Mortgage companies want to devote enough resources to compliance and record-keeping to survive audits, but they need to do it within the financial constraints set by their business' high costs.
Home loan market participants and vendors that assist them pinpointed some steps lenders can take to prepare for audits, particularly regulatory checkups that have been growing in importance recently. They also discussed some possible ways to do this cost-effectively, and some of the steps that are still necessary but taking a back seat to others.
For example, the post-closing review—although still required—has become less important in this context, according to Leonard Ryan, founder and president of QuestSoft, a mortgage compliance vendor based in Laguna Hills, Calif. Before the financial crisis, market participants felt checking loans after closing and before sale was sufficient because buyers focused more on the assets at the pool level. In buying a pool at that time, investors expected that so long as there were enough good loans for the pool to perform well, a few bad apples weren't a concern.
But the crisis taught the industry otherwise.
"My personal belief is that post-closing compliance has become somewhat useless in this industry," Ryan says. "Prior to the meltdown people sold their loans in pools. That's not the situation today. That single loan will get you into trouble."
Secondary market participants still demand post-closing quality control as they want to be sure nothing has changed during the closing process to affect the loan they are buying. But from a compliance standpoint, errors caught during this review are largely equivalent to closing the barn door after the horse gets out.
Following are five things market participants and vendors say should get more weight in preparing for audits.
"I highly recommend prefunding compliance. That's the only place you can cure your loans now in a lot of rules," says Ryan.
The reviews can result in a lot of operational improvements that will help a company fare better in an audit, he says.
"You'll do better in an audit if you identify your problems before you fund the loan, hopefully. No. 1, you're not going to have as many complaints. No. 2, you're not going to have cures, which you have to eat and affect profit. You'll more likely have your disclosures done correctly," he says.
Consider the Investors
"If you can't sell a loan on the secondary market, that's huge," says Ryan. The only option is to portfolio the loan, and many lenders today may not have the wherewithal to do that. Or if they do, they may not want to put a loan with some flaw that made it less than saleable on the balance sheet, where it could affect profitability and stick out in an audit.
If you're looking for a way to prioritize which myriad rules to apply the most scrutiny to, consider putting a focus on the ones that not only could cause problems in a compliance audit but could cause trouble down the road in the form of a repurchase.
Do a Mock Audit—to the Extent Needed
A mock audit was one of the things lending executive Eddy Perez, whose company has gone through a compliance audit, says companies should consider. Perez is the president and one of the co-founders of the Atlanta-area mortgage banker Equity Loans, which earlier this year changed its name to Equity Prime.
Mock audits require an investment in time and money, but they can be scaled to fit budgets and individual companies' needs, says Lisa Weaver, a senior vice president at ISGN, an industry technology and services provider that among other things offers mock audits.
A mock audit typically requires an identification phase in which the vendor helps a mortgage company spot potential operational concerns that could cause problems during a Consumer Financial Protection Bureau audit. Depending on the company's scale and what its executives want reviewed, this could take anywhere from three to four days or three or four weeks, to months, Weaver says. The identification phase is followed by a remediation phase which could take even longer, more than a year for some clients.
Automated compliance checks involving commonly asked questions and answers may save companies money, although pricier options that require paying for on-site reviews may provide piece of mind or be necessary for a company that feels it need to get a firmer grip on its compliance.
Paying to house and have people from a third party on-site to review a company for potential concerns during a mock audit does have a price, but at least this can be controlled at the mortgage company's discretion, Weaver says. In a real audit, companies generally have to pay for auditors to stay on-site as long as needed to investigate a concern, says Perez. A mock audit prior to any real audit may help them reduce that expense by having information that proves the company's compliance more readily at hand.
Mock audits tend to target federal concerns only. So a mock audit or other compliance review that identifies state-level compliance concerns might be a separate service. Differences in state requirements can come up in an audit, Perez says. Although more standard required testing for licensed originators designed to bridge state differences is now available, for example, there are still state-to-state differences to watch for, he says.
State auditors can be accommodating, Perez says. Weaver says it depends on the state, and recommends prioritizing compliance reviews for those that are less lenient, such as New York or Massachusetts.
Eventually, more states' licensing requirements will be standardized in line with efforts to that end. But with some states' legislatures meeting infrequently, it could take a couple years for them to consider and make the changes needed for this to happen. Weaver advises prioritizing screening for potential federal compliance concerns, simply because the scope is larger.
Ensure HMDA Data Integrity
Home Mortgage Disclosure Act data "is looked at as the gospel truth" by compliance auditors, says Ryan. "The call report is no different. Whether it's the agencies, the states, and CFPB—that's how they start investigations." Reporting errors in these areas are right up there with consumer complaints when it comes to areas likely to land companies in hot water in audits.
Use Strong Financial Reporting Technology
At one time smaller companies might escape regulatory scrutiny because of their size. But that's not true today, so even they need easily accessible automated financial reporting.
David Critzer, chief financial officer at Nations Lending Corp., a lender with offices in the Cleveland/Akron area, says even for regular yearly financial audits, it would be difficult to get by without a mortgage industry-specific accounting system that accommodates easy access to financial reports.
This is particularly important when it comes to escrow accounts where mortgage firms hold funds in trust for borrowers, says Brian Lynch, president of Advantage Systems, an industry accounting technology provider based in Orange County, Calif. In the last year or two state auditors have been looking more closely at this, he says.
Servicers as well as lenders have to be careful about having timely access to financial information on their mortgage assets. The CFPB requires servicers to be able to provide complete servicing files within five calendar days.