Mortgage Grading (Quality)

Mortgage Grading (Quality)

Written by Jack Broad

Residential Mortgage Backed Securities (whether Agency or Non-Agency) are also called RMBS or simply MBS. MBS are a type of “security” called a “bond” whose coupon and principal payments are paid for by the cash flows of a pool of individual mortgages. The individual mortgages “back” (or “support”) the payments on the bonds therefore they are called “Mortgage Backed Securities”.

Mortgages and the MBS related to them are graded as to quality in a variety of ways. For example, “Prime”, “AltA” (short for “Alternative A”) and “Sub-Prime” (this last category has been in the press a lot recently).

The person’s “FICO score” is one primary method of trying to work out how much of a credit risk any given individual is. The world “FICO” comes from the names of two men (an engineer, Bill Fair and a mathematician, Earl Isaac) who teamed up and created a “Corporation”. These guys developed a system for coming up with a “credit score” for borrowers, which incorporates a wide variety of financial information about an individual’s income and expenses resulting in the individual’s “FICO” score. This score is widely used in the industry to assist in determining any individual’s “credit-worthiness” and this assists the lender in knowing what interest rate to charge the borrower. In general, the lower your FICO score, the higher the interest rate the lender will charge you to offset the perceived credit risk of lending to you. After all, the lower the FICO score, the greater is the risk that you may not be able to pay back the lender.

FICO scores range from 300 to 850. A score of 660 and above categorizes a person as prime quality. The “Prime Rate” is defined as the interest rate banks charge their best customers.

From 620 – 659 is “Sub-Prime” – if you are a sub-prime borrower you will have to pay higher than the prime rate by some negotiated amount.

The word “credit” means “belief in a person’s ability to repay principal and interest.” Determining a person’s “credit-worthiness” is a key goal when deciding whether or not to give them a loan – whether it’s for a car, a mortgage, whatever – any kind of loan.

Another way of roughly grading mortgages is basically “A” (Prime); AltA (a variation of or alternative to “A”) and “B/C” (Sub-prime). Down at the very bottom of the barrel is the lowest grade “D” – this can also be called “Scratch and Dent” (S&D).

Recently we’ve been doing extensive work for a major Wall Street client in their Scratch and Dent area. Basically, these loans are normally in a “distressed state” – meaning the borrowers are, to a greater or lesser degree, delinquent on their payments. For example, if the client can purchase those delinquent loans from another for really cheap and then turn the borrower around so that they are no longer delinquent, the client can themselves then sell those loans at a much higher price than they originally bought them. THETICA has used it’s software components to create versatile software that assists the client to capture information relating to Scratch and Dent loans, price them and then analyse the performance of pools of these loans across time.

**Thetica Systems’ ABS Trader Tools is a high performance suite of tools that boosts productivity for ABS, CMBS, CDO and CDS traders and analysts.

Thetica Systems is a sister company to Thetica LLC, a consulting firm which over the last two decades, has developed a reputation for consistently providing top quality IT solutions to the financial industry in record time. Our deep understanding of the industry and what clients really need and want are the basic building blocks of Thetica Systems’ success.

To find out more information about Thetica Systems and our products and services visit us on the web. http://www.theticasystems.com/