Study Identifies Shift in Mortgage Market Away from Banks; Makes Case for FHA Reform and a Positive Role for Non-Banks in Mortgage Lending

CAMBRIDGE, Mass., June 1, 2015 /PRNewswire/ -- Non-bank lending institutions have increased their market share of agency purchase mortgage originations from 27 percent in mid-2012 to 48 percent in late 2014, according to a study released today by a senior fellow and a researcher at the Mossavar-Rahmani Center for Business and Government at Harvard's Kennedy School. The study analyzes the recent history of the U.S. mortgage market, focusing on the controversial re-emergence of firms unaffiliated with non-depository institutions—non-banks—in the residential mortgage market.

Non-bank servicers have realized equally unprecedented and drastic growth. These surges have caused alarm with politicians and policymakers, and resulted in Fannie Mae and Freddie Mac changing non-bank standards on May 20^th. In the study Marshall Lux, a Senior Fellow at Kennedy's Mossavar-Rahmani Center and a Senior Advisor at The Boston Consulting Group, and Robert Greene, a Research Assistant at the Center, also examine the higher-risk profile of non-banks, and find Federal Housing Administration (FHA)-insured loans are a major factor. The median FICO score of an FHA-insured non-bank borrower is 667, versus 682 for banks, and at several large non-bank originators it is below 660. Cleveland Fed research classifies this as subprime, and finds that 26 percent of recent FHA-insured loan originations were to borrowers beneath this threshold.

The study researched and analyzed data on the $9.8 trillion U.S. mortgage market and its risk profile. Lux and Greene identify several factors contributing to the non-bank boom in mortgage origination and servicing:

• Regulation of mortgages has been tightened and broadened and unlike the pre-crisis era, federal oversight now covers both banks and non-banks and state regulation has also been tightened.
• Non-bank technological innovation is improving customer experience and non-bank market share.
• Depository institutions have either retreated from the mortgage origination market, or grown more selective, as they've been hit with waves of new regulations and legal actions targeting them.
• Non-banks are disproportionately engaged in FHA-insured lending to higher-risk borrowers.
• Basel III and other regulatory actions have driven depository institutions out of mortgage servicing.

The authors stress the fact that non-banks are emerging to meet a market need and examine CFPB complaint data to conclude non-banks are improving the customer experience. Lux and Greene document non-bank originator and servicer innovations and emphasize that regulators should consider closely how non-banks have changed since before the crisis. To reduce the risks of today's non-banks, they urge regulators to monitor on two major sources of concern:

• Non-banks' reliance on FHA-insured loans is increasing their riskiness and recently lowered FHA insurance premiums may accelerate this trend.
• Some non-banks could pose a counterparty risk to Fannie Mae and Freddie Mac in the event of a downturn, but new bank-like Fannie Mae and Freddie Mac non-bank standards may hamper positive non-bank growth.

In order to ensure customers reap the benefits of non-bank innovation, and that risks are curbed, regulators must balance concerns over systemic stability, consumer protection, and market fairness. They urge policymakers to:

• Address the largest source of non-bank mortgage origination risk: inappropriately priced FHA insurance, which can be addressed through residual income testing and other reforms.
• Be wary when applying bank-like regulation to non-banks given their distinct structure, and that some new bank-like standards will be disproportionately burdensome to smaller market participants.
• Reform Fannie Mae and Freddie Mac; their poor fiscal condition causes, and recently lowered down payments intensifies, the risk that non-bank originators and servicers pose as counterparties.
• Apply OIRA-review to FHFA and other federal financial regulators to streamline regulatory approaches and mitigate unintended consequences – like Basel III capital rules driving banks out of mortgage servicing

The full paper can be downloaded at www.hks.harvard.edu/centers/mrcbg/publications/awp/awp42.

Marshall Lux is a veteran financial consultant. He is available for interviews on "What's Behind the Non-Bank Mortgage Boom?" Please contact him at [email protected].

About the Mossavar-Rahmani Center for Business and Government

The mission of the Mossavar-Rahmani Center for Business & Government is to advance the state of knowledge and policy analysis concerning some of society's most challenging problems at the interface of the public and private sectors. The scope of its work ranges from the local to the global. Drawing on the unparalleled intellectual resources of the Kennedy School and Harvard University, and bringing together thought leaders from both business and government, the Center conducts research, facilitates dialogue, and seeks answers that are at once intellectually rigorous and policy relevant. For more information, please visit www.hks.harvard.edu/centers/mrcbg.

SOURCE Mossavar-Rahmani Center for Business and Government

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