Ratings Agencies Criticized for Going Easy on Mortgage Servicers

Investors and analysts have howled over specific mortgage servicers' handling of delinquent loans for years. The ratings industry generally has not.

Despite widespread allegations of botched loan administration and conflicts of interest, a review of the three main ratings agencies' quality evaluations of servicers (including banks) show that virtually every servicer with a published rating is ranked as "proficient," "average" or better.

Fitch, which rates servicers on a scale of 1-5, has no servicers rated below a 3 — a level it designates "proficient."

Standard & Poor's rates servicers according to how they stack up against "average" performance. Out of the more than 30 servicers on which it offers a public rating, all are average or better. Subpar scores exist under S&P's system, a spokesman said, but are usually kept confidential by the servicer client paying for them until they can improve their performance.

Moody's also rates servicer performance relative to "average," with 1 being "strong" and 5 being "weak." Out of the 25 companies it publicly evaluates, only the bankrupt Lehman Brothers' Aurora Loan Services ranks as a 4, or "below average."

Larry White, a professor at New York University's Stern School of Business, called this distribution of servicer ratings problematic. A ratings system in which just about every servicer scores average or better is inconsistent with basic math, he said, and with the last three years of the servicing industry's performance.

"The cynical part of me says I'm not surprised," said White, who has been critical of ratings agencies. "The non-cynical part says that it is depressing that the rating process still isn't identifying the guys who clearly are not behaving."

Moody's vice president Bill Fricke said the generally average or better ratings of its clients reflect that only larger and more established servicers tend to commission ratings.

The unusual distribution of ratings came to American Banker's attention during research for a recent article on Carrington Mortgage Services. The Carrington Capital Management unit has pursued certain unorthodox strategies, such as holding on to foreclosed homes for long periods of time, that some investors allege benefit its holdings of bottom-ranked securities in deals it services. Carrington has argued in court documents that the interests of its holdings "may be adverse" to other investors', and the company is being sued by the state of Ohio for unworkable modifications and "incompetent, inadequate and inefficient customer service." Carrington has offered an extensive defense of its practices, which it asserts are in the interests of the trusts it serves as a whole.

Two ratings agencies evaluate Carrington, S&P and Fitch, though S&P has not made its evaluation public.

"All I can say is we are well aware of the controversies, and we commented in our report accordingly," said S&P director Richard Koch.

In its public rating of Carrington, however, Fitch cited neither investors' allegations nor Carrington's rebuttal. In December, Fitch issued a "proficient" rating for Carrington and praised the company's "experienced management team and capable default-handling practices."

In response to questions from American Banker on why its evaluation of Carrington did not address these issues, Fitch e-mailed American Banker an update to its broadly complimentary review.

"Carrington's '3' ranking denotes the lowest acceptable stand-alone servicer ratings in Fitch's scale and is in part due to its unorthodox loss mitigation and liquidation strategies," said Fitch managing director Diane Pendley in the e-mail.

Asked to reconcile that statement with the complimentary language in its public servicer quality rating materials, Fitch offered no additional comment.

"I don't know how they could have possibly missed this," said Amherst Securities analyst Laurie Goodman, who argues that Carrington's actions have harmed investors. "This is something that the market has been aware of for years. You look at Carrington's capitalization mod rate, and it just flashes, warning, warning, warning."

Clear and unbiased guidance from ratings agencies or another source on servicing quality and data reporting could potentially be extremely valuable, investors and observers said. The quality and thoroughness of data in trustee reports is so poor that key statistics must be deduced — and the results do not always align with loan level data reported by CoreLogic and other providers. Modifications aren't always reported as such, the existence of balloon payments is sometimes ignored and other key pieces of information are omitted from trustee loan data.

This problem, far from unique to Carrington deals, vastly complicates investor attempts to detect unusual activities.

"The remits are just freestyle. They tend not to be that good," said an investor who held senior positions in Carrington-serviced deals as well as many others. "With the potential restarting of the securitization markets, it's a big issue."