Should your firm join the mortgage IPO boom? Consider these facts first

The market environment enticed many mortgage companies to at least consider going public last year, and we may still see a wave of IPOs roll through the industry in 2021.

Following the IPO last August from Rocket Companies, the parent of U.S. mortgage lender Quicken Loans, other home loan originators seemed poised to follow suit. Nonbank mortgage company Guild Holdings went public in October, however, soon after that Caliber Home Loans Inc. and AmeriHome Inc. paused their IPO plans. California-based lender LoanDepot is also waiting in the wings. Some of the recent mergers, like Guaranteed Rate’s acquisition of Stearns, are positioning companies for a successful IPO.

An IPO can have many benefits for the right company, but it is not the right decision for all. IPOs often require complex decisions and difficult trade-offs. Many companies enter discussions about an IPO only to abandon the effort partway down the road. Before proceeding along this path, it is important for the company’s management and board to carefully evaluate the pros and cons of all capital alternatives.

In many cases, there are other options that better fit the company’s needs. In general, an IPO is more often the right answer for a bank than for a mortgage company; more often for a large cap than a small cap; more often for a tightly-controlled company than a flexible one.

For the right company, an IPO is the public culmination of years of hard work. In these cases, the pros far outweigh the cons, and the choice is clear. For a surprising number of companies, however, pursuing an IPO is a mistake.

Historically, the volatility of the mortgage business has resulted in poor stock price performance. During boom times like the current refinancing wave, companies trade at very low price-to-earning multiples. These low PEs are reasonable because investors are looking not just at this year’s earnings but at the prospects for a huge decline when the party is over. Unfortunately, a low PE is a red flag on the company.

Here is a look at some of the pros and cons that mortgage companies should keep in mind when considering whether an IPO is the right fit in the current environment.

Pros:

Launching an IPO can offer enhanced market visibility while diversifying the investor base. It offers broader access to equity markets to obtain growth capital; potentially broader access to more sophisticated debt markets.

The enhanced external and internal reporting requirements may result in improved financial reporting discipline. Going public also means the company gets active market feedback on its performance.

The ability to provide stock and/or options as part of compensation may attract and retain key talent. A public company has enhanced transparency and offers information dissemination to employees, customers and vendors. It provides an opportunity for founders/investors to monetize investments and exercise financial exit strategies.

Cons:

It takes a considerable amount of work to execute on going public, and hence, can be expensive ($2-3 million of expense on audits, management upgrades and infrastructure, plus a $5-7 million underwriting fee) and distracting.

The gross spread payable to the investment bank is typically 5-7% of proceeds.

To gain traction with investors, the public stock portion’s minimum size should be at least $100 million. Stocks also trade better when there is sufficient float to meet demand, and over 50% of the stock is available to trade.

Going public creates new layers of ongoing compliance requirements – SEC, SarBox, etc. Financial and operational data is publicly released, including compensation for top officers. This may result in competitors taking advantage of the company with targeted sales or recruiting efforts.

A public offering can create volatility. Most non-bank financial services companies have short-term valuation windows that offer little earnings visibility. Investors focus on earnings trajectory, which will often be discounted, thereby pressuring management to “hit” or exceed current period performance goals.

Another factor on the con side: new fiduciary obligations to investors may limit the company’s operating flexibility.

Public companies are subject to restrictions on management and control regarding personal stock sales, pledging and trading. Even when allowed, sales may send a negative message. These restrictions can make it hard to gain liquidity when needed or limit the potential upside.

Public companies open themselves to exposure to activist investors, short sellers or other nay-sayers/opportunists, which creates potential to lose control of the company.

Considering an IPO is one of the most complicated decisions any company faces. There are numerous issues that must be addressed and prioritized. In some cases, the bigger stage afforded to a public company is complementary to the rest of the business strategy. If so, an IPO is the only answer.

For most companies, however, there are viable alternatives. There is no one-size-fits-all answer to this conversation. Instead, it is a matter of finding the right fit based on the fundamentals of the company.