A funny thing happened early this year when First Union Corp. began talking to potential suitors about selling its subprime unit, The Money Store. Most firms weren't interested in the ailing TMS, but one, Wells Fargo & Co., said, more or less: We wouldn't mind bidding on your "A" paper servicing unit.

As the story goes, First Union--which planned to take a $1.7 billion hit on TMS--figured it made sense to get rid of all its potential headaches at once, and book all its pain when announcing second quarter earnings. After some back-and-forth, First Union inked a deal to sell the First Union Mortgage servicing platform and its $50 billion in servicing rights to Wells Fargo.

While all this was going on, Wells and its mortgage unit, Wells Fargo Home Mortgage of Des Moines, IA, were in the process of striking deals to buy $80 billion in servicing from G.E. Capital Mortgage Services of Cherry Hill, NJ, and another $16 billion from Crossland Mortgage Corp., which it inherits by buying its banking company parent, Salt Lake City-based First Security Corp.

Yes, Wells Fargo has been a busy beaver when it comes to mortgage servicing rights, and it always has been--under another name. Back in 1996, Wells' predecessor bank, Norwest Corp., shocked the mortgage industry when it bought Prudential Home Mortgage, an $80 billion servicer. Then, $80 billion in servicing was a massive deal. Overnight, with the PruHome purchase, Norwest just about doubled its servicing base.

Today, $80 billion doesn't seem so large, at least not to Wells, which has $301 billion in residential servicing on its books and another $152 billion set to come online after it closes on the G.E., First Union, and Crossland deals. (The $80 billion from G.E. involves an agreement whereby Wells will sub-service the mortgages for G.E., retaining an option to buy the receivables over the next three years.)

Once the three deals have been completed, Wells Fargo Home Mortgage will have total residential receivables of $454 billion, which will give it a market share of 9.3%. Stated differently, there is $4.88 trillion in outstanding residential debt in the U.S. which means Wells will own the servicing cash flow stream on almost 9.3% of it. That's nothing to sneeze at, especially when you consider the fact that the U.S. residential loan market is now the largest debt market in the world--even larger than the U.S. Treasury debt market. As the U.S. government pays down the national debt, housing receivables, by comparison, will become even larger.

To some, a 9.3% market share may not sound like all that much, but consider this: Back in 1993--just seven years ago--Countrywide Home Loans was the top servicer in the U.S., with $80 billion in servicing and a market share of 2.48%. When Wells hits the 9.3% market share plateau, it will also be the Number One residential servicer in the U.S., but with a market share more than three times that of the industry leader of seven years ago.

There also has been talk that Wells may take a run at Countrywide, the last of the nation's large independent mortgage bankers. (See the August 2000 issue of U.S. Banker.) If Wells does wind up buying Countrywide, it will have total residential receivables of $720 billion and a market share of 14.78%. Like most publicly traded companies, Wells will not comment on rumors concerning whom it might--and might not--purchase.

But it is no secret that Wells Fargo likes the residential mortgage business. In the past, its intentions may have seemed lukewarm, but when it bought PruHome, all that changed. The purchase suddenly put the company on the map.

One CEO of a top competitor of Wells Fargo Home Mortgage, requesting his name not be used, calls Wells "totally out-and-out committed to the mortgage industry." He predicts that within a few years Wells will have a servicing market share of 20%. Given its recent and pending purchases, that seems entirely doable.

Angelo Mozilo, chairman of Countrywide, predicts that within five years there will be just five major servicers left in the U.S. If he's right, it seems that Wells most certainly will be one of them.

A Wells Fargo spokesman, while refusing to comment on merger speculation, says, "We are always on the outlook for opportunities to increase shareholder value or to increase our services and products." Wells Fargo Home Mortgage president and chief operating officer Pete Wissinger was not available for an interview as this magazine went to press.

Others Heading for the Exits?

Mortgage servicing rights trade in the secondary market much the way loans and mortgage-backed securities do. If a conventional loan yields 8.25%, typically 0.25%--or 25 basis points of the cash flow--belongs to the servicer. Multiply that 25 basis points (44 basis points for government-insured loans) by the $4.88 trillion in outstanding loans, and you can see why mortgage servicing is, potentially, a lucrative business.Commercial banks and thrifts--with the exception of Countrywide, GMAC and a few others--dominate the mortgage banking industry. It is no secret in the mortgage industry that any time a large portfolio of servicing (or a medium to large company) is available, Wells takes a look. But for every "buy" transaction there is a seller.

Despite Mozilo's prediction that within five years there will be just five major servicers left in the U.S., as of June 30, 2000, the nation's top fifty servicers accounted for 66.9% of the $4.88 trillion in receivables. For his prediction to come true, scores of banks and thrifts will have to head for the exits.

Lewis S. Ranieri, the former Salomon Brothers bond trader (and father of the mortgage-backed security) who was immortalized in the book Liar's Poker, thinks Mozilo's prediction of "five in five" is a bit dire, but he too concedes that industry consolidation is a force to be reckoned with. In fact, on the eve of this issue going to press, Ranieri, struck a deal to sell his Houston-based institution, Bank United of Texas, which has a thrift charter, to none other than Washington Mutual Inc., for $1.5 billion in stock.

As already noted, First Union is throwing in the towel on mortgage servicing by selling its receivables to Wells. G.E. Capital Mortgage soon will disappear--also gobbled up by Wells. PNC Financial Services Group recently announced that it will sell its mortgage unit, PNC Mortgage. Also, several subprime mortgage banking firms--Advanta Mortgage, Nationscredit (owned by Bank of America Corp.) and Saxon Mortgage, to name a few--are on the block.

What's going on here? It's no secret that mortgage banking is profitable business. But at the same time, it is also a business with very tight profit margins. Some banks just don't have the stomach for it. Interestingly, the "old" Wells Fargo, the one that merged with Norwest to form the current Wells Fargo, gave up on mortgages in mid-1990s, citing the low profit margins. Bank of New York Co., J.P. Morgan & Co. and many other large money-center banks haven't been in the residential lending or servicing business for years.

One mortgage insurance official, requesting that his name not be used, blamed the industry's tight profit margins on Fannie Mae and Freddie Mac, the congressionally chartered, secondary marketing agencies that buy mortgages. This official, an insurance company vice president, believes that the two have turned conventional mortgage lending (that is, the making of residential loans to consumers with good credit) into a commodity business. And when something becomes a commodity--mass produced--profits plummet.

"I think what will happen is that eventually you'll have all these mega-lenders and a large universe of loan brokers, and everyone else in between gets cut out of the picture," he predicts.

Of course, mortgage insurance firms are less than enamored with Fannie and Freddie right now because the two have introduced loan products that feature self-insurance, thereby cutting into the profitability of--you guessed it--mortgage insurers.

Many banks know they can make okay money in mortgages, but okay isn't good enough anymore. Banks believe they can make more money elsewhere--in investment banking perhaps. Hence, they sell their mortgage receivables and get out of the business, vowing never to return, just like PNC Mortgage and First Union.

But not Wells Fargo. Under the tutelage of former Norwest executives Wissinger and his boss, Mark Oman, Wells is in it for the long haul. And it seems to have no fear of getting bigger.

But should Wells fear getting too big? There are some risks here. Remember, mortgage banking is a cyclical business. When interest rates fall, new loan volumes soar and servicing rights tend to disappear as borrowers refinance their loans. When Wells' servicing volume passes the $450 billion mark, will it be able to produce enough new loans to replace the mortgages that run off in the event of a refinancing boom?

And if rates rise and mortgage receivables increase in value (which is obviously good), will Wells be able to cut costs fast enough on the loan production side to post a decent profit?

In the second quarter of 2000, Wells Fargo Home Mortgage (as a stand-alone unit) posted earnings of $67 million, a mere 2% increase from the second quarter of 1999. A 2% growth rate is no great shakes, but then again the mortgage industry is the third inning of a cyclical downturn, and loan origination volumes are off 20% to 60% at some top firms, including Wells, where production fell 57% in the first three months of this year.

Some of Wells Fargo's competitors--World Savings, Washington Mutual and Countrywide--all had logged better second-quarter earnings than Wells, even though it outranks them in terms of production and servicing.

Interestingly, the nation's largest servicer, Bank of Amercia Mortgage, based in Charlotte, NC, does not report its earnings through its parent, which means it's impossible to tell how profitable its business is. There has been talk that BoA did a soup-to-nuts study of its mortgage business and considered--believe it or not--the possibility of having another firm service its residential loans. Even though BoA passed on the idea, it raises an interesting question: If BoA doesn't like the returns on servicing, who does?

Meanwhile will Wells Fargo's recent and planned acquisitions of receivables change this situation? By the fourth quarter, when its latest servicing acquisitions begin producing cash flow, Wells should have the answer.


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