Recent operational risk downgrades of various mega-servicers of securitized residential mortgage loans by Fitch Ratings indicate the agency is staying true to its resolution to start a new era in mortgage banking evaluations. It appears to involve more frequent updates of rating criteria.
Diane Pendley, Fitch’s managing director, told this publication the agency’s ratings program is “emphasizing the higher expected levels of performance for servicers” based on developing best practices and proposed new regulation. It is the second expansive downgrade since November 2010 when Fitch assigned a negative outlook to the U.S. residential mortgage servicer sector.
This month Fitch downgraded the RMBS servicer ratings of Bank of America, CitiMortgage Inc., MetLife Bank, PNC Bank, Suntrust Mortgage Inc., Wells Fargo Bank, BAC Home Loans Servicing and Chase Home Finance.
According to Fitch, “the largest bank-related mortgage servicers are most acutely impacted” by today’s increasing operational risks.
After “many months” of closely monitoring the changes in servicers' operations and risk profiles Fitch identified and sorted through issues that “could and were being addressed by the servicers” against other issues and areas of risk that continue to develop, she said.
All ratings assigned for 2011 reviews of U.S. RMBS servicers later this year will incorporate these newly “heightened measures.” Following the completion of its full annual review Fitch may downgrade the affected ratings, along with servicers that were subject to this initial ratings adjustment.
The November 2010 negative outlook was the first step toward the June actions. It was placed “due to increased concerns” surrounding procedural defects in the judicial foreclosure process. Initially procedural defects and regulators’ consent orders were the main drivers of operational risk. Now the criteria entails a combination of requirements, Pendley said, those that exist now but have not been fully implemented “and the diverse new requirements which are expected to be the result of actions and new regulation.”
Since the November outlook, Pendley said, issues that were related to bank regulator’s consent orders issued to several of the largest servicers or other broader in scope process and risk management concerns “have either been identified or suspected.”
Reasons for the operational risk downgrades include growing burdens of managing delinquent mortgages under “heightened regulatory scrutiny” and pending legislation. In order of priority, risk management programs, including audits and quality control, come first because they “should identify systemic risk and process errors.” Factored into the downgrades is the slower-than-expected pace in implementing process changes necessary to manage the foreclosure crisis.
Fitch said it has adjusted the RMBS servicer-rating criteria “to reflect the increased risks and deficiencies” identified in specific areas of performance. For example, lower credit is given to a bank’s financial condition as more weight is applied “to the company’s willingness to extend available funds to improve operations in areas of risk management, staffing levels and training, quality control/audit and technology.”
Additional risk is now attributed for a handful of reasons. Unless banks conduct internal audits of all servicing processes at least annually, they are considered higher risk and senior management will be hold accountable for results and corrective actions.
Regulated banks would disqualify for credit received for their compliance programs that previously were subject to additional risk management oversight and appear to face management risks.
Extensive use of offshore vendors or affiliates for borrower contact, which in turn requires higher levels of oversight, control and comparison to performance available from other sources, including onshore providers, also qualifies as additional risk. As does mishandling of loans subject to SCRA military special handling; insufficient staffing within all default areas, particularly in loss mitigation and foreclosure; evidence that corrective actions were needed for a high number of mortgage default processes and foreclosures; and the cost of potential regulatory actions, fines and penalties, as well as litigation, may be substantial.
In late 2010 regulatory action taken against many servicers due to alleged mishandling of foreclosure affidavits, procedural defects and borrower data prompted many servicers, including all large servicers, to halt a large number of foreclosure actions in both judicial and nonjudicial states. Consequently, Fitch said, “The full extent of the concerns resulting from this and other related functions within servicer operations is far from resolved.”
The agency joins many industry insiders who expect “continued reluctance to proceed with foreclosure” because of scrutiny from a wide range of interested parties, new regulation and litigation risk. Various reports have shown that this scenario may further extend the overall time needed to resolve all the loan issues at hand increasing property related losses and ultimately the loss severity to investors.
Downgrades apply to various products. Bank of America: RMBS primary servicer rating for prime product to RPS2 from RPS1-, alt-A product to RPS2 from RPS2+ and HELOC product to RPS2 from RPS2+. CitiMortgage: RMBS primary servicer rating for prime product to RPS2+ from RPS1, alt-A product to RPS2+ from RPS1 and subprime product to RPS2+ from RPS1-. MetLife Bank: RMBS primary servicer rating for prime product to RPS2- from RPS2 and alt-A product to RPS2- from RPS2. PNC Bank: RMBS primary servicer rating for prime product to RPS2 from RPS2+ and alt-A product to RPS2 from RPS2+. Suntrust Mortgage: RMBS primary servicer rating for prime product to RPS2' from RPS2+. Wells Fargo Home Equity Group: RMBS primary servicer rating for HELOC to RPS2+ from RPS1- and for second lien product to RPS2+ from RPS1-. Wells Fargo Home Mortgage, also a division of Wells Fargo Bank: RMBS primary servicer rating for prime product to RPS1- from RPS1, alt-A product to RPS1- from RPS1 and subprime product to RPS1- from RPS1.
Two banks were downgraded both in their primary servicer and special servicer capacity. BAC Home Loans Servicing: RMBS primary servicer rating for prime product to RPS2 from RPS1-, alt-A product to RPS2 from RPS2+, subprime product to RPS2 from RPS2+, HELOC product to RPS2 from RPS2+, closed-end seconds to RPS2 from RPS2+ and RMBS special servicer rating to RSS2 from RSS2+. Chase Home Finance: RMBS primary servicer rating for prime product to RPS2+ from RPS1, alt-A product to RPS2+ from RPS1, subprime product to RPS2+ from RPS1, HELOC product to RPS2+ from RPS1 and RMBS special servicer to RSS2+ from RSS1.
Fitch’s "U.S. Residential and Small Balance Commercial Mortgage Servicer Rating Criteria" were updated on Jan. 31 of this year. Since the increase in resolution times and loss severities already has been incorporated into its ratings analysis of outstanding rated RMBS bonds, Fitch said it does not expect the June downgrades will affect outstanding RMBS bond ratings.
Going forward, Pendley expects future adjustment actions will be taken on individual servicer ratings after a full analysis of their current condition and implementation of action plans.
Nonetheless, the RMBS servicing industry as a whole will continue to be under the microscope and “subject to both reputational and litigation risk…Therefore the negative outlook will remain in place.”
Fitch would not speculate comments on the long-term effect of the downgrades.
Because the cost of potential regulatory actions, fines and penalties, as well as litigation and reputational risk is factored into the mortgage servicing operational risk ratings of these banks, their effect on the bank ratings themselves or their reputational risk remains to be seen.