Banks will suffer in 2023 from poor quality control in loans from 2021-2022.
Fannie and Freddie are now starting to trigger repurchase requests for the loans originated post pandemic with huge penalties on the horizon in a bad market.
Majority of active/open real estate Loans were originated in 2021-2022 with low interest rates.
Many service providers were overwhelmed by huge volumes in underwriting and cut corners in the origination process quality control. Some underwriters had no capacity and turned down many clients that had to settle for subpar underwriting. Not to the same point of GFC, but still some of the grey area of underwriting was skimmed.
So where is the root of this problem? GSEs have three years to review the loan after loan purchase by GSEs for securitization purposes. As you understand, three years from 2021 and 2022 will put us in the Q4 of this year through Q4 of 2025. If the loan sold does not fit into GSE criteria, the repurchase request is triggered for the lender to buy the loan back onto the bank's books with penalties and interest. Fundamentally, there are two major issues with that:
1. First, lender needs to have extra cash on hand to pay for the loan.
2. Second, holding the loan on their books would only translate to cash back after the loan is sold on the capital markets at the deep discount as a defective loan with low interest rate. This means, that the spread on the loss can be as wide as 40 points from origination to scratch and dent sale.
Additionally, originators typically do not retain the serving in house and would need to hussle and sign up with servicing to collect monthly payments, exceture the assignment into lender, transfer to different custodian, etc.
All contributing to additional cash requirements for handling repurchase requests.
Areas of concerns by GSE were DTI values, self-employed income verification, unusual income streams, such as crypto trading, crypto holding accounts as collateral, 2-3 jobs of borrower or co-borrower, property values, high risk loans and credit scores specifically for affordable housing.
Per John Toohig from Raymond James, the defective loan was originated in 2020-2021 with 3.5% interest rate and is now selling at about 75 cents on the dollar. Loans that were repurchased by lender due to minor defects in underwriting are now discounted to 65 cents on the dollar.
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