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$NSM: GET OUT OF THE WAY

Takeaway: We are removing NSM from the Hedgeye Best Ideas list as a long.

This note was originally published September 27, 2013 at 15:07 in Financials

We Think It Makes Sense to Step Aside For Now

We have been consistently bullish on Nationstar Mortgage since adding it to Hedgeye's Best Ideas list back on February 27, 2013 at a price of $38-39. The stock has had a good run since then, recently trading in the $56-57 range, but today many of the themes and catalysts we thought were misunderstood earlier in the year have either come to pass or are now far better understood and priced in. Consequently, we think most of the good news is now reflected in the valuation. Consider that in just the last few weeks there have been at least two positive initiation reports and one upgrade of the stock from the sell side. In fact, there are currently 8 buy ratings on the stock, more than at any other point in the company's history.

 

We expect there will likely be near-term positive catalysts in the form of deal announcements. Inside Mortgage Finance has written that sizeable MSR transactions are to be expected in the near-term from Wells Fargo ($40 Bn), JPMorgan ($70 Bn) and, most recently, Citi ($61 Bn). Recall that in their second quarter earnings release, Nationstar bumped up its guided pipeline for bulk deals by $100bn, or roughly in line with the sum of the reported WFC & JPM deals. Clearly, there is high probability, but also high expectations, that NSM will win a large share of those big deals. We wouldn't be surprised to see the stock rally further on such announcements. Historically, deal announcements have been a catalyst for upside as they often led to upward guidance/estimate revisions, not just for NSM but for peer companies OCN and WAC as well.

 

So, Why the Change?

We have always regarded three dynamics as paramount for NSM shares to move higher: Growing UPB, Improving Servicing Margins and Maintaining GOS. We think the company has delivered on all three fronts to date, and we are not concerned with the progress being made toward the first two dynamics. It's the third one that worries us.  

 

Our primary concern, and the reason for our change in view, is our expectation that Nationstar will struggle to beat estimates going forward due to pressure on both volume and gain-on-sale margins in the mortgage origination business. After spending considerable time working with our model, we are now currently expecting $1.14 in 3Q13 earnings, which is down from our prior expectation of $1.72 and is now below Street expectations for $1.27. Further, we have baked 15 bp sequential quarterly increases into our expectations for long term interest rates throughout 2014 and this has had a profoundly negative effect on our outlook for next year's earnings power. Based on that bump up in rate expectations, we're now expecting NSM to earn $5.37 in 2014, down from our previous expectation for $8.30-9.35. You may find yourself at odds with our assumption of rising rates throughout 2014, particularly in light of the Fed's recent pronouncements and Summers' withdrawal from consideration. Our basis rests upon the strengthening labor market data we track in the initial jobless claims series, which we think will exert growing pressure on prices and, in turn, should pressure the Fed to begin to constrict credit.

 

HARP & Non-HARP 

We've assumed that HARP volumes are relatively unaffected by the rate change. The guidance is for half of 2013's core production target of $23 billion to be HARP, or roughly $11.5 billion. In the first half of the year, we estimate the company originated $4.5 billion in HARP loans, leaving $7 billion in production for the back half of the year. We've split this evenly at $3.5 billion per quarter. However, the remaining non-HARP origination business we have haircut by 40% vs. our prior baseline forecast. Multiple datapoints support the appropriateness of such a haircut. Cardinal Financial recently pre-announced the quarter citing a 40% drop in Q/Q mortgage origination volume (both purchase & refi) coupled with material compression in gain-on-sale margins. MBA volumes 3QTD are down Q/Q by 47% for refi and purchase volumes are down 9% 3QTD vs 2Q13. Given that most of NSM's volume is refi-based, we think a 40% haircut outside of the HARP channel is reasonable. 

 

$NSM: GET OUT OF THE WAY - stein1

 

Gain-On-Sale 

We've also assumed gain-on-sale margin pressure. Here's the comment management made on the 2Q13 earnings call, hosted in early August: "With the recent rise in interest rates, we've seen some pressure on market pricing, mainly in the premiums on HARP originations." Generally speaking, HARP loans fetch a 250-500 bps GOS premium to non-HARP loans based on a December 2012 Fed study, which can be found here: Fed Study. Taking the mid-point of the 250-500 bps premium, we estimate that last quarter HARP GOS revenue accounted for roughly 60% of total GOS revenue while only accounting for 38% of volume. The average 30-Year FRM rose to 4.45% thus far in the third quarter, up from the 2Q13 average of 3.67%. That 75-80 bps Q/Q increase in rates is likely to weigh heavily on HARP premiums. Remember, HARP loans fetch a smaller premium in a rising rate environment as traditional loans become more valuable. We've nevertheless been conservative in our treatment and assumed roughly a 25 bps decline in Q/Q total GOS margins.  

 

Based on the combination of these factors, reduced volume vs. prior baseline and lower GOS margins, we've lowered our expectation for GOS revenue to $288mn in 3Q down from our prior thinking of $365mn. While management has indicated that they can and likely will bring some further efficiency to the cost side of this business, we doubt it will be enough to offset the compressed volumes and spreads especially considering the magnitude of efficiency improvement seen in 2Q13. #ToughComps

 

In short, while we think the long-term opportunity in the servicing business remains attractive, we think expectations are already high on that front without sufficient deference being paid to the pressure on the originations business. We would sell Nationstar at these levels and consider an alternative without heavy origination exposure, like Ocwen.

 

Ocwen (OCN) as an Alternative

We think it makes sense to roll out of Nationstar and into Ocwen, ticker OCN, where investors can still benefit from the secular trend in servicing but without the significant risk to the GOS business. 

 

Our expectation is that 3Q13 earnings from NSM will disappoint and likely will serve as a catalyst for a rotation out of NSM and into OCN.

 

$NSM: GET OUT OF THE WAY - IS

 

$NSM: GET OUT OF THE WAY - 2

 

$NSM: GET OUT OF THE WAY - 3

 

$NSM: GET OUT OF THE WAY - 4

 

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com

 

Jonathan Casteleyn, CFA, CMT

203-562-6500

jcasteleyn@hedgeye.com

 


INITIAL CLAIMS: BACK TO STEADY

Takeaway: This week we're able to state definitively what's happening in the labor market, but what's less clear is why confidence is plunging.

This note was originally published November 07, 2013 at 11:00 in Financials

Editor's note: What follows below is an abridged report from Hedgeye Financials Sector Head Josh Steiner and Jonathan Casteleyn.

 

The Jury is Back and Has Reached a Verdict (on the labor market)


Last week we lamented the inability to conclude whether a negative inflection in the labor market was occurring based on lagged CA state level data. This week can speak more definitively. The labor market remains strong. The chart below shows the Y/Y trend in NSA initial claims nationally. The red line highlights the trend rate of improvement prior to CA's IT-related fiasco. The data has now resumed that pre-CA trend rate of improvement.

 

We won't belabor the point other than to say that the labor market appears not to have skipped a step as we had potentially feared. One thing we will call out, however, is that consumer confidence/comfort has fallen to a new YTD low. We include a chart later in this note illustrating that. The chart shows the 4-week rolling average of the weekly Bloomberg consumer comfort survey, but the weekly data is no less reassuring. It's unusual to see a divergence between the labor market and the consumer comfort survey data. We'll take a closer look and report back with any worthwhile findings next week.

 

 INITIAL CLAIMS: BACK TO STEADY - 20

 

Nuts & Bolts 


Prior to revision, initial jobless claims fell 4k to 336k from 340k WoW, as the prior week's number was revised up by 5k to 345k.

 

The headline (unrevised) number shows claims were lower by 9k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -9.25k WoW to 347.25k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.4%

 

INITIAL CLAIMS: BACK TO STEADY - 1

 

INITIAL CLAIMS: BACK TO STEADY - 2

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com

 

Jonathan Casteleyn, CFA, CMT

203-562-6500

jcasteleyn@hedgeye.com


 


ECB Cuts, EURO Plunges!

Who saw the 25bp interest rate cut coming this morning?  We didn’t!  In fact, what puzzles us is that we saw no need to use monetary “powder” this month given improving economic data across the region supporting our call for #GrowthAccelerating. Interestingly, Mario Draghi’s economic and inflation assessment of the Eurozone also didn’t change much today – while he underlined a forecast of a “prolonged period of low inflation”, his subdued inflation outlook (below the 2% target) had been well communicated over the last two meetings, including forecasts for low levels of inflation to extend late into 2014. So why then the cut today, especially if, as Draghi says, the level of the EUR/USD does not factory into the policy rate consideration? ... You got us!

 

Alas, we have to play the game that is front of us.

 

If you’ve been following our research, you’d know one of our Q4 macro themes is #EuroBulls, which included a bullish call on the EUR/USD and German and UK equities.

 

Today’s decision certainly moved markets:  The EUR/USD is down as much as -1.2% intraday, and European equities are shooting to the upside.  From here we’re going to re-access our positioning around the #EuroBulls theme.  However, this morning Keith made some changes to our Real-Time Alerts:

  • We sold our long EUR/USD position (via the etf FXE)
  • We sold our long Germany equity position (EWG)
  • We sold our long Swiss equity position (EWL)

On the currency front, the signal from the central bank currency wars between the USD and EUR is a lot less clear this morning, whereas before this morning we expected the Bernanke/Yellen no taper call (likely out to March 2014) to weaken the Greenback vs the EUR. Of note, we think a relative winner in all of this is the British Pound, which we’re currently long of in our Real-Time Alerts via the eft FXB

 

On the equities front, before today’s meeting we were seeing a strong correlation between the EUR/USD and the DAX.  That’s obviously inflected today. Today’s decision could well facilitate more liquidity in the system, or at least a positive psychological response, which could be bullish for equities. On this front we’re still going to let the dust settle on today’s decision.

 

To read a copy of Draghi’s prepared remarks click here.

 

Here’s a look at our EUR/USD levels going into today’s decision:

 

ECB Cuts, EURO Plunges!  - zzz. eur usd

 

Matthew Hedrick

Associate


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INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING

Takeaway: This week we're able to state definitively what's happening in the labor market, but what's less clear is why confidence is plunging.

The Jury is Back and Has Reached a Verdict (on the labor market)

Last week we lamented the inability to conclude whether a negative inflection in the labor market was occurring based on lagged CA state level data. This week can speak more definitively. The labor market remains strong. The chart below shows the Y/Y trend in NSA initial claims nationally. The red line highlights the trend rate of improvement prior to CA's IT-related fiasco. The data has now resumed that pre-CA trend rate of improvement.

 

We won't belabor the point other than to say that the labor market appears not to have skipped a step as we had potentially feared. One thing we will call out, however, is that consumer confidence/comfort has fallen to a new YTD low. We include a chart later in this note illustrating that. The chart shows the 4-week rolling average of the weekly Bloomberg consumer comfort survey, but the weekly data is no less reassuring. It's unusual to see a divergence between the labor market and the consumer comfort survey data. We'll take a closer look and report back with any worthwhile findings next week.

 

 INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 20

 

Nuts & Bolts 

Prior to revision, initial jobless claims fell 4k to 336k from 340k WoW, as the prior week's number was revised up by 5k to 345k.

 

The headline (unrevised) number shows claims were lower by 9k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -9.25k WoW to 347.25k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.4%

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 1

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 2

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 3

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 4

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 5

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 6

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 7

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 8

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 9

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 10

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 11

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 12

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 13

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 19

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 14

 

Yield Spreads

The 2-10 spread rose 12 basis points WoW to 235 bps. 4Q13TD, the 2-10 spread is averaging 228 bps, which is lower by 6 bps relative to 3Q13.

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 15

 

INITIAL CLAIMS: THE LABOR MARKET RETURNS TO STEADY IMPROVEMENT, BUT CONFIDENCE IS DROPPING - 16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


 


3Q13 GDP: Juiced By Inventories

Summary:  The strength in headline GDP is belied by rising inventory accumulation and decelerating consumption growth. Residential Investment drove further acceleration in total Private Investment while Government Expenditures and Net Exports both returned to positive GDP contributions. All in, domestic economic activity was largely flat sequentially with the headline print modestly overstating underlying strength.  

 

 

REAL GDP:  +2.8% QoQ (vs. 2.5% prior and +2.0% expected)

C: Consumption growth decelerating to +1.5% QoQ from 1.8% last quarter.  Contributed +1.04 to Total GDP.  Sequential growth in Durables was strong, NonDurables moderate, Services flat

I: Investment growth accelerating to +9.5% QoQ.  Biggest contributor to Total GDP at +1.45.

G: Government expenditure growth moving back to positive (barely) after 3 qtrs of negative growth.  Contributing 0.04 to Total GDP.

E: Exports (+4.5% QoQ) growing at a premium to imports with Net Exports contributing +0.31 to Total GDP.

 

Inventories:  Inventories helped juice Headline GDP growth with inventory accumulation providing a positive contribution of +0.8 to GDP.  Up from a positive contribution of +0.4 last quarter. 

 

Inflation:  Core PCE Inflation accelerated to 1.4%, off the near record low of 0.6% recorded in 2Q13.  With Core PCE remaining the Fed’s preferred inflation reading, at 60bps below the 2.0% target, inflationary pressures should not serve as a constraint to a continuation of easy policy. 

 

Real Final Sales (GDP less Inventory Change):  Still healthy at +2.0% QoQ vs +2.1% in 2Q

 

Gross Domestic Purchases (GDP less exports, including imports):  Flat sequentially at 2.5%

 

Real Final Sales to Domestic Purchasers (GDP less exports less inventory change):  In measuring total U.S. demand from both domestic and international sources this measure, arguably,offers the cleanest read on the health of the domestic private sector. Growth in Final Sales to Domestic Purchasers decelerated modestly from  2.1%in 2Q13  to 1.7% 3Q13.   

 

Consumption:  Consumption growth decelerated 30bps QoQ to +1.50% in the third quarter – the lowest pace of growth since 2Q11. 

 

The deceleration was not unexpected as disposable personal income growth, and consumer spending by extension, was constrained in 3Q by the ongoing reduction in the federal workforce and the implementation of sequestration related furloughing of federal employees.   

 

Federal job loss and furloughing has not been inconsequential as salary and wage income for government workers (~17% of the national workforce)  has been growing at -0.6%. 

 

Private sector personal income growth has emerged as a positive offset, however, with wage/salary income accelerating in recent months.   Forthcoming results out of the bipartisan budget committee (tasked with finding a budget resolution and alternate path to sequestration) in early January 2014 will have a meaningful impact on the trajectory of household disposable income and aggregate consumption growth.  

 

Given the existing constraints, and a rising savings rate, consumption growth in 3Q13 could probably be best characterized as 'decent'. 

 

We’ll provide an update on consumer income/spending alongside the detailed release tomorrow. 

 

3Q13 GDP: Juiced By Inventories - 3Q13 GDP Table

 

3Q13 GDP: Juiced By Inventories - GDP   Contribution

 

3Q13 GDP: Juiced By Inventories - UNITED STATES

 

Christian B. Drake

Associate 


IGT: PUNT ON 1ST DOWN

Defensive pressure starts a quarter early

 

 

IGT should not have been “extremely pleased” to report 2013 results and adjusted FQ4 EPS of $0.30, a sizeable miss from consensus of $0.34.  We suspect whisper expectations were for higher EPS.  We and others thought IGT may have been low balling FQ4 when they didn’t change annual guidance following a Q3 beat.  Our focus had been on the 2014/2015 headwinds as discussed in our recent “SLOTHY GROWTH” Black Book and indeed, the company gave pretty weak guidance that probably includes the accretive impact from an announced $200MM accelerated repurchase program.

 

FQ4 was bad across the board.  Here are some quick takeaways and our earnings table:

  • Guidance was weak and likely includes about $0.03 in accretion from the announced $200 million accelerated share repurchase. 
  • Commentary on the recognition of other significant items that are currently not determinable is also sketchy.
    • “GAAP earnings per share from continuing operations for fiscal year 2014 will include acquisition-related expenses, primarily related to DoubleDown, the amount of which is not determinable at this time.  The company may also recognize other items that are not currently determinable, but may be significant. For this reason, the company is unable to provide estimates for full-year GAAP earnings per share from continuing operations at this time.”
  • We already had $200MM in share buyback for our $1.35 estimate, although not accelerated - $0.01 accretive to our model
  • Gaming Ops below projection on all metrics – revs down, yields down, machine count down. What else can we say?
  • Sold 33% more units in NA than last year's but revenues were down 5% YoY due to a 29% decline in ASPs blamed on “product mix” and “targeted promotional activity”
    • The ASP decline isn’t just due to mix.  We had factored in that ~3,500 NA units would be sold at a steep discount of $9k (Video Poker) and used a $13k number for the balance of our estimate – which is about $1k below the average ASP in NA.  Whatever promotions IGT is offering are material.  Poor mix can also imply that their newer higher price boxes aren’t selling and customers are gravitating towards cheaper fixes.  Either way it’s not good.
    • To put the $10k handle ASP in perspective, IGT hasn’t had ASPs below $11k in any quarter since 2006
  • The only positive data point on Product sales was international box shipments which were up for the first time in 4 quarters
  • Product sales gross margins were terrible and reflective of the low ASPs and promotional activity
    • Both NA and International gross margins were the lowest we’ve seen in 3 years.
  • The bright spot on a YoY basis should’ve been Interactive but even here they missed the revenue number with MAU and DAU below our projections
    • Revenues for Double Down were flat QoQ. This is the first time IGT has reported zero QoQ growth for the crown jewel of their portfolio. 
  • SG&A up due to “increased advertising expenses in correlation with growing social gaming revenues” for the Interactive Division among other things.  Not good for this division where growth is clearly slowing. 
    • SG&A increased $21MM QoQ while social gaming revenues were FLAT.  If we strip out all of the other items on IGT’s list of increased expenses, we are still left with a big (~$13MM) QoQ increase on no revenue growth.
      • $2.4MM legal expense
      • G2E expenses are probably in the neighborhood of $3-4MM
      • Higher bad debt expense assumed to be $3MM

IGT: PUNT ON 1ST DOWN - igt


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