Some banks are shutting down or selling their mortgage operations. Refinance shops that boomed when rates were low have disappeared, scaled back, or are trying to reinvent themselves as purchase lenders. Interest rates and home prices are limiting the options for first-time homebuyers, making homeownership less affordable. Margins continue to shrink as lenders scramble to maintain market share.
As the experts have been predicting over the last few years, our industry will go through extensive consolidation in 2019 and 2020. Shakeouts in the financial sectors are not new. Stronger companies that have the financial resources typically welcome this environment and can afford to make strategic merger and acquisition (M&A) decisions that will strengthen the firm for the longer term.
As with any industry consolidation and a competitive marketplace, there are many high-quality independent mortgage banks that are trying to cope with declining originations, extreme competition, and lower margins. These firms are now considering their options: Remain independent; liquidate their balance sheet and retire; or sell and partner with a larger firm. If they choose the M&A route, they are looking for acquirers that have a larger balance sheet and/or deep-pocketed shareholders, a compatible sales culture, upgraded technology offerings, and an entrepreneurial mindset. Ideally, the deal would result in a new combination where both sides win.
What are the keys to success to mergers and acquisitions in the mortgage industry? More than a decade ago, the Guild leadership team developed a long-term strategic plan to expand nationally, by acquiring smaller, profitable, and overall successful firms that compete well in their local markets. We established initial criteria for evaluating our future partners by focusing on historical financial performance but quickly learned that the current market environment is a much better predictor of future performance. We like to see a consistency of performance over varied market cycles. It is relatively easy to make profits when times are robust; however, many firms have figured out how to generate profits when the markets are competitive and much more challenging.
Firms that are looking to acquire other companies in the current environment should engage investment bankers that know their story, are familiar with their culture, and are willing to take the time to proactively uncover opportunities where the potential candidate has not yet figured out that he or she is a seller yet. Acquirers should look at all opportunities, including where investment bankers are conducting competitive, “limited” auctions, while preferring opportunities that give them more time to get to know their future partners and that are not as widely marketed to the mortgage banking community.
Keys to Success
Here are five areas companies should make a priority to ensure an acquisition is successful: cultural fit; leadership; geographic and market opportunity; retail channel dominance; and entrepreneurial spirit.
Cultural Fit: From both the buyer and seller perspectives, culture is a No. 1 priority. Your business is based on people —how they work together and treat each other, what are their motivations, what is the tenure of senior management and loan officers, and just how strong is their company culture. If the people and values don’t mesh, there is likely very little chance for success.
Many companies believe in collaborative work environments where loan officers and employees work together and are motivated to find the right mortgage solutions for their borrowers. As a result, they look for acquisition candidates that think and act the way they do: executives that embrace active listening, are open to constructive learning and willing to adopt best practices. It is never “our way or the highway.”
Patience is a virtue; like most marriages, acquirers must be willing to devote the time and effort to a long-term courting phase to help ensure a successful partnership. Some transactions can take almost three years to reach that critical level of trust, comfort, and respect.
Leadership: Value strong management teams that have developed a loyal, productive sales force, where the leaders are prepared to stay engaged for at least three years. While an acquiring company should not insist that sellers stay on beyond three years, very often some of them do and end up joining and augmenting their executive team. Some sellers bring more to the table than the incremental loan volume. Perhaps they have developed expertise in loan products, a unique channel, certain technology apps or regional relationships and partnerships all of which enhance the value of the partnership to the acquiring firm.
Passive or absent leadership in the selling company is usually a danger sign. Many firms have considered seemingly good candidates on paper, but as they work through terms and due diligence, it becomes clear that the executive running the business was not the key driver of the company’s success or salesforce. Early on, try to determine who is really leading the organization and whether he or she is likely to be committed and motivated to keep building the platform post close.
Although most companies structure their acquisitions as “asset deals” (versus “stock deals”) the greatest assets, i.e., the loan officers, are not “acquirable” assets and leave the building every day. Hopefully, these individuals will follow the lead of their current management team but ultimately, as long as you have 12 to 18 months to work with the acquired loan officers, you should be able to retain the vast majority of the acquired sales force.
Once the transaction is announced, recruiters will exploit the uncertainty and perceived dislocation created by the deal and look to poach as many employees as possible. Therefore, maintaining deal secrecy is critical for both sides. Both the buyer and seller should anticipate that this may happen and develop communication plans to manage this potential threat. Leadership has to take the time to sell the merits of the new partnership, emphasizing how key employees’ lives will be improved.
At a minimum, loan officers’ day-to-day environments and compensation plans should stay the same but hopefully, there are identifiable improvements to brag about.
Geography: For firms seeking geographic expansion, acquirers tend to look for the more dominant regional leaders in the marketplace that may be for sale. They analyze the candidate firm’s market share, quality, and the productivity of its loan officers, production margins, and the reputations of its leaders and top producers. What does the selling firm see as its competitive advantages in the market? How healthy is the market and its prospects for the future?
Companies generally prefer to acquire a firm that is geographically concentrated. In most cases, it is just easier to acquire a collection of branches, concentrated in a new region, where there is very little overlap with the acquirer’s existing footprint. You can be successful in merging offices but also understand the potential conflicts and challenges of combining territories.
Retail Expertise: Most companies are generally stronger in one of the three origination channels—retail, wholesale or correspondent, and direct to consumer. You don’t often see organizations that are strong in all three. For example, Guild is and has been a retail-focused organization for more than 50 years. We understand this channel, have been successful in it and are less interested in developing channel expertise in wholesale or consumer direct. Sellers should clearly understand that partnering with buyers that may not understand their channel of expertise is likely more complicated and contemplates more risk than if they were to team up with a firm that is intimately familiar with their day-to-day channel specific challenges.
Entrepreneurial Spirit: In today’s environment, acquirers can be selective. Take the time to find companies that know how to creatively solve problems and at the same time look for new opportunities and better ways to operate the business. How has the company reacted to changes in market conditions? Has the company been successful through various business cycles? You want to know that the leadership team is agile and willing to listen to new ways to operate in changing times.
Considerations for Sellers
The keys to success are similar for sellers. Some of the questions they must consider include:
Do the cultures match?
Will the combination create new products?
What about pricing?
Does the buyer have experience in successfully acquiring mortgage companies?
Have they managed through market cycles?
How strong is their balance sheet?
Does management own equity?
Does the organization have good corporate governance and meet regulatory and compliance requirements
What is the status of their technology? Is it an upgrade? Will the buyer’s technology platform, systems, and applications add value and make my originators more productive?
Larger companies are investing in artificial intelligence, automation, and machine learning to improve the mortgage experience through better, faster, and more accurate processes in origination, servicing, compliance, home-loan education, and marketing. With new technology, companies are reporting happier staff who can plug into these new systems to reduce time spent on mundane, repetitive tasks. This gives loan officers, underwriters, and operations staff time to concentrate on more meaningful work, including improving customer service, focusing on relationships, and reducing production costs.
Challenges and Opportunities
Potential storms are on the horizon, with leadership changes at Fannie Mae, Freddie Mac, and the FHA, among others. Due to margin compression, retail mortgage banking may become less attractive to investors and profitability may be more elusive, as evidenced by the big banks cutting staff and eliminating mortgage banking divisions. Banks tend to have more regulatory hurdles to jump through than the independents, which creates opportunities.
The coming consolidation will see many marginal, small independents exiting the business. Larger firms with strong balance sheets will take advantage of potential fire sales to add top producing loan officers from firms that have closed or have been recently acquired, often because cultures didn’t align. The anticipated surge in M&As can lead to strong new combinations of talent, resources, and entrepreneurial cultures that will be essential to competing successfully over the next two years and beyond.