Walter Investment Management

Different people are comfortable with different levels of concentration. However, anytime you see a hedge fund putting 73 percent of the portfolio into one stock, it is probably wise to pay attention. Baker Street Capital Management is making a huge bet on Walter Investment Management. As of its most recent 13-F, the fund has 73 percent of its portfolio in this position.

http://www.sec.gov/Archives/edgar/data/1488207/000092189515002502/xslForm13F_X01/infotable.xml

In the majority of cases in the United States, when people buy houses, they take out mortgages. Then, when the payment is due, they simply write the check, or they have it automatically deducted from their bank accounts. Besides making the payment, they rarely think about what goes on behind the scenes.

There has to be someone or some company keeping track of who is paying, who is not paying, how much loan is left, and which loans are in default. In other words, the mortgage needs to be serviced by a mortgage servicer who can be a bank or a non-bank institution. Keep one thing in mind – servicing a loan is not the same thing as owning a loan. Since the loans are securitized, the owners are most likely bond holders of mortgage-backed securities. The mortgage servicer works on behalf of the loan owners.

Walter Investment Management is a mortgage servicer focused mainly on problem loans. Before the Great Recession, most loans were serviced by banks. Then, when many of the dumb loans went bad, banks were not equipped to service so many bad loans. Servicing good loans is easy. The problems start when the homeowners default. Consequently, the Great Recession started a new trend where the banks started transferring mortgage servicing rights to non-bank mortgage servicers such as Ocwen or Walter.

As a result of this trend, Walter grew significantly and became a completely different entity that it used to be. Today, the company has six business segments: Servicing, Originations, Reverse Mortgage, Asset Receivables Management, Insurance, and Loans and Residuals. The two most relevant segments are servicing and originations because they contribute the most money to the company’s bottom line.

Servicing

Walter services mortgages through a subsidiary called Green Tree Servicing, which was acquired in 2011. In order to be able to service loans, most of which are subprime, the company owns servicing rights. It services loans for the mortgage owners and also for other servicers. The latter is referred to as sub-servicing. The servicing activities are performed on a fee-for-service basis and involve the management of mortgage payments, escrow accounts, and insurance claims, as well as the administration of foreclosure procedures, and the preservation and disposal of real estate owned.

The company performs these services for many clients, the most significant of which is Fannie Mae.

As compensation, the company gets paid a percentage of the loan amount left or unpaid. As a sub-servicer, the company earns a contractual fee on a per-loan basis.

Walter performs specialty servicing activities using a “high-touch” model meaning through a call center, employees contact borrowers and ask them to pay on time or resume paying their mortgage.

Originations

In order to generate fees through servicing loans, the company has to maintain the portfolio of loans that it services. However, the natural tendency of such a portfolio is to shrink down as people refinance or repay their mortgages. Also, when some of these mortgages are sold to other owners, the servicing rights might also transfer.

The originations segment originates and purchases mortgage loans with the purpose of replenishing run-off in the servicing portfolio from prepayments and repayments. After the loans are originated or purchased, they are quickly sold to third parties while the servicing rights are retained.

The originations business grew significantly after Walter acquired ResCap’s originations platform in early 2013. This acquisition provided the company with immediate access to a national originations business and positioned it to compete as a top non-bank lender. The loans that are originated are generally eligible for sale to one of the government agencies such as Fannie Mae or Freddie Mac, thus providing Walter an immediate source of liquidity.

Reverse Mortgage

The reverse mortgage business segment focuses on the origination, securitization and servicing of reverse mortgage loans. Walter grew this business significantly after acquiring Reverse Mortgage Solutions and Security One Lending in 2012 and 2013, respectively. According to the management, the reserve mortgage market is underserved and major banks and insurance companies have exited the reverse mortgage space after seniors defaulted on their obligations to pay taxes and homeowners insurance.

Asset Receivables Management

The asset receivables management business segment performs collections of post charge-off or foreclosure deficiency balances. The fee earned is based on a percentage of the collections.

Insurance

The insurance business segment provides voluntary and lender-placed hazard insurance for residential loans through the company’s insurance agency for a commission.

Loans and Residuals

The loans and residuals business segment consists of residual interests in securitization trusts that are consolidated on the company’s balance sheet as the residual trusts, as well as unencumbered residential mortgage loans held in the company’s portfolio.

While the company reports in six business segments, it is really the first two that we should pay the most attention to.

VALUATION

Right now the stock is trading for approximately $13.50 per share. This means that the market cap is $500 million. According to the most recent balance sheet, the book value is almost $1 billion.

http://www.sec.gov/Archives/edgar/data/1040719/000104071915000043/wacfy2015q3.htm

This is a short version of my analysis. The full report was provided to the subscribers of the Ultimate Value Finder.

Disclosure: I do not own the stock

 

About Mariusz Skonieczny 60 Articles
Mariusz Skonieczny is the founder of Classic Value Investors.