Transcript Loan Buybacks: Causes and Defenses Joseph M. Kolar Clinton

Loan Buybacks: Causes and Defenses
Joseph M. Kolar
Clinton R. Rockwell
Christopher M. Witeck
June 15, 2010
Huge Exposure
 Repurchase demands soared in 2009 and early 2010
 Most originators affected, both large and small
 Demands potentially catastrophic for some originators
 Focus on loans sold 2005-2007
 Current Threats
 GSEs
 Private investors
 Going Forward
 Volume of demands expected to decrease starting in 2011 (as credit
tightened in 2008)
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Repurchase Demands on the Rise
 The pushback from the parties now holding the loans-- namely Fannie Mae
and Freddie Mac -- began in earnest in the second half of 2009. With
delinquencies and foreclosures still running at record highs, there's no sign the
demands will begin to abate this year.
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Bases for Demands
 Representations &Bases
Warranties
For Demands
 Language is crucial
 Rep often says loan contains “no untrue information”
 Agreements generally permit repurchase demand upon borrower fraud
or violation of underwriting guidelines
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Misrepresentation of income/employment (SISA, NINA, SIVA)
Misrepresentation of credit/undisclosed debt
Misrepresentation of occupancy
Appraisal fraud
Improper exceptions
 Whose underwriting guidelines?
 Early Payment Defaults
 More difficult to defend
 Some breaches permit pool-wide repurchase demands
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Response to Large Demands
 Purchasers have hired vendors to meticulously scrub loan files for
deficiencies
 Looking for any purported defect that might justify repurchase demand
 Lenders may be exposed to liability for multiple issues
 Owners up the chain may seek redress under “assigned” reps
 Originators hiring own vendors to re-underwrite loans and investigate for
issues/defenses
 Time intensive
 Costly (but not as costly as repurchase)
 Purchasers often have it wrong
 Legal analysis performed
 On individual loans
 Reasonableness of stated income (salary.com, bankruptcy filings)
 Validity of appraisal
 Appropriateness of exception
 On pool as a whole
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Seller Defenses
 Prompt and timely notice
 Purchase agreements generally require “prompt” notice of breaches
or notice within specified number of days
 Purchaser’s failure to provide timely notice of breach may give rise to
failure to mitigate damages defense, but purchasers will argue that
not a bar to repurchase demand
 Meaningful opportunity to cure
 Contracts generally provide time to cure
 Refusal to cooperate by the purchaser in curing process (e.g., refusal
to provide servicing files) or initiation of litigation before meaningful
opportunity to cure may violate purchase agreement
 Sophisticated Actors
 Purchasers knew what they were buying and cannot now claim they
are “shocked” to find borrower fraud
 Originators not responsible for market downturn
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Seller Defenses (Cont’d)
 Materiality
 Did breach materially and adversely affect the value of the loan?
 Requires loan by loan analysis
 Sampling pools may be accepted method
 Would knowledge of breach have prevented or altered the deal?
 Investor’s due diligence
 Causation
 Borrower-specific alternative causes
 Other intervening causes, e.g., general market conditions
 Standing
 Plaintiff must have purchased and currently own the loans and/or
securities
 Validity of assignments
 Statute of limitations
 Does the clock start upon sale of loan or upon denial of repurchase
demand?
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Changes in Loan Sale Agreements
 Still not a lot of non-GSE activity (other than distressed
asset/scratch and dent sales)
 Purchasers exercising leverage:
 Changes from repurchase for a breach that “materially and
adversely affects the value of a loan” to a “material breach”
 Knowledge clawbacks
 No time period requirement to give notice or demand
repurchase
 Repurchase price is based on loan balance for unmodified
loan (whether HAMP or otherwise)
 Your watch/our watch indemnities
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GSE Repurchase Issues
 GSEs expected to try to obtain $21 billion through repurchases in
2010
 In year-end filings, Freddie Mac disclosed that it forced lenders to buy
back $4.1 billion of mortgages in 2009, almost triple the amount in
2008. Fannie Mae did not disclose the amount of its repurchase
demands
 Freddie Mac and Fannie Mae have been stepping up their repurchase
requests since being put into conservatorship by the government in
September 2008, as they try to manage the mountain of delinquencies
on their books. But as those requests multiply, it's clear lenders aren't
just rolling over. In its quarterly SEC filing, Freddie said about $4
billion of loan repurchase requests were outstanding as of Dec. 31,
2009, up from $3 billion at the end of 2008. Nearly 30% of those
requests had been outstanding for more than three months
- American Banker, 2/24/10
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GSE Repurchase Issues (Cont’d)
 Increasingly less flexible in demands
 More of a short-term view – used to be long-term
business relationships
 Personnel turnover and some uncertainty
 People you may have dealt with in years past are not
there anymore
 Need to strengthen balance sheets
 More common now for outside litigators to be involved
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GSE Repurchase Issues (Cont’d)
 Under pressure to put back non-performing loans
 Using retro-appraisals
 Fannie Mae Guide permits an independent third party repurchase
review
 Expanded programs that increased risk but where GSE got all
upside
 Recent changes to Fannie Mae Guide (3/29/10)
 Lender must notify Fannie within 30 days of confirming any
misrepresentation or breach of a selling warranty, including fraud,
regardless of who committed the act or whether the lender believes
that the act resulted in an actual breach of its selling warranties
 Any fraudulent or dishonest activities by lenders, contractors, or
brokers must be reported to Fannie immediately. A record of activity
must be maintained and made available to Fannie upon request
 Fannie may perform additional audits as needed
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GSE Repurchase Issues (Cont’d)
 New “official position” regarding uniform documents
 ANY change not agreed to by Fannie/Freddie or
authorized by related Guide makes loan “nonstandard”
 Other potential remedies
 Indemnification
 Termination or suspension
 Compensatory fees
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GSE Servicing Rights
 Purchasers of Fannie / Freddie servicing rights
generally step into the shoes of the seller
 Joint and several liability, although GSE policy is
typically to go back against the current servicer
 Freddie Mac Servicing Guide provides that
Freddie Mac “may require the Seller or Servicer to
repurchase Freddie Mac’s interest in a Mortgage”
under certain defined circumstances, including seller
breaches of representations or warranties in the
selling documents
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GSE Servicing Rights (Cont’d)
 Fannie Mae Servicing Guide provides that “the servicer
assumes responsibility for all of the lender’s contractual
obligations related to the mortgages,” which would
include repurchase obligations
 In addition, “[t]he lender's termination of its servicing
arrangement does not release it from any of its
responsibilities or liabilities related to specific mortgages
. . . that we purchased before the termination, unless we
expressly agree in writing to release the lender from
those responsibilities or liabilities."
 Liability rarely waived
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GSE Termination of Servicing Rights
 GSEs have the right to terminate servicing of their loans
at any time, with or without cause
 If termination is with cause, Fannie has no obligation to
pay anything. As you would expect, the definition of
“cause” is broad
 If termination is without cause, servicer may arrange for
sale within 90 days to an approved servicer. If
approved, sale must be completed in 60 days. If not
sold, Fannie will pay a termination fee of 2x the
annualized servicing revenue minus a processing fee
 Servicer remains jointly and severally liable unless
expressly released
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Private Mortgage Insurers
 PMI policies are intended to protect the lender in the
event of borrower default
 PMI companies have been rejecting an
unprecedented number of claims – reviewing files to
justify denying insurance claim requests
 Denial of claim also means rescission of underlying
insurance policy
 Typically, the insured is a GSE and rescission of PMI
is grounds for repurchase demand
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FHA Indemnification Demands
 HUD increasingly demanding “voluntary”
indemnifications through HOC QAD, HQ Lender
Activities and Program Compliance, or MRB
 Indemnifying mortgagees not granted opportunity to
mitigate
 HUD holds the approval card
 Must determine when to offer $ (and how much)
 HUD seeking to expand its authority to require
indemnification to all DE lenders
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For further information

Joseph Kolar
[email protected]
202-349-8020
 Clinton Rockwell
[email protected]
424-203-1002
Christopher Witeck
[email protected]
202-349-8051
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