December 23, 2014
Hon. Mel Watt
Director, Federal Housing Finance Agency
400 7th Street SW
Washington, DC 20024
Capital & Liquidity Requirements for Non-Bank Servicers
Dear Director Watt:
The Community Home Lenders Association (CHLA) writes to offer our comments regarding potential changes Fannie Mae and Freddie Mac (the “Enterprises”) may be considering to capital and liquidity requirements for servicers. We write in our capacity as the only national association exclusively representing non-bank mortgage lender/servicers.
We believe it is appropriate for the Enterprises to have sound requirements to protect against counter-party servicer risk. However, we also believe that any policy changes should take into account the importance to consumers of maintaining broad market participation of a wide range of servicers, in light of the risk that certain types of policy changes might accelerate trends towards servicer concentration.
We offer the following recommendations regarding GSE servicing capital and liquidity requirements.
1. Any changes to capital and liquidity requirements should focus on provisions that are based on MSR volume and concentration risk – instead of on increases in minimum capital standards, whose primary impact would be to reduce participation and thus reduce diversification among servicers.
2. Servicing capital requirements should reflect the lower financial risk to the Enterprises of failure of community-based lender/servicers than of large mega-servicers, whether bank or non-bank.
3. Servicing capital requirements should reflect the positive financial and performance characteristics of servicers that build their servicing portfolios organically, through servicing of loans they originate – and thus have a longer term and closer relationship with their borrowers, and do a better job of loss mitigation than the large mega-servicers, whether bank or non-bank.
4. Servicing requirements should be transparent and objective, and reflect real and historical counter-party servicer failure risk. Servicers should have adequate time to respond to changes.
We offer the following observations in support of these recommendations:
1. Base Requirements on MSR Volume and Concentration, Not Higher Minimum Capital
Raising minimum capital requirements is the wrong response to concerns the Enterprises may have about servicing counter-party risk. The likely result would be an exodus from servicing of a diversified pool of small and mid-sized community based lender/servicers. This would be bad for consumers, resulting in fewer loan sources. And it would facilitate a further concentration of servicing in a small number of mega-servicers. The result would be increased financial exposure of the Enterprises.
Instead, any changes that the Enterprises might make to servicing and liquidity capital standards should be volume based. Generally, the more loans a firms servicers, the greater the counter-party risk exposure, both with respect to repurchase obligations and advance obligations. In this respect, we would suggest that the model that GNMA has used, including recent changes it has made to address growing concerns about counter-party risk, is a good one that should be emulated
Finally, if there are concerns about highly concentrated firms – mega servicers, whether bank or non-bank, and particularly firms that are growing quickly through the purchase of MSRs – then we do believe it is appropriate to have capital and liquidity provisions that are specifically targeted to such mega-servicers.
2. Requirements Should Reflect Lower Risk of Diversified Participation of Community Lenders
The potential failure of a community-based non-bank lender/servicer represents a much lower financial risk than the failure of a very large non-bank (or bank) mortgage servicer, for a number of reasons.
First, the wide range of non-bank community-based lenders is diversified, both in numbers and geography. Thus, the failure of any one of these firms represents a much lower financial risk to the Enterprises than the failure of one large mega-servicer. The same is true for consumers. The disruption to borrowers is significantly lower with the failure of any one community-based lender/servicer than a single large servicer, simply because the number of consumers that are affected is much lower.
Secondly, community-based lenders – or any bank or lender that does more than just servicing – is more diversified with respect to both profitability and financial risk. Community-based lenders generate revenue not just from servicing, but also from loan origination – and correspondingly, their financial stability is less dependent on the value of MSRs than servicing-only firms. Lender/servicers also have greater protection against MSR runoff, since they can retain servicing of borrowers through refinances.
Finally, servicing growth has been more stable among community-based non-bank mortgage lenders than among mega servicers that have purchased large volumes of MSRs. While community non-bank lender/servicers have increased market shares in recent years as a result of many of the big banks exiting or curtailing their mortgage lending, such growth has been moderate and less volatile than with firms that have been purchasing large quantities of MSRs.
3. Consumers Benefit from Community-based Lenders Continuing to do Servicing
One of the clear advantages of the community mortgage lender/servicer model is that these lenders grow their servicing organically, i.e., they service loans to borrowers that they originated loans to and have had a relationship with beginning with the underwriting of that loan. There are many reasons why this is safer for the Enterprises, and should be reflected in development of servicing capital and liquidity standards.
Community-based lenders are closer to, and generally have a better, more personalized relationship with their borrowers than large mega-servicers, both bank and non-bank, and particularly compared to large servicers who have purchased large volumes of MSRs in recent years. This generally results in better loss mitigation performance among smaller community-based lender/servicers compared, for example, to the big banks, which have had to enter into settlements totaling tens of billions of dollars relating to their faulty servicing in the years following the 2008 housing crisis. In turn, this results in better loan performance and thus, reduced risk to the Enterprises.
Consumers also benefit from such participation. Community-based lender/servicers have incentives to do personalized servicing, because it affects their ability to get return origination clients and also to market to new borrowers. In contrast, large servicing-only firms are more focused on maximizing the value of their existing servicing rights, including for the purpose of selling them off to other servicers.
It is for all these reasons that excessive minimum capital standards driving community-based lenders out of the servicing business, would be counterproductive for both consumers and for the Enterprises.
4. Requirements Should be Transparent and Objective, and Reflect Real Risk
Servicing capital and liquidity requirements should be transparent and objective. Servicers, and other parties that do business with them, have a right to know what the requirements are to maintain servicing capabilities, including at different volume levels, and non-transparent factors that do not relate directly to risk should not be a consideration in a firm maintaining its servicing authority.
Moreover, notwithstanding growing concerns about counter-party servicing risk, the temptation to overreact to this concern should be resisted. Put simply, overall capital and liquidity standards should be proportional to the real, forward going risk of non-performance of servicers’ financial obligations, taking into account historical data.
In particular, any revisions to servicing capital and liquidity requirements should take into account the fact that this has not historically been a significant financial risk to the Enterprises. And they should take into account the respective financial risks of non-performance with respect to both repurchase obligations and responsibilities for advances. In particular, with regard to the latter, while the failure of an individual servicer to advance funds may result in the need for the Enterprises to advance funds, this does not generally reflect a risk of permanent loss, and requirements should reflect this.
Finally, regardless of the changes that the Enterprises may impose on capital and liquidity requirements, there should be an adequate time to adjust and comply with the new requirements. Historically, at least a year has been given to adjust to these types of changes, and we would support such a transitional period.
PROBLEMS WITH JULY FHFA IG REPORT ON NON-BANKS
Finally, as you know, in July, the Federal Housing Finance Agency (FHFA) Inspector General (IG) issued a report that highlighted the fact that non-bank servicers specializing in delinquent or defaulted loans now hold $1.4 billion in servicing rights, and referred to a $2 billion CFPB settlement with the largest non-bank mortgage servicer in the country. While the report focused on large specialty servicers, it also drew certain negative conclusions about non-bank servicers in general.
In response, the CHLA sent a letter (enclosed) to the FHFA that offered criticisms of the conclusions drawn in that report with respect to non-bank firms that are not specialty servicers. The letter pointed out that the IG Report failed to make the proper distinctions between the two types of non-bank servicers (those that service loans they originate and large specialty servicers). Our letter raised a number of substantive criticisms about the casual way in which the IG report made sweeping generalizations about non-bank mortgage lenders, specifically noting that:
* The IG Report offered no tangible evidence or numerical analysis of community-based non-bank lender counter-party risk
* The IG Report offered no real evidence of increased reputational risk from community-based non-bank lenders
* The IG Report ignored the extensive supervision of community-based non-bank lenders
Thank you for your consideration of this letter. We would be interested in discussing these issues in more detail with you and your staff.
COMMUNITY HOME LENDERS ASSOCIATION
Cc: Mr. Timothy J. Mayopolous, President and CEO, Fannie Mae
Mr. Donald H. Layton, President and CEO, Freddie Mac