Mortgage Service Providers Boost Borrowing Confidence

By
A A A

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 ( C ) 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 Bloomberg News.

The industry is in the final stages of what Sterne Agee analyst Henry Coffey calls a mega-wave of mortgage service auctions.

"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 ( OCN ) andNationstar ( NSM ) (majority-owned byFortress Investment Group ( FIG ) have led the publicly traded mortgage servicers buying up rights to large parcels of mortgages being purged by large banks.

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 business.

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 Investment ( WAC ), 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 delinquent loans.

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 billion.

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.

Dwindling Expectations

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 portfolio.

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 expectations.

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 Bank.

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 billion.

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 confidence.

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 IBISWorld.

"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 holders.

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.

Outlook

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.



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: C , FIG , NSM , OCN , WAC

Investor's Business Daily

Investor's Business Daily

More from Investor's Business Daily:

Related Videos

Stocks

Referenced

Most Active by Volume

23,277,701
  • $4.5427 ▲ 3.95%
21,255,256
  • $15.635 ▲ 1.66%
18,531,578
  • $96.65 ▲ 1.50%
17,547,008
  • $14.90 ▲ 4.71%
16,446,869
  • $67.74 ▲ 2.11%
16,024,654
  • $48.755 ▲ 3.73%
15,350,013
  • $15.88 ▲ 4.54%
12,588,275
  • $54.47 ▼ 0.89%
As of 7/14/2014, 11:18 AM