Federal Housing Finance Agency's Office of Inspector General (FHFA OIG) has
released an evaluation of Fannie Mae's and Freddie Mac's (the GSEs) increased
recent level of purchases of loans from small banks, credit unions, and
non-bank mortgage companies. Such
purchases, OIG said, presents both potential benefits and certain risks.
GSEs have purchased loans from large commercial banks and other financial
companies that acted as loan aggregators by purchasing mortgages originated by
smaller lenders and bundling them with their own loans for sale. The
aggregation system offered several benefits to participants:
- Aggregators received volume discounts on guarantee fees and
passed a portion on to smaller lenders.
- Aggregators usually acquired associated servicing rights for
the loans they purchased, gaining ongoing fee income and cross selling
opportunities to the borrowers they serviced.
- The aggregators provided an additional layer of review to
ensure loans met GSE underwriting standards.
- The GSEs did not have to track the financial condition and
loan compliance of hundreds of small lenders.
- Aggregators may have had more financial capacity to honor
GSE repurchase demands.
This system changed radically after
the housing crisis. Fannie Mae recently reported that only 5 of the top 20 mortgage
originators in 2006 are currently active in the mortgage
market, having failed or been
absorbed by other lenders. Moreover
aggregators have stopped purchasing mortgages originated by other lenders
while others have reduced their aggregation activities. In early 2011, the GSEs' top five sellers delivered between 65% and 70% of the mortgages
purchased by each
GSE. By the third quarter of 2013 these
purchase had dropped to less than half.
In response many credit unions,
thrifts, smaller banks, and nonbank mortgage companies have stepped up their direct
sales to the GSEs which have seen a steady increase in their number of their active mortgage seller counterparties. Between late 2007 and late
2013 this number grew by an average of about 30%
for the two GSEs. At Fannie Mae, the smallest sellers-those outside the top 50-gained the most market share, increasing from 8% to 22%, while it
was mid-tier sellers
at Freddie Mac which expanded market share from 24% to 43%.
Lenders can sell loans to the GSEs in one of two
ways. They can swap the loans for GSE mortgage
backed securities backed by the same loans then sell them to investors or they
can sell the mortgages to the GSEs for cash after which the GSEs securitizes
the mortgages and sell them to investors themselves. Either way the mortgages end-up
as part of a GSE
mortgage-backed security (MBS) and lenders obtain cash they can use to make additional loans, creating
liquidity for the housing finance market.
In exchange for a "the guarantee
fee," the GSEs guarantee that investors
will continue to receive
the timely payment of principal and interest on their MBS regardless of the credit performance of the underlying mortgages. The GSEs have established ongoing post-purchase
quality reviews to determine conformance with their underwriting standards and
may require lenders to repurchase mortgages that do not comply. Since the financial crisis the GSEs have
recovered nearly $100 billion through assertion of repurchase claims.
smaller lenders have sold their mortgages to the GSEs for cash because such sales
are less operationally challenging than MBS swaps so it is not surprising that the
market share of cash-window sales has increased significantly over the past few
years. Those sales grew to between 20% and
25% of each GSEs' total mortgage purchase volume by late 2013 with Fannie Mae's
cash window sales increasing at a faster rate than Freddie Mac's.
In conducting its evaluation, OIG identified
several reasons why the surviving aggregators may no longer serve as conduits
for small lender loans.
- A high
volume of repurchase requests from GSEs for legacy mortgages they purchased
between 2005 and 2008 has led large banks to reduce future exposure to loans
originated by other lenders and increase their scrutiny of mortgages they do
GSE guarantee fees have caused large banks to realize less compensation for
assuming the risks of representation and warranty liability from small lenders.
Because of new banking financial regulations that
require higher levels of capitalization large banks have prioritized their own
lending over purchasing from third parties.
Enterprise data also indicate
that sales from nonbank mortgage companies, i.e., those unaffiliated with commercial banks, represent a growing
percentage of their mortgage purchases. According
to Fannie Mae documents, 46.6% of its mortgages
were purchased from nonbank
mortgage companies in the first three quarters of 2013, which was up from 33.2% in 2011. Freddie
Mac data shows that its share of mortgage purchases from nonbank mortgage companies more than doubled from 8.4% to 20.5% over that same period, but its share remains significantly lower than Fannie
OIG concluded that the recent shift in
sales to smaller and nonbank lenders while reducing the GSEs' concentration risks,
a product of their financial exposure
to a few large commercial banks, may
have led to new risks and challenges.
Counterparty Credit Risks. This is a
risk that a counterparty will default on representation and warranty
obligations. The GSEs' traditional top
sellers, large commercial banks, are generally well capitalized and are
regulated by federal agencies to enforce these capital standards, and have financial
strength that allows them to fill their responsibilities. In contrast some smaller and nonbank lenders
have relatively limited financial capacity and the latter are not subject to
federal safety and soundness oversight. Consequently, the GSEs could incur financial
losses on mortgages purchased from such lenders
if they do not comply
with established underwriting guidelines. There are already questions
about the long-term viability of some of these counterparties as the refinance
boom winds down.
Risks. Some smaller lenders may lack the
sophisticated systems and expertise necessary
to manage high volumes of mortgage
sales to the GSEs.
This could result in potential quality
control and fraud management and regulatory compliance problems.
The change in the composition of
sellers may also increase the GSEs operational and costs. The increasing number of lenders will require
more resources to monitor financial strength and compliance and the informal
regulatory role formerly played by the aggregators has also disappeared from
the sales equation.
Elevated Reputational Risk. Buying loans from some nonbanks could damage
GSE reputations if, for example, they bought loans from a lender later revealed
to have harmed consumers through fraud or other misconduct or if several of the
entities failed as could occur under adverse market conditions.
OIG confirmed that since at least 2012
FHFA has been aware of the risks associated with the increased sales to the
GSEs by these smaller entities. The GSEs
have reportedly taken steps to mitigate these risks but due to other examination
priorities, FHFA has not specifically tested and validated them. FHFA indicates it plans to conduct several
examinations of GSE management of these counterparties in 2014 and is developing
guidance intended to strengthen the GSEs' management of risks associated with
them. OIG said it will continue to monitor FHFA's efforts to oversee this