On HARP II Removing Bank Liability

One of the carrots that FHFA is dangling in front of banks to get them to participate voluntarily in HARP II is the removal of liability for any problems in the mortgage that gets refinanced. This means that if a bank believes it has liability on a mortgage it may jump at the chance to refinance it. it also means another bank can come along and refinance a mortgage away from a competitor without fear of bring along risks on the old mortgage. But will this be the proper encouragement?

As is almost always the case with these things, the devil is in the details. We won’t know the precise ways in which liability will be removed until November 15, so for now we are all largely speculators. But it is clear that success of HARP II appears heavily dependent on the right reps and warrants claim liabilities being reduced. A Morgan Stanley research note sent out Monday after the FHFA announcement, pointed this out:

Critical question is how is FHFA treating reps and warranties for loans refi-ed in this program? The press release is confusing. One section refers to waiving “certain” reps/warranties while another section states “eliminating the reps and warrants … will be good for borrowers, housing markets… Enterprises and taxpayers.” We need to know what it will be. Banks currently being sued by FHFA over underwriting claims and will need to have iron-clad documentation that outlines how reps/warrants are treated and which, if any, are being eliminated.

The basic take away is that if the waiver for liabilities only modestly reduces reps and warrants claims, then this program unlikely to have significant impact on banks.” But if the claims liabilities were totally removed, it would have a positive impact of lowering future reps/warranties costs, and long-term positive impact of creating more stable consumers, according to Morgan Stanley. A Friedman, Billings Ramsey analyst suggested that “R&Ws could be waived if the borrower has been current on their existing mortgage for a certain period of time. Or it could be on a forward-going basis, where the R&Ws expire after the borrower complete three years of timely payments on the new loan.”

One reason the participation may be weak if the terms do not provide enough of an incentive is that Fannie Mae already has a similar policy in place, relieving mortgage servicers of reps and warranty risks through its Refi Plus program. A Barclays Capital analyst wrote Tuesday, “From what has been stated so far, the new HARP employment and income verification process appears to be very similar to the existing one. As such, it is not clear whether refis will increase much, if at all, unless some other changes are made to this rep and warranty waiver related to income.”

Still, even if the waiver is modest, there may be some banks willing to jump at the opportunity. Swiss bank UBS, for instance, is facing lawsuits from private investors on about $45 billion of RMBS that was underwritten or issued by the Swiss bank, plus another $7.5 billion in claims from the GSEs that RMBS issued was not the quality promised by the reps and warrants—that creates serious liability. Refinancing these loans, if qualifying, would pay off the original loan, satisfying the investor claim, and then setting the bank free from future reps and warrants liability on the loan.

Banks that are looking to expand may also use HARP II as an opportunity. AmericanBanker quoted Matthew Jazoff, a managing director at JMPC, telling investors on a conference call:

“So if a [Bank of America] borrower has been current for 6 months, basically a Chase originator could go after that borrower, refinance them, and not be held to the original loan file that B of A had… Consequently, we think that does increase the willingness of cross-servicing refinancing to take place.”

Finally, Fannie Mae’s loan buyback requests to banks it considers having sold it fraudulent mortgages were up 60 percent from the first quarter of 2010 to 1Q2011, suggesting an increased need for banks to address their mortgage liabilities.

Also see previous two posts on HARP II: