Linking Pre-Funding and Post-Closing QC

(Avi Naider is chairman and CEO of ACES Risk Management Corp. (ARMCO), a provider of web-based quality control and audit technology for the financial services industry. He can be reached at anaider@armco.us. For more information, visit www.armco.us.)

Change is a risky endeavor, especially in the mortgage industry. However, for the visionary lender, taking a risk on change can lead to fantastic rewards, especially when it comes to quality control.

Historically, the underwriting function was assumed to be sufficient for pre-funding quality control and lenders performed quality test only after loans were closed. After all, what is the purpose of the underwriter if not to ensure a high quality loan to a creditworthy customer? We all know how that worked out, and the industry has learned its lesson: Prefunding QC will be effective only as a separate and distinct process from underwriting, ideally with different personnel.

Indeed, Fannie Mae’s Loan Quality Initiative moved many of the traditional post-closing QC activities to pre-funding, forcing lenders to re-adjust both processes to meet Fannie Mae’s new requirements. However, what many lenders failed to do was to link the two to create a holistic QC program that addresses quality across the loan lifecycle.

For example, many lenders use automated tools to conduct what they claim is a 100 percent file review for pre-funding. However, this “review” is really more of a glance and does not constitute a true full file review (i.e. a re-underwrite), which is the level of scrutiny Fannie Mae requires. These tools can be used as checkpoints to identify areas where further investigation is needed, but they cannot substitute the full file review required by Fannie Mae.

Of course, conducting a full file review to Fannie Mae’s standards on 100 percent of loans is often an impossible task, which is why Fannie Mae suggests that lenders conduct this review on a sample of loans produced.

Fannie Mae does not have a required sample size that lenders must use for pre-funding QC file reviews. Instead, it requires lenders to choose a sample size based on each lender’s individual risk assessment. While this may seem like yet another vague directive from regulators, in reality, this flexibility works in lenders’ favor by allowing them to choose the right-sized sample for their organization. Thus, file sampling becomes critically important in pre-funding QC.

While there are key areas that must be reviewed (income, credit, etc.), Fannie’s specific guidance on file sampling also directs lenders to “target areas that the lender identifies as having a higher potential for errors, misrepresentation, or fraud.” Some of these areas can include loans with complex income calculations, non-standard underwriting or multiple layers of credit risk. In addition, there may be changes within the organization, such as the addition of a new branch or loan officer, that would require additional pre-funding scrutiny.

Another key trigger could be loans with characteristics or circumstances related to errors or defects identified in prior pre-funding and/or post-closing review results. This area is often overlooked because pre-funding and post-closing QC tends to operate in silos, especially in larger organizations, with results reported separately and independently. By incorporating results from both reviews into the loan sampling methodology, lenders can tackle a significant element of risk while creating a QC review program that addresses risk throughout the loan lifecycle.

Of course, choosing the correct sample size and methodology simply lays the foundation for creating a linked pre-funding and post-closing QC program. From here, you can utilize additional strategies for connecting pre-funding and post-closing QC, such as:

Using Similar Exception Codes
Whether you choose to adopt existing taxonomies from Fannie Mae and FHA or develop your own proprietary system, using the same classification system and coding for exceptions for both pre-funding and post-closing QC ensures that issues are trackable throughout the process.

Comparative Defect Reporting
In many cases, upper management reviews pre-funding and post-closing QC findings as two discrete reports, making it more difficult to discern where persistent issues lie and what plan of action would best remedy those issues. By comparing these reports side-by-side, management gets a much fuller picture of quality across the organization and can make more informed decisions about how to address defects.

Action Planning
Once reporting is standardized across pre-funding and post-closing and upper management is able to compare the results from each, it becomes much easier to spot the defects that aren’t being remediated between pre-funding and post-closing. Creating an action plan to address these defects in pre-funding – and following up on results in post-closing – enables lenders to benchmark and refine remediation strategies to continuously improve quality.

Using the Same System
It’s not uncommon to hear of lenders using their LOS to conduct pre-funding QC while using a separate system for post-closing. The problem with this strategy is that it makes it difficult to compare results between the two in order to spot patterns and determine the effectiveness of action plans. The Fannie Mae 2015 Sellers Guide states that pre-funding QC should operate independently of production when possible. Thus, using a production system like an LOS to conduct pre-funding QC seems to contradict guidance from Fannie. Utilizing the same system for pre-funding and post-closing QC can create enormous efficiencies and streamline reporting for more effective defect remediation and loan sampling.

Real-Time Communication
In addition to reviewing pre-funding and post-closing reports separately, upper management also often doesn’t review these reports until the end of the month. As such, remediation doesn’t happen in time to prevent the previous month’s defects from occurring in the current month’s pipeline. With real-time communication capabilities, auditors can alert areas of responsibility the moment defects are uncovered so that remediation can happen immediately.

But of course, linking pre-funding and post-closing QC is not without its challenges. Here are a few roadblocks to lookout for:

Outsourced Providers
For those lenders that have outsourced any or all of their QC activities, matching up what happens in-house with the vendor can prove troublesome. Often times, this kind of hybrid process becomes manual, which can slow things down and opens up the possibility for items to get overlooked. To combat this, many lenders require their outsourcing vendor to use the same system as in-house QC staff to maintain control of the process and ensure consistency in reporting and communication. Furthermore, per Fannie Mae’s December 2015 updates to its selling guide, lenders must conduct QC reviews on a 10 percent sample of their QC vendors’ work to ensure consistency in the application of guidelines and requirements, as well as to assess the quality of the vendor’s work as compared to lenders’ overall quality standards.

Training
Another challenge can be the quality of training of personnel on the pre-funding side versus post-closing. Ideally, staff on both sides would have been exposed to the same kind and quality of training and would operate similarly. However, real-world experience tells us this is not always the case, especially for organizations where pre-funding and post-closing QC operate in silos. It’s important to put an equal amount of effort in training both departments on QC software and keeping them educated and informed about changing regulations and how these rules affect quality control. Always make sure your QC software provider offers a thorough implementation process, on-site training and customized support designed to help minimize the burden on your company.

Timeline
In addition, the differences in timelines for completion between pre-funding and post-closing, among other things, can create challenges of its own. In many cases, pre-funding QC is working with a 24- to 48-hour window to complete its review, whereas post-closing has a much longer timeframe. Between the mounting regulatory requirements and shorter turn-around time, QC staff are finding it very difficult to meet deadlines and maintain efficiencies. By simply replacing manual processes with technology and automation, QC staff on both sides can work in confidence knowing their reviews will be completed on-time with a low degree of risk.

Visibility of Defects
Furthermore, the visibility of certain defects is different for pre-funding versus post-closing. Depending on when pre-funding QC is conducted, there are some defects that would go unnoticed until post-closing. For example, if pre-funding QC is conducted after the initial loan approval, income and/or asset documents are often updated just before the loan is cleared to close. When the pre-funding QC review is conducted before these updated documents reach the loan file, these documents are not going to be reviewed as part of the pre-funding QC process. Any potential issues would then be flagged as a defect in the post-closing QC review. Using an automated QC auditing system can help lenders adjust their pre-funding QC timing to occur much closer to the “Clear to Close” point, which ensures auditors are reviewing a more complete loan file, thus reducing the number of touch points that can go unseen. This is also where real-time communication can help QC staff on both sides by relaying information between post-closing and pre-funding as issues arise so that auditors can adjust accordingly.

Trends v. Blips
Finally, QC staff have to contend with differentiating between trends versus blips. For example, pre-funding may see a dramatic increase in defects related to asset verification, but the post-closing review, which covers loans from three months back, shows a much lower asset verification defect rate. Without having a benchmark for previous performance, the lender could undertake a dramatic re-training effort when, in reality, the issues stemmed from a new LO in one regional office. Thus, reviewing pre-funding and post-closing QC results in conjunction month-after-month can help lenders take a historical perspective on defects to determine if issues are systemic or one-offs and what, if any, remediation is needed to correct them.

Though the challenges seem great, the rewards for linking pre-funding and post-closing QC are even greater. To put it simply, post-funding QC identifies areas of risk and trends to create better sampling for pre-funding QC, which leads to improved loan quality, fewer defects and less risk to the organization. That sounds like a risk worth taking.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor does it connote an endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions; articles and/or Q/A inquiries should be sent to Mike Sorohan, editor, at msorohan@mortgagebankers.org.)