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Ocwen Financial Corp. (NYSE:OCN)

Q3 2008 Earnings Call

November 6, 2008 11:00 am ET

Executives

Dave Gunter - EVP and CFO

Bill Erbey - Chairman and CEO

Ron Faris - President of Ocwen Assets Management

Bill Shepro - SVP of Ocwen Solutions

Dave Gunter

Thank you. Good morning, everyone, and thank you for joining us today.

Before we begin, I want to remind you that a slide presentation is available to accompany our remarks. To access the slides, log on to our website, at www.ocwen.com, select "Shareholder Relations," then "Calendar of Events," then "Click here to listen to conference call," then under conference call "Third Quarter 2008 Earnings," select "Click here to listen and view slides."

Each viewer will be able to control the progression of the slides during the presentation. To move the slides ahead, please click on the gray button pointing to the right.

As indicated on slide 2, our presentation may contain certain forward-looking statements that are made pursuant to the Safe Harbor provisions of the Federal Securities Laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology. They may involve risks and uncertainties that could cause the company's actual results to differ materially from the results discussed in the forward-looking statements.

For an elaboration of the factors that may cause such a difference, please refer to the risk disclosure statement in today's earnings release as well as the company's filings with the Securities and Exchange Commission, including Ocwen's 2007 Form 10-K. If you would like to receive our news releases, SEC filings and other materials via email, please contact Linda Ludwig at linda.ludwig@ocwen.com.

As indicated on slide 3, joining me for today's presentation are Bill Erbey, Chairman and CEO of Ocwen; Ron Faris, President of Ocwen Asset Management; and Bill Shepro, President of Ocwen Solutions.

And now, I'll turn the call over to Bill Erbey. Bill?

Bill Erbey

Thank you, Dave. Ocwen Financial Corporation's consolidated pre-tax earnings of $24.4 million for the quarter ended September 30, 2008 are an improvement of 228% over the second quarter of 2008 and 141% over the third quarter of 2007. The primary driver of our growth in pre-tax income was the servicing segment with $29.3 million as compared to $20.4 million for the same period last year. We continue to focus on being the highest quality, lowest cost servicer.

We've continued to keep a greater percentage of delinquent borrowers in their homes than any other servicer by working with borrowers to get their loans cash flowing through [overbearance] and modification plan. This is a win-win for borrowers and for investors.

The quality of our service in operation is further evidenced by our continued control over delinquencies. By keeping delinquency rate stable, while UPVs contracted at 22% to 26% annual rate, we're able to reduce the number of nonperforming loans by 4,155 during the third quarter. As a result, we've been able to decrease advance balances by $147.2 million since June 30, 2008.

We have reduced operating expenses by 5% over the second quarter of 2008 and 15% over the third quarter of 2007. Our reduction in operating expenses during the third quarter was pervasive as we reduced expenses from a range of 1% to 20% in six or seven reporting line items. We continue to enjoy a nonperforming loan servicing cost advantage of 60% over our competitors.

We increased our cash balance from a $148.8 million at June 30, 2008 to $162.3 million at December 30, 2008 due to the reduction in delinquencies and assets sales. We continue to focus on our core business lines, eliminating non-core assets, which historically have suppressed earnings.

During the third quarter, we generated $24.8 million of cash by liquidating holdings in loans, real estate owned and GSS Canada by reducing cash amounts held by indenture trustees, by collecting receivables, and by obtaining financing for receivables and for one of our AMVs, asset management vehicles.

I would like to discuss three key items for Ocwen with you; first, spinning out Ocwen Solutions as a separate company; second, liquidity; and third, new business. We are currently undergoing a feasibility study to determine whether it would be beneficial to spin Ocwen Solutions as a separate publicly traded company. We are considering the following benefits in our analysis.

First, Ocwen Solutions will be better positioned to pursue business opportunities with other servicers. Second, the spin would allow potential investors to choose between the contracting business models of servicing versus business process outsourcing. Each business model is valued differently by the equity markets.

Third, the spin would allow Ocwen Solutions flexibility in creating its own capital structure and will allow for a subsequent capital or debt raise when markets recover. And fourth, Ocwen Solutions would have the option of offering its stock as consideration to potential acquisition targets.

As for liquidity and new servicing business, we have five key initiatives ranked from highest to lowest in terms of our ability to control the outcome. First, we are currently in an environment where banks are worried about their own liquidity and capital requirements. We believe that it will take time for banks to repair their balance sheets and for the recent treasury actions to be effective.

During this time of uncertainty, we are continuing to right size our business to the financing currently available to us. While we continue to explore alternative sources of financing, we believe that it is prudent to operate our business assuming that we will receive no new financing and that no existing financing lines will be renewed. Assuming no counterparty failure, we believe that we have sufficient liquidity to sustain our current business.

Second, although we currently hold a 60% cost advantage in servicing nonperforming loans, we cannot risk on our laurels if we are to maintain profitability with a declining portfolio. Currently, we are rolling out the next generation of technology and processes for a step function improvement in cost and quality.

Through the elimination of variability in our processes, we can grow our industry leading position of keeping more people in their homes, generating greater cash flow for investors and reducing cost.

First, we are rolling out our next generation of scripting engines in conjunction with new scripts developed by our psychology department. Second, we have enhanced our modeling engines that determine the optimal resolution strategy for each loan with newly expanded capabilities from our Analytics and Econometrics Departments. Our cost structure initiatives seek to improve quality and reduce costs through the elimination of manual, repetitive or rules-based processes.

Third, we will capture a greater share of third party revenues. We expect to replace certain third-party vendors in providing services on behalf of our trustees, including real estate sales, title services, property inspection and preservation and homeowner outreach. This initiative requires little to no capital.

Fourth, we believe that the current environment affords Ocwen a unique opportunity to capitalize upon its best-in-class loss mitigation capabilities. Accordingly, we are working with guarantors and owners of mortgages to provide special servicing where we accept a reduced servicing fee, but share in the savings as compared to their existing servicers' performance.

Savings would be measured by a control group of loans remaining with their existing servicer. Two positives associated with this program are; first, if we are able to maintain our current level of performance vis-à-vis other servicers, profitability per dollar of unpaid principal balance should be greater than a standard servicing fee. Two, this program requires little to no capital. The negative to this program is that earnings under GAAP will be backend loaded.

Finally, a great deal of management's time is focused on financing. The majority of our balance sheet is comprised of advances, which have an imputed if not actual AAA rating, are short-term in duration, and for which the cost represents fair market value. When the credit markets become liquid, advances should be a highly fungible asset.

The first firm to be able to expand its financing has a unique opportunity to acquire other platforms. Therefore, we are working hard on several different structures and sources of financing. Today, there is a critical shortage of servicing capacity. Furthermore, Ocwen is the highest quality, lowest cost and only scalable platform in existence. We have developed the above five initiatives with the purpose of enhancing shareholder value.

Dave.

Dave Gunter

Thank you, Bill. First, let me summarize the key points of our earnings release. We are profitable. Our cash balances have increased. Our advance balances have decreased. Our borrowings have decreased and we have untapped borrowing capacity. Therefore, I would like to discuss three key items with you; one, financial results; two, reduction of non-core assets; and three, liquidity.

Slide 4 demonstrates the dynamic growth in our operating income, as total income from operations of $43.8 million exceeds the third quarter 2007 by 30% and the 2007 quarterly average by 36%. This continuing improvement is driven by our profit enhancement initiatives.

We have previously discussed our intent to reduce non-core assets and we'll continue to actively pursue the liquidation of our positions in residuals, $4.2 million, loans held for resale, $55.6 million, real estate owned, $7.7 million, and auction rate securities $253.9 million.

We are making progress with the intended sale of Bankhaus Oswald Kruber and are working through current proposals with the expectation of signing a contract this year, subject to regulatory approval. We will also disclose GSS Germany.

Liquidity is the major concern in our industry and I want to address that issue head-on. We responded to the need for liquidity by accomplishing the following.

We extended the investment line that finances our auction rate securities through June 30, 2009. We replaced all of the match funded advance facilities that entered amortization in 2008. We reduced advances by $147.2 million in the third quarter and by $208 million for the nine months year-to-date, and we reduced or eliminated many non-core assets.

Our loss mitigation accomplishments combined with the focus on eliminating non-core assets and the positive results of our overall operations had yielded $162.3 million of cash on our balance sheet as of September 30, 2008. This represents 12.8% year-over-year improvement and a 9.1% from the June 30 balance.

Our borrowings as of September 30, 2008 include $215 million borrowed under the investment line that is used to finance the investment grade auction rate securities. Excluding the investment line, our borrowings have decreased by $226.3 million since December 31, 2007.

This decline reflects the reduction in borrowing by; number one, the servicing segment, $158.1 million on declining advances and MSRs; number two, the loans and residuals segment, $25.5 million, due to lower balances of loans pledged as collateral; number three, the Mortgage Services segment, $4.1 million, resulting from the sale of commercial MSRs; and corporate items and other, $42.8 million, due to our sale of the remaining CMOs.

At September 30, 2008, excluding the investment line, $241.1 million of our total maximum borrowing capacity remained unused, including $235.4 million attributed to the servicing business.

So that you can better understand the health of our business, I would now like to turn the call over to Ron Faris, President of Ocwen Asset Management. Ron?

Ron Faris

Thank you, Dave. My remarks today will focus on four key aspects of the servicing business. First, prepayment speeds and delinquencies, advances and new business.

First, slide 5 shows that in 2008 we saw a modest increase in prepayment speeds after continued slowing throughout 2007. Even though the prepayment rates for the third quarter and second quarter of 2008 were 26%, they were above the third quarter 2007 rates of 22% and the first quarter 2008 rate of 23%. This is the result of a temporary increase in involuntary prepayments, occasioned by the spike in delinquencies in the summer of 2007.

Voluntary prepayments continue to decline, dropping from 10% in the first quarter to under 7% in the third quarter. The increase in the involuntary rate is a positive sign, which has a favorable affect on our advance balances and should eventually decline as the portfolio continues to age and the level of delinquent loans continues to decline.

Next, turning to slide 6, delinquencies have stabilized due to loss mitigation efforts. Nonperforming loans decreased by 4,155 loans in the third quarter of 2008 and 4,678 loans in the second quarter of 2008 as compared to a decrease of 5,707 loans in the first quarter of 2008.

This is a result of our effective loss mitigation processes, which involves prudent loan modification combined with efficient foreclosure and REO resolution practices. We continue to refine and improve our approach to repayment plan and loan modifications by systematically analyzing historical performance data and instituting appropriate enhancements.

Our industry leading success with loan modifications should result in lower overall losses for the pools of loans we service, lower advances and a better performing longer life servicing portfolio.

As shown on slide 7, during the third quarter of 2008, the ending loan servicing advance balances decreased by $138.7 million or 10.4% as compared to a decrease of $91.5 million for the second quarter of 2008 and a growth of $31.3 million for the first quarter.

In addition to our success with loan modifications, we are also starting to see a decline in our REO portfolio after a prolonged upward trend beginning in mid 2007. Since over one-third of our servicing advances are tied up in REO, this is a positive sign for the future level of advances.

Finally, as Bill already mentioned, we are working with guarantors and owners of mortgages to provide special servicing where we accept a reduced servicing fee but share their savings as compared to their existing servicers' performance.

The passage of the Emergency Economic Stabilization Act of 2008 and related government sponsored initiatives also provides a unique opportunity for us as an asset manager and loan servicer with unparallel loss mitigation expertise and a substantial operating cost advantage.

And with our highly automated artificial intelligence, driven technology platforms and global workforce, we can quickly scale up to handle multiples of current volume with modest infrastructure additions. As a result of this and other changes in the market, we are refocusing our business development efforts away from Wall Street to Washington DC.

Thank you. I'd now like to turn the call over to Bill Shepro.

Bill Shepro

Thank you, Ron. My remarks today will cover the financial performance of Ocwen Solutions and our key initiatives for the Mortgage Services, Financial Services and Technology Product segment.

Turning to slide 8, Ocwen Solutions third quarter 2008 pre-tax income was $1 million, which represents a $2.5 million decrease compared to our third quarter 2007 pre-tax income of $3.5 million. The third quarter 2007 pre-tax income includes $2.4 million in earnings from our equity interest in BMS as compared to zero in the third quarter of 2008. Net of this difference, pre-tax income decreased $100,000 compared to the third quarter of 2007.

Now to the key initiatives for each of the Ocwen Solution segments. Our Mortgage Services segment is pursuing a plan to offset the decrease in its revenue by rolling out new products and services related to delinquent loans in real estate. Mortgage Services has recently launched three new products which will generate revenue in the fourth quarter. These include default processing services, property inspections and homeowner outreach.

In addition, Mortgage Services is developing other new products which we expect will be launched toward the end of this year or early next year. These include real estate sales, property preservation and title services. With the introduction of these new services, Mortgage Services is better able to manage through both a contracting and expanding mortgage market. Importantly these new products leverage Ocwen Solutions existing capabilities and technology.

The Financial Services segment is continuing to execute on its key initiatives related to technology, people and customers at a meaningful cost to us. From a technology perspective, Financial Services continues to rationalize and improve its technology, incurring one-time costs and accelerate depreciation on inadequate technology.

We expect to rollout our first generation scripting engine to a limited number of our agents in the fourth quarter. We are optimistic that as the scripting engine gets rolled out and further developed and enhance with artificial intelligence, it will have the same positive impact on the Financial Services segment as it has had on Ocwen servicing business.

On the people front, we continue to upgrade Financial Services management team and workforce and migrate positions offshore, incurring severance costs. In the third quarter, we hired a very skilled CEO, [John McRae] to manage this segment.

On the Financial Services customer front, the management team has successfully implemented price increases for a couple of clients, demonstrating that we do have some pricing power. In other instances, we have made the determination to terminate relationships with unprofitable clients. Importantly, for our largest clients, we continue to be one of their best service providers.

The good news is that as a result of the current market environment, there will be much new business. The offset is that it is much more difficult to collect in this environment. We believe, however, that our plan positions the Financial Services segment to exploit these new business opportunities.

Finally, the Technology Product segment is working in conjunction with our Mortgage Services segment to sell its software as a service as opposed to marketing technology products. By offering this technology as part of a service, Ocwen Solutions should be paid more for its services.

I'd now like to turn the call back over to our Chief Financial Officer, Dave Gunter.

Dave Gunter

Thank you, Bill. And operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). There are no questions at this time.

Dave Gunter

Thank you, operator. This concludes our third quarter earnings release call. Thank you all for attending. Good bye.

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