With Prudential Securities' announced exodus from the institutional bond market, there will be one less player contributing to the mortgage-backed industry.
The effect of consolidation on the mortgage-backed market is twofold: while it hurts liquidity, the business becomes more profitable.
"During the 80s and the early 90s there were probably between 15 and 20 dealers in the mortgage market. How many are there now? Six, maybe?" said an MBS veteran. "How was anybody making money in this business? They weren't. But managers and boards of directors got tired of watching their capital churned into non-profitable business. But now, the business has shrunk, and now it is possible for the remaining players to make returns."
Of greatest concern is liquidity. "If you reduce market participants, you're going to have less liquidity than you had before," said Dan Castro, head of ABS research at Merrill Lynch & Co. "It definitely has some impact, because obviously, there's fewer people out there. If you have one guy swallowing up another guy, then there's one less guy out there to be providing liquidity."
Alice Young, a director at MetLife, is not too fond of the industry contraction, because fewer bids will be given for her company's bonds. "We view consolidation among Street firms as an issue from a liquidity standpoint," she said at the subprime conference in New Orleans last month, hinting that there is a "possibility of not so soft a landing."
On a positive note, she is predicting that consolidation will push the weaker players out of the market. Those left in the market could become stronger players, with more dedication to providing capital.
"Most of the consolidation is in acquisition and people wanting to expand in the business," said one ABS analyst. "If you're getting out of the business, you're pretty low on league tables, and probably weren't committing that much capital. You don't have somebody who's number one, two, three, four or five in the league tables getting out of the business."
Contraction through acquisition could actually bring more value through a larger, more committed entity. "If you lose sponsorship for the sector through these acquisitions, that would be my concern, but I really haven't seen a loss of sponsorship for the sector through the acquisitions that have occurred," said Eric Scholtz, managing director of capital markets at GMAC-RFC.
Another issue that arises is when an investment bank acquires an issuer, leaving that issuer fewer chances of getting competitive pricing for their bonds, meaning an issuer would have to seek out a competitor of its parent to do so.