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Historically low interest rates last year spiked activity in the mortgage market, and the boom in the housing market led to a year of record mortgage deals. However, with the gradual rise in mortgage rates, economists predict a slowdown in lending activity by 2022.
Due to this slowdown in credit, M. Cooper Group (NASDAQ: COOP), a residential mortgage lender, trades at a discounted price-to-earnings (P / E) ratio of about 2.8. In light of this shift in the mortgage market, the lender spent 2021 taking strategic action, divesting assets into a “mega servicer” – a move he says will help the business prosper over the long haul. term. With its cheap valuation and strategic shift, is Mr. Cooper Group a buy?
Low mortgage rates have benefited the lender, but a slowdown looms
Mr. Cooper Group is an originator and manager of residential mortgages. In 2020, the lender origination segment saw good volume growth and higher margins due to the low interest rate environment. In 2020, the lender’s income grew at an impressive rate of 36%.
In its most recent quarter of reference, the Cooper Group reported revenue of $ 574 million, down 7% from the same quarter last year. In the first half of 2021, total revenue was $ 1.8 billion, up 108% from last year. However, investors should remember that this comparison includes the first quarter of 2020, which saw the economy and mortgage deals come to a screeching halt.
The company saw its other income increase in the second quarter as it sold its securities business to Mixing laboratories for $ 500 million. The sale gave Mr. Cooper Group a gain of $ 486 million reported as other income for the quarter. The sale also generated net income of $ 439 million, up significantly from $ 73 million in the same quarter last year; Diluted EPS for the second quarter was $ 4.85, up from $ 0.77 last year.
One of the reasons Mr. Cooper Group and other mortgage lenders have such low price-to-earnings ratios is the cyclical nature of mortgage lending activity resulting from its relationship to mortgage rates. The Mr. Cooper Group benefited from the low rates of 2020 and the active mortgage refinancing and buying markets of the year. These factors have led to impressive growth in earnings, gains that are difficult to replicate. As a result, the stocks of mortgage lenders, like Mr. Cooper Group, tend to trade at cheap valuations. As lending activity slows, investors begin to expect lower income and slower income growth.
“Indications of slowing demand”
Economists Freddie mac predicts that the total mortgage origination for 2021 will amount to $ 3.9 trillion, up from the federally sponsored company’s previous projection of $ 3.5 trillion expected in April. According to Sam Khater, chief economist at Freddie Mac: “Despite recent housing market highs, there are indications of a slowdown in demand in recent data on mortgage applications for the purchase of a home. house. We expect refinancing activity to slow as higher mortgage rates dampen activity. “
Freddie Mac projects that next year’s creations will drop to $ 2.6 trillion.
In response to the slowdown in origination activity and the associated rise in mortgage rates, management is positioning the company more as a mortgage manager, collecting payments and keeping records, in order to better position itself for the next several years. .
The company has set a target of $ 1,000 billion in outstanding capital balance (UPB). UPB represents the principal amount outstanding on its mortgages. Management uses this metric along with the service charge to estimate future revenue streams from its service portfolio. Mr. Cooper Group currently owns $ 654 billion in UPB, up nearly 14% from the second quarter of 2020.
Positioning for industry consolidation
Group management Mr. Cooper expects massive consolidation in the mortgage industry. He foresees a market dominated by a few companies which he calls “mega servicers”. In order to become one of these mega-services, the company has given up assets, built its balance sheet and is positioning itself for the future.
On August 23, the lender announced the sale of Xome to Voxtur analysis. The sale is expected to close in the third quarter. During the past year, the company also sold its portfolio of reverse mortgage services as well as its securities business. Exiting these activities “will help us focus on the core business” according to CEO Jay Bray. Their sale also helps raise the company’s capital ratio above its target of 15%.
Mr. Cooper Group has taken strategic actions that will benefit his business in the long run. It expects to be one of the leading service companies in the country. He knows that origination activity will slow as mortgage rates normalize and the economic recovery continues. While these moves position the company well, it is still a very cyclical and mortgage rate sensitive business. This is a stock that I will be avoiding for the time being.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.