Have Underwriting Standards Become Too Tight?

[i]REQUIRED READING:[/i][/u] John Walsh does not need to be convinced that underwriting standards are tight [/b]- he discovered that the hard way when a home loan that he originated on a condominium unit was rejected for a reason that left him baffled and astonished. ‘We had a loan questioned by a large lender for a condo,’ recalls Walsh, president of Total Mortgage Services LLC, based in Milford, Conn. ‘It turns out that another unit in this 36-unit development was listed on Craig's List for a week as a rental. The lender considered the development to be condo hotel based on that one-week Craig's List ad and kicked out the loan – and there was nothing wrong with the other 35 units.’ For Walsh, the rejection of the loan offered prima facie evidence that underwriting standards are too tight for comfort. ‘That is the level they went down to – checking on Craig's List,’ he adds. ‘That is an example of going a little bit too far. That's not due diligence – that's brutal diligence!’ Within the industry, the current parameters on underwriting standards have become a topic of divisive debate. On one side, many originators and secondary marketing officers share Walsh's view that standards have constricted to a point that they are beginning to suffocate the market. But there is also a faction that believes underwriting standards are not creating any great damage. Indeed, this side of the debate believes that current underwriting standards offer something of a life preserver to an industry that is still treading water. [b][i]Origins of ouch[/i][/b] If there is any common ground in the debate, it comes in the agreement that today's underwriting standards represent the residue of the housing bubble's unceremonious deflation was unceremoniously deflated. ‘The whole industry is doing a bit of an over-correction,’ says Steve Jacobson, CEO of Fairway Independent Mortgage Corp. in Sun Prairie, Wis. ‘There were so many loan losses that we now have top-down thinking: We can't take any more losses. Thus, underwriting guidelines are stricter and more conservative across the board.’ David Oser, executive vice president, chief investment officer and treasurer for Chicago-based ShoreBank, agrees with that assessment. ‘Current underwriting standards are too tight, marking an overreaction to the too-loose standards in the past,’ he observes. ‘The pendulum has swung very far to the right. To every action, there is an equal but opposite reaction.’ Terrence Floyd, vice president and affordable-lending manager at People's United Bank in Bridgeport, Conn., says other sectors of the market contributed to the problem. ‘Standards are the product of the industry,’ he says. ‘Banks were able and willing to make loans, but mortgage insurance companies and investors took a big hit and tightened up standards. We know why this is, and there is a good reason for it.’ Furthermore, all sides agree that singling out underwriters as the villains behind the crisis is unfair. ‘The recent crisis showed that one culprit could have been the easy monetary policy of the last 50 years,’ explains Dr. Gregory Price, chairman of the Department of Economics at Morehouse College in Atlanta. ‘There was also the inability of the authorities to control the flow of credit.’ Dr. Anthony Sanders, professor of finance at George Mason University in Fairfax, Va., shares the view that the post-bubble underwriters have been left holding the proverbial bag. ‘The fatal mistake in the bubble and burst were the low-down-payment and exotic adjustable-rate mortgage products, including Alt-A mortgages, and not subprime, per se,’ he says. ‘The other fatal mistake was the overreliance on credit scores as a substitute for thorough underwriting.’ [b][i]Sign of the times[/i][/b] Fast forward to today, and many originators feel that underwriting guidelines have been reconfigured with too much fear of the potential for risk. ‘Mortgage underwriting guidelines have indeed tightened,’ says Dick Wertzberger, senior vice president of mortgage banking at Landmark National Bank, based in Manhattan, Kan. ‘I am always amused at the word 'guidelines.' By definition, guidelines are to direct the underwriter and all those involved in the origination process on how to process and underwrite a home loan. Given today's climate, we might as well call them underwriting commandments!’ But will tighter underwriting standards prove to be beneficial for the industry and, by extension, the recession-afflicted economy? Price believes that attempts to correct the market by placing greater pressures and controls on underwriters can have a negative effect on the recovery effort. ‘My fear is throwing the baby out with the bathwater,’ he continues. ‘This could hamper growth in our economy. You don't want to encourage too much risk-taking, but it is unfair to attack the underwriters market. Underwriting may have been a symptom of the problems, but it was not the cause.’ Walsh argues that current underwriting standards are not encouraging the recovery of the housing market. ‘The pool of available people who qualify is shrinking with each day,’ he says, ruefully. ‘This puts further pressure on the value of homes. And that, in turn, only further and further decreases the pool of potential buyers.’ Sanders considers the federal conservatorship of the government-sponsored enterprises (GSEs) a root cause for making this situation more difficult for many lenders. ‘The problem with over 90 percent of the mortgages being originated for sale to the GSEs is that government is de facto setting credit standards for lenders,’ he says. ‘And they have set the standards extremely high for borrowers other than first-time home buyers. Instead of having thorough underwriting and accepting moderate-risk borrowers at a correct price or risk premium, the government is now rationing credit to borrowers.’ As a result, he continues, today's market is the mortgage banking industry equivalent of artificial engineering. ‘Instead of social medicine with a single payer system, we now have a socialized single-family mortgage market with credit rationing,’ he says. ‘This will hurt a large number of households bitten by the recession and collapse in housing prices, particularly in the sand states.’ Oser believes that this leaves mortgage bankers in a bind from which there is no easy way out. ‘Lenders have very little choice, because the private mortgage securitization machine remains broken,’ he says. ‘Fannie Mae has effectively reinvented redlining by declaring whole cities 'distressed areas' and imposing extremely high credit score requirements and low loan-to-value (LTV) standards. Regulators are forcing write-downs to worst-case appraisals.’ [b][i]Sharing the pain[/i][/b] For Westberger, the current situation is creating a one-size-fits-all environment that, quite frankly, doesn't fit all. ‘Rare is the underwriter who is willing to allow for compensating factors,’ he says. ‘The hard reality facing those who originate and sell is that investors are quick on the recourse trigger button, forcing the underwriter to treat guidelines as such. And it isn't enough to know the agency guidelines – you must be familiar with the overlays that private mortgage insurance companies and investors have added, as well. And lest we forget, appraisals trump credit every time.’ At the moment, Westberger doesn't see the situation changing. ‘What are the agencies and investors supposed to do?’ he asks. ‘In this current economic climate, home values have not stabilized. In fact, recent reports say 25 percent of all homeowners owe more than the value of their home, and delinquencies continue to rise. And we can't forget that mortgage fraud is at an all-time high. Our industry is based on standardization, yet at the same time, it is required to minimize the risk.’ Scott B. Woll, principal with SBW Advisors LLC in Mount Laurel, N.J., worries that potential borrowers are being forced to bear the financial brunt of this situation. ‘Some underwriters are putting on layers of double approval, where they look at the same loan twice,’ he says. ‘That will now create double cost-efficiencies borne by borrowers, in some cases.’ Tom Millon, CEO of Capital Markets Cooperative, based in Ponte Vedra Beach, Fla., says the troubled jumbo mortgage market is being weighed down by today's underwriting standards. ‘The non-agency jumbo market is very aggressive for perfect loans,’ he says. ‘In that space, with its very tight underwriting, business is very slow. I believe that the very tight underwriting guidelines contributed to that.’ Elizabeth Deal, senior vice president with ICBA Mortgage, a subsidiary of the Independent Community Bankers Association, believes that community banks seeking to get involved in the secondary market will be discouraged due to the nature of today's underwriting standards. ‘From the community-bank perspective, these standards make it very difficult to get people approved in the secondary market,’ she says. ‘LTV and collateral guidelines are killing deals that would normally go to the secondary market; they are now staying in-house.’ Deal believes that community banks, in particular, are being unfairly weighed down by these requirements. ‘We all understand why parameters are what they are,’ she adds. ‘But community banks were always conservative lenders, and their ability to lend to customers is being affected by the changes now in place.’ [b][i]What problems?[/i][/b] However, there are those across the industry who are not complaining about underwriting standards – including those from the community-bank sector. ‘From our perspective, underwriting standards today aren't much different than they were a few years ago,’ says Robert DeWit, president of Manhattan Bank in Manhattan, Mont. ‘The present economy is having a negative impact upon our mortgage volume, but adopting irresponsible underwriting practices to bolster volume is not an acceptable response. Instead, mortgage providers need to be better capitalized, retaining productive capacity during these slow times and using more restraint in building overhead during headier times.’ DeWit believes that even if underwriting standards can be seen as tough medicine, the ultimate effect is therapeutic. ‘Yes, that means there are times of little to no profit from mortgage lending, and there are times where potential profits are foregone,’ he adds. ‘But it is a much more socially and ethically balanced approach to mortgage lending than the cutthroat, commission-based model the industry has embraced.’ Another community banker – Jesse Torres, president of Pan American Bank in East Los Angeles, Calif. – also doesn't feel asphyxiated by the current standards. He attributes this to the $40 million bank's history of conservative underwriting. ‘We typically require 20 percent down,’ says Torres. ‘Even during the housing market heyday, we required 20 percent down on a purchase. Historically, we are not a traditional FICO lender; we're more of an old-school lender. We look at FICO, but we are not FICO-driven – each loan is reviewed case by case, and we rely on cashflow and debt coverage.’ Torres adds that this strategy never impacted his business. ‘Our folks have no problem,’ he says of his customers. ‘We have a fairly consistent pipeline, and we are able to cherry-pick some of the better deals. The rest of the industry, obviously, is a little different, but we kept it very simple and conservative.’ And what are the results of these efforts? ‘In 2009, we had zero foreclosures,’ he says. ‘In 2008, we had one.’ Within the industry, there are people who believe the state of underwriting will help to stabilize a still-shaky market. ‘It is part of a natural evolution,’ says Brian O'Reilly, managing director at The Collingswood Group in Washington, D.C. ‘I've had folks complain that credit standards are too tight. I say that we have to be in a vital market, not just in an active one. Now, the emphasis is on home lending versus homeownership. When we come out of this, we'll be a better industry for it.’ Dennis Santiago, CEO of Institutional Risk Analytics, based in Torrance, Calif., concurs by noting that today's underwriting will ensure that only the best-qualified borrowers receive mortgages that they will ultimately repay without incident. ‘The lenders don't want to take any chances on losing money on new loans or perceived to be continuing doing risky things,’ he says. ‘It adds pressure to the lender: If they make a loan that isn't perfect, will they get caught up in that?’ People's United's Floyd adds that many underwriters have forgotten that the bubble period was an aberration. ‘Things will never be what they were from 2000 to 2007,’ he says. ‘I think we will see credit requirements and credit scores loosen up again


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