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The Value Of A Lender

What to know before putting your business up for sale

Rob Chrisman
Rob Chrisman
The Value of a Lender

Some residential lenders believe that servicing, and the mortgage servicing rights that accompany it, is the only thing of value for lenders. After all, it is an annuity that earns a return every month or can be sold. But that begs the questions, is it only the lenders who have servicing who have any value? Can small lenders with decent market share have interest from buyers? And what attributes are examined when a potential buyer and seller of a lender are negotiating?

The actual valuation analysis of a lender, or vendor, can be compared to that of appraising a house. The “Market Approach” is based on market multiples derived from publicly traded companies or actual sales of comparable companies or assets. The “Cost Approach” is based on the value of the underlying assets and liabilities of a business to estimate the equity value of the firm. (This approach, however, is not applicable to a mortgage production company without significant servicing assets). The “Income Approach” is based on the premise that the value of a business depends on its future earnings, discounted at a reasonable discount rate, that is commensurate with the time value of money and the inherent risk of the investment.

In valuing a company, a potential buyer will look at the audited net worth and the discounted cash flows, usually for the next three years of estimated earnings. (The devil’s in the details and assumptions!) The value to a potential buyer will depend on different factors, and three main variables often used in an analysis: loan volumes, margins, cost structure, and profitability, and the current policies, procedures, & business model. Of course, repurchase obligations are included, as well as existing or potential liabilities. Are there outstanding lawsuits? Is the buyer buying the entire company, or a percentage of ownership? It is not a simple process, and making assumptions about the future is problematic. A thorough examination of these factors is where the value of a competent advisor shows itself.

Estimates & Assumptions

The final price, while always negotiable, is often a combination of net worth as of a certain date and the discounted cash flows for the next three years of earnings. Valuations tend to be highly dependent on estimates and assumptions as opposed to historical numbers since the residential mortgage industry is extraordinarily cyclical with a high degree of earnings volatility. The company’s markets, products and services, historical financial results, economics and industry outlook and prospects for the future factor into the pricing.

Available documentation relating to the company and its income statements, scorecard and dashboard metrics, and cash flow also are used, as are volume forecasts from the Mortgage Bankers Association. It is important to have a knowledge of recent transactions involving the mergers or acquisitions of mortgage banking companies. The fair market value to a potential buyer will depend on loan volumes, margins, cost structure, and profitability, and the current policies, procedures, and business model. The typical buyer will want 100 percent ownership, or at least 51 percent, as the minority ownership is viewed as having little value.

Valuation is focused on a company’s purchase business share, but not just for the last six months. A consistently above-average purchase share demonstrates management’s commitment to building and maintaining referral sources over several years. There is a sense that where this is the case, a lender’s sales force will not revert to refinance volume when there is a mini-interest rate rally. A strong purchase business culture eliminates some volatility in the inherently cyclical mortgage business.

Product mix matters. A prospective seller’s government lending share (inclusive of FHA, VA, and USDA loans) is important as it is generally assumed that government originations generate higher revenues and margins than agency conventional loans. But jumbo loans, as most are brokered out, can generate significantly lower revenues and are a drag on earnings. Therefore, a significantly above-average jumbo share is generally a negative.

Management & Intangibles

Management’s ability to earn respect and appreciation from counterparties, regulators, borrowers and even competitors provide great comfort to a prospective buyer but are viewed as intangibles. Investor “Report Cards” are one source of objective reputation assessment, as is systematic measurement of borrower satisfaction.

So, what improves the value of a lender or vendor? It helps if an ongoing concern, already in the business of residential lending, has experience originating home loans in the current compliant-heavy environment, and has a good existing reputation among investors and vendors as indicated by its investor scorecards. (Many argue that in today’s difficult environment, few people would opt to start a mortgage company. Therefore, there is a slight premium placed on an ongoing operation.) Owning servicing, and therefore the mortgage servicing rights, increases value.

Factors that detract from value include minority ownership, repurchase risk due to guideline violations, undisclosed liabilities, appraisals, misstated income and occupancy issues, heavy dependence on refinance activity, compliance risk, a reliance on a narrow set of products, a high cost of funds, and a narrow geographic lending area.

On an industry-wide scale, lenders and vendors generally rise and fall in value as a group. As one can see, determining the value of a residential lender or vendor is much more complex than taking last year’s earnings and multiplying it by three. Therefore, it is important to have an experienced and knowledgeable advisor, accounting and legal assistance, as well as a good dose of common sense involved in any deal.

This article was originally published in the Mortgage Banker Magazine March 2023 issue.
Rob Chrisman
Rob Chrisman

Rob Chrisman began his career in mortgage banking – primarily capital markets – 35 years ago. He is on the board of directors of Inheritance Funding Corporation, of Doorway Home Loans, of AXIS Appraisal Management, and of the California MBA. He is also a member of the Secure Settlements Advisory Board, an associate of the STRATMOR Group, and of the Mortgage Bankers Association of the Carolinas and its membership committee.

Published on
Feb 23, 2023
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