Ratings

Stable. FHHL continues to increase its first lien mortgage servicing operations through strategic acquisitions of servicing and expansion of its branch network. The company has experienced substantial growth in its servicing portfolio since 2001. Over this period, FHHL has seen an 87% increase in outstanding dollars and a 36% increase in loans. FHHL's emphasis on maintaining operating efficiencies, securing risk management methodologies, enhancing technology initiatives, and focusing on employee development, should enable the company to continue to serve as an effective residential mortgage loan servicer. FHHL, however, needs to continue focusing on improving customer service and collection call center statistics.

Table 1 Total Portfolio
	June 2005	December 2004	December 2003	December 2002	December 2001	December 2000
Units (No.)	603,334	555,008	501,541	414,244	416,291	442,329
Volume (mil. $)	90,553	79,589	68,333	47,877	47,551	48,471

FHHL divides its organizational structure into four functional areas of operations: servicing, delivery, government insuring, and federal flood. A senior manager oversees each operational area and reports to the executive vice president of servicing and delivery services, Marion McDougall. Several members of the management staff are, or have been, members of Government Sponsored Enterprise (GSE) committees, advisory boards, and vendor advisory councils. FHHL's management team is highly experienced and maintains the following attributes:

• Senior managers are very seasoned, with an average of 20 years of industry experience and over seven years with FHHL;
• Middle managers average more than 16 years of industry experience including nine years tenure with FHHL; and
• Managerial and staff turnover annualized for the period ending June 30, 2005, are 21.4% and 22.5%, respectively. The managerial turnover rate is high when compared to FHHL's peer group and the staff turnover rate is within peer group ranges.

Despite the company's dedication to employee satisfaction, much of the turnover is attributed to mortgage servicing competition in the Dallas and Irving, Texas, areas.

FHHL maintains well-documented and comprehensive training programs, which, combined with its approach to ensure a positive people-oriented working environment, provide employees with the opportunity to achieve success. Standard & Poor's continues to support the company's conclusion that it must remain focused on fostering employee development and maintain a cohesive working environment.

The company provides a comprehensive training curriculum for all new hires. FHHL also provides a host of continuing education courses "First Power" training to refresh and sharpen skills for tenured employees. In addition, the company has partnered with the University of Phoenix to provide continuing education credits to employees. Other attributes of the training curriculum includes the following:

• Dedicated trainers support customer service and collection/loss mitigation training for new employees, which includes 96 hours and 80 hours of class room training and closely monitored on-the-job training, respectively, and an additional, two weeks of mentoring;
• The corporate training department, located in Memphis, Tenn., consists of 25 experienced trainers, and provides additional training support and assistance to FHHL;
• Comprehensive new hire orientation training, combined with job-specific training, lasts one to five weeks and focuses on topics including the Fair Debt Collections Practices Act (FDCPA), collection techniques, and a variety of servicing system application training;
• "MAGIC" (make a great impression on the customer) educational programs are administered to employees;
• Separate training rooms are available to administer classroom training, computer-based training, and self-study video base training;
• An annual training calendar is developed that includes both on-site and off-site training;
• On-the-job training is closely monitored with immediate feedback;
• Training is reinforced through the company's "The Way We Do Business" – First Power culture communication seminars, in-house and external seminars and workshops, a personal development program via an intranet site, and an education assistance program;
• An enhanced leadership development program that continues to further develop and strengthen the company's management team; and
• Employee training is monitored and tracked.

FHHL demonstrates sound controls for developing, drafting, and disseminating its servicing policies and procedures to the servicing staff.

• Policy and procedure manuals are well written and concise;
• Electronic access to policies and procedures. Online access to policies and procedures provides uniformity in location, expedites updates and communication, and reduces update costs associated with printing and distribution;
• Monthly review of regulatory policies changes;
• Annual audit of all policies and procedures; and
• All updates require the appropriate level of managerial approval.

FHHL has a highly structured independent audit program. The audit division reports to the audit committee of the board of directors of FHN. The audit committee is composed exclusively of external directors. In addition, a quality control and compliance department, whose members report to risk management, is staffed with six employees and a third-party vendor. The independent quality control and compliance department is proactively looking for fraud based on established models and wholesale administration. The department is responsible for overseeing or maintaining quality control, regulatory compliance, fair lending, and special investigations. At a minimum, servicing areas are reviewed annually, with monthly reviews directed at new loans, collections, and loss mitigation. Audits of loan-servicing operations are performed throughout the year. Audit methodology includes:

• A developed audit plan to identify potential weakness and threats;
• Use of audit-related technology tools to increase audit scope that identifies key areas of risk to include cash management and control, investor accounting and reporting, and collection and default management;
• Documented findings and recommendations for enhancements and corrections are submitted to loan servicing management for review and action plans;
• Audit rating categories are as follows: Low priority - No weaknesses in processes and/or internal controls were identified that, in the internal auditor's judgment, should result in significant risk to the corporation. Moderate priority - Weaknesses in processes and/or internal controls were identified that, in internal auditor's judgment, could result in increased risk to the corporation. High priority - Weaknesses in processes and internal controls were identified that, in the internal auditor's judgment, could result in significant increase in the risk profile of the corporation. High priority - Significant finding - Weaknesses in processes and internal controls were identified that, in the internal auditor's judgment, could result in significant increase in the risk profile of the corporation.
• Databases to track action plans and open items; and
• Periodic meetings with loan servicing management focusing on open action items.

A review of internal audits and quality control reviews performed within the past 12 months, revealed no significant findings. Any reported findings are immediately addressed. There were no issues reported in the 2004 USAP report. Also since Standard & Poor's last review, a full legal review of the servicing operation for predatory servicing exposure was conducted. The company's legal department was party to the review. To ensure there is no predatory servicing exposure present and future, a servicing compliance committee was created. Additionally, given the number of regulatory changes surrounding mortgage servicing and reporting, one compliance officer was hired to further support servicing compliance. Fraud investigation area has added staff as well and now has four full-time investigators.

Management has represented that FHHL is not involved in any material pending legal proceedings.

FHHL operates in an automated environment with effective systems that use a combination of vendor and proprietary systems. The company's primary servicing system is Fidelity National Financial Inc. (FNF). FHHL uses several of FNF's applications, allowing for transitional reporting and interfacing. FHHL's systems architecture is scalable to accommodate growth as business increases. The company's strategy includes productivity enhancements, flexibility, and mobility. The following systems architecture is used to support FHHL's loan servicing operations.

• Loan servicing records are housed in FNF's mortgage-servicing system;
• QualiSys i3 Interaction DialerTM coordinates various calling campaigns (the system also features skill-based routing and call-blending technology);
• Freddie Mac's Early Indicator and Fannie Mae's Risk Profiler credit scoring and behavior modeling software identifies and incorporates higher-risk loans into calling campaigns;
• Electronic applications are used to monitor bankruptcy case motions and verify notification of bankruptcy filings;
• An in-house system development team helps prioritize and facilitate technology projects that are business critical;
• Current systems architecture and capacity are sufficient to support projected business growth;
• Document imaging is used to store critical information and improve overall efficiencies; and
• Continuous monitoring and filtering software, interruption detection, and high-availability redundant firewalls for security.

FHHL maintains a well-developed disaster recovery and business continuity (DR/BC) plan that is tested at least annually. The company is investigating procurement/remodeling of its own disaster recovery sites, thereby, reducing its reliance on third-party vendors as well as lowering expenses. Other attributes of the DR/BC plan include:

• A fully developed plan with a hierarchy of critical business functions and calling tree;
• Coordinated recovery drills;
• Cross-training of planning analysts to support corporate policies that includes compliance to data security guidelines and section 404 of Sarbanes-Oxley (SOX 404);
• Integrated infrastructure to support self-recovery with external facilities;
• A third party vendor provides alternate facilities in the event of extended business interruption;
• A servicing capable facility, which is 12 miles from the servicing center;
• Simulated disaster recovery testing that is performed at least annually, with every user department engaged in the practice; and
• System backup tapes that are produced daily and stored at an off-site archival facility.

Loans are boarded electronically and document to system verification is performed by a third-party vendor. Exceptions from the boarding are less than 1% and are researched and resolved within six days. FHHL continues to address exception causes, which have been further reduced since Standard & Poor's last review. In addition, the company has also reduced resolution time since Standard & Poor's last review. FHHL continues to send welcome letters to new borrowers, which promote positive communication and allow demographic and financial verification by the borrower. Corporate initiatives for which mortgage servicing is greatly involved includes a records management initiative that involves imaging of mortgage documents, customer correspondence and email, and an ombudsman process for emerging markets. The ombudsman committee, which is led by the mortgage servicing-production manager, is represented by the following areas: risk management, legal, internal audit, quality control, and selected members of executive management.

FHHL's electronic payments have increased since Standard & Poor's last review. Lockbox and electronic payments including FHHL Web-based payment option account for a solid 94% payment collection capture rate. Standard & Poor's believes electronic and lockbox payments, which include image capture of payment checks and coupons, are effective and efficient ways to minimize risks associated with manual payment processing. FHHL has established payment controls as characterized by the following:

• A secured area requiring card access;
• A monthly billing statement, which, in addition to reminding customers that their payment is due, provides financial information, such as payment posting date, interest paid, and other information. The statement turnaround document has been enhanced to allow the borrower to clarify the designation of excess payment dollars;
• Use of "planet code" and Paw Prints Mail Tracking technology to track incoming payments enabling better management of collection calling campaigns and the ability to monitor lockbox posting timeliness;
• An electronic payment delivery alternative for customers through a third-party vendor;
• Periodic desk examination to eliminate unprocessed payments.
• Utilization of FNF's payment application system to expedite payment postings and payment allocation;
• Automated payoff quotes through its voice response unit (VRU) as well as automated payoff transaction processing;
• Unidentified payments remain in payment processing while a list of exceptions is forwarded to appropriate departments to assist in identification; and
• All checks to be deposited are microfilmed and sent overnight to FTB in Memphis, Tenn.

To insure proper segregation of duties, a separate group within servicing handles investor reporting and remitting. The company has controls in place to protect investors from risk of loss that may result from human error or fraud. Risk management practices in place that assist in ensuring prompt, accurate reporting to its investor base include:

• Duties are segregated among employees generating investor reports, investor remittances, and performing bank account reconciliations;
• Management reviews investor reports and bank account reconciliations;
• The data-gathering process is fully automated with no manual data manipulation, thereby maximizing the integrity of information reported to investors;
• Investor reports are generated through electronic transmission;
• Electronic reporting and remitting is low compared to the peer group at 55% and 82%, respectively;
• Tier 1 performance rating by Freddie Mac for investor accounting and reporting;
• "Superior" rating from Fannie Mae for investor performance; and
• Member of the Fannie Mae Customer Advisory Group.

Overall, the company displays good controls, managerial oversight, and risk avoidance policies over cash management, investor reporting, remitting, and account reconciling functions, which should guard against risk of loss. Management represents that there have been no late reporting fees. Standard & Poor's believes FHHL has established the controls needed to provide timely and accurate reporting to investors.

FHHL escrows on nearly 80% of the portfolio. The company has outsourced relationships with tax and insurance vendors. Customer telephone and correspondence inquires related to taxes are managed by FHHL. FHHL exercises effective managerial control over its vendors and has implemented the following controls:

• Full outsourcing of real estate tax bill as well as hazard and flood insurance policy procurement through two vendor relationships, thereby optimizing cost efficiencies and permitting better deployment of resources;
• Vendors perform proactive calling and letter campaigns prior to and subsequent to the expiration date of insurance and tax due dates for escrow and non-escrow customers;
• Established service-level agreements (SLAs) with vendors to adhere to daily performance standards;
• Vendors transmit daily disbursement requests, which are reviewed for accuracy before funds disbursement;
• Nearly all tax payments are paid within the discount period, with the majority paid electronically;
• 99.96% of real estate taxes are paid timely;
• Tax penalties related to servicing are aligned with peers;
• Lender placed hazard and flood insurance are 0.66% and 0.05% with low cancel rates of 11.78% and 10.46%, respectively. These rates are very good and lower than peers; and
• Check payments are controlled and reconciled by FHHL.

Standard & Poor's believes that outsourcing certain servicing functions to vendors can provide significant cost efficiencies, thereby permitting management to redeploy its employees to other key functions. FHHL has good oversight in its escrow administration area and appropriate monitoring procedures, management reports, and service level agreements with its vendors. The company's hazard insurance vendor's telephone coverage a week is excellent at 60 hours and maintains an average-speed-to-answer (ASA) and abandon rates of 11 seconds and 0.5%, respectively.

FHHL maintains call center sites in Dallas, Texas, and Memphis and Knoxville, Tenn. Since Standard & Poor's last review, the company has experienced slippage in its call centers (customer service and collections) statistics. FHHL is encouraged to review its call centers methodology to improve these important servicing statistics. Also since the last review, FHHL has severed its relationship with a third-party customer service provider to service inquires on an overflow basis. The customer relations department is well automated, using technology that includes an automated call distributor, a VRU, and Internet capabilities to provide a competent level of service to its customers. Turnover, through June 2005 was high compared to peers, which affects customer service statistics. Adding a customer service center in Knoxville with its good employment pool should assist FHHL in improving is call center statistics. The call centers are open from 07:00 a.m. to 07:00 p.m. CST. Also in place is a branch hotline, e-mail, and fax to effectively service customers who place their inquiries through the corporation's branch network. Training for customer service representatives is an ongoing process, especially for new employees in FHHL's customer relations' area. The company has developed a five-week training program for all new employees, which consists of three weeks of classroom training and two weeks of closely monitored on-the-job training that is accompanied by computer-based training. In addition, monthly and annual reward and recognition programs are administered as motivation instruments. Management provides a capable level of customer support as evidenced by:

• Ranked fifth by J.D. Powers & Associates 2005 Home Mortgage Study in "Overall Customer Satisfaction Ranking Among the Largest National Home Mortgage Companies";
• VRU is multifunctional 24/7, and its capture rate is within other mortgage servicer rates at 50%;
• A proficient first-call resolution rate at 87%.
• Cross-trained representatives handle delinquent account calls that are less than 30-days delinquent;
• Two toll-free telephone numbers are provided to customers. One is for customer relations and the other is for collections. Automated call channeling based on representative skill-set directs calls to the applicable representative aligned with pre-established determinants;
• ASA and abandonment rates are high and Standard & Poor's encourages management to continue to monitor its ASA and abandon rates toward 30 seconds and less than 4%, respectively;
• Installed Blue Pumpkin's Work Management Tool for call center forecasting prediction and staff alignment;
• Required "Magic" training programs –- CBT-based and currently at 24 modules;
• Calls are recorded for training purposes, and each representative is monitored during a minimum of four calls a month, and subsequently graded and scored based on a company-developed scorecard. The scorecard is used to critique each employee's performance on communication skills, professionalism, listening skills, and job knowledge to ensure a satisfactory level of customer service. Although calls are recorded and reviewed, FHHL should ensure that four to five calls per week per representative is performed;
• Desktop automation to expedite responses to a variety of customer inquiries including a branch accessible reference screen available 24/7;
• Internet Web site, which includes features in English and Spanish, allows customers to obtain general loan account information;
• Database monitoring of all customer correspondence to ensure compliance with the Real Estate Settlement Procedures Act (RESPA); and
• Robust trending analysis of customer telephone, written inquiries, and Internet contact to monitor service issues, analyze workflow demands, and identify training needs.

Mortgage reconveyance processing is effectively managed to mitigate risk of loss due to a failure to comply with state reconveyance timelines. FHHL uses Reconveyance Processing Software, REKON©, to prepare its release packages and employs a "file tracker" access database tracking and reporting system that identifies and prioritizes reconveyance workflow based on state timelines and aged items based on risk exposure. Management represents that monetary penalties arising from a failure to timely convey under state statutes has been minimal. Management further represents that the company is not presently engaged in any material litigation alleging noncompliance with state reconveyance statutes.

FHHL has an efficient customer service initiative with effective use of automation to service its mortgage customers. The company exhibits good vendor oversight with respect to mortgage reconveyance processing.

FHHL's collections/loss mitigation and foreclosure, bankruptcy, and default departments are managed by four seasoned managers who average 18 years of industry experience and four years tenure with the company. The collection department applies assertive collection practices that include strategic calling and letter campaigns combined with respectable technology to maintain good delinquency rates. Collection counselors' processing procedures follow investor guidelines and are on-line, thus enabling counselors to have immediate access to collection instructions and applicable updates. Collection counselors receive two week of classroom collection-associated training and one week side-by-side training. Training includes the FDCPA, negotiation skills, systems training, and loss-mitigation recognition. There is semiannual FDCPA testing.

Table 2 Prime Loans
	Jun-2005	Dec-2004	Dec-2003	Dec-2002	Dec-2001	Dec-2000
Units (No)	598,154	536,915	485,790	414,244	416,291	442,329
Volume (mil. $)	90,359	78,964	67,810	47,877	47,551	48,471
Total delinquency (% of units)	2.48	2.80	3.01	5.43	6.96	6.20
30 days	1.83	2.00	2.20	3.39	4.23	4.11
60 days	0.35	0.40	0.45	0.78	1.27	1.23
90+ days	0.30	0.40	0.36	1.26	1.46	0.86
Foreclosure	0.60	0.70	0.67	0.96	1.13	0.82
Bankruptcy	0.86	0.90	1.03	1.33	1.43	1.19
REO Inventory (#)	60	284	0	548	259	156

Inbound collection calls less than 30-days past due are initially handled by the customer service departments or through an automated transfer within the VRU, or through a "hot-transfer" to collection counselors. Through skill-based routing technology, high risk and 30-plus day loans are identified and channeled to seasoned collection counselors. Hours of operation are from 07:00 a.m. to 07:00 p.m. CST Monday through Friday and two Saturdays per month from 08:00 a.m. to 12:00 p.m. CST. Characteristics of the company's competent approach to collections include:

• Utilization of Freddie Mac's Early Indicator credit scoring and behavior modeling software to identify and incorporate higher risk loans into call campaigns;
• Utilization of Fannie Mae's Risk Profiler, which is a behavior-scoring model that identifies borrowers most likely to default;
• Extended evening and weekend hours to canvas geographically diverse portfolios;
• A satisfactory turnover rate of 27.5%;
• Autodialer technology is used to coordinate calling campaigns and sufficiently manage productivity;
• A very acceptable right-party contact rate nearing 30%;
• Delegated authority to a select group of collection counselors to enter into repayment plans up to six months;
• Reasons for default are hard coded in FNF, providing guidance for loss mitigation;
• Property inspections are ordered according to investor guidelines or when customer contact has not been secured; and
• Monthly performance incentive and reward and recognition programs, which are not considered excessive, are administered to promote and encourage a positive workplace environment.

Loss mitigation activities are proactive, and customer service and collection counselors are educated to identify and refer loss mitigation candidates in the early stages of delinquency. Targeted mailing and calling campaigns are executed and tracked on the default system, enabling management to focus on primary rescue opportunities. Early intervention is installed to enable delinquent borrowers to identify workout alternatives to solve delinquency prior to foreclosure action. Management has reported that the workouts per month have increased and average 34% since its implementation. The loss mitigation recidivism rate is acceptable at 32%. Three employees have completed Freddie Mac's loss mitigation certification training. FHHL has delegated authority from Freddie Mac, Fanny Mae, HUD, and VA to offer workout alternatives to delinquent borrowers. The company has maintained its Tier 1 ranking with Freddie Mac.

FHHL's foreclosure and bankruptcy management is staffed with eight employees and includes an outsource relationship with a third-party vendor. The vendor has staff on-site allowing for immediate communication and coordination to optimize timely legal activities. The FHHL departments have complemented their staff with Spanish speaking individuals, and they perform all foreclosure and bankruptcy functions involving customer contact, cash handling, and invoice approval and payment.

The four-employee foreclosure group performs a detailed analysis of each loan and ensures that all loss mitigation attempts are acted upon before proceeding with foreclosure action. As a result of upfront collection and loss mitigation efforts, the annualized foreclosure cure rate is an excellent 12%. These efforts are commendable and help avoid unnecessary foreclosure expense. Other key attributes employed by the group include the following:

• File referral to attorneys is accomplished utilizing the VendorScape system for electronic-file referral and case-status monitoring. Cases are managed via state templates and exception reporting;
• Since Standard & Poor's last review, the foreclosure department has automated foreclosure cash instructions;
• Attorneys electronically upload file status to FHHL to effectively monitor foreclosure timeline performance;
• Maintains quarterly report cards on attorneys, who are rated by each functional department within the default management team;
• Foreclosure timeline performance portfolio-wide is solid at 93%;
• Less than 1% of insurance claims is curtailed or denied; and
• Ongoing specific subject/compliance training provided by attorneys from various states.

A dedicated staff of four employees monitors bankruptcies. Chapter 13 bankruptcies are approximately 60% and are performing to the plan. Bankruptcy controls administered include:

• Electronic bankruptcy notification for ascertaining bankruptcy filings and updates;
• DAISY software is employed, which allows for generation of customized default queries and reporting capabilities;
• Proof of claims filing has been delegated to attorneys and timeline performance is an excellent 100%;
• Motion for relief adhered to a strict schedule of 45 days and 60 days for Chapter 7 and 13 bankruptcies, respectively, or at investor guideline timetables; and
• A special and unique statement is sent to performing bankruptcy borrowers.

The company employs third-party vendors to assist with REO marketing and sales activities. One asset manager and one REO manager oversee the REO process. These managers approve all marketing plans and repairs that have a cost of $1,000 or more. The following controls and procedures are in place:

• A minimum of two interior, post-acquisition valuations to determine asset value and list price;
• Management approval of marketing plans;
• Cash for keys to avoid protracted eviction proceedings and expedite marketing time;
• Cost–benefit analysis matrix for determining property repairs;
• Closely monitored vendor performance to meet established service level agreements;
• Broker contract generally limited to 90 days;
• Review monthly broker status and activity report;
• Track REO losses by originating branch office to determine if origination or appraiser fraud exists;
• Eviction average of 28 days;
• Possession to sale averaged 155 days;
• Internet marketing utilized for all REO properties;
• Installed automated application system to receive and pay invoices; and
• The average gross sale to appraised value was 100.9% and net sale-to-appraised value was 88.6%.

Standard & Poor's believes FHHL has implemented effective procedures for default management, effective use of technology, and provides efficient oversight of its vendor relationships. Management continues to look at reengineering alternatives to optimize workflow efficiency and report monitoring to mitigate risk of loss associated with processing of foreclosure and bankruptcy cases and REO properties. Management is encouraged to continue to address its collection ASA and abandon rates directing them towards 20 seconds and less than 2%, respectively.