A Trillion Dollar Market Finally Attracts MortgageTech Innovation…Big Time

FinTech, Insights, M&A Advisory

October 2019 — By John Mathis


mortgage technology

The US mortgage and services market is a multi-trilliondollar sector that until recently, was a forgotten arena for large-scale innovation.  Mortgage innovation has lagged other sectors because of high regulatory burden and a highly consolidated market of the historically poorest innovators: banks.  Add to that the inertia that comes from decades of consumers forced through a complex web of providers and high, often opaque, costs.

So, what could change large scale inertia and big incumbent players with high walls of defense?   In a word, Tech.  I worked with a systems engineer who once said “…Technology is like a leaking pen in a white shirt pocket.  It will bleed through and change everything.”

Today, the headline news is all about iBuyers, application of AI and blockchain and “straight through” processing.  The white shirt ink stain analogy has given way to a Rorschach image of new technology-enabled business models vying for what McKinsey sized as a $3.8 trillion global house ecosystem by 2025.  And the VC, PE and corporate investors are buying into this outlook with 2019 expected deal values up 50% CAGR, nearly as much as the past three years, combined.

Do you know these iBuyers?

 

Three Industry Observations:

  1. Revolution or evolution? – Changes are happening quickly and fundamentally. For example, the penetration of iBuyers is over 10% in several markets with broad national coverage (from 0% a few years ago as shown in the chart below).  Moody estimates that distributed ledger technology could save the industry more than $1 billion.  Digitization is only the first wave of change and it is affecting every step of the process from notary, closing, appraisal, underwriting and servicing.
  2. Disruption is well underway, and yes, Millennials are the key demographic – More than 35% of new home buyers are Millennials. They expect a digital experience, are driving more than half of loan application elements and are coming from online sources or mobile channels.
  3. Less risk – Notably the changes described above are driving better risk management outcomes with default rates that are 25% less than traditional channels and methods, according to the Federal Reserve Bank of New York.

Source: The New York Federal Reserve

Three M&A Observations in MortgageTech:

  1. Lessons from 2008 aren’t as relevant and investors may be better positioned to power through.
  2. The Unicorns are present in MortgageTech and they appear hungry.
  3. This year’s momentum suggests 2020 will have strong tailwinds for more investment and acquisitions.

M&A Lessons from 2008

Our discussions with industry players often touch on how deep into the expansion we are and what will happen in a downturn.  Unlike 2008, there don’t appear to be the kinds of irregularities in the mortgage market (e.g. “Robo-signing”) that created a chaotic uncertainty that frightened the funding market and appetite for innovation.  The key reasons cited for optimism through this cycle include:

  • The shifting sands of a regulatory response to the housing crisis really spooked investors. However, without the overhang of a housing bubble, the next downturn looks less crisis-driven and likely less violent;
  • For the moment, housing values, consumer debt levels and velocity of activity suggest much less uncertainty and threat of restrictive regulatory rule change; and
  • The industry appears to be gaining momentum in reduced regulations with a focus on consumer responsiveness, reduced cycle time and a modernization of consumer-facing and back office technology.

The Unicorns are hungry for M&A

Also different this time around, billion dollar private companies are looking to shape markets more quickly.  For example, we are seeing VC-backed firms using a new tactic for growth and strategic advantage: acquisitions.  We’ve seen this new dynamic in other vertical markets where Unicorns and their financial backers take a page from the private equity playbook and buy rather than build.  For example, Credit Karma acquired the startup Approved earlier this year in an effort to present its core customers, Millennials, with mortgage options more quickly through Approved’s direct access to bank and mortgage broker clients.

The outlook for 2020 M&A in MortgageTech

We see three trends driving further investments and consolidation:

  1. Business models becoming more about data and analytics.
  2. Millennials representing a large enough buyer group to move markets.
  3. The inefficient parts of the MortgageTech value chain being under pressure to adapt.

Mimicking the e-commerce disruption in the U.S. retail market, mortgage underwriting is being redefined as a data and analytics business model.   Consider the retail example of Fanatics, which isn’t just a sportswear company selling your favorite team’s jersey. It is a predictive analytics shop that anticipates a consumer’s desire for their team’s latest fashion or celebration of a big win.  OpenDoor isn’t only an iBuyer; it is the gateway to a real estate transaction ecosystem where it is both facilitating the transaction and building a knowledge base of what drives properties, financing and consumer real estate behavior.

Notably, where Amazon upended the retail world, the current mortgage market may not face such a monolithic disruptor, but more of a confluence of forces from many different angles.  Well, that is, until Amazon decides to enter the market (gasp!).  Imagine the combination of traditional service models overlaid with data and analytics that improve the home-buying, mortgage-applying and transaction-closing processes.

Closing Observations

All hail the Millennials! This generation expects an app for all of life’s necessities.  Why should home finance be any different?  Market research highlights the enthusiasm buyers, particularly Millennials, have for digital platforms. Technology firms are responding with a flurry of business models that will continue to fracture old ways.   In the Phoenix, Arizona market, for example, where iBuyers have garnered a 6% share of the mortgage market, the legacy real estate brokers are adapting with a vendor management approach to representing home buyers in iBuyer negotiations, inspections and repairs and closing.  The chart below highlights the rapid ascent of FinTech lenders (e.g., non-bank players like Rocket Mortgage).

Source: TransUnion

We see more new innovations on the horizon.  New entrants with fresh funding and ideas are finding opportunities throughout the MortgageTech value chain.  Take one example in the appraisal and collateral valuation arenas – three new ventures include: InMotion Software, Reggora and Bowery:

What about the large well-established mortgage services firms, how are they responding to the rapidly evolving market?  In our experience, when large incumbent, legacy players are threatened, they tend to react in one of two ways:

  • Ignore the losses on the edges and hold onto the core for as long as possible (think “cash cow” corner of the Boston Consulting Group’s BCG Matrix. Watch for these firms to move quickly to acquire and fill gaps in their technology.   For example, Black Knight’s acquisition of HeavyWater for AI and machine learning; and/or
  • Embrace the opportunities, suffer some near-term transition and look to come out stronger on the other side. For example, the appraisal management market is navigating both a disruption in supply (fewer appraisers) and an onslaught of new models and technology.  New models include bifurcation using lower cost inspectors, rules changes from the GSEs including waivers for lower value properties, and new technology approaches such as mobile location-based workflow with GPS tags and blockchain chain-of-custody.  One example of a company navigating these changes is CoreLogic which reported declining revenues in part cause by “growing pains” in its appraisal management company.

In closing, for the well-established players, we expect more adaption either through investment, acquisition or both.  Many will focus on the dominant players and their reaction to these strong trends.  Notable actions include:

  • CoreLogic (NASDAQ: CLGX) – Highly acquisitive, setting the high-water mark in valuation.
  • Fidelity (NYSE: FNF) – Consolidating market share despite the terminated Stewart (NYSE: STC) deal.
  • Black Knight (NYSE: BKI) – Acquisitions on several fronts, including capital markets coupled with the heavy challenge of the Dun & Bradstreet investment.
  • Xome (sub of Mr. Cooper Group: NASDAQ: COOP) – acquired Assurant’s mortgage solutions carve out (including the StreetLinks AMC and Title365)
  • EllieMae – Go private with PE firm Thoma Bravo ($3.5bn)
  • D+H – Go private with PE firm Vista Equity ($4.8bn)

Sources

https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr836.pdf-

https://www.mckinsey.com/industries/capital-projects-and-infrastructure/our-insights/getting-ahead-of-the-market-how-big-data-is-transforming-real-estate

https://my.pitchbook.com/search-results/s12753216/deal_chart

https://www.cnbc.com/2019/02/21/personal-loans-surge-to-a-record-138-billion-in-us-as-fintechs-lead-new-lending-charge.html