Now, more than ever before, the market opportunities present the right time for credit unions to reaffirm member relationships through proactive mortgage lending initiatives. Members are undeniably searching fora trusted adviser to assist with their home-financing needs. Who better to fill this role than their credit union?

Balancing members' needs with sustaining long-term financial success requires a roadmap that generates a safe, sound and successful mortgage lending operation.

This roadmap begins with identifying, managing and mitigating risk. There are three primary types of risk within mortgage lending: financial risk, interest rate risk and operational risk.

Financial risk typically exists when accounting and financial reporting practices adopted do not correlate to the economic environment. For example, the lender must understand that the loan-level economics of a single-funded loan and the accounting requirements typically produce different pictures of the profitability of the transactions, particularly under varying duration assumptions.

Financial risk can also occur as the result of nonperforming assets, legal matters and noncompliance with regulatory guidelines and federal or state legislation. As an example, proactive loss-mitigation measures can result in savings relating to membership and financial loss.

Interest rate risk occurs within three primary areas: mortgage loans unfunded but committed to be sold to a third party (pipeline), mortgage loans held on the balance sheet (portfolio) and mortgage servicing assets (MSAs). The risk associated with each occurs when shifts in interest rates result in declines in values.

The pipeline and portfolio require the implementation of hedging strategies to minimize the risk of substantial financial loss. The risks within the portfolio are increased when an asset-liability mismatch occurs with mortgages due to their long maturity. Hedging techniques might include matched borrowings or the use of interest rate swaps or options.

MSA requires insightful accounting and hedging techniques to displace the loss in value when prepayments (or run off) and delinquencies occur.

Operational risk occurs when an organization is not managing the business processes. Under operational risk follows control risk, process risk, cost risk and technological risk.

The lack of a control structure (internal controls, monitoring and performance measurement standards) can result in material losses. Controls are both financial and operational in nature. Financial controls typically include ensuring that an organization has adequate monitoring procedures to ensure the accuracy of the financial results. Operational controls are the procedures that monitor the performance of operations.

Process risk relates to the risk of not understanding the complete series of business processes within all segments of operations. Within the key functions of sales, processing, secondary or servicing there are a multitude of tasks performed that when compiled facilitate delivery of the loan. The process risk in mortgage lending primarily relates to significant numbers of nonvalue-added tasks deployed within the credit union's operations, losing sight of member needs and duplication of efforts between people and technology.

A lack of risk management over cost structures results in unnecessary expenditures, which can mean hundreds of thousands of dollars annually. In many situations the specific tasks or functions within an organization are conducted without cost justification or because the relative level of risk has not been defined.

The most obvious type of operational risk relates to technology. This type of risk typically occurs due to a lack of focus on technology and when the company overlooks options that can result in more efficient loan production, commitment and delivery.

Given today's lending environment, now is truly the time for credit unions to seize the opportunity to enhance their current mortgage lending strategies. Instead of deliberating over increased foreclosures and concerns over the financial soundness of the housing GSEs, credit unions should collectively change the tide to put more members into homes and help members stay in their homes.

Laura A. Pephens, CPA, is the managing principal at Pephens & Co.
She can be reached at 949-248-4596 or
[email protected]