In addition to the anticipated uses of cash identified above, we are also considering additional strategic investments similar to OSI and NPL, additional acquisitions and additional common share repurchases. We may also evaluate the retirement of our 10 7/8% Capital Securities, which became redeemable in whole or in part at our option beginning August 1, 2007 at a redemption price of 105.438%.
We believe that our existing sources of liquidity, including internally generated funds, will be adequate to fund planned activities, although there can be no assurances in this regard. At September 30, 2007, we had $277,890 of unused borrowing capacity under existing credit agreements. We continue to evaluate our sources of funding for renewal and expansion, and we continue to examine all of our asset classes to identify additional funding opportunities.
Cash and investment grade securities totaled $180,245 at September 30, 2007 as compared to $311,567 at December 31, 2006.
Significant uses of funds for the nine months ended September 30, 2007 include the following:
Significant sources of funds for the nine months ended September 30, 2007 include the following:
Our operating activities provided (used) cash of $(257,170) and $351,246 during the nine months ended September 30, 2007 and 2006, respectively. The decline in net cash flows from operating activities in the first nine months of 2007 as compared to the same period of 2006 primarily reflects a significant reduction in proceeds from the sale and securitization of loans held for resale and increased funding requirements of the Residential Servicing business. These reductions were somewhat offset by a decline in net cash used by trading activities. Loans held for resale provided cash of $387 and $524,897 during the first nine months of 2007 and 2006, respectively. The reason for this change is that in 2007 we decided to shut down our subprime origination business and de-emphasize our loan trading activities. The funding requirements of our residential servicing business are reflected in the decrease in servicer liabilities and increase in servicing advances, which collectively used $455,521 of cash during the first nine months of 2007. These same items provided $28,305 of cash during the first nine months of 2006. The reason for this change is the growth of our residential servicing portfolio, coupled with declining prepayment speeds and rising delinquencies. Trading activities provided (used) net cash of $93,034 and $(246,937) in the first nine months of 2007 and 2006, respectively. This change is due to a decline in excess funds available to invest in investment grade securities and the receipt of $44,607 from the sale of the UK residuals.
Our investing activities used cash flows totaling $100,780 and $149,271 during the nine months ended September 30, 2007 and 2006, respectively. In 2007, purchases of mortgage servicing rights of $108,668, investments in OSI and NPL totaling $55,583 and net cash paid to acquire NCI of $48,918 were partially offset by $66,260 of cash received from our early redemption of CDs and the return of $45,894 that we had originally invested in BMS Holdings in July 2006. Cash used by investing activities in the first nine months of 2006 consisted primarily of purchases of mortgage servicing rights of $102,198 and our investment in BMS Holdings.
Our financing activities provided (used) cash flows of $265,307 and $(279,354) during the nine months ended September 30, 2007 and 2006, respectively. Cash flows provided by financing activities in the first nine months of 2007 reflect net proceeds from match funded liabilities and lines of credit and other secured borrowings of $277,742 primarily related to increased borrowings on servicing advances. For the first nine months of 2006, cash flows used by financing activities primarily reflect the repayment of collateralized borrowings used to finance loans held
for resale as a result of loan sales and securitizations. Net repayments of match funded liabilities and lines of credit and other secured borrowings amounted to $268,609 during the first nine months of 2006.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
Contractual Obligations
We believe that we have adequate resources to fund all unfunded commitments to the extent required and meet all contractual obligations as they become due. Such contractual obligations include our Convertible Notes, Capital Trust Securities, lines of credit and other secured borrowings and operating leases. See Note 16 to the Interim Consolidated Financial Statements for additional information regarding commitments and contingencies.
Off-Balance Sheet Arrangements
In the normal course of business, we engage in transactions that are not reflected on our balance sheet. We are party to various off-balance sheet financial instruments to manage our interest rate risk and credit risk. In addition, through our investment in subordinate and residual securities, we provide credit support to the senior classes of securities. We have also entered into non-cancelable operating leases and have committed to invest up to an additional $94,417 in OSI and NPL combined. See Note 14 to our Interim Consolidated Financial Statements for additional information regarding off-balance sheet arrangements.
We conduct business with a variety of financial institutions and other companies in the normal course of business, including counterparties to our off-balance sheet financial instruments. We are subject to potential financial loss if the counterparty is unable to complete an agreed upon transaction. We seek to limit counterparty risk through financial analysis, dollar limits and other monitoring procedures.
RECENT ACCOUNTING DEVELOPMENTS
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which establishes a framework for measuring fair value and expands disclosures about fair value measurement. The FASB also issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” in February 2007, which gives entities the option to report at fair value many financial instruments and other items that are not currently required to be reported at fair value. The effective date for SFAS No. 157 and SFAS No. 159 is the first fiscal year that begins after November 15, 2007 (the year beginning January 1, 2008 for OCN). We are currently evaluating the provisions of SFAS No. 157 and SFAS No. 159 and have not yet determined the extent to which we may elect the fair value option in our accounting and reporting for financial instruments. For additional information regarding recent accounting pronouncements, see Note 2 to the Interim Consolidated Financial Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk includes prepayment risk, interest rate risk, foreign currency exchange rate risk and liquidity risk. We are exposed to interest rate risk to the degree that our interest-bearing liabilities mature or reprice at different speeds, or different bases, than our interest-earning assets. We are exposed to foreign currency exchange rate risk in connection with our investment in non-U.S. dollar functional currency operations and to the extent our foreign exchange positions remain unhedged. Market risk also reflects the risk of declines in the valuation of trading securities, MSRs and in the value of the collateral underlying loans.
We are also exposed to liquidity risk primarily because of the highly variable daily cash requirements to support the Residential Servicing business including the requirement to make advances pursuant to servicing contracts and the process of remitting borrower payments to the custodial accounts. In general, we finance our operations through operating cash flows and various other sources including match funded agreements, secured lines of credit and repurchase agreements.
Our Residential Servicing business is characterized by non-interest earning assets financed by interest-bearing liabilities. Among the more significant non-interest earning assets are servicing advances and MSRs. At September 30, 2007, we had residential servicing advances of $1,129,362 consisting of advances on loans serviced for others of $343,260 and match funded advances on loans serviced for others of $786,102.
The primary risk associated with residential MSRs is that they will lose a portion of their value as a result of higher than anticipated prepayments occasioned by declining interest rates or rapidly increasing house prices. Interest rates, prepayment speeds and the payment performance of the underlying loans significantly affect both our initial and ongoing valuations and the rate of amortization of MSRs. As of September 30, 2007, the carrying value and estimated fair value of our residential mortgage servicing rights were $204,991 and $294,715, respectively.
We face little market risk with regard to our advances and match funded advances on loans serviced for others. This is because we are obligated to fund advances only to the extent that we believe that they are recoverable and because advances generally are the first obligations
40
to be satisfied when a securitization trust disburses funds. We are indirectly exposed to interest risk by our funding of advances because approximately 80% of our total advances and match funded advances are funded through borrowing, and most of the debt is variable rate debt.
We are also exposed to interest rate risk because earnings on float balances are affected by short-term interest rates. These float balances, which are not included in our financial statements, amounted to approximately $429,200 at September 30, 2007 and averaged approximately $594,000 for the quarter then ended. We report these earnings as a component of servicing and subservicing fees. Partially offsetting this risk is the fact that a large component of our outstanding debt is variable rate debt. Therefore, declining rates will also reduce our interest expense for that financing. We entered into interest rate swap agreements to hedge our float earnings against the effects of declining interest rates. However, we terminated these swaps in June 2007. At September 30, 2007, the combined balance of our match funded liabilities, debt securities, lines of credit and other secured borrowings totaled $1,264,768. Of this amount $933,977, or 74%, was variable rate debt, for which debt service costs are sensitive to changes in interest rates, and $330,791 was fixed rate debt. We have entered into interest rate swap agreements to convert the interest rate on $165,000 of our fixed rate debt to variable.
Our balance sheet at September 30, 2007 included interest-earning assets totaling $207,647, including $36,307 of investment grade securities and $83,862 of loans held for resale.
Impact of Changes in Interest Rates on the Net Value of Interest Rate-Sensitive Financial Instruments
We perform an interest rate sensitivity analysis of our portfolio of MSRs every quarter. We currently estimate that the fair value of the portfolio increases or decreases by approximately 0.95% and 1.30%, respectively, for every 50 basis point increase or decrease in interest rates. This sensitivity analysis is limited in that it was performed at a particular point in time; only contemplates certain movements in interest rates; does not incorporate changes in interest rate volatility; is subject to the accuracy of various assumptions used, including prepayment forecasts and discount rates; and does not incorporate other factors that would impact our overall financial performance in such scenarios. We carry MSRs at the lower of amortized cost or fair value by strata. To the extent that fair value were to decline below amortized cost, we would record an impairment charge to earnings and establish a valuation allowance. A subsequent increase in fair value could result in the recovery of some or all of a previously established valuation allowance. However, an increase in fair value of a particular stratum above its amortized cost would not be reflected in current earnings. For these reasons, this interest rate sensitivity estimate should not be viewed as an earnings forecast.
Our Investment Committee is authorized to utilize a wide variety of off-balance sheet financial techniques to assist it in the management of interest rate risk and foreign currency exchange rate risk. During May 2007, we sold the UK residuals and terminated our remaining British pound currency futures. During the third quarter of 2007, the remaining interest rate swaps and Eurodollar interest futures contracts we had entered into to hedge our exposure to interest rate risk presented by our float earnings, loans held for resale and fixed-rate match funded liabilities had either matured or were terminated. At September 30, 2007, we had open interest rate swaps with a notional amount of $165,000. See Note 14 to the Interim Consolidated Financial Statements for additional information regarding our use of derivative financial instruments.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of September 30, 2007. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of September 30, 2007, our disclosure controls and procedures (1) were designed and functioning effectively to ensure that material information relating to OCN, including its consolidated subsidiaries, is made known to our chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) were operating effectively in that they provided reasonable assurance that information required to be disclosed by OCN in the reports that it files or submits under the Securities Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to management, including the chief executive officer or chief financial officer, as appropriate, to allow timely decisions regarding disclosure.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
41
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See “Note 16 Commitments and Contingencies” of the Interim Consolidated Financial Statements for information regarding legal proceedings.
ITEM 1A. RISK FACTORS
See our discussion of risk factors on page 22 of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 6. EXHIBITS
| | | |
(3) | Exhibits. | (Exhibits marked with a “ * ” denote management contracts or compensatory plans or agreements) |
| | 2.1 | Agreement of Merger dated as of July 25, 1999 among Ocwen Financial Corporation, Ocwen Asset Investment Corp. and Ocwen Acquisition Company (1) |
| | 2.2 | Stock Purchase Agreement dated as of May 23, 2006 by and among Bankruptcy Management Solutions, Inc., Its Stockholders and Warrant Holder, and BMS Holdings, Inc. (2) |
| | 2.3 | Amendment No.1 dated July 31, 2006 to the Stock Purchase Agreement by and among Bankruptcy Management Solutions, Inc., Its Stockholders and Warrant Holder, and BMS Holdings, Inc. The company agrees to furnish supplementally a copy of any omitted schedule to the Commission upon request (2) |
| | 3.1 | Amended and Restated Articles of Incorporation (3) |
| | 3.2 | Amended and Restated Bylaws (4) |
| | 4.0 | Form of Certificate of Common Stock (3) |
| | 4.1 | Certificate of Trust of Ocwen Capital Trust I (5) |
| | 4.2 | Amended and Restated Declaration of Trust of Ocwen Capital Trust I (5) |
| | 4.3 | Form of Capital Security of Ocwen Capital Trust I (included in Exhibit 4.4) (5) |
| | 4.4 | Form of Indenture relating to 10.875% Junior Subordinated Debentures due 2027 of OCN (5) |
| | 4.5 | Form of 10.875% Junior Subordinated Debentures due 2027 of OCN (included in Exhibit 4.6) (5) |
| | 4.6 | Form of Guarantee of OCN relating to the Capital Securities of Ocwen Capital Trust I (5) |
| | 4.7 | Registration Rights Agreement dated as of July 28, 2004, between OCN and Jeffries & Company Inc. (6) |
| | 4.8 | Indenture dated as of July 28, 2004, between OCN and the Bank of New York Trust Company, N.A., as trustee (6) |
| | 10.1* | Ocwen Financial Corporation 1996 Stock Plan for Directors, as amended (7) |
| | 10.2* | Ocwen Financial Corporation 1998 Annual Incentive Plan (8) |
| | 10.3 | Compensation and Indemnification Agreement, dated as of May 6, 1999, between OAC and the independent committee of the Board of Directors (9) |
| | 10.4 | Indemnity agreement, dated August 24, 1999, among OCN and OAC’s directors (10) |
| | 10.5* | Amended Ocwen Financial Corporation 1991 Non-Qualified Stock Option Plan, dated October 26, 1999 (10) |
| | 10.6 | First Amendment to Agreement, dated March 30, 2000 between HCT Investments, Inc. and OAIC Partnership I, LP (10) |
| | 10.7* | Ocwen Financial Corporation Deferral Plan for Directors, dated March 7, 2005 (11) |
| | 10.8 | Collateral Trust Agreement, dated June 28, 2005, between OCN and the Bank of New York Trust Company, N.A. (12) |
| | 10.9 | Guaranty, dated June 28, 2005, from OCN to the Guaranteed Parties (12) |
| | 10.10 | Cash Collateral Agreement, dated June 28, 2005, among OCN, Bank of New York Trust Company, N.A. as collateral Trustee and Bank of New York Trust Company, N.A. as Account Bank (12) |
| | 10.11 | Stock Purchase Agreement, dated May 5, 2006, between Wishco, Inc. and OCN (13) |
| | 10.12* | Ocwen Financial Corporation 2007 Equity Incentive Plan, dated May 10, 2007 (14) |
| | 10.13 | Stock Repurchase Agreement, dated April 30, 2007, among Wishco, Inc., BNW Partners and OCN (15) |
| | 31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
| | 31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
| | 32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
| | 32.2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
42
| |
(1) | Incorporated by reference from a similarly described exhibit included with the Registrant’s Current Report on Form 8-K filed with the Commission on July 26, 1999. |
(2) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006. |
(3) | Incorporated by reference from the similarly described exhibit filed in connection with the Registrant’s Registration Statement on Form S-1 (File No. 333-5153) as amended, declared effective by the commission on September 25, 1996. |
(4) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1998. |
(5) | Incorporated by reference from the similarly described exhibit filed in connection with our Registration Statement on Form S-1 (File No. 333-28889), as amended, declared effective by the Commission on August 6, 1997. |
(6) | Incorporated by reference from the similarly described exhibit included with Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
(7) | Incorporated by reference from the similarly described exhibit filed in connection with the Registrant’s Registration Statement on Form S-8 (File No. 333-44999), effective when filed with the Commission on January 28, 1998. |
(8) | Incorporated by reference from the similarly described exhibit to our definitive Proxy Statement with respect to our 1998 Annual Meeting of Shareholders as filed with the Commission on March 31, 1998. |
(9) | Incorporated by reference from OAC’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999. |
(10) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000. |
(11) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004. |
(12) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005. |
(13) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Form 8-K filed with the Commission on May 11, 2006. |
(14) | Incorporated by reference from the similarly described exhibit to our definitive Proxy Statement with respect to our 2007 Annual Meeting of Shareholders as filed with the Commission on March 30, 2007. |
(15) | Incorporated by reference from the similarly described exhibit included with the Registrant’s Form 8-K filed with the Commission on May 1, 2007. |
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| |
| OCWEN FINANCIAL CORPORATION |
| |
Date: November 9, 2007 | By: /s/ David J. Gunter |
|
|
| David J. Gunter, |
| Senior Vice President, |
| Chief Financial Officer and Treasurer |
| (On behalf of the Registrant and as its principal financial officer) |
44
