Regulators are preparing rules to curb financial risks of expanding nonbank mortgage companies after investigating homeowner complaints that include improper foreclosures and unauthorized fees.
Authorities are taking action after the three largest nonbank servicers, led by Ocwen Financial Corp., tripled in size since 2012. State regulators plan to issue recommendations for standards on liquidity, capital and corporate governance early next month. The Federal Housing Finance Agency will set risk management guidelines by Dec. 1 after its inspector general said the companies showed "warning signs" of financial weakness.
Regulators are seeking to ensure that Nationstar Mortgage Holdings Inc. and other nonbanks, which handle payments for about 15% of U.S. home loans, have the liquidity to withstand financial setbacks. In the event of a bankruptcy, borrowers face possible damage to their credit histories if payments are not recorded and bondholders might not receive their monthly advances, at least temporarily, said Michael Stevens, senior executive vice president of the Conference of State Bank Supervisors.
"The financial risk component becomes more critical as the nonbank servicer stake in the industry grows," said Roelof Slump, managing director at Fitch Ratings in New York. "They don't have the resources that a bank servicer has to fund and maintain ongoing business if they run into trouble."
Spokespeople for Ocwen, Nationstar and Walter Investment Management Corp., the third-largest nonbank servicer, declined to comment for this story.
"Though we anticipate minimal capital and liquidity requirements will be updated in the near term, we are not currently aware of any changes to these requirements that would affect our ability to remain compliant," Gary Tillett, chief financial officer of Tampa, Florida-based Walter Investment, said on a conference call last week.
The Consumer Financial Protection Bureau governs how the nonbank servicers interact with consumers, with no oversight of their balance sheets.
"While the CFPB and state regulators have some authority over these companies, many of them are not currently subject to prudential standards such as capital, liquidity, or risk management oversight," the Financial Stability Oversight Council, which was created by the Dodd-Frank Act, said in a report to Congress earlier this year.
Slump said nonbanks could have financial difficulties if the housing market sinks and borrowers fall behind on payments. Servicers are required to advance payments to bond investors every month even if homeowners are delinquent. And when mortgages default, the companies have to cover the costs of foreclosing and don't get paid until the property sells.
Investors in private-label securities, the mortgage bonds that aren't backed by Fannie Mae and Freddie Mac, face greater risks if a nonbank has a liquidity crisis. The firms handle about 74% of nonperforming loans in those securities, Slump said.
"The risk is elevated for portfolios that require high-touch servicing," he said. "We would expect that should a nonbank servicer have operational problems, there would be near-term cash-flow disruptions for those investors."
Nonbanks have about the same amount of liquidity as banks, using a measure that divides a company's liabilities by the cash on its books, according to data compiled by Bloomberg. Slump said the issue for nonbanks is that they don't have the same backstops as banks. They can't borrow from the Federal Reserve's discount window at near-zero financing rates to cover temporary shortages, he said.
State regulators are also examining how to assure an orderly wind-down of a nonbank facing bankruptcy, said Stevens of the conference of regulators. That would mean increasing standards for data and record keeping to make it easier for another servicer to pick up the accounts without disruption, he said.
"If a nonbank does run into trouble, we need to ensure that the servicing of the loans continues without interruption by either that entity or by transferring to another firm," Stevens said. "Another servicer is only going to take on that obligation if they can do it with the confidence the records they need are there."
Christopher Whalen, senior managing director of Kroll Bond Rating Agency in New York, said new liquidity rules are unnecessary. He said mortgage servicers don't require as much liquidity or capital as businesses such as banking.
"The liquidity needs of a servicer are relatively small — you need telephones, and people to make the calls, and an office," said Whalen. "Servicing by itself generates huge amounts of cash, which is why the concerns about capital to back the servicing part of the business are so absurd."
Fitch, Moody's Investors Service and Standard and Poor's rate the senior unsecured debt of the biggest nonbank servicers as non-investment grade, or junk. Standard & Poor's and Fitch have a B rating on Ocwen's debt and Moody's gives it a B3 with a warning it may be further downgraded.
Moody's also rates Lewisville, Texas-based Nationstar, the No. 2 nonbank servicer, and Walter Investment as non-investment grade.
The nonbanks have been rapidly expanding by buying mortgage servicing rights, or MSRs, from banks. They probably will buy the rights to collect payments on another $750 billion of mortgages in the next two to three years as banks prepare for new regulations that will make it more costly to own the assets, said Douglas Harter, an analyst at Credit Suisse AG. That will mean nonbanks will control almost one-quarter of American mortgages.
The inspector general for FHFA, which oversees Fannie Mae and Freddie Mac, said in a report in July that the nonbanks have relied too heavily on short-term financing to purchase MSRs. The bonds contain large amounts of troubled mortgages that won't generate cash flow until borrowers resume payments or the homes are sold in foreclosures, according to the report.
Since Fannie Mae and Freddie Mac back the loans, "such strains can increase credit risk," the report said. "In addition, poor or interrupted servicing — particularly for vulnerable homeowners with troubled mortgage loans — can risk the enterprises' reputation."
FHFA said in the report that it will issue risk management guidelines for nonbanks by Dec. 1. Corinne Russell, an FHFA spokeswoman, declined to comment for this story.
"If a nonbank servicer fails, of course it's going to be a headache, but that doesn't mean we need to start regulating them as if that failure is going to bring down the economy," said Hester Peirce, who was an attorney for the Senate Banking Committee and the Securities and Exchange Commission before becoming a research fellow at George Mason University. "Regulators bring with them their own limitations, and when they begin micro-managing an industry, it can make things worse."
Benjamin Lawsky, head of the New York Department of Financial Services, has been investigating Ocwen and Nationstar for issues including their handling of loan modifications. The nonbanks have said they are cooperating with Lawsky.
Shares of Atlanta-based Ocwen have plunged 59% from the beginning of the year to $23.02 yesterday. Nationstar has dropped about 26% and Walter Investment has fallen about 52%.
Lawsky probably will step down next year to take a job in the private sector, Bloomberg News reported on Tuesday, citing a person familiar with the matter.
Dan Burnstein, Lawsky's executive deputy superintendent, is a member of the task force formed last month by the conference of supervisors to develop financial standards for nonbanks. Each state will decide whether to enact the recommendations that will be contained in its December report.
"If we are going to have more of this business shift to the nonbanking side, we should make sure there is an appropriate regulatory framework in place," Stevens said.
