Based on a recent report from the Financial Stability Oversight Council (FSOC), nonbank mortgage companies (NMCs) need to prepare for additional regulatory scrutiny from both state and federal regulators. In the report, FSOC identifies NMCs as critical participants in both the residential mortgage origination and servicing industries. And in recognition of this distinction, FSOC believes that “the exposure of the federal government and the mortgage market to the vulnerabilities of these companies has increased significantly.” As a result, FSOC provides a series of recommendations for state regulators, Congress, and other entities involved in the mortgage industry. Ultimately, these recommendations would result in an increased regulatory burden for NMCs. While there likely will not be an immediate change in the regulatory environment, it is important for NMCs to assess how these proposed changes might impact their business.
NMCs are crucial to the mortgage market. According the FSOC report, in 2022, NMCs “originated approximately two-thirds of mortgages in the United States and owned the servicing rights on 54 percent of mortgage balances.” However, NMCs did not always dominate the industry as they do today. Historically, banks played a more prominent role in mortgage originations and servicing. However, “after the 2007-09 financial crisis, banks pulled back from mortgage origination and servicing in part due to heightened regulation and sensitivity to the cost and uncertainty associated with delinquent mortgages.”
While acknowledging the importance of NMCs, the report also details several risks associated with the outsized reliance on NMCs. The report outlines the risks as follows: vulnerability to macroeconomic shocks, liquidity risks, leverage, operational risk, and interconnections. Further risks include vulnerability to market swings and less cash on hand to use at a moment’s notice. According to the report, these risks have the potential to be catastrophic. If an NMC fails, funding for servicing operations disappears, and borrowers are hurt. Not only is transferring a portfolio from a failed NMC difficult, but difficulties in transferring and the time it takes to complete the process could cause additional harm to borrowers. Further, if NMCs become sparse, the government could be tasked with filling the gap.
The FSOC report also outlines what it views as weaknesses in the current regulation of nonbank mortgage servicers, namely the lack of a federal prudential regulator. While the FSOC report acknowledges states as the “primary prudential regulators” of nonbank mortgage servicers, the FSOC report also states that:
No federal regulator has direct prudential authorities over nonbank mortgage servicers. While the CFPB has examination, enforcement, and rule-writing authority for federal consumer financial law applicable to the [nonbank mortgage servicers], the CFPB is not a comprehensive prudential regulator . . . Ginnie Mae also has no regulatory authority over [nonbank mortgage servicers] or other counterparties, but it can set eligibility requirements for entities participating in Ginnie Mae programs as part of its counterparty risk management.
As a result, the FSOC report identifies the disjointed nature of regulating non-bank mortgage servicers as an additional risk for nonbank mortgage servicers.
Based on the importance of NMCs and alleged current regulatory deficiencies, the FSOC report includes several recommendations that are broken down into three overarching categories:
- Promoting Safe and Sound Operations
- States, the Federal Housing Finance Agency (FHFA), and Ginnie Mae should consider actions to “increase capital and liquidity requirements, monitor sector-wide and institution-level risks, and stress test for potential adverse scenarios.”
- States should consider enhancing “prudential requirements as appropriate.”
- Congress should allow FHFA and Ginnie Mae “to establish appropriate safety and soundness standards and to directly examine nonbank mortgage servicer counterparties.”
- Congress should authorize Ginnie Mae and encourage state regulators “to share information with each other.”
- Addressing Liquidity Pressures in the Event of Stress
- Congress should provide Ginnie Mae the authority to expand its Pass-Through Assistance Program (PTAP) “to include real estate tax payments, insurance premiums, foreclosure costs, and maintenance advances.”
- “Federal agencies should further explore and evaluate how existing policy tools and authorities could be further leverage to reduce liquidity pressures from servicing advance obligations in times of stress.”
- Ensuring Continuity of Servicing Operations
- Congress should “establish a fund financed by the nonbank mortgage servicing sector to provide liquidity to nonbank mortgage servicers that are in bankruptcy or have reached the point of failure.”
Ironically, if enacted, these recommendations would appear to force NMCs into the same position as banks following the financial crisis. As a result, many NMCs will be faced with the same analysis – is it prudent to continue participating in the residential mortgage industry or to just become a bank?
In a recent statement by Director Rohit Chopra, the Consumer Financial Protection Bureau echoed the findings of the FSOC report and noted the “report is silent on what, if any, tools the FSOC itself should use to address these risks. That must be the next phase of our work.” The CFPB also advised that, “[i]n line with the 2023 Analytic Framework and Nonbank Designation Guidance, we should carefully consider whether any large nonbank mortgage companies meet the statutory threshold for enhanced supervision and regulation by the Federal Reserve Board.” And the bureau concluded that, for now, it “will do its part to improve the functioning of this market,” as a segue to mentioning its upcoming changes to the loss mitigation rules.
The FSOC report provides an in-depth analysis of the role of NMCs in the residential mortgage industry and a look at how regulatory changes might help mitigate the risks associated with these companies and benefit industry participants and consumers. However, the FSOC report does not appear to fully acknowledge the potentially negative impact its recommendations will have on NMCs or, ultimately, taxpayers. The Wall Street Journal’s article Janet Yellen’s New Too-Big-To-Fail Firms critiqued the report, noting that “[t]axpayers would be the ultimate guarantors, as they are for the giant banks and government-sponsored enterprises. FSOC’s recommendation would encourage moral hazard, and not only by financial institutions. Progressive regulators would be emboldened to attack mortgage companies since there would be fewer practical consequences if they drive them out of business.”
While these recommendations do not have an immediate direct impact on NMCs, the industry will be watching and assessing how increased regulatory requirements at the state and/or federal level will impact their business.