Merrill Lynch & Co. said Tuesday that it agreed to buy National City Corp.'s First Franklin Financial Corp. unit for $1.3 billion to expand in sub-prime mortgage lending.
The purchase is the latest of several mergers involving sub-prime lenders, which offer loans to less creditworthy borrowers, as volumes fall and margins are squeezed.
Merrill also wants to add profit from securitizations, the packaging of mortgages into bonds that are sold to investors, and better compete with Wall Street rivals such as Bear Stearns Cos. and Lehman Bros. Holdings Inc. "They're thinking strategically in buying a business when it's out of season," said Bill Fries, a portfolio manager at Thornburg Investment Management Co.
First Franklin, based in San Jose, was the No. 10 sub-prime mortgage lender in the second quarter with $6.7 billion of loans, according to National Mortgage News. It made $29.6 billion of loans in 2005.
Merrill is also buying two other National City units: loan processor National City Home Loan Services Inc. and online direct-to-consumer mortgage lender NationPoint.
Dow Kim, Merrill's president of global markets and investment banking, said the transaction adds scale and creates "meaningful synergies" in securitization and trading.
The purchase is the latest of a mortgage company by a major investment bank.
Last month, Morgan Stanley agreed to pay $706 million for residential lender Saxon Capital Inc. Barclays and Deutsche Bank both announced mortgage servicing acquisitions this year.
"Strategically, this isn't a surprise because Merrill wanted to add an asset generator," said Jeff Harte, an analyst at Sandler O'Neill & Partners. "The price is a challenge to get my arms around. Exactly what earnings stream they bought is difficult to determine."
Merrill expects the transaction to close in the fourth quarter, pending regulatory approvals, and add to earnings per share by the end of 2007.
Cleveland-based National City, the No. 8 U.S. bank, expects to realize a pre-tax gain of $1 billion from the deal, equal to $1 a share after taxes. The company bought First Franklin from an affiliate of Bank of America Corp. for $266 million in 1999.