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   ARTICLE   |   From Scotsman Guide Residential Edition   |   June 2015

Vendor Management Under the Microscope

Regulatory agencies are increasing their focus on third-party relationships

There’s an increasing focus by the Consumer Financial Protection Bureau  (CFPB) and banking regulators on how lenders manage their myriad vendor relationships. Certainly, fines levied against lenders so far have been significant, as evidenced by the $37.5 million in fines and damages a bank was ordered to pay last year for allegedly providing misinformation to borrowers, miscalculating income and mishandling mortgage modifications.

The findings against this bank included failed vendor oversight of a third-party servicer used to assist in the bank’s foreclosure backlog. In a public statement, the CFPB affirmed its commitment to protect consumers against lender actions. CFPB public records show other actions against lenders for lack of proper vendor management, some of which have exceeded $100 million in fines.

It’s also important to note that state regulators have picked up on vendor management. Increasingly, state examiners are asking lenders about their vendor management programs and reviewing applicable policies and procedures. In addition, some regulatory examinations include a sampling of individual vendor files and transactions involving specific vendors.

Long tail of compliance

Although these costly actions came against large lenders, companies of all sizes need to be aware of the long compliance tail after findings and consent orders. The well-publicized “robo-signing” cases involving mortgage modifications are a good example of the long and costly impact stemming from lenders failing to maintain proper vendor management.

In addition to enforcing substantial civil penalties, in some of these cases regulators also required greater board oversight, stronger internal audits and enhanced compliance and risk-management programs from the companies. Thus, the impact for poor vendor management was more than just a one-time penalty; it resulted in material changes to business policies and procedures, which in turn impacted long-term operational costs.

The redefined bottom line for lenders is that they are responsible for every vendor engaged in providing a product or service. Lenders can’t take the position that they hired a vendor to replace or supplement a core competency the lender did not have. It doesn’t matter. The CFPB — and applicable state banking regulators — will look to the lender. Sure, the regulators may also seek redress from vendors, but that’s likely to be peanuts in the scope of fines, reputational risk and operational costs.

Vendors, vendors everywhere

Given the complex nature of originating and servicing mortgage loans, vendor relationships exist throughout the loan life cycle. Lenders contract with vendors from application to closing, and even through toselling loans on the secondary market, servicing loans and receiving payoffs. In addition, originators are vendors to correspondent lenders, subservicers are vendors to mortgage banks that retain servicing but outsource servicing rights and even some originators could be considered vendors in co-issuer relationships.

The Dodd-Frank Wall Street Reform and Consumer Protection Act defines service provider broadly: “Any person that provides a material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service.” Thus, if a loan servicer provides any sort of financial transaction or service involving a consumer — virtually every material business process or service that lenders acquire from external providers — the relationship with that vendor must be managed under a documented system that meets all the regulatory guidelines.

The regulatory premise is that if you acquire any service that’s material to your business, you need to either have a current and continually tested plan to bring the service in house quickly or have a backup vendor that can execute a transfer just as quickly. A great example of this is that if you can’t close a loan because your network or loan origination system is down and a consumer is injured as a result of the delay, you’re responsible.

Typical nonbank lenders have 30 to 60 Tier 1 and Tier 2 vendors, which pose high and moderate risk to a lender’s business if they fail. These top-tier vendors exclude closing agents and panels of individual appraisers — all of whom meet the vendor definition. Thus, most lenders have 30 to 60 providers for whom they must demonstrate the following to be compliant:

  • Policies. Lenders need disciplined and documented policies and processes for approving doing business with high and moderate risk providers. These processes must adequately consider the roughly 20 general-risk categories associated with a material service.
  • Service agreements. Signed agreements between lenders and vendors for covered services must meet regulatory guidelines.
  • Benchmarks. Lenders must establish reasonable benchmarks or performance standards for their critical service providers and appropriately monitor vendor performance.
  • Incident logs. The monitoring process should include incident logs that allow lenders to track trends and demonstrate they have taken appropriate actions when warranted.

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Obviously, there’s a lot more to compliant vendor management than the points mentioned here. Fortunately, there are support systems and resources to help lenders implement cost-effective solutions that don’t overly burden a company’s cost structure. For example, if implementation seems too daunting, look for turnkey solutions you can assume readily with nominal support.

Alternatively, you can acquire a toolkit that offers end-to-end solutions with optional resources to augment internal resources as needs dictate. Whatever action seems best for your company, do something now. Rolling the regulatory exam dice can become costly. 


 


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