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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: ________________to ________________
Commission File No. 1-13219
OCWEN FINANCIAL CORPORATION
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(Exact name of Registrant as specified in our charter)
FLORIDA 65-0039856
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1675 Palm Beach Lakes Boulevard
West Palm Beach, Florida 33401
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(Address of principal executive office) (Zip Code)
(561) 682-8000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE)
(Title of each class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12 (g) of the Act: Not applicable.
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Aggregate market value of the Common Stock, $0.01 par value, held by
nonaffiliates of the registrant, computed by reference to the closing price as
reported on the NYSE as of the close of business on March 10, 2005:
$284,147,823 (for purposes of this calculation affiliates include only
directors and executive officers of the registrant).
Number of shares of Common Stock, $0.01 par value, outstanding as of March 10,
2005: 62,750,904 shares
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Annual Report to
Shareholders for fiscal year ended December 31, 2004 are incorporated by
reference into Part I, Item 1 and Part II, Items 5-8 and portions of our
definitive Proxy Statement with respect to our Annual Meeting of Shareholders to
be held on May 17, 2005, are incorporated by reference into Part III, Items 10 -
12 and 14.
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OCWEN FINANCIAL CORPORATION
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business............................................................................................ 4
General........................................................................................... 4
Segments.......................................................................................... 5
Residential Loan Servicing...................................................................... 6
Ocwen Technology Xchange........................................................................ 6
Ocwen Realty Advisors........................................................................... 7
Ocwen Recovery Group............................................................................ 7
Business Process Outsourcing.................................................................... 7
Commercial Servicing............................................................................ 7
Residential Discount Loans...................................................................... 8
Commercial Assets............................................................................... 8
Affordable Housing.............................................................................. 8
Subprime Finance................................................................................ 8
Corporate Items and Other....................................................................... 9
Sources of Funds.................................................................................. 9
Risk Factors...................................................................................... 10
Competition....................................................................................... 10
Subsidiaries...................................................................................... 10
Employees......................................................................................... 10
Regulation........................................................................................ 11
Federal Taxation.................................................................................. 15
State Taxation.................................................................................... 16
Item 2. Properties.......................................................................................... 17
Item 3. Legal Proceedings................................................................................... 18
Item 4. Submission of Matters to a Vote of Security Holders................................................. 19
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........................... 19
Item 6. Selected Consolidated Financial Data................................................................ 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 19
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......................................... 20
Item 8. Financial Statements and Supplementary Data......................................................... 20
1
OCWEN FINANCIAL CORPORATION
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
(CONTINUED)
PAGE
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................ 20
Item 9A Controls and procedures............................................................................. 20
Item 9B Other Information................................................................................... 21
PART III
Item 10. Directors and Executive Officers of Registrant...................................................... 21
Item 11. Executive Compensation.............................................................................. 21
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...... 21
Item 13. Certain Relationships and Related Transactions...................................................... 21
Item 14. Principal Accounting Fees and Services.............................................................. 21
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..................................... 22
Signatures..................................................................................................... 24
2
FORWARD-LOOKING STATEMENTS
This Annual Report 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 the
following:
.. Estimates regarding the benefits of cost saving opportunities and quality
workforce in India,
.. Projections for staff reduction in the United States and growth in our India
workforce,
.. Predictions as to the potential business opportunities in business process
outsourcing,
.. Predictions regarding sales of our commercial and affordable housing assets
and
.. Intentions related to the issuance of brokered deposits and other sources of
financing.
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,
.. Availability of servicing rights for purchase,
.. 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.
Further information on the risks specific to our business are detailed within
this report and our other reports and filings with the Securities and Exchange
Commission, including our periodic reports on Form 10-K, Form 10-Q and Form 8-K.
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.
3
PART I
ITEM 1 BUSINESS (Dollars in thousands)
GENERAL
Ocwen Financial Corporation ("OCN" or "the Company") is a diversified
financial services holding company with headquarters in West Palm Beach, Florida
and operations 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, business
process outsourcing and the marketing and sales of technology solutions to third
parties. OCN is a Florida corporation that was organized in February 1988 in
connection with the acquisition of Ocwen Federal Bank FSB (the "Bank"). OCN is a
registered savings and loan holding company subject to regulation by the Office
of Thrift Supervision ("OTS"). The Bank is a wholly owned subsidiary of OCN and
is also subject to regulation by the OTS, as its chartering authority, and by
the Federal Deposit Insurance Corporation ("FDIC"), as a result of its
membership in the Savings Association Insurance Fund, which insures the Bank's
deposits to the maximum extent permitted by law. The Bank is also subject to
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board") and currently is a member of the Federal Home Loan Bank ("FHLB")
of New York, one of the 12 regional banks that comprise the FHLB System.
We have recently begun the process of having the Bank terminate its
status as a federal savings bank under OTS and FDIC supervision, which would,
among other things, eliminate certain restrictions on our growth. If this
process, which we refer to as "debanking," is completed, we would dissolve the
Bank and continue its non-depository businesses, including its mortgage
servicing business, under another subsidiary of our Company, which would be
licensed where necessary at the state or territory level. Should debanking be
completed, Ocwen Financial Corporation 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. Our ability to debank is subject to a
number of contingencies, many of which are beyond our control, including
approvals by the OTS with respect to the Application for a Voluntary Dissolution
(which we filed with the OTS on November 24, 2004) and sales of the Bank's
deposits to third parties. There can be no assurance that we ultimately will be
successful in debanking.
In connection with our debanking process, on February 4, 2005, we
entered into a Branch Purchase and Deposit Assumption Agreement (the "Branch
Purchase Agreement") with Marathon National Bank of New York ("Marathon").
Pursuant to the Branch Purchase Agreement, Marathon agreed to assume the deposit
liabilities of the accounts associated with the Bank branch facility in Fort
Lee, New Jersey. In addition, Marathon will take over the lease and other
contracts and acquire assets related to the branch. In connection with that
closing, Ocwen will make a cash payment to Marathon, which payment is calculated
based upon, among other things, the amount of those deposit account liabilities
as of the closing. As of February 28, 2005, the amount of the deposit
liabilities of the accounts subject to the Branch Purchase Agreement was
approximately $193,000. The transaction is subject to regulatory and other
customary approvals and conditions.
On September 30, 2004, we acquired Bankhaus Oswald Kruber KG ("BOK") a
German bank, for $9,737, including acquisition costs. Our primary objectives in
acquiring BOK were to diversify our funding sources and to establish a platform
to provide services to our multinational client base. The results of operations
of BOK are included in our consolidated income statement beginning on October 1,
2004. The excess of the purchase price over the fair value of the net assets
acquired (goodwill) related to this transaction is $3,694. We also recorded
$1,741 of intangible assets, none of which are subject to amortization. As of
December 31, 2004 BOK had assets of $23,043, of which $10,699 were interest
earning deposits, and total liabilities of $10,919.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports are made available free
of charge through our website (http://www.ocwen.com) as soon as practicable
after such material is electronically filed with or furnished to the Securities
and Exchange Commission. Also posted on our website, and available in print upon
request, are the charters for our Audit Committee, Compensation Committee and
Governance Committee, our Governance Guidelines, and Code of Ethics and Code of
Ethics for Senior Financial Officers. Within the time period required by the SEC
and the New York Stock Exchange, we will post on our website any amendment to or
waiver of the Code of Ethics for Senior Financial Officers, as well as any
amendment to the Code of Ethics or waiver thereto applicable to any executive
officer or director. The information provided on our website is not part of this
report, and is therefore not incorporated herein by reference.
4
PART I (Continued)
SEGMENTS
In early 2000, we began the execution of our 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 originate or invest in assets in certain of our business
segments ("non-core businesses") unless contractually committed to do so.
However, we continue to actively manage and resolve the remaining assets in
these segments. Our primary fee-based business activity is servicing subprime
residential mortgage loans for others. As of December 31, 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
Business Process Outsourcing
Commercial Servicing
In addition to our core and non-core business segments, we report other
items of revenue and expense in our Corporate Items and Other segment as
discussed later in this section.
Our decision to change our strategy and to focus on fee-based earnings
was driven by changes in the economy and in the markets we serve and in our
perception of how to maximize the long-term value of the Company. The non-core
residential discount loan business and commercial finance business involved the
acquisition of non-performing loans at a discount to par value. The objective
was to resolve the loan and return it to performing status in order to increase
its value. Once the loan was reperforming, the exit strategy was to sell or
securitize the loan for a profit. As the economy continued to expand throughout
the late 1990s, however, the supply of non-performing loans decreased. As a
result, the prices asked for non-performing loans increased, and consequently
the profit margins on the business decreased. Additionally, the earnings
patterns of the businesses could be erratic as they typically depended on the
consummation of a few large sales transactions. Simultaneously, new competitors
that had access to large amounts of capital were entering the market.
In the late 1990s we also began to originate subprime residential
mortgage loans. However, the business attracted a substantial amount of new
capital and competition increased. The competition from larger,
better-capitalized companies put pressure on pricing relative to the rates and
terms offered to subprime borrowers in general, and, as a result, profit margins
declined. Simultaneously, interest rates began to decrease and the assumptions
concerning prepayment speeds that had been used to price new loans turned out to
be overly optimistic as mortgages prepaid more quickly than expected, adding
additional risk to investments in this business line. Consequently, we
determined that our best course of action was to compete where we were
strongest, that is, by using the technology and expertise we had developed over
the years in managing our own portfolio of non-performing residential and
commercial loans and in servicing our own subprime loans and offering it to
other institutions on a fee for service basis, either as a mortgage servicer or
as a technology provider. We believe that these activities offer a more
consistent earnings stream with a more attractive risk profile. Accordingly, in
late 1999 and early 2000 we embarked on our current business strategy.
Segment results in recent years reflect growth in our residential loan servicing
segment, continued investment in the development and marketing of our technology
products, cessation of loan acquisition and origination activities and our
continuing resolution or disposition of those assets not associated with our
core businesses. To date, the Residential Loan Servicing business has been
profitable. Our Ocwen Recovery Group business and ORA are profitable but smaller
contributors to the bottom line. Both earn fee income for performing services
for third parties. OTX markets several products to the real estate and mortgage
industries. However, although we earn some fee income from sales of these
products, they have not yet been sufficient for this business line to earn a
profit. Business Process Outsourcing, which began offering business process
outsourcing services late in 2002, improved its profitability in 2003 and 2004.
Commercial Servicing was not profitable in 2003 and 2002, reflecting start-up
costs associated with expanding our asset servicing business to various other
countries, but achieved a small profit in 2004. Additional information regarding
profitability of our business segments appears under the caption "Segment
Results" on pages 23 to 29 and in "Note 26: Business Segment Reporting" on pages
105 to 107 of our 2004 Annual Report to Shareholders.
A more detailed description of each of our business segments follows.
5
PART I (Continued)
RESIDENTIAL LOAN SERVICING
We service performing, sub-performing and non-performing residential
mortgage loans. Subprime mortgages comprised the vast majority of the
$37,697,318 in total unpaid principal balance of the loans we serviced at
December 31, 2004. We serviced loans under approximately 345 servicing
agreements for 22 clients as of December 31, 2004. These clients include well
capitalized mortgage originators, such as New Century and Delta Funding, Wall
Street firms with mortgage securitization platforms, such as Lehman Brothers,
Credit Suisse First Boston and Morgan Stanley, and governmental agencies, such
as the United States Department of Veterans Affairs.
We are entitled to service mortgages because we purchased the servicing
rights from the owners of the mortgages or have entered into a subservicing
agreement with an entity that owns the servicing rights. The rights and
obligations of servicing rights are typically specified in an agreement between
the various parties to a mortgage securitization transaction. Our largest source
of revenue with respect to servicing rights is the servicing fees we earn
pursuant to servicing and subservicing agreements. Servicing fees are usually
earned as a percentage of the unpaid principal amount of the mortgages that are
being serviced. A typical servicing fee is approximately 0.50% per year and a
typical subservicing fee ranges from approximately 0.17% to 0.19% per year. The
servicing and subservicing fees are supplemented by related income, including
late fees from borrowers who are delinquent in remitting their monthly mortgage
payments and interest earned on payments made to us but not yet remitted to the
owner of the mortgage.
As servicer or subservicer, we also have a variety of obligations that
are also specified in the servicing or subservicing agreement, including the
obligation to service the mortgages according to certain contractual standards
and to advance funds to securitization trusts in the event that borrowers are
delinquent on their monthly mortgage payments. The costs incurred in connection
with meeting these obligations includes, but is not limited to, the cost of
servicing the loans and the interest expense incurred to finance the servicing
rights and servicing advances incurred in connection with conducting the
business.
The contracts for servicing may provide for a single bulk transfer of a
servicing portfolio or the ongoing transfer of loans as they are originated or
purchased by counterparties to the servicing contract. While the loan data are
transferred to us for servicing, the client retains ownership of the loans.
The acquisition of servicing rights is generally structured as a
two-part bid process. A preliminary bid is provided to each potential client
following a preliminary due diligence review of the loan portfolio, the seller's
financial status, the strategic fit of the portfolio with our servicing
capabilities and the portfolio's historical performance characteristics.
Once the preliminary bid is accepted by the potential client, we
initiate a further evaluation of the portfolio through a formal due diligence
process, which includes a more detailed analysis of historical prepayment and
delinquency experience. This formal process determines the present value of a
projected stream of cash inflows and outflows from the portfolio. Based upon the
findings of this formal process, a final bid is prepared for approval by our
Credit Committee and submitted to the client for consideration. Upon the
client's acceptance, we enter into a servicing rights purchase agreement.
The U.S. Department of Housing and Urban Development, Freddie Mac and
Fannie Mae have approved the Bank as a loan servicer. Standard & Poor's has
rated the Bank as "Strong" as a Residential Subprime Servicer and Residential
Special Servicer. "Strong" represents Standard & Poor's highest ratings
category. On April 23, 2004, Standard & Poor's placed these ratings on watch
with negative implications. Moody's has rated the Bank as "SQ2" as a Residential
Subprime Servicer and as a Residential Special Servicer. "SQ2" represents
Moody's above average rating category. Fitch has rated us "RPS2" for Residential
Subprime Servicing and "RSS2" for Residential Special Servicing. These represent
Fitch's second highest categories, respectively. On March 1, 2004, Fitch placed
our "RPS2" rating for Residential Subprime Servicing and our "RSS2" rating for
Residential Special Servicing on negative watch. On December 29, 2004, Fitch
removed our Residential Subprime Servicing and Residential Special Servicing
ratings from negative watch.
OCWEN TECHNOLOGY XCHANGE (OTX)
The OTX segment consists of the following three product lines:
REALTrans(SM), REALServicing(TM) and REALSynergy(TM). Each of these product
lines serves a different market need, and each is at a different stage of
maturity and commercial use.
Our REALTrans product is a web-based vendor management platform that
facilitates the electronic fulfillment of real estate products and services
necessary to process, approve and close residential mortgage loans, as well as
to service them. We market this product to residential lenders and servicers and
their associated vendors. By connecting these two parties through the REALTrans
platform, we allow them to conduct business more effectively and efficiently. We
earn transaction fee revenues from the vendors based on the products and
services they provide to their lenders through this platform. We also earn
revenues through annual membership fees. The transaction fees are recognized
6
PART I (Continued)
as revenue as incurred. The membership fees are deferred and recognized as
revenue over the twelve-month membership period. Among our customer base on the
REALTrans platform are several of the top 35 residential mortgage lenders and
over 4,000 vendors. These lenders account for a significant portion of the
mortgage origination market.
Our REALServicing product is a comprehensive enterprise-level
residential mortgage loan servicing platform, which has been used by the Bank
since January 2001. The REALServicing product suite also includes
REALResolution(TM), a default management platform that provides end-to-end
mortgage default processing support. The target market for this platform
includes both prime and sub-prime residential mortgage loan servicers.
On May 3, 2004, OTX entered into a Service and License Agreement with
Aegis Mortgage Corporation regarding the REALServicing product. Pursuant to that
agreement, OTX has agreed to operate the REALServicing system for use in Aegis's
residential mortgage loan servicing business in exchange for a one-time
documentation fee and a commitment to pay monthly fees. The initial term of the
agreement is for four years with an option for Aegis to renew for one additional
three-year term.
Our REALSynergy product is a comprehensive enterprise-level commercial
mortgage loan servicing platform. The target market for this platform includes
domestic and international commercial mortgage loan servicers. The market in
which REALSynergy competes is served by a limited number of companies. Our
primary competitor is a division of a large, diversified public company. The
REALSynergy product suite includes REALSAMM(TM), the REALSynergy Asset
Management Module, a web-enabled platform for the asset and default management
of performing and non-performing commercial loans and real estate. REALSAMM is
being introduced to selected international markets through GSS, our joint
venture with Merrill Lynch.
OCWEN REALTY ADVISORS (ORA)
As part of our strategic focus on fee-based businesses, we established
ORA in 1999 as a new segment. ORA provides valuation services to external
customers in the wholesale lending community as well as for our own residential
real estate transactions.
An important part of the process of acquiring and managing mortgage loan
portfolios is the accurate review and analysis of the collateral offered as
security for the loans. ORA not only provides traditional valuation products
such as appraisals and broker price opinions, it also employs valuation models
and other alternative valuation products that can more precisely meet the
specific risk management needs of our customers.
OCWEN RECOVERY GROUP
This segment 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 dollars collected. The percentage fee generally ranges
from 17% to 50%. We intend to continue to grow our third party collections
activity.
We accounted for collections of our unsecured credit card receivables
under the cost recovery method through 2001 by which time we had reduced the net
book value of these receivables to zero as a result of collections and reserves.
Our contractual obligations to acquire these receivables expired in June 2000.
We have made no purchases since that time and plan no future purchases.
BUSINESS PROCESS OUTSOURCING
This business segment began operations in December 2002. The results for
2004 and 2003 primarily reflect the initiation of new outsourcing contracts in
the third quarter of 2003. Business Process Outsourcing provides outsourcing
services to third parties, including mortgage underwriting, data entry, call
center services and mortgage research.
COMMERCIAL SERVICING
This segment includes the results of operations of both domestic and
international servicing. International servicing is conducted through Global
Servicing Solutions, LLC ("GSS"), a joint servicing venture we formed with
Merrill Lynch in March 2002 for the servicing of assets in various countries.
Prior to 2004, domestic commercial servicing was reported as a component of the
Commercial Finance segment (re-named Commercial Assets), and the results of our
international operations were reported as a separate segment. Results for prior
years have been restated to conform to this presentation. We own 70% of GSS with
the remaining 30% owned by Merrill Lynch. GSS offices in Tokyo, Japan and
Taipei, Taiwan became fully operational during 2003. We also established
servicing offices in Toronto, Canada and Mainz, Germany in 2004. We have
established consulting operations in the United Kingdom and China.
7
PART I (Continued)
RESIDENTIAL DISCOUNT LOANS
This segment consisted of operations to acquire at a discount and
subsequently resolve sub-performing and non-performing residential mortgage
loans.
We began our discount loan operations in 1991. Our strategy was to
acquire at a discount certain mortgage loans for which the borrowers were not
current as to principal and interest payments. We would work to resolve the
loans by bringing them current and then selling or securitizing the loans for a
profit, by structuring a settlement with the borrower or by foreclosing on the
loan and liquidating the collateral.
The last acquisition of residential discount loans was made in 2000.
Based on the relative insignificance of the non-core assets remaining in this
business at December 31, 2002, the remaining assets of this business and any
related income or loss arising from their resolution have been included in the
Corporate Items and Other segment beginning January 1, 2003.
COMMERCIAL ASSETS
Effective January 1, 2002, we combined our Commercial Loan and
Commercial Real Estate segments, because the assets in each had fundamentally
similar attributes and had been assigned to a single management team. Commercial
activities include both discount loans and originated loans as well as our
investment in commercial real estate.
No new commercial assets have been purchased since 2000. Since then,
this business has consisted of the management, repositioning and resolution of
the remaining non-core assets. Other than loans made to facilitate sales of our
own assets, we also have not originated any commercial loans since 2000. At
December 31, 2004, we had $21,560 of non-core assets in this segment, which
consisted of four real estate assets (a shopping center, parcel of land and two
partnership interests) and one unrated subordinate security. In February 2005,
we sold the subsidiary that held our investment in our shopping center located
in Halifax, Nova Scotia. It is difficult to project with certainty when final
sales or resolutions will be completed or whether further losses may be incurred
upon resolution. We regularly assess the value of our remaining assets and
provide additional loss reserves or impairment charges as appropriate.
AFFORDABLE HOUSING
Historically, we invested in affordable housing properties primarily
through limited partnerships for the purpose of obtaining Federal income tax
credits pursuant to Section 42 of the Internal Revenue Code of 1986, as amended.
Beginning in 2000 we ceased making investments in these properties,
except to complete those projects in which an investment had already been made.
This reflects our change in strategic focus away from capital intensive lines of
business and the fact that the volume of tax credits being generated was
exceeding our ability to utilize them effectively. At that time, we also began
the process of marketing each of these properties for sale. At December 31,
2004, our investment of $5,641 represents a 99.9% limited partnership interest
in one affordable housing property. We also have $3,198 loan outstanding to the
limited partnership. This limited partnership is not consolidated into our
financial statements. While we cannot project sales with certainty, we believe
that it is possible that this property will be sold before the end of 2005 and
that new sources of financing will be established to repay the remaining loan
balance. We regularly assess the carrying value of our remaining assets and
provide additional loss reserves as appropriate.
Tax credits may be claimed over a ten-year period on a straight-line
basis once the underlying multi-family residential properties are placed in
service. Tax credits generally can be lost or recaptured only if non-qualifying
tenants are placed in units, ownership of the project is transferred or the
project is destroyed and not rebuilt during a 15-year compliance period for the
project. There can be no assurance that the multi-family residential projects
owned by the low-income housing tax credit partnerships in which we have
currently or previously invested will satisfy applicable criteria during the
15-year compliance period and that there will not be loss or recapture of a
portion of the associated tax credits.
SUBPRIME FINANCE
We were engaged in subprime residential loan origination prior to
ceasing originations in August of 1999; however, we have continued to manage and
resolve the remaining non-core assets. Effective January 2002, the remaining
business was renamed Subprime Finance from Subprime Residential Lending to
better depict the current nature of the business activity. The remaining assets
of this segment consist primarily of subprime residual securities issued in the
United Kingdom. These securities are presently generating income and return of
principal through cash flows.
8
PART I (Continued)
CORPORATE ITEMS AND OTHER
In this segment we report business activities that are individually
insignificant (including BOK), interest income on cash and cash equivalents,
interest expense on corporate assets, general corporate expenses and gains and
losses from the early retirement of debt.
Additional financial information and related discussion regarding each
of our segments appears under the captions "Segment Results" on pages 23 to 29
and "Note 26: Business Segment Reporting" on pages 105 to 107 of our 2004 Annual
Report to Shareholders.
SOURCES OF FUNDS
General. The principal sources of funds that support our business
activities have historically been:
. Lines of credit and other secured borrowings
. Match funded debt
. Debt securities
. Securities sold under agreements to repurchase
. Deposits
. Servicing fees
. Payments received on loans and securities
. Proceeds from sales of assets
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 certificates of deposit for 2005, 2006 and
thereafter amount to $201,934, $47,006 and $28,731, respectively.
. Maturity of existing collateralized lines of credit and other secured
borrowings totaling $35,676 at various dates through 2005.
. Potential extension of resolution and sale timelines for non-core
assets.
. Ongoing cash requirements to fund operations of our holding company.
. Cash requirements to fund our acquisition of additional servicing rights
and related advances, as discussed immediately below.
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 obligation 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 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 match funded agreements, 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 unable to acquire new servicing rights and make the associated advances.
Deposits. Historically, a significant source of funds for us had been
certificates of deposit obtained primarily through national investment banking
firms and our branch office located in New Jersey. If, as described under
"GENERAL", we cease to control a federal savings bank as a result of debanking,
we would no longer be able to rely on U.S. deposits obtained through the Bank as
a source of funds. Our total deposits amounted to $301,299 at December 31, 2004,
including $290,507 at the Bank and $10,792 at BOK.
Lines of Credit and Other Secured Borrowings. In April 2003, we 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 December 31, 2004, we had a balance outstanding under this
agreement of $24,218.
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 and the balance
outstanding as of December 31, 2004 was $11,458.
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%. The balance outstanding at December
31, 2004 was $14,936.
9
PART I (Continued)
Match Funded Liabilities. On November 17, 2004, we entered into a match
funded agreement under which we transferred certain of our advances on loans
serviced for others. As of December 31, 2004, proceeds received in connection
with this transfer of advances were $149,342. As of December 31, 2004, there was
$25,658 of capacity available under this facility. The $100,000 term note under
this facility has a stated maturity of October 2013. The variable funding note
has a stated maturity of November 2010. Under a match funding agreement that we
entered into on December 20, 2001, we are eligible to finance advances on loans
serviced for others up to a maximum debt balance of $200,000 at any one time. At
December 31, 2004, we had $90,851 of match funded liabilities outstanding under
this facility, which will mature in January 2006. The transfers of advances
under these agreements did not qualify as sales for accounting purposes because
we retain effective control of the advances. Accordingly, we report the advances
transferred as match funded assets and the amount of proceeds we receive from
the transfers as a secured borrowing with pledge of collateral.
Securities Sold Under Agreements to Repurchase. We also obtain funds
pursuant to securities sold under reverse repurchase agreements. Under these
agreements, we sell securities (generally mortgage-backed and mortgage-related
securities) under an agreement to repurchase such securities at a specified
price at a later date. Reverse repurchase agreements have short-term maturities
(typically 90 days or less) and are deemed to be financing transactions. All
securities underlying reverse repurchase agreements are reflected as assets in
our consolidated financial statements and are held in safekeeping by
broker-dealers. We had no securities sold under agreements to repurchase at
December 31, 2004.
Debt Securities. Our debt securities at December 31, 2004 consisted of
10.875% Capital Securities due in 2027 with an outstanding balance of $56,249
and 3.25% Convertible Notes due in 2024 with an outstanding balance of $175,000.
In July 2004 we issued the $175,000 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.
RISK FACTORS
There are a number of risk factors that relate to our business and that
may directly or indirectly affect our results of operations and financial
condition. A discussion of our principal risk factors appears under the caption
"Overview of Risks and Related Critical Accounting Policies" on pages 13 to 21
of our 2004 Annual Report to Shareholders and is incorporated herein.
COMPETITION
A discussion of competition as it relates to our primary core businesses
appears under the caption "Risk Relating to Our Business" on pages 13 to 18 of
our 2004 Annual Report to Shareholders and is incorporated herein by reference.
SUBSIDIARIES
A list of our significant subsidiaries is set forth in Exhibit 21.0.
EMPLOYEES
As of December 31, 2004, we had a total of 3,120 employees, of which
1,032 were in our United States facilities and 2,026 were in our India
operations centers. We have developed our India operations centers over the past
three years in order to benefit from the cost savings opportunities and quality
workforce available in that country. We also had 62 employees in other countries
at December 31, 2004.
In the United States, our operations are concentrated in our
headquarters in West Palm Beach, which had 357 employees as of December 31,
2004, and our operations center in Orlando, which had 645 staff members as of
the same date. Our Orlando facility has the capacity to house 1,154 employees
on a single shift. In addition, we had 30 employees at various other locations
in the United States.
In India, our operations are located in the cities of Bangalore and
Mumbai. Of the 2,026 members of the staff in India as of December 31, 2004,
1,201 were in Bangalore and 825 were in Mumbai. Our India workforce can be
summarized by business as follows:
. 43% are engaged in activities for our Residential Loan Servicing
business,
. 22% support Business Process Outsourcing,
. 14% support OTX and Technology Services,
. 17% work in various other business units and
. 4% represent various support functions, including Human Resources and
Corporate Services, Accounting and Risk Management. Our employees are
not represented by a collective bargaining agreement. We consider our
employee relations to be satisfactory.
10
PART I (Continued)
REGULATION
U.S. financial institutions and their holding companies are extensively
regulated under federal and state laws. The Bank is regulated and examined
primarily by the OTS, which has substantial enforcement authority over the Bank.
Because the Bank accepts deposits that are insured by the FDIC, the FDIC serves
as a secondary federal banking regulator of the Bank. As such, it also has
substantial enforcement authority over the Bank. These Federal banking
regulators have the ability to assess civil monetary penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions for
violations of laws and regulations and unsafe or unsound practices. As a result,
our business can be materially affected by changes in our regulatory
environment.
If, as described under "General" we were to no longer control a federal
savings bank, we would no longer be subject to federal banking regulations but
would remain subject to certain federal, state and local consumer protection
provisions. We also would become subject to regulation in a number of states as
a mortgage service provider and/or as a debt collector. We have not previously
operated our residential loan servicing business under such regulatory regimes
and there can be no assurance that this transition would not result in
additional costs or uncertainties that would have a material adverse effect on
the profitability of our residential loan servicing business.
Although not significant to current operations, BOK is licensed as a
credit institution under the laws of the Federal Republic of Germany and is
subject to supervision and regulation in that country.
THE HOLDING COMPANY
Savings and Loan Holding Company. Ocwen Financial Corporation is a
registered savings and loan holding company under the Home Owners' Loan Act
("HOLA"). As such, we have registered with the OTS and are subject to
regulation, supervision and examination by the OTS. We are required to file
periodic reports with the OTS on our business and activities. The OTS has the
authority to review our activities and determine if any activity constitutes a
serious risk to the financial soundness, safety, or stability of the Bank. If
the OTS makes a determination that these risks exist, the OTS may place
restrictions on our activities or the activities of our subsidiaries or
affiliates. These restrictions may impact the ability of the Bank to pay
dividends, to engage in transactions with us or our subsidiaries or affiliates
and to engage in other banking activities.
Restrictions on Acquisitions. Savings and loan holding companies and
their affiliates are prohibited from acquiring more than 5% of the voting
shares, or from acquiring control, of any other savings association or savings
and loan holding company, without prior approval of the OTS. No person or entity
can acquire a controlling interest in Ocwen Financial Corporation without
receiving the approval of the OTS. Moreover, no other savings and loan holding
company can acquire more than 5% of Ocwen's voting shares without the prior
approval of the OTS.
THE BANK
General. The Bank is a federal savings bank organized under the HOLA.
The Bank is subject to regulation, supervision and examination by the OTS and by
the FDIC. The business and activities of the Bank are reported in periodic
filings with the OTS. Regulations apply to, among other things, insurance of
deposit accounts, capital requirements, payment of dividends, the nature and
amount of the investments that the Bank may make, transactions with affiliates,
community reinvestment, lending, internal policies and controls and changes in
control of the Bank as well as subsidiaries established by the Bank.
FDIC. The FDIC may terminate the deposit insurance of the Bank if the
Bank engages in unsafe or unsound practices, is in an unsafe or unsound
condition or has violated any applicable law, regulation, rule, order or
condition imposed by the OTS or the FDIC. If insurance of accounts is
terminated, the accounts at the institution at the time of the termination, less
subsequent withdrawals, shall continue to be insured for a period of six months
to two years, as determined by the FDIC. Other than in connection with the
completion of debanking as described in "General", we are aware of no existing
circumstances that would result in termination of the Bank's deposit insurance.
Regulatory Capital Requirements. Federal savings banks are subject to
minimum capital requirements set forth by the OTS. The three capital
requirements applicable to the Bank are discussed below.
Leverage Capital Requirement. The minimum leverage capital requirement
for most savings associations is a ratio of core capital to adjusted total
assets of 4%. Core capital includes common shareholders' equity, non-cumulative
perpetual preferred stock and related surplus, minority interests in the equity
accounts of fully consolidated subsidiaries and certain non-withdrawable
accounts and pledged deposits. Deductions from core capital include certain
intangibles, disallowed servicing assets and disallowed deferred tax assets.
Adjusted total assets of a savings association are total assets as reported for
consolidated entities on period-end reports in accordance with GAAP plus the
prorated assets of any includible subsidiary in which the savings association
has a minority ownership interest that is not consolidated under GAAP and any
remaining qualifying supervisory goodwill, minus certain assets not includible
in the applicable capital standard, investments in any includible subsidiary in
which a savings association has minority interests investments in a subsidiary
subject to consolidation.
11
PART I (Continued)
Tangible Capital Requirement. Tangible capital is core capital less all
intangibles other than qualifying mortgage servicing rights. Federal savings
banks are required to maintain tangible capital of at least 1.5% of their
adjusted total assets.
Risk-Based Capital Requirement. A savings bank is allowed to include
both core capital and supplementary capital in the calculation of its total
capital for purposes of the risk-based capital requirements, provided that the
amount of supplementary capital included does not exceed the savings bank's core
capital. Supplementary capital consists of certain capital instruments that do
not qualify as core capital, including subordinated debt that meets specified
requirements and loan and lease loss allowances up to a maximum of 1.25% of
risk-weighted assets. In determining the required amount of risk-based capital,
total assets, as well as residual interests (including certain off-balance sheet
items that are converted to on-balance sheet credit equivalents using a
conversion factor of 0% to 100%), are multiplied by a risk weight based on the
risks inherent in the type of assets. The risk weights assigned by the OTS for
principal categories of assets currently range from 0% to 200%, depending on the
type of asset. Deductions from risk-based capital include real estate acquired
in satisfaction of a debt and held in excess of five years.
Following an examination by the OTS in late 1996 and early 1997, the
Bank committed to the OTS to maintain a core capital ratio and a total
risk-based capital ratio of at least 9% and 13%, respectively. The Bank
continues to be in compliance with this commitment.
Prompt Corrective Action. Federal banking regulators have the authority
to take "prompt corrective action" to resolve the problems of undercapitalized
institutions. The regulations establish five categories with varying degrees of
regulators' powers: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." At December 31, 2004, the Bank was a "well capitalized"
institution under the prompt corrective action regulations of the OTS; however,
this classification is for limited purposes and may not be indicative of the
Bank's financial condition. The regulations also permit the appropriate Federal
banking regulator to downgrade an institution to the next lower category under
certain circumstances. Depending upon the capital category of an institution,
the regulators' corrective powers may affect capital and stock distributions,
limits on asset growth, acquisitions and new lines of business, transactions
with affiliates, the ability to accept brokered deposits and changes in officers
and directors, among other things.
Qualified Thrift Lender Test. The Bank is required to meet the qualified
thrift lender ("QTL") test set forth in the HOLA to avoid certain restrictions
on their operations. Under the QTL test provisions, a savings institution must
maintain at least 65% of portfolio assets in qualified thrift investments, which
generally include loans, securities and other investments that are related to
housing, small business and credit card lending. A savings bank that does not
meet the QTL test must either convert to a bank charter or comply with the
following restrictions on its operations:
. The association may not engage in any new activity or make any new
investment, directly or indirectly, unless such activity or investment
is permissible for a national bank,
. The branching powers of the association shall be restricted to those of
a national bank; and
. Payment of dividends by the association shall be subject to the rules
regarding payment of dividends by a national bank.
The Bank is currently and expects to remain in compliance with QTL
standards.
Restrictions on Capital Distributions. The Bank is required to file a
notice with the OTS at least 30 days prior to paying a dividend, or making any
payment to repurchase, redeem, retire or otherwise acquire debt instruments
included in total risk-based capital (each a "capital distribution") if (a) it
is not eligible for expedited treatment under the OTS application processing
regulations, (b) the total amount of the Bank's capital distributions (including
the proposed distribution) for the calendar year exceeds the Bank's net income
for the year to date plus retained net income for the previous two years, (c)
the Bank would not be "adequately capitalized" following the proposed capital
distribution or (d) the proposed capital distribution would violate any
applicable statute, regulation, or an agreement between the Bank and the OTS, or
a condition imposed upon the Bank by an OTS-approved application or notice. The
OTS may deny the Bank's application or disapprove the Bank's notice if the OTS
determines that (a) the Bank will be "undercapitalized," "significantly
undercapitalized" or "critically under capitalized," as defined in the OTS
capital regulations, following the capital distribution, (b) the proposed
capital distribution raises safety and soundness concerns or (c) the proposed
capital distribution violates a prohibition contained in any statute, regulation
or agreement between the Bank and the OTS or a condition imposed on the Bank in
an application or notice approved by the OTS. The Bank is in compliance with
these restrictions.
12
PART I (Continued)
Loan-To-One Borrower. The amount of loans and extensions of credit that
may be extended by the Bank to any one borrower, including related entities,
generally may not exceed 15% of the unimpaired capital and unimpaired surplus of
the institution. Loans in an amount equal to an additional 10% of unimpaired
capital and unimpaired surplus may be made to a borrower if the loans are fully
secured by readily marketable collateral, which does not include real estate
collateral. An institution's "unimpaired capital and unimpaired surplus"
includes, among other things, the amount of its core capital and supplementary
capital included in its total capital under OTS regulations. The Bank is
currently in compliance with the loan-to-one borrower limitation.
Affiliate Transactions and Tying. Transactions between the Bank and
Ocwen Financial Corporation, OAC, OTX and their non-bank subsidiaries are
subject to quantitative and qualitative restrictions. Such transactions with any
one affiliate may not exceed 10% of the Bank's capital and surplus and with all
affiliates in the aggregate may not exceed 20% of the Bank's capital and
surplus. Certain such transactions (e.g., loans and guarantees) must meet
collateralization requirements. A transaction between the Bank and its affiliate
must be on terms and conditions at least as favorable to the Bank as those
prevailing at the time for comparable transactions with non-affiliated
companies. Savings banks are required to make and retain detailed records of
transactions with affiliates. Additionally, the Bank is not permitted to make a
loan or extension of credit to any affiliate unless the affiliate is engaged
only in activities the Federal Reserve Board has determined to be permissible
for bank holding companies. The Bank is also prohibited from purchasing or
investing in securities issued by an affiliate, other than shares of a
subsidiary. The Bank is currently and expects to remain in compliance with the
affiliate transaction provisions.
Also, subject to certain exceptions, savings banks are prohibited from
conditioning the availability or pricing of their products or services on the
requirement that a customer obtain another product or service from the savings
bank or an affiliate, provide another product or service to the savings bank or
an affiliate or refrain from obtaining another product or service from a
competitor of the savings bank or an affiliate.
Insider Loans. Savings banks are also subject to various limitations and
reporting requirements on loans to insiders. These limitations require, among
other things, that all loans or extensions of credit to insiders (generally
executive officers, directors or 10% stockholders of the institution) or their
"related interests" be made on substantially the same terms (including interest
rates and collateral) as, and follow credit underwriting procedures that are not
less stringent than, those prevailing for comparable transactions with the
general public and not involve more than the normal risk of repayment or present
other unfavorable features. The Bank currently has no insider loans.
Gramm-Leach-Bliley Act. Title V of the Gramm-Leach-Bliley Act imposes
consumer financial privacy restrictions on savings banks. These restrictions
require a savings bank to safeguard non-public personal information of
consumers; provide notices to consumers about an institution's privacy policies
and practices and the about the right of consumers to opt-out of certain
information sharing by savings banks. Also, these laws provide consumers a right
to prevent a savings bank from disclosing non-public personal information about
the consumer to non-affiliated third parties, with exceptions. The Bank
currently is and expects to remain in compliance with applicable privacy
provisions.
Federal Reserve Regulation. Under Federal Reserve Board regulations, the
Bank is required to maintain a reserve against its transaction accounts, which
increases the Bank's cost of funds. The Bank may borrow from the Federal Reserve
Bank discount window, but the Federal Reserve Board's regulations require the
Bank to exhaust other reasonable alternative sources before borrowing from the
Federal Reserve Bank. Numerous other regulations promulgated by the Federal
Reserve Board affect the business operations of the Bank. These include
regulations relating to equal credit opportunity, electronic fund transfers,
collection of checks, truth in lending, truth in savings and availability of
funds.
Federal Home Loan Bank System. The Federal Housing Finance Board is an
agency of the federal government and is generally responsible for regulating the
FHLB System. FHLBs are federally chartered but privately owned institutions
created by Congress. The primary purpose of the FHLBs is to provide funding to
their members for making housing loans as well as for affordable housing and
community development lending. Generally, an institution is eligible to be a
member of the FHLB for the district where the member's principal place of
business is located. The Bank, whose home office is in Ft. Lee, New Jersey, is a
member of the New York FHLB. As an FHLB member, we are required to own FHLB
capital stock based upon the aggregate outstanding advances from the FHLB. In
addition, there are risk-based and leverage capital requirements that must be
met by FHLB members, which are similar to those currently in place for
depository institutions.
Community Reinvestment Act. The Community Reinvestment Act ("CRA")
requires financial institutions regulated by the federal banking agencies to
ascertain and help meet the credit needs of their delineated communities,
including low- to moderate-income neighborhoods within those communities, while
maintaining safe and sound banking practices. The regulatory agency assigns one
of four possible ratings to an institution's CRA performance: outstanding,
satisfactory, needs to improve and substantial noncompliance. The institution's
regulator must consider its financial capacity and size, legal impediments,
local economic conditions and demographics, including the competitive
environment in which it operates. The most recent review of the Bank's CRA
performance resulted in a "Satisfactory" rating from the OTS in 2002. Since 2002
the Bank has been evaluated as a wholesale institution. Wholesale institutions
are a type of federal savings bank that is not in the business of extending home
mortgage, small business, small farmer or consumer loans to retail customers and
for which a designation as a wholesale savings association is in effect. As a
wholesale institution for purposes of the CRA, the OTS assesses our record of
helping to meet the credit needs of our assessment area through its community
development lending, qualified investments, or community development services.
13
PART I (Continued)
USA PATRIOT Act. Among other requirements, the USA PATRIOT Act requires
savings banks to establish an anti-money laundering program and imposes
limitations and due diligence requirements on private banking accounts and
correspondent accounts with certain foreign nationals and foreign institutions.
Pursuant to the USA PATRIOT Act, the OTS has adopted regulations requiring
depository institutions, such as the Bank, to adopt customer identification
programs. The Bank has adopted an anti-money laundering program as well as a
customer identification program and currently is and expects to remain in
compliance with these laws.
Supervisory Agreement with the OTS. On April 19, 2004, the Bank and the
OTS entered into the Supervisory Agreement regarding various mortgage loan
servicing and customer service practices. The Supervisory Agreement, among other
things, requires that the Bank:
. continue to maintain and further develop an Office of Consumer Ombudsman
to address borrower issues in a timely and effective manner;
. develop a "Borrower-Oriented Customer Service Plan" to set standards and
goals for customer services, with input from one or more
consumer-interest groups;
. develop a "Consumer Dispute Resolution Initiative," to improve and
expedite the resolution of consumer issues;
. implement procedures regarding force-placed hazard insurance, by
providing borrowers/customers the opportunity to respond to a notice
that hazard insurance will be obtained on their behalf and at their
expense if the customer does not have appropriate hazard insurance
already in place;
. not impose fees relating to notice-of-default letters;
. agree not to charge fees to delinquent borrowers for entering into
forbearance agreements (i.e., formally agree to make certain payments on
loan balances in lieu of foreclosure); and
. provide borrowers and/or their attorneys/agents with itemized and
complete written loan pay-off quotes within five business days, and
ensuring that all fees and charges for the quotes are verified by the
Bank prior to issuance, and if a payoff quote, exclusive of principal
and interest, exceeds $1,000, to include conspicuous disclosure that a
borrower may contact the Bank's Consumer Ombudsman or the OTS if a
borrower has reason to dispute any of the charges.
As required under the Supervisory Agreement, the Bank has established a
compliance committee of three directors, all of whom are outside directors, to
monitor and coordinate the Bank's compliance with the Supervisory Agreement as
well as adherence with the practices adopted and implemented under the
Supervisory Agreement. Each quarter the compliance committee will report to the
Bank's board of directors with written progress reports detailing actions taken
to comply with the provisions of the Supervisory Agreement and the results of
those actions, and the Bank's board of directors will provide such reports to
the OTS. Messrs. Lacy (Chairman), Korn and Wish serve as members of the
compliance committee. The Bank also is providing the OTS with monthly reports
summarizing information about the aggregate number and nature of any unresolved
consumer complaints outstanding for 30 or more calendar days as of the last day
of the preceding month. To date, the Bank has complied fully with each of its
obligations under the Supervisory Agreement and is not aware of any reason why
it would not be able to comply with the terms and conditions of the Supervisory
Agreement in the future. The OTS continues to supervise and examine our
compliance with the Supervisory Agreement and our mortgage loan servicing and
customer service practices generally. If the OTS were to determine that we
failed to comply with the Supervisory Agreement or otherwise were to find
deficiencies in our mortgage servicing practices, the OTS could initiate an
enforcement proceeding against the Bank, which could result in civil money
penalties or the imposition of further requirements on the Bank's business
practices.
BOK
Bankhaus Oswald Kruber GmbH & Co. KG, or BOK, our German banking
subsidiary, is licensed as a credit institution (Kreditinstitut) under the laws
of the Federal Republic of Germany and is supervised and regulated in Germany by
the German Federal Financial Supervisory Authority (Bundesanstalt fur
Finanzdienstleistungsaufsicht - BaFin), the German Central Bank (Deutsche
Bundesbank) and, in respect of minimum reserves on deposits, the European
Central Bank.
Under its license, BOK may engage in a number of traditional banking
activities such as deposit and lending business, but also in investment banking,
underwriting and securities trading transactions, both for its own account and
for customers. BOK must conduct its banking activities in particular in
accordance with the German Banking Act (Kreditwesengesetz), the German
Securities Trading Act (Wertpapierhandelsgesetz) and the rules and regulations
adopted thereunder. This legal framework reflects certain recommendations of the
Basel Committee on Banking Regulations and Supervisory Practices at the Bank for
International Settlements, as well as legislative acts adopted by the European
Community.
14
PART I (Continued)
German regulatory requirements applicable to BOK concern in particular
the maintenance of adequate regulatory capital and liquidity, the monitoring of,
and limitations on, large credit exposures, limitations on equity and
equity-like participations in other companies, the protection of depositors and
the adoption of certain accounting standards and business practices. The German
Federal Financial Supervisory Authority and the German Central Bank monitor the
compliance of German banks such as BOK with the applicable German banking laws,
rules and regulations largely upon the basis of extensive reporting requirements
as well as through general and specific audits. BOK is in compliance in all
material respects with the German regulatory requirements that are applicable to
its business.
The German Federal Financial Supervisory Authority has a wide range of
means to investigate and enforce a bank's compliance with the German regulatory
requirements. It may conduct audits on a random basis or for cause (even outside
Germany, if the other jurisdiction permits the audit), it may require banks to
furnish information and documents, and it may attend meetings of a bank's
supervisory board or shareholders. If the German Federal Financial Supervisory
Authority discovers any irregularities, it may remove a bank's managers from
office or prohibit them from exercising their duties, it may prohibit a bank
from distributing profits or extending credit, and, as an ultimate measure, it
may revoke a bank's license and order the closure of the bank. The German
Banking Act also entitles the German Federal Financial Supervisory Authority to
take certain emergency measures if a bank is in danger of defaulting on its
obligations to creditors or to avoid the insolvency of a bank.
SARBANES-OXLEY ACT OF 2002
In response to the recent series of regulatory enactments in furtherance
of the provisions of the Sarbanes-Oxley Act, we have taken actions including,
but not limited to:
. Review of the responsibilities and reporting practices of our auditors,
. Development of questionnaires to identify potential conflicts of
interest,
. Establishment of Disclosure Review and Nomination/Governance Committees,
. Review of our procedures and policies with regard to independence of our
board members serving on the Audit Committee and Audit Committee
responsibilities consistent with Section 301 of the Act,
. Establishment of a Whistleblower Policy,
. Development of CEO and CFO certifications to accompany audit reports,
. Review of procedures in place to avoid any improper influence on conduct
of audits,
. Update disclosures in periodic reports to conform with Section 401 of
the Act,
. Establishment of ethics policies identifying prohibited activities under
the Act,
. Expedite insider reporting of transactions,
. Review of internal controls by management,
. Development of practices for real time disclosure of material events and
. Establishment of procedures for document retention and control.
FEDERAL TAXATION
General. OCN and all of its domestic subsidiaries currently file, and
expect to continue to file, a consolidated Federal income tax return based on a
calendar year. Consolidated returns have the effect of eliminating inter-company
transactions, including dividends, from the computation of taxable income.
Alternative Minimum Tax. In addition to the regular corporate income
tax, corporations, including qualifying savings institutions, are subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years.
Tax Residuals. From time to time, we acquired Real Estate Mortgage
Investment Conduit ("REMIC") residuals or retained residual securities in REMICs
that were formed by us in connection with the securitization and sale of loans.
Although a tax residual may have little or no future economic cash flows from
the REMIC from which it has been issued, the tax residual does bear the income
tax liability or benefit resulting from the difference between the interest rate
paid on the securities by the REMIC and the interest rate received on the
mortgage loans held by the REMIC. This generally results in taxable income for
us in the first several years of the REMIC and equal amounts of tax deductions
thereafter, although the amount and timing with which we must report taxable
income or deductions may vary based on the particular experience of the mortgage
collateral supporting each REMIC. The tax residuals may also generate excess
inclusion income that could create a tax liability for us if we have not
otherwise earned taxable Income in a particular year.
15
PART I (Continued)
Investments in Affordable Housing Properties. For a discussion of the
tax effects of investments in affordable housing properties, see
"Segments-Affordable Housing."
Examinations. The Internal Revenue Service agent has completed an
examination of the Company's Federal income tax returns for the years 1998
through 2001 and has reviewed the tax years 1995 through 1997 and 2002 as result
of carryback claims filed. The statute of limitations has run with respect to
1997 and all prior tax years. Thus, the Federal income tax returns for the years
1998 through 2000 (due to a waiver of the statute of limitations) and 2001
through 2003 are open for examination. We do not anticipate any material
adjustments as a result of any examination, although there can be no assurances
in this regard.
STATE TAXATION
OCN's income is subject to tax by the States of Florida and California,
which have statutory tax rates of 5.5% and 10.84%, respectively, and its taxable
income in these states is determined based on certain apportionment factors. We
are taxed in New Jersey on income, net of expenses, earned in New Jersey at a
statutory rate of 9.0%. Currently no state return of ours is being examined, and
we have received no notification from any state that intends to examine any of
our tax returns. We do not anticipate any material adjustments as a result of
any examination, although there can be no assurances in this regard.
16
PART I (Continued)
ITEM 2. PROPERTIES (Dollars in thousands)
The following table sets forth information relating to our facilities at
December 31, 2004:
Net Book Value of Property or
Location Owned/Leased Leasehold Improvements
---------------------------------------------------------- ------------ -----------------------------
EXECUTIVE OFFICES:
1675 Palm Beach Lakes Boulevard
West Palm Beach, FL................................... Leased $ 1,367
BANK MAIN OFFICE:
2400 Lemoine Ave
Fort Lee, NJ.......................................... Leased $ 4
SERVICING CENTERS:
12650 Ingenuity Drive
Orlando, FL........................................... Owned $ 21,087
2650 Warrenville Road
Chicago, IL........................................... Leased $ --
SOFTWARE DEVELOPMENT AND SERVICING OPERATIONS CENTER:
Salarpuria Arena
24 Hosur Luskar Road
Bangalore, India...................................... Leased $ 891
Salarpuria Adonis
3/1 Kolar Road, Sarvagna Nagar, Ward No. 85
Binnamangala, Bangalore, India........................ Leased $ --
Spectrum Towers
Mind Space Business District
Link Road, Malad West
Mumbai, India......................................... Leased $ 61
GSS OFFICES:
Taiwan office:
Taipei World Trade Center
333 Keelung Road
Taipei, Taiwan........................................ Leased $ 36
Japan office:
SK Building
3F 2-7-4 Nishi-Shinbashi
Tokyo, Japan.......................................... Leased $ 12
China office:
China World Tower 1
No. 1 Jian Guo Men Wai Avenue
Beijing, Peoples' Republic of China................... Leased $ 19
Canada office:
111 Richmond Street West, Suite 1202
Toronto, Ontario, Canada.............................. Leased $ 5
Germany office:
Bonifaziusturm B, 21st Floor, Erthalstrasse 1
D-55118 Mainz, Germany................................ Leased $ --
BOK OFFICES:
Berlin office:
Bondickstrasse 22
13469 Berlin, Germany................................. Leased $ --
Frankfurt office:
Mainzer Landstrasse 16
60325 Frankfurt, Germany.............................. Leased $ --
17
PART I (Continued)
ITEM 3. LEGAL PROCEEDINGS (Dollars in thousands)
A description of material pending or recently settled legal proceedings
to which OCN or its subsidiaries are a party follows:
OCN and certain of its affiliates, including the Bank, have been named
as defendants in purported class action lawsuits brought in various federal and
state courts challenging the Bank's mortgage servicing practices. On April 13,
2004 the United States Judicial Panel on Multi-District Litigation granted our
petition to transfer and consolidate a number of the lawsuits into a single case
to proceed in 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 "MDL Proceeding"). Additional similar
lawsuits have been brought in other courts, some of which have been or may be
transferred and consolidated in the MDL Proceeding.
The MDL Proceeding currently includes the following actions in which OCN
and/or the Bank are defendants:
(1) Patricia Antoine, et al v. Ocwen Federal Bank FSB, et al.,
case No. C-03-5503 (N.D.Cal.)
(2) Deborah Bush v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02827 (N.D.Ala.)
(3) Carolyn P. Calhoun v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-00293 (N.D.Miss.)
(4) Ralph Carreon Jr., et al. v. Ocwen Federal Bank FSB,
Case No. 5:03-5151 (Bankr. W.D.Tex.)
(5) Stevie Cooper, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 1:04-cv-00639 (S.D.Ala.)
(6) Mary Crosby v. Ocwen Federal Bank FSB, et al.,
Case No. 5:04-cv-02828 (N.D.Ala.)
(7) Billy M. Dockery, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02830 (N.D.Ala.)
(8) Thomas B. Doherty v. Ocwen Federal Bank FSB, et al.,
Case No. 04-cv-04880 (D.Minn.)
(9) Unnatiben Gandabhai, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 3:04-2582 (N.D.Cal.)
(10) Lizzie Hannah, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02833 (N.D.Ala.)
(11) Kweku Hanson, et al v. Ocwen Federal Bank FSB, et al.,
Case No. 02-CV-860 (D.Conn.)
(12) William Hearn, et al v. Ocwen Federal Bank FSB, et al.,
Case No. C-04-0291 (E.D.Cal.)
(13) Stephanie Hunter, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 2:04-cv-02864 (N.D.Ala.)
(14) Lula M. Jackson, et al v. Ocwen Federal Bank FSB, et al.,
Case No. C-03-0743 (N.D.Cal.)
(15) Freddie Jones v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-00294 (N.D.Miss.)
(16) Marion Long v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02852 (N.D.Ala.)
(17) Allie M. Maddox, et al v. Ocwen Federal Bank FSB, et al.,
Case No. CV-03-9515 (C.D.Cal.)
(18) Jeannette E. Martinez v. Ocwen Federal Savings Bank FSB,
Case No. 1:04-296 (D.N.M.)
(19) Michele McAuliffe, et al. v. U.S. Bank, N.A. as Trustee., et al.,
Case No. 03-C-1103 (N.D. Ill.)
(20) George McDonald v. Ocwen Financial Corp., et al.,
Case No. 1:04-03673 (N.D.Cal.)
(21) Al McZeal v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-1576 (S.D.Tex.)
(22) Delores B. Moore v. Ocwen Federal Bank FSB, et al.,
Case No. 2:04-2612 (E.D. Pa.)
(23) Timothy Napier, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 2:03-174 (E.D.Wash.)
(24) William A. Soto, et al v. Ocwen Federal Bank FSB, et al.,
Case No. 02-C-6818 (N.D.Ill.).
(25) Geneva Spires, et al v. Ocwen Financial Services, Inc., et al.,
Case No. C-03-5600 (N.D.Cal.)
(26) Maggie Williams, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-02869 (N.D.Ala.)
(27) Thomas Wright, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 1:04-cv-00638 (S.D.Ala.)
On August 23, 2004, plaintiffs filed a Consolidated Complaint, setting
forth claims contained in lawsuits consolidated in the MDL Proceeding. Those
claims variously involve alleged violations of federal statutes, including the
Real Estate Settlement Procedures Act and Fair Debt Collection Practices Act,
and state deceptive trade practices statutes, and assert common law claims. The
claims are based on various allegations of improper servicing practices,
including (i) charging borrowers allegedly improper or unnecessary fees such as
breach letter fees, hazard insurance premiums, foreclosure-related fees, late
fees and property inspection fees; (ii) untimely posting and misapplication of
borrower payments; and (iii) improperly treating borrowers as in default on
their loans. While some of the individual lawsuits had set forth specific damage
allegations (e.g., the Gandabhai complaint (item 9 above) claimed actual damages
of $61; the Hanson complaint (item 11 above) claimed actual damages of $150,000
and punitive and exemplary damages of $1,500,000; the various Alabama and
Mississippi cases generally alleged damages less than $75 (items 2, 3, 5, 6, 7,
10, 13, 15, 16, 26 and 27 above)), the Consolidated Complaint in the MDL
Proceeding does not set forth any specific amounts of claimed damages. The
absense of any specification of damages in the Consolidated Complaint does not,
however, preclude plaintiffs in the MDL Proceeding from requesting leave from
the court to amend the Consolidated Complaint or from otherwise seeking damages
should the matter proceed to trial.
18
PART I (Continued)
On September 30, 2004, the Ocwen defendants filed various motions to
dismiss, for summary judgment, to strike class allegations and to stay
discovery. Briefing on these motions has recently closed. Discovery in the MDL
Proceeding has been stayed pending resolution of the motions. No motion for
class certification has been submitted by plaintiffs, and the Court has not
indicated when any such motion would be permitted to be filed.
We cannot currently determine the ultimate outcome of the MDL Proceeding
or the other matters described above and have not established a reserve in
respect thereof. We believe the allegations in the MDL Proceeding and the other
matters described above are without merit and will continue to vigorously defend
against them.
On November 3, 2004, the trial judge in litigation brought by Cartel
Asset Management, Inc. ("Cartel") against OCN, the Bank and OTX in federal court
in Denver, Colorado entered final judgment in the amount of $520 against OTX and
nominal damages of two dollars against the Bank. No damages were entered against
OCN. By the November 3, 2004 order, the judge reduced a prior jury verdict in
the amount of $9,320 after trial on this matter involving allegations of
misappropriation of trade secrets and contract-related claims brought by a
former vendor. The litigation does not relate to our core Residential Loan
Servicing business practices. Notwithstanding the nominal damage award against
the Bank, it was assessed a statutory award to Cartel of attorneys' fees in an
additional amount of $170, and the Bank and OTX were further assessed costs in
the amount of $9. Cartel and defendants are pursuing cross-appeals in the United
States Court of Appeals for the Tenth Circuit. A reserve of $1,000 had been
established for this matter. We intend to continue to vigorously defend this
matter.
On February 8, 2005, a jury in Circuit Court for Palm Beach County,
Florida returned verdicts of $1,000 and $1,056 in compensatory damages in favor
of two former employees of the Bank in a lawsuit against OCN and the Bank. The
jury rejected plaintiffs' request for punitive damages. The plaintiffs brought
claims under the Florida Civil Rights Act, the Florida Whistleblower Act and
state tort law, arising out of an alleged invasion of privacy and related
incidents allegedly committed by other former employees of the Bank in 1998 for
which plaintiffs sought to hold the Ocwen defendants vicariously liable. We
believe the verdicts, which have not yet been reduced to final judgments, are
against the weight of evidence and contrary to law. Defendants have filed
motions for a new trial and/or remittitur and, if necessary, will take an appeal
to the Florida Court of Appeals for the Fourth District. We intend to continue
to vigorously defend this matter.
On February 28, 2005, a jury in County Court for Nueces County, Texas,
returned a verdict of $140 in compensatory and statutory damages in favor of two
borrowers whose mortgage loan was serviced by the Bank in a lawsuit arising out
of a disputed foreclosure. The jury rejected plaintiffs' request for punitive
damages. The verdict included $2,900 for plaintiffs' attorneys' fees, an amount,
which we believe is unsupported by the evidence and impermissibly excessive
under the controlling legal authorities. The verdict has not yet been reduced to
a final judgment. We are pursuing post-trial motions seeking to set aside or
substantially reduce the attorneys' fees award and, if necessary, will take an
appeal on that issue and perhaps other issues to the Texas Court of Appeals for
the Thirteenth Judicial District. We intend to continue to vigorously defend
this matter.
In light of the above-referenced developments in the Florida and Texas
matters, we have established a reserve of $3,000 in 2004.
On March 9, 2005, the Bank was served with a complaint filed in Superior
Court for Los Angeles County, California, by Banco Popular North America,
successor by merger to Quaker City Bank ("Banco Popular"), which claims to be a
holder of residual interest in two mortgage loan trusts for which the Bank
provides loan servicing. In this lawsuit, Banco Popular challenges the Bank's
fee charges for recoveries on charged-off loans. The complaint variously alleges
breach of contract, conversion, breach of fiduciary duty and fraud, and seeks
declaratory and equitable relief, along with claimed compensatory damages in
excess of $3,000 and punitive damages in an unspecified amount. We believe the
allegations are without merit and will vigorously defend this matter.
OCN and the Bank are also subject to various other pending legal
proceedings. In our opinion, the resolution of these other proceedings will not
have a material effect on our financial condition, results of operations or cash
flows.
We continuously monitor the status of our litigation, including advice
from external legal counsel, and perform periodic assessments of our litigation
for potential accrual of litigation reserves and disclosure. We accrue a
litigation reserve when it is probable that a liability had been incurred and
the amount of loss can be reasonably estimated.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of stockholders during the
quarter ended December 31, 2004.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Information required by this Item appears under the caption "Shareholder
Information" on page 115 of our 2004 Annual Report to Shareholders and under the
caption "Security Ownership of Certain Beneficial Owners and Related Stockholder
Matters - Equity Compensation Plan Information" in our 2005 Proxy Statement and
is incorporated herein by reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Information required by this Item appears under the caption "Selected
Consolidated Financial Information" on pages 10 to 12 of our 2004 Annual Report
to Shareholders and is incorporated herein by reference. See Item 8 below and
Part IV, Item 15 regarding our consolidated financial statements and notes.
19
PART II (Continued)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information required by this Item appears under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 13 to 64 of our 2004 Annual Report to Shareholders and is
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item appears under the captions "Asset and
Liability Management" on pages 56 to 60, "Note 1: Summary of Significant
Accounting Policies" on pages 73 to 82 and "Note 18: Derivative Financial
Instruments" on pages 96 to 97 of our 2004 Annual Report to Shareholders and is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this Item appears on pages 66 to 114 in our 2004
Annual Report to Shareholders and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company's
management, under the supervision of and with the participation of the Company's
Chief Executive Officer and Acting Chief Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures, as such term
is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), as of the end of the period covered by
this report. Based on such evaluation, the Company's Chief Executive Officer and
Acting Chief Financial Officer have concluded that, as of the end of such
period, the Company's disclosure controls and procedures are effective and are
reasonably designed to ensure that all material information relating to the
Company required to be included in the Company's reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the rules and forms of the Securities and Exchange
Commission.
Status of Management's Report on Internal Control over Financial
Reporting. The Company's management is responsible for establishing and
maintaining adequate internal control over financial reporting, as that term is
defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and
with the participation of the Company's management, including the principal
executive officer and principal financial officer, the Company is in the process
of conducting an evaluation of its internal control over financial reporting
based on the framework in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
The Company's evaluation of its internal control over financial
reporting has not yet been completed. In connection with this process, the
Company has identified certain significant deficiencies that have been or are
being remediated. There can be no assurance that as a result of the ongoing
evaluation of internal control over financial reporting, additional deficiencies
will not be identified or that any deficiencies identified, either alone or in
combination with others, will not be considered a material weakness.
Pursuant to Securities and Exchange Commission Release No. 34-50754,
which, subject to certain conditions, provides up to 45 additional days beyond
the due date of this Form 10-K for the filing of management's annual report on
internal control over financial reporting required by Item 308(a) of Regulation
S-K, and the related attestation report of the independent registered public
accounting firm, as required by Item 308(b) of Regulation S-K, management's
report on internal control over financial reporting and the associated report on
the audit of management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, are not filed
herein and are expected to be filed no later than May 2, 2005.
Changes in Internal Control over Financial Reporting. There have not
been any changes in the Company's internal control over financial reporting, as
such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act
during the Company's fiscal quarter ended December 31, 2004 that have materially
affected, or are reasonable likely to materially affect, the Company's internal
control over financial reporting.
Limitations on the Effectiveness of Controls. The Company's management,
including the Chief Executive Officer and Acting Chief Financial Officer, does
not expect that the Company's disclosure controls or the Company's internal
control over financial reporting will prevent all errors and all fraud.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(i) pertain to the maintenance of records that, in
20
PART II (Continued)
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Further, the design of disclosure controls and internal control over
financial reporting must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected.
ITEM 9B. OTHER
There was no information required to be reported on Form 8-K during the
fourth quarter of the year covered by this Form 10-K that was not so reported.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in our definitive Proxy Statement with respect
to our Annual Meeting of Shareholders to be held on May 17, 2005 and as filed
with the Commission on or about March 16, 2005 (the "2005 Proxy Statement")
under the captions "Election of Directors - Nominees for Director," "Executive
Officers Who Are Not Directors," "Board of Directors and Corporate Governance -
Committees of the Board of Directors - Audit committee", "Security Ownership of
Certain Beneficial Owners and Related Stockholder Matters - Section 16(a)
Beneficial Ownership Reporting Compliance" and "Board of Directors and Corporate
Governance - Code of Ethics" is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in our 2005 Proxy Statement under the captions
"Executive Compensation," "Board of Directors Compensation" and "Comparison of
Cumulative Total Return" is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information contained in our 2005 Proxy Statement under the captions
"Security Ownership of Certain Beneficial Owners and Related Stockholder Matters
- - Beneficial Ownership of Common Stock" and "Security Ownership of Certain
Beneficial Owners and Related Stockholder Matters - Equity Compensation Plan
Information" are incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is included in our 2005 Proxy
Statement under the caption "Ratification of Appointment of Independent
Registered Certified Public Accounting Firm" and is incorporated herein by
reference.
21
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES and REPORTS ON FORM 8-K
(a) 1 & 2 Financial Statements and Schedules. The following Consolidated
Financial Statements of Ocwen Financial Corporation and Report of
PricewaterhouseCoopers LLP, Independent Registered Certified Public
Accounting Firm, are incorporated herein by reference from pages 66 to
114 of our Annual Report to Shareholders:
Report of Independent Registered Certified Public Accounting Firm
Consolidated Statements of Financial Condition at December 31, 2004
and 2003
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 2004
Consolidated Statements of Changes in Shareholders' Equity for each of
the three years in the period ended December 31, 2004
Consolidated Statements of Comprehensive Income for each of the three
years in the period ended December 31, 2004
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 2004
Notes to Consolidated Financial Statements
Financial statement schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated
Financial Statements or notes thereto.
(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 of Ocwen Capital
Trust I (4)
4.3 Form of Capital Security of Ocwen Capital Trust I (included in
Exhibit 4.4) (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 4.6) (4)
4.6 Form of Guarantee of OCN relating to the Capital Securities of
Ocwen Capital Trust I (4)
4.7 Registration Rights Agreement dated as of July 28, 2004, between
OCN and Jeffries & Company Inc. (5)
4.8 Indenture dated as of July 28, 2004, between OCN and the Bank of
New York Trust Company, N.A., as trustee (5)
10.1 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (6)
10.2 Ocwen Financial Corporation 1998 Annual Incentive Plan (7)
10.3 Compensation and Indemnification Agreement, dated as of
May 6, 1999, between OAC and the independent committee of the
Board of Directors (8)
10.4 Indemnity agreement, dated August 24, 1999, among OCN and OAC's
directors (9)
10.5 Amended Ocwen Financial Corporation 1991 Non-Qualified Stock
Option Plan, dated October 26, 1999 (9)
10.6 First Amendment to Agreement, dated March 30, 2000 between HCT
Investments, Inc. and OAIC Partnership I, L.P. (9)
10.7 Ocwen Financial Corporation Deferral Plan for Directors dated
March 7, 2005 (filed herewith)
11.1 Computation of earnings per share (10)
12.1 Ratio of earnings to fixed charges (filed herewith)
13.1 Excerpts from the Annual Report to Shareholders for the year
ended December 31, 2004 (filed herewith)
21.0 Subsidiaries (filed herewith)
23.0 Consent of PricewaterhouseCoopers LLP (filed herewith)
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)
22
PART IV (Continued)
32.1 Certification of the Chief Executive Officer pursuant to
18 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
18 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 a 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 filed
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 our 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
included with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2004.
(6) 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.
(7) Incorporated by reference from the similarly described exhibit to our
definitive Proxy Statement with respect to our 1998 Annual Meeting of
Shareholders as filed with the Commission on March 31, 1998.
(8) Incorporated by reference from OAC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1999.
(9) Incorporated by reference from the similarly described exhibit
included with the Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2000.
(10) Incorporated by reference from "Note 17: Basic and Diluted Earnings
per Share" on page 95 of our 2004 Annual Report to Shareholders.
(b) REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 2004
(1) A Form 8-K was filed by OCN on October 21, 2004, which contained a
news release announcing our 2004 third quarter results and certain
other information.
(2) A Form 8-K was filed by OCN on November 30, 2004, which announced the
application by Ocwen Federal Bank to the OTS for Voluntary Dissolution
pursuant to 12 C.F.R. Section 546.4.
23
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 our behalf by the undersigned, thereunto duly authorized.
OCWEN FINANCIAL CORPORATION
By: /s/ WILLIAM C. ERBEY
-----------------------------------
William C. Erbey
Chairman of the Board and
Chief Executive Officer
(duly authorized representative)
Date: March 16, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
/s/ WILLIAM C. ERBEY Date: March 16, 2005
- -------------------------------------------------
William C. Erbey, Chairman of the
Board and Chief Executive Officer
(principal executive officer)
/s/ RONALD M. FARIS Date: March 16, 2005
- -------------------------------------------------
Ronald M. Faris, President and Director
/s/ RONALD J. KORN Date: March 16, 2005
- -------------------------------------------------
Ronald J. Korn, Director
/s/ WILLIAM H. LACY Date: March 16, 2005
- -------------------------------------------------
William H. Lacy, Director
/s/ W. MICHAEL LINN Date: March 16, 2005
- -------------------------------------------------
W. Michael Linn, Executive Vice President
and Director
/s/ W.C. MARTIN Date: March 16, 2005
- -------------------------------------------------
W.C. Martin, Director
/s/ BARRY N. WISH Date: March 16, 2005
- -------------------------------------------------
Barry N. Wish, Director
/s/ ROBERT J. LEIST, JR. Date: March 16, 2005
- -------------------------------------------------
Robert J. Leist, Jr., Vice President &
Chief Accounting Officer and
Acting Chief Financial Officer
(principal financial and accounting officer)
24
EXHIBIT 10.7
OCWEN FINANCIAL CORPORATION
DEFERRAL PLAN FOR DIRECTORS
ADOPTED MARCH 7, 2005
ARTICLE I
Purpose
The purpose of the Ocwen Financial Corporation Deferral Plan for
Directors is to provide Directors with the opportunity to defer the receipt of
all or a portion of their stock-based compensation earned as directors of the
Company or any Subsidiary of the Company. All capitalized terms used in the Plan
shall have the meanings set forth in Article II.
ARTICLE II
Definitions
"Board" means the Board of Directors of the Company.
"Code" means the Internal Revenue Code of 1986, as amended.
"Committee" means the Compensation Committee of the Board.
"Common Stock" means the common stock of the Company.
"Company" means Ocwen Financial Corporation, a Florida corporation.
"Deferral" shall have the meaning set forth in Section 4.1.
"Deferral Account" means a bookkeeping account in the name of a Director
who elects to defer, pursuant to the Plan, all or a portion of his or her
Director Shares.
"Deferral Election" shall have the meaning set forth in Section 4.1.
"Director" means any director of the Company or any Subsidiary, whether
or not such director is an officer or employee of the Company or any Subsidiary.
In the case of a Subsidiary other than a corporation, "Director" shall mean any
member of the board of managers or other similar board or committee responsible
for the governance of such Subsidiary.
"Director Shares" means shares of restricted stock granted to Directors
under the Stock Plan for their service on the Board, the board of directors of a
Subsidiary or, in either case, any committee thereof.
"Distribution Date" shall have the meaning set forth in Section 7.1.
"Effective Date" means May 17, 2005.
"Fair Market Value" means (i) if the Common Stock is listed or admitted
to trading on any securities exchange or national market system in the United
States, the average of the high and low sales prices on such day on the
principal securities exchange or national market system in the United States on
which the Common Stock is traded, (ii) if the Common Stock is not then listed or
admitted to trading on any such day, or if no sale takes place on such day, the
average of the closing bid and asked prices in the United States on such day, as
reported by a reputable quotation source designated by the Committee, and
(iii) if the Common Stock is not then listed or admitted to trading on any such
securities exchange or national market system and no such reported sale price or
bid and asked prices are available, the average of the reported high bid and low
asked prices in the United States on such day, as reported in The Wall Street
Journal (Eastern edition) or other newspaper designated by the Committee.
"Plan" means this Deferral Plan for Directors, as amended and restated
from time to time.
"Plan Year" means the 12-month period coincident with each Grant Year,
as defined in the Stock Plan; provided, however, that the initial Plan Year
shall begin on the Effective Date and end on the last day of the Grant Year then
in effect.
"Share Unit" means a bookkeeping unit credited to a Director's Deferral
Account and having a value equal to one share of Common Stock.
"Stock Plan" means the Ocwen Financial Corporation 1996 Stock Plan for
Directors, or any successor thereto.
"Subsidiary" means any corporation or other business entity, the
majority of the outstanding voting stock or other equity interests of which are
owned, directly or indirectly, by the Company.
"Termination Date" means the date on which a Director ceases to serve as
a Director.
"Unforeseeable Emergency" means (i) a severe financial hardship to a
Director resulting from an illness or accident of the Director, or the spouse or
a dependent (as defined in Section 152(a) of the Code) of the Director, (ii) the
loss of a Director's property due to casualty or (iii) such other similar
extraordinary and unforeseeable circumstances arising as a result of events
beyond the control of the Director.
ARTICLE III
Administration
The Plan shall be administered by the Committee. The Committee shall,
subject to the terms of this Plan, interpret this Plan and the application
thereof, and establish rules and regulations it deems necessary or desirable for
the administration of this Plan. All such interpretations, rules and regulations
shall be final, binding and conclusive. The Committee may delegate
administrative duties under the Plan to one or more agents, as it shall deem
necessary or advisable.
ARTICLE IV
Deferral Elections
Section 4.1. Eligibility for Deferral Elections. Each Director shall
be eligible to participate in the Plan. A Director shall be eligible to make a
Deferral Election pursuant to Section 4.2 if he or she is a current Director or
has been elected to serve as a Director on the date such election is made.
Section 4.2. Election Procedures. Prior to the first day of the
calendar year in which each Plan Year commences or, with respect to the Plan
Year beginning on the Effective Date, prior to the Effective Date, each Director
may make an election to defer the receipt of all or any portion of the Director
Shares to be earned by such Director in such Plan Year (each such election shall
be referred to as a "Deferral Election" and the amounts deferred pursuant to
such an election the "Deferral"). Notwithstanding the foregoing, a Director who
is elected to serve as a Director during a Plan Year may make a Deferral
Election for such Plan Year within 30 days after such election. All Deferral
Elections must be made in accordance with procedures prescribed by the
Committee. Any Deferral Election shall apply only to the Director Shares earned
in the Plan Year for which the Deferral Election is made. In no event shall an
election under the Plan apply to Director Shares issuable to the Director prior
to the date on which such election is received by the Company.
Section 4.3. Changes in Deferral Election. A Director may change his
or her Deferral Election with respect to any Plan Year by submitting a new
election in accordance with Section 4.2. A Director may elect to suspend his or
her Deferrals during a Plan Year only if the Director demonstrates to the
satisfaction of the Committee that he or she has incurred an Unforeseeable
Emergency. No other changes may be made during a Plan Year to a Director's
Deferral Election.
Section 4.4. Effect of Deferral Election. The submission of an
election form pursuant to Section 4.2 shall evidence the Director's
authorization of the Company to withhold the issuance of Director Shares
pursuant to the terms of the Stock Plan, to the extent such Director Shares are
deferred pursuant to such election, and to credit to such Director's Deferral
Account, in accordance with Article V, an equal number of Share Units. The
submission of such election form shall further evidence the Director's election
of the timing of payment of the amount credited to such Director's Deferral
Account.
ARTICLE V
Deferral Accounts
Section 5.1. Deferral Account. As of each date on which, in the
absence of a Deferral Election, a Director is entitled to receive Director
Shares from the Company, the Director's Deferral Account under the Plan shall be
credited with a number of Share Units equal to the number of Director Shares
subject to the Director's Deferral Election then in effect.
Section 5.2. Dividend Equivalents. An amount equal to the number of
Share Units credited to each Deferral Account multiplied by the dividend paid on
a share of Common Stock on each dividend payment date shall be credited to such
Deferral Account within 10 days after the dividend payment date and shall be
deemed invested in additional whole and fractional Share Units as though such
dividend credit was a Deferral for such year.
Section 5.3. Vesting of Deferral Account. A Director shall become
vested in or shall forfeit the Share Units credited to the Director's Deferral
Account to the same extent that such Director would have become vested in or
forfeited the Director Shares subject to the Deferral Election, had they been
issued to the Director, subject to the terms and conditions set forth in the
Stock Plan.
ARTICLE VI
Payment of Deferral Accounts
Section 6.1. Time and Method of Payment. Except as otherwise
specifically provided herein, the number of Share Units credited to a Director's
Deferral Account for a Plan Year, together with any dividend equivalents
relating to such Share Units and credited to such account pursuant to Section
5.2, shall be paid to such Director in a single lump sum payment as soon as
administratively practicable after the payment date elected by the Director on
the Deferral Election form submitted to the Company for such Plan Year. The
payment date elected by the Director may be (i) the six-month anniversary of the
Director's Termination Date or (ii) any other date elected by the Director which
is at least two years after the last day of the Plan Year for which the
Deferrals are credited to the Director's Deferral Account; provided, however,
that if the Director's Termination Date occurs prior to the date elected by the
Director, the payment date shall be the six-month anniversary of the Director's
Termination Date.
Section 6.2. Change in Payment Election. A Director may elect to
change the time of payment elected pursuant to Section 6.1 in accordance with
procedures prescribed by the Committee; provided that such new election shall
not be effective unless it (i) is received by the Company at least one year
prior to the previously scheduled payment date, (ii) does not take effect for 12
months after it is received by the Company and (iii) extends the payment date by
at least five years.
Section 6.3. Form of Payment. At least 30 days prior to the payment of
a Director's Deferral Account, such Director shall elect whether to receive such
payment in the form of (i) cash in an amount equal to the Fair Market Value of
the number of whole and fractional Share Units credited to such account or
(ii) whole shares of Common Stock equal to the number of whole Share Units
credited to such Deferral Account and cash in an amount equal to the Fair Market
Value of any fractional Share Unit credited to such account. If a Director does
not elect the form in which his or her Deferral Account shall be paid, such
account shall be paid in cash in accordance with clause (i) above.
Section 6.4. Unforeseeable Emergency. In the event of an Unforeseeable
Emergency, a Director may file a written request with the Committee to receive
all or any portion of the vested balance of such Director's Deferral Account in
an immediate lump sum cash payment. A Director's written request for such a
payment shall describe the circumstances, which the Director believes justify
the payment and an estimate of the amount necessary to eliminate the
Unforeseeable Emergency. An immediate payment to satisfy an Unforeseeable
Emergency will be made only to the extent necessary to satisfy the emergency
need, plus an amount necessary to pay any taxes reasonably anticipated as a
result of such payment, and will not be made to the extent the need is or may be
relieved through reimbursement or compensation, by insurance or otherwise or by
liquidation of the Director's assets (to the extent such liquidation itself
would not cause severe financial hardship). Any payment from a Director's
Deferral Account on account of an Unforeseeable Emergency shall be deemed to
cancel any Deferral Election of the Director then in effect and the Director
shall be suspended from making further Deferral Elections under the Plan during
the remainder of the Plan Year in which such payment is made.
Section 6.5. Distributions to Minor and Incompetent Persons. If a
payment is to be made to a minor or to an individual who, in the opinion of the
Committee, is unable to manage his or her financial affairs by reason of illness
or mental incompetency, such distribution may be made to or for the benefit of
any such individual in such of the following ways as the Committee shall direct:
(a) directly to any such minor individual if, in the opinion of the Committee,
he or she is able to manage his or her financial affairs, (b) to the legal
representative of any such individual, (c) to a custodian under a Uniform Gifts
to Minors Act for any such minor individual or (d) to some near relative of any
such individual to be used for the latter's benefit. Neither the Committee nor
the Company shall be required to see to the application by any third party of
any payment made to or for the benefit of a Director or beneficiary pursuant to
this Section.
ARTICLE VII
Payment Upon Death of a Director
Section 7.1. Payment to Beneficiary. In the event a Director dies
before all amounts credited to his or her Deferral Account have been paid,
payment of the Director's Deferral Account shall be made as soon as practicable
after the date of such death.
Section 7.2. Designation of Beneficiary. Each Director may file with
the Company a written designation of one or more persons as such Director's
beneficiary or beneficiaries (both primary and contingent) in the event of the
Director's death. Each beneficiary designation shall become effective only when
filed in writing with the Company during the Director's lifetime on a form
prescribed by the Company. The filing with the Company of a new beneficiary
designation shall cancel all previously filed beneficiary designations. If a
Director fails to designate a beneficiary, or if all designated beneficiaries of
a Director predecease the Director, then the Deferral Account shall be paid to
the Director's estate.
ARTICLE VIII
Funding
Benefits payable under the Plan to any Director shall be paid by the
Company. The Company shall not be required to fund, or otherwise segregate
assets to be used for payment of benefits under the Plan. Notwithstanding the
foregoing, the Company, in the discretion of the Committee, may maintain one or
more grantor trusts (each, a "Trust") to hold assets to be used for payment of
benefits under the Plan. The assets of the Trust shall remain the assets of the
Company subject to the claims of its general creditors. Any payments by a Trust
of benefits provided to a Director under the Plan shall be considered payment by
the Company and shall discharge the Company of any further liability under the
Plan for such payments.
ARTICLE IX
General
Section 9.1. Effective Date; Termination. This Plan shall be effective
as of the Effective Date. The Committee may terminate this Plan at any time.
Termination of this Plan shall not affect the payment of any amounts credited to
a Director's Deferral Account.
Section 9.2. Amendments. The Committee may amend this Plan as it shall
deem advisable. No amendment may impair the rights of a Director to payment of
his or her Deferral Account without the consent of such Director.
Section 9.3. Nontransferability of Benefits. No benefit payable at any
time under the Plan shall be subject in any manner to alienation, sale,
transfer, assignment, pledge, attachment, or other legal process, or encumbrance
of any kind. Any attempt to alienate, sell, transfer, assign, pledge or
otherwise encumber any such benefits, whether currently or thereafter payable,
shall be void. No person shall, in any manner, be liable for or subject to the
debts or liabilities of any person entitled to such benefits. If any person
shall attempt to, or shall alienate, sell, transfer, assign, pledge or otherwise
encumber his benefits under the Plan, or if by any reason of his bankruptcy or
other event happening at any time, such benefits would devolve upon any other
person or would not be enjoyed by the person entitled thereto under the Plan,
then the Committee, in its discretion, may terminate the interest in any such
benefits of the person entitled thereto under the Plan and hold or apply them
for or to the benefit of such person entitled thereto under the Plan or his
spouse, children or other dependents, or any of them, in such manner as the
Committee may deem proper.
Section 9.4. Adjustment. In the event of any stock split, stock
dividend, recapitalization, reorganization, merger, consolidation, combination,
exchange of shares, liquidation, spin-off or other similar change in
capitalization or event, or any distribution to holders of Common Stock other
than a regular cash dividend, the number of Share Units credited to each
Deferral Account under the Plan shall be appropriately adjusted by the
Committee. The decision of the Committee regarding any such adjustment shall be
final, binding and conclusive.
Section 9.5. Forfeitures and Unclaimed Amounts. Unclaimed amounts
shall consist of the amounts of the Deferral Account of a Director that are not
distributed because of the Company's inability, after a reasonable search, to
locate a Director or his or her beneficiary, as applicable, within a period of
two (2) years after the distribution date upon which the payment of any benefits
becomes due. Unclaimed amounts shall be forfeited at the end of such two-year
period. These forfeitures will reduce the obligations of the Company under the
Plan and the Director or beneficiary, as applicable, shall have no further right
to his or her Deferral Account.
Section 9.6. Governing Law. This Plan and all determinations made and
actions taken pursuant thereto shall be governed by the laws of the State of
Florida and construed in accordance therewith without giving effect to
principles of conflicts of laws.
EXHIBIT 12.1
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
COMPUTATION OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS)
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
EARNINGS:
Income (loss) from continuing operations before income
taxes and effect of change in accounting principle $ 25,238 $ 5,028 $ (82,057) $ (41,782) $ 21,139
Less:
(Losses) and undistributed income of equity investees -- -- -- -- (5,280)
Adds:
Interest expensed and capitalized, except interest on
deposits, and amortization of capitalized debt
expenses 16,805 24,650 35,681 42,738 84,897
Interest on deposits 13,634 17,546 27,455 59,967 98,224
Interest component of rental expense 907 1,169 1,108 1,176 1,124
---------- ---------- ---------- ---------- ----------
Total fixed charges (1) 31,346 43,365 64,244 103,881 184,245
---------- ---------- ---------- ---------- ----------
Earnings (losses) for computation purposes $ 56,584 $ 48,393 $ (17,813) $ 62,099 $ 210,664
========== ========== ========== ========== ==========
Ratio of earnings to fixed charges:
Including interest on deposits (2) 1.81 1.12 (3) (3) 1.14
Excluding interest on deposits (2) 2.42 1.19 (3) (3) 1.31
(1) Fixed charges represent total interest expensed and capitalized,
including and excluding interest on deposits, amortization of
capitalized debt expenses, as well as the interest component of rental
expense.
(2) The ratios of earnings to fixed charges were computed by dividing
(x) income from continuing operations before income taxes and effect of
change in accounting principal, adjusted for losses and undistributed
income of equity investees plus fixed charges by (y) fixed charges.
(3) Due to our losses in 2002 and 2001, the ratio of earnings to fixed
charges was less than 1:1. We would have had to generate additional
earnings of $82,057 and $41,782, respectively, to achieve coverage of
1:1.
EXHIBIT 13.1
FINANCIAL TABLE OF CONTENTS
SELECTED CONSOLIDATED FINANCIAL INFORMATION......................... 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................... 13
REPORT OF MANAGEMENT................................................ 65
REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM... 66
CONSOLIDATED FINANCIAL STATEMENTS................................... 67
SHAREHOLDER INFORMATION............................................. 115
9
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(Dollars in thousands, except share data)
The following tables present selected consolidated financial information
of Ocwen Financial Corporation and its subsidiaries at the dates and for the
years indicated. Our historical operations and balance sheet data at and for the
years ended December 31, 2004, 2003, 2002, 2001, and 2000 have been derived from
our audited financial statements. We have reclassified certain amounts included
in the 2003, 2002, 2001 and 2000 selected consolidated financial information to
conform to the 2004 presentation. The selected consolidated financial
information should be read in conjunction with, and is qualified in its entirety
by reference to, the information we have provided in our Consolidated Financial
Statements and the Notes to Consolidated Financial Statements on pages 65 to
114.
For the Years Ended December 31,
-----------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
BALANCE SHEET DATA
Total assets ....................................... $ 1,327,493 $ 1,240,118 $ 1,222,242 $ 1,711,150 $ 2,249,420
Trading securities, at fair value (1):
Investment grade securities .................... $ 86,215 $ 6,679 $ 21,556 $ 16,191 $ 277,595
Subordinates and residuals ..................... $ 39,527 $ 42,841 $ 37,339 $ 65,058 $ 112,647
Real estate (1) (3) .............................. $ 18,732 $ 103,943 $ 120,715 $ 240,779 $ 291,851
Affordable housing properties (1) ................ $ 5,641 $ 7,410 $ 15,319 $ 102,069 $ 142,812
Loans, net (1) ................................... $ 3,792 $ 28,098 $ 76,857 $ 185,293 $ 631,634
Match funded assets, net (2) ..................... $ 280,760 $ 130,087 $ 167,744 $ 174,351 $ 116,987
Advances on loans and loans serviced for
others (1) .................................... $ 240,430 $ 374,769 $ 266,356 $ 283,183 $ 277,055
Mortgage servicing rights (1) .................... $ 131,409 $ 166,495 $ 171,611 $ 101,107 $ 51,426
Total liabilities .................................. $ 995,855 $ 921,574 $ 853,496 $ 1,270,885 $ 1,666,464
Deposits and escrows (4) ......................... $ 427,276 $ 562,832 $ 510,956 $ 730,443 $ 1,258,360
Match funded liabilities (5) ..................... $ 244,327 $ 115,394 $ 147,071 $ 156,908 $ 107,050
Debt securities, lines of credit and other secured
borrowings (6) (7) .............................. $ 281,861 $ 206,633 $ 159,721 $ 244,609 $ 206,263
Capital Securities (7) ............................. $ -- $ -- $ 56,249 $ 61,159 $ 79,530
Stockholder's equity (8) ........................... $ 330,108 $ 317,258 $ 310,718 $ 379,106 $ 503,426
OTHER DATA
Average assets ..................................... $ 1,315,687 $ 1,300,491 $ 1,435,105 $ 1,983,657 $ 2,566,093
Average equity ..................................... $ 322,705 $ 308,940 $ 346,918 $ 448,752 $ 456,166
Return on average assets:
Income (loss) before effect of change in
accounting principle ............................ 4.39% 0.37% (5.92)% (6.29)% 0.09%
Net income (loss) ................................ 4.39% 0.37% (4.79)% (6.29)% 0.09%
Return on average equity:
Income (loss) before effect of change in
accounting principle ............................ 17.89% 1.54% (24.48)% (27.81)% 0.48%
Net income (loss) ................................ 17.89% 1.54% (19.82)% (27.81)% 0.48%
Average equity to average assets ................... 24.53% 23.76% 24.17% 22.62% 17.78%
Net interest spread ................................ 2.12% 2.78% 0.99% 1.36% 2.85%
Net interest margin ................................ (1.71)% (4.69)% (3.62)% (1.03)% (1.94)%
Efficiency ratio (9) ............................... 89.20% 96.68% 153.81% 111.55% 78.04%
Bank regulatory capital ratios at end of period:
Tangible ......................................... 21.97% 14.93% 15.28% 13.43% 13.83%
Core (Leverage) .................................. 22.07% 15.09% 15.51% 13.64% 13.83%
Risk-based ....................................... 32.16% 14.95% 21.71% 23.33% 21.83%
10
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(Dollars in thousands, except share data)
For the Years Ended December 31,
-----------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
OPERATIONS DATA
Net income (loss) .................................. $ 57,724 $ 4,772 $ (68,775) $ (124,782) $ 2,193
Total non-interest revenue (10) .................... $ 223,027 $ 177,497 $ 134,012 $ 174,289 $ 201,475
Servicing and related fees (1) ................... $ 160,062 $ 139,744 $ 127,787 $ 122,808 $ 86,450
Vendor management fees (1) ....................... $ 46,986 $ 29,842 $ 18,299 $ 13,988 $ 11,089
Gain (loss) on trading and match funded
securities, net ................................. $ (537) $ 3,344 $ 7,012 $ 16,330 $ (3,971)
Valuation gains (losses) on real estate (11) ..... $ (5,110) $ (7,430) $ (35,002) $ (22,282) $ (27,378)
Gain (loss) on sale of real estate (11) .......... $ 1,556 $ 466 $ 4,098 $ 14,156 $ 45,464
Operating income (loss) from real estate (11) .... $ 605 $ 5,128 $ 7,864 $ 4,495 $ 17,538
Amortization of excess of net assets acquired over
purchase price (13) ............................. $ -- $ -- $ -- $ 18,333 $ 14,112
Gain (loss) on repurchase of debt (6) ............ $ -- $ (445) $ (1,461) $ 3,774 $ 29,703
Net interest income (expense) ...................... $ (6,688) $ (14,594) $ (18,527) $ (9,958) $ 15,726
Provision for loan losses .......................... $ (1,881) $ (2,684) $ 13,629 $ 15,666 $ 15,177
Total non-interest expense ......................... $ 192,982 $ 157,501 $ 117,626 $ 183,316 $ 170,001
Income tax expense (benefit) (12) .................. $ (32,324) $ 748 $ 2,983 $ 83,000 $ 18,947
Distributions on Capital Securities ................ $ -- $ 3,058 $ 6,287 $ 7,131 $ 11,380
Effect of change in accounting principle,
net of taxes (13) ................................. $ -- $ -- $ 16,166 $ -- $ --
EARNINGS (LOSS) PER SHARE
Basic:
Net income (loss) before effect of accounting
change ........................................ $ 0.88 $ 0.07 $ (1.26) $ (1.86) $ 0.03
Effect of change in accounting principle, net
of tax ........................................ -- -- 0.24 -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) ............................ $ 0.88 $ 0.07 $ (1.02) $ (1.86) $ 0.03
=========== =========== =========== =========== ===========
Diluted:
Net income (loss) before effect of accounting
change ........................................ $ 0.82 $ 0.07 $ (1.26) $ (1.86) $ 0.03
Effect of change in accounting principle, net
of tax ........................................ -- -- 0.24 -- --
----------- ----------- ----------- ----------- -----------
Net income (loss) ............................ $ 0.82 $ 0.07 $ (1.02) $ (1.86) $ 0.03
=========== =========== =========== =========== ===========
Weighted average common shares outstanding:
Basic .......................................... 65,811,697 67,166,888 67,321,299 67,227,058 67,427,662
Diluted ........................................ 73,197,255 68,063,873 67,321,299 67,227,058 67,464,043
11
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(Dollars in thousands, except share data)
NOTES TO SELECTED CONSOLIDATED FINANCIAL INFORMATION
(1) Beginning in late 1999 and early 2000, we shifted our business
activities away from businesses involving the acquisition of the loans,
real estate, residual and subordinate trading securities and affordable
housing properties. Since then, our results reflect the ongoing
management and resolution of these assets. At the same time we shifted
our focus toward
(2) growing fee-based businesses, primarily Residential Loan Servicing and
Ocwen Technology Xchange ("OTX"), our technology solutions business. As
a result, our investment in mortgage servicing rights and servicing
advances has grown, as well as the related residential servicing fees.
Additionally, we have incurred losses in the development and marketing
of OTX products. Those losses (pre-tax) amounted to $(3,862), $(11,520),
$(24,144) and $(36,392) and $(33,951) during 2004, 2003, 2002, 2001 and
2000, respectively. See "Overview of Risks and Related Critical
Accounting Policies" and "Results of Operations - Segment Results".
(3) Match funded assets at December 31, 2000 were comprised solely of
securitized loans and securities. Match funded assets at December 31,
2004, 2003, 2002 and 2001 also included $276,626, $105,788, $121,702 and
$101,963, respectively, of loan servicing advances which were sold but
did not qualify as a sale for accounting purposes. We have accounted for
these transactions as secured borrowings with pledges of collateral
(match funded liabilities). See "Changes in Financial Condition - Match
Funded Assets".
(4) Real estate, which includes properties we acquired by foreclosures on
loans we owned, has declined as a result of sales and our exit from the
loan acquisition businesses. See "Changes in Financial Condition - Real
Estate".
(5) Since 2000, we have been reducing our reliance on brokered certificates
of deposit as a source of funding. The amount of such deposits
outstanding amounted to $26,418, $84,426, $198,248, $483,149 and
$968,432 at December 31, 2004, 2003, 2002, 2001 and 2000, respectively.
See "Banking Operations" and "Liquidity, Commitments and Off-balance
Sheet Risks".
(6) Match funded liabilities at December 31, 2004, 2003, 2002 and 2001
included $240,193, $94,967, $106,797 and $91,766, respectively,
collateralized by loan servicing advances. See "Changes in Financial
Condition -Match Funded Liabilities".
(7) During 2003, 2002, 2001, and 2000 we repurchased a total of $33,500,
$77,095, $13,025, and $146,755, respectively, of fixed rate debt with
high interest rates. Balance at December 31, 2004 and 2003 includes the
$56,249 outstanding balance of our Capital Securities. See "Changes in
Financial Condition - Debt Securities" and - "Lines of Credit and Other
Secured Borrowings".
(8) Effective with our adoption of Statement of Financial Accounting
Standard (`SFAS") No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity", on July 1, 2003,
we reclassified the $56,249 outstanding balance of our Capital
Securities to Debt Securities. Beginning with the third quarter of 2003,
distributions are reported as interest expense.
(9) Stockholders' equity reflects our repurchase of 5,481,100 common shares
for $49,449 in 2004, 500,000 shares for $2,262 in 2003 and 1,388,300
shares for $8,996 in 2000.
(10) The efficiency ratio represents non-interest expense divided by the sum
of net interest income before provision for loan losses and non-interest
revenue.
(11) Non-interest revenue for 2000 included a gain of $20,025 from the sale
of our unconsolidated investment in Kensington Group PLC ("Kensington")
in November 2000. Kensington was engaged in the subprime mortgage loan
origination business in the UK.
(12) Valuation losses, gains on sales and operating income related to real
estate has been declining since 2000 primarily as a result of declines
in our commercial real estate investments. At December 31, 2004,
commercial real estate consisted of one property and two partnership
interests. See (3) above.
(13) Income tax expense we recorded for 2001 and 2000 included $83,000 and
$17,500, respectively, of net provisions to increase the valuation
allowance on prior years' deferred tax assets. No such provision was
required for 2003 or 2002. The ($32,324) income tax benefit for 2004
resulted in large part from a partial reversal of the valuation
allowance on our deferred tax asset that was established in prior years.
See "Results of Operations - Income Tax Expense (Benefit)".
(14) Upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets",
effective January 1, 2002 we reversed the unamortized balance of the
excess of net assets acquired over purchase price (negative goodwill) of
$18,333 we had originally recorded in connection with our acquisition of
Ocwen Asset Investment Corp. ("OAC") in 1999 and recorded $3,333 of
impairment charges on goodwill and intangible assets. These amounts have
been reported as the effect of a change in accounting principle, net of
an income tax benefit of $1,166. See Notes 1 and 2 to our Consolidated
Financial Statements.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following discussion of our results of operations, consolidated
financial condition and capital resources and liquidity should be read in
conjunction with our Selected Consolidated Financial Information, Consolidated
Financial Statements and the related notes, all included elsewhere herein.
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
the execution of our 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 originate or
invest in assets in certain of our business segments ("non-core businesses")
unless contractually committed to do so. However, we continued to actively
manage and resolve the remaining assets in these segments. Our primary goal is
to become the leading provider of third party outsourcing solutions to the
mortgage and real estate industries. Key elements of our strategy are summarized
as follows:
. continuing to grow our residential loan servicing business, including
through the opportunistic acquisition of servicing and subservicing
rights;
. continuing our globalization efforts through both the expansion of our
international facilities and the expansion of the potential client base
for our products and services;
. expanding our other core businesses, such as unsecured debt collection,
business process outsourcing and the sale or licensing of our
proprietary technology;
. diversifying our funding sources by eliminating our reliance on deposits
and utilizing alternative funding sources, such as securitizing our
rights to receive reimbursement for servicing advances;
. terminating the status of Ocwen Federal Bank ("the Bank"), a wholly
owned subsidiary, as a federal savings bank, which would eliminate the
restrictions imposed on the amount of mortgage servicing rights that we
may obtain and therefore provide us more flexibility to grow our
residential servicing business; and
. continuing to actively manage and resolve our remaining non-core assets
and aggressively pursuing ways to reduce our exposure to these assets,
including through opportunistic sales.
As of December 31, 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
Business Process Outsourcing
Commercial Servicing
Additionally, we account for certain items of revenue and expense that
are not directly related to a business unit in our Corporate Items and Other
segment. Included in our Corporate Items and Other segment is interest income on
short-term investments of cash and the related costs of financing these
investments, results of business activities that are not significant, gains and
losses on the early retirement of debt and certain other corporate income and
expense items.
Risks Relating to Our Business. The following is a discussion of the
principal risk factors that relate to our businesses and that may affect future
results.
Our success is highly dependent upon our ability to acquire and accurately price
mortgage servicing rights, as well as general economic conditions in the
geographic areas in which we service loans.
The primary risk associated with mortgage servicing rights is that they
will lose a portion of their value as a result of higher than anticipated
prepayments occasioned by declining interest rates or because of higher than
anticipated delinquency rates occasioned by deteriorating credit conditions.
Interest rates, prepayment speeds and the payment performance of the underlying
loans significantly affect both our initial and ongoing valuations and the rate
of amortization of mortgage servicing rights. In general, the value of mortgage
servicing assets is affected by increased mortgage refinance activity that is
influenced by changes in borrowers' credit ratings, shifts in value in the
housing market and interest rates. While such assets tend to decrease in value
as interest rates decrease, they tend to increase in value as interest rates
increase. Increases in prepayment speeds result in increases in the
amortization expense of our mortgage servicing rights. As of December 31, 2004,
we held $131,409 of mortgage servicing rights.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
We acquire servicing rights principally from mortgage origination
companies and investment banks. Servicing rights are typically acquired based
upon a competitive bidding process. A number of our competitors have access to
greater capital resources, which may provide them with a competitive advantage
if they seek to increase their market share. Although the market for the
acquisition of servicing rights to subprime mortgage loans has grown in recent
years, we may be unable to acquire the desired amount and type of servicing
rights in future periods. In addition, the volume of servicing rights acquired
by us may vary over time resulting in significant inter-period variations in our
results of operations.
In determining the purchase price for servicing rights, management makes
assumptions regarding the following, among other things:
. the rates of prepayment and repayment within the pools;
. projected rates of delinquencies and defaults;
. our cost to service the loans;
. amounts of future servicing advances;
. ancillary fee income;
. our ability to service and resolve loans successfully; and
. future interest rates.
If these assumptions are inaccurate or the bases for the assumptions
change, the price we pay for servicing rights may be too high. This could result
in reduced revenue or a loss to us. Therefore, our success is highly dependent
upon accuracy in our pricing of servicing rights, as well as general economic
conditions in the geographic areas in which we service loans.
We rely on data from a third party vendor in the pricing of mortgage servicing
rights in our residential loan servicing business.
Our residential loan servicing business uses data that we purchase from
a third party that runs a model on which we base our bids for mortgage servicing
rights. This model projects, among other things, prepayment speeds and
delinquencies. Problems with this relationship or a disruption in this service
could disrupt our operations or adversely affect our financial results.
Our strategy to grow our business is subject to uncertainty.
Our corporate strategy focuses on growing our servicing of assets owned
by others, growing our activities to provide business process outsourcing to
others and the development of loan origination and servicing technology for the
mortgage and real estate industries. Many factors could adversely affect our
ability to realize this strategy, including general economic factors, the
general interest rate environment, our ability to maintain the servicing ratings
assigned to us by rating agencies, government regulation, competition, our
ability to obtain mortgage servicing rights, the effectiveness of our marketing
initiatives, our ability to recruit or replace experienced management and
operations personnel, the success of our international operations and the
availability of funding. In addition, there can be no assurance that we will be
able to accomplish our strategic objectives as a result of changes in the nature
of our operations over time or that such changes will not have a material
adverse effect from time to time or generally on our business, financial
condition or results of operations.
A downgrade in our servicer ratings could have an adverse effect on our
business, financial condition or results of operations.
We are rated as a mortgage servicer by Standard & Poor's Ratings
Services ("Standard & Poor's), Moody's Investors Service, Inc. ("Moody's") and
Fitch Ratings ("Fitch"). Our favorable servicer ratings from these entities are
important to the conduct of our loan servicing business. Standard & Poor's has
placed our servicing ratings on negative watch. We can provide no assurance that
this rating, or the ratings assigned by Moody's and Fitch, will not be
downgraded in the future. Any such downgrade could have an adverse effect on our
business, financial condition or results of operations.
Our earnings may be inconsistent.
As discussed in the overview above, since late 1999 and early 2000, we
have implemented our strategy to shift our business activities away from
capital-intensive businesses involving the purchase or origination of loans,
real estate and related assets towards less capital-intensive businesses that
generate fee-based revenues. The resulting exit from certain businesses and
entry into others resulted in variations in our results of operations and
earnings. Our past financial performance may not be considered a reliable
indicator of future performance, and historical trends may not be reliable
indicators of anticipated results or trends in future periods.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
In addition to inconsistency in results caused by our entry into or exit
from businesses in recent years, the consistency of our operating results has
been and may continue to be significantly affected by inter-period variations in
our current operations, including:
. the amount of servicing rights acquired, and the changes in realizable
value of those assets due to, among other factors, increases or
decreases in prepayment speeds;
. gains or losses realized from the disposition of our remaining non-core
assets; and
. changes in the earnings or losses of our other core business segments.
In addition, our operating results have been significantly affected by
certain non-recurring items. Items reported by us in prior periods may not be
repeated in future periods.
We incur significant costs related to governmental regulation.
Our business is subject to extensive regulation and supervision by
federal, state and local governmental authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on a substantial portion of our operations. Our banking and servicing activities
are subject to numerous federal agencies, laws and regulations, including the
Office of Thrift Supervision ("OTS"), the Federal Deposit Insurance Corporation
("FDIC"), the Board of Governors of the Federal Reserve System, the Federal Home
Loan Bank of New York, the Home Owners' Loan Act, the Federal Deposit Insurance
Act, the Community Reinvestment Act and provisions of the Gramm-Leach-Bliley Act
and USA PATRIOT Act. The Bank is currently a federally chartered savings bank.
As such, it is subject to regulation, examination and supervision by the OTS and
FDIC. We also are required to comply with a variety of federal, state and local
consumer protection laws, including the Fair Debt Collections Practice Act, Real
Estate Settlement Procedures Act and the Equal Credit Opportunity Act and are
subject to the rules and regulations of state regulatory authorities with
respect to our operations. These requirements can and do change as statutes and
regulations are enacted, promulgated or amended.
These statutes and regulations, among other things, regulate assessment,
collection, foreclosure and claims handling, investment and interest payments on
escrow balances and payment features, mandate certain disclosures and notices to
borrowers, prohibit discrimination and, in some cases, fix maximum interest
rates, finance charges, fees and mortgage loan amounts. We incur significant
costs on an on-going basis to comply with governmental regulations, which
adversely affects our net income. If our regulators impose new or more
restrictive requirements, we may incur additional significant costs to comply
with such requirements, which could adversely affect our net income.
If, as described under "Banking Operations", we were to no longer
control a federal savings bank, we would no longer be subject to federal banking
regulations but would remain subject to certain federal, state and local
consumer protection provisions. We also would become subject to regulation in a
number of states as a mortgage service provider and/or as a debt collector. We
have not previously operated our mortgage servicing business under such
regulatory regimes and there can be no assurance that this transition would not
result in additional costs or uncertainties that would have a material adverse
effect on the profitability of our mortgage servicing business.
Governmental and legal proceedings and related costs could adversely affect our
financial results.
We face the risk of governmental proceedings and litigation, including
class action lawsuits, challenging our residential loan servicing and other
business practices. On April 19, 2004, the Bank entered into a Supervisory
Agreement with the OTS. See "Banking Operations" and Note 22 to the Consolidated
Financial Statements. 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, the OTS or other regulatory agencies may take
additional actions to require the Bank to implement measures relating to our
servicing practices, including with respect to the matters that are the subject
of the Supervisory Agreement, other matters on which we communicate with the OTS
from time to time or otherwise. In addition, if the OTS were to determine that
we failed to comply with the Supervisory Agreement or otherwise were to find
deficiencies in our mortgage servicing practices, the OTS could initiate an
enforcement proceeding against the Bank, which could result in civil money
penalties or the imposition of further requirements on the Bank's business
practices. Accordingly, there can be no assurance that any such eventualities,
were they to occur, would not have a material adverse effect on our financial
condition, results of operations or cash flows.
In addition, we and certain of our affiliates, including the Bank, have
been named as defendants in a number of purported class action lawsuits
challenging the Bank's residential loan servicing practices. At least one of our
competitors has paid significant sums to settle lawsuits brought against it that
raised claims similar to those raised in the lawsuits brought against us and our
affiliates. Although we believe that we have meritorious legal and factual
defenses to the lawsuits, we can provide no assurance that we will ultimately
prevail. Litigation and other proceedings may result in the adoption of business
practices different from those of our competitors, as well as settlement costs,
damages, penalties or other charges, which would adversely affect our financial
results.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Finally, we cannot be certain that litigation relating to businesses
other than residential loan servicing will not have an adverse effect on our
financial results. For additional information regarding litigation, see Note 27
to the Consolidated Financial Statements.
We may be unable to obtain the necessary additional capital to finance the
growth of our business.
Our financing strategy includes the use of leverage. Accordingly, our
ability to remain in business and finance our operations rests in part on our
ability to borrow money. Our ability to borrow money depends on a variety of
factors, including:
. our ability to meet our current debt service obligations on our existing
debt;
. our corporate credit rating as evaluated from time to time by rating
agencies and the occasion of any changes to their published ratings;
. our financial performance and the perception that existing and potential
lenders have of our financial strength; o our ability to compete with
other banks for deposits;
. limitations imposed on us by regulatory agencies and/or existing lending
agreements that limit our ability to raise additional debt; and
. general economic conditions and the impact they have on the availability
of credit.
An event of default, a negative ratings action by a rating agency, the
perception of financial weakness resulting from continuing operating losses, an
increase in the cost of competing for deposits, an action by a regulatory
authority or a restriction imposed on us as a function of a debt covenant that
serves to limit our ability to borrow money, or a general deterioration in the
economy that constricts the availability of credit may increase our cost of
funds and make it difficult for us to renew existing credit facilities and
obtain new lines of credit.
If, as described under "Banking Operations", we were to cease to control
a federal savings bank, we would no longer be able to rely on deposits obtained
through the Bank as a source of funding. Although we believe that we would be
able to replace these deposits with other financing arrangements, we can provide
no assurance that such alternative funding sources would be adequate to meet our
needs or would not increase our cost of funds.
Our international operations are subject to political and economic uncertainties
and other risks beyond our control.
We conduct business in the United States, and we have established two
software development and servicing operations centers in India. Through Global
Servicing Solutions, LLC ("GSS"), a joint venture formed with Merrill Lynch to
service assets in other countries, we now have two fully operational offices
located in Tokyo, Japan and Taipei, Taiwan. In 2004, we established servicing
operations in Toronto, Canada and Mainz, Germany. We have established consulting
operations in the United Kingdom and China. In addition, we recently acquired a
bank in Germany. Our foreign operations are subject to risks beyond those
associated with our United States operations, including:
. unexpected changes in local regulatory requirements;
. unfavorable changes in trade protection laws;
. difficulties in managing and staffing international operations;
. potentially adverse tax consequences;
. adaptability problems;
. increased accounting and control expenses;
. the burden of complying with foreign laws;
. adverse social, political, labor or economic conditions;
. changes in foreign currency exchange rates; and
. our limited international experience.
Although we evaluate hedging strategies to limit the effects of currency
exchange rate fluctuations on our results of operations, there can be no
assurance that our strategies will achieve their intended purpose. Further, we
may be unable to effectively manage the risks listed above in order to realize
the benefits of international operations.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
We face strong competition in our primary business segment.
We face strong competition from a variety of competitors in our
residential loan servicing business. These competitors include several smaller
companies focused on servicing as well as a number of large financial
institutions. These financial institutions generally have significantly greater
resources and access to capital than we do, resulting in a lower cost of funds
and a greater ability to purchase mortgage servicing rights. Because a part of
our strategy depends on our ability to obtain mortgage servicing rights, we can
provide no assurance that such competition will not have an adverse impact on
our ability to implement our strategy.
In general, our competition has intensified in recent years as the
low-interest rate environment has created favorable conditions for other
companies and banks to enter the residential subprime loan business or expand
their existing activities within the industry. While some of these entities only
originate and do not currently service loans, there is no assurance that they
will not develop internal servicing capability or outsource the servicing
function to one of our competitors. Recently, some originators from whom we have
purchased servicing rights in the past have developed their own servicing
capabilities.
We may be unable to satisfy consumer demand for new technologies.
Part of our business strategy is to expand our sales of proprietary
technology products, including REALServicing, REALTrans and REALSynergy. Rapid
change and uncertainty due to new and emerging technologies characterize the
software industry. Our ability to grow our technology revenue is dependent upon
our ability to develop and introduce new products and enhance existing products
to satisfy customer demand for new technologies. Because the pace of change
continues to accelerate and new opportunities for competitors arise, our
business planning is subject to substantial uncertainty. If we do not
successfully identify new product opportunities and develop and bring new
products to market in a timely and efficient manner, our business will suffer.
New platforms and products may gain popularity with customers, vendors and loan
originators, reducing or eliminating the potential for future revenue.
There is fierce competition in the software industry; however, our
products compete in a limited market. While we believe REALServicing, REALTrans
and REALSynergy each present greater functionality and a better value than
competing products in the market, our products may not realize any competitive
advantage. Competitors may arrive at a technology that creates a new market
altogether and renders our product offerings obsolete. We may not be successful
in introducing the products to the market on a commercial basis or in
translating the products' business, marketing and pricing models into revenue
sufficient to produce net income.
The software industry is inherently complex. New products and product
enhancements can require long development and testing periods. While we believe
our products are attractive to the mortgage and real estate industries, the
computer software industry is subject to rapid technological change, changing
customer requirements, frequent new product introductions and evolving industry
standards that may render existing products and services obsolete. We may
experience future difficulties that could delay or prevent the successful
development, introduction or marketing of our products. Further, our products
and product enhancements may not meet the requirements of the marketplace and
achieve market acceptance. If we are unable to develop and introduce products of
acceptable quality in a timely manner in response to changing market conditions
or customer requirements, our business could be adversely affected.
We may not be able to adequately protect our proprietary rights or information.
Our success is in part dependent upon our proprietary information and
technology. We rely on a combination of copyright, trade secret and contract
protection to establish and protect our proprietary rights in our products and
technology. In general, we enter into intellectual property agreements with all
employees (including our management and technical staff) and consultants as well
as limit access to and distribution of our proprietary information. We cannot be
sure that we have taken adequate steps to deter misappropriation of our
proprietary rights or information. Independent third parties may develop
products and technology substantially similar to ours. Although we believe that
our products and technology do not infringe any proprietary rights of others, we
could be subject to claims of infringement in the future.
The loss of the services of our senior managers could have an adverse effect on
us.
The experience of our senior managers is a valuable asset to us. Our
chairman and chief executive officer, William C. Erbey, has been with us since
our founding in 1987 and our president, Ronald M. Faris, joined us in 1991.
Other senior managers of ours have been with us for 10 years or more. We do not
have employment agreements with, or maintain key man life insurance relating to,
Mr. Erbey, Mr. Faris or any of our other executive officers. The loss of the
services of our senior managers could have an adverse effect on us.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Other industry risks could affect our financial performance.
We face many industry risks that could negatively affect our financial
performance. For example, we face the risk that increased criticism from
consumer advocates or the media could hurt consumer acceptance of our services
and could lead to the adoption of different business practices. In addition, the
financial services industry as a whole is characterized by rapidly changing
technologies, and system disruptions and failures may interrupt or delay our
ability to provide services to our customers. The secure transmission of
confidential information over the Internet is essential to maintain consumer
confidence in certain of our services. Security breaches, acts of vandalism, and
developments in computer capabilities could result in a compromise or breach of
the technology that we use to protect our customers' personal information and
transaction data. Consumers generally are concerned with security breaches and
privacy on the Internet, and Congress or individual states could enact new laws
regulating the electronic commerce market that could adversely affect us. In
addition, we rely on our foreign employees for a number of our business
processes in our call and data centers overseas. The issue of outsourcing to
lower-cost foreign workers and the impact on the U.S. labor market has recently
attracted significant negative media and Congressional attention, and Congress
or individual states could enact new laws regulating outsourcing that could
adversely affect us.
We may be required to repurchase loans or indemnify investors if we breach
representations and warranties that we made in connection with the sale of those
loans.
Historically, we purchased and originated loans that were subsequently
pooled and securitized or sold outright. While we no longer purchase, originate
or securitize a significant volume of loans, on substantially all loans sold we
made representations or warranties at the time the loans were sold. We may be
required to repurchase loans at a price equal to the then outstanding principal
balance of the loan and any accrued and unpaid interest thereon, if there were a
breach of those representations or warranties. Additionally, we may be required
to advance funds to the securitization trusts or to indemnify the trustee or the
underwriters of a securitization under specific circumstances.
The representations made in connection with our loan sale agreements
typically include, among others, representations regarding the nature and
condition of the related properties, including environmental issues, the absence
of liens, the lack of undocumented mortgage modifications, and validity and
enforceability of the mortgages, and the existence of appropriate insurance
coverage. We recorded approximately $500 and $1,300 of expenses in 2004 and
2003, respectively, in fulfillment of these guarantees, and our exposure to
future obligations in this regard is not estimated to be significant.
We are subject to investment risks.
A component of our previous business strategy in the Residential
Discount Loan and Subprime Finance non-core business lines was the acquisition,
origination and securitization of residential mortgage loans. We had
historically retained subordinate and residual interests in connection with the
securitization of our loans and had acquired other residual interests in
connection with our acquisition of OAC. The performance of these securities in
prior years was negatively impacted by higher than expected prepayment speeds
and credit losses experienced on the mortgage loans collateralizing the
securities. We have reduced our exposure to loss on these investments by selling
most of the portfolio. However, we remain subject to the risk of loss on our
remaining securities primarily to the extent that future credit losses exceed
expected credit losses. The fair value of our remaining investment in
subordinate and residual securities at December 31, 2004 was $39,527, of which
$35,276 represents unrated single family subprime residuals.
Our directors and executive officers collectively own a large percentage of our
common shares and could influence or control matters requiring shareholder
approval.
As of December 31, 2004, our directors and executive officers and their
affiliates collectively owned or controlled approximately 44% of our outstanding
common shares. This includes approximately 30% owned or controlled by our
chairman and chief executive officer, William C. Erbey, and approximately 13%
owned or controlled by our director and former chairman, Barry N. Wish. As a
result, these shareholders could influence or control virtually all matters
requiring shareholder approval, including amendment of our articles of
incorporation, the approval of mergers or similar transactions and the election
of all directors.
Critical Accounting Policies. Our strategies to exit non-core businesses
and grow 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; an understanding of these
policies is fundamental to understanding Management's Discussion and Analysis of
Results of Operations and Financial Condition. Our significant accounting
policies are discussed in detail in Note 1 of our Consolidated Financial
Statements (which are incorporated herein by reference). The following is a
summary of our more subjective and complex accounting policies, as they relate
to our overall business strategy.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Our most significant business in recent years has been our Residential
Loan Servicing business, which has achieved increased transaction volumes during
the past three years. Inherent in our growth of this business has been an
increase in purchased mortgage servicing rights, an intangible asset
representing the present value of the right to service loans in a portfolio.
Therefore, the most critical accounting policy for this business line is the
methodology we use to determine the value of mortgage servicing rights.
Application of this methodology requires the development of a number of
estimates, including anticipated amortization and periodic revaluation. We
estimate the fair value of our mortgage servicing rights based on the results of
our internal valuation and an external valuation obtained from an independent
third party valuation specialist. Our internal valuation is performed using an
industry standard model which calculates the present value of estimated future
cash flows utilizing market based assumptions. The more significant assumptions
used in our internal valuation include:
. Prepayment speeds
. Compensating interest expense
. Delinquency experience
. Discount rate
. Interest rate used for computing the cost of servicing advances
. Interest rate used for computing float income
. Cost of servicing
Prepayment speeds and delinquency experience are derived from an
industry standard model, for each strata in our mortgage servicing rights. Our
strata are based upon loan type, which represents the predominant risk
characteristics of the underlying loans, including:
. Subprime
. ALT A
. High-loan-to-value
. Re-performing
. Special servicing
. Non-residential mortgage
. Other
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The graphs presented below provides the overall prepayment speed and
delinquency assumptions by strata as of December 31, 2004:
[CHART APPEARS HERE]
[CHART APPEARS HERE]
The discount rate, interest rate for the cost of financing advances,
interest rate for float income and the cost of servicing are based on the market
assumptions provided by our third party valuation specialist. As of December 31,
2004, these assumptions were as follows:
. Discount rate of 18%
. Interest rate of six-month LIBOR plus 300 basis points for the cost of
financing advances
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
. Interest rate of six-month LIBOR for float income
. Assumptions regarding the cost of servicing vary by strata, and range
from a low of $50 per year for a performing Alt A loan to a high of
$1,250 per year for a loan that is in foreclosure.
Changes in these assumptions are generally expected to impact our
results of operations as summarized below:
. Increases in prepayment speeds generally reduce the value of our
mortgage servicing rights as the underlying loans prepay faster, causing
higher mortgage servicing rights amortization, higher compensating
interest payments and lower overall servicing fees, partially offset by
lower overall cost of servicing and increased float balances and income.
. Increases in delinquencies generally reduce the value of our mortgage
servicing rights as the cost of servicing increases during the
delinquency period and the amount of servicing advances and related
interest expense increases.
. Increases in the discount rate reduce the value of our mortgage
servicing rights due to the lower overall net present value of the
combined cash flows.
. Increases in interest rate assumptions for the cost of servicing
advances will increase interest expense, while rate increases will also
increase the amount of float earnings we recognize as fee income.
. Increases in interest rate assumptions also generally increase the value
of our mortgage servicing rights as the underlying loans projected
prepayment rate slows, while decreases in interest rate assumptions
generally reduce the value of our mortgage servicing rights as the
underlying loans projected prepayment rate increases.
We perform an interest rate sensitivity analysis of our mortgage
servicing rights portfolio every quarter. We currently estimate that the fair
value of the portfolio increases by approximately 7% for every 50 basis point
(bps) increase in interest rates and reduces by approximately 9% for every 50
bps decline in interest rates.
An impairment analysis is performed after grouping our loans into the
seven strata based on loan type, which represent the predominant risk
characteristics of the underlying loans. The risk factors used to assign loans
to strata include the credit score (FICO) of the borrower, the loan to value
ratio, the type of asset (mortgage or non-mortgage) and the default risk.
We amortize mortgage servicing rights over the period of estimated net
servicing income based on our projections of the amount and timing of future
cash flows. The amount and timing of servicing asset amortization is adjusted
periodically based on actual results and updated projections. During the past
two years, the prepayment speeds in our servicing portfolio have increased,
resulting in a substantial increase in the rate of amortization of servicing
rights.
Another accounting policy that requires the use of estimates and the
application of judgment is the determination of our overall tax provision and
the evaluation of the realizability of our gross deferred tax assets in the near
term. As of December 31, 2004 we had gross deferred tax assets of $183,610, and
a corresponding valuation allowance of $165,927 resulting in a net deferred tax
asset of $17,683. Our valuation allowance was primarily established in 2001,
when we recorded an $83,000 provision to increase the valuation allowance on our
prior years' deferred tax assets. During 2003 and 2002, we provided an
additional valuation allowance equal to the amount of any deferred tax assets
recorded during the year. During 2004, we recorded a $35,518 partial reversal of
the valuation allowance we had established on the deferred tax asset in prior
years. The allowance was reduced as a result of refund claims we filed with the
IRS that reduced our deferred tax asset as of December 31, 2004 and increased
our income tax receivable balance by the same amount. The evaluation of the need
to maintain our valuation allowance takes into consideration our recent earnings
history, current tax position and estimates of taxable income in the near term.
The tax character (ordinary versus capital) and the carry forward periods of
certain tax attributes (e.g., capital losses and tax credits) must also be
considered. Significant judgment is required in considering the relative impact
of negative and positive evidence related to realizability of the deferred tax
assets. The determination of the amount of the aggregate valuation allowance is
based on scenario analyses of the projected results of operations by line of
business resulting in a range of potential valuation allowances, within which a
final amount is determined. Reversal of all or a portion of the valuation
allowance may be required in the future based on the results or our operations.
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 also operate several of our core businesses
primarily in the Bank: Residential Loan Servicing, ORA 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.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
We have an active ongoing dialogue with the OTS regarding our various
businesses and business plans, and we continue to be subject to a number of
restrictions with respect to our future operations. Arising out of our ongoing
dialogue and communications with the OTS, which includes the Supervisory
Agreement we entered into on April 19, 2004, we are no longer collecting
forbearance and breach fees directly from borrowers whose loans we service.
Forbearance fees represent a charge to compensate us for the costs we incur in
developing forbearance plans, i.e. alternative payment schedules that enable
borrowers to make affordable loan payments and retain their homes during periods
of personal economic difficulty. Breach fees represent attorneys' fees we paid
to a law firm to whom we had outsourced the process of sending obligatory
default notices to borrowers who were delinquent in making their mortgage
payments. We reassumed this process internally in September of 2003, thus
eliminating these fees prospectively. See Note 22 to the Consolidated Financial
Statements for additional information regarding the Supervisory Agreement.
We have also committed to the OTS to limit our investment in mortgage
servicing rights at no more then 60% of core capital (before any deduction
thereto for mortgage servicing rights) at the Bank and 50% of stockholders'
equity on a consolidated basis. As disclosed in Note 22 to the Consolidated
Financial Statements, our investments in mortgage servicing rights are below
these limits at December 31, 2004. These commitments effectively limit the size
of our residential loan servicing business and, consistent with our strategy of
growing that business, we have determined to begin the process of having the
Bank terminate its status as a federal savings bank under OTS and FDIC
supervision, which would, among other things, eliminate these restrictions on
our growth. If this process, which we refer to as "debanking," is completed, 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 be
completed, 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.
Our ability to debank is subject to a number of contingencies, many of
which are beyond our control, including approvals by the OTS with respect to the
application for a voluntary dissolution (which we filed with the OTS on November
24, 2004) and sales of the Bank's deposits to third parties. There can be no
assurance that we ultimately will be successful in debanking.
In connection with our debanking process, on February 4, 2005, we
entered into a Branch Purchase and Deposit Assumption Agreement (the "Branch
Purchase Agreement") with Marathon National Bank of New York ("Marathon").
Pursuant to the Branch Purchase Agreement, Marathon agreed to assume the deposit
liabilities of the accounts associated with the Bank branch facility in Fort
Lee, New Jersey. In addition, Marathon will take over the lease and other
contracts and acquire assets related to the branch. In connection with that
closing, Ocwen will make a cash payment to Marathon, which payment is calculated
based upon, among other things, the amount of those deposit account liabilities
as of the closing. As of February 28, 2005, the amount of the deposit
liabilities of the accounts subject to the Branch Purchase Agreement was
approximately $193,000. The transaction is subject to regulatory and other
customary approvals and conditions.
On September 30, 2004, we acquired Bankhaus Oswald Kruber KG ("BOK") a
German bank, for $9,737, including acquisition costs. Our primary objectives in
acquiring BOK were to diversify our funding sources and to establish a platform
to provide services to our multinational client base. The results of operations
of BOK are included in our consolidated income statement beginning on October 1,
2004. The excess of the purchase price over the fair value of the net assets
acquired (goodwill) related to this transaction is $3,694. We also recorded
$1,741 of intangible assets, none of which are subject to amortization. As of
December 31, 2004 BOK had assets of $23,043, of which $10,699 were interest
earning deposits, and total liabilities of $10,919. BOK is not significant to
our current banking operations.
WORKFORCE AND OPERATIONAL CAPACITY
As of December 31, 2004, we had a total of 3,120 employees, of which
1,032 were in our United States facilities and 2,026 were in our India
operations centers. We have developed our India operations centers over the past
four years in order to benefit from the cost savings opportunities and quality
workforce available in that country. We also had 62 employees in other countries
at December 31, 2004.
In the United States, our operations are concentrated in our
headquarters in West Palm Beach, Florida, which had 357 employees as of December
31, 2004, and our operations center in Orlando, Florida, which had 645 staff
members as of December 31, 2004. Our Orlando facility has the capacity to house
950 employees on a single shift. In addition, we had 30 employees at various
other locations in the United States.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
In India, our operations are located in the cities of Bangalore and
Mumbai. Of the 2,026 members of the staff in India as of December 31, 2004,
1,201 were in Bangalore and 825 were in Mumbai. Our India workforce can be
summarized by business as follows:
. 43% are engaged in activities for our Residential Loan Servicing
business,
. 22% support Business Process Outsourcing,
. 14% support OTX and Technology Services,
. 17% work in various other business units, and
. 4% represent various support functions, including Human Resources and
Corporate Services, Accounting and Risk Management.
RESULTS OF OPERATIONS
General. We recorded net income of $57,724 for 2004, as compared to net
income of $4,772 for 2003 and a net loss of $(68,775) for 2002. Our basic
earnings per share was $0.88 for 2004, as compared to $0.07 for 2003, and a loss
per share of $(1.02) for 2002. Net income for 2004 includes an income tax
benefit of $(32,324) that largely resulted from a $35,518 partial reversal of
the valuation allowance we had established on our deferred tax asset in prior
years. Pre-tax income (loss) before minority interest and the effect of a change
in accounting principle in 2002 was $25,238, $5,028 and $(82,057) for 2004, 2003
and 2002, respectively. As discussed in "Overview of Risks and Related Critical
Accounting Policies", our operating results reflect our ongoing strategy to
grow and expand our core businesses while at the same time actively managing and
resolving remaining assets not associated with our core business segments.
Our core businesses recorded combined pre-tax income of $25,112 for
2004, as compared to $27,944 for 2003 and $11,328 for 2002. The $2,832 decline
in pre-tax income from core businesses in 2004 as compared to 2003 is primarily
due to a $15,229 decline in pre-tax income from Residential Loan Servicing,
offset by a $7,658 decline in OTX losses and a $4,777 improvement in Commercial
Servicing results. Residential Loan Servicing results for 2004 reflect rising
prepayment speeds, low interest rates and an increase in operating expenses. The
decline in OTX losses in 2004 reflects an increase in revenue, primarily related
to our REALServicing residential loan servicing system. Commercial Servicing
results improved primarily due to the growth of our international servicing
business. Our non-core business segments recorded pre-tax income of $2,304 in
2004, as compared to losses of $(10,099) and $(65,968) in 2003 and 2002,
respectively. The $12,403 improvement in pre-tax earnings from our non-core
segments in 2004 as compared to 2003 is primarily due to a $6,380 improvement in
Subprime Finance results and a $4,391 reduction in losses from the Commercial
Assets segment. Subprime results for 2003 included the $10,000 charge resulting
from the Admiral Home Loan arbitration settlement. Commercial Assets results
have continued to improve as a result of sales and resolutions of the real
estate and loan assets. Impairment charges and loss provisions, which totaled
$46,127 in 2002, and net interest expense have all declined significantly in the
Commercial Assets segment since 2002. Results of our Corporate Items and Other
segment have also continued to improve with a pretax loss of $(2,178) in 2004 as
compared to pre-tax losses of ($12,817) and ($27,417) in 2003 and 2002,
respectively. This improvement is largely due to reduced interest expense,
resulting from reductions in corporate debt and brokered deposits and the
recognition of $6,874 of interest income on federal income tax refund claims in
2004. We discuss segment results in detail in our review of segment results,
which follows.
Segment Results. 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. As of December
31, 2004, we held $67,692, of non-core assets, compared to $182,292 and $250,230
at December 31, 2003 and 2002, respectively. As discussed in detail below, the
combined pre-tax results of our core business segments declined slightly in
2004, while our non-core segments and the Corporate Items segment all improved
significantly during 2004.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following tables present the pre-tax income (loss) and total assets
for each of our reportable segments at and for the dates indicated:
Pre-Tax Income (Loss)
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Core businesses:
Residential Loan Servicing ... $ 15,814 $ 31,043 $ 31,974
OTX .......................... (3,862) (11,520) (24,144)
Ocwen Realty Advisors ........ 6,466 5,432 2,597
Ocwen Recovery Group ......... 3,916 5,300 4,006
Business Process Outsourcing.. 2,205 1,893 118
Commercial Servicing ......... 573 (4,204) (3,223)
------------ ------------ ------------
25,112 27,944 11,328
------------ ------------ ------------
Non-core businesses:
Residential Discount Loans ... -- -- 763
Commercial Assets ............ (5,008) (9,399) (49,746)
Affordable Housing ........... (3,256) (4,888) (31,521)
Subprime Finance ............. 10,568 4,188 14,536
------------ ------------ ------------
2,304 (10,099) (65,968)
------------ ------------ ------------
Corporate Items and Other ...... (2,178) (12,817) (27,417)
------------ ------------ ------------
$ 25,238 $ 5,028 $ (82,057)
============ ============ ============
Total Assets
December 31,
---------------------------
2004 2003
------------ ------------
Core businesses:
Residential Loan Servicing ..... $ 694,175 $ 672,779
OTX ............................ 4,430 5,290
Ocwen Realty Advisors .......... 2,077 1,056
Ocwen Recovery Group ........... 541 323
Business Process Outsourcing ... 2,502 1,010
Commercial Servicing ........... 13,025 5,241
------------ ------------
716,750 685,699
------------ ------------
Non-core businesses:
Commercial Assets .............. 24,149 133,015
Affordable Housing ............. 36,715 48,974
Subprime Finance ............... 35,519 39,162
------------ ------------
96,383 221,151
------------ ------------
Corporate Items and Other ........ 514,360 333,268
------------ ------------
$ 1,327,493 $ 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
December 31
---------------------------
2004 2003
------------ ------------
Non-core businesses:
Commercial Assets ............ $ 21,560 $ 126,401
Affordable Housing ........... 8,839 13,955
Subprime Finance ............. 35,351 38,973
Corporate Items and Other .... 1,942 2,963
------------ ------------
$ 67,692 $ 182,292
============ ============
The following is a discussion of the pre-tax income (loss) for each of
our reportable business segments.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
CORE BUSINESSES
Residential Loan Servicing. Through this business we earn fees for
providing 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. Results for the past three years
reflect continued growth in the volume of mortgage loans serviced through 2003
and then a decline in 2004, as shown in the table below, reflecting continuing
earnings pressure 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 the balance of
our servicing rights. Prepayments also create an obligation for us to pay
compensating interest to investors for the full month of interest on loans that
are repaid before the end of a calendar month.
Selected information
2004 2003 2002
------------ ------------ ------------
Number of loans at December 31 ............................. 320,185 359,590 336,097
Unpaid principal balance at December 31 .................... $ 34,524,491 $ 37,697,318 $ 30,738,855
Average unpaid principal balance for the year .............. $ 35,295,755 $ 33,589,509 $ 26,533,826
Average number of employees:
United States ............................................ 682 626 837
India .................................................... 817 671 403
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Pre-tax income ........................................... $ 15,814 $ 31,043 $ 31,974
Net interest expense ..................................... $ 19,397 $ 20,892 $ 18,304
Non-interest revenue:
Servicing and related fees, net:
Fees ................................................. $ 254,270 $ 244,191 $ 196,053
Amortization of servicing rights ..................... (96,036) (93,558) (58,045)
Compensating interest expense ........................ (33,115) (32,315) (19,758)
------------ ------------ ------------
Total servicing and related fees ....................... 125,119 118,318 118,250
Vendor management fees ................................. 3,388 2,487 2,112
Other .................................................. 219 327 (338)
------------ ------------ ------------
Total non-interest revenue ............................... $ 128,726 $ 121,132 $ 120,024
============ ============ ============
Non-interest expense ..................................... $ 93,515 $ 69,196 $ 69,746
. The decline in the unpaid principal balance and number of loans we
service for others during 2004 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. In addition we have commitments with the OTS to maintain
our investment in mortgage servicing rights at or below certain levels.
See "Changes in Financial Condition - Mortgage servicing Rights".
. Servicing and related fees for 2004 and 2003 include $19,286 and $4,714,
respectively, of real estate property management fees associated with
the contract we entered into with the U.S. Department of Veteran's
Affairs (the "VA") in September 2003.
. We continue to experience low earnings on funds that we have received
from borrowers that are held on deposit with an unaffiliated bank
("float balances") as a result of low short-term interest rates. Float
income, reported as a component of fee income, amounted to $16,561,
$10,821 and $7,757 during 2004, 2003 and 2002, respectively. The yield
we earned on float balances averaged 1.38% during 2004 as compared to
1.01% and 1.56% during 2003 and 2002, respectively. See "Non-Interest
Revenue - Servicing and Related Fees" for additional details of the
principal components of servicing and related fees.
. The rate of amortization on servicing rights increased in 2004 and 2003
in response to increased actual and projected prepayment volumes,
resulting in higher amortization expense. The effect of the increased
rate of amortization has been partially offset by the reduction in
purchases of servicing rights. The balance of mortgage servicing rights
declined $35,086 during 2004 as amortization exceeded purchases. See
"Changes in Financial Condition - Mortgage Servicing Rights".
. During 2004 and 2003, prepayments on our loans serviced for others
increased significantly primarily due to lower interest rates.
Accordingly, we were required to pay increased compensating interest to
the securitization trusts for the full month of interest on loans that
are repaid before the end of a calendar month.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
. The increase in non-interest expense in 2004 as compared to 2003 is
primarily due to the following:
1) A $9,569 increase in costs associated with the property management
contract we entered into with the VA in September 2003.
2) In September 2003, we terminated our agreement with an external law
firm to manage certain aspects of our loan resolution function,
which included, among other functions, the issuance of obligatory
breach notices to delinquent borrowers, for which the law firm
charged us a fee. In consideration of evolving Fannie Mae servicing
guidelines, we decided to cease to assess these fees to borrowers,
although it was legally permissible for us to do so under the
mortgage documents. Upon termination of the agreement, we began
performing these functions internally. This resulted in the need to
hire additional staff to perform these functions, which has
increased our compensation and benefit expenses as well as the
related occupancy and technology costs. See "Banking Operations".
3) During 2004, we recorded professional fees of $5,198 and bad debt
expense of $1,000 to establish an allowance for multiple breach and
forbearance fees, respectively, that we are no longer collecting
directly from borrowers. As of December 31, 2004, advances on loans
serviced for others are net of an allowance for estimated losses of
$4,115 related to the remaining balance of these fees. See "Banking
Operations" and "Changes in Financial Condition - Advances on Loans
and Loans Serviced for Others".
OTX. Through this 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 vendor management system (REALTrans).
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income loss ...................................... $ (3,862) $ (11,520) $ (24,144)
Non-interest revenue ..................................... 16,352 9,933 6,522
Non-interest expense ..................................... 20,214 21,453 30,667
. Non-interest revenue for 2004 as compared to 2003 increased primarily as
a result of an increase in REALServicing fees, including $2,900 of
one-time fees (primarily documentation fees) earned during the second
quarter associated with a service contract for use of the REALServicing
system.
. The increase in non-interest revenue in 2003 as compared to 2002 is
primarily due to an increase in transaction fees resulting from an
increase in REALTrans transaction volumes.
. The decline in non-interest expense in 2003 as compared to 2002
primarily reflects a decline in compensation and employee benefits, and
technology and communication costs as a result of cost reduction
efforts.
. Non-interest expense for 2002 also included a goodwill write-off of
$2,231 that resulted from our annual impairment test for that year. This
write-off represented the remaining balance of goodwill associated with
our REALServicing product.
Ocwen Realty Advisors. Through ORA we provide residential property
valuation services.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income ........................................... $ 6,466 $ 5,432 $ 2,597
Property valuation fees .................................. 30,373 18,804 14,080
Non-interest expense:
Appraisal expenses ..................................... 20,747 10,647 9,463
Other .................................................. 3,089 2,704 2,021
Gross margin ............................................. 9,626 8,156 4,618
. 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 foreclosed residential 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. We
accounted for our collections of our unsecured credit card receivables portfolio
under the cost recovery method through the end of 2001, by which time we reduced
the net book value of our unsecured receivables to zero as a result of
collections and additional reserves. Beginning in 2002, income is recognized as
cash is collected.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income ........................................... $ 3,916 $ 5,300 $ 4,006
Non-interest revenue:
Servicing and related fees (third-party collections) ... 11,821 9,151 6,461
Recoveries of unsecured credit card receivables owned .. 1,811 2,737 4,191
Other .................................................. 171 252 --
Non-interest expense ..................................... 9,888 6,840 6,925
. 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 unsecured credit card receivables
since 2000.
. The increase in non-interest expense in 2004 reflects in large part an
increase in staffing levels, primarily in India.
Business Process Outsourcing. This business segment began operations in
December 2002. The results below primarily reflect the initiation of new
outsourcing contracts in 2003 and the expansion of sales and marketing
activities in 2004. Business Process Outsourcing provides outsourcing services
to third parties including mortgage underwriting, data entry, call center
services and mortgage research.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income ........................................... $ 2,205 $ 1,893 $ 118
Servicing and related fees.. ............................. $ 9,493 $ 4,496 $ 206
Non-interest expense ..................................... $ 7,264 $ 2,597 $ 88
Commercial Servicing. This segment includes the results of both our
domestic and international servicing of commercial assets. Prior to 2004,
domestic commercial servicing was reported as a component of the Commercial
Finance segment (re-named Commercial Assets), 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 Global Servicing Solutions, LLC ("GSS"), our 70%
owned 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 also
established servicing offices in Toronto, Canada and Mainz, Germany in 2004. We
have established consulting operations in the United Kingdom and China. At
December 31, 2004, this segment serviced a total of 9,794 loans with an
aggregate unpaid principal balance of $13,484,723, the majority of which were
serviced by our office in Japan.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income (loss) .................................... $ 573 $ (4,204) $ (3,223)
Servicing and related fees ............................... $ 15,035 $ 6,377 $ 3,960
Non-interest expense ..................................... $ 14,692 $ 11,151 $ 8,733
. The results for 2004 as compared to 2003 primarily reflects growth in
our international servicing of commercial assets through GSS. See
"Non-Interest Revenue - Servicing and Related Fees."
. Results for 2002 primarily reflect a one time consulting project for the
government of Jamaica as well as other precedent ventures, now
concluded.
NON-CORE BUSINESSES
Residential Discount Loans. Based on the relative insignificance of the
non-core assets remaining in this segment, the remaining assets of this business
and any related income or loss arising from their resolution have been included
in the Corporate Items and Other segment beginning January 1, 2003. This segment
consisted of operations to acquire at a discount and subsequently resolve
sub-performing and non-performing residential mortgage loans. We have not
acquired any residential discount loans since 2000. See "Changes in Financial
Condition - Loans, Net."
Commercial Assets. Results for this non-core segment reflect our
continuing exit from the commercial loan and real estate businesses. We have not
purchased any commercial assets since 2000. With the exception of loans made to
facilitate the sale of our own assets, we have also not originated any
commercial loans since 2000. Since then, this business has consisted of the
management, repositioning, and resolution of the remaining non-core assets. At
December 31, 2004, the $21,560 of non-core assets remaining in this business
consisted of four real estate assets (a shopping center, a parcel of land and
two partnership interests) with a combined net carrying value of
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
$18,217 and one unrated subordinate security with a fair value of $3,343. We
sold three real estate properties during 2004 and the remaining loans were
either repaid or sold during the year. We regularly assess the value of our
remaining assets and provide additional loss reserves or impairment charges as
appropriate. In February 2005, we sold the subsidiary that held our investment
in our shopping center located in Halifax, Nova Scotia. See "Changes in
Financial Condition - Loans, Net and - Real Estate".
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income loss ...................................... $ (5,008) $ (9,399) $ (49,746)
Net interest expense ..................................... 338 7,217 7,627
Provision for loan losses ................................ (1,651) (3,095) 12,814
Non-interest revenue:
Valuation gains (losses) on real estate ................ (5,075) (7,184) (33,313)
Gain (loss) on sales of real estate .................... 1,110 97 1,055
Operating income (loss) from real estate ............... 682 4,969 9,107
Other .................................................. 1,286 926 (695)
Non-interest expense ..................................... 4,324 4,085 5,458
. The decline in net interest expense reflects the decline in loans and
real estate.
. The negative provision for loan losses in 2004 and 2003 resulted from
the recovery of excess reserves on loan resolutions and sales during
those years. See "Provision for Loan Losses".
. The decline in valuation losses and operating income in 2004 and 2003
reflects the decline in the number of real estate assets remaining as a
result of sales and the decline in loan foreclosures. See "Non-Interest
Revenue - Operating Income (Loss) from Real Estate and - Valuation Gains
(Losses) on Real Estate".
. Non-interest expense for 2002 included a provision of $2,250 to provide
for the settlement of a lawsuit. See "Non-interest Expense -
Professional Services and Regulatory Fees" for additional information
regarding the settlement of this litigation.
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 at December 31, 2004 consisted of one limited partnership property
with a carrying value of $5,641. This compares to four properties at December
31, 2003 with an aggregate carrying value of $7,410. In addition, this segment
had $3,198 of loans outstanding at December 31, 2004 to the one remaining
limited partnership property, which we do not consolidate in our financial
statements. While we cannot project sales with certainty, we believe that it is
possible that we will sell the remaining property before the end of 2005 and
that new sources of financing will be established to repay the remaining loan
balance. We regularly assess the carrying value of our remaining assets and
provide additional loss reserves as appropriate. At December 31, 2004, our
combined reserves associated with affordable housing properties and loans
amounted to 50% of the remaining book value of such assets as compared to 55% at
December 31, 2003 and 48% at December 31, 2002.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income loss .......................................... $ (3,256) $ (4,888) $ (31,521)
Net interest expense ......................................... 1,226 2,767 4,449
Provision for loan losses .................................... (112) 151 3,392
Loss (gain) on investments in affordable housing properties .. (255) 285 21,915
. Net interest expense has declined primarily because of a decline in the
assets of this segment, most of which do not earn interest.
. Loss on investments in affordable housing properties for 2002 included
charges of $17,350 for estimated losses on the sale of the properties
and a $3,944 charge to record a discount arising from the sale of
properties. During 2002, we sold seven affordable housing properties for
cash and a non-interest bearing note receivable. A discount was recorded
on the long-term note receivable in the amount of $3,944 and is being
accreted to income over the term of the note receivable, which extends
through September 2014. The discount rate utilized was based on the
10-year Treasury rate at the date of the sale. See "Changes in Financial
Condition - Receivables".
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
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 December 31,
2004, the non-core assets remaining in this business consisted primarily of
unrated single family subprime residual trading securities with a fair value of
$35,276. These securities are presently generating income and return of
principal through cash flows. See "Changes in Financial Condition - Trading
Securities".
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income ........................................... $ 10,568 $ 4,188 $ 14,536
Interest income .......................................... 14,810 16,717 14,661
Interest expense ......................................... 1,047 1,507 2,874
Gain (loss) on trading securities, net ................... (2,004) 2,932 7,287
Non-interest expense ..................................... 2,271 13,936 4,646
. The decline in interest income in 2004 as compared to 2003 is primarily
due to a decline in cash flow distributions received on our U.K. unrated
single family subprime residual securities. Interest income increased
during 2003 as compared to 2002 primarily as a result of an increase in
cash flow distributions received on these securities.
. Gain (loss) on trading securities for 2002 included $4,840 of realized
gains on sales. See "Gain (Loss) on Trading and Match Funded Securities,
Net".
. Non-interest expense for 2003 includes the $10,000 charge related to the
conclusion of the Admiral Home Loan arbitration. See "Non-interest
Expense - Professional Services and Regulatory Fees" for additional
information regarding this arbitration.
Corporate Items and Other. Pre-tax results for this segment include
business activities that are individually insignificant (including BOK),
interest income on cash and cash equivalents, 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.
For the Years Ended December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Selected information
Pre-tax income (loss) .................................... $ (2,178) $ (12,817) $ (27,417)
Net interest income (expense) ............................ 617 (1,150) (5,952)
Non-interest revenue ..................................... 11,694 677 (5,091)
Non-interest expense ..................................... 14,606 11,327 10,085
. Net interest expense has declined primarily as a result of repurchases
and maturities of high interest rate debt, and the ongoing reduction in
brokered deposits. See "Changes in Financial Condition - Debt
Securities" and "- Deposits".
. 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 years.
. Non-interest revenue for 2004 includes $6,874 of interest income on
federal income tax refund claims. See "Changes in Financial Condition -
Receivables" for additional information regarding these claims.
. Non-interest revenue for 2003 and 2002 includes losses on repurchases of
debt of $445 and $1,461, respectively.
. Non-interest expense for 2004, 2003 and 2002 included $9,047, $1,932 and
$1,743, respectively, of legal fees and settlements.
See Note 26 to our Consolidated Financial Statements for additional
information related to our operating segments.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Non-Interest Revenue. The following table sets forth the principal
components of our non-interest revenue during the years indicated:
2004 2003 2002
------------ ------------ ------------
Servicing and related fees ................................. $ 160,062 $ 139,744 $ 127,787
Vendor management fees ..................................... 46,986 29,842 18,299
Gain (loss) on trading and match funded securities, net .... (537) 3,344 7,012
Valuation gains (losses) on real estate .................... (5,110) (7,429) (35,002)
Gain (loss) on sales of real estate ........................ 1,556 466 4,098
Operating income (loss) from real estate ................... 605 5,127 7,864
Gain (loss) on debt repurchases ............................ -- (445) (1,461)
Other revenue .............................................. 19,465 6,848 5,415
------------ ------------ ------------
Non-interest revenue ..................................... $ 223,027 $ 177,497 $ 134,012
============ ============ ============
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 for the years indicated:
2004 2003 2002
------------ ------------ ------------
Residential Loan Servicing:
Servicing and related fees:
Loan servicing fees (1) .................................. $ 166,594 $ 166,425 $ 139,178
Late charges ............................................. 40,149 35,461 28,075
Interest on custodial accounts (2) ....................... 16,561 10,821 7,757
Compensating interest expense (3) ........................ (33,115) (32,315) (19,758)
Amortization of servicing rights (4) ..................... (96,036) (93,558) (58,045)
Other, net ............................................... 10,016 7,622 6,430
------------ ------------ ------------
104,169 94,456 103,637
Other fees:
Default servicing fees ................................... 1,805 3,956 4,418
Retail banking fees ...................................... 8,575 8,496 5,036
Other .................................................... 10,570 11,410 5,159
------------ ------------ ------------
125,119 118,318 118,250
------------ ------------ ------------
Other Segments (5):
Servicing and related fees:
Loan servicing fees ...................................... 13,202 10,583 6,710
Other, net ............................................... 15,575 9,433 2,371
------------ ------------ ------------
28,777 20,016 9,081
Other fees ................................................. 6,166 1,410 456
------------ ------------ ------------
$ 160,062 $ 139,744 $ 127,787
============ ============ ============
(1) The increase in loan servicing fees during 2003 was largely due to the
growth in residential loans we serviced for others. The average unpaid
principal balance of loans we serviced in the Residential Loan Servicing
Segment during 2004, 2003 and 2002 amounted to $35,295,755, $33,589,509
and $26,533,826, respectively. In spite of the increase in the average
balance of loans serviced for others in 2004 as compared to 2003, loan
servicing fees increased only slightly due in part to a greater
concentration of sub-servicing business. Subservicing contracts provide
for lower servicing fees, but do not require the purchase of servicing
rights.
(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 $1,204,000, $993,000
and $494,000 during 2004, 2003 and 2002, respectively.
(3) Our loan servicing agreements include a requirement for us to pay to
securitization trusts the difference between a full month of interest
and the interest collected on loans that are repaid before the end of
the month. The amount of interest we are required to pay depends on the
number of borrowers that repay their loans and the timing of their
repayment during the month. An estimate of this amount is included in
the quarterly valuation of our mortgage servicing rights. The increase
in compensating interest expense reflects an increase in loan
prepayments, primarily due to lower interest rates.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
(4) Although purchases of servicing rights have declined in 2004 and 2003 as
compared to 2002, amortization expense has increased as a result of
higher actual and projected prepayment rates due to lower interest
rates. 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 - Core
Businesses" for additional information regarding servicing and related
fees for these segments.
The following table sets forth our loans serviced for others at the
dates indicated:
Loans (1)(2)(3) Real Estate (4) Total
--------------------------- --------------------------- ---------------------------
Amount Count Amount Count Amount Count
------------ ------------ ------------ ------------ ------------ ------------
Residential Loan Servicing
December 31, 2004:
Performing ............. $ 29,227,341 253,617 $ -- -- $ 29,227,341 253,617
Non-performing ......... 3,971,439 48,711 1,325,711 17,857 5,297,150 66,568
------------ ------------ ------------ ------------ ------------ ------------
$ 33,198,780 302,328 $ 1,325,711 17,857 $ 34,524,491 320,185
============ ============ ============ ============ ============ ============
December 31, 2003:
Performing ............. $ 32,413,000 292,670 $ -- -- $ 32,413,000 292,670
Non-performing ......... 4,306,794 52,922 977,524 13,998 5,284,318 66,920
------------ ------------ ------------ ------------ ------------ ------------
$ 36,719,794 345,592 $ 977,524 13,998 $ 37,697,318 359,590
============ ============ ============ ============ ============ ============
December 31, 2002:
Performing ............. $ 26,600,529 280,089 $ -- -- $ 26,600,529 280,089
Non-performing ......... 3,786,932 51,467 351,394 4,541 4,138,326 56,008
------------ ------------ ------------ ------------ ------------ ------------
$ 30,387,461 331,556 $ 351,394 4,541 $ 30,738,855 336,097
============ ============ ============ ============ ============ ============
Commercial Servicing
December 31, 2004:
Performing ............. $ 834,032 367 $ -- -- $ 834,032 367
Non-performing ......... 12,530,324 9,393 120,366 34 12,650,691 9,427
------------ ------------ ------------ ------------ ------------ ------------
$ 13,364,356 9,760 $ 120,366 34 $ 13,484,723 9,794
============ ============ ============ ============ ============ ============
December 31, 2003:
Performing ............. $ 384,869 216 $ -- -- $ 384,869 216
Non-performing ......... 11,982,257 7,400 83,665 38 12,065,922 7,438
------------ ------------ ------------ ------------ ------------ ------------
$ 12,367,126 7,616 $ 83,665 38 $ 12,450,791 7,654
============ ============ ============ ============ ============ ============
December 31, 2002:
Performing ............. $ 585,251 239 $ -- -- $ 585,251 239
Non-performing ......... 750,872 111 22,782 28 773,654 139
------------ ------------ ------------ ------------ ------------ ------------
$ 1,336,123 350 $ 22,782 28 $ 1,358,905 378
============ ============ ============ ============ ============ ============
(1) At December 31, 2004, we serviced 238,105 subprime loans with an unpaid
principal balance of $28,374,493. This compares 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 Fannie Mae and Freddie Mac ("nonconforming loans").
(2) 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.
(3) At December 31, 2004, we serviced under sub-servicing contracts 71,235
residential loans with an unpaid principal balance of $7,902,887.
(4) Includes $839,654 and $480,388 of foreclosed residential properties
serviced for the VA at December 31, 2004 and 2003, respectively.
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 Results - Ocwen Realty Advisors".
Gain (Loss) on Trading and Match Funded Securities Net. The net gain
(loss) recorded on trading and match funded securities includes both unrealized
gains (losses) on securities to record them at fair value and realized gains
(losses) resulting from sales thereof. Realized and unrealized gains (losses) on
trading and match funded securities are disclosed in the table below for the
years indicated:
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
2004 2003 2002
------------ ------------ ------------
Unrealized gains (losses):
Subprime Finance (1) ..................................... $ (2,060) $ 2,566 $ 2,447
Commercial Assets ........................................ 765 -- --
Residential Discount Loans ............................... -- -- (192)
Corporate Items and Other ................................ 228 412 (235)
------------ ------------ ------------
(1,067) 2,978 2,020
------------ ------------ ------------
Realized gains (losses) (2):
Subprime Finance ......................................... 57 366 4,840
Residential Discount Loans ............................... -- -- 152
Corporate Items and Other ................................ 473 -- --
------------ ------------ ------------
530 366 4,992
------------ ------------ ------------
$ (537) $ 3,344 $ 7,012
============ ============ ============
(1) The unrealized loss on subprime residual and subordinate securities in
2004 was primarily due to a $2,312 decline in the fair value of our U.K.
unrated single family subprime residual securities. In 2003, the
unrealized gains were a result of increases in the value of unrated
subprime residual securities that had been classified as match funded
securities in prior years. The unrealized gain in 2002 is principally
related to increases in the value of the U.K. residual securities offset
by declines in the value of other subprime residual securities.
(2) During 2002, we sold subordinate and residual securities with an
aggregate fair value of $26,438 for total realized gains of $4,992. The
decline in realized gains in 2003 and 2004, as compared to 2002,
reflects a significant decline in sales.
See "Changes in Financial Condition - Trading Securities" and Notes 1
and 5 to our Consolidated Financial Statements.
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. Valuation gains (losses) on real estate
primarily consist of impairment charges and provisions for losses in fair value
on commercial assets, as indicated in the table below for the years presented:
2004 2003 2002
------------ ------------ ------------
Residential Discount Loans ................................. $ -- $ -- $ (1,648)
Commercial Assets (1) ...................................... (5,075) (7,183) (33,313)
Subprime Assets ............................................ -- -- (12)
Corporate Items and Other .................................. (35) (247) (29)
------------ ------------ ------------
$ (5,110) $ (7,430) $ (35,002)
============ ============ ============
(1) The decline in valuation losses in 2004 and 2003 reflects the decline in
commercial assets. Only four commercial assets (a shopping center, a
parcel of land and two partnership interests) with a combined carrying
value of $18,732 remain in the Commercial Assets segment at December 31,
2004. See "Changes in Financial Condition - Real Estate".
Gain (Loss) on Sales of Real Estate. The following table sets forth the
principal components of net gains (losses) we recorded on sales of our real
estate for the years indicated:
2004 (1) 2003 2002
------------ ------------ ------------
Residential Discount Loans ................................. $ -- $ -- $ 3,025
Commercial Assets (1) ...................................... 1,110 97 1,055
Subprime Finance ........................................... -- 1 17
Corporate Items and Other .................................. 446 368 1
------------ ------------ ------------
$ 1,556 $ 466 $ 4,098
============ ============ ============
(1) Net gains from sales of commercial real estate during 2004 is comprised
of a $1,349 gain on the sale of a shopping mall and a $351 gain on the
sale of a hotel, offset in part by a $590 loss on the sale of an office
building. Only one commercial property remains at December 31, 2004. See
"Changes in Financial Condition - Real Estate".
Operating Income (Loss) from Real Estate. The following table sets forth
the operating results of our real estate for the years indicated:
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
2004 2003 2002
------------ ------------ ------------
Residential Discount Loans ................................. $ -- $ -- $ (987)
Commercial Assets .......................................... 682 4,968 9,106
Subprime Finance ........................................... (2) (5) (11)
Corporate Items and Other .................................. (75) 165 (244)
------------ ------------ ------------
$ 605 $ 5,128 $ 7,864
============ ============ ============
Operating income (loss) includes rental income, depreciation expense
(held for use properties) and operating expenses associated with holding and
maintaining our properties. Operating income (loss) for 2003 and 2002 also
included $857 and $3,967, respectively, of equity in earnings of loans accounted
for as investments in real estate. The decrease in operating income during 2004
and 2003 reflects sales of properties and the repayment of loans we accounted
for as investments in real estate. Only one commercial property remains at
December 31, 2004. See "Changes in Financial Condition - Real Estate".
Gain (Loss) on Repurchase of Debt. The following table sets forth the
components of the gains (losses) resulting from our repurchase of our debt
securities during the years indicated:
2004 2003 2002
------------ ------------ ------------
10.875% Capital Securities due August 1, 2027:
Face amount repurchased .................................. $ -- $ -- $ 4,910
Gain (loss) .............................................. $ -- $ -- $ 1,074
11.875% Notes due October 1, 2003 (1):
Face amount repurchased .................................. $ -- $ -- $ 43,550
Gain (loss) .............................................. $ -- $ -- $ (1,508)
11.5% Redeemable Notes due July 1, 2005:
Face amount repurchased .................................. $ -- $ -- $ 45
Gain (loss) .............................................. $ -- $ -- $ (2)
12.0% Subordinated Debentures due June 15, 2005 (2):
Face amount repurchased .................................. $ -- $ 33,500 $ 33,500
Gain (loss) .............................................. $ -- $ (445) $ (1,025)
Total debt repurchases (3):
Face amount repurchased .................................. $ -- $ 33,500 $ 82,005
Gain (loss) .............................................. $ -- $ (445) $ (1,461)
(1) The remaining $43,475 balance of our 11.875% Notes matured on October 1,
2003 and were repaid in full.
(2) On September 30, 2003 we exercised our redemption option and called the
remaining $33,065 balance of our 12.0% Subordinated Debentures at a
price of 101.333%, or a premium of $441. Earlier in 2003, we had
repurchased $435 in the open market resulting in a loss of $4.
(3) In November 2002 we exercised redemption options on three of our
outstanding debt obligations for a combined debt reduction of $73,545.
As provided for in the terms of the indentures, we exercised our
redemption option and called $40,000 of our 11.875% Notes at a price of
102.969%, $33,500 of our 12% Subordinated Debentures at a price of
102.667% and the remaining $45 of our 11.5% Redeemable Notes at a price
of 105.75%. As a result of these early redemptions at a premium, we
incurred $2,499 of loss, including the write-off of $416 of unamortized
issuance costs.
See "Changes in Financial Condition - Debt Securities" and Note 16 to
our Consolidated Financial Statements.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Other Income. The following table sets forth the principal components of
other income by segment for the years indicated:
2004 2003 2002
------------ ------------ ------------
Residential Loan Servicing ................................. $ 269 $ 18 $ (103)
OTX (1) .................................................... 7,729 1,382 4,533
Ocwen Recovery Group (2) ................................... 1,982 2,989 4,191
Commercial Servicing ....................................... 193 622 1,601
Commercial Assets .......................................... 402 799 423
Affordable Housing ......................................... 1 877 600
Subprime Finance ........................................... 1,082 (14) (18)
Residential Discount Loans ................................. -- -- (2,720)
Corporate Items and Other (3) .............................. 7,807 175 (3,092)
------------ ------------ ------------
$ 19,465 $ 6,848 $ 5,415
============ ============ ============
(1) Primarily represents service contract fees, maintenance fees, consulting
revenue and other income associated with our REALServicing, REALSynergy,
and REALTrans products. Income for 2004 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 - Core
Businesses - Ocwen Recovery Group".
(3) Includes $6,874 of interest income recorded during 2004 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 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 amount of interest-earning assets
relative to the amount of 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 float balances 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. See "Non-Interest Revenue - Servicing
and Related Fees".
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% at the end of 1999 to 51% at the end of 2004. Both our acquisition of OAC in
1999 and our change in strategic direction from capital-intensive businesses to
fee-based sources of revenue 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 this 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 had 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 had a negative impact on net interest income, margin and spread
because the distributions on the Capital Securities have been included in
interest on Debt Securities since that date. At the same time, our redemption of
the remaining $33,065 balance of our 12% Subordinated Debentures on September
30, 2003, the repayment of the remaining $43,475 of our 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. See "Gain (Loss) on Repurchase of Debt" and "Changes in
Financial Condition - Debt Securities".
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following table sets forth, for the years 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 years:
Years Ended December 31,
---------------------------------------------------------------------------------
2004 2003
--------------------------------------- ---------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
----------- ----------- ----------- ----------- ----------- -----------
AVERAGE ASSETS
Interest earning cash and other ............. $ 88,698 $ 1,293 1.46% $ 30,705 $ 356 1.16%
Federal funds sold and repurchase
agreements ................................. 155,519 2,087 1.34% 125,732 1,403 1.12%
Trading securities:
Investment grade securities (1) ........... 61,882 1,269 2.05% 10,054 (71) (0.71)%
Subordinates and residuals (2) ............ 42,015 16,316 38.83% 38,679 17,418 45.03%
Loans (3) ................................... 26,329 1,676 6.37% 68,613 1,614 2.35%
Match funded loans and securities (4) ....... 15,894 1,035 6.51% 37,513 3,402 9.07%
----------- ----------- ----------- -----------
Total interest earning assets ............. 390,337 23,676 6.07% 311,296 24,122 7.75%
----------- -----------
Advances on loans and loans
serviced for others ....................... 335,888 324,834
Mortgage servicing rights ................... 144,014 177,171
Match funded advances on loans
serviced for others ....................... 119,691 117,219
Other non-interest earning assets ........... 325,757 369,971
----------- -----------
Total assets .............................. $ 1,315,687 $ 1,300,491
=========== ===========
AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits ............ $ 19,968 161 0.81% $ 16,525 195 1.18%
Savings deposits ............................ 1,657 14 0.84% 1,554 12 0.77%
Certificates of deposit (5) ................. 410,024 13,459 3.28% 408,941 17,339 4.24%
----------- ----------- ----------- -----------
Total interest-bearing deposits ........... 431,649 13,634 3.16% 427,020 17,546 4.11%
Securities sold under agreements to
repurchase ................................ -- -- --% 250 3 1.20%
Match funded liabilities .................... 124,222 4,923 3.96% 129,438 5,414 4.18%
Lines of credit and other secured
borrowings (6) ............................ 66,271 2,717 4.10% 130,886 5,824 4.45%
Debt securities (7) ......................... 146,172 9,090 6.22% 85,629 9,929 11.60%
----------- ----------- ----------- -----------
Total interest-bearing liabilities ........ 768,314 30,364 3.95% 773,223 38,716 5.01%
----------- -----------
Escrow deposits ............................. 132,212 107,888
Other non-interest bearing liabilities ...... 91,404 80,812
----------- -----------
Total liabilities ......................... 991,930 961,923
Capital Securities (7) ...................... -- 28,125
Minority interest ........................... 1,052 1,503
Stockholders' equity ........................ 322,705 308,940
----------- -----------
Total liabilities and
stockholders' equity ..................... $ 1,315,687 $ 1,300,491
=========== ===========
Net interest income (expense) ............... $ (6,688) $ (14,594)
=========== ===========
Net interest spread ......................... 2.12% 2.74%
Net interest margin ......................... (1.71)% (4.69)%
Ratio of interest-earning assets to
interest-bearing liabilities .............. 51% 40%
Years Ended December 31,
---------------------------------------
2002
---------------------------------------
Interest Average
Average Income/ Yield/
Balance Expense Rate
----------- ----------- -----------
AVERAGE ASSETS
Interest earning cash and other ............. $ 13,693 $ 278 2.03%
Federal funds sold and repurchase
agreements ................................ 152,588 2,629 1.72%
Trading securities:
Investment grade securities (1) ........... 88,565 2,064 2.33%
Subordinates and residuals (2) ............ 44,251 14,522 32.82%
Loans (3) ................................... 146,671 11,279 7.69%
Match funded loans and securities (4)........ 66,233 6,463 9.76%
----------- -----------
Total interest earning assets ............. 512,001 37,235 7.27%
-----------
Advances on loans and loans
serviced for others ....................... 267,572
Mortgage servicing rights ................... 137,323
Match funded advances on loans
serviced for others ....................... 101,863
Other non-interest earning assets ........... 416,346
-----------
Total assets .............................. $ 1,435,105
===========
AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing demand deposits ............ $ 14,749 245 1.66%
Savings deposits ............................ 1,605 17 1.06%
Certificates of deposit (5) ................. 473,793 27,193 5.74%
----------- -----------
Total interest-bearing deposits ........... 490,147 27,455 5.60%
Securities sold under agreements to
repurchase ................................ 12,774 236 1.85%
Match funded liabilities .................... 147,139 6,573 4.47%
Lines of credit and other secured
borrowings (6) ............................ 94,169 4,152 4.41%
Debt securities (7) ......................... 144,044 17,346 12.04%
----------- -----------
Total interest-bearing liabilities ........ 888,273 55,762 6.28%
-----------
Escrow deposits ............................. 90,612
Other non-interest bearing liabilities ...... 50,920
-----------
Total liabilities ......................... 1,029,805
Capital Securities (7) ...................... 57,812
Minority interest ........................... 570
Stockholders' equity ........................ 346,918
-----------
Total liabilities and
stockholders' equity ..................... $ 1,435,105
===========
Net interest income (expense) ............... $ (18,527)
===========
Net interest spread ......................... 0.99%
Net interest margin ......................... (3.62)%
Ratio of interest-earning assets to
interest-bearing liabilities .............. 58%
(1) The average balance of investment grade securities outstanding decreased
between 2002 and 2003 by $78,511 as we had been investing in AAA-rated
collateralized mortgage obligations ("CMO") during 2002 to enable the
Bank to meet the Qualified Thrift Lender ("QTL") requirements. During
2003, we had only minimal investments in CMOs, reflecting a reduced need
to hold these securities to meet the QTL requirements. During the fourth
quarter of 2004, we again began investing in CMOs to meet the QTL
requirements. In addition, in order to maximize our returns on excess
cash, we also invested in AAA-rated auction rate securities during the
second half of 2004.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
(2) The increase in the average yield on subprime and residual trading
securities in 2003 was largely the result of sales of approximately
$26,400 of lower-yielding unrated subordinates and residuals during 2002
and an increase in interest income on unrated single family subprime
residuals. The average yield of 45.03% during 2003 was due to increased
cash flows from certain subprime residuals, which increased the market
value and interest earnings on these securities. This treatment is in
accordance with Emerging Issues Task Force (EITF) Issue 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets, which requires us
to update quarterly our estimates of future cash flows over the
estimated lives of the securities.
(3) The decline in the average balance of loans is the result of sales,
resolutions and repayments (primarily commercial loans) coupled with
minimal acquisitions and originations. The decline reflects our
strategic decision to exit non-core businesses and to dispose of the
related assets. The average balances included non-performing loans on
which we recognize interest on a cash basis. On loans that we acquired
at a discount, we recognize any remaining unamortized discount as
interest income upon the repayment or discharging of such loans. As the
discount loan portfolio has declined, such resolution gains have also
declined from $3,347 in 2002 to $57 in 2003. No resolution gains were
recognized in 2004.
(4) The decline in the average balance of match funded loans and securities
is the result of principal repayments coupled with the sale of the
remaining match funded single family loans at the end of the third
quarter of 2004 and the transfer of match funded securities to residual
trading securities during the second quarter of 2003. The loans were
sold in connection with the redemption of the related match funded debt
and the securities were reclassified as the result of the repurchase and
retirement of the related match funded debt.
(5) The decline in the average balance of certificates of deposit is largely
the result of maturing brokered certificates of deposit, offset in part
by increases in non-brokered certificates of deposit through the first
quarter of 2004. We have not issued any new brokered certificates of
deposit since 2000. The decline in the average rate earned on
certificates of deposit reflects the replacement of maturing brokered
certificates of deposit with non-brokered certificates of deposit that
have lower interest rates because interest rates have been declining
during the past two years.
(6) The average balance of lines of credit and other secured borrowings
increased during 2003 as we entered into lending agreements secured by
advances on loans serviced for others, purchased mortgage servicing
rights, real estate and unrated subprime residual trading securities.
During 2004, the sale of real estate and the issuance of $175,000 of
3.25% Convertible Notes, as noted below, allowed us to repay a
significant portion of this debt.
(7) The average balance of debt securities declined during 2003 as the
result of our repurchase of $33,500 of our 12% subordinated debentures
at the end of the third quarter and the maturity of $43,475 of our
11.875% notes at the beginning of the fourth quarter. These declines
were partially offset by the transfer of the $56,249 outstanding of our
10.875% Capital Securities to debt securities effective with our
adoption of SFAS No. 150 on July 1, 2003. Also as a result of our
adoption of SFAS No. 150, distributions on our Capital Securities are
included in interest expense on debt securities beginning in July 2003.
During 2004, the average balance of debt securities increased as a
result of our issuance on July 28, 2004 of $175,000 of 3.25% Contingent
Convertible Senior Unsecured Notes due 2024. See "Changes in Financial
Condition - Debt Securities" and Note 16 to the Consolidated Financial
Statements. The decline in the average rate on debt securities during
2004 is principally the result of our issuance of the 3.25% Convertible
Notes.
The following table describes the extent to which changes in interest
rates and changes in volume of our interest-earning assets and interest-bearing
liabilities have affected our interest income and expense during the periods
indicated. For each category of our interest-earning assets and interest-bearing
liabilities, we have provided information 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. We have allocated changes attributable to both volume and rate
proportionately to the change due to volume and the change due to rate.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Years Ended December 31,
---------------------------------------------------------------------------------------
2004 vs. 2003 2003 vs. 2002
------------------------------------------ ------------------------------------------
Favorable (unfavorable) variance Favorable (unfavorable) variance
------------------------------------------ ------------------------------------------
Rate Volume Total Rate Volume Total
------------ ------------ ------------ ------------ ------------ ------------
INTEREST-EARNING ASSETS
Interest-earning cash and other .... $ 113 $ 824 $ 937 $ (157) $ 235 $ 78
Federal funds sold and repurchase
agreements ........................ 310 374 684 (815) (411) (1,226)
Trading securities:
Investment grade securities ...... 892 448 1,340 (1,271) (864) (2,135)
Subordinates and residuals ....... (2,525) 1,423 (1,102) 4,896 (2,000) 2,896
Loans .............................. 1,507 (1,445) 62 (5,472) (4,193) (9,665)
Match funded loans and securities .. (778) (1,589) (2,367) (429) (2,632) (3,061)
------------ ------------ ------------ ------------ ------------ ------------
Total interest-earning assets..... (481) 35 (446) (3,248) (9,865) (13,113)
------------ ------------ ------------ ------------ ------------ ------------
INTEREST-BEARING LIABILITIES
Interest-bearing demand deposits ... 69 (35) 34 77 (27) 50
Savings deposits .................. (1) (1) (2) 4 1 5
Certificates of deposit ............ 3,926 (46) 3,880 6,467 3,387 9,854
------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing deposits .. 3,994 (82) 3,912 6,548 3,361 9,909
Securities sold under agreements
to repurchase ..................... -- 3 3 61 172 233
Match funded liabilities ........... 278 213 491 406 753 1,159
Lines of credit and other secured
borrowings ........................ 427 2,680 3,107 (38) (1,634) (1,672)
Debt securities .................... 5,896 (5,057) 839 613 6,804 7,417
------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing
liabilities ................... 10,595 (2,243) 8,352 7,590 9,456 17,046
------------ ------------ ------------ ------------ ------------ ------------
Favorable (Unfavorable) Variance ... $ 10,114 $ (2,208) $ 7,906 $ 4,342 $ (409) $ 3,933
============ ============ ============ ============ ============ ============
Provisions for Loan Losses. At December 31, 2004, our total net loan
balance was $3,792 or 0.3% of total assets as compared to $28,098 or 2.3% of
total assets at December 31, 2003. Of the balance remaining at December 31,
2004, $3,198 represents one multi-family loan in our Affordable Housing segment.
For loans held in our Affordable Housing business, we project the amount to be
realized from the disposition of the property to determine the appropriate
allowance for loan losses. Because we have only one loan remaining in the
Affordable Housing segment we are able to perform a specific assessment. 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 allowance for loan losses is management's best
estimate of probable inherent loan losses incurred as of December 31, 2004.
The following table presents the provisions for loan losses for the
years indicated:
2004 2003 2002
------------ ------------ ------------
Loans:
Ocwen Recovery Group ..................................... $ -- $ -- $ (278)
Residential Discount Loans ............................... -- -- (2,273)
Commercial Assets (1) .................................... (1,651) (3,095) 12,814
Affordable Housing ....................................... (112) 151 3,392
Corporate Items and Other ................................ (24) 311 --
------------ ------------ ------------
(1,787) (2,633) 13,655
Match funded loans:
Residential Discount Loans ............................... -- (26)
Corporate Items and Other ................................ (94) (51) --
------------ ------------ ------------
$ (1,881) $ (2,684) $ 13,629
============ ============ ============
37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
(1) During 2004, our investment in commercial loans was reduced to zero as a
result of resolutions, repayments and transfers to real estate. During
2003, our investment declined from $69,198 at December 31, 2002 to
$20,763 at December 31, 2003, primarily as a result of sales,
resolutions and repayments. Accordingly, less allowance for loan losses
was required, resulting in negative provisions for loan losses in 2004
and 2003 for the Commercial Assets segment. Of the $3,095 negative
provision in 2003, $3,078 resulted from a loan with a book value (before
allowance) of $24,882 that was discharged through a negotiated cash
repayment. The 2002 provision reflects an increase in the allowance on
the loans in the Commercial Assets segment from 4.2% at December 31,
2001 to 19.0% at December 31, 2002.
Our total allowance for loan losses as a percentage of non-performing
loans has increased from 27.5% at December 31, 2002 to 38.7% at December 31,
2003 and 58.1% at December 31, 2004. As indicated in the table below, our total
allowance as a percentage of loans increased from 21.3% at December 31, 2002 to
23.2% at December 31, 2003 and 54.5% at December 31, 2004.
The following table sets forth the allowance for loan losses as a
percentage of the respective loan balances at the dates indicated:
Allowance
as a % of
Allowance Loan Balance Loan Balance
------------ ------------ ------------
December 31, 2004
Loans:
Commercial Finance ....................................... $ -- $ -- --%
Affordable Housing ....................................... 4,468 7,666 58.3%
Subprime Finance ......................................... -- 74 --%
Corporate Items and Other ................................ 78 598 13.0%
------------ ------------
$ 4,546 $ 8,338 54.5%
============ ============
December 31, 2003
Loans:
Commercial Finance ....................................... $ 3,786 $ 24,549 15.4%
Affordable Housing ....................................... 4,579 11,124 41.2%
Corporate Items and Other ................................ 105 895 11.7%
------------ ------------
8,470 36,568 23.2%
Match funded loans:
Corporate Items and Other ................................ 94 24,393 0.4%
------------ ------------
$ 8,564 $ 60,961 14.0%
============ ============
December 31, 2002
Loans:
Residential Discount Loans ............................... $ 154 $ 1,400 11.0%
Commercial Finance ....................................... 16,179 85,377 19.0%
Affordable Housing ....................................... 4,428 10,657 41.6%
Subprime Finance ......................................... -- 184 --%
------------ ------------
20,761 97,618 21.3%
Match funded loans:
Residential Discount Loans ............................... 144 38,129 0.4%
------------ ------------
$ 20,905 $ 135,747 15.4%
============ ============
For additional information regarding our allowance for loan losses on
the above portfolios, see "Changes in Financial Condition - Allowances for Loan
Losses."
38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
NON-INTEREST EXPENSE. The following table sets forth the principal
components of our non-interest expense for the years indicated:
2004 2003 2002
------------ ------------ ------------
Compensation and employee benefits ......................... $ 87,284 $ 72,221 $ 77,778
Occupancy and equipment .................................... 15,933 13,159 11,843
Technology and communication costs ......................... 26,049 21,121 25,270
Loan expenses .............................................. 27,313 14,252 12,605
Loss (gain) on investments in affordable housing properties (255) 285 21,915
Write-off of goodwill ...................................... -- -- 2,231
Professional services and regulatory fees .................. 26,589 26,054 16,383
Other operating expenses ................................... 10,069 10,409 9,601
------------ ------------ ------------
$ 192,982 $ 157,501 $ 177,626
============ ============ ============
Compensation and Employee Benefits. The following table presents the
principal components of compensation and benefits for the years indicated:
2004 2003 2002
------------ ------------ ------------
Salaries (1) ............................................... $ 59,221 $ 49,811 $ 53,746
Bonuses (2) ................................................ 10,978 9,771 7,904
Payroll taxes .............................................. 4,496 3,708 4,352
Commissions ................................................ 5,040 2,460 3,370
Insurance .................................................. 2,381 2,251 2,668
Severance .................................................. 1,349 1,397 2,316
Other (3) .................................................. 3,819 2,823 3,422
------------ ------------ ------------
$ 87,284 $ 72,221 $ 77,778
============ ============ ============
(1) Salaries include fees paid for the services of temporary employees.
(2) Bonuses also include compensation related to employee incentive awards
of restricted stock and stock options.
(3) Other consists primarily of recruiting expenses, relocation expenses,
matching contributions to our 401(K) plan and fees paid to directors.
The increase in compensation and benefits in 2004 as compared to 2003 is
primarily due to increase in salaries and commissions. The increase in salaries
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. The average total number
of our full-time employees (domestic and international combined) amounted to
2,809, 2,083 and 1,790 during 2004, 2003 and 2002, respectively. The number of
employees in our India offices averaged 1,738 during 2004 as compared to 1,134
during 2003 and 543 during 2002. See "Workforce and Operational Capacity" for
additional information regarding our operations and workforce in India. In
September 2003, we terminated our agreement with an external law firm to manage
certain aspects of our loan resolution function of our Residential Loan
Servicing business, including the issuance of obligatory breach notices to
delinquent borrowers. Upon termination of the agreement, we began performing
these functions internally. This resulted in the need to hire additional staff
to perform these functions, which has increased our compensation and benefit
expenses. See "Results of Operations - Core Businesses -Residential Loan
Servicing" for additional information regarding these changes. The property
management contract we entered into with the VA in September 2003 also resulted
in the need to hire additional staff.
There were two principal factors contributing to the increase in
commissions in 2004. First, our re-assumption, during the fourth quarter of 2003
of certain loan resolution activities in the Residential Loan Servicing Segment,
as described in the paragraph above. Second, the property management contract
with the VA, as noted in the paragraph above.
The decline in compensation and benefits in 2003 was primarily due to a
decrease in salaries. This decline in costs occurred in spite of an increase in
the average number of our employees and is due in large part to our ongoing
globalization initiative. The goal of this initiative was to reduce labor costs
by migrating certain functions (primarily in support of our Residential Loan
Servicing, Global Outsourcing and OTX businesses) to our offices in Bangalore
and Mumbai, India. The average number of employees in our India offices as a
percent of the total average number of employees increased from 30% during 2002
to 54% during 2003. The decline in salaries is also the result of a change in
the mix of our workforce in the United States to a greater concentration of call
center and similar level positions. This change in mix occurred as we exited
capital-intensive businesses in favor of fee-based businesses, primarily
residential loan servicing
39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Occupancy and Equipment. The following table presents the principal
components of occupancy and equipment costs for the years indicated:
2004 2003 2002
------------ ------------ ------------
Postage and mailing ........................................ $ 5,701 $ 4,689 $ 4,432
Rent ....................................................... 2,796 3,515 3,238
Depreciation ............................................... 2,677 2,935 2,961
Other (1) .................................................. 4,759 2,020 1,212
------------ ------------ ------------
$ 15,933 $ 13,159 $ 11,843
============ ============ ============
(1) The increase in other occupancy and equipment costs in 2004 is primarily
the result of our reassuming in the fourth quarter of 2003 certain loan
resolution activities in our Residential Loan Servicing segment,
including the issuance of breach notices to delinquent borrowers. These
loan resolution functions were previously performed by a third party law
firm. See "Results of Operations - Core Businesses - Residential Loan
Servicing" for additional information regarding this change.
Technology and Communication Costs. The following table presents the
principle components of technology and communication costs for the years
indicated:
2004 2003 2002
------------ ------------ ------------
Depreciation expense:
Hardware ................................................. $ 6,042 $ 6,579 $ 7,154
Software ................................................. 2,925 2,455 2,562
Other .................................................... 668 437 326
------------ ------------ ------------
9,635 9,471 10,042
------------ ------------ ------------
Telecommunications expense (1) ............................. 6,619 5,927 4,990
Consulting fees - technology ............................... 1,089 1,552 1,729
Amortization expense:
Capitalized software development costs ................... 1,451 1,511 1,424
Intellectual property .................................... -- -- 1,029
------------ ------------ ------------
1,451 1,511 2,453
------------ ------------ ------------
Equipment lease expense .................................... 1,459 1,462 1,312
Other (2) .................................................. 5,796 1,198 4,744
------------ ------------ ------------
$ 26,049 $ 21,121 $ 25,270
============ ============ ============
(1) The increase in telecommunication expense during 2003 is largely due to
increased costs of telecommunication lines as a result of our expansion
in India.
(2) The increase in other technology and communication costs in 2004 is
primarily due to our reassuming in the fourth quarter of 2003 certain
loan resolution activities in our Residential Loan Servicing segment,
including the issuance of breach notices to delinquent borrowers. These
loan resolution functions were previously performed by a third party law
firm. See "Results of Operations-Core Businesses - Residential Loan
Servicing" for additional information regarding this change. Other costs
for 2002 included $1,068 of payments related to the acquisition of Amos,
Inc., an OTX subsidiary, in 1997. This represented the final
compensatory payment due in connection with this acquisition.
Loss (Gain) on Investment in Affordable Housing Properties. Net losses
we recorded on investments in affordable housing properties during 2003 and 2002
included loss provisions in the amount of $432 and $17,350, respectively, for
expected losses on the sale of properties. No such provisions were required for
2004. Losses for 2002 also included a $3,944 charge to record a discount on a
long-term sale of seven properties during the second quarter. We are accreting
this discount to income over the term of the related receivable balance, which
extends through 2014. Our remaining investment in affordable housing properties
consists of only one limited partnership interest at December 31, 2004. See
"Segment Results - Affordable Housing".
Write-off of Goodwill. Goodwill amortization and writeoffs that we
recognized during 2002 related entirely to OTX. In accordance with the
provisions of SFAS No. 142, which we adopted on January 1, 2002, we ceased
amortization of the remaining balance of our goodwill beginning in 2002.
However, we test our goodwill annually for impairment. As a result of our annual
impairment testing in 2002, we wrote-off the remaining $2,231 of goodwill
associated with the 1997 acquisition of Amos, Inc. No write-off was required as
a result of our 2004 or 2003 impairment testing. See Note 1 to our Consolidated
Financial Statements.
40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Loan Expenses. Loan expenses for 2004, 2003 and 2002 included $20,747,
$10,649 and $9,463, respectively, of appraisal fees incurred in connection with
property valuation services we provided through ORA. See "Segment Results -
ORA". 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
years indicated:
2004 2003 2002
------------ ------------ ------------
Legal fees and settlements ................................. $ 16,796 $ 18,244 $ 8,308
Consulting fees (non-technology) ........................... 2,387 2,183 2,873
Audit and accounting fees .................................. 2,763 1,745 1,236
Corporate insurance ........................................ 1,736 1,512 1,010
FDIC insurance ............................................. 342 299 398
Other ...................................................... 2,565 2,071 2,558
------------ ------------ ------------
$ 26,589 $ 26,054 $ 16,383
============ ============ ============
Legal fees and settlements in 2004 include $5,198 to establish a reserve
for multiple forbearance plan fees and breach fees that were charged to
borrowers but may no longer be collectible. See "Results of Operations - Core
Businesses - Residential Loan Servicing" for additional information on this
reserve. In addition, a reserve of $3,000 was established to provide for the
following two claims:
(a) On February 8, 2005, a jury in Circuit Court for Palm Beach County,
Florida returned verdicts of $1,000 and $1,056 in compensatory
damages in favor of two former employees of the Bank in a lawsuit
against OCN and the Bank. The jury rejected plaintiffs' request for
punitive damages. The plaintiffs brought claims under the Florida
Civil Rights Act, the Florida Whistleblower Act and state tort law,
arising out of an alleged invasion of privacy and related incidents
allegedly committed by other former employees of the Bank in 1998
for which plaintiffs sought to hold the Ocwen defendants vicariously
liable. We believe the verdicts, which have not yet been reduced to
final judgments, are against the weight of evidence and contrary to
law. Defendants have filed motions for a new trial and/or remittitur
and, if necessary, will take an appeal to the Florida Court of
Appeals for the Fourth District. We intend to continue to vigorously
defend this matter.
(b) On February 28, 2005, a jury in County Court for Nueces County,
Texas, returned a verdict of $140 in compensatory and statutory
damages in favor of two borrowers whose mortgage loan was serviced
by the Bank in a lawsuit arising out of a disputed foreclosure. The
jury rejected plaintiffs' request for punitive damages. The verdict
included $2,900 for plaintiffs' attorneys' fees, an amount, which we
believe is unsupported by the evidence and impermissibly excessive
under the controlling legal authorities. The verdict has not yet
been reduced to a final judgment. We are pursuing post-trial motions
seeking to set aside or substantially reduce the attorneys' fees
award and, if necessary, will take an appeal on that issue and
perhaps other issues to the Texas Court of Appeals for the
Thirteenth Judicial District. We intend to continue to vigorously
defend this matter.
Legal fees and settlements for 2003 include a $10,000 settlement
resulting from a proceeding before an arbitration panel. The former owners of
Admiral Home Loan sought damages exceeding $75,000 arising out of a 1997
acquisition agreement pursuant to which Ocwen Financial Services, Inc. ("OFS")
acquired all of the assets of Admiral Home Loan. OFS ceased operations in 1999.
In their decision, the arbitration panel awarded Claimants damages in the amount
of $6,000. Including of interest, costs and attorneys' fees, the total charge
associated with this matter was approximately $10,000.
Legal fees and settlements for 2002 include the settlement of two claims
for $3,250. Given the substantial costs of proceeding with litigation, coupled
with the uncertainty of jury trials in complex civil matters, we determined that
it was in our best interest to settle the two litigation claims as follows:
(c) Walton Street Capital, L.L.C. ("Walton") filed suit against Ocwen
Asset Investment Corporation ("OAC") and Ocwen Partnership, L.P.
Walton alleged that OAC committed an anticipatory breach of contract
with respect to the proposed sale by OAC of all of its interest in
its commercial mortgage-backed securities portfolio to Walton.
Walton claimed damages in an amount in excess of $27 million
including prejudgment interest. On March 3, 2003, the parties
entered into a settlement agreement under which defendants admitted
no liability, and the case was dismissed with prejudice. The amount
of the settlement was $2,250, which was included in the financial
results for 2002 because the settlement was concluded prior to the
issuance of our financial statements; and
(d) Vincent and Elizabeth Turner filed a class action lawsuit against
Ocwen Federal Bank claiming breach of contract, unjust enrichment
and violation of the New Jersey Consumer Protection Fraud Act based
on the collection of a loan satisfaction fee when the plaintiffs
paid off their loan. The Court granted plaintiffs' motion to certify
a class consisting of borrowers who were charged a similar
satisfaction fee by the Bank from 1992 through February 2002. The
parties entered into a settlement agreement, subsequently approved
by the Court, under which the Bank admitted no liability and the
case was dismissed with prejudice. The amount of the settlement was
approximately $1,000, including plaintiffs' attorneys' fees and
costs.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The increase in audit and accounting fees between 2003 and 2004 is
primarily due to $900 of fees recorded in connection with compliance with
Section 404 of the Sarbanes-Oxley Act of 2002.
Other Operating Expenses. The following table presents the principal
components of other operating expenses for the years indicated:
2004 2003 2002
------------ ------------ ------------
Travel, lodging, meals and entertainment ................... $ 3,361 $ 2,864 $ 2,585
Bad debt expense (1) ....................................... 2,655 554 39
Amortization of deferred costs ............................. 1,039 1,197 1,436
Deposit related expense .................................... 718 912 1,198
Other ...................................................... 2,296 4,882 4,343
------------ ------------ ------------
$ 10,069 $ 10,409 $ 9,601
============ ============ ============
(1) Bad debt expense for 2004 includes a provision of $1,780 recorded for
estimated uncollectible servicing advances and other receivables related
to our Residential Loan Servicing segment, including $1,000 to establish
an allowance for forbearance fees that we are no longer collecting
directly from borrowers. See "Banking Operations" and "Segment Results -
Core Businesses - Residential Loan Servicing" for additional information
regarding forbearance fees.
Distributions on Company Obligated, Mandatorily Redeemable Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Company.
Cash distributions on our 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 $6,117, $6,117 and $6,287 of distributions to holders of the Capital
Securities during 2004, 2003 and 2002, respectively. Effective July 1, 2003 with
our adoption of SFAS No. 150, these distributions are reported in the
consolidated statement of operations as interest expense. The decline in
distributions is the result of repurchases we made during 2002. See
"Non-Interest Revenue - Gain (Loss) on Repurchase of Debt", Note 16 to our
Consolidated Financial Statements and "Changes in Financial Condition - Debt
Securities".
Income Tax Expense (Benefit). The following table provides details of
our income tax expense (benefit) and effective tax rates for the years
indicated:
2004 2003 2002
------------ ------------ ------------
Income tax expense (benefit) on income (loss)
before taxes and effect of change in accounting principle.. $ 3,194 $ (1,427) $ (31,066)
Provision for (reversal of) valuation allowance on
deferred tax asset ........................................ (35,518) 2,175 34,049
------------ ------------ ------------
(32,324) 748 2,983
Income tax benefit on effect of change in accounting
principle ................................................. -- -- (1,166)
------------ ------------ ------------
Total income tax expense (benefit) ......................... $ (32,324) $ 748 $ 1,817
============ ============ ============
The provision for deferred tax asset valuation allowance is a non-cash
charge that we recorded to increase the aggregate valuation allowance. We
maintain a valuation allowance in an amount sufficient to reduce our deferred
tax asset to the amount that is more likely than not to be realized. The
valuation allowance amounted to $165,927 and $201,445 at December 31, 2004 and
2003, respectively. Our assessment of the amount of the valuation allowance was
based on consideration of all available evidence, both positive and negative,
including our recent earnings history, current tax position, and estimates of
future taxable income. The tax character (ordinary versus capital) and the carry
forward and carry back periods of certain tax attributes (e.g., capital losses
and tax credits) was also considered. Reversal of all or a portion of the
valuation allowance may be required in the future based on the results of our
operations. Given our improved profitability in 2003 and 2004, it is possible
that a portion of the valuation allowance could be reversed in 2005.
The $35,518 reduction in the valuation allowance on the deferred tax
asset is principally a result of refund claims of $56,526 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 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 "Changes in Financial Condition - Receivables" for
additional information regarding our refund claims and related income taxes
receivable.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Income tax expense (benefit) before the effect of change in accounting
principle differs from amounts that would be computed by applying the Federal
corporate income tax rate of 35% because of the effect of foreign taxes,
non-economic tax residual payments, changes in the valuation allowance and
low-income housing tax credits. See Note 19 to our Consolidated Financial
Statements for a reconciliation of taxes at the statutory rate to actual income
tax expense (benefit). Income tax expense reflects tax credits of $4,848, $2,393
and 2,685, 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. See Note 19 to
our Consolidated Financial Statements.
Effect of Change in Accounting Principle. The amortization of excess of
net assets acquired over purchase price (negative goodwill) resulted from our
acquisition of OAC on October 7, 1999. Our acquisition resulted in negative
goodwill of $60,042, which we amortized on a straight-line basis through 2001.
On January 1, 2002, upon our adoption of SFAS No. 142, we reversed the
unamortized balance of $18,333 to income. The impact from the adoption of other
elements of SFAS No. 142 resulted in our recording impairment charges of $3,333
on goodwill and intangible assets originally recorded in connection with the
formation of REALSynergy, Inc. in 1999. These amounts have been reported in 2002
as the effect of a change in accounting principle, net of an income tax benefit
of $1,166. See Notes 1 and 2 to our Consolidated Financial Statements.
CHANGES IN FINANCIAL CONDITION
Trading Securities. The following table sets forth the fair value of our
trading securities at the dates indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Investment grade securities:
U.S. Treasury securities ................................. $ 1,594 $ 6,679 $ 1,016
Collateralized mortgage obligations (AAA-rated) (1) ...... 81,466 -- 20,540
Bonds and debentures (2) ................................. 3,155 -- --
------------ ------------ ------------
$ 86,215 $ 6,679 $ 21,556
============ ============ ============
Subordinates and residuals (3):
Single family residential
BB rated subordinates .................................. $ 256 $ 579 $ 599
B-rated subordinates ................................... 435 580 606
Unrated subordinates ................................... 217 222 344
Unrated subprime residuals ............................. 35,276 38,883 33,213
------------ ------------ ------------
36,184 40,264 34,762
Commercial unrated subordinates .......................... 3,343 2,577 2,577
------------ ------------ ------------
$ 39,527 $ 42,841 $ 37,339
============ ============ ============
(1) We invest in CMOs as needed to meet the Qualified Thrift Lender
requirements of the Bank.
(2) These securities were acquired in connection with our acquisition on
September 30, 2004 of Bankhaus Oswald Kruber KG, a bank located in
Germany. See Note 3 to our Consolidated Financial statements for
additional information regarding this acquisition.
(3) During 2004, our subordinate and residual trading securities declined by
$3,314. This decline was primarily due to principal repayments and
amortization. A decrease in the fair value of our unrated subprime
residuals during 2004 was largely offset by changes in exchange rates
between the US dollar and the British Pound. The $5,502 increase in
subordinate and residual trading securities during 2003 was principally
the result of the transfer of $5,926 of match funded securities to
trading securities in June 2003 as a result of our early redemption of
the related match funded liabilities. These securities had a fair value
of $5,146 at December 31, 2003. See "Changes in Financial Condition -
Match Funded Assets". Principal repayments and amortization during 2003
were largely offset by increases in fair value. The change in fair value
between years did not result from changes in the assumptions or
methodologies used to determine fair value. See Note 1 to our
Consolidated Financial Statements for a discussion of our methodologies
used to determine the fair value of trading securities.
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.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Subordinate and residual interests are affected by the rate and timing
of payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until over
collateralization or the balance in the reserve account reaches a specified
level. For residual interests in residential mortgage-backed securities, over
collateralization is the amount by which the collateral balance exceeds the sum
of the bond principal amounts. Over collateralization is achieved by applying
monthly a portion of the interest payments of the underlying mortgages toward
the reduction of the senior class certificate principal amounts, causing them to
amortize more rapidly than the aggregate loan balance. Over collateralization
represents the first tier of loss protection afforded to the non-residual
holders. To the extent not consumed by losses on more highly rated bonds, over
collateralization is remitted to the residual holders. In periods of declining
interest rates, rates of prepayments on mortgage loans generally increase, and
if the rate of prepayments is faster than anticipated, then the yield on
subordinates will be positively affected and the yield on residuals will be
negatively affected.
We periodically assess the carrying value of our subordinate securities
and residual securities retained. There can be no assurance that our estimates
used to determine the value of subordinate securities and residual securities
retained will remain appropriate for the life of each securitization. If actual
loan prepayments or defaults exceed our estimates, the carrying value of our
subordinate securities and residual securities retained may be decreased during
the period in which we recognized the disparity.
The following table presents information regarding our trading
subordinate and residual securities summarized by classification and rating at
December 31, 2004:
ANTICIPATED ANTICIPATED ANTICIPATED
YIELD TO YIELD TO WEIGHTED
PERCENT MATURITY AT MATURITY AT AVERAGE
OWNED BY PURCHASE (2) 12/31/04 REMAINING
RATING/DESCRIPTION (1) OCWEN (3) (2) (4) COUPON LIFE (2) (5)
- ------------------------------------- -------- ------------ ----------- ------ ------------
SINGLE-FAMILY RESIDENTIAL:
BB-rated subordinates ............. 100.00% 19.23% 11.10% 6.75% 3.59
B-rated subordinates .............. 100.00 17.11 17.62 5.86 1.83
Unrated subordinates .............. 100.00 13.91 41.84 6.54 0.17
Unrated subprime residuals ........ 100.00 17.27 11.55 N/A 4.26
COMMERCIAL:
Unrated subordinates .............. 25.00 22.15 14.23 N/A 1.67
(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 December 31, 2004 anticipated yield to
maturity from that originally anticipated are due to differences between
estimated cash flows and actual cash flows. Each quarter, we update the
assumptions used to estimate future cash flows based on the actual
results to date. The primary assumptions include prepayment speeds, loss
rates and the discount rate.
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
(5) Represents the weighted average life in years based on the December 31,
2004 book value.
The following table sets forth the principal amount of mortgage loans by
the geographic location of the properties securing the mortgages that underlie
our trading subordinate and residual securities at December 31, 2004:
DESCRIPTION U.K. CALIFORNIA NEW JERSEY TEXAS NEW YORK OTHER (1) TOTAL
- ------------------------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
Single family
residential ............ $ 51,044 $ 16,469 $ 18,037 $ 18,108 $ 17,833 $ 135,706 $ 257,197
Commercial .............. -- 2,005 -- -- -- 24,415 26,420
Multi-family ............ -- 307 217 -- 208 1,124 1,856
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total ................... $ 51,044 $ 18,781 $ 18,254 $ 18,108 $ 18,041 $ 161,245 $ 285,473
============ ============ ============ ============ ============ ============ ============
Percentage of total ..... 17.88% 6.58% 6.39% 6.34% 6.32% 56.49% 100.00%
============ ============ ============ ============ ============ ============ ============
(1) Consists of properties located in 46 other states, none of which
aggregated over $15,659 in any one state.
See Note 1 and Note 5 to our Consolidated Financial Statements.
Real Estate. The decline in real estate reflects our strategy to dispose
of assets not associated with core businesses. Although we have committed to a
plan to sell these assets, we account for them in accordance with the provisions
of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets". Generally, properties held for more than one year are accounted for as
held and used. These properties are depreciated over their estimated useful
lives. Properties held less than one year are not depreciated and are carried at
the lower of carrying value or fair value less costs to sell. Our real estate
consisted of the following at the dates indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Properties accounted for as held and used:
Office building ............................................. $ -- $ 37,553 $ 42,374
Retail ...................................................... -- 43,460 41,000
------------ ------------ ------------
-- 81,013 83,374
------------ ------------ ------------
Properties accounted for as held for sale:
Retail ...................................................... 8,827 10,657 9,750
Hotel ....................................................... -- 6,171 18,616
Land ........................................................ 844 -- --
Single family residential ................................... 515 882 1,887
------------ ------------ ------------
10,186 17,710 30,253
------------ ------------ ------------
Total investment in real estate properties (1) ................ 10,186 98,723 113,627
Commercial loans accounted for as investments in real estate .. -- -- 2,188
Investment in real estate partnerships ........................ 8,546 5,220 4,900
------------ ------------ ------------
$ 18,732 $ 103,943 $ 120,715
============ ============ ============
(1) Total properties included $49,631 and $60,152 at December 31, 2003 and
2002, respectively, of properties we acquired by foreclosure or
deed-in-lieu thereof on loans, primarily those that we had previously
acquired at a discount.
Properties accounted as held and used. Properties accounted as held at
December 31, 2003 consisted of an office building and shopping mall, both
located in Florida. We acquired these properties as a result of our acquisition
of OAC in 1999. Both of these properties were sold in 2004 for a net gain of
$759.
Properties accounted as held for sale. Properties accounted as held for
sale at December 31, 2004 consisted primarily of one shopping center located in
Halifax, Nova Scotia with a net carrying value of $8,827. In February 2005, we
sold the subsidiary that held our investment in the shopping center. Properties
at December 31, 2003 consisted of our shopping center in Halifax and a hotel
located in Michigan.
45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The decline in our investment during 2004 was primarily due to the sale of our
hotel, which resulted in a gain of $351, and a $3,018 decline in the fair value
of the shopping center. Properties classified as held for sale are reported net
of reserves established to report the properties at the lower of carrying value
or fair value less costs to sell. Such reserves amounted to $3,155, $1,279 and
$4,591 at December 31, 2004, 2003 and 2002, respectively. See Note 7 for
additional information regarding these revenues.
Loans Accounted for as Investments in Real Estate. We acquired certain
acquisition, development and construction loans in January 2000 in which we
participated in the expected residual profits of the underlying real estate, and
where the borrower had not contributed substantial equity to the project. As
such, we accounted for these loans under the equity method of accounting as
though we had an investment in a real estate limited partnership. The one loan
remaining at December 31, 2002 was repaid during 2003.
Investment in Real Estate Partnerships. This balance represents
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, we forgave loans to the venture in exchange for an
increased investment in the partnership. During 2004, we also recorded an
impairment charge of $1,105 related to one of the partnership interests.
Loans, Net. Our net investment in loans of $3,792 at December 31, 2004
represents 0.3% of total assets and consisted of only 22 loans. Our loans have
been declining since 1998 as sales, resolutions and foreclosures more than
offset acquisitions and originations. This reflects our strategy to dispose of
assets associated with non-core business lines. Originations primarily represent
loans made to facilitate sales of commercial real estate assets that we owned
and fundings of pre-existing commitments on construction loans.
46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Composition of Loans. The following table sets forth the composition of
our loans by business segment at the dates indicated:
December 31,
----------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Residential Discount Loans (1):
Single family residential loans ................ $ -- $ -- $ 1,965 $ 57,954 $ 297,790
Unaccreted discount and deferred fees .......... -- -- (565) (16,804) (74,341)
Allowance for loan losses ...................... -- -- (154) (3,401) (3,493)
------------ ------------ ------------ ------------ ------------
-- -- 1,246 37,749 219,956
------------ ------------ ------------ ------------ ------------
Affordable Housing (2):
Multifamily residential loans .................. 7,466 10,924 10,803 19,714 32,330
Land and other ................................. 200 200 200 200 1
------------ ------------ ------------ ------------ ------------
7,666 11,124 11,003 19,914 32,331
Deferred fees .................................. -- -- -- -- (46)
Undisbursed loan funds ......................... -- -- (346) (1,430) (4,586)
Allowance for loan losses ...................... (4,468) (4,579) (4,428) (1,269) (139)
------------ ------------ ------------ ------------ ------------
3,198 6,545 6,229 17,215 27,560
------------ ------------ ------------ ------------ ------------
Commercial Assets:
Office buildings ............................... -- -- 41,215 56,713 98,425
Hotels ......................................... -- 10,600 11,668 38,576 102,120
Retail properties .............................. -- -- 27,500 47,492 85,924
Multifamily residential loans .................. -- 14,964 15,215 13,605 118,411
Land and other ................................. -- -- 1,188 607 36,608
------------ ------------ ------------ ------------ ------------
-- 25,564 96,786 156,993 441,488
Unaccreted discount and deferred fees .......... -- (1,015) (11,409) (19,962) (45,918)
Undisbursed loan funds ......................... -- -- -- (1,483) (4,293)
Allowance for loan losses ...................... (3,786) (16,179) (5,744) (10,877)
------------ ------------ ------------ ------------ ------------
-- 20,763 69,198 129,804 380,400
------------ ------------ ------------ ------------ ------------
Subprime Finance:
Single family residential loans ................ 94 -- 199 512 3,540
Unamortized (discount) premium ................. (20) -- (15) 13 (45)
------------ ------------ ------------ ------------ ------------
74 -- 184 525 3,495
------------ ------------ ------------ ------------ ------------
Ocwen Recovery Group:
Consumer ....................................... -- -- -- -- 17,188
Allowance for loan losses ...................... -- -- -- -- (8,770)
------------ ------------ ------------ ------------ ------------
-- -- -- -- 8,418
------------ ------------ ------------ ------------ ------------
Corporate Items and Other (1):
Single family residential loans ................ 1,125 1,307 -- -- 223
Unaccreted discount and deferred fees .......... (527) (412) -- -- --
Allowance for loan losses ...................... (78) (105) -- -- --
------------ ------------ ------------ ------------ ------------
520 790 -- -- 223
------------ ------------ ------------ ------------ ------------
Loans, net ....................................... $ 3,792 $ 28,098 $ 76,857 $ 185,293 $ 640,052
============ ============ ============ ============ ============
(1) Loans and all other assets of the Residential Discount Loans segment
were transferred to the Corporate Items and Other segment, effective
January 1, 2003. These loans were acquired by us at a discount and are
secured by mortgages on single family residential properties.
(2) Loans we made to affordable housing properties in which we have invested
as a limited partner but do not consolidate in our financial statements.
47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Activity in Loans. The following table sets forth the activity in our
net loans during the periods indicated:
Years Ended December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Amount
Balance at beginning of period .................... $ 28,098 $ 76,857 $ 185,293 $ 640,052 $ 1,115,850
Acquisitions (1) .................................. 372 420 1,018 -- 221,940
Originations (2) .................................. 16,106 6,277 18,478 18,144 39,792
Resolutions and repayments (3) .................... (38,747) (29,362) (50,965) (139,232) (312,856)
Loans transferred to real estate (4) .............. (6,841) (157) (16,000) (92,949) (201,010)
Sales ............................................. -- (49,110) (77,636) (343,262) (369,630)
Decrease (increase) in undisbursed loan proceeds .. -- 346 2,569 5,965 15,774
Decrease (increase) in discount ................... 880 10,537 24,447 83,710 125,406
Decrease (increase) in allowance .................. 3,924 12,290 (10,347) 12,865 4,786
------------ ------------ ------------ ------------ ------------
Balance at end of period .......................... $ 3,792 $ 28,098 $ 76,857 $ 185,293 $ 640.052
============ ============ ============ ============ ============
Years Ended December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Number of Loans
Balance at beginning of period .................... 22 38 931 4,282 8,765
Acquisitions (1) .................................. 11 8 17 -- 2,231
Originations (2) .................................. 1 1 3 4 4
Resolutions and repayments (3) .................... (11) (19) (77) (662) (1,572)
Loans transferred to real estate (4) .............. (1) (3) (21) (747) (2,455)
Sales ............................................. -- (3) (815) (1,946) (2,691)
------------ ------------ ------------ ------------ ------------
Balance at end of period (5) ...................... 22 22 38 931 4,282
============ ============ ============ ============ ============
(1) The decline in acquisitions reflect our strategic decision to exit
non-core businesses and dispose of the related assets. Acquisitions in
2002, 2003 and 2004 represent repurchases of single-family residential
discount loans previously sold. Acquisitions in 2000 included $164,920
(2,208 loans), of single-family residential discount loans.
(2) Originations represent loans made to facilitate sales of our own
commercial assets and fundings of construction loans we originated in
prior years.
(3) Resolutions and repayments consists of loans which we resolved and
discharged in a manner which resulted in partial or full repayment of
the loan to us, as well as principal payments on loans that have been
brought current in accordance with their original or modified terms
(whether pursuant to forbearance agreements or otherwise) or on other
loans which have not been resolved.
(4) During 2004, we forgave loans with an unpaid principal value of $6,811
to a real estate venture, in which we also had an equity ownership
interest, in exchange for an increased investment in the limited
partnership. Loans transferred to real estate in prior years represent
properties acquired through foreclosure or deed-in-lieu thereof. See
"Real Estate".
(5) Of the 22 loans remaining at December 31, 2004, one is a multi-family
loan in the Affordable Housing segment and the remainder are single
family loans in the Corporate Items and Other and Subprime Finance
segments.
48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following table sets forth certain information relating to our
non-performing loans and allowance for loan losses at the dates indicated:
December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Non-performing loans (1) (2) ..................... $ 7,827 $ 21,898 $ 75,549 $ 94,307 $ 297,547
Non-performing loans as a percentage of (1):
Total loans (2) ................................ 93.9% 59.9% 77.4% 48.2% 44.9%
Total assets ................................... 0.6% 1.8% 6.2% 5.5% 13.2%
Allowance for loan losses as a percentage of:
Total loans (2) ................................ 54.5% 23.2% 21.3% 5.3% 3.5%
Non-performing loans (1) ....................... 58.1% 38.7% 27.5% 11.0% 7.8%
(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) Loans are net of unaccreted discount, unamortized deferred fees and
undisbursed loan funds.
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
tables set forth (a) the breakdown of the allowance for loan losses on our loans
in each segment and (b) the percentage of loans in each segment to total loans
in the respective segments at the dates indicated:
December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Amount:
Residential Discount Loans ..................... $ -- $ -- $ 154 $ 3,401 $ 3,493
Commercial Asset (1) ........................... -- 3,786 16,179 5,744 10,877
Affordable Housing ............................. 4,468 4,579 4,428 1,269 139
Ocwen Recovery Group ........................... -- -- -- -- 8,770
Corporate Items and Other ...................... 78 105 -- -- --
------------ ------------ ------------ ------------ ------------
$ 4,546 $ 8,470 $ 20,761 $ 10,414 $ 23,279
============ ============ ============ ============ ============
(1) The decline in the allowance on Commercial Asset loans during 2004 and
2003 is primarily the result of sales and resolutions. As of December
31, 2004, all Commercial Asset loans had been sold or resolved. The
allowance as a percentage of loan value for this segment was 15.4% at
December 31, 2003 as compared to 19.0% at December 31, 2002 and 4.2% at
December 31, 2001. See "Results of Operations-Provisions for Loan
Losses" for additional information regarding our allowance as a
percentage of loans.
December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Percentage of Loans to Total Loans:
Residential Discount Loans ..................... --% --% 1.4% 21.0% 33.7%
Commercial Asset ............................... -- 67.1 87.5 69.3 59.0
Affordable Housing ............................. 91.9 30.4 10.9 9.4 4.2
Subprime Finance ............................... 0.9 -- 0.2 0.3 0.5
Ocwen Recovery Group ........................... -- -- -- -- 2.6
Corporate Items and Other ...................... 7.2 2.5 -- -- --
------------ ------------ ------------ ------------ ------------
100.0% 100.0% 100.0% 100.0% 100.0%
============ ============ ============ ============ ============
The allocation of the allowance to each segment is not necessarily
indicative of future losses and does not restrict our use of the allowance to
absorb losses in any other segment.
49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following table sets forth an analysis of activity in the allowance
for loan losses relating to our loans during the periods indicated:
December 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Balance at beginning of period ................... $ 8,470 $ 20,761 $ 10,414 $ 23,279 $ 26,440
Provision for loan losses ........................ (1,787) (2,633) 13,655 15,478 15,270
Charge-offs ...................................... (2,137) (9,658) (3,756) (28,827) (19,068)
Recoveries ....................................... -- -- 448 484 637
------------ ------------ ------------ ------------ ------------
Net charge-offs ................................ (2,137) (9,658) (3,308) (28,343) (18,431)
------------ ------------ ------------ ------------ ------------
Balance at end of period ......................... $ 4,546 $ 8,470 $ 20,761 $ 10,414 $ 23,279
============ ============ ============ ============ ============
Match Funded Assets. Our match funded assets were comprised of the
following at the dates indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Match funded advances on loans serviced for others:
Principal and interest ................................... $ 107,102 $ 54,516 $ 66,524
Taxes and insurance ...................................... 107,710 30,176 30,301
Other .................................................... 61,814 21,096 24,877
------------ ------------ ------------
276,626 105,788 121,702
------------ ------------ ------------
Single family residential loans ............................ -- 24,393 38,129
Commercial loans ........................................... 4,134 -- --
Allowance for loan losses .................................. -- (94) (144)
------------ ------------ ------------
Match funded loans, net .................................. 4,134 24,299 37,985
------------ ------------ ------------
Match funded securities .................................... -- -- 8,057
------------ ------------ ------------
$ 280,760 $ 130,087 $ 167,744
============ ============ ============
Match funded advances on loans serviced for others resulted from our
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
sales for accounting purposes since we retained effective control of the
advances. Accordingly, we report the amount of proceeds we received from the
sale as a secured borrowing with pledge of collateral (match funded
liabilities). The $170,838 increase in match funded advances during 2004 is
primarily the result of a servicing advance securitization that was executed in
November. See "Match Funded Liabilities" and Note 14 to our Consolidated
Financial Statements.
We acquired 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 reported the proceeds that we
received from the transfer as a liability (match funded liabilities). 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. During
the third quarter of 2004, we exercised our option to redeem the notes (match
funded liabilities) 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. Non-performing loans amounted to $2,321 and
$3,120 at December 31, 2003 and 2002, respectively.
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 (match funded liabilities).
Match funded securities resulted from our transfer of four unrated
residual securities to a trust on December 16, 1999 in exchange for non-recourse
notes. The transfer did not qualify as a sale for accounting purposes since we
retained effective control over the securities transferred. Accordingly, we
reported the amount of proceeds we received from the transfer as a secured
borrowing with pledge of collateral (match funded liabilities). In June 2003,
the Ocwen NIM Trust 1999 - OAC1 adopted a plan of complete liquidation, which
caused the early redemption of the related match funded liabilities. The match
funded securities, which had a fair value of $5,926 at the time of transfer,
were transferred to trading securities. See "Changes in Financial Condition -
Trading Securities" and "- Match Funded Liabilities".
50
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Advances on Loans and Loans Serviced for Others. Advances related to our
loan portfolios and loans we serviced for others consisted of the following at
the dates indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Loans serviced for others:
Principal and interest ................................... $ 51,782 $ 118,024 $ 63,326
Taxes and insurance ...................................... 94,926 145,507 117,937
Other .................................................... 93,375 110,802 84,455
------------ ------------ ------------
240,083 374,333 265,718
Loans ...................................................... 347 436 638
------------ ------------ ------------
$ 240,430 $ 374,769 $ 266,356
============ ============ ============
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 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.
Advances on loans serviced for others are net of reserves of $5,212, $4,002 and
$2,939 as of December 31, 2004, 2003 and 2002, respectively. The $5,212 of
reserves at December 31, 2004 includes $4,115 to provide for forbearance plan
fees and multiple breach fees that may no longer be collectible. See "Results of
Operations - Core Businesses - Residential Loan Servicing".
Advances on loans serviced for others do not include match funded
advances that were transferred to a third party in transactions that did not
qualify as sales for accounting purposes and that we account for as secured
borrowings. The $134,250 decline in advances on loans serviced for others during
2004 is in large part due to a securitization transaction that we executed in
November. See "Match Funded Assets" for information regarding these advances.
Mortgage Servicing Rights. The unamortized balance of mortgage servicing
rights is primarily related to residential assets. Our investment has declined
during 2004 and 2003 as amortization exceeded purchases. The rate of
amortization reflects increased actual and projected prepayments on subprime
residential mortgage loans due to lower interest rates. The decline in
acquisitions 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 or below certain levels. See Note 22 to the
Consolidated Financial Statements and "General - Banking Operations" for
additional information regarding these commitments. See also "Results of
Operations - Non-Interest Revenue - Servicing and Other Fees" and "- Segment
Results - Core Businesses - Residential Loan Servicing".
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Balance at beginning of period ............................. $ 166,495 $ 171,611 $ 101,107
Purchases .................................................. 60,950 88,829 128,891
Amortization ............................................... (96,036) (93,558) (58,153)
Impairment ................................................. -- (387) --
Sales ...................................................... -- -- (234)
------------ ------------ ------------
Balance at end of period ................................... $ 131,409 $ 166,495 $ 171,611
============ ============ ============
At December 31, 2004, we serviced loans under approximately 345
servicing agreements for 22 clients. Purchases during 2004 were all for
residential assets.
51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Receivables. Receivables consisted of the following at the dates
indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Residential Loan Servicing (1) ............................. $ 23,241 $ 18,564 $ 10,982
OTX ........................................................ 2,360 1,442 1,193
Ocwen Realty Advisors ...................................... 2,011 962 532
Ocwen Recovery Group ....................................... 341 260 296
Business Process Outsourcing ............................... 1,532 969 --
Commercial Servicing ....................................... 2,530 1,324 680
Residential Discount Loans ................................. -- -- 1,286
Commercial Assets .......................................... 192 2,848 2,515
Affordable Housing (2) ..................................... 18,308 25,581 40,327
Corporate Items and Other (3) .............................. 76,204 22,365 21,089
------------ ------------ ------------
$ 126,719 $ 74,315 $ 78,900
============ ============ ============
(1) Consist principally of fees earned and reimbursable expenses due from
investors. Receivables representing fees earned totaled $4,069 and
$2,769 at December 31, 2004 and 2003, respectively.
Primarily represents payments to be received in future years from the
sale of investments in affordable housing properties, net of unaccreted
discount of $2,346, $2,901 and $3,400 at December 31, 2004, 2003 and
2002, respectively. Balances are also net of reserves for doubtful
accounts of $5,596, $4,232 and $1,340 at December 31, 2004, 2003 and
2002, respectively. The decline in the balance during 2004 is primarily
due to scheduled installment payments received, offset by an additional
installment note receivable of $2,945 resulting from the sale of three
properties during the fourth quarter. See "Results of Operations -
Segment Results - Affordable Housing".
(3) Includes $61,591, $21,465 and $20,841 of income taxes receivable at
December 31, 2004, 2003 and 2002, respectively. As of December 31, 2004,
income taxes receivable includes $56,526 of federal tax refund claims,
the payment of which is subject to final approval by the Joint Committee
on Taxation of the U.S. Congress. We have agreed with the IRS to extend
the statute of limitations with respect to these claims until December
31, 2005, and we currently expect that this approval will be issued
prior to that date. The receivable balance at December 31, 2004 also
included $6,872 of accrued interest on the federal tax refund claims.
Other Assets. Other assets consisted of the following at the dates
indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Deferred tax assets, net (1) ............................... $ 17,683 $ 7,547 $ 8,387
Deferred debt related costs, net (2) ....................... 11,216 3,113 2,946
Interest earning insurance collateral deposits (3) ......... 8,905 8,813 --
Loans held for resale (4) .................................. 8,437 -- --
Interest earning reserve accounts (5) ...................... 5,850 4,279 4,254
Goodwill, net (6) .......................................... 5,312 1,618 1,618
Prepaid expenses ........................................... 4,069 3,750 3,740
Stocks and mutual funds (7) ................................ 2,886 14 1,108
Capitalized software development costs, net ................ 1,147 2,598 4,010
Other ...................................................... 3,472 1,876 3,265
------------ ------------ ------------
$ 68,977 $ 33,608 $ 29,328
============ ============ ============
(1) Deferred tax assets are net of valuation allowances of $165,927,
$201,445 and $199,270 at December 31, 2004, 2003 and 2002, respectively.
See "Results of Operations - Income Tax Expense (Benefit)".
(2) The $8,103 increase in net deferred debt-related costs during 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 $6,107 at
December 31, 2004. See "Debt Securities" for additional information
regarding the Convertible Notes.
52
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
(3) 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.
(4) 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. These loans were
sold during January 2005.
(5) Represents amounts set aside from the proceeds of our match funded
advance facilities to provide for possible shortfalls in the funds
available to pay certain expenses and interest.
(6) 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 $3,694. For additional information regarding this
acquisition, see Note 3 to our Consolidated Financial Statements.
(7) The $2,872 increase in the balance during 2004 primarily represents an
investment by the Bank in a mutual fund that invests in assets that meet
the requirements of the Community Reinvestment Act.
Deposits. Our customer deposits decreased during 2004 primarily as a
result of maturing brokered certificates of deposits. This decline reflects our
reduced reliance on deposits as a source of financing our operations. See
"General - Banking Operations".
The following table sets forth information related to our deposits at
the dates indicated:
December 31,
--------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
Weighted % of Weighted % of
Average Total Average Total
Amount Rate Deposits Amount Rate Deposits
---------- -------- -------- ---------- -------- --------
Non interest-bearing checking
accounts ....................... $ 4,513 --% 1.5% $ 4,879 --% 1.1%
NOW and money market
checking accounts .............. 12,541 .75% 4.1% 18,313 0.90% 4.1%
Savings accounts ................ 6,574 .75% 2.2% 1,657 1.00% 0.4%
---------- -------- ---------- --------
23,628 7.8% 24,849 5.6%
---------- ----------
Certificates of deposit (1) (2).. 277,671 421,657
Unamortized deferred fees ....... -- (118)
---------- ----------
Total certificates of deposit ... 277,671 3.12% 92.2% 421,539 3.41% 94.4%
---------- -------- ---------- --------
$ 301,299 100.0% $ 446,388 100.0%
========== ======== ========== ========
December 31,
--------------------------------
2002
--------------------------------
Weighted % of
Average Total
Amount Rate Deposits
---------- -------- --------
Non interest-bearing checking
accounts ....................... $ 4,378 --% 1.0%
NOW and money market
checking accounts .............. 17,720 1.20% 4.2%
Savings accounts ................ 1,592 1.00% 0.4%
---------- --------
23,690 5.6%
----------
Certificates of deposit (1) (2).. 402,917
Unamortized deferred fees ....... (637)
----------
Total certificates of deposit ... 402,280 4.89% 94.4%
---------- --------
$ 425,970 100.0%
========== ========
(1) Included $26,418, $84,426 and $198,248 at December 31, 2004, 2003 and
2002 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. During the second
quarter of 2003, we exercised our right to call brokered certificates of
deposit with a face value of $18,194 that carried an interest rate of
6%.
(2) At December 31, 2004, 2003 and 2002, certificates of deposit with
outstanding balances of $100 or more amounted to $75,899, $137,746 and
$125,451, respectively. Of the $75,899 of such deposits at December 31,
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 for our time
deposits with balances of $100 or more at December 31, 2004:
Matures within three months.................................. $ 33,258
Matures after three months through six months................ 5,032
Matures after six months through twelve months............... 21,287
Matures after twelve months.................................. 16,322
--------------
$ 75,899
==============
53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Escrow Deposits. Escrow deposits amounted to $125,977, $116,444 and
$84,986 at December 31, 2004, 2003 and 2002, 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 $105,924, $96,924 and $72,254 at December 31, 2004, 2003 and 2002,
respectively. See "Results of Operations - Non-Interest Revenue - Servicing and
Other Fees."
Match Funded Liabilities. Match funded liabilities represent proceeds
received from transfers of loans, residual securities and advances on our 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 borrowings with pledges of collateral.
Our match funded liabilities were comprised of the following at the dates
indicated:
December 31,
------------------------------------
Collateral Interest rate 2004 2003 2002
- ----------------------------------------- ----------------------------- ---------- ---------- ----------
Advances on loans serviced for others (1) LIBOR plus 175 basis points $ 90,851 $ 94,967 $ 106,797
Advances on loans serviced for others (2) See (2) 149,342 -- --
Single family loans (3) LIBOR plus 65-70 basis points -- 20,427 32,217
Commercial loans (4) 4,134 -- --
Unrated residual securities (5) 9.50% -- -- 8,057
---------- ---------- ----------
$ 244,327 $ 115,394 $ 147,071
========== ========== ==========
(1) Under the terms of the agreement, we are eligible to finance additional
advances on loans serviced for others up to a maximum balance of
$200,000. This facility will mature January 2006.
(2) In November 2004, we executed a servicing advance securitization. This
transaction involved the issuance of a term note for $100,000 and a
one-year variable funding note for a maximum of $75,000. The term note
bears interest at LIBOR plus 50 basis points. The variable funding note
bears interest at a commercial paper rate plus a margin that
approximates LIBOR plus 53 basis points. Under the terms of the
agreement, as of December 31, 2004, we are eligible to finance
additional advances on loans serviced for others of $25,658. The term
note under this facility has a stated maturity of October 2013. The
variable funding note has a stated maturity of November 2010.
(3) During the third quarter of 2004, we exercised our option to redeem the
bonds that were secured by single family loans. See "Match Funded
Assets".
(4) Represents a 100% participation interest held by a third party.
(5) During the second quarter of 2003, the Ocwen NIM Trust 1999 - OAC1
adopted a plan of complete liquidation and, thereby, caused the early
redemption of the match funded liabilities that were secured by residual
securities. See "Match Funded Assets."
See "Match Funded Assets" and "Liquidity, Commitments and Off-Balance
Sheet Risks - Liquidity".
Debt Securities. Debt securities consisted of the following at the dates
indicated:
December 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
11.875% Notes due October 1, 2003 (1) ...................... $ -- $ -- $ 43,475
12% Subordinated Debentures due June 15, 2005 (2) .......... -- -- 33,500
3.25% Contingent Convertible Senior Unsecured
Notes due August 1, 2024 (3) ............................. 175,000 -- --
10.875% Capital Securities due August 1, 2027 (4) .......... 56,249 56,249 --
------------ ------------ ------------
$ 231,249 $ 56,249 $ 76,975
============ ============ ============
(1) The remaining $43,475 balance of these notes matured on October 1, 2003.
On November 26, 2002 we had exercised our redemption option and called
$40,000 of these notes at a price of 102.969%. Earlier during 2002, we
had repurchased $3,550 of these notes in the open market.
(2) On September 30, 2003 we exercised our redemption option and called the
remaining balance of $33,065 at a price of 101.333%, or a premium of
$441. Also, during the second quarter of 2003 we repurchased $435 in the
open market resulting in a loss of $4. On November 26, 2002 we had
exercised our redemption option and called $33,500 of these debentures
at a price of 102.667%.
(3) 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 as permitted by 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
54
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
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 16 to our Consolidated Financial Statements for
additional details regarding the Convertible Notes.
(4) Capital Securities were reclassified to notes and debentures effective
July 1, 2003 with our adoption of SFAS No. 150. See Note 1 to our
Consolidated Financial Statements.
For additional information regarding our debt securities, see "Results
of Operations - Gain (Loss) on Repurchase of Debt" and Note 16 to our
Consolidated Financial Statements.
Lines of Credit and Other Secured Borrowings. We have obtained secured
line of credit arrangements from unaffiliated financial institutions as follows
at the dates indicated:
December 31,
------------------------
Borrowing Type Collateral Maturity Interest Rate (1) 2004 2003
- --------------------- ------------------------------ ------------- -------------------------- ---------- ----------
Line of credit Advances on loans serviced for March 2004 LIBOR + 200 basis points $ -- $ 68,548
others (2)
Line of credit Advances on loans serviced for October 2004 LIBOR + 200 basis points -- 9,386
others (2)
Senior secured credit Purchased mortgage servicing April 2005 LIBOR + 162.5 or 225 basis 24,218 35,321
agreement rights and advances on loans points
serviced for others (3)
Senior secured credit Purchased mortgage servicing December 2005 LIBOR + 250 basis points 11,458 --
agreement rights
Installment notes Purchased mortgage servicing July 2004 2.81% -- 2,332
rights
Mortgage note Real estate - office building May 2005 LIBOR + 350 basis points, -- 20,000
building (4) floor of 5.75%
Mortgage note Office building (5) October 2014 5.62% 14,936 --
Secured loan Trading securities - UK November 2004 LIBOR + 275 basis points -- 11,562
unrated subprime residuals
Term loan Loan receivable March 2005 LIBOR + 250 basis points -- 3,235
---------- ----------
$ 50,612 $ 150,384
========== ==========
(1) 1-month LIBOR was 2.40% and 1.12% at December 31, 2004 and December 31,
2003, respectively.
(2) This line was fully repaid subsequent to December 31, 2003 and was not
renewed.
(3) Maximum amount of borrowing under this facility is $70,000. We are
currently in negotiations with the lender to possibly extend the
maturity date and increase the maximum amount of borrowing.
(4) We sold our office building located in Jacksonville, Florida in January
2004 and the buyer assumed this note at that time. See "Changes in
Financial Condition - Real Estate".
(5) Collateral represents our loan servicing call center located in Orlando,
Florida. We entered into this mortgage in October 2004.
See "Liquidity, Commitments and Off-Balance Sheet Risks - Liquidity" for
additional information regarding sources of funding.
Company Obligated, Mandatorily Redeemable Securities of Subsidiary Trust
Holding Solely Junior Subordinated Debentures of the Company ("Capital
Securities"). As indicated in "Debt Securities" above, the outstanding balance
of the 10.875% Capital Securities due August 1, 2027 of $56,249 has been
classified as a liability effective July 1, 2003 upon our adoption of SFAS No.
150. See Notes 1 and 16 to the Consolidated Financial Statements. The
outstanding balance of the 10.875% Capital Securities amounted to $56,249 at
December 31, 2003 and 2002. During 2002 we repurchased $4,910 of the Capital
Securities in the open market. See "Results of Operations -Gain (Loss) on
Repurchase of Debt".
55
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Minority Interest in Subsidiaries. Minority interest of $1,530, $1,286
and $1,778 at December 31, 2004, 2003 and 2002, respectively, represents the
investment by others in Global Servicing Solutions, LLC, which we formed during
the third quarter of 2002 to establish, license and operate distressed asset
management servicing companies in various countries around the world. See the
Principles of Consolidation section of Note 1 to our Consolidated Financial
Statements.
Stockholders' Equity. Stockholders' equity amounted to $330,108 at
December 31, 2004 as compared to $317,258 at December 31, 2003 and $310,718 at
December 31, 2002. The $12,851 increase in stockholders' equity during 2004 was
primarily due to net income of $57,724, the issuance of 543,260 shares of common
stock as a result of stock option exercises and the issuance of 203,088 shares
of restricted stock to employees as part of our annual incentive awards, offset
in large part by our repurchase of 5,481,100 shares of common stock. See
Consolidated Statements of Changes in Stockholders' Equity, which provides the
details of changes in stockholders' equity for the past three years, and Notes 1
and 21 to our Consolidated Financial Statements.
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 falling 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 December 31,
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:
. Adjustable-rate loans, performing discount loans and 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 securities reflect prepayments that were
estimated based on analyses of broker estimates, the results of a
prepayment model we use and empirical data,
. Non-performing discount loans reflect the estimated timing of
resolutions that result in repayment to us,
. 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 $130,491 at December 31, 2004, are excluded.
We believe that these assumptions approximate actual experience and
consider them reasonable; however, the interest rate sensitivity of our assets
and liabilities in the table could vary substantially if we were to use
different assumptions or actual experience differs from the historical
experience on which we based the assumptions.
56
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
December 31, 2004
------------------------------------------------------------------------
Four to More Than
Within Three Twelve One Year to Three Years
Months Months Three Years and Over Total
------------ ------------ ------------ ------------ ------------
Rate-Sensitive Assets:
Interest-earning deposits ...................... $ 116,206 $ -- $ -- $ -- $ 116,206
Trading securities ............................. 24,303 47,222 39,542 14,675 125,742
Investment securities, net ..................... 5,859 2,877 -- -- 8,736
Loans, net (1) ................................. 234 529 1,187 1,842 3,792
Match funded loans (1) ......................... 4,134 -- -- -- 4,134
------------ ------------ ------------ ------------ ------------
Total rate-sensitive assets .................. 150,736 50,628 40,729 16,517 258,610
------------ ------------ ------------ ------------ ------------
Rate-Sensitive Liabilities:
NOW and money market checking deposits ......... 10,418 244 521 1,358 12,541
Savings deposits ............................... 4,891 259 513 911 6,574
Certificates of deposit ........................ 109,971 91,884 68,706 7,110 277,671
------------ ------------ ------------ ------------ ------------
Total interest-bearing deposits ................ 125,280 92,387 69,740 9,379 296,786
Match funded liabilities ....................... 244,327 -- -- -- 244,327
Lines of credit and other secured borrowings ... 24,218 11,458 -- 14,936 50,612
Debt securities ................................ -- -- -- 231,249 231,249
------------ ------------ ------------ ------------ ------------
Total rate-sensitive liabilities ............. 393,825 103,845 69,740 255,564 822,974
------------ ------------ ------------ ------------ ------------
Interest rate sensitivity gap (2) ................ $ (243,089) $ (53,217) $ (29,011) $ (239,047) $ (564,364)
============ ============ ============ ============ ============
Cumulative interest rate sensitivity gap ......... $ (243,089) $ (296,306) $ (325,317) $ (564,364)
============ ============ ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets ....... (94.00)% (114.58)% (125.79)% (218.23)%
AS OF DECEMBER 31, 2003
Cumulative interest rate sensitivity gap ......... $ (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) We have not reduced balances for non-performing loans.
(2) We had no rate-sensitive financial instruments outstanding at December
31, 2004.
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. At December 31, 2004, we had
servicing advances of $517,056 consisting of advances on loans and loans
serviced for others of $240,430 and match funded advances on loans serviced for
others of $276,626. Servicing advances do not bear interest but are generally
funded with interest bearing liabilities. As a result, these instruments result
in a negative interest rate sensitivity gap. In addition, we earn interest on
float balances. We earn a short term, 30 days or less, rate of interest on float
balances. These float balances, which are not included in our financial
statements, amounted to $867,884, $1,429,986 and $581,507 at December 31, 2004,
2003 and 2002, respectively. When the float balances are considered by adding
them to the within three months rate-sensitive assets, the interest rate
sensitivity gap shifts from negative to positive.
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"). We
use NPV to measure our exposure to interest rate risk. NPV is calculated as the
net present value of expected cash flows from an institution's existing assets,
less the net present value of the expected cash flows from existing liabilities,
plus the net present value of expected cash inflows from existing financial
derivatives and off-balance sheet contracts. Cash flows for each asset and
liability are based on the contractual rates and terms at the individual asset
and liability level. These cash flows are discounted to the present period using
a discount rate that is relevant to the particular asset or liability, to arrive
at the base case scenario. Deposits instruments are discounted using their
annual percentage rate paid to the depositor, loans at their contractual
interest rate. Residual and subordinate securities are discounted at rates
ranging from 18% to 21% depending on the composition of their underlying
collateral and its performance.
The NPV model does not value new business activity or other projected or
possible changes in the company's balance sheet. Rather, it takes a snapshot
view of the portfolio at each quarter-end and estimates its economic value at
that time, and the value of the portfolio under the different interest rate
scenarios. The model estimates the current, or base case, economic value of each
type of asset, liability and off-balance sheet contract at the end of each
quarter.
NPV is useful in assessing interest rate risk in that it measures how
changes in interest rates might affect the economic value of a portfolio of
assets, liabilities and off balance sheet contracts. By recalculating NPV under
various interest rate scenarios we can see the consequences of our business
strategy under several possible alternative courses of interest rates, and
evaluate the extent to which we may want to alter our interest rate exposure
through hedging or other techniques.
The board-approved limits specify the minimum net portfolio value ratio
("NPV Ratio") allowable under current interest rates and hypothetical interest
rate scenarios. An institution's NPV 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 structure 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 NPV Ratio may be interpreted as an indicator of capital strength in
each scenario: the higher the NPV Ratio, the greater is the institution's
ability to weather negative events. The change in an institution's NPV Ratio
across the various scenarios gives an indication of the institutions capacity to
withstand interest rate stress. 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
December 31, 2004:
57
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Board Limits Current
Rate Shock in basis points (minimum NPV Ratios) NPV Ratios
- -------------------------- -------------------- ----------
+300 5.00% 30.60%
+200 6.00% 29.33%
+100 7.00% 27.93%
0 8.00% 25.84%
-100 7.00% 22.97%
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. We
calculate the cash flows associated with the loan portfolios and securities
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 December 31, 2004. The base case net interest expense
is a projection of interest for the following 12 months based on the net
interest income expense in our consolidated statement of operations for the last
month of the year. A weighted average rate of interest is calculated based on
the interest rate sensitivity gap of our rate sensitive assets and liabilities
that are scheduled to mature over the first twelve months following the end of
the year. The weighted average interest rate is then applied against the
interest rate sensitivity gap for this twelve month period to determine the base
case net interest expense.
An interest rate sensitivity gap is calculated for each interest rate
scenario, and a hypothetical net interest expense is calculated based upon the
weighted average interest rate. The result is then compared to the base case net
interest expense to determine the percentage increase or decrease in net
interest expense that each scenario produces relative to the base case. The
following table quantifies the potential changes in net interest expense and NPV
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. Actual results of Ocwen Financial Corporation and its subsidiaries
could differ significantly from the results estimated in this table:
Estimated Changes in
-----------------------------------
Rate Shock in basis points Net Interest Expense (1) NPV
- -------------------------- ------------------------ ----------
+300 1890.24% 22.51%
+200 1260.16% 16.17%
+100 630.08% 9.36%
0 0.00% 0.00%
-100 (630.08)% (12.77)%
(1) The base case interest was based on net interest income of only $73 for
the month of December 2004. Therefore, the estimated changes in net
interest expense expressed as a percent are significant.
58
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The following table shows our financial instruments that are sensitive
to changes in interest rates, categorized by expected maturity or repricing
characteristics, and the fair values of those instruments at December 31, 2004:
Expected Maturity Date at December 31, 2004 (1)
----------------------------------------------------------------------------------
Total Fair
2005 2006 2007 2008 2009 Thereafter Balance Value
--------- --------- --------- --------- --------- ---------- --------- ---------
Rate-Sensitive Assets:
Interest-earning deposits ...... $ 116,206 $ -- $ -- $ -- $ -- $ -- $ 116,206 $ 116,206
Average interest rate ........ 0.75% 0.00% 0.00% 0.00% 0.00% 0.00% 0.75%
Trading securities ............. 71,525 31,319 8,223 4,679 2,288 7,708 125,742 125,742
Average interest rate ........ 4.77% 6.51% 14.65% 16.09% 19.92% 22.46% 7.63%
Investment securities, net ..... 8,736 -- -- -- -- -- 8,736 8,736
Average interest rate ........ 3.64% 0.00% 0.00% 0.00% 0.00% 0.00% 3.64%
Loans, net (2) ................. 763 728 459 339 292 1,211 3,792 3,870
Average interest rate ........ 5.00% 3.00% 4.00% 5.00% 5.00% 5.00% 5.00%
Match funded loans (2) ......... 4,134 -- -- -- -- -- 4,134 4,134
Average interest rate ........ 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
--------- --------- --------- --------- --------- ---------- --------- ---------
Total rate-sensitive assets $ 201,364 $ 32,047 $ 8,682 $ 5,018 $ 2,580 $ 8,919 $ 258,610 $ 258,688
========= ========= ========= ========= ========= ========== ========= =========
Rate-Sensitive Liabilities:
NOW and money market deposits .. $ 10,662 $ 282 $ 240 $ 203 $ 173 $ 981 $ 12,541 $ 12,184
Average interest rate ........ 0.66% 0.25% 0.25% 0.25% 0.25% 0.25% 0.60%
Savings deposits ............... 5,150 285 228 182 146 583 6,574 6,487
Average interest rate ........ 1.07% 0.75% 0.75% 0.75% 0.75% 0.75% 1.00%
Certificates of deposit ........ 201,855 46,697 22,008 4,713 130 2,268 277,671 280,659
Average interest rate ........ 1.20% 0.88% 0.65% 0.17% 0.11% 13.00% 1.18%
--------- --------- --------- --------- --------- ---------- --------- ---------
Total interest-bearing
deposits .................. 217,667 47,264 22,476 5,098 449 3,832 296,786 299,330
Match funded liabilities ....... 244,327 -- -- -- -- -- 244,327 244,327
Average interest rate ........ 3.32% 0.00% 0.00% 0.00% 0.00% 0.00% 3.32%
Lines of credit and other
secured borrowings ............ 35,676 -- -- -- -- 14,936 50,612 50,612
Average interest rate ........ 4.52% 0.00% 0.00% 0.00% 0.00% 5.62% 4.84%
Debt securities ................ -- -- -- -- 175,000 56,249 231,249 228,003
Average interest rate ........ 0.00% 0.00% 0.00% 0.00% 3.00% 10.88% 4.92%
--------- --------- --------- --------- --------- ---------- --------- ---------
Total rate-sensitive
liabilities ............... $ 497,670 $ 47,264 $ 22,476 $ 5,098 $ 175,449 $ 75,017 $ 822,974 $ 822,272
========= ========= ========= ========= ========= ========== ========= =========
(1) Expected maturities are contractual maturities adjusted for prepayments
of principal. We use certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon
contractual maturity, projected repayments and prepayments of principal.
We base the prepayment experience reflected herein on our historical
experience. The actual maturities of these instruments could vary
substantially if future prepayments differ from our historical
experience.
(2) We have not reduced balances for non-performing loans.
59
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
The expected maturity or repricing dates of interest rate-sensitive
assets and liabilities as of December 31, 2004, 2003 and 2002 compare as
follows:
1st Year 2nd Year 3rd Year 4th Year 5th Year Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets:
2004
Amount .......................... $ 201,364 $ 32,047 $ 8,682 $ 5,018 $ 2,580 $ 8,919 $ 258,610
Percent of total ................ 77.86% 12.39% 3.36% 1.94% 1.00% 3.45% 100.00%
2003
Amount .......................... $ 50,705 $ 21,938 $ 8,858 $ 5,836 $ 3,744 $ 15,453 $ 106,534
Percent of total ................ 47.59% 20.59% 8.31% 5.48% 3.51% 14.52% 100.00%
2002
Amount .......................... $ 216,990 $ 47,774 $ 9,460 $ 6,198 $ 4,494 $ 17,888 $ 302,804
Percent of total ................ 71.66% 15.78% 3.12% 2.05% 1.48% 5.91% 100.00%
Total rate-sensitive liabilities:
2004
Amount .......................... $ 497,670 $ 47,264 $ 22,476 $ 5,098 $ 175,449 $ 75,017 $ 822,974
Percent of total ................ 60.47% 5.74% 2.73% 0.62% 21.32% 9.12% 100.00%
2003
Amount .......................... $ 556,550 $ 112,780 $ 27,283 $ 7,425 $ 2,326 $ 57,172 $ 763,536
Percent of total ................ 72.89% 14.77% 3.57% 0.97% 0.30% 7.50% 100.00%
2002
Amount .......................... $ 558,547 $ 79,554 $ 62,929 $ 1,852 $ 4,213 $ 21,295 $ 728,384
Percent of total ................ 79.69% 10.92% 8.64% 0.25% 0.58% 2.92% 100.00%
The Committee is authorized to utilize a wide variety of off-balance
sheet financial techniques to assist it in the management of interest rate risk
and foreign currency exchange rate risk. These techniques include interest rate
exchange contracts or "swap" agreements, interest rate caps and floors, U.S.
Treasury interest rate futures contracts, foreign currency futures contracts,
foreign currency forwards and European swaptions and put options.
Interest Rate Risk Management. In general, we manage our interest rate
risk by monitoring the extent of our exposure to changes in interest rates as a
whole and in relation to specific transactions. As a whole, we consider the
extent to which we have an overall positive or negative interest rate gap,
including balances in the float accounts. We may manage our overall interest
rate exposure by entering into derivative contracts. For example, during 2003,
we entered into interest rate swaps to receive a two-year fixed interest rate
and pay a short-term interest rate that reduced the size of the positive 3-month
gap and reduced the size of the negative 1-3 year gap. These swaps, which were
not accounted for as hedging transactions, were subsequently closed out prior to
December 31, 2003 at a gain of $1,076.
In addition, during most of 2003 we held interest rate cap and interest
rate floor contracts that were closed out in October 2003. The cap and floor
transactions had been executed in prior years in connection with two specific
financing transactions. The purpose of the derivative instruments was to
economically hedge interest rate exposure. In one case we purchased interest
rate caps to hedge our exposure to increasing interest rates arising from our
issuance of floating rates notes. In the second case we purchased interest rate
floors to hedge our exposure to declining interest rates arising from our
issuance of fixed rate notes. See the "Derivative Financial Instruments" section
of Note 1 and the "Interest Rate Risk Management" section of Note 18 to our
Consolidated Financial Statements.
Foreign Currency Exchange Rate Risk Management. We have entered into
foreign currency futures to hedge our net investments in foreign subsidiaries
that own residual securities backed by subprime residential loans originated in
the UK and the shopping center located in Halifax, Nova Scotia. Our principal
exposure to foreign currency exchange rates exists 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 the "Derivatives Financial Instruments" section of
Note 1 and the "Foreign Currency Exchange Rate Risk Management" section of Note
18 to our Consolidated Financial Statements.
60
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
LIQUIDITY, COMMITMENTS AND OFF-BALANCE SHEET RISKS
Liquidity. Our primary sources of funds for liquidity are:
. Lines of credit and other secured borrowings
. Match funded debt
. Debt securities
. Deposits
. Servicing fees
. Payments received on loans and securities
. Proceeds from sales of assets
We closely monitor our liquidity position and ongoing funding
requirements. At December 31, 2004, we had $274,111 of unrestricted cash and
cash equivalents and $61,095 of short-term investment grade securities. Among
the risks and challenges associated with our funding activities are the
following:
. Scheduled maturities of all certificates of deposit for 2005, 2006 and
thereafter amount to $201,934, $47,006 and $28,731, respectively.
However, as noted in "Banking Operations" debanking, if successful, will
require that we make a cash payment to the purchaser of our branch that
will be based in part on the amount of deposits assumed.
. Cash requirements to fund our acquisition of additional servicing rights
and related advances.
. The maturity of existing collateralized lines of credit and other
secured borrowings totaling $35,676 at various times in 2005.
. Ongoing cash requirements to fund operations of our holding company.
. Potential extension of resolution and sale timelines for non-core
assets.
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 are successful in our de-banking efforts and cease to control a
federal savings bank, we would no longer be able to rely on deposits obtained in
the United States through the Bank as a source of funding.
Alternative sources of corporate funding that have been secured recently
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. See
"Debt Securities" for additional information regarding the Convertible
Notes.
. 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%. The balance
outstanding at December 31, 2004 was $14,936.
In the last several years, our Residential Loan Servicing business has
grown 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 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 match funded agreements, 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 is 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 at any one time. At December 31,
2004, we had $90,851 of match funded liabilities 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.
61
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
. In April 2003, we also entered into a $60,000 secured in 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 December 31, 2004, we had a balance outstanding under this agreement
of $24,218.
. 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 and the
balance outstanding as of December 31, 2004 was $11,458.
. On November 17, 2004, we entered into a match funded agreement under
which we transferred certain of our advances on loans serviced for
others. As of December 31, 2004, proceeds received in connection with
this transfer of advances were $149,342. As of December 31, 2004, there
was $25,658 of capacity available under this facility. The transfers of
advances under this agreement do not qualify as sales for accounting
purposes because we retain effective control of the advances.
Accordingly, we report the advances transferred as match funded assets
and the amount of proceeds we receive from the transfers as a secured
borrowing with pledge of collateral. The $100,000 term note under this
facility has a stated maturity of October 2013. The variable funding
note has a stated maturity of November 2010.
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
debt securities, lines of credit from unaffiliated parties, match funded debt
and other secured borrowings.
Our operating activities provided (used) $(23,287), $47,358 and $249,166
of cash flows during 2004, 2003 and 2002, respectively. The decline in operating
cash flows in 2004 as compared to 2003 is in large part due to purchases of
investment grade securities (primarily CMOs) during 2004 to meet the Bank's QTL
requirements. During 2002 cash was generated from operating activities, despite
the net loss recorded, for two reasons. First, the net losses included a
significant amount of non-cash reserves and impairment charges. Second, our
securities portfolio generated positive cash flow through sales and interest and
principal payments.
Our investing activities provided (used) cash flows totaling $39,625,
$(19,164) and $75,940 during 2004, 2003 and 2002, respectively. During the
foregoing years, cash flows from our investing activities were provided
primarily from principal payments on our loans, and 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 made to facilitate sales of
real estate. The increase in net cash provided by investing activities in 2004
as compared to 2003 is primarily due to an increase in proceeds from sales of
real estate and a decline in purchases of mortgage servicing rights.
Our financing activities provided (used) cash flows of $41,583, $9,489
and $(393,514) during 2004, 2003 and 2002, respectively. New sources of
financing in 2004, including the match funded agreements and our issuance of
$175,000 of 3.25% Convertible Notes, more than offset the run-off of deposits,
declines in secured borrowings and repurchases of common stock. Cash flows from
financing activities in 2003 reflected our efforts at that time to pay off our
high-yield debt and replace it with less expensive sources of financing
including secured credit facilities and non-brokered deposits. Financing cash
flows in 2002 were primarily used to repay maturing brokered certificates of
deposit, repurchase high-yield debt and repay securities sold under agreements
to repurchase.
Negative rating actions may adversely impact our business and financing
activities. The following is a summary of recent rating actions by rating
agencies:
. The U.S. Department of Housing and Urban Development, Freddie Mac and
Fannie Mae have approved the Bank as a loan servicer. Standard & Poor's
has rated the Bank as "Strong" as a Residential Subprime Servicer and
Residential Special Servicer. "Strong" represents Standard & Poor's
highest ratings category. On April 23, 2004, Standard & Poor's placed
these ratings on watch with negative implications.
. Moody's has rated the Bank as "SQ2" as a Residential Subprime Servicer
and as a Residential Special Servicer. "SQ2" represents Moody's above
average rating category.
. Fitch has rated us "RPS2" for Residential Subprime Servicing and "RSS2"
for Residential Special Servicing. These represent Fitch's second
highest categories, respectively. On March 1, 2004, Fitch placed our
"RPS2" rating for Residential Subprime Servicing and our "RSS2" rating
for Residential Special Servicing on negative watch. On December 29,
2004, Fitch removed our Residential Subprime Servicing and Residential
Special Servicing ratings from negative watch.
These rating actions have not had a material impact on our business or
financing activities. Certain of our servicing agreements require minimum
servicer ratings; we remain well in excess of those requirements.
62
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -
(Dollars in thousands, except share data)
Commitments. The following table sets forth certain information
regarding amounts we owe to others under contractual obligations as of December
31, 2004 based on maturities and payment due dates:
After One Year After Three
Less Than Through Three Years Through After Five
Contractual Obligations One Year Years Five Years Years Total
- ------------------------------------------- ------------ -------------- ------------- ------------ ------------
Convertible Notes.......................... $ -- $ -- $ -- $ 175,000 $ 175,000
Capital Trust Securities................... -- -- -- 56,249 56,249
Operating leases........................... 3,631 4,669 2,071 1,708 12,079
Certificates of deposit.................... 201,934 68,376 7,361 -- 277,671
Lines of credit and other secured
borrowings................................. 35,676 -- -- 14,936 50,612
------------ -------------- -------------- ------------ ------------
Total...................................... $ 241,241 $ 73,045 $ 9,432 $ 247,893 $ 571,611
============ ============== ============= ============ ============
We believe that we have adequate resources to fund all unfunded
commitments to the extent required and meet all contractual obligations as they
come due. See Note 27 to our Consolidated Financial Statements for additional
information regarding commitments and contingencies.
Off-Balance Sheet Risks. In addition to commitments to extend credit, we
are party to various off-balance sheet financial instruments in the normal
course of our business to manage our interest rate risk and foreign currency
exchange rate risk. See Note 27 to our Consolidated Financial Statements and
"Asset and Liability Management" above.
We conduct business with a variety of financial institutions and other
companies in the normal course of business, including counterparties to our
off-balance sheet financial instruments. We are subject to potential financial
loss if the counterparty is unable to complete an agreed upon transaction. We
seek to limit counterparty risk through financial analysis, dollar limits and
other monitoring procedures.
REGULATORY CAPITAL AND OTHER REQUIREMENTS
See Note 22 to our Consolidated Financial Statements.
RECENT ACCOUNTING DEVELOPMENTS
For information relating to the effects of our adoption of recent
accounting standards, see Note 1 to our Consolidated Financial Statements.
63
FORWARD-LOOKING STATEMENTS
This Annual Report 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 the following:
. Expectations regarding the earnings stream from our fee for service
businesses,
. Estimates regarding the market opportunity for our technology products,
. Predictions as to the potential business opportunities in business
process outsourcing,
. Assumptions regarding the key elements of our strategy to grow third
party outsourcing solutions through expanding core businesses,
. Expectations regarding the trends in net interest expense and negative
net interest margin,
. Expectations regarding the outcome of pending litigation and dispute
resolution,
. Predictions regarding sales of our commercial and affordable housing
assets and
. Plans to debank and secure sources of financing alternative to bank
deposits.
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,
. Availability of servicing rights for purchase,
. 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.
Further information on the risks specific to our business are detailed
within this report and our other reports and filings with the Securities and
Exchange Commission, including our periodic reports on Form 10-K, Form 10-Q and
Form 8-K. 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.
64
[LOGO OF OCWEN(R)] OCWEN FINANCIAL CORPORATION
REPORT OF MANAGEMENT
The management of Ocwen Financial Corporation is responsible for the
accompanying consolidated financial statements, which have been prepared in
conformity with accounting principles generally accepted in the United States of
America applied on a consistent basis. In preparing the financial statements, it
is necessary for management to make informed judgments and best estimates giving
due consideration to materiality. In the opinion of management, the consolidated
financial statements fairly reflect our financial position and results of
operations. Information, both financial and non-financial, presented elsewhere
in this annual report is consistent with that in the consolidated financial
statements.
PricewaterhouseCoopers LLP was engaged to perform an audit of the
consolidated financial statements in accordance with auditing standards of the
Public Company Accounting Oversight Board (United States). The Company also
maintains a professional staff of internal auditors who conduct financial,
procedural and special audits and make recommendations on both administrative
and accounting controls.
The Audit Committee of the Board of Directors is comprised solely of
independent directors and is responsible for overseeing and monitoring the
quality of our accounting and auditing practices. The independent accountants
and internal auditors have direct access to the Audit Committee and meet
periodically with the committee to discuss the scope and results of their work,
internal controls over financial reporting and financial reporting matters.
/s/ William C. Erbey /s/ Robert J. Leist
------------------------------------ -----------------------
William C. Erbey Robert J. Leist, Jr.
Chairman and Chief Executive Officer Vice President & Chief
Accounting Officer and
Acting Chief Financial
Officer
65
REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Ocwen Financial Corporation
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of operations, of
comprehensive income (loss), of changes in stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of Ocwen
Financial Corporation and its subsidiaries (the "Company") at December 31, 2004
and 2003, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2004, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, on
January 1, 2002, the Company changed its method of accounting for goodwill and
intangible assets in accordance with Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets", and on July 1, 2003,
its classification of Capital Securities in accordance with SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity".
PRICEWATERHOUSECOOPERS LLP
West Palm Beach, Florida
March 15, 2005
66
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
December 31, December 31,
2004 2003
--------------- ---------------
ASSETS
Cash and amounts due from depository institutions ....................... $ 171,645 $ 229,606
Interest earning deposits ............................................... 116,206 324
Trading securities, at fair value
Investment grade securities ......................................... 86,215 6,679
Subordinates and residuals .......................................... 39,527 42,841
Real estate ............................................................. 18,732 103,943
Affordable housing properties ........................................... 5,641 7,410
Loans, net .............................................................. 3,792 28,098
Match funded assets (including advances on loans serviced for
others of $276,626 in 2004 and $105,788 in 2003) ...................... 280,760 130,087
Premises and equipment, net ............................................. 37,440 41,943
Advances on loans and loans serviced for others ......................... 240,430 374,769
Mortgage servicing rights ............................................... 131,409 166,495
Receivables ............................................................. 126,719 74,315
Other assets ............................................................ 68,977 33,608
--------------- ---------------
Total assets ........................................................ $ 1,327,493 $ 1,240,118
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES
Deposits .............................................................. $ 301,299 $ 446,388
Escrow deposits ....................................................... 125,977 116,444
Match funded liabilities .............................................. 244,327 115,394
Lines of credit and other secured borrowings .......................... 50,612 150,384
Debt securities ....................................................... 231,249 56,249
Accrued interest payable .............................................. 6,173 4,789
Accrued expenses, payables and other liabilities ...................... 36,218 31,926
--------------- ---------------
Total liabilities ................................................... 995,855 921,574
--------------- ---------------
Minority interest in subsidiaries ....................................... 1,530 1,286
COMMITMENTS AND CONTINGENCIES (Note 27)
STOCKHOLDERS' EQUITY
Common stock, $0.1 par value; 200,000,000 shares authorized; 62,739,478
and 67,467,220 shares issued and outstanding at December 31, 2004
and December 31, 2003, respectively .................................. 627 675
Additional paid-in capital ............................................ 181,336 225,559
Retained earnings ..................................................... 148,133 90,409
Accumulated other comprehensive income (loss), net of taxes ........... 12 615
--------------- ---------------
Total stockholders' equity ............................................ 330,108 317,258
--------------- ---------------
Total liabilities and stockholders' equity .......................... $ 1,327,493 $ 1,240,118
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
67
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
For the Years Ended December 31,
-----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
REVENUE
Servicing and related fees .......................................... $ 160,062 $ 139,744 $ 127,787
Vendor management fees .............................................. 46,986 29,842 18,299
Gain (loss) on trading and match funded securities, net ............. (537) 3,344 7,012
Valuation gains (losses) on real estate ............................. (5,110) (7,430) (35,002)
Gain (loss) on sales of real estate ................................. 1,556 466 4,098
Operating income (loss) from real estate ............................ 605 5,128 7,864
Gain (loss) on debt repurchases ..................................... -- (445) (1,461)
Other income ........................................................ 19,465 6,848 5,415
--------------- --------------- ---------------
Non-interest revenue .............................................. 223,027 177,497 134,012
--------------- --------------- ---------------
Interest income ..................................................... 23,676 24,122 37,235
Interest expense .................................................... 30,364 38,716 55,762
--------------- --------------- ---------------
Net interest income (expense) before provision for loan losses .... (6,688) (14,594) (18,527)
Provision for loan losses ........................................... (1,881) (2,684) 13,629
--------------- --------------- ---------------
Net interest income (expense) after provision for loan losses ..... (4,807) (11,910) (32,156)
--------------- --------------- ---------------
Total revenue ................................................... 218,220 165,587 101,856
--------------- --------------- ---------------
NON-INTEREST EXPENSE
Compensation and employee benefits .................................. 87,284 72,221 77,778
Occupancy and equipment ............................................. 15,933 13,159 11,843
Technology and communication costs .................................. 26,049 21,121 25,270
Loan expenses ....................................................... 27,313 14,252 12,605
Loss (gain) on investments in affordable housing properties ......... (255) 285 21,915
Writeoff of excess of purchase price over net assets acquired ....... -- -- 2,231
Professional services and regulatory fees ........................... 26,589 26,054 16,383
Other operating expenses ............................................ 10,069 10,409 9,601
--------------- --------------- ---------------
Non-interest expense .............................................. 192,982 157,501 177,626
--------------- --------------- ---------------
Distributions on Capital Securities ................................... -- 3,058 6,287
--------------- --------------- ---------------
Income (loss) before minority interest, income taxes and effect of
change in accounting principle ....................................... 25,238 5,028 (82,057)
Minority interest in net income (loss) of consolidated subsidiaries ... (162) (492) (99)
Income tax expense (benefit) .......................................... (32,324) 748 2,983
--------------- --------------- ---------------
Net income (loss) before effect of change in accounting
principle ........................................................ 57,724 4,772 (84,941)
Effect of change in accounting principle, net of taxes ................ -- -- 16,166
--------------- --------------- ---------------
Net income (loss) ................................................. $ 57,724 $ 4,772 $ (68,775)
=============== =============== ===============
EARNINGS (loss) PER SHARE
Basic
Net income (loss) before effect of change in accounting
principle ........................................................ $ 0.88 $ 0.07 $ (1.26)
Effect of change in accounting principle, net of taxes ............ -- -- 0.24
--------------- --------------- ---------------
Net income (loss) ................................................. $ 0.88 $ 0.07 $ (1.02)
=============== =============== ===============
Diluted
Net income (loss) before effect of change in accounting
principle ........................................................ $ 0.82 $ 0.07 $ (1.26)
Effect of change in accounting principle, net of taxes ............ -- -- 0.24
--------------- --------------- ---------------
Net income (loss) ................................................. $ 0.82 $ 0.07 $ (1.02)
=============== =============== ===============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic ............................................................... 65,811,697 67,166,888 67,321,299
Diluted ............................................................. 73,197,255 68,063,873 67,321,299
The accompanying notes are an integral part of these consolidated financial
statements.
68
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
For the Years Ended December 31,
-------------------------------------------
2004 2003 2002
------------ ------------ ------------
Net income (loss) .............................................................. $ 57,724 $ 4,772 $ (68,775)
Other comprehensive income (loss), net of taxes
Net change in unrealized foreign currency translation loss (net of tax benefit
(expense) of $354, $(459) and $43 for 2004, 2003 and 2002, respectively) .... (603) 661 75
------------ ------------ ------------
Comprehensive income (loss) .................................................... $ 57,121 $ 5,433 $ (68,700)
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
69
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002
(Dollars in thousands, except share data)
Accumulated
Other
Common Stock Additional Comprehensive
------------------------- Paid-in Retained Income (loss),
Shares Amount Capital Earnings Net of Taxes Total
----------- ----------- ----------- ----------- -------------- -----------
Balances at December 31, 2001 ............ 67,289,313 $ 673 $ 224,142 $ 154,412 $ (121) $ 379,106
Net loss ................................. -- -- -- (68,775) -- (68,775)
Exercise of common stock options ......... 32,937 -- 214 -- -- 214
Directors' compensation .................. 17,523 -- 98 -- -- 98
Other comprehensive income, net of taxes
Change in unrealized foreign currency
translation gain ...................... -- -- -- -- 75 75
----------- ----------- ----------- ----------- -------------- -----------
Balances at December 31, 2002 ............ 67,339,773 673 224,454 85,637 (46) 310,718
Net income ............................... -- -- -- 4,772 -- 4,772
Issuance of restricted common stock awards
to employees ............................ 236,461 2 955 -- -- 957
Repurchase of common stock ............... (500,000) (5) (2,257) -- -- (2,262)
Exercise of common stock options ......... 359,419 4 2,325 -- -- 2,329
Directors' compensation .................. 31,567 1 82 -- -- 83
Other comprehensive income, net of taxes
Change in unrealized foreign currency
translation gain ...................... -- -- -- -- 661 661
----------- ----------- ----------- ----------- -------------- -----------
Balances at December 31, 2003 ............ 67,467,220 675 225,559 90,409 615 317,258
Net income ............................... -- -- -- 57,724 -- 57,724
Issuance of restricted common stock awards
to employees ............................ 203,088 2 624 -- -- 626
Repurchase of common stock ............... (5,481,100) (55) (49,394) -- -- (49,449)
Exercise of common stock options ......... 543,260 5 4,341 -- -- 4,346
Directors' compensation .................. 7,010 -- 206 -- -- 206
Other comprehensive income, net of taxes
Change in unrealized foreign currency
translation gain ...................... -- -- -- -- (603) (603)
----------- ----------- ----------- ----------- -------------- -----------
Balances at December 31, 2004 ............ 62,739,478 $ 627 $ 181,336 $ 148,133 $ 12 $ 330,108
=========== =========== =========== =========== ============== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
70
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
For the Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................................................... $ 57,724 $ 4,772 $ (68,775)
Adjustments to reconcile net income (loss) to net cash provided
(used) by operating activities
Net cash provided (used) by trading activities .................... (75,067) 20,807 186,511
Premium amortization (discount accretion) on securities, net ...... (1,319) 2,402 1,469
Amortization of servicing rights .................................. 96,036 93,558 58,153
Depreciation and amortization ..................................... 13,345 13,530 11,887
Provision for loan losses ......................................... (1,881) (2,684) 13,629
Valuation (gains) losses on real estate ........................... 5,110 7,430 35,002
(Gain) loss on trading and match funded securities, net ........... 537 (3,344) (7,012)
Provisions for losses on affordable housing properties ............ -- 432 21,294
(Gain) loss on sale of real estate ................................ (1,556) (466) (4,098)
(Gain) loss on sale of affordable housing properties .............. (965) (1,050) (444)
(Gain) loss on repurchase of debt ................................. -- 445 1,461
Effect of change in accounting principle before taxes ............. -- -- (15,000)
(Increase) decrease in match funded advances and advances
on loans serviced for others, net ............................... (36,499) (92,532) (4,945)
(Increase) decrease in receivables, net ........................... (52,404) 4,584 20,845
(Increase) decrease in other assets, net .......................... (35,369) (4,281) 8,394
Increase (decrease) in accrued expense, interest payable and
other liabilities, net ........................................... 5,676 3,612 (5,439)
Other, net ........................................................ 3,345 143 (3,766)
---------- ---------- ----------
Net cash provided (used) by operating activities .................... (23,287) 47,358 249,166
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments received on match funded loans ................. 5,757 13,736 16,490
Acquisition of match funded loans ................................. (7,119) -- --
Proceeds from sale of match funded loans .......................... 21,592 -- --
Investment in affordable housing properties ....................... -- -- (3,687)
Proceeds from sale of affordable housing properties ............... 327 5,257 25,017
Purchase of mortgage servicing rights ............................. (60,950) (88,829) (128,891)
Proceeds from sale of loans ....................................... -- 30,153 60,118
Principal payments received on loans .............................. 38,750 28,337 45,014
Purchases, originations and funded commitments on loans, net ...... (16,478) (6,201) (21,722)
Capital improvements to real estate ............................... (2,682) (8,837) (9,340)
Proceeds from sale of real estate ................................. 70,504 17,573 105,743
Additions to premises and equipment ............................... (7,594) (10,353) (12,802)
Acquisition of subsidiaries ....................................... (2,482) -- --
---------- ---------- ----------
Net cash provided (used) by investing activities .................... 39,625 (19,164) 75,940
---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial
statements.
71
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Dollars in thousands)
For the Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in deposits and escrow deposits ............... (135,556) 51,876 (219,487)
Proceeds from (repayment of) securities sold under agreement to
repurchase ....................................................... -- -- (79,405)
Proceeds from (repayments of) lines of credit and other secured
borrowings, net .................................................. (79,772) 67,638 (7,793)
Proceeds from issuance (repayments) of match funded liabilities,
net .............................................................. 128,933 (31,677) (9,837)
Issue (repayment) of debt securities, net ......................... 175,000 (77,420) (77,095)
Exercise of common stock options .................................. 2,427 1,334 103
Repurchase of common stock ........................................ (49,449) (2,262) --
---------- ---------- ----------
Net cash provided (used) by financing activities .................... 41,583 9,489 (393,514)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents ................ 57,921 37,683 (68,408)
Cash and cash equivalents at beginning of year ...................... 229,930 192,247 260,655
---------- ---------- ----------
Cash and cash equivalents at end of year ............................ $ 287,851 $ 229,930 $ 192,247
========== ========== ==========
RECONCILIATION OF CASH AND CASH EQUIVALENTS AT END OF YEAR
Cash and amounts due from depository institutions ................. $ 171,645 $ 229,606 $ 76,598
Interest-earning deposits ......................................... 116,206 324 30,649
Federal funds sold and repurchase agreements ...................... -- -- 85,000
---------- ---------- ----------
$ 287,851 $ 229,930 $ 192,247
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for
Interest .......................................................... $ 28,980 $ 41,362 $ 61,163
Income tax refunds (payments) ..................................... (16,610) (869) 2,444
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Assumption of line of credit by purchaser of real estate .......... 20,000 -- --
Exchange of loans for real estate ................................. 4,771 -- --
Accounts receivable from sale of affordable housing properties .... 2,535 2,767 44,591
Real estate acquired through foreclosure .......................... -- 161 9,492
Exchange of real estate for loan .................................. -- -- 9,153
ACQUISITION OF BUSINESSES
Fair value of assets acquired ..................................... (21,850) -- --
Fair value of liabilities assumed ................................. 11,170 -- --
---------- ---------- ----------
Cash paid ......................................................... (10,680) -- --
Less cash acquired ................................................ 8,198 -- --
---------- ---------- ----------
Net cash acquired (paid) for assets ............................... $ (2,482) -- --
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
72
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Ocwen Financial Corporation ("OCN") is a financial services holding
company engaged in a variety of business activities related to residential and
commercial mortgage servicing, real estate asset management, asset recovery,
business process outsourcing and the marketing and sales of technology solutions
to third parties. We also specialize in the related development of loan
servicing technology and software for the mortgage and real estate industries.
Our 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 ("IMI"), Ocwen Technology
Xchange, Inc. ("OTX"), Ocwen Asset Investment Corp. ("OAC") and Ocwen Financial
Solutions Pvt. Limited ("India"). In 2002, we formed Global Servicing Solutions,
LLC ("GSS"). We own 70% of 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.
The Bank is currently a federally chartered savings bank regulated by
the Office of Thrift Supervision ("OTS"), however, we have filed an application
with the OTS to turn in the Bank's thrift charter and terminate its status as a
federal savings bank. See Note 22 for additional information.
RECLASSIFICATION
Certain amounts included in our 2003 and 2002 consolidated financial
statements have been reclassified to conform to the 2004 presentation.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, our cash and cash equivalents
include cash on hand, interest-bearing and non-interest-bearing deposits and all
investments in highly liquid debt instruments that we purchased with an original
maturity of three months or less. Cash flows associated with items we intended
as hedges of identifiable transactions or events are classified in the same
category as the cash flows from the items being hedged.
SHORT-TERM HIGHLY LIQUID INVESTMENTS
Our short-term highly liquid investments generally consist of federal
funds sold and assets we purchased under agreements to resell. We invest in
these assets to maximize the return on liquid funds. At December 31, 2004 and
2003, we had no short-term highly liquid investments. The average balance of our
investment in federal funds sold and assets purchased under agreements to resell
amounted to $155,519 and $125,732 during 2004 and 2003, respectively.
The Federal Reserve System requires that the Bank maintain
non-interest-earning cash reserves against certain of its transaction accounts
and time deposit accounts. Such reserves totaled $13,740 and $9,383 at December
31, 2004 and 2003, respectively.
TRADING SECURITIES
We currently account for our investment grade, residual and subordinate
securities as trading. We report securities in our statement of financial
condition at fair value. We report changes in fair value in income in the period
of change. We determine fair value based on either third party dealer
quotations, where available, or internal values. Our internal valuations are
determined using industry standard third party software or internally developed
models. Expected future cash flows are estimated using assumptions such as
discount rates, prepayment speeds and expected losses. Discount rates for the
subordinate and residual securities range from 11% to 30%, and are determined
based upon an assessment of general market conditions. The prepayment and loss
assumptions are projected based on a comparison to actual historical performance
curves.
Interest income on subordinate and residual securities is recognized
through an "effective yield" method, with changes in expected future cash flows
reflected in the yield on a prospective basis as required by Emerging Issues
Task Force ("EITF") 99-20, "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets".
The prospective yield that is used to determine interest income is re-calculated
each time the expected future cash flows change or the actual cash flows differ
from projections. The newly calculated yield is used in the accrual of interest
income for subsequent reporting periods.
73
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
LOANS
We report loans at amortized cost, less an allowance for loan losses,
discounts, deferred loan fees and undisbursed loan funds. We defer loan
origination fees and certain direct loan origination costs and recognize them
over the lives of the related loans as a yield adjustment that we include in
interest income using the interest method applied on a loan-by-loan basis. We
accrue interest income as it is earned. We place loans on non-accrual status
after being delinquent greater than 89 days or earlier if the borrower is deemed
by management to be unable to continue performance. When we place a loan on
non-accrual status, we reverse interest accrued but not received. In addition,
we suspend the amortization of deferred loan fees when we place a loan on
nonaccrual status. We return loans to accrual status only when we reinstate the
loan and have no doubt regarding ultimate collectibility. We report as interest
income, gains on loans resolved and discharged through repayment of the loan in
full or at a negotiated amount.
In situations where we foreclose upon the collateral, we transfer the
loans to real estate upon receipt of title to the property.
ALLOWANCE FOR LOAN LOSSES
We maintain the allowance for loan losses at a level that, based upon
our evaluation of known and inherent risks in the portfolio, we consider
adequate to provide for probable losses. We establish specific valuation
allowances for impaired loans in the amount by which the carrying value, before
allowance for probable losses, exceeds the fair value of collateral less costs
to dispose on an individual loan basis. In the case of single family residential
mortgage loans, we generally evaluate for impairment as homogeneous pools of
loans. We consider a loan to be impaired when, based upon current information
and events, we believe that we will probably be unable to collect on a timely
basis all amounts due according to the contractual terms of the loan agreement.
We measure these impaired loans at the fair value of the collateral underlying
the loans, less estimated disposal costs. We may leave impaired loans on accrual
status during the period we are pursuing repayment of the loan. We place these
loans on non-accrual status at such time that either: (i) the loans become 90
days delinquent; or (ii) we determine that the borrower is incapable of, or has
ceased efforts toward, curing the cause of the non-payment. We recognize
impairment losses through an increase in the allowance for loan losses and a
corresponding charge to the provision for loan losses. When we either sell,
transfer to real estate or charge-off an impaired loan, we remove valuation
allowance from the allowance for loan losses. Charge-offs occur when we consider
loans, or a portion thereof, uncollectible and of such little value that we
consider unwarranted their continuance as bankable assets. We base our ongoing
evaluation of the allowance for loan losses upon an analysis of the portfolio,
historical loss experience, economic conditions and trends, collateral values
and other relevant factors. We may make subsequent adjustments to the allowance
if these factors differ substantially from the assumptions used in making the
evaluation.
MORTGAGE SERVICING RIGHTS
We acquire mortgage servicing rights, which we record at the price paid.
We amortize mortgage servicing assets in proportion to and over the period of
estimated net servicing income. We determine estimated net servicing income
using the estimated future balance of the underlying mortgage loan portfolio,
which, absent new purchases, declines over time from prepayments and scheduled
loan amortization. We adjust amortization prospectively in response to changes
in estimated projections of future cash flows. We evaluate the mortgage
servicing assets for impairment based on the fair value of the servicing assets
by strata. We stratify the servicing assets based on loan type. To the extent
the carrying value of the servicing assets exceeds their fair value by strata,
we establish a valuation allowance, which we may adjust in the future, as the
value of the servicing assets increases or decreases. We estimate the fair value
of our mortgage servicing rights based on the results of our internal valuation
and an external valuation obtained from an independent third party valuation
specialist. Our internal valuation is performed using an industry standard
model, which calculates the present value of estimated future cash flows
utilizing market based assumptions. The more significant assumptions used in our
internal valuation include:
. Prepayment speeds
. Compensating interest expense
. Delinquency experience
. Discount rate
. Interest rate used for computing the cost of servicing advances
. Interest rate used for computing float income
. Cost of servicing
74
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The significant cash inflows considered in our estimate of future cash
flows include servicing fees, late fees, prepayment penalties, float income and
other ancillary fees. Significant cash outflows include the cost of servicing,
compensating interest payments and the cost of making service advances.
Prepayment speeds and delinquency experience are derived from an industry
standard model for each strata in our mortgage servicing rights. The discount
rate, interest rate for the cost of financing advances, interest rate for float
income and the cost of servicing are based on market assumptions provided by our
third party valuation specialist. Our impairment analysis is performed after
grouping our loans into the seven strata based on loan type, which represent the
predominant risk characteristics of the underlying loans. The risk factors used
to assign loans to strata include the credit score (FICO) of the borrower, the
loan to value ratio, the type of asset (mortgage or non-mortgage) and the
default risk. Our strata include:
. Subprime
. ALT A
. High-loan-to-value
. Re-performing
. Special servicing
. Non-residential mortgage
. Other
MORTGAGE SERVICING FEES AND ADVANCES ON LOANS SERVICED FOR OTHERS
We earn fees for servicing mortgage loans. We collect servicing fees,
generally expressed as a percent of the unpaid principal balance, from the
borrowers' payments. We also include late fees, prepayment penalties, float
income and other ancillary fees, net of compensating interest and amortization
of servicing assets, in servicing income. 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 earnings to the extent that we estimate that
advances are uncollectible under provisions of the servicing contracts, taking
into consideration historical loss and delinquency experience, length of
delinquency and the amount of the advance.
REAL ESTATE
We account for real estate properties as held for sale in the period in
which all of the following criteria are met:
. Management, having the authority to approve the action, commits to a
plan to sell the asset.
. The property is available for immediate sale in its present condition
subject only to terms that are usual and customary for sales of such
assets.
. An active program to locate a buyer and other actions required to
complete the plan to sell the property have been initiated.
. The sale of the property is probable, and transfer of the asset is
expected to qualify for recognition as a completed sale, within one
year.
. The property is being actively marketed for sale at a price that is
reasonable in relation to its current fair value.
. Actions required to complete the plan indicate that it is unlikely that
significant changes to the plan will be made or that the plan will be
withdrawn.
If at any time the criteria in this paragraph are no longer met, a real
estate property accounted for as held for sale is reclassified and accounted for
as held and used. A property that is reclassified is measured at the lower of
its (a) carrying amount before it was classified as held for sale, adjusted for
any depreciation (amortization) expense that would have been recognized had it
been continuously accounted for as held and used, or (b) fair value at the date
of the asset is reclassified. A real estate property accounted for as held for
sale is not depreciated and is recorded at the lower of its carrying amount or
fair value less cost to sell.
We perform quarterly impairment evaluations of our real estate
investments, including consideration of the status of the property vis a vis
negotiations for sale to third party buyers. Our assessments of fair value are
based on negotiated sales prices with third party buyers where applicable or, if
not yet in active negotiations with buyers, external or internally developed
appraised values. For properties accounted for as held and used, we recognize an
impairment charge to earnings whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. For properties
accounted for as held for sale, we recognize decreases in the fair value as a
valuation allowance on a property specific basis. We report subsequent increases
in fair value as reductions in the valuation allowance, but only to the extent
the valuation allowance reaches zero. We charge or credit to income such changes
in the valuation allowance.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
For all real estate properties, we charge expenditures for repairs and
maintenance to operations as incurred but capitalize significant improvements.
We classify leases as operating. We defer fees and costs incurred in the
successful negotiation of leases and amortize them on a straight-line basis over
the terms of the respective leases. We report rental income on a straight-line
basis over the terms of the respective leases. We recognize sales proceeds and
related costs with passage of title to the buyer and, in cases where we finance
the sale, receipt of sufficient down payment. For properties classified as held
and used, we compute depreciation on a straight-line basis over the estimated
useful lives of the assets.
Our investments in real estate partnerships are accounted for under the
equity method of accounting. Under the equity method of accounting, we record an
investment in the shares or other interests of an investee at cost of the shares
or interests acquired and thereafter periodically increase (decrease) the
investment by our proportionate share of earnings (losses) of the investee and
decrease it by the dividends or distributions that we receive from the investee.
AFFORDABLE HOUSING PROPERTIES
Affordable housing partnerships own multi-family residential properties
that have been allocated tax credits under the Internal Revenue Code of 1986, as
amended (the "Internal Revenue Code"). The obligations of the partnership to
sustain qualifying status of the properties covers a 15-year period; however,
tax credits generally accrue over a 10-year period on a straight-line basis. We
account for investments in affordable housing partnerships that we made on or
after May 18, 1995 and in which we invest solely as a limited partner using the
equity method. For our limited partnership investments made before this date, we
record our receipt of income tax credits and other tax benefits on a level yield
basis over the 15-year obligation period and report the tax credits and tax
benefits net of amortization of our investment in the limited partnership as a
reduction of income tax expense. We consolidate affordable housing partnerships
in which we have invested as a limited partner and through a subsidiary act as
the general partner, and include them in our consolidated financial statements.
For all investments in affordable housing partnerships made after May 18, 1995,
we capitalized interest expense and certain direct costs incurred during the
pre-operating period.
We report affordable housing properties for which we have entered into
an agreement to sell at the lower of cost or fair value less costs to sell. As
of December 31, 2004, our investment in affordable housing properties consists
of a 99.9% limited partnership interest in a single property, which we account
for using the equity method.
EXCESS OF COST OVER NET ASSETS ACQUIRED
We report the excess of purchase price over net assets of acquired
businesses ("goodwill") at cost. Prior to our adoption of Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" on
January 1, 2002, we amortized goodwill on a straight-line basis over the
estimated future periods to be benefited, ranging from 3 to 7 years. Effective
January 1, 2002 we no longer amortize our goodwill, but we do review the
carrying value at least annually for impairment in accordance with the
provisions of SFAS No. 142.
SFAS No. 142 prescribes a methodology for performing the impairment
analyses for goodwill and other intangibles. This methodology uses an approach
based on fair value of the assets rather than on undiscounted cash flows, as was
the case prior to adoption. We perform this analysis using projections of future
income discounted at a market rate. The determination of market discount rates
is subjective and may vary by product based on the nature of the underlying
business, stage of development and sales to date.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
PREMISES AND EQUIPMENT
We report premises and equipment at cost and, except for land,
depreciate them over their estimated useful lives on the straight-line method as
follows:
Buildings 39 years
Land improvements 39 years
Furniture and fixtures 5 years
Computer hardware and software 3 years
Leasehold improvements Life of the lease, with maximum
lease term of 10 years.
CAPITALIZED SOFTWARE COSTS
We currently expense all costs attributable to enhancing our OTX
technology solutions. Prior to 2000, we capitalized certain costs, although we
expensed costs incurred up to the establishment of technological feasibility as
research and development costs. Once the products were made available for
general release to customers, we began amortization of the capitalized costs
using the straight-line method over the estimated economic lives of the
individual products. At each balance sheet date, we perform an impairment
analysis by product by comparing unamortized capitalized costs to the net
realizable value. An impairment charge is recorded to the extent the unamortized
capitalized costs exceed the net realizable value.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
We periodically enter into sales of securities under agreements to
repurchase the same securities. We report repurchase agreements as financings
and report the obligations to repurchase securities sold as a liability in our
consolidated statements of financial condition. We report all securities
underlying repurchase agreements as assets in our consolidated statements of
financial condition. Custodians hold these securities in safekeeping.
EXCESS OF NET ASSETS ACQUIRED OVER PURCHASE PRICE
The effects of our acquisition of OAC in 1999 resulted in a new basis of
accounting reflecting fair values of assets and liabilities at the date of
acquisition. We reported the excess of assets over the purchase price of
acquired net assets ("negative goodwill") resulting from the acquisition at cost
and amortized it on a straight-line basis over the estimated future periods to
be benefited. Effective January 1, 2002, upon adoption of SFAS No. 142, we
reversed the unamortized balance of the excess of net assets acquired over
purchase price to income in accordance with the provisions of SFAS No. 141,
"Business Combinations". We reported this reversal as the effect of a change in
accounting principle. See Note 2 for additional information.
DERIVATIVE FINANCIAL INSTRUMENTS
We use derivative financial instruments for the purpose of managing our
exposure to adverse fluctuations in interest and foreign currency exchange
rates. While these instruments are subject to fluctuations in value, such
fluctuations are generally offset by the change in value of the underlying
exposures being hedged. We do not enter into any derivative financial
instruments for trading purposes.
We record all of our derivative instruments in the statement of
financial condition at fair value. We record changes in the fair value of
derivatives each period in current earnings or other comprehensive (loss)
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, depending on the type of hedge transaction and the
effectiveness of the hedge.
For hedge transactions of net investments in foreign operations, we
record the effective portions of the changes in fair value of the derivative
instruments as a cumulative translation adjustment and include as a component of
accumulated other comprehensive (loss) income in stockholders' equity.
For cash-flow hedge transactions in which we hedge the variability of
cash flows related to a variable-rate asset, liability or a forecasted
transaction, we report the effective portions of the changes in the fair value
of the derivative instruments in other comprehensive (loss) income. The gains
and losses on the derivative instrument that are reported in other comprehensive
(loss) income are reclassified to earnings in the periods in which earnings are
impacted by the variability of the cash flows of the hedged item.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
We account for all other derivative instruments used for risk management
purposes that do not meet the hedge accounting criteria and, therefore, do not
qualify for hedge accounting at fair value with changes in fair value recorded
in our consolidated statement of operations. We recognize the ineffective
portions of all hedges in our current period earnings.
FOREIGN CURRENCY TRANSLATION
Where the functional currency is not the U.S. dollar, we translate
assets and liabilities of foreign entities into U.S. dollars at the current rate
of exchange existing at the statement of financial condition date and revenues
and expenses at average monthly rates. We include the resulting translation
adjustments as a component of accumulated other comprehensive income in
stockholders' equity. Where the functional currency of a foreign entity is the
U.S. dollar, translation adjustments are included in the results of operations.
INCOME TAXES
We file consolidated Federal income tax returns with our subsidiaries.
Consolidated income tax is allocated among the subsidiaries participating in the
consolidated return as if each subsidiary that has one or more subsidiaries
filed its own consolidated return and those with no subsidiaries filed separate
returns.
We account for income taxes using the asset and liability method, which
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of assets and liabilities. Additionally, we adjust deferred
taxes for subsequent tax rate changes. We conduct periodic evaluations to
determine whether it is more likely than not that some or all of our deferred
tax asset will not be realized. Among the factors considered in this evaluation
are estimates of future earnings, the future reversal of temporary differences
and the impact of tax planning strategies that we can implement if warranted.
BASIC AND DILUTED EARNINGS PER SHARE
We calculate basic earnings per share based upon the weighted average
number of shares of common stock outstanding during the year. We calculate
diluted earnings per share based upon the weighted average number of shares of
common stock outstanding and all dilutive potential common shares outstanding
during the year. The computation of diluted earnings per share includes the
impact of the exercise of the outstanding options to purchase common stock using
the treasury stock method, which assumes that the proceeds from such issuance
are used to repurchase common shares at fair value. If the Company incurs a net
loss for the period, we exclude common stock equivalents from the diluted
calculation since the common stock equivalents would be antidilutive. The
computation of diluted earnings per share also includes the potential shares of
converted common stock associated with our contingently convertible notes using
the if-converted method. Under the if-converted method, the convertible notes
are assumed to have been converted, regardless of whether any of the contingent
features have been met, and the resulting shares are included in the denominator
(if dilutive). Interest expense applicable to the convertible notes is added
back to the numerator (i.e. net income).
COMPREHENSIVE INCOME
Comprehensive income represents the change in equity of a business
enterprise during a period from transactions and other events and circumstances
excluding those resulting from investments by and distributions to owners. We
present comprehensive income beginning with net income and adding the elements
of comprehensive income not included in the determination of net income to
arrive at comprehensive income. We present accumulated other comprehensive
income net of income taxes and include unrealized foreign currency translation
gains and losses.
RISKS AND UNCERTAINTIES
In the normal course of business, we encounter two significant types of
risk: economic and regulatory. There are three main components of economic risk:
credit risk, market risk and concentration of credit risk. Credit risk is the
risk of default on our loan portfolios and derivative financial instruments that
results from a borrower's inability or unwillingness to make contractually
required payments. Market risk includes interest rate risk, foreign currency
exchange rate risk and liquidity risk. We are exposed to interest rate risk to
the degree that our interest-bearing liabilities mature or reprice at different
speeds, or different bases, than our interest-earning assets. We are exposed to
foreign currency exchange rate risk in connection with our investment in
non-U.S. dollar functional currency operations and to
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
the extent our foreign exchange positions remain unhedged. Market risk also
reflects the risk of declines in the valuation of trading securities, and in the
value of the collateral underlying loans and the value of real estate held.
Concentration of credit risk refers to the risk that, if we extend a significant
portion of the total outstanding credit to borrowers in a specific geographical
area or industry or on the security of a specific form of collateral, we may
experience disproportionately high levels of default and losses if those
borrowers, or the value of such type of collateral, is adversely affected by
economic or other factors that are particularly applicable to such borrowers or
collateral.
We are also exposed to liquidity risk. Our business requires substantial
cash to support the residential loan servicing business, including acquisitions
of mortgage servicing rights and the unfinanced portion of servicing advances
and to fund holding company operations, including OTX operations. In general, we
finance our operations through operating cash flows and various other sources,
including Bank deposits, long-term debt and financing facilities, some of which
have 90% advance rates. As we continue to purchase mortgage servicing contracts
and fund other core business operations from operating cash flows, we must
secure additional capital to support our growth. Failure to secure additional
financing sources or to achieve profitable operations could result in a
significant adverse effect on our financial position and results of operations.
The Bank is subject to the regulations of various government agencies.
These regulations can and do change significantly from period to period. The
Bank also undergoes periodic examinations by the regulatory agencies, which may
subject it to further changes with respect to asset valuations, amounts of
required loss allowances and operating restrictions resulting from the
regulators' judgments based on information available to them at the time of
their examination.
The preparation of financial statements in conformity with generally
accepted accounting principles requires that we make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly significant in the near or medium term relate to our determination
of the allowance for loan losses and our valuation of securities, real estate,
affordable housing properties, advances on loans and loans serviced for
others, servicing rights, intangibles and our deferred tax asset.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure", which amends SFAS No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. Certain provisions of the statement were effective
December 31, 2002. We currently account for stock-based compensation under the
intrinsic value method set forth in Accounting Principles Board ("APB") Opinion
No. 25 and related interpretations. For this reason, the transition guidance of
SFAS No. 148 did not have an impact on our consolidated financial position or
consolidated results of operations. The Statement did amend existing guidance
with respect to required disclosures, regardless of the method of accounting
used. As discussed in the "Current Accounting Pronouncements" section below, the
FASB issued a revision of SFAS No. 123 in December 2004, which supercedes APB
Opinion No. 25 and is effective for the third quarter of 2005.
We maintain stock-based compensation plans that provide for the granting
of stock and stock options to our employees and directors. As indicated above,
we account for our stock option plans based on the intrinsic value method set
forth in APB Opinion No. 25 and related Interpretations, under which no
compensation cost has been recognized, except with respect to stock options that
are granted with an exercise price that is less than the fair value of the
Company's stock at the date of the grant, as disclosed in the accompanying
table. The following table presents net income, basic and diluted earnings per
share as reported and pro forma net income and pro forma earnings per share. We
have determined pro forma amounts by assuming that compensation costs for our
stock option plans had been determined based on the fair value at the grant
dates for awards under those plans granted after December 31, 1994, consistent
with the method described by SFAS No. 123.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
NET INCOME
Net income (loss) as reported ............................................ $ 57,724 $ 4,772 $ (68,775)
Add stock-based compensation expense included in reported net
income, net of tax .................................................... 823 797 599
Deduct total stock-based employee compensation expense
determined under fair value based method for all awards, net of tax ... (2,668) (1,559) (1,344)
---------- ---------- ----------
Pro forma net income (loss) .............................................. $ 55,879 $ 4,010 $ (69,520)
========== ========== ==========
BASIC EPS
As reported .............................................................. $ 0.88 $ 0.07 $ (1.02)
Pro forma ................................................................ $ 0.85 $ 0.06 $ (1.03)
DILUTED EPS
As reported .............................................................. $ 0.82 $ 0.07 $ (1.02)
Pro forma ................................................................ $ 0.80 $ 0.06 $ (1.03)
We estimate the fair value of our option grants using the Black-Scholes
option-pricing model with the following assumptions:
2004 2003 2002
---------- ---------- ----------
Expected dividend yield..................................................... 0.00% 0.00% 0.00%
Expected stock price volatility............................................. 43.00 48.00 62.00
Risk-free interest rate..................................................... 3.61% 3.25% 2.73%
Expected life of options.................................................... 5 years 5 years 5 years
CURRENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 123 (R), "Share-Based Payment". This Statement was issued by
the FASB on December 16, 2004 and is a revision of SFAS No. 123, "Accounting for
Stock-Based Compensation". This Statement also supersedes APB Opinion No. 25 and
its related implementation guidance.
SFAS No. 123 (R) requires a public entity to measure the cost of
employee services received in exchange for an award of equity instruments based
on the grant-date fair value of the award (with limited exceptions). That cost
will be recognized over the period during which an employee is required to
provide service in exchange for the award - the requisite service period
(usually the vesting period). No compensation cost is recognized for equity
instruments for which employees do not render the requisite service. The fair
value of an award is not re-measured after its initial estimation on the grant
date (except in the case of a liability award or if the award is subsequently
modified). The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless observable market prices for
the same or similar instruments are available). The notes to financial
statements will disclose information to assist users of financial information to
understand the nature of share-based payment transactions and the effects of
those transactions on the financial statements.
SFAS No. 123 (R) eliminates the alternative to use Opinion 25's
intrinsic value method of accounting that was provided in SFAS No. 123 as
originally issued. Under APB Opinion No. 25, issuing stock options to employees
generally resulted in recognition of no compensation cost, except with respect
to options that were granted with an exercise price that was less than fair
value of the stock at the date of grant.
This Statement is effective as of the beginning of the first interim or
annual reporting period that begins after June 15, 2005, which in our case is
the beginning of the third quarter of 2005. SFAS 123 (R) applies to all awards
granted after the required effective date and to awards modified, repurchased,
or cancelled after that date. The cumulative effect of initially applying this
Statement, if any, is recognized as of the required effective date.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
As of the required effective date, all public entities will apply this
Statement using a modified version of prospective application. Under that
transition method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under Statement 123 for either recognition or pro forma
disclosures. For periods before the required effective date, public entities may
elect to apply a modified version of retrospective application under which
financial statements for prior periods are adjusted on a basis consistent with
the pro forma disclosures required for those periods by SFAS No. 123.
We have not yet determined which transition method we will apply or the
cumulative effect of initially adopting this Statement. We have determined that
awards we have granted to date will be classified as equity awards (versus
liability awards) because their terms contain service conditions. Therefore, the
fair value of these awards will not be re-measured after our initial estimation
on the grant date. As disclosed in the "Stock-Based Compensation" section above,
we currently account for our stock option plans based on the intrinsic value
method set forth in APB Opinion No. 25. Therefore, we anticipate that the amount
of compensation expense we recognize in connection with our stock option awards
will increase under the fair value based method of SFAS No. 123 and 123(R).
Earnings Per Share - An Amendment of SFAS No. 128. In December 2004,
the FASB decided to defer the issuance of a final standard on EPS until 2005.
When issued, the provisions of the final standard will be effective in 2005 and
will require retrospective application for all prior periods presented. When
computing diluted EPS for year-to-date periods, companies will be required to
use the year-to-date average stock price to compute the number of treasury
shares that could theoretically be purchased with the proceeds from exercise of
share contracts such as options or warrants. The year-to-date computation would
be performed independently from the quarterly computations. The old method
required companies to calculate an average of the potential incremental common
shares computed for each quarter when computing year-to-date incremental shares.
This will apply to Ocwen as we use the treasury stock method to determine the
number of incremental shares from the assumed exercise of stock options to be
included in the denominator of diluted EPS computations. Under the treasury
stock method, the proceeds from the assumed exercise of options are assumed to
be used to purchase common stock at the average market price during the period.
The incremental shares (the difference between the number of shares assumed
issued and the number of shares assumed purchased) are included in the
denominator of the diluted EPS computation.
EITF Issue 04-8, "The Effect of Contingently Convertible Debt on Diluted
Earnings per Share". EITF Issue 04-8 was approved on September 30, 2004 and
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 did 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 16). Beginning with our
2004 annual financial statements, we have included the potential shares of stock
associated with our contingently convertible debt in diluted earnings per share
computations using the if-converted method regardless of whether any of the
contingent features have been met. See Note 17 for information regarding the
effect on diluted EPS.
FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"). This interpretation was issued in January 2003 and
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 applies 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 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. As of December 31, 2004, we are a limited partner in one partnership that
developed low-income housing properties. We do not consolidate this partnership
but rather record our investment in it using the equity method of accounting. As
of December 31, 2004, our investment in such limited partnership amounted to
$5,641. In addition, we had a loan to this partnership with a net book value of
$3,198 at December 31, 2004. FIN 46R did not have a significant impact on our
consolidated financial statements because prior to its adoption we had already
recorded our 99.9% limited partnership interest in this affordable housing
property.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Statement of Position 03-3, "Accounting or Certain Loans or Debt
Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 was issued in December
2003 and is effective for loans acquired on or after January 1, 2005. Our net
investment in loans at December 31, 2004 amounted to $3,792; therefore, it is
expected that the application of SOP 03-3 will not have a significant impact on
our consolidated financial statements.
NOTE 2 EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
We adopted SFAS No. 142 effective January 1, 2002. As a result, in
accordance with the provisions of SFAS No. 141, we reversed the unamortized
balance of negative goodwill we had originally recorded in connection with our
acquisition of OAC. This reversal resulted in a credit to income of $18,333. The
impact from the adoption of other elements of SFAS No. 142 resulted in our
recording impairment charges of $3,333 on goodwill and intangible assets
originally recorded in connection with the formation of REALSynergy, Inc. in
1999. These amounts have been reported, net of an income tax benefit of $1,166,
in 2002 as the effect of a change in accounting principle of $16,166. The
negative goodwill and the effect of the change in accounting principle related
to its reversal were recorded in the Corporate Items and Other Segment.
NOTE 3 ACQUISITIONS
On September 30, 2004, we acquired Bankhaus Oswald Kruber KG ("BOK") a
German bank, for $9,737, including acquisition costs. Our primary objectives in
acquiring BOK were to diversify our funding sources and to establish a platform
to provide services to our multinational client base. The results of operations
of BOK are included in our consolidated income statement beginning on October 1,
2004. The excess of the purchase price over the fair value of the net assets
acquired (goodwill) related to this transaction is $3,694. We also recorded
$1,741 of intangible assets, none of which are subject to amortization. As of
December 31, 2004 BOK had assets of $23,043, of which $10,699 were interest
earning deposits, and total liabilities of $10,919.
On December 31, 2004, we acquired a residential mortgage fulfillment
center and due diligence operation, including staff, facilities and systems, for
approximately $1,000. The objective of this acquisition was to enhance our
ability to provide mortgage fulfillment and due diligence services to others. We
simultaneously entered into a one-year renewable contract to provide these
services to the seller. We have recorded approximately $700 of intangible assets
as a result of this acquisition, all of which are subject to amortization.
NOTE 4 FAIR VALUE OF FINANCIAL INSTRUMENTS
A majority of our assets, liabilities and off-balance sheet instruments
and commitments are considered financial instruments. For the majority of our
financial instruments, principally loans and deposits, fair values are not
readily available since there are no available trading markets as characterized
by current exchanges between willing parties. Accordingly, fair values can only
be derived or estimated using various valuation techniques, such as computing
the present value of estimated future cash flows using discount rates
commensurate with the risks involved. However, the determination of estimated
future cash flows is inherently subjective and imprecise. In addition, for those
financial instruments with option-related features, prepayment assumptions are
incorporated into the valuation techniques. Minor changes in assumptions or
estimation methodologies can have a material effect on these derived or
estimated fair values.
The fair values reflected below are indicative of the interest rate
environments as of December 31, 2004 and 2003, and do not take into
consideration the effects of interest rate fluctuations. In different interest
rate environments, fair value results can differ significantly, especially for
certain fixed-rate financial instruments and non-accrual assets. In addition,
the fair values presented do not attempt to estimate the value of our fee
generating businesses and anticipated future business activities. In other
words, they do not represent our value as a going concern. Furthermore, the
differences between the carrying amounts and the fair values presented may not
be realized.
Reasonable comparability of fair values among financial institutions is
difficult due to the wide range of permitted valuation techniques and numerous
estimates that must be made in the absence of secondary market prices. This lack
of objective pricing standards introduces a degree of subjectivity to these
derived or estimated fair values. Therefore, while disclosure of estimated fair
values of financial instruments is required, readers are cautioned in using this
data for purposes of evaluating our financial condition.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The methodologies used and key assumptions made to estimate fair value,
the estimated fair values determined and recorded carrying values follow:
CASH AND CASH EQUIVALENTS
We have valued cash and cash equivalents at their carrying amounts as
these are reasonable estimates of fair value given the relatively short period
of time between origination of the instruments and their expected realization.
TRADING SECURITIES
We adjust our securities portfolio to fair value within a range based on
third party dealer quotations, where available, and internal values, subject to
an internal review process. For those securities that do not have an available
market quotation we will request market values and underlying assumptions from
the various securities dealers that underwrote, are currently financing the
securities, or have had prior experience with the type of security to be valued.
When we obtain quotations from two or more dealers, we generally use the average
dealer quote.
LOANS AND MATCH FUNDED LOANS
We estimate the fair value of our performing loans based upon quoted
market prices for similar whole loan pools. We base the fair value of our
non-performing loans on estimated cash flows discounted using a rate
commensurate with the risk associated with the estimated cash flows. We estimate
the fair value of our match funded loans and our loans based upon current market
yields at which recent pools of similar mortgages have traded taking into
consideration the timing and amount of expected cash flows.
ADVANCES ON LOANS AND LOANS SERVICED FOR OTHERS
We value advances we make on our loans and loans we service for others
at their carrying amounts because they have no stated maturity and do not bear
interest.
RECEIVABLES
The carrying value of receivables approximates fair value because of the
relatively short period of time between their origination and realization.
Certain long-term receivables are carried at a discounted value that we believe
approximates fair value.
DEPOSITS AND ESCROWS
The fair value of our demand deposits, savings accounts, money market
deposits and escrow deposits is the amount payable on demand at the reporting
date. We estimate the fair value of fixed-maturity certificates of deposit by
discounting the required cash payments at the market rates offered for deposits
with similar maturities on the respective financial statement dates.
BORROWINGS
We base the fair value of our match funded liabilities and debt
securities on quoted market prices. The fair value of our other borrowings,
including obligations outstanding under lines of credit, approximates carrying
value because these borrowings are either short-term or bear interest at a rate
that is adjusted regularly based on a market index.
DERIVATIVE FINANCIAL INSTRUMENTS
We base the fair values of our derivative financial instruments on
quoted market prices.
83
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
LOAN COMMITMENTS AND LETTERS OF CREDIT
The fair values of loan commitments and letters of credit estimated
considering the difference between interest rates on the respective financial
statement dates and the committed rates.
The carrying amounts and the estimated fair values of our financial
instruments are as follows:
December 31, 2004 December 31, 2003
--------------------------- ----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------ ------------ ------------ ------------
Financial assets:
Interest earning and non-interest earning cash $ 287,851 $ 287,851 $ 229,930 $ 229,930
Trading securities ............................ 125,742 125,742 49,520 49,520
Loans, net .................................... 3,792 3,870 28,098 29,407
Match funded assets ........................... 280,760 280,760 130,087 128,860
Advances on loans and loans serviced for others 240,430 240,430 374,769 374,769
Receivables ................................... 126,719 126,719 74,315 74,315
Financial liabilities:
Deposits ...................................... 301,299 303,622 446,388 452,015
Escrow deposits ............................... 125,977 125,977 116,444 116,444
Match funded liabilities ...................... 244,327 244,327 115,394 115,401
Lines of credit and other secured borrowings .. 50,612 50,612 150,384 150,384
Debt securities ............................... 231,249 228,003 56,249 55,581
Derivative financial instruments:
British Pound futures ......................... 301 301 (737) (737)
Canadian Dollar futures ....................... 109 109 (34) (34)
Other:
Loan commitments (1) .......................... -- 35 -- 451
(1) Our loan commitment represents the unfunded portion of a loan commitment
to our affordable housing limited partnership.
NOTE 5 TRADING SECURITIES
The fair value of our trading securities are as follows at December 31:
2004 2003
---------- ----------
Investment grade securities:
U.S. Government and sponsored enterprise securities ........................ $ 1,594 $ 6,679
Collateralized mortgage obligations (AAA-rated) ............................ 81,466 --
Bonds and debentures ....................................................... 3,155 --
---------- ----------
$ 86,215 $ 6,679
========== ==========
Subordinates and residual securities:
Single family residential
BB-rated subordinates .................................................... $ 256 $ 579
B-rated subordinates ..................................................... 435 580
Unrated subordinates ..................................................... 217 222
Unrated subprime residuals ............................................... 35,276 38,883
---------- ----------
36,184 40,264
Nonresidential unrated subordinates ........................................ 3,343 2,577
---------- ----------
$ 39,527 $ 42,841
========== ==========
A profile of the maturities of our trading securities at December 31,
2004 follows. Mortgage-backed securities are included based on their
weighted-average maturities, reflecting anticipated future prepayments.
84
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Investment Grade Securities Subordinates and Residuals
------------------------------ ------------------------------
Weighted Weighted
Average Yield Fair Value Average Yield Fair Value
------------- ------------- ------------- -------------
Due within one year ........ 2.63% $ 61,095 17.59% $ 10,300
Due after 1 through 5 years 3.10 24,939 17.05 21,851
Due after 5 through 10 years 4.00 181 21.44 6,023
Due after 10 years ......... -- -- 24.60 1,353
------------- -------------
$ 86,215 $ 39,527
============= =============
Realized and unrealized gains on trading and match funded securities for
the years ended December 31, 2004, 2003 and 2002 were comprised of the
following:
2004 2003 2002
---------- ---------- ----------
Unrealized gains (losses):
Trading securities .............. $ (1,067) $ 3,226 $ 1,727
Match funded securities ......... -- (248) 293
---------- ---------- ----------
(1,067) 2,978 2,020
---------- ---------- ----------
Realized gains:
Trading securities .............. 530 366 4,992
---------- ---------- ----------
$ (537) $ 3,344 $ 7,012
========== ========== ==========
Our subordinate and residual securities at December 31, 2004, 2003 and
2002 include retained interests with a fair value of $907, $1,346 and $1,465,
respectively, from securitizations of our loans completed in prior years. We
have not securitized any loans since 1999.
NOTE 6 MATCH FUNDED ASSETS
Our match funded assets are comprised of the following at December 31:
2004 2003
---------- ----------
Match funded advances on loans serviced for others:
Principal and interest ........................ $ 107,102 $ 54,516
Taxes and insurance ........................... 107,710 30,176
Other ......................................... 61,814 21,096
---------- ----------
276,626 105,788
---------- ----------
Match funded loans:
Commercial loans .............................. 4,134 --
Single family residential loans ............... -- 24,393
Allowance for loan losses ..................... -- (94)
---------- ----------
4,134 24,299
---------- ----------
$ 280,760 $ 130,087
========== ==========
Match funded advances on loans serviced for others resulted from the
transfer of certain advances on loans serviced for others to third parties under
two lending facilities. The second lending agreement is the result of the
advance securitization completed in November 2004. According to the terms of the
agreements, we retain the option, at any time, to purchase from the transferee
up to 5% under one agreement and up to 20% under the other agreement of the
aggregate advances outstanding and the right to select the specific advances to
be repurchased. Accordingly, we retain control of the advances and therefore the
transfer did not qualify as a sale for accounting purposes. As a result, the
proceeds we received from the transfer are reported as a secured borrowing with
pledge of collateral (match funded liabilities) in our consolidated statement of
financial condition. See Note 14 - "Match Funded Liabilities".
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 (match funded liabilities).
85
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
We acquired single-family residential match funded loans in connection
with our acquisition of OAC in 1999. OAC had previously securitized these loans
in 1998 and transferred them to a real estate mortgage investment conduit, 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 reported the proceeds that we received
from the transfer as a liability (match funded liabilities). 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. During the third
quarter of 2004, we exercised our option to redeem the notes (match funded
liabilities) 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.
NOTE 7 REAL ESTATE
Our real estate assets consisted of the following at December 31:
2004 2003
---------- ----------
Properties accounted for as held and used (1)
Office building .............................. $ -- $ 37,553
Retail ....................................... -- 43,460
---------- ----------
-- 81,013
---------- ----------
Properties accounted for as held for sale (2)
Retail ....................................... 8,827 10,657
Hotel ........................................ -- 6,171
Land ......................................... 844 --
Single family residential .................... 515 882
---------- ----------
10,186 17,710
---------- ----------
Total investment in real estate properties ....... 10,186 98,723
Investment in real estate partnerships (3) ....... 8,546 5,220
---------- ----------
$ 18,732 $ 103,943
========== ==========
(1) Properties accounted for as held and used at December 31, 2003 consisted
of an office building and one shopping mall, both located in Florida.
These properties were sold in 2004 for a net gain of $759.
(2) Properties accounted for as held for sale at December 31, 2004 primarily
consisted of one retail shopping center in Halifax, Nova Scotia. In
February 2005, we sold the subsidiary that held our investment in the
shopping center. At December 31, 2003, properties classified as held for
sale were comprised primarily of the retail shopping center in Halifax,
and one hotel located in Michigan. During 2004, we sold the hotel for a
gain of $351.
(3) Consists 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 2004, we forgave these loans to the
venture in exchange for an increased investment in the partnership.
86
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The following schedule presents the activity, in aggregate, in the
valuation allowance on our real estate classified as held for sale for the years
ended December 31:
2004 2003 2002
---------- ---------- ----------
Balance at beginning of year ......... $ 1,279 $ 4,591 $ 19,098
Provision for losses ................. 3,059 (96) 19,685
Charge-offs .......................... (37) (2,459) (5,304)
Sales ................................ (1,146) (757) (7,835)
Basis adjustment (1) ................. -- -- (21,053)
---------- ---------- ----------
Balance at end of year ............... $ 3,155 $ 1,279 $ 4,591
========== ========== ==========
(1) Our shopping mall property, which we had held for more than one year,
was being repositioned for future sale. This valuation allowance had
been established to carry this asset at the lower of cost or fair value
less estimated costs to sell. Under SFAS No. 144, which became effective
in 2002, we began accounting for this property as held for use, and we
applied the valuation allowance as a reduction of cost.
We recorded impairment charges on properties, while classified as held
and used, of $946, $7,526 and $14,549 during 2004, 2003 and 2002, respectively.
In addition, we recorded impairment charges on our real estate partnership
interests of $1,105 and $768 during 2004 and 2002, respectively.
NOTE 8 RESIDENTIAL LOAN SERVICING
Under contractual servicing agreements with investors, we service
mortgage and non-mortgage loans that we do not own. The total unpaid principal
balance of such loans we serviced for others was $34,524,491 and $37,697,318 at
December 31, 2004 and 2003, respectively, and is excluded from our consolidated
statements of financial condition. We similarly exclude from our statements of
financial condition funds representing collections of principal and interest we
have received from borrowers that are on deposit with an unaffiliated bank.
Those funds amounted to $867,884 and $1,429,986 at December 31, 2004 and 2003,
respectively. Servicing fees and other servicing-related income we earned on
loans we serviced for others, net of servicing rights amortization, amounted to
$125,119, $118,318 and $118,250 for the years ended December 31, 2004, 2003 and
2002, respectively. These net fees are included in servicing and other fees in
our consolidated statements of operations. In general, these servicing
agreements include guidelines and procedures for servicing the loans, including
servicing, remittance and reporting requirements, among other provisions.
We earn servicing and sub-servicing income primarily on mortgage loans
secured by real estate in 50 states. At December 31, 2004, the geographic
distribution based on the unpaid principal balance of the loans we serviced was
as follows:
Amount (1) No. of loans (1)
---------------- ----------------
California ....................................... $ 7,903,488 41,158
Florida .......................................... 2,660,650 26,196
New York ......................................... 2,319,472 15,370
Texas ............................................ 1,757,856 25,040
Illinois ......................................... 1,679,636 14,586
Other (2) ........................................ 18,203,389 197,835
---------------- ----------------
$ 34,524,491 320,185
================ ================
(1) Included 1,338 non-mortgage loans with an unpaid principal balance of
$140,757.
(2) Consisted of loans in 45 other states, the District of Columbia, three
U.S. territories and one foreign country, none of which aggregated over
$1,296,839 in any one state.
The risk inherent in such concentrations is dependent upon regional and
general economic conditions that affect property values.
87
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The following table summarizes the activity in our servicing rights for
the years ended December 31:
2004 2003 2002
---------- ---------- ----------
Balance at beginning of year ......... $ 166,495 $ 171,611 $ 100,765
Purchases ............................ 60,950 88,829 128,891
Amortization ......................... (96,036) (93,558) (58,045)
Impairment ........................... -- (387) --
---------- ---------- ----------
Balance at end of year ............... $ 131,409 $ 166,495 $ 171,611
========== ========== ==========
At December 31, 2004 and 2003, we estimated the fair value of our
servicing rights to be $152,148 and $227,825, respectively, by discounting
future underlying loan cash flows. As more fully described in Note 1, the more
significant assumptions used in the December 31, 2004 valuation include a
discount rate of 18%, constant prepayment speeds ranging from 29% to 42%
(depending on loan type), delinquency rates ranging from 2% to 34% (depending on
loan type), an interest rate of six-month LIBOR plus 300 basis points for
computing the cost of servicing advances and an interest rate of six-month LIBOR
for computing float income.
Advances on loans serviced for others consisted of the following at
December 31:
2004 2003
---------- ----------
Principal and interest ............................ $ 51,782 $ 118,024
Taxes and insurance ............................... 94,926 145,507
Other ............................................. 93,375 110,802
---------- ----------
$ 240,083 $ 374,333
========== ==========
Advances on loans serviced for others are net of reserves of $5,212 and
$4,002 at December 31, 2004 and 2003, respectively. The $5,212 of reserves at
December 31, 2004 include $4,115 to provide for forbearance plan fees and
multiple breach fees that may no longer be collectible. Advances on loans
serviced for others do not include advances on our loan portfolios of $347 and
$436 at December 31, 2004 and 2003, respectively. These advances also do not
include advances reported as part of match funded assets. See Note 6.
NOTE 9 PREMISES AND EQUIPMENT
Our premises and equipment are summarized as follows at December 31:
2004 2003
---------- ----------
Computer hardware and software .................... $ 67,483 $ 61,748
Building .......................................... 19,641 19,601
Leasehold improvements ............................ 10,508 8,985
Land and land improvements ........................ 4,049 4,041
Furniture and fixtures ............................ 8,677 8,395
Office equipment and other ........................ 3,887 3,572
Less accumulated depreciation and amortization .... (76,805) (64,399)
---------- ----------
$ 37,440 $ 41,943
========== ==========
Depreciation expense amounted to $12,312, $12,406 and $13,004 for 2004,
2003 and 2002, respectively (of which $2,925, $2,455 and $2,562 for 2004, 2003
and 2002, respectively, related to computer software). Building represents our
customer service and collection facility in Orlando, Florida. We used this
building as collateral to secure a mortgage in October 2004. See Note 15.
88
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 10 RECEIVABLES
Receivables consisted of the following at the dates indicated:
December 31,
-----------------------
2004 2003
---------- ----------
Residential Loan Servicing (1) .................... $ 23,241 $ 18,564
OTX ............................................... 2,360 1,442
Ocwen Realty Advisors ............................. 2,011 962
Ocwen Recovery Group .............................. 341 260
Business Process Outsourcing ...................... 1,532 969
Commercial Servicing .............................. 2,530 1,324
Commercial Assets ................................. 192 2,848
Affordable Housing (2) ............................ 18,308 25,581
Corporate Items and Other (3) ..................... 76,204 22,365
---------- ----------
$ 126,719 $ 74,315
========== ==========
(1) Consist principally of fees earned and reimbursable expenses due from
investors. Receivables representing fees earned totaled $4,069 and
$2,769 at December 31, 2004 and 2003, respectively.
(2) Primarily represents payments to be received in future years of proceeds
from the sales of affordable housing properties, net of unaccreted
discount of $2,346 and $2,901 at December 31, 2004 and 2003,
respectively. Balances are also net of reserves for doubtful accounts of
$5,596 and $4,232 at December 31, 2004 and 2003, respectively.
(3) Includes $61,591 and $21,465 of income taxes receivable at December 31,
2004 and 2003, respectively. At December 31, 2004, income taxes
receivable includes $56,526 of federal tax refund claims, the payment of
which is subject to final approval by the Joint Committee on Taxation of
the U.S. Congress. We have agreed with the IRS to extend the statute of
limitations with respect to these claims until December 31, 2005, and we
currently expect that this approval will be issued prior to that date.
The receivable balance at December 31, 2004 also included $6,872 of
accrued interest on the federal tax refund claims.
NOTE 11 OTHER ASSETS
Other assets consisted of the following at the dates indicated:
December 31,
-----------------------
2004 2003
---------- ----------
Deferred tax assets, net (1) ...................... $ 17,683 $ 7,547
Deferred debt related costs, net (2) .............. 11,216 3,113
Interest earning insurance collateral deposits (3) 8,905 8,813
Loans held for resale (4) ......................... 8,437 --
Interest earning reserve accounts (5) ............. 5,850 4,279
Goodwill, net (6) ................................. 5,312 1,618
Prepaid expenses .................................. 4,069 3,750
Stocks and mutual funds (7) ....................... 2,886 14
Capitalized software development costs, net ....... 1,147 2,598
Other ............................................. 3,472 1,876
---------- ----------
$ 68,977 $ 33,608
========== ==========
(1) Deferred tax assets are net of valuation allowances of $165,927 and
$201,445 at December 31, 2004 and 2003, respectively. See Note 19 for
additional information regarding deferred tax assets.
(2) Deferred debt related costs at December 31, 2004 include $6,107 of
capitalized costs directly related to our issuance of the $175,000
Convertible Notes on July 28, 2004. See Note 16 for additional
information regarding the Convertible Notes.
89
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
(3) 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.
(4) Loans originated in response to requests from Residential Loan Servicing
customers to refinance their mortgages. Only loans with sales
commitments prior to closing are originated under this program. All of
these loans were sold in January 2005.
(5) Represents amounts set aside from the proceeds of our match funded
advance facilities to provide for possible shortfalls in the funds
available to pay certain expenses and interest.
(6) Goodwill at December 31, 2004 includes $3,694 related to our acquisition
of BOK on September 30, 2004. See Note 3 for additional information
regarding this acquisition.
(7) The balance at December 31, 2004 primarily represents an investment by
the Bank in a mutual fund that invests in assets that meet the
requirements of the Community Reinvestment Act.
NOTE 12 DEPOSITS
Our deposits consisted of the following at December 31:
2004 2003
---------- ----------
Non-interest-bearing deposits ..................... $ 4,513 $ 4,879
NOW and money market checking accounts ............ 12,541 18,313
Savings accounts (1) .............................. 6,574 1,657
---------- ----------
23,628 24,849
---------- ----------
Certificates of deposit (1) (2) (3) ............... 277,671 421,657
Unamortized deferred fees ......................... -- (118)
---------- ----------
277,671 421,539
---------- ----------
$ 301,299 $ 446,388
========== ==========
(1) Deposit balances at December 31, 2004 include $4,770 of savings accounts
and $6,022 of certificates of deposit held by BOK, a German bank we
acquired in 2004. See Note 3 for additional information regarding this
acquisition.
(2) At December 31, 2004 and 2003, certificates of deposit included $26,418
and $84,426, respectively, of brokered deposits originated through
national, regional and local investment banking firms, which solicit
deposits from their customers, all of which are non-cancelable. We have
not issued any new brokered certificates of deposit since 2000 and, at
this time, do not intend to issue any such deposits in the foreseeable
future.
(3) At December 31, 2004 and 2003, certificates of deposit with outstanding
balances of $100 or more amounted to $75,899 and $137,746, respectively.
Of such deposits at December 31, 2004, $8,800 were from political
subdivisions in New Jersey and are secured or collateralized as required
under state law.
The contractual remaining maturity of our certificates of deposit at
December 31, 2004 is as follows:
Within one year ................................ $ 201,934
Within two years ............................... 46,759
Within three years ............................. 21,617
Within four years .............................. 7,226
Within five years .............................. 135
----------
$ 277,671
==========
90
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
We amortize deferred fees on certificates of deposit on a straight-line
basis over the term of the respective certificates of deposit. Such amortization
amounted to $118, $519 and $912 for the years ended December 31, 2004, 2003 and
2002, respectively, and is included in interest expense on deposits. Interest
expense we incurred by type of deposit account was as follows for the years
ended December 31:
2004 2003 2002
---------- ---------- -----------
NOW accounts and money market checking ........... $ 572 $ 514 $ 527
Savings .......................................... 14 14 18
Certificates of deposit .......................... 13,048 17,018 26,910
---------- ---------- ----------
$ 13,634 $ 17,546 $ 27,455
========== ========== ==========
Accrued interest payable on our deposits amounted to $910 and $1,693 at
December 31, 2004 and 2003, respectively.
NOTE 13 ESCROW DEPOSITS
Escrow deposits on loans we own and on loans we serviced for others
consisted of the following at December 31:
2004 2003
---------- ----------
Taxes and insurance payments held on loans serviced for others $ 105,924 $ 96,924
Other escrow deposits ........................................ 20,053 19,520
---------- ----------
$ 125,977 $ 116,444
========== ==========
NOTE 14 MATCH FUNDED LIABILITIES
Our match funded liabilities are accounted for as secured borrowings
with pledges of collateral and were comprised of the following at December 31:
December 31,
------------
Collateral Interest rate 2004 2003
- ----------------------------------------- ----------------------------- ------------ -----------
Advances on loans serviced for others (1) LIBOR plus 175 basis points $ 90,851 $ 94,967
Advances on loans serviced for others (2) See (2) 149,342 --
Single family loans (3) LIBOR plus 65-70 basis points -- 20,427
Commercial loans (4) 4,134 --
------------ -----------
$ 244,327 $ 115,394
============ ===========
(1) Under the terms of the agreement, we are eligible to finance additional
advances on loans serviced for others up to a maximum balance of
$200,000. This facility will mature January 2006.
(2) In November 2004, we executed a servicing advance securitization. This
transaction involved the issuance of a term note for $100,000 and a
one-year variable funding note for a maximum of $75,000. The term note
bears interest at LIBOR plus 50 basis points. The variable funding note
bears interest at a commercial paper rate plus a margin that
approximates LIBOR plus 53 basis points. Under the terms of the
agreement, as of December 31, 2004, we are eligible to finance
additional advances on loans serviced for others of $25,658. The term
note under this facility has a stated maturity of October 2013. The
variable funding note has a stated maturity of November 2010.
(3) During the third quarter of 2004, we exercised our option to redeem the
bonds that were secured by single family loans. See Note 6.
(4) Represents a 100% participation interest held by a third party.
Match funded liabilities are obligations secured by the collateral
underlying the related match funded assets, and are repaid through the cash
proceeds arising from those assets.
At December 31, 2004 and 2003, match funded liabilities had a weighted
average interest rate of 3.32% and 2.56%, respectively. Accrued interest payable
on our match funded liabilities amounted to $121 and $71 at December 31, 2004
and 2003, respectively. We incurred interest expense on match funded liabilities
of $4,923, $5,414 and $6,573 during 2004, 2003 and 2002, respectively.
91
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Match funded liabilities contain various qualitative and quantitative
covenants that, among other things, establish requirements for the monitoring
and reporting of specified financial transactions and reporting on defined
events affecting the collateral underlying the agreements. We are currently in
compliance with these covenants. We are also in discussions with our lenders to
amend the lending agreements such that we will not be in default should we
succeed in terminating our status as a federal savings bank. We anticipate
successful completion of the discussions prior to debanking.
NOTE 15 LINES OF CREDIT AND OTHER SECURED BORROWINGS
Through our subsidiaries we have obtained secured lines of credit from various
unaffiliated financial institutions at December 31 as follows:
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
Line of credit Advances on loans serviced October 2004 LIBOR + 200 basis -- 9,386
for others (2) points
Senior secured credit Purchased mortgage April 2005 LIBOR + 162.5 or 24,218 35,321
agreement servicing rights and 225 basis points
advances on loans
serviced for others (3)
Senior secured credit Purchased mortgage December 2005 LIBOR + 250 basis 11,458 --
agreement servicing rights points
Installment notes Purchased mortgage July 2004 2.81% -- 2,332
servicing rights
Mortgage note Real estate - office May 2005 LIBOR + 350 basis -- 20,000
building (4) points, floor of
5.75%
Mortgage note Office building (5) October 2014 5.62% 14,936 --
Secured loan Trading securities - UK November 2004 LIBOR + 275 basis -- 11,562
unrated subprime points
residuals
Term loan Loan receivable March 2005 LIBOR + 250 basis -- 3,235
points
------------- -----------
$ 50,612 $ 150,384
============= ===========
(1) LIBOR was 2.40% and 1.12% at December 31, 2004 and 2003, respectively.
(2) This line was fully repaid subsequent to December 31, 2003 and was not
renewed.
(3) Maximum amount of borrowing under this facility is $70,000. We are
currently in negotiations with the lender to possibly extend the
maturity date and increase the maximum amount of borrowing.
(4) We sold our office building located in Jacksonville, Florida in January
2004 and the buyer assumed this note at that time. See Note 7.
(5) Collateral represents our loan servicing call center located in Orlando,
Florida. See Note 9.
Each of our lines contains qualitative and quantitative covenants that
establish, among other things, the maintenance of specified net worth and
restrictions on future indebtedness, as well as the monitoring and reporting of
various specified transactions or events. We are currently in compliance with
these covenants. While we have not historically paid dividends, our covenants,
by establishing net worth requirements, in effect limit the amount of dividends
that could be paid. As of December 31, 2004, the most restrictive limitation of
all the covenants would limit dividends that could be paid to $50,500. As
required under the terms of certain of the lending agreements, we have obtained
approval of the lenders accepting the replacement of our chief financial
officer, who resigned on March 2, 2005. We are also in discussions with our
lenders to amend the lending agreements such that we will not be in default
should we succeed in terminating our status as a federal savings bank.
The maximum month end amount outstanding under lines of credit and other
secured borrowings was $113,790 and $188,947 for the years ended December 31,
2004 and 2003, respectively. The average balance of obligations outstanding
under lines of credit and other secured borrowings was $66,271 and $130,886
during the years ended December 31, 2004 and 2003, respectively, and the
weighted average interest rates were 4.10% and 4.45%, respectively.
92
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Accrued interest payable on our obligations outstanding under lines of
credit and other secured borrowings amounted to $112 and $516 at December 31,
2004 and 2003, respectively. Interest expense we incurred on our obligations
outstanding under lines of credit and other secured borrowings amounted to
$2,717, $5,824 and $4,152 during 2004, 2003 and 2002, respectively.
At December 31, 2004 and 2003, we had no repurchase agreements
outstanding. The average balance of repurchase agreements outstanding was $0 and
$250 during the years ended December 31, 2004 and 2003, respectively, and the
weighted average interest rate was 1.20%, for the year ended December 31, 2003.
The weighted average interest rates on our obligations outstanding
under lines of credit and other secured borrowings were 4.84% and 3.59% at
December 31, 2004 and 2003, respectively.
NOTE 16 DEBT SECURITIES
Our debt securities consisted of the following at December 31:
2004 2003
---------- ----------
3.25% Convertible Notes due August 1, 2024......... $ 175,000 $ --
10.875% Capital Securities due August 1, 2027 ..... 56,249 56,249
---------- ----------
$ 231,249 $ 56,249
========== ==========
In addition to the specific requirements discussed below, each of our
debt securities contain qualitative and quantitative covenants that establish,
among other things, the maintenance of specified net worth and restrictions on
future indebtedness, as well as the monitoring and reporting of various
specified transactions or events. We are currently in compliance with these
covenants.
Convertible Notes. In July 2004, OCN issued $175,000 aggregate principal
amount of 3.25% Contingent Convertible Senior Unsecured Notes due 2024
("Convertible Notes") in a private placement as permitted by 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. Interest expense for the period from July 28, 2004 through
December 31, 2004 amounted to $2,972, including amortization of issuance costs.
Interest payable on the Convertible Notes amounted to $2,417 at December 31,
2004. 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 December 31, 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. We elected not to permit
conversion following the implementation of EITF 04-8 in the fourth quarter of
2004.
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.
93
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
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 $6,107 at December 31, 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
investment grade securities.
In conjunction with our issuance of the Convertible Notes, we entered
into a registration rights agreement for the benefit of the holders of the
notes. Pursuant to the agreement, we agreed to file with the Securities and
Exchange Commission a registration statement covering re-sales by holders of all
notes and the common stock issuable upon conversion of the notes. We also agreed
to use our reasonable best efforts to cause such registration statement to
become effective not later than January 24, 2005. The registration statement was
declared effective on March 15, 2005. As a result, cash liquidated damages have
accrued on the notes since January 24, 2005, totaling $61, of which $10 was paid
on the first semiannual interest payment date of February 1, 2005. Liquidated
damages accrue at a rate per year equal to 0.25% of the principal amount of a
note to and including the 90th day following such registration default; and
0.50% of the principal amount of a note from and after the 91st day following
such registration default. The balance of the liquidated damages will be paid on
the second semiannual interest payment date of August 1, 2005.
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 were reported on the Capital
Securities in a separate caption immediately following non-interest expense in
our consolidated statement of operations. Effective with our adoption of SFAS
No. 150 on July 1, 2003, the Capital Securities are presented as a liability in
the consolidated statement of financial condition as a component of Debt
Securities. At the same time, we began reporting distributions on the Capital
Securities as a component of interest expense in the consolidated statement of
operations. During 2002 and 2001, we repurchased $4,910 and $18,371,
respectively, of our Capital Securities in the open market, resulting in gains
of $1,074 and $3,723, respectively.
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
$1,000 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 $6,117 and $6,118 in 2004 and
2003, respectively, of which $6,117 and $3,059 has been reported as interest
expense as discussed in the paragraph above. Accumulated distributions payable
on the Capital Securities amounted to $2,549 at both December 31, 2004 and 2003,
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
any dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, their capital stock or (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 thereof on August 1, 2007, declining ratably on
each August 1 thereafter to 100% on or after August 1, 2017, plus accrued
interest thereon, 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.
94
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
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.
In connection with our issuance of the Capital Securities, we incurred
certain costs that we capitalized and are amortizing over the term of the
Capital Securities. The unamortized balance of these issuance costs amounted to
$1,691 and $1,766 at December 31, 2004 and 2003, respectively, and is included
in other assets.
NOTE 17 BASIC AND DILUTED EARNINGS PER SHARE
We are required to present both basic and diluted EPS on the face of our
statement of operations. Basic EPS excludes common stock equivalents and is
calculated by dividing net income by the weighted average number of common
shares outstanding during the year. We calculate diluted EPS by dividing net
income, as adjusted to add back interest expense on the Convertible Notes, by
the weighted average number of common shares outstanding, including the dilutive
potential common shares related to outstanding stock options, restricted stock
awards and the Convertible Notes.
The following is a reconciliation of the calculation of basic EPS to
diluted EPS for the years ended December 31:
2004 2003 2002
------------- ------------- -------------
Basic EPS:
Net income (loss) ................................. $ 57,724 $ 4,772 $ (68,775)
============= ============= =============
Weighted average shares of common stock ........... 65,811,697 67,166,888 67,321,299
============= ============= =============
Basic EPS ......................................... $ 0.88 $ 0.07 $ (1.02)
============= ============= =============
Diluted EPS:
Net income (loss) ................................. $ 57,724 $ 4,772 $ (68,775)
Interest expense on Convertible Notes,
net of income tax (1) .......................... 2,378 -- --
------------- ------------- -------------
Adjusted net income (loss) ........................ $ 60,102 $ 4,772 $ (68,755)
============= ============= =============
Weighted average shares of common stock ........... 65,811,697 67,166,888 67,321,299
Effect of dilutive elements:
Convertible Notes (1) ........................... 6,129,022 -- --
Stock options (2) ............................... 992,337 493,889 --
Restricted stock awards ......................... 264,199 403,096 --
------------- ------------- -------------
Dilutive weighted average of common stock ......... 73,197,255 68,063,873 67,321,299
============= ============= =============
Diluted EPS ....................................... $ 0.82 $ 0.07 $ (1.02)
============= ============= =============
(1) The effect of our Convertible Notes on diluted EPS is computed using the
if-converted method in accordance with the provisions of EITF 04-8, as
described in Note 1. The Convertible Notes are assumed to have been
converted to common shares at the time the Convertible Notes were issued
on July 28, 2004. Interest expense applicable to the Convertible Notes,
including amortization of capitalized costs, which we report as a
component of interest expense, is added back to net income.
(2) Excludes the effect of all options in the year 2002, because options are
antidilutive in the event of a loss, and the effect of an average of
1,274,364 and 2,818,332 of options that were antidilutive for 2004 and
2003, respectively, because their exercise price was greater than the
average market price of our stock.
95
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 18 DERIVATIVE FINANCIAL INSTRUMENTS
FOREIGN CURRENCY EXCHANGE RATE RISK MANAGEMENT
We entered into foreign currency derivatives to hedge our net
investments in foreign subsidiaries that own residual securities backed by
subprime residential loans originated in the UK and that own a shopping center
located in Halifax, Nova Scotia. Our principal exposure to foreign currency
exchange rates exists 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 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. 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 our investment in 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 the dates indicated:
Position Maturity Notional Amount Strike Rate Fair Value
---------- ------------ --------------- ------------ ------------
December 31, 2004:
Canadian Dollar currency futures (1) .. Short March 2005 C$ 11,500 0.8416 $ 109
British Pound currency futures (1) .... Short March 2005 (Pound) 17,000 1.9248 301
------------
$ 410
============
December 31 2003:
Canadian Dollar currency futures ...... Short March 2004 C$ 10,000 0.7660 $ (34)
British Pound currency futures ........ Short March 2004 (Pound) 16,500 1.7292 (737)
------------
$ (771)
============
(1) The U.S. Dollar equivalent notional amount of the Canadian Dollar
currency futures and British Pound currency futures at December 31, 2004
was $9,570 and $32,609, respectively.
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.
INTEREST RATE RISK MANAGEMENT
From time to time we enter into interest rate swaps. Under interest rate
swaps, we agree with other parties to exchange, at specified intervals, the
difference between fixed-rate and floating-rate interest amounts calculated by
reference to an agreed upon notional amount. We are exposed to credit loss when
we enter into interest rate swaps if: (i) the counterparty to the interest rate
swap does not perform and (ii) the interest rate that we receive exceeds the
interest rate that we pay.
We had no interest rate swaps outstanding at December 31, 2004 or 2003.
During 2003, we realized gains of $1,076 on swaps that we included in
non-interest revenue. While these two swaps were entered into for interest rate
risk management purposes, they did not meet the criteria to be accounted for
under hedge accounting. Accordingly, they were accounted for at fair value with
changes in fair value recorded in our consolidated statements of operations. We
entered into no swap agreements during 2004 or 2002.
The amortizing interest rate caps and floors we had purchased in 1999 to
hedge our interest rate exposure relating to our match funded loans and
securities matured in October 2003. Net realized and unrealized gains and
(losses) included in earnings to record these caps and floors at fair value
during 2003 and 2002 amounted to $(592) and $188, respectively.
96
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The following table summarizes our use of interest rate risk management
instruments:
Notional Amount
-----------------------------------------------
Interest Rate
Swaps Caps Floors
------------- ------------- -------------
Balance, December 31, 2002 ....................... $ -- $ 111,799 $ 30,563
Purchases ........................................ 200,000 -- --
Maturities ....................................... -- (111,799) (30,563)
Terminations ..................................... (200,000) -- --
------------- ------------- -------------
Balance, December 31, 2003 ....................... $ -- $ -- $ --
============= ============= =============
NOTE 19 INCOME TAXES
The components of income tax expense (benefit) were as follows:
Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Current:
Federal ............................................................. $ (23,019) $ 667 $ 1,817
State ............................................................... 241 49 --
Foreign ............................................................. 224 163 --
---------- ---------- ----------
(22,554) 879 1,817
---------- ---------- ----------
Deferred:
Federal ............................................................. 25,742 (2,401) (30,798)
State ............................................................... -- 95 (2,085)
Foreign ............................................................. 6 -- --
Provision for (reversal of) valuation allowance on deferred tax
asset .............................................................. (35,518) 2,175 34,049
---------- ---------- ----------
(9,770) (131) 1,166
---------- ---------- ----------
Income tax expense (benefit) before change in accounting principle .... (32,324) 748 2,983
Income tax benefit on change in accounting principle .................. -- -- (1,166)
---------- ---------- ----------
Total ................................................................. $ (32,324) $ 748 $ 1,817
========== ========== ==========
Income tax expense (benefit) before the effect of change in accounting
principle differs from the amounts computed by applying the U.S. Federal
corporate income tax rate of 35% as follows:
Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Expected income tax expense (benefit) at statutory rate ............... $ 8,890 $ 1,760 $ (27,933)
Differences between expected and actual expense (benefit)
Excess of cost over net assets acquired, net ...................... (1,023) (931) 1,051
State tax (after Federal tax benefit) ............................. 157 94 (1,355)
Low-income housing tax credits .................................... (4,848) (2,393) (2,685)
Deferred tax asset valuation allowance expense (benefit) .......... (35,518) 2,175 34,049
Other ............................................................. 18 43 (144)
---------- ---------- ----------
Actual income tax expense (benefit) ........................... $ (32,324) $ 748 $ 2,983
========== ========== ==========
97
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The net deferred tax asset was comprised of the following as of
December 31:
2004 2003
---------- ----------
Deferred Tax Assets:
Tax residuals and deferred income on tax residuals ........................... $ 1,159 $ 5,688
State taxes .................................................................. 8,465 8,456
Accrued incentive compensation ............................................... 2,368 2,609
Accrued other liabilities .................................................... 1,423 418
Interest expense related to discount loan portfolio .......................... -- 5,453
Valuation allowance on real estate owned ..................................... 444 10,455
Gain on loan foreclosure ..................................................... -- 4,430
Bad debt and allowance for loan losses ....................................... 3,067 7,936
Impairment on securities available for sale and unrealized gains and losses on
trading securities ......................................................... 7,226 10,011
Mortgage servicing rights amortization ....................................... 61,216 24,094
Goodwill amortization ........................................................ 960 1,152
Foreign currency exchange .................................................... 1,075 1,075
Capital loss carryforward .................................................... 8,601 21,110
Net operating loss carryforward .............................................. 27,086 71,061
Partnership losses and low-income housing tax credits ........................ 62,904 42,550
---------- ----------
185,994 216,498
---------- ----------
Deferred Tax Liabilities:
Deferred interest income on loans ............................................ 1,255 6,421
Loss on loan foreclosure ..................................................... 61 --
Research and development costs ............................................... 324 647
Other ........................................................................ 744 439
---------- ----------
2,384 7,507
---------- ----------
183,610 208,991
Valuation allowances ............................................................. (165,927) (201,445)
---------- ----------
Net deferred tax asset ........................................................... $ 17,683 $ 7,546
========== ==========
We conduct periodic evaluations of positive and negative evidence to
determine whether it is more likely than not that the deferred tax asset can be
realized in future periods. Among the factors considered in this evaluation are
estimates of future taxable income, the future reversal of temporary
differences, tax character and the impact of tax planning strategies that can be
implemented if warranted. As a result of this evaluation, we included in the tax
provision a decrease of $35,518 to the valuation allowance for 2004 and an
increase of $2,175 and $34,049 to the valuation allowance for 2003 and 2002,
respectively.
As of December 31, 2004, we had a deferred tax asset valuation allowance
totaling $165,927. This allowance is comprised of $38,873 relating to built-in
loss limitations arising from our acquisition of OAC and $127,054 relating to
our evaluation of the future realization of prior years deferred tax asset.
Before our acquisition of OAC, OAC was a REIT for federal tax purposes
and filed a REIT federal income tax return through October 20, 1999. We have
included OAC in our consolidated federal income tax return since October 21,
1999. OAC had, at October 6, 1999, approximately $131,567 of net unrealized
built-in losses. Any such losses recognized within the five-year period
beginning on October 7, 1999 (the "recognition period") are treated as
pre-change losses and, as such, are subject to an annual limit as to the amount,
which may offset the taxable income of Ocwen Financial Corporation and its
subsidiaries ("the IRC section 382 limitation"). A net unrealized built-in loss
is an amount by which the tax basis of the corporation's assets at the time of
the change in ownership exceeds the aggregate fair market value of those assets
at that time. The IRC section 382 limitation is determined by multiplying the
value of OAC's stock by the federal long-term tax-exempt rate and amounts to
approximately $5,700. If a deduction is denied for any recognized built-in loss
in any post-change year, the loss is carried forward to subsequent years under
rules similar to the standard loss carryforward rules. As a result of these
limitations, we established a corresponding deferred tax asset valuation
allowance at the acquisition date as part of purchase accounting in the amount
of $38,873. At December 31, 2004, we had realized built-in losses of $101,938,
which consists of net operating loss carryforwards of $77,390 and capital loss
carryforwards of $24,548.
98
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Deferred tax assets, net of deferred fees, include tax residuals, which
result from the ownership of Real Estate Mortgage Investment Conduits ("REMIC").
While a tax residual is anticipated to have little or no future cash flows from
the REMIC from which it has been issued, the tax residual does bear the income
tax liability and benefit resulting from the annual differences between the
interest paid on the debt instruments issued by the REMIC and the interest
received on the mortgage loans held by the REMIC. Typically this difference
generates taxable income to the Company in the first several years of the REMIC
and equal amounts of tax losses thereafter, thus resulting in the deferred tax
asset. The current Federal income tax expense in 2003 and 2002 is the result of
excess inclusion income generated by REMIC residuals.
At December 31, 2003, we had net operating loss carryforwards of
$123,699 and capital loss carryforwards of $35,767. During 2004, we filed claims
with the Internal Revenue Service to carryback these net operating losses and
capital losses to prior years in which taxes were paid. At December 31, 2004, we
had tax credit carryforwards of $51,057 related to our low-income housing tax
credits, which expire in the years 2018 through 2024.
Prior to December 31, 1996, The Bank was permitted to deduct from
taxable income an allowance for bad debts, which was in excess of the provision
for such losses charged to income. Accordingly, at December 31, 2004, retained
earnings includes $5,700, for which no provision for income tax has been
provided. The base reserves will continue to be subject to recapture, and the
Bank could be required to recognize a tax liability if: (1) the Bank fails to
qualify as a "bank" for federal income tax purposes, (2) certain distributions
are made with respect to the stock of the Bank, (3) the bad debt reserves are
used for any purpose other than to absorb bad debt losses or (4) there is a
change in federal tax law.
We have not recognized a deferred tax liability for the tax bad debt
reserves of the Bank. If in the future, this portion of retained earnings is
distributed or the Bank no longer qualifies as a bank for tax purposes, federal
income tax of approximately $2,000 would be imposed.
NOTE 20 EMPLOYEE BENEFIT AND COMPENSATION PLANS
We maintain a defined contribution plan to provide postretirement
benefits to our eligible employees. We also adopted a number of compensation
plans for certain of our employees. We designed these plans to facilitate a
pay-for-performance policy, further align the interests of our officers and key
employees with the interests of our shareholders and assist in attracting and
retaining employees vital to our long-term success. These plans are summarized
below.
RETIREMENT PLAN
We maintain a defined contribution 401(k) plan. We match 50% of each
employee's contributions, limited to 2% of the employee's compensation. Our
contributions to the 401(k) plan for the years ended December 31, 2004, 2003 and
2002, were $490, $417 and $593, respectively.
In connection with our acquisition of Berkeley Federal Savings Bank in
June 1993, the Bank assumed the obligations under a noncontributory defined
benefit pension plan (the "Plan") covering substantially all employees upon
their eligibility under the terms of the Plan. We froze and fully funded the
Plan after the plan year ended December 31, 1993.
ANNUAL INCENTIVE PLAN
The Ocwen Financial Corporation 1998 Annual Incentive Plan (the "AIP")
is our primary incentive compensation plan for executives and other key
employees. Under the terms of the AIP participants can earn cash and equity
based awards as determined by the Compensation Committee. The awards are based
on objective performance criteria established by the Committee, including growth
in our core businesses, reduction in non-core assets, cost savings through Six
Sigma initiatives and utilization of India operations and the achievement of
other established performance goals. Non-qualified stock options to purchase our
common stock are issued as part of the AIP and are granted pursuant to the Ocwen
Financial Corporation 1991 Non-Qualified Stock Option Plan.
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OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The following table provides a summary of our stock option activity for
the years ended December 31, 2004, 2003 and 2002, respectively, and stock
options exercisable at the end of each of those years:
2004 2003 2002
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at beginning of year ....... 4,581,370 $ 8.08 4,723,166 $ 7.97 4,655,269 $ 9.01
Granted (1) ............................ 633,169 $ 8.01 431,982 $ 6.15 634,228 $ 1.87
Exercised .............................. (543,260) $ 4.47 (359,419) $ 4.51 (32,937) $ 4.62
Forfeited .............................. (392,010) $ 10.08 (214,359) $ 7.74 (533,394) $ 9.98
---------- ---------- ----------
Outstanding at end of year ............. 4,279,269 $ 8.34 4,581,370 $ 8.08 4,723,166 $ 7.97
========== ========== ==========
Exercisable at end of year ............. 2,805,555 $ 9.60 2,541,593 $ 9.72 2,744,160 $ 9.46
========== ========== ==========
(1) The weighted average grant-date fair value was $9.48 in 2004, $8.74 in
2003 and $2.67 in 2002.
The following table summarizes information about our stock options
outstanding at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Weighted Weighted
Average Remaining Average
Number of Exercise Contractual Number of Exercise
Award Year Options Price (1) Life Options Price
- -------------------- ---------- ---------- ----------- ---------- ----------
2004 ............... 633,169 $ 8.01 10 76,634 $ 6.57
2003 ............... 393,494 $ 6.15 9 101,660 $ 6.18
2002 ............... 402,751 $ 1.87 8 158,840 $ 1.87
2001 ............... 933,867 $ 8.68 7 695,392 $ 9.68
2000 ............... 728,121 $ 4.09 6 585,162 $ 4.09
1999 ............... 116,828 $ 6.25 5 116,828 $ 6.25
1998 ............... 69,123 $ 12.31 4 69,123 $ 12.31
1997 ............... 481,336 $ 20.35 3 481,336 $ 20.35
1996 ............... 431,580 $ 11.00 2 431,580 $ 11.00
1995 ............... 89,000 $ 2.88 1 89,000 $ 2.88
---------- ----------
4,279,269 $ 8.34 2,805,555 $ 9.60
========== ==========
(1) With the exception of 2004, 2003, and 2001 the weighted average exercise
price of outstanding options represents the actual exercise price. For
those years, options were granted at more than the exercise price. The
number of options outstanding and the respective exercise price for
award years 2004, 2003 and 2001 is as follows:
Award Year Options Outstanding Exercise Price
- -------------------- ------------------- --------------
2004 ............... 383,169 $ 6.57
2004 ............... 200,000 $ 10.60
2004 ............... 30,000 $ 8.56
2004 ............... 20,000 $ 8.75
-------------------
633,169
===================
2003 ............... 383,494 $ 6.18
2003 ............... 10,000 $ 4.92
-------------------
393,494
===================
2001 ............... 533,868 $ 5.79
2001 ............... 400,000 $ 12.55
-------------------
933,868
===================
After the awards of 633,169 options for 2004, the number of authorized
shares remaining and available for future awards of stock options is 5,660,385.
100
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Stock options we awarded under the annual incentive plan prior to 1998
had a one-year vesting period. Stock options we awarded under the AIP for 1998
and 1999 vested ratably over a three-year period. Stock options we awarded under
the AIP for 2000 and thereafter generally vest ratably over a five-year period,
including the award year. The term of all options granted is ten years from the
grant date. As discussed in the "Stock-Based Compensation" and "Current
Accounting Pronouncements" sections of Note 1, we currently treat the
difference, if any, between the fair market value of our stock at the date of
grant and the exercise price as compensation expense. We recognize this
compensation expense ratably over the vesting period of the grant. Included in
compensation expense for the years ended December 31, 2004, 2003 and 2002 was
$1,266, $1,226 and $922, respectively, related to options granted below fair
market value. Upon adoption of SFAS No. 123 (R), compensation expense related to
options will be measured based on the grant-date fair value of the options using
an option-pricing model.
NOTE 21 STOCKHOLDERS' EQUITY
On May 9, 2000, we announced that our Board of Directors authorized the
repurchase of up to 6,000,000 of our issued and outstanding shares of common
stock. To date, 431,100 shares have been repurchased under this plan (all in
2004). A total of 5,568,900 shares may still be purchased under this plan. On
May 16, 2003 we announced our initiation of a stock repurchase program to
purchase 700,000 shares of our issued and outstanding common stock with the
intent to utilize these repurchased shares as a portion of our annual incentive
awards to employees for service in 2002. During 2004 and 2003, we repurchased
200,000 and 500,000 shares, respectively, and issued 203,088 and 236,461 shares,
respectively, to employees. No shares remain to be purchased under this plan. We
also repurchased 4,850,000 shares in 2004 with a portion of the proceeds from
our issuance of the Convertible Notes in July. No shares remain to be purchased
under this plan.
NOTE 22 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 U.S. 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 borrowers
attorneys' fees for issuing notices of default (breach fees). 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
(forbearance fees). 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. Consistent with practices
in place prior to the date of the Agreement, 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.
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.
101
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
At December 31, 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 December 31, 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 limit our investment in mortgage servicing rights to an amount no
greater than 50% of stockholders' equity on a consolidated basis and no greater
than 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 limit and represented 40% of stockholders' equity
at December 31, 2004. At the Bank, mortgage servicing rights are also below the
limit, amounting to 49% of core capital at December 31, 2004.
We have recently begun the process of having the Bank terminate its
status as a federal savings bank under OTS and FDIC supervision, which would,
among other things, eliminate certain restrictions on our growth. If this
process, which we refer to as "debanking," is completed, 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 be completed,
Ocwen Financial Corporation 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. Our ability to debank is subject to a number of
contingencies, many of which are beyond our control, including approvals by the
OTS with respect to the application for a voluntary dissolution (which we filed
with the OTS on November 24, 2004) and sales of the Bank's deposits to third
parties. There can be no assurance that we ultimately will be successful in
debanking.
In connection with our debanking process, on February 4, 2005, we
entered into a Branch Purchase and Deposit Assumption Agreement (the "Branch
Purchase Agreement") with Marathon National Bank of New York ("Marathon").
Pursuant to the Branch Purchase Agreement, Marathon agreed to assume the deposit
liabilities of the accounts associated with the Bank branch facility in Fort
Lee, New Jersey. In addition, Marathon will take over the lease and other
contracts and acquire assets related to the branch. In connection with that
closing, Ocwen will make a cash payment to Marathon, which payment is calculated
based upon, among other things, the amount of those deposit account liabilities
as of the closing. As of February 28, 2005, the amount of the deposit
liabilities of the accounts subject to the Branch Purchase Agreement was
approximately $193,000. The transaction is subject to regulatory and other
customary approvals and conditions.
102
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
The following table summarizes the Bank's actual and required regulatory
capital at December 31, 2004 and 2003:
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
-------- ----------- ------- --------- ---------- --------- -------------
December 31, 2004
Shareholders' equity, and ratio to total assets 25.62% $ 214,054
Disallowed mortgage servicing rights ........... (9,042)
Disallowed deferred tax assets ................. (25,362)
Non-includable subsidiary ...................... (807)
Intangible assets (1) .......................... (2,845)
-----------
Tier 1 (core) capital and ratio to adjusted
total assets ................................. 22.07% 175,998 4.00% $ 31,892 5.00% $ 39,865 9.00%
Non-mortgage servicing rights .................. (1,014)
-----------
Tangible capital and ratio to tangible assets .. 21.97% $ 174,984 1.50% $ 11,944
===========
Tier 1 capital and ratio to risk-weighted assets 31.50% $ 175,998 6.00% $ 33,527
Tier 2 capital - Allowance for loan losses ..... 4,572
Real estate required to be deducted ............ (844)
Total risk-based capital and ratio to risk-
weighted assets .............................. 32.16% $ 179,726 8.00% $ 44,703 10.00% $ 55,879 13.00%
===========
Total regulatory assets ........................ $ 835,378
===========
Adjusted total assets .......................... $ 797,306
===========
Tangible assets ................................ $ 796,292
===========
Risk-weighted assets ........................... $ 558,791
===========
December 31, 2003
Shareholders' equity, and ratio to total assets 18.10% $ 183,230
Disallowed mortgage servicing rights ........... (10,846)
Disallowed deferred tax assets ................. (21,052)
Non-includable subsidiary ...................... (839)
Intangible assets (1) .......................... (3,078)
-----------
Tier 1 (core) capital and ratio to adjusted
total assets ................................. 15.09% 147,415 4.00% $ 39,064 5.00% $ 48,830 9.00%
Non-mortgage servicing rights .................. (1,892)
------------
Tangible capital and ratio to tangible assets .. 14.93% $ 145,523 1.50% $ 14,621
===========
Tier 1 capital and ratio to risk-weighted assets 20.00% $ 147,415 6.00% $ 44,230
Tier 2 capital - Allowance for loan losses ..... 6,247
Real estate required to be deducted (2) ........ (43,460)
-----------
Total risk-based capital and ratio to risk-
weighted assets .............................. 14.95% $ 110,202 8.00% $ 58,973 10.00% $ 73,717 13.00%
===========
Total regulatory assets ........................ $ 1,012,437
===========
Adjusted total assets .......................... $ 976,606
===========
Tangible assets ................................ $ 974,714
===========
Risk-weighted assets ........................... $ 737,168
===========
(1) Unamortized balance of computer software.
(2) Retail shopping mall, which we originally acquired in satisfaction of a
debt and had held in excess of five years prior to its sale in November
2004.
103
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Bankhaus Oswald Kruber GmbH & Co. KG, or BOK, our German banking
subsidiary, is licensed as a credit institution (Kreditinstitut) under the laws
of the Federal Republic of Germany and is supervised and regulated in Germany by
the German Federal Financial Supervisory Authority (Bundesanstalt fur
Finanzdienstleistungsaufsicht - BaFin), the German Central Bank (Deutsche
Bundesbank) and, in respect of minimum reserves on deposits, the European
Central Bank.
Although currently not significant to our operations, BOK, under its
license, may engage not only in a number of traditional banking activities such
as deposit and lending business, but also in investment banking, underwriting
and securities trading transactions, both for its own account and for customers.
German regulatory requirements applicable to BOK concern in particular
the maintenance of adequate regulatory capital and liquidity, the monitoring of,
and limitations on, large credit exposures, limitations on equity and
equity-like participations in other companies, the protection of depositors and
the adoption of certain accounting standards and business practices. The German
Federal Financial Supervisory Authority and the German Central Bank monitor the
compliance of German banks such as BOK with the applicable German banking laws,
rules and regulations largely upon the basis of extensive reporting requirements
as well as through general and specific audits. BOK is in compliance in all
material respects with the German regulatory requirements that are applicable to
its business.
NOTE 23 NET INTEREST INCOME (EXPENSE) BEFORE PROVISION FOR LOAN LOSSES
The following table presents the components of net interest income
(expense) for each category of our interest-earning assets and interest-bearing
liabilities for the years ended December 31:
2004 2003 2002
---------- ---------- ----------
Interest income:
Interest earning cash and other ........................................ $ 1,293 $ 356 $ 278
Federal funds sold and repurchase agreements ........................... 2,087 1,403 2,629
Trading securities ..................................................... 17,585 17,347 16,586
Loans .................................................................. 1,676 1,614 11,279
Match funded loans and securities ...................................... 1,035 3,402 6,463
---------- ---------- ----------
23,676 24,122 37,235
---------- ---------- ----------
Interest expense:
Deposits ............................................................... 13,634 17,546 27,455
Securities sold under agreements to repurchase ......................... -- 3 236
Match funded liabilities ............................................... 4,923 5,414 6,573
Lines of credit and other secured borrowings ........................... 2,717 5,824 4,152
Debt securities (1) .................................................... 9,090 9,929 17,346
---------- ---------- ----------
30,364 38,716 55,762
---------- ---------- ----------
Net interest income (expense) before provision for loan losses ......... $ (6,688) $ (14,594) $ (18,527)
========== ========== ==========
(1) Includes $6,117 and $3,058 of interest expense on Capital Securities as
a result of our adoption of SFAS No. 150 effective July 1, 2003. See
Note 16.
104
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 24 OTHER INCOME
The following table presents the principal components of other income we
earned during the years ended December 31:
2004 2003 2002
---------- ---------- ----------
Interest on federal tax refund claims (1) .................................. $ 6,874 $ -- $ --
Technology and related revenue (2) ......................................... 6,871 1,472 910
Collections of credit card receivables (3) ................................. 1,811 2,737 4,191
Consulting fees ............................................................ 76 208 1,409
Gain (loss) on sales of interest-earning assets ............................ -- 28 (3,485)
Other ...................................................................... 3,833 2,403 2,390
---------- ---------- ----------
$ 19,465 $ 6,848 $ 5,415
========== ========== ==========
(1) See Note 10 for additional information regarding these federal tax
refund claims.
(2) Represents service contract fees, maintenance fees, consulting revenue
and other fees earned through OTX and its technology products. Those
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(SM)).
(3) We recorded collections on charged-off unsecured credit card receivables
that we have purchased from third parties on the cost recovery method
through the end of 2001, at which time we reduced the net book value of
these receivables to zero as a result of collections and reserves. Since
that time, we have recorded all collections on the receivables as other
income.
NOTE 25 OTHER OPERATING EXPENSES
The following table presents the principal components of other operating
expenses we incurred during the years ended December 31:
2004 2003 2002
---------- ---------- ----------
Travel, lodging, meals and entertainment ................................... $ 3,361 $ 2,864 $ 2,585
Bad debt expense ........................................................... 2,655 554 39
Amortization ............................................................... 1,039 1,197 1,436
Deposit related expenses ................................................... 718 912 1,198
Conferences and seminars ................................................... 363 361 475
Marketing .................................................................. 273 345 241
Investment and treasury services ........................................... 261 282 340
Other ...................................................................... 1,399 3,894 3,287
---------- ---------- ----------
$ 10,069 $ 10,409 $ 9,601
========== ========== ==========
NOTE 26 BUSINESS SEGMENT REPORTING
An operating segment is defined as a component of an enterprise that (a)
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 loan
servicing including asset management and resolution services to third
party owners of subprime residential mortgage and high loan-to-value
loans for a fee. We acquire the rights to service loans and obtain such
rights 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), a commercial loan servicing
system (REALSynergy) and an internet-based mortgage loan processing
application and vendor management system (REALTrans).
105
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
. Ocwen Realty Advisors (ORA). Through ORA we provide residential property
valuation services.
. 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.
. Business Process Outsourcing. This core business segment began
operations in December 2002. Business Process Outsourcing provides
outsourcing services to third parties including mortgage underwriting,
data entry, call center services and mortgage research.
. Commercial Servicing. This segment includes the results of both our
domestic and international servicing of commercial assets. Prior to
2004, domestic commercial servicing was reported as a component of the
Commercial Finance segment (re-named Commercial Assets), and the results
of our international operations were reported as a separate segment.
International servicing is conducted through GSS. Results for 2002
primarily reflect a one time consulting project for the government of
Jamaica as well as other precedent ventures.
Non-Core Businesses
.. Residential Discount Loans. This segment consisted of operations to
acquire at a discount and subsequently resolve sub-performing and
non-performing residential mortgage loans. We completed our last
acquisition of residential loans in 2000. Based on the relative
insignificance of the non-core assets remaining in this segment, the
remaining assets of this business and any related income or loss arising
from their resolution have been included in the Corporate Items and
Other segment beginning January 1, 2003.
. 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 that time, this business has
consisted of the repositioning, management and resolution of the
remaining non-core 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 Code.
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, which had been conducted primarily through OFS.
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 (including BOK), 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.
106
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
Non- Net Interest Provision Non- Pre-Tax
Interest Income for Loan Interest Income Total
Revenue (Expense) Losses Expense (Loss) Assets
----------- ------------ ----------- ----------- ----------- -----------
At or for the year ended December 31, 2004
Core businesses:
Residential Loan Servicing ............ $ 128,726 $ (19,397) $ -- $ 93,515 $ 15,814 $ 694,175
OTX ................................... 16,352 -- -- 20,214 (3,862) 4,430
Ocwen Realty Advisors ................. 30,373 (71) -- 23,836 6,466 2,077
Ocwen Recovery Group .................. 13,803 -- -- 9,888 3,916 541
Business Process Outsourcing .......... 9,493 (24) -- 7,264 2,205 2,502
Commercial Servicing .................. 15,277 (12) -- 14,692 573 13,025
----------- ------------ ----------- ----------- ----------- -----------
214,024 (19,504) -- 169,409 25,112 716,750
----------- ------------ ----------- ----------- ----------- -----------
Non-core businesses:
Commercial Assets ..................... (1,997) (338) (1,651) 4,324 (5,008) 24,149
Affordable Housing .................... 230 (1,226) (112) 2,372 (3,256) 36,715
Subprime Finance ...................... (924) 13,763 -- 2,271 10,568 35,519
----------- ------------ ----------- ----------- ----------- -----------
(2,691) 12,199 (1,763) 8,967 2,304 96,383
----------- ------------ ----------- ----------- ----------- -----------
Corporate Items and Other ................ 11,694 617 (118) 14,606 (2,178) 514,360
----------- ------------ ----------- ----------- ----------- -----------
$ 223,027 $ (6,688) $ (1,881) $ 192,982 $ 25,238 $ 1,327,493
=========== ============ =========== =========== =========== ===========
At or for the year ended December 31, 2003
Core businesses:
Residential Loan Servicing ............ $ 121,132 $ (20,892) $ -- $ 69,196 $ 31,043 $ 672,779
OTX ................................... 9,933 -- -- 21,453 (11,520) 5,290
Ocwen Realty Advisors ................. 18,804 (21) -- 13,351 5,432 1,056
Ocwen Recovery Group .................. 12,140 -- -- 6,840 5,300 323
Business Process Outsourcing .......... 4,496 (5) -- 2,597 1,893 1,010
Commercial Servicing .................. 6,998 (52) -- 11,151 (4,204) 5,241
----------- ------------ ----------- ----------- ----------- -----------
173,503 (20,970) -- 124,588 27,944 685,699
----------- ------------ ----------- ----------- ----------- -----------
Non-core businesses:
Commercial Assets ..................... (1,192) (7,217) (3,095) 4,085 (9,399) 133,015
Affordable Housing .................... 1,595 (2,767) 151 3,565 (4,888) 48,974
Subprime Finance ...................... 2,914 15,210 -- 13,936 4,188 39,162
----------- ------------ ----------- ----------- ----------- -----------
3,317 5,226 (2,944) 21,586 (10,099) 221,151
----------- ------------ ----------- ----------- ----------- -----------
Corporate Items and Other ................ 677 1,150 260 11,327 (12,817) 333,268
----------- ------------ ----------- ----------- ----------- -----------
$ 177,497 $ (14,594) $ (2,684) $ 157,501 $ 5,028 $ 1,240,118
=========== ============ =========== =========== =========== ===========
At or for the year ended December 31, 2002
Core businesses:
Residential Loan Servicing ............ $ 120,024 $ (18,304) $ -- $ 69,746 $ 31,974 $ 579,115
OTX ................................... 6,522 1 -- 30,667 (24,144) 6,172
Ocwen Realty Advisors ................. 14,080 -- -- 11,484 2,597 532
Ocwen Recovery Group .................. 10,652 -- (278) 6,925 4,006 296
Business Process Outsourcing .......... 206 -- -- 88 118 6
Commercial Servicing .................. 5,561 (51) -- 8,733 (3,223) 5,385
----------- ------------ ----------- ----------- ----------- -----------
157,045 (18,354) (278) 127,643 11,328 591,506
----------- ------------ ----------- ----------- ----------- -----------
Non-core businesses:
Residential Discount Loans ............ (2,354) 6,068 (2,299) 5,250 763 44,759
Commercial Assets ..................... (23,847) (7,627) 12,814 5,458 (49,746) 196,249
Affordable Housing .................... 864 (4,449) 3,392 24,544 (31,521) 62,092
Subprime Finance ...................... 7,395 11,787 -- 4,646 14,536 41,950
----------- ------------ ----------- ----------- ----------- -----------
(17,942) 5,779 13,907 39,898 (65,968) 345,050
----------- ------------ ----------- ----------- ----------- -----------
Corporate Items and Other ................ (5,091) (5,952) -- 10,085 (27,417) 285,686
----------- ------------ ----------- ----------- ----------- -----------
$ 134,012 $ (18,527) $ 13,629 $ 177,626 $ (82,057) $ 1,222,242
=========== ============ =========== =========== =========== ===========
107
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 27 COMMITMENTS AND CONTINGENCIES
We lease certain premises under various non-cancelable operating leases
with terms expiring at various times through 2012, exclusive of renewal option
periods. Our annual aggregate minimum rental commitments under these leases are
summarized as follows:
2005 ............................................. $ 3,631
2006 ............................................. 2,626
2007 ............................................. 2,043
2008 ............................................. 1,164
Thereafter ....................................... 2,615
----------
Minimum lease payments ........................... $ 12,079
==========
We converted rental commitments for our facilities outside the United
States of America to U.S. dollars using exchange rates in effect at December 31,
2004. Rent expense for the years ended December 31, 2004, 2003 and 2002 was
$2,725, $3,511 and $3,326, respectively.
Through our investment in subordinated securities and subprime
residuals, which had a fair value of $39,527 at December 31, 2004, we support
senior classes of securities.
Under the terms of the sales agreements entered into in connection with
the sale of certain of our affordable housing properties, we have a commitment
to fund cash deficits that may arise from the operations of those properties.
The remaining term of these commitments ranges from two to five years. The
obligation under these commitments was $4,813 as of December 31, 2004. Any
operating deficits we fund are supported by a promissory note to be repaid to us
from future cash flows of the property. In addition, we have provided to the
purchasers of certain affordable housing properties guaranties against the
possible recapture of future tax credits. We have never experienced a recapture
of tax credits on any of the affordable housing properties in which we invested
or sold. We have not recognized these guaranties as a liability because the
probability of recapture is considered remote.
OCN and certain of its affiliates, including the Bank, have been named
as defendants in purported class action lawsuits brought in various federal and
state courts challenging the Bank's mortgage servicing practices. On April 13,
2004 the United States Judicial Panel on Multi-District Litigation granted our
petition to transfer and consolidate a number of the lawsuits into a single case
to proceed in 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 "MDL Proceeding"). Additional similar
lawsuits have been brought in other courts, some of which have been or may be
transferred and consolidated in the MDL Proceeding.
The MDL Proceeding currently includes the following actions in which OCN
and/or the Bank are defendants:
(1) Patricia Antoine, et al v. Ocwen Federal Bank FSB, et al.,
case No. C-03-5503 (N.D.Cal.)
(2) Deborah Bush v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02827 (N.D.Ala.)
(3) Carolyn P. Calhoun v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-00293 (N.D.Miss.)
(4) Ralph Carreon Jr., et al. v. Ocwen Federal Bank FSB,
Case No. 5:03-5151 (Bankr. W.D.Tex.)
(5) Stevie Cooper, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 1:04-cv-00639 (S.D.Ala.)
(6) Mary Crosby v. Ocwen Federal Bank FSB, et al.,
Case No. 5:04-cv-02828 (N.D.Ala.)
(7) Billy M. Dockery, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02830 (N.D.Ala.)
(8) Thomas B. Doherty v. Ocwen Federal Bank FSB, et al.,
Case No. 04-cv-04880 (D.Minn.)
(9) Unnatiben Gandabhai, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 3:04-2582 (N.D.Cal.)
(10) Lizzie Hannah, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02833 (N.D.Ala.)
(11) Kweku Hanson, et al v. Ocwen Federal Bank FSB, et al.,
Case No. 02-CV-860 (D.Conn.)
(12) William Hearn, et al v. Ocwen Federal Bank FSB, et al.,
Case No. C-04-0291 (E.D.Cal.)
(13) Stephanie Hunter, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 2:04-cv-02864 (N.D.Ala.)
(14) Lula M. Jackson, et al v. Ocwen Federal Bank FSB, et al.,
Case No. C-03-0743 (N.D.Cal.)
(15) Freddie Jones v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-00294 (N.D.Miss.)
(16) Marion Long v. Ocwen Federal Bank FSB, et al.,
Case No. 7:04-cv-02852 (N.D.Ala.)
(17) Allie M. Maddox, et al v. Ocwen Federal Bank FSB, et al.,
Case No. CV-03-9515 (C.D.Cal.)
108
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
(18) Jeannette E. Martinez v. Ocwen Federal Savings Bank FSB,
Case No. 1:04-296 (D.N.M.)
(19) Michele McAuliffe, et al. v. U.S. Bank, N.A. as Trustee., et al.,
Case No. 03-C-1103 (N.D. Ill.)
(20) George McDonald v. Ocwen Financial Corp., et al.,
Case No. 1:04-03673 (N.D.Cal.)
(21) Al McZeal v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-1576 (S.D.Tex.)
(22) Delores B. Moore v. Ocwen Federal Bank FSB, et al.,
Case No. 2:04-2612 (E.D. Pa.)
(23) Timothy Napier, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 2:03-174 (E.D.Wash.)
(24) William A. Soto, et al v. Ocwen Federal Bank FSB, et al.,
Case No. 02-C-6818 (N.D.Ill.).
(25) Geneva Spires, et al v. Ocwen Financial Services, Inc., et al.,
Case No. C-03-5600 (N.D.Cal.)
(26) Maggie Williams, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 4:04-cv-02869 (N.D.Ala.)
(27) Thomas Wright, et al. v. Ocwen Federal Bank FSB, et al.,
Case No. 1:04-cv-00638 (S.D.Ala.)
On August 23, 2004, plaintiffs filed a Consolidated Complaint, setting
forth claims contained in lawsuits consolidated in the MDL Proceeding. Those
claims variously involve alleged violations of federal statutes, including the
Real Estate Settlement Procedures Act and Fair Debt Collection Practices Act,
and state deceptive trade practices statutes, and assert common law claims. The
claims are based on various allegations of improper servicing practices,
including (i) charging borrowers allegedly improper or unnecessary fees such as
breach letter fees, hazard insurance premiums, foreclosure-related fees, late
fees and property inspection fees; (ii) untimely posting and misapplication of
borrower payments; and (iii) improperly treating borrowers as in default on
their loans. While some of the individual lawsuits had set forth specific damage
allegations (e.g., the Gandabhai complaint (item 9 above) claimed actual damages
of $61; the Hanson complaint (item 11 above) claimed actual damages of $150,000
and punitive and exemplary damages of $1,500,000; the various Alabama and
Mississippi cases generally alleged damages less than $75 (items 2, 3, 5, 6, 7,
10, 13, 15, 16, 26 and 27 above)), the Consolidated Complaint in the MDL
Proceeding does not set forth any specific amounts of claimed damages. The
absense of any specification of damages in the Consolidated Complaint does not,
however, preclude plaintiffs in the MDL Proceeding from requesting leave from
the court to amend the Consolidated Complaint or from otherwise seeking damages
should the matter proceed to trial.
On September 30, 2004, the Ocwen defendants filed various motions to
dismiss, for summary judgment, to strike class allegations and to stay
discovery. Briefing on these motions has recently closed. Discovery in the MDL
Proceeding has been stayed pending resolution of the motions. No motion for
class certification has been submitted by plaintiffs, and the Court has not
indicated when any such motion would be permitted to be filed.
We cannot currently determine the ultimate outcome of the MDL Proceeding
or the other matters described above and have not established a reserve in
respect thereof. We believe the allegations in the MDL Proceeding and the other
matters described above are without merit and will continue to vigorously defend
against them.
On November 3, 2004, the trial judge in litigation brought by Cartel
Asset Management, Inc. ("Cartel") against OCN, the Bank and OTX in federal court
in Denver, Colorado entered final judgment in the amount of $520 against OTX and
nominal damages of two dollars against the Bank. No damages were entered against
OCN. By the November 3, 2004 order, the judge reduced a prior jury verdict in
the amount of $9,320 after trial on this matter involving allegations of
misappropriation of trade secrets and contract-related claims brought by a
former vendor. The litigation does not relate to our core Residential Loan
Servicing business practices. Notwithstanding the nominal damage award against
the Bank, it was assessed a statutory award to Cartel of attorneys' fees in an
additional amount of $170, and the Bank and OTX were further assessed costs in
the amount of $9. Cartel and defendants are pursuing cross-appeals in the United
States Court of Appeals for the Tenth Circuit. A reserve of $1,000 had been
established for this matter. We intend to continue to vigorously defend this
matter.
On February 8, 2005, a jury in Circuit Court for Palm Beach County,
Florida returned verdicts of $1,000 and $1,056 in compensatory damages in favor
of two former employees of the Bank in a lawsuit against OCN and the Bank. The
jury rejected plaintiffs' request for punitive damages. The plaintiffs brought
claims under the Florida Civil Rights Act, the Florida Whistleblower Act and
state tort law, arising out of an alleged invasion of privacy and related
incidents allegedly committed by other former employees of the Bank in 1998 for
which plaintiffs sought to hold the Ocwen defendants vicariously liable. We
believe the verdicts, which have not yet been reduced to final judgments, are
against the weight of evidence and contrary to law. Defendants have filed
motions for a new trial and/or remittitur and, if necessary, will take an appeal
to the Florida Court of Appeals for the Fourth District. We intend to continue
to vigorously defend this matter.
On February 28, 2005, a jury in County Court for Nueces County, Texas,
returned a verdict of $140 in compensatory and statutory damages in favor of two
borrowers whose mortgage loan was serviced by the Bank in a lawsuit arising out
of a disputed foreclosure. The jury rejected plaintiffs' request for punitive
damages. The verdict included $2,900 for plaintiffs' attorneys' fees, an amount,
which we believe is unsupported by the evidence and impermissibly excessive
under the controlling legal authorities. The verdict has not yet been reduced to
a final judgment. We are pursuing post-trial motions seeking to set aside or
substantially reduce the attorneys' fees award and, if necessary, will take an
appeal on that issue and perhaps other issues to the Texas Court of Appeals for
the Thirteenth Judicial District. We intend to continue to vigorously defend
this matter.
109
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
In light of the above-referenced developments in the Florida and Texas
matters, we have established a reserve of $3,000 in 2004.
On March 9, 2005, the Bank was served with a complaint filed in Superior
Court for Los Angeles County, California, by Banco Popular North America,
successor by merger to Quaker City Bank ("Banco Popular"), which claims to be a
holder of residual interest in two mortgage loan trusts for which the Bank
provides loan servicing. In this lawsuit, Banco Popular challenges the Bank's
fee charges for recoveries on charged-off loans. The complaint variously alleges
breach of contract, conversion, breach of fiduciary duty and fraud, and seeks
declaratory and equitable relief, along with claimed compensatory damages in
excess of $3,000 and punitive damages in an unspecified amount. We believe the
allegations are without merit and will vigorously defend this matter.
OCN and the Bank are also subject to various other pending legal
proceedings. In our opinion, the resolution of these other proceedings will not
have a material effect on our financial condition, results of operations or cash
flows.
We continuously monitor the status of our litigation, including advice
from external legal counsel, and perform periodic assessments of our litigation
for potential accrual of litigation reserves and disclosure. We accrue a
litigation reserve when it is probable that a liability had been incurred and
the amount of loss can be reasonably estimated.
110
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 28 PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF FINANCIAL CONDITION OF OCWEN FINANCIAL CORPORATION
December 31,
---------------------------
2004 2003
------------ ------------
Assets
Cash and cash equivalents .................................. $ 104,027 $ 22
Cash held at bank subsidiary - OFB ......................... 1,272 19,708
Cash held at bank subsidiary - BOK ......................... 627 --
Investments in subsidiaries
Bank subsidiary - OFB .................................. 207,491 178,838
Bank subsidiary - BOK .................................. 12,124 --
Non-bank subsidiaries .................................. 377,656 374,876
Advance due from bank subsidiary - OFB ..................... 13,578 3,345
Loan, net .................................................. -- 7,134
Match funded assets ........................................ 175,679 --
Investment in Capital Securities issued by OCT ............. 68,751 68,751
Mortgage servicing rights .................................. 34,365 58,033
Income taxes receivable .................................... 57,610 21,217
Receivables and other assets ............................... 19,914 6,867
------------ ------------
$ 1,073,094 $ 738,791
============ ============
Liabilities and Stockholders' Equity
Match funded liabilities ................................... $ 149,341 $ --
Secured borrowings ......................................... 11,458 5,567
Debt securities (3.25% Convertible Notes) .................. 175,000 --
Notes and debentures payable to non-bank subsidiaries ...... 131,251 131,251
Accrued interest payable to non-bank subsidiaries .......... 8,921 8,562
Advance due to non-bank subsidiaries ....................... 243,530 244,614
Deferred tax liability ..................................... 8,569 20,645
Other liabilities .......................................... 14,916 10,894
------------ ------------
Total liabilities ...................................... 742,986 421,533
Stockholders' equity ....................................... 330,108 317,258
------------ ------------
$ 1,073,094 $ 738,791
============ ============
111
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
CONDENSED STATEMENTS OF OPERATIONS OF OCWEN FINANCIAL CORPORATION
For the Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
Servicing and related fees (1) ........................................ $ 6,062 $ 28,760 $ 7,392
Non-interest revenue .................................................. 8,034 3,333 2,528
Interest income ....................................................... 2,110 782 555
Interest income from subsidiaries
Bank subsidiary - OFB ............................................. 263 87 222
Non-bank subsidiaries ............................................. 7,485 7,486 7,307
Interest expense ...................................................... 4,097 4,263 9,937
Interest expense - non bank subsidiaries .............................. 14,531 14,372 14,372
---------- ---------- ----------
Net interest expense before provision for loan losses ............. (8,770) (10,280) (16,225)
Provision for loan losses ............................................. (887) (125) 1,144
---------- ---------- ----------
Net interest expense after provision for loan losses .............. (7,883) (10,155) (17,369)
---------- ---------- ----------
Total revenue ................................................. 6,213 21,938 (7,449)
---------- ---------- ----------
Non-interest expense - non bank subsidiaries .......................... 3,754 1,625 96
Non-interest expense .................................................. 11,585 19,525 3,636
Servicing fee expense - bank subsidiary - OFB ......................... 14,224 21,392 10,772
---------- ---------- ----------
Income (loss) before income taxes ................................. (23,350) (20,604) (21,953)
Income tax expense (benefit) .......................................... (50,704) 3 (1,658)
---------- ---------- ----------
Income (loss) before equity in net income (losses) of
subsidiaries ..................................................... 27,354 (20,607) (20,295)
Equity in net income (losses) of subsidiaries
Bank subsidiary - OFB ............................................. 28,652 20,366 (40,341)
Bank subsidiary - BOK ............................................. (157) -- --
Non-bank subsidiaries ............................................. 1,875 5,013 (8,139)
---------- ---------- ----------
Net income (loss) ..................................................... $ 57,724 $ 4,772 $ (68,775)
========== ========== ==========
112
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
CONDENSED STATEMENTS OF CASH FLOWS OF OCWEN FINANCIAL CORPORATION
For the Years Ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .................................................... $ 57,724 $ 4,772 $ (68,775)
Adjustments to reconcile net income to net cash (used) provided by
operating activities
Equity in (income) loss of Bank subsidiary - OFB ................. (28,652) (20,366) 40,341
Equity in (income) loss of Bank subsidiary - BOK ................. 157 -- --
Equity in (income) loss of non-bank subsidiary ................... (1,875) (5,013) 8,139
Equity in loss (income) of unconsolidated entity, net ............ -- (38) (142)
Amortization of mortgage servicing rights ........................ 32,991 35,889 9,125
Impairment charges on mortgage servicing rights .................. 6,623 387 --
Provision for loan losses ........................................ (887) (125) 1,144
(Increase) decrease in match funded advances on loans serviced for
others .......................................................... (175,679) -- --
(Increase) decrease in income taxes receivable ................... (36,394) (321) (4,046)
(Increase) decrease in receivables ............................... (4,619) -- --
(Increase) decrease in other assets .............................. (10,140) (3,346) 3,297
Increase (decrease) in deferred tax liability .................... (12,076) 451 3,945
(Decrease) increase in accrued expenses and other liabilities .... 5,399 2,501 (578)
Other ............................................................ 2,794 -- --
---------- ---------- ----------
Net cash provided (used) by operating activities ................. (164,634) 14,791 (7,550)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in and advances to subsidiaries ...................... (13,797) 65,443 111,016
Purchase of mortgage servicing rights ............................ (15,946) (29,196) (74,121)
Origination of loans ............................................. -- -- (9,153)
Principal payments received on loans ............................. 8,153 1,000 --
Proceeds from sale of real estate ................................ -- -- 1,797
Acquisition of subsidiaries ...................................... (10,680) -- --
---------- ---------- ----------
Net cash provided (used) by investing activities ................. (32,270) 37,247 29,539
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from (repayment of) match funded agreements, net ........ 149,341 -- --
Proceeds (repayments) of lines of credit and other secured
borrowings, net ................................................. 5,891 1,332 4,235
Issue (repayment) of debt securities, net ........................ 175,000 (43,475) (43,550)
Exercise of common stock options ................................. 2,317 1,334 103
Repurchase of common stock ....................................... (49,449) (2,262) --
---------- ---------- ----------
Net cash provided (used) by financing activities ..................... 283,100 (43,071) (39,212)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents ................. 86,196 8,967 (17,223)
Cash and cash equivalents at beginning of year ....................... 19,730 10,763 27,986
---------- ---------- ----------
Cash and cash equivalents at end of year ............................. $ 105,926 $ 19,730 $ 10,763
========== ========== ==========
113
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except share data)
NOTE 29 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarters Ended
----------------------------------------------------------------
December 31, September 30, June 30, March 31,
2004 2004 2004 2004
------------- ------------- ------------- -------------
Revenue .................................................. $ 52,874 $ 51,556 $ 57,568 $ 56,222
Non-interest expense ..................................... 50,966 44,078 48,468 49,470
------------- ------------- ------------- -------------
Income (loss) before minority interest and income taxes .. 1,908 7,478 9,100 6,752
Minority interest in net income (loss) of subsidiaries ... (112) 18 (47) (21)
Income tax expense (benefit) ............................. (544) (31,845) 55 11
------------- ------------- ------------- -------------
Net income (loss) ........................................ $ 2,565 $ 39,305 $ 9,092 $ 6,762
============= ============= ============= =============
Earnings (loss) per share
Basic ................................................ $ 0.04 $ 0.61 $ 0.13 $ 0.10
Diluted (1) .......................................... $ 0.04 $ 0.53 $ 0.13 $ 0.10
Quarters Ended
----------------------------------------------------------------
December 31, September 30, June 30, March 31,
2003 2003 2003 2003
------------- ------------- ------------- -------------
Revenue .................................................. $ 46,019 $ 39,675 $ 40,245 $ 39,648
Non-interest expense ..................................... 41,619 35,026 34,335 46,521
Distributions on Capital Securities ...................... -- -- 1,529 1,529
------------- ------------- ------------- -------------
Income (loss) before minority interest and income taxes .. 4,400 4,649 4,381 (8,402)
Minority interest in net income (loss) of subsidiaries ... (184) 28 (73) (263)
Income tax expense (benefit) ............................. 130 6 305 307
------------- ------------- ------------- -------------
Net income (loss) ........................................ $ 4,454 $ 4,615 $ 4,149 $ (8,446)
============= ============= ============= =============
Earnings (loss) per share
Basic ................................................ $ 0.07 $ 0.07 $ 0.06 $ (0.13)
Diluted .............................................. $ 0.07 $ 0.07 $ 0.06 $ (0.13)
(1) The third quarter diluted EPS has been restated from $0.60 to include
the dilutive effect of the Contingent Convertible Notes issued during
that quarter. This restatement is the result of a retroactive
application of EITF 04-08, which became effective December 15, 2004.
114
SHAREHOLDER INFORMATION
PRICE RANGE OF THE COMPANY'S COMMON STOCK
The common stock of Ocwen Financial Corporation is traded under the
symbol "OCN" on the New York Stock Exchange ("NYSE"). The following table sets
forth the high and low closing sales prices for our common stock, as traded on
the NYSE:
High Low
---------- ----------
2004
First quarter .................................... $ 11.50 $ 8.48
Second quarter ................................... 12.57 9.56
Third quarter .................................... 11.99 7.75
Fourth quarter ................................... 9.56 7.50
2003
First quarter .................................... $ 3.40 $ 2.71
Second quarter ................................... 4.87 3.13
Third quarter .................................... 5.09 4.12
Fourth quarter ................................... 8.88 4.60
At the close of business on March 10, 2005, our common stock price was
$8.04.
As a holding company, the payment of any dividends by us will be
significantly dependent on dividends and other payments received from our
subsidiaries, including the Bank, which may be affected by either restrictive
covenants or regulatory limits. We do not currently pay cash dividends on common
stock and have no current plans to do so in the future. The timing and amount of
future dividends, if any, will be determined by our Board of Directors and will
depend, among other factors, upon our earnings, financial condition, cash
requirements, the capital requirements of the Bank and other subsidiaries and
investment opportunities at the time any such payment is considered. In
addition, the indentures relating to the Junior Subordinated Debentures as well
as the covenants relating to our lines of credit and other secured borrowings
contain certain limitations on the payment of dividends by us. See Notes 15 and
16 to the Consolidated Financial Statements.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATES
Information regarding purchases of our own common stock during 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) Plans
- ----------------------------------- ---------------- ------------- ---------------------- ----------------------
Three months ended March 31 ....... -- -- -- 6,200,000
Three months ended June 30 ........ -- -- -- 6,200,000
Three months ended September 30 ... 5,481,100 $ 9.02 5,481,100 5,568,900
Three months ended December 31 .... -- -- -- 5,568,900
----------------
Total for the year ............ 5,481,100
================
(1) Shares were repurchased under the following plans:
(a) A plan was announced May 9, 2000 to repurchase up to 6,000,000
shares of outstanding common stock.
(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. No shares remain to be repurchased
under this plan.
(c) 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 21 to our Consolidated Financial
Statements. No shares remain to be repurchased under this plan.
115
NUMBER OF HOLDERS OF COMMON STOCK
At March 10, 2005, 62,750,904 shares of our common stock were
outstanding and held by approximately 1,270 holders of record. Such number of
stockholders does not reflect the number of individuals or institutional
investors holding our stock in nominee name through banks, brokerage firms and
others.
NEW YORK STOCK EXCHANGE SECTION 303A INFORMATION
On July 15, 2004, pursuant to Section 303A.12 of the New York Stock
Exchange's listing standards, the Company's Chief Executive Officer certified to
the New York Stock Exchange that he was not aware of any violation by the
Company of the New York Stock Exchange corporate governance listing standards as
of that date. Additionally, the Company filed with the SEC the CEO/CFO
certifications required under Section 302 of the Sarbanes-Oxley Act as Exhibits
to its Form 10-K.
116
EXHIBIT 21.0
SIGNIFICANT DIRECT AND INDIRECT SUBSIDIARIES OF OCWEN FINANCIAL CORPORATION
Name State or Other Jurisdiction of Organization
- ------------------------------------------------ -------------------------------------------
Ocwen Federal Bank FSB (2) New Jersey
RMSI, Inc (2) New Jersey
Investors Mortgage Insurance Holding Company (1) Delaware
Ocwen Properties, Inc. (1) New York
Ocwen Asset Investment Corp. (1) Florida
Ocwen General, Inc. (1) Virginia
Ocwen Asset Investment - UK, LLC (2) Delaware
Ocwen Partnership, L.P. (2) Virginia
OAIC Halifax, LLC (2) Delaware
Ocwen NIMS Corp. (2) Florida
Ocwen Technology Xchange, Inc. (2) Florida
REALTrans.Com, Inc. (2) Florida
Residential Real Estate Solutions, Inc. (2) Florida
Ocwen Capital Trust I (2) Delaware
Ocwen Luxembourg, Sarl (1) Luxembourg
Ocwen Asia Holdings Ltd. (1) Mauritius
Ocwen Financial Solutions Private Limited (2) India
(1) Holding company with no significant assets or operations
(2) Operating company
EXHIBIT 23.0
CONSENT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 filed on January 27, 1998 (Registration No. 333-44999),
Registration Statement on Form S-8 filed on August 25, 1998 (Registration No.
333-62217), Registration Statement on Form S-3 filed on November 5, 1998
(Registration No. 333-64915), and Registration Statement on Form S-3 filed on
October 12, 2004 (Registration No. 333-119698) of Ocwen Financial Corporation of
our report dated March 15, 2005 relating to the financial statements, which
appears in the 2004 Annual Report to Shareholders, which is incorporated in this
Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
West Palm Beach, Florida
March 16, 2005
EXHIBIT 31.1
CERTIFICATIONS
I, William C. Erbey, certify that:
1. I have reviewed this annual report on Form 10-K 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) [Reserved];
(c) Evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in this
report our conclusions 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
(d) 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 or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over financial
reporting.
Date: March 16, 2005 /s/ William C. Erbey
-----------------------
William C. Erbey
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATIONS
I, Robert J. Leist, Jr., certify that:
1. I have reviewed this annual report on Form 10-K 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) [Reserved];
(c) Evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in this
report our conclusions 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
(d) 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 or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over financial
reporting.
Date: March 16, 2005 /s/ Robert J. Leist, Jr.
--------------------------------------
Robert J. Leist, Jr., Vice President &
Chief Accounting Officer and Acting
Chief Financial Officer
EXHIBIT 32.1
CERTIFICATIONS
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 Annual Report on Form 10-K of the Registrant for the year ended
December 31, 2004 (the "periodic report") containing financial
statements fully complies with the requirements of Section 13(a) or
15(d) 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: March 16, 2005
EXHIBIT 32.2
CERTIFICATIONS
I, Robert J. Leist, Jr., state and attest that:
(1) I am the Acting 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 Annual Report on Form 10-K of the Registrant for the year ended
December 31, 2004 (the "periodic report") containing financial
statements fully complies with the requirements of Section 13(a) or
15(d) 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/ Robert J. Leist, Jr.
------------------------
Title: Vice President & Chief Accounting Officer and
Acting Chief Financial Officer
Date: March 16, 2005