Unfortunately for me, the drama never seems to end at the Erbey complex (OCN/ASPS/HLSS/RESI/AAMC). Ocwen’s regulatory problems has been cascading into other problems. I suppose the lesson here is that some companies sit on very unusual risks. When it rains it pours.
I believe Ocwen’s financing deal with HLSS exposes it to a very unusual risk. Ocwen had (more or less) sold excess servicing rights on its MSRs to HLSS. If Ocwen loses its MSRs, then it has to compensate HLSS for HLSS’ loss. The payment will be for the purchase price of the excess servicing rights adjusted for run-off at rates pre-determined in the contract between Ocwen and HLSS (8-K filing).
Here’s what the Ocwen 10-K says [emphasis mine]:
A significant portion of our non-Agency servicing portfolio servicing agreements contain provisions whereby we could be terminated as servicer without compensation upon the failure of the serviced loans to meet certain portfolio delinquency or cumulative loss thresholds or in the event we fail to maintain required servicer ratings, among other provisions. As a result of the economic downturn of recent years, the portfolio delinquency and/or cumulative loss threshold provisions have been breached by many private-label securitizations in our non-Agency servicing portfolio. Terminations as servicer as a result of a breach of any of these provisions have been minimal. In the event we were terminated as servicer and the Rights to MSRs were sold to HLSS, we would be obligated to compensate HLSS.
Ocwen is currently at risk of losing a portion of its MSR portfolio because its servicer ratings have fallen too low. Page 20 of the latest 10-Q shows how much Ocwen has had to pay so far in the 3 quarters ending September 2014:
In the event of a transfer of servicing to another party related to Rights to MSRs sold to HLSS, we are required to reimburse HLSS at predetermined contractual rates for the loss of servicing revenues. Settlements for Financing liability – MSRs pledged for the three and nine months ended September 30, 2014 includes $2.0 million of such reimbursements.
Note that these 3 quarters were before Ocwen’s current problems surfaced.
One way in which Ocwen might face a huge liability is if it loses a lot of MSRs due to mortgage investors firing Ocwen as the servicer. While mortgage investors are normally stuck with their servicer and cannot fire the servicer, they have an opportunity to fire the servicer if Ocwen breaches the minimum servicer rating requirements. A small portion of Ocwen’s MSR portfolio have such clauses.
- We are currently a servicer on approximately 4,000 private label securities (PLS) agreements.
- Of these, approximately 695 with about $44.8 billion of UPB have minimum Servicer Ratings criteria.
- While rating agencies have taken actions largely based on public information regarding issues with regulators, they have not pointed to actual servicing performance deficiencies. For example, the Fitch action of February 4th, 2015 starts by noting that “the company continues to perform servicing functions at a proficient level.” Objective data on PLS performance continues to show that Ocwen excels in managing loss mitigation timelines, bringing borrowers current on their payments and keeping them current. For these reasons, we believe it is in the best interests of all stakeholders to continue to keep Ocwen on the job.
- To date, including the recent announcement from Fitch, our servicer ratings have fallen below the minimum criteria set forth in 482 PLS agreements. This represents approximately $34.6 billion in UPB serviced by Ocwen, or 8.7% of our total servicing portfolio.
- We have not been notified by any RMBS trustee of any intent to move Non-Agency RMBS servicing as a result of changes in servicer ratings or any other reason.
Since the Feb 5 investor update, one trustee concluded voting on 3 mortgage pools. Ocwen was fired as the servicer for 2 of the 3. See Ocwen’s March 2 update.
If Ocwen loses more MSRs, my theory is that Ocwen may have to make substantial payments to HLSS.
HLSS can pull subservicing from Ocwen
Under the contract between HLSS and Ocwen (8-K filing), HLSS can direct the sale of the underlying MSRs to other parties if Ocwen breaches any number of clauses in their contract. This has happened because Ocwen’s servicer ratings are below a certain level. If the MSRs are sold, Ocwen will not receive any compensation for its loss of subservicing.
To recap how this works:
- The underlying MSR is essentially split into subservicing and excess servicing.
- Ocwen has the subservicing.
- HLSS has the excess servicing.
- HLSS can direct the sale of MSRs on which it owns excess servicing rights. If we cancel out the excess servicing, HLSS can basically sell off subservicing rights that it can acquire for free.
- I’m not sure but I believe that HLSS can cherry-pick the portfolio and selectively choose the MSRs with the most attractive subservicing.
- The buyer of the MSR will be buying a complete MSR.
The probability of Ocwen losing subservicing
On the conference call for the merger of HLSS and NRZ, NRZ’s CEO commented that they have no intention of transferring servicing away from Ocwen.
Altisource’s CEO stated on the Q4 2014 conference call that he would like to see NRZ’s intentions memorialized in writing:
And then just one last thing, can you just expand on your comments at the beginning of the call about memorializing in writing some of the commitments that were made on the NRZ-HLSS merger call?
Bill Shepro – Altisource CEO
Yes, sure. There’s not much more we want to say beyond what we said in the prepared remarks. But I think, look, NRZ and HLSS said all the right things, at least from Altisource’s perspective, in wanting to work with Ocwen, which obviously benefits Altisource. We would love to see that, those commitments made in writing, and we’ll leave it to HLSS and NRZ and Ocwen as to how they move forward.
If NRZ’s intentions are not memorialized in writing, then it will retain the option to essentially sell off Ocwen’s subservicing. If market conditions change, this option could theoretically become a viable way for HLSS/NRZ to make money at Ocwen’s expense.
In hindsight, Ocwen could have prevented its current situation
If Ocwen had given HLSS fewer protections, it would have fewer problems today.
To avoid MSR transfers, the Ocwen/HLSS contract currently requires Ocwen to maintain all 3 of the following ratings:
(e) Seller fails to maintain residential primary servicer ratings for subprime loans of at least “Average” by Standard & Poor’s Rating Services, a division of Standards & Poor’s Financial Services LLC (or its successor in interest), “SQ3” by Moody’s Investors Service, Inc. (or its successor in interest) and “RPS4+” and “RSS4+” by Fitch Ratings (or its successor in interest);
In comparison, this NRZ contract requires Nationstar to maintain just one rating:
(e) Seller fails to maintain residential primary servicer ratings for subprime loans of at least “Average” by Standard & Poor’s Rating Services, a division of Standards & Poor’s Financial Services LLC (or its successor in interest);
I believe Ocwen’s current ratings are average for S&P (pass), SQ3- for Moody’s (fail), and RPS4 for Fitch (fail). Mangrove’s letter to HLSS indicated that Ocwen had failed the latter two ratings thresholds and therefore HLSS should terminate its relationship with Ocwen.
The California DBO
The California DBO essentially threatened Ocwen with a death blow. If it were to pull Ocwen’s license, Ocwen would be forced to hold a fire-sale of virtually its entire MSR portfolio because most mortgage pools contain mortgages in California. I believe such a move would be quite harmful to borrowers because transferring a portfolio of that size would be extremely difficult (especially within a short timeframe). Nonetheless, the DBO is crazy/angry enough to threaten Ocwen with such a move. Not only that, its spokesman even suggested that they were more focused on suspending Ocwen’s license than on reaching a settlement:
“Ocwen’s behavior is egregious enough that we believe it warrants suspension of license”
“Like any enforcement action, settlement is always a possibility, but at this point we are focused on suspension,” he added. (Reuters)
The DBO seems very displeased that it did not receive the documentation it asked for from Ocwen. Its spokesman has made other comments such as:
“We can’t just sit around and let them do that to us,” Dresslar said today in a telephone interview. “So we ultimately, after giving them plenty of opportunity to provide us the information, decided that we would go after their license.” (Bloomberg)
Because Ocwen ran into many problems with its servicer ratings, I believe it has an incentive to push it problems into the future with its settlement with the DBO. This is why the settlement does not solve any of the underlying issues. Under the settlement, Ocwen agreed to not purchase any MSRs (with mortgages in California) until the DBO is satisfied with Ocwen’s compliance. Unlike the NY DFS settlement, there is no qualification to the injunction. The NY DFS’s approval is “not to be unreasonably withheld”. That language does not exist for the DBO settlement.
As well, Ocwen will have to pay for a monitor appointed by the DBO. It is likely that the monitor will uncover problems at Ocwen because all servicers make errors (and also because California’s mortgage laws are more difficult than other States’). In the future, Ocwen will likely be facing down an angry regulator with plenty of ammo.
*Disclosure: Long OCN and ASPS. The pain continues.