OCN, ASPS, NSM, and inflated fees

I made a mistake.  I did not figure out the game that Ocwen and Altisource are playing.  Ocwen seems to receive fees from Altisource that could be (mis)construed as kickbacks under its “Data Access and Services Agreement”.  These fees could be seen as a quid pro quo (“you scratch my back I’ll scratch yours”) for the big profits that Altisource formerly earned for lender placed insurance “brokerage”.

From Altisource’s latest 10-K page 61:

Additionally, we purchase certain data relating to Ocwen’s servicing portfolio in connection with a Data Access and Services Agreement. The Data Access and Services Agreement may be renegotiated and may be cancelled by either Altisource or Ocwen with 90 days prior written notice. Ocwen bills us a per asset fee for this data. For the years ended December 31, 2014, 2013 and 2012, Ocwen billed us $38.6 million, $20.0 million and $13.5 million, respectively. These amounts are reflected as a component of cost of revenue in the consolidated statements of operations.  On December 31, 2014, we notified Ocwen that we are canceling the Data Access and Services Agreement, effective March 31, 2015.

Ocwen’s latest 10-Q contains the most information about the Data Access and Services Agreement (pages 44-45):

Our business is currently dependent on many of the services and products provided by Altisource under various long-term contracts, including the Services Agreements, Technology Products Services Agreements, Intellectual Property Agreements and the Data Center and Disaster Recovery Services Agreements. Under the Services Agreements, Altisource provides various business process outsourcing services. Under the Technology Products Services Agreements and the Data Center and Disaster Recovery Services Agreements, Altisource provides technology products and support services. In addition, we have entered into
(i) Support Services Agreements pursuant to which we and Altisource provide administrative and corporate services to each other and
(ii) a Data Access and Services Agreement pursuant to which we make available to Altisource certain data from our servicing portfolio in exchange for a per asset fee. The revenues and expenses related to our agreements with Altisource for the three and nine months ended September 30, 2014 and 2013 are set forth in the table below.

Services provided by Altisource under the Services Agreements with Ocwen are generally charged to the borrower and/or loan investor. Accordingly, such services, while derived from our loan servicing portfolio, are not reported as expenses by Ocwen. These services include residential property valuation, residential property preservation and inspection services, title services and real estate sales services. We believe the rates charged for these services are market rates as they are materially consistent with one or more of the following: the rates Ocwen pays to or observes from other service providers and the fees we believe Altisource charges to other customers for comparable services.

To recap:

  • Ocwen found an excuse to charge Altisource roughly $38.6M a year.
  • Altisource has a lender placed insurance “brokerage” business that generates somewhere in the ballpark of $47M to $61M a year. Arguably, any kickbacks on lender placed insurance belong to Ocwen shareholders.  By funneling the kickbacks into Altisource, Ocwen is essentially transferring money to Altisource.

The optics of this situation may not look good to regulators.  Regulators may look at this situation and see the companies colluding to generate inflated fees and using these agreements to shuffle kickbacks around.

Going forward, it seems like Ocwen and Altisource are moving away from risky practices that could get them into trouble with regulators.  (At least, I hope that this is what they’re doing.)  This will hurt the profitability of both companies.

Transparency

On December 31, 2014, Altisource notified Ocwen that it was cancelling the Data Access and Services Agreement.  This seems like a material event with wide-ranging implications for both Ocwen and Altisource.  It seems like the managements of both companies would like to have this fact buried in their 10-Qs and 10-Ks.  Neither company addressed the Dec 31, 2014 cancellation of this agreement in their shareholder updates.

Culture of integrity

On the December 22, 2014 conference call Ocwen’s CEO Ronald Faris stated:

In summary, Ocwen is committed to a culture of integrity, transparency and accountability.

It seems that his actions do not match his words.

Things that seem off

Altisource’s January 16, 2015 presentation has some things that don’t seem right to me.

#1

Projections given in the presentation slides assume a lower share count from share repurchases.
EDIT (3/4/2015):  The share count at the end of Q4 2014 is roughly 20.3M shares.  The presentation slides show the weighted average over the entire year.

However, I’m not sure if management really wants to buy back shares.  Altisource’s 10-K states:

During January 2015, we used $4.0 million to repurchase Altisource common stock.

This is a weak buyback given that the CEO stated that the stock was undervalued (“Now if you look at where the share price is trading today which is roughly 3 times the midpoint of our adjusted 2015 earnings per share scenario that we just gave you today, we believe the stock is trading at a very substantial discount to its value“).  A few sentences later in the 10-K:

We intend to closely monitor the Ocwen related uncertainties and to modify our business plan as needed in response. As a result of these uncertainties, we intend to increase our cash and cash equivalents position throughout 2015. However, we will continue to monitor market conditions, and may, at some point in the future, consider repurchasing our common stock and/or our debt if conditions are favorable.

The projections strike me as deceptive given that management is not 100% sure it will repurchase shares.

#2

In the Q&A, Henry Coffee asked the CEO if he was aware of any controversial product offerings that might see a sudden cancellation like the lender placed insurance business.  Bill Sherpro’s response was: “Yes, Henry, we feel very good about the products and services that we’re in today. And the answer is no, we’re not aware of anything.”  Sherpro’s overall tone on the conference call seem to contradict a sentence on page 81 of the 10-K: [There is a risk if] “The contractual relationship between Ocwen and Altisource changes significantly or there are significant changes to our pricing to Ocwen for services from which we generate material revenue.”

#3

Turning to Altisource’s pricing to Ocwen, a recent analyst report has generated a lot of confusion on this topic and whether Altisource will need to reduce its pricing to Ocwen. Let me start by saying that we strive to provide services to Ocwen at rates comparable to the market and we firmly believe we charge Ocwen market rates for those services.

Again, this does not entirely agree with the sentence on page 81 of the 10-K.

Nationstar

Nationstar does not need to enter into convoluted contracts because it owns its default-related services businesses (or adjacent businesses).  Because the servicing and default-related services businesses are under common ownership, the conflicts of interest are stronger.  What Nationstar does with HomeSearch.com is a slightly more ruthless version of what Ocwen/Altisource does with Hubzu.com.  See my post on the mortgage servicing game.  I believe that Nationstar has very high regulatory risk because its fees are more inflated, it allows shill bidding, and it still seems to take insurance commissions on lender placed insurance.

Nationstar is in a tough spot.  If Nationstar attracts the scrutiny of regulators like the NY DFS or the California DBO, it could end up paying a high price like Ocwen:

  • A big fine.
  • (A second big fine if regulators are unhappy.  There is a precedent for this with the NY DFS.)
  • The cost of a monitor.
  • An injunction against buying more MSRs.
  • Ongoing costs from complying with regulations that other servicers do not have to comply with.

I believe that Nationstar is avoiding purchases of high-delinquency MSRs because it does not want to attract regulatory scrutiny.  I do not know why it purchased agency MSRs (presumably with very low delinquencies) from Ocwen.  Maybe it is trying to keep its servicing capacity filled and/or is trying to juice its earnings by taking prepayment risk; Nationstar’s private equity owners likely want to continue to sell down their stake.  In any case, I do not see growth ahead for Nationstar.

Thoughts on the mortgage servicing industry

I made a mistake.  So far, mortgage servicing has turned out to be an ugly industry.  Servicers have no idea what their future costs will beThe rules are arbitrary and constantly changing.  Any number of regulators can cause serious harm to any given servicer or the industry (NY DFS, California DBO, CFPB, FTC, FHFA, other state regulators, state attorney generals, etc.).  This is an industry where a very large number of regulators (arguably over 30) have the power to cause major harm to the industry or individual companies.

*Disclosure:  Long OCN and ASPS.  If these stocks rally strongly there is a good chance I may sell.

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9 thoughts on “OCN, ASPS, NSM, and inflated fees

  1. I agree with your points. The lack of integrity and overall shadiness in the complex is really off-putting. Unfortunately I can’t say that the signs weren’t there and I must admit that the only reason I was still willing to be invested before HLSS deal was greed.

    As for the HLSS deal, I still don’t understand why they felt the need to sell at book value (which obviously makes it more shadier). At that point I really understood how hard / impossible it’s to estimate the risks related to the companies and as time has gone forward since the beginning of last year, the fundamentals have always turned down to the worse.

    I think that the lesson is to consider every sign of lack of integrity somewhat seriously.

    I usually refrain quoting Buffett as it has a tendency to feel like fanboyism nowadays, but he did appropriately mention how after you see one cockroach, you meet their family soon afterwards.. I don’t have a long history at markets, but to come at such conclusion, what happened with Ocwen isn’t unusual at all.

    The most misleading part was that Erbey really looked like a good bet. but I probably should have paid more attention to the fact that before the subprime crisis it looks like they’ve failed to create value and it seems that history is repeating itself.

  2. Hi Glenn. Very much enjoy reading your posts. I know in your previous posts you stated that you thought ASPS was a better value vs. OCN. What are your views now on the relative value of OCN vs. ASPS? It seems that while OCN has bounced off of its lows as it sells assets to raise liquidity, ASPS has performed worse. Does it make sense to you to sell ASPS and replace with OCN?

    • I feel like ASPS is better. Apparently it has a fast-growing subservicing business where it manages REO and perhaps non-performing loans for other companies.

      • I would have said Ocwen is “safer”, in that it has actual assets backing it. If it transfers too much servicing too fast, ASPS will dry out.

        Disclosure: I own a lot more ASPS than I own Ocwen (but I bought the former some time ago when it was still high, and the latter only when it became really cheap)

  3. Glenn – to your point #1, I see the presentation showing 21.5-20.1mm diluted shares out as the range of their two scenarios. There are only about 20.1mm actual shares outstanding today, and very little dilution at current stock prices. So I’m not sure I understand your point … the presentation implies basically no share buybacks – probably just the ones they had already done before the presentation – and reflects a range of possible dilution outcomes given where the stock might trade during the year. Am I missing something?

    • Page 10 in the presentation outlines the diluted share count assumptions. Clearly they assume different levels of buybacks between scenarios A and B.
      Prelim Q4 – 22.1M diluted shares
      2015 scenario A – 21.5M diluted
      2015 scenario B – 20.1M diluted

      • They were way off on their preliminary 4Q figure (actual was 20.3m), for reasons hard to understand since all the information was baked in.

        In any case, they knew that they ended the 4Q with 20.3m shares out and effectively no currently dilutive stock options. I’m pretty sure the difference between the two assumptions reflects different amounts of potential dilution. I think both scenarios assume no significant buybacks.

        If the stock stays where it is (leaving all the options anti-dilutive), full year diluted average share count will likely be around 20.1mm with no buybacks.

  4. Same thought as Abe, Glenn. I appreciate your in-depth analysis of Ocwen – my first and last foray into mortgage servicing! An ugly business that [I now know] doesn’t have the optics for me to understand risk clearly.

    A huge problem that Ocwen will have is that no one likes the business. A necessary evil. So you aren’t going to get a lot of empathy from regulators, the general public, or the media. Which does, I think, affect how the company will be treated. It reminds me of the payday loans business in terms of both optics and general perception. Fortunately I decided to avoid that area.

    Ocwen leadership is frustrating me not buying stock back at the $7-8 level. It wouldn’t have taken very much cash at all to retire a far amount of stock. Exploring strategic options. Not encouraging signs of competence.

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