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Kass: Nationstar vs. Ocwen

This column originally appeared on Real Money Pro at 12:47 p.m. EDT on Aug. 8.

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

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.)

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.

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