Originators create composite unity for investor marketplacePatrick Weaversub-prime, legislative, economic, political, mortgage-backed securities Changes in past year serve to strengthen entire industry going forward The trying times our industry has been experiencing this year, particularly in the sub-prime sector, may well be viewed in hindsight one day as a relatively normal -- albeit large scale -- underwriting recalibration. Although much recent discussion has centered on legislative, economic, political and even social concerns related to the sub-prime sector, the issue ultimately comes back to the core loan approval process and whether a proposed home finance request should be granted. A loan originated at the broker level or through some other respected channel still involves a relatively simple risk-benefit paradigm that must estimate whether a particular financial relationship will be a sound one within the limits of such anticipations. Originators -- lenders and brokers alike -- on the frontlines of the loan-making process have to conclude whether a financing request should continue through the multi-layered and often daunting process that finally produces a closing. That's where managing and mitigating risk through underwriting excellence can separate good outcomes from bad, and finally spell the difference between the success and failure of the organization. There is widespread awareness of what has happened to the industry in the last year; what now needs to be addressed is how we restructure our business models to move on. The new market in which we operate requires all of us to tighten our guidelines and remain faithful to sound underwriting practices. The lender-investor relationship also has changed, with the secondary market now exercising more influence over the front-end decision-making by virtue of what can be securitized -- and for good reason. Recently, the market saw an unprecedented number of rating agency downgrades of mortgage-backed securities (MBS), asset-backed securities supported by home equity loans and collateralized debt obligations containing residential and commercial MBS. While we may all pursue revenues and profits individually, lenders together create a composite unity that sets the tone for how the investor marketplace will interact with each of us. Just this year, in fact, we've seen dozens of lenders disappear, mostly from poor underwriting and planning. As a result, by next year, the top 10 sub-prime lenders will control 80 percent of the market -- up from 65 percent in 2005 and 55 percent in 2000. Collateral damage affects the whole sector No one has escaped the market's contraction and too many good companies suffered the worst blow -- closing up shop, examples of the collateral damage affecting the whole sector. Even the big players are not immune to the vicissitudes of today's environment. Countrywide Financial Corporation, a bellwether leader in our sector, saw a 37 percent decline in net earnings in the first quarter of this year. The company's mortgage banking revenues from sub-prime operations plummeted some $400 million in the first quarter of 2007 from those of the fourth quarter of 2006. Undeniably, the foreclosure trends we are seeing today are the result of a departure from sound underwriting guidelines, increased exceptions and an overly optimistic view of borrower credit and market appreciation. As originators pick their way through and around the changes coming at them fast these days, it is worthwhile to consider what regulators have said, especially in the form of guidance about what we should be offering consumers. Last fall, in a widely anticipated announcement, five federal regulatory agencies issued a single policy document called Interagency Guidance on Non-traditional Mortgage Product Risks, addressing numerous concerns related to mortgages that permit borrowers to defer repayment of principal, and sometimes interest as well. A nearly 9,000-word declaration, the guidance was issued jointly by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision and the National Credit Union Administration. It established several safety measures for lenders that are designed to lessen the risks posed by these [non-traditional] loans. Market beset by changing expectations But safety measures imposed externally can only go so far in righting a market beset by changing expectations on the part of regulators, consumers and investors. Rather than establishing ability-to-repay standards on sub-prime mortgages, lawmakers may want to acknowledge how much we, as an industry, have done to make homeownership more than a dream for many Americans, established and newly arrived. Lenders and brokers who have been the bridge for these citizens, enabling them to attain the financial power to enjoy housing security, now can revive those possibilities with a renewed commitment to sound underwriting principles designed to mitigate risk not only for consumers, but investors as well. Arguably, the actions being taken by lenders, regulators, trade organizations and consumer groups will help sub-prime borrowers avoid foreclosure, but must also protect the borrowers right to choose and thus the right to pursue, or maintain the dream of homeownership. The efforts of the National Association of Mortgage Brokers, the Mortgage Bankers Association, Fannie Mae, Citi, JPMorgan Chase and others demonstrates a willingness to be good citizens, as well as practical business people. Our collective and continued concern for both the borrower and market liquidity will temper spurious debate and instead focus our energies on solutions. The change we have all experienced this past year should serve to strengthen us going forward as we learn from our past and become even more successful in the future. Patrick Weaver is president of California-based Quality Home Loans. He may be reached at [email protected].