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Nationstar revenue growth accelerates

Brent Nyitray, Sr Real Estate Analyst

Nationstar is a mortgage originator and servicer

Nationstar (NSM) is one of the largest non-bank servicers in the United States. It’s also in the mortgage origination business. A mortgage servicer is the entity a borrower usually interfaces through with their mortgage. A servicer acts on behalf of the ultimate mortgage-backed security (MBS) holder and is charged with sending out the monthly bills and statements, remitting principal and interest to the MBS holders, remitting property taxes and insurance, maintaining escrow balances, dealing with the borrower if they become delinquent, and handling that delinquency all the way through modification or even foreclosure.

(Read more: Annaly Capital Management portfolio yield continues to fall)

Servicers are paid a fee that’s usually the difference between the underlying note rate on the mortgage and the interest rate on the mortgage-backed security. For example, a mortgage with a 4.5% note rate would fit in a 4% mortgage-backed security. So the amount the servicer collects every month is slightly more than what passes on to the security holder. That difference is compensation for the servicer. Servicing can be a tough business because one of the responsibilities of the servicer is to pay bondholders even if the borrower stops paying. These are called advance payments, and the servicer will get repaid in full once the property is foreclosed upon. But in the meantime, they have to use their own funds to advance principal and interest to the bondholders, and that’s a big use of capital. Pre-crisis, banks would offer advancement lines of credit that servicers could draw upon. Those are no longer available.

(Read more: Fannie Mae mortgage-backed securities fall nearly 3 points in a week)

Highlights of the quarter

Nationstar reported earnings per share for the second quarter of 2013 of $1.37 per share, well in excess of the Street estimate of $0.96 per share. Revenue increased 40% quarter-on-quarter to $603.7 million. Nationstar’s servicing portfolio increased 21% over the prior quarter to reach $315 billion. Origination revenues increased 45% to $268.7 million on $7.1 billion in origination, and 38% of its origination was under the HARP (Home Affordable Refinance Program), which refinances underwater conforming mortgages.

(Read more: Bonds and REITs collapse on FOMC statement)

Read-across to other mortgage REITs

Nationstar isn’t a mortgage REIT exactly, like Annaly (NLY) or American Capital (AGNC), but it’s similar to some REITs, like PennyMac (PMT). On the servicing side, it’s most similar to Ocwen (OCN). One of the interesting things about the servicing business is that your portfolio increases in value as rates increase. This is a rarity in the fixed-income world, where bond prices usually fall as rates increase. Why is this the case? Prepayments. If you’re servicing a 3.5% mortgage and rates increase, what happens to that cash flow stream? It will lengthen in expected maturity because the odds that the mortgage will prepay has fallen. If the expected life of that mortgage was seven years when rates were 3.5%, that expected life may increase to ten years if rates go up to 4.5%. The use of mortgage servicers is one way the retail investor can hedge the interest rate risk in their portfolio without having to pay carry.

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