Mortgage lenders, already reeling from a downturn in the mortgage market, now face yet another wave of woe in the form of a huge volume of loan-repurchase requests stemming, in large part, from alleged violations of loan-sale pacts inked with Fannie Mae and Freddie Mac during the boom years of 2020 and 2021. And it just might push some smaller lenders over the cliff.

Fannie had outstanding loan-repurchase requests to mortgage lenders totaling $939 million based on unpaid principal balance (UPB) as of Sept. 30, 2022, according to a recent agency filing with the U.S. Securities and Exchange Commission (SEC). That does not include additional repurchase requests that have come through during the fourth quarter of this year.

Freddie’s most recently available tally of repurchase requests, per SEC filings, is as of Dec. 31, 2021, showing a total of $1.3 billion based on UPB. That amount, of course, doesn’t include settlements or recoveries made in 2022, but it also doesn’t reflect the volume of new repurchase requests made so far this year.

Even though it’s not an apples-to-apples comparison, it’s clear the annual repurchase-request volumes for single-family mortgages at each agency are in the $1 billion range. The repurchase-request volume, which includes both depository lenders and nonbanks, is being driven up this year, according to industry experts, by the huge volume of lower-rate loans made in 2020 and 2021 that Fannie and Freddie are continuing to vet for loan-sale representations and warranties violations.

It’s the lenders that had been really running at 180 miles an hour, with inadequate checks, with the quality low on the originations and are out of program compliance, and then they have a series of these [loan-repurchase requests] as we are entering a down phase in the economy. Those are the ones [the IMBs] that are going to start to see the cracks in the wall.

Sean Stephens, who is of counsel in the mortgage-banking practice group at law firm of Johnston Thomas

So-called reps and warranties representations are legally binding claims a lender makes in a loan-sale agreement with the agencies. Spread across a multitrillion dollar mortgage-lending industry, the volume of repurchase requests stemming from alleged reps and warranties violations so far may not seem like a huge number. And industry experts say it’s not a systemic threat. 

For some of the affected lenders, however, particularly small lenders with limited liquidity that are already battling red ink, it could represent another cut of the knife that brings them to their knees. 

The legacy single-family home loans from 2020 and 2021 that are now the subject of repurchase requests were originated at rates in the range of 3% while today’s 30-year fixed rates are in the 6% to 7% range. That means the loans from those years that end up being repurchased by lenders at their original value, often due to compliance issues such as elevated debt-to-income ratios, are now underwater. In today’s market, most are likely worth in the range of 75-80 cents on the dollar, possibly less, depending on credit dings, according to John Toohig, head of whole-loan trading at Raymond James in Memphis.

Toohig added that “if the advance rate on a warehouse line is 85% [of a loan’s value] and now that loan is worth 75% [of its original value], in theory that could put some pressure on the warehouse providers as well.” 

Toohig said based on what he’s heard about the loan-repurchase wave now hitting the market, the big culprit on the reps and warranties noncompliance seems to be “miscalculation of debt-to-income ratios,” and not by huge margins.

Fannie’s SEC filing shows that the agency issued repurchase demands on 0.25% of the $1.4 trillion in single-family mortgages delivered to the agency by lenders in 2021. Freddie Mac did not break out those figures in its SEC filing.

“A total of $939 million of repurchase demands are outstanding [at Fannie as of Sept. 30, 2022], some of those from pre-2021 as well as 2022 vintages,” said Brett Ludden, managing director of Virginia-based Sterling Point Mortgage Advisors, which specializes in mergers and acquisitions (M&A). “That means they [Fannie] have resolved at least 73% of all the 2021 demands as of September 2022 [based on $3.5 billion in total repurchase requests that year], but more demands from the 2022 vintage could still be coming in Q4 2022 and beyond.

“So, the fourth quarter is our estimate of where it’s going peak, if you follow historical trends of loans that are being repurchased. It should start to go back down after that, but it still can be at an elevated for the next year,” he said.

Paying in full

Attorney Sean Stephens, who is of counsel in the mortgage-banking practice group at the California-based law firm of Johnston Thomas, said independent mortgage banks (IMBs) have “more skin in the game” with respect to the loan-repurchase activity than the depository institutions, “so that’s a concern.” Stephens represents clients in the mortgage industry who are concerned about or have received loan-repurchase requests — with the goal of bullet-proofing their loan-purchase agreements in advance when still possible. 

A lot of these little mortgage companies, particularly the mom-and-pop ones, they’re already struggling for capital and net worth.

John Toohig, head of whole loan trading at raymond james

He said those IMBs most likely to be rocked by loan-purchase requests from the agencies are small to mid-sized lenders “some of whom are already having difficulty meeting their warehouse-bank covenants or their other investor covenants because of net worth requirements.”

“So, it’s almost becoming a perfect storm, where you have volume compression and then the repurchase activity all impacting them,” he said. “It’s the lenders that had been really running at 180 miles an hour, with inadequate checks, with the quality low on the originations and are out of program compliance, and then they have a series of these [loan-repurchase requests] as we are entering a down phase in the economy. 

“Those are the ones [the IMBs] that are going to start to see the cracks in the wall.”

Compounding the problem is that in cases where IMBs are required to buy back boom-era loans from Freddie and Fannie because of compliance issues, they are repurchasing the mortgages at full price based on the original balance. Now, however, those loans, though likely of good quality, are worth far less than par, forcing the lenders to carry them on their books, if possible, at a loss, or to sell them in the “scratch and dent” loan-trading market at a loss.

“A lot of these little mortgage companies, particularly the mom-and-pop ones, they’re already struggling for capital and net worth,” Toohig said. 

Ludden added: “While it will impact each lender differently, the $250 million lenders have a lot less equity, especially in relation to net worth requirements, so the fair value treatment of the repurchases could be more of a concern. The $1 billion to $4 billion [annual origination] lenders might find the cash/liquidity impacts associated with repurchasing the sheer volume of loans during a short time period to be more problematic.”

Downside risk for small-to-medium size IMBs

Ludden’s analysis of the IMB market shows that more than half of the 1,000 largest IMBs in the country are forecasted over the 12 months ending June 2023 to have annual loan-origination volume under $250 million and another 14% or so are expected to record annual origination volume over $250 million but under $500 million. That is the segment of the industry most likely to be impacted by a high volume of repurchase activity.

The M&A costs and everything else, it just doesn’t pan out for them, so many are kind of in a bad spot.

Ken Richey, Practice Leader-M&A Services at Richey May & Co.

‘If you’re [one of those lenders] doing planning, and you’re looking out through the entirety of 2023, there’s a decent chance you’re looking at a pretty big loss,” Ludden explained. “And this [the repurchase requests] adds on another element of uncertainty and downside risk.

“So, some of the companies that we’re talking to that are choosing to exit are doing so based not on the fact that they don’t think they can survive, but it’s that they don’t want to take a chance that they’re going to eat into all their capital. They’d rather make a smart move now, whether it’s a sale or merger, to take some form of strategic action.”

Ken Richey is the founder and practice leader-M&A services at Colorado-based accounting, tax and business-advisory services firm Richey May & Co. He said his firm isn’t seeing a lot of M&A activity prompted by loan-repurchase activity at this time.

However, he said those lenders most likely to be affected “the mom and pops … those that are under half a billion in [annual] originations, [particularly at the] $200 million to $300 million level,” also are least likely to be in position to hire an M&A advisory firm.

“The M&A costs and everything else, it just doesn’t pan out for them, so many are kind of in a bad spot,” he said. “We sometimes refer to them as walkovers – they have to find a partner and walk their business over, and they don’t often get a whole lot for it.”

The value in fighting it?

One agency source, who asked not to be named, stressed that “just because you [lenders] get a repurchase request, that doesn’t mean they will end up having to purchase the loan back” because there is an appeal process. That’s where Stephens and his law firm can play a role.

If there are serious defects, they [the lenders] were never eligible to sell the loan to us in the first place…we do give them ample opportunities [to fix the issues].

Agency source

“What we’re doing is analyzing the cost of the repurchase activity,” Stephens explained with respect to clients he represents. “How much is it impacting the bottom line? What’s the value in fighting it?

“And the value can be high, depending on the circumstances.”

The agency source also stressed that “if there are serious defects, they [the lenders] were never eligible to sell the loan to us in the first place.”

“We’re very clear about that … but we do give them ample opportunities [to fix the issues],” the source added.

Thomas Yoon, president and CEO of California-based Excelerate Capital, a non-QM lender, said repurchase requests are not an issue with his company because it does so little agency lending. Still, he said that’s not the case for some other lenders of late.

“The market that we’re in now, where it’s kind of a death by a thousand cuts, because no one’s really earning money on loan production, it’s the smaller-sized lenders that have repurchase [requests], depending on how small they are, that could be material, right?” Thomas said. “So, it’s absolutely a problem.”