Nationstar Mortgage Holdings Inc. (NSM) managed to set off a mini firestorm in mortgage industry stocks during early November 2013, when the lender-but-mostly-servicer missed on its quarterly earnings and surprised analysts to the downside, while also announcing it would sell off assets to Stonegate Mortgage (SGM), consolidate operations and reduce its payroll.
The company logged third-quarter earnings of 91 cents a share, up 49% from the previous year but well below analysts’ estimates for $1.26 a share.
“In the origination segment, the interest rate volatility in the quarter negatively impacted loan pipeline growth and gain-on-sale margins, resulting in a challenging origination quarter,” CEO Jay Bray said in discussing the company’s third-quarter performance.
So where does this member of the HW 30 stock index go from here? Below, we'll look at both the bear and bull cases for this industry stock and member of the HW 30 equity index.
The bear case
Originations are struggling as lenders like Nationstar are forced to adjust to the new reality of the mortgage business, while at the same time the servicing segment isn’t seeing the growth many had forecasted.
Refinancing activity dropped nearly 42% during the third quarter of 2013, according to Mortgage Bankers Association data, pulling the rug out from under those mortgage companies dependent on this channel for revenues. And it’s not a short-term trend, either — Nationstar’s decision to unload the bulk of its lending business shows that management at least understands that the shift away from refis is perhaps more structural a shift than most in the industry want to admit.
In early and mid-2013, an increase in the transfer of mortgage servicing rights (MSRs) away from large banks had many investors giddy about the prospects for independent loan servicers, who looked primed to capture market share as banks looked to shed assets that were set to become burdensome to their capital structures under the rubric of Basel III and other programs.
Nationstar was one of the brightest beneficiaries of this trend, with the stock up a whopping 42% between Jan. 2 and its peak in late September.
But then a funny thing happened — while there have been numerous MSR deals in 2013 and Nationstar has certainly benefitted from a number of these deals, the mass exodus of MSR holdings out of banks to nonbanks like Nationstar hasn’t materialized as quickly as many investors had earlier expected to see.
Further, management didn’t see the wheels coming off the bus, either; or if they did, they held their cards awfully close. The company reaffirmed both its 2013 and 2014 fiscal year earnings guidance in early August, saying it expected earnings per share of between $4.05 and $4.75 in 2013 and between $6.45 and $7.50 in 2014.
Now? In November, the company said its EPS would instead more likely be in the range of $2.65 and $3.10 for 2013, and $4.50 and $6 for 2014. That’s nearly 35% less per share in 2013 at the high end of the EPS estimates — a pretty big shift in outlook between just August and November.
The industry has known for some time that the mortgage market was going to shift away from refis, and many have been warning that such a change would come this year — in fact, Ben Bernanke actually set off a firestorm regarding planned ‘tapering’ of government stimulus measures in late May, well ahead of the company’s initial confirmation of EPS guidance two months later in August.
If management didn’t anticipate this shift ahead of time, what else aren’t they anticipating now?
The bull case
While Nationstar has certainly seen its stock price drop from its 2013 high of $57.45 in late September to a range of the high $30s to low $40s at current, perspective is important.
Even at the stock’s close of $39.40 on Dec. 4, 2013, Nationstar shares were still up 31.8% from where they had been one year earlier. That beats the S&P 500, which rose by 27.6% during the same time frame.
The reality check of third-quarter earnings at Nationstar (and other nonbank mortgage companies) didn’t take the sheen off of fundamentals — it just drove some irrational exuberance out of the marketplace.
The company’s fundamentals remain strong, and a negative earnings surprise seems to make people forget that Nationstar beat analyst expectations for three straight quarters prior to the third quarter of 2013 — most recently delivering an EPS surprise that was more than 50% above analyst forecasts during the second quarter.
Nationstar’s price-to-earning ratio, price-to-cash flow ratio, price-to-sales ratio, and change in EPS over a trailing 12-month period are all well ahead of the company’s peers in the thrift and mortgage finance segment, too. What’s not to like here? The company is positioned to take advantage of the eventual shift of MSRs away from banks to nonbanks; it’s a transition that is taking longer to happen than many initially expected, yes, but that doesn’t mean it won’t happen at all.
Further, the company’s decision to jettison a suddenly outdated lending business should be seen as good news, as it removes a legacy overhang that may have clouded operations in what is effectively a “new” mortgage banking environment.
And while nearly every analyst has reduced their EPS estimates in light of the company’s own revised earnings guidance, Nationstar is still rated a buy overall by the seven major analyst firms that cover the stock (three of the firms still rate NSM a “strong buy.” the rest have moved the stock to “hold” as of publication date).
Lastly, here’s a real reason to be even more bullish on this stock: a Mel Watt-led Federal Housing Finance Agency. Mel Watt recenlty passed his confirmation vote on December 9. Now that Watt is confirmed as FHFA director, as was largely expected by most market participants, Nationstar should get a boost for 2014.
Watt is widely seen as being more sympathetic to borrower aid, and in the near-term this likely means an extension of the Home Affordable Refinance Program (HARP) cutoff date. Most MBS strategists say they see a June or December 2010 date (versus current June 2009 date) as the most likely outcome.
A HARP extension will increase prepayment speeds — a negative for REITs but a significant positive for loan servicers with meaningful legacy portfolios, like Nationstar.
Analysts at Barron’s have suggested that between $34 billion and $41 billion of mortgages would become eligible (greater than 80% LTV) if the HARP cutoff were extended through June or December 2010, with the potential size growing to $80 billion to $100 billion if re-HARPing is allowed.
NOTE: Nationstar Mortgage is a component of HousingWire’s exclusive HW 30 equity index. The HW 30 is designed to capture the heartbeat of those publicly traded firms that represent the very backbone of what we at HousingWire have taken to calling the “housing economy” in the United States. Residential mortgage lending, servicing, investments, as well as real estate transactions represent nearly one-third of U.S. GDP annually — yet prior to the HW 30, no existing equity index had attempted to capture this broad, important aspect of the U.S. economy. Learn more.
