Digital Risk In The News

Investors Require Sound Underwriting, Fraud Management

May 9, 2008
Palaparty, Vijay

BOSTON—Sound underwriting remains at the heart of bringing investors back to the market, according to panelists speaking this week at the Mortgage Bankers Association's National Secondary Market Conference & Expo. Increased investor scrutiny forces the industry to consider underwriting practices as well as issues of fraud.

“We’ve come out of a bad hangover because products that were appropriate for only certain types of borrowers saw a larger category of borrowers,” said Stephen Ornstein, partner at Thatcher Proffitt & Wood LLP, New York. “It’s a matter of sound underwriting—matching the borrower with the right product. There is also concern about fraud. The market will begin to come back once these fundamentals are established again.”

Sadie Gurley, managing director and portfolio manager at the Marathon Asset Management, New York, said, “we need to implement good underwriting and also see the results of those improvements. It will require time to evaluate outcomes.”

“Fraud and asset price are completely intertwined and time will be required to see how loans perform,” said Jeffrey Taylor, managing director at Digital Risk LLC, Orlando. He said underwriting guidelines tend to only be viewed as checklists but should better account for exceptions.

John Prendergast, chief risk officer at the Massachusetts Division of Banks, Boston, said problems in underwriting are not a “subprime problem,” but result from fraud.

“There was a letdown of controls of every entity that touched credit,” Prendergast said. “There was a lot of money involved and the trick now is how we turn around the market as quickly as possible. That’s what has to happen right now. Confidence among investors has to come back.”

Taylor said borrowers’ behavior also contributed to problems in the market—present day homeowners acting more as renters rather than working toward owning their homes by paying down their mortgages.

Prendergast disagreed saying, “I don’t think that because there is an elevated level of demand of putting people in homes, it is a question of sustainable homeownership. House prices should not have been driving underwriting criteria. That cannot happen because confidence in the market will never come back. Investors have to know a rock solid investment before they ever touch it.”

Anand Narayanan, founder of 14e Consulting, Irvine, Calif., said “evaluating risk is about credit, collateral and capacity. For investors to be confident, underwriters need to do more with asset creation. If you talk about creating an asset, you talk about whether it will provide value. What type of asset is it? The key question is about how the loan will perform.”

Narayanan said one of the basic things that could have been done is forecasting when rate resets would occur. “The industry could also measure equity build up or decline two years into the future,” he said. “There are enough market indicators to implement risk-based pricing. If loans perform according to underwriting guidelines, they are seasoned and they will be worth something—allowing investors to come back.”

Prendergast called for a sweeping modification of loans to prevent “unbelievable delinquencies.” He said mass modifications would be the only way to address growing problems instead of on a case-by-case basis.

Gurley countered that the loan modification process is complicated and reaching borrowers in distress is an arduous task. “When borrowers are completely under water, getting a hold of them is difficult," she said. "Sometimes it’s a question of whether they even want to stay in the property.”