Ocwen Financial Corporation
OCWEN FINANCIAL CORP (Form: 10-Q, Received: 08/04/2010 17:10:42)
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2010
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 Number: 1-13219
 
Ocwen Financial Corporation
(Exact name of registrant as specified in its charter)

Florida
 
65-0039856
(State or other jurisdiction
 
(I.R.S. Employer
of incorporation or organization)
 
Identification No.)
 

1661 Worthington Road, Suite 100, West Palm Beach, Florida 33409
(Address of principal executive offices) (Zip Code)
 
(561) 682-8000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  o  No o
 
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
 
Number of shares of Common Stock, $0.01 par value, outstanding as of July 30, 2010: 100,192,127 shares.
 
 
 

 
 
OCWEN FINANCIAL CORPORATION
FORM 10-Q
 
INDEX
 
 
      PAGE
         
     
       
 
3
 
         
   
3
 
         
   
4
 
         
   
5
 
         
   
6
 
         
   
7
 
         
   
8
 
         
 
38
 
         
 
55
 
         
 
56
 
         
PART II – OTHER INFORMATION      
       
 
56
 
         
Item 1A.  
56
 
         
 
57
 
         
 
58
 
         
Signatures  
59
 
 
 
1

 
 
FORWARD-LOOKING STATEMENTS
 
This Quarterly 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:
 
 
assumptions related to the sources of liquidity, our ability to fund advances and the adequacy of financial resources;
     
 
estimates regarding prepayment speeds, float balances, delinquency rates, advances and other servicing portfolio characteristics;
     
 
assumptions about our ability to grow our business;
     
 
our plans to continue to sell our non-core assets;
     
 
our ability to reduce our cost structure;
     
 
our analysis in support of the decision to spin Ocwen Solutions as a separate company;
     
 
our continued ability to successfully modify delinquent loans and sell foreclosed properties;
     
 
estimates regarding our reserves, valuations and anticipated realization on assets; 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 include, but are not limited to, the risks discussed in “Risk Factors” below and the following:
 
 
availability of adequate and timely sources of liquidity;
     
 
delinquencies, advances and availability of servicing;
     
 
general economic and market conditions;
     
 
uncertainty related to government programs, regulations and policies; 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 Annual report on Form 10-K for the year ended December 31, 2009, our quarterly reports on Form 10-Q and our 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 – FINANCIAL INFORMATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
 
   
June 30, 2010
   
December 31, 2009
 
Assets
           
Cash
  $ 143,386     $ 90,919  
Restricted cash – for securitization investors
    1,012        
Trading securities, at fair value:
               
Auction rate
    78,073       247,464  
Subordinates and residuals
    52       3,692  
Loans held for resale, at lower of cost or fair value
    30,696       33,197  
Advances
    150,870       145,914  
Match funded advances
    1,184,851       822,615  
Loans, net – restricted for securitization investors
    70,860        
Mortgage servicing rights
    126,668       117,802  
Receivables, net
    56,939       67,095  
Deferred tax assets, net
    117,253       132,683  
Premises and equipment, net
    3,528       3,325  
Investments in unconsolidated entities
    13,533       15,008  
Other assets
    99,808       89,636  
Total assets
  $ 2,077,529     $ 1,769,350  
                 
Liabilities and Equity
               
    Liabilities                
Match funded liabilities
  $ 835,172     $ 465,691  
Secured borrowings – owed to securitization investors
    67,199        
Lines of credit and other secured borrowings
    100,667       55,810  
Investment line
          156,968  
Servicer liabilities
    1,970       38,672  
Debt securities
    82,554       95,564  
Other liabilities
    90,037       90,782  
Total liabilities
    1,177,599       903,487  
                 
Commitments and Contingencies (Note 25)
               
                 
Equity
               
Ocwen Financial Corporation stockholders’ equity
               
Common stock, $.01 par value; 200,000,000 shares authorized; 100,192,127 and 99,956,833 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively
    1,002       1,000  
Additional paid-in capital
    461,890       459,542  
Retained earnings
    444,370       405,198  
Accumulated other comprehensive loss, net of income taxes
    (7,572 )     (129 )
Total Ocwen Financial Corporation stockholders’ equity
    899,690       865,611  
Non-controlling interest in subsidiaries
    240       252  
Total equity
    899,930       865,863  
Total liabilities and equity
  $ 2,077,529     $ 1,769,350  
   
The accompanying notes are an integral part of these consolidated financial statements.

 
3

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
(Dollars in thousands)
 
For the periods ended June 30,
 
Three months
   
Six months
 
   
2010
   
2009
   
2010
   
2009
 
Revenue
                       
Servicing and subservicing fees
  $ 65,936     $ 65,488     $ 132,416     $ 144,298  
Process management fees
    8,315       40,086       16,221       73,778  
Other revenues
    1,702       3,605       2,902       5,693  
Total revenue
    75,953       109,179       151,539       223,769  
                                 
Operating expenses
                               
Compensation and benefits
    13,089       27,254       25,866       55,799  
Amortization of mortgage servicing rights
    7,854       8,543       14,229       18,584  
Servicing and origination
    2,458       15,835       3,049       28,473  
Technology and communications
    6,191       4,481       11,855       9,289  
Professional services
    9,134       8,208       12,389       15,394  
Occupancy and equipment
    3,870       4,818       8,316       10,864  
Other operating expenses
    2,062       3,511       4,131       6,513  
Total operating expenses
    44,658       72,650       79,835       144,916  
                                 
Income from operations
    31,295       36,529       71,704       78,853  
                                 
Other income (expense)
                               
Interest income
    1,900       2,254       5,545       4,419  
Interest expense
    (13,359 )     (17,300 )     (25,830 )     (33,963 )
Gain (loss) on trading securities
    (1,710 )     5,435       (945 )     5,055  
Loss on loans held for resale, net
    (1,049 )     (2,987 )     (2,087 )     (7,541 )
Equity in earnings (losses) of unconsolidated entities
    343       (576 )     1,078       (549 )
Other, net
    (4,158 )     2,990       (4,758 )     3,335  
Other expense, net
    (18,033 )     (10,184 )     (26,997 )     (29,244 )
                                 
Income from continuing operations before income taxes
    13,262       26,345       44,707       49,609  
Income tax expense (benefit)
    (2,777 )     9,472       7,797       17,509  
Income from continuing operations
    16,039       16,873       36,910       32,100  
Income from discontinued operations, net of income taxes
          1,052             864  
Net income
    16,039       17,925       36,910       32,964  
Net income attributable to non-controlling interest in subsidiaries
    (1 )     (95 )     (12 )     (25 )
Net income attributable to Ocwen Financial Corporation (OCN)
  $ 16,038     $ 17,830     $ 36,898     $ 32,939  
                                 
Basic earnings per share
                               
Income from continuing operations attributable to OCN
  $ 0.16     $ 0.25     $ 0.37     $ 0.49  
Income from discontinued operations attributable to OCN
          0.01             0.02  
Net income attributable to OCN
  $ 0.16     $ 0.26     $ 0.37     $ 0.51  
                                 
Diluted earnings per share
                               
Income from continuing operations attributable to OCN
  $ 0.15     $ 0.24     $ 0.35     $ 0.48  
Income from discontinued operations attributable to OCN
          0.02             0.01  
Net income attributable to OCN
  $ 0.15     $ 0.26     $ 0.35     $ 0.49  
                                 
Weighted average common shares outstanding
                               
Basic
    100,168,953       67,316,446       100,072,950       65,045,842  
Diluted
    107,728,092       72,854,415       107,526,786       70,375,555  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
(Dollars in thousands)
 
For the periods ended June 30,
 
Three months
  Six months  
   
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 16,039     $ 17,925     $ 36,910     $ 32,964  
                                 
Other comprehensive loss, net of income taxes:
                               
                                 
Unrealized foreign currency translation loss arising during the period (1)
    (14 )     (187 )     (85 )     (227 )
Change in deferred loss on cash flow hedges arising during the period (2)
    (7,383 )           (7,383 )      
      (7,397 )     (187 )     (7,468 )     (227 )
                                 
Comprehensive income
    8,642       17,738       29,442       32,737  
                                 
Comprehensive loss attributable to non-controlling interests
    4       (5 )     12       97  
                                 
Comprehensive income attributable to OCN
  $ 8,646     $ 17,733     $ 29,454     $ 32,834  
 
(1)
Net of income tax benefit (expense) of $5 and $110 for the three months ended June 30, 2010 and 2009, respectively, and $35 and $133 for the six months ended June 30, 2010 and 2009, respectively.
   
(2)
Net of tax benefit of $4,336 for the three and six months ended June 30, 2010.

The accompanying notes are an integral part of these consolidated financial statements.
 
 
5

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(Dollars in thousands, except share data)
 
   
OCN Shareholders
           
   
Common Stock
   
Additional
Paid-in
   
Retained
   
Accumulated
Other
Comprehensive
Loss,
   
Non-
controlling
Interest in
       
   
Shares
   
Amount
   
Capital
   
Earnings
   
Net of Taxes
   
Subsidiaries
   
Total
 
                                           
Balance at December 31, 2009
    99,956,833     $ 1,000     $ 459,542     $ 405,198     $ (129 )   $ 252     $ 865,863  
                                                         
Adoption of ASC 810 (FASB Statement No. 167), net of tax
                      2,274                   2,274  
Net income
                      36,898             12       36,910  
Exercise of common stock options
    217,775       2       1,023                         1,025  
Issuance of common stock awards to employees
    9,865                                      
Equity-based compensation
    7,654             1,325                         1,325  
Other comprehensive loss, net of income taxes
                            (7,443 )     (24 )     (7,467 )
Balance at June 30, 2010
    100,192,127     $ 1,002     $ 461,890     $ 444,370     $ (7,572 )   $ 240     $ 899,930  
                                                         
Balance at December 31, 2008
    62,716,530     $ 627     $ 201,831     $ 404,901     $ 1,876     $ 406     $ 609,641  
Net income
                      32,939             25       32,964  
Issuance of common stock
    5,471,500       55       60,132                         60,187  
Repurchase of common stock
    (1,000,000 )     (10 )     (10,990 )                       (11,000 )
Exercise of common stock options
    282,012       3       1,861                         1,864  
Issuance of common stock awards to employees
    29,907             (138 )                       (138 )
Equity-based compensation
    12,147             1,379                         1,379  
Repurchase of 3.25% Convertible Notes
                (4 )                       (4 )
Other comprehensive loss, net of income taxes
                            (227 )     (122 )     (349 )
Balance at June 30, 2009
    67,512,096     $ 675     $ 254,071     $ 437,840     $ 1,649     $ 309     $ 694,544  
     
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
 (Dollars in thousands)
 
   
For the six months ended June 30,
 
   
2010
   
2009
 
Cash flows from operating activities
           
Net income
  $ 36,910     $ 32,964  
Adjustments to reconcile net income to net cash provided by operating activities
               
Amortization of mortgage servicing rights
    14,229       18,584  
Premium amortization and discount accretion
          1,445  
Depreciation and other amortization
    741       4,862  
Write-off of investment in commercial real estate partnership
    3,000        
Reversal of valuation allowance on mortgage servicing assets
    (101 )      
Reversal of valuation allowance on discontinued operations                                                                                                
          (1,227 )
Loss (gain) on trading securities
    945       (5,055 )
Loss on loans held for resale, net
    2,087       7,541  
Equity in (earnings) losses of unconsolidated entities
    (1,078 )     549  
Decrease in deferred tax assets
    12,838       12,590  
Net cash provided by trading activities
    168,453       2,000  
Net cash provided by loans held for resale activities
    849       2,738  
Changes in assets and liabilities:
               
Decrease in advances and match funded advances
    153,997       164,979  
Decrease in receivables and other assets, net
    11,983       15,089  
Decrease in servicer liabilities
    (36,702 )     (57,977 )
Decrease in other liabilities
    (11,178 )     (5,626 )
Other, net
    3,822       (337 )
Net cash provided by operating activities
    360,795       193,119  
                 
Cash flows from investing activities
               
Purchase of mortgage servicing rights
    (23,425 )     (10,241 )
Acquisition of advances and other assets in connection with the purchase of mortgage servicing rights
    (528,882 )      
Distributions of capital from unconsolidated entities
    2,146       3,246  
Additions to premises and equipment
    (2,202 )     (1,110 )
Proceeds from sales of real estate
    2,046       1,322  
Increase in restricted cash – for securitization investors
    743        
Principal payments received on loans – restricted for securitization investors
    2,223       396  
Net cash used by investing activities
    (547,351 )     (6,387 )
                 
Cash flows from financing activities
               
Proceeds from (repayment of) match funded liabilities
    369,481       (195,226 )
Repayment of secured borrowings – owed to securitization investors
    (4,852 )      
Proceeds from lines of credit and other secured borrowings
    96,657       102,106  
Repayment of lines of credit and other secured borrowings
    (53,904 )     (83,685 )
Repayment of investment line
    (156,968 )     (24,051 )
Repurchase of debt securities
    (11,659 )     (24,602 )
Repurchase of common stock
          (11,000 )
Issuance of common stock
          60,187  
Exercise of common stock options
    935       1,515  
Other
    (667 )     910  
Net cash provided (used) by financing activities
    239,023       (173,846 )
                 
Net increase in cash
    52,467       12,886  
Cash at beginning of period
    90,919       201,025  
Cash at end of period
  $ 143,386     $ 213,911  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
7

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
JUNE 30, 2010
(Dollars in thousands, except share data)
 
NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Organization
 
Ocwen Financial Corporation (NYSE: OCN) (Ocwen or OCN), through its subsidiaries, is a leading provider of residential and commercial mortgage loan servicing, special servicing and asset management services. Ocwen is headquartered in West Palm Beach, Florida with offices in California, the District of Columbia, Florida, Georgia and global operations in India and Uruguay. Ocwen is a Florida corporation organized in February 1988. Ocwen Loan Servicing, LLC (OLS), a wholly-owned subsidiary of Ocwen, is a licensed mortgage servicer in all 50 states, the District of Columbia and two U.S. territories.
 
At June 30, 2010, Ocwen owned all of the outstanding stock of its primary subsidiaries: OLS; Ocwen Financial Solutions, Private Limited (OFSPL); and Investors Mortgage Insurance Holding Company. OCN also holds a 45% interest in BMS Holdings, Inc. (BMS Holdings), a 25% interest in Ocwen Structured Investments, LLC (OSI) and an approximate 25% interest in Ocwen Nonperforming Loans, LLC (ONL) and Ocwen REO, LLC (OREO). While OCN continues to own 70% of Global Servicing Solutions, LLC (GSS) with the remaining 30% interest held by ML IBK Positions, Inc., GSS had no material operations during the first six months of 2010 and 2009 and no material assets as of June 30, 2010.
 
On August 10, 2009, we completed the distribution of our Ocwen Solutions line of business, except for BMS Holdings and GSS, via the spin-off of a separate publicly-traded company, Altisource Portfolio Solutions S.A. (Altisource). Altisource common stock is listed on the NASDAQ market under the ticker symbol “ASPS.” We distributed all of the shares of Altisource common stock to OCN’s shareholders of record as of August 4, 2009 (the Separation). We eliminated the assets and liabilities of Altisource from our Consolidated Balance Sheet effective at the close of business on August 9, 2009. Beginning August 10, 2009, the operating results of Altisource are no longer included in our operating results. We do not report the historical operating results of Altisource as a discontinued operation because of the significance of the continuing involvement between Altisource and Ocwen under the long-term services agreements described in Note 24. Accordingly, for periods prior to August 10, 2009, the historical operating results of Altisource are presented in continuing operations.
 
Principles of Consolidation
 
Our financial statements include the accounts of Ocwen and its majority-owned subsidiaries. We apply the equity method of accounting to investments when the entity is not a variable interest entity (VIE) and we are able to exercise significant influence, but not control, over the policies and procedures of the entity but own less than 50% of the voting securities. We have eliminated intercompany accounts and transactions in consolidation.
 
Variable Interest Entities
 
We evaluate each special purpose entity (SPE) for classification as a VIE. When an SPE meets the definition of a VIE and we determine that Ocwen is the primary beneficiary, we include the SPE in our consolidated financial statements.
 
We have determined that the SPEs created in connection with the match funded financing facilities discussed below are VIEs of which we are the primary beneficiary. We have also determined that we are the primary beneficiary for certain residential mortgage loan securitization trusts. The accounts of these SPEs are included in our consolidated financial statements.
 
Securitizations or Asset Backed Financing Arrangements
 
Ocwen or its subsidiaries have been a transferor in connection with a number of securitizations or asset-backed financing arrangements. As of January 1, 2010, we had continuing involvement with the financial assets of eight of these securitizations or asset-backed financing arrangements. We also hold residual interests in and are the servicer for three securitizations where we were not a transferor.
 
We have aggregated these securitizations and asset-backed financing arrangements into two groups: (1) securitizations of residential mortgage loans and (2) financings of advances on loans serviced for others.
 
Securitizations of Residential Mortgage Loans. In prior years, we securitized residential mortgage loans using certain trusts. These transactions were accounted for as sales even though we continued to be involved with the trusts, typically by acting as the servicer or sub-servicer for the loans held by the trust and by retaining a beneficial ownership interest in the trust. The beneficial interests we held consisted of both subordinate and residual securities that were either retained at the time of the securitization or acquired subsequently.
 
 
8

 
 
As a result of our adoption of Accounting Standards Update (ASU) No. 2009-16 (ASC 860, Transfers and Servicing) and ASU 2009-17 (ASC 810, Consolidation), we have included four of these trusts in our consolidated financial statements. The remaining trusts are currently excluded from our consolidated financial statements because we have determined that Ocwen is not the primary beneficiary.
 
We have determined that Ocwen is the primary beneficiary of the consolidated securitization trusts because:
 
 
1.
as the servicer we have the right to direct the activities that most significantly impact the economic performance of the trusts through our ability to manage the delinquent assets of the trusts and
     
 
2.
as holder of all or a portion of the residual tranches of the securities issued by the trust, we have the obligation to absorb losses of the trusts, to the extent of the value of our investment, and the right to receive benefits from the trust both of which could potentially be significant to the trusts.
 
Upon adoption of ASU 2009-17 (ASC 810, Consolidation) on January 1, 2010 we began consolidating the four trusts and recorded a $75,506 increase in total assets, a $73,232 increase in liabilities and a $2,274 increase in the opening balance of retained earnings. Included in these amounts were the following transition adjustments:
 
 
Consolidation of $1,755 of cash held by the trusts (Restricted cash – for securitization investors);
     
 
Consolidation of loans held by the trust with an unpaid principal balance (UPB) of $77,939 (Loans, net – restricted for securitization investors), including $14,780 of non-performing collateral;
     
 
Recording of an allowance for loan losses of $4,461, not previously required, for the newly consolidated loans;
     
 
Consolidation of $2,346 of real estate owned from the trusts (included in Other assets);
     
 
Consolidation of $72,918 of certificates issued by the trusts (Secured borrowings – owed to securitization investors);
     
 
Elimination of our $3,634 investment in trading securities that were issued by the newly consolidated trusts against $867 of the face amount of the related certificates and retained earnings;
     
 
Recording of net deferred tax assets of $1,561, principally related to establishing an allowance for loan losses for the newly consolidated loans; and
     
 
Recording of $1,181 of other liabilities representing accrued interest payable and the fair value of interest rate swap instruments entered into by one of the consolidated trusts.
 
The consolidation of the four trusts on January 1, 2010 did not affect Cash and, therefore, the transition adjustments are not reported in the Consolidated Statement of Cash Flows.
 
Our Consolidated Statement of Operations for the three and six months ended June 30, 2009 and our Consolidated Balance Sheet at December 31, 2009 have not been retroactively adjusted to reflect the effect of our adoption of ASU 2009-16 and ASU 2009-17. Therefore, current period results and balances will not be comparable to prior period amounts particularly with regard to the following:
 
 
Trading securities (Subordinates and residuals)
     
 
Loans, net – restricted for securitization investors
     
 
Deferred tax assets, net
     
 
Secured borrowings – owed to securitization investors
     
 
Interest income
     
 
Interest expense
     
 
Gain (loss) on trading securities
 
Beginning January 1, 2010, interest income on the securities that we hold that were issued by the securitization trusts is eliminated in consolidation against the interest expense of the trusts.
 
 
9

 
 
Ocwen has no obligation to provide financial support to the trusts and has provided no such support. The creditors of the trusts can look only to the assets of the trusts themselves for satisfaction of the debt and have no recourse against the assets of Ocwen. Similarly, the general creditors of Ocwen have no claim on the assets of the trusts. Our exposure to loss as a result of our continuing involvement is limited to the carrying values of our investments in the residual and subordinate securities of the trusts, our mortgage servicing rights that are related to the trusts and our advances to the trusts.
 
The following table presents a summary of the involvement of Ocwen with seven unconsolidated securitization trusts and summary financial information for the trusts. Although we are the servicer for these trusts, the residual interests that we hold in these entities have little to no value. As a result, we are exposed to no loss from these holdings. Further, since our valuation of the residual interest is based on anticipated cash flows, we are unlikely to receive any benefits from these trusts.
 
For the periods ended June 30,
 
Three months
   
Six months
 
   
2010
   
2009
   
2010
   
2009
 
Total cash received on beneficial interests held
  $     $ 8     $     $ 62  
Total servicing and subservicing fee revenues
    923       975       1,874       2,203  

   
As of
 
   
June 30, 2010
   
December 31, 2009
 
Total servicing advances
  $ 17,545     $ 19,027  
Total beneficial interests held at fair value (1)
    52       58  
Total mortgage servicing rights at amortized cost
    1,466       1,659  
 
(1)
Includes investments in subordinate and residual securities that we retained in connection with the loan securitization transactions completed in prior years.
 
With regard to these unconsolidated securitization trusts, we have no obligation to provide financial support to the trusts and have provided no such support. Our exposure to loss as a result of our continuing involvement is limited to the carrying values of our investments in the residual and subordinate securities of the trusts, our mortgage servicing rights that are related to the trusts and our advances to the trusts. We consider the probability of loss arising from our advances to be remote because of their position ahead of most of the other liabilities of the trusts. See Note 5, Note 6, Note 7 and Note 9 for additional information regarding Trading securities, Advances, Match funded advances and Mortgage servicing rights.
 
Match Funded Advances on Loans Serviced for Others. Match funded advances on loans serviced for others result from our transfers of residential loan servicing advances to SPEs in exchange for cash. These SPEs issue debt supported by collections on the transferred advances. We made these transfers under the terms of four advance facility agreements. These transfers do not qualify for sales accounting because we retain control over the transferred assets. As a result, we account for these transfers as financings and classify the transferred advances on our Consolidated Balance Sheet as Match funded advances and the related liabilities as Match funded liabilities. Collections on the advances pledged to the SPEs are used to repay principal and interest and to pay the expenses of the entity. Holders of the debt issued by these entities can look only to the assets of the entities themselves for satisfaction of the debt and have no recourse against OCN. However, OLS has guaranteed the payment of the obligations under the securitization documents of one of the entities, Ocwen Servicer Advance Funding (Wachovia), LLC (OSAFW). The maximum amount payable under the guarantee is limited to 10% of the notes outstanding at the end of the facility’s revolving period on May 5, 2011. As of June 30, 2010, OSAFW had $250,000 of notes outstanding.
 
The following table summarizes the assets and liabilities of the SPEs formed in connection with our match funded advance facilities, at the dates indicated:
 
   
June 30, 2010
   
December 31, 2009
 
Match funded advances
  $ 1,184,851     $ 822,615  
Other assets
    48,776       19,343  
Total assets
  $ 1,233,627     $ 841,958  
                 
Match funded liabilities
  $ 835,172     $ 465,691  
Other liabilities
    104,046       138,210  
Total liabilities
  $ 939,218     $ 603,901  
 
 
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Reclassification
 
Certain immaterial amounts in our 2009 consolidated financial statements have been reclassified to conform to the 2010 presentation. In the fourth quarter of 2009, we reclassified gains and losses on debt redemptions to Other, net on the Consolidated Statements of Operations. On the Consolidated Statements of Changes in Equity, we condensed share-based compensation amounts and associated excess tax benefits into one line item, Equity-based compensation. Within the operating activities section of the Consolidated Statements of Cash Flows we condensed several immaterial items to Other, net. Similarly, in the financing section of the Consolidated Statements of Cash Flows we condensed several immaterial items to Other.
 
NOTE 2
RECENT ACCOUNTING PRONOUNCEMENTS
 
In June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. This establishes the FASB Accounting Standards Codification (ASC) as the only source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP, with the exception of Statements of Financial Accounting Standards not yet included in the Codification.
 
ASU 2009-16 (ASC 860, Transfers and Servicing). This statement eliminates the exceptions for qualifying special purpose entities (QSPE) from the consolidation guidance (ASC 810) and clarifies that the objective of the standard is to determine whether a transferor and all of the entities included in the transferor’s financial statements being presented have surrendered control over transferred financial assets. That determination must consider the transferor’s continuing involvements in the transferred financial asset including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. This statement modifies the financial-components approach currently used and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset.
 
This statement defines the term participating interest to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale. If the transfer does not meet those conditions, a transferor should account for the transfer as a sale only if it transfers an entire financial asset or a group of entire financial assets and surrenders control over the entire transferred asset(s). This statement requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. Enhanced disclosures are required to provide financial statement users with greater transparency about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets.
 
The provisions for guaranteed mortgage securitizations are removed to require those securitizations to be treated the same as any other transfer of financial assets within the scope of the standard. If such a transfer does not meet the requirements for sale accounting, the securitized mortgage loans should continue to be classified as loans in the transferor’s statement of financial position.
 
We adopted this standard effective January 1, 2010 as a result of which, we reevaluated certain QSPEs with which we had ongoing relationships as further described under ASU 2009-17, below, and reassessed the adequacy of our disclosures with regard to our servicing assets and servicing liabilities.
 
ASU 2009-17 (ASC 810, Consolidation). This standard requires an enterprise to perform ongoing periodic assessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. We adopted this standard effective January 1, 2010. This analysis identifies the primary beneficiary of a VIE as the enterprise that has both of the following characteristics:
 
 
(a)
The power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance
     
 
(b)
The obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.
 
In addition to reintroducing the concept of control into the determination of the primary beneficiary of a VIE, this statement makes numerous other amendments to the current standards primarily to reflect the elimination of the concept of a QSPE under ASC 860 (above). This statement also amends the current standards to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. The enhanced disclosures are required for any enterprise that holds a variable interest in a VIE. The additional disclosures required by this statement are included in Note 1—Summary of Significant Accounting Policies.
 
 
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As also disclosed in Note 1—Securitizations of Residential Mortgage Loans, we previously excluded certain loan securitization trusts from our consolidated financial statements because each was a QSPE. Effective January 1, 2010, we reevaluated these QSPEs as well as all other potentially significant interests in other unconsolidated entities to determine if we should include them in our consolidated financial statements.
 
ASU No. 2010-06 (ASC 820, Fair Value Measurements and Disclosures) . ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. These new disclosure requirements became effective for our financial statements for the period ending June 30, 2010, except for the requirement concerning gross presentation of Level 3 activity, which will become effective for fiscal years beginning after December 15, 2010. See Note 4 for our fair value disclosures related to financial instruments.
 
ASU No. 2010-20 (ASC 310, Receivables). On July 21, 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses . This standard outlines specific disclosures required for the allowance for credit losses and all finance receivables, as defined. A finance receivable is defined as a contractual right to receive money on demand or on fixed or determinable dates that is recognized as an asset in the entity’s statement of financial position. This definition includes instruments such as certain trade receivables, notes receivable and lease receivables as well as the instruments more traditionally associated with an allowance for credit loss, such as mortgage loans, auto loans, credit card loans and other consumer or commercial lending agreements.
 
A significant change from the current disclosure requirements will be to provide information for both the finance receivables and the related allowance for credit losses at disaggregated levels. The standard introduces two new defined terms that will govern the level of disaggregation. These include a “portfolio segment” and a “class” of financing receivable. A portfolio segment is defined as the level at which an entity determines its allowance for credit losses. For example, this may be by type of receivable, industry or risk. A class of financing receivable is defined as a group of finance receivables determined on the basis of their initial measurement attribute (i.e., amortized cost or purchased credit impaired), risk characteristics, and an entity’s method for monitoring and assessing credit risk.
 
The new guidance requires an entity to provide the extensive disclosures or information for the reporting periods presented including, but not limited to:
 
Presented by portfolio segment: A rollforward schedule of the allowance for credit losses (with the ending allowance balance further disaggregated based on impairment methodology) together with the related ending balance of the finance receivables; and significant purchases and sales of financing receivables.
 
Presented by class:   The credit quality of the financing receivables portfolio at the end of the reporting period; the aging of past due financing receivables at the end of the period; the nature and extent of troubled debt restructurings that occurred during the period and their impact on the allowance for credit losses; the nature and extent of troubled debt restructurings, that occurred within the last year, that have defaulted in the current reporting period, and their impact on allowance for credit losses; the nonaccrual status of financing receivables; and impaired financing receivables.
 
Disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred prior to the issuance of the ASU, such as the allowance rollforward and modification disclosures will be required for periods beginning after December 15, 2010.
 
NOTE 3
PENDING ACQUISITION
 
On May 28, 2010, Barclays Bank PLC and Barclays Capital Real Estate Inc. (together the “Sellers”), OLS and Ocwen entered into an Asset Purchase Agreement pursuant to which, among other things, OLS has agreed to acquire the Sellers’ U.S. non-prime mortgage servicing business known as “HomEq Servicing” including, but not limited to, the mortgage servicing rights and associated servicer advances of HomEq Servicing as well as the servicing platform.
 
The aggregate purchase price is approximately $1,300,000, payable in cash upon consummation of the acquisition. The purchase price is subject to adjustment mechanisms and repurchase rights in limited circumstances.
 
 
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As part of the acquisition, the Sellers have agreed to provide OLS with approximately $1,045,000 in secured financing. In addition, OLS obtained a syndicated $350,000 five year senior secured term loan facility on July 29, 2010 that will be used in part to fund the acquisition. See Note 26 for additional information.
 
Consummation of the acquisition is subject to closing conditions, including, among other things, the absence of legal impediments or an injunction and the receipt of required consents. Unless agreed to by the parties, the acquisition will be consummated no earlier than 90 days from the signing of the Asset Purchase Agreement.
 
The transaction is expected to close on September 1, 2010. Through June 30, 2010, we have incurred approximately $1,250 of fees for professional services related to the acquisition which are included in operating expenses for the second quarter of 2010. Also included in operating expenses was approximately $1,500 of additional compensation, telecommunications and occupancy expenses related to the acquisition.
 
NOTE 4
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The carrying amounts and the estimated fair values of our financial instruments are as follows at the dates indicated:
 
   
June 30, 2010
   
December 31, 2009
 
   
Carrying
Value
   
Fair
Value
   
Carrying
Value
   
Fair
Value
 
Financial assets:
                       
Trading securities:
                       
Auction rate
  $ 78,073     $ 78,073     $ 247,464     $ 247,464  
Subordinates and residuals
    52       52       3,692       3,692  
Loans held for resale
    30,696       30,696       33,197       33,197  
Loans, net – restricted for securitization investors
    70,860       69,341              
Advances
    1,335,721       1,335,721       968,529       968,529  
Receivables, net
    56,939       56,939       67,095       67,095  
Financial liabilities:
                               
Match funded liabilities
  $ 835,172     $ 758,024     $ 465,691     $ 463,716  
Lines of credit and other secured borrowings
    100,667       101,766       55,810       56,220  
Secured borrowings – owed to securitization investors
    67,199       66,325              
Investment line
                156,968       156,968  
Servicer liabilities
    1,970       1,970       38,672       38,672  
Debt securities
    82,554       76,807       95,564       84,551  
Derivative financial instruments, net
  $ (12,278 )   $ (12,278 )   $ 781     $ 781  
 
Fair value is estimated based on a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs to valuation techniques into three broad levels whereby the highest priority is given to Level 1 inputs and the lowest to Level 3 inputs. The three broad categories are:
 
 
Level 1:
Quoted prices in active markets for identical assets or liabilities.
     
 
Level 2:
Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly for substantially the full term of the financial instrument.
     
 
Level 3:
Unobservable inputs for the asset or liability.
 
Where available, we utilize quoted market prices or observable inputs rather than unobservable inputs to determine fair value. We classify assets in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
 
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The following table sets forth assets and liabilities measured at fair value categorized by input level within the fair value hierarchy:

   
Carrying value
   
Level 1
   
Level 2
   
Level 3
 
At June 30, 2010:
                       
Measured at fair value on a recurring basis:
                       
Trading securities (1):
                       
Auction rate
  $ 78,073     $     $     $ 78,073  
Subordinates and residuals (2)
    52                   52  
Derivative financial instruments, net (3)
    (12,278 )                 (12,278 )
Measured at fair value on a non-recurring basis:
                               
Loans held for resale (4)
    30,696                   30,696  
Mortgage servicing rights (5)
    348                   348  
                                 
At December 31, 2009:
                               
Measured at fair value on a recurring basis:
                               
Trading securities (1):
                               
Auction rate
  $ 247,464     $     $     $ 247,464  
Subordinates and residuals (2)
    3,692                   3,692  
Derivative financial instruments, net (3)
    781                   781  
Measured at fair value on a non-recurring basis:
                               
Loans held for resale (4)
    33,197                   33,197  
Mortgage servicing rights (5)
    613                   613  
 

(1)
Because our internal valuation model requires significant use of unobservable inputs, these securities are classified within Level 3 of the fair value hierarchy.
   
(2)
Effective January 1, 2010, we eliminated our investment in trading securities that were issued by newly consolidated securitization trusts as more fully described in Note 1—Securitizations of Residential Mortgage Loans.
   
(3)
The fair values of derivative financial instruments as of January 1, 2010 were adjusted to include $(826) related to an interest rate swap that is held by one of the newly consolidated securitization trusts. Derivative financial instruments consist of interest: rate caps that we use to protect against our exposure to rising interest rates on two of our match funded variable funding notes; interest rate swaps to protect against our exposure to rising interest rates on a third match funded facility and a match funded facility forecast in connection with the HomEq Servicing acquisition; the interest rate swap that is held by one of the newly consolidated loan securitization trusts; and foreign exchange forward contracts to protect against changes in the value of the Indian Rupee. See Note 18 for additional information on our derivative financial instruments.
   
(4)
Loans held for resale are measured at fair value on a non-recurring basis. At June 30, 2010 and December 31, 2009, the carrying value of loans held for resale is net of a valuation allowance of $13,546 and $15,963, respectively. Current market illiquidity has reduced the availability of observable pricing data. Consequently, we classify loans within level 3 of the fair value hierarchy.
   
(5)
The carrying value of MSRs at June 30, 2010 and December 31, 2009 is net of a valuation allowance for impairment of $2,853 and $2,954, respectively. The carrying value of the impaired stratum, net of the valuation allowance, was $348 and $613 at June 30, 2010 and December 31, 2009, respectively. The estimated fair value exceeded amortized cost for all other strata. See Note 9 for additional information on MSRs.
 
 
14

 
 
The following table sets forth a reconciliation of the changes in fair value of our Level 3 assets that we measure at fair value on a recurring basis:
 
   
Fair value at beginning of period
   
Purchases, collections and settlements, net (1)
   
Total realized and unrealized gains and (losses) (2)(3)
   
Transfers in and/or out of Level 3
   
Fair value at
June 30
 
                               
For the three months ended June 30, 2010:
                             
Trading securities:
                             
Auction rate
  $ 125,036     $ (45,260 )   $ (1,703 )   $     $ 78,073  
Subordinates and residuals
    59             (7 )           52  
                                         
Derivative financial instruments
    (480 )     76       (11,874 )           (12,278 )
                                         
For the three months ended June 30, 2009:
                                       
Trading securities:
                                       
Auction rate
  $ 238,161     $ (900 )   $ 6,024     $     $ 243,285  
Subordinates and residuals
    4,028       1       (589 )           3,440  
                                         
Derivative financial instruments
    355             602             957  
                                         
For the six months ended June 30, 2010:
                                       
Trading securities:
                                       
Auction rate
  $ 247,464     $ (168,453 )   $ (938 )   $     $ 78,073  
Subordinates and residuals
    59             (7 )           52  
                                         
Derivative financial instruments
    (45 )     76       (12,309 )           (12,278 )
                                         
For the six months ended June 30, 2009:
                                       
Trading securities:
                                       
Auction rate
  $ 239,301     $ (2,000 )   $ 5,984     $     $ 243,285  
Subordinates and residuals
    4,369             (929 )           3,440  
                                         
Derivative financial instruments
    193             764             957  
 
(1)
Purchases, collections and settlements, net, related to trading securities exclude interest received.
   
(2)
Total gains and (losses) on auction rate securities for the second quarter include unrealized gains (losses) of $(53) and $6,024 on auction rate securities still held at June 30, 2010 and 2009, respectively. For the year to date periods, unrealized gains on auction rate securities still held at June 30, 2010 and 2009 were $559 and $5,984, respectively. The total gains and (losses) attributable to subordinates and residuals and derivative financial instruments were comprised principally of unrealized gains (losses) on assets held at June 30, 2010 and 2009.
   
(3)
Total gains (losses) on derivatives for the three and six months ended June 30, 2010 include unrealized losses of $11,719 reported in changes in Other comprehensive loss. All other unrealized gains (losses) on derivatives for the 2010 and 2009 periods are reported in Other, net. The total gains and (losses) attributable to derivative financial instruments were comprised principally of unrealized gains (losses) on assets still held at June 30, 2010 and 2009.
 
 
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The methodologies that we use and key assumptions that we make to estimate the fair value of instruments are described in more detail by instrument below:
 
Trading Securities
 
Auction Rate Securities. We estimated the fair value of the auction rate securities based on a combination of observable market inputs provided by actual orderly sales of similar auction rate securities and a discounted cash flow analysis. This discounted cash flow analysis incorporates expected future cash flows based on our best estimate of market participant assumptions. In periods of market illiquidity, the fair value of auction rate securities is determined after consideration of the credit quality of the securities held and the underlying collateral, market activity and general market conditions affecting auction rate securities.
 
The discounted cash flow analysis included the following range of assumptions at June 30, 2010:
 
Expected term
 
18 months
Illiquidity premium
  0.61%
Discount rate
  1.50% – 3.67%
 
The expected term was based upon our best estimate of market participants’ expectations of future successful auctions. The discount rate and illiquidity premium are consistent with prevailing rates for similar securities. Other significant assumptions that we considered in our analysis included the credit risk profiles of the issuers, the impact on the issuers of the increased debt service costs associated with the payment of penalty interest rates and the collateralization of the securitization trusts. We do not assume defaults in our valuation due to the high credit quality of both the securities we hold and the underlying collateral.
 
Subordinates and Residuals. Our subordinate and residual securities are not actively traded, and, therefore, we estimate the fair value of these securities based on the present value of expected future cash flows from the underlying mortgage pools. We use our best estimate of the key assumptions we believe are used by market participants. We calibrate our internally developed discounted cash flow models for trading activity when appropriate to do so in light of market liquidity levels. Key inputs include expected prepayment rates, delinquency and cumulative loss curves and discount rates commensurate with the risks. Where possible, we use observable inputs in the valuation of our securities. However, the subordinate and residual securities in which we invest typically trade infrequently and therefore have few or no observable inputs and little price transparency. Additionally, during periods of market dislocation, the observability of inputs is further reduced.
 
Discount rates for the subordinate and residual securities range 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 a comparison to actual historical performance curves adjusted for prevailing market conditions.
 
Derivative Financial Instruments
 
Exchange-traded derivative financial instruments are valued based on quoted market prices. If quoted market prices or other observable inputs are not available, fair value is based on estimates provided by third-party pricing sources.
 
Loans Held for Resale
 
Loans held for resale are reported at the lower of cost or fair value. We account for the excess of cost over fair value as a 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. All loans held for resale were measured at fair value because the cost of $44,242 exceeded the estimated fair value of $30,696 at June 30, 2010.
 
When we enter into an agreement to sell a loan to an investor at a set price, the loan is valued at the commitment price. The fair value of loans for which we do not have a firm commitment to sell is based upon a discounted cash flow analysis. We stratify our fair value estimate of uncommitted loans held for resale based upon the delinquency status of the loans. We base the fair value of our performing loans on the expected future cash flows discounted at a rate commensurate with the risk of the estimated cash flows. Significant assumptions include collateral and loan characteristics, prevailing market conditions and the creditworthiness of the borrower. The fair value of our non-performing loans is determined based upon the underlying collateral of the loan and the estimated period and cost of disposition.
 
Loans – Restricted for Securitization Investors
 
Loans – restricted for securitization investors are reported at cost, less an allowance for loan losses and are comprised of loans that are secured by first or second liens on one- to four-family residential properties. We base the fair value of our loans on the expected future cash flows discounted at a rate commensurate with the risk of the estimated cash flows. Significant assumptions include expected prepayment rates and delinquency and cumulative loss curves.
 
 
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Mortgage Servicing Rights
 
We estimate the fair value of our MSRs by calculating the present value of expected future cash flows utilizing assumptions that we believe are used by market participants. The most significant assumptions used in our internal valuation are the speed at which mortgages prepay and delinquency experience both of which we derive from our historical experience and available market data. Other assumptions used in our internal valuation are:
 
 
Cost of servicing
 
Interest rate used for computing float earnings
 
Discount rate
 
Compensating interest expense
 
Interest rate used for computing the cost of servicing advances
     
 
The significant components of the estimated future cash inflows for MSRs include servicing fees, late fees, prepayment penalties, float earnings and other ancillary revenues. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments. We derive prepayment speeds and delinquency assumptions from historical experience adjusted for prevailing market conditions. We develop the discount rate internally, and we consider external market-based assumptions in determining the interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing. The more significant assumptions used in the June 30, 2010 valuation include prepayment speeds ranging from 14.03% to 19.55% (depending on loan type) and delinquency rates ranging from 13.25% to 31.88% (depending on loan type). Other assumptions include an interest rate of 1-month LIBOR plus 4% for computing the cost of financing advances, an interest rate of 1-month LIBOR for computing float earnings and a discount rate of 20%.
 
We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata based on one or more of the predominant risk characteristics of the underlying loans. The risk factors used to assign loans to strata include the credit score (FICO) of the borrower, the loan to value ratio and the default risk. Our strata include:
 
 
Subprime
 
Re-performing
 
ALT A
 
Special servicing
 
High-loan-to-value
 
Other
 
Advances
 
We value advances that we make on loans that we service for others at their carrying amounts because they have no stated maturity, generally are realized within a relatively short period of time and do not bear interest.
 
Receivables
 
The carrying value of receivables generally approximates fair value because of the relatively short period of time between their origination and realization.
 
Borrowings
 
Borrowings not subject to a hedging relationship are carried at amortized cost. We base the fair value of our debt securities on quoted market prices. The carrying value of match funded liabilities and secured borrowings that bear interest at a rate that is adjusted regularly based on a market index approximates fair value. For other match funded or secured borrowings that bear interest at a fixed rate, we determine fair value by discounting the contractual future principal and interest repayments at a market rate commensurate with the risk of the estimated cash flows. We carry certain zero-coupon long-term secured borrowings with an implicit fixed rate at a discounted value and determine fair value by discounting the contractual future principal repayments at a market rate that is commensurate with the risk of the estimated cash flows.
 
Servicer Liabilities
 
The carrying value of servicer liabilities approximates fair value due to the short period of time the funds are held until they are deposited in collection accounts, paid directly to an investment trust or refunded to borrowers.
 
 
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NOTE 5
TRADING SECURITIES
 
Trading securities consisted of the following at the dates indicated:
 
   
June 30, 2010
   
December 31, 2009
 
             
Auction rate (Corporate Items and Other)
  $ 78,073     $ 247,464  
                 
Subordinates and residuals:
               
Loans and Residuals (1)
  $     $ 3,634  
Corporate Items and Other
    52       58  
    $ 52     $ 3,692  
 
Gain (loss) on trading securities for the periods ended June 30, was comprised of the following:
 
   
Three months
   
Six months
 
   
2010
   
2009
   
2010
   
2009
 
Unrealized gains (losses):
                       
Auction rate securities
  $ (53 )   $ 6,024     $ 969     $ 5,984  
Subordinates and residuals (1)
    (7 )     (589     (7 )     (929 )
    $ (60 )   $ 5,435     $ 962     $ 5,055  
Realized losses (2)
    (1,650 )           (1,907 )      
    $ (1,710 )   $ 5,435     $ (945 )   $ 5,055  
 
(1)
Effective January 1, 2010, we eliminated our investment in trading securities that were issued by newly consolidated securitization trusts as more fully described in Note 1—Securitizations of Residential Mortgage Loans, as well as the related unrealized gains and losses.
   
(2)
The realized losses for the 2010 periods were incurred on sales of auction rate securities.
 
Auction Rate Securities
 
During the first quarter of 2008, we invested investment line borrowings (see Note 15) in auction rate securities backed by student loans originated under the U. S. Department of Education’s Federal Family Education Loan Program (FFELP). Auction rate securities are long-term variable rate bonds tied to short-term interest rates that reset through an auction process that historically occurred every 7 to 35 days. The student loans underlying the auction rate securities carry a U.S Government guarantee of at least 97% of the unpaid principal balance in the event of default. The auction rate securities that we hold are in the senior-most position and are smaller in amount than the federally guaranteed portion of the underlying loans.
 
On January 21, 2010 and March 4, 2010, we negotiated settlements of two of our auction rate securities litigation actions. Under the terms of these settlements, the broker/dealers repurchased $103,625 par value of auction rate securities for cash proceeds of $92,745. On February 10, 2010, we sold auction rate securities with a par value of $33,350 for cash proceeds of $29,848.
 
Under the terms of the liquidity option agreement we entered into in October 2009, we have the right to sell specific securities for cash. We also have the right to repurchase the same following the initial sale at the same price. On February 11, 2010, we exercised a portion of our option to sell auction rate securities with a par value of $88,150 and received proceeds of $74,953. We recognized the sale as a secured borrowing because of our ability to repurchase the same securities until the maturity of the liquidity option in October 2012. On June 24, 2010, we repurchased $46,800 par value of these securities at the initial sale price of $40,504 and sold them for cash proceeds of $44,460. We continue to report on our Consolidated Balance Sheet the remaining $41,350 par value of these auction rate securities, with a fair value of $41,128 as of June 30, 2010. However, these securities are pledged to collateralize a $34,449 borrowing reflecting the proceeds received upon exercise of the option. We no longer receive cash interest income on the pledged securities nor do we pay cash interest on this secured borrowing. The remaining $2,400 par value of auction rate securities are not financed. See Note 14 for additional information on this secured borrowing.
 
Proceeds from the January 21, 2010 litigation settlement and the February 10, 2010 sale were used to pay down the investment line. On February 17, 2010, we used the proceeds from the February 11, 2010 exercise of the liquidity option and an additional $3,664 cash to repay the remaining balance of the investment line.
 
 
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In June 2010, we sold auction rate securities with a par value of $35,000 under an agreement to repurchase and received proceeds of $21,704. We report repurchase agreements as collateralized financings and report the obligations to repurchase the assets sold as a liability on our Consolidated Balance Sheet. See Note 14 for additional details regarding the terms of the financing obligation. We report the auction rate securities underlying the repurchase agreement, which had a fair value of $34,635 at June 30, 2010, in our Consolidated Balance Sheet.
 
During the six months ended June 30, 2010, issuers also redeemed, at par, auction rate securities that we held that had a face value of $1,400.
 
Subordinates and Residuals
 
Through our investment in subordinate and residual securities, we support senior classes of securities. Principal from the underlying mortgage loans generally is allocated first to the senior classes with the most senior class having a priority right to the cash flow from the mortgage loans until its payment requirements are satisfied. To the extent that there are defaults and unrecoverable losses on the underlying mortgage loans, resulting in reduced cash flows, the most subordinate security will be the first to bear this loss.
 
NOTE 6
ADVANCES
 
Advances consisted of the following at the dates indicated:
 
   
June 30, 2010
   
December 31, 2009
 
Servicing:
           
Principal and interest
  $ 62,184     $ 51,598  
Taxes and insurance
    46,191       52,813  
Foreclosure and bankruptcy costs
    24,260       28,021  
Other
    14,009       8,998  
      146,644       141,430  
Loans and Residuals
    4,088       4,321  
Corporate Items and Other
    138       163  
    $ 150,870     $