Auditing Your Document Custodian, an Often Overlooked Practice - Mortgage Compliance Magazine

11/19/16, 3(19 PM

Auditing Your Document Custodian, an Often Overlooked Practice

! November 6, 2014

" Compliance, Featured, Quality Assurance

By Nicholas Corpuz &

Ben Madick

What Are Document Custodians?

Document Custodians hold an important, and often overlooked, place
in the real estate finance industry. They perform some of the most
basic procedures underpinning the entire industry, and yet, they are often a mere after-thought. This
attitude is best summarized by my own personal example. One spring day, my business partner and I
were travelling to visit a client. We drove past a large document custodian warehouse on our way to visit
the client. My business partner pointed out the large warehouse containing millions of collateral files.
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Bemused by the size of the warehouse, he said Can you believe that the total value of the collateral files
held in that warehouse is more valuable than most banks? That statement got me thinking; how was
something so valuable, overlooked so often?
Because they are ubiquitous, its easy to overlook the documents that underpin the real estate finance
industry. Every federally regulated mortgage in the United States is secured to the underlying real estate
by a signed mortgage/deed of trust, a signed promissory note and a title policy. These documents must be
treated with care. For example, if the borrower pays off the loan, the mortgage/deed of trust needs to be
released from the title record and the promissory note must be returned to the borrower. In addition, if
the borrower fails to make their payments and the lender is forced to foreclose, the foreclosure cannot
occur without the signed note.
These documents underpin the legal existence of the real estate finance industry; without them, the
industry would not exist. It would be impossible to secure financing to real estate without the legal
protections the mortgage/ deed of trust, the promissory note and the title policy provide to the lender and
the borrower. These documents are very important, and, because of their importance, many investors,
including Ginnie Mae, require that holders of MBS pools audit their document custodians. The failure to
maintain adequate controls over a document custodian can have negative impacts to a lenders business
operations.

Ginnie Mae MBS Pools

In total, Ginnie Mae MBS Pools consist of over seven million loans. Every single loan contains a collateral
file. Each collateral file must be held by a Document Custodian. Ginnie Mae requires their issuers to
review the Document Custodian. This is an often overlooked compliance area; the Document Custodians
are often afterthoughts when lenders build their vendor audit regimes. In the worst case scenarios, only
after a HUD audit does it become evident to a lender that they overlooked their Document Custodian. It
shouldnt take a HUD audit to make a lender pay attention to their Document Custodian.
Ginnie Mae is explicit in its requirements for each issuer to review their Document Custodians.All of the
requirements for auditing Document Custodians are detailed in HUD Handbook 2000.04 Rev-2 CHG-11,
Section 6-5 (Handbook). Per the Handbook, the reviews must be regular and onsite. If an issuer has more
than one Document Custodian, Ginnie Mae requires that at least one custodial institution must be
reviewed each year, and all must have an onsite review within a three-year cycle. The review must be
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comprehensive because the Document Custodian is essentially a vendor of the pool issuer. In many
instances, it may be to the advantage of a Document Custodian to hire a certified public accounting firm
(or third party auditor) to conduct a review of the mortgage documents that are held by that custodian
when they are responsible for several issuers documents, rather than having each issuer send a different
auditor to review the custodial documents pertaining to each issuers respective pools (commonly
referred to as the single auditor approach). The single auditor approach may also resolve practical
problems associated with travel when the issuer, custodian, and auditor are not located near each other,
thus reducing the cost of compliance while ensuring necessary audit coverage. Under the single auditor
approach, the custodian will arrange with an auditor to review documents relating to each of its respective
issuers pools, and then issue a report which may be used by each issuers auditor in lieu of an on-site
review.

Scope of a Document Custodian Audit:

The On-Site audit
If you follow HUDs Handbook as outlined in 2000.04 Rev-2 Ch-11 Section 6-5, a full and complete review
of a Document Custodian consists of an on-site review of the Custodians premises and a loan-level
review. The Gramm-Leach-Bliley Act of 1999 (GLBA) requires financial institutions to safeguard consumer
information. To be compliant with GLBA requirements, the on-site should be divided into two parts. First is
the building security, proof of insurance, fire safety, shipping and receiving, and a review of the file room
capacity and vault. Second is a review of the corporate structure of the Document Custodian, including
organization charts, policies and procedures, personnel biographies and business continuity plans. GLBA
requires a review of an entitys physical security, information systems and service providers, and a proper
Document Custodian review will touch upon all sections regarding an entitys physical status.

Loan Level Review

The meat and potatoes business of a Document Custodian is the collateral files themselves. Ginnie Mae
requires a loan level review of a selection of files held by the Document Custodian. The loan level review
should consist of a selection of the loan pools being held by the Document Custodian. The pools should be
reviewed to ensure that HUD-11711B and HUD-11706 are in compliance. From those pools, individual loan
files then need to be selected for testing. All files must be reviewed to ensure that the collateral file is
intact and that it contains all the necessary original documents and endorsements. The selection of
audited files must consist of a good sample of files held by the Document Custodian to ensure adequate

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coverage from a statistical sampling standpoint. Ultimately, the auditor must verify the appropriate
documents are in the file, and he or she should ensure that all pools are final certified within 12 months of
being issued. There can be severe consequences if a lender fails to get their pools final certified within the
allocated time.

Consequences of Failing Final Certification

There can be major repercussions if the pool isnt final certified. The guidelines outlined in the Ginnie Mae
5500.3 Rev. 1 Handbook state that Ginnie Mae requires that the issuer post a letter of credit (LOC) for the
pool amount if the pool isnt final certified. The LOC must be issued from a bank with a long-term deposit
rating of A-2 or better. If an issuer is required to obtain a LOC, it could negatively impact the cash position
of the issuer. Eventually, failure to certify pools could cause the issuer to lose commitment authority.
A failure of proper oversight of the Document Custodian can cause problems in other business areas. As
an example, the Document Custodian may exercise weak controls over collateral files and lose a
promissory note. A file with a missing note will cause major problems when it comes time to foreclose the
note. In many non-judicial states, a servicer must undertake a judicial foreclosure if the note is lost. Not to
mention, missing collateral documents raises the specter of reputational damage.
Ginnie Mae guidelines are clear, administration of the pools of mortgages is the responsibility of the
issuer. The risk of lost files and uncertified pools falls to the issuer of the pool. The single auditor
approach is the least disruptive for the Document Custodian and is therefore generally the most efficient
means of a Document Custodian review. However, in the absence of the Document Custodian arranging
for a single audit, the issuer is ultimately responsible to ensure that its Document Custodian is reviewed.

External Auditors Can Perform Document

Custodian Audits to Ensure Compliance
External auditors can be an effective way to ensure the Document Custodian is compliant with Ginnie Mae
guidelines. By completing on-site reviews of your Document Custodian, you can significantly increase the
chance that your collateral files are being handled with proper care.

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Nicholas Corpuz is Vice President of Subsequent QC, a division of MQMR. He

can be reached at NCorpuz@MQMResearch.Com.
Benjamin Madick is President of Mortgage Quality
Management and Research (MQMR). He can be
reached at bmadick@mqmresearch.com.
Eric Gallagher, an Audit Partner at Kushner, Smith,
Joanou & Gregson, LLP in Irvine, California, also
contributed to this article.

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