Mortgage market is now dominated by non-bank lenders

Most borrowers, whether they are purchasing property or refinancing their home, focus on their mortgage rate and loan terms rather than the type of lender they choose.

Yet the landscape of the lending market has shifted dramatically over the past few years from domination by big banks to a market where more loans are made by non-banks - financial institutions that only make loans and do not offer deposit accounts such as a savings account or checking account.

“For consumers, it doesn’t really matter whether you get your loan through a bank or a non-bank, although in some ways nonbanks are a little more nimble and can offer more loan products,” said Paul Noring, a managing director of the financial-risk-management practice of Navigant Consulting in Washington, D.C. “The impact is bigger on the housing market overall, because without the non-banks we would be even further behind where we should be in terms of the number of transactions.”

In 2011, 50 percent of all new mortgage money was loaned by the three biggest banks in the United States: JPMorgan Chase, Bank of America and Wells Fargo. But by September 2016, the share of loans by these three big banks dropped to 21 percent.

At the same time, six of the top 10 largest lenders by volume were non-banks, such as Quicken Loans, loanDepot and PHH Mortgage, compared with just two of the top 10 in 2011. --Before the financial crisis, mortgages were the last thing a consumer would default on, Noring said.

“That flipped in 2009, when people started defaulting on their mortgages first,” he said. “That was a tsunami for everyone in the mortgage business, and we’re still seeing the fallout. Lenders were not prepared to deal with it and didn’t do a great job, plus new rules were coming out that they needed to follow.”

The withdrawal of banks from the mortgage business is the result of the fundamental shift in regulations that took place in response to the housing crisis, said Meg Burns, managing director of the Collingwood Group, an adviser for financial services companies in D.C.

“The regulatory atmosphere changed from a risk-management regime to a zero-tolerance and 100-percent-compliance regime,” Burns said. “Not only were new regulations implemented, but new regulators like the Consumer Financial Protection Bureau were created. At the same time, the CFPB and other agencies became more assertive in their enforcement practices.”

Burns said that steppedup regulations from the CFPB include prescriptive rules that pinpoint exactly how lenders are to make loan decisions.

“The intent should be to broadly make sure borrowers can repay their loans and sustain homeownership instead of this narrow approach,” Burns said. “In the face of stiff penalties and aggressive scrutiny, banks were left with a tremendous uncertainty and risk that made it hard to keep lending.”

Jeffrey Taylor, managing partner of Digital Risk, a provider of mortgage-processing services and risk analytics in Maitland, Florida, said that while the postcrisis regulations were wellintentioned, the result was to make banks more cautious.

“Now banks only approve ‘perfect’ loans, not ‘goodenough’ loans,” Taylor said. “This created an opportunity for non-banks that focus entirely on mortgages and are less regulated than big banks.”

The cost of complying with new regulations and the risk of making mistakes drove many banks to reduce their mortgage business, said Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace in Irvine, California.

“Headline risk is another element of this, because if the media perceives you’re doing something incorrectly, it can really hurt your entire business,” he said.

In the initial aftermath of the housing crisis and the debacle of loan defaults, banks began to add their own overlays, which are loan-approval guidelines and fees that go beyond the requirements of Fannie Mae and Freddie Mac, said Susan Wachter, a professor of real estate and finance at the Wharton School at the University of Pennsylvania in Philadelphia.

Not only have banks reduced their mortgage loan volume, but the entire private market of investors in mortgages disappeared in 2007 and 2008 and, unlike other financial markets, has yet to come back, Wachter said.

“The aftermath of the crisis was lots of litigation and a decline in trust across the board,” Wachter said.

Banks were forced to pay fines and to take back loans that were considered flawed. At the same time, they were required to meet stress tests and have more capital on their books in case they have to handle more defaults, Wachter said.

“Non-banks don’t have to have capital, which could mean that taxpayers are more exposed than in 2009 if numerous defaults take place among loans made by non-banks,” Wachter said.

Noring said that nonbanks were more lightly regulated in the initial aftermath of the housing crisis, although in the past two years, regulators have stepped up their scrutiny of these lenders.

Non-banks are regulated in every state where they are licensed to provide loans, said David Norris, chief revenue officer for loanDepot in Foothill Ranch, California.

“Prior to the financial meltdown, loan-guarantee fees charged by Fannie Mae and Freddie Mac were substantially lower for banks compared to non-banks, but as part of the financial reform, those fees are now similar for all types of lenders,” Norris said. “Now banks and non-banks are competing on a level playing field, which encouraged more non-banks to increase their business.”