Things at Ocwen just went from bad to much, much worse

Embattled company hit with an avalanche of bad news

Just when it looked Ocwen Financial (OCN) may finally be getting some good news, in the form of Moody’s Investors Service saying that the $1.3 billion acquisition of Ocwen associate Home Loan Servicing Solutions (HLSS) by New Residential Investment (NRZ) will actually help stabilize Ocwen’s own servicing operations and improve Ocwen’s future prospects, the troubled nonbank was just hit with an avalanche of bad news.

According to a report from Compass Point Research and Trading, the HLSS deal will actually have a “material adverse impact” on Ocwen’s servicing margins, due to the increased cost of maintaining the relationship with HLSS, and operational changes that are required by regulators, including the New York Department of Financial Services.

But that’s not all. Compass Point believes that New Residential may actually pull the servicing on the HLSS portfolio from Ocwen.

“We believe the risk of having servicing pulled on private label trusts or transferred by New Residential is high,” Compass Point Analysts Kevin Barker and Jesus Bueno said in the report. “If this were to occur, it would have a serious adverse impact on the sustainability of Ocwen’s business model.”

Barker and Bueno cite the recent servicer downgrades as a reason for a potential Ocwen-HLSS separation.

“We believe the recent servicer downgrades at OCN have created an ‘event of default’ between HLSS and OCN,” Barker and Bueno write. “An event of default would give HLSS the option to terminate OCN as a servicer and transfer the servicing ‘upon HLSS's written direction to such affect (and)…HLSS shall be entitled to receive all proceeds of such transfer.’ These clauses within the purchase agreement between OCN and HLSS essentially give NRZ control to re-negotiate the terms of the HLSS-OCN agreements (in our opinion).”

Losing the servicing on the HLSS portfolio would be a serious body blow to Ocwen, which been the target of several investor power plays in recent weeks.

With the prospect of losing the HLSS servicing hanging over Ocwen, the nonbank also just lost more servicing rights in rather dramatic fashion.

According to the Compass Point note, Ocwen was terminated as the servicer on two residential mortgage-backed securitizations after the deals’ trustee, Wells Fargo (WFC), asked the RMBS holders whether they wanted to terminate Ocwen as the servicer.

The two deals, SABR 2006-FR1 and SABR 2006-FR3, represent $264 million in unpaid principal balance. The bond holders voted to terminate Ocwen as servicer and Wells Fargo chose Select Portfolio Servicing as the deal’s new servicer.

Barker and Bueno say that the financial impact of this decision is “immaterial,” but caution that this move may be a harbinger of things to come.

“The termination will cause an impairment of the underlying mortgage servicing rights and cause in an indemnification payment to Home Loan Servicing Solutions,” Barker and Bueno said. “The financial impact of this termination is immaterial, but it does increase the risk of other trustees looking to protect their self-interests and also potentially terminating OCN as a servicer. In addition, we believe this increases the risks of other RMBS holders looking to terminate OCN as servicer.”

Ocwen responded to its dismissal as servicer, saying that the two RMBS deals are only 0.07% of Ocwen's total servicing portfolio, represent only $0.8 million in mortgage servicing rights value and will have an “immaterial” financial impact on the company.

"We regret the decision made by this particular group of investors who have been critical of Ocwen's superior loan modification results, but are pleased that in the majority of the affected securities investors are keeping Ocwen as their servicer," said Ron Faris, President and CEO of Ocwen.

"We were also gratified to see reports earlier this week by Morgan Stanley and reported by Bloomberg confirming Ocwen has been more effective at keeping borrowers in their homes, and it is unlikely that investors will replace Ocwen in the small percentage of cases where the servicer ratings have fallen below the minimum criteria set forth in certain pooling and servicing agreements."

But the worst news of all may be new allegations from law firm of Gibbs & Bruns, which is representing a group of bond investors who recently accused Ocwen of failing to properly collect payments on $82 billion of home loans.

According to the Compass Point note, Gibbs and Bruns recently sent a letter to Wells Fargo accusing Ocwen of a litany of failures as a mortgage servicer, saying that Ocwen’s failures cost bond investors approximately $26 billion.

“Within this letter, the Gibbs & Bruns study of the RMBS trusts states that if other servicers provided the services done by Ocwen, investors would have received approximately $26 billion more in cash flows,” Barker and Bueno said. “We do not believe Ocwen will be subject to damage claims anywhere near this number, but even if a small fraction of these supposed damages have merit, it would seriously impair the equity value of the company.”

In the letter, Gibbs & Bruns accused Ocwen of conflicts of interests and use of affiliated vendors, imprudent modification practices, failure to account for principal and interest to the trusts, poor record-keeping and failure to comply with applicable laws and regulations, poor trust performance, recouping advances at time of modifications in violation of the PSAs, and use of trust assets to resolve investigations into Ocwen's servicing.

Because of all of these factors, Compass Point downgraded Ocwen to “sell,” and lowered it price target on Ocwen from $7.50 to $7.00. As of 11:59 a.m. Eastern, Ocwen was trading at $8.47, down more than 15% for the day.

The analysts establish four scenarios that may befall Ocwen in the future. Of the four, the analysts say that the one that seems most likely at this point is the “adverse” scenario.

In that instance, all of Ocwen’s private label servicing is pulled from the company and Ocwen also incurs $500 million on future litigation expenses. “Although severe, in this case, OCN would be able to service its debt via cash generated from asset sales and thereby, continue operating as a going concern, but would be close to liquidating most assets,” the analysts say.

“The revelation from Gibbs & Bruns that they believe OCN's servicing practices caused $26 billion of damages to the RMBS trusts that the company serviced from 2008 to 2013 creates an enormous litigation and operational risk,” Barker and Bueno write. “We believe these risks represent some of the severe hurdles OCN will need to address in the next several quarters/years and the risk- reward of owning the stock is unfavorable.”

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