The higher level of activity in the servicing market, as a result of mergers, acquisitions, transfer of servicing rights, and bankruptcies, has increased the focus on the servicers and the effect they have on the performance of structured transactions. The potential increase of defaults in portfolios, due to general economic trends, has caused all market participants to agree on the elevated importance of this role.
In 1999, Fitch introduced ratings for residential mortgage servicers that included primary, master and special servicer ratings. Fitch has been rating commercial loan servicers since 1992 and has recently announced the development of servicer assessments for a variety of Asset Backed products. This article discloses the most significant measures used in the evaluation of servicer's abilities in default loan management.
The analysis of a servicer's ability to manage loan defaults involves a close examination of three key variables: Servicer performance history by product type; current operational status and efficiencies; and stress testing for future stable execution.
Each of these three, along with how and to what extent they affect the servicer score, is further discussed below.
Servicer performance history by product type
As performance benchmarks analyzed may differ from servicer to servicer, therefore, comparing performance statistics is a difficult, but not impossible, task. In order to make the assessment relevant, as well as fair to the servicer, individual portfolio features and history must be fully recognized. This involves removing some assets and/or grouping those assets which are comparable in credit grade range, in seasoning, and, where possible, in source.
For specific transactions within the servicer's portfolio and for which initial deal analysis and projections are available, Fitch will use these projections for the baseline comparison to the actual delinquency history, frequency of default, and loss severity statistics. This review is performed in conjunction with Fitch's surveillance and with benefit of their judgement and history on each transaction. However, the initial projections must be adjusted in light of actual historical market conditions prior to a comparison.
One of the key factors, which must always be considered when reviewing deal projections to actual results, is the effect of the value as established by the initial appraisal. If the initial appraisal or stated value of the property was inflated, and therefore there is less or no equity in the property, the incentive for the borrower to perform, the servicer's options for loss mitigation scenarios, and of course, the ultimate severity of the loss are greatly impacted. In order to objectively apply an assessment of the validity of the property values, Fitch will use an automated valuation model to assess a range of accuracy for the initial valuations.
In several cases there is not sufficient transaction volume within a servicer's portfolio, or the servicer under analysis had not been the one responsible for performance for a sufficient length of time, to rely solely on the above review. In these cases, to supplement the review several additional methods are available to assess the servicer's historical effectiveness. These methods include:
a) Roll Rates: Roll rates show the number and percentage of loans that migrate to a more serious delinquency status, improved in status, or stayed the same, over a designated period of time. They allow the reviewer to assess the effectiveness of various steps in the servicer's default process, e.g., the ability to bring loans to re-performing status from the more delinquent buckets - 90 or 120 days, or out of foreclosure status. Roll rates have the added benefit of allowing the reviewer to verify the significance of new or modified tools or procedures by focusing on before and after their implementation. Fitch believes that roll rates are often a better indicator of a servicer's effectiveness, since they provide a clear picture of loan migration, both positive and negative.
b) Resolution Rates: Resolution rates are used by Fitch to establish the effectiveness of default management procedures and practices, again by product type. The servicer must provide documentation that indicates the current status of assets that were 90+ days delinquent at one point in time and then a later date (e.g., 12/31/99 and 12/31/00), indicating their status in three groupings:
1. Loans that are likely to stay in the pool - current, 30, 60, 90+, performing on a payment plan, or modified
2. Loans more likely to move to a liquidation status - in bankruptcy and foreclosure
3. Loans that will or have liquidated from the pool - note sale, third party sale, short payoff, full payoff, REO from deed-in-lieu, REO from foreclosure, liquidated as REO, or liquidated by charge off.
c) Timeline Management: Timeline management, or the timeliness of a servicer's actions, is an important component in the assessment of servicer performance. There are timeline standards for several of these processes readily available from both Fannie Mae and Freddie Mac. These include guidelines for the determination of allowable delays (e.g., multiple bankruptcies) with state-specific time frames that can be a baseline for benchmarking.
The servicer's timelines for call and letter campaigns should reflect the specific product's needs, such as sub-prime or high LTV, etc. All servicers of products that require intensive default management must have the technology to report compliance to stated timelines as well as exceptions to these timelines, by stages or function. Servicers who do not track and have the ability to report these exceptions are not eligible for the higher rating levels.
Timeline tracking for the stage between the foreclosure sale date (obtaining of title to the property) and the liquidation and subsequent pass through of losses to the trust, is slightly more difficult to monitor since there is not as much easily obtainable data for these time periods. Therefore, Fitch uses its state-by-state averages and projections for the eviction timing, listing to sale, and sale to liquidation as a benchmark when determining a servicers' conformity to timelines and variances between servicers.
d) Disposition Cost Containment: The last in this list of performance measures is the servicers effectiveness in containing costs involved in the default management and liquidation of a loan. Timeliness of the process has a direct impact on interest carrying cost and these should be separated from other costs when analyzing the servicer's efficiencies. Other items, which are directly related and impacted by the timeliness of the sale process, include required advances for taxes and insurance, and maintenance or preservation and inspection costs during the liquidation period.
The servicer must work with the market value of the property, so its ability to impact the price at which the property is sold is limited. However, there are several efficiencies with regard to realtor selection, decisions to repair or sell as is, when to move a listing, lower the asking price, etc. which will affect the final outcome. The areas most directly controlled by the servicer's ability to negotiate favorable contracts or effectively monitor its vendors are broker price opinion and/or appraisal cost, eviction cost, title and legal cost, and realtor fees. Each of these can be compared to state averages of servicers of similar products to determine effectiveness in cost containment.
status and efficiencies
Fitch performs an in-depth review of a servicers default management area as part of the overall servicer review process. This includes criteria for collections, loss mitigation, bankruptcy, foreclosure, REO, and claims and liquidation reporting. Within each of these areas, staff tenure and experience, case loads, training, incentives, quality of management oversight, reporting, and quality control are reviewed in order to compare the servicer to established benchmarks based on servicers of like size and product. These benchmarks take into consideration the product type serviced, as well as the level of technology implemented. For details on the servicer review process and elements used to assess servicers, see fitchratings.com.
This assessment of a servicer's operational efficiencies for its default areas is designed to both provide Fitch the information necessary to factor these functions into the overall servicer score and to begin or add to the servicer's profile. Each year, based on changes to the servicer's portfolio both in size and product type, the implementation of new initiatives and technology, and the servicer's willingness to address concerns discussed in the prior visit, its overall rating will be affirmed, upgraded or downgraded.
Stress testing for future
Fitch's stress test analysis is designed to determine the servicer's ability to withstand and effectively manage loan defaults under an increased default environment. These conditions could be either projected market scenarios, known increases from portfolio acquisitions, or potential increased defaults in an under-performing transaction.
If the portfolio increase is relatively large, or if it has high defaults and would cause the servicer's caseloads to be outside the acceptable ranges, the servicer must present an adequate plan with a realistic timeline. The plan would address the hiring and training of additional staff, specifically in each of the default areas, collections, loss mitigation, bankruptcies, foreclosures, and REO. The plan must deal with vendor activities and/or incentives to retain key staff, if necessary, in order to reasonably ensure that the loan status will not deteriorate. Effects on the servicer's system capacity and facilities must also be determined. The expected increases in advancing requirements are forecasted based on projected delinquencies added to the servicer's current average advances. If a servicer cannot present adequate documentation to represent their ability as servicer in light of these conditions, Fitch would take the appropriate action, either to adjust downward its servicer rating or the related transaction ratings.