Should Lenders Have Zero-Defect-Rate Targets for Loan Production Quality?

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FM Commentary

Should Lenders Have Zero-Defect-Rate Targets for Loan Production Quality?

Steve SpiesQuality in the loan manufacturing process is critical, and Fannie Mae requires our customers to implement strategies to minimize defects. This has raised some interesting questions: Should lenders have a target of zero eligibility defects in loan production? Is it achievable? And does Fannie Mae expect it?

We always aspire to no eligibility defects, and encourage our lenders to produce defect-free loans, but we do not evaluate lenders by a zero-defect-rate standard. 

Fannie Mae requires lenders to set and manage to their own target defect rates to help them originate high-quality loans. The lender also must define at least two severity levels for defects, with the highest level representing breaches of eligibility for loan delivery to Fannie Mae. Lower severity levels may define defects that also should be addressed in the lender's process, but that do not, in Fannie Mae's opinion, make the loans ineligible for delivery to Fannie Mae. These requirements are intended to help lenders mitigate risk – the lower the lender’s eligibility defect rate, the less its repurchase risk exposure will be. 

Each lender must establish its own set of standards for loan quality that define its credit culture and aid in the development of appropriate controls. We expect lenders to set defect rate targets as low as reasonably possible based on a formal cost-benefit analysis of meeting that target. Then we expect them to demonstrate to us how they are managing loan quality to meet their established target. 

Fannie Mae’s updated requirements for lender quality control (QC), which must be implemented by January 2014, require the lender to have an “effective” QC program. An effective program defines the lender’s individualized loan quality standards and establishes processes designed to achieve them throughout the lender’s entire origination book of business, including identifying deficiencies and implementing plans to quickly remediate those deficiencies. 

A lender that focuses on having an effective QC program is on the right road to minimizing serious loan defects, but the real test is whether a lender’s loans delivered to Fannie Mae meet our eligibility requirements. 

This year Fannie Mae implemented a new process to review loans soon after we acquire them to confirm that the loans were originated in accordance with applicable underwriting and eligibility requirements. Fannie Mae will notify lenders when we have concerns that might trigger a request for a loan file review or a data change. This approach supports the updated representation and warranty framework, and will provide lenders more clarity, certainty, and transparency regarding their obligations after delivering a loan to Fannie Mae. 

We also are committed to providing both loan-level and lender-level feedback to help lenders identify and address any potential issues in their business processes. New loan quality reports will be made available to our lenders by the end of 2013, and issued monthly thereafter, to provide a detailed view into loan defects we identify in the lender’s deliveries to us. By using Fannie Mae-provided feedback in conjunction with an effective QC program and diligent senior management engagement, lenders will be well-positioned to produce high-quality loans with minimal defects and reduced risk exposure.

Steve Spies
Vice President, Loan Quality and Lender Assessment

October 29, 2013
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