Mortgage Markets Get a Hand from BoFA

The giants are taking hold of the mortgage industry. Bank of America's purchase of Countrywide is a vote of confidence in the revival of the housing industry.
By: James R. Hagerty: The Wall Street Journal Online
The giants are taking control of the home-mortgage market.

Friday's agreement for Bank of America Corp. to buy Countrywide Financial Corp. for $4 billion shows how size and financial solidity are trumping everything else in mortgage lending. With the heft to withstand rising defaults and falling home prices, these big companies are helping prevent a total shutdown of mortgage lending.

"Bank of America stepping in right now is a very good thing for the market" because it signals confidence in an eventual revival of the housing and mortgage markets from what appears to be the worst slump since the Great Depression, said Susan M. Wachter, a finance and real-estate professor at the University of Pennsylvania's Wharton School.

There is a price to pay: Their greater role means less competition and higher costs for consumers, at least in the short run.

But giant banks like Bank of America have the ability to finance their lending relatively cheaply through deposits and to keep on their books loans that are hard to sell to investors. That insulates them from the market fears that, in the past year, have knocked thousands of small and midsized lenders and brokers out of business because they could no longer find takers for loans they generate or borrow money at reasonable rates.

Those fears may drive other big mortgage lenders into deals. Washington Mutual Inc., which had 5.9% of the mortgage market in the first nine months of 2007, has been struggling with heavy loan losses and is considered a potential takeover candidate, as is IndyMac Bancorp Inc., whose share was 3.3%. Both Washington Mutual and IndyMac operate thrifts and are heavily focused on home mortgages.

One potential buyer for Washington Mutual is J.P. Morgan Chase & Co., which has expressed interest in expanding its retail-banking franchise in places like California and the Southeast. Executives at J.P. Morgan also have expressed interest in other regional banks.

The Bank of America purchase is "the first step on a new way of life" for the mortgage industry, said Paul J. Miller Jr., an analyst at Friedman, Billings, Ramsey & Co. To survive, major lenders will have to hold more capital and charge higher interest rates, in relation to their cost of funds, to compensate for the risks of home loans. Those risks have increased because house prices are falling, lowering the value of collateral, and it is no longer easy to sell loans other than those that match the criteria for sale to government-sponsored mortgage investors Freddie Mac and Fannie Mae.

Having a well-known name like Bank of America or J.P. Morgan Chase also is important in this period of turmoil because home buyers, and the real-estate agents who advise them, don't want to risk finding out at the closing table that their lender has just shut down. "Right now people are afraid, and they're looking for certainty," said Tom LaMalfa, a managing director of Wholesale Access, a mortgage-research firm in Columbia, Md. He said many are willing to pay a bit more in fees or interest rate to get a loan from a lender they view as solid.

The shakeout follows an unprecedented boom. During the first half of the decade, when falling interest rates encouraged millions of Americans to refinance, big lenders couldn't keep up with demand. That left plenty of room for small lenders and mortgage brokers, which originate loans for sale to bigger lenders.

Now, defaults are forcing lenders to tighten their standards, and mortgage volume has been plunging, along with home sales. The Mortgage Bankers Association has projected home mortgage originations of about $1.86 trillion this year, down from a peak of $3.95 trillion in 2003.

With much less business, big lenders are much less inclined to accept loans generated by brokers, especially as those loans in the past often have been more prone to default. The number of mortgage-brokerage firms - mostly tiny operations with a handful of employees - has dropped to 40,000 from 53,000 a year ago, estimates Mr. LaMalfa of Wholesale Access. He thinks the number is likely to fall to 30,000 by the end of this year.

Mr. LaMalfa thinks brokers will remain a significant part of the mortgage business because they tend to have low costs, a willingness to work in the evenings or on weekends and an ability to reach borrowers in neighborhoods with few or no bank branches.

For now, lenders are being forced to concentrate on loans that either can be sold to Fannie or Freddie or those considered safe enough to retain as long-term investments.

For Bank of America, buying Countrywide will gain it a commanding position in mortgages. Bank of America and Countrywide had a combined market share of about 25% in the first nine months of 2007, according to Inside Mortgage Finance, a trade publication. That puts them far ahead of the No. 2 mortgage lender, Wells Fargo & Co., with a market share of about 11%. The other top contenders in terms of loan volume are Citigroup Inc. and J.P. Morgan Chase, which both had about 8% of the market in last year's first nine months.