It wasn't that long ago that companies like Nationstar Mortgage Holdings (NYSE: NSM ) , Ocwen Financial Corp. (NYSE: OCN ) and Walter Investment Management Corp. (NYSE: WAC ) were the darlings of the newly minted mortgage-servicing sector. Taking advantage of new financial reform rules that induced banks to shed their mortgage servicing rights, these three companies have been greedily scooping up MSRs left and right over the past two years.
Growth has been impressive. At barely two years old, Nationstar now has a market cap of over $2 billion, while Ocwen increased revenues to more than $2 billion last year, compared to a mere $845 million in 2012.
But cracks are appearing in the business model. Consumer complaints are piling up, and Ocwen has experienced two recent blows: The state of New York's Department of Financial Services has indefinitely suspended the transfer of $39 billion in MSRs to Ocwen from Wells Fargo & Co. (NYSE: WFC ) , and, as part of that purchase, is investigating possible conflicts of interest between Ocwen and other companies it deals with.
Servicing complaints increase
As companies like Ocwen and Nationstar bulk up their stable of MSRs, customer complaints have surged. Servicers don't own the loans they service, but make money taking over the administrative tasks that go along with collecting the payments on those loans. Instead of an increase in the quality of the servicing – which is what regulators hoped would happen – things have gotten worse since these players have entered the field. Of all servicers, which include the biggest U.S. banks, Ocwen and Nationstar have been the least responsive to customers.
As the New York Times notes, Ocwen and Nationstar have approved many fewer loan modifications than the big banks. This could be due to the servicing model itself, which pays servicers more when loans have larger balances. With no limitations on fees, these companies can actually make more if homeowners default, which reduces the chances of the servicer offering or granting a loan modification.
Ocwen, in particular, has been taken to task for this type of behavior by the Consumer Financial Protection Bureau, and recently agreed to pay back $125 million to consumers who had been unfairly foreclosed upon – in addition to granting $2 billion in loan modifications to troubled borrowers.
Walter hasn't been immune to customer complaints, either. The company revealed last November that its subsidiary, Green Tree Servicing, was being scrutinized by the CFPB for various infractions of consumer laws, and could face enforcement actions.
Conflict of interest?
In addition to putting the Wells Fargo deal on hold, the chief of the NYSDFS, Benjamin Lawsky, has expressed concerns about companies doing business with Ocwen – such as Altisource Residential Corp., which buys delinquent loans, and Home Loan Servicing Solutions, which purchases servicing rights from Ocwen, then hires the company to service the loans. All of these companies are owned by billionaire William C. Erbey, who declares that they all operate at "arm's length" from each other.
Servicing troubles seem to have had a depressing effect upon the share prices of the entire sector. Nationstar has lost nearly 27% over the past year, while Walter has dipped by 45%. Ocwen itself has dropped by only 6.5% in that time period, but has lost 33% in the last three months. Even Altisourse, which had doing swimmingly, dropped by 40% during the past three months, as well.
Can the sector rebound? Probably, but it has a lot of work to do. Servicing mortgages has proved to be extremely lucrative, and the value of MSRs will rise right along with long-term interest rates, making them even more valuable as prepayment rates stay low. In the long term, throwing all that potential profit away just doesn't make good business sense.
Stocks to hold on to forever
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love.