M&A Activity in 2005

As we begin 2006, it's appropriate to step back and review merger and acquisition (M&A) activity within the mortgage banking industry in 2005. This column looks at some of the more prominent deals of 2005 and the potential implications for future deal activity.

Within mortgage banking, the

deal pace in 2005 lagged behind 2004 in terms of the number of deals and aggregate value. There were 31 deals announced in 2005 (see Figure 1), compared with 46 deals announced in 2004. The total aggregate value of the 10 deals for which pricing was disclosed in 2005 totaled $915 million, compared with $1.55 billion for four deals for which pricing was disclosed in 2004. However, there were a total of seven deals announced in 2005 valued in excess of $35 million, compared with only four during the same period in 2004. Moreover, one of the four deals in 2004 was valued at 51.26 billion, with most of that value attributed to the acquired servicing portfolio.

Although 2005 has not been an explosive year for M&A activity in the mortgage banking arena, there were some notable deals in the sector that are indicative of future consolidation in the industry. A main driver for M&A activity was the anticipation of a tougher operating environment ahead.

Since June 2004, the Fed has increased interest rates 13 consecutive times. The Fed's actions have resulted in a flattening yield curve, which has led to declining spreads throughout the financial services industry.

Many smaller players began to explore their strategic alternatives in 2005 as a result of spread compression and its negative impact on profitability, the expectation that mortgage originations would decline from the robust levels of recent years, and concerns about the frothy housing market and a possible turn in consumer credit quality.

During 2005 we did not see the megamortgage banking players emerge as buyers. With fully built origination platforms already in place, the megalenders are well-positioned to tap all segments of the market and efficiently source a diversity of products through their retail, wholesale and correspondent channels. Additionally, the largest players found little motivation to expand through acquisition in the face of a market environment that could require significant "rightsizing."

According to Inside Mortgage Finance, during the first nine months of 2005, the 10 largest originators increased their overall production by more than $100 billion compared with the same period in 2004. During this period the megalenders achieved an increase in market share of more than 2 percent, facilitated largely through organic growth.

A notable exception was San Francisco-based Wells Fargo & Co.'s announcement in March 2005 of its acquisition of Omaha, Nebraska-based Commercial Federal Corporation's servicing portfolio and correspondent origination platform. This was largely a servicing play and a means for the thrift to exit the third-party mortgage servicing business and focus on its core banking operations.

Another exception, Calabasas, California-based Countrywide Financial Corporation's acquisition of Los Angeles-based KB Home Mortgage Co., the lending arm of KB Home, in June 2005, was the first significant consolidation play by a top-10 lender since Horsham, Pennsylvania-based GMAC Mortgage Corporation's acquisition of Anaheim, California-based Pacific Republic Mortgage Co. in July 2004. Countrywide and KB Home also formed a joint venture through which Countrywide will service the mortgage needs of future KB Home customers.

For Countrywide, this deal is potentially a valuable source of future customers. KB Home is the fifth-largest home builder in the country, and expected to build 40,000 homes in the United States and France in 2005.

The most active acquirers of mortgage lenders in 2005 were banks, thrifts and real estate investment trusts (REITs) that were not already megaplayers in the business. The recurring theme throughout these deals was that the targets were complementary to the acquirer's existing business.

Mortgage lenders have long been attractive acquisition targets for commercial banks. They serve as vehicles for asset generation, and create opportunities for asset diversification and cross-selling. A number of banks acquired mortgage lenders in 2005.

The most notable of such transactions was San Juan, Puerto Rico-based Popular Inc.'s acquisition of Pleasanton, California-based E-LOAN Inc. As Popular seeks to expand its presence in the U.S. mainland, the acquisition provides the opportunity for increased penetration in the U.S. market, complementing its existing nonprime and warehouse lending businesses, and the opportunity to enhance Popular's technology platform.

In September 2005, Charlotte, North Carolina-based Wachovia Corporation announced it had signed a definitive agreement to acquire San Diego-based AmNet Mortgage Inc. and planned to integrate the company into its fixed-income division. AmNet's stable production of alternative-A paper is a valuable source of captive volume for Wachovia's securitization business. Being able to source product internally rather than rely on the wholesale market should result in lower origination costs, especially in the explosive alt-? sector, which has grown rapidly in the last couple years and sports fierce competition.

A common characteristic of E-LOAN and AmNet is that they were both relatively small public companies. Life as a small public company can be difficult. In particular, the burden on management's time and the additional expense imposed by Sarbanes-Oxley Act compliance, along with the lack of research coverage and institutional interest in the stock because of its illiquidity, can be reasons for a board and its management team to consider merging with a much larger partner.

United Financial Mortgage Corporation, Oak Brook, Illinois, another small public company, announced that it would be acquired by an affiliate of the Airlie Group LP, Greenwich, Connecticut, in the third quarter of 2005. The acquirer, a hedge fund, had purchased Alliance Bancorp earlier in 2005. Could this deal mark renewed interest of private equity in the sector?

In the increasingly difficult operating environment that was described earlier, Charlottesville, Virginia-based SNL Financial's REIT index (a broad classification of mortgage REITs) was down 30 percent in 2005. The self-originating mortgage REITs have seen their stock prices sink far less than those REITs dependent on buying mortgage loans and securities in the market.

Owning a captive source of origination volume with which to replenish and grow their portfolios was the motivation behind a number of acquisitions in 2005. It is this notion that drove Vero Beach, Florida-based Bimini Mortgage Management Inc.'s acquisition of Paramus, New Jersey-based Opteum Financial Services LLC.

IMAGE TABLE 1

Figure 1 Select Mortgage Banking Deals in 2005

Perhaps the largest transaction in terms of origination volume in 2005, and the largest acquisition accomplished by a mortgage REIT, was Irvine, California-based New Century Mortgage Corporation's acquisition of Toronto-based Royal Bank of Canada's (RBC's) mortgage assets. Having cornered the subprime market as the second-largest originator, New Century needed to look for new markets to penetrate in order to grow its business.

By acquiring the mortgage assets of RBC, New Century has gained entry into the prime and near-prime business. In addition, the purchase makes New Century the loth-largest originator in the country and has added 135 branches to its Home123 network, establishing New Century as a leader in the retail channel. While the terms of the deal were not disclosed, during a call with investors in May 2005, Patti Dodge, New Century's chief financial officer, said that the purchase price plus integration costs were roughly 4 percent of the company's market capitalization at the time-implying a deal value of $113.1 million.

And last, but not least, we visit the very first deal of the year in which Arlington, Virginia-based Friedman, Billings, Ramsey Group Inc. (FBR) acquired Deerfield Beach, Florida-based First NLC Financial Services LLC six months after the subprime mortgage lender abandoned its plans to go public. The acquisition was part of a strategy to expand the types of assets in FBR's si ? billion REIT portfolio, which consisted primarily of agency-backed securities prior to the acquisition.

In conclusion, during 2005, we saw a number of small and midsized mortgage companies, both public and private, sell in anticipation of the tougher operating environment that lies ahead. For a number of banks and REITs, this was an opportunistic time to enter into or expand their presence in the mortgage business.

As competition in the industry remains fierce, the consolidation trend is likely to continue. We anticipate buyers' interest will come from those seeing opportunity in the downturn, including financial institutions that are underweighted in the mortgage banking business, mortgage REITs seeking to enhance their captive origination capability and possibly a smattering of interest from private equity players.

SIDEBAR

The most active acquirers of mortgage lenders in 2005 were banks, thrifts and real estate investment trusts (REITs) that were not already megaplayers in the business.

SIDEBAR

Owning a captive source of origination volume with which to replenish and grow their portfolios was the motivation behind a number of acquisitions in 2005.

AUTHOR_AFFILIATION

Brenda B. White is a managing director of Deloitte & Touche Corporate Finance LLC (D&TCF) and a principal at Deloitte Financial Advisory Services LLP, New York. She has been an investment banker to the mortgage banking industry since 1984. She can be reached at bbwhite@deloitte.com. Efrat Yellin, a vice president at Deloitte & Touche Corporate Finance LLC. and Manish Pahlajani, an associate at Deloitte & Touche Corporate Finance LLC. contributed to this article. Unless otherwise stated, all market data and statistics referenced in this column have been provided by SNL Financial. Charlottesville, Virginia.

(NOTE: The views expressed in this column are those of the authors and not those of Deloitte Financial Advisory Services LLP, Deloitte & Touche LLP or of any member firm of Deloitte Touche Tohmatsu or their respective affiliates. Any reference to or omission of any company in this column should not be construed as a recommendation to sell, buy or take any other action with respect to any security of any such company. Neither the authors of this article nor Deloitte & Touche Corporate Finance LLC is soliciting any action with respect to any security or company based on this review. The companies mentioned in this article may be clients of D&TCF or its affiliates or related entities.)