Onity Group Inc. (ONIT) Q1 2012 Earnings Report, Transcript and Summary

Welcome to the Ocwen 2012 First Quarter Earnings Conference Call. [Operator Instructions] This call is being recorded, if you have any objections, please disconnect at this time. I would now like to go ahead and turn today’s call over to Mr. John Britti. Sir, you may begin.

Thank you. Good morning, everyone and thank you for joining us today. My name is John Britti and I am Executive Vice President and Chief Financial Officer of Ocwen. Before we begin, I want to remind you that a slide presentation is available to accompany our remarks. To access the slides, log on to our website at www.ocwen.com, select Shareholder Relations. Then, under Events and Presentations you will see the date and time for Ocwen’s First Quarter 2012 Earnings. Click on it and register. When done, click on “Access event”. Click on how you would like to listen to the event, either Adobe Flash Player or Windows Media. Each viewer will be able to control the progression of the slides during the presentation. To move the slides ahead, please click on the gray button at the bottom of the page, pointing to the right. As indicated on Slide 2, our presentation may contain certain forward-looking statements pursuant to the Safe Harbor provisions of the Federal Securities Laws. These forward-looking statements may be identified by a reference to a future period or by use of forward-looking terminology. They may involve risks and uncertainty that could cause the Company’s actual results to differ materially from the result discussed in the forward-looking statements. For an elaboration of the factors that may cause a difference, please refer to the Risk Disclosure Statement in today’s Earnings Release, as well as the Company’s filings with the Securities and Exchange Commission including Ocwen’s Form S-3, 1st, 2nd and 3rd Quarter 2011 Form 10-Qs and 2011 Form 10-K. If you would like to receive our new releases, SEC filings and other materials via email, please contact: Linda Ludwig at linda.ludwig@ocwen.com. Our presentation also contains references to normalized results which are non-GAAP performance measures. We believe these non-GAAP performance measures may provide additional meaningful comparisons between current results and results in prior periods. Non-GAAP performance measures should be viewed in addition to and not as an alternative for the Company’s reported results under accounting principles generally accepted in the United States. As indicated on Slide 3, joining me for today’s presentation are Bill Erbey, Chairman of Ocwen and Ron Faris, President and Chief Executive Officer of Ocwen. Now I will turn the call over to Bill Erbey. Bill? Bill Erbey

Thank you, John. Let me start by summarizing a few key points for today’s call. First, Ocwen’s core earnings potential has increased substantially with the Litton acquisition and the close of the Saxon and Chase transaction. Additionally, we expect to incur less than $1 million in additional transaction expenses on these deals in the second quarter. Second, our operating results continue to meet or exceed our pro forma projections. Third, we have a very strong pipeline of potential transactions including agency and non-agency products including both MSR acquisitions and subservicing opportunities. Finally, our very strong cash flow and the success of HLSS put us in an excellent position to finance future business. We believe that we are well-positioned to fund all but the very largest new transactions without accessing the equity markets. All of these position Ocwen to deliver substantial value to our shareholders. Ron and John will discuss our financial results in more detail later. But let me start by discussing point one. The “Earnings Power of Ocwen.” In the first quarter of 2012, Ocwen’s normalized pretax earnings were $56.8 million, if we include ramp-up related expenses of $3.4 million. John will provide more information on our normalizing entries later. This represents a year-over-year increase of over 25% compared to the first quarter of 2011 where we had no ramp-up costs. Additionally, we deployed $615 million of capital in the Saxon and Chase transactions with targeted pretax returns of 25%. By increasing our capital invested by 50% we are creating robust earnings momentum for future quarters. Slide 4 demonstrates our performance expectations for recent transactions. As discussed in previous earnings calls, capital requirements start high and come down as we improve delinquencies and collect advances. Moreover, we incur higher expenses up front. As delinquencies and expenses declined, returns increase over the first 24 months and then level out. As seen in the graph on right-hand side of Slide 4. With respect to point 2, our strong operating performance, Slide 5 shows delinquencies and advances declining as planned, particularly on the Litton portfolio. By consistently meeting or exceeding our pro forma expectations, we are confident that we will meet our targeted return on capital. Ron will discuss our operating results in more detail later. With regard to point 3, our strong new business pipeline, we are currently pursuing new business opportunities with UPB in excess of $450 billion. We believe additional opportunities will develop over the next 18 to 24 months as banks continue to shed Legacy services and assets through sales of MSRs or subservicing arrangements. The largest opportunities are concentrated in several large banks and we are currently working with 2 large banks on slow subservicing arrangements. I’m pleased to announce that on March 2012 Ocwen entered into an agreement with Aurora Bank to purchase servicing rights for $1.9 billion in UPB of commercial mortgage loans, closing and servicing transfers expected at the end of May. We also see increased opportunity for Correspondent One, which should help us accelerate our long term growth strategy of acquiring prime slow-servicing. This is because significant changes are occurring in the prime lending market. There has been a contraction in Correspondent lending driven by market participants either significantly reducing their volume or leaving the business altogether. This has created a void of buyers to acquire closed loans from mortgage bankers including the members of Lenders One. Not surprisingly at the same time, there has been a sizable reduction in the current price paid for prime loan servicing rights. Agency MSRs that had been priced at a multiple of 4 to 4-and-a-half times the annual servicing fee, are now selling at a 2.5x multiple. As shown on Slide 6, paying 2.5x the annual servicing fee for agency MSRs at a 15% long-term constant pre-payment rate or CPR, resulted in a 19% return in equity which makes it attractive for non-bank institutions to retain servicing. At this pricing, Correspondent One should be competitive in buying loans. The critical assumption in this analysis is the long term CPR. Everything else is simply math. While it is true that mortgage rates are at an all-time low and the re-financing incentive for newly originated is minimal, Americans have historically moved on average every 7 years resulting in a minimum pre-payments fee of approximately 15%. During the first quarter of 2012, Correspondent One purchased $6 million of loans from the 3 members of Lenders One that were selected for its pilot program. Correspondent One also began selling the majority of its purchased loans to a large commercial bank. With the pilots phase operations now complete, Correspondent One in a measured fashion is rolling out its program to other members of Lenders One. During the remainder of this year, Correspondent One is targeting acquiring $500 million to $1 billion in loans. We expect to see a significant ramp-up in Correspondent One’s volume in 2013. Nevertheless, it is worth noting that newly originated prime servicing is not as profitable per dollar of UPB as subprime servicing or non-performing prime loan servicing. Please note that we do not differentiate between subprime servicing and highly delinquent prime servicing. How a loan starts its life is less important than how it ends up. What really matters is the delinquency rate. Performing loans servicing deploys less capital at lower returns than pools of highly delinquent loans. Highly delinquent mortgage servicing consumes 5-times the capital per dollar of UPB, principally in the form of advances not MSRs and can generate about 10 points rate of return on capital for Ocwen. So to generate the same level of profitability on performing loans servicing, Ocwen’s portfolio would need to be at least 6 to 7 times its current size. Non-performing loans generate higher returns on capital because there is greater scope to exploit cost and quality advantages. On Slide 7, we show an analysis of Ocwen’s cost advantage in servicing non-performing loans. Based on analysis comparing MIACS’s estimate of average industry cost for non-performing loans versus Ocwen’s, we have approximately a 70% cost advantage. In addition to operating expense advantages, Ocwen has demonstrated an ability to bring down advance rates and has interest rates far faster than others. To illustrate the impact of cost and quality advantages on overall margins, Slide 8 shows estimated average cumulative pro forma cash flow as a percentage of total revenue over the first 5 years on our most recent transactions. As you can see on the left, we expect to generate average cumulative pre-tax margins of about 53% on revenues. If Owen’s cost of servicing non-performing loans were in line with industry average, it would essentially reduce our pre-tax margin by half. In addition, as advances only declined over the first 5 years in line with UPB runoff, then higher interest cost would drive cumulative pre-tax margins under 10% which would mean pre-tax returns on capital in the low single-digits. Finally, on my last key point regarding our funding capacity, Ocwen is increasingly capable of funding all but the very largest new business opportunities without accessing equity markets. By completing the initial asset sale to HLSS in March and a follow-on $2.9 billion sale on May 1st, Ocwen has demonstrated that HLSS can be a solid source of financing. Indeed, the sale of HLSS plus internally generated cash enabled Ocwen to close this Saxon and Chase transaction without issuing $200 million of new Senior Secured Term debt as had been originally planned. Further, we believe that we can access Senior Secured Debt markets for up $600 million. In addition, Ocwen currently generates over $120 million a month of cash flow from operations. It remains our long-term to goal to sell our servicing assets to HLSS and turn Ocwen into an equity like, fee-for-service business. The impact of this should be higher returns on equity than we could achieve by keeping assets on Ocwen’s balance sheet. The effective cost of capital for HLSS is between 8% and 9%. Whereas, Ocwen seeks a 25% return on its capital. I will now turn the call over to Ron who will cover our operating results including the Litton integration and our onboarding of Saxon and Chase. Ron will also comment on the current regulatory environment as it relates to our servicing business. Ron?

Thank you, Bill. As Bill mentioned, integration of Litton continues to meet or exceed our expectations. As you can see on Slide 9, we saw a healthy increase in revenue in the Litton portfolio as a result of our modification efforts that drove a 3 point decrease in delinquencies during the first quarter. The Ocwen team has done an exemplary job in boarding over 240,000 Litton loans while simultaneously driving down delinquencies. Keep in mind, about one-third of these loans were over 60 days delinquent or in REO at boarding. Such performance is without precedent in the industry and demonstrates both the talent of Ocwen staff and the strength and scalability of our platform. The strong performance on Litton also did not distract Ocwen from improving its Legacy servicing portfolio. In the first quarter, we reduced overall delinquency from 27.9% to 25.6%. We completed 23,491 modifications in the quarter, an increase of almost 26% over the prior quarter. This was above the top-end of last quarter’s guidance of 20,000 to 22,000. In the first 3 months of the year, modification offers reached 28,500 which is a 32% increase over the last 3 months of 2011. This bodes very well for second quarter modifications, which we expect to be between 23,500 to 25,500. HAMP represented about 14.8% of these modifications. Principal reduction modifications including our shared appreciation modification or SAM, accounted for over half of our total modifications. SAM accounted for 28.5% of total modifications. On top of excellent operating results, we were also able to board approximately 104,000 loans on April 2nd for Saxon and Chase. I also believe that closing 2 such large highly delinquent transactions from different servicers on the same day is without precedent in the industry. As shown on Slide 10, we made substantial progress in reducing advances this quarter. In the first 3 months of 2012 net advances declined by $319 million. We expect continued declines in future quarters as we reduce Litton delinquencies. More detail on our first quarter results are available in today’s earnings release and our first quarter 10-Q which we expect to release in the next few days. To further improve upon our industry-leading cost structure, Ocwen also continues to invest in productivity enhancements. We have several initiatives underway that could substantially lower unit cost by year-end. On final note, I would like to say a few words about the current regulatory environment. Even though we are not signatories to the Federal Bank consent orders or the State Attorney General/Federal DOJ settlements, we believe that servicing requirements in those orders and settlements will become de facto vet industry practices. Likewise, we are mindful of the servicing practices announced by the new federal regulatory agency, the Consumer Financial Protection Bureau. We frankly welcome these rules and emerging best practices as they provide greater certainty regarding what is required of servicers. Moreover, these rules and practices present expansion opportunities, as financial institutions will look to subservice more business to specialty servicers with scalable capacity and a demonstrated ability to meet compliance requirements. In particular, the State AG/DOJ federal settlements with 5 large banks and potentially 9 additional banks require principle reduction modifications. Ocwen is a pioneer in principle reduction modifications. We have developed substantial process technology and unique product offerings to support principle reductions that keep homeowners in their homes and provide positive net present value results for loan investors. An important example is our share appreciation modification initiative, which has been extremely well-received by federal and state government agencies. Thank you for your time today. I would now like to turn the call over to our CFO John Britti. John?

Thank you, Ron. I would like to first walk through our normalized pretax income as shown on Slide 11. The first item is transaction related expenses of $16.1 million. Litton related transaction costs accounted for $9.7 million of this amount. Going forward, we expect no further transaction expenses for Litton. Overall, we came in about $4.3 million below our original estimate for Litton shutdown costs. The remaining transaction related expenses for the quarter are for Saxon and Chase. We expect to incur less than $1 million in additional transaction expenses on these deals in the second quarter. Our progress -- our revenue ramp-up on Litton and the addition of Saxon and Chase provide us with substantial earnings momentum going into the second quarter. The $4.6 million normalizing item related to our senior secured term loan, or SSTL, is made up of 2 components. As mentioned earlier, we canceled the $200 million upsize on the SSTL that we had originally planned to fund Saxon and Chase. As a result, we paid a $3.7 million cancellation fee to SSTL investors. The second item was triggered by the HLSS transaction in March. Under the terms of the SSTL, we are required to pay 25% of any funds received from asset sales to pay down the loan. The prepayment in March totaled $37.5 million. As a result, Ocwen incurred a $900,000 expense for early amortization of original issue discount. Hedge related adjustments account for the final normalizing item. As you may recall from last quarter we normalized a loss on currency hedges. This quarter we balanced that with $3.4 million net gain on the termination of our entire Indian rupee currency hedge position in January. Against this gain we had a $6 million unrealized loss on interest rate swaps. These swaps were put in place to hedge advanced financing on our HomEq transactions. When HLSS assumed a substantial portion of the HomEq match funded liabilities we lost hedge accounting. We are keeping the swaps in place to hedge new business. Overall, we had a net hedge related normalized loss of $2.6 million. Ocwen also incurred $3.4 million of ramp-up costs in the first 3 months of 2012. In the past we have not normalized for ramp-up costs so we did not do so this quarter as it would have complicated prior period comparisons. Nevertheless, we are providing ramp up expenses this quarter as they were unusually large and investors have asked that we provide additional direction on such costs. These costs primarily involve staffing and facilities expansion ahead of needs. We expect these costs to drop substantially in the 2nd quarter though we will continue to carry some excess capacity as long as opportunities warrant. Backing normalized costs out of our pre-tax income results in normalized pre-tax income from continuing operations of $53.4 million for the 1st quarter of 2012. Adding the impact of ramp-up expenses would have resulted in $56.8 million of adjusted normalized pre-tax income. This is a 25% improvement over Q1 2011 when the company had no ramp-up costs. As we will be executing more deals with HLSS, I want to spend a little time walking through the HLSS transaction in some more detail, though I would refer you to our 10-Q for a more complete description. Because Ocwen sold rights to mortgage servicing rights and not the M.S.R.s themselves the transaction is accounted for as a financing rather than a sale. As such, Ocwen's revenues do not change and M.S.R.s on our balance sheet do not change apart from our regular amortization. The largest financial statements impact shows up in 2 areas. First, the match funded advance assets and related match funded liabilities are removed from Ocwen's balance sheet. Second, Ocwen's interest expense increases. The increased interest expenses partially offset by removal of the match funded liabilities. The remaining interest expense is effectively what we must pay to compensate HLSS for their capital. As Bill noted earlier, we price our deals to higher rates of return than the implicit yield at which we sell assets through HLSS which should provide higher returns to Ocwen shareholders. It is worth noting that we sold the rights to M.S.R.s in March at a price that is $10 million more than the carrying value of the M.S.R.s. This amount will be realized over time as the rights to M.S.R.s amortize. At the end of March 2011, Ocwen had $683.9 million dollars in cash on the balance sheet in anticipation of the Saxon and Chase closings. Our liquidity position remained strong after these closings. Cash flow from operations in the first quarter of 2012 was a robust $373 million dollars. We also retained substantial unused borrowing capacity. As Bill mentioned earlier, we believe that we are well positioned to fund all but the very largest in new transactions without accessing equity markets. We anticipate further asset sales to HLSF and we have the ability to access substantial funding in senior secure debt markets. Thank you. We would now like to open up the call to questions. Operator?

[Operator Instructions] Our first question comes from Bose George.

My first question, I just wanted to get a break out of that $16.1 million charge between compensation and benefits and the other operating expenses. And also is the run rate for expenses the $86 million less the $16.1 and then less the $3.6 million of the ramp-up expenses?

I’m sorry, let's do one at a time. The $16.1 million dollars, the majority of the Litton related expenses are related to leases that we -- and closed down facilities. The majority of the -- about half of the Saxon and Chase related are compensation costs for folks we were carrying without the related revenues.

Okay, for the 16.1, do you just have the number that just goes into comp and benefits?

I don't have that handy, I'm sorry. You should be able to discern that from our 10-Q though.

Okay, and then just when I think about the run rate going forward is the way to think about it is the 86 less the 16.1 and the 3.6?

I think going forward it would be fair to say that we'll see substantial reduction in the ramp-up related expenses. We would probably at most run about $200,000 per month to carry some of the additional capacity we've got.

That’s in the numbers already. Our operating run rate is and I don't have the numbers right in front of me, but that is our current expenses in the quarter for comp and benefits, our current operating expenses less the 16 and the 3.8.

Yes, we should be running the same comp and benefits.

Okay. And I just wanted to go back to the comment you made about the HLSS and the impact on the interest expense. I didn't really understand that could you just repeat that, the interest expense impact from HLSS?

What happens is our overall interest expense goes up a bit. It's made it to 2 parts, we take the match funded liabilities off the balance sheet, and so that covers part of it. There is some net increase in our interest expense and that's effectively what we're paying for the capital that HLSS has to put up against those. Because we get that capital back when we execute the transaction.

Bo, this is Ron. One way we look at it is, the interest expense related to the associated advances that move off, that goes away, but we're still recording the 50 basis points servicing fee on the mortgage servicing rights that went over to HLSS. But you actually see an increase then in interest expense for what we're paying to HLSS to compensate them for, in effect, financing the MSR's.

Yes, that makes perfect sense. And then just a quick question on the Aurora commercial transaction, I'm just curious what the opportunities are like in that market. Could we see more along those lines or just any comment on that?

Well, it's still a much smaller market than our residential market. We did pick up some small commercial servicing when we took on Litton and this is a nice addition to that portfolio. As we continue to see opportunities in the commercial space, we will look to pursue them, but it is still a much smaller market at least what we think fits with our platform than the residential market. So it's going to be more opportunistic and won't have a significant impact on overall bottom line but we still think it's a good addition to our product mix and one we've been involved with for many, many years so we're very familiar with the asset class.

Our next question comes from Mike Grondahl.

Yes. The first one is just kind of getting at your comment in the press release where you say you expect to close additional transactions in the coming months. Can you kind of give us a flavor of what you think those transactions are, maybe, kind of, number, size, and type? And your confidence in that?

Mike, this is Bill. We'll try to give you some information without going into that level of detail. I think we're reasonably comfortable that we will close a fairly large agency servicing deal, and we're making, I think, very good progress on a flow business with respect to non-core servicing that several large banks have. Those tend to be, at the present time, in process. We're well down the path with those transactions. There are obviously other competitive deals out there that obviously you don't know until you've won the deal. So these are other deals that we've spent a lot of time on and have made reasonably good progress on.

Would you be willing to comment on the volume of UPB that is associated with those 2 deals?

That is a little difficult for us to do at this time. We would like not to do that. It is a meaningful number. Those deals represent a meaningful number compared to our existing book of business. Let me just leave it at that. Now some of them -- since some of them are subservicing and others are agency deals, they do not represent the same relative weighting in terms of profitability. It is very difficult. The most profitable business out there in terms of generating raw dollars by a wide margin, as I said in my prepared comments is non-performing loans, whether they are prime or subprime, where you own the MSRs. Those are quite substantial income generators. Obviously as you go down into more current product and as you go into subservicing as opposed to servicing, the impact of that is definitely mitigated. So really do not look at our business internally in terms of UPB, we think that a fairly -- that doesn’t tell you a whole lot. What really matters is the quality of that UPB in terms of its ability to generate income.

Great. And then can you maybe comment Bill, on just the progress or what you have done on the agency side to get some traction there because historically that has been less emphasis for you guys?

Right. I think we feel reasonably sanguine in terms of we will show some progress there in terms of deals in that space. And it just diversifies our business space but even if we won $100 billion of agency servicing, it would not materially move the needle on net income just because it has much lower capital investment within it. It actually has slightly lower return parameters than you would in our current piece of business. But we do think it provides diversification and shows that we can access that market. If you want us to generate income growth, income growth is really associated with the more delinquent portfolios where you have servicing. The 2 new deals we just closed last month represents a 50% increase in normalized earnings for the business and it’s only $30 billion or $27 billion of servicing but it deploys $615 million of equity at a 25% return. That is very, very important. You would have to do many, many more – 7x that amount to get anywhere close to that same level of income in terms of prime space.

Got you, that’s helpful Bill. And then 2 quick other questions; did you say that your backlog is not $450 billion? Did I hear that correctly?

Yes. I mean, with sort of that number you can pick. Let's say it's a huge number and you can pick a wide variety of numbers depending on where you assess yourself to be in the pipeline on transactions. There's certainly an enormous amount of business out there in the marketplace. So it just depends on where we put our marker as to what we say is a deal that's active and what we're pursuing.

Got you and then lastly, any surprises in the March quarter good or bad that you just kind of see as you've been going along?

Not really. What we're starting to see with the business and we've worked very hard on this for almost a period of 4 or 5 years, if you internalize Slide 4, the business really does track those curves. And it relates to our ability to do modifications, to reduce delinquencies within the portfolio and to maintain strict cost discipline in our operations. If you look at those charts, what it does is it shows you that -- the first quarter, I think, did extremely well because the one deal that shows, starts off negative in the first year was really the Litton transaction, so you have some degree of headwind with regard to that but as these deals and transactions mature the ramp-up in ROE far more outweighs any sort of amortization that you would have within the UPB. So I think we've gotten the business model down to a point where we track very closely or meet or exceed those projections that we’re showing or the performance that we're showing rather with respect to delinquencies and our cost structure.

Our next question comes from Ryan Zacharia.

The first thing is, you've got to be pretty big on the revenue line item and I saw that the Litton fees were 72 bps, which seems pretty high especially given the contractual rate is lower. I assume that was the first servicing fees due delinquencies going down. So is it really sustainable?

I think as you see long term, those should eventually come back down toward the contractual fee level. But we still have over $200 million in deferred servicing fees. They don't appear on our balance sheet and are ultimately what we are targeting to collect as we either bring loans current or take them through REO. I think that those lines, while inevitably they will come down, they are sustainable for probably some extended period of time.

Yes. I mean, Ryan, if you look at Page 9 and look at how many quarters on the HomeEq deal that we've been just under 70, it will level off at some point, but it stays above that line, the 50 basis point line, at least for many quarters. And Litton shouldn't perform any materially different than the Saxon and the HomeEq deals we've had on the books for quite a while.

Right. It's just that Litton was 4 basis points higher than either of those ended have a contractual fee that's 4 basis points lower so it's a pretty material difference if it's going to hang around 72 for a while.

Yes, but then again, I would point you to the revenues on the Saxon and HomeEq lines. I mean, even if you subtracted 4 basis points from those lines, and you will see some volatility quarter-to-quarter, but if it bounced around a few basis points below those lines, you'd still see substantial revenues for an extended period of time.

It should run at least in the high 60s for revenue off of that portfolio for the foreseeable future.

Okay. And I was surprised the advance facilities didn't come down more. Your advances were down $727 million, including HLSS. What drove that?

Well, there’s $413 million of that advance reduction was a sale to HLSS. So we excluded that from the advance reduction, from that chart.

No, no, no, but the corresponding liabilities didn't come down commensurate with the…

No, that's because we still carry all those as if they're on our…

Well, I think maybe the answer, Ryan, is keep in mind on April 2nd, we were funding the 2 new deals and so we were making sure that we were fully borrowing and had available cash ready to fund those 2 transactions. So I think had we not had 2 transactions ready to close, we would have used a lot of the cash to pay down the liabilities but we were carrying a tremendous amount of cash right at that point in time simply because we were closing 2 big transactions the day following the quarter.

Yes. Okay. That's what I thought it was. And what were hand payments in the quarter?

I can get you that number in a second.

Okay.

Go to the next question.

Yes, go to the next question while I'm pulling that up.

And then, I just wanted a little bit more clarity on these-ramp up expenses. Are you characterizing them as one-timers, or just expenses leading revenues? I wasn't clear on that.

Well, they were associated with the fact that the transaction closed much later than we thought and we were running through most of the quarter with fully staffed for those 2 new deals.

Right. So it's just expenses leading revenues that you would not expect OpEx to drop in the following quarter?

No, you wouldn't expect it to drop, but you would expect the revenues to ramp-up materially.

Got it. Got it. And on that last point.

I should say you'll see the normal ramp up, but it takes about a quarter. You'll see a lot more revenue but you won't get fully ramped until the subsequent quarter.

And by the way, those half-fees [ph] for the quarter were $12.7 million.

And one other question was, you just mentioned it, why did the transactions tax and then JP Morgan take so long to close?

I think as there's been more and more of these larger type transactions out there, they continue to get more scrutiny from regulatory bodies and other interested parties that creates friction. We did, I think, a great job of holding to our timelines on HomEq and Litton. And believe me, it was not easy to hold to our timelines there. But you're generally not going to make these things go shorter, if anything, they’re going to go longer. Both of these deals just ran into some friction. You saw in some of our filings that we changed, the Saxon deal changed from a stock purchase to an asset purchase. Which from our standpoint, we looked at it as very positive but it did create some delays in getting the deals closed. We think that some of the things that caused the friction, to the extent that they're in our control, we've dealt with them in such a way that on future transactions we can potentially minimize some of that. But a lot of the friction was on the seller's sides and so we would potentially see similar things on future transactions. Mostly it's there's a lot more scrutiny by regulatory parties and interested parties in these deals which just makes getting the process complete that much more difficult.

Okay. And then just 2 more questions, quickly. So the HLSS payment and interest expense, is that effectively the 32.5 bps on UPB?

Yes.

Like it would be like $12 million this quarter or something? Or fully ramped it would be about $12 million on a$15 billion portfolio?

Right and we added a deal on May 1st, as well.

Yes, yes. And then the final question is just on this $450 billion does that include ResCap being $350 billion?

Certainly that's something that's in our sights but it doesn't make up that large a portion of that, it does not make up as large a portion as you just stated.

Okay. You may have some portion of that in there.

We may have some portion of that in there, but that is not quite as large as you laid out.

And our next question comes from Douglas Katz [ph].

Bill, a 3-parter, real quick. Firstly, you recently have been outbid by Nationstar Mortgage on an immense transaction. If as you say, you are the low cost servicer, how could someone outbid you? Second question is some of your competitors including, again, Nationstar, apply aggressive gain on sale accounting. What is your posture on this subject? And finally, third, in the chart that you gave earlier in your presentation where you hypothesized a 19% ROE on new business, might that number be higher given the loss of homeowner mobility, because of the large decline in home prices nationwide, which would result in a longer turnover period. In other words, a longer period where people stay in their homes? Lower prepayments.

I'll try to answer your 3 questions in order. We don't know what happened with respect to the Aurora transaction. It certainly is a little puzzling to us given the change in -- given the cost advantage that we have, with respect to that portfolio. But again, the more delinquent a portfolio is, as you see on that slide, the greater the competitive advantage that we have with respect to winning those deals. I really can't comment specifically on what Nationstar was thinking in their bid there. But it did very much surprise us with respect to that. The second thing on gain-on-sale is, I was at a conference one time and Peter Lynch, he was referring to the airline industry, he said, “If investors knew then what they know today, they would have shut down Orville or Wilbur Wright.” Ostensibly, we’re in an industry that has managed to out-do the airline industry, specialty finance industry, in terms of generating negative retained earnings. You're seeing what I think is critical in this business, I can't comment on the airline business, is really your ability to generate cash. Cash is really the denominator that enables you to, basically, go ride through the cycles and be able to survive within this business. When you look at what's happening now in the industry, we're back to gain-on-sale. We saw gain-on-sale blow up the specialty finance businesses, in the 90s and again in the mid-2000s, and we're repeating that. Going back to the slide for example, on what you can afford to pay for prime MSRs, that sort of feeds into your third question Doug. The market has collapsed from what used to be a 5x multiple to 4x to 4.5x multiple. Today, you could arguably say the market is between 2x and 2.5x multiple. Keep in mind we own Lenders One. So we have more than a passing view into the market place. 1 in every 10 mortgage loans originated comes through our members. The key to that gain-on-sale assumption is, as you pointed out, what is your prepayment speed, what are you going to assume. And yes, it is true that today people are much less mobile, for a variety of reasons, not the least of which is that their homes are under water. So to the extent that you assume that we will have an extended recession going on many, many years, but you will tend to see lower mobility. Mobility tends, then to go back to the -- mean reversion if you will, tends to go back the 15% per year as the economy picks up. In other words, you get greater in good times.When you're dealing with a 30-year mortgage I think betting against the long term trend in U.S. -- in America's mobility doesn’t make a lot of sense. I mean, literally, if you book these assets at 4.5x and only assume no refinance premium, but just long term mobility movement you're almost at 0 in terms of return. So you’ve booked all of your profits up front and then you put a multiple on them. It's really a kind of perplexing thing to me. When we do our deals through Correspondent One we're going to book them at what we paid for them, which is 2.5x. I think you'll have then, a long term earnings stream that's justifiable. It may not always turn out to be that way, but it's justifiable. Same thing as when we bid on MSR's in the auctions. I mean the last time I checked, at auction the guy who bids the most wins. Arguably, you could state that if you were the high bidder you ought to market down to the cover bid because that's the next willing buyer and seller of the assets. I mean we see people out there being the high bidder and then marking them up. You can mark them up. Perhaps you can argue, like in our case, we are -- our costs are so low that we'll make more money on those assets. But when you don't have fundamental earnings besides the markups it just doesn't make a lot of sense to me. The market has gone back to embracing gain on sale, and there's very little measurement of quality of earnings I see in the marketplace today.

Our next question comes from Henry Coffey

The $86 million obviously includes about $16 million of the acquisition related cost. Under the assumption that there are no major transactions in the second quarter, is it fair for us to simply look at that as your core expense rate, just 86 minus 16, and then build forward from there? I mean, assuming that there's no new major flood of business.

I think that's fair. Apart from new business would be right.

Right. Exactly. Then secondly, you make a great point about the financial returns, but obviously the ROE's on prime MSR's given the capital deployment is attractive. Have you, on that front there have been some political issues surrounding MSR transfers, have you made any headway in terms of developing a U.S. front that will help you address some of those issues?

Are you taking about buying existing pools, or originating them?

No, buying existing pools.

Yes, we have, and that's what I was alluding to previously in a prior comment that I think you'll see something there.

And then...

And keep in mind that all of the agencies -- we’ll put anything on shore somebody wants to have on shore.

Right.

And I’ve sat in meetings with at least one of the agencies that, I won’t go into which one, and they were saying, "Well, we'd like it on shore", and I said, "That's fine. We'll do that." Then they said, "By the way what's the price?" Well, we gave them price onshore and offshore and they said, “We're going offshore, because we have an obligation as a conservator to get the best value for the taxpayers.” We'll do it any place. We'll put it on -- if you can find somebody that can speak English, I'll put it in Washington D.C. if they want it. It's an economic issue. It has nothing to do with where you can do it or where we want to do it. We'll do it with whatever our customers want to pay for. And the primary difference in cost between all the players because productivity levels, while some are better than others, the primary driver of cost structure is the location of personnel. It costs us 1/10 in India what it costs in the United States. There is no way, nor would you be permitted by any of the rating agencies, et cetera, to deviate materially from numbers of loans per servicer. So that is purely an economic issue with regard to it, we will be as efficient, if not more so, than anybody else, but the major driving impact on costs and profitability is the cost of your labor.

And then, on the servicer acquisition front, obviously everybody is looking and waiting to see what ResCap and Ally [ph] are going to do, the press has talked a lot about it, I don't know whether you have any thoughts on how that process is going to unfold, do you think the bondholders are likely to demand an open market bid for the servicing?

It's really, we're not in a position at the current time, unfortunately, Henry, to comment on that.

Mr. Bruce, of Bank of America.

My question, which I'll get to, following the comment, I guess I look at the quarter and it was very good execution obviously with the delinquencies falling and modifications growing, obviously, the onboarding of portfolios and the like, so that's very good, I guess, when you step back and look at what's going on there's clearly a little bit of a horse race that's gotten set up between Ocwen and Nationstar has been alluded to here, several times and obviously, that has kind of created an interesting dynamic around the stock, but that may or may not necessarily be the right way to think about shareholder value creation. The one that does tend to interest me is, you alluded to in several of your comments, the allocation capital into the different businesses where you can optimize the returns and ultimately grow earnings. We get a lot of questions as to what the depth of this non-performing or sub-performing part of the market will ultimately be and how you think about that is very interesting. If you could kind of just explore where this can ultimately go from a size standpoint and how you would look to optimize your capital base to best extract earnings out of that, please?

Sure. The last time I checked there was really not a limit on the amount of non-performing product that's out there today. There's well over $1 trillion worth of portfolios of loans that are not performing, both prime, subprime, Alt-A, etcetera. If you were to assume that you were to bundle those all into portfolios that had 30% delinquencies which looks like a subprime pool, you obviously would run into a number that's more than 3x greater than that, so you're up to almost a $4 trillion market potential. The real key, then, is really the willingness of the owners or the servicers, the owners of that servicing, whether they want to keep it themselves or they wish to get rid of it. I think there is an increasing trend on the part of the large banks to rationalize their portfolios and to begin to more aggressively dispose of portfolios within the market or dispose of servicing out there. I see a lot of interest right now in the subservicing aspect of it. We're dealing with 2 large banks right now on flow subservicing portfolios, so you're looking at a company that has $119 billion in servicing. There's potentially $4 trillion worth of market available. Most companies, if they were to grow 30% a year, everybody would think that's just amazing, and that truly is a drop in the bucket compared to the market potential. But it all depends on, not a lack of non-performing loans, my God, we're at an almost all-time high, it really relates to the willingness of the owners of that servicing to either subservice it or to sell that servicing.

And just as you are looking at these subservicing opportunities, is that, do you think, a by-product of the agreements that recently have been signed or is there anything you think is, maybe, focusing the current servicers willingness to want to subservice versus sell that servicing?

Well, I think a couple things. I think certainly the 2 levels on the agreements. I think the agreements sort of added clarity to the environment for the banks, so I think most of the banks now have a greater -- have vision as to where they'd like to go. I think that was very much a gating item, the agreement to do this. I think there's certain elements of it to, as banks have requirements to do a certain level principle reduction-mods within that. I think we've done about as many principle reduction-mods as the rest of the industry combined. So, I think that there's some impedance behind that. The reason we're seeing, I think, more sub-servicing today, granted I rather do servicing because you deploy more capital and you have larger gross profit, but the reason you're seeing more sub-servicing I think is because of our cost structures and our quality of bringing down advances. You match that with a bank's cost of capital and it's a pretty attractive alternative for them. We can put out there when there's really not a debate about what your capital is worth and everything else. If you really want to go head-to-head on what is the cost to sub-service, we think we'll win that every day.

Right. You've got a fairly well-demonstrated low cost structure. I guess that the challenge is always that other buyers can talk themselves into paying higher prices based on marginal costs that they may use in their fabrication of a particular bid. So that, I guess, tends to ultimately boil down to who's got the lowest cost of capital, in addition to the cost structure. Is that how you think about HLSS and other financing opportunities as ultimately just driving down the cost of capital to Ocwen?

Well, I think certainly in sub-servicing, it's really not a cost of capital. It's just sort of mano-on-mano in terms of what your cost structure is and do they think you're effective at reducing delinquencies. So on sub-servicing it's a little more straightforward. Obviously the other part that you mentioned on servicing, it becomes more of a cost of capital view. Now, we've tried to be pure as Cesar's wife here, in that, we happen to like -- if you were going to basically take a bet on servicing as a capital provider, we believe the smart bet, and I think the market shows that because of the discount rate, is to bet on sub-prime servicing. 90% of it is advances, which have 0 credit risk and 0 valuation risk, and 10% is MSR, which has 0 credit risk, but has limited valuation risk. If we go into the performing space on prime product, we are not intending to put that product into HLSS, because we think to do so, arguably everything else being equal, would drive the required dividend yield up. We would hope that given the amount of product that's out there in the market, that driving the cost of servicing down to the marginal cost of capital in terms of these vehicles is a very large supply of product, it's not exactly a thoughtful strategy.

Yes. I would agree.

I would add one thing or a couple of things. We think that as a non-bank, our cost of capital is highly competitive. But I think, as we demonstrated on the Slide 8, the quality of servicing matters a lot, when it comes to bringing down advance rates. So we believe we're very competitive for 2 reasons. One is, I think, versus other non-bank institutions, we believe we have a very competitive cost of funds. But more importantly, we've demonstrated our capabilities to drive down advances, and that makes a big difference even if the cost of capital was the same.

Yes, so even on the interest expenses we showed there, we just use, over time, far less capital than other players because of our ability, as John said, to reduce our advances.

Right. Well that all makes good sense and I do enjoy the horse race of sorts. Maybe lastly, if you could give us some thoughts as to how deep you believe the HLSS market to be, just in terms of capital formation for that particular vehicle? If you could address that at all?

Sure. The short answer is until we do it, we really don't know for sure. But if you look at several markets, which we haven't really addressed yet, I think we would be hopeful that we could ultimately not only expand the market but also drive the required yield down significantly. On a risk adjusted basis, it represents about a 400 basis point alpha. We happen to think the product would be useful in both the pension plan area, where there looking to get a 7.5% return and very, very low risk, and also in the retail market with people who want very, very safe investments and very good yield. Both of those markets we have not yet effectively addressed. Obviously the fiduciary or pension fund market or Taft-Hartley market takes a little longer to develop than it does with the other institutions that are major shareholders today. And when a stock comes out as an IPO, the investment banks, as you're well aware, tend to put it in a -- it's only suitable for growth accounts and high risk accounts, which is kind of a mismatch between what our investment objectives are and how it's marketed. So we're hopeful, as we begin to demonstrate our ability to generate excess cash flow and consistent dividends, that we will be permitted to access the retail systems for whom the product was really intended, which is really people who want to put money away and be able to sleep at night and still get a nice yield. We think when we do that the market will be fairly substantial, as you've seen in other sorts of income oriented investments and we'll be able to achieve a lower return than we have today.

Our next question comes from DeForest Hinman [ph].

I think you talked about potentially going to the Senior Secured Bond markets, $600 million if you did do a transaction. Do we have any indication of what that cost, that funding, might be?

We said we think we have the availability, but we're not planning on doing it today until we win a large transaction where we need it.

Do you have any indication as to how much that could cost?

Our SSTL today trades in the high 5s as a yield.

Our last question comes from Mike Randall.

Yes. Bill, just 2 follow up questions. With some of the sellers that you're talking to, can you talk about what's resonating with them and why their choosing Ocwen. And then maybe secondly, as it relates to Correspondent One, that appears to be a nice opportunity for some forward slow business in 2013. Any sense on the volume that you might be able to get from that?

Yes. Well trend [indiscernible] reverse, reverse over there, Mike. We're only comfortable today saying well we think we can do for the latter half of 2012, which is $500 million to a $1 billion. Obviously that is a huge ramp-up from what we did in the pilot program. And so I look at when we ramp businesses up we try to start slowly, but you tend to get a fairly exponential growth rate within it obviously. If we did a $1 billion next year in 2013 that would -- we wouldn't be talking about it, we wouldn't be spending the management time and effort to do it. So we would like to be a reasonably moderate size originator in that product in the marketplace today. When you talk to sellers, what resonates I think is -- are number of different things, particularly the longer the term the relationship. First of all, let's just be rather clear about it. Price matters. You need to be in the price range. I think the other part of it that's very important is really your operating systems, your ability first of all to get slow business from large banks you have to go through a very detailed underwriting by the parts of those banks, to make certain that you will comply with everything. That your systems are sound, that your processes are effective. So that you will be able to provide good quality service to their customers, because the large banks, that is a major concern for them is that you will provide quality service. So our ability to provide that quality of service, demonstrate those systems, processes, and procedures, and our ability to board it without causing massive amounts of brain damage for them are really becoming very important. In order to join the club you have to have a price that makes sense for them. On the longer term relationships, not just the trade, the longer term relationships really resonate around quality and performance.

And I have no other questions from the phone line.

Thank you very much. We appreciate your time.

Thank you for participating in today’s conference. You may now disconnect at this time. Have a wonderful day.