Why Haven’t Loan Officers Been Told These Facts?

Know Before You “Show” – The Loan Estimate

Let’s recap last week’s Journal article Know Before You “Show.” The Journal suggested that specific disclosures within the Loan Estimate (LE) coupled with how the LE is delivered (including oral explanations from the Mortgage Loan Officer) can improve or degrade communications with applicants. Furthermore, using basic risk management practices coupled with a clear understanding of Regulation Z disclosure requirements may alleviate unnecessary applicant confusion.

Using incremental improvements, Mortgage Loan Originators can SAW needless confusion and Loan Estimate defects in half. SAW is a simple approach to improving the effectiveness of the LE. SIMPLIFY. AVOID. WIPEOUT. SAW the LE problems in half. Simplify the LE. Avoid errors. Wipe out needless revisions.

In the Kleiman Groups (the developer of the LE and CD) follow-up report to the Know Before You Owe: Evolution of the Integrated TILA-RESPA Disclosures Report, Kleiman conducted rounds of consumer testing to measure the efficacy of the proposed TRID disclosures.

Kleiman’s follow-up report is titled, “Know Before You Owe: Quantitative Study of the Current and Integrated TILA-RESPA Disclosures.” From the Executive Summary, Kleiman stated, “For the Qualitative Study, the CFPB team conducted ten rounds of consumer testing to develop and test the integrated disclosures—a Loan Estimate and a Closing Disclosure. The Loan Estimate was developed and tested with consumers in five rounds of testing, the Closing Disclosure in two rounds of testing, and the Loan Estimate and Closing Disclosure together in three rounds of testing. As a result, the CFPB obtained data showing that consumers could comprehend the proposed disclosures and explain a rationale for their choices through the qualitative testing. In addition, the data indicated that consumers could compare the information on two disclosures, choose a loan, and use the disclosures to compare initial and final loan terms and costs.”

Laboratory experiments are helpful and provide valuable data within the lab, yet mortgage financing variability doesn’t allow for every possible complexity when structuring mortgage offerings. Moreover, as any MLO will tell you, the disclosure environment is less than perfect. Applicants are up to their eyeballs with distractions and are easily overwhelmed by the sheer number of priorities, communications, and decisions that accompany mortgage financing – especially purchase financing. Frequently, applicants are stunned by the complexities and incongruent messages that occur in the context of the disclosure.

If only MLO’s could read the applicant’s mind or, suppose the consumer would speak-up, and ask questions when confused? That is an MLO dreamscape but an exception to reality. Lenders should not depend on the applicant to lead the disclosure by asking clarifying questions. That’s the hail mary approach to disclosure. Toss it up and hope for the best.

The imperfect financial disclosures and delivery processes lead to misunderstanding, noncompliance, and substantial dissatisfaction among stakeholders. There is no silver bullet, but undoubtedly, there is room for simple improvements.

The Journal is partial to the kaizen approach to improvements. When applied to the workplace, kaizen means continuous improvement, focusing on many minor improvements that add up to tremendous overall improvement.

More minor changes are easier to implement. In addition, the connection between the change and the improvement is more visible, allowing for better change assessments.

How can you apply kaizen to the LE delivery? SIMPLIFY. AVOID. WIPEOUT. SAW the LE problems in half. Simplify the LE. Avoid errors. Wipe out needless revisions. That’s an excellent place to begin. Better communication means more satisfied customers and fewer fixes to the loan manufacture.

The positive effects of improving one problem often ignite salutary improvements that overlap multiple processes and outcomes. This overlap means that when you fix one defect, other issues may fade or disappear. For example, better communication upfront reduces phone tag and phone tag frustration. Additionally, fewer fixes to the loan manufacture improve efficiency—improved efficiency and better communication equal satisfied stakeholders. Defects are counter-productive. The less time you spend fixing defects, the greater your production. Your success will improve. Rather than get mired in the vicious cycle of defects and inefficiency, start a virtuous cycle instead. Merriam-Webster describes a virtuous cycle as “the positive effects of improvement to one problem often overlap multiple processes and outcomes.”

Qualitative Risk Analysis

Experience drives most estimates. Uncertainties drive complexity. Complexities drive underestimates. Most experienced MLO’s rely on their subjective experience to establish the range of estimates when the Loan Origination System permits. If you are highly confident in accurately estimating the charges, you have little need for deliberate qualitative risk analysis. If not, see if this simple risk analysis technique helps identify specific charges requiring greater care.

Let’s tackle the SAW challenge and cut LE defects in half. First, grab a recently delivered LE. Then, beginning with page 2, Loan Costs, under Subheadings A, B, and C, SAW your problems in half.

Next, identify discrete items from Subheadings A, B, and C (e.g., points, appraisal fee, lenders title insurance). Then, group the fees according to your ability to estimate the costs accurately and the impact of underestimating the fee (e.g., LE revisions, customer dissatisfaction, confused closing). If you need some help, confer with colleagues using the qualitative risk assessment technique. You might be surprised by the perspective of your processor, closer, or manager.

Start with the probability of providing an accurate estimate with a minimal chance of underestimating the charge. Then, if appropriate, lower the probability of underestimating the fee by increasing the estimate to the upper end of the known range.

Use a 1-5 scale. For example, 1 means there is little chance of underestimating the fee – less than 20%. On the other hand, 5 means the probability of underestimating the fee is highly probable.

Next, determine the impact of the underestimated charge. Think in terms of how the underestimate may impact efficiency and stakeholder satisfaction. Again, stick with the 1-5 metric. 1 is little to no impact. 5 is an impact likely to result in significant stakeholder dissatisfaction or derail the manufacture. For example, the borrower received two LE revisions in one week for a total of $116 in revisions – unwise, unprofitable, and unprofessional. That might be a 2 or 3 in terms of impact. The applicant was upset, the buyer’s agent was upset. Forty-five minutes worth of avoidable calls later, the MLO’s stature and social capital are diminished.

This qualitative risk analysis evaluates two important risk characteristics, probability and impact. Using qualitative risk scores of 1-25, rate the significance of each fee estimate. Place each discrete line item in the following bins: High Risk 19-25, Medium Risk 10-18, and Low Risk 1-9.

Next, repeat the risk analysis for the Category “Other Costs,” Subheadings E, F, G, and H.

Experience drives risk identification. However, faulty assumptions can be dangerously misleading, hence the benefit of careful consideration of probability and impact to establish risk parameters to rank the risks. Risk identification and assessments profit from a multitude of perspectives.

Next week, the Journal will apply the qualitative risk analysis to discrete elements of the Loan Estimate to simplify the disclosure, avoid errors, plus wipe out needless revisions. By identifying the most significant risks, MLO’s can better handle manageable risks.


Behind the Scenes

Fair Lending Laws Have a New Target – Discriminatory Appraisal Practices, Regulators Take Aim
Who is the ASC and how will they impact your mortgage originations?

How Current Appraisal Standards Came to Be
Zombie Lenders and the Savings And Loan Debacle

Before the 2008 and meltdown, the industry had a 1980’s styled, meltdown commonly referred to as the “Savings and Loan Debacle.”

S&Ls, sometimes called thrifts, are generally smaller than banks, both in number and in the assets under their control. As inflation and interest rates began to decline in the early 1980s, S&Ls began to recover somewhat, but the basic problem was that regulators did not have the resources to resolve institutions that had become insolvent. For instance, in 1983 it was estimated that it would cost roughly $25 billion to pay off the insured depositors of failed institutions. But the thrifts’ insurance fund, known as the Federal Savings And Loan Insurance Corporation (FSLIC), had reserves of only $6 billion.

As a result, the regulatory response was one of forbearance – many insolvent thrifts were allowed to remain open, and their financial problems only worsened over time. They came to be known as “zombies.” Moreover, capital standards were reduced both by legislation and by decisions taken by regulators. Federally chartered S&Ls were granted the authority to make new (and ultimately riskier) loans other than residential mortgages. A number of states also enacted similar or even more expansive rules for state-chartered thrifts. The limit on deposit insurance coverage was raised from $40,000 to $100,000, making it easier for even troubled or insolvent institutions to attract deposits to lend with.

From 1982 to 1985, thrift industry assets grew 56 percent, more than twice the 24 percent rate observed at banks. This growth was fueled by an influx of deposits as zombie thrifts began paying higher and higher rates to attract funds. These zombies were engaging in a “go for broke” strategy of investing in riskier and riskier projects, hoping they would pay off in higher returns. If these returns didn’t materialize, then it was taxpayers who would ultimately foot the bill, since the zombies were already insolvent and the FSLIC’s resources were insufficient to cover losses.

Texas was the epicenter of the thrift industry meltdown. In 1988, the peak year for FSLIC-insured institutions’ failures, more than 40 percent of thrift failures (including assisted transactions, meaning FSLIC assisted acquisition by other lenders) nationwide had occurred in Texas, although they soon spread to other parts of the nation. Emblematic of the excesses that took place, in 1987 the FSLIC decided it was cheaper to actually burn some unfinished condos that a bankrupt Texas S&L had financed rather than try to sell them.

To make a rather long story, shorter, high-risk residential development loans and takeout mortgages on the same iffy properties were the primary drivers for the 1980 thrift failures. By the late 1980s, Congress decided to address the thrift industry’s problems. Resolution of the S&L crisis did not really begin until February 6, 1989, when newly inaugurated President George Bush announced his proposed program, whose basic components were enacted later that year in the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA).

The main S&L regulator (the Federal Home Loan Bank Board) was abolished, as was the bankrupt FSLIC. In their place, Congress created the Office of Thrift Supervision (OTS) and placed thrifts’ insurance under the FDIC. The OTS, a Bureau of the Department of the Treasury, was abolished by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or Act)  on October 19, 2011. Titles III and X of the Act transferred the powers, authorities, rights, and duties of the OTS to the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, and the Consumer Financial Protection Bureau effective July 21, 2011.

(Some of the historical accounts provided courtesy of the Federal Reserve, FDIC, and the US Department of the Treasury)

Like the SAFE Act supervision and licensing mandate for mortgage origination organizations and individuals, FIRREA mandated state supervision and licensing standards for appraisers in connection with appraisals on federally related mortgages.

The Federal Financial Institutions Examination Council (FFIEC) was established on March 10, 1979, is a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions and to make recommendations to promote uniformity in the supervision of financial institutions. In addition, in accordance with the Financial Services Regulatory Relief Act of 2006, a representative state regulator was added as a voting member of the Council in October 2006.

The Appraisal Subcommittee (ASC) of the Federal Financial Institutions Examination Council (FFIEC) was created on August 9, 1989, under Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (Title XI). Title XI purposes to “provide that Federal financial and public policy interests in real estate transactions will be protected by requiring that real estate appraisals utilized in connection with federally related transactions are performed in writing, following uniform standards, by individuals whose competency has been demonstrated and whose professional conduct will be subject to effective supervision.”

Next week the Journal unpacks the ASC and the interest of other stakeholders concerning appraisal discrimination.


Tip of the Week

Project Management Skills for Loan Origination

Last week, the Journal described the iterative process of identifying stakeholders and how to begin to identify stakeholders. So then, once we have a list of these stakeholders, then what? The mortgage loan officer must then determine which of the stakeholders are key stakeholders.

A common hallmark of key stakeholders is that their opinions greatly matter and effectively determine if the lender and MLO did a great job or not. They are those who define whether or not your efforts were successful, passable, or outstanding. You might think you did a good job, but if a key stakeholder thinks you did a lousy job, you did a lousy job.

The Power/Interest approach provides a simple way to prioritize stakeholders to ensure your attention is focused on the right stakeholder at the right time. Power describes the relative ability of the stakeholder to set the agenda and impose their will on the loan manufacture. Interest essentially defines how important the loan manufacture is to the stakeholder. The nexus of Power and Interest allows for ranking stakeholders relative to their importance in meeting the loan manufacturing objectives.

At a minimum, a Stakeholder Register is a simple document that identifies the stakeholders and their contact information. Using our stakeholder rankings, group the stakeholders in bins of 1-6, 7-12, 13-18, 19-25. Key Stakeholders fall in the 19-25 bin. MLO’s must closely engage the Key Stakeholders. Identify their success criteria and communications preferences. The next stakeholder group, those in the 13-18 bin, keep updated and contact as you can. The stakeholders in the lower half of the rankings are catch as catch can. The concept of effective stakeholder engagement is that the MLO has finite hours in the day. Consequently, when closely engaging one stakeholder, the MLO is not closely engaging another. Ensuring that you engage the right stakeholder appropriately helps alleviate missteps with the stakeholders you cannot afford to disappoint.

The primary means of effective stakeholder management is effective and efficient communications. The Journal will unpack communications management in next week’s issue.