Merrill Lynch says the Fairbanks was "too focused on servicing for investors..."

Chatter on the troubles at former all-star subprime servicer Fairbanks Capital Corp. continued through last week, perhaps heightened by the PMI Group's conference call concerning its exposure to Fairbanks as majority equity investor.

Interestingly, if PMI, which accounts for Fairbanks under the equity method, were to provide too much financial support, it could risk being forced to consolidate Fairbanks onto its balance sheet, noted researchers at Credit Suisse First Boston early in May. PMI and Financial Security Assurance, also an investor in Fairbanks, have both contributed leadership to the restructured company. FSA director James Ozanne is now chief executive officer at Fairbanks, while Brad Shuster of PMI assumes the role of chief operating officer.

Fairbanks recently lost its top servicer status from all three rating agencies.

Fairbanks is champion to some of the highest profile servicing transfers in the industry, including the $26 billion EquiCredit portfolio. Fairbanks also took the reigns on the ContiFinancial portfolio just as the lender's bankruptcy was officiated.

On the ABS side, the market remains concerned with the potential impact on Fairbanks' serviced deals, especially if the firm is unable to finance servicing advances. Fairbanks is in negotiation with its primary lenders and the regulators, both the Federal Trade Commission and the Department of Housing and Urban Development. On the conference call last week, officials at PMI confirmed that Fairbanks is facing lawsuits in other states, in addition to California and Maryland, though at this point PMI is not. PMI is named as a defendant in the California lawsuit.

In Merrill Lynch research last week, analyst Glenn Costello notes that major concerns going forward include significant fines and/or imposed regulation the could reduce Fairbank's effectiveness as a loan servicer. Merrill warns that steps already taken by Fairbanks to appease the regulators - such as slowing down its foreclosure timeline - are "indicative of the risk."

"It appears now that Fairbanks was too focused on servicing for investors, and did not pay enough attention to a growing chorus of consumer complaints and litigation over what were alleged to be unfair' or predatory' practices, particularly in the Baltimore, Maryland area," Costello writes.

Ironically, the impetus to protect investors could ultimately do them harm, if ABS serviced by Fairbanks suffers from the firm's loss of liquidity. The rating agencies have not taken action on any ABS serviced by Fairbanks at this point. Merrill makes the distinction between servicer ratings that "largely address operational capabilities" versus credit ratings, which address "ability to repay debt."

To that point, there have been new issue ABS with Fairbanks as servicer - named so in rating agency releases - since the Fairbank's downgrade.

Meanwhile, it was rumored last month that PMI was considering a bid for Financial Guaranty Insurance Corp. (FGIC), a surety arm of GE Capital Corp. During last week's conference call, a PMI official declined to comment on the rumor whatsoever, only that the company would continue its acquisition strategy.

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