As mortgage banking giants were choking on home loans in late 2008, a subprime lender named Nationstar Mortgage Holdings was intent on getting deeper into the servicing business.

Borrowing money at a steep interest rate, it bought from Fannie Mae rights to administer a small portfolio of deeply troubled government guaranteed loans.

Over the next four years, Nationstar outpaced its rivals in a growth spurt that has propelled it into the upper reaches of the servicing business with oversight of more than $200 billion in mortgages and a $3.2 billion market capitalization.

Along the way, the Lewisville, Texas company has been lauded for its financial innovation, high-quality service and deep pockets of its majority owner — Fortress Investment Group, the publicly listed New York-based money management firm.

One other ingredient critical to Nationstar's meteoric rise is a deal it struck with Fannie Mae at the height of the mortgage servicing crisis. Under it, the taxpayer-backed entity agreed to feed Nationstar business on exclusive and favorable terms. In exchange, Nationstar granted Fannie veto power over decisions made by the unit handling its loans and a secret option to buy the division out.

By all accounts, the Fannie-Nationstar relationship has worked out well for both parties. Fannie Mae's special servicing deals were heralded as "an essentially sound initiative" in a September report by the Federal Housing Finance Agency's (FHFA) inspector general, and the transfers helped make Nationstar the preeminent player in a servicing industry shift toward non-banks. But the GSE and its conservator long resisted disclosing the terms of the deals — even as a handful of top Fannie executives jumped to Nationstar.

The FHFA has rejected an American Banker Freedom of Information Act request for access to the Fannie-Nationstar agreement on the grounds that Fannie is still nominally a private company. The FHFA's head of conservatorship relations, Jeff Spohn, referred to Fannie questions about why it would have demanded that the terms of its agreement with Nationstar be kept secret. So did Nationstar. Fannie declined to comment on its reasons.

Although little discussed, the FHFA maintains that Nationstar, and at least one other company which received a similar deal, were best positioned to help the government minimize Fannie's servicing-related losses by taking on work at a time when many other players were in no condition to do so.

"The idea was to get the loans into the best hands, and that's where they ended up," Spohn said.

One certainty is that Nationstar has every intention of expanding well beyond its current servicing portfolio of nearly 1 million mortgages with a face value of $200 billion. It is the lead bidder for GMAC's Residential Capital mortgage assets in an upcoming bankruptcy auction. The acquisition would more than double the value of the mortgages that Nationstar services to well over a half-trillion dollars and vault it past Citigroup as the nation's fourth largest player. It would also further expand the firm beyond the special servicing of troubled loans and into direct competition with major banks in servicing performing mortgages.

Jay Bray, Nationstar's chief executive, said his company is uniquely well positioned to maintain its rapid servicing expansion for years to come, and investors seem to agree: shares that have more than doubled since their March listing to a recent $33. Fortress is still in control with a 76% stake.

"You're going to have to have the capability" to fund and manage growth, insists the 45 year-old former banker and Arthur Andersen accountant. "You'll have to get the approvals. We've proven we can bring [servicing] platforms into Nationstar and improve portfolio performance."

Others have doubts. Warren Kornfeld, a Moody's Investors Service analyst, has cautioned Nationstar bondholders of the risks that accompany breakneck expansion — and which plagued similarly fast growing servicers, such as Fairbanks Financial Capital.

"It comes down to whether management is disciplined enough to avoid taking on more than it can handle," he said. "They appear to have done a good job of servicing transfers and growth, but history has many examples of servicers who hit operational difficulties."

Rough Start

Nationstar's early ambitions nearly proved fatal. Its creation was the brainchild of Wesley Edens, the Fortress founder and private equity chief who cut his teeth at Blackrock and made a name for himself buying troubled assets from the Resolution Trust Corp. in the early 1990s. Edens had experience with subprime servicing, having bought Green Tree, a mobile-home heavy servicer, out of insurer Conseco's bankruptcy in 2003.

That investment was already a success by the time of Fortress acquired Centex Mortgage's subprime home equity division, a deal which brought Bray on board. Soon afterward, Fortress sold Green Tree to another private equity firm, making Nationstar its main subprime bet.

The deals came about at a heady time for Fortress: in February of 2007, Edens and his partners took Fortress public, a sale that instantly brought them into the ranks of the world's billionaires. A month later they acquired Keycorp's former subprime arm Champion Mortgage, turning a business by then known as Nationstar into one of the nation's ten largest subprime lenders.

Fortress's timing on Nationstar proved awful. The ink was hardly dry on their Champion buyout when the easy money that financed the housing boom dried up. Within six months, Nationstar ceased writing new subprime business, which up until then accounted for the overwhelming majority of its revenue. Its total losses for 2007 and 2008: $442 million.

"[I] certainly did not distinguish myself from a performance standpoint as the market went straight down on the resi [residential] side," Edens said during the company's most recent earnings call.

Though Nationstar's underwriting business was a wreck, it had a very sizable advantage in its owner: Even though Edens and his partners had already been burned once by Nationstar, they were willing to underwrite a bid at reinventing the operation. The rest of the Wall Street competition — companies including Lehman Brothers' Aurora Loan Services, Morgan Stanley's Saxon Mortgage, Goldman Sachs' Litton Loan Servicing, and Bear Stearns' EMC Mortgage — either backed away from their subprime units or failed.

Bray, who was Nationstar's chief financial officer at the time, said the company also benefited because the former Centex portfolio performed better than those of many other subprime lenders — a fact that caught the attention of Fannie Mae execs.

"We continued to originate Fannie Mae product [after halting subprime], and then we started talking with them about how we can help ... on the servicing side," Bray said.

Nationstar began inspecting Fannie's portfolios in the summer of 2008 and took on its first servicing work with the GSE later that year.

Even as it bet that Nationstar could profit from banks' misfortunes, Fortress was struggling with its own portfolio. Edens stepped down as CEO in July 2009 to focus on managing the firm's private equity holdings.

Fortress turned to Daniel Mudd to run the company. Mudd was already a Fortress director and investor, known for his administrative acumen and history at Fannie. He'd arrived at the GSE in 2000 after running GE Capital Asia and took over as its CEO four years later, when Franklin Raines was forced out by an accounting scandal. Mudd was himself shown the door when Fannie Mae went into conservatorship in 2008.

Preferred Partners

In the few months that followed Mudd's arrival at Fortress, Fannie's new managers identified hundreds of billions of dollars in high-risk loans that they believed needed more attention than major banks could provide.

The value to Fannie of moving those loans to new servicers was confirmed by a FHFA inspector general's report released in September. The big, established servicers were poorly positioned amid the housing bust to take on the high-touch servicing that subprime accounts required, it stated.

"Larger financial institutions with bigger and bigger backlogs weren't equipped to handle the volume," says the FHFA's Spohn.

Mark Calabria, a former senate banking committee staffer who is now at the Cato Institute, agrees. "It wasn't even clear at that time that Bank of America was going to survive, and Countrywide [which Bank of America acquired 2008] was Fannie's number one partner," he said. "They [Fannie Mae officials] needed capacity if their current partners got in more trouble."

To gain that capacity, Fannie initially proposed buying its own servicer, but the plan was never implemented, according to Spohn and the inspector general's report. Instead, it turned to "specialty servicers," a group that included one long-time servicer, Ocwen Financial Corp., and a number of recently acquired ones, including IBM's Seterus and Green Tree, which had been acquired by Walter Investment Management.

At the time, Nationstar was a relatively small fish, with a servicing portfolio of just $21 billion at the end of 2008. But it and the newer entrants received a substantial boost. Between late 2009 and the fall of 2011, Fannie moved the servicing of more than $200 billion in mortgages out of major banks and into specialty servicers, among them Nationstar. Industry sources say Nationstar received somewhere between 20% and 25% of the Fannie-purchased servicing. The company received servicing from other sources, too, including the Federal Deposit Insurance Corp., The Fed's Maiden Lane, and First Tennessee. But as important as the volume of loans from Fannie was their timing: Nationstar received much of the GSE transfers early on, accelerating its growth.

Behind the transfers was a "strategic relationship" that Fannie and Nationstar entered into in December, 2009. It required Nationstar to keep elements of its special relationship with Fannie secret from all outsiders—including "Governmental Authorities." According to the deal, Nationstar agreed to house the Fannie servicing in a separate division that maintained independent staffing and financials. It also gave the GSE the option, with one month's notice, to break off the division into a subsidiary which Fannie could then buy.

"Nationstar shall not externally distinguish the Division from its general servicing and subservicing operations," the contract states, according to Nationstar's IPO disclosures.

(The FHFA said it knew of the buyout option, and referred questions about why Fannie would have wanted to avoid disclosing the special division to other government bodies to the GSE, which declined comment.)

Outlines of the deal were disclosed in Nationstar's public offering prospectus but have never been previously reported. Under it, Fannie agreed to purchase servicing rights from existing contract holders, swallow a chunk of the cost and feed the contracts to Nationstar at subsidized rates. One "hypothetical" transfer cited in the agreement involved Fannie paying the original servicer the equivalent of 0.9% of the value of outstanding mortgages and selling the contracts to Nationstar at a 66% discount, according to the IPO disclosures.

Along with a buyout option, Fannie gained significant control over Nationstar's servicing business. That included the right to establish guidelines for the financial incentives that Nationstar employees received. The agreement created a joint Fannie-Nationstar advisory committee with absolute say over how Fannie loans were serviced and the right to interrogate Nationstar about its broader business.

Assuming Fannie's objective was to encourage specialty servicers to bulk up, its insistence on secrecy is perplexing, says Cato Institute's Calabria. The best way for Fannie to build up industry capacity, he argues, would have been for it to broadcast as widely as possible its plans to subsidize high-quality services.

"If this was a 'strengthen the market' type thing, it's weird that [Fannie] would go out of the way to hide it," Calabria says, noting that Fannie was using government assets to "transfer money out of Fannie and into Nationstar."

The GSE's conservator disagrees.

Fannie and the FHFA "looked pretty broadly in terms of partners," said the FHFA's Spohn. "But you've got to realize that a lot of special servicers were pretty full up at the time, and their numbers weren't that great to begin with."

Now that the mortgage market has settled down, the possibility of a Fannie Mae buyout of a Nationstar subsidiary is out of the question, says Bray and industry observers. Spohn agreed and added that a Fannie buyout would have had to be approved by its government overseer in advance.

Fannie's buyout option was "simply done in an abundance of caution [in the event] that something should happen we hadn't anticipated," he says.

Fannie officials were "exploring various alternatives," says Nationstar's Bray, adding that they "wanted the ability at that time to potentially control their own destiny, and have a large special servicer themselves."

Kate Berry contributed to this article.

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