"The product we service is a very difficult product to service by and large." -- Ocwen Executive Chairman Bill Erbey
That could be the understatement of the year!
A daunting regulatory environment, a deluge of bad press, and increased costs involved with attempting to service and resolve delinquent mortgages have big money center banks running for the exits. Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM), and Citigroup (NYSE:C) are selling the mortgage servicing rights, or MSRs, to third-party companies. The largest of these is Ocwen Financial (NYSE:OCN). Part I of this series focused on the recent performance of the five publicly traded Ocwen entities .
The financial settlement
On March 18, 2014 Joseph A. Smith of the National Mortgage Settlement monitor reported that all four of the money center banks had fulfilled their financial obligations under the 2012 settlement agreement. Based upon the formula in the settlement, each bank achieved its required share of over $20 billion of homeowner debt forgiveness and refinancing assistance.
This consumer relief primarily resulted from the practice of robo-signing and other faulty foreclosure documentation. In aggregate, the banks provided over $50 billion of relief to more than 600,000 households. Ocwen entered into a similar agreement with the same monitor in December, 2013 to provide $2.1 billion in relief to homeowners. This settlement was approved by the court on Feb. 26, 2014.
Compliance with mortgage servicing rules
This is proving to be difficult for all of the banks, and to a certain extent Ocwen as well. There are 304 servicing standards and 29 metrics used to measure compliance. This past December, Joseph Smith reported that B of A failed three metrics, and JPMorgan and Citi each failed two.
ResCom, a portfolio managed by Ocwen passed all 29 metrics. Wells Fargo did not fail in any of the metrics that were tested. Does that mean that these two companies are out of the regulatory woods? Nope.
In October, 2013 the New York Attorney General filed a lawsuit against Wells Fargo for allegedly not processing loan modification requests in a timely manner. The NYDFS has initiated several investigations into Ocwen servicing practices and business structure. The NYDFS has also caused Ocwen to put a deal to acquire the MSR's to 184,000 loans from Wells Fargo -- with $39 billion of unpaid principal balance, or UPB -- on "indefinite hold."
One man's trash is another man's treasure
In the words of Ocwen's Bill Erbey "... the more difficult the environment becomes, the less attractive it becomes" for others. At the end of the day this is a very thorny environment for the money center banks. Let's face it, losing money is bad, being hassled by regulators is annoying, but the constant bad press is toxic. These homeowners are also potential retail banking customers who could provide low cost deposits and sign up for high margin financial products.
On the other hand this is a comfy briar patch for Ocwen. Mr. Erbey created a company with patented technology and processes designed specifically to maximize the net present value of delinquent loans for customers. Meanwhile, the current pricing of MSRs is generating a targeted 25% return of equity for Ocwen.
Plans for future growth
Investing in compliance management programs will eventually allow Ocwen to continue to grow its lucrative sub-prime MSR business. Recently the company has announced additional profit centers including:
· Ocwen Asset Servicing Income Series, or OASIS. This is an agency MSR financing program whereby the company issues notes backed by individual closed-end pools of Ocwen MSR's. These notes will help accelerate growth in prime mortgage origination for Ocwen, while shifting the prepayment risk to investors. The initial private placement is for $11.8 billion in unpaid principle balance with a 14 year term.
· Reverse mortgages. In April, 2013 Ocwen purchased Liberty Home Equity Solutions -- the company pitched on TV by Robert Wagner. Liberty currently has a 16% of this $90 billion market. Ocwen estimates it has the potential to grow to $1.9 trillion.
Clearly servicing delinquent loans is not for the faint of heart. Ocwen appears to be building a competitive moat based upon patents and processes developed over the past 15 years. According to the Fed -- five years after the sub-prime crises came to light -- 8.5% of residential mortgages are still delinquent.
This is a sad state of affairs, however, it represents tremendous opportunity for the Ocwen family of companies. The regulatory environment appears to be both a blessing and a curse. In the short-term it is slowing Ocwen's growth; but moving forward it will limit competition, which will accelerate growth and help protect margins.
Bill Stoller has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.