Servicers Face Challenges Related to Reg AB Transition

With a key deadline for compliance with Regulation AB drawing near, rating agencies are stepping up efforts to monitor the compliance of loan servicers with the new reporting requirements.

Both Standard & Poor's and Fitch Ratings have recently issued guidance highlighting the role that Reg AB will play in servicer evaluation criteria. The new SEC rule is designed to increase transparency for publicly traded structured securities, including MBS.

S&P believes that Regulation AB, which takes effect early next year, will have more widespread implications for mortgage servicers than many in the industry realize.

S&P plans to factor Reg AB compliance into its 2007 servicer ratings. But S&P largely supports the new SEC reporting requirements, saying that the rule represents a turn toward "better internal audit validation."

Servicer analyst Mike Merriam said that the current Uniform Single Attestation Program, or USAP standards, is not sufficient. Reg AB's standards "significantly exceed those of USAP," Mr. Merriam said in an S&P announcement.

"We expect the scope of Reg AB to encompass and satisfy our minimum internal audit requirements, but we would like to review some completed attestations before making a final determination," Mr. Merriam said. In those attestations, servicers involved in structured finance transactions must file a servicer assessment report that verifies compliance with the new regulation.

He also noted that there is still some uncertainty about who is covered by Reg AB, which covers servicers involved with more than 5% of a transaction's pooled assets but doesn't specify whether that threshold is based on dollar volume or number of loans.

He said there remain other questions about Reg AB compliance that may require some time to get resolved. Nor is it clear how much added costs servicers will have to bear and how that will affect operating margins, especially on small companies and subservicers.

And Michael Gutierrez, head of the U.S. servicer evaluation group at S&P, said that Reg AB will play a "notable role" in his group's analytical process going forward.

Mr. Gutierrez said S&P will adopt a case-by-case approach to evaluating servicers that are not currently in compliance with Reg AB. Servicers that have shortcomings in their compliance will either be affirmed or receive a lower rating, S&P said. They will not be eligible for an upgrade until they are in compliance.

Fitch also put out a criteria report last week that includes some details of the rating agency's views on Reg AB. Fitch also highlighted the role that new loan products and other developments are affecting its servicer ratings.

"Certain product types, such as subprime loans and option adjustable-rate mortgages, need a special operational focus due to their unique nature and the potential for customer disputes or practices that could be deemed predatory," the Fitch report said.

Earlier this year, Fitch added two new primary servicer rating categories, one for subservicing and one for "specialty products" such as manufactured housing, reverse mortgages, tax liens and farm loans.

With regard to Reg AB, Fitch said that key considerations include developing contingency plans for possible noncompliance, the expense of implementing new reporting capability, and possible operational interruptions related to compliance.

"If they are not properly addressed, these considerations could cause timing delays and restatement of noncompliant servicer reports," Fitch said. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com