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Revisiting Regulations for Nonbank Mortgage Lenders

Federal Reserve Governor Michelle Bowman last week suggested revisiting the regulatory framework that defines how nonbank mortgage lenders operate.

Speaking via webcast to the 2020 Financial Stability Conference hosted by the Federal
Reserve Bank of Cleveland and the Office of Financial Research, Bowman noted that the U.S.
economy and financial services system came into the COVID-19 pandemic in a strong position,
although strains soon emerged regarding the residential mortgage market. While the Federal
Reserve sought to address the situation through its massive purchasing of agency-guaranteed
mortgage-backed securities, Bowman observed that the “crisis period has also revealed a number
of new—or, in some cases, renewed—vulnerabilities related to lending and loan servicing by
nonbank mortgage companies.”

Bowman pointed out that although nonbank lenders originate roughly half of all mortgages,
including more than 70% of loans securitized through Ginnie Mae and the government-sponsored enterprises, they are vulnerable when it comes to accessing liquidity. Unlike banks,
the nonbank lenders cannot tap into the Federal Home Loan Banks or the Federal Reserve
System for assistance, nor do they have the ability to use deposits as a funding source. Instead, she
noted, they rely on warehouse lines of credit that are usually offered by banks.

“During the last financial crisis, when the private-label mortgage securitization market started to
freeze, mortgage lenders could not transition their originations from the warehouse lines to
securitization,” she said. Warehouse lenders became concerned about their exposures to the
nonbank companies and cut off their access to credit. As a result of this funding crunch and other
factors, many lenders failed, including household names like New Century Financial
Corporation.”

While Bowman did not foresee the aftermath of the 2008 crash repeating itself, she expressed
concern about liquidity-tightening through mortgage servicing, which many nonbank lenders
handle in-house.

“If borrowers do not make their mortgage payments, mortgage servicers are required to advance
payments on the borrowers' behalf to investors, tax authorities, and insurers,” she said. “Although servicers are ultimately repaid most of these advances, they need to finance them in
the interim. The servicers' exposure is greatest for loans securitized through Ginnie Mae, as they
require servicers to advance payments for a longer period than the GSEs. In some cases,
servicers may also have to bear large credit losses or pay high costs out of pocket.

“Because mortgage companies are now the major servicers for Ginnie Mae, this liquidity risk—
and possibly solvency risk—is a significant vulnerability for these firms if borrowers stop
making their payments,” she added.

The collapse of these servicers could create a domino effect, Bowman continued, impacting the
lower-income areas and Black and Hispanic borrowers that rely heavily on these companies for
their mortgages. She forecasted the worst-case scenario where “if some large mortgage
companies fail and other firms do not step in to take their place, we could see adverse effects on
credit availability.”

Although Bowman admitted the liquidity concerns that regulators had regarding oversight of
nonbanks were raised before the pandemic, the severity of the crisis and the different situations
that nonbanks face compared to their banking counterparts is giving the issue additional
attention.

“I would also note one lesson we learned in March, which is that conditions in financial markets
can deteriorate very rapidly and unexpectedly,” she said. “I'm paying close attention to the issues
highlighted in my remarks today and keeping an open mind. But I think it's clear that doing the
hard thinking and planning now—at a time when conditions afford us the time do so—is a very
worthwhile investment. Our financial system and our mortgage market will be more resilient
when they welcome and appropriately manage the risks associated with both bank and nonbank
mortgage firms.”

About Author: Phil Hall

Phil Hall is a former United Nations-based reporter for Fairchild Broadcast News, the author of nine books, the host of the award-winning SoundCloud podcast "The Online Movie Show," co-host of the award-winning WAPJ-FM talk show "Nutmeg Chatter" and a writer with credits in The New York Times, New York Daily News, Hartford Courant, Wired, The Hill's Congress Blog and Profit Confidential. His real estate finance writing has been published in the ABA Banking Journal, Secondary Marketing Executive, Servicing Management, MortgageOrb, Progress in Lending, National Mortgage Professional, Mortgage Professional America, Canadian Mortgage Professional, Mortgage Professional News, Mortgage Broker News and HousingWire.
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