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Nonbank mortgage providers like Rocket Mortgage could make the next recession worse, federal regulators warn.
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CNN
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US officials worry the next recession could be intensified by a cascading series of failures in the mortgage industry caused by crashing home prices, frozen financial markets and soaring delinquencies.
The US Financial Stability Oversight Council, a SWAT team of financial regulators formed after the 2008 crisis, sounded the alarm on Friday about an increasingly influential corner of the industry that has largely escaped scrutiny: nonbank mortgage companies.
Unlike traditional banks, nonbank mortgage companies like Rocket Mortgage are heavily exposed to swings in the mortgage market, depend on funding that can dry up during times of stress and don’t have stable deposits to rely on as a safety net. And, unlike banks, these companies are lightly regulated at the national level.
FSOC warned that these unique vulnerabilities risk a domino effect in a future crisis where multiple mortgage companies fail, borrowers are locked out of the mortgage market and the federal government is left holding the bag.
“Put simply, the vulnerabilities of nonbank mortgage companies can amplify shocks in the mortgage market and undermine financial stability,” Treasury Secretary Janet Yellen, who chairs FSOC, said in the report.
Federal regulators are calling for states and Congress to take action to address the risks posed here, including creating an industry-funded backstop to ease turmoil caused when a mortgage company goes under.
Despite the wonky term, nonbank mortgage companies have become vital players that make most home mortgages in the United States today. They include major brands such as Rocket Mortgage, PennyMac and Mr. Cooper.
As of 2022, nonbank mortgage companies originated about two-thirds of US mortgages and owned the servicing rights on 54% of mortgage balances, according to FSOC. That’s up significantly from 2008.
In fact, nonbank mortgage servicers hold the servicing rights on nearly $6.3 trillion in unpaid balances on agency-backed mortgages — representing 70% of the total.
Nonbank mortgage companies have “vulnerabilities” that could cause them to “amplify and transmit the effect of a shock to the mortgage market and broader financial system,” FSOC said.
For example, if home prices crash in a future crisis, mortgage companies could simultaneously lose money and face cash crunches that would make it hard for them to make required payments to investors on behalf of struggling borrowers, FSOC said. These challenges would be exacerbated by the relatively high amounts of debt these companies have.
This pressure on nonbank mortgage companies would then hurt borrowers seeking mortgages and could force the federal government to assume the obligations, according to regulators.
Yellen and her colleagues on Friday called for state regulators to enhance requirements and standards on nonbank mortgage companies, including requiring them to map out how they could be safely wound down in a crisis.
To address liquidity pressure during a time of stress, regulators called for Congress to consider legislation to provide new authorities to Ginnie Mae to expand an assistance backdrop program.
Additionally, regulators said Congress should consider establishing a fund — financed by nonbank mortgage companies — to “provide liquidity to nonbank mortgage servicers that are in bankruptcy or have reached the point of failure.”
In response, the Mortgage Bankers Association, an industry trade group, said it supports FSOC’s goals of a “safe, stable and sustainable financial services marketplace” but described some of the recommendations as “unnecessary.”
“Years of punitive regulatory capital treatment have already limited the willingness and ability of depository institutions to participate in the mortgage lending and servicing markets,” Bob Broeksmit, president and CEO of the MBA, said in a statement on Friday. “While we support national standards for capital and liquidity requirements, layering duplicative supervision requirements or supervisory entities onto a heavily regulated market will add significant cost and complexity.”
The ABA warned that managing these changes could reduce competition and raise borrowing costs.
Scott Olsen, executive director of Community Home Lenders of America, another trade group, said the FSOC report does not indicate significant taxpayer risk and only limited risk to the financial system as a whole.
“Given the current homeownership affordability challenges, CHLA hopes regulators do not overreact to this limited risk with regulations and fees that restrict mortgage access to credit,” Olsen said in a statement.
Even some regulators have concerns about the new FSOC plan.
Brandon Milhorn, president and CEO of the Conference of State Bank Supervisors, cautioned in a statement on Friday that the recommendation to establish a new liquidity fund is “premature at best.”
“Before considering any such proposal, Congress should require substantially more research and analysis regarding the potentially dramatic, unintended consequences of this recommendation,” Milhorn said. “I am concerned that this recommendation could negatively impact the nonbank mortgage market, particularly for low- and moderate-income borrowers, communities of color, first-time homebuyers, and veterans.”
However, Patricia McCoy, a professor at Boston College Law School, cautioned that nonbank mortgage companies’ reliance on short-term loans for financing “makes them vulnerable to collapse” if borrowing rates spike or lending dries up.
“Nonbank mortgage firms are thinly capitalized, which makes them vulnerable to failure if they lose financing or mortgage defaults spike,” said McCoy, a former mortgage regulator. “Starting in early 2007, we saw a tsunami of nonbank mortgage firms fail precisely for these reasons.”
