DLJ Would Buy Mortgages Mainstream Dealers Would Avoid

Moving into an area that most Wall Street dealers deserted after the 1998 liquidity crisis, the investment bank Donaldson, Lufkin & Jenrette Inc. is starting a subsidiary that it hopes will become a major buyer and securitizer of nonconforming mortgages.

The unit, which has yet to be named, will be based in Princeton, N.J., though most of its 100 employees will work out of Austin, Tex. It will be led by Jeffrey Detwiler, who was recruited from GMAC-Residential Funding Corp. in March. Donaldson did not say when the subsidiary will officially start doing business.

In an interview this week, Mr. Detwiler said New York-based DLJ is buying a broader array of loans and building its own servicing operation to service troubled loans.

By doing so, Donaldson would become a place where banks can sell riskier, illiquid mortgages that mainstream loan buyers such as Fannie Mae and Freddie Mac cannot or will not touch.

Mr. Detwiler said few Wall Street dealers commit themselves as his company will to these asset classes.

Indeed, it would have a competitive advantage shared by only one of its Wall Street peers, Bear Stearns & Co. - a division to service troubled loans. The 550-employee unit, EMC Mortgage Corp. in Irving, Tex., has been servicing delinquent and nonperforming loans for 10 years.

DLJ has long been a buyer of nonconforming mortgages but confined most of its purchases to safer, more fungible categories such as alternative-A, A-minus, and jumbo loans. That changed in January, when it started aggressively seeking subprime and second-lien mortgages, delinquent or defaulted loans, and those that were seasoned or originated for banks' portfolios.

Donaldson's forthcoming subsidiary appears to have been in the works since last year, when the investment bank took full control of Calmco Servicing LP of Austin. The investment bank previously held a partial stake in Calmco, a "special servicer" of troubled loans.

Then DLJ went on a hiring spree. In March, it hired Mr. Detwiler and Daniel Thompson away from GMAC-RFC, a unit of General Motors. The two executives spent last year building Homecomings, GMAC-RFC's special servicing division.Zan Hamilton, who helped Intuit shape its mortgage strategy, joined Donaldson in June. He will be an executive vice president of product and client management in the new subsidiary. And last week, Mr. Detwiler recruited another colleague from GMAC-RFC, Terry Farley. She will be executive vice president for structured finance and regulatory oversight in the new company.

James F. Schneider, director of business development for C-Bass, a New York company that invests in higher risk mortgages and has a special servicing shop, said the largest barrier to entering this business is gaining access to a "superior special servicer." He said a company that has a good special servicer before it goes out and buys loans will increase the chances that the loans it buys will perform as anticipated.

Mr. Detwiler said that one advantage he will have is the ability to draw on Donaldson Lufkin's expertise in handling credit; that will ensure that dicier loans get repaid.

Diane M. Pendley, senior director of servicer ratings at Fitch IBCA, said the advantage to a company of owning a special servicer is that it has direct control over the servicer's actions, and that the parent company's loans do not have to compete for attention with another company's loans.

Because it will buy troubled loans at steep discounts, DLJ's new unit could reap big profits, Ms. Pendley said. "If they get them re-performing and securitize them, it could be a home run," she said.

She said Donaldson may be acting in anticipation of an economic downturn that conceivably could produce "an abundance" of nonperforming and subperforming loans for sale.

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