Large US Bank Ratings Vulnerable to GSE Mortgage Loan Repurchases
The credit ratings of banks with large mortgage origination businesses could come under threat if Fannie Mae and Freddie Mac succeed in forcing them to increase the amount of bad loans they repurchase.
Fitch Ratings is undertaking a review to assess whether investors such as the GSEs have expanded their interpretation of what constitutes a mortgage that would be eligible to be repurchased by the originating bank 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.
In assessing potential exposure, Fitch is concentrating on the four largest U.S. banks – JP Morgan (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) – which service approximately 50% of the GSE’s portfolio. But 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).
- 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.
- To put these figures in perspective, these institutions had annualized pre-provision net revenues and net income of $390 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 will also consider other mortgage investors such as private mortgage insurance companies and private-label MBS investors. 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 (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.
Over the intermediate term, assuming investors are successful returning the problem loans to the originating banks, Fitch says it will have to give further consideration to its existing analytical approach to assessing returns, capital, and liquidity for U.S. banks.
Edited excerpts from Large U.S. Bank Ratings Vulnerable to GSE Mortgage Loan Repurchases
See also Banks Face Fight Over Mortgage-Loan Buybacks (WSJ)
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
