In July, Freddie Mac announced new revisions to its rating requirements for determining the eligibility of depositories to hold custodial accounts. These revisions follow changes made by Fannie Mae in March to their guidelines.
The Freddie Mac requirements are an example of how the secondary market agencies and the industry can work together and come up with reasonable solutions to a common problem. The common problem is that seller/servicers and Freddie Mac are exposed to risk of loss in the event the institution fails while holding custodial accounts. If such a failure occurs, and federal deposit insurance coverage is inadequate to prevent losses, the secondary market agency will hold the seller/servicer liable. An additional problem for seller/servicers is the potential loss of their warehouse lines typically tied to these deposits.
Freddie Mac's initial attempt at a solution to the risk-of-loss issue was to modify its existing guidelines for evaluating the financial soundness of an institution. This modification, announced in December 1990, required that an institution had to meet an IDC rating of 125 or better by July 1, 1991, without consideration of an institution's rating by the Thompson BankWatch rating service. Any institution falling below a 125 rating for IDC would have been required to relinquish Freddie Mac custodial and escrow accounts. In a hastily scheduled meeting with Freddie Mac, the Freddie Mac Liaison Committee and MBA's Banking and Finance Subcommittee, comprised of warehouse lenders and mortgage companies, MBA was able to persuade Freddie Mac that this policy would have a direct effect on a large segment of the warehouse lending community, particularly money-center banks. Fortunately, that policy was then withdrawn, and Freddie Mac began to work with the industry on another policy that would be fair to the banking community and would have less of an impact on credit availability to mortgage companies.
One major criticism of the prior standard is that it relies on too few measures of financial stability, IDC and BankWatch ratings. Another major criticism was that the IDC rating was too volatile. A number of institutions' IDC ratings swung as much as 50 points or more from quarter to quarter.
In addition to requesting that Freddie Mac look at different rating service measures of financial soundness, MBA recommended that institutions meeting minimum regulatory capital be considered eligible depositories even if the institution failed to meet the ratings standard. The banking regulators have never seized an institution that had positive capital, let alone one that met minimum capital. MBA also argued for a BankWatch rating cutoff of C/D instead of C. Finally, MBA tried to persuade Freddie Mac to allow institutions that failed to meet S&P, Moody's or BankWatch ratings to meet the credit scoring rating as an alternative. The revised Freddie Mac approach is a reasonable compromise and disqualifies 15 percent fewer institutions than its original proposal and 33 percent fewer institutions than Fannie Mae's current policy. Freddie Mac will also have a procedure for granting waivers in appropriate cases. All waivers will be handled in the headquarters. It is not anticipated that the waivers will be frequent. The framework for the new approach is to apply a subjective comprehensive evaluation (BankWatch, Moody's and S&P) to large regional and money-center banks. For small financial institutions objective credit scoring evaluations are applied. The new requirement will be effective October 1, 1991. The new approach actually looks at six different rating services and, therefore, any idiosyncracies associated with a particular rating service do not skew the evaluation based on temporary events. The details of Freddie Mac's new policy are summarized below:
Tier 1: If rated by at least one of the following rating services, the depository must meet the following ratings according to these rules:
* Standard & Poor's--A-3; * Moody's--P-3; * TBW--C
Tier 1 rules: If rated by all three rating services, the depository must meet any two ratings. If rated by two rating services, the depository must meet both ratings. If rated by only one rating service, the depository must meet that rating service's rating.
Tier 2: If not rated by any Tier 1 rating services, the depository must meet one of the following ratings according to these rules:
* IDC--75; * LACE--C; * Cates--3.5
Tier 2 rules: If rated by all three rating services, the depository must meet any two ratings. If rated by two rating services, the depository must meet one rating. (This rule is different from Tier 1.) If rated by only one rating service, the depository must meet that rating service's rating.
Seller/servicers can call Freddie Mac's customer service department to get their depository's eligibility status so they will not have to subscribe to all the rating services.
Under Fannie Mae's policy, which became effective June 1, depository institutions must meet a TBW of C or better and an IDC rating of 75 or better in order to hold custodial and escrow funds for Fannie Mae. Institutions may apply for waivers in the regional office if they do not meet those ratings. The regional offices have the option of allowing the Fannie Mae headquarters to rule on requests for waivers. Fannie Mae's waiver of policy appears to be active. Substantial numbers have been granted. Unlike Freddie Mac, seller/servicers are responsible for determining whether or not their depository is eligible. Fannie Mae will not provide a depository institution's ratings.
As it currently stands, the approach that Freddie Mac has taken is better for the industry than the Fannie Mae approach. It is better because it is a fair, reasonable and reliable way to assess risk.
Michael S. Taliefero Staff Vice President
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|Title Annotation:||secondary mortgage market|
|Author:||Taliefero, Michael S.|
|Date:||Aug 1, 1991|
|Next Article:||Economic trends.|