Replenishment Poses Challenge

Washington-It's starting to get lonely at the top for the "big five" of residential servicing. Then again, that might be OK with them.

In the world of residential loan servicing it's all about economies-of-scale: the more units a company can shovel into their servicing factories, the cheaper their costs and the better the profits. At least, that's what the experts have been telling us for years.

Before he left the mortgage industry with his tail between his legs, Countrywide Home Loans chief Angelo Mozilo hoped that his firm would achieve a 30% share within a few years. CFC's new owner, Bank of America, appears to have a crack at meeting such an aggressive goal with its current share of 21.68%.

Thanks to the meltdown in both the mortgage and credit markets and the resulting M&A binge - some of which was assisted by the federal government - the nation's top five residential servicers now control a stunning 67.06% of the market, according to figures compiled by Mortgage Servicing News and the Quarterly Data Report.

Two years ago the top five controlled about 53% the business.

Today, when it comes to doing the monthly processing on the nation's $9.6 trillion worth of mortgage debt the market share of big five look like this: Bank of America (21.68%), Wells Fargo (17.65%), Chase (15.09%), CitiMortgage (8.49%) and Residential Capital LLC (4.14%).

The top three as a group control 54.42% or $5.23 trillion in home mortgages.

At press time the Treasury Department said that it was investing $250 billion in several banks - including the servicing giants mentioned above - as a way to assure confidence in the U.S. banking system. None of the nine financial giants that Treasury had targeted for investment was in immediate danger of failing. But now that Treasury will soon own a piece of them it's assured that none of them will fail - giving these firms incredible market power. They can shout: "Do business with us. The government owns part of us. We won't fail."

A few years back, Brenda White, an analyst and investment banker, raised concerns about large servicers and their "replenishment ratios," which can be calculated by dividing a firm's receivables by its originations. The conclusion was this: the higher the ratio the better.

Now that Bank of America owns Countrywide, Chase controls WaMu, and with Wells about to swallow Wachovia, one question these companies face concerns their ability to originate enough new loans to replace the run-off on their servicing portfolios.

Every single one of these firms, without exception, has scaled back their production networks over the past 18 months in response to declining originations, rising delinquencies and ailing home prices.

The only "good news" for these mega-servicers is that many of their customers probably will not be able to refinance as easily as once before because of tighter loan underwriting guidelines, especially when it comes to "cash-out" refis. The bad news? Answer: delinquencies.

But once the mortgage business revives it will be interesting to watch if the big five - BoA, Wells, Chase, Citigroup and ResCap - will be able to produce enough new loans to prevent their portfolios from declining.

ResCap, in particular, likely will have the toughest time. General Motors, which owns 49% of ResCap's parent company, GMAC, is on the ropes financially, though it may merge with Chrysler. Hedge fund giant Cerberus Capital owns 51% of GMAC and 80% of Chrysler.

ResCap recently exited the wholesale business and slashed its retail origination network to the bone. When residential fundings pick up again it may have to rely on correspondent purchases to stem portfolio run-off.

Correspondent originations usually have tight profit margins. Then again, it's always possible that Cerberus may consider selling ResCap. Stay tuned.

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