Repurchase demands have recently ballooned at the four biggest banks, and Fitch Ratings is trying to determine whether the increase is only the result of higher defaults or if secondary investors are expanding their interpretation of which loans can be sent back for repurchase. In an extremely adverse scenario, the four biggest banks could face as much as $180 billion in mortgage repurchases. But repurchase risks aren’t limited to the biggest lenders.
Fannie Mae and Freddie Mac have recently stepped up their repurchase demands.
The activity is part of a strategy by the two secondary lenders to shift losses on poorly performing loans to the seller in cases where deficiencies are found in the origination or underwriting of the loan.
According to Fitch Ratings, which released the report yesterday, Fannie and Freddie have issued $10.7 billion in pending repurchase demands to the four largest U.S. banks that service around half of all conforming loans. Increased activity, however, has been expected to some extent because of higher defaults and is considered “manageable” given the banks’ earning capacities.
If Fannie or Freddie find that a seller-servicer didn’t meet their underwriting and eligibility standards, the government sponsored housing enterprises are entitled to issue buyback demands under representations and warranties made by seller-servicers. They are also entitled to reimbursement for foreclosure expenses.
In the past, repurchase demands by Fannie and Freddie were less severe given their appetite to increase secondary market share. They “likely weighed the costs and benefits of exercising their repurchase rights under representation and warranty provisions with originators with whom they had maintained long-standing relationships,” the New York-based firm explained.
The two companies also were not facing the kind of losses they’ve seen since the financial crisis. Troubled loans at Fannie and Freddie stood at around $355 billion as of June 30.
In all, including GSE demands and demands from other secondary market investors, Fitch said the four banks — JP Morgan & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. — have received pending repurchase requests totaling $19.1 billion. Reserves for the requests have been established in the amount of $8.3 billion.
But Fitch said the pool of loans at risk of repurchase demands by the GSEs could conceivably balloon to $175 billion to $180 billion at the big four given an extremely adverse scenario. Most at risk would be reduced-documentation Alt-A mortgages.
Michael Waldron, a partner at Patton Boggs LLP who helps lenders that face repurchase demands, said in a phone interview to expect the high end of Fitch’s estimate.
“We are gonna see numbers towards the higher end of not only Fitch’s estimates but the other estimates that we’ve been tracking over the last year, year and a half, since we began to sound the alarm bell on this,” Waldron said.
Under a “mild-loss” scenario, Fitch estimates as little as $17 billion in losses at the four largest banks. But under a less likely but more adverse scenario, losses could reach $42 billion — though losses would be offset by the ability to cure deficiencies. The report assumes losses will come in somewhere between the two scenarios — around $27 billion.
Fitch said it is reviewing whether increased reserves are only the result of currently troubled mortgages or if Fannie, Freddie and other secondary investors “have expanded their interpretation of what constitutes a mortgage that would be eligible to be repurchased under existing representation and warranty provisions.”
A more aggressive stance by secondary investors could expose banks with large mortgage origination operations to losses that have not yet been factored in, Fitch warned.
“Fitch typically regarded loan sales to the GSEs as a transfer of both credit and interest rate risk, and thus excluded these from calculations of leverage and liquidity for the banking industry, bolstering these ratios compared to banks that kept originated mortgages on their own balance sheet,” the report said. “Adjustments to the current view that an effective sale has occurred between the bank and the GSE could have negative repercussions to how Fitch ultimately views the U.S. banking industry on a go-forward basis, particularly for those banks active in mortgage banking.”
While Fitch focused on the big four, it also cautioned that any active mortgage lender could feel the impact of increased repurchases or even be impacted more greatly.
“This is impactful across the industry; this is not limited to the four largest banks,” he said. “This is an issue that has a trickle down effect.”
Although a number of lawsuits are pending against originators of private-label mortgage-backed securities, Fitch said it did not include any associated potential risk of buybacks on troubled mortgages situated in existing private-label securitizations. It also didn’t factor in potential liabilities from a number of subpoenas issued by the Federal Housing Financing Agency in July against mortgage originators.