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Automatic Underwriting in Home Equity:

Preparing for Opportunities in the Gray Area


Jim Leath
BenchMark Consulting International

Over the past 20 years, institutions have undergone At the same time, technology was making it easier for
massive structural, regulatory, social and technological credit repositories to track and supply consumer credit
changes that have changed the very nature of the information. Decisioning engines were developed that
underwriting function. Recent data indicate that industry could take this credit information, primarily the Fair,
leaders, particularly in the home equity sector, are Isaac and Company FICO score, along with the
relying more heavily on automated systems for their institution’s established lending guidelines and
underwriting and decisioning functions. At the same determine automatically whether a loan or line should be
time, the environment in which lenders operate is accepted, denied or investigated further.
becoming more competitive and may be forcing them
outside the traditional A-paper space into riskier credit Today, automated underwriting engines are used
grades. Lenders are approaching a fork in the road that industrywide on nearly every type of lending product.
will force them to choose to rely more heavily on Additional automation, primarily built into the
human underwriters or on technology to underwrite origination and processing system, makes it possible for
their lending business in the future. The question may processors to complete most applications and shepherd
have serious implications when institutions lose internal them to the closing table without an underwriter ever
underwriting expertise. getting involved.

A Brief History of Underwriting Automated Decisioning on the Rise


Prior to the 1990s, the bank underwriter was the The trend toward greater levels of automated
individual upon whose authority the institution would decisioning in the institution is well documented and
enter into a lending agreement with a borrower. The expected to continue. In BenchMark’s home equity
recommendation of the underwriter was of utmost lending program the numbers clearly indicate that auto
importance. Each branch employed professional decisioning is on the rise, especially among the
underwriters that examined the specifics of each industry’s leaders.
borrower and property in order to make a lending
decision every time a customer entered the bank. BenchMark also performs the annual CBA Home
Equity Lending Survey, which further validates this
But by the 90s, lending was big business and larger trend (see Figure 1). While the institutions studied
organizations realized that it was dangerous to have a change from year to year, we have found that more
different interpretation of the institution’s credit policy home equity lenders are relying more heavily on these
being used in each branch. With many banks operating automated systems each year.
hundreds of branches, this was a critical concern.
Centralized credit was the answer. Institutions that use auto decisioning
2004 – 48% (n=10)
By sending every deal to a single department, staffed by
2003 – 44% (n=14)
a much smaller group of highly trained underwriters well
2002 – 43% (n=15)
versed in the company’s policy, banks were able to
2001 – 34% (n=12)
ensure that the same rules were applied to every deal. In
Source: CBA Home Equity Lending Survey
addition, more deals could be completed with fewer
Figure 1
people because underwriting personnel were no longer
shared by other departments, but were rather dedicated
to that single operation.

Copyright © 2005. BenchMark Consulting International NA, Inc. All Rights Reserved
But the fact that a lender uses an automated There is also a positive financial reason that some
underwriting system does not necessarily mean that the lenders, particularly home equity and subprime lenders,
company is making underwriting decisions in an would rather find a way to profit from a riskier deal
automated fashion. There is a clear distinction between through risk-based pricing than to deny the application
auto decisioning and auto recommend. Many lenders outright. Consequently, the lenders will utilize their
assume that since they have an engine that helps them technology to place the loan or line in a gray area and
make decisions that they have auto decisioning in their create an exception for review by an underwriter.
shop. What most actually have is a system that
automatically returns a recommendation. While the Every institution has a different appetite for risk.
system may recommend that a lender approve a deal, a Likewise, each underwriting department is made up of
human underwriter still concurs with the deal before it is professionals with different backgrounds and
approved. experience. Since there is no legal standard for how
these technologies are employed, each institution is free
Automated underwriting systems evaluate all criteria to use them as they see fit. Today, many lenders are
relating to an application and then return one of three using their automated technology to make
recommendations: approve, decline or underwriter recommendations. But that is changing.
review (gray area) that is sometimes referred to as
caution. Auto decisioning systems automatically approve How Lenders Use Technology Today
and or deny applications based on the findings of these
systems and either move them on to the processing While the data generally indicate that the use of
department or send out a rejection letter. The technological systems for auto decisioning is on the rise
exceptions left in the gray area are sent to underwriters. in institutions, that conclusion does not hold generally
All applications that pass through an auto recommend for all lenders. In our own studies of the home equity
system end up on the underwriter’s desk. sector, we received a vast range of responses to our
questions about automated underwriting. Most of the
Lenders are attracted to automatic decisioning because it firms we studied auto decisioned very few of their equity
offers them significant competitive advantages. By applications.
allowing technology to underwrite the majority of the
applications received, lenders can do more with the The data below (see Figure 2) were taken from our most
same number of full time employees, lowering their recent home equity lending program and provide an
fixed expenses. In addition, turnaround times are indication of how lenders are employing their
reduced, allowing the company to move deals to the technology in regards to home equity products.
closing table more quickly than competitors while still
mitigating risk. Five of the anonymous clients represented in the
accompanying table are current home equity sector
leaders. While these companies relied far more heavily
on technology – with two clients handling about half of
their applications in an automated fashion – not all
leaders were operating at this level.

Lender Code 1 2 3 4 5 6 7 8 9 10 11 12
approved 65.6% 68.7% 72.9% 76.1% 70.6% 60.9% 70.8% 68.3% 77.5% 79.1% 70.0% 70.8%
auto-decisioned 52.1% 1.4% 22.6% 11.5% 13.0% 46.2% 0.0% 0.0% 6.1% 0.0% 5.3% 15.8%
auto-approved 52.1% 0.0% 14.5% 8.0% 0.0% 35.3% 0.0% 0.0% 4.3% 0.0% 0.0% 0.0%
auto-declined 0.0% 1.4% 8.0% 3.5% 13.0% 10.9% 0.0% 0.0% 1.9% 0.0% 5.3% 15.8%
booked 53.0% 55.0% 51.4% 65.5% 53.0% 49.9% 66.7% 41.4% 66.9% 68.6% 51.7% 53.5%
Source: 2005 Home Equity BenchMark Program
Figure 2

BenchMark Consulting International 2 Automatic Underwriting – April 2005


If we look at all of the data BenchMark has gathered in This is perhaps the best evidence for the conclusion that
this area since 2001, we find that lenders operating in lenders will continue to move in the direction of more
the 80th percentile are auto decisioning roughly a auto decisioning in the future. As they do so, they are
quarter of their home equity volume (See Figure 3). But less likely to depend upon professional underwriters.
the median is still only 3.4 percent.
It is conceivable that some institutions will find
As we would expect, given the current legislative and themselves without an underwriting staff in the future,
regulatory climate, home equity lenders are far more relying completely on automation to determine whether
likely to auto approve an application than auto decline a particular deal falls within the acceptable guidelines
one. Lenders in the 80th percentile are more than twice and then counting on processors to collect the
as likely to auto approve than decline. Lenders that rely documents that verify the facts on the application.
less heavily on these technologies will auto approve even
smaller percentages, with those in the 75th percentile Implications for the Future
approving roughly three times as many.
Since the largest home equity firms appear to be
Interestingly, those lenders operating around the median embracing auto decisioning most rapidly, it seems clear
did tend to use auto decline more often than auto that these technologies are part of a strategy that is
approve. However, the low incidence of use (less than effective in the short term. But will it always be so?
half of one percent) indicates that these applications
We think there are a number of reasons lenders should
may have been outlying deals that were so far away from
be thinking about this now.
an acceptable borrower that the technology could easily
cull them. First of all, auto decisioning involves the auto approved
and auto declined applications, but those applications
These data also indicate that equity lenders that use that fall in the gray area between these extremes must
automated decisioning tend to approve more loans and still be underwritten. Technology is improving, to be
lines, as a percentage of total applications, and book a sure, but it is unlikely that it will squeeze this gap to zero
higher percentage of those applications they approve. in the near term.
Those lenders in the 80th percentile will approve, on
average, 77.6 percent of the equity applications they see However, higher levels of competition, particularly in
and eventually book 65.8 percent, losing only 11.8 the A-credit home equity business, will force lenders to
percent (77.6% - 65.8%) of the deals. Those in the 75th seek out business in other credit grades. As FICO scores
percentile will approve slightly fewer applications, but drop, it is realistic to expect more loans and lines to fall
lose more, 12.7 percent (76.3% - 63.6%). Finally, the out of the auto decisioning range and into the gray area
lenders operating around the median will approve only where manual underwriting is required. This means that
72.9 percent of the applications and book only 53.4 institutions, if they wish to get this business, will have to
percent. These lenders are losing one in five deals find some way to underwrite it.
(72.9% - 53.4%).
Lenders will have basically two options, they can
Lenders that utilize a higher level of automation will outsource it or they can hire, train and maintain a staff
move their deals to the closing table faster than those of in-house underwriters that can handle this work for
that don’t rely as heavily on these systems. In the home them.
equity business, where access to the cash locked up in
the borrower’s home is the primary reason for the Contract underwriters could potentially handle this
transaction, speed is of the essence. Therefore, auto business more cheaply and perhaps faster than
decisioning constitutes a significant competitive originators could themselves, making it attractive to
advantage and our data bear that out, with the larger send that business outside of the institution. Increased
lenders utilizing more technology and closing a higher competition, especially in the home equity sector, could
percentage of the deals they approve. push originators in the direction of outsourcing.

Includes '05, '03 and '01 Data


High Low 80th % 75th % Median
% Equity applications auto-decisioned 52.5% 0.0% 22.6% 16.2% 3.4%
% Equity applications auto-approved 52.1% 0.0% 16.3% 15.2% 0.0%
% Equity applications auto-declined 15.8% 0.0% 8.0% 5.3% 0.4%
% Equity applications approved 87.8% 54.4% 77.6% 76.3% 72.9%
% Equity applications booked 79.4% 45.4% 65.8% 63.6% 53.4%
2001, 2003, and 2005 Home Equity BenchMark Programs
Figure 3

BenchMark Consulting International 3 Automatic Underwriting – April 2005


If lenders embrace increased technology with In the end, we believe lenders will eventually settle on
outsourced underwriting as the solution of choice for one of these two options.
the future, will it lead to fewer qualified underwriters in
the marketplace? If it does, underwriters could Those lenders that see auto decisioning handling fewer
command higher fees for their services. Likewise, the of their applications as they move away from the easy A-
costs associated with outsourced underwriting could credit loans and lines and into riskier territory, but that
rise. Under this scenario, the institutions that maintained are averse to sending the underwriting function outside
and trained a core workforce of professional the company, will want to re-evaluate their plan for
underwriters could be at a competitive advantage. hiring, training and maintaining professional
underwriters.
In the meantime, and perhaps for all time if outsourced
underwriting becomes commoditized and prices remain Those lenders that see technology handling an
low, institutions that choose to shoulder the additional increasing percentage of their overall application load
costs of FTE in the underwriting department could find and that believe contract underwriting will become more
themselves suffering from an unnecessary drain on commoditized over time will begin to exhibit behavior
resources. similar to that seen among the larger home equity
lenders today. We can expect those firms to invest more
These questions are not simply dependent upon heavily in technology, to forge strong relationships with
economic elements in the future, such as the cost of outsourcers and to pay more attention to the processors
personnel or outsourcing services. They are also who will inherit some of the risk mitigation work that
dependent on the decisions these lenders make about was previously performed by the underwriters.
their business, their appetite for risk and the level of
their investment in technology. In fact, these questions Either strategy could be utilized effectively in the days
cannot be answered until these additional factors are ahead, allowing lenders to profit by originating more of
taken into consideration. Furthermore, the correct the loans and lines that fall into this gray area. Not
answers for one institution will differ from the correct settling on one could pose a significant threat to
answers for another. institutions as these trends play out in the future.

Jim Leath is the Mortgage and Consumer Lending practice manager at BenchMark Consulting International. He has
extensive background in mortgage and consumer lending, strategic planning, consolidations and corporate restructuring.

BenchMark Consulting International has specialized in improving the financial services industry since 1988. The
company is a management consulting firm that improves the profitability of its financial services clients through the
delivery of management decision making information and change management services to realize the benefits of
business process changes. BenchMark Consulting International’s expertise is in the measuring, designing and managing
of operational processes.

The firm has worked with 36 of the top 50 (in asset size) commercial banks, all 14 automobile captive finance
corporations, several of the largest consumer finance corporations and many regional banks throughout the United
States. Internationally, BenchMark Consulting International has worked with the five largest Canadian commercial
banks, more than 40 European organizations in 11 different countries, in addition to financial institutions in Latin
America, Asia and Australia.

The company is a wholly owned subsidiary of Fidelity Information Services, Inc., with clients in more than 50 countries
and territories, providing application software, information processing management, outsourcing services and
professional IT consulting to the financial services and mortgage industries. BenchMark has dual headquarters in
Atlanta, GA and Munich, Germany. For more information please go to www.benchmarkinternational.com

BenchMark Consulting International


14 Piedmont Center NE, Suite 950
Atlanta, GA 30305
(404) 442-4100
www.benchmarkinternational.com

BenchMark Consulting International 4 Automatic Underwriting – April 2005

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