In Conversation: Lenders Face Surge In Repurchase Demand

Repurchase demand by mortgage investors is growing sharply, creating significant financial losses for lenders, according to the latest episode of SitusAMC's "In Conversation" podcast. Justin Vedder, president of Securent Risk and Insurance Services, a SitusAMC subsidiary, spoke with Rob Chrisman, consultant and publisher of the Chrisman Commentary, a daily industry snapshot and podcast; and Mike Fontaine, co-president and COO of Plaza Home Mortgage, based in San Diego. They discussed the problem's roots, its impact on lenders and the industry, and strategies to prevent and manage the growing risk. 

Record Production and Office Shutdowns Lead to Errors 

The massive surge in origination volume in 2020 and 2021, coupled with the sudden shift to a work-from-home environment during the Covid-19 pandemic, led to more underwriting errors. "Building the systems and the people capacity to deal with that explosive growth really was the spark of the problem," Chrisman explained. "The issues tend to spring from trying to do a lot of volume in a hurry. Nobody wanted to turn a loan away because their operations staff wasn't keeping up." 

Investors have become more aggressive in pursuing repurchase demands, even for performing loans with minor defects. Currently, about 50% of loan repurchase requests result in buybacks, Chrisman estimates. And this may just be the tip of the iceberg: Under most agreements, investors have up to 36 months to review loans purchased, so they may uncover defects months or years after loans were originated. 

Rising Rates Exacerbate Losses 

Rising interest rates exacerbate the repurchase problem. "A lot of those loans were originated around 3%, but today rates are in the upper 6s," Fontaine said. This rate differential creates losses for lenders who must buy back loans, fix them and try to resell them to investors in the scratch-and-dent market.  

Lenders are taking hits of 30% and more on the value of these loans, Fontaine said. "Smaller independent mortgage banks in particular just don't have the balance sheet to hold the loans, so they're stuck selling them," he said. "And those losses are huge." And they may grow: On July 26 the Federal Reserve raised its benchmark federal funds rate by 0.25%, to a new range of 5.25% and 5.5%, the highest level since March 2001, and the eleventh increase since March 2022. 

Problems Range from Minor Defects to Overt Fraud  

Issues with income, appraisals, employment verification or missing documentation are largely driving repurchase demand. But it also arises from borrower blunders that occur just before mortgage closing -- such as changing jobs and being unemployed for a few weeks or taking out an auto loan -- without informing the lender.  

"That's actually fraud, because you don't have the same financial position that you represented, and you're signing the document at closing that you have not taken on additional debts," Fontaine noted. "I don't think the intent was to commit fraud in some cases. But it is fraud, and it creates a buyback." 

Overt fraud also plays a role in some instances, with unqualified borrowers presenting fake bank statements or W-2s to get approved for mortgages in a competitive housing market. 

Meanwhile the issue of repurchase demand is cascading into the mergers and acquisitions landscape. Buyers are cautious about overpaying and may discount a firm's value or impose holdbacks to mitigate repurchase risks. "The potential for buybacks has increased, and so the wariness of buyers has increased as well," Chrisman said. 

Insurance Programs Help Mitigate Risks 

Plaza Home Mortgage has implemented Securent's certified loan program, which limits sellers' exposure in the event of manufacturing defects and fraud. Rather than the 30% losses other lenders face selling mortgages in the scratch-and-dent market, Plaza's clients pay a small deductible, typically $10,000, plus an amount over par. "It really limits the seller's risk of the repurchase tail," Fontaine explained. 

In addition, the program provides helpful feedback shortly after origination, minimizing the chance of future defects. "We look at the loans right before we purchase them, (offering) instant feedback on manufacturing quality," Fontaine said. "The loan file may be missing a page out of a document, or require three months' worth of bank statements, and there are only two. It's a lot easier to fix that right near or after closing," he said, versus trying to track down borrower documents and resolve issues when a repurchase demand occurs months or even years later. 

"Owners of the IMBs in particular find the program very valuable (for) protecting their net worth, minimizing their requirement for loss reserves, and giving them some peace of mind," Fontaine said. 

Listen to the podcast above.