United Wholesale Mortgage, Pennymac downgraded by KBW

Keefe, Bruyette & Woods has downgraded both UWM Holdings and Pennymac Financial Services, both based on their current valuation in the stock market, although it was still relatively positive on both.

The move follows the Jan. 2 downgrade of rival Rocket Cos., also based on valuation, but also because of the perceived weakness of its purchase mortgage business.

"Similar to Rocket (which we also recently downgraded to underperform), UWM shares have rallied significantly since late October (+39%), and while they have pulled back -11% from the recent high, we think there could be further downside if mortgage volumes remain muted in 2024," Bose George, an analyst with KBW said in a report that was also a preview of fourth quarter earnings.

Pennymac was dropped to market perform from outperform while the parent company of United Wholesale Mortgage was reduced to underperform from market perform.

Pennymac's stock was trading near its fair market value at the time of the KBW report, Jan. 9, and "we think further multiple expansion is unlikely unless interest rates fall further," George said. Its originations business is a natural hedge to the servicing portfolio if rates decline, he noted.

But Pennymac "will take a roughly $2.85 per share one-time charge in the fourth quarter related to its lawsuit with Black Knight, and as a result, we estimate tangible book value will be down -2% in the fourth quarter despite our expectation for reasonably solid operating earnings," George noted. The Black Knight (recently acquired by ICE Mortgage Technology) litigation is an intellectual property dispute regarding an internally developed servicing platform.

Pennymac declined to comment, citing the quiet period prior to earnings. UWM also did not comment on the report.

As of 2:40 p.m. on Jan. 10, Pennymac was trading at $86.81 per share, up 53 cents from its previous close.

However, UWM was down 2 cents per share at that point, at $6.66 per share, after opening the day at $6.46.

"We continue to assign a premium to UWM shares given the company's relative strength in the purchase market, and we would note that a risk to our thesis is that the stock will likely outperform in a scenario where interest rates decline rapidly and purchase volumes return meaningfully as the shares have historically been inversely correlated to interest rates," George said.

George also addressed Mr. Cooper, noting that he remains positive on the company even with the impact on its earnings from the cybersecurity incident and a negative mark-to-market on the unhedged portion of its mortgage servicing portfolio.

Overall, he is expecting the publicly traded companies to report a hit to their MSR values for the fourth quarter.

"The level of the loss will depend on the hedging," George said. "UWM and Rocket don't hedge their MSRs, and UWM has a larger MSR vs equity, so they should have the biggest MSR loss in the group, followed by Rocket."

But Pennymac and Mr. Cooper hedge their portfolios. Pennymac is at 80% and Mr. Cooper at 75%, so those companies' losses "are likely to be more modest," George said.