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   ARTICLE   |   From Scotsman Guide Residential Edition   |   August 2009

How to Avoid Due-Diligence Drama: 7 Steps

It's wise to study any firm you consider hiring to improve loan quality

Traditionally, mortgage investors hired due-diligence underwriters to help them find the long-term-investment and securitization viability of mortgages. In the past year, however, more mortgage brokers and lenders have hired due-diligence underwriters to help improve the origination, underwriting and approval processes.

All would-be clients of due-diligence underwriting firms should evaluate carefully any firm or provider they consider using. A failure to do so could result in due-diligence underwriting that provides the same results as front-end underwriting -- or far worse.

Understanding the issue

The goal of due-diligence underwriting is to protect firms against potential repurchase events and to prepare for prepurchase rebuttals that secondary-market investors could send.

In addition to reviewing loans and training on fraud prevention, due-diligence firms also can explain how to avoid approving questionable loan applications before these approvals cause problems.

The relatively small cost of a weeklong due-diligence-underwriting course can pay for itself when its training allows a broker to avoid a single repurchase demand of a poorly performing mortgage. Brokers who learn and apply due-diligence-underwriting concepts and practices to their businesses -- and can prove as much to secondary-market investors -- often will find it easier to sell their closed mortgages. They also likely will face fewer repurchase and rebuttal costs associated with those sales.

But the growing demand for due diligence has led to an increase in firms advertising these services. This represents a double-edged sword for brokers seeking a reputable provider.

With alarming frequency, wholesale account representatives, brokers, front-end underwriters, title-service employees and even real estate agents are attempting to reinvent themselves as due-diligence experts. This seems to result from economic opportunism more than a desire to provide a meaningful, useful service to the mortgage industry.

Moreover, the tools that make a great due-diligence underwriter aren't the same as those of the aforementioned professionals.

Guidelines to consider

Adhering to the following seven steps will help ensure due-diligence providers actually can perform the services they claim.

1. Request the résumés of all due-diligence-underwriting staff: Compare the staff's underwriting experience and employers with lists of companies associated with the origination, underwriting, approval and funding of the mortgages to be reviewed -- assuming the due-diligence provider would be hired to review problem loans. Chances are if a front-end underwriter missed something when the mortgage was approved, it will happen again. The eyes performing the due-diligence underwriting must be completely independent.

2. Ask about and verify the firm's information- and data-security systems: Because of the immense cost involved in ensuring data safety, many wannabe due-diligence companies skimp on information technology and security. Deadbolt locks, burglar alarms and security guards aren't enough. Companies should keep file-access logs that show when staff members accessed clients' information and for how long. Servers that handle client data storage and access should have multiple firewalls. Company computers should have unique logins and passwords linked to individual users to enable monitoring data access. These login-and-password combinations should be on 90-day renewal cycles so any misappropriated login or password eventually expires.

Most important, company employees who access client data outside of the main office should do so through a secure Web site that requires a second unique login-and-password combination. Remote access also should be limited to normal business hours.

3. Submit a test set of mortgages for review: Make sure the test set has certain recognizable errors and see if the company catches them. If the results show anything less than a 97-percent-accuracy level, take your business elsewhere.

4. Make the provider take a competency exam: Many large secondary-market mortgage investors have developed exams that prospective due-diligence-underwriting providers must pass. These exams should cover credit and compliance issues, as well as mortgage-fraud investigation and general logic problems. Avoid any firm not willing to take such an exam.

5. Ask to see the firm's training and quality-control procedures: The absence of either should cause you to run the other way.

6. Never deal with due-diligence-underwriting firms that don't perform annual state, national and federal criminal-background checks on their staff members: While a crime on someone's record does not always mean the person has ulterior motives, it can cast a pall of suspicion. Obtain copies of the most-recent criminal-background checks before paying for any services.

7. Ask to watch the due-diligence underwriters in action: Ideally, you can watch as they evaluate your batch of test loans. See how they review the files and how they cover all areas of interest. If you see something that makes you nervous, ask about it. If you get anything other than a sincere, no-nonsense answer, look for another provider.

•  •  •

Properly executed due-diligence underwriting serves a growing purpose. The problems mortgage-industry participants face likely would be less-exaggerated had such underwriting taken place at the outset.

Rather than look to the past, however, brokers should look forward. As they do, due-diligence underwriting emerges as a logical answer to many questions. Improper due-diligence underwriting, however, could cause more problems than it solves.


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