Mortgage Strategies By Michele Francis Builder & Remodelor, July 2003 Securities Firms See the Advantage of Mortgages

It’s no secret that Wall Street is feeling the pinch from declines in its traditional equities-related businesses.

The Standard and Poor’s 500 fell 40% in the three years through the end of March after rising 100% for the three-year period before that. This is part of a decline that has created the longest declining market for stocks since World War II.

With mergers and stock offerings continuing their slump into 2003, firms that include Goldman Sachs, Morgan Stanley and Lehman Brothers relied on the bond business to boost earnings.

Bear Stearns Companies, the only Wall Street securities firm whose share price rose last year is a big player in the mortgage securities market. As the mortgage industry prospers, Wall Street is planning to play a bigger role in the business, correspondent lending in particular.
Morgan Stanley, the second-largest securities firm, has decided to commit significant efforts to the U.S. residential mortgage market and has introduced a correspondent conduit in June. Lehman Brothers, through its Aurora Loan Services (ALS) division, was an early entrant in the field, beginning operations in 1997 with 118 employees servicing about 26,000 loans. At present, ALS have approximately 1,100 employees and service over 269,000 loans with a combined principle balance of $30.5 billion.

The investment banks stress niche products and underwriting flexibilities, key features which give them an advantage. Merrill Lynch Credit Corp, for example, offers mortgage bankers an “origination edge” with these underwriting guidelines:

• Borrowers can qualify for larger loan amounts with an interest only   program, which has a single back-end ratio of 50%.
• Up to 100% financing for loans, including financing or cash-out   refinancing.
• Most property types are eligible, including co-ops and high-rise    condos.

Morgan Stanley is starting with a full range of non-conforming products, including jumbo, Alt-A and expanded criteria Alt-As.

Despite Wall Street’s enthusiasm it’s not clear what their ultimate impact will be. Personally, I am concerned that the mortgage market’s newest kids on the block are unfamiliar with the business they’re entering. The mortgage market presents a special set of risks that are different from other industries. I am not surprised to see them go into this field right now, since mortgage banking looks so good. However, to the extent that they get into activities such as retaining servicing, this will bring them into an entirely new area, involving both pre-payment and credit risk. Let’s see how these new players will deal with these risks. It is a little uncertain as to how things will end up.

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