Not all jumbo issuers are alike

Mortgage Banking, Dec, 1998 by David Teicher, Mark H. Adelson, Linda A. Stesney

Many factors distinguish jumbo mortgage-backed security issuers. Some factors, like the share of retail versus wholesale production, play a key role in determining credit quality. This series of profiles reveals how Moody's weighs these factors in setting baseline credit-enhancement levels for major jumbo players.

Contrary to conventional wisdom, not all Mortgage-Backed Security (MBS) issuers are the same. To believe otherwise is to ignore the fact that differences in issuers' business practices, strategies, underwriting guidelines and market experience necessarily translate into different expectations about the performance of the pools these issuers produce. To subscribe to the conventional wisdom, then, is to ignore how the disparate approaches of disparate issuers affect credit quality.

In fact, credit quality varies significantly among the jumbo mortgage pools securitized by the major MBS issuers. (Jumbo mortgage loans are conventional mortgage loans, made to prime-quality borrowers, that exceed the applicable size limits of Fannie Mae and Freddie Mac. Jumbo mortgage loans do not include subprime loans or Alternative-A loans.)

Although there can be material differences in the quality of pools from a single company, even greater quality variations occur between pools from different companies. And differences in credit quality naturally translate into differences in the levels of credit enhancement needed for securitizations to attain Moody's Investors Service's Aaa ratings.

Within a particular product type (e.g., 30-year, fixed-rate, jumbo mortgage loans), each major MBS issuer is assigned a "baseline Aaa credit-enhancement level" for its typical loan pool. This baseline level reflects the performance of the company's past originations, the company's present business practices and the characteristics of a typical pool from the company. Naturally, if a particular pool has markedly stronger or weaker characteristics than is typical for that company, the actual Aaa credit-enhancement level for that particular pool could be higher or lower than the baseline level.

Only Significant Differences Produce Different Levels

Credit-enhancement levels for jumbo mortgage securitizations move - from one deal to the next or from one company to the next - in response to material changes in credit quality but never as a result of merely slight or trifling changes. The levels move in substantial steps. The size of these steps is an inevitable byproduct of the credit analysis process. Credit analysis is neither a mathematical exercise nor an exact science. The precision of credit opinions is limited by the necessarily subjective nature of some aspects of analysis.

The Range of Risk in Jumbo Mortgage Pools

Baseline Aaa credit-enhancement levels for 30-year, fixed-rate, jumbo mortgage loans range from 4 percent to 5 1/2 percent for all the major MBS issuers (see Figure 1). Thus, those with the riskiest jumbo pools need about a third more protection to achieve Aaa ratings than those with the least risky pools. Between those extremes, there are companies with baseline levels at 4 1/4 percent. 4 1/2 per cent and 5 percent.

Figure 1 Selected MBS Issuers' Credit Enhancement Level

                                                   Baseline Aaa C.E.
Jumbo MBS Issuer                                    Level (FRM-30)

ABN AMRO                                                    5%
Bank of America                                             4%
Cendant Mortgage Corporation (f/k/a PHH)                    4%
Chase Manhattan Mortgage                                4 1/4%
Citicorp Mortgage                                       5 1/2%
Countrywide Home Loans                                      4%
First Union Mortgage Loan Conduit                           5%
GE Capital Mortgage Services                            4 1/2%
Norwest Mortgage                                            4%
PNC Mortgage Securities                                 5 1/2%
Residential Funding Corporation (RFC)                   5 1/2%

SOURCE: MOODY'S INVESTORS SERVICE

Smaller increments between levels would falsely suggest a degree of analytic precision that simply does not exist. For other types of jumbo mortgage loans (e.g., adjustable-rate mortgages [ARMs] or 15-year loans), the range of baseline levels is different, but the increments between levels are spaced proportionately.

Figure 1 lists selected MBS issuers, together with each issuer's respective baseline Aaa credit-enhancement level for 30-year, fixed-rate, jumbo mortgage loans.

Practices and Strategies That Drive Credit Quality

Following are brief summaries of the rationale behind the baseline credit-enhancement level established for each of these jumbo MBS issuers. (The summaries focus on baseline levels for 30-year, fixed-rate loans, but the discussion applies equally to the full range of product types offered by each issuer.) While each individual summary is interesting, the more compelling conclusions come from viewing the summaries as a whole.