The Office of the Inspector General (OIG) for the Federal Housing Finance Agency (FHFA) released a report Tuesday highlighting the risks associated with banks that have traditionally serviced mortgages backed by Fannie Mae or Freddie Mac selling the rights to service troubled mortgages to nonbank servicers that specialize in handling them.
According to the report, nonbank special servicers currently hold approximately $1.4 trillion in mortgage servicing rights out of the nearly $10 trillion market. However, these new servicers have less stringent regulatory and financial requirements than traditional banks.
OIG concluded that while FHFA, Fannie Mae, and Freddie Mac had each done a good job of responding to specific problems at nonbank servicers, the agency has not established a risk management process or overall oversight framework to handle general risks posed by nonbank special servicers by the very nature of their business model.
While not naming names, one such risk specifically cited by the report was the practice of using short term financing to purchase troubled mortgages that will require long term work to resolve their difficulties. The principal reason these mortgages are sold to the nonbank servicers is that they require extra time and money to cure the deficiency. The banks sell them in order to mitigate the loss that comes with servicing them. If short term financing is utilized to acquire the assets, the bill could come due before the profit from acquiring the mortgage is realized.
Another risk the report cites is the possibility that nonbank servicers are taking on a portfolio that is larger than their infrastructure is equipped to handle. The OIG notes that the rise in these nonbank servicers has been accompanied by a corresponding rise in consumer complaints, lawsuits, and other regulatory actions.
OIG recommended two specific actions for FHFA to take to mitigate the risk. First, the agency should issue guidance to Fannie Mae and Freddie Mac on the risk management process that should be employed to identify and mitigate risks related to nonperformance under Enterprise contracts with nonbank special servicers.
The other step that OIG recommended was for the agency to develop a comprehensive framework to mitigate the risks nonbank special servicers pose to the Enterprises including routine FHFA examinations, Enterprise reviews, and capacity testing before acquisition of servicing rights to ensure these servicers can continue to fulfill their servicing requirements.
To accomplish the recommendations, OIG pointed to the 2013 risk management guidance published by the Consumer Financial Protection Bureau and the Office of the Comptroller of Currency as a possible model.