MortgageIT went public only two years ago as a mortgage REIT, and in light of industry consolidation, decided there was not much hope to remain independent for much longer. Unlike most other buyouts, this transaction is surprisingly clean without significant conflicts of interest or excessive payoffs to management. Of course, there are the usual vesting acceleration and golden parachutes, but the amounts involved are modest by the standards that we have become accustomed to in today’s buyouts.
Instead, we are concerned that MortgageIT’s business could be as tough to maintain as that of the venerable Bankers’ Trust. Recall that Deutsche never managed to restore its investment banking unit to the level of Bankers’ Trusts’, and former BT employees fled in droves to competitors. Deutsche’s only comfort is that the record of Dresdner Bank (AZ), its compatriot, is even worse: after paying Bruce Wasserstein a 10-figure amount, Bruce and his team escaped to Lazard (LAZ) as soon as their contract was up, where he made another 10-figure fortune. Furniture and pencils were all that Dresdner was left with of its billion dollar investment.
MHL trades at a discount to the buyout price as if the deal were expected to collapse. Three aspects of MortgageIT’s business are of concern: first, the downtrend in mortgage lending generally, and in particular cratering mortgage volumes in California, where 50% of MHL’s mortgages are originated. Then, there is the quality of loans originated by MortgageIT: Bear Stearns is currently suing MHL to repurchase $70 million worth of loans. Finally, the Chairman and CEO Doug Naidus has been selling three quarters of his holdings near $14.60 this summer, approximately 1% below the buyout price (excluding dividends).
Even though there are enough reasons to doubt that anyone would actually want to buy MortgageIT, Deutsche’s purchase is of a strategic nature, so that cost and risk considerations are of secondary concern. Think BT or Wasserstein Perella.
The mortgage industry is consolidating through mergers of lenders, and also through purchases of lenders by other financial institutions. The current acquisition activity includes: Morgan Stanley buying Saxon Capital, Bear Stearns acquiring ECC Capital’s mortgage banking platform, and Wachovia’s purchase of Golden West.
The need to buy an originator is even greater at a time when mortgage originations plummet. Bringing a reliable source of new mortgages in-house is more a necessity now than in the past when plenty of volume was available in the market. And while Deutsche’s competitors in the securitization market buy up other originators, the volume that makes it into the wholesale market will decline even more rapidly than originations. For Deutsche, securitization and trading are an even greater share of overall revenues than for other investment banks, which tend to be stronger in advisory.
Therefore, strategic reasoning will prevail and it is very likely that the purchase will be consummated, despite its poor tactical timing. In the long run, it is likely to turn into yet another expensive and loss-making adventure of a European financial institution that finds itself under pressure to buy market share in the U.S. at any price before the doors close. Patience pays, but when your ROE gets to its target of 25%, management is easily tempted to spend on strategic visions at the wrong time.
The author manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which owns shares of MHL.