Surviving Repurchases

A 30 percent decrease in subprime volume and a 10 percent to 15 percent reduction in Alt-A production as a result of slowing house price appreciation and tightened credit standards is expected, according to a slide presentation by Laurie Goodman, managing director and co-head of global fixed income research at UBS.

But UBS anticipates agency volume will increase due to a much greater percentage of new production coming in agency form.

In turn, private mortgage insurance will play a larger role in the market, as tighter lending standards and a “huge” decline in second lien demand have squeezed out 80/20s and insurance is now tax deductible, she said while presenting at the Mortgage Bankers Association’s recent annual National Secondary Market Conference & Expo in New York.

Faced with lower volumes, originators will rely more heavily on servicing income, the presentation stated. Given slower price appreciation, the analysts suggested “retaining more servicing, especially on products with weaker credit.”

Meanwhile, there has been a shift in the investor base from banks and government-sponsored enterprises to foreign investors, which “dovetails nicely with the changing asset mix,” UBS said.

Agency residential mortgage-backed securities represented about half of RMBS issuance this year through March while non-agency made up the other half. In 2006, the agency share edged down from the prior to about 44 percent and non-agency edged up to 56.

Of non-agency RMBS through March, the Alt-A share was over 18 percent, subprime loans backed 17 percent and jumbo nearly 11 percent. The numbers are slightly higher than in 2006 for Alt-A and jumbo, but the subprime share saw a decline from about 22 percent.

Collateral characteristics have deteriorated, the presentation stated. From 2002 through 2006, the percentage of full doc loan originations has mostly been decreasing, while the percentages of seconds and interest only originations have for the most part been climbing.

Among other statistics in the presentation, a chart showed that the percentage of Fannie Mae and Freddie Mac issuance of fixed-rate interest only mortgage pools grew to 14 percent as of April from 5.2 percent in the same month in 2006.

In another presentation, Laura A. Pephens, managing principal, Pephens & Co. Inc. labeled loss mitigation as the new secondary marketing department activity and stressed the importance of having such strategy in place.

“MBS issuers can be demanding for specific niche products, then pull the plug — overnight,” the presentation stated. Plus, repurchases are increasing and not only in the subprime market.

Pephens recommended the first step to a loss mitigation strategy is doing a performance assessment. This would involve answering what happens when a borrower doesn’t make a payment on a loan the company is holding, how to respond to repurchase requests, what happens when the company is unable to sell into secondary market and whether the company has policies or procedures.

The second step involves analyzing whether partners can help. Recommendations for determining this were knowing whether warehouse lenders could assist in longer-term financing, what investors/conduits will do to help, whether relationships with investors should be reassessed, what rights the company has to challenge investors, whether good legal counsel is in place or if there are alternate avenues to sell loans besides current investors.

The next step would be to keep production rolling by conducting a thorough review of loan product offerings, identifying alternate products and investors, focusing beyond a product class, and rapidly and proactively redesigning offerings and pricing methods.

Pephens then suggests to become loss mitigation specialists by first proactively safeguarding the company against repurchases. An internal collection effort is critical – especially when the lender does not service the loans it originates. Lenders should identify a resource responsible for contacting borrowers plus turn to the loan and quickly identify options, such as modifying the transaction, alternative sources of interim financing and temporarily holding the loans, negotiating a settlement, actual repurchase or indemnification with the investor, sources for “scratch and dent” sales, and working will all originating parties to share the losses.

Other suggestions for becoming specialists included being prepared to move out of specific high-risk niches, no rolling over for the investor, hiring a great attorney to chase third parties when fraud is suspected, reporting bad brokers, monitoring performance of high-risk fundings, and being “proactive, not reactive, with all relationships and transactions.”

“Minimize losses while sustaining production,” Pephens recommended. And be quick and nimble, “and able to address time sensitive situations quickly and efficiently.”

A loss mitigation strategy not only protects earnings capital, but could save valued relationships and prevent the loss of financing and more, the slide show concluded.