Loan Buybacks: Causes and Defenses

Joseph M. KolarClinton R. RockwellChristopher M. Witeck

June 15, 2010

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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)

Huge Exposure

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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 & Warranties

Language is crucial Rep often says loan contains “no untrue information”

Agreements generally permit repurchase demand upon borrower fraud or violation of underwriting guidelines

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

Bases for Demands

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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

Response to Large Demands

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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

Seller Defenses

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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?

Seller Defenses (Cont’d)

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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

Changes in Loan Sale Agreements

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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

GSE Repurchase Issues

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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

GSE Repurchase Issues (Cont’d)

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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

GSE Repurchase Issues (Cont’d)

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New “official position” regarding uniform documents ANY change not agreed to by Fannie/Freddie or

authorized by related Guide makes loan “non-standard”

Other potential remedies Indemnification Termination or suspension Compensatory fees

GSE Repurchase Issues (Cont’d)

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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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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

GSE Servicing Rights (Cont’d)

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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

GSE Termination of Servicing Rights

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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

Private Mortgage Insurers

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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 Kolarjkolar@buckleysandler.com

202-349-8020

Clinton Rockwell

crockwell@buckleysandler.com

424-203-1002

Christopher Witeck

cwiteck@buckleysandler.com

202-349-8051