Due Diligence – the term conjures studious, erudite, educated, skilled, seasoned professionals who at all costs provide fiduciary, sage and prudent advice to clients that have retained them to review and audit the pool of loans to be purchased by them for securitization. 

So it should, the task is monumental, hundreds and hundreds, perhaps thousands of files must be reviewed to determine credit worthiness, the ability of the borrower to repay the credit from the aspect of capacity and willingness.  Reviewed from the aspect that the lender or lender correspondents have met the applicable guidelines and in the case of exceptions, have prudently determined and documented the compensating factors to support and compel those exceptions.  Audited as to all aspects of income, assets, credit worthiness (willingness factors), stability in all the aforementioned areas to determine risk layering for the benefit of the future investors in these collective credits.  This segment of the review required careful and insightful assessment of risk and the depth and breadth of exposure to that risk as related to each file and the whole pool collectively.

Collateral (Appraisals) reviewed for condition of the property, value supported and marketable within acceptable tolerances -time and value, purpose, ownership, subject property transaction histories (flipping), costs to cure (in the case of acknowledged and acceptable deferred maintenance), compliance to zoning and usage.  In other words, if the Investor does have to take the collateral in lieu of payment is the value, condition and legal usage confirmed and viable and can it be marketed and sold with impunity and the expectation that the collateral can reasonably support and offset the loss with a sale of the subject property in a reasonable amount of time.  

Title Commitments/Preliminary Title Reports reviewed for issues of encumbrances, chain of title, clouds and other land mines that would affect/effect title to the subject property adversely for the sake of the Lender and Borrower as both interests are served equally here.  Vastly underrated items those Title Commitments and Preliminary Title reports, they contain a plethora of data and when they do not match other aspects of the file, beware.

The final and very crucial review is the compliance review for Federal, State and Local regulatory issues.  In the past we did this by hand, and the teams that reviewed were split into two sections, Credit and Compliance.  Not this go round, the teams were reviewing both credit and compliance with what were supposed to be sophisticated computer programs that would weed out the non-compliant transactions.  For basics sake, those loans that did not meet the 3 Day Right of Rescission period, Under or Over disclosure of APR’s on the TILA, these are the very fundamental Federal Regulatory requirements enacted with RESPA in 1974.  Then you have State Regulatory requirements with the worst states, at least in my book either Texas or Massachusetts, take your pick – oh Indiana is ugly to.   In the last few years State Lawmakers at the behest of disgruntled constituents have passed a plethora of incredible do nothing look noble Regulations with tree killing form sets.  None of them are very effective, go to a closing some time and listen to them get glossed over, and those that are supposed to be signed prior to the closing, well I wonder sometimes if the borrower was actually the signatory party.  Then there are the Local Regulations, Cook County, Illinois, and others, but just more tree killing legislation with little protection to the borrower. 

The pertinent data from these documents – HUD-1 and TILA with the date of Rescission are entered into the data bases of the computer, which if the program was written properly, will catch and determine that the loan was in compliance with Federal Regulations.  The phrase written properly is the operative term, they were not.  I have been in this industry since 1974, so I can still compute an APR on a very old, very used, very beloved circa 1988 TI, believe me those programs were flawed.  The biggest problem was that they did not pick up the index for the ARM’s properly throwing the APR computation out of whack, they were skewed to pass the loan regardless of the highly critical data entered, and pass them they did.  The reason the index was not accurately reported was that the program choose the index rather arbitrarily, as the reviewers for the most part did not know what an index was, so it was impossible to get a manual index from the file, if indeed it was even contained in the file, the Lender had problems with that concept as well.  As for the State Regulations, there were programs that picked up the form sets required based on the subject property state….but you had to find people that could recognize the forms and the dating requirements for timely disclosure and borrower signature, another very operative problem.  All in all entire segments of Compliance Regulatory Law was ignored, i.e. 3 day notice by lender/originator of GFE and TIL after application, timely FICO notification, ah heck all of the timely disclosure documentation notification to the borrower was ignored due to the fact that:  1.  We did not check for it, that’s right we did not care if there was an initial GFE or TIL sent to the borrower within 3 days of application.  Not one party to this process cared or wanted that data  2.  We were mandated to obtain application dates from other than the application so it would not have worked even if we did care.

So there we sit 30 or 40 of us to a room, boxes upon boxes of loan files, mostly hostile Lenders glaring over the carts that delivered the files.  The day, week, month of reckoning, depending on the number of files to be reviewed, is at hand.  All of those Due Diligence Underwriters with computers and roll aways.  What a ghastly cosmic joke, of those 30 or 40 Due Diligence Underwriters, maybe 8 or 9 actually could spell the word mortgage correctly, they did not and could not derive one scintilla of accurate data from the employment, asset or credit documentation in the files to analyze the Capacity and Willingness of the borrower and further determine the veracity of the documentation (misrep was mandated to be utterly ignored on these projects, fraud just did not occur), no…..they took it directly from the Lender Documentation i.e. 1003 or 1008.  They did not know that a borrower who had never been on Title could not refinance the subject property for cash back at closing.  Stated income – he flips Hamburgers at In and Out, states 8000.00 per month, we have a VVOE that confirms he is a picker for some grower in the Fresno area, reviewer did not see a problem there, for that matter neither did the Investor.  Actual DTI with all monthly obligations accurately computed (stated income) 68.32%; per reviewer 38.24% with obligations obtained from who knows where, the Lender had 42.22%.  Actual LTV/CLTV of 112%; per reviewer 100%, utterly mystifying to the reviewer that the total amount of the loans had to at least meet the total value of the subject property, not exceed the value.  Reviewers just used the Lender data, they had no knowledge, skills, prior mortgage professional standing to determine or derive the actual data.  As for the compliance segment of the review, well, that was obviously doomed to fail.  This was not just 5 or 6 files, no, this was every damn file in the review.  The few experienced mortgage professionals on these jobs were ostracized by the Due Diligence Firms and others on the Teams – Transaction Managers, Leads and QC’s.  They knew to much, they created
problems by actually getting it right, the files that the experienced mortgage professional rejected/”kicked” were manipulated by the QC’s and Leads and passed on through to the pool.  The maximum acceptable kick rate was 10% or less, and that was directly from the Investors’ unwritten but tacitly communicated specifications.

The only reason that a file would really find itself out of the pool was by not meeting the 3 day owner occupy refinance rescission regulatory requirement.  However, I was amazed to discover that Thanksgiving was not a Holiday on one project.  There have been I assume some repercussions from that 1000+ file project.

The real interesting and important lessons to be learned here are that the loans are failing because Wall Street demanded this slovenly quality of review, they wanted everyone of those files delivered – regardless.  Wall Street set the bar for this crisis, the Lender was given the green light by virtue of Wall Street’s willingness to purchase this ever downward spiral of toxic lending.  By September of 2005 guidelines were all but non-existent, lip service only and the files were increasingly fetid with “fraud” (to extreme to call misrep).  The other lesson and one that has to be painful for these dolts, is that compliance and the inherent lack thereof, can, when the borrower employs experienced Counsel, result in a “free” loan in extreme cases or extremely serious litigation where the borrower will prevail and the Lender/Investor will be rightfully relieved of a whole boatload of money.