New Servicer Rules from GSEs to Take Focus off Private-Label Securities

Last month, ""Fannie Mae"":http://www.fanniemae.com and ""Freddie Mac"":http://www.freddiemac.com announced that they will be issuing new guidelines this summer that will ""align their procedures"":http://dsnews.comarticles/gses-issue-new-servicing-guidelines-for-delinquent-mortgages-2011-04-28 for handling past due mortgages and implement a new incentive and penalty structure based on individual servicers' performance.

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""Moody's Investors Service"":http://www.moodys.com says this new directive â€" in particular the monetary motivation involved â€" will likely shift servicers' focus to loans backing the GSEs' mortgage bonds and away from loans in private-label residential mortgage-backed securities (RMBS).

This shift will mean that defaulted loans in private-label RMBS will take longer to resolve and their severity of loss will increase, according to the ratings agency's analysts.

""The revised GSE servicing incentives and penalties are credit negative for private-label RMBS,"" Moody's says.

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The agency expects mortgage servicers to move more staff onto their Fannie and Freddie portfolios, prioritize technology enhancements toward GSE loan servicing, and implement stronger contact strategies within their collections departments for GSE loans.

Although for private-label RMBS, servicers will continue to perform basic servicing duties required by the pooling and servicing agreements, reduced oversight and less attention to defaulted loans in private deals will cause foreclosure timelines to extend even further, resulting in increasing loss severities for non-GSE investors, Moody's explained.

Unlike GSE RMBS, private-label RMBS do not have mechanisms to provide incentives or enforce monetary penalties, and the base service fee is no longer enough to cover the cost of servicing non-performing loans, the ratings agency asserts.

Moody's analysts say they saw a similar shift in focus last year. During the third quarter of 2010, when Fannie Mae indicated it would assess penalties for servicers not meeting their established foreclosure timelines, GSE foreclosure starts spiked to an all-time high as servicers attempted to avoid penalties. At the same time, the agency's data show that new foreclosures in private-label RMBS dropped.

Moody's expects to see this same type of divergence in resolving defaulted loans for the GSEs vs. for investors when Fannie and Freddie formally implement their planned inventive and penalty structures.