Rising Tide of Operational Risk Demands Due Diligence in Vendor Selection

Considering the potential liability associated with outsourcing by the mortgage banking and mortgage servicing industries, as witnessed by widely publicized high-dollar settlements in government enforcement actions, recent comments of federal financial regulators, and guidance by the Consumer Financial Protection Bureau, servicers cannot be cavalier about the choice of their vendors, or select them with a check-the-box approach to due diligence. Instead, banks and mortgage servicers must ensure that their vendors perform critical mortgage servicing functions in a manner that is consistent with their legal and regulatory obligations and service level standards. Unfortunately, much that has been written on vendor selection focuses on intangible principles associated with risk reduction, with much less practical guidance available on “best practices” for identifying and selecting vendors. This article attempts to fill that gap, and focuses on practical criteria relevant to conducting appropriate due diligence on potential vendors.

Why Outsource Servicing Functions?

A handful of reasons are usually cited for outsourcing mortgage servicing functions: first, outsourcing creates opportunities for enhanced profits through reduction of expenses or creation of revenue; second, it allows servicers to concentrate on their core competencies; third, not withstanding occasional regulatory focus on the risks of outsourcing, the use of third-party vendors is believed by most financial institutions to reduce their risk exposure; and last, outsourcing permits banks and servicers to access needed services from providers with greater expertise and efficiency. Other reasons for outsourcing include third parties’ ability to perform local tasks far from the servicer’s location. While the recent federal-state $26 billion settlement with the largest mortgage servicers may have called the risk-reduction rationale into question, these principles, combined with the near-ubiquity of outsourcing, leaves little doubt that this aspect of the business is here to stay. How then, should a servicer select its vendors?