'SnD' Loans Getting Sent Back to GSEs?

Perhaps it's more of a mortgage urban legend than anything else, but certain secondary market investors are said to be buying "scratch and dent" loans on the cheap, fixing them up (so to speak) and sending them back to Fannie Mae and Freddie Mac as performing mortgages.

Then again, even if this is a real trend, it may not necessarily pose much of a risk to the GSEs. Keep in mind that scratch-and-dent loans are mostly performing mortgages kicked back to lenders by either Fannie Mae, Freddie Mac and any of the big bank aggregators such as Bank of America or Wells Fargo & Co.

These "kick" or "pushbacks" occur because the loan buyer (a GSE, for example) is auditing its book of business (which is all the rage right now) and discovers underwriting deficiencies that went undetected when the mortgage was first funded and securitized two, three, four years ago. With the underwriting deficiency in hand, the GSE approaches its seller/servicer and offers a few options including buy back the loan, pay us some more money to cover any potential loss, or buy back the loan. (You get the drift.)

Many of these buyback requests are coming on mortgages originated in the most troubled housing states in the nation: Arizona, California, Florida and Nevada.

If a nonbank lender is forced to repurchase a problematic loan it very well may choose to mitigate its problem by selling the mortgage in the SnD market, accepting a haircut on the note.

During the height of the credit crisis, investors could purchase performing SnD loans for 70 to 80 cents on the dollar. But with home values firming up a bit the past six months, those prices have risen to 90 to 92 cents on the dollar.

One private investor who has bid on SnD loans says he knows of firms that purchase such notes, pooling them with other mortgages. The firm then sells the whole package to Fannie or Freddie.

"They take what they've bought, throw them in with their own stuff and hope they don't get caught on a 10% audit."

A 10% audit refers to spot checks the GSEs perform on loans they've purchased either recently or within the past few years.

The investor didn't want his name used and declined to name some of the firms engaged in such behavior. A GSE official said his company has no information that such behavior is occurring.

Chris Whalen, senior vice president of Institutional Risk Analytics, a consulting firm, said he has heard about SnD loans being resold to the GSEs but is uncertain about how common the practice is.

"They could be tidying up the documentation and resubmitting," he said. "If they are not modifying or refinancing the loan, it should show up as a seasoned mortgage purchase."

As for the profit motive, he noted that the SnD investor is "paying 80 to 90 [cents on the dollar] because they get par on repurchase." In other words, the returns are nice.

Again, if such behavior is happening it may not necessarily result in any losses for Fannie and Freddie but it's allowing for certain middle men in the market to profit due to fear of default.

Meanwhile, lenders and seller/servicers continue to complain about buybacks-be it requests on performing or nonperforming loans. Steven Nilssen, an executive at Summit Funding, Lodi, Calif., said his company is rarely asked to repurchase SnD loans but it occasionally gets requests on nonperformers.

What bothers him the most is that some of these requests come on loans that are three to four years old. Summit is a correspondent lender for the nation's largest banks and deals mostly with them and not the GSEs.

"It's not like we can tell 'The Big 4' to pound sand and take our business elsewhere."