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3 Promising Stocks From the Mortgage & Related Services Industry (Revised)

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The Zacks Mortgage & Related Services industry continues to suffer from a weak mortgage environment. Rising mortgage rates continue to affect mortgage volumes, particularly refinancing. Housing price appreciation and increasing competition are near-term headwinds.

Nonetheless, robust servicing opportunities and diversified business models will be saving grace for the industry players. Slow prepayment speed and technological enhancements are anticipated to drive UWM Holding Corporation (UWMC - Free Report) , PennyMac Financial Services, Inc. (PFSI - Free Report) and Sixth Street Specialty Lending, Inc. (TSLX - Free Report) .

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 increase their capacity to gain 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

Origination Volume Deterioration to Persist: The Fed has been tackling high inflation levels through interest rate hikes. This has resulted in mortgage rates climbing to the highest level in more than a decade and significant affordability challenges. These factors are likely to subdue purchase and refinancing origination volumes in the upcoming period. In fact, the Mortgage Bankers Association (MBA) forecast now calls for a 50% decline in mortgage originations in 2022 with the declining trend continuing into 2023, albeit at a slower pace. Also, it expects the 30-year fixed rate mortgage rate to end at 6.7% in 2022, a notable leap from 3.1% in 2021. These are expected to hinder origination volumes and revenue growth for the industry participants with production businesses.

Competition Picking Up: According to a forecast by MBA, U.S. single-family mortgage debt outstanding is expected to see an increasing trend in the upcoming years. This is anticipated to be primarily driven by house price appreciation. While this typically results in the growth of the single-family mortgage portfolio for industry players, there has been a decline in total application volumes. Hence, the competitive landscape in the mortgage industry is likely to heat up and participants are expected to resort to price cutting. This might result in a significant reduction in 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.

Servicing Segment Performance to Improve: Amid the significant declines in gain-on-sale margins and lower loan origination volume, industry players are likely to increase reliance on the service segment for profitability. In a rising rate environment, the servicing segment offers a natural operational hedge to the origination business. We expect slow prepayment speed to offer mortgage service rights (MSR) tailwinds. With the primary-secondary mortgage spread compression, mortgage originator profitability has declined. This has been incentivizing MSR sales to generate cash returns. Hence, MSR investments are poised to deliver significant value appreciation and offer attractive unlevered yield. Such MSR appreciation can drive book value.

Industry Players to Resort to Capacity Reductions: The mortgage industry continues to be labor-intensive despite efforts to increase automation and cut costs. Hence, employment trends within the industry are a key indicator of origination trends. Assuming mortgage rates continue their climb, homeowners will be less keen on home purchases and refinancings. This will likely compel companies to shed excess headcount capacity as they re-adjust to a slower market. We expect a higher focus on industry consolidations and expense reduction plans to alleviate bottom-line pressure.

Zacks Industry Rank Reflects Bright Prospects

The Zacks Mortgage & Related Services industry, housed within the broader Zacks Finance sector, currently carries a Zacks Industry Rank #98, which places it in the top 39% 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 encouraging 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 top 50% of the Zacks-ranked industries is an outcome of the positive earnings outlook for the constituent companies.

Industry Underperforms Sector and S&P 500

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

The industry has declined 39.5% in this period compared with the broader sector's fall of 16.9% and the S&P 500 composite’s decline of 21.2% in the past year.

One-Year Price Performance

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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 1.35X compared with the S&P 500's 5.27X.

Over the last five years, the industry has traded as high as 2.53X, as low as 0.78X, and at the median of 1.79X, as the chart below shows.

Price-to-Book Ratio (TTM)

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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 3.20X for the same period is above the Zacks Mortgage & Related Services industry's ratio, as the chart shows below.

Price-to-Book Ratio (TTM)

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3 Mortgage & Related Services Stocks to Buy

UWM Holding: The company has been one of the largest wholesale mortgage lender and purchase lender in the nation. The company leverages on its proprietary and exclusively-licensed technology platforms, top-class service and focused partnership with the independent mortgage broker ecosystem.

A notable influx of retail loan officers into wholesale over the year is in line with its focus on expanding market share in the broker channel. This is expected to support growth momentum amid a weak overall mortgage market.

UWMC expects fourth-quarter 2022 originations between $19-$26 billion and an origination margin of 40-70 basis points. Contrary to its peers, the company reassured that it will not be laying off employees but will resort to expense control through technological efficiencies.

The Zacks Consensus Estimate for its 2022 and 2023 earnings has been unchanged over the past month. For the ongoing and the next year, its revenues are expected to fall 31.5% and 3.86%, respectively. The company carries a Zacks Rank of 2 (Buy) at present.

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

Price: UWMC

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PennyMac Financial: This Zacks Rank #2 stock is a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the origination and servicing of mortgage loans, along with the management of investments related to the U.S. mortgage market. The company is based in Westlake Village, CA.

The company’s production technology seems to be working well. While the company’s mortgage production business will likely be affected by industry headwinds, its growing servicing portfolio is likely to provide support. Lower prepayment speed will reduce amortization expenses and inflate pretax income for PFSI. Its efficient and low-cost operating platform along with strong capital levels will help sail through the current choppy waters.

The stock has seen upward estimate revisions for current-year earnings over the past 30 days by 17.5%. Estimates for 2023 have been revised 6.4% upward in the same time frame.

Price: PFSI

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Sixth Street Specialty Lending, Inc.: This specialty finance company is focused on lending to middle-market companies. TSLX generates current income through direct originations of senior secured loans and mezzanine loans as well as investments in corporate bonds and equity securities. 

Amid persistent macro headwinds, the company’s senior floating rate-focused portfolio seems attractive. In fact, 90.4% of its portfolio constitutes first-lien debt investments, while 98.9% is floating-rate debt investments. Amid the rising interest environment, this is expected to boost its top line.

Supported by strong liquidity, the company announced a 7% hike in quarterly dividends in November. This increased dividend underlines its confidence in core earnings power despite an unfavorable industry backdrop.

The Zacks #2 Ranked company’s earnings for the ongoing year are expected to decline 9.7% but the same is anticipated to improve 12.7% in 2023. Revenues for 2022 and 2023 are projected to rise 9.8% and 30% year over year.

Price: TSLX

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(We are reissuing this article to correct a mistake. The original article, issued on November 08, 2022, should no longer be relied upon.)

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