“Can’t see the forest from the trees…” a phrase that describes someone’s inability to see the big picture, someon who makes decisions based on short-term consequences without considering long-term implications.
Investor repurchase demands and “make-whole” claims continue to nag most mortgage bankers, especially those who have originated stated income loans in the past five years. Real estate values keep dropping and foreclosure inventory continues to increase. Any time there is a foreclosure and an investor is asked to make the GSEs whole for it, the originating mortgage banker is eventually contacted by the pass-through investor in the form of a repurchase demand. Investors’ loss mitigation departments are doing everything they can to reduce losses at their firms. This has trickled down the supply chain.
The process starts with a loan repurchase request, but generally mortgage bankers are unable to meet the demand because they're working with limited liquidity. In that case the originator usually lets the investor take care of the liquidation of the property, but that doesn't mean they're off the hook. Several months later, the mortgage banker gets a large bill for the shortfall. And in today's market, those shortfalls are generally large. So large that many independent mortgage bankers can’t absorb it without depleting their net worth. This leads to a downward spiral where a mortgage banker eventually violates their warehouse lending covenants and/or investor net worth requirements, which can lead to a loss of funding lines and the end of their operation.
Most investors understand the problem and attempt to design a settlement arrangement to keep the mortgage banker in business. If they drive a mortgage banker to bankruptcy, there's no chance in the future to enforce purchase agreement reps and warrant, resulting in the investor taking the entire losses on bad loans. A typical plan is for the investor to offer a settlement (after fierce negotiations on the part of the mortgage banker) that includes a partial payment and a commitment to deliver a certain amount of loans over some commitment period. As loans are purchased, the investor will “clip” part of the GOS to pay for the settlement. In many cases, investors actually offer a pricing spiff on the commitment to help finance the payments.
Is this practice extortion? The answer is yes and no. A large percentage of mortgage bankers probably violated the reps and warrants and do need to "make whole" their investors. A smart mortgage banker will have a loss mitigation process determine if they do in fact owe the money. If a mortgage banker is liable, they should figure out a way to remedy the problem. Tying a settlement to loan sales seems sleezy, but beggars can’t be choosers. This may be the best way to stay in business as a mortgage banker.
What some mortgage bankers are also doing is taking a hard stand against settling with an investor. Generally, when negotiations break down, investors will discontinue the relationships immediately. If the owner operator continues with this practice of not settling, he may find himself with a limited number of investors. Or, he may wake up one day with no investors at all.
Today, there are only a handful of investors buying loans from mortgage bankers. There’s even a smaller amount of investors that offer mandatory commitments. Think of the long term consequences when analyzing your repurchase demands with investors. It might be better to view the forest rather than just the trees.