Nationstar downgraded a notch

Origination headwinds shift early 2014 outlook

Analysts with FBR Capital Markets (FBR) downgraded mega servicer Nationstar Mortgage Holdings (NSM) to ‘market perform’ from ‘outperform’ this week on slowing origination activity.  

Judging by current origination levels, FBR believes the Dallas-based servicer's guidance could be pushed lower in the very near future.   

"While we believe that the mortgage market will pick up in 2H14, the first half of the year is likely to be a tough one for those companies whose earnings are sensitive to originations," FBR Capital Markets Managing Director Paul Miller wrote. "Should the company realize better-than-expected volumes through refis or its retail platform, we could become more constructive on the shares."

FBR Capital adjusted its NSM price target downward to $32 per share from $45. The change was made just ahead of the company’s 4Q-2013 earnings report. 

Despite this shift, FBR is maintaining its fiscal year 2013 earnings per share estimate of $2.43 a share, while lowering its FY-2014 earnings estimate from $4.85 EPS to $3.50 per share. That reduction factors in lower origination volume, which inevitably plays a big role in the company’s annual earnings.

It’s not just originations challenging Nationstar. The servicing side of the house comes with its own risk and rewards.

A month ago, Nationstar decided to sell New Residential Investment Corp. (NRZ) and co-investors $3.2 billion in servicing advances tied to non-agency residential mortgages with unpaid principal balances of $58 million.

New Residential and the investors assumed two servicing advance debt facilities and agreed to make future advances on the underlying loans.

Nationstar agreed to service the loans in exchange for servicing fees and has the ability to continue to earn performance compensation.

The good news is the recent advance transaction released large amounts of capital, FBR says of the deal. 

"If Nationstar is able to put the capital to work through accretive transactions, we would likely view this as a positive for the company," the company added.

But the extent of the impact is still unclear, with Paul Miller, managing director for FBR, noting in his report that the true earnings impact from the NRZ deal remains unknown since the company needs to get the level of advances down to $5 billion or less before it reaches "revenue neutral" status.

The takeaway from Nationstar is it has great potential for higher servicing profitability, but remains immersed in an organizational clean-up.

"However, we continue to believe a 9.0x multiple can be justified given the potential for future transfers and higher servicing profitability over time," Miller said. "That said, many investors are applying a discount to NSM's earnings as the ultimate impact from its servicing advance transfers and lower originations remains unclear, and we believe the bias is to the downside on valuation in the near term until management restores investor confidence."

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