It finally happened. After months of speculation, PHH Corporation (PHH) announced on June 2, 2014, that it would shed its fleet leasing business, PHH Arval — leaving the finance company centered squarely on residential mortgages.

When all is said and done, the long-expected deal will leave PHH with $750 million to $800 million in net proceeds from the $1.4 billion sale, and a new business direction.

At a time when residential mortgages are a tough market on every side, PHH is about to become a pure-play mortgage company, from mortgage banking to loan servicing.

This month’s Angle asks a simple question: is now the time to invest in the future of PHH, or are there simply too many question marks to make an investment prudent? As with all Angle columns, the answer, dear reader, lies entirely with you.

THE BEAR CASE

It’s not difficult to make a bear case for investing in any mortgage-related stock right now, PHH included. After all, mortgage originations saw what may have been the worse quarter in over a decade to start 2014, with signs that the second quarter was just as bad.

In fact, at the end of May, Bank of America Merrill Lynch analysts cited what they called a “grim situation” in mortgage-backed securities as new securities issuance came to a near standstill at the end of that month. Worse yet, purchase volumes only increased 6% between April and May — a timeframe that typically sees a 20% pickup.

No mortgage company, whether directly involved in originating loans or dependent on loan flow for servicing volume, can fight that sort of aggregate technical successfully. 

Not that PHH management is hiding from reality. Citing “a highly challenging mortgage industry environment this year,” PHH president and CEO Glen Messina said during the company’s Q1 conference call that they are expecting industry-wide loan volumes to fall short of the Mortgage Banker Association’s most recent forecast of $1.2 trillion.

“If current market conditions and the straight levels persists, our mortgage production segment will likely be unprofitable on cash consumption this year,” Messina said. “We continue to expect to report negative core earnings and adjusted cash flow on a consolidated basis for the full year 2014.”

What this means is that the best reason to stay away from PHH may not be anything specific to PHH itself — but instead that an industry in the doldrums overall will prevent PHH from showing much growth that can benefit an investor in the near-term.

That said, there are plenty of issues at PHH specifically that should catch the eye of an experienced investor:

The company saw net income drop over 180% YoY in the first quarter, falling from $52 million to -$42 million.

Debt-to-equity ratio is extremely high at 3.29, as the company remains highly leveraged with costly debt, even after the sale of its fleet unit.

Despite a gross profit margin of over 57%, the company’s net margin of -6.7% should be a concern about costs and overhead.

Much of this comes as the company is burdened with existing PLS (private-label servicing) contracts that don’t reflect revenue/expense realities in the modern servicing environment; and as the company’s cost of funding mortgage servicing right holdings is much higher than other, competing MSR purchasers.

Technical indicators like those above have led some analysts to downgrade the stock recently, with Compass Point most recently moving PHH from “Buy” to “Neutral” on June 3 over concerns about the company’s ability to generate returns in the current environment.

THE BULL CASE

The bear case listed challenges, and to be sure — there are plenty. But investing isn’t about seeing challenges, it’s about understanding how a company will face them.

And in that regard, analysts at FBR & Co. are clearly ahead of the curve, reiterating their “Outperform” rating on the company’s stock in the wake of the fleet leasing business sale.

Ridding itself of a business that didn’t complement mortgages should allow management to better focus on managing its mortgage business, FBR analysts said.

“Any move by the company to reduce its high-costing debt and/or manage excess capital should be well received by investors,” FBR said. And that’s precisely what management intends to do with the proceeds from the sale of its fleet leasing business.

In announcing the sale, management at PHH said it intends to streamline operations, invest into its mortgage business, de-leverage the balance sheet and return capital to shareholders.These are all good goals that should have investors understanding that the new direction of the business is improving, even if the mortgage business as a whole remains stormy overall.

“Our actions aligned to disciplined growth are focused on reengineering our PLS business model and pursuing options to increase scale in mortgage production and servicing,” said Messina on the company’s recent first-quarter earnings call.

“Our actions aligned to operational excellence are focused on reducing production and overhead costs, improving cycle time, and enhancing customer experience, and our actions aligned to liquidity are focused on diversifying our MSR funding alternatives.”

This isn’t likely to be idle talk. After adjusting for the sale, FBR analysts noted that PHH will be sitting on cash holdings of roughly $1.7 billion, leaving the company liquid and well capitalized to make precisely the sort of moves management is talking about.

To the extent the management team is successful here — in particular, in renegotiating its existing servicing contacts — the road ahead could look much brighter for PHH, rewarding shareholders who are willing to jump in while shares currently trade at a discount given overall market concerns.

While it’s all a matter of timing, FBR analysts said they expect to see the company moving in a positive direction — from using excess cash productively, to decreasing its cost base, to generating sustained profitability out of the mortgage business — within the next 12 months.

At the time this analysis was written, PHH shares were trading at $23.38, a significant discount off of the company’s pro forma book value of over $30 per share, according to FBR analysis.

What this means is simple: don’t let the rough mortgage environment scare you away. 

PHH is a company that has ample resources to adjust course and the management team appears committed to doing just that in the wake of unloading the fleet leasing business. When the dust settles — and it will, eventually — investors will jump back in.

But the rewards are there now for those willing to take the risk with PHH now.

Editor’s note: The Angle is a non-positional column designed to present both “bull” and “bear” cases surrounding a publicly traded stock representative of the U.S. housing economy. Analysis focuses primarily on macro-economic factors, and the column is designed to allow investors to choose for themselves which case presented makes the most sense for their own investment objectives. HousingWire does not recommend any specific investments.