Treasure Chest: Rates Key To Computershare

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FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. As rates on US 10-year Treasuries start to turn around is there a brighter outlook for Computershare's mortgage servicing?

-US conventional mortgage rates have started to increase
-Main unknown is duration of forbearance programs
-And growth in high-margin business likely to be slow
 

By Eva Brocklehurst

Mortgage servicing, particularly in the US, has hit an interesting juncture and the growth path for Computershare ((CPU)) may well hinge on developments in mortgages.

Computershare has material leverage to global rates, which affect the level of new mortgages and refinancing, and 10-year US Treasuries are the bellwether indicator for the mortgage servicing segment. Hence, Goldman Sachs believes the market may be overlooking the degree to which movements in rates can be reflected in growth, cash flow and valuation.

Following a lift in 10-year Treasury rates, conventional mortgage rates in the US have started to increase. This is good news for Computershare as, from a mortgage servicer perspective, lower rates have been driving increased pre-payments and refinancing.

Lower mortgage rates may trigger elevated levels of new lending but, as the broker explains, the drag on the company's cash flow in any growth scenario is always greater for an equivalent level of earnings in a heightened early-payment or paying-down environment.

Hence, pre-payments are one of the most sensitive inputs into the valuation. Computershare lowered the useful life assumption on its mortgage service ratio to eight years from nine years at the FY20 results.

Goldman Sachs suspects management is not keen to make such adjustments regularly but can envisage some upside over the medium term should US rates continue to rise and pre-payment rates return to more normal levels. The debate, therefore, centres on whether the risk of elevated pre-payments is receding and the broker considers the latest indications on this front encouraging.

Morgan Stanley finds underlying revenue resilient and looks for 7% growth in FY22, despite a step-down in margin income, expecting US mortgage servicing can recover to 24% revenue growth in FY22, as foreclosure fees catch up.

Mortgage servicing went into loss-making territory in the first half, affected by the moratorium on foreclosures. Credit Suisse is more cautious and suspects the accelerated run-off in mortgages because of lower US mortgage rates is unlikely to turn around soon.

As cost reductions are largely leading the recovery, the broker believes this a lower quality item compared with a revenue-led recovery and anticipates a larger rebound in mortgage servicing will not occur until FY23. Ord Minnett concurs, noting gearing is at the top end of management's target and, while cost savings efforts are progressing, expenses are still rising.

Forbearance

The main unknown, Goldman Sachs concedes, is the timing of the cessation of forbearance programs. As a result of the pandemic the US allowed for a period of relief from bankruptcy filings and mortgage stress, and these programs have recently been extended.

A moratorium on foreclosures will continue restricting Computershare's ability to collect fees. Citi also points out mortgage servicers are incentivised in the US to modify loans, given the one-off fee income on offer. Loan modification fees are unlikely to be earned when a loan is in forbearance.

The company's guidance assumes minimal recovery in foreclosure-related revenue so the broker assesses the adverse impact of extensions to mortgage foreclosures on revenue is likely to be modest. The bankruptcy administration business was up strongly in the first half and there is potential for further improvement over the next two years as this tends to be counter-cyclical.

Citi notes issuer services are the highest margin business and have proven resilient in terms of revenue despite the loss from US mortgage services. On the other hand, growth is expected to take time to eventuate. Moreover, the level of mortgage originations is likely to soften from recent peaks, although the company is proactively attempting to retain more of its mortgages on the servicing book.

If some of the loans on forbearance convert to true non-performing loans then this should present Computershare with more opportunities for higher margin work. All up, Citi believes there is a lot priced into the shares and has a Sell rating.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, believes the outlook now has more clarity and maintains a Buy rating with a $15.38 target. The database has the lot, three Buy ratings, two Hold and two Sell. The consensus target is $14.54, suggesting -1.1% downside to the last share price. Targets range from $10.75 (Ord Minnett) to $16.45 (Macquarie).

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