Nonbank Loan Sales to GSEs Skyrocket, and So Do Risks: Watchdog

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Nonbank mortgage lenders pose greater risks to Fannie Mae and Freddie Mac because they have limited government oversight and generally weaker finances than banks, according to a government watchdog report.

Small lenders and nonbank mortgage firms often lack sophisticated systems or do not have the expertise to manage high volumes of mortgage sales. These problems increase the risk that the government-sponsored enterprises will suffer losses, according to the report due for release Thursday by the Federal Housing Finance Agency's Office of Inspector General.

The GSEs are purchasing more loans than they have in recent memory from small lenders and nonbank mortgage companies largely because large banks pulled back from selling to Fannie and Freddie after getting clobbered with repurchase requests.

Some nonbank lenders also have an elevated risk of what the inspector general called "reputational harm." One unidentified nonbank lender became a top 20 seller to one of the GSEs during the refinance boom of 2012 and 2013, even though this outfit had engaged in abusive lending practices, according to the report.

State regulators filed enforcement actions against the lender and the FHFA terminated the GSE's relationship last year after an on-site review found deficiencies in the company's processes for fraud prevention and quality control.

The shift in the mix of lenders selling loans to Fannie and Freddie is striking.

Last year, 47% of Fannie's mortgage purchases came from nonbank mortgage companies, up from 33% in 2011. Freddie purchased 20% of its loans last year from nonbank mortgage companies, up from 8% in 2011. From 2011 to 2013, the smallest mortgage lenders – those below the top 50 – increased their market share with Fannie Mae to 22% from just 8%. At Freddie Mac, midtier sellers saw the biggest gain during that same three year period, expanding their market share to 43% from 24%, the report found.

Small lenders and nonbank mortgage companies often rely on short-term funding sources, such as lines of credit from commercial banks that "may be threatened during periods of financial stress," the report found. These lenders typically are not as well-capitalized as commercial banks and are not subject to the same degree of federal regulatory oversight, the inspector general said.

Because of the increased risks, Fannie Mae has restricted the "notional" dollar value of monthly or annual loan sales from new and smaller sellers. Freddie Mac has established internal risk-based exposure limits for its counterparties, the inspector general said.

The inspector general found that FHFA examiners did not specifically test or validate controls over the risks associated with direct mortgage sales from small lenders and nonbank mortgage companies. Still, the FHFA plans to conduct several exams of these smaller nonbank lenders this year and also is developing guidance to strengthen counterparty risk management.

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