By, Robert J. Moss
While buying a home may not be top of mind for most of our Gen-Z audience, let alone how to finance one, it’s worth discussing the dramatic shift in who funds America’s mortgages. Since the Subprime Mortgage Crisis, thousands of nonbanks have stolen market share from the large banks who used to dominate the US mortgage industry.
These large banks include: Wells Fargo, JP Morgan Chase, Bank of America, and Citibank. Each can be classified as a depository institution. They use their national network of bank branches to accept deposits from clients and fund loans with these deposits. Origination is industry jargon for creating a mortgage. In 2008, large banks controlled 50.0% of US origination market share.
Since then, their dominance has waned. A report by the Mortgage Banker’s Association shows non-depository institutions (nonbanks) have eroded the market share of large banks, essentially inverting the market share held by both groups in 2008.
Who are nonbanks? Well, they’re mostly small, privately owned businesses; the largest public one being Quicken Loans. Nonbanks do not accept deposits and usually rely on 4.0-5.0% of their own equity and warehouse lines of credit to fund mortgages. A warehouse line of credit is a short-term credit facility from a commercial or investment bank. Think of credit facilities like a credit card, companies can draw down a certain amount to a pre-approved limit, except there is no grace period and they pay interest on all of the money they draw on. Plus, there is usually a lot of covenants (rules) around the warehouse line of credit. Nonbanks follow an originate-to-distribute model. Since, they are funding the mortgage with short-term credit, they usually try to sell them quickly to get the loan off their balance sheet.
Government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac are usually the buyers of such loans. Once the GSE owns the loan, they package them into mortgage backed securities (MBSs). If you paid attention to the Big Short, you will know MBSs are bonds comprised of mortgages that make monthly payments. The GSEs then sell the MBSs to investors or keep them in their own portfolio.
Many attribute the rise of nonbanks to the increasing regulations on banks since the Subprime Mortgage Crisis. Banks use to have a competitive advantage through their balance sheet. They could make loans for cheaper than nonbanks due to their deposits. Now banks have to hold a higher amount of equity for each loan they make which constrains their balance sheet from the pre-crisis days and has allowed nonbanks to be much more competitive.
Nonbanks have also been at the forefront of digitizing the mortgage journey. Quicken Loans’ Rocket Mortgage app allows you to apply for a mortgage on your phone and has been a massive success.
These businesses are not new, but they offer an interesting window into the complex world of the US mortgage industry. Given their need for fast credit, nonbanks have been criticised for their exposure to systematic risk and the role they played in the Subprime Mortgage Crisis. However, proponents would argue they’ve changed since the crisis and provide a valuable role in promoting home ownership.