The parting words of advice from one mortgage company executive, when asked about risk management, are to handle what he sees as the industry's expanded definition of this term by prioritizing loan quality and negotiating the cost of doing business whenever possible.
“Risk management used to mean hedging a pipeline. Unfortunately I think it now means every element of running a mortgage company,” said Scott Stern, CEO of cooperative Lenders One, who indicated that he plans to leave the group in mid-March to look for opportunities with more entrepreneurial ventures that will most likely lie outside the industry.
In the mortgage industry today, risk management is an “operational” concern that tends to be managed through quality control partners, compliance attorneys and risk advisory services as well as pipeline hedging advisors, he said. Companies today, said Stern, will “rue the day they are not managing risk in any of those areas,” largely because of the repurchase and regulatory risks they are more likely to be exposed to if they don't.
Repurchases, Stern said, have been a particular concern in the industry. Lenders today also need to make sure they are in line with many high-profile regulations from Dodd-Frank and the new Consumer Financial Protection Bureau to equal opportunity measures and salary/overtime requirements. “Every step of the mortgage industry now has some element of risk,” said Stern.
Fraud is another element of risk management that most companies today are using tools to verify borrower information like taxes/income and Social Security numbers in order to address, he noted. Stern added that out of what he sees are the two main types of fraud, borrower fraud and employee fraud, the latter is “more dangerous because that can be systemic and it can be catastrophic, and that's something you really can't push through a computer program.” He suggests a combination of internal management, quality control and underwriting checks as ways to manage this risk. Also he noted that industry education efforts and licensing requirements can help mitigate this.
As far as loan quality, in the current market, Stern said, “the safest bet” is to stick to conventional, FHA and VA loans. Also, in addition to those guidelines he recommends overlaying automated underwriting systems with the aforementioned anti-fraud software programs and verifications. These should include multiple credit reports during the origination process, including credit verification at closing, he said. While risk management steps like legal representation can be costly, “it's a lot less expensive than a lawsuit and going out of business.”
As far as the traditional aspect of risk management, pipeline hedging, Stern's advice is only to use mandatory delivery in situations where executives have a strong grasp of their pipeline fallout.
Lenders One has had plenty of member companies successful using the strategy for everything from single-loan to bulk sales as part of an overall secondary market strategy, but mandatory delivery is “not for everyone,” he said, noting that it should not be used in an effort to “chase margin.” An executive who miscalculates fallout from an interest rate swing can lose “a lot more money than you'll ever make by selling mandatory,” Stern said.
When asked how to manage the combined cost of all these various types of risk mitigation and how to prioritize them, Stern agreed that “managing the balance sheet is another part of risk management” and said that executives should use as their guide for what to prioritize the extent to which any risk can affect loan quality broadly.
“Now it not the time to cut corners” on anything that can affect loan quality, Stern said. He also noted that while some aspects of the business like interest rates cannot be controlled, executives can take steps to control expenses. This is “a good time to look at all costs in the manufacturing of loans,” negotiating terms with product providers and drawing on economies of scale whenever possible for things like document preparation, appraisal and/or title services.
“If you do all these things that I mentioned, you will likely run the safest mortgage company in the United States,” he said, summarizing his recommendations as a combination of “old-fashioned” due diligence “sprinkled” with some technology overlays and “originating high-quality loans in the first place.”
Stern said that in his opinion it appears that many mortgage companies have been doing things right in the past two years, underwriting conservatively and producing loans with high credit scores and low loan-to-value ratios.
