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by Michael T. Morrongiello

Today’s discount note marketplace along with the involvement over the last few years of a variety of new investors has created underwriting criteria and philosophy which crossover in similarities to mortgage loan origination companies. Learning the mortgage industry “alphabet” as it relates to credit grading and acquiring a good fundamental grasp of how to interpret payor / borrower credit profiles is imperative in sizing up a particular file.

Most credit accounts are paid either as an ( I ) installment account or a ( R ) revolving account. Installment accounts are obligations that have the same monthly payment amount each and every month until paid. Examples of installment type accounts would be a home mortgage, an automobile loan or lease, a consumer finance loan, etc. By contrast revolving accounts are accounts where a monthly payment is due but the payment amount can change dependent on the outstanding balance owed. Some examples of revolving accounts would be Visa, Mastercard, Department store, or Gasoline credit charge cards, etc.

In the past to be rated an  “A” credit borrower (payor) meant that the payor customer had to display a perfect unblemished credit history.  All revolving and installment accounts indicated would have to be rated as R-1 and I-1 respectively. This rating signifies that the account was paid as agreed within a (30) thirty-day collection period.  There could not be any slow paid accounts showing within the last 24 months (2 years) nor any prior accounts that indicated that they had turned into a collection status account. The market has change drastically, in part caused by Wall Street’s general acceptance and willingness to securitized less than perfect real estate loans, the advent and acceptance of credit scoring, and the refinance mania that existed being long gone. In the capital markets there exist a lot of fund promoters who have investor money that needs to be put out. With the mortgage industry pushing “sub-prime” lending programs an “A” credit borrower and the criteria identifying one can be much more forgiving.  Many lenders and paper investors will rate a payor an “A” rated account as long as there are at least a minimum of 4 - 6 credit accounts profiled where ALL credit indicated is current. The majority of the accounts indicated MUST be rated as I-1 and R-1, however an installment or revolving account or two may have had a lower rating like a 1x 30 (one time past 30 days) indicating the account may have gone past thirty days within the last year, with it now being rated as current.

A “B” rated borrower should have reasonably good credit. There should be no major credit blemishes like a bankruptcy within the last (2) two years and if there is a previous bankruptcy then credit should be re-established after the bankruptcy.  Their mortgage must be current, however some prior 2 x 30 days, 4 x 30 days, and even a 1 x 60 days late mortgage payment during the last 12 months may be acceptable. Additionally other installment or revolving accounts that became collection accounts can be indicated along with other public record liens like prior judgments as long as they have been paid.  Dependent on how many derogatory accounts are indicated, there are slight grade variations to this type of borrower rating such as “B” minus, “C” plus, etc.

An individual who has had significant credit problems in the past, but who has demonstrated some willingness to continue to make payments would create a “C” rated borrower. For instance their mortgage payment history during the last 12 months may show significant and repeated slow payments. It is not uncommon for the “C” rated borrower to have been 6 x 30 days, with perhaps a 1 x 60 days or a 1 x 90 days past due showing on their mortgage payment history. If there was a prior bankruptcy it might be just on the inside of 24 months ago, perhaps at 18 months. This borrower might have some current outstanding judgments, or tax liens indicated.

When a borrower displays serious credit problems, numerous slow paying accounts, a slow or slightly behind mortgage payment history, other major credit blemishes such showing such as State or Federal tax liens, repossessions, delinquent alimony or child support obligations, and / or creditor judgments, but where no active bankruptcy exists, this borrower will grade out as a “D” rated debtor. Believe it or not there is a so-called “E” rating as well, and this is where consumer credit is generally not considered, the borrower may be currently on the brink of bankruptcy or foreclosure.  The “E” rating is synonymous with EQUITY as no one in their right mind would want to extend further credit to a borrower with these characteristics unless there were plenty of protective EQUITY cushion in the property available.

Even though credit scoring is becoming more and more acceptable it should be noted that different investors still affixed and interpret different standards to their underwriting and credit grading criteria. One investors “A” might be another investor’s “B” and vice versa. Therefore a review of a credit score and the grading of a payor credit profile alone is only one of many variables you should look for in an investor. In addition to their funding capabilities one should take into account, their service, response time & speed to file submissions, closing procedures and policies, a willingness or flexible allowance of offsetting factors to still make a deal work, etc.  Many note brokers & note sellers have lost income when an investors advertised seemingly low yield buy rate could not be delivered because of restrictive tight credit & underwriting requirements.