GSE Guidance: The Elephant In The Room

To put the context of this article on the right footing, I offer the perspective of how dependent we are on the functioning parts of our vehicle.  Whether it be a sedan, SUV, or a truck, the parts of the whole make the product work, and it must work to the highest level possible for our safety. I remember last year, when the outside temperature was in the mid 90’s the battery on our SUV failed to start. Here I was stuck in a parking lot, dealing with an increasing level of frustration in accepting the failure, coming to terms with reality, and then waiting for a tow truck. One, and only one of the parts of the whole failed.

Sound familiar?  The entire mortgage loan origination cycle is dependent upon the parts of the whole – working, together. When gaps occur in this cycle additional risk occurs in the quality of the product. Whether it be the service level that the customer receives, or actual mistakes that occur in making sure the loan meets the eligibility criteria and underwriting standards of secondary market investors, gaps do exist. And, let’s all agree that there are some bad character’s in the lending environment that have keenly learned how to take advantage of processes that do not have controls in place – another reason why Quality Control is not an option, it’s a mandatory method in which a firm works.

It is for these reasons that industry best practices for Quality Control are in existence with both Fannie Mae and Freddie Mac. Each of the GSE’s state what their Quality Control requirements are – so why do these gaps still occur? 

Is your firm opting for a “short version”  Quality Control program? This can be the lack of leadership engagement, the result of staff simply not understanding the requirements, resource restrictions, and the fact that there are internal technology limitations.  Let’s simply admit it – there is an Elephant in the Room”. When an organization opts to take the “short version” in its Quality Control program – you will be guaranteed product failure, which includes portfolio risk, or strained investor relationships which results in additional investor repurchase risk.  

Ask yourself this question: How does your firm score itself on its report card for Quality Control? If you are in a Senior Leadership position and don’t know the answer to this question, that’s the first problem.  Whether your firm sells loans to Correspondent Aggregators, and/or the GSE’s Quality Control standards have certain requirements. So don’t be short sighted in the context of this article, Correspondent Aggregators rely on a firm following GSE standards. Why? These firms are packaging the loan in a GSE mortgage-backed security for sale in the open market, or selling the loan to the GSE’s under their cash window. 

Both Fannie Mae and Freddie Mac require that individuals in Senior Leadership positions have ongoing and regular benefit of understanding where Quality Control has identified breaks in processes, how were those breaks remediated (i.e., corrective action, systems, people, training.) To make the information be of benefit to everyone – staff, management, and leadership – there are also standards for how the gaps – “defects” are scored via a Targeted Defect Rate method, and identifying if the defect is assessed as a High, Moderate, or Low Risk.   

The ability to build out an effective Quality Control program is not simply the mechanics of being able to do so – it is the ability to monitor, measure, and report on the defect via Trend Reporting. So, think of it this way – when an automobile manufacturer looks at its assembly line, it has in place various steps, processes, and controls that ensures each part of the process is working effectively so that the final product has met, if not exceeded the manufacturing specifications for the product. This is exactly what an effective Quality Control program does.

If the answer to my second question was – you don’t know, that’s your first red flag.  Let me share with you some of the misunderstandings about the Quality Control processes that I have seen as a consultant:

• Quality Control is viewed as a negative result to an employee’s performance
• Internal infrastructure can be isolated to “function specific” knowledge
• Cohesiveness in cross-departmental roles and responsibilities
• Quality Control Plan partially meets GSE requirements
• Targeted Defect Rate lacks clear definition and monitoring
• Dependencies upon outsourcing the function to a Quality Control Vendor  
• Mindset that Vendor is the expert – Vendor oversight is a GSE requirement.

In your Senior Leadership position, I encourage you to use this article as a tool to ask questions. If you get a negative or avoidance reaction to the word Quality Control then this topic needs further exploration. Listen to your instincts!

If you need professional advisory assistance, then bring forward “The Elephant in the Room” and rely upon a consultant to help maneuver through the process. There is not just one part to the Quality Control program, there are many parts that need to work effectively to produce the highest quality loan product. If your firm achieves these measurables, the word “repurchase” rarely occurs.