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 (
) buys mortgage servicing rights, or MSRs, as well as associated
equity in servicing advances fromOcwen (
). 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
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
"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."
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."