Essentials of a Compliant QC Plan

OCTOBER 9, 2014

PRESENTED BY: BRADY W. MEADOWS

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Establish Your Credit CultureA lender must establish its own set of standards for loan quality.

Standards will define a company’s credit culture and help develop appropriate controls necessary to ensure loans are of investment quality.

A lender’s overall commitment (or lack thereof) to Quality Control will ultimately determine how effective their Quality Control program is.

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What QC Requirements do I need to follow?

Your QC plan needs to be based on the following entities you conduct business with and rules, requirements and regulations.

• Investors

• Government Agencies

• Warehouse Lines

• Regulatory Agencies

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Objectives of a QC Plan:• Ensure company is producing a quality product to sell to investors

• Maintain compliance with contractual obligations and applicable federal, state, and local laws and regulations

• Guard against fraud, negligence, errors, and omissions

• Guard against unacceptable levels of risk & potential law suits

• Assess compliance with internal policies

• Protect against repurchase demands

• Improve loan quality & production processes

• Minimize costs by:◦ Reducing time file spends with UW

◦ Reducing time on warehouse line (By reducing investor conditions)

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Objective of a QC Plan (cont.):

And the final reason you should have a QC plan in place is...

Because it’s required

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Drafting Your QC PlanTailor your QC plan to meet the specific needs of your organization.

◦ Size

◦ Product Mix

◦ Agency & Investor Approval

◦ Business Structure

◦ Market

◦ Day-to-Day Operational Processes

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Basic Elements of a QC PlanQC plan must be in writing and dated.

It should cover:◦ Company overview and philosophy regarding QC

◦ Goals of your QC plan

◦ Who will perform the QC

◦ What you are going to audit

◦ When you will audit

◦ How you will correct issues found during audit

◦ How and who you will issue QC reports to

◦ What and how will you trend your QC data

◦ Document retention

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QC Staff

QC can be performed in-house or be outsourced

Report to Senior Management

QC staff must be independent from production staff

QC staff must be properly trained and experienced in the audits they perform

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Types of Audits RequiredFannie

◦ Random Post Close

◦ Discretionary Post Close

◦ Prefunding

◦ EPD (if servicing)

◦ QC of the QC Vendor (if outsourcing QC file audits)

Freddie◦ Random Post Close

◦ Targeted/EPD’s (if servicing)

◦ Discretionary

◦ Preclosing

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Types of Audits RequiredFHA

◦ Random Post Close◦ EPD (regardless of who holds servicing of the loan)

◦ Rejected Loans/Adverse Action◦ Branch Audits

FHA – Proposed◦ Prefund Audits◦ Discretionary Audits

FHA Proposed New Quality Control, Oversight, & Compliance rules◦ http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sf

h/SFH_policy_drafts/qc_mortgagees

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Severity LevelsDefects, Exceptions, Violations, Findings, etc. They all meant the same thing.

FHA

Mortgagees may develop a system of evaluating each Quality Control sample on the basis of the severity of the violations found during the review.

Fannie

The lender must define the severity levels appropriate to its organization and reporting needs, however, the highest level of severity must be assigned to those loans with defects resulting in the loan not being eligible as delivered to Fannie Mae.

afafr

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Low Risk Acceptable Risk Moderate Risk Material Risk

Moderate Significant

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Pre-Fund QCPre-funding is a requirement for Fannie Mae & Freddie Mac approved lenders.

FHA recommends pre-funding QC. (soon to be required)

The pre-funding portion of the quality control plan can contain procedures to assess:

◦ Overall underwriting process◦ Validation methods◦ Risk assessment

Pre-funding needs to be independent of processing and underwriting.

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Pre-Fund QC:When do we audit?

Fannie written guidelines -• Prefunding QC reviews must be conducted early enough in the origination

process to allow adequate time to make loan selections, complete the reviews, and properly inform the loan production organization so that corrections and/or revisions can be made prior to loan closing. Fannie Mae requires reviews to be done when there is sufficient documentation in the file to perform the required review of data and documents described in Verification of Data and Documents, below.

What Fannie really wants –

• Perform prefunds after a clear to close has been given.

Freddie does not give guidance on timing.

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Pre-Fund Selection ProcessEach lender is required to create their own pre-funding selection process to ensure it meets each company’s needs.

Prefund selections should focus on areas that may pose a elevated risk for errors, misrepresentation and fraud.

There is no minimum volume review requirement.

High LTV Low FICO 1% to 100%

Loan Originator/TPO Closer Branch

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Pre-Fund ReviewsFannie Mae says an effective pre-funding process includes reviews of the following:

◦ Data entered into AUS

◦ Social Security numbers used to verify borrowers

◦ Income calculations consistent with supporting documentation

◦ Verification of employment

◦ Assets are adequate to meet cash to close and reserve requirements

◦ Appraisal valuation data is acceptable

◦ Mortgage insurance is acceptable

◦ Review of past 120 inquiries

◦ Review of condo project approval

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Pre-Fund QC (cont.)Additional automated compliance tools can be part of your pre-funding QC Plan:

◦ ComplianceEase

◦ Interthinx

◦ Mavent

◦ Early Check

◦ AVM applications

Address all red flags uncovered by the compliance tools, and retain documentation used to resolve them.

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Pre-Fund QC (cont.)Pre-funding QC is your last chance to correct any errors before investor purchase.

Reviewing final documents is critical.

Steps should allow for the review of RESPA, MDIA, and state timing rules.

Review GFE and HUD-1 to ensure fees are within tolerance.

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Pre-Fund QC (cont.)Create monthly reports to analyze any findings trends discovered in your pre-funding process.

◦ Compare you post close findings with your pre-fund findings.

◦ Implement post close findings into your prefund reviews for quicker implementation.

Re-evaluate your pre-fund QC on a regular basis to make sure it is up to date with current trends.

Investor and lender requirements are constantly changing.

Perform periodic re-evaluation to gain the most benefit.

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Pre-Fund QC (cont.)Prefunding reviews are generally a change to the production and sales culture.

Everyone want to close immediately after final underwriter approval.

Establish realistic turn time for prefunds and be consistent with the turn times.

Consistency will help everyone adapt to this new process.

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Post-Closing File AuditsPost-closing file audits are the most encompassing portion of your QC Plan.

Random post-closing file audits are required by many investors and most agencies, including:

◦ FHA

◦ Fannie Mae

◦ Freddie Mac

◦ Wells Fargo

◦ Chase

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Selection of Files to AuditYou must do a random or statistical selection of the files to be audited. All files must be available for selection.

◦ FHA is 10% of FHA loans closed

◦ Fannie and Freddie is 10% of your ‘book of business”

◦ Investors typically follow the Fannie and Freddie rule.

Most companies chose to do a random 10% minimum selection.

Over a specified time period, all company segments should have 10% audited.

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Timing of Selections and Reviews

•FHA – Reviews within 90 days of end of month closed.– Management report due within one month of the completion of the initial

report.– Changes to the timing of audits has been proposed

•Fannie Mae– Selections within 30 days of end of month closed.– Reviews and rebuttals within 60 days of selection.– Management report due within 30 days of reviews.

• If you are more than 30 days behind, you must report this to Fannie Mae

•Freddie Mac– Selections within 90 days of the note date.– Report to management within 90 days of selection.

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Loan Review ElementsPost-close file audit selection details should be outlined in your QC plan and should contain at least the following:

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Accuracy and Completeness of the Loan Application The Appraisal

The Existence and Accuracy of the Underwriting Documents Property Eligibility

Data Integrity Review Project Eligibility

Supported Underwriting Decision Documentation of Adequate Mortgage Insurance Coverage

Re-Verifications of Underwriting Documents Compliance with Mortgage Insurer’s Guidelines

Output from any Third-Party Data Analysis Tools Existence and Accuracy of Legal and Closing Documentation

Ability-to-Repay StandardsCompliance with all Federal, State and Local Law and

Regulations

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Discretionary ReviewsFannie Mae & Freddie Mac require discretionary reviews post close audits.

FHA only recommend discretionary reviews when necessary. ◦ Proposed discretionary are required.

Discretionary reviews are in addition to the random selections.

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Discretionary Reviews (cont.)The purpose of a Discretionary Review is to focus on areas that may pose a elevated risk for errors, misrepresentation and fraud.

There are no volume requirements. The review must meet the needs of the lender.

Example of discretionary reviews:

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10% of new Loan Originators All high LTV loans

Low FICO scores Manufactured homes

LTV ratios over 90% Investment properties

High risk credit scores Cash-out refinances

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Appraisal ReviewsFannie Mae, Freddie Mac, and FHA all require appraisal desk reviews and appraisal field reviews.

Field reviews must be completed on 10% of the files selected for audit.◦ Field reviews must be done by a licensed appraiser.

For the remaining 90% of the files selected for audit, a desk review is required.

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Re-VerificationsFannie Mae, Freddie Mac, and FHA require verifications on the following:

FHA requires all verifications be written. If re-verification is not returned, then a follow up phone call must be made.

Fannie Mae and Freddie Mac both recommend written but allow verbal re-verifications.

If re-verification is not returned, lender must document all attempts made to verify documentation.

Employment Income Assets

Gift Funds Rent Non-Traditional Credit

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Adverse Action ReviewsAdverse action file reviews are audits of all your denied and cancelled files.

Only FHA requires you to review 10% of all adverse action files.

Must be reviewed within 90 days from the day in which the decision was made.

◦ Review to ensure file was correct in its denial

◦ Denial was approved by Officer or Senior Level Underwriter

◦ Ensure ECOA guidelines were met

◦ Review no Civil Rights were violated

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Early Payment Default (EPD) ReviewsFHA , Fannie Mae, and Freddie Mac all require you to review 100% of your EPD files.

Fannie Mae and Freddie Mac define an EPD as 60 days late in the first 24 months months.

FHA defines an EPD as 60 days late in first 6 months◦ Must be reviewed 45 days from the end of the month the loan is reported 90 days past due.

The purpose of reviewing EPD files is to uncover any patterns to determine if those patterns can be corrected with new company policy.

EPD reviews are also done to identify any information that could have been used to predict default.

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HUD's Neighborhood Watch

Neighborhood Watch:◦ https://entp.hud.gov/sfnw/public/

Neighborhood Watch FAQs: ◦ http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/files/02-15a1.doc

Compare Ratio HUD Action

150+ Concern

175 – 200 Appear on Watch List

200+ Likely lose FHA DE

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Branch ReviewsIt is a good business practice to make random on-site visits to your branches to make sure they are compliant with all company policies

◦ Signage and licenses posted

◦ Compliance with Gramm-Leach-Bliley

◦ Operation structure meets company requirements

◦ Meets all company policy and procedures

FHA requires branch reviews, and Fannie and Freddie recommend them.

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Branch Reviews (cont.)A few of FHA’s branch review requirements:

◦ Office is properly registered with FHA and address is current.

◦ Regulatory Lending signage posted and evident in each branch location including Fair Housing and Equal housing signage.

◦ Operations are conducted in professional, business-like environment.

◦ If located in non-commercial space, office has adequate office space and equipment.

◦ Office does not employ or have a contract with anyone currently under debarment or suspension, or a Limited Denial of Participation.

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Defect RateDefect rate is a metric created by Fannie Mae to track loans identified in the QC process that do not meet Fannie Mae Guidelines/ Ineligible for delivery.

Defect Rate Calculation: the number of loans with a defect divided by the number of loans in the QC sample.

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Defect Rate CalculationExample 1 - Monthly:

Random Post Close review of 10 loans.

Two loans of the 10 files audited had defects.

2/10 = 20% defect rate for that month.

2 loans x loan amount = Monthly exposure

2 x $200k = $400,000 exposure for the month.

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Defect Rate Calculation (cont.) Example 2 - Annualized:

Company closed 75 loans for each of the previous last 12 months. (900 loans)

The company defect rate for that period was 1.25%.

900 x 1.25% = 11.25 defective loans.

11.25 loans x $200,000 = $2.250 million

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Target Defect RateTarget Defect Rate is the defect rate your company has established as reasonable for the appetite of risk you company operates.

You must show how and why you have decided on this defect rate.

Its recommended that you take financial risk into consideration when establishing you target defect rate.

Review your Target Defect Rate at least annually.

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Target Defect Rate (cont.)Target Defect Rate Example:

$1 million set aside a year for repurchases

Lender ABC closes 50 loans a month or 600 per year.

$1 million divided by average loan amount◦ $1 mil divided by $200,000 = 5 defective loans

5 defective loans / estimated originations per year ◦ 5 / 600 = .83% (.0083)

.83% would be the Target Defect Rate for ABC Mortgage

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Trend TrackingTrend tracking is the best way to track and monitor your QC. Trend tracking gives you added value to your completed post close audits. Trending is required by Fannie Mae.

Simply place a numerical value to each file audit and track that numerical value over time.

Trend tracking is an effective way to ensure your employees and business segments are producing quality loans.

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Trend Tracking (cont.)Our audits include a loan score and risk rating on each file

◦ Track ratings over time to see if score is decreasing or increasing

In addition, run tracking reports to determine most common findings and how often they reoccur.

Track the performance of many categories, including the following:◦ Loan originators

◦ Underwriters

◦ Branches

◦ Processor

◦ TPO (correspondents or brokers)

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Trend Tracking Charts

-

10

20

30

40

50

60

70

80

90

100

UNDERWRITER LOAN SCORE TRENDING

Underwriter 1 Underwriter 2 Underwriter 3

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Trend Tracking Charts

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Trend Tracking Charts

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Trend Tracking Charts

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Trend Tracking Charts

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Trend Tracking Charts

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Trend Tracking Charts

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Trend Tracking Charts

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Classifying Defects

8%6% 3%

11%

24%

1%

10%

15%

2%

2%17%

1%

Loan Defect Categories

Assets

Borrower & Mortgage Eligibility

Credit

Liabilities

Income/Employment

Insurance

Legal/Regulatory/Compliance

Loan Package Documentation

Project Eligibility

Property Eligibility

Appraisal

Other

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Subcategories and Defects

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Fannie Mae Defect Categories Listing:

https://www.fanniemae.com/content/fact_sheet/loan-

defect-categories.pdf

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Management ReportingWe have our Post-Closing audits completed…Now what?

•Report to Management– Deliver to senior management within 30 days of the audits being completed.

•Management’s Response & Action Plan– Management must respond to the report and make an action plan as to who should

do what to correct the findings.

•Corrective Action Plan and Monitoring– Action report should identify actions taken, timetable for completion, and planned

follow-up.

•Reporting to Investors and Agencies– Report any misrepresentation, breach of your contract agreement, or detection of

fraud within 30 days of uncovering the findings.

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Management Reporting•Lenders must design reporting procedures that are useful internal management tools for evaluating and monitoring the quality of their mortgage loan production.

•Reporting procedures must be in writing and identify critical components to be included in the reports.

•Pre-Funding and Post-Closing Reporting is to be conducted monthly, at a minimum.

•Reporting to use consistent methodology and terminology across all review types.

•Reports must distinguish between compliance-related defects versus credit related defects.

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Management Reporting•Lenders must summarize the results of each individual review type into a comprehensive, summary report of all QC findings.

•Reports of summary-level findings must be distributed to senior management. Rebuttals must be completed prior to final reporting to senior management.

•Reports of loan-level findings must be distributed to the business units, specifically to parties within the business units responsible for the resolution.

•When findings and trends are identified through the review processes, the lender must establish an action plan for specific corrective actions to be taken, including the expected resolution and timely implementation.

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Management ReportingConsiderations

•Who needs this information?

•What are the critical components of information that they need?

•How often do they need the information?

•How should this information be formatted?

If you can’t take action on the reporting information you’re generating, it is time to re-evaluate your reporting process.

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Minimum Components•Reports must reflect the final defect rate for the current review period, taking into account responses and resolution of the initial QC findings.

•Defects must be categorized by severity level. Report should clearly delineate the severity level of cited defects, defect rates, etc.

•Reports must include selection criteria (where appropriate) and defect trending information, such as issues and top defects.

•Classify a defect with sufficient granularity to foster quality analysis and action.

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Potential Report Types

Summary of Selection Method Detailed Loan Report

Detailed Overview Report Loan Review Status Report

Senior Management Report Management Directive Report

Reports to Investors and MI Companies Tracking and Trending Reports

Departmental Reports Special Reports

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Audit and Review of the QC ProcessReview of QC process is a requirement of most agencies.

Complete an annual review of your entire QC process to ensure it is working as intended.

◦ No gaps in the process

◦ All elements of QC plan are addressed

◦ Unnecessary items are removed

◦ Changes are updated in your written QC plan

Continuously evaluate your QC process and update to correct recurring errors.

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Audit and Review of the QC Process (cont.)Remember, no QC plan will fit every company.

◦ Each QC plan needs to be customized to your company and product mix.

◦ Each company will have unique portions of their QC process that need more attention than others.

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QC on the QC VendorFannie only Requirement

Must review 10% of all Post Close (discretionary included) Audits conducted by the QC Vendor, including loans with no findings.

Fannie wants these done monthly and wants reports generated much like the standard post close reporting process

This is not solely just files reviews, you need to be making sure the vendor is performing all the required tasks as outlined in the SOW.

◦ Examples: ◦ Are they sending out all the required reverification letters

◦ Are their turn times acceptable

◦ Selecting the correct files and field reviews

◦ Are finding levels accurate

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Record RetentionEach agency requires you to keep all documentation pertaining to QC review

FHA 2 years

FNMA 3 years

FHLMC 3 years

Also check with each state your are licensed in to ensure you are retaining the correct documentation for the required amount of time.

Records include documentation of QC review findings as well as documentation related to any corrective actions.

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FHA Specific

• Review 100% of early payment default files• EPD files are files that are 90 days past due in the first 6 months.

• Must be completed within 45 days of the end of the month the loan was 90 days past due.

• Branch Audits• Annual visits are required

• Denied File Review• Must review 10% of all denied files each month.

• Must be completed within 90 days of the end of the month the decision was made.

• LDP/GSA review on each file for each party involved in the transaction.

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New Fannie QC RequirementsEffective January 1, 2014

• Clarified Discretionary and Prefund reviews are required

• Clarified occupancy verification on all primary residences selected for audit

• 10% monthly review on the QC vendor

• Establish action plans to correct QC findings

• Highest finding level is for eligibility findings/defects only

• Highly Recommends lenders adopt their trending methodology

• Recommends you track gross and net defects

• Lenders must trend their defect rate and establish a target defect rate

• Detailed QC polices and procedures provided to all employees (this is not your QC plan)

Effective October 1, 2014

• Loans acquired by delegated TPO, lender must review loans prior to purchase (considered prefund)

• Expected to incur 3rd party fees to get a re-verifications

• Clarification of self reporting requirements

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Fannie Hot Button Items• Defect Rate

• Target Defect Rate

• Trending

• Re-verifications

• Highest level of findings as eligibly violations

• Large deposits not sourced

• Number of financed properties

• Seasoning of Derogatory Credit

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FNMA QC Specialist•Fannie Mae has created a new position called the QC Specialist

•The QC Specialist’s job is to contact approved Fannie Mae Seller/Servicers and assure they are meeting all of Fannie Mae’s QC requirements. They will ask for the following:

– Copies of Pre-Funding and Post Closing QC plans and procedures– Training materials for QC or Vendor staff– Statistical sampling methodology (if applicable)– QC reports for the last 3 months– Documented action plans in place to correct loan defect issues– Corrective tracking reports– Management Response to QC Reports– Internal Audit QC reports for the past 3 years– Most recent independent audit of your QC function– TPO Approval Process and Monitoring documents

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Regulatory Changes in 2014• January 10, 2014 - Qualified Mortgage and Ability-to-Repay Requirements

• January 10, 2014 - Mortgage Servicing Requirements – Reg Z (TILA) and Reg X (RESPA)

• January 10, 2014 - Loan Originator Compensation and Training, Certification and Identifier Disclosure

• January 10, 2014 - High-Cost/HOEPA Mortgage Loans and Homeownership Counseling Disclosures

• January 18, 2014 - Disclosure and Delivery of Free Copies of Appraisals –Regulation B

• January 18, 2014 - Appraisals for Higher-Priced Mortgage Loans

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GSE Top Ten Defects① Borrower/Eligibility: 5-10 multiple financed property overlays

② Incorrect income calculations: Rental and self-employed

③ Insufficient income

④ Insufficient assets/reserves

⑤ Discrepancies with comparable selections cited on appraisal

⑥ Excessive obligations

⑦ Unable to properly calculate DTI ratio

⑧ Original appraisal does not support the value

⑨ CAIVRS/LDP/GSA lists not checked/cleared

⑩ Data integrity

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Top 5 Findings for Manually Underwritten Loans

① Obligations of the borrower

② Source of funds

③ Qualifying ratios

④ Income not properly documented

⑤ Income not properly calculated

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MCA Top 10 Significant Findings

① GFE, TIL, and Servicing Disclosure not provided within 3 business days of application

② Initial Servicing Disclosure not provided to Borrower within 3 days of application

③ Initial TIL was not issued within 3 days of application

④ Dates on Notice of Right to Cancel do not correspond with 3 day waiting period

⑤ Initial GFE not included in file

⑥ YTD and prior year Borrower income does not support amount used to qualify loan

⑦ Field review appraisal does not support estimate of value on file appraisal

⑧ Inadequate deposited funds for required reserves, per HUD Settlement Statement

⑨ ALT documentation (e.g. pay stubs, W-2’s, accountant letter, etc.) is unacceptable

⑩ Streamline Refinance and loan payoff are not included in the file

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MCA Top 10 Moderate Findings

① Underwriter approval is not in the file and all conditions have not been satisfied

② GFE, TIL, and Servicing Disclosure not mailed or signed within 3 days of application

③ Question 2 of Important Dates section incomplete or not correctly completed

④ Question 1 of Important Dates section incomplete or not correctly completed

⑤ Adjusted Origination Charges (within GFE section page 2) not correctly completed

⑥ Change of Circumstance documentation in file is incomplete

⑦ Figures on Final HUD Settlement Statement incomparable to recent GFE figures

⑧ Verbal VOE was not provided in file, per AUS requirements

⑨ APR increase or decrease by more than .125% from most recent TIL compared to final TIL

⑩ Final 1003 application was not provided for review

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We are proud to offer these monthly webinars free of charge and hope by doing so, we will be fortunate enough to earn

your business.

www.MortgageComplianceAdvisors.com

• Post-Closing QC Audits• Pre-Funding Reviews• QC Plan Implementation• Red Flag Policies• Training and Consulting• Agency Approval• Etc.

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Contact InformationWe will be answering a few of your questions in just a moment. Questions not addressed at this time will be emailed directly to you, as well as answered in our next newsletter. You are also welcome to contact us directly at any time:

Mortgage Compliance Advisors, LLC

5505 South 900 East # 300

Salt Lake City, Utah 84117

•Phone: (877) 940-4546

•Email: Info@MortgageComplianceAdvisors.com

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Resources•Fannie Mae

https://www.efanniemae.com

•Fannie Mae’s QC Self-Assessment Toolhttps://www.fanniemae.com/singlefamily/loan-quality

•Freddie Machttp://www.freddiemac.com

•Mortgage Compliance Advisorswww.mortgagecomplianceadvisors.com

•HUD/FHAhttp://www.hud.gov

•HUD’s Neighborhood Watchhttps://entp.hud.gov/sfnw/public/

•CFPBhttp://www.consumerfinance.gov/

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Questions&

AnswersYou can find today’s slides on our News & Resources page:

http://www.mortgagecomplianceadvisors.com/index.php/news-resources#resources

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Thank You!

The information provided by Mortgage Compliance Advisors, LLC has been taken from various public resources and does not constitute legal advice.