LoanLogics’ Jenevieve Impavido: Overcoming a New Catch-22—Fannie Mae’s QC Requirements

Jenevieve Impavido is Vice President of Audit Services with LoanLogics, Jacksonville, Fla. She will moderate Adopting Best Practices for Pre-Funding QA and Post Closing QC on Tuesday, Sept. 12 at 9:15 a.m., during the MBA Compliance and Risk Management Conference.

It’s been one of the hottest summers ever in the U.S.—in fact, according to NASA, July 2023 was the warmest month in recorded history. Likewise, the mortgage industry has started feeling heat of its own with new, more stringent Fannie Mae guidelines for QC reviews and rising GSE repurchase activity.

As we approach the end of the third quarter, Fannie Mae seller/servicers are now grappling with tougher requirements when it comes to prefunding audits and post-closing reviews. As everyone knows, as of September 1, Fannie Mae began requiring seller/servicers to perform pre-funding QC reviews on at least 10% of loans or up to 750 loans per month that are sold to the GSE. Lenders must also complete post-funding reviews in just 90 days instead of 120 days.

Meanwhile, industry pushback on rising repurchase activity has not caused either Fannie Mae or Freddie Mac to budge. They continue to stand firm without any concessions. Which means many lenders will need to rethink their loan QC strategies if they hope to pass muster with Fannie Mae, Freddie Mac—or for that matter any other investor in the secondary market.

The Catch-22

Meeting more stringent loan QC requirements would be challenging enough in a normal housing market, but is particularly difficult today. Almost every lender is struggling with lower volumes brought on by the recent spike in interest rates and rising fraud risk due to the unique financial pressures on borrowers.

According to Fannie Mae’s most recent Quality Insider reports, in the current market environment, lenders are more likely to originate loans at or near eligibility thresholds, leaving little margin for error. As well, they are seeing rising fraud risk due to the unique financial pressures facing borrowers. Both create a high degree of uncertainty in the loan manufacturing process. However, at a time when loan quality matters most, lenders have been reducing staff to trim expense and sustain their business. This has left them with fewer resources available to spend on the very loan QC processes that can surface defects, allow them to guard against misrepresentations and fraud, and lower the risk and expense of repurchase.

The Catch-22: a lender can’t optimize profit unless they lower expenses, but they can’t lower expenses without raising the cost of risk, which impacts profitability.

Both Fannie Mae and Freddie Mac’s efforts to identify loan defects earlier in the manufacturing process has created speculation that the agencies are worried that some lenders are struggling to stay afloat in the current environment. There has already been a significant increase in how frequently the two GSEs make loan repurchase requests. Lower origination volumes have made it harder to absorb the cost of buying back loans, while higher rates have negatively impacted sales in the scratch and dent market. Recently, the Community Home Lenders of America found that the average member has been losing about 30% of the value of each loan repurchased.

To be sure, ensuring loan quality on conforming loans—or any other type of loan—is not a new problem. Lenders have been wrestling with the GSEs’ continually evolving policies since the collapse of the housing market in 2008. So far, their strategies have involved a combination of tactical shifts and accelerated adoption of new technologies. But has it been enough? Now, with fewer staff shouldering greater burdens, and perhaps losing vital expertise and institutional wisdom by right-sizing their staffs, lenders face operational voids that expose them to even higher risks, and a greater need for automation to close the gap.

A Technological Lifeline

Fortunately, innovation has come a long way since the last housing crisis. New QC technologies have enabled some lenders to speed up their loan review processes and reduce repurchase risks while enhancing ROI. And while Fannie Mae’s new requirements are already in effect, there is still time for lenders to leverage these solutions to improve their QC and due diligence processes and stay compliant with Fannie Mae—or any other investor—for mortgages closed during the remainder of the third quarter and for the rest of the calendar year.

For lenders that are managing to successfully meet Fannie Mae’s new requirements, the key has been leveraging machine learning automated technologies that are constantly trained from vast libraries of loan documents, ideally billions of docs. This ensures accurate document classification and data extraction, so that the integrity of the loan file information can be validated before an audit takes place. The “purified” data can be consumed by audit-specific business rules, enabling in-house or outsourced audit staff to pinpoint conditions accurately and detect loan defects in a fraction of the time it would take manually.

This same machine learning process to create verified data can also feed other applications, such as automated income calculations. In light of the fact that income is still a defect trouble spot and often a driver of repurchases, greater accuracy in this area also provides significant benefit.

While a growing number of lenders are tapping automation and AI, especially for critical loan production processes like quality control and income calculations, their full potential remains underutilized by much of the industry. Lenders should seek to “automate first” wherever they can to avoid the use of spreadsheets and manual efforts, regardless of who is performing those tasks. This approach can not only create efficiencies that make compliance with new Fannie Mae requirements a breeze, but also puts lenders in a position to respond quickly to Freddie Mac or other investors that decide to tighten guidelines as well.

If fact, lenders we’re working with have tapped into the advantages of AI-driven document processing, data mining, automated auditing, and reporting, complemented by human experts, to support compliance that is responsive and can easily scale. By reducing the number of underwriter touches on loan files while simultaneously reducing loan defects and increasing loan quality, some lenders have been able to successfully slash their costs by as much as 35% to 50%.

Creating an Action Plan

The first step lenders can take to ensure they are able to meet Fannie Mae’s new quality control requirements for prefunding reviews and the expedited 90-day post-close review window is to understand whether and how their existing QC partners are utilizing all available technologies to complete loan file reviews earlier and faster. For instance, how do they evaluate high risk loan characteristics prior to closing, and what tools are they using to do so? Before post-close audits are conducted, do they have a way to validate loan file data? And can their solutions detect loan file defects for all of the lender’s products?

With the right partner, lenders can review loans with high-risk characteristics to identify defect trends that might be addressed by training or process changes, as well as review loan quality sooner to prevent systemic pipeline risk. In a wider context, such partners do even more by helping lenders scale operations based on future market trends. During market upswings, they can grow without overstaffing. In downturns, they can run a tight ship without sacrificing quality or compliance—while lessening both layoffs and the knowledge voids that frequently follow.

It also needs to be said that heightened attention to loan quality isn’t confined solely to Fannie Mae and Freddie Mac. The entire investor community is sharpening its focus in this domain. Regardless of a lender’s secondary partners, gaining early insights into loan quality and tackling systemic issues that reduce the risk of repurchases is always a sound strategy.

The bottom line is that overcoming new compliance hurdles requires constant change. But so does building a profitable mortgage business. As Winston Churchill said, “To improve is to change; to be perfect is to change often.” At a time when lenders are truly feeling the heat from both Fannie Mae’s QC requirements and lower volumes, embracing both technology and collaboration is not only prudent—it’s a necessary change that defines the road to success.

(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 NewsLink Editor Michael Tucker at mtucker@mba.org or Editorial Manager Anneliese Mahoney at amahoney@mba.org.)