Battle of the Bank Buybacks - Part II
Published on Monday, December 6, 2010, 12:47 PM Last Update: 2 week(s) ago by Preston Howard

In one of my previous articles, I shared how the Federal mortgage alphabet soup entities (FHFA/FNMA/FHLMC/FHA) were starting to exercise the buyback/repurchase provisions which are built into their agreements with various banks, brokers, and “direct lenders” to recoup some of the massive losses associated with the loans they’ve purchased.

Now, the ante has been upped significantly because even though Bank of America has dug in its heels and retained the best counsel that money can buy to engage in “day-to-day, hand-to-hand combat” as described by their CEO, to fight each and every repurchase request, the Federal mortgage agencies and other mortgage pool investors are fighting back with their own army of super sleuths.

Former bank quality control officers, auditors and analysts across the country and in various business parks across the Bible belt are actively engaged in the “loan detective” industry. Scores of these former bank employees are literally pouring over thousands of pages of mortgage documents scouring for fraud, misrepresentations, and violations of bank underwriting policies in their attempt to give the Feds (and investors) the upper hand in their battle against financial institutions for the ownership of non-performing loan pools. Ironically, in many cases, the firms that function in the role of loan detective against the financial institutions were the same ones that performed quality control (QC) for the banks when the loan pools were first originated (a clear case of biting the hand that once fed you if I ever saw one).

As you can imagine, the stakes are quite high as bank losses from repurchases could exceed $90 billion. Given that the repurchase losses are related to a Non Interest Expense (NIE), the financial repercussions would go straight to the bank’s bottom line and onto the company’s stock price. Accordingly, the banks are vehemently fighting every last repurchase request. In many cases, because the banks have such deep pockets, and can pay for the services of the best attorneys, they can afford to drag out negotiations and lawsuits on repurchase requests. These stall tactics are quite effective, as in many instances repurchase requests do not lead to recoveries for the Feds and/or loan investors, as such, many of them choose not to pursue their legal remedies.

However, for those agencies and investors who are now willing and able to fight back, the reward can be huge. In many instances, the bank can be required to pay the difference between the original loan amount and the amount that the Fed/investors received through the process of foreclosure. Considering that many of these loans were underwritten based on values that were exorbitantly high, but foreclosed on at record lows, the spreads will be large, and so will the banks’ losses. With potential profits in the billions for uncovering fraud and other misrepresentations, loan detective agencies are in great demand right now, and the loan file “autopsies” are mounting.

For example, one former auditor turned loan detective has sifted through credit reports, title records, Google maps, and phone listings looking for the smallest pieces of evidence that a borrower lied to obtain a loan. This mortgage sleuth has uncovered investment properties that should have been primary residence loans, sales managers stating $250,000 in earnings that are actually $47,000, undisclosed properties that weren’t on the loan application, and other discrepancies to present a solid case for fraud. The firm that she works for has been successful in obtaining repurchases for 65% of its clientele, with recoveries in excess of $140 million. For some detective firms, a flat fee is earned; for others, a fee plus a percentage of the recovery is the reward. Accordingly, many detectives are extremely aggressive and hungry to find and substantiate mortgage fraud.

Therefore, depending on who you are and how you examine it, this twist in the buyback debacle can be a boon or a bust. As taxpayers, we are rooting for the Federal agencies to obtain buybacks as it translates into money flowing back into our Treasury’s pockets. This action also provides more liquidity for Fannie, Freddie and the FHA and we will not have to prop up and provide backstops for these agencies as initially thought. However, as users of mortgage capital, when the buybacks mount and the banks incur more losses, their appetite for risk decreases; subsequently, they are more likely to become disinterested in lending money on mortgages due to potential fraud and looming repurchases. This is further complicated by the fact that although Fannie/Freddie/FHA purchase and securitize the loans for sale in the secondary market, it is the banks, brokers, and direct lenders who are the institutions that originate them. To date, no one that I know has ever applied for a home loan directly with Fannie Mae (and the FHA doesn’t buy mortgages at all. It only guarantees the loans that the banks underwrite).

As such, when you sit back and consider how mortgages are currently originated and sold, either way we win and lose. If the Feds enforce more buybacks, banks incur greater losses; subsequently, they have less capital to deploy for new loans; and if loans are deployed by the banks, they are more expensive than they previously were (either through fees or rates). Conversely, if the banks win, the Feds eat the losses, and the only way to recoup the losses is through higher taxes. So in the end, I see yet another opportunity for reform!

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at howardpr@rosecityrealtyinc.com.