Ocwen Financial Corporation
OCWEN FINANCIAL CORP (Form: 10-Q, Received: 11/05/2013 06:01:27)
 

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, 2013

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 Exchange Act).

Yes o No x

Number of shares of Common Stock, $0.01 par value, outstanding as of October 31, 2013: 135,822,932  shares.

 
 

OCWEN FINANCIAL CORPORATION

FORM 10-Q

 

INDEX

 

         
PART I – FINANCIAL INFORMATION   PAGE
         
Item 1.   Financial Statements (unaudited)   3
         
    Consolidated Balance Sheets (unaudited) at September 30, 2013 and December 31, 2012   3
         
    Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012   4
         
    Consolidated Statements of Comprehensive Income (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012   5
         
    Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the Nine Months Ended September 30, 2013 and 2012   6
         
    Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2013 and 2012   7
         
    Notes to unaudited Consolidated Financial Statements   9
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   46
         
Item 3.   Quantitative and Qualitative Disclosures About Market Risk   69
         
Item 4.   Controls and Procedures   72
         
PART II – OTHER INFORMATION    
         
Item 1.   Legal Proceedings   73
         
Item 1A.   Risk Factors   73
         
Item 6.   Exhibits   73
         
Signatures   75
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 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,” “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 and involve a number of assumptions, risks and uncertainties that could cause actual results to differ materially from expected results. Important factors that could cause actual results to differ include, but are not limited to, the risks discussed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 and the following:

the adequacy of our financial resources, including our sources of liquidity and ability to fund and recover advances, repay borrowings and comply with debt covenants;
the characteristics of our servicing portfolio, including prepayment speeds along with delinquency and advance rates;
our ability to grow and adapt our business, including the availability of new loan servicing and other accretive business opportunities;
our ability to contain and reduce our operating costs;
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 disposition timelines on foreclosed properties;
uncertainty related to the actions of loan owners, including mortgage-backed securities investors and government sponsored entities (GSEs), regarding loan put-backs, penalties and 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 claims, litigation and investigations brought by private parties and government agencies regarding our servicing, foreclosure, modification and other practices;
uncertainty related to legislation, regulations, regulatory agency actions, government programs and policies, industry initiatives and evolving best servicing practices;
uncertainty related to acquisitions, including our ability to integrate the systems, procedures and personnel of acquired companies;
our ability to maintain our technology systems and our ability to adapt such systems for future operating environments;
failure of our internal security measures or breach of our privacy protections;
uncertainty related to the political or economic stability of foreign countries in which we have operations;
conflicts of interest with our officers and directors; and
the loss of the services of our senior managers.

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, 2012, 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 except for our ongoing obligations under the U.S. federal securities laws, we undertake no obligation to update or revise forward-looking statements whether as a result of new information, future events or otherwise .

2
 

PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

(Dollars in thousands, except share data)

 

    September 30,
2013
    December 31,
2012
 
Assets                
Cash   $ 357,486     $ 220,130  
Loans held for sale, at fair value     335,102       426,480  
Advances     946,287       184,463  
Match funded advances     533,725       3,049,244  
Mortgage servicing rights, at amortized cost     1,736,943       678,937  
Mortgage servicing rights, at fair value     96,938       85,213  
Receivables, net     223,404       137,713  
Deferred tax assets, net     93,343       92,136  
Goodwill and intangibles     407,620       412,866  
Premises and equipment, net     56,837       33,247  
Debt service accounts     45,462       88,748  
Other assets     478,533       273,578  
Total assets   $ 5,311,680     $ 5,682,755  
                 
Liabilities, Mezzanine Equity and Stockholders’ Equity Liabilities                
Match funded liabilities   $ 363,012     $ 2,532,745  
Other borrowings     2,592,591       1,096,679  
Other liabilities     554,708       288,537  
Total liabilities     3,510,311       3,917,961  
                 
Commitments and Contingencies (Note 25)                
                 
Mezzanine Equity                
Series A Perpetual Convertible Preferred stock, $.01 par value; 200,000 shares authorized; 62,000 and 162,000 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively; redemption value $62,000 plus accrued and unpaid dividends at September 30, 2013     59,945       153,372  
                 
Stockholders’ Equity                
Common stock, $.01 par value; 200,000,000 shares authorized; 135,822,932 and 135,637,932 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively     1,358       1,356  
Additional paid-in capital     864,723       911,942  
Retained earnings     882,412       704,565  
Accumulated other comprehensive loss, net of income taxes     (7,069 )     (6,441 )
Total stockholders’ equity     1,741,424       1,611,422  
Total liabilities, mezzanine equity and stockholders’ equity   $ 5,311,680     $ 5,682,755  

 

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

3
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(Dollars in thousands, except per share data)

    Three Months     Nine Months  
For the Periods Ended September 30,   2013     2012     2013     2012  
Revenue                                
Servicing and subservicing fees   $ 483,267     $ 223,011     $ 1,333,392     $ 578,435  
Gain on loans held for sale, net     28,262             72,912        
Other revenues     19,711       9,689       76,014       30,178  
Total revenue     531,240       232,700       1,482,318       608,613  
                                 
Operating expenses                                
Compensation and benefits     118,054       29,759       330,679       90,546  
Amortization of servicing rights     79,183       20,150       197,435       53,561  
Servicing and origination     34,236       9,838       89,740       18,988  
Technology and communications     38,809       11,608       102,698       31,999  
Professional services     19,090       5,241       99,228       19,743  
Occupancy and equipment     30,786       10,899       74,631       36,484  
Other operating expenses     26,102       5,298       66,007       13,489  
Total operating expenses     346,260       92,793       960,418       264,810  
                                 
Income from operations     184,980       139,907       521,900       343,803  
                                 
Other income (expense)                                
Interest income     5,379       2,084       17,330       6,434  
Interest expense     (110,055 )     (58,417 )     (303,339 )     (163,660 )
Gain (loss) on debt redemption     1,282       (653 )     (12,556 )     (653 )
Other, net     (5,311 )     (2,175 )     (8,215 )     (4,895 )
Other expense, net     (108,705 )     (59,161 )     (306,780 )     (162,774 )
                                 
Income before income taxes     76,275       80,746       215,120       181,029  
Income tax expense     9,273       29,346       26,250       65,447  
Net income     67,002       51,400       188,870       115,582  
Preferred stock dividends     (1,446 )           (4,450 )      
Deemed dividend related to beneficial conversion feature of preferred stock     (4,401 )           (6,573 )      
Net income attributable to Ocwen common stockholders   $ 61,155     $ 51,400     $ 177,847     $ 115,582  
                                 
Earnings per share attributable to Ocwen common stockholders                                
Basic   $ 0.45     $ 0.38     $ 1.31     $ 0.87  
Diluted   $ 0.44     $ 0.37     $ 1.27     $ 0.84  
                                 
                                 
Weighted average common shares outstanding                                
Basic     135,787,834       134,928,486       135,705,892       133,483,354  
Diluted     140,057,195       138,702,881       139,747,490       138,301,865  

 

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

4
 

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

 

    Three Months     Nine Months  
For the Periods Ended September 30,   2013     2012     2013     2012  
                         
Net income   $ 67,002     $ 51,400     $ 188,870     $ 115,582  
                                 
Other comprehensive income (loss), net of income taxes:                                
                                 
Unrealized foreign currency translation income (loss) arising during the period     30       (1)       707       (1)  
                                 
Change in deferred loss on cash flow hedges arising during the period (1)           (1,743 )     (7,537 )     (5,476 )
Reclassification adjustment for losses on cash flow hedges included in net income (2)     4,714       1,947       6,198       6,749  
Net change in deferred loss on cash flow hedges     4,714       204       (1,339 )     1,273  
                                 
Other     1       1       4       4  
                                 
Total other comprehensive income, net of income taxes     4,745       204       (628 )     1,276  
Comprehensive income   $ 71,747     $ 51,604     $ 188,242     $ 116,858  
                                 
(1) Net of income tax benefit of $0.9 million for the three months ended September 30, 2012 and $4.8 million and $3.1 million for the nine months ended September 30, 2013 and 2012, respectively.
(2) Net of income tax expense of $3.1 million and $1.1 million for the three months ended September 30, 2013 and 2012, respectively, and $3.9 million and $3.8 million for the nine months ended September 30, 2013 and 2012, respectively.

 

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

5
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Dollars in thousands)

 

    Common Stock     Additional
Paid-in
    Retained     Accumulated
Other
Comprehensive
Loss,
       
    Shares     Amount     Capital     Earnings     Net of Taxes     Total  
                                     
Balance at December 31, 2012     135,637,932     $ 1,356     $ 911,942     $ 704,565     $ (6,441 )   $ 1,611,422  
Net income                       188,870             188,870  
Preferred stock dividends ($27.92 per share)                       (4,450 )           (4,450 )
Deemed dividend related to beneficial conversion feature of preferred stock                       (6,573 )           (6,573 )
Conversion of Series A preferred stock     3,145,640       31       99,969                   100,000  
Repurchase of common stock     (3,145,640 )     (31 )     (157,849 )                 (157,880 )
Exercise of common stock options     172,969       2       (188 )                 (186 )
Equity-based compensation     12,031             10,849                   10,849  
Other comprehensive loss, net of income taxes                             (628 )     (628 )
Balance at September 30, 2013     135,822,932     $ 1,358     $ 864,723     $ 882,412     $ (7,069 )   $ 1,741,424  
                                                 
                                                 
Balance at December 31, 2011     129,899,288     $ 1,299     $ 826,121     $ 523,787     $ (7,896 )   $ 1,343,311  
Net income                       115,582             115,582  
Conversion of 3.25% Convertible Notes     4,635,159       46       56,364                   56,410  
Exercise of common stock options     462,041       5       2,058                   2,063  
Equity-based compensation     8,877             4,572                   4,572  
Other comprehensive income, net of income taxes                             1,276       1,276  
Balance at September 30, 2012     135,005,365     $ 1,350     $ 889,115     $ 639,369     $ (6,620 )   $ 1,523,214  

 

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

6
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)

 

For the Nine Months Ended September 30,   2013     2012  
Cash flows from operating activities                
Net income   $ 188,870     $ 115,582  
Adjustments to reconcile net income to net cash provided by operating activities                
Amortization of mortgage servicing rights     197,435       53,561  
Amortization of debt discount     1,082       2,679  
Amortization of debt issuance costs – senior secured term loans     3,264       3,050  
Depreciation     17,153       3,896  
Gain on sales of loans     (72,912 )      
Realized and unrealized losses on derivative financial instruments, net     12,896       3,900  
Loss on extinguishment of debt     12,556       653  
Origination and purchase of loans held for sale     (7,072,260 )      
Proceeds from sale and collection of loans held for sale     7,006,883       1,136  
Changes in assets and liabilities:                
Decrease in advances and match funded advances     424,008       1,213,917  
Decrease in receivables and other assets, net     265,554       3,184  
Increase in servicer liabilities     13,046       14,474  
Increase in other liabilities     14,737       7,911  
Other, net     8,143       10,208  
Net cash provided by operating activities     1,020,455       1,434,151  
Cash flows from investing activities                
Cash paid to acquire ResCap Servicing Operations (a component of Residential Capital, LLC)     (2,260,830 )      
Cash paid to acquire Liberty Home Equity Solutions, Inc.     (26,568 )      
Purchase of mortgage servicing rights, net     (676,750 )     (175,508 )
Acquisition of advances in connection with the purchase of mortgage servicing rights     (445,478 )     (1,914,687 )
Origination of loans held for investment     (274,081 )      
Principal payments received on loans held for investment     2,164        
Proceeds from sale of MSRs     21,511        
Proceeds from sale of advance financing subsidiary and special purpose entity           76,334  
Proceeds from sale of match funded advances     3,492,489       1,084,309  
Proceeds from sale of diversified fee businesses to Altisource Portfolio Solutions, S.A.     215,700        
Net cash acquired in acquisition of Correspondent One S.A.     22,108        
Distributions of capital from unconsolidated entities       1,300       2,839  
Additions to premises and equipment     (24,475 )     (16,596 )
Purchase of real estate           (6,501 )
Other     2,947       5,009  
Net cash provided by (used in) investing activities     50,037       (944,801 )
Cash flows from financing activities                
Net repayment of match funded liabilities     (2,169,732 )     (352,963 )
Proceeds from other borrowings     7,935,374       29,784  
Repayment of other borrowings     (7,182,275 )     (191,238 )
Payment of debt issuance costs – senior secured term loan     (25,547 )      
Proceeds from sale of mortgage servicing rights accounted for as a financing     404,509       184,205  
Proceeds from sale of loans accounted for as a financing     272,652        
Redemption of 10.875% Capital Securities           (26,829 )
Repurchase of common stock     (157,880 )      
Proceeds from exercise of common stock options     947       1,969  
Payment of preferred stock dividends     (4,534 )      
Other     (6,650 )     (8,009 )
Net cash used in financing activities     (933,136 )     (363,081 )
Net increase in cash     137,356       126,269  
Cash at beginning of period     220,130       144,234  
Cash at end of period   $ 357,486     $ 270,503  

 

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

7
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(Dollars in thousands)

 

For the Nine Months Ended September 30,   2013     2012  
Supplemental non-cash investing and financing activities                
Conversion of Series A preferred stock to common stock   $ 100,000     $  
Conversion of 3.25% Convertible Notes to common stock           56,410  
                 
Supplemental business acquisition information – ResCap Servicing Operations                
Fair value of assets acquired                
Advances   $ (1,722,379 )   $  
Mortgage servicing rights     (391,853 )      
Premises and equipment     (16,423 )      
Goodwill     (201,810 )      
Receivables and other assets     (2,989 )      
      (2,335,454 )      
Fair value of liabilities assumed                
Accrued expenses and other liabilities     74,624        
Total consideration     (2,260,830 )      
Amount due to seller for purchase price adjustments            
Cash paid     (2,260,830 )      
Less cash acquired            
Net cash paid   $ (2,260,830 )   $    

 

(1) See Note 4 – Business Acquisitions for additional information regarding the acquisitions of Liberty Home Equity Solutions, Inc. and Correspondent One S.A. and Note 9 – Mortgage Servicing for additional information regarding the acquisition of mortgage servicing rights from Ally Bank and OneWest Bank.

 

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

8
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2013

(Dollars in thousands, except per share data or if otherwise indicated)

 

Note 1 Description of Business, Basis of Presentation and Significant Accounting Policies

Organization

Ocwen Financial Corporation (NYSE: OCN) (Ocwen, OCN, “we”, or “us”) is a financial services holding company which, through its subsidiaries, is engaged in the servicing and origination of mortgage loans. Ocwen is headquartered in Atlanta, Georgia with offices throughout the United States and in the United States Virgin Islands (USVI) with support operations in India and Uruguay. Ocwen is a Florida corporation organized in February 1988. Ocwen owned all of the common stock of one of its primary operating subsidiaries, Ocwen Mortgage Servicing, Inc. (OMS), and directly or indirectly owned all of the outstanding stock of its other primary operating subsidiaries: Ocwen Loan Servicing, LLC (OLS), Ocwen Financial Solutions Private Limited, Homeward Residential, Inc. (Homeward) and Liberty Home Equity Solutions, Inc. (Liberty) (formerly known as Genworth Financial Home Equity Access, Inc.).

We are licensed to service mortgage loans and to originate mortgage loans in all jurisdictions in which we operate.

We purchase existing mortgage servicing rights (MSRs) from market participants and generate new servicing rights through our origination activities. We perform primary and master servicer activities on behalf of investors and other servicers, including the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Government National Mortgage Association (Ginnie Mae) (collectively, the GSEs). We service prime and non-prime mortgages including mortgages included in private label mortgage-backed securities. As primary servicer, we may make certain payments of property taxes and insurance premiums, default and property maintenance payments, as well as advances of principal and interest payments before collecting them from borrowers. As master servicer, we collect mortgage payments from primary servicers and distribute the funds to investors in the mortgage-backed securities. To the extent that the primary servicer does not advance the scheduled principal and interest, as master servicer we are responsible for advancing the shortfall subject to certain limitations.

We originate, purchase, sell and securitize prime forward and reverse mortgages. These loans are insured or guaranteed by the Federal Housing Authority (FHA) or the Department of Veterans Affairs (VA) or conform to the underwriting standards of Fannie Mae or Freddie Mac. The GSEs guarantee these securitizations.

We are actively engaged in identifying and completing asset and other acquisitions in connection with our growth strategy. This could involve the acquisition of domestic and international servicing and/or origination platforms or related assets. See Note 4 – Business Acquisitions for additional information.

On June 13, 2013, OLS entered into a mortgage servicing rights purchase and sale agreement (Purchase Agreement) with OneWest Bank, FSB, a federal savings bank (the Seller), pursuant to which OLS agreed to purchase MSRs and related servicing advance receivables (the OneWest MSR Transaction).  No operations, entities or other assets were acquired in the transaction. Contemporaneously with the execution of the Purchase Agreement, Ocwen executed a guarantee pursuant to which it agreed to guarantee the obligations and performance of OLS under the Purchase Agreement. As part of the OneWest MSR Transaction, each of the Seller and OLS have agreed to indemnification provisions for the benefit of the other party.

The OneWest MSR Transaction is closing in stages, and we expect that the majority of loans will be boarded onto our primary servicing platform by December 31, 2013. The GSE loans were boarded during August and September, and we expect to board the majority of the private label securities in November. Each closing is subject to, among other things, receipt of certain investor and third party consents and customary closing conditions. In the event that all of the closings have not been completed by January 31, 2014, the unsettled component of the transaction would be subject to termination in accordance with the terms of the Purchase Agreement.

On various dates beginning on April 1, 2013 and continuing through August 31, 2013, the date on which our purchase obligation terminated, we completed the acquisition of Fannie Mae and Freddie Mac MSRs and related advances from Ally Bank (Ally MSR Transaction), a wholly-owned subsidiary of Ally Financial Inc. (Ally), the indirect parent of Residential Capital, LLC (ResCap). Prior to the closing, we subserviced the related MSRs on behalf of Ally Bank. We assumed certain origination representation and warranty obligations in connection with the Ally MSR Transaction. No operations, entities or other assets were acquired in the transaction.

9
 

On April 1, 2013, we completed the acquisition of Liberty (the Liberty Acquisition) through a stock purchase agreement. Liberty is engaged in the origination, purchase, sale and securitization of reverse mortgage loans, both retail and wholesale.

On February 15, 2013, we completed the acquisition of certain assets and operations of ResCap in connection with the asset sale by ResCap and certain of its subsidiaries pursuant to a plan under Chapter 11 of the Bankruptcy Code (the ResCap Acquisition). We purchased MSRs related to private label, Freddie Mac and Ginnie Mae residential forward mortgage loans and certain master and subservicing agreements. The ResCap Acquisition included advances and elements of the servicing platform related to the acquired MSRs. Under the terms of the ResCap Acquisition, we are obligated to acquire certain servicing rights and subservicing agreements that were not settled as part of the initial closing on February 15, 2013 as a result of objections raised in connection with the sale. We completed subsequent settlements as objections were resolved on July 1 and September 1, 2013. We expect to have additional settlements through December 31, 2013 in connection with the ResCap Acquisition.

On December 27, 2012, we completed the merger by and among Ocwen, O&H Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of Ocwen, Homeward Residential Holdings, Inc. (Homeward Holding) and WL Ross & Co. LLC, a Delaware limited liability company as shareholder representative. Pursuant to the merger, O&H Acquisition Corp. merged with and into Homeward Holding with Homeward Holding continuing as the surviving corporation and becoming a wholly-owned subsidiary of Ocwen (the Homeward Acquisition). Homeward primarily engages in the origination, purchase, sale and securitization of prime loans and the servicing of residential forward mortgage loans.

Basis of Presentation

The accompanying unaudited 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 consolidated 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, 2013 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2013. The unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.

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 differ materially from those estimates. Material estimates that are particularly significant in the near or medium term relate to fair value measurements, the provision for potential losses that may arise from litigation proceedings, representation and warranty and other indemnification obligations, the amortization of MSRs and the valuation of goodwill and deferred tax assets.

Principles of Consolidation

Our financial statements include the accounts of Ocwen, its majority-owned subsidiaries and any variable interest entity (VIE) where we have determined that we are the primary beneficiary. We apply the equity method of accounting to investments when the entity is not a 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 have eliminated intercompany accounts and transactions in consolidation.

Reclassification

Within the revenue section of the Consolidated Statement of Operations for the three and nine months ended September 30, 2012, we reclassified Process management fees of $8.9 million and $27.6 million to Other revenues. In addition, certain other insignificant amounts in the Consolidated Statements of Operations and Cash Flows for prior periods have been reclassified to conform to the current period presentation. These reclassifications had no impact on our consolidated financial position, cash flows or results of operations.

Significant Accounting Policies

Transfers of Financial Assets

We securitize, sell and service forward and reverse residential mortgage loans. Securitization transactions typically involve the use of VIEs and are accounted for either as sales or as secured financings. We typically retain economic interests in the securitized assets in the form of servicing rights and obligations. In order to efficiently finance our assets and operations and create liquidity, we may sell servicing advances, MSRs and the right to receive servicing fees, excluding ancillary income, relating to certain of our MSRs (Rights to MSRs).

10
 

In order to determine whether or not a VIE is required to be consolidated, we consider our ongoing involvement with the VIE. In circumstances where we have both the power to direct the activities that most significantly impact the VIEs performance and the obligation to absorb losses or the right to receive benefits that could be significant, we would conclude that we would consolidate the entity, which precludes us from recording an accounting sale in connection with the transfer of the financial assets. In the case of a consolidated VIE, we continue to record the underlying residential mortgage loans or servicing advances, and we record the securitized debt on our consolidated balance sheet.

In the case of transfers where either one or both of the power or economic criteria above are not met, we evaluate whether we achieve a sale for accounting purposes. In order to achieve a sale, the transferred assets must be legally isolated, not be constrained by restrictions from further transfer, and be deemed to be beyond our control. If we fail any of these three criteria, the accounting is consistent with a secured financing as described in the preceding paragraph. Subsequent to the determination that a transaction does not meet the accounting sale criteria, we may determine that we meet the criteria. In the event we subsequently meet the accounting sale criteria, we derecognize the transferred assets and related liabilities.

In the case of transfers of MSRs and Rights to MSRs where we retain the right to subservice, we defer the related gain or loss and amortize the balance over the life of the subservicing agreement.

Gains or losses on off-balance sheet securitizations take into consideration any retained interests, including servicing rights and representation and warranty obligations, both of which are initially recorded at fair value at the date of sale in Gain on loans held for sale, net, in our Consolidated Statements of Operations.

Recent Accounting Pronouncements

Accounting Standards Update (ASU) 2011-11, (Accounting Standards Codification (ASC) 210, Balance Sheet): Disclosures about Offsetting Assets and Liabilities and ASU 2013-01: Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This ASU contains new disclosure requirements regarding the nature of an entity’s rights of offset and related arrangements associated with financial and derivative instruments. ASU 2013-01 clarified the scope of transactions that are subject to ASU 2011-11 . The new disclosures also provide information about gross and net exposures. Retrospective application is required for all comparative periods presented. Our adoption of these standards on January 1, 2013 did not have a material impact on our unaudited consolidated financial statements, as the requirements relate to disclosures only.

ASU 2013-02 (ASC 220, Comprehensive Income): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (which amends ASC 220, Comprehensive Income). ASC 2013-02 contains new requirements related to the presentation and disclosure of items that are reclassified out of accumulated other comprehensive income. The ASU is required to be applied prospectively. Adoption of this standard on January 1, 2013 did not have a material impact on our unaudited consolidated financial statements, as the requirements relate to disclosures only.

ASU 2013-04 (ASC 405, Liabilities): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, a consensus of the FASB Emerging Issues Task Force (EITF). On February 28, 2013, the FASB issued ASU 2013-04. The ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following:

a. The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and
b. Any additional amount the reporting entity expects to pay on behalf of its co-obligors.

Required disclosures include a description of the joint-and-several arrangement and the total outstanding amount of the obligation for all joint parties. The ASU permits entities to aggregate disclosures (as opposed to providing separate disclosures for each joint-and-several obligation). The ASU is effective for all prior periods in fiscal years beginning on or after December 15, 2013 (and interim reporting periods within those years). The ASU should be applied retrospectively to obligations with joint-and-several liabilities existing at the beginning of an entity’s fiscal year of adoption. Entities that elect to use hindsight in measuring their obligations during the comparative periods must disclose that fact. Early adoption is permitted. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

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ASU 2013-05 (ASC 830, Foreign Currency Matters): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity, a consensus of the FASB Emerging Issues Task Force . On March 4, 2013, the FASB issued ASU 2013-05, which requires that the entire amount of a cumulative translation adjustment (CTA) related to an entity’s investment in a foreign entity should be released when there has been a:

sale of a subsidiary or group of net assets within a foreign entity and the sale represents the substantially complete liquidation of the investment in the foreign entity,
loss of a controlling financial interest in an investment in a foreign entity (i.e., the foreign entity is deconsolidated), or
step acquisition for a foreign entity (i.e., when an entity has changed from applying the equity method for an investment in a foreign entity to consolidating the foreign entity).

The ASU does not change the requirement to release a pro rata portion of the CTA of the foreign entity into earnings for a partial sale of an equity method investment in a foreign entity. The ASU is effective for fiscal years (and interim periods within those fiscal years) beginning on or after December 15, 2013. The ASU should be applied prospectively from the beginning of the fiscal year of adoption. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

ASU 2013-10 (ASC 815, Derivatives and Hedging): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force). On July 17, 2013, the FASB issued ASU 2013-10, which permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815, in addition to interest rates on direct Treasury obligations of the U.S. government (UST) and the London Interbank Offered Rate (LIBOR). The ASU also removes the restriction on using different benchmark rates for similar hedges. The ASU is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. Because we terminated our remaining interest rate swap agreements on May 31, 2013, our adoption of this standard did not have a material impact on our consolidated financial condition or results of operations.

ASU 2013-11 (ASC 740, Income Taxes) : Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). On July 18, 2013, the FASB issued ASU 2013-11, which clarifies that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date.

The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The ASU should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

 

Note 2 Securitizations and Variable Interest Entities

We securitize, sell and service forward and reverse residential mortgage loans and regularly transfer financial assets in connection with asset-backed financing arrangements. 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.

We have determined that the SPEs created in connection with our match funded financing facilities are VIEs of which we are the primary beneficiary. We also determined that we were the primary beneficiary for certain residential mortgage loan securitization trusts which were de-recognized at December 31, 2012, upon sale of our retained interest to a third party.

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Securitizations of Residential Mortgage Loans

Currently, we securitize forward and reverse residential mortgage loans involving the GSEs. We retain the right to service these loans and receive servicing fees based upon the securitized loan balances and certain ancillary fees, all of which are reported in servicing and subservicing fees on the Consolidated Statements of Operations. In prior years, we securitized residential mortgage loans through “private label” securitization trusts. We continued to be involved with the securitization 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 securitization trust. The beneficial interests that we held consisted of both subordinate and residual securities that were either retained at the time of the securitization or subsequently acquired. We also acquired residual and subordinated interests in trusts where we were not the transferor but were the servicer.

In December 2012, we sold the beneficial interests that we held in the four consolidated securitization trusts and deconsolidated these securitization trusts. All assets and liabilities associated with the trusts were derecognized. We have no obligation to provide financial support to unconsolidated securitization trusts and have provided no such support. The beneficial owners of the trusts can look only to the assets of the securitization trusts for satisfaction of the debt issued by the securitization trusts and have no recourse against the assets of Ocwen. The general creditors of Ocwen have no claim on the assets of the trusts.

Transfers of Forward Loans

As part of our origination activities, we sell or securitize forward loans that we originate or that we purchase from third parties, generally in the form of mortgage-backed securities guaranteed by the GSEs. Securitization usually occurs within 30 days of loan closing or purchase. We retain servicing rights associated with the transferred loans and receive a servicing fee for services provided. We act only as a fiduciary and do not have a variable interest in the securitization trusts. As a result, we account for these transactions as sales upon transfer.

We elected to measure loans held for sale at fair value. We report interest income on loans held for sale in other income (expense). We report the gain or loss on the transfer of the loans held for sale in Gain on loans held for sale, net in the Consolidated Statements of Operations. We also include in Gain on loans held for sale, net changes in fair value of loans and the gain or loss on the related derivatives. See Note 19 – Derivative Financial Instruments and Hedging Activities for information on these derivative financial instruments. We include all changes in loans held for sale and related derivative balances in operating activities in the Consolidated Statements of Cash Flows.

The following table presents a summary of cash flows received from and paid to securitization trusts related to transfers accounted for as sales that were outstanding during the periods ended September 30, 2013:

    Three Months     Nine Months  
Proceeds received from securitizations   $ 1,776,309     $ 6,240,459  
Servicing fees collected     6,317       13,125  
Purchases of previously transferred assets, net of claims reimbursed     (358 )     (358 )
    $ 1,782,268     $ 6,253,226  

In connection with these transfers, we recorded MSRs of $16.3 million and $63.2 million for the three and nine months ended September 30, 2013. We initially record the MSRs at fair value and subsequently account for them at amortized cost. See Note 9 – Mortgage Servicing for information relating to MSRs.

Certain guarantees arise from agreements associated with the transfers of loans. Under these agreements, we may be obligated to repurchase the loans, or otherwise indemnify or reimburse the investor or insurer, for losses incurred due to material breach of contractual representations and warranties. See Note 16 – Other Liabilities for further information.

The following table presents the carrying amounts of our assets that relate to our continuing involvement with forward loans that we have transferred with servicing rights retained since the Homeward Acquisition as well as our maximum exposure to loss including the unpaid principal balance of the transferred loans:

    September 30,
2013
    December 31,
2012
 
Carrying value of assets:                
Mortgage servicing rights, at amortized cost   $ 53,562     $  
Mortgage servicing rights, at fair value     2,751       2,908  
Advances and match funded advances     16,254        
Unpaid principal balance of loans transferred (1)     6,125,869       238,010  
Maximum exposure to loss   $ 6,198,436     $ 240,918  
(1) The UPB of the loans transferred is the maximum exposure to loss under our standard representations and warranties obligations.
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At September 30, 2013, only 1.0% of the transferred residential loans that we serviced were 60 days or more past due. During the three and nine months ended September 30, 2013, there were no charge-offs, net of recoveries, associated with these transferred loans.

Transfers of Reverse Mortgages

We are an approved issuer of Ginnie Mae Home Equity Conversion Mortgage-Backed Securities (HMBS) that are guaranteed by Ginnie Mae. With the acquisition of Liberty, we have begun to originate Home Equity Conversion Mortgages (HECMs or reverse mortgages) that are insured by the FHA. We then pool the loans into HMBS that we sell into the secondary market with servicing rights retained. Based upon the structure of the Ginnie Mae securitization program, we have determined that loan transfers in the HMBS program do not meet the definition of a participating interest because of the servicing requirements in the product that require the Issuer/Servicer to absorb some level of interest rate risk, cash flow timing risk and incidental credit risk. As a result, HECMs do not qualify for sale accounting, and we, therefore, account for these transfers as secured borrowings. Under this accounting treatment, the HECMs remain on our Consolidated Balance Sheet as loans held for investment (Loans – Restricted for Securitization Investors) in Other assets. We record the proceeds from the transfer of assets as secured borrowings (Secured borrowing – owed to securitization investors) in Other borrowings and recognize no gain or loss on the transfer. Holders of participating interests in the HMBS have no recourse against Ocwen, except for standard representations and warranties and our contractual obligation to service the HECMs and the HMBS, and have no recourse against the assets of Ocwen.

We have elected to measure the HECMS and HMBS-related borrowings at fair value. The changes in fair value of the HECMs and HMBS-related borrowings are included in other revenues in our Consolidated Statement of Operations. Included in net fair value gains on the HECMs and related HMBS borrowings are the interest income that we expect to be collected on the HECMs and the interest expense that we expect to be paid on the HMBS-related borrowings. We report originations and payments of HECMs in investing activities in the Consolidated Statements of Cash Flows. We report net fair value gains on HECMs and the related HMBS borrowings as an adjustment to the net cash provided by or used in operating activities in the Consolidated Statements of Cash Flows. Proceeds from securitizations of HECMs and payments on HMBS-related borrowings are included in financing activities in the Consolidated Statements of Cash Flows.

We had HMBS-related borrowings of $284.3 million and $290.9 million of HECMs pledged as collateral to the pools at September 30, 2013.

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. We consolidate these SPEs because the transfers do not qualify for sales accounting treatment or because Ocwen is the primary beneficiary of the SPE.

These SPEs issue debt supported by collections on the transferred advances. We made these transfers under the terms of our 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. The SPEs use collections of the pledged advances to repay principal and interest and to pay the expenses of the SPE. Holders of the debt issued by these entities can look only to the assets of the SPE for satisfaction of the debt and have no recourse against Ocwen. However, Ocwen and OLS have guaranteed the payment of the obligations under the securitization documents of one of the entities. The maximum amount payable under the guarantee is limited to 10% of the notes outstanding at the end of the facility’s revolving period in December 2014. The entity to which this guarantee applies had $37.6 million of notes outstanding at September 30, 2013. Ocwen and OLS had previously guaranteed the payment of obligations under the securitization documents of one additional entity; however, in July 2013, the notes outstanding under this facility were repaid, and the facility was terminated. The assets and liabilities of the advance financing SPEs are comprised solely of Match funded advances, Debt service accounts, Match funded liabilities and amounts due to affiliates. Amounts due to affiliates are eliminated in consolidation.

See Note 8 – Match Funded Advances, Note 12 – Debt Service Accounts and Note 14 – Match Funded Liabilities for additional information.

 

Note 3 Transfers of Financial Assets

In order to efficiently finance our assets and operations and create liquidity, we periodically sell MSRs, Rights to MSRs and servicing advances to market participants, including Home Loan Servicing Solutions, Ltd. and its wholly owned subsidiary, HLSS Holdings, LLC (collectively HLSS). We typically retain the right to subservice loans when we sell MSRs and rights to MSRs. To the extent applicable, HLSS may also acquire advance SPEs and the related match funded liabilities (together with the purchase of Rights to MSRs and servicing advances, the HLSS Transactions). During the nine months ended September 30, 2013 and 2012, we completed HLSS Transactions relating to the Rights to MSRs for $109.8 billion and $48.2 billion of UPB, respectively.

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As part of the HLSS Transactions, we retain legal ownership of the MSRs and continue to service the related mortgage loans. We are obligated to transfer legal ownership of the MSRs to HLSS upon obtaining all required third party consents. At that time, we would subservice the MSRs pursuant to our subservicing agreement, as amended, with HLSS. See Note 23 – Related Party Transactions for additional information.

The following table provides a summary of the assets and liabilities sold to HLSS in connection with the HLSS Transactions during the nine months ended September 30:

    2013     2012  
Sale of MSRs accounted for as a financing   $ 388,472     $ 184,269  
                 
Sale of match funded advances     3,489,907       1,088,505  
                 
Sale of advance SPEs:                
Match funded advances           413,374  
Debt service account           14,786  
Prepaid lender fees and debt issuance costs           5,422  
Other prepaid expenses           1,928  
Match funded liabilities           (358,335 )
Accrued interest payable and other accrued expenses           (841 )
Net assets of advance SPEs           76,334  
Sales price, as adjusted     3,878,379       1,349,108  
Amount due to (from) HLSS for post-closing adjustments at September 30           (4,260 )
      3,878,379       1,344,848  
Amount received from (paid to) HLSS as settlement of post-closing adjustments outstanding at the end of the previous year     1,410        
Total cash received   $ 3,879,789     $ 1,344,848  

Because we retained legal title to the MSRs, the sales of Rights to MSRs are accounted for as financings. To the extent that we obtain all third party consents, legal title will transfer to HLSS, at which point we will derecognize the related MSRs. Upon derecognition, any resulting gain or loss will be deferred and amortized over the expected life of the related subservicing agreement. Until such time, we continue to recognize the full amount of servicing revenue and amortization of the MSRs.

The related advance sales meet the requirements for sale accounting under GAAP. When HLSS acquired advance SPEs from Ocwen, we derecognized the consolidated assets and liabilities of the Advance SPEs at the time of the sale. In subsequent sales of advances, HLSS acquired the advances directly and the transferred financial assets were accounted for as a sale and were derecognized from our financial statements. We have also evaluated our relationship with the financing SPEs to which HLSS has transferred the servicing advances that it has acquired from us and have determined that we are not required to consolidate these SPEs. 

 

Note 4 Business Acquisitions

We completed the Liberty, Correspondent One S.A. (Correspondent One), ResCap and Homeward acquisitions as part of our ongoing strategy to expand our residential origination and servicing businesses. We accounted for these transactions using the acquisition method which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. In a business combination, the initial allocation of the purchase price is considered preliminary and, therefore, subject to change until the end of the measurement period (up to one year from the acquisition date). 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 pro forma consolidated results presented below for each business acquisition are not indicative of what our consolidated net earnings would have been had we completed the acquisitions on the dates indicated because of differences in servicing practices and cost structure between Ocwen and each acquiree. In addition, the pro forma consolidated results do not purport to project our combined future results nor do they reflect the expected realization of any cost savings associated with the acquisitions.

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The ResCap acquisition was 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 purchase price allocation table below. We expect 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 U.S. tax purposes. The acquisitions of Liberty and Homeward were treated as stock purchases for U.S. tax purposes.

Purchase Price Allocation

The following table summarizes the fair values of assets acquired and liabilities assumed as part of the ResCap and Homeward Acquisitions:

                                     
    ResCap     Homeward  
Purchase Price Allocation   March 31,
2013
    Adjustments     Revised     December 31,
2012
    Adjustments     Revised  
Cash   $     $     $     $ 79,511     $     $ 79,511  
Loans held for sale                       558,721             558,721  
MSRs (2)     393,891       (2,038 )     391,853 (1)     358,119       2,225       360,344  
Advances and match funded advances (2)     1,622,348       100,031       1,722,379 (1)     2,266,882             2,266,882 (1)
Deferred tax assets                       47,346             47,346 (1)
Premises and equipment     22,398       (5,975 )     16,423 (1)     16,803       (4,288 )     12,515 (1)
Debt service accounts                       69,287             69,287  
Investment in unconsolidated entities                       5,485             5,485 (1)
Receivables and other assets (3)     2,989             2,989       56,886       (29,746 )     27,140  
Match funded liabilities                       (1,997,459 )           (1,997,459 )
Other borrowings                       (864,969 )           (864,969 )
Other liabilities                                                
Liability for indemnification obligations     (49,500 )           (49,500 )     (32,498 )           (32,498 )(1)
Liability for certain foreclosure matters (4)                             (13,602 )     (13,602 )(1)
Accrued bonuses                       (35,201 )           (35,201 )
Checks held for escheat                       (16,418 )     (35 )     (16,453 )(1) 
Other     (24,840 )     (284 )     (25,124 )     (47,614 )     2,763       (44,851 )(1)
Total identifiable net assets     1,967,286       91,734       2,059,020       464,881       (42,683 )     422,198  
Goodwill     204,743       (2,933 )     201,810 (1)     300,843       41,783       342,626 (1)
Total consideration   $ 2,172,029     $ 88,801     $ 2,260,830     $ 765,724     $ (900 )   $ 764,824  
(1) Initial fair value estimate.
(2) As of the acquisition date, the purchase of MSRs with a UPB of $9.0 billion from ResCap was not complete pending the receipt of certain consents and court approvals. During the third quarter we obtained the required consents and approvals for a portion of these MSRs and paid an additional purchase price of $93.3 million to acquire the MSRs and related advances. The purchase price allocation has been revised to include the resulting adjustments to MSRs, advances and goodwill. We anticipate there will be additional settlements in connection with the ResCap Acquisition in the fourth quarter of 2013.
(3) The purchase price allocation has been revised to include a $29.7 million income tax liability, with an offsetting increase to goodwill.
(4) See Note 16 - Other Liabilities.

The estimated fair values of the assets acquired and liabilities assumed at the acquisition date, as set forth in the table above, includes some amounts based on preliminary fair value estimates. The following factors led to certain balances having preliminary fair value estimates:

The complex nature of certain acquired assets and assumed liabilities prevents us from completing our valuations and reconciliations;
We engaged a third party specialist to assist in valuing certain assets and liabilities and this work is not yet complete; and
16
 
Underlying information such as unpaid principal balance (UPB) and other loan level details have not yet been boarded and reconciled onto our servicing platform, and therefore, we have not been able to fully validate and reconcile certain asset and liability balances correlated with UPB data.

Because the measurement period is still open, we expect that certain fair value estimates will change once we receive all information necessary to make a final fair value assessment. Any measurement period adjustments that we identify and determine to be material will be applied retrospectively to the period of acquisition, and depending on the nature of the adjustments, other periods subsequent to the period of acquisition could also be affected. We have adjusted the initial purchase price and purchase price allocations related to the Homeward and ResCap Acquisitions as indicated in the table above. These measurement period adjustments were applied retrospectively to the period of acquisition. The December 31, 2012 Consolidated Balance Sheet has been revised to reflect the adjustments attributable to the Homeward Acquisition. None of the adjustments had a material effect on earnings.

ResCap Acquisition

We completed the ResCap Acquisition on February 15, 2013. We acquired MSRs to “private label,” Freddie Mac and Ginnie Mae loans with a UPB of $103.8 billion and master servicing agreements with a UPB of $40.7 billion. We also assumed subservicing contracts with a UPB of $26.3 billion, including $9.0 billion we agreed to subservice on behalf of ResCap until we obtain certain consents and court approvals. We purchase these MSRs and assume the subservicing contracts from ResCap when such consents and approvals are obtained. As disclosed above, we completed the purchase of certain of these MSRs during the third quarter. We also acquired certain diversified fee-based business operations that included recovery, title and closing services.

To finance the ResCap Acquisition, we deployed $840.0 million from the proceeds of a new $1.3 billion senior secured term loan (SSTL) facility and borrowed an additional $1.2 billion pursuant to two new servicing advance facilities and one existing facility. We settled the third quarter closings from operating cash. Ocwen assumed certain limited liabilities as part of the transaction, including certain employee liabilities and certain business payables outstanding at the closing date. Under the agreement with ResCap, Ocwen generally did not assume any contingent obligations, including pending or threatened litigation, financial obligations in connection with any settlements, orders or similar agreements entered into by ResCap or obligations in connection with any representations or warranties associated with loans previously sold by ResCap except for litigation that may arise in the ordinary course of servicing mortgage loans relating to servicing agreements assumed by Ocwen. Ocwen assumed all liabilities related to servicing loans that are guaranteed by Ginnie Mae, whether arising prior to or after the closing date.

On April 12, 2013 in connection with the sale to Altisource Portfolio Solutions, S.A. (Altisource) of the diversified fee-based business acquired in connection with the ResCap Acquisition, Ocwen agreed to establish additional terms related to existing servicing arrangements between Altisource and Ocwen for mortgage servicing assets acquired from ResCap. The cash consideration paid by Altisource to Ocwen under the Agreement totaled $128.8 million. At the time of the closing, we derecognized goodwill of $128.8 million associated with the diversified fee-based business sold to Altisource. There were no other significant assets or liabilities associated with this business. See Note 22 – Business Segment Reporting for a discussion of the additional terms of the servicing arrangements.

Post-Acquisition Results of Operations

The following table presents the revenue and earnings of the ResCap Business operations that are included in our unaudited Consolidated Statements of Operations from the acquisition date of February 15, 2013 through September 30, 2013:

For the Periods Ended September 30, 2013:     Three Months     Nine Months  
Revenues   $ 212,164     $ 508,589  
Net income   $ 8,230   $ 81,362  

Pro Forma Results of Operations

The following table presents supplemental pro forma information for Ocwen as if the ResCap Acquisition occurred on January 1, 2012. Pro forma adjustments include:

conforming servicing revenues to the revenue recognition policies followed by Ocwen;
conforming the accounting for MSRs to the valuation and amortization policies of Ocwen;
adjusting interest expense to eliminate the pre-acquisition interest expense of ResCap and to recognize interest expense as if the acquisition-related debt of Ocwen had been outstanding at January 1, 2012; and
17
 
reporting acquisition-related charges for professional services as if they had been incurred in 2012 rather than 2013.
For the Periods Ended September 30:   Three Months     Nine Months  
    2012     2013     2012  
Revenues   $ 374,751     $ 1,530,055     $ 1,027,102  
Net income   $ 2,696   $ 205,062     $ 21,921  

Homeward Acquisition

We completed the Homeward Acquisition on December 27, 2012. We acquired the MSRs and subservicing for approximately 421,000 residential mortgage loans with a UPB of $77.0 billion. We also acquired Homeward’s loan origination platform and its diversified fee-based businesses, including property valuation, REO management, title, closing and advisory services. On March 29, 2013, Ocwen sold the Homeward diversified fee-based businesses to Altisource Solutions S.à r.l. and Altisource Portfolio Solutions, Inc., wholly-owned subsidiaries of Altisource, for an aggregate purchase price of $87.0 million in cash. Ocwen sold its investment in two subsidiaries of Homeward, Beltline Road Insurance Agency, Inc. and Power Default Services, Inc. As part of this transaction, Ocwen also agreed to sell certain designated assets used or usable in the business conducted by another Homeward subsidiary, Power Valuation Services, Inc., as well as certain designated intellectual property and information technology assets that are used or usable in the business conducted by the acquired subsidiaries or by Powerline Valuation Services, Inc. Altisource also assumed certain liabilities of the diversified fee-based business. The carrying value of the net assets sold, including allocated goodwill, approximated the sales price. The assets sold consisted of receivables and other assets of $9.4 million. The liabilities assumed by Altisource of $4.0 million consisted principally of deferred revenue. At the time of the sale, we derecognized goodwill of $81.6 million associated with the sold business. In connection with this transaction, Ocwen entered into amendments to certain of its services and intellectual property agreements with Altisource. See Note 23 – Related Party Transactions for a discussion of these amendments.

Pro Forma Results of Operations

The following table presents supplemental pro forma information for Ocwen as if the acquisition of Homeward occurred on January 1, 2011. Pro forma adjustments include:

conforming servicing revenues to the revenue recognition policy followed by Ocwen;
conforming the accounting for MSRs to the valuation and amortization policies of Ocwen;
reversing depreciation recognized by Homeward 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 Homeward and to recognize interest expense as if the acquisition-related debt of Ocwen had been outstanding at January 1, 2011; and
reporting acquisition-related charges for professional services as if they had been incurred in 2011 rather than 2012.
For the Periods Ended September 30, 2012: Three Months     Nine Months  
Revenues $ 346,037     $ 949,587  
Net income $ 57,013     $ 133,821  

Other Acquisitions

Correspondent One

On March 31, 2013, we increased our ownership in Correspondent One, an entity formed with Altisource in March 2011, from 49% to 100%. We acquired the shares of Correspondent One held by Altisource (49% interest) for $12.6 million and acquired the remaining shares held by an unrelated entity for $0.9 million. We accounted for this transaction as an acquisition and recognized the assets acquired and liabilities assumed at their fair values as of the acquisition date. The acquired net assets were $26.3 million and consisted primarily of cash ($23.0 million) and residential mortgage loans ($1.1 million). We remeasured our previously held investment, which we accounted for using the equity method, at fair value and recognized a loss of $0.4 million. We also recognized goodwill of $0.1 million. We began including the accounts of Correspondent One in our consolidated financial statements effective on the date of acquisition and have eliminated our investment in consolidation. Correspondent One facilitates the purchase of conforming and government-guaranteed residential mortgages from approved mortgage originators and resells the mortgages to secondary market investors. Correspondent One is not material to our financial condition, results of operations or cash flows.

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Liberty

On April 1, 2013, we completed the Liberty Acquisition for $22.0 million in cash. In addition, and as part of the closing, Ocwen repaid Liberty’s $9.1 million existing outstanding debt to the sellers. We acquired approximately 420 reverse mortgage loans with a UPB of $55.2 million. We also acquired Liberty’s reverse mortgage origination platform. The acquired net assets were $31.1 million and consisted primarily of residential reverse mortgage loans ($60.0 million), receivables ($11.2 million), loans held for investment ($10.3 million), intangible assets ($3.2 million) and cash ($4.6 million) less amounts due under warehouse facilities ($46.3 million) and HMBS-related borrowings ($10.2 million). We did not recognize any goodwill in connection with this acquisition. The acquisition of Liberty did not have a material effect on our financial condition, results of operations or cash flows.

 

Note 5 Fair Value of Financial Instruments

We estimate fair value 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 that 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.

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

 

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3: Unobservable inputs for the asset or liability.

We classify assets in their entirety based on the lowest level of input that is significant to the fair value measurement.

The carrying amounts and the estimated fair values of our financial instruments and our nonfinancial assets measured at fair value are as follows:

        September 30, 2013     December 31, 2012  
    Level   Carrying
Value
    Fair
Value
    Carrying
Value
    Fair
Value
 
Financial assets:                                    
Loans held for sale, at fair value (1)   2   $ 335,102     $ 335,102     $ 426,480     $ 426,480  
Loans held for sale, at lower of cost or fair value (2)   3     86,753       86,753       82,866       82,866  
Loans – restricted for securitization investors, at fair value (1)   3     290,853       290,853              
Advances and match funded advances (3)   3     1,480,012       1,480,012       3,233,707       3,233,707  
Receivables, net (3)   3     223,404       223,404       137,713       137,713  
                                     
Financial liabilities:                                    
Match funded liabilities (3)   3   $ 363,012     $ 363,012     $ 2,532,745     $ 2,533,278  
Other borrowings:                                    
Senior secured term loan (3)   3     1,287,821       1,278,273       305,997       310,822  
Secured borrowings – owed to securitization investors, at fair value (1)   3     284,276       284,276              
Other (3)   3     1,020,494       1,020,494       790,682       790,682  
Total Other borrowings         2,592,591       2,583,043       1,096,679       1,101,504  
                                     
Derivative financial instruments (1):                                    
Interest rate lock commitments (IRLCs)   2   $ 13,491     $ 13,491     $ 5,781     $ 5,781  
Interest rate swaps   3                 (10,836 )     (10,836 )
Forward MBS trades   1     (12,185 )     (12,185 )     (1,719 )     (1,719 )
U.S. Treasury futures   1                 (1,258 )     (1,258 )
Interest rate caps   3                 168       168  
                                     
MSRs, at fair value (1)   3   $ 96,938     $ 96,938     $ 85,213     $ 85,213  
(1) Measured at fair value on a recurring basis.
(2) Measured at fair value on a non-recurring basis.
(3) Disclosed, but not carried, at fair value.
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The following tables present a reconciliation of the changes in fair value of Level 3 assets that we measure at fair value on a recurring basis:

 

    Loans –
restricted for
securitization
investors
    Secured
borrowings –
owed to
securitization
investors
    Derivative
Financial
Instruments
    MSRs at
Fair
Value
    Total  
                               
Three Months Ended September 30, 2013:                                        
Beginning balance   $ 76,649     $ (73,641 )   $ 176     $ 97,163     $ 100,347  
                                         
Purchases, issuances, sales and settlements:                                        
Purchases                              
Issuances     211,052       (206,714 )                 4,338  
Sales                              
Settlements     (1,293 )     1,021       (176 )           (448 )
      209,759       (205,693 )     (176 )           3,890  
                                         
Total realized and unrealized gains and (losses) (1):                                        
Included in Other, net     4,445       (4,942 )           (225 )     (722 )
Included in Other comprehensive income (loss)                              
      4,445       (4,942 )           (225 )     (722 )
                                         
Transfers in and / or out of Level 3                              
Ending balance   $ 290,853     $ (284,276 )   $     $ 96,938     $ 103,515  
                                         
Three Months Ended September 30, 2012:                                        
Beginning balance   $     $     $ (14,905 )   $     $ (14,905 )
                                         
Purchases, issuances, sales and settlements:                                        
Settlements                 102             102  
                  102             102  
                                         
Total realized and unrealized gains and (losses) (1):                                        
Included in Other, net                 1,397             1,397  
Included in Other comprehensive income (loss)                 (2,688 )           (2,688 )
                  (1,291 )           (1,291 )
                                         
Transfers in and / or out of Level 3                              
Ending balance   $     $     $ (16,094 )   $     $ (16,094 )
20
 
    Loans –
restricted for
securitization
investors
    Secured
borrowings –
owed to
securitization
investors
    Derivative
Financial
Instruments
    MSRs at
Fair
Value
    Total  
                               
Nine Months Ended September 30, 2013:                                        
Beginning balance   $     $     $ (10,668 )   $ 85,213     $ 74,545  
                                         
Purchases, issuances, sales and settlements:                                        
Purchases     10,251       (10,179 )                 72  
Issuances     274,081       (272,652 )                 1,429  
Sales                 24,156             24,156  
Settlements     (2,164 )     1,888       (1,242 )           (1,518 )
      282,168       (280,943 )     22,914             24,139  
                                         
Total realized and unrealized gains and (losses) (1):                                        
Included in Other, net     8,685       (3,333 )     117       11,725       17,194  
Included in Other comprehensive income (loss)                 (12,363 )           (12,363 )
      8,685       (3,333 )     (12,246 )     11,725       4,831  
                                         
Transfers in and / or out of Level 3                              
Ending balance   $ 290,853     $ (284,276 )   $     $ 96,938     $ 103,515  
                                         
Nine Months Ended September 30, 2012:                                        
Beginning balance   $     $     $ (16,676 )   $     $ (16,676 )
                                         
Purchases, issuances, sales and settlements:                                        
Settlements                 2,524             2,524  
                  2,524             2,524  
                                         
Total realized and unrealized gains and (losses) (1):                                        
Included in Other, net                 6,645             6,645  
Included in Other comprehensive income (loss)                 (8,587 )           (8,587 )
                  (1,942 )           (1,942 )
                                         
Transfers in and / or out of Level 3                              
Ending balance   $     $     $ (16,094 )   $     $ (16,094 )
(1) For derivative financial instruments held at September 30, 2012, total net losses were $1.3 million and $7.7 million for the three and nine months ended September 30, 2012, respectively.

The methodologies that we use and key assumptions that we make to estimate the fair value of financial instruments and other assets and liabilities measured at fair value on a recurring or non-recurring basis are described below:

Loans Held for Sale

We originate and purchase residential forward and reverse mortgage loans that we intend to sell to the GSEs. We also own residential mortgage loans that are not eligible to be sold to the GSEs due to delinquency or other factors. Residential forward and reverse mortgage loans that we intend to sell to the GSEs are carried at fair value as a result of a fair value election. Such loans are subject to changes in fair value due to fluctuations in interest rates from the closing date through the date of the sale of the loan into the secondary market. These loans are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. We have the ability to access this market, and it is the market into which conforming mortgage loans are typically sold.

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We report all other loans held for sale at the lower of cost or fair value. Current market illiquidity has reduced the availability of observable pricing data for certain of these loans. When we enter into an agreement to sell a loan or pool of loans to an investor at a set price, we value the loan or loans at the commitment price. We base the fair value of uncommitted loans on the expected future cash flows discounted at a rate commensurate with the risk of the estimated cash flows. Assumptions used in the valuation of performing loans include historical default rates, re-performance rates on defaulted loans, loss severity on defaulted loans, average resolution timeline, average coupon rate and a discount rate. Significant assumptions used in the valuation of nonperforming loans include the current market value of the underlying collateral based on third party sources such as appraisals or broker price opinions, resolution timeline, estimated foreclosure and disposition costs that are based on historical experience and a discount rate. The assumptions we used in the valuation of these performing and non-performing loans at September 30, 2013 have not changed significantly from those we used in the December 31, 2012 valuations.

We repurchase certain loans from Ginnie Mae guaranteed securitizations in connection with loan modifications and loan resolution activity as part of our servicing obligations. These are classified as loans held for sale at the lower of cost or fair value, in the case of modified loans, as we expect to redeliver (sell) the loans to new Ginnie Mae guaranteed securitizations.  The fair value of these loans is estimated using published forward Ginnie Mae prices.  Loans repurchased in connection with loan resolution activities are modified or otherwise remediated through loss mitigation activities or are reclassified to receivables.  Because these loans are insured or guaranteed by the FHA or VA, the fair value of these loans represents the net recovery value taking into consideration the insured or guaranteed claim.

Loans – Restricted for Securitization Investors

These loans are not traded in an active, open market with readily observable prices. We base the fair value of transferred reverse mortgage loans that do not qualify as sales for accounting purposes on the expected future cash flows discounted over the expected life of the loans at a rate commensurate with the risk of the estimated cash flows. Significant assumptions included expected prepayment and delinquency rates and cumulative loss curves. The discount rate assumption for these assets is primarily based on an assessment of current market yields on newly originated reverse mortgage loans, expected duration of the asset, and current market interest rates.

The more significant assumptions used in the September 30, 2013 valuation of our Loans – Restricted for Securitization Investors include:

Life in years ranging from 2.97 to 23.52 (weighted average of 6.79);
Conditional repayment rate ranging from 4.80% to 38.40% (weighted average of 8.44%); and
Discount rate of 1.84%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Mortgage Servicing Rights

Amortized Cost MSRs

We estimate the fair value of MSRs carried at amortized cost using a combination of internal models and data provided by third-party valuation experts. The most significant assumptions used in the valuation of MSRs are the speed at which mortgages prepay and delinquency experience. Other assumptions typically used in the valuation of MSRs are:

  Cost of servicing
     
  Discount rate
     
  Interest rate used for computing the cost of financing servicing advances
     
  Interest rate used for computing float earnings
     
  Compensating interest expense
     
  Collection rate of other ancillary fees

The significant components of the estimated future cash inflows for MSRs include servicing fees, late fees, float earnings and other ancillary fees. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments.

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

We estimate fair value using internal models and with the assistance of third-party valuation experts. Our internal models calculate the present value of expected future cash flows utilizing assumptions that we believe are used by market participants. We derived prepayment speeds and delinquency assumptions from historical experience adjusted for prevailing market conditions. We utilize a discount rate provided by third-party valuation experts, 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.

22
 

Third-party valuation experts generally utilize: (a) transactions involving instruments with similar collateral and risk profiles, adjusted as necessary based on specific characteristics of the asset or liability being valued; and/or (b) industry-standard modeling, such as a discounted cash flow model, in arriving at their estimate of fair value. The prices provided by the valuation experts reflect their observations and assumptions related to market activity, including risk premiums and liquidity adjustments. The models and related assumptions used by the valuation experts are owned and managed by them and, in many cases, the significant inputs used in the valuation techniques are not reasonably available to us. However, we have an understanding of the processes and assumptions used to develop the prices based on our ongoing due diligence, which includes regular discussions with the valuation experts. We believe that the procedures executed by the valuation experts, combined with our internal verification and analytical procedures, provide assurance that the prices used in our consolidated financial statements comply with the accounting guidance for fair value measurements and disclosures and reflect the assumptions that a market participant would use.

The more significant assumptions used in the September 30, 2013 valuation of our MSRs carried at amortized cost include:

Prepayment speeds ranging from 7.39% to 19.23% (weighted average of 14.87%) depending on loan type;
Delinquency rates ranging from 6.55% to 29.42% (weighted average of 17.04%) depending on loan type;
Interest rate of 1-month LIBOR plus 3.75% for computing the cost of financing advances;
Interest rate of 1-month LIBOR for computing float earnings; and
Discount rates ranging from 11.33% to 17.13% (weighted average of 12.80%).

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. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

Fair Value MSRs

MSRs carried at fair value are classified within Level 3 of the valuation hierarchy due to the use of third party valuation expert pricing without adjustment. The fair value of these MSRs is within the range of prices provided by the valuation experts, however, a change in the valuation inputs utilized by the valuation expert or a change in the best point price in the range might result in a significantly higher or lower fair value measurement.

The key assumptions (generally unobservable inputs) used in the valuation of these MSRs include:

Mortgage prepayment speeds;
Delinquency rates, and
Discount rates.

The primary assumptions used in the September 30, 2013 valuation include an 8.95% weighted average constant prepayment rate and a discount rate equal to 1-Month LIBOR plus 10.50%.

Advances

We value advances that we make on loans that we service for others at their net realizable value which generally approximates fair value because advances 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.

Secured Borrowings – Owed to Securitization Investors

We recognize the proceeds from the transfer of reverse mortgages as a secured borrowing that we account for at fair value. These borrowings are not actively traded and therefore quoted market prices are not available. We determine fair value by discounting the future principal and interest repayments over the estimated life of the borrowing at a market rate commensurate with the risk of the estimated cash flows. Significant assumptions include prepayments, discount rate and borrower mortality rates for reverse mortgages. The discount rate assumption for these liabilities is based on an assessment of current market yields for newly issued HMBS, expected duration and current market interest rates.

23
 

The more significant assumptions used in the September 30, 2013 valuation of our Secured Borrowings – Owed to Securitization Investors include:

Life in years ranging from 2.94 to 22.85 (weighted average of 6.15),
Conditional repayment rate ranging from 4.80% to 37.97% (weighted average of 8.44%) and
Discount rate of 1.17%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Match Funded Liabilities and Other Borrowings

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 future principal and interest repayments at a market rate commensurate with the risk of the estimated cash flows. We estimate principal repayments of match funded liabilities during the amortization period based on our historical advance collection rates and taking into consideration any plans to refinance the notes. At September 30, 2013, the interest on all borrowings under match funded facilities was based on a variable rate adjusted regularly using a market index and therefore the carrying value approximates fair value. For the SSTL, we used a discount rate of 5.50% and the repayment schedule specified in the loan agreement to determine fair value.

Derivative Financial Instruments

We may execute interest rate swaps to hedge against the effects of changes in interest rates on our borrowings under advance funding facilities. These derivatives are not exchange-traded and, therefore, quoted market prices or other observable inputs are not available. Fair value is based on information provided by third-party pricing sources. Third-party valuations are derived from proprietary models based on inputs that include yield curves and contractual terms such as fixed interest rates and payment dates. Although we have not adjusted the information obtained from the third-party pricing sources, we review this information to ensure that it provides a reasonable basis for estimating fair value. Our review is designed to identify information that appears stale, information that has changed significantly from the prior period and other indicators that the information may not be accurate. For interest rate contracts, significant increases or decreases in the unobservable portion of the yield curves in isolation will result in substantial changes in the fair value measurement. We terminated our outstanding interest rates swaps on May 31, 2013.

In addition, we may use interest rate caps to minimize future interest rate exposures on variable rate debt issued on servicing advance facilities from increases in one-month LIBOR interest rates. The fair value for interest rate caps is based on counterparty market prices and adjusted for counterparty credit risk.

We enter into forward trades to provide an economic hedge against changes in the value of residential forward and reverse mortgage loans held for sale that we carry at fair value. Forward trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Forward contracts are actively traded in the market and we obtained unadjusted market quotes for these derivatives, thus they are classified within Level 1 of the valuation hierarchy.

IRLCs represent an agreement to purchase loans from a third-party originator, or an agreement to extend credit to a mortgage applicant (locked pipeline), or an agreement to sell a loan to investors, whereby the interest rate is set prior to funding. IRLCs are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. Fair value amounts of IRLCs are adjusted for expected “fallout” (locked pipeline loans not expected to close), using models that consider cumulative historical fallout rates and other factors.

We previously entered into derivative contracts that included interest rate swaps, U.S. Treasury futures and forward contracts to hedge against the effects of changes in the value of the MSRs that we carry at fair value. Effective April 1, 2013, we modified our strategy for managing the risks of the underlying loan portfolios and no longer use derivative contracts to hedge against the effects of changes in the value of MSRs which we carry at fair value. The fair value of interest rate swaps were based upon projected short-term interest rates and volatility based on published market based sources, a Level 3 valuation. Because futures and forward contracts are actively traded in the market, they are classified within Level 1 of the valuation hierarchy.

See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information regarding derivative financial instruments.

24
 
Note 6 Loans Held for Sale, at Fair Value

Loans held for sale, at fair value, represent residential forward and reverse mortgage loans originated or purchased and held until sold to secondary market investors, such as GSEs or other third party investors. The following table summarizes the activity in the balance of Loans held for sale during the nine months ended September 30, 2013:

Balance at December 31, 2012   $ 426,480  
Originations and purchases (1)     5,988,501  
Proceeds from sale     (6,033,785 )
Loss on sale of loans (2)     (46,962 )
Other     868  
Balance at September 30, 2013   $ 335,102  
(1) Purchases include $60.0 million of reverse mortgages acquired in the Liberty Acquisition.
(2) Includes gains of $14.5 million and $20.6 million recorded during the three and nine months ended September 30, 2013, respectively, to adjust Loans – Restricted for Securitization Investors to fair value.

The following table summarizes the activity in Gain on loans held for sale, net, during the periods ended September 30:

    Three Months     Nine Months  
    2013     2012     2013     2012  
Gain on sales of loans (1)   $ 4,622     $     $ 36,156     $  
Change in fair value of IRLCs     18,912             5,918        
Change in fair value of loans held for sale     14,362             1,452        
Gain (loss) on hedge instruments     (9,408 )           30,989        
Other     (226 )           (1,603 )      
    $ 28,262     $     $ 72,912     $  
(1) Includes gains of $16.3 million and $63.2 million for the three and nine months ended September 30, 2013, respectively, representing the value assigned to MSRs retained on sales of loans. Also includes gains of $4.1 million and $20.3 million recorded during the three and nine months ended September 30, 2013, respectively, on sales of repurchased loans into Ginnie Mae guaranteed securitizations. These loans are classified as held for sale at the lower of cost or fair value. See Note 13 – Other Assets.
Note 7 Advances

Advances, representing payments made on behalf of borrowers or on foreclosed properties, consisted of the following at the dates indicated:

    September 30,
2013
    December 31,
2012
 
Servicing:                
Principal and interest   $ 149,184     $ 83,617  
Taxes and insurance     604,636       51,447  
Foreclosures, bankruptcy and other     183,861       41,296  
      937,681       176,360  
Other     8,606       8,103  
    $ 946,287     $ 184,463  
25
 
Note 8 Match Funded Advances

Match funded advances on residential mortgage loans that we service for others are comprised of the following at the dates indicated:

    September 30,
2013
    December 31,
2012
 
Principal and interest   $ 235,766     $ 1,577,808  
Taxes and insurance     218,952       1,148,486  
Foreclosures, bankruptcy, real estate and other     79,007       322,950  
    $ 533,725     $ 3,049,244  
Note 9 Mortgage Servicing

Mortgage Servicing Rights – Amortization Method

The following table summarizes our activity related to MSRs for the nine months ended September 30:

    2013     2012  
Balance at December 31   $ 678,937     $ 293,152  
Additions recognized in connection with business and asset acquisitions (1)     1,208,222       181,949  
Additions recognized on the sale of residential mortgage loans     63,154        
Sales (2)     (17,523 )      
Servicing transfers, adjustments and other     2,052       (88 )
Amortization (3)     (197,899 )     (54,678 )
Balance at September 30   $ 1,736,943     $ 420,335  
                 
Estimated fair value at September 30   $ 2,532,239     $ 488,499  
(1) MSR recognized in connection with business and asset acquisitions during the first nine months of 2013 include:
MSRs of $391.9 million acquired in the ResCap Acquisition. See Note 4 – Business Acquisitions for additional information.
MSRs of $683.8 million acquired in the Ally MSR Transaction. The acquired MSRs relate to mortgage loans with a UPB of $87.5 billion owned by Freddie Mac and Fannie Mae. We also acquired servicing advances and other receivables of $73.6 million. We assumed the origination representation and warranty obligations of approximately $136.7 million in connection with a majority of the acquired MSRs. We had been subservicing these MSRs on behalf of Ally under a subservicing contract assumed by us in connection with the ResCap Acquisition.
MSRs of $127.0 million with a UPB of approximately $30.5 billion and related servicing advance receivables of $371.6 million acquired in the OneWest MSR Transaction.  We expect the remainder of the transaction to close during the fourth quarter. The total estimated purchase price is approximately $2.4 billion with $432.2 million attributed to MSRs and $2.0 billion attributed to servicing advances. The total UPB to be acquired is estimated at $72.4 billion. No operations or other assets were purchased in the transaction. In October 2013, we closed the purchase of approximately $6.6 million of MSRs with a UPB of approximately $1.1 billion and approximately $37.1 million of servicing advances. On November 1, 2013, we closed the purchase of approximately $235.6 million of MSRs with a UPB of approximately $32.9 billion and approximately $1.3 billion of servicing advances. See Note 26 - Subsequent Events for additional information.
(2) Cash proceeds from the sale were $21.5 million. These MSRs were sold with subservicing retained. The gain on the sale of $3.2 million has been deferred and will be recognized in earnings over the life of the subservicing contract.
(3) 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.

As disclosed in Note 3 – Transfers of Financial Assets, we sold certain Rights to MSRs during 2012 and 2013 as part of the HLSS Transactions. The carrying value of the related MSRs which have not been derecognized at September 30, 2013 was $465.8 million.

Mortgage Servicing Rights—Fair Value Measurement Method

This portfolio comprises servicing rights for which we elected the fair value option and includes prime forward mortgage loans for which we hedged the related market risks. We acquired these MSRs as part of the Homeward Acquisition. See Note 4 – Business Acquisitions for additional information.

26
 

The following table summarizes the activity related to our fair value MSRs for the nine months ended September 30, 2013:

Balance at December 31, 2012   $ 85,213  
Changes in fair value:        
Due to changes in market valuation assumptions     19,800  
Realization of cash flows and other changes     (8,075 )
Balance at September 30, 2013   $ 96,938  

Because the mortgages underlying these MSRs permit the borrowers to prepay the loans, the value of the MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and increase in periods of rising interest rates (as prepayments decrease). The following table summarizes the estimated change in the value of the MSRs that we carry at fair value as of September 30, 2013 given hypothetical instantaneous parallel shifts in the yield curve:

    Adverse change in fair value  
    10%     20%  
Weighted average prepayment speeds   $ (3,695 )   $ (7,234 )
Discount rate (Option-adjusted spread)   $ (2,148 )   $ (4,128 )

The sensitivity analysis measures the potential impact on fair values based on hypothetical changes (increases and decreases) in interest rates.

Servicing Revenue

The following table presents the components of servicing and subservicing fees for the periods ended September 30:

    Three Months     Nine Months  
    2013     2012     2013     2012  
Loan servicing and subservicing fees:                                
Servicing   $ 335,884     $ 145,861     $ 887,500     $ 394,454  
Subservicing     35,286       14,257       115,437       27,619  
      371,170       160,118       1,002,937       422,073  
Home Affordable Modification Program (HAMP) fees     40,213       21,687       118,412       55,761  
Late charges     30,445       16,370       85,930       52,891  
Loan collection fees     8,387       4,102       22,524       11,271  
Custodial accounts (float earnings)     743       942       4,533       2,393  
Other     32,309       19,792       99,056       34,046  
    $ 483,267     $ 223,011     $ 1,333,392     $ 578,435  

Portfolio of Assets Serviced

The following table presents the composition of our servicing and subservicing portfolios by type of asset serviced as measured by UPB. The servicing portfolio represents loans for which we own the MSRs while subservicing represents all other loans.

    Residential     Commercial     Total  
UPB at September 30, 2013                        
Servicing (1)   $   362,792,312     $     $   362,792,312  
Subservicing     72,027,114       495,312       72,522,426  
    $ 434,819,426     $ 495,312     $ 435,314,738  
                         
UPB at December 31, 2012                        
Servicing (1)   $ 175,762,161     $     $ 175,762,161  
Subservicing     27,903,555       401,031       28,304,586  
    $ 203,665,716     $ 401,031     $ 204,066,747  
(1) Includes UPB of $177.1 billion and $79.4 billion at September 30, 2013 and December 31, 2012, respectively, for which the Rights to MSRs have been sold to HLSS.

Residential assets serviced consist principally of residential mortgage loans, but also include foreclosed real estate. Residential assets serviced also include small-balance commercial assets with a UPB of $2.5 billion and $2.1 billion at September 30, 2013 and December 31, 2012, respectively, that are managed using the REALServicing™ application. Commercial assets consist of large-balance foreclosed real estate. The UPB of assets serviced for others are not included on our unaudited Consolidated Balance Sheets.

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Custodial accounts, which hold funds representing collections of principal and interest that we receive from borrowers, are held in escrow by an unaffiliated bank and are excluded from our unaudited Consolidated Balance Sheets. Custodial accounts amounted to $3.5 billion and $1.3 billion at September 30, 2013 and December 31, 2012, respectively.

Note 10 Receivables

Receivables consisted of the following at the dates indicated:

    Receivables     Allowance for
Losses
    Net  
September 30, 2013                        
Servicing (1)   $ 155,076     $ (19,413 )   $ 135,663  
Due from related parties (2)     35,383             35,383  
Income taxes receivable     23,955             23,955  
Other     30,372       (1,969 )     28,403  
    $ 244,786     $ (21,382 )   $ 223,404  
                         
December 31, 2012                        
Servicing (1)   $ 84,870     $ (1,647 )   $ 83,223  
Income taxes receivable     25,546             25,546  
Due from related parties (2)     12,361             12,361  
Other     18,577       (1,994 )     16,583  
    $ 141,354     $ (3,641 )   $ 137,713  
(1) The receivable balances arise from our Servicing business and include reimbursable expenditures due from investors and amounts to be recovered from the custodial accounts of the trustees. The balances at September 30, 2013 also include $67.4 million of receivables and $16.2 million of allowance for losses related to defaulted FHA or VA insured loans repurchased from Ginnie Mae guaranteed securitizations.
(2) See Note 23 – Related Party Transactions for additional information regarding transactions with Altisource and HLSS.
Note 11 Goodwill AND INTANGIBLES

The following table provides a summary of activity in the carrying value of goodwill during the nine months ended September 30, 2013:

                               
    ResCap
Acquisition
    Homeward
Acquisition
    Litton
Acquisition
    HomEq
Acquisition
    Total  
Balance at December 31, 2012   $     $ 342,626     $ 57,430     $ 12,810     $ 412,866  
Derecognition of goodwill in connection with the sale of a business (1) (2)     (128,750 )     (81,607 )                 (210,357 )
ResCap Acquisition (2)     201,810                         201,810  
Balance at September 30, 2013   $ 73,060     $ 261,019     $ 57,430     $ 12,810       404,319  
Liberty Acquisition (2) (3)                                     3,200  
Correspondent One (2)                                     101  
Balance at September 30, 2013                                   $ 407,620  
(1) On March 29, 2013, we sold the diversified fee-based business acquired in the Homeward Acquisition to Altisource and derecognized the assigned goodwill. On April 12, 2013, we sold the diversified fee-based business acquired in the ResCap Acquisition to Altisource and derecognized the assigned goodwill.
(2) See Note 4 – Business Acquisitions for additional information regarding this transaction.
(3) Acquired intangible asset related to licenses. The useful life is considered indefinite and therefore the intangible asset is not amortized.

 

For the ResCap Acquisition, the $73.1 million of remaining goodwill is assigned to the Servicing segment. For the Homeward Acquisition, $140.7 million of the remaining goodwill is assigned to the Servicing segment and $120.3 million is assigned to the Lending segment. The assignment of goodwill in the ResCap, Homeward and Liberty Acquisitions is preliminary pending the final purchase price allocation. For the Litton and HomEq Acquisitions, the entire balance of goodwill pertains to the Servicing segment.

28
 

We perform an annual impairment test of goodwill as of August 31 of each year. Based on our 2013 annual assessment, we determined that goodwill was not impaired.

Note 12 Debt Service Accounts

Under our advance funding facilities, we are contractually required to remit collections on pledged advances to the trustee within two days of receipt. The collected funds are not applied to reduce the related match funded debt until the payment dates specified in the indenture. The balances also include amounts that have been set aside from the proceeds of our match funded advance facilities and certain of our warehouse lines to provide for possible shortfalls in the funds available to pay certain expenses and interest. These funds are held in interest earning accounts in the name of the SPE created in connection with the match funded financing facility. The balance of such debt service accounts at September 30, 2013 and December 31, 2012 was $45.5 million and $88.7 million, respectively.

Note 13 Other Assets

Other assets consisted of the following at the dates indicated:

    September 30,
2013
    December 31,
2012
 
Loans – restricted for securitization investors, at fair value (1)   $ 290,853     $  
Loans held for sale, at lower of cost or fair value (2)     86,753       82,866  
Prepaid lender fees and debt issuance costs, net (3)     25,197       14,389  
Prepaid income taxes     23,112       23,112  
Derivatives, at fair value (4)     12,849       10,795  
Investment in unconsolidated entities (5)     11,767       25,187  
Real estate, net     8,346       6,205  
Interest earning collateral deposits (6)     6,533       31,710  
Acquisition deposits (7)           57,000  
Prepaid expenses and other     13,123       22,314  
    $ 478,533     $ 273,578  
(1) Loans sold into Ginnie Mae guaranteed securitizations that we include in our Consolidated Financial Statements because the transfers of reverse mortgage loans to the trusts did not qualify for sale accounting treatment. See Note 2 – Securitizations and Variable Interest Entities for additional information.
(2) The carrying values at September 30, 2013 and December 31, 2012 are net of valuation allowances of $27.0 million and $14.7 million, respectively. The balances include non-performing subprime single-family residential loans that we do not intend to hold to maturity. The balance at September 30, 2013 includes $67.8 million of loans that we are required to repurchase from Ginnie Mae guaranteed securitizations in connection with loan modifications and loan resolutions. The balance at December 31, 2012 includes non-performing mortgage loans with a carrying value of $65.4 million that we acquired in December 2012 and sold to Altisource Residential, LP in February 2013 for an insignificant gain.
(3) These balances relate to match funded liabilities and other secured borrowings.
(4) See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information.
(5) The balance at December 31, 2012 includes an investment of $13.4 million that represented our 49% equity interest in Correspondent One. As disclosed in Note 4 – Business Acquisitions, we increased our ownership to 100% on March 31, 2013. Effective on that date, we began including the accounts of Correspondent One in our consolidated financial statements and eliminated our current investment in consolidation.
(6) These balances include $1.5 million and $25.8 million of cash collateral held by the counterparties to certain of our derivative agreements at September 30, 2013 and December 31, 2012, respectively.
(7) The balance at December 31, 2012 represents an earnest money cash deposit we made in connection with the ResCap Acquisition. This deposit was subsequently applied towards the purchase price upon closing of the transaction on February 15, 2013. See Note 4 – Business Acquisitions for additional information.
29
 
Note 14 Match Funded Liabilities

Match funded liabilities are comprised of the following at the dates indicated:

                               
                Available     Balance Outstanding  
        Maturity   Amortization   Borrowing     September 30,     December 31,  
Borrowing Type   Interest Rate   (1)   Date (1)   Capacity (2)     2013     2012  
2011-Servicer Advance Revolving Trust 1 (3)   2.23%   May 2043   May 2013   $     $     $ 325,000  
2011-Servicer Advance Revolving Trust 1 (3)   3.37 – 5.92%   May 2043   May 2013                 525,000  
2012-Servicing Advance Revolving Trust 2 (3)   3.27 – 6.90%   Sep. 2043   Sept. 2013                 250,000  
2012-Servicing Advance Revolving Trust 3 (3)   2.98%   Mar. 2043   Mar. 2013                 248,999  
2012-Servicing Advance Revolving Trust 3 (3)   3.72 – 7.04%   Mar. 2044   Mar. 2014                 299,278  
Total fixed rate                             1,648,277  
Advance Receivable Backed Notes (4)   1-month
LIBOR (1ML)
+ 285 bps
  Apr. 2015   Apr. 2014                 205,016  
Advance Receivable Backed Notes Series 2012-ADV1 (5)   Commercial
paper (CP)
rate + 225 or
335 bps
  Dec. 2043   Dec. 2013     18,959       81,041       232,712  
Advance Receivable Backed Notes Series 2012-ADV1   1ML + 250
bps
  June 2016   June 2014           225,000       94,095  
Advance Receivable Backed Note   1ML + 300
bps
  Dec. 2015   Dec. 2014     12,383       37,617       49,138  
2011-Servicing Advance Revolving Trust 1 (3)   1ML + 300
bps
  May 2043   May 2013                 204,633  
2012-Servicing Advance Revolving Trust 2 (3)   1ML + 315
bps
  Sep. 2043   Sep. 2013                 22,003  
2012-Servicing Advance Revolving Trust 3 (3)   1ML + 300
bps – 675 bps
  Mar. 2044   Mar. 2014                 40,626  
2012-Homeward Agency Advance Funding Trust 2012-1 (6)   1ML + 300
bps
  Nov. 2013   Nov. 2013     5,646       19,354       16,094  
2012-Homeward DSF Advance Revolving Trust 2012-1 (3)   1ML + 450
bps
  Feb. 2013   Feb. 2013                 20,151  
Total variable rate                 36,988       363,012       884,468  
                $ 36,988     $ 363,012     $ 2,532,745  
(1) The amortization date of our facilities is the date on which the revolving period ends under each advance facility note and repayment of the outstanding balance must begin if the note is not renewed or extended. The maturity date is the date on which all outstanding balances must be repaid. In two advance facilities, there are multiple notes outstanding. For each note, after the amortization date, all collections that represent the repayment of advances pledged to the facility must be applied to reduce the balance of the note outstanding, and any new advances are ineligible to be financed.
(2) Borrowing capacity is available to us provided that we have additional eligible collateral to pledge. Collateral may only be pledged to one facility. At September 30, 2013, $0.1 million of the available borrowing capacity could be used based on the amount of eligible collateral.
(3) Facility was repaid in February 2013 from the proceeds of a new $1.4 billion bridge facility (Homeward Residential Bridge Loan Trust – 2013) with an amortization date of August 14, 2013. On July 1, 2013, we repaid the new bridge facility in full from proceeds received on the sale of servicing advances to HLSS.
(4) We repaid this facility in full in July 2013.
(5) On August 30, 2013, we amended this facility to reduce the maximum borrowing capacity to $100 million from $450 million.
(6) On October 21, 2013, we extended the maturity date of this facility to November 29, 2013 with two optional six-month extensions subject to lender approval.
30
 
Note 15       Other Borrowings

Lines of credit and other secured and unsecured borrowings are comprised of the following at the dates indicated:

                               
                Available     Balance Outstanding  
                Borrowing     September 30,     December 31,  
Borrowings   Collateral   Interest Rate   Maturity   Capacity     2013     2012  
Servicing :                                    
SSTL (1)   (1)   1ML + 550 bps;
LIBOR floor of
150 bps (1)
  Sept. 2016   $     $     $ 314,229  
SSTL (2)   (2)   (2)   Feb. 2018           1,293,500        
                                     
Senior unsecured term loan (3)       1-Month Euro-
dollar rate + 675
bps with a
Eurodollar floor
of 150 bps
  Mar. 2017                 75,000  
Financing liability – MSRs pledged (4)   MSRs (4)   (4)   (4)           643,595       303,705  
Financing liability – MSRs pledged (5)   MSRs (5)   (5)   (5)                 2,603  
Promissory note (6)   MSRs   1ML + 350 bps   May 2017           17,163       18,466  
Repurchase agreement   Loans held
for sale
(LHFS)
  1 ML + 250 – 345
bps
  Apr. 2014     47,878       52,122        
                  47,878       2,006,380       714,003  
                                     
Lending:                                    
Master repurchase agreement (7)   LHFS   1ML + 175 bps   Mar. 2014     230,085       69,915       88,122  
Participation agreement (8)   LHFS   N/A   May 2014           19,588       58,938  
Master repurchase agreement (9)   LHFS   1ML + 175 to 275
bps
  Aug. 2014     60,989       89,011       133,995  
Master repurchase agreement (10)   LHFS   1ML + 175 to 200
bps
  Sep. 2014     265,898       34,102       107,020  
Master repurchase agreement (11)   LHFS   1ML + 275 bps   Nov. 2013     21,873       78,127        
Financing liability – MSRs pledged (5)   MSRs (5)   (5)   (5)           10,403        
Mortgage warehouse agreement   LHFS   1 ML + 275 bps;
floor of 3.50%
  Jun. 2014     56,755       3,245        
Secured borrowings - owed to securitization investors (12)   Loans held
for
investment
  1ML + 220 bps   (12)           284,276        
                  635,600       588,667       388,075  
                                     
Corporate Items and Other                                    
Securities sold under an agreement to repurchase (13)   Ocwen Real
Estate Asset
Liquidating
Trust 2007-1
Notes
  Class A-2 notes:
1ML + 200 bps;
Class A-3 notes:
1ML + 300 bps
  Monthly           3,223       2,833  
                  683,478       2,598,270       1,104,911  
                                     
Discount (1)(2)                       (5,679 )     (8,232 )
                $ 683,478     $ 2,592,591     $ 1,096,679  
31
 
(1) In February 2013, we repaid this loan in full and wrote off the remaining discount as part of the loss on extinguishment.
(2) On February 15, 2013, we entered into a new SSTL facility agreement and borrowed $1.3 billion that was used principally to fund the ResCap Acquisition and repay the balance of the previous SSTL. The loan was issued with an original issue discount of $6.5 million that we are amortizing over the term of the loan. We are required to repay the principal amount of the borrowings in consecutive quarterly installments of $3.3 million. In addition, we are generally required to use the net cash proceeds (as defined) from any asset sale (as defined) to repay loan principal. Generally, this provision applies to non-operating sales of assets, and net cash proceeds represent the proceeds from the sale of the assets, net of the repayment of any debt secured by a lien on the assets sold. However, for assets sales that are part of an HLSS Transaction, we have the option, within 180 days, either to invest the net cash proceeds in MSRs or related assets, such as advances, or to repay loan principal. The borrowings are secured by a first priority security interest in substantially all of the assets of Ocwen. Borrowings bear interest, at the election of Ocwen, at a rate per annum equal to either (a) the base rate [the greatest of (i) the prime rate in effect on such day, (ii) the federal funds rate in effect on such day plus 0.50% and (iii) the one-month Eurodollar rate (1-Month LIBOR)], plus a margin of 2.75% and a base rate floor of 2.25% or (b) the one month Eurodollar rate, plus a margin of 3.75% with a 1-Month LIBOR floor of 1.25%. To date we have elected option (b) to determine the interest rate.
   
  On September 23, 2013, we entered into Amendment No. 1 to the Senior Secured Term Loan Facility Agreement and Amendment No. 1 to the related Pledge and Security Agreement. These amendments:
permit repurchases of all of the Preferred Stock, which may be converted to common stock prior to repurchase, and up to $1.5 billion of common stock, subject, in each case, to pro forma financial covenant compliance;
eliminate the dollar cap on Junior Indebtedness (as defined in the SSTL) but retain the requirement for any such issuance to be subject to pro forma covenant compliance;
include a value for whole loans (i.e., loans held for sale) in collateral value for purposes of calculating the loan-to-value ratio and include specified deferred servicing fees and the fair value of specified mortgage servicing rights in net worth for purposes of calculating the ratio of consolidated total debt to consolidated tangible net worth; and
modify the applicable quarterly covenant levels for the corporate leverage ratio, ratio of consolidated total debt to consolidated tangible net worth and loan-to-value ratio.
(3) We repaid this loan in full in February 2013.
(4) As part of the HLSS Transactions, we transfer certain Rights to MSRs to HLSS. Because we have not yet transferred legal title to the MSRs, we account for these transfers as financings with the proceeds from the sale of the Rights to MSRs recorded as a financing liability. The financing liability is amortized using the interest method with the servicing income that is remitted to HLSS representing payments of principal and interest. The liability has no contractual maturity but is amortized over the estimated life of the transferred Rights to MSRs. See Note 3 –Transfers of Financial Assets for additional information.
(5) We sold MSRs for certain loans to an unrelated third party in December 2012 and June 2013; however, we are required to repurchase the MSRs for any loans that cannot be refinanced by the purchaser under the federal government’s Home Affordable Refinance Program (HARP). As a result, the sale is being accounted for as a financing. The financing liability is being amortized using the interest method with the servicing income that is remitted to the purchaser representing payments of principal and interest. In June 2013 and September 2013, we derecognized the liability from the December 2012 sale related to loans that had been refinanced under HARP and recognized a total gain of $4.5 million gain on the retirement of the financing liability.
32
 
(6) Prepayments of the balance on this note may be required if the borrowing base, as defined, falls below the amount of the note outstanding.
(7) On March 19, 2013, the maturity date of the Master Repurchase Agreement was extended to March 18, 2014 and the maximum borrowing capacity was increased from $120.0 million to $300.0 million.
(8) Under this participation agreement, the lender provides financing on an uncommitted basis for up to $100.0 million at the discretion of the lender. The participation agreement allows the lender to acquire a 100% beneficial interest in the underlying mortgage loans. However, the transaction does not qualify for sales accounting treatment and is, therefore, accounted for as a financing. The lender earns the stated interest rate of the underlying mortgage loans while the loans are financed under the participation agreement. In April 2013, we extended the participation agreement maturity date to May 31, 2014.
(9) On August 3, 2013, we extended the maturity date of this facility to August 2, 2014.
(10) On September 27, 2013, we extended the maturity date of this facility to September 26, 2014,
(11) On October 28, 2013, we extended the maturity date of this facility to November 12, 2013.
(12) This represents amounts due to the holders of beneficial interests in Ginnie Mae guaranteed securitization that we include in our consolidated financial statements because the transfers of reverse mortgage loans to the trusts did not qualify for sales accounting treatment. There are no maturity dates; the borrowings mature as the related loans are repaid.
(13) This agreement has no stated credit limit and lending is determined for each transaction based on the acceptability of the securities presented as collateral.
Note 16 Other Liabilities

Other liabilities are comprised of the following at the dates indicated:

    September 30,
2013
    December 31,
2012
 
Liability for indemnification obligations (1)   $ 206,074     $ 38,140  
Accrued expenses     97,497       68,068  
Liability for certain foreclosure matters (2)     66,431       13,602  
Payable to servicing and subservicing investors (3)     27,063       9,973  
Checks held for escheat     24,965       33,259  
Liability for selected tax items     22,338       22,702  
Due to related parties (4)     16,535       45,034  
Derivatives, at fair value (6)     11,660       18,658  
Servicing liabilities (5)     11,568       9,830  
Accrued interest payable     9,455       5,410  
Other     61,122       23,861  
    $ 554,708     $ 288,537  
(1) The balance includes origination representation and warranty obligations and compensatory fees for foreclosures that may ultimately exceed investor timelines. These obligations were primarily assumed in connection with the Ally MSR Transaction, the ResCap Acquisition and the Homeward Acquisition. See Note 4 – Business Acquisitions, Note 9 – Mortgage Servicing and Note 25 – Commitments and Contingencies for additional information.
(2) We recognized $52.8 million of expense in Professional services in the second quarter of 2013 to establish the liability. We recognized the remaining $13.6 million of the liability as an adjustment to the initial purchase price allocation related to the Homeward Acquisition. We applied this measurement period adjustment retrospectively to our Consolidated Balance Sheet at December 31, 2012 with an offsetting increase in goodwill. See Note 25 – Commitments and Contingencies for additional information.
(3) The balance represents amounts due to investors in connection with loans we service under servicing and subservicing agreements.
(4) See Note 23 – Related Party Transactions for additional information.
(5) During the nine months ended September 30, 2013 and 2012, amortization of servicing liabilities exceeded the amount of charges we recognized to increase our servicing liability obligations by $0.5 million and $1.1 million, respectively. Amortization of mortgage servicing rights is reported net of this amount in the unaudited Consolidated Statement of Operations.
(6) See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information.
33
 
Note 17 Mezzanine Equity

Preferred Stock

On December 27, 2012, we issued 162,000 shares of Series A Perpetual Convertible Preferred Stock (the Preferred Shares) having a par value of $0.01 per share and paying dividends at a rate of 3.75% on the liquidation preference of $1,000 per share as part of the consideration for the Homeward Acquisition. The dividends are payable quarterly at the end of each calendar quarter.

The Preferred Shares are accounted for as equity and are classified as “mezzanine” equity in the unaudited Consolidated Balance Sheets. The conversion option of the Preferred Shares represents a Beneficial Conversion Feature (BCF) with an intrinsic value of $8.7 million which we accounted for as a discount on the Preferred Shares with an offsetting increase in additional paid in capital upon issuance. The BCF will be amortizing through the second anniversary of the issue date, the first date at which we can redeem the Preferred Shares.

We amortize the BCF discount on the Preferred Shares as a deemed dividend with an offsetting reduction in retained earnings.

The carrying value of our Preferred Shares reflects the following:

Initial issuance price on December 27, 2012   $ 162,000  
Discount for beneficial conversion feature     (8,688 )
Accretion of BCF discount (Deemed dividend)     60  
Carrying value at December 31, 2012     153,372  
Conversion of 100,000 Preferred Shares (1)     (100,000 )
Accretion of BCF discount (Deemed dividend) (2)     6,573  
Carrying value at September 30, 2013   $ 59,945  
(1) On September 23, 2013, holders elected to convert 100,000 of the Preferred Shares into 3,145,640 shares of common stock. See Note 23 – Related Party Transactions for additional information.
(2) Accretion includes a $3.5 million accelerated write-off of the unamortized discount related to the 100,000 Preferred Shares converted on September 23, 2013.
Note 18 Equity

Common Stock

On September 23, 2013, Ocwen paid $157.9 million to repurchase from the holders of our Preferred Shares all 3,145,640 shares of common stock that were issued upon their election to convert 100,000 of the Preferred Shares into shares of common stock. See Note 23 – Related Party Transactions for additional information.

On October 31, 2013, we announced that our Board of Directors had authorized a share repurchase program for up to an aggregate of $500.0 million of our issued and outstanding shares of common stock. Repurchases may be made in open market transactions at prevailing market prices or in privately negotiated transactions. Unless we amend the share repurchase program or repurchase the full $500.0 million amount by an earlier date, the share repurchase program will continue through July 2016. No assurances can be given as to the amount of shares, if any, that we may repurchase in any given period. The repurchase of shares issued in connection with the conversion of Preferred Shares is not considered to be part of this repurchase program and, therefore, does not count against the $500.0 million aggregate value limit.

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss (AOCL), net of income taxes, were as follows at the dates indicated:

    September 30,
2013
    December 31,
2012
 
Unrealized losses on cash flow hedges   $ 7,649     $ 6,310  
Other     (580 )     131  
    $ 7,069     $ 6,441  
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Note 19 Derivative Financial Instruments and Hedging Activities

Because many of our current derivative agreements are not exchange-traded, we are exposed to credit loss in the event of nonperformance by the counterparty to the agreements. We control this risk through credit monitoring procedures including financial analysis, dollar limits and other monitoring procedures. The notional amount of our contracts does not represent our exposure to credit loss.

The following table summarizes the changes in the notional balance of our holdings of derivatives during the nine months ended September 30, 2013:

    IRLCs     U.S.
Treasury
Futures
    Forward
MBS
Trades
    Interest
Rate Caps
    Interest
Rate Swaps
 
                               
Balance at December 31, 2012   $ 1,112,519     $ 109,000     $ 1,638,979     $ 1,025,000     $ 1,495,955  
Additions     4,062,236       85,000       9,316,350             1,280,000  
Amortization     (228,806 )           (33,372 )     (24,000 )      
Maturities     (3,709,513 )           (4,558,971 )           (295,604 )
Terminations     (549,877 )     (194,000 )     (5,627,670 )     (1,001,000 )     (2,480,351 )
Balance at September 30, 2013   $ 686,559     $     $ 735,316     $     $  
                                         
Fair value of net derivative assets (liabilities) at:                                        
September 30, 2013   $ 13,491     $     $ (12,185 )   $     $  
December 31, 2012   $ 5,781     $ (1,258 )   $ (1,719 )   $ 168     $ (10,836 )
                                         
Maturity     Oct. 2013 – Jan. 2014             Oct. 2013 – Nov. 2013              

Interest Rate Management

Match Funded Liabilities

We have previously entered into interest rate swaps in order to hedge against the effects of changes in interest rates on our borrowings under our advance funding facilities. These interest rate swap agreements required us to pay a fixed rate and receive a variable interest rate based on one-month LIBOR. At the time that we entered into the agreements, these swaps were designated as hedges for accounting purposes. As disclosed in Note 5 – Fair Value of Financial Instruments, we terminated these interest rate swaps on May 31, 2013 primarily because the custodial account float balances, which earn a variable rate of interest, are well in excess of variable rate borrowings under advance facilities. The earnings on these deposits reduce our exposure to changes in interest rates. We also purchased interest rate caps to minimize future interest rate exposure from increases in one-month LIBOR interest rates, as required by the certain of our advance financing arrangements. These caps were terminated with the payoff and termination of the related financing facilities.

Loans Held for Sale, at Fair Value

The mortgage loans held for sale that we carry at fair value are subject to interest rate and price risk from the loan funding date until the date the loan is sold into the secondary market. Generally, the fair value of a loan will decline in value when interest rates increase and will rise in value when interest rates decrease. To mitigate this risk, we enter into forward trades to provide an economic hedge against those changes in fair value on mortgage loans held for sale. Forward trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market.

Interest Rate Lock Commitments

IRLCs represent an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage applicant, whereby the interest rate is set prior to funding. The loan commitment binds us (subject to the loan approval process) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. The borrower is not obligated to obtain the loan, thus we are subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. Our interest rate exposure on these derivative loan commitments is hedged with derivatives, including forward contracts. We enter into forward contracts with respect to fixed rate loan commitments.

35
 

MSRs at Fair Value

The MSRs which we measure at fair value are subject to interest rate risk as the mortgage loans underlying the MSRs permit the borrowers to prepay the loans. Therefore, the fair value of these MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and increase in periods of rising interest rates (as prepayments decrease). Although the level of interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices, underwriting standards and product characteristics. Effective April 1, 2013, we terminated our hedging program for fair value MSRs. Prior to their termination, we used economic hedges including interest rate swaps, U.S. Treasury futures and forward contracts to minimize the effects of loss in value of these MSRs associated with increased prepayment activity that generally results from declining interest rates.

Asset Acquisitions

In March 2013, we entered into an interest rate swap to hedge the impact on cash flows of changes in the purchase price to be paid for MSRs acquired in the Ally MSR Transaction. This purchase was forecasted to occur in stages with the purchase price subject to adjustment based on changes in the 10-year swap rate between the date of the MSR purchase agreement and the date of each closing. We entered into an interest rate swap with a notional amount sufficient to yield changes in the fair value of the interest rate swap in response to changes in the swap rate that were essentially equal to and offsetting to changes in the purchase price of the MSRs. We designated the swap as a hedge for accounting purposes. We completed the transaction in April 2013 and terminated the swap agreement at the same time. See Note 9 – Mortgage Servicing for additional information regarding the Ally MSR Transaction.

The following summarizes our use of derivatives at September 30, 2013 and the gains (losses) on those derivatives for the nine months then ended. None of these derivatives was designated as a hedge for accounting purposes at September 30, 2013:

Purpose   Expiration
Date
    Notional
Amount
    Fair Value
(1)
    Gains /
(Losses)
    Consolidated
Statement of
Operations
Caption
Interest rate risk of mortgage loans held for sale and IRLCs                                    
Forward MBS trades     2014     $ 735,316     $ (12,185 )   $ 30,989     Gain on loans held for sale, net and Other, net
                                     
IRLCs     2013       686,559       13,491       5,918     Gain on loans held for sale, net
Total derivatives                   $ 1,306     $ 36,907      
(1) Derivatives are reported at fair value in Receivables, Other assets or in Other liabilities on our unaudited Consolidated Balance Sheets.

Included in AOCL at September 30, 2013 and December 31, 2012, respectively, were $12.1 million and $9.9 million of deferred unrealized losses, before taxes of $4.5 million and $3.6 million, respectively, on interest rate swaps that we designated as cash flow hedges. Changes in the losses on cash flow hedges included in AOCL during the nine months ended September 30, 2013 were as follows:

Accumulated losses on cash flow hedges at December 31, 2012   $ 9,878  
Additional net losses on cash flow hedges     12,363  
Ineffectiveness of cash flow hedges reclassified to earnings     (657 )
Losses on terminated hedging relationships amortized to earnings (1)     (9,434 )
Accumulated losses on cash flow hedges at September 30, 2013   $ 12,150  
(1) Where the hedging relationship has been terminated but the hedged transaction is still forecast to occur, losses on the hedging relationship that are included in AOCL are amortized to earnings in the periods in which earnings are affected by the hedged transaction. Amortization in the third quarter included $4.1 million of accelerated amortization as a result of the early repayment and termination of four advance financing facilities as a result of the July 1, 2013 HLSS Transaction.
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The statements of operations include the following related to derivative financial instruments for the periods ended September 30:

    Three Months     Nine Months  
    2013     2012     2013     2012  
Servicing and origination expense                                
Gains on economic hedges   $     $     $ 1,017     $  
Gain on loans held for sale, net                                
Gains on economic hedges     9,608             36,907        
Other, net                                
Gains (losses) on economic hedges (1)     (103 )     1,397       (3,822 )     6,645  
Ineffectiveness of cash flow hedges           47       (657 )     46  
Write-off of losses in AOCL for a discontinued hedge relationship     (7,780 )     (3,089 )     (9,434 )     (4,633 )
Write-off of losses in AOCL for hedge of a financing facility assumed by HLSS (See Note 3 –Transfers of Financial Assets)                       (5,958 )
    $ 1,725     $ (1,645 )   $ 24,011     $ (3,900 )
(1) Includes a gain of $3.4 million recognized during the three months ended March 31, 2012 from the termination of foreign exchange forward contracts.
Note 20 Interest Expense

The following table presents the components of interest expense for the periods ended September 30:

    Three Months     Nine Months  
    2013     2012     2013     2012  
Match funded liabilities   $ 11,249     $ 32,359     $ 66,678     $ 99,394  
Other borrowings (1)     95,496       24,877       228,198       60,160  
Debt securities:                                
3.25% Convertible Notes                       153  
10.875% Capital Trust Securities           473             1,894  
Other     3,310       708       8,463       2,059  
    $ 110,055     $ 58,417     $ 303,339     $ 163,660  
(1) Includes interest expense of $74.2 million and $14.0 million for the three months ended September 30, 2013 and 2012, respectively, and $168.6 million and $27.6 million for the nine months ended September 30, 2013 and 2012, respectively, related to financing liabilities recorded in connection with the HLSS Transactions. See Note 3 –Transfers of Financial Assets and Note 15 – Other Borrowings for additional information.
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Note 21 Basic and Diluted Earnings Per Share (EPS)

Basic EPS excludes common stock equivalents and is calculated by dividing net income attributable to Ocwen common stockholders by the weighted average number of common shares outstanding during the year. We calculate diluted EPS by dividing net income attributable to Ocwen, as adjusted to add back preferred stock dividends and interest expense net of income tax on the Convertible Notes, by the weighted average number of common shares outstanding including the potential dilutive common shares related to outstanding stock options, restricted stock awards, the Preferred Shares and the Convertible Notes. The following is a reconciliation of the calculation of basic EPS to diluted EPS for the periods ended September 30:

    Three Months     Nine Months  
    2013     2012     2013     2012  
Basic EPS:                                
Net income attributable to Ocwen common stockholders   $ 61,155     $ 51,400     $ 177,847     $ 115,582  
                                 
Weighted average shares of common stock     135,787,834       134,928,486       135,705,892       133,483,354  
                                 
Basic EPS   $ 0.45     $ 0.38     $ 1.31     $ 0.87  
                                 
Diluted EPS:                                
Net income attributable to Ocwen common stockholders   $ 61,155     $ 51,400     $ 177,847     $ 115,582  
Preferred stock dividends (1)                        
Interest expense on Convertible Notes, net of income tax (2)                       98  
Adjusted net income attributable to Ocwen   $ 61,155     $ 51,400     $ 177,847     $ 115,680  
                                 
Weighted average shares of common stock     135,787,834       134,928,486       135,705,892       133,483,354  
Effect of dilutive elements:                                
Preferred Shares (1)                        
Convertible Notes (2)                       1,347,642  
Stock options     4,263,965       3,769,099       4,030,297       3,468,156  
Common stock awards     5,396       5,296       11,301       2,713  
Dilutive weighted average shares of common stock     140,057,195       138,702,881       139,747,490       138,301,865  
                                 
Diluted EPS   $ 0.44     $ 0.37     $ 1.27     $ 0.84  
                                 
Stock options excluded from the computation of diluted EPS:                                
Anti-dilutive (3)           255,000             190,833  
Market-based (4)     547,500       1,726,250       547,500       1,726,250  
(1) The effect of our Preferred Shares on diluted EPS is computed using the if-converted method. For the three and nine months ended September 30, 2013, we assumed no conversion to common shares because the effect was anti-dilutive.
(2) Prior to the redemption of the 3.25% Convertible Notes in March 2012, we also computed their effect on diluted EPS using the if-converted method. Interest expense and related amortization costs applicable to the Convertible Notes, net of income tax, were added back to net income. We assumed the conversion of the Convertible Notes into shares of common stock for purposes of computing diluted EPS unless the effect was anti-dilutive. We issued 4,635,159 shares of common stock upon conversion of $56.4 million of the Convertible Notes.
(3) These stock options were anti-dilutive because their exercise price was greater than the average market price of our stock.
(4) Shares that are issuable upon the achievement of certain performance criteria related to OCN’s stock price and an annualized rate of return to investors.
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Note 22 Business Segment Reporting

Our business segments reflect the internal reporting that we use to evaluate operating performance of services and to assess the allocation of our resources. A brief description of our current business segments is as follows:

 

Servicing. This segment is primarily comprised of our core residential servicing business. We provide residential and commercial mortgage loan servicing, special servicing and asset management services. We earn fees for providing these services to owners of the mortgage loans and foreclosed real estate. In most cases, we provide these services either because we purchased the MSRs from the owner of the mortgage, retained the MSRs on the sale of residential mortgage loans or because we entered into a subservicing or special servicing agreement with the entity that owns the MSR. Our residential servicing portfolio includes both Agency and Non-Agency loans. Non-Agency loans include prime and subprime loans which represent residential loans that generally did not qualify under GSE guidelines or have subsequently become delinquent.

Lending. The Lending segment is focused on originating and purchasing Agency-conforming residential forward and reverse mortgage loans mainly through correspondent lending arrangements. We also commenced a direct lending business to pursue refinancing opportunities from our existing portfolio, where permitted. The loans are typically sold shortly after origination into a liquid market on a servicing retained basis.

Corporate Items and Other. Corporate Items and Other includes items of revenue and expense that are not directly related to a business, business activities that are individually insignificant, interest income on short-term investments of cash, corporate debt and certain corporate expenses. Business activities that are not considered to be of continuing significance include subprime loans held for sale (at lower of cost or fair value), investments in unconsolidated entities and affordable housing investment activities. Corporate Items and Other also included the diversified fee-based businesses that we acquired as part of the Homeward and ResCap Acquisitions and subsequently sold to Altisource.

We allocate interest income and expense to each business segment for funds raised or for funding of investments made, including interest earned on cash balances and short-term investments and interest incurred on corporate debt. We also allocate expenses generated by corporate support services to each business segment.

Financial information for our segments is as follows:

    Servicing     Lending     Corporate
Items and
Other
    Corporate
Eliminations
    Business
Segments
Consolidated
 
Results of Operations                                        
                                         
Three Months Ended September 30, 2013:                                        
                                         
Revenue   $ 496,302     $ 33,539     $ 1,801     $ (402 )   $ 531,240  
Operating expenses (1)     305,654       29,504       11,143       (41 )     346,260  
Income (loss) from operations     190,648       4,035       (9,342 )     (361 )     184,980  
Other income (expense), net:                                        
Interest income     859       3,066       1,454             5,379  
Interest expense (1)     (106,848 )     (3,279 )     72             (110,055 )
Other     (6,631 )     1,843       398       361       (4,029 )
Other income (expense), net     (112,620 )     1,630       1,924       361       (108,705 )
Income (loss) before income taxes   $ 78,028     $ 5,665     $ (7,418 )   $     $ 76,275  
                                         
Three Months Ended September 30, 2012:                                        
                                         
Revenue   $ 232,104     $     $ 873     $ (277 )   $ 232,700  
Operating expenses (1)     88,743             4,162       (112 )     92,793  
Income (loss) from operations     143,361             (3,289 )     (165 )     139,907  
Other income (expense), net:                                        
Interest income                 2,084             2,084  
Interest expense (1)     (58,144 )           (273 )           (58,417 )
Other     (963 )           (2,030 )     165       (2,828 )
Other income (expense), net     (59,107 )           (219 )     165       (59,161 )
Income (loss) before income taxes   $ 84,254     $     $ (3,508 )   $     $ 80,746  
39
 
    Servicing     Lending     Corporate
Items and
Other
    Corporate
Eliminations
    Business
Segments
Consolidated
 
Nine Months Ended September 30, 2013:                                        
                                         
Revenue   $ 1,381,872     $ 81,180     $ 19,758     $ (492 )   $ 1,482,318  
Operating expenses (1)     795,645       69,543       95,361       (131 )     960,418  
Income (loss) from operations     586,227       11,637       (75,603 )     (361 )     521,900  
Other income (expense), net:                                        
Interest income     1,382       12,432       3,516             17,330  
Interest expense (1)     (293,381 )     (10,108 )     150             (303,339 )
Other     (30,961 )     6,852       2,977       361       (20,771 )
Other income (expense), net     (322,960 )     9,176       6,643       361       (306,780 )
Income (loss) before income taxes   $ 263,267     $ 20,813     $ (68,960 )   $     $ 215,120  
                                         
Nine Months Ended September 30, 2012:                                        
                                         
Revenue   $ 606,689     $     $ 2,736     $ (812 )   $ 608,613  
Operating expenses (1)     252,542             12,659       (391 )     264,810  
Income (loss) from operations     354,147             (9,923 )     (421 )     343,803  
Other income (expense), net:                                        
Interest income                 6,434             6,434  
Interest expense (1)     (162,810 )           (850 )           (163,660 )
Other     (204 )           (5,765 )     421       (5,548 )
Other income (expense), net     (163,014 )           (181 )     421       (162,774 )
Income (loss) before income taxes   $ 191,133     $       $ (10,104 )   $     $ 181,029  
                                         
Total Assets                                        
September 30, 2013   $ 3,925,510     $ 778,777     $ 607,393     $     $ 5,311,680  
                                         
December 31, 2012   $ 4,498,043     $ 550,569     $ 634,143     $     $ 5,682,755  
                                         
September 30, 2012   $ 3,611,768     $     $ 544,248     $     $ 4,156,016  

(1) Depreciation and amortization expense are as follows:

 

    Servicing     Lending     Corporate
Items and
Other
    Business
Segments
Consolidated
 
Three Months Ended September 30, 2013:                                
Depreciation expense   $ 3,589     $ 135     $ 2,973     $ 6,697  
Amortization of MSRs     79,035       148             79,183  
Amortization of debt discount     330                   330  
Amortization of debt issuance costs – SSTL     1,178                   1,178  
                                 
Three Months Ended September 30, 2012:                                
Depreciation expense   $ 395     $     $ 1,564     $ 1,959  
Amortization of MSRs     20,150                   20,150  
Amortization of debt discount     1,199                   1,199  
Amortization of debt issuance costs – SSTL     1,207                   1,207  
                                 

Nine Months Ended September 30, 2013:

                               
Depreciation expense   $ 9,968     $ 209     $ 6,976     $ 17,153  
Amortization of MSRs     197,287       148             197,435  
Amortization of debt discount     1,082                   1,082  
Amortization of debt issuance costs – SSTL     3,264                   3,264  
                                 
Nine Months Ended September 30, 2012:                                
Depreciation expense   $ 1,069     $     $ 2,827     $ 3,896  
Amortization of MSRs     53,561                   53,561  
Amortization of debt discount     2,679                   2,679  
Amortization of debt issuance costs – SSTL     3,050                   3,050  
40
 
Note 23 Related Party Transactions

Relationship with Executive Chairman of the Board of Directors

Ocwen’s Executive Chairman of the Board of Directors, William C. Erbey, also serves as Chairman of the Board of Altisource, HLSS, Altisource Residential Corporation (Residential) and Altisource Asset Management Corporation (AAMC) . As a result, he has obligations to Ocwen as well as to Altisource, HLSS, Residential and AAMC. As of September 30, 2013, Mr. Erbey owned or controlled approximately 13% of the common stock of Ocwen, approximately 23% of the common stock of Altisource, approximately 1% of the common stock of HLSS and approximately 9% of the common stock of AAMC. Mr. Erbey’s percentage interest in Residential declined to 4% as a result of an additional public offering by Residential that closed on October 1, 2013.

Relationship with Altisource

Under the Services Agreement, Altisource provides various business process outsourcing services, such as valuation services and property preservation and inspection services, among other things. Altisource also provides certain technology products and support services to Ocwen under the Technology Products Services Agreement and the Data Center and Disaster Recovery Services Agreement. In addition, under the Data Access and Services Agreement, Ocwen has agreed to make available to Altisource certain data from Ocwen’s servicing portfolio in exchange for a per asset fee. Under the Support Services Agreement, Ocwen and Altisource provide to each other services in such areas as human resources, vendor management, corporate services, accounting, tax matters, risk management, law and consumer psychology.

In connection with the March 29, 2013 sale to Altisource of the diversified fee-based business acquired in connection with the Homeward Acquisition, Ocwen agreed to extend to August 31, 2025 the terms of the Services Agreement, the Technology Products Services Agreement, the Data Center and Disaster Recovery Services Agreement and the Intellectual Property Agreement with Altisource. In addition, Ocwen agreed to expand the terms of the Services Agreement to apply to the services as they relate to the Homeward servicing platform and further to establish Altisource as the exclusive provider of such services as they relate to the Homeward servicing platform. In addition, Ocwen agreed not to establish similar fee-based businesses (or establish relationships with other companies engaged in the line of similar fee-based businesses) that would directly or indirectly compete with diversified fee-based businesses as they relate to the Homeward servicing platform acquired by Altisource.

Certain services provided by Altisource under these contracts are charged to the borrower and/or loan investor. Accordingly, such services, while derived from our loan servicing portfolio, are not reported as expenses by Ocwen. These services include residential property valuation, residential