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Pressure Mounts on Small Banks to Buy Mortgage Firms

More mortgage originators could change hands in coming months as pressure mounts on small banks and servicers to deploy excess capital and pad revenue.

More than a dozen mortgage lenders have sold this year, and Charles Welch, a managing director at Deloitte Corporate Finance, said this type of M&A activity is expected to increase in 2014.

"It is better today to sell as a mortgage company than it was a year ago, and it should be even better next year," Welch said this week at a mortgage conference hosted by the North Carolina Bankers Association.

Community banks are the most likely buyers, said Welch, who was at McColl Partners in Charlotte, N.C., before it was acquired in June by Deloitte. A number of small banks have capital in hand and credit under control but are struggling to book loans.

Bankers continue to lament the midsummer increase in long-term interest rates, which simultaneously curbed refinancings and demand for new mortgages. As a result lenders must work harder to court borrowers.

"We are doing a lot of training for our officers, sitting down and talking through how to become salesmen again," Ken Irvin, mortgage department manager at Bank of Tennessee in Kingsport, said during the mortgage conference. Due to high refinance activity "we lost the part about really going out and making sales calls."

That shift could also motivate banks to buy an originator, particularly those with an established track record courting new home buyers, said Welch, who is working with a pair of mortgage lenders that are exploring strategic alternatives. "If you have a successful purchase model … you will still be viewed quite favorably by an acquirer," he said.

Originators with a traditional focus on the purchase business are apt to command better premiums, says Daniel Jacobs, a partner at Pro Mortgage Branching Solutions in Charlotte.

"A company that was doing 90% refi … would have negative value in an acquisition," Jacobs says. "The only mortgage companies with value are those that were outpacing their peers from the perspective of the purchase business."

As a rule of thumb, buyers will want to know that at least half of an originator's business is coming from new homebuyers, Jacobs says. Still, acquirers might be willing to buy a lender with a higher percentage of refinancings if it also can show an ability to generate a significant amount of volume, he says.

Community banks are mostly interested in mortgage lenders that already operate on their home turf, and those that have been approved by Fannie Mae and Freddie Mac have a higher franchise value, Welch said.

However, private equity may seize on acquisition opportunities than community banks, which tend to be more cautions, Jacobs says.

"I doubt community banks have a big appetite for the mortgage business," Jacobs says. "They should, though, because the fee income far outpaces the return on equity they can achieve from core banking services."

The most likely PE buyers are those that have already invested in servicing platforms, Jacobs says. Welch also noted that companies that bought servicing rights in recent years could have an interest in buying large originators. "That's interest that didn't exist a year ago," Welch said.

Earlier this year, Ocwen Financial (OCN) in Atlanta agreed to pay $2.5 billion for mortgage servicing rights and related servicing advances from OneWest Bank in Pasadena, Calif., and Quicken Loans in Detroit bought a pool of MSRs from Ally Bank. Nationstar (NSM), Walter Investment (WAC) and PennyMac have also been lining up to buy mortgage servicing rights from banks that are scaling back to comply with expected Basel III capital requirements.

The terms of mortgage acquisitions tend to be complicated, experts warn. Few assets change hands; buyers are paying for an origination platform and future income streams. So buyers usually are insistent that acquisitions consist of very little up-front money and heavy earn-out periods that could extend three years past a deal's closing. Those terms could be unsatisfactory for potential sellers, Welch said.

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Baloney! Most small banks do not have the management skills or systems to run a commission based residential mortgage company. You take out the refi and actually there is very little purchase money business to speak of to support the cost of platform.

Second the effect of Basel III on the value of servicing will decrease the worth the business.

Third, the risk of buy-backs and fraud is something the community bank has very little experience in.

The actual value in a sales platform is in many cases a negative number
regardless of what the smiling consultant would have believe. Take away the GSEs and the entire industry will "tube."

I would rather spend capital on a model supporting the SBA loan or perhaps the Title One home improvement loan. No matter what course of action is taken it must have a clear path to profit or it will cause a
clear path to the unemployment line.

Allen Hardester
410-997-1115
Posted by hardester | Friday, September 13 2013 at 2:07PM ET
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