by John Sinna

Notes:

1. LDI redacts certain disclosure around various facilities, more specifically secured facilities, as allowed for by SEC Regulation S-K 601(b)(10)(iv).
2. Warehouse Facilities. For the quarter ended 30 June 2023, the weighted average interest rate for LDI’s warehouse facilities was 6.99%. Our estimates for facility level rates are based on average 1-month SOFR over the same period of time and this disclosure. We have assumed the two warehouse facilities that expired in September 2023 (Facility 6 – 29 September 2023, and Facility 8 – 21 September 2023) were all rolled forward 1year.
3. MSR Facilities We have assumed the three MSR Facilities carry the same coupon as the Warehouse Facilities and that MSR Facility 3 variable funding notes mature 30 September 2024.
4. Securities Financing Facilities. We have assumed the Securities Financing Facilities mature on 30 September 2024 and carry the same coupon as the Warehouse Facilities.
5. Servicing Advance Facilities. We have assumed the Servicing Advance Facilities carry the same coupon as the Warehouse Facilities and that the Servicing Advance Facility 1 rolled for another year and matures on 30 September 2024.
6. Term Note. We have assumed the Term Notes are extended to October 2025 in accordance with their terms and carry the same coupon as the Warehouse Facilities.
7. Based on research by Xtract, Debtwire estimates that LDI is able to issue up to USD 250m in non-financing related secured debt.

Overview

loanDepot, Inc [NYSE: LDI] is a non-bank consumer finance company. LDI primary provides mortgage loans to customers primarily in California, Florida and Texas. The company’s primary sources of income are gains from loan originations and sales of loans to investors, income from servicing loans, and settlement fee service charges for loan origination and servicing. LDI went public on 10 February 2021. In the wake of market turmoil, LDI exited the wholesale business and also took loan servicing in-house in attempt to lower operating costs.

LDI has experienced significantly lower mortgage loan origination volumes as the overall market has shrunk dramatically, driven by lower demand for new mortgages and refinancing in the wake of higher interest rates. Management has suggested the company is forecasting the overall annual mortgage origination market to settle in at ~USD 1.5t, down from ~USD 4.1t in FY2020 and USD 1.7t as of 2Q23.

Source: LDI 2Q23 Investor Presentation.

According to Freddie Mac, mortgage rates have moved up significantly from their recent 2021 lows, making new loans meaningfully more expensive for potential borrowers.

According to the Mortgage Bankers Association by way of ZeroHedge, the dramatic increase in borrowing rates has led to mortgage applications falling to levels not seen since 1996, which suggests hard times for originators who are left to compete for dwindling business.

LDI’s business model exposes the company to significant concentration risks. LDI does not disclose actual mix, but it does disclose that a substantial portion of aggregate mortgage loan origination is tied to properties in California, Florida and Texas. For the same period, four investors accounted for 35%, 28%, 12% and 6% (81% in total) of the company’s loan sales purchases. As of 30 June 2023, 19% and 11% of LDI’s warehouse lines were payable to two separate lenders.

Based on the expansive exhibits to LDI’s SEC filings:

1. Parties that purchase or historically purchased loans from LDI include: Bank of America; Atlas Securitized Products and related entities (the former Credit Suisse business now owned by Apollo Global Management); JP Morgan Chase Bank; UBS AG; Flagstar Bank (purchased rights and obligations from Signature Bridge Bank, the successor in interest to Signature Bank); Bank of Montreal; Barclays Bank PLC; and Jefferies Funding LLC.
2. Parties that finance or have historically been involved in financing LDI in various capacities include: Nexbank, Citibank, JP Morgan, Credit Suisse and Signature Bank.

Owing to a legacy pre IPO structure, the company now has multiple share classes. The class A shares have one vote per share while the class C and D have five votes per share.  Taken together holders related to Anthony Hseih the company’s founder and former chairman, hold approximately 57.6% of the total voting power, and when combined with holdings related to Parthenon Capital Partners roughly 94.5% of the total voting power. Hseih was ousted earlier this year after a board dispute. Frank Martell succeeded Hseih as CEO in April 2022 and Hseih and LDI later came to a settlement related to the board dispute.

During FY22 the company announced aggressive cost structure rightsizing actions. Included in this has been a reduction in headcount from 31 December 2021 to 30 June 2022 from 11,307 employees to 4,683. In addition, the company is increasing its focus on HELOC products. On the 2Q23 call, management noted that refinancing volume in the quarter was driven primarily by cash-out refinancings, suggesting the company is having some success with this strategic pivot.

Recent Events

On 8 August 2023, LDI reported 2Q23 results after market close. Revenue of USD 272m exceeded estimates for USD 259m. Loan originations of USD 6.3bn came in at the higher end of guidance for USD 4.5bn to USD 6.5bn and sale margins of 2.75% also came in at the higher end of guidance. For 3Q23, management guided to originations of USD 5bn to USD 7bn and margins on sales in the range of 2.45% to 2.85%. LDI’s equity gained as much as 5.9% in the 9 August 2023 session and closed up ~1.4%. Since the release, the equity is down ~21%. LDI’s 2025 bonds were flat on the release are down ~1pt since the release. The company’s 2028 bonds were up ~1.25pts on the release and are down ~2.75pts since the release.

Financials 

LDI reported net revenue of USD 272m for 2Q23 versus USD 309m for 2Q22, a roughly 12% decline. Loan originations in the most recent quarter of USD 6.3bn were down ~61% YoY. Higher margin on loan sales, 2.75% for 2Q23 versus 1.16% for 2Q22, driven by a higher mix of more profitable FHA loans in the most recent quarter, drove a USD 7m YoY increase in related fees. Origination fees declined USD 21m, or 53% YoY, driven by lower loan origination volumes partially offset by higher fee rate in the most recent quarter, again due to mix. Servicing fee income was essentially flat YoY, as declines in overall unpaid balance were made up for by slightly higher margin. Change in fair value of servicing rights, net was slightly higher in the current quarter and other revenue was essentially flat. Finally, NIM for 2Q23 of USD 3m was down from USD 23m in the prior year period, again due to an overall lower loan origination volume in the current period.

Operating margin for 2Q23 was -6% versus -71% in 2Q22. Prior period margin was impacted by a USD 41m goodwill impairment charge and was -58% net of this charge. Origination volumes fell precipitously in the wake of the US Federal Reserve interest rate moves and LDI has been playing catch up with its cost structure. While margins remain pretty ugly, embedded in them are meaningful improvements. Personnel expenses for 2Q23 were 58% or net revenue versus 96% for 2Q22; marketing and advertising expenses for 2Q23 were 12.8% of net revenue versus 19.7% for 2Q22; serving expense for 2Q23 was 4.9% of servicing fee income versus 9.2% for 2Q22. Clearly LDI has more work to do in order to right size its cost structure to navigate the new market dynamics.

Adjusted EBITDA for 2Q23 was USD 6m, up from USD (192)m a year ago, driven generally by lower operating costs on a dollar basis and also the improved margins noted. Given the revenue declines over the past few years, it is commendable to see the cost savings the company has been able to achieve.

Our NTM estimates assume USD 6.5bn in quarterly originations, a 95% sale to origination rate and a 2.8% gain on sale margin. These levels represent the higher end of recent management guidance for 3Q23 and are consistent with recent performance versus 2Q23 guidance. We have assumed an origination fee of ~25bps, consistent with recent levels. We have forecast a flat servicing book and ~31bps of annual fee, consistent with recent levels. NIM is forecast to be USD 3m per quarter, change in servicing rights USD -38m per quarter and other revenue USD 17m per quarter, flat with 2Q23 results. We have kept operating expenses flat with 2Q23 levels, along with D&A and stock-based compensation. Taken together, we forecast revenue growth in the NTM period as well as slightly positive Adj EBITDA. LDI may ultimately be able to reduce costs even more from here, but we are taking a wait and see approach given the magnitude of the most recent cuts. Assuming break-even cash flow from operations and dividends and shareholder distributions and CapEx flat with the LTM period results in expected (30)m in free cash flow.

Valuation 

LDI is currently trading at a price / tangible book multiple of 0.7x, versus a peer average of 1.5x. Debt/book equity is 5.4x, and debt/tangible book equity is 5.4x versus a peer average of 2.0x and 2.1x, respectively. LDI trades at a discount to its peers as it carries a significantly higher amount of debt. LDI’s originations are also somewhat commodity products. Unlike specialty lending platforms that focus on unique niche offerings and can charge higher rates, LDI’s loans are home mortgages. Accordingly, it appears that the market isn’t ascribing LDI meaningful platform value, which seems logical in our view.

LDI’s senior unsecured notes trade, and both trade wide to comparables and indices, likely as they are meaningfully subordinated to the secured debt stack, which benefits from the pledge of significant assets. Based on our liquidation analysis using the 30 June 2023 balance sheet, we believe the 2025 and 2028 bonds are fully covered and LDI’s equity is overvalued based on recent pricing. Current market prices suggest that investors in the 2025 and 2028 notes would likely be better off if LDI liquidated rather than continue to burn cash and use assets to generate liquidity in order to try to right-size operations in today’s mortgage market while the equity is already trading at essentially option value and would likely prefer LDI continue on as there isn’t much left to lose. Leaving aside the near impossibility of shorting a very low dollar value equity, long bonds versus short equity could make for a compelling trade. Short 25s versus long 28s is also potentially compelling for those who do not expect LDI to make it out of the current situation as the pricing spread between the two issuances should collapse in the event of a restructuring, and this capital structure trade almost self-finances (leaving borrow cost aside) given the coupons are very similar. 

According to our analysis, 30year fixed mortgage rates and US 10yr and 30yr Treasury yields are historically highly correlated and spreads are near their highs since 1990, indicative of a more “risk off” environment. 

Based on recent spreads versus historical levels and forecasts for 30yr and 10yr treasury yields over the next several quarters, we believe mortgage rates could fall from current levels and provide some relief to borrowers and also potentially lead to more origination volume for LDI, all else being equal. That being said, rates are expected to remain elevated relative to 2021 and 2022 levels, which may not provide enough relief for LDI’s origination dependent business model ahead of the maturity of its 2025 bonds. 

A number of mortgage originators have fallen on hard times and gone through formal reorganizations, including companies from prior cycles such as American Home Mortgage Investment, Accredited Home Lenders, Ditech, Fieldstone Mortgage, Fremont General, IndyMac and WMC Mortgage, as well as companies hit hard by recent market dynamics including First Guaranty Mortgage, and AmeriFirst Financial. Unlike the last cycle, which was predominantly driven by credit quality issues, and in certain cases fraud and other illegal activity on both sides of loan agreements, this cycle is rate and demand driven, leaving levered non-bank origination platforms dependent on loan origination and sales in bad shape. Unlike the last cycle, it appears that the market remains interested in purchasing the loans platforms like LDI originate, but the lack of volume is putting significant pressure on these levered originators who simply cannot right-size cost structures fast enough to keep pace with the origination declines, including LDI. LDI has capacity to issue up to USD 250m in secured debt for potential uptiering of current notes, but given the nature of the current stress, we do not believe tapping this capacity is beneficial for either bond holders or the company. For instance, bondholders, specifically 2025 holders, may benefit from (partially) moving up in seniority, but given our return estimates, there is no reason for them to accept a distressed / discounted exchange offer to the benefit of LDI. Conversely, LDI does not benefit from either issuing senior paper or offering to (partially) move holders of the 2025s up in seniority as the new paper would also likely require a higher coupon. While it is better to have the capacity than not, in total we do not see a scenario where parties will see benefit from making us of it in the current situation.

Based on Debtwire’s analysis and estimates, LDI’s various secured facilities have collateral pledges that in aggregate exceed the principal amount of these facilities by USD 964m. Even if none of this excess pledged collateral is available for the waterfall, which we think is unlikely, our analysis suggests the 2025s and 2028s should still recover 96 if the company was liquidated in the near term, but we have no reason to believe that would happen given LDI’s current liquidity profile.    

Assuming the market requires USD 200m in “run-rate” EBITDA from LDI to refinance the 2025s with a new facility (~5x gross leverage excluding the various origination tied facilities, ~2x EBITDA/ non-finance interest assuming new paper carries a rate of ~13.5%, a market rate consistent with the current rating for the 2025s), we estimate that LDI would need to deliver origination volume of ~USD 33.3bn with its current revenue and cost structure. Based on expectations for the overall origination market to remain well below recent highs in terms of volume, LDI then needs to represent 2%+ total share, consistent with its market position in 2017/2018/2019. This is not out of the question, but also not an easy feat as competition remains fierce.

While we are not saying LDI is certain to face a formal reorganization process, we do think it is worth sharing some initial high-level thoughts. LDI does not hold a bank charter or own / operate a bank, which drastically reduced the complexity and also potential urgency should it face a bankruptcy filing or other similar out of court reorganization. A reorganization could take a number of forms (not mutually exclusive), including:

1. Equitization (complete or partial) of the 2025 and 2028 bonds, leaving the rest of the business as is. This could work in the scenario where LDI’s origination volumes rebound into the 2025 maturity, but not enough to allow for a refinancing of the 2025s. 
2. A partial liquidation of either the servicing business or the origination business. Again depending on the state of origination volumes at the time of a reorganization, it may prove to be more valuable or viable to retain one of these two business lines and reorganize around the other. Given the current state of the business as a whole, we suspect creditors would rather try to sell the origination business and retain the servicing business, and also in saying that we realize a buyer might be tough to find given the widespread market meltdown on the origination side. The mortgage servicing rights business is one that benefits from scale, and another market participant may find LDI’s book accretive from a contribution margin standpoint.
3. A complete liquidation. A full liquidation may end up being the most valuable alternative. Given our liquidation analysis above, convincing creditors that another solution is more valuable might prove difficult.
4. Complicating the above, LDI likely has some potentially valuable net-operating losses given its recent financial performance. A reorganization might be based on this pool of assets as well, and then may require a creative solution to keeping existing shareholders in place in order to retain the value of the tax losses for future use.