A warning siren has been sounded about the risk from the growth in market share of non-bank mortgage originators and servicers.
Around half of all mortgages opened in 2016 were originated by non-bank home lenders. The share was the highest it’s been since 2000.
On loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs, 75 percent were originated by non-banks.
The issue was discussed in Liquidity Crises in the Mortgage Market authored by three economists from the Federal Reserve Board and two professors from the University of California, Berkeley.
“The extremely high share of non-bank lenders in FHA and VA lending suggests that non-bank failures could be quite costly to the government, but this issue has received very little attention in the housing-reform debate,” the report states.
Non-bank mortgage companies are vulnerable to liquidity pressures in both originations and servicing as became evident during the financial crisis —
leading to the failure of many non-bank companies, requests for government assistance and harm to consumers.
Non-bank originators, most of which are not publicly traded, rely on warehouse lines of credit to fund new production. Lines are typically provided by commercial banks and investment banks.
But the problem with warehouse lines is that there are margin calls due to aging risk, there is roll-over risk, and there are
covenant violations that can lead to cancellation of the lines.
In addition, warehouse credit quickly dried up in the run-up to the financial crisis. For instance, in the fourth-quarter 2006 there were 90 warehouse lenders with roughly $200 billion in outstanding committed warehouse lines.
By the second-quarter 2008, however, there were just 40 warehouse lenders with less than $25 billion in committed lines. By the first-quarter 2009, the number of such lenders had fallen to 10.
“The collapse of the short-term funding structure of non-banks and some depositories such as Countrywide led to rapid losses in liquidity and lending activity,” the report said. “Origination volumes by the non-banks, which hovered around $800–900 billion a year from 2003 to 2006, plummeted to $280 billion in 2008.”
Another factor is the high refinance share among non-banks — making them more vulnerable to interest rate increases.
On the servicing side, advances are required by servicers
to continue making payments to mortgage-backed securities investors, tax authorities and insurers when borrowers miss payments. While servicers are eventually reimbursed for the advances, they still need to finance the advances in the interim.
The issue becomes more pronounced on Ginnie Mae loans because more types of payments need to be advanced for much longer than on government-sponsored enterprise loans.
Difficulty in obtaining private-market financing for servicing advances leads some servicers to pull the cash from current operations.
During times of turmoil, financing for servicing advances becomes even more difficult.
The report cited the example of Ocwen Financial Corp., which saw servicing advances go from a third of its assets in 2004 to 79 percent in 2011 and warned investors about the financial strain it was causing.
Mortgages originated by non-banks are generally considered to be of lower quality than bank-originated loans — leaving non-bank servicers more vulnerable to rises in delinquencies.
The report indicated that non-banks would be disproportionately impacted by changes in interest rates and house prices as warehouse lenders pull or reprice their lines and servicing advances rise due to defaults.
Another factor is the weaker balance sheets of non-banks.
While 70 percent of the average non-bank mortgage firm’s assets are mortgages held for sale, these resources wouldn’t be available to weather tough times.
“Although the monitoring of non-banks on the part of the GSEs, Ginnie Mae and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data and staff resources still seem somewhat lacking relative to the risks,” the report concluded. “Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual non-banks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business.”