S&P Enhances Its Review Of Data Quality Practices For U.S. Residential Mortgage Originations
|October 11, 2007|
Standard & Poor's
NEW YORK --Among the many factors contributing to the poor performance of recent vintages of U.S. residential mortgage-backed securities (RMBS), the two that are cited most often are stretched underwriting guidelines and home price declines. However, industry reports have also mentioned fraud at the origination stage. It's important to note that rating opinions are neither audits nor due-diligence reviews of mortgage originators. Yet, in light of industry reports questioning origination practices, it's increasingly important for both mortgage originators and RMBS issuers to be able to demonstrate appropriate data quality—-in other words, to have proper practices for addressing fraud prevention and detection. Standard & Poor's Ratings Services is undertaking an analysis of data quality capabilities as part of its conduit and originator reviews.
Recently, we sent the top 25 RMBS issuers a questionnaire about their respective practices and capabilities for detection and management of fraud in the origination process. We constructed the survey to help us gain a greater understanding of the procedures and controls that lenders use in their origination practice, including underwriting procedures and processes for approving and monitoring mortgage brokers and appraisers. This is only the first step. We intend to send this questionnaire to a larger set of RMBS issuers and originators. We will analyze this information, and if appropriate, publish the relevant findings. In addition, the information we obtain may ultimately have a bearing on our opinions of mortgage loan performance in the future.
In general, members of the mortgage industry report fraudulent activity to the Mortgage Asset Research Institute (MARI) to be included in its MIDEX national fraud database. A study released in May 2007 shows the number of fraud reports pertaining to 2006 originations is approximately 30% higher than in the 2005 vintage at the same time last year. It also shows that the most common types of fraud in underwriting are statements about borrower income and employment. Therefore, we highlighted the procedures for verifying this information in our questionnaire.
Control and mitigation of fraudulent activity are even more complicated when independent mortgage brokers have originated a considerable portion of the mortgages in a portfolio. Preliminary conversations with industry participants indicate that misrepresentations and data-quality issues are more common for broker-originated loans than for loans originated through the retail channel. The limited amount of oversight on brokers and the absence of regulation of their business may have led to increased incidents of fraud as both brokers and borrowers have incentives to close on the loan.
These issues become more acute when coupled with excessive home price valuations, or "inflated appraisals," in which appraisers face pressure to meet the value needed to "get the deal done." The mortgage market has for some time been evaluating the extent to which properties may have been appraised at artificially high values.
To mitigate these risks, RMBS issuers generally have in place processes for approving mortgage brokers and appraisers as well as for monitoring their performance. Our questionnaire asked for a more in-depth explanation of these processes, as to both initial approval and ongoing monitoring.
Over the past couple of years, we've seen an increase in the number of automated tools to help prevent and detect fraud in the sector as well as the advent of risk management firms that advise on risk mitigation mechanisms. Some of these tools include products that:
Source: Standard & Poor's