Hedge fund BlueMountain Capital Management sent notices of default to embattled nonbank Ocwen Financial (OCN) and its affiliated company, Home Loan Servicing Solutions, Ltd. (HLSS) on Friday, saying that Ocwen’s regulatory troubles have caused an “irrefutable” default on notes the hedge fund holds in connection with the HLSS Servicer Advance Receivables Trust.

BlueMountatin Capital also stated in a letter addressed to Home Loan Servicing Solutions, Ocwen Loan Servicing, HLSS Servicer Advance Receivables Trust, and Deutsche Bank National Trust Company that Ocwen’s servicing issues caused a default on “certain residential mortgage-backed securities collateralized by loans serviced by Ocwen Loan Servicing” that BlueMountain Capital owns.

“The facts establishing these events of default are irrefutable,” BlueMountain added in the letter. “BlueMountain also has directed the trustees of certain of the RMBS Certificates to investigate and/or take action with respect to Ocwen Loan Servicing.”

BlueMountain Capital also disclosed that it holds a short position in, and put options on, the common stock of Ocwen and holds a short position in, and put options on, the common stock of Home Loan Servicing Solutions, as well.

In the letter, BlueMountain Capital states that the events of default are the result of “Ocwen's material breach of its covenants to, among other things, comply with applicable laws and requisite servicing obligations; resulting from Ocwen's breach of a warranty in the Senior Secured Term Loan Facility Agreement and a subsequent amendment thereto that it is not in violation of any law that could reasonably be expected to cause, among other things, a material adverse effect on Ocwen's business and financial condition; and resulting from the failure of the Collateral Test, which measures whether the Notes are adequately collateralized.”

BlueMountain Capital cites Ocwen’s recent troubles with regulators as a main reason for the default.

The hedge fund specifically notes Ocwen’s recent $150 million settlement with the New York Department of Financial Services over allegations into Ocwen’s servicing practices and its close relationships with its corporate affiliates.

Under the terms of that settlement, the NYDFS forced Ocwen’s now-former Executive Chairman William Erbey to resign from his position with Ocwen, as well as his position as non-executive chairman of Ocwen’s affiliated companies, Altisource Portfolio Solutions (ASPS), Altisource Residential Corporation (RESI), Altisource Asset Management Corporation (AAMC), and Home Loan Servicing Solutions.

BlueMountain also cites Ocwen’s recent troubles in California, which said recently that it was seeking to suspend Ocwen’s mortgage license because the company failed to turn over documentation showing that it complies with the state’s laws.

Ocwen, for its part, says that it is “fully cooperating” with the California Department of Business Oversight. In a statement issued by the company recently, Ocwen’s president and CEO, Ron Faris, said that the company believes it has provided all the appropriate documentation to the CDBO.

“We are cooperating fully with the Department of Business Oversight,” Faris said. “Since this notification, we have dedicated substantial resources towards satisfying the DBO's requests. We believe we have provided the requested information in the format requested. We expect that we will receive follow up requests or clarifications and that further document and information exchanges may take place.”

But Ocwen’s attempts to alleviate the concerns of its investors don’t change the material facts of the situation, BlueMountain said.

“These (and other) agencies' findings and enforcement actions demonstrate Ocwen's systemic, long-standing and continuing servicing failures and disregard of applicable and analogous laws,” BlueMountain said.

“Evidencing the significance of these affirmations of Ocwen's servicing misconduct, the rating agencies expressly referenced the state regulatory authorities' actions as a basis for their decisions to downgrade Ocwen's servicer rating and the corporate ratings of related entities, Ocwen Financial Corporation and Home Loan Servicing Solutions, Ltd,” the letter continues. “Likewise, the share price of the two related companies fell precipitously following the announcement of the California suspension proceeding, i.e., by approximately 36% and 20%, respectively.”

BlueMountain adds that these recent disclosures “demonstrate Ocwen's material breaches of its covenants and warranties not to engage in such illicit and imprudent practices; and those breaches in turn materially increase the risk of loss on the notes that are collateralized by receivables affected by Ocwen's standing as a servicer.”

BlueMountain also said that the “offering memorandum governing the issuance of the notes explicitly recited the very servicing misconduct that Ocwen engaged in as a factor that would increase the risk of loss on the notes,” adding that the material increase in the risk of loss gives rise to the specified events of default, and a corresponding right to an increased return for the noteholders.

“Specifically, under the bargained-for terms of the indenture, the note interest rate is increased by 3.00% upon the occurrence of any event of default to compensate the noteholders for the associated increased risk of loss,” BlueMountain added.

The news of the letter drove both Ocwen’s and Home Loan Servicing Solutions’ stock down significantly.

As of 12:05 p.m. Eastern, HLSS was trading at $14.06, down nearly 9% for the day. Earlier in the day, the stock fell to as low as $12.35.

Ocwen’s stock, which has been in the tank since the NYDFS settlement was revealed, is down another 10% on Friday, trading at $6.88 after trading at as high as $21.90 just over a month ago.