Mortgage lenders facing a dark, cold winter

The next six months will be a test of the survival of the fittest in the industry, M&A experts say

The coming winter is expected to be an existential test of survival for many independent mortgage banks (IMBs), according to leaders of several mortgage advisory firms.

It’s expected to be dark, difficult doldrums ahead, one marked by unyieldingly high mortgage rates — now hovering near 8% — and a dearth of mortgage-origination opportunities.

“We’re really at the darkest part of the market this winter,” Brian Hale, CEO and founder of consultancy Mortgage Advisory Partners, said. “And it’s going to be horrible.”

Brett Ludden, managing director and co-head of the financial services team at Sterling Point Advisors, agrees, adding, “the current forecast for the next six months is a really bad one.”

“Anybody who says 2024 is going to be a little bit better … the reality is 2024 could be worse than 2023,” Ludden said. “… I would say the next six months will likely be the worst because [IMB] margins are continuing to erode at the moment.

“… I think there are going to be a lot of companies that likely won’t come out on the other side of that six-month period.”

Dave Stevens, CEO at Mountain Lake Consulting and former president and CEO of the Mortgage Bankers Association (MBA), said the current rate environment “is what’s crushing the mortgage industry and grinding it to a halt.”

“This is a really tough one because it’s an inflationary recession, where the Federal Reserve is having to actually contract the economy by driving interest rates high,” Stevens added. “…This is going to be the hardest, slowest winter, and you’re going to have a hard time finding anybody who’s old enough to remember a period that was this hard.”

Jeff Walton, CEO and co-founder of mortgage data analytics company InGenius, which provides loan-officer data to IMBs for recruiting purposes, said it’s going to be a “tough time through winter.” He added that the hope is we see some improvement in the spring or summer, “but it’s anyone’s guess.”

“I was speaking to someone the other day who said, ‘If you’re in this business [mortgage lending], I can’t see a downside to a recession.’”

Industry consolidation underway

Hale said he would not be surprised to see 40 to 50 merger and acquisition (M&A) deals play out over the next six months.

“I think there could be some big deals,” he said. “And to be blunt, I’ve been in conversations around deals that I think would be shocking, but nothing’s transacted yet. 

“… I can tell you that I have two [potential M&A deals] that I’m leading currently. I have four more that I’m in negotiations on representing buyers, and in some cases, buyers who might be interested in multiple transactions, and I think I’ll know the results of those [talks] in the next couple of weeks.”

Ludden said what he sees ahead is the thinning of the mid-sized IMB ranks due to mergers and acquisitions as well as a thinning of the smaller IMB players, many of whom will “become brokers or just dissolve.”

“In our pipeline of deals underway, the vast majority involve [lenders with] $500 million to $5 billion in annual originations, and it’s as big of a pipeline as we’ve ever had,” Ludden said. “…There are roughly 1,000 lenders [IMBs], and our expectation is that probably 70% of them are sub-$500 million [in annual origination volume].

“I think you’re going to see a lot of them transition to brokers.”

He said of the remaining 300 or so IMBs with $500 million or more in annual origination volume, “it’s not unreasonable to assume that group will be whittled down to 150 or 200.”

Ludden said much of the consolidation is expected to take place via M&A deals involving IMBs in the $500 million to $2 billion range in annual originations. 

“So, we’ll be much more top heavy [at the end of this cycle], with the remaining three-quarters of IMBs in that group [of 150 to 200] being in the $2 billion-plus category [due to mergers and acquisitions],” he said.

Ludden added that in many cases, the M&A deals ahead will be handled quietly without press announcements, and that “nobody ever sees” to guard against recruiting headhunters luring away the loan officers of companies being acquired prior to deals closing.

Stevens stressed that financing costs are prohibitively high right now and, in most cases, are not favorable for leveraged buyout deals. 

“The guys who are doing buyouts now are going to be buying with their own cash,” he said. “I don’t think anybody’s going to borrow to buy, … so, that limits the pool of buyers.

“… There are some folks who were very successful in 2020 and 2021, generated huge portfolios and have retained earnings, probably, in large part, from servicing, and they didn’t buy corporate jets or things of that sort,” Stevens added. “These are the folks who are buying right now, and I you know because some of them are my clients.”

Loan officers going away

Data from InGenius shows that the average number of active IMB and bank loan officers with valid Nationwide Mortgage Licensing System (NMLS) licenses dropped 49% between the third quarter of 2021 and the second quarter of 2023 — from 181,656 in Q3 2021 to 89,094 in Q2 2023. 

Mortgage-origination volume between 2021 and yearend 2023, however, is projected to drop 63% — from $4.44 trillion to $1.64 trillion, according to the MBA’s forecast. Hale said he thinks that 2023 origination forecast may even turn out to be on the high side.

“… We’re in the business of giving data for recruiting, and we’re still growing as a company because the haves [the healthy IMBs] are buying data … to go after the have-nots’ [loan officers],” Walton said. “There’s no question about it, the ‘haves’ definitely have a growth hat on and are buying data to recruit, and they are definitely extremely active.”

Hale added: “I’ll bet you a dinner that by February [2024], those [LO] numbers are down by 20,000 to 25,000 from where they are now because [NMLS license] renewals in all the states happen at the end of the year. A lot of originators or companies won’t pay the license-renewal fees at the end of the year for originators who haven’t closed a loan in the last six months.”

Hale continued: “… I worked for a guy at one time who said, ‘You know, you don’t know who’s not wearing swim trunks until the tide goes out,’ and the tide is now receding. We could be down to 60,000 to 70,000 originators by 2025.”

Walton said there is going to be more IMB consolidation this winter, adding that he doesn’t see any other outcome at this point. “Even if rates don’t go up [further], it’s going to get worse. And if they do go up, then it’s going to get really worse.”

Sevens said most acquisition deals taking place now involve lenders who might have gotten an up-front cash offer a year ago. 

“Today, almost every originator has been losing money several quarters in a row,” he added. “And so virtually every deal being put on the table now is an asset-only, earn-out offer, with no money upfront, so they [the seller] get paid assuming the buyer makes a profit.

“So, the deals aren’t as attractive to sellers. …We’ll definitely see between now and April more [M&A] transactions occur in the [IMB] space. And some [IMBs] may just decide to get out of mortgage banking and become brokers, and some may shut their doors, so we’ll have to see how this all plays out.

Disruption opportunities

Walton stressed that as difficult as the winter ahead will be for the IMB industry, at the end of this dark period — which could last through next year, unfortunately — “there will be lenders who come out the other side of this in better shape than before the downturn.” 

“Market disruptions create opportunities,” Walton said, adding “for IMBs that are structured right, this is actually an opportune time.”

Stevens added that a phrase coined at a recent MBA convention by Susan Wachter, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, has now become a bit of an industry slogan: “Survive until ‘25.”

“We are going to see who the best leaders are in our industry by who survives this downturn,” Stevens said. “…A lot of people thought they were really good at this business in 2020 and 2021, and they got really arrogant based on their success, some becoming multi-millionaires or billionaires during that period of time.

“But if you couldn’t be successful then, you shouldn’t have been in any business because rates went to 3%, and you could refinance the world and make a great margin. Now, we’re going to separate the winners from the losers in terms of who’s really built for long-term survival.”

Stevens added that those IMBs that do make it through this dark period “are going to have the strongest management quality.”

“And we’ll probably end up with a much stronger industry on the backend of this [downturn],” he said.

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