By Tom Adams, securitization professional for over 20 years and partner at Paykin, Krieg & Adams, LLP. You can follow him on Twitter at @advisoryA
It’s been a while since I wrote here about Ocwen Financial Corporation http://www.nakedcapitalism.com/2015/02/tom-adams-ocwens-servicing-meltdown-proves-failure-of-obamas-mortgage-settlements.html , the large non-bank mortgage servicer, but things haven’t gotten any better for the company or its affiliates since then. Based on the information that is seeping out from the Ocwen machine, the countdown clock appears to be ticking for the mortgage servicing empire that Bill Erby created.
The most recent news is that both Ocwen and its affiliate, Home Loan Servicing Solutions, face delisting of their stock from their respective exchanges (NYSE and NASDAQ, respectively) due to the failure to file quarterly and annual reports on a timely basis. Both companies requested extensions earlier in the month and then both companies missed those deadlines and are now uncertain when they will be able to deliver the reports. The reason both companies are simultaneously failing to deliver their quarterly reports is because they are so closely tied and because problems with one company causes problems for the other. It’s a little unclear which is the chicken and which is the egg.
I’ll return to this issue shortly, but it’s worth mentioning that in my experience, companies that are unable to deliver earnings reports on a timely basis are usually facing a host of bigger issues related to investigations, accounting concerns and/or control issues – which all seem to be the case with Ocwen and friends.
The bigger reason that multiple Ocwen related entities are facing difficulties goes back to when Erby, the founder and former CEO of Ocwen, decided to disaggregate his main business, the mortgage servicing company then known as Ocwen Financial, into a series of separate but related companies. Basically, what he did is split out various functions of the servicing business into new companies, portions of which he then sold via initial public offerings, while remaining the CEO and/or chairman and largest shareholder of various of them. Ostensibly, the reason for these splits was the supposed creation of operation efficiencies and tax advantages, such as locating some (including Erby’s own primary residence) in tax friendly jurisdictions like the Luxembourg or Cayman Islands. The actual result was a complex mess of companies that had an unusually high number of conflicts of interest (related to their dependence on Ocwen and each other for business, rather than, you know, having actual competitive businesses) and were all held together by Erby, himself. Among the companies he created were:
Ocwen Financial (OCN) – the entity that performed traditional servicing functions, typically for “high-risk” loans.
Home Loan Servicing Solutions (HLSS) – a company created in 2012 to “acquire mortgage servicing rights, rights to fees and other income from servicing mortgage loans, and associated servicing advances.” Erby was Chairman of HLSS when it was created and Ocwen was its primary source of business for the servicing rights.
Altisource Portfolio Services (ASPS) – spun off from Ocwen in 2009, with Erby as the Chairman, to perform “default and REO management” for servicers, primarily Ocwen. Pursuant to the terms of the spinoff, Ocwen contracted to use ASPS for its default management services, though ASPS could also contract with other servicers. Subesquently, ASPS spun off two entities:
Altisource Residential Corp (RESI) — spun off from ASPS in 2012, also with Erby originally as the Chairman, to invest in REO and distressed residential properties, originally with its IPO proceeds, and then manage the related rental properties; and
Altisource Asset Management Corp (AAMC) – also spun off from ASPS, also with Erby as its original Chairman. AAMC describes it business as “portfolio management and corporate governance services to investment vehicles that own real estate related assets.” It’s sole client is RESI, and it’s sort of an ASPS for RESI and contracts a fair amount of its business from Ocwen.
Unfortunately for Erby, and the companies, as part of the deal Ocwen entered into with the NY Department of Financial Services in 2014, Erby was forced to relinquish his management and chairman roles at Ocwen and the various affiliates listed above (though not his shares and ownership in the companies). As a result, the force that held the companies together, and the relationships that gave them their purpose, began to come undone. Suddenly, the conflicts of interest that were disclosed in the registration statements for the companies began to look a bit more glaring to investors in the companies (as well as looking problematic to regulators).
The disclosed potential conflicts related to things like:
• dependency on Ocwen for business (or depency on Ocwen affiliates for business),
• the quality and prices of services Ocwen, or its affiliates, agreed to provide,
• relationships with other Ocwen affiliates, which may result in business terms or dispute resolutions that are less favorable than they would be with unaffiliated third parties,
• original contracts among the parties might not have been negotiated on an arm’s length basis,
• competitive actions by Ocwen, as it relates to potential third party clients, and
• of course, the overarching link of Erby and other management, directors and personnel.
With Erby gone, soon enough opportunities to undermine or work against the interest of Ocwen or its affiliates began to seem more attractive, or at least a way to survive. Unfortunately for the Ocwen machine, the fortunes of the companies are still tied together and they are having a hard time figuring out what to do about it.
For example, in February, 2015, RESI decided to transfer servicing on a substantial portion of its portfolio away from Ocwen. In addition, in February RESI had an investor, Capstone Equities, call on the company to terminate its relationship with AAMC (whose sole business is providing services to RESI) due to the harm that the Ocwen relationship has done to the company. Capstone argued that because Ocwen had engaged in numerous violations of laws, regulations and servicing practices, AAMC should have terminated Ocwen as servicer for RESI’s portfolio and, by failing to do so, AAMC had breached its agreement with RESI. Capstone also reminded the board of RESI that they “should act loyally and in good faith to its company and its shareholders, but the RESI board has repeatedly failed to do so at the expense of both the company and its shareholders.”
Unlike Ocwen and HLSS, RESI managed to release its year end and 2014 4th quarter earnings, so its not at risk to being delisted, but it did reschedule its earnings call for the report to some undetermined date in the future, after it had finishing modifying its agreement with AAMC. Poor AAMC also managed to release its year end and 4th quarter earnings but has also rescheduled its earnings call to “unknown date in the future” and said it is trying to restructure its agreement with RESI.
HLSS also had its share of messy relationships. They agreed to be purchased by a company called New Residential, which is affiliated with the hedge fund Fortress, a big player in mortgage loans, distressed real estate and servicing, through another affiliate called Nationstar. Nationstar is a prime competitor with Ocwen for the purchase of servicing rights on mortgage pools. As owner of HLSS, assuming the sale is completed, New Residential has the right, potentially, to terminate Ocwen as servicer on a portion of the deals that they subservice for HLSS and sell those servicing rights or transfer them to another party, like perhaps an affiliate such as Nationstar. A number of analysts have been asking the companies about this issue on the call announcing the merger as well as on ASPS’s 4th quarter earnings call.
ASPS has also not been immune from the troubles of messy relationships. Leon Cooperman of Omega, a large investor in ASPS, earlier in the year called in to an ASPS to mockingly ask the ASPS CEO about the company’s share buyback policy, since it had been buying back its stock when the price was around $100/share earlier in 2014 but at the time of the call the stock had fallen to about $28/share. Cooperman’s Omega owned about 11% of ASPS at average prices between $39.42 and $47.47 at that time. On their March earnings call ASPS announced that “we have continued to monitor Ocwen-related news and have suspended our share repurchasing activity.”
Apparently, Cooperman wasn’t happy with that answer because he sold a substantial portion of his shares in ASPS soon after (at an average price of around $15 or $16) http://www.marketfolly.com/2015/03/lee-cooperman-trims-altisource.html .
It’s messy and complicated trying to act in the best interests of unaffiliated shareholders! But, caveat emptor, I guess – shareholders were warned that the companies had lots of conflicts of interests with interlocking management, boards, and affiliates and this is what conflicts of interest can do in real life.
So, back to the late filings of Ocwen and HLSS. According to Ocwen, the company has had to delay the filing of its 4th quarter, 2014 earnings report because of uncertainty about HLSS’s ability to fund advances to the trusts on which HLSS owns the servicing rights but for which Ocwen provides the servicing.
As the owner of these servicing rights, and nominal servicer of the trusts, HLSS is required to pay to the trusts on the day before the distribution date to certificate holders, the advance requirements – an amount equal to the past due mortgage payments and any insurance and taxes that had to be paid that period. If the servicer fails to make this payment, the trustee for the trust steps in to make it and also terminates the servicer. In this case, that would mean, potentially, the termination of both HLSS, as nominal servicer and advancing party, and Ocwen as nominal subservicer but really the actual servicer for the trust.
According to HLSS, the reason the company has been unable to file its 4th quarter, 2014 earnings report (and 2014 annual report) is because of this problem with the advancing, plus other issues, such as “its ability to operate as a going concern.”
HLSS was essentially started from scratch in February 2012. Ocwen used the IPO of HLSS to “sell” the ownership rights of a portion of its servicing portfolio to the new company – the proceeds of the IPO were used to fund the purchase. HLSS then “hired” Ocwen to act as subservicer on these same deals for which they were paid a subservicing fee, which was equal to a portion of the fee they had previously been paid as servicer.
As nominal owner of the servicing rights, HLSS retained a portion of the servicing fee and also acquired the obligation to fund the advances required on the MBS trusts every month. Previously, of course, all of this activity and ownership were contained within Ocwen, as is typically the case with a mortgage servicer.
Since HLSS was a thinly capitalized start up, it didn’t really have any spare cash to make advancing payments to the trusts so it went to the capital markets and raised the money through the creation of various advancing facilities. Basically, these facilities were revolving loans (via securitization of the advancing payments) to HLSS for 75-85% of the advancing obligation.
As part of the financing of the advances, HLSS sold notes in the facility to third party investors. Advancing facilities are considered strong deals by investors because advances are “at the top of the waterfall” – the servicer is paid back for its prior advances on a first priority basis from the liquidation proceeds of a foreclosed home or from the repayment of the loan to current status or prepayment in full. So investors believe that the facility has a high likelihood of getting its principal back at some point in the future, at an attractive rate of interest. Obviously, the investors keep a close on the servicing of the mortgages which, in this case, was actually being performed by Ocwen, despite the nominal ownership by HLSS.
In January 2015, a hedge fund called Blue Mountain Capital sent a notice to the trustee on HLSS’s advance facility that the facilities were in default due to the various regulatory problems that Ocwen was suffering. In particular, Blue Mountain alleged that Ocwen had failed to comply with applicable laws and servicing obligations which was having a materially adverse affect on Ocwen’s business and, potentially, on the trusts covered by the facility (sound familiar?).
In addition, Blue Mountain added that Ocwen had breached various representations and warranties when it signed the agreement and said that it was in compliance with all applicable laws. As a result of the alleged default by Ocwen under the advance facility, Blue Mountain said that investors were entitled to have the deals go into early amortization and to be paid a penalty rate of an addition 300bps. If the default allegation were to stand, HLSS would lose the tool it used to fund the advances on the deals Ocwen serviced. Lacking any other significant funds, HLSS would then default on the MBS deals causing its and Ocwen’s termination. Also, without the advancing facilities, HLSS would have a pretty hard time staying in business because advancing is pretty much all they do.
Ocwen and HLSS were obviously quite upset by these allegations, but they managed to convince the trustee on the advancing facility to hold off on getting a judicial determination for guidance on Blue Mountain’s claims until the conducted an investigation. The investigation is presumably on-going. The trustee has not been publicly heard from since, which is the reason for the delayed earnings.
This week HLSS also filed an 8-K with the SEC noting that it had signed amendments to its credit agreement and advancing facility with the relevant parties that, among other things,
• extended its deadline to file its annual audited financials to April 10, 2014,
• put a hold on any cross-defaults of the advancing facility,
• proposed to amend the subservicing agreement with Ocwen for the purpose of curing or waiving Ocwen’s ratings termination triggers (and agreeing to pay its lenders 2.5% of the principal balance of the mortgage loans under their facilities if Ocwen’s ratings termination trigger is not cured by the time of the proposed sale of HLSS), and
• provided for HLSS to pay the lenders a consent fee equal to 0.50% of the balance of the mortgage loans under the respective facilities (which based on about $6 billion of outstanding facilities as of September 2014, I calculate to be about $30 million, but it really depends on how much is outstanding currently).
It’s a dense agreement, but it sounds like HLSS is agreeing to try to help Ocwen cure its ratings downgrade triggers or perhaps come up with some other solution to Ocwen’s troubles (could that mean transferring the servicing from Ocwen?).
All of these troubles with Ocwen and its empire have been dragging on for months. At least this agreement appears to give a hard deadline to the ticking clock: April 10th, 2015 – by which time HLSS has to come up with audited financials which depend on the trustee determining whether Ocwen has breached its obligations under the advancing facility, so that HLSS’s auditors can give it a “going concern” opinion so Ocwen and HLSS can avoid being delisted and paying a huge penalty to the lenders under its advancing facility. Once they’re done with that, HLSS has to come up with a cure to Ocwen’s rating triggers, RESI presumably has to respond about AAMC’s alleged breach and AAMC has to figure out whether they have any business without RESI.
It’s hard to keep track, but it looks like Ocwen and its affiliates have managed to upset its state regulators, shareholders, lenders, bond holders, auditors, each other, the SEC, and of course, a host of borrowers on the mortgage loans. Meanwhile Ocwen keeps selling off its servicing rights to friends and foes alike.
How will this end? Well, even under the most optimistic scenarios – not many of which are showing up these days outside of day trading penny stock pitchers on Twitter:
— Stock Dawgzz (@StockDawgzz) March 26, 2015
Ocwen is facing some pretty large hurdles. It is safe to say their reputation has been considerably impaired. They may be able to put out some of the fires, but with the various former affiliates being pulled in opposing directions and the regulatory and investor scrutiny continuing, a more cataclysmic resolution is a real possibility. If so, considering the still very large servicing portfolio at Ocwen, there will probably be a need for some outside party – a regulator, a buyer with a strong stomach, or something – to step in and resolve the house of cards that Erby built.