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What’s the number one way mortgage lenders are managing risk in the new regulatory environment? As we learned in part one of this two-part series, lenders have adopted an assembly line approach that brings greater accuracy, consistency and transparency to the loan manufacturing process. By leveraging technology to automate the mortgage process, lenders are better able to comply with ever-increasing layers of regulations while improving loan quality at the same time.

Using an assembly line approach gives lenders the unprecedented opportunity to continuously monitor each loan as it moves through the process, eliminating defects before they get further down the line. Using this approach, lenders have been able to significantly reduce the threat of regulatory enforcement action and/or loan buybacks.

When lenders today describe the loan manufacturing process, they often tend to break it down into three main components: people, processes and technology. But as we learned in part one, it is processes and technology that have really made the difference. Regulations today, such as the Consumer Financial Protection Bureau’s (CFPB) new integrated disclosure rules, are requiring lenders to automate their processes and improve data accuracy - and the only way to achieve that is to embrace technology.

Although loan quality has improved vastly in recent years, as evidenced by the performance of recent vintages, some loan defects continue to show up in post-closing audits. Although many of these defects are immaterial - meaning they would not have prevented the loan from funding - their presence is nonetheless disconcerting for lenders, as they pose a potential legal and regulatory enforcement threat. Many of these defects stem from improper data hand offs between systems; however, they can also be caused by human error or from glitches in the documents themselves.

As covered in part one, lenders have made great strides in terms of improving data accuracy on the front end of the mortgage process. Most have deployed sophisticated Web portals that walk borrowers through the process of applying for a mortgage, which, in turn, ensures that borrower information is more accurate and complete. In addition, most lenders are using data-scrubbing tools that can automatically verify if the information provided by a borrower (such as income) is accurate - almost immediately upon ingestion. This push to collect more accurate data up front has done much to reduce the number of defects showing up in post-closing audits.

Today’s document technologies are central to collecting borrower data consistently and accurately. Via today’s Web portals, borrowers can easily download, complete, sign and upload their mortgage application and other critical documents. Although many lenders continue to use traditional “paper-based” document files (such as PDFs), borrowers can nevertheless download, print, complete, sign and scan those documents and upload them into the portal with relative ease. From there, OCR technology can be used to scan the documents and “map” the data to the corresponding data fields in the lender’s loan origination system (LOS).

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Document technology’s prominent role

Documents, including borrower disclosures, contain the genetic material of a loan and evidence of lenders’ adherence to borrower-protective regulations. As such, documentation quality and timeliness is paramount to manufacturing zero-defect loans.  

Where document and e-signature technologies are really pulling their weight is in the loan application process. With the advent of new technology standards, including MISMO 3.3, e-documents and their underlying systems are set to revolutionize the application process, not only by making it many times easier for consumers to complete, sign and upload documents, but also by improving operational efficiency through automation. Not only will this help lenders speed the mortgage process and “wow” borrowers, but it will also enable them to reduce their operating costs and deliver complete transparency into the mortgage process to investors and regulators - end to end, at the loan level.

“The upfront process has improved tremendously - the data collected up front is much more complete and can be readily verified - and no doubt, e-document technology is playing a critical role there,” explains Mark Mackey, new CEO of e-doc technology firm IDS (when he was still serving as executive vice president). “Lenders are much better about collecting the data they need up front - so you are seeing more complete data sets. ”

As Mackey explains, the new MISMO 3.3 document standard will help “eliminate the need for custom data paths” between systems, “because the data will be much more standardized.” This, he says, will reduce the number of defects resulting from improper data hand offs between systems.

Not only will MISMO 3.3 greatly improve data accuracy, it will also make the entire mortgage process that much more trackable and transparent. As Mackey explains, having a uniform data set that accompanies the documents means that “when a lender furnishes e-docs to Fannie Mae and Freddie Mac, they’ll also be giving them the data set that goes with those documents. My guess is that the [government-sponsored enterprises (GSEs)] won’t even bother reading those documents anymore - they’re just going to plug the data directly into their system.”

What’s more, MISMO 3.3 means that same data set is passed on to investors after the loan is sold onto the secondary market. As such, investors will have insight into the entire lifecycle of every loan in a portfolio. Mackey says that in his view, getting the industry to adopt the new MISMO 3.3 documents on a widespread basis is one of the last hurdles to achieving defect-free loans.

“I would say the standardization of the files is the final barrier to creating a more defect-free mortgage process,” he says. “Things like lost docs and improper mapping of data fields will become much less likely once the new standard comes out. That’s because the required data must be in the required docs.”

One juncture where errors can still find their way into the loan assembly process, however, is when a lender inadvertently makes an unintended change to a critical e-doc - or worse, uses the wrong version of a critical e-doc. One of the advantages of today’s e-docs is that they can be readily changed (i.e., customized) in response to changes in the regulations or in a lender’s internal processes. As a result of this new ease-of-editing, it is expected that the traditional mortgage docs so many lenders have grown accustomed to will see more changes over time. This means it will be critical for lenders, moving forward, to be certain that they are using the proper versions of their e-documents.

“Lenders need assurance that the documents themselves are accurate - and that’s where lenders rely on their third-party vendors,” Mackey says. “Most lenders have a compliance department, but it’s broad in its knowledge base. It is the document companies that really understand the documents - and cover the lenders on that front.”

Document technology is also playing a critical role in document delivery. With the CFPB’s new integrated disclosure rules - and the tricky timing requirements for the delivery of the new loan estimate and pre-closing disclosures - lenders basically have no choice but to automate the process if they are to achieve compliance on a consistent basis.

“As far as document delivery goes, in general, it is going to have to be automated,” Mackey says. “This way, lenders can look at the dates in the docs and automatically email the required disclosure to the borrower. Then, at that point, the borrower consents to receiving the documents electronically - which is an important part of the process because once they consent, you can pretty much send them all the other docs electronically. If the borrower does not consent, then the lender must send the docs via flat mail within the required timelines - typically three days.”

 

Automation and analytics now a necessity

As explained by Avi Naider, CEO of ACES Risk Management Corp., “in the environment we’re in right now, it is not possible to [comply with the CFPB’s integrated disclosure rules] using manual processes - or an ad hoc approach.” He says not only are lenders going to have to embrace automation and improve data accuracy, they’re also going to have to collect more data and run analytics if they are to improve forecasting and get a better handle on the big picture.

“This is the year where big data meets quality control (QC),” Naider says. “In just about any industry, they’re realizing that through big data, you can drive dramatic business improvements. There are a lot of cyclical businesses in our economy - but what they’re all realizing is that if you leverage big data, you’re not as tied to those economic cycles. You’re going to go up and down, but you’re going to be able to ride the tide.”

Naider points out that it’s not only the quality of the data provided by the borrower that has become so critical, but that it’s also the “quality of the process” - in other words, how well that data is leveraged as the loan moves through the assembly line.

“If you want to improve your processes, you start by collecting as much data as you possibly can about your loans, from within your quality control systems,” Naider explains. “It’s about having quality control systems that can take in potentially hundreds and hundreds of discrete pieces of data about your loans and then being able to track that process data. For example, one of the key measures that lenders look at from a QC standpoint is the loan defect rate - and if you’re not getting inside that, you could be missing opportunities.”

As Naider explains, there has been a recent push in the industry to take a closer look at lenders’ gross versus net defect rates, “because you want to understand not just if a file is defective when it rolls off the line, but you want to know where the error occurred in the process, whether it was application or pre-funding. Then, find and locate the document. But if you can’t do that along the whole chain, you’re missing opportunities for improvement, and you’ll find yourself doing the same things over and over again.”

Naider says looking at the loan defect rate alone, however, is a mistake, as there are many other data points lenders should be capturing and comparing.

“Tracking just your defect rate doesn’t really tell you anything,” he says. “If you’re bringing in a lot of data from your LOS and a lot of data from your loan officers and all your business channels - and you’re tracking whether it is a purchase or refi, the property types, the loan-to-value ratios and credit scores - well, the more data you bring into the system, the more you can drive quality through your analytics.”

“There are potentially hundreds of different places along the loan assembly line where defects can occur,” Naider adds. “The key is to use analytics to root out the problems. Where are they coming from? Why is this particular loan type showing a higher defect rate for this particular category of defect? That’s what you want to understand. ”

As more and more of the mortgage process becomes automated, an interesting question arises: Are we working our way toward a day when human judgment will no longer be part of the process? Are underwriters - one of the last major human components in the process - threatened by automation increasingly encroaching on their jobs?

“If anything, from my perspective, it is the opposite,” Naider says. “The human underwriter has become even more important to the process.”

“When [Freddie Mac and Fannie Mae] rolled out Loan Prospector and Desktop Underwriter in the late 1990s and early 2000s, there was great concern on the part of underwriters that these automated underwriter systems would replace their role,” Naider says. “But [the GSEs] used those systems to their fullest, so that they could put underwriters - full-time, direct-endorsement, VA-automatic underwriters - in the role and exploit their expertise. By that I mean they used the underwriters for the hardest and most challenging of loans that wouldn’t fly through those systems.”

Because of the complexity of today’s underwriting standards, human underwriters are more needed today than they ever have been in the past, Naider says.

“Today, the [Federal Housing Administration} direct-endorsement underwriter is very valuable - and, to be honest, I think they feel empowered by, not set aside by, the technology,” he explains. “They’ve had many years to see how technology can improve the process - plus, there are incredibly valuable enhancements: In terms of credit reporting, beyond a consumer credit score, you can really dig into dis-aggregated credit variables to look at potential borrower behavior. All those enhancements make the role of the traditional underwriter that much more important.”

As we learned in part one, human intervention in the loan assembly process is often - unfortunately - the cause of loan defects. In a process that has now become mostly automated, humans have become the “wild card” in the overall equation. When considering risk, this “human variable” cannot be overlooked: Lenders must closely monitor and track the impact personnel have on the loan manufacturing process.

Risk Management

Risk Management In The New Regulatory Environment: Part 2

By Patrick Barnard

Lenders have adopted an assembly line approach that brings greater accuracy, consistency and transparency to the loan manufacturing process.

 

 

 

 

 

 

 

 

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