Up 150% in the Past Year, This Mortgage Stock Has MUCH MORE Upside

Since the real estate bubble burst in 2007, many people have fallen behind on their mortgage payments. As a result, banks and financial firms have seen profits decline as short sales and foreclosures pile up.

Five years later, the country is still feeling the effects of the bubble burst. About 28% of all single-family homes with a mortgage in the United States are now underwater, with U.S. home prices down nearly 33% from where they were during the peak of the housing bubble, real estate intelligence firm Zillow Inc. (Nasdaq: Z) reports.#-ad_banner-#

As a whole, the U.S. housing market lost nearly $6.3 trillion in value since the housing crisis first began. This lost value has hit homeowners and lenders equally hard. Historically, the percentage of residential mortgages in foreclosure in the United States hovered between 1 and 1.5%. Today, it is up about 4.5%. Foreclosure filings in the United States are projected to keep increasing for the next few years, according to RealtyTrac, an online database of foreclosures, auction and bank-owned homes.

To make things worse, the foreclosure process is taking longer. Just two years ago, the average U.S. homeowner in the foreclosure process hadn’t made a payment in 11 months. Today, that number has jumped to 17 months. These foreclosures are destroying the profitability of banks and other lenders. 

And the numbers going forward don’t look too encouraging either. It is estimated that there are currently more than 4.5 million home loans either in some stage of foreclosure or at least 90 days delinquent. Currently, there are about 8 million Americans who are at least one month behind on their mortgage payments and another 5 million who are two months behind, according to Mortgage Bankers Association. Many of these homes will likely go into foreclosure.

But there is one company that’s successfully helping lenders and borrowers mitigate their losses in a big way. Ocwen Financial Corp. (NYSE: OCN) is maneuvering through the crisis and helping troubled individuals and companies get back on their feet without filing for bankruptcy or defaulting on their loans. The demand for this company’s services has been so great, that the stock is up 150% in the past year alone. The best part is there is still tremendous upside potential from here for investors who want to take advantage of the trend.

Take a look at the chart below and notice how the stock has soared as the mortgage crisis worsened:

The financial services company helps borrowers with residential and commercial real estate, business and consumer loans. It also acquires non-performing loans and negotiates with the originator to repay or foreclose on the loan as quickly as possible. The company also specializes in the development of loan servicing technology and software for the mortgage and real estate industries.

Through the company’s new Shared Appreciation Modification program (SAM), borrowers are able to slash their mortgages by an average of about $75,000. With a SAM program, the principal of the loan is written down to 95% of the current market value of the home. The written-down portion is forgiven in one-third increments during the next three years, so long as the homeowner stays current on the modified mortgage. When the house is later sold or refinanced, borrowers must share 25% of the appreciation with the investors that own the loan and keep the remaining 75% of the gain. So far, there are 34 U.S. states that have given the SAM program regulatory clearance.

Ocwen has been able to achieve resolution rates of 70% or more from pre-foreclosures, while keeping its re-default rates the lowest among its competitors. As a result, Ocwen has been able to mend loans and keep the highest amount of existing borrowers than any other company in this industry.

The good news is the stock appears undervalued right now, based on its price-to-cash flow ratio of 2.95, which is much less than the average of 5.47 in the financial sector.

Financially, the stock also shows signs of its strength. Total revenue for the first nine months of the year increased 79% to $608.6 million compared with the same period last year. Net earnings were up about 68% to $115.6 million, or 84 cents a share, compared with $68.7 million (64 cents a share) in the first three quarter of 2011.

Risk to Consider: Last quarter, Ocwen had missed on earnings when it announced quarterly earnings of 37 cents per share, a negative surprise of 7.7% below the consensus forecast of 40 cents a share. Additionally, because Ocwen is in the business of lending money, there is default risk. It also has a bit of downside risk and volatility as the financial sector could get hit hard with another major economic downturn. For example, during the past 90 days, the stocks’ standard deviation, which measure the volatility of a stock, has been 3.4 while that of the S&P 500 Index has been only 0.7. 

Action to Take –> Having said that, Ocwen is well diversified with lending, and technology services, so it should fare much better than others in the industry.

Buy Ocwen up to $38 a share. This stock could easily hit $50 or higher during the next 12 months, as unemployment remains high and loan delinquencies continue to rise.