In the good old days when the US mortgage industry was healthy, there was a growing school of thought and statistics to back it up that the entire residential finance sector would one day be 90% controlled by just five lenders and servicers.
These would be mostly mega-firms such as Angelo Mozilo’s Countrywide Financial Corporation. In fact, Mozilo who was the poster child for mortgage banking and is now a disgraced figure and retired once spouted such thoughts to me, boasting that his beloved Countrywide would one day have an origination and receivables market share of 30%.
Dreams rarely come true and now that the US housing depression is three years old, no-one in their right mind would want to have a market share of 30% for the simple reason it would have 30% of a big mess.
Everyone is watching Bank of America as they could reap the benefits if it continues its market retreat
Of course, there is a great irony to such a statement. The surviving mortgage firms are making a fat profit on their current originations because loan standards are tight and the spread between their cost of funds and the rates they charge are so wide.
The problem most firms face is on their old legacy loans that is, the ones that are delinquent the units they are servicing and foreclosing on, on a monthly basis.
Five companies Wells Fargo, Bank of America, Chase, Citigroup and Ally Financial continue to control roughly 60% of the lending and servicing receivables market, but there’s a growing belief the historic march toward industry-wide consolidation is reversing and more small to mid-sized companies will have room to post handsome market share gains.
In the mid-1980s if a company had a 3% market share it was considered a major achievement. Much of the talk of more being available to smaller lender and servicers hinges on what the megabanks do in regard to their residential mortgage operations.
Bank of America, obviously, is a key focus of speculation because it has exited the wholesale channel, thrown its reverse lending business overboard, and is actively trying to sell huge chunks of its troubled receivables portfolio.
Most of Bank of America’s problem was that its receivables came to the bank via its 2008 acquisition of Countrywide, a deal that will go down in the annals of mortgage banking as the worst ever. Most mortgage professionals expect the company to continue to downsize its residential presence or even exit the business entirely.
“Everyone is watching Bank of America because they could benefit from an increase in market share if it continues to retreat,” says Paul Hindman, a senior vice-president at Management Advisors International, which among other chores provides staffing services to mortgage bankers.
Bank of America clearly is de-emphasising mortgages both originations and mortgage servicing rights. In Q1 while loan volume blossomed somewhat, every top five ranked originator posted double-digit growth rates except Bank of America, whose production plunged by 20%.
In Q2 the bank’s lending volume fell by 40%. And it’s no secret many of its top performers are looking at employment opportunities elsewhere or have already left. When a handful of its senior lending officials departed in the early summer for PennyMac, a small publicly-traded real estate investment trust, tongues were clucking in the industry that it was only a matter of time before yet another shoe dropped at the bank.
PennyMac, headed by former Countrywide Financial president Stan Kurland, is a perfect example of a small firm with no legacy issues and big plans to steal share away from established players.
The irony is that Countrywide Financial’s legacy business is at the heart of Bank of America’s problems, though Kurland was forced out of that company before its problems escalated. More on Bank of America in a future column.
Mid-sized lenders such as US Bank Home Mortgage, Branch Banking & Trust and Fifth Third also are poised to reap the benefits of deconsolidation, should it happen. These banks, all of which have established mortgage affiliates, mostly avoided non-prime lending during the go-go years and have few legacy issues.
Meanwhile, there is plenty of chatter about private equity money sitting on the sidelines, waiting and salivating at the opportunity to buy into mortgage banking on the cheap.
“You have the real estate investment trusts talking about jumbos, and there’s lots of talk about private equity money out there,” says one New York-based advisory. “There’s lots of talking, but it’s just that.”
The biggest fear about investing in non-bank lenders is whether they will have enough capital to deal with higher net worth requirements from government-controlled mortgage-buying giants Fannie Mae and Freddie Mac, and whether they can compete against banks in regard to compliance costs and testing for loan officers.
At least one investor, David Fleig of Financial Analysis Partners of Texas, is putting his money where his mouth is.
A former financer of lenders, Fleig has started a fund to buy into non-bank lenders with established track records. In a recent interview Fleig described himself as a firm believer that the industry could be in for significant change.
“The subject of de-consolidation dovetails precisely into the investment thesis of the private equity fund we are launching,” he says.
Among other things, he points to Basel III capital rules that will make it less advantageous for the megabanks to keep servicing rights.
“The potential impact of Basel III on bank MSR ownership, the dominant market share of the large banks they have had an oligopoly since the crisis hit and the looming impact of financial regulations has created a secondary market environment which we believe heavily favours well-managed middle market mortgage bankers,” he says.