Changing Winds in the GSEs' Rep and Warrant Framework: Part 1

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A relaxing in the implementation of mortgage regulations by Fannie Mae, Freddie Mac and their regulator is getting accolades from the housing finance industry.

However, critics argue that it also may have an unintended implication for taxpayers.

In late November, Fannie and Freddie announced changes to the representations and warranties regulations under which lenders and these government-sponsored enterprises operate with respect to the purchasing and selling of mortgages. The changes occurred approximately one month after the chairman of the GSEs' regulator, the Federal Housing Finance Agency, Melvin Watt, gave a speech at the 2014 Mortgage Bankers Association Annual Conference highlighting them. In essence, the changes are intended to change tight credit conditions and allow for increased lending, but critics argue that such loosening could alternatively cause losses by the GSEs related to the purchases of bad loans; such losses would eventually be passed on to taxpayers.

Effective January 2013, as part of the FHFA’s "seller-servicer contract harmonization initiative," the first of many ongoing changes to the representations and warranties framework was unveiled. Such regulatory changes to the framework have undergone ongoing review and interpretation by those subject to it. Industry leaders and organizations, including the MBA, have argued that the regulations are too restrictive. During his opening remarks at the MBA annual conference, MBA chairman Bill Cosgrove challenged the FHFA and other regulatory agencies to change this, saying that "the future of housing in America is on the line" as a result. "Regulators must be our partners to solve the overlapping regulations that are holding back the mortgage and housing markets. If they are going to regulate us, they must work to better understand the unintended consequences on consumers," he said. The GSEs implemented the aforementioned changes approximately one month later.

Ongoing Review of Representations and Warranties

Other industry leaders also have been vocal about their concern over the framework and the negative effect it has on providing credit to borrowers. David Lowman, executive vice president of Freddie Mac, has stated that the concern is that, under the current structure, there was a “back door for the GSE to put loans back to [the lender] after granting relief.” In his speech in October 2014 at the MBA conference, Watt highlighted several ongoing issues related to FHFA's statutory obligations, focusing on the representation and warranty framework. He acknowledged that the framework currently in place did not provide enough clarity to enable lenders to understand when Freddie or Fannie would repurchase loans. In turn, he stated, this drove lenders to impose credit overlays, driving up lending costs.

Initial changes to the representations and warranties framework effective as of January 2013, “relieved lenders of representation and warranties obligations related to the underwriting of the borrower, the property or project for loans that have clean payment histories for 36 months,” according to Watt. In May 2014, the FHFA and GSEs provided additional clarity regarding the 36 month benchmark, including: (1) confirmation to lenders when mortgages sold to the GSEs meet the 36-month performance benchmark or pass a quality control review; (2) revising the payment history requirement by borrowers to allow, within the first 36 months after acquisition, up to two 30-day delinquencies; and (3) eliminating automatic repurchases by lenders when a loan’s primary mortgage insurance is rescinded. Nonetheless, lenders did not loosen their credit standards as a result of continued fear of buybacks.

One of the major changes implemented in November by the GSEs is to provide clarity around life-of-loan exclusions to better define how they can trigger a repurchase. (Life-of-loan exclusions are intended to allow Fannie Mae and Freddie Mac to require lenders to repurchase loans at any point during the term of the loan, thus to prevent fraud or non-compliance, and can increase liability for lenders.) Exclusions fall into six categories: (1) misrepresentations, misstatements, and omissions (2) data inaccuracies, (3) charter compliance issues, (4) first lien priority and title matters, (5) legal compliance violations; and (6) unacceptable mortgage products. 

With respect to category (1) above, the misrepresentation or data inaccuracy must meet a “significance” requirement for post-relief date repurchases and the definition of fraud makes a distinction between fraud and misstatement. The threshold for misrepresentations is now three loans or more, rather than two, by the same lender; the threshold for data inaccuracies has increased to five loans. GSEs will have to conclude that, had the information been accurately reported, the loan would initially have been ineligible for purchase. The purpose, it appears, is to limit buybacks caused by errors to situations in which there is a routine pattern of a repeated mistake by a lender despite the fact that there is no timeline indicated in the guidelines around error.

The recent revisions by the GSEs to the life-of-loan exclusion will be applied retroactively to loans that were purchased or pooled on or after Jan. 1, 2013. The November changes by the GSEs also make modifications to the compensatory fee structure with respect to jurisdictions and de minimis exceptions. In implementing these changes, the GSEs amended the “Compliance-with-Law” definition in their selling guides, effective for mortgages with settlement dates on our subsequent to Nov. 20, 2014, to limit the instances of triggering buybacks in scenarios in which there is a violation of law by a lender.

GSE leaders make it clear that these changes are intended to provide clarity and have tighter definitions, allowing increased availability to credit to a wider variety of qualified borrowers.