Bank Loan Castoffs Are Walter Investment's Jewels

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It was once a sleepy division of a conglomerate-turned-energy company.

Now Tampa, Fla.-basedWalter Investment Management ( WAC ) seems to have shot up from nowhere to become one of the top specialty mortgage servicers in the U.S.

In its field, onlyNationstar Mortgage Holdings ( NSM ) andOcwen Financial ( OCN ) are bigger.

And its fee-based business keeps getting bigger. On Jan. 7, Walter snagged a $93 billionFannie Mae ( FNMA ) servicing portfolio fromBank of America ( BAC ) for $519 million. It includes 650,000 loans, 80% of them current.

That followed an agreement to take on $50 billion in loan servicing from bankrupt Residential Capital, or ResCap.

When those and other new loans are boarded, Walter's servicing portfolio will jump from $79 billion in unpaid principal, as of Sept. 30, to $230 billion.

And that is if no other new business comes on line. As Walter's vice chairman, Denmar John Dixon, told analysts and investors recently, "There's plenty more to do."

That includes both prime and "high-touch, credit-sensitive" loans, Walter's forte.

"We've got the capability to handle a very broad set of products," Dixon said.

Headaches Are Us

This is a good time to be an independent mortgage servicer. Banks continue to sell off servicing rights of their home-loan portfolios -- and for good reason. With ever more regulatory scrutiny and new rules, out go the headaches and costs that come with them.

Specialty servicers don't mind the hassle. That's what they are born to do, and their soaring growth rates speak to just how much they are in demand.

"I'm finding more and more evidence that there is a secular shift in the market and that it makes sense for originators and mortgage bankers to sell servicing rights to the special servicers," said analyst Kevin Barker of Compass Point.

He says government service agencies are also urging banks to shift loans to top special servicers such as Nationstar, Ocwen and Walter. A majority of Walter's servicing platform is on Fannie Mae loans, Barker has noted.

Walter's revenue has grown from $180 million in 2010 to an estimated $658 million in 2012. Analysts forecast 2013 revenue will top $1.2 billion, according to Thomson Reuters.

Walter's growth took off in 2011 after it acquired loan servicer Green Tree Credit Solutions in a deal valued at more than $1 billion. Green Tree added nearly 2,000 employees to Walter's 350 and more than two dozen offices in as many states.

With Green Tree, Walter lost its REIT status. But the Green Tree acquisition let Walter go after more business in the growing specialty mortgage services market, especially risky mortgages, which come with higher fees. And it landed an origination platform that allows it to capture refinancings of loans that may have gone elsewhere.

Since the Green Tree acquisition, Walter's shares have climbed from 15 to as high as 49 on Jan. 8. Shares are now trading around 43.

At the same time as the Bank of America announcement, Walter said it would acquire the government-agency-focused home-mortgage servicing platform and related assets of MetLife Bank, based in Irving, Texas.

Walter's earnings, meanwhile, have gone from a loss of $2.51 a share in 2011 to a forecasted $2.76-per-share profit in 2012. EPS is projected to reach $6.32 this year, says Thomson Reuters.

Economies Of Scale

Nonbank servicers that buy new business at a decent price can achieve economies of scale and thus "cover the cost of loans that go bad," said Fitch Ratings' managing director, Diane Pendley. "So they can still be profitable."

Management expects Bank of America's servicing prize to add $55 million to $60 million in operating cash flow this year and $70 million to $80 million the next two years. Originations and insurance could add $110 million to $135 million.

Walter's has the largest insurance business of the top-three nonbank servicers, but regulatory crackdowns on "force-placed" insurance could weaken commissions, Barker has warned.

Reverse mortgage originations following Walter's acquisition last year of Reverse Mortgage Solutions will also contribute to earnings, despite regulatory head winds, analysts say.

How much more business will banks offload? "That is the big question," Barker said. "I think banks have a long way to go."

Barker says Bank of America could likely sell $100 billion to $300 billion more in servicing rights, primarily to Nationstar, Ocwen and Walter.

He seesJPMorgan Chase (JPM) and home loan kingWells Fargo (WFC) selling larger chunks of their servicing portfolios as well.

Walter's management says $2 trillion of assets could shift to special servicers by 2015. Today's U.S. mortgage market is about $10 trillion.

Walter, Nationstar and Ocwen "have grown tremendously since September," Barker said, mostly via acquisitions. "They are almost completely different companies."

In 2009, Walter was spun off from Walter Industries as an independent publicly traded REIT. The parent company then changed its name toWalter Energy (WLT) as part of a rebranding campaign.

Walter is considered "capital light" relative to Nationstar and Ocwen. A larger share of its portfolio is subserviced vs. rivals, so not as much capital investment is needed, though that's changing as its own originations rise and it pursues more acquisitions.

It earns incentive and performance-based fees on subservicing contracts, which boosts profits.

In the third quarter, Walter's return on net investment on servicing was 83.3% vs. Nationstar's 26.2% and Ocwen's 52.2%, as measured by earnings before interest, taxes, depreciation and amortization, according to a recent Sterne Agee industry report.

Walter's originations business helps offset outflow as loans are paid off or refinanced out of its portfolio.

Its deal with ResCap includes an origination platform. Originations give it the ability "to generate servicing assets long-term," Barker said.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: BAC , FNMA , NSM , OCN , WAC

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