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Regulators See Nonbank Mortgage Firms as Potential Risk to U.S. Financial System -- 2nd Update

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12/04/2019 | 07:22pm EST

By Andrew Ackerman

WASHINGTON -- Financial regulators identified fast-growing mortgage lending companies as a potential source of instability in the U.S. financial system, while finding that overall risks are moderate.

The Financial Stability Oversight Council, in a report released Wednesday, highlights mortgage companies as a potential vulnerability for the first time, Treasury officials said. The lenders, which aren't regulated as closely as banks, originate and service a growing portion of U.S. home loans.

Other financial risks identified in the report include high levels of borrowing by nonfinancial companies and the growth of digital assets such as bitcoin.

The report generally recommends continued coordination among federal and state policy makers to address activities that could harm the financial system.

Since the 2008 financial crisis, banks have pulled away from mass-market mortgages to focus on wealthier consumers. Nonbank lenders such as Quicken Loans Inc. and Freedom Mortgage have filled the void, representing the only route to homeownership for many first-time buyers and moderate-income families.

Postcrisis regulations curb banks and nonbank lenders from making the loans that wiped out many lenders and forced a wave of foreclosures during the crisis. What worries some industry participants is that little has changed about nonbank lenders' structure.

In its report, the council said that those firms have relatively few resources to absorb economic shocks and most lack a stable funding base, instead relying on short-term funding that could dry up in times of stress. Strains in one nonbank lender could cause counterparties to question the viability of others.

"Broader contagion could lead to dislocation in the housing and mortgage markets during periods of stress," according to the report. Among the 25 largest players in the $10 trillion market, nonbanks originated and serviced roughly half of mortgage loans, up from a fraction a decade ago, according to the Treasury.

Separately, the council completed new standards under which insurance companies, asset managers and other nonbank financial firms could be tagged for stricter supervision. The standards impose significant hurdles for the council to navigate should it seek to tag a firm in the future.

The council also said it would seek to identify risky activities in a sector rather than singling out individual firms. Any new designation would have to be subjected to a cost-benefit analysis.

As recently as 2016, four nonbank firms were designated as systemically important by the risk panel, while the Obama administration also considered applying the label to Wall Street companies such as BlackRock Inc. and Berkshire Hathaway Inc.

The tide shifted with the arrival of the Trump administration. Regulators removed the last of the nonbank financial institutions from enhanced scrutiny in October 2018, when Prudential Financial Inc. was released from federal oversight. MetLife Inc. won its removal in federal court, while AIG and General Electric Co.'s GE Capital shed their labels after they jettisoned major parts of their businesses.

Write to Andrew Ackerman at andrew.ackerman@wsj.com

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