REQUIRED READING: If your firm originated loans prior to 2009, you have buybacks and need to know how to defend yourself. Loan buyback demands are a dirty little secret of the mortgage banking industry. Nobody wants to talk about them, but ignoring the problem will not make it go away. The good news is, you are not alone.
Before 2006, most buyback requests involved an early payment default within the first 90 days of the loan's being sold. Defaults after 90 days were minimal, and the cost was priced into the loan pool at the time of sale. The industry had years of data available, and that were, in retrospect, most of the trouble centered around stated-income loans above 80% loan-to-value (LTV), loose underwriting guidelines and pricing models that enticed lenders to place borrowers in loans not in the borrower's best interest.
Today, Fannie Mae, Freddie Mac and the mortgage insurance (MI) companies are demanding that the seller buy back loans up to five years old. In the first quarter of this year, the government-sponsored enterprises (GSEs) forced lenders to repurchase $3.1 billion of mortgages, up 64% from the first quarter of 2009. Additionally, Ginnie Mae pushed back $15.5 billion of loans in the first quarter of 2010 versus $4.9 billion in the first quarter of 2009.
An optimistic view is that the industry will deal with this issue for at least two more years. Realistically, it is likely that the high level of pushback will continue for three to five years. With respect to MI rescission, we are seeing only the tip of the iceberg on both individual and pool insurance.
As an originator, you are in the crosshairs of the loan-buybacks mess. Any loan you originated in the last five years that is seriously delinquent or has been foreclosed could come back to you in the form of a repurchase demand. The GSEs and MI companies are pushing back to the aggregators – Wells Fargo, Citigroup, Chase, Bank of America, etc. – which, in turn are pushing back to the originators – assuming they are still in business. To further complicate things, the Federal Deposit Insurance Corp. is pushing back on loans it inherited from seized banks, most notably IndyMac.
The most common alleged bases for pushback are stated-income misrepresentation, appraisal misrepresentation, occupancy misrepresentation and undisclosed debts. If the lender made an error regarding the loan program or underwriting requirements that would have changed the credit decision, originators are generally accepting responsibility for the loans.
However, a large percentage of the demands that we see fall into an entirely different category: In these loans, the originating lender underwrote to the program rules and guidelines in place at the time of origination. Facts arising after the loan origination, such as job loss, new debt, etc. – or a misreading of the credit report or closing documents – are being asserted as a reason for the pushback.
Minor defects, such as an undisclosed debt at the time of origination that, when accounted for, do not push the debt-to-income ratio out of the guidelines, are also being asserted. Sadly, the originator still has to devote resources to address these issues and fend off the repurchase demand.
The effect of loan buybacks is far-reaching and one of the major obstacles to a housing recovery. Loan buybacks have led to fewer lenders, an increase in loan-loss reserves, increased overhead to handle the buyback demands, fewer choices for the consumer, and a lack of loan product availability. The overall effects on lenders is to tighten guidelines, more time-consuming underwriting of each file and a reluctance to take reasonable risks.
Additionally, the GSEs pricing model has forced a major shift to Federal Housing Administration (FHA) lending, which is arguably the next ticking time bomb.
Despite what you may think, buybacks can be resisted successfully. First of all, do not ignore the repurchase demand. From there:
- Devote resources to measure, mitigate and control the exposure.
- Establish procedures to handle all claims.
- Select one employee to be your point person to handle initial review and to contact the investor.
- Respond to all letters quickly and let the investor know you are researching the matter.
- Do not be afraid to go around the investor straight to the GSE if you feel strongly about the situation and have a good relationship with the GSE.
- Request all pertinent servicing records and pay history, along with any additional supporting documentation. Make sure to audit the file thoroughly; the investor is not always correct.
- Additionally, consult your contract for the repurchase provision. Remember that the burden of proof is on the investor.
For obvious reasons, you do not want to have the original underwriters handle repurchase demands. Unless you have – or are prepared to hire – dedicated staff to deal with these, it is likely in your best interest to seek an outside third party to get an unbiased analysis of the loan file and assessment of your position.
Fannie Mae agrees with this. ‘A lender that is in good standing with Fannie Mae and believes Fannie Mae's repurchase request is not justified may request an independent third-party repurchase review at its own expense,’ says the Fannie Mae Seller/Servicer Guide from June 30, 2010.
Larger firms can effectively pursue a hybrid approach. Initially assess all demands internally and outsource only those files you believe you will have to buy back or litigate/settle. If the third-party firm can save one file you believe is hopeless from being bought back or litigated, they have paid for its service many times over.
When seeking a third-party vendor, you should ask the following questions:
- Is the vendor performing a computer-based review or a comprehensive analytical reunderwrite of the loan file tailored to the scope of the repurchase demand?
- What type of report will you receive? Will it be a computer-generated checklist with trend analysis, or a full narrative review to assist you in writing your rebuttal?
- Is the firm attorney-, underwriter- or auditor-based?
No matter which route you take, a high-quality, independent file review is your first line of defense. Additionally, you can obtain insurance for potential future repurchase claims. From there, in consultation with your attorney, you could pursue global settlement options.
Obviously, this is the best option, but it is hard to come by. Settlements can involve pennies on the dollar for X-number of loans, possible increases in indemnification, make-wholes on certain segments of your portfolio, or taking a ‘haircut’ on current production gains as a way to indemnify the investor. You can also offer volume commitments to your investors to perhaps lessen the impact of buybacks. Another strategy is actual litigation. But that is costly, time consuming and has no guarantee of a favorable outcome.
Both industry changes and effective quality-control strategies will go a long way toward preventing future repurchase demands. Fannie Mae prefunding review and your investor's pre-purchase checklist will help. Internally, the first step is to develop a legal defense plan. Review your contract representations and warranties – you should be fully informed on the nature and extent of your exposure.
Next, conduct a third-party review of your operational procedures. Outsourcing your quality assurance and quality control (QA/QC) functions can avoid conflicts of interest and ensure transparency. But if you decide to diversify your investors and warehouse banks, you may find that some repurchase policies are incompatible with your business needs and constraints. Consider underwriting centralization for better quality control.
Lastly, it is recommended that your company's focus and demand quality from your production team. As a company, you should be performing QA/QC audits monthly. If you are outsourcing this function, a maximum acceptable turn time is 60 days, not six months.
Considering the current environment, a random 10% of file audit in not enough. You need to target high-risk files: high LTV, low FICO, self-employed or full commission earners, manual underwrites, third-party originator (TPO) loans and TPO/FHA loans of non-HUD approved brokers, to name a few.
You may need to audit 20%, 30% or 100% of these files over and above your random 10% of normal files. Actually using the audit results to identify trends before they get out of control and become a buyback should be your goal.
Hopefully, this has given you a better understanding of the loan buy back problem and knowledge of the proper steps to take to resolve your buybacks. If there is any good news to come from this, it is the knowledge that you are not alone in this environment.
Scot D. Baker is senior vice president of business development at Pyramid Quality Assurance, based in Reno, Nev. He can be reached at email@example.com.