Stratmor's Garth Graham on mortgage M&A in 2025

November 18, 2024 5:00 AM

Mortgage companies didn't completely lose their appetite for mergers and acquisitions this year despite the sluggish housing market.

Stratmor Group expects the pace of M&As this year to be less than half of 38 transactions completed in both 2022 and 2023. While the majority of companies are turning profits toward the end of this year, according to the Mortgage Bankers Association, those losing money could be feeling renewed pressure from warehouse lenders funding origination pipelines.

"We are in a very seasonal market," he said. "In many parts of the country, late Q4 and into Q1 next year are going to be lean."

Still, the number of transactions will exceed the 13 completed in 2020, when rates dipped and every mortgage player was enjoying profits, Graham added. National Mortgage News spoke with the industry veteran about the M&A environment today, where interest has picked up, and how the incoming Trump administration could affect future transactions.

This interview has been edited for length and clarity.

Are mortgage M&As happening at a slower pace this year?

Garth Graham: Yes. It was muted in the third quarter because a lot of people felt interest rates were coming down, and they did. At the end of the third quarter they immediately went up, and of course, we're up in the last week as well.

I do think there are counterparties that are beginning to encourage some of their lenders to make decisions. That is, warehouse banks bringing pressure on some of the struggling mortgage companies. And Fannie Mae and Freddie Mac perhaps considering suspending tickets.

Another way to put it is, the Mortgage Bankers Association data shows 70% of mortgage companies made money [in Q3]. That means the inverse is, about 30% didn't. And if you're in the 30%, that's a tough spot to be in because you're gonna have to be putting more capital in your business or consider what your options might be.

Which companies have felt the pressure?

Graham: I wouldn't talk about who, but part of it is that two warehouse banks exited. So there are less options than there were, and some have come in. But there certainly is pressure. The pressure is that warehouse lenders always have a watch list and when the market was rough, they weren't going to start cutting off companies that weren't making money, because they'd have to cut off too many.

But as the market turns, there is going to be that bottom 20% to 30% that at some point to whereas lenders may say, "Okay, that's enough." [A company] might have four warehouse lenders, but if one pulls, it can be a death spiral. Not always, but it can be.

Which companies are ready for M&A?

Graham: The biggest thing that factors into acquisitions for independent mortgage bankers is the lifestyle, or life stage of the IMB owner. In many cases, it is an individual who may be approaching retirement, who cleared their net worth hurdle, and finally says, "I don't think we're going to get a new refi boom. So maybe now's the time for the exit."

I don't think it's quite clear. Some companies are breaking even. Maybe they have a good enough balance sheet so they can survive, but they're getting pressure from counterparties. It's not a legacy business, or maybe it was and the kids are in it, but they really don't want it. We see that all the time, and then they just say, "Hey, look, it's not time."

We are seeing our top-of-funnel begin to fill up again. It was pretty lean in September and in the third quarter, but I think some lenders are beginning to say, "uh oh." There are some who think the outcome of the election will be extremely inflationary, which will put pressure on or cause a drag on interest rates.

Some believe that's not the case, and deregulation will help the housing market. But at least some chunk of the market is concerned about the outcome of the election, or may be concerned because of the potential for inflationary pressures.

Potential inflationary pressures could also impact home builders. Are they more likely to be involved in M&A?

Builders are always interested in M&A. The big builder-owned mortgage companies, their M&A is not driven by the mortgage side. It's driven by the builder's side. They make public statements regarding their appetite for acquisition, and many of them always have an appetite. Often it's geographic expansion driving it. I could see that absolutely positively being a 2025 thing.

Where is the M&A interest today?

Graham: Mostly all the action was in retail during the down cycle, because that's where purchase activity was. I think there's a little more interest in the third-party origination space right now, and there's definitely more interest in consumer direct. Most feel at some point we're going to start seeing the lowering of mortgage rates, which creates runoff, which means you need capacity for recapture.

We have had in the last 60 to 90 days more interest from external investors like private equity. That comes and goes. They know maybe there'll be another quarter or two of losses, but they think we're closer to the trough and are now willing to invest.

They also make bets around the potential for deregulation, or the potential for corporate tax reductions being lower, making them more likely to want to invest in certain segments. They also may have a thesis that as the average sales price continues to go up, which is bad news for affordability, it's good news for potential profitability.

So we've got more private equity and financial investor types than we've had in quite a while. They were on the sideline last year saying "When is the Fed going to turn?" We at least now know the Fed has begun to turn. The question is whether it really helps mortgage rates, because it hasn't much.

What other areas are drawing interest for M&A?

Graham: There's some action around home equity too, because there's certainly an investment thesis around: There's a lot of equity, there's a lot of consumers and very low coupons, and if they want their equity, home equity loans are a good option. Historically, until Figure and some of the other fintechs came along, the home equity side really was all banks. We're beginning to see more independence, which means we'll be able to see more investment and potential acquisition and home equity too.

What else are you hearing, or telling lenders?

Graham: What we're telling clients is you need to stress test your own business model on multiple rate scenarios. The problem is so many lenders say, "The market's going to go up next year, say 26%, so I add 26% to my volume and I'm good." Well, first of all, what if it doesn't?

What if it's refis that are down and purchase being up? What if your location lacks the 26% growth because of affordability or new construction challenges? And by the way, new construction might get spiked over supply chain problems and inflationary pressure.

You don't want to just assume, there could be some real disruptions in certain markets. You just need to forecast in a more complex way, like three or four scenarios. And not every mortgage banking company really looks at it in that sophisticated way. I do think the warehouse banks are that type of way because they have regulations.

This is the other problem with warehouse banks: There may be a place they can allocate the capital to make more money, in which case they may pull out. You just never are quite sure what might happen. And if you wait too long to have a plan, you usually are not going to have an opportunity to execute your plan, because then it's a fire sale. Those are rough.