Fannie, Freddie Chase Bad Mortgages
Lenders Like BofA, J.P. Morgan Repurchase Billions in Faulty Loans; Just a Drop in the Default Pool
By Nick Timiraos
The Wall Street Journal
January 30, 2010
It is payback time for Fannie Mae and Freddie Mac on some mortgages sold to the finance companies by lenders.
Stuck with about $300 billion in loans to borrowers at least 90 days behind on payments, Fannie and Freddie have unleashed armies of auditors and other employees to sift through mortgage files for proof of underwriting flaws. The two mortgage-finance companies are flexing their muscles to force banks to repurchase loans found to contain improper documentation about a borrower's income or outright lies.
The result: Freddie Mac required lenders to buy back $2.7 billion of loans in the first nine months of 2009, a 125% jump from $1.2 billion a year earlier. Fannie Mae won't disclose its figure, but trade publication Inside Mortgage Finance said Fannie made $4.3 billion in loan-repurchase requests in the first nine months of 2009.
"Because taxpayers are involved, we're being very vigilant," said Maria Brewster, who oversees Fannie's repurchase team. "No taxpayer should have to pay for a business decision that caused a bad loan to be sold to Fannie Mae."
The get-tough stance comes amid pressure on Fannie and Freddie to make the most out of more than $100 billion in taxpayer funds they got to stay afloat. The U.S. government took them over in September 2008.
The biggest losers are likely to be Bank of America Corp., J.P. Morgan Chase & Co. and other mortgage lenders when the housing bubble burst. Such lenders also are being deluged with loans kicked back to them by holders of mortgage-backed securities who uncover deficiencies with loans bundled into the pools. One common example: a borrower who said the loan was for an owner-occupied home but used it for a second house.
Overall, banks repurchased about $14.2 billion in loans from holders of mortgage-backed securities in the first nine months of last year, up from $3.6 billion a year earlier, according to Barclays Capital. The figures are based on data reported to regulators by federally insured banks and savings institutions.
Forced loan buybacks threaten to "wipe out a significant portion of the [loan] origination profits…made in the last year," said Nicholas Strand, a Barclays analyst.
Strong-arming lenders to swallow loans that were guaranteed by Fannie Mae and Freddie Mac helps cushion the mortgage-finance companies from defaults, though repurchases represent a sliver of all defaulted loans.
Fannie reported Thursday that borrowers of 5.29% of the loans it guarantees were at least 90 days behind as of November, up from 2.13% a year earlier. Fannie guarantees $2.9 trillion in loans.
At Freddie, such delinquencies reached 3.87% at the end of December, up from 1.72% a year earlier.
While growth in subprime defaults is slowing, defaults on prime loans are accelerating. Such loans account for 90% of all mortgages guaranteed by Fannie and Freddie.
"Delinquency rates are up, so it's not surprising" that buyback demands are up, said Brad German, a Freddie Mac spokesman. "Consequently, the number of loan put-backs will reflect that."
Keefe, Bruyette & Woods analysts warned this week that repurchases would "contribute to further weakness in mortgage banking profitability in 2010, which is difficult for an industry that will already have to cope with materially lower production volume."
The Federal Housing Administration, which has seen its market share rise and its capital reserves decline during the past two years, has indicated it is considering more aggressive steps to force banks to pick up the tab on certain loans that default.
The FHA doesn't lend money to home buyers, but insures lenders against default on loans that meet the agency's criteria.
To spurn a mortgage, Fannie and Freddie must conduct a forensic analysis to find misrepresentations, as they now are doing for millions of delinquent loans. Employees zero in on loan pools with the steepest losses and highest likelihood of faulty underwriting.
In response, lenders are being much more careful about new loans. Average credit scores for loans backed by Fannie and Freddie have climbed to about 760 from 720 two years ago.
"If you're being hit with a lot of repurchases very suddenly, the easiest thing to do is to tighten your standards rapidly," said Glenn Boyd, a Barclays analyst.
As banks improve their quality controls, they might become more flexible with some borrowers.
Many of the loans bounced back to lenders were made in late 2007 and early 2008, before underwriting standards were toughened by Fannie, Freddie and most banks, said Guy Cecala, publisher of Inside Mortgage Finance.
In 2003, Fannie Mae and Freddie Mac bought or guaranteed $2.2 trillion of mortgages. Their combined market share fell to about 40% during the peak of the housing boom as Wall Street and other private issuers ramped up business.
Since the market's collapse in 2007, Fannie and Freddie's market share has swelled to about 70%.
Bank of America repurchased nearly $4.5 billion of loans during the first nine months of 2009, according to data compiled by Barclays. That was triple the $1.5 billion repurchased in all of 2008. Some of the bad mortgages were made by Countrywide Financial Corp., which was acquired by the Charlotte, N.C., bank in 2008. A bank spokeswoman declined to comment.
At J.P. Morgan, total buyback demands surged to $5.3 billion in 2009 from $4 billion in 2008, according to Barclays. The New York company, which bought the failed banking operations of Washington Mutual Inc. in 2008, reported higher reserves for loan repurchases in the fourth quarter.
"It's early on that score," J.P. Morgan Chief Financial Officer Michael Cavanagh said when asked earlier this month about the outlook for loan buybacks. A bank spokesman declined to comment.
J.P. Morgan and Bank of America don't disclose how many loans they repurchased from Fannie and Freddie.
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