Don't Count Your Chickens Before They Are Hatched

The National Credit Union Administration (NCUA) wants several investment banks to repurchase $50 billion in non-agency mortgage-backed securities that they sold to five failed corporate credit unions; but there is no guarantee that NCUA's repurchase request will succeed.

There are a number of factors that will influence the success of such a repurchase request.

The first issue is materiality. In general, pooling and servicing agreements (PSA) permit a loan to be put-back due to a breach in warranties and reps, if the breach materially and adversely affect the interest of the bondholders in any mortgage. But materiality may be difficult to prove, especially where borrowers made their payments for a period of time before defaulting. In other words, did the default arise from a breach or from factors unrelated with the origination of the loan that caused the default.

A second factor is access to loan files and voting rights. Before a trustee can request access to loan files, investors in private-label MBS need to reach a certain voter threshold. In some PSAs, this requires reaching a certain voter threshold for each tranche. According to Fitch, this voter threshold is a large hurdle to overcome.

Third, once access is obtained, investors will need to review the loan files. This could result in substantial cost with no guarantees of sizable returns.

The next issue deals with guidelines, as most private-label loans are underwritten to the guidelines in effect at the time the loan was originated. Investors will need to identify loans that were not underwritten to the originator's guidelines and this could be very difficult.

Furthermore, most PSAs include a qualified fraud representations stating that to the best of the seller's knowledge no fraud was committed. Therefore, it is not enough for the investor to prove fraud, the investor needs to prove that the representation provider knew about the fraud or should have known.

Ultimately, if NCUA's repurchase request are ignored or denied, the agency can sue, as they have threatened. But litigation could take years to work its way through the legal system and there is not any guarantee that the NCUA will prevail.

So, there are a number of hurdles confronting NCUA that may limit the success of its put-back requests.

Therefore, credit unions should not start counting their chickens until they are hatched. In other words, credit unions should not expect this put-back gambit to have any impact for the foreseeable future on their corporate credit union assessments.