As things fall apart at MBS and CDO operations throughout the securitization industry - creating a void in financial services - small teams of executives have begun to regroup as hedge and distressed-asset funds to start picking up the pieces.

And so it is with the mortgage and MBS industries.

Word has it that a handful of executive teams are forming MBS special servicer operations to meet the demands of hedge funds, insurance companies, and other investors who are willing to buy mortgage assets, whether they are in the form of mortgage-backed securities or whole loans. The general idea is that investors who buy the mortgage assets will do so at a steep discount, work with the borrower to rehabilitate the loan, and resell it for a profit.

Marc Geredes, former CEO of First Franklin, is preparing to launch a special servicer operation and has put together all the necessary pieces to run such a company, said a market source familiar with the situation.

Geredes was at the helm of First Franklin from 1999 to 2003, when it was owned by National City Corp. More recently, Geredes was president and CEO of a subprime wholesale mortgage company called LownHome Financial Holdings, in San Jose, Calif. That company reportedly went out of business after less than two years of existence.

Another special servicer in the works, apparently, is being spearheaded by Rob DiOrio, a former managing director at HSBC, and Michael Mittleman, a former director at Credit Suisse.

Word also has it that Impac Mortgage, a company that also runs auctions on foreclosed properties, is planning to start a special servicer operation as well, although company officials did not return a call seeking comment.

Getting a special servicer off the ground successfully takes much more than years of market experience and a plan to rehabilitate poorly performing mortgages. Those types of companies need a huge economy of scale and a solid track record in the industry, say market sources.

"There is a lot of talk on it, and a lot of capital," one market observer said. "I got the sense that there is a lot of dry powder, but I'm not sure if any of them are large enough to move the needle in terms of the movement of credit."

Still, such startups are undeterred. Fitch Ratings has been approached by startups looking to get a special servicer rating, said Mary Kelsch, a senior director at Fitch Ratings in the operational risk group. Kelsch is also in charge of residential mortgage servicer ratings.

"They are anxious to get some kind of rating agency or third party to give them a public rating, so that enables them to get more business," Kelsch said.

Special servicer practices are generally determined by industry standards and Fitch Ratings does assign ratings to such companies, Kelsch said. Still, an unrated special servicer could work on a pool of loans that had been securitized, as long as the primary servicer could provide oversight and attest to federal regulators, under compliance with Regulation AB, that the special servicer did the job well, she said.

In the past, special servicers worked closely with borrowers who were 60 or 90 days delinquent on their mortgage payments, Kelsch said. Over time, special servicers broadened the scope of their businesses, so that now they take on responsibilities previously assigned to a primary servicer.

In terms of getting a Fitch rating, a special servicer's credibility revolves around three Ps - platform, people and process, according to Kelsch.

"We do need to see a track record," Kelsch said. "We like to see a minimum of 10,000 assets, a minimum of a three-year track record. We like to see that they can board the loans, manage cash properly, collect escrow accounts, pay hazard insurance, to make sure the property is insured and that they can report and remit to either the primary servicer or the master servicer."

There are potential roadblocks along the way as well, as Credit Suisse pointed out in a recent report. In the spirit of proposing solutions to the current market crisis, the company suggested that government and private entities create a public/private partnership that would buy delinquent loans and REO properties from securitization trusts and portfolio lenders at levels that are close to market prices and be given the scale, flexibility and incentives to stabilize the market.

"Currently, servicers are not incented to maximize recoveries since most are paid a fixed fee and other servicers are restricted in seeking optimal resolutions due to the many and varied restrictions placed on them by mortgage ABS deal documents," wrote Credit Suisse analysts in a report last month titled "Meet the new NEIGHBOR".

In an earlier report, Credit Suisse examined the risks facing the mortgage servicing industry, wherein it highlighted financial instability, rising servicing costs and weak incentives to get loans to perform at satisfactory levels as particular concerns.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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