On February 2, 2016, Freddie Mac and Fannie Mae took another step towards helping sellers of loans manage risk more effectively, and in turn, strengthen the home lending system.
Through concurrently released announcements, Freddie Mac and Fannie Mae, at the direction of the Federal Housing Finance Agency (FHFA), jointly announced the Independent Dispute Resolution (IDR) process. Freddie Mac’s Bulletin 2016-1 explains that the IDR process provides sellers of loans an opportunity to request a neutral third party arbitrator to settle disputes regarding alleged loan-level origination defects. This announcement marks the completion of the selling representation and warranty framework, which was first introduced on September 11, 2012 in Bulletin 2012-18.
Each referenced Freddie Mac Bulletin includes updates to the Single-Family Seller/Servicer Guide, which contains Freddie Mac’s selling and servicing requirements. Similarly, Fannie Mae concurrently distributes these statements as Announcements, which update the Fannie Mae Selling Guide. Beginning with Bulletin 2012-18, Freddie and Fannie have limited those situations when remedies, such as a repurchase demand, will be sought, and have provided sellers with a clearer framework under which to issue loans. This goal was advanced by Bulletin 2014-8, which introduced relaxed acceptable payment history requirements, and Bulletin 2014-21, which better clarified situations that do not qualify for relief from the remedy provisions.
The IDR process is available for disputes related to alleged loan-level origination defects for Mortgages acquired by Freddie or Fannie on and after January 1, 2016. A defect occurs when a Mortgage sold to Freddie or Fannie does not comply with the requirements in the purchase agreement (i.e. breaches of representations or warranties). As explained by the newly implemented remedies framework provided by Bulletin 2015-17, Freddie and Fannie will categorize each origination defect in one of three ways: (1) Findings; (2) Price-Adjusted Loans; or (3) Significant Defects.
Only defects categorized as “significant defects” may require the repurchase of the mortgage or a repurchase alternative, such as an indemnification agreement. A significant defect is one that either necessitates a change to the price on which the Mortgage was acquired or results in the Mortgage being unacceptable for purchase had the true and accurate information about the Mortgage been known at the time of purchase.
Essentially, if the defect resulted in the wrong price being paid for the Mortgage or caused Freddie or Fannie to purchase a Mortgage that did not meet the requirements of the purchase agreement, it is a “significant defect.”
In the event of an alleged “significant defect,” Freddie or Fannie will issue a demand for repurchase or other remedy. The seller then has the opportunity to correct the defect or appeal the demand. If the issue is not resolved, the seller can again appeal, rebut, or provide further evidence that the defect does not exist or has been corrected. In instances that remain unresolved after the second appeal, an escalation process is available. Bulletin 2016-1 explains that Freddie and Fannie will update the appeal and escalation processes in 2016, in order to more clearly describe the ability of sellers to appeal and escalate prior to initiating the IDR process.
If the dispute remains unresolved after the appeals and escalation steps are completed, either the seller, Freddie, or Fannie may elect the IDR process. The IDR process, while new and not fully incorporated into the Freddie and Fannie guides, will provide a cost-effective and clearly defined alternative to bringing a claim in court. Bulletin 2016-1 sets forth components that the IDR process will incorporate, such as timelines for initiating IDR and selecting a neutral arbitrator, the option of each party to use legal counsel and experts, and a hearing with an arbitrator conducted by telephone or videoconference, among others. Lastly, the party that does not prevail at the IDR hearing will be responsible for paying the prevailing party a “Cost and Fee Award” in the amount of 10% of the unpaid principal balance of the related Mortgage at the time the Mortgage was acquired.
The IDR process will likely only apply to a small share of disputes, given that the current appeal and escalation process will remain (and be improved upon). However, the new IDR process should provide confidence for lenders, because there now is an opportunity to resolve disputes regarding alleged origination defects without needing to bring a claim in court. Importantly, Bulletin 2016-1 anticipates that the IDR process will also become available for servicing-related disputes in the future, which will be yet another step towards Freddie and Fannie’s goals of ensuring liquidity in the housing finance market and providing greater access to credit for borrowers.
If you have any questions or would like further information regarding the foregoing or anything related to this topic, please contact Chris Dueringer at (310) 576-2183 or Jason Stavely at (310) 576-2173.
In connection with the contemplated pooled auction of TARP CPP securities, Treasury has explicitly reminded potential participants that purchasers are responsible for compliance with the Bank Holding Company Act of 1956, as amended. The Form of Bid Letter includes a representation that each bidder is “aware of the potential implications of a purchase of any CPP securities under the Bank Holding Company Act, in particular, with respect to holding certain percentages of “voting securities” or more than one third of a financial institutions total equity.”
These statements have led to a number of questions regarding the impact of the Bank Holding Company Act vis-a-vis the TARP CPP securities.
We understand that the Federal Reserve Board is considering providing updated guidance specific to the CPP securities, but the contents of that guidance have not been finalized.
On July 9, 2012, the U.S. Treasury announced its intent to commence the fourth round of individual auctions of TARP CPP securities, commencing July 23, 2012. In this fourth round, Treasury has identified 12 institutions holding a total of approximately $346 million of TARP CPP securities.
Specifically, the fourth round will include:
- First Western Financial, a privately traded bank holding company in Denver, Colorado, with approximately $21 million in TARP CPP securities (preferred stock).
- CBS Banc-Corp, a privately traded bank holding company in Russellville, Alabama, with approximately $26 million in TARP CPP securities (preferred stock).
- Exchange Bank, a privately traded bank in Santa Rosa, California, with approximately $47 million in TARP CPP securities (noncumulative preferred stock).
- Market Street Bancshares, a subchapter S bank holding company in Mount Vernon, Illinois, with approximately $21 million in TARP CPP securities (subordinated debt).
- Fidelity Financial Corp, a privately traded bank holding company in Wichita, Kansas, with approximately $38 million in TARP CPP securities (preferred stock).
- Marquette National Corp, a privately traded bank holding company in Chicago, Illinois, with approximately $39 million in TARP CPP securities (preferred stock).
- Premier Financial Bancorp, a publicly traded bank holding company in Huntington, West Virginia, with approximately $22 million in TARP CPP securities (preferred stock).
- Diamond Bancorp, a subchapter S bank holding company in Washington, Missouri, with approximately $21 million in TARP CPP securities (subordinated debt).
- Park Bancorporation, a privately traded bank holding company in Madison, Wisconsin, with approximately $24 million in TARP CPP securities (preferred stock).
- Trinity Capital Corporation, a privately traded bank holding company in Los Alamos, New Mexico, with approximately $39 million in TARP CPP securities (preferred stock).
- First Community Financial, a privately traded bank holding company in Joliet, Illinois, with approximately $24 million in TARP CPP securities (preferred stock).
- Commonwealth Bancshares, a subchapter S bank holding company in Louisville, Kentucky, with approximately $21 million in TARP CPP securities (subordinate debt).
The prior individual TARP auctions have only included publicly traded bank holding companies, but the fourth round will include only one publicly traded bank holding company along with seven privately traded bank holding companies, three subchapter S bank holding companies, and one privately traded bank. The results of these auctions may provide further guidance as to the relevant market value for much of the remaining TARP portfolio, which largely consists of privately traded holding companies and banks (as well as subchapter S institutions). These institutions may trade at greater discounts, either because of reduced information available about the institutions, or because of the different terms of the various instruments.
On June 27, 2012, Treasury completed its third round of individual auctions for TARP CPP banks, further solidifying the $19 billion positive return recognized by Treasury on the TARP CPP program. As discussed further below, this third round also brought the best results to Treasury.
Summary results (along with links to the Treasury Press Releases announcing pricing) are presented below:
- Round 1 – 6 Institutions – $411 Million Liquidation – $367 Million Gross Proceeds – 10.6% Discount
- Round 2 – 7 Institutions – $281 Million Liquidation – $249 Million Gross Proceeds – 11.3% Discount
- Round 3 – 7 Institutions – $224 Million Liquidation – $208 Million Gross Proceeds – 7.5% Discount
Treasury also stated that it intends to announce additional individual auctions of TARP CPP stock, with those auctions taking place in late July and including investments in privately held institutions. Treasury confirmed that it intends to commence a series of pooled auctions this fall.
Looking on an aggregated basis at the 20 institutions that have been sold by Treasury in the individual auctions, on average the Treasury has recognized a 10% discount in order to move the positions. Overall, these 20 institutions were healthy, well-capitalized, profitable financial institutions, and all were current on their TARP dividends.
On May 3, the Treasury Department announced (via blog post) its intentions with regard to the 343 banks that remain in the TARP Capital Purchase Program. Specifically, Treasury identified three approaches: (1) allow repayments over the next 12-18 months; (2) limited restructurings in the context of mergers or capital raises; and (3) auctioned sales of the TARP securities, either for individual banks or in pools. These intentions are flexible and sufficiently vague to allow Treasury to moderate from these plans, particularly if political pressures necessitate. However, they also provide a road map (at least a current road map) of the path that Treasury anticipates using.
Treasury invested a total of $245 billion under the TARP bank programs, and has already recovered $264 billion through repayments and other income. This represents a $19 billion positive return, without providing any value to the remaining investments. Every additional dollar recovered is an additional return for the US taxpayers.
Of the 364 remaining investments, Treasury notes that most are smaller, community banks. Treasury is careful to point out that these banks have just as much desire to repay TARP, but have generally found it harder to raise funds from private investors in the capital markets and have often been particularly hard hit by troubled real estate loans.
Notably, Treasury now indicates that it intends to continue to hold the TARP securities of those banks that Treasury believes will have the ability to repay over the next 12 to 18 months. This could suggest that those banks that Treasury believes could obtain regulatory approval to repay will not be provided the opportunity, at least in the short term, to participate in a public auction (and therefore repurchase their securities at a discount to par value). The Treasury also indicates that they will communicate “regularly” with the group of banks that they think can repay over the next 12 to 18 months and will share with them Treasury’s “expectations” for repayment. Treasury has expressly indicated that its expectations regarding which banks will be able to repay may change over time.
On March 29, 2012, the Treasury announced the pricing of the public offerings of TARP preferred stock in six banks. In aggregate, the Treasury took a 12% discount to move the TARP investments off the books of the Treasury, selling preferred stock with an aggregate liquidation value of $411 million for $362 million.
While Treasury took a loss on these six investments (at least partially because of Treasury’s desire to go ahead and move the investments rather than hold them for future payment), it is important to remember that the total TARP CPP portfolio has already returned a profit to taxpayers. Including the results of these auctions, Treasury has recovered $260 billion from repayments, dividends, interest and other income, compared to the $245 billion initially invested.
Details of each of the six auctions are provided below.
- Banner Corporation, Walla Walla, WA – Auction proceeds of $108 million against an original investment of $124 million. The discount to the liquidation value of the shares was 11.5%.
- First Financial Holdings Inc., Charleston, SC – Auction proceeds of $56 million against an original investment of $65 million. The discount to the liquidation value of the shares was 12.6%.
- MainSource Financial Group, Inc., Greensburg, IN – Auction proceeds of $52 million against an original investment of $57 million. The discount to the liquidation value of the shares was 6.9%. MainSource had previously indicated that it intended to place one or more bids itself, and was ultimately successful in repurchasing 36.9% of its TARP preferred stock in the auction. Specifically, MainSource redeemed $21 million in liquidation value preferred stock for $19.6 million, and will still have approximately $36 million outstanding, now in the hands of private parties.
- Seacoast Banking Corporation of Florida, Stuart, FL – Auction proceeds of $40 million against an original investment of $50 million. The discount to the liquidation value of the shares was 18.0%.
- Wilshire Bancorp, Inc., Los Angeles, CA – Auction proceeds of $58 million against an original investment of $62 million. The discount to the liquidation value of the shares was 5.6%. Wilshire had previously indicated that it intended to place one or more bids itself, and was ultimately successful in repurchasing 96.5% of its TARP preferred stock in the auction. Specifically, Wilshire redeemed $60 million in liquidation value preferred stock for $56.6 million, and will still have approximately $2.2 million outstanding, now in the hands of private parties.
- WSFS Financial Corporation, Wilmington, DE – Auction proceeds of $47 million against an original investment of $53 million. The discount to the liquidation value of the shares was 8.5%.
- Banner Corporation, Walla Walla, WA (“Banner”)
- First Financial Holdings Inc., Charleston, SC (“First Financial”)
- MainSource Financial Group, Inc., Greensburg, IN (“MainSource”)
- Seacoast Banking Corporation of Florida, Stuart, FL (“Seacoast”)
- Wilshire Bancorp, Inc., Los Angeles, CA (“Wilshire”)
- WSFS Financial Corporation, Wilmington, DE (“WSFS”)
The link to each institution takes you to the preliminary prospectus on file with the SEC.
MainSource and Wilshire have both indicated that they have received regulatory approvals to submit one or more bids in the auction, while Banner, First Financial, Seacost and WSFS have each indicated that they do not intend to bid in their respective auctions.
On March 14, 2012, Treasury issued a press release announcing its intent to sell the preferred TARP CPP interests in six financial institutions on or about March 26, 2012. Specifically, the Treasury plans to sell its preferred stock positions in Walla Walla, Wash.-based Banner Corp., Charleston, S.C.-based First Financial Holdings Inc., Greensburg, Ind.-based MainSource Financial Group Inc., Stuart, Fla.-based Seacoast Banking Corp. of Florida, Los Angeles-based Wilshire Bancorp Inc. and Wilmington, Del.-based WSFS Financial Corp.
Consistent with prior discussions, Treasury is commencing activities to exit the federal government’s involvement in the TARP CPP program, with an initial focus on large investments in relatively healthy, public institutions. The Treasury’s results in this initial round of auctions is likely to influence policy and expectations going forward. If Treasury is only able to get 70 to 80 cents on the dollar in the auctions for these relatively healthy and public institutions, its appetite to engage in further sales could be severely limited (while the willingness/ability to settle individual TARP investments for a discount – either directly by Treasury or via a third party purchaser – may significantly increase).
The TARP investments selected by Treasury are each among the largest 50 TARP investments that currently remain outstanding, and represent approximately 2.5% of the currently outstanding TARP CPP investments. All six financial institutions selected by Treasury are presently current in their dividend payments (although Seacoast Financial had previously deferred its TARP dividends).
On March 12, 2012, Treasury released its February 2012 Dividends and Interest Report providing an updated look at the status of TARP CPP funds, including the first update following the February 2012 dividend due date under the terms of the TARP CPP investments. As of February 29, 2012, there were 163 TARP recipients that had missed at least one dividend payment (excluding any TARP recipients that have filed bankruptcy or who have been placed into receivership).
As a result of the missed dividends, Treasury has appointed a total of 13 directors to eight different institutions. In addition, the Treasury has appointed observers to an additional 39 institutions.
Although the Treasury has the right, under the terms of the TARP investments, to appoint two directors once a TARP recipient misses six dividend payments, Treasury has focused its efforts on the largest recipients. This likely partially reflects that it is not necessarily easy to identify qualified individuals who are willing to serve as directors of troubled financial institutions. Directors appointed by Treasury have the same rights and responsibilities as all other directors, and are not provided any additional legal or financial protection or benefit due to their appointment by Treasury. Treasury has only appointed one or more directors at institutions that have now missed at least nine quarterly dividend payments, and event amongst that group, have generally focused on the larger recipients, with a focus on those who are behind over $3 million in dividend payments. Based on the Treasury appointees that we’re aware of, the Treasury has identified highly qualified independent bank directors, that can act as a real benefit to the institution they’re being appointed to. As a general matter, they tend to be well-credentialed outside directors, frequently former bank executives that understand the condition of the bank. Technically, Treasury only has the right to appoint the directors at the holding company level, although we understand that Treasury has requested that they also be appointed to any subsidiary bank boards – and that most TARP recipients with appointed directors have done so, perhaps reflecting the quality of the appointed directors.
Over the last several months, we have become aware of a number of changes to various regulator’s frequently asked questions. These changes are frequently made without any public announcement, and, in some cases, without any notation that the FAQ’s have been modified at all. Frequently, banks are made only made aware of the change when they (a) aren’t aware of the initial FAQ, and (b) subsequently ask the question and are directed to the FAQ.
On November 1, 2011, the FDIC updated its Frequently Asked Questions regarding the “High-Rate Area” exception to the market rate caps for less than well-capitalized institutions. Previously, institutions relying on a “high-rate area” designation had to re-apply every calendar year to maintain the designation. However, late in 2011, the FDIC determined that institutions that had received a high-rate determination from the FDIC would no longer be required to submit an annual high-rate determination request. Instead, the high-rate area designation will automatically renew until and unless the FDIC notifies the institution that it is no longer operating in a high-rate area. In light of continued historically low interest rates, the current national rate caps have not proven to generally be difficult for banks to comply with, but this modification (if it isn’t changed again) could provide welcome relief if/when rates rise.
On February 16, 2011, the Treasury updated its Frequently Asked Questions regarding the Capital Purchase Program changes under the American Recovery and Reinvestment Act of 2009. Without acknowledging any change to the FAQ, Treasury reduced the minimum repurchase amount to the greater of (i) 5% of the issue price of the preferred and (ii) $100,000.00 in principal amount. Previously, Treasury required institutions seeking to repurchase their TARP investment to repurchase at least 25% of the principal investment.