Investor Sentiment Undermines Mortgage Stocks

steady, the market continues to pummel mortgage stocks as investors react to recent hikes and their effect on lenders' volumes.

American Banker's index of independent mortgage companies fell 11.4% last week amid a major selloff in the bond market, which pushed U.S. Treasury yields -- the benchmark for mortgage rates -- higher. Every publicly traded home lender came under pressure, from Internet-oriented startups that have not yet turned a profit to established companies that have weathered previous cycles.

Bank exposure to the mortgage business is part of the reason bank stocks have languished in recent months, as rising interest rates killed last year's refinancing boom.

Lenders protest that the selloff has been overdone. They say plenty of people are shopping for loans to buy homes and that this indicates the housing market is still strong. What's more, big banks that own mortgage banks say their servicing portfolios should perform well in a rising rate environment, offsetting any decline in new lending. But Countrywide Credit Industries, the largest independent mortgage company, boasts a large servicing portfolio, and its stock has suffered nevertheless.

Even lenders that don't service loans argue that they have variable cost structures that will blunt the impact of reduced volumes. But the market remains skeptical.

"We have all been frustrated by the performance of our stock over the past year," said Edward J. Sebastian, chairman of Resource Bancshares Mortgage Group, in a letter to shareholders Thursday.

The Columbia, S.C., lender's stock, which dipped below $5 a share last week, off from a 52-week high of $18.8125, "is trading below its fair value," said Mr. Sebastian, who for health reasons stepped down as CEO last week and plans to retire as chairman at yearend.

Observers agree that the market is overreacting to the rise in rates -- at least in some cases.

"Some of them are being unfairly punished," said Sy Jacobs, a hedge fund manager at JAM Partners LP in New York, who nevertheless said he fears the stocks could go lower. "A lot deserve to be punished because they're origination-oriented. The origination business is going through, and will go through, some lean times."

American Home Mortgage Holdings, a small New York retail lender, made its initial public offering Thursday but raised only $15 million of the $22.5 million it had hoped for. "The market's been tough the last 10 to 15 days for mortgage companies," Michael Strauss, chairman and chief executive, said of the offering, which was led by Friedman, Billings & Ramsey. "It got done, and the stock's traded up. I'm happy for that."

The company had touted its Internet presence in the prospectus for its IPO. But as last week's performance of two closely watched on-line lenders, E-Loan and Mortgage.com, suggests just being an Internet play won't always buoy a company's stock price.

E-Loan of Dublin, Calif., lost 27% of its market value in two days -- and that was before it issued a warning Thursday that it would report a bigger loss for the third quarter than analysts were expecting. Then it fell some more and ended the week at $23, off 31% from the previous Friday.

Shares of another Internet lender, Plantation, Fla.-based Mortgage.com, fell 17% last week, to $10.0625. Seth Werner, chairman of Mortgage.com, complained that investors' use of the Internet has sped the decline in Internet lenders' stock. "We are both in the hands of the day traders," he said. "They trade on news that they read in the chat rooms. It's not a very sophisticated analysis of the business."

In its preliminary earnings release, E-Loan said its revenues would be hurt by failure to deliver loans to its wholesalers on time. E-Loan can extend its commitments for forward sales, for a fee; if rates rise during the extension period, the fee increases. Critics said this demonstrated that though the company may boast advanced technology it has yet to master the rudiments of mortgage banking.

Janina Powlowski, president of E-Loan, defended its performance, noting that it started out as an on-line loan broker and only recently added mortgage banking.

"It's hard to grow so fast," Ms. Powlowski said. "We're going to have our knocks. I wouldn't say this is the last one, though for shipping it will be. As long as we don't make the same mistakes twice, I don't think we are failing." E-Loan stock is still "well above" $14, where it opened the day after its IPO, she noted.

Ms. Powlowski said that applications at E-Loan were up 35% in the third quarter, when other companies' volumes were declining. And despite criticisms that E-Loan is overly reliant on refinancings, she said, the company's fundings of loans to buy homes jumped 163%.

Mr. Werner of Mortgage.com said initial logistical problems are to be expected of growing companies.

"I would discount 100% anybody who says that just because there are some problems starting out there is not a business there," Mr. Werner said. "Just because some people are having problems delivering the servicing component in the early stages doesn't mean that it's not going to be worked out."

Both E-Loan and Mortgage.com sell servicing rights along with their loans, so in a rising rate environment they don't benefit from the increased value of servicing. But they say they have other lines of business to offset the cyclical nature of the origination business.

Mr. Werner cited the fees Mortgage.com gets for licensing its technology to other companies. Ms. Powlowski said that E-Loan recently cut a deal to market credit cards for "a leading nationwide credit card company," whose name will be announced shortly.

The selloff has hit companies with big servicing businesses, too. Countrywide, a 30-year-old Calabasas, Calif. lender, says its $236 billion servicing book should act as a "macro hedge," keeping its earnings stable even when originations decline, but its stock has been in the doldrums.

When Countrywide released second-quarter earnings that met analysts' expectations two weeks ago, its stock briefly jumped into the $34 range, but it has since come back down to the low 30's, and it closed the week at $31.50. Countrywide was trading around $50 in January.

"We've been working long and hard to educate analysts and investors how we think we've developed strategies that are countercyclical," said a Countrywide spokesman. These include not only the servicing portfolio but also Countrywide's home equity and subprime lending, as well as ancillary businesses such as insurance. Winning back investors will be "a matter of demonstrating continued earnings in a non-refi market," the spokesman said.

Prism Financial Corp. of Chicago announced on Monday that despite the rough environment, it will meet analysts' third-quarter earnings consensus of 24 to 26 cents per share. Skeptics -- including short-sellers -- had cast doubt on the company's ability to do so, given its focus on retail originations.

"Our current stock price reflects an overreaction to mortgage market conditions," said David Fisher, Prism's chief financial officer, in the statement. Prism, which went public in May, closed Friday at $9.50, off 69% from its high; after its announcement Monday morning it jumped more than 10%, to $10.25.

Resource puts its money where its mouth is when it says its shares are undervalued -- it has been buying back stock. According to Sandler O'Neill & Partners analyst Michael McMahon, the company has bought 4.45 million shares this year, at an average price of $11.22, reducing shares outstanding by 15%.

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