Ocwen's challenge.

Author:England, Robert Stowe
Position:PROFILE
 
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"In theory, there is no difference between practice and theory. In practice, there is," baseball legend Yogi Berra famously quipped. President and Chief Executive Officer (CEO) Ronald Faris and other senior managers at Ocwen Financial Corporation, Atlanta, are learning all about the difference between theory and practice as they implement changes integral to their turnaround strategy. [paragraph] In the near term, Ocwen will soon complete its plans to sell about half its agency servicing. Blocked from acquiring new servicing rights by regulators until certain requirements are met, Ocwen's revenues, earnings and book values have been declining. Proceeds from the sale of agency assets are being applied to reduce corporate debt the company took on to make acquisitions and to lower the company's overall leverage ratio. [paragraph] In the longer term, Ocwen intends to gradually ramp up its currently modest origination volumes so that the flow of new mortgage servicing rights it generates from its own originations can eventually replace the natural runoff from its servicing portfolio. Such a transition would transform the company from a servicing-focused business to one that looks more like a traditional mortgage banking company, according to Faris.

After trimming back its agency servicing holdings, Ocwen Financial intends to gradually shift its business model from that of a servicing specialist to a full-fledged mortgage company.

The vision

The road ahead is challenging, acknowledges Faris, who addressed his vision for the company in an exclusive interview with Mortgage Banking at his office in West Palm Beach, Florida. "It's going to take some time to transform the company into a long-term profitable and sustainable enterprise," he says.

"I think in the end, what we want to do is provide really good service to our customers, both on the servicing and origination side. We want to have a very strong corporate governance and compliance infrastructure. We want to have great leaders within the organization. And we want to have engaged employees," Faris says. "And I think over time, all of that will take hold and the profitability part will take care of itself."

So far, equity analysts have taken a wait-and-see attitude.

"The good thing is that it looks like most of their regulatory issues have been largely addressed. Now they can focus on executing their plans," says Bose George, equity analyst at Keefe Bruyette & Woods Inc. (KBW) in New York, which has a neutral rating on the company's stock.

In George's view, Ocwen has made the right strategic moves.

"I think they are moving in the right direction. They need approval from regulators to grow again through acquisitions. Until that happens, they are essentially running off the main portfolio," George says. "It's going to be hard to do anything apart from cutting costs until they are allowed to become active again on the acquisitions side."

In the near term, Ocwen is facing a squeeze, according to Kevin Barker, senior vice president and research analyst at Compass Point Research and Trading LLC, Washington, D.C. "The company is in the process of shrinking its servicing portfolio to satisfy regulator demands and pay down term loans to satisfy debt holders," he says.

"The process of selling part of their portfolio is reducing the revenue faster than they can cut expenses," Barker points out. "At the same time they need to satisfy regulator demands, which is causing them to increase staff, consultants, compliance and risk management personnel. This is very expensive," Barker notes.

"So what you have is a company that is going to end up losing money for a few quarters before they right-size operations for the amount of revenue they are bringing in," Barker says. Compass Point upgraded Ocwen's shares on Aug. 26 from a "sell" to a "neutral" rating.

The CFO's perspective

Ocwen Chief Financial Officer (CFO) Michael Bourque is positive about the progress the company has made in downsizing its agency servicing portfolio. "So far, it's gone as expected. From an asset sale standpoint, we actually sold more faster--and that allowed us to get on with the strategy very quickly," says Bourque.

The company should complete and close on all its planned asset sales by the end of 2015. "It's a big deal for the company to work through both the sales strategically, to follow on with cost optimization but also to [deleverage] and position the company in 2016 for hopefully what will be a bit more of offense" in terms of its strategic focus, Bourque says.

In the short term, the transition will be challenging. "Until your transfers are actually done, you can't begin to right-size the cost structure accordingly. So, there will be a lag between the time the revenue comes out and the cost comes out," says Bourque.

In the second quarter, Ocwen earned $10 million on revenues of $463 million, down from earnings of $43 million on $510 million in revenues in the first quarter. In a July 30 conference call after the markets closed, Faris and Bourque answered questions by analysts about the company's statement that it plans to reduce its cost by "at least $150 million."

Analysts raised questions about the timing, pace and extent of the costs savings. The next day, there were two downgrades of Ocwen. Bank of America Merrill Lynch lowered its rating from "neutral" to "underperform" while Sterne Agee lowered its rating from "buy" to "neutral." The same day, Ocwen's share price plunged 28 percent to 8.43 from the prior day's 11.76 closing price. A week after the conference call, three analysts had a "sell" rating on Ocwen shares while eight analysts rated it a "hold."

Bourque, however, thinks the markets jumped to the wrong conclusion. "We were aiming above $150 million but we were just not saying where," Bourque says. "It was a point that was somewhat missed by the markets," he adds, as investors appeared to have assumed the cost-improvement target was $150 million and no more.

During the conference call, Faris outlined a framework for the company's future revenues and earnings expectation that gave more hints on expected cost improvements. Faris explained that structural changes in the business made it necessary for the company to reset its operating margin benchmark from 57 percent, where it was set in 2012, to 43 percent.

Faris cautioned, however, that operating margins for 2015 may ultimately come in between 20 percent and 30 percent before heading back up toward the company's new benchmark. If agency servicing sales go as planned, "we should remain profitable for the full year," Faris said.

Ocwen is more upbeat about 2016. "We believe we will be profitable next year and show margin improvements next year," Bourque says. "That's going to be largely the result of cost improvements, but also continued operational improvements and our investment in our infrastructure and technology," he adds.

Growth brings challenges

Ocwen's meteoric rise as a servicer peaked in 2013 with a $455.17 billion servicing portfolio, according to Inside Mortgage Finance, when the company toppled mortgage industry giant Citibank from fourth place on the servicing rankings.

Nationstar Mortgage Holdings...

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