Mortgage Stocks Give Brighter Signals

The sector known as "thrifts and mortgages" covers financial institutions that provide mortgages and mortgage-related services. The major segments are:

• thrift banks, which accept deposits and invest them; and
• mortgage banks, which concentrate on issuing and servicing mortgage loans.

There are two unique competitors: Fannie Mae (FNM - commentary - Cramer's Take)and Freddie Mac (FRE - commentary - Cramer's Take), both sponsored by the U.S. government and regulated by the Office of Federal Housing Enterprise Oversight (OFHEO).

The mortgage market is cyclical and highly competitive. The level and volatility of interest rates significantly affects the profitability of the financial institutions and the industry at large.

In recent years, thrift and mortgage finance banks experienced robust growth due to low interest rates and a buoyant housing market. Refinancing activity by homeowners and an expansion of loan volume -- particularly subprime mortgage lending -- also skyrocketed. Mortgage debt outstanding grew 9.2% in 2007 to $14.56 trillion even as industry conditions turned sour.

The subprime crisis, of course, has turned the industry on its head. A combination of tightening credit and softening real estate prices throughout the U.S. resulted in a near-collapse of the market and an industrywide increase in delinquencies and foreclosures.

Moreover, many mortgage lenders were forced to sell loans and securities at distressed prices, and many that were not depository institutions were crippled or collapsed. The absence of secondary market liquidity for non-conforming mortgage debt, increased interest rates and tightened underwriting standards are the main reasons for the ensuing credit crunch and coincident downturn in the housing market.

These factors have led financial institutions to significantly alter key elements of their business models. Mortgage production has been brought down by eliminating channels and suspending many higher-risk products, such as real estate and home equity divisions.

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This article was written by a staff member of TheStreet.com Ratings.