EY point of view - US mortgage banking M and A trends and outlook
1. Consolidation of the US mortgage industry continues
The amount of capital required and the cost to originate and service mortgage loans continues to rise due
to regulatory changes driven by Dodd-Frank and Basel III, and is further affected by prolonged low interest
rates in the US. Market participants looking to grow their businesses and maintain profit margins will need
to aggressively leverage new technologies and global labor sources. Long-term growth in a market with
stagnating volume is expected to be achieved through M&A activity.
• Non-bank mortgage originations have increased dramatically over the last few years. Non-bank lenders such
as Freedom Mortgage, Quicken Loans, PennyMac, Nationstar, PHH Mortgage and Loan Depot accounted for
over 45% of mortgages originated in 2015, compared to 13% in 2011.
• Given the low mortgage-interest rate environment and the rebound of the residential mortgage (RMBS) and
commercial mortgage-backed securities (CMBS) securitization markets since the crisis, and considering the
seasonality affecting housing activity, MBS issuance is expected to remain strong for the remainder of 2016
and 2017.
Long-term growth
in the US mortgage
banking market
is expected to be
achieved through
M&A. Various
participants are
looking for ways to
remain competitive
while navigating
pressures and
uncertainties, such
as the interest
rate environment,
Dodd-Frank rules
and potential
disruptions from
FinTech companies,
among others.
US mortgage banking
M&A trends and outlook
November 2016
Industry trends and outlook
• Interest rate environment — The spread between
the fed funds and mortgage rates narrowed after the
rate increase in December 2015. The long end of
the yield curve flattening, due to global headwinds
with large economies and recent news of Brexit,
has resulted in an increase in refinance activity.
• Margin pressure due to new rules — New mortgage
documentation requirements introduced by
Dodd-Frank led to an increase in the average loan
origination cost by 18% in the past two years,
according to the Mortgage Bankers Association.
• Loan volume stagnating — Total outstanding
mortgage debt declined from its peak of $14.8
trillion in Q4 2013 to its lowest point in a decade,
$12.5 trillion in Q1 2016. Due to increasing
operational complexity combined with decreasing
profitability, large and small banking institutions are
slowing down the origination of new mortgages;
however, refinancing activity has increased.
• Loan quality improves — The quality of loans,
on the other hand, continues to improve, with
decreases in charge-off rates to pre-crisis levels
of 0.08% in Q1 2016, compared to 2.85% toward
the end of 2009, indicating that the recovery
from the 2008-09 credit crisis continues.
• Housing demand — According to the Mortgage
Bankers Association, housing demand is expected
to surge over the next 10 years as an additional
14 million—16 million households will be formed,
primarily driven by baby boomers and millennials.
• Property valuation — According to the National
Association of Realtors, property values in the
housing market continue to rise nationally; the
average sales price of existing homes increased by
6.8% in the twelve months ending June 2016.
• MSR valuation — Interest rate volatility toward
the end of 2015 and Q1 2016 has significantly
affected mortgage servicing rights (MSR)
valuations in Q1 2016. Several banks reported
MSR valuation declines since Q4 2015. Industry
rankings indicate second-tier servicers and non-
banks increased market share in the mortgage
servicing space in Q1 2016, whereas overall
mortgage servicing segment growth was stagnant.
• Construction spending continues to grow — The
growth in overall construction spending is one
of the main drivers of the general profitability in
the mortgage industry and directly correlates
with low interest rates and economic growth
that stimulates the demand of new residential
properties. Annual spending on residential property
construction has increased from its low in 2011
to reach $5.0 trillion in 2015, with annualized
construction spend of $5.2 trillion through the
first four months of 2016. While residential spend
is still far below the pre-crisis high of $7.3 billion
in 2006, both residential and non-residential
construction are expected to increase further,
even under a higher interest rate environment.
2. 3 | US mortgage banking: M&A activity and outlook
M&A outlook
• Banking M&A — M&A is expected to continue
to accelerate as organic earnings per share
(EPS) growth challenges continue to persist
and the cost of capital is exceeding returns for
many players. Activist pressure is also seizing
on strategic and financial vulnerabilities.
• Loan portfolio acquisitions — Pressures
on top-line growth of banks from the low
interest rate environment are expected to
continue the momentum of loan portfolio
acquisitions, as seen in 2014 and 2015,
in order to achieve a boost in net interest
income, although the momentum may change
if interest rates begin to increase.
• FinTech as an opportunity to cut costs —
Streamlining the sales process through an
electronic documentation process may help
certain lenders lower their origination costs.
Developing these capabilities on one’s own
requires high capital expenditures and bears
risks of failure. Investing or partnering with
FinTech companies or acquiring a competitor
that possesses the desired digital technology
is becoming a more preferred option. Growth
of blockchain and the use of distributed
ledger may also help mortgage servicing
businesses lower their administrative cost
burdens.
• Asset acquisitions — Industry analysts
expect 2016 asset-based acquisitions to
surpass their 2015 levels. While deal activity
during the first nine months of 2016 has
been slow due to economic uncertainty,
mortgage portfolio acquisitions are expected
to increase during the second half of 2016
to surpass their 2015 levels, as various
mortgage lenders have publicly stated their
intentions as future 2016 and 2017 buyers.
• Industry consolidation — The bulk of the
deals in the mortgage space over the last
three years were strategic acquisitions of
small- to medium-size mortgage lending
businesses. High regulatory costs from new
lending and servicing requirements will
continue to force smaller and midsize market
participants, unable to achieve economies of
scale, to be takeover targets from their larger
competitors to maintain profit margins. The
need to consolidate will increase M&A activity
in the last three months of 2016 and beyond.
• REIT deal activity — 2015 and 2016 saw
high levels of REIT transactions, including
ten deals in the first nine months of 2016.
This consolidation trend in the REIT industry
may be impacted in 2016 due to the recent
Financial Industry Regulatory Authority
(FINRA) regulatory scrutiny on the growing
non-traded REIT market.
• MSR deal activity — MSR valuations
experienced impairments in Q1 2016 due to
the continued low interest rate environment,
which results in higher prepayments from
loan refinancings. This uncertainty has
led to a slowdown of servicing businesses/
MSR portfolio deals; however, this trend
is expected to reverse when interest rates
increase. REITs, however, may become an
attractive investment opportunity for various
investors as buyers look for safe havens
post-Brexit, especially if the adverse effects of
Brexit are long-term.
M&A activity
• 2015 and 2016 deal activity included various
mortgage and MSR portfolios, as well as
mortgage origination, refinance and servicing
businesses. The number of mortgage
business deals in 2016 has exceeded the
numbers in 2015, whereas the number of
portfolio acquisitions appears to have slowed
down. The first nine months of 2016 saw 24
mortgage business acquisitions, on pace to
eclipse the 21 deals that occurred in 2015.
• The number of mortgage portfolio deals
appears to be on a downward trend, declining
30.7% in FY15 and on pace for a further 56%
decline into FY16. CW Capital Management
and Nationstar Mortgage Holdings sold $2.3
billion and $1.1 billion from the sales of
their commercial and residential mortgage
portfolios in the first half of 2014, with
no similar large dispositions occurring in
2015 and the first nine months of 2016.
• Blackstone and its affiliates were active in
2015, making six acquisitions of mortgage
businesses and loan portfolios for a total
disclosed deal value of $8.6 billion.
• The increase in average deal size, excluding
GE Capital, was driven by two large real
estate investment trust (REIT) deals in
FY16, the $2.0 billion three-way merger
among NorthStar Realty, NorthStar Asset
Management and Colony Capital, as well
as Annaly Capital Management’s $1.5
billion acquisition of Hatteras Financial
Corp. and American Finance Trust Inc.’s
$1.0 billion acquisition of American
Reality Capital. These mergers echo a
previous trend of consolidation in the
REIT space experienced in 2015.
• Freedom Mortgage, one of the largest
nonbank mortgage lenders (originating
$36.8 billion of mortgages in 2015),
has made five acquisitions since 2014,
a sign of industry consolidation among
the largest nonbank lenders.
• The mortgage industry has seen little
capital markets activity, with no IPOs
being completed during 2015 or 2016.
Number of deals by deal type
Deal value by deal type
Mortgage
business
acquisitions
MSR
acquisitions
Mortgage
portfolio
acquisitions
3,9139M16
2015
2014
19,662
6,898
339M16
2015
2014
51
33
66
3. 4Driving the Capital Agenda — Transaction Advisory Services |
What you should know
Financing and Accounting
• Valuation implications — Mortgage
portfolio valuations are significantly
affected by duration, vintage (pre- or
post-crisis originations), mix of interest
rates (fixed vs. floating), expected
credit losses and prepayment rates.
• Repurchase reserve — Mortgage originators
possess a put-back risk of loans previously
sold to investors due to contractual reps
and warranties included within sold loans.
Upon breach, originators may be required to
repurchase the defective loan or indemnify
(or make whole) the investor or government-
sponsored enterprise (GSE). This requires
originators to record a liability for repurchase
reserves on the balance sheet, which may
be affected by the level of breaches and
quality of the underlying operations.
• Securitization accounting — Originated
loans are often grouped and sold to investors
in a securitization transaction, which
requires complex accounting guidance to be
evaluated for off-balance-sheet treatment.
Incorrect application of generally accepted
accounting principles (GAAP) could result
in consolidation of previously securitized
assets, eliminating any economics of
such securitization transactions from the
financial statements. Off-balance-sheet
treatment of securitizations is also based
on the assumption the transferred assets
are legally isolated from the transferor
(generally validated by a true sale opinion).
Tax
• Tax treatment of MSRs and loan origination
fees and any special elections (and whether
any excess servicing exists) or tax accounting
methodologies could have significant impacts
on the acquirer’s future tax obligations.
• REIT implications — Acquisitions of
mortgage businesses by REITs need to
consider the implications on its REIT status,
as REITs have certain tax qualification
requirements, such as asset portfolio mix,
types of income, information reporting
and withholding, distribution of earnings,
type and number of shareholders, etc.
Underwriting and Servicing
• Credit quality — Mortgage originators and
servicers are greatly affected by the credit
profile (e.g., prime, sub-prime, FICO score,
loan-to-value (LTV) ratios, etc.) of the
mortgage loan portfolios being acquired.
The mortgage loans or servicing rights
are also affected by overall economic
factors, such as interest rates, as they
affect prepayment speeds. Moreover,
a buyer should consider evaluating
whether credit policies and procedures
are in place and followed consistently,
and limit significant manual overrides.
• Cost structure — For mortgage
originators and servicers, the small
shifts in net costs to originate and
service loans can have significant impact
on overall business profitability.
• Servicing advances — Servicers advance
funds on behalf of delinquent borrowers
and also to repair, maintain and market
foreclosed real estate properties, which
may require additional financing. Excessive
shifts in level of servicing advances (or
long-dated balances) may also indicate a
deterioration in quality of loan portfolio/
borrower and strain a company’s liquidity.
• Underwriting practices — In early June
2016, Fannie Mae postponed the expected
new requirement that lenders must use
trended credit data when underwriting,
in an effort to make the home mortgage
market open to more consumers. This
potential additional regulatory change
should be considered with respect to
the underwriting processes and control
environment in a potential acquisition.
Separation and Integration
• Integration risks — Potential negative
borrower experience due to deterioration in
service levels during integration and related
changes to the borrower (e.g., payment
information changes, call center integration,
online services integration) should be
mitigated through adequate planning.
• Carve-outs — Acquisitions of mortgage
businesses that are commingled with parent
or other operations of a seller reduce
transparency and require an understanding
of interdependencies, shared services and
analysis of carved-out “deal-basis” financials.
For mortgage businesses, earnings can
significantly fluctuate due to various factors,
including the prevailing interest rates,
origination volume and gains on sale margins.
IT
• Mortgage businesses rely greatly on the
loan origination and servicing systems
that, if based on older technologies or
heavily customized, may pose risks to
updating, compliance and integration.
The IT environment may not have seen
adequate levels of investment, which may
require a buyer to increase one-time costs
to remediate systems or infrastructure to
address performance or risk issues. Clear
technology strategy for scaling-up systems
in growth periods will also be critical.
Regulatory
• Fannie Mae and Freddie Mac have extended
the deadline for mortgage lenders to comply
with the Consumer Financial Protection
Bureau’s (CFPB) new TILA-RESPA Integrated
Disclosure (TRID) regulation; however, TRID
requires lenders to significantly change
their business operations to maintain the
pace of lending activity. In addition to TRID,
compliance with other emerging/changing
rules, the company’s risk management
structure and compliance oversight,
effects of any litigation risks resulting
from foreclosure proceedings (including
robo-signing) and mishandling of escrow
accounts are important to consider.
Funding
• An understanding of future funding
commitments, relationships with lenders,
expected extension terms, capacity and
whether prepayment penalties exist are
critical for a mortgage origination acquisition
to continue to fund originations through the
company’s warehouse lines post-acquisition.
Human Capital
• Costly change of control payments
may become payable as a result of a
transaction, or loss of key personnel
could result in significant erosion of value
and create disruption to the business.
We have the right teams
that are made up of industry
professionals who have
worked together on significant
financial services transactions,
particularly in the mortgage
banking sector. These teams
have deep, hands-on experience
planning and advising on
transactions, including
assessing deal opportunities,
analyzing transactions from
both a strategic and tactical
perspective, helping set up
and optimize new operations,
restructuring and integrations.
