WOHICA. Not a small town in Kansas. Instead a simple acronym for “watch out, here it comes…” For all lenders - small, medium or large - buybacks and rescissions are the haymaker punch aimed squarely at their 2010 financials. Last year was nothing compared to what we expect to see this year, as rescissions from the MI’s and the repurchases from the GSE’s will fuel their capital starved balance sheets. The days of governmental coddling of the lending community are over. The gloves are off, here it comes.
Lenders can’t dodge this fight. And they can’t win it. The best they can hope for is to duck the haymaker and remain standing at the end of the day. The only recourse, implementing a strong defense process platform is the key to success to make it through this crisis. We have found a number of best practices will drive a good process and enable survival.
Stemming the Flow: Improved Quality Control
While almost all loans being originated today are high-quality vanilla products, robust quality control processes that catch operational issues proactively and before delivery, will stem the flow of “bad” loans into prospective repurchase and rescission queues. Strong front-end controls, including automatic fraud detection, background checks on new loan officers and thorough due diligence on new brokers and correspondents are important facets of a program.
A rigorous back-end quality control program will extend beyond parameters required by investors. Elements of the program may include:
- Performing 100% file reviews on first month’s production from new loan officers, branches & correspondents.
- Monitoring delinquencies and early payment defaults by origination source such as by branch, broker, and correspondent.
- Identify root causes and push the findings back to the origination teams and the product managers, to insure guidelines are correct in the system.
In short, the best quality-control defense is a good offense, in this case a closed loop process that finds trends on the back end, and quickly pushes training, controls and remediation to the front-end operations.
Softening the Backlog Blow
Several critical defense tactics will allow the lender to manage through 2010 to a “least worst” outcome:
The Defense Executive
To manage the defense of demands from the seasoned book, step one is dedicating an experienced executive in charge of this function as a full-time job. Standing up the apparatus needed to defend the current backlog, as well as an expected onslaught, cannot be accomplished in the margins of the day. The head of underwriting does not have time to do the job, nor does the head of quality control. Both should be involved, but not in the leadership role. This role requires a “ringer” who has extreme focus and a direct line to the C-suite. An outsider, someone who’s not drinking the corporate Kool-Aid, may be a good bet.
Lenders are approaching this problem reactively (defensively), in most cases because they do not have a handle on their data. The new Defense Executive will need basic reconnaissance to become proactive and offensive:
- How many loans, which investors, what reasons?
- Stratification by investor, loan type, origination channel, etc.
- A database of all pending repurchase requests and related metrics (e.g., delinquency rates, BPOs, MI coverage, etc.) and of all indemnifications to facilitate handling of future “make whole” invoices.
This is a battle of information. He who manages his data best - wins, or at least survives to fight another day.
Executing the Defense
Organizationally, all repurchases and indemnifications should be approved by a cross functional team comprised of secondary marketing, underwriting, quality control, and post-closing managers. An appropriately sized team with underwriting backgrounds should be assigned to investigate the facts and write defense letters where appropriate. Assuming 5-7 loans reviewed per day, the math to eliminate the backlog and manage incoming flow becomes straightforward.
Guidelines and contracts for the 2005-2008 book years should be gathered and scrutinized carefully. There will be many changes and potentially poor documentation on both the lender side and the investor or insurer sides. The organization of this information is a tedious but critical task.
Once the organizational infrastructure, the information management platform and control of the governing documentation is in order, the lender is prepared to begin the negotiation process with counterparties. It is our experience that executives need to be very practical at this stage and make every effort to avoid litigation. The old trader maxim - pair it off and move on - is applicable here. There will be clear cases that you made a mistake and you should admit it and buy the loan back. There will also be clear cases of the counterparty overreaching and they should retract their demand. The real fun comes in the gray areas. Our best advice is to have executives of the two firms meet and devise the rules of the road ahead of time. Next, pilot a batch of loans through what has been agreed on and monitor and review the results. This process should be iterated until both sides are comfortable, attempting to indemnify the loan in lieu of repurchase when possible.
There is no substitute for senior management getting down in the weeds and looking at individual loans. Working off reports and worst case examples will not necessarily provide all the information needed to make the right decisions. A clear understanding of a lender’s loan quality should be understood before making threats about litigation. Understand what your real position is. Do not delegate this.
Even sophisticated financial institutions make mistakes. Product guidelines, contracts and policies all had many changes in the difficult book years. This problem for some is temporary although for others it could be life and death. Don’t throw in the towel, become offensive, and duck the haymaker. Put in the right process.