Stonegate Mortgage IPO a test of housing recovery

Stonegate Mortgage—potentially the first company in Indianapolis to go public since ExactTarget in 2012—plans to entice investors with a nationwide expansion, a diversified income stream, and the prospect that federal reforms will benefit such loan aggregators.

It also doesn’t hurt that 8-year-old Stonegate has been profitable every year since 2008, and last year earned a $17 million profit on revenue of $95.5 million, according to filings with the Securities and Exchange Commission. Stonegate has yet to price its initial public offering.

woodley Woodley

Stonegate originates, finances and services mortgage loans—a combination it says helps hedge against housing cycles and interest-rate swings. The company based near Interstate 465 and Keystone Avenue has 650 employees at nearly 30 offices around the country.

Despite profitability and fast growth, can Stonegate lure investors who still have painful memories of the housing market collapse six years ago?

After all, Indiana is littered with the remains of lenders that went bust or were sold off, such as Irwin Mortgage, now owned by Freedom Mortgage.

Then there was longtime Indiana lender Waterfield Mortgage, of Fort Wayne, which was bought by a Long Island company that later went bankrupt.

Closer to home, there’s Oakstreet Mortgage, which only a few years before its 2007 demise was planning a $150 million initial public offering.

But analysts say Stonegate will indeed draw notice from potential investors, thanks to housing market improvements since the Great Recession.

“I would think so, because you are starting to see that recovery. People are starting to look for opportunities in that area … trying to find an inexpensive exposure to the housing market,” said Mark Foster, chief investment officer at Columbus, Ind.-based Kirr Marbach & Co.

“Coming out of 2008, it took a while for the housing market to get some traction.”

Housing-related stocks, including those of financial institutions, have been trending upward, noted Donald Woodley, principal of Woodley Farra Manion Portfolio Management, in Indianapolis.

Lenders have cleaned up their bad loans, and interest rates are still low as the economy slowly grows.

“They’re out of the doghouse, these days,” Woodley added.

Eyeing opportunities

If anything, it seems the housing industry’s troubles could wind up helping Stonegate.

The fallout left fewer mortgage originators to securitize mortgage loans or sell loans to investors such as jumbo loans. These are typically larger mortgages that exceed the loan limits imposed by Fannie Mae and Freddie Mac, the government-sponsored agencies that buy mortgages from lenders. Generally, that limit is $417,000.

Stonegate says, in recent filings with the SEC, that as the market normalizes and private securitization returns, it will be one of few non-bank originators positioned to sell such loans, “giving us the ability to be an aggregator for others and establishing ourselves as a market leader.”

Later this year, it plans to offer investors an opportunity to invest in securities backed by these loans.

Jerimy Horner, a vice president and head of structured securities at Carmel-based 40/86 Advisors who invests in mortgage-backed bonds, said Stonegate should find lookers.

That’s because jumbo loans are often what one would consider “super-prime,” consisting of borrowers with high credit scores who sometimes put down half the amount of the loan in cash. While mortgages on expensive homes can be dangerous because those homes often aren’t as easy to resell upon default, packaging them as securities spreads the risk.

The financial crisis also caused the government agencies that buy mortgages to impose greater compliance requirements on originators, including proposed fees based on volume for smaller originators. That should drive more firms to sell their originations to aggregators, including Stonegate, the company said, rather than directly to government agencies.

stonegate-factbox.gifStonegate also said it expects regulation and changing market conditions will drive industry consolidation, with smaller originators that lack scale being bought by larger firms.

“We believe that the fragmented mortgage industry, increasing regulation and stricter policies provide an attractive opportunity to an aggregator such as ourselves.”

Retail expansion

Industry consolidation could also provide opportunities to grow Stonegate’s own retail channel, which consists of more than 25 offices in 12 states. That includes 16 retail branches in 10 states opened in late 2012 and the first half of this year. Among the states it wants to tap are California and New York.

Stonegate has three principal mortgage origination channels. Besides its retail locations, which generated $508.9 million in loans last year, it counted $894 million in loans generated through the wholesale channel—loans solicited through brokers.

The largest source of its originations—$2 billion in loans last year, came from correspondent lenders—third parties who can fund mortgages or get a customer a mortgage funded by a traditional lender. Stonegate’s correspondent origination volume soared 445 percent, to $2.8 billion, in the six months ended June 30, compared with $521.5 million in the same six months of 2012.

Currently, Stonegate is licensed in 38 states and Washington, D.C., and by year-end plans to become licensed in 45 states. Among individual states, Stonegate services the most loans—as measured by unpaid principal balance—in Texas, at 13 percent. That’s followed by Indiana and Ohio, at 11 percent and 9 percent.

Stonegate’s other big source of income is loan servicing, which produced $17.9 million during the first six months of this year, 21 percent of revenue. Loan administration includes collections and customer service. It produces fee-based revenue with little credit risk.

The company’s portfolio consists of $7.6 billion of residential first mortgages. It has avoided subprime loans—its portfolio has an ultra-low delinquency rate, and a weighted average FICO score of 733. That’s well within the upper third of the most creditworthy customers.


Stonegate further diversified its business last year when it bought from Guggenhein Partners the St. Petersburg, Fla.-based NattyMac, which provides financing to independent mortgage bankers, known as warehouse financing.

Revenue from NattyMac has yet to show up in Stonegate’s most recent financials. Nor is it apparent from Stonegate’s recent SEC filing how much NattyMac could generate down the road.

Such loans will allow correspondents to sell Stonegate loans on an accelerated basis—moving them off the correspondent’s balance sheets and freeing up their loan lines so they can fund additional loans.

NattyMac will earn Stonegate fees and net interest income on the loans, which are usually held about 15 days before being sold.

“Our three businesses—mortgage origination, servicing and financing—complement each other and create a natural hedge against interest rate volatility and business cyclicality,” Stonegate states in its securities filing.

The industry remains highly cyclical, however. Woodley noted that rising interest rates put a damper on some home buying and caused refinancing to reach a crescendo, for now.

Given the cyclicality of the mortgage industry, “it’s nice to see that they have several different income streams,” said Horner, of 40/86.

Stonegate has 652 employees and was founded by Jim Cutillo, who came out of the residential mortgage industry. He’d been a director at GMAC Residential Funding, back when the Minnesota company was the biggest issuer of private-label mortgages and asset-based securities.

Last May, Stonegate completed a private offering through Long Ridge Equity Partners that generated $115 million, based on an offering price of $18 per share.•

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