(Altisource/Ocwen) Mortgage servicing rights overview

Lately, Ocwen has been receiving a lot of bad press due to its problems with regulators.  Both Ocwen and Altisource have seen their share prices tank.  I think that the selloffs are overdone.  If anything Ocwen should have sold off worse than Altisource.

Here’s my take on the situation.

DISCLAIMER: I do not understand this industry very well and am trying to learn more about it.  I recommend you do your own due diligence.

The economics of mortgage servicing rights

In the past, mortgages were pooled into mortgage-backed securities (MBS).  A MBS might have several hundred different mortgages that appear to be diversified in different ways: geography, FICO scores, type of building, first or second mortgage, etc. etc.  These securities were then sold to investors.  (I will ignore how MBSes were often sliced up into different tranches and insured by companies that later blew up.)

Somebody has to do all of the administration work on these mortgages such as collecting payments, tracking delinquencies, handling foreclosures, etc.  The “servicer” is the party that does this.  The company that owns the mortgage servicing rights (MSRs) has the ability to select the servicer, to choose themselves as the servicer, and to collect servicing fees.  One such structure is that the servicer will receive 0.25% of the unpaid principal balance (UPB).

Here’s how the servicer maximizes their profit:

  1. Keep the unpaid principal balance high.  The UPB will drop to things such as refinancings and a homeowner selling his/her house and moving.  The servicer largely has no control over that.  However, the UPB will also drop if there is a foreclosure.  The servicer can try to modify the mortgage to reduce the loss in UPB.
  2. Cut costs.  Negotiating and arranging mortgage modifications costs the servicer money in terms of labour.  There is presumably a balance between keep costs low and trying to keep the UPB high.

Ocwen’s regulatory problems

Ocwen recently had a large settlement that is supposedly $2.1B.  It will pay virtually none of this.  $125M in cash will be paid to affected homeowners (it might be more accurate to call them homedebtors).  Ocwen will pay roughly half of this.  Ocwen will need to provide at least $2B in principal reductions to homeowners in the coming years.  Ocwen will not pay any of that $2B as it will be paid by the MBS investors.

In my opinion, the settlement is largely an exercise in politics.  Those at the top of the relevant regulatory agencies can further their own political ambitions by creating the impression that they are protecting homeowners against evil corporations.  (Regulators often use their job to generate publicity for themselves so they can later run for public office.  Eliot Spitzer is an example of a regulator who later became a politician.)  The $2.1B figure is largely smoke and mirrors as Ocwen pays virtually none of it.

However, there is a very real cost to Ocwen that is hard to quantify.  As part of the settlement agreement, Ocwen has to implement new measures to improve the quality of its mortgage servicing.  Non-electronic legal documents have to be signed by hand.  No signature stamps are allowed.  (I think that this is a rather silly stipulation.)

Ocwen has to develop loan portals.  These are electronic websites where borrowers can get information on their loan, loan modification, etc.  The consent order (PDF) further stipulates:

Servicer shall participate in the development and implementation of a neutral, nationwide loan portal system linked to Servicer’s primary servicing system, such as Hope LoanPort to enhance communications with housing counselors, including using the technology used for the Borrower Portal, and containing similar features to the Borrower Portal.

In general, there are several different areas where Ocwen has to increase its servicing quality.  I think that this will increase its costs across the board.  It will also have to increase its IT/software spending on things like the loan portal, which may be a good thing for Altisource as Altisource provides IT services and software for Ocwen.

Effect of regulation on the industry

In the short term, profits may be lower.

In the long term, I think that regulations will push the industry into consolidation and into fewer players.  The cost of compliance is somewhat fixed so larger companies will benefit from economics of scale.  The higher cost of compliance will ultimately force mortgage investors to spend more on servicing, which will make the industry larger.  Ultimately, the unintended consequences might actually be good for Ocwen and Altisource.

The settlement is actually kind of a good thing for Altisource, though Altisource is specifically not protected against future regulatory action under the consent order.  Regulators have figured out that a really rich capitalist (William Erbey) owns more of Altisource than Ocwen and that the regulations don’t necessarily hurt him that much.  They are currently conducting a witch hunt into the relationships between Ocwen (OCN), Altisource (ASPS), AAMC, RESI, and HLSS.  Politically, it might look bad if the perception is that they were outsmarted by a rich, evil capitalist mastermind (Erbey).  They will definitely try to dig up dirt on Erbey and rack up legal bills for all of his other companies.

DISCLAIMER: I do not understand this industry very well and am trying to learn more about it.  I recommend you do your own due diligence.

*Disclosure: Long Altisource (ASPS).

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