Consolidation of the mortgage servicing business has continued this year, though at a slower pace than during last year's refinancing boom.
The market has seen a smattering of medium- and large-size deals, the biggest being Chase Manhattan Mortgage's acquisition of Mellon Mortgage, announced in August. That deal adds $55 billion to Chase's already considerable portfolio of mortgage servicing rights, boosting it to the No. 1 spot among servicers, with nearly $300 billion.
Two main factors have driven mortgage servicers to either get bigger or exit the business in recent years. The obvious impetus for consolidation is the benefits of scale. Servicing - the business of collecting loan payments, remitting them to investors, and keeping track of obligors' accounts - requires major technological investments. The more loans a servicer has under management, the greater the payoff.
The other driver is fear. Servicing is a very risky and volatile business. When interest rates fall and homeowners refinance, servicers' fees disappear and companies have to replenish their portfolios or else write them down. If they find that the market value of their servicing assets has fallen below the value they previously placed on them, they must take charges against earnings.
While some of the more sophisticated servicers have used financial hedges - derivative instruments that gain value when rates fall - to guard against runoff, others could no longer stomach the risk and sold their portfolios.
A change in accounting rules in 1995 exacerbated the problem; the new rules required servicers to book servicing rights on most loans they originated. (They had always been required to book servicing rights they purchased.)
Last year, falling interest rates prompted a record refinancing boom - which was great for mortgage brokers and retail loan officers, but a problem for those on the servicing side of the business. Several companies had to take big writedowns, and some of those opted to get out of servicing.
The pressure has eased somewhat this year. "Now that rates are stable to rising, the desperation for people to get out (of servicing) has slowed down," said Edward Elanjian, managing director at Cohane Rafferty Securities Inc. of Harrison, N.Y., one of the top servicing brokers.
Still, there have been deals this year. One of the first was HomeSide Lending's acquisition of $18 billion from Bank One Corp. in March.
This was the portfolio that had been serviced by First Chicago NBD, which merged with the old Banc One Corp. last year. HomeSide, based in Jacksonville, Fla., had already purchased a like amount of servicing from Banc One right around the time the two Midwest banks' planned merger was announced in April 1998.
Banc One became one of HomeSide's "preferred partners," which sell all their production, servicing released, to the National Australian Bank unit. When it inherited First Chicago's servicing portfolio, the new Bank One Corp. again had to consider whether it belonged in the servicing game.
It decided it did not, and shopped the First Chicago portfolio around to a select group of potential buyers before striking another deal with HomeSide, which purchased $10 billion of the portfolio and agreed to subservice the other $8 billion.
Also in March, Bank One renewed its "preferred partner" agreement with HomeSide, but changed the manner in which it handed off servicing to the giant. Before, the two parties had a "flow" arrangement, in which the bank would sell each individual loan as it was originated to HomeSide.
Now they use a "minibulk" structure, in which Bank One will sell a loan in the secondary market, service it for a few months, and then sell servicing rights in large bundles to HomeSide. Many mortgage executives consider this method more efficient.
In April, BankAtlantic Bancorp sold its $3 billion servicing portfolio to First Nationwide Mortgage, a unit of California Federal Bank. BankAtlantic, based in Fort Lauderdale, Fla., took a $15 million writedown on its portfolio in October 1998 and decided to quit servicing in December.
One of the ongoing soap operas in the servicing market this year centered around Atlantic Mortgage and Investment, a $20 billion servicer based in Jacksonville, Fla., and owned by Pitney Bowes, a leading manufacturer of postage meters. In January, Pitney said in its annual earnings report that interest rate volatility had prompted it to look at "a range of strategic options to address the changing profile of this business in a way that maximizes value for shareholders." That meant Atlantic was for sale.
By early April, American Banker was hearing that Pitney was close to a deal, with the home-loan units of Fleet Financial Group, PNC Bank, and Bank United of Houston the leading bidders. But apparently Pitney could not find a bid to its liking, and by mid-May the company was said to be off the market.
But in mid-July, word circulated that Pitney had put Atlantic back on the block, this time using different investment bankers. A team comprised of Countrywide Servicing Exchange, a unit of home loan leader Countrywide Credit Industries, and Wasserstein Perella & Co., a prominent merger specialist, would replace Warburg Dillon Read LLC, which represented Pitney the first time around.
As of this writing, no announcement had been made about Atlantic's fate.
Another company that apparently decided not to sell its servicing was Colonial Bancgroup. The Montgomery, Ala., bank was a highly efficient servicer, largely due to low labor costs. But until late last year, it did not use any financial hedges, and it took a $30 million writedown in the third quarter of 1998.
Last December, it said it would stop relying solely on originations to make up for prepayments and started using Treasury futures and the like to hedge. But in mid-August, the buzz in the dealmaking community was that Goldman, Sachs was shopping around a book for Colonial Mortgage.
In September, Colonial said it had sold its wholesale origination offices to Union Planters Corp. of Memphis, Tenn., but that it would keep its $5 billion servicing book.
HomeSide continued to add to its roster of feeders this year. In June, Cendant Mortgage of Mount Laurel, N.J., agreed to sell it servicing rights on $7 billion of existing loans, and to sell it another $7 billion over the next five years.
HomeSide replaced Capstead Mortgage, which had had a "flow" arrangement to buy servicing on new loans from Cendant. Capstead sold its mortgage banking subsidiary after 1998's falling interest rate environment had forced it to take losses on both its mortgage-backed securities and its servicing asset. Similar to Cendant's arrangement with Capstead, the deal with HomeSide included a cobranding arrangement.
In August, Bank One supplemented its strategic partnership with HomeSide with an agreement to sell $3 billion of servicing over 12 months to First Nationwide.
Bank One wanted to diversify its partnerships, an executive at the Chicago bank told American Banker at the time. Having more than one partner gave it a better feel for the market.
Indeed, since Bank One had renewed its agreement with HomeSide in March, interest rates have risen significantly, increasing the value of servicing.
First Nationwide, meanwhile, got to geographically diversify its portfolio, which was heavily weighted with California loans, and it got a stable source of growth for its servicing book, so it would not have to bid aggressively for every single bulk package that hit the market.
Much fanfare surrounded Chase's announcement that it would purchase Mellon Mortgage. The industry had been eagerly anticipating the outcome of the Mellon negotiations for months, and Chase gained more than 600,000 new customers it could cross-sell to, not to mention more economies of scale and the ceremonial crown of top servicer.
But Chase has quietly participated in two other sizable transactions.
In September, word got out that Chase was actually selling $9 billion of servicing - a large package, certainly, but a drop in the bucket for what had recently become the biggest player in the industry. The servicing rights were for loans that Chase had not originated. Rather, it had purchased the servicing in several bulk transactions 18 to 24 months beforehand.
Chase is believed to have made a pretty penny on that auction, given that it purchased most of the servicing in early 1998 (the beginning of the refinancing boom) and sold it in an environment of rising interest rates and much tamer prepayments.
Chase never disclosed the identity of the buyer. In a recent interview, Steve Rotella, chief operating officer of Chase Manhattan Mortgage, was reluctant to give many details about the transaction. He did acknowledge that the sale was driven in part by earnings management, in part by a desire to diversify the portfolio geographically and in other ways, but mostly to manage "operational risk."
Chase just bought $55 billion of servicing from Mellon and buys a lot of bulk and flow packages regularly, he noted. Transferring servicing is a complicated, often tedious activity. "We need to make sure that we're sequencing, timing, and effectively handling those (transfers) and not allowing ourselves to get ahead of ourselves from a growth standpoint," Mr. Rotella said.
"When you buy a big deal, it doesn't mean there aren't pieces that have less value to you from some angle that other players might want. You have an opportunity to reduce operating risk by shedding assets."
Subsequent to that interview, American Banker learned that in August, Chase was the winning bidder for a large forward sale from Ohio Savings Bank.
Phoenix Capital, the Denver boutique, brokered the transaction. Chase agreed to purchase $5 billion to $10 billion from Ohio Savings over 12 months.
Again, the two banks will use the "minibulk" structure: Ohio Savings closes the loan and sells it to Fannie Mae; it sells servicing rights to Chase in bulk monthly and transfers the servicing quarterly.
The consolidation of the
servicing business is far from finished.
"When you look at the companies that have been selling and you examine where they stood in terms of having a well-diversified, well balanced business that could operate through different economic environments, they were not as well-positioned as others," said Mr. Rotella at Chase.
"If you look at other companies in the market today, there are some you could pick out that fall into the same category, where you'd question whether they have that kind of balance to carry them through. That would lead you to conclude there's going to be more consolidation."
