Trevor Gauthier of ACES Quality Management on Early Payment Defaults

Trevor Gauthier is CEO of ACES Quality Management, formerly known as ACES Risk Management (ARMCO). He has more than 20 years of executive experience in leading growth initiatives for tech organizations and building teams both organically and through acquisition. During his tenure at Mortgage Cadence, Gauthier held several positions on the marketing and sales side globally, including Chief Sales & Marketing Officer, before becoming President and COO. One of his primary focuses at ACES is leading the product development team to stay at the forefront of enterprise quality management solutions.

MBA NEWSLINK: Because of COVID-19, early payment defaults (EPDs) are on the rise. How will such a large volume of EPDs affect lenders or servicers and what resources are there to help them navigate?

Trevor Gauthier

TREVOR GAUTHIER, ACES QUALITY MANAGEMENT: COVID-19 has created unusual circumstances for lenders and has caused changes that we typically don’t see in the market, one of which has been a rise in early payment defaults. An EPD is defined by the Agencies as any loan that goes 60-days delinquent within the first six contractual payments due. When we look at this rise, it’s important to remember that unemployment due to COVID-19 began to grow in February 2020, meaning that loans originated way back in August were still within their first six payments due. This also extends to loans originated since mid-last year, which puts into perspective the exact volume of loans we’re discussing.

Under typical market conditions, EPDs can cause concern because they signify that something went wrong shortly after origination, sometimes indicating that the underwriting process was flawed, and the repurchase risk is certainly greater for lenders on EPDs as compared to a non-lender. The combination of sudden and historical increases to unemployment we’ve experienced this year with the automatic forbearance requirements of the CARES Act makes it fair to say that we can expect a significant rise in EPDs. Judging by the preliminary numbers in the ACES’ Mortgage QC Industry Trends Report for Q1 2020, we could see a roughly 30% increase in EPDs overall.

NEWSLINK: How have lenders historically handled QC reviews of EPDs? How should they be handled now?

GAUTHIER: Such a significant increase in EPDs is going to prompt additional quality control requirements, which will incur additional costs. In the past, lower volumes of EPDs have been handled as one-off QC reviews, with lenders doing the bulk of the work offline or through spreadsheets. As lenders will be required to review 100% of EPDs, those methods are not going to scale well for the sheer volume of EPDs requiring reviews and the increased scrutiny lenders will be facing from a compliance standpoint. It’s in lenders’ best interest to mitigate risks by moving away from handling EPDs as they typically have and begin leveraging more compliant and efficient methods of managing these reviews.

Lenders also have to make a very important decision around how to perform QC on EPD reviews. The Agencies have given lenders temporary flexibility to manage the increase in EPD reviews. However, they did not provide any relief from repurchase risk so lenders need to decide what their risk is and design their QC processes to understand and handle those risks.

NEWSLINK: How does the CARES Act factor into EPDs?

GAUTHIER: One of the largest effects on EPDs is the ability of the borrower to receive a “no questions asked” forbearance for up to six monthly payments, which can then later be extended in a similar “no questions asked” way.  Because the forbearance must be automatically granted, it’s possible that a borrower on a newly originated loan could put the loan into EPD status regardless of whether or not the borrower had a legitimate COVID hardship. Fortunately, we saw the rate of new requests begin to slow in mid-May and that decline accelerated more recently. Our assumption, which bears watching, is that the decline in forbearance is largely attributed to two factors: (1) improving unemployment numbers, and (2) borrowers coming out of forbearance because they didn’t necessarily need a forbearance but requested one out of an abundance of caution. This means that those loans left in forbearance are likely the most distressed out of the entire bunch, with borrowers who are unlikely to be able to catch up quickly or at all. We remain concerned about the long-term default probabilities with loans remaining in forbearance.     

Regarding automatic reviews of EPDs, it will be interesting to watch whether or not that leads to an increase in repurchase and indemnification demands.  A full review could uncover underwriting issues unrelated to the EPD situation but are cause for a repurchase demand.  Fannie Mae and Freddie Mac have both stated that EPDs won’t trigger an automatic repurchase demand, but they will be putting the loans through a quality control review and lenders view the door as wide open on this risk. 

Lastly, I would say that one concern is liquidity and the ability of lenders to deliver newly delivered loans that go into forbearance to the Agencies. The Agencies have been helpful in recognizing this problem and have largely alleviated it by allowing CARES Act loan deliveries.  Lenders must follow strict protocols and timelines so there is some risk.  There are also some exceptions – cash out refinances being the major one.

NEWSLINK: With the end of forbearance periods quickly approaching, what areas of CARES Act compliance will regulators be examining from a servicing perspective?

GAUTHIER: This is certainly a timely issue for lenders, as it stands to reason that a significant portion of borrowers are not going to be able to resume payments at the end of the forbearance period due to continued unemployment and/or other hardships.

From a compliance perspective, the CFPB and state regulators have said they will be taking a close look at how servicers are handling CARES Act forbearance requests. In upcoming examinations, they will be testing to make sure servicers did not condition forbearance approval, vary from the number of payments allowed in the CARES Act or add additional fees.  We can also assume they will be looking at payment histories and listening to incoming borrower calls to call centers and will be especially concerned with any attempt to steer borrowers away from forbearance and any fees charged to borrowers, as the CFPB has warned lenders that fees are prohibited and the servicer is to treat the borrower as if all scheduled payments were made in full and on time.

Looking ahead, servicers should be evaluating their call scripts for strict compliance with loss mitigation requirements, as a portion of loans currently in forbearance will most certainly need other loss mitigation options, and increasing quality control and call monitoring on incoming calls. The good news is most servicers have already put measures in place in this regard as a result of the previous financial crisis,  which put loss mitigation in the regulatory crosshairs.

NEWSLINK: While the industry brainstorms the next best ways to operate a work-from-home mortgage market, digital closings present themselves as a social distancing-approved tool. Are digital closings as compliant as we might think? What concerns do you see?

GAUTHIER: The push to implement digital closings might have intensified as of late because they comply with COVID-19 social distancing guidelines by nature, but that doesn’t necessarily mean a reduced level of risk. Digital closings are certainly a next-generation innovation for the industry that many lenders might be eager to adopt, especially since most personnel are not in-office and instead doing business from their homes. Fortunately, we’ve been seeing a lot of news recently on the possibility that digital closings might employ more secure methods than the traditional closing process. From a quality control standpoint, examining the uncertainty that still exists around digital closings and their potential compliance issues should not be rushed, as doing so could end up driving QC defects higher. This notion should also extend beyond digital closings to include other methods being developed to work around the distancing barriers and complications created by COVID-19.

Along these same lines, remote online notarization (RON) has gained considerable traction this year, with 26 states now allowing RON at a permanent level and others allowing it temporarily as a result of the pandemic. However, other states still haven’t passed RON measures – temporary or permanent, creating a patchwork of legislation that still doesn’t fully cover the entire country. The challenge today is that RON transactions are happening in both lending and servicing, and nobody is truly prepared. There are a variety of requirements at the state and investor level and from an audit perspective, the industry is struggling to implement guidelines.  The MBA-ALTA model bill, which is still in legislation, would create a national RON model, and that is an effort the entire industry needs to get behind to ensure a consistent standard that can be applied to transactions in all 50 states.

NEWSLINK: In what other areas do you expect we might see quality issues?

GAUTHIER: COVID has not done any favors for the reverification process, which has always been complicated. Even in 2020, a good number of reverifications still have to be mailed and faxed and can be difficult to scale at large volumes when employees are working from home. Paper checks have to be sent with many of the requests, meaning that someone typically has to go into the office to pick up and process checks. The return mail also comes back to the physical office location. Those are simply problems with the process – we haven’t even touched on the issues that spring up from employers’ and financial institutions’ need to be in their offices to answer the mail, complete the reverification information and return the envelope. 

The Agencies are aware of the problem and have relaxed requirements on reverifications in the quality control process, putting together a checklist that lenders can use when Field Reviews are not possible, but there’s a catch: A lender must track which reverifications they weren’t able to complete and include them in a targeted sample at some point in the future. As such, lenders will need a systematic way of tracking all of these reverifications and a plan to perform them when the time comes.

NEWSLINK: We are still seeing plenty of volume for the rest of 2020, but do you foresee unemployment recovery for the close of 2020? What will that mean for 2021?

GAUTHIER: Lenders certainly will have plenty of volume to work through for the rest of the year, though the manufacturing process is more complicated and costs will increase. Quality control defects are going to be difficult to predict, but it should not come as a surprise if we see a modest increase in defect rates. Ultimately, the industry is anxiously waiting to see if low interest rates will boost the economy enough to offset the increase in unemployment and if unemployment will recover enough to have a positive effect in 2020. Of course, it’s also possible that a job recovery might end up taking place in 2021. In the grand scheme of things, it is reassuring to work in an industry that’s merely been disrupted by COVID-19 – not demolished.  Mortgage lending and servicing are still supporting hundreds of thousands of jobs, which makes me optimistic that 2020 will go down as a good year for our industry, and one that forced innovation in areas where it has been needed.

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