ONITY GROUP INC. quarterly report, Q2 FY2011

Business Context and Reporting Period

The filing is a Form 10-Q for Ocwen Financial Corporation (NYSE: OCN), although the request metadata identifies “ONITY GROUP INC.” The report covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods. Ocwen provides residential and commercial mortgage servicing, subservicing, special servicing and asset-management services.

The company’s business is increasingly concentrated in its Servicing segment, which generated nearly all consolidated revenue. The servicing portfolio totaled $71.2 billion of unpaid principal balance at June 30, 2011, including $70.8 billion of residential assets.

Key Financial Metrics

Metric	Three months ended June 30, 2011	Three months ended June 30, 2010	Six months ended June 30, 2011	Six months ended June 30, 2010
Total revenue	$105.8 million	$76.0 million	$216.8 million	$151.5 million
Income from operations	$63.6 million	$31.3 million	$133.4 million	$71.7 million
Operating margin	60.1%	41.2%	61.5%	47.3%
Net income attributable to Ocwen	$26.4 million	$16.0 million	$48.5 million	$36.9 million
Net margin	24.9%	21.1%	22.3%	24.4%
Diluted EPS	$0.25	$0.15	$0.45	$0.35
Net cash provided by operating activities	Not separately reported	Not separately reported	$630.4 million	$360.8 million

Second-quarter revenue increased 39%, operating income increased 103% and net income attributable to Ocwen increased 64%. Six-month revenue increased 43%, operating income increased 86% and attributable net income increased 31%.

Balance Sheet, Debt and Liquidity

Total assets were $2.29 billion at June 30, 2011, down from $2.92 billion at December 31, 2010.
Cash was $104.2 million, compared with $127.8 million at year-end 2010.
Total equity was $955.8 million, compared with $904.8 million at December 31, 2010.
Match-funded advances were $1.42 billion and match-funded liabilities were $1.04 billion, down from $1.92 billion and $1.48 billion, respectively.
Reported debt-related liabilities included $1.04 billion of match-funded liabilities, $58.7 million of secured borrowings owed to securitization investors, $41.5 million of lines of credit and other secured borrowings, and $82.6 million of debt securities.
Total borrowings outstanding were reported at $1.17 billion, excluding secured borrowings owed to securitization investors.
Management-defined liquidity was $205.7 million, consisting of cash plus unused collateralized advance-financing capacity, down 20% from December 31, 2010. Of $649.0 million of total unused borrowing capacity, only $101.6 million was readily available based on pledged collateral.

Cash Flow and Operating Metrics

Operating cash flow of $630.4 million was driven primarily by $518.5 million of collections from advances and match-funded advances, net income and non-cash amortization.
Investing activities provided $1.4 million, including distributions from asset-management entities, partially offset by a $3.0 million investment in Correspondent One.
Financing activities used $655.4 million, principally for repayment of $440.5 million of match-funded liabilities and repayment of the remaining $197.5 million senior secured term loan.
Mortgage servicing rights declined to $175.6 million from $194.0 million, primarily because of $19.1 million of amortization.
Residential non-performing assets serviced, excluding Freddie Mac, declined to 24.2% of UPB from 26.2% in the comparable 2010 period and from 27.3% at December 31, 2010.
Ocwen completed 16,825 loan modifications in the second quarter and 41,327 in the first six months, compared with 14,384 and 33,991, respectively, in the prior-year periods.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven principally by the HomEq and Saxon servicing acquisitions, loan modifications and growth in the servicing portfolio. Residential servicing and subservicing fees increased 44% in the second quarter and 49% for the first six months.
Operating expenses declined 5% in the second quarter because 2010 included a $5.2 million MDL litigation accrual and $1.25 million of HomEq acquisition-related professional fees. For the six months, expenses increased 5% because of higher staffing and mortgage-servicing-right amortization.
Interest expense increased to $21.8 million in the second quarter and $59.4 million for the first six months, primarily from borrowings associated with the HomEq acquisition and accelerated amortization of debt discounts and issuance costs.
The company repaid its $197.5 million remaining senior secured term loan balance, including $180.0 million of voluntary prepayments, and terminated the facility on June 9, 2011.
The effective tax rate for the first six months was 35.9%, compared with 17.4% in 2010. The prior-year rate benefited from an $8.3 million release of a tax reserve and recognition of certain foreign deferred tax assets.
Corporate Items and Other reported a pretax loss of $2.1 million for the first six months, improved from a $9.2 million loss in 2010, partly because prior-year results included auction-rate-security losses and a $3.0 million commercial real-estate investment write-off.

Guidance, Outlook, Risks and Unusual Items

Strategic Outlook

Ocwen expected to acquire Litton Loan Servicing from Goldman Sachs, subject to regulatory and other closing conditions, with an anticipated September 1, 2011 closing. The transaction included a $263.7 million base purchase price, approximately $337.4 million to retire certain Litton advance-facility debt, and planned financing for approximately $2.47 billion of servicing advances.
Management expected the Litton transaction to add approximately $39 billion of servicing UPB, increasing the total servicing portfolio to more than $100 billion and making Ocwen the largest U.S. non-prime servicer.
Management planned to pursue additional servicing platforms, special-servicing opportunities, flow servicing and new servicing segments, while reducing servicing costs and improving delinquency and advance management.
Ocwen was exploring a potential transaction with Home Loan Servicing Solutions to sell MSRs or rights to receive servicing fees and potentially operate in a more capital-light, fee-for-service model. Completion was not assured.

Risks and Contingencies

Extended foreclosure timelines, foreclosure moratoria, regulatory actions or changes in servicing practices could increase advances, operating expenses and borrowing needs, while delaying collections and revenue recognition.
Liquidity depends substantially on collections of servicing advances, availability of match-funded facilities, collateral eligibility and compliance with debt covenants. Management stated that it was in compliance with applicable covenants.
Interest-rate exposure remained material. Variable-rate borrowings totaled $722.9 million, fixed-rate borrowings totaled $448.6 million, and interest-rate swaps had a notional balance of $765.6 million. Management estimated that a 1% increase in relevant rates would have an annual net positive impact of approximately $5.4 million based on June 30 balances.
Ocwen remained subject to litigation, regulatory inquiries and investigations concerning servicing and foreclosure practices. A proposed MDL class settlement requiring Ocwen to pay $5.2 million received final court approval on July 1, 2011, subject to potential opt-outs or appeals.
An ABFS bankruptcy-trustee action sought compensatory damages in excess of $100 million and punitive damages; Ocwen disputed the allegations and was defending the matter.
India tax proceedings involved proposed tax and interest assessments, including a reported demand of approximately $1.4 million for one assessment year and additional proposed amounts for another. The ultimate exposure was not determinable.
Ocwen disclosed a guarantee related to one match-funded facility. The maximum payment was limited to 10% of the applicable notes outstanding at the end of the facility’s revolving period.

Most Important Facts for Investors to Verify

Confirm the registrant identity: the filing text is for Ocwen Financial Corporation, not Onity Group Inc.
Verify the closing, financing structure and final economics of the Litton acquisition, including the effect on servicing UPB, debt and advances.
Reconcile management-defined liquidity of $205.7 million with the much larger headline unused borrowing capacity, recognizing collateral restrictions.
Monitor advance balances, foreclosure timelines, delinquency rates and the renewal or amortization dates of advance-financing facilities.
Assess the sustainability of the sharp operating-margin improvement after adjusting for acquisition-related scale, prior-year litigation charges and unusual debt-cost write-offs.
Review the outcome and financial exposure from the ABFS litigation, tax proceedings, foreclosure-related inquiries and other regulatory matters.
Evaluate MSR valuation sensitivity to prepayment speeds, delinquency rates, financing costs and the 20% discount rate used in the reported valuation.
Verify whether the proposed Home Loan Servicing Solutions transaction and the Correspondent One strategy produced the expected capital and servicing benefits.