MReport February 2019

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TH E M R EP O RT | 47 O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T THE LATEST ORIGINATION After the Disaster How do natural disasters impact rates of mortgage defect risk? T he First American Loan Application Defect Index revealed an in- crease of 1.3 percent in the frequency of defects, fraudu- lence, and misrepresentation in the information submitted in mortgage loan applications in October 2018. However, it noted a decline of 4.8 percent in the Defect Index, compared to October 2017. The index also indicates a 22.5 percent fall from the high point of risk in October 2013. "While the overall risk of loan application defects, fraud, and misrepresentation declined from a year-over-year perspective, there are regions with the potential for higher defect risk due to the impact from natural disasters," said Mark Fleming, Chief Economist at First American. "Historical data indicates that natural disasters and loan applica- tion defect risk go hand-in-hand", Fleming said. While losses from the wildfires in California continue to be assessed, Fleming indicated that the risk of mortgage loan applica- tion frauds in California and other affected markets is likely to see an increase in the months ahead. Los Angeles has trended down in re- cent months, according to Fleming. Wildfires in Northern California "gutted 6,800 homes and resulted in $12.6 billion in insured losses." "The Defect Index in Los Angeles has trended down in recent months, while Oxnard has experienced a relatively flat trend in fraud risk following the post-Thomas Fire surge. Given historical trends, it's fair to expect increases in defect and fraud risk in these affected markets in the near future," Fleming said. Speaking of the Camp Fires and Woolsey Fires in California, Fleming indicated that a higher estimate in losses may be expected since the damage from the recent wildfires greatly exceeded that of 2017. "Fraud and misrepresentation risk remained elevated for five months after the wildfire, before trending down again. Defect, fraud, and misrepresentation risk in the Oxnard metropolitan area, which had been declining prior to the Thomas Fire, has yet to return to pre-wildfire levels," he said. What's Impacting Post- Close Loan Defects? Here's how certain lender operations affect critical defects of post-close loans. C ritical defects attrib- uted to Borrower and Mortgage Eligibility increased by 70 percent to 11.36 percent in the second quarter of 2018, according to the latest Mortgage QC Industry Trends Report by Aces Risk Management (ARMCO). The report represents an analysis of post-closing quality control data derived from loan files analyzed by the ACES Analytics benchmarking system, during the second quarter of 2018 (Q2 2018). It revealed that critical defects were most frequently related to core underwriting and eligibility issues, a trend that has been seen since the first quarter of 2017. Q2 was also the second con- secutive quarter to see a signifi- cant increase (23.8 percent) in the number of defects related to loan package documentation. On the other hand, the critical defect rate remained relatively steady at 1.71 percent compared to the first quarter of 2018. According to ARMCO, a critical defect is defined as a defect that would result in the loan being uninsurable or ineligible for sale. The critical defect rate reflects the percentage of loans reviewed for which at least one critical defect was identified during the post- closing quality control review and all reported defects are net defects. Looking at the distribution of critical defects across loan trans- action types, the report found a higher percentage of these defects in purchase transactions compared to refinances. "This finding aligns with the assertion that purchase originations are typically more in- tricate and complex than refinance transactions and therefore present a greater risk of critical defects," the ARMCO report stated. The top three defect categories were income/employment, loan package documentation, and assets, which accounted for 22.73 percent, 19.89 percent, and 17.61 percent of all critical defects respectively. The report cited that the increase in defects in loan package documen- tation were often associated with understaffing and downsizing by the lender. When broken down by loan type, conventional loans account- ed for 54.91 percent of all loans reviewed, FHA loans accounted for 33.10 percent, VA loans com- prised 8.25 percent of the total, and USDA loans accounted for 3.75 percent. The report cited that the increase in defects in loan package documentation were often associated with understaffing and downsizing by the lender.

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