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How much capital does a independent mortgage bank need - Rayyes Finance and Market News
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How much capital does a independent mortgage bank need

Back in 2016, this writer authored a number of research papers and reports that examined the differences between depositories and finance companies in terms of the sources and uses of capital. This effort responded to a dangerous trend in the public policy debate on independent mortgage banks that focused on concepts and benchmarks more appropriate to commercial banks.

Finance companies, after all, are part of the private sector, while banks are government-sponsored entities that enjoy numerous public subsidies and the monopoly protection of the Federal Reserve Board over the U.S. payments system. If you are not an insured depository, then you are a customer of a bank.

Nonbanks are dependent upon banks for financing. This group includes all IMBs and, of note, Fannie Mae and Freddie Mac. The fundamental economic difference between banks and nonbanks colors the conversation that proceeds from the question: How much capital does a non-bank mortgage company need?

Banks hold capital as a source of strength, if for no other reason than to reduce the cost of resolution to the FDIC’s bank insurance fund. Banks have capital to absorb credit losses. Nonbank finance companies, on the other hand, have levels of working capital that are correlated to interest rate movements. The chart below from the Mortgage Bankers Association shows pre-tax production income divided by loan volume in basis points.

IMBs do not have the ability to absorb significant losses. Properly understood, IMBs are sales networks that often buy rather than make loans, then sell these loans to investors. IMBs enable an ecosystem of correspondents and wholesale brokers that have one purpose, to make loans and sell them into the secondary market as quickly as possible. Banks are about maintaining capital, but non-banks are about maximizing asset turns.

It’s no accident that commercial banks like Western Alliance Bancorp (NYSE:WAL), which acquired hyper-efficient aggregator AmeriHome, or American Express (NYSE:AXP), trade at a premium to other banks in the equity markets. Why? Because they have finance company DNA flowing through their veins. These banks maximize asset turnover and thus the use of capital, generating outsized equity returns.

Most commercial banks, on the other hand, are deliberately made dysfunctional via regulation to avoid risk and especially the risk of facing consumers directly. Commercial banks have fled direct exposure to the Federal Housing Administration, Veterans Affairs and U.S. Department of Agriculture markets in the past decade, but at the same time, they increased wholesale exposure to IMBs via warehouse and advance lines.

Bank credit lines to IMBs are fully secured by government-insured, conventional or private loans but isolate the bank from facing consumers, who are rightly viewed as being toxic in terms of reputation risk. Commercial lending is a better business for banks, a fact reinforced by prudential regulators since the 2008 financial crisis.

IMBs, for their part, are far more efficient than banks operationally and better able to service one-to-four family loans without running afoul of state or federal regulators. A decade since the 2008 crisis, the partnership between commercial banks and IMBs seems to be in balance. Banks provide financing to the wholesale mortgage finance business and IMBs make and service the loans. Indeed, IMBs often sell loans to commercial banks.

Over the past several years, first the Financial Stability Oversight Council, then the Federal Housing Finance Agency, then the Conference of State Bank Supervisors, have threatened IMBs with ill-informed capital rules designed for banks. These rules, including for the GSEs themselves, ignore the major economic and financial differences between a bank and a finance company.

Hint to all of the above agencies: If a regulation does not work economically, then it is probably not going to work as public policy either.

Most recently, Ginnie Mae has threatened IMBs…

Read More: How much capital does a independent mortgage bank need

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