public offering
and a concurrent private placement with our founder and Chairman of our Board of
Directors to acquire mortgage servicing assets relating to a portfolio of
subprime and Alt-A mortgage loans with an unpaid principal balance of $15.2
billion from Ocwen Loan Servicing, LLC, or “Ocwen Loan Servicing.” As of
March 31, 2012, our total assets and total liabilities were $546 million and
$368 million, respectively. As of September 30, 2012, our total assets and total
liabilities increased to $1,703 million and $1,285 million, respectively. Since
completing our initial acquisition of mortgage servicing assets, we have
purchased additional mortgage servicing assets from Ocwen Loan Servicing, and as
of September 30, 2012, we had acquired mortgage servicing assets with an unpaid
principal balance of approximately $48.0 billion from Ocwen Loan Servicing.
We do not originate or purchase mortgage loans, and as a result we are not
subject to the risk of loss related to the origination or ownership of mortgage
loans. We have engaged Ocwen Loan Servicing, a high quality residential mortgage
loan servicer, to service the mortgage loans underlying our mortgage servicing
assets and therefore have not and do not intend to develop our own mortgage
servicing platform. While we have only completed two full quarters of
operations, we believe that our revenue and expense structure is predictable and
will generate a stable income stream and that the quality of our assets is and
will continue to be strong. We believe this combination will accomplish our
primary objective of delivering attractive and consistent risk-adjusted returns
to our shareholders. We intend to distribute at least 90% of our net income over
time to our shareholders in the form of a monthly cash dividend. In addition,
unlike many income-oriented investment alternatives, we believe that our income
stream and the valuation of our assets are not substantially correlated to
movements in interest rates.
Our results of operations for the quarter ended September 30, 2012 reflect
consistent earnings that were in line with our expectations.
We reported net income of $6.6 million, or $0.37 per ordinary share, for the
third quarter of 2012. Our third quarter business performance highlights include
the following:
• declaration of dividends of $0.10 per share per month totaling $5.9 million
for the quarter.
• receipt of net proceeds of $236.0 million in connection with our public
offering of 16,387,500 shares at $15.25 per ordinary share that closed on
September 12, 2012. The net proceeds from the offering were used to acquire
mortgage servicing assets from Ocwen Loan Servicing with an unpaid
principal balance of $27.8 billion.
• completion of the acquisition of mortgage servicing assets with an unpaid
principal balance of $2.1 billion from Ocwen Loan Servicing on August 1,
2012.
On September 13, 2012, we amended and restated the servicing advance facility
agreements that we originally entered into simultaneously with the closing of
our initial public offering and the Initial Ocwen Purchase to (i) add Wells
Fargo Securities, LLC as an administrative agent, (ii) create a master trust
(the “Trust”) that can issue multiple series of notes with varying maturity
dates and credit ratings ranging from AAA to BBB, including 2a-7 money market
eligible notes and medium term notes and (iii) allow for deferred servicing fees
to be included in the borrowing base as principal and interest advances for
pooling and servicing agreements that meet certain conditions. This resulted in
a reduced cost of our financing.
Our executive management team has extensive experience in the mortgage servicing
industry and each of our executive managers was formerly in a senior management
role at Ocwen. We believe our executive management team’s extensive experience
provides us with the ability to assess the vital characteristics of the mortgage
loans underlying the mortgage servicing assets we have acquired and may seek to
acquire and evaluate the quality of our current and potential mortgage
servicers. We believe this experience further enables us to accurately value
mortgage servicing assets and better forecast future asset performance and
servicing cash flows. In addition, our management team has demonstrated
historical success in arranging cost-effective servicing advance financing
through a variety of economic cycles. Under the terms of our professional
services agreement with Ocwen, which we refer to as the “Ocwen Professional
Services Agreement” throughout this prospectus, the Company and its management
team provide Ocwen valuation and analysis services for mortgage servicing
rights, advance financing management, treasury management, legal services and
other similar services. None of our officers or employees holds positions at Ocwen
or its affiliates. Nonetheless, because of our management team’s past or current
relationships with Ocwen, conflicts of interest could occur with respect to the
services performed under the Ocwen Professional Services Agreement or the other
agreements the Company has with Ocwen. Matters that could give rise to conflicts
include pricing, valuation and quality of assets or services that Ocwen and the
Company purchase from one another, including Mortgage Servicing Assets (as
defined below) or services under the Ocwen Professional Services Agreement. In
addition, William C. Erbey, the Chairman of our Board of Directors, is the
Chairman of the Board of Directors of Ocwen. We will seek to mitigate these
potential conflicts through oversight by the independent members of our Board
of Directors.
Our business strategy is focused on acquiring mortgage servicing rights. In many
cases, however, the transfer of legal ownership of mortgage servicing rights
requires the prior approval or consent of various third parties, including
rating agencies. If the seller from whom we have agreed to purchase mortgage
servicing rights has not obtained the necessary approvals and consents to
transfer legal ownership of the mortgage servicing rights to us, we will instead
seek to acquire the rights to receive the servicing fees that the current
servicer is entitled to receive, and the current servicer will continue to
service the mortgage loans and receive compensation from us for its servicing
activities. We refer to these rights, along with the right to acquire legal
ownership of the related mortgage servicing rights automatically upon obtaining
the necessary approvals and consents to transfer the mortgage servicing rights,
as Rights to MSRs. Acquiring Rights to MSRs results in the Company recording
assets such as Notes Receivable—Rights to MSRs and match funded advances, and
liabilities such as match funded liabilities. It also entitles us to collect the
contractual servicing fees related to such Rights to MSRs, which are typically
50 basis points annually of the unpaid principal balance of the related mortgage
loans. Servicing fees collected are reduced by the portion of fees paid to
Ocwen, and the retained fees are further reduced by the amortization of the
Notes Receivable—Rights to MSRs, to arrive at revenue or Interest Income—Notes
Receivable—Rights to MSRs. This source of revenue allows us to pay operating
expenses and other expenses such as interest expense on the match funded
liability, and the income that remains is expected to compensate our investors
for their investment. These balances are expected to grow in the future in
periods where we are acquiring additional Mortgage Servicing Assets. In periods
when we are not acquiring additional Mortgage Servicing Assets, these balances
would likely decrease as the underlying mortgage loans are repaid.
Upon receipt of the necessary third party approvals and consents, the seller is
obligated to transfer legal ownership of the mortgage servicing rights to us
without any additional payment. Whether we acquire mortgage servicing rights or
Rights to MSRs, we also acquire servicing advances and other associated assets.
We do not believe that our business strategy or economic performance has been or
will be materially affected by whether we directly own mortgage servicing rights
or the related Rights to MSRs. All of our acquisitions of mortgage servicing
assets to date have been structured as acquisitions of Rights to MSRs and we
expect that any additional acquisitions of mortgage servicing assets will be
structured in the same manner, at least in the near term.
Throughout this prospectus, when we refer to our “Mortgage Servicing Assets,” we
are referring to the Rights to MSRs that we own and the mortgage servicing
rights that we may acquire in the future, and when we refer to “Purchased
Assets,” we are referring to the Mortgage Servicing Assets, together with the
associated servicing advances and any other assets related to such Mortgage
Servicing Assets that we have acquired. We refer to the mortgage servicing
rights related to the Rights to MSRs that we have acquired and any mortgage
servicing rights we may acquire in the future and which are or will be serviced
by Ocwen Loan Servicing as the “Ocwen Mortgage Servicing Rights.”
We have not and do not intend to develop our own mortgage servicing platform but
instead will rely on high quality third-party residential mortgage loan
servicers. All of the Rights to MSRs that we have acquired to date have been
acquired from, and are serviced by, Ocwen Loan Servicing. Ocwen Loan Servicing
is a leader in the residential subprime and Alt-A mortgage servicing industry
based on its historical servicing performance through a variety of real estate
and economic cycles. Prior to the transfer of legal ownership of any Ocwen
Mortgage Servicing Rights to us, Ocwen Loan Servicing will remain obligated to
service the underlying mortgage loans and will remit to us the servicing and
other related fees (excluding any ancillary income that Ocwen Loan Servicing
will retain) it collects in each month related to the Rights to MSRs. Following
the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us,
Ocwen Loan Servicing will service the underlying mortgage loans on our behalf as
subservicer, and we will receive the servicing and other related fees (excluding
any ancillary income). As compensation for its servicing and subservicing
activities, Ocwen Loan Servicing receives from us a monthly base fee initially
equal to 12% of such recognized servicing fees collected each month. Ocwen Loan
Servicing also earns a monthly performance-based incentive fee that fluctuates
based on collections and servicing advance reduction criteria with respect to
the underlying mortgage loans. We believe this arrangement aligns the interests
of both companies. We will compensate Ocwen Loan Servicing for the services it
performs for us prior to the transfer of legal ownership of the Ocwen Mortgage
Servicing Rights to us. The method used to calculate the fees that we pay to
Ocwen Loan Servicing under the Purchase Agreement with respect to the Rights to
MSRs is the same as the method used to calculate the fees that we will pay to
Ocwen Loan Servicing under the Subservicing Agreement with respect to any Ocwen
Mortgage Servicing Rights that we subsequently acquire. As a result, the
compensation to be paid to Ocwen Loan Servicing will not vary based on whether
Ocwen Loan Servicing or we hold legal title to the underlying Ocwen Mortgage
Servicing Rights.
The assets we have purchased from Ocwen to date have pertained solely to
subprime and Alt-A loans. This reflects the fact that the majority of the assets
Ocwen owns pertain to servicing subprime and Alt-A loans. Additionally, the
prepayment rate on subprime and Alt-A loans has demonstrated little correlation
to interest rates in recent years which is a characteristic that we find
attractive and which fits within our business strategy.
We intend to continue to acquire assets pertaining to subprime and Alt-A
mortgage loans that were originated prior to 2008. Given the low volume of
originations of subprime and Alt-A loans since 2007, at some point in the future
we may be unable to acquire sufficient similar assets, which would likely cause
us to reduce or not be able to pay dividends to our shareholders and we would
reevaluate our long-term business strategy at such time. If we are unable to
acquire sufficient assets meeting our investing criteria, we may return cash to
shareholders in the form of increased dividends, a special dividend or share
repurchases, the effect of which may be to reduce future earnings and dividends.
We anticipate future growth through subsequent acquisitions of Mortgage
Servicing Assets. As part of our strategy to acquire additional Mortgage
Servicing Assets, we expect to acquire over time substantially all of Ocwen Loan
Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A
mortgage loans, which had an unpaid principal balance of approximately $63.8
billion as of September 30, 2012. In addition, in connection with Ocwen’s
announced acquisition of Homeward Residential Holdings, Inc. and Ocwen Loan
Servicing’s announced acquisition of certain assets of Residential Capital, LLC,
Ocwen and Ocwen Loan Servicing are anticipated to acquire additional rights to
service mortgage loans with approximately $120.0 billion of unpaid principal
balance that are similar to those in our current portfolio. We believe that
Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us
in connection with our previous acquisition transactions. Although we cannot
guarantee that future acquisition transactions will occur, we also believe that
Ocwen will benefit from such transactions and therefore will continue to sell
mortgage servicing assets to us in this manner which will allow us to maintain
or grow the unpaid principal balance of our servicing portfolio.
We intend to continue to acquire additional similar mortgage servicing assets
from Ocwen in the near term in two ways:
• In order to remain fully invested and to offset the impact of prepayments
in our servicing portfolio, we expect to continue to utilize cash flow from
operations in excess of our dividend to purchase mortgage servicing assets
that are similar to our initial portfolio from Ocwen Loan Servicing under
substantially similar terms. We refer to such transactions as “flow
transactions.” We expect flow transactions to take place at regular
intervals. Certain terms of such flow transactions, including the servicing
incentive fee and advance ratio targets, will vary over time through these
transactions.
• In order to increase the scale of our business we will look for
opportunities to issue additional equity in the form of ordinary shares to
allow us to execute larger purchases of mortgage servicing assets similar
to our initial portfolio from Ocwen under similar terms. We refer to such
transactions as “follow on purchases.” These follow on purchases will be
subject to equity market conditions and will likely require that additional
advance financing capacity be arranged in advance or concurrent with each
transaction in order to maintain leverage similar to our current level.
Although we believe that competitive and regulatory dynamics in the mortgage
servicing industry will present us with opportunities to acquire Mortgage
Servicing Assets from banks, other financial institutions and independent
mortgage servicers and we remain open to purchasing mortgage servicing assets
from third parties other than Ocwen Loan Servicing, given the large amount of
mortgage servicing assets remaining at Ocwen Loan Servicing, we do not view
initiating purchases from other third parties as a near-term priority. The
provisions of our Amended and Restated Memorandum and Articles of Association
(“Articles of Association”) restrict our ability to issue and sell additional
ordinary shares at a price below our then current net asset value per share
without first obtaining the prior approval of holders of at least a majority
of the outstanding ordinary shares voted with respect to such approval. Future
sales of ordinary shares by us will dilute the ownership percentage of our
then-existing shareholders, including shareholders that purchase in this
offering.
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Our principal executive offices are located in the Cayman Islands c/o Intertrust
Corporate Services (Cayman) Limited (formerly Walkers Corporate Services
Limited), 87 Mary Street, George Town, Grand Cayman KYI-9005, Cayman Islands. We
also maintain offices in the United States located at 2002 Summit Boulevard,
Sixth Floor, Atlanta, Georgia 30319 and at 1661 Worthington Road, Suite 100,
West Palm Beach, Florida 33409. We can be reached by telephone at
(561) 682-7561, and our website is www.hlss.com.