Banks, credit unions, independent mortgage banks, brokers, vendors, and others in the residential lending business have various short-and long-term goals. These change over time, of course, but given the trillions of refinances that took place in 2020 and 2021, a deeper discussion has evolved regarding the goals of those in our industry in terms of survival. Will a company be around in three to six months? Has it managed to cut costs as quickly as volume and revenue has dropped? How much capital might a company “burn through” before things “turn around,” whenever that is? A key part of that discussion involves the classic fight or flight decision whether to fight through the tough market or consider a strategic exit for the business.
Overall, the environment has changed. Merger and Acquisition (M&A) activity tends to heat up when profits decline, such as 2022. STRATMOR states that roughly 60 percent of IMBs lost money in Q2 2022, and that number may be higher in Q3. In 2019 and 2020 we saw IPO mania as the owners of, and investors in, those companies “took chips off the table” through public offerings. In 2022 that has changed, and few lenders or vendors are talking about issuing stock or finding equity investors. Projections and assumptions have changed as rates have moved higher than most anticipated. Most lenders hope to breakeven in 2022. Smaller lenders are even considering a move from being mortgage bankers to brokers, thereby eliminating underwriters, secondary marketing, and other corporate expenses.
M&A talk has only increased this year. On the buyer side of the teeter totter, companies are viewing the market shift in terms of adding production, focusing on growing market share in a down market. They are thinking in terms of adding market expertise. “Hey, that lender has a well-respected reverse mortgage group ….” How long will the seller stay involved? How financially stressed is the seller? Economies of scale, talent acquisition, strategic opportunities, and growing in a down market are often cited as reasons.
Potential sellers are asking another set of questions. “We have limited capital; how much do we want to use up surviving?” “What value do we bring to a potential buyer?” “What are the long-term prospects of our company in this environment?” “Is my life going to be better?” “What about my employees?” “What is my time of life?” Retirement, preservation of capital, and demands for additional technology are often cited as reasons to sell.
The ways in which deals are structured have changed. A few years ago, initial public offerings were popular and received a lot of publicity as owners sold stock to the public. Now the thinking has shifted toward “asset sales” as a method of transferring ownership, with the buyer purchasing the most valuable assets of the company — typically that is purchasing the branches and the production capabilities.
Generally speaking, IMBs typically sell via an asset sale, based on a go-forward proforma of forecasted earnings. STRATMOR’s M&A team can provide ROE (return on equity) and ROI (return on investment) multiple calculations of recent transactions, but those ratios are just an output of the result. Numbers can change week by week or month by month. STRATMOR reports that up-front premiums are down from a year ago but are still being offered on well matched deals. Sellers also get to liquidate their balance sheet and usually receive an earnout from the buyer for two or three years.
Numbers aside, as always, the cultural fit between a buyer and seller is paramount in any deal. What difference do great numbers and geographic fit make if the two groups don’t mesh? Even if the owners get along, other members of the senior management team should be able to cooperate and have similar values, as should employees. An unbiased evaluation and validation of cultural compatibility among parties can be critical to a transaction’s success. STRATMOR has a questionnaire that nails down this sort of cultural analysis.
The devil is in the details. What will be told, and when will the deal details be shared with the employees? Information is important, especially as recruiters swoop in. Transparency is critical in measured doses. Public announcements are becoming fewer, as those are viewed as doing nothing other than promoting the advisors behind the deal and may even have a negative impact on the two lenders or vendors involved in the merger or acquisition.
In normal markets buyers and sellers may talk on and off for years. I’m told conversations today are much more deliberate so being prepared is key. STRATMOR helps clients with several transaction evaluation and preparation services, including sale readiness, peer performance benchmarking, current valuation and a strategic review of multiple alternatives.
The actual deal fluctuates based on deal size and complexity. STRATMOR tells me that preparation, interaction with prospective buyers, negotiation of a letter of intent, due diligence and signing generally takes three to five months, although they recently completed a deal in two months. Onboarding and integration must be organized and executed properly to help get things started on the right foot.
As we wrap up 2022 and start thinking about 2023, few believe that the residential lending environment will improve. Owners and managers must constantly consider their business models and strategies, and what is best for the long term for the company and its employees. And a potential acquisition can be beneficial if mapped out and executed well.
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