A new report by the Financial Stability Oversight Council (FSOC) recommended state regulators and Congress take steps to minimize “significant liquidity risk” posed by the nonbank mortgage servicing industry.

The FSOC report, released Friday, noted that while the nonbank mortgage servicing industry has implemented innovations in technology and mortgage default servicing, the sector as a whole is vulnerable to liquidity risk in the event of a housing market downturn, which would affect many industry players at the same time.

Nonbanks currently originate roughly 65 percent of all mortgages and service more than 50 percent of outstanding mortgage balances, according to the Consumer Financial Protection Bureau. The top 10 nonbanks service almost $5 trillion in mortgages and originate trillions of dollars of mortgages annually, the agency’s director, Rohit Chopra, said in a statement.

The vulnerabilities of the industry described by the report could lead to significant losses for federal mortgage originators including the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae).

The report made three recommendations to lower the sector’s liquidity risk:

  • Increase collaboration between state regulators, states, and federal government. State regulators, which are the primary regulators of the industry, should require nonbank mortgage servicing companies to adopt recovery and resolution plans. The FSOC encouraged Congress to give the Federal Housing Finance Authority (FHFA) and Ginnie Mae the “authority to establish appropriate safety and soundness standards and to directly examine nonbank mortgage servicer counterparties for, and enforce compliance with, such standards.” The report encouraged more collaboration between the states, FHFA, and Ginnie Mae on liquidity risks.
  • Congress should authorize Ginnie Mae to expand the Pass-Through Assistance Program. The program acts as a liquidity backstop during periods of severe market stress. There are also steps Ginnie Mae can take without Congressional action to relieve liquidity issues for issuers, the report said.
  • Congress should establish a liquidity fund for the industry, financed by nonbank mortgage servicing companies. The fund would “provide liquidity to nonbank mortgage servicers that are in bankruptcy or have reached the point of failure” and help facilitate the continuation of servicing of affected mortgages, the FSOC said in an accompanying press release.

“If a nonbank mortgage company fails, it may be difficult for it to find funding to continue critical servicing operations, such as making required servicing advances or providing adequate loss mitigation for distressed borrowers,” Treasury Secretary Janet Yellen said in a statement. “Suspending services can in turn harm borrowers and other stakeholders. Even transferring the portfolio of a distressed servicer is a resource-intensive and time-consuming process, and disorderly servicing transfers can cause additional harm to borrowers. And if a new servicer cannot be found, the federal government may be left to assume the servicing obligations itself. All of these outcomes could disrupt economic activity and the provision of financial services.”

“Moving these recommendations forward is crucial to protecting borrowers and preventing disruptions to economic activity,” she added.

Adrienne Harris, superintendent of the New York State Department of Financial Services, said in a statement Congress could encourage collaboration between state and federal regulators by taking certain actions, like removing legal impediments to information sharing between Ginnie Mae and state regulators.

While she supported the FSOC’s recommendations, Harris expressed concern that recovery and resolution plans adopted by nonbank mortgage servicing companies must be kept practical and actionable, and that the establishment of a liquidity fund “raises complex operational and policy questions that warrant further development.”