With volume growth elusive, mortgage companies look for partners

0
51

Sharp Credit – Credit News – Credit Information

Mortgage company merger and acquisition activity, on the upswing over the past three years, is expected to intensify as originations stay flat and production costs rise.

Industry observers view independent mortgage banks to be at the forefront of the coming consolidation given their funding disadvantages relative to depositories. “Those that are at the lower end of the continuum with respect to capital and liquidity, those are the lenders that are really needing to find a partner,” said Jim Cameron, senior partner at consulting firm Stratmor Group.

As originations declined throughout last year, lenders proved themselves willing to accept a certain level of margin compression and financial losses. But that trend isn’t sustainable, said John Campbell, managing director at Stephens. In his view, the surprise has been “that it’s taken as long as it has to get closer and closer to that true M&A cycle and consolidation.”

M&A-sellers

Expectations of consolidation remain intact despite a slow dealmaking start to the year — a pause generally attributed to valuation concerns and a preference by potential sellers to wait out the seasonally strong part of the year. Longer-term, the trend is clear. In 2016, there were 11 announced deals involving a mortgage company; for 2017, there were 16. That number doubled to 32 for 2018, according to Stratmor Group.

“We’re in an environment where lenders are trying to cut costs and reduce capacity — or at least redirect capacity — and meanwhile they’re trying to keep up with Rocket Mortgage on the front end,” said Cameron. “The bottom players know they need to develop that front end point of sale just to stay in the game, so there is pressure to write checks for technology at the same time they are struggling to generate positive cash flow for operations.”

In general, independents have been more likely to profile as sellers in recent deals and banks more likely as buyers. Of the 59 transactions over those three years, an independent mortgage banker was the seller in 50 of them and the purchaser in 39. Banks were the sellers in seven and the buyers in 11. Whether that bias holds is currently a topic of debate as some independents have the means to acquirer depositories.

One example was a deal in August 2018, when the Stitt Family Trusts, which owns Gateway Mortgage, purchased Farmers Exchange Bank, now Gateway First Bank.

Becoming a bank is “a pivotal part of our strategy,” said Gateway’s CEO, Stephen Curry, and it plans to grow its mortgage business. “We are actively looking at growth strategies including acquisitions. We’ve had a few shopped to us and we would expect to be a consolidator in 2019.”

Gateway has an $18 billion mortgage servicing portfolio, which provides liquidity for the company, he said. Servicing “is an invaluable counterbalance to the retail mortgage business cyclicality,” he added.

Gateway did sell some MSRs to facilitate the purchase, partially to raise cash as well as because of the regulatory capital requirements.

Becoming a depository alleviates some of Gateway’s concerns regarding profitability because it can offer other services including different loan types to its customers.

In addition, buying a depository helps to shield independent mortgage bankers from political risk, Whalen said in a follow-up interview. Right now there is a “quiet spell in terms of regulation,” but if Democrats regain control of the White House and the CFPB, the environment will change. And that will occur as the recent vintage of loans hit their peak default period, he said.

What will not change is that Gateway will remain privately held, Curry said. The Stitt Family Trusts were created by former Gateway Mortgage CEO and current Oklahoma Gov. Kevin Stitt.

It is not an easy task to purchase a depository, Gateway’s Curry said. “Finding a seller willing to partner and undergo a long review and approval process is challenging. Additionally, there are challenges with transforming a mortgage firm to meet the regulatory compliance requirements of a depository.

“Once a depository, maintaining sufficient capital would be challenging for most independents, and requires a careful balance between banking and mortgage activities. For these reasons, we believe there will be few who choose to follow this path,” he added.

The Gateway deal is of a kind with a model argued for by industry analyst Christopher Whalen in a February blog. In that piece, Whalen argued that mortgage bankers with a choice would do well to sell their servicing rights because of the financial and reputation risk of a down market and use the proceeds to buy depositories where they can “safely operate a lending and mortgage subservicing business,” he said.

“It radically changes the nature of your business. Suddenly you’re self-financing, you’re paying yourself for things like warehouse loans,” Whalen said.

Another option, he said, is selling MSRs to and coming to an agreement to subservice for a fee, pointing to Flagstar — which is a depository — as an example. “Regulators don’t mind that simply because you’ve taken the most problematic issue off the table, which is where the MSRs go,” Whalen added.



Original Source