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This year's hottest IPO: A mortgage broker

October 24, 2012: 5:00 AM ET

Nationstar is benefiting from a resurgent home loan market and Washington gridlock.

Update: 3:30 PM, 10/24

I guess I called the top. On Wednesday, Nationstar lost out to rival Ocwen in its bid to take over servicing the mortgage portfolio of GM's former finance arm ResCap. In late afternoon, shares of Nationstar had tumbled 10% to $31. That makes Nationstar still one of the best performing IPO of the year. But no longer the best. I still think Nationstar will benefit from paralysis in Washington to come up with a permanent fix for Fannie and Freddie. But it appears its shares had priced in rapid growth of its mortgage servicing portfolio, which may not be sustainable. Anyway, here's my story from this morning  .  .  .  .   

FORTUNE -- Perhaps the IPO market's biggest surprise this year is not what flopped (Facebook), but its biggest winner - a former subprime mortgage broker.

Shares of Nationstar Mortgage (NSM), at a recent $34.86, are up 149% since going public in March, making it the best performing IPO of the year, according to IPO-specialist Renaissance Capital. The performance is a victory for private equity and hedge fund firm Fortress, which saved Nationstar during the financial crisis rather than let it go under. It now owns 80%.

In part, Nationstar's performance is another sign that the mortgage business is back. Last month, the Federal Reserve said it would buy up mortgage bonds in an effort to drive down rates and spur home lending. It has. Even more so, though, the Fed's actions have increased the spread between what it costs to fund a mortgage and what lenders can charge, significantly fattening profits for banks and a handful of upstarts, like Nationstar, who are now charging in and trying to redefine the mortgage market.

MORE: The next generation of pre-IPO financing

Nationstar, which has recruited a number of former Fannie Mae executives, is also cashing in on another trend. Banks are jettisoning their mortgage servicing units. Collecting borrowers payments can be a good business in good times, but got messy after the housing bust. What's more, new capital requirements would make the business less profitable for big banks.

Nationstar has picked up units on the cheap. It also benefited from a somewhat secretive deal with Fannie Mae, which netted Nationstar a large chunk of the giant, government-controlled mortgage insurer's servicing work. Nationstar services nearly $200 billion in mortgage loans, about double a year ago.

And that business may be about to grow again. The company is one of the main bidders in an auction this week for the right to service the mortgage portfolio of ResCap, the former financing arm of General Motors. If Nationstar wins, it would more than double its loan servicing portfolio again.

Fortress created Nationstar in the early 2000s by cobbling together subprime mortgage brokers. After the financial crisis, many mortgage lenders went out of business. Fortress doubled down. Nationstar got out of the business of making loans, and into the business of servicing them. More recently, Nationstar has begun making new loans, again, but this time only ones to prime borrowers. The moves have clearly paid off.

But some analysts think the stock has risen too high. Bose George, an analyst at Keefe Bruyette and Woods, recently downgraded the stock to a neutral. Nationstar, like other servicers, benefits from an unusual financing arrangement with a REIT also owned by Fortress. So far the IRS has approved the tax treatment of those deals. Some borrowers have picketed Fortress' offices complaining about Nationstar's foreclosure practices. But a review from Fannie Mae gave Nationstar high grades.

MORE: Housing is indeed heading higher

More importantly, the Bernanke fueled mortgage gravy train is only likely to last for so long. Profits are likely to narrows. JPMorgan Chase CEO Jamie Dimon recently said his bank is considering cutting its prices. That could be a problem for Nationstar. Last quarter, all of the company's profits came from lending. It's servicing business lost money, but is expected to rebound.

A bigger issue could be that we still don't know what the mortgage business will be in a few years. Regulators and politicians have talked about the need to get rid of Fannie Mae and Freddie Mac, or at least fully privatize them. That would surely shake up the market.

But, yet, four years after the financial crisis, nothing has happened. Meanwhile, new players like Nationstar and PennyMac and a number of mortgage REITs are trying to fill the void, and reshape the mortgage market in a way that best suits their bottom lines. And the longer Congress does nothing, the more likely they will be able to do just that.

So in the end Nationstar may be the ultimate investment play on Washington gridlock. Not a bad bet.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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