Lenders must address repurchase risk before they go bankrupt

While buyback volumes remain well below their 2022 peak, they are still high compared to pre-pandemic levels. The additional costs add salt to the wound for credit unions, banks and independent mortgage bankers, which already post an average pre-tax loss of $534 per loan originated. This challenging environment, characterized by high operating costs and low production volumes, has pushed lenders to operate leaner than ever, as evidenced by reports from the Mortgage Bankers Association that independent mortgage bankers have reduced their sales and non-sales staff by 44% since 2022. Reducing headcount helps reduce costs, but it also leads to capacity constraints and burnout – factors that increase the risk of costly human errors.

In this context, the financial consequences of errors are serious, with the specter of mortgage buybacks looming for lenders who fail to proactively manage their risks. In this environment, strategies to reduce buyback risk – through technology, precise quality control and strong collaboration – are essential to avoid serious financial and reputational consequences.

The cost of a bad hand

When selling a loan, lenders provide legal guarantees to the government sponsored enterprises (GSEs) that guarantee the accuracy and completeness of the loan information, known as representations and warranties. These representatives and warrants relate to the borrower’s income, employment, and real estate information. When lenders or their technology providers fail to maintain a high level of data accuracy, loan repurchases increase.

Just as the flop is only revealed after the first bet in Texas Hold’em Poker, defects come to light after a loan is sold – and they can make or break profit margins. Mortgage loan repurchases, also known as repurchases, occur when a loan sold to an investor or GSE does not meet agreed-upon underwriting, legal or regulatory standards. Whether the discrepancies are caused by inefficient technology, underwriting errors that bypass quality control, inadequate documentation, misrepresentations, or omissions, the GSEs may require the lender to repurchase the loan for the unpaid principal balance, resulting in significant financial losses only exacerbated by legal problems. fees, reputational damage and strained relations with investors that damage the future liquidity and market position of lenders.

Buying back loans also hurts investors because it introduces volatility and lowers returns. And while borrowers are not directly involved in the repurchase process, they often feel its negative effects in the form of stricter standards, higher fees or higher interest rates. Minorities and first-time buyers in the housing market are disproportionately affected by this reduced access to affordable credit.

Do not fold yet

Instead of walking away from the table, lenders, technology providers, investors and the GSEs are looking for risk mitigation solutions. As technology providers focus on increasing data accuracy to help lenders effectively access reps and waivers, Fannie Mae and Freddie Mac have begun exploring alternatives to the traditional repurchase process. Freddie Mac is testing a fee-based buyback alternative through a pilot program that could significantly reduce costs for lenders if minor defects are found. Fannie Mae has taken steps to revive defect reporting for “potential” loan defaults before purchase, giving lenders additional time to address errors without facing immediate repurchase demands. Such programs provide lenders with alternative options to resolve defects, reduce costs and reduce repurchase volume.

Despite these developments, repurchase costs remain a pressing issue for many lenders. In July, The Mortgage Collaborative, a cooperative network of independent mortgage companies, banks and credit unions representing approximately 10% of total U.S. mortgage volume, announced the launch of a Repurchase Request Tracker that allows members to record every repurchase request. These data collection efforts highlight the industry’s ongoing concerns and show that buyback requests are far from disappearing. Buybacks are usually driven by:

• Loan defaults: Inaccuracies regarding the borrower’s income, assets, or employment that were not noted at the time the insurance was purchased.
• Documentation issues: Missing or inadequate documentation.
• Fraud: Third party or internal fraud is particularly problematic and leads to immediate action from investors.
• Insurance errors: Loans that do not meet GSE or investor standards, either due to oversight or systemic process issues.

What is on the cards?

Over the past two years, the trend in buyback volumes has been downward, but recent data suggests a revival may be in the offing. In the first quarter of 2024, critical defect rates in mortgage loans showed a modest increase, ending five consecutive quarters of decline. While the increase is low by historical standards, it was notable given the reduced volume of credit production during the quarter. Income and employment data – the main category for gaps – showed significant improvement, but other areas suffered worrying setbacks.

In the second quarter, Freddie Mac seller repurchases rose to $430 million – an increase of 29.1% from the first quarter. In contrast, Fannie Mae sellers repurchased $268.5 million in non-conforming loans, marking a 27.7% decline in repurchases over the same period. This discrepancy is attracting attention in the industry, with one mortgage manager complaining to HousingWire: “The Freddie Mac repurchase problem has increased tenfold. Our requests are up 100% month over month.”

Stack your deck

Lenders have the tools to minimize repurchase risk, but success requires proactive risk management strategies. There are three critical steps lenders must take:

1) Start with quality control

The most effective way to combat repurchase risk is to improve loan quality from the start. Lenders must invest in rigorous pre- and post-closing audits, provide thorough training for their staff and apply consistent underwriting standards. The increase in credit defects and compliance errors shows that quality control is essential. Automated compliance tools can also help lenders catch errors early, flag potential problems, and ensure that loans meet investor and GSE guidelines before going to market.

2) Use automation to stay ahead

Lenders can use automated tools to validate data and obtain reps and guarantees at the point of origin, significantly reducing repurchase risk. For example, for certain loans, home value waivers and warrants are waived when the appraised value closely matches the GSE’s Automated Valuation Model (AVM) estimate.

In addition, the GSEs will not enforce reps and warrants on assets, employment or income if properly validated through an approved service provider, such as Argyle. Checking the list of approved suppliers for Fannie Mae And service providers for Freddie Mac is a good start, but lenders should keep in mind that even approved vendors vary widely in the accuracy of the data, which in turn directly impacts the frequency with which rep and warrant waivers are granted. So rather than judging suppliers solely on their GSE approval status, lenders should ask themselves how consistently a given technology actually results in mitigating repurchase risk.

3) Promote open communication with investors

Transparency and collaboration are critical in managing buyback risk. By maintaining open channels of communication with investors, lenders can better understand changing expectations and avoid future buyback triggers. Collaborating with third-party quality control providers can also help strengthen relationships with investors. By providing objective oversight and ensuring loan quality at every stage of the process, lenders reduce the risk of reputational damage from repeated errors.

Go all-in to reduce buyback risk

Despite a downward trend in overall repurchases, the recent increase in critical defects shows that mortgage lenders cannot afford to be complacent. Mitigating buyback risk requires a targeted approach, combining proactive quality control, the latest technology tools and strong investor relationships. Lenders may soon find relief from the financial burden of traditional buybacks through GSE buyback alternatives, but only if they maintain high loan quality standards. In a rapidly changing market there is no room for hesitation; Only proactive, strategic action can ensure long-term success.

By John Hardesty, EVP of Mortgage, Argyle.

This column does not necessarily reflect the opinion of HousingWire’s editorial staff and its owners.

To contact the editor responsible for this piece: [email protected].