TheMReport — News and strategies for the evolving mortgage marketplace.
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42 | TH E M R EP O RT FEATURE The Discounted Cash Flow methodology is preferred by mortgage investors as well as those operating in many other indus- tries. That said, figuring out the projected earnings of a mortgage company can be something of an art form. What makes it even trickier in the mortgage business is the unpredictable movements of interest rates, which have a signifi- cant impact on cash flow. The Build-Cost for the Same Production: This is the one that's appealing for larger, independent mortgage lenders. These compa- nies know what it costs to recruit a billion dollars of production be- cause they've already experienced that recruiting process and know the expense and difficulty of it. STRATMOR data shows that the average loan officer (LO) attrition is approximately 40%; however, 80% of the business is done by the top 40% of originators, and the attrition of this segment of LOs (the high producers) is less than 10%. They are hard to recruit and can be expensive to obtain. The thinking behind the build-cost method is, "I know what it costs me, so I'd rather just buy it. If I buy a company, I can ramp up within 30 to 60 days, which is better than continually recruit- ing top producers," especially in today's highly competitive marketplace. Getting Help L et's say you're the owner of a $1 billion mortgage bank, and you have somewhere between $5 million and $10 million locked up on your balance sheet. In many cases, that equity is a significant chunk of your personal net worth. However, you can't liquidate that equity until you sell the company. The market starts to go south, and accordingly, the equity on the balance sheet goes down. If you're like most owners who have been thinking about selling, you start to panic and rush forward with a deal—which is exactly the worse time to sell. That's just one reason why it's so important to seek the help of an advisory firm that's experi- enced in mortgage mergers and acquisitions. If a potential buyer contacts a potential seller directly and asks, "Are you for sale?" most prospective sellers are going to say "no" whether they are or are not. They don't want to tip their hand, and they don't want to appear desperate. They also don't want to give another company inside information that can be used against them in the hand-to-hand combat of recruiting and retain- ing staff. With an advisory firm in the middle, buyers and sellers can become acquainted with each other privately and anonymously. Having an advisor who serves as a middleman in the first rounds of negotiations when each party is still anonymous and under a non-disclosure agreement (NDA) is optimal. The initial role of the advisor is to help both sides understand each other. For example, the buyer may say, "I like this com- pany, but I'm concerned about X, Y, and Z." These concerns would be communicated to the advisor up front, who would share them with the selling company. The seller can then address the con- cerns and give a pitch back to the buyer. With an advisor, the buyer and seller can size each other up without having to know the identity of the other party until the timing is right. An effective advisor can help with matters like due diligence and weighing risks, but with- out question, the greatest value provided by an advisor is as- sessing whether the cultures of two companies are reasonably compatible. Cultural compatibility is the most critical factor in a suc- cessful transaction, and a third- party independent advisor is often better suited to offer an objective assessment on the strategic fit for both parties, or at a minimum to facilitate the discussions between parties about culture, values, and future aspirations. Timing It Right I n terms of merger and ac- quisition activity during the remainder of 2019, we'll see fewer deals in the latter months of the year. By and large, mortgage companies are doing well right now. However, if we experience another slow fourth quarter as we did in 2018 or in 2014, a staggering number of companies will come to market, because by then, many companies will have "used up their mulligans." What does that mean? When a company's retained earnings drop, its secondary investors and warehouse lend- ers start sweating, and they put that company on their watchlist. It was reported that at least one- third of independent mortgage banks were on someone's watch- list at the end of last year. When the market improved in the spring, many of these com- panies performed their way off the watchlists—but it doesn't take many bad months to get back on those lists. The next time it happens to some lenders, investors may decide not to buy their loans anymore. Perhaps their warehouse partner wants to renegotiate ware- house terms, increasing costs, or cutting liquidity. At some point, the warehouse lenders could cut them off, and then things could go from bad to worse. After all, a mortgage banker without "the bank" has little value in a sale. At that point, more mortgage company owners will decide they need to sell and there will be a glut of sellers on the market, with many of them selling under duress. That's why I advise any mortgage company that may be thinking of selling to take advan- tage of times when the market is good—and for most, it's very good right now. If you're in the game for the long haul, then you know the market is subject to ups and downs. So, enjoy the "ups" while they last. But if you've thought about selling your business, there is no better time to explore your options than now. GARTH GRAHAM is a senior partner at STRATMOR Group, a 30-year-old mortgage banking consulting firm. Graham has more than 25 years' experience in mortgage banking, ranging from Fortune 500 companies to successful startups. At STRATMOR, he manages M&A activities, providing strategies for Independent and Bank-owned mortgage lenders. He may be reached at Garth.Graham@stratmorgroup.com By and large, mortgage companies are doing well right now. However, if we experience another slow fourth quarter as we did in 2018 or in 2014, a staggering number of companies will come to market, because by then, many companies will have "used up their mulligans."