How Compliance Concerns Are Shaping Mortgage M&A Agreements

In December, Affinity Lending Solutions, based in Houston, approached Mid America Mortgage in Addison, Texas. Affinity was looking to be acquired. Fast.

The target company's investment banker was looking to wrap up the deal within 24 hours after the initial contact, recalled Jeff Bode, Mid America's owner and CEO. That was a tall order in the current regulatory environment.

Among the complications was how to deal with the Home Mortgage Disclosure Act requirements and the Nationwide Mortgage Licensing System call reports for the loans in process at Affinity.

"We certainly had to plan through how we were going to treat those in advance, before we moved forward. And that was a big part of our discussions, on how to accurately report," Bode said.

The anecdote shows how the compliance burden originators have faced since the 2008 meltdown has not only been the main driver of acquisition activity in the mortgage business but also affects the way some are structuring transactions. Acquirers are looking to craft the deals so that they don't get burned by compliance lapses at the company being sold.

Dealing with compliance is why the cost to originate a loan for an independent mortgage banker is now nearly $7,000, versus $4,500 a few years ago, said Michael Fratantoni, the chief economist of the Mortgage Bankers Association.

Companies have had to add "highly skilled" regulatory and compliance personnel to their back offices to deal with the change. As a result, non-revenue-generating employees make up nearly 60% of the full-time workers in the origination sector, with sales staff just 40%. This is the opposite of what it was in the fourth quarter of 2008, where 58% of origination segment employees were sales people, Fratantoni said at the MBA National Secondary Mortgage Market Conference in New York last month.

These are fixed costs that many smaller mortgage bankers cannot afford. "Smaller lenders, if they can't reach a volume that they can profitably cover at higher loan level fixed costs, they are looking for partners, looking to be acquired," he said. "The minimum stakes to be in this game have certainly increased."

That might be motivating some lenders to act quickly to get out of the game.

Affinity and Mid America got their deal done in the time sought. But it wasn't easy.

There needed to be an understanding of what each company was going to be responsible for reporting, centered on when a customer met application requirements. Customers who had started the process with Affinity, but did not make a formal application, had the process moved over to Mid America. Those already in the application stage remained under Affinity's umbrella for NMLS and HMDA reporting purposes. Affinity's NMLS number stayed active until those loans were wrapped up. Once closed, they were sold to Mid America through the correspondent channel.

Another compliance issue involved contacting those customers whose loans were in process. The company was unable to find any regulatory guidance on how to handle consumer contacts in a transaction of this nature, said Jennifer Olsen, Mid America's manager of business systems and compliance analyst. There were privacy concerns involved, including making certain the customer understood how Mid America got their name and what was going on.

So Mid America used the servicing transfer contact regulations of the Real Estate Settlement Procedures Act as a guide for notifying consumers about the change, she said.

Another example of regulation influencing dealmaking: When Tulsa, Okla.-based Gateway Mortgage Group acquired Liberty Mortgage Co., an originator with offices in Pennsylvania and New Jersey, the deal was structured as an asset purchase and liability assumption and Liberty remained as a separate corporate entity, said Scott Gesell, the general counsel for Gateway.

"Lincoln was a viable stand-alone company before and Lincoln was a viable stand-alone company after. We basically bought the retail production assets and leases," he said. Gateway did acquire the rights to use the Liberty name, which it did until recently when the acquired offices were rebranded as Gateway locations.

This deal structure eliminated a lot of the issues when it comes to ensuring compliance in the loan pipeline being assumed; Gesell is familiar with those issues from other transactions at other companies he has been involved with during his career.

The deal was completed on April 1, 2014. Anything originated and closed before that date remained with Lincoln.

"So it was a pretty clean break. So therefore we didn't have a lot of issues with stuff going back and forth on the NMLS and HMDA and other issues you sometimes see in these transactions," said Gesell.

One reason why Gateway structured the deal this way was to avoid any unanticipated legacy issues. Lincoln's owners got the return on their business they needed to get, and they did not worry about providing indemnifications against investor buyback requests for older loans. Those indemnifications would have caused Gateway to hold back some of the compensation for the transaction.

"To us it was the most logical way to split the balance sheet and the risks associated with the balance sheet in the process," Gesell said.

Gateway did not have to go back into old files to look for missing data and other items needed for HMDA reporting. But Gesell said that was the case in past deals at other firms he worked at, and to recreate that information was "an absolute headache to say the least."

Whether Gateway will use this kind of arrangement in a future acquisition is up in the air, as each deal has to be structured to meet the needs of both the buyer and the seller, Gesell said. "But from our perspective it's a logical way" to proceed, he said, noting it allows Gateway to pay an economic return that is pretty certain for the seller.