April 10, 2020
This has been an alarming thing to watch play out in real time. In the middle of a global pandemic, the administration and Congress passed sweeping legislation that could rock the foundation of the nation’s nonbank mortgage servicing for years to come. And while all of us “arm chair quarterbacks” will debate this event and how the government responded long into the future, what is clear about this crisis is that it is entirely different than the other two major downturns in this country.
The Great Depression was the result of weakness in Europe following WWII, bad tax policies from Smoot-Hawley that reduced revenues, and rampant and unregulated stock speculation. The Great Recession of 2008 was largely the result of excessive credit risk distributed globally from the U.S- housing sector and a demographic mix that dropped demand for owner occupied housing. Simply put, you can blame the Great Recession on the mortgage and real estate industry.
This recession, though, is no fault of the industry, lending or real estate. It is the fault of this virus. Yet when the government stepped in with their attempts to cushion the blow they transmitted an outrageous amount of risk into this sector, resulting in a deep credit contraction in mortgage lending and threatening the viability of many of the nation’s largest mortgage servicers.
Make no mistake about it, supporting families who cannot make their mortgage or rental payment for a short period of time until we can get back to work makes complete sense. But offering to anyone that option, even if they can make their mortgage payment, is a policy that is filled with moral hazard and one that simply dumped an unfathomable burden onto private industry.
What’s even more shocking is that when given the chance, the FHFA Director did just the opposite. He refused to create any facility to provide liquidity to the market and doubled down with public comments about the housing finance sector that worsened the impact significantly.
As said in several interviews, Calabria made clear that he was more than willing to let nonbanks fail and even suggested that consumers would be better off with a bank or mega servicer, something, by the way, that was proven incorrect in the wake of the Great Recession.
This nation and its policy makers, particularly Director Calabria, need to be honest about the realities of housing. Post-2008, it was the nonbank community that established specialty servicing companies to handle the “high touch” requirements of the thousands of Americans in trouble. They did this because many of the largest banks just could not keep up.
Post-recession, it was the nonbanks that continued lending in the FHA program, extending greater access to homeownership for first-time buyers and minority buyers than any of the larger banks. And to be clear, when you reflect on what failed during the last Great Recession, it was the big banks and Wall Street firms that stand out as failing, not the nonbanks.
But what is most alarming is the fact that Calabria would call out this critical sector amidst a crisis where Washington’s own solutions were the ones that threatened to impair this important segment that will be critically important to the post-corona recovery.
The result of his reckless comments and failure to back up the very plan he and others have implemented is that warehouse lenders, repo lenders, servicing buyers, investors, and more are now tightening overlays on these same companies solely because of his remarks and his shirking of responsibility to back up the very program Washington has put in place.
IMBs are key to this nation’s housing sector. What makes an IMB unique is that they only do mortgage lending. This structure proved itself invaluable to the housing market over the past decade when many banks, in the face of increased regulatory scrutiny, legal risk, cost and complexity, simply left the mortgage business altogether or reduced exposure by limiting product types and terms, tightening credit standards greater than investors required, or shutting down whole channels that were previously used for mortgage origination.
IMBs, on the other hand, did not. The result? While IMBs make up only about 15% of companies reporting annual data under HMDA requirements, they were the dominant force in lending overall.
But in the midst of this growth, some influential voices have cried foul. Some claim that they are taking on more risk than should be allowed by originating some loans with more flexible underwriting criteria than banks.
Others claim that they are less regulated and may pose greater risk to the U.S. financial system. They claim concerns about access to liquidity in the event of a credit “event.” The calls have come from the current FHFA Director, the former GNMA president and others.
But, are these cries of concern legitimate? Given the current state amidst the responses to the coronavirus, the question is important. My short answer is that while there is risk in any mortgage lending entity, most of the risks in the IMB sector have been created by this administration and could be solved through readily available platforms controlled by federal agencies.
But to be clear, the data shows that over this past decade, without the IMBs lending to underserved communities, opportunities for first-time homebuyers — especially minority first-time buyers — would have been significantly impaired.
Let’s start with some basic facts:
- From 2007 to 2012, more than 450 banks failed under the weight of the Great Recession.
These firms were taxpayer-backed through FDIC and in some cases required incentives from the federal government to their acquiring institution due to their size and risk profile.
I highlight this to emphasize one point: it’s difficult for most policy officials to name an IMB that failed during this same period other than perhaps one or two. To make matters worse, some of these banks were huge, requiring significant support from the government to help ease the transition burden, with names like Wachovia, WAMU, Indy Mac, Amtrust, and more topping the charts.
- As the Mortgage Bankers Association points out in their own IMB Fact Sheet, in 2018 over 80% of all FHA loans were done by IMBs and more than 65% of all VA and USDA loans as well.
And of critical importance, per HMDA data, in 2018 IMBs made 64% of all purchase loans to minority buyers, despite being only about 15% of total lending companies.
- Claims of not being well regulated, or under regulated, are simply not true.
While banks may be regulated by federal government agencies such as the OCC, the IMBs face a steady stream of prudential regulators at the state and federal level who parade through and camp out in their offices that include each state regulator where they are licensed, the CFPB, each investor with whom they do business, their warehouse lenders, servicing buyers, FHA, VA, USDA, and GNMA, and even some of the larger banks who purchase their correspondent business.
They are analyzed and scored for credit quality, liquidity, capital, compliance, operations, servicing, and more. Having worked in both business models, I often pined for federal pre-emption when I ran nonbank companies.
- The IMB business model is the only one where personnel are required by federal law to complete the testing requirements under the “SAFE” Act to ensure a well-trained and compliant employee. Banks are exempted from this requirement.
Without IMBs serving our communities, the picture of homeownership access in this country would look far more segregated, as IMBs have been the pivotal access point as proven by the data. Think about this: Between 2007-2018, 64% of all purchase loans for minority borrowers were done by the approximately 900 IMB companies, leaving 36% for the several thousand banks and credit unions who did the rest. The comparison should be a stark eye-opener for anyone who cares about access to homeownership.
As to concerns about systemic risk, as was proven in the recent Great Recession, the nation is far better served by distribution of institutional risk over hundreds of relatively smaller companies as the concern over too-big-to-fail, or SIFI risk, is drastically reduced.
Keep in mind, IMBs are generally not holders of risk. They do not retain credit or interest rate risk on their balance sheets. As the Mortgage Bankers Association pointed out in their research, the intermediary role of the “mortgage banking business model serves as an ‘importer’ of capital to local communities, moving investment dollars from the capital markets on Wall Street to make home mortgages available on Main Street.”
Many have put forth recommendations to address inflexibilities with GNMA servicing and make proposed changes. The MBA has made specific recommendations that would provide for greater support in providing liquidity to IMBs for them to continue making advances to bond holders on delinquent loans in the event of a liquidity crisis leveraging the FHLB system.
The bottom line? While risk certainly exists in mortgage banking, and institutional counterparty risk should always be looked at, the IMB is not unique to that risk.
In fact, banks that retain interest and credit risk on their balance sheets versus the pass-through model of the IMB who originates and sells all credit and interest rate risk, pose a vastly different systemic implication to the U.S. finance system. What has made this event such a high-risk scenario comes from the poorly thought out forbearance program, one that still does not even lay out how to make up those payments after the fact with the GSE loans.
The lack of taking responsibility for their own program only exacerbates the adverse impact. The reckless comments from the regulatory leadership at FHFA is tantamount to yelling fire in a crowded theater.
Certainly, risk should be carefully analyzed and it is the responsibility of political leadership to look for options to leverage resources in the event of a credit event, and many unique ideas have been put forth to date. It is somewhat outrageous, however, to shirk responsibility in a time of crisis. This has led to an even tighter credit market and will only delay the recovery of the economy as we all try to kick the gears of forward progress back into motion.