Photo Credit: Benson Kua via Flickr
I know that I said at the end of Part 3 that we would see how computers changed the nature of lending, but I realized that before we look at that, we need to look at how "modern" lending practices were conducted before there was computer software to help us service the loans. As a representative model, let's look at the standard 30-year mortgage. These mortgages really took off in this country as veterans returning from World War II purchased homes on an unprecedented scale (often referred to as the "post war boom") and yet, computers were not widely used in consumer banking until the early 1980s.
So, what were the phases that the servicing of a mortgage loan went through, how long did each take, and based on the assumptions made, how many servicers did it take to service a block of loans? To simplify, we will assume that all of the people who do the various functions on the loans are interchangeable, even though many of these functions are done by different departments. We will also make the assumption that each individual worker puts in a 40 hour week 48 weeks a year. (Note: I'm not making the assumption that the average back office bank worker in 1950 got four weeks of vacation a year, but since we are going to assume that the loans in question are all monthly, then to assume the worker is working exactly four weeks a month, or 160 hours will simplify our calculations.)
Now, for the phases of a loan, dealing with servicing processes, and not underwriting or origination:
Phase 1: Account Preparation
Much of the work for what will become account preparation was done during the origination and underwriting process. Loan applications have been completed, and verified (all by hand or on a mechanical typewriter) and the loan has been approved and funded. Now the loan moves to the servicing department. In order to save time in accrual calculations over the life of the loan, this loan will follow a fixed amortization schedule, with the monthly accruals predetermined. However, preparing that amortization schedule, which will serve as the coversheet of the loan file, will be a somewhat time consuming process. First we must determine the monthly payment amount and type up and prepare the file. Fortunately, professional mathematicians have done most of the work for us ahead of time. As the loan officer, I take a small book out of my desk drawer. Each page of this book contains a table for a different interest rate. Each table has an axis of term (in years) and another axis for payment period. The resulting table cell is the payment that would be required to pay off a loan of $1,000 in the time period specified at the specified rate. I take this number and multiply it by the size of the loan (in thousands of dollars) and that gives me my periodic payment. The simple multiplication might take a few minutes as my only computing devices are my paper, pencil, and logarithmic slide rule.
Now, let's say that the entire process of typing up the file and determining the payment amount takes an hour. We still need to finish preparing the amortization schedule. Fortunately, we have a table prepared for that, too. Given our loan of $1,000 at a certain rate and for a certain term, we have an entire schedule for the loan all ready to go, but if our loan was for $5,000, then we need to type up a version of that schedule with all of the numbers multiplied by five. If we are good at typing and quick at multiplying, we can probably do a line a minute (actually that is pretty quick multiplying). But the schedule for a 30 year loan has 360 lines, which means 6 hours of calculating. Let's round the prep time up to a full day's work. Fortunately, that work will last us for the full term of the loan. But how many mortgages actually go a full 30 years before being paid off? Probably more back then than today, but still, for the purposes of this discussion, let's assume that the average loan will exist for half the time of its term. So, if we amortize the total preparation time for the account out over the time of the loan's existence, then for each loan, the amount of time spent on Account Preparation in a month is about 3 minutes. That's not too bad.
Phase 2: Accounting for Income
In the accounting department, I have 20 stacks of files for which I'm responsible. Each stack is for a different work day of my month. Each day, I pick up that day's stack and set it on the left side of my desk. I take the first file off the stack. I note the line of the amort schedule corresponding to this month, and write the interest figure from the schedule onto my sub-ledger sheet. I check to see if there is a notification that a payment came in this month. If one did, I place the file on the right side of my desk. If not, I place it on the front of my desk. I am building two piles - one for loans in good standing and one for loans in arrears. This process has taken me about a minute. Periodically, I will add up the columns on my sub ledger sheet, and at the end of the day, I will send the number up to the head accountant for transcription to the running total of the company's general ledger income statement (debit accrued interest receivable; credit interest income). This adding took about half my time, so I probably took two minutes per loan total. I do this every month on every loan, so I am up to 5 minutes now.
Phase 3: Accounting for Payments
Mail came in. We have a check with a payment stub. The payment stub came from a payment book that had been prepared at the same time as the amortization schedule. That job alone probably added an additional 5 minutes to our running total back in the account preparation phase. So, now we are at 10 minutes per month per loan.
Now that I have my check and stub, what do I do with it? If we did our planning and coding in a smart way, the loan number should reference the specific pile that this loan's file resides in. Assuming that we are not receiving the payment on the same day that the pile in question is on the accountant's desk in phase 2, we should be able to go find the file and make note in it that the payment has been received. We locate the file, check the amount against the check, and then check a box in the file. We'd better hope the check was written for the right amount. Partial payments will really mess us up. There will be some special handling there, but on average, we should be able to find the file, verify the payment amount, and check it off in about ten minutes. And for this step, we aren't even doing any calculations as they are all done in the schedule ahead of time. We send the stub to one department where a ledger entry will be made and the check to another for deposit, clearing, etc. We are now 20 minutes in on every loan we have to service for every month.
Phase 4: Late loans, Collections, NSF
So, now we are writing letters, making entries and notations for late charges, and making collections calls. These all take a lot of time, but fortunately, are only done on a small percentage of loans. So, let's just estimate an average of five minutes per account, per month. That brings us up to 25 minutes.
Phase 5: Payoff (and goofing off)
At some point, we need to prepare a payoff letter, process a payoff, close out the ledger book, and file paperwork to release liens, etc. We are into considerable time on this one, but fortunately in parallel with the initial account preparation, this only has to be done once at the end of the loan. When we divide the many hours of work by the infrequency in which this has to happen on any one loan, we get about five more minutes, per loan, per month. Now we are up to a half hour. But, let's be reasonable. We are, so far, talking about a worker who never goes to the bathroom or takes a break or discusses with his co-workers what the Lone Ranger did on the radio last night. And have you seen this new Television thing? Don't get me started on that. Anyway, reasonably we have to double the time estimates to make a determination of the amount of loans that can be serviced by one worker, or the number of workers that it takes to service a block of loans. So we are at one hour, per loan, per month.
Our workers put in 160 hours in a month. So, with our highly efficient loan servicing operation, each loan servicer can handle 160 loans. We need seven people working full time to manage a portfolio of 1,000 loans. A portfolio of 10,000 loans takes 63 people to manage. These functions scale linearly. In order to get any kind of scaling benefits, we are going to need computers. Fortunately, they are right around the corner.