Housing Reform's Investor Bonanza: Street Whispers

NEW YORK ( TheStreet) -- Democrats and Republicans appear to agree the U.S. government's multi-trillion dollar support for the U.S. housing market needs to shrink, and there is massive money to made for investors who can correctly handicap the companies that stand to benefit from the shakeout.

"Moving the U.S. residential mortgage industry back into the private sector offers the greatest growth opportunities in U.S. financials over the next ten years," states a report published Tuesday by Keefe Bruyette & Woods.

Such a bold statement would seem to call for a few stock picks, but alas, KBW's report offers not a single one. Still, it has some ideas worth considering.

First, post-crisis housing winners such as Ocwen Financial ( OCN) Annaly Capital Management ( NLY) and American Capital Agency Corp. ( AGNC), and will have to reinvent themselves if they are going to continue their success of the past few years.

"These firms took advantage of the growth in GSE mortgage production and the spin out of non-prime mortgage servicing. Neither of these trends is likely to continue indefinitely," KBW's report contends.

Ocwen, which services long-delinquent mortgages, has picked up massive market share as troubled companies like Bank of America ( BAC) and bankrupt ones like Residential Capital have been eager to rid themselves of difficult servicing responsibilities while raising funds to boost capital levels or pay creditors.

Annaly and American Capital--the giants of the mortgage real estate investment trust space, have paid out double-digit dividends by borrowing cheaply and using leverage to buy mortgage backed securities (MBS) issued by Government Sponsored Enterprises (GSEs) Fannie Mae ( FNMA) and Freddie Mac ( FMCC). Since the 2008 crisis, the GSEs have supported the mortgage market as private capital has virtually disappeared.

Private capital will presumably have to come back at some point, and politicians appear determined to shrink the government's role, though whether they will agree on how to accomplish this goal without sinking the U.S. economy remains to be seen.

The task is so perilous that KBW Washington analyst Brian Gardner arguesno first term President would take it on. Thus, the reelection of President Obama--not to mention Congress's urgent need to find expenses to cut to avoid sending the U.S. economy over the dreaded "fiscal cliff"-- has increased the odds of something being done.

Still, the wait may be longer than KBW's report appears to suggest. If it isn't, and President Obama and Congress manage to put a plan in place, KBW offers just a single sentence in the report to suggest how investors might position themselves.

"As the housing market recovers and the government moves to wind down the GSEs, we expect that value growth to shift to non-agency MBS REITs, bank portfolio lending, mortgage insurers, and specialty mortgage service providers," is what that sentence says.

However, KBW has a "market perform" rating on the three main publicly-traded mortgage insurers: Genworth Financial ( GNW), Radian Group ( RDN) and MGIC Investment Corp ( MTG). KBW analyst Bose George, who covers Radian and MGIC, told me in August their exposure to legacy losses remains too big a risk, notwithstanding the opportunity that awaits them if they can survive to take advantage of what many believe will be a bigger role for the private mortgage insurance industry.

Bank portfolio lenders are too many to name here, and many will have to navigate a difficult interest rate environment before they can begin to take advantage of the expected government pullback from the mortgage market.

Specialty mortgage service providers are not exactly a secret. Shares of Ocwen have roughly quadrupled in the past two years, while those of the two other notable publicly-traded players, Nationstar Mortgage Holdings ( NSM) and Walter Investment Corp. ( WAC), have more than doubled.

KBW analyst George, who also covers specialty mortgage servicers, has a "market perform" rating on all three names, arguing they are fairly valued.

That leaves non-agency MBS REITs. These are REITs that, unlike Annaly and American Capital, do not buy MBS issued by the GSEs, whose MBS are often called "agency securities," or "agencies." Many are mortgage REITs are hybrids, which buy both agency and non-agency debt. Still, the two non-agency REITs George covers--again it is George who follows this space--he rates "market perform." These are Redwood Trust ( RWT) and PennyMac Mortgage Investment Trust ( PMT).

So KBW's big picture strategists, led by research chief Fred Cannon, see lots of opportunities in a broad sense, but when one starts looking at individual stocks, they're nearly all covered by Bose George and he isn't especially enthusiastic about any of them.

Neither George nor Cannon was available for an interview prior to the publication of this article, but they would likely respond that these are longer-term opportunities. If they are right, it may make sense to start buying some of these stocks now. Usually, by the time analysts get around to upgrading a stock, much of the upside is already gone.

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.