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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2009

With Risk Management, It Pays to Plan

Implementing some simple safeguards can keep brokers from the brink of disaster

Mortgage brokers operate in a zero-tolerance world. Investors can terminate a relationship for even the most insignificant inconsistency, and mortgage firms can refuse to commit to a deal without multiple take-out strategies. To complicate matters further, the extraordinarily volatile rate market makes ensuring a reasonable profit tentative at best.

A practical front-end risk-management plan can mitigate the possibility of fraud, investor jeopardy and interest-rate risk.

Mortgage origination has been transformed in the past few years, partly because of the advent of credit-scoring, automated-underwriting systems and electronic documentation. Powerful and sophisticated sales-and-communications tools decreased face-to-face interaction with applicants and let firms operate profitably without meeting a single consumer. Unfortunately, the double-edged sword of technology also has given consumers and brokers greater ability to commit fraud.

According to a March report by mortgage database Mortgage Asset Research Institute, approximately 28 percent of mortgage fraud involved misrepresentation of tax returns or financial statements in 2008. In comparing that analysis to an FBI-reported estimate of $4 billion to $6 billion lost to mortgage fraud each year, more than $1 billion may be lost annually because of tax-return misrepresentation.

It is therefore imperative that an applicant's income verification come via use of Internal Revenue Service (IRS) Form 4506-T. Given the downside risks to investor relationships and criminal penalties, responsible mortgage brokers must review the IRS transcript on every file before submission. A number of firms provide expedited handling of this tool, ultimately helping brokers maintain a healthy investor roster and most important, stay out of jail.

Although reliance on statistically based models -- such as FICO scores -- rather than human experience has been cited as a potential cause for our current economic crisis, technological tools also offer many advantages. For instance, investors can verify appraisals with an automated-valuation model (AVM), desk review or additional appraisals. Although AVMs can be inconsistent when used on less-common property types, they play an important role in supporting appraisals. AVMs also bolster appraisals' veracity, underline brokers' commitment to provide accurate data to their investor partners and significantly diminish the likelihood of a repurchase demand or account termination.

In addition, if AVMs do not corroborate appraisal values, brokers can seek a rebuttal, field review or an additional appraisal before the file's submission -- resulting in reduced turn time in an investor's underwriting. Although appraisal fraud is estimated at more than 22 percent of all mortgage fraud, AVMs provide credibility in a timely manner.

Investors' agreements require assurance about the accuracy of all information submitted. Even when brokers' unsupported loan-to-value ratios (LTVs) are 65 percent, they will remain liable if two other appraisals cite LTVs of 75 percent. Again, the investor will seek to verify the appraisal with an AVM, desk review or additional appraisal. The minimal cost and inconvenience of an AVM can outweigh the time saved in underwriting and the protection afforded by an industry-endorsed review.

Good processing technique depends on brokers' risk-management plan. Investor underwriters determine applicants' creditworthiness as opposed to ferreting out fraud on brokers' behalf. Processors must aggregate the documentation and ensure the credibility of the information presented to the investor. They are the last line of defense.

With the applicant's permission, brokers can easily confirm identity, residence, Social Security number and other critical data points online. In addition, simple Internet searches can provide a treasure trove of background information.

Given the rapid changes in the market, an investor may withdraw a product or even its entire wholesale or correspondent program at any given time. Thus, brokers must secure alternative investors for their entire pipeline. They also should prepare their files to comply with universal requirements, rather than specific ones, by gathering a comprehensive set of documents, including W-2s. 

When possible, brokers should use third-party companies to provide objective and rapid underwriting of their files. Additionally, brokers who identify inconsistencies should report those items for further investigation. Addressing these issues before investors raise them is worth its weight in gold.

Finally, brokers should consider pricing, rate-risk and premium protection. Many brokers know the pain of closing a deal for no fee or at a loss. Often, these circumstances result from improper pipeline management. Online systems and best-execution programs avoid the guesswork of market movements, pricing, rate-lock management and in the case of mortgage bankers, warehouse management. Despite their cost, these systems can pay for themselves.

At one time, a mortgage broker could simply originate a file and move to the next transaction. Investor repurchases happened only to bad players, and criminal charges were reserved for only the most heinous of operators.

That was then, this is now.

Once considered the exclusive purveyance of secondary-market participants, risk management has become a critical function for all brokers. Risk-management tools can significantly reduce liability at a minimal cost. Brokers without good risk management are dying off, and those with it will gain market share, increase profitability and sleep easier at night.


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