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Repurchasing a Healthy Process

Fitch report looks at increased repurchase activity

October 11, 2006

By MortgageDaily.com staff

Mortgage loan repurchases have recently been on the rise, according to new report. But the increase does not necessarily indicate a troubling trend.

Rather than indicating an acceleration of default trends, the increase in repurchasing activity is a "self-correcting mechanism" and a reality check for mortgage originators, Fitch Ratings said in its Mortgage Loan Repurchases: Reality Check or Troubling Trend? report.

The report comes after several originators experienced adverse impact on their earnings due to higher repurchasing activity. Option One and Fremont General, for example, recently recorded higher provisions for repurchase losses due to higher-than-expected repurchase requests from the secondary market, Fitch noted.

While early payment defaults were the primary cause of increased repurchases, Fitch believes secondary market behavior was largely responsible for the unexpected repurchase provisions recognized by some originators.

"Fitch does not believe there has been a significant surge in the volume of [early payment defaults]," the report said. "The increase in repurchase activity appears to be more a result of loan buyers consistently using their right to put loans back to sellers."

A high percentage of the early defaults were linked to higher risk products with low FICO scores. Risk-layered products -- lower FICO, second lien, stated income loans -- were the biggest loan repurchase offenders, Fitch said.

In response, "mortgage companies are quickly playing catch-up with the changing rules of the game" by tightening underwriting guidelines to prevent repurchase requests as a result of [early payment defaults], said Vincent Arscott, a Fitch director, in a written statement.

Originators that have tightened underwriting standards have seen an overall improvement with respect to early payment defaults and, thereby, more normalized levels of repurchase requests, according to the report.

After analyzing accounting for mortgage loan repurchases, Fitch suggested that investors would benefit from more disclosure, especially where repurchase charges spike and materially affect earnings. Additional disclosures could include a narrative discussing policies and trends, as well as write-down totals by product type, the report said.

"The increased representation of nonstandard loans has subjected some originators to take more severe write-downs on a per loan basis," Fitch said. "With few exceptions, public filings do not disclose the components of loan repurchase charge-offs or write-down policies."

Repurchase volume is only the starting point in assessing a company's exposure to repurchase risk and could be misleading, but charge-offs or actual losses can be more revealing, as these measure the impact repurchases have on provision expense as well as gauge the underwriting discipline of the issuer.

Going forward, "we expect loss provisions related to loan purchases to rise in the near term as origination volume contracts and buyers tighten contractual terms," Fitch said. Although the impact of alternative mortgage products and adjustable-rate mortgage resets is yet to be felt, in the longer term, "as market participants adapt to the new ground rules and originators take steps to prevent [early payment defaults], Fitch believes loan repurchase activity should normalize."

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