European structured finance professionals are starting to scrutinize servicer risk in a bid to stave off some of the painful servicer-induced losses seen in the U.S. market.
Rating agencies expect a sharp increase in the number of servicers seeking ratings this year. Fitch Ratings, for one, will soon institute a policy requiring less credit enhancement from bond issuers with high servicer ratings, said Edward Register, director and head of the European servicer ratings at Fitch in London.
The servicer focus coincides with a maturing of the European structured market and proliferation of lower-rated originators and products. Because the companies selling bonds are weaker, structured finance professionals argue it is prudent to rank their ability to process receivables and not just the characteristics of the underlying pool. It also comes at a time when the consumer credit environment is benign, leading market professionals to predict bond investors are more likely to lose money from company-specific failures rather than any kind of systemic risks. "We don't want what's happened in the U.S. to happen in Europe," said Jean Dornhofer, senior v.p. in structured finance at Moody's Investors Service in London, referring to deals sold by U.S. issuers including DVI, Conseco and Heilig Meyers that went sour due to servicing issues.
Servicer ratings are only starting to gain ground in Europe, with Fitch and Standard & Poor's rating 18 and 19 servicers, respectively, and Moody's rates a dozen. The agencies say they are seeing increased interest in servicer ratings from servicers themselves, in particular back-up servicers wishing to establish themselves in the market, and from an investor base that is becoming more sophisticated. "Basel II has increased the focus on operational risk, which largely resides with the servicer, and hence investors are asking more questions about the servicing arrangements," said Register. In addition, more U.S. investors are entering the European market and they are accustomed to servicer ratings and focus more on servicer risk.
Fitch plans to start awarding credit for rated servicers in residential mortgage-backed deals this quarter, with servicer ratings going from a high of one to a low of four. "An RMBS deal with a '2+' or '1' rated servicer could receive a 5-10% credit to gross enhancement at the triple-A level, and a 15-20% benefit at the single-B level," said Register.