In other words, independent mortgage banks (IMBs) acting as buyers in M&A deals are being asked to assume the future R&W liabilities for past loans sold to Fannie Mae by the seller should the seller, at some point, be unable to honor the terms of the contracts. An R&W contract is a legal assurance that “a mortgage loan sold to Fannie Mae or Freddie Mac (the enterprises) complies with the standards outlined in the enterprise’s selling and servicing guides, including underwriting and documentation,” according to the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac.

It is not clear how many other lenders received the request from Fannie Mae. The industry sources who spoke with HousingWire indicated that so far they had not been approached by Freddie Mac with a similar request.

Officials from Fannie Mae and Freddie Mac did not respond to a request for comment prior to the deadline for this story.

The industry sources, who asked not to be identified, also alleged that in the conversations with “mid-level” Fannie officials, it was not clear whether the agency would formalize the request into an official policy requirement in the future or whether there were any consequences to the lenders should they choose not to honor the request to take on that added R&W liability risk. Still, there is a fear, expressed by more than one industry source, that no one “wants to get sideways” with the agencies.

“The mere fact that the request is being made, and the uncertainty as to what Fannie will do if it’s not honored, does create a chilling effect on M&A at a time when those deals are good for the industry and the borrowers,” one industry source explained. “That chilling effect won’t be so much a factor in small deals where the risk of assuming liabilities is far less, but it could definitely scare off buyers in large deals, which are the most impactful to the industry and consumers alike.”

Asset-only deals

That chilling effect is compounded by the fact that Fannie Mae’s request was allegedly extended to IMBs involved in asset-only purchase deals, industry sources indicate. Unlike a stock-purchase acquisition, in which the buyer typically does assume R&W liability for the seller’s loans — unless expressly specified otherwise — asset-only deals are designed to avoid the assumption of most liability risk.

“I’d say 90% of deals [involving the acquisition of an IMB] are asset purchases, not stock purchases,” said Brett Ludden, managing director and co-head of the financial services team at Sterling Point Advisors, which specializes in IMB merger and acquisition transactions. “In an asset deal, the buyer is specifying the assets it is acquiring … and explicitly states that it’s not buying any other assets, and it’s not assuming any other liabilities.”

The assets acquired in an asset-only purchase deal, according to one industry source, typically include computers, furniture and fixtures, leases, company databases and potentially a company name. Plus, such deals often involve incentives extended to certain high-performing or key employees of the acquired firm that encourage them to sign new employment agreements with the buyer.

“The seller continues to have an obligation to manage their company that they still own after an asset deal,” one industry source explained. “Whether they choose to wind that company down or whatever it might be, they still have to fulfill their contractual obligations.”

Sean A. Stephens, a certified mortgage banker and an attorney with the business and financial-services law firm of Garris Horn LLC, said a key reason that a buyer structures an acquisition as an asset sale, versus a stock sale, “is so that the assets are transferred without taking on the seller’s liabilities.”

“Risk mitigation is critical right now on all levels,” Stephens added. “In the M&A context, you have a lot of the small to midsized [IMBs] who are deciding whether they want to wind down or sell their business.

“… And, depending on their book of business, if this [alleged added R&W risk] is layered in, this could be an additional factor to consider in any M&A deal. Even if you are not buying those loans, because there could be recourse down the road, this could require additional due diligence on past loan production, which could result in more time, more cost and then possibly the renegotiation of purchase price depending on the results.”

Rising tide

Much of the problem with the rising tide of repurchase requests from the enterprises Fannie Mae and Freddie Mac stems from the huge volume of low-rate loans originated in 2020 and 2021 at a time when the industry was continuously working to build capacity to deal with the explosive origination growth. That capacity issue, industry experts contend, resulted in a higher rate of underwriting errors than in more normal times that the enterprises are still uncovering as part of their ongoing quality-control checks — sometimes months or even years after a loan was originated.

There is a concern among IMBs, however, that Fannie Mae and Freddie Mac are being too aggressive in pursuing the repurchase option on loans with minor underwriting defects that could be cured far short of a draconian buyback demand.  

The Community Home Lenders of America (CHLA) said due to the rapid rise in interest rates over the past year, “our consensus member conclusion is that the average loss to the lender is now 30% on every loan repurchase.”

“This equates to a loss of over $100,000 on a $335,000 loan,” CHLA states in a recent press statement focused on the problem. “The loss is even greater for high-cost loans; 30% equates to a $218,000 loss for a loan at the conventional loan limit — and a $327,000 loss for a loan at the maximum nationwide loan amount. This is for one loan that is not even in default!”

In response to the problem, the CHLA recently sent a letter to the FHFA and the enterprises asking that the GSEs adopt a policy of offering some type of reasonable indemnification-payment remedy to lenders for all performing loans “in lieu of the practice of a repurchase demand.” The letter indicates that lenders would still be responsible for repurchasing defective loans that move to a nonperforming status.

“Given the complexity, we don’t want to get into details [of how the indemnification-payment program would work], but discussing the details would certainly be part of the discussion with the FHFA and the [enterprises],” said Rob Van Raaphorst, spokesperson for the CHLA.

Stephens, for his part, said, “We do see the indemnification in lieu of repurchase as a viable option when it’s available.”

Scott Olsen, executive director of the CHLA, said the industry group’s members are concerned about the potential impact of loan-repurchase demands from Fannie Mae and Freddie Mac, “and, you know, sort of anecdotally, they’re under the impression that the level of repurchase requests is increasing.”

Stephens echoes Olsen, adding that “generally speaking, as we get into 2023 [and starting at the end of 2022] we have seen more repurchase request activity occurring.” 

“While we don’t know the exact percentage of loans leading to repurchase requests,” he added, “even if it’s the same percentage [of repurchase requests as in prior years], it’s going to result in more activity because of that sample size [2021 loan originations] being so large.”

Sterling’s Ludden stressed that if lenders are approached by Fannie Mae or Freddie Mac “with the expectation that they should be backstopping rep and warranty [liabilities] in an asset purchase, I would strongly recommend that they reach out to the Mortgage Bankers Association (MBA).”

“I’m sure they’re likely not the only lender [that is in that position],” Ludden added. “And I’m sure that the MBA can play a role in helping facilitate this conversation.”

MBA also did not respond to a request for comment prior to the deadline for this story.

“It is understandable that the GSEs want to take away all of their risk, but there should be proportion here,” one industry source added. “The GSEs are making profits in a difficult environment, and last I checked, they are supposed to take on some risk.”

Whether more IMBs acting as buyers in M&A asset-only deals will be approached by Fannie Mae, or possibly Freddie Mac, with a request to assume the future R&W liabilities of the seller is not known at this point. Potentially, the requests that have surfaced so far are little more than trial balloons that will disappear soon over the horizon.

Regardless, it seems tensions between mortgage lenders and the enterprises over the loan-repurchase issue are not going to disappear any time soon.

“… As to the timing, many of the originators out there were in a much better financial situation and could have absorbed a repurchase request two years ago, but since then finances have changed,” Stephens said. “Therefore, we have seen an uptick on requests to negotiate, appeal and to provide a comprehensive review of mitigation strategies that can be used to defend against repurchase-demand requests.”