Misconceptions about Ocwen and Altisource

This year, both Ocwen and Altisource’s share prices have gone down roughly two thirds.  I think that some of the fears regarding these stocks are based on misconceptions.

Regulators may force Ocwen into run-off

There are fears that Ocwen will be prevented from buying MSRs in the future.  While theoretically this can happen, I think that it is unlikely.

  1. Many of the problems in the mortgage market exist because there wasn’t enough servicing capacity to handle the huge wave of delinquencies from the US housing/subprime bubble.  If Ocwen were forced to stop buying MSRs, its servicing capacity would eventually be wasted.  Doing so strikes me as harmful to the consumer.
  2. Allowing companies to transfer servicing from one company to another is necessary for the current mortgage market to work.  Suppose that a servicer cannot service a mortgage pool profitably.  It would make sense for the servicing to be transferred before the servicer simply stops servicing that mortgage pool.  It would be crazy if servicers (or trustees) were not allowed to transfer the servicing.
  3. Perhaps regulators might try to prevent bad actors from growing.  However, choosing winners and losers would set a dangerous precedent.  Also, Ocwen is one of the better mortgage servicers out there.  Punishing them would seem quite perverse.
  4. Regulators have nothing to gain from it.  Regulators have political goals.  They need to reach settlements that would make them look good.  In the case of the NY DFS, there may be an incentive to extort large settlements to help fund the state of New York.  Forcing a company into run-off does not seem like it would achieve the regulators’ goals.  If the regulators were to pick winners, those winners would be just as bad as Ocwen if not worse.

Regulation is awful for Ocwen and Altisource

While regulation hurts earnings in the short run, there is a silver lining.  Regulation is one reason why the non-bank mortgage servicing industry has been growing so fast.  Regulation makes mortgage servicing a lot more difficult.  This encourages companies to get out of the mortgage servicing business so that they can focus on their core competencies.

Secondly, regulation rewards companies with scale due to the fixed costs of hiring compliance staff.  Ocwen is currently the largest non-bank servicer.  All of the major banks have been selling down their MSR portfolios.  At the current rate, Ocwen looks like it will become the largest mortgage servicer if it is allowed to buy more MSRs.  Eventually, Ocwen will have a huge competitive advantage over the rest of the mortgage servicing industry.  Historically, companies with large competitive advantages due to scale (e.g. Intel, Visa, broadcast networks like ABC/CBS/NBC, Liberty/TCI, DTV, etc.) have done quite well for shareholders.

I believe that the NY DFS’ egregious extortion-style regulation is making everybody in the mortgage servicing space scared.  Everybody will be looking at:

  1. Avoiding anything resembling kickbacks on force-placed insurance.  This will reduce profitability.
  2. Working towards zero errors.  This will reduce profitability.
  3. Providing better customer service that they were not originally contractually obligated to do so, e.g. online web portals, single point of contact, more first-class mail, explanations of consumer rights, etc. etc.  This will reduce profitability.
  4. Getting out of the mortgage servicing business due to low profitability and possible reputational damage.

So, I think that banks will be even more interested in selling all or most of their MSRs ahead of Basel III regulations.  Ironically, this will hurt homeowners because the MSR transfers will cause homeowners to be lost in the shuffle.  It hurts even more when large transfers have to happen in a shorter timeframe, as rapid boarding of new loans will cause servicing issues.  Because Benjamin Lawsky of the NY DFS blocked Wells Fargo’s sale of MSRs to Ocwen, other market participants will be hesitant to do similar mega-deals if it would attract regulatory scrutiny.  But once the coast is clear, it is likely that the banks will try to rapidly sell their MSR portfolios in a short timeframe.

While these sales will hurt and annoy homeowners, there may be a huge opportunity for Ocwen if it is allowed to buy a lot of MSRs.  Because Ocwen has lower costs than its competitors, it should have very attractive internal rates of returns on future MSR purchases.

EDIT (11/17/2014):  I’m probably wrong about the big banks selling all of their MSRs.  In their origination and underwriting businesses, the banks already service loans.  Because there are costs in transferring loans, it is more efficient for the big banks to retain MSRs.  They may continue to sell subprime MSRs to more efficient servicers.

Regulation may be even better for Altisource

More rules and regulations means that software and business processes become more complicated.  This will drive demand for better software and grow the software/technology market.  Ocwen has already said that it is making an investment in compliance infrastructure.  This will almost certainly be built by its preferred technology vendor, which is Altisource.  Altisource will be able to sell similar software to other servicers.

Compared to Ocwen, Altisource should have less exposure to regulatory-related costs because it does not own MSRs.  It did manage to have exposure to force-placed insurance but that should no longer be a recurring issue for Altisource.

AAMC may also be worth looking at because it is unlikely to have a high regulatory burden.  Because it deals with a very small number of homes, it is unlikely to be targeted due to size.  Because AAMC/RESI has skin in the game, there aren’t conflicts of interest between the servicer and the mortgage investor.  AAMC/RESI will be highly incentivized to provide loan modifications and won’t be restricted by servicing contracts in providing loan mods.  It should be homeowner-friendly when dealing with the non-performing loans that it buys.  And lastly, they may reduce community blighting from REO that isn’t maintained properly because their servicer (Ocwen) is good at avoiding foreclosures and reducing foreclosure timelines.  Additionally, there is a benefit because the REO properties are not in a mortgage-backed security.  The servicer does not have an incentive to spend as little money on possible renovating and maintaining the property.

Ocwen paid $2B in fines as part of its consent order with the CFPB

It did not.  Ocwen does not pay for any of these loan modifications; mortgage investors do.

This $2B figure isn’t too meaningful given that Ocwen will be modifying loans anyways in its normal course of business.  The onus on the servicer is to make sure that their staffing levels are high enough to avoid missed opportunities to modify a mortage.

However, Ocwen promised to make $2B in loan modifications for any of the borrowers that it services.  This includes any future borrowers from future MSRs purchased by Ocwen.  The company could simply meet its target by buying more MSRs.  Incidentally, Ocwen wanted to buy huge volumes of MSRs following its settlement with the CFPB.  Ironically enough, Ocwen’s purchases of future MSRs could hurt homeowners.  A loan modification that was agreed to by the previous servicer may not be honoured by the subsequent servicer.  This effect is worse if Ocwen tries to rapidly board a lot of loans at once.  In theory, this part of the settlement may not necessarily have the desired effect.

I also think that it is a little weird that mortgage servicers have suddenly become obligated to make loan modifications.  A loan modification is vaguely like giving the borrower free money.  Regulators are essentially pushing mortgage servicers into making mortgage investors give free money to borrowers.  (Or, servicers can arrange for the US taxpayer to give borrowers free money via loan modification programs such as HAMP.)  While I don’t think this is good economic policy, this is what America has turned into.  Regulators get to announce a big number that makes them look good.  Meanwhile, in reality, the obligation to produce “$2B” in loan modifications doesn’t really change Ocwen’s servicing quality.

As far as the press goes, there are many journalists who misleadingly point out that Ocwen was forced to pay a $2B fine and that therefore Ocwen must be evil given that it paid such a huge penalty.  You should take what these journalists say with a grain of salt.

*Disclosure:  Long ASPS and OCN.

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11 thoughts on “Misconceptions about Ocwen and Altisource

  1. I wonder if OCN or ASPS are becoming a punch card investment. If the regulators were going to shutdown Ocwen it would have done so by now. ASPS has the most leverage here if OCN is allowed to continue in some capacity.

    Have you looked into Nationstar? It seems the regulators are looking into them as well, but I haven’t heard anything from it.

    • I feel like they’re all going to get a colonoscopy.

      Some of the other servicers might have difficulty becoming/staying profitable as regulation hurts all of their profitability.

  2. Do you see potential for a short-squeeze in asps?

    Personally I’m not familiar at all with shorting, so I’d like to hear whether I’m missing something with my conclusions:

    ASPS total shares: 21,6m + 2m dilution = 23,6m
    Erbey owns: 6m (+ 873k options, dunno how to think about these)
    Float minus Erbeys stake -> 17,6m

    Short interest is 4,7m and when we consider Erbeys stake, it’s 26% of float.

    ASPS is buying back shares, optimal case in this Q would be 2m shares
    -> short interest would be 30% of float

    4 Biggest whales own 7.2m shares (excluding of course Cooperman who exited) and if they hold their shares, the short interest / float would be around 56%.

    http://whalewisdom.com/stock/asps

    Of course whether the whales are going to hold is pure speculation, but the float interest for me seems to kinda high anyways.

    Like I said though, I’m not familiar with shorting at all so I was curious about your thoughts. I remember you having a fairly sizeable short-basket so you’ve probably given some thoughts about the matter.

    • I believe Cooperman added slightly to ASPS.

      2- I heavily diversify my shorts so I don’t have to worry about short squeezes.

      3- There are some people who engineer short squeezes on other market participants (e.g. Jim Cramer, Steinhart). They pay a lot of commissions to their brokers so that the broker will leak information to them about which hedge funds are vulnerable. So then what you do is buy up the shares and put them into a cash account so that they can’t be lent out to short sellers. Short sellers are then forced to buy-in their positions.

      4- I don’t think ASPS will see a short squeeze. The cost to borrow is only 2% (though short interest is high). If the borrow goes up to 20% then the chance of a squeeze is much higher.

      5- I am not very good at predicting short squeezes.

      • >I believe Cooperman added slightly to ASPS.

        It seems I mixed it up with him unloading OCN. Thanks for the reply.

  3. Glenn,

    Have you looked into NSM and their SolutionStar division? It looks similar to ASPS. There has been talks about spinning it off eventually.

    • Not really. I know that their CFO is Robert D Stiles, who left Ocwen to become Altisource’s CFO. He must have made a killing on his options.

      The regulatory environment may make it difficult for NSM to make a profit. They may want to keep their businesses together for higher liquidity.

  4. Glenn what are the numbers like for AAMC? At below 500$ it looks pretty interesting now. it seems they will get like a 5% net yield on renting out those homes, and between a 35-50% premium on flipping those houses?

    Given that there are hundreds of billions out there that could be bought by RESI, Im curious how you see various upside scenario’s.

  5. Glenn,

    I haven’t been following the ins and outs of these Erbey companies at a granular level though I have been reading your posts on these companies. I have a couple ideas for future posts.

    1) Consider doing a post that is akin to Gary Klein’s pre-mortem or a serious attempt at thoughtful writeup on why we should short these companies. In either case, these write-ups would force you to look at events and data in a different light. I am not suggesting your long orientation is wrong, but I am concerned about confirmation bias / avoidance of cognitive dissonance distorting your current viewpoint. Spending time on writing a counter-thesis may be quite useful in this regard.

    2) Given the exposure to regulatory events (and I believe Lawsky is expected to be stepping down in the next year or so), not to mention the possibility of these companies getting to be hard to borrow, are there any option trades people should be thinking of? Part of me thinks people should be considering buying the underlying stocks on margin, and buying ATM puts thought I haven’t spent much time looking at the volatility surface.

    • Thanks for the comments.

      1- I could understand why somebody would want to short WAC. I don’t understand why somebody would want to short ASPS. So I feel like I would be making a straw man argument.

      2- The options don’t seem interesting to me. The puts seem fairly valued. Though if you think that they are overvalued, then maybe you could sell the puts.

      In general I don’t like trading options due to high transaction costs.

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