ONITY GROUP INC. annual report, FY2016

Business Context and Reporting Period

The filing is Ocwen Financial Corporation’s Form 10-K for the fiscal year ended December 31, 2016. The request metadata identifies “ONITY GROUP INC.,” but the supplied filing is for Ocwen Financial Corporation (NYSE: OCN), a mortgage servicing and lending company.

Ocwen operates through Servicing, Lending, and Corporate Items and Other. Its residential servicing portfolio totaled 1,393,766 loans with $209.1 billion of unpaid principal balance at year-end. The company also originates forward and reverse mortgages and operates Automotive Capital Services (ACS), which provides inventory-secured loans to used-car dealers.

Key Financial Metrics

Metric	2016	2015	Change
Total revenue	$1.387 billion	$1.741 billion	Down 20%
Servicing and subservicing fees	$1.187 billion	$1.532 billion	Down 23%
Gain on loans held for sale	$90.4 million	$135.0 million	Down 33%
Total expenses	$1.223 billion	$1.478 billion	Down 17%
Interest expense	$412.6 million	$482.4 million	Down 14%
Loss before income taxes	$206.4 million	$129.9 million	Loss increased
Net loss attributable to common stockholders	$199.8 million	$247.0 million	Improved 19%
Basic and diluted loss per share	$1.61 loss	$1.97 loss	Improved
Operating cash flow	$474.7 million	$581.6 million	Down 18%
Cash at year-end	$256.5 million	$257.3 million	Essentially unchanged

Reported net loss improved primarily because expenses declined and 2015 included a larger tax charge. However, the pretax loss widened because revenue declined faster than expenses and corporate costs increased. The company reported a quarterly profit in the third quarter of 2016, but remained unprofitable for the full year.

Total assets increased 4% to $7.656 billion, while total liabilities increased 7% to $7.000 billion.
Total equity declined 23% to $655.3 million, primarily because of the annual loss and share repurchases.
Mortgage servicing rights declined 8% to $1.043 billion.
Advances and match-funded advances declined 21% to $1.710 billion.
Reverse mortgage loans held for investment increased 43% to $3.566 billion, with related financing liabilities increasing to $3.434 billion.
Outstanding match-funded liabilities were $1.281 billion; other secured borrowings were $678.5 million; and senior notes were $346.8 million.

Material Changes Versus the Prior Comparable Period

The residential servicing portfolio declined 17% by unpaid principal balance, from $251.0 billion to $209.1 billion, reflecting prior MSR sales, portfolio runoff, servicing transfers, and limited acquisition activity.
Servicing revenue declined 23%, principally because of the 2015 sale of $87.6 billion of Agency MSRs, continued portfolio runoff, and lower modification volume.
Ocwen sold an additional $3.7 billion of MSRs in 2016 and recognized an $8.5 million net gain, compared with an $83.9 million gain on $87.6 billion of MSR sales in 2015.
Expenses declined 17% as the company reduced headcount, technology costs, occupancy costs, and other operating expenses. Average headcount declined 14% to 7,452, and year-end employees declined to approximately 9,700 from 10,500.
Direct regulatory monitoring costs increased to $81.7 million from $49.9 million. Total third-party monitoring costs recognized from 2014 through 2016 reached $171.0 million.
Lending production increased modestly: forward loan production rose 7% to $4.188 billion and reverse loan production rose 2% to $825.5 million. Nevertheless, Lending segment pretax income declined to $10.0 million from $34.0 million due to lower margins and increased staffing and development costs.
HAMP fees declined to $110.3 million from $135.0 million. HAMP expired on December 31, 2016, although certain borrowers may finalize modifications through September 30, 2017.
In December 2016, the company refinanced its senior secured term loan with a new $335.0 million facility maturing in 2020 and exchanged $346.9 million of 6.625% senior unsecured notes for 8.375% senior secured second-lien notes due 2022.

Cash Flow, Liquidity, Debt, and Capital

Operating activities generated $474.7 million of cash, largely from $452.4 million of net servicing-advance collections. Investing activities used $791.6 million, including $855.2 million of net cash outflows for reverse mortgages, $35.0 million for ACS, and $33.5 million of capital expenditures, partly offset by $150.1 million of net MSR and related-advance sale proceeds. Financing activities provided $316.2 million, principally from reverse mortgage securitizations accounted for as secured financings.

Management stated that liquidity was sufficient to fund operations and meet obligations through 2017, but this conclusion depended on renewing, replacing, or extending maturing financing facilities.
Approximately $1.2 billion of debt related to match-funded liabilities and mortgage warehouse facilities was expected to mature or begin amortizing within 12 months.
Advance facilities had $1.3 billion outstanding, with $655.0 million of revolving capacity periods ending in 2017 and $400.0 million of two-year term notes maturing in 2017.
Mortgage warehouse facilities had $355.0 million outstanding, including $304.9 million under arrangements maturing in 2017.
Although $274.0 million of advance-facility capacity was reported as available, the filing states that none could be used based on the amount of eligible collateral pledged.
The company repurchased 991,985 shares for $5.9 million in 2016. The repurchase program expired July 31, 2016. No cash dividends have been paid, and management did not intend to pay dividends in the foreseeable future.

Guidance, Outlook, Risks, and Unusual Items

Management’s strategy is to return to profitability through cost reductions, continued investment in residential lending, growth of ACS, and improved customer, risk, and compliance infrastructure.
ACS had $83.8 million of credit lines outstanding to dealers, of which $39.5 million was drawn, and was not profitable in 2016. Management indicated that rapid scaling and low-single-digit average loan losses would be necessary for success.
The company remains heavily exposed to regulatory actions, litigation, servicing-practice allegations, licensing requirements, and technology and cybersecurity risks.
Ocwen accrued $12.5 million for potential CFPB resolution costs but had not reached an agreement. The filing states that losses could materially exceed the accrued amount.
The February 2017 California consent order, disclosed after year-end, terminated the prior California consent order and auditor appointment. It requires a $25.0 million cash payment, $198.0 million of borrower debt forgiveness over three years, policy updates, borrower outreach, and a three-year California borrower hotline. The filing states that the California MSR-acquisition prohibition was rescinded.
Litigation accruals totaled $44.6 million at year-end, including a $30.0 million accrual for settlement of the Fisher False Claims Act cases, subject to final government approval. The company could not estimate reasonably possible losses above recorded amounts.
Servicer-rating termination rights had been triggered for 174 non-Agency servicing agreements representing approximately $10.8 billion of UPB, or 6.8% of the non-Agency servicing portfolio.
Ocwen depends substantially on New Residential Investment Corp. for advance funding associated with approximately $118.7 billion of UPB. If NRZ cannot fund advances, Ocwen may still be contractually required to provide them.
Approximately 62% of consolidated assets and 56% of liabilities were measured at fair value, with 94% of fair-value assets and 100% of fair-value liabilities using Level 3 inputs. Valuations are sensitive to prepayment speeds, delinquencies, servicing costs, discount rates, and interest rates.
Management reported effective disclosure controls and effective internal control over financial reporting, and Deloitte & Touche issued unqualified audit opinions.

Most Important Facts for Investors to Verify

Whether servicing revenue can stabilize after the MSR sales, portfolio runoff, and expiration of HAMP.
Whether cost reductions are sufficient to offset the shrinking servicing portfolio and ongoing compliance and monitoring expenses.
Successful renewal or refinancing of 2017 advance and warehouse maturities, particularly given limited usable collateral-based capacity.
The ultimate cost and timing of CFPB, NY DFS, California, SEC, Massachusetts Attorney General, litigation, and RMBS servicing matters.
Whether NRZ continues funding servicing advances and whether servicing transfers or fee resets reduce future revenue.
The sustainability and valuation sensitivity of reverse mortgage assets and related HMBS financing liabilities.
Whether Lending and ACS achieve the scale and profitability required to diversify the company away from servicing.
Potential increases in repurchase, indemnification, foreclosure, cybersecurity, and technology-related losses beyond recorded reserves.