When Bank of America (NYSE:BAC) acquired Merrill Lynch in 2008, it presumed the two companies would be worth more together than the sum of their individual parts; that the combination would enrich both by allowing them to seamlessly cross-sell each other's products.
Given this, it's odd that Merrill Lynch continues to outsource the origination and servicing of its customers' residential mortgages to PHH Corporation (NYSE:PHH), a completely separate company providing mortgage banking services to financial institutions and real estate brokers.
I almost didn't believe it when Guy Cecala, CEO of Inside Mortgage Finance, told me this. "My sense is that Merrill Lynch doesn't feel like it's losing any customers by doing so," he said. "It also doesn't seem like the two companies have been very successful at integrating their operations."
In 2014, PHH Corporation originated $36 billion worth of mortgages. Nearly a quarter of the total, or 24%, came from Merrill Lynch. That equates to $8.6 billion in originations. Had Bank of America underwritten those, its mortgage origination volume would have jumped 20% last year -- 16% if you include home equity originations.
It's worth noting, moreover, that most of these are probably super-prime jumbo loans -- just the thing a commercial lender needs to see it through the lean times of ultra-low interest rates. To be a Merrill customer, a person needs at least $250,000 in investable assets, not including their home.
To be clear, this doesn't mean Bank of America is relinquishing $8.6 billion in annual revenue, much less net income. Last year, PHH Corporation generated $495 million in top-line revenue from its mortgage origination business, or only 14% of its volume. If you take Merrill Lynch's proportional share of that, it means Bank of America surrendered something like $120 million in revenue last year to a competitor.
This may seem insignificant given that the North Carolina-based bank generated $84.3 billion in net revenue last year. However, the more trenchant takeaway is what the current arrangement suggests about Bank of America's ability to realize the once-proselytized synergies between the companies. That Merrill Lynch's thundering herd of financial advisors is unwilling or unable to recommend something as basic as a Bank of America mortgage, makes one to wonder what other integration-related problems lie beneath the surface.
That said, PHH Corporation has intimated that it may soon be kicked to the curb by Merrill Lynch -- replaced presumably by Bank of America. PHH's agreement with Merrill Lynch expires at the end of this year, and the parties are struggling to agree on the terms of a new one.
"[T]here can be no assurances that the agreement will be renewed on favorable terms, if at all," PHH said in its latest 10-K. And on its most recent conference call, held at the beginning of May, CEO Glen Messina explained:
We are near the end of negotiations with clients representing 30% of our 2014 total [private label] closing volume and we should complete these negotiations by the end of the second quarter. . . . For clients representing the remaining 20% of our 2014 total [private label] closing volume, these clients remain highly engaged, and we continue to work diligently with them to conclude the negotiations as soon as possible.
Messina was understandably coy about which group Merrill Lynch fell into. The percentages seem to suggest the former, as Merrill's share of PHH's private-label volume last year was markedly over 20%. But one can't help but wonder whether the investment bank is instead the one that's still "highly engaged" in negotiations.
For PHH, this amounts to a substantial threat, as the failure to renew its agreement with Merrill Lynch would subtract a material share of its mortgage underwriting activity. For Bank of America, though, if it does in fact choose to go its own way, then I believe investors can interpret the move as a thawing of the ice, be it voluntarily or involuntarily, between its commercial and investment banking units.