Citigroup to Buy Mortgage Unit

[T Roosevelt]

Knowing that interest rates must inevitably rise, and that we are facing a real estate bubble, why would Citigroup increase their mortgage exposure?

Citigroup to Buy Mortgage Unit
NEW YORK (Reuters) - Citigroup Inc. (NYSE:C - news), the world's largest financial services group, on Wednesday said it will buy Principal Financial Group Inc.'s (NYSE:PFG - news) mortgage servicing business, bolstering its position as one of the country's largest mortgage providers.

Principal estimated proceeds from the transaction will be $1.26 billion, including $290 million in excess of the book value of assets and transferred liabilities of $970 million.

[Frodo]

1. Rising rates doesn't necessarily mean lower profits

There are two parts to the mortgage business: Origination and servicing. They react differently to differing rate environments.

When rates are falling everyone expects mortgage companies to make a killing on refinancing. But they don't realize that all of those re financings can damage the performance of the servicing portfolio.

Now, some companies only do one end of the business (usually origination) and rate increases can hurt them badly. But a company with a heavy servicing portfolio will actually show an improvement from higher rates as fewer loans payoff early by being refinanced.

[T Roosevelt]

2. The Principal is a heavy purchaser of mortgages

They hold ours now - only took a few months after we bought our house before it (our note) was sold to them. But it seems that by holding mortgages in a rising rate environment, they are assuming a higher risk of foreclosures and defaults - something that to me seems bad for business. And with all the ARMs that are going to rise, it seems especially risky (though I don't know what Principal's ARM-Fixed spread is).