There has been an astounding amount of mortgage banking M&A activity in recent months and probably more to come in the near future.

Since early 1993, with the Troy and Nichols and Sears Mortgage sales, we have seen a cascade of mortgage banking transactions. By my count, during the last approximately 18 months, there have been 16 significant transactions involving an origination capacity of over $80 billion and servicing portfolios aggregating $160 billion.

These transactions have included seven mortgage banks with origination volumes in excess of $4 billion and six companies with servicing portfolios in excess of $10 billion. Buyers have paid well over $2 billion over and above hard assets for the servicing and origination capacity acquired.

Activity has included such landmark transactions as the sale of Sears Mortgage to FNC, the sale of Margaretten to Chemical Banking and, most recently, the .sale of American Residential to Chase Manhattan. Recent deal activity has resulted in a halving of the number of significant publicly traded mortgage banks (and much of the remainder of the universe is reported to be for sale).

The unprecedented pace of activity continues: There are at least 10 or 11 significant mortgage banks for sale, reportedly for sale, entertaining buyer interest, or publicly considering their options -- companies with 1994 origination volume aggregating over $25 billion and servicing portfolio balances well in excess of $160 billion. That's $160 billion done and $160 billion on deck.

All this activity has taken place and continues in an extremely volatile environment. Originators which in early 1993 were expanding their networks today are cutting capacity to match the almost 50% decline in industry production volume. Prepayments on portfolios have slowed considerably and portfolio valuations have increased commensurately.

Yet, in spite of the unsettled operating environment, the volume of M&A activity has continued at a robust pace -- and even increased in intensity. The strength of this activity and the ability of buyers and sellers to look through the current turmoil and agree on value evidences the powerful catalysts that are driving this transaction volume.

One of the more prominent forces to be considered is the appearance of commercial banks on the scene as aggressive acquirers. Commercial banks' interest has been driven by the confluence of a number of factors, including, among other things, a strong desire to increase the scale and geographic span of their mortgage origination businesses, significant perceived expense and revenue synergies, a buildup of bank capital, a desire to increase fee revenues, and lack of a lot of other financially attractive alternatives.

All indications are that there will continue to be a strong interest among commercial banks and they will remain the primary type of buyer for mortgage banks.

Another topic high on the agenda will be valuation. In recent transactions, buyers have ascribed and continue to ascribe valuations to mortgage banks -- particularly to the production capacities of targets -- that are unprecedented.

The question of how to value an origination franchise is an interesting, important, and controversial one. In many recent transactions, most of the leverage in valuation has related to the amount a buyer is willing to pay for future loan production.

There is a disparity of views among different buyers as to how to approach this question -- resulting at times in wide ranges of levels of interest and valuations. Difficulty in dealing with this issue is compounded by the environment we are in today in which buyers must guess how far industry production will fall this year and next, what a target's market share will be, and what the unit costs are given the production scenario.

Of course, servicing valuation also is an important aspect of value.

In recent months, as the market for servicing has finned, we have seen certain buyers getting aggressive and transactions getting done which are more servicing-motivated and less production-motivated.

Finally, the X-Factor in pricing in recent deals has been the degree of competition for a specific target. In a number of recent mortgage banking transactions, spirited competition has impacted price meaningfully -- in some cases almost 25% of the production premium paid.

We seem to be on a trajectory where the number of opportunities is increasing faster than the buyer universe, which obviously may temper future valuation. On the other hand, as the refi wave ends and sellers rationalize their operations and can market companies off their profitability and market share growth in a low-refi environment, buyers may perceive less risk and bid more aggressively.

This article is excerpted from a speech delivered at a recent American Banker conference on mergers in mortgage banking.

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