While it’s too early to claim interest rates will continue to move higher given previous run-ups and subsequent declines in the 10-year Treasury yield, certain business models will fare better in an environment where investors are focused on higher rates.
As a result, there are financial services companies that are better positioned to weather interest rates, FBR Capital Markets & Co. noted in its latest report.
"We remain conservative with regard to our gain-on-sale margin projections, and with all of second quarter and third quarter product being locked in at this point, we continue to believe the coming quarters will be strong ones for mortgage banking – exposed names such as Flagstar Bancorp, HomeStreet, PHH Corporation and Redwood Trust," FBR Capital analysts explained.
Additionally, servicers like Nationstar and Walter Investment are less vulnerable to movements in rates than "pure-play originators."
For instance, the average coupon on both servicing portfolios is well above 5%, and even a 30-year mortgage rate of 4% or high still provides incentives for borrowers to refinance.
While there may be near-term weakness within these servicers, the long-term outcome will prove to be beneficial to investors, FBR Capital analysts claimed.
Meanwhile, companies in the structured finance space are more immune to higher interest rates, but hybrid mortgage real estate investment trusts can still win on credit, the same report said.
Hybrid mREITs are attractive for two reasons: they can strategically allocate capital to investments earning wider spreads and book values can still rise on nonagency portfolios as credit quality continues to improve.
"Two Harbors Investment Corp continues to be our favorite name within the hybrid mREIT space; MFA Financial may also benefit from higher interest rates given a greater allocation to adjustable-rate mortgages in both agency and nonagency mortgage-backed securities," the FBR analysts noted.
They concluded, "Traditional agency mREITs will continue to be a difficult group for investors to own, but there may be opportunities down the road if book values stabilize, wider spreads lead to new investments and rate volatility subsides."