An industry group that says its members have been hammered hard by expensive buyback demands from government-sponsored enterprises is asking their oversight agency to consider making an alternative for performing loans with defects.
The Community Lenders of America is calling for indemnification rather than forcing agency sellers to repurchase loans. Those mortgage bankers have had to sell these in the scratch-and-dent market at steep discounts at a time when the GSEs have increased the share of loans they review for manufacturing errors.
While buybacks tend to be Fannie Mae and Freddie Mac’s standard response, lenders in the group say they’ve become untenable due to the way the rapid rise in rates from around 3% to 6% has magnified losses associated with reselling the loans in the nonagency secondary market. The preferred way of resolving a defect is to refinance the borrower and resell the loan at the current coupon, but that is impossible because of the rate increase.
“What has changed in the last year is the back-end cost of a repurchase to the originating lender,” the CHLA said in a letter sent Thursday to the Federal Housing Finance Agency, noting that the average member has been losing around 30% of the value of each loan.
That represents an average loss of about $100,000 on a $335,000 loan, according to the association. The number is somewhat in line with March estimates of a $70,000 loss on a $300,000 mortgage. Historically, a loss on a repurchase would be around $20,000.
“The penalty to the lender is wildly disproportionate” for loans with minor flaws that otherwise are performing, the association said in the letter, suggesting that “an indemnification option, in a reasonable range” could be an alternative.
Routine indemnification such as that used by the Federal Housing Administration, would allow originators to pay for the loss on a flawed loan without a repurchase and sale at a discount. (However, the FHA insures loans but unlike Fannie and Freddie, it does not purchase them, so its risks are different.)
“A policy of automatically offering an indemnification on these performing loans with defects is fairer to the lender, more efficient overall and provides more protection for consumers so they don’t lose their loss mitigation rights,” Scott Olson, CHLA’s executive director, said in an interview about the suggested change to GSE policy.
In a repurchase, a transfer of ownership leaves the loan without certain consumer protections it had when it was in a mortgage-backed security guaranteed by the GSEs, according to the group. (However, it remains subject to Consumer Financial Protection Bureau rules.)
“This is not to say lender-servicers will not take actions to try to keep borrowers in their home. However, with the enterprises removing their MBS wrap, lenders’ best execution option is often to sell to opportunistic buyers on the scratch-and-dent market. In turn, these buyers are solely motivated by the profit motive, and will not hesitate to foreclose if the borrower stops making payments,” the letter says.
If Fannie and Freddie automatically indemnify a performing loan, the seller will still remain on the hook for it, and they can call upon the lender to repurchase it later if the borrower stops paying, Olson noted.
FHFA had not responded to a request for comment at deadline. When asked if the CHLA has received any responses from the regulator or the agencies, Olson said, “We hope and expect we’ll have follow up conversations regarding the letter with all parties.”
At a high level, widespread GSE indemnification for performing loans, rather than occasional allowances for it, may be operationally feasible, but there are some questions about whether Fannie, Freddie and their regulator will be open to the idea, experts say.
One thing the GSEs may weigh is the counterparty risk associated with a loan, which gets removed once a lender buys it back. Due to industry consolidation, there has been heightened concern about failed companies being unable to repurchase mortgages.
On the other hand, continuing to force expensive buybacks on lenders could negatively affect an industry the GSEs count on to fulfill their affordable housing missions.
“By these actions, they’re only increasing their likelihood that these mortgage companies will fail,” said David Stevens, CEO of Mountain Lakes Consulting and an industry veteran with experience holding high-level public and private roles in housing finance.
Stevens said his phone has been ringing off the hook with concerns about clients related to repurchases.
“They’re kicking back literally anything with a defect, that’s what it sounds like,” Stevens said of the GSEs, noting that this seems to mark a reversal in agreements established several years ago with previous FHFA leaders related to when flaws were considered material and when they weren’t.
When asked if frequency in addition to the extent of the losses was part of the CHLA’s concern about loan putbacks, Olson said, “Our members experience that repurchases have been going up.”
Some lenders have been able to exercise alternatives to scratch-and-dent sales, Stevens said, noting those with enough wherewithal have been able to hold onto repurchased loans and servicing instead. Loans have often continued to perform given historically high equity levels.
And while there is not a formal appeals process for repurchases, Olson said, “Sometimes they’ll talk it through with you.”
Fannie and Freddie do sometimes offer indemnification currently, but “more on an ad-hoc basis,” said Matthew Moosariparambil, a director at Guidehouse.
Increasingly frequent buybacks are still a considerable hardship for lenders given that they come on top of several other fiscal challenges. While lenders have made some headway in reducing their overall losses, many have continued struggling with profitability.
“Meanwhile, the GSEs are making billions of dollars,” said Stevens, referencing Fannie and Freddie’s latest earnings. “Something’s not right here.”