Moving Beyond the Ordinary Dogma and Common Dialogues -- February 2008 (Also appearing in the MBA Tech NewsLink)

What has become clear in the early weeks of 2008 is that everyone is still asking a lot of increasingly pointed questions – there aren’t many definitive answers.  It was clear during a recent conference, that the questions asked and the topics presented are still slightly out-of-phase. Below are four of the more critical questions that were being asked by business personnel.

What does the next consumer model look like and how will these post-euphoric clients behave?

There is a new consumer paradigm – keep the car, boat, and HDTV, but default on the “upside down” mortgage.  It appears from all indicators, that even prime mortgage borrowers could be adopting a new and permanent mindset that is unprecedented in the lending industry.  Consumers in droves are making choices on their lending payments treating property deals as no more important than a payment on a car, couch, or a gym membership.

In a very insightful article published in the Financial Times of London on January 31, 2008 entitled “Last year’s model: stricken US homeowners confound predictions,” by Krishna Guha and Gillian Tett the reporters present a new market and consumer reality.  The divergence from accepted and dogmatic lending logic has created a huge wound not only for lenders, but the rating agencies who attempt to provide investors with risk ratings.  To say we have failed miserably in recognizing the changing sentiment is an understatement.

Across the board from prime to subprime, defaults are increasing as the new consumer reassesses their priorities in dealing with historical debt levels and obligations.  The downstream implications of this will, if left unchanged, create a new market reality that few vendors, lenders, and pundits are prepared to address.

If the consumer is no longer behaving along historical patterns, then the cross-selling, up selling, targeted campaigns and even customer preferences can no longer be relied upon – not to mention scoring.  Furthermore, the ability to securely lend or find individuals worth lending to will require extensive front-end screening, credit counseling, and even new types of default protections.  The models of acceptable candidates will be greatly changed as this new consumer has little loyalty and treats the purchase of a home as little more than another financial transaction. 

For organizations seeking to find “what’s next” in the markets and how can money be made, they are advised to read this article closely and objectively.  Within the American lenders and their vendors, the blinders of delivery have still not been taken off to meet the new reality.  At a recent conference, it was stated that American mortgage operations need to adopt practices from 10 years ago – it received great acceptance from lenders. 

The problem is that the consumer has changed and without brain scans of consumers and artificial intelligence prediction models, no amount of fraud protection can prepare lenders and investors for a consumer that has adopted non-historical behaviors. 

How can mortgage organizations secure not only new customers, but product and service additions to existing customers with known histories?

With the financial markets in decline and a belief that the customer base is disappearing, organizations are seeking new methods and techniques to leverage consumer relationships.  With the merging of customer bases as part of an integration effort, an energized effort will be undertaken to up sell and cross sell products and services that have the greatest likelihood of closure. 

How?  Smart integrated organizations will look to outside firms that offer not only new media delivery techniques, but fact-based algorithms, third-party cross industry customer data integration, and of course, sound data mining of existing repositories.

Once considered the domain of internal groups using just expert vendor software, this customer data integration (CDI) specialization has led to a business and knowledge sourcing set of functions and processes that are best served with the active collaboration of third-party servicers.  Now viewed as an integral component of securing and retaining customer profits, organizations are compelled to seek specialized providers who can not only target results with a high-degree of lock-in, but also can address consumer privacy, regulatory adherence, predatory marketing, and even community standards. 

1. For the FSI and mortgage industry, this often requires a specialized relationship with a targeted provider that may not be normally visible to the deal advisors who are seeking a “one-stop” provider.  Again, industry expertise and market knowledge will point to the need for secondary relationships that are governed by not only independent SLA’s but OLA’s.  While the operating complexity is higher, the need for survival results will demand their usage and overall global sourcing agreement integration. 
2. What is fundamentally happening with the market headlines and what do they signify?  Are there similarities within the historical records?
3.  The financial and mortgage markets are becoming increasingly consumed with survival – just survival. We believe the U.S. Financial industry is not only undergoing a “double bottoming,” but also a loss of worldwide financial status that is unlikely to be recaptured before 2010. As written about in the Financial Times in several articles -- “US deal making enters state of transformation,” and “McKinsey warns US may lose financial leadership” -- these leadership pieces reinforce our last six months of projections and underlying fears.
4.  Furthermore, analytical data and conclusions from it are starting to show that America may be today where the British were at the end of the 19^th century. No longer a singular world power or economic powerhouse, Britain became a facilitating, non-prime player and sometimes a flashpoint for many of the world events early in the 20^th century. American corporations (facing a similar challenge this century) are not prepared for this redistribution of wealth or the globalization of markets erasing 100+ years of comfort and management training. Market influence is clearly shifting to the East at an accelerated pace.
5. As for domestic businesses, they are completely unprepared for the next steps and very few of the business or knowledge sourcing providers have any innovative approaches as to how to help -- they have only been taking orders and making money. The void is huge and it could take 5 to 10 years before it is recognized and then only in hindsight. This could materially explain, using history as a reference, why the mortgage pain will linger as the financial markets reel and vary widely. There is a permanent and fundamental shift ongoing and the roadmap has not been drawn.
6.  For the technologists, established providers, and the media reporters, it truly appears that there is a demand for a “new currency and content change.”  The growth factors that brought to executive offices the demands for AVM’s, state-of-the-art LOS’s, VoIP and high-tech contact centers, and data storage farms that grew at over 50% a year are now facing the new market realities.  The old discussions and recommendations of the past are exactly that – history.

So what regulatory and audit challenges should be anticipated as the market rebalances and reassesses?

It is a gross oversimplification to suggest that today’s audited financial statements are easy to read, understand, and internalize the implications on the precise meaning of the footnote language.  With ever greater post-Enron and WorldCom prescriptive accounting rules, the ability of a non-professional to act on the quarterly and annual statements has been impaired.  Yes, the changes enacted were to tighten financial treatments and were sought by regulators and the auditors themselves to denote risks within a corporation and for, let’s face it, post reporting litigation against the auditing and regulatory agencies themselves.

Regardless of the intentions and the outcomes, what has become clear this decade is that with prescriptive standards there is a challenge to react quickly to market demands and financial instrument complexity.  In essence, the standards appear to be continually lagging the ability of corporations and their advisors to create and use new forms of currency and “off-balance” sheet items that don’t properly assess the fair market value for assets and risk positions.  Post 2007, there is clearly a divergence from intent to reality when it comes to accounting transparency and an ability by the average investor to understand the implications within accounting statements.

With market conditions continually uncertain and auditors in fear of another Authur Anderson series of litigation, it should be expected that the financial statements for 2008 and 2009 will be even more difficult to understand.  Why?  It has been suggested that with the fear of liability facing the partners of the top 6 international accounting firms (which audit a significant majority of public firms), the caveats facing publically audited firms will be significant as auditors and investors seek to concretely assess asset holdings, valuations and ratios, and of course, risk exposures.

As the top audit firms seek limited liability for any potential litigation by activists or investors seeking to assign blame and retribution for FSI firms in distress or failure, global equity markets are searching for a more uniform method to apply consistency to increasingly globally interconnected operations.  Some are terming this “principles-based” auditing, but the markets and the regulating agencies are just now debating the rules and downstream implications of the draft rules.  It is unlikely that with continued market pressures, illiquid assets, and struggling operations that new accounting treatments would be quickly adopted.  The rising tide of litigation may prevent this.  However, fearing the loss of another international accounting firm and even less competition, regulators and government agencies may become the audit firm’s best asset for change. 

What’s the net of all these challenges?  Auditors and their practices will take a very critical eye towards corporations and the stated valuations that have been historically assigned to such items and SIV’s, CDO’s, MBS’s, and ABS’s.  If there is any concern over the fair market valuations of these portfolioed or investment instruments, look for account statement footnotes that try to direct the investor to the “discrepancy.” 

From a global sourced operations standpoint, look for additional scrutiny along the entire supply chain and the risks associated with alliances and partners.  Sourced processes may be subject to 100% validation rather than just using sample sets resulting in a longer audit response / due diligence, greater audit fees, and increased auditor to management team disagreements.  For global sourcing providers, increased regulatory, oversight, and governance demands will be placed into the relationship by corporate personnel.  For operating transitions, the impact may be an increase in checkpoints, signoffs, and test cases to ensure conformance especially with latter stage business processes and all knowledge sourcing efforts.

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The challenges of the future cannot be addressed singularly with the same approaches and conference events.  New and stimulating topics and personnel must be put forth as organizations and individuals seek answers in an uncertain environment. 

 

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