An acute lack of warehouse capacity is rapidly diminishing the rate of survival for mortgage banks. Faced with the risk that poorly underwritten loans won't clear their lines, warehouse lenders are scrutinizing mortgage bankers like never before, raising their expectations for loan performance as a prerequisite for warehouse approval.

In order to satisfy the rigorous requirements of warehouse lenders, mortgage bankers need to focus on what really matters to them: high investor scorecard ratings that demonstrate an ability to deliver quality loans on a consistent basis.

It's easy to see why warehouse lenders are so sensitive to risk. The entire financial industry is still licking their wounds from painful write-downs and scathing attacks on their role in the economic crisis.

Although the government is pushing big financial institutions to increase lending, they've also placed them under a regulatory microscope, leaving very little room for error. Their situation is not unlike airport security in the post-9/11 world: every loan must be checked and then double-checked, to ensure they don't let anything through that even hints at fraud or substandard underwriting.

With a heightened sensitivity to risk, warehouse lenders have become even more cautious about extending credit to mortgage bankers. And given that the number of active warehouse lenders has shrunk from a peak of 115 in 2005 to a mere handful today, it should come as no surprise that warehouse lenders have raised their approval requirements and are exercising their right to be very, very selective.

But the characteristics of a quality mortgage banking operation are still based on the fundamentals of delivering saleable loans to investors. When loans are delivered quickly, it reduces the risk to the warehouse lender that they will be stuck with a loan that nobody wants. Therefore, warehouse lenders evaluate a mortgage banker's investor scorecard rating because it provide a gauge of profitability and pull-through.

In order to have a chance at establishing new warehouse lines, or more importantly, renew existing ones, mortgage bankers need to improve their pull-through and demonstrate that they understand the nature of warehouse lending risk.

Of all the processes that go into producing a saleable loan, underwriting has the biggest impact on pull-through.

The underwriting process generally involves two steps: qualifying the borrower according to loan product guidelines, and satisfying conditions required to approve the loan. Although both of these steps seem straightforward, everyone knows that the devil is in the details.

GSE needs
In today's conforming-heavy market, qualifying borrowers is certainly easier than the complex requirements of subprime products from the past. Guidelines are fairly uniform and most bankers simply rely on a decision from Fannie Mae or Freddie Mac to determine loan eligibility.

But unless a mortgage banker is a direct seller-servicer, loans will ultimately be sold to investors, each whom have their own set of guidelines that are applied on top of government-sponsored enterprise (GSE) eligibility.

This is typically where mistakes are made, especially given the fact that investors frequently change their guidelines and bankers frequently change investors. Staying on top of these changes and manually checking guidelines is a time-consuming and error-prone process. Any mistakes can lead to fallout, which can hurt a mortgage banker's scorecard rating.

Automated underwriting systems (AUS) provide a perfect solution for this problem. These systems are designed to handle the investor guidelines that Fannie Mae and Freddie Mac can't. By combining the eligibility results of the GSEs with a third-party AUS decision, loans are better screened for saleability and ensure that mortgage bankers spend their valuable resources on loans that have a high probability of pull-through.

The ability of an AUS to properly qualify loans can be summed up as "garbage in, garbage out." The accuracy of a decision relies on the amount of loan and borrower data an AUS can receive, and the amount of detail that is stored on loan product guidelines. This highlights a key distinction between an AUS and a product and pricing engine (PPE).

An AUS is capable of reading borrower credit report data, a tremendous source of information that dramatically improves the accuracy of an eligibility decision.

PPE systems cannot read credit reports, which limits their effectiveness in determining loan eligibility and minimizes their impact on pull-through.

Another area where AUS technologies can differ is in the management of loan product guidelines. Full-service AUS providers build and maintain investor guidelines on behalf of the mortgage banker, ensuring that products incorporate the latest updates from investors.

Do-it-yourself systems, on the other hand, place the responsibility of managing guidelines on the mortgage banker, requiring trained staff and lots of faith that updates can be made correctly and on time.

Conditions that apply

Assuming that a loan has been properly qualified, satisfying underwriting conditions is another step that is rife with the potential for delays and errors. Missed conditions, last minute changes and general confusion all threaten to derail a successful loan sale and lower pull-through rates. Orchestrating the interaction between originators, borrowers, processors and underwriters is more art than science, so efficient communication is the key to clearing conditions properly. 

Like a game of Telephone, even simple instructions can become confused when they're passed between multiple individuals. The more times this occurs, the greater the risk that conditions become an unidentifiable mass of "he said, she said." Preventing miscommunication can be achieved by reducing the amount of times instructions need to be sent, and by providing originators with a detailed and easy to manage list of conditions.

An AUS can help a mortgage banker minimize confusion by automatically generating investor-specific conditions when the eligibility decision is made. With a detailed list of conditions already in their hands, there is less back and forth taking place with the underwriter, reducing the risk of miscommunication.

The way to survive and thrive in today's lending environment is to ensure that pull-through rates are high, as it is a sign that a mortgage banker has the processes and technologies required to run a profitable business. In the end, this is a win-win situation for everyone: the mortgage bankers, their investors and warehouse lenders.