We anticipate a continued challenging environment for purchase originations in 2010 as an excess inventory of homes, declining home values and increased foreclosures may make it difficult for many homeowners to sell their homes or qualify for a new mortgage. The declining housing market, general economic conditions and a significant increase in loan payoffs have continued to negatively impact our Mortgage Servicing segment.
I agree. The above quote is a disclosure statement from PHH’s 2009 10-K, (p19); the quote was repeated in the company’s most recent 10-Q filing (3Q09). Now, this clearly is not PHH’s headline statement. Yet, it concisely gets across a good point, and I expect this to continue into 2011.
PHH has three business lines:
Mortgage Production – originates, purchases, & sells mortgage loans; appraisals
Mortgage Servicing – services loans, purchases MSRs, mortgage guarantee
Fleet Management – vehicle leasing, fuel card
Over the past several quarters, the Fleet Management Business has been a steady, profitable endeavor. The Mortgage Production and Mortgage Servicing Businesses, however, have been more volatile and, at times, lost significant money. It is these two lines of business that draw my attention.
Over the past few years, I have been bearish on US housing and traded upon that thesis. Today’s trade is an extension of my previous thoughts—just a different way to execute the idea. To review, I believe that the current and future supply of houses vastly trumps the current and near term demand for houses. In theory, this causes housing prices to fall, and in turn, creates problems for homebuilders and financing entities (banks, REITs, PHH, etc). In practice, this is playing out true to form. Even in the past two weeks, we witnessed a falling home price forecast from an FHA audit, a growing housing inventory, and declining housing sales.
Valuing PHH stock is difficult. Currently, it neither generates positive earnings nor distributes dividends. This right here should be a red flag for investors. In addition, the stock is rarely followed in the investment world. So, a discounted cash flow analysis should be in order. Yet, this valuation process is primarily driven by macroeconomic inputs. As I alluded to above, I have pessimistic views on housing, financials, and the economy. Hence, I jump straight to the conclusion that when those three decline, PHH will follow suit. (Of course, this argument assumes that PHH lacks competitive advantages and cannot shield itself from macroeconomic troubles. As for PHH’s own quote, I believe this is a good assumption).
The trade: I shorted 100 shares of PHH at $20.90. The dollar amount involved places this trade in my Top Five.
<Additional Disclosure: I covered PHH as an analyst in 2008. All information used to conduct this trade is publicly available. For more, please see Legal Disclaimer.
