This mortgage company is taking advantage of rising interest rates. His action is a buy.
Rising mortgage rates could have a chilling effect on housing. A 30-year loan is averaging 3.5%, down from 3% last month. If rates continue to rise as the Federal Reserve tightens monetary policy, housing inventories will struggle as home loans become less affordable. The outlook is also not good for mortgage originators, with volumes likely to fall.
But a mortgage company could be a winner:
Mr. Cooper Group
(symbol: COOP). The company, renamed Nationstar Mortgage in 2017, issues loans like other mortgage lenders. But about half of its revenue comes from service — processing payments, managing escrows and handling loan issues. Cooper derives a higher percentage of its revenue from maintenance than any other major mortgage company. And the company is rising in value amid rising rates, which is bolstering Cooper’s balance sheet assets.
Cooper’s stock, at around $42, is up 3% this year, outperforming pure mortgage issuers like
(RKT), which is down 6%.
Cooper’s stock might just pick up steam. Its book value should continue to rise, with gains in its mortgage service rights, or MSR. The stock trades at less than one times its book value, a relatively low multiple. Cooper also owns an auction platform for foreclosed properties called Xome. Inventory on Xome is picking up, since a federal moratorium on foreclosures expired last summer. Cooper aims to sell Xome once he recovers. Analysts estimate it could fetch between $750 million and $1 billion, or about 20-30% of Cooper’s market capitalization of $3.2 billion.
“Xome’s value is not in our stock price or book value,” Cooper CEO Jay Bray said. Barrons. “The business is starting to come back and we will actively try to sell it once we feel the market has normalized.”
|Change over 52 weeks:||53.9%|
|Market value (bil):||$3.3|
|2022E sales (bil):||$2.3|
|2022E net income (millions):||$410|
Based in Dallas, Cooper is the nation’s largest non-bank mortgage manager and fourth overall. The company handles payments for 3.5 million customers, with $668 billion in loan balances. Cooper aims to reach $1 trillion in servicing balances over the next three years through a combination of refinancing existing customers, issuing new loans and purchasing mortgages from other businesses. After Cooper issues a loan, he sells it to a government agency like
; they include loans in mortgage-backed securities. Cooper retains servicing rights, which are typically worth a quarter of a percentage point of a loan’s interest rate.
Cooper’s MSRs are its crown jewels in a bullish climate. Higher rates reduce the pool of borrowers who opt to refinance into cheaper mortgages. This creates a longer life for management rights, extending their cash flow. “Our MSRs will clearly increase in value as rates rise,” Bray says. Competitors like Rocket derive only about 5% of their total revenue from maintenance, compared to 50% for Cooper.
Cooper’s MSRs are worth $3.7 billion. They stand to earn $200 million for every quarter-point increase in mortgage rates, according to company filings. “These rate changes can be a huge tailwind for the value of MSRs,” says Ben Schweitzer, portfolio manager at Ellington Management, a hedge fund that owns the stock.
Xome, meanwhile, should rebound as the pipeline of seizures resumes. Cooper estimates that Xome, which hasn’t generated a profit in months, could generate $50 million in pre-tax profits this year and $150 million in 2023. Cooper sold a securities business for $500 million in 2021, and Bray expects Xome to bring in “significantly more.” “Estimates vary widely, but in a bullish scenario, valuing the asset at 10 times estimated 2023 earnings of $150 million, it would be worth $1.5 billion.
Cooper faces obstacles. Rising rates are likely to drive down mortgages and earnings on loan sales to Fannie Mae and other agencies. Analysts expect revenue to fall 31%, to $2.3 billion, and earnings to fall 34%, to $5.61 per share, in 2022, according to consensus estimates.
Yet Cooper could also acquire MSRs as the market hardens, putting pressure on loan issuers to sell the rights at a discount. “We’re seeing that happening right now,” Bray says. MSRs are expected to reach 60% of sales next year. And, says Bray, “We have a war chest with significant capacity to buy back stocks and assets.”
Compass Point Research analyst Giuliano Bologna sees Cooper’s book value at $62 at the end of 2023. By then, he estimates, Cooper will have $1.5 billion in excess capital, not including the sale of Xome. If Xome recovers $700 million, the company could have $2.2 billion in excess cash above working capital and reserve requirements. “The amount of capital it will be able to raise is extremely large relative to its market capitalization,” he says.
Piper Sandler analyst Kevin Barker calls Cooper his top pick with a price target of $60. “It will be more sensitive to rising rates than almost any other mortgage company,” he says. Xome could be worth $16 a share in a sale, he estimates, pushing Cooper’s book value to $66 by 2023. At its target of $60, the shares would still trade below the book, in assuming that shares increase with the value of the company’s assets.
The market may not want to look past the hit to Cooper’s earnings and revenue as rates rise. And investors may need to see more gains in asset values before pushing stocks higher.
A hedge fund manager is betting that Cooper’s book value will continue to rise. “They’re very sharp guys, and I wouldn’t be shocked if the company was sold at a big premium to the current share price,” he says. “It’s a cheap stock in an expensive market.”
Write to Daren Fonda at [email protected]