ADVISORY Mortgage Origination Operations kpmg.com
Contents Tested Methodologies and Services for an Evolving Landscape 1 Developing the Right Approach 8 KPMG at Work 9 member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. NDPPS 109126
1 Mortgage Origination Operations Tested Methodologies and Services for an Evolving Landscape Today s mortgage loan origination industry is under tremendous pressure to evaluate and enhance its business practices. Companies are being driven by supervisors and investors to contain costs, improve service levels, capture new markets, and increase profitability all while addressing a growing range of regulatory and compliance requirements. In addition to the regulatory challenges faced by mortgage origination companies, the imminent transformation of the mortgage industry, from the current state of excessive GSE dependence to an industry that relies on private sector capital with reduced government support, will likely provide both opportunities and additional challenges. Adapting to the new and developing environment will require companies to rethink their loan origination processes. The fluid regulatory landscape and business risks leave mortgage lenders with virtually no room for error. Being able to maintain operational efficiency while addressing compliance requirements on a timely basis without sacrificing quality will be required to maximize profitability and stay ahead of the competition. With stakes high, lenders must evaluate ways to refine processes across lending verticals to mitigate regulatory compliance issues and business risks to position themselves for success in the mortgage industry of the future. A key area of development will come out of initiatives by the Federal Housing Finance Agency (FHFA) to contract the dominance of the GSEs to create a new secondary mortgage market defined by the private sector with downsized dependence on the government. This new secondary market will be accompanied by standardized lender practices that promote strong risk management, transparency, and consistency. Investor demands combined with continually developing government regulations will likely require lenders to not only refine lending practices, but also accommodate for new securitization practices. As the mortgage market continues to develop into a system that will be sustainable, industry-wide acceptance of a system focused on transparency, standardization, affordability, and consumer protection will be absolutely necessary. In order to build a sustainable system, the industry will implement standards, which are currently in place or are being proposed by regulatory agencies, surrounding fair lending practices, transparency for borrowers and investors, and a holistic responsibility during the loan life cycle. This need will be met not only by regulatory requirements, but by the full buy-in of the changes required by industry participants. The multiple initiatives in the pipeline are formidable challenges for all lending institutions. One-off regulatory projects cannot substitute for the need of holistic integrated strategies. As the mortgage industry transforms, an end-to-end approach to loan origination will be required. Consolidated loan origination automation plays a key role in critical regulatory related activities. Organizations involved in originating mortgage loans, whether they are retail, wholesale, correspondent originators or other industry participants, will need to continuously evaluate their compliance with new regulations, costs associated with new processes, potential liabilities, and risk of loss. Without a strategic and integrated approach to loan origination and securitization, your organization can be at risk of perpetuating the rising cost of operating in a heavily regulated, competitive, and changing environment. Dynamic changes are necessary as increased regulation and investor demand creates additional challenges around cost structure. New accounting rules will change original terms and accounting treatments, requiring systems to balance their large volume processing capabilities with new dynamic flexibilities. Manual processes will likely require automation and standardization to protect data integrity and ensure completeness. Whether it is a matter of implementing process automation, assessing risks and liabilities, implementing or strengthening third-party vendor management, increasing fraud protection, updating reporting systems, mining and analyzing existing data, or rethinking and reengineering an entire process layout, how you prepare for and react to these challenges will define how your company competes in the future. KPMG is ready to help you make these changes and achieve a competitive advantage.
Mortgage Origination Operations 2 A Typical Control Environment Framework A control environment framework can help support the processes and controls needed for effective mortgage loan origination. KPMG s mortgage specialists use a tested control environment framework that can be easily adapted to the specific needs of individual clients. Risk Drivers and Control Framework Quality Control Reviews Compliance Processes Risk Control Framework Business Management: Profitability, Credit and Efficiency Analytics, and Oversight Borrower Activity Originator Activity Internal Audit Enterprise Risk Management Risk Drivers Credit and Quality Drivers Regulatory Drivers Business Drivers House Hunting Prospecting Application Loan Comparison Shopping Pricing Qualification Preclosing Settlement Postclosing Advertising and Marketing Prequalification Execution of Uniform Residential Loan Application and RESPA/TILA Disclosures Loan Application Processing Rate Lock/Forward Commitment Loan Underwriting Loan Processing Funding of Loan Loan Sales Credit Risk: Loans originated may not be attractive to investors Price Risk: Borrowers may withdraw loan applications causing difficulty in meeting forward sales commitments Interest Rate Risk: Rising rates may decrease affordability of loans and decreasing rates may increase loan prepayments Repurchase Risk: Loans originated may fail to meet investor expectations Transaction Risk: Loans originated may be processed incorrectly Fraud Risk: Fraud by originators/borrowers/thirdparty servicers may impact loan quality Liquidity Risk: Capital available to bank is not adequate to meet funding needs Compliance Risk: Origination process may be affected by the following regulations: 1. CFPB and Related Regulations: Disclosures, licensing, advertising, recordkeeping and compensation 2. Basel II/III: Higher capital requirements may affect loan sales as investors are restricted 3. Dodd-Frank Act Section 941: Securitization risk retention requirements may impact the demand for certain loan products 4. SCRA: Loans originated to servicemembers must receive certain benefits that may cause severe penalties for violations Strategic Risk and Profitability: Lending organization may not properly align strategic goals, business strategies developed to meet goals, resources deployed, and implementation efforts, causing potential losses and operating issues Reputational Risk: Operational breakdown/ weakness or borrower harm may expose lender to litigation, financial loss, or damage to customer base
3 Mortgage Origination Operations Whether it is a matter of updating review processes, understanding compliance gaps, evaluating a control structure, or rethinking and reengineering business processes, how you prepare for and react to the risks below will define how your company competes in the future, and KPMG is ready to help you achieve a competitive advantage. Credit and Quality Drivers Credit risk: If the quality of loans produced or serviced deteriorates, the bank will not be able to sell the loans at prevailing market prices. Poor credit quality can also result in the loss of favorable terms or the possible cancellation of contracts with secondary market agencies. For banks that service loans for others, credit risk directly affects the market value and profitability of a bank s mortgage servicing portfolio. These agreements also require the bank to undertake costly collection efforts on behalf of investors. When a customer defaults on a loan under a recourse arrangement, the bank may be responsible for all credit loss through the repurchase of the loan. Price risk: Falling interest rates may cause borrowers to seek more favorable terms and withdraw loan applications before the loans close. If customers withdraw their applications, a bank may be unable to originate enough loans to meet its forward sales commitments. Due to this kind of fallout, a bank may have to purchase additional loans in the secondary market at prices higher than anticipated. Alternatively, a bank may choose to liquidate its commitment to sell/deliver mortgages by paying a fee to the counterparty, commonly called a pair-off arrangement. Interest rate risk: Higher interest rates can reduce homebuyers willingness or ability to finance real estate loans and, thereby, can adversely affect a bank that needs a minimum level of loan originations to remain profitable. Rising interest rates, however, can increase the cash flows expected from the servicing rights portfolio and, thus, increase both projected income and the value of the servicing rights. Falling interest rates normally result in faster loan prepayments, which can reduce cash flows expected from the rights and the value of the bank s servicing portfolio. Repurchase Risk: Loan sales to the secondary market are generally accompanied by repurchase agreements between the seller and investor. If the loan was not underwritten according to investor requirements, the investor may execute a repurchase claim requesting the lender to take custody of the loan and hold it in its portfolio or reimburse the investor for incurred losses. To mitigate this risk, lenders should evaluate their processes and controls that ensure their loans are being underwritten in line with investor requirements. As investors become more stringent in their repurchase reviews, lenders may even want to go beyond historical practices to avoid this risk. Transaction risk: Transaction risk is a function of internal controls, information systems, employee integrity, and operating processes. To be successful, a mortgage banking operation must be able to originate, sell, and service large volumes of loans efficiently. Transaction risks that are not controlled can cause the company substantial losses. To limit transaction risk, a bank s information and record-keeping systems must be able to accurately and efficiently process large volumes of data. Fraud Risk: Mortgage fraud by originators, borrowers, and third-party servicers has created many issues that have plagued the mortgage industry since the beginning of the financial crisis. Loans originated through fraudulent activities will often impact the credit quality of the loans that may cause financial losses to the lender as loans can default causing the lender to be forced to remediate the existing loan or repurchase the loan. Liquidity risk: Liquidity risk can arise from the bank s failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value. Credit and transaction risk weaknesses can also cause liquidity problems if the bank fails to underwrite or service loans in a manner that meets investors requirements. Banks business operations rely on liquidity, and to be successful, a bank must carefully manage its liquidity. Regulatory Drivers Compliance risk exposes the institution to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk can lead to a diminished reputation, reduced franchise value, limited business opportunities, lessened expansion potential, and lack of contract enforceability. A bank that originates and/ or services mortgages is responsible for complying with applicable federal and state laws and failure to comply with requirements, such as those imposed under the Consumer Financial Protection Bureau (CFPB), the Dodd-Frank Act, Basel II/III, and the Servicemembers Civil Relief Act (SCRA), could make the bank a target of class-action litigation, as well as stricter lending requirements. Mortgage banking managers must be aware of fair lending requirements and implement effective procedures and controls to help them identify practices that could result in discriminatory treatment of any class of borrowers. Business Drivers Strategic risk and profitability are a function of the compatibility of an organization s strategic goals, the business strategies developed to achieve those goals, the resources deployed against those goals, and the quality of implementation. Strategic risk
Mortgage Origination Operations 4 can expose the bank to financial losses caused by changes in the quantity or quality of products, services, operating controls, management supervision, hedging decisions, acquisitions, competition, and technology. If these risks are not adequately understood, measured, and controlled, they may result in high earnings volatility and significant capital pressures. Management should understand the economic dynamics and market conditions of the industry, including the cost structure and profitability of each major segment of mortgage banking operations to ensure initiatives are based upon sound information. Reputation risk affects the institution s ability to establish new relationships or services or continue servicing existing relationships. This risk can expose the institution to litigation, financial loss, or damage to its customer base. An operational breakdown or general weakness in any part of its mortgage banking activities can harm a bank s reputation. A bank must maintain efficiency, quality, and be effective to control its reputational risk.
5 Mortgage Origination Operations Originations Meet the Changing World of Regulation Dodd-Frank Act: The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) created the Consumer Financial Protection Bureau (CFPB). The mandate of the CFPB is to protect American consumers in the market for consumer financial products and services. The Dodd-Frank Act generally transferred the rulemaking authority from the historical regulatory agencies to the CFPB. The CFPB continues to evaluate and refine mortgage disclosures and has proposed changes in a discussion period that impacts the mortgage origination process. The CFPB is also focused on identifying and regulating risks such as potentially unfair, deceptive, or abusive acts or practices (UDAAPs) with respect to mortgage originators treatment of consumers. The CFPB examination and oversight standards require mortgage lenders to comply with the following regulations. RESPA/TILA: The CFPB released a proposed rule on July 9, 2012 that would combine certain mortgage disclosures to be delivered to consumers when applying for and closing on a mortgage loan. The proposed rule, expected to go into effect in early 2013, would implement the Real Estate Settlement Procedures Act (Regulation X) and the Truth in Lending Act (Regulation Z) as a single, integrated disclosure for all mortgage loan transactions covered. The CFPB has proposed requiring a new Loan Estimate form as well as a new Closing Disclosure form that will provide helpful disclosures to consumers (at application and closing). The proposed rule also protects borrowers through regulations around recordkeeping, APR requirements, finance charge calculations, fee restrictions, subsequent change requirements, and loan transfer disclosures. The Equal Credit Opportunity Act (ECOA), and its implementing regulation, Regulation B, prohibit creditors from discriminating against any applicant with respect to any aspect of a credit transaction. In addition, creditors are also prohibited from making any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application. The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act) establishes requirements for registration and, when applicable, standards for licensing of individuals who are residential mortgage loan originators. The SAFE Act and Regulation H require each mortgage loan originator who is not an employee of a federally regulated depository institution to obtain a state license register with the NMLSR, and obtain a unique identifier. Employees of depository institutions are subject to different requirements, which include being required to register through the NMLSR, obtain a unique identifier and provide it to consumers in certain circumstances, and maintain registration. The Home Mortgage Disclosure Act (HMDA) and its implementing regulation, Regulation C, require mortgage lenders that meet certain threshold conditions to collect, report to federal regulators, and disclose to the public certain data about applications for, and originations and purchases of, home purchase loans, home improvement loans, and refinancings for each calendar year. The data include information about the loan or application, the applicant, and the property.
Mortgage Origination Operations 6 The Fair Credit Reporting Act (FCRA) and its implementing regulation, Regulation V, impose disclosure requirements on mortgage lenders that obtain information from a consumer reporting agency to determine a consumer s creditworthiness. These include the disclosure of credit score information, disclosure of adverse action, and disclosure of risk-based pricing. Mortgage Acts and Practices Advertising Rule (MAP Rule), Regulation N, applies to nondepository mortgage lenders, state-chartered credit unions, and entities that market and advertise mortgage products but are not mortgage lenders. The MAP Rule sets forth specific deceptive acts and practices in the advertising of mortgage loan products. Section 941 of the Dodd-Frank Act mandates that securitizers of asset-backed securities, including mortgage-backed securities, be required to retain 5 percent of the credit risk of the assets collateralizing the asset-backed securities. The only exception to this requirement is provided for qualified residential mortgages (QRM) that meet specific guidelines. Basel II/III: Basel II/III are international capital requirements that will cause banks to update current operations to evaluate capital structures and assets portfolios. The regulation requires banks to hold more capital against their risk-weighted assets and adjust as needed. These requirements will affect investor behavior as we move forward. Servicemembers Civil Relief Act: The Servicemembers Civil Relief Act (SCRA) has come under regulatory focus recently as banks have received large penalties for violations. Under SCRA, active servicemembers must receive certain benefits for loans held including a maximum rate of interest (including most fees) of 6 percent as well as foreclosure protection. Banks will need to monitor SCRA compliance during the origination process and thereafter. Each regulation can impact multiple layers of the originations process across the company, underscoring the need to develop a holistic integrated strategy to comply with regulatory requirements.
7 Mortgage Origination Operations Regulation Heat Map by Origination Activity Origination Process Regulations CFPB RESPA/ TILA Integrated Disclosures ECOA (Reg B) SAFE Act (Reg G) HMDA (Reg C) GLB Act (Reg P) FCRA (Reg V) MAP (Reg N) Basel II/II Dodd-Frank Section 941 SCRA Advertising and Marketing X X X X Prequalification Execution of Uniform Loan Application & Borrower Disclosures Loan Application Processing Rate Lock/Forward Commitment X X X X X X X X Loan Underwriting X X Loan Funding X X X X X Loan Sales X X X X X
Mortgage Origination Operations 8 Developing the Right Approach KPMG employs a comprehensive, risk-based review methodology comprised of the following four phases, which can be customized to meet an organization s specific needs: 1 Objectives Engagement kickoff Interview key loan origination stakeholders including loan officers, underwriters, and compliance officers Prioritize objectives of origination operations, such as: Performance metrics Target state planning Loan Origination System Integration and Automation Risk management Regulatory implementation Compliance 2 Scoping Review risks for origination management processes and practices: Establish a risk-based approach predicated on understanding core processes Identify key controls and evaluate control design Structure review plan to test operating effectiveness of key controls Determine business units, locations, and resources Assemble a multidisciplinary as-needed team, including mortgage and consumer lending data analysts, contract compliance, regulatory compliance, and other advisory professionals Specific scope considerations based on contract terms, nature of the operations, and specific risks identified 3 Perform Fieldwork Identify relevant data and information (e.g., vendor sites to review, key personnel, etc.): Perform procedures to control and stratify population Select confidence intervals and sampling methodology. Update process flows and operational walk-through Perform control testing steps as well as transactional testing Aggregate preliminary results Determine propriety and representativeness of results Expand sampling/procedures to validate or explain outlier data and unexpected results: Deploy proprietary, database-driven workflow tool to help create an efficient, effective, and transparent engagement environment 4 Findings and Results Final report detailing: Potential control and/or process deficiencies Summary of compliance with contract Regulatory deficiencies and reporting needs Gaps and process improvement opportunities Root cause analysis Recommendation of solutions to those causes Remediation strategies Key capabilities include maintaining flexibility and the ability to establish the framework based on your operations and the ability to deploy programs in a tailored manner, with a risked-based focus on specific attributes, to improve both the value to the organization and return on investment. KPMG deploys active project management on each engagement to foster real-time communication of activities, progress, and roadblocks. This helps avoid surprises and mitigate issues before they become significant. Our timely reporting provides a periodic update to all stakeholders including process owners and project sponsors to promote continuing alignment with corporate objectives. For each origination operation or process identified for review, our team will coordinate with the internal stakeholders and business process owners to understand the nature of the operation and the financial and operational transactions associated with the operation. We recognize that relationships are important to every business, and that reputation for treating business partners with integrity and respect is critical to the ongoing health of the relationship. Accordingly, our project management approach provides proactive management and communication.
9 Mortgage Origination Operations KPMG at Work Case Study Engagement Credentials Advisory Area of Assistance Quality Control Program Assessment and Industry Better Practice Comparison Client Challenge Client has the opportunity to review a high volume of loans for potential representation and warranty breaches and other defects leading to a potential risk reduction via repurchase. Client s regulators and their internal audit group questioned the methodology used by the company in selecting loans for quality control review and follow-up with mortgage sellers for possible remedy or repurchase. Client wanted to reassess the objectives of the Quality Control (QC) function and the resources to be devoted to each. Client s QC team has grown significantly over the past several years and wanted an assessment of whether their current processes have any gaps and/or risks that can/should be mitigated. The client further wanted to compare their QC processes and organization structure to those used by other significant players in the mortgage origination and related counterparty risk operations. Key Activities Assist the company in the following: Clearly defining an updated QC mission based on the feedback from the client regulator, its internal QC staff, and the internal business partners of the QC group. Evaluating the current QC processes to determine nature, timing, and extent of existing activities. Identifying gaps in the process based on industry leading practices, and provision of recommendations as to the future state of Quality Control at the company. Outcomes Detailed QC Process Review and Industry Comparison documentation. Actionable better practice recommendations for various aspects of QC operations including: Loan sampling methodology Loan file solutions (use of Cloud technology) Improvements to data quality Use of third-party vendors Systems improvements (QC system platform, appraisals, file collection, and remedy) Development of stronger linkages within different business areas (remedy, external operation risk operations, servicing, data analytics and reporting, credit risk management) Staffing factors QC oversight function
Mortgage Origination Operations 10 Area of Assistance Conducted a comprehensive risk assessment of Repurchase and MI Rescission operations for a major mortgage company. Review includes GSE, nonagency, and MI companies. Client Challenge Client is concerned about the effectiveness in responding to investor demand letters and Mortgage Insurance (MI) company indemnification requests related to representations and warranties (R&W) with related agreements. Client is concerned about being prepared for targeted supervisory exams specific to counterparty risk management operations and its ability to manage the associated credit risk. The comprehensive assessment needed to include not only the related operational area but other company-wide interlinkages. Areas considered include recovery, operating systems, reporting, operational risk management, and data capture, especially as required for loss reserving. The results from the assessment needed to be compiled into an executive summary, risk prioritization, follow-up work plans, detailed process designs, and detailed process and testing reports. Key Activities KPMG conducted a thorough analysis of all material documentation related to the review. This includes investor and MI contracts (the R&Ws), policy and procedures, training and job aides, existing process flows, negotiation decision trees, existing reports, and data and associated meta data. KPMG further conducted a comprehensive on-site risk assessment of the bank s Repurchase and MI Rescission business operations through conducting process walk-throughs and interviewing key management personnel. This was extended beyond the operations to include relevant company interlinkages with both upstream and downstream impact. Transactional file testing to review negotiation and decision-making processes. Review included the information collection process to substantiate (or refute) investor demands, the decision making process, the negotiation process, and the accounting process to track demand disposition. KPMG compiled these results into a document accepted by the bank s risk management and chief operating officer. Outcomes KPMG successfully assisted the bank in meeting its risk assessment needs to make operating improvements to its Repurchase and MI Rescission operations and to prepare for a potential targeted supervisory exam.
11 Mortgage Origination Operations Area of Assistance Conducted a comprehensive risk assessment of the mortgage company s Repurchase Risk management. Review include processes and controls related to the proper origination of credits for agency execution. Client Challenge Client is concerned about the potential repurchase risk it may have related to agency execution. The client has recently grown from major acquisitions of established mortgage companies. As such, the client is concerned about the integration and proper implementation of a consistent control environment. Agency repurchase demand volume has increased from the 2006 2007 book. In addition, there is concern about the more recent FHA-based originations. Client is concerned about being prepared for targeted supervisory exams specific to operational controls and investor execution. The results from the assessment needed to be compiled into an executive summary, risk prioritization, follow-up work plans, detailed process designs, and detailed process and testing reports. Key Activities KPMG conducted a thorough analysis of all material documentation related to the review. This includes investor contracts (the R&Ws), investor guidelines (all regs), policy and procedures, training and job aides, existing process flows, existing reports, and data management processes. KPMG further conducted a comprehensive on-site risk assessment of the bank s mortgage originations business operations and secondary marketing data management areas. This included conducting process walk-throughs and interviewing key management personnel. Transactional file testing to review underwriting and control processes. Review included all key underwriting processes to fulfill investor requirements as well as related control processes and governance frameworks. KPMG compiled these results into a document accepted by the bank s business operations and operations risk management. Outcomes KPMG successfully assisted the bank in meeting its risk assessment needs to improve its repurchase risk management. The bank has begun implementing many of the recommendations made.
Mortgage Origination Operations 12 KPMG s Mortgage and Consumer Lending Services Practice KPMG mortgage originations specialists are backed by the full resources of our Mortgage and Consumer Lending (MCL) Services practice. The MCL Services practice group includes approximately 300 KPMG professionals who focus specifically on mortgage and consumer lending. They provide a broad array of advisory services to the majority of financial institutions, government agencies, and specialty finance companies, including: Five of the top 10 global financial institutions Five of the top 8 U.S. banks Four of the top 10 FORTUNE 1000 commercial banks Seventy percent of the top 15 mortgage and consumer lending companies GSEs Our service offerings support business process improvement and redesign, compliance assistance with new regulations, and financial assistance at the portfolio and loan level. We use credit analytics, financial analysis, and other tools and methodologies to support informed decision making. We can also monitor loan performance, forecast borrower behavior, estimate credit losses, and help mitigate credit and lease residual risks. KPMG member firms are well positioned to help organizations gain market share and stay competitive in the mortgage and consumer lending marketplace. We also possess the advantage of access to additional advisory, tax, and audit resources, enabling them to examine and address issues from a variety of business perspectives.
For more information To learn more about our services and capabilities, please contact one of the following KPMG professionals: Mark Twerdok Partner T: 412-232-1599 E: mtwerdok@kpmg.com Kimberly Davis-Riffe Partner T: 703-286-6850 E: kdavisriffe@kpmg.com Anthony Sepci Partner T: 213-955-8665 E: asepci@kpmg.com Jeffrey P. Hulett Managing Director T: 703-286-6695 E: jhulett@kpmg.com Edmund Green Managing Director T: 703-286-8692 E: elgreen@kpmg.com kpmg.com member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. NDPPS 109126