Secondary market investors and quality control (QC)—will it ever get easier? As I shake my Magic 8 Ball for an answer, I get the response, “Don’t count on it.”
Hot Button Updates for 2016
Most of us are aware by now that the Big 3 investors (Fannie Mae, Freddie Mac, and Federal Home Loan Bank) require secondary market QC reviews, but are we all aware that a secondary market QC review is not just restricted to these investors? Have you checked your contracts lately with investors such as Wisconsin Housing and Economic Development Authority (WHEDA), Chase, Wells Fargo, and Associated to name a few? You might be surprised to learn that your financial institution is required to maintain a QC program for loans sold to these investors as well, and they have been asking for proof QC is being completed.
Secondary market investors have recently been requesting evidence that discretionary file reviews are included in the sample selection in addition to the random selection. What are discretionary file reviews? Typically discretionary file reviews are completed on higher risk loan files such as files with high loan-to-value, complex income calculations, or multiple financed properties. They could include loans originated by new employees or by employees who have recently departed.
What does this mean for your institution?
If you have not been completing your QC reviews because you sell to someone other than Fannie, Freddie, or the Federal Home Loan Bank, we recommend that you review your agreement with your investor. If you have been flying under the radar, we recommend getting your QC process set up before it’s too late. Not complying gives your investor the ability to “pull the plug” and prevent you from selling to them.
Whether you have a vendor do your post-closing QC review or you do it in-house, ensure your reviews include some discretionary sampling.
Basics of a Quality Control Program
Fraud can strike at any stage of the mortgage process, and a QC review can detect indicators of fraud and serve as an alert to management.
A QC program must be in writing. It must provide standard operating procedures for all employees involved with or affected by the QC process. Timeliness is also a major factor and challenge. A good program ensures your institution has the ability to evaluate and monitor the overall quality of mortgage production on a regular and timely basis. Procedures should be in place to ensure that sample selection, mortgage file reviews, and reports to senior management are all conducted on a timely basis.
A QC program may be managed internally or outsourced. If the QC program is handled in-house, management must ensure personnel are knowledgeable of underwriting requirements and any automated underwriting systems used, as well as informed of the additional requirements for manually underwritten loans. Access to resources and current guidelines for the areas being reviewed should be provided to individuals involved in the review process.
Naturally, a major component of an effective QC review is verification of the data integrity of the underwriting decision. Information used to qualify and approve a borrower must be verified. This includes income, debts, and assets. Loan documents, such as the note, mortgage, and appraisal, should be further evaluated for adequacy and conformance with regulatory requirements and industry standards.
Personnel performing the post-closing QC review must be independent of the loan origination and servicing functions. Personnel completing a pre-quality control review must be independent of the loan origination (i.e., cannot be the same loan originator, processor, closer, etc.). Documentation of the review must be retained, and reports must be provided to senior management.
Reports should also include management’s responses. This ensures management is aware of any findings and can take appropriate action such as providing additional training or putting additional controls in place to prevent future findings.
Tips and Friendly Reminders
The expectation continues to be that your financial institution develop and maintain a QC program that defines your standards for quality and establishes processes and controls designed to achieve those standards throughout your entire origination book of business. All investors require lenders to establish a process to review outsourced QC contractor’s work and procedures to address findings identified in the outsourced QC contractor’s mortgage loan reviews. The QC program should also specify the knowledge and competencies that the outsourced QC contractor must possess and the information that must be included in the outsourced QC contractor’s written QC policies and procedures, such as the details of the outsourced contractor’s review methodologies.
As of April 2015, Freddie Mac has followed Fannie Mae and the Federal Home Loan Bank’s lead and now also requires lenders’ QC plans to include a pre-closing QC review process. These reviews are expected to provide information that should prevent closing mortgage loans with significant defects such as misrepresentation, inaccurate data, or inadequate documentation. All secondary market investors recommend establishing a loan selection process, reviewing specific data and documentation, and reporting results of the pre-closing reviews to senior management.
Your financial institution may continue to use statistical sampling for your selection process instead of the standard minimum 10% random selection process without receiving approval from Fannie Mae. However, you must provide written justification of the methodology used, if Fannie Mae asks. In addition, discretionary mortgage selections are now a requirement even when using a statistical sampling methodology, and reviews must include a review of all property types, such as condominiums, cooperatives, and manufactured housing. You are also required to review Early Payment Default loans in addition to a regular post-closing sample review. Also, the Federal Home Loan Bank and Freddie Mac have confirmed that any loans excluded from the post-closing sampling are not eligible for sale to them.
You must have a policy requiring verification of owner occupancy on primary residences. In addition, the QC process must include a review of potential red flag messages or alerts provided by the automated underwriting system, the credit report, or any other source. Your institution must ensure that all potential red flag messages have been addressed and documented and that the loan is eligible for delivery to the secondary market investor.
The QC policy must require QC contractors/service providers to be proficient in knowledge and use of all automated underwriting systems utilized by your financial institution and demonstrate competency in the review of manually underwritten loans. You must ensure that the contractor's review personnel possess the qualifications and experience necessary to provide quality reviews and meaningful analysis.
A post-closing QC review of tax transcripts is required on all loans unless the loan is extended to an FHA or VA non-self-employed borrower. As a reminder, you will want to order both the personal and business tax transcripts if the borrower is self-employed. Also, when ordering the business tax transcripts on self-employed borrowers, the IRS will reject your request if you ask for more than one form (e.g., both Form 1040 and Form 1120) on line six of the 4506 tax transcript request. In September 2015, the IRS revised the form and your institution will want to use the correct version. In addition to this, the IRS will want documentation that authorizes the consumer borrower to have access to the business tax transcripts.
A new tri-merge credit report is required on all loans unless the loan is sold to Freddie Mac, is an FHA streamline refinance, or is an FHA loan underwritten through an automated underwriting system such as Loan Prospector or Desktop Underwriter. Secondary market investors are also asking for a data integrity review of the delivery data documentation such as confirmation of the details of the loan that was sold to the investor. Management is required to establish a defect rating and defect rate tolerances and to evaluate the defect rates at least annually.
Sound Policy Backed by Strong Review
Getting loan QC right is a necessity. A good QC program can ensure that loans conform to your institution’s policies, are of acceptable quality, comply with lending requirements and regulations, and will ultimately not be subject to a repurchase request.