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Nationstar Eyeing Big Bank, Big Buck Mortgage Rights

Posted
2/26/2013 2:26:00 PM
By: Investor's Business Daily
Referenced Stocks:BAC;FNMA;NSM;OCN;WAC

One person's trash is another's treasure. And so it goes in the world of residential mortgages.

Boatloads of distressed home loans from big banks that don't want to work them anymore are being turned over to independent specialists that do.

One of the biggest specialty mortgage servicers,Nationstar Mortgage Holdings ( NSM ), has been growing in giant steps as banks offload servicing rights.

It'll soon start boarding $215 billion in loan servicing rights fromBank of America ( BAC ), representing 1.3 million home loans.

The deal brings its customer base to more than 2.5 million and its servicing portfolio to $425 billion.

"It's a gigantic growth company with a lot of moving parts," said FBR Capital Markets analyst Paul Miller. "Two years ago, it had (servicing rights on) $120 billion in unpaid principal balances."

Secondary Market

One moving part that makes Nationstar stand out from rivals such asOcwen Financial ( OCN ) andWalter Investment Management ( WAC ) is its mature mortgage origination platform.

After it makes a loan, typically a refinancing these days, it sells it into the secondary market, recording a gain on the sale. But it keeps the servicing rights. And with interest rates low, those rights are seen staying on the books for some time.

Nationstar is active in government-promoted HARP loan modifications, where gain-on-sale margins are especially strong as it sells the newly modified loans back toFannie Mae ( FNMA ) andFreddie Mac (FMCC), Miller says.

"What people like about Nationstar is all the profits that are coming from originations," he said.

Sterne Agee analyst Henry Coffey estimates that mortgage origination operations will make up 30% of Nationstar's per-share earnings next year.

Nationstar also has a growing mortgage origination business with homebuilderKB Home (KBH). It's been KB's preferred lender since last March and will be part of a new home-loan company KB Home is forming later this year, to be called Home Community Mortgage.

Nationstar execs say they expect to originate at least $16 billion in loans this year, more than double the annualized run rate through the third quarter of 2012.

"As the economy improves there will be more opportunities to originate home loans," said CEO Jay Bray in a recent interview.

As banks pulled back from making new loans, 20% of the capacity in the origination market has gone away in the last two years, creating opportunities for Nationstar, a company spokesman said.

But while origination profits are enticing, profits on servicing loans is another matter. As Nationstar's servicing portfolio has soared, so has overhead, Miller says.

"They need to get expenses down," he said.

Even though Nationstar was founded in 1994, it's like a "brand-new company" because of the new business it's boarded the last couple of years, Miller says.

Revenue has gone from $79 million in 2009 to what analysts estimate will come in at $941 million in 2012 and $1.8 billion this year.

Nationstar expects the new Bank of America portfolio to translate into earnings of 70 to 80 cents per share in this year's ramp-up phase and $2.30 to $2.70 next year.

It forecasts total per-share earnings of between $3.70 and $4.35 for this year and sees 2014's at $5.60 to $6.50. That would be up from 2012's estimated $2.34, according to Thomson Reuters.

The company will report results for the fourth quarter and full year March 7.

Many of the servicing portfolios Nationstar has picked up from banks are from the bad old subprime days and are in need of a helping hand. Costs are higher to service impaired loans, but so are the fees for doing so.

Nationstar gets good marks for its servicing standards and procedures.

"It's a true skill and a core competency," said Bray. "Financial institutions don't really consider servicing core to their platform."

Nationstar lost out in a bankruptcy auction in October to Ocwen and Walter for $374 billion in mortgage servicing assets of Residential Capital, a unit of Ally Financial. But as the "stalking horse" selected to make the first bid, it got a consolidation breakup fee of $24 million.

And then it went on to win over Bank of America. Of the new loans coming from Bank of America, 53% are nonconforming, held in private-label securitizations. The rest are government agency loans owned, insured or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.

With all the new regulatory and capital hurdles big banks face, servicing loans has become a big headache, giving them more reason to outsource the work.

Analysts expectWells Fargo (WFC), Bank of America,JPMorgan Chase (JPM) and Ally Financial to sell servicing rights in coming months.

Bray says Nationstar is pursuing a $300 billion to $400 billion pipeline over the next year. Management also expects to keep working the "flow" it gets loan-by-loan from banks that don't want to service the loans they originate. Flow could amount to $25 billion to $50 billion this year, execs have said.

Leading Division

Nationstar was once the lending division of national homebuilder Centex (acquired byPulte (PHM) in 2009). In 2006, Fortress Investment Group acquired the business and named it Nationstar. Last March, Fortress took it public, retaining a 76% ownership stake.

Fortress and its REIT partnerNewcastle Investment (NCT) were co-investors in the $1.3 billion Bank of America deal. They mean to invest with Nationstar in other servicing assets.

Nationstar contends the collaboration is a "capital-light" way to grow its business.

Since the IPO, Nationstar shares have soared as much as 200%, reaching a high of 42 on Feb. 15.

Lately, Nationstar has been touting a "third business," its Solutionstar division, which provides services such as appraisals and property management.

On Feb. 6, Nationstar acquired Equifax Settlement Services for an undisclosed sum. The well-known appraisal, title insurance and settlement services firm will become part of the growing Solutionstar business.