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» VISIT US ONLINE @ DSNEWS.COM GSES WORK WITH MORE THAN 300 'HIGH-RISK' COUNTERPARTIES: REPORT 300 sellers and/or servicers (counterparties) were placed in the high-risk category by Fannie Mae and Freddie Mac, according to a report from the Federal Housing Finance Agency Office of Inspector General (FHFA-OIG). In addition, the report stated the GSEs ended business relationships with more than 40 servicers/sellers on their high-risk watch lists since 2007. The counterparties placed in the "high-risk" category raised concern due to financial health. The report stated the GSEs estimate a loss As of the third quarter of 2011, more than of up to $6.1 billion from failures involving only four servicers and lenders since 2008, and the remaining risk exposure is approximately $7.2 billion. Before deciding whom to conduct business with, the GSEs assess the financial strength and operating capabilities of the lenders and servicers, such as minimum financial capacity standards, according to the FHFA-OIG report. Even with the precautions, the report pointed out there are always risks, such as worsening conditions due to changes in the market. In order to decrease risks when working MORTGAGE LENDERS' NEXT CRISIS: INSURERS' DENIALS OF REPURCHASE DEMANDS By David A. Shaneyfelt, Anderson Kill Wood & Bender, P.C. Mortgage lenders who survived the resi- dential mortgage meltdown must now brace for repurchase demands from third-party investors—and for the refusal of their liability insurers to defend and indemnify them against these demands. Mortgage lenders should pre- pare to protect themselves against such denials of coverage. Insurance companies often deny coverage any insured's actual or alleged obligation to repurchase a loan." One lender recently tried to avoid application of this exclusion, claiming it was "ambiguous." The court disagreed. Perhaps the better argument (not raised in for repurchase demands by invoking the com- mon exclusion for claims arising under contract. This argument should not fly. Repurchase de- mands typically accuse the mortgage lender not only of breaching the terms of the agreement, but also of having sold loans "negligently." The lender's negligence typically did not with a "high-risk" counterparty, the GSEs take certain corrective actions when they find certain deficiencies. One example the report gave involved an unnamed seller/servicer with an underperforming portfolio. The counterparty faced the risk of collapsing, and Fannie Mae responded by reducing its credit exposure to the counterparty and requiring additional collateral. The counterparty did not fail and continues to work the GSE. However, despite the number of risky counterparties identified, "FHFA has not required the Enterprises to prepare contingency plans to avoid or mitigate the consequences of counterparty deterioration or failure," the report stated. OIG made recommendations for FHFA to issue standards for comprehensive contingency plans. "At a minimum, these standards should include quantitative assessment, event management (e.g., curtailing business with or transferring business from a seller/servicer or specifying reasonable time frames for reducing risks), monitoring, and testing elements," OIG stated in the report. "arise from the contract" but arose during underwriting and origination of the loan—for example, failing to follow buyer eligibility guidelines or failing to do due diligence con- cerning property value, income history, credit worthiness, or employment background. These are acts of lender negligence that insurance typically protects against. An exclusion for restitution is more problematic. Insurance covers "loss" but not amounts one is required to give back. Insurers say repurchase demands fall in that category. Repurchase demands are not really de- that case) is the exclusion renders the policy's coverage illusory. An insurance policy cannot promise terms of coverage and then rob the policyholder of exactly the same coverage through an exclusion. However, some policies promise to cover a mortgage lender for negligence in "selling" residential loans and then purport to exclude from coverage all "repurchase demands." For mortgage lenders whose primary business is selling residential loans, such an exclusion may mean that, for its primary business interest, the lender has no coverage for its only meaningful liability exposure. When faced with a denial on these grounds, the lender should first check whether its policy has a repurchase exclusion. If so, it should dis- cuss with its broker whether and to what extent the policy delivers value. Second, the lender should scrutinize any mands for the return of the mortgage loan nor are they demands to rescind the deal. Instead, these demands specify the damages the buyer sustained because of the allegedly defective mortgage, which may well be more than the value of the original loan, given interest, penalties, resale discounts, and other costs and expenses incurred. In many cases the defective mortgage was repurchase demand carefully, distinguishing between "inquiries" and actual claims. "Claims" typically must be reported to the insurance company. If notice is delayed until the demand ripens into a lawsuit, the insurance company may argue that the "claim" arose before the policy period and is not covered. The lender should give the insurance com- already resold and there was no demand to "take it back." In short, a repurchase demand is often not a demand to rescind the deal but a detailed assessment of the losses the third-party incurred because of the loan sale. In that case, the repurchase demand seeks legal damages that, all else being equal, fall squarely within an insurer's coverage obligations. Also potentially troublesome is an exclusion in some mortgage lenders' policies specifically for repurchase demands: "Any claim arising out of or resulting, directly or indirectly, from pany as much information as it can regarding the demand, not only whether and to what extent employee negligence occurred in the initial procurement of the loan, but also the specific items of damage claimed and how and why they are not restitutionary amounts. Above all, the lender should not raise any white flag if its insurance company claims that none of these repurchase demands are covered. Usually, the lender will have much to argue about and plenty of room for negotiation and settlement. David A. Shaneyfelt is a shareholder with Anderson Kill Wood & Bender, P.C., where he represents policyholders in claims against insurance companies. 25

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