Merger Mania in the mortgage sector: a new residential buys Caliber
WWe have seen a lot of mergers in the mortgage banking industry lately. Western Alliance recently purchased AmeriHome and Galton Funding, while New residential (NYSE: NRZ) just signed an agreement to purchase Caliber home loans from Lone Star Funds. After the best year ever for mortgages, New Residential looks to the future. What does this transaction mean for the company?
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A big acquisition, yes, but is it a good deal?
New Residential has agreed to buy Caliber for $ 1.675 billion in cash. He will fund the transaction with $ 675 million in cash and cash on hand, a capital increase and Caliber’s balance sheet liquidity. Immediately after the deal was announced, New Residential announced plans for a secondary stock offering of 45 million shares at $ 10.10 per share, which roughly supports the capital increase.
New Residential pays roughly the book value of Caliber, which had net income of $ 665 million in 2020, and a mortgage services portfolio with an outstanding principal balance of $ 153 billion. At first glance, a price tag of $ 1.675 billion for this company looks like a good deal. The acquirer pays 2.5 times the profits and gets a portfolio of services valued at $ 1.45 billion. The service portfolio is valued at 1.03% of the principal outstanding balance, which seems fully valued given that 29% of the book is in the Ginnie Mae service, which tends to trade at a discount. Indeed, Ginnie Mae loans show poor performance (currently 6.3% of Ginnie Mae borrowers are in abstention against 2.5% of borrowers Fannie Mae and Freddie Mac). Note that New Residential owns 19% of its Ginnie Mae loan services portfolio.
The 2020 profit before tax figure is also irrelevant. 2020 has been a record year, and volumes and margins will drop in 2021. Given that this transaction is expected to close in the second half of 2021, the really relevant figure for the purchase price is the expected profit for 2022. We believe expects Caliber to earn $ 295 million in 2022. Based on that figure, New Residential pays around 5.7 times expected profits in 2022, which roughly matches the position of mortgage banks these days .
This deal makes a lot of strategic sense
Caliber will add a commercial presence to New Residential, making the transaction a good fit. With the rise in interest rates, mortgage refinancing activity will decline and purchasing activity will become dominant. Having 378 retail credit institutions and 1,463 loan originators facilitates the acquisition of purchase loans, as much of this activity is driven by relationships with real estate agents. Additionally, New Residential praised Caliber’s investments in technology, which can lower creation costs and improve customer satisfaction.
New Residential has talked in the past about parting with its mortgage origination business because the market really didn’t value it that much. Asked about this during the conference call following the announcement of the merger, New Residential did not indicate that it had changed its mind. That said, as a real estate investment trust, New Residential is required to distribute most of its profits as dividends. This could end up being a constraint if he preferred to keep the profits for growth investments.
Non-government loans will only increase
Overall, the transaction makes a lot of sense for New Residential, and the retail presence it gains will help the company as refinancing activity dries up. The price might not be a bargain as it seems at first glance, but the buyer is certainly not paying too much and probably got the best outcome of the transaction. New Residential is also a leading originator of unsecured government loans, and its opportunity in this segment is expected to grow as the government moves to reduce Fannie Mae and Freddie Mac’s footprint in the mortgage market. This sets New Residential apart from its peers such as Rocket or UWM participations, and the company is ahead of its competition here.
New Residential also gave preliminary guidance for first quarter earnings and forecast the book value per share to be between $ 11.32 and $ 11.42. At recent levels, New Residential is trading at a 9% discount to its book value, and its dividend is earning 7.3%. These measures alone are attractive enough, and the potential of a spin-off from a mortgage operating company gives the company a catalyst for increasing shareholder value. There are many ways to win here.
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