The rise in mortgage rates since the beginning of the year has been a concern for the US housing sector, particularly when the Fed is doing its best to keep them at their lowest. An imbalance between the supply and demand for mortgages is believed to be one factor for higher mortgage rates this year. While creating the balance might take some time, it is not without its risks. This imbalance is impeding a speedy housing recovery. Therefore, I am bearish on companies that provide home improvement products, building materials and supply makers.
Why A Lender Shortage?
Before the credit crunch of 2008, ample funds available for housing were available for all sorts of borrowers. However, the same is not true post credit crunch. Most of the lenders who were spreading funds back then are either underwater or gone out of business. In addition, most of the major mortgage lenders, including Citigroup Inc. (NYSE:C) and Bank of America Corp (NYSE:BAC), are shying away from lending, because they are burdened by MBS liabilities.
According to Inside Mortgage Finance, the market share of the largest five lenders came down from 66% in 2010 to 53% in 2012. The situation has given rise to shortage of willing mortgage lenders, particularly at a time when the Fed is doing its best to support the recovery of the US housing sector. The lack of supply and the ramped up demand, as a result of the Fed’s efforts, could be one factor behind relatively higher mortgage rates this year. Such a demand/supply dynamic could impede the housing recovery.
Risk Inherent In Balancing The Supply Dynamics
New smaller players have entered the field to balance the supply dynamics, however, until they fill in the void, mortgage rates will continue to climb as indicated in the Mortgage Bankers Association’s latest survey. Therefore, an opportunity lies ahead of the younger participants to spread funds.
However, this could also indicate a return of risk taking. Independent mortgage companies and community banks that are originating mortgages are making more use of FHA than larger banks. Further, the less seasoned management at these smaller players, raises the question that whether the lessons of the credit crunch are forgotten already.
Stocks To Avoid
As a speeding housing recovery is obstructed by the imbalance of supply and demand for mortgage, companies that provide home improvement products, building materials and supply makers will experience a slowdown. Therefore, you should avoid The Home Depot, Inc.(NYSE:HD) (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW).
Lowe’s Companies, Inc. (NYSE:LOW) is a home improvement retailer offering a range of products for repair, remodel and home decorating. Lowe’s reported solid fourth quarter results which were also in line with the company’s 5-year plan. During the quarter, sales accelerated, gross margin turned positive while the management confidence increased. Comps increased 1.9% while gross margin expanded by five basis points, below the third-quarter 15-basis-point expansion.
Lowe’s Companies, Inc. (NYSE:LOW) management expects the comps to grow by 3.5% during 2013. However, I believe the company’s growth will actually slow down, as a lack of mortgage lenders leads to fewer home sales.
Home Depot is a similar home improvement retailer which sells an assortment of building materials, lawn and garden improvement products and a variety of other services. During the fourth quarter, HD reported 19% growth in its EPS. HD delivered another strong quarter due the impact of one extra week and China closure. I expect less upside in Home Depot upcoming quarter’s results.
An expected slowdown in housing can bring meaningful downside to the $3.37 EPS guidance. Besides, the tailwind from Sandy is expected to further compress the company’s gross margins. According to Reuters, a majority of the analysts already have a hold rating for the stock, while one recommends its investors sell the stock.
Conclusion
I recommend investors stay away from Home Depot and Lowe’s until a balance in the supply and demand dynamics for mortgages is reached, causing the mortgage rates to stabilize.
The article Lender Shortage Impeding Housing Recovery originally appeared on Fool.com and is written by Adnan Khan.
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