As recent incidents of double-pledging risk increase outside the domestic single-family mortgage market, questions arise as to whether they could soon be a concern for home lenders in the United States.
Double pledging occurs when an asset such as a mortgage or auto loan gets used as collateral for more than one source of financing without full disclosure or awareness on the part of all parties involved.
Most monoline mortgage businesses in the United States, which tend to be nonbanks, are unlikely to be directly affected by recent double-pledging concerns at subprime auto lender Tricolor or
That said, banks often are broader consumer finance players and nonbanks may also be
What follows are some reasons why domestic home lenders should pay attention to the latest round of double-pledging risks in adjacent markets, and what's available to mitigate the concern.
Where the risks are
Some banks and other financial services firms that also have domestic mortgage business lines have been impacted by Tricolor, MFS or both: including Barclays, Atlas and several banks. Barclays and Atlas had not responded to inquiries from NMN at the time of this writing.
Some of these institutions help provide warehouse lines or other corporate financing to nonbank mortgage companies who otherwise would have no exposure to auto loan or UK mortgage lending.
This isn't necessarily a concern for domestic mortgage lenders – and it could even work in their favor – but it's worth monitoring.
Mortgages' relatively lower risk profile may look attractive to financiers given the issues in auto lending and the United Kingdom, so they might even consider shifting more of their business away from other types of private credit and toward the domestic nonbank-home lending sector.
That said, some of the losses related to the issues at Tricolor and MFS are considerable. To be on the safe side, lenders may want to remember the common advice to diversify their warehouse lending sources in case a player drops out of the business.
Many standard domestic home loan products have explicit or implicit government backing that comes with rules aimed at mitigating risks like double pledging, but a private market like the one for nonqualified mortgages, which offers alternative documentation, may be more vulnerable.
"You don't have some of the GSE controls. You don't have some of those same processes in that world," said Shane Hartzler,a director in product management in Wolters Kluwer's financial and corporate compliance division.
Hartzler said there are three main bases to cover in configuring efforts to mitigate double pledging risk in mortgage operations.
"The structural issues to address are what sort of processes do you have to: establish control, that you have the single authoritative copy of records, and make sure that you're managing all of that across multiple stakeholders," he said.
A history lesson
The double-pledging risks that have recently appeared in auto lending and the United Kingdom may be familiar to some domestic mortgage and banking industry veterans who remember the ones that materialized during the Great Financial Crisis.
Notably,
Today, most but not all home mortgage companies in the United States typically employ certain technologies that provide protection against double pledging.
Preventative measures
One of the biggest reasons double-pledging is less likely in the single-family mortgage market today is that most of the industry uses Mortgage Electronic Registration Systems (MERS), in one way or another.
The growing number of US mortgage businesses using electronic promissory notes on MERS registry may have a higher level of protection. MERS recently reported there are now 3 million eNotes outstanding and lead users are utilizing them for 30%-80% of loan production.
In addition, most players have paper notes on the MERS system, which also provides some protection by tracking beneficial and servicing rights for the mortgage or the deed of trust, said Harry Gardner, director of digital services in Intercontinental Exchange's mortgage technology unit.
"The MERS system also provides an added hedge against double pledging. It cannot wholly prevent it, since loans are not registered instantly the way eNotes are, but any attempts to do so would be easily detected," he said.
However, there are still a small number of lenders that don't use either the system or registry that may have some exposures if they don't utilize other alternatives.
"Some banks and credit unions that hold their loans in portfolio may choose not to register on the MERS System because they do not expect a transfer to occur, but even then, many do register them to retain flexibility in the future," Gardner said.
Other options outside or used in conjunction with MERS include electronic vaults that companies like Wolters Kluwer offer.
A vault aims to ensure that the copy of the electronic note it holds is the authoritative copy. So warehouse lenders with access to collateral in electronic vaults have access to a "single source of truth" through which they can check to make sure that an asset is not double pledged.
"Paper just doesn't have that level of transparency," Hartzler said.
In the future, it's possible that more first-mortgage ownership records could be kept on an indelible blockchain as has been done more commonly in the home equity market by
Blockchain proponents like Figure have called their technology more efficient and conducive to data integrity, but to date it has operated in a less established regulatory environment with lower traditional mortgage adoption rates than other options.
Some attorneys have advised mortgage firms choosing among digital options to ensure they have representation and compliance experts familiar with the legal framework and regulation involved, because it does differ from that which was established for traditional methods.
"We certainly wouldn't discourage anyone from having their legal counsel look at it all, but I think the good news is that e-notes and infrastructure with the electronic vault are well established now," Gardner said.
