Does your institution’s secondary market loan quality control
program measure up?
Financial institutions selling loans to the secondary market are required to have a loan
quality control (QC) program to monitor and evaluate the integrity of the loan origination and underwriting processes and to provide feedback to management on originations so appropriate action can be taken if issues are uncovered. In today’s environment with its renewed emphasis on the quality of a financial institution’s loans, a robust quality control function is more important than ever. Ensuring quality begins even before an application is taken and must continue throughout the processing, underwriting, and closing functions.
Basics of a Quality Control Program
A quality control program may be managed internally or outsourced. Naturally, a major component of an effective QC review is to verify 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.
A quality control program must be in writing. It must provide standard operating procedures for all employees involved with or affected by the quality control process. Timeliness is also a major factor and challenge. A good program ensures the 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.
Fraud can strike at any stage of the mortgage process, and a QC review can detect indicators of fraud and alert management.
If the quality control 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. Personnel performing the quality control review must be independent of the loan origination and servicing functions. Documentation of the review and reports to senior management must be maintained.
Updates, Tips, and Friendly Reminders
Loan repurchase requests continue to be high. In response, investors have increased how far back they will review loans they have purchased, and they have become more proactive and review loans soon after they are closed to provide more timely feedback to the financial institution. They have also increased their quality control requirements.
Institutions selling loans on the secondary market are required to have a quality control program. Following are some reminders, tips, and notable changes for 2014:
- The expectation continues to be that a lender is to develop and maintain a QC program that defines the lender’s standards for quality and establishes processes and controls designed to achieve those standards throughout its entire origination book of business. All investors require the lender to establish a process to review the QC contractor’s work and procedures to address findings identified in the QC contractor’s mortgage loan reviews. The quality control program should also specifies the knowledge and competencies that the QC contractor must possess and the information that must be included in the QC contractor’s written QC policies and procedures, such as the details of the contractor’s review methodologies.
- Federal Home Loan Bank (FHLB) and Fannie Mae require a lender’s QC plan to include a prefunding 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. Both Fannie Mae and FHLB recommend establishing a loan selection process, reviewing specific data and documentation, and reporting results of the prefunding reviews to senior management.
- FHLB’s and Fannie Mae’s policies require selections to be made within 30 days of closing and reviews be completed within 60 days of selection. FHLB has made a slight change for financial institutions that close less than ten loans per month. If the financial institution closes less than ten loans per month, FHLB permits deferment of a loan sample selection until the closed list reaches a combined total of ten loans, with at least one loan per quarter being reviewed. The lender is also required to notify its investor if its QC cycle is in arrears more than a 30-day period.
- The lender may continue to use statistical sampling for its selection process instead of the standard minimum 10% random selection process without having to request approval from Fannie Mae. The lender must provide written justification of the methodology used, if requested. In addition, discretionary mortgage selections are now a requirement and must include a review of all property types, such as condominiums, cooperatives, and manufactured housing. The lender is also required to review EPD (Early Payment Default) loans in addition to its regular post-closing sample review. Also, FHLB and Freddie Mac have confirmed that any loans excluded from post-closing review are not eligible for sale to them.
- A policy must be established that requires the lender to attempt to verify owner occupancy. In addition, the lender’s QC process must include a review of potential red flag messages or alerts provided by the automated underwriting system or any other source. The lender 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 also require quality control contractors/service providers to be proficient in knowledge and use of all automated underwriting systems utilized by the lender and demonstrate competency in the review of manually underwritten loans. The lender must ensure that the contractor's review personnel possess the qualifications and experience required to provide quality reviews and meaningful analysis.
- Post-closing QC review tax transcripts are required on all loans unless the loan is 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 on line six of the 4506 tax transcript request (i.e., if you request a 1040 and an 1120). In addition to this, the IRS will want documentation that authorizes the customer to have access to the business tax transcripts.
- A new tri-merge credit report is required on all loans unless the loan is a Freddie Mac underwritten through Loan Prospector, 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 that there be a data integrity review of the delivery data documentation (i.e., confirmation of the details of the loan that was sold to the investor). The GSEs typically follow each other’s lead in the implementation of new or revised programs. Therefore, it would be beneficial for those institutions selling loans to Freddie Mac to be mindful of the changes Fannie Mae has implemented and be aware these revisions may be adopted by Freddie Mac for its quality control program as well.
Sound Policy Backed by Strong Review
Getting loan quality control right is a necessity. A good quality control program can ensure that loans conform to an institution’s policies, are of acceptable quality, comply with lending requirements and regulations, and will ultimately not cause a repurchase request.