UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 1-13219
OCWEN FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Florida 65-0039856
- --------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
Of incorporation or organization) Identification No.)
1675 Palm Beach Lakes Boulevard, West Palm Beach, Florida 33401
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(Address of principal executive offices) (Zip Code)
(561) 682-8000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ].
Number of shares of Common Stock, $0.01 par value, outstanding as of
November 5, 2004: 62,735,478 shares.
OCWEN FINANCIAL CORPORATION
FORM 10-Q
INDEX
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Page
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PART I - FINANCIAL INFORMATION
Item 1. Interim Consolidated Financial Statements (Unaudited)............................. 3
Consolidated Statements of Financial Condition at September 30, 2004 and
December 31, 2003................................................................. 3
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2004 and 2003....................................................... 4
Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine
Months Ended September 30, 2004 and 2003.......................................... 5
Consolidated Statement of Changes in Stockholders' Equity for the Nine Months
Ended September 30, 2004.......................................................... 6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30,
2004 and 2003..................................................................... 7
Notes to Consolidated Financial Statements........................................ 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................ 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................ 50
Item 4. Controls and Procedures........................................................... 53
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................................. 54
Item 6. Exhibits and Reports on Form 8-K.................................................. 54
Signature................................................................................. 56
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS (Unaudited)
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
September 30, December 31,
2004 2003
------------- -------------
ASSETS
Cash and amounts due from depository institutions ........................... $ 189,446 $ 215,764
Interest earning deposits ................................................... 52,541 324
Trading securities, at fair value
Investment grade securities ............................................... 98,179 6,679
Subordinates and residuals ................................................ 40,310 42,841
Real estate ................................................................. 68,480 103,943
Affordable housing properties ............................................... 8,356 7,410
Loans, net .................................................................. 11,459 28,098
Match funded assets ......................................................... 108,328 130,087
Premises and equipment, net ................................................. 39,000 41,944
Advances on loans and loans serviced for others ............................. 345,945 374,769
Mortgage servicing rights ................................................... 135,319 166,495
Receivables ................................................................. 114,500 88,157
Other assets ................................................................ 73,623 33,607
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Total assets .............................................................. $ 1,285,486 $ 1,240,118
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits .................................................................. $ 412,117 $ 446,388
Escrow deposits ........................................................... 146,074 116,444
Bonds - match funded agreements ........................................... 97,712 115,394
Lines of credit and other secured borrowings .............................. 35,502 150,384
Debt securities ........................................................... 231,249 56,249
Accrued interest payable .................................................. 3,083 4,789
Accrued expenses, payables and other liabilities .......................... 31,529 31,926
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Total liabilities ....................................................... 957,266 921,574
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Minority interest in subsidiaries ......................................... 1,296 1,286
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY
Common stock, $.01 per value; 200,000,000 shares authorized; 62,719,552
and 67,467,220 shares issued and outstanding at September 30, 2004 and
December 31, 2003, respectively .......................................... 627 675
Additional paid-in capital ................................................ 181,071 225,559
Retained earnings ......................................................... 145,568 90,409
Accumulated other comprehensive income (loss), net of taxes ............... (342) 615
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Total stockholders' equity ................................................ 326,924 317,258
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Total liabilities and stockholders' equity .............................. $ 1,285,486 $ 1,240,118
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
3
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
Three Months Nine Months
--------------------------- ---------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ---------------------------------------------------------------------- ------------ ------------ ------------ ------------
REVENUE
Servicing and related fees ......................................... $ 34,587 $ 35,651 $ 115,310 $ 101,703
Vendor management fees ............................................. 13,614 7,722 40,442 21,721
Gain (loss) on trading and match funded securities, net ............ (171) 159 1,688 2,924
Valuation gains (losses) on real estate ............................ (165) (686) (3,990) (6,695)
Gain (loss) on sales of real estate ................................ 311 316 (149) 408
Operating income (losses) from real estate ......................... 444 1,269 1,017 3,461
Gain (loss) on debt repurchases .................................... -- (441) -- (445)
Other income ....................................................... 4,995 2,852 16,599 5,550
------------ ------------ ------------ ------------
Non-interest revenue ........................................... 53,615 46,842 170,917 128,627
------------ ------------ ------------ ------------
Interest income .................................................... 4,988 4,071 15,555 17,826
Interest expense ................................................... 7,141 10,823 22,040 29,554
------------ ------------ ------------ ------------
Net interest income (expense) before provision for loan losses.. (2,153) (6,752) (6,485) (11,728)
Provision for loan losses .......................................... (94) 415 (913) (2,670)
------------ ------------ ------------ ------------
Net interest income (expense) after provision for loan losses... (2,059) (7,167) (5,572) (9,058)
------------ ------------ ------------ ------------
Total revenue ............................................... 51,556 39,675 165,345 119,569
------------ ------------ ------------ ------------
NON-INTEREST EXPENSE
Compensation and employee benefits ................................. 21,300 17,667 64,229 52,505
Occupancy and equipment ............................................ 3,981 3,254 11,999 8,769
Technology and communication costs ................................. 6,190 5,583 19,476 14,577
Loan expenses ...................................................... 6,885 3,835 22,272 10,836
Loss (gain) on investments in affordable housing properties ........ (100) 4 (179) 319
Professional services and regulatory fees .......................... 3,187 2,510 16,328 21,854
Other operating expenses ........................................... 2,635 2,173 7,890 7,023
------------ ------------ ------------ ------------
Non-interest expense ........................................... 44,078 35,026 142,015 115,883
------------ ------------ ------------ ------------
Distributions on Capital Securities .................................. -- -- -- 3,058
------------ ------------ ------------ ------------
Income (loss) before minority interest and income taxes .............. 7,478 4,649 23,330 628
Minority interest in net income (loss) of subsidiaries ............... 18 28 (50) (308)
Income tax expense (benefit) ......................................... (31,845) 6 (31,779) 618
------------ ------------ ------------ ------------
Net income (loss) .................................................. $ 39,305 $ 4,615 $ 55,159 $ 318
============ ============ ============ ============
EARNINGS (LOSS) PER SHARE
Basic .............................................................. $ 0.61 $ 0.07 $ 0.83 $ 0.005
Diluted ............................................................ $ 0.60 $ 0.07 $ 0.81 $ 0.005
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic .............................................................. 64,637,454 66,865,412 66,853,296 67,148,447
Diluted ............................................................ 65,813,457 67,880,310 68,146,122 67,864,096
The accompanying notes are an integral part of these
consolidated financial statements.
4
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
Three Months Nine Months
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For the periods ended September 30, 2004 2003 2004 2003
- --------------------------------------------------------------------------- -------- -------- -------- --------
Net income (loss) ......................................................... $ 39,305 $ 4,615 $ 55,159 $ 318
Other comprehensive income (loss), net of taxes:
Change in unrealized foreign currency translation adjustment arising
during the period (1) .................................................... 43 (294) (957) 221
-------- -------- -------- --------
Comprehensive income (loss) ............................................... $ 39,348 $ 4,321 $ 54,202 $ 539
======== ======== ======== ========
(1) Net of tax benefit (expense) of $181 and $(149) for the three months
ended September 30, 2004 and 2003, respectively, and $769 and $(201) for
the nine months ended September 30, 2004 and 2003, respectively.
The accompanying notes are an integral part of these
consolidated financial statements.
5
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(Dollars in thousands)
Accumulated
Other
Common Stock Additional Comprehensive
---------------------- Paid-in Retained Income (loss),
Shares Amount Capital Earnings Net of Taxes Total
---------- ---------- ---------- --------- --------------- ---------
Balances at December 31, 2003 .................... 67,467,220 $ 675 $ 225,559 $ 90,409 $ 615 $ 317,258
Net income ....................................... -- -- -- 55,159 -- 55,159
Issuance of restricted common stock to
directors and employees ......................... 210,098 2 712 -- -- 714
Exercise of common stock options ................. 523,334 5 4,194 -- -- 4,199
Repurchase of common stock ....................... (5,481,100) (55) (49,394) -- -- (49,449)
Other comprehensive loss, net of taxes ........... -- -- -- -- (957) (957)
---------- ---------- ---------- --------- --------------- ---------
Balances at September 30, 2004 ................... 62,719,552 $ 627 $ 181,071 $ 145,568 $ (342) $ 326,924
========== ========== ========== ========= =============== =========
The accompanying notes are an integral part of these
consolidated financial statements.
6
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
For the nine months ended September 30, 2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .......................................................................... $ 55,159 $ 318
Adjustments to reconcile net income (loss) to net cash provided (used) by
operating activities
Net cash provided by trading activities ................................................ (87,084) 20,474
Premium amortization (discount accretion) on securities, net ........................... (1,608) 1,847
Amortization of servicing rights ....................................................... 71,173 68,677
Depreciation and other amortization .................................................... 10,354 10,069
Provision for loan losses .............................................................. (913) (2,670)
Valuation (gains) losses on real estate ................................................ 3,990 6,695
(Gain) loss on trading and match funded securities ..................................... (1,688) (2,924)
(Gain) loss on sale of real estate ..................................................... 149 (408)
(Gain) loss on repurchases of debt ..................................................... -- 445
(Increase) decrease in advances and match funded advances on loans
and loans serviced for other .......................................................... 28,457 (109,808)
(Increase) decrease in receivables and other assets, net ............................... (66,359) (326)
Increase (decrease) in accrued expense, interest payable and other liabilities, net .... (2,103) 2,910
Other, net ............................................................................. (1,891) 3,878
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Net cash provided (used) by operating activities ........................................... 7,636 (823)
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CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments received on match funded loans ...................................... 7,559 10,991
Acquisitions of match funded loans ..................................................... (7,119) --
Proceeds from sale of match funded loans ............................................... 21,592 --
Proceeds from sale of affordable housing properties .................................... 327 2,245
Proceeds from sale of loans ............................................................ -- 30,347
Purchase of mortgage servicing rights .................................................. (39,997) (78,971)
Principal payments received on loans ................................................... 29,661 28,166
Purchases, originations and funded commitments of loans, net ........................... (16,007) (6,225)
Capital improvements to real estate .................................................... (2,536) (5,357)
Proceeds from sale of real estate ...................................................... 18,910 10,024
Additions to premises and equipment .................................................... (6,166) (9,195)
Acquisition of subsidiary .............................................................. 1,376 --
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Net cash provided (used) by investing activities ........................................... 7,600 (17,975)
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CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in deposits and escrow deposits .................................... (4,641) 48,961
Proceeds from (repayment of) lines of credit and other secured borrowings, net ......... (94,882) 94,000
Proceeds from (repayment of) bonds - match funded agreements, net ...................... (17,682) (33,286)
Issuance of notes ...................................................................... 175,000 --
Repurchase and repayment of notes and subordinated debentures .......................... -- (33,945)
Exercise of common stock options ....................................................... 2,317 15
Repurchase of common stock ............................................................. (49,449) (2,262)
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Net cash provided (used) by financing activities ........................................... 10,663 73,483
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Net increase (decrease) in cash and cash equivalents ....................................... 25,899 54,685
Cash and cash equivalents at beginning of period ........................................... 216,088 192,247
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Cash and cash equivalents at end of period ................................................. $ 241,987 $ 246,932
============== ==============
The accompanying notes are an integral part of these
consolidated financial statements.
7
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
For the nine months ended September 30, 2004 2003
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CASH AND CASH EQUIVALENTS AT END OF PERIOD
Cash and amounts due from depository institutions .......................... $ 189,446 $ 118,820
Interest-earning deposits .................................................. 52,541 28,112
Federal funds sold and repurchase agreements ............................... -- 100,000
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$ 241,987 $ 246,932
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for
Interest ................................................................... $ 23,746 $ 30,164
============== ==============
Income tax refunds (payments) .............................................. $ 1 $ (688)
============== ==============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Assumption of line of credit by purchaser of real estate ................... $ 20,000 $ --
============== ==============
ACQUISITION OF BUSINESSES
Estimated fair value of assets acquired (1) ................................ $ (20,986) $ --
Estimated fair value of liabilities assumed ................................ 10,743 --
-------------- --------------
Cash paid .................................................................. (10,243) --
Less cash acquired ......................................................... 11,619 --
-------------- --------------
Net cash acquired (paid) for assets ........................................ $ 1,376 $ --
============== ==============
(1) Including goodwill of approximately $6,100 resulting from the
acquisition. See Note 9.
The accompanying notes are an integral part of these
consolidated financial statements.
8
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
(Dollars in thousands)
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NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by U.S.
generally accepted accounting principles ("GAAP") for complete financial
statements. Ocwen Financial Corporation's ("OCN") interim consolidated financial
statements include the accounts of OCN and its subsidiaries. OCN owns directly
and indirectly all of the outstanding common and preferred stock of its primary
subsidiaries, Ocwen Federal Bank FSB (the "Bank"), Investors Mortgage Insurance
Holding Company, Ocwen Technology Xchange, Inc. ("OTX"), Ocwen Asset Investment
Corp. ("OAC") and Ocwen Financial Solutions, Private Limited ("India"). OCN also
owns 70% of Global Servicing Solutions, LLC ("GSS") with the remaining 30%
minority interest held by ML IBK Positions, Inc. ("Merrill Lynch"). We have
eliminated all significant intercompany transactions and balances in
consolidation.
In our opinion, the accompanying unaudited financial statements contain
all adjustments, consisting only of normal recurring accruals, necessary for a
fair statement of our financial condition at September 30, 2004 and December 31,
2003, the results of our operations for the three and nine months ended
September 30, 2004 and 2003, our comprehensive income (loss) for the three and
nine months ended September 30, 2004 and 2003, our changes in stockholders'
equity for the nine months ended September 30, 2004 and our cash flows for the
nine months ended September 30, 2004 and 2003. The results of operations and
other data for the three and nine months ended September 30, 2004 are not
necessarily indicative of the results that may be expected for any other interim
periods or the entire year ending December 31, 2004. The unaudited consolidated
financial statements presented herein should be read in conjunction with the
audited consolidated financial statements and related notes thereto included in
our Annual Report on Form 10-K for the year ended December 31, 2003. Certain
reclassifications have been made to the prior periods' interim consolidated
financial statements to conform to the September 30, 2004 presentation.
In preparing the consolidated financial statements, we are required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the dates of the statements of financial condition and revenues
and expenses for the periods covered. Material estimates that are particularly
significant in the near or medium term relate to our determination of allowances
for loans, servicing advances, and receivables, as well as our valuation of
securities, real estate, affordable housing properties, servicing rights,
intangibles and deferred tax assets. Actual results could differ from those
estimates and assumptions.
NOTE 2 CURRENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). This interpretation
provides guidance with respect to the identification of variable interest
entities and when assets, liabilities, noncontrolling interests and the results
of operations of a variable interest entity need to be included in a company's
consolidated financial statements. The Interpretation requires consolidation by
business enterprises of variable interest entities in certain cases. The factors
to be considered in making this determination include the adequacy of the equity
of the entity and the nature of the risks, rights and rewards of the equity
investors in the entity. The Interpretation applied immediately to variable
interest entities created after January 31, 2003 and to variable interest
entities in which an enterprise obtains an interest after that date. Due to
significant implementation concerns, the FASB modified the wording of FIN 46 and
issued FIN 46R in December of 2003. FIN 46R deferred the effective date for the
provisions of FIN 46 to entities other than Special Purpose Entities ("SPEs")
until financial statements are issued for periods ending after March 15, 2004.
SPEs are subject to the provisions of either FIN 46 or FIN 46R as of December
15, 2003. This Interpretation does not have a material impact on our financial
statements.
On September 30, 2004, the Emerging Issues Task Force ("EITF") approved
Issue 04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings per
Share." EITF Issue 04-8 provides guidance as to when the dilutive effect of
contingently convertible debt should be included in diluted earnings per share.
The EITF reached the conclusion that the potential shares of stock associated
with contingently convertible debt should be included in diluted earnings per
share computations (if dilutive) regardless of whether the market price trigger
(or other contingent feature) has been met. EITF Issue 04-8 is effective for all
periods ending after December 15, 2004 and is to be applied by restating
previously reported diluted earnings per share.
EITF Issue 04-8 will have an impact on our diluted earnings per share
computations because of the $175,000 of 3.25% Contingent Convertible Senior
Unsecured Notes we issued on July 28, 2004 (see Note 3 below). Beginning with
our 2004 annual financial statements, we will include the potential shares of
stock associated with our contingently convertible debt in diluted earnings per
share computations (if dilutive) using the if-converted method regardless of
whether any of the contingent features have been met. For the three and nine
months ended September 30, 2004, we have excluded the potential shares of stock
associated with our contingently convertible debt from diluted earnings per
share computations in accordance with accounting guidance currently in effect.
Had we included the potential shares of stock associated with our contingently
convertible debt, diluted earnings per share for the three and nine months ended
September 30, 2004 would have been $0.53 and $0.79, respectively, a decrease of
$0.07 and $0.02, respectively, from reported diluted earnings per share.
9
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
NOTE 3 DEBT SECURITIES
Convertible Notes. On July 28, 2004, OCN issued $175,000 aggregate
principal amount of 3.25% Contingent Convertible Senior Unsecured Notes due 2024
("Convertible Notes") in a private placement under the Securities Act of 1933,
as amended. The Convertible Notes are senior unsecured obligations of Ocwen
Financial Corporation and bear interest at the rate of 3.25% per year. Interest
is payable on February 1 and August 1 of each year, beginning on February 1,
2005. The Convertible Notes will mature on August 1, 2024.
Holders may convert all or a portion of their notes into shares of our
common stock under the following circumstances: (1) at any time during any
calendar quarter commencing after September 30, 2004, if the closing sale price
of our common stock for at least 20 trading days in a period of 30 consecutive
trading days ending on the last trading day of the calendar quarter prior to
such quarter is greater than 125% of the conversion price per share of common
stock on such last day; (2) subject to certain exceptions, during the five
business day period after any five-consecutive-trading-day period in which the
trading price per $1 principal amount of the notes for each day of the
five-consecutive-trading-day period was less than 98% of the product of the
closing sale price of our common stock and the number of shares issuable upon
conversion of $1 principal amount of the notes; (3) if the notes have been
called for redemption; (4) upon the occurrence of specified corporate
transactions; or (5) if we elect at our sole discretion to permit conversion
following the implementation of EITF Issue 04-8.
The conversion rate will be 82.1693 shares of our common stock per $1
principal amount of the notes, subject to adjustment. Events that may cause the
conversion rate to be adjusted, as more fully described in the related indenture
agreement, primarily relate to cash dividends or other distributions to holders
of our common stock. Upon conversion, we may at our option choose to deliver, in
lieu of our common stock, cash or a combination of cash and common stock as
described herein.
Beginning August 1, 2009, we may redeem all or a portion of the notes
for cash for a price equal to 100% of the principal amount of the notes to be
redeemed plus accrued and unpaid interest, if any.
Holders may require us to repurchase all or a portion of their notes for
cash on August 1, 2009, August 1, 2014, and August 1, 2019 or upon the
occurrence of a "fundamental change" at a repurchase price equal to 100% of the
principal amount of the notes to be repurchased plus accrued and unpaid
interest, if any. A "fundamental change", as further defined in the indenture
agreement, is deemed to have occurred upon a change of control or a termination
of trading in our common stock.
In connection with our issuance of the Convertible Notes, we incurred
certain costs that we capitalized and are amortizing over the period from the
date of issuance to August 1, 2009, the first date at which holders may require
us to repurchase their notes. The unamortized balance of these issuance costs
amounted to approximately $5,800 at September 30, 2004.
In privately negotiated transactions concurrent with the private
placement of the Convertible Notes, we used 25% of the gross proceeds from the
sale of the Convertible Notes to repurchase 4,850,000 shares of our common stock
at a price of $9.02 per share. We used the remaining proceeds, net of
underwriting discount and other expenses, primarily to repay maturing deposits
and other liabilities, to increase our cash and to invest in short-term
AAA-rated securities.
Capital Securities. In August 1997, Ocwen Capital Trust ("OCT") issued
$125,000 of 10.875% Capital Securities (the "Capital Securities"). OCT invested
the proceeds from issuance of the Capital Securities in 10.875% Junior
Subordinated Debentures issued by OCN. The Junior Subordinated Debentures, which
represent the sole assets of OCT, will mature on August 1, 2027. Prior to our
adoption of SFAS No. 150 on July 1, 2003, we presented the Capital Securities in
a separate caption between liabilities and stockholders' equity in our
consolidated statement of financial condition as "Company-obligated, mandatorily
redeemable securities of subsidiary trust holding solely Junior Subordinated
Debentures of the Company", and distributions on the Capital Securities were
reported in a separate caption immediately following non-interest expense in our
consolidated statement of operations. Effective with our adoption of SFAS No.
150, the Capital Securities are presented as a liability in the consolidated
statement of financial condition as a component of notes. At the same time, we
began reporting distributions of the Capital Securities as a component of
interest expense in the consolidated statement of operations.
10
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
Holders of the Capital securities are entitled to receive cumulative
cash distributions accruing from the date of original issuance and payable
semiannually in arrears on February 1 and August 1 of each year, commencing on
February 1, 1998, at an annual rate of 10.875% of the liquidation amount of $1
per Capital Security. OCN guarantees payment of distributions out of moneys held
by OCT, and payments on liquidation of OCT or the redemption of Capital
Securities, to the extent OCT has funds available. If Ocwen Financial
Corporation does not make principal or interest payments on the Junior
Subordinated Debentures, OCT will not have sufficient funds to make
distributions on the Capital Securities, in which event the guarantee shall not
apply to such distributions until OCT has sufficient funds available therefore.
Distributions on Capital Securities amounted to $1,529 in the third quarter of
both 2004 and 2003 ($4,587 for the year to date periods). Accumulated
distributions payable on the Capital Securities amounted to $1,020 and $2,549 at
September 30, 2004 and December 31, 2003, respectively, and are included in
accrued interest payable.
We have the right to defer payment of interest on the Junior
Subordinated Debentures at any time or from time to time for a period not
exceeding 10 consecutive semiannual periods with respect to each deferral
period, provided that no extension period may extend beyond the stated maturity
of the Junior Subordinated Debentures. Upon the termination of any such
extension period and the payment of all amounts then due on any interest payment
date, we may elect to begin a new extension period. Accordingly, there could be
multiple extension periods of varying lengths throughout the term of the Junior
Subordinated Debentures. If we defer interest payments on the Junior
Subordinated Debentures, distributions on the Capital Securities will also be
deferred, and we may not, nor may any of our subsidiaries, (i) declare or pay
and dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, their capital stock of (ii) make any
payment of principal, interest or premium, if any, on or repay, repurchase or
redeem any debt securities that rank pari passu with or junior to the Junior
Subordinated Debentures. During an extension period, interest on the Junior
Subordinated Debentures will continue to accrue at the rate of 10.875% per
annum, compounded semiannually.
We may redeem the Junior Subordinated Debentures before maturity at our
option, subject to the receipt of any necessary prior regulatory approval, (i)
in whole or in part on or after August 1, 2007, at a redemption price equal to
105.438% of the principal amount or (ii) at any time, in whole (but not in
part), upon the occurrence and continuation of a special event (defined as a tax
event, regulatory capital event or an investment company event) at a redemption
price equal to the greater of (a) 100% of the principal amount thereof or (b)
the sum of the present values of the principal amount and premium payable with
respect to an optional redemption of such Junior Subordinated Debentures on
August 1, 2007, together with scheduled payments of interest from the prepayment
date to August 1, 2007, discounted to the prepayment date on a semiannual basis
at the adjusted Treasury rate plus accrued interest thereon to the date of
prepayment. The Capital Securities are subject to mandatory redemption, in whole
or in part, upon repayment of the Junior Subordinated Debentures at maturity or
their earlier redemption, in an amount equal to the amount of the related Junior
Subordinated Debentures maturing or being redeemed and at a redemption price
equal to the redemption price of the Junior Subordinated Debentures, plus
accumulated and unpaid distributions thereon to the date of redemption.
For financial reporting purposes, we treat OCT as a subsidiary and,
accordingly, the accounts of OCT are included in our consolidated financial
statements. We eliminate intercompany balances and transactions with OCT,
including the balance of Junior Subordinated Debentures outstanding, in our
consolidated financial statements.
11
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
NOTE 4 FOREIGN CURRENCY EXCHANGE RATE RISK MANAGEMENT
We have entered into foreign currency derivatives to hedge our
investments in foreign subsidiaries that own residual interests backed by
residential loans originated in the UK ("UK residuals") and a shopping center
located in Halifax, Nova Scotia (the "Nova Scotia Shopping Center"). It is our
policy to periodically adjust the amount of foreign currency derivative
contracts we have entered into in response to changes in our investments in
these assets. Currency futures are commitments to either purchase or sell
foreign currency at a future date for a specified price. We have determined that
the local currency of our investment in UK residuals and the Nova Scotia
Shopping Center is the functional currency. Our foreign currency derivative
financial instruments were designated as hedges. Accordingly, we include the
gains or losses in the net unrealized foreign currency translation in
accumulated other comprehensive income in stockholders' equity. The following
table sets forth the terms and values of these foreign currency financial
instruments at September 30, 2004 and December 31, 2003:
Position Maturity Notional Amount Strike Rate Fair Value
----------- ------------- --------------------- ----------- -----------
September 30, 2004
- --------------------------------------------
Canadian Dollar currency futures ............ Short December 2004 C$ 13,000 0.7713 $ (269)
British Pound currency futures .............. Short December 2004 (POUND) 17,500 1.7690 (583)
-----------
$ (852)
===========
December 31, 2003
- --------------------------------------------
Canadian Dollar currency futures ............ Short June 2004 C$ 10,000 0.7660 $ (34)
British Pound currency futures .............. Short June 2004 (POUND) 16,500 1.7292 (737)
-----------
$ (771)
===========
Because foreign currency futures contracts are exchange traded, holders
of these instruments look to the exchange for performance under these contracts
and not the entity holding the offsetting futures contract, thereby minimizing
the risk of nonperformance under these contracts. The notional principal amount
does not represent our exposure to credit loss.
NOTE 5 REGULATORY REQUIREMENTS
The Bank, as a federal savings bank organized under the Home Owners'
Loan Act, and OCN, as a registered savings and loan holding company under the
Act, are subject to extensive federal and state regulation under the Act and
other federal and state laws. Our primary regulatory authority is the U.S.
Office of Thrift Supervision ("OTS"). As such, the OTS periodically conducts an
examination of the Bank and its business practices.
On April 19, 2004, the Bank and the OTS entered into a Supervisory
Agreement (the "Agreement"). The Agreement memorializes various loan servicing
and customer service practices, some of which the Bank had previously adopted
and some of which it has implemented on a going-forward basis. Under the
Agreement, the Bank will continue to maintain and further develop its Office of
Consumer Ombudsman, an initiative implemented effective January 1, 2004. The
Agreement acknowledges that the Bank no longer assesses delinquent borrower
attorneys' fees for issuing notices of default. Beginning with the effective
date of the Agreement, the Bank will no longer charge delinquent borrowers a fee
for providing forbearance plans in lieu of foreclosures. The Agreement also
establishes the procedures to be followed to determine whether appropriate
hazard insurance is in place before placing insurance on behalf of the borrower.
Those procedures include some already implemented by the Bank, as well as new
requirements, including that the second notice shall be sent to borrowers by
certified mail. The Bank will not place the borrower's loan in default, assess
fees or initiate foreclosure proceedings solely due to the borrower's nonpayment
of insurance premiums. The Agreement also provides that the Bank agrees "to
utilize best efforts" to provide borrowers or their agents pay-off quotes within
five business days and sets forth new guidelines regarding documentation of
charges on such pay-off quotes.
The Bank also is required to meet a number of deadlines and submit
reports relating to its implementation of the Agreement. While we do not expect
that compliance with the Agreement will have a material adverse impact on our
financial condition, results of operations or cash flows, we do not know whether
the OTS or other regulatory agencies will seek to implement additional measures
relating to the Bank's servicing practices, including with respect to the
matters that are the subject of the Agreement. Accordingly, there can be no
assurance that any such measures, if implemented, would not have a material
adverse effect on our financial condition, results of operations or cash flows.
12
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
and the regulations promulgated thereunder established certain minimum levels of
regulatory capital for savings institutions subject to regulation by the OTS. As
a federally chartered savings bank regulated by the OTS, the bank must follow
specific capital guidelines stipulated by the OTS. These guidelines involve
quantitative measures of the Bank's assets, liabilities and certain off-balance
sheet items. An institution that fails to comply with its regulatory capital
requirements must obtain OTS approval of a capital plan and can be subject to a
capital directive and certain restrictions on its operations.
At September 30, 2004, the Bank was "well capitalized" under the prompt
corrective action regulations adopted by the OTS pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991. To be categorized as "well
capitalized", the Bank must maintain minimum core capital, Tier 1 risk-based
capital and risk-based capital ratios as set forth in the following table. The
Bank's capital amounts and classification are subject to review by federal
regulators regarding components, risk-weightings and other factors. There are no
conditions or events since September 30, 2004 that we believe have changed the
Bank's category.
Since 1997, the Bank has committed to the OTS to maintain a core capital
(leverage) ratio and a total risk-based capital ratio of at least 9.00% and
13.00%, respectively. The Bank continues to be in compliance with this
commitment as well as with the regulatory capital requirements of general
applicability (as indicated in the table below). In addition during 2002, we
committed to maintain our investment in mortgage servicing rights at
approximately 50% of stockholders' equity on a consolidated basis and 60% of
core capital (before any deduction thereto for mortgage servicing rights) at the
Bank. On a consolidated basis, our investment in mortgage servicing rights is
below the committed level and represented 41% of stockholder's equity at
September 30, 2004. At the Bank, mortgage servicing rights are also below the
committed level, amounting to 46% of core capital at September 30, 2004.
13
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
The following table summarized the Bank's actual and required regulatory
capital at September 30, 2004:
To be Well Capitalized Committed
Minimum for Capital for Prompt Corrective Capital
Actual Adequacy Purposes Action Provisions Requirements
------------------- ------------------- ---------------------- ------------
Ratio Amount Ratio Amount Ratio Amount Ratio
------ ---------- ------ ---------- --------- ---------- ------------
Shareholders' equity, and ratio to total
assets .......................................... 21.97% $ 200,987
Disallowed mortgage servicing rights ............. (8,117)
Disallowed deferred tax assets ................... (21,639)
Non-includable subsidiary ........................ (807)
Intangible assets (1) ............................ (2,866)
----------
Tier 1 (core) capital and ratio to
adjusted total assets .......................... 19.01% 167,558 4.00% $ 35,258 5.00% $ 44,072 9.00%
Non-mortgage servicing rights .................... (1,217)
----------
Tangible capital and ratio to tangible assets..... 18.90% $ 166,341 1.50% $ 13,203
==========
Tier 1 capital and ratio to risk-weighted
assets........................................... 25.44% $ 167,558 6.00% $ 39,524
Tier 2 capital - Allowance for loan losses ....... 4,653
Real estate required to be deducted (2) .......... (44,169)
----------
Total risk-based capital and ratio to
risk-weighted assets ............................ 19.44% $ 128,042 8.00% $ 52,698 10.00% $ 65,873 13.00%
==========
Total regulatory assets .......................... $ 914,889
==========
Adjusted total assets ............................ $ 881,444
==========
Tangible assets .................................. $ 880,227
==========
Risk-weighted assets ............................. $ 658,728
==========
(1) Unamortized balance of computer software.
(2) Retail shopping mall, which we originally acquired in satisfaction of a
debt and have held in excess of five years. This property was
subsequently sold in a transaction which closed in November 2004.
14
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
NOTE 6 NET INTEREST INCOME (EXPENSE) BEFORE PROVISION FOR LOAN LOSSES
Three Months Nine Months
-------------------- --------------------
For the periods ended September 30, 2004 2003 2004 2003
- --------------------------------------------------------------------------- -------- -------- -------- --------
Interest income:
- ----------------
Interest earning cash and other ....................................... $ 371 $ 79 $ 709 $ 224
Federal funds sold and repurchase agreements .......................... 677 341 1,420 1,078
Trading securities .................................................... 3,447 2,748 11,000 12,372
Loans ................................................................. 221 213 1,391 1,321
Match funded loans and securities ..................................... 272 690 1,035 2,831
-------- -------- -------- --------
4,988 4,071 15,555 17,826
-------- -------- -------- --------
Interest expense:
- -----------------
Deposits .............................................................. 3,124 4,009 10,839 13,408
Securities sold under agreements to repurchase ........................ -- -- -- 3
Bonds - match funded agreements ....................................... 1,143 1,075 3,239 3,640
Lines of credit and other secured borrowings .......................... 148 1,927 2,178 4,103
Notes and debentures .................................................. 2,726 3,812 5,784 8,400
-------- -------- -------- --------
7,141 10,823 22,040 29,554
-------- -------- -------- --------
Net interest income (expense) before provision for loan losses ........ $ (2,153) $ (6,752) $ (6,485) $(11,728)
======== ======== ======== ========
NOTE 7 INCOME TAX EXPENSE (BENEFIT)
The following table provides details of our income tax expense (benefit)
for the periods indicated:
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- --------------------------------------------------------------------------- --------- --------- --------- ---------
Income tax expense (benefit) on income (loss) before taxes ................ $ 3,074 $ 1,035 $ 7,350 $ (957)
Provision for valuation allowance on current year's deferred tax asset .... 2,066 (1,029) (2,144) 1,575
--------- --------- --------- ---------
5,140 6 5,206 618
Partial reversal of valuation allowance on prior year's deferred
tax asset ................................................................ (36,985) -- (36,985) --
--------- --------- --------- ---------
Total income tax expense (benefit) ........................................ $ (31,845) $ 6 $ (31,779) $ 618
========= ========= ========= =========
The $36,985 reduction in the valuation allowance on the prior year's
deferred tax asset is a result of refund claims filed with the IRS that reduced
our gross deferred tax asset and increased our income tax receivable balance by
the same amount. These refund claims, which were affirmed in writing by the IRS
agent during the third quarter of 2004, arose because of changes in the tax law
that allowed us to carry back net operating losses from 2001 and 2002 to taxes
paid in earlier years. Reversal of all or a portion of the remaining valuation
allowance, which amounted to $162,314 at September 30, 2004, may occur in the
future based on the results of our operations. The provision for deferred tax
asset valuation allowance is a non-cash charge that we recorded to increase the
aggregate valuation allowance. We estimated this valuation allowance based on
our assessment of the portion of the deferred tax asset that will more likely
than not be realized.
Excluding foreign taxes, non-economic tax residual payments and the
valuation allowance reduction, our federal effective tax rate was 20% and (162)%
for the year to date periods of 2004 and 2003, respectively, and reflected tax
credits of $3,507 and $1,795, respectively. Although we have substantial unused
tax credits available to reduce the liability arising from income taxes on our
current year income, tax credits can be used to reduce income tax expense only
to the corporate alternative minimum tax rate of 20% of taxable income.
15
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
NOTE 8 BUSINESS SEGMENT REPORTING
An operating segment is defined as a component of an enterprise (a) that
engages in business activities from which it may earn revenues and incur
expenses, (b) whose operating results are regularly reviewed by the enterprise's
chief operating decision maker to make decisions about resources to be allocated
to the segment and assess its performance, and (c) for which discrete financial
information is available. A brief description of our segments follows.
Core Businesses
. Residential Loan Servicing. Through this business, we provide
for a fee, loan servicing, including asset management and
resolution services, to third party owners of subprime
residential mortgage and "high loan-to-value loans". We acquire
the rights to service loans by purchasing them outright or by
entering into sub-servicing contracts.
. OTX. Through this segment we provide technology solutions for
the mortgage and real estate industries. OTX products include a
residential loan servicing system (REALServicing(TM)), a
commercial loan servicing system (REALSynergy(TM)) and an
internet-based mortgage loan processing application and vendor
management system (REALTrans(TM)).
. Ocwen Realty Advisors (ORA). Through ORA we provide residential
property valuation services to external customers in the
wholesale lending community as well as for our own residential
real estate transactions.
. Ocwen Recovery Group (formerly Unsecured Collections). This
business conducts collection activities for third party owners
of unsecured receivables and for a portfolio of unsecured credit
card receivables that we acquired at a discount in 1999 and
2000.
. Business Process Outsourcing. This business segment began
operation in December 2002. Business Process Outsourcing
provides outsourcing services, including data processing, call
center maintenance, mortgage research and others, to third
parties and leverages the operational capacity of our facilities
in India.
. Commercial Servicing. This segment now includes the results of
both our domestic and international servicing of commercial
assets, including commercial real estate loans, corporate loans
and unsecured loans. Previously, domestic commercial servicing
was included as a component of the Commercial Finance Segment,
and the results of our international operations were reported as
a separate segment. International servicing is conducted through
GSS, our joint servicing venture with Merrill Lynch.
Non-Core Businesses
. Commercial Assets. This segment comprised operations to acquire
sub-performing commercial loans at a discount, as well as
operations to invest in and reposition under-performing real
estate assets. No assets have been acquired since 2000. Since
then, this business has consisted of the management,
repositioning and resolution of the remaining loan and real
estate assets.
. Affordable Housing. Includes our investments, primarily through
limited partnerships, in qualified low-income rental housing for
the purpose of obtaining Federal income tax credits pursuant to
Section 42 of the Internal Revenue Code of 1986, as amended.
Except to complete those projects in which an investment had
already been made, we ceased making investments in properties in
2000.
. Subprime Finance. In August 1999, we closed our domestic
subprime origination business. Previously, activities of this
segment included our acquisition and origination of
single-family residential loans to non-conforming borrowers. We
have continued to manage and resolve the remaining non-core
assets, which consist primarily of unrated single-family
subprime residual securities.
Corporate Items and Other
This segment includes business activities that are individually
insignificant, interest income on cash and cash equivalents,
interest expense on corporate assets, gains and losses from debt
repurchases and general corporate expenses.
We allocate interest income and expense to each business segment for the
investment of funds raised or funding of investments made. We also make
allocations of non-interest expense generated by corporate support services to
each business segment.
16
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
Financial information for our segments is as follows for the dates
indicated:
Total Assets
----------------------------
September 30, December 31,
2004 2003
------------- ------------
Core businesses:
Residential Loan Servicing .................. $ 641,186 $ 672,779
OTX ......................................... 5,636 5,290
Ocwen Realty Advisors ....................... 3,540 1,056
Ocwen Recovery Group ........................ 425 323
Business Process Outsourcing ................ 2,161 1,010
Commercial Servicing ........................ 9,232 5,241
------------- ------------
662,180 685,699
------------- ------------
Non-core businesses:
Commercial Assets ........................... 81,219 133,015
Affordable Housing .......................... 37,382 48,974
Subprime Finance ............................ 35,927 39,162
------------- ------------
154,528 221,151
------------- ------------
Corporate Items and Other ..................... 468,778 333,268
------------- ------------
$ 1,285,486 $ 1,240,118
============= ============
The following table summarizes our remaining investment in non-core
assets, which are included in the total asset amounts presented above:
Non-Core Assets
----------------------------
September 30, December 31,
2004 2003
------------- ------------
Non-core businesses:
Commercial Assets ........................... $ 78,627 $ 126,401
Affordable Housing .......................... 12,020 13,955
Subprime Finance ............................ 35,909 38,973
Corporate Items and Other ................... 2,049 2,963
------------- ------------
$ 128,605 $ 182,292
============= ============
17
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
Net Interest Provision Pre-Tax
Non-Interest Income for Loan Non-Interest Income
Revenue (Expense) Loses Expense (Loss) (1)
------------ ------------ ------------ ------------ ------------
For the three months ended September 30, 2004
- ---------------------------------------------
Core businesses:
Residential Loan Servicing ................ $ 29,438 $ (4,238) $ -- $ 21,820 $ 3,380
OTX ....................................... 2,959 -- -- 5,092 (2,133)
Ocwen Realty Advisors ..................... 7,042 (21) -- 5,542 1,478
Ocwen Recovery Group ...................... 3,299 -- -- 2,591 708
Business Process Outsourcing .............. 2,551 (6) -- 1,858 687
Commercial Servicing ...................... 3,334 (4) -- 3,267 63
------------ ------------ ------------ ------------ ------------
48,623 (4,269) -- 40,170 4,183
------------ ------------ ------------ ------------ ------------
Non-core businesses:
Commercial Assets ......................... (259) (378) -- 1,208 (1,845)
Affordable Housing ........................ -- (356) 1 531 (888)
Subprime Finance .......................... (241) 2,818 -- 462 2,116
------------ ------------ ------------ ------------ ------------
(500) 2,084 1 2,201 (617)
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... 5,492 32 (95) 1,707 3,912
------------ ------------ ------------ ------------ ------------
$ 53,615 $ (2,153) $ (94) $ 44,078 $ 7,478
============ ============ ============ ============ ============
For the three months ended September 30, 2003
- ---------------------------------------------
Core businesses:
Residential Loan Servicing ................ $ 30,292 $ (5,300) $ -- $ 16,832 $ 8,159
OTX ....................................... 2,891 -- -- 5,244 (2,353)
Ocwen Realty Advisors ..................... 4,687 (5) -- 3,526 1,156
Ocwen Recovery Group ...................... 2,952 -- -- 1,812 1,140
Business Process Outsourcing .............. 1,877 (2) -- 872 1,004
Commercial Servicing ...................... 1,477 (17) -- 2,571 (1,111)
------------ ------------ ------------ ------------ ------------
44,176 (5,324) -- 30,857 7,995
------------ ------------ ------------ ------------ ------------
Non-core businesses:
Commercial Assets ......................... 1,165 (1,853) 393 943 (2,025)
Affordable Housing ........................ 1,385 (630) 1 757 (3)
Subprime Finance .......................... 107 2,007 -- 395 1,720
------------ ------------ ------------ ------------ ------------
2,657 (476) 394 2,095 (308)
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... 9 (952) 21 2,074 (3,038)
------------ ------------ ------------ ------------ ------------
$ 46,842 $ (6,752) $ 415 $ 35,026 $ 4,649
============ ============ ============ ============ ============
(1) Income (loss) before minority interest and income taxes.
18
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
Net Interest Provision Pre-Tax
Non-Interest Income for Loan Non-Interest Income
Revenue (Expense) Loses Expense (Loss) (1)
------------ ------------ ------------ ------------ ------------
For the three months ended September 30, 2004
- ---------------------------------------------
Core businesses:
Residential Loan Servicing ................ $ 98,278 $ (14,777) $ -- $ 69,738 $ 13,763
OTX ....................................... 12,846 -- -- 15,216 (2,370)
Ocwen Realty Advisors ..................... 23,638 (46) -- 18,580 5,013
Ocwen Recovery Group ...................... 9,958 -- -- 6,959 2,998
Business Process Outsourcing .............. 6,899 (14) -- 5,094 1,791
Commercial Servicing ...................... 10,302 (6) -- 10,236 60
------------ ------------ ------------ ------------ ------------
161,921 (14,843) -- 125,823 21,255
------------ ------------ ------------ ------------ ------------
Non-core businesses:
Commercial Assets ......................... (2,302) (159) (764) 3,198 (4,895)
Affordable Housing ........................ 17 (1,238) (28) 1,853 (3,047)
Subprime Finance .......................... 1,043 8,809 -- 1,610 8,243
------------ ------------ ------------ ------------ ------------
(1,242) 7,412 (792) 6,661 301
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... 10,238 946 (121) 9,531 1,774
------------ ------------ ------------ ------------ ------------
$ 170,917 $ (6,485) $ (913) $ 142,015 $ 23,330
============ ============ ============ ============ ============
For the nine months ended September 30, 2003
- --------------------------------------------
Core businesses:
Residential Loan Servicing ................ $ 89,685 $ (15,125) $ -- $ 48,752 $ 25,808
OTX ....................................... 7,898 -- -- 16,224 (8,327)
Ocwen Realty Advisors ..................... 13,414 (14) -- 9,634 3,766
Ocwen Recovery Group ...................... 8,457 -- -- 5,035 3,422
Business Process Outsourcing .............. 2,629 (2) -- 1,620 1,007
Commercial Servicing ...................... 4,412 (50) -- 7,638 (3,276)
------------ ------------ ------------ ------------ ------------
126,495 (15,191) -- 88,903 22,400
------------ ------------ ------------ ------------ ------------
Non-core businesses:
Commercial Assets ......................... (2,256) (6,250) (3,064) 3,251 (8,692)
Affordable Housing ........................ 1,530 (2,278) 149 2,710 (3,608)
Subprime Finance .......................... 2,570 10,867 -- 13,417 20
------------ ------------ ------------ ------------ ------------
1,844 2,339 (2,915) 19,378 (12,280)
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... 288 1,124 245 7,602 (9,492)
------------ ------------ ------------ ------------ ------------
$ 128,627 $ (11,728) $ (2,670) $ 115,883 $ 628
============ ============ ============ ============ ============
(1) Income (loss) before minority interest and income taxes.
NOTE 9 ACQUISITION
On September 30, 2004, we acquired Bankhaus Oswald Kruber KG ("BOK") for
the U.S. dollar equivalent of $9,015 (7,250 euros), plus acquisition costs. The
initial purchase price is subject to final adjustment. BOK holds a universal
banking license issued by the German Federal Financial Supervisory Agency and is
a member of the German Deposit Protection Fund and the Association of Private
German Banks. BOK, which is headquartered in Berlin, with a branch office in
Frankfurt, was established in 1924. Our preliminary estimate of the excess of
the purchase price over the fair value of the net assets acquired (goodwill)
related to this transaction is approximately $6,100. The purchase price
information as disclosed may subsequently be adjusted to reflect changes in the
purchase price and allocations thereof. The net assets acquired consisted
primarily of cash and cash equivalents and receivables, net of customer
deposits.
19
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SEPTEMBER 30, 2004
(Dollars in thousands)
- --------------------------------------------------------------------------------
NOTE 10 COMMITMENTS AND CONTINGENCIES
OCN and certain of its affiliates, including the Bank, have been named
as defendants in a number of purported class action lawsuits challenging the
Bank's mortgage servicing practices. The lawsuits allege that the defendants
violated federal and state statutes, including the federal Real Estate
Settlement Procedures Act, Fair Debt Collection Practices Act and state
deceptive trade practices statutes, and assert common law claims. The lawsuits
seek actual and punitive damages, and injunctive and other relief. These
lawsuits have been consolidated into a single proceeding before the United
States District Court for the Northern District of Illinois, under caption
styled: In re Ocwen Federal Bank FSB Mortgage Servicing Litigation, MDL Docket
No. 1604. The consolidated action is at an early stage of proceedings, and the
court has not yet considered a motion for class certification. We are defending
and intend to continue to defend the consolidated action vigorously. While the
outcome of litigation is always uncertain, we believe that we have meritorious
legal and factual defenses to all of the claims in the consolidated action.
On July 9, 2004, a jury rendered a verdict of $9,320, which included
both actual and punitive components, against Ocwen, the Bank and OTX in
litigation brought by Cartel Asset Management, Inc. ("Cartel") in federal court
in Denver, Colorado. Cartel alleged trade secret and contract-related claims
arising out of real estate valuation services performed from 1997 through the
first quarter of 2001, at which time we ceased doing business with Cartel. On
July 16, 2004, the judge in the Cartel litigation ordered a new trial on damages
on the ground that the testimony of plaintiff's damages expert should have been,
but was not, excluded. On November 3, 2004, the judge reversed his prior order
requiring a new trial on damages and instead entered a final judgment with a
reduced damage award to Cartel of $520. The judge also reduced Cartel's request
for attorneys' fees from $570 to $170. It is not known whether Cartel intends to
appeal the trial judge's rulings. We are currently considering issues for a
possible appeal or cross-appeal. The lawsuit does not involve challenges to our
core Residential Loan Servicing business practices.
OCN and the Bank are also subject to various other pending legal
proceedings. In our opinion, the resolution of these proceedings will not have a
material effect on our financial condition, results of operations or cash flows.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
GENERAL
OCN is a diversified financial services company with headquarters in
West Palm Beach, Florida, and a presence in Canada, China, Germany, India, Japan
and Taiwan. We are engaged in a variety of businesses related to residential and
commercial mortgage servicing, real estate asset management, asset recovery,
global outsourcing and the marketing and sales of technology solutions to third
parties.
OVERVIEW OF RISKS AND RELATED CRITICAL ACCOUNTING POLICIES
For the past several years, we have been undergoing a fundamental
transition in the nature of our business. In late 1999 and early 2000, we began
to execute a strategic plan to shift our business activities away from
capital-intensive businesses involving the purchase or origination of loans,
real estate and related assets toward less capital-intensive businesses that
generate fee-based revenues. As a result, we generally ceased to invest in
assets in certain of our business segments ("non-core businesses") unless we
were contractually committed to do so. However, we continue actively to manage
and resolve the remaining assets in these segments. As of September 30, 2004,
our core and non-core businesses were as follows:
Core Businesses Non-Core Businesses
---------------------------------------- -------------------
Residential Loan Servicing Commercial Assets
Ocwen Technology Xchange ("OTX") Affordable Housing
Ocwen Realty Advisors ("ORA") Subprime Finance
Ocwen Recovery Group (formerly Unsecured
Collections)
Business Process Outsourcing
Commercial Servicing
In addition to our business segments, we use our Corporate Items and
Other segment to account for certain items of revenue and expense that are not
directly related to a business unit. We include in our Corporate Items and Other
segment interest income on cash and cash equivalents, interest expense on
corporate assets, gains and losses from debt repurchases and general corporate
expenses.
Principal Risk Factors. We included a discussion of the principal risk
factors that relate to our businesses and may affect future results on pages 14
through 17 of Management's Discussion and Analysis of Operations and Financial
Conditions in our Annual Report on Form 10-K for the year ended December 31,
2003.
Critical Accounting Policies. Our strategies to exit non-core businesses
and expand our core businesses are affected by risks in the marketplace.
Further, our ability to measure and report our operating results and financial
position is heavily influenced by the need to estimate the impact or outcome of
these risks, or other future events. Our critical accounting policies are those
that relate to the estimation and measurement of these risks, and an
understanding of these policies is fundamental to understanding Management's
Discussion and Analysis of Results of Operations and Financial Condition. We
summarize our more subjective and complex accounting policies as they relate to
our overall business strategy on pages 17 and 18 of Management's Discussion and
Analysis of Results of Operations and Financial Condition in our Annual Report
on Form 10-K for the year ended December 31, 2003. We discuss our significant
accounting policies in detail in Note 1 to our Consolidated Financial Statements
included in our Annual Report on Form 10-K for the year ended December 31, 2003.
BANKING OPERATIONS
The Bank operates one bank branch in Fort Lee, New Jersey. This
location, which provides most of our retail banking services, is primarily
focused on the issuance of retail certificates of deposit that currently serve
as a source of financing for us. We do not conduct loan origination activities
in the Fort Lee branch.
We currently operate several of our core businesses primarily in the
Bank: Residential Loan Servicing, ORA, the domestic operations of Commercial
Servicing and portions of Ocwen Recovery Group. In addition, our non-core
Affordable Housing business operates in the Bank, as does a portion of our
non-core Commercial Assets business.
As described in Note 5 to our Interim Consolidated Financial Statements,
we have committed to the OTS to maintain our investment in mortgage servicing
rights at approximately 60% of core capital at the Bank (before any deduction
thereto for mortgage servicing rights) and 50% of stockholders' equity on a
consolidated basis. These commitments effectively limit the size of our
Residential Loan Servicing business. Consistent with our strategy of growing
that business, we are currently exploring the possibility of the Bank
terminating its status as a federal savings bank under OTS and FDIC supervision,
which would, among other things, eliminate these restrictions on our growth. If
we were to go forward with this process, which we refer to as "debanking," we
would dissolve the Bank and continue its non-depositary businesses, including
its mortgage servicing business, under another subsidiary of our company, which
would be licensed where necessary at the state level. Should debanking occur, we
would no longer be a savings-and-loan holding company and would no longer be
able to take deposits in the United States or benefit from federal preemption.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
No final determination has yet been made with respect to whether we will
pursue this strategy. Were we to decide to do so, our ability to debank would be
subject to a number of contingencies, many of which are beyond our control,
including approvals by the OTS with respect to applications for a voluntary
dissolution as well as sales of the Bank's deposits to third parties. There can
be no assurance that we ultimately would be successful in debanking.
The following discussion of our consolidated financial condition,
results of operations, capital resources and liquidity should be read in
conjunction with the Interim Consolidated Financial Statements and related Notes
included in Item 1.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following tables present selected consolidated financial information
at the dates and for the periods indicated.
Increase (Decrease)
September 30, December 31, -------------------
2004 2003 $ %
------------- ------------- ---------- -----
Financial Condition Data
- ------------------------
Total assets ........................................ $ 1,285,486 $ 1,240,118 $ 45,368 4%
Trading securities, at fair value ................. $ 138,489 $ 49,520 $ 88,969 180%
Real estate ....................................... $ 68,480 $ 103,943 $ (35,463) (34)%
Loans, net ........................................ $ 11,459 $ 28,098 $ (16,639) (59)%
Match funded assets, net .......................... $ 108,328 $ 130,087 $ (21,759) (17)%
Advances on loans and loans serviced for others ... $ 345,945 $ 374,769 $ (28,824) (8)%
Mortgage servicing rights ......................... $ 135,319 $ 166,495 $ (31,176) (19)%
Receivables ....................................... $ 114,500 $ 88,157 $ 26,343 30%
Other assets ...................................... $ 73,623 $ 33,607 $ 40,016 119%
Total liabilities ................................... $ 957,266 $ 921,574 $ 35,692 4%
Deposits .......................................... $ 412,117 $ 446,388 $ (34,271) (8)%
Escrow deposits ................................... $ 146,074 $ 116,444 $ 29,630 25%
Bonds-match funded agreements ..................... $ 97,712 $ 115,394 $ (17,682) (15)%
Lines of credit and other secured borrowings ...... $ 35,502 $ 150,384 $ (114,882) (76)%
Notes and debentures (1) .......................... $ 231,249 $ 56,249 $ 175,000 311%
Stockholders' equity ................................ $ 326,924 $ 317,258 $ 9,666 3%
For the Three Months Ended September 30,
---------------------------------------------------
Favorable/(Unfavorable)
-----------------------
2004 2003 $ %
---------- ---------- ---------- ---------
Operations Data
- ---------------
Net income (loss) ................................... $ 39,305 $ 4,615 $ 34,690 752%
Non-interest revenue ................................ $ 53,615 $ 46,842 $ 6,773 14%
Net interest income (expense) (1) ................... $ (2,153) $ (6,752) $ 4,599 68%
Provision for loan losses ........................... $ (94) $ 415 $ 509 123%
Non-interest expense ................................ $ 44,078 $ 35,026 $ (9,052) (26)%
Income tax expense (benefit) ........................ $ (31,845) $ 6 $ 31,851 530,850%
Net income (loss) per share:
Basic ............................................. $ 0.61 $ 0.07 $ 0.54 771%
Diluted ........................................... $ 0.60 $ 0.07 $ 0.53 757%
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
For the Nine Months Ended
September 30, Favorable/(Unfavorable)
------------------------- ------------------------
2004 2003 $ %
---------- ---------- ---------- ----------
Operations Data
- ---------------
Net income (loss) ................................... $ 55,159 $ 318 $ 54,841 17,246%
Non-interest revenue ................................ $ 170,917 $ 128,627 $ 42,290 33%
Net interest income (expense) (1) ................... $ (6,485) $ (11,728) $ 5,243 45%
Provision for loan losses ........................... $ (913) $ (2,670) $ (1,757) (66)%
Non-interest expense ................................ $ 142,015 $ 115,883 $ (26,132) (23)%
Distributions on Capital Securities (1) ............. $ -- $ 3,058 $ 3,058 100%
Income tax expense (benefit) ........................ $ (31,779) $ 618 $ 32,397 5,242%
Net income (loss) per share:
Basic ............................................. $ 0.83 $ 0.005 $ 0.825 16,500%
Diluted ........................................... $ 0.81 $ 0.005 $ 0.805 16,100%
(1) Effective with our adoption of SFAS No. 150 on July 1, 2003, we
reclassified our $56,249 balance of 10.875% Capital Securities to notes.
Distributions for the three and nine months ended September 30, 2004
amounted to $1,529 and $4,587, respectively, and are included with
interest expense. Distributions for the three months ended September 30,
2003 were $1,529 and are also included with interest expense.
RESULTS OF OPERATIONS
General. We recorded net income of $39,305 for the third quarter of
2004, as compared to $4,615 for the third quarter of 2003. Year to date, we
recorded net income of $55,159 for 2004 as compared to $318 for the same period
of 2003. Net income for 2004 reflects an income tax benefit of $31,845 for the
third quarter resulting primarily from the partial reversal of the valuation
allowance we had established on our deferred tax asset in prior years. See
"Results of Operations - Income Tax Expense (Benefit)" for a detailed discussion
of our income taxes.
Our core businesses recorded combined pre-tax income of $4,183 in the
third quarter of 2004, a decrease of $3,812 or 48% as compared to the third
quarter of 2003. Year to date, pre-tax income from our core businesses amounted
to $21,255, a decrease of $1,145 or 5% compared to the same period of 2003.
Declines in Residential Loan Servicing income during the 2004 periods were
partially offset by improvements in the operating results of OTX and other core
businesses. Our non-core business segments recorded a pre-tax loss of $(617) in
the third quarter of 2004 as compared to $(308) for the third quarter of
2003.Year to date, our non-core businesses recorded pre-tax income of $301, an
improvement of $12,581 over the loss incurred for the same period in 2003. The
improvement in the combined results of our year-to-date non-core segments is
largely due to the $10,000 charge in the first quarter of 2003, related to
settlement of the Admiral Home Loan arbitration. Results of our Corporate Items
and Other segment for the 2004 periods improved over the 2003 periods and
included $2,730 and $6,476 of interest income on federal tax refund claims for
the three and nine months ended September 30, 2004, respectively. We discuss
these segment results in detail in our review of segment profitability, which
follows.
Segment Profitability. In general, we have ceased conducting any new
business activities related to our non-core businesses, although we are actively
engaged in the sale or other resolution of the remaining non-core assets. These
assets are comprised of loans, real estate, securities held in our residual and
subordinate trading portfolio and affordable housing properties.
The following is a discussion of pre-tax income (loss) before minority
interest and income taxes for each of our core and non-core reportable business
segments.
CORE BUSINESSES
Residential Loan Servicing. Through this business, we provide for a fee,
loan servicing, including asset management and resolution services, to third
party owners of subprime and "high loan to value" residential mortgage loans.
Subprime residential mortgages comprise the vast majority of loans we service.
We acquire the rights to service loans by purchasing them outright or by
entering into sub-servicing contracts. As shown in the table below, results
reflect a decline in the average volume of mortgage loans serviced during the
third quarter of 2004 as compared to 2003, and an increase in the average volume
serviced year to date 2004 as compared to 2003. In addition we have continued to
experience earnings pressure resulting from low interest rates and high
prepayments in our servicing portfolio. Not only do prepayments result in the
loss of future servicing fees, they also result in increases to the rate at
which we amortize our servicing rights. Prepayments also create an obligation
for us to remit a final month of interest to the investor.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Selected information
2004 2003
------------ ------------
Number of loans at September 30 .............................. 327,562 355,446
Unpaid principal balance at September 30 ..................... $ 34,365,953 $ 37,109,678
Average unpaid principal balance for the following periods:
Three months ended September 30 ............................ $ 34,347,201 $ 36,436,563
Nine months ended September 30 ............................. $ 35,696,362 $ 32,632,084
Three Months Nine Months
---------------------- ------------------------
For the periods ended September 30, 2004 2003 2004 2003
- -------------------------------------- --------- --------- ---------- ----------
Pre-tax income (loss) ................ $ 3,380 $ 8,159 $ 13,763 $ 25,808
Net interest expense ................. $ 4,238 $ 5,300 $ 14,777 $ 15,125
Servicing and related fees:
Fees ............................... $ 57,479 $ 63,143 $ 187,859 $ 178,678
Amortization of servicing rights ... $ (22,504) $ (25,272) $ (71,173) $ (68,677)
Compensating interest expense ...... $ (8,728) $ (8,658) $ (25,839) $ (22,278)
Non-interest expense ................. $ 21,820 $ 16,832 $ 69,738 $ 48,752
. The decline in the unpaid principal balance and number of loans we
service for others in the period since September 30, 2003 is the result
of a continued high level of runoff due to prepayments, and a more
cautious acquisition strategy we adopted given the uncertainty of
prepayment speeds in the current environment.
. The decline in fees in the third quarter of 2004, as compared to the
third quarter of 2003, is primarily the result of a decline in the
average volume of loans serviced for others and a greater concentration
of sub-servicing business. Sub-servicing contracts provide for lower
servicing fees but do not require the purchase of servicing rights. This
decline in average volume is the result of high prepayment rates and
reduced purchases of servicing rights. Year to date 2004, fees have
increased as compared to 2003 primarily due to the increase in the
average volume of loans serviced. For the three and nine month periods
of 2004, earnings on float balances have increased as compared to the
2003 periods due to higher average collection account balances, but
these earnings remain low due to low short-term interest rates. The
yield we earned on float balances averaged 1.57% and 1.14% during the
third quarter of 2004 and 2003, respectively, and 1.08% and 1.13% for
the year to date periods of 2004 and 2003, respectively. See
"Non-interest Revenue - Servicing and Related Fees" for a detail of the
principal components of servicing and related fees.
. Although the rate of amortization on servicing rights has been
increasing in response to increased actual and projected prepayment
volumes, amortization expense declined during the third quarter of 2004
as compared to 2003, primarily as a result of a reduction in purchases
of servicing rights in recent periods. The balance of mortgage servicing
rights declined $31,176 during the nine months ended September 30, 2004
as amortization exceeded purchases. See "Changes in Financial Condition
- Mortgage Servicing Rights."
. The increase in compensating interest expense on loans repaid before the
end of a calendar month reflect higher prepayments in our servicing
portfolio.
. The increase in non-interest expense reflects costs associated with the
property management contract we entered into with The U.S. Department of
Veteran's Affairs ("the VA") in September 2003 and our reassumption in
the fourth quarter of 2003 of certain collection activities, which were
previously outsourced to a third-party vendor. The total number of
employees in this business segment averaged 1,519 and 1,266 during the
third quarter of 2004 and 2003, respectively, and 1,486 and 1,267 for
the year to date periods of 2004 and 2003, respectively. Our workforce
in India assigned to this segment averaged 857 and 675 during the third
quarter of 2004 and 2003, respectively, and 796 and 658 for the year to
date periods of 2004 and 2003, respectively.
. Non-interest expense for 2004 also reflects a $1,393 increase in the
provision for uncollectible advances and other servicing related
receivables recorded during the first quarter.
OTX. Through this core segment we provide technology solutions for the
mortgage and real estate industries. OTX products include a residential loan
servicing system (REALServicing), a commercial loan servicing system
(REALSynergy) and an internet-based mortgage loan processing application and
vendor management system (REALTrans).
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Selected information
Three Months Nine Months
---------------------- ------------------------
For the periods ended September 30, 2004 2003 2004 2003
- -------------------------------------- --------- --------- ---------- ----------
Pre-tax income (loss) ................ $ (2,133) $ (2,353) $ (2,370) $ (8,327)
Non-interest revenue ................. $ 2,959 $ 2,891 $ 12,846 $ 7,898
Non-interest expense ................. $ 5,092 $ 5,244 $ 15,216 $ 16,224
Non-interest revenue for 2004 includes $2,900 of one-time fees
(primarily documentation fees) earned during the second quarter associated with
a service contract for the use of our REALServicing system.
Ocwen Realty Advisors. Through ORA we provide residential property
valuation services to external customers in the wholesale lending community as
well as our own residential real estate transactions.
Selected information
Three Months Nine Months
--------------------- -----------------------
For the periods ended September 30, 2004 2003 2004 2003
- -------------------------------------- --------- --------- ---------- ----------
Pre-tax income (loss) ................ $ 1,478 $ 1,156 $ 5,013 $ 3,766
Property valuation fees .............. $ 7,042 $ 4,688 $ 23,638 $ 13,414
Non-interest expense:
Appraisal expenses ................. $ 4,415 $ 2,865 $ 16,525 $ 7,697
Other .............................. $ 1,127 $ 661 $ 2,055 $ 1,937
Gross margin ......................... $ 2,627 $ 1,823 $ 7,113 $ 5,717
. The increase in property valuation fees and appraisal expenses reflects
a significant increase in the volume of property valuation services
performed, primarily as a result of the contract we entered into in
September 2003 to service residential REO properties for the VA.
Ocwen Recovery Group. This core business conducts collection activities
for third party owners of unsecured receivables and for a portfolio of unsecured
credit card receivables that we acquired at a discount in 1999 and 2000. On
collections for third party owners, we generally earn a fee based upon a
percentage of the amount collected. We accounted for our collections of our
unsecured credit card receivables portfolio under the cost recovery method
through the end of 2001 when we reduced the net book value of our unsecured
receivables to zero as a result of collections and additional reserves.
Beginning in 2002, income on that portfolio is recognized as cash is collected.
Selected information
Three Months Nine Months
--------------------- -----------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------------------------- --------- --------- ---------- ----------
Pre-tax income (loss) ..................................... $ 708 $ 1,140 $ 2,998 $ 3,422
Non-interest revenue:
Third-party collection fees ............................. $ 2,660 $ 2,236 $ 8,264 $ 6,138
Recoveries of unsecured credit card receivables owned ... $ 492 $ 691 $ 1,457 $ 2,237
Other ................................................... $ 147 $ 25 $ 237 $ 82
Non-interest expense ...................................... $ 2,591 $ 1,812 $ 6,959 $ 5,035
- Recoveries of unsecured credit card receivables owned have declined in
2004 as these portfolios have declined in size and have not been
replaced. We have not purchased any portfolios of unsecured credit card
receivables since 2000.
- The increase in non-interest expense in 2004 reflects an increase in
staffing levels, primarily in India.
Business Process Outsourcing. Business Process Outsourcing provides
outsourcing services, including data processing, call center maintenance,
mortgage research and others, to third parties and leverages the operational
capacity of our facilities in India. This Business segment began operations in
December 2002. Results reflect the initiation of new outsourcing contracts in
the third quarter of 2003.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Selected information
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------- --------- --------- --------- ---------
Pre-tax income (loss) ............. $ 687 $ 1,004 $ 1,791 $ 1,007
Non-interest revenue .............. $ 2,551 $ 1,877 $ 6,899 $ 2,629
Non-interest expense .............. $ 1,858 $ 872 $ 5,094 $ 1,620
Commercial Servicing. This segment now includes the results of both our
domestic and international servicing of commercial assets. Previously, domestic
commercial servicing was included as a component of the Commercial Finance
segment, and the results of our international operations were reported as a
separate segment. Results for the prior periods have been restated to conform to
this presentation. International servicing is conducted through GSS, our joint
servicing venture with Merrill Lynch. As of the end of 2003, our two offices in
Tokyo, Japan and Taipei, Taiwan were fully operational. We are also in the
process of establishing servicing offices in other locations, including Canada
and Germany. We have established consulting operations in the United Kingdom and
China. At September 30, 2004, this segment serviced a total of 9,190 loans with
an aggregate unpaid principal balance of $12,379,390, the majority of which were
serviced by our office in Japan.
Selected information
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------- --------- --------- --------- ---------
Pre-tax income (loss) ............. $ 63 $ (1,111) $ 60 $ (3,276)
Servicing and related fees ........ $ 3,178 $ 1,371 $ 10,089 $ 4,001
Non-interest expense .............. $ 3,267 $ 2,571 $ 10,236 $ 7,638
. The results for the 2004 periods as compared to 2003 primarily reflect
growth in our international servicing of commercial assets through GSS.
See "Non-Interest Revenue - Servicing and Related Fees."
Non-Core Businesses
Commercial Assets. Results for this non-core segment reflect our
continuing exit from our loan and real estate businesses. We have not purchased
any commercial assets since 2000. See "Changes in Financial Condition - Loans,
Net". Since then, this business has consisted of the management, repositioning
and resolution of the remaining non-core assets. At September 30, 2004 the
non-core assets remaining in this business consisted of six loan and real estate
assets and one unrated subordinate security with a fair value of $3,525. These
six assets consisted of one loan with a carrying value of $7,134 and five real
estate assets totaling $67,968. We have entered into contracts to sell three of
the remaining real estate assets. One of these transactions involves the sale of
our shopping mall located in Florida, which had a carrying value of $44,169 at
September 30, 2004, and closed in November 2004. The other two transactions have
not yet closed and involve the sales of our shopping center in Nova Scotia and
our hotel in Michigan, which had an aggregate carrying value of $15,075 at
September 30, 2004. These transactions are subject to due diligence and other
contingencies.
Selected information
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- -------------------------------------- --------- --------- --------- ---------
Pre-tax income (loss) ................ $ (1,845) $ (2,025) $ (4,895) $ (8,692)
Net interest income (expense) ........ $ (378) $ (1,853) $ (159) $ (6,250)
Provision for loan losses ............ $ -- $ 393 $ (764) $ (3,064)
Non-interest revenue ................. $ (259) $ 1,165 $ (2,302) $ (2,256)
Non-interest expense ................. $ 1,208 $ 943 $ 3,198 $ 3,251
. The decline in net interest expense reflects a decline in real estate
assets, which do not earn interest but are financed with
interest-bearing liabilities. Also, for the nine months ended September
30, 2004 we recorded $719 of interest income on our unrated subordinate
security. We first began receiving cash flow from this security in the
second quarter of 2004.
. Non-interest revenue for 2004 includes impairment charges on our real
estate assets of $175 and $3,952 for the three and nine month periods,
respectively. Year to date impairment charges for 2003 were $5,526, all
of which was recorded in the second quarter.
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
. Year to date non-interest revenue for 2004 also includes a $948
unrealized gain on the unrated subordinate security, reflecting the
probability of receiving additional cash flows in the future.
. The negative provision for loan losses in 2003 primarily resulted from
the recovery of reserves on loan sales during the second quarter. See
"Provisions for Loan Losses".
Affordable Housing. Historically, we invested in affordable housing
properties primarily through a series of limited partnerships. Except to
complete those projects in which an investment had already been made, we ceased
making investments in properties in 2000 as part of our shift in strategy to
fee-based businesses and because the volume of tax credits being generated was
exceeding our ability to utilize them effectively. Since that time, we have been
marketing these properties for sale. Our investment in affordable housing
properties consists of four properties and amounted to $8,356 and $7,410 at
September 30, 2004 and December 31, 2003, respectively. In addition, this
segment has $3,664 of loans outstanding to limited partnership properties that
we do not consolidate in our financial statements. During the second quarter we
entered into a contract to sell three of the remaining properties, which had an
aggregate net carrying value of $2,434 at September 30, 2004. This transaction
closed in October 2004. We anticipate that new sources of financing will be
established to repay the remaining loan balances. We regularly assess the
carrying value of our remaining assets and provide additional loss reserves as
appropriate. Our combined reserves associated with affordable housing properties
and loans amounted to 55% of the remaining book value of such assets at both
September 30, 2004 and December 31, 2003.
Subprime Finance. We were engaged in domestic subprime residential
lending prior to ceasing originations in August of 1999; however, we have
continued to manage and resolve the remaining non-core assets. At September 30,
2004, the non-core assets remaining in this business consisted primarily of
unrated single-family subprime residual trading securities with a fair value of
$35,834. These securities are presently generating income and return of
principal through cash flows. See "Changes in Financial Condition - Trading
Securities".
Selected information
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- --------- --------- --------- ---------
Pre-tax income (loss) ................... $ 2,116 $ 1,720 $ 8,243 $ 20
Interest income ......................... $ 3,030 $ 2,500 $ 9,674 $ 11,987
Interest expense ........................ $ 211 $ 493 $ 865 $ 1,120
Gain (loss) on trading securities, net .. $ (278) $ 111 $ 47 $ 2,577
Non-interest expense .................... $ 462 $ 395 $ 1,610 $ 13,417
. The decrease in interest income year to date 2004 as compared to 2003 is
largely the result of a decline in cash flow distributions received on
our U.K. unrated single-family subprime residual securities.
. The $11,807 decline in non-interest expense year to date 2004 as
compared to 2003 is primarily due to the $10,000 charge recorded during
the first quarter of 2003 related to the conclusion of the Admiral Home
Loan arbitration.
Corporate Items and Other. Pre-tax results for this segment include
business activities that are individually insignificant, interest income on cash
and cash equivalents, interest income on our income tax refund receivable,
interest expense on corporate assets, gains and losses from debt repurchases,
and general corporate expenses. The table below presents the more significant
amounts included in each of the periods indicated.
Selected information
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- --------- --------- --------- ---------
Pre-tax income (loss) ................... $ 3,912 $ (3,038) $ 1,774 $ (9,492)
Net interest income (expense)............ $ 32 $ (952) $ 946 $ (1,935)
Non-interest expense..................... $ 1,707 $ 2,074 $ 9,531 $ 7,602
Non-interest revenue..................... $ 5,492 $ 9 $ 10,238 $ 288
. Effective with our adoption of SFAS No. 150 effective July 1, 2003,
distributions on our Capital securities are reported in the consolidated
statement of operations as interest expense beginning in the third
quarter of 2003. For purposes of this analysis, net interest expense
includes distributions on Capital Securities for all periods.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
. Non-interest revenue includes $2,730 and $6,476 of interest income
recognized during the three and nine month periods of 2004,
respectively, on federal income tax refund claims. See "Changes in
Financial Condition - Receivables" for additional information regarding
these claims.
See Note 8 to the Interim Consolidated Financial Statements, for
additional information related to our operating segments.
Non-Interest Revenue. The following table sets forth the principal
components of our non-interest income during the periods indicated:
Three Months Nine Months
----------------------- -----------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------------------------- ---------- ---------- ---------- ----------
Servicing and related fees ................................ $ 34,587 $ 35,651 $ 115,310 $ 101,703
Vendor management fees .................................... 13,614 7,722 40,442 21,721
Gain (loss) on trading and match funded securities, net ... (171) 159 1,688 2,924
Valuation gains (losses) on real estate ................... (165) (686) (3,990) (6,695)
Gain (loss) on sales of real estate ....................... 311 316 (149) 408
Operating income (losses) from real estate ................ 444 1,269 1,017 3,461
Gain (loss) on debt repurchases ........................... -- (441) -- (445)
Other income .............................................. 4,995 2,852 16,599 5,550
---------- ---------- ---------- ----------
$ 53,615 $ 46,842 $ 170,917 $ 128,627
========== ========== ========== ==========
Servicing and Related Fees. Our servicing and related fees are primarily
comprised of fees we earned from investors for servicing residential mortgage
loans on their behalf. The following table sets forth the principal components
of our servicing and related fees by segment for the periods indicated:
Three Months Nine Months
----------------------- -----------------------
For the periods ended September 30, 2004 2003 2004 2003
- ------------------------------------------ ---------- ---------- ---------- ----------
Residential Loan Servicing:
- ---------------------------
Loan servicing and related fees:
Loan servicing fees (1) ................ $ 38,991 $ 44,059 $ 128,292 $ 122,021
Late charges ........................... 9,653 9,188 31,200 27,234
Interest on custodial accounts (2) ..... 4,958 3,255 10,721 7,529
Compensating interest expense (3) ...... (8,728) (8,658) (25,839) (22,278)
Amortization of servicing rights (4) ... (22,504) (25,272) (71,173) (68,677)
Other, net ............................. (1,780) 260 1,808 5,100
---------- ---------- ---------- ----------
20,590 22,832 75,009 70,929
Other fees:
- -----------
Default servicing fees ................. 291 1,014 1,629 3,007
Retail banking fees .................... 2,102 1,979 6,551 5,531
Other .................................. 3,264 3,388 7,658 8,256
---------- ---------- ---------- ----------
26,247 29,213 90,847 87,723
---------- ---------- ---------- ----------
Other Segments (5):
- -------------------
Loan servicing and related fees:
Loan servicing fees .................... 3,026 2,666 9,419 7,134
Other, net (6) ......................... 4,197 2,890 11,494 5,650
---------- ---------- ---------- ----------
7,223 5,556 20,913 12,784
Other fees ............................... 1,117 882 3,550 1,196
---------- ---------- ---------- ----------
8,340 6,438 24,463 13,980
---------- ---------- ---------- ----------
$ 34,587 $ 35,651 $ 115,310 $ 101,703
========== ========== ========== ==========
(1) The decline in residential loan servicing fees during the third quarter
of 2004 as compared to 2003 primarily reflects a decline in the average
balance of residential loans we serviced for others and a greater
proportion of subservicing contracts, which generate lower servicing
fees. The average unpaid principal balance of loans serviced by our
Residential Loan Servicing segment declined from $36,436,563 during the
third quarter of 2003 to $34,347,201 for the third quarter of 2004. On a
year to date basis, residential loan servicing fees increased as the
average balance of loans serviced increased from $32,632,084 for the
nine months ended September 30, 2003 to $35,696,362 for the same period
of 2004. See "Segment Results - Residential Loan Servicing".
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
(2) Interest we earned on custodial accounts during the holding period
between collection of borrower payments and remittance to investors.
These custodial accounts are held by an unaffiliated bank and are
excluded from our statement of financial condition. The average balances
held in these custodial accounts were approximately $1,259,700 and
$1,142,200 for the third quarter of 2004 and 2003, respectively. Year to
date, the balances in these accounts averaged $1,322,200 and $890,400
for 2004 and 2003, respectively.
(3) A servicer of securitized loans is typically obligated to pay the
securitization trust the difference between a full month of interest and
the interest collected on loans that are repaid before the end of a
calendar month. The increase in compensating interest expense reflects
an increase in loan prepayments.
(4) The increase in amortization expense year to date 2004 as compared to
2003 reflects an increase in the rate of amortization due to the
increase in actual and projected prepayment rates on subprime
residential mortgage loans. In spite of the increased rate of
amortization, the amount of amortization expense recorded during the
third quarter of 2004 declined as compared to 2003 as a result of a
decline in purchases of servicing rights. See "Changes in Financial
Condition - Mortgage Servicing Rights".
(5) Other segments primarily includes Commercial Servicing, Ocwen Recovery
Group and Business Process Outsourcing. See "Segment Results" for
additional discussion regarding loan servicing and related fees for
these segments.
(6) Includes $2,551 and $1,877 of fees earned by our Business Process
Outsourcing segment for the third quarter of 2004 and 2003,
respectively. Year to date, these fees amounted to $6,899 and $2,629 for
2004 and 2003, respectively. See "Segment Results - Business Process
Outsourcing".
The following table sets forth loans we serviced at the dates indicated.
Non-performing loans serviced for others have been delinquent for 90 days or
more. Performing loans serviced for others are current or have been delinquent
for less than 90 days.
Loans (1) REO (2) Total
-------------------------- -------------------------- -------------------------
Amount Count Amount Count Amount Count
------------ ----------- ----------- ------------ ------------ ----------
Residential Loan Servicing
- --------------------------
September 30, 2004:
Performing.......................... $ 28,793,177 257,094 $ -- -- $ 28,793,177 257,094
Non-performing ..................... 4,091,480 49,865 1,481,295 20,603 5,572,775 70,468
------------ ----------- ----------- ------------ ------------ ----------
$ 32,884,657 306,959 $ 1,481,295 20,603 $ 34,365,952 327,562
============ =========== =========== ============ ============ ==========
December 31, 2003:
Performing.......................... $ 32,413,747 293,007 $ -- -- $ 32,413,747 293,007
Non-performing ..................... 4,306,047 52,585 977,564 14,000 5,283,611 66,585
------------ ----------- ----------- ------------ ------------ ----------
$ 36,719,794 345,592 $ 977,564 14,000 $ 37,697,358 359,592
============ =========== =========== ============ ============ ==========
Commercial Servicing
- --------------------
September 30, 2004:
Performing.......................... $ 698,378 360 $ -- -- $ 698,378 360
Non-performing ..................... 11,533,634 8,782 147,378 48 11,681,012 8,830
------------ ----------- ----------- ------------ ------------ ----------
$ 12,232,012 9,142 $ 147,378 48 $ 12,379,390 9,190
============ =========== =========== ============ ============ ==========
December 31, 2003:
Performing.......................... $ 461,276 264 $ -- -- $ 461,276 264
Non-performing ..................... 12,148,555 7,434 85,290 40 12,233,845 7,474
------------ ----------- ----------- ------------ ------------ ----------
$ 12,609,831 7,698 $ 85,290 40 $ 12,695,121 7,738
============ =========== =========== ============ ============ ==========
(1) At September 30, 2004 we serviced 241,473 subprime loans with a total
unpaid principal balance of $28,372,285, as compared to 257,089 subprime
loans with an unpaid principal balance of $30,563,123 at December 31,
2003. Subprime loans represent residential loans we service which were
made by others to borrowers who generally did not qualify under
guidelines of the Fannie Mae and Freddie Mac ("nonconforming loans").
The decline in residential loans serviced at September 30, 2004 as
compared to December 31, 2003 is the result of high prepayment rates and
reduced purchases of servicing rights.
(2) Includes $984,956 and $480,388 of residential REO properties serviced
for the VA at September 30, 2004 and December 31, 2003, respectively.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Vendor Management Fees. Vendor management fees are primarily comprised
of property valuation fees earned by our ORA segment, fees earned from vendors
in the REALTrans network and commissions on real estate sales. The increase in
vendor management fees in 2004 as compared to 2003 primarily reflects an
increase in the volume of valuation services performed by ORA, primarily as a
result of the VA contract. See "Segment Profitability - Ocwen Realty Advisors".
Gain (Loss) on Trading and Match Funded Securities, Net. Gain (loss) on
trading and match funded securities, net, includes both unrealized gains
(losses) on securities and realized gains (losses) resulting from sales thereof.
The year to date gains for 2004 include an unrealized gain of $948 on our
commercial unrated subordinate security. The year to date gains for 2003 were
primarily the result of net unrealized gains of $2,577 on our unrated subprime
residual and subordinate securities.
Valuation Gains (Losses) on Real Estate. We regularly assess the value
of our remaining real estate assets and provide additional loss reserves or
impairment charges as appropriate. The losses for the three and nine months
ended September 30, 2004, included impairment charges of $175 and $3,952,
respectively. Year to date 2003, such charges were $5,526 and were recognized
during the second quarter. See "Changes in Financial Condition - Real Estate."
Operating Income (Loss) from Real Estate. Operating results of our real
estate include rental income, depreciation expense and operating expenses
associated with holding and maintaining the properties. The decline in operating
income in 2004 as compared to 2003 is largely due to sales of commercial real
estate properties. Only five commercial real estate assets remain at September
30, 2004. See "Changes in Financial Condition-Real Estate."
Other Income. The following table sets forth the principal components of
other income by segment for the periods indicated:
Three Months Nine Months
--------------------- ---------------------
For the periods ended September 30, 2004 2003 2004 2003
- ---------------------------------------- --------- --------- --------- ---------
Residential Loan Servicing ............. $ 2 $ -- $ 320 $ 4
OTX (1) ................................ 1,101 551 6,480 1,226
Ocwen Recovery Group (2) ............... 514 721 1,542 2,331
Commercial Servicing ................... 140 105 170 412
Commercial Assets ...................... 26 662 96 731
Affordable Housing ..................... -- 730 -- 812
Subprime Finance ....................... 38 (3) 999 (3)
Corporate Items and Other (3) .......... 3,174 86 6,992 37
--------- --------- --------- ---------
$ 4,995 $ 2,852 $ 16,599 $ 5,550
========= ========= ========= =========
(1) Includes $2,900 of one-time fees earned during the second quarter,
primarily documentation fees, associated with a service contract for the
use of our REALServicing system. See "Segment Results - OTX".
(2) Primarily comprised of collections of credit card receivables accounted
for under the cost recovery method. See "Segment Results - Ocwen
Recovery Group".
(3) Includes $2,730 and $6,476 of interest income recorded during the three
and nine months ended September 30, 2004, respectively, on federal tax
refund claims due from the Internal Revenue Service ("IRS"). Our policy
is to recognize interest income on income tax receivable balances upon
receipt of a written finding from the IRS agent that validates our
claim. See "Changes in Financial Condition - Receivables".
Net Interest Income (Expense). Net interest income (expense) is the
difference between the interest income earned from our interest-earning assets
and the interest expense incurred on our interest-bearing liabilities. Net
interest income (expense) is determined by net interest spread (i.e., the
difference between the yield earned on our interest-earning assets and the rates
incurred on our interest-bearing liabilities), the relative amount of
interest-earning assets and interest-bearing liabilities and the degree of
mismatch in the maturity and repricing characteristics of our interest-earning
assets and interest-bearing liabilities.
In addition to interest income reported in this caption, we also earn
interest on the balance of custodial accounts we hold in connection with our
Residential Loan Servicing business. These amounts are reported as a component
of servicing fees and are not included in the following information.
Our net interest income and net interest margin began declining in 2000
and have been negative since 2001. This trend reflects a decline in the ratio of
interest-earning assets to interest-bearing liabilities, which has fallen from
98% for 1999 to 57% for the third quarter of 2004. Both our acquisition of OAC
in 1999 and our change in strategic direction from capital-intensive businesses
to fee-based sources of income have contributed to an increase in the relative
amount of non-interest-earning assets (such as real estate, advances on loans
serviced for others and mortgage servicing rights) that are funded by
interest-bearing liabilities. We expect the trend of net interest expense and
negative net interest margin to continue as we dispose of our remaining non-core
assets, a portion of which are interest-bearing, and increase
non-interest-earning assets of our core businesses. While it has no impact on
consolidated net income, the reclassification of our 10.875% Capital Securities
to interest-bearing liabilities on July 1, 2003 as a result of our adoption of
SFAS No. 150 has also had a negative impact on net interest income, margin and
spread. At the same time, our redemption of the remaining $33,065 balance of 12%
subordinated debentures on September 30, 2003, the repayment of the remaining
$43,475 of 11.875% notes on October 1, 2003 (the maturity date) and the
continuing reduction in brokered certificates of deposit all have had a positive
impact on net interest income, spread and margin.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
The following table sets forth, for the periods indicated, information
regarding the total amount of income from our interest-earning assets and the
resultant average yields, the interest expense associated with our
interest-bearing liabilities, expressed in dollars and rates, and the net
interest spread and net interest margin. Information is based on average daily
balances during the indicated periods:
2004 2003
--------------------------------------- ---------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
For the three months ended September 30, Balance Expense Rate Balance Expense Rate
- -------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Average Assets:
- ---------------
Interest-earning cash and other ............ $ 100,819 $ 371 1.47% $ 46,556 $ 79 0.68%
Federal funds sold and repurchase
agreements ................................ 196,827 677 1.38% 136,617 341 1.00%
Trading securities (1):
Investment grade securities .............. 54,627 145 1.06% 6,909 (4) (0.23)%
Subordinates and residuals ............... 41,814 3,302 31.59% 41,663 2,752 26.42%
Loans (2) .................................. 17,161 221 5.15% 42,974 213 1.98%
Match funded loans and securities (3) ...... 18,178 272 5.99% 29,845 690 9.25%
----------- ----------- ----------- -----------
Total interest earning assets ............ 429,426 4,988 4.65% 304,564 4,071 5.35%
----------- -----------
Advances on loans and loans serviced
for others ................................ 338,364 337,463
Mortgage servicing rights .................. 133,807 187,848
Match funded advances on loans
serviced for others ....................... 104,481 124,513
Other non-interest earning assets .......... 264,848 380,917
----------- -----------
Total assets ............................. $ 1,270,926 $ 1,335,305
=========== ===========
Average Liabilities and Stockholders Equity:
- --------------------------------------------
Interest-bearing demand deposits ........... $ 19,537 31 0.63% $ 16,788 49 1.17%
Savings deposits ........................... 1,602 3 0.75% 1,618 3 0.74%
Certificates of deposit (4) ................ 396,652 3,090 3.12% 387,470 3,957 4.08%
----------- ----------- ----------- -----------
Total interest-bearing deposits .......... 417,791 3,124 2.99% 405,876 4,009 3.95%
Bonds-match funded agreements (5) .......... 110,426 1,143 4.14% 129,572 1,075 3.32%
Lines of credit and other secured
borrowings (6) ........................... 41,204 148 4.88% 148,573 1,927 5.19%
Debt securities (7) ........................ 180,443 2,726 6.04% 132,422 3,812 11.51%
----------- ----------- ----------- -----------
Total interest-bearing liabilities ....... 749,864 7,141 4.00% 816,443 10,823 5.30%
----------- -----------
Escrow deposits ............................ 142,451 119,126
Other non-interest bearing liabilities 63,928 91,102
----------- -----------
Total liabilities ........................ 956,243 1,026,671
Minority interest .......................... 1,280 1,411
Stockholders' equity ....................... 313,403 307,223
----------- -----------
Total liabilities and stockholders'
equity .................................. $ 1,270,926 $ 1,335,305
=========== ===========
Net interest income (expense) .............. $ (2,153) $ (6,752)
=========== ===========
Net interest spread ........................ 0.65% 0.05%
Net interest margin ........................ (2.01)% (8.87)%
Ratio of interest-earning assets to
interest-bearing liabilities .............. 57% 37%
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
2004 2003
--------------------------------------- ---------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
For the nine months ended September 30, Balance Expense Rate Balance Expense Rate
- -------------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Average Assets:
- ---------------
Interest-earning cash and other ............ $ 77,701 $ 709 1.22% $ 29,396 $ 224 1.02%
Federal funds sold and repurchase
agreements ................................ 163,625 1,420 1.16% 125,697 1,078 1.14%
Trading securities (1):
Investment grade securities .............. 21,506 176 1.09% 11,176 (92) (1.10)%
Subordinates and residuals ............... 42,199 10,824 34.20% 38,340 12,464 43.35%
Loans (2) .................................. 29,865 1,391 6.21% 79,264 1,321 2.22%
Match funded loans and securities (3) ...... 21,282 1,035 6.48% 41,319 2,831 9.14%
----------- ----------- ----------- -----------
Total interest earning assets ............ 356,178 15,555 5.82% 325,192 17,826 7.31%
----------- -----------
Advances on loans and loans serviced
for others ................................ 341,504 302,718
Mortgage servicing rights .................. 147,470 176,972
Match funded advances on loans
serviced for others ....................... 105,080 121,013
Other non-interest earning assets .......... 293,415 360,267
----------- -----------
Total assets ............................. $ 1,243,647 $ 1,286,162
=========== ===========
Average Liabilities and Stockholders Equity:
- --------------------------------------------
Interest-bearing demand deposits ........... $ 21,416 130 0.81% $ 16,808 170 1.35%
Savings deposits ........................... 1,641 9 0.73% 1,533 9 0.78%
Certificates of deposit (4) ................ 438,442 10,700 3.25% 397,664 13,229 4.44%
----------- ----------- ----------- -----------
Total interest-bearing deposits .......... 461,499 10,839 3.13% 416,005 13,408 4.30%
Securities sold under agreements to
repurchase ................................ -- -- --% 333 3 1.20%
Bonds-match funded agreements (5) .......... 113,849 3,239 3.79% 136,470 3,640 3.56%
Lines of credit and other secured
borrowings (6) ............................ 68,286 2,178 4.25% 121,495 4,103 4.50%
Debt securities (7) ........................ 97,647 5,784 7.90% 95,422 8,400 11.74%
----------- ----------- ----------- -----------
Total interest-bearing liabilities ....... 741,281 22,040 3.96% 769,725 29,554 5.12%
----------- -----------
Escrow deposits ............................ 131,586 101,867
Other non-interest bearing liabilities 48,912 68,139
----------- -----------
Total liabilities ........................ 921,779 939,731
Capital Securities (7) ..................... -- 37,499
Minority interest .......................... 1,313 1,529
Stockholders' equity ....................... 320,555 307,403
----------- -----------
Total liabilities and stockholders'
equity .................................. $ 1,243,647 $ 1,286,162
=========== ===========
Net interest income (expense) .............. $ (6,485) $ (11,728)
=========== ===========
Net interest spread ........................ 1.86% 2.19%
Net interest margin ........................ (2.43)% (4.81)%
Ratio of interest-earning assets to
interest-bearing liabilities .............. 48% 42%
(1) The increase in the average yield on subordinates and residual
securities in the third quarter of 2004 is largely the result of higher
interest on our U.K. unrated single-family subprime residual securities.
Year to date 2004, interest on these securities was less than the year
to date 2003 period, resulting in a lower average yield. The increase in
our average investment in subordinates and residuals is primarily due to
the transfer in the second quarter of 2003 of securities previously
reported as match funded, as noted in (3) below, offset in part by
principal repayments.
(2) The decline in the average balance of loans is a result of sales,
resolutions and repayments; (primarily commercial loans) coupled with
minimal acquisitions and originations. This reflects our strategic
decision to exit non-core businesses and dispose of the related assets.
The average balances include non-performing loans, interest on which is
recognized on a cash basis. The increase in yields for the 2004 periods
reflects a decline in non-performing loans.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
(3) The decline in the average balance of match funded loans and securities
was primarily the result of principal repayments received on the loans
and the sale of the remaining single family loans at the end of the
third quarter of 2004 in connection with the redemption of the related
match funded debt. In addition we transferred the match funded
securities to residual trading securities during the second quarter of
2003 as a result of the repurchase and retirement of the related match
funded debt.
(4) The increase in the average balance of certificates of deposits resulted
primarily from an increase in non-brokered certificates of deposit,
offset in part by maturing brokered certificates of deposit. We have not
issued any new brokered certificates of deposit since 2000. The decline
in the average rate earned on deposits reflects the replacement of
maturing brokered certificates of deposit with non-brokered certificates
of deposit that have lower rates of interest because of the current
interest rate environment. See "Changes in Financial Condition -
Deposits".
(5) The decline in the average balance of bonds-match funded agreements is
due primarily to principal repayments, and the redemption at the end of
the third quarter 2004 of the match funded debt secured by single family
loans (as noted in (3) above). In addition, in the second quarter of
2003 the match funded debt related to the match funded unrated residual
securities was repurchased and retired as noted above.
(6) The decline in the average balance of lines of credit and other secured
borrowings is due to repayments and maturities. See "Changes in
Financial Condition - Lines of Credit and Other Secured Borrowings".
(7) The increase in the average balance of debt securities outstanding
resulted in part from the transfer of our $56,249 of 10.875% Capital
Securities to debt securities effective with the adoption of SFAS No.
150 on July 1, 2003, offset in part by repurchases and maturities of
debt securities during September and October of 2003. Distributions on
Capital Securities are included in interest expense on debt securities
effective with the adoption of SFAS No. 150. In addition, on July 28,
2004, we issued $175,000 of 3.25% Contingent Convertible Senior
Unsecured Notes due 2024. See "Changes in Financial Condition - Debt
Securities" and Note 3 to the Interim Consolidated Financial Statements.
The declines in average rates for the 2004 periods are primarily the
result of our issuance of the $175,000 of 3.25% Convertible Notes
referred to above.
The following table describes the extent to which changes in interest
rates and changes in volume of interest-earning assets and interest-bearing
liabilities have affected our interest income and expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior rate), (ii) changes in rate (change
in rate multiplied by prior volume) and (iii) total change in rate and volume.
Changes attributable to both volume and rate have been allocated proportionately
to the change due to volume and the change due to rate.
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Three Months Nine Months
--------------------------------------- ---------------------------------------
2004 vs. 2003 2004 vs. 2003
--------------------------------------- ---------------------------------------
Favorable (Unfavorable) Variance Favorable (Unfavorable) Variance
--------------------------------------- ---------------------------------------
For the periods ended September 30, Rate Volume Total Rate Volume Total
- ------------------------------------------------ ----------- ----------- ----------- ----------- ----------- -----------
Interest Income from Interest-Earning Assets
- ------------------------------------------------
Interest earning cash and other ................ $ 146 $ 146 $ 292 $ 52 $ 433 $ 485
Federal funds sold and repurchase agreements ... 155 181 336 19 323 342
Trading securities:
Investment grade securities .................... 91 58 149 299 (31) 268
Subordinates and residuals ................... 540 10 550 (2,810) 1,170 (1,640)
Loans .......................................... 192 (184) 8 1,273 (1,203) 70
Match funded loans and securities .............. (198) (220) (418) (674) (1,122) (1,796)
----------- ----------- ----------- ----------- ----------- -----------
Total interest income from
interest-earning assets ..................... 926 (9) 917 (1,841) (430) (2,271)
----------- ----------- ----------- ----------- ----------- -----------
Interest Expense on Interest-Bearing Liabilities
- ------------------------------------------------
Interest-bearing demand deposits ............... 25 (7) 18 79 (39) 40
Savings deposits ............................... -- -- -- 1 (1) --
Certificates of deposit ........................ 959 (92) 867 3,793 (1,264) 2,529
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing deposits .............. 984 (99) 885 3,873 (1,304) 2,569
Securities sold under agreements to
repurchase .................................... -- -- -- -- 3 3
Bonds-match funded agreements .................. (242) 174 (68) (226) 627 401
Lines of credit and other secured borrowings ... 136 1,643 1,779 217 1,708 1,925
Notes and debentures ........................... 2,184 (1,098) 1,086 2,808 (192) 2,616
----------- ----------- ----------- ----------- ----------- -----------
Total interest expense on
interest-bearing liabilities ................ 3,062 620 3,682 6,672 842 7,514
----------- ----------- ----------- ----------- ----------- -----------
Favorable (unfavorable) variance, net .......... $ 3,988 $ 611 $ 4,599 $ 4,831 $ 412 $ 5,243
=========== =========== =========== =========== =========== ===========
Provisions for Loan Losses. At September 30, 2004, our total net loan
balance was $11,459 or 0.9% of total assets. Of this balance, $7,134 represents
one non-residential loan held in our Commercial Assets segment and $3,664
represents three multi-family loans held in our Affordable Housing segment.
Because of the small number of remaining loans, we are able to perform a
specific risk assessment on each loan in the Commercial Assets and Affordable
Housing segments. Our risk assessment of loans in the Commercial Assets segment
includes a review of the underlying loan collateral, general and local economic
conditions, property type risk, borrower's capacity and willingness to pay, and
projections of prospective cash flows based on property-specific events. For
loans held in our Affordable Housing business, we project the amounts to be
realized from the disposition of the property to determine the appropriate
allowance for loan losses. We also analyze the historical trends in the gains or
losses on disposition and resolution of loans as compared to the allowance for
loan losses at the time of disposition and resolution. The results of this
analysis are also taken into consideration in evaluating the allowance for loan
losses on the remaining loans. The allowance for loan losses is management's
best estimate of probable inherent loan losses incurred as of
September 30, 2004.
The following table presents the provisions for loan losses by business
segment for the periods indicated:
Three Months Nine Months
------------------- -------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------- -------- -------- -------- --------
Loans:
Commercial Assets ............... $ -- $ 393 $ (764) $ (3,064)
Affordable Housing .............. 1 1 (28) 149
Corporate Items and Other ....... (6) 65 (27) 286
-------- -------- -------- --------
(5) 459 (819) (2,629)
Match funded loans:
Corporate Items and Other ....... (89) (44) (94) (41)
-------- -------- -------- --------
$ (94) $ 415 $ (913) $ (2,670)
======== ======== ======== ========
The negative loan loss provision for 2004 primarily reflects a reduction
in non-performing loans in the Commercial Assets segment. Our allowance for loan
losses as a percentage of non-performing loans has increased from 38.7% at
December 31, 2003 to 66.9% at September 30, 2004. Overall, our allowance as a
percentage of loans increased from 23.2% at December 31, 2003 to 33.0% at
September 30, 2004. The negative provision that we recorded during 2003 results
primarily from the recovery of reserves on sales of loans in the Commercial
Assets segment during the second quarter. For additional information, see
"Changes in Financial Condition - Loans, Net" and "Allowance for Loan Losses".
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Non-Interest Expense. The following table sets forth the principal
components of our non-interest expense during the periods indicated:
Three Months Nine Months
---------------------- -----------------------
For the periods ended September 30, 2004 2003 2004 2003
- --------------------------------------------- --------- --------- ---------- ---------
Compensation and employee benefits .......... $ 21,300 $ 17,667 $ 64,229 $ 52,505
Occupancy and equipment ..................... 3,981 3,254 11,999 8,769
Technology and communication costs .......... 6,190 5,583 19,476 14,577
Loan expenses ............................... 6,885 3,835 22,272 10,836
Loss (gain) on investments in
affordable housing properties .............. (100) 4 (179) 319
Professional services and regulatory fees ... 3,187 2,510 16,328 21,854
Other operating expenses .................... 2,635 2,173 7,890 7,023
--------- --------- ---------- ---------
$ 44,078 $ 35,026 $ 142,015 $ 115,883
========= ========= ========== =========
Compensation and Employee Benefits. The following table presents the
principal components of compensation and benefits we incurred for the periods
indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- ----------- ----------- ----------- -----------
Salaries (1) ............................ $ 14,643 $ 12,487 $ 43,339 $ 36,116
Bonuses (2) ............................. 2,673 2,364 7,882 7,607
Payroll taxes ........................... 899 837 3,601 2,861
Commissions ............................. 1,374 597 3,941 1,398
Insurance ............................... 556 554 1,784 1,628
Severance ............................... 33 89 1,012 906
Other (3) ............................... 1,122 739 2,670 1,989
----------- ----------- ----------- -----------
$ 21,300 $ 17,667 $ 64,229 $ 52,505
=========== =========== =========== ===========
(1) Salaries include fees paid for the services of temporary employees.
(2) Bonus expense includes compensation related to employee incentive awards
of restricted stock and stock options.
(3) Other consists primarily of recruiting expenses, matching contributions
to our 401(K) plan and fees paid to directors.
The increase in compensation and benefits in the 2004 periods as
compared to the 2003 periods is primarily due to increases in salaries and
commissions. The increase in salaries and commissions has occurred primarily
because of an increase in the average number of our full-time employees, both in
the U.S. and our India offices. Our total combined workforce (domestic and
international) averaged 2,935 employees in the third quarter of 2004 as compared
to 2,120 for the third quarter of 2003. For the year to date periods, our total
number of employees averaged 2,754 and 1,983 in 2004 and 2003, respectively. An
average of approximately 1,822 and 1,225 employees were based in our India
locations during the third quarter of 2004 and 2003, respectively. For the nine
months ended September 30, 2004 and 2003, our India workforce averaged 1,642 and
1,054, respectively. Our reassumption of certain collection activities in the
Residential Loan Servicing segment, which were previously outsourced to a
third-party vendor, contributed to the growth in headcount and resulting
increase in salaries and commissions. Severance for 2004 includes a one-time
payment of $750 during the first quarter to the former president of OTX in
accordance with the terms of his employment agreement.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Occupancy and Equipment. The following table presents the principal
components of occupancy and equipment costs for the periods indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- ----------- ----------- ----------- -----------
Postage and mailing ..................... $ 1,491 $ 1,304 $ 4,332 $ 3,380
Rent .................................... 691 904 2,079 2,640
Depreciation ............................ 649 687 2,017 2,080
Other (1) ............................... 1,150 359 3,571 669
----------- ----------- ----------- -----------
$ 3,981 $ 3,254 $ 11,999 $ 8,769
=========== =========== =========== ===========
(1) The increase in other occupancy and equipment costs is primarily the
result of our reassuming certain collection activities in our
Residential Loan Servicing segment during the fourth quarter of 2003
that were previously performed by a third party vendor.
Technology and Communication Costs. The following table presents the
principle components of technology and communication costs for the years
indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- ----------- ----------- ----------- -----------
Depreciation:
Hardware .............................. $ 1,469 $ 1,545 $ 4,564 $ 5,191
Software .............................. 716 597 2,150 1,830
Other ................................. 215 135 504 348
----------- ----------- ----------- -----------
2,400 2,277 7,218 7,369
----------- ----------- ----------- -----------
Telecommunications ...................... 1,725 1,506 5,013 4,272
Contract service and maintenance ........ 761 1,030 2,381 2,362
Other (1) ............................... 1,304 770 4,864 574
----------- ----------- ----------- -----------
$ 6,190 $ 5,583 $ 19,476 $ 14,577
=========== =========== =========== ===========
(1) The increase in other technology and communication costs is largely due
to our reassuming certain collection activities in our Residential Loan
Servicing segment during the fourth quarter of 2003 that were previously
performed by a third party vendor.
Loan Expenses. Loan expenses are primarily comprised of appraisal fees
incurred in connection with property valuation services we provided through ORA,
which amounted to $4,415 and $2,865 for the three months ended September 30,
2004 and 2003, respectively. For the nine month periods of 2004 and 2003, these
appraisal fees were $16,525 and $7,697, respectively. The increase in ORA
appraisal fees in the 2004 periods reflects an increase in the volume of
property appraisals completed, primarily in connection with the VA contract. See
"Segment Profitability - Ocwen Realty Advisors" for additional discussion of
these costs. Loan expenses also include other miscellaneous expenses incurred in
connection with loans we own and those we service for others.
Professional Services and Regulatory Fees. The following table presents
the principal components of professional services and regulatory fees for the
periods indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- ----------- ----------- ----------- -----------
Legal fees and settlements (1) .......... $ 1,109 $ 1,143 $ 9,437 $ 16,351
Consulting fees (non-technology) ........ 547 433 1,805 1,655
Audit and accounting fees ............... 610 65 1,742 982
Corporate insurance ..................... 380 289 1,178 1,125
Other ................................... 541 580 2,166 1,741
----------- ----------- ----------- -----------
$ 3,187 $ 2,510 $ 16,328 $ 21,854
=========== =========== =========== ===========
(1) The $6,914 decline in legal fees and settlements in the nine months
ended September 30, 2004 as compared to 2003 is primarily the result of
a $10,000 charge recorded during the first quarter of 2003 in connection
with the arbitration award to the former owners of Admiral Home Loan.
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Other Operating Expenses. The following table presents the principal
components of other operating expenses for the periods indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ------------------------------------------- ----------- ----------- ----------- -----------
Bad debt expense (1) ...................... $ 850 $ 59 $ 2,619 $ 256
Travel, lodging, meals and entertainment .. 815 695 2,430 2,010
Amortization of deferred costs ............ 325 223 749 900
Deposit related expense ................... 224 303 548 700
Other ..................................... 421 893 1,544 3,157
----------- ----------- ----------- -----------
$ 2,635 $ 2,173 $ 7,890 $ 7,023
=========== =========== =========== ===========
(1) Bad debt expense for 2004 includes a provision of $1,393 recorded during
the first quarter for estimated uncollectible servicing advances and
other receivables related to our Residential Loan Servicing segment.
Distributions on Company Obligated, Mandatorily Redeemable Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company.
Cash distributions on the Capital Securities are payable semi-annually in
arrears on February 1 and August 1 of each year at an annual rate of 10.875%. We
recorded $1,529 of such distributions to holders of the Capital Securities
during the three months ended September 30, 2004 and 2003, and distributions of
$4,587 during the nine months ended September 30, 2004 and 2003. Effective July
1, 2003 with our adoption of SFAS No. 150, these distributions are reported in
the consolidated statement of operations as interest expense. See Note 3 to the
Interim Consolidated Financial Statements.
Income Tax Expense (Benefit). The following table provides details of
our income tax expense (benefit) for the periods indicated:
Three Months Nine Months
------------------------- -------------------------
For the periods ended September 30, 2004 2003 2004 2003
- ----------------------------------------- ----------- ----------- ----------- -----------
Income tax expense (benefit) on income
(loss) before taxes .................... $ 3,074 $ 1,035 $ 7,350 $ (957)
Provision for valuation allowance on
current year's deferred tax asset ...... 2,066 (1,029) (2,144) 1,575
----------- ----------- ----------- -----------
5,140 6 5,206 618
Partial reversal of valuation allowance
on prior year's deferred tax asset ..... (36,985) -- (36,985) --
----------- ----------- ----------- -----------
Total income tax expense (benefit) ...... $ (31,845) $ 6 $ (31,779) $ 618
=========== =========== =========== ===========
The $36,985 reduction in the valuation allowance on the prior year's
deferred tax asset is a result of refund claims filed with the IRS that reduced
our gross deferred tax asset and increased our income tax receivable balance by
the same amount. These refund claims, which were affirmed in writing by the IRS
agent during the third quarter of 2004, arose because of changes in the tax law
that allowed us to carry back net operating losses from 2001 and 2002 to taxes
paid in earlier years. See "Receivables" for additional information regarding
our refund claims and related income taxes receivable. Reversal of all or a
portion of the remaining valuation allowance, which amounted to $162,314 at
September 30, 2004, may occur in the future based on the results of our
operations. The provision for deferred tax asset valuation allowance is a
non-cash charge that we recorded to increase the aggregate valuation allowance.
We estimated this valuation allowance based on our assessment of the portion of
the deferred tax asset that will more likely than not be realized.
Excluding foreign taxes, non-economic tax residual payments and the
valuation allowance reduction, our federal effective tax rate was 20% and (162)%
for the year to date periods of 2004 and 2003, respectively, and reflected tax
credits of $3,507 and $1,795, respectively. Although we have substantial unused
tax credits available to reduce the liability arising from income taxes on our
current year income, tax credits can be used to reduce income tax expense only
to the corporate alternative minimum tax rate of 20% of taxable income.
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
CHANGES IN FINANCIAL CONDITION
Trading Securities. The following table sets forth the fair value of our
trading securities at the dates indicated:
September 30, December 31,
2004 2003
------------- -------------
Investment grade securities:
U.S. government and sponsored enterprise
securities ............................... $ 1,651 $ 6,679
Auction rate securities (AAA-rated) ....... 96,528 --
------------- -------------
$ 98,179 $ 6,679
============= =============
Subordinates and residuals:
Single family residential
BB-rated subordinates ................... $ 259 $ 579
B-rated subordinates .................... 460 580
Unrated subordinates .................... 232 222
Unrated subprime residuals .............. 35,834 38,883
------------- -------------
36,785 40,264
Commercial unrated subordinates ........... 3,525 2,577
------------- -------------
$ 40,310 $ 42,841
============= =============
Subordinate and residual interests in mortgage-related securities
provide credit support to the more senior classes of the mortgage-related
securities. Principal from the underlying mortgage loans generally is allocated
first to the senior classes, with the most senior class having a priority right
to the cash flow from the mortgage loans until its payment requirements are
satisfied. To the extent that there are defaults and unrecoverable losses on the
underlying mortgage loans, resulting in reduced cash flows, the most subordinate
security will be the first to bear this loss. Because subordinate and residual
interests generally have no credit support, to the extent there are realized
losses on the mortgage loans comprising the mortgage collateral for such
securities, we may not recover the full amount or, indeed, any of our remaining
investment in such subordinate and residual interests.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
The following table presents information regarding our subordinate and
residual trading securities summarized by classification and rating at September
30, 2004:
ANTICIPATED ANTICIPATED ANTICIPATED
YIELD TO YIELD TO WEIGHTED
PERCENT MATURITY AT MATURITY AT AVERAGE
OWNED PURCHASE 09/30/2004 REMAINING
RATING/DESCRIPTION (1) BY OCWEN (2) (3) (2) (4) COUPON LIFE (2) (5)
- ------------------------------------- -------- ----------- ----------- -------- ------------
Residential:
BB-rated subordinates ........... 100.00% 19.23% 10.75% 6.75% 3.53
B-rated subordinates ............ 100.00% 17.14% 18.14% 5.86% 1.85
Unrated subordinates ............ 100.00% 13.97% 40.33% 6.64% 0.15
Unrated subprime residuals ...... 100.00% 17.23% 10.40% N/A 4.32
Commercial:
Unrated subordinates ............ 25.00% 22.15% 14.23% N/A 1.83
(1) Refers to the credit rating designated by the rating agency for each
securitization transaction. Classes designated "A" have a superior claim
on payment to those rated "B." Additionally, multiple letters have a
superior claim to designations with fewer letters. Thus, for example,
"BBB" is superior to "BB," which in turn is superior to "B." The lower
class designations in any securitization will receive interest payments
after senior classes and will experience losses before any senior class.
The lowest potential class designation is "unrated" which, if included
in a securitization, will always receive interest last and experience
losses first.
(2) Subordinate and residual securities do not have a contractual maturity
but are paid down over time as cash distributions are received. Because
they do not have a stated maturity, we disclose the weighted average
life of these securities.
(3) Represents the effective yield from inception to maturity based on the
purchase price and anticipated future cash flows under pricing
assumptions.
(4) Represents the effective yield based on the purchase price, actual cash
flows received from inception until the respective date, and the then
current estimate of future cash flows under the assumptions at the
respective date. Changes in the September 30, 2004 anticipated yield to
maturity from that originally anticipated are primarily the result of
changes in prepayment assumptions and loss assumptions.
(5) Represents the weighted average life in years based on the September 30,
2004 book value.
The mortgages that underlie our trading subordinate and residual
securities, which totaled $305,344 at September 30, 2004, are secured by
properties located in forty-nine states and the United Kingdom. The aggregate
value of mortgages in any one state or country did not exceed $52,078.
Real Estate. Our real estate totaled $68,480 or 5.3% of total assets at
September 30, 2004 and consisted of the following at the dates indicated:
September 30, December 31,
2004 2003
------------- -------------
Properties:
Office building ........................... $ -- $ 41,467
Retail .................................... 57,002 57,321
Hotel ..................................... 6,206 6,171
Single family residential ................. 512 882
------------- -------------
63,720 105,841
Accumulated depreciation .................. (3,964) (7,118)
------------- -------------
59,756 98,723
Investment in real estate partnerships ...... 8,724 5,220
------------- -------------
$ 68,480 $ 103,943
============= =============
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Properties. Properties at September 30, 2004 consisted primarily of one
shopping center located in Halifax, Nova Scotia, one shopping mall located in
Florida and one hotel located in Michigan. The shopping mall, which had a
carrying value of $44,169 at September 30, 2004, and the hotel were originally
acquired as a result of loan foreclosures. The $38,967 decline in the carrying
value of our properties during the nine months ended September 30, 2004 was
primarily due to the sale of our office building, which had a carrying value of
$37,553 at December 31, 2003, and $2,847 of charges we recorded to reflect
declines in fair value. We have entered into contracts to sell all three of our
commercial properties. The sale of our shopping mall in Florida closed in
November 2004, while the sales of our other two properties have not yet closed
and are subject to due diligence and other contingencies.
Investment in Real Estate Partnerships. Our investment at both September
30, 2004 and December 31, 2003 consisted of interests in two limited
partnerships operating as real estate ventures, consisting of multi-family type
properties. At December 31, 2003 we also had loans with combined net book value
of $4,771 ($6,811 before discount and allowance for loan losses) due from one of
the real estate ventures. During the first quarter of 2004 our loans to the
venture were forgiven in exchange for an increased investment in the
partnership. During the three and nine months ended September 30, 2004, we
recorded impairment charges of $121 and $1,105, respectively, related to one of
our partnership interests. See "Loans, Net" below.
Loans, Net. Our total net investment in loans of $11,459 at September
30, 2004 represents 0.9% of total assets. Originations in 2004 represent loans
we made to facilitate sales of real estate assets we owned. The decline in our
investment reflects our strategy to dispose of these non-core assets.
Composition of Loans, Net. The following table sets forth the
composition of our loans by business segment and type of loan at the dates
indicated:
September 30, December 31,
2004 2003
------------- -------------
Commercial Assets:
- ------------------
Hotels .................................... $ -- $ 10,600
Multifamily residential ................... 8,153 14,964
------------- -------------
8,153 25,564
Unaccreted discount and deferred fees ..... -- (1,015)
Allowance for loan losses ................. (1,019) (3,786)
------------- -------------
7,134 20,763
------------- -------------
Affordable Housing:
- -------------------
Multifamily residential (1) ............... 8,016 10,924
Unsecured ................................. 200 200
------------- -------------
8,216 11,124
Allowance for loan losses ................. (4,552) (4,579)
------------- -------------
3,664 6,545
------------- -------------
Corporate Items and Other:
- --------------------------
Single family residential ................. 1,158 1,307
Unaccreted discount and deferred fees ..... (422) (412)
Allowance for loan losses ................. (75) (105)
------------- -------------
661 790
------------- -------------
Loans, net .................................. $ 11,459 $ 28,098
============= =============
(1) Loans we made to affordable housing properties in which we have invested
as a limited partner but do not consolidate in our financial statements.
Our mortgage loans at September 30, 2004 are secured by mortgages on
property located in 14 states throughout the United States, none of which
aggregated over $3,773 in any one state.
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Activity in Loans. The following table sets forth our loan activity at
the dates indicated:
Balance at December 31, 2003 .......................... $ 28,098
Originations and repurchases (1) ...................... 16,033
Resolutions and repayments (2) ........................ (29,662)
Other (3) ............................................. (6,841)
Decrease (increase) in discount and deferred fees ..... 1,005
Decrease (increase) in allowance for loan losses ...... 2,826
-----------
Balance at September 30, 2004 ......................... $ 11,459
===========
(1) Originations represent loans made to facilitate sales of our own assets
and fundings of construction loans we originated in prior years.
Originations include a loan in the amount of $15,500 made during the
first quarter to facilitate the sale of our office building in
Jacksonville, Florida. This loan was repaid during the second quarter.
See "Real Estate". Repurchases represent acquisitions of single-family
residential discount loans previously sold.
(2) Resolutions and repayments consists of loans that were resolved in a
manner which resulted in partial or full repayment of the loan to us, as
well as principal payments on loans which have been brought current in
accordance with their original or modified terms (whether pursuant to
forbearance agreements or otherwise) or on other loans that have not
been resolved.
(3) As discussed in the "Real Estate" section, our loans to a real estate
partnership in which we also had an equity ownership interest were
converted to an increased investment in the partnership.
The following table sets forth certain information related to our
non-performing loans at the dates indicated:
September 30, December 31,
2004 2003
------------- -------------
Non-performing loans (1) .................... $ 8,439 $ 21,898
Non-performing loans as a percentage of: (1)
Total loans (2) ........................... 49.3% 59.9%
Total assets .............................. 0.7% 1.8%
Allowance for loan losses as a percentage of:
Total loans (2) ........................... 33.0% 23.2%
Non-performing loans (1) .................. 66.9% 38.7%
(1) Loans which are contractually past due 90 days or more in accordance
with the original terms of the loan agreement. We do not accrue interest
on loans past due 90 days or more.
(2) Total loans are net of unaccreted discount, unamortized deferred fees
and undisbursed loan funds.
See "Changes in Financial Condition - Allowance for Loan Losses" below
for additional information regarding the allowance for loan losses.
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Allowances for Loan Losses. As discussed in the "Results of Operations -
Provision for Loan Losses" section, we maintain an allowance for loan losses for
each of our loans at a level that we consider adequate to provide for probable
losses based upon an evaluation of known and inherent risks. The following table
sets forth (a) the breakdown of the allowance for loan losses and loan balance
in each segment and (b) the percentage of allowance and loans in each segment to
totals in the respective segments at the dates indicated:
September 30, 2004 December 31, 2003
----------------------------------------- -----------------------------------------
Allowance Loan Balance Allowance Loan Balance
------------------- ------------------- ------------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent
-------- -------- -------- -------- -------- -------- -------- --------
Loans:
Commercial Assets .......... $ 1,019 18.1% $ 8,153 47.7% $ 3,786 44.7% $ 24,549 67.1%
Affordable Housing ......... 4,552 80.6% 8,216 48.0% 4,579 54.1% 11,124 30.4%
Corporate Items and Other .. 75 1.3% 736 4.3% 105 1.2% 895 2.5%
-------- -------- -------- -------- -------- -------- -------- --------
$ 5,646 100.0% $ 17,105 100.0% $ 8,470 100.0% $ 36,568 100.0%
======== ======== ======== ======== ======== ======== ======== ========
Match funded loans:
Corporate Items and Other .. $ -- --% $ -- --% $ 94 100.0% $ 24,393 100.0%
Commercial Servicing ....... -- --% 2,173 100.0% -- --% -- --%
-------- -------- -------- -------- -------- -------- -------- --------
$ -- --% $ 2,173 100.0% $ 94 100.0% $ 24,393 100.0%
======== ======== ======== ======== ======== ======== ======== ========
The allocation of the allowance to each category is not necessarily
indicative of future losses and does not restrict use of the allowance to absorb
losses in any other category.
The following table sets forth an analysis of activity in the allowance
for losses relating to our loans and match funded loans at the dates indicated:
Balance at December 31, 2003 .......................... $ 8,564
Provision for loan losses ............................. (913)
Charge-offs ........................................... (2,005)
-----------
Balance at September 30, 2004 ......................... $ 5,646
===========
Match Funded Assets. Match funded assets are comprised of the following
at the dates indicated:
September 30, December 31,
2004 2003
------------- -------------
Match funded advances on loans serviced for
others:
Principal and interest .................... $ 54,678 $ 54,516
Taxes and insurance ....................... 30,598 30,176
Other ..................................... 20,879 21,096
------------- -------------
106,155 105,788
------------- -------------
Commercial loans ............................ 2,173 --
Single family residential loans ............. -- 24,393
Allowance for loan losses ................... -- (94)
------------- -------------
Match funded loans, net ................... 2,173 24,299
------------- -------------
$ 108,328 $ 130,087
============= =============
Match funded advances on loans serviced for others resulted from the
transfer of certain residential loan servicing related advances to a third party
in exchange for cash. The original and subsequent transfers did not qualify as a
sale for accounting purposes since we retained effective control of the
advances. Accordingly, we report the amount of proceeds we received from the
transfers as a secured borrowing with pledge of collateral (bonds-match funded
agreements). See "Bonds-Match Funded Agreements".
Commercial match funded loans held by our GSS subsidiary in Japan
resulted from the transfer, on a non-recourse basis, of an undivided 100%
participation interest in certain real estate loans to a Japanese subsidiary of
Merrill Lynch on March 30, 2004 in exchange for cash. The transfer did not
qualify as a sale for accounting purposes as we did not meet all of the
conditions for surrender of control over the transferred loans. Accordingly, we
report the amount of proceeds we received from the transfer as a secured
borrowing with pledge of collateral (bonds-match funded agreements).
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
During the third quarter of 2004, we exercised our option to redeem the
notes (bonds-match funded agreements) thereby causing the termination and
liquidation of the trust. Upon redemption of the notes, the loans were released
from the Trust and were sold by us to a third party. We acquired these
single-family residential match funded loans in connection with our acquisition
of OAC. OAC had previously securitized these loans in 1998 and transferred them
to a real estate mortgage investment conduit (the "Trust") which then issued two
classes of notes secured by the loans. The transfer did not qualify as a sale
for accounting purposes since we retained effective control of the loans
transferred. Accordingly, we have reported the proceeds that we received from
the transfer as a liability (bonds-match funded agreements). Each class of the
notes was subject to redemption at our option when the remaining aggregate
principal balance of the loans had declined to less than 20% of the initial
aggregate principal balance of the loans at the transfer date.
Advances on Loans and Loans Serviced for Others. Advances consisted of
the following at the dates indicated:
September 30, December 31,
2004 2003
------------- -------------
Loans ......................................... $ 352 $ 436
Loans serviced for others ..................... 345,593 374,333
------------- -------------
$ 345,945 $ 374,769
============= =============
During any period in which the borrower is not making payments, we are
required under certain servicing agreements to advance our own funds to meet
contractual principal and interest remittance requirements for certain
investors, pay property taxes and insurance premiums and process foreclosures.
We generally recover such advances from borrowers for reinstated and performing
loans and from investors for foreclosed loans. We record a charge to the extent
that we estimate that advances are uncollectible, taking into consideration the
age and nature of the advance and our historical loss experience, among other
factors. The balances of advances on loans serviced for others do not include
match funded advances that are transferred to a third party in a transaction
that does not qualify as a sale for accounting purposes and that we account for
as a secured borrowing. See "Match Funded Assets".
Mortgage Servicing Rights. The unamortized balance of our mortgage
servicing rights is primarily related to residential assets. Our investment
decreased by $31,176 during the nine months ended September 30, 2004 as
amortization exceeded purchases. The rate of amortization reflects increased
projected prepayment volumes on subprime residential mortgage loans. The
following table sets forth the activity in our mortgage servicing rights at the
dates indicated:
Balance at December 31, 2003 .......................... $ 166,495
Purchases (1) ......................................... 39,997
Amortization .......................................... (71,173)
-----------
Balance at September 30, 2004 ......................... $ 135,319
===========
(1) Purchases for the nine months ended September 30, 2003 totaled $78,971.
The decline in the 2004 period reflects the more cautious acquisition
strategy that we adopted given the uncertainty of prepayment speeds in
the current environment. In addition, we have commitments with the OTS
to maintain our investment in mortgage servicing rights at certain
levels. See Note 5 to the Interim Consolidated Financial Statements and
"General - Banking Operations" for additional information regarding
these commitments.
At September 30, 2004, we serviced loans under approximately 338
servicing agreements for 22 investors. Purchases during the nine months ended
September 30, 2004 were all for residential assets.
43
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Receivables. Receivables consisted of the following at the dates
indicated:
September 30, December 31,
2004 2003
------------- -------------
Residential Loan Servicing (1) .............. $ 19,738 $ 18,564
OTX ......................................... 3,033 1,442
Ocwen Realty Advisors ....................... 3,469 962
Ocwen Recovery Group ........................ 289 260
Business Process Outsourcing ................ 2,131 969
Commercial Servicing ........................ 2,120 1,324
Commercial Assets ........................... 507 2,848
Affordable Housing (2) ...................... 15,767 25,581
Corporate Items and Other (3) ............... 67,446 36,207
------------- -------------
$ 114,500 $ 88,157
============= =============
(1) Consist principally of fees earned and reimbursable expenses due from
investors.
(2) Primarily represents payments in future years of proceeds from the sale
of investments in affordable housing properties, net of an unaccreted
discount of $2,171 and $2,901 at September 30, 2004 and December 31,
2003, respectively. Balances are net of reserves for doubtful accounts.
The decline in the balance during 2004 is primarily due to scheduled
installment payments received.
(3) Includes $55,526 and $21,465 at September 30, 2004 and December 31,
2003, respectively, of federal tax refund claims, which are pending
approval that is required by the Joint Committee on taxation of the U.S.
Congress before the claims can be paid. We have received written
findings from the IRS agent that validate the $55,526 of claims due to
us. These claims have been sent to the Joint Committee for final review
and approval of the payment to us. The receivables balance at September
30, 2004 also includes accrued interest of $6,476 on the federal tax
refund claims. At December 31, 2003, the receivables balance for this
segment also included amounts related to our overnight collection
account activities.
Other Assets. Other assets consisted of the following at the dates
indicated:
September 30, December 31,
2004 2003
------------- -------------
Loans held for resale (1) .......................... $ 12,060 $ --
Interest earning insurance collateral deposits (2).. 8,865 8,813
Deferred debt related costs, net (3) ............... 8,609 3,114
Deferred tax assets, net (4) ....................... 8,209 7,547
Goodwill, net (5) .................................. 7,732 1,618
Investments (6) .................................... 7,079 4,293
Deposits on purchases of mortgage servicing rights.. 1,716 --
Capitalized software development costs, net ........ 1,446 2,599
Other (7) .......................................... 17,907 5,623
------------- -------------
$ 73,623 $ 33,607
============= =============
(1) Loans originated in response to requests from Residential Loan Servicing
customers to refinance their mortgage. Only loans with sales commitments
prior to closing are originated under this program. During October 2004,
approximately $10,900 of these loans were sold.
(2) These deposits were required in order to obtain surety bonds for
affordable housing properties that we sold before the end of the
fifteen-year tax credit amortization period, and on which we have
previously claimed tax credits on our income tax returns. The surety
bond is necessary in order to avoid the recapture of those tax credits
previously claimed.
(3) The $5,495 increase in net deferred debt related costs during the nine
months ended September 30, 2004 is primarily the result of capitalized
costs directly related to our issuance of the $175,000 Convertible Notes
on July 28, 2004. The unamortized balance of these issuance costs
amounted to $5,832 at September 30, 2004. See Note 3 to our Interim
Consolidated Financial Statements for additional information regarding
the Convertible Notes.
44
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
(4) Deferred tax assets are net of valuation allowances of $162,314 and
$201,445 at September 30, 2004 and December 31, 2003, respectively. See
"Results of Operations - Income Tax Expense (Benefit)".
(5) The increase in goodwill during 2004 is the result of our acquisition on
September 30, 2004 of Bankhaus Oswald Kruber KG, a bank located in
Germany. The purchase price, plus acquisition costs, exceeded the net
assets acquired by approximately $6,100. For additional information
regarding this acquisition, see Note 9 to our Interim Consolidated
Financial Statements.
(6) The $2,786 increase in the balance during the nine months ended
September 30, 2004 primarily represents an investment by the Bank in a
mutual fund that invests in assets that meet the requirements under the
Community Reinvestment Act.
(7) Includes $13,961 and $1,128 of miscellaneous other assets and prepaid
expenses of the Residential Loan Servicing segment at September 30, 2004
and December 31, 2003, respectively.
Deposits. The following table sets forth information related to our
deposits at the dates indicated:
September 30, 2004 December 31, 2003
----------------------------------------- ----------------------------------------
Weighted Weighted
Average % of Total Average % of Total
Amount Rate Deposits Amount Rate Deposits
----------- ----------- ----------- ----------- ----------- -----------
Non-interest bearing checking accounts.. $ 16,007 --% 3.9% $ 4,879 --% 1.1%
NOW and money market checking accounts.. 20,835 0.75% 5.0% 18,313 0.90% 4.1%
Savings accounts ....................... 1,645 0.75% 0.4% 1,657 1.00% 0.4%
----------- ----------- ----------- -----------
38,487 9.3% 24,849 5.6%
----------- -----------
Certificates of deposit (1) (2) ........ 373,630 421,657
Unamortized deferred fees .............. -- (118)
----------- -----------
Total certificates of deposit .......... 373,630 3.09% 90.7% 421,539 3.41% 94.4%
----------- ----------- ----------- -----------
$ 412,117 100.0% $ 446,388 100.0%
=========== =========== =========== ===========
(1) Included $40,114 and $84,393 at September 30, 2004 and December 31,
2003, respectively, of brokered deposits originated through national,
regional and local investment banking firms that solicit deposits from
their customers, all of which are non-cancelable.
(2) At September 30, 2004 and December 31, 2003, certificates of deposit
with outstanding balances of $100 or more amounted to $144,724 and
$142,408, respectively. Of those deposits at September 30, 2004, $8,800
were from political subdivisions in New Jersey and were secured or
collateralized as required under state law. The basic insured amount of
a depositor is $100. Deposits maintained in different categories of
legal ownership are separately insured.
The following table sets forth the remaining maturities of our time
deposits with balances of $100 or more at September 30, 2004:
Matures within three months ................................... $ 47,907
Matures after three months through six months ................. 51,076
Matures after six months through twelve months ................ 10,139
Matures after twelve months ................................... 35,602
-----------
$ 144,724
===========
Escrow Deposits. Escrow deposits on our loans and loans we serviced for
others amounted to $146,074 and $116,444 at September 30, 2004 and December 31,
2003, respectively. The balance consisted principally of custodial deposit
balances representing collections that we made from borrowers for the payment of
taxes and insurance premiums on mortgage properties underlying loans that we
serviced for others. Such balances amounted to $124,337 and $96,924 at September
30, 2004 and December 31, 2003, respectively. See "Results of Operations -
Non-Interest Income - Servicing and Related Fees".
45
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Bonds-Match Funded Agreements. Bonds-match funded agreements represent
proceeds received from transfers of loans and advances on loans serviced for
others. Because we retained effective control over the assets transferred, these
transfers did not qualify as sales for accounting purposes, and therefore we
report them as secured borrowing with pledges of collateral. See "Match Funded
Assets" for additional details regarding these transactions. Bonds-match funded
agreements were comprised of the following at the dates indicated:
September 30, December 31,
Collateral (Interest Rate) Interest Rate 2004 2003
- ----------------------------------------- ----------------------------- ------------- -------------
Advances on loans serviced for others (1) LIBOR plus 175 basis points $ 95,539 $ 94,967
Commercial loans 2,173 --
Single family loans (2) LIBOR plus 65-70 basis points -- 20,427
------------- -------------
$ 97,712 $ 115,394
============= =============
(1) Under the terms of the agreement, we are eligible to sell additional
advances on loans serviced for others up to a maximum balance of
$200,000.
(2) During the third quarter of 2004, we exercised our option to redeem the
bonds-match funded agreements that were secured by single family loans.
See "Match Funded Assets".
Lines of Credit and Other Secured Borrowings. We have obtained secured
borrowings from unaffiliated financial institutions as follows:
September 30, December 31,
Borrowing Type Collateral Maturity Interest Rate (1) 2004 2003
- --------------------- -------------------------- ------------- ---------------------- ------------- --------------
Line of credit Advances on loans serviced March 2004 LIBOR + 200 basis $ -- $ 68,548
for others (2) points
Secured loan Trading securities - UK November 2004 LIBOR + 275 basis 3,888 11,562
unrated subprime residual points
securities (3)
Installment notes Purchased mortgage July 2004 2.81% -- 2,332
servicing rights
Line of credit Advances on loans serviced (4) LIBOR + 200 basis -- 9,386
for others points
Term loan Loan receivable (4) LIBOR + 250 basis -- 3,235
points
Senior secured credit Purchased mortgage April 2005 LIBOR + 162.5 or 225 19,114 35,321
agreement servicing rights and basis points
advances on loans
serviced for others (5)
Mortgage note Real estate - office (6) LIBOR + 350 basis -- 20,000
building points, floor of 5.75%
Senior secured credit Purchased mortgage December 2005 LIBOR + 250 basis
agreement servicing rights points 12,500 --
------------- --------------
$ 35,502 $ 150,384
============= ==============
(1) 1-month LIBOR was 1.84% and 1.12% at September 30, 2004 and December 31,
2003, respectively.
(2) This line was fully repaid during the first quarter of 2004 and was not
renewed upon maturity.
(3) The outstanding principal balance has been reduced through the
assignment of principal and interest payments received on the unrated
subprime residual securities.
(4) This borrowing was repaid prior to its contractual maturity.
(5) Subsequent to December 31, 2003, the original maturity date of April
2004 was extended to April 2005, and the maximum amount of borrowing
under this facility was increased from $60,000 to $70,000.
(6) We sold our office building in January 2004, and the buyer assumed this
note at that time.
46
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Each of our credit facilities provides qualitative and quantitative
covenants that establish, among other things, the maintenance of specified net
worth and liquidity, and restrictions on future indebtedness, as well as the
monitoring and reporting of various specified transactions or events.
Debt Securities. Notes consist of the following at the dates indicated:
September 30, 2004 December 31, 2003
------------------ ------------------
3.25% Contingent Convertible Senior Unsecured
Notes due August 1, 2024 .......................... $ 175,000 $ --
10.875% Capital Securities due August 1, 2027 (1)... 56,249 56,249
------------------ ------------------
$ 231,249 $ 56,249
================== ==================
On July 28, 2004, OCN issued $175,000 aggregate principal amount of
3.25% Contingent Convertible Senior Unsecured Notes due 2024 ("Convertible
Notes") in a private placement under the Securities Act of 1933, as amended. The
Convertible Notes are senior unsecured obligations and bear interest at the rate
of 3.25% per year. Interest is payable on February 1 and August 1 of each year,
beginning on February 1, 2005. The Convertible Notes will be convertible at the
option of the holder thereof under certain circumstances into shares of our
common stock at an initial conversion rate of 82.1693 shares per $1 principal
amount of the Convertible Notes, subject to adjustment. Upon conversion, we may
at our option choose to deliver, in lieu of common stock, cash or a combination
of cash and common stock. See Note 3 to our Interim Consolidated Financial
Statements for additional details regarding the Convertible Notes.
(1) See Note 3 to our Interim Consolidated Financial Statements for
additional details regarding the Capital Securities.
Stockholders' Equity. Stockholders' equity increased $9,666 during the
nine months ended September 30, 2004. The increase was primarily due to net
income of $55,159 and the issuance of common stock resulting from exercises of
stock options, offset by our repurchase of 5,481,100 shares of common stock in
the amount of $49,449 during the third quarter. See the Consolidated Statements
of Changes in Stockholders' Equity in the Interim Consolidated Financial
Statements.
Information regarding purchases of our own securities during the nine
months ended September 30, 2004 is as follows:
Total Number of Shares Maximum Number of
Purchased as Part of Shares That May Yet Be
Average Share Publicly Announced Purchased under The
Period Number of Shares Price Paid Plans (1) (2) Plans
------ ---------------- ---------- -------------- ---------------------
July 28 - 30, 2004 4,876,300 $ 9.02 4,876,300 173,700
August 2 - 31, 2004 275,300 $ 8.67 173,700 --
September 1 - 23, 2004 329,500 $ 9.34 -- --
--------------- --------------
Total 5,481,100 5,050,000
=============== ==============
(1) Shares were repurchased under the following plans:
(a) A plan was announced July 27, 2004 to repurchase 4,850,000
shares of common stock using 25% of the gross proceeds from the
sale of our Convertible Notes. See Note 3 to our Interim
Consolidated Financial Statements. As of September 30, 2004, no
shares remain to be repurchased under this plan.
(b) A plan was announced May 16, 2003 to repurchase up to 700,000
shares of common stock to be used in connection with our annual
incentive awards to employees. As of September 30, 2004, no
shares remain to be repurchased under this plan.
(2) We repurchased 431,100 shares under an unannounced plan to repurchase up
to 1,000,000 shares of common stock. These purchases were made in open
market transactions.
LIQUIDITY, COMMITMENTS AND OFF-BALANCE SHEET RISKS
Our primary sources of funds for liquidity are:
. Lines of credit and other secured borrowings
. Match funded debt
. Debt securities
. Servicing fees
. Payments received on loans and securities
. Proceeds from sales of assets
. Deposits
At September 30, 2004, we had $228,819 of unrestricted cash and cash
equivalents and $98,179 of short-term investment grade securities. Unrestricted
cash and cash equivalents and short-term investment grade securities combined
represented 25% of total assets at September 30, 2004. Under certain of our
credit facilities we are required to maintain minimum liquidity levels. We
closely monitor our liquidity position and ongoing funding requirements. Among
the risks and challenges associated with our funding activities are the
following:
. Scheduled maturities of all certificates of deposit for the twelve
months ending September 30, 2005, the twelve months ending September
30, 2006 and thereafter amount to $248,337, $79,560 and $45,733,
respectively.
47
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
. Potential extension of resolution and sale timelines for non-core
assets.
. Ongoing cash requirements to fund operations of our holding company.
. Cash to fund our acquisition of additional servicing rights and related
advances.
While we have not issued brokered deposits since mid-2000, which
amounted to $40,114 at September 30, 2004, we continue to use non-brokered
deposits as a source of funding. Our reliance on deposits has been reduced
through sales of non-core assets, and by diversifying our funding sources,
including obtaining credit facilities for servicing rights and advances. If, as
described under "Banking Operations," we cease to control a federal savings
bank, we would no longer be able to rely on non-brokered deposits obtained
through the Bank as a source of funding.
Alternative sources of corporate funding that have been secured in
recent months include the following:
. On July 28, 2004 we issued $175,000 aggregate principal amount of 3.25%
Convertible Notes due 2024. The notes are convertible at the option of
the holders, if certain conditions are met, into shares of our common
stock. We have used 25% of the gross proceeds of the sale of the
Convertible Notes to repurchase, in privately negotiated transactions
concurrent with the private placement of the Convertible Notes,
4,850,000 shares of our common stock at a price of $9.02 per share. We
have used the remaining proceeds, net of underwriting discount and other
expenses, primarily to repay maturing deposits and other liabilities,
increase our cash and invest in short-term AAA-rated securities.
. In October 2004, we obtained a mortgage on our call center in Orlando,
Florida in the amount of $15,000. The note matures in October 2014 and
interest accrues at an annual fixed rate of 5.62%.
In the last several years, our Residential Loan Servicing business has
grown primarily through the purchase of servicing rights. Servicing rights
entitle the owner to earn servicing fees and other types of ancillary income and
impose various obligations on the servicer. Among these are the obligations to
advance our own funds to meet contractual principal and interest payments for
certain investors and to pay taxes, insurance and various other items that are
required to preserve the assets being serviced.
Our ability to continue to expand our Residential Loan Servicing
business depends in part on our ability to obtain additional financing to
purchase new servicing rights and to fund servicing advances. We currently use a
variety of sources of debt to finance these assets, including deposits, credit
facilities and seller financing. Our credit facilities provide financing to us
at amounts that are less than the full value of the related servicing assets
that serve as collateral for the credit facilities. If we cannot replace or
renew these sources as they mature or obtain additional sources of financing, we
may be unable to acquire new servicing rights or make the associated advances.
Credit facilities directly related to our Residential Loan Servicing business
are summarized as follows:
. Under a match funding agreement that we entered into on December 20,
2001, we are eligible to sell advances on loans serviced for others up
to a maximum debt balance of $200,000 ant any one time. At September 30,
2004, we had $95,539 of bonds-match funded agreements outstanding under
this facility, which will mature in January 2006. The sales of advances
do not qualify as sales for accounting purposes; therefore, we report
them as secured borrowings with pledges of collateral.
. In April 2003, we also entered into a $60,000 secured credit agreement
that may be used to fund servicing advances and acquisitions of
servicing rights. The agreement matured in April 2004 and was renewed
through April 2005. The size of the facility was increased to $70,000.
At September 30, 2004, we had a balance outstanding under this agreement
of $19,114.
. In December 2003, we entered into a $12,500 secured credit agreement
under which any borrowings are collateralized by mortgage servicing
rights. In January 2004, we borrowed $12,500 under this facility, which
is the balance outstanding as of September 30, 2004.
. In addition to the credit agreements above, we are currently in the
process of closing a securitization transaction involving approximately
$100,000 of our servicing advances.
We believe that our existing sources of liquidity, including internally
generated funds, will be adequate to fund our planned activities for the
foreseeable future, although there can be no assurances in this regard. As
discussed above, we continue to evaluate other sources of liquidity, such as
notes, lines of credit from unaffiliated parties, match funded debt and other
secured borrowings.
48
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
- --------------------------------------------------------------------------------
Our operating activities provided (used) $7,636 and $(823) of cash flows
during the nine months ended September 30, 2004 and 2003, respectively. The
improvement in operating cash flows in 2004 primarily relates to advances on
loans serviced for others, as collections exceeded new advances, offset in large
part by a decline in cash related to trading activities that largely resulted
from our purchases of short term AAA-rated auction rate securities during the
third quarter. During the nine month period of 2003, new advances on loans
serviced for others exceeded collections.
Our investing activities provided (used) cash flows totaling $7,600 and
$(17,975) during the nine months ended September 30, 2004 and 2003,
respectively. During the foregoing periods, cash flows from our investing
activities were provided primarily from principal payments on loans and match
funded loans, as well as proceeds from sales of loans and real estate. We used
cash flows from our investing activities primarily to purchase mortgage
servicing rights and fund loans to facilitate the sales of real estate assets.
Purchases of mortgage servicing rights during the nine month period of 2004 have
declined as compared to the same period of 2003 thereby reducing the amount of
cash used for investing activities.
Our financing activities provided cash flows of $10,663 and $73,483
during the nine months ended September 30, 2004 and 2003, respectively. Proceeds
from our issuance of the $175,000 Convertible Notes in 2004 was largely offset
by repayment of credit lines and match funded debt and our repurchase of
5,481,100 shares of our common stock. The financing cash flows for 2003
primarily represent proceeds from lines of credit and an increase in deposits,
offset in part by repayments of match funded debt and repurchases of notes and
debentures.
See the Consolidated Statements of Cash Flows in the Interim
Consolidated Financial Statements for additional details regarding cash flows
during the nine months ended September 30, 2004 and 2003.
Commitments. We believe that we have adequate resources to meet our
contractual obligations as they come due. Such contractual obligations include
our Convertible Notes, Capital Trust Securities, lines of credit and other
secured borrowings, certificates of deposit and operating leases. See Note 10 to
our Interim Consolidated Financial Statements regarding our commitments and
contingencies.
Off-Balance Sheet Risks. We are party to off-balance sheet financial
instruments in the normal course of our business to manage our foreign currency
exchange rate risk. See Note 4 to our Interim Consolidated Financial Statements
and "Asset and Liability Management".
We conduct business with a variety of financial institutions and other
companies in the normal course of business, including counter parties to our
off-balance sheet financial instruments. We are subject to potential financial
loss if the counter party is unable to complete an agreed upon transaction. We
seek to limit counter party risk through financial analysis, dollar limits and
monitoring procedures.
REGULATORY CAPITAL AND OTHER REQUIREMENTS
See Note 5 to our Interim Consolidated Financial Statements.
RECENT ACCOUNTING DEVELOPMENTS
For information relating to the effects of our adoption of recent
accounting standards, see Note 2 to our Interim Consolidated Financial
Statements.
49
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Dollars in thousands)
- --------------------------------------------------------------------------------
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and
magnitude of the repricing of assets and liabilities. Our objective is to
control risks associated with interest rate and foreign currency exchange rate
movements. Our Asset/Liability Management Committee (the "Committee"), which is
composed of certain of our officers, formulates and monitors our asset and
liability management strategy in accordance with policies approved by our Board
of Directors. The Committee meets to review, among other things, the sensitivity
of our assets and liabilities to interest rate changes and foreign currency
exchange rate changes, the book and market values of assets and liabilities,
unrealized gains and losses, including those attributable to hedging
transactions, purchase and sale activity, and maturities of investments and
borrowings. The Committee also approves and establishes pricing and funding
decisions with respect to overall asset and liability composition.
The Committee's methods for evaluating interest rate risk include an
analysis of the our interest rate sensitivity "gap", which is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of failing interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
The following table sets forth the estimated maturity or repricing of
our interest-earning assets and interest-bearing liabilities at September 30,
2004. The amounts of assets and liabilities shown within a particular period
were determined in accordance with the contractual terms of the assets and
liabilities, except:
. Securities are included in the period in which they are first scheduled
to adjust and not in the period in which they mature,
. Fixed-rate mortgage-related reflect prepayments that were estimated
based on analyses of broker estimates, the results of a prepayment model
we use and empirical data,
. NOW and money market checking deposits and savings deposits, which do
not have contractual maturities, reflect estimated levels of attrition,
which are based on our detailed studies of each such category of deposit
and,
. Escrow deposits and other non interest-bearing checking accounts,
which amounted to $162,081 at September 30, 2004, are excluded.
50
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - (Continued)
(Dollars in thousands)
- --------------------------------------------------------------------------------
September 30, 2004
------------------------------------------------------------------------
Four to More Than
Within Three Twelve One Year to Three Years
Months Months Three Years and Over Total
------------ ------------ ------------ ------------ ------------
Rate-Sensitive Assets (1):
- --------------------------
Interest-earning deposits .................. $ 52,541 $ -- $ -- $ -- $ 52,541
Trading securities ......................... 102,816 6,400 14,843 14,430 138,489
Investments ................................ 4,288 2,519 -- -- 6,807
Loans, net (2) ............................. 1,060 7,566 1,159 1,674 11,459
Match funded loans (2) (3) ................. 2,173 -- -- -- 2,173
------------ ------------ ------------ ------------ ------------
Total rate-sensitive assets .............. 162,878 16,485 16,002 16,104 211,469
------------ ------------ ------------ ------------ ------------
Rate-Sensitive Liabilities:
- ---------------------------
NOW and money market checking deposits ..... 18,913 221 472 1,229 20,835
Savings deposits ........................... 112 236 467 830 1,645
Certificates of deposit .................... 110,653 137,735 118,141 7,101 373,630
------------ ------------ ------------ ------------ ------------
Total interest-bearing deposits .......... 129,678 138,192 119,080 9,160 396,110
Bonds-match funded agreements .............. 97,712 -- -- -- 97,712
Lines of credit and other secured borrowings 35,502 -- -- -- 35,502
Notes and debentures ....................... -- -- -- 231,249 231,249
------------ ------------ ------------ ------------ ------------
Total rate-sensitive liabilities ......... 262,892 138,192 119,080 240,409 760,573
------------ ------------ ------------ ------------ ------------
Interest rate sensitivity gap (4) ............ $ (100,014) $ (121,707) $ (103,078) $ (224,305) $ (549,104)
============ ============ ============ ============ ============
Cumulative interest rate sensitivity gap (5) . $ (100,014) $ (221,721) $ (324,799) $ (549,104)
============ ============ ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets ... (47.29)% (104.85)% (153.59)% (259.66)%
As of December 31, 2003:
- ------------------------
Cumulative interest rate sensitivity gap (5) . $ (372,312) $ (505,845) $ (615,111) $ (657,002)
============ ============ ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets ... (349.48)% (474.82)% (577.38)% (616.71)%
(1) Excludes balances in the collection accounts of our Residential Loan
Servicing business. These balances, which totaled approximately $946,000
at September 30, 2004, are not included in our statements of financial
condition and earn interest at short term rates. This interest is
included as a component of servicing fees. See "Segment Results -
Residential Loan Servicing".
(2) We have not reduced balances for any non-performing loans.
(3) Excludes match funded advances on loans serviced for others, which do
not earn interest, of $106,155 at September 30, 2004.
(4) We had no rate -sensitive derivative financial instruments outstanding
at September 30, 2004.
(5) We have experienced a large negative interest rate sensitivity gap in
recent years. The negative interest rate sensitivity gap reflects the
economics of our Residential Loan Servicing business. Servicing
advances, the largest asset class on our balance sheet, is not sensitive
to changes in interest rates. However, we finance servicing advances
with interest rate sensitive liabilities.
The OTS has established specific minimum guidelines for thrift
institutions to observe in the area of interest rate risk as described in Thrift
Bulletin No. 13a, "Management of Interest Rate Risk, Investment Securities, and
Derivative Activities" ("TB 13a"). Under TB 13a, institutions are required to
establish and demonstrate quarterly compliance with board-approved limits on
interest rate risk that are defined in terms of net portfolio value ("NPV"),
which is defined as the net present value of an institution's existing assets,
liabilities and off-balance sheet instruments. These limits specify the minimum
net portfolio value ratio ("NPV Ratio") allowable under current interest rates
and hypothetical interest rate scenarios. An institution's NVP Ratio for a given
interest rate scenario is calculated by dividing the NPV that would result in
that scenario by the present value of the institution's assets in that same
scenario. The hypothetical scenarios are represented by immediate, permanent,
parallel movements (shocks) in the term structured of interest rates of plus
100, 200 and 300 basis points and minus 100 basis points from the actual term
structure observed at quarter end. The current NPV Ratio for each of the five
rate scenarios and the corresponding limits approved by the Board of Directors,
as applied to Ocwen Financial Corporation and its subsidiaries, are as follows
at September 30, 2004:
51
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - (Continued)
(Dollars in thousands)
- --------------------------------------------------------------------------------
Board Limits Current
Rate Shock in basis points (minimum NPV Ratios) NPV Ratios
- -------------------------- -------------------- ----------
+300 5.00% 33.89%
+200 6.00% 31.95%
+100 7.00% 29.82%
0 8.00% 27.43%
-100 7.00% 24.60%
The Committee also regularly reviews interest rate risk by forecasting
the impact of alternative interest rate environments on net interest income or
expense and NPV and evaluating such impacts against the maximum potential
changes in net interest income and NPV that is authorized by the Board of
Directors, as applied to Ocwen Financial Corporation and its subsidiaries. The
following table quantifies the potential changes in net interest expense and net
portfolio value should interest rates go up or down (shocked) 300 or 100 basis
points, respectively, assuming the yield curves of the rate shocks will be
parallel to each other. We calculate the cash flows associated with the loan
portfolios and securities available for sale based on prepayment and default
rates that vary by asset. We generate projected losses, as well as prepayments,
based upon the actual experience with the subject pool, as well as similar, more
seasoned pools. To the extent available, we use loan characteristics such as
loan-to-value ratio, interest rate, credit history, prepayment penalty terms and
product types to produce the projected loss and prepayment assumptions that are
included in the cash flow projections of the securities. When we shock interest
rates we further adjust these projected loss and prepayment assumptions. The
base interest rate scenario assumes interest rates at September 30, 2004. Actual
results of Ocwen Financial Corporation and its subsidiaries could differ
significantly from the results estimated in the following table:
Estimated Changes in
------------------------------------
Rate Shock in basis points Net Interest NPV
- -------------------------- -------------------- ----------
+300 (181.52)% 29.33%
+200 (121.01)% 20.21%
+100 (60.51)% 10.55%
0 0.00% 0.00%
-100 60.51% (12.23)%
The Committee is authorized to utilize a wide variety of off-balance
sheet financial techniques to assist in the management of interest rate risk and
foreign currency exchange rate risk. These techniques include interest rate caps
and floors and foreign currency futures contracts.
Foreign Currency Exchange Rate Risk Management. We have entered into
foreign currency futures to hedge our net investments in foreign subsidiaries
that own residual interests backed by residential loans originated in the UK and
the shopping center located in Halifax, Nova Scotia. Our principal exposure to
foreign currency exchange rates with the British Pound versus the U.S. dollar
and the Canadian Dollar versus the U.S. dollar. Our policy is to periodically
adjust the amount of foreign currency derivative contracts that we have entered
into in response to changes in our recorded investment in these foreign entities
as well as to changes in our assets denominated in a foreign currency. Our net
exposures are subject to gain or loss if foreign currency exchange rates
fluctuate. See Note 4 to our Interim Consolidated Financial Statements.
52
ITEM 4. CONTROLS AND PROCEDURES.
- --------------------------------------------------------------------------------
Our management, with the participation of our chief executive officer
and chief financial officer, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) under the securities
Exchange Act) as of September 30, 2004. Based on this evaluation, our chief
executive officer and chief financial officer concluded that, as of September
30, 2004 our disclosure controls and procedures were (1) designed to ensure that
material information relating to the Company, including its consolidated
subsidiaries, is made known to our chief executive officer and chief financial
officer by others within those entities, particularly during the period in which
this report was being prepared and (2) effective, in that they provide
reasonable assurance that information required to be disclosed by the Company in
the reports that it files or submits under the Securities Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d -15(f) under the Exchange Act) occurred during the
fiscal quarter ended September 30, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including, but
not limited to discussions of the future availability of funds, beliefs
regarding regulatory compliance and litigation resolution, expectations as to
resolution of our non-core assets, predictions on loan yield and the adequacy of
our finding needs, resource assumptions and beliefs, intentions with regard to
the issuance of brokered deposits, estimates for loan losses and carrying
values, and plans for growth in India. Forward-looking statements are not
guarantees of future performance, and involve a number of assumptions, risks and
uncertainties that could cause actual results to differ materially.
Important factors that could cause actual results to differ materially
from those suggested by the forward-looking statements include, but are not
limited to, the following: general economic and market conditions, prevailing
interest or currency exchange rates, governmental regulations and policies,
international political and economic uncertainty, availability of adequate and
timely sources of liquidity, uncertainty related to dispute resolution and
litigation, and real estate market conditions and trends, as well as other risks
detailed in OCN's reports and filing with the Securities and Exchange
Commission, including our annual report on Form 10-K for the year ended December
31, 2003 and our Form 10-Q for the quarter ended June 30, 2004. The
forward-looking statements speak only as of the date they are made and should
not be relied upon. OCN undertakes no obligation to update or revise the
forward-looking statements.
53
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS.
See "Note 9 Commitments and Contingencies" of Ocwen Financial
Corporation's Interim Consolidated Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a)3 Exhibits.
2.1 Agreement of Merger dated as of July 25, 1999 among Ocwen Financial
Corporation, Ocwen Asset Investment Corp. and Ocwen Acquisition
Company (1)
3.1 Amended and Restated Articles of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.0 Form of Certificate of Common Stock (2)
4.1 Certificate of Trust of Ocwen Capital Trust I (4)
4.2 Amended and Restated Declaration of Trust to Ocwen Capital Trust I
(4)
4.3 Form of Capital Security of Ocwen Capital Trust I (Included in
Exhibit 4.2) (4)
4.4 Form of Indenture relating to 10.875% Junior Subordinated Debentures
due 2027 of OCN (4)
4.5 Form of 10.875% Junior Subordinated Debentures due 2027 of OCN
(Included in Exhibit 4.4) (4)
4.6 Form of Guarantee of the OCN relating to the Capital Securities of
Ocwen Capital Trust I (4)
4.7 Form of Registration Rights Agreement dated as of July 28, 2004,
between OCN and Jeffries & Company Inc. (10)
4.8 Form of Indenture dated as of July 28, 2004, between OCN and the
Bank of New York Trust Company, N.A., as trustee (10)
10.1 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (5)
10.2 Ocwen Financial Corporation 1998 Annual Incentive Plan (6)
10.3 Compensation and Indemnification Agreement, dated as of May 6, 1999,
between OAC and the independent committee of the Board of Directors
(7)
10.4 Indemnity agreement, dated August 24, 1999, among OCN and OAC's
Board of Directors (8)
10.5 Amended Ocwen Financial Corporation 1991 Non-Qualified Stock Option
Plan, dated October 26, 1999 (8)
10.6 First Amendment to Agreement, dated March 31, 2000, between HCT
Investments, Inc. and OAIC Partnership I, L.P. (8)
10.7 Form of Employment Agreement dated as of April 1, 2001, by and
between Ocwen Financial Corporation and Arthur D. Ringwald (9)
31.1 Certification of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2 Certification of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1 Certification of the Chief Executive Officer pursuant to U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
32.2 Certification of the Chief Financial Officer pursuant to U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
(1) Incorporated by reference from the similarly described exhibit included
with the Registrant's Current Report on Form 8-K filed with the
Commission on July 26, 1999.
(2) Incorporated by reference from the similarly described exhibit in
connection with the Registrant's Registration Statement on Form S-1
(File No. 333-5153), as amended, declared effective by the Commission on
September 25, 1996.
(3) Incorporated by reference from the similarly described exhibit included
with the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998.
(4) Incorporated by reference from the similarly described exhibit filed in
connection with Ocwen Financial Corporation's Registration Statement on
Form S-1 (File No. 333-28889), as amended, declared effective by the
Commission on August 6, 1997.
(5) Incorporated by reference from the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-8
(File No. 333-44999), effective when filed with the Commission on
January 28, 1998.
(6) Incorporated by reference from the similarly described exhibit to Ocwen
Financial Corporation's Definitive Proxy Statement with respect to Ocwen
Financial Corporation's 1998 Annual Meeting of Shareholders filed with
the Commission on March 31, 1998.
(7) Incorporated by reference from OAC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1999.
54
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
(8) Incorporated by reference from the similarly described exhibit included
with Registrant's Quarterly Report of Form 10-Q for the quarterly period
ended March 31, 2000.
(9) Incorporated by reference from the similarly described exhibit included
with the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2001.
(10) Incorporated by reference from the similarly described exhibit included
with Registrant's Quarterly Report on Form10-Q for the quarterly period
ended June 30, 2004.
(b) REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED SEPTEMBER 30, 2004.
(1) A Form 8-K was filed by OCN on July 19, 2004 reporting, under Item 12, a
news release announcing Ocwen Financial Corporation's financial results
for the second quarter ended June 30, 2004.
(2) A Form 8-K was filed by OCN on July 20, 2004 reporting, under Item 5, a
news release announcing the order of a federal judge vacating a jury
award of $9.3 million against two of the Registrant's subsidiaries,
Ocwen Federal Bank, FSB and Ocwen Technology Xchange, and ordering a new
trial and reporting, under Item 12, a news release announcing increased
second quarter 2004 net income.
(3) A form 8-K was filed by OCN on July 21, 2004 reporting, under Item 5, a
news release clarifying certain statements about its subsidiary, Ocwen
Federal Bank FSB, appearing in a trade press sidebar and a news release
announcing the private placement of $125 million of convertible senior
unsecured notes.
(4) A form 8-K was filed by OCN on July 23, 2004 reporting, under Item 5, a
news release announcing the pricing of its convertible senior unsecured
notes.
(5) A form 8-K was filed by OCN on July 27, 2004 reporting, under Item 5, a
news release announcing the repurchase of 4,850,000 shares of common
stock and the exercise of an option to purchase additional notes.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
OCWEN FINANCIAL CORPORATION
By: /s/ Mark S. Zeidman
-----------------------
Mark S. Zeidman,
Senior Vice President and
Chief Financial Officer
(On behalf of the Registrant and as its
principal financial officer)
Date: November 9, 2004
56
EXHIBIT 31.1
CERTIFICATIONS
I, William C. Erbey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ocwen Financial
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusion about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any changes in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether on not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 9, 2004 /s/ William C. Erbey
---------------------------
William C. Erbey
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATIONS
I, Mark S. Zeidman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ocwen Financial
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e) for the
registrant and have:
(d) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(e) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusion about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(f) Disclosed in this report any changes in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether on not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 9, 2004 /s/ Mark S. Zeidman
---------------------------
Mark S. Zeidman
Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES OXLEY ACT OF 2002
I, William C. Erbey, state and attest that:
1. I am the Chief Executive Officer of Ocwen Financial Corporation (the
"Registrant").
2. I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that
. the Quarterly Report on Form 10-Q of the Registrant for the
quarter ended September 30, 2004 (the "periodic report")
containing financial statements fully complies with the
requirements of Section 13(a) or 15(b) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
. the information contained in the periodic report fairly
represents, in all material respects, the financial condition
and results of operations of the Registrant for the periods
presented.
Name: /s/ William C. Erbey
-----------------------
Title: Chief Executive Officer
Date: November 9, 2004
EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES OXLEY ACT OF 2002
I, Mark S. Zeidman, state and attest that:
1. I am the Chief Financial Officer of Ocwen Financial Corporation (the
"Registrant").
2. I hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that
. the Quarterly Report on Form 10-Q of the Registrant for the
quarter ended September 30, 2004 (the "periodic report")
containing financial statements fully complies with the
requirements of Section 13(a) or 15(b) of the Securities
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
. the information contained in the periodic report fairly
represents, in all material respects, the financial condition
and results of operations of the Registrant for the periods
presented.
Name: /s/ Mark S. Zeidman
------------------------
Title: Chief Financial Officer
Date: November 9, 2004
