A nonbank mortgage servicer that took on more loans than it could handle ended up delaying payments to Fannie Mae and Freddie Mac, according to a government watchdog report.

The servicer, which the report does not identify by name, used short-term financing to acquire a large portfolio of delinquent loans backed by one or both of the government-sponsored enterprises. This company lacked the infrastructure to handle so many loans, leading to consumer complaints and the payment delays, and limited credit availability threatened the servicer's ability to fund its operations.

The example is indicative of broader problems in mortgage servicing, according to the report due for release Tuesday by the Federal Housing Finance Agency's Office of Inspector General.

Borrowers whose loans are backed by Fannie or Freddie "may not have their loans properly serviced" by nonbanks, says Russell Rau, a deputy inspector general for audits who wrote the 17-page report. Rau recommends that FHFA develop a formal framework that would include routine exams, reviews and testing to ensure nonbank servicers can meet current servicing requirements.

Since last year, regulators have ratcheted up their scrutiny of nonbank mortgage servicers after receiving thousands of complaints from borrowers for mishandled foreclosures, denied loan modifications and overcharging on fees. Benjamin Lawsky, the Superintendent of New York's Department of Financial Services, has launched separate investigations into two nonbank servicers, Ocwen Financial (OCN) and Nationstar Mortgage (NSM).

The FHFA inspector general's report describes the massive growth since 2008 of nonbank servicers, which it says are not subject to the same capital requirements as banks. The FHFA, Fannie and Freddie have been supportive of banks selling mortgage servicing rights to nonbanks largely to help struggling homeowners and to limit the GSEs' own losses.

Despite receiving more scrutiny, some nonbank servicers do not have the infrastructure to properly service all of the loans they have acquired, the report found. Fannie and Freddie have been aware of operational problems and have sent teams to specific servicers only to find weak infrastructure and lax handling of borrower complaints.

"This rise in nonbank special servicers has been accompanied by consumer complaints, lawsuits, and other regulatory actions as the servicers' workload outstrips their processing capacity," the report found.

The numbers tell the story.

Banks and thrifts now hold just $40 billion in mortgage servicing rights, down from $84 billion in mid-2008, the inspector general's report found. Overall nonbank servicers currently hold $1.4 trillion of the nearly $10 trillion market in mortgage servicing rights. Nine of the top 20 servicers for Fannie Mae loans and seven for Freddie Mac are nonbanks.

Because nonbank mortgage servicers are not subject to the same capital requirements as banks, they may be more vulnerable to economic downturns. One unnamed nonbank servicer failed to maintain Fannie's minimum capital requirements, a major risk to the GSE and a breach of contract. It is not clear if this is the same servicer that delayed payments, and the report does not say when the incident (or incidents) occurred.

The FHFA agreed with most of the report's recommendations. It plans to issue guidance by Dec. 1 on how to better manage counterparty risks associated with troubled loans, including those serviced by nonbanks.

Because Fannie and Freddie are responsible for developing their own policies and procedures to mitigate counterparty risks, the FHFA did not agree to create its own supervisory framework for nonbank servicers. On June 11, the FHFA issued an advisory bulletin describing its supervisory expectations for the transfer of mortgage servicing rights. It also will conduct exams and ongoing monitoring of nonbank servicers by April 30 of next year.

In February, Lawsky halted the transfer of $2.7 billion in mortgage servicing rights from Wells Fargo (WFC) to Ocwen.

Ocwen Financial agreed in December to a $2 billion settlement with the Consumer Financial Protection Bureau, though it paid only a fraction of that amount.

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