In assuming an ‘extremely adverse scenario,’ it is conceivable that Bank of America, Wells Fargo, JPMorgan Chase and Citi could be on the hook for as much as $180 billion in loan repurchase requests from Fannie Mae and Freddie Mac, Fitch Ratings says.
The rating agency announced this week that it will undertake a review to assess whether investors – namely, the government-sponsored enterprises (GSEs) – have expanded their interpretation of what constitutes a mortgage that would be eligible to be repurchased under existing representation and warranty provisions. Fitch says it is concerned that a more aggressive request for loan repurchases could potentially expose banks with large mortgage origination operations to future losses that have not been previously incorporated into Fitch's existing exposures, and effectively into current ratings.
As of the end of June, the GSEs combined had troubled mortgages of $354.5 billion. Based on data through the second quarter this year, Fitch estimates that the four largest U.S. banks have received pending repurchase requests totaling $19.1 billion, with $10.7 billion related to requests from the main housing GSEs. To date, these institutions have established $8.3 billion of representation-and-warranty reserves – an amount Fitch calls ‘a large sumâ�¦but one that Fitch would view as manageable within each firm's inherent earnings capacity.’
If all of the existing GSEs' troubled mortgages were at risk of being repurchased based on market share, the pool of ‘at-risk’ loans eligible to be repurchased by the four largest banks could total between $175 billion and $180 billion, Fitch says.
Fitch anticipates that a focal point of repurchase requests will be reduced-documentation loans. The actual number of repurchase requests will ultimately depend on key variables such as quality of the originator's underwriting, documentation standards and foreclosure rates, and losses will be a function of cure rates and home prices.
Although Bank of America, Wells Fargo, Chase and Citi collectively service approximately 50% of the GSEs' portfolio, Fitch notes that any entity that has been actively engaged in mortgage lending could feel the impact of this development, and to some degree on a relative basis, could be affected to a greater degree.
Under a ‘mild’ loss scenario, in which the GSEs collectively and successfully put back 25% of the current outstanding inventory of seriously delinquent loans, and assuming recovery rates of 60%, Fitch believes the expected loss for the four largest banks could be about $17 billion. Using a more moderate loss scenario, whereby the put-back rate goes to 35% and recovery rate drops to 55%, Fitch believes losses could come in around $27 billion.
These figures do not incorporate the ability to cure deficiencies in loans. Thus, ultimate realized losses could be lower than these figures.
In the near term, Fitch says it will monitor the ongoing developments between the banks and the GSEs related to loan repurchases, as well as consider other mortgage investors such as private mortgage insurance companies and private-label mortgage-backed securities investors.
SOURCE: Fitch Ratings