Update: Blend Labs & loanDepot Inc.

August 25, 2022 | Premium Service | In this issue of The Institutional Risk Analyst, we take a look at two of the more depressed equity market valuations in the world of mortgage lending and servicing and ask a basic question: Is there value in some of these companies far beyond what the markets recognize at present? Some simple arithmetic suggests that the answer is yes.

First on the list is loanDepot (LDI), a name we mentioned last week in the context of industry-wide cost cutting. We noted at the time that the new CEO Frank Martell needs to cut operating expenses in half and we believe that he will, regardless of whether the endgame is a sale or salvation. To us, even in a sale, the LDI stock should be north of $6 instead of $1.65.

The market capitalization of LDI as of yesterday’s close was $510 million or so, but at the end of June 2022 the company owned mortgage servicing rights in excess of $2.2 billion fair value plus almost $1 billion in cash. If we net out the loans in pipeline and the secured bank lines, half of the debt goes away.

To us, LDI looks to have substantial value whether in a sale or positioned for a rebound when the FOMC reduces interest rates. The LDI financials from the latest 10-Q are shown below.

loanDepot

Obviously this situation has considerable execution risk, but we have added some LDI to our portfolio as a speculative investment on the likelihood that the intrinsic value of the servicing book will be recognized one way or another. At $1.60, LDI is down ~80% YTD, but has considerable value in either a sale or rebound scenario. We see a great deal more upside potential in LDI than in some of the mortgage names that are down single digits after the recent rally.

How do we measure success? If we see new CEO Martell get LDI into positive territory in terms of EBITDA by the end of Q3 2022, that will be your signal that a turnaround has begun in earnest. LDI is paying down debt and canceling unneeded bank facilities to adjust expenses to a much lower floor in terms of operating volumes. Stay tuned.

Blend Labs Inc.

Next on the list is Blend Labs (BLND), the point-of-sale (POS) startup that went public in 2021 above $20 per share and is now trading around $3.00 as of yesterday’s close. In 2021, BLND acquired a Title365 from Mr. Cooper (COOP) at a crazy multiple of book value in order to add some revenue to the platform pre-IPO. Very expensive revenue. We view the Title365 transaction as public evidence that these folks at BLND have no idea about value other than consuming shareholder value with both hands.

A year later, BLND has written down the goodwill associated with the Title365 business, pushing the company into $550 million loss in the first six months of Q2 2022. Title365 is now about half the revenue of BLND, a bad business in a declining residential mortgage market. The revenue segments from the Q2 2022 BLND earnings presentation are shown below.

Notice in the table above that mortgage segment revenues at BLND were down seven percent in 1H 2022 while the market was down 35% on volume. We suspect that the direct revenues from the mortgage segment and the Title365 business will both decline further in 2H 2022. Mortgage transactions for BLND went from 380,000 in Q1 2022 to 348,000 in Q2 2022.

Note too that the incumbent managers of BLND awarded themselves an additional $52 million in stock options in 1H 2022, one of the most bizarre examples of corporate pillaging we can ever recall. How does a management team at BLND award themselves $50 billion in stock options after flushing half a billion in shareholder funds down the toilet? The Title365 acquisition was made just a year ago.

If you back out the goodwill impairments and restructuring charges, BLND “only” lost $90 million in the first six months of 2022. But it is important to recall that these “extraordinary” charges are a reflection of the general incompetence of the BLNB management team in acquiring Title365 at 4x book value in the first place. Title companies generally trade at or below book value.

We do not see any catalyst for value creation in this company until there is a wholesale change in the board and management team. The message of industry change and innovation contained in the BLND investor materials does not really square with the operating environment in the channel. CEO Nima Ghamsari seems to be living in a parallel universe:

Ghamsari then addresses the issue of expenses:

We view the whole strategy of BLND, both in banking and mortgage lending, as marginally additive to the customer experience, but there is no transcendent improvement in loan acquisition or time-to-close. To us, aside from selling the well-worn fiction of “transformation” in the markets addressed, the incumbent managers at BLND seem more interested in personal gain than in building shareholder value.

Chief Finance Officer Marc Greenberg describes the company’s financial performance, but fails to mention the more significant equity award to the incumbent managers:

Of interest, during the Q&A, Greenberg suggests that business volumes from defaulted loans serviced by COOP will make up for a decline in purchase mortgage business at Title365:

The bad news for current shareholders is that there is little real value in the BLND POS business, whether you look at the mortgage segment or banking, the latter of which has suddenly become the focus of management attention. More, we do not see any potential acquirors on the horizon for BLND or some of the other startups in the mortgage POS space.

POS tools are increasingly ubiquitous and available, allowing most issuers to develop in-house POS solutions at little costs. Indeed, if the merger of Black Knight (BKI) and Intercontinental Exchange (ICE) goes through, you can expect the expanded ICE monopoly in mortgage tech and data applications to simply give away POS tools to destroy the remaining incumbents other than Sagent Lending Technologies.

L: CVX, CMBS, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, NOVC, LDI

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