FBR Capital Markets upgraded Nationstar Mortgage Holdings (NSM) to outperform from market perform based on expectations for continued portfolio and earnings growth.
Shares at Nationstar have traded off over the last few months due to general regulatory concerns and questions about capital requirements.
Most recently the nonbank likely took a hit from the news of Ocwen Financial Corp. (OCN).
At the end of December 2014, Ocwen Financial Executive Chairman William Erbey resigned from the Ocwen family of companies. Ocwen also announced that it would pay $150 million to homeowners under an agreement with the New York Department of Financial Services.
Ocwen admitted in the agreement with the New York regulatory agency that it didn't properly deal with distressed homeowners and failed to maintain adequate systems for servicing hundreds of billions of dollars in mortgages.
“However, we believe that Nationstar is the best positioned of the large specialty servicers to continue purchasing portfolios as it remains in constant communication with its various regulators and has funding support from New Residential (NRZ – Outperform),” said FBR.
The nonbank servicer has also targeted 20%-plus annual earnings growth as it decreases costs, de-leverages the business, and is able to grow its business through strategic acquisitions.
As a result, FRR expects the company to outperform its specialty servicing peers in the coming quarters and adjusted its fiscal year 2015 earnings per share estimate to $4.00 from $3.70 and introduced it FY16 EPS estimate of $4.35.
Here are the three key factors that play in FBR’s position:
1. Regulatory concerns
Nationstar is ahead of the game. While we know better than to say never, we think Nationstar's proactive approach to communicating with its various regulators seems to be paying off in the form of continued servicing portfolio acquisitions. This is especially important as large banks still have plenty of legacy and distressed MSRs they are interested in selling, especially to a partner that has the regulators' blessing. We believe that further portfolio acquisitions will be an important component of the company's targeted earnings growth over the next several quarters and model $40 billion of net servicing growth through the end of FY15. Should the company be able to grow its portfolio faster and at reasonable prices, there could potentially be meaningful upside to our estimates.
Solutionstar continues to add to the bottom line. Nationstar's Solutionstar platform remains a key contributor to earnings growth as it increases property sales, builds out HomeSearch.com, and takes on third-party business. Management's most recent guidance points to more than 30% earnings growth for the segment in FY15, with up to 20% of revenues coming from third-party business. We take a more conservative approach to the segment and estimate largely flat revenues in FY15 and roughly 15% growth in FY16. Should the segment perform to management's expectations, we believe earnings could rise over $0.50 per share in FY15.
As regulatory concerns likely abate and the company is able to acquire further servicing portfolios, we expect Nationstar to trade more off earnings. Our $35 price target represents 8x our FY16 EPS estimate of $4.35, which we think is an appropriate multiple for a specialty finance company in today's environment.
FBR Capital Markets is not the only firm that is upgrading its rating on Nationstar.
Although boutique investment bank Keefe Bruyette & Woods downgraded Nationstar to “underperform” in October 2014 on the pricey valuation amid slowing mortgage servicing rights acquisitions, it upgraded the nonbank servicer to “market perform” on November 2014.
Wells Fargo (WFC) also took a second look in November and upgraded their recommendation from sell, moving it up from “underperform” to “market perform" because they know that despite the challenges, this may be the bottom.
In the long term, Nationstar is still picking up MSRs, and few other institutions could handle -- or want to handle -- these rights.