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Critical Defect Rate Dips

The critical defect rate in the first quarter of 2021 trended downward from Q3 2020’s peak, ending at 2.01%. That is down slightly from last quarter’s 2.09% and is 14% lower than the peak of 2.34% in Q3 2020. ACES Quality Management (ACES), a provider of management software for the financial services industry, reports that and more in its quarterly ACES Mortgage QC Trends Report. The latest report, which provides nationwide loan quality findings based on data from the proprietary ACES Quality Management and Control Software, covers the first quarter of this year.

"Even though the decline was modest from last quarter, we do like to see the overall trend heading lower," noted the report authors. "Given the continued improvement in the macro-economic environment, we remain positive that defect rates can return to the sub-2% levels that we saw for much of 2019 and 2020."

The authors highlighted the following from the report:

The downward trend in critical defects continued in Q1 2021, ending the quarter at 2.01% versus the prior quarter’s rate of 2.09%.

A rapid rise in the "income/employment" category led all defect categories, with several of the core "underwriting/qualification" categories increasing as well.

Declines in the "regulatory compliance" and "loan documentation" categories show that lenders are self-correcting and stabilizing their operations.

Refinance review share continues to be strong, and defect performance has improved.

Conventional loans dominated while defect performance declined.

Early payment defaults fall below pre-pandemic levels in a hopeful sign that the worst is behind us, though we remain cautious about loans exiting forbearance status.

ACES Executive VP Nick Volpe says that with Q1 2021 marking a second consecutive quarter of decline in the critical defect rate, the record spike observed in Q2 2020 "appears to have been a one-off increase, which is encouraging.

"However, lenders and servicers should still proceed with caution, as declines in gain-on-sale, the conclusion of the eviction moratorium, persistent inflation and a potential default wave as forbearances come to an end all have the potential to trigger industry disruption," he added.

Findings for the Q1 2021 ACES Mortgage QC Industry Trends Report are based on post-closing quality control data derived from the ACES Quality Management and Control benchmarking system and incorporates data from prior quarters and/or calendar years, where applicable. All reviews and defect data evaluated for the report were based on loan audits selected by lenders for full file reviews.

ACES CEO Trevor Gauthier says the report reflects a sector working to get back on track.

"The declines observed in not only the overall critical defect rate, but also in EPDs and the Regulatory Compliance and Loan Documentation defect categories speak to an industry that has made considerable strides to course-correct after the tumultuous year that was 2020," Gauthier said. "Unfortunately, 2021 may not prove to be any less challenging, which places even greater emphasis on lenders’ defect tracking and reporting efforts to remain ahead of the curve and adjust their operations as necessary to stay on track."

ACES Q1 2020 report is available on ACES' website. Based on Fannie Mae's Loan Defect Taxonomy.

About Author: Christina Hughes Babb

Christina Hughes Babb is a reporter for DS News and MReport. A graduate of Southern Methodist University, she has been a reporter, editor, and publisher in the Dallas area for more than 15 years. During her 10 years at Advocate Media and Dallas Magazine, she published thousands of articles covering local politics, real estate, development, crime, the arts, entertainment, and human interest, among other topics. She has won two national Mayborn School of Journalism Ten Spurs awards for nonfiction, and has penned pieces for Texas Monthly, Salon.com, Dallas Observer, Edible, and the Dallas Morning News, among others. Contact Christina at [email protected].

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