Banks Face Fight Over Mortgage-Loan Buybacks
While mortgage delinquencies are easing, banks are facing a new round of losses from loans made just before the financial crisis, and the fight to keep them off their balance sheets is intensifying.
Leading the charge to make originators repurchase their loans are Fannie Mae and Freddie Mac, the two government-owned finance agencies that guaranteed the mortgages. The firms are sorting through delinquent loans for signs of any violations of the representations and warranties, known as "reps and warranties." In essence, they are looking for lies made by borrowers or lenders in loan applications.
Freddie last week said it would begin taking tougher action against banks that drag their feet on buybacks as it renegotiates its contracts to renew loan-sales agreements from those banks. Freddie said it had received $2.7 billion from lenders on repurchases during the first half of the year, up from $1.7 billion in the year-earlier period. The number of repurchase requests that haven't yet been satisfied jumped to $5.6 billion at the end of June, up from $3.8 billion six months earlier.
While the company isn't likely to cut off its partners, it could use those renegotiations to force banks to settle up on repurchases.
Banks are pushing back. "It's a loan-by-loan fight," Bank of America Corp. Chief Executive Brian Moynihan told investors in March. "This will be a war that will go on for a while." On Aug. 6, Bank of America said it faces $11.1 billion in unresolved repurchase demands, up 46% in just six months.
The bounced loans are mounting fast as investors try to deflect losses back to their sources and put an end to the lingering aftereffects of the financial meltdown. When banks receive repurchase requests, they often try to force other banks that originated the loans to repurchase them.
Given the hundreds of billions in nonperforming mortgages at stake, "these battles could just go on for years," says Christopher Whalen, managing director for Institutional Risk Analytics. "We have at least two more years of misery."
Big banks may be getting close to facing the worst of their repurchase losses, since original buyers are currently scouring the worst years of underwriting, notably 2006 and 2007, says Gerard Cassidy, analyst at RBC Capital Markets.
"As the industry works these loans off," he said, "they're not being replaced with loans underwritten as badly."
The banks are marshaling lawyers and auditors to challenge loan put-backs and issue repurchase requests of their own.
They are also resolving disputes with mortgage insurers, which could help limit repurchase exposure. Mortgage insurers can rescind insurance coverage on loans, which typically prompts Fannie and Freddie to kick back loans. But some banks have begun paying insurers lump sums to avoid dealing with rescissions and triggering repurchase requests. Fannie warned it could face higher losses if insurers aren't rescinding loans, because that might yield fewer buyback opportunities for Fannie.
Banks also are complaining that Fannie and Freddie are kicking back loans that performed for two to three years if they can provide any pretext, such as undisclosed debt, faulty appraisals or bogus income, employment data or credit ratings.
A representative for Bank of America said the bank has "an established history of working with the [government-sponsored enterprises] on repurchase requests and has generally established a mutual understanding of what represents a valid defect."
A representative for Wells Fargo & Co. said the bank "continues to have an open and productive relationship with the agencies, including Freddie Mac, as we work together to mutually resolve repurchase requests as quickly as possible." A spokesman for Citigroup Inc. said, "We believe we are appropriately positioned for repurchases with our current $727 million of reserves for that purpose." J.P. Morgan Chase & Co. declined to comment beyond the company's regulatory filing.
Efforts to claw back loan losses took a more aggressive turn last month, when the agency that regulates Fannie and Freddie, the Federal Housing Finance Agency, threw its weight behind a wider effort to collect repayment on defective loans within the so-called private-label securities issued during the bubble without agency backing by Wall Street firms.
The FHFA sent out subpoenas to 64 issuers of mortgage-backed securities and other parties to probe for potential loan repurchases.
The Federal Reserve Bank of New York hinted earlier in August that it, too, could make some repurchase claims after reviewing investments it inherited through its 2008 rescues of Bear Stearns Cos. and American International Group Inc.
So far, repurchase demands have hit hardest at banks that acquired the bubble's leading subprime-mortgage lenders as they tottered and fell. For example, analyst Chris Gamaitoni of Compass Point Research & Trading LLC predicts the biggest agency-related pretax loss of as much as $21.8 billion at Bank of America, which acquired Countrywide Financial Corp. in 2008. He projects pretax losses of as much $6.9 billion at Wells Fargo, $6.6 billion at J.P. Morgan and $4 billion at Citigroup.
Still, the rising level of repurchase activity hasn't cooled all analysts' enthusiasm. Betsy Graseck of Morgan Stanley, in a note published after BOFA's most recent repurchase announcement, says her estimates for its earnings already include $17 billion of "reps and warranty expenses" through 2014.
While large banks should weather the storm, their efforts to push repurchases down the chain could squeeze smaller, nonbank mortgage lenders, which don't have deposits or other ready sources of cash.
"It's become an epidemic," says David Lykken, a partner at Mortgage Banking Solutions, an Austin, Texas, consulting firm. "The choices are to negotiate, stand up and fight or go out of business."—Randall Smith
and Marshall Eckblad
contributed to this article.
We are in the middle of this fight, they keep examining our loan, looking for a reason to not restructure a bad loan.