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Posts tagged ‘Nationstar Mortgage’

Why is PHH Corp so cheap?

Let’s just get right to it.  I don’t understand why PHH is as cheap as it is.

I have talked about this before, and I don’t want to reiterate the conclusions of my prior post on PHH (You can be a stock market genius: By Buying PHH Corp), but I do want to take a look at the company from a slightly different perspective to show that, even after the 50% run up since my original post, it remains undervalued.

This week, during one of my lunch hours, I made a comparison between PHH and Nationstar.  I was somewhat surprised by the results.   The table below lists key statistics of the mortgage origination and servicing businesses for both companies. Read more

Impac Mortgage: Where the money comes from

When I first bought Impac Mortgage (back at the beginning of August) it was on the basis of GAAP earnings (which were 50 cents per share in the second quarter), and revenue growth from the mortgage origination business.  Soon after, when I looked more closely into earnings, I determined that much of what was reported in GAAP was obscured by mark to market adjustments and a legacy business that is no longer operating.  Fortunately if I ignored these effects, the resulting picture was even better than the one painted by GAAP.

So I left it alone and went on to other things.

To digress for a minute, this is my process.  Once I feel like I have a clear answer on a stock, I don’t look too much further into the details.  When I look at a stock I look hard, and I usually come up with a fairly accurate picture, but after I feel able to draw a conclusion, I don’t spend a lot more time quibbling over the details.

I don’t have time.  I have time to look into maybe 2 stocks per week.  If I spent week after week evaluating a single security, it is simply inefficient.

Does this lead to mistakes?  Absolutely.  Sometimes I miss a key aspect that changes the equation.  But to mitigate mistakes I have learned to reevaluate when the market tells me I am wrong, and to act quickly when it turns out I am.  And actually, this has been one advantage of starting this blog.  There have been a couple of cases where readers have pointed out something that I have missed.  And I’ve saved money as a result.

Given the amount of time I have to allocate to investing, this remains, in my opinion, my most efficient process.  Study the business, figure out what the key drivers are and where problems are most likely to arise, evaluate those drivers and problems, make a decision and move on to the next one.  Take another look if things start to go amiss.

With respect to Impac, as the stock moved up from $2.50 to $10, I wasn’t that concerned with getting a better grasp on the specifics of earnings.  My initial analysis showed me the drivers, and they led me to conclude that the stock wasn’t even close to reflecting those drivers, and that was enough for me.

But now, with Impac hovering between $10 and $11, further analysis is warranted.  My intent below is to understand how each of the businesses that Impac operates generates earnings, and to compare the earnings generation capacity to GAAP, hopefully eliminating some of the confusion introduced by GAAP. Read more

Answering questions about Nationstar Mortgage: Part I – Getting to know them

A couple of weeks ago I parsed out the business of Nationstar , stepping through the prospectus the company put out in March, but I never got around to posting what I learned.  While I’m not yet ready to do a full write-up of the company, I want to share that here,  since I have had a fairly large position in the stock for about a month now, but written very little about it.

Often when I am first learning about a company I will ask myself some basic questions about the business and then look through the available materials for answers.  Below are the first 9 questions of what will be a two (or maybe three) part series on the business of Nationstar.

1. What do they do?

The following excerpts are all taken from Nationstar’s prospectus:

  • We have been the fastest  growing mortgage servicer since 2007 as measured by growth in  aggregate unpaid principal balance (“UPB”), having     grown 70.2% annually on a compounded basis.
  • As of  December 31, 2011, we serviced over  645,000 residential mortgage loans with an aggregate UPB of  $106.6 billion (including $7.8 billion of servicing     under contract), making us the largest high touch non-bank     servicer in the United States.
  • Our clients include national and regional banks, government organizations, securitization trusts, private investment funds and other owners of residential     mortgage loans and securities.
  • We service loans as the owner of mortgage servicing rights (“MSRs”), which we refer to as “primary servicing,” and we also service loans on behalf of other MSR or mortgage owners, which we refer to as “subservicing.”
  •  As of December 2011, a GSE ranked us in the top 5 out of over 1,000 approved servicers in foreclosure prevention workouts.
  •  In 2011, we were in the top tier of rankings for Federal Housing Administration-(“FHA”) and Housing and Urban Development-approved servicers, with a Tier 1 ranking (out of four possible tiers).
  • As of December 31, 2011, our delinquency and default rates on non-prime mortgages we service on behalf of third party investors in asset-backed securities (“ABS”) were each 40% lower than the peer group average.

2. How do they generate revenues and earn income?

Nationstar has two businesses. They originate mortgages, and they service mortgages.  The mortgages that they service are split between those that they originate, those that they purchase the servicing rights to, and those that the contract out subservicing to.

Nationstar refers to servicing that they own as primary servicing.  They refer to mortgage servicing rights that they don’t own as subservicing.  With primary servicing Nationstar takes a sliver of interest each month in return for performing servicing duties.  With secondary servicing, Nationstar receives a contracted fee in return for performing the servicing.

This is an excerpt from the prospectus describing the primary servicing business:

We have grown our primary servicing portfolio to $45.8 billion in UPB as of December 31, 2011 (excluding $7.8 billion of servicing under contract) from $12.7 billion in UPB as of December 31, 2007, representing a compound annual growth rate of 37.8%.

There has been noticeable growth in what could be thought of as a hybrid subservicing business. In this business model Nationstar enters into agreements like the ones they made with Newcastle in the fourth quarter of last year and first quarter of this year.  Speaking generally of this strategy in the prospectus:

We acquire MSRs on a standalone basis and have also developed an innovative model for investing on a capital light basis by co-investing with financial partners in “excess MSRs.”

Nationstar partnered with Newcastle on two mortgage servicing right portfolios. One of the portfolios has an unpaid principle balance of $63B, while the other has an unpaid principle balance of $9.9B.

These two investments are significant relevant to the existing subservicing portfolio.

We have grown our subservicing portfolio to $53.0 billion in UPB as of December 31, 2011 by completing 290 transfers with 26 counterparties since we entered the subservicing business in August 2008.

Below are excerpts from the prospectus describing the origination business.

  • We are one of only a few non-bank servicers with a fully integrated loan originations platform to complement and enhance our servicing business.
  • In 2011, we originated approximately $3.4 billion of loans, up from $2.8 billion in 2010.
  • We originate primarily conventional agency (GSE) and government-insured residential mortgage loans and, to mitigate risk, typically sell these loans within 30 days while retaining the associated servicing rights.
  • Our originations efforts are primarily focused on “re-origination,” which involves actively working with existing borrowers to refinance their mortgage loans. By re-originating loans for existing borrowers, we retain the servicing rights, thereby extending the longevity of the MSR

3. How big is Nationstar’s servicing business?

Nationstar ended 2011 with UPB of $99B.

The company has shown quite impressive growth in servicing assets over the last 3 years.  Unpaid balance owned more than doubled from the year end 2009 to 2010, and was up another 50% from year end 2010 to year end 2011.

4. What will be the upside of the recent servicing deals that Nationstar has done?

In 2011 Nationstar produced 24 cents of earnings, or about $20M, on an average unpaid balance servicing balance of $81B over the year.  However, 24 cents is not representative of the true earnings of the company.  That number  includes losses from non-recourse legacy assets that are pooled as variable interest entities on the balance sheet.  It also includes changes in valuation of servicing rights that is not generally considered a core expense to servicers.  I am going to spend my second installment talking about earnings, but for the purposes of answering this question, lets just go with the roughly correct estimate of 80 cents (or $70M) of core earnings for 2011.

They have since done two deals with Newcastle, one for $63B UPB and the other for $9.9B UPB.  They participated with a 35% interest for those deals.  So they’ve added another $25B to their UPB, not including that for the full loan amount of $73B they are doing the subservicing.  They have also added $18B in UPB at the end of 2011 in a deal with a Merrill Lynch affiliate.  So in total they have added an UPB of $43B in the last 4 months.

My work on Newcastle suggested that they would get $14.8M the first year on the 9.9B deal.  They should be able to get $110M on the full $73B in the first year.  So Nationstar is going to get $60M from the same deal.

Plus Nationstar is going to collect 6 bps on the full deal so that is another $43M.

I don’t know any of the details of th reverse mortgage deal with Merrill but presumably based on the size of the deal Nationstar should be able to generate in the area of $60M to $80M from it.

Total income from the three deals comes to somewhere between $160-$180M.

The company had revenue from servicing of $280M in 2011 so these deals are not inconsequential, being worth in the neighbourhood of a 60% increase in servicing revenues.

5. What revenue should we expect out of the KB Homes deal?

KB Homes and Nationstar recently reached an agreement whereby Nationstar would take on the role of preferred borrower.  Historically KB Homes had its own in-house originator:

KBA Mortgage originated residential consumer mortgage loans for 67% of our customers who obtained mortgage financing during the period the unconsolidated joint venture operated in 2011. In 2010, KBA Mortgage originated such loans for 82% of our customers who obtained mortgage financing during that year.

In Q1 KB Homes had new orders for 1,197 homes versus 1,302 homes the previous year.  Homes delivered in Q4 were 1,150.  So let’s say that KBH sells 1,200 homes per quarter.

The average selling price of the homes sold was $219,000 for Q1.  The price was $205,700 a year earlier.  On the CC they said “Going forward, we expect our average selling price to continue to increase and to exceed an average of 240,000 for the year.”

Assume $220,000 per home and 1,200 homes per quarter  that together and you have a total balance of $264M per quarter.

So let’s assume NSM captures 50% of origination and that has a 20% down payment on average.   That would add $419M of unpaid balance per year to NSM.  Which isn’t that significant to total UPB for a single year.

It is significant origination volumes though.  The company has the following origination statistics over the past 4 years.

So this is another $400M or 12% of originations.  And if they can capture a greater percentage it could be double that.

6. How many of the loans is Nationstar recapturing through re-origination?

One of the questions I am interested in answering both for my investment in Nationstar and for my investment in Newcastle is how good Nationstar is at keeping its servicing clients.  if a servicer can retain clients that are refinancing their mortgages it makes it far easier to sustain strong growth.  In the case of Newcastle, it will mean a longer stream of cash flow on the servicing rights they have bought in partnership with Nationstar.

We recaptured 35.4% of the loans we service that were refinanced or repaid by the borrower during 2011 and our goal for 2012 is to achieve a recapture rate of over 55%. Because the refinanced loans typically have lower interest rates or lower monthly payments, and, in general, subsequently refinance more slowly and default less frequently, these refinancings also typically improve the overall quality of our primary servicing portfolio.

Newcastle has made the assumption of a 35% recapture rate on the servicing packages it has invested in.  This compares favorably with Nationstar’s average recapture rate in 2011.

7. How many shares did they do in the offering?

They are offering 16.7M shares.  After the offering they will have about 87M shares outstanding.  At the current price of $14.50 the market cap is $1.26B

Before the offering Nationstar was wholely owned by Fortress Investment Group through one of their private equity funds.  Fortress remains the majority holder in the company with 70M shares, or about 80% of the shares outstanding.

8. How much of the offering did they spend on the Newcastle deal?

They spent $115M on the Newcastle deals.  They offered $233M worth of shares.  So they spent about half of it.

9. How much debt do they have?

Next…Part II

In the next installment I am going to look at the earnings power of Nationstar and how there are a number of GAAP accounting rules that are fogging up what would otherwise be considered to be an attractive valuation.

Pounding the table on Mortgage Servicing Rights

In my opinion mortgage servicing rights (MSR’s) are the best opportunity in the market right now. The potential is there for returns as much as 30-40% IRR for the companies involved. The companies involved are not trading at premiums that reflect this, and in some cases they are trading at discounts to the market (PHH) or with extremely attractive dividends (Newcastle).

I believe the opportunity is being ignored by a market for three reasons:

  1. The market lumps MSRs in as just another housing play, and housing is still 2-3 years away from recovering
  2. MSR’s are complicated and most market participants don’t want to take the time to understand them
  3. MSR’s have traditionally been a crappy business and over the past 5 years they have been a really crappy business

In order to consistently beat the market I have learned that I have to look for value in typically crappy businesses and be willing to learn complex and sometimes opaque things.  When I started investing I knew nothing about oil and gas.  A few years ago I knew nothing about potash.  A couple of years ago I knew nothing about the pulp industry.  A year ago I knew nothing about regional banking.  And two months ago I knew nothing about mortgage servicing rights.

I continue to go wherever my nose takes me.  And right now it has lead me straight to mortgage servicing rights.

What is a mortgage servicing right?

A mortgage servicing right (MSR) is a list of conditions and responsibilities that are completed in return for a payment.

I’m going to simplify the details, but essentially here is how it works.  When a mortgage company originates a loan, along with the note that binds the borrower to making payments, they get a right to a tiny sliver of interest that will be paid in return for making sure that the money gets from the borrower to the lender (along with some other responsibilities, most of which deal with what happens in the case of delinquency).  Usually this sliver of interest is around 25-50 basis points.  For example, for a loan for $200,000 will include the right to receive $250-$500 a year in return for making sure that the money gets collected from the borrower (among other responsibilities).

Its that sliver of interest that is paid in return for the collection and other servicing duties that is called the Mortgage Servicing Right.

As a mortgage originator you have two choices of what to do with the mortgage servicing right.  You can keep it, in which case you will collect the sliver of interest from now until the mortgage is either  paid off or defaults.  Or you can sell it to someone else in return for cash up front.

Traditionally it has been the preference of small originators to sell the MSR for cash up front. Origination is a cash heavy business and managing cash flow is key.  So while it might be nice to have a steady monthly income flowing in from the MSR, typically the more immediate concern is getting cash on the books right now.

When the originator sells the MSR up front they receive a servicing release premium (SRP).  This sounds like a complicated term but its not.  All a SRP is, is a lump sum payment that is paid in return for the stream of cash flows from the MSR that you are giving up.

If you are interested in an even more detailed explanation of a MSR, there was an excellent discussion paper put out by the FHFA that is accessible here.

The collapse of the SRP

Of course, to make it worth your while to sell the MSR you need to get a decent amount of cash up front for it.  Traditionally SRP’s have fetched in the neighborhood of 4x to 6x the underlying MSR yearly payment.  Going back to our theoretical mortgage above, if you were receiving $250 a year from the MSR, you might have expected to fetch $1000 (or maybe even $1500 if you are lucky) up front for that income stream.  To the buyer of the SRP it would become a good deal if the mortgage didn’t go into default or get repaid for more than 4 years.  After 4 years they get their money back, and every year after that they get incremental return.  For you as the cash strapped originator that needs to pay your employees and keep yourself liquid to make further originations, the $1000 up front helps you stay afloat and generate further originations.

A little over a month ago I wrote about a great discussion on the Lykken on Lending mortgage banking podcast.  Lykken had Austin Tilghman and David Stephens, CEO & CFO respectfully of United Capital Markets, on the program for an interview.  These fellows are industry experts in the mortgage servicing market.  The discussion begins about a half hour into the podcast.   Here is a particularly relevant comment from Stephens on the current state of the SRP market:

Prior to the meltdown the price paid for an SRP [servicing release premium] was generally 5x or more of the [mortgage] service fee.  That multiple dropped to 4x a few years ago and we are hearing that its dropped to 0x in some cases today.

This comment was followed up by Andy Schell, a co-host on the broadcast.  Schell said that he had recently done an analysis of SRP’s and MSR’s and, in his words, “I couldn’t believe the numbers are so low.”  He reiterated that the SRP’s are in some cases approaching zero.

As an originator, maybe it made sense to sell the MSR in return for a SRP that was 4x or 5x as much as you would get from the MSR in the first year.  But now you are looking at a SRP that is approaching 0 in some cases.  Even in the case of strong originations (good quality loans with low default rates) you aren’t going to get more than 2x the MSR’s yearly return, and are probably going to get somewhere between 1x and 2x.

It doesn’t make as much sense.

Take our example: would you give up an income stream of $250 a year if you were only going to get $350 or at best $500 for it?  If you held it instead you could return double that amount in only 4 years?

Who is selling MSRs at these bargain basement prices?

I think that there are two reasons that MSR’s are getting sold down to such low prices:

  1. The big banks are getting out of the business
  2. The little guys have difficulty getting into the business

The big banks

There are a couple of things going on with the big banks.  First of all,  there are regulatory capital changes about to take place that are going to effect how much capital a bank has to keep on its books to hold an MSR.  Under Basil III requirement of how much capital must be held for an MSE changes dramatically:

One of the biggest changes in capital definitions for U.S. banks involves mortgage servicing rights (MSR). Under Basel III, banks will be allowed to include only a maximum 10% of MSR in their capital measures. Any amount above that is deducted; and then, in combination with financial holdings and deferred tax assets (DTA), that can only be up to 15% of aggregate capital. In contrast, under current rules MSRs are included in capital up to 90% of fair value or book value, whichever is lower.

The second reason is simply the consolidation of the banking industry.  Again referring to David Stephens:

Its the aggregation of the aggregators.  In 2007 an originator might have 20 take outs for the loan they produced.  After the spectacular failures of 2008 and the combination of large companies into even larger ones there may have been 10 takeouts.  Recently we’ve seen BoA and Citi getting out of the market and you can count on one hand the number of people that account for 50% of the market.  And they have their own capacity limitations.  It just gets tougher and tougher to find a takeout and then those that are left are becoming more selective about what they buy.

A third reason that the banks want out of the business is the way that MSR’s are accounted for.  The GAAP accounting standards for MSR’s forces banks to account for them on a mark to market basis.  This means that a bank has to revise the value of the MSR every quarter.  The nature of the MSR is that it is going to be extremely sensitive to interest rates.  If interest rates go down then more borrowers are going to look to refinance their mortgage.  When a mortgage is refinanced the existing mortgage is paid off and the MSR that is tied to the existing mortgage stops paying interest.  So as interest rates go down the probability of prepayment increases, bringing the value of the existing MSR’s on the books down.

Banks have been writing down MSR’s for a number of years now as the Fed does everything in its power to lower interest rates.  They are sick of having to book quarterly writedowns on the MSR assets.  In addition, they have been booking further writedowns because so many mortgages have gone into default over the past 5 years.  If you add to those factors the stigma of being involved too heavily with the mortgage business, you can see why so many banks are either getting out of the business entirely (Bank of America) or scaling back on the business considerably (Citi and JP Morgan).

And there you have it.  A simple supply and demand imbalance where demand for SRP’s has been decimated by the housing collapse have caused a disconnect in servicing valuations.

The little guys

The reason that more originators aren’t keeping the MSR on their books is simple.

  1. They need the cash up front and they can’t wait a couple of years to recoup it
  2. They don’t have the cash to make the start-up investments to get into the business

We are in a period where originations are strong because of the strong refinancing activity that has been brought about by low interest rates.  This creates more pressure on the smaller originators to sell their MSR’s and realize the cash up front.  Meanwhile the drop in SRPs creates what is almost a snowball effect.  Getting less cash for the MSR’s you sell precipitates the need to sell more of your MSR’s in order to meet your cash needs.

It is also not an easy process to get approved as a servicer if you are an originator that has traditionally sold off your MSRs but you want to begin holding them on your books.  According to Tilghman:

Its not an easy process.  Some started the process a couple of years ago, had their approvals in place for this market opportunity.  It is daunting though… there is a huge backlog at Ginnie Mae and at the GSE’s… the people we talk to says this is still incredibly slow and its taking months for companies to get approvals.  We talked to one subservicer and he as 20 companies waiting for approvals. And frankly we are talking to 30 companies that 6 months ago weren’t interest in owning MSRs and are now looking to get approvals. 

Selling at the bottom

The irony is that all this selling is taking a place at a time when underwriting standards have never been better.

The quality of the servicing has never been better, low interest rates, tough underwriting, good appraisals, those are the positives.  A lot of potential for the servicing to gain value in the future when rates go up, but most importantly to have it in place when rates go up as a hedge against your production dropping maybe 80%.

As the servicer of a mortgage, there are 3 things you don’t want to see:

  1. The house get sold
  2. The loan get refinanced
  3. The borrower defaults on the loan

There isn’t much that can be done about number one.  But two and three are functions of the market and of loan quality, and they are notably strong right now.

Interest rates are probably as low as they are going to get.  This has led to the boom in housing refinancing that I mentioned earlier.  The refinancing boom has been a hit to servicers who have seen their MSR’s stop paying out when the house gets refinanced.  The upside of this is that the new loans being put on the books are unlikely to be refinanced for some time.  Rates are more likely to go up than down.  The opportunity is there to realize servicing revenues on new loans for a significant period time.

Banks were hit hard when subprime borrowers walked away from their homes.  Because loans weren’t getting paid, neither were the servicing fee.  Compounding the problem, servicing rights often have clauses whereby the servicer incurs additional responsibilities when the borrower goes into the foreclosure chain.

Now we have the opposite scenario.  Lending standards are so tight that only the most fool-proof borrowers are able to get loans.  The risk of default should be greatly reduced.  The result again is for the MSR to stay on the books, paying out cash, for longer.

The risk of regulation

The main risk to the thesis that I see is regulation.  There was a lot of concern that that the FHFA was going to change the servicing model for agency servicing model, either by reducing the fee that a servicer received or by changing the structure to a fixed fee that was independent on loan value.  The FHFA put out a talking paper to talk about the proposed changes back in September of last year.

In its talking paper, FHFA once again floats the idea of paying a set dollar amount for servicing loans, while keeping open to the idea of maintaining a minimum servicing fee model similar to the current structure, but one with a reserve account option. “The reserve account would be available to offset unexpectedly high servicing costs resulting from extraordinary deteriorations in industry conditions,” the talking paper notes.

There was a lot of resistance against the proposed ideas, particularly from the smaller servicers, who said that the reduced servicing premium would basically squeeze them out of the business. The FHFA recently stepped back from the proposals, but they have yet to put an end to the discussion completely.  Tilghman said the following about the matter:

We are continuing to be disturbed that the FHFA refuses to clearly state the servicing compensation issue that it is off the table.  The responses to their December proposal were 80% against any change or for a moderate change and yet they will not acknowledge that and continue to leave open the potential for that issue.  If they understood the markets and were serious about competition well frankly that is going on as we speak, they’d provide certainty and they would kill the issues that have no substantive support. 

How to invest

Finding companies to take advantage of the opportunity hasn’t been easy.  The two obvious one’s that I have owned since the start are Newcastle Financial (whichI have written about here) and PHH Corporation (which I have written about here).

There are also a couple of new IPO’s for companies looking to take advantage of the opportunity.  Both Nationstar Mortgage Holdings (NSM) and Home Loan Servicing Solutions (HLSS) have had IPO’s in the last month

Nationstar is a well established servicer that had been held by Fortress Investment Group (FIG). Nationstar looks to be in the same vein as PHH; an originator with a large servicing business. Nationstar also has a large subservicing business, which means that they take on the servicing responsibilities for servicing rights held by other companies in return for a fee.

Fortress Investment Group is also an interesting idea. FIG owns about 80% of Nationstar. That puts FIG’s investment in Nationstar at a value of about $900M. If you look at FIG, the stock is at $3.75 right now and fully diluted Class A and Class B shares are a little less than 500M. So just roughly here, FIG has a market capitalization of $1.875B, meaning that Nationstar alone is worth half the market cap. FIG has about $43B in total assets under management so in the grand scheme of things Nationstar shouldn’t be that big of a part of FIG.

It’s a situation that brings up your spidey senses. Is the value of Nationstar sneaking in under the radar of FIG shares? The problem is that I can’t be sure yet. I am looking at FIG right now and it’s a tough slog; its difficult to get the details about what they actually own and what the value actually is because of the nature of their corporation of funds structure. You can do a search through the 10-K and the name Nationstar isn’t mentioned once. But I’m going to keep investigating. FIG smells to me like one of those 5-bagger opportunities, but I just don’t understand the company enough yet to say for sure.

Finally, Home Loan Servicing Solutions is a spin-off of Ocwen Financial. Having read the prospectus, it appears that HLSS will be a income vehicle. They are going to buy up the MSR’s currently on Ocwen’s books in return for a portion of the servicing fee. Ocwen would still do the servicing on the mortgages (acting in the capacity of subservicer) and in return they would be paid a base fee plus an incentive fee that is structured to entice Ocwen to keep as many of the borrowers current as possible.

It’s a similar sort of deal to what Newcastle and Nationstar are doing. Its structured a bit different, with the main difference being because the loans involved are subprime and not agency. Servicing subprime loans has an extra aspect that doesn’t occur with agency loans. When you are dealing with subprime loans, the servicer is responsible for putting up money in the short term when the payments are late. This means that the servicer has to have access to a credit facility, (or some other sort of funding) that they can borrow from when they need to cover payments. And that funding costs you in interest.

Now admittedly my understanding on this isn’t completely clear yet, but from what I’ve read I don’t think the servicer is ultimately on the line for payments they put up. They are eventually reimbursed, either from the borrower when the payment is made, or from other payments in the pool if the mortgage goes into foreclosure and the payment will never be made. But they do have to put up cash in the interim.

So along with the servicing commitments, HLSS is taking over a number of credit facilities that had previously belonged to Ocwen. In this case they are commercial paper facilities, and they provide access to the short term credit that HLSS needs to have so it can cover any late payments to the pool. HLSS has to pay the interest on these facilities and that comes out of their profits

So that’s the downside of a subprime deal versus an agency deal. The upside of a subprime deal is that HLSS is taking a bigger piece for less up front than Newcastle did. HLSS is getting 32.5 bps in servicing fees and, based on the Dec 31st estimate of fair value, they will only pay 41 bps up front. In the first Newcastle deal, which was all agency, Newcastle paid 60bps and is getting 29 bps in servicing fees. In the second Newcastle deal, which was only 25% agency and 75% private label, Newcastle paid 42 bps. Its not clear to me whether Newcastle is going to have to manage the cash on the private label, but given the cheap price I wouldn’t be surprised.

I am looking for more ideas in the mortgage servicing sector. Please comment or write me ( if you have any ideas.


In my opinion mortgage servicing rights (MSR’s) are the best opportunity in the market right now.  The potential is there to return as much as 30-40% IRR for the companies involved. The companies involved are not trading at premiums that reflect this, and in some cases they are trading at discounts to the market (PHH) or with extremely attractive dividends (Newcastle).