Non-Depository Institutions Gaining Higher Share in Mortgage Market

A working paper titled, “What’s Behind the Non-Bank Mortgage Boom?” released by the Mossavar-Rahmani Center for Business and Government at Harvard's Kennedy School found that non-bank lending institutions have increased their market share of agency purchase mortgage originations from 27 percent in mid-2012 to 48 percent in late 2014. The study is authored by senior fellow, Marshall Lux, and research assistant, Robert Greene.

The study reviews the recent history of the U.S. mortgage market, making note of the how non-depository institutions, or non-banks are re-emerging in the residential mortgage market.

“Mortgages constitute a large, complex, and controversial market in the United States, shaped largely by federal policymaking,” the authors wrote. “Since 2010, the role of non-banks – a term commonly used to define firms unassociated with a depository institution – in the overall mortgage market has grown handedly.”

Last year, in terms of dollar volume, non-banks accounted for over 40 percent of total originations, compared to 12 percent in 2010, the report says. Of the 40 largest servicers, 16 were non-banks, making up 20.5 percent of the market and 28 percent of outstanding top-40 servicing balances, compared to 8 percent in 2010.

“Some policymakers have expressed a sense of growing alarm about non-banks’ increased participation in the mortgage market,” the authors noted. “Regulators have moved to regulate non-banks using bank-like rules to reduce counterparty risk; for example, the Federal Housing Finance Administration (FHFA)–tasked with ensuring the safety and soundness of the housing government sponsored enterprises(GSEs) – recently proposed minimum capital standards for non-bank mortgage originators and servicers, and in May 2015, the GSEs adopted these proposed standards.”

The authors found that both, regulatory and market factors are pushing the non-bank boom forward, and identify key distinctions between pre-crisis non-banks and non-banks now.

“Today’s non-banks are subject to much more regulation and supervision, more active in mortgage servicing than ever before, and are using technology to transform the mortgage market. Non-bank servicers have realized equally unprecedented and drastic growth. These surges have caused alarm with politicians and policymakers, and resulted in Fannie Mae and Freddie Mac changing non-bank standards on May 20th.”

The higher-risk profile of non-banks was also taken into consideration by the authors.  The Federal Housing Administration (FHA)-insured loans are a major factor in recent preference of non-banks. The median FICO score of an FHA-insured non-bank borrower is 667, compared to 682 for banks, and at several large non-bank originators it is below 660. Cleveland Fed research deemed this to be subprime, and found that 26 percent of recent FHA-insured loan originations were approved to borrowers that did not quite meet this mark.

“In the event of a housing market downturn, an excessive proliferation of risky FHA-insured loans to non-creditworthy borrowers could result in system-wide risk by bringing about higher rates of defaults that, in turn, could bring about counterparty risk,” Lux and Greene said. “This concern should draw the focus of policymakers.”

View the complete paper at: HKS.Harvard.edu