The term “doing it right the first time” carries significant weight with Mortgage Originators concerned about the cost of Loan Quality. There are two categories to determine the Cost of Loan Quality, the costs associated with producing a poor-quality loan, and the post-production costs of a poor quality loan. Knowing the difference between the two and applying methods to measure for each category is the key to reducing the cost of quality and achieving higher profits.
The Cost of Producing Poor Quality
Costs of producing poor quality are called failure costs. Research conducted on the cost of quality estimates that failures cost companies in any industry an average of 25 to 40 percent of their annual revenue. Companies regulated by agencies such as the Bureau of Consumer Financial Protection (BCFP) average failure costs between $2.2 million to $39.2 million (The True Cost of Compliance with Data Protection Regulations, 2017) in total. Failure Costs are related to two types of failures: internal and external. This article will focus on the cost of quality concerns for mortgage loan originators and how to utilize the cost of quality measurements to establish a Zero Defects loan quality program.
Internal Failure Costs are incurred before a loan has closed or been sold. These costs are typically associated with production, including the cost of lost effort and loan pipeline loss due to loans falling through for not meeting quality, rework needed to bring the loan back to required quality levels, missing of loan deadlines due to quality issues needing corrections, costs of downtime or other production delays, etc.
External Failure Costs are incurred after a loan has closed or been sold. The reasons for these costs include rework needed on closed loans to bring them back to compliance, loan buybacks, concessions or penalties due to sub-standard loan quality, costs of resolving borrower, investor or MI complaints, losses incurred due to the need of sale of the loan in the distressed or ‘scratch and dent’ market (quality downgrading), etc. There are also costs incurred from overburdened audit department personnel and employee turnover.
The Cost of Producing Good Quality
The costs of producing good quality are called control costs and are associated with a quality assurance (QA) protocol. Failure costs can be classified into prevention costs and appraisal costs.
Prevention Costs are costs incurred to prevent poor quality and hinge on the philosophy of “doing it right the first time.” Prevention and control costs include activities such as quality planning, new loan product review, employee quality training, instilling a culture of quality within the company, origination process planning, the cost of the collection along with the analysis of audit data and the cost of loan quality improvement projects.
Appraisal costs are associated with costs of inspecting overall loan quality, the loan production process and the costs of operating loan quality checkpoints to inspect loans at all stages of production. Appraisal costs are incurred at every stage of the quality control and production process to make sure each loan is originated per requirements. A workflow-enabled, “full-featured” and easy-to-use quality management system that integrates with the loan origination, point of sale and pipeline management systems is essential to carry out an effective loan quality appraisal process.
Total Cost of Quality
Measuring the cost of quality involves adding total failure costs (internal failure costs + external failure costs = total failure costs) and total control costs (prevention costs + appraisal costs = total control costs). Control costs plus failure costs equal the total cost of quality for a company. When the loans are of a high quality (high conformance), the costs of failures are low but the costs of control very high. Conversely, when loan quality is low (low conformance) the costs of control is low but the costs of failure extremely high.
Opting for a least acceptable loan quality standard that reduces loan defects while keeping control costs reasonable is not the right approach. The constant aim should be to reduce the total costs of quality by revising and upgrading both production and control systems. Using a quality management software tool where the individual learnings can be “institutionalized” so the entire organization can gain from them is of utmost importance.
Zero Defects Program to Reduce Cost of Quality
The total cost of loan quality is a monetary amount attached to creating a good quality loan. Most originators are unaware of how much and to what extent poor loan quality costs affect their profitability. A proper analysis and quantification of the total cost of loan quality is an important first step in improving loan quality and reducing the cost of quality. The saying “if you cannot measure it you cannot improve it” holds true in this case as it does in other disciplines.
Reducing the total cost of quality begins with establishing a Zero Defects management-led program. Zero Defects is a management tool aimed at reducing defects through prevention. The best-managed companies see an average of 3 percent in cost of quality compared with their poorly performing counterparts who report 25 to 40 percent in cost of quality (Buthmann).
Paradigm Shift to a Quality-Oriented Organization
The Zero Defect approach is the literal application of doing things right the first time, limiting failures to a few or none in the audit and compliance process, it is the achievement of the greatest level of conformance resulting in minimal quality costs. Despite the startup costs associated with establishing a quality assurance program, over time a reduction in the total cost of quality makes up for these costs many times. Change to a Zero Defects program starts with implementing new technology, employee and management training, and shifting the company culture toward a Zero Defects mindset.
To achieve Zero Defects, the entire company must have the same views on quality. Performance must adhere to established specifications without compromise. Inspired by quality experts Philip Crosby’s Zero Defects (ZD), Absolutes of Quality Management and W. Edwards Deming’s timeless 14 Points for Management here are five components with 12 actionable steps to guide companies toward Zero Defects and a significant reduction in loan quality costs.
Step 1: Management Paradigm Shift
A paradigm shift begins with changing senior management’s view from “to err is human” to “no room for errors.” The goal here is to educate senior managers about the costs associated with quality and instill a comprehensive understanding of how eliminating errors can change the way they do business and achieve higher profits.
The re-framing of management’s mindset is accompanied by a shift from fragmented ways of running an audit department (such as different systems for different departments) to a centralized quality management and audit system (all departments work within one centralized platform). A centralized audit system with a robust technology that digitizes and organizes quality, risk management, audit and compliance into one place provides companies with a holistic view of quality across the organization.
The quality-focused approach also provides management with essential tools for monitoring progress and measuring results in real-time. Continuous monitoring prevents poor quality and staves off the potential for current and future losses.
Step 2: Formal Training of Supervisors
A key to changing the way a company views quality is through formal education of supervisors in the Zero Defects program, who, in turn, educate managers.
Formal training of supervisors starts with finding how the company is performing within the current quality process. If the current format involves data collected from various spreadsheets, then a centralized system to enable performance tracking needs to be considered. The ability to track true performance through detailed quality reports, which provide the scoring of each individual agent and supervisor, is essential for a quality-centered company. If the company is now utilizing a centralized system, it is important to make sure a goal-oriented approach is used using performance tracking to improve quality and not to repeat the finding of the same flaws.
Step 3: Established Companywide Zero Defects Education Days
As part of a company’s culture, reminders of the company’s commitment to Zero Defects are ongoing and clear throughout day-to-day operations. Posters, employee manuals, and regular meetings designed to educate and reinforce expectations and commitment to Zero Defects should be consistent. Meetings should show the importance of the program and should include a special venue, employee meals, and recognition. Proper items of recognition are plaques, certificates, premium parking spots. etc.
Meetings are an excellent setting to share companywide quality results. Displaying the company’s volume of work, quality scores, and highlighting top performers aids in boosting morale. The setting is also a prime opportunity for management to discuss any defects found and define corrective actions.
Another morale-booster is creating a fun and competitive environment based on the performance of each department and running it from one meeting to the next. Quality scores of individuals or departments can be tied to incentives such as quality improvement-based bonuses and commissions. The data needed to carry out the above activities for Zero Defects education days can be quickly extracted from a centralized quality management and audit system.
Step 4: Quality Assurance Leaders
Quality assurance leaders, who can make sure quality actions and expectations are carried out without fail, should be established from each department of the company. Their role is to set up the quality functions in their departments. They are typically administrators and senior audit managers who have a higher level of access to features in the audit platform.
Setting up quality leaders in the quality management platform enables companies to define rules and hierarchies to fine-tune and improve reporting of failures and quality levels.
Step 5: Quality Education for Every Team Member
This step is essential in creating a company culture of Zero Defects and a companywide focus on quality. Employees at every level are educated in all facets of quality as it relates to costs, fines, reputation, and their jobs. This step should inform employees of the impact of errors, corrective actions, and company policies about errors.
All members should be trained in their domain of specialty within the company and trained in the quality management and audit platform used to do quality audits. All staff members should understand the importance of operating in a standardized fashion, achieved by using a centralized audit management system. Having production employees self-certify their quality using the same checklists auditors used to check their work is also advisable to move the quality consciousness upstream to the production floor.
Step 6: Corrective and Preventative Action Protocol
Throughout the quality process, all teams at every grade will have experiences with quality issues requiring corrective action to meet the Zero Defects goal. The quality system should foster an environment of accountability where every member is a valuable participant in the solution to quality problems. Lower level quality issues are best addressed at that level unless upper management involvement is required. Corrective and preventative actions should be defined within the quality management system to ease corrective recommendations at department levels and for the entire organization.
Step 7: Individual Commitment
Supervisors should instill individual team member commitment to quality through written guidelines. The commitment should outline specific goals, targets, and realistic timelines in which to achieve results (for example, 30 days, quarterly, and annually).
Managers can evaluate performance and goals through a detailed scoring mechanism within the quality management system. Scoring and performance reports inform team members, managers, and senior management of quality at every level of the organization. Every member of the quality organization should receive a score to stay fully accountable to the quality process (360-degree scoring).
Step 8: Continuous Error Removal Processes
As quality failures appear, team members must actively take initiative to discuss the problem at the time of failure. They should follow an established protocol that includes documenting the description of a failure and a solution. Quality practitioners must focus on what needs to be changed so the job can be completed correctly the first time. When every level of an organization works toward failure reduction, failures decrease substantially.
Producing quality is an ongoing and day-to-day activity; so a centralized audit platform is essential to achieving companywide quality results. With a high volume of audits and the need to track errors and correct them, a robust audit platform is a holistic way for companies to check and improve quality.
Step 9: Measure Quality Often and at Every Level
Quality measurements need to be implemented in all areas of the company, including external products and services from vendors. Using the built-in measurement features within the audit platform helps companies find failures quickly with robust dashboards and reporting capabilities. Quality administrators can quickly find whether the company needs attention at the individual, departmental, or organizational levels.
Step 10: Measuring the Cost of Quality
Department leaders are given the task of monitoring the measurement of quality and tracking and correcting failures. A methodical way of measuring the cost of quality is paramount in identifying the true cost of quality for a company. Quantification of the cost of quality within the audit platform and the ability to view it in a real-time fashion is essential to focus on the measurement and efforts to reduce the cost of quality.
Step 11: Quality Oversight Committee
A quality oversight committee is made up of professionals from different departments within the company, or within the audit process. They focus on specific areas of quality and take a macro than a micro approach to quality concerns. They meet periodically to share ideas to correct failures, or to improve quality. The quality oversight committee ensures a unified company view of quality.
Step 12. Repeat Steps One to Eleven
It will take a year or two to set up and refine a Zero Defects company culture. Committees, leaders, Zero Defects days, recognition, daily quality corrections, and the oversight committees should undergo renewal once a year. With a consistent renewal and evaluation through the audit platform, 360-degree scoring and a focus on quality, a companywide Zero Defects attitude will remain fresh and vibrant. Once the cost of quality and its underlying data has been recorded for posterity, the company can start creating historical trends and analysis relating to their cost of quality and achievement.
Producing quality is a journey, not a destination. Understanding the Total Cost of Quality and how to start a Zero Defects quality program is essential to creating a profitable quality-focused company.