Description

loanDepot (LDI) is a contrarian investment idea if you believe the world is overly worried about rising interest rates.   Profits disappointed last quarter, as lower mortgage origination volumes hit gain-on-sale numbers (223 bp overall / retail channel at 261 bp / partner channel at 101 bp) and costs were elevated on continued marketing and technology spend.  LDI has acknowledged margins will continue be pressured for a few more quarters, as excess capacity in the mortgage origination industry needs to be wrung out to reach equilibrium with lower origination volumes. LDI has guided for Q1 2022 gain on sale margins of 200 to 250 bp on substantially lower funded-origination volume, decreasing from $29B in Q4 to a range of $19B to $24B in Q1 2022.   While quarterly earnings are certainly headed lower, the stock is priced for a complete collapse in mortgage refinancing, with total company revenue expected to be cut in half during 2020 -2022.

The Mortgage Banker’s Association (MBA) projects the 10-Year Treasury yield will average 2.3% in 2022 and 2.4% in 2023 and 2024, sending the 30-year fixed mortgage rate to 4.0% and then 4.3% over the next three years.   The average rate for a 30-year fixed-rate loan was 3.92% as of Feb. 17th, a three-year high and up from 3.69% only a week ago.  A year ago, the average 30-year fixed rate was 2.73%, just above the all-time low of 2.65%.    

 Given its rate assumptions, the Mortgage Banker’s Association projects mortgage origination activity to drop > 40% over 2021-24, with refinance activity expected to drop from $2.6T in 2020 to a $0.7T in 2023 & 2024.  Applying the anticipated industry declines in purchase and refinance volumes to loanDepot weighted volumes, suggests a 50% decline in LDI origination volume (ignoring likely continued share gain):

Translating a 50% decline in LDI mortgage originations to a 50% decline in LDI revenue over 2022-24 and applying a 5% net income margin, you are buying LDI at a forward run-rate P/E of 11-12.  Revenues actually could drop even more at LDI given part of their reported retail origination segment is direct to consumer (i.e. not traditional brick and mortar) – which has a high share of refinance.

Buying LDI at a P/E of 12 seems reasonable, knowing market share gains are likely for many years.   The dividend yield is 7%+ as well, although we view that as more of a risk in that the dividend could be cut.  Q1 2022 will be a tough quarter, expected to produce breakeven earnings.  If the company shows a profit, the stock will pop, as sentiment is extremely negative.   However, momentum on the stock, business and mortgage rates are terrible.  Buying now may be more rewarding but is speculative.  We recommend being ready to buy the stock after the Q1 report. 

LDI has $1.6B in corporate (non-warehouse related) debt.  $200 million is due October 2023, with the next maturities being $500M in 2025 and $600M in 2028.   Liquidity looks ample, with $400 million in cash and another $600 million cash in its warehouse facility.

LDI trades at a P/B of 0.8.   When the base effect on industry mortgage originations kicks in and 2024 or 2025 is projected to show growth, LDI valuation should move back above book value.  loanDepot is a good business, which typically can generate double digit ROE.  LDI and RKT have not been public long enough to look at mid-cycle multiples of book.  But LDI is building a digital, fin-tec oriented business.  We see the stock trading at 1.5x+ a $6 book value in two years, representing 100%+ potential return without too much having to go right other than being able to see past the end of the refinancing wave and the time needed to reset industry capacity.  The company’s servicing book will be revalued higher this year on now higher interest rates, which will produce a nice bump to book value in addition to the meaningful contribution to earnings.

There are some reasons LDI may be oversold.  The company went public a year ago and it was a fiasco.  The offering, previously canceled, was touch-and-go and the stock was issued at a reduced $14 price and severely limited float.   The limited float precludes the company from buying back stock.  The company did pay a special dividend in its first year public, an indication of willingness to return capital to shareholders.  The lock-up ended in November and there are now a lot of motivated sellers.

Reasons the stock may be attractive:

1) The CEO successfully built and sold two prior mortgage companies.   Already a large shareholder, he’s been buying shares in the open market; over $15 million in total.

2) loanDepot and peer Rocket Mortgage are disrupting the incumbent $12T mortgage industry, taking share in a highly fragmented industry.   LDI is able to draft off Rocket, which spends 5x LDI on making customers aware they can use their phone to get a loan.  Only ten years old, LDI has built a strong brand and digital platform, possessing a database of 40M unique individuals.    LDI has invested $1.6B in its brand and is the #2 retail-focused, non-bank US mortgage originator.  The company is able to match customers to the best loan officer for their specific needs across channels in a way the big banks don’t – which you know if you’ve refinanced through your bank.

3) loanDepot has started packaging real estate transactions, title, escrow, closing and insurance into its digitally-driven offering.   The opportunity is larger than just mortgage origination, as the $34T residential real estate services industry is moving toward consolidation of products and services for homeowners. 

 4) The mortgage industry is experiencing a price war in the wholesale channel.   This has created investment opportunity, as price wars always end.  Many originators are underwriting unprofitable business to fill operating capacity.  That can’t go on forever and, loanDepot, as a survivor, will gain share.    In the meantime, LDI employs a data-driven, multi-channel strategy which enables it to pivot away from tough market conditions.   Competitive pressures are typical when rates rise, as it takes a few quarters for labor costs to reach equilibrium relative to lower demand, with pressures on gain on sale margins until then.  

5) As refinancing activity wanes, loanDepot is pivoting toward less interest-rate-sensitive loans.  Purchase and cash out refinance was up 13% last quarter, representing 75% of volume (purchase being 35% of total volume).  This and meaningful share gain (up from 2% in 2019 to 3.3% LTM) will support earnings.  LDI loan origination CAGR since 2017 was 46% vs. 28% for the industry.   Confirming agency loan limits may be increased, which would be boost refinancing volumes.  

6) Growth in loan servicing will also boost earnings.  Loan servicing is countercyclical, recurring revenue which enables LDI to sell ancillary services to customers.  Now 10+ years old, LDI is large enough and has invested enough in its business to be able to ramp up servicing, and that’s what it has been doing.   Serviced loans are stickier, at a 95% refinance retention rate, and LDI’s industry-leading 60-70% total loan recapture rate drives revenue at minimal marketing cost.  Loan servicing is capitalized based on length of life, thus higher interest rates will be accretive to earnings and book value for this growing business.    The $160B servicing portfolio generated roughly $90 million in cash earnings in 2021 to give a sense of how valuable this growing business is.

Catalyst

Showing profitability at now lower volumes 

Lapping the decline in refinancing volumes