Nonbank Mortgage Lenders Bite Back

"Thinly capitalized." "Lightly regulated." "Risky."

Those words set off a firestorm among independent mortgage lenders that now dominate FHA lending and object to being characterized as inherently dodgier partners for the government – now the guarantor of most new mortgages – than large banks.

The ruckus started with an American Banker article Monday about a study that found nonbanks now do the lion's share of home-purchase lending backed by the Federal Housing Administration.

The nonbanks do not dispute the data showing that their share of FHA-backed home loans has climbed to 62.2% in February, while large banks' share has slipped to 29.6%. In 2012, those numbers were virtually the reverse. This is concerning to some observers, who fear that the nonbanks don't have deep enough pockets to indemnify the government for defaults on loans that aren't underwritten properly. Or as one finance professor quipped on Twitter:

@Frances_Coppola @AmerBanker @kateberry1 what could possibly go wrong...

— brian lucey (@brianmlucey) April 7, 2015

But independent lenders take issue with the American Enterprise Institute study suggesting that having less capital necessarily makes them riskier, or that the credit quality of loans they originate is worse than those made by large banks.

"Nonbanks are not some form of exception," said David Stevens, president and CEO of the Mortgage Bankers Association. "While they may be less capitalized compared to banks, their business model alone is not a problem."

Even the term "nonbank" sounds pejorative and dismissive, said Brian Hale, chief executive officer of Stearns Lending, the eleventh-largest mortgage lender in the U.S.

"I am regulated and examined by 50 state regulators, plus Washington, D.C., plus the Consumer Financial Protection Bureau," said Hale. "Name me a bank that has 52 regulators. This concept that we are under-regulated or thinly capitalized is simply false."

Mortgage bankers also are subject to audits by Ginnie Mae, Fannie Mae and Freddie Mac. Moreover, they are funded by banks through warehouse lines of credit that provide the capital to make loans, and those relationships entail further scrutiny and discipline.

"The banks are banking the nonbank segment and we have covenants requiring liquidity and profitability requirements that are far higher than regulatory requirements," said Hale. "What you really have is a re-democratization of the mortgage industry away from the Big Five banks who just a few years ago had a 75% share of the mortgage market."

Mortgage bankers were once a major force in lending up through the 1990s, when the five largest banks started picking up more market share. Now it is the large banks that have pulled back for a host of reasons including legacy loan issues, buyback requests, and regulatory requirements from Dodd-Frank to Basel III.

Julia Gordon, a senior director of housing and consumer finance at the Center for American Progress, said that nonbank lenders have stepped in to lend at a critical time when large banks have pulled back.

As far as the risk that to taxpayers, "as long as we have strong counterparty requirements that we enforce, this isn't something to wring our hands about, it's just something to work on," Gordon said.

Ginnie Mae has tightened its minimum net worth for lenders to $2.5 million plus 0.35% of outstanding single-family obligations. Ginnie issuers also have to have liquid assets of either $1 million or 0.10% of their outstanding single-family securities, whichever is greater. (Ginnie guarantees the timely payment of principal and interest on securities backed by loans that are ultimately guaranteed FHA and other government agencies.)

Ted Tozer, Ginnie's president, has made a point of praising nondepositories for providing access to credit when large banks pulled back. But Tozer also is closely watching how nonbanks handle operational risks and defaulted loans.

Glen Corso, executive director of the Community Mortgage Lenders of America, a trade group, said that mortgage banks often are family-run businesses owned by a single individual or a team of senior managers. As such, the risk to their personal net worth drives a more prudent approach to underwriting, he said.

"These owners have virtually all of their personal net worth and frequently their families' net worth tied up in the company," Corso said. "So their financial well-being, and their families', is on the line with every single major decision they make, including the underwriting guidelines they impose on the loans they originate."

He added, "You will recall that the largest mortgage lender failures in the financial crisis were largely banks or bank owned companies — Washington Mutual, IndyMac, Wachovia."

Lenders and housing policy observers also argue that risky lending is largely a thing of the past.

The Consumer Financial Protection Bureau's qualified mortgage rule eliminated risky features like balloon payments and negative amortization that led to millions of defaults during the financial crisis.

But the Department of Housing and Urban Development, which oversees the FHA, adopted its own QM standard that dropped the CFPB's maximum 43% debt-to-income ratio.

Independent mortgage lenders have quietly built the home purchase business after the downturn, and since FHA specializes in lending to first-time homebuyers, it makes sense that they have gained market share.

"If nonbankers stopped making FHA mortgages tomorrow, for 90 days housing in America would fall dead," Hale said.