Fortress Investment Group (FIG:US), whose funds own 77 percent of mortgage servicer Nationstar Mortgage Holdings Inc., is leading the race for $4 trillion in home loan collection rights as banks exit the business.
Nationstar is positioned to become the largest non-bank residential loan servicer by the end of this year with rights of $550 billion, according to Chief Executive Officer Jay Bray. Over the next five years, lenders are expected to sell $4 trillion in servicing rights on the $10 trillion U.S. mortgage market as they seek to avoid new regulations and reduce damage to their reputations, according to a presentation from New York- based Fortress obtained by Bloomberg News.
“The major servicers created a disaster and these guys are fixing it,” Henry Coffey Jr., an analyst with Sterne Agee & Leach Inc. who rates Nationstar (NSM:US) a buy, said in a telephone interview. “They’re buying from people who want out.”
Nationstar, based in Lewisville, Texas, added $36.3 billion to its servicing portfolio in the first quarter from a year earlier, exceeding the $33.2 billion gain for market leader Wells Fargo & Co., according to trade publication Inside Mortgage Finance. That took the portfolio to $103.3 billion.
The company has also agreed to acquire (NSM:US) $437 billion in new servicing rights deals: $63 billion coming on its books this month from Aurora Bank FSB, a unit of defunct Lehman Brothers Holdings Inc., and $374 billion from Residential Capital LLC, a division of Ally Financial Inc. (ALLY:US), expected to close by yearend.
Mortgage servicers earn monthly fees ranging from about 25 to 35 basis points, or 25 cents to 35 cents per $100 in unpaid balance of the loans, according to the confidential Fortress presentation. They handle billing and collections for mortgages, as well as work related to troubled loans, such as foreclosures and loan modifications. Investors can expect unlevered gross returns of 15 to 20 percent before management fees, the presentation said.
Nationstar, Fortress and the New York-based private-equity firm’s Newcastle Investment Corp. (NCT:US) offered $2.3 billion for the ResCap rights, ResCap Chairman and Chief Executive Officer Thomas Marano said in an interview this month. While other companies can still bid for the ResCap portfolio, they would have to pay Nationstar a $72 million breakup fee on top of a higher price for the rights under the terms of the offer, called a stalking horse bid.
“Our confidence factor that this deal goes to Nationstar is 75 to 85 percent,” Coffey said in an interview from his office in Nashville, Tennessee.
Fortress’s acquisitions of Aurora and ResCap outmaneuvered rival non-bank mortgage servicers vying for mortgage pools that decline in revenue like a “melting ice cube” as borrowers refinance or sell their homes, Coffey said.
Billionaire Warren Buffett sought to buy ResCap before the company, which is majority-owned by the U.S. government, filed for bankruptcy, three people with knowledge of the matter said last week. Ocwen Financial Corp. (OCN:US), which had $95 billion in servicing rights at the end of the first quarter, was outbid for the Aurora portfolio by Nationstar.
“I really can’t comment specifically on what Nationstar was thinking in their bid there,” Ocwen Chief Executive William Erbey said about Nationstar’s Aurora deal during a May 3 earnings conference. “But it did very much surprise us.”
The unpaid balance of mortgages in the U.S. peaked in the first quarter of 2008 at $11.24 trillion and declined to $10.29 trillion at the end of last year as home values declined and borrowers paid down debt, according to data compiled by the Federal Reserve.
Wells Increases Lead
The largest mortgage lenders -- Wells Fargo & Co. (WFC:US), Bank of America Corp. (BAC:US), JPMorgan Chase & Co. (JPM:US) and Citigroup Inc. (C:US) -- controlled 50.3 percent of the servicing market at the end of the first quarter, down from 54.2 percent a year earlier, according to Inside Mortgage Finance. Servicing rights at Bank of America, JPMorgan and Citigroup fell a combined $545 billion, or 14 percent, in the past 12 months.
Wells Fargo, the largest originator of mortgages, increased its market share lead, as the biggest banks eschewed new business that brings servicing rights with it.
Banks are reducing their loan-servicing portfolios to meet capital requirements proposed under the Basel III accord. The new regulation forces banks to hold more capital against mortgage servicing rights that exceed 10 percent of tier 1 capital, a measure of high-quality, loss-absorbing reserves that banks must hold against risky assets.
With U.S. housing prices down 35 percent from their July 2006 peak, the largest U.S. banks have booked more than $72 billion in losses tied to faulty home loans and foreclosures, including more than $40 billion by Bank of America alone.
Banks are also cutting servicing portfolios because their reputations have suffered from complaints about their management of delinquent borrowers, Ocwen Chief Financial Officer John Britti said.
In February, the five largest servicers agreed to pay $25 billion to settle allegations they used faulty or forged paperwork to seize homes from delinquent borrowers. Under the agreement, servicers must foot more of the cost of homeowner loan modifications and refinancing and compensate people who lost property in wrongful foreclosures.
“To the extent that they can’t do as good a job as they’d like, it harms their reputation,” Britti said in a telephone interview. “So they’d prefer to get a subservicer or sell the servicing to somebody who can do a better job.”
Ocwen, an Atlanta-based specialist in servicing distressed commercial and residential loans, is purchasing $10.7 billion of servicing rights from Bank of America, according to a May 22 regulatory filing. The contracts are tied to 53,100 mortgage loans owned by a government-sponsored agency with the transfer expected in June.
It also acquired rights in April to service $30.3 billion in loans from JPMorgan and Saxon Mortgage Services Inc., a former unit of Morgan Stanley. (MS:US) Last year, it paid Goldman Sachs Group Inc. (GS:US) $263.7 million for rights to Litton Loan Servicing LP’s $51.2 billion mortgage portfolio.
Foreclosure filings, including notices of default and bank repossessions, plunged in April to their lowest level since July 2007, RealtyTrac Inc. reported May 17, as a housing recovery started to take hold and as servicers delayed filings while trying to comply with the nationwide settlement. A decline in foreclosure filings won’t threaten business for Ocwen or other loan servicers that earn higher fees for handling distressed mortgages, Britti said.
“Unfortunately for this country, there’s plenty of bad loans to go around,” he said.
While mortgage-servicing fees provide a steady revenue stream, the firms’ earnings fluctuate depending on the cost of acquiring and administering portfolios, according to Bray. Nationstar reported first quarter net income (NSM:US) of $50.2 million, or 67 cents, a share on May 15. Earnings are expected to fall to 35 cents in the quarter ending June 30, the median estimate of six analysts surveyed by Bloomberg.
Nationstar fell 2.6 percent to $16.40 as of 10:29 a.m. in New York trading. It’s risen more than 17 percent since pricing shares at $14 in a March 7 initial public offering.
Fortress shares dropped 0.7 percent to $3.02 and have declined 8.1 percent this year including reinvested dividends. They’re down more than 80 percent since its February 2007 initial public offering, when the company sold stock at $18.50 a share to become the first U.S.-listed buyout and hedge-fund manager.
One potential challenge is how servicing-fee reductions under review by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, will affect the value of mortgage-servicing rights, according to a report by Bose George, an analyst with Keefe, Bruyette & Woods Inc.
“While we do not believe that lower servicing fees would directly impact the economics of the mortgage business, it could still change the structure of the industry in very meaningful ways,” George wrote in the April 17 report. “There could be increased earnings volatility as servicing earnings would fall sharply.”
PHH Corp. (PHH:US), the largest non-bank servicer with $149.7 billion in unpaid principal balance at the end of the first quarter, reported a $26 million first quarter loss on its mortgage-servicing unit, driven by requests from Fannie Mae and Freddie Mac to repurchase loans that defaulted because of alleged misrepresentations.
“We expect repurchase requests and foreclosure costs to remain high during 2012 and potentially into 2013,” Mount Laurel, New Jersey-based PHH said in a May earnings statement.
PHH continues to expand into mortgage servicing, which accounted for about one-fourth of the company’s revenue in fiscal 2011, increasing its portfolio 4.9 percent from a year earlier. On May 7, it acquired subservicing rights to $52 billion of loans from HSBC Bank USA. A subservicer handles work for a servicer on a contract basis, without being directly responsible to the ultimate investor or bank.
This “allows us to generate additional revenue through our servicing platform, without the capital intensity or repurchase risk,” Dico Akseraylian, a PHH spokesman, said in an e-mail.
The number of companies vying for the servicing business is limited because it requires ability to manage interactions with large numbers of borrowers, Coffey said.
“You can’t board a $100 billion servicing portfolio if you’re some yahoo,” he said. “We see growth and momentum with special servicers acquiring by the shipload.”
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