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Ocwen Financial Corp. (NYSE:OCN)

Q2 2009 Earnings Call

August 04, 2009 11:00 AM ET

Executives

David J. Gunter - Executive Vice President and Chief Financial Officer

William Erby - Chairman and Chief Executive Officer

Ronald Faris - President, Ocwen

William Shepro - President, Ocwen Solutions

Analysts

Robert Napoli - Piper Jaffray

Richard Shane - Jefferies & Co.

Bose George - KBW

Jordan Hymowitz - Philadelphia Financial

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. (Operating Instructions). Today's conference is being recorded. If you have any objections you may disconnect at this time.

I will now turn the call over to Mr. David Gunter, sir you may begin.

David J. 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 Calls, Second Quarter 2009 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 two, 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 Form S-3 First Quarter 2009 Form 10-Q, and 2008 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 three, joining me for today's presentation are Bill Erby, Chairman and CEO of Ocwen; Ron Faris, President of Ocwen; and Bill Shepro, President of Altisource Portfolio Solutions.

And now I'll turn the call over to Bill Erby.

William Erby

Thank you and good morning everyone. The second quarter has been exceptionally a busy time for the Ocwen team. For the first time since December, 2007, we've been able to devote a majority of our time to growing the business. However, we made great strides in generating liquidity and financing capacity, we became very focused on growing our servicing and update principle balance.

We are currently negotiating the purchase of at least one substantial servicing platform. Given Ocwen's operating leverage and current excess capital, we believe that acquisition will be accretive to earnings. Second, we expect to complete the separation of Altisource Portfolio Solutions S.A., on Monday August 10th via tax free distribution to shareholders. We're expecting to incur some taxes at Ocwen as a result of the steps necessary to complete this transaction.

Altisource Portfolio Solutions began when issued' trading on July 31st and will trade regularly on August 10th. Completing the spin will free up resources both in terms of management time as well as property expense of cash for attorneys and accountants of $2.3 million for the second quarter and 3.7 million for the first six months of 2009. As Bill Shepro will cover later on we believe that this effort will be rewarded in terms of a gain value for our shareholders.

Third, we have solid liquidity and substantial excess financing capacity to say, and we intend to position ourselves for future portfolio acquisition. The industry appears to have reached a tipping point leading to a period of consolidation. As a result, we will launch our road show later this week to raise $300 million in equity.

We have not however, neglected the important tab of disposing of non-core assets. First, GSS Germany, part of international commercial servicing joint venture and BOK our German bank subsidiary, went under contract for sale with GSS closing during the quarter at a gain of $715,000. BOK is expected to close in the third quarter, we recognized a gain of $1.2 million to reverse previous write-downs. This gain only partially reflects the higher sales volume and includes the $750,000 non-refundable deposits from the buyer.

Second, we're in advanced negotiations with one of the auction rate counterparties to write-off and the right to sell $88 million of face amount of these auction rate securities at 85% of par, and retain our upside of the securities for a period of three years in exchange for terminating pending litigation. Separate from that negotiation, we recognized a $6 million gain this quarter as a result of increased profitability of the near-term liquidity solution for an additional $17 million related amount of the auction rate securities.

As for our operations, our servicing segment continues to be our largest income producer with 15.5 million in pre-tax income that’s worth however a 38.5% or $9.7 million reduction for the first quarter; 6.3 million of which was due to the short-term impact of the HAMP program which truncated our pipeline of non-HAMP modification.

We only recognized income in the form of deferred servicing fees, and ancillary fee income when we returned the loan to performing status, whether it be through a HAMP modification, a non-HAMP modification or otherwise. We are making solid progress in increasing the number of potential modifications under HAMP. The number of HAMP trial period offers we have made to our borrowers has dramatically increased.

We've made more than five times the number of trial plan offers in June that we did in April. In July alone, we made offers on almost as many loans as we did in the entire second quarter. It just takes three to four months from the time of HAMP trial to plan offers made, until the loan is officially modified. As soon as the borrower makes all three trial plan payments, it comprises of all other program requirements, we get to recognize any revenue under the program.

As you will recall, treasury pays us $1000 for each one modified under the program plus ongoing fees for three years to the extent the modified loan remains current. The fly wheel appears to be picking up momentum, the number of changes by the government to the HAMP machine and adjustments to our technology platform are beginning to be delivered.

This week, enhancements to our loan resolution model will be released into production eliminating significant manual work necessitated by HAMP. We also have additional significant HAMP related enhancements to our scripting workflow, telephony and under-writing systems that are planned to become operational over the next eight weeks. Ultimately, HAMP will become a far more streamlined process than the process we have employed to-date.

I would now like to ask Ronald Faris to cover our modification of the HAMP performance including the sense of what can be expected going forward followed by Dave Gunter who will review our liquidity, provide an analysis of the short-term impact of HAMP on pre-tax profit and provide insight into servicing to operating leverage. And finally, Bill Shepro will describe the growth engine for Altisource.

Ron?

Ronald Faris

Thank you, Bill. I would like to focus my comments today on some of the key metrics of the loan servicing business, including some further updates on loan modifications and our implementation of HAMP. As shown on slide four, prepayment speeds maintained remained slow at 21.5% annualized. As has been the case over the past few quarters, the vast majority of the run-off of the portfolio is related to defaults and not voluntary pre-payment. We anticipate that voluntary prepayments speed will remain low for the remainder of the year.

Turning to loan modifications; first, we have seen a very strong interest by our borrowers in the HAMP program. However, when we adopted HAMP, we had to make a number of changes to accommodate the programs, more document intensive requirement an extensive set of rules. This obligated us to review all in-process loan modifications essentially restarting the process using different underwriting and documentation requirements.

The delay in borrowers responding to document request and the three month trial period significantly extend the timeline in most instances to complete a loan modification. If a borrower is unable to qualify for the program, we work to complete a non-HAMP loan modification when appropriate.

As a result, we saw a 61% decline in the number of completed modifications this quarter as compared to both the second quarter of 2008 and the first quarter of 2009. As shown on slide five, we completed over 20,000 modifications in both the second quarter 2008 and the first quarter of 2009, while only completing just over 8,000 loan modifications in the second quarter of 2009.

Dave will comment on the financial impact to our second quarter operating results created by this timing difference. The more extensive documentation requirements along with the extensive set of rules in force by the government under HAMP required us to revamp our process, technology and scripts. All of this takes time and a great deal of coordination.

Fortunately, we are starting to see the fruits of our labor as evidenced by increases each month in the number of modification offers being made to our borrowers under HAMP. As seen on slide six, in April we made only 404 HAMP offers. That number increased to 836 in May, and to 2,172 in June for a total of 3,412 HAMP offers in the second quarter. In July, we initiated 3,292 offers or almost as many offers as we made in the whole second quarter. As of June 30, 2009, 1,058 borrowers began making trial payments under HAMP eligible modifications.

As of last Friday, that number has more than doubled to 2,517. We expect completed HAMP and non-HAMP loan modifications to progressively increase in the third and fourth quarters until such time as we return to a normal level of loan modification based on our UPB service. We are hopeful that this positive trend will continue especially as we roll out new scripting and technological enhancements specifically designed for HAMP.

As Bill mentioned, this week we have a significant release to our loan resolution model which includes the HAMP underwriting module, the HAMP modification terms calculator and the HAMP specific NPV calculation. We have also been developing and rolling out new scripts and letters designed to increase borrower participation in HAMP.

Over the next eight weeks, we expect to complete numerous other initiatives deigned to increase our efficiency and further increase borrower participation. These initiatives include more automation of the document processing and HAMP underwriting process, increase self-service options for the borrower, scientifically enhance customer scripts and robust reporting under the program.

Our goal is to have a process that is fully integrated and automated eliminating unstructured thinking and decisions, plus reducing variability and performance of our staff and increasing the number of executed HAMP modifications. As shown on the next slide, advances continued to decline decreasing by 16.8 million from March 31, 2009.

In addition to the impact on revenue, the implementation of HAMP and the slowdown in completed loan modifications in the quarter also negatively affected the pace of our advanced balance reductions. This impact is because completed loan modifications result in the recovery of previously made advances. Despite the slowdown in completed loan modifications, our ability to control delinquencies and effectively liquidate REO allowed us to keep our advanced balances in check for the quarter. An increase in completed modifications will reaccelerate the decline in advance balances.

Moving on to business development. As Bill already mentioned, we've begun to spend a great deal of more management time on exploring growth opportunities for the servicing business. We are particularly excited about various large servicing platforms and portfolios that are or may be available for acquisition.

By expanding the portfolio size we service, we can significantly increase efficiencies and reduce our fixed cost burden. To the extent, we're successful in acquiring some of these portfolios, our technology and low cost labor advantages to allow us to create significant value for our shareholders.

Finally, before I turn the call over to Dave, I'd like to make one more comment about our implementation of the HAMP modification program as compared to many of the other servicers out there today.

HAMP allows the servicer to select two approaches to implementing the program. One option is where a servicer can simply take verbal income information from the borrower, send them an offer and then follow up afterwards on gathering all the required documentation. This option will likely result in higher offers initially, but substantial fall out on the back end.

The second option and the one chosen by Ocwen is to gather all income documentation first and fully underwrite the modification in accordance with the HAMP guideline before approving an offer and sending it out. This option results in a lower number of initial offers, but it will have substantially less fall out. Many of the big servicers are using the first option and therefore showing more initial offers and more active trial plans. We believe that in the long run, our approach will result in a greater number of sustainable loan modifications.

Thank you. I would now like to turn the call over to Dave Gunter. Dave?

David J. Gunter

Thank you, Ron. We are pleased with the continued success of our liquidity and balance sheet management programs. Our high level of liquidity is a significant advantage in the current market.

As of June 30th, we have $213.9 million in cash, we reduced debt during the quarter by $56.7 million; cash provided by operations was $193.1 million and we had $653 million or 80.1% excess advanced financing capacity.

In addition to our plan to increase our effective capital by raising equity, we expect to participate in the TALF program beginning in September which should provide term fixed rate financing at tighter spreads than we are paying under our existing financing arrangements. And a minimum, the TALF financing would replace a $165 million note on one of our current advanced financing structures that would have begun amortizing in December of 2009, and as said, repay this notes in August of 2009, as we have received no forward concerns to repay these notes early to facilitate the TALF issuance.

Depending upon our success in acquiring another portfolio, we may either upsize the September TALF issuance or execute a second TALF deal later in the year. As we previewed last quarter, at driving greater deals detailed by Ron, have had a short-term impact on revenues and earnings that many of the pending modifications in the pipeline needed to be reevaluated and operating procedures needed to be adjusted to confirm with the President's program.

As Bill and Ron pointed out, the reduction in modifications caused by the majority of the decline in our second quarter's servicing revenues and earnings. But compared to the first quarter of 2009, servicing and subservicing fees decreased $12.1 million, of which 52.5% or $6.3 million is due to the lower number of completed modifications. However, the decline in modifications represents delayed modification, not loan modification.

We believe the decline in the second quarter revenue is a timing difference that will be recognized in future periods as loan modifications return to normal levels based on our UPB service. We expect to see HAMP revenues beginning in the third quarter of 2009 and accelerating in the fourth quarter as qualifying loan modifications pass the ninety day trial period.

HAMP modifications are expected to provide incremental revenue and pre-tax income versus non-HAMP loan modifications as a result of the government incentives of $1000, for completed loan modifications. Accordingly, we expect revenue improvement in Q3 and particularly Q4 as the flow of completed HAMP modifications accelerates and combined HAMP and non-HAMP completed modifications return to normal level.

Finally, Bill said that we are beginning to look at acquiring servicing portfolios which we believe will be accretive to earnings. First, the servicing business has historically been very profitable generating greater than a 30% return each year since 2007, as shown on slide eight. Growing servicing and eliminating non-core assets will be beneficial to earnings growth.

Second, based on the substantial operating leverage within the servicing business, we expect that growing our unpaid principal balance should be accretive to earnings. As we grow our business, we do not anticipate material additions to our supervisory burden or technology expenditures. Furthermore, a majority of our personnel will be added at low cost locations.

Now, I would like to turn the call over to Bill Shepro.

William Shepro

Thank you, David. Ocwen Solutions remains focused on three issues for 2009. First, expanding Mortgage Services from a standpoint of scope and geographic coverage of the product offerings. Second, combating the continuing decline in collection rates on receivables in the Financial Services segment and third completing the separation.

Our efforts in Mortgage Services are bearing fruit as indicated by the $42.2 million in revenue achieved year-to-date, a 35% increase over the same six month period in the prior year. This improvement reflects the growth of our Knowledge Process Outsourcing business and the rollout in geographic expansion of our new default oriented products. Our new products contributed $8.8 million in revenue for the quarter and $12.2 million in revenue year-to-date. We achieved this growth in revenue at attractive margins as evidenced by the 33% year-to-date margin and income from continuing operations.

With respect to Financial Services, revenue was down 5% as compared to the first quarter. This was expected as the first quarter is generally the strongest quarter. Overall, market conditions continue to be difficult, however we believe by executing on our strategic initiatives of implementing next generation scripting and reducing variability in operating performance that we'll position this segment for future growth when market conditions improve.

We are encouraged with the progress of our cost reduction initiatives as well as our efforts to expand opportunities with existing and new clients. Our efforts are starting to pay off as we recently began providing services to another large financial institution. We now serve six of the most recognizable credit card issuers. For most of those clients we are a top tier performer which should afford an increased market share with those clients overtime.

Our Technology Product segment continues to deliver services cost effectively while enhancing the technology capabilities for Ocwen Servicing business and our Financial Services and Mortgage Services segments. This business benefited in the quarter from an increase in services performed by our existing customers.

Finally, I share both enthusiasm with respect to completing the necessary steps that separate the majority of the former businesses that make up Ocwen Solutions into a new public entity and Altisource Portfolio Solutions. Building off the strong heritage of Ocwen, Altisource remains committed to creating long-term shareholder value by focusing on our customers and growing our core businesses.

We believe that our independents will also provide us the financial and operational flexibility to take advantage of opportunities in the Knowledge Process Outsourcing space. Our shares became available for trading on the NASDAQ Global Select Market on a when issue basis on July 31st, under the symbol ASPSV. The shares will begin trading regular way on August 10th under the ticker symbol ASPS. I encourage you to learn more about us at www.altisource.com.

I would now like to turn the call back over to Bill Erby. Bill?

William Erby

Thank you, Bill. I'll conclude our remarks by referring you to slide nine. The key takeaways to our second quarter performance are first; we continue to increase liquidity and financing capacity. Second, the Altisource separation will be completed on August 10th.

Third, as expected, second quarter servicing results were lower due to the delay associated with the HAMP. Fourth, we are gaining momentum in HAMP modification that should more than recoup revenues and pretax income talking differences. And fifth, we are currently negotiating exploring opportunities to significantly expand our services portfolio.

With that, I will open the call to questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin with the question and answer session. (Operator Instructions). The first question comes from Bob Napoli, Piper Jaffray. Your line is open.

Robert Napoli - Piper Jaffray

Thank you, good morning.

William Erby

Good morning, Bob.

Robert Napoli - Piper Jaffray

Just a couple of questions, and first on the growth opportunity in the servicing business. Can you put some quantification around the opportunity you see in the market; the amount of portfolios, where are they coming from and potential pricing?

William Erby

There are numerous portfolios available in the market today. I think that many sellers, many owners are coming to the realization that their cost structures and their advancing obligations simply don't work in this environment. So, I think that whereas our cost structure is very much aligned in this competitive advantage in this kind of an environment.

We really can't talk about the pricing, I think that right now with regard, but I believe to say that one of the real reasons of these opportunities because right now there is financing available between now and the end of the year. And that has obviously significant impact on valuation, so big sellers that intend to sell probably would try to take advantage of this window because after by December 31st, that will be expanded, their valuations will probably be adversely affected as a result of that.

Robert Napoli - Piper Jaffray

Abilities, should bank subsidiaries primarily that are --

William Erby

I prefer not to comment on it.

Robert Napoli - Piper Jaffray

Okay.

William Erby

Each one and I think that at least confidentiality as well as modification.

Robert Napoli - Piper Jaffray

Okay. On the modifications, so I guess the way I read what you said there is you kind of expect to get back up to a run rate generally similar to where you were in the first quarter of 2009, adjusted for the size of your servicing portfolio. Is that kind of --

William Erby

Correct.

Robert Napoli - Piper Jaffray

The theory, okay. And then --

William Erby

That will not diminish the number of modifications done, as a matter of fact it should be positive with respect to another modification. It was more the impact of the other type of modification that needed to be reevaluated with in light of HAMP program. But given the non-HAMP program, non-HAMP modification, without the HAMP modification.

The biggest challenge that we see in the HAMP program is really complying with the documentation and requirements and we have elected to basically require that to get that done upfront so you do not end up with the problem whereby you give someone a HAMP modification based on a verbal, and then they don't produce information that's equivalent to that. And that becomes a very difficult situation further on down the line.

Robert Napoli - Piper Jaffray

Are you finding that the, enough of your borrowers qualify for HAMP in the similar manner to prior modification program you utilized? Besides the documentation, what other financial differences or major financial differences are there?

William Erby

Why would they not qualify for HAMP in other words?

Robert Napoli - Piper Jaffray

Right. But where they did qualify for a prior Ocwen modification?

William Erby

Certainly the documentation is one major issue that's hopefully will one where we believe hopefully we'll be able to overcome that by working with the borrowers, it's just going to take a lot of time to do that.

And the second one really is there are a group of borrowers that are delinquent, that are in fact have less than a 31% debt-to-income ratio, front end ratio, they have very high back end ratios if you will, because of other debt obligations. They could not be eligible for HAMP, they would in fact eligible to loan to deposit net present value outcome for the investor, and they would still be eligible for non-HAMP modification.

Robert Napoli - Piper Jaffray

Okay. Then just last question for now, the Altisource mortgage business was much stronger than I guess we thought it would be and you talked a little bit about that, I would like a little more clarity on that and what percentage of that business or how much success are you having getting non-Ocwen customers for Altisource?

William Erby

Well at the present time, we really are focused very much on rolling out the product and rolling out the geographic coverage making sure our processes and procedures are in place, there are still a lot more coverage that we need to avail ourselves just to cover Ocwen.

Once we in fact have basically developed that infrastructure, and are capable of providing that in a seamless manner, we will go out and basically intend to be more aggressive in selling that product to other third-party providers. But right now, it’s really more question of just satisfying the existing demand.

Robert Napoli - Piper Jaffray

And the product that drove that growth, and this was you internalized this from other third-parties that would have provided these services?

William Erby

That's correct.

Robert Napoli - Piper Jaffray

And it's mostly default was the growth in the quarter?

William Shepro

Yeah most of the products around the default for example real estate sales, field services, legal and process were giving for the foreclosure.

Robert Napoli - Piper Jaffray

All right. Thank you.

Operator

The next question comes from Rick Shane Jefferies and Company.

Richard Shane - Jefferies & Co.

Thanks guys, good morning, for taking my questions. A couple of different things here so, by the run rate it looks like modifications were down about 12,000 mods quarter-over-quarter and you stated in the press release that that created basically an $8.1 million variance from the first quarter in terms of servicing.

Help us understand the economics of HAMP modifications versus non-HAMP. Because my understanding is that what happens is -- I would say HAMP and blending terms HAMP and non-HAMP deal that you collect on non-HAMP modifications you collect the back fees but you have to forego those on HAMP modifications, but in lieu of that you get a $1000 fee. Help us understand the economic difference and how that relates to the 8 million you saw this quarter?

William Erby

Well first to be clear, one of the largest recoveries that we get that the loan [inaudible] modified to become current is that we recognize deferred servicing fees. In other words, we record our servicing fee which is absolutely the top of the waterfall. We only record it when we receive it even though the probability of not receiving has been insusceptible. So when you get a loan current you actually recognize those servicing fees that we have deferred. And when you get those deferrals HAMP and non-HAMP modification.

Richard Shane - Jefferies & Co.

But you forgo the late fees in the non-HAMP and assuming the HAMP modifications?

William Erby

That is correct. That is the difference.

Richard Shane - Jefferies & Co.

And typically what are the late fees that you're foregoing. Is it about $750 a loan?

William Erby

No, Ron do you have the number?

Ronald Faris

Yeah, it’s more been in the 400 to $500 range.

Richard Shane - Jefferies & Co.

Okay. So basically there is an incremental – if you can do a HAMP modification there is an incremental 4 or $500 per loan that you collect?

William Erby

Right, 600.

Richard Shane - Jefferies & Co.

And you have made the comment that a percentage of these loans are not going to qualify for HAMP modifications going forward. What do you think when you get back to the, call it 2000 mod per quarter run-rate, what percentage of those do you believe will be HAMP versus non-HAMP given that you have all the data now in terms of what qualifies and what doesn't?

William Erby

We gave last quarter, I believe we stated that I thought it was 60% of our modifications would be eligible for HAMP historically, is that the number Ron?

Ronald Faris

Yes.

Richard Shane - Jefferies & Co.

And now that your quarter ended, has that view changed it all given -- because it seems to me that the biggest issue you are running into is that lot of these loans were low dark loans and the requirement from the government that you -- that there is greater excuse me, greater documentation of them I'm struggling this morning I apologize. Is it fairly significant shift now that you've been through the program basically for three months, do you still feel that 60% is a good target rate?

William Erby

Ron.

Ronald Faris

Well, I think as you somewhat pointed out and Bill has pointed out that the number probably is going to be a little bit lower than that simply because as we gather that documentation in some cases we do find out that although the borrower meets all the other requirements like they live in the home. They are defaults or in default but that their front end ratio is already at 31 or below. We don't know that information until we gather their financial information. Those accounts will fall out of the HAMP program and have to be replaced with a non-HAMP modification so the 60% number is probably -- will ultimately not turn out to be that maybe it will be closer to 50-50.

Richard Shane - Jefferies & Co.

Okay. That's great. In terms of the equity offering, how quickly do you expect, I mean this is a significant transaction in terms of size. It's roughly a third of your existing share count. How quickly do you expect to deploy that capital, what's your target?

David Gunter

This is Dave, we can't talk on this call about the equity offering. All we can do for now is 0.22 that percept that customer satisfies (ph). But we’ve been advised by legal counsel just to simply separate the two issues, and we can talk on this call about the earnings release.

Ronald Faris

Understood. I will abide by the lawyers wishes, thanks guys.

William Erby

Thank you.

Operator

The next question comes from Bose George, KBW.

Bose George - KBW

Hi good morning. I have a follow up on the servicing and I didn't know if this is something you might not be able to address here either. But in general when you think about servicing, do you guys have some sort of IRR or hurdle rates that you look at in terms of investing in servicing assets?

William Erby

We can refer you to our historical returns in business. Generally the historical return in the business has been somewhere north of 30%.

Bose George - KBW

Okay. So we can just use that as kind of good benchmark. Great and then switching to your -- you had commented earlier about the auction rate securities and the progress you've made there. I was just wondering on the amount of equity you have in there and how much of it, if you mark all that up to par, how much equity would you realize. I just want to see how much you could recover, since I assumed since these are self loans that you are getting far back at some point seems pretty reasonable.

David Gunter

If you see on the balance sheet at 243.3 million. The principle today is 265.6.

Bose George - KBW

So, that 20 is the mark basically on that?

William Erby

Yes, a lot of the differences today a lot of equity that could be deployed elsewhere.

Bose George - KBW

And on top of that mark credits 243 minus 170 odd ability?

David Gunter

That's right. 176.7.

William Erby

Both are different things because... Anything else. Hello? Operator.

Operator

We will take the next question, Jordan Hymowitz, Philadelphia Financial. Your line is open.

Jordan Hymowitz - Philadelphia Financial

Yeah. Most of my questions have been answered, my only follow up is to Mr. Shane's question. You said that there are 500 and 600 variance per loan. That would only be in year one correct, because you get a thousand in year two and three as well.

William Erby

That's correct. You get that, but except that they remain current throughout the 12 months period you get another $1000 and to the extent that you do more defaults difference is 1500 or 1600 in year one, an exception rather.

Jordan Hymowitz - Philadelphia Financial

And also in terms of the servicing acquisitions or potential service acquisitions, are you only looking for sub prime or would you be expanding in whatever's available at this point?

William Erby

Mostly we will be expanding into is San Hose primarily because prime servicing even though they both have the word servicing is economically much different than the sub-prime, prime servicing is pretty much all about the IO strip and the capital intensity of it. A very low operating intensity, whereas when you get into non-performing products such as sub-prime in San Hose, you have much higher operating cost where we bring to bear our operating cost advantage of about 15% lower costs than the rest of the industry. So we really want to focus on those areas where we have the highest competitive advantage.

Jordan Hymowitz - Philadelphia Financial

And there is lots of servicing platforms in the market available today, would you actually buy a platform that's been shutting down or would just try and buy the portfolio if you had your druthers?

William Erby

Our preference would be to buy a portfolio. We however are prepared to be flexible on not to combine any sort of auction to the seller in terms of all of the above whether it be the platform or portfolio or whether it be servicing, sub-servicing et cetera. So we try to maintain flexibility there.

Jordan Hymowitz - Philadelphia Financial

Thank you.

Operator

The next question comes from Bob Napoli with Piper Jaffray.

Robert Napoli - Piper Jaffray

Thank you, just want to follow-up on your Freddy Mac relationship and any, how that's progressing and if you can talk it all about your interest in any progress in doing business with either Fannie Mae or the FHA?

William Erby

Ron, would to like to handle that please.

Ronald Faris

Sure. Yes, the pilot program that they initiated is continuing on nicely with that recent meetings with their senior people and I think both sides are pleased with the relationship and yes, at least on our side we're optimistic that it will long-term result in some additional business coming our way.

At this point, I don't think we have anything really new or additional to report on similar type of arrangements with Fannie Mae or FHA or any of the other government agencies although, we continue I think to have a very solid, very good reputation with the various agencies in Washington DC and continue to have ongoing discussions with many of them about various opportunities.

Robert Napoli - Piper Jaffray

How much -- what are you servicing today on Freddie Mac and what is the opportunity do you think out of the potential opportunity out of that portfolio?

Ronald Faris

Yeah. Unfortunately kind of our arrangement at Freddie Mac is somewhat confidential. So it's difficult for me to kind of get into that. I mean as far number of non-performing loans, it is reasonably substantial number to our overall portfolio of non-performing loans.

I think what still needs to happen is the various parties that control servicing or at least control the risk of what are still making steps in gaining more control over the servicing rights. And as that evolves, that will open up more opportunities I think for them to move loans to a special servicer like Ocwen, which is I think that process is taking more time than maybe was initially thought.

Robert Napoli - Piper Jaffray

Okay. Thank you. The converts, Dave do you have the converts or what is -- what to have convert holders I guess in August, that this month that they are put up, or has anybody put, and they're in the money I guess a little bit, right now?

David Gunter

The first window closed yesterday at close of business. We are reporting our Form 10-Q today that there has been low put. And then remember in our recent Form 8-K we announced that we are distributing to the convert holders a proportion of share, and so as of this moment there is no window open.

Robert Napoli - Piper Jaffray

Okay. Now do you intend to call those or do you have the other opportunity to call, don't you?

David Gunter

The opportunity to call is open on August 1st, and goes on indefinitely. We have made no announcement about whether to call.

Robert Napoli - Piper Jaffray

And then how confident are you that you will get a TALF deal done in September?

William Erby

Well I mean that's -- I can say look forward, the process is leading a space with regards to that. I think we made excellent progress. As we have no information today that would lead us to believe that we will not get it accomplished.

Robert Napoli - Piper Jaffray

Thank you.

Operator

At this time, I show no further questions.

William Erby

Thank you very much everybody. Have a great day.

Operator

Thank you for participating in today's call. You may disconnect at this time.

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