Profiting from Troubled Mortgages

The Financial Crisis of 2007 was triggered by the bursting of the largest US housing bubble in history. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012.

Assets left over from the housing meltdown, mortgages known as residential mortgage servicing rights (MSRs), have become increasingly onerous for banks to hold onto. The rights allow banks to earn fees from mortgage investors in exchange for collecting home loan payments from borrowers.

The housing bust has made collecting mortgage payments an expensive business, as borrowers go delinquent and into foreclosure. New capital rules will also make mortgage-servicing rights more expensive for banks to hang onto, so at least some of the assets are migrating toward non-bank companies that purchase and service these loans.

One of the fastest-growing and more profitable companies in this industry is Nationstar Mortgage Holdings Inc (NYSE: NSM). Nationstar buys troubled mortgages from big banks seeking to cut costs and comply with tougher banking regulations. Nationstar earns fees from servicing the mortgages and has done well thanks to falling delinquency rates and a gradually improving economy.

Recently, Nationstar Mortgage Holdings Inc announced that Nationstar Mortgage LLC, a wholly owned subsidiary, has signed a definitive agreement to acquire approximately $215 billion in residential MSRs, as measured by unpaid principal balance as of November 30, 2012, and certain other assets from Bank of America (NYSE: BAC).

Nationstar will fund approximately $680 million of the MSR purchase price with the proceeds of a co-investment by Newcastle Investment Corp. and Fortress-managed funds, similar in structure to previous transactions. Nationstar will fund the $665 million portion of the MSR acquisition price with investable cash.

In a research report last month, FBR Capital Markets said there could still be $600 billion to $700 billion in assets that will eventually shift to specialty MSR servicers such as Nationstar.

Nationstar is also in the conventional mortgage industry; it just signed an agreement to service mortgages for customers of KB Home (NYSE: KBH), the fifth-largest U.S. homebuilder. The new company, to be called Home Community Mortgage LLC, is expected to start business in the latter part of this year.

Nationstar went public in March 2012 and the stock more than doubled in price over the next 10 months. The company has a $3.5 billion market cap and is growing fast.  But like many stocks connected to the housing industry, Nationstar is a turnaround play. The company posted its first profit in five years in 2011 and is expected to report that earnings soared 926 percent in the year just ended.

Revenue growth has accelerated for three straight quarters, tripling in the latest period. Profit growth has been similarly strong.  The amount of revenue and earnings growth projected in 2013 and 2014 will create a double in the Nationstar stock price.

Nationstar Mortgage Holdings reported that net income grew by 52 percent to $55.1 million, or $0.61 in earnings per share (EPS), for the third quarter 2012 compared to $36.3 million, or $0.41 in EPS, in the second quarter 2012 and a loss of $3.1 million in the third quarter of 2011.

Nationstar’s revenue grew 39 percent to $277.2 million for the quarter from $200 million in the prior quarter and was up 205 percent from $90.9 million in the third quarter of 2011. Pre-tax income from operating segments for the quarter increased by 47 percent to $82.7 million, or $0.92 in EPS, up from $56.4 million, or $0.63 in EPS, in the second quarter of 2012 and was up 1,738 percent from $4.5 million in the third quarter of 2011.

Nationstar Mortgage Holdings Inc announced that for fiscal 2013, it expects net income of between $335 million and 395 million and EPS of between $3.70 and $4.35. For fiscal 2014, it expects net income of between $510 million and $590 million and EPS of between $5.60 and $6.50.

First Call analysts’ consensus have projected 2013 EPS of $3.93 which is 67 percent higher than 2012. For 2014, Nationstar has a consensus EPS of $5.81, an increase of 48 percent from 2013. 

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Greg Pugh, an income-investing expert, publishes a newsletter called Investing for Monthly Income.

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