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Evolving Due Diligence Models Offer Advantages Over Current MethodsRecognizing the shortcomings of current due diligence, many secondary market players are adapting an alternative approach.By Bill Garland Sr. and Greg Hansen |
Author's Bio Bill
Garland Sr. is senior vice president, capital markets, for Fidelity
Hansen Quality, a Fidelity National Financial Company. Greg Hansen is
president of Fidelity Hansen Quality.
www.fnis.com |
Credit
worthiness
of the borrower
and the real market value of the underlying collateral define the
quality of every mortgage loan. In order to define risk and set
portfolio values, secondary market executives must analyze these and
other factors by deploying due diligence strategies that are economical
and effective at detecting misinformation and mortgage fraud. 
Since transaction timing is critical on the secondary market, both
sellers and buyers need analytical solutions that can generate results
without unnecessarily delaying transactions. Yet, there is a heightened
awareness that many traditional due diligence strategies are failing to
meet the complex requirements that are inherent in today’s secondary
market.The due diligence process evaluates four primary elements: credit, compliance, collateral and fraud. In this process, loan files are manually reviewed to analyze and validate the accuracy of the original verifications, reports and worksheets that were used to make underwriting decisions. Loan file information is then evaluated using technology-assisted methods to ensure that original findings have not been compromised. In addition to comparing the original information to current findings, the technology also enables a wide range of additional compliance and risk factors to be evaluated. Multiple companies typically manage the four areas reviewed during the due diligence process. Firms that evaluate credit-related documentation typically handle compliance as well. However, two additional, separate firms are usually deployed to evaluate collateral valuation and fraud-related issues. Credit and compliance Firms managing the credit aspect of the due diligence process examine loans for adherence to the underwriting guidelines established by their client lenders and investors. With an in-depth understanding of loan products, these firms are hired to ensure that all mortgage loans comply with the underwriting guidelines associated with their respective product descriptions. The firms managing credit analysis usually manage the compliance aspect of due diligence as well, evaluating loans for adherence to anti-predatory lending laws and Section 32 requirements. They reverify the accuracy of loan fee calculations, and then compare them against federal and local jurisdictional statutes to confirm that total loan costs fall within maximum permissible fee structures. Firms managing the collateral aspect of the due diligence process focus on verifying the accuracy of the original property appraisal. The reported value can be affirmed - or called into question - using a variety of collateral valuation tools and services, such as automated valuation models (AVMs), desktop reviews, field reviews or hybrids that combine multiple approaches. 
The
latest development in this arena involves the assignment of a
collateral risk score, which is an indicator of the reliability of the
underlying valuation. This risk score is generated by deploying
sophisticated technology that automatically analyzes property values
against traditional and nontraditional information sources, including
comparable sales, area economic trends, supply and demand predictions,
and area fraud statistics. Several leading fraud-detection technology firms have developed comprehensive analytical systems that can be used to perform fraud checks prior to loan sales or the creation of securities. These systems are designed to compare loan applicant information to a wide variety of databases to identify possible red flags, such as Social Security numbers associated with more than one name, property legal descriptions that don’t match land title records, borrower names associated with suspected mortgage fraud in other states, and so on.  The
best
of these systems provide clients with a data integrity
score for each loan to indicate the level of fraud risk. They also
recommend steps that could help rule out fraud and offer advice on how
to handle situations that appear to involve fraud.The credit underwriting due diligence process has traditionally been conducted by contracted providers that send staff members to loan sellers’ locations. Sellers have preferred this arrangement predominately because of the communication exchange that may be required once due diligence firms report their findings. As loan files are evaluated by due diligence providers, they are classified based on how closely analysis results compare with the original loan file verifications. These classifications can then lead to an iterative negotiating process between buyers and sellers to adjust deal terms based on the due diligence findings. While sellers can often work with their outsource partners to resolve documentation inconsistencies or loan file defici encies,
they
may also be forced to give investors a discount against their original
bid if issues or concerns are unresolvable.Employees vs. contractors Most credit and compliance outsource firms currently use third-party contractors to provide the labor for the on-site due diligence services they provide to the secondary market. However, this business model has some inherent problems, not the least of which are issues of accountability and quality control. To address these and other challenges, some due diligence firms are starting to embrace a business model that deploys their own company employees in lieu of third-party contractors to improve efficiency and quality for clients. By utilizing their own employees, firms have a higher degree of control over the work effort and, ultimately, more control over analysis quality and the speed of output. This employee-based model allows firms to establish an accountability and performance review structure, as opposed to simply managing logistical operations. Conversely, firms that continue to utilize the logistical approach must rely mainly on their ability to maintain contractor lists, manage contractor availability, schedule contractors and coordinate travel. Unfortunately, there are a wide variety of uncontrollable factors that make this approach unpredictable and more costly, resulting in higher rates for clients. To most effectively manage the due diligence process and reduce client costs, firms implementing an employee-based model will be most effective when establishing and operating a centralized, off-site facility located near client locations. By doing so, these firms can recruit, train, motivate and manage a stable workforce on behalf of their clients, as well as eliminate many of the travel expenses related with the logistical approach.SME |
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