Although investors are requiring mortgage originators to repurchase more loans because of early payment defaults, the rise in repurchases does not signify a troubling trend, Fitch Ratings concludes in a special report.
The report, published today, examines whether rising early payment defaults and loan repurchases are signs of a more serious credit crisis.
After surveying an unspecified number of subprime residential lenders, Fitch analysts agreed with originators who maintain that repurchases are up primarily because investors have become more risk averse — not because they made too many bad loans.
While early payment defaults are on the rise in some regions and with certain types of loans, originators say, investors who purchase loans in the secondary market have become more insistent on enforcing agreements that require originators to repurchase loans that go into early default.
“Although (early defaults) are the root cause of the increased repurchase activity, we do not believe there has been a significant surge in the volume of (early defaults),” Fitch analysts conclude in the report. “The increase in repurchase activity appears to be more a result of loan buyers increasingly enforcing their rights to put loans back to sellers.”
Fitch said in the past, investors required that originators repurchase about 20 percent of loans that experienced early defaults. Today, “virtually all (early default) violations are returned,” the report concluded.
When repurchase activity increased, that made investors even more skittish, the report concluded, “and buyers scrutinized whole loan trades even further. Under renewed scrutiny, a small pocket of whole loan deals underperformed, leading to higher-than-normal repurchase-related charges for some companies.”
In August, H&R Block announced it was setting aside $102.1 million to cover anticipated losses on loans by its Option One Mortgage Corp. unit, including $46.1 million to cover defaults and repurchase requests from loan buyers in the previous quarter.
Fitch analysts said that with the exception of Option One, they expect losses from repurchases to have “only minimal impact” on lenders’ near-term earnings.
Lenders surveyed by Fitch said a high percentage of early defaults were linked to higher risk products with low FICO scores, and that originators have tightened underwriting guidelines and eliminated some higher-risk products.
Lenders that tightened underwriting guidelines “have seen an overall improvement with respect to (early defaults) and, as a result, more normalized levels of purchase requests,” Fitch analysts said.
Lenders can expect to see higher default rates as their portfolios age along with loans made when looser underwriting standards were applied. But Fitch analysts said they believe “the recent rise in loan repurchase activity served as a reality check for mortgage originators rather than the acceleration of default trends.”
The report, “Mortgage Loan Repurchases: Reality Check or Troubling Trend?” did not address the broader impact of adjustable-rate mortgage resets or alternative mortgage products, which Fitch analysts say carry a higher likelihood of delinquencies and charge-offs.