Ocwen Financial Corporation (NYSE:OCN) Q1 2019 Earnings Conference Call May 7, 2019 8:30 PM ET
Hugo Arias - Managing Director, IR
Glen Messina - CEO
June Campbell - CFO
Conference Call Participants
Bose George - KBW
Thank you for standing by. This is the conference operator. Welcome to the Ocwen Financial First Quarter 2019 Earnings Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. [Operator Instructions]
I would now like to turn the conference over to Hugo Arias, Managing Director, Investor Relations and Treasury. Please go ahead, sir.
Good morning, and thank you for joining us for Ocwen's first quarter 2019 earnings call. Please note that our first quarter 2019 earnings release and slide presentation have been released and are available on our Web site for your review. Speaking on the call today will be Ocwen's Chief Executive Officer, Glen Messina; and Chief Accounting Officer, June Campbell. 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. 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 several 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 statements whether as a result of new information, future events or otherwise.
In addition, the presentation and our comments contain references to non-GAAP financial measures such as expenses excluding MSR valuation adjustments and notables, income statement notables, available liquidity, and an alternative view of the impact of our NRZ transactions, among others. We believe these non-GAAP financial measures provide a useful supplement to discussions and analysis of our financial condition.
We also believe these non-GAAP financial measures provide an alternate way to view certain aspects of our business that is instructive. Non-GAAP financial measures should be viewed in addition to, and not as, an alternative for the company's reported results under accounting principles generally accepted in the United States.
For an elaboration of these factors I just discussed, please refer to our presentation and today's earnings release as well as the company's filings with the Securities and Exchange Commission, including Ocwen's 2018 Form 10-K, and once filed its 2019 Form 10-Q.
Now, I will turn the call over to Glen Messina.
Thank you, Hugo. Good morning and thank you for joining us. Today, I'll provide an update regarding our progress in executing our key business initiatives and how we are repositioning Ocwen to deliver growth and value creation for our shareholders. Our CFO, June Campbell, will follow with a review of the first quarter 2019 financial results. I will then close the call with some brief remarks before opening it up for questions.
Now, please turn to slide four. We remain focused on executing our key business initiatives and positioning the company for profitability in the shortest timeframe possible, while executing the integration of PHH in a prudent and disciplined manner. We have taken decisive action to achieve the objectives of our key initiatives that I am excited by the progress we are making. Since our last earnings call, we have realized several significant achievements.
We have closed or been awarded additional MSRs with current UPB of approximately $26 billion, which brings our total volume since reentering the bulk MSR acquisition market to $31 billion. We upsized our senior secured term loan by $120 million to supplement our liquidity in anticipation of $98 million in PHH Corporation bonds maturing in September. We expect to close $300 million of committed MSR financing in the second quarter subject to standard closing and documentation conditions for transactions of this type.
We have successfully boarded approximately $390,000 additional loans onto Black Knight MSP, bringing the percentage of loans transferred for RealServicing to approximately 61% from 23% at the end of February. We remain on track to complete the system conversion in the second quarter. We continue to execute against our cost reengineering plan, and have realized annualized adjusted expense savings of $139 million for the first quarter as compared to our annualized second quarter 2018 adjusted expense baseline for Ocwen and PHH combined. We estimate that approximately $36 million of these savings will reduce the volume differences primarily in our servicing business.
We completed the merger of Homeward Residential into PHH Mortgage, and we are on track complete the merger of Ocwen loan servicing into PHH Mortgage by the end of the second quarter. We continue to proactively engage with regulators and track our progress as it relates to our regulatory commitments. In the first quarter, we settled our outstanding litigation with the Massachusetts Attorney General, which leaves the CFPB and Florida matters as the only unresolved regulatory matters remaining from April 2017. Our actions to date have reduced the annualized pre-tax loss excluding notable, one-time expensive, certain temporary expense benefits, and amortization at NRZ lump sum cash payments by approximately $60 million from the combined Ocwen and PHH level of $322 million in the second quarter of 2018.
Overall, we believe we are on track to deliver on the objectives we have established. Our progress to date demonstrates our focus and commitment to reposition Ocwen for growth and value creation for our shareholders. If executed in full, we believe portfolio replenishment and cost reengineering actions could position the company for profitability in the next 10 to 13 months assuming there are no adverse changes to current market and industry conditions or legal and regulatory matters. I will now provide a detailed update on each of the initiatives to transform and strengthen our business.
Now, please turn to slide five. We have made strong progress this quarter on our initiative to replenish portfolio run off and restore our growth focus. The pace of MSR acquisition has exceeded our expectations driven by robust levels of bulk MSR transactions in the marketplace. Through March 31st, we are close to being awarded MSRs with current UPB of approximately $31 billion which exceeds our MSR acquisition expectations.
To date, the mix of MSRs consists of approximately $3 billion of Ginnie Mae UPB and $28 billion of agency UPB. We closed at $5 billion of MSR UPB during the first quarter and deployed $49 million for MSR acquisitions. We expect to close on the remaining $26 billion of MSR UPB by the end of the second quarter subject to negotiation of definitive purchase agreement and satisfactory final due diligence. In connection with these MSR acquisitions, we expect to invest an additional $310 million with approximately $220 million coming from MSR financing.
We remain disciplined in our MSR biding activity and continue to target MSR portfolio return of at least 9% on an un-levered basis. However, the bidding activity for bulk MSR purchases continues to be very competitive, and we are seeing returns at the lower end of our targeted range. Our focus on achieving adequate returns have resulted in limited success when biding on Ginnie Mae MSRs. We believe this is due to our default rate assumptions which appear to be higher than most other market participants. In our view, current market sentiments does not fully appreciate the long-term risks and cost associated with Ginnie Mae MSRs which has caused the mispricing of the asset class.
Given our accelerated pace of MSR acquisitions, we intend to concentrate our replenishment and growth actions for the balance of the year on developing our flow channels for portfolio replenishment. We are focused on rebuilding our correspondent lending, portfolio retention and flow MSR purchase capabilities. Any near-term bulk MSR bidding activity will be calibrated around achieving higher marginal returns and managing our excess liquidity. At current market return levels, we will remain intensely focused on acquiring low complexity MSR portfolios with strong credit characteristics as well as high quality collateral in the form of complete loan files supported by compliant practices. This is an important consideration to avoid long boarding and operating complexities and to minimize risk of incurring unanticipated future cost and servicing advance procurements.
We continue to target servicing portfolio of at least $260 billion of UPB as one of the key components of our roadmap to profitability. We closed the first quarter with $251 billion in servicing UPB, and we expect to close $26 billion in UPB related to MSR acquisitions, subject to negotiation of definitive purchase agreement, and satisfactory final due diligence. However, our portfolio run-off can vary depending upon the level of market interest rates, and we are evaluating the impact of a persistently low interest rate environment on our portfolio and the required buying to achieve replenishment.
As we evaluate our portfolio in the current low interest rate environment, we believe our GAAP financial results are likely to experience some near-term pressure, primarily due to negative fair value adjustments on our owned MSR portfolio. However, we believe the negative impact should be largely offset by the accelerated pace of MSR acquisitions today. Since MSR amortization and fair value changes or non-cash expenses, we anticipate cash flow improvement at a greater rate than GAAP earnings during the second-half of the year.
Now, please turn to slide six. Our progress in establishing funding for growth has been commensurate with our portfolio replenishment and growth actions. Since the fourth quarter, we have seen a material improvement in the capital markets, which may provide us with greater opportunities to lower our cost of capital, improve our overall access to financing. These types of opportunities are evidenced by the upsizing of our senior secured term loan by $120 million in the first quarter. We lost the upsizing targeting new money of $100 million, and the transaction met strong investor demand. As a result, we decided to take an additional $20 million to support our liquidity and growth initiatives.
With respect to our MSR financing initiative, we expect to close $300 million of committed MSR financing in the second quarter subject to standard closing conditions and final documentation for transactions of this type. This initial MSR financing facility is bank-sourced and should provide the primary funding vehicle until we achieve critical mass, which we estimate to be approximately $450 million of MSR financing. Upon achieving critical mass, we plan to establish a diversified funding platform by issuing term ABS.
Along with term ABS, we expect to continue using bank-funded facilities to warehouse new MSR acquisitions and to provide us with the flexibility to manage the overall level of borrowings based on the value of our MSR portfolio. We believe our longer-term funding strategy should provide us with certain benefits, including longer tenants, improved advanced rates, lower overall funding costs, and funding diversification.
Now, please turn to slide seven. With respect to our integration initiatives, the systems conversion from our legacy real servicing system to MSP and the merger of our primary legal entities remains on track for completion in the second quarter. We continue our prudent multi-phased approach to boarding loans on to MSP and have transferred an additional 390,000 loans since the end of February. This brings the total percentage of Ocwen loans transferred onto MSP to 61%, up from 23% at the end of February.
All loan transfers were executed after a significant amount of preparation and rigorous pre-boarding testing, and we are pleased with the outcome of the loan transfer process today. The sequencing and timing of the loan transfers is primarily driven by the complexity associated servicing requirements. The initial loan transfers consisted mostly of agency loans, while subsequent loan transfers have been focused on loans and securitized pools with distinct private investor Pooling and Servicing Agreement or PSA requirements. The private loan transfers have required significant level of pre-boarding preparation and testing to validate compliance with all aspects of the PSAs. We expect to complete the last phase of the loan boarding process in June, or the timeline could be extended to the extent any unexpected challenges are encountered.
With respect to the merger of our primary licensed entities, the timeline has progressed as expected. During the first quarter, we completed the merger of Homeward Residential into PHH mortgage, and we anticipate the merger of Ocwen loan servicing to be completed during the second quarter. Completion of the legal entity merger process is expected to enable our cost reengineering objectives for the second-half of 2019 and 2020. Upon completion of the legal entity consolidation, Ocwen Financial Corporation will provide mortgage services through two primary brands, PHH Mortgage for forward servicing and lending, and Liberty Home Equity Solutions for reverse lending and servicing. Operating under these two brands is only an interim step necessitated by the legal entity merger process. We expect to evaluate future planning alternatives once we successfully complete several of our key business initiatives.
Now, please turn to slide eight. We continue to target approximately $300 million in cost savings at an annualized run rate basis by the end of the fourth quarter 2019, and at least an additional $40 million by the end of the second quarter 2020. These cost saving targets are measured against our annualized second quarter 2018 total expense baseline for the combined companies after adjusting for notable items. Through the end of the first quarter, we have realized annualized adjusted expense savings of $139 million as compared to our 2018 second quarter annualized baseline for the combined Ocwen and PHH. We estimate that approximately $36 million of these expense savings was due to volume differences primarily in our servicing business.
To date, we have reduced over 900 of the 2100 targeted total reduction in staffing. These reductions are measured relative to staffing levels in the second quarter of 2018 for the combined Ocwen and PHH. We expect the remaining targeted staffing reductions to take place primarily through the balance of the year.
In addition to our cost reengineering actions, we intend to adjust staffing levels and direct cost to changes in volume levels and servicing and originations. We also intend to reduce our primary U.S. base facilities footprint from 10 locations to four locations during the remainder of the year. Our facilities reduction actions are on track and by year-end, we expect our primary U.S. facilities will be West Palm Beach Florida, Mt. Laurel, New Jersey, Rancho Cordova, California and St. Croix, U.S. Virgin Islands. The staffing reductions and site closures are difficult but necessary choices. I'm proud of the entire team for their hard work, resilience and commitment through these challenging actions. My thanks to the leadership team, our legacy Ocwen, PHH and new employees for quickly working together to stay focused on serving our customers and investors.
For those employees, who will be leaving the company due to our reengineering actions, I especially want to commend you for your contributions as well as your professionalism during a time of transition. We are mindful of our risk tolerances as well as existing and evolving regulatory requirements. We are monitoring and reassessing risk management and compliance requirements as necessary. But we believe our current cost reengineering plans are consistent with prudent and sustainable business, risk management and compliance practices.
We continue to estimate incurring $55 million to $65 million in upfront cost to execute our reengineering actions in 2019. Through the end of the first quarter, we have incurred $22 million of this amount primarily related to severance accruals, employee retention payments and other expenses. Although we are making solid progress in our cost reengineering efforts, the amount of targeted annual cost reengineering is significant and is dependent on several complex actions. These include but are not limited to the MSP systems conversion, legal entity mergers, facilities consolidation and our organizational redesign and staffing reductions. We operate with a largely predetermined revenue structure and a highly competitive rules-based environment.
I believe that sustained profitability and competitiveness under these conditions requires continuous business reengineering. Based on what we are learning as we execute our current reengineering actions, I also believe we continue to have meaningful opportunity for additional benefits from reengineering and process innovation. We can drive performance excellence in four critical dimensions of our operations, speed, cost, compliance and customer experience through further optimization of our offer operations, strategic sourcing, lean process design and digitization.
I believe our proprietary captive offshore operations are a distinct competitive advantage with the opportunity for continued optimization as we grow. While our captive offshore operating capability is well developed, we have not applied strategic sourcing, lean process design and digitization to their full potential.
For example, with the conversion of our core servicing platform to Black Knight MSP and core originations platform to encompass, we are evaluating opportunities to introduce both proven and evolving technologies. Our initial efforts are focused on harnessing the full potential of these platforms as well as understanding the potential of automated data interfaces, robotics robots and combined applications of optical character recognition with machine learning capability. I'm energized by the potential to deliver incremental positive impact to our operating performance and competitiveness and deliver value to our customers and investors through sustained focus and investment in these areas.
I look forward to sharing additional insights on these topics as we continue our reengineering journey. Now please turn to slide nine. Our fifth initiative is to fulfill regulatory commitments and resolve remaining legacy matters. We've made significant investments over the past several years in building a three line of defense risk management model, improving management and board oversight and maintaining a compliance management framework to drive performance consistent with regulatory expectations.
We continue to proactively engage our regulators on a regular and frequent basis and track our progress as it relates to regulatory commitments. In the first quarter, we settled our outstanding litigation with the Massachusetts Attorney General which leaves the CFPB and Florida matters as the only unresolved regulatory matters remaining from April 2017. We have no updates at this time with respect to these matters. We believe executing on our regulatory commitments is also key to reducing our legal and regulatory related expenses and a critical aspect of our plan to return to profitability.
Now, I would like to introduce our new CFO, June Campbell. June joins us from GE Capital where she spent more than 20 years serving in various senior finance, capital markets and operations leadership roles in domestic and global financial services business platforms. It's great to have June as part of the Ocwen leadership team and she's already making meaningful contributions to the business. I'll turn over to June, who will discuss the results for the quarter.
Thank you, Glen. My comments today will focus on our first quarter results as compared to the prior quarter. As previously noted, our first quarter investor presentation includes more details on our results and is available on our Web site. Please turn to slide 11, first quarter 2019 reported net loss of $44 million compares unfavorably to net loss of $2 million in the fourth quarter of 2018.
Our first quarter was impacted by $22 million of severance, retention and other reengineering costs and $14 million of unfavorable net fair value changes driven by changes in interest rates and valuation assumptions. This was offset by a $31 million recovery of announced previously expense from the service provider. As a reminder our fourth quarter results included the $64 million bargain purchase gains recognized in connection with the PHH acquisition.
The positive pre-tax earnings impact from the amortization of the lump sum cash payments received from NRG in 2017 and 2018 was $16 million in the first quarter and $32 million in the prior quarter. The amortization of these lump sum cash payments will have $120 million positive impact to our pre-tax income over future quarters through April of 2020. Revenue of $304 million decreased by $7 million from the prior quarter, servicing revenue of $259 million decreased $18 million due to portfolio run-off. The pace of MSR purchases is ahead of expectations and is expected to offset this negative revenue trend going forward.
Lending revenue of $41 million was flat to the fourth quarter excluding a $12 million favorable fair value change from a financing assumption update attributable to a reverse mortgage portfolio. Glen updated you on our progress related to expenses versus our annualized second quarter 2018 baseline. First quarter non-MSR expenses were lower compared to the prior quarter and included the previously stated recovery and cost savings resulting from our reengineering actions.
With respect to the $109 million unfavorable MSR valuation adjustments in the first quarter, a 30 basis point decline in the 10-year swap rate drove a $64 million reduction in the value of its forward MSRs. You may recall the acquired PHH portfolio is primarily agency MSRs, which are more sensitive to changes in interest rates. The remaining $45 million resulted from portfolio run-off.
A portion of the $64 million unfavorable agency MSR valuation adjustments resulting from interest rate changes was offset by $33 million of favorable NRG financing liability valuation change which was recorded in interest expense. We have provided additional information related to the MSR valuation impacts on slide 24 of the deck.
I would now like to provide comments on our services and lending segment results. As outlined on slide 12, our servicing segment recorded a $58 million pre-tax loss compared to a $41 million pre-tax loss in the prior quarter. We've restarted bulk MSR acquisitions and get replenishing portfolio run-off, which is expected to improve servicing segment's financial performance. The servicing business remains focused on providing sustainable loan modification solutions to qualifying borrowers in need. We completed approximately 8,300 modifications in the quarter, 28% of which resulted in some type of debt forgiveness, totaling $67 million.
Please turn to slide 13. Our forward lending business recorded a pre-tax loss of $4 million, which was $1 million favorable to the prior quarter due to cost reduction. Revenue was $2 million unfavorable to the prior quarter, driven by lower volume. We are focused on improving portfolio retention and placement rates, and expanding our platform by reentering the corresponding channel in the second quarter.
As discussed last quarter, we will discontinue recapture marketing on the NRZ portfolio in the second quarter, which is not expected to have a material adverse impact on lending profitability. A reverse lending business recorded pre-tax income of $24 million, which included $17 million of favorable net fair value changes. The first quarter fair value change includes $12 million from a financing assumption update. We also recorded $3 million of revenue in the quarter from a fair value election for future draw commitments on reverse loans purchased or originated after December 31, 2018. Unrecognized future value related to future draw commitments on loans purchased or originated prior to January 1, 2019 is estimated to be $64 million on a present value basis, and will be recognized over time as future draws or securitized or sold.
As you can see on slide 14, we entered the quarter with available liquidity of $418 million. This included $263 million of unrestricted cash, $155 million of available liquidity on our advanced facilities and warehouse lines. We view available liquidity as cash on hand plus available borrowing capacity on advanced facilities and warehouse lines that can be drawn based on eligible collateral. In the first quarter, we elected to pay down these facilities with excess corporate cash. However, they could be redrawn to generate cash based on eligible collateral available to be pledged to these facilities.
During the first quarter, we upsized our Senior Secured Term Loan or SSTL by $120 million, in addition to upsizing the SSTL, our cash position is impacted by $93 million at excess corporate cash used to pay down advanced facilities and warehouse line, $49 million of cash paid for MSR acquisitions, and $44 million of other cash uses, which included with seasonally higher outflows. We ended the quarter with corporate debt outstanding of $795 million. Excluding the $98 million in PHH bonds maturing in September, our corporate debt to book equity ratio would have been 1.4 times.
I'll now turn it back over to Glen.
Thank you, June. Now, please turn to slide 15. We remain focused on executing our key business initiatives and positioning the company for future profitability in the shortest timeframe possible. We've taken decisive action to achieve the objectives of our key initiatives, and I'm excited by the progress we're making.
Since our last earnings call, we have realized several significant achievements, including -- we have closed or been awarded additional MSRs with current UPB of approximately $26 billion, which brings our total since restarting our bulk MSR acquisition initiative to $31 billion as of March 31. The pace of MSR purchases is ahead of our expectations. We upsized our senior secured term loan by $120 million to supplement our liquidity in anticipation of $98 million in PHH corporate bonds maturing in September.
We expect to close $300 million of committed MSR financing in the second quarter, subject to standard closing and documentation conditions for transactions of this type. We have successfully boarded approximately 390,000 additional loans onto Black Knight MSP. This brings the percentage of loans transferred from middle servicing to approximately 61% from 23% at the end of February. We continue to execute against our cost reengineering plan, and have realized annualized adjusted expense savings of $139 million for the first quarter as compared to our annualized second quarter 2018 adjusted expense baseline for the combined companies.
We estimate that approximately $36 million of these savings were due to volume indifferences. We completed the merger of home and residential into PHH Mortgage and are on track to complete the merger of Ocwen loan servicing into PHH Mortgage by the end of the second quarter. We continue to proactively engage with regulators on a regular and frequent basis and track our progress as it relates to our regulatory commitments. Our actions to date have reduced the annualized pretax loss excluding notables onetime expenses, certain temporary expense benefits and amortization as NRZ lump sum cash payments by approximately $60 million from the combined Ocwen and PHH level of $322 million in the second quarter of 2018.
Overall, we believe we are on track to deliver on the objectives we have established. Our progress to date demonstrates our focus and commitment to reposition Ocwen for growth and value creation for our shareholders. If executed in full, we believe our portfolio replenishment and cost reengineering actions could position the company for profitability in the next 10 to 13 months assuming there are no adverse changes to current market and then street conditions or legal and regulatory matters. These are dynamic times for the mortgage industry. The volume of MSR trading is increasing as is the potential for further industry consolidation. The funding alternatives for MSRs are improving, the regulatory landscape continues to evolve and there is renewed effort for GSE reform.
The potential for continued technology driven reengineering and process innovation is substantial. We believe our key initiatives address the opportunities and challenges ahead and will position us to continue to play a leadership role in the industry while remaining dedicated to our mission of creating positive outcomes for homeowners, communities, and investors through caring service and innovative solutions.
And with that we're ready to take questions. Operator?
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Bose George with KBW. Please go ahead, sir.
Hey guys, good morning. You've talked in the past about -- after you completed the MSP integrations that you could potentially speak to the New York regulators and keep at 2% cap per de-listed [ph], do you think that's still a possibility now after this is done in the second quarter and the CFPB issue, is that a parallel issue that doesn't need to be addressed in terms of growth of the portfolio?
Good morning, Bose.
Addressing the New York matter first, as it relates to New York, we do have to get through the integration of the PHH, of the [technical difficulty] the PHH systems in order to satisfy the requirements. So, once we get through that process [technical difficulty] New York proving that we've achieved the requirements of their conditional approval.
As it relates to the CFPB matter, that is a litigation matter, it does not affect our growth in the business. So, there are no restrictions imposed from a growth perspective as it relates to that litigation.
Okay, great. That's helpful. And then, the $263 million of cash you have, is that fully available for deployment or is there anything else that -- other uses we should think about?
That's fully available for deployment as for the needs for investment and operating purposes.
Okay, great. Thank you.
[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Glen Messina for any closing remarks.
Thank you, everyone, for joining the call today. We look forward to providing an update on our progress in our business on our next earnings call.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.