Investment banks are bulking up their presence in mortgage lending, once the exclusive domain of their commercial and retail brethren. For some, such as Merrill Lynch, the advantage lies in being able to offer yet another financial product to its wealthy private clients.
Lehman Brothers has spent the past two years quietly building up its mortgage loan origination efforts. ?We now originate 55% of the MBS we underwrite,? says Lehman Brothers CFO David Goldfarb. ?A few years ago that used to be zero.?
Some of this has come from expanding the operations of its bank subsidiary, Lehman Brothers FSB. But it has also been buying loan origination platforms in the US and UK, the most significant of the three it bought last year being Aurora Loan Services.
It is at once both an offensive and defensive move. ?We wanted to continue to increase our market share in MBS, so it was important to get supply,? says Goldfarb, explaining the offensive tactics.
Despite not having a large mortgage loan origination platform in the past, Lehman has usually been a top three underwriter of mortgage-backed securities in the US since the early 1990s. In fact, along with two other institutions lacking a loan platform ? Bear Stearns and PaineWebber, now within UBS ? Lehman has dominated the MBS league tables. Goldman Sachs, CSFB and other investment banks have also performed well over the years.
Growing competition
It?s unlikely to stay that way if these banks don?t invest. ?Supply has been getting competitive,? says Goldfarb. Other investment banks have invested in their MBS platforms, and the mortgage originators have started setting up MBS businesses as well.
That latter point is perhaps the more important. The mortgage loan origination business is consolidating fast ? witness, for example, Citigroup?s purchase last month of Principal Financial?s platform ? with the top 10 players accounting for more and more supply. And they want in on the lucrative MBS business.
JPMorgan and Citigroup are already in it, but it?s the interest of the big players such as Countrywide, Washington Mutual and Wells Fargo that has the investment banks worried. Countrywide Securities is furthest ahead in taking supply from the street to repackage for itself.
Most of the investment banks are relying on building their own origination business. Only Lehman is buying. ?We looked at the platforms they?ve bought, and others,? says one of Lehman?s MBS competitors. ?That kind of vertical integration does make sense, but they seemed too expensive to us.? According to another competitor, ?it?s turning Lehman into a finance company. These deals mean about 3,000 of their staff of 14,000 now work on mortgages. And don?t forget they almost bought CIT a couple of years ago.?
Not so, says Goldfarb: ?Our mortgage business is part of the investment bank. Vertical integration makes logical sense, and brings an economic benefit. It allows us to control our MBS business in a broader and more profitable way.? The loan platform acquisitions, he contends, were fairly priced.
So far the strategy is paying off. Lehman has increased its share of the MBS market with its own loans, and has not suffered a drop in the amount of loans it is buying fromoriginators.