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Contracting out quality control.


The word "audit" probably means more to mortgage bankers than to most other businesses. Webster's defines the word "audit" to mean: (noun) "a methodical examination and review," and (verb) "to examine with intent to verify."

Quality control is an area that encompasses all aspects of the word "audit." But beyond that, the word takes on a somewhat different meaning when Fannie Mae, Freddie Mac, HUD or VA comes to a lender's door to perform an audit of the ability to perform quality control on the company's files. The nature of this audit is somewhat repetitive: it is an audit of quality control audit procedures to determine compliance with each agency's regulations in this area. Failure to have proper audit procedures and a good program for quality control have become very serious matters with agencies and investors, particularly in these times when fraud has become more evident and, unfortunately, too common.

Quality control departments are a costly part of the mortgage lending industry - both in terms of money and personnel. Generally, the personnel in the quality control area are experienced in processing and underwriting. They could be utilized in the production function but are needed instead to oversee the quality control function and to review and maintain compliance with agencies and investors.

Enter a third party: the "quality control service," which offers to do quality control for mortgage bankers on a contractual basis. Although some lenders today are using contract services, others have never heard of such a service. As quality control has grown in importance in the mortgage lending industry, the need for better services and reports has spawned this relatively new service industry. What are the disadvantages and the advantages to such a service, and what should mortgage bankers look for to determine if contracting out their quality control function would be valuable to their company?

Logistical challenges

First, the disadvantages. The obvious disadvantage is less in-house control of the personnel involved in the quality control process. Most managers are comforted by knowing that they have a qualified staff they can rely upon, who are familiar with their operations and personnel.

Another disadvantage is the logistics involved with sending files to a third party for review. What if a file is lost in transit or if it is immediately needed for solving some other problem that has nothing to do with the quality control review? This disadvantage can be overcome through the use of document replacement insurance for lost files. Also, overnight mail can expedite the return of a file, should it be needed back immediately. The quality control service company usually will have a fast turnaround on files, returning them in less than a week.

Some providers of quality control services will work from copies of the files if sending the original file creates a problem. Working with copies may, in itself, create certain problems such as: failure to copy all or both sides of a particular document; failure to copy all pieces of the file; the cost incurred to copy every piece of documentation - down to the sticky notes; and inability to determine where correction ink was used to correct or alter a document. The best quality control comes from review of the original file.

The objective approach

Turning to the advantages of using contract services for quality control, the most obvious is the independence of using third parties for review, thus gaining a more objective look at loan processing and underwriting without the personal prejudices that can come between co-workers.

Additionally, quality control companies can spot problems faced by other lenders for whom they work, such as the review of work from correspondents and originating companies that submit files to a number of lenders. In such cases, the contract quality control company may be sensitive to problems of various correspondents prior to the lender picking up on the same problem. For example, a particular correspondent has been discovered by the quality control company to have a history of misrepresentations in verifications of employment or deposit (VOEs or VODs) on loans submitted to one lender and has been cut off by that lender. If another lender using the same quality control company is unaware of the correspondent's previous history, and is buying loans from that same correspondent, the quality control company can immediately adjust its audit to include a higher percentage of files from that correspondent. The quality control company can then determine if the same problems continue to exist and, through the focus of the second client's audit, make a quicker determination as to the root of the problem.

The broad geographical spectrum of reviews done by third-party firms can allow the contractor to pick up on regional and national problems before the lender has become aware of the trend. For example, a history of declining values on appraisals could involve fraudulent schemes devised by individuals who, as they are exposed, travel across the country from region to region.

Contract quality control companies allow both small and large lenders to access sophisticated equipment and trained personnel. Overhead for the mortgage banker, however, remains flexible, and costs will vary with actual production levels without the need for increasing or reducing cost of personnel, support and/or space requirements to meet the peaks and valleys of production. The management headache of trying to find qualified personnel to perform quality control tasks when needed can be eliminated.

Cost to contract

Costs for all services vary among contract quality control providers. Full services that cover file selection, review appraisals (on one in ten files), ordering credit reports as needed, file review (to include processing, underwriting and closing) and management reporting will vary depending on the volume of files being submitted to the company. Basic charges are incurred on a per-file basis and generally range from around $100 to more than $150 per file, depending on the particular quality control company, the services performed and the volume of work. Depending on the contract company, basic charges may include a variety of items and should be reviewed closely to determine a mortgage banker's exact needs. Review appraisals, certain verifications, additional credit reports and other charges may be billed separately, in addition to the basic charges.

Contract providers will not eliminate the need to have an employee within the mortgage banking company who can follow up with the report and provide management with answers to any exceptions found in the quality control review. Further, management must continue to be involved in the process - reviewing the quality control report, determining corporate policy and guiding the processing, underwriting and closing of loans.

Selecting a third party

When analyzing a service company to do quality control, a lender should determine the following: * Whether the quality control company has qualified people who will be working on the lender's files. Ask for resumes on the people who will be doing the actual work. * What the base charges are and what additional charges above the base fee will be incurred. Additionally, ask about the company's history of fee increases. * Does the company provide full service from selection through review, including tracking loans by branch, originator, processor, correspondent, etc. and providing reports on each? Will the quality control review be a comprehensive review or a cursory review? * Is the quality control company a bona fide business with a permanent staff that will maintain the business without disruption due to loss of a key employee? * When the quality control company is finished with its review, how much staff is required to follow up on the report rendered? * What is the ease of reviewing the quality control management reports to identify problems? * What is the turnaround time from delivery of the files to return of the quality control report? * Can the company tailor reports to individual company needs and, as part of the reporting, provide graphic presentations of data for easy review and spotting of trends? * Has the quality control company had its work audited by Fannie Mae, Freddie Mac, HUD or VA? Lenders might want to talk to local or regional agency offices to determine their opinion of the quality control company's work. * Will the quality control company handle the review of all appraisals and order a review appraisal on the proper number of cases?

When looking at quality control companies, be on the lookout for certain problem areas, such as one-man operations with no backup; additional charges to help investigate potentially fraudulent transactions; and additional charges for necessary verifications on VOE and VOD items.

Additionally, lenders should be fully aware of any failure to meet Fannie Mae, Freddie Mac, HUD or VA guidelines. Although the agencies themselves do not provide information stating which companies meet their guidelines, mortgage bankers should be sure these parameters are met by comparing an example of the company's quality control report with the agencies' guidelines.

The number of firms currently providing contract quality control services is small. There are at least three such companies currently known to this author, but others may exist and deserve to be explored as possible service providers if the lender decides this option is useful. ADFITECH (Advanced Financial Technology, Inc.), Oklahoma City; TENA Companies, Inc., Minneapolis; and American Portfolio Services, Citrus Heights, California, are three providers of these services.

To contract, or not?

There are a number of alternatives in looking for a contract service. If lenders find that such a service is of interest, they should start sorting out the best service by interviewing the contract quality control company's key personnel. Check the references of each company to determine how the existing clients view their work in terms of timing and quality. It can also pay off to take the extra step and visit the office of any contract company a lender is seriously considering to see how files will be handled.

Quality control is a very serious matter. It can save companies large sums of money by detecting patterns of misrepresentation or fraud that, if undetected, could cause mortgage bankers to be stuck with loans that are unmarketable or uninsurable. Failure to maintain good procedures and personnel to perform good quality control reviews on originations can end up costing far more and eclipsing any small savings achieved by skimping on this area. In most cases, the contract quality control company can provide the lender with a more complete quality control package, from review to reports, at less money than the per-file cost of doing the work in-house.

Finally, in a business in which loan volume fluctuates from month to month and income rises and falls relative to loan volume, contract quality control services provide a variable cost center that can fluctuate with loan volume. Such an approach alleviates the need for management decisions on whether to expand or contract the in-house quality control department.
COPYRIGHT 1991 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:quality control audits
Author:Hagan, James C.
Publication:Mortgage Banking
Date:Mar 1, 1991
Previous Article:Seeking common ground.
Next Article:Essay.

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