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.
On July 23, 2009, we provided notice that all holders of the Convertible Notes as of the close of business on August 4, 2009 will participate in the distribution of Altisource shares based on the conversion ratio of the Convertible Notes, consistent with the pro rata distribution ratio of one share of Altisource common stock for every three shares of OCN common stock, without conversion of the Convertible Notes into common shares of OCN. Accordingly, upon the Separation of Altisource and OCN, there will be no adjustment to the conversion ratio of the Convertible Notes. As of August 4, 2009, there were no requests to repurchase the Convertible Notes pursuant to the notice provided to holders of the Convertible Notes on July 26, 2009.
In July 2009, OCN communicated to its employees a plan to close two of its offices within its Financial Services segment. The offices will be closed in August 2009, and will result in severance costs, losses on the disposal of the assets that will be abandoned and lease termination costs. OCN will record the actual and estimated costs in the third quarter of 2009. We are unable to estimate the total costs of these office closures at this time. We are currently negotiating with the landlords for the leased space in order to exit the leases early, and expect to incur additional costs relating to the leases.
We have evaluated subsequent events through August 4, 2009.
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:
| | |
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). As more fully described below under Executive Summary—Separation of Ocwen Solutions, on August 10, 2009, the OS line of business, excluding BMS Holdings and GSS, will be separated from Ocwen.
We are focused on growing our core business of servicing loans, as more fully described below under Executive Summary—Revenue Opportunities. At the same time, we continue to sell our non-core assets, including BOK and our remaining Global Servicing Solutions, LLC (GSS) partnerships. On June 19, 2009, we completed the sale of GSS Germany for $1,180, resulting in a gain of approximately $715.
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, with our Consolidated Financial Statements and the related notes, included as Exhibit 99.1 to the Form 8-K filed July 16, 2009, and with our Annual Report on Form 10-K for the year ended December 31, 2008.
Unless specifically stated otherwise, all references to June 2009, December 2008 and June 2008 refer to our fiscal periods ended, or the dates, as the context requires, June 30, 2009, December 31, 2008 and June 30, 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
Three Months Ended June 2009 versus June 2008. We generated net income of $17,830 or $0.26 per share in the second quarter of 2009 compared to a net loss of $2,717 or $0.04 per share for the second quarter of 2008. Income from continuing operations before income taxes was $26,345 for the second quarter of 2009 as compared to $3,112 for the second quarter of 2008.
Our results benefited from the cost reduction efforts that we announced in the fourth quarter of 2008 as evidenced by the 11% decline in operating expenses in the second quarter of 2009 compared to the second quarter of 2008. We achieved this improvement despite $1,850 in professional services expenses, primarily related to the Altisource Separation.
We recorded unrealized fair value gains of $5,435 on trading securities in the second quarter of 2009. In comparison, the net loss in the second quarter of 2008 included approximately $22,795 of unrealized losses comprised of $8,140 of mark-to-market losses on trading securities and $14,655 in unrealized losses primarily related to derivative mark-to-market losses at an unconsolidated subsidiary.
Servicing segment revenues declined as expected due to the implementation of new underwriting and documentation requirements to complete modifications under the federal government’s Home Affordable Modification Program (HAMP) (see Segments—Servicing for additional details of this impact) and as a result of lower average UPB. However, this decline was partially offset by higher process management revenues in the second quarter of 2009 as compared to the second quarter of 2008. Servicing also benefited from lower interest expense in the second quarter of 2009 compared to 2008. Both Loans and Residuals and Asset Management Vehicles reported a decrease in unrealized losses due to smaller declines in the estimated market value of loans, real estate and securities.
Mortgage Services income from continuing operations benefited from geographic expansion, increased penetration of existing clients and the introduction of new default-oriented products. Financial Services experienced a decline in revenue as lower collection rates, due to the current economic climate and consistent with the experience of the collections industry in general, continued to adversely impact results in the second quarter of 2009 as compared to 2008. Technology Products’ income from continuing operations improved in the second quarter of 2009, as compared to 2008, benefiting from the growth of an existing client in the second quarter of 2009 and because we did not recognize any of the losses of BMS Holdings, an unconsolidated subsidiary, in 2009. We suspended the equity method of accounting for our investment in BMS Holdings in the second quarter of 2008 because losses had reduced our investment to zero.
32
Six Months Ended June 2009 versus June 2008. We generated net income of $32,939 or $0.49 per share in the six months ended June 2009 compared to $2,555 or $0.04 per share for the six months ended June 2008. Income from continuing operations before income taxes was $49,609 as compared to $11,529 for the six months ended June 2009 and 2008, respectively.
Our results for the six months ended June 2009 benefited from the cost reduction efforts that we announced in the fourth quarter of 2008 as evidenced by the 14% decline in operating expenses in the first half of 2009 compared to 2008. We achieved this improvement despite $2,981 in professional services expenses, primarily related to the Altisource Separation.
We recorded unrealized fair value gains of $5,055 on trading securities in the six months ended June 2009. In comparison, the net loss in the six months ended June 2008 included approximately $27,749 of unrealized losses comprised of $20,049 of mark-to-market losses on trading securities and $7,700 in unrealized losses primarily related to losses at an unconsolidated subsidiary.
Strategic Priorities
Ocwen continues to focus on four initiatives:
| | |
| 1. | Liquidity and balance sheet strength |
| 2. | Revenue opportunities |
| 3. | Quality and cost structure leadership |
| 4. | Separation of Ocwen Solutions |
Achieving these initiatives, as more fully described in the following sub-sections, will reinforce our core competitive strengths. Our core competitive strengths are:
| | |
| · | Lowest Cost Provider. We believe OLS has the lowest operating cost in the mortgage servicing industry. Based on average industry cost information provided by a third party valuation consultant OLS’ net cost to service a non performing loan was 58% lower than the average net cost for the subprime industry as of May 31, 2009. |
| | |
| · | Superior Loss Mitigation and Cash Management. Two recent independent studies comparing servicer performance in servicing non-performing residential loans confirmed that we lead the industry in realizing cash flows for investors and keeping families in their homes. A Moody’s Investors Service study in January 2007 showed that we achieved double the cure rate of subprime servicers rated “average” by Moody’s and 6% higher than the cure rate of subprime servicers rated “strong” despite having a more challenging portfolio consisting of older mortgages with lower credit quality and a higher proportion of second liens. Similarly, in July 2009, Bank of America/Merrill Lynch found that we have the highest “roll rate from 90+ days delinquent to current” for both subprime fixed and adjustable rate loans. We believe these studies, together with our selection by Freddie Mac as a special servicer (as described below), demonstrate our capability to work effectively with delinquent borrowers and generate greater cash flows than any other servicer. This success in returning loans to performing status enables us to decrease our need for advances which, in turn, reduces our interest expense. |
| | |
| · | High Barriers to Entry. Our servicing platform runs on a proprietary information technology system developed over a 20-year period at a cost of more than $140,000. Currently, we employ over 270 software developers focused on identifying additional opportunities to automate manual processes to eliminate variability and to increase the quality and timeliness of decision-making processes and information transfers. Our proprietary tools and contractual arrangements are utilized to analyze the data collected and are enhanced by a feedback loop that provides updated information on the latest servicing and property valuation data gathered by various Ocwen entities. |
| | |
| · | Scalability and Flexibility. With our highly automated, artificial intelligence driven technology platforms and global workforce, we can quickly scale our servicing platform to handle acquired loan portfolios with modest infrastructure additions. |
Liquidity and Balance Sheet Strength. We believe our improved liquidity position and strengthened balance sheet provide us with greater flexibility and a competitive advantage over our peers to pursue attractive investment opportunities. We focused this quarter on further increasing borrowing capacity and were successful, as more fully described in the Executive Summary—Liquidity section below. Furthermore, on July 16, 2009, we filed a Form S-3 enabling us to pursue additional equity funding on an as needed basis. We expect to partially or wholly fund servicing rights acquisition opportunities by issuing additional equity through an equity issuance.
We believe an offering under the Term Asset-Backed Securities Loan Facility program (TALF) will enhance our liquidity and balance sheet. We are currently working on a TALF offering to replace an existing $165,000 medium term advance note prior to this note entering its amortization period in December 2009 and have secured consent from the holders of the note to repay these notes on August 11, 2009. We may increase this TALF issuance or execute a second TALF deal depending upon our success in acquiring additional servicing rights.
Revenue Opportunities. We believe that the current economic environment combined with government financial stability initiatives affords us a unique opportunity to capitalize upon our core competitive strengths. Our revenue growth efforts are focused on developing opportunities in each of our lines of business.
33
Opportunities for revenue growth in the Ocwen Asset Management line of business include:
| | |
| · | Acquisition of Servicing Rights. Servicing rights for several loan portfolios are for sale in our industry, and we are in the process of evaluating these opportunities. We expect that any acquisition will be within our core competency of servicing subprime portfolios. We estimate that the total size of the market for such loan portfolios is approximately $800,000,000 UPB, and we are evaluating opportunities to buy the servicing rights for over $75,000,000 UPB. |
| | |
| · | Special Servicing Opportunities. We are aggressively pursuing special servicing opportunities that require little capital. In February 2009, we were selected as a special servicer of non-performing loans for Freddie Mac under a high-risk-loan pilot program. This pilot program with Freddie Mac is an example of the kind of business that we are targeting. |
| | |
| · | Asset Management Vehicle. Based on our investment track record, our expertise in the mortgage sector and the strength of our servicing platform, we believe the current distressed mortgage market may provide an opportunity to sponsor an asset management vehicle focused on investment opportunities in the mortgage sector including, among others, investments in residential mortgage-backed securities, whole loans and servicing rights. If undertaken, we would expect to earn fee income and a carried interest for investment advisory services as well as sub-servicing fees for any investments by the vehicle in whole loans and servicing rights. Any such opportunity will depend upon a variety of considerations to be evaluated at the relevant time. |
Our Ocwen Solutions line of business is focused on two primary opportunities to grow revenues:
| | |
| · | Product Diversification. We continue to develop a suite of services addressing the entire mortgage lifecycle. We believe our technological capabilities are a differentiating factor across our entire product platform. |
| | |
| · | 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 grow our revenue base. |
In the second quarter of 2009, our results benefited from our efforts to diversify our product line and expand our geographic footprint at Ocwen Solutions.
Quality and Cost Structure. We believe that quality and cost are intrinsically related in that errors increase costs and destroy quality. We are beginning to realize quality improvements and cost savings from three specific initiatives that we launched last quarter. 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. On August 1, 2009, we introduced our new Loan Resolution Module specifically designed to increase our HAMP loan modification efforts. We expect numerous additional scripting and technology enhancements in the third quarter as we seek to implement a process that is fully integrated and automated, eliminating unstructured thinking and decisions. 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 (the Separation). Given the need to consolidate the businesses to be separated and the domicile of the newly formed entity, Altisource Portfolio Solutions S.A. (Altisource) (NASDAQ: ASPS), Ocwen will incur taxes to the extent that the fair market value of Altisource assets exceeds Ocwen's tax basis in such assets in accordance with section 367 of the Internal Revenue Code. We made our decision based upon a strategic analysis that concluded that the Separation would:
| | |
| · | 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. |
On July 22, 2009, a registration statement on Form 10 was declared effective by the Securities and Exchange Commission (SEC) for the Separation. On August 10, 2009, the shares of Altisource will be distributed to the OCN shareholders and Convertible Notes holders of record as of August 4, 2009, in the form of a pro rata stock distribution. Each OCN shareholder will receive one share of Altisource common stock for every three shares of OCN common stock held as of the close of business on the record date of the distribution, August 4, 2009. Each Convertible Notes holder will participate in the distribution of Altisource shares based on the conversion ratio of the Convertible Notes, consistent with the pro rata distribution ratio of one share of Altisource common stock for every three shares of Ocwen common stock, without conversion of the Convertible Notes into common shares of Ocwen. Accordingly, upon the separation of Altisource and Ocwen there will be no adjustment to the conversion ratio of the Convertible Notes. No action is required by OCN shareholders or Convertible Notes holders to receive the shares of Altisource common stock.
After the completion of the spin-off, Altisource’s largest customer will initially be Ocwen, and Altisource will enter into long-term servicing contracts with Ocwen for terms of up to eight year. There are other arrangements between Altisource and Ocwen that will continue following the spin-off to govern certain ongoing relationships and to provide for an orderly transition to the status of two independent companies. Under these agreements Altisource and Ocwen will both provide and receive certain corporate services at prevailing market rates.
34
Although Altisource will be a separate company from Ocwen after the spin-off, Altisource and Ocwen will have the same Chairman of the Board, William C. Erbey. Mr. Erbey is also the current Chief Executive Officer of Ocwen and will remain in that role after the spin-off (Mr. Erbey will serve as Altisource’s Non-executive Chairman). As a result, he has obligations to Ocwen as well as to Altisource.
Outlook
Ocwen Asset Management. We are currently evaluating acquisition opportunities for mortgage servicing portfolios. In addition, we are aggressively pursuing special servicing opportunities that require limited capital such as our pilot program with Freddie Mac. Advances, including match funded advances, declined $165,699 in the six months of 2009. We expect this trend to continue through the remainder of 2009 although the rate of decline is likely to slow.
We recognize revenue in the form of deferred servicing fees and ancillary fee income whenever we return a loan to performing status whether it be through a HAMP modification, a non-HAMP modification or otherwise. We completed over 20,000 modifications in both the second quarter of 2008 and the first quarter of 2009, while only completing just over 8,000 HAMP and non-HAMP loan modifications in the second quarter of 2009. The decline in modifications in the second quarter represents delayed modifications, not lost modifications. If a borrower is unable to qualify for the HAMP, we work to complete a non-HAMP loan modification when appropriate. We expect to begin generating revenues under the HAMP in the third quarter of 2009 after qualifying loan modifications pass the 90-day trial period. Additionally, HAMP modifications are expected to provide incremental revenue and pre-tax income versus non-HAMP loan modifications as a result of the government incentive of $1,000 (actual dollars) per completed loan modification. We expect revenue improvement in the third and fourth quarters as the number of completed HAMP modifications accelerates, and the combined HAMP and non-HAMP completed modifications return to normal levels based on our UPB serviced. See Segments—Servicing below for additional details of regarding the HAMP.
We continue to reduce non-core assets through sales and deploy cash proceeds in our core businesses. We are also currently working on a TALF offering to replace an amortizing medium term advance note with longer term financing at attractive rates. We expect to continue to improve the strength of our balance sheet. We expect to expand the size of the servicing portfolio, thereby utilizing our technological and low cost labor advantages to create significant value for our shareholders.
Ocwen Solutions. The primary growth engine for Ocwen Solutions in the near term will continue to be Mortgage Services. We continue to expand the array and geographical range of services that we provide to originators and servicers. These services include due diligence, valuation, real estate sales, default processing services, property inspection and preservation services, homeowner outreach, closing and title services and knowledge process outsourcing services.
We expect limited revenue growth in Financial Services in 2009 but remain focused on implementing our strategic initiatives to favorably position ourselves for future growth when market conditions improve. 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. Most importantly, however, NCI remains a top tier performer for its most important clients. NCI will continue to focus on reducing operating costs by closing offices, improving processes and implementing its strategic initiatives which include scoring, scripting and optimal debtor resolution.
Liquidity
Cash totaled $213,911, or 11% of total assets at June 30, 2009. This compares to cash of $201,025, or 9% of total assets at December 31, 2008, and cash of $148,835, or 6% of total assets a year ago at June 30, 2008.
Servicer liabilities, which represent cash collected from borrowers but not yet remitted to securitization trusts, declined by $57,977 from December 31, 2008 to June 30, 2009. Servicer liabilities have a very short duration as funds collected must be remitted to the trust in accordance with the contractual obligation. The $165,699 decline in total advances in the first six months of 2009 is attributable to the success of our efforts to stabilize the delinquency rate which has allowed advances to decline somewhat faster than UPB.
Our borrowings as of June 30, 2009 include $176,668 borrowed under the Investment Line term note that is used to finance the auction rate securities which we are carrying at a fair value of $243,285. In the first six months of 2009, we repaid $24,051 of the Investment Line term note principal. This amount includes proceeds of $2,000 from the redemption of certain securities. On April 30, 2009, we renewed this term note through June 2010. We renewed this agreement early under terms substantially similar to the previous agreement, except that amortization payments are now $3,000 per month in place of the previous quarterly reductions in the advance rate.
Excluding the Investment Line, our borrowings have decreased by $215,809 since December 31, 2008, primarily reflecting a reduction in borrowings by the Servicing and Loans and Residuals segments and Corporate Items and Other. 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 February 2009 repurchase of 3.25% Convertible Notes with a face value of $25,910.
35
Excluding the Investment Line, our total maximum borrowing capacity was $1,536,810 as of June 30, 2009, an increase of $196,063 as compared to December 31, 2008. This increase is primarily due to an increase in borrowing capacity of the Servicing segment offset by a decline in borrowing capacity of the Loans and Residuals and Financial Services segments. The increase in Servicing borrowing capacity is principally the result of entering into two new facilities in March 2009 and expanding an existing facility in May 2009. One of the new facilities represented a $60,000 advance in the form of zero-coupon bonds that we initially recorded at $45,373, net of a discount of $14,627. The other new facility is a $7,000 term note. Both of these new facilities are secured by the pledge of advances. We secured an increase in the maximum borrowing under the existing facility from $300,000 to $500,000 and extended the amortization date by one year to May 4, 2010.
At June 30, 2009, excluding the Investment Line, $653,118 of our total maximum borrowing capacity remained unused, all attributable to the Servicing business. The unused borrowing capacity in the Servicing business may be utilized in the future by pledging qualifying collateral to our facilities.
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 cover possible additional principal repayments on our MSR term note in the event that declines in the collateral value as determined by a third party appraiser are greater than the scheduled amortization of this note of $6,999 per month.
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 meet their commitments to provide us with the cash that is required to make remittances to the Servicing investors. Some of the financial institutions lending to us have experienced significant financial losses and as a result have undergone restructuring and raised additional capital, either as part of or outside of the various government rescue plans. 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 six months of 2009, financing costs declined from the level in the first six months of 2008 due to lower advance balances and a reduction in interest rates. One-month LIBOR, which is the reference rate for most of our borrowings declined significantly in the first six months of 2009, although the effect of this decrease on our cost of borrowing was more than offset by higher facility costs and higher average spreads over LIBOR. As a result, the interest rate we incurred on the average balance of our debt outstanding under match funded facilities and lines of credit and other secured borrowings increased to 6.67% for the first six months of 2009 from 6.29% for the first six months of 2008.
CRITICAL ACCOUNTING POLICIES
Our ability to measure and report our operating results and financial position is significantly 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 for the year ended December 31, 2008 included in Exhibit 99.1 on Form 8-K filed July 16, 2009.
36
RESULTS OF OPERATIONS AND CHANGES IN FINANCIAL CONDITION
Operations Summary
The following table summarizes our consolidated operating results for the periods ended June 30, 2009 and 2008. We have provided a more complete discussion of operating results by line of business in the Segments section.
| | | | | | | | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | % Change | | 2009 | | 2008 | | % Change | |
| | | | | | | | | | | | | |
Consolidated: | | | | | | | | | | | | | | | | | | | |
Revenue | | $ | 109,179 | | $ | 131,225 | | (17 | ) | | $ | 223,769 | | $ | 259,476 | | (14 | ) | |
Operating expenses | | | 72,650 | | | 81,266 | | (11 | ) | | | 144,916 | | | 169,341 | | (14 | ) | |
| | | | | | | | | | | | | | | | | | | |
Income from operations | | | 36,529 | | | 49,959 | | (27 | ) | | | 78,853 | | | 90,135 | | (13 | ) | |
Other income (expense), net | | | (10,184 | ) | | (46,847 | ) | (78 | ) | | | (29,244 | ) | | (78,606 | ) | (63 | ) | |
| | | | | | | | | | | | | | | | | | | |
Income from continuing operations before taxes | | | 26,345 | | | 3,112 | | 747 | | | | 49,609 | | | 11,529 | | 330 | | |
Income tax expense | | | 9,472 | | | 424 | | 2,134 | | | | 17,509 | | | 3,363 | | 421 | | |
| | | | | | | | | | | | | | | | | | | |
Income from continuing operations | | | 16,873 | | | 2,688 | | 528 | | | | 32,100 | | | 8,166 | | 293 | | |
Income (loss) from discontinued operations, net of taxes | | | 1,052 | | | (5,182 | ) | 120 | | | | 864 | | | (5,386 | ) | 116 | | |
| | | | | | | | | | | | | | | | | | | |
Net income | | | 17,925 | | | (2,494 | ) | 819 | | | | 32,964 | | | 2,780 | | 1,086 | | |
Net loss (income) attributable to minority interest in subsidiaries | | | (95 | ) | | (223 | ) | (57 | ) | | | (25 | ) | | (225 | ) | (89 | ) | |
| | | | | | | | | | | | | | | | | | | |
Net income (loss) attributable to Ocwen Financial Corp | | $ | 17,830 | | $ | (2,717 | ) | 756 | | | $ | 32,939 | | $ | 2,555 | | 1,189 | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Segment income (loss) from continuing operations before taxes: | | | | | | | | | | | | | | | | | | | |
Servicing | | $ | 15,503 | | $ | 31,862 | | (51 | ) | | $ | 40,700 | | $ | 53,291 | | (24 | ) | |
Loans and Residuals | | | (2,843 | ) | | (5,441 | ) | (48 | ) | | | (6,981 | ) | | (9,100 | ) | (23 | ) | |
Asset Management Vehicles | | | (1,402 | ) | | (1,278 | ) | 10 | | | | (1,929 | ) | | (2,724 | ) | (29 | ) | |
Mortgage Services | | | 8,848 | | | 4,228 | | 109 | | | | 13,995 | | | 7,382 | | 90 | | |
Financial Services | | | (1,733 | ) | | (2,592 | ) | (33 | ) | | | (3,034 | ) | | (2,572 | ) | 18 | | |
Technology Products | | | 4,935 | | | (11,032 | ) | 145 | | | | 7,259 | | | (1,420 | ) | 611 | | |
Corporate Items and Other | | | 3,037 | | | (12,635 | ) | 124 | | | | (401 | ) | | (33,328 | ) | (99 | ) | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 26,345 | | $ | 3,112 | | 747 | | | $ | 49,609 | | $ | 11,529 | | 330 | | |
| | | | | | | | | | | | | | | | | | | |
Income from operations declined by 27% in the second quarter of 2009 as compared to 2008, reflecting a significant reduction in revenues that was partially offset by a decline in operating expenses. Lower interest expense and lower fair value adjustments on securities and loans resulted in a $23,233 increase in income from continuing operations before income taxes.
Total revenues declined by $22,046 or 17% in the second quarter of 2009 as compared to 2008 principally because of a decrease in Servicing revenue. Of the total decline in Servicing revenue in the second quarter of 2009, $8,142 was attributable to the implementation of new underwriting and documentation requirements to complete modifications under the HAMP, while the majority of the remainder was due to lower UPB. Financial Services segment revenue also declined in the second quarter of 2009 largely due to lower collection rates. Mortgage Services revenue increased over the second quarter of 2008 primarily as a result of geographic expansion, increased penetration of existing clients and the introduction of new default-oriented products.
Total operating expenses were $8,616, or 11% lower in the second quarter of 2009 as compared to 2008. This is primarily due to declines in operating expenses of the Servicing segment. Operating expenses of the Servicing segment declined primarily due to lower amortization of servicing rights on a smaller servicing portfolio, and lower servicing and origination expense as a result of a reduction in loan payoffs and reduced staffing levels.
Other expense, net, for the second quarter of 2009 was $10,184 as compared to $46,847 for the second quarter of 2008, a favorable variance of $36,663. This variance is the result of several factors:
| | |
| · | In the Servicing segment, interest expense on match funded liabilities and lines of credit was $3,056 lower in the second quarter of 2009. This decline occurred primarily because the decline in the average balance of advances outweighed the impact of an increase in interest rates that resulted from higher spreads over LIBOR and higher facility fees charged by lenders on new and renewed financing facilities. |
| | |
| · | In the Loans and Residuals segment, losses on loans declined by $2,942 in the second quarter of 2009 reflecting lower charges to reduce loans to fair value. |
37
| | |
| · | In the AMV segment, our equity interest in the losses of OSI and ONL and affiliates for the second quarter of 2009 was $576. This compares to losses of $1,103 for the second quarter of 2008. The losses in 2008 reflect higher charges to reduce residual securities, loans and real estate to fair value. |
| | |
| · | In the Technology Products segment, our share of the losses of BMS Holdings was $13,552 for the second quarter of 2008 as compared to zero for the second 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 gain of $6,024 on our auction rate securities in the second quarter of 2009 based on improvements in the underlying collateral markets and liquidity solution discussions with counterparties. This compares to an unrealized loss of $6,768 in the second quarter of 2008. |
Financial Condition Summary
Total assets declined by $202,815, or 9%, in the first six months of 2009. This decrease was due to declines in all asset categories except for cash, auction rate securities and receivables:
| | |
| · | Cash increased by $12,886 to a balance of $213,911 at June 30, 2009. |
| | |
| · | Auction rate securities increased by $3,984 due to unrealized gains of $5,984 that were partially offset by $2,000 of redemptions at par value. |
| | |
| · | Loans held for resale declined by $10,192 due to foreclosures, charge-offs, payoffs and declines in estimated values. |
| | |
| · | Total advances declined by $165,699 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 $217,346 decline in match funded advances and a $51,647 increase in advances as a result of moving collateral from match funded advance facilities to a non-match funded facility. |
| | |
| · | MSRs decreased by $6,771 as amortization of $17,005 exceeded acquisitions of $10,241 for the first six months of 2009. |
| | |
| · | Investment in unconsolidated entities declined by $4,394 primarily due to $3,246 of distributions received from our asset management entities and charges to reduce residual securities, loans and real estate held by those entities to fair value. |
Total liabilities declined by $287,718, or 18%, in the first six months of 2009. This decrease was the result of declines in all liability categories except for lines of credit and other secured borrowings and other liabilities:
| | |
| · | Match funded liabilities declined by $196,916 as a result of the decline in match funded advances. |
| | |
| · | Lines of credit and other secured borrowings increased by $4,940 principally because of $53,519 of borrowings, net of discount, under two new facilities offset in part by $41,995 of repayments of borrowings under the senior secured credit agreement term note that is used to finance MSRs. |
| | |
| · | The Investment Line term note declined by $24,051 due to repayments. |
| | |
| · | Servicer liabilities declined by $57,977 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 $23,833. 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 June 30, 2009, total equity was $694,544, an increase of $84,903 over December 31, 2008. This increase was primarily due to net income of $32,939 and the sale of 5,471,500 shares of common stock for $60,187, less the repurchase of 1,000,000 shares of common stock for $11,000. The exercise of stock options and the compensation related to employee share-based awards also contributed to the increase in equity in 2009.
38
SEGMENTS
The following section provides a discussion of changes in the financial condition of our business segments during the six months ended June 30, 2009 and a discussion of the results of continuing operations of our business segments for the three and six months ended June 30, 2009 and 2008.
The following table presents assets and liabilities of each of our business segments at June 30, 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 | | $ | 7 | | $ | 141 | | $ | — | | $ | 228 | | $ | 6,553 | | $ | — | | $ | 206,982 | | $ | — | | $ | 213,911 | |
Cash held for clients | | | — | | | — | | | — | | | — | | | 416 | | | — | | | — | | | (416 | ) | | — | |
Trading securities, at fair value: | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Auction rate | | | — | | | — | | | — | | | — | | | — | | | — | | | 243,285 | | | — | | | 243,285 | |
Subordinates and residuals | | | — | | | 3,341 | | | — | | | — | | | — | | | — | | | 99 | | | — | | | 3,440 | |
Loans held for resale | | | — | | | 39,726 | | | — | | | — | | | — | | | — | | | — | | | — | | | 39,726 | |
Advances | | | 148,865 | | | 4,739 | | | — | | | — | | | — | | | — | | | 128 | | | — | | | 153,732 | |
Match funded advances | | | 883,209 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 883,209 | |
Mortgage servicing rights | | | 132,729 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 132,729 | |
Receivables | | | 14,483 | | | 1,362 | | | 563 | | | 4,654 | | | 5,517 | | | 1,659 | | | 19,685 | | | — | | | 47,923 | |
Deferred tax asset, net | | | — | | | — | | | — | | | — | | | — | | | — | | | 161,180 | | | — | | | 161,180 | |
Goodwill and intangibles | | | — | | | — | | | — | | | — | | | 44,464 | | | 1,618 | | | — | | | — | | | 46,082 | |
Premises and equipment | | | 46 | | | — | | | — | | | 7 | | | 3,700 | | | 4,467 | | | 2,860 | | | — | | | 11,080 | |
Investment in unconsolidated entities | | | — | | | — | | | 21,190 | | | — | | | — | | | — | | | 79 | | | — | | | 21,269 | |
Other assets | | | 54,590 | | | 4,829 | | | (100 | ) | | 69 | | | 1,123 | | | 916 | | | 15,122 | | | 170 | | | 76,719 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,233,929 | | $ | 54,138 | | $ | 21,653 | | $ | 4,958 | | $ | 61,773 | | $ | 8,660 | | $ | 649,420 | | $ | (246 | ) | $ | 2,034,285 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Match funded liabilities | | $ | 765,023 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 765,023 | |
Lines of credit and other secured borrowings | | | 109,511 | | | 12,299 | | | — | | | — | | | — | | | — | | | — | | | — | | | 121,810 | |
Investment line | | | — | | | — | | | — | | | — | | | — | | | — | | | 176,668 | | | — | | | 176,668 | |
Servicer liabilities | | | 77,674 | | | — | | | — | | | — | | | — | | | — | | | 100 | | | — | | | 77,774 | |
Cash due to clients | | | — | | | — | | | — | | | — | | | 416 | | | — | | | — | | | (416 | ) | | — | |
Debt securities | | | — | | | — | | | — | | | — | | | — | | | — | | | 109,534 | | | — | | | 109,534 | |
Other liabilities | | | 38,753 | | | 1,292 | | | 435 | | | 1,791 | | | 6,581 | | | 2,224 | | | 37,584 | | | 272 | | | 88,932 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | $ | 990,961 | | $ | 13,591 | | $ | 435 | | $ | 1,791 | | $ | 6,997 | | $ | 2,224 | | $ | 323,886 | | $ | (144 | ) | $ | 1,339,741 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
39
The following table presents the statements of continuing operations before income taxes for each of our business segments for the six months ended June 30, 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 | | $ | 117,877 | | $ | — | | $ | — | | $ | 530 | | $ | 26,495 | | $ | — | | $ | 5 | | $ | (609 | ) | $ | 144,298 | |
Process management fees | | | 19,544 | | | — | | | — | | | 41,667 | | | 7,292 | | | 1,553 | | | — | | | 3,722 | | | 73,778 | |
Other revenues | | | — | | | — | | | 997 | | | (15 | ) | | — | | | 21,129 | | | 360 | | | (16,778 | ) | | 5,693 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | | 137,421 | | | — | | | 997 | | | 42,182 | | | 33,787 | | | 22,682 | | | 365 | | | (13,665 | ) | | 223,769 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Operating expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Compensation and benefits | | | 16,345 | | | 11 | | | 1,781 | | | 5,770 | | | 16,712 | | | 4,388 | | | 10,792 | | | — | | | 55,799 | |
Amortization of servicing rights | | | 18,584 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 18,584 | |
Servicing and origination | | | 4,181 | | | 7 | | | — | | | 17,074 | | | 7,211 | | | — | | | — | | | — | | | 28,473 | |
Technology and communications | | | 5,968 | | | 92 | | | 201 | | | 1,986 | | | 3,956 | | | 8,071 | | | 1,815 | | | (12,800 | ) | | 9,289 | |
Professional services | | | 4,619 | | | (90 | ) | | 428 | | | 416 | | | 1,247 | | | 6 | | | 8,768 | | | — | | | 15,394 | |
Occupancy and equipment | | | 5,005 | | | — | | | 68 | | | 623 | | | 2,438 | | | 1,098 | | | 1,632 | | | — | | | 10,864 | |
Other operating expenses | | | 12,471 | | | 1,289 | | | (700 | ) | | 3,040 | | | 4,142 | | | 1,731 | | | (15,194 | ) | | (266 | ) | | 6,513 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses | | | 67,173 | | | 1,309 | | | 1,778 | | | 28,909 | | | 35,706 | | | 15,294 | | | 7,813 | | | (13,066 | ) | | 144,916 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Income (loss) from operations | | | 70,248 | | | (1,309 | ) | | (781 | ) | | 13,273 | | | (1,919 | ) | | 7,388 | | | (7,448 | ) | | (599 | ) | | 78,853 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest income | | | 78 | | | 3,875 | | | — | | | 2 | | | — | | | — | | | 464 | | | — | | | 4,419 | |
Interest expense | | | (31,484 | ) | | (1,149 | ) | | — | | | (22 | ) | | (1,138 | ) | | (250 | ) | | 80 | | | — | | | (33,963 | ) |
Gain (loss) on trading securities | | | — | | | (863 | ) | | — | | | — | | | — | | | — | | | 5,918 | | | — | | | 5,055 | |
Gain on debt repurchases | | | — | | | — | | | — | | | — | | | — | | | — | | | 534 | | | — | | | 534 | |
Loss on loans held for resale, net | | | — | | | (7,541 | ) | | — | | | — | | | — | | | — | | | — | | | — | | | (7,541 | ) |
Equity in earnings of unconsolidated entities | | | — | | | — | | | (1,148 | ) | | — | | | — | | | — | | | — | | | 599 | | | (549 | ) |
Other, net | | | 1,858 | | | 6 | | | — | | | 742 | | | 23 | | | 121 | | | 51 | | | — | | | 2,801 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other income (expense), net | | | (29,548 | ) | | (5,672 | ) | | (1,148 | ) | | 722 | | | (1,115 | ) | | (129 | ) | | 7,047 | | | 599 | | | (29,244 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Income (loss) from continuing operations before income taxes | | $ | 40,700 | | $ | (6,981 | ) | $ | (1,929 | ) | $ | 13,995 | | $ | (3,034 | ) | $ | 7,259 | | $ | (401 | ) | $ | — | | $ | 49,609 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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
Three Months Ended June 2009 versus June 2008. Servicing continues to be our most profitable segment despite a 32% decline in total revenue in the second quarter of 2009 as compared to 2008. Servicing fees have declined due to a decline in the average balance of loans serviced and the implementation of HAMP, as discussed below. The average UPB of loans that we service for others was 17% lower in the second quarter of 2009 as compared to the second quarter of 2008. Lower float balances and lower interest rates have resulted in a decline in float earnings. The decline in revenue was somewhat offset by a 23% 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 a 23% reduction in average staffing levels. As a result, income from operations declined by $19,920, or 40% in the second quarter of 2009 as compared to 2008. Total interest expense declined by $2,852, or 15% and income before income taxes declined by $16,359, or 51%, in the second quarter of 2009.
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, the number of non-performing loans serviced declined by 2,321 in the second 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 second quarter of 2009 to 27.4% at June 30, 2009 from 25.1% at March 31, 2009, as the average size of delinquent loans increased. Servicing and subservicing fees, excluding float earnings and ancillary income, declined by 27% in the second quarter of 2009 as compared to 2008 due to the decline in UPB serviced. Prepayment speed was lower in the second 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 84% of prepayments during the second quarter of 2009 as compared to approximately 65% for the second 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.
40
During the first quarter of 2009, the President and U.S. Department of the Treasury announced and issued guidelines for the HAMP. On April 13, 2009, we announced our active participation in this plan. The HAMP provides a financial incentive for us to modify qualifying loans in accordance with the plan’s guidelines and requirements. 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 that 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. An additional 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 recognize revenue in the form of deferred servicing fees and ancillary fee income whenever we return a loan to performing status whether it be through a HAMP modification, a non-HAMP modification or otherwise.
The HAMP program is more document intensive than most of our previous loan modification efforts (which extends timelines due to the delay in borrowers responding to document requests). This, along with the extensive set of rules imposed by the government under the HAMP, obligated us to review all in-process loan modifications, essentially restarting the process using different underwriting and documentation requirements.
As a result, we experienced a 61% decline in the number of completed modifications as compared to both the second quarter of 2008 and the first quarter of 2009. We completed over 20,000 modifications in both the second quarter of 2008 and the first quarter of 2009, while only completing just over 8,000 loan modifications in the second quarter of 2009. The decline in modifications represents delayed modifications, not lost modifications. If a borrower is unable to qualify for the HAMP, we work to complete a non-HAMP loan modification when appropriate.
Of the total decline in Servicing and subservicing fees in the second quarter of 2009, $8,142 was attributable to implementing the HAMP which caused loan modifications that would ordinarily have been completed in the quarter to be delayed. HAMP modification offers were extended to 404 borrowers in April 2009, 836 in May 2009 and 2,172 in June 2009. In July 2009 HAMP modification offers were extended to 3,292 borrowers as compared to a total of 3,412 for the three months ended June 2009. As of June 30, 2009, 1,058 borrowers began making trial payments under HAMP-eligible modifications. We expect revenue improvement in the third quarter and increasing in the fourth quarter as the number of completed HAMP modifications accelerates, and the combined HAMP and non-HAMP completed modifications return to normal levels.
Six Months Ended June 2009 versus June 2008. Year to date revenue declined by 23% in 2009 as compared to the same period of 2008, largely due to a decline in servicing and subservicing fees. The decline in servicing fees and subservicing fees is primarily the result of the continued contraction of the loan servicing portfolio. The average UPB of loans that we service for others was 20% lower in the first six months of 2009 as compared to 2008. Lower float balances and lower interest rates have resulted in a decline in float earnings. The decline in revenue was somewhat offset by a 21% decline in operating expenses, primarily amortization of servicing rights, compensation and benefits and servicing and origination. Amortization of MSRs declined due to declines in projected prepayment speeds and acquisitions of MSRs. 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 a 21% reduction in average staffing levels. As a result, income from operations declined by $24,004, or 25% in the first six months of 2009 as compared to 2008. Total interest expense declined by $10,355, or 25%, and income before income taxes declined by $12,591, or 24% in the first six months of 2009.
41
The following table provides key business drivers and other selected revenue and expense items of our residential servicing business at or for the three and six months ended June 30:
| | | | | | | | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | %
Change | | 2009 | | 2008 | | %
Change | |
| | | | | | | | | | | | | |
Average UPB of loans and real estate serviced | | $ | 39,588,301 | | $ | 47,833,365 | | (17 | )% | | $ | 39,718,475 | | $ | 49,746,825 | | (20 | )% | |
Prepayment speed (average CPR) | | | 22 | % | | 26 | % | (15 | ) | | | 21 | % | | 25 | % | (16 | ) | |
UPB of non-performing loans and real estate serviced as a % of total at June 30 (1)(2) | | | 27.4 | % | | 22.4 | % | 22 | | | | 27.4 | % | | 22.4 | % | 22 | | |
Average number of loans and real estate serviced | | | 295,139 | | | 386,213 | | (24 | ) | | | 304,118 | | | 402,403 | | (24 | ) | |
Number of non-performing loans and real estate serviced as a % of total at June 30 (1)(2) | | | 18.5 | % | | 16.9 | % | 10 | | | | 18.5 | % | | 16.9 | % | 10 | | |
Average float balances | | $ | 436,600 | | $ | 430,300 | | 1 | | | $ | 399,800 | | $ | 419,600 | | (5 | ) | |
Average balance of advances and match funded advances (3) | | $ | 1,001,274 | | $ | 1,317,607 | | (24 | ) | | $ | 1,062,525 | | $ | 1,334,156 | | (20 | ) | |
Average balance of MSRs | | $ | 137,796 | | $ | 177,407 | | (22 | ) | | $ | 136,162 | | $ | 183,119 | | (26 | ) | |
Collections on loans serviced for others | | $ | 1,787,802 | | $ | 2,967,140 | | (40 | ) | | $ | 3,631,001 | | $ | 6,039,951 | | (40 | ) | |
Servicing and subservicing fees (excluding float and ancillary income) | | $ | 42,360 | | $ | 58,056 | | (27 | ) | | $ | 88,238 | | $ | 113,243 | | (22 | ) | |
Float earnings | | $ | 1,191 | | $ | 2,568 | | (54 | ) | | $ | 3,040 | | $ | 7,001 | | (57 | ) | |
Amortization of servicing rights (4) | | $ | 7,879 | | $ | 14,529 | | (46 | ) | | $ | 17,005 | | $ | 28,332 | | (40 | ) | |
Interest expense on match funded liabilities and lines of credit | | $ | 13,766 | | $ | 16,822 | | (18 | ) | | $ | 26,812 | | $ | 37,611 | | (29 | ) | |
Compensating interest expense | | $ | 389 | | $ | 1,020 | | (62 | ) | | $ | 663 | | $ | 2,130 | | (69 | ) | |
Operating expenses directly related to loss mitigation activities | | $ | 6,491 | | $ | 8,389 | | (23 | ) | | $ | 13,684 | | $ | 15,167 | | (10 | ) | |
| |
(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 $1,123,776 for the first quarter of 2009. |
(4) | During the three and six months ended June 30, 2009, the amount of charges we recognized to increase our servicing liability obligations exceeded amortization by $664 and $1,579, respectively, 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 three and six months ended June 30, 2009 is $8,543 and $18,584, respectively. |
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 | |
| | | | | | | | | | | | | |
June 30, 2009: | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 27,290,158 | | | 230,334 | | $ | — | | | — | | $ | 27,290,158 | | | 230,334 | |
Non-performing (3) | | | 8,606,847 | | | 44,877 | | | 2,509,002 | | | 11,311 | | | 11,115,849 | | | 56,188 | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 35,897,005 | | | 275,211 | | $ | 2,509,002 | | | 11,311 | | $ | 38,406,007 | | | 286,522 | |
| | | | | | | | | | | | | | | | | | | |
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 | |
| | | | | | | | | | | | | | | | | | | |
June 30, 2008: | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 34,802,474 | | | 299,253 | | $ | — | | | — | | $ | 34,802,474 | | | 299,253 | |
Non-performing | | | 6,605,987 | | | 43,945 | | | 4,259,606 | | | 25,580 | | | 10,865,593 | | | 69,525 | |
| | | | | | | | | | | | | | | | | | | |
| | $ | 41,408,461 | | | 343,198 | | $ | 4,259,606 | | | 25,580 | | $ | 45,668,067 | | | 368,778 | |
| | | | | | | | | | | | | | | | | | | |
| |
(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. |
42
| |
(2) | Real estate includes $836,192 of foreclosed residential properties serviced for the VA at June 30, 2008. We elected not to renew our contract with the VA in July 2008. |
(3) | Non-performing loans at June 30, 2009 include loans serviced for Freddie Mac. |
(4) | At June 30, 2009, we serviced 203,603 subprime loans and real estate with a UPB of $29,350,298 as compared to 227,929 with a UPB of $32,776,696 at December 31, 2008. At June 30, 2008, we serviced 256,495 subprime loans and real estate with a UPB of $37,088,298. |
(5) | We serviced under subservicing contracts 97,362 residential loans with a UPB of $9,809,427 as of June 30, 2009. This compares to 108,545 residential loans with a UPB of $10,340,878 as of December 31, 2008 and 120,285 residential loans and real estate with a UPB of $12,605,953 at June 30, 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 | | | 57,000 | | | 180 | |
Runoff | | | (2,440,128 | ) | | (17,758 | ) |
| | | | | | | |
Servicing portfolio at June 30, 2009 | | $ | 38,406,007 | | $ | 286,522 | |
| | | | | | | |
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. We expect various large servicing portfolios are or may be available for acquisition in the near term. We are pursuing opportunities to acquire additional servicing and subservicing business. We are optimistic about our prospects for maintaining our scale and growing the Servicing business through additional servicing acquisitions.
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 June 30, 2009, we were not servicing any loans under these agreements.
Comparative selected balance sheet data is as follows:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Advances | | $ | 148,865 | | $ | 97,098 | |
Match funded advances | | | 883,209 | | | 1,100,555 | |
Mortgage servicing rights (Residential) | | | 132,729 | | | 139,500 | |
Receivables | | | 14,483 | | | 7,936 | |
Debt service accounts | | | 43,090 | | | 58,468 | |
Other | | | 11,553 | | | 13,058 | |
| | | | | | | |
Total assets | | $ | 1,233,929 | | $ | 1,416,615 | |
| | | | | | | |
| | | | | | | |
Match funded liabilities | | $ | 765,023 | | $ | 961,939 | |
Lines of credit and other secured borrowings | | | 109,511 | | | 97,987 | |
Servicer liabilities | | | 77,674 | | | 135,649 | |
Other | | | 38,753 | | | 23,138 | |
| | | | | | | |
Total liabilities | | $ | 990,961 | | $ | 1,218,713 | |
| | | | | | | |
43
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 six months ended June 2009, the combined balance of advances and match funded advances decreased by $165,579, or 14%, due to an 11% 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 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 May 2010.
Mortgage Servicing Rights. The unamortized balance of residential MSRs is primarily related to subprime residential loans. Residential MSRs decreased by $6,771 during the first six months of 2009primarily due to amortization expense of $17,005 which exceed acquisitions of $10,241.
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 $196,916 decrease in match funded liabilities during the first six months of 2009 is primarily the result of the $217,346 reduction in the balance of match funded advances. At both June 30, 2009 and December 31, 2008, 86% of match funded advances were pledged to support borrowings.
Unused borrowing capacity under our match funded facilities increased from $257,893 at December 31, 2008 to $653,118 at June 30, 2009. Our maximum borrowing capacity under our match funded facilities was $1,415,000 at June 30, 2009 as compared to $1,215,000 at December 31, 2008.
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 $41,995 during the first six months of 2009. At both June 30, 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 issued 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 $57,975 during the first six 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.
44
Comparative selected operations data for the periods ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue: | | | | | | | | | | | | | |
Servicing and subservicing fees | | $ | 52,898 | | $ | 83,592 | | $ | 117,877 | | $ | 163,929 | |
Process management fees | | | 9,828 | | | 8,822 | | | 19,544 | | | 14,997 | |
| | | | | | | | | | | | | |
Total revenue | | | 62,726 | | | 92,414 | | | 137,421 | | | 178,926 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Compensation and benefits | | | 7,733 | | | 11,143 | | | 16,345 | | | 21,330 | |
Amortization of servicing rights | | | 8,543 | | | 14,529 | | | 18,584 | | | 28,332 | |
Servicing and origination | | | 2,149 | | | 2,882 | | | 4,181 | | | 6,668 | |
Technology and communications | | | 3,149 | | | 3,544 | | | 5,968 | | | 5,762 | |
Professional services | | | 2,705 | | | 3,034 | | | 4,619 | | | 5,401 | |
Occupancy and equipment | | | 2,143 | | | 3,074 | | | 5,005 | | | 6,460 | |
Other | | | 6,533 | | | 4,517 | | | 12,471 | | | 10,721 | |
| | | | | | | | | | | | | |
Total operating expenses | | | 32,955 | | | 42,723 | | | 67,173 | | | 84,674 | |
| | | | | | | | | | | | | |
Income from operations | | | 29,771 | | | 49,691 | | | 70,248 | | | 94,252 | |
| | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | |
Match funded liabilities | | | (12,736 | ) | | (14,065 | ) | | (24,652 | ) | | (31,765 | ) |
Lines of credit and other secured borrowings | | | (1,030 | ) | | (2,757 | ) | | (2,160 | ) | | (5,846 | ) |
Other | | | (2,216 | ) | | (2,012 | ) | | (4,672 | ) | | (4,228 | ) |
| | | | | | | | | | | | | |
| | | (15,982 | ) | | (18,834 | ) | | (31,484 | ) | | (41,839 | ) |
Other | | | 1,714 | | | 1,005 | | | 1,936 | | | 878 | |
| | | | | | | | | | | | | |
Total other expense | | | (14,268 | ) | | (17,829 | ) | | (29,548 | ) | | (40,961 | ) |
| | | | | | | | | | | | | |
Income before income taxes | | $ | 15,503 | | $ | 31,862 | | $ | 40,700 | | $ | 53,291 | |
| | | | | | | | | | | | | |
Servicing and Subservicing Fees. The principal components of servicing and subservicing fees for the periods ended June 30 are:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Residential | | | | | | | | | | | | | |
Loan servicing and subservicing | | $ | 42,360 | | $ | 58,056 | | $ | 88,238 | | $ | 113,243 | |
Late charges | | | 5,381 | | | 14,428 | | | 16,079 | | | 25,140 | |
Custodial accounts (float earnings) | | | 1,191 | | | 2,568 | | | 3,040 | | | 7,001 | |
Loan collection fees | | | 1,796 | | | 2,577 | | | 3,861 | | | 5,495 | |
Other | | | 1,803 | | | 5,887 | | | 5,954 | | | 12,812 | |
| | | | | | | | | | | | | |
| | | 52,531 | | | 83,516 | | | 117,172 | | | 163,691 | |
Commercial (US) | | | 367 | | | 76 | | | 705 | | | 238 | |
| | | | | | | | | | | | | |
| | $ | 52,898 | | $ | 83,592 | | $ | 117,877 | | $ | 163,929 | |
| | | | | | | | | | | | | |
Residential loan servicing and subservicing fees for the three and six months ended June 2009 declined by 27% and 22% respectively, as compared to the same periods of 2008. These declines are primarily due to a decline in the average balance of loans serviced. The average balance of loans serviced during the three and six months ended June 2009 declined by 17% and 20% respectively, as compared to the same periods of 2008 primarily because of a decline in portfolio acquisitions in 2008. The UPB of the servicing portfolio has declined from $45,668,067 at June 30, 2008 to $38,406,007 at June 30, 2009. For the three months ended June 2009, $8,142 of the decline in Loan servicing and subservicing fees was attributable to the implementation of new underwriting and documentation requirements to complete modifications under the HAMP. We completed over 8,000 loan modifications in the three months ended June 2009 compared to over 20,000 loan modifications in the same period in June 2008.
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 an even 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 second quarter of 2009 the balance of uncollected and unrecognized servicing fees related to delinquent borrower payments increased by $1,925 as compared to a decline of $1,040 during the second quarter of 2008. For the year to date periods, uncollected and unrecognized servicing fees related to delinquent borrower payments increased by $5,632 and $2,661 for 2009 and 2008, respectively. As of June 30, 2009, we estimate that the balance of uncollected delinquent servicing fees that we had not yet recognized as revenue was $55,733 compared to $50,101 at December 31, 2008.
45
The decline in float earnings in the 2009 periods as compared to the same periods 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 periods ended June 30:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Average custodial account balances | | $ | 436,600 | | $ | 430,300 | | $ | 399,800 | | $ | 419,600 | |
Float earnings (1) | | $ | 1,191 | | $ | 2,568 | | $ | 3,040 | | $ | 7,001 | |
Annualized yield | | | 1.09 | % | | 2.39 | % | | 1.52 | % | | 3.34 | % |
| |
(1) | For the second quarter of 2009 and 2008, float earnings included $1,103 and $2,551, respectively, of income from auction rate securities. For the year to date periods, income from auction rate securities included in float earnings was $2,934 and $6,861, respectively, for 2009 and 2008. |
Process Management Fees. Process management fees are primarily comprised of revenues associated with foreclosed residential real estate marketing activities. These revenues were $9,768 and $8,364 for the second quarter of 2009 and 2008, respectively. Year to date, the revenues related to real estate marketing activities were $19,425 and $14,140 for 2009 and 2008, respectively. The increases in the 2009 periods were largely due to more effective marketing and pricing related to foreclosed residential real estate in the Servicing portfolio. The effect of the increase in rates was partly offset by declines in both the number of properties sold and the average price.
Compensation and Benefits Expense. The decrease in compensation expense and benefits in the first six months of 2009 as compared to the first six months of 2008 is due to a 21% decline in the average number of employees as management responded to a 24% decrease in the average size of the residential servicing portfolio between periods. Average U.S. employment declined by 38% as compared to an 18% 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 34% in the first six months of 2009 as compared to first six months of 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 second quarter of 2009 and 2008, respectively. Year to date, the average projected prepayment speeds were 21% and 25% for 2009 and 2008, respectively. Average projected delinquency rates (past due 90 days or more) used to compute amortization expense were 24% and 25% for the 2009 periods as compared to 22% and 21%, for the 2008 periods, 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 both the 2009 periods 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 in the three and six months ended June 2009 periods were lower than the 2008 periods by $2,852, or 15%, and $10,355, or 25%, respectively, primarily because of the decline in match funded advances that was partly offset by an increase in effective interest rates. The average combined balance of advances and match funded advances decreased by 24% and 20% during the three and six months ended June 2009 as compared to the same periods of 2008. Average borrowings of $819,401 were $401,683, or 33%, lower in the second quarter of 2009 than in 2008. Year to date, the average borrowings of $862,177 were $365,093, or 30% lower when compared to 2008. The effective average rate on these borrowings of 7.08% was higher by 157 basis points, or 28%, in the second quarter of 2009 as compared to the second quarter of 2008. For the six months ended June 2009, the average rate of 6.39% increased by 26 basis points, or 4%, as compared to the same period of 2008. The majority of our credit facilities bear interest at rates that are adjusted regularly based on 1-Month LIBOR. During the second quarter of 2009, the average of 1-Month LIBOR was 0.37% as compared to 2.59% in the second quarter of 2008. The average of 1-Month LIBOR was 0.42% and 2.95% during the first six months of 2009 and 2008, respectively.
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 those renewed or added in 2009 and because of higher facility fees charged by the lenders. Interest expense includes amortization of facility costs of $4,810 and $3,018 during the second quarter of 2009 and 2008, respectively. Year to date, amortization of facility costs were $9,678 and $7,196 for 2009 and 2008, respectively. Amortization of facility costs in the first six months of 2008 included the write-off of $2,000 in the first quarter of deferred costs that related to a match funded facility that we decided not to expand or renew.
46
Loans and Residuals
Three Months Ended June 2009 versus June 2008. The loss before income taxes for the second quarter of 2009 declined by $2,598 as compared to the second quarter of 2008. This decline is largely due to a $2,942 decline in losses on loans held for resale that primarily reflects lower charges to reduce loans to fair value.
Six Months Ended June 2009 versus June 2008. The year to date loss before income taxes for 2009 declined by $2,119 as compared to the same period of 2008. Combined losses on loans held for resale and securities declined by $4,422 in 2009, which more than offset the $2,511 decline in interest income on these assets. The decline in losses primarily reflects lower charges to reduce loans, real estate and securities to fair value.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Subordinate and residual trading securities | | $ | 3,341 | | $ | 4,204 | |
Loans held for resale | | | 39,726 | | | 49,918 | |
Advances on loans held for resale | | | 4,739 | | | 4,867 | |
Real estate | | | 4,266 | | | 4,682 | |
Other | | | 2,066 | | | 3,646 | |
| | | | | | | |
Total assets | | $ | 54,138 | | $ | 67,317 | |
| | | | | | | |
| | | | | | | |
Lines of credit and other secured borrowings | | | 12,299 | | | 17,760 | |
Other | | | 1,292 | | | 1,409 | |
| | | | | | | |
Total liabilities | | $ | 13,591 | | $ | 19,169 | |
| | | | | | | |
Subordinate and Residual Trading Securities. The $863 decrease in subordinate and residual securities during the first six months of 2009 was due to net unrealized losses that reflect a decline in fair value as a result of conditions in the subprime mortgage market.
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 we calibrate 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 18% 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 1.14 years at June 30, 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 June 30, 2009 and December 31, 2008 are net of fair value allowances of $17,570 and $17,491, respectively. Loans held for resale at June 30, 2009 and December 31, 2008 include non-performing loans with a carrying value of $16,928 and $19,193, respectively. The $10,192 decline in carrying value during the first six months of 2009 is due to payoffs, foreclosures and charge-offs. There were no loan sales during the first six 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 $4,847 and $4,748 at June 30, 2009 and December 31, 2008, respectively. During the first six months of 2009, sales of real estate more than offset transfers from loans held for resale.
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 $5,461 decline in borrowings during the first six 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.
47
Comparative selected operations data for the three and six months ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue | | $ | — | | $ | — | | $ | — | | $ | — | |
Operating expenses | | | 747 | | | 551 | | | 1,309 | | | 1,469 | |
| | | | | | | | | | | | | |
Loss from operations | | | (747 | ) | | (551 | ) | | (1,309 | ) | | (1,469 | ) |
| | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | |
Interest income: | | | | | | | | | | | | | |
Loans held for resale | | | 1,055 | | | 2,081 | | | 2,489 | | | 4,220 | |
Subordinate and residual trading securities | | | 936 | | | 650 | | | 1,386 | | | 2,166 | |
| | | | | | | | | | | | | |
| | | 1,991 | | | 2,731 | | | 3,875 | | | 6,386 | |
Interest expense | | | (519 | ) | | (423 | ) | | (1,149 | ) | | (1,279 | ) |
Unrealized losses on subordinate and residual trading securities | | | (581 | ) | | (1,356 | ) | | (863 | ) | | (2,388 | ) |
Loss on loans held for resale, net | | | (2,987 | ) | | (5,929 | ) | | (7,541 | ) | | (10,438 | ) |
Other, net | | | — | | | 87 | | | 6 | | | 88 | |
| | | | | | | | | | | | | |
Total other expense, net | | | (2,096 | ) | | (4,890 | ) | | (5,672 | ) | | (7,631 | ) |
| | | | | | | | | | | | | |
Loss before income taxes | | $ | (2,843 | ) | $ | (5,441 | ) | $ | (6,981 | ) | $ | (9,100 | ) |
| | | | | | | | | | | | | |
Interest Income. Interest income on loans held for resale for the three and six months ended June 2009 declined by 49% and 41%, respectively, as compared to the same periods of 2008 due to a reduction in the average balance of the loans and an increase in the percentage of loans that are nonperforming. The average balance of loans held for resale declined by 31% and 30% in the three and six months ended June 2009, respectively. Year to date, interest income on subordinate and residual trading securities has declined in 2009 as compared to 2008. Cash flows from the remaining subordinate and residual securities are lower 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 is primarily comprised of valuation adjustments, charge-offs and losses on real estate owned. For the second quarter of 2009 and 2008, combined valuation adjustments, charge-offs and losses on real estate owned were $2,987 and $5,929, respectively. Year to date, these combined amounts were $7,541 and $10,558 for 2009 and 2008, respectively. Valuation losses represent charges that we recorded to reduce loans held for resale to their fair values. 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 53% at June 30, 2009.
Asset Management Vehicles
Three Months Ended June 2009 versus June 2008. The loss before income taxes for the second quarter of 2009 was slightly higher than 2008. The increase in the loss was attributable to a decline in management fee revenues, offset in large part by the decline in our share of the losses incurred by OSI and by ONL and affiliates. Losses incurred by these entities in 2009 and 2008 largely resulted from charges to reduce loans, real estate and residual securities to their fair values which were lower in the second quarter of 2009 as compared to 2008.
Six Months Ended June 2009 versus June 2008. The year to date loss before income taxes for 2009 was $795 lower than the same period of 2008. A decline in our share of the losses incurred by OSI and by ONL and affiliates more than offset the decline in management fee revenue.
These losses largely resulted from charges to reduce loans, real estate and residual securities to their fair values which were lower in the second quarter of 2009 as compared to 2008.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Investment in unconsolidated entities | | | | | | | |
OSI | | $ | 12,554 | | $ | 15,410 | |
ONL and affiliates | | | 8,636 | | | 10,174 | |
| | | | | | | |
| | | 21,190 | | | 25,584 | |
Other | | | 463 | | | 1,171 | |
| | | | | | | |
Total assets | | $ | 21,653 | | $ | 26,755 | |
| | | | | | | |
48
Comparative selected operations data for the periods ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue (management fees) | | $ | 460 | | $ | 1,127 | | $ | 997 | | $ | 2,178 | |
Operating expenses | | | 1,016 | | | 926 | | | 1,778 | | | 1,616 | |
| | | | | | | | | | | | | |
Income (loss) from operations | | | (556 | ) | | 201 | | | (781 | ) | | 562 | |
Other income (expense): | | | | | | | | | | | | | |
Equity in earnings (losses) of unconsolidated entities | | | | | | | | | | | | | |
OSI | | | (379 | ) | | (1,455 | ) | | (106 | ) | | (2,091 | ) |
ONL and affiliates | | | (467 | ) | | 116 | | | (1,042 | ) | | (930 | ) |
| | | | | | | | | | | | | |
| | | (846 | ) | | (1,339 | ) | | (1,148 | ) | | (3,021 | ) |
Other, net | | | — | | | (140 | ) | | — | | | (265 | ) |
| | | | | | | | | | | | | |
Other expense, net | | | (846 | ) | | (1,479 | ) | | (1,148 | ) | | (3,286 | ) |
| | | | | | | | | | | | | |
Loss before income taxes | | $ | (1,402 | ) | $ | (1,278 | ) | $ | (1,929 | ) | $ | (2,724 | ) |
| | | | | | | | | | | | | |
Investment in Unconsolidated Entities. We account for our 25% interest in OSI and our approximately 25% interest in ONL and its affiliates using the equity method of accounting. During the first six months of 2009, we received distributions totaling $3,246. We did not make any investments in OSI during 2009 because our commitment to invest additional capital has expired. We did not make any investments in ONL and its affiliates during the first six months of 2009, but have a remaining commitment as of June 30, 2009 to invest up to an additional $33,902. The commitment expires in September 2010.
Equity in earnings of unconsolidated entities. The losses incurred by OSI in the 2009 periods primarily reflect unrealized losses on residual securities. Unrealized losses on the residual securities have declined significantly in 2009, offset in part by a decline in interest income on the securities. The losses incurred by OSI in the 2008 periods 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.
The results of ONL and its affiliates in the 2009 and 2008 periods include charges to reduce loans and real estate to fair value. Declines in these charges and a reduction in operating expenses in 2009 have been largely offset by declines in interest income on the loans.
Reported results for these unconsolidated entities 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
Three Months Ended June 2009 versus June 2008. Income from operations improved by $4,598, or 130% in the second quarter of 2009 as compared to 2008. Revenues are $9,670, or 67% higher than in the second quarter of 2008. In 2009, we have offset the effect of declining origination volumes by increasing the array and geographical range of default services that we provide to 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, increased client penetration and success in controlling operating expenses, income from operations as a percent of revenue improved from 24% in the second quarter of 2008 to 34% in the second quarter of 2009. In November 2008, our Board of Directors authorized management to investigate the possible sale or liquidation of our remaining GSS partnerships that are included in this segment. In June 2009, we sold our investment in our GSS Germany partnership and recognized a gain before minority interest of $715.
Six Months Ended June 2009 versus June 2008. Year to date, income from operations improved by $6,487 or 96% in 2009 as compared to 2008 largely due to a 35% increase in revenues. Although operating expenses increased by 18% in 2009, income from operations as a percent of revenue improved from 22% in the first six months of 2008 to 31% in the first six months of 2009. The increase in operating expenses is primarily attributed to the new lines of business discussed above.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 228 | | $ | 749 | |
Receivables | | | 4,654 | | | 2,680 | |
Other | | | 76 | | | 129 | |
| | | | | | | |
Total assets | | $ | 4,958 | | $ | 3,558 | |
| | | | | | | |
| | | | | | | |
Total liabilities | | $ | 1,791 | | $ | 2,442 | |
| | | | | | | |
49
Receivables. Receivables increased by $1,974 largely due to revenue growth in our new businesses, some of which have longer payment cycles than our pre-existing operations.
Comparative selected operations data for the periods ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue: | | | | | | | | | | | | | |
Servicing and subservicing fees | | $ | 209 | | $ | 1,055 | | $ | 530 | | $ | 2,528 | |
Process management fees | | | 24,013 | | | 13,325 | | | 41,667 | | | 28,476 | |
Other | | | (57 | ) | | 115 | | | (15 | ) | | 245 | |
| | | | | | | | | | | | | |
Total revenue | | | 24,165 | | | 14,495 | | | 42,182 | | | 31,249 | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Compensation and benefits | | | 2,971 | | | 2,853 | | | 5,770 | | | 5,824 | |
Amortization of servicing rights | | | — | | | 63 | | | — | | | 274 | |
Servicing and origination | | | 9,822 | | | 5,930 | | | 17,074 | | | 13,414 | |
Technology and communication | | | 1,072 | | | 1,141 | | | 1,986 | | | 2,055 | |
Other | | | 2,152 | | | 958 | | | 4,079 | | | 2,896 | |
| | | | | | | | | | | | | |
Total operating expenses | | | 16,017 | | | 10,945 | | | 28,909 | | | 24,463 | |
| | | | | | | | | | | | | |
Income from operations | | | 8,148 | | | 3,550 | | | 13,273 | | | 6,786 | |
Other income, net | | | 700 | | | 678 | | | 722 | | | 596 | |
| | | | | | | | | | | | | |
Income before income taxes | | $ | 8,848 | | $ | 4,228 | | $ | 13,995 | | $ | 7,382 | |
| | | | | | | | | | | | | |
Servicing and Subservicing Fees. Our GSS offices in Germany and Canada earned fees by providing loan servicing to owners of commercial loans. The decline in fees earned in the 2009 periods as compared to the 2008 periods 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 operations. We sold the GSS Germany operations in June 2009.
Process Management Fees. The principal components of process management fees for the periods ended June 30, relate to our fee-based loan processing services as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Residential property valuation | | $ | 6,690 | | $ | 7,533 | | $ | 14,035 | | $ | 15,855 | |
Title services | | | 4,161 | | | 2,942 | | | 8,537 | | | 6,941 | |
Outsourcing services | | | 5,187 | | | 2,850 | | | 8,252 | | | 5,680 | |
Property inspection and preservation services | | | 5,057 | | | — | | | 6,999 | | | — | |
Other mortgage and default services | | | 2,918 | | | — | | | 3,844 | | | — | |
| | | | | | | | | | | | | |
| | $ | 24,013 | | $ | 13,325 | | $ | 41,667 | | $ | 28,476 | |
| | | | | | | | | | | | | |
Servicing and Origination Expenses. Servicing and origination expenses for the periods ended June 30 consist primarily of costs incurred in connection with providing fee-based loan processing services as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Residential property valuation | | $ | 3,025 | | $ | 4,106 | | $ | 6,319 | | $ | 9,169 | |
Title services | | | 2,035 | | | 1,813 | | | 4,166 | | | 4,227 | |
Property inspection and preservation services | | | 4,026 | | | — | | | 5,605 | | | — | |
Other mortgage and default services | | | 736 | | | 11 | | | 984 | | | 18 | |
| | | | | | | | | | | | | |
| | $ | 9,822 | | $ | 5,930 | | $ | 17,074 | | $ | 13,414 | |
| | | | | | | | | | | | | |
The decline in residential property valuation services expenses in the 2009 periods 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. During the second quarter of 2009, we added to the range of title services that we offer which contributed to an increase in our title services revenues and generated additional expenses.
Financial Services
Three Months Ended June 2009 versus June 2008. The $859 decrease in the loss before income taxes for the second quarter of 2009 as compared to 2008 primarily reflects a $1,012 decline in the loss from operations. Operating expenses were $3,571, or 17% lower in the second quarter of 2009 in large part due to a decline in compensation and benefits because of our efforts beginning in the fourth quarter of 2008 to reduce the number of collectors and our continued focus on reducing technology and communication costs. Revenues declined by $2,559, or 13%, in the second quarter of 2009 primarily due to lower collection rates that we have experienced and which we believe are due to the current economic climate and are consistent with the collections industry in general.
50
Six Months Ended June 2009 versus June 2008. The loss before income taxes for the first six months of 2009 was $462, or 18% higher than 2008, primarily reflecting a $309 increase in the loss from operations. Revenues were $4,742, or 12%, lower in 2009 while operating expenses declined by $4,433, or 11%.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 6,553 | | $ | 2,256 | |
Receivables | | | 5,517 | | | 5,848 | |
Goodwill and intangibles | | | 44,464 | | | 44,609 | |
Premises and equipment | | | 3,700 | | | 3,967 | |
Other | | | 1,539 | | | 2,027 | |
| | | | | | | |
Total assets | | $ | 61,773 | | $ | 58,707 | |
| | | | | | | |
| | | | | | | |
Lines of credit and other secured borrowings | | $ | — | | $ | 1,123 | |
Accrued expenses and other | | | 6,997 | | | 7,081 | |
| | | | | | | |
Total liabilities | | $ | 6,997 | | $ | 8,204 | |
| | | | | | | |
Goodwill and Intangibles. Goodwill and intangibles arising from the acquisition of NCI are as follows:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
Goodwill | | $ | 9,409 | | $ | 8,218 | |
| | | | | | | |
| | | | | | | |
Intangibles | | | 40,500 | | | 40,500 | |
Accumulated amortization | | | (5,445 | ) | | (4,109 | ) |
| | | | | | | |
Intangibles, net | | | 35,055 | | | 36,391 | |
| | | | | | | |
| | $ | 44,464 | | $ | 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. During the first quarter of 2009, we repaid the outstanding balance in full. During the second quarter of 2009, we determined that we no longer needed the facility to meet the liquidity needs of the Financial Services segment and terminated the agreement after considering the administrative costs of maintaining the facility. See Note 13 to the Interim Consolidated Financial Statements for additional information.
Comparative selected operations data for the three and six months ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue | | $ | 16,471 | | $ | 19,030 | | $ | 33,787 | | $ | 38,529 | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Compensation and benefits | | | 8,158 | | | 10,732 | | | 16,712 | | | 20,434 | |
Servicing and origination | | | 3,857 | | | 2,804 | | | 7,211 | | | 5,889 | |
Technology and communication | | | 1,796 | | | 2,964 | | | 3,956 | | | 4,943 | |
Professional services | | | 530 | | | 948 | | | 1,247 | | | 1,655 | |
Occupancy and equipment | | | 1,198 | | | 1,162 | | | 2,438 | | | 2,243 | |
Other operating expenses | | | 2,018 | | | 2,518 | | | 4,142 | | | 4,975 | |
| | | | | | | | | | | | | |
Total operating expenses | | | 17,557 | | | 21,128 | | | 35,706 | | | 40,139 | |
| | | | | | | | | | | | | |
Loss from operations | | | (1,086 | ) | | (2,098 | ) | | (1,919 | ) | | (1,610 | ) |
Other expense, net | | | (647 | ) | | (494 | ) | | (1,115 | ) | | (962 | ) |
| | | | | | | | | | | | | |
Loss before income taxes | | $ | (1,733 | ) | $ | (2,592 | ) | $ | (3,034 | ) | $ | (2,572 | ) |
| | | | | | | | | | | | | |
The decrease in revenue in the 2009 periods as compared to the 2008 periods 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 expense in the 2009 periods as compared to the 2008 periods 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.
51
Technology Products
Three Months Ended June 2009 versus June 2008. Income from operations improved by $2,376 in the second quarter of 2009 as compared to 2008 primarily due to a $1,841 decline in technology and communications expenses. Income before income taxes for the second quarter of 2009 was $15,967 higher than the second quarter of 2008. Results for the second quarter of 2008 include our recognition of our share of the losses of BMS Holdings of $13,552. Because of an accumulated deficit at BMS Holdings, we have not resumed applying the equity method of accounting since the second quarter of 2008.
Six Months Ended June 2009 versus June 2008. Income before income taxes improved by $8,679 in the first six months of 2009 as compared to 2008, reflecting a $3,174 improvement in income from operations and our recognition of $5,666 of losses of BMS Holdings in 2008. The improvement in income from operations in 2009 reflects a $3,387 decline in operating expenses, primarily compensation and technology related costs.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Receivables | | $ | 1,659 | | $ | 974 | |
Goodwill | | | 1,618 | | | 1,618 | |
Premises and equipment | | | 4,467 | | | 5,452 | |
Other | | | 916 | | | 862 | |
| | | | | | | |
Total assets | | $ | 8,660 | | $ | 8,906 | |
| | | | | | | |
| | | | | | | |
Total liabilities | | $ | 2,224 | | $ | 3,361 | |
| | | | | | | |
Comparative selected operations data for the periods ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue: | | | | | | | | | | | | | |
Technology support | | $ | 5,388 | | $ | 6,446 | | $ | 11,026 | | $ | 12,298 | |
REAL products | | | 6,720 | | | 5,964 | | | 11,656 | | | 10,597 | |
| | | | | | | | | | | | | |
Total revenue | | | 12,108 | | | 12,410 | | | 22,682 | | | 22,895 | |
| | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | |
Compensation and benefits | | | 2,151 | | | 2,772 | | | 4,388 | | | 5,523 | |
Technology and communications | | | 3,813 | | | 5,654 | | | 8,071 | | | 10,055 | |
Other | | | 1,157 | | | 1,373 | | | 2,835 | | | 3,103 | |
| | | | | | | | | | | | | |
| | | 7,121 | | | 9,799 | | | 15,294 | | | 18,681 | |
| | | | | | | | | | | | | |
Income from operations | | | 4,987 | | | 2,611 | | | 7,388 | | | 4,214 | |
| | | | | | | | | | | | | |
Other income (expense), net: | | | | | | | | | | | | | |
Interest expense | | | (118 | ) | | (154 | ) | | (250 | ) | | (318 | ) |
Equity in losses of unconsolidated entities (BMS Holdings) | | | — | | | (13,552 | ) | | — | | | (5,666 | ) |
Other | | | 66 | | | 63 | | | 121 | | | 350 | |
| | | | | | | | | | | | | |
Other expense | | | (52 | ) | | (13,643 | ) | | (129 | ) | | (5,634 | ) |
| | | | | | | | | | | | | |
Income (loss) before income taxes | | $ | 4,935 | | $ | (11,032 | ) | $ | 7,259 | | $ | (1,420 | ) |
| | | | | | | | | | | | | |
Compensation and benefits expense. Compensation and benefits costs are lower in the 2009 periods primarily reflecting a reduction in staff through our integration of NCI personnel into the existing technology group.
Technology and communications expense. The decline in technology and communications expense in the 2009 periods as compared to 2008 is largely due to a decline in depreciation expense as several assets became fully depreciated in 2008.
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. BMS holdings reported a loss for the second quarter and year to date periods of 2009 that was primarily due to unrealized losses on derivative financial instruments and a decline in revenues, partially offset by unrealized gains on auction rate securities. The second quarter 2008 results for BMS Holdings reflect $4,384 of operating income, $47,766 in unrealized losses on derivative financial instruments and $9,259 in unrealized losses on auction rate securities. For the year to date period in 2008, the results of BMS reflect $9,814 of operating income, $138 of unrealized gains on derivative financial instruments and $21,501 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 of 2008, driven by significant volatility in LIBOR during those periods.
52
Corporate Items and Other
Three Months Ended June 2009 versus June 2008. Income before income taxes of $3,037 for the second quarter of 2009 represents an improvement of $15,672 over the loss of $12,635 incurred in the second quarter of 2008. Results for the second quarter of 2009 include $6,024 of unrealized gains on auction rate securities as compared to $6,768 of unrealized losses in the second quarter of 2008. Professional services expense for the three months ended June 2009 includes $1,850 principally related to services performed in connection with the Altisource Separation.
Six Months Ended June 2009 versus June 2008. The loss before income taxes declined from $33,328 for the first six months of 2008 to $401 for the same period of 2009. Gains on trading securities were $5,918 for the first six months of 2009, as compared to losses of $19,357 for the first six months of 2008. Year to date operating expenses in 2008 include $9,532 of expenses incurred in the first quarter in connection with the terminated “going private” transaction. Professional services expense for the six months ended June 2009 includes $2,981 principally related to services performed in connection with the Altisource Separation.
Comparative selected balance sheet data:
| | | | | | | |
| | June 30, 2009 | | December 31, 2008 | |
| | | | | |
Cash | | $ | 206,982 | | $ | 197,874 | |
Trading securities, at fair value: | | | | | | | |
Auction rate | | | 243,285 | | | 239,301 | |
Subordinates and residuals | | | — | | | 165 | |
Income taxes receivable | | | — | | | 5,386 | |
Receivables | | | 19,685 | | | 17,372 | |
Deferred tax assets, net | | | 161,180 | | | 175,145 | |
Premises and equipment, net | | | 2,860 | | | 3,415 | |
Interest earning collateral deposits | | | 7,623 | | | 9,684 | |
Other | | | 7,805 | | | 7,129 | |
| | | | | | | |
Total assets | | $ | 649,420 | | $ | 655,471 | |
| | | | | | | |
| | | | | | | |
Investment line | | $ | 176,668 | | $ | 200,719 | |
Debt securities | | | 109,534 | | | 133,367 | |
Other | | | 37,684 | | | 41,514 | |
| | | | | | | |
Total liabilities | | $ | 323,886 | | $ | 375,600 | |
| | | | | | | |
Trading Securities. As disclosed in Note 5 to the Interim Consolidated Financial Statements, because of failed auctions, we have been unable to liquidate the 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 5.4%. 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 3.9%. 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.
The $3,984 decline in auction rate securities during the first six months of 2009 is due to unrealized gains of $5,984, partially offset by redemptions of $2,000 at par value.
We are currently negotiating terms with one of the auction rate counterparties to provide Ocwen the right to sell approximately $88,150 principal amount of auction rate securities at 85% of par and retain a call option on the securities for a period of three years. In addition, we recognized a $6,024 unrealized gain in the second quarter of 2009 which was due, in part, to the increased probability of a near term liquidity solution for certain tranches representing approximately $70,350 principal amount of the auction rate securities. However, we continue to pursue alternatives, including negotiations and/or legal action, which may result in a liquidity event for one or more tranches, which we hold.
Deferred Tax Assets, Net. Net deferred tax assets decreased by $13,965 during the first six months of 2009 primarily due to the realization of tax benefits associated with the sale of MSRs.
53
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 are $3,000 per month in place of the previous quarterly reductions in the advance rate.
During the six months ended June 2009, we made principal payments totaling $24,051 which reduced the Investment Line term note obligation to $176,668.
Debt Securities. Debt securities declined by $23,833 during the first six months of 2009 primarily because we repurchased $25,910 of our 3.25% Convertible Notes in the open market in February 2009 which generated a gain 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 principal balances at June 30, 2009 and December 31, 2008 of $56,445 and $82,355 are reported net of the unamortized debt discount of $290 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. Other liabilities also include customer deposits held by BOK. Other liabilities declined by $3,830 during the first six months of 2009 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 and a decline of $3,403 in accrued bonuses principally as a result of the payment of 2008 annual bonuses. These declines were partially offset by a $1,462 increase in accrued costs related to the Separation.
Comparative selected operations data for the periods ended June 30 is as follows:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Revenue | | $ | 112 | | $ | 134 | | $ | 365 | | $ | 142 | |
Operating expenses | | | 3,830 | | | 3,344 | | | 7,813 | | | 11,979 | |
| | | | | | | | | | | | | |
Loss from operations | | | (3,718 | ) | | (3,210 | ) | | (7,448 | ) | | (11,837 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Other income (expense): | | | | | | | | | | | | | |
Gain (loss) on trading securities | | | 6,016 | | | (8,366 | ) | | 5,918 | | | (19,357 | ) |
Gain (loss) on debt repurchases | | | — | | | (86 | ) | | 534 | | | (86 | ) |
Other, net | | | 739 | | | (973 | ) | | 595 | | | (2,048 | ) |
| | | | | | | | | | | | | |
Other income (expense) | | | 6,755 | | | (9,425 | ) | | 7,047 | | | (21,491 | ) |
| | | | | | | | | | | | | |
Income (loss) before income taxes | | $ | 3,037 | | $ | (12,635 | ) | $ | (401 | ) | $ | (33,328 | ) |
| | | | | | | | | | | | | |
Operating Expenses. The $4,166 decline in operating expenses for the first six months of 2009 as compared to 2008 is largely due to a $4,703 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 six months of 2009, we recorded $2,981 of costs related to the Separation, including $1,850 during the second quarter. Operating expenses are net of overhead allocations to other segments.
Gain (loss) on Trading Securities. The gain (loss) on trading securities for the periods ended June 30 was comprised of the following:
| | | | | | | | | | | | | |
| | Three months | | Six months | |
| | | | | |
| | 2009 | | 2008 | | 2009 | | 2008 | |
| | | | | | | | | |
Realized losses: | | | | | | | | | | | | | |
Auction rate | | $ | — | | $ | (662 | ) | $ | — | | $ | (662 | ) |
CMOs | | | — | | | (920 | ) | | — | | | (1,034 | ) |
| | | | | | | | | | | | | |
| | | — | | | (1,582 | ) | | — | | | (1,696 | ) |
| | | | | | | | | | | | | |
Unrealized gains (losses): | | | | | | | | | | | | | |
Auction rate | | | 6,024 | | | (6,768 | ) | | 5,984 | | | (15,707 | ) |
CMOs | | | — | | | — | | | — | | | (1,813 | ) |
Subordinates and residuals | | | (8 | ) | | (16 | ) | | (66 | ) | | (141 | ) |
| | | | | | | | | | | | | |
| | | 6,016 | | | (6,784 | ) | | 5,918 | | | (17,661 | ) |
| | | | | | | | | | | | | |
| | $ | 6,016 | | $ | (8,366 | ) | $ | 5,918 | | $ | (19,357 | ) |
| | | | | | | | | | | | | |
The unrealized gains of $6,024 and $5,984 for the three and six months ended 2009, respectively, were principally based on improvements in the underlying collateral markets and liquidity solution discussions with counterparties.
54
EQUITY
Total equity amounted to $694,544 at June 30, 2009 as compared to $609,641 at December 31, 2008. The $84,903 increase in total equity during the first six months of 2009 was primarily due to net income of $32,939 and a $52,240 increase in additional paid-in capital. The increase in additional paid-in capital was primarily due to $60,187 of proceeds received from the sale of 5,471,500 shares of common stock in a private placement transaction that closed on April 3, 2009, partially offset by $11,000 we paid to repurchase 1,000,000 shares of common stock on the same date. We used a portion of the proceeds received from the private placement transaction to acquire the 1,000,000 shares, which we repurchased from William C. Erbey, Chairman of the Board and Chief Executive Officer of OCN. See Note 18 to the Interim Consolidated Financial Statements for additional information regarding these transactions.
Information regarding purchases of our common stock during the six months ended June 30, 2008 is as follows:
| | | | | | | | | | | | | |
Period | | Number of shares | | Average
Share Price
paid | | Total number of shares purchased as part of publicly announced plans | | Maximum number of shares that may yet be purchased under the plans | |
| | | | | | | | | | |
April 1 – April 30 | | | 1,000,000 | | $ | 11.00 | | | — | | | 5,668,900 | |
Our ability to repurchase shares of our common stock is restricted under the terms of the Guaranty that we entered into with the OTS in connection with debanking.
Minority interest of $309 and $406 at June 30, 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 $9,472 and $424 for the second quarter of 2009 and 2008, respectively. For the first six months of 2009 and 2008, income tax expense was $17,509 and $3,363 respectively. Income tax expense for prior periods reflects the impact of the change in accounting for the Convertible Notes due to the adoption of FSP APB 14-1. See Note 1 to the financial statements for additional details relating to the impact of the adoption of this new accounting pronouncement.
Our effective tax rate for the first six months of 2009 was 35.3% as compared to 29.2% for the first six 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 six months of 2009 includes a benefit of approximately 1.5% associated with the recognition of certain foreign deferred tax assets. The effective tax rate includes a 0.7% benefit for the reduction in the valuation allowance for certain NCI related state net operating losses due to a change in the state rate applied to these losses. The effective tax rate for the first six months of 2009 was not impacted by the expiration of certain vested stock options.
Our effective tax rate for the first six months of 2008 includes a benefit of approximately 3.8% associated with the recognition of certain foreign deferred tax assets. The effective tax rate for the six months of 2008 would have been 25.4% but was increased by approximately 3.8% due to the recognition of additional tax expense associated with the expiration of certain vested stock options.
LIQUIDITY AND CAPITAL RESOURCES
Our cash position remains strong with a balance of $213,911 at June 30, 2009, of which $210,691 is unrestricted. Our total cash balance increased by $12,886, or 6% during the first six months of 2009.
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 for $60,187 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. These transactions generated net cash of $49,187.
During the first six months of 2009, we purchased servicing rights for $10,241. We also 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 $41,995 on our MSR financing facility due to amortization, reducing the balance outstanding to $55,992; and |
| · | Repaying $24,051 on our auction rate securities Investment Line due to amortization, reducing the balance outstanding to $176,668. |
55
Despite a credit environment that remains challenged, during the first six months of 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; and |
| · | Increased the maximum borrowing capacity of a $300,000 advance financing facility to $500,000 in May. |
By renewing and increasing advance facility notes before they entered their amortization period, we increased maximum borrowing capacity for match funded advances from $1,215,000 at December 31, 2008 to $1,415,000 at June 30, 2009. Combined with a reduction in advances and match funded advances of $165,699, we increased our unused advance borrowing capacity from $257,893 at December 31, 2008 to $653,118 at June 30, 2009. We believe that our prospects for advance financing have improved due to the inclusion of servicer advances in TALF which was announced by the Federal Reserve Bank of New York in February. TALF 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, with a note term of up to three years for servicer advances. We are working on a TALF offering to replace an existing $165,000 term advance note prior to this note entering its amortization period in December 2009 and have secured noteholder consent to repay these notes on August 11, 2009.
Plans to improve liquidity further in 2009 include continued reductions in advances and the sale of non-core assets. Although we cannot guarantee successful execution, 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 of these obligations is the requirement that we 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 18.6% of the total number of loans serviced at June 30, 2009. This compares to 17.2% at March 31, 2009 and 19% at December 31, 2008. The UPB of delinquent loans as a percentage of total UPB serviced continued its gradual trend upward to 27.5% at June 30, 2009 from 25.1% at March 31, 2009 and 24.3% at December 31, 2008. Prepayment speeds averaged 21% and 22% for the first and second quarters of 2009, respectively. This compares to 23% and 26% for the first and second quarters of 2008, respectively, and 25% for the fourth quarter of 2008.
Management initiatives that we began in 2008 and that are designed to maximize the return to the loan investors have been further enhanced in 2009. The number of loan modifications is only marginally higher in the first half of 2009 than in the first half of 2008 because of our decision to pursue HAMP modifications for loans that we believed may be eligible for this program. The implementation of HAMP reduced the total number of modifications in the second quarter that would otherwise have been completed primarily due to the time needed to develop compliant guidelines and processes and the fact that the 90-day trial period in the HAMP is longer than the average trial period for non-HAMP modifications. We expect the number of completed HAMP modifications to accelerate and the combined number of HAMP and non-HAMP completed modifications to return to normal levels progressively during the third and fourth quarters of 2009. The reduction in the rate of loan modifications in the second quarter, as compared to the first quarter of 2009, reduced the rate of liquidity improvement somewhat by slowing the rate at which advances are declining. However, we believe that the rate at which advances decline will accelerate again in the third quarter as the loan modification rate increases from what we experienced during the second quarter.
Our ability to finance servicing advances continues to be a significant factor that affects our liquidity. Three of our match funded advance facilities that are 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. While several rating agencies have adjusted their methodology for rating servicer advances and advance rates for newly issued notes appear to be somewhat lower than in the past, we do not expect this change to have a material affect on our liquidity. There is some risk that the advance rate on our existing notes could be reduced in order to maintain the required rating but to date this has not occurred. 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 and do not expect them to restrict our activities.
56
Maximum borrowing capacity of the Servicing segment was $1,524,511 at June 30, 2009, an increase of $211,524 as compared to $1,312,987 at December 31, 2008. The increase in the total borrowing capacity of all segments during the first six months of 2009, excluding the Investment Line, was $196,063. The increase in Servicing segment borrowing capacity principally reflects the effect of two new facilities into which we entered in March 2009 and the expansion of an existing match funded facility from $300,000 to $500,000 in May 2009. One of the new facilities represented an advance in the form of zero-coupon bonds that we initially recorded at $45,373, net of a discount of $14,627. The other new facility is a $7,000 term note. Both facilities are secured by the pledge of advances. The maximum borrowing capacity of our match funded servicing advance facilities of $1,415,000 at June 30, 2009 was $200,000 greater than the maximum capacity of $1,215,000 at 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 this facility matured in August 2008. The facility included 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 $55,992 at June 30, 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 $41,995 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 June 30, 2009, 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 that note must be applied to reduce the balance outstanding for that note, and any new advances under the securitizations pledged to the facility are ineligible to be financed, unless another note with available capacity exists in that facility. In order for us to maintain liquidity, borrowings under notes that have entered their amortization period and have not been renewed or are not covered by unused capacity within that facility must be repaid and the advances under the securitizations affected must be pledged to another facility.
Our credit facilities, excluding the Investment Line term note, are summarized as follows at June 30, 2009:
| | | | | | | | | | | | | | |
| | Amortization
Date | | Maturity | | Maximum
Borrowing
Capacity (1) | | Unused
Borrowing
Capacity | | Balance
Outstanding | |
| | | | | | | | | | | |
Servicing: | | | | | | | | | | | | | | |
Match funded liability (2) | | Dec. 2009 (2) | | Dec. 2014 – Nov. 2015 | | $ | 465,000 | | $ | 185,205 | | $ | 279,795 | |
Match funded liability (3) | | Jan. 2010 | | Jan. 2019 | | | 200,000 | | | 76,378 | | | 123,622 | |
Match funded liability | | Dec. 2010 | | Dec 2013 | | | 250,000 | | | 71,258 | | | 178,742 | |
Match funded liability (4) | | May 2010 | | May 2011 | | | 500,000 | | | 320,277 | | | 179,723 | |
| | | | | | | | | | | | | | |
| | | | | | | 1,415,000 | | | 653,118 | | | 761,882 | |
| | | | | | | | | | | | | | |
Secured credit agreement - Term note | | Aug. 2008 | | Feb. 2010 | | | 55,992 | | | — | | | 55,992 | |
Advance fee reimbursement (5) | | Mar. 2010 | | Mar. 2014 | | | 46,519 | | | — | | | 46,519 | |
Term note | | Mar. 2014 | | Mar. 2014 | | | 7,000 | | | — | | | 7,000 | |
| | | | | | | | | | | | | | |
| | | | | | | 109,511 | | | — | | | 109,511 | |
| | | | | | | | | | | | | | |
| | | | | | | 1,524,511 | | | 653,118 | | | 871,393 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Loans and Residuals: | | | | | | | | | | | | | | |
Class A-1 Note | | N/A | | Apr. 2037 | | | 12,299 | | | — | | | 12,299 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Corporate Items and Other: | | | | | | | | | | | | | | |
Convertible notes | | N/A | | Aug. 2024 | | | — | | | — | | | 56,155 | |
Capital securities | | N/A | | Aug. 2027 | | | — | | | — | | | 53,379 | |
| | | | | | | | | | | | | | |
| | | | | | | — | | | — | | | 109,534 | |
| | | | | | | | | | | | | | |
Total borrowings | | | | | | | 1,536,810 | | | 653,118 | | | 993,226 | |
Basis adjustment (2) | | | | | | | — | | | — | | | 3,141 | |
| | | | | | | | | | | | | | |
| | | | | | $ | 1,536,810 | | $ | 653,118 | | $ | 996,367 | |
| | | | | | | | | | | | | | |
| |
(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 June 30, 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. |
57
| |
(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. In June 2009, we received unanimous noteholder consent to repay this note early on August 11, 2009. |
(3) | In January 2009, we renewed this facility early and extended the amortization date to January 2010. We secured AAA ratings from two rating agencies on this note in July 2009 as required in the renewal and in subsequent amendments. |
(4) | 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) | 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, we recorded the advance as a zero-coupon bond issued at an initial implied discount of $14,627. |
Certain of our credit facilities require that we maintain minimum liquidity levels or borrowing capacity As of June 30, 2009, we are in compliance with these requirements.
We had an aggregate balance of $583,140 outstanding at June 30, 2009 under match funded financing facilities that are scheduled to enter their amortization period or reach their maturity date during the next twelve months.
With the expectation that advance balances will decline into the future, we continue to pursue additional advance financing to provide the flexibility to acquire new servicing business. If the credit markets deteriorate, we may need to increase our advance financing capacity at a cost that is 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, including acquiring MSRs; |
| · | 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, to prevent the borrowing balance from exceeding 65% of the appraised value of the MSRs; |
| · | Repayment of the Investment Line in the amount of $3,000 per month; and |
| · | Repayment of advance borrowing should the advance rate decline or the collateral become ineligible. |
Regarding our equity investment in BMS Holdings, we are under no obligation to provide additional funding.
Significant uses of funds during the first six months of 2009 included the following:
| | |
| · | Net repayments under match funded advance financing facilities of $195,226; |
| · | Repayments on the Investment Line term note of $24,051; |
| · | Reduction in servicer liabilities of $57,977; |
| · | Reduction in the MSR term note of $41,995; |
| · | Repurchase of $25,910 face amount of our 3.25% Convertible Notes for $24,602; |
| · | Purchases of MSRs of $10,241; and |
| · | Repurchase of 1,000,000 shares of outstanding common stock at a per-share price of $11.00. |
Significant sources of funds during the first six months of 2009 included the following:
| | |
| · | $18,421 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 $164,979; |
| · | Distributions of $3,246 received from asset management entities; and |
| · | Proceeds of $60,187 from the sale of 5,471,500 shares of common stock at a per-share price of $11.00 in a private placement transaction. |
Our operating activities provided (used) $193,119 and $(152,252) of cash flows during the first six months 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 $107,002 of net cash during the first six months of 2009. These same items used $20,979 of cash during the first six months of 2008. We collected net cash of $164,979 and $60,517 on advances and match funded advances during the first six months of 2009 and 2008, respectively. Servicer liabilities declined by $57,977 and $81,496 during the first six months of 2009 and 2008, respectively, due to lower collections.
58
Trading activities provided (used) net cash of $2,000 and $(240,145) during the first six months of 2009 and 2008, respectively. Net cash used by trading activities during the first six months of 2008 primarily reflects our net cash investment in auction rate securities of $271,114 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 $(6,387) and $12,091 during the first six months of 2009 and 2008, respectively. The increase in cash used in the first six months of 2009 over 2008 is primarily due to a $6,601 increase in purchases of MSRs. In addition, cash provided by investing activities during the first six months of 2008 included proceeds of $5,985 received from the sale of commercial MSRs. In the first six months of 2009, purchases of MSRs of $10,241 were partially offset by distributions of $3,246 that we received from our asset management entities. In the first six months of 2008, distributions of $8,950 received from the asset management entities and proceeds of $5,985 received from the sale of commercial MSRs exceeded purchases of residential MSRs of $3,640 and investments in asset management entities totaling $1,250.
Our financing activities provided (used) cash flows of $(173,846) and $174,753 during the first six months of 2009 and 2008, respectively. The cash flows used by financing activities in the first six months of 2009 primarily reflect the $195,226 net repayment of match funded liabilities as a result of the decline in servicing advances. Repayments of $41,995 on the MSR term note, $24,051 on the Investment Line and $24,602 paid to repurchase $25,910 of our 3.25% Convertible Notes more than offset the net proceeds of $67,000 from two new secured borrowings. Cash flows from financing activities for the first six months of 2009 include $49,187 of net proceeds from sales and repurchases of our common stock. The cash flows provided by financing activities in the first six months of 2008 primarily reflect the $229,774 of net borrowing under the Investment Line used to invest in auction rate securities. This net borrowing was partially offset by the repayment of $44,229 of borrowings under match funded advance facilities and other secured borrowings and the payment of $10,797 to repurchase $14,545 of our 3.25% Convertible Notes.
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 21 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 19 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.
59
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 2 to our Interim Consolidated Financial Statements.
FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” This FSP clarifies 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, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” 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 $19,838 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 $21,293. The adjustment to additional paid-in capital includes the recognized debt discount, adjusted for note redemptions, and the effect of deferred taxes, as well as net gains or losses attributable to redemptions of the equity component. Interest expense for the three and six months ended June 30, 2008 has been adjusted to include amortization of debt discount of $899 and $1,970, respectively, and a reduction in the amortization of debt issue costs of $32 and $71, respectively. Prospectively, the consolidated statement of operations will recognize non-cash interest expense over the remaining estimated life of the notes. The gain previously recognized on the redemption of debt securities during the quarter ended June 30, 2008 of $3,595 has been adjusted to reflect a loss of $86 on the debt component of the convertible notes in the statement of operations and a gain of $2,800 in additional paid in capital for the equity component.
SFAS No. 166, “Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140”. This statement removes the concept of a qualifying special-purpose entity from SFAS No. 140 and removes the exception from applying FASB Interpretation No. (“FIN”) FIN 46 (revised December 2003), “Consolidation of Variable Interest Entities.” (FIN 46(R)) to QSPEs.
This statement clarifies that the objective of paragraph 9 of SFAS No. 140 is to determine whether a transferor and all of the entities included in the transferor’s financial statements being presented have surrendered control over transferred financial assets. That determination must consider the transferor’s continuing involvements in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. This statement modifies the financial-components approach used in SFAS No. 140 and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset.
This statement defines the term participating interest to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. If the transfer does not meet those conditions, a transferor should account for the transfer as a sale only if it transfers an entire financial asset or a group of entire financial assets and surrenders control over the entire transferred asset(s). This statement requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. Enhanced disclosures are required to provide financial statement users with greater transparency about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets.
The provisions in SFAS No. 140 and SFAS No. 65, “Accounting for Certain Mortgage Banking Activities,” for guaranteed mortgage securitizations are removed to require those securitizations to be treated the same as any other transfer of financial assets within the scope of SFAS No. 140, as amended by this statement. If such a transfer does not meet the requirements for sale accounting, the securitized mortgage loans should continue to be classified as loans in the transferor’s statement of financial position.
We must adopt this statement as of January 1, 2010 and all reporting periods thereafter. Earlier application is prohibited. This statement must be applied to transfers occurring on or after the effective date. Additionally, the disclosure provisions of this statement should be applied to transfers that occurred both before and after the effective date of this Statement. We are evaluating the potential impact of this statement.
SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” This Statement amends FASB Interpretation (FIN) No. 46(R) to require an enterprise to perform ongoing periodic assessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. This analysis identifies the primary beneficiary of a VIE as the enterprise that has both of the following characteristics:
| | |
| c. | The power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance |
|
| d. | The obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. |
In addition to reintroducing the concept of control into the determination of the primary beneficiary of a VIE, this statement makes numerous other amendments to FIN 46(R) to primarily reflect the elimination of the concept of a QSPE. This statement also amends FIN 46(R) to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. The enhanced disclosures are required for any enterprise that holds a variable interest in a VIE. The additional disclosures required by this statement are included in Note 1—Principles of Consolidation.
60
This statement shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited.
As disclosed in Note 1—Securitizations of Residential Mortgage Loans, we currently exclude certain securitization trusts from our consolidated financial statements because each is a QSPE. Once this statement becomes effective, we will be required to reevaluate these QSPEs to determine if we should include them in our consolidated financial statements. We are evaluating the potential impact of this statement.
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 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 June 30, 2009, we had total advances and match funded advances of $1,036,941.
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.
| | | | |
| | June 30, 2009 | |
| | | |
Total borrowings outstanding (1) | | $ | 1,183,706 | |
Fixed rate borrowings | | | 334,824 | |
Variable rate borrowings | | | 848,882 | |
Float balances (held in custodial accounts, excluded from our balance sheet) | | | 385,100 | |
Notional balance of interest rate caps | | | 408,333 | |
| |
(1) | Borrowing amounts are exclusive of any related discount or basis adjustment. |
We report float earnings, which totaled $3,040 for the first six months of 2009, as a component of servicing and subservicing fees.
Our balance sheet at June 30, 2009 included interest-earning assets totaling $411,703 including $60,688 of interest-earning cash accounts $243,285 of auction rate securities, $43,090 of debt service accounts, $39,726 of loans held for resale and $7,623 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 June 30, 2009, the carrying value and estimated fair value of our residential mortgage servicing rights were $132,729 and $138,427, 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 79% 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.
61
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 5.7% or 5.2%, 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 June 30, 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 $158,333 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 $10,172 to hedge against the foreign exchange rate risk represented by our investment in BOK. See Note 19 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 June 30, 2009. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of June 30, 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.
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 June 30, 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 21, 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. In connection with the Separation, we have added the following risk factors:
Risks Related to Ocwen
We are exposed to market risk, including, among other things, liquidity risk, prepayment risk and foreign currency exchange risk. We are exposed to liquidity risk primarily because of the high variable daily cash requirements to support our 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. Because of the failed auctions, the market for 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 capital.
We are exposed to interest rate risk to the degree that our interest-bearing liabilities mature or reprice at different speeds, or different bases, that 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 June 30, 2009, we had total advances and match funded advances of $1,036,941. 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.
62
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, Uruguay and India expose us to foreign currency exchange rate risk, but we consider this risk insignificant. We have entered into foreign currency futures contracts to hedge the value of our net investment in BOK against changes in the value of the Euro against the U.S. dollar.
We may not realize all of the anticipated benefits of potential future acquisitions. Our ability to realize the anticipated benefits of potential future acquisitions of assets and/or companies will depend, in part, on our ability to scale-up to appropriately service any such assets and/or integrate the businesses of such acquired companies with our business. The process of acquiring assets and/or companies may disrupt our business, and may not result in the full benefits expected. The risks associated with acquisitions include, among others:
| |
· | coordinating market functions; |
| |
· | unanticipated issues in integrating information, communications and other systems; |
| |
· | unanticipated incompatibility of purchasing, logistics, marketing and administration methods; |
| |
· | retaining key employees; and |
| |
· | the diversion of management’s attention from ongoing business concerns. |
There is no assurance that we will realize the full benefits anticipated for any future acquisitions, or that we will be able to consummate any future acquisitions.
Because of certain provisions of our organizational documents, takeovers may be more difficult possibly preventing you from obtaining an optimal share price. Our amended and restated articles of incorporation provide that the total number of shares of all classes of capital stock that we have authority to issue is 220 million, of which 200 million are common shares and 20 million are preferred shares. Our board of directors has the authority, without a vote of the shareholders, to establish the preferences and rights of any preferred or other class or series of shares to be issued and to issue such shares. The issuance of preferred shares could delay or prevent a change in control. Since our board of directors has the power to establish the preferences and rights of the preferred shares without a shareholder vote, our board of directors may give the holders of preferred shares preferences, powers and rights, including voting rights, senior to the rights of holders of our common shares.
Future legislative changes and other actions and changes may adversely affect future incremental revenues. Under government programs such as the Home Affordable Modification Program (“HAMP”), a participating servicer may be entitled to receive financial incentives in connection with any modification plans it enters into with eligible borrowers and subsequent “pay for success” fees to the extent that a borrower remains current in any agreed upon loan modification. Changes in current legislative actions regarding such loan modification and refinance programs, future U.S. federal, state and/or local legislative or regulatory actions that result in the modification of outstanding mortgage loans, and changes in the requirements necessary to qualify for refinancing mortgage loans may impact the future extent to which we participate in and receive financial benefits from such programs and may have a material effect on our business. Additionally, the U.S. Congress and/or various states and local legislators may enact additional legislation or regulatory action designed to address the current economic crisis or for other purposes that could have an effect on the execution of our business strategies. To the extent we participate in the HAMP, there is no guarantee as to the continued expectation of future incremental revenues.
Risks Related to Ownership of Our Common Shares
Our common share price may experience substantial volatility, which may affect your ability to sell our common shares at an advantageous price. The market price of our common shares has been and may continue to be volatile. For example, the closing market price of our common shares on the New York Stock Exchange has fluctuated during the past twelve months between $5.27 per share and $14.56 per share and may continue to fluctuate. Therefore, the volatility may affect your ability to sell our common shares at an advantageous price. Market price fluctuations in our common shares may be due to acquisitions, dispositions, the spin-off of Altisource or other material public announcements along with a variety of additional factors including, without limitation, those set forth under “Risk Factors” and “Forward-Looking Statements.” In addition, the stock markets in general, including the New York Stock Exchange, recently have experienced extreme price and trading fluctuations. These fluctuations have resulted in volatility in the market prices of securities that often has been unrelated or disproportionate to changes in operating performance. These broad market fluctuations may adversely affect the market prices of our common shares.
Shares of our common stock are relatively illiquid. As of June 30, 2009, we had 67,512,096 shares of common stock outstanding. As of that date, approximately 36% of our common shares were held by our officers and directors and their affiliates and another approximately 21% of our common shares were held by three investors. As a result of our relatively small public float, our common stock may be less liquid than the common stock of companies with broader public ownership. The trading of a relatively small volume of our common stock may have a greater impact on the trading price of our common stock than would be the case if our public float were larger.
63
There may be future sales or other dilution of our equity, which may adversely affect the market price of our common stock. We are not restricted from issuing additional shares of our common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock.
We have currently outstanding approximately $56,000 aggregate principal amount of 3.25% contingent convertible senior unsecured notes due 2024. In addition, we may issue additional shares of common stock in satisfaction of our make-whole obligations relating to our 3.25% contingent convertible senior unsecured notes due 2024. The issuance of additional shares of our common stock in this offering, upon conversion of the 3.25% contingent convertible senior unsecured notes due 2024, or other issuances of our common stock or convertible or other equity linked securities, including options, and warrants, or otherwise, will dilute the ownership interest of our common stockholders.
Sales of a substantial number of shares of our common stock or other equity-related securities in the public market could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities. We cannot predict the effect that future sales of our common stock or other equity-related securities would have on the market price of our common stock.
Risks Relating to the Altisource Spin-off
We could have conflicts with Altisource, and our Chief Executive Officer and Chairman of the Board, and other officers and directors, could have conflicts of interest due to their relationships with Ocwen and Altisource, which may be resolved in a manner adverse to us. Conflicts may arise between Ocwen and Altisource as a result of our ongoing agreements and the nature of our respective businesses. Among other things, we will become a party to a variety of agreements with Altisource in connection with the spin-off and we may enter into further agreements with Altisource after the spin-off. Certain of our executive officers and directors may be subject to conflicts of interest with respect to such agreements and other matters due to their relationships with Altisource.
William C. Erbey, who will remain our Chief Executive Officer and Chairman of the Board, will become Altisource’s non-executive Chairman of the Board as a result of the spin-off. As a result, he has obligations to us as well as to Altisource and may potentially have conflicts of interest with respect to matters potentially or actually involving or affecting Altisource and us.
Mr. Erbey will own substantial amounts of Altisource common stock and stock options because of his relationships with Altisource. This ownership could create or appear to create potential conflicts of interest when our Chairman of the Board is faced with decisions that involve Ocwen, Altisource or any of their respective subsidiaries.
Matters that could give rise to conflicts between Altisource and us include, among other things:
| | |
| · | our ongoing and future relationships with Altisource, including related party agreements and other arrangements with respect to the administration of tax matters, employee benefits, indemnification and other matters; |
| · | the quality and pricing of services that Altisource has agreed to provide to us or that we have agreed to provide to Altisource and |
| · | any competitive actions by Altisource. |
We will also seek to manage these potential conflicts through dispute resolution and other provisions of our agreements with Altisource and through oversight by independent members of our Board of Directors. There can be no assurance that such measures will be effective, that we will be able to resolve all conflicts with Altisource or that the resolution of any such conflicts will be no less favorable to us than if we were dealing with a third party.
The tax liability to Ocwen as a result of the spin-off could be substantial. In the pre-spin-off restructuring, any assets that are transferred to Altisource Portfolio Solutions S.A. or non-U.S. subsidiaries will be taxable pursuant to Section 367(a) of the Internal Revenue Code (Code), or other applicable provisions of the Code and Treasury regulations. Taxable gains not recognized in the restructuring will generally be recognized pursuant to the spin-off itself under Section 367(b). The taxable gain recognized by Ocwen attributable to the transfer of assets to Altisource will equal the excess of the fair market value of each asset transferred over Ocwen’s basis in such asset. Ocwen’s basis in some assets transferred to Altisource may be low or zero which may result in a substantial tax liability to Ocwen. In addition, the amount of taxable gain will be based on a determination of the fair market value of Ocwen’s transferred assets. The determination of fair market values of non-publicly traded assets is subjective and could be subject to closing date adjustments or future challenge by the Internal Revenue Service (IRS), which could result in an increased United States federal income tax liability to Ocwen.
64
New prospective tax regulations, if held applicable to the spin-off, could materially increase tax costs to Ocwen. On June 10, 2009, the IRS issued new regulations under Section 7874 of the Code. The IRS further indicated that it intends to issue additional regulations with respect to transactions where a U.S. corporation contributes assets, including subsidiary equity interests, to a foreign corporation and distributes the shares of such corporation, as in the Separation. Our understanding of the IRS’s plans regarding these forthcoming regulations is that they would apply to the spin-off only if the value of assets held by Ocwen’s corporate or partnership subsidiary entities (either currently, or those that were distributed from such entities as part of the plan encompassing the spin-off) exceeds, in the aggregate, 60% of the value of Altisource when contributed to Altisource. It is not certain, however, what these regulations will provide for once adopted. Prior to completing the spin-off, Ocwen’s board of directors will require Ocwen and Altisource to receive a valuation from an independent valuation firm that will enable the Company to determine whether the value of these assets is less than 60% of the value of Altisource. Because we believe the value of these assets does not exceed the 60% threshold, as we expect to be confirmed by information we derive from the independent valuation, we do not believe that Code Section 7874 applies to the spin-off. The independent valuation is not binding on the IRS. If the IRS were to successfully challenge this valuation, and find that the value of these assets exceeds 60% of the value of Altisource, then Ocwen would not be permitted to offset gain recognized on the transfer of these assets to Altisource with net operating losses, tax credits or other tax attributes. This could materially increase the tax cost to Ocwen of the spin-off.
The Altisource spin-off will initially reduce our market value and balance sheet and may impact our ability to obtain or maintain financing. The Altisource spin-off will initially reduce our market value and balance sheet. There can be no assurances regarding whether or to what extent the Altisource spin-off or these factors may be viewed by our current or potential lenders or other counterparties as negatively impacting our ability to obtain, maintain or renew financings, credit agreements, guaranties or other contractual relationships.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Shareholders held on May 6, 2009, the following individuals were elected to the Board of Directors of OCN:
| | | | | | | |
| | Votes For | | Votes Withheld | |
| | | | | |
William C. Erbey | | 59,602,018 | | | 566,713 | | |
Ronald M. Faris | | 59,941,351 | | | 227,380 | | |
Martha C. Goss | | 59,960,774 | | | 207,957 | | |
Ronald J. Korn | | 57,979,329 | | | 2,189,402 | | |
William H. Lacy | | 57,961,493 | | | 2,207,238 | | |
David B. Reiner | | 59,947,581 | | | 221,150 | | |
Barry N. Wish | | 55,008,694 | | | 5,160,037 | | |
Ratification of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2009 was also voted on and approved by the shareholders as follows:
| | | | |
Votes for | | | 60,003,164 | |
Votes against | | | 157,270 | |
Abstentions | | | 8,296 | |
65
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. |
66
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: August 4, 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) | |
67
