Computershare's Margin Outlook Is Better Than We Thought

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Equity Bottom-Up

<div class="content-highlight"><p style="text-align: center;"><strong>Mortgage servicing underpins group earnings growth.</strong></p></div><hr><h2>Mortgage Servicing to Become the Largest Division by Fiscal 2021</h2><p>The U.S. mortgage servicing sector has a patchy track record, with many banks and third-party mortgage servicing firms receiving large fines in recent years for violating mortgage servicing rules, particularly during the global financial crisis. The sector is also vulnerable to an increase in mortgage delinquencies which usually cause a significant increase in mortgage servicing costs and mortgage servicing companies must continue to make mortgage payments to lenders in the short term at least. In some circumstances, mortgage servicing firms can also be exposed to the credit risk of borrowers.</p><p>However, despite the risks, we are comfortable with narrow-moat <a href="https://www.smartkarma.com/entities/679" target="_blank" data-smartkarma-citation="entities:679:1">Computershare Ltd (CPU AU)</a>'s rapid expansion into the mortgage servicing sector. The company's mortgage servicing business is spread across both the U.S. and the U.K., and we believe the U.K. exposure diversifies and reduces risks as obligations of mortgage servicers are typically lower in the U.K. We also believe the mortgage servicer fines are more reflective of industry practices before the GFC and subsequent increase in regulation, meaning it shouldn't be considered a recurring industry cost. Computershare has a long history of successfully managing regulatory risks in similar industries and its mortgage services are relatively highly rated by the credit agencies. The company also has a relatively low exposure to Ginnie Mae RMBS meaning credit risks are low. We expect Computershare to grow its mortgage servicing revenue at a CAGR of 5% over the next decade, driven by UPB growth due to the acquisition of mortgage servicing rights and mortgage servicing contract appointments. We expect the division to become the largest in the consolidated company by fiscal 2021, excluding margin income.</p><h2>Key Takeaways</h2><ul>
<li>We expect Computershare's mortgage servicing division to become the largest in the group by fiscal 2021, accounting for 28% of group revenue. Excluding margin income, we expect 39% of group EBITDA to come from mortgage servicing by fiscal 2021, or 24% including margin income.</li>
<li>Computershare benefits most from slowly rising interest rates, which is what we assume in our financial model and which is discussed further in our recent report <a href="https://www.smartkarma.com/insights/computershare-s-margin-outlook-is-better-than-we-thought" target="_blank" data-smartkarma-citation="insights:26493">Computershare's Margin Outlook Is Better Than We Thought</a>.</li>
<li>Mortgage servicing is exposed to cash flow and credit risks in the U.S., but we consider the probability of issues arising to be low.</li>
</ul><p><em>Analyst: Gareth James, CFA</em></p>

Mortgage servicing underpins group earnings growth.Mortgage Servicing to Become the Largest Division by Fiscal 2021The U.S. mortgage servicing sector has a patchy track record, with many banks and third-party mortgage servicing firms receiving large fines in recent years for violating mortgage servicing rules, particularly during the global financial crisis. The sector is also vulnerable to an increase in mortgage delinquencies which usually cause a significant increase in mortgage servicing costs and mortgage servicing companies must continue to make mortgage payments to lenders in the short term at least. In some circumstances, mortgage servicing firms can also be exposed to the credit risk of borrowers.However, despite the risks, we are comfortable with narrow-moat Computershare Ltd (CPU AU)'s rapid expansion into the mortgage servicing sector. The company's mortgage servicing business is spread across both the U.S. and the U.K., and we believe the U.K. exposure diversifies and reduces risks as obligations of mortgage servicers are typically lower in the U.K. We also believe the mortgage servicer fines are more reflective of industry practices before the GFC and subsequent increase in regulation, meaning it shouldn't be considered a recurring industry cost. Computershare has a long history of successfully managing regulatory risks in similar industries and its mortgage services are relatively highly rated by the credit agencies. The company also has a relatively low exposure to Ginnie Mae RMBS meaning credit risks are low. We expect Computershare to grow its mortgage servicing revenue at a CAGR of 5% over the next decade, driven by UPB growth due to the acquisition of mortgage servicing rights and mortgage servicing contract appointments. We expect the division to become the largest in the consolidated company by fiscal 2021, excluding margin income.Key Takeaways
We expect Computershare's mortgage servicing division to become the largest in the group by fiscal 2021, accounting for 28% of group revenue. Excluding margin income, we expect 39% of group EBITDA to come from mortgage servicing by fiscal 2021, or 24% including margin income.
Computershare benefits most from slowly rising interest rates, which is what we assume in our financial model and which is discussed further in our recent report Computershare's Margin Outlook Is Better Than We Thought.
Mortgage servicing is exposed to cash flow and credit risks in the U.S., but we consider the probability of issues arising to be low.
Analyst: Gareth James, CFA

Computershare Is Well Placed to Manage Mortgage Servicing Risks