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JUN 19, 2012

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Servicing Lens

The Future of Underwriting Standards

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Traditionally, underwriting focused on applying a static set of guidelines to determine an approve/reject decision. Most of the rules were developed when underwriting was almost exclusively a manual process. Although the industry has embraced the technological improvements offered through standardized credit scoring and Automated Underwriting Systems, recent experience has shown that approach is inadequate to predict delinquency or default.

A significant part of the weakness in the traditional underwriting process is an inability to fully track “layered risk.”

Volumes of the data are collected, but not always analyzed or applied fully. One way to address this issue would be to convert the process to a weighted score on a per-loan basis.

For example, debt-to-income ratios for approval purposes are calculated using gross debt-to-gross income.

Take the case of two borrowers at or near maximum DTI for the program. A borrower whose gross income is a base salary of $10,000 would be treated the same way as a borrower relying on $2,000 base salary, which is to say $5,000 in commission, $2,000 on a second job and $1,000 net rental income.

Yet in the above example the second borrower is arguably subject to greater risk due to economic forces beyond his control.

Understanding what portions of the income are subject to economic factors would allow for more detailed tracking of loan performance based on these factors.

Over time, the performance data gathered would allow refinements to existing guidelines based on actual results. 

Likewise, the current system fails to take advantage of existing improvements in technology in favor of outdated manual verification processes. Taking advantage of available direct data connections to employers, banks and creditors would reduce chances of fraud, thereby reducing losses.

Authority to grant exceptions to standard guidelines was normally based on job title or position. Subsequent tracking of the performance of loans with exceptions to guidelines varied from company to company and was rarely accessible to outside investors.

Given the above, the conclusion is that analysis of the actual subsequent performance of loans approved based on exceptions will help to further refine future underwriting standards.

 

Chad Burance is head of NewOak Solutions.

 

Comments (2)
Layered Risk assessment is yet another bill of goods that will be sold to the buffoons that design or run underwriting systems, much like the credit scoring system as an accurate predictor of default risk. The industry concept that underwriting risk assessment is really based on even halfway accurate historical data trends is laughable at best. The complexities of the secondary and tertiary mortgage market systems as they have evolved will give rise to a futile attempt to use layered risk assessment to refine underwriting, but what will instead emerge is unnecessarily strict approval criteria that will further handcuff the real estate market. Your example that infers a single source salary income is judged less risky than a multiple source income earner has no basis in fact. That salaried guy is 1 pink slip away from 0 income and in THIS economy, no assurance of another job at that income, while the other borrower isn't likely to lose all sources of income simultaneously. Layer-risk THAT!
Posted by Rob | Monday, June 25 2012 at 3:51PM ET
I agree with Rob. The industry is trying to come up with more fool proof methods of underwriting. The reason for the problems of the meltdown have more to do with fraud and not verifying income. People were given loans without any verification of their ability to qualify. The foreclosures led to the current downturn which is leading us to higher unemployment of good borrowers who had solid income that have had their hours reduced or lost their job. It was the ignorance of th industry (banks that is) that brought us to today's problems. Just like the QRM rule that is about to kick in and treats 80% loans more favorably. They are no less likely to go bad than a 90% loan when it comes to a loss of equity in the house.

Some areas of the country have lost 50% of their values at the high. Do you think that a person with an 80% loan, who experiences a 50% drop in value will be a better candidate to stay in that house than a person with a 90% loan.

If you believe that they will, then I have a bridge in Brooklyn for sale.

It all sounds good but, you must not make loans to people who cannot afford them.

Posted by John | Monday, June 25 2012 at 5:13PM ET
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