TheMReport — News and strategies for the evolving mortgage marketplace.
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40 | TH E M R EP O RT FEATURE I f last year was a good year to acquire mortgage compa- nies, 2019 is shaping up to be a good year to sell them. We saw a few notable deals to start off the year—Marketplace to New American Funding for $1 bil- lion in annual originations, Eagle Home to Movement Mortgage for $2 billion, Platinum Mortgage to HomePoint for $3 billion. Those three transactions alone amounted to $6 billion in production that transitioned in the first few months of the year. With lower interest rates in the spring, came a surge in origina- tion volume and an ensuing increase in mortgage banking profits that began in the second quarter. A number of lenders that were thinking about selling their businesses are now holding off, waiting to see what the market will do while they continue to reap the outsized (some might label as "windfall") profits they are presently enjoying. What these lenders don't seem to recog- nize is that they may be better off selling their business when rates are relatively low and financial performance is good. It's obvi- ously a sellers' market right now. Why not take advantage of it? However, getting the market timing right is just one of the many challenges that come with selling a company. It's why po- tential sellers owe it to themselves to consider all the reasons why mortgage company acquisitions succeed or fail, how the value of each company is determined, and what they should be doing now to maximize their chance of a successful acquisition. Shifting Goalposts W hile last year's uptick in merger and acquisition (M&A) activity in the mortgage business was primarily driven by a decline in income, most compa- nies sold their businesses for one or more of the following reasons: • Their balance sheet was under stress • They saw bigger competitors making significant investments in technology and marketing that were unaffordable to them • Personal reasons Companies in the last category are often led by aging execu- tives who are thinking about their retirement options, or who have much of their personal net worth tied up in their business. The thinking is, "I'll do better financially to work for somebody else or to turn the keys over and let my leadership team go work for somebody else." The drop in interest rates in the spring of this year changed their motivations. Suddenly, there weren't nearly as many "dis- tressed" sellers. Mortgage lenders who were stressing over balance sheet pressure and squeezing profit margins in 2018 and early 2019 saw business improve so markedly by mid-2019 that it was almost magical. As the pressures on their businesses eased and financial performance became a monthly celebration, many of those lenders who were previously thinking about selling decided to hang in there for a while longer. This is the wrong strategy to adopt. To achieve an optimal sale execution, you want to negoti- ate from a position of strength. By deferring a sale decision until the market signals that the party is over, you risk turning into a "scratch and dent" company that's now under more pressure to sell. Selling isn't easy under any market conditions, but a profit- able lender that is growing has the economic means to address deficiencies that need improve- ment, to demonstrate that they are profitable rather than try to explain why they aren't, and to still keep earning the bottom line while options are being explored. The Value Proposition T here are various ways to determine what sort of value a mortgage origination company would command under current market conditions, but for this article, I'll stick to the three that I see used most often. Speed to Market: New entrants generally look to acquire a mortgage company because it fits into a broader strategic roadmap for their business. For example, Zillow is a dominant player in the real estate industry, and their purchase of a mortgage compa- ny—Mortgage Lenders of America (MLOA) in late 2018—fit into their desire to have a broader range of mortgage capabilities. When Zillow acquired MLOA, they ob- tained the agency tickets (Fannie Mae, Freddie Mac, and Ginnie Mae), the state licenses, and an existing origination platform. It would have taken years and a significant expense to build those capabilities on their own. Discounted Cash Flow: With most deals, buyers purchase the assets of the selling company. So, how do you determine what the com- pany is worth? The traditional way is to evaluate the historical performance data as the basis to most accurately forecast the production cash flows, which you believe your platform will gener- ate over the next three years, and then apply a discount rate that reasonably reflects the inherent risks in mortgage banking. In other words, the premium value of the company is driven by its expected cash flow in the future. Making the Most of Mortgage Mergers As interest rates plummet, here's why now might be the right time to pull off an M&A transaction. By Garth Graham