Daily Briefing Weekend Edition

Cartel of 4 Will Dominate

By Brad Finkelstein & Bonnie Sinnock

NEW YORK-When the smoke finally clears from the two "mega" deals of the past week - both of them the result of the nation's credit/housing crisis - the mortgage industry faces a stark new reality: just four firms will control 65% of the residential servicing business.

Over on the origination side of the industry, the emergence of this "cartel of four" - Bank of America, Wells Fargo, Chase and Citigroup - will be only slightly less stark. When it comes to loan production, these four will have a combined market share of 60.03%, according to figures compiled by National Mortgage News and the Quarterly Data Report.

Before the last edition of NMN went to press, two monumental takeovers occurred: JPMorgan Chase bought the ailing Washington Mutual and Citigroup purchased Wachovia, which also was in trouble. All four of these players were already top 10 ranked firms in both residential servicing and originations.

JPM's acquisition of WaMu will make the bank/investment banker the second largest originator of home mortgages in America - at a time when the residential lending arena is becoming a precarious place to be.

In the brave new world of home finance, the top four (once all the checks clear) will include Bank of America/Countrywide (a 19.99% market share), Chase (15.56%), Wells (13.84%) and Citigroup (10.64%). In servicing, where consumers owe $9.6 trillion on their loans, the market leaders will be Bank of America/Countrywide (21.06%), Wells (15.56%), Chase (14.9%) and Citigroup (10.58%).

For the mortgage industry as a whole, consolidation means these four - in theory - could hold more sway over a host of third-party service providers, including mortgage insurance companies, loan brokers and technology vendors.

In years past - when the mortgage industry boomed - large players could extract volume discounts from vendors (such as mortgage insurers and even Fannie Mae and Freddie Mac) but the boom times also created an atmosphere where loan brokers could shop their loan packages to multiple wholesalers such as WaMu, Countrywide, Chase, Wells Fargo and a host of others.

With the WaMu and Wachovia sales still somewhat fresh, it's unclear what all this consolidation means for loan brokers. All four of these firms continue to use loan brokers to fund mortgages, albeit and a greatly reduced pace.

The capital markets' near collapse has accelerated the trend toward servicing consolidation. George Christo, executive vice president of Prestwick Mortgage Group, Alexandria, Va., a servicing brokerage firm, called the WaMu deal a "harbinger of more consolidation." A decade ago, the nation's top servicer had a market share of just 5%.

For the last 10 years, the mortgage industry has been perceived to be following the path of the credit card industry, where accounts are managed by a very small number of very big players. The turmoil in the industry is adding fuel to that paradigm shift, making once unimaginable acquisitions look attractive.

In the short term, Mr. Christo says the WaMu collapse probably won't have much impact on the market for mortgage servicing rights. Over the longer term, however, he is concerned that consolidation may lead to an oligopoly, where a small number of players control pricing for portfolios.

Already, one source who works with the government-sponsored enterprises noted that Fannie Mae has issued new net-worth requirements for seller/servicers, suggesting that the agency expects in the future to do more of its business with a smaller number of larger mortgage companies.

When it comes to residential originations, Chase is not gaining much in terms of market share because WaMu's loan production volumes had become a shadow of their former self. (Prior to the deal, Chase ranked second with a 13.16% share, WaMu eighth with 2.4%).

But WaMu's disappearance from the market eliminates yet another competitor, which means once the business returns Chase will be in the envious position of gaining hundreds of new storefront branches through which it can make retail loans.

Analyst David Olson of Wholesale Access, Columbia, Md., noted that although WaMu had basically shut its wholesale production channel down this summer, given the lack of product differentiation in the marketplace, it is just one less outlet for consumers and mortgage brokers to get the same thing. There is "a trickle" of new start-ups in the mortgage business, he said, noting that not only are the number of firms declining but so is their willingness to lend.

Even before the shutdown, WaMu's main product was the payment-option ARM where volumes were declining tremendously. "There is no lending other than vanilla (Fannie Mae, Freddie Mac and FHA)," said Daniel Jacobs, chief executive of 1st Metropolitan Mortgage, Charlotte, N.C., the nation's second largest mortgage broker. Mr. Jacobs said wholesalers are being pickier about who they do business with.

Meanwhile, JPM's purchase of both WaMu and Bear Stearns - and Bank of America's purchases of Countrywide and Merrill Lynch - leave two bank industry players in charge of not only the embattled mortgage industry's lending and servicing but also in control of the troubled real estate finance capital markets that have jeopardized the country's financial system.

Deals and liquidity have been relatively sparse in the problematic subperforming mortgage/securities markets both Chase and Bank of America now hold substantial stakes in. To date, relatively small bank players have been most active in terms of the limited number of transactions done in them of late but BoA and Chase's new leadership in this area, combined with the potential for a Treasury plan to revive the market, could possibly change that.

Small regional banks have been perhaps most likely to buy distressed mortgage deals of late because they tend to be familiar with and have expertise in the regional peculiarities of the collateral, said Frank Pallotta, chief executive officer of Steel Curtain Capital Group LLC, a former Wall Street mortgage capital markets executive and owner of a company that specializes in these assets.

In putting a value on WaMu assets in the deal, including some problematic ones such as payment-option adjustable-rate mortgages, Chase has provided the market with some price discovery that may encourage other players to invest and improve liquidity, he said. Also, consolidation may help large players like Chase and BoA be able to do more in terms of leveraging investment banking relationships.

- Paul Muolo and Ted Cornwell contributed to this report