The latest in a string of blockbuster mega-mergers to hit Wall Street has given the mortgage market pause as it contemplates what looks to be the formation of an extremely formidable competitor in the mortgage world.
Last week's proposed merger of Chase Manhattan Corp. and J.P. Morgan & Co., for $34.3 billion, would combine a leading residential mortgage industry player with a Wall Street firm that, when it comes to real estate finance, has been more active recently in spotlighting the commercial side of the business.
However, sources say that the mortgage portfolios of each of the banks is thought to be between $20 billion and $25 billion each, with relentlessly and actively managed portfolios - and a corporate combination of the two firms can very well lead to market dominance.
"A mortgage portfolio of that size could dictate value to the market," said the MBS head of a major Street firm. "The Street is much more apprehensive about the combined mortgage portfolios of these two companies."
To put these figures in perspective, consider that dealers held in inventory $37.7 billion of agency passthrough and Remic securities combined this year, and the weekly average for the year 2000 is $22.9 billion. Therefore, Chase's portfolio alone is approximately equal to average dealer inventory; when that figure is doubled in size as a result of the merger, a dominating figure in the market is born.
"The Street will regard the combination of these portfolios with fear and trembling," said an MBS investment banker.
Moreover, talk on the Street last week hinted that the federal pooling-of-interest accounting methodologies for bank mergers that were supposed to expire at the end of the year may be extended indefinitely - creating an environment that would be conducive to more bank mergers in the next few months.
All of this consolidation has worried buy-siders and dealers alike, who fear that an already battered liquidity scenario for mortgage-backed securities can degrade further.
"I don't think these mergers are necessarily very good," said Lisa Brown Premo, an MBS investor at First Union. "There has been a curtailment in liquidity already, and this brings liquidity further in that direction."
"This will most certainly hurt liquidity in the deals," added Robert Calhoun, director of research at fixed-income experts Tattersall Advisory Group.
League Table Moves
Among Chase's notable mortgage-related strengths is its position as the No. 2-ranked servicer; it is also a top-ranked conventional credit mortgage originator. Among J.P. Morgan's notable real estate finance activities have been its commercial mortgage origination and securitization efforts.
As to whether trading costs will be affected as a result of all the mergers, sources indicate that it will be less of an issue for the Chase/Morgan deal, mainly because JPM pulled back slightly from its mortgage business in 1994 and 1995. On the other hand, Donaldson, Lufkin & Jenrette, a firm which had fits and starts as far as being involved in the more liquid sectors, will probably be more affected by its merger with Credit Suisse First Boston.
DLJ had a huge business in whole-loan collateralized mortgage obligations. Many market players feel that the newly formed company may not be able to maintain the breadth of the old DLJ whole-loan business.
"The DLJ/First Boston merger is definitely more significant for MBS, because both firms were full-service and significant when it comes to mortgages," said an MBS trader.
Additionally, Chase/J.P. Morgan's combined league table rankings would not be as greatly affected as DLJ/First Boston (see charts page 8). While Chase maintained the No. 12 position for U.S. MBS year-to-date, and J.P. Morgan had the No. 14 slot, if the two companies were combined today, the new company would only move up to the No. 9 slot, with approximately $4.4 billion in proceeds, according to Thomson Financial Securities Data. Similarly, the combined company would move up to the No. 6 slot for global mortgage-backed debt.
On the other hand, the combined DLJ/Credit Suisse First Boston would be catapulted to the No. 1 slot for both domestic and global MBS issuance, according to TFSD.
As for how the combination will affect the other structured finance sectors, sources say that the merger of CMBS operations should prove to be the most interesting. Chase's conduit has done two or three issues a year, and the head of Chase's real estate group originally came from J.P. Morgan.
"Chase, as well as J.P. Morgan, have very good reputations, and Chase trades as a top-tier name," said a CMBS investor. "DLJ and CSFB originate a decent amount of collateral too, and UBS had been originating collateral. So I hope to see these larger firms raising the average deal sizes again. It has been disappointing in CMBS to see deals go back to the $600 million to $800 million range."
"J.P. Morgan has an excellent CMBS team but are very thin on the ground everywhere else," added another market observer. "They blew up rather messily in mortgage derivatives twice in the early nineties and have been out of the business since then. Each time it cost them $50 million, and since then they've only had a surface presence."
However, Morgan remains an active conduit issuer, the source said.
As for asset-backed securities, "Chase has an excellent ABS team expensively hired from Merrill Lynch", a source noted. The real-estate ABS team was brought over from Merrill last year, which morphed into the general ABS group. "If you combine the ABS and MBS teams of Chase with the CMBS team of J.P. Morgan, you have a strong team indeed."