Home Loan's Goal: Own Low-Risk Assets, Pay Dividend


Shutterstock photo

One of the keys to business success is creating win-win situations. Such is the case for Home Loan Servicing Solutions, which was started by key executives of Ocwen Financial a little over a year ago, Ocwen itself and investors, all of whom benefit from the created structure.

Cayman Islands-basedHome Loan ( HLSS ) buys mortgage servicing rights, or MSRs, as well as associated equity in servicing advances fromOcwen ( OCN ). It retains Ocwen as a subservicer to whom it pays part of the fees back. Meanwhile, it takes on the responsibility for financing servicing advances as well as assumes the risk of increased prepayments.

Mortgage servicing fees are usually paid to collect monthly mortgage payments, set-aside taxes and insurance premiums in escrow and forward interest and principal to the mortgage lender. MSRs are rights to those fees. Advances are paid in case of delinquencies where the contracted party will advance the unpaid principal and interest to the lender.

No Credit Risk

"Our mission is to own very high-quality assets that have no credit risk and very limited mark-to-market risk and to (put) these assets in a vehicle that pays an attractive dividend," said John Van Vlack, Home Loan's president. "So, we have some specific assets that we're buying from Ocwen."

Home Loan buys assets that relate to the nonagency servicing portfolio from Ocwen. This portfolio holds old subprime and Alt-A mortgages that were generated in the period 2000-2008, explains Van Vlack. "So we own servicing rights and we find these servicing rights and the associated advances to be a very attractive asset because there's no correlation between interest rates and prepayments."

The company services these loans because the prepayments are very steady. It earns 50 basis points, or 0.5%, in servicing fees. But since it retains Ocwen as a subservicer, which effectively services the loans, the fee is split approximately in half between the two. In this kind of structure, Home Loan is not exposed to any mortgage credit losses.

"They own an asset class in which they get the most senior cash flows off of the servicing and their primary risk factor is the trends in servicing advances, which is a relatively predictable, stable asset," said Henry Coffey, analyst and Sterne, Agee & Leach. "And so from those very senior cash flows you're getting a dividend of 7%."

The company has been upping the dividend gradually and announced a 14-cents-a-share payout for the months of April, May and June. This is equivalent to a disbursement of more than 90% of its net earnings, something that can be compared to what REITs, or real estate investment trusts, pay.

In order for Home Loan to pay out advances, it needs to have capital and its REIT-like structure provides for a cost-efficient way to finance those. This was one of the reasons why the company was created in the first place: to allow Ocwen to benefit from cheap capital in order to be a profitable and successful business.

"Ocwen is responsible for all of the servicing requirements, so it's bearing all of the operational risk," said Van Vlack. "HLSS holds the assets. So the idea was that we could provide a lower risk-return to our investors and we could pay a dividend. And that would result in a lower required cost of equity."

Home Loan's market cap has grown from $200 million at its IPO in March 2012 to over $1.3 billion today. Its conservative leverage, low fixed infrastructure costs and strong cash flow gives the company the ability to finance many future projects at attractive rates. Ocwen in turn benefits from that.

"HLSS has grown very nicely since their IPO and they've used their capital to purchase MSRs and advances from Ocwen," said Michael Grondahl, senior research analyst at Piper Jaffray. "And there are a lot more MSRs and advances at Ocwen as Ocwen has done or continues to do more acquisitions. Secondly, HLSS' financing or funding costs have dropped quite a bit since the IPO and that's allowed its dividend to be increased from 10 cents to 14 cents a quarter."

Preforeclosure Resolution

Some of the underlying factors for being able to access capital more cheaply are decreasing prepayment speeds. This depends greatly on Ocwen being able to provide high-quality servicing. At the same time, Grondahl says that's one of the risks for Home Loan.

"The preforeclosure resolution rate is very high, at roughly 70% of the loans, that are resolved by Ocwen before foreclosure," said Van Vlack. "Ocwen has very well developed servicing practices. They use technology and psychological principals to get more borrowers current. So Ocwen modifies more loans because the borrowers are more likely to accept a loan modification offer. ... It's not just the offer that you make to a borrower, but it's how you secure their commitment to stay in the home and to continue to pay on that loan."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas
More Headlines for: HLSS , OCN

More from Investor's Business Daily


Investor's Business Daily

Investor's Business Daily

Follow on:

Find a Credit Card

Select a credit card product by:
Select an offer:
Data Provided by BankRate.com