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This Industry Owes a Debt to Uncle Sam

Tuesday - 4/9/2013, 3:33pm  ET

The mortgage servicing companies are firing on all cylinders, with rising assets, profitability ratios, and stock prices. Their business model is pretty straightforward: collect payments from debtors, remit payments to creditors, and provide administration for any legal or settlement issues. While the industry is dominated by the internal units of the large national banks, more stringent government regulations have forced the banks to sell servicing rights in order to meet risk-based capital levels. In the process, the independent servicers have enjoyed massive growth. So, which players are worth a look?

Ocwen Financial

Founded in 1988, Ocwen focuses on the sub-prime market, the high-risk loan segment that caused much of the trouble during the financial crisis. However, since the company is predominantly a servicer, rather than a lender, it has much less exposure to homeowner defaults. Ocwen has used the acquisition channel to grow at a tremendous rate over the past few years, including purchases of Barclays’ HomEq unit in 2010 and Goldman Sachs’ Litton unit in 2011.

In FY2012, Ocwen reported vastly better financial results, with increases in revenues and adjusted operating income of 70.4% and 87.7%, respectively, versus the prior year. The company’s operating margin hit a five-year high, as it benefited from a more diversified loan servicing portfolio and lower delinquencies across the board. In addition, the company generated a 9% increase in loan modifications, triggering incentive fees from the federal government.

Looking ahead, Ocwen has recognized the need to have its own loan origination platform, which was the impetus for its acquisition of WL Ross’ Homeward unit in December 2012. The company also purchased the ResCap unit of Ally Financial, in partnership with Walter Investment Management , which provides Ocwen with additional origination capabilities. Given the improving financial position of the large U.S. banks, Ocwen will need to increasingly rely on its origination segment to generate loans for its servicing segment.

Nationstar Mortgage

Nationstar has also achieved strong growth recently, although the company employs more of the traditional mortgage banking business model. Founded in 1994, Nationstar was bought by private equity giant Fortress during the financial crisis and only re-emerged as a public company in 2012. Since then, Nationstar has moved into acquisition mode, including acquiring large servicing portfolios from Aurora Bank in 2012 and Bank of America in 2013.

In FY2012, Nationstar reported very strong financial results, with increases in revenues and adjusted operating income of 160.5% and 235.7%, respectively, compared to the prior year. The company’s huge gain in revenues was caused by a more than 100% increase in mortgage loan originations and sales, as well as a large increase in its servicing portfolio. Similar to Ocwen, Nationstar benefited from significant incentive payments from the federal government for completing loan modifications.

Looking ahead, Nationstar is attempting to further diversify its revenue base, with recent acquisitions that target the reverse mortgage origination and settlement services segments. Nationstar generated $40 million in revenue from the reverse mortgage segment in 2012 and it expects significant growth in the segment as the elderly population looks to cash out their home equity positions. With a well-funded equity partner in Fortress, Nationstar has the necessary capital to build a national footprint.

Walter Investment Management

Walter arrived to the servicing segment late, but it is using the loose credit markets to quickly gain critical mass. The company’s $500 million acquisition of servicing rights from Fannie Mae in January 2013 more than doubled its servicing loan base, putting Walter in the same league as its chief competitors. Similar to Nationstar, Walter is pursuing diversification in the reverse mortgage segment, including purchases of two smaller competitors for roughly $167 million in 2012.

In its latest fiscal year, Walter reported sharply higher financial results, with increases in revenues and adjusted operating income of 65.7% and 95.7%, respectively, versus the prior year. The company’s revenue growth benefited from its acquisitions in the servicing segment, as well as gains in its insurance and asset recovery units. While Walter’s profitability continues to be weighed down by higher default rates in its legacy loan business, overall results should improve as the loans are repaid or are resolved through foreclosure proceedings.

The bottom line

The independent loan servicers have benefited immeasurably from the more stringent capital levels that are required by the bank regulators. While the new regulations also impose higher costs on the industry, it is unlikely that the banks will be allowed to return to their under-capitalized corporate structures. In the new world order, customer service is king and these three companies have built organizations to deliver high touch service.

This article was originally published as This Industry Owes a Debt to Uncle Samon Fool.com

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