Evolution of Underwriting Practices: A 15-Year Journey in the Mortgage Industry

1. It’s all about the underwriting!

2. 15 years ago: • Fully documented, very good credit, all manual (no AU) , 5% down with MI (extra U/W) • 3% FHA, gift allowed, no DPA’s • Fixed, ARM, balloon products available. • No Stated, No No Doc (except private banking) • No such thing as credit scores

3. 15 years ago • U/W bottlenecks, costs, variability of decisions, discrimination issues creates need for automated approval process

4. 10 years ago: • Credit scores developed by looking backwards at how loans performed based on various criteria • Once scores developed, AU was possible • 3% down Conventional, many CRA programs come into being • Subprime exists but normally limited to 85% and is quite expensive. Very small market share. • Some stated some no-doc programs exist at 80% LTV maximum.

5. 5 years ago to current: • Stated Income and No Doc Loans become more commonplace even for salaried workers • Option ARMS, though existed previously become more commonplace • 2% payment rate (neg am), monthly adjustable interest cost at 30yr fixed plus 1-1.5% • Easy to buy over your head.

6. 5 years ago to current: • 100% financing becomes more available and is used in record numbers. • Frequently taking the form of 80% 2/28 ARM first, 20% second HELOC, packaged and sold separately on Wall Street • 100% stated, 620 (bad) score, 80/20, 2/28 ARM is just about as loose as it got. • 5% down, no job, 620 and fog a mirror

7. 5 years ago to current: • Wall Street had an insatiable appetite and no end of buyers for mortgage securities offering yields somewhat higher than treasuries. • Highly rated mortgage backed securities were considered almost as good as cash and can be found in many very conservative funds. Oops! • Fear, Greed and extraordinarily low rates drove buyers into the market. • Homeowners spent their equity on stuff. Equity also used to buy more real estate. • 95 and 100% loans dominate the market.

8. 5 years ago to current: • High LTV loans have never been tested by a bust in values. Now they are being tested and not doing so well everywhere.

9. Property Value/Sales • Property values boom longer and farther by the assistance of loose underwriting • Property values in some parts of country get hyper-inflated, frequently by investor activity • Inventory and value ‘overhang’ fairly severe in many parts of country (Florida, Las Vegas, parts of CA and AZ) • Prices in those areas will go down until supply and demand come back to equilibrium • 43 states are not in a price bubble per Case Schiller. All real estate is local, national numbers are interesting but not of much practical use. • Media covers national numbers and especially ‘disaster areas’. • Buyers are scared and on the sidelines.

10. Last August to Now • Losses due to bad loans mount. Investors stop buying non-prime securities. • Value of security goes to zero for everything except FNMA and FHLMC(conforming). • Even quality jumbo loans are hit and cost much more. • Conforming money is dirt cheap (5-5.75%) • Everything else much more expense, if it exists • No doc loans have gone away, stated income loans on their way out • Underwriting very picky. Buybacks make people very careful.

11. Contraction • Mortgage industry companies drop(ping) like flies. • Over 120,000 jobs lost so far nationwide. • In Washington State, Mortgage Brokers go from over 17,000 to around 7,000. • Brokerages drop by 25-33%. More casualties to come. • Business is down 30-50% and participants continue to struggle.

12. Legislative/Regulatory • National Registry of all Loan originators (including banks) is on horizon and being implemented. • Fed Reserve • HOEPA triggers will be lowered. Fed wants 3% current is 8% • Reasonability to Pay - Bye Bye Stated Income • Mandatory Escrows on Subprime loans • Prepayment penalty limitations • Comment period closed

13. HUD/FHA • FHA wants risk based pricing for mortgage insurance and lower downpayment requirements • FHA does not want DPA’s (shell game) but may have it imposed. • New “simplified” four page Good Faith Estimate: Summary page, YSP disclosure, average based costs versus exact, place to shop, escrow script • Comment period still open

14. Washington State • All loans officers licensed 1/1/07 • Pass a test, background check, continuing education, finances scrutinized • Fiduciary duty to both borrowers and lenders with right to be compensated by either • Governors Omnibus Bill: prepayment penalty restrictions, new one page disclosure of loan terms, funding for homebuyer couseling, restricitions on neg am loans

15. Other States • No Negative Amortization • No Stated Income • No Yield Spread Premium • Closing Cost Limitations (like HOEPA) • Licensing, education, national registry participation, • Borrower education • Fiduciary Duty

16. Appraisal Proposal • FNMA and FHLMC sign agreement with New York AG to buy only loans with “independent” appraisal • Brokers can’t choose appraiser • Bank can’t use captive appraiser • Comment period still open

17. Insurance • Most brokers only need a surety bond to operate • If they have a warehouse line (loan funding facility), they need E/O as well as Fidelity Coverages. • My insurance broker has told me my current carrier is getting out of this sort of insurance.

18. I was hoping my insurance rates would go down with my decreased loan volume.

19. I was hoping my insurance rates would go down with my decreased loan volume. • I don’t think I’ll see it.