Digital Mortgage and Consumer Lending Trends and Innovations

Financial technology, or fintech, is transforming rapidly the marketplace for financial services, affecting how consumers and businesses make payments, access their financial accounts, make investment decisions and obtain loans. The consumer mortgage market, which has been slower to adopt customer self-service technologies, is taking steps now to digitalize operational processes, improve the customer experience and reduce time to close loans. An increasing number of industry leading players are bringing forth new digital mortgage products, platforms and other innovative services that are disrupting long-standing home buying and mortgage lending practices.

The primary factors fueling this rapid increase in digital innovations in the consumer mortgage space include:

• Consumer demand for a faster and easier home buying experience. Research reinforces the notion that consumers will abandon trusted lenders in droves if they cannot deliver a digital home-buying transaction that matches the slick, speedy and effortless experience consumers have come to expect in other transactions.
• Significant costs to deliver mortgages due to increasing regulation, in addition to inefficient back-end processes to process, underwrite and close loans, provide timely and accurate disclosures to borrowers, and manage the communications flow with the multitude of stakeholders beyond just the borrowers (such as sales agents/brokers, title companies, appraisers and many others).
• Increased evidence that utilizing tools, such as application programming interfaces (APIs) and robotic process automation (RPA), can alleviate major pain points associated with manual processes and antiquated systems, thereby reducing the average loan application-to-closing turn time.

Early adopters of digital capabilities have focused on delivering a better process for the consumer with faster turn times. Practically speaking, this means enhancing both the front-end point-of-sale process (by implementing technology that provides a sleek user interface and consumer-friendly tools that let the borrowers self-direct their mortgage applications) and the back-end processes (by implementing technologies that automate manual tasks, enhance regular communications with customers and coordinate the multiple stakeholders).

In order to truly embrace the full digital mortgage process, lenders must work diligently to address data connectivity issues and seek out process improvements in the back office, which is often plagued by delays with redundant manual workflows, legacy systems and over-reliance on documents rather than data. Two examples of technology solutions include APIs and use of RPA:

• An API is code that allows two software programs to communicate with each other. For example, customers are required to provide numerous documents to support the underwriting of a mortgage application (bank statements, tax returns, proof of employment, etc.) that could be provided through independent and secure sources by utilizing an API. This automated process not only increases efficiency, but also allows for automated quality checks throughout the process.
• RPA is the use of software programs that mimic human activity. Although it does not literally employ robots, it involves automated routines and macros developed to automate a task within a servicing system, or even connecting multiple systems or tools to complete a task. For example, RPA can help automate the closing process by comparing the final credit approval to the documents being prepared by loan administrators that will be executed at the closing table. Speed to development, lower build-out cost and user ownership are three main reasons a lender may want to implement RPA. Capabilities of RPA include data-scraping, data entry, rule-based triggers, third-party integration, document and data extraction and document image capture, among others.

Regulation is often cited as the root cause for why the mortgage industry has been slow to adopt fintech and why the industry tends to ignore the inefficiencies of back-end processes, long closing timelines and poor borrower experience. The digital mortgage, however, is a trend that financial institutions cannot afford to ignore.

Financial institutions should examine their back-end processes, data and systems and understand root causes of loan-processing delays. They should identify where opportunities might exist to practically apply automation techniques that would greatly reduce delays and improve quality. And while not every process is an ideal candidate for automation, institutions should consider the regulatory impacts of automating certain processes as well as how user experience would be impacted by the change.

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Guidance Issued Regarding Expanded Russian Sanctions Under CAATSA

​In October and November 2017, the U.S. Department of State and the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) each issued guidance related to the Countering America’s Adversaries Through Sanctions Act (CAATSA). Signed into law in August 2017, CAATSA codifies certain executive orders that previously established certain sanctions against Russia and introduced new requirements related to existing U.S. sanctions against Russia, Iran and North Korea, as well as creates a congressional review process for any future modifications that would ease these sanctions (so as to limit their use as a diplomatic measure handled solely by the president through executive order). The issued guidance focuses primarily on implementation and enforcement of the new Russia-related sanctions and dealings that involve Russian business interests under CAATSA.

The Russia-related executive orders codified under CAATSA include the sectoral sanctions authorized against Russia for its military involvement in Ukraine and Crimea, in addition to other sanctions. The guidance emphasizes limitations on commerce involving financial services and energy production, as well as the directed application of secondary sanctions. OFAC specifically updated its Frequently Asked Questions (FAQs) to offer direction for interpreting CAATSA compliance and compliance with sanctions targeting Russia-related dealings. Insight and clarification of CAATSA requirements addresses the following regulatory objectives:

• Restriction of Transactions Related to Energy Exploration and Production. CAATSA expands restrictions on dealings involving Russian energy production through new sanctions on “significant investment” in Russian deep-water oil exploration and off-shore oil production effective Jan. 29, 2018. The expansion modifies Directive 4 of Executive Order 13662. State Department guidance provides interpretation for enforcement to include individual review of the facts and circumstances surrounding investment and development of oil-exploration and deep-water projects, as well as guidance related to oil-export pipelines.

In addition, OFAC FAQs include guidance on exports and re-exports for oil exploration and production (FAQ 412) and sectoral sanctions on railway transportation and metal and mining sectors (FAQ 539).

• Debt financing for energy production. CAATSA tightens the authorized timeframe for new debt maturity on transactions involving energy-related dealings with Russian businesses from 90 days to 60 days effective Nov. 28, 2017. This enhanced restriction modifies Directive 2 and is applicable to dealings with Russian energy businesses including those with 50 percent or greater ownership by persons and business entities subject to sectoral sanctions. OFAC guidance outlines debt issuance requirements (FAQ 370) and distinguishes debt and equity (FAQ 371).
• Debt financing for financial services. CAATSA also tightens the authorized timeframe for new debt maturity on transactions involving Russia-related financing from 30 days to 14 days effective Nov. 28, 2017. This enhanced restriction modifies Directive 1 and is applicable to dealings with Russian financial institutions including those with 50% or greater ownership by persons subject to sectoral sanctions. OFAC guidance outlines debt-issuance requirements (FAQ 370) and distinguishes debt and equity (FAQ 371).
• Mandatory secondary sanctions for facilitating transactions or investments. CAATSA requires OFAC to impose secondary sanctions against foreign financial institutions (FFIs) that facilitate significant Russia-related transactions involving persons named on OFAC’s Specially Designated Nationals (SDN) List or involve energy-or defense-related dealings. OFAC guidance clarifies the applicability of mandatory secondary sanctions on FFIs (FAQ 541) and when a FFI is determined to be a facilitator and a transaction deemed to be significant (FAQ 542). Similarly, State Department guidance clarifies that secondary sanctions may be imposed against foreign persons engaged in energy transactions with non-financial investments.

Financial institutions implementing risk-based sanctions compliance strategies to manage the existing and expanded sanctions imposed by CAATSA will need to evaluate the complexity of navigating Russian-related sanctions and identify the correlated impact on the institution’s sanctions filtering programs, and due diligence involving the facilitation of global transactions to identify counterparties, ownership, transaction relevance and other factors.

Due-diligence and compliance functions require review at all levels of the organization, from client relationship management to compliance and audit teams. To ensure the effectiveness of sanctions compliance under this section of CAATSA on Russian-related sanctions, filtering systems and interdiction processes should be updated and tested in the compliance operations and audit review processes to identify and mitigate sanctions risk associated with conducting Russia-related transactions.

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FASB Releases New Lease Accounting Standards

Asset leasing is a common business practice among companies in all industries. Leasing allows businesses to utilize real estate, equipment, transportation assets and technology to support day-to-day operations and functions, while providing flexibility and control over working capital. In February 2016, the Financial Accounting Standards Board (FASB) released a new standard impacting the accounting for leases, representing a substantial change to lease accounting that will affect virtually all companies (public and private) in all industries. This new standard will take effect starting in the fiscal year beginning after Dec. 15, 2018 for public companies and after Dec. 15, 2019 for private companies.

Traditional accounting rules require leases to be classified as capital leases (leased asset and liability are recorded on the balance sheet) or operating leases (lease is expensed on the profit and loss, or P&L, statement), based on the intended use and ownership of the underlying asset being leased. This has historically provided an avenue for off-balance sheet financing that allows for expenditures classified as operating leases to be excluded from the company’s balance sheet, which may have affected the company’s debt and liability posture.

With the new FASB standard, companies will now be required to recognize a lease liability and a right-of-use asset (ROU) for all leases (except those with a duration of less than one year). Among the stated goals of this standard is to address the so-called off-balance sheet financing loophole and ensure consistency in financial reporting.

There are many important impacts and considerations for financial services companies aside from the financial reporting impacts described above. Specifically:

• Financial institutions may need to adjust how they evaluate their corporate clients for credit worthiness (such as how these changes will impact the financial statements of their borrowers and their loan covenants) and insurance eligibility and even for investment purposes and recommendations.
• Institutions may also incur changes to various capital ratios and other key financial reporting measures utilized by regulators, lenders and investors (e.g., risk-based ratios, leverage ratios, and debt-covenant compliance).

Entities with large amounts of operating lease commitments could experience a significant increase in the asset and liability balances on their balance sheets due to this new accounting guidance. Regulatory capital at institutions will also be impacted, as the ROU assets that relate to leased tangible assets will be required to be included in regulatory capital.

In light of these challenges, the effort of becoming compliant with the new FASB standard will require companies to:

• Identify and understand the full population of their leases (including real estate, automobiles, office equipment, construction projects and embedded leases, among other assets).
• Assess the terms, obligations and rights of each lease to determine the specific treatment of each lease (e.g., classification as both an operating or finance lease, and the timing of such treatments).
• Identify and review other types of arrangements that may explicitly or implicitly contain the right to use an asset. In these arrangements, leases may be considered embedded if the company controls the use of the asset through-out the arrangement term.
• Develop processes to regularly assess whether circumstances pertaining to leases have changed, which might necessitate an adjustment to the leases recorded (for example, where a lease has an option that can be or has been exercised).
• Implement technology-based solutions to facilitate lease management processes and ensure compliance with the new standard.

In addition to the defined steps noted above, and depending upon the extent to which the financial institution is impacted by this change, the new FASB standard could impact other business processes such as:

• Budgeting/planning processes that account for the evaluation of leasing decisions.

• Procurement and purchasing processes that support the entire process of acquiring the assets in question.

While the effective dates for this new standard may seem well into the future, the effort of complying will be substantial for many companies, particularly so for those that do not yet have a robust inventory of their existing leases. The introduction of the new standard requires both lessees and lessors to evaluate its effect on the business processes, policies, financial statements, technology and internal controls within their company.

As achieving compliance will take some time, financial institutions should begin taking steps to evaluate their use of lease arrangements and the processes or systems that may be impacted from this transformation. A road map for compliance should include the following components: (1) an effort to establish the inventory of leases and understand the scope; (2) a determination of the impact on the financial statements resulting from the population of leases, processes, policies and systems; (3) development of necessary project plans to incorporate enhancements to policies, processes and systems that satisfy the business and financial reporting needs; and (4) implementation of the plan, including a well-suited project management office (PMO) structure and clear reporting on progress and issues.

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