QUESTION
I am the compliance manager at a lender in the Midwest. We downsized our Quality Control department recently due to market conditions. However, we still have a quality control manager and two other QC employees. Frankly, we may outsource all the quality control soon.
I am interested in keeping stability in QC, whether we keep or outsource it. To do that, I need to know two things: (1) how to maintain QC independence and (2) what kind of audit will provide oversight of the QC department and functions.
We have solved the second item since we are using your firm for the QC Tune-up. But I still don't know how to determine if our QC department is truly independent. Last year, our regulator told us that our QC department was not operating independently. We expect them back soon for another examination, and I'm sure this will come up again.
How should we maintain QC independence?
And, what are some audit features for overseeing the QC department?
ANSWER
Our QC Tune-up reviews of post-closing frequently find that the Quality Control department and functions are not independent of the originations and production lines. I will add that the same is the case for prefunding, as the prefunding process sometimes doesn't operate independently of production.
We've even encountered situations where the head of underwriting is also involved in managing QC. That's about as big a violation of independence as imaginable! I have a business card from somebody that says she's the "VP / Underwriting and Quality Control." Regulators go ballistic when they come upon such inappropriate situations. And investors, such as Fannie, forbid it.
If you're serious about preserving the integrity of the QC process, all your post-closing QC employees (including those related to establishing, monitoring, and enforcing procedures) must be independent of the production, underwriting, and closing departments. Furthermore, the reporting lines should not be blurred and must reflect the independence of the audit QC process at all levels.
Prefunding QC process must operate independently of the lender's production department. If, for some reason, that is not possible, prefunding QC must nevertheless be done by individuals without involvement in reviewing the subject loan's processing and underwriting decision.
Here's the point: the wall between QC and the production, underwriting, and closing departments ensures that the QC staff is not influenced to alter QC results. Obviously, it is critical that QC auditing is conducted without bias or compromising the quality control findings resulting from internal influences or conflicts of interest.
Thank you for retaining us for the QC Tune-up. By using the QC Tune-up, you are acting responsibly to determine the strengths and weaknesses of the QC department and its functions. If others want information about the QC Tune-up, please contact us here.
You may have a written QC plan, but how are you ensuring that the QC program operates according to the requirements set forth therein or whether the QC department's activities are verifiably independent, without influence by parties with a vested interest in QC results? Most investors demand an effective QC program. Indeed, if you check your investor PSAs and supporting documents, you'll likely find that it is a breach of your contractual obligations with them if you do not have an effective QC department.
To monitor the
QC department, four factors should be considered.
1. Oversight
procedures should be independent of all key functions of the loan manufacturing
process. This ensures that the reviews provide an objective and unbiased
evaluation.
2. Reporting
lines should reflect the independence of the audit process at all levels,
thereby ascertaining that QC activities are performed in an unbiased manner.
3. The
audit function must not share any reporting lines with functional areas under
review.
4. The oversight function must report directly to senior management and/or the Board of Directors. Reports derived from the procedures should recommend remedies, if needed, to ensure risk management, internal control, and governance objectives.
If remediation is needed, I recommend drafting an action plan. The plan should be continually updated, as appropriate, with remediation initiatives and changes to policies and procedures. Also, ratify an audit or oversight review schedule that contains areas subject to review and the timeframe required to fulfill the review process. Be sure the scope of the review is clearly defined.
QC oversight is so important and mission-critical that most of our clients have us conduct a QCTune-up every twelve months. Over twelve months, many testing protocols can change, statutes and investor guidelines vary, approval authorities and personnel change, ongoing change management is updated, and loan level documentation may be revised, all of which affect the effectiveness of the QC department.
Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
