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Are Nonbanks Susceptible to Liquidity Vulnerabilities?

Nonbanks originated about half of all mortgages in 2016 and 75 percent of mortgages insured by the FHA or VA. However, a recent study by the Brookings Institution has found that nonbank mortgage lenders are vulnerable to liquidity pressures in loan origination and servicing.

Titled “Liquidity Crises in the Mortgage Market” the study looks at factors that drove growth in the nonbank lending and servicing space and the risks associated with it over the past few years. It found that the liquidity vulnerabilities of the short-term loans that fund nonbank mortgage origination in addition to liquidity pressures that are typical in mortgage servicing when defaults are high, pose a substantial risk within the housing market.

The study indicated that the nontraditional segment of the market increased to represent nearly half of all mortgage originations in 2016, an increase from the 20 percent recorded in 2007. Additionally, these nonbanks represented close to half of all mortgage originations sold to Government-Sponsored Enterprises (GSEs) in 2016 as well as 80 percent of all originations sold to Ginnie Mae as of December 2017 (a five percent increase from the previous year, according to the Urban Institute).

This risk has only increased in its potential effects on operators within the market due to the escalation of nonbank servicers over the years since the crisis, the study noted.  A collapse of the nonbank mortgage sector has the potential to result in substantial costs and harm to consumers and the U.S. government.

For consumers, the study found that the costs would come in the form of borrowers with low credit scores not being able to borrow from other financial institutions in case of a failure of nonbanks. “Nonbanks disproportionately serve borrowers with low credit scores, higher loan-to-value ratios, and higher debt-to-income ratios; they also disproportionately serve lower-income minority borrowers. If nonbank failure resulted in a reduction in mortgage origination capacity, it is not clear that other financial institutions would extend credit on the same terms to these borrowers or perhaps even extend credit at all.”

When it came to impact on the government, the study found that though the Ginnie Mae servicing model assumed nonbank servicers would have the resources to absorb a substantial share of credit losses before government assistance was mandated it was not clear this sector had the capability to absorb these losses. The history of the financial crisis suggests that the government will be pressured to backstop the sector in a time of stress, even if such a backstop is not part of the government’s mandate, the study said.

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