Secondary mortgage market waits for data, creates workarounds amid shift to alternative credit scores

Mortgage lenders are rolling out new credit scoring models, but in the secondary market, investors and credit rating agencies are awaiting additional performance data while developing workarounds to keep loans moving through the system.

Susan Hosterman, senior director for North America RMBS and covered bonds at Fitch Ratings, said the company can currently rate securitizations that feature the new models, provided that the vast majority of the underlying mortgages (roughly 90%) are still based on traditional FICO Classic scores. The remaining 10% of loans scored using alternative models would essentially be treated as unscored.

“We would be able to rate the transaction if they did include VantageScore or FICO 10T, if the concentration was 10% or less,” Hosterman said. “The majority of loans would have to be classic FICO scores and the non-FICO scores, unfortunately, would be treated as not having a FICO score, so the losses would be a good potential.”

But the calculus changes significantly if the alternative-score bucket grows.

“If we were to see a pool with a higher than 10% concentration, we may be able to rate it, but there may be a rate where we have a single A, triple B, just because we don’t know the full extent of the rest, because no one is releasing the data,” Hosterman added. “So that’s where we’re at right now.”

Hosterman delivered the remarks during a panel at the Information Management Network’s (IMN) Residential Mortgage Securitization conference in New York on Wednesday.

The secondary market‘s hesitation comes amid a broader industry shift.

In late April, the Federal Housing Finance Agency (FHFA) rolled out a program allowing a select group of lenders to deliver loans to Fannie Mae and Freddie Mac exclusively through VantageScore 4.0.

FICO 10T will also serve as an approved alternative to the FICO Classic model. The Department of Housing and Urban Development (HUD) signaled that Federal Housing Administration (FHA) loans will adopt these alternative models in the coming months.

To help the industry benchmark these new metrics, the FHFA released historic credit data for VantageScore 4.0 in July 2024, covering individual mortgage scores spanning from 2013 to 2023.

A similar data sharing agreement for FICO 10T was struck in December, although the industry is still waiting for that information to be published. The missing historical context is something that Hosterman and other capital markets players are demanding before they fully embrace the transition.

Mortgage investors at the IMN conference told HousingWire they are generally agnostic about which credit model to use — they simply need the data to accurately price the borrower risk attached to each.

“I want to see the impact in terms of seasoning and collateral performance, so calling it a few years of data on actual performance track record is what investors would be asking for,” Pramit Mukherjee, managing director of insurance solutions at SLC Management, said on stage.

Mukherjee noted that investors are actively waiting for rating agencies to issue clear guidance on how these alternatively scored loans will be treated inside securitization pools. Heavier concentrations could trigger rating caps and ultimately drive up the cost of capital. Investors will likely demand higher spreads on securities backed by these loans.

“From my standpoint, competition, innovation in this space is only going to expand the qualifying borrower base,” said Barath Sankaran, portfolio manager for mortgages at Loomis Sayles. “On the other hand, we’ll see how ultimately this is implemented. The one statistic we most care about is the recidivism rate — is that improving or getting worse? — and time will allow investors to parse through the data.”

While risk is the main topic in the secondary market, originators are concerned with costs.

“This is an issue of massive interest to the origination community, where there’s just a long-standing history of frustration with legacy credit scoring cost, so that’s made this a very political issue in Washington,” said Sam Valverde, a nonresident fellow in the Housing Finance Policy Center at the Urban Institute, who previously held leadership positions at both Freddie Mac and Ginnie Mae.

According to Valverde, proponents argue that modernizing credit models will increase competition and ultimately drive down the cost of pulling credit. But the cost savings at the front end could be wiped out if the secondary market asks for more risk premiums due to model uncertainty.

“What does concern me is that this sort of political, origination-focused conversation is ignoring the fact that FICO was well understood by capital markets, and that you might save something at origination that you lose in execution,” Valverde warned.

“If you really want to adopt and create some parity, then your score needs to start trickling into the capital markets and having some back and forth between policymakers and investors.”