Fitch Ratings recognizes that the quality, stability, and financial condition of seller/servicer operations have a direct effect on the performance of asset-backed securities (ABS) transactions across all product types. Therefore, Fitch has always used seller/servicer assessments to augment its ABS default, loss, and cash flow models when analyzing structures and assigning credit enhancement levels.
Building on this experience, Fitch has established a more formalized procedure to evaluate ABS seller/servicers' capabilities. The ultimate goal of the seller/servicer rating process is to enhance the overall credit process to appropriately measure and incorporate financial and operational risk while giving investors the increased transparency that they have come to expect from Fitch.
The ABS sector is characterized by a wide range of securitized products, currently estimated at more than 20 distinguishable asset types, although the vast majority of ABS issuance is concentrated in the credit card, student loan, and auto sectors. Fitch is committed to identifying and differentiating the traits and requirements of these diverse asset classes in both origination and servicing of the products.
This report outlines Fitch's review process for ABS seller/servicers, the methodology used to assign ratings, and the ongoing monitoring activities that apply generally to most, if not all, ABS products. Additionally, Fitch will publish individual, product-specific reports to delineate features of origination and servicing that are unique to individual asset types.
Highlights of Fitch's review process include:
* Seller/servicer reviews will become a required component of Fitch's ABS analysis.
* Product-specific programs tailored to reflect the risks unique to each asset type.
* Recognition of the impact of the seller's role, in addition to the servicer's, in ABS transactions.
* A clear description of the impact of the seller/servicer's financial condition on the ultimate operational rating.
* Ratings for ABS seller/servicers on the same scale established by Fitch's Operational Risk Group for other areas of structured finance, from 1' (highest) to 5' (lowest).
Fitch's approach to rating ABS seller/servicers capitalizes on the expertise of product specialists, transaction analysts, and financial institution and corporate analysts, in addition to the experience of the Operational Risk Group, which has established rating programs for residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) sellers and servicers and collateralized debt obligation (CDO) asset managers.
Why a customized approach?
Fitch's ABS operational review approach is customized in its recognition of the seller/servicer arrangement typical to the ABS sector overall and its acknowledgment of the differing asset level requirements for the wide variety of ABS asset types. This customization allows for the appropriate measurement - and communication to investors - of the impact of operational and financial risks on ABS transaction performance. In addition, an approach customized to the specific asset ensures that the factors most important to that product type are weighed appropriately.
The demands of ABS investors for analysis and data relating to origination and servicing risk assessment vary greatly. The requirements of investors tend to be correlated with their position in the deal's capital structure. Generally, investors in the higher risk mezzanine and subordinated tranches seek the most detailed information for use in their default and loss modeling and ultimate investment decisions. Other investors may be concerned with a particular aspect of the origination or servicing infrastructure, such as technology or collection. To meet this challenge, within the ABS seller/servicer reports, Fitch will provide a summary evaluation for each of the three major evaluation factors: corporate; origination; and servicing. Fitch will assign a separate score for each, with a detailed explanation following the summary evaluation.
ABS transactions differ not only in deal structures, but also in the characteristics of underlying loans (e.g. revolving or nonrevolving), loan securities (with or without collateral), obligors (consumer or corporate, prime, or subprime), issuers (from large, established banks to non-investment-grade entities), exposure to various regulations, and many other factors. Different terminology used in designating similar situations - for example, "revolving" for credit cards, versus "recycling" for student loans - further complicates analysis. Many of these differences significantly affect the nature of the operational risks that the seller/servicer must deal with. To reflect such variability, Fitch will supplement this report with additional reports specifically written for each product type. Fitch intends to evaluate seller/servicers in the following areas:
1) Credit cards; student loans; 2) Auto loans; 3) Equipment loans and leases; 4) Other commercial assets
Why seller/servicer combined ratings?
Fitch recognizes that ABS issuers typically fall into one of three categories:
1) Captive finance company; 2) Monoline bank or financial institution; 3) Multiline bank or finance company
As such, the vast majority of the assets serviced by an institution were also originated by the institution. For example, prime credit card receivables, receivables, or consumer loans are not typically originated with the intention to sell, servicing released, into the secondary market, as is common for other assets (RMBS and CMBS). In addition, many products, such as auto loans and equipment leases, lack any industry-accepted origination practices, as might be present for areas like prime RMBS (Fannie Mae and Freddie Mac guidelines). This lack of industry-accepted origination practices can affect transferability of servicing.
Additionally, for certain asset types, particularly assets with a revolving feature, like credit cards, seller/servicers re-underwrite on an ongoing basis to manage risk. Furthermore, in the case of captive finance companies, the product securing the loan may have been manufactured by the parent company, requiring the servicer to have a more active relationship with the seller than in RMBS or CMBS transactions.
These factors, along with other characteristics of ABS issuers and their collateral, make it more difficult to look at the servicer function in isolation. Therefore, where appropriate, Fitch will review both the origination and servicing operations of the organization to properly assess the risks associated with ABS transactions. Alternatively, Fitch is able to evaluate either seller or servicer operations separately, if appropriate.
Effects of seller/servicer ratings on Fitch ABS rating analysis
A seller/servicer evaluation has always been an integral component of Fitch's ABS transaction analysis. As an additional measure of risk or benefit, these evaluations have been used qualitatively to augment Fitch's default, loss, and cash flow modeling. In an effort to quantify risks and benefits associated with seller/servicers, Fitch has established a more precise connection between the operational attributes of a seller/servicer's operation and the performance of a transaction.
A more standardized incorporation of the seller/servicer rating in transaction analysis, such as calibration of the maximum allowable adjustment to credit enhancement levels, expected default rates, or other relevant measures, is being tested to determine appropriate levels. When seller/servicer rating reviews of major players in each ABS product area are complete, a quantitative matrix indicating the level of adjustments will be established. (For Fitch's approaches to servicer and asset manager ratings for other types of securitization, see Fitch Research on "Residential Mortgage Servicer Ratings," dated Feb. 21, 2003, "Commercial Mortgage Servicer Rating Criteria," dated April 11, 2002, and "Rating CDO Asset Managers," dated Feb. 13, 2004, all available on Fitch's web site at www.fitchratings.com)
However, levels of uniformity in deal structure, product characteristics, and required servicing vary by ABS product. Fitch expects some ABS segments, such as credit cards and student loans, to be more conducive to this defined arrangement than others. For other ABS product sectors, if there are insufficient data to support standardization and quantification of adjustments, Fitch may decide not to quantify factors. In such cases, Fitch will continue to incorporate the results of seller/servicer evaluations, on a case-by-case basis, in transaction analysis, fully taking into consideration pertinent individual factors.
Fitch's assessment of the quality of the seller/servicer's financial condition and operations will have a direct impact on the determination of credit enhancement levels. seller/servicers that are rated in the 1' category are likely to receive the most beneficial influence on enhancement levels. seller/servicers rated in the 2' category are likely to receive a smaller but still measurable adjustment to Fitch's enhancement calculation. seller/servicers rated in the 3' category could receive a mildly negative to mildly beneficial credit enhancement adjustment, depending on their position as compared with other 3' category seller/servicers. Seller/servicers rated below the 3' category will receive a negative adjustment to enhancement levels, which may be mitigated by an alternative servicing arrangement. Many of the adjustments referenced above already have been taken into consideration as part of Fitch's seller/servicer review process. However, Fitch's expanded and more detailed reviews will allow for better communication to the market of these adjustments, as well as the potential for further modifications to enhancement calculations.
ABS seller/servicer rating criteria
Corporate Performance: 1) Company and management experience; 2) Financial condition; 3) Operational risk management
Origination: 1) Origination and underwriting process; 2) Risk management; 3) Staffing and training;
Servicing: 1) Account maintenance; 2) Customer service; 3) Payment processing and cash management; 4) Investor reporting and remitting; 5) Collections and loss mitigation; 6) Default loan management; 7) Risk management; 8) Staffing and training; 9) Technology
Fitch's criteria report will be available on Tuesday Sept. 14 at www.fitchratings.com'
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