The credit ratings of U.S. banks may be vulnerable to being required to repurchase mortgages from two government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, reports Fitch Ratings.
 
Fitch said Wednesday that the GSEs have been actively exercising their right to put back to the original lenders a considerable amount of the troubled mortgages in their portfolios. The housing GSEs have the right to require the seller/servicers of mortgages to repurchase loans or foreclosed properties, or reimburse them 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.
 
As a result of these increased repurchases, banks have been increasing their reserves, Fitch notes. And, it says it is undertaking a review to assess whether these increased reserves are just a part of the flood of current troubled mortgages, or whether the GSEs have expanded their interpretation of what constitutes a mortgage that would be eligible to be repurchased.
 
The rating agency adds that it 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 factored into current ratings.
 
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 U.S. banks could be about US$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 US$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 US$42 billion.
 
These figures do not incorporate the ability to cure deficiencies in loans, thus ultimate realized losses could be lower than these figures, it notes. Moreover, the four largest banks had annualized pre-provision net revenues and net income of US$390 billion and US$54 billion, respectively, and US$391 billion of tangible common equity.
 
Still, recognizing the potential risk, Fitch says that it will be monitoring mortgage loan repurchases. And, it says that if the GSEs are successful in putting back a sizeable portion of the troubled loans, bank credit ratings could be susceptible to a downgrade.
 
IE