CHLA Letter to FHFA Director Mel Watt Re: IG Report Conclusions – 7/23/14


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2101 Wilson Boulevard, Suite 610

Arlington, VA 22201

(571) 527-2601

 July 23, 2014
Hon. Mel Watt
Federal Housing Finance Agency
400 7th Street SW
Washington, DC  20024

 FHFA IG Report – Recent Trends in the Enterprises’

Purchases of Mortgages from Smaller Lenders and

Nonbank Mortgage Companies

Dear Director Watt:
The Community Home Lenders Association (CHLA) writes to respond to last week’s FHFA IG Report. We offer these comments in our capacity as the only national association exclusively representing nonbank mortgage bankers.
We agree with a number of conclusions in the report – including that there has been an increase in the level of Enterprise purchases from smaller, nonbank mortgage lenders in recent years, that there are financial diversification benefits from increased sales to smaller nonbank lenders, and that it is appropriate to address issues of Enterprise counterparty risk.
However, the IG Report seems to have started with a pre-conceived conclusion that it is riskier for the Enterprises to deal with smaller mortgage lenders than larger ones. And it provides no real evidence to back up this conclusion and ignores many factors that call it into question.  
 More importantly, any policies that the FHFA or the Enterprises might pursue that use these conclusions to impose increased barriers to small lender mortgage sales to  the Enterprises will result in increased mortgage market concentration by “Too-Big-to-Fail” TBTF institutions.  Such a result would mean reduced consumer access and affordability, including higher mortgage rates and costs and reduced access to credit for under-served and minority borrowers.  These impacts would likely occur with little or no evidence that they would result in a measurable reduction in risk.
 We appreciate that the Enterprises have a responsibility to manage their counterparty risk responsibly.  However, we believe that such policies should be directly related to specific risks associated with indemnification and advance responsibilities, and should not simply be used to reduce the role of smaller lenders.  Moreover, all policies in this area – including the level of G fees, required capital standards, and comparative policies regarding DU.LP waivers, indemnification liability, and the terms of seller-servicer agreements – should be  non-discriminatory as to lender size and volume and be fully transparent.
Following are specific responses to some of the points and conclusions made in the IG Report:
1. IG Report Ignores Massive Mortgage Failures of Large TBTF Institutions
The conservatorship of the Enterprises and the resulting taxpayer bailout was based overwhelmingly on the credit risk of loans they purchased, which were predominately originated by larger mortgage lenders, led by institutions such as Countrywide and WAMU.   The report seems to ignore this basic fact, focusing instead on counterparty risk of smaller nonbank lenders as an important source of concern.
The report seems to imply that it is safer to deal with FDIC-insured institutions. This ignores the basic fact that taxpayers are ultimately responsible for FDIC-insured institutions.  Moreover, it was the large banks that disproportionately used the $700 billion in TARP taxpayer bailout funds approved by Congress after the 2008 housing and economic crisis – a bailout that was largely necessitated by bad mortgage loans made by these very same large banks.  Focusing on counterparty risk of smaller lenders, while ignoring the significant risks of dealing with large TBTF banks and other institutions does not seem like a balanced approach.
      2. IG Report Ignores Negative Consumer Impact of  Market Concentration of TBTF Institutions
In seeming to argue for increased financial requirements for smaller nonbank lenders, the Report fails to take into account the profound impact of any policies that might impose unreasonable barriers to participation by smaller nonbank lenders in Enterprise purchases.  To some extent these smaller lenders have entered the market because some of the larger lenders have concluded they do not want to originate mortgage loans if they can’t meet their target rates of returns – a step that mortgage banking firms don’t take because that is what they do for a living.
However, if FHFA and the Enterprises pursue policies which discourage small lender participation, the result could be a highly concentrated market – dominated by a few TBTF banks and other firms.  This would inevitably lead to higher mortgage rates and costs – and would deprive consumers, particularly in rural and underserved areas, of access to mortgage credit and localized mortgage services.
      3. IG Report Offers No Real Evidence of Increased Reputational Risk from Smaller Lenders
One of the major conclusions in the summary of the Report is that “Some Nonbank lenders may present the Enterprises with an elevated risk of reputational risk.”  Yet the Report offers no real evidence of that, except for citing one lender sanctioned by state regulators for engaging in abusive lending practices.
Further, this conclusion seems to ignore the tremendous reputational risk that the Enterprises have already suffered as a result of dealing with large TBTF institutions.  The Justice Department has recently reached agreement on a number of multibillion settlements with large money center banks, alleging that the mortgage loans they created and originated were abusive, and those investors to whom they sold the MBS  were defrauded. It is hard to see how dealing with smaller, nonbank lenders can pose more of a reputational risk than this.
Moreover, the conclusion fails to recognize the contributions of smaller lenders to the recovery of the Enterprises’ reputation, by being locally accessible to borrowers during the depth of the housing crisis.  Smaller lenders have been more responsive to the needs of borrowers than larger lenders, and the settlements and payments made by the larger lenders for loans made leading up to the housing crisis reflect to a significant degree their failure to dedicate servicing resources to serving such borrowers.
The Report also fails to acknowledge that nonbanks are subject to SAFE Act requirements (a basic mortgage competency exam and pre-licensing and continuing education courses) – while depository institutions are not.  Available data indicates there are thousands of bank mortgage originators that failed (and never passed) the SAFE Act exam , and  suggests that if all bank mortgage originators were required to take the test today, tens of thousands  – and perhaps as many as 100,000, – bank mortgage originators might fail this test if required to take it today  The reputational risk of the Enterprises of  dealing with banks may be a greater risk, simply because the individuals that originate loans at the banks are not subject to these basic minimum training, competency, and independent background check requirements.
      4. IG Report Offers No Tangible Evidence or Numerical Analysis on Counterparty Risk
The Report chastises the Enterprises for their alleged failure to “test and validate the effectiveness of the controls put in place by the Enterprises to address the recent increase in mortgage sales from smaller and nonbank lenders.” 
Yet the Report appears to have concluded – without having any evidence of its own – that such controls are not sufficient.    Moreover, the Report offers no real evidence as to the extent of risk this poses to the Enterprises – eg., the likelihood of failures and the specific risk that such failures will exceed the capital that is required to protect such failures.  Instead, the Report seems to take it as a given that small lender counterparty risk levels are excessive.
5. IG Report Ignores  Broad Range of Recent Rules and Supervision of Smaller Nonbank lenders
The Report concludes that the Enterprises face increased risk from smaller nonbank lenders because they have “relatively limited financial capacity” and “are not subject to safety and soundness regulation.”  In fact, since the 2008 housing crisis, more controls have been put in place to address the quality and financial soundness of nonbank lenders than on any other market participants. These include:
(a) Net Worth Requirements and Other Financial Scrutiny.  Even the IG notes that the Enterprises have increased their regulatory scrutiny both through heightened net worth requirements and other controls.
(b) CFPB Supervision.  Through the creation of the CFPB, nonbank lenders are now subject to rigorous financial and other regulatory supervision, including being subject to examinations by this new federal agency.  This supervision is in addition to regulation by the states (and by FHA and VA for lenders that originate those agency loans).
(c) SAFE Act – As noted above, since adoption of this law in 2008, all non-bank mortgage  loan originators are subject to licensing and a background check by the states pursuant to the Federal SAFE Act , must complete 20 hours of pre-licensing courses and an exam prior to origination, and must complete 8 hours of continuing education each year.  Of course, banks are exempt from all of these licensing, exam, course and independent background check requirements.
(d) Dodd-Frank Mortgage Provisions.  A number of federal requirements, with monetary sanctions, have been put in place to ensure better loan quality and consumer protection – including limits on points and fees and an Ability to Repay requirement (QM), and other restrictions on mortgage practices.
The Report generally seems to ignore or give little consideration to these developments.
We thank you for consideration of this request.
Sincerely Yours,
cc: Timothy J. Mayopoulos
President and CEO, Fannie Mae
Donald H. Layton
CEO, Freddie Mac