The role of loan doctors, which help ease investor and issuer concern, is expanding in the subprime mortgage securitization business, according to a new report issued by Moody's Investors Service.
Volatility in the subprime mortgage market has led to more careful scrutiny of loan performance by issuers and subordinate class investors, the report found.
Loan doctors are companies that specialize in default management.
They are called upon to address loan problems before a foreclosure becomes necessary, or to speed the foreclosure process in certain cases.Loan doctors are most useful for subordinate classes of securities, because these low-rated securities have the highest exposure to credit risk and therefore can benefit the most from good default management, the report said.
"Loss severity on certain loan pools is higher than it should be," said Diane Westerback, an analyst and the author of the report.
When a pool of mortgages is securitized, investors hold the certificates.
It is the servicer that calls up borrowers, tracks payments, and pursues foreclosures. "The servicer to some extent controls the destiny of the portfolio from that point forward," Ms. Westerback said.
Realizing this, investment bankers are involving loan doctors in transactions to make sure the process runs smoothly, Ms. Westerback said. Bankers are pursuing both lower credit-support levels, a benefit for the issuers, and better performance, a benefit for the investor, she added.
Fannie Mae and Freddie Mac are also playing a role in encouraging mainstream servicers to implement efficient procedures for the conforming market that are used by good default managers in the subprime market, the report said.
Companies offering default management services, and which have from $1.5 to $2 billion of delinquent loans in their porfolios, include EMC Mortgage Corp., Fairbanks Capital Corp., Litton Loan Servicing LP, and Ocwen Federal Bank FSB.
The report said a good default manager can reduce the loss on a pool of mortgages by up to 20%. The "most identifiable savings" come from a loan doctor's ability to resolve more loans before foreclosure, and by speeding up the foreclosure process, the report added.
"A servicer will have the most positive impact on a securitization transaction as a 'cradle-to-grave' servicer," the report said, noting that this type of arrangement allows the default manager to keep close contact with the borrower.
This arrangement is most often used for loan pools with higher credit risk.
The report also found that profitability and lower losses come from servicing a portfolio of at least $1 to $2 billion of delinquent mortgages in addition to performing loans, the report said.
An equity interest or an incentive fee will encourage better performance by servicers, Ms. Westerback said. Most servicers earn a fixed fee for work in the subprime market, but "don't have the motivation" to do extra work, she added.
A default manager is judged by its ability to complete foreclosure quickly, resolve loans without completing foreclosure, sell a property in a timely manner for maximum return, monitor and control costs, and prevent repeat defaults, according to the report.
