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Credit rating agency Morningstar Credit Ratings developed a new, highly detailed plan to scrutinize how mortgage servicers handle cash flows to investors and foreclosure timelines.
Rating agencies grade servicers on behalf of investors in the mortgage bonds handled by these firms. Morningstar, which opened its mortgage-backed securities service in October, will take a closer inspection than before.
Analysts will cover 29 significant drivers of loan performance and build ways to gauge a servicer performance based on loan types as well.
"We cannot expect a portfolio of subprime California loans to perform as well as prime New England loans, so how can we hold the servicers to the same standards?" wrote Michael Biddle and Michael Gutierrez, analysts for Morningstar, in a paper released Tuesday. "Credit and market risks are outside the servicer's control, so a mechanism that accounts for these components to create an attainable goal is required."
Their "zero age" model will anticipate performance in a servicer portfolio broken down by loan type. Servicers will be graded on how they handle cash flows on first-lien adjustable-rate mortgages, first-lien fixed, hybrids, interest only, second liens and others.
Morningstar will look at other variables as well, such as macro and regional economic factors at the point of origination. Analysts will adjust grades based on changes to a borrower's employment status and loan-to-value ratios as home prices fall and rise.
From here, Biddle and Gutierrez said the models will be able to describe the probability of a mortgage slipping into default, and how well the servicer can continue moving cash to investors during delinquency and liquidation.
The difference between the actual cash collected and the expected cash is averaged across all servicers.
"The adjusted mean allows for servicers to be judged for their comparison to their peers, not for their comparison to the zero age model," the analysts wrote. "The comparison of the cash collected to cash expected is at the heart of the servicer score."
Biddle and Gutierrez said 68% of servicers would rate an average score. But to date, there is some variance among firms, meaning investors can see stark contrasts to their cash flows based who is servicing the loan.
More than one-third of servicers had either an above average or below average score, and 11% had either a very poor score or an excellent score.
Morningstar could not immediately give a more specific breakdown of the findings.
But those servicers with the highest scores collected 45% more cash than servicers with average scores. Firms with poor scores collected nearly 13% less cash than their average competitors.
Servicers with the highest grades and better delinquency prevention practices averaged half the losses on the life of loan compared to servicers with poor scores.
"Given the circumstances experienced in today's market, the servicer score—in conjunction with the traditional servicing ranking—is a powerful tool to be utilized for the assessment of servicer effectiveness," the analysts wrote.
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