As brokers, correspondents, community banks and smaller credit unions took a more prominent role in the origination of mortgage loans during the height of the housing finance boom, the funding of the loan moved away from the originating entity, as they lacked the capital to produce any significant volumes.Â Â Â
When real estate values rose steadily in most areas of the country and foreclosures were minimal, the originating lender could safely produce the loan and have it funded by a wholesaler or investor without much risk after the closing and delivery. But as the housing market collapsed and losses mounted on investors, there was a strong push to find discrepancies in the originating process on non-performing loans and force lenders to repurchase the mortgage.Â
The larger banks and mortgage companies have the capital to both challenge the repurchase and even ultimately buy the loan back without putting much risk to the ongoing operation. But most brokers, correspondents and smaller financial institutions do not – and that has led to a significant reduction in originators over the past four years.
The big banks have been able to survive, and even thrive, through this era of growing repurchase requests from the government-sponsored enterprises (GSEs). Losses from repurchases have hurt the bottom line of the nation's largest financial institutions, with Bank of America leading the headlines in their fight against the billions of dollars in loans under dispute with the GSEs.Â
The mortgage origination industry recognized the risk of not following GSE or regulatory guidelines, but was not prepared to deal with non-performing loans that they believed were generated in a compliant and prudent manner. There was also the issue of performing loans that could be considered as being at-risk of default – investors tried to find any discrepancy to divest themselves of the danger of non-performance. The reaction by many lenders was a tightening of credit standards beyond the regulatory requirements that reduced the pool of homeowners out of repurchase fears.Â
The industry, led by the Mortgage Bankers Association and other trade organizations, pressured the Federal Housing Finance Agency (FHFA) to develop a policy that was transparent and fair to originators. In September 2012, the FHFA announced a revised representations and warranty (rep and warrant) policy for conventional loans sold to Fannie Mae and Freddie Mac, starting this year.Â
Under the heading of ‘Increased Transparency and Certainty for Lenders,’ FHFA Acting Director Edward DeMarco and the FHFA developed a concept called ‘seller-servicer contract harmonization,’ which is intended to be the framework for increased clarity on lender repurchase risk for new loans delivered to the GSEs. The new structure includes providing lenders rep and warranty relief for loans having 36 months of consecutive, on-time payments; Home Affordable Refinance Program loan rep and warranty relief after only 12 months of an ‘acceptable’ payment history; information to lenders for exclusions to rep and warranty relief such as for violations of law; and the use of improved tools from Fannie Mae and Freddie Mac to help lenders originate better quality loans.
The new FHFA model also directs the GSEs to conduct quality control reviews earlier in the process, establish consistent timelines for lender submissions, use tools to detect potentially defective loans and provide a more transparent appeals process to the repurchase process.
Fitch Ratings was quick to respond with positive feedback to the FHFA move and stated the improved framework ‘will potentially have a positive impact on both the mortgage lending and housing markets’ and believes it could ‘spur broader credit availability.’
While this news is a much-welcomed development in the ongoing conflicts between lenders and the GSEs, it still highlights the need for originators and lenders to be meticulous in following laws, government regulations and investor requirements. In its memorandum, the FHFA added ‘review of past repurchase requests issued by Fannie Mae and Freddie Mac revealed that these requests were based on substantive underwriting and documentation deficiencies.’Â Â
As a result…
So, what are the real effects of the new rep and warrants model on lenders? Transparency and clarity of the repurchase process will create a better understanding on the rules of being a seller to the GSEs, but the risk of repurchase does not go away. The bottom line is that lenders need to improve their loan approval and fulfillment procedures and maintain a proactive and rigorous quality control process to stop repurchase demands.Â Â
There are many ways lenders can make sure that the rep and warrants being provided on their loan sales are accurate and meet all industry requirements and guidelines. The reliability and efficiency of mortgage technology has vastly improved over the last decade. The ability to integrate crucial services such as credit, flood, title, automated underwriting, fraud detection and compliance checks through the web and with cloud-based computing allows lenders to have up-to-date and seemingly reliable information throughout the origination and fulfillment process.Â Â
But things still continue to go wrong. It is important for lenders to develop comprehensive policies and procedures that detail the capture of information, its methods for data verification and the quality control measures being used throughout the loan's life cycle.
Building and maintaining error-checking and business rules in the lender's mortgage technology is a good start. However, many lenders lack updated policies and controls that can ensure the quality of the information and provide the necessary checks and balances.Â Â
Key ingredients to a useful policy guide should include details on how the lender will ensure adherence to regulatory compliance, and should detail the being work being done by employees and vendors to meet the policies and procedures and how information is being managed throughout the process. It should show how security measures are in place to prevent information from being changed by the wrong people at the wrong time, as well as show how an integrated workflow can help guide mortgage personnel to limit errors and ensure proper disclosures and documents are being generated. Developing and maintaining a thorough policies and procedures manual can be a daunting task, but lenders have experienced outside vendor resources that can help.
The DL on QC
The term ‘quality control’ does not just apply to the post-closing reviews that involve the random selection of a fraction of a lender's closed loan volume. Pre-funding quality control has become a necessity in the age of growing repurchase demands.Â
The best method to resolve a problem is to prevent it from occurring. A pre-funding quality control audit or review should do the following:
- Validate the critical decisioning data, including credit, liabilities, assets and employment;
- Validate the collateral by reviewing the home value and checking the appraisal or AVM; and
- Review the file for potential fraud by validating Social Security numbers, using MERS data to identify ownership changes and verifying the legitimacy of the borrower's financials.
Reviews should not only be random but targeted to historically problematic geography, property types and loan types. Problems should be quickly identified and the loan process halted until discrepancies can be resolved.
Although the process of a pre-funding audit review may seem to be costly and time-consuming, the losses that occur by not doing audits on the front-end and funding a bad loan can be devastating.
Post-closing quality control continues to be a requirement of the investment community and needs to occur quickly to identify a problem before it advances too far down the road. While a 10% random selection of closed loans is the common requirement, making sure you use targeting and loan profiling methodology can better identify broken procedures, improve training needs and better understand the risk associated with certain mortgage products.
The process to originate, process, underwrite, close and fund a mortgage loan is increasing in complexity. The regulators and investors continue to put more rules into the mix, and missteps during the loan fulfillment stages cause a bulk of the repurchase demands. The aforementioned data integrity, policies and procedures, and quality control measures will help improve the business of fulfilling a mortgage loan – but that still may not be enough.
Smaller lenders – whether they are independent mortgage companies, community banks or credit unions – increasingly struggle with adequately staffing a back-office operation to fulfill loans. Fluctuating volumes can be the biggest challenge. Forecasting has proven to be somewhat unreliable in the past several years as drastic drops in interest rates created an unforeseen refinance boom.Â
Lenders can ensure having a qualified mortgage staff at their disposal, regardless of volume, by partnering with a reputable service provider. A ‘reputable’ business partner will have leading-edge technology within a secured SSAE 16 compliant facility with experienced U.S.-based mortgage professionals and clearly documented policies and procedures. The trend to turn a fixed expense of a full-time, employee-based, back-office operation into a variable expense through outsourcing has taken hold, and many of the smaller lending entities have adopted this philosophy.
All loans that are being delivered to Fannie Mae and Freddie Mac since Jan. 1 fall under the new FHFA rep and warrant policy. As the industry applauds the move and breathes a little easier when originating those loans, the real effect of the move is a lender's need for stronger due diligence, compressive quality control and well-documented and up-to-date policies and procedures.
The memorandum from FHFA stated that the ‘fundamental responsibility of lenders to meet the contractual requirements for loan quality remains the same.’ Lenders now have a better view of the repurchase rules and, therefore, less defense of a failure to comply. The industry should be relieved at the system's new transparency and clarity, but keep in mind that the reasonability for following federal, state and local laws, as well as regulatory rules and investor requirements in order to make the mortgage a saleable asset, still falls on the shoulders of the originators.Â
David Green is founder, president and CEO at The StoneHill Group, headquartered in Atlanta. He can be reached at (770) 399-1936.