|The likelihood that smaller seller-servicers are falsely reporting loan performance — including making delinquent payments themselves to avoid repurchases — is remote, according to a survey of the three major ratings agencies. But it could happen and not be detected, an official at one agency told MortgageDaily.com.
“I’m not sure how we would detect that,” admitted David Teicher, a managing director and co-head of the residential mortgage-backed securities team at Moody’s Investors Service, referring to the possibility of servicers making fraudulent payments on loans to hide the fact they have become delinquent. “Obviously the servicer can do that. But we would hope it’s unlikely.”
Whether they are “reporting what they’re supposed to be reporting,” cannot be detected easily, Nicolas Weill, head of Moody’s surveillance team, said to MortgageDaily.com.
“But if there’s a blatant error in the servicing report, such as cumulative losses going down or a sudden peak in delinquencies that doesn’t seem reasonable,” he said, “that would show up on pour screen as a data question mark. And then we would pick up the phone and would call the trustee of the servicer.”
Moody’s, like Fitch and S&P, relies on servicers to comply with their contracts.
“There’s very strong covenants in their contracts to report the loans as they become delinquent,” Weill explained. “So there’s a legal obligation to report loans as they become delinquent.”
Most servicers, pointed out Warren Kornfeld, co-managing director of RMBS at Moody’s, are monitored throughout their lives as servicers of the loans in the MBS that the agency rates in order to ensure contract compliance and quality servicing.
Even a broker or other loan originator, as well as a servicer, said Grant Bailey, a senior director in Fitch’s residential mortgage group, could, in cases of early defaults, make a payment, claiming it came from the borrower, so as to avoid a repurchase. Early defaults are the ones most likely to be covered by repurchase agreements and these typically occur before securitizations take place, he noted.
“Repurchases are an issue that’s really in the first couple months of the transaction and a lot of it takes place before the securitization occurs,” Bailey explained to MortgageDaily.com. “So we’re not concerned about servicers manipulating payments on a securitization in order to manipulate the repurchase agreements.”
But he admitted that payments could be manipulated for other reasons and that this would be hard to detect, at least initially.
Adam Tempkin, manager of structured finance at Standard & Poor’s, also said he does not think servicers would forward fraudulent payments, or in other ways manipulate payment reports, but that, if they did, it could be hard to detect.
But the agencies have instituted changes in the rating processes and reviews in response to the poor performances of many subprime loan securitizations.
They are checking loan performances more frequently as they identify new problems related to both borrowers and loan products in today’s economic environment. And every loan is look at separately because of the wide range of different characteristics found with each loan, characteristics whose importance keeps increasing.
S&P is now taking a proactive approach to its surveillance of securitized loans, assessing them for risk earlier than it once did because of the current environment, according to Tempkin. Tranches believed to have concentrations of high-risk loans are targeted for tracking by its automated process.
But all subprime mortgage transactions are actively monitored on a monthly basis, he pointed out.
“We have what we call loan level analysis,” he explained. “Our modeling tool looks at each individual loan because all of those loans have different characteristics. It’s a deal-by-deal, loan-by-loan type of analysis that we do. It completely depends on the risk profile of the specific loans in a transaction.”
S&P also now does modeling and analyses to determine the effects of “payment shock” when loan rates reset, which could lead to refinances or to delinquencies. It began simulations to determine future stresses on borrowers under different interest rate, home price and wage-growth scenarios in August 2005.
S&P expects negative rating actions to keep increasing in the near-term relative to previous years because of likely minor home price declines through most of 2007.
“As the market evolves, we refine our tools and update our assumptions,” explained Moody’s Weill. “As we’ve seen the speed at which servicers try to foreclose on properties increase, seen the percentage of loans that move from delinquent to foreclosure increase, and seen servicers write off second liens faster, we’ve updated the roll rates we use. That’s the probability that loans that are currently delinquent will end up in default. And as the severity of losses on properties has gone up, we’ve taken that into account as well.”
Moody’s, using its automated tools, reviews every single loan in some 30,000 MBS tranches every day, Weill noted.
And that automated tool, which flags individual loans that are identified as risky, is continually fed updated information on economic and loan performance trends as well as new information on new loan products, he explains. Not only are flagged loans given individual attention, but so are other transactions from the same vintage or same originator.
“So we’ve ended up looking a lot more often at a lot of transactions based on the fact that our filtering tools are generating larger lists of loans we have to look at,” Weill said.
But every single loan, whether flagged or not, is reviewed at least once a year, Weill added.
And while one team used to concern itself with both rating new MBS issues and reviewing existing ratings, three years ago, as reviewing existing MBS became more important and more frequent, those functions were divided between two teams, he said.
S&P’s Tempkin said he is concerned with risk layering — leading to the rise in early payment defaults, loans that become past due by two or more payments within the first four months after a loan closes.
“A year ago,” he said, “we identified through our loan level analyses the trend of deterioration in this latest vintage of mortgages, the 2006 subprime. What had changed is what we call risk layering. There was more than one risk with these borrowers. The risk factors were compounded.”
Thus, he noted, a borrower might have a low FICO score and also a second lien or piggyback loan or a loan with limited or no income verification. “For the first time all these factors were happening at the same time,” he points out.
“What we did,” he explained, “was change our criteria and raise credit enhancement levels so there’s more cushion to protect the investment grade tranches.”
As a result, Tempkin said, while bonds initially rated before the higher credit enhancement levels were established have often seen downgrades, bonds rated since then won’t see many downgrades “because we feel we have sufficient credit enhancement to cushion those investment grade bonds.”
Fitch’s methodology, said Bailey, “has not changed much in the last couple of years. It’s just where the methodology is leading us that’s changed quite a bit.
“More bonds are now being analyzed and the ratings are reviewed and reassessed much more often now,” he points out. “When the collateral was doing fine, the reviews would often be just once a year. But now that more bonds are facing some stress it can be a couple times a year.
“In the last six months the list of bonds facing some pressure from the collateral performance and need review has really grown. With the ’06 vintage, the serious delinquencies are ramping up faster than expected.”
A team of about a dozen analysts or screeners, as Fitch calls them, look for month-to-month movements in credit risk, including geographic areas, and then when they survey all of Fitch’s rated transactions, about 3,000 — one-third of them subprime, they identify and review the transactions to which those movements apply, Bailey explained.
The three rating agencies are also watching developments in the economy especially closely, they all said.
“We make all of our criteria changes and outlooks,” noted S&P’s Tempkin, “based on the general economic scenario backdrop. You have to look at all this in a broad economic context. If there’s more unemployment going forward, or, if other economic factors get worse, there is the potential for more downgrades.”
Closer looks also are being given to the servicers of the securitized loans, who are rated on the basis of these reviews of their practices, policies and procedures.
Servicer reviews are now of even greater depth than are the reviews of originators, according to Susan Barnes, managing director of RMBS for S&P, and they provide a sense of the reliability of the information servicers, like originators, provide to S&P for its ratings.
Jerry DeMuth is an award winning journalist who has been reporting for four decades.
e-mail Jerry at firstname.lastname@example.org