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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2013

Taking the Heat Off Buyback Demands

The GSEs’ new representation and warranty policy may mitigate lenders’ repurchase risk

Taking the Heat Off Buyback Demands

In the aftermath of the housing crisis, Fannie Mae and Freddie Mac issued repurchase requests on nearly $100 billion in mortgages. Not surprisingly, this caused many lenders to look toward the future with uncertainty as to whether repurchases would abate or continue to abound. In the crisis era, the government-sponsored enterprises (GSEs) could at any time in the lifespan of a loan issue a repurchase request as part of their representation and warranty policies, even when a loan had been performing for many years. This created a tremendous amount of pressure on lenders that were unable to estimate and quantify the potential repurchases that would come their way.

Today, however, there’s a new sense of certainty in this regard. The GSEs recently released guidance on a new representation and warranty framework that reduces lenders’ repurchase risk on loans that have performed over an extended period of time. In exchange for this “sunset” provision in the representation and warranty framework, lenders should expect an initial uptick in the number of loan-level quality-control reviews to be conducted by the GSEs within months after a loan’s delivery.

Here’s what you need to know about this new framework and the pressure it relieves. 

Under the new framework, mortgage bankers and lenders should know that they may receive loan-file requests as soon as four months after a sale to the GSEs. For loans delivered at the inception of the new representation and warranty framework this past January, that means requests could have begun already for some lenders.

Regardless, the GSEs expect all lenders to adhere to the new quality-control review guidelines.

Within the new framework, the GSEs will perform discretionary — or targeted — quality-control reviews shortly after the purchase of a loan. The GSEs have established a consistent timeline for lenders to supply loan files for review, and to check data and underwriting quality more comprehensively. They also have created a transparent process for lenders to appeal repurchase requests. 

Many industry experts view this new representation and warranty framework as a step toward greater clarity for mortgage bankers. The new rules of the road create awareness of how the GSEs will review loans for potential breaches of representations and warranties, and at the same time, create awareness of how remedies will be enforced. In a statement released this past September, the Mortgage Bankers Association called the new representation and warranty guidance “a huge step that helps bring more certainty for lenders as they attempt to offer affordable mortgage credit to more qualified borrowers and advance the housing recovery.” This rings largely true, but mortgage bankers and lenders still should exercise caution, as the GSE policy changes necessitate a significant shift in the way that lenders operate their origination, delivery and quality-control operations.

In response to this guidance, lenders proactively should review and revise their operational business processes with regards to origination practices. This review should include an assessment of data quality, ensuring a process to respond to data questions from the GSEs. It also should entail preparation for a greater volume of loan-file reviews completed shortly after loan sale to the GSEs.

This framework creates further need for lenders to ensure that their quality controls are in place and are being met, specifically with regards to meeting the underwriting and eligibility requirements for Fannie Mae and Freddie Mac loans. In addition, with these new changes, lenders will need to invest in improving their business processes, and in some cases, they’ll need to evaluate whether or not staffing levels are sufficient to respond within prescribed timeframes. 

The sunset provision

The incorporation of a “sunset” provision into this new framework means that lenders will be relieved of obligations to repurchase mortgage loans that do not meet specified representation and warranty guidelines as long as certain payment-history requirements are met. Previously, the GSEs were able to request repurchases for loans that did not meet eligibility criteria at any point in time after the date of sale. As mentioned earlier, this created significant uncertainty for bankers and lenders that were unable to gauge what the potential repurchase risks were for any given loan.

Under the sunset provision, beginning this past January, lenders can be assured that they will not be obligated to repurchase a loan as long as several key details hold true in the 36 months following the acquisition date, including:

  • The borrower had no 30-day delinquencies.
  • The borrower had no more than two 30-day delinquencies with no 60-day or greater delinquencies, and was current as of the 60th month following the acquisition date.

In the eyes of many mortgage bankers and lenders, this is a significant improvement over the previous framework.

Implementation

In adjusting to this new guidance, mortgage companies should be aware of the specific challenges that their brokers and originators will face, as well as best practices that can be incorporated into business practices throughout the new framework’s adoption. 

The initial impact on the industry likely will be an immediate increase in the number of loan-file requests from the GSEs. Fannie Mae, for example, has explicitly stated that there will be an increase in the number of file-review requests compared to the prior process, and lenders should expect to receive them as early as this month, if they haven’t received them already.

Previously, Fannie and Freddie conducted random samplings of loans for quality-assurance review, which was augmented by discretionary sampling. Now there will be an increase in discretionary sampling, however, and added scrutiny applied based on technology tools and internal models applied by the GSEs. Going forward, there also will be incentive to reduce defects. Fannie Mae has stated that if its loan-level assessment tools find fewer loans with potential defects from a certain lender, a lower percentage of loan files will be requested from that lender.

With that in mind, mortgage organizations that have already reduced defects or have managed to incorporate quality-assurance guidelines early on will find that they should receive fewer file-review requests. On the other hand, those lenders with the greatest number of defects will find that they receive the greatest number of file-review requests — and potentially the greatest number of repurchase requests, as well, which will affect their bottom line. 

These changes are creating a need for lenders to augment staffing levels and contract workers to support their new business processes. Lenders that have integrated the new standards into their business practices early on will be able to manage their staffing needs most effectively, but this requires upfront investment in designing effective business processes. Lenders that integrate effective practices early should be able to reduce the need for staffing over time as they witness reductions in defects and improvements in data.

An important consideration that mortgage organizations should not overlook is the need for improved business processes and an ability to respond quickly to the GSEs’ requests. For example, a failure to respond to file requests by Fannie Mae within a 30-day window will lead to a repurchase request. By becoming efficient in processing these requests, lenders can avoid repurchases that are the result of operational issues.

Lenders’ feedback loop

Mortgage bankers and lenders also should know that the GSEs have indicated their intentions to create an actionable feedback loop whereby the file-review process can help identify areas in which lenders can improve and strengthen their loan quality. Lenders that have subject-matter experts in place will be able to incorporate the feedback and adhere to what is a condensed and initially more rigid process.

"In this regard, lenders must ensure that they have incorporated quality controls that meet the standards of the GSEs. Fannie Mae has stated that it will be validating that loans purchased were originated according to applicable underwriting and eligibility requirements. In addition, Fannie Mae will be providing lenders with data and feedback about the quality of their loan-origination processes. Loans that do not meet eligibility standards will result in repurchase requests. "

In this regard, lenders must ensure that they have incorporated quality controls that meet the standards of the GSEs. Fannie Mae has stated that it will be validating that loans purchased were originated according to applicable underwriting and eligibility requirements. In addition, Fannie Mae will be providing lenders with data and feedback about the quality of their loan-origination processes. Loans that do not meet eligibility standards will result in repurchase requests. 

As part of this, there is an opportunity for lenders to assess risk-management tools that may enable avoiding triggers for repurchases — tools relating to fraud detection, identity verification, income verification and data vulnerabilities, among others. Strong property and collateral-valuation tools also will help provide guidance for pricing adjustments.

•  •  •

As the housing market continues to seek the firm footing of recovery, the clarification of GSE policy will engender confidence in the allocation of credit. It stands to reason that lenders have been reluctant to participate in a purchase-market business that previously had seen tens of billions of dollars lost to the repurchase demands of the GSEs. Now it’s become opportunistic for lenders to leverage and implement change to grow their businesses in step with the recovery.

Although the GSEs’ new framework likely will necessitate upfront investments for lenders, it’s also an opportunity for lenders to better align themselves with the underwriting and eligibility requirements of the GSEs and more effectively gauge the potential impact and cost of repurchase risk. More important, as lenders continue on the road to recovery from the housing crisis, the sunset provision for loans that perform over a long-term period provides increased certainty for mortgage companies as they look ahead, and policy clarity is always beneficial overall.



 


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