Ocwen Financial Corporation
OCWEN FINANCIAL CORP (Form: 10-Q, Received: 11/09/2011 08:37:33)
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 September 30, 2011
   
 
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.)

2002 Summit Boulevard, 6 th Floor, Atlanta, Georgia 30319
(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 x 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
x
 
Accelerated filer o
 
 
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 November 4, 2011: 101,101,951 shares.

 
 

 

OCWEN FINANCIAL CORPORATION

FORM 10-Q

INDEX
 


   
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57
 
 
 
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. All statements, other than statements of historical fact included in this report, including, without limitation, statements regarding our financial position, business strategy and other plans and objectives for our future operations, are forward-looking statements.

These forward-looking statements include declarations regarding our management’s beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “intend,” “consider,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict” or “continue” or the negative of such terms or other comparable terminology. Such statements are not guarantees of future performance as they are subject to certain assumptions, inherent risks and uncertainties in predicting future results. Important factors that could cause actual results to differ materially include, but are not limited to, the following:

 
·
our sources of liquidity; our ability to fund and recover advances, repay borrowings, and comply with debt covenants; and the adequacy of financial resources;
     
 
·
servicing portfolio characteristics, including prepayment speeds, float balances, delinquency and advances rates;
     
 
·
our ability to grow or otherwise adapt our business, including the availability of new servicing opportunities and joint ventures;
     
 
·
our ability to reduce our cost structure;
     
 
·
our ability to successfully modify delinquent loans, manage foreclosures and sell foreclosed properties;
     
 
·
our reserves, valuations, provisions and anticipated realization on assets;
     
 
·
our ability to effectively manage our exposure to interest rate changes and foreign exchange fluctuations;
     
 
·
our credit and servicer ratings and other actions from various rating agencies;
     
 
·
uncertainty related to general economic and market conditions, delinquency rates, home prices and real-estate owned disposition timelines;
     
 
·
uncertainty related to the actions of loan owners, including mortgage-backed securities investors, regarding loan putbacks or legal actions;
     
 
·
uncertainty related to the processes for judicial and non-judicial foreclosure proceedings , including potential additional costs or delays or moratoria in the future or claims pertaining to past practices;
     
 
·
uncertainty related to litigation or dispute resolution and inquiries from government agencies into past servicing and foreclosure practices;
     
 
·
uncertainty related to legislation, regulations, regulatory agency actions, government programs and policies, industry initiatives and evolving best servicing practices; and
     
 
·
uncertainty related to acquisitions.

Further information on the risks specific to our business is detailed within this report and our other reports and filings with the Securities and Exchange Commission (SEC) including our Annual Report on Form 10-K for the year ended December 31, 2010, 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 were 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

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
(Dollars in thousands, except share data)
 
   
September 30,
2011
   
December 31,
2010
 
Assets
           
Cash
  $ 152,037     $ 127,796  
Restricted cash – for securitization investors
    910       727  
Loans held for resale, at lower of cost or fair value
    21,933       25,803  
Advances
    118,872       184,833  
Match funded advances
    3,756,834       1,924,052  
Loans, net – restricted for securitization investors
    60,389       67,340  
Mortgage servicing rights
    299,717       193,985  
Receivables, net
    53,141       69,518  
Deferred tax assets, net
    138,483       138,716  
Goodwill
    57,380       12,810  
Premises and equipment, net
    28,376       5,475  
Investments in unconsolidated entities
    23,364       12,072  
Other assets
    185,739       158,282  
Total assets
  $ 4,897,175     $ 2,921,409  
                 
Liabilities and Equity
               
Liabilities
               
Match funded liabilities
  $ 3,080,228     $ 1,482,529  
Secured borrowings – owed to securitization investors
    55,323       62,705  
Lines of credit and other secured borrowings
    555,110       246,073  
Servicer liabilities
    4,417       2,492  
Debt securities
    82,554       82,554  
Other liabilities
    141,600       140,239  
Total liabilities
    3,919,232       2,016,592  
                 
Commitments and Contingencies (Note 22)
               
                 
Equity
               
Ocwen Financial Corporation stockholders’ equity
               
Common stock, $.01 par value; 200,000,000 shares authorized; 101,093,217 and 100,726,947 shares issued and outstanding at  September 30, 2011 and December 31, 2010, respectively
    1,011       1,007  
Additional paid-in capital
    470,862       467,500  
Retained earnings
    514,136       445,456  
Accumulated other comprehensive loss, net of income taxes
    (8,307 )     (9,392 )
Total Ocwen Financial Corporation (OCN) stockholders’ equity
    977,702       904,571  
Non-controlling interest in subsidiaries
    241       246  
Total equity
    977,943       904,817  
Total liabilities and equity
  $ 4,897,175     $ 2,921,409  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
3

 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
 
For the periods ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
Revenue
                       
Servicing and subservicing fees
  $ 112,611     $ 86,424     $ 310,953     $ 218,840  
Process management fees
    9,215       7,911       26,151       24,132  
Other revenues
    636       1,234       2,201       4,136  
Total revenue
    122,462       95,569       339,305       247,108  
                                 
Operating expenses
                               
Compensation and benefits
    29,067       43,886       59,107       69,752  
Amortization of mortgage servicing rights
    11,210       7,874       30,059       22,103  
Servicing and origination
    1,969       1,707       5,192       4,756  
Technology and communications
    8,529       6,727       21,774       18,582  
Professional services
    5,075       25,132       10,729       37,521  
Occupancy and equipment
    6,720       5,201       15,003       13,517  
Other operating expenses
    3,080       2,847       7,239       6,978  
Total operating expenses
    65,650       93,374       149,103       173,209  
                                 
Income from operations
    56,812       2,195       190,202       73,899  
                                 
Other income (expense)
                               
Interest income
    2,186       2,962       6,644       8,507  
Interest expense
    (27,658 )     (24,187 )     (87,014 )     (50,017 )
Loss on trading securities
          (3,013 )           (3,958 )
Loss on loans held for resale, net
    (1,011 )     (539 )     (3,531 )     (2,626 )
Equity in (loss) earnings of unconsolidated entities
    (140 )     266       (690 )     1,344  
Other, net
    (1,238 )     1,604       (1,135 )     (3,154 )
Other expense, net
    (27,861 )     (22,907 )     (85,726 )     (49,904 )
                                 
Income (loss) from continuing operations before taxes
    28,951       (20,712 )     104,476       23,995  
Income tax expense (benefit)
    8,730       (7,487 )     35,808       310  
Income (loss) from continuing operations
    20,221       (13,225 )     68,668       23,685  
Income from discontinued operations, net of taxes
          4,383             4,383  
Net income (loss)
    20,221       (8,842 )     68,668       28,068  
Net loss (income) attributable to non-controlling interests
    7       7       12       (5 )
Net income (loss) attributable to OCN
  $ 20,228     $ (8,835 )   $ 68,680     $ 28,063  
                                 
Basic earnings per share
                               
Income (loss) from continuing operations
  $ 0.20     $ (0.13 )   $ 0.68     $ 0.24  
Income from discontinued operations
          0.04             0.04  
Net income (loss) attributable to OCN
  $ 0.20     $ (0.09 )   $ 0.68     $ 0.28  
                                 
Diluted earnings per share
                               
Income (loss) from continuing operations
  $ 0.19     $ (0.13 )   $ 0.64     $ 0.23  
Income from discontinued operations
          0.04             0.04  
Net income (loss) attributable to OCN
  $ 0.19     $ (0.09 )   $ 0.64     $ 0.27  
                                 
Weighted average common shares outstanding
                               
Basic
    101,016,777       100,329,915       100,908,473       100,159,547  
Diluted
    108,273,444       100,329,915       108,067,981       107,379,725  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
4

 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)

For the periods ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net income (loss)
  $ 20,221     $ (8,842 )   $ 68,668     $ 28,068  
                                 
Other comprehensive income (loss), net of income taxes:
                               
                                 
Unrealized foreign currency translation income (loss ) arising during the period (1)
    (16 )     54       10       (31 )
                                 
Change in deferred loss on cash flow hedges arising during the period (2)
    460       (5,835 )     227       (13,239 )
Reclassification adjustment for losses on cash flow hedges included in net income (3)
    105       268       828       289  
Net change in deferred loss on cash flow hedges
    565       (5,567 )     1,055       (12,950 )
                                 
Other (4)
    24             27        
                                 
Total other comprehensive income (loss),  net of income taxes
    573       (5,513 )     1,092       (12,981 )
                                 
Comprehensive income (loss)
    20,794       (14,355 )     69,760       15,087  
                                 
Comprehensive income (loss) attributable to non-controlling interests
    10       (11 )     5       1  
                                 
Comprehensive income (loss) attributable to Ocwen Financial Corporation
  $ 20,804     $ (14,366 )   $ 69,765     $ 15,088  
 
(1)
Net of income tax (expense) benefit of $2 and $(8) for the three months ended September 30, 2011 and 2010, respectively, and $(7) and $27 for the nine months ended September 30, 2011 and 2010, respectively.

(2)
Net of income tax (expense) benefit of $(260) and $3,428 for the three months ended September 30, 2011 and 2010, respectively, and $(102) and $7,775 for the nine months ended September 30, 2011 and 2010, respectively.

(3)
Net of income tax expense of $59 and $158 for the three months ended September 30, 2011 and 2010, respectively, and $468 and $169 for the nine months ended September 30, 2011 and 2010, respectively.

(4)
Net of income tax expense of $9 and $10 for the three and nine months ended September 30, 2011, respectively.
 
The accompanying notes are an integral part of these consolidated financial statements.
 
5

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
(Dollars in thousands)
 
   
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, 2010
    100,726,947     $ 1,007     $ 467,500     $ 445,456     $ (9,392 )   $ 246     $ 904,817  
Net income (loss)
                      68,680             (12 )     68,668  
Exercise of common stock options
    354,906       4       966                         970  
Equity-based compensation
    11,364             2,396                         2,396  
Other comprehensive income, net of income taxes
                            1,085       7       1,092  
Balance at September 30, 2011
    101,093,217     $ 1,011     $ 470,862     $ 514,136     $ (8,307 )   $ 241     $ 977,943  
 
   
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
                      28,063             5       28,068  
Exercise of common stock options
    502,026       5       2,495                         2,500  
Issuance of common stock awards to employees
    9,865                                      
Equity-based compensation
    7,654             2,968                         2,968  
Other comprehensive loss, net of income taxes
                            (12,975 )     (6 )     (12,981 )
Balance at September 30, 2010
    100,476,378     $ 1,005     $ 465,005     $ 435,535     $ (13,104 )   $ 251     $ 888,692  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
6

 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Dollars in thousands)
 
   
For the nine months ended
September 30,
 
   
2011
   
2010
 
Cash flows from operating activities
           
Net income
  $ 68,668     $ 28,068  
Adjustments to reconcile net income to net cash provided by operating activities
               
Amortization of mortgage servicing rights
    30,059       22,103  
Amortization of debt discount
    8,101       3,390  
Amortization of debt issuance costs – senior secured term loan
    8,888       497  
Depreciation
    1,974       1,434  
Write-off of investment in commercial real estate property
          3,000  
Reversal of valuation allowance on mortgage servicing assets
    (868 )     (185 )
Loss on trading securities
          3,958  
Loss on loans held for resale, net
    3,531       2,626  
Equity in loss (earnings) of unconsolidated entities
    690       (1,344 )
Unrealized losses on derivative financial instruments
    4,743       442  
Gain on extinguishment of debt
    (3,651 )     (152 )
Increase in deferred tax assets, net
    (354 )     (421 )
Net cash provided by trading activities
          168,853  
Net cash provided by loans held for resale activities
    1,050       1,163  
Changes in assets and liabilities:
               
Decrease in advances and match funded advances
    699,516       204,343  
Increase in receivables and other assets, net
    (5,349 )     (20,382 )
Increase (decrease) in servicer liabilities
    1,925       (36,304 )
(Decrease) increase in other liabilities
    (23,341 )     44,912  
Other, net
    8,039       8,581  
Net cash provided by operating activities
    803,621       434,582  
                 
Cash flows from investing activities
               
Cash paid to acquire Litton Loan Servicing LP
    (2,646,486 )      
Cash paid to acquire HomEq Servicing (a business within Barclays Bank PLC)
          (1,167,122 )
Purchase of mortgage servicing rights
          (23,425 )
Acquisition of advances and other assets in connection with the purchase of mortgage servicing rights
          (528,882 )
Distributions of capital from unconsolidated entities – Ocwen Structured Investments, LLC, Ocwen Nonperforming Loans, LLC and Ocwen REO, LLC
    2,415       3,542  
Investment in unconsolidated entity – Correspondent One S.A.
    (15,000 )      
Additions to premises and equipment
    (1,236 )     (3,261 )
Proceeds from sales of real estate
    1,448       3,001  
(Increase) decrease in restricted cash – for securitization investors
    (183 )     813  
Principal payments received on loans – restricted for securitization investors
    4,610       3,558  
Net cash used by investing activities
    (2,654,432 )     (1,711,776 )
                 
Cash flows from financing activities
               
Proceeds from match funded liabilities
    1,597,699       1,140,655  
Repayment of secured borrowings – owed to securitization investors
    (7,382 )     (7,487 )
Proceeds from lines of credit and other secured borrowings
    563,500       448,316  
Repayment of lines of credit and other secured borrowings
    (266,275 )     (63,018 )
Payment of debt issuance costs – senior secured term loan
    (12,070 )      
Repayment of investment line
          (156,968 )
Repurchase of debt securities
          (11,659 )
Exercise of common stock options
    1,285       2,381  
Other
    (1,705 )     (2,034 )
Net cash provided by financing activities
    1,875,052       1,350,186  
Net increase in cash
    24,241       72,992  
Cash at beginning of period
    127,796       90,919  
Cash at end of period
  $ 152,037     $ 163,911  
                 
Supplemental business acquisition information
               
Fair value of assets acquired
               
Cash
  $ (23,791 )   $  
Advances
    (2,468,137 )     (1,062,873 )
Mortgage servicing rights
    (135,341 )     (84,683 )
Premises and equipment
    (24,224 )     (8,008 )
Goodwill
    (44,570 )     (19,457 )
Receivables
          (1,423 )
Other assets
    (5,829 )      
      (2,701,892 )     (1,176,444 )
Fair value of liabilities assumed
               
Other liabilities
    31,615       9,322  
Cash paid
    (2,670,277 )     (1,167,122 )
Less: Cash acquired
    23,791        
Net cash paid
  $ (2,646,486 )   $ (1,167,122 )
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
7

 
 
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(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 Atlanta, Georgia with offices in West Palm Beach, Florida, Orlando, Florida, the District of Columbia and support 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 September 30, 2011, 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 49% equity interest in Correspondent One S.A. (Correspondent One), an entity formed with Altisource Portfolio Solutions S.A. (Altisource) in March 2011, 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).

On September 1, 2011, Ocwen completed its acquisition (the Litton Acquisition) of (i) all the outstanding partnership interests of Litton Loan Servicing LP (Litton), a subsidiary of The Goldman Sachs Group, Inc. (Goldman Sachs) and a provider of servicing and subservicing of primarily non-prime residential mortgage loans and (ii) certain interest-only servicing securities (the Litton IO Strips) previously owned by Goldman Sachs & Co., also a subsidiary of Goldman Sachs (collectively referred to as Litton Loan Servicing Business). See Note 3 for additional information regarding the Litton Acquisition.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in conformity with the instructions of the Securities and Exchange Commission (SEC) to Form 10-Q and SEC Regulation S-X, Article 10, Rule 10-01 for interim financial statements. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. In our opinion, the accompanying unaudited financial statements contain all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation. The results of operations and other data for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for any other interim period or for the entire year ending December 31, 2011. The unaudited interim consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

The preparation of financial statements in conformity with GAAP requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates. Material estimates that are particularly significant relate to our fair value measurements, the provision for potential estimates that may arise from litigation proceedings, the amortization of mortgage servicing rights (MSRs) and the valuation of goodwill and deferred tax assets.

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 50% or less of the voting securities. We account for our investments in OSI, ONL, OREO and Correspondent One using the equity method. 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.

 
8

 
 
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. We have continuing involvement with the financial assets of eight of the securitizations and three of the 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 subsequently acquired.

For four of these trusts, we have determined that our involvement represents a variable interest and that we are the primary beneficiary. We have included these four trusts in our consolidated financial statements. Our involvement with each of the remaining trusts does not represent a variable interest, and therefore, we exclude them from our consolidated financial statements.

For the three months ended September 30, 2011 and 2010, the four consolidated trusts generated income from continuing operations before income taxes of $697 and $1,312, respectively. For the nine months ended September 30, 2011 and 2010, these trusts generated income from continuing operations before income taxes of $664 and $1,646, respectively. See Note 7 and Note 12 for additional information regarding Loans – restricted for securitization investors and Secured borrowings – owed to securitization investors.

The following table presents a summary of the involvement of Ocwen with unconsolidated securitization trusts and summary financial information for the trusts where we are the transferor and hold beneficial interests. Although we are the servicer for these trusts, the residual interests that we hold in these entities have no value and no potential return of significant cash flows. As a result, we are not exposed to loss from these holdings. Further, since our valuation of the residual interest is based on anticipated cash flows, we are unlikely to receive any future benefits from our residual interests in these trusts.
 
For the periods ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
Total servicing and subservicing fee revenues
  $ 772     $ 947     $ 2,342     $ 2,820  

   
As of
 
   
September 30, 2011
   
December 31, 2010
 
             
Total servicing advances
  $ 13,015     $ 16,886  
Total MSRs at amortized cost
    1,200       1,330  
 
With regard to both the consolidated and the unconsolidated securitization trusts, we have no obligation to provide financial support to the trusts and have 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 MSRs 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. At September 30, 2011 and December 31, 2010, our investment in the securities of the trusts was $2,508 and $2,691, respectively, all of which is eliminated in consolidation. See Note 5 and Note 8 for additional information regarding Advances and Mortgage servicing rights.

 
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Financings of 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 three advance facility agreements. We 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 July 1, 2013. As of September 30, 2011, OSAFW had $194,534 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:
 
   
September 30, 2011
   
December 31, 2010
 
Match funded advances
  $ 3,756,832     $ 1,924,052  
Other assets
    134,121       103,448  
Total assets
  $ 3,890,953     $ 2,027,500  
                 
Match funded liabilities
  $ 3,080,228     $ 1,482,529  
Due to affiliates (1)
    865,159       262,900  
Other liabilities
    2,665       2,890  
Total liabilities
  $ 3,948,052     $ 1,748,319  

(1)
Amounts are payable to Ocwen and its consolidated affiliates and eliminated in consolidation.

See Note 6 and Note 11 for additional information regarding Match funded advances and Match funded liabilities.

Reclassification

Within the operating activities section of the Consolidated Statement of Cash Flows for the nine months ended September 30, 2010, we made the following reclassifications to conform to the 2011 presentation:

 
·
reclassified the components of Depreciation and other amortization to the Amortization of debt discount and the Depreciation line items;
     
 
·
reclassified Amortization of debt issuance costs – senior secured term loan from Increase in receivables and other assets, net; and
     
 
·
reclassified Gain on extinguishment of debt and Unrealized losses on derivative financial instruments from Other, net.

NOTE 2 RECENT ACCOUNTING PRONOUNCEMENTS

Accounting Standards Update (ASU) 2011-02 (ASC 310, Receivables): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. This additional guidance will assist creditors in determining whether a restructuring or modification of a receivable meets the criteria to be considered a troubled debt restructuring. If the restructuring is considered a troubled debt restructuring, creditors are required to make certain disclosures in their financial statements. In addition, the calculation of the allowance for credit losses for that receivable follows the impairment guidance specific to impaired receivables. Our adoption of this standard on July 1, 2011 did not have a material impact on our consolidated financial statements.

ASU 2011-03 (ASC 860, Transfers and Servicing): Reconsideration of Effective Control for Repurchase Agreements . ASC 860 prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets. Repurchase agreements are accounted for as secured financings if the transferee has not surrendered control over the transferred assets. The amendments in this ASU remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. The Financial Accounting Standards Board (FASB) concluded that this criterion is not a determining factor of effective control. Consequently, the amendments in this update also eliminate the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets.

 
10

 
 
The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. We do not expect our adoption of the provisions in this ASU to have a material impact on our consolidated financial statements.

ASU 2011-04 (ASC 820, Fair Value Measurement): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs . The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments clarify FASB’s intent about the application of existing fair value measurement and disclosure requirements and prescribe certain additional disclosures about fair value measurements, including: for fair value measurements within Level 3 of the fair value hierarchy, disclosing the valuation process used and the sensitivity of fair value measurement to changes in unobservable inputs; and for items not carried at fair value but for which fair value must be disclosed, categorization by level of the fair value hierarchy. The provisions of this ASU are effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. We do not anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.

ASU 2011-05 (ASC 220, Comprehensive Income): Presentation of Comprehensive Income , Current U.S. GAAP allows reporting entities three alternatives for presenting other comprehensive income and its components in financial statements. One of those presentation options is to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU eliminates that option. This ASU also requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2011. Our adoption of this standard will not have a material impact on our consolidated financial statements.

ASU 2011-08 (ASC 350, Intangibles – Goodwill and Other): Testing Goodwill for Impairment. With this ASU, the FASB has taken action to reduce the cost and complexity of the annual goodwill impairment test by providing reporting entities with the option of performing a “qualitative” assessment of impairment to determine if any further quantitative testing for impairment may be necessary. An entity can choose to apply the qualitative assessment to all, some or none of its reporting units. The ASU is effective for reporting periods beginning after December 15, 2011; however, an entity can early adopt the revised standard even if its annual impairment test date is before September 15, 2011, the date that the ASU was issued. We intend to early adopt the revised standard during the fourth quarter of 2011. We do not anticipate that the adoption of the standard will have a material impact on our consolidated financial statements.

NOTE 3 ACQUISITION

As disclosed in Note 1, Ocwen completed its acquisition of the Litton Loan Servicing Business on September 1, 2011. The transaction was completed in accordance with the provisions of the Purchase Agreement (the Agreement) between Ocwen and Goldman Sachs dated June 5, 2011.

Ocwen completed the acquisition in order to expand its Servicing segment. The Litton Acquisition resulted in the acquisition by Ocwen of a servicing portfolio of approximately 245,000 primarily non-prime residential mortgage loans with approximately $38.6 billion in unpaid principal balance (UPB) and the servicing platform of Litton Loan Servicing Business based in Houston, Texas and McDonough, Georgia.

The base purchase price for the Litton Acquisition was $247,154, which was paid in cash by Ocwen at closing. In addition, Ocwen repaid at closing Litton’s $2,423,123 outstanding debt on an existing servicing advance financing facility that was provided by an affiliate of the Goldman Sachs and entered into a new advance financing facility under which it borrowed $2,126,742 from Goldman Sachs. On September 1, 2011, Ocwen and certain of its subsidiaries also entered into a $575,000 senior secured term loan facility agreement to fund the base purchase price and the amount by which the repayment of Litton’s advance financing facility debt exceeded the proceeds from the new advance financing facility. Borrowings under the senior secured term loan facility are net of an original issue discount of $11,500, which is being amortized over the life of the loan. See Note 11 and Note 13 for additional details of the new advance financing facility and the senior secured term loan.

The purchase price was based in part on estimated closing-date measurements specified in the Agreement and may be further adjusted as these estimated closing-date measurements are finalized.

The actual base purchase price is subject to additional post-closing adjustments for a period of 60 days as a result of certain adjustments specified in the Agreement such as for changes in Litton’s estimated closing date net worth, servicing portfolio UPB and advance balances, among others.

 
11

 
The transaction has been accounted for using the acquisition method of accounting which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The following table summarizes the preliminary estimate of the fair values of assets acquired and liabilities assumed as part of the Litton Acquisition:
 
Cash
  $ 23,791  
Advances
    2,468,137  
MSRs
    135,341  
Premises and equipment, net
    24,224  
Other assets
    5,829  
Other liabilities
    (31,615 )
Total identifiable net assets
    2,625,707  
Goodwill
    44,570  
Total consideration
    2,670,277  
Litton debt repaid to Goldman Sachs at closing
    (2,423,123 )
Base purchase price
  $ 247,154  
 
Consistent with our fair value policy for MSRs as disclosed in Note 4, we estimated the fair value of the MSRs by calculating the present value of expected future cash flows utilizing assumptions that we believe are used by market participants. The Litton IO Strips that Ocwen acquired and holds are entitled to a portion of the servicing revenues from the securitization trusts to which they relate. However, Ocwen has relinquished the rights to these revenues to the holder of the MSRs. As a result, the MSRs include the right to all the servicing revenues from those securitization trusts, and we have estimated the fair values of the related MSRs on that basis.

The valuation of premises and equipment was based on the in-use valuation premise, where the fair value of an asset is based on the highest and best use of the asset that would provide maximum value to market participants principally through its use with other assets as a group. This valuation presumes the continued operation of the Litton Loan Servicing Business platform as installed or otherwise configured for use.

Advances are non-interest bearing receivables that are expected to have a short average collections period and were, therefore, valued at their face amount, consistent with Ocwen’s fair value policy for servicing advances. Other assets and liabilities that are expected to have a short life were also valued at the face value of the specific assets and liabilities purchased, including receivables, prepaid expenses, accounts payable and accrued expenses.

Goodwill is calculated as the excess of the consideration transferred over the net assets recognized and represents the expected revenue and cost synergies of the combined business. The goodwill portion of the purchase price allocation shown in the table above pertains to the Servicing segment and is subject to adjustment as the fair value of certain other components of the purchase price are adjusted. All components of the purchase price allocation are considered preliminary. We anticipate finalizing the purchase price allocations by December 31, 2011. Potential changes in advances, premises and equipment and goodwill could be significant. If certain of the acquired premises and equipment are not used in the future, they may be written down to their estimated liquidation value. Ocwen is considering subleasing office space acquired as part of the Litton Acquisition. Further changes to the opening balance of advances will result in a cash exchange between Ocwen and Goldman Sachs and, as such, should not result in any change to goodwill.

The acquisition of Litton is treated as an asset acquisition for U.S. tax purposes. We expect the opening tax basis for the acquired assets and liabilities to be the fair value as shown in the table above. We expect the MSRs and goodwill to be treated as intangible assets acquired in connection with the purchase of a trade or business and as such, amortized over 15 years for tax purposes.

Additionally, the Agreement provides that the severance plans of Litton and the Goldman Sachs remain in effect for one year. We recognized severance expense of $3,913 during the third quarter as steps taken to reorganize and streamline the operations of Litton obligated Ocwen to pay severance under those plans. Severance expense is included in Compensation and benefits in our Consolidated Statements of Operations.

In connection with the establishment of the match funded advance facility Ocwen funded a reserve in the initial amount of $42,535 which is held by the facility Indenture Trustee for the benefit of the note holders. Ocwen also paid Barclays an $11,500 arrangement fee in connection with the senior secured term loan agreement. This fee along with the discount and certain other professional fees incurred in connection with the establishment of the facility are being amortized over the five-year life of the loan.

 
12

 
 
As part of the Litton Acquisition, Goldman Sachs and Ocwen have agreed to indemnification provisions for the benefit of the other party. Additionally, Goldman Sachs has agreed to retain certain contingent liabilities for fines and penalties that could potentially be imposed by certain government authorities relating to Litton’s pre-closing foreclosure and servicing practices. Further, Goldman Sachs and Ocwen have agreed to share certain losses arising out of third-party claims in connection with Litton’s pre-closing performance under its servicing agreements. Goldman Sachs has agreed to be liable for (i) 80% of any such losses until the amount paid by Goldman Sachs is equal to 80% of the Goldman Shared Loss Cap and (ii) thereafter, 20% of any such losses until the amount paid by Goldman Sachs is equal to the Goldman Shared Loss Cap. Ocwen has agreed to be liable for (i) 20% of any such losses until the amount paid by Ocwen is equal to 20% of the Goldman Shared Loss Cap, (ii) thereafter, 80% of any such losses until the amount paid by Ocwen is equal to the Goldman Shared Loss Cap and (iii) thereafter, 100% of any such losses in excess of the Goldman Shared Loss Cap. The “Goldman Shared Loss Cap” is currently approximately $123,577 or 50% of the adjusted purchase price of the Litton Acquisition, but which may be further adjusted after final reconciliations of the purchase price are made.

In connection with the Litton Acquisition, Ocwen, Goldman Sachs Bank USA, Litton and the New York State Banking Department have entered into an agreement (the NY Agreement) that sets forth certain loan servicing practices and operational requirements. No fines, penalties or other payments were assessed against Ocwen or Litton under the terms of the NY Agreement. We do not believe that our commitments under the NY Agreement will have a material impact on our financial statements.

Actual and Pro forma impact of the Litton Acquisition

The following table presents the revenue and earnings of the Litton Loan Servicing Business that is included in our Consolidated Statement of Operations from the acquisition date of September 1, 2011 through September 30, 2011:
 
Revenues
  $ 14,560  
Net loss (1)
  $ (10,107 )

(1)
Net loss includes non-recurring transaction related expenses of $18,431, including severance and other compensation of $12,933 related to Litton employees and $304 of fees for professional services related to the acquisition. Net loss also includes $2,276 of amortization of the acquired MSRs. Net loss does not include an allocation of costs related to the servicing of the Litton loans on Ocwen’s platform. We computed income taxes using a combined statutory rate of 36.12% for federal and state income taxes.

The following table presents supplemental pro forma information as if the Litton Acquisition had occurred on January 1, 2010. Pro forma adjustments include:

 
·
conforming revenues to the revenue recognition policy followed by Ocwen rather than the policy followed by Litton;
     
 
·
conforming the accounting for MSRs to the valuation and amortization policy of Ocwen rather than the policy followed by Litton;
     
 
·
reversing Litton depreciation and reporting depreciation based on the estimated fair values and remaining lives of the acquired premises and equipment at the date of acquisition;
     
 
·
adjusting interest expense to eliminate the pre-acquisition interest expense of Litton and to recognize interest expense as if the acquisition-related debt of Ocwen had been outstanding at January 1, 2010; and
     
 
·
reporting acquisition-related charges, including severance paid to Litton employees and fees for professional services related to the acquisition as if they had been incurred in 2010 rather than 2011.

The pro forma consolidated results are not indicative of what Ocwen’s consolidated net earnings would have been had Ocwen completed the Litton Acquisition on January 1, 2010 because of differences in servicing practices and cost structure between Ocwen and Litton. In addition, the pro forma consolidated results do not purport to project the future results of Ocwen combined nor do they reflect the expected realization of any cost savings associated with the Litton Acquisition.
 
Periods ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
Revenues
  $ 155,420     $ 160,308     $ 485,408     $ 455,016  
Net income (loss)
  $ 6,792     $ (28,468 )   $ 10,019     $ (16,770 )
 
Through September 30, 2011, we have incurred approximately $1,100 of fees for professional services related to the Litton Acquisition which are included in Operating expenses.

 
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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:
 
   
September 30, 2011
   
December 31, 2010
 
   
Carrying Value
   
Fair Value
   
Carrying Value
   
Fair Value
 
Financial assets:
                       
Loans held for resale
  $ 21,933     $ 21,933     $ 25,803     $ 25,803  
Loans, net – restricted for securitization investors
    60,389       56,789       67,340       64,795  
Advances
    3,875,706       3,875,706       2,108,885       2,108,885  
Receivables, net
    53,141       53,141       69,518       69,518  
Financial liabilities:
                               
Match funded liabilities
  $ 3,080,228     $ 3,096,522     $ 1,482,529     $ 1,486,476  
Lines of credit and other secured borrowings
    555,110       566,353       246,073       252,722  
Secured borrowings – owed to securitization investors
    55,323       54,280       62,705       62,105  
Servicer liabilities
    4,417       4,417       2,492       2,492  
Debt securities
    82,554       89,534       82,554       75,325  
Derivative financial instruments, net
  $ (18,389 )   $ (18,389 )   $ (15,351 )   $ (15,351 )
 
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.

The following table presents 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 September 30, 2011:
                       
Measured at fair value on a recurring basis:
                       
Derivative financial instruments, net (1)
  $ (18,389 )               $ (18,389 )
Measured at fair value on a non-recurring basis:
                               
Loans held for resale (2)
    21,933                   21,933  
MSRs (3)
    741                   741  
                                 
At December 31, 2010:
                               
Measured at fair value on a recurring basis:
                               
Derivative financial instruments, net (1)
  $ (15,351 )               $ (15,351 )
Measured at fair value on a non-recurring basis:
                               
Loans held for resale (2)
    25,803                   25,803  
MSRs (3)
    334                   334  

(1)
The derivative financial instruments are not exchange-traded and therefore quoted market prices or other observable inputs are not available. Fair value is based on certain assumptions provided by third-party pricing sources. See Note 15 for additional information on our derivative financial instruments.
 
 
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(2)
Loans held for resale are reported at the lower of cost or fair value. The fair value of loans for which we do not have a firm commitment to sell is based upon a discounted cash flow analysis with 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. All loans held for resale were measured at fair value because the cost exceeded the estimated fair value. At September 30, 2011 and December 31, 2010, the carrying value of loans held for resale is net of a valuation allowance of $14,407 and $14,611, respectively. Current market illiquidity has reduced the availability of observable pricing data. Consequently, we classify loans within Level 3 of the fair value hierarchy.
   
(3)
Balances represent the carrying value of the impaired stratum of MSRs, net of a valuation allowance of $1,996 and $2,864 at September 30, 2011 and December 31, 2010, respectively. The estimated fair value exceeded amortized cost for all other strata. See Note 8 for additional information on MSRs, including significant assumptions used in their valuation.

The following tables present a reconciliation of the changes in fair value of our Level 3 assets that we measure at fair value on a recurring basis for the periods indicated:
 
   
Derivative Financial Instruments
 
For the periods ended September 30, 2011:
 
Three months
   
Nine months
 
             
Beginning balance
  $ (15,787 )   $ (15,351 )
                 
Purchases, issuances, sales and settlements:
               
Purchases
           
Issuances
           
Sales
           
Settlements
    9       80  
      9       80  
                 
Total realized and unrealized gains and (losses) (1):
               
Included in Other, net
    (2,722 )     (3,970 )
Included in Other comprehensive income (loss)
    111       852  
      (2,611 )     (3,118 )
                 
Transfers in and / or out of Level 3
           
Ending balance
  $ (18,389 )   $ (18,389 )
 
 
15

 

 
         
Trading Securities
       
Three months ended September 30, 2010:
 
Derivative Financial Instruments
   
Auction Rate Securities
   
Subordinates and Residuals
   
Total
 
                         
Beginning balance
  $ (12,278 )   $ 78,073     $ 52     $ 65,847  
                                 
Purchases, issuances, sales and settlements:
                               
Purchases
                       
Issuances
                       
Sales
          (400 )           (400 )
Settlements
    58                   58  
      58       (400 )           (342 )
                                 
Total realized and unrealized gains and (losses) (1) (2):
                               
Included in Loss on trading securities
          (2,961 )     (52 )     (3,013 )
Included in Other, net
    (362 )                 (362 )
Included in Other comprehensive income (loss)
    (8,837 )                 (8,837 )
      (9,199 )     (2,961 )     (52 )     (12,212 )
                                 
Transfers in and / or out of Level 3
                       
Ending balance
  $ (21,419 )   $ 74,712     $     $ 53,293  

         
Trading Securities
       
Nine months ended September 30, 2010:
 
Derivative Financial Instruments
   
Auction Rate Securities
   
Subordinates and Residuals
   
Total
 
                         
Beginning balance
  $ (45 )   $ 247,464     $ 59     $ 247,478  
                                 
Purchases, issuances, sales and settlements:
                               
Purchases
                       
Issuances
                       
Sales
          (75,508 )           (75,508 )
Settlements
    134       (93,345 )           (93,211 )
      134       (168,853 )           (168,719 )
                                 
Total realized and unrealized gains and (losses) (1) (2):
                               
Included in Loss on trading securities
          (3,899 )     (59 )     (3,958 )
Included in Other, net
    (952 )                 (952 )
Included in Other comprehensive income (loss)
    (20,556 )                 (20,556 )
      (21,508 )     (3,899 )     (59 )     (25,466 )
                                 
Transfers in and / or out of Level 3
                       
Ending balance
  $ (21,419 )   $ 74,712     $     $ 53,293  

(1)
Total net losses attributable to derivative financial instruments for the three and nine months ended September 30, 2011 include losses of $2,611 and $2,900, respectively, on derivatives held at September 30, 2011. Net losses attributable to derivative financial instruments for the three and nine months ended September 30, 2010 include losses of $9,140 and $21,373, respectively, on derivatives held at September 30, 2010.
   
(2)
Total net losses on trading securities for the three and nine months ended September 30, 2010 include unrealized gains (losses) of $(2,417) and $13,298, respectively, on auction rate securities held at September 30, 2010.
 
 
16

 

NOTE 5 ADVANCES

Advances, representing payments made on behalf of borrowers or on foreclosed properties, consisted of the following at the dates indicated:
 
   
September 30,
2011
   
December 31,
2010
 
Servicing:
           
Principal and interest
  $ 45,133     $ 82,060  
Taxes and insurance
    32,049       49,785  
Foreclosure and bankruptcy costs
    12,588       27,163  
Other
    25,177       21,701  
      114,947       180,709  
Corporate Items and Other
    3,925       4,124  
    $ 118,872     $ 184,833  
 
Servicing advances of $75,489 were pledged as collateral under the term reimbursement advance borrowing as of December 31, 2010. See Note 13 for additional information regarding the fee reimbursement advance facility.

NOTE 6 MATCH FUNDED ADVANCES

Match funded advances on residential loans we service for others, as more fully described in Note 1—Principles of Consolidation-Financings of Advances on Loans Serviced for Others, are comprised of the following at the dates indicated:
 
   
September 30,
2011
   
December 31,
2010
 
Principal and interest
  $ 1,841,536     $ 947,990  
Taxes and insurance
    1,388,320       684,928  
Foreclosure and bankruptcy costs
    299,243       140,181  
Real estate servicing costs
    111,710       116,064  
Other
    116,025       34,889  
    $ 3,756,834     $ 1,924,052  
 
NOTE 7 LOANS – RESTRICTED FOR SECURITIZATION INVESTORS

Loans – restricted for securitization investors are held by four securitization trusts that we include in our consolidated financial statements, as more fully described in Note 1—Securitizations of Residential Mortgage Loans. Loans – restricted for securitization investors consisted of the following at:
 
   
September 30,
2011
   
December 31,
2010
 
Single family residential loans (1)
  $ 62,673     $ 69,718  
Allowance for loans losses
    (2,284 )     (2,378 )
    $ 60,389     $ 67,340  

(1)
Includes nonperforming loans of $12,671 and $12,933 at September 30, 2011 and December 31, 2010, respectively.

At September 30, 2011, the trusts held 1,447 loans that are secured by first or second liens on one- to four-family residential properties. These loans have a weighted average coupon rate of 9.19% and a weighted average remaining life of 130 months.

 
17

 
 
NOTE 8 MORTGAGE SERVICING RIGHTS

Servicing Assets. The following table summarizes the activity in the carrying value of residential servicing assets for the nine months ended September 30, 2011:
 
Balance at December 31, 2010
  $ 193,985  
Purchases (1)
    135,341  
Decrease in impairment valuation allowance
    868  
Amortization (2)
    (30,477 )
Balance at September 30, 2011
  $ 299,717  

(1)
Purchases represent the MSRs acquired as a part of the Litton Acquisition.
   
(2)
In the Consolidated Statement of Operations, Amortization of mortgage servicing rights is reported net of the amortization of servicing liabilities and includes the amount of charges we recognized to increase servicing liability obligations.

The following table presents the composition of our servicing and subservicing portfolios by type of property serviced as measured by UPB. The servicing portfolio represents purchased MSRs while subservicing generally represents all other MSRs.
 
    Residential     Commercial     Total  
UPB of Assets Serviced:
                       
September 30, 2011:
                       
Servicing
  $ 80,518,944     $     $ 80,518,944  
Subservicing
    25,607,224       311,624       25,918,848  
    $ 106,126,168     $ 311,624     $ 106,437,792  
December 31, 2010:
                       
Servicing
  $ 51,252,380     $     $ 51,252,380  
Subservicing
    22,634,011       434,305       23,068,316  
    $ 73,886,391     $ 434,305     $ 74,320,696  
 
MSRs are an intangible asset representing the right to service a portfolio of mortgage loans. We generally obtain MSRs by purchasing them from the owners of the mortgage loans. Residential assets serviced consist principally of mortgage loans, primarily subprime, but also include foreclosed real estate. Commercial assets serviced consist of foreclosed real estate. Assets serviced for others are not included on our Consolidated Balance Sheet.

Custodial accounts, which hold funds representing collections of principal and interest we receive from borrowers, are held in escrow by an unaffiliated bank and excluded from our Consolidated Balance Sheet. Custodial accounts amounted to approximately $540,500 and $320,300 at September 30, 2011 and December 31, 2010, respectively.

Valuation Allowance for Impairment. During 2008, we established a valuation allowance for impairment of $3,624 on the high-loan-to-value stratum of our MSRs as the estimated fair value was less than the carrying value. Changes in the valuation allowance for impairment are reflected in Servicing and origination expenses in our Consolidated Statement of Operations. Net of the current valuation allowance of $1,996, the carrying value of this stratum was $741 at September 30, 2011. For all other strata, the fair value was above the carrying value at September 30, 2011.

The estimated fair value of residential MSRs at September 30, 2011 and December 31, 2010 was $335,013 and $237,407, respectively. The more significant assumptions used in the September 30, 2011 valuation include prepayment speeds ranging from 11.8% to 24.2% (depending on loan type) and 90+ non-performing delinquency rates ranging from 18.5% to 32.1% (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%.

Servicing Liabilities. Servicing liabilities are included in Other liabilities. See Note 14 for additional information.

 
18

 
 
NOTE 9 RECEIVABLES

Receivables consisted of the following at the dates indicated:
 
   
Receivables
   
Allowance for Credit Losses
   
Net
 
September 30, 2011
                 
Servicing (1)
  $ 43,308     $ (1,084 )   $ 42,224  
Income taxes receivable
    5,969             5,969  
Affordable housing (2)
    5,617       (5,067 )