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IPO / M&AMortgage

The great mortgage bank consolidation wave is underway

Lenders strong enough to withstand the fallout will see their opportunities expanded, market experts say

merges and aquisitions
One mortgage M&A expert believes that of the 130 or so IMBs that did $1 billion to $2 billion for production in 2021, 17% of them will not even be able to do $500 million over the 12 months ending June 30, 2023.

Up to 30% of the 1,000 largest independent mortgage banks are projected to disappear by the end of 2023 via sales, mergers or failures in the wake of the double whammy of still-rising inflation and interest rates.

That’s the projection offered by Brett Ludden, managing director of Sterling Point Advisors, a merger and acquisitions (M&A) advisory firm based in Virginia.

“We have a number of buy-side and sell-side clients and an even larger stable of industry owners and CEOs that we speak to regularly,” Ludden said. “The outlook is not good for large cohorts of the industry.”

That’s particularly true for independent mortgage banks (IMBs) that have been too reliant in recent years on refinancing production. The Mortgage Bankers Association (MBA) projects refinancing volume will be down by 24% next year, compared with 2022, to $513 billion — and that’s after plunging from $2.6 trillion in 2021.

Sterling’s industry consolidation outlook is even more dire than a recent projection offered by Tom Capasse, managing partner and co-founder of New York-based Waterfall Asset Management, a global alternative investment manager with some $11 billion in assets under management. Capasse, working from a much larger base of IMBs, including many more smaller lenders beyond the 1,000 largest, predicts that some 20% of the IMB segment will disappear via sales, mergers or failures over the next 18 months to two years.

“Lenders that turn all their attention to refinancing when that business skyrockets enjoy huge profits,” said Garth Graham, senior partner and manager of M&A activities for the Stratmor Group, a Colorado-based mortgage advisory firm. “But the tide always eventually turns, and when it does, many of those lenders struggle to stay afloat. 

For the smaller lenders that were doing $125 million up to $250 million in 2021 [a 14% slice, or some 140 IMBs], 72% [about 100] will do less than $125 million in the next 12 months [ending June 30, 2023].

Brett Ludden, managing director at Sterling Point advisors

“We’re seeing a lot of that this year, and it will certainly continue in 2023. … Purchase loans are simply harder to market and convert, harder to process, and they generate lower revenues and higher expenses.”

Stratmor predicts that by year’s end, nearly 50 M&A transactions involving IMBs will have been announced or closed. That’s up 50% from 2018, the “next highest year of lender consolidations in the past three decades,” a recent Stratmor report states.

Time to eat the minnows?

The consolidation fervor is being fed by several factors, according to David Hrobon, a principal with Stratmor. Those include the following: IMB performance this year on average is about break-even; origination volume is expected to be down 50% this year from 2021 levels and down even more next year; and “net production income is trending toward its lowest point since 2018.”

“It took us a number of years to get to this point, largely fueled by Federal Reserve policy to maintain zero or near-zero Fed funds rates,” said Bill Shirreffs, senior director and head of MSR services and sales operations at California-based Mortgage Capital Trading (MCT). “The current market conditions were also impacted by the Treasury actively purchasing MBS [mortgage-backed securities] to maintain stability in the capital markets.

“Both of those actions created artificial demand, which when removed results in dramatic market corrections. That’s what we are experiencing right now, a market correction, and as a result, it might take years for things to normalize.”

To better illustrate what is taking place in the mortgage-lending industry, Sterling’s Ludden provided mortgage-origination estimates for the 1,000 largest IMBs broken down by production tranches. 

We are probably in the first few innings of a clean-up exercise on the housing-finance, nonbank-originator [IMB] side.

Leon Wong, a partner at Waterfall asset management

For calendar year 2021, according to Sterling’s estimates, 38% of the 1,000 largest IMBs, or roughly 380, had mortgage production of $250 million or less. For that same group of 1,000 IMBs, over the 12 months ending June 30, 2023, some 54%, or about 540, are projected to have mortgage production of $250 million or less.

“For the smaller lenders that were doing $125 million up to $250 million in 2021 [a 14% slice, or some 140 IMBs], 72% [about 100] will do less than $125 million in the next 12 months [ending June 30, 2023],” Ludden said in breaking down the production shift further. “They’re just not going to have enough scale to be able to break even, and there’s not enough costs to cut and, importantly, these smaller firms they don’t have the cash and equity that the large firms do.”

The same downward production shift holds true on the high end of the loan-production scale. 

For all last year, 33% (roughly 330) of the largest 1,000 IMBs had loan production of $1 billion or greater — with 20% (about 200 of the 330) recording $2 billion in mortgage originations or more, according to Ludden. For the 12 months through June 2023, only 18% of the largest IMBs (or about 180) are expected to have production of $1 billion or more — with 10% of them (or about 100 of the 180) at $2 billion in loan production or greater.

“Of the [13%, or roughly 130] companies that did $1 billion to $2 billion for production in 2021,” Ludden said, “… 17% of them will not even be able to do $500 million [over the 12 months ending June 30, 2023].”

Ludden added that consolidation in the IMB space over the next year is expected to be as high as 30% — meaning nearly one-third of the 1,000 largest IMBs are expected to merge or go away by the end of 2023. “And of the names that will disappear from the corporate registries, about one-third [roughly 100] will go out of business and two-thirds [about 200] will merge.”

The great pivot?

Despite the dire outlook, some will benefit from the period of consolidation, according to several market observers.

This could be the time many long-time, small-to-midsized originators look to sell their loan origination platform outright or joint venture with the right partner that gets them through these most difficult times.

Tom Piercy, managing director of incenter mortgage advisors

Leon Wong, a partner at Waterfall Asset Management, said at this point “we are probably in the first few innings of a clean-up exercise on the housing-finance, nonbank-originator [IMB] side.”

“Our focus is really on the nonbank originators needing to work themselves through their liquidity considerations over the next couple of years,” he added.  “One solution to that could be augmenting two additional asset classes — like HELOCs [home-equity lines of credit] and second-lien loans, or reverse mortgages.”

In fact, some of that is already happening, according to Sterling’s Ludden. 

“Several lenders tell us that they just have no avenue to continue, and some inform us that they’re closing the doors, while others are desperately trying to cut costs even beyond what I think is probably feasible cost-cutting,” Ludden shared. “One small East Coast lender has in the last couple of months picked up their California license and is now almost exclusively focused on doing high-dollar reverse-mortgage transactions in California because that’s the only way they think they can potentially survive without having to essentially go out of business.”

Tom Piercy, managing director of Colorado-based Incenter Mortgage Advisors, said the outlook for the housing industry generally “is bad for the foreseeable future.”

“[However,] it could be very good for companies who are well-positioned on their balance sheets — meaning lower debt ratios and strong cash or liquid assets, and cost-efficient retail originations,” he added. “They will see opportunities expand.”

For others, he said, “This could be the time many long-time, small-to-midsized originators look to sell their loan origination platform outright or joint venture with the right partner that gets them through these most difficult times.”

Andrew Rhodes, senior director and head of trading at MCT, said there is little doubt the mortgage market is going to consolidate, but stressed that is after “coming off of record profits and boom years.”

“Optimistic and well-prepared companies are starting to see opportunities to pick up key staff and to prepare for a [future] refinance boom when rates eventually do fall,” Rhodes said.

The MBA estimates that there will need to be up to a 30% decrease in mortgage industry employment “peak to trough,” given the projected decrease in production volume from the bullish years of 2020 and 2021. Still, the MBA offers some hope that a new normal on the interest-rate front will emerge by the end of 2023.

“Inflation will gradually decline toward the Fed’s 2% target by the middle of 2024,” said the MBA’s chief economist, Mike Fratantoni. 

The Fed-driven interest-rate spike, too, is subject to market gravity.

“After more than doubling so far in 2022 [recently topping 7%], MBA’s baseline forecast is for mortgage rates to end next year at around 5.4%,” MBA’s recent mortgage-market forecast predicts.

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