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Some lenders cutting riskier mortgages due to Wall Street pressure

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NEW YORK -- Some mortgage lenders are feeling the heat from Wall Street to tighten their lending standards and cut their exposure to riskier loans.

The force at work is the increasing demand from investment banks for lenders to buy back the loans due to borrowers' failure to make their first few payments on those loans.

Such "early payment defaults" so far have largely been limited to nonprime mortgages made to borrowers who pay higher rates than those qualifying for standard loans due to their weak credit or inadequate documentation.

Buybacks of defaulted loans demanded by whole-loan acquirers, particularly Wall Street firms, have in recent quarters led some lenders to incur losses and set aside more money in their reserve funds for potential loan repurchases in the future. An increase in those reserves then cut into their profits.

To shield themselves from future buybacks, some lenders including NetBank Inc. and Fremont General Corp. have backed away from offering loans that have seen greater delinquencies, such as those featuring higher loan amount relative to the property value and lower credit scores.

Some subprime lenders also have raised the bar for qualifying borrowers for loans requiring only limited paperwork and implemented more stringent procedures to fend off fraud, a common cause for early delinquencies.

Though some of the tightening measures might make it harder for some borrowers to swing a loan, they could prevent lenders from issuing loans they shouldn't make in the first place.

"You'll continue to see us change policies, products and processes to ensure that we achieve the correct returns for our shareholders and minimize repurchase activities," says Jerry McCoy, chief capital markets executive at NetBank. Due to a spike in the buybacks of loans previously sold to investors, the Atlanta bank added $13.2 million to its provision expense in the second quarter, which in turn ate into its mortgage gain-on-sale income.

At subprime lender Fremont General, the amount of home loans repurchased and re-priced reached $238.4 million in the second quarter, up from $67.7 million in the year-ago quarter and $107.7 million in the first quarter of this year. The Santa Monica company said it had cut back on "certain higher loan-to-value products and lower FICO" loans during the second quarter to reduce early payment defaults and thereby loan repurchases from investors.

In its fiscal year ended April 30, H&R Block Inc. (NYSE: HRB) increased its loss reserves $11.6 million above its normal loss accrual, also blaming loan buybacks triggered by early payment defaults. "The mortgage industry has seen an increase in early payment defaults over the past few months, and we have taken steps in reaction to our loss exposure," the Kansas City company said in its annual report.

A spokesman at the tax-preparation firm, which has been expanding into mortgage banking and other financial services, declined to comment on the specific steps it has taken to cut its loss exposure, citing the quiet period ahead of its earning release.

As a way to manage risk as well as to have more funds available for making mortgages, more lenders are opting to sell the new loans they create in the secondary market rather than keep them on their books. Buyers of those mortgages, such as Wall Street investment banks, pool and package the loans into mortgage-backed securities and then sell them to investors.

When inking those loan purchase deals, industry experts say, Wall Street buyers increasingly ask to retain the right to request the seller to take back the loans in event of an early default, which typically occurs within the first three months.

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