The market for companies that originate subprime mortgages is heating up.
Investment bankers say further mergers and acquisitions will take place soon in the volatile, but highly profitable, sector of the home loan business in the wake of two recent deals.
Earlier this week, Resource Bancshares Mortgage Group announced it was merging with Walsh Holdings, a subprime lender, to form a new company. This merger followed last week's announcement that H&R Block Inc. had agreed to purchase Fleet Financial's subprime unit, Option One.
Geoffrey Glick, executive vice president of Hamilton, Carter, Smith & Co., a Beverly Hills investment banking firm for mortgage banks, said his company has been contacted by several conventional mortgage lenders about brokering deals for companies that make loans to consumers with battered credit histories.
Other investment bankers identfied Champion Mortgage Holdings, Parsippany, N.J., and Access Financial Lending Corp., Minnetonka, Minn., as subprime lenders likely to be sold.
In general, conventional mortgage lenders have shown a greater interest in expanding into the subprime arena in the last year. Large mortgage banks, such as Countrywide Credit Industries, Pasadena, Calif., and Chase Manhattan Mortgage Corp., Edison, N.J., have started their own subprime divisions.
Others have formed partnerships with subprime companies. North American Mortgage president and chief operating officer Terrance G. Hodel said there was no way his company could have started a subprime division on its own. That's why it entered into a partnership last year with Contifinancial Corp., a leading subprime lender in New York.
Contifinancial underwrites subprime loans for North American, the 12th- largest originator of mortgages, and is training North American workers so the company can eventually run the subprime operation itself.
And HomeSide Inc., last year's fifth-largest originator, is looking to form strategic alliances with lenders in which it would receive fees for offering other companies' B and C products, said HomeSide's chief financial officer, Kevin D. Race.
But now seems to be as good a time as any for a company to make a subprime acquisition. Many of the subprime companies are perceived as bargains right now. The stock prices of most of the publicly traded subprime mortgage lenders have plunged in the last few months as blowups in the subprime auto market raised concerns about similar accounting fiascoes surfacing with the mortgage lenders.
And despite strong first-quarter earnings increases for subprime mortgage lenders, investors have been wary about rising delinquencies.
"There has been some sort of queasy feeling at the moment about B and C companies," said Hilary Renz, senior vice president of Cohane Rafferty Securities, a Harrison, N.Y.-based investment banking firm and servicing broker. "Perhaps people making these loans are not keeping enough in the kitty to protect from losses."
One investment banker said it makes sense for subprime lenders to look to be acquired by a larger conventional lender because it provides a way for companies to finance future growth plans.
"(Conventional) mortgage companies as a whole are looking to enhance their revenue stream, and there are a lot of growing companies out there looking for capital," said Dan McDermott, managing director of Charbonneau- Klein Inc., a Houston-based investment banking firm for mortgage companies.
To that end, several subprime lenders have announced they will go public. Long Beach Mortgage, New Century Financial, and Champion have all filed for initial public offerings so far this year.
But placing a value on subprime lenders, especially those that aren't publicly traded, is a difficult task. Gerry Risi, senior vice president for CoreStates Capital Markets, Fort Lauderdale, Fla., said subprime servicing is not traded as often as conventional servicing so there is no general rule of thumb for how much B and C servicing is worth.
Typically when mortgage banks are being sold, much of the value lies in the servicing portfolio because most of the profits are derived from servicing, not originating loans. Depending on the quality of the loans in a portfolio, servicing can be sold for a premium of between 125 and 175 basis points.
For example, a company with a $2 billion conventional servicing portfolio could fetch between $25 million and $35 million for its servicing and slightly more for origination capability. But H&R Block agreed to pay $190 million for Option One, a company that serviced only about $1.9 billion. Is this an outrageous price?
Not necessarily. Mr. Glick said that companies are basing their valuation of subprime lenders more on their future production capabilities than their servicing.
And Mr. Risi added that for most lenders, it is cheaper to buy existing origination networks than to build their own.