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We have downgraded our recommendation on Lender Processing Services Inc. to Neutral from Outperform based on a host of factors like lower-than-expected revenue in the third quarter, a conservative guidance for the fourth quarter, continued underperformance in Default Services, and last but not the least macroeconomic uncertainties.

While we believe that Lender Processing’s technology-driven end-to-end solutions for the mortgage and real estate industries will aid in generating modest business growth and positions it to capitalize on market recovery, the company’s recent revenue performance refrains us from being too optimistic. Total revenue in the third quarter declined year over year and lagged the Zacks Consensus Estimate as well.

The continued underperformance in the company’s Default Services business remains a cause of concern. Default Services revenue declined 15% sequentially and 22% year over year in the third quarter of 2012, due to muted industry volumes. Hit by lower transaction volumes, the Default Services revenue continues to experience challenging market conditions, which calls for new regulations and process changes related to foreclosure activity.

Providing cost-effective services to clients’ needs for regulatory compliance in a profitable manner has been difficult for Lender Processing in the recent quarters. At the same time, management expects foreclosure activity to continue to reel under pressure and default services revenue to decline in the fourth quarter of 2012.

We are also skeptical about the company’s 2013 outlook as there are certain near-term hurdles in the economy including the result of the U.S. presidential election and its consequence on the overall market.

The impact of the federal programs due to budget pressures is also a matter of concern. Any unfavorable legislation will likely impact the housing, origination and foreclosure business as well as the company’s growth.

In the upcoming fourth quarter of 2012, management expects revenue from its rather well-positioned segment, Technology, Data, and Analytics solutions, to remain flat sequentially. It also expects refinance origination volumes, which is one of the most important lines of LPS’ business, to remain slightly down in the fourth quarter.

Estimate Revisions

Over the last 30 day period, four analysts out of eight slashed Lender Processing’s fourth quarter earnings estimate, while three analysts moved in the opposite direction. The Zacks consensus Estimate also fell 2 cents to 67 cents over that period. This downward trend was also visible over the last 7 day period. Lender Processing, which competes with the likes of Envestnet Inc. (ENV - Snapshot Report), currently carries a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.


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