By Ben Madick
Over the past 12 months, I’ve personally performed over 60 due diligence reviews on mortgage lenders as part of a new or existing warehouse facility or investor relationship. Through these reviews I’ve concluded that all lenders are not created equal, especially when it comes to their servicing/sub-servicing oversight and quality control (“QC”). Every master servicer I interviewed knew of certain obligations in this regard, but rarely (10%+ of the time) did I find a master servicer that actually demonstrated an acceptable level of oversight of its servicing department or sub-servicer. I could place each of these lenders into one of three categories:
1) Those that know what they are required to do, but don’t know how to do it;
2) Those that know what they are required to do, but don’t have the resources to do it; or
3) Those that don’t know what they are required to do.
As a result of my experience in this regard over the past year, I decided to write this article to provide insight, which all seller/servicers should find beneficial. Whether you’ve been servicing loans for many years or are relatively new to servicing, trust me, “doing nothing is bad” and will come back to haunt you down the road.
Are you overseeing/monitoring your sub-servicer?
To be an approved seller/servicer for Fannie Mae, Freddie Mac, and/or Ginnie Mae, a servicer must show it has written procedures which demonstrate how it oversees quality control and monitors all components of their servicing unit or third party sub-servicer. This is not optional. Not only do approved seller/servicers need to have these written procedures in place, but they also must follow these procedures, which usually call for monthly, quarterly or annual monitoring and auditing based upon the particular item being audited. These written procedures are not the same procedures provided by a sub-servicer, which demonstrate that manner upon which the sub-servicer conducts its business. These written procedures demonstrate how the seller/servicer will verify that the sub-servicer is actually following their own procedures and how quality control checks will be implemented.
My experience has revealed that most servicers do not have proper procedures in place to monitor their servicing department or sub-servicer to ensure they meet the level of service required by the GSE’s and regulators. In instances when a sub-servicer is utilized, the risk of non-compliance remains the responsibility of the servicer that owns the MSR as they represent and warrant that the sub-servicer is compliant. Moreover, any investor, warehouse bank, or partner to the MSR owner will verify that the servicer maintains proper oversight. Their counterparty risk relies on this as well.
To quote the guidelines specific to servicing, Fannie Mae requires that all servicers have QC procedures in place. The decision on how to implement the QC procedures is left to the lender [I, 202: Servicer’s Basic Duties and Responsibilities]. FHA guidelines are much more explicit, FHA Single Family: 4060.1 Rev-2: Mortgagee Approval Handbook, Ch.7 Quality Control Plan, Part A, Chapter 7, completely details a scope of audit that HUD expects that its servicers follow. A lender must ensure that their sub-servicer is compliant with RESPA, TILA, investor guidelines, CFPB guidelines and state and federal laws and regulations. The penalties for non-compliance can be severe, and may impact future business opportunities. As such, all QC audit plans must address the tracking and correcting of errors swiftly and properly. Therefore, an audit regime must continue indefinitely as long as loans remain in the servicing portfolio. As Chapter 7-10 of FHA guidelines state, “Quality Control of servicing must be an ongoing function.”
A proper quality control audit process will cover many aspects of compliance. If you are unsure where to start, the items set forth below should give you a good starting point:
- Re-verification of loan documentation
- Review of New Loan Setup data integrity
- Review of Escrow Administration
- Review of Delinquent Loans to ensure Servicing Alignment Initiatives are achieved
- Review of loans in bankruptcy and foreclosure
- Review of MIP to ensure timely payment and accuracy
- Review of Payoffs to ensure compliance with all servicing guidelines
- Review of Customer Service to ensure servicing best practices are met
- Review of Fair Lending to ensure there was no unfair or discriminatory acts or practices
- Confirmation that Investor and Regulatory requirements have been met and ensure compliance with Servicing Guidelines
It is not required that every loan in the servicing portfolio be reviewed. A sampling in each category is all that is required. The sample size and frequency of the audit is dependent upon many factors related to the servicer and sub-servicer. In no case should the sample size be less than 10% unless a statistical representation can be achieved with portfolios greater than 15,000 or 20,000 loans. Most experts are of the view that some items must be audited monthly, others quarterly and a select few annually. If problems are found in one particular area, corrective action should be taken, and the sample size in that particular area increased for a short period of time to ensure that the corrective action implemented has been effectuated by the servicer or sub-servicer.
The GSEs require that a prospective and existing servicer establish and follow policies as described above in order to achieve and maintain master servicer approval. You do not want to face your next GSE examination without having these procedures in place and without being able to evidence that the actual auditing and monitoring is taking place as set forth in the written procedures.
Going back to my three categories of lenders, what is certainly lacking with most servicers, is the wherewithal, knowledge, staffing and procedures to properly complete these quality control checks. As a servicer, you are not permitted to wait to have a mature portfolio to start auditing your sub-servicer. Once you have greater than one loan in the portfolio, your audit procedures should include ongoing, constant monitoring of new loan setup, disclosure practices, and proper management and investor reporting to document your findings.
When reviewing audit reports and speaking with servicers I commonly find problems relating to unexplained data discrepancies between the loan file, the servicer’s origination system and the loan data boarded onto the servicing platform. If not properly identified and corrected, these discrepancies, such as incorrect escrow account balances or a borrower’s mailing address, may result in lawsuits, monetary penalties, GSE actions etc. Repeated failures in this regard could lead to loss of master servicer approval. These type of problems need to be detected and corrected. In addition, corrective action must take place to ensure that these errors are eliminated. To err is human. Failure to detect errors and correct the cause of the errors will not be forgiven by the CFPB, the regulators or the GSE’s.
Best Practice Suggestion
For many lenders, outsourcing this monitoring requirement to a third party auditing firm who conduct audits on behalf of a servicer is a terrific option. This is certainly allowed by the GSEs. Similar to post closing QC for originators, it is important to maintain a good, working relationship with a credible vendor that is capable of protecting your servicing assets. Servicing managers, Compliance Managers and all executives of the Master Servicer should hold monthly or quarterly meetings to review all audit findings and create an action plan to be addressed with the servicing department or sub-servicer. It’s important to document the findings, corrective action plan, and summary report to demonstrate your proactive steps in continual surveillance of servicing.
Proper QC of a lender’s servicing department or their sub-servicer is essential for survival in today’s highly regulated compliance world. Lenders have been required to expend an enormous amount of time and resources to keep up with the requirements imposed upon them by the CFPB and various newly enacted federal and state regulations. While lenders have time constraints with complying with all changes immediately, I suggest that you should not waste anytime whatsoever in making sure your quality control procedures are developed and implemented as required.
Ben Madick is the Founder of Mortgage Quality Management and Research,LLC and the President of Subsequent QC. MQMR specializes in helping lenders and warehouse banks manage risk, mitigate losses, and improve efficiencies. Subsequent QC provides servicing and sub-servicer oversight to lenders nationwide.