Morgan Stanley has joined the growing list of investment banks making major investments in their mortgage securitization businesses by buying originators, servicers, or both.
On Wednesday the New York company said it had agreed to buy Saxon Capital, a Glen Allen, Va., real estate investment trust that originates and services mortgages, for $706 million in cash, or $14.10 a share - a 29% premium over Saxon's Tuesday closing price. The deal is expected to close this year.
Morgan Stanley has been expanding its mortgage capabilities over the past eight months. In June it hired Wes Iseley and Arvin Wijay from the Santa Monica, Calif., subprime specialist Fremont General Corp. to build a unit that will originate loans through brokers.
Anthony Tufariello, the head of Morgan Stanley's global securitized products group, said in an interview Wednesday that it found Saxon's servicing platform, which services about $26 billion of loans, particularly appealing. The subsidiary Morgan Stanley Credit Corp. services prime retail loans, but the company does not have an in-house servicing platform for nonprime products, Tufariello said. "We felt we had a void to fill, and Saxon, with its servicing capabilities, fit."
In addition, "servicing is a very important in this environment," he said.
Morgan Stanley also recently purchased two European mortgage businesses. On Tuesday it said it had hired David Spector, a veteran of Countrywide Financial Corp., to help build a European residential mortgage securitization business.
Last month Deutsche Bank AG agreed to purchase the New York lender MortgageIT Holdings for $429 million. Goldman Sachs Group said in May that it bought a minority stake in LownHome Financial Holdings, a San Jose, Calif., home lending start-up.
In June, Barclays PLC agreed to purchase Wachovia Corp.'s subprime servicing unit, HomEq Servicing Corp., for $469 million but said it has no plans to get into the origination business.
Morgan Stanley's decision to buy Saxon was not influenced by its rivals' recent dealmaking, Mr. Tufariello said. "We've been looking at opportunities for a while now. We will look at other opportunities in the mortgage space as they present themselves."
Saxon has had a rough time lately. It reported Wednesday that second-quarter earnings rose 23% from a year earlier, but dropped 67% from the first quarter, to $8.6 million, or 17 cents a share, which was 16 cents short of the average estimate of analysts.
The REIT recorded $4.4 million of one-time expenses that reduced earnings by nine cents a share. The items were a $2.5 million write-off of deferred tax assets, a $1.4 million reduction in servicing income, and a $500,000 provision for the settlement of a lawsuit.
In an industry that has been grappling with intense price competition and margin pressure, Saxon also has been criticized for originating loans at a high cost.
In the first quarter, Saxon had the highest origination costs - 4.1% of production volume - among nine nonprime lenders, according to a June report by Flagstone Securities. (The company has argued that it spends more to produce higher-quality loans.).
Tufariello said Morgan Stanley "did a fair amount of due diligence" on Saxon. "There were no surprises." His firm believes that with "our capital and our expertise coupled with what they already developed, we can make this a much more scalable and profitable entity." The investment bank plans to expand Saxon's product mix, he said.
Saxon also holds a loan portfolio of $6.7 billion, some of which Tufariello said Morgan Stanley plans to sell. How much will depend on market conditions, he said.
Michael Sawyer, Saxon's chief executive, said during its earnings call Wednesday that Wall Street firms will bring more efficiency to the mortgage industry, by lowering costs and increasing access to capital. Consolidation will continue as "the customer continues to be brought closer to the provider of capital."
Brad Hintz, an analyst at AllianceBernstein Holding LP's Sanford C. Bernstein & Co. LLC, said the deal "makes perfect sense" for Morgan Stanley.
The company "wants to be in the asset-backed securities business," Hintz said. "They want to gain market share, they want to be up there with the leaders ... and this is one way of gaining that share and positioning themselves for the longer term."
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