Business Context and Reporting Period
The filing is Ocwen Financial Corporation’s Form 10-K for the fiscal year ended December 31, 2011, filed February 29, 2012. The request metadata identifies “ONITY GROUP INC.”, but the filing itself identifies the registrant as Ocwen Financial Corporation (NYSE: OCN).
Ocwen primarily provides residential and commercial mortgage servicing, special servicing and asset-management services. At December 31, 2011, it serviced 671,623 residential assets with $102.2 billion of unpaid principal balance and 91 commercial assets totaling $290.9 million. The Servicing segment generated nearly all consolidated revenue.
The company completed the Litton Loan Servicing acquisition on September 1, 2011, adding approximately 245,000 primarily non-prime residential loans and $38.6 billion of UPB. Ocwen ceased operating the Litton platform during the fourth quarter and moved servicing activity onto its own platform.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total revenue | $495.9 million | $360.4 million | +38% |
| Servicing and subservicing fees | $458.9 million | $321.7 million | +43% |
| Operating expenses | $239.6 million | $236.5 million | +1% |
| Income from operations | $256.3 million | $123.9 million | +107% |
| Income before taxes | $123.0 million | $39.2 million | +214% |
| Net income attributable to Ocwen | $78.3 million | $38.0 million | +106% |
| Diluted EPS | $0.71 | $0.36 | +97% |
| Operating margin | 51.7% | 34.4% | Improved |
| Net margin | 15.8% | 10.5% | Improved |
| Net cash provided by operating activities | $982.1 million | $727.5 million | +35% |
Interest expense increased to $132.8 million from $85.9 million, primarily because of borrowings supporting the HomEq and Litton acquisitions. Income tax expense was $44.7 million, producing a 36.3% effective tax rate versus 14.2% in 2010.
Fourth-quarter 2011 revenue was $156.6 million, operating income was $66.1 million, pretax income was $18.5 million and net income attributable to Ocwen was $9.7 million, or $0.08 diluted EPS.
Balance Sheet, Debt and Liquidity
- Total assets increased 62% to $4.74 billion, principally because of acquired servicing advances and MSRs.
- Cash was $144.2 million, compared with $127.8 million at December 31, 2010.
- Advances and match-funded advances totaled $3.73 billion, including $3.63 billion of match-funded advances.
- Mortgage servicing rights were $293.2 million, compared with $194.0 million, and had an estimated fair value of $340.0 million.
- Total liabilities were $3.39 billion and total equity was $1.34 billion.
- Match-funded liabilities were $2.56 billion, compared with $1.48 billion. Lines of credit and other secured borrowings were $540.4 million.
- Reported liquidity, defined as cash plus unused collateralized advance capacity, was $551.1 million, including $406.8 million of readily available unused capacity.
- The company reported $1.57 billion of total unused borrowing capacity, although additional collateral was required to access much of that capacity.
- Net cash used in investing activities was $2.66 billion, primarily reflecting $2.65 billion paid for Litton, including acquired advances. Financing activities provided $1.69 billion.
Material Changes Versus Prior Comparable Period
- The servicing portfolio increased 38% to $102.2 billion of UPB from $73.9 billion, and the number of serviced residential assets increased 40% to 671,623.
- Residential servicing and subservicing fees increased 42%, driven by portfolio growth, the full-year effect of HomEq and the Litton acquisition.
- Servicing pretax income increased 74% to $135.9 million from $78.2 million.
- Operating expenses were broadly stable despite portfolio growth. Acquisition-related costs were $50.3 million in 2011 versus $52.6 million for HomEq in 2010.
- Non-performing residential assets increased to 27.9% of UPB from 27.3%, primarily because Litton had higher delinquencies when boarded. Excluding Litton, the rate would have been 23.4%.
- Average prepayment speed increased to 14.4% from 12.7%, while average borrowings increased 71% and interest expense on borrowings increased 66%.
- Ocwen issued 28.75 million common shares in November 2011 and received $354.4 million of net proceeds, temporarily using the proceeds to reduce advance-facility borrowings.
- Standard & Poor’s downgraded Ocwen’s residential subprime servicer rating from “Strong” to “Above Average,” and Fitch downgraded its residential subprime and special servicing ratings to “RPS3” and “RSS3.”
Guidance, Outlook, Risks and Unusual Items
- Management expected advances to decline absent significant changes in foreclosure processes or further acquisitions, but stated that this outcome was not assured.
- Ocwen expected to complete the Saxon acquisition in March 2012, involving approximately $26.8 billion of servicing UPB and approximately $292.2 million of servicing advances to be funded by Ocwen.
- Ocwen expected the JPMorgan Chase MSR transaction to close in early April 2012, involving approximately 82,000 non-prime loans with $15 billion of UPB and an expected cash purchase price of approximately $950 million. Closing remained subject to conditions and was not assured.
- On February 10, 2012, Ocwen agreed to sell rights to servicing fees on approximately $16 billion of UPB to HLSS Holdings and transfer related financing obligations, subject to HLSS completing an initial public offering and other conditions. Expected proceeds were approximately $181 million, but the transaction was not yet closed at the filing date.
- Foreclosure timelines increased materially in 2011, delaying recovery of servicing fees and advances and potentially increasing operating expenses, borrowings and interest expense.
- The business is highly dependent on financing capacity, advance recoveries, servicer ratings, interest-rate hedges and the performance of acquired portfolios. Approximately 34% of outstanding debt was variable rate at year-end.
- Regulatory scrutiny of foreclosure and servicing practices, CFPB implementation of Dodd-Frank requirements, government investigations and private litigation could increase compliance costs, penalties, servicing restrictions and liquidity needs.
- Material legal matters included a $5.2 million MDL class-action settlement and an ABFS bankruptcy proceeding seeking more than $100 million in compensatory damages plus punitive damages. Ocwen could not estimate a possible loss for the ABFS matter.
- The company reported $7.4 million of derivative losses in 2011, including foreign-exchange and interest-rate-related losses. The India-rupee forward contracts were terminated in January 2012, generating a $3.4 million gain.
- Ocwen notified holders that it would redeem $56.4 million of 3.25% convertible notes on March 28, 2012. Management expected most holders to convert, potentially increasing shares outstanding by approximately 4.6 million.
- The company’s OTS Guaranty expired by its terms on February 29, 2012. Ocwen stated that it was in compliance with the Guaranty’s covenants at December 31, 2011.
Most Important Facts to Verify
- Whether the Saxon, JPMorgan Chase and HLSS transactions closed as planned and their effect on servicing UPB, advances, debt and liquidity.
- Post-acquisition delinquency, advance-recovery and servicing-cost trends, particularly for Litton and other acquired portfolios.
- Available borrowing capacity after collateral, covenant, advance-rate and servicer-rating limitations.
- Results of regulatory inquiries, foreclosure-related litigation, the ABFS proceeding and any loss-sharing obligations from Litton or Saxon.
- The impact of higher foreclosure timelines, prepayment speeds and variable interest rates on MSR valuations, revenue recognition and interest expense.
- Whether the convertible notes converted or were redeemed in March 2012 and the resulting diluted share count.
- The sustainability of 2011 earnings after excluding acquisition-related costs, derivative losses, debt-extinguishment gains and other unusual items.