Wall Street has become the latest camp to embrace credit scoring for mortgages. And banks whose loans are securitized stand to benefit.
Credit rating agencies like Standard & Poor's Corp. and Duff & Phelps are now considering credit scores when determining how pools of mortgages are likely to behave. When the pools score well, less financial support is needed to secure a desired rating. This translates into better prices for the mortgages that banks supply.
Lenders that use the scores can also "more efficiently allocate resources to underwrite loans to investor standards," said W. Roger Haughton, president of PMI Mortgage Insurance Co.
The rating agencies are using scoring models developed by mortgage insurers like PMI. Insurers pioneered the approach during the last decade, developing systems to score loans when they are originated and when there is a likelihood they might fail. Now, they are applying the same standards to loans bound for Wall Street.
The rating agencies are applying the scores to loans that do not meet criteria set by the Federal National Mortgage Association and Federal Home Loan Mortgage Corp., or Freddie Mac. Lenders originate more than $100 billion of such loans each year.
Banks, life insurance companies, and other financial giants make up the bulk of mortgage securities buyers, but Freddie Mac isn't forgetting the little guy.
The housing finance agency has just crafted an unusual arrangement with A.G. Edwards & Co., a regional investment house based in St. Louis, to reach more retail buyers.
A.G. Edwards will, for the first time, underwrite an issue of mortgage securities from Freddie Mac. The deal involves $12 million of securities, a figure that could grow to $50 million under an option A.G. Edwards has been granted.
Until now, the task of underwriting has fallen to Wall Street investment houses like Bear, Stearns & Co. that deal largely with institutional clients.
But A.G. Edwards has a different type of investor in mind. The St. Louis brokerage is designing the mortgage securities to appeal to its prime constituency, thousands of individual investors. The products will be less complex and have simpler redemption structures than many other mortgage securities. The new bonds will also have features like an estate clause to make it easier for survivors to make redemptions.
A.G. Edwards is no stranger to mortgage securities or to Freddie Mac. But until now, it had played a secondary role, distributing mortgage products underwritten by other investment firms. The new deal "is a way for A.G. Edwards to directly tap Freddie Mac, as opposed to going through an intermediary," said Andrew Blocher, the agency's mortgage securities marketing account manager for dealers.
Freddie Mac is clearly comfortable with A.G. Edwards as a leader. The investment firm has "the technical knowledge and distribution to become more of a strategic partner," Mr. Blocher said.
A.G. Edwards sees the arrangement with Freddie as something of a coup and believes that investors will be responsive. "Our customers really do like the agency's name" on their mortgage securities, said Scott Zajac, vice president for mortgage securities trading at A.G. Edwards.