Broken mortgage servicing regulations limiting access to credit
Mortgage servicers perform all the processing work after a borrower takes out a mortgage, including remitting monthly mortgage payments, property taxes and insurance premiums, as well as working with delinquent borrowers. This last duty has created significant friction between consumer advocates and the servicing industry, with advocates concerned about protecting borrowers from abusive servicing, and servicers worried about the skyrocketing cost of servicing delinquent mortgages and an uncertain regulatory environment.
At a Housing Finance Policy Center (HFPC) seminar last week, a diverse panel of experts moderated by Faith Schwartz of CoreLogic discussed the current state of mortgage servicing and future trends. One key takeaway emerged: Mortgage servicing regulations have not yet fully caught up with the significant industry transformation over the past five years.
The rise of non-bank mortgage servicers. Large banks curtailed their servicing operations significantly in response to higher capital requirements post-crisis, prompting many smaller “non-bank” servicers to step in to fill that void. According to Michael Drayne, senior vice president at Ginnie Mae, the servicing industry, which was largely concentrated in a few large banks pre-crisis, is now scattered across a larger number of smaller players. For example, 82 percent of Ginnie Mae’s issuers in 2010 were depository institutions. However by 2014, this number had fallen to 49 percent as the non-bank share grew.
Non-bank servicers differ significantly from their bank counterparts. Because of their small size and limited balance sheet capacity, non-bank servicers also have very different financing and operating structures compared to bank servicers. As an example, non-banks tend to rely more on monetizing mortgage servicing rights (MSRs) to meet capital and liquidity requirements. In contrast, bank servicers – especially large banks, which have better credit ratings – might find it cheaper to issue debt instead. These factors require regulators to take a different approach towards non-bank regulation.
Safety and soundness regulation has made progress. This industry shift has necessitated a new round of regulatory changes to ensure safety and soundness of mortgage servicers and their counterparties. Greater reliance on MSRs – which are complex instruments to value, according to Stephen Fleming, senior vice president at Phoenix Capital – has forced regulators to pay more attention to non-bank servicer capital and liquidity requirements. Consequently, both Ginnie Mae and the Federal Housing Financing Agency (FHFA) – the regulator of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac – have issued new eligibility requirements for non-bank servicers that include minimum quantitative thresholds for net worth, capital and liquidity.
Too much regulation? Or too little? Alys Cohen, attorney at the National Consumer Law Center presented results of a recent survey highlighting the challenges delinquent borrowers face while working with servicers. These surveys showed high levels borrower burden with respect to documentation requirements and long delays in achieving loan modifications, as well as a general misalignment of incentives between servicers, borrowers and investors, suggesting the need for better oversight. On the other hand Jeffrey Naimon, partner at BuckleySandler LLP highlighted the new “rigidified” and overly prescriptive regulatory regime that penalizes servicers even for very minor errors. Higher cost of compliance ultimately results in higher costs for borrowers, according to Naimon.
Regulatory uncertainty and a broken servicer compensation model are partly responsible for tight credit. Presently this “higher cost” is manifesting itself in the form of overly tight access to credit. According to Laurie Goodman, director of HFPC, two factors – the excessively high cost of servicing non-performing mortgages and regulatory uncertainty regarding the treatment of delinquent borrowers – have made lenders extremely wary of making loans that have even a slight chance of defaulting. Other factors such as long foreclosure delays in judicial states, onerous and arcane foreclosure guidelines, and at times, contradictory servicing requirements across regulators have only compounded the access-to-credit problem further.
Indeed, mortgage servicing regulation – like any other regulation – is a balancing act. Improper foreclosures, the robo signing scandal and servicer settlements with government authorities are all proof that the borrower concerns highlighted by Cohen are real and persistent. However, a regulatory regime that is inconsistent, overly prescriptive and poorly targeted also creates uncertainty and drives lenders away from those market segments that are affected most by that uncertainty – in this case low-income and less creditworthy borrowers.
The government has attempted to ease credit availability recently by taking several meaningful steps such as lowering FHA insurance premiums, adjusting the guarantee-fees charged by the GSEs, and permitting the GSEs to finance loans with 97 percent loan-to-value ratio. Servicing may seem a less obvious constraint on credit availability but its effects are significant. It is high time regulators intensify their efforts to strike the right balance with respect to servicer regulation and servicing compensation.