In the years leading up to the 2008 financial crisis, mortgage lenders fueled the housing bubble by issuing loans to high-risk borrowers. But instead of funding the loans by tapping deposits, as banks had done for generations, many lenders borrowed against lines of credit — and then sold the mortgages to investors.
Then the crisis hit, and many lenders collapsed.
Now the housing market is strong again, and the successors to those eager financial institutions — known as non-bank lenders — have quickly become the largest source of mortgage lending in the country.
The growing dominance of these firms — including Quicken Loans, PennyMac and LoanDepot — is raising concerns among analysts, academic researchers and government officials about what could happen if the housing market collapses again.
Although observers say non-bank lenders today are probably not engaged in the sort of risky lending that dragged down their predecessors, the business model still makes them vulnerable to a housing market downturn. If they stumbled, many borrowers — particularly lower-income and minority borrowers who disproportionately rely on non-bank lenders — could find themselves locked out of homeownership, experts say.
And taxpayers could be on the line, too.
“We’ve never been in an environment where there were quite this many non-banks,” said Michael Bright, executive vice president and chief operating officer of Ginnie Mae, a government housing agency that buys and insures many of the loans issued by non-bank lenders. “So we need to take some additional measures, in my view, to prepare for an economic environment with either higher delinquencies or higher interest rates.”
Growing market share
More than half of all mortgages issued last year came from non-bank lenders, up from 9 percent in 2009 and higher than non-banks’ market share before the financial crisis, according to Inside Mortgage Finance, a publication that tracks the residential mortgage market. Six of the 10 largest mortgage lenders in the United States are non-banks.
Non-bank lenders are gaining market share in large part because traditional banks are scaling back their presence in the mortgage market. New consumer protections and more rigorous underwriting standards have made it more expensive to offer mortgages by adding paperwork and increasing the liability of lenders. Many banks are limiting loans to borrowers with nearly perfect credit or taking other steps to shrink their mortgage business. Some banks, including Capital One, are getting out of the residential mortgage market completely.
Enter non-bank lenders, which stand ready to make loans to people with less than perfect credit. Non-bank lenders are not subject to the same rigorous, and expensive, oversight that the Dodd-Frank act imposed on traditional banks in the aftermath of the housing crash. Scrutiny of most non-banks is further reduced by virtue of their being privately owned, and technology has helped level the playing field in mortgage lending.
In addition, non-bank lenders are helped by mortgage guarantees offered by federal agencies such as the Federal Housing Administration and the Department of Veterans Affairs, which promise to pay back investors if borrowers default. The guarantees not only reduce the risk to lenders, but also contribute to lower rates for borrowers.
The FHA’s congressional mandate is to make mortgage credit accessible to the middle class. Consumers buying a home with a loan backed by the FHA can provide down payments as low as 3.5 percent, much smaller than the 20 percent that is typically required for a conventional loan.
About 85 percent of FHA mortgages were originated by non-bank lenders in 2016, up from 57 percent in 2010, according to the agency. Non-bank lenders are serving many black and Latino borrowers, who tend to have less inherited wealth and are more likely to need a loan that requires a smaller down payment, according to a Brookings Institution paper this year about the rise of non-bank lenders.
Non-banks originated 53 percent of all mortgages in 2016, but 64 percent of the mortgages extended to black and Hispanic borrowers, according to the Brookings paper. Non-bank loans accounted for 58 percent of the mortgages made to borrowers with low-to-moderate incomes.
Instead of tapping customer deposits to make mortgage loans, non-banks fund loans using credit. Ultimately, they sell the mortgages to investors around the world, often retaining responsibility for collecting payment (and receiving fees for doing so) but no longer owning the mortgages or receiving interest income.
The model works well when the economy is strong and borrowers are making payments on time. But if a recession or a housing slump hits, things can go south quickly — as they did in the crisis.
The lines of credit non-bank lenders tap today could be revoked if the firms providing the credit become concerned about the lenders’ financial health. And without credit, many lenders could be forced out of business because they wouldn’t have enough capital to issue new mortgages or to meet other financial obligations, said Nancy E. Wallace, a finance and real estate professor at the University of California Berkeley and a co-author of the Brookings paper.
“If there is this shock, they’re much more likely to fail as firms because they’re much more exposed to the risks,” she said.
Broadly speaking, non-banks could operate for a little more than two months without receiving additional financing, according to the Mortgage Bankers Association, a trade group representing mortgage lenders. The MBA says that’s enough because most lenders have enough assets that they could obtain additional financing if needed.
“Non-banks are appropriately capitalized for the risks that they take,” said Mike Fratantoni, chief economist for the MBA.
Non-bank lenders are still particularly vulnerable to a rise in defaults because they tend to issue mortgages to people who have lower credit scores than do people who borrow from banks, according to the Brookings paper. And they could suffer if interest rates continue to go up, because that would reduce the demand for refinancing. Refinancing is a big part of the business done by some non-bank lenders, including some of the largest, and a decline in that activity could cause a significant loss in revenue for them, the Brookings report says.
A contraction in the lending market could leave people with fewer options if they want to buy a home or refinance, Wallace said. Some homeowners could be uncertain about where to send monthly mortgage payments if the company servicing the loan shuts down.
Non-bank lenders say they shouldn’t be criticized for extending loans to people who are being turned away by banks.
“Banks aren’t really making loans to low- to moderate-income families, so non-banks are doing it,” said Scott Olson, executive director of the Community Home Lenders Association, a trade group representing small and midsize non-bank lenders. “The criticism is that it’s only the non-banks that are making loans to the people that aren’t the wealthiest people, so what would happen if the non-banks went away? Those people wouldn’t be served. If we went away that wouldn’t be good.”
Taxpayer dollars at stake
Not only the companies and their borrowers are at risk. Taxpayers could also be on the line in a significant downturn.
Ginnie Mae buys mortgages from lenders and repackages them to sell to investors. The government-owned corporation guarantees that investors will receive principal and interest payments even if borrowers default.
The companies servicing the mortgages — often the lenders — are responsible for paying investors when borrowers fall behind. If the companies can’t keep up, Ginnie Mae must step in, which is why it is taking steps to ensure that most lenders are financially stable.
In recent years, the agency has been purchasing more and more loans from non-bank lenders: 76 percent of new loans guaranteed by Ginnie Mae last year were issued by non-bank lenders, up from 18 percent in 2009.
The agency now backs nearly $2 trillion in mortgages, three times the amount it guaranteed a decade ago. The growth presents challenges for Ginnie Mae, which has a dual mandate: making sure that home buyers can get loans and minimizing the costs to taxpayers.
“We would want to avoid an environment where many non-bank servicers were going out of business all at the same time,” Bright said.
Ultimately, taxpayers could be on the hook for some of the losses, especially in the rare scenario where Ginnie Mae would step in to prevent mortgage bond investors from taking a hit.
That is a situation Bright is looking to avoid.
Ginnie Mae is testing mortgage lenders to evaluate their ability to cope financially during tough times. Lenders that appear not to have enough cash to survive higher interest rates or a bump in defaults may be required to hold more capital, Bright said. Ginnie may also require large non-bank lenders to undergo credit ratings by third parties.
The changes could help Ginnie Mae assess the financial health of the non-bank lenders and help them prepare for a tough economic environment, Bright said. They could also help prevent the loan market from freezing up and locking out consumers who want to buy homes or refinance their mortgages.
Concerns about supervision
Some consumer groups are concerned that non-bank mortgage lenders are not receiving enough surveillance because they are privately held companies. They say the lenders, which are regulated at the state level, should be monitored more closely.
“They have much less oversight,” said Jaime Weisberg, senior campaign analyst for the Association for Neighborhood and Housing Development, an umbrella organization for 100 nonprofits serving low- and moderate-income residents of New York City. “They don’t have safety and soundness exams like banks do.”
But supporters of the non-bank industry say lenders are watched closely by the states they do business in and by federal regulators such as the Consumer Financial Protection Bureau. The agency has taken several enforcement actions against mortgage lenders.
Last year, for example, the CFPB sued Ocwen Financial Corp., a large non-bank loan servicer with a 19 percent delinquency rate, alleging “widespread errors, shortcuts, and runarounds” that “cost some borrowers money and others their homes.” Ocwen gave some consumers incorrect monthly statements, failed to process all payments correctly and illegally foreclosed on some owners, according to the agency.
Ocwen said that the claims were “unfounded” and that the suit was based on “isolated incidents” that the company had already addressed.
Consumer safeguards and higher underwriting standards put in place since the financial crisis have helped scale back the risk in the housing market. All mortgage lenders are required to take steps to ensure that borrowers can afford their loans, such as verifying income, assets and employment.
Mortgage companies are also required to work with consumers and give them more chances to stay in their homes and avoid foreclosure. Mortgage default rates are the lowest they’ve been in more than a decade.
Olson, the executive director of the trade group for many non-bank lenders, pointed out that FHA and VA loans, which account for a large share of non-bank lenders’ business, have strict underwriting standards. Lenders can also face steep financial penalties if they cut corners when evaluating a borrower’s ability to repay.
And Ginnie Mae will often cut a lender off if its default rate rises, and Ginnie will try to shift responsibility for servicing loans to another company when a lender fails, Olson said.
“There’s a whole raft of protections that exist on these government loans,” he said.
Clarification: This story has been updated to make clear why the Mortgage Bankers Association believes that nonbank lenders have enough capital to continue to operate when they are low on liquidity.