It has been pointed out that Altisource Portfolio Solutions (NASDAQ:ASPS) has contracts with Ocwen Financial (NYSE:OCN) that some believe are "very solid." These ASPS bulls incorrectly assume that ASPS will be protected from a potential shift of service fee revenue that we believe will occur after New Residential Investment (NYSE:NRZ) acquires $117 billion of UPB in mortgage servicing rights ("MSRs") from OCN as proposed on May 1, 2017, in a joint press release from NRZ and OCN (the "MSRs Transaction"). We believe that the language in the ASPS, OCN Services Agreement (dated August 10, 2009) and two subsequent amendments (dated October 1, 2012, and March 29, 2013, respectively), does not protect ASPS from NRZ directing "downstream services" after it owns and controls the $117 billion in UPB of MSR, causing the loss of a significant high-margin revenue stream for ASPS.
We would expect that as the new owner in control of the MSRs, if the MSRs Transaction is completed, NRZ will direct how services are provided. First, and as described publicly by NRZ and OCN, we anticipate that NRZ would enter into a "standard" sub-servicing contract with OCN. We expect that under that contract, OCN would provide all services EXCEPT "downstream" services. This would be consistent with what NRZ's CEO said on their Q1 2017 earnings call: "NRZ will also fully control all of the downstream services associated with this portfolio." Furthermore, we expect that as part of this sub-servicing agreement, NRZ would require OCN to send all copies of loan files that require "downstream" services to either Nationstar Mortgage (NYSE:NSM) or NRZ, which could then refer/pass on the files to NSM.
ASPS bulls likely rely on non-compete language in the Services Agreement and its two amendments to defend their position that ASPS is protected from loss of the significant high-margin service fee revenue stream referred by OCN. For purposes of this write-up, we will refer to the Second Amendment to the Services Agreement, which includes the latest language on the non-compete, filed in an 8-K March 29, 2013. Exhibit 10.1, page two of section 3. Standard of Performance; Marketing and Promotion; and Noncompete and in the sub-section (C) Noncompete, (emphasis added):
"During the term of the Services Agreement, Providing Party [ASPS] shall be the exclusive provider of Services to Customer Party [OCN] with respect to the Services that Providing Party provides to the Homeward Platform, which Services shall include, but not be limited to, default management, mortgage charged-off and deficiency collection services, technology-related services, valuation services, property preservation and inspection services, real estate owned sales services, trustee services, title services, due diligence services, mortgage fulfillment services, and underwriting services. In furtherance of the foregoing, during the term of the Services Agreement, Customer Party [OCN] agrees not to establish, on its own or with the assistance of third parties, fee-based businesses that would directly or indirectly compete with the provision of Services by Providing Party [ASPS] to Customer Party [OCN] with respect to the Homeward Platform."
A few points to consider: First, it is important to note that the Services Agreement is between OCN and ASPS, not NRZ and ASPS. Any breach of this non-compete would arise in a claim by ASPS against OCN, not NRZ. Second, as part of the MSRs Transaction, OCN would have a relationship with NRZ which simply owns the MSRs and doesn't engage in a line of fee-based businesses similar to those provided by ASPS. NRZ would be referring the REO auction and other services to NSM, which has no relationship with OCN. Third, even if somehow OCN could be seen as having violated the non-compete, the Services Agreement provides that in no event shall damages for a breach of contract exceed fees for the most recent six-month period (page 16 of Services Agreement). We estimate such fees would be less than half of what OCN would receive from NRZ in the MSRs Transaction, and since ASPS would have to rely on ambiguity rather than a violation, at best, ASPS could hope to settle for a lesser amount. In any event, we think the point is moot. We believe the Services Agreement and its two Amendments actually contemplate a scenario in which OCN can sell the MSRs to NRZ and provide sub-servicing while NRZ directs "downstream" services without violating the non-compete.
From page two of the Second Amendment, same section 3., but from sub-section (B) Marketing and Promotion (emphasis added):
"To the extent that the Customer Party [OCN] does not direct or have control over the selection of the service provider of Services, Customer Party [OCN] shall encourage its third party relationships to use Providing Party [ASPS] for those Services that Providing Party [ASPS] provides."
We believe that following completion of the MSRs Transaction, NRZ would be the outright owner of the MSRs it acquires from OCN and, as such, will have control over the selection of the service provider of Services. We further believe that OCN will not be in a position to "direct" nor will it "have control over the selection of the service provider of Services." Moreover, we expect that NRZ will be considered a "third party relationship" for OCN.
OCN can "encourage" NRZ all it wants to use Providing Party ASPS for "downstream" services. However, we think the smart business decision for NRZ and NRZ's likely choice will be to engage NSM for the "downstream" services. We also believe that regulators may prefer the selection of NSM given the issues that the 25 states, CFPB, and SEC have raised with respect to OCN's problems with its REALServicing technology platform and REO auction fees, among other issues, for which ASPS is partially responsible.
Finally, we note a large overlap of shareholders exists between OCN and ASPS. OCN shareholders, and not to mention bond holders, who do not own shares of ASPS should be rightfully concerned about the conflicts of interest between the two companies. OCN has referred billions of dollars of fee revenue to ASPS over many years. Meanwhile, ASPS's technology platform appears to be at the root of OCN's problems with regulators, as evidenced by the claims in recent litigation and cease-and-desist orders filed by 25 states. Regulatory fines and monitor expenses have cost OCN hundreds of millions of dollars. And yet, OCN continues to refer revenues to ASPS. One must wonder why OCN has never turned to ASPS to share some of the burden, as it appears that ASPS bears much responsibility for the root problems. The inaction could be explained by certain large shareholders of OCN having a relative larger investment in ASPS and, therefore, a greater economic interest in protecting that larger investment. We suggest that OCN shareholders who do not own ASPS should be aware of the potential conflicts of interest which could also come into play in the pending NRZ-OCN MSRs Transaction. A potential activist investor in OCN, or plaintiff's attorney, might find it interesting to explore these conflicts of interest further.
We once again suggest that long investors in ASPS should sell what we believe are overvalued shares which face significant downside risks.
Disclosure: I am/we are short ASPS, 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.
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