that the dust of TRID has far from settled.
Unfortunately, most mortgage bankers see no end in sight to their struggles. Many focused originally on getting documents correct but less so on their processes, and this is what is now driving their cost and customer service issues. A continued investment of time and energy is required as lenders to conduct on-going evaluations of their existing processes―knowing that any changes can send ripple effects throughout the end-to-end process. As a result, CC Pace recently launched a targeted service called ―TRID Rapid Relief―to help our customers cope.
In my blog post on October 8, 2015, The Value of Looking Back while Looking Ahead, I posted the question, “What’s next for lenders after TRID goes live?” The short answer turns out to be “clean up.” But once the aftermath of TRID gets laid to rest and the struggle subsides, what does come next?
During the last several years lenders nationwide have understandably put off large-scale projects due to TRID. It is now time for lenders to start reconsidering those large-scale projects in order to effectively reduce cost to produce, increase return on investment and position themselves to move forward successfully and profitably in the new age of mortgage banking.
Moving forward, it will be imperative that lenders start to take a long-term, strategic approach to their process, people and technology―a long-term strategic approach that will eliminate the rubber bands, glue, Band-Aids and manual steps they have come to rely upon. As technology, regulations and customer needs have evolved―and with the coming of the millennial home buyer and homeowner―lenders need to start re-thinking their long-term approach, recognizing that the technology and the process strategy they employed to get through the financial crisis may not be the scalable, long-term solution that will allow them to successfully grow as the housing markets continue to recover. CC Pace has been successfully orchestrating the design and implementation of large-scale, business transformation projects for mortgage bankers for over 35 years. We are currently in the final stages of helping implement a Business Transformation project for one of the nation’s largest and most respected regional banks. This has been one such transformative project, where fair lending and the customer experience has been at the forefront of the bank’s requirements. CC Pace facilitated the ground-breaking merger of the mortgage and home equity business units while helping move them onto a shared technology platform. While some industry colleagues have considered this concept “bleeding edge” and others say it’s “cutting edge”, most industry executives will recognize this as representing the new age of lending, one that truly represents fair lending at its best due to the bank’s ability to now offer all the home lending products a customer is qualified for at point of sale, Mortgage AND Home Equity products. Rather than the traditional approach of a loan originator only being able to represent and sell the home lending product their particular origination channel represents, Mortgage OR Home Equity loan products.
Executives are recognizing that in this new era of mortgage banking, walls need to be torn down and operational efficiencies gained throughout to drive the ultimate customer experience, while still mitigating risk across the board. Now more than ever, it is important for mortgage banking leaders to stop looking down and to start looking up―scanning the horizon and moving their organizations towards the future of mortgage banking. It’s time to start transitioning from survival to transformational.
When speaking with leaders in the mortgage banking industry of late, the chorus always remains the same, “we are heads down on TRID.” Despite the CFPB’s recent announcement regarding leniency on enforcement of this new regulation, industry executives know full well that there is no delay. Only firms who make a “good faith effort” to comply with the new regulation will experience leniency on enforcement. The theme at lenders nationwide therefore remains “stay the course” for hitting the August 1st deadline.
TRID has been widely recognized as one of the single most impactful regulations to befall the mortgage banking industry in recent memory. The real significance of this regulation goes well beyond the requirement to change an already comprehensive and sophisticated consumer disclosure document. By shifting the burden for the consumer closing document three days prior to close from the title company to the lender, it also forces both the lender and title companies to rethink a hundred year old workflow and business relationship, engaging in a more collaborative partnership. To accomplish this effectively, TRID requires lender reconfiguration of business rules, workflows and processes, which has a direct impact on business strategy, technology requirements and system configurations while making certain audit trails go deeper and wider. Amidst it all, lenders are having to work overtime to protect the customer experience by reengineering the loan closing process and better setting expectations with consumer to ensure a positive customer experience and to avoid multiple reschedulings of loan closings. Ultimately putting added pressure on each lender’s cost to produce, not to mention potentially increasing housing costs for consumers.
With less than 60 days remaining to implementation, lenders continue to break the glass and retrieve their proverbial Mortgage Bankers First Aid Kit in order to swiftly bandage together the disparate impact points of TRID, not only to ensure compliance, but for self-preservation. With almost two years to prepare and most vendor organizations fully focused on developing various document solutions and workflow assistance, it’s unfortunate there has been little offered in the way of a universal “one size fits all solution” that lenders can simply plug in and safely implement to help ensure compliance, workflow efficiency and a winning customer experience. Yet after twenty-seven years in the mortgage banking industry, I remain confident mortgage bankers will once again be resourceful, agile and pliable to ensuring successful adoption of the new TRID regulations to ensure consumer satisfaction. After all, it’s in our DNA. We will do what it takes, even if it means throwing bodies at it (similar to days gone by) or adding new layers of manual processes and procedures or quality control checks. I am convinced most will be ready to meet the industry’s new requirements. But at a cost.
So the question remains, “What’s next? Where do mortgage bankers focus after August 1st?”.
As with many disruptive changes, focus before the deadline is on complying with the regulation. Afterwards the focus must shift to actually making it work effectively and efficiently. This could mean that lenders need to take a pause, step back and get back to the basics by conducting an end-to-end full-scale process assessment. A business process assessment serves to help ensure lenders are originating loans at the lowest possible cost to produce by looking to remove redundancies, maximize technology configurations, better integrate appropriate vendor solutions and new business rules, or by simply amending a series of processes and procedures in light of new ones.
Veteran mortgage banking executive, A.W. Pickel, President and CEO at Leader One Financial, is very concerned about the impact of TRID regulation on consumers. “My concern is, what happens to customers with a moving van in the driveway and due to circumstances beyond their control they now have to wait three more days to close. Regulations meant to do good may cause further harm. Will this regulation then cause realtors and loan officers to do off balance sheet items?” In regards to how to how to mitigate the risk, Mr. Pickel goes on to say, “The only way to offset this risk is through the adoption of additional procedures. In the end, however, additional procedures can equate to increased cost to produce a loan.”
Pete Lansing, former President of Colorado Mortgage Lenders Association and President of Universal Lending for over thirty-four years, feels TRID really isn’t any different than any other regulation. “Post August 1st we will be in full force compliance evaluation and review, looking for any holes left over that were not covered before the implementation date. Every organization must keep their eye on regulatory compliance at the same time keeping customer service as its number one objective. The balance between these two objectives has always been the mortgage banker’s concern and goal. I believe these new changes are no more difficult than those previously issued by the regulatory forces.”
Taking it one step further, Gellert Dornay, President & CEO of Axia Home Loans, when speaking of his TRID implementation strategy, put it this way, “Post TRID implementation, lenders should be auditing compliance with the new rule and identifying any areas that require further training or process tweaks. However, if you’re not doing a full-scale operational assessment until after the rule has gone into effect, you’ve missed the boat.”
While the mortgage banking apocalypse is not likely to take place on August 1st, what is more likely is that lenders are going to need to take time post-TRID implementation to conduct a full-scale audit of their end-to-end origination process in order to lower cost to produce and ensure consumer satisfaction. Based on CC Pace’s experience in conducting business process assessments in the mortgage banking industry, we encourage lenders to keep three key components in mind when conducting their post TRID operational assessments. First, be honest in asking yourself if your recently amended TRID process is actually economically “scalable”―is it scalable enough to support what is anticipated to be a growth market if secondary liquidity truly returns due to a rising interest rate environment? Second, when reviewing the operational assessment, challenge yourself with this question, “Is the right long-term answer to take the temporary bandages off and look at full-scale reconstructive surgery of processes, systems and organizational structures in order to successfully implement long-term, scalable growth strategies?” Lastly, decide on a strategy and move forward. Meaningful operational assessments that end up sitting idle on the shelf collecting dust are generally reflective of an overly conservative approach and commitment to long-term failure. Such efforts are best defined as exercises in futility.
After August 1st there is no better time to stop, rebuild the origination’s foundation and prepare for the new mode of lending.
A frequent topic of discussion these days is what division should own equity lending: consumer lending or mortgage. This question comes from our banking clients that offer a wide selection of lending products to their customers, and thus often face organizational design challenges triggered by changing business dynamics.
At one time, the high volume of piggyback loans made the move from consumer to mortgage lending for closed end seconds a common sense decision. This allowed the loans to be originated and, more importantly, underwritten in tandem, saving time and money in the process. Coordinated closings were simple, without the need for communication across divisions. But interest in seconds waned with the credit crisis and volume declined, and many organizations moved equities back to consumer lending.
Recently, increasing rates and renewed interest in piggyback lending for affordability has brought focus back to the equity side. Many banks are re-thinking their production of equity products, and what makes sense about where they are originated.
There is no “right” answer for everyone, but decisions should be based on resources, technology, compliance and other factors, including what the strategic focus for the product is.
- A closed-end second has always been a stepchild in the consumer lending world, taking more time and requiring a more complex skill-set to complete the origination process. With the parallels between closed-end seconds and first mortgages, the skill-set exists within the mortgage lending division, but a streamlined process may be needed to allow them to co-exist without slowing the origination of seconds. HELOCs, on the other hand, are more consumer lending friendly and require more skills and knowledge to be added within the mortgage division if responsibility for these products were to shift.
- Most consumer and mortgage loan origination systems are delivered supporting the production of closed-end seconds. Tasks such as setting up the appropriate products and pricing guidelines, defining new workflow and integrating of new documents will be needed, however. Note that mortgage loan origination systems are not well suited for the HELOC product, although some vendors are moving in this direction.
- Compliance is a critical part of the equation these days. The pending CFPB Integrated Disclosure regulations affect both mortgages and closed-end seconds. Lenders must support new calculations and meet new guidelines to provide the borrower with disclosures and documentation in a timely manner. Lenders have a significant amount of work ahead of them, even if their system vendor is supporting their technology to meet the August 2015 deadline. The level of effort should not be underestimated, and in many cases aligning first and second mortgages represent a timesaver for both the testing and ongoing compliance oversight activities. Addressing these regulations is particularly important given the new, higher penalties that CFPB will impose should the regulations not be met.
- Equity products are often considered a bank branch product, and are promoted within the bank as part of the branch’s offerings. The platform staff support the application and delivery of these products, increasing branch traffic as well as providing them with a revenue stream. Mortgage lending, on the other hand, may be connected to a branch but is not as intrinsically linked. A separate mortgage loan officer is involved and responsible for maintaining service levels to the customer. Each organization must weight their pros and cons to any changes to the status quo, and ensure that all employees are appropriately incentivized for their efforts.
- Ideally, the bank should involve resources knowledgeable about both mortgage and equity products to help guide them towards the right product for their situation. Unfortunately, staff can only promote the products they know. Mortgage loan officers should have deep knowledge of the mortgage products, pricing and process. Bank branch personnel have knowledge and experience about consumer lending products, and their role in the process. If equity is under consumer lending, then the mortgage loan officers likely have no incentive, interest or even knowledge about equity products. Likewise, the bank branch personnel are not well versed in mortgage, and given the current regulatory environment, are often prohibited from discussing too much with a customer for fear they will say the wrong thing or collect too much information.
The mortgage industry is entering a new phase, loan officers need all the tools and information they can get to offer the best solution to their customers. This doesn’t always require that equity and mortgage be originated within a single division, rather that training is provided across the product spectrum to provide mortgage loan officers with a complete portfolio of knowledge, with opened communication lines between divisions (when needed), access to current pricing and product descriptions, and streamlined workflows established to take and process an application, regardless of whether the customer selected a mortgage or equity product.
Where are you on this issue?