Wall Street's Mortgage Troubles

For the mortgage industry, Wall Street's big investment banks might seem like one of those friends who disappear when the going gets tough.

It wasn't that long ago that the investment houses, looking for ways to cash in on the then-booming housing industry, were buying mortgage lenders at a frenetic pace.

The story now is quite different. This past week, 1,200 people lost their jobs after Lehman Brothers Holdings Inc. closed subprime-lending unit BNC Mortgage LLC, a company it fully acquired in 2004. Similar steps are expected as investment banks try to erase any connection with loans to borrowers with weak credit.

"The mortgage industry has always viewed Wall Street as fair-weather friends, active when things are good and abandoned when times are bad," said Guy Cecala, publisher of trade publication Inside Mortgage Finance. "We're just at the beginning of them pulling away from mortgage operations, and the ones that are not closed down will be cut back severely."

Cecala, whose subscriber base is dwindling as mortgage bankers are laid off, said the investment banks are mostly looking after their image on the Street -- shedding these mortgage units is an easy way to bolster investor confidence. Many of the takeovers were completed at bargain prices, and unwinding them will have little impact on earnings.

Investment banks' stocks have been hurt by the defaults and delinquencies on subprime loans, which sent the overall stock market falling but in particular pummeled financial companies. For the most part, it hasn't threatened the health of the companies, although Bear Stearns Cos. took a harder hit after disclosing that two hedge funds it managed collapsed because of investments in mortgage-backed securities. Its stock, which has since recovered somewhat, fell about 33 percent and wiped about $5 billion in market value.

Those mortgage-backed securities are one of the reasons investment banks wanted to buy subprime mortgage lenders. The banks originate the loans, then bundle them together and sell them as securities to institutional investors.

More than 50 lenders have already gone bust since June and trading in the once-lucrative secondary mortgage market has dried up.

Lehman Brothers said it will take a $52 million charge for closing BNC when it reports third-quarter earnings next month -- hardly anything when compared to the investment bank's record profit of $4 billion last year. The company said it would continue to offer loans through its Aurora Loan Services, which it full acquired in 2003.

"The closure of this has greater implications than simply shuttering a business during a cyclical downturn," said Richard X. Bove, an analyst with Punk Ziegel & Co. "The nature of the mortgage banking business is to boom and then go bust and then boom one more time."
Analysts believe Lehman got out of the subprime business fairly cheaply, especially since it has held a stake in BNC for a number of years before buying it. Others might not be so lucky.

Merrill Lynch, the nation's largest brokerage, acquired First Franklin Financial Corp. from Cleveland-based National City Corp. for $1.3 billion in 2006. Merrill Lynch declined to comment about First Franklin Financial, but Chief Financial Officer Jeff Edwards told analysts during the second quarter that it has taken steps to curb losses in its subprime loan portfolio through risk management.

Bear Stearns operates subprime lender Encore Credit, which it acquired in the past year for about $26 million. It also owns Bear Stearns Residential and EMC Mortgage Corp. The nation's fifth-biggest investment bank laid off about 240 workers earlier this month from its mortgage businesses.

Morgan Stanley bought Saxon Capital in 2006 for about $706 million, Credit Suisse acquired subprime lender Lime Financial Services in April, and Barclays PLC bought EquiFirst Corp. for $225 million that same month. Deutsche Bank bought MortgageIT in 2006 for about $429 million last year.

Barclays and Deutsche Bank did not return telephone calls seeking comment, and the other banks declined to comment.