The Federal Reserve’s monetary tightening policy, which has proved beneficial for most finance companies, has turned out to be a major growth hurdle for mortgage lenders. As interest rates rise, borrowing becomes expensive, leading to a decline in demand for mortgage loans. This is the primary reason why shares of mortgage lenders have remained under pressure lately. However, the stocks are expected to gain ground in the near term, as recuperating income of consumers might convince them to take loans at the current rates to avoid higher rates in the future.
In the latest federal open market committee meeting, interest rates were left unchanged with indications of next rate hike in September. This is likely to spur demand for mortgage leading. Particularly, the industry may experience higher mortgage originations in the near term.
However, refinancing has been declining since interest rates began to rise and reached an 18-year low in July 2018, per data by the Mortgage Bankers Association. Also, the mortgage market was impacted by tight supply of existing homes, thus leading to higher home prices.
Nevertheless, sales of new homes are slowly gaining strength, which could keep the demand for mortgage loans reasonable in the near term. Moreover, improving economic conditions, especially strong labor market indicate higher incomes and rising levels of consumer spending, which might lead to more consumers seeking mortgage loans for home purchases.
Industry Lags S&P 500 on Falling Loan Originations
It appears that reduced mortgage origination volumes and increased competitive pressures despite the border economic recovery failed to enhance investors’ confidence in the industry’s growth prospects over the past year. Moreover, any improvement shown by these mortgage lenders wasn’t enough to shift investors’ focus from other finance companies that have been thriving in a rising rate environment.
The Zacks Mortgage & Related Services Industry, which part of the broader Zacks Finance Sector, has underperformed the S&P 500 but outperformed its own sector over the past year.
While the stocks in this industry have collectively gained 11.5%, the Zacks S&P 500 Composite and Zacks Finance Sector have rallied 20.2% and 9.9%, respectively.
One-Year Price Performance
Mortgage-Related Stocks Trading Cheap
The industry’s valuation looks inexpensive now, thanks to the underperformance of the industry compared with the S&P 500 over the past year. One might get a good sense of the industry’s relative valuation by looking at its price-to-book ratio (P/B), which is probably the most appropriate multiple for valuing mortgage stocks considering the fact that their assets and liabilities represent fair values of the securities held. Meaning, the book value of such companies might actually be representative of their market value.
This ratio essentially measures a mortgage stock’s current market value relative to what it would be worth if all assets were sold and debt was paid.
The industry currently has a trailing 12-month P/B ratio of 2.14X, near the one-year median level. Over the past year, the industry has traded as high as 2.60x.
The space also looks reasonable when compared with the market at large, as the trailing 12-month P/B ratio for the S&P 500 is 3.95X and the one-year median is 3.78X.
Price-to-Book Ratio (TTM)
As finance stocks typically have a lower P/B ratio, comparing mortgage stocks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/B ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance Sector’s trailing 12-month P/B ratio of 2.61X and the median level of 2.58 for the same period are way above the Zacks Mortgage & Related Services Industry’s respective ratios.
Price-to- Book Ratio (TTM)
Industry May Perform Better on Bright Earnings Outlook
Expectations of higher demand for houses on the back of improving job market and growth in consumer spending should help mortgage-related stocks generate higher returns in the near future.
But what really matters to investors is whether this group has the potential to outperform the broader market in the quarters ahead. Investors may consider the current price levels as good entry points, as there are convincing reasons to predict a decent upside in the near term.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, which reflects the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. Estimates for current year as well as for 2019 have been showing improvement.
Price and Consensus: Zacks Mortgage & Related Services Industry
The industry's earnings outlook becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $2.86 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Mortgage & Related Services industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings per share of the industry for 2018, but how this dollar number has evolved recently.
Current-Year EPS Estimate Revisions
As you can see here, the $2.86 'EPS' estimate for 2018 is up from $2.01 at the end of May and $2.79 at the end of the July. In other words, the sell-side analysts covering the companies in the Zacks Mortgage & Related Services industry have been steadily raising their estimates.
Zacks Industry Rank Indicates Solid Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.
The Zacks Mortgage & Related Services industry currently carries a Zacks Industry Rank #89, which places it at the top 35% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Industry Displays Promising Long-Term Growth Prospects
Along with bright near-term prospects, long-term (3-5 years) EPS growth estimates for the Zacks Mortgage & Related Services industry seem impressive too. The group’s mean estimate of long-term EPS growth rate has increased modestly since the beginning of 2018 to 9.77%. This compares with 9.82% for the Zacks S&P 500 Composite.
Mean Estimate of Long-Term EPS Growth Rate
Nonetheless, revenues remained a challenge for the industry in the past as seen from its downtrend since the beginning of 2014. The adverse impact of higher interest rates on the bottom-line numbers might reduce gradually.
Though current macro headwinds such as rising interest rates and increasing home prices are likely to linger, the companies in this space have been venturing out for other sources of income and are building up on the technological front.
Moreover, recently, the U.S. Treasury has put forth a report that highlights areas in mortgage lending and servicing sector that require relaxing of regulations. The report was mostly in favor of digital modes of mortgage activities. Ease of regulations might lend some support to the mortgage lenders.
Keeping the long-term expectations in mind, investors could take advantage of the cheap valuation and bet on a few stocks that have a strong earnings outlook.
Here are two stocks from the Mortgage & Related Services industry carrying a Zacks Rank #2 (Buy):
(You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.)
Essent Group Ltd. (ESNT - Free Report) : The stock of this Hamilton, Bermuda-based lender has gained 5.1% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 4.1% upward over the last 30 days.
Price and Consensus: ESNT
TPG Specialty Lending (TSLX - Free Report) : The consensus EPS estimate for this San Francisco, CA-based specialty finance company has moved 4.2% higher for the current year, over the last 30 days. This Zacks Rank #2 stock has rallied 1.5% over the past year.
Price and Consensus: TSLX
Also, investors may hold on to the following stock, as it has been seeing positive earnings estimate revisions and has solid long-term growth potential. It currently carries a Zacks Rank #3 (Hold).
LendingTree (TREE - Free Report) : The Charlotte, NC-based bank has gained 6.6% over the past year. The consensus EPS estimate for the current year has been revised 6.6% upward over the last 30 days.
Price and Consensus: TREE
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