Three mid-sized lenders are ripe for acquisition, analyst finds

Large publicly traded mortgage companies could be out to gobble up some of their mid-sized competitors as the origination market shrinks, a report from Keefe, Bruyette & Woods speculates.

Historically, shrinking mortgage markets lead to industry consolidation. But during the big run-up in volume during the pandemic, a number of major players took the opportunity to go public.

The mortgage sector's stock has "underperformed meaningfully" so far this year, Bose George, an analyst at KBW, said. "[But] generally, we think larger mortgage companies are quite well-capitalized and are likely to take more strategic actions to stem losses before their debt is impaired," he added

George identified three targets for acquisition — Homepoint, loanDepot and Guild Mortgage.

"Over the past few months, we have seen a modest pickup in M&A amongst small/mid-sized originators," he said. "Given our expectations for a multi-year challenging operating environment for mortgage originators, we think we could see a pickup in consolidation activity."

The combination of falling values and rising rates are pressuring independent mortgage banker results, likely leading to operating losses, a report from Shampa Bhattacharya, Fitch Ratings' director, Non-Bank Financial Institutions, noted. Home price appreciation, a driver of mortgage origination volume, is expected to shrink. Fannie Mae just predicted annual price growth to turn negative in the second quarter. But others are still expecting positive growth, including Veros Real Estate Solutions, which now forecasts that home prices will appreciate on average 1.5% for the next 12 months. But it is a significant drop from the 4.5% annual appreciation forecast Veros made just one quarter ago.

The declining revenue from lower origination volume at nonbanks is outpacing their expense cuts. "Weakening gain on sale margins from intense competition, has led to outsized pressure in the wholesale channel, with margins also pressured by higher repurchase charges," Bhattacharya said in the Fitch report.

Of the three targets KBW mentioned, only Homepoint is a wholesaler, and it is the third largest producer in the channel. loanDepot closed its wholesale business earlier this year, and Guild does retail and correspondent

Of the three likely buyers cited by KBW's George, two are the largest wholesale originators in the market (as well as overall): Rocket Mortgage and United Wholesale Mortgage. The third potential buyer, Mr. Cooper, on the other hand, exited the wholesale business in April 2020.

In the KBW report, George quoted comments about consolidation in a recent earnings call from Rocket's Jay Farner in addition to less certain responses from UWM's Mat Ishbia. He also referred to statements on M&A from Guild's Mary Ann McGarry at a HousingWire conference and in an interview.

The likelihood that it will be many years before another strong refinance market will arise is one of the drivers of consolidation.

"This is not ideal for small/midsized originators that are already taking strategic actions (selling mortgage servicing rights/other assets, exiting channels, reducing headcount, etc.)" George said. "Worth noting, given that headline inflation is still elevated at 8.3% and the September median dot suggests 3.1% core personal consumption expenditures in 2023, the threshold for aggressively lowering rates is probably relatively high."

Furthermore, given current industry headcounts, more job reductions need to occur.

"On the other hand, we also think there is a limit to how much companies can reduce headcount without sacrificing technology or damaging morale," George said. "We think this creates a challenge that could be supportive of consolidation."

Another consideration is that products that are dominated by banks — adjustable rate mortgages, jumbo mortgages, home equity loans and home equity lines of credit  — are growing share in the current environment, taking share from the non-depositories for the next few years, also driving consolidation.

But potential takeover targets still have options, George said.

Even with MSR sales, ancillary business segment sales, channel exits and headcount reductions, "many of these companies have additional levers they can pull to attempt to break even: cutting/reducing dividends; further headcount reductions; or ceding market share," George said. "All the public companies that we mention as potential merger partners have balance sheets that should allow them to continue operating even if they are losing money; and some (such as Guild) should remain profitable."