The New Role of Automated Underwriting Systems in Today's Market

During the subprime and Alt-A days, proprietary in-house automated underwriting systems (AUS) were a must have for mortgage bankers. Typically, lenders purchased expensive AU platforms whereby they were responsible for hosting and managing the business rules behind underwriting manuals. Change management, as it's referred to, was entirely left up to lenders to maintain guidelines and pricing. This meant that several business analysts had to be on staff to make constant changes to business rules. Once the market shifted toward only A paper borrowers, however, the role of the AUS changed. The AUSs used during the subprime era were designed to evaluate the complexities and granularities of a subprime borrower's credit worthiness. But the secondary market's appetite for anything other than conventional, conforming loans came to a swift halt. Investors begin requiring lenders to use Fannie Mae's Desktop Underwriter (DU) or Freddie Mac's Loan Prospector® (LP) AUS as conditions to accept loans for purchase.

Subsequent to the mortgage meltdown, lenders were left in a financially challenged position to restructure operations, production, technology models and every other functional area --- across the board. Cost cutting became king in order to sustain the business and weather the storm. Lenders had no choice but to bear expensive per application fees on loans submitted to GSE AU engines for approval and investor purchase.

In late December of 2008 interest rates dropped to historic lows and the mortgage market begin to enjoy a mini-refi boom. Lenders started adding staff to accommodate the market's upswing, but amid unpredictable market conditions lenders still needed to keep cost control at the forefront of expansion.

With that in mind, lenders sought additional methods and tools to operate efficiently and cost effectively. Technology is one avenue by which to achieve this. Software-as-a-service (SaaS) gained momentum virtually overnight due to it being less expensive, easy to implement and having a low total cost of ownership (TCO). Lenders predominantly begin to use the SaaS model in the LOS and PPE arena. In particular, product and pricing engines (PPE) became popular because lenders could use these low-cost engines as simple pre-qual product finders and then use DU/LP to underwrite loans. The problem is the costs associated with the number of applications sent through GSE operated AUSs. In an incredibly tough, profit-pinched market this quickly adds up and hurts the bottom line. Consequently, the industry's loan approval paradigm has again begun to shift.

AUS as a Deal Filter
Many lenders empower their loan officers with the discretion to use DU/LP at the point-of-sale (POS) as a means to check if deals may work. Pulling DU/LP at the POS and then having to again pull it in the back office to satisfy investor conditions doubles the cost to originate and sell loans. This results in lenders spending thousands of unnecessary dollars each month in order to capture business at the POS.

This pain point has created the need to utilize proprietary AUSs. An AUS houses and mirrors each investor's underwriting manual and corresponding pricing to a "T." Hence, lenders are turning to proprietary AUSs as a POS "deal filter" to check if deals will work before incurring unnecessary transaction fees. So, if a lender's in-house AUS renders a conditional underwriting pre-approval at the POS, they need only pull DU/LP on the back end to satisfy investor requirements.

In late 2007, consulting firm CC Pace published a white paper entitled The Future of Automated Underwriting. In the white paper, the firm's research revealed that companies should emphasize the AUS as their key operating platform. The firm further stated that AUSs provide the best way to balance efficiency with loan quality and to establish consistency and control. In addition, research also determined that "an AUS carries the same weight as a human underwriter's decision." In essence, an AUS answers the questions: "Is this loan approved? What do I have to do? In contrast, a PPE delivers a result (typically using stated borrower information) that does not pull and evaluate credit. CC Pace states that PPE's answer the question: "Assuming that this loan is approved, what product and price can I offer the customer?" DU/LP is often pulled by salespeople to ensure deals work on the front-end, and the lender also pulls DU/LP on the back-end, which doubles the cost to approve and sell loans. CC Pace points out that lenders using what's termed a "Decisioning System" enjoy a combination of pre-qual, PPE and an AUS, which improves the granularity and accuracy of the pricing and underwriting process.

AUS Integrations
Upfront cost savings is but one advantage of utilizing an AUS in today's market. Equally important are integrations to other platforms. To gain the maximum benefit of using an AUS, integrations must exist with GSE operated AUSs, the FHA's TOTAL Scorecard platform and back office loan origination systems (LOS), which is paramount to gain efficiencies, maximize profitability, elevate service and realize return on investment. As an example, an AUS that is tightly integrated with an LOS allows loan officers and brokers to pre-qual, price and underwrite loans while at the POS without ever having to leave the application they are accustomed to working in. The 1003, pricing, loan details and underwriting conditions automatically appear within the LOS. When an underwriter clears a condition, it moves to the loan officer or broker's pipeline. This fluid, bi-directional integration of disparate systems offers real-time visibility and provides faster turn times.

Managed Services
During the re-fi boom lenders typically had their own databases that resided behind their firewall to house pricing, products, underwriting manuals and approval procedures. The task and associated cost for lenders to manage and maintain this information is now cost prohibitive in the market's new lending landscape. This is where managed services gained momentum. Managed services is a department within a vendor that maintains your data for you using a software-as-a-service (SaaS) delivery and communication model. A SaaS-based AUS provider maintains not only pricing and products, but manages the entire set of underwriting manuals for each investor. The old model of managing business rules would have put this challenging responsibility into the hands of the lender. Today, however, SaaS-based AUS vendors manage both vanilla off-the-shelf investor guidelines as well as lender-specific blended guidelines, overlays and custom pricing.

Doing More With Less
The current business environment obviously has lenders looking for ways to do more with less. Whether it's wholesale, retail or consumer direct lending, mortgage bankers are aggressively pursuing growth opportunites. However, growing existing channels or launching new channels accompanies the addition of more staff to support them. An AUS helps lenders avoid having to hire more underwriters when volume picks up or a new channel is launched. As an example, let's assume lender XYZ has a retail channel that is doing roughly 30 million a month in volume and growing by about 10% each month. The lender's underwriters are already resource constrained, and the owner also has a mandate to launch a new wholesale channel. In order to do this, more underwriters would have to be hired and trained. However, using an in-house AUS moves the onus of underwriting to the POS for LOs and brokers. As a result, the bulk of the decisioning and underwriting process is completed at the POS with files then being sent to underwriting for QC. This allows underwriters to increase productivity without adding more staff, as they are able to become highly efficient reviewers. As previously cited, CC Pace's research determined that "an AUS carries the same weight as a human underwriter's decision."

Achieving Better Secondary Marketing Execution
A proprietary AUS is also effective at making secondary marketing departments more profitable. There are a couple of ways lenders accomplish this depending on secondary marketing strategy.

If lenders are utilizing best efforts as their execution model, off-the-shelf investor products are usually private-labeled whereby LOs see only the best investor price for a particular program, and then locks the loan. Secondary marketing later re-decisions the individual loan or bulk decisions the entire locked loan pipeline to determine which investor to sell the loan(s) to. This prevents a laborious, time consuming burden of having to visit each investor's website to attain pricing and eligibility.

If the lender desires to use a more sophisticated secondary marketing strategy that involves mandatory, bulk, AOT or co-issues, then the use of custom guidelines and custom pricing are generally needed. Lenders are able to place their own overlays on top of investor guidelines and also add their own custom pricing. This translates to the lender being able to offer "blended guidelines" to originators at the POS. For instance, let's say XYZ lender does business with five investors. The advantage of blending guidelines is to show originators only a single set of programs and pricing to choose from. This increases the secondary desk's flexibility to fill different investor pools that best fit their execution strategy. Whichever secondary strategy you use, AUSs drive improved profitability both at the POS and in secondary marketing.

So Is An In-House AUS Right For You?
Our industry has clearly gone through many changes and experienced significant retrenchment. After the market crashed, lenders scrambled to harness just enough technology to get by. Automated underwriting systems as we once knew them died in a resource constrained climate with new loan approval needs. However, with an upswing in volume the in-house proprietary AUS again has a role in mortgage banking. Sooner than later, the AUS will become a must have for lenders to accurately evaluate loan risk, effectively grow and manage volume, provide better and quicker service, prevent unnecessary costs, and maximize profitability.

Generally, the more sophisticated mortgage banker that is focused on aggressively growing its volume is an ideal candidate to utilize a proprietary in-house AUS. On the other hand, brokers and smaller mortgage bankers are typically better suited to utilize a PPE that returns a pre-qual and price. Many organizations often start with a PPE and later graduate to the functionality of an AUS. CC Pace put it best in defining a Decisioning System as a combination of pre-qual, PPE, and an AUS." This type of comprehensive decision management and underwriting platform coupled with seamless integrations to GSE AUSs, FHA TOTAL Scorecard and LOSs helps lenders reach the holy grail in lending efficiency, profitability and cost cutting as it relates to pricing, underwriting, processing, fulfillment and secondary marketing. All lenders' business models are slightly different. Only you can determine what is right for your organization --- both for the now and the future.

Authored by
Joe Bowerbank
SVP, Marketing & Strategic Alliances
Loan-Score Decisioning Systems

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