Mortgage Originators Are On Fire

Summary

• Mortgage Origination companies benefit when interest rates decline significantly.
• This is not just because origination volumes spike as people go to refinance their homes, but also because gain on sale margins typically also increase considerably.
• The combination of the two leads frequently leads to exponential growth in profits.
• Flagstar Bank, PennyMac Financial, and Impac Mortgage are three firms which could disproportionately benefit.

30 year home mortgage rates are currently available at 3.75%.  15 years at almost 3%. 

Source: Bankrate.com

Homeowners can benefit from refinancing their mortgages as can real estate investment trusts 'REIT's' by refinancing their commercial mortgages.  As a result, the Vanguard REIT ETF (VNQ) is up about 20% year to date 'YTD' vs. 7% for the S&P 500. 

However, probably the biggest beneficiaries aren't REIT's, but rather the individual companies who most directly specialize in mortgage originations.  Impac (IMH), Pennymac (PFSI) and Flagstar (FBC) are continuing their run, up 126%, 36%, and 10% respectively in less than two months.

Souce: Yahoo Finance

There is justification for this.  According to the Mortgage Bankers Association refinances are up 152% vs. the same time last year.  Additionally, while these firms are highly scalable and they are adding and training help as fast as possible, various indications are they are regularly hitting their short run processing capacity.  This typically results in these firms managing the incoming origination flow by not reducing rates offered as much as their cost of funding has declined.  It creates a spread which can be visualized by comparing the change in the 10 year T bill rate to that of the 30 year mortgage rate.

Source: YCharts

As you can see above this spread has widened considerably the over the last couple months which means originators are making more money on each loan they process.  In the industry, this is referred to as the gain on sale margin.

So you have a perfect storm of spiking origination volume and increasing gain on sale margin that in combination typically leads to exponential growth in profit reported.  Last time we saw this kind of environment was back in 2015 when PFSI increased from $14.50 to 19.50, FBC increased from $14 to $25 per share, and IMH at one point was up a whopping 480% in less than 6 months ($5.60 to $26.90).

The thing to be careful of is how much MSR's they own relative to their origination platform (MSR's are hurt by lower rates), and of course ultimately when it's time to close the trade. 

The Power of Multiple Cash Flow Streams

Since inception, the CFK Income Portfolio has generated a total return of 50.8% (versus 27.8% for the S&P 500, and 35.7% for the Russell 2000).

We accomplished this while also producing a very attractive dividend stream, typically in the 7-9% range. A focus on strong and growing company cash flows, as well as management alignment and capital allocation skills is at the core of what we do. Please join us at Cash Flow Kingdom, "the place where cash flow is king" and see if we can help you achieve your financial goals.