Continuing a full-throttle drive into the mortgage business, Mellon Bank Corp. has agreed to buy Michigan-based Source One Mortgage Services Corp. for $718 million, sources close to the deal said.

The purchase of Source One - which is subject to Mellon's thorough inspection of the company's books - would cap a string of mortgage banking acquisitions that the Pittsburgh-based banking company began last year.

Since the beginning of 1994, Mellon has bought four mortgage lending businesses - and in the process has more than doubled its mortgage servicing assets to $45 billion. Its biggest purchase up to now was the September acquisition of Metmor Financial Inc., which serviced $13.6 billion of loans.

The addition of Source One's $28.7 billion servicing portfolio would lift Mellon to sixth place from 11th place among mortgage servicers, putting it firmly in the mortgage industry's upper echelon.

Mellon's aggressive pursuit of mortgage assets underscores its intensified focus on fee income. The company has also been buying fee- producing businesses in mutual funds and money management.

Mortgage servicers earn fees by collecting and processing monthly loan payments, a business that can be highly profitable for companies that attain sufficient scale.

With the planned purchase of Source One, Mellon is "saying you have to be very sizable to create sustainable streams of fee income," said Edward Furash, a Washington-based consultant.

"That's important, because banks' traditional net interest margin business is declining," Mr. Furash added.

News of the planned purchase came Wednesday when Source One announced that it had signed a letter of intent with "a significant financial institution," which it did not name.

Sources close to the negotiations told the American Banker that the buyer was Mellon. Executives at Mellon and Source One declined to comment.

Source One said the transaction calls for the buyer to pay book value - $653 million as of Sept. 30, according to SNL Securities Data - plus a $65 million premium. A definitive deal is expected by the end of January, and the transaction should close by the end of the first quarter, a spokesman for the Farmington Hills-based company said.

The sale represents a switch in strategy for Source One, which is headed by chief executive James A. Conrad. The company has at times been an acquirer itself, buying $5 billion in servicing rights as recently as November. It was also one of four companies that expressed interest in buying assets from Lomas Financial Corp., which entered bankruptcy in October after 19 months on the auction block.

However, Source One has also experimented with downsizing or an outright sale.

Indeed, Source One's parent company, Fund American Enterprises Holdings, put the company on the auction block in August 1994, but yanked it back when it failed to attract an acceptable offer. Shortly after, the company sold $10 billion of servicing to NationsBank Corp. It also has an agreement pending to sell $1 billion in servicing to Capstead Mortgage Corp.

Source One was not actively seeking a buyer when Mellon made its offer. But mortgage merger and acquisition advisers have considered the company ripe for sale in recent years, pointing to a runoff in assets amid the refinance boom of 1992 and 1993. Profits also suffered, with earnings of $40.1 million in 1993 giving way to a loss of $43.5 million in 1994.

Mellon, on the other hand, has pushed consistently over the past two years to boost mortgage assets, and is expected to continue doing so.

Observers point out that Mellon Mortgage Co.'s chairman, David R. Lovejoy, had a big hand in the banking company's merger and acquisition efforts before assuming his current position in October.

"This may not be the last acquisition in the mortgage area," said Anthony Davis, a bank analyst with Dean Witter Reynolds.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.