Fannie and Freddie face dilemma in loan repurchases

Concern is mounting among housing-industry experts that loan-repurchase rates in upcoming quarters are likely to continue to trend upward for independent mortgage banks (IMBs), well above historical rates — even as mortgage originations have declined dramatically.

A new report by mergers-and-acquisitions consulting firm Sterling Point Advisors seems to add credence to that worry. It shows that loan-repurchase rates have been on the rise in recent quarters at a time when many IMBs are struggling to keep the lights on.  

The stakes on the loan-repurchase front are high for IMBs. John Toohig, head of whole-loan trading on the Raymond James whole-loan desk and president of Raymond James Mortgage Co, explained that IMBs forced to repurchase low-rate legacy loans from 2020 or 2021 — with even minor defects — now face grim prospects in the current rate environment if they seek to sell those loans through the whole-loan market. 

He said a performing legacy mortgage with a fixed 3% to 3.5% coupon was selling for about 75 cents to 78 cents on the dollar through the whole-loan market in late August, “then add the 10-point discount for scratch-and-dent loans” — such as reperforming loans or loans that are current but with minor flaws in documentation, underwriting or payment history.

“So, you’re probably talking today, for true scratch-and-dent, in that 65 to 67 context,” Toohig said.

For IMBs now struggling to remain profitable, being forced to repurchase loans in this environment is like adding salt to an open wound. The Mortgage Bankers Association (MBA) reported IMBs recorded an average pre-tax net loss of $534 on each loan originated in the second quarter of this year.

“What feels more painful now is that … we’re not seeing a rapid downward trend in repurchases, even though we’ve seen a pretty marked reduction in total originations,” said Brett Ludden, managing director and co-head of the financial services team at Sterling Point Advisors.

Single-family mortgage originations are projected to top out at $1.7 trillion in 2023, according to the MBA. That’s down from $2.3 trillion in 2022 — and down dramatically from some $4 trillion in 2021 and $3.8 trillion in 2020.

David Stevens, CEO of Mountain Lake Consulting and past president and CEO of the MBA, said IMB executives he has spoken with about the loan-repurchase issue indicate that many of the repurchase requests coming from the agencies involve appraisal or debt-to-income issues.

“I’m hearing they’re [Fannie and Freddie] challenging the appraisal or, if it’s self-employed borrower, a borrower with unusual income streams, like two or three jobs or other family members who contribute income, whatever, they’re challenging the underwriting calculation … and they may lower it, which then adjusts the debt-to- income ratio higher,” he said. 

“If this continues,” Stevens added, “IMBs are going to start having to curtail credit standards or charge more for borrowers who may be those kinds of borrowers that [FHFA Director] Sandra Thompson wants the GSEs [government-sponsored enterprises] to do more business with — such as first-time homebuyers, minorities, [more specifically, low- to moderate income borrowers as mandated in the GSE’s congressional charters]. So, it’s a real challenge.”

Fannie Mae and Freddie Mac, which are overseen by the Federal Housing Finance Agency (FHFA), were each queried for this story. Fannie officials declined to comment. 

Freddie Mac provided the following response to HousingWire, asking that it be attributed to a Freddie Mac spokesperson: “We’re seeing a positive trend in loan quality and materially fewer repurchase letters as a result of the progress we’ve made by working collaboratively with our industry partners in the past year. We will continue to look for opportunities to build on this progress. 

“Freddie Mac is always looking for ways to improve our quality control processes, and we will continue to engage in open and productive dialogue with lenders to find ways to further improve loan quality while fostering sustainable homeownership.”

The data

A recent report prepared by Sterling Point provides some rare insight into what’s playing out on the loan-repurchase front in the housing industry. 

The report, provided to HousingWire, offers a detailed analysis of agency loan-level repurchase data. It is based on all single-family loan sales to Fannie and Freddie, including loans sold by both banks and IMBs — although the report itself focused on Fannie’s data. 

“There is no way to carve out bank vs. IMB in the datasets,” Ludden explained. 

IMBs, however, represent the largest and still-growing share of agency originations in the single-family mortgage market — about 79% of the market as of June, according to the Urban Institute. 

Sterling’s repurchase report zeroing in on Fannie Mae data is based on the most recent agency data available ­— current as of the end of the third quarter (Q3) of 2023. The Sterling report does not reflect repurchase requests that are resolved short of a loan buyback.

The report reveals the following with respect to Fannie Mae’s repurchase data only, broken down by the year of repurchase:

• 2020 — $1.1 billion in repurchases on $1.4 trillion of Fannie single-family loan-acquisition volume (loans originated by lenders and purchased by Fannie Mae), or an 8 basis-point repurchase rate.
• 2021 — $1.5 billion in repurchases on $1.3 trillion of Fannie single-family loan-acquisition volume, or an 11 basis-point repurchase rate.
• 2022 — $2.1 billion in repurchases on $539 billion of Fannie loan-acquisition volume, or a 40 basis-point repurchase rate.
• Q1 2023 — $459 million in repurchases on about $68 billion in Fannie loan-acquisition volume, or a 68 basis-point repurchase rate. 

It’s important to note that loan-repurchases are subject to a pipeline effect in that in any given quarter, loans flowing through to the repurchase stage could include two or more loan-year vintages. Ludden said agency loan-repurchase volume through that pipeline appears to have peaked last year, with a total of about $1.2 billion in repurchases registering in the second and third quarters combined, the bulk of which involved 2021 vintage loans.

“The reason it [the loan-repurchase volume] looks so bad is that lenders [in 2022, for example] repurchased loans that they had originated in 2020 and 2021 [as well] … while loan-origination volume was substantially lower [in 2022],” Ludden explained. “So, the pain they felt, and are feeling in 2023, is very real.”

The concern moving forward is with the repurchase rate, which has been increasing even as loan volume is declining. In fact, Fannie’s annual loan-repurchase rates have trended upward since 2016, when the average repurchase rate was about 5 basis points, according to Sterling’s report. The average repurchase rate had escalated to 15 basis points by 2019 — after which it declined slightly to the 12 basis-point range for the boom lending years of 2020 and 2021. 

The Q1 2022 loan-vintage repurchase rate, however, has already hit 15 basis points — based on data current as of Q1 2023­. If historical trends persist, the rate could exceed 20 basis points by year’s end, according to Sterling Point’s projections. The consulting firm’s report indicates that repurchases from “the 2020 vintage are still burning out” while 2021 vintage loans “will likely burn out in the second half of 2023.”

“Repurchases from 2022 originations remain our cause of concern, with repurchases in Q1 [2023] coming in at the high end of our expectations,” the Sterling report notes.

Fannie Mae repurchase rates for Q2 and Q3 2022 loan vintages, again as a percentage of the agency’s total loan-acquisition volumes, could grow to between 25 and 30 basis points by yearend 2023 as more 2022 loans move through the agency’s quality-review pipeline this year — if historical growth trends persist, according to Sterling’s report.

Despite the progress cited by Freddie Mac, loan-repurchase trend lines for IMBs selling loans to Freddie Mac remain a concern as well. 

“I had a well-known CEO of a pretty sizable independent mortgage bank at my lake house [recently], and he was just going through the number of repurchase-requests demands they have from one of the GSEs,” Stevens said. “By the way, everybody seems to think that one [GSE] is tougher than the other one — and that’s Freddie.”

Ludden added: “Freddie historically has a little bit higher repurchase-rate levels than Fannie Mae.” 

The fight to get resolution

Pete Mills, senior vice president of residential policy and strategic industry engagement at the MBA, says the organization’s leadership has been meeting with Fannie, Freddie and FHFA executives over the repurchase issue, and those conversations are ongoing. 

The main concern MBA has with loan repurchases, he explained, is with how the “rep and warranty framework” — worked out years ago between FHFA and the MBA — is being applied in the repurchase process. The concern is that Fannie and Freddie are being too aggressive in pursuing the repurchase option on loans with minor underwriting defects that could be cured far short of a draconian loan-buyback demand. 

In fact, many GSE loan-repurchase demands are settled far short of a loan being repurchased. The problem, according to Mills, is the fight to get to that resolution.

“I think there should be more diligence on identifying the initial remedy, and I think a lot of these [repurchase demands] would resolve faster,” Mills said. “There’s a lot of back-and-forth, and in that back-and-forth there’s a lot of costs as these things get elevated to senior management and the like.

“Again, it’s not a new framework [that is needed]. It’s a reset on how the GSEs are implementing it [the existing rep and warranty framework].”

Another factor that may be at play with Fannie and Freddie, some industry experts speculate, is concern over so-called “counterparty risk.” Merger and acquisition experts expect continued contraction of the IMB industry in the months ahead, given originations have plummeted from the historic highs of 2020 and 2021. 

That creates a scenario in which loan-defect protection (via rep and warranty coverage) could be jeopardized on loans that Fannie or Freddie have acquired from lenders (or counterparties) that subsequently go out of business.

“I’m not saying they’re [Fannie and Freddie] doing it, but I’m saying I share the concern that there may be an element of counterparty risk-management in this [repurchase] process, and it this should be based on loan-level determinations,” Mills said. “[Unlike IMBs], if a bank fails, the FDIC [Federal Deposit Insurance Corp.] finds a successor, so the GSEs [Fannie and Freddie] … worry less about banks because they have federal backstops.”

The unintended consequences for underserved borrowers

Tim Rood is head of government and industry relations for SitusAMC, one of the largest providers of technology and services related to loan origination, servicing, quality control and sales across real estate sectors. The company works with both private-sector and public-sector clients, including Fannie and Freddie. 

“I’ve had plenty of conversations with the GSEs [Fannie and Freddie executives] regarding the topic of repurchases in the past few years,” Rood said. “…And they seem to be genuinely anxious over the problem of FHFA compelling them to be more vigorous on the repurchases while also being consistent with both the [rep and warranty] framework that was negotiated in 2015-2016 between the MBA and the GSEs … and also to be consistent with reviews in the past.”

Rood added that Fannie and Freddie face a dilemma created by the FHFA’s seemingly conflicting missions to have a focus on serving underserved, riskier borrowers while at the same time protecting taxpayers from loan-credit risks. 

“That’s a perfect opportunity for them to count those [social-mission loans] and how relevant they are to the administration’s economic and social agendas … while at the same time, when defensible, mitigating the actual credit risks associated with those loans by being hypervigilant on repurchases for at-fringe credit-risk loans.

“The problem is [lenders] will be less willing to originate goals-rich business if they know those loans are going to be scrutinized, and they further understand that originating a perfect loan is darn near impossible.”

Ludden said a notable divergence in loan repurchases by FICO credit-score buckets does appear in Fannie’s purchase-only loan data starting in the fourth quarter of 2021 — just as interest rates began to rise. Freddie Mac’s Primary Mortgage Market Survey shows average 30-year fixed mortgage rates first rose above 3% in Q4 2021 and then continued to rise steadily, reaching 7.23% as of late August.

“There is definitely growth in the FICO-score buckets above 740 — roughly 60% growth over the four quarters ending Q2 2022,” Ludden said, referring to the firm’s loan-repurchase data analysis. “But the growth in [the lower bucket of] 740-and-under FICO scores is approximately 170% [over the same period]. 

“The story is similar for LTV (greater than 80% LTV, or loan to value) saw larger repurchase-rate increases [than lower LTV loans] from the 2020 period to 2022, but the difference is not as dramatic. Still, there was a larger increase in the higher-risk segment than the lower-risk one.”

Dean Kelker is senior vice president and chief risk officer at SingleSource Property Solutions, a leading provider of property-related services across the loan-origination process and servicing cycle. He agrees that Fannie and Freddie “have kind of conflicting goals.”

“They’re supposed to protect the taxpayer, who’s ultimately at the end of their funding by maintaining credit quality,” Kelker said. “At the same time, they have affordable-housing goals, which cause you to expand the [loan] guidelines to the extent that you deal with more marginal credits, and trying to balance those two goals certainly is challenging. 

“In many cases, however, some of the IMBs have probably taken on a deeper risk profile than what they were doing before the market slowed down. So, the ‘Why’ [of the loan-repurchase data] is pretty complicated, and without knowing the inner workings of Fannie and Freddie and FHFA, it becomes very speculative as to what they’re doing or what they’re thinking.”