REQUIRED READING: If lenders have some ‘skin in the game,’ they're going to originate loans that are safe for the consumer and sound for the investor. That's the thought process behind recent proposals from the U.S. Department of the Treasury and U.S. House of Representatives to require retention of 5% of the credit risk tied to loans that are sold in the secondary market.
The 5% requirement, put forth in the Treasury's plan for financial regulatory reform and in a recent House bill, is a controversial idea to many mortgage industry players, who, not surprisingly, they have varying opinions about it.
Lenders and the trade groups that represent them generally argue that 5% of credit risk, if any amount, is too much to ask. In many cases, they feel the originators and issuers that drove the current mortgage and housing crisis with shoddy lending practices have long gone out of business as a result of those practices. That means that those left standing should not be penalized for the bad actions of a few.
Consumer advocacy groups and many legislators, on the other hand, feel lenders should retain even more than 5% of credit risk. This, they argue, will help to ensure that history doesn't repeat itself. Having ‘skin in the game’ will ensure that lenders make each loan with the borrower and investor in mind, as well.
It's still too early to tell if any measures designed to hold mortgage originators accountable for some credit risk will pass in the next congressional session. What is clear, however, is the fact that the president, Congress, the Treasury and financial regulators are paying closer attention to the quality of loans being issued to borrowers and sold on the secondary market. They will all be watching lenders closely going forward to ensure all loans underwritten benefit not only the underwriter, but also the investor who purchases them and the consumers who pay them back.
Financial regulators will play a large role in making sure this happens through more stringent exams that make certain lenders comply with all regulatory requirements. They are currently focusing particularly on those laws and requirements designed to promote fair and non-discriminatory lending and that protect all parties involved from mortgage fraud.
The broad array of federal, state and municipal laws focused on protecting consumers from predatory lending practices are complex, confusing and continually evolving. Noncompliance with any of them is simply not an option, especially given the current regulatory environment. So, what is the key to ensuring consistent and thorough compliance in the most efficient manner? The answer lies in making compliance an automated part of your lending workflow, instead of making it a separate process.
Protecting borrowers
The first step is to create a comprehensive compliance risk management program that is electronically woven into all of your business processes. This allows your organization to take an automated, enterprise-wide approach to managing regulatory requirements, which is important from both a compliance and cost-containment standpoint.
By establishing automated safeguards throughout the lending process that actively flag potential loans with predatory and/or discriminatory pricing, it is possible to intervene immediately. Lenders can then adjust pricing to prevent an overpriced loan from ever being funded. They will, therefore, comply with all applicable laws and avoid underwriting a loan that might contribute to deteriorating the quality of their overall portfolio and hamper their ability to sell loans to the secondary market.
Putting these safeguards in place can be done manually, of course, but it's important to keep in mind that any compliance program or process should not hamper lenders' ability to keep making as many loans as they can, especially in this soft real estate market. While manual processes can be effective, they are also notoriously slow and labor-intensive, creating the potential for management and sales to offer resistance to implementing them.
By automating your fair and anti-predatory lending compliance processes, you can meet your regulatory obligations more effectively and efficiently. There are compliance technology solutions available that allow lenders to review each loan, starting at application and continuing on through to funding, to determine if the loan meets all fair and anti-predatory lending requirements.
A technology solution that gives the lender the capability to review loans for compliance throughout their life cycle is much more beneficial than one that only lets the lender perform a post-closing sampling. This capability means lenders can check for compliance more quickly and in real time, decreasing the likelihood of having to reprocess a loan.
There are also systems available that will let lenders check each loan for compliance with secondary market regulatory requirements. This is extremely important, because many jurisdictions can hold investors liable for violations of the law by a loan's originator.
A system that lets lenders check each loan to see if it meets applicable secondary market anti-predatory lending requirements in a similar fashion is also essential. All it takes is one or two noncompliant loans to destroy an originator's reputation in the secondary market.
In addition, many systems will allow you to create reports of compliance and noncompliance with fair and anti-predatory lending requirements for each individual loan and for the entire portfolio. These reports will allow lenders to identify problem areas quickly and correct them before they violate any regulatory requirements. They will also be useful in proving to investors, regulators and Wall Street rating agencies that the lender is proactive in its compliance efforts.
Crisis avoidance
Besides examining loans for fair and anti-predatory lending compliance, investors and regulators are much more likely to review them closely for accurate and compliant documentation than they have in past years. No-doc loans and those that contained falsified loan documents were substantial contributing factors to the current financial crisis. It will be important to have a process in place to ensure all loans are fully documented in accordance with regulatory requirements so that investors will feel confident in purchasing them.
Additionally, through automation, lenders can electronically prepare and deliver the compliant documents to the borrower for e-signature. They can also e-record the loan in any U.S. jurisdiction, saving additional paperwork.
Given the weak U.S. economy, the stakes for meeting regulatory requirements and satisfying investor guidelines have never been higher for U.S. mortgage lenders. Today's lenders need to understand the drastic implications of noncompliance with fair and anti-predatory lending laws and regulations, as well as loan documentation requirements, can have on their and business, as well as on their investors' business. Missing the mark means loss of revenue, current and future customers, secondary market presence and, ultimately, reputation.
Edward Kramer is executive vice president of regulatory programs at Wolters Kluwer Financial Services, based in Minneapolis. He can be reached at (800) 397-2341.
