NEW YORK (
) -- Banks are facing a wave of requests to repurchase troubled mortgage loans in yet another ripple effect from the housing bust.
The pushback from the parties now stuck with the loans-- namely
-- began in earnest in the second half of 2009. With delinquencies and foreclosures still running at record highs, there's no sign the demands will begin to abate anytime soon.
Bank of America
, are among the institutions that have pointed to increasing requests for added documentation on mortgage loans they've underwritten and since sold or securitized, according to recent regulatory filings and investor presentations.
Such requests are precursors to kicking the loans back to the banks if problems are found and it's determined the loans should never have been approved in the first place.
While repurchases are typically requested of defaulted or seriously delinquent loans, Fannie and Freddie are scrutinizing loans much more closely these days as they try to shore up their own loan books in the face of outsized losses in the wake of the recession. Not all of the loans being requested for repurchase are nonperforming -- some just look iffy -- all are single-family residential loans with vast majority of those currently being questioned classified as prime loans, observers say.
Last year, banks made $30.87 billion in mortgage loan repurchases vs. $7.34 billion in 2008, according to trade publication
Inside Mortgage Finance
. Eighty-four percent of the repurchases came in the second half of the year, according to the Bethesda, Md.-based trade publication.
In addition to Fannie and Freddie, the pushback is being fueled by demands from private mortgage insurers and monoline financial guarantors including
. These companies are looking to limit their own losses from defaulted mortgages through loan put-backs to originators and also by denying claims on mortgage insurance.
Moody's Investor Service estimated in a December report that the mortgage insurers had rescinded roughly $6 billion of submitted claims since January 2008 and could potentially rescind an additional $2 to $4 billion of claims in the next few years. Additionally, financial guarantors have recorded more than $4 billion of credits for loan put-backs, Moody's said.
Mortgage repurchase information for individual companies is spotty at best. Not all banks provide the data and of those that do, the information is not uniform. (
for instance, one of the largest mortgage lenders in the U.S., made no mention of mortgage repurchases in its annual filing, while its large bank peers did).
Still, from the information that is available, it's clear that mortgage loan repurchases are becoming increasingly burdensome for the banks, and could hold back their stocks.
"A significant investor concern about bank stocks with major mortgage banking operations in the past few weeks has been that mortgage insurers, particularly the GSEs, would increasingly challenge the originators' representations and warranties that the loans were properly originated in the first place," writes Oppenheimer analyst Chris Kotowski in a recent research note. "In such cases, the originator, not the insurer, is liable for any losses."
Kotowski estimates that 2% to 4% of loans that are delinquent or in foreclosure get put back to the originators. He expects "earnings drag" from the problem will be "manageable," likely in the "several hundred million per quarter range for each company, and not in the several billion per quarter range," he writes.
JPMorgan, which says that repurchase demands and associated loan losses have "grown significantly" over the last 12-18 months, attributes the increased repurchase requests to problems with representations made by the borrower when applying for the loans, and also with warranties placed in contracts when the loans are sold.
Remember a majority of these loans were made in the days where income only had to be stated, not verified, and other financial documentation was not required. So the borrower could have provided incorrect income or employment information, or else didn't disclose additional credit availability or debt. A misrepresentation in the appraisal could also be a factor.
"Historically, up until a year or two ago, it wasn't an issue," Charlie Scharf, JPMorgan's head of retail financial services, said during the company's investor day last week. "It's become a very meaningful issue and it will continue to be an issue for the next couple of years."
Last year, JPMorgan bought back $1.08 billion worth of troubled mortgage loans, and it's currently receiving requests for added documentation running at roughly $1 billion worth of loans per quarter, according to presentation slides. JPMorgan said that recent repurchase demands have been concentrated in loans originated primarily in the 2005 through 2007 period, essentially the height of the bubble.
Scharf said that, of the loan questions it's receiving, 50% of the requests have been "successfully rescinded, which means we cured them by providing an additional document." Also, he noted the company is able to claim back any losses on 40% of the loans that were originated by a third party and purchased by the larger bank.
Still "the demands are not abating. We would expect them to continue at least through next year" at roughly the same volume, Scharf said. As of Dec. 31, JPMorgan had built up $1.5 billion worth of reserves in its retail financial services business for repurchase demands.
The regionals are also being affected. SunTrust's fourth-quarter loss included $220 million in estimated losses related to the potential repurchase of mortgage loans previously sold to third parties. That figure is nearly four times the $60.4 million in similar losses it recognized in the fourth quarter of 2008.
The bank has put in place a reserve for losses related to the repurchases rose to nearly $200 million, up $77 million, from the prior quarter. SunTrust says the majority of repurchase requests are on loans originated in 2007, before tightened underwriting guidelines and other changes were implemented.
"The increased demand activity has allowed us to recalibrate and refine the precision of our estimate of incurred losses, and as a result, we have more confidence that the reserve should not increase significantly from here," SunTrust's CFO Mark Chancy said during the company's quarterly conference call. "As for charge-offs, fourth-quarter request volumes and vintage composition suggest that losses are likely to remain elevated over at least the next quarter or two."
Fannie Mae acknowledged in its annual filing with the
Securities and Exchange Commission
that in order to minimize credit losses it must "aggressively pursue collections on repurchase and compensation claims due from lenders and mortgage insurers," among other things.
The government mortgage agency said that as delinquencies have increased on purchased loans, it has "increased our reviews of delinquent loans to uncover loans that do not meet our underwriting and eligibility requirements," according to the filing. "We expect the amount of our outstanding repurchase and reimbursement requests to remain high throughout 2010."
Fannie Mae's largest single-family mortgage servicer is Bank of America, followed by JPMorgan and Wells Fargo.
"Right now the only entities that are really doing any significant amount of repurchases and have the clout to do it is Fannie Mae and Freddie Mac," says Guy Cecala, CEO and publisher of
Inside Mortgage Finance
. "It started showing up in 2008. It took off in 2009."
But unlike in past periods, banks are now looking at their options in regards to honoring repurchase requests.
"Historically repurchases have always gone on, but haven't been a huge amount. There's really never been any pushback on it because you couldn't push back on it (to Fannie/Freddie). Now the numbers are so big they're getting plenty of pushback even from the big lenders," Cecala says.
Bank of America acknowledged increased repurchase demands were resulting in disputes with third-party buyers and financial guarantors.
"We expect to contest such demands that we do not believe are valid. In the event that we are required to repurchase loans that have been the subject of repurchase demands or otherwise provide indemnification or other recourse, this could significantly increase our losses and thereby affect our future earnings," Bank of America warned in its own annual filing.
The repurchase of delinquent government-insured loans from securitizations added $9.4 billion to Bank of America's loans that were at least 90-days delinquent, despite still being insured, Joseph Price, formerly the company's chief financial officer and now its head of consumer and small business banking, said during the company's fourth-quarter conference call.
With the consensus being that requests and subsequent repurchases will remain elevated in the near term, the question becomes how long will the cycle persist?
"The good news is it's the kind of fallout that comes in the second half in the credit crisis but it could last," says Cecala of
Inside Mortgage Finance
. "As long as we have record foreclosures, you're going to have record repurchases and
loan buy backs."
Mortgage banking consultant and industry veteran Corky Watts expects to see a trickle-down effect with the repurchased loans as more banks look to third-party bankers to assume the risk of loans that were sold to them
"It's kind of like a pecking order," Watts says, whose clients are small- to mid-size independent mortgage bankers. "
When large banks have issues from agencies they're probably going to go back to small mortgage banker who originally sold them the loans and if there is a defect or repurchase they may come back to small mortgage banker and ask them to repurchase the loan."
On a positive note though, mortgage brokers are becoming "really good at insuring every loan and making sure every loan is high quality," Watts says. "In the long run that's going to be very positive for the industry."
--Written by Laurie Kulikowski in New York.