Recent sell-offs among mortgage servicer stocks signal
investors are nervous, as analysts report a two-year rush of
mortgage-servicing rights auctions may be nearing its end.
But at least some analysts see more opportunity on the
horizon. AndCitigroup (
) announced on Oct. 25 it would, by the middle of next year,
auction the rights to service $63 billion in mortgage loans --
nearly 21% of its contracts, according to sources cited by
The industry is in the final stages of what Sterne Agee
analyst Henry Coffey calls a mega-wave of mortgage service
"There is probably another wave of sorts coming," he said,
"but people won't admit to selling servicing rights until they
actually sell it."
For more than two years,Ocwen Financial (
) andNationstar (
) (majority-owned byFortress Investment Group (
) have led the publicly traded mortgage servicers buying up
rights to large parcels of mortgages being purged by large
The housing meltdown led to a tougher set of international
banking guidelines known as Basel III, which raised pressure on
large mortgage lenders. The financial crisis also triggered the
May 2012 bankruptcy of loan servicer Residential Capital, putting
$374 billion in mortgages on the auction block. In addition, a
February 2012 deal between the Justice Department and the five
largest mortgage service banks set in motion a broader move among
banks away from the increasingly complex, thin-margin servicing
Loan servicing stocks responded in kind. Ocwen has soared
nearly 245% since the start of 2012. In September, Nationstar
peaked more than 300% above its March 2012 IPO price. Other top
players consolidating the servicing territory includeWalter
), in IBD's Financial Services-Specialty group, and Seterus,
which tech giant IBM acquired from Bank of America in 2010.
The Distressed Loan Test
Ocwen and Nationstar both cut their teeth as servicers of
sub-prime loans -- loans to borrowers below the financial
threshold required by mainstream banks and lenders. That gave
them an edge in dealing with delinquent and stressed mortgages --
key to turning profits in the new regulatory scheme.
Seriously delinquent mortgages are on the rise, according to
Coffey -- more bad news for banks.
"Banks aren't any good at servicing distressed pools because
they are losing money doing it," Coffey said.
Distressed mortgages require more manpower and finesse, things
banks are strained to provide cost-effectively. Weak customer
service leaves harried borrowers even more frustrated.
Nationstar and others have teams of customer-service loan
officers trained to hand-hold such borrowers and work to fix
Nationstar and Ocwen now handle both traditional and
distressed assets. The companies collect payments, assess fees
and handle customer communications. They deliver payments
collected on mortgages back to Fannie Mae or the banks
originating the loans.
Service providers make pennies on the dollar. But high volume
left Nationstar with income from servicing fees of $263 million
in the second quarter.
Nationstar and Ocwen also originate their own loans. But
Nationstar announced Thursday it will sell its wholesale and a
portion of its retail origination business, and restructure in
order to "focus on its core loan-servicing business."
The wholesale business originated mortgages worth $3.26
billion in the first half of the year. The company's total
origination volume in the third quarter, by comparison, was $8
The company plans to keep and build its direct-to-consumer
origination, which it bolstered with the acquisition of
Greenlight Financial Services during the second quarter.
The Home Affordable Refinance Program (HARP), launched by the
Federal Housing Finance Agency in 2009, helped lenders like
Nationstar refinance loans of weaker borrowers. Nationstar
originated $2.7 billion of loans under the program during Q2 and
has more than $45 billion in additional HARP opportunities in its
Walter said its originations segment generated revenue of
$251.2 million in the second quarter, up 230% year-over-year,
partly on the recapture of HARP-eligible accounts.
Despite the lift from HARP, rising interest rates
significantly slowed refinancing activity during the third
quarter. The result left servicers struggling to meet
Ocwen's third-quarter EPS rose 19%, missing estimates by 60%.
Revenue more than doubled, but still failed to measure up to
views. Chairman Bill Erbey said in the earnings statement that
revenue was "suppressed due to delays, that have now been
resolved," related to Ocwen's purchase of servicing rights to
mortgages worth $78 billion from California-based OneWest
On Thursday, Nationstar reported a 69% jump in adjusted
earnings, to $1.08. Analysts were expecting $1.26. Revenue more
than doubled to $631.84 million, above estimates. Nationstar's
servicing portfolio rose 90% to end the quarter at $375
But the company lowered its full-year 2014 EPS outlook to
between $4.50 and $6 -- about a 20% cut. Analysts pared consensus
expectations to $6.62, from $6.97.
Origination volume is projected to decline 8% this year to
$1.6 trillion, according to the Mortgage Bankers Association, and
is expected to fall to $1.1 trillion in 2014. The overall
mortgage servicing market is roughly $10 trillion.
Lower origination volumes could negatively affect earnings,
both Jefferies and Wells Fargo wrote in research notes.
The Going Rate Goes Higher
Mortgage rates started climbing in May as the Federal Reserve
hinted at reducing the current round of quantitative easing. The
rise has chewed into demand from borrowers with existing
mortgages looking to refinance.
Interest rates on 30-year mortgages fell to 4.13% in late
October, according to Freddie Mac, from 4.28%. That was the
lowest rate since June.
The government shutdown stopped mortgage activity cold for two
weeks in October, preventing lenders and borrowers from obtaining
tax records and other information and services crucial to closing
a mortgage loan. The turmoil hit consumer and homebuilder
Still, the lending industry is growing faster than the overall
economy, which is both good and bad news for mortgage service
providers. Growth in the industry, including that of Fannie Mae
and Freddie Mac, is likely to attract more scrutiny from
financial regulators, says Jeremy Edwards, an analyst at
"They are concerned over the rate this is growing and if
customers will be adversely affected," he said.
Agencies such as the Consumer Financial Protection Bureau
increased efforts to protect borrowers after the financial
crisis, working to broaden communication with mortgage
In January 2014, Edwards says new rules will cover
communication with family members after a borrower's death,
contact with delinquent borrowers and treatment of consumers.
The rules are aimed at helping protect consumers. And while
they point to a slower rate of mortgage origination, they are
also aimed at preventing delinquencies and defaults, ultimately a
plus for loan services like Ocwen and Nationstar.
Analysts are bullish as more mortgage servicing sales are
expected from banks next year.
Jefferies analysts are expecting another round of bulk
servicing sales later this year or early next year, according to
a September research note. Also in September, Oppenheimer
initiated coverage on Ocwen with an outperform rating, and
Jefferies upgraded Nationstar to buy.
But Wells Fargo downgraded Walter this month to market perform
from outperform. For the rest of this year, lower origination
volumes are expected and more taper talks from the Federal
Reserve could further hinder the refinancing market.