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As the shape of the mortgage industry shifts with a rising number of non-bank entities now selling loans directly to Fannie Mae and Freddie Mac, the supervisor for the GSEs' regulator continues to express concerns about potential risks in these transactions.
After releasing a similarly focused report at the start of the month, the Federal Housing Finance Agency Office of Inspector General (FHFA OIG) published a report last week detailing current trends in the GSEs' loan purchases and the office's concerns regarding potential risks.
Prior to the housing crisis, Fannie Mae and Freddie Mac purchased the majority of their mortgage loans from a few large financial institutions. However, since the crisis, the GSEs purchase from a much wider share of institutions, many of them smaller banks, credit unions, and thrifts.
This shift is the result of the changing face of the mortgage market as specialty servicers take on a greater role in the market and large financial institutions purchase fewer loans from third parties.
At the start of 2011, the GSEs made between 65 and 70 percent of their loan purchases from just five institutions, according to FHFA OIG. However, currently, the GSEs make less than half their purchases from these same institutions.
Furthermore, between 2007 and 2013, the list of institutions from which the GSEs purchased loans grew about 30 percent, according to FHFA OIG.
In the first three quarters of last year, the share of purchases from non-bank institutions at Fannie Mae and Freddie Mac were 46.6 percent and 20.5 percent, respectively. Among these non-bank entities, specialty servicers are a major contributor, with Nationstar Mortgage and Walter Investment Management Corporation as major players, according to FHFA OIG.
This diversification offers certain benefits as it "reduces the Enterprises' highly concentrated financial exposure to their largest counterparties," according to FHFA OIG. However, the supervising office also finds certain additional risks inherent in purchases from smaller, non-bank entities.
To start, non-bank lenders are not subject to the same rules and regulations as large financial institutions, and they may have less capital. "Smaller and non-bank lenders may have relatively limited financial capacity, and the latter are not subject to federal safety and soundness oversight," stated FHFA OIG.
These institutions "may lack the capacity to honor their representation and warranty commitments to the Enterprises," FHFA OIG stated.
A second source of potential risk lies in small institutions' operations, according to FHFA OIG, which said FHFA officials voiced concerns that "the increased pace of the specialty servicers' business could cause them to stretch their operational capacity or overrun their quality control procedures."
The last major concern FHFA OIG noted in its report is reputational risk, which could occur if institutions from which the GSEs purchase loans fail, commit fraud, or mistreat consumers.
The GSEs are working to mitigate these risks through heightened financial requirements, financial and operational reviews, and limiting their purchases from "sellers that may represent elevated risks."
FHFA did not test these methods' effectiveness last year but plans to do so this year, according to FHFA OIG, which plans to continue to monitor "this critical issue."
