Now that the subprime mortgage meltdown has claimed some casualties, market observers are assessing who will emerge as the winners.
One obvious answer is the companies that regularly buy distressed assets at bargain-basement prices. However, a number of would-be bottom-feeders are lining up to buy delinquent loans and wobbly businesses, and their success will depend largely on how much they pay and how they manage the assets.
For expertise on such matters, they may turn to another potential beneficiary: companies that specialize in acquiring and servicing "scratch-and-dent" loans. As such outfits clean up the messes of the last few years, traditional secondary buyers and guarantors - namely, Fannie Mae, Freddie Mac, and the Federal Housing Administration - stand to regain the ground they lost during the subprime boom.
Among originators, the big banking companies that can withstand the current credit and trading losses have an opportunity to consolidate their market share.
Nearly a dozen major hedge funds, leveraged buyout shops, and private-equity and venture capital firms have entered the mortgage market in the past six months, bidding for distressed loans, lending platforms, and servicing operations.
Keith Johnson, the president and chief operating officer of Clayton Holdings Inc., a Shelton, Conn., due diligence, surveillance, and specialized loan servicing firm, said he speaks to at least 10 new private-equity players a month - "those who have big paychecks and can negotiate a good price."
Matthew Howlett, an analyst at Fox-Pitt, Kelton Inc. in New York, said he did not know how many "hungry mouths there were out there" until the volume of distressed assets on the market forced prices down.
"The smart buyers that make smart investments," such as Cerberus Capital Management LP, Citadel Investment Group LLC, and Ellington Management Group LLC, "have torn down the pricing," he said.
But it can be difficult to say how much prices have been torn down, because these largely unregulated, private investors often do not disclose how much they paid.
Mr. Johnson said, "I'm worried that there are a lot of people rushing in, and some of these guys may go in too fast and pay too little attention to due diligence."
WALL STREET
Investment banks fall on both sides of the aisle as winners and losers of the subprime mortgage downturn. Not only have they provided funding and warehouse lines to failed lenders, but they also own origination and servicing platforms and securitize all types of residential mortgage assets, generating substantial underwriting and trading revenue.
In a report issued last week, Leslie Bright, a senior director in Fitch Inc.'s financial institutions group, singled out Bear Stearns Cos. and Lehman Brothers as the two investment banks "expected to manage this weaker mortgage cycle well," even though they may suffer "sharper declines in revenues compared with their peers."
Bear Stearns began reducing its purchases of subprime mortgages in the first quarter of last year, Ms. Bright wrote. Lehman has "actively hedged its credit exposures" and "expects healthy profit margins" from Aurora Loan Services, its alternative-A servicing unit.
Merrill Lynch & Co. Inc.'s $1.3 billion purchase of First Franklin Financial Corp., and Morgan Stanley's $706 million purchase of Saxon Capital Inc., both of which closed in December, "were less fortuitous," she wrote, since they occurred just before the subprime market weakened.
LOAN DOCTORS
Special servicers are in strong demand, not only because servicing is counter-cyclical to mortgage origination, but also because vulture investors need special servicers to cure, manage, and liquidate nonperforming residential mortgage assets worth billions.
Special servicers that have received high marks from the rating agencies include Bayview Loan Servicing LLC, a unit of Bayview Financial LP of Miami; Litton Loan Servicing LP, a unit of the scratch-and-dent investor C-Bass LLC; and Wilshire Credit Corp., a Beaverton, Ore., unit of Merrill.
Stuart Waldman, a managing director at Bayview Financial, said there are "plenty of good loans out there" that offer "relative value," even though they have been relegated to the scratch-and-dent market.
"As portfolios deteriorate, there will be an increased need for the expertise of special servicers," he said, noting that Bayview created its servicing operations a decade ago to maximize value for its own bids. "Servicers for hire will have an opportunity."
However, "special servicing is something that requires a great deal of expertise and strong analytics to understand how to deal with borrowers on the credit counseling side," Mr. Waldman said. "The barriers to entry are fairly great."
OLD SCHOOL
Many alt-A lenders are selling their loans to Fannie and Freddie, because the government-sponsored enterprises are offering better profit margins and execution than Wall Street firms, which are no longer out buying loans aggressively.
Brian Simon, a senior vice president at Freedom Mortgage Corp., a privately held Mount Laurel, N.J., lender that acquired Irwin Financial Corp.'s origination business last year, said many lenders have been unable to sell loans because Wall Street firms have stopped purchasing certain products, mostly high-loan-to-value second liens.
"The herd is just going to be thin, and the agencies should have an opportunity to assert themselves," he said.
Selling loans to the GSEs can be more complex, largely because the servicing rights have to be sold separately, Mr. Simon said.
The FHA, a Depression-era program that insures low-income homebuyers, has been losing business for years to subprime lenders. Now lenders that have survived the downturn are looking to FHA products as a potential alternative.
FHA-insured loans can be made to first-time homebuyers with severely impaired credit, and once the mortgage insurance certificate is secured, "there is really no risk of ever having to buy back the loan," Mr. Simon said. (However, in past years other lenders have complained that the FHA requires indemnifications for even minor mistakes.)
Some lenders are hoping lawmakers will pass a reform package that would increase the loan limits and reduce or eliminate down payment requirements for FHA insurance.
GOLIATHS
"Even the best of the mortgage lending companies were vulnerable to the very different excesses of 2005 and 2006," said Michael Youngblood, a portfolio manager and managing director of research at the boutique investment bank Friedman, Billings, Ramsey & Co. Inc.
However, he predicted that Countrywide Financial Corp., IndyMac Bancorp Inc., GMAC LLC, Wells Fargo & Co., Washington Mutual Inc., and Capital One Financial Corp. will weather the storm and gain market share, largely because, as large, diversified companies, they can absorb any hits from subprime loans.
