Ocwen Financial Corporation (NYSE:OCN) Q3 2017 Earnings Conference Call November 2, 2017 8:30 AM ET
Stephen Swett - Investor Relations, Managing Director at ICR
Ron Faris - President, Chief Executive Officer, Director
Michael Bourque - Chief Financial Officer, Executive Vice President
Bose George - KBW
Fred Small - Compass Point
Good day ladies and gentlemen and welcome to the Ocwen Financial's Third Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]
I would now like to turn the call over to your host, Mr. Stephen Swett. Sir, you may begin.
Good morning, and thank you for joining us today for Ocwen's third quarter 2017 earnings conference call. Before we begin, please note that a slide presentation is available to accompany today's call. To access the presentation, please go to the Shareholder Relations section on our website at www.ocwen.com and click on the Events & Presentations link.
As a reminder, the presentation and our comments today may contain forward-looking statements 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, such as certain statements relating to our expectations and strategies for growth, for costs and our cost improvement efforts and the financial and other impacts of our July, 2017 agreements with New Residential Investment Corp or NRG.
Forward-looking statements, by their nature, address matters that are, to different degrees, uncertain. Our business has been undergoing substantial change, which has magnified such uncertainties. You should bear these factors in mind when considering such statements and should not place undue reliance on such statements. Forward-looking statements involve a number of assumptions, risks and uncertainties that could cause actual results to differ materially. In the past, actual results have differed from those suggested by forward-looking statements and this may happen again.
Our forward-looking statements speak only as of the date they are made, and we disclaim any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. In addition, the presentations posted online and our comments contain references to non-GAAP financial measures, such as adjusted operating expense, adjusted pretax income, adjusted pretax income before corporate debt expense, normalized adjusted cash flow from operations, illustrative servicing cash flow or servicing cash generation.
We believe these non-GAAP financial measures provide useful supplement to discussions and analysis of our financial condition. We also believe these non-GAAP financial measures provide an alternative way to view certain aspects of our business that is instructive. Non-GAAP financial measures should be viewed in addition to, not as an alternative for, company's reported results under accounting principles generally accepted in United States.
For an elaboration of the factors I just discussed, please refer to today's earnings release, as well as the company's filings with the Securities and Exchange Commission, including Ocwen's 2016 Form 10-K and Ocwen's third quarter 2017 Form 10-Q.
Joining me on the call today is Ron Faris, President and Chief Executive Officer; and Michael Bourque, Chief Financial Officer.
Now I will turn the call over to Ron.
Thank you, Steve. Good morning and thank you all for joining the call today. I'm going to start the discussion today where I left off at the end of the call last quarter providing some updates on our go-forward plan. In short, we are closely examining each of our businesses and product lines, especially those that are not generating acceptable returns and those where we may be able - where we may not be able to effectively support longer term growth.
As I said last quarter, we will not hesitate to scale back close or sell underperforming businesses or product lines. As previously reported, we closed our Correspondent lending channel for forward originations earlier this year due to unacceptable margins. We have now as of yesterday also effectively exited the forward wholesale lending channel for similar reasons.
We continue to explore opportunities to improve servicing scale, reduce corporate overhead, reduce interest rate risk and reduce funding risks. As I mentioned last quarter, opportunities could include strategic transactions, and/or selling certain assets or businesses. As we announced on October 24th, we are seeking to focus the company's operations on mortgage servicing and our retail forward lending channel, primarily through retail lending recapture.
While we believe that our reverse mortgage business, Liberty Home Equity Solutions, Inc., has performed well. We are currently evaluating our long-term strategy there, including the potential sale of the reverse lending business or some assets of the business. Barclays Capital is inviting us on the alternative days related to our reverse mortgage assets and business.
As noted in our earnings release, our reverse mortgage portfolio ended the quarter with an estimated $98.7 million in undiscounted future gains from forecasted future draws on existing loans. These projected gains have not yet been recognized in our financial statements but could potentially be realized earlier on a discounted basis through the sale transaction.
In addition, we have also been evaluating our long-term strategy for our automotive capital services business, which provides floor plan lending to independent car dealers. While we still believe this business has long-term potential, it is a relatively capital-intensive business and still in the startup phase.
As Ocwen's ability to raise capital at competitive levels in the current business and regulatory environment is limited, we believe the automotive capital services business may be worth more to a depository institution and investments fund or an existing auto industry participant than it is to the company. Consequently, the company is considering the potential benefits of monetizing its investment in this business in the near-term.
To date this new initiative has operated at a loss and currently consumes approximately $12 million in capital. Exiting the business could over time improve our bottom line, reduce leverage, and improve our overall liquidity position. In our last discussion, I summarized our primary objectives to be, first, resolving our regulatory issues, which we have made substantial progress on, having now settled with 21 states, plus the District of Columbia, generally on relatively similar terms to each other.
We hope to eventually settle with the remaining nine states and two states' attorney general, but caution that we may not be able to do so on similar terms or other appropriate terms and settling the remaining matters may require additional or different terms some of which may be more challenging and costly.
Second, expeditiously completing the transfer of the MSRs to new residential or NRZ. Here we made good progress in Q3 having received $55 million in cash from NRZ, but there is a lot more work to be completed, as obtaining the required concerns has been and remains a challenging process. We are working closely with NRZ to obtain these remaining consents.
Third, resolving our legacy high exposure litigation to reduce future uncertainty. This remains in focus and a challenge. We have made good progress this year, but still face various high exposure litigation cases including but not limited to various securities matters in the CFPB. We remain focused on resolving these as best we can and I'll refer you to our 10-Q for more details.
Fourth, reducing our corporate overhead expenses. As reported in our last update, we have identified various cost out opportunities, which have begun to occur and should be substantially completed by year end. However, as we shift our business strategy more towards servicing and recapture, additional work is needed here. We are reevaluating all of our corporate costs in this way.
Fifth is improving our quality and reducing leverage over time. We have and continue to make progress on this front. As we close more of the NRZ transaction, we expect liquidity should improve. In addition, as mentioned above, we are exploring various alternatives for some of our business lines, which could result in sales of assets. We have not yet decided where, when, and how that potential cash will be deployed, but some reduction in overall leverage may result from any transaction that occurs.
Finally and most importantly, we continue to reduce RMBS losses and keep struggling families in their homes through effective servicing and loan modifications. As reported, we completed an additional 6500 loan modifications this quarter. In Q4, we will be partnering with various nonprofit organizations, including the NAACP and HS New York City and New Jersey Citizens Action on borrower outreach events.
Before I turn the call over to Michael Bourque who will discuss in more detail the NRZ transaction, as well as some financial update, I would like to hit on a few additional highlights. Our net loss in Q3 '17 of $6 million was a significant improvement over the first two quarters of this year.
Our reverse mortgage business continues to perform very well and remains an industry leader. Our servicing segment had its fifth consecutive profitable quarter. Our retail recapture direct lending channel showed positive momentum. Our overall liquidity position improved in Q3, despite paying out certain significant legal settlements.
We have signed an agreement to move to a new servicing platform. We have withstood hurricanes impacting our offices in St. Croix, Florida, and Houston along with significant storms in our Mumbai and Manila offices. Additionally we are working very hard to assist our customers who have been also impacted by these hurricanes.
We continue to go above and beyond to help consumers struggling with their mortgage payments as demonstrated by our industry leading loan modification and principal forgiveness results and community outreach involvement. And finally our management team and staff have continued to stay together and continued to perform at a high level under challenging circumstances.
I would now like to turn the call over to Michael Bourque, our CFO. Michael?
Thanks, Ron. And good morning everyone. I wanted to first start with a discussion of the NRZ transaction and summarize some of the key financial impacts. You can follow this discussion on slide six through eight of the presentation. As background, Ocwen entered into various rights to MSR transactions with HLSS, now NRZ from 2012 to 2013 and those transactions, the advances receive sale treatment.
For various reasons, the MSR component of the transaction was treated as a financing liability and the underlying MSRs were deconsolidated from our balance sheet. The cash received for the MSR portion was treated as a financing liability. Both the MSR asset and the offsetting financing liability are carried at fair value.
The quarterly fair value mark-to-market of the MSR is recorded in servicing and origination expenses and the quarterly fair value mark-to-market of the financing liability is recorded in interest expense. On July 23rd of this year, Ocwen entered into various agreements to effectuate the legal transfer of the MSRs underlying the 2012-2013 rights to MSR transactions subject to the receipt of all required third-party consents.
After receiving the consents, the MSR ownership will transfer to NRZ and NRZ will pay us a lump sum payment, which equals the contracted price in basis points times the UPB at the time of the transfer. Over time the contracted lump sum price falls reflecting the reduced future cash flows being purchased.
For September 2017 the price was 34.4 basis points. The payment by NRZ is primarily to compensate Ocwen for the reduction in servicing fees down to 13 basis points over the remaining life of the original agreement, the loss of REO related compensation, fees on call rate transactions, and other economic changes to the relationship as part of the July agreement, Ocwen will act as the sub-servicer for an initial five year term.
Similar to the 2012, 2013 agreements the July 2017 transactions will be treated as a financing. We will retain the MSRs on our balance sheet and we will not deconsolidate the MSR and associated financing liability even after concerned service and NRZ becomes the legal owner of the MSR. Each lump sum payment will simply increase the existing financial liability.
This means there we will now be two elements to our financing liability, the first part from the initial rights to MSR transaction, which reflects the fair value of the course funding asset, of course funding MSR asset and the second part which reflects the fair value of the lump sum payment received under the July 2017 transaction. As concerns in cash payments our received from NRZ to financing liability balance will grow.
Since the financing liability is carried a fair value, each reporting period we will update the value to reflect the underlying MSR cash flows which have a finite term. So once all the transfers with NRZ occur we expect the fair value of the financing to then decline overtime because the cash flows depend on the remaining life of the servicing asset. It is possible that if interest rates raise enough, the value of the underlying liability could increase in some periods.
In most periods however the liability should decline in value and we will record to reduction in interest expense. This mechanism effectively results in the amortization of the lump sum payments and the recognition of Ocwen's foregone economics to income over the remaining life of the original 2012, 2013 contracts.
Now, given the fair value accounting model and the nature of the concerned process and payment mechanics, there are two specific impacts worth noting. First there is a chance to have MSR characteristics in a particular consent group that are different from the average upon which the contract price is based grading potential income statement variability. The transaction with NRZ was based on a pricing schedule linked to the weighted average service fee of the entire rights to MSR population.
The first transfer for example had a lower weighted average service fee than the overall population. Thus we were effectively paid more for these MSRs than the underlying characteristics would indicate in a fair value analysis. This difference resulted in a benefit to the income statement by reducing our interest expense.
The implication of this however is that in the future we will receive less cash for transferring populations than the fair value analysis indicates which will result in an increase in interest in those periods.
Over the entire transfer population, the positive and negative impacts on the income statement from these underlying MSR characteristic differences would cancel out assuming no portfolio runoff during the time it takes to complete all the transfers and ignoring any impact from changes in fair value assumptions for any underlying collateral. Nevertheless we expect some income statement variability between reporting periods as the concerned process is completed.
The second noteworthy impact relates to differences between the total payments we expect to receive in the fair value of the economic transfer to NRZ in this transaction to financing liability. This is primarily the result of utilizing market based assumptions in determining fair value. Assuming no change to fair value assumptions in the future, this would result in a permanent benefit of Ocwen. However changes in interest rates in particular could result in additional fair value changes and depending on which way rates move the impact could be either positive or negative.
I will now turn to the impact in the third quarter 2017 and direct you to slide 8, specifically the middle column of the analysis which shows the impact for the population of servicing transferred in September. Given the UPB of this population, NRZ paid us $55 million in cash. However this population only had a fair value of financing liability of $17 million primarily because the weighted average service fee was lower than the average of the entire NRZ population.
This $38 million difference was recorded as a reduction interest expense in the quarter. You can see below in the chart that $31 million of this benefit was related to the differences in the MSR characteristics for weighted average service fee which means we are likely to see offsets to that amount in the future. There was a $5 million benefit related to differences between underlying NRZ deal assumptions and the fair value assumptions.
Examples of the drivers of these differences are things like delinquency rates, collection rates etcetera. The remaining 1 million benefit reflects the amortization of the fair value financing liability in September. Assuming the fair value assumption, they don't change in the future these last two impacts would be a permanent benefit to Ocwen.
On that note, I direct you to the remains concerns column where you can see how this impact should play out again assuming no major changes to the underlying fair value assumptions or underlying collateral. We expect at this specific characteristic differences would other things being equal result in future losses that offset the benefit to interest expense recognized in this quarter.
However, we expect to recognize the remaining benefits from the difference between the NRZ specific deal terms and the fair value assumptions as additional transfer's takes place. Ideally these two financial impacts would be perfectly offset across reporting periods, but that may not the case. Additionally there could be changes to the fair value assumptions and the underlying collateral which may result in changes to the information presented on slide 8.
I am sure this will take some time to settle in. the third quarter 10-Q which was filed this morning as additional informational as well as the relevant material agreement with NRZ. I will also make myself available if needed in the future to answer any questions.
Moving on the financial results on slide 10, we have the traditional financial information for the quarter. We recorded per share loss $0.05, a $0.31 improvement from the second quarter. Our revenues of $285 million were down $26 million versus the prior quarter driven by lower servicing revenues primarily from portfolio runoffs and lower hand fees. Our lending revenues were about flat.
Our operating expenses of $273 million were down $7 million from the prior quarter. We had $26 million lower legal fees in settlements and $10 million of favorability in our Ginnie Mae and GSE, MSR fair value mark-to-market changes versus the prior quarter. These benefits were partially offset by a15 million increase in our servicing reserves and 7 million write off of internally developed capitalized software related to our exit from the forward lending whole sale channel.
Our other expenses were 38 million which was 35 million better than the second quarter. This was driven by the reduction in interest expense from the mark-to-market impact on the NRZ transaction.
The net loss is 6 million was helped by a 23 million benefit from the release of our reserve for a previously recorded uncertain tax positions. As the applicable statue to limitations expired for these tax positions in September, our reserve is no longer necessary.
Finally, the business generated 120 million of operating cash flow. This was primarily driven by a reduction in advances. In the remainder of the financial presentation we include our typical slides. I'd like to take one minute though to high light a new slide, slide 13 that shows our employee headcount.
Given the potential changes we have announced to our strategic direction, we have separated a head count into our service and into corporate resources which for purposes of this slide exclude our ACS employees are currently sitting corporate and our lending resources which for this chart include ACS.
You could see the trends clearly. While never easy the management team has been focused on right sizing it's servicing in corporate head count given a continued runoff from our servicing portfolio while balancing our desire to provide exceptional service within a robust control and compliance infrastructure. In the last year, our servicing in corporate head count is down 18%. Despite that progress there is still a need to more and we are focused on that.
Moving on to the lending data, while we have been trying to grow our lending businesses we have maintained about 1000 resources predominantly in the U.S. across forward lending, reverse lending in ACS.
As we explore different options for most of these businesses we expect to be able serve our remaining retail recapture business with partial resources and there in the process now designing what the remaining organization will look like. We expect this should result in significant cost savings in the future.
With that we will now ask the Operator to open up the call for questions.
[Operator Instructions] Our first question comes from Bose George from KBW. Your line is open.
Hi, good morning. So just wanted to touch on the accounting on the other you went through for the NRZ contract. When we think of the cash impact do you guys is it really the reduction of the 13 basis points servicing fee and the answer is as you mentioned around the interest expense marks will just net out overtime to zero so we should just really think about the 13 of kind of the economic impact of the transaction.
Yeah, so there's - I guess that is partially right. I think if you just think about the go forward economics typically as it relates to cash, what will flow through kind of operating cash flow, it will be the resulting impact of the 13 basis points to the P&L. The upfront cash payments we receive through the mechanism I described effectively compensate us for the foregone economics by switching to these new contracts with NRZ. And so those upfront payments through that value mechanism effectively amortized the income subject to certain assumptions over the remaining life of the original contracts. That, those cash flows will actually show up as a financing cash flow, so it won't be an operating cash, but we will reflect those cash flows as received obviously upfront.
Okay, those cash flows will basically reduce interest expense in the quarters that comes in, is that right?
To the extent, there is an international market-to-market impact between the fair value of the transfers in that period. But, just generally the way to think about it is, assuming everything kind of was equal, and you had a concerned population that perfectly match the fair value. Going forward those would have amortizing cash balance, or that amortizing fancy line ability of setting interest expense, over the next two or three years.
Okay, and so the cash benefit you mentioned is really a cash flow benefit supposed to a, an income statement benefit?
Well, we get the - it's effectively pulling forward, cash we would have otherwise received over the next two or three years, we are getting paid for that upfront as the transfers occur. So, we'll record the cash day, we create the financing liability, because it's effectively a financing transaction that the recognition of that cash or from a flow standpoint, will show up in cash cum financing activities instead of operations. But it's cash into the company, and the recognition of that cash, connect to income overtime as through the interest expense mechanism.
Okay, so that makes sense. And, then in terms of the ancillary that a couple of the other components apart from the 13 basis points, is there a way to think about, how much that adds up? Is that another couple of basis points?
So, the reduction from, kind of the overall economics we received down to the 13 basis point was effectively covered by those upfront payments. So, we mentioned the change in servicing fees, we mentioned the change in some of the REO commissions. We've effectively given up our right to earn fees on future call right transactions, so these upfront cash payments compensate us for that. And so, the go forward economics of 13 bps is kind of what's left.
Obviously, okay, great thanks.
[Operator Instructions] Our next question comes from Fred Small from Compass Point. Your line is open.
Hi, good morning thanks for taking my questions. Are there thinking about cash coming in from NRZ, what are your options for that as it comes in? And at one point you talked about, and I don't know how connected it is to the account you were just discussing. But, is that say, you have to keep that on the balance sheet and then sort of leave it in overtime or can you actually go and do something else out of that cash?
So we can choose to do whatever we want with the cash but, as Michael mentioned from the accounting standpoint it will go on to balance sheet and then generally amortize the income overtime. Since, we are receiving less cash going forward in receiving more cash up front, you can assume that some of them would be utilized for ongoing operations. But, we have your discretion over, how do you guys use the cash once we receive it.
Okay, but then, does that, if you receive the cash and record some liability for the long term value of a transaction over time, I think, Michael you were describing that sort of, you are bringing in the cash now and then there's an offsetting item for it on the balance sheet or on the liabilities. And, then that would reduce operating interest expense overtime?
Okay, and so, if you were to do something else with that cash, those operating interest expense, is that no longer, does that benefit no longer flow through overtime.
No, think about it as two separate, once we have the cash, we have the cash as Ron described. And, that financing liability it's really just a mechanism by which we recognize the benefit of the upfront payment income overtime. It's to recognize in the fair value of that liability as the changes, as we service our obligation goes down, so that liability gives them a boost shrink as we reduce the liability, we have a credit income and that shows up to our interest expense. But, it has nothing to do with the actual cash received on day 1.
Okay, got it I think. And then, in the receipt of cash for the fore transfer and the change in the economics, does that trigger any payment over the next year to decor this? You want any of this cash have to be used to pay it on debts, no?
Okay thanks, and then, second question, do you have any estimate of the time or the one-time cost that you think you incur in transferring the system of record over top like 9?
Yeah, there will be a cost and we are not going to connect this, you know disclose at that time, probably because we just signed the contract and we are still working through , the overall implementation plan. But, primarily, being around having to take, in four years that currently we are staying in the Servicing Operation today and dedicating them over the next couple of years to working on the implementation process and obviously we would need to backfill those positions of in-servicing operation during that time frame.
There may be some other causes, well, but we are not disclosing what our estimated at is, at this point in time.
In terms of the, sorry it's just a follow-up. In terms of the time line, you said the next few years and that's for everything, and I guess for implementation. Do you have an estimated timeline for a sort of the woke up transfer, to the Black Knight to occur?
Yeah, it will take potentially a couple of years before anything before anything starts the transfer over.
Okay, got it. That's helpful. And then, I know that you haven't talked about the on-time, I was asking about the one-time expense for this sort of ongoing perspective, any sense of what run rate expenses for NST and for all sort of Black Knight Suite versus Real Servicing.
Yeah, I don't think we are disclosing that, but our contract with Black Knight is going to be similar to what other industry participants have I would assume. And, our contract that we had with our existing vendor was on kind of similar take terms, so, we are not expecting any significant change there.
Thanks a lot.
Ladies and gentlemen that concludes today's call. Thank you for attending the Ocwen Financial Corporation third quarter earnings call. Everyone have a great day.