FHFA Inspector General counters: Here’s why nonbanks need prudent regulation

Nonbanks hold $1.4 trillion of $10 trillion market

Nonbank special servicers wield roughly $1.4 trillion in mortgage servicing rights out of a nearly $10 trillion market, yet with all that power, they have very miniscule regulations compared to their banking peers.

And to the Federal Housing Finance Agency Office of the Inspector General, this is a problem.

In the FHFA-OIG’slatest  review to the FHFA on actions to manage enterprise risks from nonbank servicers specializing in troubled mortgages, it said, “The Agency has not established a risk management process or overall oversight framework to handle some general risks posed by nonbank special servicers.”

These risks can be seen in two areas:

1. Nonbanks use short-term financing to buy servicing rights for troubled mortgage loans that will likely not pay off until difficulties resolve in the long-term.

“This practice can jeopardize the companies’ operations and also the Enterprises’ timely payment guarantees and reputation for loans they back,” the report said.

2. Infrastructures might not be able to handle the responsibility of servicing large volumes of mortgage loans.

For example, the report said, of the 30 largest mortgage servicers, those that were not banks held a 17% share of the mortgage servicing market at the end of 2013, up from 9% at the end of 2012, and 6% at the end of 2011.

“Specifically, the nonbank special servicers do not have the same capital requirements as a bank, which means they are more susceptible to economic downturns. Such downturns could substantially increase nonperforming loans that require servicer loss mitigation while at the same time impact the ability of the servicer to perform,” the report said.

But the FHFA-OIG is not without opposition.  

According to a recent white paper by the head of research at Kroll Bond Ratings Agency, Christopher Whalen, "Nonbank servicers do not require the same capital levels as a large bank lender.” (Note, the FHFA Inspector General report is not directly related to the Whalen piece.)

“We believe that imposing capital requirements similar to those applicable to insured depository institutions may not be appropriate given the existing capital levels and true risk profiles of these entities,” Whalen said. “After all, the original reason for prudential standards for banks was deposit insurance and the sense that IDIs could impose risks on tax-payers. Non-banks don’t have similar risk-taking opportunities or incentives.”

The FHFA does have some power in this situation though.

When Fannie Mae and Freddie Mac approve a transfer, they evaluate the servicer in various areas: servicing performance, capacity to service the amount, delinquency ratios, status of unresolved issues related to repurchase request and financial condition.

If the portfolio transfer exceeds 25,000 loans, the FHFA must approve the transferring the right to service the loan.

The FHFA-OIG's answer to the problem: establish a risk management process unique to nonbank special servicers to better oversee how the enterprises control inherent risks in transferring mortgage servicing rights and performing large scale servicing operations.

In addition, the FHFA should structure its oversight of nonbanks and the controls employed by the enterprises under a formal oversight framework.

“These actions are particularly important given the growth in use of nonbank special servicers and the more limited regulatory oversight of these servicers as compared to banks performing servicing functions,” the report said.

A recent example of this cited in the report is when New York State banking regulators stopped a servicer’s plan to buy 184,000 loans worth $39 billion from Wells Fargo (WFC) because they were concerned about the acquiring servicer’s aggressive growth rate.

Back in May, Ocwen Financial Services’ (OCN) $2.7 billion mortgage-servicing rights transaction with Wells Fargo was said to be on an indefinite hold by Ronald Faris, president and CEO of Ocwen, during the first-quarter earnings conference call. 

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