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| OCN > SEC Filings for OCN > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-2009
Quarterly Report
INTRODUCTION
Ocwen is among the leaders in our industry in realizing loan values for investors and in keeping Americans in their homes, as evidenced by our high cure rate. Our primary goal is to make our clients' loans worth more by leveraging our superior processes and innovative technology. In a recent comparison of servicer performance in servicing non-performing residential loans, Moody's reported that we had a "cure and cash flowing rate" that exceeded the average rate for Moody's highest-rated servicers as a group.
Our current and former business segments, aligned within the two lines of business, are as follows:
Servicing
Loans and Residuals
Asset Management Vehicles (AMV)
Mortgage Services
Financial Services
Technology Products
In addition to our core residential servicing business, Ocwen Asset Management (OAM) includes our equity investments in asset management vehicles and our remaining investments in subprime loans and residual securities.
In addition to our unsecured collections business, Ocwen Solutions (OS) includes our residential fee-based loan processing businesses, all of our technology platforms and our equity interest in BMS Holdings, Inc. (BMS Holdings). As more fully described below under Executive Summary-Separation of Ocwen Solutions, on August 10, 2009, the OS line of business, excluding BMS Holdings and GSS, was separated from Ocwen.
We are focused on growing our core business of servicing loans, as more fully described below under Executive Summary-Revenue Opportunities. At the same time, we continue to sell our non-core assets, including BOK and our remaining Global Servicing Solutions, LLC (GSS) partnerships. On June 19, 2009, we completed the sale of GSS Germany for $1,180, resulting in a gain of approximately $715.
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Interim Consolidated Financial Statements and the related notes, included in Item 1 in this Quarterly Report on Form 10-Q, with our Consolidated Financial Statements and the related notes, included as Exhibit 99.1 to the Form 8-K filed July 16, 2009, and with our Annual Report on Form 10-K for the year ended December 31, 2008.
Unless specifically stated otherwise, all references to September 2009, December 2008 and September 2008 refer to our fiscal periods ended, or the dates, as the context requires, September 30, 2009, December 31, 2008 and September 30, 2008, respectively.
When we use the terms "Ocwen," "we," "us" and "our," we refer to Ocwen Financial Corporation (Ocwen) and its consolidated subsidiaries.
EXECUTIVE SUMMARY
Three Months Ended September 2009 versus September 2008. We incurred a net loss of $42,031 or $0.51 per share in the third quarter of 2009 compared to net income of $14,976 or $0.23 per share for the third quarter of 2008. Income from continuing operations before income taxes was $23,458 for the third quarter of 2009 as compared to $23,410 for 2008. The net loss for the third quarter of 2009 is due to the income tax that Ocwen recognized on the gain resulting from the separation of Altisource Portfolio Solutions S.A. (Altisource) (formerly Ocwen Solutions). The distributed assets are taxable at the excess of fair market value over the tax basis of each asset. The total impact on our income tax expense for the third quarter of 2009 is $50,631.
Servicing segment revenues declined as expected due to our implementation of new underwriting and documentation requirements to complete modifications under the federal government's Home Affordable Modification Program (HAMP) (see Segments-Servicing for additional details of this impact) and as a result of lower average unpaid principal balance (UPB). Servicing results benefited from our cost reduction efforts and lower interest expense as evidenced by the 24% decline in operating expenses and the 9% reduction in interest expense in the third quarter of 2009 compared to the third quarter of 2008.
Both Loans and Residuals and Asset Management Vehicles reported a decrease in unrealized losses due to smaller declines in the estimated fair value of loans, real estate and securities. We recorded unrealized fair value gains of $8,291 on trading securities in the third quarter of 2009 compared to unrealized losses of $621 in 2008.
Our Ocwen Solutions line of business, consisting of the Mortgage Services, Financial Services and Technology Products segments, was separated as of August 10, 2009. For the six weeks of the third quarter for which Ocwen Solutions is included in our results, revenue was $24,023 and pre-tax income was $3,215. Operating expenses included a one-time charge of $2,304 for the closure of two locations. These partial quarter results of Ocwen Solutions may not be indicative of results for the full quarter, and were ahead of the previous quarter's results for the same period, excluding the one time charge mentioned. As a separate, publicly-traded company, Altisource (NASDAQ:ASPS) will file a Form 10-Q with the Securities and Exchange Commission.
Our operating results for the nine months ended September 2009 benefited from a 20% decline in operating expenses in the first nine months of 2009 compared to 2008. We achieved this improvement despite $3,501 in professional services expenses related to the Ocwen Solutions Separation (the "Separation"). We also recorded unrealized fair value gains of $13,346 on trading securities, compared to $22,366 of unrealized fair value losses on trading securities for the nine months ended September 2009 and 2008, respectively.
Strategic Priorities
Our competitive strengths are:
• Lowest Cost Provider. We believe OLS has the lowest operating cost in the sub-prime mortgage servicing industry. Based on average industry cost information provided by a third party valuation consultant, OLS' net cost to service a non performing loan was 57% lower than the average net cost for the subprime industry as of August 31, 2009.
• Superior Loss Mitigation and Cash Management. Two recent independent studies comparing servicer performance in servicing non-performing residential loans confirmed that we lead the industry in realizing cash flows for investors and keeping families in their homes. A Moody's Investors Service study in January 2007 showed that we achieved double the cure rate of subprime servicers rated "average" by Moody's and 6% higher than the cure rate of subprime servicers rated "strong" despite having a more challenging portfolio consisting of older mortgages with lower credit quality and a higher proportion of second liens. Similarly, in July 2009, Bank of America/Merrill Lynch found that we have the highest "roll rate from 90+ days delinquent to current" for both subprime fixed and adjustable rate loans. We believe these studies, together with our selection by Freddie Mac as a special servicer (as described below), demonstrate our capability to work effectively with delinquent borrowers and generate greater cash flows than any other servicer. This success in returning loans to performing status enables us to decrease our need for advances which, in turn, reduces our interest expense.
• High Barriers to Entry. Our servicing platform runs on a proprietary information technology system developed over a 20-year period at a cost of more than $140,000. We license this technology from Altisource under long-term agreements. These licensed tools are enhanced by a feedback loop that provides updated information on the latest servicing and property valuation data gathered by Ocwen and its affiliates. Currently, Altisource employs over 270 software developers focused on identifying additional opportunities to automate manual processes to eliminate variability and to increase the quality and timeliness of decision-making processes and information transfers.
• Scalability and Flexibility. With our highly automated, artificial intelligence driven technology platforms and global workforce, we can quickly scale our servicing platform to handle acquired loan portfolios with modest infrastructure additions.
To enhance our competitive strengths, we continue to focus on three initiatives having completed the Separation on August 10, 2009:
1. Liquidity and balance sheet strength
2. Revenue opportunities
3. Quality and cost structure leadership
Achieving these initiatives, as more fully described in the following sub-sections, will reinforce our competitive strengths.
Liquidity and Balance Sheet Strength. We believe our liquidity position and balance sheet provide us with greater flexibility and a commercial advantage over our competitors to pursue attractive investment opportunities. We focused this quarter on further increasing borrowing capacity and were successful, as more fully described in the Executive Summary-Liquidity section below. On August 18, 2009, we completed a secondary equity offering and raised $274,980, net of offering expenses. As a result, we ended the quarter with $408,869 of liquidity, which is more than triple our recourse borrowings of $120,781, and $720,221 of unused lines of credit. The unused borrowing capacity in the Servicing business may be utilized in the future by pledging additional qualifying collateral to our facilities.
We negotiated a significant change to our advance financing facilities during the third quarter whereby we are permitted to borrow less than the maximum available funds. This enabled us to minimize interest expense by reducing our intra-quarter cash balances. We reduced our third quarter interest expense by $620. Third quarter other expense, net, reflects a $1,600 net gain resulting from the early termination of the $165,000 medium term advance note in anticipation of a TALF offering. This gain includes the realization of an unamortized basis adjustment from the prior extinguishment of a related hedge position, partly offset by early termination consent payments to note holders and recognition of unamortized financing costs.
We believe an offering under the Term Asset-Backed Securities Loan Facility program (TALF) will enhance our liquidity and balance sheet. We expect to issue an initial TALF note of $165,000 to $200,000 and expect to raise an additional $200,000 to $300,000 via the TALF facility shortly thereafter.
• Acquisition of Servicing Rights. We expect $50 billion of mortgage servicing portfolios to come to market by the end of the first quarter of 2010.
• Subservicing Opportunities. We were awarded $9.7 billion of subservicing on October 29, 2009. Advances on this portfolio are financed by the servicer, not Ocwen.
• Special Servicing Opportunities. We are aggressively pursuing special servicing opportunities. In February 2009, we were selected as a special servicer of non-performing loans for Freddie Mac under a high-risk-loan pilot program. On August 10, 2009, we entered into an Interim Servicing Master Agreement under which we will provide mortgage loan servicing with respect to approximately 24,000 non-performing single family mortgage loans owned by Freddie Mac with an aggregate UPB of approximately $4.4 billion. As with subservicing, special servicing requires limited capital.
• HAMP and Non-HAMP Modifications. We expect completed loan modifications for the fourth quarter of 2009 to increase significantly to approximately 10,000 to 15,000.
Quality and Cost Structure. As detailed under Superior Loss Mitigation and Cash Management above, two recent independent studies comparing servicer performance in servicing non-performing residential loans confirmed that we lead the industry in realizing cash flows for investors and keeping families in their homes. We were able to reduce operating expenses by 31% in the third quarter of 2009 compared to the third quarter of 2008 and 20% in the first nine months of 2009 compared to 2008.
Separation of Ocwen Solutions. We completed the Separation on August 10, 2009.
On November 12, 2008, our Board of Directors authorized management to
pursue the Separation, through a tax-free spin-off into a newly formed
publicly-traded company, of all of our business operations currently included
within the OS business line except for BMS Holdings and GSS. In accordance with
Section 367 of the Internal Revenue Code, Ocwen incurred income tax expense of
$50,631 determined based on the excess of the fair market value of Altisource
assets over Ocwen's tax basis in the same assets.
We made our decision based upon a strategic analysis that concluded that the Separation would:
• Allow each of Ocwen and Altisource to separately focus on their core business and be better able to respond to initiatives and market challenges;
• Better position OS to pursue business opportunities with other servicers;
• Provide OS the option of offering its stock as consideration to potential acquisition targets (subject to certain limitations);
• Grant OS flexibility in creating its own capital structure which may include a subsequent raise of equity or debt; and
• Allow potential investors to choose between the contrasting business models of knowledge processing or servicing, each of which may be valued differently by the equity markets.
On August 10, 2009, the shares of Altisource were distributed to the Ocwen shareholders and Convertible Notes holders of record as of August 4, 2009, in the form of a pro rata stock distribution. Each Ocwen shareholder received one share of Altisource common stock for every three shares of Ocwen common stock held as of the close of business on the record date of the distribution, August 4, 2009. Each Convertible Notes holder participated in the distribution of Altisource shares based on the conversion ratio of the Convertible Notes, consistent with the pro rata distribution ratio of one share of Altisource common stock for every three shares of Ocwen common stock, without conversion of the Convertible Notes into common shares of Ocwen. Accordingly, upon the separation of Altisource and Ocwen, there was no adjustment to the conversion ratio of the Convertible Notes.
Altisource's largest customer will initially be Ocwen, and Altisource entered into long-term services contracts with Ocwen for terms of up to eight years. There are other arrangements between Altisource and Ocwen that will continue following the Separation to govern certain ongoing relationships and to provide for an orderly transition to the status of two independent companies. Under these agreements, Altisource and Ocwen will both provide and receive certain corporate services at prevailing market rates. See Note 23 to the Interim Consolidated Financial Statements for additional details of the contractual agreements between Ocwen and Altisource.
Although Altisource is a separate company from Ocwen after the Separation, Altisource and Ocwen have the same Chairman of the Board, William C. Erbey. Mr. Erbey is also the current Chief Executive Officer of Ocwen and will remain in that role. (Mr. Erbey will serve as Altisource's Non-executive Chairman). As a result, he has obligations to Ocwen as well as to Altisource.
Outlook
Revenue of our servicing segment is a function of UPB and the number of delinquent loans that resolve either through borrower payments, modifications (HAMP and non-HAMP) or through REO sales. The importance of loan resolution is heightened by our revenue recognition policies. We do not recognize delinquent servicing fees or late fees until cash is collected.
1. When a loan is brought current via our non-HAMP modification process, we earn $500 on deferred servicing fees and $500 on late fees.
2. When a loan is brought current via our HAMP modification process we earn $500 on deferred servicing fees, forfeit $500 of late fees and accrue $1,000 in HAMP success fees, or $1,500 if the loan was in imminent risk of default. However, if the loan is in imminent risk of default there will be no deferred servicing fees.
We conceptualize the flow of loan modification activities as a pipeline leading to modification of the loan or sale of the REO. The following process describes our modification pipeline:
1. First, the loan and borrower are evaluated for HAMP eligibility. If the criteria are met, then the HAMP documentation and trial offer phases proceed. The three most common reasons for failure to qualify for HAMP are inability to meet the debt to income (DTI) ratio, inadequate documentation or inadequate or inconsistent income.
2. If the criteria to qualify for HAMP are not met, then the loan and borrower are evaluated utilizing non-HAMP criteria that are more flexible than HAMP and focus on ability to pay and maximizing returns for investors. If the criteria are met, then the non-HAMP documentation and trial offer phases proceed.
3. If the loan and borrower qualify for neither a HAMP nor a non-HAMP modification, then liquidation proceeds via either the short sale or foreclosure and REO sales process.
For the nine months ended September 30, 2009, 4% of completed modifications have been HAMP and the remaining 96% non-HAMP. The split between HAMP and non-HAMP modifications is to be expected since the earliest period in which completed HAMP modifications could occur was the third quarter. As of September 30, 2009, 53% of active trial modifications were HAMP and 47% were non-HAMP.
Completed modifications have been lower in the second and third quarters of 2009 than in prior quarters due to the challenges in collecting the requisite documentation from borrowers and changes in our work streams required by the HAMP program. At this point, the principal process and system enhancements have been placed in production.
We completed 7,003 modifications in the third quarter of 2009, of which 1,229 were HAMP and 5,774 were non-HAMP. The number of completed modifications in the third quarter of 2009 is 14% lower than the 8,157 modifications completed in the second quarter of 2009.
The number of completed modifications correlates with the number of trial offers made to borrowers in the prior quarter, and this figure declined by 72% from the first quarter of 2009 to the second quarter. Trial offers increased by 39% in the third quarter of 2009 compared to the second quarter of 2009. Active trial modifications represent an inventory of potential completed modifications in the following quarter. We expect the 6,937 active trial modifications in the third quarter of 2009 to contribute about half of the completed modifications in the fourth quarter of 2009 with the remainder coming from non-HAMP modifications initiated and completed in the fourth quarter. We expect to complete 10,000 to 15,000 total modifications during the fourth quarter of which approximately 20% to 30% are likely be HAMP modifications.
Liquidity
Cash totaled $195,584, or 10% of total assets at September 30, 2009. This compares to cash of $201,025, or 9% of total assets at December 31, 2008, and cash of $162,306, or 7% of total assets a year ago at September 30, 2008. Cash and available credit on advance facilities (representing undrawn capacity for which collateral has been pledged) totaled $408,869 as of September 30, 2009. Cash and available credit as of June 30, 2009 was $213,911. Thus, our cash and available credit increased by $194,958 or 91% through the quarter. The net increase is less than the net proceeds from our common stock offering having paid off other borrowings of $77,842.
Our borrowings as of September 30, 2009 include $167,168 borrowed under the investment line term note that is used to finance the auction rate securities that we are carrying at a fair value of $250,099. In the first nine months of 2009, we repaid $33,551 of the investment line term note principal. This amount includes proceeds of $2,500 from the redemption at par of certain securities. On April 30, 2009, we renewed this term note through June 2010. We renewed this agreement early under terms substantially similar to the previous agreement except that amortization payments are now $3,000 per month.
Excluding the investment line, our borrowings have decreased by $517,918 since December 31, 2008. The decline in borrowings of the Servicing segment reflects a decline in advances and the $97,987 repayment of our MSR facility, including a final payment of $41,994 on August 21, 2009. The decline in borrowings of the Loans and Residuals segment represents the early redemption of the $18,154 note on which the loans had been pledged as collateral, including a final payment of $11,315 on September 23, 2009. Corporate Items and Other borrowings declined as a result of the $33,551 repayments on the investment line through September 30, 2009 and the February 2009 repurchase of 3.25% Convertible Notes with a face value of $25,910.
Excluding the investment line, our total maximum borrowing capacity was $1,317,000 as of September 30, 2009, a decrease of $23,747 as compared to December 31, 2008. This decrease is primarily due to a decline in the borrowing capacity of the Loans and Residuals and Financial Services segments. The continued strength in Servicing borrowing capacity is principally the result of entering into two new facilities in March 2009, expanding an existing facility in May 2009 and the early termination of a $165,000 medium term advance note in anticipation of a TALF offering. One of the new facilities represented a $60,000 advance in the form of zero-coupon bonds that we initially recorded at $45,373, net of a discount of $14,627. The other new facility is a $7,000 term note. Both of these new facilities are secured by the pledge of advances. We also increased the maximum borrowing capacity under an existing facility from $300,000 to $500,000 and extended the amortization date by one year to May 4, 2010.
With the continuing decline of our advance balances and the success of our other liquidity initiatives, we believe that we will have sufficient borrowing capacity to finance advances on our current servicing portfolio through the first quarter of 2010 even if we are unable to negotiate any new facilities or any renewals or increases of existing facilities. However, we anticipate issuing an initial fixed-rate medium term TALF note of $165,000 to $200,000.
In the first nine months of 2009, financing costs declined from the level in the first nine months of 2008 due to lower advance balances and the strategy we implemented to reduce interest expense by using our cash reserves and proceeds from our equity offering to reduce advance finance borrowings. One-month LIBOR, which is the reference rate for most of our borrowings declined significantly in the first nine months of 2009, although the effect of this decrease on our cost of borrowing was more than offset by higher facility costs and higher average spreads over LIBOR. As a result, the interest rate we incurred on the average balance of our debt outstanding under match funded facilities and lines of credit and other secured borrowings increased to 6.86% for the first nine months of 2009 from 6.22% for the first nine months of 2008.
CRITICAL ACCOUNTING POLICIES
Our ability to measure and report our operating results and financial position is significantly influenced by the need to estimate the impact or outcome of risks in the marketplace or other future events. Our critical accounting policies are those that relate to the estimation and measurement of these risks. Because they inherently involve significant judgments and uncertainties, an understanding of these policies is fundamental to understanding Management's Discussion and Analysis of Results of Operations and Financial Condition. Our significant accounting policies are discussed in detail on pages 24 through 27 of Management's Discussion and Analysis of Results of Operations and Financial Condition and in Note 1 of our Consolidated Financial Statements for the year ended December 31, 2008 included in Exhibit 99.1 on Form 8-K filed July 16, 2009. Such policies have not changed during 2009.
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