The fallout of the housing bubble and crash is still sorting out, but it looks like we're now at the point where regulators are going hunting for trophies to display to their still-angry voting constituents. While major banks continue to seek settlements for their part in the wrong-doing, Lender Processing Services (NYSE:LPS) is also finding itself in the crosshairs. Although this company's strong data and service offerings is likely to survive this mess on an operational basis, the legal liabilities and regulatory uncertainties could well weigh on the shares for some time to come.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Underlying Business Conditions Are Tough
Absent some charges and adjustments, it was pretty clear from LPS's fourth quarter that operating conditions are still difficult. Revenue was down 14% this quarter, as transactions services revenue plunged 21% on lower default and loan facilitation service revenue. The company's data and analytics business fared reasonably well, though, and saw roughly 5% growth.

Reported gross margin actually ticked up a bit (about one point), but adjusted operating income dropped 22%. All of that said, the company fared better than analysts expected and the company saw some scale benefits in re-fi volumes.

Legal and Regulatory Uncertainties Abound
LPS stock is prone to getting batted around these days by various legal announcements and developments. The stock got a lift a little while ago when the company succeeded in having a major claim in a $155 million filed by the FDIC tossed out, leaving the company with a much more easily digestible breach of contract claim in play. (For more on the FIDC, see Who Backs Up The FDIC?)

On the flip side, Nevada recently filed suit against LPS alleging "widespread" document execution fraud and other wrongdoing tied to the servicing of defaulted Nevada mortgages. According to RealtyTrac, there could be around 200,000 mortgages in play and the state of Nevada is seeking $5,000 per violation. Unfortunately, there just isn't much information out there as to how many violations could be found per defaulted mortgage, the extent of LPS's culpability (or if they were at fault at all), and so on.

Regulation is likewise a so-called developing story. Major LPS customers like Wells Fargo (NYSE:WFC) have already had to adapt to new rules regarding the fees it can charge and the process it must use when processing loans, and this filters through to LPS. Financial companies are nothing if not clever and they will find new ways around the rules, but the reality is that nobody really knows today what the future profitability of the services business is going to look like.

There's Money in Data
None of this is to say that there won't be money left to be made in mortgage/default servicing. LPS has close to 50% share in this market and major banks like Wells Fargo outsource to LPS for valid reasons. So, LPS and Fiserv (Nasdaq:FISV) are not going to see the servicing business just go away.

That said, data and analysis may be an increasingly important part of LPS's future business. Although there's more competition here (companies like CoreLogic (Nasdaq:CLGX), First American (NYSE:FAF) and Fidelity National (NYSE:FIS)), there's also less regulation. Moreover, it stands to reason that banks are going to be "once bitten, twice shy" when it comes to underwriting and arguably more interested in paying for more advanced analytics to fuel their underwriting process and de-risk the lending process, particularly in an environment where lending is not especially profitable.

The Bottom Line
Even though Lender Processing Services has quite a bit of debt and the mortgage market is likely to be weak for some time, it's quite clear that there are significant expectations for legal settlements/judgments baked into the valuation today.

Even if LPS can only grow free cash flow at a rate of 1% a year for the next decade (below even pessimistic/bearish analyst expectations), the stock should be worth considerably more than today's price. Comparing the suggested discounted cash flow valuation with present valuation, the gap is about $1 billion. (For related reading, see Top 3 Pitfalls Of Discounted Cash Flow Analysis.)

With LPS having had a hand in about half of the mortgages that went bad and being a popular target for regulators looking to follow up on the abuses of the foreclosure process, there is definitely some legal liability here. Unfortunately, I don't know any way for an investor to assess that liability today and that makes the stock temptingly cheap, but very risky.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  4. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  5. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  6. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  7. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  8. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  9. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  10. Insurance

    Biggest Life Insurance Companies in the US

    Read about the top life insurance companies in the United States as measured by written premiums and learn a little more about their business operations.
  1. How can insurance companies find out about DUIs and DWIs?

    An insurance company can find out about driving under the influence (DUI) or driving while intoxicated (DWI) charges against ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!