June 6, 2007 / 5:49 PM / in 12 years

Brokers, lenders head for standoff on subprime risk

NEW YORK (Reuters) - Mortgage brokers and lenders may be headed for a standoff. The housing slump, now in its second year, is testing alliances between the two, who have become more mutually dependent as the competition for borrowers has intensified.

One of many homes for sale in Perris, California, May 2, 2007. Mortgage brokers and lenders may be headed for a standoff. The housing slump, now in its second year, is testing alliances between the two, who have become more mutually dependent as the competition for borrowers has intensified. REUTERS/Mark Avery

A particular rub is the increase in bad loans returned to lenders for refund, putting many out of business and leading others to spread risk to brokers who thought themselves immune.

Lenders have been telling brokers to make good on contracts that previously had been ignored, or are refusing to soften contract language that had allowed brokers to wash their hands of responsibility after a loan is closed, brokers said.

About two-thirds of mortgages flow from brokers, according to research firm Wholesale Access.

Lenders in the past few years have increasingly used brokers to match them up with customers. Brokers typically have at least 10 lenders they go to for quotes for a potential borrower. When a loan closes, the broker earns a fee or a slice of the loan’s profit.

“I’ve seen cyclical swings before but I haven’t seen them (lenders) going after the brokers,” said Eric Weinstein, chief executive officer of Centreville, Virginia-based Carteret Mortgage Corp., one of the nation’s largest privately held brokers.

“Lenders make the decisions, I’m just selling what they have out there,” Weinstein said.

The broker says he’s been rejecting contracts offered by wholesale lenders that require he buy back loans with any inaccuracies or that go delinquent during the first year. In the past, brokers could agree to buy back loans only in cases of known fraud, he said.

Carteret is rejecting one in every two contracts today, compared with one in 20 a year ago, he said.

The change in the broker-lender relationship is the latest illustration of finger-pointing over who’s to blame for the subprime mortgage meltdown that has exacerbated the housing downturn and hurt the entire $10 trillion mortgage market. The heads of two main U.S. mortgage organizations — the Mortgage Bankers Association (MBA) and the National Association of Mortgage Brokers (NAMB) — have traded barbs on the issue.

John Robbins, chairman of the MBA, last month said “unethical” people — including “short-term folks” who care about the commission and not the loan — have given the industry a black eye.

NAMB President Harry Dinham later said Robbin’s comments were “truly unfortunate” and that the MBA was trying to shift blame away from banks and Wall Street, which buys loans and packages them into securities.

Lenders, forced by Wall Street investment banks in the past year to buy back billions of dollars in bad loans, claim they already had tough contracts with brokers.

The meteoric rise in loan repurchases due to poor underwriting and dormant housing markets has dented profit at lenders — including Countrywide Financial Corp. CFC.N and Washington Mutual Inc. (WM.N) — and has left them looking for ways to reduce liabilities going forward, analysts said.

“The problem is that all this is being forced down on them from Wall Street,” said Douglas L. Davies, a Seattle-based lawyer who represents lenders and brokers.

Some lenders have said they will police their relationships with brokers more closely. Others have taken the more draconian route of severing ties with brokers associated with bad loans.

Fremont General Corp’s FMT.N Fremont Investment & Loan subprime lender, in a massive housecleaning last year, cut off 8,000 brokers responsible for loans that later hastened the demise of the unit.

Chase Home Finance, the residential mortgage arm of JPMorgan Chase & Co. (JPM.N), has “become strict in negotiating any changes that brokers request to our standard contract,” Tom Kelly, a Chase spokesman, said in an e-mail.

Lender-broker contracts “weren’t particularly strict, nor enforced,” said Scott Everett, president of Supreme Lending, a mortgage broker in Dallas, Texas. But now he digs out those contracts frequently to fend off lender assertions of liability.

“Two years ago, I never even had (a loan buyback demand) and now I get them every week,” said Everett, a mortgage broker since 1993.

Lenders and brokers will eventually hammer out their difference and find common ground on contracts, analysts predicted.

The level of liability placed on brokers in the agreements will probably vary from lender to lender, and brokers must juggle the value of their relationships with new risks they must accept, analysts said.

One big lender has reduced the potential risks for brokers, Supreme’s Everett said.

EMC Mortgage Corp., owned by Wall Street mortgage titan Bear Stearns Cos. BSC.N has changed some broker contracts to require buybacks if a borrower fails to make payment within 30 days instead of 120 days, he said. This means brokers would be in the clear sooner.

With the incidence of buybacks from investors on the rise, lenders are becoming more litigious, said attorney Davies. He warned of “gridlock” in the mortgage market.

“As the players become embroiled in litigation, they stop doing business with one another and instead spend scarce resources trying to hash out the issues in court,” he wrote in the June issue of Scotsman Guide, a trade publication.

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