Nonbanks and Mortgage Securitization

Abstract

This article reviews the dramatic growth of nonbank mortgage lending after the Global Financial Crisis, especially to borrowers with lower credit scores, and the related importance of mortgage-backed securitization. Our literature review suggests that the existing theoretical and empirical work on securitization is more relevant to bank than to nonbank lenders, thus leaving outstanding questions as to why nonbank market shares have increased to their current levels and how best to structure nonbank oversight. To highlight key differences in the mortgage-lending incentives of banks and nonbanks, we build a simple theoretical model of bank versus nonbank mortgage lending and use it to generate and test empirical hypotheses. We find, in particular, that loans issued by nonbanks are more likely to prepay early than loans issued by banks, the difference not explainable by nonbank borrowers prepaying more rationally. Using regulatory filings from nonbanks that are typically unavailable to academic researchers, we examine the balance sheets and liquidity and capital positions of large Ginnie Mae nonbank servicers, which face and pose more risk in the current mortgage system. We find that on average these servicers have reasonable liquidity and capital positions relative to standard regulatory thresholds, particularly in 2022:Q1 after a few quarters of elevated profits. However, some large Ginnie Mae servicers appear to have inadequate capital, as gauged by risk-based capital measures. If defaults rise on a large scale, the liquidity and capital positions of these servicers may amplify the disruption in the mortgage and housing markets. Expected final online publication date for the Annual Review of Financial Economics, Volume 13 is November 2022. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

Liquidity in the mortgage market: How does the COVID‐19 crisis compare with the global financial crisis?

“…By way of preview, by and large, these concerns did not come to pass, with some notable exceptions. In fact, mortgage companies were wildly profitable in 2020 and 2021 (Fuster et al, 2021), and their cash positions improved; at the typical mortgage company, the amount of cash on hand rose from 5 weeks of expenses in 2019 to 9 weeks in mid-2021 (Kim et al, 2021). Mortgage companies were so profitable because the Federal Reserve's cut in interest rates at the onset of the pandemic triggered an enormous refinancing wave.…”

“…In the academic literature, researchers are starting to document the structure and fragilities of the nonbank mortgage sector (E. Jiang, 2021; E. Jiang et al., 2020; Kim et al., 2018; Kim et al., 2021). However, much work remains to be done.…”

Mortgage-Backed Securities

“…The origination process begins with the borrower and originator agreeing on the terms (interest rate, contract type, and upfront payments including "points"). The loan originator could be a bank or a nonbank mortgage com-pany, with nonbanks accounting for about two-thirds of originations in recent years (see Buchak et al, 2018, Kim et al, 2018and Kim et al, 2022 for analysis of the growth of nonbank lending and its implications for systemic risk). The terms are guaranteed by the originator for a "lock period" of typically 30 to 90 days, during which time the borrower's application is evaluated and processed-in particular, to ensure that they fulfill agency guidelines.…”

“…As evidence on this point, Loutskina and Strahan (2009) show that bank liquid assets and deposit costs play much less of a role in the origination of conforming mortgages, which can easily be securitized, compared to less-liquid jumbo mortgages. Securitization is also fundamental to the rise of nonbank lenders (financed through wholesale funding) as the dominant origination channel in the US (Buchak et al, 2020;Gete and Reher, 2020;Kim et al, 2022). 29 Since securitization increases liquidity and broadens the set of lenders able to originate mortgages, one would naturally expect that it also leads to an outward shift in credit supply, plausibly increasing credit access for otherwise "marginal" borrowers.…”

“…We also highlight topics for future research. This paper can only scratch the surface of such a complex topic, however, and for other surveys and further information, we refer the reader to Hayre (2001), McConnell and Buser (2011), Green (2013), Davidson and Levin (2014), Fabozzi (2016) and Kim et al (2022).…”