Risk Rating

THE RISK-RATING PROCESS

  1. The many individual factors which contribute to
    risk have been combined and grouped into a few significant relation-
    ships which are called “features” in the risk-rating system. These
    METHODS OF MORTGAGE RISK RATING Part I
    221-222
    features are, in turn, combined into larger groups described as
    “categories. ” There are twenty-eight features grouped into four
    categories, as follows:
    The
    Property
    :
    Structural Soundness
    Resistance to Elements
    Resistance to Use
    Livability
    and
    Functional
    Plan
    Mechanical
    and
    Convenience
    Equipment
    Natural
    Light
    and
    Ventilation
    Architectural Attractiveness
    Adjustment for Nonconformity
    The
    Location
    :
    Relative
    Economic
    Stability
    Protection from Adverse Influences
  2. Transportation Highways
  3. Transportation
  4. Adequacy of Transportation
    Need
    for
    Housing
    Appeal
    Sufficiency
    of
    Utilities
    and
    Conveniences
    Adequacy
    of
    Civic
    ,
    Social
    ,
    and
    Commercial
    Centers
    Level of
    Taxes
    and
    Special
    Assessments
    Topography and
    Special
    Hazards
    The
    Borrower
    :
    Reputation
    Attitude
    Toward
    Obligations
    Ability
    to
    Pay
    Prospects
    for
    Future
    Past Record
    The Mortgage Pattern :
    Ratio of Loan to Value
    Ratio of Debt Service to Rental Value
    Ratio of Life of Mortgage to Economic Life of Building
    Lowest Category Rating Intermediate Category Rating
    Highest Category Rating
  6. Certain individual elements of risk are incapable of intelligent rating. For example, if an attempt is made to rate a property according to the number of baths, no satisfactory clue to rating is possible unless the Valuator relates the number of baths to the
    requirements of the local market and the size of the house. However,
    when he is asked to rate a factor such as “Livability and Functional
    Plan”, he is able to form a very definite conclusion . Such a relation-
    ship is ratable. The system does not rate the income of the borrower.
    Instead, it rates the ability of the borrower to pay the debt service.
  7. Part I UNDERWRITING MANUAL
    222-227
    That is, the judgment of the Mortgage Risk Examiner is applied to
    the relationship existing between the borrower’s income and the debt
    service of the contemplated mortgage. The selected twenty-eight
    features or relationships are sufficiently different from each other so
    that an intelligent independent judgment in connection with any one
    of them can be formed. In the aggregate, the twenty-eight features
    embrace all the most important ratable elements of risk in the making
    of a mortgage loan on a dwelling property.
  8. In the processing of an application for insurance,
    each feature is given a rating which varies according to the extent
    to which conditions regarding it contribute to the risk involved in
    the mortgage project. Each risk feature is either an individual
    risk factor or comprised of a number of correlated factors which can
    be analyzed separately but treated as a unit. For example, the
    feature “Sufficiency of Utilities and Conveniences” requires con-
    sideration of the extent and adequacy of the pattern of street improve-
    ments , public utilities, and municipal services. The resulting risk
    contributed by the presence, absence, or grades of quality of any of
    these things is reflected in the rating of the entire feature.
  9. In each of the four categories of risk, the individual
    feature ratings when combined comprise the rating of the category.
    The Rating of Property is assigned by Architectural Inspectors and
    Valuators. The Rating of Location is assigned by Valuators. The
    Rating of Borrower is assigned by Mortgage Risk Examiners. The
    Rating of Mortgage Pattern is assigned by Chief Underwriters. All
    ratings are reviewed and finally established by Section Chiefs or
    Chief Underwriters in accordance with jurisdictions and responsi
    bilities outlined elsewhere in this Manual.
  10. The ratings ascribed to the first three categories are
    treated as three features in the Mortgage Pattern category and when
    combined with three other features in the Mortgage Pattern category
    result in the final risk-rating index of the mortgage. The final result
    is referred to as the Rating of Mortgage Pattern .
  11. The forms used by the underwriting staff contain
    four rating grids, one for each of the four categories of risk . Each
    grid lists the several features in a column at the left-hand side. Oppo-
    site, on the right-hand side, are seven columns headed , respectively,
    “Reject”, “1”, “2” , “3” , “4” , “5” , and “Rating.” The accompanying
    illustration of a grid indicates the typical arrangement.
  12. In rating the individual risk features, the risk-
    rating system requires differentiation between six degrees of excellence
    or poorness of conditions . First, differentiation must be made
    between a condition that is so poor as to result in risk so great as to
    warrant rejection of the insurance application . Above this margin
    METHODS OF MORTGAGE RISK RATING Part I
    227-229
    below which a “Reject” rating of a feature is necessitated , differentia-
    tion must be made between conditions ranging from “poor but accept-
    able ” on up the scale of excellence through “fair” and “good” to
    “excellent.” These designations are presented here simply to indicate
    that the system recognizes that risk measurements are relative.
    The terms themselves are not used on the forms because they would
    convey implications beyond the simple idea of rating as suggested
    by the use of the figures “1”, “2” , “3”, “4” , and “5”. Each feature
    is rated by placing an X mark opposite it in the grid. Every
    feature must be rated but not more than one such mark is made for
    any one feature. A feature rating in the “Reject ” column indicates
    that conditions relating to it are such that insurance of the mortgage
    should be refused. A “1” column rating would indicate a very poor
    condition just above the reject margin. A “5” column rating would
    indicate that unusually excellent conditions pertain to the feature.
    Intermediate ratings would cover the range in between.
    228.
    A
    small
    numeral
    or “weight
    “
    appears
    in
    each
    rating
    column
    after
    each
    feature
    .
    These
    are
    the weights
    assigned
    for
    differ-
    Rating of Borrower
    Capacity Character
    Reputation
    Feature
    Attitude
    Toward
    Obligations
    Ability
    to
    pay
    Future
    Prospects
    Past
    Record
    REJECT 1
    2
    3
    4
    RATING
    10
    15
    20 25
    14
    12
    16
    20 ·
    12 18 24 30
    9 19
    12 15
    18
    10
    TOTAL RATING OF BORROWER
    ent degrees of risk . When all X marks have been entered on the
    grid, the indicated weights are copied in the right-hand column,
    headed “Rating .” The sum of the weights carried over and placed
    in the last column is entered at the lower right-hand corner of the grid
    and becomes the total rating ascribed to the entire category. The
    only exception is found in the Property grid. In it one feature weight
    is deducted instead of added in securing the final Rating of Property.
  13. The final rating for the mortgage is obtained by
    recording ratings upon a grid known as “Rating of Mortgage Pattern. ”
    On this grid there are several features involving the relationships
    between certain features of the mortgage instrument, such as the
    amount of the loan and the mortgage term in years, and matters
    pertaining to the property, such as its estimated value and the esti-
    mated remaining economic life of the building. Also listed as
    features on this grid are the ratings of the several other risk categories.
    Ratings on this grid are made for these last named features according
    to the amount of the category ratings which have been previously
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    229-232
    determined. The sum of the ratings made on the Rating of Mort-
    gage Pattern grid is the final index of the relative risk involved in the
    mortgage project under analysis.
  14. If the sum of the individual feature ratings in
    any category is less than 50%, this indicates a degree of risk too
    great to permit insurance of the mortgage. A large number of low
    feature ratings will result in rejection of the application for insurance
    because the resulting category rating will fall below the 50 % margin
    of acceptability. The use of the percentages to describe degrees of
    risk is apt to be misleading unless it is recognized that there is no
    implication that the 50 % rating which constitutes the lower limit of
    eligibility in a category represents “one-half” of the amount of risk
    indicated when a category is rated at 100%. The range from 50%
    to 100 % is intended to represent different degrees of risk above the
    lower limit of acceptability.
  15. The risk-rating system is so devised that after the
    quality of the real estate security and the characteristics of the
    borrower have been determined and found to be such that no undue
    mortgage risk is created on their account, then by means of the system
    it can be determined what is the maximum loan principal and maxi-
    mum loan term in years which would represent the margin beyond
    which economic soundness and, therefore, insurability would cease to
    exist. Thus, after the ratings of Property, Location, and Borrower
    have been made in a case, the Chief Underwriter in rating the Mort-
    gage Pattern can determine whether or not the loan described in the
    application is insurable, and if not insurable because the loan is too
    large, or the term too long, or both, he can determine how large a loan
    would be insurable and for what maximum term the loan could be
    made.
  16. Under the risk-rating system the determination of
    economic soundness and eligibility of mortgages proceeds in four
    steps as follows:
    ( 1 ) Determination as to whether mortgages submitted for
    insurance are eligible or ineligible for further consideration, as indi-
    cated by the application of eligibility tests based on certain provi-
    sions in the National Housing Act, in the official administrative rules,
    and in property standards.
    (2) Determination as to whether mortgages accepted for
    further consideration are insurable or non-insurable, by rating indi-
    vidual risk features and ascertaining if any individual feature receives
    a “Reject” rating.
    (3) Determination as to whether mortgages receiving no indi-
    vidual feature reject ratings are insurable or non-insurable, by rating
    METHODS OF MORTGAGE RISK RATING Part I
    232-236
    risk categories and ascertaining if any category receives a rating of
    less than 50%.
    (4) Final determination of the degree of economic soundness
    of mortgages receiving no individual feature reject ratings and no
    category ratings under 50%, by means of a rating based on all feature
    and category ratings.
  17. It may be pointed out that the relative importance
    of the several categories of risk differs from case to case. For example,
    in a case in which either the Property, the Location, or the Borrower
    Category receives a very low rating and the other two categories
    receive relatively high ratings, the relative importance of the one
    low-rated category in the over-all degree of risk is substantially
    greater than in a case in which all three categories are rated alike.
    For this reason the fourth category, namely, the Mortgage Pattern,
    includes a device by means of which to take account of this relation-
    ship. The category having the lowest rating is more heavily weighted
    than the other two on the grid of the Mortgage Pattern.
  18. The Mortgage Pattern is also so arranged that it
    is possible to determine counter-proposals on a uniformly fair basis.
    For illustration, consider a case in which the loan is too hazardous to
    be acceptable for insurance because the amount of the loan is too
    great. Analysis of the Mortgage Pattern, after the three other cate-
    gories have been rated, makes it possible to determine how much of
    a reduction in the amount of the loan is necessary to make it eligible
    for insurance.
  19. Detailed instructions in connection with the rating
    of the twenty-eight features and four categories are presented in
    Part II of this Manual.