John Devaney is back with another positive take on Ocwen (NYSE:OCN), and for anyone invested in any company within the non-bank servicing industry -- PHH (NYSE:PHH), Nationstar (NYSE:NSM) or Walter Investment Management (WAC) -- it is a worthy read. There is more to see here than a case of a hedge fund manager talking his book.
While we both ended up being too early in our Ocwen buys in hindsight, we both still see the same long-term potential. As much as I believe I understand this company and the RMBS industry from my time working within the business at the analyst level, there is another level of understanding that comes from actually trading and investing in RMBS for more than two decades. In what is admittedly a hard-to-understand stock,you can learn a lot on Ocwen by leveraging his enormous amount of expertise. For those that do not know John's history and his company (United Capital Markets), they should know that his specialty has always been bonds, particularly illiquid issues. Buying equity simply isn't his modus operandi. The fact he invested in Ocwen (by his own statement, his first equity buy in over ten years) shows his conviction in the name. Just like I rarely dabble in fixed income unless I see something deeply compelling, the same goes the other way.
Setting The Stage
Within his research note, John spends a significant amount of time going through the history of Ocwen, particularly between the 2012 to 2015 time period; a time where Ocwen encountered the largest chunk of its problems. In particular, he goes into great deal in the events immediately preceding the stock price collapse late in 2014/early 2015. While I've highlighted most of this before, there are some key issues at play, and some connections that I did not make at the time. Perhaps that's my naivety.
As a recap, in 2012 Pimco and Blackrock lobbied through law firm Gibbs and Bruns to support a transfer of assets to Ocwen, presumably because of its reputation, along with its compelling top bid for those assets. Less than two years later, this same group turned negative on Ocwen and its handling of this portfolio. To air their grievances, they went public via the media, hinting at bringing action against Ocwen for its servicing practices. John notes that short interest just so happened to nearly double before the New York Post published the statement. Color me surprised.
The one-two punch that followed was the New York Department of Financial Services punitive consent order, which pushed Bill Erbey out the door, levied a $150M fine, and put in place the first operations monitor. A little over a month later, and our aforementioned friends BlackRock and Pimco (along with others), issued a notice of default on more than $80B of Ocwen-serviced RMBS via Gibbs and Bruns. To back up that default allegation, these parties alleged missing money, loan modification violations, and poor servicing results (re-default rates, etc.). Conveniently on the same day, hedge fund Blue Mountain issued similar notices of defaults on HSART service advance deals on which it was an investor. Further adding pain, the California Department of Business Oversight settlement came out just a few days later, throwing more fuel on the regulatory flame started by New York. Short interest, once again, conveniently nearly doubled immediately preceding these events. While some of this short interest was disclosed (Blue Mountain), the rest was not (per John, some of this is related to members of Gibbs and Bruns being short Ocwen equity).
The result of all of this was a steep dive from $22/share to $5/share in roughly a month. The plunge in equity and regulatory action forced the eventual asset sales, and lead to the malaise that we see in Ocwen today. This is despite the LL Funds white paper, Duff & Phelps investigation, and eventual operations monitor statements, which debunked substantially all of the claims made in these allegations. See the below from LL Funds:
"The Investor Lobby Group stated that Ocwen had a far worse re -default rate over the rest of the industry. LL Funds pointed out how misleading the tables were presented by these sophisticated investors. They compared Ocwen who services mainly subprime to other servicers that handle far less subprime. Since re-default rates are higher for subprime over higher quality Prime or ALT-A credits this comparison was comparing apples to bananas."
It's beyond unfathomable that professionals would make such egregious mistakes in reporting. Could it have been intentionally malicious? Possibly. There are links between all of these parties (large firms, regulators, the government), and certainly there was likely a flow of information going on between them all. How much of what led to Ocwen's investigation was based on inaccurate data?
Like John, I dealt with Ocwen on a daily basis on loan servicing for years, including what was supposed to be a period of poor behavior (2010-2014). Performance was solid compared to other servicers, and I had no indications based on the performance I saw to have cause for concern. I was surprised when these allegations came out regarding Ocwen's performance back in 2014/2015, just as John was surprised. These allegations ran counter-intuitive to what we both knew.
While these issues were eventually proven to be unfounded, the damage was done. All this created a situation where Ocwen got put under a regulator spotlight, their cost of capital spiked, the company was pushed out of the market for acquiring servicing rights, and were forced into asset sales to deleverage.
Heading Into 2017
John touches on a wide swath of positives from Q2 2016 earnings, an area I've already touched on in the past. Those positives range from the California Monitor accrual, the return to operating profit, sequential revenue growth, etc. Look for Ocwen to build off of that earnings momentum, along with other positives. Those positives range from the Standard & Poor's upgrade, which removes the New Residential (NYSE:NRZ) transfer risk, to improving metrics regarding consumer complaints.
Of particular interest is John's explanations for off balance sheet value. Many investors have lost sight of these assets, with all the focus on costs. Honestly, despite including these assets on presentations, Ocwen management has done only a marginal job of explaining to investors why these assets are valuable and from where that value comes. I'll refer you to read that breakdown directly on his report (located here) on pages 19-21, but for investors with only marginal knowledge of the RMBS and Ocwen, it's the best breakdown you're going to get.
Could Ocwen see $1/share in earnings in 2017? Perhaps a touch on the aggressive side and somewhat dependent on interest rates, but I've always maintained that positive EPS is likely in 2017. Yet, oddly enough, the Street still seems stuck on guiding negative on 2017 earnings. I think that is woefully low, and there is substantial opportunity for Ocwen to beat on the bottom line over the next six quarters. With the spread between current consensus and potential positive earnings, that means opportunity for massive upside from here if the company can throw off positive earnings per share.
Both of us continue to build our positions in Ocwen. There seem to be signs of others beginning to build large stakes as well. Sentiment clearly seems to be starting to turn, and with a wave of potential catalysts around the corner in 2017, it appears that things may finally start to turn positive. It has been a long time coming, but hopefully patient investors who were willing to take a gamble get rewarded.
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Disclosure: I am/we are long OCN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.