Back on July 6, I
two emerging financial names to readers of our InsideOptions Pro
premium service. Since then, both have significantly outperformed
the S&P 500 and probably have plenty more upside in store. This
is especially true because they remain barely known and could rally
as their stories attract a following.
The companies are Nationstar Mortgage (NSM) and Ocwen Financial
(OCN), which service mortgages held in large pools. Before the
crash of 2008, major lenders such as Bank of America and
Countrywide Financial focused on originating mortgages and treated
servicing as an afterthought. This is one of the reasons that such
confusion occurred when delinquencies and foreclosures shot through
the roof after the bubble broke.
Banks are essentially retail institutions, focused on selling
products. Their loan officers are compensated by origination, not
the performance of a mortgage years down the road. That's why they
never anticipated the kind of problems that eventually occurred.
The result is a giant opportunity for NSM and OCN. By selling the
servicing rights, banks can stick with their core retail business
while shedding a major headache. And investors get pure-play stocks
focused on a business that was never independent before.
Based on the results so far, these stocks are major winners. They
have been rapidly growing their loan portfolios and often stand to
make more money when they successfully rehabilitate delinquent
mortgages and prevent foreclosures. Even better, they are emerging
at the sweet spot of the credit cycle as borrowers increasingly
make payments on time and home prices recover.
NSM has another trick up its sleeve. Because it has access to more
than 1 million borrowers, it is perfectly positioned to originate
new loans through refinancing. That gives it a big advantage over
most lenders, which must advertise to gain refis.
In other words, banks pay NSM to service loans. It then uses that
opportunity to compete against the very same banks in the
Lender Processing Services (LPS) and Corelogic (CLGX) are riding a
similar wave. They are not loan servicers, but also providers of
data and software to companies in the industry. Both have beaten
expectations in recent quarters and made bullish comments about the
Another reason I like these companies is that skeletons continue to
fall out of the closets at the big banks such as JP Morgan and
Citigroup. Whether it's Libor, robosigning, credit-default swaps,
or even questionable dealings with foreign governments, the
megabanks still remain under a cloud. Mortgage-servicing companies
give investors direct exposure to the improving mortgage market
without any of those legacy issues.
Most of these stocks are up pretty big recently, so it's probably
smart to wait for a pullback. But they seem to be in the midst of a
real bull market and could offer many trading opportunities in the
Three other companies seem to be following a similar trend. One is
Fortress Investment Group (FIG), which owns 75 percent of NSM.
Second is iStar Financial REIT (SFI), which owns a basket of
commercial mortgages. It trades for about half of book value and
has a big short interest.
Lastly, Portfolio Recovery Associates (PRAA) is a collections
agency that has been catching fire recently as debtors increasingly
pay back overdue accounts.
(A version of this article appeared in optionMONSTER's
What's the Trade?
newsletter of Aug. 15.)