GSEs: Recession-Era QC Has Lenders Well-Prepared for Current Crisis (MBA LIVE)

(Clockwise from top left: MBA Chief Economist Mike Fratantoni; Ronald Feigles of Freddie Mac; and Candace Kubida of Fannie Mae.)

Representatives of Fannie Mae and Freddie Mac said lenders thus far have weathered the coronavirus pandemic very well, thanks to lessons learned from the Great Recession.

Speaking at the Mortgage Bankers Association’s virtual Risk Management, Quality Assurance and Fraud Prevention Forum, GSE analysts said despite challenges resulting from increased volumes, economic instability and a sharp spike in unemployment–as well an abrupt shift to remote working–lenders have shown adaptability and a commitment to loan quality.  

“We’re still early in the crisis, but things appear to be stable,” said Candace Kubida, Director of Loan Quality with Fannie Mae, Washington, D.C. “We’re not anticipating any quality derailments. One of the reasons was because after the last crisis we built new quality control requirements that enable us to meet stronger standards and the ability to react when things move in the wrong direction.”

Earlier this year, Fannie Mae and Freddie Mac issued COVID-related loan processing flexibilities, including alternative appraisals on purchase and rate term refinance loans; alternative methods for documenting income and verifying employment before loan closing; and expanding the use of power of attorney and remote online notarizations to assist with loan closings. Kubida said these flexibilities were well-received by lenders.

“These are intended to get us through all cycles—the good times, the bad times and everything in between,” Kubida said. “The frameworks and standards are intended for flexibility. The key to ensuring quality control is to continuously assess your environment, starting with being intentional about your sampling and making sure your new policies and procedures have been implemented properly. QC is not just about finding problems, but also ensuring that your policies and procedures have been developed and implemented properly.

A 2020 continues, Kubida said, “we are starting to see some outliers. Volume is not an excuse for deteriorating loan quality and defect rates; if they are, look at your controls to be sure you are addressing that risk.”

In June, Fannie Mae reported top defects as Incorrect Income Verification for Self-Employed Borrowers; Borrower Not Employed; and Undisclosed Liabilities. Kubida also said Appraisal Defects are on the rise, but income and employment discrepancies has been increasingly noticeable.

“The borrower not employed scenarios for 2020 is going to look a lot different than in 2018, when the employment situation was more stable,” Kubida said. “You have to verify that the borrower is employed as certainly as possible. If you have any doubt, get that additional verification.”

Ronald Feigles, Vice President of Single-Family Quality Control and Fraud with Freddie Mac, McLean, Va., said in many ways, 2020 has been a “perfect storm” for quality assurance issues.

“We had record volumes ahead of the COVID-19 pandemic,” Feigles said. “The pandemic forced us to a full shift to all-remote work and as kind of an outplay, we had the economic downturn and the jump in unemployment.”

From a QC standpoint, “we’re dealing with opposite ends of the challenges,” Feigles said. “On one hand, we have record volume that everyone is struggling with, and an economy moving in the opposite direction, which has been a challenge for everyone in the industry to reconcile those differences.”

Feigles said feedback about the GSEs’ loan flexibilities has been mmixed. “What we learned is that while overall it was beneficial to the industry, it was also another level of change that the industry had to absorb—one more challenge,” he said. “This layer has its pros and cons. It provided needed flexibilities, but it also required a lot of coordination and change management among our originators. It was stressful, but the lenders did their best to adjust to the situation and ensure that their loan quality met the new standards.”

Feigles said despite the challenges, the results have been promising. “We’re happy to say that credit quality is improving—lower LTVs, slightly better credit scores and expanded use of automated assessments,” he said. “The loans being originated today have improved for the past three years—the types of loans we are buying are showing very good quality.

But from a QC standpoint, Freddie Mac noted increased defect rates over the past 12-18 months. “These rates were historically low in 2018, but in 2019 and 2020 we are seeing an increase in defect rates than we have in the past,” Feigles said. We can’t point that back to any one lender or group of lenders—the increase in defects is being seen very broadly. A lot of it is in the smaller lenders, but we’re also seeing it among larger lenders as well. It underscores the challenges we are going to continue to see through 2020.”

Echoing Kubida’s data, Feigles said income defects remain the most prevalent—“far and away year after year, undefeated and constantly the leader. Eligibility is always a close second. The good news is, most of those defects are self-inflicted wounds, and not fraud.”

So, if credit results are better, why are credit results worse? “One trend has been the increase in volume, which dates back to 2019,” Feigles said. “Part of it is the amount of change but we’re all looking for a better answer. QC is a lagging indicator, which is a challenge for all of us. We all know that loans get originated then sampled and sent in and it takes a while to get back and provide feedback. We are working on targeted reviews that enables us to provide QC reviews faster and more efficiently.”

On the fraud front, Freddie Mac has not seen an uptick thus far, “and we want to know why,” Feigles said. “There might not be a ‘need’ for fraud at this point, but sometime soon refi volume is going to dry up, and the risk of fraud could elevate significantly,” as loan originators try to maintain volume.

“We know fraud is out there; we know it exists,” Feigles added. “And what we think we’ll see is that the fraud will increasingly involve the lender working with the borrower in committing fraud. This affinity-based fraud, in which the employer is part of the scheme, is going to be a little bit different than what we’ve seen in the past.”