Reports of lackluster holiday sales, despite the best efforts of retailers to pump up "Black Friday" and even sales on Thanksgiving, U.S. consumers continue to show a careful approach to spending.
The aftershock from the bursting of the housing bubble, high unemployment and very slow income growth have brought the level of household debt to 1.04 times annual disposable income from 1.39 times, at the end of 2007, according to data included in a report on "The State of The Consumer Balance Sheet" published by FBR on Monday.
But there are signs that consumers can and will increase their borrowings, and several of the largest credit card lenders have reported year-over-year loan growth.
"We believe that the only way consumers can re-lever is if the labor market improves meaningfully, and policies out of Washington loosen the supply of credit; ultimately, this boils down to Economics 101-supply and demand," FBR's analysts wrote. The analysts also believe that the process of consumer de-leveraging in the United States will end "over the next one to two years."
In addition to improving consumer confidence as unemployment continues to decline, FBR expects a boost to consumer lending as the government takes a less draconian approach on regulations covering consumer lending and mortgage underwriting. This may include "actions by the [Consumer Financial Protection Bureau] to loosen credit," as well as "new initiatives by Mel Watt," the who is expected soon to be confirmed as the director of the Federal Housing Finance Agency, which regulates Fannie Mae (FNMA) and Freddie Mac (FMCC).
Mortgage Stock Picks
FBR's "base case" economic scenario includes annual gross domestic product growth of 1% to 2% over the next five years. The third-quarter GDP growth rate was 2.8%, accelerating from 2.5% during the second quarter.
While FBR's base case includes slower GDP growth than we have been seeing, it's quite a rosy scenario for the mortgage industry, including $1.5 billion in loan originations during 2014, which greatly exceeds the Mortgage Bankers Association's current estimate of $1.180 billion.
For long-term investors, FBR's favorite mortgage plays include Flagstar Bancorp (FBC - Get Report) of Troy, Mich., and HomeStreet (HMST) of Seattle.
Mortgage lenders have seen a large drop in volume this year, as rising long-term rates have curtailed refinancing applications. But FBR expects a pickup in home purchase activity to offset further declines in refinancing.
In addition to Flagstar and Homestreet, FBR includes Stonegate Mortgage Corp. (SGM) of Indianapolis among its list of lenders rated "outperform," that also have "growing originations and favorable valuations."
Flagstar's shares were down 0.7% in morning trading Monday, to $18.22, while HomeStreet was down 0.4% to $21.08 and Stonegate was down 0.4% to $16.94.
FBR's base case includes an increase of demand for student loans and a recovery of the private student lending market as rising long-term interest rates make the business more attractive for lenders.
The firm's favorite long-term student lending play is SLM Corp. (SLM) which FBR expects to "will continue to outperform on a relative basis in our base-case scenario because demand for higher education has remained relatively constant, even during a weak economy."
SLM's shares were up slightly in morning trading Monday, to $26.69.