Determining a portfolio’s exact level of risk is particularly challenging due, in part, to the sheer volume of data and information requiring thorough review.
One area of risk that often vexes servicers is evaluating lien risk, especially determining the proper reserves to hold for junior liens. This is an area that must be mastered, since regulators are putting more attention on loan loss reserves to mitigate risk.
Junior liens present several areas of potential risk in a portfolio, but the greatest is the possibility of partial or nonrepayment as senior liens are paid in first.
To counter this risk, servicers must evaluate their total portfolio to determine which liens are senior and junior. This analysis will help identify involuntary liens (such as tax liens) that could usurp the senior loan, help understand the relationship of junior liens to the total property value and gauge the borrower’s financial state to identify warning signs of default.
The more accurate the risk assessment, the more precise the resulting loss reserve calculation will be. This is vital since too small of a reserve may not cover losses and too large a reserve can unnecessarily restrict available operating capital.
Effectively Managing the Risk
In accordance with a January 2012 interagency guidance, regulatory examiners are expanding their scope to include a review of each institution’s efforts to identify the current level of risk in its entire portfolio. Regulators are looking for lenders to prove they can effectively manage risk and performance, as well as accurately calculate loss reserves.
There are several primary steps to managing junior lien risk.
• An efficient process to collect the necessary data: Has the servicers built out a process that collects all needed data, including credit files on the borrower, clear information on all liens (internal and external) and valuation data?
• A focused analysis of risk on each loan or line of credit: Servicers should use the actual values and current information instead of valuation estimates to provide insight into each loan. The challenge here is the analysis must be consistent with the organization’s business rules and policies at each review.
• An accurate assessment of risk across the portfolio: Servicers should then apply the individual results to portfolio-wide analysis, including segmentation of the full portfolio into relevant risk categories.
• A flexible analysis that is always compliant and relevant: Servicers must ensure their processes are flexible enough to allow growth over time as the market and industry evolve. This will help identify new and emerging risks in time to adequately handle them.
Once the right data sources have been identified, collecting each type of data from the corresponding sources will require added time and money. By investing in an automated solution, servicers can alleviate the burden of creating and implementing new internal processes and instead gain valuable speed, consistency and accuracy necessary to remain compliant and successfully meet internal goals.
Fully understanding lien risk does not have to be difficult and time-consuming.
The winning combination of processes, planning and automation can accurately identify risk and determine the appropriate strategies needed to maximize portfolio performance.
Randy Wussler is vice president of product management and marketing for San Diego-based DataQuick.