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May 5, 2016

Non-depository institutions, more specifically non-bank mortgage lenders, have gained considerable prominence since the 2008-09 financial crisis. In 2014 alone, non-bank organizations accounted for over 40 percent of total mortgage originations in dollar volume versus 12 percent in 2010.

It is significant to note that majority of the loans originated by non-bank lenders have been Federal Housing Administration (FHA) loans. In the absence of funding from banks and warehouse lenders, non-bank lenders, in turn, relied on Ginne Mae to fund their loans. As a result, non-bank originated securities issued by Ginne Mae grew from 20 percent in 2012 to 64 percent in 2014. In an interview with the National Mortgage News in May 2015, Ted Tozer, President of Ginnie Mae, expressed his excitement about non-depositories coming into the program, The housing market would be a lot worse off without them,” he said.

There were other reasons too, for the growing popularity and market share of non-bank lending institutions. After the financial crisis, banks became a little too cautious, and with the increased regulatory oversight of the Consumer Financial Protection Bureau (CFPB), many avoided thin credit borrowers and focused on the ones with better credit profiles. Also, non-bank lenders have shown technology innovation in the origination process, along with providing personalized services, making most consumers prefer them over regular banks. This has been a welcome relief for many distressed borrowers, especially because the bigger banks havent focused on this segment much.

Among the first to analyze this situation and signal a warning was John Stumpf, Chief Executive Officer of Wells Fargo & Co. In a May 2015 interview with Bloomberg News, he said that Non-bank lenders including hedge funds and peer-to-peer companies were driving competition for loans and could pose a hazard to the U.S. financial system. He further added that the situation would become a risky one if you had to stretch for loans to generate some revenue.

Researchers at the Harvard Kennedy School recommend greater regulatory reforms to lower the risk associated with non-bank lenders. Per their research conducted in June 2015 on a set of banks in the US, the average FICO score for an FHA-insured non-bank borrower stood at 667, and at 682 for banks. Unsurprisingly, the Cleveland Fed views this as subprime. However, many also say risks posed by today’s non-banks are different from those of the pre-crisis subprime-originating non-banks.

Analysts believe that some non-bank lenders have been engaging borrowers with low creditworthiness due to FHA policies, which have led to an increase in their risk profile relative to depository institutions. Therefore, in order to reduce the risk of originating risky mortgages, they insist on including residual income into FHAs decision-making process while evaluating consumer eligibility. Whether a mortgage is being insured or not, this inclusion holds, and is therefore similar to the mortgages insured by the Department of Veterans Affairs (VA).

There is also a growing concern among the non-bank lenders of a possible enforcement action by regulators, for non-compliance related to underwriting practices. These institutions will therefore need to act swiftly, use advanced statistical tools to identify potential risks, and perform risk assessment of loan applications and underwritten data of existing loan portfolios. Accordingly, they will need to take corrective measures to include policy, procedures, and process related changes to their current operating models. Likewise, it would be advisable for the FHA to take responsibility for curbing another subprime situation by tightening the lending policies for loans insured by these non-bank players, in a bid to ensure greater stability of the US financial market.

Minesh Mudaliar is a business architect with the Lending Advisory Group of TCS’ Banking, Financial Services and Insurance (BFSI) business unit. He has more than 16 years of experience in the lending space and was a retail banker before joining TCS. Having worked on various projects for North American banking players, Minesh has built a strong expertise in the lending domain. He works closely with various TCS banking relationships for thought leadership and domain-related support.


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