OCN - Ocwen Financial

[maxthetrade]

But Mr. Eisman was much more upbeat about the situation in the United States.

 

He singled out Ocwen Financial as a mortgage company that seemed undervalued, arguing that it would generate more than $1 billion of cash flow next year. The company’s stock, he said, represents a “powerful” and “counterintuitive” bet on housing.

 

Ocwen’s stock climbed as much as 3 percent after the remarks, and then gave up some gains to close up 1.6 percent, at $39.76 a share.

 

“Once in a while you come across a stock that is just completely and utterly mispriced, and that company is Ocwen,” he said.

 

 

Anyone familiar with Ocwen?

 

[ItsAValueTrap]

It seems to me that you should rather own Altisource (ASPS) or AAMC than Ocwen.  (AAMC is probably overvalued right now.)

 

Overall, Erbey’s empire looks something like this:

 

Altisource Asset Management (AAMC) – 30.1%

Altisource (ASPS) – 25.4%

Altisource Residential (RESI) – 25.3%

Ocwen (OCN) – 13.2%

Home Loan Servicing (HLSS) – 2.8%

 

Because his greatest stakes are in Altisource and AAMC, those are probably the companies you want to own.

 

I've written about Altisource here:

http://glennchan.wordpress.com/tag/altisource-asps/

[Phaceliacapital]

Anyone looking at this stock with recent price weakness?

[Phaceliacapital]

Not a good way to start my analysis :D

 

UPDATE 1-Investors mull action against Ocwen Financial -source

 

http://www.reuters.com/article/2014/02/12/blackrock-idUSL2N0LG23J20140212

[Phaceliacapital]

http://seekingalpha.com/author/michael-spacey/instablog

 

Did a good write up on the real cash flows + some comments on the recent situation.

[bz1516]

Everything about OCN is counter-intuitive.  It's price is driven by potential acquisitions.  Yet anything that makes the business more profitable drives the price of the stock downward as it makes it less likely the sellers will want to sell or else make the cost of the acquisition more dear. 

 

At the same time companies that have their own origination platforms therefore less reliant on acquisitions seem to get hurt because the earnings are more volatile even though without these platforms the assets are depleting.

 

An enigma inside a riddle.  It was one of my most profitable trades and in retrospect least understood.  Just lucky I guess.  With the end of the acquisition trail getting closer I wouldn't touch any of them, OCN, WAC or NSM.

[scorpioncapital]

selling option insurance on these mortgage servicers is making crazy profits.

 

27% return on collateral with a put that is 44%(!) out of the money, on a stock that is already relatively inexpensive and expires in 6 months.

 

Even if the entire origination business shuts down and the only thing left is existing servicing, the risk reward profile is exceedingly tempting.

 

 

 

 

 

[greenbriar]

selling option insurance on these mortgage servicers is making crazy profits.

 

27% return on collateral with a put that is 44%(!) out of the money, on a stock that is already relatively inexpensive and expires in 6 months.

 

Even if the entire origination business shuts down and the only thing left is existing servicing, the risk reward profile is exceedingly tempting.

 

Which exact options are you seeing this return on?  I only see one put for Oct 2014, and it's firmly in the money?

[yitech]

A House With a Modified Loan Is a Symbol of Servicers’ Tug of War With Investors

http://dealbook.nytimes.com/2014/02/27/a-house-with-a-modified-loan-is-a-symbol-of-servicers-tug-of-war-with-investors/

 

"Regulators that have taken aim at Ocwen in recent months for its practices also face a dilemma. While they may have raised questions about the company’s practices, the firm may in fact be more efficient, and more supportive of homeowners, than its rivals. As the regulators lean on Ocwen, it may hamper its ability to grow, leaving more servicing in the hands of large banks, which were criticized for the way they handled the torrent of foreclosures after the financial crisis."

 

[jay21]

Erbey: I certainly get those questions asked. I'll tell you how I got all the shares that I have in each company, they were related to just spins out of the original. I haven't really bought or sold much at all ever, and so if you were an original Ocwen shareholder, you would have an investment profile, and if you didn't sell or buy anything, you'd have an investment profile very similar to mine. All the shares have been through the creation of value of those companies.

 

I don't have enough extra liquidity to true up -- if one company's doing better or worse at any given point in time, I don't run around with a hundred million free cash just to buy more shares.

 

We started the company. We had a few invested alongside me at the beginning. In that period in time, you would have relatively the same, and hadn't sold anything, just do what I did, you'd have the same number of shares.

 

It's just impossible. I get paid a very good salary, but I am not anywhere close to what I could do bearing other wealth. I've kept almost all our money invested in the companies, as you can tell by the data I just gave you, right? The numbers become in such magnitude, I can't true them up every day. I'm not selling stock. I'm not selling to one company and reinvesting in another. I'm not moving that stuff around.

 

http://www.thestreet.com/story/12087139/1/ocwen-chairman-bill-erbey-talks-housing.html

[jay21]

Great article on Erbey: http://www.thestreet.com/story/12083751/1/bill-erbey-made-23b-off-your-underwater-mortgage.html

 

"Erbey's dedication to his work is undisputed among colleagues and business associates.

 

"The guy is a workaholic," says Lee Cooperman, Chairman and CEO of Omega Advisors, which owns shares in three companies Erbey oversees.

 

Erbey says he works between 70 and 75 hours per week, but age has slowed him down.

 

"It just becomes physically more difficult to put in 80 or 100 hours a week," he says. In 1983 and 1984, he and his wife Elaine, who used to work with him but has since retired, "literally worked every day but one day for two years."

 

I asked a former manager at Ocwen what Erbey does for fun, and he responded, "you don't get it."

 

Erbey laughed when he heard this.

 

"One of my investors called me up one time and wanted to take me shark fishing. I said 'I'll do it for you if you want, but I'll make more money for you if I go to the office.'"

 

Erbey's admirers say he has a dedication to creating shareholder value that is something like an obsession.

 

Ross cites the recent move of Ocwen's top management to the Virgin Islands to save on taxes.

 

"In order to make that really work, and not just be a phoney boloney gimmick, it became necessary for him to move there. I don't know if you spend a lot of time in St. Thomas, and I certainly don't mean to disparage it, but there not a lot of people, who are wealthy people, who live in Palm Beach, who would welcome moving to St. Thomas. He did that simply to make his company better. And when you think about how wealthy he's become, it's really quite amazing," Ross says."

 

"Splitting up the businesses doesn't necessarily make them simpler, however. Erbey says creating HLSS allows Ocwen to fund itself less expensively than it would be able to do on its own.

 

The key lies in the fact that HLSS pays a dividend.

 

"When stocks pay dividends people require lower returns. You can argue about whether that's right or wrong but it is a fact," says one investor in a few of Erbey's companies. The investor acknowledges, however, that creating HLSS merely to buy MSRs from Ocwen is "just splitting up the pie in different ways." (He says he doesn't want to discuss this on the record because he doesn't want the hassle of having other investors calling him up to argue about this point.)"

[accutronman]

In Barron's this week, while Doug Kass is bearish on the overall market, he's a believer in Ocwen:

 

Do you still see any opportunities in the stock market?

 

One of my long holdings is Ocwen Financial [OCN], a leading player in origination and servicing of subprime loans. The nonprime mortgage business is likely to undergo a renaissance. No company is better positioned than Ocwen, the largest player in subprime. Prior to the financial crisis, about 60% of U.S. households could qualify for a prime mortgage, and about 10% could qualify for a subprime mortgage. The remaining 30% were renters. Postcrisis, approximately 30% of households qualify for a prime mortgage, and subprime is almost nonexistent. So unless we're destined to become a nation of renters, something has to change. At the same time, the recent rise in home prices hasn't coincided with income gains for average home buyers. That represents an opportunity for nonprime mortgage companies. Gone are the days of low- and no-documentation nonprime loans. Today, these loans are very secure. The nonprime industry space has been abandoned and created a void for Ocwen.

[jay21]

From one of their presentations:

 

Strong cash-flows and under-levered balance sheet provides ability to fund future

growth and increase returns on equity

 Existing book with modest cash reinvestment rate and improving economy generates over $10

billion of present value at a 10% discount rate

 Estimated capacity of approximately $6 billion to fund new acquisitions without raising equity

 Stock repurchases and debt-funded growth should drive higher ROEs

 

 Sustained history of growth in servicing portfolio

 Compound annual growth rate of 35% in unpaid principal balance (UPB) since 2000*

 Over $480 billion servicing portfolio at the end of Q3 2013 on a pro forma basis*

 From 2012 through September 2013, acquired more than $325 billion in servicing

 

 Substantial growth prospects

 Embedded growth from existing book and improving economy

 $400 billion pipeline of opportunities that may close over next 12 to 18 months

 Adjacent markets and other long-term opportunities

 

I may be having "crack brain" syndrome for the 2nd time this week, but this looks like a pretty good deal.  Current MV ~5b.  A base case might be a MV of ~10b consistent with their number above and they probably have a few levers that can drive that MV potential higher with new origination platforms, more servicing transfers, etc.  More digging to do on this one.

[ItsAValueTrap]

It's just impossible. I get paid a very good salary, but I am not anywhere close to what I could do bearing other wealth. I've kept almost all our money invested in the companies, as you can tell by the data I just gave you, right? The numbers become in such magnitude, I can't true them up every day. I'm not selling stock. I'm not selling to one company and reinvesting in another. I'm not moving that stuff around.

 

At AAMC he is taking a lot of stock-based compensation.  It's a subtle form of insider trading especially because there's a wealth transfer from RESI-->AAMC and to a smaller degree ASPS-->AAMC if Altisource's title insurance flow turns out to be crazy profitable.

 

Title insurance is normally ridiculously profitable because homeowners do not shop around.  Most people use the mortgage originator's preferred title insurance company (the paperwork will go through faster).

[ItsAValueTrap]

Moving to the US Virgin Islands is pretty hardcore though.  To take advantage of the tax incentives, I believe he actually has to live there for more than 6 months out of the year.

[jay21]

Latest call transcript highlights:

 

"With respect to capital, Ocwen is also in a different position than other nonbank servicers. Ocwen is the best capitalized public nonbank servicer by a large margin, as you can see on Slide 4. We affirm our equity and net worth relative to debt compared to our peers. By other metrics of balance sheet strength, such as debt coverage ratio, we are similarly stronger. You can see that we show both unadjusted and adjusted levels. This is because, unlike our peers, we carry our MSRs at the lower of cost or market rather than marking them to market. Were we to mark to market our MSRs, we would to substantially increase book equity."

 

"Next, I would like to cover developments on our mortgage lending operation. Yesterday, we closed our first notes issuance under our new Ocwen Asset Servicing Income Series or our OASIS program in a private placement. These notes were secured by Ocwen-owned mortgage servicing rights relating to $11.8 billion in unpaid principal balance of Freddie Mac 30-year fixed-rate mortgages. This financing is an example of an Ocwen innovation that should substantially improve our ability to compete in the prime origination space.

 

Notice that I said prime, not subprime. Ocwen has always been concerned about our exposure to prepayment risk inherent in prime mortgage loans. As a result, we've been somewhat tentative in our pricing of such assets. Now with OASIS, we can originate prime loans and sell the prepayment risk to investors seeking such exposure. And with OASIS, our cost of capital is now more than competitive with commercial banks. The OASIS transaction also demonstrates the substantial unrealized value in our prime servicing portfolio. On the deal we just closed, the assets in the transaction were on our books at a 3.1 multiple of the servicing spread, while the notes traded at a 5x multiple. Therefore, the market is pricing the servicing at more than 1.9x 31 basis points, over 59 basis points of UPB higher than we were carrying the servicing on our books, and also substantially higher than the third-party marks utilized in Slide 5.

 

Also, the bid in the aftermarket is up significantly. Based upon the aftermarket bid/ask spread of 5.2 to 5.5x the servicing fee, the difference increased to between 65 and 74 basis points of unpaid principal balance. I might point out that we have over $260 billion of agency servicing. If one remembers back to the ResCap transaction, pundits claimed that we overpaid for that acquisition. I can assure you that whether it be ResCap or more recent acquisitions, we're very focused on our return profile, which we believe is as strong today as it has ever been. Ocwen continues to evaluate other adjacent business opportunities that will benefit from our operational capabilities and where we can deploy our capital at high rates of return. I would hope to have a substantial update on our second quarter earnings call.

 

Our relatively low leverage, combined with our substantial positive cash flow, means that we can both fund new investments and repurchase stock to maximize returns on equity. As we have noted previously, the cash flow generated by Ocwen is sizable. Our revenue run rate is now over $2 billion annually. Moreover, the value of our existing portfolio will generally increase as the economy improves. This is true for a few reasons. First, higher interest rate slow [ph] prepayments, especially on our prime portfolio, which prepaid at an annual rate of 14.5% in the fourth quarter. On our non-prime portfolio, the fourth quarter constant prepayment rate or CPR of 11% was at an all-time low for at least the past few years. Most non-prime prepayments are a result of principal reduction modifications, REO sales, short sales or charge-offs. As we improve performance through our loss mitigation efforts and the economy improves, prepays should continue to decline.

 

Lower delinquencies also mean lower operating cost, as it's far less expensive to service a performing loan versus a nonperforming loan. Lower delinquencies also reduce advances and related interest expense. All of this means that we expect our existing portfolio will generate substantial value.

 

In addition, we believe that our company has substantial value embedded in our operating capabilities, both through our existing business and, more importantly, new business line. A source of strength should not be turned upside down. The fact that we did not need to do any new business to maintain high levels of profitability does not mean that this is how we should be valued. Rather, our sizable intrinsic cash flow, combined with substantial competitive advantage, should suggest we are worth a sizable premium for the net present value of our future cash flow.

 

With all this in mind, we will continue to be a buyer of our common stock under our authorized $500 million stock repurchase program. Generally, our goal is for our purchases in the first 3 months following our earnings announcement to be at least as much as our prior quarter's earnings, keeping in mind our desire to maintain the strongest capital ratios in the industry. Nevertheless, we may purchase more or less in any given time period."

 

"Let me update you on our share repurchase activities in the fourth quarter of 2013. We purchased 1.1 million shares at an average price of $53.34 per share, for a total value of $60 million. And as Bill said, we will continue to be a buyer of our own stock."

 

[yadayada]

Can someone explain me this business?

 

As I see it now, a bank loans money to some family to buy a house. Now they dont want to have to worry about collecting it, so they sell the right to collect interest etc from the family to a company like Ocwen. If they would receive a 500$ fee for that each year, Ocwen would buy this right for like 1500$ or something from the bank?

 

So the value they provide, they specialize in collecting loans for the bank basicly, and in return the bank pays them a sliver of what they make of the loan. And the bank also gets some money upfront.

 

And their edge is that they have a different system of doing this then their competitors. They also use Altisource, and you need to have this different set up to collecting then almost all their competitors have, to actually use the Altisource products (software mostly?). This would require a radical reorganization for their competitors and this isnt likely to happen. I think they can set up operations on Philipines , and all they have to do is read up the lines provided by this software? So you dont need skilled collectors, and you can expand business quickly.

 

So they are the low cost provider, they dont take any risks really. Except if they pay too much for servicing rights? And this is where their jolly and bigboned CEO comes in, he seems extremly dedicated and skilled. So this wont be much of a risk.

 

Am I missing something here?

[ItsAValueTrap]

So you dont need skilled collectors, and you can expand business quickly.

You do need somewhat skilled collectors.  The ideal collector:

- Is trained.

- Follows the script.  Because some people don't.

- Has empathy

- Won't leave because they don't like the job.  (Employee churn is a little high.)

- Does well based on metrics used to measure their performance as well as QA where their supervisors listen to their calls

- Speaks English reasonably well??  In general, Americans do not like call center employees with Indian accents.  Some people find the accent very difficult to understand, especially if they live in an area where there are no Indians around.  There are probably some xenophobic Americans too.

I might be forgetting something else.

 

Sometimes these call center employees are kind of like debt collectors.  They have to convince homeowners to stay current on their mortgage.

Sometimes a homeowner will definitely lose his or her home.  The call center employee has to convince the homeowner to voluntarily leave without messing up the home.  If the homeowner doesn't, the formal foreclosure process costs thousands of dollars (more depending on damage to the home).

[ItsAValueTrap]

Mortgages themselves are complicated.

They are often packaged together into securitization deals.  Things get even more complicated.

 

a- There are pools of mortgages backed by Fannie and Freddie ("agency").  These are easier to analyze (because they're less risky) and understand than b.  Fannie and Freddie impose certain rules on mortgage servicing.  Some of these rules are good (Fannie Mae for example pays the servicer for some foreclosure costs), some of the rules can be questioned.

b- There are pools of mortgages that investment banks churn out.  They may have acronyms like MBS and CDO.  In the past, they were responsible for the subprime crisis.  They're very complicated.  I'm very surprised that people thought that these were a good idea.  I would be shocked if the people buying these truly understood what they bought.

 

When I say that mortgage securitizations are complicated... I'm not kidding.

[yadayada]

and it seems people are thinking this is sort of the same thing as those MBS and CDO's, while what they are doing is relatively straight forward?

 

And now there is a politician who is abusing this by using people's ignorance about this to gain his political career?

 

ALso Ocwen does subservicing. So they dont even take the risk of having to buy these service rights. They service for other servicers. Sort of an inception in servicing. :D . This makes it lower margin, but more capital light?

 

Also, it seems upside on this is anywhere between 100-300% right (possibly more with buybacks)? What is upside (and risk) like for altisource? Is there more upside leverage if you buy them? If there is not business left for these guys, then altisource will dry up too right? Because for them to sell this to other Mortgage servicing providers they would have to radicallly change their business model?

 

It seems subprime is largely untapped right now, and there is a pretty good growth runway left. And it seems you get to join with very excellent and an extremly committed operator.

 

- Won't leave because they don't like the job.  (Employee churn is a little high.)

Is this a problem?

 

some write ups on altisource and Ocwen that havent been posted yet I think

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/114927

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/17622

http://oraclefromomaha.wordpress.com/2014/04/29/altisource-portfolio-solutions/#comments

 

[ItsAValueTrap]

If you want to simplify things, there are basically two things you need to understand with Ocwen.

1- The risk of the mortgage ending early.

2- Does Ocwen have a low-cost advantage?

 

If you simply assume that the answer to #2 is yes, then the story is not that hard to understand.  Ocwen is buying back its shares partly because it sees value in its franchise.  Because they are the low-cost operators, the stock deserves to trade at a premium to what its assets are worth.  (e.g. similar to how a well-managed restaurant deserves a premium to what it would cost to buy the exact same equipment and furnishings.)

 

Now to #1.  The mortgage ending early is bad because it prematurely terminates the servicer's stream of fees.

 

Mortgages can end early if the homeowner chooses to refinance.  This depends on interest rates, how loose lending standards are, and whether or not home prices are rising.  It seems likely to me that interest rates will go up, lending standards will get tighter, and that home prices won't rise as fast as the housing bubble days.  This is very good for Ocwen.

 

Mortgages can end early due to foreclosures.  Usually caused by unemployment.  Foreclosures are usually very expensive for the mortgage servicer.  For non-agency MBS, the servicer often doesn't get compensated for dealing with the foreclosure.

 

Some people have variable-rate mortgages.  If the interest rate goes up and the homeowner cannot afford the higher mortgage payments, then there is a problem.  This will result in a foreclosure or a loan modification. 

 

Some people have ARM mortgages.  When this type of mortgage results, there may be problems.  In the subprime days, a lot of silly ARM mortgages were originated.  I believe that most of the ARM mortgages have reset by now.

 

Some people have "NINJA" mortgages.  They lied about their income and/or their job.  If they are self-employed and their income fluctuates a lot, then they might have problems with their mortgage.  Normally, mortgage originators are extremely wary about lending money to the self-employed.  But crazy stuff happened during the subprime crisis.

 

Mortgages can end early if somebody decides to sell their house.  In other countries there is a penalty for terminating the mortgage early; America doesn't have that.

 

---

Anyways, if you want to simplify things, just assume that mortgage servicing rights depend on interest rates.

 

If interest rates rise a lot, then it is bad.  A MSR is like a bond.  Bonds lose value when interest rates rise.

 

If interest rates fall a lot, that is also bad.  People refinance their homes.

[jay21]

The front part of the curve also matters as servicers earn float on collections.

[ItsAValueTrap]

and it seems people are thinking this is sort of the same thing as those MBS and CDO's, while what they are doing is relatively straight forward?

It's not so straight forward because they have lots of exposure to interest rate risk.  You need to understand the macroeconomic forces that can hurt them.

 

Altisource is somewhat simpler.  They just take fees.  No prepayment risk.

However, Altisource has a very large number of adjacent businesses.  They have a business that helps mortgage servicers deal with delinquent mortgages (default services).  As the number of foreclosures come down, that market will shrink. 

 

And now there is a politician who is abusing this by using people's ignorance about this to gain his political career?

Yeah that is a big issue right now.

 

I think that the high costs of regulation are good for companies that specialize in mortgage servicing.  Without onerous regulations, more mortgage owners would service their own mortgages.  A long time ago, banks used to service the mortgages they originated.  Nowadays, few banks want to own mortgages and very few of them want to service mortgages.

 

In the short term, this regulation causes short-term pain.  Ocwen wants to buy more MSRs but it can't.  Its cost of servicing will go up a little because it has to comply with the cost of new regulations imposed on it.

But in the long run, the banks that are securitizing mortgages want to sell their MSRs to companies like Ocwen.  The MSR market is about to get even larger.  In the past, investment banks would hold onto the MSRs from the mortgage pools that they securitized.  Now these investment banks are getting out of that game.

[ItsAValueTrap]

The front part of the curve also matters as servicers earn float on collections.

 

Overall, I think that the servicers have negative float because they need to put up advances.

 

If a mortgage becomes delinquent, the servicer still has to pay advances to the mortgage investors.  Only after that mortgage is dealt with do they get their advances back.  These advances suck up a lot of capital.

[yadayada]

alright thanks for explaining.

 

There is also another tailwind and that is new banking regulations regarding MSR's right?

http://seekingalpha.com/article/522501-the-opportunity-in-mortgage-servicing-rights

 

One of the biggest changes in capital definitions for U.S. banks involves mortgage servicing rights. Under Basel III, banks will be allowed to include only a maximum 10% of mortgage servicing rights in their capital measures. Any amount above that is deducted; and then, in combination with financial holdings and deferred tax assets, that can only be up to 15% of aggregate capital. In contrast, under current rules mortgage servicing rights are included in capital up to 90% of fair value or book value, whichever is lower.

 

And also I am assuming that if you buy Ocwen, you buy into Erbey. And that lowers the risk of those NINJA, ARM mortgages etc.

 

You say that ASPS has the more attractive business model with less risk, but part of that is also priced in already right? And it seems at 33$, Ocwen is relatively cheaper here?