Ocwen Financial Scores On Others' Distressed Loans

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The arcane world of specialty mortgage servicers has moved into the limelight as banks and other large holders of risky mortgages have sold off servicing rights to them.

Ocwen Financial ( OCN ), one of the chief beneficiaries, has seen its shares rise 41% since early October, when it announced the first of a string of deals.

That first one, which sent shares rising 20% on Oct. 3, was an agreed merger with Homeward Residential, and with it, $77 billion worth of mortgage servicing rights.

In a bigger announcement later that month, Ocwen outbid the favoredNationstar Mortgage ( NSM ) in a high-profile bankruptcy auction.

It won more than $300 billion of Residential Capital's mortgage servicing and origination business, for $2.5 billion. Co-bidderWalter Investment Management ( WAC ) landed the $50 billion Fannie Mae part.

ResCap is the mortgage unit of government-owned Ally Financial, the former financing arm ofGeneral Motors ( GM ) . The transaction was approved by a bankruptcy court Nov. 21 and is expected to close in March.

Ocwen earns servicing fees on the unpaid principal balance of the mortgage loans it services. It focuses on reducing delinquencies on non-prime loans, including those backed by government service enterprises, such asFannie Mae ( FNMA ) andFreddie Mac (FMCC).

Government Loans

It also works on government-sponsored loan modifications.

Homeward and ResCap will add nearly $200 billion in mortgage servicing rights and at least $37 billion in subservicing.

"By the time they integrate Homeward and ResCap they will have a very dynamic platform," said Sterne Agee analyst Henry Coffey.

Loan originations from the deals will be a boon for business "because the more originations you can do the more sustainable the servicing portfolio is," says analyst Kevin Barker of Compass Point.

"Loans naturally prepay and payoff over time, Barker said. "To the extent you can refill that with originations, the better you can capture the runoff. They can do refinancings that aren't necessarily in their portfolio right now."

Homeward comes with an origination business that has been generating around $800 million a month.

But to justify its stock price on the heels of the recent acquisitions, Ocwen must prove it can integrate them profitably, Barker says.

"These are definitely larger in scale than past acquisitions," he said. "But they have been successful in the past and I think they can do it."

Ocwen has been around for a quarter of a century, its name said to be a take on the "new company" it once was -- "newco" spelled backward. But it has operated under the radar on a far smaller scale.

In 2010, it generated revenue of $360 million and earnings of just 36 cents a share. In contrast, revenue this year is expected to reach almost $1.7 billion, up 100% from 2012, according to Thomson Reuters. Earnings are seen rising 213% to $4.48 a share.

Fourth-quarter and full-year 2012 results will be released on Feb. 28.

Analysts estimate Q4 earnings will jump 81% over last year's same period to 51 cents a share. Revenue in the quarter is expected to grow 46% to $228 million and for the full year 69% to $837 million.

What's behind all this growth? U.S. financial reform, consumer regulations and new global banking rules coming in 2014 from the Basel Committee on Banking Supervision have been causing large banks to sell off mortgage servicing rights, especially those in distress.

A lot of that business has been going to Ocwen and rivals Nationstar and Walter, all experienced at handling distressed loans.

Ocwen claims it's the lowest cost servicer due in large part to its efficient technology platform and large workforce based in India. More than 80% of its employees are based in India.

In a recent presentation, Ocwen noted that its cost for each non-performing loan averages $260 vs. the industry average of $875.

"India definitely plays a part. The costs for salaries and benefits are much lower," said Barker.

In addition, Ocwen says its ties with investment partnerHome Loan Servicing Solutions (HLSS) allows it to keep a "capital light" profile -- to fund growth at a reduced cost.

Typically, specialty servicers borrow lots of money to fund the costs for advances on delinquent loans. Such costs include principal and interest and taxes and insurance, as well as corporate expenses such as legal fees, property valuation fees and inspections.

Interest expenses on these secured borrowings were one of the company's largest expenses.

Home Loan essentially helps buy and then holds servicing rights for Ocwen, who acts as Home Loan's subservicer.

Home Loan has recently issued securitizations using advances as the collateral, bringing rates paid on them down significantly.

Advance Securitization

"There is a growing market for advance securitizations," Barker said. "It definitely is a tail wind to earnings."

Other tail winds are expected, of course, from recent acquisitions, including a smaller deal forged in October but one management thinks offers long-term growth: reverse-mortgage originator Genworth Financial Home Equity Access.

Management expects Genworth, to be renamed Liberty Home Equity Solutions, to add $8 million to $9 million in net income this year alone. The deal is expected to close in the current quarter.

Among other deals, earlier in 2012 Ocwen bought Saxon Mortgage Services fromMorgan Stanley (MS), following its purchase of Litton Loan Servicing fromGoldman Sachs (GS).

In addition, small-balance commercial loans totaling $1.8 billion in principal balance came onboard in late May from Aurora Bank.

There's a lot more to come, according to Ocwen.

Execs say the firm is tracking deals worth $350 billion in unpaid principal, part of $1 trillion of servicing and subservicing portfolios that they think could come on the market in the next two to three years.

But Sterne Agee's Coffey says beyond the clear visibility through 2014, "nobody really knows what the mortgage business is going to look like in 2015, 2016 and 2017."

He added, "I would say (Ocwen) is very well positioned to step into the brave new world of whatever this business will look like in 2015 and 2016."



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



This article appears in: Investing , Investing Ideas

Referenced Stocks: FNMA , GM , NSM , OCN , WAC

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