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Why the Top Five Won't Be Buying Anytime Soon

In case you haven't noticed, the top five residential servicers in the U.S. have a combined market share of 43%. The top 10, as a group, have a 53.33% market share. Translated into English, that means the top five service a huge chunk of the $6 trillion or so in outstanding mortgages on our shores.

It's no secret in the industry that consolidation among residential servicers has been rampant. The trend really caught fire back in 1996 when Norwest Mortgage (since merged with Wells Fargo) bought one of its top competitors, Prudential Home Mortgage of Clayton, Mo.

At the time it was the largest deal in the annals of mortgage banking, involving $81 billion in servicing rights. Eventually, Norwest/Wells wound up with about half the $81 billion, because it didn't want the risk associated with some of Pru's jumbo product.

Since that deal, it's been off to the races for mortgage M&A, with Wells, Chase Manhattan and Washington Mutual each taking their turn and being the aggressive acquirer of the year. (Countrywide, smartly, has avoided taking a drink from the M&A bottle.)

In 2002, WaMu was the big kahuna of mortgage M&A buying both Dime Savings/NAMC of New York and CalFed and its First Nationwide unit. But don't expect the M&A gauntlet to heat up any time soon. As one investment banker put it: "The M&A business is dead, period."

Yes, even WaMu is taking a rest from gobbling up competitors. Wells? Mark Oman and company don't seem interested in buying anymore, neither does Chase (parent: J.P. Morgan), which probably still has a bad taste in its mouth from its acquisition of midsized subprime lender/servicer, Advanta Mortgage.

Stated differently, the top five servicers which also happen to be (more or less) the top five loan producers, don't need to buy anymore because they've already become fattened cows. And in this business, when it comes to servicing, being fat, or big, I should say, is good.

Big means economies-of-scale and scale is what it's all about. (Or so the experts tell us.) Just ask WaMu, which is about to tell its servicing vendor, Alltel, that it soon won't be needing its servicing technology tools anymore. WaMu is building an in-house system with servicing technology it inherited when it purchased HomeSide, a deal that closed in early 2002.

Of course, being really big also means you lose liquidity. Let's just say the top dogs at Wells or Chase wake up one day and decide they want to get out of the mortgage business. These two (and others) are so big that the only one who can buy them is another top servicer or maybe a foreign bank. Then again, HomeSide's parent, a foreign bank, got clobbered on its foray into the U.S. market. (Let's just hope HSBC doesn't meet the same fate when it finally closes on subprime giant Household International.)

But what if that "other" top servicer doesn't want to buy? Or what if that top servicer knows that they're the only bidder? Being the only bidder means you call the shots. Perhaps Fannie Mae or Freddie Mac would step up to the plate. Their charters may not allow them to originate, but they're allowed to service.

Anyway, the next five years will be quite interesting for the industry. Consolidation among servicers likely will slow as originators remain fragmented among three production channels. The wild card, as always, will be interest rates. Rates stir the straw of mortgage banking.

If the federal budget continues to spiral upward, rates could rise dramatically which means production will die, but servicing rights will be gold. Could we see the return of the 8% mortgage? Do I hear 9%?

Paul Muolo is executive editor of both Mortgage Servicing News and National Mortgage News. He can be e-mailed at: Paul.MuoloThomsonMedia.com.

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