(Ocwen/Altisource) Force-placed insurance

Altisource’s share price fell dramatically today following a letter by Benjamin Lawsky to Ocwen (PDF link) that finds problems with a practice called force-placed insurance.  Normally, lenders will require the homeowner to pay for hazard/property insurance.  Part of each mortgage payment goes into an escrow account that pays for insurance and property taxes.  However, there are some rare cases where the borrower pays hazard/property insurance separately.  Perhaps they already had insurance before getting a HELOC.  Or, they wish to exercise their right to choose their own insurance provider.  In those situations, a borrower who has run into financial difficulties may stop paying their hazard/property insurance because they have more important expenses to pay.  This exposes both the lender and the borrower to the risk of catastrophic damage to the home.  Mortgage contracts generally allow the mortgage servicer to obtain hazard/property insurance elsewhere on behalf of the borrower.

There are two issues with force-placed insurance:

  1. It’s almost always significantly more expensive than the original hazard/property insurance policy.
  2. The mortgage servicer can take kickbacks/commissions from the insurance company.

Force-placed insurance is expensive

Force-placed insurance (also called lender-placed insurance) is inherently more expensive even without kickbacks.  The insurer generally agrees to insure all of the houses from a given mortgage servicer where the insurance has lapsed, without the ability to reject loans that do not meet their normal underwriting criteria.

Unfortunately, the consequences for the home owner are tough.  Somebody who is behind on their mortgage will suddenly be even more behind due to the increased cost of hazard/property insurance.  While this is a concern from a consumer protection standpoint, force-placed insurance is a “necessary evil”.  Without it, the borrower and lender are exposed to catastrophic risk.  (Or mortgages will suddenly become more expensive and difficult to obtain if force-placed insurance clauses aren’t allowed…)

For non-delinquent homeowners, force-placed insurance is a nasty surprise.  They may have accidentally forgotten to renew or pay their insurance, unaware that force-placed insurance is significantly more expensive.  Insurance companies will generally contact their clients before their policy lapses so that they do not forget to renew their insurance.

The mortgage servicer can take kickbacks

Because the mortgage servicer originates the flow of force-placed insurance, the mortgage servicer could take kickbacks or commissions from the insurance company.  The real losers from this practice are typically the mortgage investors.  Many borrowers who aren’t paying their insurance will likely default on their mortgage anyways.  Once the loan goes into foreclosure, it will be the mortgage investors who pay for the kickbacks on force-placed insurance.  Mainly for this reason, the GSEs have changed their rules in the past few years to forbid servicers from taking kickbacks on force-placed insurance.

Consequences for Ocwen

Benjamin Lawsky’s letter to Ocwen basically implies the following things:

  • That Altisource is taking kickbacks for force-placed insurance.  (The practice hurts consumers and mortgage investors because they will be paying for those kickbacks.  As well, it arguably hurts Ocwen’s sub-servicing clients.)
  • That Altisource is trying to side step borrower protections through complex arrangements.
  • That Bill Erbey is hurting Ocwen shareholders to benefit Altisource shareholders.  The letter does not expand on this conflict of interest but shareholders should be concerned about the implications of the alleged wealth transfer.  Because it is Ocwen that determines the flow of force-placed insurance, it should be Ocwen that receives any kickbacks (not Altisource).  Ocwen is further hurt by the arrangement because Ocwen has to provide advances on forced-placed insurance and pay for the financing of those advances.

Here is my version of the narrative laid out in Lawsky’s letter:

  1. Ocwen’s existing force-placed arrangement with the insurer Assurant was set to expire in March 2014.
  2. In August 2013, Ocwen appointed an Altisource subsidiary called Beltline Road Insurance Agency, Inc. (“Beltline”) as its exclusive insurance representative.
  3. Beltline’s stated task was to find an alternative arrangement.
  4. In January 2014, Altisource provided a memo to the Credit Committee of Ocwen Mortgage Servicing.  Altisource recommended itself to provide fee-based services to SWBC.
  5. Ocwen’s new force-placed arrangement with Altisource replaced Assurant with Southwest Business Corporation (“SWBC”).
  6. The agreement is apparently a pass-through agreement so that Ocwen and Altisource are not directly contracting with each other.
  7. However, Altisource can still receive insurance commissions and certain fees seemingly for doing very little work.  The NY DFS letter is basically implying that Altisource, not Ocwen, is keeping kickbacks/fees from force-placed insurance.  (Note: The letter uses the word “kickback”.  While it suggests that Altisource is taking kickbacks on force-placed insurance, it does not use the word kickback when describing Ocwen’s and Altisource’s activities.)
  8. In emails dated January 15 and 16, 2014, the transaction was approved by the three members of the Credit Committee: William Erbey, Duo Zhang, and Richard Cooperstein. The Credit Committee did not meet to discuss this proposal, no minutes were taken of the Credit Committee’s consideration of this proposed transaction, and the proposed transaction apparently was not presented for review or approval to any member of the Ocwen Board of Directors.
  9. Just one month after this Credit Committee approval, on February 26, 2014, the company received a letter from Lawsky’s New York Department of Financial Services raising concerns about potential conflicts of interest between Ocwen and its related public companies.
  10. Disregarding the concerns raised in the Department’s letter, Ocwen proceeded to execute contracts formalizing this new force-placed arrangement.
  11. It appears that payment of the kickbacks/fees exclude premium generated by policies issued on properties in New York State.
  12. The new force-placed insurance contracts, dated as of June 1, 2014, indicate that Altisource will generate significant revenue from Ocwen while apparently doing very little work.
  13. A careful review of these and other documents suggests that Ocwen hired Altisource to design Ocwen’s new force-placed program with the expectation and intent that Altisource would use this opportunity to steer profits to itself.

Do the numbers add up?

The numbers in Lawsky’s letter are quite significant.  The letter states:

Documents indicate that Ocwen expects to force-place policies on its borrowers in excess of $400 million net written premium per year; a 15% commission on $400 million would be $60 million per year.

It seems slightly implausible to me that there would be a wealth transfer of this magnitude from Ocwen shareholders to Altisource shareholders.  The actual wealth transfer is slightly larger than $60M/year because Ocwen has to put up advances for the inflated cost of force-placed insurance.  $60M/year is substantial compared to Altisource’s operating income of $162M in YE2013.  The contract described in Lawsky’s letter seems like an egregious violation of securities law.

Secondly, I’m not sure if Ocwen generates that level of force-placed insurance premiums on the ~2.8M loans that it services and on the loans that it sub-services.  Force-placed insurance only applies if the borrower was paying insurance separately and if the borrower stops paying his/her insurance policy.  It would only apply to a small portion of Ocwen’s delinquent loans and a small portion of loans that Ocwen sub-services.  Looking at Altisource’s 10-K, the “insurance services” segment only generated $42.483M in revenue from Ocwen (page 31).  Altisource describes its segment as follows:

Insurance services include an array of title insurance services, including pre-foreclosure and REO title searches, title commitments, settlement and escrow services and other title insurance services including title insurance for loan originations.  We also provide insurance program management and insurance agency and brokerage services applicable to lenders and residential loan servicers.

To me, the description suggests that non-kickback revenue accounts for most of Altisource’s insurance services revenue.  The part that can be construed as kickbacks on force-placed insurance seems to be, at the most, a very minor part of the insurance services segment.

Thirdly, there has been a lot of scrutiny regarding the practice of force-placed insurance.  The Ocwen 10-K notes that there was scrutiny regarding this practice since January 2012:

On January 18, 2012, OLS received a subpoena from the NY DFS requesting documents regarding OLS’ policies, procedures and practices regarding lender-placed or “force-placed” insurance which is required to be provided for borrowers who allow their hazard insurance policies to lapse.

Since then, other servicers have settled class action lawsuits relating to the practice.  The CFPB has also been scrutinizing the practice.  It seems like a dumb move for Bill Erbey to transfer wealth from Ocwen to Altisource (in the manner laid out in the DF NYS letter) given the increased scrutiny over the practice.

Did Ocwen or Altisource take kickbacks in the past?

According to the NY DFS letter, Assurant provided force-placed insurance to Ocwen in the past.  Assurant and Ocwen’s competitors seem to have engaged in kickbacks in the past:

  • Assurant and JP Morgan settled a class action lawsuit for $300M (Wall Street Journal article).
  • Assurant and Citigroup paid $110M to settle its lawsuit relating to force-placed insurance (Marketwatch article).
  • Assurant, QBE (another major insurance provider), and Wells Fargo settled a lawsuit against it (Marketwatch article).

I believe Ocwen is currently facing a lawsuit over alleged kickbacks from force-placed insurance.  I do not believe that the kickbacks/commissions are clearly illegal.  A small commission is reasonable given that it costs the servicer money to obtain and finance force-placed insurance.  I believe excessive commissions/kickbacks run afoul of consumer protection-type laws.

The bottom line

To recap, the issues are:

  1. Did Ocwen or Altisource take kickbacks in the past?  If so, what would be the cost of settling lawsuits related to that practice?
  2. Is Ocwen or Altisource still taking kickbacks?  I doubt that Bill Erbey would do that considering the previous class action settlements, Ocwen’s settlement with the CFPB, etc. etc.  On the other hand, the history of certain areas of the finance industry is that some companies will repeatedly commit wrongdoing and make huge profits despite all the settlements they pay (e.g. most investment banks).
  3. Did Bill Erbey transfer wealth from Ocwen to Altisource?  I don’t think he’s that stupid.

I added slightly to my position in ASPS today after the stock fell by almost a fifth.  I think that the fears are overblown.

*Disclosure:  Long OCN and ASPS.

Links

Ocwen Accused Of Forcing Costly Insurance On Homeowners – 2012 news article

Mortgage loan companies skirting federal regulations – 2014 news article.

Walter Investment most at risk of FHFA forced-placed insurance suit – This article suggests that Ocwen did not take kickbacks on force-placed insurance for FHFA loans.

(Assurant) Frequently Asked Questions: Lender-Placed Insurance – For some reason this website is broken but you can view the HTML source code to read the answers to the questions.

(added 11/12/2014) Force-Placed Insurance Kickbacks Still Alive – This article quotes the executive director of the Center for Economic Justice as saying that Beltline is a means by which Ocwen and Altisource are getting around rules on force-placed insurance.  Instead of receiving a continual stream of kickbacks, Ocwen received a front-loaded one-time payment when it sold Beltline to Altisource.

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27 thoughts on “(Ocwen/Altisource) Force-placed insurance

  1. this post is very confusing. bottom line: you got ASPS benefiting from forced placed insurance without any arms length bidding process…does that sound fishy to you? The affiliated relationship between OCN and ASPS has been the root problem. ASPS has been mooching off of OCN on a number of front. Since OCN is not footing the bill (the mortgage borrowers or RMBS holders are), it turns a blind eye. OCN is failing on its duty.

    • 1- If what Lawsky is saying is true, then Erbey is more or less stealing from Ocwen to benefit Altisource. There is no business reason as to why Altisource should pocket any kickbacks/commissions/fees from force-placed insurance… those should rightfully belong to Ocwen.

      2- I don’t believe that Ocwen or Altisource is currently taking kickbacks. However, that’s just my guess.

  2. The commissions represent higher amounts that borrowers have to pay for the Forced Placed insurance. ASPS is not stealing from OCN as OCN is prohibited from getting any commission for forced placed insurance in the first place. This is fundamentally not about economics shifting from OCN to ASPS, but about economics ASPS is getting without arms length contracting process and OCN is failing its duty! Why do you think the NYDFS is addressing the letter to OCN???

    • Normally mortgage servicers keep all of the commissions/kickbacks/fees for themselves. I don’t see why Ocwen should “contract” it out and give free money to somebody else. Perhaps I misunderstand you.

  3. Servicers are not allowed to earn commissions for force-placed insurance. That’s why OCN should contract out this business to someone else. It’s obviously a potential area of conflict if they contract it out to ASPS…

  4. An admirer is right. Ocwen the mortgage servicer is no longer allowed (by law) to make commission revenue from referring force placed insurance business on the same mortgages that it services. So to make sure that revenue stream doesn’t disappear Ocwen “sold” that insurance agency business to Altisource so Altisource can collect the kickback instead, which is legal and constitutes standard practice in the industry.

    What’s concerning is the fact that Lawsky is singling them out and using this as an example to show that Erbey is engaging in self-dealing transactions. It’s unclear whether lawsky’s made adequate research to prove the point, but just the fact that he’s sent out the letter so publicly and portraying OCN/ASPS in negative light even before he has solicited any responses from OCN/ASPS shows that he’s already determined Ocwen’s guilt regardless of whether any facts will prove him wrong.

    Also notice in his letter that when the force placed insurance contract was signed, it specifically did not allow ASPS to charge any commissions on insurance placed in NY state, presumably because Erbey didn’t want Lawsky to look into this issue because if he did, he would be overstepping his NY state regulator authority. This didn’t deter Lawsky from an investigation anyway even though the whole thing has nothing to do with his own NY constituency. The point is that Lawsky IS over-stepping his authority and HAS BEEN all along and he knows it.

    Lawsky is not targetting OCN/ASPS to protect consumers, but to earn political points. Whether Ocwen/ASPS can defend themselves with facts is irrelevant because Lawsky is out to get them. The mistake that Erbey is making is thinking that he can avoid a costly settlement by cooperating with the investigation, not realizing that Lawsky is a corrupt, rogue regulator with hidden political aspirations (how can you not be when you work for Andrew Cuomo?).

    What Erbey needs to do is to bend his knees and settle as quickly as possible or else Lawsky will never stop bothering them.

    • Doesn’t Ocwen have to profit on the sale of the insurance agency business? Otherwise Ocwen’s directors and/or officers are violating their fiduciary duty to Ocwen shareholders.

      If so, aren’t they still receiving kickbacks? Does disguising the kickback in that fashion really make it legal?

      2- Thanks for the other comments. That’s the impression I got too. I find it interesting that the letter ends by asking for information/evidence that Lawsky doesn’t have.

    • looking at the accusation of related party transactions being approved by Erbey, and this being a violation, it seems he is flat out wrong. SWBC is not a related party. Erbey does not have a stake and is not a chairman of that entity. So Lawsky is basicly contradicting himself there.

      • Wrong! the accusation states that OCN tried to use SWBC as a conduit for fees to ASPS. even if SWBC is not a related party, it’s fishy to structure deals like these…OCN better have a good explanation for how the transaction works and why it’s structured this way.

  5. Lawsky has had a long history of over-stepping his authority and abusing his power to exhort large settlement payments from financial services companies (just study the standard chartered and BNP settlements), which are a very easy target. The problem with Ocwen is that Lawsky doesn’t have the same leverage as he does with the big banks (ability to take away state license) since Ocwen would be more than happy to have its NY state license taken away and never do business in that state ever again, so he has had to resort to destroying Erbey’s reputation to get a win out of the situation.

    The last letter he sent regarding Hubzu is the perfect proof. He alleged that Hubzu was charging a higher fee for its services than competing auction sites, which is a total lie. Hubzu’s fees, which range from 3.5 – 4.5%, are among the lowest in the industry. Auction.com and other similar sites charge 5 – 10% and that data requires very little effort to find out. The point is that Lawsky was lying and he knew he was lying because he doesn’t care if Ocwen is a good or bad company. Erbey should have cooperated a long time ago by proposing a settlement. The longer this drags on the more damage will come.

    • From what I understand, most RMBS are geographically diversified so they will contain New York mortgages. If Ocwen cannot service New York mortgages, then it will be difficult for it to buy mortgage servicing rights. They would need to farm out all the New York mortgages.

      The trustee of the RMBS has to approve changes in the servicer. (Or it’s the master servicer, I can’t remember.) Not being able to operate in New York seems extremely complicated? The trustee may not want to hire lawyers to figure it out, because who is going to cover their legal expenses?

  6. The discussion of whether Lawsky is overstepping his boundary is moot. the discussion on OCN getting out of New York is also moot. the key question you need to ask yourself is: do you trust Erbey to be an honest businessman and that he operates OCN/ASPS in an above board manner. If you believe this, then the Lawsky investigation is just temporary nuisance, but a good opportunity to buy shares cheaply. If not, don’t touch the stock (this is true in all investments, but particularly true for OCN/ASPS given the regulatory scrutiny).

  7. From what I’ve seen from Erbey is that he does have integrity (and naturally talent as well). It’s really hard to make conclusions where this will lead so in the end it comes down to trusting Erbey. As long as the business is doing fine, I’m fine with staying and adding as well.

    I think that’s the most rational thing to do as the risk/reward to me seems currently very attractive. I do understand though that people are selling in face of uncertainty, but really, what’s the worst case scenario that causes ASPS to lose a lot of its business (which market is currently implying)?

    I believe that’s the most important question to ask. I don’t see why Erbey wouldn’t be able to handle this, though anything is possible. It’s part of taking the risk.

    In the end it’s a great opportunity if all ends well without the business getting too hindered, both investors and asps are currently be able to buy shares at fire-sales. It would be sort of ironic situation looking from Lawskys point of view.

    That being said, I’m not too worried until ASPS releases a sub-par quarterly earnings report.

    • 1- I think Glaucus’ arguments about AAMC being a parasite are silly. These stocks were spun-off with the current structure in place.

      2- I think calling Erbey diabolical is way off the mark. I’ve seen a lot of scummy stocks and people and he is far from diabolical.

      3- I don’t understand why Glaucus likes RESI. Obviously RESI is for yield chasing chumps.

      • #1 and #2 – You are not correct because you don’t know him. He’s wicked smart, but incredibly greedy.

        #3 – It was a pair trade to minimize risk.

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