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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2008

Less Risky Business

By using operational-risk analysis to qualify their loans, brokers can inspire investor confidence

A recent editorial cartoon about the nonprime crisis shows two investment bankers walking down Wall Street. One turns to the other and says, “Turns out poor people with bad credit can’t afford to buy a home. Who knew?”

While this story may elicit a chuckle, the reality is that we as an industry should have known what we were getting into. Brokers are in the business of creating risk -- the risk that the loans they originate will not be repaid. Therefore, they must manage and mitigate that risk so that they can assure investors they can control it. Only then can this industry make a recovery. 

The risks that have damaged the industry need to be exposed and brought under control. The one risk that brokers, loans officers and staff can help control is operational risk. In other words, they can spot and fix errors made during their regular operations. By using automated operational-risk-analysis programs, brokers can do this quickly and accurately.

Operational risk includes mistakes made during the processing, underwriting or closing stages of a loan. To keep these from occurring, brokers should ensure that loans have accurate data, that calculations are done correctly and that guidelines are followed. 

Doing inspections manually for every loan just isn’t practical. With an automated risk-analysis program, brokers can find and correct mistakes within a few minutes.

Brokers should look for a program that tests for data integrity, accurate calculations and adherence to guidelines. While there are many different fraud-detection programs and automated valuation models available, brokers may benefit the most from a program that incorporates all of the loan-risk factors into one analysis.

This is how it works: Once the production staff completes the broker-controlled functions of origination, the loan data is downloaded into the program, which calculates a score based on the findings. The broker can use this information to determine what errors are in the file and to correct them before sending it to the lender. Or if there aren’t errors, brokers can communicate that to the lender.

Because these programs are Web-based and costs are transactional, they allow brokers and lenders to determine how and when to score their loans. With these scores, wholesale lenders can determine if the loan application adheres to their specific requirements.

The value of an operational-risk-analysis program can make up for any associated cost because it allows brokers to prove they have better-quality loans. Further, once brokers start using operational-risk-analysis programs, two critical changes may take place.

First, the programs can put confidence back in the market. Investors do not like to buy unknowns. Since the nonprime crisis started, their confidence in the advertised risk on many loans has vanished. Once brokers can ensure the quality of their data, however, investors will have an established way to quantify risks, and their confidence may be restored. 

Operational-risk-analysis programs also can result in investors being willing to pay more for loans, thus providing an incentive for lower-risk loans. If brokers continue to produce high-quality loans as a result of stricter operational-risk analysis, the demand for these loans will increase. In a free economy, if the demand increases, the price increases. Therefore, investors who wish to buy the best loans will pay more for them, thus giving brokers an increased revenue stream.

By running their loans through automated operational-risk-analysis programs, brokers can feel more secure about the loans they originate and pass that confidence on to investors. While it may seem like a bad time to be in the mortgage business, for those brokers who can grasp the potential opportunities that are emerging, it is a great time to get prepared for a less-risky future.


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