Nationstar vs. Ocwen

 | Aug 08, 2013 | 3:30 PM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

nsm

,

ocn

This commentary originally appeared at 12:47 p.m. EDT on Aug. 8 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

As I will explain in this column, in the mortgage-servicing space I favor Ocwen Financial (OCN) over Nationstar Mortgage Holdings (NSM).

Yesterday, mortgage servicer Nationstar Mortgage reported a beat to second-quarter 2013 expectations and initially ticked much higher in premarket trading, changing hands as high as $53 a share, up $4. (Note: The shares closed yesterday at $50 a share and are now trading lower at about $49.15 a share.)

In my view, the gap was unjustified as the buyers and some of the sell-side analysts who applauded the report and the share price gap higher didn't appear to understand the quality of the earnings very well.

I tried to short the stock but missed the trade.

The reason I write this is because, among other liberal accounting recognition techniques, Nationstar utilizes a more aggressive gain-on-sale accounting in its earnings reports -- as such, I have an issue with Nationstar's quality of earnings. (I don't think this is well understood in the marketplace.)

As you will find in this column, if competitor Ocwen reported on a similar accounting basis (adding mortgage-servicing rights valuation adjustment and discount on advances), its second-quarter operating profits would have been over $400 million, and its pretax earnings would be $323.6 million compared to $199 million at Nationstar, rather than the reported pretax income of $87.5 million. If we further remove the impact of contribution to consumer relief fund, Ocwen's pretax income would have stood at $376.6 million vs. $199 million at Nationstar.

Conversely, if Nationstar reported with the similar accounting conventions as Ocwen, taking out mortgage-servicing rights valuation adjustment and discount on advances, Nationstar's reported pretax income of $199 million would be adjusted and reduced to about $117 million.

What follows is my more detailed analysis and calculation of how Nationstar's accounting policies differ appreciably with Ocwen's accounting.

It is for the reasons discussed in this post (and others) that I favor Ocwen over Nationstar and, at some point, will consider putting back on the pair trade of long Ocwen/short Nationstar.

Fine Points on Nationstar's Accounting

Discount on advances purchased is recognized under "interest income" in the proportion of advance collected:

  • This component contributed $6.5 million to first-quarter 2013 earnings and $11.5 million to fourth-quarter 2012 earnings.
  • The accurate number for second quarter 2013 will be disclosed in the 10Q, and we estimate it to be in the range of $20 million to $25 million.

Mortgage-servicing rights on book are mark-to-market:

  • Nationstar increased its mortgage-servicing rights mark by $118 million.
  • 50% of the benefit is passed onto excess spread holder.
  • Unlike Ocwen, Nationstar does not have 100% ownership of mortgage-servicing rights.

Accrued servicing fees are recognized on balance sheet:

  • For first quarter 2013, it was $101 million -- the company does not provide any further details.

Mortgage-servicing liabilities are provided on the balance sheet:

  • The amount provisioned has been between $81 million and $83 million since second quarter 2012, though the servicing portfolio has more than doubled over the past year. This might be underprovided.
  • Delinquent agency portfolios recently acquired should have increased this amount by $125 million to $150 million.

Legacy book:

  • The company recognizes a $7 million to $8 million loss on its legacy book every quarter despite improvements in credit and interest rate markets over the past two years.
  • The legacy book might still be overvalued at $257 million.

Columnist Conversations

Under Armour has been fading since the opening bell. The stock is off just shy of 1.6% as it extends Frid...
I wrote on RMP last week that I thought CVS Health (CVS) was too pricey. Today independent research firm Trefi...
Shares of Lockheed Martin are pushing further into new all time high ground. LMT is up just shy of 2% a...
We are feeling the pain today with our long GILD calls, these things happen and is why we A. Do not oversize ...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.