Business context and reporting period
The source is an Ocwen Financial Corporation Form 10-K for the fiscal year ended December 31, 2015, filed February 26, 2016. The request metadata identifies “ONITY GROUP INC.,” but the filing itself identifies Ocwen Financial Corporation (NYSE: OCN). Ocwen provides residential mortgage servicing and forward and reverse mortgage lending through operations in the United States, U.S. Virgin Islands, India and the Philippines.
Primary segments were Servicing, Lending, and Corporate Items and Other. Servicing remained the principal revenue source, but regulatory settlements and MSR sales materially reduced portfolio scale and constrained future servicing acquisitions.
Financial performance and key metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total revenue | $1.741 billion | $2.111 billion | Down 18% |
| Servicing and subservicing fees | $1.532 billion | $1.894 billion | Down 19% |
| Gain on loans held for sale | $135.0 million | $134.3 million | Up 1% |
| Total expenses | $1.478 billion | $2.035 billion | Down 27% |
| Interest expense | $482.4 million | $541.8 million | Down 11% |
| Income before taxes | $(129.9) million | $(443.2) million | Improved |
| Net loss attributable to common stockholders | $(247.0) million | $(472.6) million | Improved |
| Basic loss per share | $(1.97) | $(3.60) | Improved |
| Operating cash flow | $581.6 million | $352.5 million | Up 65% |
2015 expenses benefited from the absence of the $420.2 million goodwill impairment and the $150.0 million New York Department of Financial Services settlement charge recorded in 2014. These benefits were partly offset by higher regulatory monitoring, compliance, legal and strategic advisory costs. Income tax expense was $116.9 million despite the pretax loss, primarily because Ocwen recorded a $97.1 million valuation allowance provision against deferred tax assets.
At December 31, 2015, cash was $257.3 million, total assets were $7.405 billion, total liabilities were $6.550 billion, and total equity was $854.6 million. Mortgage servicing rights were $1.139 billion, while advances and match funded advances were $2.151 billion. Debt included $1.584 billion of match funded liabilities, $3.089 billion of financing liabilities, $782.4 million of other secured borrowings and $350.0 million of senior unsecured notes.
Material changes versus the prior comparable period
- The residential servicing portfolio declined 37% to $251.0 billion of unpaid principal balance from $398.7 billion, primarily due to MSR sales and portfolio runoff.
- Ocwen sold approximately $87.6 billion of Agency MSRs, recognizing cumulative gains of $83.9 million and receiving approximately $1.2 billion of cash proceeds, including $686.8 million from MSR sales and $486.3 million from advance recoveries.
- Debt was reduced by approximately $1.4 billion during 2015, including $865.8 million of Senior Secured Term Loan prepayments.
- Servicing segment pretax results improved to $15.9 million from a $174.1 million loss, but the improvement was driven substantially by lower impairment and settlement charges; servicing revenue and average portfolio UPB fell materially.
- Lending segment pretax income improved to $34.0 million from a $26.8 million loss. Forward originations declined 8% to $3.9 billion, while reverse mortgage originations increased 20% to $809.7 million.
- Residential servicing delinquency increased to 14% of UPB from 13% at December 31, 2014. Completed modifications declined 18% to 84,488.
- Effective January 1, 2015, Ocwen elected fair-value accounting for a new class of non-Agency MSRs, resulting in a $52.0 million pretax cumulative-effect increase to retained earnings. A $17.3 million impairment charge was recorded on government-insured MSRs.
- Ocwen repurchased 625,705 common shares for $4.1 million and reinitiated its broader repurchase program in November 2015.
Cash flow, liquidity and debt
- Operating activities generated $581.6 million, largely from $531.3 million of net servicing-advance collections and $124.5 million of net cash from loans held for sale.
- Investing activities generated $280.4 million, primarily from MSR and advance-sale proceeds, partially offset by $1.0 billion of reverse mortgage originations.
- Financing activities used $734.2 million, primarily for repayments of match funded liabilities and the Senior Secured Term Loan.
- Advance funding facilities had $1.584 billion outstanding at year-end, with stated unused capacity of $141.0 million; however, only $24.5 million was usable based on eligible collateral.
- Warehouse facilities had $342.3 million outstanding and $550.0 million of total capacity. Substantially all warehouse and certain advance facilities matured or required renewal, replacement or extension during 2016.
- Management stated that it believed liquidity was adequate through 2016, but acknowledged reliance on refinancing, asset sales, operating performance and continued lender support.
Guidance, outlook, risks and unusual items
Management did not provide conventional earnings guidance. It targeted at least $150 million of 2016 expense reductions versus 2015, focusing on servicing operations, professional services, technology and other costs. Management stated that meaningful near-term servicing profitability was unlikely without a structural change in the business model and expected lending and new businesses to become primary growth drivers.
- Senior Secured Term Loan covenant: Management projected that the consolidated total debt to consolidated tangible net worth covenant could be breached during 2016. Ocwen intended to repay, refinance or amend the facility before September 30, 2016, or potentially issue equity and reduce lending or other investments. Failure could trigger default, acceleration and cross-defaults.
- Regulatory restrictions: The NY DFS settlement imposed a $100.0 million penalty, $50.0 million of borrower restitution, monitorship, governance changes and restrictions on MSR acquisitions. The California settlement imposed a $2.5 million penalty, an independent auditor and restrictions on California MSR acquisitions.
- Ongoing investigations and litigation: Ocwen faced CFPB investigative demands, a Massachusetts Attorney General demand, U.S. Attorney subpoenas, private litigation, False Claims Act cases, RMBS-related claims and potential servicing termination claims. Accrued litigation losses were $40.2 million, but the filing states that additional losses could materially exceed recorded amounts and could not be reasonably estimated.
- NRZ dependency: Ocwen serviced approximately $137.1 billion of UPB for which rights to MSRs had been sold to New Residential Investment Corp.; associated advances were approximately $5.2 billion. If NRZ could not fund advances, Ocwen could be contractually required to fund them.
- Servicer-rating risk: Rating downgrades triggered termination rights in 664 non-Agency servicing agreements representing approximately $34.3 billion of UPB, or 18.3% of the non-Agency portfolio. Four agreements had transferred servicing by year-end 2015.
- NRZ transfer risk: Because Ocwen’s S&P servicer rating was below “Average,” NRZ could direct transfers of affected servicing agreements beginning April 7, 2017 if the rating was not restored.
- Program risk: HAMP and HARP were scheduled to expire December 31, 2016. HAMP fees contributed $135.0 million of servicing revenue, and HARP originations represented approximately 20% of forward originations.
- Unusual items: The filing includes the $83.9 million MSR-sale gain, $97.1 million deferred-tax valuation allowance provision, $17.3 million MSR impairment, $25.1 million of strategic advisory costs and $14.3 million of NRZ-related rating-downgrade compensation costs.
Most important facts for investors to verify
- Whether the planned $150 million of 2016 cost reductions were achieved without impairing servicing quality, compliance or borrower outcomes.
- Whether Ocwen refinanced, amended or repaid the Senior Secured Term Loan before any projected covenant breach.
- Renewal terms and available collateral for 2016 advance funding and warehouse facilities.
- Changes in servicer ratings, servicing termination rights and potential NRZ-directed transfers after April 7, 2017.
- Resolution and potential exposure from CFPB, state and federal investigations, False Claims Act matters, RMBS claims and other litigation.
- Whether the reduced servicing portfolio can generate sustainable margins and whether lending, Automotive Capital Services and Liberty Rental Finance can replace lost servicing revenue.
- The expiration or modification of HAMP and HARP and the resulting impact on servicing and origination revenue.
- Assumptions supporting MSR valuations, including prepayment speeds, delinquencies, cost to service and discount rates.
- Potential losses above recorded representation-and-warranty and indemnification liabilities; outstanding repurchase demands were $97.5 million of UPB covering 506 loans at year-end.