Ocwen’s issues with the California DBO might turn into a witchhunt?

The consent order is now up on the DBO’s website (PDF).  The original issue seemed to be that the DBO requested information on 10 + 1200 + 120 loan files and did not feel that Ocwen fully complied with its request.  The consent order now dictates that an auditor will look into many aspects of Ocwen’s business including “the adequacy of Ocwen’s staffing levels” and “staff training”.  It seems to me that the DBO has decided to change the rules on Ocwen.

*Disclaimer: I am definitely NOT a lawyer.

In the past, it didn’t seem to be the case that servicers were legally required to maintain certain staffing levels.  For example, this webpage summarizing of the California Housing Bill of Rights does not mention anything about the servicer’s staffing levels.  The chaptered bill text does not seem to contain the word “staff”.  This strikes me as the DBO deciding to change the rules of the game.

It is highly likely that the auditor will find some problems at Ocwen because all mortgage servicers will make mistakes.  I do not believe that the DBO or California mortgage law has defined what an acceptable error rate is (or what acceptable staffing levels are, etc. etc.).  So, they can put the goalposts wherever they want.  If they can put the goalposts wherever they want, then I think that the DBO will be able to use servicing problems as a pretext to go after Ocwen and to punish them.  In contrast, the CFPB has been a more reasonable regulator for Ocwen because it has clearly defined what the acceptable errors rates are for its compliance metrics.  While the CFPB has been continually adding more compliance metrics, I believe that it has behaved far more reasonably than the NY DFS or the California DBO.

At the end of the day, I think that Ocwen’s operating expenses will continue to go up due to the current regulatory environment.  As well, I believe its nonagency MSRs will become less profitable due to Altisource’s decision to exit the lender placed insurance “brokerage” business.  The regulatory and litigation issues will reduce the value of its MSR portfolio.  I do not have access to current market pricing on MSRs so I do not have a means to quantify the current market value of Ocwen’s assets beyond what Ocwen provides in its investor presentations and SEC filings.

The bigger picture

So far, Ocwen’s long-term advantages as a low-cost operator seem intact.  This could change if management is not as good without Bill Erbey around.

The nasty regulatory environment creates slightly bigger barriers to entry.  However, the regulatory environment is also stifling subprime lending and eroding the size of the subprime MSR market.  In the shorter-term, I think that the big banks will be strongly incentivized to sell off their subprime MSRs portfolios given the regulatory climate, reputation risk and litigation risk (e.g. big banks have been sued over kickbacks on force-placed insurance).  Wells Fargo already tried to sell subprime MSRs to Ocwen but unfortunately the deal was scuttled by the NY DFS.  Ocwen’s future returns on invested capital will depend on the volume of subprime MSRs it can buy (limited by what regulators will allow it to buy) and the pricing on those purchases.  A large number of motivated subprime MSR sellers and a limited supply of buyers may mean attractive prices for Ocwen someday… even if Ocwen were to try to dramatically grow its market share in a rapidly shrinking market.  Once the subprime MSR opportunity gets smaller, Ocwen will need to find something else to do.  This will be a big problem if it cannot stick to its bread and butter.

Over the past year, Ocwen’s share price has fallen dramatically.  In my opinion, a good portion of this decline was justified.  However, I think that investors have overreacted.  In October 2014, Ocwen repurchased shares at an average price of around $23.63 (See Note 23 in the 10-Q).  At the time it was negotiating with the NY DFS (the settlement announcement was on Dec 22) and would have known that the California DBO was threatening to revoke its license (around October 3).  Ocwen’s current market price is well below the $23 it paid for share repurchases a quarter ago.

*Disclosure: Long OCN and ASPS.

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9 thoughts on “Ocwen’s issues with the California DBO might turn into a witchhunt?

  1. How much have you given thought to ASPS profits in the future?

    IIRC the price rose to ~$25 in aftermarket which would put the market cap of ASPS to around little less than $600m. EV is around $1B.

    Their low-end assumption is around $100m for next year and for the sake of conservatism I keep the higher estimates as an option.

    The high-margin business is both naturally declining and OCN being in run-off for now so I’ll assume in the future those profits will decline. ASPS uses average multiplier around 0.86 / 14% yearly decline for profits/revs from the current OCN portfolio over 5 years.

    Using low-end estimates the current OCN portfolio may be around $500m worth of cash to ASPS over 5-6 years. What we are left with is whatever residue is from OCN + their non-ocwen revenue. The contract expires (IIRC) 2025 and it will _most likely_ get renewed.

    We are possibly looking at declining profits from OCN + whatever non-OCN revenue is worth. Current (2015 est.) non-OCN revenues are $300m and with 5% margin that’s $15m and with 10% that’s $30m not taking possible revenue growth into consideration. Slapping a 15x multiplier on $15-$30m is $225-$450, which is at least reasonable looking at their potential.

    The profits from OCN can be even lower if they can’t down-scale expenses at the same rate with the revenues, though to be fair they were a lot smaller before and had nice profitability so that most likely won’t be a problem.

    Personally I’m not too convinced with their ability to provide lots of value to non-OCN / RESI customers as a lot of their growth has come from acquisitions. The prices paid have looked reasonable though. Their slides look promising, though there have been few set-backs.

    These are obviously back of the envelope conservative calculations, but in the end with these estimates I think fair value of ASPS might be in low-case around $30 and in mid-high case we are looking at significant under-valuation.

    The ultimate problem is that one has to make a lot of assumptions with ASPS and I probably have some terribly wrong. I could understand if a conservative investor who wants to account for some potential unknown-disaster (not to mention their “black-box” kind of business, which is very hard to make clear sense of) that happens for ASPS wouldn’t want to pay more than $20/share.

    Some “unknown disaster” would be OCN contract disappearing suddenly for whatever reason (regulators?) – if that would happen during the next few years then ASPS could be at least 50% over-valued, though I have no idea how much money they could make from their non-ocn revenue and whether that grows organically or not.

    There are some nice options for upside though:
    1. OCN gets to buy some non-agency MSRs at some point
    2. non-OCN revenues grow and the business is successful (hubzu takes off?)
    3. They hit their mid-high-estimates.

    Looking at how regulators have been going after OCN, it’s reasonable to assume that they don’t necessarily have their shit together, even though the “regulators are being unfair” story feels good from the bull side of view. I think that the only fact we can state is that we simply can’t know.

  2. It seems if you buy a stock, and say downside is 70-90$, you should not panic sell at 20$ when a lot of panic and uncertainty is priced in. It seems even if there is only 50% upside, there is a quick catalyst when the situation is more clear 6-12 months from now.

    And it is highly unlikely regulators run OCN out of business. That would not be in their best interest at all (of the regulators). They just want to squeeze OCN. So this should not be that bad for ASPS.

    I remember an investor saying that the best investments slap you in the face with their cheapness. They dont require you to find documents in the back corner of the internet to make your case. Lesson learned I guess. I think my bias here was that because I figured out how all this MSR business works, I had an edge. And that it is harder to get an edge with simple stuff (which it is not).

    • If you thought downside was $70-90 and the stock is now at $20, then I think you need to question your previous assumptions. It should also be clear that you didn’t understand the company/investment as well as you thought you did…

  3. I agree that it would be mad to sell when the uncertainty and panic is at its peak, especially when it looks like market has over-reacted.

    To be short, my point was to stress-test the thesis with following assumptions:

    1. OCN is in run-off
    2. ASPS hits low-end guidance ($100m) going forward

    With current $1B EV you are looking at 10 EV/CF with declining profits in the bear case. This doesn’t include potential growth from non-OCN revs. Also, IIRC ASPS expenses their software development costs so that hinders the profitability too, but gives some runway for future profits.

    It does look more probable that OCN will be able to buy more MSR’s at some point, but I believe it’s worth noting that past assumptions about Ocwen and regulators have been simply wrong. Current situation is that they can’t buy new MSRs and we have no idea when they can. OCN has proven to have scalable platform with high degree of profitability, but so far it seems that they really suck at compliance.

    I don’t want to sound “hysterical” here – I’m long ASPS (+ nominal amount of OCN), but I think it’s a good idea to understand both bull and bear views to try to make objective conclusions. I also like to think that the management knows better about their business and like to buy back shares when they are undervalued, but as Shepro said in the call that the buybacks at $100 made sense based on “what they knew back then”.

    They obviously make sense now too, but if what we know right now changes, suddenly they don’t. There are massive amounts of grey areas, not to mention the fact that they aren’t currently even buying the shares, for whatever reason they don’t want to tell. One can’t help but to be suspicious about this, though I want to believe it’s because something bullish they can’t or don’t want to disclose (Glenns theory).

    I do believe that the bull case is more probable and I’m just looking to bounce some ideas and discussion.

    • So far Hubzu has gained less traction than what management projected in an investor presentation a long time ago. Ocwen is the main source of REO. Altisource picked up HSBC as a client so that “top 10 bank” will be Hubzu’s second customer. I don’t think Hubzu will break into mainstream for-sale-by-owner because people searching on Hubzu are looking for REO deals and willing to put up with REO nonsense (Altisource is one of the more difficult companies to deal with and some lenders won’t work with them in some situations).

      I think they have excellent fee-based businesses. For broker price opinions, they use technology to post BPO gigs online and allow approved contractors to take those jobs. They’ve really driven down their labour costs by doing this. I think Altisource may be a low cost operator there.

      • In the near term they will almost certainty shrink… that’s why Altisource fired a bunch of people (800 or so or roughly a tenth of their workforce).

  4. If you look at hubzu, non bank owned, and traditional (so no auction), they do have 5k homes for sale. Im not sure what to make of that though.

  5. Pingback: Ocwen/Altisource: What went wrong | Glenn Chan's Random Notes on Investing

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