This article, the second of two parts, is adapted from a talk by Mr. O'Donnell delivered last month at the senior executives conference of the Mortgage Bankers Association.

I estimate that originations in 1994 fell by more than 40% to nearly $700 billion. This year I estimate we will be very lucky to reach $600 billion. And in the future, anything above $600 billion will likely be considered a very good year.

The rise in rates and the wide spread between adjustable and fixed-rate loans has made adjustables, which are the bread-and-butter product of portfolio lenders - mainly commercial banks and thrifts - very popular.

Consequently, banks and thrifts are back in the market in force, and they are pricing very aggressively. They are often not subject to market discipline: That is, there is no one to say a 6#1/2%, no-point loan will not be profitable over its life. Because mortgage bankers must meet secondary-market pricing standards, by contrast, they are finding it difficult to compete. So portfolio lenders are increasingly gaining market share.

Nevertheless a smarter, stronger, mortgage lending industry will be able to handle its major challenges better than in the past. Why do I think so?

I believe that most publicly traded mortgage lending companies will end up owned by larger entities, mainly commercial banks. And these publicly traded companies account for a very significant percentage of originations.

The industry will therefore divide into two types of companies: privately owned, mostly smaller companies at one end of the spectrum, and subsidiaries of strong parents, mostly the large industry players, at the other end.

This is a back-to-the-past scenario. Until 1992, mortgage banking did not exist as an industry with publicly traded companies. The only exception of note was Countrywide. The unexpected surge in Countrywide's stock in 1991 from $5 to $19 prompted a dozen major competitors to go public the next year.

In 1994 that trend was reversed. Some examples: Margaretten was acquired by Chemical, Loan America by Barnett, American Residential by Chase, Arbor National by Bank of America. Now Plaza is to be acquired by Fleet Mortgage, which itself has received an offer from Fleet Bank for the 19% stake Fleet Bank does not own.

Larger parents simply make mortgage banking subsidiaries more efficient operations, less subject to economic ups and downs and - most important - better able to withstand interest rate movements than are free-standing companies.

And by looking to the long term rather than quarterly earnings, subsidiary companies can better avoid the boom-and-bust cycles of cost buildups and cutbacks, as originations wax and wane. Banks can also provide low funding costs and substantial capital bases. Finally, they can provide needed funds for investment in technology.

Why do banks want to acquire mortgage banks? The major reason is that residential lending currently looks very attractive when compared to other potential revenue sources. The banks' best and most traditional customers - large blue chip corporations - have simply found other sources of funding, mainly the commercial paper market. Other activities that seem to be likely replacements, such as commercial real estate lending or lending overseas, have turned sour, or are seen as far riskier than they once were.

So, the bottom line is this: a mortgage banking industry made up of well-run, smaller, privately owned companies and subsidiaries of large companies will be better able to meet the challenges in the future than the industry has in the past.

And mortgage banking as a business, regardless of ownership structure, should continue to flourish. Fannie Mae, Freddie Mac and the rest of the secondary market will continue to buy - and at increasingly higher levels - the loans that mortgage bankers produce, both in good times and in bad. The secondary market is an enormous source of liquidity. The secondary market can even be called the lifeline of the industry.

Moreover, it's simply cheaper and more efficient to raise funding for mortgages in the capital markets than it is to fund mortgages by government-sponsored deposits.

Thus, despite the fact that it will remain a cyclical business, with its ups and downs and changing ownership patterns, the longer-term outlook for mortgage banking as a business remains very bright.

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