FDIC Research Shows Effect of Regulation on Nonbank Mortgage Market

In recent years, nonbanks have made major inroads into sectors like the single-family mortgage market, where they now originate more than half of loans. Research published today by the FDIC shows that this shift was driven in part by regulatory trends as well as market responses to the financial crisis. While banks’ ownership of mortgages outstanding has held steady in the 20th percentile for decades, due to the role of GSEs, nonbanks surpassed banks in mortgage originations in 2016 and are approaching parity in market share for servicing.

Banks’ share of originations dropped sharply between 2012 and 2014, when a set of Dodd-Frank Act mortgage rules—including the Ability-to-Repay Rule—came into effect, and banks’ origination volume has not recovered beyond 2012 levels since. Banks’ servicing volume shrank as well, although not as sharply as for originations. The FDIC noted that Basel III standards tightened limits on mortgage servicing assets as capital and assigned them higher risk weights, adding that “economic incentives to avoid the regulatory capital deduction is likely one factor influencing the size and distribution of MSAs.”

The growth of nonbanks in mortgage lending may increase risk to the financial system and to taxpayers. Nonbanks are “vulnerable to liquidity and funding risks,” the FDIC said. They originate a majority of federally backed mortgages, either directly backed through the Federal Housing Administration, Department of Agriculture or Department of Veterans Affairs or indirectly through Ginnie Mae and the GSEs. “[I]f nonbanks have liquidity or solvency issues, nonbank servicers may not have cash on hand to fulfill advances to Ginnie Mae and GSE bondholders, particularly if delinquencies rise.” Moreover, many nonbanks have a refinancing model vulnerable to interest rate shifts, and their originate-to-sell model may erode underwriting quality, the research found.