Mortgage shares take a battering – what happens next??

In a period of one week between the 10. and 17. June, 11 publicly traded mortgage banks lost a collective $6.14 billion in market capitalization. As investors fled the space, their valuations dropped 17.4% to a total of $29 billion, according to a HousingWire analysis of stock data.

And it's unclear when – or if – they will recover from the sell-off.

The companies include Finance American Companies, Flagstar Bancorp, Guild Holdings Company, Home Point Capital, CreditDepot, Mr. Cooper Group, New Residential Investment Corp., Ocwen Financial Corporation, Pennymac Financial Services, Rocket Companiesand UWM Holdings Corporation.

"People are hesitant to invest in the mortgage space right now because it's unclear how long the downturn will last," Bose George, mortgage finance analyst at Keefe, Bruyette& Woods (KBW), said. "You don't know how much money these companies are going to lose and what their book values are going to look like when this is done."

The bear market in the stock market began on Friday, 10. June, when the U.S. consumer price index showed an 8.6% year-on-year increase in May 30 basis points above consensus estimates and the highest mark in four decades.

Consequently, the federal reserve raised the federal funds rate by 75 basis points Wednesday, an increase it hadn't seen since 1994. Chairman Jerome Powell also signaled the possibility of raising another 75 basis points at the Fed's next meeting in July.

Faced with growing fears that the Fed will send the U.S. economy into recession this year, investors scrambled to sell riskier assets last week. In a note released Monday, a team of economists at Goldman Sachs raised its outlook for a U.S. recession and expressed concerns that the Fed will act aggressively to control inflation even as economic activity weakens. Goldman Sachs economists now see a 30% chance of entering a recession next year, up from 15% previously, and a 25% chance of entering a recession in the second year if avoided in 2022.

All the turmoil in the markets sent mortgage rates for purchase up 55 basis points last week to 5.78%, which is the largest one-week increase since 1987 Freddy Mac PMMS. Other indices showed rates above 6% last week. Well-qualified buyers in the nonqualified mortgage space were achieving double-digit interest rates, several LOs told HousingWire.

"In terms of mortgage lenders, refis are already largely gone, so the question is whether this interest rate move is enough to slow buying more meaningfully. It's a little early to say," said George. "We are fairly negative on the industry and have not recommended buying any of these names."

Who was hit harder?

Investors are fleeing mortgage companies that are struggling to generate cash – those that aren't delivering profits. They are also punishing the classes of 2020 and 2021, a group of lenders that went public with high valuations, often due to lower mortgage rates and refi euphoria.

Non-bank heavyweight KreditDepot suffered the largest valuation decline during the one-week period. The company lost 37.7% of its market capitalization to $538 million on Friday, according to analysis by HousingWire. The stock debuted at $14 per share in 2021 and closed Friday at just $1.52 per share.

The Orange County-based lender, founded by Anthony Hsieh, reported a net loss of $91.3 million in the first quarter due to a sharp decline in loan volume and cost cuts that failed to keep pace with the rapidly changing environment. Company executives said they do not expect a profitable fiscal year, citing pressure on margins and lower market volume.

Among the six mortgage banks that went public during the good times – besides leihDepot – Rakete (-19.4%), UWM (-16.4%), Heimatpunkt Hauptstadt (-8.7%) and Gilde (-5.35%) also suffered significant valuation losses last week. Most notably, FoAwith a 9.55% decline, closed Friday at $1.80 per share, joining LoanDepot's $1 club.

The remaining companies also suffered valuation losses due to the chaos in the financial markets: New Residential (-20.4%), Ocwen (-14.4%), Pennymac (-11.3%), Mr. Cooper (-9.85%) and Flagstar (-6.3%).

The turmoil in the markets caused Wedbush Securities's team of analysts to lower estimates for several mortgage companies.

"Mortgage rates have risen at an unprecedented pace to near 6% levels from ~3% in recent years, quickly evaporating the rate and term refinance market," Jay McCanless, Brian Violino and Henry Coffey said in the report.

"While purchase volumes remain quite strong from a historical perspective, purchase rate locks are starting to come under pressure, and total volume forecasts for the big three (Fannie, Freddie, and the MBA) for 2022 and 2023 have steadily declined over the year. "

Wedbush lowered Flagstar's price target to $48 from $50 and maintained its Neutral rating. For UWM, which also has a neutral recommendation, analysts reduced the price target to $4 from $5.

Pennymac's price target fell to $55 from $65, with an outperform rating; Wedbush analysts expect total returns to outperform analysts' median forecast over the next 6-12 months.

Wedbush has an outperform rating on Guild ($12 price target), Home Point ($5.50) and Mr. Cooper Group ($60). Analysts also have a neutral target on Rocket, with a price target of $7.

The worst since 2008?

A number of industry watchers said the mortgage market is facing its worst downturn since the financial crisis in 2008.

On 10. June, the day inflation data was released, the mortgage-backed securities (MBS) market went to "no bid," according to longtime mortgage broker Louis Barnes. Faced with a flight to quality caused by expectations of higher U.S. Treasury rates, investors demanded higher premiums to invest in these assets.

"It's a difficult time in the market right now because you don't know what rates to offer borrowers," Kevin Heal, senior analyst and fixed income strategist at Argus research said.

He added: "On the mortgage side, there's still securitization – the concern is if you issue collateral at 5.5%, but it could be the next day, you go in and then you're underwater."

Heal expects profit margins for mortgage originators to drop dramatically in coming quarters due to volatility and lenders having to sell loans on the secondary market at lower profits.

He estimates margins in the retail channel could fall to an average of 2%, down from 3% in previous quarters.

However, there is no need to panic: Analysts agree that originators are in a better position than in the past because they made money during the 2020 and 2021 refi boom.

Only three of the group of 11 companies had a reduction in liquidity position in the first quarter of 2022 compared to the fourth quarter of 2021, including Home Point, Mr. Cooper and Flagstar. Some have put away huge profits from the boom – Rocket has more than $2.3 billion in cash and New Residential more than $1.6 billion. Finance of America saw its cash position increase 60.6% quarter-over-quarter, and Pennymac's cash position increased 44% over the same period. Many of these companies also bought back shares that investors had dumped.

Lenders have already begun to cut costs and protect the remnants of their declining margins. The Wedbush analysts said in their report that although most mortgage companies have begun to reduce their workforces to account for a problem with excess capacity, "it will likely take a quarter or two for excess capacity to be flushed out of the system".

In addition, as lending rates fall, some lenders can increase their revenue by capitalizing on strong demand for their servicing portfolios. Mortgage servicing rights (MSRs) values tend to rise when mortgage rates rise, and borrowers are less likely to refinance or prepay their loans.

"There is a long-term trend reflected in the mortgage industry on many days, including Friday, toward higher interest rates, less refinancing and what appears to be downward pressure in the purchase money market," said Henry Coffey, mortgage and housing analyst at Wedbush. "Against this backdrop, we expect the servicing portfolio to drive more profits for mortgage lenders in the coming quarters."

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