On Nov. 12, 2015, traders on the floor of the New York Stock Exchange witnessed the Dow suffer its worst one-day loss in six weeks, plunging 254 points. That afternoon, in Washington, D.C., members of the Federal Reserve’s Federal Open Market Committee discussed hiking interest rates.
And in Foothill Ranch, California, with the markets in chaos and an IPO expected that day, Anthony Hsieh, loanDepot chairman and CEO, made one of the biggest calls of his career: he would abort the potential $2.6 billion public offering, citing adverse market conditions and poor valuations for other newly public fintech companies. Though undoubtedly disappointed, Hsieh at the time didn’t rule out another bite at the IPO apple.
Five years later, analysts and competitors expect loanDepot – backed by private equity shop Parthenon Capital Partners and now the nation’s sixth-largest retail originator – to join United Wholesale Mortgage, Caliber Home Loans, AmeriHome, Guild Mortgage, and Finance of America in gunning for market leader Rocket Companies, which made its successful public splash in early August.
“For the industry, especially for private equity that typically supports independent mortgage firms, this is a once-in-a-generation chance to monetize equity, that frankly was trapped inside of these companies,” said Christopher Whalen, an investment banker and author. “You couldn’t really take them public at book value. So if you were private equity, and you would put money into one of these things, it was basically in there and you could take out income, but you really didn’t have much chance to sell the business.”
The emergence of nonbank mortgage lenders as public companies may fundamentally change the composition of the industry, giving a host of companies access to cash they couldn’t have dreamed of a year ago.
But more importantly, industry observers say, the IPO craze should separate the wheat from the chaff, and will test the strength of various lender models like never before.
“It’s so exciting,” said an executive at one large nonbank lender. “We’re going to finally see who’s full of shit and who isn’t.”
Whether investors believe nonbank lenders are a good value during a time of record origination, outsized margins and historically low interest rates, remains to be seen.
Window of opportunity
In the decade that has followed the global financial crisis of 2008, independent mortgage banks (IMBs) have moved quickly to seize the land ceded by risk-averse depository institutions. Today, the IMBs control about two-thirds of the overall residential mortgage market in the U.S. And they continue to grow: While most of the depository banks merely maintained lending levels or turned off the spigot, nonbanks hired thousands of workers, toiled on weekends and played a game of mortgage Pac-Man, eating every loan in front of them while stretching capacity.
“Mortgage banks are the anti-bank,” Whalen explained. “So when commercial banks are typically dealing with credit issues like right now, obviously, rates fall, unemployment rises and the Fed reacts. And so the entities out there that can take advantage of lower rates by increasing volumes, and, also hopefully increasing spreads, benefit. Right now the banks have low funding costs. But they’re getting hit left and right from different parts of the bank that are saying, ‘Hey, I’ve got to charge off this loan.’ Credit’s going to hang over banks through next year.”
UWM reported record earnings of $1.45 billion in the third quarter, and Rocket, the parent company of Quicken Loans, is expected to actually top the second quarter’s $3.4 billion in profit. The smaller operators too are posting outsized numbers, whether they’re retail, wholesale, correspondent, or a blend. Caliber, with an upcoming IPO that could be valued at north of $2 billion, cleared $36 billion in originations in the first half of the year. It operates in all three channels. Retail-heavy Guild Mortgage posted a $111 million profit in the first half of the year, and generated $10 billion in originations in the third quarter. And AmeriHome, one of the country’s largest correspondent lenders, has been profitable since 2015 and generated $642 million in revenue for the first half of the year.
In short, everyone is making money – mostly due to refinancings – and they’re doing so at higher margins than seen in years (Rocket, for example, managed an outrageous 5.19% gain-on-sale margin in the second quarter).
But it’s a highly fragmented space. Rocket is the largest player at around 9% market share and has a market cap of $41 billion. UWM follows at around 6%. In filings with the SEC, the hopeful ascendants variously describe the opportunity ahead – it’s a two trillion dollar market, their platform has sticking power, they’re powered by world-class technology, and they’re growing every year.
“These companies aren’t all that different from each other, even though they’ll tell a different story,” said Jack Micenko, a housing and mortgage analyst at Susquehanna Parters.
Rocket, primarily a direct-to-consumer dynamo with some wholesale ambition, and UWM, a focused wholesale colossus with servicing aspirations, each envision a future in which they solidify over 25% market share in the next decade. That isn’t possible without the ability to scale their tech platforms, greatly expand their marketing clout, and – most importantly – find new customers. That costs money. Bags full of it.
“For a nonbank lender, the issue you’ve always had is accessing capital,” said Patrick Stone, CEO and Chairman of Williston Financial Group. “And going public takes care of that in a couple ways. Obviously you access capital by going public, but you also put yourself in a position to access the debt markets a lot easier, to borrow money easier.”
Analysts and lending executives alike described the climate for nonbank lenders to go public as about as good as ever, a perfect storm of low inventory, near-zero interest rates, and a strong capital markets environment, one that didn’t exist even a year ago.
“The next year or so is really the window for a lot of these companies,” said an executive at one nonbank lender. “If you don’t make the jump now, you’ll probably never get off the ground. You’ll probably get swallowed by a competitor or get bought by a bank.”
The current climate has led to a confluence of very positive events for the industry, according to Micenko. “You’ve got a really strong purchase market, you’ve got a record refi market. We’ll probably do $3.5 trillion of mortgage dollar volume in the industry this year,” he said. “You’ve got limited capacity and one of the ways these companies manage capacity is through price. So, the margins which are earning on each loan you make, are at all-time highs. That’s the good news.”
One nonbank lending executive told HousingWire that the wave of public debuts is “really good” for the mortgage industry. In the executive’s opinion, mortgage banks have been undervalued, the public markets are a cheaper source of capital than private investors, and this gives IMBs the ability to retain more servicing.
“Just think about who you have going public – you have very different models,” he said. “You have people that are heading into servicing, people that aren’t. You have people that have bet everything on distributed retail, and people that have bet everything on wholesale, or you have people that are fully focused on consumer direct. So it’s going to be really interesting to see how being publicly traded companies – these companies are some of the largest in the country – kind of rationalize behavior a little bit. As well as it starts to expose who’s full of shit and who’s not.”
Will investors buy in?
Though lenders will be able to avoid paying exorbitant coupons to access investor capital as they once did as private companies, analysts are skeptical that there’s clear long-term value in the lenders as public companies, for now at least.
“Margins are double historical averages,” said Micenko. “And it’s not just Rocket, it’s everybody. The problem with that is, in our view, investors buying IPOs in the sector today are buying peak earnings. There’s probably 14 or 15 million refi loans left to do and these will carry these companies through the back half of this year. But inevitably, refi volumes will fall and there’s a peculiar dynamic in mortgage banking when, when volumes fall, so do margins, because all of a sudden, when there’s less volume to do, the lenders become more competitive and the margins get squeezed. And it’s been that way for 20 years.”
Micenko said the lenders that are flirting with public offerings are “six-to-eight multiple businesses,” not the 20X businesses that grace the S&P 500.
“So generally, these are seen as lower multiple, lower-value businesses and it’s really for two reasons: One is, there’s no visibility to the business at all. It’s transactional,” he said. “And then the second thing is, the accounting’s all wacky. Cash versus GAAP earnings is different, MSR valuation adjustments cause reported results to be drastically different from quarter to quarter, and no one’s almost figured out how to model it. They’re hard companies to model and they’re hard companies to predict the future, because the future is outside of their only control. None of them can control their own destiny. They’re all at the mercy of the broader economy.”
Different approaches, mileage will vary
Several insiders who spoke to HousingWire said that while UWM and Rocket are swimming in money, they’re doing so on the strength of heavy refi volume. When interest rates rise and refi volumes fall, they’ll have to increase their purchase business to justify their valuations. It’s easier said than done.
Rocket, easily the biggest brand name, is prolific with direct-to-consumer, but its partner and wholesale business, which generates purchase originations, is roughly one-third the size, though it’s growing, according to Micenko. UWM is the biggest player in the broker channel, which provides direct access to new homebuyers, but it hasn’t been over 50% purchase originations at this point.
UWM’s CEO Mat Ishbia has expressed confidence that his company can adjust when the cycles change. “Our scale, our technology, our efficiencies make it so we will win in these cycles, regardless if rates go up or down,” Ishbia said on a September call with investors of his newly-formed company, which is expected to debut via SPAC at a $16.1 billion valuation by the end of 2020. “We’ve done it before and we’re going to continue to do it again.”
Even more historically purchase-focused lenders such as Caliber and Guild – who operate through correspondent channels – have increased their refi businesses to take advantage of the cycle. Could they be best positioned to take advantage when the market turns back to purchase?
“Typically Guild is at 80, 85% purchase, which is great,” said Whalen. “And Sanjiv [Das], remember he fixed Citi, he had to come in right after the crisis and clean up their correspondent business. So he knows very well what can happen if you buy too much third-party production and if you’re not careful. Look at that document, see how little leverage he has. That man is being very conservative. It’s a boom time, you would think he’d throw more sail up on the mast, right? No, he’s a cautious man.”
Meanwhile, on its S-1, AmeriHome, which originated $55 billion worth of mortgages in the 12 months ending on June 30, touted its heft in correspondent, direct-to-consumer and servicing as reason for investor confidence.
“We deliberately chose to enter these business segments based on a purchase origination orientation, ability to efficiently achieve scale, and the ongoing opportunities afforded by owning mortgage servicing rights all to achieve stability of earnings through varying economic cycles,” the company said. “Our consumer direct channel then originates mortgages directly with individual homeowners, primarily for refinancing opportunities with our existing servicing customers. Our servicing segment allows us to retain the customer relationship from these originations while taking an asset management approach to achieve steady returns on the servicing.”
LoanDepot, which still has yet to file its S-1, operates a direct-to-consumer operation and a wholesale business. Like UWM, it does wholesale, and like Rocket, it does direct-to-consumer, though it hasn’t been as successful in either channel. Anthony Hsieh‘s firm is hoping for an IPO between $12 billion and $15 billion, and like others, it’s likely to tout its supposed technological prowess as a key to unlocking future business. In 2015, Hseih was targeting $2.6 billion with LoanDepot’s doomed IPO.
Beyond questions about who can thrive when the market isn’t as glossy, there’s another central issue for prospective investors: it’s about who gets paid when the new stock tickers are traded on the NYSE floor. Typically, Wall Street likes to see investors and founders raise money and reinvest it in the business.
“Rocket didn’t get any money from their offering,” said Micenko. “Caliber’s not getting any money from their offering. What you’re getting primarily so far has been ownership of private equity monetizing their stake, not raising capital for the company going forward. With Caliber, Lone Star’s getting the money. Not Caliber.”
Observers said the same is likely to be true for Guild, backed by McCarthy Partners Management; AmeriHome, partly owned by Apollo Global; Blackstone Group-controlled Finance of America; and potentially even loanDepot, which is also backed by private equity.
According to its S-1, private investors at UWM are also getting paid on the deal, which includes $425 million in the SPAC’s trust plus $500 million in equity from a private investment. The proceeds will be used to buy out a portion of UWM’s private shareholders. None of the cash is going to UWM, according to the S-1. But Ishbia says he is going to control 94% of the company, isn’t going anywhere, and now he’ll now finally have the access to capital he needed to scale. The firm expects to pay a dividend starting in 2021.
Analysts and rival executives who spoke to HousingWire were intrigued – but unsurprised – by Caliber’s upcoming debut, in particular. The company’s private capital is over 15 years old (well beyond the usual 10-year cycle in private equity), and it’s no secret in the industry that Lone Star has been looking to take Caliber public for years.
“This has been a long time coming,” said one observer. “Lone Star has been licking their chops hoping to sell Caliber. That doesn’t suggest it’s an unimpressive business at all. They do well in three origination channels.”
The wave of IPOs – and early equity cash-outs from investors – similarly doesn’t necessarily mean C-Suite members at these companies can exit lickety-split.
Even if the firms raise capital and executives sell 10% to 20% of their equity, they’ll have to do it multiple times to actually cash out, and then there’s a lockout period of up to a year where the stock isn’t liquid. They’ll be at their companies for at least a few years.
Ultimately, even if private equity backers of IMBs are quick to clear their debts and find a new industry altogether, retail investors will find some strong, viable businesses to choose from, an executive at a nonbanking lender said.
“The big thing is this further levels the playing field with the banks in that it gives independents access to another source of capital that I do think, by and large, people are going to use to invest in the business and grow,” he told HousingWire. “The lifeblood of mortgage banking is liquidity. Those who have the most cash, and manage that cash, and protect it, win.”
Stay tuned for a future analysis on how the IPO craze will impact servicing.