QUESTION
We are a lender in the southwest. I am the VP of mortgage lending. Our loans are only conventional on 1-4 single family residential property. Our primary investor is Fannie Mae. We do not originate government loans or investor loans.
Recently, we ended the relationship with our quality control auditor. So, we're now looking around to replace them. We went to a conference where several lenders highly recommended your firm. So, our compliance manager will be contacting you soon.
Now, we're updating our quality control plan. We need to start over with a new quality control plan. We need guidance about the areas we should outline in the QC plan. I realize this is a big subject, so maybe you can provide an overview of the basic elements.
What are the basic requirements of a QC Plan?
ANSWER
There are essentially six parts to a basic Quality Control Plan ("Plan" or "Program"). More about that shortly. Depending on the company's size, risk profile, complexity, loan products, and investor conduits, to name a few factors, the Plan's purpose is central to controlling a mortgage lender's originating environment.
Thank you for contacting us to handle your quality control auditing. We can accommodate any production size and audit virtually all loan products. We have an entire group devoted to quality control, headed by an Executive Director, and staffed with an accomplished audit staff.
Please contact us here. We'll see that you speak directly with our audit management team.
I would add that it is critical to ensure that the Plan and the QC auditing are aligned. When regulators and investors review your QC reports, they want to see that you are implementing the requirements of your specific Program. When LCG conducts QC, we can provide a Plan that properly reflects your auditing needs. Be sure to discuss the Plan requirements when you speak to us.
You should consider establishing a baseline review of your quality control compliance. To effectuate this assessment, many company's use our QC Tune-up. This mini-audit provides substantive evaluation of your quality control function and provides a risk rating. It's cost-effective, hands-on, and quick. If interested, contact us here for information about the QC Tune-up.
Because you originate only conventional loans
and your primary investor is Fannie Mae (“Fannie”), my response will address the QC
requirements for conventional generally and Fannie in particular.[i]
Your QC Plan must define your lending standards for loan quality, establish processes designed to achieve those standards and mitigate risks associated with the loan origination processes. In that regard, Fannie requires the lender to develop and implement a QC program that provides a structure for identifying the deficiencies in the loan manufacturing process and implementing plans to remediate those deficiencies and underlying issues quickly.
Six Parts of a Quality Control Program
I mentioned above that there are six parts to a basic Quality Control Plan. I am going to provide a brief description of each part. I urge you to contact us if you want a more detailed discussion.
The six parts of a QC Program are:
1. Overview;
2. Contents;
3. Standards and Measures;
4. File Reviews; and
5. Reporting and Remediation.
Overview
Put simply, the Program must include a documented QC Plan that outlines requirements for validating that loans are originated under its established policies and procedures.
The Overview must provide guidelines to ensure that:
· the loans comply with applicable federal, state, and local laws and regulations;
· the loans comply with investors' guidelines, such as Fannie Mae's Selling Guide, all related contractual terms and agreements, and are in all respects eligible for delivery to Fannie; and
· the Plan must guard against fraud, negligence, errors, and omissions by officers, employees, contractors (whether or not involved in the origination of the mortgage loans), brokers, borrowers, marketing partners, and others involved in the mortgage process.
Contents
The Plan must include documented QC procedures
that establish standards for quality and incorporate systems and processes for
achieving those standards. At a minimum, the Plan must contain the following categories.
· Quality
standards and measures, including:
o
a
general overview and description of the QC philosophy;
o
the
plan objectives;
o
specific
risks to be measured, monitored, and managed; and
o
the
methods used to ensure the Program is an independent and unbiased function,
including program governance (targets, sampling) and transaction execution.
· Procedures involving detailed operating and
reporting methods for all employees affected by the QC process.
· QC file
review process: a process for performing prefunding and post-closing QC
file reviews, including, at a minimum, a method for
o
confirming
compliance with the investors’ guidelines, all related contractual terms and
agreements, and that the loans are in all respects eligible for delivery to
Fannie; and
o
confirming
compliance with applicable federal, state, and local laws and regulations.
· Sample
selection process: the procedures and metrics for identifying a
representative sample of loans for QC file reviews using both random and
discretionary selection methodologies, as applicable, that include loans
o
originated
through each applicable production channel (for example, retail, correspondent,
and third-party originators);
o
originated
under all mortgage products (for instance, fixed, ARM, and special or niche
programs); and
o
originated
using all underwriting methods (manual and AUS).
· Reporting: written procedures for reporting the
results of the QC file reviews, including the method of monthly reporting of
review findings, including
o
the
method of monthly reporting of review findings;
o
identifying
critical components included in the reports;
o
distributing
summary-level findings to senior management;
o
distributing
loan-level findings to the business unit(s), specifically to parties within the
business unit(s) responsible for resolution;
o
requiring
a timely response to and resolution – or resolution plan – of findings
identified in the QC review process; and
o
maintaining
accurate and detailed records of the QC reviews’ results.
· Vendor
review: a process for
reviewing the QC work performed by the third-party auditors.
· File
retention: procedures
for maintaining for three years records of the QC findings and reports, loan
files reviewed, and all related documentation, including chronicling the
location of such records.
· Audit: an audit process to ensure that the lender’s QC processes and procedures are followed by the QC staff and that its assessments and conclusions are recorded and consistently applied.
Quality Standards and Measures
This is a somewhat complicated area, often leading to confusion. So, I will offer a high-level description. A lender is responsible for the development and maintenance of standards for loan quality and the establishment of processes designed to achieve those standards.
To evaluate and measure loan quality standards effectively, the lender must establish a methodology for identifying, categorizing, and measuring defects and trends against an established target defect rate.
At a minimum, the lender must identify any loans with a defect; specifically, these are loans not in compliance with investor guidelines or other related contractual terms and agreements. A methodology must be established by which all loans with identified defects can be categorized based on the severity of the defect. The lender must define the severity levels appropriate to its organization and reporting needs; however, the highest severity level must be assigned to those loans with defects resulting in the loan not being eligible as delivered to Fannie.
The lender must also establish target defect rates for its organization, reflecting its quality standards and goals. Establishing a target defect rate is based on a lender’s post-closing random QC sample. It enables the lender to regularly evaluate and measure progress in meeting loan quality standards.
Different target defect rates may be established for different severity levels; however, at a minimum, a target defect rate must be established for the lender’s highest level of severity.
Here’s an suggestion: a target defect rate that is as reasonably low as possible should be established. Once the targets are set, performance against the targets must be measured at least quarterly and reported to management. It is also essential that the target defect rate(s) be evaluated and, if necessary, reset at least annually. The lender must document the rationale for establishing the target rate(s). During a Fannie review, consideration may be given to how the lender’s chosen target defect rate affects the investor’s risk. Sometimes, this leads to the investor requiring a more realistic target.
QC File Review Overview
As part of its Program, the lender must implement procedures to evaluate and monitor the overall quality of mortgage production through prefunding and post-closing reviews. A loan file review assesses loan quality, ensures eligibility, and confirms that the underwriting decision is justified. Loan-level file reviews must include, at a minimum, an assessment of
· compliance with Fannie requirements by confirming that
o
the
loan meets eligibility and underwriting requirements,
o
the
underwriting decision is adequately supported, and all documentation required
to support the decision is contained in the file, and
o the loan is secured by a property that provides acceptable collateral; and
· compliance with all federal, state, and local laws and regulations.
When a loan file review identifies discrepancies between the data and information used in the underwriting decision and the data or information verified through the QC process, the lender must reassess the underwriting decision based on the newly confirmed information to determine whether the loan remains eligible as delivered to Fannie.
If it is determined that the mortgage loan was not eligible as delivered, the lender must advise Fannie of these findings.
Selection of Loans for QC Review
The QC process must include mechanisms for monitoring the quality of work performed by employees, contractors, vendors, and other third parties involved in loan origination, property appraisal, processing, underwriting, appraisal review, and closing functions.
The lender must implement and document a process for identifying a representative sample of loans for QC file reviews for both prefunding and post-closing QC. While utilizing discretionary file selections for prefunding QC is appropriate, the post-closing QC process must include both random and discretionary file selections. The lender must assess and understand the overall risk inherent in its origination processes when determining the appropriate selection methodology and sample size for its prefunding and post-closing discretionary QC sampling.
Concerning discretionary reviews, the lender should consider risks inherent in its processes and errors or defects identified through prior reviews. To be effective, the sampling methodology for discretionary review types must be flexible and fluid enough to target loans with higher potential for risk and to be able to adjust as these risks change over time. Discretionary review selection methodologies must be regularly re-evaluated to ensure their effectiveness. They may change frequently due to findings from prior reviews or changes in the lender's product mix, staffing, sources of business, or other risk factors.
When the lender sells mortgage loans from Third Party Originators (“TPO”) to Fannie, the QC process must include additional steps to monitor the quality of third-party originations. At a minimum, the lender’s QC selection process must consist of a representative sample of the mortgage loans received from the TPO to ensure that those originations meet the lender’s standards for loan quality. Review cycles must be structured to ensure that transactions originated by each TPO are reviewed at least once annually.
Reporting and Remediation
QC reports are obviously a critical component of the QC program. The reports enable management to evaluate and monitor the loan origination process's quality and identify specific loans or broad-based systemic, procedural, or operational issues that need to be addressed or remedied to reduce the lender’s defect rate and improve loan quality. When trends are identified through the review process, a plan should be implemented for specific corrective actions, including the expected resolution and the time frames for implementation.
The lender must report on the results of both prefunding and post-closing QC file reviews to senior management on no less than a monthly basis.
Contact Us for information regarding our Quality Control Audits.
Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
[i] Fannie
Mae provides an outline of its expectations with respect to Quality Control
Programs. See the Fanne Mae Selling Guide, specifically the various parts under
Ensuring Quality Control, in particular, D1-1-01 Lender Quality Control
Programs, Plans, and Processes (08/07/2019).
