OCN - Ocwen Financial

[davidoosnk]

On the bright side it's the type of thing that enables people to buy stocks for less than they're worth :)

[cogitator8]

Does anybody have any insight into this repo fiasco going on and how it can affect OCN's funding ?

[davidoosnk]

Could you please elaborate on the "repo fiasco"?

[cogitator8]

I meant reverse repo fed will use when they will raise interest rate. Will it affect OCN funding ?

[JayGatsby]

Is anyone still following this? I understood the large drop earlier this year when there was all the regulatory noise, but the recent drop from $12 to $7 seems overblown. The recent focus seems to be that the company is having trouble achieving profitability due to the added regulatory/compliance costs. Based on the balance sheet and the amortization of the MSRs it looks like the company can cover their equity value if they slowly liquidate (which is the current path they're on). Management's prior estimates were that there's at least $1B of MSR value not included in book value, although they seem to have backpedaled on this given the profitability issues (this slide isn't in their latest deck). Any enterprise value from the lending business would be incremental.

 

Am I missing anything here or is this a case of people ignoring a terribly complicated balance sheet (the balance sheet implies signifantly more leverage than they actually have) amidst a ton of negative press?

[valueinvestor82]

It remains one of my largest positions and I've been very frustrated with the apparent disconnect. I think you nailed it, based on my conversations with the actual analysts who made decisions to downgrade the stock. I can factually state that they are assuming $150 million is all that can be cut, which isn't enough for long term profitability "IF" they never grow again, which sounds ridiculous since they're so significant in the world of mortgage servicing. So a short term problem projected into perpetuity on some analysts spreadsheet. Another reason given is the uncertainty of California DBO coming up with something else, which would be unprecedented by any other action ever by the DBO. Klarman had maintained a big stake despite slightly trimming close to $12 last quarter.

[BeerBBQ]

Agree. Company continues to be priced as if short term issue is permanent.  Management team laid out specific steps for mitigating a multitude of issues over the past year and has been delivering on them.  I think part of the concern may stem from their not recognizing/being overly conservative with cost cuts related to MSR sales (want to make sure their are no issues - don't want to be too lean and have more compliance related issues with transfers?) and/or the amount of added expense of dealing with all those issues.  Investors are not willing to give them the benefit of the doubt that they will deliver on improving profitability even though they have made substantial progress rectifying many of the outstanding issues.  With the continued pay down of their term loan, compliance with NYDFS, NMS, etc. and general improved certainty as it relates to other issues, it seems that S&P should be more willing to improve rating and the NYDFS should allow them to grow again (possibly later this year?). 

 

I am interested in hearing from those with negative outlook to see what I may be missing.

[abitofvalue]

Agree. Company continues to be priced as if short term issue is permanent.  Management team laid out specific steps for mitigating a multitude of issues over the past year and has been delivering on them.  I think part of the concern may stem from their not recognizing/being overly conservative with cost cuts related to MSR sales (want to make sure their are no issues - don't want to be too lean and have more compliance related issues with transfers?) and/or the amount of added expense of dealing with all those issues.  Investors are not willing to give them the benefit of the doubt that they will deliver on improving profitability even though they have made substantial progress rectifying many of the outstanding issues.  With the continued pay down of their term loan, compliance with NYDFS, NMS, etc. and general improved certainty as it relates to other issues, it seems that S&P should be more willing to improve rating and the NYDFS should allow them to grow again (possibly later this year?). 

 

I am interested in hearing from those with negative outlook to see what I may be missing.

 

 

Since you want the negative outlook --  Let me play the devil's advocate (not short the stock):

 

Fist lets go big picture -

Well this management team claimed it was getting out of Agency servicing since its lower margin and highly sensitive to interest rates. Then after the stock dropped and investors/analysts pointed out that there isn't that much non-agency paper being written these days - it came back and said oh no OCN wasn't getting out of Agency servicing after all, in fact it was done with sales for now..  Wait a few months and the latest presentation says - they are looking at more agency servicing sales! WTF? Also, their entire reason for leaving Agency servicing makes no sense from the perspective that this same leadership team took OCN into agency servicing. If it was so low margin why did you get into it? And if its so interest rate sensitive why are you leaving it when interest rates are so low (pretty much cant get lower). Wouldn't holding on to it lead to higher values if interest rates rise over the next year? Is servicing margin on Agency servicing so low because OCN messed up and has to take write-offs on non reimburseable expenses?

 

On their claims about growing to be a top 20 originator. Sure that's a great idea.  Only they aren't even top 50 right now. Plus they want to grow through the consumer direct origination channel - a channel that is quite expensive to build out and it's not clear what OCN's advantage is. What they are trying to do is replicate Quicken's model of setting up a super-efficient call center model and compete on speed to close, cost and better targeting since they have better data (from servicing so many homes).  Sounds perfectly reasonable till you remember - OCN has no brand value with consumers. The few borrowers who know them - generally don't like them. They remain the most complained about mortgage servicer by some distance. Plus they are selling so much of their agency servicing, that's the core customer in a call center origination model, a refinance since the interest rate you can offer is below the current rate. That servicing is going to other servicers who are going to be offering the same product.  OCN;'s credit impaired customers are going to be a bigger underwriting risk and investors will rightly worry about reps & warranties / loan buybacks. OCN is also not going to have an obvious cost advantage what with their regulatory issues and them competing with a Wells Fargo or JPM. Some will point to non-agency customers but as with their strategy to shift to nonagency servicing - how will they fund these originations? Who is the buyer? Look at non-agency issuance its down big. If you want to play the recovery of nonagency residential mortgages there are surely better players than this one. 

 

Now even if you ignore all these points, think of OCN and what their typical call center is - relying on scripts and cheap labor in India service mortgages cheaply - how does that translate to mortgage origination? How receptive is the typical American homeowner going to be to an Indian call center employee telemarketing a refinancing or a new mortgage? How likely are real estate agents going to be to recommend OCN to their clients? Till they don't lay out a real strategy for the origination business I don't think it is going to be given much credit.

 

To say Management laid out a multitude of positive steps and is delivering on them is to ignore this management team was the same one that was leading the company last year when the issues came up. Sure Erbey is gone but the rest of the team is pretty much the same, sans a new hire in-charge of compliance which was forced on them after the whistleblower complained to the NMS. Another examples of their brilliance was touting the value of the calls a few months before transferring them NRZ. In short, Management isn't exactly loved or considered very credible these days.

 

Frankly, Management seems to be trashing around trying to figure out a strategy on the fly. Can't blame them - they were dealt a terrible hand but doesn't mean I have to give them my capital either.

 

Short term-

OCN's expense reduction target is absurdly low. Maybe they are being conservative in their guidance and they will deliver much much greater numbers but clearly they completely misunderstood their shareholder base by giving the guidance. The math is pretty straight forward - you cant sell the amount of servicing they are and cut expenses so little.  If they are being conservative to make sure there are no issues as they sell MSR - great but guess what as shareholders you are paying for the conservatism and costs will actually be cut only $150M. You may say that means eventually they will cut those - fine but that means profitability is a long way off because they will need to be conservative with expense cuts as run-off happens too.

 

They say they will build a bank-like compliance function - well that's expensive. I mean Dimon & Lloyd keep complaining about the regulatory burden so that seems like an expensive job for OCN to undertake as they are cutting expenses.  As discussed above, building a consumer focused origination channel is expensive.  They are also going to need to pay NRZ $3M / month for the S&P downgrade, the CA monitor, the NY DFS monitor, but I am sure those will be treated as one-time and somehow ignored from "normalized" cash-flows.

 

They keep touting their debt paydown - but a vast majority of it isnt voluntary. They have to use proceeds of asset sales to pay down debt. Infact that was part of the deal when they renegotiated their debt deals after the regulatory fiasco.  Also, I see some investors saying things like once debt is paid down, they wont have interest expense. That's not actually the case since their HLSS subservicing very much flows through the interest expense line.  IF advance rates don't start coming down fast, their incentive fees on those deals will be impacted.

 

Also achieving break-even or marginal profitability is meaningless.  What are shareholders going to get from that?  Till they can't grow servicing again or they lay out a real strategy for growth in origination's (or some other business), how are shareholders going to earn a return?  Not saying there is no way shareholder's win. Heck, the stock may be a 4x from here but I just don't see how you can get comfortable with what this business looks like in a few quarters let alone years. 

 

This notion that they are going to let the business run-off and run-off value is more than equity value is great theory. But how does this play out? At what point does management actually put it in liquidation and basically fire themselves. Wouldn't they be more likely to engage a strategic advisor and sell? In which case they get what book? or a little below book given their issues and profitability.. Is that much of a return worth the risks?

 

No position in the stock.  But a very interested observer.

[ItsAValueTrap]

the NYDFS should allow them to grow again (possibly later this year?). 

The Operations Monitor (already appointed by the NY DFS) will develop a set of benchmarks to measure Ocwen’s capability in boarding new MSR portfolios.  Once Ocwen can demonstrate that it can meet all of the benchmarks, Ocwen will be able to board new MSR portfolios.  Future servicing transfers are conditional on the NY DFS’ approval.  Its approval is “not to be unreasonably withheld” according to the consent order.

 

*In the past, Ocwen agreed to follow the NY DFS' servicing guidelines.  Ocwen more or less co-operated with the NY DFS and followed those guidelines, though some of the guidelines were vague and didn't set out benchmarks.  Then the NY DFS ****ed Ocwen over by going after them, even though Ocwen was complying with the NY DFS' servicing guidelines.  So you could make the argument that the NY DFS could try to change the rules yet again.

 

it came back and said oh no OCN wasn't getting out of Agency servicing after all, in fact it was done with sales for now..

Where does it say that?

 

If it was so low margin why did you get into it?

Ocwen purchased other mortgage servicers that had a lot of agency MSRs.

 

 

And if its so interest rate sensitive why are you leaving it when interest rates are so low (pretty much cant get lower).

I think their decision partly has to do with agency MSRs fetching higher prices, as other market participants chase yield.

 

 

Is servicing margin on Agency servicing so low because OCN messed up and has to take write-offs on non reimburseable expenses?

I don't think they messed up on agency servicing.  Fannie Mae has a STAR rating scheme for servicing from Fannie's perspective.  Ocwen has a good STAR rating; GreenTree's is better.  (If you want to look at mortgage servicing from the homeowner's perspective, then GreenTree is terrible according to the CFPB metrics while Ocwen and Wells Fargo are tied for #1.)

 

On their claims about growing to be a top 20 originator. Sure that's a great idea.  Only they aren't even top 50 right now. Plus they want to grow through the consumer direct origination channel - a channel that is quite expensive to build out and it's not clear what OCN's advantage is. What they are trying to do is replicate Quicken's model of setting up a super-efficient call center model and compete on speed to close, cost and better targeting since they have better data (from servicing so many homes). 

I do agree that origination is a tough business.  In the past, Ocwen was involved in originating subprime mortgages.  As US housing collapsed, they shut that business down.  They also held onto residuals and lost a lot of money on them, like everyone who held onto them (from a moral perspective, the right thing to do is to hold onto residuals because having skin in the game aligns your interests with the mortgage investors).

 

 

Some will point to non-agency customers but as with their strategy to shift to nonagency servicing - how will they fund these originations? Who is the buyer? Look at non-agency issuance its down big.

I think Ocwen is trying to stay away from subprime and non-QM origination, except for the Ginnie Mae reverse mortgages business (which can be characterized as subprime / higher delinquency lending).

 

If you want to play the recovery of nonagency residential mortgages there are surely better players than this one.

I don't see why higher-delinquency lending would be an attractive business.  That's why Ocwen is staying out of it.

 

Now even if you ignore all these points, think of OCN and what their typical call center is - relying on scripts and cheap labor in India service mortgages cheaply - how does that translate to mortgage origination?

I believe Liberty Home Equity Solutions (purchased by Ocwen) uses American call center employees.  I don't think Ocwen has plans to use Indian reps there??

 

The idea behind origination is to try to use technology to drive efficiencies there... which would probably look a lot like Quicken Loans.

 

To say Management laid out a multitude of positive steps and is delivering on them is to ignore this management team was the same one that was leading the company last year when the issues came up.

I'm not sure that management deserves a lot of criticism here.  If they could jump in a time machine, here's what I think they would have done differently:

 

1- In hindsight, Ocwen's biggest issue was that the NY DFS went after them.  I'm not sure how Ocwen could have reasonably avoided that.  In terms of servicing quality from the consumer's perspective, Ocwen and Wells Fargo are tied for the least number of failed CFPB metrics.  So their servicing quality was pretty good.  (*The CFPB metrics don't measure how aggressive the servicer is in giving out loan mods / free money.)  In hindsight, they should have spent more money on improving servicing quality.  Without the benefit of hindsight, I think that would have been a really, really difficult move to make.  To make that decision, you would have needed to be extremely risk adverse.  And because higher servicing quality would hurt your profits, maybe you'd just look at getting into another business altogether.

 

2- In hindsight, Ocwen becoming the #2 servicer would have been helpful.  Because Ocwen has the most delinquent mortgages, it got the most complaints and got into the press the most.  For whatever reason, the NY DFS went after Ocwen and only Ocwen.  One of Lawsky's speeches mentioned Ocwen's rapid growth and cost savings as reasons to doubt Ocwen.  Ex ante, I doubt that anybody would have made the decision to become the #2 servicer (in New York).

 

3- In hindsight, Ocwen should have changed the terms of its HLSS financing and gave fewer protections to HLSS.  The servicer ratings clauses in the contract led to unintended effects.  Ocwen's risk management could have been better because it ended up in a run-on-the-bank type situation.

 

4- Not piss off the California DBO.

 

On the other hand, NSM somehow managed to avoid getting badly hurt by the NY DFS.  Personally, I think that NSM got lucky.  Ocwen behaved the best and still got screwed.

 

 

I think a huge problem for Ocwen is that subprime mortgage servicing is not a good industry right now.  Right now, their high-delinquency book is running off and they don't have good options for getting more high-delinquency MSRs.  Very few subprime mortgages are being originated.  You can try to buy subprime MSRs from others.  However, Ocwen tried to buy subprime MSRs from Wells Fargo and the NY DFS decided to block the deal.  Frustratingly, Ocwen had complied with the NY DFS in the past and the NY DFS simply decided to change the rules of the game.  That's terrible for business. 

 

The way things are looking now, there won't be much of a subprime mortgage industry in the future.  Erbey had the right idea in forseeing a nation of renters as subprime consumers can't get a mortgage.  Ocwen does have significant run-off value on its MSR portfolio.  Its servicing business will not be that great if the subprime servicing industry continues to shrink.

 

Ocwen also has to deal with the California DBO.  From what I can tell, they are NOT happy with Ocwen right now given how they were publicly saying negative things about Ocwen.

[Guest roark33]

What publicly negative things has CA DBO said about Ocwen?  Thanks.

[ItsAValueTrap]

What publicly negative things has CA DBO said about Ocwen?  Thanks.

 

I was referred to old comments that the DBO spokesperson made.

 

“Ocwen’s behavior is egregious enough that we believe it warrants suspension of license”

“Like any enforcement action, settlement is always a possibility, but at this point we are focused on suspension,” he added. (Reuters)

“We can’t just sit around and let them do that to us,” Dresslar said today in a telephone interview. “So we ultimately, after giving them plenty of opportunity to provide us the information, decided that we would go after their license.” (Bloomberg)

https://glennchan.wordpress.com/2015/03/06/unusual-risks-at-ocwen/

 

The DBO website has a June 2015 filing against Ocwen:

http://www.dbo.ca.gov/ENF/List/O/ocwenloanservicingllc.asp

 

[BeerBBQ]

abitofvalue and ItsAValueTrap,

 

Thanks for those detailed posts - very helpful.

 

Obviously market price is suggesting that MSR value is going to be eroded and/or there are future liabilities/costs that are going to continue impacting profitability.  I also see the concern as to what does the future business model look like and the potential for management (in an effort to remain employed) to spend $ on unprofitable business ventures.  However, with 3 sophisticated shareholders and erbey owning a combined 45% of the company, I think those shareholders have an incentive to guard against management job preservation outcome and obviously want to capture the value that is in the MSR's one way or another. 

 

As it relates to what is the business worth, seems to me it is worth more than current market price in a shrinking/slow runoff scenario which is what is happening now (assuming higher cost structure is temporary) Since market price is already saying that cost structure is permanent, as long as management can execute on cost cuts, then current expectations in stock price will be wrong.

 

Real upside comes from the optionality associated with potential for growing the servicing business.  From what I understand, the company has remediated the issues that caused them to not be able to grow and it is now up to the regulators to assess those corrections i.e. OCN has done what they are supposed to do and are now waiting for green light (not sure how long that will take nor if that info is in fact correct so if someone knows differently, please correct me).  Also, while volume of new nonagency mortgages is not what it was in the past, isn't there still a ton of it outstanding and aren't banks still interested in getting rid of it?

 

On another note, I'm sure you've seen the PR regarding the workforce reduction (http://finance.yahoo.com/news/ocwen-announces-workforce-reduction-waterloo-143000311.html). Is $35k per employee a good estimate for cost reduction?  If so, 300 employees would represent about $10m and is half of the low end of the range given for employee cost takeout available.  I do understand that management doesn't have much credibility given the history of this situation (I am not ignoring the fact that current management team is part of that history) but from the point of Erbey's ouster, it does appear that they have made progress on the issues and today's announcement is another small step in the right direction.

[ItsAValueTrap]

Real upside comes from the optionality associated with potential for growing the servicing business.  From what I understand, the company has remediated the issues that caused them to not be able to grow and it is now up to the regulators to assess those corrections i.e. OCN has done what they are supposed to do and are now waiting for green light (not sure how long that will take nor if that info is in fact correct so if someone knows differently, please correct me).

The timeline is sort of laid out in the NY DFS settlement.  The monitor has to come up with benchmarks shortly after they are hired, from what I remember.

 

see https://glennchan.wordpress.com/2014/12/22/ocnasps-ocwen-settles-with-the-ny-dfs-erbey-steps-down/

 

Also, while volume of new nonagency mortgages is not what it was in the past, isn't there still a ton of it outstanding and aren't banks still interested in getting rid of it?

In hindsight, Wells Fargo tried to get rid of their MSRs (by selling them to Ocwen) but the deal was blocked.  The current Ocwen agreement with the California DBO prevents them from buying MSRs (once Ocwen gets a monitor and passes everything, presumably Ocwen will be allowed to buy subprime MSRs).  Nobody is trading subprime MSRs at the moment.

 

Going forward, Ocwen will faced increased compliance costs on servicing transfers.

 

Eventually I see Ocwen buying subprime MSRs from banks who want to get rid of them (e.g. because banking regulations will lower their attractiveness for big banks).  Ocwen gets to keep more of its servicing capacity filled, and gets to apply its scale and low-cost operations on those MSRs.

[jay21]

Interesting read: http://seekingalpha.com/article/3590536-ocwen-financial-positive-takeaways-on-sstl-amendment-going-on-offense-credit-metrics?li_source=LI&li_medium=liftigniter-widget

[JayGatsby]

On October 31, 2013, Ocwen Financial Corporation (the “Company”) announced that our board of directors had authorized a share repurchase program for an aggregate of up to $500 million of our issued and outstanding shares of common stock. On February 5, 2015, we announced that we had suspended our share repurchase program.

 

The Company believes it is appropriate at this time to re-initiate our stock repurchase program effective November 19, 2015. As of November 19, 2015, the approximate remaining value of shares that may be repurchased under the program is $129.7 million.

 

There's still uncertainty about the business's long-term business plan (there might not really be a long-term business). The balance sheet value seems to be there although they've lowered estimates as they haven't achieved the profitability figures they'd hoped. Any repurchases at this price appear pretty accretive to shareholders. So far management has shown a willingness to shrink the business if it's the right business decisions, so if they keep doing that going forward we should be ok. New management has followed through on their promises about as well as one could hope. They sold off the non-agency MSRs, got debt/equity to 0.8, and are now repurchasing shares. We'll see I guess.. definitely an odd one.

 

[jay21]

I believe they mostly sold agency MSRs

[JayGatsby]

I believe they mostly sold agency MSRs

Yes, you're right. Just keeping people on their toes!

[valueinvestor82]

The looming uncertainty has created opportunity, in my view. I've listened to each of the last two quarters conf calls, and management sounds so conservative and reserved in what they say, I'd almost say purposefully if I were a "conspiracy theorist." Wall Street hates not being able to plug their precious estimates into their spreadsheets, and OCN has only outlined the LOW end of what they think they'll save by cutting expenses. And they have no ability to make projections until they have more visibility on growth initiatives recently enacted. So one must make a decision based on A) that managements plans will work out, or B) they won't grow, won't get MSR approval, and liquidate. Of course I'd say option B is moot, because the company is already worth more dead than alive.

[maverick]

My 2 cents on OCN.....Seth Klarman is a great value investor and I have copied him into Keryx, which I still believe in, in spite of the drop in price. However, when Klarman went long OCN, it appeared to me that it was not the right move. All the servicers (OCN, NSM, WAC) were trading at high valuation level because investors were expecting long term rates to go up which increases the value of the servicing assets.......however, the 10 year treasury rate has been hovering around 2.25% and the market doesn't seem to believe that rates could shoot up rapidly.....if the market were to believe that then equities should be trading at a lower level because their earnings would get discounted at a higher rate.......therefore, it's not just OCN but other servicers too which are trading at close to their 52 weeks low.......if you want to make a bet that rates could rapidly shoot up to 3.5%-4% level on the 10yr, I believe that OCN and other servicers could see higher stock prices in that scenario.......however, if rates stay low it's hard to see a catalyst to take the stock higher.....

 

Servicing as a business is very size dependent....your costs are fixed and you are better off spreading those costs over a large number of mortgage loans serviced.......it is true that new subprime mortgages are not being originated in size and the existing universe keeps shrinking every month due to defaults and prepays......also those who invest in subprime mortgage assets have a preference to get those mortgages serviced by smaller more niche servicers rather than large servicers.....

[cogitator8]

Now the rates are up and S&P upgrade happenned, going forward things are looking much better for OCN, it took me  16 months to build my position, let us see what happens next !

[Guest roark33]

I think it is always interesting to look back on old investment thesis and see how they played out.  I guess you could still give OCN more time, but I think the "book value" argument has long since been negated in this company.

 

 

[JayGatsby]

I think it is always interesting to look back on old investment thesis and see how they played out.  I guess you could still give OCN more time, but I think the "book value" argument has long since been negated in this company.

Has intrinsic value changed or has share price changed? Probably both but they aren't necessarily perfectly correlated.

 

Still seems to cash flow pretty well between EBITDA (adding back amort of the MSRs) and wind-down of the advances

 

I guess we'll see next week.

[valueinvestor82]

Don't forget the re-upping of the buyback. $125 million is a huge portion of the market cap

[BeerBBQ]

Any thoughts on why they continue to tout the value of the MSR's that are not captured in BV and yet have refused to repurchase meaningful amounts of stock at significant discounts to stated book (and even larger discount to what they think BV is)?

 

If the return profiles for the emerging businesses are so much better than buying back stock at discounts to BV (esp when adjusted for their view of the value of MSRs), why don't they sell off the MSR business and plow the proceeds into the new ventures they are launching?

 

 

 

[valueinvestor82]

Good points, Beer! I (as a shareholder) am glad that they didn't buy back a huge amount of stock. Not that they predicted the decline last week, but the result of avoiding buying back stock (ok they did buy back $10 million when operating income was mid $20 million last quarter) means that we can now use cash to retire a huge amount of stock for the same funds used. None of us know if they bought since last week. We saw one small insider buy.

 

Given that apparently analysts are plugging into their spreadsheets a perpetual loss and permanent government monitors ($170 million of extra annual expenses), perhaps the monitors finally leaving will be the biggest catalyst at this point. I know it's not totally accurate, but if you back out the temp cost of monitors, I show that they basically break even at the current revenue run rate. I don't see why the market obliterated the stock.