Making home loans to borrowers with bruised credit has long been a quirky, high-margin outpost of the staid, commodity-like mortgage business.

That is set to change as large players, fed up with meager profits on home loans to A-credit borrowers, rush to the subprime niche. If subprime loans follow the mainstream market, they will likely become more standardized and less profitable.

In the past year, three companies - North American Mortgage Co., Santa Rosa, Calif.; KeyCorp Mortgage Inc., Cleveland; and Countrywide Funding Corp., Pasadena, Calif. - have entered the fray. Unlike the mom and pop companies that have made most such loans up to now, these publicly traded players demand lower and better-quantified risk. So do the new securities investors needed to finance the explosion of subprime home lending.

Standard & Poor's, which grades the credit risk of most subprime mortgage securities, has developed a statistical model for precisely measuring the likelihood of default on a given loan.

The model assigns each loan to one of seven finely calibrated risk buckets intended to replace the loosely defined A, B, C and D credit ratings.

Working with mortgage insurers and investors, Standard & Poor's has incorporated its model into several of the mortgage industry's automated underwriting systems. Only a small fraction of subprime loans have been processed through these electronic underwriters.

But the model has been so widely accepted that by yearend, the rating agency will apply it on its own to all subprime loans it evaluates, said Frank Raiter, managing director for structured finance. To run the model, Standard & Poor's will require lenders to provide the Fair Isaac & Co. credit score with each loan, Mr. Raiter said.

Standard & Poor's partnership with Freddie Mac - one of two government-sponsored enterprises that dominate the A-credit mortgage business - is a case study of how the mainstream and subprime markets intersect.

Freddie Mac was the first major player to offer Standard & Poor's rating model through its Loan Prospector underwriting system in an experimental program that began in fall 1995.

The partnership has allowed Freddie to shore up its underwriting system so lenders can evaluate the subprime and jumbo loans that Freddie may not buy, as well as the prime credits in which it specializes. Freddie thus can support and, ideally, profit from the burgeoning interest in subprime lending among its mainstream, A-credit lenders.

It's all part of making the system a "holistic solution" for lenders, said Mike May, vice president for loan prospector business operation at Freddie Mac.

At the time it announced the experiment, Freddie Mac also said its underwriting model would reveal that a sizable chunk of loans routinely lumped into the subprime category are actually low-risk loans that would meet its own investment standards.

This year, Freddie made the subprime program more widely available. Lenders who use Freddie's system can obtain the Standard & Poor's rating through it and then can shop the loan to one of seven large conduits that respond within two hours, Mr. May said.

For the seven, the Freddie Mac link-up is "an interesting opportunity for developing an origination channel at low cost," said Mr. Raiter of Standard & Poor's.

The system has proven to be a "modest" source of loans, said Robert Benson, executive vice president and chief credit officer of Money Store's mortgage division in Sacramento, Calif.

But the nation's largest subprime lender sees the Freddie link as a way to reach out to mortgage lenders that specialize in prime credits, Mr. Benson said.

Freddie Mac said 20,000 subprime loans have been run through its system, half of those since it became widely available in January. The agency would not share its estimates of future loan volumes.

Each loan generates a transaction charge of approximately $100 for the agency, comparable to what it charges to underwrite a prime loan.

Standard & Poor's is evaluating a similar program with Fannie Mae, the other government-sponsored prime mortgage investor.

S&P also has linked its subprime scoring model to the underwriting systems marketed by mortgage insurers PMI, San Francisco, United Guaranty Insurance Co., GE Capital Mortgage Services, and MGIC.

Citicorp's in-house scoring system also uses the Standard & Poor's model to grade subprime loans.

Mr. Benson said Money Store is hedging its bets by developing its own underwriting system, which will incorporate the Standard & Poor's model. But he doesn't think the system soon will replace the case-by-case analysis of loans by human underwriters.

"The challenge in B and C lending is that we have said 'yes' when others (A-credit lenders) say 'no,' " he said.

It will be "slower and more difficult to build (underwriting models with) high degrees of predictability" for this group of borrowers, he said. "I do believe it can be done, but not as easily as in the conforming side of the business."

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