The Plight of Small Independent Mortgage Issuers

Following the financial crisis of 2008-10, nonbank mortgage companies have been very crucial in maintaining direct access to mortgage credit. According to the Brookings

Institute, nonbank lenders originated more than half of all mortgages in 2016, which is 20 percent more than the share of their originations in 2007.

Part of the reason for this growth is the fact that banks withdrew from giving mortgages to people with low credit scores following the Financial Crisis, but nonbank mortgage companies felt the need to take advantage of the technological innovations and trends in mortgage lending further-reaching even the people banks could not.

Even though this was a positive shift, reaching more people and helping them become homeowners, this growth poses risks to borrowers, the communitie, and even the government (both state and federal governments). Small nonbank mortgage issuers operate on the principle of short-term credit to finance their operations. This credit can become expensive and when the financial markets tighten up, this credit will definitely dry up. On the other hand, some non-bank lenders depend on mortgage refinancing, and in most cases, this revenue will diminish as the interest rate rises. In addition, what you will realize about the nonbank mortgage servicers is that they tend to service mortgages that have a higher rate of default which means, they are exposed to greater risk of loss should the prices of the housing decline. Nonbank mortgage servicers, mostly originating the mortgages insured by FHA or guaranteed by the Department of Veterans Affairs are prone to these issues.

The nonbank lenders were particularly hit harder by the 2008 financial crisis forcing so many out of business. In fact, at the time, the number of mortgage companies fell in half from 2006 to 2012 which means a drop of nearly 1,000 companies (both nonbank and independent issuers). The mortgage market today is somewhat stronger and more robust and suppose the events of 200810 were to happen again the nonbank sector, especially those originating mortgages insured or guaranteed by FHA or the VA would be very vulnerable, suffering a huge loss.

SO, LET’S FOCUS ON THE ‘WHAT-IF’ SCENARIO OF A 2008 CRISIS HAPPENING AGAIN TODAY.

First, today’s mortgage market is more robust and if a 2008-crisis were to happen agai, securitization activity would occur currently through the entities that have governmental support. Indeed, today underwriting guidelines have also improved thus improving the mortgage credit quality. But, the federal government, communities, and borrowers would also suffer huge losses. The government must keep its promise, and in the process of following through on its guarantees on the mortgages, it would incur some losses. Borrowers would suffer too and even though the mortgage servicing sector is in a better condition than it was more than a decade ago, the loss on the part of borrowers would mostly occur as a result of disorderly servicing transfer when a servicer fails. In addition, let’s not try to underrate the importance of nonbank lenders. In the event of a reduction in the nonbanks, it could result in reduced access to credit where financial institutions are not comfortable with extending mortgage credit at similar rates and terms and if this reduction was large enough, it definitely would have an impact on the home prices. The reduction in the home prices would be more felt in some communities than others.

I think the question should not be of whether the nonbank mortgage companies have the resources to help them withstand and overcome the shock, rather it should be if the regulators have the information and tools to spot the issues early on and resolve the problems effectively.

As such, it is best to understand the room in which these nonbank servicers operate. Most have fairly low amounts of ‘unencumbered’ assets or assets that are not currently used as collateral for a loan which means, supposing unexpected emergencies occur, they could tap into that resource. But still, unlike many financial institutions, non-bank lenders do not have access to the government institutions such as the Federal Reserve System or the Federal Home Loan Bank System which provide short-term credit to depository institutions with liquidity needs. Additionally, the regulatory framework for monitoring the nonbanks for safety and soundness is less developed compared to the framework governing the banks, and also, the data on the financial condition of the nonbanks is less standardized and not widely available.

In response to these ‘flaws’ in the nonbank sector, Ginne Mae unveiled a set of proposals meant to alleviate some of the liquidity strains faced by some of the nonbank mortgage companies. In a separate press release, the CSBS approved the new regulatory framework to enhance and alo align the states’ existing authority over the growing nonbank mortgage market. These proposals would ensure that there is enough publicly available information about the financial conditions of the large nonbank lenders. Additionally if well implemented, these steps would improve the resilience of the nonbank mortgage market reducing the risk to the government, communities, and borrowers.

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Sources

https://www.brookings.edu/blog/up-front/2018/09/10/mapping-the-boom-in-nonbank-mortgage-lending-and-understanding-the-risks/ https://www.csbs.org/policy/research-data-tools/nonbank-mortgage-servicer-prudential-standards