The liability, if any, for the claims noted below against Ocwen Federal Bank FSB (the “Bank”) has been assumed by OLS as successor in interest under an Assignment and Assumption Agreement, dated June 28, 2005, whereby OLS assumed all of the Bank’s remaining assets and liabilities, including contingent liabilities, in connection with its voluntary termination of its status as a federal savings bank.
We are named as a defendant in lawsuits brought in various federal and state courts challenging the Bank’s mortgage servicing practices, including charging improper or unnecessary fees, misapplying borrower payments, etc. In April 2004, our petition was granted to transfer and consolidate a number of lawsuits filed against the Bank, OCN and various third parties into a single proceeding pending in the United States District Court for the Northern District of Illinois (the MDL Proceeding). Additional lawsuits similar to the MDL proceeding have been brought in other courts, some of which may be transferred to and consolidated in the MDL Proceeding. The borrowers in many of these lawsuits seek class action certification. Others have brought individual actions. No class has been certified in the MDL Proceeding or any related lawsuits. In April 2005, the trial court entered a partial summary judgment in favor of defendants holding that plaintiffs’ signed loan contracts authorized the collection of certain fees by Ocwen as servicer for the related mortgages. In May 2006, plaintiffs filed an amended complaint containing various claims under several federal statutes, state deceptive trade practices statutes and common law. No specific amounts of damages are asserted, however, plaintiffs may amend the complaint to seek damages should the matter proceed to trial. In June 2007, the United States Court of Appeals for the Seventh Circuit issued an opinion holding that many of the claims were preempted or failed to satisfy the pleading requirements of the applicable rules of procedure and directing the trial judge to seek clarification from the plaintiffs so as to properly determine which particular claims are to be dismissed. In March 2009, the Court struck the amended complaint in its entirety on the grounds of vagueness. Plaintiffs filed a third amended complaint on April 20, 2009. Our deadline to answer the latest complaint is May 20, 2009. We believe the allegations in the MDL Proceeding are without merit and will continue to vigorously defend against them.
In November 2004, a final judgment was entered in litigation brought by Cartel Asset Management, Inc. (Cartel) against OCN, the Bank and Ocwen Technology Xchange, Inc. (OTX), a subsidiary that has been dissolved. This matter involved allegations of misappropriation of trade secrets and contract-related claims brought by a former vendor. Initially, a jury verdict awarded damages of $9,320. However, the November 2004 judgment awarded $520 against OTX and nominal damages of two dollars against the Bank. Additionally, the Bank was assessed a statutory award to Cartel for attorneys’ fees in an additional amount of $170. The Bank and OTX were further assessed costs in the amount of $9. In September 2007, the United States Court of Appeals for the Tenth Circuit upheld the damage award against OTX and remanded the case for a new trial on damages against the Bank. In December 2007, we paid the full amount of the judgment against OTX, including accrued interest. In March 2008, the trial court entered an order joining OLS, as the Bank’s successor-in-interest, and OCN, as guarantor of the Bank’s obligations, as additional defendants. The trial court has not yet set a date for the new trial against the Bank, OLS and OCN. We do not believe that Cartel is entitled to additional damages, if any, in an amount that would be material to our financial condition, results of operations or cash flows, and we intend to continue to vigorously defend against this matter.
In September 2006, the Bankruptcy Trustee in Chapter 7 proceedings involving American Business Financial Services, Inc. (ABFS) brought an action against multiple defendants, including OLS, in Bankruptcy Court. The action arises out of Debtor-in-Possession financing to ABFS by defendant Greenwich Capital Financial Products, Inc. and the subsequent purchases by OLS of MSRs and certain residual interests in mortgage-backed securities previously held by ABFS. OLS brought a separate action against the Trustee seeking damages of approximately $2,500 arising out of the ABFS MSRs purchase transaction. OLS’ separate action against the Trustee was dismissed by agreement without prejudice with the right to replead such claims or otherwise file a separate action should the Trustee’s action be dismissed. In February 2007, the court granted OLS’ motion to dismiss some claims but refused to dismiss others. The Trustee filed an amended complaint in March 2007. This complaint sets forth claims against all of the original defendants. The claims against OLS include turnover, fraudulent transfers, accounting, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, breach of contract, fraud, civil conspiracy and conversion. The Trustee seeks compensatory damages in excess of $100,000 and punitive damages jointly and severally against all defendants. In March 2008, the court denied OLS’ motion to dismiss. In April 2008, OLS denied all charges and filed a counterclaim for breach of contract, fraud, negligent misrepresentation and indemnification in connection with the MSR purchase transaction. Fact discovery is complete and expert discovery is in progress. We believe that the Trustee’s allegations against OLS are without merit and intend to continue to vigorously defend against this matter.
Ocwen together with Bankruptcy Management Solutions, Inc. (BMSI) the wholly owned subsidiary of BMS Holdings, commenced separate arbitrations before the Financial Industry Regulatory Authority against Goldman Sachs & Co., Banc of America Securities LLC, and Citigroup Global Markets, Inc. (collectively the Broker/Dealers) primarily alleging fraud, breach of duty and statutory violations arising out of the sale of AAA-rated student loan auction rate securities (SLARS) backed by the Federal Family Education Loan Program. Ocwen and BMSI subsequently voluntarily dismissed their arbitration claims against Citigroup Global Markets, Inc, and filed a complaint in federal court. Ocwen purchased the SLARS based on the Broker/Dealer representation that the SLARS were liquid securities which could be sold at regularly scheduled auctions to meet the Investment Line requirement to pay the borrowings at quarter end. The Broker/Dealers represented that the SLARS would remain liquid because if there were not sufficient buyers in the auctions, the Broker/Dealers would purchase to make the auctions succeed. Contrary to those representations, in February 2008, the Broker/Dealers stopped supporting the SLARS auctions and the market for SLARS became illiquid. Ocwen seeks to require the Broker/Dealers to repurchase the SLARS at par (aggregating $199,275), and pay consequential damages, potentially including damages related to the repayment of the Investment Line, and punitive damages.
OCN is subject to various other pending legal proceedings. In our opinion, the resolution of these proceedings and those noted above will not have a material effect on our financial condition, results of operations or cash flows.
Tax matters
On December 28, 2006, the India tax authorities issued an income tax assessment order (the Order) with respect to IT-enabled services performed for OCN by its wholly-owned Indian subsidiary, OFSPL. The Order relates to the assessment year 2004-05 and determined that the percent mark-up on operating costs with respect to the IT-enabled and software development services that OFSPL provided to OCN was insufficient. The proposed adjustment would impose upon OFSPL additional tax of INR 45,290 ($889) and interest of INR 14,922 ($293) for the assessment year 2004-05. In December 2008, the India tax authorities issued an additional income tax assessment order (the Second Order) with respect to assessment year 2005-06. The proposed adjustment would impose upon OFSPL additional tax of INR 23,225 ($456) and interest of INR 10,200 ($200) for the assessment year 2005-06. In accordance with standard Indian procedures, penalties may also be assessed in the future in connection with the assessment.
OCN and OFSPL intend to vigorously contest the Order, the Second Order and the imposition of tax and interest and do not believe they have violated any statutory provision or rule. OFSPL has filed a domestic appeal with the India Commissioner of Income Tax (Appeals) in response to the Order and Second Order. In March 2007, OCN filed a request for Competent Authority Assistance with the Internal Revenue Service under the United States – India Income Tax Treaty. In January 2009, OCN filed a request with the Internal Revenue Service to include assessment year 2005-2006 in its Competent Authority case.
Due to the uncertainties inherent in the appeals and Competent Authority processes, OCN and OFSPL cannot currently estimate any additional exposure beyond the amount detailed in the Order. We can also not predict when these tax matters will be resolved. The Competent Authority Assistance filing should preserve OCN’s right to credit any potential India taxes against OCN’s U.S. taxes.
In a private placement transaction that closed on April 3, 2009, OCN sold 5,471,500 shares of its common stock for a price of $11.00 per share. We realized approximately $60,000 in proceeds from this issuance. The purchasers, most of whom are existing OCN shareholders, purchased approximately 8% of OCN’s total outstanding shares pursuant to this new issuance. Accordingly, the purchasers own approximately 9.6% of OCN’s total outstanding shares as of the closing of the transaction. In addition to making customary representations, warranties and covenants, the purchasers have agreed to certain restrictions on the sale of the shares for a one-year period following the closing date. OCN is obligated to register the newly-issued shares and will apply to list such shares on the New York Stock Exchange within 270 days of the closing.
On April 3, 2009, OCN repurchased from William C. Erbey, its Chairman of the Board and Chief Executive Officer, one million shares of its common stock at a per-share price of $11.00. We used a portion of the proceeds received from the above-described private placement transaction to acquire the shares from Mr. Erbey. In addition to making customary representations and warranties, Mr. Erbey agreed to certain restrictions on the sale or transfer of the remainder of his shares for a one-year period following the closing date.
On April 30, 2009, we renewed through June 2010 our Investment Line term note used to finance auction rate securities. This agreement was renewed early under terms substantially similar to the previous agreement. Amortization payments will now be $3,000 per month in place of the previous quarterly reductions in the advance rate.
On May 5, 2009, we negotiated an increase in a $300,000 advance facility to $500,000 and extended the amortization date by one year to May 4, 2010. Under the terms of the new facility, we pay interest on drawn balances at 1-Month LIBOR plus 275 basis points.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
| (Dollars in thousands, except share data) |
INTRODUCTION
Ocwen is among the leaders in our industry in realizing loan values for investors and in keeping Americans in their homes, as evidenced by our high cure rate. Our primary goal is to make our clients’ loans worth more by leveraging our superior processes and innovative technology. In a recent comparison of servicer performance in servicing non-performing residential loans, Moody’s reported that we had a “cure and cash flowing rate” that exceeded the average rate for Moody’s highest-rated servicers as a group.
Our current business segments, aligned within our two lines of business, are as follows:
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Ocwen Asset Management | | Ocwen Solutions |
| | | |
| | |
Servicing | | Mortgage Services |
Loans and Residuals | | Financial Services |
Asset Management Vehicles (AMV) | | Technology Products |
In addition to our core residential servicing business, Ocwen Asset Management (OAM) includes our equity investments in asset management vehicles and our remaining investments in subprime loans and residual securities.
In addition to our unsecured collections business, Ocwen Solutions (OS) includes our residential fee-based loan processing businesses, all of our technology platforms and our equity interest in BMS Holdings, Inc. (BMS Holdings).
Our plans are to continue to sell our non-core assets, including BOK, or to finance them. In November 2008, our Board of Directors authorized management to investigate the possible sale of our remaining Global Servicing Solutions, LLC (GSS) partnerships.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Interim Consolidated Financial Statements and the related notes, included in Item 1 in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2008.
Unless specifically stated otherwise, all references to March 2009, December 2008 and March 2008 refer to our fiscal periods ended, or the dates, as the context requires, March 31, 2009, December 31, 2008 and March 31, 2008, respectively.
When we use the terms “Ocwen”, “we,” “us” and “our,” we refer to Ocwen Financial Corporation (Ocwen) and its consolidated subsidiaries.
EXECUTIVE SUMMARY
March 2009 versus March 2008.We generated net income of $15,109 or $0.24 per share in the first quarter of 2009 compared to $5,272 and $0.08 per share for the first quarter of 2008. Income from continuing operations before taxes was $23,264 for the first quarter of 2009 as compared to $8,417 for the first quarter of 2008.
Our results benefited from cost reduction efforts announced last quarter. This was evidenced by an 18% improvement in operating expenses in the first quarter of 2009 compared to the first quarter of 2008.
No significant non-cash unrealized fair value adjustments on trading securities were recorded in the first quarter of 2009. In comparison, net income in the first quarter of 2008 included approximately $5,068 in net unrealized losses comprised of a $12,023 mark-to-market loss on trading securities and $6,955 in unrealized earnings primarily related to derivative mark-to-market gains at an unconsolidated subsidiary.
While Servicing segment revenues continued to decline as a result of lower average unpaid principal balances (UPB), this was partially offset by higher process management revenues in the first quarter of 2009 as compared to the first quarter of 2008. Servicing benefited from lower interest expense in the first quarter of 2009 compared to 2008. Loans and Residuals were adversely impacted by lower interest income primarily due to reduced loan balances. Asset Management Vehicles reported a decrease in unrealized losses due to smaller declines in the estimated market value of loans, real estate and securities at unconsolidated subsidiaries.
Mortgage Services benefited from new lines of business and from higher order volumes in existing businesses. These increases were offset by revenue declines in Financial Services as lower collection rates, due to the current economic climate and consistent with the collections industry in general, adversely impacted results in the first quarter of 2009 compared to 2008. Technology Products’ income from continuing operations declined in the first quarter of 2009, as compared to 2008, because we did not recognize any earnings of BMS Holdings, an unconsolidated subsidiary, in the first quarter of 2009. We suspended the equity method of accounting for our investment in BMS Holdings in the second quarter of 2008 because of losses that reduced our investment to zero.
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Strategic Priorities
Ocwen is focused on a strategic plan centered on four essential initiatives:
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| 1. | Liquidity and balance sheet strength |
| 2. | Revenue opportunities |
| 3. | Quality and cost structure leadership |
| 4. | Separation of Ocwen Solutions |
We are aggressively pursuing each of these priorities as more fully discussed in the following sub-sections. We believe our efforts will significantly increase shareholder value by building on our core competitive strengths to capture existing economic opportunities.
Liquidity and Balance Sheet Strength.We believe maintaining liquidity and strengthening our balance sheet will provide us with greater flexibility to pursue attractive investment opportunities that we believe are on the horizon. We focused this quarter on adding borrowing capacity and term advance financing. We were successful on both fronts, as more fully described in the Executive Summary—Liquidity section below. We believe we will benefit from the inclusion of servicer advances in the Term Asset-Backed Securities Loan Facility program (TALF), which will lead to improved access to term financing for servicer advances.
Revenue Opportunities. We believe the current economic environment combined with government financial stability actions affords us a unique opportunity to capitalize upon our long track record of: (1) demonstrated expertise with servicing rights, legacy loans and assets; (2) exceptional loss mitigation capabilities; and (3) successfully providing business processes services to the mortgage industry. Our revenue growth efforts are focused on developing opportunities in each of our segments.
Opportunities for revenue growth in the Ocwen Asset Management line of business include:
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| · | Special Servicing Arrangements.We began to perform under a special servicing arrangement with Freddie Mac as part of a high risk loan pilot program announced in February 2009. We are in discussions with various counter parties on how we can assist them with their special servicing needs. |
| · | Loan Modifications.We expect to accelerate work with qualifying borrowers to modify loans consistent with the federal government’s Home Affordable Modification Program (HMP). |
| · | Acquisition of Servicing Rights.We are actively pursuing several initiatives to provide us with an increased supply of servicing. |
Our Ocwen Solutions line of business is focused on two primary opportunities to grow revenues:
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| · | Product Diversification.We continue our efforts to offer a balanced service across all aspects of the mortgage lifecycle. We believe our technological capabilities are a differentiating factor across our entire product platform. |
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| · | Geographic Expansion.We are expanding our product offering into new states. We expect to continue to build our national footprint for services as part of our strategy to diversify our revenue base. |
Quality and Cost Structure. According to a third-party industry study, our cost to service non-performing and performing residential loans are 60% and 21%, respectively, lower than the subprime industry. An industry trade association study shows that we are 28% less expensive than the nearest competitor in terms of servicing expense per loan. We believe that quality and cost are intrinsically related in that errors increase costs and destroy quality.
We have launched three specific initiatives which we believe are designed to not only maintain, but improve our profitability even with a declining portfolio of serviced loans. These three initiatives are: (1) consolidation and automation of manual processes; (2) improvement of process uniformity to eliminate variability; and (3) job function analyses to improve supervisory effectiveness. We are implementing our next generation of technology and processes to achieve this step function improvement in cost and quality. By eliminating variability in our processes, we can grow our industry leading programs that keep more people in their homes, generate greater cash flow for investors and reduce our costs.
Separation of Ocwen Solutions. On November 12, 2008, our Board of Directors authorized management to pursue a plan to separate, through a tax-free spin-off into a newly formed publicly-traded company, all of our business operations currently included within the OS business line except for BMS Holdings and GSS. We made our decision based upon a strategic analysis that concluded that the Separation would:
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| · | Allow each of Ocwen and Altisource to separately focus on their core business and be better able to respond to initiatives and market challenges; |
| · | Better position OS to pursue business opportunities with other servicers; |
| · | Provide OS the option of offering its stock as consideration to potential acquisition targets (subject to certain limitations); |
| · | Grant OS flexibility in creating its own capital structure which may include a subsequent raise of equity or debt; and |
| · | Allow potential investors to choose between the contrasting business models of knowledge processing or servicing, each of which may be valued differently by the equity markets. |
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The ownership interest in this new company will be distributed to OCN’s existing shareholders in the form of a pro rata stock distribution. Each OCN shareholder will receive one share of OS common stock for every three shares of OCN common stock held as of the close of business on the record date of the distribution. We continue to move ahead with our efforts to address the legal and regulatory requirements for the Separation with the goal of effecting the transaction in the third quarter of 2009. We believe this transaction does not require OTS approval. These efforts include filing a registration statement on Form 10 with the Securities and Exchange Commission (SEC) for the proposed transaction in the second quarter of 2009. A vote of OCN shareholders is not required in connection with the Separation.
In connection with the Separation, OAM expects to enter into contractual agreements at prevailing market rates with OS to both provide certain corporate services as well as receive commercial services.
Outlook
Ocwen Asset Management.We are aggressively pursuing special servicing opportunities that require little capital such as our pilot program with Freddie Mac. Advances declined significantly in the first quarter. We expect this trend to continue in 2009, although the rate of decline is likely to slow.
Under the HMP, we expect to generate revenues after qualifying loan modifications pass the 90-day trial period. Late fee revenues must be waived for loan modifications included in the HMP. Accordingly, second quarter revenues will likely not include HMP qualifying loan modifications.
With the inclusion of servicer advances in TALF, we may issue TALF notes to increase the amount and duration of advance financing. We will also continue to reduce non-core assets and deploy that cash in our core businesses.
Ocwen Solutions. The primary growth engine for Ocwen Solutions will be Mortgage Services, which we are expanding by increasing the array and geographical range of the mortgage and default services that we provide to originators and servicers. These services include default processing, property inspection and preservation, homeowner outreach, real estate sales and title services.
We expect limited revenue growth but increased profitability in Financial Services in 2009. The difficult collection environment that all receivables management firms currently are facing stems from growing unemployment and consumers’ limited access to credit. These issues have lowered NCI’s collection rate, but NCI remains a top performer for its most important clients. NCI will continue to focus on reducing operating costs by improving processes and implementing its strategic initiatives which include: scoring, scripting and optimal debtor resolution. As NCI begins to experience positive results from these efforts, it will turn its attention toward revenue growth.
Liquidity
Cash totaled $158,855, or 7.8% of total assets at March 31, 2009. This compares to cash of $201,025, or 9% of total assets at December 31, 2008, and cash of $174,684, or 6.4% of total assets a year ago at March 31, 2008.
Servicer liabilities, which represent cash collected from borrowers but not yet remitted to securitization trusts, declined by $45,386 from December 31, 2008 to March 31, 2009. Servicer liabilities have a very short duration as funds collected must be remitted to the trust in accordance with the contractual obligation. The $148,937 decline in total advances in the first quarter of 2009 is attributable to the success of our efforts to stabilize the delinquency rate which has allowed advances to decline significantly faster than UPB.
Our borrowings as of March 31, 2009 include $186,568 borrowed under the Investment Line term note that is used to finance the investment grade auction rate securities which we are carrying at a fair value of $238,161. In the first quarter of 2009, we repaid $14,151 of Investment Line term note principal. This amount includes proceeds of $1,100 from the redemption of certain securities. On April 30, 2009, we renewed this term note through June 2010. This agreement was renewed early under terms substantially similar to the previous agreement, except amortization payments will now be $3,000 per month in place of the previous quarterly reductions in the advance rate.
Excluding the Investment Line, our borrowings have decreased by $168,968 since December 31, 2008. This decline reflects a reduction in borrowings by the Servicing segment, Loans and Residuals segment, Financial Services segment and Corporate Items and Other of $140,263, $3,058, $1,123 and $24,524, respectively. The decline in borrowings of the Servicing segment reflects a decline in advances. The decline in borrowings of the Loans and Residuals segment is primarily the result of a decline in the balance of the loans pledged as collateral. Corporate Items and Other borrowings declined as a result of the repurchase of 3.25% Convertible Notes with a face value of $25,910.
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Excluding the Investment Line, our total maximum borrowing capacity was $1,369,065 as of March 31, 2009, an increase of $28,318 as compared to December 31, 2008. This increase is primarily due to a $31,376 increase in borrowing capacity of the Servicing segment and a $3,058 decline in borrowing capacity of the Loans and Residuals segment. The increase in Servicing borrowing capacity is principally the result of entering into two new facilities in March 2009. One facility represented an advance in the form of zero-coupon bonds that we recorded at $45,373, net of a discount of $14,627. The other is a $7,000 term note. Both facilities are secured by the pledge of advances.
At March 31, 2009, excluding the Investment Line, $438,690 of our total maximum borrowing capacity remained unused, including $428,690 attributed to the Servicing business. Of the unused borrowing capacity of the Servicing business, none was readily available because we had no additional assets pledged as collateral but not drawn under our facilities.
In January 2009, we negotiated an early renewal of a $200,000 facility. The start of the amortization period for this note is now January 2010. With the continuing decline of our advance balances and the success of our other liquidity initiatives, we believe that we will have sufficient borrowing capacity to finance advances on our current servicing portfolio through the remainder of 2009 even if we are unable to negotiate any new facilities or any renewals or increases of existing facilities. We will endeavor to retain sufficient cash to repay any advances in excess of our borrowing capacity if such borrowing capacity declines under this worst-case scenario for financing. Another reason that we will retain cash is to cover possible additional principal repayments on our MSR term note in the event that the collateral value determined by a third party appraiser declines faster than the scheduled amortization of this note.
During these challenging times in the financial markets, we have given careful consideration to counterparty risk. Our advance facilities revolve, and in a typical monthly cycle, we repay up to one-third of the borrowings from collections. During the remittance cycle, which starts in the middle of each month, we must depend on our lenders to provide us with the cash that is required to make remittances to the Servicing investors. However, this is possible only when new advances represent eligible collateral under our advance facilities, and we can borrow additional funds against this collateral. Some of the financial institutions lending to us have experienced significant financial losses and have been the subject of investor concern. Several of these lenders are undergoing restructuring activities, including merging with stronger institutions or raising additional capital, either as part of or outside of the various government rescue plans that have been announced. These actions appear to have succeeded in stabilizing our largest lenders and thereby reducing our counterparty risk, but we continue to monitor closely the financial condition of our lenders.
In the first quarter of 2009, financing costs came down from the level in the first quarter of 2008 due to lower advance balances and a reduction in interest rates. The one-month LIBOR, which is the reference rate for most of our borrowings declined significantly in the first quarter of 2009, and this decrease was partly offset by higher average spreads over LIBOR. The rate paid on the average balance of our debt outstanding under our match funded facilities and our lines of credit and other secured borrowings was 6.01% and 6.87% in the first quarter of 2009 and 2008, respectively.
CRITICAL ACCOUNTING POLICIES
Our ability to measure and report our operating results and financial position is heavily influenced by the need to estimate the impact or outcome of risks in the marketplace or other future events. Our critical accounting policies are those that relate to the estimation and measurement of these risks. Because they inherently involve significant judgments and uncertainties, an understanding of these policies is fundamental to understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. Our significant accounting policies are discussed in detail on pages 24 through 27 of Management’s Discussion and Analysis of Results of Operations and Financial Condition and in Note 1 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.
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RESULTS OF OPERATIONS AND CHANGES IN FINANCIAL CONDITION
Operations Summary
The following table summarizes our consolidated operating results for the three months ended March 31, 2009 and 2008. We have provided a more complete discussion of operating results by line of business in the Segments section.
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| | 2009 | | 2008 | | % Change | |
| | | | | | | |
Consolidated: | | | | | | | | | | |
Revenue | | $ | 114,590 | | $ | 128,251 | | (11 | ) | |
Operating expenses | | | 72,266 | | | 88,075 | | (18 | ) | |
| | | | | | | | | | |
Income from operations | | | 42,324 | | | 40,176 | | 5 | | |
Other income (expense), net | | | (19,060 | ) | | (31,759 | ) | (40 | ) | |
| | | | | | | | | | |
Income from continuing operations before taxes | | | 23,264 | | | 8,417 | | 176 | | |
Income tax expense | | | 8,037 | | | 2,939 | | 173 | | |
| | | | | | | | | | |
Income from continuing operations | | | 15,227 | | | 5,478 | | 178 | | |
Loss from discontinued operations, net of taxes | | | (188 | ) | | (204 | ) | (8 | ) | |
| | | | | | | | | | |
Net income | | | 15,039 | | | 5,274 | | 185 | | |
Net loss (income) attributable to minority interest in subsidiaries | | | 70 | | | (2 | ) | 3,600 | | |
| | | | | | | | | | |
Net income attributable to Ocwen Financial Corp | | $ | 15,109 | | $ | 5,272 | | 187 | | |
| | | | | | | | | | |
| | | | | | | | | | |
Segment income (loss) from continuing operations before taxes: | | | | | | | | | | |
Servicing | | $ | 25,196 | | $ | 21,429 | | 18 | | |
Loans and Residuals | | | (4,138 | ) | | (3,658 | ) | 13 | | |
Asset Management Vehicles | | | (527 | ) | | (1,446 | ) | (64 | ) | |
Mortgage Services | | | 5,148 | | | 3,153 | | 63 | | |
Financial Services | | | (1,301 | ) | | 23 | | (5,757 | ) | |
Technology Products | | | 2,324 | | | 9,611 | | (76 | ) | |
Corporate Items and Other | | | (3,438 | ) | | (20,695 | ) | (83 | ) | |
| | | | | | | | | | |
| | $ | 23,264 | | $ | 8,417 | | 176 | | |
| | | | | | | | | | |
Income from operations improved by 5% in the first quarter of 2009 as compared to 2008, reflecting a significant reduction in operating expenses that was partially offset by a decline in revenues. Lower interest expense and lower fair value adjustments on securities and loans resulted in a 176% increase in income from continuing operations.
Total revenues declined by $13,661, or 11%, in the first quarter of 2009 as compared to 2008 principally because of a decrease in Servicing revenue due to a smaller servicing portfolio. Revenue of the Financial Services segment also declined in the first quarter of 2009 largely due to lower liquidation rates in contingency collections. Mortgage Services revenue increased over the first quarter of 2008 primarily as a result of a broader array of product offerings across the mortgage life cycle (i.e. default products) and selectively expanding in new states considering the market opportunities in each.
Total operating expenses were $15,809, or 18%, lower in the first quarter of 2009 as compared to 2008. This is primarily due to declines in operating expenses of the Servicing segment and Corporate Items and Other. Operating expenses of the Servicing segment declined primarily due to lower amortization on a smaller servicing portfolio, lower servicing and origination expense as a result of a reduction in loan payoffs and reduced staffing levels. In Corporate Items and Other, operating expenses declined largely because the first quarter of 2008 included $9,532 of due diligence and other costs related to the “going private” transaction which was initiated in January 2008 and which the parties mutually terminated in March 2008.
Other expense, net, for the first quarter of 2009 was $19,060 as compared to $31,759 for the first quarter of 2008, a favorable variance of $12,699. This variance is the result of several factors:
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| · | In the Servicing segment, interest expense on match funded liabilities and lines of credit was $7,744 lower in the first quarter of 2009 because of a decline in the average balance of advances and a decline in interest rates. | |
| | | |
| · | In the Loans and Residuals segment, interest income on loans and residual securities declined by $1,773 in the first quarter of 2009 because of declines in assets. | |
| | | |
| · | In the AMV segment, our consolidated share of the earnings of OSI and ONL and affiliates for the first quarter of 2009 was $27. This compares to losses of $931 for the first quarter of 2008. The losses in 2008 reflect higher charges to reduce residual securities, loans and real estate to fair value. | |
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| | | |
| · | In the Technology Products segment, our share of the earnings of BMS Holdings was $7,886 for the first quarter of 2008 as compared to zero for the first quarter of 2009. Unrealized gains on derivatives in the first quarter of 2008 were largely reversed in the second quarter of 2008 as a result of volatility in LIBOR during those periods. During the second quarter of 2008, our share of the losses of BMS Holdings reduced our investment to zero and we suspended the application of the equity method of accounting for our investment. | |
| | | |
| · | In Corporate Items and Other, we recorded an unrealized loss of $40 on our investment grade auction rate securities in the first quarter of 2009. This compares to an unrealized loss of $8,939 in the first quarter of 2008. In addition, the first quarter of 2008 included $1,813 of unrealized losses on CMOs which were sold in the second quarter of 2008. | |
Financial Condition Summary
Total assets declined by $207,584, or 9%, in the first three months of 2009. This decrease was due to declines in all asset categories other than receivables and MSRs:
| | |
| · | Cash declined by $42,170 to a balance of $158,855 at March 31, 2009. |
| | |
| · | Loans held for resale declined by $5,248 due to foreclosures, charge-offs, payoffs and declines in estimated values. |
| | |
| · | Total advances declined by $148,937 primarily because of declines in UPB serviced and because we were able to stabilize the rate of loan delinquencies and reduce average delinquencies per loan. This decline is the net result of a $219,311 decline in match funded advances and a $70,374 increase in advances as a result of moving collateral from match funded advance facilities to a non-match funded facility. |
| | |
| · | MSRs increased by $1,103 as acquisitions of $10,241 exceeded amortization of $9,126 for the first quarter of 2009. |
| | |
| · | Investment in unconsolidated entities declined by $3,548 primarily due to $3,246 of distributions received from our asset management entities. |
Total liabilities declined by $224,621, or 14%, in the first three months of 2009. This decrease was the result of declines in all liability categories other than lines of credit and other secured borrowings:
| | |
| · | Match funded liabilities declined by $171,639 as a result of the decline in match funded advances. |
| | |
| · | Lines of credit and other secured borrowings increased by $27,195 principally because of $52,373 of borrowings, net of discount, under two new facilities offset in part by $20,997 of repayments of borrowings under the senior secured credit agreement term note that is used to finance MSRs. |
| | |
| · | The Investment Line declined by $14,151 due to repayments. |
| | |
| · | Servicer liabilities declined by $45,386 largely because of a decrease in the amount of borrower payments that have not yet been remitted to custodial accounts. The decline in borrower payments is the result of slower repayments and a decline in UPB serviced. |
| | |
| · | Debt securities declined by $24,524. During February 2009, we repurchased $25,910 of our 3.25% Convertible Notes in the open market at a price equal to 95% of the principal amount. We recognized total gains of $534 on these repurchases, net of the write-off of discount and unamortized issuance costs. |
At March 31, 2009, total equity was $626,678, an increase of $17,037 over December 31, 2008 that was primarily due to net income of $15,109 for the first quarter of 2009, the exercise of stock options and compensation related to employee share-based awards.
33
SEGMENTS
The following section provides a discussion of changes in the financial condition of our business segments during the three months ended March 31, 2009 and a discussion of the results of continuing operations of our business segments for the three months ended March 31, 2009 and 2008.
The following table presents assets and liabilities of each of our business segments at March 31, 2009:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Ocwen Asset Management | | Ocwen Solutions | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | Servicing | | Loans and Residuals | | Asset Management Vehicles | | Mortgage Services | | Financial Services | | Technology Products | | Corporate Items and Other | | Corporate Eliminations | | Business Segments Consolidated | |
| | | | | | | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash | | $ | 8 | | $ | 141 | | $ | — | | $ | 264 | | $ | 5,189 | | $ | — | | $ | 153,253 | | $ | — | | $ | 158,855 | |
Cash held for clients | | | — | | | — | | | — | | | — | | | 414 | | | — | | | — | | | (414 | ) | | — | |
Trading securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Investment grade auction rate | | | — | | | — | | | — | | | — | | | — | | | — | | | 238,161 | | | — | | | 238,161 | |
Subordinates and residuals | | | — | | | 3,921 | | | — | | | — | | | — | | | — | | | 107 | | | — | | | 4,028 | |
Loans held for resale | | | — | | | 44,670 | | | — | | | — | | | — | | | — | | | — | | | — | | | 44,670 | |
Advances | | | 167,644 | | | 4,689 | | | — | | | — | | | — | | | — | | | 126 | | | — | | | 172,459 | |
Match funded advances | | | 881,244 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 881,244 | |
Mortgage servicing rights | | | 140,603 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 140,603 | |
Receivables | | | 15,343 | | | 1,369 | | | 854 | | | 3,702 | | | 5,703 | | | 776 | | | 21,686 | | | — | | | 49,433 | |
Deferred tax asset, net | | | — | | | — | | | — | | | — | | | — | | | — | | | 167,913 | | | — | | | 167,913 | |
Goodwill and intangibles | | | — | | | — | | | — | | | — | | | 43,971 | | | 1,618 | | | — | | | — | | | 45,589 | |
Premises and equipment | | | 55 | | | — | | | — | | | 12 | | | 3,802 | | | 4,950 | | | 2,980 | | | — | | | 11,799 | |
Investment in unconsolidated entities | | | — | | | — | | | 22,036 | | | — | | | — | | | — | | | 79 | | | — | | | 22,115 | |
Other assets | | | 74,237 | | | 5,235 | | | (100 | ) | | 24 | | | 807 | | | 1,145 | | | 11,130 | | | 169 | | | 92,647 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,279,134 | | $ | 60,025 | | $ | 22,790 | | $ | 4,002 | | $ | 59,886 | | $ | 8,489 | | $ | 595,435 | | $ | (245 | ) | $ | 2,029,516 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Match funded liabilities | | $ | 790,300 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 790,300 | |
Lines of credit and other secured borrowings | | | 129,363 | | | 14,702 | | | — | | | — | | | — | | | — | | | — | | | — | | | 144,065 | |
Investment line | | | — | | | — | | | — | | | — | | | — | | | — | | | 186,568 | | | — | | | 186,568 | |
Servicer liabilities | | | 90,262 | | | — | | | — | | | — | | | — | | | — | | | 103 | | | — | | | 90,365 | |
Cash due to clients | | | — | | | — | | | — | | | — | | | 414 | | | — | | | — | | | (414 | ) | | — | |
Debt securities | | | — | | | — | | | — | | | — | | | — | | | — | | | 108,843 | | | — | | | 108,843 | |
Other liabilities | | | 37,536 | | | 1,322 | | | — | | | 1,898 | | | 6,972 | | | 2,500 | | | 32,188 | | | 281 | | | 82,697 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | $ | 1,047,461 | | $ | 16,024 | | $ | — | | $ | 1,898 | | $ | 7,386 | | $ | 2,500 | | $ | 327,702 | | $ | (133 | ) | $ | 1,402,838 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
34
The following table presents the statements of continuing operations before income taxes for each of our business segments for the three months ended March 31, 2009:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Ocwen Asset Management | | Ocwen Solutions | | | | | | | | | | |
| | | | | | | | | | | | | | |
| | Servicing | | Loans and Residuals | | Asset Management Vehicles | | Mortgage Services | | Financial Services | | Technology Products | | Corporate Items and Other | | Corporate Eliminations | | Business Segments Consolidated | |
| | | | | | | | | | | | | | | | | | | |
Revenue | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Servicing and subservicing fees | | $ | 64,979 | | $ | — | | $ | — | | $ | 321 | | $ | 13,831 | | $ | — | | $ | 3 | | $ | (324 | ) | $ | 78,810 | |
Process management fees | | | 9,715 | | | — | | | — | | | 17,654 | | | 3,487 | | | 806 | | | — | | | 2,030 | | | 33,692 | |
Other revenues | | | — | | | — | | | 537 | | | 42 | | | — | | | 9,767 | | | 250 | | | (8,508 | ) | | 2,088 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | | 74,694 | | | — | | | 537 | | | 18,017 | | | 17,318 | | | 10,573 | | | 253 | | | (6,802 | ) | | 114,590 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Compensation and benefits | | | 8,613 | | | 6 | | | 988 | | | 2,799 | | | 8,555 | | | 2,236 | | | 5,348 | | | — | | | 28,545 | |
Amortization of servicing rights | | | 10,041 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 10,041 | |
Servicing and origination | | | 2,032 | | | — | | | — | | | 7,252 | | | 3,354 | | | — | | | — | | | — | | | 12,638 | |
Technology and communications | | | 2,819 | | | 8 | | | 103 | | | 914 | | | 2,160 | | | 4,259 | | | 882 | | | (6,337 | ) | | 4,808 | |
Professional services | | | 1,914 | | | (100 | ) | | — | | | 208 | | | 718 | | | 3 | | | 4,443 | | | — | | | 7,186 | |
Occupancy and equipment | | | 2,862 | | | — | | | 36 | | | 291 | | | 1,239 | | | 635 | | | 983 | | | — | | | 6,046 | |
Other operating expenses | | | 5,937 | | | 647 | | | (365 | ) | | 1,428 | | | 2,125 | | | 1,040 | | | (7,674 | ) | | (136 | ) | | 3,002 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses | | | 34,218 | | | 561 | | | 762 | | | 12,892 | | | 18,151 | | | 8,173 | | | 3,982 | | | (6,473 | ) | | 72,266 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Income (loss) from operations | | | 40,476 | | | (561 | ) | | (225 | ) | | 5,125 | | | (833 | ) | | 2,400 | | | (3,729 | ) | | (329 | ) | | 42,324 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest income | | | 59 | | | 1,883 | | | — | | | 2 | | | — | | | — | | | 221 | | | — | | | 2,165 | |
Interest expense | | | (15,503 | ) | | (629 | ) | | — | | | (12 | ) | | (470 | ) | | (132 | ) | | 83 | | | — | | | (16,663 | ) |
Loss on trading securities | | | — | | | (282 | ) | | — | | | — | | | — | | | — | | | (98 | ) | | — | | | (380 | ) |
Gain on debt repurchases | | | — | | | — | | | — | | | — | | | — | | | — | | | 534 | | | — | | | 534 | |
Loss on loans held for resale, net | | | — | | | (4,554 | ) | | — | | | — | | | — | | | — | | | — | | | | | | (4,554 | ) |
Equity in earnings of unconsolidated entities | | | — | | | — | | | (302 | ) | | — | | | — | | | — | | | — | | | 329 | | | 27 | |
Other, net | | | 164 | | | 5 | | | — | | | 33 | | | 2 | | | 56 | | | (449 | ) | | — | | | (189 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income (expense), net | | | (15,280 | ) | | (3,577 | ) | | (302 | ) | | 23 | | | (468 | ) | | (76 | ) | | 291 | | | 329 | | | (19,060 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Income (loss) from continuing operations before income taxes | | $ | 25,196 | | $ | (4,138 | ) | $ | (527 | ) | $ | 5,148 | | $ | (1,301 | ) | $ | 2,324 | | $ | (3,438 | ) | $ | — | | $ | 23,264 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
We report the operating results of BOK, which are included in Corporate Items and Other, as discontinued operations. See Note 4 to the Interim Consolidated Financial Statements for additional information.
Servicing
Servicing continues to be our most profitable segment despite a 14% decline in total revenue in the first quarter of 2009 as compared to 2008. Servicing fees have declined due to a decline in the average balance of loans serviced. The UPB of loans that we service for others increased in the first quarter of 2009 for the first time since 2007, as the UPB for newly acquired servicing agreements exceeded the reduction of our existing servicing portfolio. This increase did not result in an increase in revenue because the servicing acquisition occurred relatively late in the quarter. Lower float balances and lower interest rates have resulted in a decline in float earnings. The decline in revenue was somewhat offset by a 18% decline in operating expenses. Amortization of MSRs declined due to a decline in projected prepayment speeds. Servicing and origination expense declined as a result of a decline in voluntary loan payoffs, and compensation and benefits expense declined as a result of an 18% reduction in average staffing levels. As a result, income from operations declined by $4,084, or 9% in the first quarter of 2009 as compared to 2008. However, pre-tax income improved by $3,767, or 18%, in the first quarter of 2009 as total interest expense declined by $7,502.
The delinquency rate has remained relatively stable and total advances have continued to decline in 2009. In part, advances declined as a result of increased loan modifications and sales of foreclosed real estate. We expect delinquency rates to remain flat for the remainder of 2009 which will lead to further reductions in advances as our seasoned portfolio matures.
Excluding non-performing loans serviced for Freddie Mac but including the newly acquired servicing agreements, the number of non-performing loans serviced declined by 8,130 in the first quarter of 2009. While the number of non-performing loans declined, the UPB of non-performing loans as a percentage of the portfolio serviced increased during the first quarter of 2009 to 25.1% at March 31, 2009 from 24.3% at December 31, 2008, as the average size of delinquent loans increased. Servicing advances declined by 12% in the first quarter of 2009 as compared to an increase of 2% for the first quarter of 2008. Interest expense on borrowings of the Servicing segment was 37% lower for the first quarter of 2009, as compared to 2008, and declined by 14% as compared to the fourth quarter of 2008. Servicing and subservicing fees, excluding float earnings and ancillary income, declined by 17% in the first quarter of 2009 as compared to 2008 due to the decline in UPB serviced. Prepayment speed averaged 22% in the first quarter of 2009 as compared to 23% in the same period of 2008. Prepayment speed declined in the first quarter of 2009 primarily due to a decline in loan payoffs offset by an increase in real estate sales. Real estate sales and other involuntary liquidations accounted for approximately 85% of prepayments during the first quarter of 2009 as compared to approximately 58% for the first quarter of 2008. We expect prepayment speed to decline somewhat in the future as the number of loans in foreclosure and properties awaiting liquidation decrease. Another factor contributing to the decline in prepayment speed is an increase in the fixed rate portion of our loan portfolio as ARM loans continue to prepay at a faster rate and become a smaller portion of total loans.
35
During the first quarter of 2009, the President and U.S. Department of the Treasury announced and issued guidelines for HMP. The HMP provides a financial incentive for us to modify qualifying loans in accordance with the plan’s guidelines and requirements. On April 13, 2009, we announced our active participation in this plan and expect it to impact our revenue and profits for the full year 2009. However, we expect an adverse impact in the second quarter of 2009 as the program ramps up and modifications that ordinarily would have completed in this quarter are delayed. In order to qualify for the initial and subsequent financial incentives, each loan modification must meet specific guidelines and criteria. A significant part of the process is a trial modification period which must last for 90 days in order to qualify for the initial base incentive fee of $1,000 (actual dollars) or $1,500 (actual dollars) per loan. The higher initial payment is earned on loans that are still performing when modified but where default is likely. The subsequent annual success incentive fee of up to $1,000 (actual dollars) per loan is earned annually, provided the borrower continues to perform under the modification in accordance with program guidelines. We expect to recognize revenue only after all conditions are met, including the fulfillment of the 90 day trial period. In addition, for loans modified under the HMP, we will be required to forego accrued late fees incurred in the year of the modification. Of the 20,651 loans modified in the first quarter of 2009, we believe 12,741 would have qualified under the HMP.
The following table provides key business drivers and other selected revenue and expense items of our residential servicing business at or for the three months ended March 31:
| | | | | | | | | | |
| | 2009 | | 2008 | | % Change | |
| | | | | | | |
Average UPB of loans and real estate serviced | | $ | 40,116,314 | | $ | 51,754,789 | | (22 | )% | |
Prepayment speed (average CPR) | | | 22 | % | | 23 | % | (4 | ) | |
UPB of non-performing loans and real estate serviced as a % of total at March 31 (1)(2) | | | 25.1 | % | | 21.8 | % | 15 | | |
Average number of loans and real estate serviced | | | 313,093 | | | 401,623 | | (22 | ) | |
Number of non-performing loans and real estate serviced as a % of total at March 31 (1)(2) | | | 17.2 | % | | 16.8 | % | 2 | | |
Average float balances | | $ | 361,300 | | $ | 408,800 | | (12 | ) | |
Average balance of advances and match funded advances (3) | | $ | 1,123,776 | | $ | 1,350,706 | | (17 | ) | |
Average balance of MSRs | | $ | 134,348 | | $ | 188,831 | | (29 | ) | |
Collections on loans serviced for others | | $ | 1,843,200 | | $ | 3,072,811 | | (40 | ) | |
Servicing and subservicing fees (excluding float and ancillary income) | | $ | 45,878 | | $ | 55,187 | | (17 | ) | |
Float earnings | | $ | 1,850 | | $ | 4,433 | | (58 | ) | |
Amortization of servicing rights (4) | | $ | 9,126 | | $ | 13,804 | | (34 | ) | |
Interest expense on match funded liabilities and lines of credit | | $ | 13,045 | | $ | 20,789 | | (37 | ) | |
Compensating interest expense | | $ | 275 | | $ | 1,110 | | (75 | ) | |
Operating expenses directly related to loss mitigation activities | | $ | 7,193 | | $ | 6,778 | | 6 | | |
| |
(1) | Excluding non-performing loans serviced for Freddie Mac. Also excludes real estate serviced pursuant to our contract with the VA which expired on July 24, 2008. |
(2) | At December 31, 2008, the UPB of non-performing assets comprised 24.3% of the total and the number of non-performing assets serviced comprised 19% of the total. |
(3) | The combined average balance of advances and match funded advances was $1,146,613 for the fourth quarter of 2008. |
(4) | During the three months ended March 31, 2009, the amount of charges we recognized to increase our servicing liability obligations exceeded amortization by $915, and we reported this net expense as amortization of servicing rights. The total amount of amortization of servicing rights reported by the servicing segment for the first quarter of 2009 is $10,041. |
36
The following table sets forth information regarding residential loans and real estate serviced for others:
| | | | | | | | | | | | | | | | | | | |
| | Loans (1) | | Real Estate (2) | | Total (4)(5) | |
| | | | | | | |
| | Amount | | Count | | Amount | | Count | | Amount | | Count | |
| | | | | | | | | | | | | |
March 31, 2009: | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 29,880,797 | | | 248,215 | | $ | — | | | — | | $ | 29,880,797 | | | 248,215 | |
Non-performing (3) | | | 8,118,175 | | | 43,657 | | | 2,790,163 | | | 12,228 | | | 10,908,338 | | | 55,885 | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 37,998,972 | | | 291,872 | | $ | 2,790,163 | | | 12,228 | | $ | 40,789,135 | | | 304,100 | |
| | | | | | | | | | | | | | | | | | | |
December 31, 2008: | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 30,416,049 | | | 261,387 | | $ | — | | | — | | $ | 30,416,049 | | | 261,387 | |
Non-performing | | | 6,937,002 | | | 47,611 | | | 2,818,481 | | | 13,517 | | | 9,755,483 | | | 61,128 | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 37,353,051 | | | 308,998 | | $ | 2,818,481 | | | 13,517 | | $ | 40,171,532 | | | 322,515 | |
| | | | | | | | | | | | | | | | | | | |
March 31, 2008: | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 38,573,686 | | | 328,783 | | $ | — | | | — | | $ | 38,573,686 | | | 328,783 | |
Non-performing | | | 7,294,604 | | | 48,623 | | | 4,256,286 | | | 26,298 | | | 11,550,890 | | | 74,921 | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 45,868,290 | | | 377,406 | | $ | 4,256,286 | | | 26,298 | | $ | 50,124,576 | | | 403,704 | |
| | | | | | | | | | | | | | | | | | | |
| |
(1) | Performing loans include those loans that are current or have been delinquent for less than 90 days in accordance with their original terms and those loans for which borrowers are making scheduled payments under modification, forbearance or bankruptcy plans. We consider all other loans to be non-performing. |
(2) | Real estate includes $804,814 of foreclosed residential properties serviced for the VA at March 31, 2008. We elected not to renew our contract with VA in July 2008. |
(3) | Non-performing loans at March 31, 2009 include loans serviced for Freddie Mac. |
(4) | At March 31, 2009, we serviced 213,802 subprime loans and real estate with a UPB of $30,951,647 as compared to 227,929 with a UPB of $32,776,696 at December 31, 2008. At March 31, 2008, we serviced 277,660 subprime loans and real estate with a UPB of $40,161,725. |
(5) | We serviced under subservicing contracts 87,256 residential loans with a UPB of $10,428,990 as of March 31, 2009. This compares to 108,545 residential loans with a UPB of $10,340,878 as of December 31, 2008 and 121,725 residential loans and real estate with a UPB of $11,967,956 at March 31, 2008. |
| |
| The following table sets forth information regarding the changes in our portfolio of residential assets serviced for others: |
| | | | | | | |
| | Amount | | Count | |
| | | | | |
Servicing portfolio at December 31, 2007 | | $ | 53,545,985 | | | 435,616 | |
Additions | | | 518,439 | | | 4,483 | |
Runoff | | | (3,939,848 | ) | | (36,395 | ) |
| | | | | | | |
Servicing portfolio at March 31, 2008 | | | 50,124,576 | | | 403,704 | |
Additions | | | 255,912 | | | 2,421 | |
Runoff | | | (4,712,421 | ) | | (37,347 | ) |
| | | | | | | |
Servicing portfolio at June 30, 2008 | | | 45,668,067 | | | 368,778 | |
Additions | | | 146,000 | | | 1,075 | |
Runoff | | | (3,365,036 | ) | | (27,366 | ) |
| | | | | | | |
Servicing portfolio at September 30, 2008 | | | 42,449,031 | | | 342,487 | |
Additions | | | 677,000 | | | 1,790 | |
Runoff | | | (2,954,499 | ) | | (21,762 | ) |
| | | | | | | |
Servicing portfolio at December 31, 2008 | | | 40,171,532 | | | 322,515 | |
Additions | | | 3,626,000 | | | 11,036 | |
Runoff | | | (3,008,397 | ) | | (29,451 | ) |
| | | | | | | |
Servicing portfolio at March 31, 2009 | | $ | 40,789,135 | | | 304,100 | |
| | | | | | | |
Additions primarily represent servicing purchased from the owners of the mortgages and servicing obtained by entering into subservicing agreements with other entities that own the MSRs. MSR runoff primarily results from principal repayments on loans and sales of real estate. The market for the acquisition of servicing rights to newly originated subprime mortgage loans slowed significantly in the latter part of 2007. Since then, servicing transactions have consisted mostly of trades of seasoned portfolios. Because of the turmoil in the credit markets, we have been cautious in our acquisition of MSRs, and we did not make any significant additions to our residential servicing portfolio during 2008. In the longer term, our continued growth and success in the Servicing business is in part dependent on our ability to acquire MSRs at an appropriate price. As a result, we will continue to selectively pursue opportunities for additional servicing and subservicing business. We are optimistic about our prospects for maintaining our scale and growing the Servicing business over time based on our expected ability to act on opportunities we see in the market.
37
In addition to acting as servicer and subservicer, we have entered into backup servicing agreements with two large financial institutions. As backup servicer, we have agreed to accept the servicing responsibilities on up to $40,000,000 of mortgage loans in the event that the primary servicer is terminated. As back up servicer, we are entitled to all servicing compensation to which the terminated servicer would have been entitled. We are not required to fund the delinquency or servicer advance obligations or the compensating interest obligations on the loans that we accept. As of March 31, 2009, we were not servicing any loans under these agreements.
Comparative selected balance sheet data is as follows:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Advances | | $ | 167,644 | | $ | 97,098 | |
Match funded advances | | | 881,244 | | | 1,100,555 | |
Mortgage servicing rights (Residential) | | | 140,603 | | | 139,500 | |
Receivables | | | 15,343 | | | 7,936 | |
Debt service accounts | | | 58,440 | | | 58,468 | |
Other | | | 15,860 | | | 13,058 | |
| | | | | | | |
Total assets | | $ | 1,279,134 | | $ | 1,416,615 | |
| | | | | | | |
| | | | | | | |
Match funded liabilities | | $ | 790,300 | | $ | 961,939 | |
Lines of credit and other secured borrowings | | | 129,363 | | | 97,987 | |
Servicer liabilities | | | 90,262 | | | 135,649 | |
Other | | | 37,536 | | | 23,138 | |
| | | | | | | |
Total liabilities | | $ | 1,047,461 | | $ | 1,218,713 | |
| | | | | | | |
Advances and Match Funded Advances. When the borrower does not make a full principal and interest payment, we are required under most servicing agreements to advance funds to the investment trust. However, we are obligated to advance funds only to the extent that we believe that the advances are recoverable from loan proceeds. Most of our advances have the highest standing for reimbursement from payments, repayments and liquidation proceeds at the loan level. In addition, for any advances that are not covered by loan proceeds, the large majority of our pooling and servicing agreements provide for reimbursement at the pool level using collections on other loans. We are also required to pay property taxes and insurance premiums, to process foreclosures and to advance funds to maintain, repair and market real estate properties on behalf of investors, and these advances are accorded the same high priority for repayment as principal and interest advances. We generally recover our advances in full when foreclosed properties are sold, and this is also generally true when we modify a loan.
During the first three months of 2009, the combined balance of advances and match funded advances decreased by $148,765, or 12%, due to a 6% decline in the number of loans serviced and the relative stabilization of the rate of loan delinquencies. Within the combined balance of advances and match funded advances, advances increased due to the transfer of certain collateral from SPEs categorized as match funded to an SPE not categorized as match funded.
Match funded advances on loans serviced for others result from our transfers of residential loan servicing advances to SPEs in exchange for cash. We make these transfers under the terms of four advance facility agreements. We either retain control of the advances, or the advances are transferred to trusts that are not QSPEs. As a result, we include the SPEs in our Consolidated Financial Statements. The match funded advances are owned by the SPEs and are not available to satisfy general claims of our creditors. Conversely, the holders of the debt issued by the SPEs generally can look only to the assets of the issuer for satisfaction of the debt and have no recourse against OCN. However, OLS has guaranteed the payment of the obligations of the issuer under the match funded facility that we executed in April 2008. The maximum amount payable under the guarantee is limited to 10% of the notes outstanding at the end of the facility’s revolving period in April 2009.
Mortgage Servicing Rights. The unamortized balance of residential MSRs is primarily related to subprime residential loans. Residential MSRs increased by $1,103 during the first three months of 2009primarily due to acquisitions of $10,241 offset by amortization expense of $9,126.
Match Funded Liabilities. Match funded liabilities are obligations secured by the related match funded assets and are repaid through the cash proceeds arising from those assets. We account for and report match funded liabilities as secured borrowings with pledges of collateral. All of our match funded liabilities are secured by advances on loans serviced for others. The $171,639 decrease in match funded liabilities during the first three months of 2009 is primarily the result of the $219,311 reduction in the balance of match funded advances. At March 31, 2009, 90% of match funded advances were pledged to support borrowings as compared to 87% at December 31, 2008.
Unused borrowing capacity under our match funded facilities increased from $257,893 at December 31, 2008 to $428,690 at March 31, 2009. Our maximum borrowing capacity under our match funded facilities was $1,215,000 at March 31, 2009 and December 31, 2008.
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Lines of Credit and Other Secured Borrowings. In August 2008, we exercised the option contained in our senior secured credit agreement to issue an 18-month term note to finance MSRs. We transferred the advance collateral that had been pledged to the senior secured credit agreement to existing match funded facilities. The amount outstanding under the term note declined by $20,997 during the first three months of 2009. At both March 31, 2009 and December 31, 2008, the amount outstanding under the term note was equal to the maximum borrowing capacity. We entered into two new facilities in March 2009. We recognized a $60,000 zero-coupon bond with a five-year term at $45,373, net of a discount of $14,627. We also recognized a $7,000 term note maturing in five years with a stated interest rate of 1-Month LIBOR plus 350 basis points. Both notes are similar to the match funded advance facilities, and are secured by the pledge of advances.
Servicer Liabilities. Servicer liabilities represent amounts we have collected, primarily from residential borrowers whose loans we service, which we will deposit in custodial accounts, pay directly to an investment trust or refund to borrowers. We exclude custodial accounts from our balance sheet. Servicer liabilities declined by $45,387 during the first three months of 2009 largely due to a decline in the amount of borrower payments due to the custodial accounts. This decline reflects the impact of low collection volume primarily resulting from slower voluntary prepayments and a smaller servicing portfolio.
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | | 2009 | | | 2008 | |
| | | | | |
Revenue: | | | | | | | |
Servicing and subservicing fees | | $ | 64,979 | | $ | 80,337 | |
Process management fees | | | 9,715 | | | 6,175 | |
| | | | | | | |
Total revenue | | | 74,694 | | | 86,512 | |
| | | | | | | |
| | | | | | | |
Operating expenses: | | | | | | | |
Compensation and benefits | | | 8,613 | | | 10,187 | |
Amortization of servicing rights | | | 10,041 | | | 13,804 | |
Servicing and origination | | | 2,032 | | | 3,786 | |
Technology and communications | | | 2,819 | | | 2,219 | |
Professional services | | | 1,914 | | | 2,366 | |
Occupancy and equipment | | | 2,862 | | | 3,386 | |
Other | | | 5,937 | | | 6,204 | |
| | | | | | | |
Total operating expenses | | | 34,218 | | | 41,952 | |
| | | | | | | |
Income from operations | | | 40,476 | | | 44,560 | |
| | | | | | | |
Other income (expense): | | | | | | | |
Interest expense: | | | | | | | |
Match funded liabilities | | | (11,916 | ) | | (17,700 | ) |
Lines of credit and other secured borrowings | | | (1,129 | ) | | (3,089 | ) |
Other | | | (2,458 | ) | | (2,216 | ) |
| | | | | | | |
| | | (15,503 | ) | | (23,005 | ) |
Other | | | 223 | | | (126 | ) |
| | | | | | | |
Total other expense | | | (15,280 | ) | | (23,131 | ) |
| | | | | | | |
Income before income taxes | | $ | 25,196 | | $ | 21,429 | |
| | | | | | | |
Servicing and Subservicing Fees.The principal components of servicing and subservicing fees for the three months ended March 31 are:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Residential | | | | | | | |
Loan servicing and subservicing | | $ | 45,878 | | $ | 55,187 | |
Late charges | | | 10,698 | | | 10,711 | |
Custodial accounts (float earnings) | | | 1,850 | | | 4,433 | |
Loan collection fees | | | 2,065 | | | 2,918 | |
Other | | | 4,149 | | | 6,925 | |
| | | | | | | |
| | | 64,640 | | | 80,174 | |
Commercial (US) | | | 339 | | | 163 | |
| | | | | | | |
| | $ | 64,979 | | $ | 80,337 | |
| | | | | | | |
Residential loan servicing and subservicing fees for the three months ended March 31, 2009 declined by 17% as compared to the same period of 2008. This decline is primarily due to a 22% decline in the average balance of loans serviced, as the first quarter servicing rights acquisition occurred relatively late in the quarter. The average balance of loans serviced declined because of a decline in portfolio acquisitions in 2008. The UPB of servicing portfolio has declined from $50,124,576 at March 31, 2008 to $40,789,135 at March 31, 2009.
39
We collect servicing fees, generally expressed as a percent of the UPB from the borrowers’ payments and from reimbursements from the securitization trusts. We recognize servicing fees as revenue when earned which is generally upon collection of borrower payments. Delinquencies affect the timing of servicing fee revenue recognition but not the ultimate collection of the fees because servicing fees generally have a higher standing than advances which are satisfied before any interest or principal is paid by the securitization trust on the bonds. We estimate that during the first quarter of 2009 the balance of uncollected and unrecognized servicing fees related to delinquent borrower payments increased by $3,552 as compared to an increase of $3,701 during the first quarter of 2008. As of March 31, 2009, we estimate that the balance of uncollected delinquent servicing fees that we had not yet recognized as revenue was $53,652 compared to $50,101 at December 31, 2008.
The decline in float earnings in the first three months of 2009, as compared to the same period of 2008, reflects a decline in both the average custodial account balances and the yield. The decline in the average balance of these accounts is the result of a decline in the servicing portfolio and a reduction in collections related to loan payoffs. The annualized yield declined as short-term interest rates declined and banking fees increased for short-term interest-earning deposits. The underlying servicing agreements restrict the investment of float balances to certain types of instruments. We are responsible for any losses incurred on the investment of these funds.
Float earnings includes revenues generated from investments in permitted investments, as well as revenues from our investment in auction rate securities. Our investment in auction rate securities is funded by the Investment Line. The following table summarizes information regarding float earnings for the three months ended March 31:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Average custodial account balances | | $ | 361,300 | | $ | 408,800 | |
Float earnings (1) | | $ | 1,850 | | $ | 4,433 | |
Annualized yield | | | 2.05 | % | | 4.34 | % |
| |
(1) | For the first quarter of 2009 and 2008, float earnings included $1,831 and $4,310, respectively, of income from auction rate securities. |
Process Management Fees. Process management fees are primarily comprised of revenues associated with foreclosed residential real estate marketing activities. These revenues were $9,657 and $5,777 for the three months ended March 31, 2009 and 2008, respectively. The increase in the first quarter of 2009 was due to higher sales volume that is in part attributed to our efforts to more effectively market and price foreclosed residential real estate in the Servicing portfolio.
Compensation and Benefits Expense.The decrease in compensation expense and benefits in the first three months of 2009 as compared to the first three months of 2008 is due to an 18% decline in the average number of employees as management responded to a 22% decrease in average size of the residential servicing portfolio between periods. Average U.S. employment declined by 30% as compared to a 17% decline in India principally because of our decision in July 2008 not to renew our contract with the VA.
Amortization of Servicing Rights. Amortization expense declined by 27% in the first three months of 2009 as compared to 2008. This decline occurred because of a reduction in the rate of amortization and a decline in the acquisition of MSRs during 2008. We amortize mortgage servicing rights in proportion to and over the period of estimated net servicing income. Slower projected mortgage prepayment speeds have reduced the rate of amortization as we expect to earn the servicing income over a longer period of time. Average projected prepayment speeds used to compute amortization expense were 20% and 23% for the first quarter of 2009 and 2008, respectively. Average projected delinquency rates (past due 90 days or more) used to compute amortization expense were 23% and 24% for the first quarter of 2009 and 2008, respectively.
Servicing and Origination Expenses. Servicing and origination expense is comprised of compensating interest, satisfaction fees and other servicer expenses. Compensating interest on loan payoffs and satisfaction fees declined in the first three months of 2009 as compared to the same periods of 2008 primarily as a result of the decline in the servicing portfolio and a decline in voluntary loan prepayments.
Interest Expense.Total interest expense for the first three months of 2009 was lower than 2008 by $7,502, or 33%, primarily because of the decline in match funded advances coupled with declines in interest rates. The average combined balance of advances and match funded advances decreased by 17% during the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. Average borrowings of $904,952 were $328,502, or 27%, lower in the first quarter of 2009 than in 2008. The effective average rate on these borrowings of 5.77% was lower by 97 basis points, or 14%, in the first quarter of 2009 as compared to the first quarter of 2008. The majority of our credit facilities bear interest at rates that are adjusted regularly based on 1-Month LIBOR. During the first quarter of 2009, the average of 1-Month LIBOR was 0.46% as compared to 3.30% in the first quarter of 2008.
Average rates have not declined in proportion to the decline in LIBOR principally because of the higher spread over LIBOR charged on the new match funded facilities added in 2008 and because of higher facility fees charged by the lenders. Interest expense includes amortization of facility costs of $11,916 and $4,178 during the first quarter of 2009 and 2008, respectively. Amortization of facility costs in the first quarter of 2008 included the write-off of $2,000 of deferred costs related to a match funded facility that we decided not to expand or renew.
Loans and Residuals
The loss before income taxes for the first quarter of 2009 increased by $480 as compared to 2008 largely due to a decline in net interest income on subordinate and residual securities and loans held for resale offset in part by a decline in unrealized losses on subordinate and residual securities. The average balances of subordinate and residual securities and loans held for resale declined by 43% and 33%, respectively, in the first quarter of 2009 as compared to 2008. Losses on the valuation and resolution of loans held for resale continue to negatively impact operating results. Losses on loans held for resale, net, were $4,554 in the first quarter of 2009 as compared to $4,509 in 2008.
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Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Subordinate and residual trading securities | | $ | 3,921 | | $ | 4,204 | |
Loans held for resale | | | 44,670 | | | 49,918 | |
Advances on loans held for resale | | | 4,689 | | | 4,867 | |
Real estate | | | 3,662 | | | 4,682 | |
Other | | | 3,083 | | | 3,646 | |
| | | | | | | |
Total assets | | $ | 60,025 | | $ | 67,317 | |
| | | | | | | |
| | | | | | | |
Lines of credit and other secured borrowings | | | 14,702 | | | 17,760 | |
Other | | | 1,322 | | | 1,409 | |
| | | | | | | |
Total liabilities | | $ | 16,024 | | $ | 19,169 | |
| | | | | | | |
Subordinate and Residual Trading Securities. The $283 decrease in subordinate and residual securities during the first three months of 2009 was primarily due to a decline in fair value that reflects conditions in the subprime mortgage market. Net unrealized losses on subordinate and residual trading securities were $282 during the first three months of 2009.
As disclosed in Note 3 to the Interim Consolidated Financial Statements, our subordinate and residual securities are not actively traded, and therefore, market quotations are not available. We estimate fair value using an industry accepted discounted cash flow model that is calibrated for trading activity wherever possible. We estimate fair value based on the present value of expected future cash flows using our best estimate of key assumptions that market participants would use such as discount, delinquency and cumulative loss rates as well as prepayment speeds associated with the loans underlying mortgage backed securities. The estimated fair value of our residuals and subordinate trading securities is significantly influenced by the loss assumptions utilized in the discounted cash flow model. Our loss assumptions range between 14% and 28%.
Subordinate and residual securities do not have a contractual maturity but are paid down over time as cash distributions are received. The weighted average remaining life of these securities was 1.19 years at March 31, 2009.
Loans Held for Resale. Loans held for resale represent single-family residential loans originated or acquired that we do not intend to hold until maturity. The balances at March 31, 2009 and December 31, 2008 are net of fair value allowances of $18,166 and $17,491, respectively. Loans held for resale at March 31, 2009 and December 31, 2008 include non-performing loans with a carrying value of $18,505 and $19,193, respectively.
The $5,248 decline in carrying value during the first three months of 2009 is due to payoffs, foreclosures and charge-offs. There were no loan sales during the first three months of 2009. When we foreclose on the collateral, we transfer the loans to real estate upon receipt of title to the property, and market the property for sale.
Real Estate. Real estate is comprised of properties that we acquire by foreclosure on loans held for resale. These properties are held for sale and are net of fair value allowances of $3,574 and $4,748 at March 31, 2009 and December 31, 2008, respectively. During the first three months of 2009, transfers from loans held for resale were more than offset by sales of real estate.
Lines of Credit and Other Secured Borrowings. Through July 2008, borrowings under lines of credit and other secured borrowing consisted principally of amounts borrowed under repurchase agreements collateralized by loans held for resale. In August 2008, we used the proceeds from the sale of $23,200 of Class A-1 notes, net of a discount of $928, to repay the balance of repurchase agreements outstanding at the time. The $3,058 decline in borrowings during the first three months of 2009 results from borrower payments on the loans that serve as collateral for the notes. See Note 13 to our Interim Consolidated Financial Statements for additional information on the terms and balances of our lines of credit and other secured borrowings.
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Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue | | $ | — | | $ | — | |
Operating expenses | | | 561 | | | 917 | |
| | | | | | | |
Loss from operations | | | (561 | ) | | (917 | ) |
| | | | | | | |
Other income (expense): | | | | | | | |
Interest income: | | | | | | | |
Loans held for resale | | | 1,433 | | | 2,139 | |
Subordinate and residual trading securities | | | 450 | | | 1,517 | |
| | | | | | | |
| | | 1,883 | | | 3,656 | |
Interest expense | | | (629 | ) | | (856 | ) |
Unrealized losses on subordinate and residual trading securities | | | (282 | ) | | (1,032 | ) |
Loss on loans held for resale, net | | | (4,554 | ) | | (4,509 | ) |
Other, net | | | 5 | | | — | |
| | | | | | | |
Total other expense, net | | | (3,577 | ) | | (2,741 | ) |
| | | | | | | |
Loss before income taxes | | $ | (4,138 | ) | $ | (3,658 | ) |
| | | | | | | |
Interest Income.Interest income on subordinate and residual trading securities declined by $1,067 or 70% in the first quarter of 2009. Cash flows from the remaining subordinate and residual securities have declined in 2009 because of an increase in defaults and unrecoverable losses on the underlying mortgage loans.
Loss on Loans Held for Resale, Net. Loss on loans held for resale, net for the three months ended March 31 2009 and 2008 include combined valuation adjustments, charge-offs and losses on real estate owned of $4,554 and $4,629, respectively. Valuation losses represent charges that we recorded to reduce loans held for resale to their fair values which have declined due to the deteriorating conditions in the subprime mortgage market. In addition to these valuation adjustments, we have recorded charge-offs on resolved loans. The UPB of nonperforming loans as a percentage of total UPB has increased from 48% at December 31, 2008 to 52% at March 31, 2009.
Asset Management Vehicles
The losses before income taxes for the first quarter of 2009 and 2008 primarily reflect our share of the net losses incurred by OSI and by ONL and affiliates. These losses largely resulted from charges to reduce loans, real estate and residual securities to their fair values.
Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Investment in unconsolidated entities | | | | | | | |
OSI | | $ | 12,933 | | $ | 15,410 | |
ONL and affiliates | | | 9,103 | | | 10,174 | |
| | | | | | | |
| | | 22,036 | | | 25,584 | |
Other | | | 754 | | | 1,171 | |
| | | | | | | |
Total assets | | $ | 22,790 | | $ | 26,755 | |
| | | | | | | |
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue (management fees) | | $ | 537 | | $ | 1,051 | |
Operating expenses | | | 762 | | | 690 | |
| | | | | | | |
Income (loss) from operations | | | (225 | ) | | 361 | |
| | | | | | | |
Other income (expense): | | | | | | | |
Equity in earnings (losses) of unconsolidated entities | | | | | | | |
OSI | | | 273 | | | (636 | ) |
ONL and affiliates | | | (575 | ) | | (1,046 | ) |
| | | | | | | |
| | | (302 | ) | | (1,682 | ) |
Other, net | | | — | | | (125 | ) |
| | | | | | | |
Other expense, net | | | (302 | ) | | (1,807 | ) |
| | | | | | | |
Loss before income taxes | | $ | (527 | ) | $ | (1,446 | ) |
| | | | | | | |
42
Investment in Unconsolidated Entities. We account for our 25% interest in OSI and approximately 25% ownership interest in ONL and its affiliates using the equity method of accounting. During the first three months of 2009, we received distributions totaling $3,246. We did not make any investments in OSI during 2009, and our commitment to invest additional capital has expired. We did not make any investments in ONL and affiliates during the first quarter of 2009, but have a remaining commitment as of March 31, 2009 to invest up to an additional $33,902.
Equity in earnings of unconsolidated entities. The losses incurred by ONL and affiliates in the first quarter of 2009 are primarily the result of charges to reduce loans and real estate to fair value. The losses incurred by OSI and ONL in the first three months of 2008 primarily reflect unrealized losses on residual securities and the write-off of loan facility fees, offset in part by unrealized gains on OSI’s investment in derivative financial instruments. Reported losses include the approximately 25% share of loan servicing and management expenses that are charged to OSI and ONL by the Servicing segment and eliminated in consolidation. See Note 10 to the Interim Consolidated Financial Statements for additional details regarding our investment in these entities.
Mortgage Services
Income from operations improved by $1,889 or 58% in the first quarter of 2009 as compared to 2008. We have offset the effect of declining origination volumes by increasing the array and geographical range of the mortgage and default services that we provide to originators and servicers. These services include default processing, property inspection and preservation, homeowner outreach, real estate sales and title services. As a result of the growth in revenue from these services and because of our success in reducing operating expenses, income from operations as a percent of revenue improved from 19% in the first quarter of 2008 to 28% in 2009. In November 2008, our Board of Directors authorized management to investigate the possible sale of our remaining GSS partnerships that are included in this segment.
Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 264 | | $ | 749 | |
Receivables | | | 3,702 | | | 2,680 | |
Other | | | 36 | | | 129 | |
| | | | | | | |
Total assets | | $ | 4,002 | | $ | 3,558 | |
| | | | | | | |
| | | | | | | |
Total liabilities | | $ | 1,898 | | $ | 2,442 | |
| | | | | | | |
Receivables.Receivables increased by $1,022 largely due to revenue growth in our new business, some of which have longer payment cycles than our existing operations.
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue: | | | | | | | |
Servicing and subservicing fees | | $ | 321 | | $ | 1,473 | |
Process management fees | | | 17,654 | | | 15,151 | |
Other | | | 42 | | | 131 | |
| | | | | | | |
Total revenue | | | 18,017 | | | 16,755 | |
| | | | | | | |
Operating expenses: | | | | | | | |
Compensation and benefits | | | 2,799 | | | 2,972 | |
Amortization of servicing rights | | | — | | | 210 | |
Servicing and origination | | | 7,252 | | | 7,485 | |
Technology and communication | | | 914 | | | 914 | |
Other | | | 1,927 | | | 1,938 | |
| | | | | | | |
Total operating expenses | | | 12,892 | | | 13,519 | |
| | | | | | | |
Income from operations | | | 5,125 | | | 3,236 | |
Other income (expense), net | | | 23 | | | (83 | ) |
| | | | | | | |
Income before income taxes | | $ | 5,148 | | $ | 3,153 | |
| | | | | | | |
Servicing and Subservicing Fees.Our GSS offices in Germany and Canada earn fees by providing loan servicing to owners of commercial loans. The decline in fees earned in the first quarter of 2009 as compared to 2008 is principally the result of our sale of servicing rights owned by GSS Canada in the second quarter of 2008 and the runoff of the GSS Germany portfolio. At March 31, 2009, we serviced 323 international commercial loans and real estate assets totaling $1,139,095. This compares to 356 assets totaling $1,250,997 serviced at December 31, 2008. The decline in assets serviced in the first quarter of 2009 is the result of the runoff of the GSS Germany portfolio.
43
Process Management Fees. The principal components of process management fees for the three months ended March 31, relate to our fee-based loan processing services as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Residential property valuation | | $ | 7,345 | | $ | 8,321 | |
Title services | | | 4,376 | | | 3,999 | |
Outsourcing services | | | 3,065 | | | 2,831 | |
Property inspection and preservation services | | | 1,941 | | | — | |
Other mortgage and default services | | | 927 | | | — | |
| | | | | | | |
| | $ | 17,654 | | $ | 15,151 | |
| | | | | | | |
Servicing and Origination Expenses. Servicing and origination expenses for the three months ended March 31 consist primarily of costs incurred in connection with providing fee-based loan processing services as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Residential property valuation | | $ | 3,295 | | $ | 5,063 | |
Title services | | | 2,131 | | | 2,414 | |
Property inspection and preservation services | | | 1,578 | | | — | |
Other mortgage and default services | | | 248 | | | 8 | |
| | | | | | | |
| | $ | 7,252 | | $ | 7,485 | |
| | | | | | | |
The decline in residential property valuation and title services expenses in the first quarter of 2009 is due to the decline in the related revenues and improvements in our processes relating to order placements with subcontractors that enabled us to deliver our services more timely while also lowering the fees we pay to subcontractors.
Financial Services
The $1,301 loss before income taxes for the first quarter of 2009 primarily reflects a $2,182, or 11% decline in revenues as compared to the first quarter of 2008 primarily due to lower collection rates that we experienced and which we believe are due to the current economic climate and are consistent with the collections industry in general. Income from operations was $1,324 lower in the first quarter of 2009.
Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 5,189 | | $ | 2,256 | |
Receivables | | | 5,703 | | | 5,848 | |
Goodwill and intangibles | | | 43,971 | | | 44,609 | |
Premises and equipment | | | 3,802 | | | 3,967 | |
Other | | | 1,221 | | | 2,027 | |
| | | | | | | |
Total assets | | $ | 59,886 | | $ | 58,707 | |
| | | | | | | |
| | | | | | | |
Lines of credit and other secured borrowings | | $ | — | | $ | 1,123 | |
Accrued expenses and other | | | 7,386 | | | 7,081 | |
| | | | | | | |
Total liabilities | | $ | 7,386 | | $ | 8,204 | |
| | | | | | | |
Goodwill and Intangibles. Goodwill and intangibles arising from the acquisition of NCI are as follows:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Goodwill | | $ | 8,218 | | $ | 8,218 | |
| | | | | | | |
| | | | | | | |
Intangibles | | | 40,500 | | | 40,500 | |
Accumulated amortization | | | (4,747 | ) | | (4,109 | ) |
| | | | | | | |
Intangibles, net | | | 35,753 | | | 36,391 | |
| | | | | | | |
| | $ | 43,971 | | $ | 44,609 | |
| | | | | | | |
Intangibles consist primarily of customer lists that we are amortizing over their estimated useful lives which range from 10 to 20 years.
Lines of credit and other secured borrowings.In July 2008, NCI entered into a revolving secured credit agreement with a financial institution that provides for borrowings of up to $10,000 through July 2011. Interest on the borrowings is based on either a rate of LIBOR plus two percent that is fixed for a period of 1, 3, 6 or 12 months, or a floating rated based on the prime rate less one percent as elected by NCI when the borrowing is made. Substantially all of NCI’s assets, which comprise substantially all of the assets in our Financial Services segment, are pledged as collateral for this credit agreement. These borrowings are limited to 85% of eligible accounts receivable as defined in the agreement. The agreement contains financial covenants that reset annually and that require minimum adjusted pre-tax income levels for NCI as defined in the agreement. During the first quarter of 2009, the outstanding balance was repaid in full; however, the agreement is still in effect and available to meet the liquidity needs of the Financial Services segment. See Note 13 to the Interim Consolidated Financial Statements for additional information.
44
In February 2009, we negotiated favorable modifications to the financial covenants for 2009 and agreed to an increase in the interest rate on the floating rate advances to prime plus 1.25%.
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue | | $ | 17,318 | | $ | 19,499 | |
| | | | | | | |
Operating expenses: | | | | | | | |
Compensation and benefits | | | 8,555 | | | 9,702 | |
Servicing and origination | | | 3,354 | | | 3,085 | |
Technology and communication | | | 2,160 | | | 1,978 | |
Professional services | | | 718 | | | 707 | |
Occupancy and equipment | | | 1,239 | | | 1,081 | |
Other | | | 2,125 | | | 2,455 | |
| | | | | | | |
Total operating expenses | | | 18,151 | | | 19,008 | |
| | | | | | | |
Income (loss) from operations | | | (833 | ) | | 491 | |
Other expense, net | | | (468 | ) | | (468 | ) |
| | | | | | | |
Income (loss) before income taxes | | $ | (1,301 | ) | $ | 23 | |
| | | | | | | |
The decrease in revenue in the first quarter of 2009 as compared to the first quarter of 2008 is primarily due to lower collection rates that we experienced and which we believe are due to the current economic climate and are consistent with the collections industry in general.
The decrease in compensation and benefits in the first quarter of 2009 as compared to the first quarter of 2008 is largely the result of our continuing efforts to increase our revenue per collector and to focus on improving our service to our largest customers while also renegotiating rates or terminating our relationship with unprofitable customers.
Technology Products
Although income from operations improved by $798 in the first quarter of 2009 as compared to 2008, pre-tax income declined by $7,287 due to a decline in our equity in the earnings of BMS Holdings, which was $7,886 in the first quarter of 2008. Because of an accumulated deficit at BMS Holdings, we have not resumed applying the equity method of accounting since the second quarter of 2008.
Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Receivables | | $ | 776 | | $ | 974 | |
Goodwill | | | 1,618 | | | 1,618 | |
Premises and equipment | | | 4,950 | | | 5,452 | |
Other | | | 1,145 | | | 862 | |
| | | | | | | |
Total assets | | $ | 8,489 | | $ | 8,906 | |
| | | | | | | |
| | | | | | | |
Total liabilities | | $ | 2,500 | | $ | 3,361 | |
| | | | | | | |
45
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue: | | | | | | | |
Technology support | | $ | 5,637 | | $ | 5,851 | |
REAL products | | | 4,936 | | | 4,633 | |
| | | | | | | |
Total revenue | | | 10,573 | | | 10,484 | |
Operating expenses: | | | | | | | |
Compensation and benefits | | | 2,236 | | | 2,751 | |
Technology and communications | | | 4,259 | | | 4,401 | |
Other | | | 1,678 | | | 1,730 | |
| | | | | | | |
| | | 8,173 | | | 8,882 | |
| | | | | | | |
Income from operations | | | 2,400 | | | 1,602 | |
| | | | | | | |
Other income (expense), net: | | | | | | | |
Interest expense | | | (132 | ) | | (164 | ) |
Equity in earnings of unconsolidated entities (BMS Holdings) | | | — | | | 7,886 | |
Other | | | 56 | | | 287 | |
| | | | | | | |
Other income (expense), net | | | (76 | ) | | 8,009 | |
| | | | | | | |
Income before income taxes | | $ | 2,324 | | $ | 9,611 | |
| | | | | | | |
Equity in earnings of unconsolidated entities. We suspended the application of the equity method of accounting for our investment in BMS Holdings in the second quarter of 2008 after our share of BMS Holdings’ 2008 losses had reduced our investment to zero. We will not resume applying the equity method until our share of BMS Holdings’ earnings exceeds our share of their losses that we did not recognize during the period when the equity method was suspended. The first quarter 2008 results for BMS Holdings reflect $5,431 of operating income and $47,904 of unrealized gains on derivative financial instruments that were driven by declining interest rates partially offset by $12,242 of unrealized losses on auction rate securities. The unrealized gains on derivatives in the first quarter of 2008 were largely reversed in the second quarter, driven by the significant volatility in LIBOR during those periods. BMS Holdings recognized a net loss for the first quarter of 2009 that was primarily due to operating income of $567 as a result of a $3,451 decline in revenues. Interest expense of $9,974 was partially offset by unrealized gains on derivatives of $5,809. As a result, BMS realized a net loss of $2,159 even though it recognized no additional unrealized losses on its portfolio of auction rate securities.
Corporate Items and Other
The first quarter 2009 loss before income taxes of $3,438 represents an improvement of $17,257 over the first quarter of 2008. Results for the first quarter of 2008 included $8,939 of unrealized losses on auction rate securities and $9,532 of expenses incurred in connection with the terminated “going private” transaction.
Comparative selected balance sheet data:
| | | | | | | |
| | March 31, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 153,253 | | $ | 197,874 | |
Trading securities | | | | | | | |
Investment grade auction rate | | | 238,161 | | | 239,301 | |
Subordinates and residuals | | | 107 | | | 165 | |
Receivables | | | 21,686 | | | 22,758 | |
Deferred tax assets, net | | | 167,913 | | | 175,145 | |
Premises and equipment, net | | | 2,980 | | | 3,415 | |
Interest earning collateral deposits | | | 5,000 | | | 9,684 | |
Other | | | 6,335 | | | 7,129 | |
| | | | | | | |
Total assets | | $ | 595,435 | | $ | 655,471 | |
| | | | | | | |
| | | | | | | |
Investment line | | $ | 186,568 | | $ | 200,719 | |
Debt securities | | | 108,843 | | | 133,367 | |
Other | | | 32,291 | | | 41,514 | |
| | | | | | | |
Total liabilities | | $ | 327,702 | | $ | 375,600 | |
| | | | | | | |
46
Trading Securities.As disclosed in Note 5 to the Interim Consolidated Financial Statements, because of failed auctions, we have been unable to fully liquidate the investment grade auction rate securities that we invested in during the first quarter of 2008. These securities are collateralized by student loans originated under the Federal Family Education Loan Program. The loans are guaranteed for no less than 97% of their unpaid principal balance in the event of default. Our determination of the estimated fair value, which included our consideration of the strong credit quality of the underlying collateral and the securities we hold, limited market activity (including sales of our own holdings), creditworthiness of the issuers, estimated holding period and general auction rate securities market conditions, required the significant use of unobservable inputs. We estimate that an increase in the holding period of 12 months, with a commensurate increase in the discount rate, would reduce the estimated fair value by approximately 3.4%. Alternatively, a decrease in the holding period of the auction rate securities of 12 months, with a commensurate decrease in the discount rate, would increase the estimated fair value by approximately 5.5%. When liquidity returns to the auction rate securities market we expect to sell our securities. Additionally, we continue to aggressively pursue litigation and arbitration actions against certain investment banks.
Deferred Tax Assets, Net.Net deferred tax assets decreased by $7,232 during the first three months of 2009 primarily due to the realization of tax benefits associated with the sale of MSRs.
Investment Line. As disclosed in Note 14 to the Interim Consolidated Financial Statements,we executed an amendment to the Investment Line in July 2008 that created a term note maturing on June 30, 2009. The note is secured by our investment in auction rate securities. Maximum borrowing as of March 31, 2009 was limited to 70% of the face amount of the securities. Under the term note, we receive the interest on the auction rate securities while the proceeds from the redemption or sale of auction rate securities are applied to the outstanding balance. On April 30, 2009, we renewed the term note through June 2010. This agreement was renewed under terms substantially similar to the previous agreement, except that payments will be $3,000 per month in place of the previous quarterly reductions in the advance rate.
During the three months ended March 31, 2009, we made principal payments totaling $14,151 which reduced the Investment Line term note obligation to $186,568.
Debt Securities. Debt securities declined by $24,524 during the first three months of 2009 primarily because we repurchased $25,910 of our 3.25% Convertible Notes in the open market in February 2009 generating total gains of $534, net of the write-off of unamortized issuance costs. As a result of our adoption of FSP No. APB 14-1, we recognized a discount on the Convertible Notes that we are amortizing to interest expense over a five-year period to August 1, 2009. The outstanding balance at March 31, 2009 and December 31, 2008 of $56,445 and $82,355 is reported net of the unamortized debt discount of $981 and $2,367 respectively. The outstanding balance of the 10.875% Capital Trust Securities of $53,379 is unchanged from December 31, 2008. See Note 16 to the Interim Consolidated Financial Statements for additional details regarding the Convertible Notes and Capital Trust Securities.
Other Liabilities. Other liabilities include accruals for incentive compensation awards, audit fees, legal matters, other operating expenses and interest on debt securities, including customer deposits held by BOK. Other liabilities declined by $9,223 primarily due to the settlement of $3,900 of liabilities accrued in connection with the December 2008 assignment of the lease on our Orlando facility, a decline of $5,578 in accrued bonuses as a result of the payment of 2008 annual bonuses and a $2,260 decline in accrued interest payable resulting from the semiannual payment of interest on our Convertible Notes and Capital Trust Securities.
Comparative selected operations data for the three months ended March 31 is as follows:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Revenue | | $ | 253 | | $ | 5 | |
Operating expenses | | | 3,982 | | | 8,636 | |
| | | | | | | |
Loss from operations | | | (3,729 | ) | | (8,631 | ) |
| | | | | | | |
| | | | | | | |
Other income (expense): | | | | | | | |
Gain (loss) on trading securities | | | (98 | ) | | (10,991 | ) |
Gain (loss) on debt repurchases | | | 534 | | | — | |
Other, net | | | (145 | ) | | (1,073 | ) |
| | | | | | | |
Other income (expense), net | | | 291 | | | (12,064 | ) |
| | | | | | | |
Loss before income taxes | | $ | (3,438 | ) | $ | (20,695 | ) |
| | | | | | | |
Operating Expenses. Operating expenses for the first quarter of 2009 declined by $4,654 largely due to a $6,976 decline in professional services. In the first quarter of 2008, we recognized $9,532 of due diligence and other costs related to the “going private” transaction which was initiated in January 2008 and which the parties mutually terminated in March 2008. In the first quarter of 2009, we recorded $1,163 of costs related to the Separation. Operating expenses are net of overhead allocations to other segments.
47
Loss on Trading Securities.The loss on trading securities for the three months ended March 31 was comprised of the following:
| | | | | | | |
| | 2009 | | 2008 | |
| | | | | |
Realized losses on CMOs | | $ | — | | $ | (114 | ) |
| | | | | | | |
| | | | | | | |
Unrealized losses: | | | | | | | |
Investment grade auction rate | | | (40 | ) | | (8,939 | ) |
CMOs | | | — | | | (1,813 | ) |
Subordinates and residuals | | | (58 | ) | | (125 | ) |
| | | | | | | |
| | | (98 | ) | | (10,877 | ) |
| | | | | | | |
| | $ | (98 | ) | $ | (10,991 | ) |
| | | | | | | |
EQUITY
Total equity amounted to $626,678 at March 31, 2009 as compared to $609,641 at December 31, 2008. The $17,037 increase in total equity during the first three months of 2009 was primarily due to net income of $15,039 and a $2,067 increase in additional paid-in capital. The increase in additional paid-in capital was primarily due to $1,477 related to the exercise of common stock options by employees and compensation of $522 related to employee share-based awards.
Minority interest of $304 and $406 at March 31, 2009 and December 31, 2008, respectively, primarily represented the 30% investment in GSS held by ML IBK Positions, Inc. With our adoption of SFAS No. 160 on January 1, 2009, we reclassified minority interest from a separate classification in our consolidated balance sheets to classification as a component of equity.
INCOME TAX EXPENSE
Income tax expense was $8,037 and $2,939 for the three months ended March 31, 2009 and 2008, respectively.
Our effective tax rate for the first three months of 2009 was 34.44% as compared to 35.08% for the first three months of 2008. Income tax expense on income before income taxes differs from amounts that would be computed by applying the Federal corporate income tax rate of 35% primarily because of the effect of foreign taxes, foreign income with an indefinite deferral from U.S. taxation, losses from consolidated VIEs, state taxes and low-income housing tax credits.
Our effective tax rate for the first three months of 2009 includes a benefit of approximately 2.31% associated with the recognition of certain foreign deferred tax assets. The effective tax rate excludes any additional valuation allowance for certain NCI related state net operating losses which management deems immaterial. The effective tax rate for the first three months of 2009 was not impacted by the expiration of certain vested stock options.
Our effective tax rate for the first three months of 2008 includes a benefit of approximately 2.38% associated with the recognition of certain foreign deferred tax assets. The effective tax rate for the first quarter of 2008 would have been 30.47% but was increased by approximately 4.61% due to the recognition of additional tax expense associated with the expiration of certain vested stock options.
LIQUIDITY AND CAPITAL RESOURCES
Although our cash balance declined by $42,170, or 21% during the first quarter of 2009, our cash position remains strong with a balance of $158,855 at March 31, 2009, of which $157,097 is unrestricted. Cash declined because we purchased servicing rights for $10,241 and reduced our outstanding liabilities by:
| | |
| · | Purchasing for $24,602 convertible notes with a face value of $25,910, reducing the face value of notes outstanding to $55,464 |
| · | Repaying $20,997 on our MSR financing facility due to amortization, reducing the balance outstanding to $76,990 |
| · | Repaying $14,151 on our ARS Investment Line due to amortization, reducing the balance outstanding to $186,568 |
The cash used to purchase servicing rights and reduce the above liabilities totaled $69,991, which exceeds the reduction in cash by $27,821 and indicates the positive net impact of all other cash transactions. In a private placement transaction that closed on April 3, 2009, we sold 5,471,500 shares of common stock at a price of $11.00 per share, or approximately $60,000 in proceeds. On the same date, we also purchased 1,000,000 shares of common stock from our Chairman of the Board at a price of $11.00 per share. The net cash generated by these transactions of approximately $49,000 more than offsets the cash decline in the first quarter of 2009.
48
Despite a credit environment that remains challenged, so far in 2009 we have:
| | |
| · | Renewed a $200,000 advance note in January |
| · | Obtained $67,000 in new term advance financing in March |
| · | Renewed our Investment Line in support of the auction rate securities through June 30, 2010 in April |
| · | Increased the maximum borrowing capacity of our former $300,000 advance financing facility to $500,000 in May |
We renewed and refinanced notes entering amortization in 2009. As a result, we maintained maximum borrowing capacity for match funded advances of $1,215,000 at March 31, 2009 and December 31, 2008. Combined with a reduction in advances and match funded advances of $148,937, we increased our excess advance borrowing capacity from $257,893 on December 31, 2008 to $428,690 on March 31, 2009. Excess advance borrowing capacity would have been $628,690 on March 31, 2009 if we include on a pro forma basis the $200,000 of additional capacity that we obtained on May 5, 2009.
Further plans to improve liquidity in 2009 include continued reductions in advances, increases in match funded advance financing and selling non-core assets. Our prospects for advance financing have improved due to the introduction of TALF announced by the Federal Reserve Bank of New York in February. This program includes servicer advances as an asset class and allows lenders to invest a relatively small amount of equity while borrowing the remainder from the Federal Reserve Bank at a modest spread over LIBOR. The TALF notes have a term of up to three years. Although successful execution cannot be guaranteed, management believes that these plans are sufficient to meet our liquidity requirements for the next twelve months. We are currently in compliance and expect to remain in compliance with all financial covenants. However, if our efforts to maintain liquidity are not successful, or if unanticipated market factors emerge, the result could have a material adverse impact upon our business, results of operations and financial position.
Our primary sources of funds for liquidity are:
| | | | | |
| · | Match funded liabilities | | · | Payments received on loans held for resale |
| · | Lines of credit and other secured borrowings | | · | Payments received on trading securities |
| · | Servicing fees, including float earnings | | · | Debt securities |
Our primary uses of funds are the funding of servicing advances, the payment of interest and operating expenses, the purchase of servicing rights and the repayment of borrowings. We closely monitor our liquidity position and ongoing funding requirements, and we invest available funds in short-term investment grade securities.
Our servicing agreements impose on us various rights and obligations that affect our liquidity. Among the most significant is our obligation to advance our own funds to meet contractual principal and interest payments for certain investors and to pay taxes, insurance, foreclosure costs and various other items that are required to preserve the assets being serviced. Delinquency rates and prepayment speed affect the size of servicing advance balances. The number of delinquent loans comprised 17.2% of the total number of loans serviced at March 31, 2009. This compares to 19% at December 31, 2008. The UPB of delinquent loans as a percentage of total UPB serviced continued its gradual trend upward to 25.1% at March 31, 2009 from 24.3% at December 31, 2008. Prepayment speeds averaged 22% for the first quarter of 2009. This compares to 23% for the first quarter of 2008 and 25% for the fourth quarter of 2008.
Management initiatives that are designed to maximize the return to the loan investors resulted in increased loan modifications. Based on current trends, we believe that servicing advances for our current portfolio peaked in March 2008. However, we expect the 90-day trial period in the HMP will reduce the number of modifications becoming effective in the second quarter, and this will slow the rate of advance reduction. If prepayment speeds decrease in 2009 or if the success of the loan modification programs does not continue, advances on the existing servicing portfolio will decline at a slower pace or could increase.
Our ability to finance servicing advances is a significant factor that affects our liquidity. Two of our match funded advance facilities that are rated and a third that is in the process of being rated are subject to increases in the financing discount if deemed necessary by the rating agency in order to maintain the minimum rating required for the facility. Several rating agencies have announced that they are developing a new methodology for rating servicer advances. We believe this is likely to reduce advance rates. If a rating agency that we currently use stops rating servicer advance facilities or withdraws existing ratings, which seems unlikely, we will work with the note holders of the affected facility to remain in compliance with all requirements. If this is not successful we will work to move collateral to compliant facilities and/or secure new financing capacity so that we can repay any notes potentially becoming non-compliant.
Our ability to continue to pledge collateral under each advance facility depends on the performance of the collateral. Currently, the majority of our collateral qualifies for financing under the advance facility to which it is pledged.
Some of our existing debt covenants limit our ability to incur additional debt in relation to our equity and require that we maintain minimum levels of liquid assets, earnings and unused borrowing capacity. Failure to comply with these covenants could result in restrictions on new borrowings or the early termination of our borrowing facilities. We are currently in compliance with these covenants. We do not expect them to restrict our activities. Sufficient financing capacity, limiting the growth in servicing advances and maintaining loan performance are all essential requirements to maintain liquidity.
49
Maximum borrowing capacity of the Servicing segment was $1,344,363 at March 31, 2009, an increase of $31,376 as compared to $1,312,987 at December 31, 2008. The increase in total borrowing capacity of all segments during the first quarter of 2009, excluding the Investment Line, was $28,318. The increase in Servicing segment borrowing capacity principally reflects the effect of two new facilities into which we entered in March 2009. One facility represented an advance in the form of zero-coupon bonds that we recorded at $45,373, net of a discount of $14,627. The other is a $7,000 term note. Both facilities are secured by the pledge of advances. The capacity of our match funded servicing advance facilities of $1,215,000 at March 31, 2009 was unchanged from December 31, 2008.
During the first half of 2008, our $355,000 senior secured credit facility was the only source of debt that was available to fund the purchase of residential MSRs, and the facility matured in August 2008. This facility contained the option of an 18-month term note to finance MSRs. We exercised this option, and in August 2008, we repaid the borrowings under the facility that were secured by advances and converted our remaining borrowings that were secured by MSRs to a term note that matures in February 2010. Our borrowing to fund MSRs was $76,990 at March 31, 2009. The borrowing amount each month is limited to the lesser of a predetermined straight-line, eighteen-month amortization schedule or 65% of a third party appraisal value of the MSRs. Borrowing under this facility declined by $20,997 as compared to December 31, 2008.
In the table below, we provide the amortization dates and maturity dates for each of our credit facilities as of December 31, 2008, excluding the Investment Line. The amortization date is the date on which the revolving period ends under our advance facilities and repayment of the outstanding balance must begin if the facility is not renewed or extended. The maturity date is the date on which all outstanding balances must be repaid. After the amortization date, all collections that represent the repayment of advances that have been financed through the facility must be applied to reduce the balance outstanding under the facility, and any new advances under the securitizations pledged to the facility are ineligible to be financed. In order for us to maintain liquidity, borrowings under facilities that have entered their amortization period and have not been renewed must be repaid and new advances under the securitizations must be pledged to another facility.
Our credit facilities, excluding the Investment Line term note, are summarized as follows at March 31, 2009:
| | | | | | | | | | | | | | |
| | Amortization Date | | Maturity | | Maximum Borrowing Capacity (1) | | Unused Borrowing Capacity | | Balance Outstanding | |
| | | | | | | | | | | |
Servicing: | | | | | | | | | | | | | | |
Match funded liability (2) | | Nov. 2009 (2) | | Dec. 2014 – | | | | | | | | | | |
| | – Dec. 2009 | | Nov. 2015 | | $ | 465,000 | | $ | 195,225 | | $ | 269,775 | |
Match funded liability (3) | | Jan. 2010 | | Jan. 2019 | | | 200,000 | | | 65,578 | | | 134,422 | |
Match funded liability | | Dec. 2010 | | Dec. 2013 | | | 250,000 | | | 66,403 | | | 183,597 | |
Match funded liability (4) | | Apr. 2009 | | Apr. 2009 | | | 300,000 | | | 101,484 | | | 198,516 | |
| | | | | | | | | | | | | | |
| | | | | | | 1,215,000 | | | 428,690 | | | 786,310 | |
| | | | | | | | | | | | | | |
Secured credit agreement - Term note (5) | | Aug. 2008 | | Feb. 2010 | | | 76,990 | | | — | | | 76,990 | |
Advance fee reimbursement (6) | | Mar. 2010 | | Mar. 2014 | | | 45,373 | | | — | | | 45,373 | |
Term note | | Mar. 2014 | | Mar. 2014 | | | 7,000 | | | — | | | 7,000 | |
| | | | | | | | | | | | | | |
| | | | | | | 129,363 | | | — | | | 129,363 | |
| | | | | | | | | | | | | | |
| | | | | | | 1,344,363 | | | 428,690 | | | 915,673 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Loans and Residuals: | | | | | | | | | | | | | | |
Class A-1 Note | | N/A | | Apr. 2037 | | | 14,702 | | | — | | | 14,702 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Financial Services: | | | | | | | | | | | | | | |
Revolving note | | N/A | | Jul. 2011 | | | 10,000 | | | 10,000 | | | — | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Corporate Items and Other: | | | | | | | | | | | | | | |
Convertible notes | | N/A | | Aug. 2024 | | | — | | | — | | | 55,464 | |
Capital securities | | N/A | | Aug. 2027 | | | — | | | — | | | 53,379 | |
| | | | | | | | | | | | | | |
| | | | | | | — | | | — | | | 108,843 | |
| | | | | | | | | | | | | | |
Total borrowings | | | | | | | 1,369,065 | | | 438,690 | | | 1,039,218 | |
Basis adjustment (2) | | | | | | | — | | | — | | | 3,990 | |
| | | | | | | | | | | | | | |
| | | | | | $ | 1,369,065 | | $ | 438,690 | | $ | 1,043,208 | |
| | | | | | | | | | | | | | |
| |
(1) | Unused borrowing capacity is available for use only to the extent that there are assets that have been pledged as collateral to a facility but against which no funds have been drawn. With respect to our match funded facilities, all eligible advances had been pledged to a facility at March 31, 2009. As a result, none of our available borrowing capacity was readily available because we had no additional assets pledged as collateral but not drawn under our facilities. With respect to the revolving note, at March 31, 2009, we had $4,096 of available borrowing capacity based on the amount of eligible collateral that was available. |
50
| |
(2) | The $165,000 fixed-rate term note issued in 2006 was carried on the balance sheet at fair value as the result of a designated fair value hedging relationship that we established through the use of an interest rate swap. We terminated the related interest rate swap in February 2008 and began amortizing the basis adjustment to interest expense over the remaining term of the note. |
(3) | In January 2009, we renewed this facility early and extended the amortization date to January 2010. |
(4) | In April 2009, the lender agreed to extend the amortization date for this facility to May 16, 2009. On May 5, 2009, we negotiated an increase in the borrowing capacity under this facility to $500,000 and extended the amortization date by one year to May 4, 2010. |
(5) | This facility contained the option of an 18-month term note to finance MSRs. Upon conversion to a term note, we repaid all borrowings under this facility that were secured by advances and moved the collateral to other, match funded advance facilities. |
(6) | The advance is payable annually in five installments of $12,000. The advance does not carry a stated rate of interest. However, we are compensating the lender for the advance of funds by forgoing payment of fees due from the lender over the five-year term of the advance. Accordingly, the advance has been recorded as a zero-coupon bond issued at an implied discount of $14,627. |
Certain of our credit facilities require that we maintain minimum liquidity levels or borrowing capacity, and we are in compliance with these requirements.
We had an aggregate balance of $404,197 outstanding at March 31, 2009 (excluding the advance facility renewed subsequent to quarter end) under match funded financing facilities that are scheduled to enter their amortization period or reach their maturity date during the next twelve months.
Even with the expectation that advance balances will decline into the future, we will continue to pursue additional advance financing to increase our margin of safety and to provide the flexibility to acquire new servicing business. However, if advances do not continue to decline and the credit markets do not improve, we may need to increase our advance financing capacity at a cost that is significantly higher than under our current advance facilities. We will continue to work closely with current and prospective lenders as we monitor our operating results, financing capacity requirements and terms for advance funding available in the market. We are poised to take advantage of opportunities to increase financing at a reasonable cost or to act aggressively to ensure adequate liquidity if additional financing is needed and credit markets remain challenged.
We have the following potential uses of cash:
| | |
| · | Cash requirements to fund advances and the cash needs of our existing operations; |
| · | Commitment to invest up to an additional $33,902 in ONL and affiliates; |
| · | Retirement of our 3.25% Convertible Notes; |
| · | Repayment of the balance of the term note which finances our MSRs in the amount of $6,999 per month or more if necessary such that the borrowing balance does not exceed 65% of the appraised value; and |
| · | Repayment of advance borrowing should the advance rate decline or the collateral become ineligible. |
We may also evaluate the retirement of our 10.875% Capital Trust Securities. Regarding our investment in BMS Holdings, we are under no obligation to provide additional funding.
Cash totaled $158,855 at March 31, 2009.
Significant uses of funds during the first quarter of 2009 included the following:
| | |
| · | Net repayments under match funded advance financing facilities of $170,797; |
| · | Repayments on Investment Line term note of $14,151; |
| · | Reduction in servicer liabilities of $45,386; |
| · | Reduction in the MSR term note of $20,997; |
| · | Repurchase of $25,910 face amount of our 3.25% Convertible Notes for $24,602; and |
| · | Purchases of MSRs of $10,241. |
Significant sources of funds during the first quarter of 2009 included the following:
| | |
| · | $41,822 of net proceeds from lines of credit and other secured borrowings, including $67,000 under two new facilities; |
| · | Cash flows from operating activities, including net cash collections on advances and match funded advances of $148,509; and |
| · | Distributions of $3,246 received from asset management entities. |
Our operating activities provided (used) $130,094 and $(306,946) of cash flows during the first quarter of 2009 and 2008, respectively. The improvement in 2009 over 2008 primarily reflects a decline in net cash used by trading activities and a decline in the funding requirements of our Servicing operations.
The operating funding requirements of our Servicing business are primarily reflected in the change in servicing advances and servicer liabilities which collectively provided $103,123 of net cash during the first quarter of 2009. These same items used $45,790 of cash during the first quarter of 2008. We collected net cash of $148,509 on advances and match funded advances in the first quarter of 2009. This compares to net cash paid of $30,761 to fund advances and match funded advances during the first quarter of 2008. Servicer liabilities declined by $45,386 and $15,029 during the first quarter of 2009 and 2008, respectively, due to lower collections.
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Trading activities provided (used) net cash of $1,100 and $(286,640) in first quarter of 2009 and 2008, respectively. Net cash used by trading activities during the first quarter of 2008 primarily reflects our net cash investment in auction rate securities of $299,964, offset in part by the sale or maturity of CMOs and other short-term investment grade securities.
Our investing activities provided (used) cash flows totaling $(6,648) and $162 during the first quarter of 2009 and 2008, respectively. The increase in cash used in the first quarter of 2009 over 2008 is primarily due to a $6,615 increase in purchases of MSRs. In the first quarter of 2009, our $10,241 of MSR purchases were partially offset by $3,246 of distributions we received from our asset management entities. In the first quarter of 2008, distributions of $3,875 received from the asset management entities and proceeds of $1,967 received from the sale of real estate were largely offset by purchases of residential MSRs of $3,626 and investments in asset management entities totaling $1,250.
Our financing activities provided (used) cash flows of $(165,616) and $367,225 during the first quarter of 2009 and 2008, respectively. The cash flows used by financing activities in the first quarter of 2009 primarily reflect the $170,797 net repayment of match funded liabilities as a result of the decline in servicing advances. Net proceeds of $67,000 from two new secured borrowings were largely offset by repayments on the Investment Line and repurchases of our 3.25% Convertible Notes. The cash flows provided by financing activities in the first quarter of 2008 primarily reflect the $283,836 of net borrowing under the Investment Line used to invest in auction rate securities and the utilization of unused borrowing capacity available under match funded advance facilities, offset in part by our repayment in full of a $100,000 term note that began its amortization period in January 2008.
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 come due. Such contractual obligations include our Convertible Notes, Capital Trust Securities, lines of credit and other secured borrowings, the Investment Line term note and operating leases. See Note 20 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 with a variety of financial institutions and other companies that are not reflected on our balance sheet. In addition, through our investment in subordinate and residual securities, we provide credit support to the senior classes of securities. We are subject to potential financial loss if the counterparties to our off-balance sheet transactions are unable to complete an agreed upon transaction. We seek to limit counterparty risk through financial analysis, dollar limits and other monitoring procedures. We have also entered into non-cancelable operating leases and have committed to invest up to an additional $33,902 in ONL and related entities.
Derivatives.We record all derivative transactions at fair value on our consolidated balance sheets. We use these derivatives primarily to manage our interest rate risk and foreign exchange rate risk. The notional amounts of our derivative contracts do not reflect our exposure to credit loss. See Note 18 to our Interim Consolidated Financial Statements for additional information regarding derivatives.
Involvement with SPEs.We use SPEs for a variety of purposes but principally in the financing of our servicing advances and in the securitization of mortgage loans.
Our securitizations of mortgage loans have been structured as sales and the SPEs to which we have transferred the mortgage loans are qualifying special purpose entities (QSPEs) and are therefore not currently subject to consolidation. We have retained both subordinated and residual interests in these QSPEs. Where we are the servicer of the securitized loans, we generally have the right to repurchase the mortgage loans from the QSPE when the costs exceed the benefits of servicing the remaining loans.
We generally use match funded securitization facilities to finance our servicing advances. The SPEs to which the advances are transferred in the securitization transaction are included in our consolidated financial statements either because the transfer did not qualify for sales accounting treatment or because the SPE is not a QSPE, and we have the majority equity interest in the SPE, or we are the primary beneficiary where the SPE is also a VIE. The holders of the debt of these SPEs can generally look only to the assets of the SPEs for satisfaction of the debt and have no recourse against OCN. However, OLS has guaranteed the payment of the obligations of the issuer under a match funded facility that closed in April 2008. The maximum amount payable under the guarantee is limited to 10% of the notes outstanding at the end of the facility’s revolving period.
VIEs.In addition to certain of our financing SPEs, we have invested in several other VIEs primarily in connection with purchases of whole loans. If we determine that we are the primary beneficiary of a VIE, we report the VIE in our consolidated financial statements.
See Note 1 to our Interim Consolidated Financial Statements for additional information regarding our investment in SPEs and VIEs.
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RECENT ACCOUNTING DEVELOPMENTS
Recent Accounting Pronouncements
Listed below are recent accounting pronouncements which did or are expected to have a significant impact upon adoption. For additional information regarding these and other recent accounting pronouncements, see Note 1 to our Interim Consolidated Financial Statements.
Proposed amendment of SFAS No. 140 and FIN 46(R) and issuance of FSP No. FAS 140-4 and FIN 46(R)-8. In April 2008, the FASB voted to eliminate the QSPE concept from SFAS No. 140 and to remove the scope exception for QSPEs from FIN 46(R). During September 2008, the FASB issued three separate but related exposure drafts for public comment. The proposed FASB Statements address amendments to SFAS No. 140 and to FIN 46(R). The proposed changes will require an analysis of all QSPEs which are currently exempt from the consolidation provisions of FIN 46(R), to determine if consolidation as VIEs is required.
FSP FAS 140-4 and FIN 46(R)-8 was issued in December 2008 and requires improved disclosures by public entities until the pending amendments to SFAS No. 140 and FIN No. 46(R) are effective. This FSP amends SFAS No. 140 and FIN 46(R) to require enhanced disclosures by public entities about transfers of financial assets and interests in VIEs. Additionally, the FSP requires certain disclosures by a public entity that is (a) a sponsor that has a variable interest in a VIE (irrespective of the significance of the variable interest) and (b) an enterprise that holds a significant variable interest in a QSPE but was not the transferor of financial assets to the QSPE. The additional disclosures required by FSP FAS 140-4 and FIN 46(R)-8 are included in Note 1.
We have retained investments in certain subordinate and residual securities in connection with loan securitization transactions completed in prior years (primarily 2006). Our subordinate and residual securities at March 31, 2009 include retained interests with a fair value of $107.
FSP No. APB 14-1clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14. Additionally, this FSP specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Upon adoption of this FSP on January 1, 2009, we recognized a discount to reduce the carrying value of the 3.25% Convertible Notes and an offsetting increase to stockholders’ equity. The cumulative effect of adoption resulted in: (1) a reduction of retained earnings of $21,202 due to the retrospective accretion of the resulting debt discount to interest expense over the expected life of the notes; (2) adjustments to debt issue cost amortization and gains or losses recognized on previous redemptions; and (3) an increase in additional paid-in capital of $22,657. The adjustment to additional paid-in capital includes the recognized debt discount, adjusted for note redemptions, and the effect of deferred taxes. Interest expense for the quarter ended March 31, 2008 has been restated to include non-cash interest of $1,071. Prospectively, the consolidated statement of operations will recognize non-cash interest expense over the remaining estimated life of the notes.
For additional information regarding these and other recent accounting pronouncements, see Note 2 to our Interim Consolidated Financial Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollars in thousands)
Market risk includes liquidity risk, interest rate risk, prepayment risk and foreign currency exchange rate risk. 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 exposed to liquidity risk primarily because of the highly variable daily cash requirements to support the 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 of funding including match funded agreements, secured lines of credit and repurchase agreements. We believe that we have adequate financing for the next twelve months. On April 30, 2009, we were successful in negotiating a one-year extension of the Investment Line to June 30, 2010. However, because of the failed auctions, the market for investment grade auction rate securities is not currently liquid. In the event we need to liquidate our investment, we may not be able to do so without a loss of principal.
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 or when financed assets are not interest-bearing. Our 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 March 31, 2009, we had total advances and match funded advances of $1,053,703.
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We are also exposed to interest rate risk because a portion of our outstanding debt is variable rate. Rising interest rates may increase our interest expense. Nevertheless, earnings on float balances (assets) partially offset this variability. We have also entered into interest rate caps to hedge our exposure to rising interest rates on a $250,000 match funded advance facility and on a $200,000 match funded advance facility that both have variable rates of interest.
| | | | |
| | March 31, 2009 | |
| | | |
Total borrowings outstanding | | $ | 1,225,786 | |
Fixed rate borrowings | | | 319,216 | |
Variable rate borrowings | | | 906,570 | |
Float balances (held in custodial accounts, excluded from our balance sheet) | | | 345,400 | |
Notional balance of interest rate caps | | | 450,000 | |
We report float earnings, which totaled $1,850 for the first quarter of 2009, as a component of servicing and subservicing fees.
Our balance sheet at March 31, 2009 included interest-earning assets totaling $358,218 including $238,161 of investment grade auction rate securities, $58,440 of debt service accounts, $44,670 of loans held for resale and $5,000 of interest-earning collateral accounts.
Interest rates, prepayment speeds and the payment performance of the loans significantly affect both our initial and ongoing valuations of and the rate of amortization of MSRs. As of March 31, 2009, the carrying value and estimated fair value of our residential mortgage servicing rights were $140,603 and $146,876, 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 to be satisfied when a securitization trust disburses funds. We are indirectly exposed to interest risk by our funding of advances because advances bear no interest, and approximately 80% of our total advances and match funded advances are funded through borrowings, most of which are variable rate debt.
We are exposed to foreign currency exchange rate risk in connection with our investment in non-U.S. dollar functional currency operations to the extent that our foreign exchange positions remain unhedged. Our operations in Canada, Germany, Uruguay and India expose us to foreign currency exchange rate risk, but we consider this risk to be insignificant. We have entered into foreign currency futures contracts to hedge the value of our net investment in BOK against adverse changes in the value of the Euro versus the U.S. Dollar.
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 decreases or increases by approximately 6.1% or 5.8%, respectively for every 50 basis point increase or decrease in interest rates. This sensitivity analysis is limited in that it is 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 declines below amortized cost, we 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. At March 31, 2009, we had interest rate caps with a notional amount of $250,000 to protect us against the effects of rising interest rates related to a variable-rate match funded note issued in December 2007 and $183,333 to protect us against the effects of rising interest rates on a variable-rate match funded note that was renewed on February 2008. We also sold short foreign currency futures with a notional amount of $9,605 to hedge against the foreign exchange rate risk represented by our investment in BOK. See Note 18 to our Interim Consolidated Financial Statements for additional information regarding our management of interest rate and foreign currency exchange rate risk.
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, 2008. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of March 31, 2009, 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 of 1934 (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.
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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 March 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See “Note 20, Commitments and Contingencies” of the Interim Consolidated Financial Statements for information regarding legal proceedings.
ITEM 1A. RISK FACTORS
We include a discussion of the principal risks and uncertainties that affect or could affect our business operations under Item 1A on pages 11 through 15 of our Annual Report on Form 10-K for the year ended December 31, 2008.
ITEM 6. EXHIBITS
| | |
(3) | Exhibits. | |
| 3.1 | Amended and Restated Articles of Incorporation (1) |
| 3.2 | Amended and Restated Bylaws (2) |
| 4.0 | Form of Certificate of Common Stock (1) |
| 4.1 | Certificate of Trust of Ocwen Capital Trust I (3) |
| 4.2 | Amended and Restated Declaration of Trust of Ocwen Capital Trust I (3) |
| 4.3 | Form of Capital Security of Ocwen Capital Trust I (included in Exhibit 4.4) (3) |
| 4.4 | Form of Indenture relating to 10.875% Junior Subordinated Debentures due 2027 of OCN (3) |
| 4.5 | Form of 10.875% Junior Subordinated Debentures due 2027 of OCN (included in Exhibit 4.6) (3) |
| 4.6 | Form of Guarantee of OCN relating to the Capital Securities of Ocwen Capital Trust I (3) |
| 4.7 | Indenture dated as of July 28, 2004, between OCN and the Bank of New York Trust Company, N.A., as trustee (4) |
| 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) |
| |
(1) | 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. |
(2) | 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, 2007. |
(3) | 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. |
(4) | 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. |
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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: | May 7, 2009 | By: /s/ David J. Gunter | |
| | | |
| | David J. Gunter, | |
| | Executive Vice President and | |
| | Chief Financial Officer | |
| | (On behalf of the Registrant and as its principal financial officer) | |
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