After careful thought, I am recommending Ocwen Financial (NYSE:OCN) equity as well as Ocwen 6.625% 05/15/19 corporate bonds to the network of institutional clients and others I have been established relationships with for 22 years as an active participant of the RMBS/ABS investing community. I know firsthand from my bond investing experience and extensive research of data that Ocwen Financial is the top servicer of subprime mortgage loans of any servicer. After 18 months of intense corporate challenges caused by their prior rapid growth, regulatory fines and sanctions, and spillover from what I consider bad behavior from a conflicted lobby group, Ocwen has now turned the corner and is on road to profitability. Ocwen senior management is known to be honest and its 28 years in the servicing business makes it the most experienced of any servicer.
The past four months have seen a series of meaningful events that have greatly de-risked the company and added credibility to the management and the company's reputation. The equity represents a deep value considering the adjusted tangible book value is over $10 share. I am expecting the company to return to profitability in 2017 earning $1 share of EPS. Ocwen has a vastly lower debt/equity ratio of any of the non-bank mortgage servicers with about one unit of debt and one unit of equity highlighting a conservative balance sheet that is a barometer for its future stability while giving the possibility for future growth. There are several positive catalysts underway now that can benefit the corporate credit ratings and liquidity, help grow new business, and increase the company's standing with its regulators and rating agencies.
The investment opportunity now has an asymmetric profile created by low leverage, a .36x adjusted price/book ratio, improving fundamentals, and expected continued positive catalysts. As the company's investments in new growth engines produce continued results and the company ends the expensive monitoring relationship with the three states and federal monitors, the company will continue to re-rate as an operating company instead of a runoff and the share price will close 2017 at $6.75 share.
This research paper will transfer much of my understanding of Ocwen Financial as an experienced RMBS investor, capital markets sell-side market-maker, technical researcher, and Ocwen equity investor on a variety of topics. Hopefully, I can look down from a 10,000 foot view and also drill down on point covering some specifics that will include history, balance sheet valuation, cash flow and liquidity, future profitability, Ocwen's core competency, positive catalysts, and future growth.
Ocwen has been servicing residential mortgage loans since 1988 and subprime loans since 1994. In 2010, Ocwen grew its subprime servicing business to $50 billion and by 2014 Ocwen, through a number of acquisitions, grew its residential servicing business to over $500 billion. Following the financial crisis many of the largest banks such as Goldman Sacs (NYSE:GS), Barclays (NYSE:BCS), Morgan Stanley (NYSE:MS), and the bankrupt GMAC/RFC sold their servicing portfolios of mainly subprime loans to Ocwen Financial. One of the ironies in this history involved the fact that these larger banks originated, aggregated, and repacked these mainly subprime loans into RMBS securities that contributed to financial crisis. As time went on following the crisis, these banks faced with an explosion of delinquencies from struggling homeowners decided to skirt the responsibility to service the loans they had a hand in creating, and offload this job by selling these servicing rights to Ocwen Financial who, at that point, was the most experienced subprime servicer.
It's not surprising the banks wanted to exit this area as six of the top banks are reported to have now paid $110 billion in fines and consumer relief to the Department of Treasury, Fannie Mae (OTCQB:FNMA) and Freddie (OTCQB:FMCC), CFPB, Justice Department, and FDIC for their hand in originating, packaging, and selling private label mortgage bonds. Any mortgage servicers like the big banks and the acquiring non-bank mortgage servicers were having a difficult time keeping up with this explosion of delinquent borrowers caused by shoddy underwriting, the real estate crash, and higher unemployment caused by the great recession.
Had Ocwen known in 2010 and 2011 that the CFPB and 49 states was preparing a case against five of the biggest banks (Citibank (NYSE:C), Wells Fargo (NYSE:WFC), Bank America (NYSE:BAC), JPMorgan (NYSE:JPM), and GMAC/RFC) for mortgage servicing practices (lost paperwork, rob signing, cut corners, and consumer harm) that resulted in a $5bb fine and $20bb of consumer relief under the 2012 National Mortgage Settlement (NMS), it likely would not have purchased the portfolios of Goldman, Morgan Stanley, and Barclays who did not wind up ever being a party to this NMS getting off scot-free.
"The NMS also established first-ever nationwide reforms to mortgage servicing. These standards require better communication with borrowers, a single point of contact, adequate staffing levels and training, and appropriate standards for executing documents in foreclosure cases. The servicers' performance in meeting the standards is tested by the Monitor through a series of metrics."
In December 2013, Ocwen, in part because Ocwen purchased the portfolio from GMAC/RFC who was a party to this settlement, did its own settlement with the CFPB and the 49 states agreeing to comply with the reform standard and give $2 billion of relief through load mods to borrowers. New York State was a party to this agreement. PIMCO and BlackRock (NYSE:BLK) through their attorneys were strongly against this settlement and the large amounts of assistance this deal provided to borrowers through mainly principal forgiveness.
As all of these mortgage servicing rights were moving from the big banks to the non-banks some of the institutional investors such as PIMCO and BlackRock were weighing in on where the servicing should go or not go. They made efforts to lobby regulators and trustees to make these views known. In 2012, PIMCO and BlackRock lobbied through their attorney, Kathy Patrick at law firm Gibbs & Bruns to support a transfer of part of the ResCap/GMAC $300 Billion servicing portfolio to Ocwen because the $3 billion bid paid the most to them on their corporate bond claims against ResCap/GMAC. Then shortly after, announced through the media, in a New York Post article, on February 12, 2014, the Gibbs/PIMCO/BlackRock group discussed possibly bringing an action to RMBS bond trustees over Ocwen's servicing practices. The short interest on OCN just about doubled from $3mm to $5.7mm in a 30-day period before this group announced this possible action. The OCN equity went down almost 10% the day these investors through their Gibbs attorney decided to present this threat to the media, including to the NY Post.
At this point, it's widely known that certain law firms like Gibbs & Bruns were also providing information to State and Federal prosecutors on various cases to help solidify their lawsuits against the banks and others. The Gibbs & Bruns attorneys representing investors like PIMCO and BlackRock on the "Rep and Warranty Case" against Bank of America (BAC) for $8.5 Billion and the state and federal prosecutors are in effect on the same team going after the same objectives to get money.
Enter Ben Lawsky at the NYDFS into the picture. A week before the Gibbs threat towards Ocwen mentioned in the preceding paragraphs, Ben Lawsky at the NYDFS blocked Ocwen from purchasing the $2.7 billion Wells Fargo mortgage servicing deal according to this Wall Street Journal article. PIMCO and BlackRock has been vocal wanting to block Ocwen from growing further through any more acquisitions. It appears the "lobbying worked."
Flash forward to December 19, 2014. Ben Lawsky on behalf of the New York Department of Financial Services (NYDFS) enters into a very punitive consent order with Ocwen requiring the Chairman Bill Erby to step down, pay a $150mm fine, and agree to an operations monitor. New York threatened to pull the coveted New York State license, a potential death blow to any financial firm and a tactic that NYDFS used against half a dozen mainly foreign investment banks to obtain billions of outsized monetary settlements paid to New York. This agreement stated that Ocwen must pay a fine in cash to borrowers and could not provide any relief through loan mods. This smells just like the same issue that Gibbs/PIMCO/BlackRock had made strongly objecting to the requirement of the NMS that five top banks give $25bb of mainly principal forgiveness to the struggling borrowers on their mortgage loans. It smells like this group was cooperating with the NYDFS to further its objectives.
Ocwen just a year before had already entered into the aforementioned consent order with 49 states (including New York) and the CFPB in the December 2012 Ocwen National Mortgage Settlement that covered many of the same servicing practices, technology issues, and faulty customer correspondence. It is my understanding that the 49 states were agreeing to let the CFPB implement the needed mortgage servicing reforms and supervise the performance through the Monitor appointed by the CFPB. In fact, the agreement with the December 2012 Ocwen National Mortgage Settlement on page D13 - D14 discusses how if a state wants to bring unilateral enforcement action against Ocwen, it must give the CFPB/NMS Monitoring Committee notice of enforcement action, then let the group decide if it will pursue an action. NY presumably gave such notice and waited the 21-day cooling off period before acting unilaterally against Ocwen. The New York action and consent order covered about 90% of the same servicing reforms that Ocwen had already agreed to in the CFPB/NMS.
Lobby Group issues PHONY ALLEGATIONS against Ocwen: PIMCO, BlackRock, MetLife (NYSE:MET), Neuberger Berman, and Kore Advisors (Gibbs & Bruns law firm)
Then on January 23rd, 2015, a group of investors including BlackRock, PIMCO, Neuberger Berman, Metropolitan Life Insurance Company, and Kore Advisors directed their law firm Gibbs & Bruns to issue a notice of default to the trustees of 119 RMBS deals making up $82 Billion of Ocwen's mainly subprime loans, representing about of third of Ocwen's private-label RMBS servicing portfolio. This notice was followed up on January 24th, 2015, in the Ocwen Notice of Non-Performance with a detailed list of allegations that they allege constitute an event of default under the RMBS bond trust governing documents specially the Pooling and Servicing Agreements (PSAs). These allegation are very serious and included missing money from the trusts (possible fraud), loan modifications in violation of the PSA, loan modifications violating the Net Present Value test under the PSA, modifications solely motivated by taking cash out of the deals, use of trust assets to adhere to the required $2bb of borrower relief directed by the CFPB/NMS, cash flowing metrics to RMBS investors worse than any servicer, and re-default rates on loan mods far worse than the industry. This group hired Scott Gimpel, co-founder of a startup research firm Webbs Hill Advisors, to argue and present data to support the above claims. If an Event of Default (EOD) was found by the Trustees they would be obligated to move servicing away from Ocwen on the $82mm RMBS deals in the complaint but if an EOD existed in these deals it would be likely that there could be an EOD on all $200+ billion of Ocwen's entire portfolio. This was a possible death blow to Ocwen if the data presented and allegations were true. Gibbs & Bruns released the notices to the media and Kathy Patrick was quoted in a Reuters article.
And in what seems to be a coordinated attack by investors, at the same day January 23, 2015, the hedge fund Blue Mountain also sent a Notice of Default to the Trustees of a "AAA" rated HSART servicer advance ABS deals alleging that the deals are in an event of default caused by violations in the governing documents pointing to Ocwen's failure to comply with laws as well as stating that both Ocwen and Ocwen's financing subsidiary, Home Loan Servicing Solutions (OTCPK:HLSSF), are in a default of their respective $1+ billion Bank Term Loan Facilities. If the events of default alleged in this complaint proved to be true, Ocwen would likely face bankruptcy since the HLSSF subsidiary was providing over $6 billion in funding on behalf of Ocwen's obligations to provide principal and interest payments on the delinquent borrowers referencing about $150 billion of mortgage loans. Ocwen would not have the resources to advance this $6bb under any scenario if the HSART ABS servicer advance trusts went into a required early amortization event outlined in the trust documents as a remedy to EOD. Blue Mountain disclosed owning a token piece of the ABS bond deal and disclosed both purchasing put options and shorting equity in Ocwen and Home Loan Servicing Solutions. Additionally, if an EOD existed as was alleged in these two companies $1+bb Bank Sr. Secured Term Loan Agreements these bank loans would also accelerate and be immediately payable resulting in possible bankruptcy.
In the 90 days before the PIMCO, BlackRock, Neuberger, MetLife, Kore Advisors and Blue Mountain same day (appears coordinated) Notice of Defaults, the short interest found here on Ocwen went up from $11.6mm to $22.0mm for $260mm market value of added short positions a sizeable increase. Short interest on HLSSF also increased mean fully and put option contracts on both companies surged.
Then just three days later on January 26th, 2015, the California Department of Business Oversight (CDBO) announced a settlement with Ocwen requiring Ocwen to pay a $2.5mm fine, prevent any new Mortgage Servicing Rights (MSRs) acquisitions, and agree to an outside independent monitor to explore Ocwen's adherence to California servicing requirements. It is possible that the Gibbs lobby group (PIMCO/BlackRock/Neuberger, MetLife, and Kore Advisors) also might have presented the Phony Data in the EOD Trustee notices previously mentioned to New York and California as part of their motivations that included: being short OCN equity, stopping Ocwen from buying more servicing, and having the servicing transferred somewhere else as they believed their RMBS bond returns would be higher. Allegations from this seemingly sophisticated lobby group to the States that included allegations of fraud, you would think, might have led the States to want to take these actions, and at worst, install these monitors and prevent any new MSR acquisitions while they investigated the serious allegations by the lobby group. As a reminder, the CPFB + 49 states had already also installed a monitor at Ocwen a year prior. So, now Ocwen has three monitors: CFPB/NMS, New York, and California.
This attack on Ocwen by the released EOD notices by the Gibbs group, EOD notice of Blue Mountain hedge fund, and the state actions drove Ocwen equity from $22 to $5 share from late December to late January of 2015. OCN equity was at $56 on January 1, 2014.
HLSS sells to New Residential Investment in fire sale
The Ocwen financing affiliate HLSSF sells at a fire sale to New Residential Investment (NYSE:NRZ) for just around $900mm. This makes the EOD on these trusts a moot point and makes sure that Ocwen has a stable entity to continue providing and borrowing on the $6+ billion of servicer advances. NRZ is owned by Fortress (NYSE:FIG) who also owns Ocwen's biggest competitor Nationstar Mortgage (NYSE:NSM). I might note that there was never proven to have been any EOD anyway. This is the first of several assets that the Fortress affiliates started buying from Ocwen. NRZ gets Ocwen to agree that its servicer rating issued by Standard & Poor's maintains the current "average" rating or else NRZ would have the right to move servicing somewhere else.
Ocwen starts fighting for survival. The important servicer ratings and corporate credit ratings were downgraded by Moody's, Fitch, and Standard & Poor's making things worse. Some of the rating agencies in the downgrades referenced the serious allegations made by the investor lobby group as one of the reasons for the servicer rating downgrades. Ocwen announced its intent to sell its entire agency MSR book and project this will pay off over $1 billion of debt in its SSTL bank term loan.
Enter John Devaney March 2015
My firm, United Capital Markets (UCM), has been a leader in making markets and investing in the riskier subordinate private label RMBS bonds since 1999. As these events unfolded, the inventory of bonds I owned at the time fluctuated between $100mm to $150mm of proceeds across over 100 to 150 unique bonds. Because I frequently own lower-priced bonds, the face amount of my portfolio was frequently over $500mm and sometimes event at $1 billion.
About half of my entire book of mainly subprime investments was serviced by Ocwen. One of the best trades I had done in my career was purchasing RMBS bonds serviced by Ocwen in 2012 and 2013 at low prices such as $2, $5, $15, $20 most of which went to over $50. I realized early on, that the confusing higher count of loan modifications that Ocwen was doing relative to other servicers was going to protect the RMBS trusts and my own investments from losses. My firm in 2012, 2013, and 2014 traded an average of about 3 billion buys and 3 billion sells each year. My distribution and client base is very robust and includes pretty much all of the players in structured finance. Over the history of my firm, I owe much of my success to the relationship I have maintained with my clients.
When I read the Gibbs & Bruns's complaint I knew the allegations were not true. It claimed Ocwen had the worst loan re-default rate and I believed it has the best. It said Ocwen had the worst trust performance and I knew it had the best. I also knew that members of the Gibbs & Bruns group had shorted the OCN equity. I believe this was WRONG.
My firm has had a history of following the rules. UCM or my former SEC-registered investment advisor (UCAM) has never had any sanction or disciplinary enforcement action in all 16 years against my FINRA member nor had my prior SEC-registered investment advisor besides a minor books and records violation. I have maintained a history of following the rules.
My firm has offered the highest degree of transparency of dealer in the world offering over 100 bonds every day on my daily excel offering sheet entirely of hard to value subordinate investments. The big banks that my firm competes against might only offer five bonds at a time wanting to keep the trading prices and "color" close to the vest so the clients participating in buying and selling these extremely illiquid "sub" bonds don't have as much information.
I have spoken on over 40 panels in my career at industry conferences never afraid to speak my mind calling out bad behavior in many cases against originators, misleading research, and faulty bond structures when any other sell-side participants would never dream of saying those things in public. This candid and honest approach is a strength that helped grow my business and my following of clients. My 3, 7, 10, and sometimes 20 page commentaries on the RMBS market or research pieces I send on my Bloomberg client distribution loop are a hallmark of my business. My individual bond "write-ups" are often 2-3 pages per bond advertisement and I would never dream of presenting data in a phony way or bending the truth.
John Devaney - February 2015 very concerned an unstable OCN would cause a crisis
I did a survey on my Bloomberg loop in February 2015 and asked my client base if it supported Ocwen and would transfer servicing away. I got over 100 responses from leading money managers, insurance companies, hedge funds, and banks that all said they would not transfer servicing with over 95% saying they supported Ocwen.
I knew a crisis might be bubbling to fruition in the private label RMBS market and I knew I needed to do something to protect my firm's clients who I had sold billions of Ocwen-serviced investments. I called Moody's Investors Service (NYSE:MCO) and spoke to the team in the servicer evaluations group. They asked me to send them a list of names and numbers of clients that supported Ocwen via email. That night I found myself writing a long letter (are you surprised) to Moody's talking about how important Ocwen is to the entire mortgage RMBS investor base, how Ocwen, I feel, has leading performance in subprime, and how homeowners might be at risk if these efforts by the lobby group to effectively KILL Ocwen were successful. I sent Moody's the following letter the next day that I decided to make public to media since what I had written in this letter I felt was critical to the RMBS industry.
The next few days, a slew of interested parties were calling me. There was even more support from Ocwen than I previously thought. Over time, I was put in touch with bankers, state regulators, company management, the management of Ocwen's related companies, Ocwen's founder Bill Erby, who was forced to resign by the NYDFS, Ocwen corporate bond holders, Ocwen equity holders, and Ocwen's SSTL bank loan holders. No one had spoken up in favor of Ocwen publically up until this point so my phone exploded. I felt then, as I do now, like I was doing the right thing for my industry.
I started studying the Ocwen balance sheet to see if the asset sales would let it survive. I figured its debt to equity ratio would go from about 2.5 units of debt verses 1 unit of equity to 1 unit of debt verses 1 unit of equity selling the agency MSR portfolio. I did not believe the regulators would want to kill Ocwen because Ocwen has been the leader in keeping borrowers in their homes and quite frankly for the servicing business - it is too big to fail.
This is when I decided to buy Ocwen equity. I had not owned equity in over 10 years and this was a big change for my investing and my business. I felt loyalty to Ocwen because I had made very large profits on Ocwen bonds. I basically rolled my Ocwen bond profits into the Ocwen equity position I took. Many other RMBS clients that I respect, as I found out over time, also decided to buy Ocwen equity feeling it would come through the turmoil and believing Ocwen is a top servicer. As it turns out, this proved to be too soon to jump in. Although in 2015 the equity went over $10, it came crashing back down.
As it turns out, if I had to do it again, I'd do it the same way. I stand behind my principles to have the courage to speak up in the face of powerful players if I feel that what they are saying or doing is wrong or isn't in the interest of my important firm clients.
Ocwen Fires back to the Gibbs Investor Lobby Group
Ocwen fires back at the Phony Gibbs allegations on March 22, 2015 with the following letter denying that Ocwen was in an EOD in its obligations to follow the governing trust documents and talking on point to each of the allegations. On the point of missing money on several individual loan ID numbers that the servicer expect selected, Ocwen said it was simply recovering back servicer advances in accordance normal practice. Ocwen explained each item point by point providing data proving that the allegations were not true and it stated many times that the presentation was very misleading.
LL Funds - White Paper debunks much of the data in the Gibbs allegations
In April 2015, LL Funds a leading subprime investor, who recently disclosed it owns 1% of all Ocwen-serviced bonds, issued a white paper released on the internet entitled, In Defense of Ocwen Servicing. LL Funds also said it felt Ocwen has the top performance of any subprime servicer and disagreed with the findings of the expert Scott Gimpel hired by PIMCO, BlackRock, Neuberger, MetLife, and Kore Advisors.
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. It 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.
Shame on any member of the RMBS industry for knowingly presenting misleading information.
This LL Funds' white paper was read by hundreds of institutional accounts who are investors in RMBS market. All of the folks I have spoken to have said something like, "I can't believe they would risk presenting data in such a misleading way."
This would be the same thing as if I was advertising a subprime bond and decided to knowing "misrepresent" my assumption for a future default rate saying I expected the default rate to equal performance of the entire private label universe (Subprime, ALT-A, Prime). A subprime bond with far higher delinquencies would experience a far higher default experience. It's as simple as that. I would never risk my reputation presenting data in a misleading way in writing or on the telephone - period.
It has also been pointed out that this investor lobby group decided to collect errors it found in Ocwen's own database it is required to maintain for investors called Real Portal. There are literally 1 billion pieces of data in this database. PIMCO, BlackRock, etc all have an industry-leading RMBS loan level database called Loan Performance (LP). This group scrubbed Ocwen's own database for errors and then instead of verifying that there was no such error simply looking at its $600,000 a year in-house database, it chose to use bad data it found in Ocwen's system. Now, is it really ok to throw your hands up and say "its Ocwen's data?" As it turns out, some of the things this group said in its allegations would have easily been answered by using its own $600k a year in-house database.
Again, this is misleading. These are misrepresentations. How can you sign your name on something if you believe you are bending the truth?
Rant and rave session
If I sound like I'm mad and upset, I am. But I want the truth to come out. My career has been defined by being a straight shooter. I have never done anything that knowing hurt another investor. I've been hurt by these actions and so have other Ocwen equity and corporate bond investors. These actions are not ok.
A good start to remedy these misdeeds should be an investigation reviewing the emails, any possible misrepresentation by the risk/compliance/legal departments of these large firms to determine if in fact there has been any wrong doing, and if so, terminate the committee members that worked on the allegations. Do they want a few bad eggs to ruin their role reputation?
This behavior is very bad for the RMBS industry. One day, non-QM securitization will come back. This will benefit homeowners providing cheaper mortgage loans to eligible borrowers. These misrepresentations are creating a deep mistrust among the investor base, which is not good for the industry, or home homeowners. Further, it's just unconscionable to think that these larger firms would favor "liquidations" over providing homeowners modifications keeping them in their homes that hurt the very constituents like teachers, police officers, and public workers that they are managing money for. The motivations were to get a slightly higher return on their bonds.
Ocwen, for sure, has been harmed by the phony allegations. These allegations and lobby efforts has made it get far more intense scrutiny by regulators, its cost of capital has been higher, and its turnaround efforts have been harder than it otherwise might have been had these misrepresentations not been asserted.
Ok rant session is over - Back to the important history.
New Residential Transfer Risk - Tied to S+P rating
On June 19, 2015, Standard & Poor's downgraded Ocwen's servicing rating from "average" to "below average." When Ocwen consented to the sale of the HLSSF financing subsidiary previously mentioned to NRZ, one of the criteria was that Ocwen must maintain an "average" servicer rating by S+P or else NRZ would hold the right, not the obligation, to transfer servicing away to another servicer. This downgrade triggers their option to move $120 billion of servicing away from Ocwen.
During 2016, one of the biggest worries the OCN equity investors had was what would happen to Ocwen if about $120 billion of $160 billion of Ocwen's private label RMBS portfolio was transferred away to another servicer. Many investors thought that NRZ who is owned by the hedge fund Fortress, would make every effort to transfer the lucrative servicing business to Fortress's brother/sister affiliate Nationstar now the largest non-bank servicer. NSM had already bought agency MSR assets from Ocwen and the fear was that NSM would get these assets for no acquisition cost. I had maintained that I did not think that NRZ would do such a transfer because the $900mm it spent acquiring the HLSSF financing business would have far lower returns under Nationstar servicing practices over Ocwen. Also, in a worst case, this NRZ servicing contract is marked at zero in its balance sheet so losing it would be bad but not a death blow.
As time went by in 2016, the share price of Ocwen was under intense pressure as investors were concerned that Ocwen would not get the S+P upgrade preserving Ocwen's servicing contracts with NRZ until mid-2020. The April 2017 trigger date for Ocwen to get an S+P upgrade was fast approaching.
Many OCN investors lost faith and dumped fairly sizeable positions driving Ocwen to all-time lows having fears that Ocwen's would not get the S+P upgrade. Several large investors that also owned NRZ equity dumped their Ocwen shares fearing somehow that NRZ and NSM would profit from continued Ocwen problems. NRZ having a $3.5 billion market capitalization and $14 billion of debt was widely thought by many investors to be gunning to get much of Ocwen's assets or maybe to buy Ocwen if the opportunity presented itself much in the same way it bought HLSSF previously. NRZ and NSM could have stood to gain through any speed bump in Ocwen's turnaround plan.
Flash forward to Mid 2016 - Vindication of Ocwen
1.) To clear, as from an accusation, imputation, suspicion, or the like: to vindicate someone's honor. 2.) To afford justification for; justify: Subsequent events vindicated his policy. 3.) To uphold or justify by argument or evidence:
Duff & Phelps
Independent Expert Consultant Finds RMBS Investors' Allegations Against Ocwen to be Baseless
May 25, 2016 (GLOBE NEWSWIRE) - Ocwen Financial Corporation, a leading financial services holding company, today commented on the (Duff & Phelps) independent analysis, which determined that none of the allegations in the Gibbs & Bruns, LLP's January 23, 2015, Notice of Non-Performance investigated by Duff & Phelps were supported by evidence.
Duff & Phelps, a global corporate valuation and financial advisory firm, was engaged by Wells Fargo Bank N.A. in its capacity as Master Servicer for 42 Ocwen-serviced Residential Mortgage Backed Securities trusts (Trusts), to investigate allegations regarding the Trusts alleged by: 1) Gibbs & Bruns's January 23, 2015 Notice of Non-Performance on behalf of certain Institutional Investors; and 2) Ocwen's Consent Orders with the Consumer Financial Protection Bureau and New York Department of Financial Services.
Duff & Phelps conducted a 12-month review of Ocwen's servicing operations, accounting, loan modifications, borrower compliance, and operations and governing practices. This review involved an analysis of thousands of servicing files, data points, invoices, as well as a comprehensive review of the company's systems and records.
The Duff & Phelps investigation:
- Did not find any evidence that Ocwen failed to account for P&I payments to the Master Serviced Trusts.
- Did not find any evidence that Ocwen charged the Master Serviced Trusts for any undisclosed or 'mysterious' expenses.
- Did not find evidence that Ocwen made negative NPV modifications in order to maximize servicing fees and prematurely recoup advances.
- Did not find evidence that Ocwen engaged in modifications in order to prematurely recover advances at the time of modification.
- Did not find evidence to conclude generally that Ocwen made extreme and imprudent modifications.
- Found that Ocwen applied the Stop Advance Tag on loans consistently with Ocwen's Stop Advance model and not with regard to whether or not the loan had been modified or whether the borrower defaulted immediately after modification.
- Did not find evidence that Ocwen failed to comply with the SCRA requirements for borrowers on active military duty.
- Did not find evidence sufficient to conclude generally that Ocwen engaged in deceptive, misleading, or inadequate practices with regard to newly boarded loans.
- Did not find evidence sufficient to conclude generally that Ocwen improperly imposed lender-placed insurance.
- Did not find evidence to conclude generally that the Master Serviced Trusts were charged higher fees in connection with sales of REO properties involving Hubzu (NASDAQ:ASPS) auctions or REALHome brokers as opposed to traditional sales and/or unrelated brokers.
"We are pleased with the results of Duff & Phelps's year-long independent review. We continue to focus on servicing loans in the best interest of loan investors and on being a leader in helping homeowners," said Ron Faris, President and CEO of Ocwen.
Powerful Moody's Statement
On June 29, 2016, Moody's maintains Ocwen's servicing rating but makes some striking comments about Ocwen's top position in the servicing business saying:
- Ocwen continues to have best total cure and cash flowing metrics among servicers assessed by Moody's
- Foreclosure and REO timeline performance remains at Above Average, with particular strength in pre-foreclosure and foreclosure timelines
- Loan modification re-default rate not as strong as some of its peers
Moody's is saying that Ocwen has the best cure rate and cash flowing metrics among all servicers. This is not saying it is above average. This is saying it is #1.
I hope the New York DFS and California did not rely on the phony evidence presented by PIMCO, BlackRock, Neuberger Berman, MetLife, and Kore Advisors claiming that Ocwen has the worst cure rate. The investor group also asserted a wild claim that Ocwen has $26 billion of less cash flow over other servicers comparing its portfolio to the industry.
This statement is saying it is #1.
Shouldn't these big investors know how to analyze the data? The short interest exploded on Ocwen before the bombshell of the phony allegations came out. I know members of the Gibbs investor group were short Ocwen stock which I find to be highly unethical considering it sent official EOD notices to $82 Billion of Ocwen serviced RMBS deals. There should have been a disclosure made. At least the EOD notice Blue Mountain sent (did not result in EOD either) disclosed it was short the equity.
I hope, California DBO and New York DFS are taking this fact into account as they look at releasing Ocwen from the expensive monitor costs that have been at a run rate of over $110mm a year.
Ocwen has the #1 cure rate. This benefits homeowners the most. The states should favor this.
Update to LL Funds White Paper
In July 7th, 2016, LL Funds a leading subprime investor with some of the top returns of any investor in the RMBS space, published an update on Ocwen's servicing. This report compared Ocwen subprime servicing to SPS servicing, rated above average by S+P and considered to be the leading non-bank residential mortgage servicer. The findings found that Ocwen's servicing over a six-year period resulted in 6% lower RMBS trust losses over SPS in the subprime category. These are very meaningful lower losses to RMBS bonds. There is no wonder why the vast majority of RMBS investors prefer Ocwen in the subprime category.
OCN- Earnings Release - Best Earnings call in over a year
July 27, 2016
The second quarter earnings release and investor presentation provides the turning point for investors realizing that there is light at the end of the tunnel for Ocwen. The important and significant highlights are below
- Ocwen accrues $15mm to settle the California monitor. The California independent monitor cost, I believe, is about $20mm of the $28mm quarterly total cost. Settling this for $15mm would be very advantageous.
- Ocwen reports an operating profit of $2mm, less the one-time items, for the first time in over a year. If the monitors went away tomorrow or the California accrual for a settlement is finalized, Ocwen would therefore be close to having positive EPS right now.
- Revenue, quarter over quarter, moved higher for the first time in 18 months. This was driven by the release of deferred servicing fees on delinquent loans as the modification pace picked up 19% in the quarter. Also, the lending segment originated $1.3 billion of new loans up 35% over the prior quarter earning higher pretax income.
- The new Automotive Capital Services (used car dealer floor plan) business line continued its expansion doubling outstanding loans to $18mm providing loans to 21 dealers in two markets. The presentation discusses that a national rollout is under way and it expects to grow from 21 markets to 52 markets in 34 states by the end of 2016. It discusses anticipating tapping into the liquid ABS floor plan securitization market in the future. The ABS bond deals are generally $200-400mm in size so this might wind up being a decent growth business into the future in the lending segment if it can hit that securitization goal. I believe it is earning over 10% gross yield with fees, so if it borrows at 3.25% and puts 25% equity down this drives a 25-30% return on equity capital down. Maybe, Ocwen management is smart to diversify into this niche market.
- Reported that its CFPB complaints were down 26% in the last reporting period down more than any mortgage servicer. This momentum is likely going to help Ocwen break free of the expensive State Monitors earlier than investors might be anticipating.
Ocwen RMBS Investors hire Counsel - preparing to block a NRZ transfer
August 1, 2016
I was asked to join a group of investors that were exploring their rights under the governing RMBS bond documents to retain Ocwen as the servicing even if NZR decided to exercise its right to move servicing.
OCN Corporate Bondholders
In early August 2016, a group of Ocwen corporate bondholders who I have gotten to know started informal talks at the possibility of extending the maturities of the Ocwen corporate debt in exchange for moving from a senior unsecured position to a junior bank loan obtaining more secure collateral. The aim is to help Ocwen. If this type of initiative is completed, the current price of the OCN 6.625 '19 could perform very well.
John Devaney sends S+P public letter
Friday, August 5, 2016
Knowing how important the Standard & Poor's upgrade is for Ocwen's future, I sent the following letter to Standard & Poor's and also released this letter to the media. This letter discussed: that Ocwen's data has shown that it is the #1 servicer of subprime protecting RMBS trusts the most from losses, that the vast majority of the RMBS clients support Ocwen, the allegations from the Gibbs lobby group were misrepresentations (this is a legal word that means you know what you're saying isn't true) and have been vindicated by the Duff report, that the Gibbs group members were short OCN equity which I find to be highly unethical and unprofessional considering they sent legal EOD notices to trustees of $82 billion, and that RMBS Ocwen bondholders are organizing a group through counsel to block any transfer of servicing if S+P doesn't upgrade, and of course, I urged them to upgrade Ocwen's rating.
Standard and Poor's Upgrades Ocwen's Servicer Rating to Average
Tuesday, August 9, 2016
Standard & Poor's upgraded Ocwen's servicer rating and places Ocwen on "Positive Outlook". Moody's and Fitch currently have Ocwen's servicer outlook as "stable" so the long awaited Standard & Poor's rating is now the highest of the rating agencies.
It deserves it.
Ocwen is very committed to its servicing business and is looking to continue to win over the rating agencies. I am expecting a positive outlook from Fitch and Moody's or a small upgrade from the equivalent of "average minus" to "average." I met with both Fitch and Moody's recently in September to give my industry and professional perspectives.
Two Former Ocwen research "Shorts" switch to a BUY rating
Prior short Compass Point, Fred Small, issues a recent Buy rating
Independent research firm, Oozing Alpha who recommending shorting Ocwen in the 20s is now recommending Ocwen in a lengthy report entitled, Ocwen Revived: "Where do we go from here"
Ocwen ranks #1 in the Treasury's New Streamlined Modification Program
September 16, 2016
The U.S. Department of the Treasury Making Home Affordable Program (MHA) report states that in the second quarter, Ocwen Financial was responsible for 53% of all Streamline HAMP modifications or a count of 4,112.
The second quarter MHA report also states Ocwen received three-star ratings across all compliance categories, which is the highest rated category, and was the best or second best mortgage servicer in all secondary rating criteria.
The quote from Ocwen's CEO Ron Faris sounds particular confident, "Ocwen is a new company with a management team and Board of Directors that is committed to a culture of compliance and service excellence," added Mr. Faris. "We have made and continue to make significant investments across our risk and compliance infrastructure. We are also continuing to improve our service levels as evidenced by the superior borrower assistance results revealed in the recent MHA Report."
Valuation: Adjusted Tangible Book Value
Ocwen has assets marked at zero on its balance sheet that have value. In order to figure out what the real book value is, or the adjusted tangible book value, these other assets need to be recognized. The sentiment this past year has been so negative that investors have been reluctant to recognize these assets. Since the tide has turned for Ocwen on a number of fronts, investors will likely start to recognize these assets and the share price will re-rate in accordance.
The book value, or assets minus liabilities, is currently at $5.25. Slide 9 on the Q2 Investor Presentation discusses $491mm of value of off balance sheet assets or another $3.92 per share of additional assets. These assets are:
NRZ Subservicing contract $277mm @ 14% discount rate worth $2.21 share
This asset reflects a revenue stream the company gets from collecting the 50 bps servicing fee minus the 18 bps paid to NRZ. Ocwen more importantly collects 1.25% of a mortgage loan balance at the time of modification and also collects 1.25% of the sale proceeds of liquidations. A third-party broker opinion valued this contract at $277mm using a 14% discount rate. Embedded in this subservicing contract is a large amount of deferred servicing revenue of over $200mm. The reason I bring this up, is that these deferred servicing revenues are released to Ocwen when Ocwen does a modification or liquidation on a delinquent loan. The profit margin on these revenues goes up over time because some of these delinquent loans in judicial states have been delinquent for 3-4 years and Ocwen has already paid out expenses to service those loans. This money comes in when the loans are resolved. The direction of delinquencies is lower and will continue to be on the seasoned RMBS legacy private label loans. This legacy RMBS servicing is a cash cow. This is the primary reason I am an equity investor.
The reason that Ocwen's revenues went up this last quarter is because it did mods that released these deferred servicing revenues. Ocwen's revenues went up quarter over quarter when the servicing portfolio size went down - This is a very powerful sign.
Reverse Mortgage Future Tail Draws: $64mm @ 12% discount rate worth $.51 share
This asset is rock solid. These are profits that Ocwen will collect on reverse mortgage loan draws. Ocwen has already underwritten these reverse mortgage loans. The future draws or advances to the borrowers are securitized into the government insurance HECM bond deals. When these loans are placed into the deals, Ocwen collects the 11-12 points premium on these loans. It has already for the most part paid the expenses to underwrite the loans and now these future tail draws are gravy. Ocwen is basically going to get this money no matter what and the financing is backed by the government.
Call Rights: $109mm @ 10% discount rate worth $0.87
Ocwen owns, or is a partner in, call rights on approximately $159 billion of private label mortgage RMBS deals. The call rights are valuable as when the deal's delinquencies reduce to a certain level, the deals can be called and the seasoned performing loans can be sold at a premium exceeding the losses taken on selling off the non-performing loans. NRZ who is a partner with Ocwen on $121 billion of call rights is required to pay Ocwen 0.5% of the unpaid principal balance of any deal it wishes to call. Ocwen in this agreement is "at the top of the waterfall." NRZ has already called dozens of deals paying Ocwen its fee. Ocwen also owns $38 billion of call rights that does not entail this partnership with NRZ, where the expected profit calling deals would be more like 1.5 to 2.5 points on the loan balance.
Deferred Servicing Fees: $23mm @ 15% discount rate worth $.18 share
These are deferred servicing fees or deferred servicing revenues that Ocwen is entitled to collect no matter what on loans living in RMBS trusts that are currently delinquent. When Ocwen does a modification or liquidation it gets this money. Ocwen has decided not to accrue these revenues so this asset is marked at zero on the balance sheet. This is a very secure claim.
Agency MSR's $18mm @ 10% discount rate Worth $0.15 share
This asset is marked by a third-party broker. Ocwen is carrying this asset at cost even though the asset is marked at a higher value by a third party.
Tax Asset: Worth $.60 share
GAAP accounting required Ocwen to write off on operating loss tax asset from Ocwen's balance sheet as the rules say that there needs to be an expectation to earn a profit. Because Ocwen has been in the middle of a fire storm for the last year, this asset was written off. If it appears that Ocwen will return to profitability which is what I am expecting in 2017, then Ocwen will be able to increase the GAAP book value by about $75mm or about $.60 cents a share.
Ocwen's Loan Originator Business Worth $0.80 share
Ocwen is the #2 originator in the reverse mortgage business. An acquirer would pay a nice premium for this business. Ocwen is set on growing its agency origination business and the previous $10+mm investment spent in this area looks like it is yielding results. Ocwen's origination volume grew by 35% in the second quarter to $1.3mm and it earned pretax income of $8mm in Q2 in this segment. At this run rate, this would be $32mm of pretax profit worth $100mm.
All this adds up to $5.25 + $2.21 +$.51 + $.87 + $.18 + $.15 + $.60 + $.80 = $10.57 share
Future Profitability: what can 2017 look like? $1 share EPS
Ocwen earned $2mm of operating profit backing out the one-time items.
Boosts to Profitability:
Lower Monitor Costs in 2017 $55mm to $95mm in savings (right to pretax profit)
The only one-time item set for this next quarter is the $28mm of monitor costs (California, New York, and SFPB/NMS) paid last quarter. I've heard California made up $20mm of the $28mm and the other $8mm was split between NY and CFPB/NMSD.
If California finalizes the proposed $15mm settlement Ocwen accrued for in the Q2 10-Q, Ocwen could be free from $20mm a quarter. This could drive profits higher by $80mm in 2017. This item alone could greatly help Ocwen to start growing profits and book value. At worst, the California settlement is up in June 2017 with the right to extend. New York is up in April 2017. Based on the Duff & Phelps report and the recent S+P upgrade, I do not see a lot of reason why the state regulators would extend.
The total reduction of monitor costs if California settles and NY sunsets in April 2017 is about $95mm cost savings. Ocwen won the S+P upgrade and it is winning over the states now.
This last quarter in Q2, I feel, is going to be the high-point in monitor costs. I feel that, in Q3, the monitor costs will come down by $5mm as Ocwen has made significant progress and has been lobbying the states to reduce these costs.
If the New York and California monitor agreements sunset in April and June of 2017 on schedule without a California settlement, the savings in 2017 would still be $55mm.
Further reductions in corporate expenses and headcount:
Ron Faris has maintained the attitude that he would right the ship setting up for long term success at the expense of profits. Ocwen has been waiting for the Standard & Poor's upgrade. This has proven that in many respects the ship has been righted. It certainly did not want to send a message that it would risk lowering servicing quality by making too deep of cuts nor did it do this. There likely is going to be a prudent and measured decline of headcount to right size the business for the large decline in outstanding servicing balances. There likely is some fat to trim in corporate overhead considering the servicing portfolio has shrunk from over $500 billion to just over $200 billion. I think there is going to be another $25-50mm in more cost saves across the entire business. This is going to drive EPS higher by $.30 cents in 2017.
Servicing segment is going to return to profitability in the very near term.
In 2012, Ocwen earned $274mm of pretax income in the servicing segment on just $118 billion of Unpaid Principal Balance (UPB) of mortgage loans. This is 23 bps of the UPB. With the higher compliance and regulatory costs hitting the entire servicing industry, it is not likely that Ocwen will return to this margin in the near term. I do expect however, that Ocwen can earn .05 bps of margin on the $160bb of private label portfolio in 2017. This is $80mm of pretax income. The agency servicing business will probably lose $25mm in 2017. $80mm - $25mm = $55mm of profit in the servicing segment. In Q2, Ocwen just reported a -$15mm loss in the servicing segment. This included a $11mm loss on unfavorable rate move and $4.5mm of payments to NRZ that it doesn't have to make anymore. A tailwind is at the back of the Ocwen's core business = servicing.
Ocwen will pick up 450mm if the 10-yr rate goes to about 2.18% in reversing prior unfavorable MSR mark downs. If rates go up this is gravy and could add $50mm of profit or an extra $0.40 of EPS.
Lending and Origination Segment/Auto Floor plan Business:
Ocwen has stated it has spent some meaningful investment capital like $10-20mm to set the stage for future growth. I'm expecting this to bear fruit.
Walter Investment Management (NYSEMKT:WAC) has liquidity issues and I heard might close down the entire Reverse Mortgage Business or greatly curtail it business to save cash and fired the head of that area. Since Ocwen has the #2 Reverse market share, it likely will pick up business.
FHA Opportunity: Could be the Golden Goose
Folks, me included, wanting Ocwen to refinance the non-QM portfolio. Some smart investors have said that Ocwen has $10-20 billion (out of $150 billion total portfolios) of pristine subprime loans that have been current for more than five years. The logic has been, why doesn't Ocwen enter the non-QM space securitization market and refi these pristine borrowers into new non-QM loans, then make 2 points profit. 10 billion x 2 points = $200mm
On the Q2 conference call Ron Faris when asked about the non-QM Origination opportunity, replied and said he is looking at it, but that he can say that Ocwen had just for the first time in Q2, refinanced loans in the $160bb private label portfolio into FHA.
This is very powerful. FHA loans get 3-4 points off profit the most off any agency program. FHA loans can have 580 to 640 ficos. A good portion of the $10-20 billion of the pristine subprime loans that have been current for more than 60 months in a row will qualify for FHA.
This might be one reason origination volume went up this last quarter 35%.
10 billion x 3 points = $300mm of revenue. This could be the golden goose. This wouldn't happen so all in 2017 but if Ocwen refinanced $1 billion of the $160bb private label portfolio into FHA which I think it is going to do, this would make $30mm = $0.24 EPS 2017.
So adding up the tailwinds in the business segments, the reduction from monitor costs, and the expected continued expense savings, I am predicting a $1/ share EPS in 2017. Considering the OCN share price is at $3.64 this makes the equity very cheap. Also, remember, that profits are just going to drive up book value.
S+P changed everything New Sponsors:
I basically doubled my last reported 6mm position after the S+P upgrade. This S+P upgrade changes everything for a stable Ocwen future. I know of a large bank that bought a 4% OCN position recently and a leading RMBS hedge fund also bought a 4% position recently. These new sponsors can add value to the company. There is also a large new corporate bond investor that bought over $40mm of OCN corporate bonds in the higher 80s recently. The tide has turned.
The investment opportunity now has an asymmetric profile created by low leverage, a .36x adjusted price/book ratio, improving fundamentals, and expected continued positive catalysts. As the company's investments in new growth engines produce continued results and the company ends the expensive monitoring relationship with the three states and federal monitors, the company will continue to rerate as an operating company instead of a runoff and the share price will close 2017 at $6.75 share. Ocwen has a strong business franchise considering the RMBS investors like myself all prefer Ocwen for servicing subprime loans and the data and the rating agency comments prove it.
I remain committed to this investment as you can tell. I have stuck in this investment as I believe in the adjust tangible book value and Ocwen's return to profitability.
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. I have no business relationship with any company whose stock is mentioned in this article.