Large US Banks Could Loose Between 17 And 42 Billion On GSE

Fitch estimates the four largest U.S. banks have received pending repurchase requests totaling $19.1 billion with $10.7 billion related to requests from the main housing Government Sponsored Enterprises (GSE). Fitch believes the expected loss for the four largest banks could be about $17 billion, the rating agency says in a statement.

“Using a more moderate loss scenario, whereby the put-back rate goes to 35% and recovery rate drops to 55%, Fitch believes losses could come in around $27 billion.”

Fitch Ratings


“Recently, the main housing government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, have been actively exercising their right to put back to the original lenders a considerable amount of the troubled mortgages in their portfolios. To some extent, this has been expected given the significantly larger volume of troubled mortgages sitting on the housing GSE’s books,” Fitch says.

Major banks have effectively acknowledged this development and have increased their representation and warranty reserves as requests for deficient loan repurchases expand.

“Based on data through the second quarter of 2010, Fitch estimates the four largest U.S. banks have received pending repurchase requests totaling $19.1 billion with $10.7 billion related to requests from the main housing GSEs. To date, these institutions have established $8.3 billion of representation and warranty reserves. A large sum, but one that Fitch would view as manageable within each firm’s inherent earnings capacity,” the statement says.

Purchasers of residential mortgage loans, such as the housing GSEs, have had the right under specific representations and warranties to require the seller/servicers of mortgages to repurchase loans or foreclosed properties or reimburse the investor for losses if the foreclosed property is sold if it is determined that the mortgage loan did not meet the investors’ underwriting and eligibility standards.

“Historically, Fitch has viewed purchasers of mortgages or mortgage-backed securities (MBS) as being fairly judicious in exercising their representation and warranty rights on troubled loans or foreclosed properties. More specifically, prior to the beginning of the mortgage crisis, mortgage losses were very manageable and the housing GSEs used to compete actively against one another to gain market share from the major bank originators. Accordingly, the housing GSEs likely weighed the costs and benefits of exercising their repurchase rights under representation and warranty provisions with originators with whom they had maintained long-standing relationships.”

Fitch says it is now undertaking a review to assess whether these increased reserves are just a part of the flood of current troubled mortgages or whether investors, such as the housing GSEs, have expanded their interpretation of what constitutes a mortgage that would be eligible to be repurchased under existing representation and warranty provisions.

“Fitch is concerned that a more aggressive request for loan repurchases could potentially expose banks with large mortgage origination operations to future losses that have not been previously incorporated into Fitch’s existing exposures, and effectively into current ratings. As of June 30, 2010, the housing GSEs combined had troubled mortgages (delinquent mortgages and real estate owned) of $354.5 billion.”

Losses Between 17 And 42 Billion Dollar

In assessing potential exposure, Fitch is concentrating on the four largest U.S. banks (JP Morgan & Co., Citigroup, Inc., Bank of America Corp., and Wells Fargo & Co.), given the likelihood of materiality, in absolute terms, since they collectively service approximately 50% of the GSE’s portfolio.

“This concern, however, is not isolated to only the four largest banks. Any bank or other entity that has been actively engaged in mortgage lending could feel the impact of this development, and to some degree on a relative basis, could be affected to a greater degree. In assuming an extremely adverse scenario where all of the existing GSE’s troubled mortgages were at risk of being repurchased based on market share, it is conceivable that the pool of “at-risk” loans eligible to be repurchased by the four largest banks could total about $175 billion-$180 billion. Fitch anticipates that a focal point of repurchase requests will be reduced documentation loans (sometimes known as Alt-A loans). The actual amount of repurchase requests will ultimately depend on key variables such as quality of the originator’s underwriting, documentation standards, and foreclosure rates, while losses will be a function of “cure” rates and home prices.”

“Under a mild loss scenario, where the GSEs collectively and successfully put back 25% of the current outstanding inventory of seriously delinquent loans, and assuming recovery rates of 60%, Fitch believes the expected loss for the four largest banks could be about $17 billion.”

“Using a more moderate loss scenario, whereby the put-back rate goes to 35% and recovery rate drops to 55%, Fitch believes losses could come in around $27 billion.”

“Finally, under a more adverse but less likely scenario, if repurchase requests were to run at 50% of delinquent loans, and recovery rates fall to 50%, then losses are about $42 billion.”

Fitch emphasize that  these figures do not incorporate the ability to cure deficiencies in loans, thus ultimate realized losses could be lower than these figures.

“To put these figures in perspective, these institutions had annualized pre-provision net revenues and net income of $164 billion and $54 billion, respectively, in aggregate and $391 billion of tangible common equity.”

Fitch believes that any of the scenarios listed above is a possibility,

However, for purposes of current bank rating analysis, Fitch is assuming the more moderate cases are the most likely outcome.

Fitch also notes that the repurchase scenarios listed above do not include any potential risk of buybacks on troubled mortgages situated in existing private-label MBS transactions.

“At the present time, there are a number of legal suits outstanding against the originators of private-label MBS deals. In addition, our assumptions do not incorporate any potential financial liabilities that may result from the recent subpoenas issued by the Federal Housing Financing Agency (FHFA) in July 2010 against a number of mortgage originators,” the rating agency points out.

Ratings In Danger

Recognizing this potential risk, Fitch in the near term will be monitoring the on-going developments between the banks and the GSEs related to mortgage loan repurchases. Fitch will also consider other mortgage investors such as private mortgage insurance companies and private-label MBS investors, the statement says.

“If these investors are successful in putting back a sizeable portion of the troubled loans presently in inventory, Fitch believes the existing bank Individual and Issuer Default Ratings (IDR) not already at their Support Floor (i.e. Bank of America and Citigroup are the only two U.S. banks active in mortgage lending that are currently at their Support floors) could be susceptible to a downgrade in the future.”

Full Press Release Here.

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2 responses to “Large US Banks Could Loose Between 17 And 42 Billion On GSE

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