Fannie Mae and Freddie Mac may force lenders including Bank of America Corp., JP Morgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. to buy back $21 billion of home loans this year as part of a crackdown on faulty mortgages.
That’s the estimate of Oppenheimer & Co. analyst Chris Kotowski, who says U.S. banks could suffer losses of $7 billion this year when those loans are returned and get marked down to their true value. Fannie Mae and Freddie Mac, both controlled by the U.S. government, stuck the four biggest U.S. banks with losses of about $5 billion on buybacks in 2009, according to company filings made in the past two weeks.
The surge shows lenders are still paying the price for lax standards three years after mortgage markets collapsed under record defaults. Fannie Mae and Freddie Mac are looking for more faulty loans to return after suffering $202 billion of losses since 2007, and banks may have to go along, since the two U.S.- owned firms now buy at least 70 percent of new mortgages.
“If you want to originate mortgages and keep that pipeline running, you have to deal with the push-backs,” said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia, and former examiner for the Federal Reserve. “It doesn’t matter how much you hate Fannie and Freddie.”
Freddie Mac forced lenders to buy back $4.1 billion of mortgages last year, almost triple the amount in 2008, according to a Feb. 26 filing. As of Dec. 31, Freddie Mac had another $4 billion outstanding loan-purchase demands that lenders hadn’t met, according to the filing. Fannie Mae didn’t disclose the amount of its loan-repurchase demands. Both firms were seized by the government in 2008 to stave off their collapse.
Taxpayer Dollars
“We are trying to be good stewards of taxpayer dollars and as part of that, it’s important that those dollars not go to loans that should not have been sold to us in the first place,” said Sharon McHale, a spokeswoman for McLean, Virginia-based Freddie Mac.
Terry Edwards, Fannie Mae’s executive vice president for credit portfolio management, said in an e-mailed statement that failure to send back the faulty loans “would undermine important tenets of the housing-finance system.”
The government’s efforts might be counterproductive, since the Treasury and Federal Reserve are trying to help banks heal, FBR’s Miller said. The banks have to buy back the loans at par, and then take an impairment, because borrowers usually have stopped paying and the price of the underlying home has plunged. JP Morgan said in a presentation last month that it loses about 50 cents on the dollar for every loan it has to buy back.
Striking a Balance
“It’s a fine line you’re walking, because the government’s trying to recapitalize the banks, not put them in bankruptcy, and then here’s Fannie and Freddie putting more pressure on the banks through these buybacks,” FBR’s Miller said. “If it becomes too big of an issue, the banks are going to complain to Congress, and they’re going to stop it.”
Bank of America recorded a $1.9 billion “warranties expense” for past and future buybacks of loans that weren’t properly written, seven times the 2008 amount, the bank said in a Feb. 26 filing. A spokesman for Charlotte, North Carolina- based Bank of America, Scott Silvestri, declined to comment.
JP Morgan, based in New York, recorded $1.6 billion of costs in 2009 from repurchases, including $500 million of losses on repurchased loans and $1 billion to increase reserves for future losses, according to a Feb. 24 filing.
“It’s become a very meaningful issue, and it will continue to be a meaningful issue for the next couple of years,” Charlie Scharf, JPMorgan’s head of retail banking, said at a Feb. 26 investor conference. He declined to say when the repurchase demands might peak.
Hiring Staff
Barbara Desoer, head of Bank of America’s mortgage division, said at a Feb. 10 investor conference that the bank added staff to handle increased claims from Fannie Mae and Freddie Mac.
“I can’t forecast the rates at which they’re going to continue,” she said. Her division lost $3.84 billion last year, as the bank overall posted a $6.28 billion profit. “The volume is increasing.”
Wells Fargo, ranked No. 1 among U.S. home lenders last year, bought back $1.3 billion of loans in 2009, triple the year-earlier amount, according to a Feb. 26 filing. The San Francisco-based bank recorded $927 million of costs last year associated with repurchases and estimated future losses.
Citigroup’s Reserve
Citigroup increased its repurchase reserve sixfold to $482 million, because of increased “trends in requests by investors for loan-documentation packages to be reviewed,” according to a Feb. 26 filing.
“The request for loan documentation packages is an early indicator of a potential claim,” New York-based Citigroup said.
JP Morgan spokesman Thomas Kelly, Wells Fargo spokeswoman Mary Eshet and Citigroup spokesman Mark Rodgers declined to comment.
Banks that sell mortgages to Fannie Mae and Freddie Mac have to provide “representations and warranties” assuring that the loans conformed to the agencies’ standards. With more loans going bad, the agencies are demanding that banks turn over loan files, so they can scour the records for missing documentation, inaccurate data and fraud.
Providing Proof
The most common include inflated appraisals or falsely stated incomes in the loan applications, said Larry Platt, a Washington-based partner at law firm K&L Gates LLP who specializes in mortgage-purchase agreements. The government agencies hire their own reviewers who go back and compare the appraisals with prices from historical home sales, he said. “They may do a drive-by for a visual inspection,” he said.
Wells Fargo said three-fourths of its repurchase requests came from Freddie Mac and Fannie Mae. While investors may demand repurchase at any time, most demands occur within three years of the loan date, Wells Fargo said.
The mortgage firms are looking at every loan more than 90 days past due and “asking us basically to give them all the documentation to show that it was properly underwritten,” JPMorgan’s Scharf said. “We then go through a process with them that takes a period of time, and literally it’s every loan, loan-by-loan, and have the discussion on whether or not we actually should buy the loan back.”
So far, JP Morgan has succeedeJP MorganJP Morgand in getting about half its repurchase demands rescinded, Scharf said.
Mortgage repurchases may crimp bank earnings through 2011, Oppenheimer’s Kotowski said. That’s because the worst mortgages -- those underwritten in 2007 -- are just now coming under the heaviest scrutiny, he said. “The worst of the stress is the 2007 vintages, though 2006 and 2005 weren’t a whole lot better and 2008 wasn’t much better,” Kotowski said.
Original Business Week Article
Reporter on this story: Bradley Keoun with assistance from Elizabeth Hester in New York, Dawn Kopecki in Washington and Dakin Campbell in San Francisco. Editors: Rick Green, Steve Dickson.
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