Due diligence refers to the duty to take the appropriate level of carefulness with a particular activity to ensure viability or legitimacy. With the implementation of the Consumer Financial Protection Bureau (CFPB) rules, lenders and servicers will likely increase outsourcing of non-revenue generating activities to trusted, capable and knowledgeable third parties because it helps to offset the rising cost of compliance. Many due diligence functions have historically been outsourced to achieve independence and tap into specific areas of expertise. Regulators are increasingly examining institutions’ vendor risk management processes to ensure lenders and servicers are practicing due diligence in the vendor selection process and proactively managing vendor risk.
Given the rising cost of due diligence and the highly variable flows in the mortgage business, one would think that many originators and servicers would merely outsource the problem and forget about it. Unfortunately, one can outsource but cannot forget about it.
Selection of a third party to perform the due diligence on a loan requires its own due diligence but the elements of this due diligence are not provided by statute. There is no “Dodd-Frank check list” for a reasonable regulated entity to clear. Instead, companies are back to basics in terms of selecting outsourcing firms to perform a due diligence function.
There are many different types of due diligence functions in the mortgage industry. Before engaging a service provider for any type of due diligence work one should consider these issues:
- Does the due diligence firm have the deep domain experience for the intended due diligence purpose(s)?
- How long has the firm been doing business? How many mortgage cycles has it experienced?
- Does the due diligence firm operate in an independent but collaborative manner with their business partners?
- Is the due diligence company up-to-date with compliance regulations and best practices?
For specific due diligence purposes like bulk loan or acquisition mortgage servicing, a company needs to consider some additional qualities:
- Does the due diligence firm have a robust technology platform that stratifies and analyzes loan level data and provides for a statistically loan sampling methodology?
- Does the firm have the capacity to provide qualified staff to perform the due diligence reviews on short notice and complete the due diligence process within the desired time constraints?
- Does the firm provide client-friendly reports that address data integrity, underwriting, servicing, and compliance exceptions and track required follow-up activities?
- Can the firm provide added value with services such as loan delivery and bid package analysis?
Ongoing back office due diligence services for flow loan purchases and/or loan sales require a somewhat different set of qualities:
Does the service provider build partnerships with their clients and work with their business partner to build and maintain an efficient and cost effective process?
- Does the firm have the ability to quickly ramp-up production to meet the client’s volume needs?
- Can the provider demonstrate high quality and quick-turn times?
- Is the supplier’s cost structure based on a per transaction basis with tiered pricing for volume?
- Does the firm offer the option to have some due diligence tasks performed offshore, but managed onshore, which reduces turn-times and lowers pricing?
These short lists are representative of the types of issues that arise in outsourcing different types of due diligence. Each firm will undoubtedly have slightly different factors to consider but the process of selection should be well thought through—your regulator would expect it.