By Amey Stone
It says something about a sector when an analyst’s best idea is a short.
That’s the case with Keefe, Bruyette & Woods analyst Bose George‘s outlook on the mortgage finance sector.
He lists as his “2017 best idea” a company he rates underperfrom — title insurer Stewart Information Services (STC). It was the only short position in a list of 10 “2017 best ideas” featured by KBW at a media briefing last week.
Stewart’s stock price factors in a big improvement in operating margins and a possible sale, but George doesn’t think either are likely, despite an activist investors presence. He also sees headwinds for the title industry as higher interest rates constrain mortgage issuance. He expects mortgage refinance volume to fall by 42% this year.
George, who covers mortgage real estate investment trusts, sees tough times ahead for them as well.
KBW forecasts higher interest rates and moderate economic growth for 2017. That’s not a great backdrop for mortgage REITs, which Bose describes as essentially bond funds. “If we’re right and interest rates rise, it’s difficult for a bond fund to outperform in that environment,” he says.
He also notes in a December podcast that changes in corporate tax rates could make make the REIT structure less advantageous.
Still, he has his favorites among mortgage REITS. He likes New Residential Investment (NRZ), which has exposure to mortgage servicing assets, which get more valuable when refinancing slows. He also recommends Two Harbors Investment (TWO) which trades at a discount to book value. Those two stocks both yield about 11%.
NAREIT, the trade group for REITs, report s that mortgage REITs posted a 22.85% total return for 2016. That was made up of a 10% price return and a 12.85% income return.