A MAP FOR NAVIGATING THE MORTAGE MINEFIELD

Legal Forensic Loan Audits: A Powerful Tool from Underwriting to Loan Mitigation

By August Blass, CEO and president of National Loan Auditors

A time bomb is ticking in the portfolio of a lender. It is scheduled to explode in early 2009 when an adjustable rate mortgage written by an aggressive broker, an anxious home seeker, and an insatiable wall street banker collaborated to create products, that falsify income to qualify for an ARM rate that the borrower could hardly afford to begin with. Now that interest rates are almost ready to reset, this time bomb could explode and cause serious damage to any loan portfolio. Sometimes ignorance is bliss, but not this time.

At the very least, the lender is in a better position to deal with the realities of the situation when they know the true value of the portfolio. Advance knowledge can also be an effective tool in loss mitigation by allowing the lender to explore alternatives to foreclosure.

How prevalent is this problem today? Interest rates on approximately 121,000 adjustable mortgages reset in November 2008, and experts suggest that the industry is headed for another round of foreclosure activity reminiscent of the S&L crisis of the 1980s. In yet another turn of unsettling events, some 3.7 million sub-prime loans are expected to reset soon as noted in a recent Citigroup report. If ever there were a time to look seriously at loan portfolios and assess risk, it is now.

Legal Risks that Reside in Many of Today’s Portfolios

In the years leading up to today’s crisis, many lenders substantially relaxed their standards, qualifying applicants based on unverified information. State statutes such as those found in California, Michigan and Nevada, clearly outline that lenders must have an accurate system in place to verify a borrowers income as being accurate. If a lender failed to have these adequate quality controls in place, the loans may be considered unenforceable under state law and the Truth in Lending Act (TILA).

TILA violations and carry the most weight in court. It is important to note that loans with illegal terms or conditions are not enforceable; neither is a foreclosure resulting from an illegal loan product, and a lender is at great risk that an illegal foreclosure may be overturned.

The Truth In Lending Act, or Regulation Z as it is also known, was developed in 1968 to promote the informed use of consumer credit by requiring disclosures about terms and cost. The regulation also gives consumers the right to cancel certain credit transactions that involve a lien on a consumer's principal dwelling; regulates certain credit card practices; and provides a means for fair and timely resolution of credit billing disputes. In short, this regulation was enacted to protect consumers from being locked-in to loan products that were misrepresented at the time of closing.

Lenders, servicers, hedge funds, and the Government Sponsored Enterprises (GSEs) can be proactive and assess risky, or even toxic, loans in their portfolios, or loans that were delivered into a security. Obtaining an audit on a single loan, or a complete portfolio of loans will give investors and those entities a clearer picture of where they are at risk, and may even provide the means to “put-back” these toxic loans to the original entity that sold them in the first place. A no return policy, simply will not work when there are legal violations discovered.

Tackling the daunting task of risk assessment and portfolio valuation

The task of portfolio auditing will depend on size, complexity, and internal resources. At some point, however, external resources may likely be needed, especially since internal quality control procedures failed to provide the intended protection and safety they were created for. In many cases the need to provide accurate, legally sound, reliable portfolio assessments will dictate that the mortgage should be subjected to a complete in-depth analysis, or a forensic loan audit.

What is a forensic loan audit? In short, it is a thorough risk assessment audit performed by professionals who have both industry and legal qualifications to review loan documents and portfolios for potential compliance or underwriting violations, and provide an informative, accurate loan auditing report detailing any errors or misrepresentations in legal documents. Not all forensic loan audits are equal. Some key elements should include:

• A compliance analysis report based on data from the actual file.
• Post-closing underwriting review and analysis.
• Summary of applicable statutes, prevailing case law, and action steps that the attorney or loss mitigation group may choose to act upon.

The end product of any forensic loan audit should be a quality report done accurately and legally, citing any and all violations, current or prevailing case law, and the action steps that should be considered to bring the loan into compliance. Most large lenders run a “topical data tape” compliance audit on all their loans bought and sold, but a forensic loan audit goes further by examining the actual loan documents and gleaning the actual data from the file. Tapes may contain errors with inaccurate and misleading information.

How legal forensic loan audits can also help borrowers

Homeowners are particularly eager to find a way to avoid foreclosure and keep their homes. Many distressed borrowers reach out to the public sector, and consumer advocacy groups to help them in negotiating with lenders. Many of these groups consist of attorneys licensed to practice real estate law, Non Profits, and CPA’s. They help clients with the modification process by obtaining loan audits to find possible errors in loan documents or lending practices. Before any progress can be made to modify loans that are at some level of risk or default, a complete analysis would ensure that when underwritten the loans were legally valid and met original investor underwriting standards. Then, and only then, can a modification program be offered taking lending practices and loan factors into account, allowing borrowers to receive a loan or modification based on their financial hardship and a legal mandate to correct erroneous or even illegal lending practices.

Forensic loan audits expose mistakes and unscrupulous predatory lending practices that will help the borrower in their negotiation efforts. Federal, state or county specific lending violations, and the legal guidelines for remedy, can pave the way to a successful and expedient modification.

Choosing a Forensic Loan Audit Provider

Three key elements in selecting a forensic loan audit provider are quality, rapidity, and legality. Quality involves an outsourcing resource that offers industry capabilities for loan documentation review; accurate loan auditing reports through the use of leading compliance software; customer service and a staff providing quality control, strategic planning and risk assessment consulting.

Rapidity is the capacity to promptly respond thoroughly to the needs and demands of a stressed and urgent client base. It also includes the ability to keep track of the ever- changing laws and government policies that are being offered as solutions. One of the unique and helpful capabilities of our firm is the ability to provide a legal opinion letter of our audits on a national level, endorsed by Ex-Attorney Generals, retired judges and state-specific licensed attorneys. Without a legal opinion or validation, an audit cannot be considered true or accurate.

Legality includes the ability to provide the necessary legal review and analysis validating all violations contained in any audit report.

Conclusion

There is no way to put a pretty face on the reality of today’s mortgage marketplace, but the reality is that the industry provides an essential service to our society, and will continue to be an important force in the survival of the economic downturn and future recovery.

The time bomb is ticking. It will take bravery and nerves of steel to disarm the situation and prevent further damage to loan portfolios and society. Those who best navigate these trying times will be the survivors and the future industry leaders. They will accomplish this by knowledge, judgment and perseverance.

August Blass is CEO and president of National Loan Auditors, a company providing quality control, pre-close and post-close auditing, risk assessment consulting and fraud prevention to the mortgage and banking industries. He is a mortgage industry veteran with more than 20 years of experience. For more information on NLA and their services please visit the website at www.nlaudit.com.