Repurchases Can Destroy A Lender

The volume of repurchase demands comes amidst improving credit

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Contributing Writer

Freddie Mac and Fannie Mae, aka the GSEs (government sponsored enterprises), became more aggressive in their levels of buybacks with lenders as we moved through 2023. Needless to say, as the year progressed and many lenders barely eked out profits, watching the GSEs earn billions every quarter was both upsetting and controversial for nearly every lender.

Lenders feel like the GSEs are not being consistent with commitments made in recent years about materiality and options for remediation. They feared retribution if they made these points, so instead, they simply engaged with their respective GSE each month to try to get them to take back the repurchase requirement on this loan or that loan. It’s a loan-by-loan drudgery that takes staff time and adds costs to a lender’s bottom line. Even if the GSE drops the request for the buyback, the lender has still spent time and effort to rebut the request and prove it wrong.

Given the changes in loan loss reserves as the GSEs reported earnings throughout the year, Freddie and Fannie’s portfolios are stronger, but they are kicking back a noticeable increase in loans to lenders. Clearly, the GSEs have changed their sampling methodology for quality control review early in 2023 with a specific focus on nonbank originators, which drive 80% of the loans being sold to the GSEs. This more aggressive posture is because they are concerned about the potential failures of some of their customers during these tough times, and therefore, they would lose their counterparty to warranty defects on loans should they go into default.

Horrendous Prices

Banks, in their view, are less risky, and therefore, the need to force buybacks on them is less. In fact, it is rumored that some banks are given options to simply indemnify defective loans found in the QC process, whereas for nonbanks the only option is repurchase versus nonbanks that must re-sell the repurchased loans. The prices in the secondary markets are horrendous, as the loans are not only “scratch and dent,” but most are at far discounted rates compared to today’s market. Investors would rather earn 7.5% than 3% and thus discount the 3% note to earn the equivalent of 7.5%.

Throughout 2023, repurchase demands have come from appraisal errors, miscalculation of income (usually self-employed or variable income over time), the borrower buying a large appliance or vehicle days before funding, and more. The volume of repurchase demands added financial stress and increased counterparty risk to the GSEs at a time when their earnings say that credit risk is declining. In fact, it was the key contributor to Q2 earnings.

Analysts wonder if policy changes from Washington could contribute to a mortgage credit crunch in the coming years as banks face capital challenges, and a tougher economic environment, while the government appears unlikely to take key steps to ensure non-banks will remain key providers of mortgage credit. Dave Stevens with Mountain Lake Consulting points out that “The GSEs, with the assumed support of FHFA, is increasing risk to their IMB customers by implementing what appears to be a far more non-negotiable buyback policy while at the same time reaping massive profits in the billions from these same customers. The irony continues in that a key contributor to earnings was reducing loan loss reserves due to higher equity and loan quality, yet they are saddling lenders, their customers, with repurchase demands.”

In October, at the MBA Annual, FHFA Director Sandra Thompson stated that the GSEs will be working to revise language in their selling guides to improve clarity and provide more consistent feedback to lenders when a repurchase request is made. She also noted that FHFA remains committed to ensuring that alternatives to repurchases are available and offered on a regular basis, including the consideration of initiatives to test and learn from various options for performing loans with defects.

Freddie and Fannie’s portfolios are stronger, but they are kicking back a noticeable increase in loans to lenders.

Updated Framework

In a press statement sent after Director Thompson’s remarks, MBA President Bob Broeksmit said, “The MBA has advocated strongly for FHFA to address the GSEs’ increased incidence of loan repurchase requests, especially for performing loans and those with relatively minor issues underwritten during the pandemic. We share FHFA and the GSEs’ goal of high-quality underwriting and will continue to work with them to ensure the rep and warranty framework is being applied in a balanced way and that there are appropriate alternatives that lead to outcomes short of a repurchase request. FHFA’s policy change to provide rep and warrant relief for performing seasoned loans that have successfully exited COVID-19 forbearance plans is a longstanding recommendation that we are pleased to see implemented.”

The updated framework went into effect on Oct. 31, 2023. The MBA said it will continue to call on FHFA and the GSEs to improve the quality control and repurchase process to ensure the rep and warranty framework is being applied in a fair and balanced way.

The industry hopes that is the case, as the repurchases contributed to a very difficult environment, complete with high rates, low volumes, low margins, and losing money. The GSEs, arguably, are literally squeezing the life out of many institutions that are needed to keep the housing market functioning.

More importantly, perhaps, the trust deficit between this power duopoly of Fannie Mae and Freddie Mac, each reaping billions in profits in a market where almost all others are struggling, is only widening. Saddling the IMBs with ever-increasing financial risk, unless the defects are intentional, material, or repeated consistently, appears to violate the purpose of Freddie Mac and Fannie Mae: to help promote the stability of the mortgage market.