Ocwen Financial Corporation
OCWEN FINANCIAL CORP (Form: 10-K, Received: 03/17/2008 17:24:26)

 

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, 2007

 

 

OR

 

o

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


(Exact name of Registrant as specified in our charter)


 

 

 

Florida

 

65-0039856


 


(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

1661 Worthington Road, Suite 100

 

 

West Palm Beach, Florida

 

33409


 


(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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o   No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o   No x

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 o

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. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

 

 

 

 

Large Accelerated filer o

Accelerated filer x

 

 

Non-accelerated filer     o (Do not check if a smaller reporting company)

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o   No x

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 June 30, 2007: $497,783,003 (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, 2008: 62,650,550 shares

DOCUMENTS INCORPORATED BY REFERENCE: Portions of our definitive Proxy Statement with respect to our Annual Meeting of Shareholders to be held on May 8, 2008, are incorporated by reference into Part III, Items 10 - 12 and 14.



 

 

 

OCWEN FINANCIAL CORPORATION
2007 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS


 

 

 

 

 

PAGE

 

 


 

PART I

 

 

 

 

Item 1.

Business

3

 

 

 

Item 1A.

Risk Factors

7

 

 

 

Item 1B.

Unresolved Staff Comments

10

 

 

 

Item 2.

Properties

10

 

 

 

Item 3.

Legal Proceedings

11

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

12

 

 

 

 

PART II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

12

 

 

 

Item 6.

Selected Financial Data

14

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

40

 

 

 

Item 8.

Financial Statements and Supplementary Data

43

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

43

 

 

 

Item 9A.

Controls and Procedures

43

 

 

 

Item 9B.

Other Information

43

 

 

 

PART III

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

44

 

 

 

Item 11.

Executive Compensation

44

 

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

44

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

44

 

 

 

Item 14.

Principal Accounting Fees and Services

44

 

 

 

 

PART IV

 

 

 

 

Item 15.

Exhibits, Financial Statement Schedules

44

 

 

 

Signatures

47

1


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:

 

 

projections as to the performance of our asset management vehicles and fee-based loan processing business;

 

 

plans related to our strategic investment initiatives and our ability to fund advances;

 

 

assumptions related to the sources of liquidity and the adequacy of financial resources;

 

 

estimates regarding our reserves and valuations; and

 

 

expectations as to the effect of resolution of pending legal proceedings on our financial condition.

          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 risks discussed in “Risk Factors” below and the following:

 

 

general economic and market conditions,

 

 

prevailing interest rates,

 

 

governmental regulations and policies,

 

 

availability of adequate and timely sources of liquidity, and

 

 

uncertainty related to dispute resolution and litigation.

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 quarterly reports on Form 10-Q and current reports on Form 8-K. Forward-looking statements speak only as of the date they are made and should not be relied upon. Ocwen Financial Corporation undertakes no obligation to update or revise forward-looking statements.

2


PART I

ITEM 1. BUSINESS (Dollars in thousands)

GENERAL

          Ocwen Financial Corporation (“OCN”), through its subsidiaries, is a business process outsourcing provider to the financial services industry specializing in loan servicing, mortgage fulfillment and receivables management services. OCN is headquartered in West Palm Beach, Florida with additional offices in Arizona, California, Florida, Georgia, Illinois and New York and global operations in Canada, Germany and India. OCN is a Florida corporation that was organized in February 1988 in connection with the acquisition of Ocwen Federal Bank FSB (the “Bank”).

          Effective June 30, 2005, the Bank voluntarily terminated its status as a federal savings bank. This process, which we have referred to as “debanking,” was approved by the Office of Thrift Supervision (“OTS”) and resulted in the divestiture to Marathon National Bank of New York (“Marathon”) of the Bank’s deposit liabilities and assignment of the Bank’s remaining assets and liabilities to Ocwen Loan Servicing, LLC (“OLS”). We are continuing the Bank’s non-depository businesses, including its residential mortgage servicing business, under OLS, which is a licensed servicer in all 50 states, the District of Columbia and Puerto Rico.

          As disclosed in a filing with the Securities and Exchange Commission (the “SEC”) on January 14, 2008, our Chief Executive Officer, together with members of OCN management and funds managed by Oaktree Capital Management, L.P. and Angelo, Gordon & Co., L.P. (collectively, the “Sponsors”), proposed to acquire by merger, for a purchase price of $7.00 per share in cash, all of the outstanding shares of OCN Common Stock. The Board of Directors of OCN formed a Special Committee of independent directors to consider the proposal. On March 11, 2008, OCN announced that the Special Committee and the Sponsors had been unable to reach an agreement as to the terms of a definitive agreement. As a result, the parties have mutually agreed to terminate discussions regarding the proposal. The Special Committee will continue to consider possible strategic opportunities for OCN, but has not made a decision with regard thereto. There can be no assurance that any transaction involving OCN will occur.

SEGMENTS AND STRATEGY

          Our current business segments are as follows:

 

 

 

 

Residential Servicing

 

 

 

 

Ocwen Recovery Group

 

 

 

 

Residential Origination Services

          In addition to these business segments, we report business activities that are individually insignificant in Corporate Items and Other as discussed later in this section.

          Key elements of our business strategy are:

 

 

 

 

to grow our residential servicing business;

 

 

 

 

to grow and develop asset management vehicles that allow us to leverage our servicing and loss mitigation capabilities;

 

 

 

 

to grow our residential fee-based loan processing services, including property valuation, mortgage due diligence and title services; and

 

 

 

 

to grow our unsecured debt collection business.

          A more detailed description of each of our business segments follows.

Residential Servicing

          Revenue from the Residential Servicing segment comprised 74%, 80% and 74% of our consolidated revenues in 2007, 2006 and 2005, respectively. Through this segment, we earn fees by providing services to owners of residential mortgage loans. We are one of the largest servicers of subprime mortgage loans. These loans have typically been securitized in Real Estate Mortgage Investment Conduits (“REMICs”). As of December 31, 2007, we serviced 435,616 loans with an aggregate unpaid principal balance (“UPB”) of $53,545,985 under 509 servicing agreements for over 45 clients. These clients include Wall Street firms such as Deutsche Bank, Lehman Brothers and Credit Suisse, mortgage originators and the United States Department of Veterans Affairs (“VA”). This segment includes our investments in joint ventures that are operated as asset management vehicles and primarily invest in mortgage-related assets that benefit from our asset management capabilities. This segment also includes revenues from the licensing to others of REALServicing TM , our comprehensive enterprise-level residential mortgage loan servicing platform that we have used since January 2001.

          We are entitled to service loans either because we purchased the mortgage servicing rights (“MSRs”) from the owners of the mortgages or because we entered into subservicing agreements with the entities that own the MSRs. A Pooling and Servicing Agreement between the various parties to a mortgage securitization transaction typically specifies the rights and obligations of servicing rights. Our largest source of revenue with respect to servicing rights is the servicing fees that we earn pursuant to servicing and subservicing agreements. In the majority of cases, we purchase the MSRs, which generally entitle us to receive 50 basis points annually on the average UPB of the loans serviced. We typically purchase the MSRs for between 25 and 95 basis points of the UPB. Under subservicing arrangements, where we do not pay for the MSRs, we generally receive between 5 and 35 basis points annually on the UPB. The servicing and subservicing fees are supplemented by related income, including late fees from borrowers who are delinquent in remitting their monthly mortgage payments, Speedpay ® fees from borrowers who pay by telephone or through the Internet and interest earned on loan payments that we have collected but have not yet remitted to the owner of the mortgage (“float earnings”). In 2007, we collected approximately $16,223,124 in monthly mortgage payments and one-time payoffs on behalf of the owners of these loans.

3


          Subprime mortgage loan servicing involves special loss mitigation challenges not usually present in prime loan servicing. Over a period of years, we have applied scientific management to developing proprietary best practices for reducing loan losses. We have embedded those best practices in our technology in order to ensure that they are consistently and efficiently applied. Our eight global operating centers allow us to recruit in broad, deep talent pools. Rigorous screening and training of our workforce allows us to implement specialized loss mitigation techniques that minimize losses. Our proactive measures to keep borrowers current on their payments are effective in forestalling foreclosures in the overwhelming majority of the cases. The best outcome for the loan investor is to keep the loan performing. When a delinquency occurs and the home is the primary residence of the borrower, we are successful in approximately 80% of the cases in working out a resolution that avoids a foreclosure. We pride ourselves on keeping borrowers in their homes and avoiding foreclosure. This is a “win-win” situation for both the investors and borrowers that we serve.

          As a servicer or subservicer, we have a variety of contractual obligations including the obligation to service the mortgages according to certain standards and to advance funds to securitization trusts in the event that borrowers are delinquent on their monthly mortgage payments. When a borrower becomes delinquent, we “advance” cash to the REMIC Trustees on the scheduled remittance date thus creating a receivable due us from the REMIC Trust. We advance principal and interest (“P&I Advances”), taxes and insurance (“T&I Advances”) and legal fees, maintenance and preservation costs on properties heading into the foreclosure process and on properties that have already been foreclosed (“Corporate Advances”). If we determine that we cannot recover our advances by working with the borrower or from the value of the property, we generally have the right to halt advances, declare the advances to be non-recoverable and, in most cases, recover our advances from the respective general collections accounts owned by the REMIC Trustees. Most of our advances have the highest standing and are “top of the waterfall” so that we are entitled to repayment before any interest or principal is paid on the bonds. The costs incurred in meeting these obligations include, but are not limited to, the interest expense incurred to finance the servicing advances.

          The U.S. Department of Housing and Urban Development, Freddie Mac and Fannie Mae have approved OLS as a loan servicer. Standard & Poor’s Rating Services (“Standard & Poor’s”) has rated OLS “Strong” as a Residential Subprime Servicer and Residential Special Servicer. “Strong” represents Standard & Poor’s highest ratings category. Moody’s Investors Services, Inc. (“Moody’s”) has rated OLS “SQ2–” as a Residential Subprime Servicer and “SQ2” as a Residential Special Servicer. “SQ2” represents Moody’s second highest rating category. Fitch Ratings (“Fitch”) has rated OLS “RPS2” for Residential Subprime Servicing and “RSS2” for Residential Special Servicing. These represent Fitch’s second highest categories.

Ocwen Recovery Group

          This segment primarily provides collection services to owners of delinquent and charged-off receivables. We generally earn a fee based upon a percentage of the dollars collected on behalf of the owners of the receivables. The percentage fee generally ranges from 6% to 35%. Revenue from this segment comprised 9%, 2% and 3% of our consolidated revenues in 2007, 2006 and 2005, respectively.

          On June 6, 2007, we acquired NCI Holdings, Inc. (“NCI”) for $57,000 in cash, including $2,000 of closing adjustments. NCI, through its operating subsidiary, Nationwide Credit, Inc., is ranked as one of the top 10 U.S. companies in the accounts receivable management industry. NCI’s primary business is contingency collections for credit card issuers and other consumer credit providers. The majority of NCI’s annual revenue comes from credit card related collections, with the remainder coming from other consumer credit collections, first-party customer service solutions and student loan collections. NCI primarily serves large credit issuers and has a blue chip customer list. Ocwen Recovery Group includes the operations of NCI since the date of the acquisition.

Residential Origination Services

          Revenue from the Residential Origination Services segment comprised 15%, 16% and 18% of our consolidated revenues in 2007, 2006 and 2005, respectively. Our strategic focus in this segment is on fee-based loan processing businesses that include residential property valuation services, mortgage due diligence and title services; and business process outsourcing services to third parties, including mortgage underwriting, data entry, call center services and mortgage research. We also sell due diligence services on closed whole loans to Wall Street firms. These fee-based businesses have limited capital requirements and provide a balance between resolution, servicing and origination of loans. Success in this area is dependent on our ability to provide our customers with quality and timely services at competitive prices.

          The segment also includes trading and investing activities and our former subprime loan origination operation. Our trading and investing activities include our investments in subprime residual mortgage-backed trading securities, as well as the results of our loan purchase and securitization activities and the loans remaining from our subprime origination business. In January 2007, we decided to close our start-up subprime loan origination operation, and during 2007, we de-emphasized our trading and investing activities. Our loan origination operation included the results of Funding America, LLC, (“Funding America”), which we began to include in our consolidated financial statements as of December 31, 2005. Our discontinuance of the subprime loan origination business included closing Funding America.

4


          Residential Origination Services also includes REALTrans SM , our 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.

Corporate Items and Other

          In Corporate Items and Other, we report business activities that are individually insignificant, items of revenue and expense that are not directly related to a business unit, interest income on short-term investments of cash and the related costs of financing these investments and certain other corporate expenses. Insignificant business activities include, among others, our former Commercial Servicing segment, our 46% equity interest in BMS Holdings, Inc. (“BMS Holdings”) and our wholly-owned German banking subsidiary, Bankhaus Oswald Kruber GmbH & Co. KG (“BOK”). In the fourth quarter of 2007, management approved and committed to a plan to sell its investment in BOK. The results of operations of BOK have been reclassified in the consolidated financial statements as discontinued operations.

          See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Segments” for additional financial information and related discussion regarding each of our segments.

SOURCES OF FUNDS

          We meet our current need for funds through financings, such as match funded liabilities, lines of credit and other secured borrowings, through funds generated by operations, such as servicing fees (including float earnings and ancillary fees), and through payments received on or from the sale of trading securities and loans held for resale. Our primary uses of funds are the funding of servicing advances, purchases of MSRs, payment of interest and operating expenses and repayments of borrowings. Our funding needs related to loan originations have declined significantly in 2007 as the result of our decision to close our subprime loan origination business. We closely monitor our liquidity position and ongoing funding requirements, and we invest available funds in short-term investment grade securities.

          Our ability to sustain and grow our Residential Servicing business depends in part on our ability to maintain and expand sources of financing to fund servicing advances and to purchase new servicing rights. We finance most of our advances using match funded securitization facilities through Barclays Capital, Inc., Deutsche Bank AG, Greenwich Capital Financial Products, Inc. and JPMorgan Chase Bank, N.A. We also finance advances through our banking syndication, which is led by JPMorgan Chase Bank, N.A. This syndication is currently our sole source of financing for MSRs.

          An increase in delinquency rates has increased the amount of funds that we, as servicer, must advance to meet contractual principal and interest payments to certain investors, to pay taxes, insurance and other costs necessary to preserve the assets that secure the loans and to pay the costs of foreclosure when past due loans cannot be returned to performing status. A continued increase in delinquency rates could further increase the need to fund advances beyond the current level. Meeting the need to advance these funds requires readily available unused borrowing capacity. We work with multiple financing sources to ensure that we have sufficient capacity to finance servicing advances at all times. However, as noted earlier, we are generally obligated to advance funds only to the extent that we believe that the advances are recoverable, and the risk of loss on advances is low because, when the trust disburses funds that it has collected, advances generally have priority over the securities that the securitization trust has issued.

          See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” for additional financial information regarding our sources of funds.

COMPETITION

          A discussion of competition as it relates to our primary businesses appears in Item 1A, “Risk Factors.”

SUBSIDIARIES

          A list of our significant subsidiaries is set forth in Exhibit 21.0.

EMPLOYEES

          As of December 31, 2007, we had 4,614 employees, of which 1,668 were resident in our U.S. facilities, 2,833 were resident in our India operations centers and 113 were based in other countries. We have developed our India operations centers over the past six years in order to benefit from the cost savings opportunities and the quality workforce.

          In the U.S., our principal locations as of December 31, 2007 included our headquarters in West Palm Beach, Florida, which had 246 employees, our operations center in Orlando, Florida, which had 275 employees, and NCI locations in Vestal, New York with 476 employees, Kennesaw, Georgia with 240 employees and Phoenix, Arizona with 211 employees. In total, NCI operations included 1,096 employees at five locations in the U.S. plus 66 employees in Canada. We also had 51 employees at various other locations in the U.S.

5


          Of our employees in India as of December 31, 2007, 1,702 were in the city of Bangalore, 963 were in the city of Mumbai and 168 were in our offices in the state of Goa. Our India workforce is deployed as follows:

 

 

 

 

40% are in Residential Servicing,

 

 

 

 

10% are in Ocwen Recovery Group,

 

 

 

 

9% are in Residential Origination Services,

 

 

 

 

15% work in various other business units,

 

 

 

 

18% provide technology support to the business groups and

 

 

 

 

8% support other functions, including Human Resources and Corporate Services, Accounting, Legal and Risk Management.

REGULATION

          Our business is subject to extensive regulation by federal, state and local governmental authorities, including the Federal Trade Commission and the state agencies that license our servicing and collection entities. We also must comply with a number of federal, state and local consumer protection laws, including, among others, the Gramm-Leach-Bliley Act, the Fair Debt Collection Practices Act, the Real Estate Settlement Procedures Act, the Truth in Lending Act, the Fair Credit Reporting Act and the Homeowners Protection Act. These statutes apply to debt collection, foreclosure and claims handling, investment of and interest payments on escrow balances and escrow payment features, and they mandate certain disclosures and notices to borrowers. These requirements can and do change as statutes and regulations are enacted, promulgated or amended.

          We are subject to certain federal, state and local consumer protection provisions. We are also subject to licensing and regulation as a mortgage service provider and/or debt collector in a number of states. We are subject to audits and examinations that are conducted by the states. From time to time, we receive requests from state and other agencies for records, documents and information regarding our policies, procedures and practices regarding our loan servicing and debt collection business activities. We incur significant ongoing costs to comply with governmental regulations.

          In addition, in connection with debanking, we entered into various agreements to meet the conditions to the OTS’ approval. We also entered into an Assignment and Assumption Agreement, dated June 28, 2005, with our subsidiaries Investors Mortgage Insurance Holding Company, Rocaille Acquisition Subsidiary, Inc., the Bank and OLS whereby the Bank assigned to OLS, directly or indirectly, all of its assets, liabilities and business remaining after the consummation of the debanking transactions (the “Assignment”). Also on June 28, 2005, we entered into an agreement (the “Guaranty”) in favor of the OTS and any holders of claims with respect to liabilities assumed by OLS from the Bank in connection with the Assignment. The Guaranty contains affirmative covenants relating to the maintenance of a cash collateral account, reporting requirements, transactions with affiliates, preservation of the existence of our subsidiaries and maintenance of not less than $35,000 of unencumbered assets. The Guaranty also contains negative covenants that restrict our ability to (i) incur indebtedness if certain financial ratios are not achieved or if we fail to maintain a specified minimum net worth, (ii) enter into merger transactions or a sale of substantially all of our assets, (iii) sell, lease, transfer or otherwise dispose of our assets, or (iv) pay dividends or acquire our capital stock. While we do not expect that compliance with the Guaranty will have a material adverse impact on our financial condition, results of operations or cash flows, if an event of default were to occur we would be obligated to increase the cash collateral amount. Furthermore, the OTS and other beneficiaries of the Guaranty are entitled to initiate enforcement proceedings against us, which, in the case of the OTS, could result in monetary civil penalties.

AVAILABLE INFORMATION

          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 SEC. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers, including OCN, that file electronically with the SEC. The address of that site is www.sec.gov. We have also posted on our website, and have available in print upon request, the charters for our Audit Committee, Compensation Committee and Governance Committee, our Governance Guidelines and our 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.

          On May 30, 2007, pursuant to Section 303A.12 of the listing standards of the New York Stock Exchange, our Chief Executive Officer certified to the New York Stock Exchange that he was not aware of any violation by Ocwen Financial Corporation of the New York Stock Exchange corporate governance listing standards as of that date. Additionally, we filed with the SEC the CEO/CFO certifications required under Section 302 of the Sarbanes-Oxley Act as Exhibits to our Form 10-K.

6


ITEM 1A. RISK FACTORS (Dollars in thousands)

          An investment in our common stock involves significant risks that are inherent to our business. We describe below the principal risks and uncertainties that management believes affect or could affect us. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. You should carefully read and consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report before you decide to invest in our common stock. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

Continued economic slowdown and/or continued deterioration of the housing market could increase delinquencies, defaults, foreclosures and advances and could reduce the market for loan servicing rights and origination processing services. During any period in which the borrower is not making payments, we are required under most of our 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 also advance funds to maintain, repair and market real estate properties on behalf of investors. We are entitled to recover advances from borrowers for reinstated and performing loans and from investors for foreclosed loans. Advance requirements have increased in 2007 primarily as a result of higher delinquencies and slower prepayments, which has led to higher interest expense on the financing of advances.

          An increase in the balance of advances outstanding relative to the change in the size of the servicing portfolio can result in substantial strain on our financial resources. This occurs because excess growth of advances increases financing costs with no offsetting increase in revenue, thus reducing profitability. If we are unable to fund additional advances, this could cause us to breach the requirements of our servicing contracts. Such developments could result in our losing our servicing rights, which would have a substantial negative impact on our financial condition and results of operations and could trigger cross-defaults under our various credit agreements.

          The significant decline in subprime originations in 2007 has had and may continue to have an adverse impact on our ability to maintain or expand further our servicing portfolio. Periods of economic slowdown or recession may be accompanied by a decrease in the demand for consumer credit and a reduction in the number of new loans available for servicing and the demand for origination processing services.

We may be unable to obtain sufficient capital to meet the financing requirements of our business. Our financing strategy includes the use of significant leverage. Accordingly, our ability to finance our operations rests in large part on our ability to borrow money. Our ability to borrow money is affected by a variety of factors including:

 

 

limitations imposed on us by existing lending and similar agreements that contain restrictive covenants that may limit our ability to raise additional debt; and

 

 

the recent decline in liquidity in the credit markets due in part to the recent turmoil in the subprime mortgage market.

          An event of default, a negative ratings action by a rating agency, the perception of financial weakness, an adverse action by a regulatory authority 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.

We face strong competition in our primary business segment. Our competitors include 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 MSRs and finance advances. Because a part of our strategy depends on our ability to obtain MSRs, we can provide no assurance that such competition will not have an adverse impact on our ability to implement our strategy.

          In general, competition intensified in recent years as the low interest rate environment 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. Some originators from whom we have purchased servicing rights in the past have developed their own servicing capabilities.

A significant increase in prepayment speeds could adversely affect our financial results. A significant driver of our business is prepayment speed, which is the measurement of how quickly borrowers pay down the UPB of their loans. Prepayment speed has a significant impact on our revenues, our expenses and on the valuation of our MSRs. A significant increase or decrease in prepayment speeds would affect these items as follows:

 

 

Revenue . If prepayment speeds increase, our servicing fees will decrease because of the faster decrease in UPB on which those fees are based. The reduction in servicing fees would be somewhat offset by increased float earnings, because the faster repayment of loans will result in higher balances in the custodial accounts that generate the float earnings. Conversely, decreases in prepayment speeds drive increased servicing fees and lead to lower float balances and income.

7


 

 

Expenses . Amortization of MSRs is the largest operating expense of our Residential Servicing business. Since we amortize servicing rights in proportion to total expected income over the life of a portfolio, an increase in prepayment speeds or delinquencies will lead to increased amortization expense as we revise downward our estimate of total expected income. Faster prepayment speeds would also result in higher compensating interest expense. Compensating interest expense represents the difference, in the month in which a loan is repaid, between the full month of interest that we are required to remit to the trust and the amount of interest that we actually collect from the borrower. Decreases in prepayment speeds lead to decreased amortization expense as the period over which we amortize MSRs is extended. Slower prepayment speeds also lead to lower compensating interest expense.

 

 

Valuation of MSRs . We base the price we pay for MSRs and the rate of amortization of those rights on, among other things, our projections of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If prepayment speeds were significantly greater than expected, the carrying value of our MSRs could exceed their estimated fair value which is based on our cash flow projections. Were the carrying value of MSRs to exceed their fair value, we would be required to record an impairment charge, which would have a negative impact on our financial results.

Our success is dependent upon our ability to acquire and accurately price MSRs. The primary risk associated with MSRs is that they will lose a portion of their value because of the higher than anticipated prepayments that may be occasioned by declining interest rates or rapidly increasing housing prices. 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 MSRs. In general, the value of mortgage servicing assets is affected by increased mortgage refinance activity that is, in turn, influenced by changes in borrower credit ratings, shifts in value in the housing market and changes in interest rates.

          We acquire servicing rights principally from investment banks and mortgage origination companies. We typically acquire servicing rights through a competitive bidding process. Although the market for the acquisition of servicing rights to subprime mortgage loans has grown in recent years, this market slowed dramatically in 2007. As a result, we may be unable to acquire sufficient MSRs in future periods to sustain growth or even to maintain our current level of business. In addition, the volume of servicing rights that we acquire 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 underlying pools of mortgage loans;

 

 

projected rates of delinquencies and defaults;

 

 

amounts of future servicing advances;

 

 

our cost to service the loans;

 

 

ancillary fee income; and

 

 

future interest rates.

          If these assumptions are inaccurate or the bases for the assumptions change, the price we pay to acquire servicing rights may prove to be too high. This could result in lower than expected profitability or a loss. Therefore, our success is highly dependent upon accurate pricing of servicing rights.

We are subject to investment risks. We have, in some cases, retained subordinate and residual interests in connection with the securitization of our loans and have acquired other residual interests outright or in connection with our acquisition of subsidiaries. In addition, we have invested in certain asset management vehicles that invest principally in the same classes of assets. The performance of these types of securities has at times been negatively impacted by higher than expected prepayment speeds and credit losses experienced on the mortgage loans collateralizing the securities. We remain subject to the risk of loss on our remaining securities primarily to the extent that actual credit losses exceed expected credit losses in the future.

          We also have invested in loans that we hold for resale related to our Residential Origination Services business. We believe that we have established adequate valuation allowances for declines in fair values below the cost of these loans in accordance with generally accepted accounting principles. However, future increases to these valuation allowances may be necessary due to changes in economic conditions and the performance of these loans prior to their sale or securitization. Increases in our valuation allowances for declines in fair value below cost would adversely affect our results of operations.

We use estimates in determining the fair value of certain assets, such as MSRs and residual securities. If our estimates prove to be incorrect, we may be required to write down the value of these assets , which could adversely affect our earnings. We use internal financial models that use, wherever possible, market participant data to value our MSRs and residuals. These models are complex and use asset-specific collateral data and market inputs for interest rates. In addition, the modeling requirements of MSRs and residual securities are complex because of the high number of variables that drive cash flows associated with MSRs and the complex cash flow structures, which may differ on each securitization, that determine the value of residual securities.

8


          Even if the general accuracy of our valuation model is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of the model. Such assumptions are complex, as we must make judgments about the effect of matters that are inherently uncertain. If prepayment speeds increase more than estimated or loan loss levels are higher than anticipated, we may be required to write down the value of certain assets, which could adversely impact our earnings.

A downgrade in our servicer ratings could have an adverse effect on our business, financial condition or results of operations. Standard & Poor’s, Moody’s and Fitch rate us as a mortgage servicer. Our current favorable servicer ratings from these entities are important to the conduct of our loan servicing business. We can provide no assurance that these ratings will not be downgraded in the future. Any such downgrade could have an adverse effect on our business, financing activities, financial condition or results of operations.

Governmental and legal proceedings and related costs could adversely affect our financial results. An adverse judgment in various governmental proceedings and lawsuits, including class action lawsuits, challenging our residential loan servicing and other business practices could affect our financial condition and results of operations.

          We and certain of our affiliates have been named as defendants in a number of purported class action lawsuits challenging our 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 require us to adopt business practices different from those of our competitors, as well as to pay settlement costs, damages, penalties or other charges, which could adversely affect our financial results. For more information about our legal proceedings, see “Legal Proceedings.”

          The OTS and other beneficiaries of the Guaranty are entitled to initiate enforcement proceedings against us, which, in the case of the OTS, could result in civil money penalties. Accordingly, there can be no assurance that any such events, were they to occur, would not have a material adverse effect on our financial condition, results of operations or cash flows.

The expanding body of federal, state and local regulation and/or licensing of loan servicing, collections or other aspects of our business increase the cost of compliance and the risks of noncompliance . As noted in “Regulation,” our business is subject to extensive regulation 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. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan servicing activities. If our regulators impose new or more restrictive requirements, we may incur additional significant costs to comply with such requirements, which could further adversely affect our results of operations or financial condition. In addition, our failure to comply with these laws and regulations can possibly lead to civil and criminal liability; loss of licensure; damage to our reputation in the industry; inability to sell or securitize our loans; demands for indemnification or loan repurchases from purchasers of our loans; fines and penalties and litigation, including class action lawsuits; or administrative enforcement actions. Any of these outcomes could harm our results of operations or financial condition.

Our earnings may be inconsistent. Our exit from certain businesses and entry into others has resulted in variations in our results of operations and earnings. Our past financial performance should not be considered a reliable indicator of future performance, and historical trends may not be reliable indicators of anticipated financial performance or trends in future periods.

          In addition to inconsistency in financial performance caused by our entry into or exit from certain businesses, the consistency of our operating results may 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.

          Certain non-recurring gains and losses that have significantly affected our operating results may result in substantial inter-period variations in financial performance.

An increase in interest rates could harm our business. An increase in interest rates could result in a reduction in the volume of new loans requiring our servicing and origination processing services. An increase in rates could also generate an increase in delinquency, default and foreclosure rates occasioning an increase in both operating expenses and interest expense on advances and could cause a reduction in the value of, and income from, our loans and subordinate and residual securities. Rising delinquencies also delay our collection of servicing fees, although we anticipate that we will ultimately collect these fees.

Our hedging strategies may not be successful in mitigating our risks associated with interest rates. From time to time, we have used various derivative financial instruments to provide a level of protection against interest rate risks, but no hedging strategy can protect us completely. The derivative financial instruments we select may not have the effect of reducing our interest rate risks. In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies, improperly executed and recorded transactions or inaccurate assumptions could actually increase our risks and losses. In addition, hedging strategies involve transaction and other costs. We cannot be assured that our hedging strategy and the derivatives that we use will adequately offset the risks of interest rate volatility or that our hedging transactions will not result in or magnify losses.

9


We have significant operations in India that could be adversely affected by changes in the political or economic stability of India or by government policies in India or the U.S. Nearly two-thirds of our employees are located in India. A significant change in India’s economic liberalization and deregulation policies could adversely affect business and economic conditions in India generally and our business in particular. The political or regulatory climate in the U.S. or elsewhere also could change so that it would not be lawful or practical for us to use international operations centers. For example, changes in privacy regulations could require us to curtail our use of lower-cost operations in India to service our businesses which could reduce the cost benefits we currently realize from using these operations. If we were to cease our operations in India and transfer these operations to another geographic area, we could incur increased overhead costs that could materially and adversely affect our results of operations.

Technology failures could damage our business operations and increase our costs. 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 our maintaining 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.

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 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.

Our directors and executive officers collectively own a large percentage of our common shares and could influence or control matters requiring shareholder approval. Our directors and executive officers and their affiliates collectively own or control approximately 42% of our outstanding common shares. This includes approximately 30% owned or controlled by our chairman and chief executive officer, William C. Erbey, and approximately 11% 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 the amendment of our articles of incorporation, the approval of mergers or similar transactions and the election of all directors.

ITEM 1B. UNRESOLVED STAFF COMMENTS

          None.

ITEM 2. PROPERTIES

          The following table sets forth information relating to our primary facilities at December 31, 2007:

 

 

 

 

 

 

 

 

Location

 

Owned/Leased

 

Square Footage

 


 


 


 

Executive office and headquarters:

 

 

 

 

 

 

 

 

 

West Palm Beach, Florida

 

 

 

Leased

 

 

 

 

41,860

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Servicing operations center:

 

 

 

 

 

 

 

 

 

 

 

Orlando, Florida

 

 

 

(1)

 

 

 

 

124,500

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage fulfillment center:

 

 

 

 

 

 

 

 

 

 

 

Lisle, Illinois

 

 

 

Leased

 

 

 

 

20,452

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NCI office and customer support centers:

 

 

 

 

 

 

 

 

 

 

 

Kennesaw, Georgia

 

 

 

Leased

 

 

 

 

46,700

 

 

Vestal, New York

 

 

 

Leased

 

 

 

 

54,957

 

 

Phoenix, Arizona

 

 

 

Leased

 

 

 

 

21,626

 

 

Goa, India

 

 

 

Leased

 

 

 

 

17,216

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Business operations and technology support offices:

 

 

 

 

 

 

 

 

 

 

 

Bangalore, India

 

 

 

Leased

 

 

 

 

92,650

 

 

Bangalore, India

 

 

 

Leased

 

 

 

 

56,960

 

 

Mumbai, India

 

 

 

Leased

 

 

 

 

46,280

 

 

(1) In October 2006, we entered into an agreement to lease 58,900 square feet of this facility (which increased to 61,400 square feet in October 2007) to a third party through September 2011. On December 31, 2007, we sold this facility to another third party in a “sale-leaseback” transaction. Under the sale-leaseback transaction, the buyer assumed the existing lease between OLS and one of its wholly-owned subsidiaries. We will continue to occupy the building under this lease which runs through September 2019. We will also continue to sublease 61,400 square feet of the facility to the third party subtenant.

          In addition to the facilities listed above, Global Servicing Solutions, LLC (“GSS”) leases two offices for commercial servicing and consulting operations, one each in Canada and Germany. BOK has two offices in Germany, one in Berlin and one in Mainz. NCI leases three smaller offices in Miramar, Florida, Sacramento, California and Victoria, British Columbia. We also lease a small office in Atlanta, Georgia.

10


I TEM 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:

          The liability, if any, for the claims noted below against Ocwen Federal Bank FSB (the “Bank”) has been assumed by OLS as successor in interest under an Assignment and Assumption Agreement, dated June 28, 2005, whereby OLS assumed all of the Bank’s remaining assets and liabilities, including contingent liabilities, in connection with its voluntary termination of its status as a federal savings bank.

          On April 13, 2004, the United States Judicial Panel on Multi-district Litigation granted our petition to transfer and consolidate a number of lawsuits against the Bank, OCN and various third parties arising out of the servicing of plaintiffs’ mortgage loans 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”). Currently, there are approximately 67 lawsuits against the Bank and/or OCN consolidated in the MDL Proceeding involving 95 mortgage loans that we currently service or previously serviced. Additional similar lawsuits have been brought in other courts, some of which may be transferred to and consolidated in the MDL Proceeding. The borrowers in many of these lawsuits seek class action certification. Others have brought individual actions. No class has been certified in the MDL Proceeding or any related lawsuits. On May 19, 2006, plaintiffs filed an Amended Consolidated Class Action Complaint (“Amended Complaint”) containing various claims under federal statutes, including the Real Estate Settlement Procedures Act, Fair Debt Collection Practices Act and bankruptcy laws, state deceptive trade practices statutes and common law. The claims are generally based on allegations of improper loan servicing practices, including (i) charging borrowers allegedly improper or unnecessary fees such as breach letter fees, hazard insurance premiums, foreclosure-related fees, late fees, property inspection fees and bankruptcy-related fees; (ii) untimely posting and misapplication of borrower payments; and (iii) improperly treating borrowers as in default on their loans. While the Amended Complaint does not set forth any specific amounts of claimed damages, plaintiffs are not precluded from requesting leave to amend further their pleadings or otherwise seek damages should the matter proceed to trial. On April 25, 2005, the trial court entered an Opinion and Order granting the Bank partial summary judgment finding that, as a matter of law, the mortgage loan contracts signed by plaintiffs authorize the imposition of breach letter fees, foreclosure-related fees and other legitimate default-related fees. The trial court explained that its ruling was in favor of defendants to the specific and limited extent that plaintiffs’ claims challenge the propriety of the above-mentioned fees. On May 16, 2006, after having denied a motion to dismiss based on federal preemption, the trial court granted our motion to take an interlocutory appeal on the issue. On July 29, 2006, the United States Court of Appeals for the Seventh Circuit granted our request to hear the appeal. On June 22, 2007, the Seventh Circuit issued its opinion holding that many of the claims were preempted or failed to satisfy the pleading requirements of the applicable rules of procedure and directing the trial judge to seek clarification from the plaintiffs regarding various aspects of the Amended Complaint so as to properly determine which particular claims are to be dismissed. On September 24, 2007, plaintiffs filed their Second Amended Complaint, which contains servicing practices allegations similar to those set forth in the prior version of their Complaint. On November 13, 2007, we filed a motion to dismiss the Second Amended Consolidated Class Action Complaint on the grounds that the claims are preempted and are deficient as a matter of law. Briefing on that motion has not yet been completed by the parties. We believe the allegations in the MDL Proceeding 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 Ocwen Technology Xchange, Inc. (“OTX”), a subsidiary that has been dissolved, 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. In so doing, 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. 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. On September 18, 2007, the United States Court of Appeals for the Tenth Circuit upheld the damage award against OTX and remanded the case for a new trial on damages against the Bank. On December 10, 2007, we paid the full amount of the judgment against OTX, including accrued interest. The trial court has not yet set a date for the new trial against the Bank.

          On February 9, 2006, the County Court for Galveston County, Texas entered judgment in the amount of $1,830 against OLS and in favor of a plaintiff-borrower who defaulted on a mortgage loan that we serviced. The plaintiff claimed that OLS’ foreclosure on the loan violated the Texas Deceptive Trade Practices Act and other state statutes and common law. This judgment reduced a prior jury verdict of $11,500. We believe the judgment, comprised of $5 in actual damages, approximately $675 in emotional distress, statutory and other damages and interest, and $1,150 for attorneys’ fees, is against the weight of evidence and contrary to law. On December 20, 2007, we reached a final settlement with the plaintiff. The amount we paid in connection with the settlement did not exceed the amount of the reserve we had previously established related to this case.

          On September 13, 2006, the Bankruptcy Trustee in Chapter 7 proceedings involving American Business Financial Services, Inc. (“ABFS”) brought an action against multiple defendants, including OLS, in Bankruptcy Court in Delaware. The action arises out of Debtor-in-Possession financing to ABFS by defendant Greenwich Capital Financial Products, Inc. and the subsequent purchases by OLS of MSRs and certain residual interests in mortgage-backed securities previously held by ABFS. OLS brought a separate action against the Trustee, in his representative capacity, seeking damages of approximately $2,500 arising out of the ABFS MSRs purchase transaction. OLS’ separate action against the Trustee was dismissed by agreement without prejudice with the right to replead such claims as counterclaims in the Trustee’s action or otherwise as a separate action should the Trustee’s action be dismissed. By opinion dated February 13, 2007, the Court granted OLS’ motion to dismiss some claims but refused to dismiss others. The Court allowed the Trustee leave to file an Amended Complaint, which the Trustee filed on March 13, 2007. The Amended Complaint sets forth claims against all of the original defendants and as against OLS alleges turnover, fraudulent transfers, accounting, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, breach of contract, fraud, civil conspiracy and conversion. The Trustee seeks compensatory damages in excess of $100,000 and punitive damages jointly and severally against all defendants. We believe that the Trustee’s allegations against OLS are without merit and intend to continue to vigorously defend against this matter.

11


          On January 30, 2008, Roger A. Inglese, alleging he is an OCN shareholder, filed an action on behalf of a purported class of shareholders in the Circuit Court of the 15th Judicial Circuit in Palm Beach County, Florida, against OCN and all of the members of its board of directors seeking equitable relief as to a contemplated acquisition of OCN by entities affiliated with William C. Erbey, Oaktree Capital Management L.P. and Angelo Gordon & Co. L.P. Plaintiff alleges the proposed purchase price for the OCN stock is inadequate. No monetary or other relief is requested against OCN and no class has been certified. We believe that the allegations are without merit and intend to continue to vigorously defend against this matter.

          OCN is subject to various other pending legal proceedings. In our opinion, the resolution of these proceedings will not have a material effect on our financial condition, results of operations or cash flows.

I TEM 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, 2007.

P ART II

I TEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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

 

 

 


 


 

2007

 

 

 

 

 

 

 

First quarter

 

$

16.72

 

$

10.66

 

Second quarter

 

 

14.52

 

 

12.75

 

Third quarter

 

 

12.72

 

 

7.75

 

Fourth quarter

 

 

10.59

 

 

4.99

 

 

 

 

 

 

 

 

 

2006

 

 

 

 

 

 

 

First quarter

 

$

10.22

 

$

8.65

 

Second quarter

 

 

13.23

 

 

9.95

 

Third quarter

 

 

16.17

 

 

12.56

 

Fourth quarter

 

 

16.10

 

 

14.84

 

          The closing sales price of our common stock on March 10, 2008, was $5.63.

          The payment of any dividends by us will be dependent on dividends and other payments received from our subsidiaries which may be affected by either restrictive covenants or regulatory compliance. We do not currently pay cash dividends on our 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 subsidiaries and investment opportunities at the time any such payment is considered. In addition, the Guaranty agreement with the OTS and the indentures and covenants relating to certain of our borrowings contain limitations on our payment of dividends.

          The following graph compares the cumulative total return on the common stock of Ocwen Financial Corporation since December 31, 2002, with the cumulative total return on the stocks included in the Standard & Poor’s 500 Market Index and the Standard & Poor’s Diversified Financials Market Index.

12


(LINE GRAPH)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Period Ending

 

 

 


Index

 

12/31/02

 

12/31/03

 

12/31/04

 

12/31/05

 

12/31/06

 

12/31/07

 


Ocwen Financial Corporation

 

100.00

 

316.43

 

341.43

 

310.71

 

566.43

 

197.86

 

S&P 500

 

100.00

 

126.29

 

137.75

 

141.88

 

161.20

 

166.89

 

S&P Diversified Financials

 

100.00

 

139.80

 

148.05

 

158.74

 

191.65

 

151.90

 

Purchases of Equity Securities by the Issuer and Affiliates

          Although we did purchase shares of our own common stock during 2007, we purchased none during the fourth quarter.

          Our ability to repurchase shares of our common stock is restricted under the terms of the Guaranty that we entered into with the OTS in connection with debanking. See Note 24 to the Consolidated Financial Statements for additional information regarding common stock repurchases.

Number of Holders of Common Stock

          At March 10, 2008, 62,650,550 shares of our common stock were outstanding and held by approximately 144 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.

Securities authorized for issuance under equity compensation plans

          The information required by this item with respect to securities authorized for issuance under equity compensation plans is incorporated by reference from the section entitled “Security Ownership Of Certain Beneficial Owners And Related Shareholder Matters – Equity Compensation Plan Information” in our definitive Proxy Statement with respect to our Annual Meeting of Shareholders to be held on May 8, 2008 and as filed with the SEC on or about March 30, 2008 (the “2008 Proxy Statement”).

13


I TEM 6. SELECTED FINANCIAL DATA (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 balance sheet and operations data at and for the five years ended December 31, 2007 have been derived from our audited financial statements. We have reclassified certain amounts included in the prior years to conform to the 2007 presentation. The selected consolidated financial information should be read in conjunction with the information we have provided in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 


 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 


 


 


 


 


 

Selected balance sheet data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and investment grade securities (1)

 

$

149,119

 

$

311,567

 

$

271,296

 

$

629,106

 

$

322,846

 

Subordinate and residual securities (2)

 

 

7,362

 

 

65,242

 

 

30,277

 

 

39,527

 

 

42,841

 

Investment in certificates of deposit (3)

 

 

 

 

72,733

 

 

 

 

 

 

 

Loans held for resale, at lower of cost or market (4)

 

 

75,240

 

 

99,064

 

 

624,671

 

 

8,437

 

 

 

Advances (1)

 

 

292,887

 

 

324,137

 

 

219,716

 

 

240,430

 

 

374,769

 

Match funded advances (1)

 

 

1,126,097

 

 

572,708

 

 

377,105

 

 

280,760

 

 

130,087

 

Mortgage servicing rights

 

 

197,295

 

 

183,743

 

 

148,663

 

 

131,409

 

 

166,495

 

Other (5)

 

 

546,696

 

 

380,549

 

 

182,445

 

 

254,474

 

 

291,230

 

 

 



 



 



 



 



 

Total assets

 

$

2,394,696

 

$

2,009,743

 

$

1,854,173

 

$

1,584,143

 

$

1,328,268

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Match funded liabilities (1)

 

$

1,001,403

 

$

510,236

 

$

339,292

 

$

244,327

 

$

115,394

 

Debt securities, lines of credit and other secured borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term (1) (4)

 

 

339,976

 

 

310,149

 

 

611,787

 

 

35,676

 

 

127,149

 

Long-term (6)

 

 

150,279

 

 

164,700

 

 

168,990

 

 

246,185

 

 

79,484

 

Servicer liabilities (1)

 

 

204,484

 

 

383,549

 

 

298,892

 

 

291,265

 

 

98,763

 

Deposits and escrows (7)

 

 

 

 

 

 

 

 

376,591

 

 

546,145

 

Other

 

 

110,429

 

 

81,340

 

 

85,952

 

 

58,461

 

 

42,791

 

 

 



 



 



 



 



 

Total liabilities

 

 

1,806,571

 

 

1,449,974

 

 

1,504,913

 

 

1,252,505

 

 

1,009,726

 

Minority interest in subsidiary

 

 

1,979

 

 

1,790

 

 

1,853

 

 

1,530

 

 

1,284

 

Stockholders’ equity

 

 

586,146

 

 

557,979

 

 

347,407

 

 

330,108

 

 

317,258

 

 

 



 



 



 



 



 

Total liabilities and stockholder’s equity

 

$

2,394,696

 

$

2,009,743

 

$

1,854,173

 

$

1,584,143

 

$

1,328,268

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential loans and real estate serviced for others

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Count

 

 

435,616

 

 

473,665

 

 

368,802

 

 

320,185

 

 

359,590

 

Amount

 

$

53,545,985

 

$

52,834,028

 

$

42,779,048

 

$

34,524,491

 

$

37,697,318

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

 


 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 


 


 


 


 


Selected operations data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue (5):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Servicing and subservicing fees

 

$

379,277

 

$

340,584

 

$

293,382

 

$

288,078

 

$

277,428

 

Other

 

 

101,384

 

 

90,994

 

 

81,753

 

 

71,780

 

 

37,705

 

 

 



 



 



 



 



 

Total revenue

 

 

480,661

 

 

431,578

 

 

375,135

 

 

359,858

 

 

315,133

 

Operating expenses (5)

 

 

360,070

 

 

344,535

 

 

346,678

 

 

335,137

 

 

294,967

 

 

 



 



 



 



 



 

Income from operations

 

 

120,591

 

 

87,043

 

 

28,457

 

 

24,721

 

 

20,166

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income (2) (4)

 

 

29,651

 

 

47,609

 

 

24,551

 

 

23,582

 

 

24,122

 

Interest expense (1) (4)

 

 

(72,670

)

 

(53,371

)

 

(36,986

)

 

(30,317

)

 

(38,716

)

Other (2) (3)

 

 

(19,193

)

 

946

 

 

6,659

 

 

7,640

 

 

(52

)

 

 



 



 



 



 



 

Other income (expense), net

 

 

(62,212

)

 

(4,816

)

 

(5,776

)

 

905

 

 

(14,646

)

 

 



 



 



 



 



 

 

Income from continuing operations before income taxes

 

 

58,379

 

 

82,227

 

 

22,681

 

 

25,626

 

 

5,520

 

Income tax expense (benefit) (8)

 

 

16,610

 

 

(126,377

)

 

5,815

 

 

(32,324

)

 

748

 

 

 



 



 



 



 



 

Income from continuing operations

 

 

41,769

 

 

208,604

 

 

16,866

 

 

57,950

 

 

4,772

 

Loss from discontinued operations, net of taxes (9)

 

 

(3,172

)

 

(2,094

)

 

(1,801

)

 

(226

)

 

 

 

 



 



 



 



 



 

Net income

 

$

38,597

 

$

206,510

 

$

15,065

 

$

57,724

 

$

4,772

 

 

 



 



 



 



 



 

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.67

 

$

3.32

 

$

0.27

 

$

0.88

 

$

0.07

 

Loss from discontinued operations

 

 

(0.05

)

 

(0.04

)

 

(0.03

)

 

 

 

 

 

 



 



 



 



 



 

Net income

 

$

0.62

 

$

3.28

 

$

0.24

 

$

0.88

 

$

0.07

 

 

 



 



 



 



 



 

 

Diluted earnings per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.62

 

$

2.94

 

$

0.26

 

$

0.82

 

$

0.07

 

Loss from discontinued operations

 

 

(0.04

)

 

(0.03

)

 

(0.02

)

 

 

 

 

 

 



 



 



 



 



 

Net income

 

$

0.58

 

$

2.91

 

$

0.24

 

$

0.82

 

$

0.07

 

 

 



 



 



 



 



 

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

62,712,076

 

 

62,871,613

 

 

62,912,768

 

 

65,811,697

 

 

67,166,888

 

Diluted (2)

 

 

71,458,544

 

 

71,864,311

 

 

63,885,439

 

 

73,197,255

 

 

68,063,873

 

(1)   Our 2007 consolidated financial statements reflect the impact of rising mortgage delinquencies and declining prepayment speeds. Servicing advance requirements increased in 2007, primarily due to higher delinquencies and slower prepayments. This has resulted in an increase in borrowings and interest expense. Cash and investment grade securities declined in 2007 largely due to lower collections and the increased servicing advance funding requirements. Servicer liabilities, which represent cash collected from borrowers but not yet remitted to securitization trusts, also declined in 2007.

(2)   In the second quarter of 2007, we sold our residual securities, which were backed by subprime residential loans originated in the United Kingdom (the “UK residuals”), and realized a gain of $25,587. Unrealized losses on subordinate and residual securities were $29,140 in 2007, including $23,559 in the fourth quarter.

(3)   In the third quarter of 2007, we redeemed our investment in certificates of deposit (“CDs”) prior to their scheduled maturity in order to meet an unanticipated liquidity need and realized a loss of $8,673.

(4)   During 2005 and 2006, we acquired significant amounts of loans held for resale through whole loan purchases and subprime loan origination activities. We funded these acquisitions through the use of repurchase agreements and other short-term credit facilities. The majority of these loans were disposed of during 2006 through securitization transactions and whole loan sales and the related debt was repaid. In 2007, we decided to discontinue our subprime loan origination business.

(5)   The operations of NCI are included in our consolidated financial statements effective June 6, 2007, the date of acquisition. NCI is a receivables management company specializing in contingency collections for credit card issuers and other consumer credit providers. The allocation of the purchase price has resulted in total goodwill and intangibles of $53,260 at December 31, 2007. NCI revenues and operating expenses for the 2007 period were $35,978 and $38,400, respectively.

(6)   In July 2004, we issued $175,000 of 3.25% Contingent Convertible Senior Unsecured Notes. The outstanding balance of the Notes at December 31, 2007, 2006, 2005 and 2004 was $96,900, $96,900, $100,900 and $175,000, respectively. The assumed conversion of the notes has been reflected in the calculation of weighted average common shares outstanding in computing diluted earnings per share for 2007, 2006 and 2004. Conversion of the notes to common stock was not assumed for 2005 because the effect would be antidilutive. Interest expense, net of income tax, has been added back to net income for purposes of computing diluted earnings per share for 2007, 2006 and 2004.

15


(7)   Effective June 30, 2005, we terminated our banking subsidiary’s status as a federal savings bank, and as a result, we are no longer able to accept customer deposits in the U.S. On that same date, an unaffiliated bank assumed the customer deposits associated with our bank branch facility in New Jersey. Since 2000, we had been reducing our reliance on deposits as a source of funding.

(8)   The income tax benefit for 2006 reflects the reversal of $155,377 of valuation allowances on our deferred tax assets in order to increase the net deferred tax asset to the amount that is more likely than not to be realized in future periods. The benefit in 2004 principally reflects the reversal of $35,518 of valuation allowances on our deferred tax assets as a result of $56,526 of refund claims that were filed with the IRS. As a result of filing the claims, we reduced our deferred tax asset and increased our current income tax receivable by the amount of the claims. We collected these claims, plus accrued interest, in 2005.

(9)   In the fourth quarter of 2007, management of OCN approved and committed to a plan to sell its investment in BOK, a wholly-owned German banking subsidiary acquired in 2004. We have reclassified the results of operations of BOK in the consolidated financial statements from those of continuing operations.

ITEM 7. 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 Consolidated Financial Statements and the related notes, all included elsewhere in this annual report on Form 10-K.

EXECUTIVE SUMMARY

Strategic Goals

          Ocwen Financial Corporation is a business process outsourcing provider to the financial services industry, specializing in loan servicing, mortgage fulfillment and receivables management services. Our primary goal is to make our client’s loans worth more by leveraging our superior processes, innovative technology and high quality, cost effective global human resources. Our business is comprised of three segments – Residential Servicing, Ocwen Recovery Group and Residential Origination Services.

Results of Operations

          The following table summarizes our consolidated operating results for the periods indicated. Refer to the Segments section for a more complete discussion of operating results by line of business.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the years ended December 31,

 

2007-2006
% change

 

2006-2005
% change

 

 

 


 

 

 

 

 

2007

 

2006

 

2005

 

 

 

 

 


 


 


 


 


 

Consolidated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

480,661

 

$

431,578

 

$

375,135

 

 

11

 

 

15

 

Operating expenses

 

 

360,070

 

 

344,535

 

 

346,678

 

 

5

 

 

(1

)

 

 



 



 



 

 

 

 

 

 

 

Income from operations

 

 

120,591

 

 

87,043

 

 

28,457

 

 

39

 

 

206

 

Other expense, net

 

 

(62,212

)

 

(4,816

)

 

(5,776

)

 

1,192

 

 

(17

)

 

 



 



 



 

 

 

 

 

 

 

Income from continuing operations before taxes

 

 

58,379

 

 

82,227

 

 

22,681

 

 

(29

)

 

263

 

Income tax expense (benefit)

 

 

16,610

 

 

(126,377

)

 

5,815

 

 

(113

)

 

(2,273

)

 

 



 



 



 

 

 

 

 

 

 

Income from continuing operations

 

 

41,769

 

 

208,604

 

 

16,866

 

 

(80

)

 

1,137

 

Loss from discontinued operations, net of taxes

 

 

(3,172

)

 

(2,094

)

 

(1,801

)

 

51

 

 

16

 

 

 



 



 



 

 

 

 

 

 

 

Net income

 

$

38,597

 

$

206,510

 

$

15,065

 

 

(81

)

 

1,271

 

 

 



 



 



 

 

 

 

 

 

 

Segment income (loss) from continuing operations before taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Servicing

 

$

65,957

 

$

80,460

 

$

21,661

 

 

(18

)

 

271

 

Ocwen Recovery Group

 

 

(7,350

)

 

(563

)

 

(684

)

 

1,206

 

 

(18

)

Residential Origination Services

 

 

4,826

 

 

5,902

 

 

(3,191

)

 

(18

)

 

(285

)

Corporate items and other

 

 

(5,054

)

 

(3,572

)

 

4,895

 

 

41

 

 

(173

)

 

 



 



 



 

 

 

 

 

 

 

 

 

$

58,379

 

$

82,227

 

$

22,681

 

 

29

 

 

263

 

 

 



 



 



 

 

 

 

 

 

 

2007 Compared to 2006

          Our results for 2007 were characterized by higher income from operations, increased interest expense related to funding requirements for servicing advances and losses on residual securities and loans held for resale. Unrealized losses on residual securities were significantly offset by the gain we realized from our sale of the UK residuals. Interest income decreased due to reduced investments in loans held for resale, and we recognized a loss on our early redemption of CDs.

16


          Although Residential Servicing continues to be our most profitable segment, rising delinquencies and declining prepayments on residential mortgages have had a negative impact on 2007 results. The significant rise in delinquencies and decline in prepayment speeds have resulted in revenue growth that has lagged portfolio growth and increased interest expense related to the financing of higher servicing advance balances. This was offset somewhat by lower amortization of MSRs due to the decline in prepayment speeds. The results for Ocwen Recovery Group in 2007 reflect the June 6, 2007 acquisition of NCI, which incurred a loss for the period. The 2007 results for Residential Origination Services are characterized by lower interest income attributed to reduced balances of loans held for resale and our sale of the UK residuals and higher charges to reduce loans and residual securities to estimated market values, largely offset by improved earnings from fee-based businesses, a realized gain from the sale of the UK residuals and the closing of our subprime loan origination operation, which generated a loss in 2006.

          Total revenues increased by $49,083 or 11% in 2007 principally because of the acquisition of NCI, which added $35,978 of revenues to the Ocwen Recovery Group segment. Residential Servicing revenue increased by 3% in 2007. Rising delinquencies constrained revenue growth because we do not recognize servicing fees until payments are collected. We estimate that we had $49,550 of uncollected delinquent servicing fees at December 31, 2007 that we had not recognized as revenue, an increase of $24,946 as compared to December 31, 2006. Declining prepayment speeds resulted in lower custodial account balances and related float income. Revenues of the Residential Origination Services segment were 2% greater than 2006 as increases in fees from residential property valuations and title services offset declines in mortgage due diligence and loan refinancing fees.

          Total operating expenses were $15,535, or 5%, higher in 2007. Ocwen Recovery Group operating expenses increased by $38,804 largely because of the acquisition of NCI, which added $38,400 of operating expenses in 2007. Residential Servicing operating expenses declined by $3,231, or 1%, as an $11,400 decline in the amortization of MSRs and a $4,288 decline in professional services, primarily legal fees, offset a $4,587 increase in compensation and benefits due to increased staffing levels in India as a result of portfolio growth and an increase in non-performing loans. Slower prepayment speeds have reduced the rate of MSR amortization as we expect to earn the servicing income over a longer period of time. Residential Origination Services operating expenses were $13,636 or 16% less in 2007 as compensation and benefits declined by $11,010 largely due to our closing of the subprime loan origination operation, and professional services declined by $5,828 because of lower fees paid in connection with securitizations of loans held for resale.

          As a result, income from operations for Residential Servicing and Residential Origination Services improved by $14,673 (13%) and $15,244 (111%), respectively. These increases were partly offset by a decrease of $5,178 (573%) in the income from operations of Ocwen Recovery Group that resulted from the acquisition of NCI.

          Other expense, net increased in 2007 as a result of several significant factors. The costs of financing servicing advances and servicing rights increased in 2007 because of the growth in these assets and higher interest rates on average, resulting in a $27,593, or 91%, increase in interest expense for the Residential Servicing segment. Our Residential Origination Services segment suffered a decline in interest income in 2007 due to a lower investment in loans held for resale and our sale of the UK residuals. In addition, Residential Origination Services incurred unrealized losses of $29,031 in 2007 due principally to the write-down during the fourth quarter of subprime subordinate and residual securities to their estimated market values reflecting significantly higher projected loss assumptions, largely offset by a gain of $25,587 realized from our sale of the UK residuals in the second quarter. These changes resulted in a $16,320 decrease in other income (expense), net for Residential Origination Services. In Corporate Items and Other, other income (expense), net decreased by $10,291 largely because of a loss of $8,673 realized when an unanticipated liquidity need that arose in the third quarter caused us to redeem our zero coupon certificates of deposit prior to their maturity.

2006 Compared to 2005

          Our 2006 results reflect a strong performance in our Residential Servicing segment, which is our most profitable segment. The significant improvement over 2005 was primarily due to higher servicing fees because of growth in the portfolio and slower run-off of the existing portfolio due to a reduction in mortgage prepayments. In addition, rising short-term interest rates increased revenue from float earnings. In spite of the revenue growth, operating expenses declined slightly in 2006 because of cost containment measures and the positive impact of slower prepayment speeds on amortization and compensating interest expense. The costs of financing servicing advances and servicing rights increased in 2006 because of the growth in these assets and rising interest rates. Results of our Residential Origination Services segment improved in 2006 because of higher earnings from our fee-based loan processing activities partially offset by higher losses in our subprime origination activities, which we discontinued in 2007.

          In 2006, revenues of the Residential Servicing segment grew by $63,988 or 23% principally because of the growth in servicing fees generated by a 26% increase in the average balance of loans serviced. Float earnings also increased by $16,625 or 52% because of higher yields on the investment of custodial balances. Residential Origination Services revenues increased by $4,913 or 7% as higher fees generated by title services were partially offset by declines in fees from property valuation services. Finally, the revenues of the Ocwen Recovery Group segment declined by $4,017 or 34% on a decline in volume as management focused on cost reduction and enhancing staff effectiveness rather than on revenue growth.

          Operating expenses for 2006 were relatively unchanged from 2005 as increases in expenses of the Residential Origination Services segment were largely offset by declines in the Residential Servicing and Ocwen Recovery Group segments. Residential Origination Services operating expenses rose by $8,003 or 10% principally because of the $6,501 of compensation and benefits added by the operation of our subprime loan origination operation and an increase in fees paid in connection with the securitization of loans held for resale.

          As a result, income from operations increased by $58,586, or 206%.

17


          Other income (expense), net was also relatively unchanged in 2006. Higher interest expense in the Residential Servicing segment driven by the need to finance our growing investment in advances and MSRs was largely offset by an increase in interest income on loans held for resale in the Residential Origination Services segment that was greater than the increase in interest expense needed to fund our investment in these loans. We acquired the loans in the latter part of 2005 and the first half of 2006, and securitized them in the first, second and fourth quarters of 2006.

          The 2006 income tax benefit of $126,377 primarily reflects the reversal of $155,377 of deferred tax asset valuation allowances to increase the net deferred tax asset to the amount that is more likely than not to be realized in future periods.

Changes in Financial Condition

          Total assets grew by $384,953 or 19% in 2007. This increase was primarily due to a $522,139 increase in total advances, a $70,356 increase in other assets and a $51,248 increase in goodwill and intangibles. Our advance requirements have increased in 2007 as a result of higher delinquencies, slower prepayments and growth in the residential servicing portfolio. The increase in other assets was primarily due to an increase in the balance of debt service accounts related to advance funding facilities. The increase in goodwill and intangibles is primarily the result of our acquisition of NCI. These increases were partially offset by a $162,448 decrease in cash and investment grade securities, redemption of our CDs, which had a carrying value of $72,733 at December 31, 2006, and a $57,880 decrease in subordinate and residual securities. The decline in cash and investment grade securities reflects lower collections and increased advance funding requirements. The decline in subordinates and residuals reflects our sale of the UK residuals and valuation declines reflecting conditions in the subprime market.

          Total liabilities increased by $356,597 or 25% in 2007. This increase was largely the result of a $491,167 increase in amounts due under match funded liabilities primarily because of increased funding requirements on advances. This increase was offset in part by a $179,065 decrease in servicer liabilities that was primarily due to lower collections caused by declining prepayment speeds and rising delinquencies.

          At December 31, 2007, we had $586,146 of stockholders’ equity, a $28,167 increase over December 31, 2006 that was primarily due to net income of $38,597 for 2007 partially offset by our repurchase of one million shares of our common stock for $14,520.

Residential Servicing

          The key business drivers in the Residential Servicing segment are prepayment speed, aggregate UPB and delinquencies.

          Prepayment Speed. The most significant driver of our business is prepayment speed, which is the measurement of how quickly borrowers pay down their UPB, including payments in full as a result of refinancings. Prepayment speed has a significant impact on servicing fees, amortization of servicing rights, float income, interest expense on advances and compensating interest expense.

          If prepayment speed increases, our servicing fees will decrease because of the decline in the UPB on which those fees are based. Additionally, since we amortize servicing rights in proportion to total expected income over the life of a portfolio, an increase in prepayment speed will lead to accelerated amortization expense as we revise downward the estimated lives of the pools of loans that we service. Conversely, decreases in prepayment speeds drive increased revenue and can extend the period over which we amortize MSRs. When interest rates rise, it is relatively less attractive for borrowers to refinance their loans, and as a result, prepayment speed tends to decrease. When rates fall, prepayment speed tends to increase.

          Prepayment speed affects our float balances which in turn affects float income. Increased prepayment speed leads to higher float balances since we hold the entire loan pay off amount before we remit it to the investor as opposed to a single monthly payment. These higher float balances lead to increased float income. Slower prepayment speed leads to lower float balances and income.

          Slower prepayment speeds result in lower collections which increases the average outstanding balance of servicing advances and the amount of interest expense we incur on the financing of those advances.

          In addition, prepayment speed has a significant impact on compensating interest expense. Faster prepayment speeds mean that more loans pay off early which results in higher compensating interest expense. Compensating interest expense represents the difference between the full month of interest that we are required to remit to the REMIC Trustee in the month that a loan pays off and the amount of interest that we actually collect from the borrower for that month. Slower prepayment speeds lead to lower compensating interest expense. Compensating interest expense is included in “Servicing and origination expenses” in our consolidated statements of operations.

           Aggregate Unpaid Principal Balance. Aggregate UPB is another key revenue driver. As noted earlier, servicing fees are usually earned as a percentage of UPB, and growth in the portfolio means growth in servicing fees. Additionally, a larger servicing portfolio generates increased ancillary fees and leads to larger custodial balances which generate greater float income. Larger UPB also drives increases in expenses. To the extent that we grow UPB through the purchase of MSRs, our amortization of MSRs will generally increase with our servicing revenues. We will also incur additional interest expense to finance the purchase of MSRs and servicing advances, and our compensating interest expense will increase as the size of our portfolio increases.

          Delinquencies. Delinquencies also have a significant impact on our results of operations. Non-performing loans are more expensive to service than performing loans because our cost of advance funding and our cost of servicing are higher. Performing loans include those loans that are current or have been delinquent for less than 90 days in accordance with their original terms and those loans for which borrowers are making scheduled payments under forbearance or bankruptcy plans. We consider all other loans to be non-performing.

18


          When borrowers are delinquent, the amount of funds that we are required to advance to the investors on behalf of the borrowers increases. While the collectibility of advances generally is not an issue, we do incur significant costs to finance those advances. We utilize both securitization, (i.e., match funded liabilities) and revolving credit facilities to finance our advances. As a result, increased delinquencies result in increased interest expense.

          In addition, the cost of servicing non-performing loans is higher than the cost of servicing performing loans primarily because the loss mitigation techniques that we employ to keep borrowers in their homes are more costly than the techniques used in handling a performing loan. When loans are performing, we have limited interaction with the borrowers, and relatively low-cost customer service personnel conduct most of that interaction. Once a loan becomes delinquent, however, we must employ our loss mitigation capabilities to work with the borrower to return the loan to performing status. These procedures involve increased contact with the borrower and the development of forbearance plans or loan modifications by highly skilled consultants who command higher compensation. On those occasions when loans go into foreclosure, we incur additional costs related to coordinating the work of local attorneys to represent us in the foreclosure process. Finally, when we foreclose on loans, we employ specialists to service the real estate and manage the sale of those properties on behalf of our investors. A significant increase in delinquencies would cause us to increase our activities in these areas resulting in increased operating expenses. This increase in operating expenses should be somewhat offset by increased late fees for loans that become delinquent but do not enter the foreclosure process.

          In spite of a 10% increase in the average number of loans we serviced in 2007 and a doubling of the percentage of such loans that were non-performing at December 31, 2007, operating expenses excluding amortization of servicing rights increased by only 7% in 2007 as compared to 2006. This reflects our continued progress in controlling costs which results in a lower cost per unit to service.

          The following table provides key business drivers and other selected revenue and expense items of the Residential Servicing segment at or for the years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

2007-2006
% change

 

2006-2005
% change

 

 

 


 


 


 

 


 


 

Average UPB of loans and real estate serviced

 

$

55,253,914

 

$

47,819,667

 

$

37,850,025

 

 

 

16

%

 

26

%

Prepayment speed (average CPR)

 

 

23

%

 

30

%

 

38

%

 

 

(23

)

 

(21

)

UPB of non-performing loans and real estate serviced as a percentage of total at December 31 (1) (2)

 

 

20

%

 

8

%

 

8

%

 

 

150

 

 

 

Average number of loans and real estate serviced

 

 

464,309

 

 

421,524

 

 

338,417

 

 

 

10

 

 

25

 

Number of non-performing loans and real estate serviced as a percentage of total at December 31 (1)

 

 

16

%

 

8

%

 

10

%

 

 

100

 

 

(20

)

Average float balances

 

$

677,200

 

$

1,026,500

 

$

1,119,400

 

 

 

(34

)

 

(8

)

Average balance of advances and match funded advances

 

$

861,402

 

$

632,206

 

$

555,274

 

 

 

36

 

 

14

 

Average balance of MSRs

 

$

207,953

 

$

157,012

 

$

130,992

 

 

 

32

 

 

20

 

Collections on loans serviced for others

 

$

16,223,124

 

$

19,799,590

 

$

19,143,020

 

 

 

(18

)

 

3

 

Servicing and subservicing fees (excluding float and ancillary income)

 

$

227,716

 

$

207,312

 

$

170,488

 

 

 

10

 

 

22

 

Float earnings

 

$

29,299

 

$

48,289

 

$

31,663

 

 

 

(39

)

 

53

 

Amortization of servicing rights

 

$

99,118

 

$

110,518

 

$

96,692

 

 

 

(10

)

 

14

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense on match funded liabilities and lines of credit

 

$

52,458

 

$

26,464

 

$

17,146

 

 

 

98

 

 

54

 

Compensating interest expense

 

$

8,440

 

$

13,513

 

$

22,210

 

 

 

(38

)

 

(39

)

Operating expenses directly related to loss mitigation activities

 

$

16,189

 

$

11,753

 

$

13,342

 

 

 

38

 

 

(12

)


 

 

(1)

Excluding real estate serviced pursuant to our contract with the VA.

 

 

(2)

As of February 29, 2008, the UPB of non-performing loans was 21% of the total.

          The increase in non-performing loans in 2007 is a result of an increase in the average age of our portfolio, the poor performance of 2006 originations, an increase in the number and level of adjustable rate mortgage (“ARM”) resets and a slow down in home price appreciation amongst other factors.

          In 2008, we do not expect to make significant additions to our servicing portfolio and, therefore, expect revenues to decline as a result of the net runoff of the portfolio. The rate of growth in our advances and delinquency rates has slowed through February 2008, relative to the rate of growth experienced in the latter half of 2007, and we expect this trend to continue in 2008. Our outlook on prepayment speeds is that they will remain at or near current levels in 2008.

19


Residential Origination Services

          Our Residential Origination Services segment consists of three components:

          Fee-based loan processing businesses. These businesses provide various loan processing services to clients involved in the mortgage origination, servicing, loan acquisition and securitization processes. The services that we provide to our clients include:

 

 

 

 

Residential property valuation services,

 

 

 

 

Mortgage due diligence,

 

 

 

 

Title services, and

 

 

 

 

Outsourcing services, including mortgage underwriting, data entry, call center services and mortgage research.

          These fee-based businesses have limited capital requirements and represent a balance between resolution, servicing and origination of loans, thereby producing relatively stable earnings in spite of the decline in loan origination activity in 2007. We believe that our continued success in this area is dependent on our ability to efficiently manage our operating costs and continue to improve the quality and timeliness of service delivery so that we can provide high quality products at competitive prices.

          Trading and investing activities . This business includes our investments in subprime residual mortgage backed securities as well the results of our whole loan purchase and securitization activities and the loans remaining from our subprime origination business. During 2007, we deemphasized our whole loan purchase and securitization activities. The key to our results in this area is the performance of our assets, particularly with respect to default risk associated with our loans held for resale and with the loans underlying our mortgage backed securities. The current liquidity environment has had a negative impact on asset valuations, resulting in significantly higher charges in 2007 to reduce subprime residual securities and loans to their estimated market values.

           Subprime originations . In January 2007, we decided to close our subprime loan origination operation and no longer originate loans.

Ocwen Recovery Group

          Ocwen Recovery Group is our unsecured collections business. Effective June 6, 2007, this segment includes the results of NCI, a receivables management company we acquired that specializes in contingency collections for credit card issuers and other consumer credit providers. Our current focus is on the improvement of NCI’s financial performance. In that regard, we have developed an action plan that includes:

 

 

appropriate staffing of collectors to address the current shortage and the expected increase in volume reflective of rising delinquencies and charge-offs in the current credit environment;

 

 

improved financial performance on NCI’s largest first party outsourcing client through a fee increase and revised pricing methodology; and

 

 

the ramp up of collection operations at our new facility in India.

          We also continue to focus on the integration of NCI and Ocwen Recovery Group operations to take advantage of NCI’s strong customer relationships and OCN’s global infrastructure. We have implemented an integration plan to generate cost savings from the combined operations through the elimination of redundant expenses and migration of U.S. based collector and administrative jobs, primarily through attrition, to India. We believe the key to our success in this segment is our ability to perform well for our customers, which in turn, will lead to more account placements and continued growth of top line revenue. Our ability to perform well for our customers is largely dependent on our success in the training and retention of collection staff.

Strategic Initiatives

           Investments in Asset Management Vehicles. In 2007, we began developing asset management vehicles that benefit from our servicing and loss mitigation capabilities. These entities provide us with a controlled source of servicing.

           Ocwen Structured Investments, LLC (“OSI”). To date we have invested $37,500 in OSI and have committed to invest up to an additional $37,500 under our agreement with the other investors. OSI began operations during the second quarter of 2007. Our ownership interest in OSI is 25%. OSI invests primarily in MSRs and the related lower tranches and residuals of residential mortgage-backed securities, the credit risk of which is hedged with single name credit default swaps and the ABX Index. We are responsible for managing OSI’s portfolio under a management agreement and for subservicing its MSRs. We, along with the other principal investors, receive a preferential return in excess of our ownership interest in the event that OSI achieves certain performance objectives. These preferential distributions are, however, subject to a repayment provision should the future performance of OSI not support the preference payments made to the principal investors.

           Ocwen Nonperforming Loans, LLC (“ONL”). Our investments in ONL and related entities represent 25% equity interests. These entities invest in non-performing loans purchased at a discount and foreclosed real estate. We act as the servicer of the loans. To date we have invested a combined $36,013 in ONL and related entities and have committed to invest up to an additional $38,987.

           Segment Realignment. We are realigning our business segments in 2008 in conjunction with implementing our revised business strategy. In addition to our core Residential Servicing business, Ocwen Asset Management or “OAM” will include our existing asset management vehicles and planned future investments. We expect to grow our existing asset management vehicles and develop other vehicles that leverage our asset management capabilities.

20


          In addition to our unsecured collections business, Ocwen Solutions or “OS” will include the fee-based businesses that currently are part of our Residential Origination Services segment, all of our technology platforms and our interest in BMS. OS is a knowledge process outsourcer. Our competitive advantage, which is similar to the Residential Servicing business, is our ability to migrate high value, knowledge-based job functions to low cost global platforms utilizing artificial intelligence, scripting engines, decisioning models and workflow management to improve quality through the elimination of variability.

Liquidity

          Our balance sheet reflects the impact of rising mortgage delinquencies and declining prepayment speeds. Cash and investment grade securities totaled $149,119 at December 30, 2007, a $162,448 decline as compared to December 31, 2006 due to lower collections and increased advance funding requirements. Collections on residential loans serviced for others were $16,233,124 in 2007, down 18% from the $19,799,590 we collected in 2006. Servicer liabilities, which represent cash collected from borrowers but not yet remitted to securitization trusts, have declined by $179,065 from December 31, 2006 to December 31, 2007 while total advances have increased by $522,139 during the same period, principally in our Residential Servicing segment. Our borrowings have increased by $506,573 since December 31, 2006, including $534,236 related to our Residential Servicing segment.

           Our increased advance funding requirements have caused us to increase our borrowing capacity through the renewal and expansion of existing credit facilities and the establishment of new facilities. We have also taken actions toward obtaining additional increases in the future. Our total maximum borrowing capacity was $1,646,018 as of December 31, 2007, an increase of $471,018 as compared to December 31, 2006. This increase is primarily due to a $720,000 increase in borrowing capacity of the Residential Servicing segment offset by a $260,000 decline in borrowing capacity of the Residential Origination Services segment. The increase in Residential Servicing borrowing capacity represents a $665,000 increase under new and existing match funded advance agreements and a $55,000 increase under the existing secured line of credit. The decline in Residential Origination Services borrowing capacity is primarily the result of our closing of the subprime loan origination operation and our de-emphasis on loan trading activities. At December 31, 2007, $337,648 of our total maximum borrowing capacity remained unused, including $327,063 attributed to the Residential Servicing business. Of the unused borrowing capacity, approximately $83,000 was collateralized and readily available.

          On February 12, 2008, we negotiated a renewal of one of our match funded facilities under which we increased our maximum borrowing capacity from $140,000 to $200,000 and extended the stated maturity of the facility to February 2011. During the first quarter of 2008, a match funded term note in the amount of $100,000 that was issued under our largest facility entered its amortization period. When the amortization period begins, all collections representing the repayment of advances that have been financed through this note must be applied to reduce the balance of the note, and any new advances under the securitizations pledged to the note are not eligible to be financed. As of February 29, 2008, the total maximum borrowing capacity of our Residential Servicing business through match funded facilities and lines of credit was $1,545,000, of which approximately $285,000 was unused and approximately $78,000 was collateralized and readily available. Borrowing capacity under a secured advance facility may only be utilized to the extent that underlying collateral is pledged to that financing facility. As of December 31, 2007, we were in compliance with all covenants under our credit facilities. For more information about our credit facilities, see Note 17 to the Consolidated Financial Statements.

          Despite our success in renewing and expanding our credit facilities, the liquidity crisis that occurred in the global capital markets beginning in the third quarter of 2007 affected us in several ways. It caused lenders to tighten their lending standards which made financing for advances more difficult to obtain. It slowed the lending process by causing the major rating agencies to work more slowly on rating new financing because of the reevaluations of 2006 and other ratings that they were required to perform. It caused the cost of funding to increase because of both larger interest rate spreads over LIBOR and commercial paper rates and increased up-front fees that were demanded by lenders. Our MSRs continue to be financed under our senior secured credit agreement based on fair value less a financing discount, which is the difference between the fair value of the assets pledged as collateral to secure our financings and the amount that the lenders will advance to us.

CRITICAL ACCOUNTING POLICIES

          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 risks in the marketplace or other future events. Our critical accounting policies are those that relate to the estimation and measurement of these risks. Because they inherently involve significant judgments and uncertainties, an understanding of these policies is fundamental to understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. We discuss our significant accounting policies 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.

Valuation and Amortization of Residential Mortgage Servicing Rights

          Our most significant business is our Residential Servicing business. Inherent in this business is the acquisition of MSRs, an intangible asset representing the value of the right to service the loans in a portfolio. As of December 31, 2007, we held residential MSRs with a carrying value of $191,935 and an estimated fair value of $271,108. The most critical accounting policy for this business is the methodology we use to value and amortize MSRs. Application of this methodology requires the development of a number of estimates, including anticipated amortization, and periodic re-evaluation of these estimates.

21


          We estimate the fair value of our MSRs based on the results of our internal valuation. Our internal valuation calculates the present value of estimated future cash flows utilizing external assumptions that we believe are used by market participants. In addition, we periodically review third-party valuations of certain of our MSRs to assess the reasonableness of our valuation assumptions and the resulting fair value estimates. The most significant assumptions used in our internal valuation are the expected speed at which mortgages prepay and expected delinquencies, both of which we derive from our historical experience and available market data. Other assumptions used in our internal valuation include:

 

 

Cost of servicing

 

 

Compensating interest expense

 

 

Discount rate

 

 

Interest rate used for computing the cost of servicing advances

 

 

Interest rate used for computing float earnings

          The significant cash inflows considered in estimating future cash flows include servicing fees, late fees, prepayment penalties, float earnings and other ancillary fees. Significant cash outflows include the cost of servicing, the cost of making servicing advances and compensating interest payments. We base our strata on the predominant risk characteristics of the underlying loans. Our strata include:

 

 

Subprime

 

 

ALT A

 

 

High-loan-to-value

 

 

Re-performing

 

 

Special servicing

 

 

Other

          At December 31, 2007, we had MSRs relating to the Subprime, ALT A and High-loan-to-value strata. The following table provides the range of prepayment speed and delinquency assumptions (expressed as a percentage) by strata projected over the five-year period beginning December 31, 2007:

 

 

 

 

 

 

 

Prepayment Speed

 

Delinquency

 

 


 


Subprime

 

15% – 33%

 

17% – 26%

ALT A

 

16% – 43%

 

16% – 29%

High-loan-to-value

 

25% – 47%

 

16% – 23%

          While we develop the discount rate internally in light of prevailing market conditions, we base the interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing on external market-based assumptions. As of December 31, 2007, these assumptions were as follows:

 

 

Discount rate of 18%

 

 

Interest rate of one-month LIBOR plus 200 basis points for the cost of financing advances

 

 

Interest rate equal to the Federal Funds Rate for float earnings

 

 

Assumptions regarding the cost of servicing represent industry averages, vary by strata and range from a low of $110 per year for a performing ALT A loan to a high of $900 per year for a loan in foreclosure.

 

 

 

Changes in these assumptions are generally expected to affect our results of operations as summarized below:

 

 

Increases in prepayment speeds generally reduce the value of our MSRs as the underlying loans prepay faster which causes accelerated MSR amortization, higher compensating interest payments and lower overall servicing fees, partially offset by a lower overall cost of servicing, increased float balances on higher float earnings and lower interest expense on decreased servicing advance balances.

 

 

Increases in delinquencies generally reduce the value of our MSRs as the cost of servicing increases during the delinquency period, and the amount of servicing advances and related interest expense also increase.

 

 

Increases in the discount rate reduce the value of our MSRs 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 although this effect is partially offset because rate increases will also increase the amount of float earnings we recognize.

          We periodically perform an impairment analysis based on the difference between the carrying amount and estimated fair value of MSRs after grouping our loans into the applicable strata. The risk factors used to assign loans to strata include the credit score (FICO) of the borrower, the loan to value ratio and the default risk.

          We amortize MSRs over the period of estimated net servicing income based on our projections of the amount and timing of future cash flows. We determine these projections using the same assumptions that we use in our internal valuation of MSRs. The amount and timing of servicing asset amortization is adjusted periodically based on actual results and updated projections. During most of 2005, mortgage prepayment speeds in our servicing portfolio remained high resulting in a historically high rate of amortization. In 2006 and 2007, which featured rising subprime mortgage interest rates and home prices that were declining or appreciating much more slowly, we experienced lower mortgage prepayment speeds which resulted in a slower rate of amortization.

22


Valuation of Trading Securities and Loans Held for Resale

          We currently account for our investment grade, residual and subordinate securities as trading securities at fair value. We report changes in fair value in gain (loss) on trading securities in the period of change. We adjust our investment grade securities for which external marks are available to fair value based on third party dealer quotations. Our subordinate and residual securities are not actively traded and, therefore, market quotations are not available. We estimate fair value using an industry accepted discounted cash flow model which is calibrated for trading activity whenever possible. Expected future cash flows are estimated using our best estimate of key assumptions such as discount, delinquency and cumulative loss rates as well as prepayment speeds associated with the loans underlying mortgage backed securities. Discount rates for the subordinate and residual securities range from 21% to 35% and are determined based upon an assessment of prevailing market conditions and prices for similar assets. We project the delinquency, loss and prepayment assumptions based on historical experience, adjusted for prevailing market conditions. Delinquency assumptions range from 20% to 35%, and loss assumptions range from 11% to 21%. Average prepayment assumptions range from 15% to 20%. Estimated fair value represents management’s best estimate of an amount that could ultimately be realized in an actual sale transaction. As of December 31, 2007, investment grade securities had a fair value of $34,876, net of unrealized losses of $2,862. Residual and subordinate securities had a fair value of $7,362 at December 31, 2007, net of unrealized losses of $27,752.

          We classify loans that we do not intend to hold to maturity as loans held for resale and report them at the lower of cost or market value. We account for the excess of cost over market value as a market valuation allowance with changes in the valuation allowance included in gain (loss) on loans held for resale, net, in the period in which the change occurs. Loans for which we have entered into an agreement to sell to an investor at a set price are valued at the commitment price. For uncommitted performing loans, we estimate fair value based on quotes for similar loans. We base the fair value of uncommitted non-performing loans on estimates of expected future cash flows discounted using a rate commensurate with the risks involved. We defer loan origination fees and direct loan origination costs until the loans are sold. These fees and costs are considered in the carrying value of the loans when determining a market valuation allowance. As of December 31, 2007, loans held for resale of $75,240 were net of market valuation allowances of $21,155.

Valuation of Deferred Tax Assets

          The use of estimates and the application of judgment is involved in the determination of our overall tax provision and the evaluation of the realizability of our gross deferred tax assets. As of December 31, 2007, we had gross deferred tax assets of $178,530, and a corresponding valuation allowance of $352 resulting in a net deferred tax asset of $178,178. During 2006, we reversed $155,377 of valuation allowances on our deferred tax assets, including $145,211 during the second quarter, in order to increase the net deferred tax asset to the amount that is more likely than not to be realized in future periods. We established our valuational lowance during the period 2001 through 2003. Our evaluation of the need to maintain a valuation allowance takes into consideration 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) are also considered. Judgment is required in considering the relative impact of negative and positive evidence related to realizability of the deferred tax assets. We base the determination of the amount of the aggregate valuation allowance 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. We assess the amount of the valuation allowance each quarter.

Litigation

          We continuously monitor the status of our legal matters. We obtain advice from external legal counsel in our periodic assessment of legal matters for potential loss accrual and disclosure. We make a determination of the amount of the reserves required in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” We establish reserves for settlements, judgments on appeal and filed and/or threatened claims for which we believe it is probable that a loss has been incurred, and the amount of the loss can be reasonably estimated.

SEGMENTS

          The following section provides a discussion of the changes in financial condition of our business segments during the year ended December 31, 2007 and a discussion of pre-tax results of operations of our business segments for the three yearly periods ended December 31, 2007, 2006 and 2005.

23


          The following table presents the assets and liabilities and the pre-tax statement of continuing operations for each of our business segments at and for the year ended December 31, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential
Servicing

 

Ocwen
Recovery
Group

 

Residential
Origination
Services

 

Corporate
Items and
Other

 

Business
Segments
Consolidated

 

 

 


 


 


 


 


 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

 

$

 

$

197

 

$

114,046

 

$

114,243

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade

 

 

 

 

 

 

 

 

34,876

 

 

34,876

 

Subordinates and residuals

 

 

 

 

 

 

7,016

 

 

346

 

 

7,362

 

Loans held for resale

 

 

 

 

 

 

75,240

 

 

 

 

75,240

 

Advances

 

 

285,880

 

 

 

 

6,872

 

 

135

 

 

292,887

 

Match funded advances

 

 

1,126,097

 

 

 

 

 

 

 

 

1,126,097

 

Mortgage servicing rights

 

 

191,935

 

 

 

 

 

 

5,360

 

 

197,295

 

Receivables

 

 

25,159

 

 

5,775

 

 

11,758

 

 

36,702

 

 

79,394

 

Deferred tax asset, net

 

 

 

 

 

 

 

 

178,178

 

 

178,178

 

Goodwill and intangibles

 

 

 

 

53,260

 

 

1,618

 

 

3,423

 

 

58,301

 

Premises and equipment

 

 

418

 

 

4,881

 

 

773

 

 

29,500

 

 

35,572

 

Investment in unconsolidated entities

 

 

70,720

 

 

 

 

 

 

5,745

 

 

76,465

 

Other assets

 

 

85,871

 

 

2,226

 

 

10,479

 

 

20,210

 

 

118,786

 

 

 



 



 



 



 



 

Total assets

 

$

1,786,080

 

$

66,142

 

$

113,953

 

$

428,521

 

$

2,394,696

 

 

 



 



 



 



 



 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Match funded liabilities

 

$

1,001,403

 

$

 

$

 

$

 

$

1,001,403

 

Lines of credit and other secured borrowings

 

 

260,976

 

 

147

 

 

46,472

 

 

32,381

 

 

339,976

 

Servicer liabilities

 

 

204,484

 

 

 

 

 

 

 

 

204,484

 

Debt securities

 

 

 

 

 

 

 

 

150,279

 

 

150,279

 

Other liabilities

 

 

25,324

 

 

8,749

 

 

5,354

 

 

71,002

 

 

110,429

 

 

 



 



 



 



 



 

Total liabilities

 

$

1,492,187

 

$

8,896

 

$

51,826

 

$

253,662

 

$

1,806,571

 

 

 



 



 



 



 



 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Servicing and subservicing fees

 

$

332,715

 

$

39,608

 

$

328

 

$

6,626

 

$

379,277

 

Process management fees

 

 

14,704

 

 

1,684

 

 

71,377

 

 

2

 

 

87,767

 

Other revenues

 

 

7,637

 

 

 

 

847

 

 

5,133

 

 

13,617

 

 

 



 



 



 



 



 

Total revenue

 

 

355,056

 

 

41,292

 

 

72,552

 

 

11,761

 

 

480,661

 

 

 



 



 



 



 



 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

36,196

 

 

20,888

 

 

13,959

 

 

35,823

 

 

106,866

 

Amortization of servicing rights

 

 

99,118

 

 

 

 

 

 

832

 

 

99,950

 

Servicing and origination

 

 

28,565

 

 

5,147

 

 

29,247

 

 

(21

)

 

62,938

 

Technology and communications

 

 

18,168

 

 

5,714

 

 

7,638

 

 

(9,006

)

 

22,514

 

Professional services

 

 

9,259

 

 

2,811

 

 

1,052

 

 

9,850

 

 

22,972

 

Occupancy and equipment

 

 

13,195

 

 

3,999

 

 

2,209

 

 

5,063

 

 

24,466

 

Other operating expenses

 

 

24,760

 

 

8,814

 

 

16,924

 

 

(30,134

)

 

20,364

 

 

 



 



 



 



 



 

Total operating expenses

 

 

229,261

 

 

47,373

 

 

71,029

 

 

12,407

 

 

360,070

 

 

 



 



 



 



 



 

 

Income (loss) from operations

 

 

125,795

 

 

(6,081

)

 

1,523

 

 

(646

)

 

120,591

 

 

 



 



 



 



 



 

 

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

1,146

 

 

6

 

 

20,485

 

 

8,014

 

 

29,651

 

Interest expense

 

 

(57,888

)

 

(1,305

)

 

(7,907

)

 

(5,570

)

 

(72,670

)

Gain (loss) on trading securities

 

 

 

 

 

 

(3,379

)

 

(3,284

)

 

(6,663

)

Gain (loss) on loans held for resale, net

 

 

 

 

 

 

(8,467

)

 

 

 

(8,467

)

Equity in earnings of unconsolidated entities

 

 

(825

)

 

 

 

 

 

5,488

 

 

4,663

 

Other, net

 

 

(2,271

)

 

30

 

 

2,571

 

 

(9,056

)

 

(8,726

)

 

 



 



 



 



 



 

Other income (expense), net

 

 

(59,838

)

 

(1,269

)

 

3,303

 

 

(4,408

)

 

(62,212

)

 

 



 



 



 



 



 

Income (loss) from continuing operations before income taxes

 

$

65,957

 

$

(7,350

)

$

4,826

 

$

(5,054

)

$

58,379

 

 

 



 



 



 



 



 

24


          Management decided during the fourth quarter of 2007 to sell its investment in BOK. We have reclassified the operating results of BOK, which are included in Corporate Items and Other, to discontinued operations. See Note 4 to the Consolidated Financial Statements for additional information.

Residential Servicing

          The following table sets forth information regarding residential loans and real estate serviced for others:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans (1) (2) (3)

 

Real Estate (4)

 

Total (5)

 

 

 


 


 


 

 

 

Amount

 

Count

 

Amount

 

Count

 

Amount

 

Count

 

 

 


 


 


 


 


 


 

December 31, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Performing

 

$

42,389,849

 

 

356,937

 

$

 

 

 

$

42,389,849

 

 

356,937

 

Non-performing

 

 

7,433,386

 

 

54,330

 

 

3,722,750

 

 

24,349

 

 

11,156,136

 

 

78,679

 

 

 



 



 



 



 



 



 

 

 

$

49,823,235

 

 

411,267

 

$

3,722,750

 

 

24,349

 

$

53,545,985

 

 

435,616

 

 

 



 



 



 



 



 



 

December 31, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Performing

 

$

47,918,258

 

 

427,572

 

$

 

 

 

$

47,918,258

 

 

427,572

 

Non-performing

 

 

3,436,416

 

 

31,037

 

 

1,479,354

 

 

15,056

 

 

4,915,770

 

 

46,093

 

 

 



 



 



 



 



 



 

 

 

$

51,354,674

 

 

458,609

 

$

1,479,354

 

 

15,056

 

$

52,834,028

 

 

473,665

 

 

 



 



 



 



 



 



 

(1)  At December 31, 2007, we serviced 292,148 subprime loans with a UPB of $41,947,660, as compared to 309,222 subprime loans with a UPB of $40,092,000 at December 31, 2006.

(2)  Performing loans include those loans that are current or have been delinquent for less than 90 days in accordance with their original terms and those loans for which borrowers are making scheduled payments under forbearance or bankruptcy plans. We consider all other loans to be non-performing. The increase in non-performing loans in 2007 is a result of an increase in the average age of our portfolio, the poor performance of 2006 originations, an increase in the number and level of adjustable rate mortgage (“ARM”) resets and a slow down in home price appreciation amongst other factors.

(3)  We serviced under subservicing contracts 147,570 residential loans with a UPB of $15,539,986 as of December 31, 2007. This compares to 160,226 residential loans with a UPB of $15,298,238 at December 31, 2006.

(4)  Real estate includes $798,148 and $674,279 of foreclosed residential properties serviced for the VA at December 31, 2007 and 2006, respectively.

(5)  The average UPB of assets serviced during 2007, 2006 and 2005 was $55,253,914, $47,819,667 and $37,850,025, respectively.

          The following table sets forth information regarding the changes in our portfolio of residential assets serviced for others:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount

 

Count

 

 

 


 


 

 

 

2007

 

2006

 

2007

 

2006

 

 

 


 


 


 


 

Servicing portfolio at beginning of year

 

$

52,834,028

 

$

42,779,048

 

 

473,665

 

 

368,802

 

Additions

 

 

21,074,550

 

 

37,592,725

 

 

129,709

 

 

308,075

 

Runoff

 

 

(20,362,593

)

 

(27,537,745

)

 

(167,758

)

 

(203,212

)

 

 



 



 



 



 

Servicing portfolio at end of year

 

$

53,545,985

 

$

52,834,028

 

 

435,616

 

 

473,665

 

 

 



 



 



 



 

          Additions primarily represent servicing purchased from the owners of the mortgages and servicing obtained by entering into subservicing agreements with other entities that own the servicing rights. Additions were lower in 2007 largely as a result of the significant decline in subprime loan originations, particularly in the second half of the year. Runoff includes principal repayments on loans, servicing transfers and other asset resolutions. The decline in runoff in 2007 primarily reflects lower collections due to falling prepayments and rising delinquencies.

          In addition to acting as servicer and subservicer, we have entered into a backup servicing agreement with a large trust company that acts as trustee for securitizations encompassing more than $250,000,000 of mortgage loans. As backup servicer, we have agreed to accept the servicing responsibilities on up to $30,000,000 of mortgage loans in the event that the trustee terminates the primary servicer. The agreement requires that we complete within 60 days the transfer of servicing from the terminated primary servicer. As back up servicer, we are entitled to all servicing compensation to which the terminated servicer would have been entitled. We are not required to fund the delinquency or servicer advance obligations or the compensating interest obligations on the loans that we accept.

25



 

 

 

 

 

 

 

 

Comparative selected balance sheet data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 


 

 

 

2007

 

2006

 

 

 


 


 

Advances

 

$

285,880

 

$

314,869

 

Match funded advances

 

 

1,126,097

 

 

572,708

 

Mortgage servicing rights

 

 

191,935

 

 

179,246

 

Investment in unconsolidated entities

 

 

70,720

 

 

 

Debt service accounts

 

 

77,819

 

 

21,255

 

Other

 

 

33,629

 

 

31,676

 

 

 



 



 

Total assets

 

$

1,786,080

 

$

1,119,754

 

 

 



 



 

 

 

 

 

 

 

 

 

Match funded liabilities

 

$

1,001,403

 

$

510,236

 

Lines of credit and other secured borrowings

 

 

260,976

 

 

217,907

 

Servicer liabilities

 

 

204,484

 

 

383,549

 

Other

 

 

25,324

 

 

26,990

 

 

 



 



 

Total liabilities

 

$

1,492,187

 

$

1,138,682

 

 

 



 



 

          Advances and Match Funded Advances. During any period in which the borrower is not making payments, we are required under most of our 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 also advance funds to maintain, repair and market real estate properties on behalf of investors. We are entitled to recover advances from borrowers for reinstated and performing loans and from investors for foreclosed loans. However, we are only obligated to advance funds to the extent that we believe the advances are recoverable. Furthermore, there is little risk of loss on advances because most of our advances have the highest standing for reimbursement from payments, repayments and liquidation proceeds at the loan level. In addition, for any advances that are not covered by loan proceeds, most of our pooling and servicing agreements provide for reimbursement at the loan pool level, either by using collections on other loans or by requesting reimbursement from the securitization trust.

          During 2007, the combined balance of advances and match funded advances increased by $524,400. This reflects an increase in advance requirements as a result of higher delinquencies and slower prepayments.

          Match funded advances result from our transfers of residential loan servicing advances to special purpose entities (“SPEs”) in exchange for cash. We made these transfers under the terms of four match funded advance financing agreements, as amended. The match funded advances are owned by the SPEs and are not available to satisfy general claims of our creditors. In response to the growth in advances, we increased the maximum borrowing capacity under our match funded liability agreements by $665,000 during 2007. See Notes 8 and 9 to the Consolidated Financial Statements for additional details of the composition of advances and match funded advances.

           Mortgage Servicing Rights . The unamortized balance of MSRs is primarily related to subprime residential loans. MSRs increased by $12,689 during 2007 as purchases of $111,807 exceeded amortization of $99,118. At December 31, 2007, we serviced loans under 509 servicing agreements for 45 investors. This compares to 487 servicing agreements for 43 investors at December 31, 2006. See Note 10 to the Consolidated Financial Statements for additional information on mortgage servicing rights.

           Investment in Unconsolidated Entities . Investment in unconsolidated entities is comprised of our 25% ownership interests in OSI and ONL and other related asset management entities, all of which we account for using the equity method of accounting. At December 31, 2007, we had committed to invest up to an additional $76,487 in these entities. Our equity in the earnings of these entities was a loss of $825 in 2007, comprised of losses attributed to ONL and related entities totaling $1,920 less earnings from OSI of $1,095. See Note 14 to the Consolidated Financial Statements for additional details regarding our investment in these entities.

           Match Funded Liabilities . 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. We account for and report match funded liabilities as secured borrowings with pledges of collateral. As of December 31, 2007 and 2006, all of our match funded liabilities were secured by advances on loans serviced for others. The $491,167 increase in match funded liabilities during 2007 primarily reflects a net increase in borrowing capacity and an increase in advance funding requirements. Our maximum borrowing capacity under match funded liabilities was $1,230,000 at December 31, 2007, as compared to $565,000 at December 31, 2006, an increase of $665,000. See Note 16 to the Consolidated Financial Statements for additional information on the terms and balances of our match funded liabilities.

           Lines of Credit and Other Secured Borrowings . As of December 31, 2007, the maximum borrowing capacity under our senior secured credit agreement was $355,000, an increase of $55,000 as compared to December 31, 2006. Borrowings under this agreement may be secured by MSRs, advances on loans serviced for others, receivables and mortgage loans. The $43,069 increase in the amount outstanding under this facility during 2007 reflects an increase in our utilization of the borrowing capacity which was used to help fund the growth in advances and MSRs. See Note 17 to our Consolidated Financial Statements for additional information on the terms and balances of our lines of credit and other secured borrowings.

26


           Servicer Liabilities . Servicer liabilities represent amounts we have collected, primarily from Residential Servicing borrowers, which we will deposit in custodial accounts, pay directly to an investment trust or refunded to borrowers. Custodial accounts are excluded from our balance sheet. The balance of servicer liabilities at both December 31, 2007 and 2006 consisted primarily of borrower payments due to custodial accounts. Servicer liabilities declined by $179,065 during 2007 largely due to a $188,335 decline in the amount of borrower payments due to custodial accounts. This decline reflects the impact of lower collections due to declining prepayment speeds and rising delinquencies. See Note 18 to the Consolidated Financial Statements for additional details of the principal components of servicer liabilities.

 

 

 

 

 

 

 

 

 

 

 

Comparative selected operations data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Revenue:

 

 

 

 

 

 

 

 

 

 

Servicing and subservicing fees

 

$

332,715

 

$

328,369

 

$

268,088

 

Other

 

 

22,341

 

 

15,245

 

 

11,538

 

 

 



 



 



 

Total revenue

 

 

355,056

 

 

343,614

 

 

279,626

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

36,196

 

 

31,609

 

 

35,022

 

Amortization of servicing rights

 

 

99,118

 

 

110,518

 

 

96,692

 

Servicing and origination

 

 

28,565

 

 

28,501

 

 

36,446

 

Technology and communications

 

 

18,168

 

 

19,923

 

 

22,700

 

Professional services

 

 

9,259

 

 

13,547

 

 

13,862

 

Occupancy and equipment

 

 

13,195

 

 

10,812

 

 

9,605

 

Other operating expenses

 

 

24,760

 

 

17,582

 

 

22,190

 

 

 



 



 



 

Total operating expenses

 

 

229,261

 

 

232,492

 

 

236,517

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

125,795

 

 

111,122

 

 

43,109

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

Match funded liabilities

 

 

(41,541

)

 

(23,061

)

 

(15,740

)

Lines of credit and other secured borrowings

 

 

(10,917

)

 

(3,403

)

 

(1,406

)

Other

 

 

(5,430

)

 

(3,831

)

 

(4,606

)

 

 



 



 



 

 

 

 

(57,888

)

 

(30,295

)

 

(21,752

)

Equity in losses of unconsolidated entities

 

 

(825

)

 

 

 

 

Other

 

 

(1,125

)

 

(367

)

 

304

 

 

 



 



 



 

Total other expense, net

 

 

(59,838

)

 

(30,662

)

 

(21,448

)

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

$

65,957

 

$

80,460

 

$

21,661

 

 

 



 



 



 

          Servicing and Subservicing Fees. The principal components of servicing and subservicing fees are:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Loan servicing and subservicing

 

$

227,716

 

$

207,312

 

$

170,489

 

Late charges

 

 

37,742

 

 

37,843

 

 

35,094

 

Custodial accounts (float earnings)

 

 

29,299

 

 

48,289

 

 

31,663

 

Loan collection fees

 

 

12,451

 

 

10,288

 

 

8,681

 

Other

 

 

25,507

 

 

24,637

 

 

22,161

 

 

 



 



 



 

 

 

$

332,715

 

$

328,369

 

$

268,088

 

 

 



 



 



 

          Loan servicing and subservicing fees for 2007 are up 10% over 2006 primarily due to a 16% increase in the average balance of loans serviced. Loan servicing and subservicing fees for 2006 increased by 22% as compared to 2005 primarily because of a 26% increase in the average balance of loans serviced. The growth in revenue attributed to the higher average balance of loans serviced was partially offset by the impact of rising delinquencies. We collect servicing fees, generally expressed as a percent of the UPB, from the borrowers’ payments. We recognize servicing fees as revenue upon collection. Delinquencies affect the timing of servicing fee revenue recognition, but not the ultimate collection of the fees because servicing fees generally have the same standing as advances in that they are satisfied before any interest or principal is paid by the securitization trust on the bonds. We estimate that for 2007 and 2006, revenue excludes $24,946 and $7,666, respectively, of uncollected servicing fees related to delinquent borrower payments. As of December 31, 2007, we estimate that we had $49,550 of uncollected delinquent servicing fees that had not been recognized as revenue.

27


          The increase in the average balance of loans serviced is the result of portfolio acquisitions coupled with reduced run-off of the existing portfolio due to slower prepayment speeds. Mortgage prepayment speeds averaged 23% in 2007 compared to an average of 30% and 38% for 2006 and 2005, respectively. The decline in mortgage prepayment speeds is largely due to credit tightening, rising subprime mortgage interest rates and slowing home price appreciation.

          Late charges are slightly lower in 2007 as compared 2006 in spite of the fact that delinquencies have risen and the average balance of the loan servicing portfolio grew by 16% during 2007. This is because late charges are not recognized as revenue until they are collected.

          The following table summarizes information regarding float earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Average custodial account balances

 

$

677,247

 

$

1,026,500

 

$

1,119,400

 

Float earnings

 

$

29,299

 

$

48,289

 

$

31,663

 

Yield

 

 

4.33

%

 

4.70

%

 

2.83

%

          The decline in float earnings in 2007 as compared to 2006 is due to a decline in both the average float balance and the average yield we earned on these funds. The decline in the average balance of these accounts results from a decline in mortgage prepayment speeds and an increase in delinquencies, offset in part by the growth in the servicing portfolio. The higher yield in 2006 as compared to 2005 reflects rising short-term interest rates. The underlying servicing agreements restrict the investment of float balances to certain types of instruments. We are responsible for any losses incurred on the investment of these funds.

          We generate float earnings through a facility provided by JPMorgan Chase (the “Investment Line”). Using the Investment Line, we borrow funds each month from JPMorgan Chase at a nominal interest rate and invest those funds in certain permitted investments, including US Treasury Securities, US Agency Securities, commercial paper, auction rate securities, bank certificates of deposit and JPMorgan Chase time deposits. Funds provided by the Investment Line are available only for investment purposes and are not available for general operating purposes.

          The amount borrowed is based on projected average custodial balances for the month. No actual custodial funds are invested, since we invest only the funds provided through the Investment Line. The custodial funds remain on deposit with JPMorgan Chase for the benefit of the securitization trusts. The terms of the Investment Line require that we sell the investments and pay off the associated borrowings prior to the end of each quarter. As a result, the Investment Line historically has had no impact on our quarterly balance sheets.

           Compensation and Benefits Expense. The 15% increase in compensation and benefits expense in 2007 is largely due to an increase in average employment in India where the average number of employees during the year grew from 987 during 2006 to 1,120 during 2007, an increase of 13%. Average employment grew principally because of increases in staffing during 2006 in support of servicing portfolio growth. In addition, we increased the number of higher paid loss mitigation staff in response to the increase in non-performing loans. The decrease in compensation and benefits expense in 2006 occurred primarily due to a decline in the average number of employees in the U.S. because of cost reduction initiatives put in place in 2005, including a greater utilization of the lower cost workforce in India. Although average employment in India increased in 2006, total average employment declined, and the ratio of India employment to total employment increased from 64% in 2005 to 70% in 2006.

          Average employment in the Residential Servicing segment for the last three years is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

India

 

 

1,120

 

 

987

 

 

918

 

United States

 

 

413

 

 

418

 

 

520

 

 

 



 



 



 

 

 

 

1,533

 

 

1,405

 

 

1,438

 

 

 



 



 



 

          Amortization of Servicing Rights. We amortize mortgage servicing rights in proportion to and over the period of estimated net servicing income. Slower actual and projected mortgage prepayment speeds have reduced the rate of amortization as we expect to earn the servicing income over a longer period of time. Despite a 32% increase in the average balance of our investment in MSRs, amortization expense for 2007 decreased by $11,400, or 10%, as compared to 2006. In 2006, the average balance of MSRs increased by 20% as compared to 2005 while amortization expense increased by only 14%. Average prepayment speeds were 21%, 30% and 38% for 2007, 2006 and 2005 respectively.

           Servicing and Origination Expenses. The principal components of servicing and origination expense are:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Compensating interest

 

$

8,440

 

$

13,513

 

$

22,210

 

Satisfaction expense

 

 

5,949

 

 

6,473

 

 

6,273

 

Other

 

 

14,176

 

 

8,515

 

 

7,963

 

 

 



 



 



 

 

 

$

28,565

 

$

28,501

 

$

36,446

 

 

 



 



 



 

28


          The decline in compensating interest expense in 2007 and 2006 primarily reflects slower prepayment speeds. In addition, during 2006 there was a shift towards a higher percentage of loans serviced under a mid-month structure versus a calendar month structure. Under a calendar month structure, compensating interest is paid to the securitization trust for a full month of interest on all loans that prepay during the month. Under a mid-month structure, we are not obligated to pay the compensating interest on prepayments that occur during the first half of the month.

          Other servicing and origination expense for 2007 includes $4,313 of expenses related to amounts due from borrowers that were subsequently deemed uncollectible. These expenses primarily relate to serviced loans that paid off during 2006.

           Professional Services Expense. In 2007, legal fees declined by $4,722 as compared to 2006. This decline is primarily due to the reversal of excess accruals on settled cases and the absence of an increase in accruals related to ongoing cases. Professional services expense for 2006 included a provision of $3,537 recorded to increase litigation accruals related to ongoing cases. Professional services expense for 2005 included $3,700 to provide for current and pending litigation. See Note 31 to our Consolidated Financial Statements for information regarding litigation.

           Other Operating Expenses. Other operating expenses primarily consist of overhead allocation charges and bad debt expense. Other operating expenses for 2007 reflect higher overhead allocation charges. Other operating expenses for 2005 reflect higher bad debt expense as a result of providing for aged reimbursable expenses.

           Interest Expense. The higher interest expense in 2007 and 2006 reflects an increase in financing costs associated with our servicing advances and MSRs because of the growth in our investment in these assets and higher interest rates. The average combined balance of advances and match funded advances was 36% higher in 2007 than 2006, and 14% higher in 2006 than 2005. Interest expense in 2007 was higher than 2006 both because of borrowings that were $282,762, or 65% higher on average in 2007 than in 2006 and because the average rate on these borrowings increased by 124 basis points, or 20%. Average rates increased principally because of the higher spread over LIBOR charged on the new match-funded facilities added in 2007 and because of higher facility fees charged by the lenders. In 2006, interest expense increased principally because average borrowings were $107,241, or 33% higher than in 2005 and average rates that were 86 basis points, or 16% higher than in 2005. Average rates increased in 2006 principally because of increases in LIBOR. The majority of our credit facilities bear interest at rates that are adjusted regularly based on 1-Month LIBOR. The average of 1-Month LIBOR was 5.25%, 5.09% and 3.39% during 2007, 2006 and 2005, respectively.

Ocwen Recovery Group

 

 

 

 

 

 

 

 

Comparative selected balance sheet data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 


 

 

 

2007

 

2006

 

 

 


 


 

Receivables

 

$

5,775

 

$

318

 

Goodwill and intangibles

 

 

53,260

 

 

 

Premises and equipment

 

 

4,881

 

 

40

 

Other

 

 

2,226

 

 

2

 

 

 



 



 

Total assets

 

$

66,142

 

$

360

 

 

 



 



 


 

 

 

 

 

 

 

 

 

 

 

Comparative selected operations data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Revenue

 

$

41,292

 

$

7,666

 

$

11,683

 

Operating expenses

 

 

47,373

 

 

8,569

 

 

12,715

 

 

 



 



 



 

Loss from operations

 

 

(6,081

)

 

(903

)

 

(1,032

)

Other income (expense), net

 

 

(1,269

)

 

340

 

 

348

 

 

 



 



 



 

Loss before income taxes

 

$

(7,350

)

$

(563

)

$

(684

)

 

 



 



 



 

          Ocwen Recovery Group’s results for 2007 have been impacted by our acquisition of NCI on June 6, 2007. NCI’s primary source of revenue is fees for collections on behalf of credit card issuers and other consumer credit providers on a contingency basis. For the period June 6, 2007 through December 31, 2007, NCI incurred a pre-tax loss of $3,716. Revenues for the 2007 period were $35,978 and operating expenses were $38,400. Assets of NCI included in this segment at December 31, 2007 were $65,863, including $53,260 of goodwill and intangibles. Liabilities of NCI included in this segment at December 31, 2007 were $6,440. In September 2007, we repaid the $27,500 of debt that we had incurred to fund the acquisition of NCI.

29


Residential Origination Services

Comparative selected balance sheet data:

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 


 

 

 

2007

 

2006

 

 

 


 


 

Subordinate and residual trading securities

 

$

7,016

 

$

64,576

 

Loans held for resale

 

 

75,240

 

 

99,064

 

Other

 

 

31,697

 

 

31,161

 

 

 



 



 

Total assets

 

$

113,953

 

$

194,801

 

 

 



 



 

 

 

 

 

 

 

 

 

Lines of credit and other secured borrowings

 

 

46,472

 

 

92,242

 

Other

 

 

5,354

 

 

5,464

 

 

 



 



 

Total liabilities

 

$

51,826

 

$

97,706

 

 

 



 



 

           Subordinate and Residual Trading Securities . We acquired residual securities directly from third parties or retained them in connection with loan securitization transactions. The $57,560 decrease in subordinate and residual securities during 2007 was primarily due to declines in fair value that reflect conditions in the subprime mortgage market, our sale of the UK residuals, which had a value of $20,728 at December 31, 2006, and the receipt of cash distributions on other securities. Unrealized losses on subordinate and residual trading securities were $29,031 in 2007.

          Subordinate and residual securities do not have a contractual maturity but are paid down over time as cash distributions are received. The weighted average remaining life of these securities was 1.34 years at December 31, 2007. The anticipated effective yield to maturity as of December 31, 2007 based on the purchase price, actual cash flows received to date and the current estimate of future cash flows under the assumptions used in valuing the securities was 23.23% as compared to 25.12% at December 31, 2006.

          Loans Held for Resale . Loans held for resale represent single-family residential loans originated or acquired by our Residential Origination Services segment that we do not intend to hold until maturity. The carrying value of these loans amounted to $75,240 and $99,064 at December 31, 2007 and 2006, respectively. The balances at December 31, 2007 and 2006 are net of market valuation allowances of $21,155 and $13,794, respectively. Loans held for resale at December 31, 2007 and 2006 include non-performing loans with a carrying value of $31,998 and $55,714, respectively.

          The loans at December 31, 2007 are comprised of those remaining from our subprime origination operation, which we closed in January 2007, and those acquired as a part of our whole loan purchase and securitization activities. The $23,824 decline in carrying value during 2007 is primarily due to principal payments, charge-offs, foreclosures and an increase in market valuation allowances as a result of declining values, partially offset by the origination of loans pursuant to commitments that existed at December 31, 2006 and the repurchase of loans that were sold in 2006. There were no loan sales during 2007. As of December 31, 2007, we had no outstanding commitments to fund subprime loans, and we do not anticipate any additional loan repurchases related to our subprime origination operation.

          Effective in the third quarter of 2007, we discontinued our program under which we originated loans in response to requests from Residential Servicing customers to refinance their mortgages. At December 31, 2006, loans held for resale included $11,652 of such loans.

           Lines of Credit and Other Secured Borrowings. Our borrowings under lines of credit and other secured borrowing consisted principally of amounts borrowed under repurchase agreements to fund the purchase or origination of loans held for resale and the purchase of residual trading securities. The decline in borrowing of $45,770 during 2007 was primarily due to declines in the assets that serve as collateral for this debt due to repayment of principal and declines in the market value of pledged securities, loans and real estate. See Note 17 to our Consolidated Financial Statements for additional information on the terms and balances of our lines of credit and other secured borrowings.

30


Comparative selected operations data:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Revenue:

 

 

 

 

 

 

 

 

 

 

Process management fees

 

$

71,377

 

$

69,600

 

$

65,776

 

Other

 

 

1,175

 

 

1,344

 

 

255

 

 

 



 



 



 

Total revenue

 

 

72,552

 

 

70,944

 

 

66,031

 

 

 



 



 



 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

13,959

 

 

24,969

 

 

16,357

 

Servicing and origination

 

 

29,247

 

 

24,833

 

 

24,049

 

Technology and communication

 

 

7,638

 

 

9,177

 

 

9,924

 

Professional services

 

 

1,052

 

 

6,880

 

 

3,560

 

Occupancy and equipment

 

 

2,209

 

 

3,070

 

 

2,226

 

Other operating expenses

 

 

16,924

 

 

15,736

 

 

20,546

 

 

 



 



 



 

Total operating expenses

 

 

71,029

 

 

84,665

 

 

76,662

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

1,523

 

 

(13,721

)

 

(10,631

)

 

 



 



 



 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

 

Subordinate and residual trading securities

 

 

9,907

 

 

14,539

 

 

11,778

 

Loans held for resale

 

 

10,441

 

 

24,656

 

 

4,642

 

Other

 

 

137

 

 

228

 

 

325

 

 

 



 



 



 

Total interest income

 

 

20,485

 

 

39,423

 

 

16,745

 

Interest expense

 

 

(7,907

)

 

(19,195

)

 

(6,768

)

Gain (loss) on trading securities

 

 

(3,379

)

 

2,691

 

 

(7

)

Loss on loans held for resale, net

 

 

(8,467

)

 

(5,684

)

 

(4,380

)

Other, net

 

 

2,571

 

 

2,388

 

 

1,850

 

 

 



 



 



 

Total other income, net

 

 

3,303

 

 

19,623

 

 

7,440

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

$

4,826

 

$

5,902

 

$

(3,191

)

 

 



 



 



 

          Process Management Fees . The principal components of process management fees relate to our fee-based loan processing services as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

Residential property valuation

 

$

30,777

 

$

26,603

 

$

29,122

 

Title services

 

 

13,834

 

 

10,470

 

 

4,642

 

Outsourcing services

 

 

11,242

 

 

10,461

 

 

11,265

 

Mortgage due diligence

 

 

8,153

 

 

11,604

 

 

9,161

 

Loan refinancing

 

 

3,434

 

 

8,428

 

 

6,078

 

Other

 

 

3,937

 

 

2,034

 

 

5,508

 

 

 



 



 



 

 

 

$

71,377

 

$

69,600

 

$

65,776

 

 

 



 



 



 

          In spite of the decline in loan origination activity in 2007, fees from residential property valuations and title services increased as a result of rising delinquencies and foreclosures. Mortgage due diligence fees declined in 2007 due to the decline in originations and the nonrenewal of a contract that was not profitable. The decline in loan refinancing fees in 2007 reflects a decline in loan prepayments and our decision in the third quarter to discontinue our program under which we originated loans in response to requests from Residential Servicing customers to refinance their mortgages.

           Compensation and Benefits Expense. Compensation and benefits expense include our subprime loan origination operation, which we decided to close in January 2007. Compensation and benefits expense related to this operation amounted to $465 and $6,501 in 2007 and 2006, respectively. In addition, compensation and benefit expenses associated with our mortgage due diligence operation amounted to $5,046, $9,435 and $6,744 in 2007, 2006 and 2005, respectively. The decrease in 2007 largely reflects a decrease in staffing in response to the decline in loan originations and the nonrenewal of a contract that was not profitable. The increase in 2006 was primarily due to increased staffing as a result of building capacity in this business.

31


          Servicing and Origination Expenses. Servicing and origination expenses consist primarily of costs incurred in connection with providing fee-based loan processing services as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Residential property valuation

 

$

18,313

 

$

16,229

 

$

19,426

 

Title services

 

 

8,036

 

 

4,977

 

 

2,302

 

Loan refinancing

 

 

1,355

 

 

3,099

 

 

2,228

 

Mortgage due diligence

 

 

1,332

 

 

338

 

 

13

 

Other

 

 

211

 

 

190

 

 

80

 

 

 



 



 



 

 

 

$

29,247

 

$

24,833

 

$

24,049

 

 

 



 



 



 

          Professional Services Expense. Professional services expenses were higher in 2006 primarily due to underwriting fees and other direct costs incurred in connection with loan securitization transactions.

          Other Operating Expenses. Other operating expenses are primarily comprised of overhead allocation charges, provisions for bad debt and charge-offs. Bad debt provisions and loan charge-offs amounted to $8,406, $5,570 and $9,101 in 2007, 2006 and 2005, respectively. Bad debt expense for 2005 includes a charge of $7,238 to recognize the full impairment of our investment in Funding America.

          Interest Income. The $14,215 or 58% decline in interest income on loans held for resale in 2007 as compared to 2006 was largely due to a 51% decrease in the average balance of loans held for resale, primarily as a result of loan sales and securitizations during 2006 and our efforts to reduce non-core subprime mortgage assets. We began winding down our subprime loan origination operation in January 2007 and have also deemphasized loan trading activities in 2007. The increase in interest income on loans held for sale in 2006 as compared to 2005 was largely due to an increase in the average balance of loans held for resale, primarily as a result of the higher volume of loans attributed to our subprime originations operation and acquisitions that closed during 2006 and the latter part of 2005.

          Interest income on subordinate and residual trading securities declined in 2007 primarily as a result of our sale of the UK residuals in the second quarter of 2007. We recognized interest income of $4,034, $11,842 and $10,256 on the UK residuals in 2007, 2006 and 2005, respectively.

           Interest Expense. The $11,288 or 59% decline in interest expense in 2007 was primarily the result of reduced funding requirements on loans held for resale, the average balance of which declined 51% during 2007. The average outstanding balance of lines of credit and other secured borrowings utilized by Residential Origination Services during 2007 declined by 65% as compared to 2006. The increase in interest expense in 2006 as compared to 2005 reflects the additional funding requirements as a result of the increase in the average balance of loans held for resale. Rising interest rates also contributed to the increase in interest expense in 2006. The majority of our credit facilities bear interest at rates that are adjusted regularly based on 1-Month LIBOR. The average of 1-Month LIBOR was 5.25% in 2007, as compared to 5.09% and 3.39% in 2006 and 2005, respectively.

          Gain (Loss) on Trading Securities. The following table sets forth the unrealized and realized gains (losses) on trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Unrealized losses, net

 

$

(29,031

)

$

(1,558

)

$

(5,475

)

Realized gains, net

 

 

25,652

 

 

4,249

 

 

5,468

 

 

 



 



 



 

 

 

$

(3,379

)

$

2,691

 

$

(7

)

 

 



 



 



 

          We recognized the majority of the 2007 unrealized losses in the fourth quarter as a result of a significant increase in projected loss assumptions on residential mortgage-backed securities. These projections were released by Standard & Poor’s rating service on February 4, 2008.

          Realized gains in 2007 are primarily comprised of a $25,587 gain from our sale of the UK residuals during the second quarter. In 2006 and 2005, we purchased unrated residual securities related to loans for which we were already the master servicer for the securitizations. As the master servicer, we had the right to collapse the related trusts once the balance of the underlying loans outstanding reached the optional termination amount of 10% of the original amount of loans in the securitization. In the third quarter of both 2005 and 2006, we exercised our call rights and purchased the remaining loans from the trusts. As a result, the over collateralization was remitted to us, and we realized gains on the residual securities that we had purchased of $12,729 and $8,495 in 2006 and 2005, respectively. We purchased the loans, which we classified as loans held for resale, with the intention of securitizing or selling them. Some of the loans that we acquired were nonperforming, and we recorded provisions of $9,012 and $6,476 in 2006 and 2005, respectively, to reduce these nonperforming loans to their market value. This yielded net realized gains of $3,717 and $2,019 in 2006 and 2005, respectively.

           Gain (Loss) on Loans Held for Resale, Net. The components of gain (loss) on loans held for resale, net, are:

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Gain (loss) on sales and securitizations

 

$

1,214

 

$

609

 

$

 

Valuation losses, net

 

 

(9,681

)

 

(6,293

)

 

(4,380

)

 

 



 



 



 

 

 

$

(8,467

)

$

(5,684

)

$

(4,380

)

 

 



 



 



 

32


          In 2007, the gain on sales and securitizations consists principally of the recovery in the second quarter of premiums on loans repurchased by the original seller and the reversal in the first quarter of the majority of a reserve that we established in 2006 to provide for a contingent repurchase obligation on sold loans. During 2006, we recorded net gains of $2,134 on securitizations of loans with a combined carrying value of $718,008, a significant portion of which we had acquired during the fourth quarter of 2005. Net losses on sales of loans related to our subprime origination activities amounted to $1,525 for 2006. During 2006, Funding America sold to third parties loans with an UPB of $367,479.

          Valuation losses represent charges that we recorded to reduce loans held for resale to their market values which have declined in 2007 due to the deteriorating conditions in the subprime mortgage market. In addition, we have recorded charge-offs on resolved loans in other operating expenses. These charge-offs totaled $8,204, $4,632 and $1,407 in 2007, 2006 and 2005, respectively.

           Other, Net. Other income for 2007, 2006 and 2005 included $2,199, $1,543 and $872, respectively, of net realized and unrealized gains related to Eurodollar interest rate futures contracts, interest rate swap agreements and credit default swap agreements. These agreements did not qualify for hedge accounting; therefore, we reported all changes in fair value in earnings. All of these agreements either matured or were terminated during 2007. See Note 21 to the Consolidated Financial Statements for additional information on our use of derivative financial instruments.

Corporate Items and Other

Comparative selected balance sheet data:

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 


 

 

 

2007

 

2006

 

 

 


 


 

Cash

 

$

114,046

 

$

235,449

 

Trading securities

 

 

35,222

 

 

75,652

 

Investment in certificates of deposit

 

 

 

 

72,733

 

Mortgage servicing rights (Commercial Servicing)

 

 

5,360

 

 

4,497

 

Receivables

 

 

36,702

 

 

26,812

 

Deferred tax assets, net

 

 

178,178

 

 

176,135

 

Goodwill and intangibles

 

 

3,423

 

 

5,435

 

Premises and equipment, net

 

 

29,500

 

 

32,943

 

Investment in unconsolidated entities

 

 

5,745

 

 

46,151

 

Other

 

 

20,345

 

 

19,021

 

 

 



 



 

Total assets

 

$

428,521

 

$

694,828

 

 

 



 



 

 

 

 

 

 

 

 

 

Lines of credit and other secured borrowings

 

 

32,381

 

$

14,371

 

Debt securities

 

 

150,279

 

 

150,329

 

Other

 

 

71,002

 

 

46,732

 

 

 



 



 

Total liabilities

 

$

253,662

 

$

211,432

 

 

 



 



 

           Trading Securities. The $40,430 decline in trading securities during 2007 was primarily due to a $46,212 decline in short-term investment grade commercial paper partially offset by a $6,671 increase in investment grade collateralized mortgage obligations. Lower cash collections related to the Residential Servicing business have contributed to the decline in both cash and short-term investment grade securities in 2007.

          Investment in Certificates of Deposit. On August 17, 2007, we redeemed our investment in CDs prior to their maturity in order to meet an unanticipated liquidity need. The cash received from issuer upon redemption was less than the adjusted cost basis of the CDs, resulting in a loss of $8,673. We had acquired the CDs in November 2006 at a discount from the face value. The adjusted cost basis at December 31, 2006 of $72,733 is net of an unaccreted discount of $77,267. Prior to redemption, we were accreting the discount on the CDs to income using the interest method. See Note 6 to the Consolidated Financial Statements for additional information.

           Investment in Unconsolidated Entities. Our investment in unconsolidated entities consists primarily of our 46% equity investment in BMS Holdings. The $40,406 decline in our investment during 2007 is the result of a distribution of $45,894 that we received in February that was equal to our initial investment in BMS Holdings partly offset by equity in earnings of $5,488. For 2006, our equity in earnings of BMS Holdings was $637. The 2007 earnings of BMS Holdings include significant unrealized gains on derivative financial instruments. See Note 14 to the Consolidated Financial Statements for additional details on investment in unconsolidated entities.

           Lines of Credit and Other Secured Borrowings. The $18,010 increase in lines of credit and other secured borrowings during 2007 is the result of two new borrowings partly offset by our repayment of the mortgage note collateralized by our loan servicing call center located in Orlando, Florida. In January 2007, we entered into a securities repurchase agreement. The balance outstanding at December 31, 2007 was $28,291 which was secured by $33,171 of investment grade securities. In February 2007, we also entered into a line of credit agreement secured by commercial MSRs and advances. As of December 31, 2007, we had borrowed $4,090 under this agreement. The mortgage note, which had an outstanding balance of $14,371 at December 31, 2006, was repaid in December 2007 as part of a sale-leaseback transaction involving our customer service and collection facility in Orlando, Florida. See Note 17 to the Consolidated Financial Statements for additional details on lines of credit and other secured borrowings.

33


          Debt Securities. Debt securities consisted of the following at December 31:

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

 

 


 


 

3.25% Contingent Convertible Senior Unsecured Notes due August 1, 2024

 

$

96,900

 

$

96,900

 

10.875% Capital Securities due August 1, 2027

 

 

53,379

 

 

53,429

 

 

 



 



 

 

 

$

150,279

 

$

150,329

 

 

 



 



 

          See Note 19 to the Consolidated Financial Statements for additional details regarding the Convertible Notes and Capital Securities.

          Other Liabilities. Other liabilities are generally comprised of accruals for incentive compensation awards, audit fees, legal matters, other operating expenses and interest on debt securities, as well as customer deposits held by BOK. At December 31, 2007, other liabilities also includes a financing obligation of $24,515 which represents the sales proceeds received in connection with the sale-leaseback transaction whereby we sold and immediately leased back our customer service and collection facility in Orlando, Florida. This transaction did not qualify for sale-leaseback accounting because of our continuing involvement in the form of a significant sublease and a collateral deposit securing a letter of credit that guarantees our lease payments. As a result, we have accounted for the transaction as a financing. We are continuing to depreciate the building, which had a net book value of $19,020 at December 31, 2007. See Note 31 to the Consolidated Financial Statements for additional details regarding the lease and sublease.

Comparative selected operations data :

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

2006

 

2005

 

 

 


 


 


 

Revenue

 

$

11,761

 

$

9,354

 

$

17,795

 

Operating expenses

 

 

12,407

 

 

18,809

 

 

20,784

 

 

 



 



 



 

Loss from operations

 

 

(646

)

 

(9,455

)

 

(2,989

)

 

 



 



 



 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

8,014

 

 

7,698

 

 

7,483

 

Interest expense

 

 

(5,570

)

 

(3,881

)

 

(8,466

)

Gain (loss) on trading securities

 

 

(3,284

)

 

(679

)

 

17

 

Gain (loss) on debt repurchases

 

 

(3

)

 

25

 

 

4,258

 

Equity in earnings of unconsolidated entities (BMS Holdings)

 

 

5,488

 

 

637

 

 

 

Other, net

 

 

(9,053

)

 

2,083

 

 

4,592

 

 

 



 



 



 

Other income (expense)

 

 

(4,408

)

 

5,883

 

 

7,884

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

$

(5,054

)

$

(3,572

)

$

4,895

 

 

 



 



 



 

          Revenue. Revenues primarily represent loan servicing and consulting fees earned by the Commercial Servicing business. Revenues for 2007 also include $1,139 of fees earned by the Affordable Housing business, the majority of which are non-recurring. The decline in revenues in 2006 as compared to 2005 primarily reflects the sale of our Japan servicing operations in 2005, the winding down of our Taiwan servicing operations in 2006 and a decline in our portfolio of domestic primary-serviced commercial assets, an operation we decided to close in 2007. At December 31, 2007, we serviced 973 commercial assets totaling $5,149,977 of which 966 assets totaling $5,114,289 were serviced by our offices in Canada and Germany.

           Operating Expenses. Operating expenses are primarily comprised of costs incurred by the Commercial Servicing business. These expenses have declined primarily as a result of our sale of the Japan servicing operations as well as the winding down of our Taiwan and domestic primary servicing operations. Operating expenses also include costs incurred by the Affordable Housing business which in 2007 included a $964 reversal of a $1,500 litigation accrual that we had established in 2006 in connection with the potential settlement of a contractual dispute.

           Interest Expense. Interest expense for 2005 included interest on customer deposits prior to debanking. We retained a greater amount of interest expense in Corporate Items and Other during the first six months of 2005 reflecting the large cash and investment balances that we were holding in preparation for debanking.

          Other, net. Other, net for 2007 includes the $8,673 loss on our early redemption of CDs during the third quarter. Other, net for 2005 included $1,900 of interest income on federal income tax refund claims and a gain of $1,750 resulting from the sale of our customer deposit liabilities in connection with debanking.

MINORITY INTEREST IN SUBSIDIARIES

          Minority interest of $1,979 and $1,790 at December 31, 2007 and 2006, respectively, primarily represented the 30% investment in GSS held by Merrill Lynch.

34


STOCKHOLDER’S EQUITY

          Stockholders’ equity amounted to $586,146 at December 31, 2007 as compared to $557,979 at December 31, 2006. The $28,167 increase in stockholders’ equity during 2007 was primarily due to net income of $38,597, compensation of $4,231 related to employee share-based awards and $1,875 related to stock option exercises, partially offset by the repurchase of one million common shares for $14,520, a $1,483 reduction of retained earnings that represents the cumulative effect of adopting FIN 48 and a $1,969 reduction of additional paid-in capital that represents our share of the equity offering costs of OSI and ONL.

          Information regarding purchases we made of our own common stock during 2007 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Period

 

Number of shares

 

Average
Share Price
paid

 

Total number
of shares
purchased as part
of publicly
announced
plans

 

Maximum number
of shares that
may yet be purchased
under the
plans

 


 


 


 


 


 

May 1 – May 31

 

1,000,000

 

 

$

14.52

 

 

5,568,900

 

          We purchased these shares on May 1, 2007 from two entities controlled by a member of OCN’s Board of Directors.

INCOME TAX EXPENSE (BENEFIT)

          Income tax expense (benefit) was $16,610, $(126,377) and $5,815 for 2007, 2006 and 2005, respectively. The 2006 tax benefit primarily reflects the reversal of $155,377 of valuation allowances on our deferred tax assets, including $145,211 in the second quarter, in order to increase the net deferred tax asset to the amount that is more likely than not to be realized in future periods.

          In assessing the amount of the valuation allowance in 2006, we primarily based our determination on the following:

 

 

 

 

 

 

Cumulative taxable earnings in recent periods;

 

 

 

 

 

 

Positive outlook for future taxable earnings;

 

 

 

 

 

 

The disposal of nearly all of our non-core assets.

          Excluding the effect of the reversal of valuation allowances, our effective tax rate was 29.38%, 25.36% and 28.61% for 2007, 2006 and 2005, respectively. Income tax expense (benefit) on income before income taxes differs from amounts that would be computed by applying the Federal corporate income tax rate of 35% primarily because of the effect of foreign taxes, foreign income with an indefinite deferral from U.S. taxation, losses from consolidated VIEs, state taxes, low-income housing tax credits and changes in the valuation allowance. See Note 22 to our Consolidated Financial Statements for a reconciliation of taxes at the statutory rate to actual income tax expense (benefit).

          Our effective rate for 2006 excludes the impact of the reversal of the valuation allowance but includes a reduction of 10.83% for the anticipated use of tax credits during that year. No such benefit is included in our effective tax rate for 2007 because we reversed the valuation allowance against our deferred tax assets during the second quarter of 2006. Our effective tax rate for 2007 includes a benefit of approximately 3.32% associated with the recognition of certain foreign deferred tax assets and 5.23% associated with certain provision-to-return reconciling items recognized in the fourth quarter. These reconciling items are a result of certain estimates we used in our 2006 year-end tax provision for which we obtained additional information as part of the tax return preparation process.

LIQUIDITY AND CAPITAL RESOURCES

          Our primary sources of funds for liquidity are:

 

 

 

 

 

 

Match funded liabilities

 

 

 

 

 

 

Lines of credit and other secured borrowings

 

 

 

 

 

 

Servicing fees, including float earnings

 

 

 

 

 

 

Payments received on loans held for resale

 

 

 

 

 

 

Payments received on trading securities

 

 

 

 

 

 

Debt securities

          Our primary uses of funds are funding of servicing advances, purchases of MSRs, the payment of interest and operating expenses and the repayment of borrowings. Our funding needs related to loan originations have declined significantly in 2007 as the result of our decision to close our subprime loan origination business. We closely monitor our liquidity position and ongoing funding requirements, and we invest available funds in short-term investment grade securities. At December 31, 2007, we had $113,047 of unrestricted cash, which represented 5% of total assets. We also had $34,876 of investment grade securities at December 31, 2007, of which $33,171 were sold under agreements to repurchase. Total cash and investment grade securities comprised 6% of total assets at December 31, 2007, as compared to 16% at December 31, 2006.

          We maintain and grow our Residential Servicing business primarily through the purchase of servicing rights or by entering into subservicing agreements. Servicing rights entitle us to earn servicing fees and other types of ancillary income, but they also impose on us various obligations as 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. Most of our servicing agreements require that we remit contractual principal and interest payments to the securitization trusts even if the serviced loans are delinquent. In addition, we are required to pay property taxes and insurance on mortgaged properties even if funds from the borrowers are not available to meet these obligations. We also are required to use our own funds to process loan foreclosures and to maintain, repair and market properties held on behalf of the securitization trusts because of foreclosures. As a result, rising delinquencies and declining prepayments in 2007 resulted in the balances of our advances growing at a faster rate than our servicing portfolio.

35


          We currently use diversified sources of financing, including match funded lending agreements and secured credit facilities with various lenders and syndicates. Even though these arrangements recognize that advances have minimal credit risk due to their highest repayment priority in our servicing agreements, a financing discount is applied to the fair value of the advances and mortgage servicing rights that we pledge as collateral. As a result, we must use internally generated cash to fund the financing discount associated with such servicing assets. In 2007, the amount that we funded internally increased largely because of the growth in advances. Furthermore, there was an increase in advances associated with loans and/or securitizations that do not qualify for financing under the advance facility to which they are pledged.

          We anticipated the recent turmoil in the subprime lending market and in 2007, took steps to expand our existing credit facilities and to establish new facilities in order to meet increased demands for liquidity in our Residential Servicing operations. Maximum borrowing capacity of the Residential Servicing segment was $1,585,000 at December 31, 2007, an increase of $720,000 as compared to December 31, 2006. However, as a result of declines in loans held for resale and residual trading securities, the increase in total borrowing capacity in 2007 was $471,018. As we anticipated, rising delinquencies and declining prepayment speeds have resulted in increases in advances, increased interest expense related to advance financing, lower float balances and float income and revenue growth that has lagged behind the growth of our servicing portfolio. Delinquencies delay the collection of fees including servicing fees and late fees. Rising delinquencies also reduce the volume of loan payment collections from borrowers relative to the size of the servicing portfolio which results in relatively lower float balances and float income on such balances.

          Although we have been successful in negotiating increases in our sources of debt, our ability to sustain and grow our Residential Servicing business depends in part on our continuing success in maintaining and expanding sources of financing to fund servicing advances and in maintaining an average financing discount on advances and MSRs at or near the current levels. Two of our match funded advance facilities that are rated by one or more rating agencies are subject to increases in the financing discount if deemed necessary by any agency in order to maintain the minimum rating required for the facility. Our senior secured credit facility is the only source of debt that is currently available to fund the purchase of MSRs. 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.

          Although the market for advance financing has further tightened in 2008, we expanded one of our match funded facilities in the first quarter of 2008. On February 12, 2008, we renewed and expanded the borrowing capacity under our match funded facilities from $140,000 to $200,000. We intend to renew or extend a $200,000 match funded advance facility prior to the beginning of its amortization period in March 2008.

          We are also in discussions with two banks regarding adding borrowing capacity to an existing match funded advance facility or creating a new match funded advance facility to provide added capacity if advances continue to grow, or if one or more of the facilities scheduled to amortize this year fails to renew in a timely manner. There is a practical limit on our ability to finance operations and growth through the addition of debt, because some of our existing debt covenants limit our ability to incur additional debt beyond a certain level in relation to our equity and require that we maintain minimum levels of liquid assets and unused borrowing capacity, among other requirements. As a result of such limitations, if we were to close all the new match funded advance facilities and renew all existing facilities, we would still be unable to fully utilize our total available borrowing capacity. As a result, taking operational steps to limit the growth of advances is also important.

          Due in part to the initiatives that we implemented late in 2007, the rate of growth in our advances and delinquency rates has slowed through February 2008, relative to the rate of growth experienced in the latter half of 2007. At February 29, 2008, total Residential Servicing advances were $1,495,420 as compared to $1,411,977 at December 31, 2007. At February 29, 2008, the percentage of the UPB our Residential Servicing portfolio representing nonperforming loans was 21% as compared to 20% at of December 31, 2007. Loan modifications have increased, and within the parameters provided by our pooling and servicing agreements, we expect to continue to modify loans when it is in the best interest of our investors to do so. We also expect to more effectively market and price the foreclosed real estate in our Residential Servicing portfolio. In 2008, we expect that prepayment speeds will remain at or near current levels and that the growth rate of delinquencies and advances will continue to decrease. However, if prepayment speeds further decrease in 2008, or if the success of the loan modification programs diminishes, advances on the existing servicing portfolio will increase.

          Although the rate of growth of servicing advances has slowed and is expected to continue to slow, we expect total servicing advances to continue to increase and reach approximately $1,650,000 before balances begin to decrease in the second half of 2008. In order to fund this projected level of servicing advances, we will need to renew, replace or extend our $200,000 advance financing line that is scheduled to go into amortization in March 2008 and our $355,000 secured line of credit prior to its maturity date in August 2008. Based on our active negotiations, we expect to renew or extend the $200,000 advance financing line prior to the amortization date in March 2008. We expect to renew our secured line of credit prior to its August 2008 maturity date. We are also in active negotiations to secure additional advance financing capacity totaling $450,000 which we expect to close during the second quarter of 2008. If we are unable to renew our existing facilities and/or obtain additional borrowing capacity, we may need to consider more aggressively selling non-core assets, issuing subordinated debt or obtaining additional equity capital.

36


          In the table below, we provide the amortization dates and maturity dates for each of our credit facilities as of December 31, 2007. The amortization date is the date on which the revolving period ends under our advance facilities and repayment of the outstanding balance must begin if the facility is not renewed or extended. The maturity date is the date on which all outstanding balances must be repaid. After the amortization date, all collections that represent the repayment of advances that have been financed through the facility must be applied to reduce the balance outstanding under the facility, and any new advances under the securitizations pledged to the facility are ineligible to be financed. In order for us to maintain liquidity, advances under facilities that have entered their amortization period and have not been renewed must be repaid and pledged to another facility.

Our credit facilities are summarized as follows at December 31, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization
Date

 

Maturity

 

Maximum
Borrowing
Capacity (1)

 

Unused
Borrowing
Capacity

 

Balance
Outstanding

 

 

 


 


 


 


 


 

Residential Servicing:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Match funded liability (2)

 

Dec. 2007 –Mar. 2009

 

Nov. 2013 –Mar. 2014

 

$

640,000

 

$

81,410

 

$

558,590

 

Match funded liability (3)

 

Feb. 2009

 

Jan. 2008

 

 

140,000

 

 

248

 

 

139,752

 

Match funded liability (4)

 

Mar. 2008

 

Mar. 2011

 

 

200,000

 

 

25,419

 

 

174,581

 

Match funded liability (5)

 

Mar. 2009

 

Dec 2013

 

 

250,000

 

 

125,962

 

 

124,038

 

Secured line of credit (6)

 

Aug. 2008

 

Aug. 2008

 

 

355,000

 

 

94,024

 

 

260,976

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

1,585,000

 

 

327,063

 

 

1,257,937

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ocwen Recovery Group:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Senior Notes

 

N/A

 

Jan. 2008

 

 

 

 

 

 

147

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential Origination Services:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase agreement (7)

 

N/A

 

Mar. 2008

 

 

50,000

 

 

3,657

 

 

46,343

 

Repurchase agreement (8)

 

N/A

 

Apr. 2036

 

 

 

 

 

 

129

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

50,000

 

 

3,657

 

 

46,472

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate Items and Other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured line of credit

 

N/A

 

Aug. 2008

 

 

11,018

 

 

6,928

 

 

4,090

 

Repurchase agreement (8)

 

N/A

 

 

 

 

 

 

 

28,291

 

Convertible Notes

 

N/A

 

Aug. 2024

 

 

 

 

 

 

96,900

 

Capital Securities

 

N/A

 

Aug. 2027

 

 

 

 

 

 

53,379

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

 

11,018

 

 

6,928

 

 

182,660

 

 

 

 

 

 

 



 



 



 

Total borrowings

 

 

 

 

 

 

1,646,018

 

 

337,648

 

 

1,487,216

 

Fair value adjustment (2)

 

 

 

 

 

 

 

 

 

 

4,442

 

 

 

 

 

 

 



 



 



 

 

 

 

 

 

 

$

1,646,018

 

$

337,648

 

$

1,491,658

 

 

 

 

 

 

 



 



 



 

1) Borrowing capacity under a secured advance facility may only be utilized to the extent that underlying collateral is available to be pledged to that financing facility.

2) The $165,000 fixed-rate term note issued in 2006 is carried on the balance sheet at fair value as the result of a designated fair value hedging relationship that we established through the use of an interest rate swap. Maximum borrowing through the variable funding note issued under this facility increased from $100,000 to $200,000 as a result of an amendment negotiated in April 2007. In November 2007, we extended the maturity of the variable funding note for an additional year to November 2013 and increased the maximum borrowing from $200,000 to $300,000.

3) In January 2007, we reduced the borrowing capacity from $125,000 to $90,000 and extended the maturity by one year to January 2008. In October 2007, maximum borrowing under this facility was increased from $90,000 to $140,000. Subsequently, on February 12, 2008, we negotiated a further increase in the maximum borrowing to $200,000 and extended the stated maturity to February 2011.

4) In September 2007, we executed a servicing advance securitization and issued a variable funding note under which we may borrow a maximum of $200,000. We intend to renew or extend this facility. The interest rate increased from 1-Month LIBOR plus 80 basis points to 1-Month LIBOR plus 200 basis points on November 1, 2007 and to 1-Month LIBOR plus 500 basis points on January 1, 2008.

5) In December 2007, we executed a servicing advance securitization and issued a variable funding note under which we may borrow a maximum of $250,000. The interest rate for this note is determined using a commercial paper rate that reflects the borrowing costs of the lender plus a margin of 150 basis points. This rate approximated 1-Month LIBOR plus 150 basis points.

6) In August 2007, the maturity of this agreement was extended to August 2008 and the maximum borrowing capacity was increased from $300,000 to $355,000. We intend to downsize this facility to $300,000 if, and when, a larger facility currently under ratings agency review is issued.

7) This agreement is secured by “A” rated securities issued in connection with the transfer of loan and real estate collateral to OREALT, a bankruptcy remote VIE that we consolidate. We expect to market these securities to third parties as the credit markets begin to stabilize.

37


8) This agreement has no stated credit limit or maturity; however, each transaction matures and is renewed monthly.

          Certain of our credit facilities require that we maintain minimum liquidity levels, and we are in compliance with these requirements.

          A number of our credit agreements mature at various dates during the next twelve months. At December 31, 2007, we had an aggregate balance of $451,308 outstanding under agreements maturing within one year, subject to possible renewal and extension.

          We have the following anticipated uses of cash:

 

 

 

 

Cash requirements to fund increases in advances, the acquisition of additional servicing rights and the cash needs of our existing operations; and

 

 

 

 

Our commitment to invest an additional $76,487 in asset management vehicles.

          In addition to the anticipated uses of cash identified above, and to the extent we have available funds, we will also consider additional strategic investments similar to OSI and NPL, additional acquisitions and additional common share repurchases. We may also evaluate the retirement of our 10 7/8% Capital Securities which became redeemable in whole or in part at our option beginning August 1, 2007 at a redemption price of 105.438%. From time to time, we may also repurchase our 3.25% Convertible Notes on the open market.

          During the second half of 2007, disruption in global capital markets and increased funding requirements for servicing advances due to rising delinquencies and declining prepayments have negatively impacted our liquidity position. In response to these events, we have increased borrowing capacity for servicing advances and have developed plans to ensure sufficient liquidity throughout 2008. These plans include renewing or replacing our existing financing facilities (identified in Notes 16 and 17 to our Consolidated Financial Statements) that either enter amortization or mature in 2008; reducing the growth of servicing advances by implementing operational changes such as increased use of loan modifications; closing new advance financing facilities, selling non-core assets; and evaluating issuing subordinated debt or preferred stock.

          Although successful execution cannot be guaranteed, management believes that the plans are sufficient to meet liquidity requirements for the next twelve months. We expect to comply with all financial covenants during that time. If we are unable to successfully implement these plans, or if unanticipated market factors emerge, it could have a material adverse impact upon our business, results of operations and financial position.

          Cash and investment grade securities totaled $149,119 at December 31, 2007 as compared to $311,567 at December 31, 2006.

          Significant uses of funds for 2007 included the following:

 

 

 

 

The principal funding requirements of our Residential Servicing operations totaled $815,272 and consisted of:


 

 

 

 

 

 

 

 

 

 

o

Increase in advances and match funded advances

 

$

524,400

 

 

 

o

Reduction of servicer liabilities

 

$

179,065

 

 

 

o

Purchase of mortgage servicing rights

 

$

111,807

 


 

 

 

 

Purchase of NCI for $48,918, net of cash acquired

 

 

 

 

Investment in asset management vehicles of $73,513

 

 

 

 

Repurchase of 1,000,000 shares of our common stock for $14,520

          Significant sources of funds for 2007 included the following:

 

 

 

 

Net borrowings under match funded advance financing facilities and lines of credit of $515,560

 

 

 

 

Proceeds from early redemption of CDs of $66,260

 

 

 

 

Distribution from BMS Holdings of $45,894

 

 

 

 

Proceeds from the sale of the UK residuals of $44,607

          Our operating activities provided (used) $(512,044), $391,781 and $(328,174) of cash flows during 2007, 2006 and 2005, respectively. The decline in net cash flows from operating activities in 2007 as compared to 2006 primarily reflects a significant reduction in proceeds from the sale and securitization of loans held for resale and increased funding requirements of the Residential Servicing business. These reductions were somewhat offset by a decline in net cash used by trading activities. Loans held for resale provided (used) cash of $3,485, $633,205 and $(551,037) during 2007, 2006 and 2005, respectively. The reason for this change is that in 2007 we decided to shut down our subprime origination business and de-emphasize our loan purchase and securitization activities. The funding requirements of our Residential Servicing business are reflected in the decrease in servicer liabilities and increase in servicing advances which collectively used $703,465 of cash in 2007. These same items used $210,609 and $66,089 of cash during 2006 and 2005, respectively. This change resulted from declining prepayment speeds and rising delinquencies. Trading activities provided (used) net cash of $96,246, $(199,477) and $99,842 in 2007, 2006 and 2005, respectively. This change is due to the maturity of short-term investment grade securities as a result of a decline in excess funds available to invest in such securities and the receipt of $44,607 from the sale of the UK residuals. The net cash flows provided by operating activities in 2006 largely reflect the sale and securitization of loans held for resale, a significant portion of which were acquired in 2005. Although net income for 2006 increased by $191,445, it included a tax benefit of $126,377 primarily reflecting the reversal of $155,377 of deferred tax asset valuation allowances.

          Our investing activities used cash flows totaling $122,957, $261,504 and $104,796 during 2007, 2006 and 2005, respectively. In 2007, purchases of mortgage servicing rights of $113,502, investments in asset management entities totaling $73,513 and net cash paid to acquire NCI of $48,918 were partially offset by $66,260 of cash received from our early redemption of CDs and the return of $45,894 that we had originally invested in BMS Holdings in 2006. Investing activities for 2006 consisted primarily of purchases of mortgage servicing rights of $141,741, a $72,424 investment in CDs and $45,894 used to acquire a 46% equity interest in BMS Holdings. Investing activities for 2005 consisted primarily of purchases of mortgage servicing rights totaling $113,946.

38


          Our financing activities provided (used) cash flows of $512,663, $(163,307) and $159,690 during 2007, 2006 and 2005, respectively. Cash flows provided by financing activities in 2007 reflect net proceeds from match funded liabilities and lines of credit of our Residential Servicing business totaling $529,292 which were primarily related to increased borrowings on servicing advances. Cash flows used by financing activities in 2006 primarily reflect a $438,327 net decrease in lines of credit and other secured borrowings used to finance loans held for resale offset in part by $308,135 of net borrowings under Residential Servicing match funded liabilities and lines of credit. Cash flows provided by financing activities in 2005 include $530,569 of net cash we received under agreements to finance the purchase of loans held for resale offset by a $376,591 decline in deposits and $70,445 paid to repurchase debt securities. The decline in deposits in 2005 resulted from maturing certificates of deposit and the cash payment in connection with our sale of our customer deposits as part of debanking.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

Contractual Obligations

          The following table sets forth certain information regarding amounts we owe to others under contractual obligations as of December 31, 2007 based on maturities and payment due dates:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note (1)

 

Less Than
One Year

 

After One Year
Through Three
Years

 

After Three
Years Through
Five Years

 

After Five
Years

 

Total (5)

 

 

 


 


 


 


 


 


 

3.25% Convertible Notes (2)

 

19

 

$

 

$

 

$

 

$

96,900

 

$

96,900

 

10.875% Capital Trust Securities (3)

 

19

 

 

 

 

 

 

 

 

53,379

 

 

53,379

 

Capital leases

 

31

 

 

1,290

 

 

1,783

 

 

5

 

 

 

 

3,078

 

Operating leases

 

31

 

 

7,426

 

 

12,046

 

 

7,044

 

 

17,506

 

 

44,022

 

Lines of credit and other secured borrowings (4)

 

17

 

 

339,847

 

 

 

 

 

 

129

 

 

339,976

 

 

 

 

 



 



 



 



 



 

 

 

 

 

$

348,563

 

$

13,829

 

$

7,049

 

$

167,914

 

$

537,355

 

 

 

 

 



 



 



 



 



 

(1) See respective Notes to our Consolidated Financial Statements.

(2) The Convertible Notes will mature on August 1, 2024. However, 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 also 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” is a change of control or a termination of trading in our common stock. Expected annual interest on the Convertible Notes is $3,896.

(3) Expected annual interest on the Capital Trust Securities is $5,808.

(4) Actual interest on lines of credit and other secured borrowings was $20,661 in 2007. Future interest could vary depending on utilization and changes in LIBOR and spreads.

(5) We have excluded match funded liabilities of $1,001,403 from the contractual obligation table above because it represents non-recourse debt that has been collateralized by match funded advances which are not available to satisfy general claims against OCN. Holders of the notes issued by the SPEs have no recourse against any assets other than the match funded advances that serve as collateral for the securitized debt. Actual interest on match funded liabilities was $41,541 in 2007. Future interest could vary depending on utilization and changes in LIBOR and spreads.

          We believe that we have adequate resources to meet all contractual obligations as they come due.

Off-Balance Sheet Arrangements

          In the normal course of business, we engage in transactions with a variety of financial institutions and other companies that are not reflected on our balance sheet. In addition, through our investment in subordinate and residual securities, we provide credit support to the senior classes of securities. We are subject to potential financial loss if the counterparties to our off-balance sheet transaction are unable to complete an agreed upon transaction. We seek to limit counterparty risk through financial analysis, dollar limits and other monitoring procedures. We have also entered into non-cancelable operating leases and have committed to invest up to an additional $76,487 in asset management vehicles.

           Derivatives. We record all derivative transactions at fair value on our consolidated balance sheets. We use these derivatives primarily to manage our interest rate and credit risks. The notional amounts of our derivative contracts do not reflect our exposure to credit loss.

           Involvement with SPEs. We use SPEs for a variety of purposes but principally in the securitization of mortgage loans and in the financing of our servicing advances.

          Our securitizations of mortgage loans have been structured as sales in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”) and the SPEs to which we have transferred the mortgage loans are qualifying special purpose entities (“QSPEs”) under SFAS No. 140 and are therefore not subject to consolidation. We have retained both subordinated and residual interests in these QSPEs. Where we are the servicer of the securitized loans, we generally have the right to repurchase the mortgage loans from the QSPE when the costs exceed the benefits of servicing the remaining loans.

          We generally use match funded securitization facilities to finance our servicing advances. The SPEs to which the advances are transferred in the securitization transaction are included in our consolidated financial statements either because the transfer did not qualify for sales accounting treatment or because the SPE is not a QSPE and we have the majority equity interest in the SPE or we are the primary beneficiary where the SPE is also a VIE. The holders of the debt of these SPEs can look only to the assets of the SPEs for satisfaction of the debt and have no recourse against OCN.

           VIEs. In addition to certain of our financing SPEs, we have invested in a number of other VIEs, primarily in connection with purchases of whole loans. If we determine that we are the primary beneficiary of a VIE, we report the VIE in our consolidated financial statements.

39


          See Notes 1, 21 and 31 to our Consolidated Financial Statements for additional information regarding off-balance sheet arrangements.

RECENT ACCOUNTING DEVELOPMENTS

Recent Accounting Pronouncements

          In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which establishes a framework for measuring fair value and expands disclosures about fair value measurement. The FASB also issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” in February 2007, which gives entities the option to report at fair value many financial instruments and other items that are not currently required to be reported at fair value. The effective date for SFAS No. 157 and SFAS No. 159 is the first fiscal year that begins after November 15, 2007 (the year beginning January 1, 2008 for OCN). The adoption of SFAS No. 157 on January 1, 2008 did not have a material impact on our consolidated balance sheet or consolidated statement of operations, but the implementation of SFAS No. 157 will require additional disclosures. Upon adoption of SFAS No. 159 on January 1, 2008, we did not elect the fair value option for any financial instrument we do not currently report at fair value.

          For additional information regarding these and other recent accounting pronouncements, see Note 1 to our Consolidated Financial Statements.

The ASF Framework and Subprime ARM Loans

          In December 2007, the American Securitization Forum (“ASF”) issued the “Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (the “ASF Framework”). The ASF Framework provides guidance for servicers to streamline borrower evaluation procedures and to facilitate the use of foreclosure and loss prevention efforts (including refinancings, forbearances, workout plans, loan modifications, deeds-in-lieu and short sales or short payoffs) for certain subprime adjustable rate mortgage (“ARM”) loans.

          While there is no standard definition for subprime loans, we generally consider loans to borrowers with a credit score of less than 670 to be subprime. Lenders typically assess higher interest rates and additional fees on subprime loans in order to compensate for the increased credit risk associated with this type of loan.

          The Framework applies to all first-lien subprime ARM loans that have a fixed rate of interest for an initial period of 36 months or less, are included in securitized pools, were originated between January 1, 2005, and July 31, 2007, and have an initial interest rate reset date between January 1, 2008, and July 31, 2010 (“ASF Framework Loans”).

          The Framework categorizes the population of ASF Framework Loans into three segments. Segment 1 includes loans where the borrower is current and is likely to be able to refinance into any available mortgage product. Segment 2 includes loans where the borrower is current, is unlikely to be able to refinance into any readily available mortgage industry product and meets certain defined criteria. Segment 3 includes loans where the borrower is not current, as defined, and does not meet the criteria for Segments 1 or 2.

          ASF Framework Loans in Segment 2 of the Framework are eligible for “fast-track” modification under which the interest rate will be kept at the existing initial rate, generally for five years following the interest rate reset date. The goal of the ASF Framework is to reduce the number of U.S. subprime residential mortgage borrowers who might default because the borrowers cannot afford to pay the increased interest rate on their loans after their subprime residential mortgage variable loan rate resets.

          In January 2008, the SEC’s Office of Chief Accountant (the “OCA”) issued a letter (the “OCA Letter”) addressing accounting issues that may be raised by the ASF Framework. The OCA Letter expressed the view that if a Segment 2 subprime ARM loan is modified pursuant to the ASF Framework and that loan could legally be modified, the OCA will not object to the continued status of the transferee as a QSPE under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”). The OCA requested that the FASB immediately address the issues that have arisen in the application of the QSPE guidance in SFAS No. 140.

          We may make loan modifications in accordance with the ASF Framework in 2008 but do not expect them to have a material effect on our accounting for subprime residential mortgage loans or securitizations or retained interests in securitizations of subprime residential mortgage loans.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollars in thousands)

          Market risk includes liquidity risk, interest rate risk, prepayment risk and foreign currency exchange rate risk. Market risk also reflects the risk of declines in the valuation of trading securities, MSRs and in the value of the collateral underlying loans.

          We are exposed to liquidity risk primarily because of the highly variable daily cash requirements to support the Residential Servicing business including the requirement to make advances pursuant to servicing contracts and the process of remitting borrower payments to the custodial accounts. In general, we finance our operations through operating cash flows and various other sources including match funded agreements, secured lines of credit and repurchase agreements.

40


          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. Our Residential Servicing business is characterized by non-interest earning assets financed by interest-bearing liabilities. Among the more significant non-interest earning assets are servicing advances and MSRs. At December 31, 2007, we had residential servicing advances of $1,418,984 consisting of advances on loans serviced for others of $292,887 and match funded advances on loans serviced for others of $1,126,097.

          We are also exposed to interest rate risk because earnings on float balances are affected by short-term interest rates. These float balances, which are not included in our financial statements, amounted to approximately $356,700 at December 31, 2007 and averaged approximately $677,200 for the year 2007. We report these earnings as a component of servicing and subservicing fees. Partially offsetting this risk is the fact that a large component of our outstanding debt is variable rate debt. Therefore, declining rates will also reduce our interest expense for that financing. At December 31, 2007, the combined balance of our match funded liabilities, debt securities, lines of credit and other secured borrowings totaled $1,491,658. Of this amount $1,171,790, or 79%, was variable rate debt, for which debt service costs are sensitive to changes in interest rates, and $319,868 was fixed rate debt. We have entered into interest rate swap agreements to convert the interest rate on $165,000 of our fixed rate debt to variable.

          Our balance sheet at December 31, 2007 included interest-earning assets totaling $217,417, including $34,876 of investment grade securities and $75,240 of loans held for resale.

          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 MSRs. As of December 31, 2007, the carrying value and estimated fair value of our residential mortgage servicing rights were $191,935 and $271,108, respectively.

          We face little market risk with regard to our advances and match funded advances on loans serviced for others. This is because we are obligated to fund advances only to the extent that we believe that they are recoverable and because advances generally are the first obligations to be satisfied when a securitization trust disburses funds. We are indirectly exposed to interest risk by our funding of advances because approximately 80% of our total advances and match funded advances are funded through borrowings, and most of the debt is variable rate debt.

          We are exposed to foreign currency exchange rate risk in connection with our investment in non-U.S. dollar functional currency operations to the extent that our foreign exchange positions remain unhedged.

Impact of Changes in Interest Rates on the Net Value of Interest Rate-Sensitive Financial Instruments

          We perform an interest rate sensitivity analysis of our portfolio of MSRs every quarter. We currently estimate that the fair value of the portfolio decreases or increases by approximately 3.39% and 3.12%, respectively, for every 50 basis point increase or decrease in interest rates. This sensitivity analysis is limited in that it was performed at a particular point in time; only contemplates certain movements in interest rates; does not incorporate changes in interest rate volatility; is subject to the accuracy of various assumptions used, including prepayment forecasts and discount rates; and does not incorporate other factors that would impact our overall financial performance in such scenarios. We carry MSRs at the lower of amortized cost or fair value by strata. To the extent that fair value were to decline below amortized cost, we would record an impairment charge to earnings and establish a valuation allowance. A subsequent increase in fair value could result in the recovery of some or all of a previously established valuation allowance. However, an increase in fair value of a particular stratum above its amortized cost would not be reflected in current earnings. For these reasons, this interest rate sensitivity estimate should not be viewed as an earnings forecast.

41


          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, 2007:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected Maturity Date at December 31, 2007 (1)

 

 

 

 

 

 

 


 

Total
Balance

 

Fair
Value

 

 

 

2008

 

2009

 

2010

 

2011

 

2012

 

Thereafter

 

 

 

 

 


 


 


 


 


 


 


 


 

Rate-Sensitive Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning cash

 

$

13,091

 

$

 

$

 

$

 

$

 

$

 

$

13,091

 

$

13,091

 

Average interest rate

 

 

3.64

%

 

%

 

%

 

%

 

%

 

%

 

3.64

%

 

 

 

Trading securities

 

 

6,148

 

 

332

 

 

75

 

 

320

 

 

435

 

 

34,928

 

 

42,238

 

 

42,238

 

Average interest rate

 

 

17.26

%

 

27.10

%

 

27.73

%

 

20.72

%

 

20.30

%

 

6.12

%

 

8.20

%

 

 

 

Loans held for resale (2)

 

 

75,240

 

 

 

 

 

 

 

 

 

 

 

 

75,240

 

 

75,240

 

Average interest rate

 

 

10.12

%

 

%

 

%

 

%

 

%

 

%

 

10.12

%

 

 

 

Interest–earning collateral and debt service deposits

 

 

86,796

 

 

 

 

 

 

 

 

 

 

 

 

86,796

 

 

86,796

 

Average interest rate

 

 

4.66

%

 

%

 

%

 

%

 

%

 

%

 

4.66

%

 

 

 

 

 



 



 



 



 



 



 



 



 

Total rate-sensitive assets

 

$

181,275

 

$

332

 

$

75

 

$

320

 

$

435

 

$

34,928

 

$

217,365

 

$

217,365

 

 

 



 



 



 



 



 



 



 



 

Rate-Sensitive Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Match funded liabilities

 

$

832,144

 

$

 

$

169,259

 

$

 

$

 

$

 

$

1,001,403

 

$

1,001,403

 

Average interest rate

 

 

6.94

%

 

%

 

5.34

%

 

%

 

%

 

%

 

6.67

%

 

 

 

Lines of credit and other secured borrowings

 

 

339,976

 

 

 

 

 

 

 

 

 

 

 

 

339,976

 

 

339,976

 

Average interest rate

 

 

6.34

%

 

%

 

%

 

%

 

%

 

%

 

6.34

%

 

 

 

Debt securities

 

 

 

 

96,900

 

 

 

 

 

 

 

 

53,379

 

 

150,279

 

 

121,067

 

Average interest rate

 

 

%

 

3.25

%

 

%

 

%

 

%

 

10.88

%

 

5.96

%

 

 

 

 

 



 



 



 



 



 



 



 



 

Total rate-sensitive liabilities

 

$

1,172,120

 

$

96,900

 

$

169,259

 

$

 

$

 

$

53,379

 

$

1,491,658

 

$

1,462,446

 

 

 



 



 



 



 



 



 



 



 

(1) Expected maturities are contractual maturities adjusted for prepayments of principal. We use certain assumptions to estimate fair values and expected maturities. For assets, we base expected maturities 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) The balances are net of market valuation allowances and include non-performing loans.

          The expected maturity of interest rate-sensitive assets and liabilities as of December 31, 2007 and 2006 compare as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 st Year

 

2 nd Year

 

3 rd Year

 

4 th Year

 

5 th Year

 

Thereafter

 

Total

 

 

 


 


 


 


 


 


 


 

Total rate-sensitive assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount

 

$

181,275

 

$

332

 

$

75

 

$

320

 

$

435

 

$

34,928

 

$

217,365

 

Percent of total

 

 

83.40

%

 

0.15

%

 

0.03

%

 

0.15

%

 

0.20

%

 

16.07

%

 

100.00

%

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount

 

$

211,990

 

$

8,902

 

$

10,088

 

$

6,674

 

$

5,788

 

$

115,067

 

$

358,509

 

Percent of total

 

 

59.13

%

 

2.48

%

 

2.82

%