Move by GNMA Hitting Lender Profit Outlooks

25 March 2004
American Banker
By Jody Shenn

SEATTLE -- Some of the record profits big home lenders generated during the refinancing boom came from a little-discussed practice of buying delinquent loans that were securitized through the Government National Mortgage Association.

However, a recent policy change by the federal agency, known as Ginnie Mae, is making it harder for lenders to use these purchases to supplement earnings. And an expected rise in interest rates would make the practice even less lucrative.

The issue came to light Tuesday in a Morgan Stanley analyst's report, which said Washington Mutual Inc. generated a substantial portion of its mortgage income last year through the practice, which is commonly known as early buyout.

The Seattle thrift company is clearly not the only Ginnie servicer that profited from so-called early buyouts. WaMu appears to be the only one that broke out those gains (and it stopped breaking them out in the fourth quarter).

In his report, Kenneth Posner wrote that WaMu received "nonrecurring, windfall gains" in the past two years by buying -- at par -- delinquent FHA and VA-insured loans from Ginnie pools.

WaMu (and others) would bring the loans back to performing status and then usually resecuritize them through Ginnie. Since the loans usually carried higher interest rates than newly originated ones, the companies pocketed big gains on the resale.

Sometimes they would simply keep the cured loans in their portfolios and earn spread income.

WaMu's pretax income from this activity increased from essentially zero in 2001 to $319 million in 2002 and $692 million last year -- or 49 cents per diluted share, 12% of its total per-share profits, Mr. Posner wrote.

"The bottom line is that this obscure line item contributed a sizeable portion" of the earnings, he wrote.

Alan Gulick, a WaMu spokesman, said early buyouts "are a normal part of our business and the business of all mortgage lenders who make or service government" loans.

In its annual report, WaMu said $369 million of its early buyout profits last year came from reselling the cured loans, compared with $126 million the previous year. Mortgage income last year nearly tripled, to $1.97 billion.

Other top Ginnie servicers include Wells Fargo & Co., J.P. Morgan Chase & Co., Countrywide Financial Corp., National City Corp., and Principal Financial Group Inc.

An executive at one of those firms, who requested anonymity, called the reselling of cured loans "an unexpected enhancement" to earnings that is expected to fade. "It's been nowhere near a major portion of our earnings."

The ability to buy out loans is intended to give servicers more flexibility to work problems out with borrowers, prevent foreclosures, and reduce FHA and VA claims.

Ginnie used to allow issuers to repurchase loans where borrowers have missed one payment and failed to catch up within four months. But starting with pools created in January 2003, only loans where borrowers miss payments for at least three straight months are eligible for buyout. Because such delinquencies are less common, analysts expect fewer buyouts.

"Anecdotally, servicers tell us about three-quarters" of the early buyouts are for loans with only one missed payment, said Arthur Frank, the director of MBS research at Nomura Securities International Inc.

Mr. Posner said the policy change would reduce the number of loans eligible for a buyout by about 70%.

In its annual report, WaMu acknowledged the likely effect of Ginnie's policy change: "Over time, we expect gains from the repurchase of rolling 30 loans to diminish as the pools that are eligible for repurchase are depleted."

Curing the more seriously delinquent loans is generally tougher. "As far as a resecuritization, you're rolling the dice a lot more with a three-payment delinquency rather than the rolling 30-day delinquency," said a Ginnie official, who also requested anonymity.

Rising rates will further limit the potential gain from a resale, since loans with below-market rates would be tough to sell at or above par, observers say.

"Our best guess is that changes in pool buyout loan eligibility requirements and rising interest rates will reduce gains" at WaMu from repurchased loan sales "to about 50% of 2003 levels in 2005," Mr. Posner said.

Ginnie cut back on the types of loans eligible for early buyout in part because so many servicers were buying loans that they caused a prepayment spike that did not sit well with bondholders.

Still, the availability of cheap short-term funding has persuaded servicers to continue taking delinquent loans out of pools when allowed, rather than incurring the expense of temporary advances to bondholders. Hence the "dramatic difference" between overall delinquency rates on government loans and those in Ginnie pools, the official said.