Analysts at Sterne Agee believed that a contrarian view is necessary to invest in mortgage equities as the sectors faces several challenges such as another lackluster year of origination and rising cost.

They also noted the general expectation that the servicing sales would be small in size and number. Based on the expected headwinds confronting mortgage equities, the analysts used a contrarian heart and picked Nationstar Mortgage Holdings to invest.

Mortgage Equities

$1 trillion origination market for mortgage sector

Sterne Agee analysts Jason Weaver, Henry Coffey and Calvin Hotrum noted that that 2015 will be another $1 trillion origination market for the mortgage sector based on the combined consensus view.

Weaver and his fellow analysts believed that servicing transfers/sales will be periodic blocks of $10-$20 billion in UPB, absent the situation with Ocwen Financial.

According to the analysts, “Estimates for purchase money volumes could prove too high and none of the mortgage companies or banks with which Sterne Agee works have led us to believe they will be loosening the mortgage templates anytime soon.”

Weaver and his team noted that the guidance of the FHFA on exemptions from life of loan put-back risk sounds reassuring, but not to the mortgage companies they talked with. They believed that the cost of originating mortgages should remain high. They will also monitor any action to restrict the ancillary fees from loss mitigation servicers such as REO sales because it is a specific risk factor for NSM.

Mortgage Equities

Mortgage equities: NSM expected to deliver positive EPS in FY15

Weaver and his team emphasized that they are not ready to call for a significant uptick in mortgage volumes, but they noted that selective companies may be able to adjust and adapt in a way that produces higher-than-expected mortgage volumes and earnings.

The analysts believed that NSM is focused on $60 billion of “out of the money mortgages” within its servicing assets that are eligible for refinance due to the improvement of consumer credit or gains in home values.

Weaver and his fellow analysts expected NSM to deliver EPS that is in-line with or higher than estimates in FY15. They also believed that the company will be able to resolve tits problem with Solutions Star in the fourth quarter.

In addition, the analysts believed that there is no reason for NSM not to bid on the entire servicing portfolio of OCN that expected to be for sale. They also believed that the company already resolved the concerns of the New York Department of Financial Services (DFS), which recently approved the sale of $9 billion of servicing to NSM from JP Morgan Chase & Co. (JPM).

Mortgage Equities

Questions remain on OCN

Weaver and his fellow analysts believed that a number of questions on OCN are still lingering despite its settlement with DFS because of the lack of open discussion regarding the Lawsky matter. However, they admitted that the conference call on Monday night regarding the settlement helped clarify OCN’s focus.

The analysts are wondering about their initial assessment of OCN’s capacity as a servicer. They are also curious if the DFS is focusing in on a narrow band of aberrant outcomes or if the agency will stop with OCN and go after the entire special servicing industry.

Weaver and his team noted that OCN is selling $100 billion + in servicing. The company is expecting to gain $400 to $500 million from its GSE portfolio.

Mortgage Equities

Analysts also recommend PHH

The analyst also recommended PHH among the mortgage equities, but they excluded the stock from their list. According to them, their Buy rating for the stock is based on their expectation that the company’s management will resolve the problems in its fee for service business and right-size its capital structure. They believe that the shares of PHH will trade closer to tangible book value over time.