Although the new QM rules are expected to bring stability to loan manufacturing, the many nuances of compliance have resulted in doubling the cost of loan origination. This assessment was offered by Tom Showalter, Chief Analytic Officer at Digital Risk, a top provider of risk, compliance, and transaction management solutions.
A major part of the increased cost is attributable to a new kind of risk involved in the process, which Showalter calls "manufacturing risk." During an interview with Louis Amaya on Mortgage Markets Today, Showalter explained that "manufacturing risk" consists of a corrupted or misrepresented key data element in the loan process.
"There are several areas that could be corrupted or stated incorrectly," Showalter said, "including the borrower's income, debt-to-income (DTI) ratio, and loan-to-value (LTV) comparison, which are all key elements in assessing credit risk."
Showalter explained that QM has one particular information element that is very crucial, and it's called the ability-to-repay, which is determined by DTI. A potential borrower with a DTI greater than 43 percent is considered to be unacceptable. To ensure that the loans they purchase are sound loans, the GSEs are now publishing a list of defects standards. "There is a target defects rate for a lender's population, and lenders have to be below that defect rate or Fannie will not buy their loans," Showalter said. "Freddie is issuing similar guidelines."
In addition, Showalter said that not only are the GSEs issuing defects standards for their sellers, they are also issuing what they call governance guidelines. "This is a new twist," he explained. "Not only are the GSEs interested in the defect rate of a population of loans, they are also interested in how well the lender is organized to manage and control a specific defect rate. This means that the GSEs are not only holding the head of the QC team accountable, they are actually going all the way up to the CEO and holding him or her accountable as well," he said.
As a result, there will be an application of penalties, fines, and other kinds of retribution should the GSEs feel that a particular lender is not following the program.
To determine whether information is accurate or not, GSEs in the past would review maybe 1 to 2 percent of the loans they received each month.
"So, you have this process where 2 percent of the loans were subject to a manual review by experts and 98 percent of the loans were not reviewed at all, and that is the current process," Showalter said.
In order to achieve a higher rate of accuracy in defect detection, he said, "That's going to eventually prompt the industry to go from its current manual methods to something much higher tech that produces more efficient results without having to crack a loan file every time a defect rate needs to be calculated," he continued.
Showalter said that lender communities, especially the larger ones, are starting to explore such technology that will detect manufacturing defects, enabling them to take a more efficient look at a broader population of loans.
Among smaller and mid-sized lenders that do not have the financial ability to purchase such technology, he said there are two trends emerging.
"One is that some are also seeking less expensive tools that will help augment their process in surveying loans electronically and therefore not expend as much labor in the process of analyzing and meeting a defect rate goal," Showalter explained. "Others are thinking about issuing non-QM qualified mortgages and selling them on the private market, therefore avoiding any dealings with the GSEs,” he continued.
However, he noted that at the present time, this segment is waiting and watching to see what may happen to the private label market.
Showalter thinks a coming trend will be that small lenders may rely on larger ones who have invested millions in the creation of infrastructure capable of managing the new and more stringent loan requirements. "I honestly think that the loan manufacturing requirements placed on the industry is far more than most lenders will be able to respond to quickly, especially the smaller or mid-sized ones," he concluded.
Showalter offers some predictions for 2014: "I think you will see bigger lenders buying up smaller ones so that they can increase their market share and spread the expenses for compliance across more loans. Another reason for acquisition and consolidation is that the mortgage loan volume is not particularly high right now, and as long as it's in the doldrums, there will be a lot of pressure to consolidate."
He also believes that although housing prices have gone up a little and interest rates are still stable, median income and the labor participation rate will continue to go down. "This means there are fewer well-employed people who are able to qualify and buy a home," he explained. "In addition, most origination now is going to be on a purchase money basis as opposed to a refinance basis, which brought in a lot of borrowers in the past several years. Now mortgage lenders are looking for purchase money candidates, and let's face it, the number of fish in that pond is just not what it used to be.”
This year's attendance at the Five Star Government Forum on March 25, 2014, is more critical than ever. Leaders of the Housing and Mortgage Servicing industry will engage government officials and regulators in meaningful discussion on housing and mortgage policy. This show was brought to you by Iserve Companies.