Bank of America Corporation’s (BAC) mortgage servicing ratings have been downgraded by Moody’s Investors Service, a rating arm of Moody’s Corp. (MCO). The main reason behind the cut was the deterioration in the company’s collections and loss mitigation on home loans.

The rating agency lowered BofA’s servicing rating on prime, subprime and second lien mortgages to “SQ2” from “SQ1”. Similarly, the company’s grade as a primary and special servicer for both first and second lien mortgages was cut to “SQ2-“ from “SQ1-“.

The rating agency rates the mortgage servicer on a scale of SQ1 to SQ5, with the latter being the lowest one. These servicer ratings are reflections of the company’s capability to avoid or lessen losses in a securitization.

Additionally, the rating agency stated that due to irregularity and flaws in BofA’s foreclosure processes, it has put all the SQ ratings of the company, excluding primary servicer of second lien mortgages, under review for future downgrades.

In October 2010, the rating agency had put the primary and special servicer ratings of BofA under review for potential downgrade, after the company suspended foreclosures in 23 states due to flaws in foreclosure documents.

Apart from BofA, JPMorgan Chase & Co. (JPM) and Ally Financial Inc. had also temporarily halted foreclosures due to similar reasons.

Following this experience, the regulators along with the state attorney generals (AGs) initiated an inquiry on almost all mortgage servicers including JPMorgan, BofA, Ally Financial Inc. and Wells Fargo & Company (WFC).

Finally, in mid-April, the regulators announced an agreement, according to which the 14 largest mortgage servicers, including JPMorgan, BofA and Well Fargo, would review all foreclosed loans from 2009 and compensate the losses caused by the foreclosure mess.

Hence, in the first quarter of 2011, BofA expanded its staff to strengthen its loan servicing business and handle the loan servicing backlog as well as review all the foreclosed loans. At present, the company has a servicing portfolio of 13.3 million loans, accounting for nearly $2.05 trillion of unpaid principal balance.

BofA’s spokesperson Mr. Dan Frahm commented that the servicing ratings downgrade was not totally unanticipated. The company expects to tide over the foreclosure problem soon and hopes to get higher ratings once it fully complies with the settlement deal provisions and secures its foreclosure processes.

Currently, BofA retains a Zacks # 5 Rank, which translates into a short-term ‘Strong Sell’ rating. Also, considering the fundamentals, we maintain our long-term “Underperform” recommendation on the stock.

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