Sharon Reichhardt of ACES Quality Management: Changes to Fannie Mae’s Pre-Funding QC Requirements are on the Horizon. Are You Ready?

Sharon Reichhardt is the EVP of Operations with ACES Quality Management, Denver. She brings 30+ years of industry experience in auditing for mortgage originations and servicing, consumer banking and lending and commercial lending to her role at ACES. She is also a former ACES administrator and senior report writer, with extensive experience coordinating external regulatory and investor audits, and continuous improvement initiatives. Reach her at sreichhardt@acesquality.com.

As industry headlines and first-hand experience has demonstrated, market change is underway. However, market conditions aren’t the only thing showing signs of change. At the recent Mortgage Bankers Risk Management, Quality Assurance and Fraud Prevention conference, Fannie Mae hinted at forthcoming changes to its pre-funding quality control requirements. While specifics regarding the changes remain to be seen, the teaser serves as a warning for lenders to shore up their current pre-funding QC program to ensure they are ready to meet the new standards.

Quality has been top of mind for Fannie Mae over the last 12 to 18 months. In May 2021, Fannie Mae updated its post-close QC appraisal quality requirements to reinforce a robust collateral review. Now, all lenders must continually evaluate the quality of their appraisals through Fannie Mae’s routine underwriting review of all appraisal reports and by utilizing prudent collateral risk assessment processes as part of the QC process. In June of this year, Fannie Mae introduced QC calibrations in their Seller’s Guide to require all lenders to perform a collateral risk assessment — a comprehensive review on all post-closing random quality control (QC) reviews, as well as discretionary reviews, if applicable. Most recently, at the MBA’s RMQA conference, Fannie Mae clarified that calibrations beginning in 2023 would be conducted on its top 50 lenders annually and 51-100 roughly once every 3-5 years. It may also perform a QC calibration if loan quality performance concerns arise from a lender.

Given this context, updating its pre-funding QC guidelines seems like the natural next step for Fannie Mae. As requirements currently stand, lenders are required to provide a copy of their entire pre-funding quality control plan, written procedures over pre-funding QC functions, a pre-funding review checklist, a copy of the pre-funding QC report, a description of the sample selection defect and a trending summary of the pre-funding QC findings.

The elements of Fannie’s pre-funding QC guidelines that have caused lenders the most consternation are the guidance around setting target defect rates and loan sampling. Current guidance directs lenders to conduct full-file reviews on their production pipeline to identify and cure issues before loans reach closing but leaves the selection process for these reviews to the lender’s discretion, cautioning that this should be based on “the lender’s assessment of the risks inherent in its origination processes, business sources and volume, and product mix.” As for defect rates, Fannie Mae guidelines do not currently require lenders to establish a target defect rate for their pre-funding QC findings, just for post-closing.

In its presentation at the 2022 RMQA Conference, Fannie Mae noted that “new and improved ‘beyond the guide’” updates for pre-funding QC were in the works and would focus on two key areas – sample effectiveness and defect capture rate.

Pre-funding QC provides the best opportunity to identify risks ahead of time for both originators and investors. With originations slowing, lenders should double down on their QC processes to create automation and prepare for the next market surge. To achieve this, lenders must look at their current processes and procedures with a fine-tooth comb. In the case of pre-funding QC, the focus should be on collateral quality. As purchase transactions typically have a higher average loan-to-value ratio when compared to limited cash-out refinances. Fannie Mae’s Senior Director of Loan Quality Compliance Duane Gilkison noted in his RMQA presentation that a loan sample strategy should be intentional and answer multiple questions, including:

• What % of production does this element represent?
  • What % of defects does this element represent?
  • Will this sample size make an impact on quality?
  • How often are you updating the criteria?

When testing loan samples for effectiveness, samples should be designed intentionally to generate high defect rates and pull quality risk forward to resolve before closing. The same goes for defect capture rates; it needs to utilize a post-close significant defect rate to provide a metric of how much quality risk the pre-fund sample is finding. These functions are critical to supporting high-quality originations and will likely form the basis for Fannie Mae’s pre-funding QC updates next year.

With these possible changes in mind, there are a few ways lenders can shore up their current QC programs to ensure they are prepared to meet Fannie Mae’s changing requirements. To start, QC departments need to be enabled to take action based on trends. For example, if credit defects are a growing trend from QC testing, there should be a procedure to identify why. Review for symmetry of pre-funding and post-close QC reports should also happen regularly. Leadership also needs to be aware of these QC findings to ensure action throughout the organization is followed.

Another key focus area deserving of lender’s attention is reviewing areas near eligibility cut-offs; these small mistakes can have a significant ripple effect. Suppose a borrower’s calculated base pay is incorrect, and the borrower is on the cusp of their eligibility. In that case, this can significantly change the outcome for both the borrower and lender. Incorrect income calculations are the most significant purchase defect so far in 2022. Applying these parameters to your QC process ensures a thorough and effective QC department.

While it may feel like salt in the wound to talk about pre-funding QC with originations at an eight-year low, what lenders do now will affect their success when volumes inevitably rise. There is no better time for lenders to take action to address collateral defects, mitigate risk, and ensure loan quality by assessing the effectiveness of their QC policies and procedures.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)