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Nationstar Mortgage went from private equity flop to a top servicer of troubled loans, thanks to deft management and a Fannie Mae partnership once hidden even from parts of the government.
October 2 -
Nationstar has figured out how to profit from troubled loans that have bedeviled major banks. It also seems to be producing better outcomes for borrowers and the government.
October 3
Editor's note: This is the last in a three-part series on the rise of Nationstar Mortage, a former subprime home equity lender which transformed itself into a leading nonbank mortgage servicer within four years. Part one looked at the
Wesley Edens, the private equity mogul behind Fortress Investment Group, announced plans to take Nationstar Mortgage public in December 2009, the same month the company inked a key deal with Fannie Mae. But getting the company on the market took time.
In May of 2011, Nationstar filed an initial prospectus with the Securities and Exchange Commission, aiming to sell 20% of the company for $233 million.
"We believe that we will continue to benefit from our strong relationships with the GSEs," Nationstar said in the prospectus. While the documents did not outline the full scope of Nationstar's servicing transfers from Fannie, it did offer some hints about their significance. In the span of just two months in late 2010, Fannie had provided Nationstar with servicing rights equal to 40% of its entire portfolio of $60 billion.
Nationstar has not disclosed what percentage of business it has sourced from Fannie, but Jay Bray, the company's chief executive, insists that it has received a big chunk of business elsewhere. It has acquired servicing rights 340 times since 2008 from the GSEs, the Federal Deposit Insurance Corp., the Federal Reserve Bank of New York's Maiden Lane vehicle and private sources, he says.
Nationstar soon had to become even more independent. In August of last year, Bank of America Chief Executive Brian Moynihan announced that his company had sold the rights to service a $73 billion portfolio of loans. The deal was part of Fannie's servicing transfer program, but where the loans ultimately went has never been made public.
The reported price of the deal — more than $500 million — sparked talk of a "backdoor bailout" of B of A, an allegation that the Federal Housing Finance Agency inspector general later concluded was unfair. But even though the inspector general would eventually find that the servicing transfers were "essentially sound," the FHFA clamped down on the transfers all the same. The subsidized servicing purchases for Nationstar and other special servicers came to an end.
PRIVATE DEALS, FORTRESS FUNDING
Nationstar's acquisitions continued apace in the private market. In mid-2011, the company reached an agreement to take on subservicing for a $25 billion pool of loans from First Tennessee Bank. It also reached a series of deals to buy servicing directly from Bank of America.
A key reason Nationstar was able to grow so quickly is that its owners have concocted creative ways to raise capital at a time when many rivals were strapped. Servicing is an expensive business, especially at the front end. Servicers pay up front for rights to collect mortgage fees for years to come. Then, when some borrowers miss payments, they are required to meet their financial obligations to bondholders until debtors catch up or their properties are foreclosed upon and sold.
To fortify Nationstar's balance sheet, Fortress brought in Newcastle Investment Corp., a real estate investment trust which it controls and partly owns.
Newcastle's trick was to win Internal Revenue Service approval last autumn to designate servicing income a "passive asset." REITs are barred from taking active roles in developing assets, so the ruling put servicing income within a REIT's orbit for the first time ever.
Rival subprime servicer Ocwen Financial devised a similar method of funding multi-servicer rights investments with Home Loan Servicing Solutions, a Cayman Islands-based investment company it created a few months after Newcastle's first servicing investment.
Even so, Nationstar's arrangement with Newcastle is "extraordinarily elegant," says Dave Stephens, the chief operating officer of UCM, a mortgage servicing investment consultant.
"I might think about doing something like that for one of our deals," he says.
Over the last nine months, Nationstar and Newcastle have jointly bought the rights to service more than $100 billion in loans. Newcastle has put up 65% of the capital and taken an equal share of the "excess" income beyond modest administrative fees. That's the structure the partners used in June, when Nationstar acquired Aurora Loan Services from Lehman Brothers' bankruptcy administrator for $177 million.
So far Newcastle has enjoyed the 18% internal rate of return it had predicted. The churn caused by foreclosures and refinancings is more than one-third below what the REIT expected, meaning its investment will likely keep paying for longer than originally forecast.
Since Newcastle entered into its first Nationstar deal in late 2011, the REIT's stock price has surged roughly 80%, or nearly triple the sector average.
That steep rise is attributable in part to the expectation that Newcastle will get more servicing asset deals. And in the auction of Ally Financial's Residential Capital, Newcastle and other Fortress affiliates have already pledged to supply Nationstar with $450 million—most of the capital it would likely need to fund a winning bid.
Now that Nationstar has forged a financing path, other big servicing deals may follow.
"There are many folks who'd like to engage with us in that structure, and we've certainly had dialogue around that," says Bray.
There's nothing preventing other servicers from doing the same thing: Ocwen's Home Loan Servicing Solutions plays a similar function.
OPERATING CHALLENGES
Nationstar's other big challenge lay in managing its super-sized growth. It did so with the help of some prominent Fannie executives. John Sayre, a Fannie vice president, joined Nationstar to handle new business acquisitions. Two former top lieutenants of Daniel Mudd, the former Fannie CEO who later ran Fortress, took senior-level jobs at Nationstar: David Hisey as chief financial officer and Harold Lewis as chief financial officer. (Sayre recently left Nationstar.)
By the time Hisey and Lewis arrived in February, however, Mudd was no longer Fortress's chief executive officer. Last December, the SEC accused Mudd of misleading investors about Fannie's subprime exposure while overseeing the GSE. He stepped down a month later to fight the civil suit.
Face with Fannie's policy change, Bray steered Nationstar toward large private-market deals. Its bid for ResCap's roughly $370 billion portfolio is a prime example. The bankrupt former home financing arm of Ally Financial (which used to be known as GMAC) is set to be auctioned off. Nationstar won court approval to serve as the lead bidder after putting up a $2.5 billion offer. Other firms that have expressed the intention of bidding include GreenTree (now in the hands of Walter Investment Management), Warren Buffett's Berkshire Hathaway and Ocwen. The bankruptcy auction is scheduled for Oct. 23.
Bray is hoping that Nationstar's reputation will give it an edge. That includes the positive reviews it has received from the GSEs and regulators. Nationstar officials are also quick to refer in pubic to its college-educated, Texas-based staff — drawing an implicit comparison with Ocwen, whose customer call centers are mostly overseas.
"If a large servicer was not performing at a level that Fannie or Freddie or Ginnie expected today, they would have a hard time buying a larger portfolio," Bray says.
That position has been endorsed by attorneys for both ResCap and the GSEs. At a bankruptcy hearing in June, attorneys for ResCap argued that Nationstar's bid for its assets should take precedence over rival Berkshire Hathaway's because the government was already familiar with Nationstar's record.
"We went down to the GSEs … and said, 'will you be comfortable if we file for bankruptcy and we sell assets?' And they said, 'Maybe. It depends on who the buyer is,'" Morrison & Foerster attorney Larren Nashelsky, representing ResCap, told the judge.
An advisor to ResCap piled on, saying it was a "great question" to ask what would happen if the GSEs didn't get a buyer they wanted. And an attorney for Freddie Mac also weighed in — though the smaller of the GSEs only has one-fourth as many loans in the ResCap portfolio, it wanted to put "everyone on notice" that "we believe our consent is necessary" for a sale.
If Nationstar does prevail, ResCap will go a long way toward moving its business away from taking bum loans off big banks' hands and toward competing with them for lower-maintenance portfolios. A win would also pose new management challenges.
"On the pristine stuff, you've really got to be a great payment processor," admits Bray. "We're focused on getting better in those areas, looking at our costs, and looking at our workflows."
Another question is whether the move into the private, prime-servicing market will take a toll on Nationstar's profitability. The company has stated that its recent deals all have expected internal rates of return north of 20%. KBW analyst Bose George doubts that's achievable buying ResCap at public auction.
"It seems like by definition you shouldn't have really high returns on the assets," he says.
Another Nationstar growth initiative involves partnering with KB Homes to provide the builder's customers with financing. Nationstar has also built an origination platform geared toward refinancing its own portfolio. But origination is going to remain a "complement to our servicing business," says Bray.
"Do we want to open up 100 branches? No."
Given that refinancings run off about one-fourth of loans each year, a Nationstar that succeeded in acquiring ResCap would have to bring in well over $100 billion in servicing annually just to stay in place. Bray is aiming to do far better than that — the company says it has a $300 billion pipeline of servicing separate from ResCap that it expects to bring on board by the end of next year.
That would make the company by far the largest nonbank mortgage servicer under the auspices of the Consumer Financial Protection Bureau. Bray says Nationstar already meets the servicing standards the CFPB has proposed.
If neither competition nor regulatory pressure curbs Nationstar's ability to grow, the question remains whether the ability to manage its fast-growing empire will. Bray scoffs at the notion.
"We don't have a lot of legacy issues or the stress some of these large institutions have," he says.
