As astonishing as it may sound, the Consumer Financial Protection Bureau and Fannie Mae may actually be helping banks and mortgage lenders boost their bottom lines through better oversight of their third-party vendors.
Initially, lenders scoffed when the CFPB issued a bulletin in early 2012 that set expectations for how to manage the risks of third party service providers. At the same time, lenders were struggling to comply with new requirements from Fannie Mae to weed out loan defects and improve quality control.
Now, some lenders are lauding the process of vendor oversight. Lenders are catching more loan defects while improving underwriting and training. That means they are avoiding fines for potentially selling bad mortgages to the government-sponsored enterprises. Vendor oversight also helps lenders move loans more quickly off their warehouse lines so they can fund more loans.
“One bad loan can eat up an entire month’s profit,” said Kevin Marconi, the chief investment officer at United Fidelity Funding, a Kansas City, Mo., wholesale lender. “At first glance we thought this was just another expense, but Fannie had it right. By achieving a zero defect loan, you’re actually saving money and in some cases making money. I believe this does pay for itself.”
Many lenders outsource quality control functions to a third-party vendor, and are now required to audit 10% of their vendors’ work, a process known as “auditing the auditor.”
Marconi, who hired several staff members to perform the audits, said that the process has caught “numerous amounts of defects.” Internal reviewers first began checking 50 items, but the checklist has now grown to 100 items.
“Everybody felt that this was a hassle, an extra layer and additional cost that we had to spend just to make Fannie happy,” said Craig Wells, the residential underwriter in charge of pre-funding quality control at United Fidelity. “But we found our defect rate has plummeted. We are getting loans off our line quicker and turning our money faster. We’ve essentially taken sour grapes and turned it into sweet candy.”
Fannie’s quality control framework should have been put in place “a decade ago,” Wells said.
Though United Fidelity has been doing audits for less than a year, it already is seeing positive results. The company’s suspense ratio — the number of times it stops to review and fix a problem before locking in a loan — has dropped dramatically. For the first time ever, the wholesale lender submitted Veterans Administration loans that had “zero deficiencies up front,” Wells said.
The CFPB’s audit guidelines often dovetail with the work that lenders are already doing for Fannie Mae. The CFPB requires that banks and mortgage lenders manage third-party vendors so they do not present a risk to consumers and are complying with consumer protection laws. To that end, mortgage lenders have to review a provider’s policies, internal controls and training materials, as well as conduct ongoing monitoring.
Bob Simpson, the president of IMARC, a Laguna Hills, Calif., loan data verification firm, said the data uncovered by such audits can be invaluable to top executives.
“When you start keeping metrics on your vendors, you have a lot more comfort defending your work,” Simpson said. “In a world of hefty CFPB fines, where metrics can mean dollars, executives are really paying attention to this.”
If a defect is found in a loan file, state auditors and the CFPB “want to see if there’s a policy in place that should have caught this,” said Marconi.
Annemaria Allen, the president and CEO of The Compliance Group, a Carlsbad, Calif., company that performs quality control and compliance audits for lenders, said the audits have forced originators to improve underwriting.
“It does help for the lender to have some checks and balances,” Allen said. “Our lenders are going back behind us and doing a 10% audit and it hits home a little bit harder and gets their attention a bit better.”
Audits help lenders identify certain trends such as high-risk loans. They also may result in a lender needing its quality control vendor to do a deeper dive, known as a targeted review, which are typically done on new loan officers, processors or underwriters. The audits also help with the remediation process because lenders are supposed to rebut the findings.
Ironically, many nonbank mortgage lenders are not necessarily aware that they need to audit their auditors. When Fannie conducts an audit of a lender, it typically wants to review three months’ worth of quality control reports. These reports should cover a random sampling of loans, a discretionary review and a pre-funding review of risky loans, Allen said.
“The bottom line is that even though QC and compliance is a cost center, it really is a profit center because our goal is to mitigate risk, which can save the lender money,” Allen said.
Wells from United Fidelity Funding said the auditing process has actually improved his company’s relationships with mortgage brokers because it forces the brokers to know the exact lending guidelines and keep better records.
“We will not close a noncompliant loan,” said Wells. “And that says to our brokers that we’re looking out for their compliance responsibilities. It’s a benefit to their business practices so they want to deal with us.”
Marconi called his company’s quality control audits “a living, breathing organism” that is constantly evolving. Because of this, lenders must constantly try to find new ways to improve.
“We find more things that can go wrong as time goes on, and we educate, and then when we find something else that is defective on the loan so we can internally root it out at the source,” he said. “It has really helped us move forward.”