Ocwen Financial To Keep Taking Over Banks' Ill Loans

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Ocwen Financial ( OCN ) has shown such explosive growth that some industry observers have speculated it might have nowhere to go but down.

Doubters figured the specialty mortgage servicer wouldn't get enough new mortgages to service to offset those running off its books.

But Ocwen insists it is anything but a "melting ice cube," as Chairman William Erby told analysts Aug. 1 on the heels of a strong second-quarter report.

In that report, the firm said it has more than $400 billion in its current pipeline of potential new business opportunities. That was up from $375 billion it forecast at the end of March.

Management still thinks at least $1 trillion will be up for grabs over the next two to three years.

Investors took the company's commentary as a positive sign, sending shares up more than 7% that day to 51.11. A week later, shares hit an all-time high of 52.25.

Ocwen is the largest specialty mortgage servicing company in the U.S., focused on high-risk loans. Revenue has more than doubled in the last year alone as a string of wins from banks and other mortgage holders came onboard.

Ocwen gets fees for servicing loans and is adept at reducing delinquencies on nonprime loans, including those backed by Fannie Mae and Freddie Mac.

Growing Portfolio

Its servicing portfolio has gone from $40 billion in 2009 to around $500 billion currently, says Piper Jaffray analyst Mike Grondahl.

"We think Ocwen's prospects are very strong," he said, adding that banks will keep selling mortgages to specialty servicers for at least two to three years.

For example, top residential mortgage servicerWells Fargo ( WFC ) indicated in a recent conference call that it would likely return to selling mortgage servicing rights as early as the current quarter or the next quarter.

With $1.7 trillion in servicing rights, Wells has "a big pool to pull from," Grondahl said. "Ocwen can clearly get some of it."

Because of Ocwen's deeper pipeline and Wells' coming transfers, the focus on Ocwen has "shifted" from whether it can offset the run-off of its portfolio "to how much further can the servicing portfolio grow," analyst Kevin Barker wrote in an Aug. 7 research note.

Rising interest rates are also a positive for Ocwen, Grondahl says. That's because loans it services would less likely be refinanced and taken off its books.

The same goes for Ocwen's chief nonbank rivalsNationstar ( NSM ) andWalter Investment Management ( WAC ), both of which have also been showing strong gains over the last two years.

Two of Ocwen's biggest deals closed earlier this year, adding nearly $200 billion in mortgage servicing rights to its books. They were from Homeward Residential and Residential Capital, the mortgage unit of government-owned Ally Financial.

The integration of the two portfolios is going well, management said in its second-quarter report.

Revenue in the quarter jumped 151% to $530 million. But transition expenses and reserves added for a consumer-relief fund for a possible settlement with state and federal agencies impacted earnings, which rose 9% to 36 cents a share.

More business was added during the second quarter. About $87 billion in Fannie Mae and Freddie Mac mortgage servicing rights were acquired from Ally.

Ocwen also acquired $8.3 billion in servicing rights from Greenpoint Mortgage in late June.

All of that more than offset the $10 billion of mortgage business that ran off in the second quarter.

And the firm expects to close on a total of $6 billion in bank-related subservicing business during the third quarter.

Ocwen also announced it would purchase $78 billion in servicing rights from OneWest Bank for $2.5 billion, to close in stages over the next several months. OneWest had bought assets of bankrupt IndyMac in 2009.

"There is a lot of new (bank) servicing that will be coming up by the end of the year," said analyst Henry Coffey of Sterne, Agee & Leach.

Ocwen's revenue is expected to hit nearly $2.2 billion this year, up from $845,000 in 2012 and $496,000 in 2011.

Earnings are seen rising 190% over last year to $4.23 a share, according to Thomson Reuters.

Ocwen says it has the lowest operating costs in the industry in terms of servicing nonperforming loans, at $262 per nonperforming loan vs. the industry average of $877.

That's due in part to the scalability of its technology platform and large number of servicing employees who work offshore, where wages are lower.

Selling Continues

Banks will continue to sell off mortgage servicing rights to nonbank servicers because of stricter capital requirements, other banking regulations and the higher costs of servicing troubled loans, Grondahl says.

Jefferies' analyst Daniel Furtado said in a recent note that his team "remain believers in the long-term thesis" of banks shedding such assets.

"Given that the recent move higher in (interest) rates will drive banks to mark MSRs higher, capital pressure is only likely to increase" to get them off their books, Furtado wrote.

As the housing market continues to strengthen, there will be fewer distressed loans for Ocwen to acquire, Grondahl acknowledges.

"But at some point the subprime cycle will start all over again," he said.

In the meantime, Grondahl says, banks will keep selling servicing rights for two or three more years at least.

And those on its books "will keep (Ocwen) busy for seven to 10 years," he said.



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: NSM , OCN , WAC , WFC

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