The rise of nonbank mortgage lenders and servicers poses a risk to the stability of the U.S. economy, mainly because they are not adequately capitalized, according to the Financial Stability Oversight Council’s (FSOC) 2019 Annual Report.
Nonbanks have increased their share of residential mortgage origination and servicing markets over the last decade, with independent originators now covering about half the market.
Although these companies play “an important part in the extension of credit to certain key market segments, such as borrowers requiring Federal Housing Administration (FHA) insurance; in providing additional liquidity in the market for servicing rights; and in providing greater competition in the market for mortgage servicing,” they “could transmit risk to the financial system should they experience financial stress,” the report states.
It adds that although these companies may use different business models, they have “similar fragilities.”
“The council recommends that federal and state regulators continue to coordinate closely to collect data, identify risks, and strengthen oversight of nonbank companies involved in the origination and servicing of residential mortgages,” the report states. “Regulators and market participants have taken steps to address the potential risks stemming from nonbanks, including additional sharing of data and strengthening prudential requirements. The council encourages regulators to take additional steps to address the potential risks of nonbank mortgage companies.”
As the report points out, “most nonbanks rely heavily on short-term funding sources and generally have relatively limited resources to absorb financial shocks.”
Nonbank mortgage servicers pose a special kind of risk because they service a disproportionately high ratio of government-backed mortgages, including FHA loans, which tend to have higher default rates when the economy tanks.
“Nonbanks are heavily involved in servicing mortgages held in [government-sponsored enterprise (GSE)] and Ginnie Mae mortgage-backed securities,” the report states. “Servicers of these mortgages often have the obligation to make payments to investors even if the borrower does not make mortgage payments.
“If delinquency rates rise or nonbanks otherwise experience solvency or liquidity strains, their distress could transmit risk to the financial system,” the report adds. “Many nonbanks specialize in the origination and servicing of mortgages to low-income and higher-risk borrowers and those mortgages that are insured by the FHA. Widespread defaults or financial difficulties among nonbank mortgage companies could result in a decline in mortgage credit availability among these borrowers.”
Another risk is: What if numerous nonbank mortgage servicers all fail at once?
According to the report, the GSEs and Ginnie Mae “may have difficulty transferring servicing from failed nonbank servicers to healthy servicers if multiple large nonbank servicers simultaneously face distress – which may be a risk given the similarities in their business models – and if other firms are unwilling or unable to assume the servicing responsibilities.”
In a statement, Robert Broeksmit, CMB, president and CEO of the Mortgage Bankers Association (MBA), says “independent mortgage banks (IMBs) play a crucial role in the economy and in the lives of millions of Americans by responsibly providing mortgages to qualified borrowers, including low- and moderate-income, minority, and first-time homebuyers.”
“They also provide liquidity in the mortgage servicing rights (MSR) market and spur competition and innovation across the housing market, which ultimately helps borrowers,” Broeksmit says. “We appreciate that the FSOC report recognizes these important facts, and we believe it calls for policies that strengthen the sector and deepen overall market liquidity, not simply force market share away from IMBs.
“MBA has been working with federal and state regulators, Ginnie Mae, the GSEs, and other counterparties to ensure that IMBs operate within an oversight and counterparty framework that appropriately reflects any potential risks they may pose to the financial system,” Broeksmit adds. “We look forward to continuing that work. In the end, any proposed policy solutions must be thoughtful and measured to ensure that IMBs can continue to lend to the important market segments they currently serve.”