Do you expect a quick recovery of the RE? Read this.

This is an email from the president of the mortgage bank to bank employees. I removed name of the bank and other names.

“I am wondering if you could take a moment to provide some clarification on an issue I am having trouble understanding. This issue has caused 4 lost agency eligible deals as of late. I recall your email to the company where you laid out the plan for OUR BANK to move away from originating Alt-A loans as a primary source of business to becoming the premier GSE lender. On a daily basis we receive correspondence layering on further risk reductions that Fannie/Freddie/FHA do not require. I would be happy to provide some of the recent changes if you would like to see them. I can't seem to find anyone who can fully explain why OUR BANK would need to do this when the GSEs are setting their own risk tolerances. Can you shed some light on this? “

 

Response by president of the bank:
“This is an excellent question that is a very new issue and you are correct, we have yet to explain it well.
I hope you don’t mind…but I am going to use your note to explain it to all of OUR BANK personnel.
Simply speaking, just because a loan meets the GSEs guidelines and/or they issue an approval through their automated underwriting engines, does not mean that OUR BANK is not liable to repurchase that loan if it goes delinquent. The GSEs, in fact, are like insurance companies....they charge a guarantee fee, to cover their costs (including their estimate of credit losses for particular types of loans) and make a profit. In order to insure that they make a profit….they quality control review every loan that goes 60 days delinquent and look for reasons to require OUR BANK to repurchase the loan (and because of their size and duopoly power…it is hard for a mortgage lender like OUR BANK to fight a repurchase demand…some of which can be quite subjective…and they deliberately want to keep their guidelines subjective, because it gives them broader authority to require us to repurchase a loan). In addition, recently….the GSEs have come to all lenders and essentially said, “We are suffering too great a credit losses and as a result, we have not only tightened our guidelines (purchasing less risky loans) and are making you repurchase more loans….but we expect you to reduce your delinquency rates down”.

As a result of not only increased repurchase activity…but this last point, we started to look very carefully at our early delinquency trends on GSE loans and were astonished to find that certain loan types that were eligible for sale to the GSEs….had excessive first payment and early delinquencies….in particular, loans under their Expanded Approval Program (where they did subprime, Alt-a, and other programs) and High LTV first-time homebuyer programs. Literally, something like 5% of these loans were missing their first payments and 13% were delinquent in the first 90days….more than ten times higher than the delinquency rates they are asking lender to meet!!!!

So the GSEs…..because of politics (involved in low income and Community Reinvestment Act lending) can’t say…we have to eliminate these programs, because they are creating excessive delinquencies and credit losses…instead they, through their actions on repurchases and early delinquency monitoring, essentially are forcing lenders to cut back significantly on these “eligible programs” or risk being flooded with repurchases.

That is why we have paired back these programs.

OUR BANK is going to offer loan programs….that we believe will perform over the long run…because investors are not really “setting their own risk tolerances” as you note below…practically, they will make us take back all the worst performing loans. In addition, the MI companies are also saying that they won’t insure many of these high-risk GSE programs for the very same reason.

It may mean that in the short-run, we lose some loans, customers, and sales people (who are not really sales people…because they can only sell the most extreme products, at the very best prices) to the competition….but it will also mean that we build a team of committed, loyal employees…and we build a safer, sounder, more profitable and stable company. Also, right now…if we are not “pristine” in terms of credit quality…it would be impossible to sell loans to skeptical investors….our industry has to rebuild trust with investors and the way to do that is produce great quality loans.

One of our top production managers recently gave me a book of memos from Bear Stearns’ legendary Chairman….Ace Greenberg. Many quotes in this excellent book apply to OUR BANK and the mortgage business (and I sure wish I had read it before 2005)…here are just a couple gems:

1. “Make decisions based on common sense. Avoid the herd mentality. Control expense with unrelenting vigil. Execute the fundamentals.”
2. “The prosperity in Wall St. has caused some of our competitors to start reaching for business, and once again we will decline to participate.”
3. “Humans tend to get sloppy when making money is easy. We are in a period now that will cause the stupid to be careless and overconfident, and the results are totally predictable…financial catastrophe.”

Loan officers and mortgage brokers….I know, are struggling to make a living these days and our approach above does not help….but we have to make sure that we protect our overall company and don’t allow a relatively small amount of risky business to jeopardize everything we are doing right. In this regard, on a loan that is eligible to be sold to the GSEs or FHA/VA that we don’t offer (because we believe it is too risky)…I would challenge the loan officer and/or mortgage broker to step up and “align themselves with OUR BANK and the investor”….agree to defer their commission or broker fee and put 1 additional point up and when the loan is still current after 12 months…we will rebate all of this back to the producer, plus interest…I am not saying I would do everyone…but this would go along way to ensuring that the mortgage professional in the field really believes in the borrower and the loan. Lastly, we have are “digging” into the high, early delinquencies of these products and as we find pockets of good performing loans (which I full expect)…we will improve our guidelines.

I hope this helps explain what we are doing. Thanks. President

P.S. Specifically on FHA…on mobile homes (not manufactured homes) on permanent foundations…where we can get clear title on both the dwelling and land….and these are allowed by FHA….and right now we don’t allow them….due to the depreciating nature of these homes and their high delinquencies and losses….but OTHER GUY and I discussed developing some guidelines that “make sense to us” that would allow us to do some of this business. “

 

Interesting - thanks.

A forced repurchase would force recapitalization on the bank - that's what I think is unsaid and what the CEO is concerned about too.

Put viciously, the gummint dropped its loan quality standards to the gutter level the bank had gleefully embraced. This now terrifies them.

 

I don't think I've ever read a press release by a major bank commenting on mobile homes. Just out of curiosity, whats the market cap of this bank? And do the employees have all their teeth?

 

does anyone know which of the big banks have most exposure to a flood of forced repurchases from GSEs?

 

Seems to me it would be the ones that bought subprime lenders that stand to get loans "put" back on to them.