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Ocwen Financial Corporation (NYSE:OCN)

Q1 2010 Earnings Call

May 4, 2010 11:00 AM EST

Executives

Dave Gunter – EVP, CFO and Chief Accounting Officer

Bill Erby – Chairman and CEO

Ron Faris – President

Analysts

Mike Grondahl – Northland Securities

Bob Napoli – Piper Jaffray

DeForest Hinman – Walthausen & Company

Dean Choksi – Barclays Capital

Bose George – KBW

Operator

Welcome to the Ocwen Financial’s first quarter 2010 conference call. All lines have been placed on listen-only until the question-and-answer session. (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 Dave Gunter. Thank you, sir. You may begin.

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 Calls, First Quarter 2010 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 and 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; and Ron Faris, President of Ocwen.

And now, let’s turn the call over to Bill Erby. Bill?

Bill Erby

Thank you, Dave. In the process of raising equity last year, we committed to acquire a new business, increasing loan modifications, and issuing TALF financing. With the completion of our recently announced acquisition, we acquired $23.5 million of servicing and subservicing over the past four quarters, one of the highest 12-month periods ever. We led the industry in half modifications and we issued two TALF securities.

At present, our servicing portfolio is $55.1 billion, an increase of 35% since March 31st, 2009. This performance has enabled us to generate pretax income 35% greater than Q1 2009, even though last year included our former Ocwen solutions line of business, which separated in August, 2009 as out of the source portfolio solutions.

The key to the servicing business is to convert the maximum number of loans from nonperforming to performing status. This process increases revenue and reduces operating expenses, interest expense and required equity capital. This enables us to be the leading bidder for servicing portfolios. First, our industry leading cost structure allows us to target attractive returns, while being the highest bidder. Secondly, we are the low risk solution for sellers given our ability to improve portfolio performance. And third, we have already accessed the capital to close deals which Dave will cover later in the coal.

Even with the $20 plus billion of servicing transactions that we have closed over the past year, we have a substantial pipeline of transactions that we are pursuing.

I will now turn the call over to Ron, who will review Q1 results in the servicing business and the success of our modification program. Following that, Dave will review our liquidity position and our balance sheet gross-up related to recent changes in accounting standards. Ron?

Ron Faris

Thank you, Bill. We have made a commitment to reduce asset intensity in 2010. This means, we will reduce growth advances by minimizing the amount of time that a loan remains in a nonperforming status.

From December 31st, 2009 the ratio of advances to unpaid principal balance where Ocwen has responsibility for advancing declined from 3.01% to 2.94%. This decrease is significantly greater than the reduction in the unpaid principal balance of our portfolio. On a net advance basis, we have achieved a 33% reduction during the first quarter of 2010.

As shown on slides five through seven, in the first quarter, our servicing business grew revenue by 4%, while expenses were stable. This resulted in a 7% improvement in income from operations over the fourth quarter of 2009. The revenue lift reflects the $9.7 billion sub servicing deal that we signed in Q4. We have yet to recognize any revenue from the $6.9 billion servicing transaction awarded in the second quarter, which should generate greater revenue and earnings given the capital intensity of the transaction.

Turning to slide eight, the common sized format measures our performance as basis points of UPB. Our pretax income of 6.9 basis points is the best quarterly performance, since we began tracking results in this format.

Slide nine shows Ocwen completed 19,612 modifications during Q1, exceeding our previous guidance of 12,500 to 17,500. Off these completed modifications, 32% were HAMP. We are proud of this performance as the Congressional Oversight Panel recognized us for the leading the industry in total dollars of HAMP incentive as of February 2010.

The number of HAMP trial mods in Q1 declined to 4805 compared to the 7093 in Q4. We expect total completed modifications in Q2 to decrease between 12500 and 15500. However, we are beginning to see results of some new operating processes having completed over 2000 new HAMP trial mods in April alone.

Now, I would like to turn the call over to Dave Gunter. Dave?

Dave Gunter

Thank you, Ron. We issued a second TALF note of $200 million at a fixed rate of 3.59% on February 12th, 2010. This additional borrowing increased our cash position to $300 million at March 31, 2010, and our total unused maximum borrowing capacity to $1.03 billion as shown on slide 10.

We continue to eliminate non-servicing assets from our balance sheet. This allows us to allocate more resources to the servicing business. Since December 2009, auction rate securities with a carrying value of $122.88 million were sold at a $284,000 loan. This enabled us to repay the remaining balance on the investment line on February 17th, 2010.

We deployed, however, $160 million of cash in the $6.9 billion May servicing acquisition. We adopted statements of accounting standards, 810 and 860 effective January 1, 2010. As a result, we identified four securitizations where we are the servicer and hold a residual interest. We have recorded incremental assets of $76 million and liabilities of $73 million with the difference being booked to opening equity.

Thank you. I would now like to open the call up to questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question will be from Mike Grondahl of Northland Securities. Your line is open, you may ask your question.

Mike Grondahl – Northland Securities

Yes, thanks for taking my question guys. Quick question, last quarter, Bill, you kind of gave us an overview of some of the acquisitions you are evaluating. I think there was four of them, two of which totaled $35 billion. Could you give us an update on kind of where you stand in that process please?

Bill Erby

I am really surprised you asked that question, Mike.

Mike Grondahl – Northland Securities

I believe.

Bill Erby

Yes. I mean, there is a very strong pipeline that we are evaluating. The – we closed one of the two transactions that comprised the $35 billion. The second transaction – these transactions are never closed until they are closed. We are in negotiations on documentation. We will – certainly people will know if and when we in fact are able to complete those negotiations, but we are obviously optimistic about that.

There is – I mean, I think the – there isn’t at least in the industry a recognition that the sales need to occur. They are probably the most difficult transactions that we have experienced close to 40 years in the business, but there is a very large – there are large number of the portfolios that in fact are either in discussions or further along than that in terms of trying to move those transactions along. They have a remarkably longest patient period of – for the transactions to occur.

So I think there is a just one thing – economically, I think there needs – a number of portfolios need to be sold. They in fact are noneconomic platforms that are shrinking with economics that make it difficult to make money, they are not strategic any longer to many of the businesses. So I think there is an overall positive outlook for a transaction is occurring.

I think we are the undisputed price determiner within the industry. And we provide, well, very little cost servicing and lend very high-quality servicing which enables to get that price as well. So I am long-term optimistic, it just takes a while to close each of these transactions, but we have a very strong pipeline and I think in good shape.

Mike Grondahl – Northland Securities

Would you say the pipeline is growing?

Bill Erby

No, I think it’s more just a realization as these things are circling out there, there are a large numbers of – I should say there is more than a handful of transactions. They come and they go in a sort of a – it’s an interesting pattern of them getting active and then inactive and then active again. So I think that there is a large opportunity set. There has to be this confluence of basically, there pretty much the sellers’ desire to sell at a particular point in time.

Mike Grondahl – Northland Securities

Got you. And then just lastly, your pretax income per UPB, you commented that it was 6.9. That’s a very strong number. Directionally, where can that number go? I mean, I assume you are still making progress as you are layering in new servicing.

Bill Erby

The biggest drivers what I alluded to in my remarks is, in this business, it’s all about basically getting more loans current and the portfolio is reducing if you will, the inventory of nonperforming loans, because those loans drive all your costs in your capital consumption within your business. They will drive your operating cost which is less of a variable for us. They drive particularly your interest expense. They drive your overall capital intensity and the amount of equity required within the business.

We have done a better job than anyone in the industry. I think we can do still better yet with regard to reducing the cycle time for the loan that’s in nonperforming status primarily through getting it back current and maintaining that inter current status without a redefaulting. That’s why – that’s putting our operating costs aside, which are important, that’s probably the largest single determinant of why we can put out of effective business. We are just that much better than any other servicer are getting their loan current and we intend to get a lot better still.

Mike Grondahl – Northland Securities

Got you. And then one more thing, I noticed your pre-payment speed or you CPR felt to 12%, it has been running 19%, 20%, 22%, and that’s a pretty significant drop, and it means the portfolio is a lot stickier. What caused that drop?

Bill Erby

If you look at our historical prepays for the last year or so, it’s been primarily because of involuntary prepayments, i.e. through foreclosure. It’s another indicia. I mean all these elements that you look at come back to how well do we take a borrower that is not paying and figure out a way to come up with a solution without foreclosing.

So we are able to improve those performance of getting more people to take a loan, to a resolution and maintain that resolution. You will not only drop your interest expense, your operating expense, the amount of equity capital you dedicate to the business, you will also reduce your amortization expense.

It’s a very – when you cut through this business, it’s a very complex business, but there is a simple rule, keep your nonperforming loans done.

Mike Grondahl – Northland Securities

Well, you are obviously doing it. Thank you.

Bill Erby

Thank you.

Operator

Thank you. Our next question will be from Bob Napoli of Piper Jaffray. Your line is open.

Bob Napoli – Piper Jaffray

Thank you, good morning. So, on the – I know these deals take time to close. I mean is there – how is the competition right now in bidding? And from the bidders that I know of you should easily be the most competitive, but are there new bidders emerging? I guess you had IBM come out of nowhere on one transaction. What is going on in a competitive market for these transactions?

Bill Erby

Yes, I mean, I think that there is really effectively, only one bidder for servicing. There maybe a second one or so for subservicing, but again that’s just straight, that’s just really revolves during our straight cost structure which that’s a pretty difficult – we were a very difficult competitor for people in that place.

Yes, we lost to IBM. We were the high bidder in the contract. We were in negotiations with them at particular point in time and IBM came in and took a platform that we assigned a negative value to and they paid – I don’t know the exact number, but at least the rumors I have heard $80 million or $90 million for the platform to get into the business, we can’t do that. And they picked up a platform that was costing monies to run.

So if there are other bidders like that, we will lose. But if there is a normal solution set of bidders that we normally are familiar with, we don’t lose.

Bob Napoli – Piper Jaffray

The larger transaction – that’s the transaction that you are negotiating a larger one. I guess if you did the math, it’s $28 billion or so. Is that – I mean what would prevent that from closing and I mean would you expect that? And I know these things, they generally take longer and you probably hate to put in an exact date on it, but would you look at – if that’s closed this month, in the month of May?

Bill Erby

Let’s put it this way. The people that are actually we are negotiating absolutely are on the phone, so I would prefer not to answer that question. I am not the brightest guy in the world.

Bob Napoli – Piper Jaffray

The modifications – when you have a tick down in modifications for the second quarter, when you talked about a new process, I mean are we working through? I mean are more moving to foreclosure, is there – I mean have you kind of – are the amount of loans that are – that can be modified under the HAMP program diminishing and therefore more of them are moving towards foreclosure. What is going on? Why the drop? And maybe talk about the foreclosure trends if you could.

Ron Faris

This is Ron. I think – first off, I think we did board the large subservicing deal in the fourth quarter and I think there is always a little bit of a period of getting your hands around a portfolio. And so I think, now, where we stand today, that now is a kind of a I will call it a slightly fresher portfolio for us to mind for new modifications among other prior servicer was also aggressive in their modifications prior to transferring it to us. So I think to the extent we bring in new portfolios that helps kind of provide a bigger population to go after and get more modifications.

The first quarter, I think, yes, we had a really good fourth quarter as far as getting new loans on to payment plans that resulted in better than expected completed modifications in the first quarter. I think, maybe that partly was the result of why we saw a few less in the first quarter, because we kind of did a good job in the fourth quarter. But there were – we continued to look for ways to improve our process, speed up the process as Bill just said, it’s all about moving things through and getting them out of that nonperforming category.

So we have put in some things in place which I think will help shortened our timeline from when talk to a borrower, start to gather information and actually close the trial plans process. And I think we are starting to see that results of that in April, by putting on a pretty good number of trial plan HAMP mods which then should fare well for us going into the third quarter, so we expect a little bit of a dip here. But with the new portfolio coming on and some of the process changes, we should hopefully see that improve as we hit the following quarters.

Bill Erby

After foreclosures, our delinquency buckets, the severe delinquency bucket has been consistently coming down. And obviously that’s something that we want to focus on and make it come down even faster than it currently is.

Bob Napoli – Piper Jaffray

Okay. And then last question, have you made much progress to date on trying to flow business and I understand it’s a longer-term strategy. But Mark, you have any updates in trying to develop? I guess today would be an FHA related flow business.

Bill Erby

Yes, I mean, I think we are looking at that. We are having some discussions with Altisource. Altisource has purchased lenders, one, which represents about somewhere around 6% of all residential originations in the United States.

We have a second relationship in place that we are putting in, we will pickup another 2%. We think that there are some interesting opportunities to provide real value to our members that are cooperative, and by enabling them to get better price execution on their products by delivering directly to the agencies and to the FHA.

Obviously, Ocwen is approved to do that and be able to help them with the servicing on the front end of that. So that is a strategy that we are developing jointly with Altisource. And I think our expectations are to – that we are seeing some production through that methodology by the end of this year.

Bob Napoli – Piper Jaffray

Great thank you.

Bill Erby

You’re welcome.

Operator

Thank you. Our next question will be from DeForest Hinman of Walthausen & Company. Your line is opened.

DeForest Hinman – Walthausen & Company

Hi. Could you just help me better understand these restricted loans for securitization, both on the asset side and then the corresponding liability?

Dave Gunter

Hi, it’s Dave. That’s the new accounting standard that came in. So what you see would be for securitization trusts where the servicer or subservicer, and we hold a residual interest. And we have listed for you a separate line items from the balance sheet, the assets and the liabilities that you see in the low 70s to millions of dollars, and it’s simply in conformance to that accounting standards. The reason that they are separate line items is that we don’t have access to the cash into this trust nor do we have a really large exposure to them and yet the new accounting rules simply say to bring it on.

DeForest Hinman – Walthausen & Company

Okay. And just to be clear, were those in place in the fourth quarter as well?

Dave Gunter

Yes.

Bill Erby

They have been in place for years. This is probably to be rather impolitic about it, probably one of the worst drafted pieces of accounting literature ever drafted. When you guys start to see what it will do for the banks, it’s going to be breathtaking. These are assets and liabilities that have absolutely no impact on Ocwen. Yet, the way the literature reads you have to basically consolidate them. So there is – all it does is just bulk up the balance sheet to no effect.

DeForest Hinman – Walthausen & Company

Alright. And my last question on those is, well, is there kind of a runoff type business at this point?

Bill Erby

Yes, it’s been a runoff for years.

DeForest Hinman – Walthausen & Company

Alright thank you.

Bill Erby

You’re welcome.

Operator

Thank you. And our next question will be from Dean Choksi of Barclays Capital. Your line is open.

Dean Choksi – Barclays Capital

Good morning. Can you just provide an update on the Freddie Mac servicing trial and then kind of where you are with Fannie Mae signing them up?

Bill Erby

Yes, I mean we continue – on Freddie Mac, we have – two, we did a pilot program with them and then we also took on a – another very large portfolio, the Taylor Bean portfolio of nonperforming loans with Taylor Bean had its financial trouble. We continue to receive a flow of business from the Taylor Bean portfolio, from the servicer that services all the performing loans as they were nonperforming. They continue to flow into us, so there is an ongoing kind of pipeline of business that comes to us.

We continue to have positive discussions with Freddie Mac and look to work with them as they further develop their sort of special servicing strategy and I think they are making progress with that. And as they progress with that, we would expect that we would be one of select group of servicers that will be participating with them in that strategy. It’s very difficult for us to gauge at what levels and as what the timing is on that.

Fannie Mae has been more challenging. We have had positive discussions with Fannie Mae, but at this point, have not been designated by them to do any particular special servicing. So I think it’s – there is really no way for us to forecast any meaningful business from them at this point in time, because we just haven’t seen any to date and it’s unclear what their strategy is or where we fit into it.

But I think with Freddie Mac, we are part of their strategy, it’s just a matter of ultimately what that strategy is and when it’s rolled out and how much that means for the special servicers that they select.

Dean Choksi – Barclays Capital

You mentioned that the Taylor Bean portfolio was generating incremental growth. Are there any other contracts that are kind of generating incremental growth? Can you quantify that what the organic growth in the portfolio is?

Bill Erby

I mean, at this point, there really is no other material organic growth or flow business that’s coming into the portfolio.

Dean Choksi – Barclays Capital

And I guess, Bill you mentioned that there a handful of transactions in the markets where the portfolios are shrinking and they are noneconomic, their level of a portfolio where it becomes noneconomic.

Bill Erby

It’s all relative to where it was previously. In other words, companies tend to build up – have a natural tendency to build up some infrastructures that are larger. So obviously a portfolio that is shrinking does create some challenges with respect to the economics that I would start seeing portfolios. I would think much below $20 billion or less really starts to be problematic just because your infrastructure costs are so high.

Dean Choksi – Barclays Capital

You mentioned sellers were kind of coming in and out of the market, are they approaching you to take a look at their portfolio and bid on it or are you approaching them, kind of how would the sales process work?

Bill Erby

A little bit of both. We certainly do reach out to everyone there. I mean, we had one potential seller expressed the other day that said, that we are the only credible buyer in the market. That doesn’t mean we are going to get – that doesn’t mean they are going to sell. But I think there is – if you had to ask most sellers who they would put on their list for nonagency rated product as the number one bidder, I think we would be on the top of the list on almost every buyer and seller. But again, it takes a willing buyer and a willing seller to consummate a transaction.

Dean Choksi – Barclays Capital

Great, thank you.

Operator

Thank you. We have a question from Bose George of KBW. Your line is open.

Bose George – KBW

Good morning. My question was – I was wondering if there was anymore detail you could provide on the $6.9 billion servicing portfolio you required either purchase price servicing advances, delinquency rates? And also just in terms of modeling the returns. Can we just assume it’s fairly similar to what you guys already own?

Bill Erby

Yes, I think the only thing we probably feel comfortable at divulging really is the amount of equity investment we had which Dave says is $150 million, and it would be in line with our historic profitability.

Bose George – KBW

Okay, great, thanks. And then just in terms of – just going back to the potential sellers that are in the market, would you characterize them as sort of medium sized originators that essentially the ones that didn’t have the scale to keep their servicing platform, is that the cohort that’s really trying to sell.

Bill Erby

I mean, that’s certainly an element of it. I mean, I think that outside of the active – the companies that are trying to grow would be your nation star and on a noncapital intensive basis, on a subservicing would be Greentree. And then a question is on America Home, I think is in that mix as well. So that’s a fairly limited – can you think of anyone else Ron, I haven’t seen anyone that really show up with those –

Ron Faris

I think Saxon maybe looking to go on some –

Bill Erby

That’s correct.

Ron Faris

Subservice, they have announced new initiatives on special servicing and subservicing is their focus.

Bill Erby

Right. But I think apart from those players to a greater or lesser extent, people are trying to examine their strategic options.

Bose George – KBW

Okay. Just in terms of the potential sellers, I mean, are they de-characterized as sort of the medium sized subprime originators of whatever 2005 to 2007?

Bill Erby

Well, I mean, I certainly think that’s one element of it. I am a little reluctant to go and try to characterize who sellers would be just because of competitive issues.

Bose George – KBW

Okay, great. Thanks for the detail.

Bill Erby

Sorry.

Operator

Thank you. And it looks like our final question is a follow-up question from Bob Napoli of Piper Jaffray. Your line is open.

Bob Napoli – Piper Jaffray

Thank you. Just on maybe a little more color on the auction rate securities. Is there any ability to sell what’s left on the balance sheet in the near term?

Dave Gunter

Yes, depending upon how the market moves, but yes.

Bill Erby

We are probably going to look to finance those Bob a longer term and use that equity to redeploy within the servicing business. In other words, we can pretty much make our – the earnings of Ocwen are pretty much made off of about 450 – pre the last transaction about $450 million of equity. So our challenge initially getting loans current is to dedicate more and more of that equity base into the servicing business and eliminate those assets really that don’t earn those rates of return.

Bob Napoli – Piper Jaffray

Right. So in lieu of being able to sell them, you feel like you can long-term finance, match fund finance them or is something like that that would mitigate?

Bill Erby

Most of them are – a good deal of them already are with the city core financing.

Bob Napoli – Piper Jaffray

Okay. And I just – I am just trying to get to is basically the capital you have available maybe – I mean, your balance sheet looks pretty good, I mean you just mentioned that you used a $160 million of equity for the $7 billion – for the $6.9 billion transaction and trying to figure out how much capacity you have, you have a lot more debt capacity than you have had in the past, the ability to –

Bill Erby

Right. I mean, we have about $160 million of those with the cash, okay, after we spent the other, so say $150 million. We actually have available – readily available capacity on the debt side of at least another $0.25 billion that’s already pretty well done. So we have reasonable levels of debt capacity particularly as we grow.

We are not going to be in prudent. I mean, I still do remember 2007, 2008. But effectively we had almost no recourse debt to Ocwen. I mean nominal amount is probably under $200 million of recourse debt to the company when you take out the nonrecourse advance financing. So we have a very, very unlevered balance sheet that gives us some means of expansion of profitability without being too aggressive at all in terms of additional leverage.

Bob Napoli – Piper Jaffray

So if you try to put that into how much additional servicing you could buy portfolio, I mean is that – do you look at that as – and I know each deal is different and some of the sellers may finance part of the deal, so may take less equity.

Bill Erby

About $27 billion, $28 billion.

Bob Napoli – Piper Jaffray

Right, yes. So I mean you feel like you have the capacity to buy $50 billion worth of servicing, and I guess I am just trying to put some –

Bill Erby

No. I mean no. I mean obviously not. I mean we have enough financing right now to close the next transaction and that would obviously – we would have deployed capital if you will of somewhere around $600 million of capital on those transactions versus the $500 million that we had pre the last year we did. We clearly will – clearly we would need additional capital at that particular point to go out to the next transaction. But we are not going to do that until we are able to demonstrate that we have effectively deployed the capital we ask our shareholders to give us.

Bob Napoli – Piper Jaffray

Alright, thank you.

Bill Erby

Thank you.

Operator

Thank you. I have no further questions. I will turn it over to the speakers for any closing remarks.

Bill Erby

Thank you very much everyone. Have a great day. We appreciate it.

Operator

We thank everyone for their participation today. That does conclude today’s conference. You may now disconnect. Thank you.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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