Even some of the biggest players in the commercial mortgage servicing industry are asking, "Should I stay or should I go?"
Pittsburgh-based Mellon Bank had been a major player in the servicing industry. In 1998, its commercial servicing portfolio totaled $14.8 billion, ranking the bank as the seventh-busiest servicer, according to Commercial Mortgage Alert. Mellon Bank's decision to sell its entire portfolio to Horsham, Pa.-based GMAC Commercial Mortgage was a surprise.
The purchase agreement was signed on March 31, and by the beginning of August, the entire Mellon portfolio will be transferred, making GMAC an even bigger mortgage servicer. In 1998, GMAC Commercial Mortgage was the largest commercial mortgage servicer in the country with a portfolio of more than $52 billion, according to Commercial Mortgage Alert. Considering that when GMAC started in the business back in 1993 its portfolio was only $3 billion, the company's growth has been explosive.
GMAC originated about $9 billion of new business last year, partially through third-party acquisition. "Rarely a month goes by that we haven't picked up a billion or two in acquisitions," says Barry Alan Moore, executive vice president and board member of GMAC.
While commercial-mortgage service industry consolidation is a reality, it has not happened in a mad rush. In fact, the pace has been maddeningly uneven: The previous merger of the Mellon-GMAC magnitude occurred in 1997 when Mellon purchased Bankers Trust's $7.9 billion portfolio.
So why did Mellon get out of the business? For its part, Mellon says the change was made to focus on its core businesses, but others speculate that when it bought the Bankers Trust portfolio, it did so too aggressively and couldn't make it profitable. The truth is probably somewhere in between - commercial mortgage servicing has become a low margin, commodity industry, and the increasingly high cost of technology necessary to manage huge portfolios only means those with enough client bulk and deep-pocket commitments can make it profitable.
"A year ago, commercial mortgage servicing was a commodity business," says Paul Smyth, managing director at Banc One Mortgage Capital in Dallas. "Servicing rights have been compressed with the competition, so you need a certain scale. Once you maintain that scale, profits are still there."
Pricing problems There were other problems, mostly in the general markets, that altered the commercial mortgage landscape. First, competitive pricing drove down margins, and then a worldwide capital crisis developed that affected the U.S. commercial mortgage industry.
Even today, the market is experiencing "suicide pricing," Moore observes. "In the master servicing arena, people are still trying to get marketshare, and when you are bidding on servicing, you are bidding on a low cost basis."
Servicing fee objectives generally run from 10 to 12 basis points for master servicing to 5 to 7 points for primary servicing. Some companies are servicing at 1 to 2 basis points.
By the end of 1998, Dallas-based AMRESCO's commercial mortgage servicing portfolio totaled approximately $41 billion, ranking it third. Unlike the other top servicers, AMRESCO is an independent company, not a subsidiary of a big corporation.
Without corporate sponsorship, when capital markets turmoil crunched the CMBS market last year, AMRESCO was buffeted much more than others. "There were a lot of rumors swirling about our company, most of which turned out to be grossly overexaggerated and revolved around whether we would be around or not," recalls Don Skidmore, president of AMRESCO Services LP. "If it had not been for the problems in the fourth quarter, we would have been number one last year by a wide margin," Skidmore says.
Despite the turmoil, AMRESCO still picked up 18% of the market in 1998 and this year has been on roll. In March, AMRESCO acquired three loan-servicing pools worth $7 billion and servicing rights on $6.5 billion from subsidiaries of Nomura Holding America Inc. It also was selected as master servicer for an $859 million Morgan Stanley Capital securitization.
But one company's pain can be another's gain, and Kansas City, Mo.-based Midland Loan Services says it received more new master servicing CMBS contracts last year than any other company by virtue of nabbing a $3.9 billion Lehman deal that probably would have gone to AMRESCO. Midland ended 1998 with a $41.2 billion servicing portfolio, making it the number two player in the industry.
"We benefited in the post-market crash third and fourth quarter last year, and we wouldn't have been in that position if we were privately held or had gone public," says Tim Mazetti, Midland's senior vice president.
"If you look back at 1993, the top five servicers were all traditional mortgage bankers except for Midland," he says. "The largest had $10 billion in servicing. Here we are five years later and we have one servicer over $50 billion, two over $40 billion and a couple more around $20 billion or better, and not one of them is a mortgage banker."
The top five servicers of 1998 accounted for 76% of the CMBS market, says Skidmore. "While the top five gained market share, we haven't seen these smaller guys selling out or exiting the business."
Banks avoid 'la vida loca' Some of the nation's biggest banks are also among the largest-volume servicers, but many take a cautious approach - servicing loans generated in-house and taking a judicious look at pricing for third-party deals.
Rounding out the top five servicers in 1998 were First Union with a $34.7 billion portfolio and Banc One Mortgage Capital with $18.4 billion. GE Capital trailed close behind with an $18.03 billion portfolio. All three take different approaches.
Charlotte, N.C.-based First Union remains one of the most aggressive portfolio acquirers. By May, the company had already boosted its portfolio above $40 billion through indigenous growth and winning numerous third party deals from securitizations done by companies such as Prudential Heller and Peachtree Financial. The company also services for Wall Street houses such as Lehman Brothers.
Whether a company stays in the servicing business really depends on the parent corporation's strategic plan, says Tim Ryan, a vice president and director of Commercial Mortgage Services at First Union. "First Union is going to stay big in commercial real estate and CMBS, and they heavily support our business," he says. "Others like Mellon that have exited the business strategically didn't have it together in this market."
Some players, especially banks such as a San Francisco-based Wells Fargo or a Chase Manhattan, don't bid on third party deals, but instead support internal originations.
The servicing horizon As to commercial mortgage servicing's future, it all depends on which companies want to make the investment in technology. "The business has really gotten expensive because there are a tremendous amount of requirements for more timely information from the investor community, especially in the CMBS market," says Janice Smith, a vice president at Chase Manhattan, the tenth-largest servicer in 1998 with a $4.8 billion portfolio. "If you can leverage technology you are going to keep the cost down."
Dallas-based Banc One Capital Mortgage is similar to First Union, fast-growing through a combination of internal growth and new clients. Banc One has been in the mortgage servicing business since 1990, but only averaged a $5 billion portfolio through December 1997. Last year, the portfolio shot above $18 billion. "None of that growth came from portfolio acquisition. All have been straight up new clients," says Ed Smith, COO of Banc One Capital.
Banc One Capital's outstanding 1998 continued into 1999. By the end of the first quarter, its servicing portfolio grew to almost $21 billion. "We have a couple of large clients that are very active in the CMBS market," says Smith.
GE Capital seems to be skating along the same track as Banc One and some of the other major commercial mortgage services, mixing substantial internal growth with third-party servicing. While GE Capital ended 1998 as the country's sixth largest servicer, it may move up this year since new business has been brisk. By the beginning of the second quarter, the company's portfolio had climbed to $21 billion from the $18 billion at the end of 1998.
Scanning the list of largest mortgage servicer organizations, there are three basic groups: subsidiaries of large corporate parents (GMAC and GE Capital); one independent (AMRESCO); and a handful of banks (First Union, Chase Manhattan, Banc One and Wells Fargo). Only one of the group is a subsidiary of a life insurance company - Newport Beach, Calif.-based Pacific Life. With $13.5 billion in servicing last year, Pacific Life ranked number eight, most of it internally generated.
Unlike many others in the field, Pacific Life is a major real estate investor in both mortgage loans and CMBS. Of its $13.5 billion portfolio, $3 billion comes from mortgage loans and $10.5 billion from CMBS By the end of 1999, the company expects to be in the $14.5 billion portfolio range, with additions coming from large single transactions by the company or servicing picked up from Credit Suisse First Boston.
"We are not in the game anymore at its current pricing," says Michael Robb, an executive vice president in real estate investments at Pacific Life. "We aren't going to be servicing for one basis point. We would not be interested in a new billion CMBS deal unless we could get a fair price. As for us buying other servicers, we have been asked, but we don't want to buy something that is losing money on its own as a stand-alone business."
Others might that's why the list of servicers is top heavy.