Feature: Acquisitions in the Reverse Mortgage Sector

Written by Jessica Guerin, as originally published in The Reverse Review.

In the past several months, two publicly traded companies have entered the reverse mortgage market. Walter Investment Management Corporation came onto the scene when it completed its purchase of RMS in November, and then, just two months later, solidified its long-term presence in the market by announcing its intent to acquire Security One Lending. Meanwhile, Ocwen Financial Corporation pursued an acquisition of Genworth Financial’s reverse mortgage division, announcing the deal’s completion just last month.

This recent interest in the reverse mortgage market has left many in the industry to wonder what’s in store for the space, which has endured a tumultuous few years as big banks entered and left, regulatory action intensified and volume dipped. While the future does hold promise, the current landscape remains plagued by uncertainty as lenders await pending changes to the product, which HUD has said will come sometime this year.

But despite these challenges, the entrance of corporations like Walter and Ocwen confirms that some investors maintain a solid belief in the profit potential of the HECM market, regardless of pending modifications to the product. Likely motivated by statistics about the country’s aging demographic and expectations for continued home price recovery, some investors are recognizing the product’s promise. In a time of uncertainty for the industry, these recent acquisitions serve as

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a reminder that the HECM market has substantial growth potential as millions of America’s baby boomers approach their retirement years.

Walter Buys RMS
In November, Walter Investment Management Corporation (NYSE: WAC) completed its purchase of Reverse Mortgage Solutions (RMS) in a transaction totaling $122 million. The purchase price—which represented four times RMS’ expected core earnings for 2012—was a significant sum that surprised some in the industry, while those familiar with RMS’ strong and diversified presence in the space said the hefty price made sense.

In addition to its substantial reverse mortgage servicing operations, Texas-based RMS maintains healthy correspondent, REO management, wholesale and retail channels. The company also upped its presence in the secondary market since the big banks left the space, issuing $1.1 billion in securities in the first half of 2012.

Industry analyst Jeff Taylor, founder of Wendover Consulting, said RMS’ varied operations are exactly what made the company so valuable. “RMS was building a war chest of reverse mortgage servicing. They are a huge aggregator, and they issue Ginnie Mae securities. Therein lies a significant amount of value,” Taylor said. “They aren’t just an origination company, and their crown jewel is their ability to issue securities and service them and aggregate for wholesale clients.”

Michael McCully of New View Advisors agrees. “They were a one-of-a-kind opportunity,” McCully said, pointing out that RMS is unique because it is a servicer, a special servicer, an issuer, an originator and a technology provider. “No one else can say that they have all of the attributes that RMS has.”

Based in Tampa, Florida, Walter services a diversified loan portfolio that totals $82 billion through its subsidiary, Green Tree. The company says it has pioneered a “disciplined approach” to underwriting and that it operates a high-touch servicing platform, describing its specialty as “offering creative, structured solutions to owners of less-than-prime, non-conforming and other credit-challenged mortgage assets.”

Walter Chairman and CEO Mark J. O’Brien said the company’s presence in the reverse market will be supported by its existing operations on the forward side. “The acquisition of RMS creates a natural extension of our forward platform into the reverse mortgage space and will allow us to capitalize on the customer overlap between the two entities,” O’Brien said in a public statement announcing the deal’s completion.

O’Brien has stressed to investors the company’s belief in the potential of the reverse mortgage market. “The sector has very attractive long-term growth prospects and is currently undergoing significant structural change, providing us with an opportunity to capitalize on those dynamics,” he said.

According to McCully, Walter’s move will enable RMS to expand in ways it could not under its former owner. “Walter is a savvy company, and they recognize opportunity,” McCully said. “Having more capital to combine with their expertise was something RMS needed to be able to grow aggressively, to issue adjustable-rate HMBS and to take advantage of other dislocations in the market.”

Taylor agrees that the move was a smart one for RMS. “They had been for sale for some time and looking for the right partner, a partner who wanted 8

to enter the space with adequate capitalization and wanted to build a business,” he said. “I think it was the perfect fit.”

Walter Pursues Security One
Not long after its acquisition of RMS, Walter announced its intention to expand its presence in the space with the purchase Security One Lending (S1L). The definitive agreement, which was announced

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in January and finalized on May 1, closed for as much as $31 million, a purchase price that comprises $20 million in cash plus up to $11 million to be paid based on Security One’s achievement of certain performance benchmarks in one year’s time. According to Walter, the acquisition represents 1.2 times Security One’s projected pro forma EBITDA for 2013.

San Diego-based Security One Lending runs both retail and wholesale operations, originating just

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under 5,000 reverse mortgage loans with an aggregate unpaid principal balance of more than $700 million in 2012. In late 2012 the company beefed up its operations by hiring nearly 90 reverse specialists from MetLife when the bank left the space. With a 300-plus sales force, the company was listed as No. 2 on Reverse Market Insight’s latest Top Lenders list.

O’Brien said the move to acquire Security One was intended to enhance RMS’ origination program. “This addition is a key step in achieving our previously stated goal to increase the retail mix of RMS’ originations business,” he said in a January press release. “This acquisition creates a combined platform with diverse, established originations channels without significant overlap.”

According to Taylor, the deal amounts to a natural synergy. “Walter saw it as an opportunity to have boots on the ground,” Taylor said. “They’re vertically integrated now, so Security One can originate at the kitchen table and, at the end of the day, it winds up in a security that RMS issues and goes into a bond.”

Walter has indicated that it may make more acquisitions in the space down the road. Already, the company has secured a $100 million credit line with the Royal Bank of Scotland to support funding obligations, and just last month, it purchased $12 billion in reverse mortgage servicing rights from Wells Fargo, a move that will double the size of RMS’ servicing portfolio.

Ocwen Enters the Market
Walter isn’t the only public company stepping into the reverse space. Last month, Ocwen Financial Corporation (NYSE: OCN) finalized its purchase of Genworth Financial’s reverse mortgage division in a transaction totaling $22 million in cash. As part of the deal, the lender changed its name earlier this year from Genworth Financial Home Equity Access to Liberty Home Equity Solutions. The new name references the company’s former moniker, Liberty Reverse Mortgage, as it was known before Genworth purchased the company in 2007.

Liberty is a leading lender in the reverse mortgage space, topping Reverse Market Insight’s recent list of lenders. Ocwen CEO Ronald M. Faris said the company sees significant opportunity in the reverse mortgage market. “We believe this promising market offers enormous long-term growth potential, and this purchase positions Ocwen to capture that growth,” Faris said in a statement announcing the deal.

A financial services holding company, Ocwen services and originates mortgage loans with a mission to “provide solutions that help homeowners and make our clients’ loans worth more.” The Atlanta-based company has offices in several states across the U.S. and in India, Uruguay and the Virgin Islands. As one of the largest mortgage servicers in the country, Ocwen’s portfolio includes $128 billion in loans as of the second quarter of 2012, a sum it acquired by buying the servicing rights formerly owned by Residential Capital, Ally Bank and Homeward Residential, among others.

In a statement to TRR, Ocwen said the company strongly believes in the potential of the HECM product. “Ocwen Financial Corporation believes the reverse mortgage industry is a promising market that offers significant long-term growth potential. We acquired Liberty Home Equity Solutions because of its strong historical performance, national footprint and highly experienced team,” the company said. “We are excited about Liberty’s prospects for further growth.”

Liberty CEO Pete Engelken said the company plans to expand under its new ownership.

“Liberty will continue to look for opportunities to help seniors and grow our business through retail, wholesale and correspondent lending. Ocwen brings to us a deep understanding of the mortgage industry with infrastructure and resource support to help further our growth plans,” he said. “With a focus on innovation, technology, capital markets and operational excellence, I expect Ocwen to help Liberty drive the growth of the reverse mortgage industry, including the development of improved products, pricing, securitization, liquidity and infrastructure.”

Ocwen is also a Ginnie Mae-approved issuer, a fact that may elevate Liberty’s rate of issuance. Engelken said the company has been an active HMBS issuer since 2011 and will continue to assess its involvement in the HMBS market. “We will continue to 8

evaluate secondary market outlets and we will be issuing Ginnie Mae securities as needed to support our business growth,” he said.

Engelken also said the company does not expect any potential program changes to have a negative impact in the product’s growth potential. “We expect Liberty and other lenders in the industry to evolve product features, origination processes and underwriting guidelines as we have over our 20-plus year history. Any future FHA modifications will have a positive impact on the reverse mortgage industry’s sustainability over the long term,” he said. “As part of Ocwen, we expect to gain access to increased liquidity and resource support to help fuel our growth plans, including opportunities to launch new proprietary products that will enable us to tap into new customer segments.”

From his perspective, McCully said Ocwen’s move appears to be strategic and long-term. “Ocwen brings a lot of resources that a straight private equity firm might not possess, like servicing, mortgage expertise and systems, so in some ways it’s more of an add-on to their existing infrastructure,” he said. “It’s a vote of confidence for the industry that a party such as Ocwen would be willing to enter the space.”

McCully said Ocwen’s entrance into the reverse mortgage space is likely to benefit the industry as a whole. “They’ll bring more servicing capacity to the industry, which it has needed,” he said. “I think Ocwen will be opportunistic and creative and will bring more vitality and more solutions to the industry over time.”

Nationstar Eyes Servicing Acquisitions
Nationstar Mortgage Holdings (NYSE: NSM) is another corporation that has shown interest in the reverse mortgage market. While it hasn’t made any moves on the origination side, the company has upped its presence in the reverse servicing sector. Nationstar bought Bank of America and MetLife’s reverse mortgage servicing rights after both companies left the space, and it now has one of the largest reverse servicing portfolios in the country.

Recently, the company raised more than $200 million in capital and said it plans to pursue more acquisitions in mortgage servicing, although it refrained from specifically naming acquisitions in the reverse sector. But, according to Reverse Mortgage Daily (RMD), Nationstar executives have stated an interest in the market and may choose to up their presence in the arena. Quoting Nationstar CEO Jay Bray in a quarterly call with analysts, RMD said the company noted opportunity in the reverse sector. “I think that [reverse mortgages are] an area of growth. Clearly not close to what we can do on the forward side. And then longer-term, if you think about again the demographics of the country and politically how important that product could become over time, I think it is a strategic space for us to seriously consider to invest in,” Bray said.

What This Means for the Future of the HECM Market
The entrance of larger corporations into the reverse mortgage space appears to be a welcome development from all sides and a positive indication of the product’s promise. These latest developments suggest that investors are being swayed by more than just demographics.

As a unique type of loan that allows borrowers to access their home equity, the HECM can be strategically leveraged as a smart financial planning tool to support a senior’s needs in retirement. If lenders can move beyond the needs-based population and find a way to access the discretionary borrower—and the financial planners who advise them—the loan could become a commonplace financial tool. New investors in the reverse mortgage market seemed to have recognized this possibility and what it could mean for the industry down the road.

“It’s a healthy sign to see outside investors buying into reverse mortgage origination and servicing companies,” said John K. Lunde of Reverse Market Insight. “Beyond the validation of the space, it challenges existing companies to sharpen up their business models—whether it’s to prepare to sell themselves or simply compete against competitors with newly enlarged capital bases.”

In effect, big companies like Walter and Ocwen will bring some much-needed liquidity back to the HECM market. “Well-capitalized, nonbank, public companies are entering into the space, and that was sorely needed when the big banks left,” Taylor said, adding that some lenders struggled to handle the surge in volume that followed in the wake of big bank exits, and with larger entities investing, lenders might have access to additional warehouse lines to fund future growth.

Some in the industry are hopeful that these recent acquisitions will rejuvenate the market for investments in the space, even despite the current low volume. According to McCully, the recent dip in volume may not be such a deterrent. “The industry’s volume is, unfortunately, less than half of what it was at its peak, but I think that for those who are contrarians, it’s a great opportunity to make an investment because prices are not as high, and everybody still sees the long-term trends and the demographics,” McCully said. “So as an institution, if you’re a believer in those trends, this might be an excellent time to be investing in the space.”

Still, others point out that HUD’s pending changes to the program could put the brakes on movement for a while as investors might pause to observe the impact before writing any checks. According to McCully, these pending changes could be problematic. “HECM is at risk of becoming a marginalized product for a very select group of people,” McCully said. “Without more effort to overturn negative publicity, educate financial planners and appeal to discretionary borrowers, if the product continues to be curtailed, then no matter how ambitious and long-term thinking the industry is, at some point it becomes too small to become meaningful for new entrants in the space. Of course, this might open the door for the return of proprietary products,” he said, adding, “HUD’s mission was never to serve 100 percent of any given market.”

Regardless, Walter and Ocwen have proved to be unfazed by this looming uncertainty. According to RMD, Walter execs told investors earlier this year that any program changes are unlikely to impact volume, citing the potential for “explosive growth.” Taylor said their willingness to buy in at such a time does mean something. “The demographics are overwhelming,” he pointed out. “I think they’re prepared to weather the storm.”

Now that there’s been an increase in investor interest, many are left wondering if more acquisitions are on the horizon.

McCully said future interest from outside investors would also be enhanced by home price appreciation. “Even if it’s modest— 1 or 2 percent annual growth, as long as home values are collectively increasing rather than decreasing, then that creates additional opportunity,” he said.

McCully also said he anticipates continued consolidation in the industry, not just because of capital concerns, but also as a means to mitigate operational expenses. “In a shrinking industry, the best way to continue to make the product profitable is to reduce costs,” McCully said. “One of the ways to reduce costs is to reduce overlap. If you can double the size of your origination network from an acquisition, then it makes sense because you don’t need to double your cost structure to do so.”

Lunde said the consolidation of both origination and servicing/issuing by one outside company—as seen in both the Walter and Ocwen acquisitions—is an interesting trend that may alter the future landscape of the space. “That is a similar strategy that the industry has seen before from Financial Freedom a decade ago,” Lunde said. “It resulted in one of the most dominant franchises we’ve seen in the RM market, helping to power the industry to its record volume levels in 2008 and 2009. Only time will tell if the current consolidation and investment portend a similar volume expansion.”

3d rendering of a row of luxury townhouses along a street

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