REQUIRED READING: Back in 1933, Franklin D. Roosevelt took over the presidency by declaring to the nation, ‘The only thing we have to fear is fear itself.’ But if you fast-forward to today and take a good look at the due diligence process utilized by originators, it is easy to believe that the only thing mortgage bankers have is fear.
‘Mortgage bankers fear the wrath of God, and they know it could put them out of business,’ says Bob Rubin, principal of The Business Loan Connection LLC, based in Southfield, Mich. ‘They want to manufacture perfect products that won't bite them in the rear end.’
In many ways, part of the fear that shapes today's due diligence is based on having mortgage bankers operating in a reactive, rather than a proactive, environment. A great deal of apprehension and agitation that drives today's due diligence comes from the federal government, which gives the impression that it is constantly changing the playing field.
‘Uncertainty from the Consumer Financial Protection Bureau (CFPB) is a prime example,’ says David Green, president of The StoneHill Group, based in Atlanta. ‘There are a lot of areas where the CFPB is kind of writing the rules as it goes along.’
Sue Allon, founder and CEO of Denver-based Allonhill, observes that the Federal Housing Finance Agency is adding an increased level of pressure to the process, especially in view of its recent announcement that the government-sponsored enterprises (GSEs) are launching a new representation and warranty framework for conventional loans sold or delivered on or after Jan. 1.
‘This is important to the industry and a positive thing,’ says Allon. ‘The GSEs are saying, 'Listen, originators, we've taken whatever you submit to us and we've been the filter. Now, you guys filter it out and don't submit loans to us that don't meet guidelines.' It is a transfer of legitimacy for GSEs to the originators, which is fundamental to the recovery of the mortgage industry.’
However, Allon warns that while the changes will require extra work, lenders should not be afraid of these changes.
‘Originators will have to ask: 'Are we doing it right?'’ she continues. ‘Originators want to make sure they don't receive penalties for not doing the process right. But it's not that originators don't have the capability to do it – it is just that no one asked them to do it.’
Frank Pallotta, managing partner at Loan Value Group, based in Rumson, N.J., believes that the industry is up to the challenge.
‘Mortgage bankers will go the extra mile,’ he predicts. ‘If Fannie, Freddie and Ginnie draw a line, mortgage bankers will draw a line even farther back. They want to stay so far back from that line as possible.’
But at the same time, the proverbial line being drawn often seems to disappear and abruptly reappear elsewhere.
‘Rules are still fungible and being decided upon,’ says Nick Volpe, vice president of capital markets and servicing at Agoura Hills, Calif.-based Interthinx. ‘And even after they're decided upon, they are delayed. There are still a lot of hurdles to face.’
Indeed, one hurdle that continually emerges is trying to tailor due diligence to meet a myriad of different requirements demanded by a variety of investors.
‘There is a lack of uniformity as to what different investors will accept,’ says John Walsh, president of Milford, Conn.-based Total Mortgage Services. ‘We have to run different software for different investors. Uniformity would be a big pick-up for us – if I had a wish, it would be great if everyone used XYZ Software. But everyone has different reasons and agendas for what they want to have.’
Another hurdle involves a CFPB bulletin released in April that informed financial institutions they would be held responsible for the actions of the third-party vendors they employ for products and services. Les R. Kramsky, executive vice president and general counsel for The Silk Companies, based in Plymouth Meeting, Pa., observes that the CFPB bulletin puts a new layer of due diligence concern on mortgage bankers that outsource part of their operations.
‘With all the fraud that went on a few years ago between title companies and attorneys, lenders have to be very, very careful on who is getting the loan closing,’ he says. ‘A lot of lenders are hiring companies to do an investment banking check on closing agents.’
And yet another hurdle is the aforementioned GSE framework, in which representation and warranty relief will be provided for loans with 36-months of consecutive, on-time payments. Furthermore, Home Affordable Refinance Program loans will be eligible for representation and warranty relief after an acceptable payment history of only 12 months, following the acquisition date. According to The StoneHill Group's Green, this new scenario will only add to greater apprehension in due diligence.
‘Fear of buybacks has been rampant since 2007,’ he says. ‘But now, Fannie and Freddie have put a lot more intense focus on quality control in the first 36 months that the loan is on the books.’
Thomas J. Pinkowish, president of Community Lending Associates in Essex, Conn., notes that this framework is quite different from the GSEs' previous due diligence expectations.
‘Fannie and Freddie used to say, 'We'll look at 10 percent of normal origination,'’ he recalls. ‘But that created the opportunity for nine other loans to be wrong.’
Volpe warns that due diligence may have swung from one extreme to another.
‘Sample sizes are still too high,’ he says. ‘In some cases, mortgage bankers are still reviewing 100 percent of their loans. That is not viable in the long term.’
However, the fear of making mistakes has significant repercussions nowadays – especially with the rise of forensic due diligence, where errors can lead to civil or even criminal litigation.
‘The government wants to see that all layers of compliance are adhered to,’ says Cindi Dixon, CEO of Sunrise, Fla.-based Mela Capital Group. ‘And there are a number of issues that arise out of each individual audit. Foreclosure attorneys, for example, may want to look at loans from the fraud side, including violations of RICO and money laundering laws.’
Dixon acknowledges that forensic due diligence practices could easily be dubbed ‘CSI: Mortgage Banking’ due to the intensity of the investigative process. ‘A lot of procedures are the same,’ she says, referring to police department sweeps of crime scenes. ‘It sometimes comes down to handwriting analysis and signature discrepancies.’
Pallotta adds that this practice is already in place as a new normal.
‘All constituents – banks, GSEs, mortgage insurers – use forensic due diligence to find breaches,’ he says.
But, then again, originators have no choice but to push forward.
‘The worst-case scenario is buybacks of property on a massive scale,’ warns Phil Huff, CEO of Platinum Data, based in Aliso Viejo, Calif. ‘We're not just talking about buying back a single property.’
It all works out
However, the fear surrounding due diligence is not completely suffocating. Many originators have used this new environment to bring quality levels to unprecedented heights.
‘Today's individual loans are some of the cleanest paper ever,’ says Jeff Statz, loan officer at Inlanta Mortgage Inc., based in in Madison, Wis.
‘Redwood Trust was oversubscribed,’ says Volpe. ‘They had more demand for bonds than they had bonds to sell. This is Economics 101 – when demand outstrips supply, that is telling us something.’
Yet there is a cost for this new due diligence environment, and mortgage bankers and their borrowers are footing the bill.
‘The more due diligence that is done on a loan file, the higher the cost of that loan,’ says Andrew Peters, CEO of McLean, Va.-based First Guaranty Mortgage Corp. ‘Depending on your business model, it can be cumbersome. The highest quality loan is the most important thing today.’
Peters adds that anyone hoping to perform due diligence on the cheap will be out of luck.
‘If you want to do it correctly, it will require substantial capital investment,’ he says.
Yet Total Mortgage Services' Walsh sees that expenditure as both an investment and a long-term savings.
‘Every day, we're getting better and better at picking things up,’ he says. ‘It creates more work for us, but at the end of the day, it solves more problems than it creates.’