Servicing Quality Control: Why’s and Wherefore’s

QUESTION 

I am the Chief Compliance Officer of a mid-size mortgage lender. I started here about three months ago. We are Fannie and Freddie approved and subservice our loans. However, I have discovered some serious lapses in compliance involving our subservicing oversight. 

Last week, I was shocked to find out that we have never done loan servicing quality control. To make matters worse, we have never done an annual review of the servicer. When I discussed this with the CEO, he blew me off. He doesn’t want to do loan servicing QC. As to the annual review, he only wants to do the bare minimum. 

He reads your weekly newsletter and quotes you all the time. I do too. But I have to get through to him somehow about the urgency of doing loan servicing QC. We are scheduled for our Fannie MORA review soon, and I know this may be an issue. I thought you would be willing to write an article about this requirement. 

I spoke to your firm’s representative to get a proposal for loan servicing QC, the most pressing issue. She sent me the proposal and other materials. But I can’t get anything done until the CEO authorizes this compliance service. I hope the CEO reads your response. I will show it to him! 

What is the importance of doing loan servicing quality control? 

ANSWER 

Loan servicing quality control is not an option. My sense of your CEO’s reaction is that he views it as an optional rather than a mandatory compliance requirement. If he wants to talk, ask him to contact me. Your investors, such as Fannie and Freddie, will demand servicing QC as a condition of their relationship with your firm. 

Think about it! You are entrusting the precious product of your loan originations into the hands of another company to conduct loan servicing; however, for whatever reason, you are not implementing ongoing, loan level, quality control of the servicing activities nor checking on the subservicer annually to ensure there are no risk-related issues that could affect the safety and soundness of your financial institution. Doesn’t make much sense, does it? 

My impression from your inquiry is that you also do not have a Loan Servicing Quality Control Plan (“Plan”). That, too, is a requirement. Just as you have a quality control plan for loan originations, if you are subservicing you must have a quality control plan for servicing through a subservicer. 

Loan servicing QC covers Fannie Mae, Freddie Mac, HUD/FHA, VA, Ginnie Mae, USDA, CFPB, many investors, and state (statutory) mandates. In most cases, your firm is still liable for the actions of your subservicer. For example, Freddie mandates implementing a written quality control program for servicing its mortgages. Subject to audit, Freddie will review and require changes to the Plan. Servicers must have written policies and procedures documenting their Plan’s requirements and consistently monitor compliance with these policies and procedures as part of a prudent risk management framework.[i] 

Need compliance support for loan servicing quality control? Contact us HERE. 

Consider the areas subject to loan servicing quality control reviews conducted for HUD/FHA loans. Except for particular factors associated with certain loans (i.e., FHA, VA), the servicing QC review, which should be conducted monthly, would include, but not be limited to, a per file selection audit of:[ii] 

·       ARM adjustments, conversions, and disclosures;

·       Assumption processing;

·       Bankruptcy procedures;

·       Claims, and claims without conveyance of title;

·       Collections and defaults;

·       Continuity of contact with the borrower;

·       Customer service;

·       Deficiency judgments;

·       Document retention;

·       Early intervention;

·       Early payment defaults (i.e., FHA);

·       Error resolution;

·       Escrow administration;

·       Fees and charges;

·       Flood monitoring;

·       Force-placed insurance;

·       Foreclosure processing;

·       Handling of prepayments;

·       Hazard insurance;

·       HECM disbursement reporting;

·       Information requests;

·       Loss Mitigation efforts;

·       Maintenance of records.

·       MIP billings;

·       New loan boarding;

·       New loans, servicing transfers, acquisitions;

·       Paid-in-full mortgages;

·       Payment processing;

·       Payoffs, demands, and satisfaction;

·       Periodic billing;

·       Pre-foreclosure;

·       REOs;

·       Reporting under the Single Family Default Monitoring System (SFDMS);

·       Section 235 (FHA) recertifications;

·       Servicing delinquent accounts; and,

·       Trustee Sales. 

Federal, state, and agency statutes and requirements apply to mortgage lending, servicing (and foreclosure). Loan level reviews such as foreclosure, loss mitigation, ARM adjustments, and servicing transfers are reviewed to ensure compliance with regulatory requirements. Actually, we have counted at least twenty-six essential loan servicing functions. We target these functions. They are called Areas of Inquiry or AOI. Sampling is usually random, which allows the file selection to show the implementation of the Life Events applicable to the file in particular and the servicing portfolio in general. Our audits are done by credentialed auditors, compliance professionals with expertise in servicing compliance. Although there are automated auditing platforms, we know from experience that there is no replacement for a hands-on review of documents subject to audit. 

Let’s zero in on your Fannie Mae Seller/Servicer arrangement.[iii] It appears you are a Master Servicer.

Although your firm has chosen to use a subservicer, you may do so only if that arrangement does not interfere with your ability to meet Fannie Mae’s remitting and reporting requirements. And, crucially, though you are using a subservicer, your firm remains fully liable to Fannie Mae for the performance of all servicing obligations. Fannie Mae may enforce any rights and remedies it may have against a Master Servicer for breach of the servicing obligations, whether such breach was caused by the Master Servicer or by the subservicer. In addition to the foregoing, and not in limitation thereof, Fannie Mae also may enforce any rights and remedies it may have against the subservicer for breach of the servicing obligations. 

Indeed, Fannie Mae has virtually zero tolerance for unresolved servicing compliance issues. The Master Servicer can’t just push liability onto the subservicer. A typical mortgage loan subservicing agreement has indemnification clauses for the subservicer and the lender. To that, I say, so what? The Master Servicer must ensure that its written agreement with the subservicer acknowledges Fannie Mae’s right to rescind its recognition of the subservicing arrangement if Fannie Mae decides to transfer the Master Servicer’s portfolio for any reason. 

Some lenders say they get their subservicer’s reports on their loan servicing activities, which, it is claimed, should be sufficient. It is not! The Master Servicer is required to conduct its own due diligence and not rely on the reporting of the subservicer. From the investor’s point of view, it was your choice to use a subservicer. Liability does not transfer. For instance, the Master Servicer represents and warrants to Fannie Mae that the subservicer will service the mortgage loans in accordance with all Fannie Mae requirements. If the subservicer messes up, providing their reports to the investor is simply not a viable affirmative defense. Even if loan servicing QC were not required, I think it is irresponsible to rely on the subservicer’s reports rather than conduct loan servicing QC. It implies the company is overtly willing to operate at a high risk of compliance failure as well as a potential breach of contract with investors. 

Both the Master Servicer and the subservicer must have policies and procedures to address servicing functions which include, but are not limited to, mortgage payoffs, modifications to an eNote, foreclosure, bankruptcy, and other legal proceedings. Indeed, the very selection of a subservicer should be performed pursuant to the policies and procedures. 

We have designed and built servicing platforms. One issue that usually comes up is aligning the Master Servicer’s and subservicer’s policies and procedures, whether that means aligning the Master Servicer to a subservicer or the subservicer to the Master Servicer. This alignment must be done in a way that, among other things, the subservicing agreement does not conflict with the investor’s servicing requirements. 

Ultimately, the purpose of the monthly, loan level, per file, loan servicing QC review should provide valuable information and observation regarding the servicing portfolio handled by the subservicer. As in most due diligence reviews, it is not what you are told but what you are not told – the uncovered and unreported issues – that are dispositive in determining appropriate remedies. Our clients conduct loan servicing quality control not only because it is required but also because the findings derived therefrom drive value to their businesses. Your firm should be proactively overseeing the loan subservicer relationship regularly, whether you conduct your own reviews or utilize the services of an outside auditor.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] § 3403.1, Servicer’s Quality Control Program, Chapter 3403, Freddie Mac Single-Family Seller/Servicer Guide

[ii] Quality Control for Single Family Servicing, Chapter 7, Quality Control Plan, Part C

[iii] § A2-1-06, Subservicing, Fannie Mae, Single Family, Servicing Guide, October 12, 2022