Zacks Industry Outlook Highlights UWM Holding, PennyMac Financial Services and Federal Agricultural Mortgage
For Immediate Release
Chicago, IL – April 24, 2023 – Today, Zacks Equity Research discusses UWM Holding Corp. UWMC, PennyMac Financial Services, Inc. PFSI and Federal Agricultural Mortgage Corp. AGM.
Industry: Mortgage Services
Link: https://www.zacks.com/commentary/2082600/3-stocks-to-watch-in-a-struggling-mortgage-related-services-industry
The Zacks Mortgage & Related Services industry continues to bear the brunt of a deteriorating mortgage environment. Along with the Silicon Valley Bank fallout reverberating across the U.S. fixed-income market, rising mortgage rates, purchase market tightening and declining refinancing volumes cast a shadow over a speedy recovery of the industry. Additionally, housing price appreciation and increasing competition are near-term headwinds.
Nonetheless, diversified business operations and encouraging scenarios for the servicing segment will help industry players tide over choppy waters. Slow prepayment speed and technological enhancements are anticipated to drive UWM Holding Corp., PennyMac Financial Services, Inc. and Federal Agricultural Mortgage Corp.
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 significant affordability challenges and mortgage rates climbing to the highest level in more than a decade. These factors are likely to subdue purchase and refinancing origination volumes in the upcoming period. The Mortgage Bankers Association (MBA) forecast calls for an 18% decline in mortgage originations in 2023. It expects the 30-year fixed-rate mortgage rate to end at 5.3% in 2023. Although declining from 6.6% in 2022, it is still expected to remain at high levels. 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. However, customer acquisition in the mortgage services industry is becoming more competitive due to housing shortages. Moreover, pricing actions by GSEs to support enterprise goals are driving pricing and margin volatility. Hence, the competitive landscape in the mortgage industry is likely to heat up and participants are expected to resort to price cutting. This may result in a significant reduction in sales margins across the space. With tighter margins, many originators may struggle to remain profitable in the upcoming period, especially if rates continue to be high.
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 their 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. Hence, MSR investments are poised to deliver significant value appreciation and offer attractive unlevered yields. Such MSR appreciation can drive book value.
Zacks Industry Rank Reflects Bleak Prospects
The Zacks Mortgage & Related Services industry, housed within the broader Zacks Finance sector, currently carries a Zacks Industry Rank #206, which places it in the bottom 17% 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 drab near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform 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 losing confidence in this group’s earnings growth potential. The industry’s bottom-line estimate has declined 50% from April 2022.
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 valuation picture.
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 16.5% in this period compared with the broader sector's fall of 8.1% and the S&P 500 composite’s slip of 3.3% in the past year.
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 1.58X compared with the S&P 500's 5.70X.
Over the last five years, the industry has traded as high as 2.53X, as low as 0.78X, and at the median of 1.73X.
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 3.31X for the same period is above the Zacks Mortgage & Related Services industry's ratio.
3 Mortgage & Related Services Stocks to Watch
UWM Holding: The company has been one of the largest wholesale mortgage lender and purchase lenders 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.
The company has a strategic business model with relatively higher purchase mix positioning it to perform well when rates are not conducive for refinance activity. Encouragingly, the company has grown its share of the wholesale channel and anticipates to remain a dominant player in a growing channel.
On the cost front, the company’s highly flexible cost structure is a competitive moat offering scope for sustained profitability and growth. Also, its variable costs primarily relate to origination, without the cost of loan officers allowing scalable growth.
UWMC expects first-quarter 2023 originations between $16-$23 billion and a gain margin of 75-100 basis points. The company has resorted to expense control through technological efficiencies.
The Zacks Consensus Estimate for its 2023 and 2024 earnings has been unchanged over the past month. For the ongoing and the next year, its revenues are expected to fall 12.1% and 22%, respectively. While earnings are expected to decline in the ongoing year, it is expected to jump 55.6% in 2024. The company sports a Zacks Rank of 1 (Strong Buy) at present.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Federal Agricultural Mortgage Corp: Also known as Farmer Mac, the company is a federally-chartered corporation that combines private capital and public sponsorship to create a secondary market for various loans made to rural borrowers.
The company’s lines of business include agriculture finance (consisting of farm and ranch and corporate AgFinance), rural infrastructure finance (consisting of rural utilities and renewable energy) and treasury (funding and investment).
Given the expected rise in agricultural productivity to meet global demand, growing U.S. agriculture mortgage market and significant scope of growth in renewable electricity capacity, the company is expected to enjoy strong pipelines and volumes in the upcoming years. Moreover, the expanding corporate AgFinance and renewable energy business lines also carry higher margins relative to other operations.
Supported by strong fundamentals, the company announced a 15.8% sequential hike in quarterly dividends in February 2023, the 12th consecutive annual increase. This increased dividend underlines its confidence in core earnings power despite an unfavorable industry backdrop.
The Zacks Consensus Estimate for its 2023 and 2024 earnings has been unchanged over the past month. The Zacks #1 Ranked company’s earnings for the ongoing year and 2024 are expected to rise 9.9% and 10%, respectively. AGM sports a Zacks rank of 1 at present.
PennyMac Financial: This Zacks Rank #3 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. As of 2022 end, PFSI serviced $552-billion loans in unpaid principal balance, securing a position in the top five mortgage servicers of the nation.
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 Zacks Consensus Estimate for PFSI’s 2023 and 2024 earnings has been unchanged over the past month. For the ongoing year, earnings are expected to fall 22% year over year on a 16.4% decline in revenues. Nonetheless, in 2024, earnings are projected to grow 55% on 19.7% revenue growth.
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