Exhibit 99.1
RISK FACTORS (Dollars in thousands)
Each of the factors set forth below could, directly or indirectly,
affect the results of operations and financial condition of Ocwen Financial
Corporation ("OCN"). Capitalized terms that are not defined herein shall have
the meanings ascribed to them in our Annual Report on Form 10-K to which this
Exhibit relates.
Changing Nature of Risks; No Assurances as to Consistency of Earnings
Changing Nature of Risks. In the past, our corporate strategy
emphasized the identification, development and management of specialized
businesses that we believed were not accurately evaluated and priced by the
marketplace due to market, economic and competitive conditions. This strategy
can result in the entry into or development of businesses and investment in
assets which produce substantial initial returns, which may be followed by an
exit from any of those businesses or the sale of those assets if, for example,
results decrease because markets become more efficient in the evaluation and
pricing of such businesses and assets. For example, historically, our efforts
have focused on lending, the acquisition and resolution of discounted loans, and
investment in various types of mortgage-related securities. However, on October
26, 1998, we announced that we would refocus our resources on our core
competencies, namely the acquisition and management of servicing-intensive
assets and the development of exportable loan servicing technology for the
mortgage and real estate industries. This strategy involves the potential to
enter into and exit from different businesses; therefore, past financial
performance may not be considered a reliable indicator of future performance and
historical trends may not be reliable indicators of anticipated results or
trends in future periods. In addition, there can be no assurance that we will be
able to accomplish our strategic objectives as a result of changes in the nature
of our operations over time or that such changes will not have a material
adverse effect from time to time or generally on our business, financial
condition or results of operations.
Inconsistency of Results and Non-Recurring Items. In addition to
inconsistency in results caused by our entry into or exit from businesses, the
consistency of our operating results has and may continue to be significantly
affected by inter-period variations in our current operations, including:
o The amount of servicing rights acquired;
o The amount of resolutions of discounted loans, particularly large
multi-family residential and commercial real estate loans;
o The amount of multi-family residential and commercial real estate
loans which mature or are prepaid, particularly loans with terms
pursuant to which we participate in the profits of the underlying
real estate; and
o Sales by us of loans and/or securities acquired from our
securitization of loans.
In addition, our operating results have been significantly affected by
certain non-recurring items. For example, we have earned significant
non-interest income from gains on sales of interest-earning assets and real
estate owned. Gains on sales of interest-earning assets and real estate owned
generally are dependent on various factors that are not within our control,
including market and economic conditions and accounting regulations. In
addition, in the third quarter of 1999, we decided to discontinue the practice
of structuring securitizations as sales transactions, thus precluding
recognition of gain-on-sale accounting. There can be no assurance that the level
of gains on sales of interest-earning assets and real estate owned reported by
us in prior periods will be repeated in future periods or that there will not be
substantial inter-period variations in the results from such activities or as a
result of other non-recurring items.
Risks Related to Non-Traditional Operating Activities
As discussed below, we are engaged in a variety of businesses that
generally involve more uncertainties and risks than the single-family
residential lending activities historically emphasized by savings institutions.
In addition, many of our business activities are conducted on a nationwide
basis, which reduces the risks associated with concentration in any one
particular market area but involves other risks because, among other things, we
may not be as familiar with market conditions and other relevant factors as we
would be in the case of activities that are conducted in the market areas in
which our executive offices and branch office are located.
Discounted Loan and Servicing Rights Acquisition and Loan Resolution
Activities. Our activities have included the acquisition (in 2000 and prior
years), sale and resolution of non-performing or underperforming single-family
(one to four units) residential loans, multi-family (over four units)
residential loans and commercial real estate loans that were purchased at a
discount. Non-performing and subperforming mortgage loans may be in default or
may have a greater than normal risk of future defaults and delinquencies, as
compared to newly-originated, high-quality loans of comparable type, size and
geographic concentration. Returns on an investment of this type depend on the
borrower's ability to make required payments or, in the event of default, the
ability of the loan's servicer to foreclose and liquidate the mortgage loan.
There can be no assurance that the servicer can liquidate a defaulted mortgage
loan successfully or in a timely fashion.
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We have acquired discounted loans from governmental agencies, which in
the early years of the program consisted primarily of the Federal Deposit
Insurance Corporation (the "FDIC") and the Resolution Trust Corporation, a
federal agency that was formed to resolve failed savings institutions and has
since ceased operations, and in recent years has consisted primarily of the U.S.
Department of Housing and Urban Development. In addition to governmental
agencies, we have acquired discounted loans from various private sector sellers,
such as banks, savings institutions, mortgage companies and insurance companies.
We acquire servicing rights principally from private sellers. Although we
believe that a permanent market for the acquisition of servicing rights to
non-performing and underperforming mortgage loans has emerged in recent years,
there can be no assurance that we will be able to acquire the desired amount and
type of servicing rights in future periods or that there will not be significant
inter-period variations in the amount of such acquisitions. There also can be no
assurance that the discount on the non-performing and underperforming loans
acquired by us will enable us to resolve discounted loans in the future as
profitably as in prior periods. Adverse changes in national economic conditions
or in the economic conditions in regions in which we have acquired pools of
loans and servicing rights could impair our ability successfully to resolve
loans and could have an adverse effect on the value of those loan pools and
servicing rights. The yield on our discounted portfolio also is subject to
significant inter-period variations as a result of the timing of resolutions of
discounted loans, particularly multi-family residential and commercial real
estate loans and non-performing single-family residential loans, interest on
which is recognized on a cash basis, and the mix of the overall portfolio
between performing and non-performing loans. In addition, the volume of
servicing rights acquired by us may vary over time, thereby affecting results of
operations in future periods.
Multi-Family Residential, Commercial Real Estate and Construction
Lending Activities. Prior to our decision to cease origination of such loans in
1999, our lending activities included nationwide loans secured by existing
commercial real estate, particularly hotels and office buildings, and existing
multi-family residential real estate. In addition, from time to time we have
originated loans for the construction of multi-family residential real estate
and land acquisition and development loans. Multi-family residential real
estate, commercial real estate and construction lending generally are considered
to involve a higher degree of risk than single-family residential lending due to
a variety of factors, including generally larger loan balances, the dependency
on successful completion or operation of the project for repayment, the
difficulties in estimating construction costs and loan terms which often require
little or no amortization of the loan over its term (typically five years) and,
instead, provide for a balloon payment at stated maturity. Furthermore,
mezzanine loans, which are subordinate to senior loans, and construction loans
generally have higher loan-to-value ratios than conventional loans. Although our
borrowers generally have an equity investment of 10% to 15% of total project
costs, such equity may not be sufficient to protect our investment in these
higher-yielding loans. There can be no assurance that any multi-family
residential, commercial real estate and construction lending activities engaged
in by us previously will not be adversely affected by these and the other risks
related to such activities.
Subprime Family Residential Lending Activities. We closed our domestic
subprime origination business in August 1999 and exited the UK subprime
origination business by selling our investment in our Ocwen UK subsidiary in
September 1999 and our investment in Kensington Group plc in November 2000.
Prior to these dates, our lending activities also included the origination or
purchase on a nationwide basis of single family residential loans made to
borrowers who have significant equity in the properties that secure the loans
but who, because of prior credit problems, the absence of a credit history or
other factors, were unable or unwilling to qualify as borrowers under federal
agency guidelines. These loans were offered pursuant to various programs,
including programs that provide for reduced or no documentation for verifying a
borrower's income and employment. Subprime loans present a higher level of risk
of delinquency or default than loans made to more creditworthy borrowers, and
may not be as saleable as loans that conform to the guidelines established by
various federal agencies. While we believe that the business practices that we
employ enable us to reduce higher risks inherent in these loans, no assurance
can be given that such practices will afford adequate protection against higher
delinquencies, foreclosures or losses than anticipated, and as a result, our
financial condition or results of operation could be adversely affected.
Environmental Risks of Loan Acquisition and Lending Activities. We
evaluated the potential for significant environmental problems prior to
acquiring or originating a loan because there is a risk for any mortgage loan,
particularly a multifamily residential and commercial real estate loan, that
hazardous substances or other environmentally restricted substances could be
discovered on the related real estate. Through foreclosure, we could become the
owner of the real estate that secured our loan and might be required to remove
such substances from the affected properties or to engage in abatement
procedures at our sole cost and expense. There can be no assurance that the cost
of such removal or abatement will not substantially exceed the value of the
affected properties or the loans secured by such properties, that we would have
adequate remedies against the prior owners or other responsible parties or that
we would be able to resell the affected properties either prior to or following
completion of any such removal or abatement procedures. If such environmental
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problems are discovered prior to foreclosure, we generally will not foreclose on
the related loan; however, the value of such property as collateral will
generally be substantially reduced, and as a result, we may suffer a loss upon
collection of the loan.
Investments in Low-Income Housing Tax Credit Interests. We invest in
affordable housing (generally limited partnerships) in order to obtain federal
income tax credits that are allocated pursuant to Section 42 of the Internal
Revenue Code of 1986, as amended (the "Code"). There are many uncertainties and
risks associated with an investment in low-income housing tax credit interests,
including the risks involved in the construction, lease-up and operation of
multi-family residential real estate, the investor's ability to earn sufficient
income to utilize the tax credits resulting from such investments in accordance
with the requirements of the Code and the possibility of required recapture of
previously-earned tax credits. In addition, there are numerous tax risks
associated with tax credits resulting from potential changes to the Code.
Potential changes in the Code, which have been discussed from time to time,
could reduce the benefits associated with our existing investments in low-income
housing tax credit interests, including the replacement of the current graduated
income taxation provisions in the Code with a "flat tax" based system and
increases in the alternative minimum tax, which cannot be reduced by tax
credits. We are unable to predict whether any of the foregoing or other changes
to the Code will be subject to future legislation and, if so, what the contents
of such legislation will be and its effects, if any, on us.
Investments in Mortgage-Related Securities. From time to time we invest
in a variety of mortgage-related securities, such as senior, subordinate and
residual interests in collateralized mortgage obligations ("CMOs"), including
CMOs which have qualified as Real Estate Mortgage Investment Conduits. Some
mortgage-related securities exhibit considerably more price volatility than
mortgages or ordinary mortgage pass-through securities, due in part to the
uncertain cash flows that result from changes in the prepayment rates of the
underlying mortgages. Other mortgage-related securities, such as subordinate
interests, also involve substantially more credit risk than the senior classes
of the mortgage-related securities to which such interests relate and generally
are not as liquid as such senior classes. We have generally acquired subordinate
and residual interests primarily in connection with the securitization of our
loans, particularly single-family residential loans to non-conforming borrowers
and discounted loans, and under circumstances in which we continue to service
the loans that back the related securities. We have sought to offset the risk of
changing interest rates on certain of our mortgage-related securities by selling
U.S. Treasury futures contracts and through other hedging techniques, and
believe that the resulting interest-rate sensitivity profile compliments our
overall exposure to changes in interest rates. See "Economic Conditions" below.
Although generally intended to reduce the effects of changing interest rates on
us, investments in certain mortgage-related securities and hedging transactions
could cause us to recognize losses depending on the terms of the instrument and
the interest rate environment.
Ability to Manage Growth. We have undergone rapid and significant
growth and are continuing to pursue a policy of rapid growth, including growth
in foreign countries. Our rapid growth has imposed a significant strain on our
management resources and there can be no assurance that we will be able to
attract and retain the necessary personnel to manage our operations effectively,
in which event our business, operating results and financial condition could be
materially and adversely affected.
Risk of Future Adjustments to Allowances for Losses
We believe that we have established adequate allowances for losses for
each of our loan portfolio, discounted loan portfolio and match funded loans in
accordance with generally accepted accounting principles. Future additions to
these allowances, in the form of provisions for losses on loans, discounted
loans and match funded loans, may be necessary, however, due to changes in
economic conditions and the performance of our loan and discounted loan
portfolios. In addition, the OTS, as part of its examination process,
periodically reviews our allowances for losses and the carrying value of our
assets. As a result of OTS reviews, we, in the past, have increased our
allowances for losses on loans and discounted loans and written down the
carrying value of certain loans. There can be no assurance that we will not
determine, at the request of the OTS or otherwise, to further increase our
allowances for losses on loans and discounted loans or adjust the carrying value
of our real estate owned or other assets. Increases in our provisions for losses
on loans would adversely affect our results of operations.
Risks Related to Real Estate Owned
General. Our real estate owned consists almost entirely of
single-family residential real estate and multi-family residential and
commercial real estate acquired by foreclosure or deed-in-lieu thereof on loans
in our discounted loan portfolio. Generally, real estate owned properties are
non-earning assets, although multi-family residential and commercial real estate
owned may provide some operating income to us depending on the circumstances.
Such operating income may be affected by problems experienced by lessees, which
may weaken their financial condition and result in failure to make rental
payments when due. At any time, a lessee of our properties may seek the
protection of bankruptcy laws, which could result in rejection and termination
of the lessee's lease and thereby cause a reduction in cash flow available for
distribution to us. Moreover, the value of real estate can be significantly
affected by adverse changes in national or local economic conditions,
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competition from other properties offering the same or similar services, changes
in interest rates and in the availability, cost and terms of mortgage funds,
acts of nature, including earthquakes, hurricanes and other natural disasters,
and other factors which are beyond our control. These factors may require the
establishment of provisions for losses to ensure that real estate owned
properties are carried at the lower of cost or fair value, less estimated costs
to dispose of the properties, which may adversely affect operations. Real estate
owned may also require increased allocation of resources and expense to the
management and work out of the asset, payment of property taxes and costs
associated with compliance with environmental laws and the Americans with
Disabilities Act of 1990, which can also adversely affect operations. There can
be no assurance that the amount of our real estate owned will not increase in
the future as a result of our discounted loan resolution activities and our
single-family residential, multi-family residential, commercial real estate and
construction loan portfolio.
Environmental Risks. Operating costs and the value of real property may
be affected by the obligation to pay for the cost of complying with existing
environmental laws, ordinances and regulations, as well as the cost of future
legislation. Under various federal, state and local environmental laws,
ordinances and regulations, a current or previous owner or operator of real
property may be liable for the costs of removal or remediation of hazardous or
toxic substances on, under or in such property. Such laws often impose liability
whether or not the owner or operator knew of, or was responsible for, the
presence of such hazardous or toxic substances. Therefore, an environmental
liability could have a material adverse effect on the underlying value of a real
property, and the revenue therefrom. Although we believe that our
pre-acquisition due diligence identified all material environmental concerns
which relate to our current investments in real estate and accurately assessed
the costs and liabilities to be incurred by us in this regard, there can be no
assurance that such investments will not raise material unanticipated
environmental concerns or costs in the future.
Risks Associated with Acquisitions and Divestitures
Acquiring businesses and business assets has been and may continue to
be an important focus of our strategic efforts. Any acquisitions could vary in
size and may include those that are large relative to OCN. There can be no
assurance that suitable acquisition candidates can be identified, that financing
for such acquisitions would be available on satisfactory terms, that we would be
able to accomplish our strategic objectives as a result of any such
acquisitions, that any business or business assets acquired by us would be
integrated successfully or that integration of acquired businesses would not
divert management resources or otherwise have a material adverse effect on our
business, financial condition or results of operations. We are continually
evaluating possible acquisitions and engage in discussions with acquisition
candidates from time to time.
In addition, in the event that we choose to divest any business or sell
any asset in the future, there can be no assurance that a suitable purchaser
could be identified, that we would be able to accomplish our strategic
objectives as a result of any such sale, that any proposed asset or business
sold by us would be completed or that the separation of any such asset or
business from us would not diminish management resources or otherwise have a
material adverse effect on our business, financial condition or results of
operations.
Risks Associated with Technology
Our wholly-owned subsidiary, Ocwen Technology Xchange, Inc. ("OTX"),
licenses our mortgage loan servicing resolution and work flow technology to
third parties in the mortgage and real estate industries. The products offered
by OTX have resulted from the enhancement of software products acquired through
our purchases of Amos, Inc., a developer of residential mortgage loan servicing
software, DTS Communications, Inc., a real estate technology company, and the
assets of Synergy Software, LLC, a developer of commercial and multi-family
mortgage servicing software, with our own proprietary technology.
Revenue Recognition. A portion of our revenue attributable to OTX
operations includes license fees and implementation fees related to the
installation of our technology solutions. In certain instances, customers
receive certain elements of OTX's products or services over a period of time and
in some instances, fees received may be refundable based on the provisions of
the underlying agreements. Consequently, certain revenue is deferred and
recognized over future periods.
Rapid Technological Change and Competition. Rapid change, uncertainty
due to new and emerging technologies, and fierce competition characterize the
software industry. OTX's ability to grow is dependent upon our ability to
develop and introduce new products and enhance existing products to satisfy
consumer demand for new technologies. Because the pace of change continues to
accelerate, new opportunities for competitors are created and OTX's business
planning is subject to substantial uncertainty. Competitors, working with new
technology, may arrive at a technology that creates a new market altogether and
renders our product offerings obsolete. If we do not successfully identify new
product opportunities and develop and bring new products to market in a timely
and efficient manner, our business growth will suffer and demand for our
products will decrease. Competing platforms and products may gain popularity
with customers, vendors and loan originators, reducing or eliminating the
potential for OTX's future revenue.
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Future Initiatives. We plan to continue significant investments in
software research and development including the ongoing development of increased
functionality for OTX's products, including REALTransSM, REALServicingTM and
REALSynergyTM, where we have the opportunity to capture significant market share
through improved efficiencies offered by these products. We anticipate that
these investments in research and development will increase over historical
spending levels without corresponding growth in revenue in the near future.
Significant revenue from these product opportunities may not be achieved for a
number of years, if at all.
Software Development. The software industry is inherently complex. New
products and product enhancements can require long development and testing
periods. While we believe we have developed products attractive to the mortgage
and real estate industries, the computer software industry is subject to rapid
technological change, changing customer requirements, frequent new product
introductions and evolving industry standards that may render existing products
and services obsolete. There can be no assurance that OTX will not experience
future difficulties that could delay or prevent the successful development,
introduction or marketing of our products, or that our products and product
enhancements will meet the requirements of the marketplace and achieve market
acceptance. If OTX is unable to develop and introduce products of acceptable
quality in a timely manner in response to changing market conditions or customer
requirements, our business, operating results and financial condition could be
adversely affected.
Prices. The competitive factors described above may require OTX to
lower product prices to meet competition, reducing our net income.
International Operations. We are continuing to conduct more of our
business outside the United States. The costs of selling our products and
providing our services in foreign countries may be higher than our prices in the
United States because of the costs incurred in localizing both products and
financial services for non-U.S. markets. While we seek to set our prices for our
products and services higher to compensate for the additional expense, pressure
to globalize our pricing structures might require that we reduce the sales price
of our financial services and software in other countries, even though the costs
continue to be higher than in the United States. Our business and results of
operations outside of the United States could also be impacted by: difficulties
in staffing and managing foreign operations; unexpected changes in regulatory
requirements for financial services and software; negative changes in software
"piracy" trade protection laws, policies and measures and other regulatory
requirements affecting trade and investment; social, political, labor or
economic conditions in a specific country or region; and potential adverse
foreign tax consequences, among other factors.
Risks Associated with Mortgage Loan Servicing
Extensive Use of Financial Leverage. We are highly leveraged and will
continue to be highly leveraged. Our ability to make payments of principal or
interest on or to refinance our indebtedness depends on our future operating
performance and our ability to effect additional debt and/or equity financing,
which is subject to economic, financial, competitive and other factors beyond
our control, including restrictions on our ability to obtain additional debt
financing contained in the indentures relating to our 11.875% Notes and 10.875%
Junior Subordinated Debentures.
We intend to continue financing the servicing advances that we are
required to make in connection with the acquisition of servicing rights for
pools of loans and the servicing of the loans throughout the life of the
mortgage loan. Generally, we expect to be able to finance up to ninety percent
of these advance amounts. While the leveraged nature of our assets offers the
opportunity for increased rates of return on our invested capital, it involves a
greater degree of risk.
This degree of leverage also makes us more vulnerable to a downturn in
real estate values or the economy generally. Although we generally expect to
repay any indebtedness incurred in connection with a servicing acquisition from
the related servicing fees, a downturn in the economy or real estate market
could reduce those proceeds. An increase in market interest rates or a decline
in the value of the collateral securing the pool of loans for which we have
acquired the servicing rights could adversely effect servicing fees and our
ability to repay our borrowings and could have a material adverse effect on our
results of operations and financial condition.
Need for Additional Financing. Our expansion strategy will result in
the need for additional debt and/or equity financing in the future, and there
can be no assurance that we will be able to obtain such financing on acceptable
terms. In addition, the indentures relating to our 11.875% Notes and 10.875%
Junior Subordinated Debentures restrict our ability to obtain additional debt
financing. Our degree of leverage may make it more difficult for us to obtain
additional financing for future working capital, capital expenditures, servicing
related acquisitions, general corporate purposes or other purposes and may cause
us to dedicate a substantial portion of our cash flow from operations to the
payment of principal and interest on indebtedness, thereby reducing the funds
available for operations and future business opportunities. To the extent we are
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unable to extend or replace existing facilities or generate sufficient cash flow
from the servicing rights, we may have to curtail our acquisition of servicing
rights, which could have a material adverse effect on our financial position and
results of operations.
Risks Related to Acquired Servicing Rights on Pools of Loans. In
determining the purchase price for servicing rights, management makes certain
assumptions regarding, among other things, the rates of prepayment and repayment
within the pools, the credit categories of the borrowers within the pools, the
collateral values and loan-to-value ratios of the pools, the origination
practices of the loan originators, the real estate market and our ability
successfully to service and resolve loans and to dispose of any foreclosed real
estate. To the extent that our underlying assumptions prove to be inaccurate or
the basis for those assumptions change (for example, an unanticipated decline in
the real estate market), or there is some other diminution in the value of the
assets, the price paid by us for servicing rights may prove to have been
excessive, resulting in a lower yield or a loss to us. Therefore, our success is
highly dependent on our pricing of servicing rights as well as general economic
conditions in the geographic areas in which the foreclosed real estate or
properties underlying the loans that we service are located. Adverse changes in
national economic conditions or in the economic conditions in regions in which
we have acquired pools of loans could impair our ability to successfully resolve
loans and have an adverse effect on the value of those pools of loans. In
addition, because non-performing loans do not make regular cash payments and in
various servicing relationships, we are repaid for advances out of proceeds from
the loans, the return to us may be significantly influenced by the time it takes
to resolve the loan, which varies based on, among other things, state consumer
protection and foreclosure laws, both of which are subject to change. Both our
initial and ongoing valuations and the rate of amortization of mortgage
servicing rights are significantly affected by interest rates, prepayment speeds
and the payment performance of the underlying loans. In general, during periods
of declining interest rates, the value of mortgage servicing assets declines due
to increasing prepayments attributable to increased mortgage refinance activity.
We amortize mortgage servicing rights over the period of estimated net servicing
income based on our projections of the amount and timing of future cash flows.
The amount and timing of servicing asset amortization is adjusted periodically
based on actual results and updated projections.
Risks Related to International Servicing Operations. We have invested
in joint ventures with servicing operations currently in Italy and anticipated
in Japan, Korea, Europe and Taiwan. The ventures plan to use our servicing
system, which must be adapted for servicing loans in Europe and the Far East.
Our international servicing operations are subject to most of the same risks
associated with our U.S. operations as well as additional risks as fluctuations
in foreign currency exchange rates, unexpected changes in regulatory
requirements, heightened risks of political and economic instability,
difficulties in managing international operations, potentially adverse tax
consequences, enhanced accounting and control expenses and the burden of
complying with a wide variety of foreign laws. In addition, we have only limited
experience in servicing loans in foreign countries. Accordingly, there can be no
assurance that one or more of these factors will not have a materially adverse
effect on our operations.
Risk of Increased Capital Requirements. Federally insured savings
associations are required to maintain minimum levels of regulatory capital.
These standards generally are as stringent as the comparable capital
requirements imposed on national banks. The OTS also is authorized to impose
capital requirements in excess of those standards on individual associations on
a case-by-case basis. In making such determination, the OTS can take into
account a number of factors, including the bank's loan portfolio quality, recent
operating losses or anticipated losses, the condition of our holding company and
whether the bank is receiving special supervisory attention, among other
matters. If the OTS were to impose higher capital requirements than it has
currently established for the Bank or additional capital were required as a
result of an adverse determination by the OTS or otherwise, we might inject
additional capital into the Bank, whether or not such usage of capital is
optimal for OCN. Such additional capital contributions may have the effect of
reducing or eliminating our overall net income or requiring us to obtain
additional debt or equity capital. In the event that we were unable or refused
to inject capital into the Bank as required by the OTS, significant adverse
consequences could result. See "Regulation and Regulatory Capital," below.
Risks Related to Securitization. Under certain circumstances, we may be
required to advance funds to securitization trusts, indemnify the trustee and
the underwriters of a securitization and repurchase certain loans that were
securitized. In connection with a securitization, we may be required to agree
that, in the event of a breach of any representation or warranty made by us that
materially and adversely affects the value of an underlying mortgage loan, we
will repurchase that loan at a price equal to the then outstanding principal
balance of the loan and any accrued and unpaid interest thereon.
International Operations
We conduct business in the United States, Jamaica and, through a joint
venture, Italy, are exploring opportunities in Japan, Korea, Europe and Taiwan
and may explore opportunities outside of these markets. We are establishing two
software development and servicing operations centers in India. Our foreign
operations are subject to most of the same risks associated with our U.S.
operations, as well as additional risks, such as unexpected changes in local
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regulatory requirements, difficulties in managing international operations,
potentially adverse tax consequences, enhanced accounting and control expenses
and the burden of complying with foreign laws. Changes in foreign currency
exchange rates may also affect the value of our foreign assets and the gains
realized from the sale of such assets. Although we implement hedging strategies
to limit the effects of currency exchange rate fluctuations on our results of
operations, currency hedging strategies, like those for interest rates, may not
perform their intended purpose. See "Economic Conditions". There can be no
assurance that such factors will not have a material adverse effect on our
business, results of operations or financial condition. In addition, we have
only limited international experience outside of the U.S., which could limit our
ability to capitalize on investment opportunities that may arise elsewhere.
Regulation and Regulatory Capital Requirements
OCN, as a savings and loan holding company, and the Bank, as a
federally-chartered savings institution, are subject to significant governmental
supervision and regulation, which is intended primarily for the protection of
depositors. Statutes and regulations affecting OCN and the Bank may be changed
at any time, and the interpretation of these statutes and regulations by
examining authorities also is subject to change. There can be no assurance that
future changes in applicable statutes and regulations or in their interpretation
will not adversely affect our business. The applicable regulatory authorities
may, as a result of such regulation and examination, impose regulatory sanctions
upon OCN or the Bank, as applicable, as well as various requirements or
restrictions which could adversely affect our business activities. A portion of
the Bank's operations involve businesses that are not traditionally conducted by
savings institutions and, as a result, there can be no assurance that future
actions by applicable regulatory authorities, or future changes in applicable
statutes or regulations, will not limit or otherwise adversely affect the Bank's
ability to engage in such activities.
Following an examination of the Bank in late 1996 and early 1997 by the
Office of Thrift Supervision (the "OTS"), the Bank committed to the OTS to
maintain, commencing on June 30, 1997, regulatory capital ratios that
significantly exceed the requirements that are generally applicable to
federally-chartered savings institutions such as the Bank. Specifically, the
Bank has committed to the OTS to maintain a core capital (leverage) ratio and a
total risk-based capital ratio of at least 9% and 13%, respectively (the
requirements of general applicability are 3% and 8%, respectively). At December
31, 2001, the Bank's core capital, Tier 1 risk-based capital and total
risk-based capital ratios amounted to 13.64%, 18.41% and 23.33%, respectively.
Based on discussions with the OTS, the Bank believes that this commitment does
not affect its status as a "well-capitalized" institution, assuming the Bank's
continued compliance with the regulatory capital requirements that it committed
to maintain. Under applicable laws and regulations, an institution is considered
to be "well-capitalized" if it maintains a total risk-based capital ratio of
10.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more and a core
capital (leverage) ratio of 5.0% or more and is not subject to a written
agreement, order or directive issued by an appropriate agency to meet and
maintain a specific capital level for any capital measure.
There can be no assurance that in the future the OTS either will agree
to a decrease in the 9% core capital (leverage) ratio and the 13% total
risk-based capital ratio committed to be maintained by the Bank or will not seek
an increase in such requirements. Unless and until these regulatory capital
requirements are decreased, the Bank's ability to leverage its capital through
future growth in assets (including its ability to continue growing at historical
rates) will be adversely affected, as will OCN's ability to receive dividends
from the Bank. Although OCN and its non-banking subsidiaries will not be
restricted in their growth by these capital requirements, because they do not
have access to the Bank's funding sources, their profitability may be different
from the Bank's for particular types of businesses. In addition, there can be no
assurance that the Bank will continue to meet the regulatory capital
requirements that it has committed to maintain or that the OTS will not formally
impose such requirements pursuant to a written agreement, order or directive,
which would cause the Bank to cease to be a "well-capitalized" institution under
applicable laws and regulations. In the event that the Bank ceased to be a
"well-capitalized" institution, it could become subject to other regulatory
restrictions on its operations.
Economic Conditions
General. Our success is dependent to a certain extent upon the general
economic conditions in the geographic areas in which we conduct substantial
business activities. Adverse changes in national economic conditions or in the
economic conditions of regions in which we conduct substantial business likely
would impair our ability to collect on outstanding loans or dispose of real
estate owned and would otherwise have an adverse effect on our business,
including the ability of customers to repay loans and the value of both the
collateral pledged to us to secure our loans and our real estate owned.
Moreover, earthquakes, hurricanes and other natural disasters could have similar
effects. Although such disasters have not significantly adversely affected us to
date, the availability of insurance for such disasters in Florida, in which we
conduct substantial business activities, is limited. Moreover, changes in
building codes and ordinances, environmental considerations and other factors
also might make it infeasible to use insurance proceeds to replace a property if
it is damaged or destroyed. Under such circumstances, the insurance proceeds
received by a borrower or by us might not be adequate to restore our economic
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position with respect to the affected collateral or real estate. At December 31,
2001, we had loans aggregating $6,590 (including match funded loans and loans
available for sale) secured by properties located in Florida and $50,694 of our
real estate owned was located in Florida, which collectively represented 3.3% of
our total assets at such date.
Effects of Changes in Interest Rates. Net interest income (expense) is
the difference between the interest income earned on interest-earning assets and
the interest expense incurred in connection with our interest-bearing
liabilities. Changes in the general level of interest rates can affect our net
interest income (expense) by affecting the spread between our return on
interest-earning assets and our cost of interest-bearing liabilities, as well
as, among other things, the value of our interest-earning assets and our ability
to realize gains from the sale of such assets; the average life of our
interest-earning assets; the value of our mortgage servicing rights; and our
ability to obtain deposits in competition with other available investment
alternatives. Interest rates are highly sensitive to many factors, including
governmental monetary policies, domestic and international economic and
political conditions and other factors beyond our control. Although we believe
that the maturities of our assets are well balanced in relation to our
liabilities (which involves various estimates and assumptions, including as to
how changes in the general level of interest rates will impact our assets and
liabilities), there can be no assurance that our profitability would not be
adversely affected during any period of changing interest rates.
Potential Adverse Effects of Hedging Strategies. We may utilize a
variety of financial instruments, including interest rate swaps, caps, floors
and other interest rate exchange contracts and foreign currency futures
contracts, in order to limit the effects of interest rates or changes in foreign
currency exchange rates on our operations. Among the risks inherent with respect
to the purchase and/or sale of such derivative instruments are:
o Interest rate risk, which consists of the risks relating to
fluctuating interest rates;
o Basis risk, which consists of the risk of loss associated with
variations in the spread between the asset yield and the funding
and/or hedge costs;
o Credit or default risk, which consists of the risk of insolvency or
other inability of the counterparty to a particular transaction to
perform our obligations thereunder;
o Prepayment risk, which consists of reinvestment risk to the extent
we are not able to reinvest repayments, if any, at a yield which is
comparable to the yield being generated on the particular security;
o Liquidity risk, which consists of the risk that we may not be able
to sell a particular security at a particular price;
o Legal enforceability risk, which consists of the risks related to
our ability to enforce the terms of a particular instrument or to
obtain or collect upon a legal judgment in the United States in the
event that the counterparty to the transaction is a foreign entity
or the underlying collateral is located in a foreign jurisdiction;
and
o Volatility risk, which consists of the risk that actual volatility
(i.e., the degree of uncertainty relating to the price of the
underlying asset) differs from the historical volatility or
"implied" volatility of the instrument.
Risks Related to Reliance on Brokered and Other Wholesale Deposits
We historically have utilized as a source of funds certificates of
deposit obtained through national investment banking firms which obtain funds
from their customers for deposit with us ("brokered deposits") and, to a lesser
extent, certificates of deposit obtained from customers of regional and local
investment banking firms and direct solicitation efforts by us of institutional
investors and high net worth individuals. We believe that the effective cost of
brokered and other wholesale deposits, as well as other non-branch dependent
sources of funds, such as securities sold under agreements to repurchase
("reverse repurchase agreements") and advances from the Federal Home Loan Bank
("FHLB") of New York, generally is more attractive to us than the effective cost
of deposits obtained through branch offices after the general and administrative
costs associated with operating a branch office network are taken into account.
However, such funding sources, when compared to retail deposits attracted
through a branch network, are generally more sensitive to changes in interest
rates and volatility in the capital markets and their availability and terms are
more likely to be subject to competitive pressures. In addition, such funding
sources may be more sensitive to significant changes in our financial condition.
There are also regulatory limitations on an insured institution's ability to
solicit and obtain brokered deposits in certain circumstances. See "Regulation
and Regulatory Capital Requirements" above. As a result of our past reliance on
brokered and other wholesale deposits, significant changes in prevailing
interest rates, in the availability of alternative investments for individual
and institutional investors or in our financial condition, among other factors,
could have a much more significant affect on our liquidity and results of
operations than might be the case with an institution that attracted a greater
portion of its funds from retail or core deposits obtained through a branch
network. During 2001, we did not issue any new brokered certificates of deposit
and presently do not intend to utilize such deposits as a source of new funds in
the foreseeable future.
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Risks Associated with Current Sources of Liquidity and Additional Financing for
Growth
Current Sources of Liquidity. Our primary sources of funds for
liquidity consist of deposits, FHLB advances, reverse repurchase agreements,
lines of credit, match funded debt, servicing fees and maturities and principal
payments on loans and securities and proceeds from sales thereof. We believe
that our existing sources of liquidity will be adequate to fund planned
activities for the foreseeable future, although there can be no assurances in
this regard. Moreover, we continue to evaluate other sources of liquidity, such
as lines of credit from unaffiliated parties, which will enhance our ability to
increase our liquidity position. Our inability to maintain adequate sources of
liquidity, including as a result of the failure to extend or replace existing
lines of credit or as a result of the factors described under "Risks Related to
Reliance on Brokered and Other Wholesale Deposits" above or "Risks of
Securitization" below, could have a material adverse effect on our business,
financial condition or results of operations.
Additional Financing for Growth. Our ability to enter into and exit
from certain business lines as opportunities emerge depends to a significant
degree on our ability to obtain additional indebtedness, obtain additional
equity capital or have access to other sources of capital (e.g., through
partnering, joint venturing or other economic or contractual relationships). We
have no commitments for borrowings in addition to those under our current debt
securities, match funded debt and lines of credit, no commitments for future
sales of equity capital and no commitments to provide access to other sources of
capital. There can be no assurance that we will be successful in consummating
future financing transactions, if any, on terms satisfactory to us, if at all.
Factors which could affect our access to the capital markets or other economic
or contractual relationships, or the conditions under which we could obtain
additional financing, involve the perception in the capital markets and the
financial services industry of our business, results of operations, leverage,
financial condition and business prospects. Each of these factors is to a large
extent subject to economic, financial and competitive factors beyond our
control. In addition, covenants under our current debt securities and lines of
credit do, and future ones may, significantly restrict our ability to incur
additional indebtedness, to issue Preferred Stock and to enter into certain
other contractual relationships.
Risks Associated with Holding Company Structure
As a holding company, our ability to pay dividends, to pay indebtedness
and to conduct our financial operating activities directly or in non-banking
subsidiaries will depend on any cash reserves and other liquid assets held by
us, any proceeds from securities offerings or other borrowings, any dividends
from our non-banking subsidiaries and the receipt of dividends or other
distributions from the Bank. The ability of the Bank to pay dividends or make
other distributions to us generally is dependent on the Bank's compliance with
applicable regulatory capital requirements and regulatory restrictions. The Bank
is also subject to contractual restrictions on its ability to pay dividends
under its subordinated debt indenture.
The Bank's ability to make capital distributions as a Tier 1
association pursuant to the OTS capital distribution regulation are limited by
the regulatory capital levels that it has committed to the OTS to maintain,
commencing on June 30, 1997. As a result of a verbal agreement between the Bank
and the OTS to dividend subordinate and residual mortgage-related securities
resulting from securitization activities previously conducted by the Bank, the
Bank has been limited in its ability to pay cash dividends to OCN.
In addition, the right of OCN to participate in any distribution of
assets of any subsidiary, including the Bank, upon such subsidiary's liquidation
or reorganization or otherwise, will be subject to the prior claims of creditors
of that subsidiary, except to the extent that any claims of OCN as a creditor of
such subsidiary may be recognized as such.
Risks of Securitization
Prior to the third quarter of 1999, we had historically generated a
significant amount of revenues, earnings and cash flows from our pooling and
selling through securitizations of mortgages and other loans originated or
purchased by us. Adverse changes in the secondary market for such loans could
impair our ability to sell mortgages and other loans on a favorable or timely
basis. Accordingly, such impairments could have an adverse effect upon our
business and results of operations. Market and other considerations, including
rating agency requirements, could also affect the timing of such transactions.
Any delay in the sale of loans beyond the reporting period in which such sale is
anticipated to take place may adversely affect our reported earnings for such
reporting period. In addition, we retain some degree of credit risk on
substantially all loans sold. During the period of time that loans are held
pending sale, we are at risk for loan delinquencies and defaults and the risk
that the rapid increase in interest rates would result in a decline in the value
of loans to potential purchasers. For loans sold through a securitization, our
direct risk with respect to loan delinquency or default on such loan is limited
to those circumstances in which we are required to repurchase such loans due to
a breach of a representation or warranty in connection with the securitization.
9
Competition
The businesses in which we are engaged generally are highly
competitive. The acquisitions of servicing rights to pools of loans are
particularly competitive, as such acquisitions are often based on competitive
bidding. Although many of our competitors have access to greater capital and
have other advantages, we believe that we have a competitive advantage relative
to many of our competitors as a result of our experience in managing, servicing
and resolving discount loans, our investment in computer systems, technology and
other resources that are necessary to conduct this business, our reputation and
the strategic relationships and contacts that we have developed in connection
with these activities. We also encounter significant competition in connection
with our investment activities, our deposit-gathering activities, our servicing
activities and our information technology activities. Many of our competitors
are significantly larger than us and have access to greater capital and other
resources. In addition, many of our competitors are not subject to the same
extensive federal regulations that govern federally-insured institutions, such
as the Bank, and their holding companies. As a result, many of our competitors
have advantages over us.
We also face competition in purchasing the servicing rights to pools of
loans from several other companies that specialize in this business, some of
which have greater resources than us.
With respect to information technology, OTX's products compete in a
limited market. While we believe REALServicing, REALTrans and REALSynergy each
present to the market greater functionality and a better value than the products
against which they compete, there can be no assurance that we will be successful
in preserving any competitive advantage of our products on value or
functionality, in introducing the products to the market on a commercial basis
or translating the product's business, marketing and pricing models into revenue
sufficient to produce net income.
Importance of the Chief Executive Officer
William C. Erbey, our Chairman and Chief Executive Officer, has had,
and will continue to have, a significant role in the development and management
of our business. The loss of his services could have an adverse effect on us.
OCN and Mr. Erbey are not parties to an employment agreement, and we currently
do not maintain key man life insurance relating to Mr. Erbey or any of our other
officers.
Control of Current Shareholders
As of March 15, 2002, our directors and executive officers and their
affiliates in the aggregate beneficially owned or controlled 44.56% of the
outstanding Common Stock of OCN, including 27.49% owned or controlled by William
C. Erbey, Chairman and Chief Executive Officer of OCN, and 13.33% owned or
controlled by Barry N. Wish, currently a director and formerly the Chairman of
OCN. As a result, these shareholders, acting together, would effectively be able
to influence decisively, if not control, virtually all matters requiring
approval by the shareholders of OCN, including amendment of our Articles of
Incorporation, the approval of mergers or similar transactions and the election
of all directors.
Dependence on Proprietary Information
Our success is in part dependent upon our proprietary information and
technology. We rely on a combination of copyright, trade secret and contract
protection to establish and protect our proprietary rights in our products and
technology. We generally enter into confidentiality agreements with our
management and technical staff and limit access to and distribution of our
proprietary information. There can be no assurance that the steps taken by us in
this regard will be adequate to deter misappropriation of our proprietary rights
or information or independent third party development of substantially similar
products and technology. Although we believe that our products and technology do
not infringe any proprietary rights of others, the growing use of copyrights and
patents to protect proprietary rights has increased the risk that third parties
will increasingly assert claims of infringement in the future.
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