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3 Mortgage & Related Services Stocks to Watch as Mortgage Rates Rise

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The Zacks Mortgage & Related Services industry has been feeling the heat from the receding mortgage origination tide. Adding to the woes, low housing supply and a sharp increase in home prices are likely to limit origination volumes, while tighter margins compound challenges for the industry players. Regulatory risks such as any change to the conservatorship or the existence of Freddie Mac (FMCC - Free Report) might limit the origination ability of industry players, and reduce revenues from loan originations and servicing fees.

Nonetheless, expectations of higher demand for houses on the back of improving job market and growth in consumer spending should help mortgage-related stocks to generate higher returns in the near future. This along with portfolio diversity and technological enhancements is anticipated to keep Walker & Dunlop, Inc. (WD - Free Report) , Ellington Financial LLC (EFC - Free Report) and Velocity Financial, Inc. (VEL - Free Report) afloat.

Industry Description

The Zacks Mortgage & Related Services industry comprises providers of mortgage-related loans, refinancing and other loan-servicing facilities. Numerous banks have been retreating from the mortgage business due to higher compliance and capital requirements. This provided an opportunity for non-banks to shore up capacity to increase market share in the mortgage loans business, which accounts for the largest class of U.S. consumer debt. Players in the industry are somewhat dependent on the interest rates determined by the Federal Reserve, as prevailing rates influence customers' decisions to apply for mortgages. The companies also generate investment income from several financial assets such as residential or commercial mortgage-backed securities, and asset-backed securities. Further, the firms make equity investments in mortgage-related entities, among others.

3 Mortgage & Related Services Industry Trends to Watch Out For

Originations to Fall: After a banner 2020 for mortgage originators, with the robust purchase and refinance originations, this wave has moderated in the subsequent quarters. Despite strong demand, homebuyers are being held back due to the tight supply of existing homes and a sharp increase in home prices. Moreover, mortgage rates have been increasing in 2021. The trend is expected to continue in 2022. These factors are likely to lead to lower purchase volumes. Also, with a rise in mortgage rates, incentives for borrowers to refinance their loans are likely to fade. This is anticipated to result in a decline in mortgage volumes, making revenue growth challenging.

Competition Picking Up: House price appreciation, rebound in the economy, and continued GDP and employment growth are likely to drive U.S. single-family mortgage debt outstanding in the upcoming years. Yet, customer acquisition for industry players is becoming more competitive. The increase in mortgage debt outstanding underlines growth of the single-family mortgage portfolio for industry players. However, the competitive landscape of the mortgage services industry is likely to be a deterrent. Notably, numerous companies have hinted at significant declines in gain-on-sale margins across the space. With tighter margins, many originators might struggle to remain profitable in the upcoming period, especially if rates continue to trend higher.

Regulatory Changes Might Limit Origination Capacity: Mortgage originators are significantly dependent on the government-sponsored enterprises' (GSEs) programs for the origination of a majority of loans for sale. Hence, any change to the conservatorship of Freddie Mac and related actions or a revamp in regulations (affecting the relationship between Freddie Mac, other GSEs and the federal government) might affect the mortgage service providers. Also, since a significant chunk of the substantial majority of the industry player's servicing portfolio represents loans serviced through the GSEs' programs, changes in the business charters, structure, or the existence of Freddie Mac or other GSEs could markedly reduce the number of loans that originators can produce with the GSEs. This might reduce revenues from loan originations and servicing fees, and adversely impact business and financial performance.

Zacks Industry Rank Reflects Dismal Prospects

The Zacks Mortgage & Related Services industry, housed within the broader Zacks Finance sector, currently carries a Zacks Industry Rank #173, which places it in the bottom 32% of more than 250 Zacks industries.

The group's Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak prospects in the near term. 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.

The industry's positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group's earnings growth potential. For the past year, the industry's earnings estimates for the current year have been revised 29.5% downward.

Before we present a few stocks that you may want to consider for your portfolio, let's take a look at the industry's recent stock market performance and the valuation picture.

Industry Underperforms Sector and S&P 500

The Zacks Mortgage & Related Services industry has underperformed the broader Zacks Finance sector and Zacks S&P 500 composite over the past year.

The industry has declined 35.4% during this period against the broader sector's rise of 23.4%. The S&P 500 composite has grown 26.1%.

One-Year Price Performance

Industry's Current Valuation

On the basis of the price-to-book ratio (P/B), which is commonly used for valuing mortgage loan providers, the industry currently trades at 1.76X compared with the S&P 500's 7.04X.

Over the last five years, the industry has traded as high as 2.43X, as low as 0.78X, and at the median of 1.84X, as the chart below shows.

Price-to-Book Ratio (TTM)

As finance stocks typically have a lower P/B ratio, comparing mortgage loan providers 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 of 3.26X for the same period is above the Zacks Mortgage & Related Services industry's ratio, as the chart shows below.

Price-to-Book Ratio (TTM)

3 Mortgage & Related Services Stocks to Keep a Close Eye on

Velocity Financial: Based in Westlake Village, CA, Velocity Financial is a vertically-integrated real estate finance firm, which offers and manages investor loans for 1-4 unit residential rental and small commercial properties. VEL originates loans across the United States through its extensive network of independent mortgage brokers.

Considering the increased economic activity, supported by market normalization and progress with the reopening of the economy, the demand for investor properties is anticipated to remain robust. This is expected to drive investor loan demand. Given Velocity Financial's expanded liquidity capacity, it is well-poised to capitalize on growth in the addressable market and, thereby, fund loan volume in the upcoming period.

The Zacks Consensus Estimate for VEL's current-year earnings has been revised slightly upward to 91 cents over the past month. This implies whopping year-over-year growth of 158.7%. The company's 2022 earnings are expected to rise 5.6% year over year. Velocity Financial currently carries a Zacks Rank of 2 (Buy). Shares of VEL have surged 104.5% over the past year. 

You can see the complete list of today's Zacks #1 (Strong Buy) Rank stocks here.

Price and Consensus: VEL

Walker & Dunlop: Based in Bethesda, MD, Walker & Dunlop is one of the largest U.S.  providers of capital to the multifamily industry and the fourth-largest lender for all commercial real estate, including industrial, office, retail, and hospitality. The company's expansion strategies, and strengthening of the online lending platform through acquisitions are likely to drive the top line. Further, Walker & Dunlop's commitment to capturing consumers on the back of heavy investments in artificial intelligence and machine-learning capabilities is commendable.

Shares of this Zacks Rank #2 company have surged 78% over the past year. The Zacks Consensus Estimate for WD's 2021 and 2022 earnings has been revised 3.6% and 19.2%, upward over the past month, respectively. Also, Walker & Dunlop's earnings for the ongoing year and the following year are projected to witness year-over-year growth of 4.42% and 23.1%, respectively.

During its recent investor day, Walker & Dunlop outlined several medium-term goals to expand its business and enhance returns. Notably, this included expanding annual origination volumes to $65B+, growing the servicing portfolio to $160B, achieving $25B+ in annual property sales volume, and accumulating $10B+ of assets under management. Further, Walker & Dunlop committed to increasing diverse leadership, reducing carbon emissions, and donating 1% of pre-tax profits. Taken together, management is targeting total revenues of $1.7-$1.2B and earnings per share of $13-$15 by 2025.

Price and Consensus: WD

Ellington Financial: Old Greenwich, CT-based Ellington Financial invests in a diverse array of financial assets. These include residential and commercial mortgage loans & mortgage-backed securities, consumer loans, and asset-backed securities. The assets are supported by consumer loans, collateralized loan obligations, non-mortgage and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments.

The diversified model is a flywheel for Ellington Financial, with its credit portfolio offering higher returns and Agency portfolio providing liquidity to be nimble in challenging times.  Moreover, the vaccine-driven recovery should boost Ellington Financial's small-balance commercial portfolio, with economy reopening underway.

The Zacks Consensus Estimate for EFC's current-year earnings has been revised slightly upward to $1.85 over the past month. This indicates year-over-year growth of 13.5%. Moreover, EFC's 2022 earnings are expected to be up 2.2% year over year. Ellington Financial carries a Zacks Rank #3 (Hold). EFC's shares have surged 17.3% over the past year.

Price and Consensus: EFC