When Taking on More Bad Loans Seems a Good Idea

US Banker | March, 2010

With delinquencies rising on Federal Housing Administration-insured loans, banks are expected to repurchase billions of dollars of such loans this year from the Government National Mortgage Association.

These purchases require huge up-front outlays, but taking the delinquent loans back on to their balance sheets enables banks to stop making regular principal and interest payments to bond investors.

While this can cause some short-term pain, analysts say it's a better long-term strategy than making regular payments to cover delinquent borrowers. And, since the loans are insured by the FHA, the banks will eventually be reimbursed for any losses.

"We saw very high volumes of buyouts in the second half of 2009, and we would expect that to continue into 2010 given the high delinquency rates of FHA loans," said Robert Fishman, Ginnie Mae's chief risk officer.

How high?

Qumber Hassan, a mortgage strategist at Credit Suisse, said delinquencies on the securities that Ginnie has packaged from FHA loans could double or even triple by yearend, to between 7.4% and 12%, though not all the loans will require that the FHA pay claims and most have not even begun the process of loss mitigation.

"If delinquencies reach as high as 10%," banks "will potentially need to buy out $50 billion of loans," Hassan said.

Once an FHA loan has been delinquent for 90 days, the bank that issued it can buy it back from the Ginnie bond pool, and stop advancing principal and interest to the bondholders. Even if borrowers are no longer making monthly payments, the banks are required to continue doing so.

In an interview Friday, FHA Commissioner David Stevens said that while he expects a much higher claim rate this year, "the numbers coming in are lower than what we forecast" in an audit report the FHA released in October. The actuarial report had forecast 135,000 claims for fiscal 2010, which ends on Oct. 31 of this year, and Stevens said "we're well behind that pace."

Roughly 75% of Ginnie pools are backed by FHA loans. Delinquent loans that were repurchased by banks last year "are absolutely folded into the FHA's insurance fund calculations," Fishman said.

Repurchasing delinquent FHA loans is expensive, and results in a massive increase in delinquent loans on banks' balance sheets.

For example, Bank of America Corp. repurchased $9.4 billion of delinquent government-insured loans from Ginnie securitizations in the fourth quarter alone, up from $1.8 billion of repurchases in the third quarter.

This caused B of A's total nonperforming loans to zoom to $62 billion in the fourth quarter, from $49.5 billion in the third quarter.

Wells Fargo & Co. held $15.3 billion of delinquent FHA loans at yearend, up from $8.2 billion in 2008.

Banks are not obligated to repurchase these loans, but Fishman said doing so is cheaper than continuing to advance principal and interest to investors.

Also, issuers with higher delinquency rates can be subject to greater scrutiny, Fishman said; most will opt to buy back the debt to avoid this kind of attention.

"If it's above 5%, … we have a talk" with the issuer, he said.

The agency has urged issuers to keep delinquency rates below 5%, and buying back delinquent loans can help them reach that level. The current delinquency rate of FHA loans is 9.1% while Ginnie's delinquent rate is 2.35%, he said.

Stevens also wants to have more authority to force banks to buy back bad loans. He is asking Congress to give the agency more power to require indemnification for loans that were improperly originated or where fraud or misrepresentations occurred.