Onity Group Inc. (ONIT) Q2 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ocwen Financial Second Quarter 2014 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Michael Bourque, Executive Vice President and CFO. Please go ahead, sir.

Thank you, Jamie. Good morning, everybody, and thank you for joining us today for Ocwen's Second Quarter 2014 Earnings Conference Call. Before we begin, please note that a slide presentation is available to accompany today's call. To access the presentation, please go to Shareholder Relations section on our website at www.ocwen.com and click on the Events and Presentations tab. As a reminder, the presentation and our comments this morning may contain forward-looking statements made pursuant to the Safe Harbor provisions of the federal securities laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. Forward-looking statements involve risks and uncertainties that could cause the company's actual results to differ materially from the results discussed in these forward-looking statements. In addition, the presentation and our comments contain references to non-GAAP financial measures such as normalized pretax earnings and adjusted cash flow from operations. We believe these non-GAAP financial measures may provide additional meaningful comparisons between current results and results in prior periods. Non-GAAP financial 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. For an elaboration of the factors I just discussed, please refer to today's earnings release as well as the company’s filings with the Securities and Exchange Commission, including Ocwen’s 2013 Form 10-K and quarterly 10-Qs. Note that we expect to file our second quarter 2014 Form 10-Q in the coming days. Joining me on the call today are Bill Erbey, our Chairman; and Ron Faris, President and Chief Executive Officer. Now I will turn the call over to Bill.

Thank you, Michael. Good morning, and thank you for joining us for today's call. As on our recent calls, I'm going to focus my comments specifically on why Ocwen enjoys a unique market position which should support continued portfolio growth going forward, and more importantly, how we believe the macro trends are truly aligned with Ocwen's strengths. I'll then close with a discussion on how we think about new business opportunities and share one idea we're in the process of launching. Ron will then provide an overview on the regulatory and compliance environment before discussing some highlights from the recent U.S. Department of Housing and Urban Development report on Making Home Affordable Program. Finally, he'll provide an update on our partnership with various constituencies on VAR outreach programs and our efforts to encourage dialogue around positive changes in the housing policy. Michael will then summarize our financial results for the second quarter and review our balance sheet and recent capital activity. First, let me address the macro environment, which we believe aligns extremely well with Ocwen's strengths. There are 4 key points: First, an improving U.S. economy increases the value of our business; second, the increased regulatory scrutiny presents both challenges and opportunities to Ocwen; third, large banks have a strong preference for outsourcing delinquent servicing; and fourth, there is a significant population of non-prime consumers whose financial needs are not being met. The U.S. economy continues to improve, albeit slowly. An improving economy serves to increase the value of our portfolio of MSRs by reducing the reasons for delinquency and lowering prepayments. Second, the heightened regulatory environment, of which we are all keenly aware, is both a challenge and an opportunity. Obviously, it's a challenge in the near term because it increases operating risk costs and can result in longer timelines for servicing transfers. It also adds uncertainty for those wishing to execute transactions, including specialty servicers and banks. Over the long run, however, we believe the regulatory changes have created opportunity for Ocwen. Most large banks don't like loans that are likely to default. Banks that already have huge servicing pools with higher levels of nonperforming loans than profitable before the recent changes in regulatory compliance increased their already high cost to service. So the increasing regulatory burden amplifies an already strong desire to shift away from credit-challenged products and transfer those activities to other participants. And for non-bank servicers, it levels the playing field, ensuring they are held to the same high standards as banks. We firmly believe that Ocwen has size and scale advantages, and we are very well capitalized in comparison to our peers. Ocwen is deeply committed to adhering to the highest standards of compliance and regulatory oversight. We've made significant investments in this area over many years and will continue to do so. Later in the presentation, Ron will review some of our recent investments with you. Based on comments from several regulators, the other potential change that could come out of the current environment are more stringent capital requirements. As we said before, we believe that any mandated capital requirements would be a relative benefit to Ocwen because our capital position is stronger than other non-bank servicers. Later in the presentation, we'll discuss what we call our economic balance sheet, which is our balance sheet after removing assets and liabilities or where we have sold our economic interest. The impact is significant and illustrates a robust balance sheet highlighted by a 1:1 relationship between our MSR value and tangible net worth and a low, 1.1:1 debt-to-equity ratio. Third, the forces that are expected to shift delinquent loan services away from the banks remain intact. Most important of the forces is that many banks have shifted their focus to activities that support their core banking franchise. These banks have a wide variety of consumer products they want to sell, and delinquent nonperforming borrowers are generally not their target customers. Moreover, these customers can be more of a distraction and increase the risk of adverse publicity. And as I discussed, most banks are not structured to profitably service nonperforming loans. As a result, we believe there's been a long-term shift in how mortgage servicing will work. At a minimum, we would expect 2 things: First, higher risk mortgage products are more likely to be serviced by specialists; and second, lower risk loans that do default will more than likely also be serviced by specialists. We believe this emerging servicing market will be one where Ocwen will compete very effectively. Finally, several factors suggests that there is significant unmet demand for alternative credit products to support home ownership. CoreLogic estimated last year that only 25% of all American households could qualify for a mortgage to buy a home. This compares to a precrisis estimate that approximately 60% of households could get mortgage loans financing in either the prime or non-prime lending market. Thus far, mortgage standards have been maintained on the origination and there has been no return of a non-prime lending market. We've recently received reverse inquiries from major sources of capital to create mortgages that serve borrowers slightly below the prime lending standard. Expanding the credit metrics has also been solidly supported by community groups with whom we are in close contact. Let me state that we have no interest in originating non-QM loans given the penalties that an originator could incur. We do believe, however, that there are innovative products that could safely serve this underserved market and would not violate the QM rules. In most cases, these products will require a flexible servicing platform that can manage the risks associated with non-prime or credit-impaired servicing, which is where Ocwen has its greatest competitive advantage. Clearly, there's lots of work to do. We anticipate that it will be next year before this could become a meaningful opportunity. Next, let me discuss Ocwen's strengths and track record. We continue to believe that Ocwen is uniquely positioned as the most efficient and effective provider of non-prime mortgage servicing in an environment where the demand for our services should continue to rise, despite the current uncertainty on portfolio transfers. As we have shown in prior presentations, we've been ranked #1 in numerous third-party studies of aspects of servicing quality. We have a scalable platform, designed from the beginning to handle nonperforming loans. For example, by using in-depth dialogue engines and automated decision-making, we're extremely effective at returning loans to re-performing status and keeping them performing. As a result, we've been able to drive superior results for the loans we service. We have demonstrated consistent cost advantages in our platform. For example, based on comparisons against an independent third-party study, we estimate that our cost of servicing nonperforming, non-agency loans on the real servicing platform is 67% lower than the industry averages. Certainly, the heightened regulatory environment is raising compliance costs and extending processing times. But over longer term, we believe this strengthens Ocwen's competitive advantage because the changes increase the importance of scale and efficiency, and we believe that it places a greater premium on operational skills, where Ocwen excels relative to our competitors. Ocwen's platform is designed in such a way that we can more easily automate requirements than others, even if initially, almost everyone's processes, including ours, are more manual than we might like. As a result, we expect that, over time, our margin should improve and our competitive advantage will be maintained, if not increased. Further, Ocwen is subject to its own National Mortgage Settlement, which we agreed to abide by in 2013. Ocwen is the only non-bank and one of only 6 institutions which is specifically subject to its own National Mortgage Settlement. We believe we are uniquely positioned as a partner to banks as they look to shed nonperforming assets from their books. No one can actively claim that banks selling servicing to Ocwen are in any way undermining [ph] regulatory supervision. As a result, we believe we're better positioned than other potential acquirers as a low-risk solution to banks looking at possible buyers of their non-prime MSRs. Ocwen has a strong track record of integrating large portfolios and platform acquisitions. Since 2009, we've acquired and boarded over 3 million loans representing unpaid principal balance of over $510 billion. At the same time, we've continued to produce superior results in servicing these loans and resolving delinquencies more quickly and more effectively than the industry in general. Since 2008, we've helped more than 510,000 families keep their homes with sensible modifications, which is more than any other non-bank mortgage loan servicer in the country. Ocwen has been a leader in HAMP modifications as shown by Treasury data. We are a leader as well in private label modifications. We've also led the industry with innovative programs such as the Shared Appreciation Modification. Third-party studies by a variety of analysts point to Ocwen as a best-in-class loss mitigation servicer. In short, we help more homeowners become current on their mortgages, and by doing so, provide better results for mortgage investors. Our management team is fully aligned with shareholders. Our leadership team and board own approximately 17% of our stock. In addition, the board has put in place a share repurchase program under which we have purchased and retired more than 5.8 million shares so far in 2014, returning over $210 million to shareholders. Ocwen is financially sound, in keeping with the strategic goals we've followed for our entire history. Almost 50% of our asset base is investment grade. We also enjoy significantly lower leverage than our peers. As of the first quarter of 2014, our reported corporate debt to net worth ratio is roughly 1/3 our closest competitor. If you adjust the balance sheet for differences in fair value accounting to make a like comparison, we estimate our ratio is roughly 1/5 that competitor. Further, we've created and utilized innovative capital structures and relationships, such as with HLSS and with our recent OASIS bond transaction, through which we reduced the capital required and significantly lowered Ocwen's exposure to shifting prepayment rates and interest rate volatility. As a result of all these factors, we are the true leader in the industry as a best-in-class loss mitigation servicer. With our track record of efficiently boarding large acquisitions and our cost advantages and regulatory alignment, we believe we are the most attractive partner for banks looking to reduce their servicing of delinquent and non-prime loans. We generate the strongest operating margins and highest operating cash flow among our closest competitors in the non-bank servicing sector, which we expect to sustain in the future. Looking forward, we continue to look to use our capital to grow and capture attractive returns for shareholders. In addition to growing our core servicing business, we are also interested in expanding into adjacent or complementary businesses in which we can utilize our competitive advantages to achieve our return hurdles. A lot of you have asked us what opportunities we are considering, so I'd like to give you a construct of how we consider opportunities. First, any new opportunity we pursue has to align with long-term macro trends. We're not looking for short-term value creation, but opportunities that can add meaningfully to our long-term growth rate and return on equity. Second, we'll only enter a business if we feel we can capture and maintain a long-term competitive advantage. Our advantage may be related to our operational efficiencies or cost of capital or even tax structure, but we must view it as meaningful and sustainable versus our other competitors in the market. Third, any business we enter must have a demonstrated ability to generate positive cash flows with manageable risks, particularly liquidity and interest rate risks. Fourth, we prefer businesses that can be structured efficiently around repetitive processes where we can bring our operational expertise and innovation to bear to create best-in-class practices. Fifth, any use of a franchise would dilute our core servicing business. Sixth, once an opportunity is identified, we are not wedded to a single path of entry. Depending on the opportunity and the competitive environment, we would consider a combination of acquisitions or internal start-ups as a path to build the right platform with the right competitive advantages. And lastly, we must ultimately be able to capture a target of pretax return on equity of 25% or more. While we've had several new opportunities in various stages of development, I wanted to discuss one that builds directly off of our core mortgage servicing business. I'll also talk in broad terms at the end about an opportunity we're examining in the non-mortgage lending space. I believe that Ocwen has substantial opportunities to leverage our strong servicing capabilities by exercising cleanup calls, call rights or investing in existing private label RMBS tranches that we service. Most of RMBS securities we service have cleanup call provisions that allows the servicer to call the deal at par, typically when it has been paid down to 10% of the original unpaid principal balance. Notwithstanding slower prepayments, we see a steady stream of deals maturing in the next several years. The opportunity results from the arbitrage of the underlying loans in REO being worth more than the securities. In other words, the whole is worth less than the sum of the parts. A condition precedent to our investment is our belief that Ocwen's servicing creates strong cash flows for the securities overall. We're building out this program and expect to be in the market purchasing securities in the next few months. Ocwen is also close to executing on diversification efforts in an adjacent lending space as well. It's a bit premature to describe this initiative in detail, but we believe we can build a new franchise for Ocwen, largely organically, that will leverage our world-class collections ability, tax and operating efficiency, funding innovations, technology expertise and knowledge of managing a distributed vendor network to add a significant value for our shareholders. We're excited about this opportunity and expect to speak to you more about it in the very near future. And with that, I'll turn the call over to our President and CEO, Ron Faris.

Thank you, Bill. This morning, I will cover 3 main topics in my prepared remarks. First, I will provide an update on the regulatory environment and the impact this is having on Ocwen and the industry. And second, I would like to share with you some recently released results from the U.S. Treasury that highlight Ocwen's performance in the Making Home Affordable Program. And third, I will review our recent Housing Policy Day in Washington, D.C. and discuss our recent announcement about our Community Advisory Council. Let me start -- let me begin by stating that the notion that non-bank servicers are subject to less stringent regulation is simply untrue. We are subject to federal regulatory oversight by the Consumer Financial Protection Bureau or CFPB. In addition, we are subject to oversight from a host of others, including state regulators, Freddie Mac, Fannie Mae, FHFA, Ginnie Mae, FHA, private trustees and a broad range of clients for whom we service or sub-service loans, including some large national banks. Overall, we welcome regulatory oversight because it is good for the industry as it increases confidence in the markets, raises the standards for all servicers and removes marginal players from the market. Moreover, we believe that stricter regulation is ultimately a competitive advantage for Ocwen, as we're the only large non-bank fully subject to its own National Mortgage Settlement and monitoring. Certainly, in the near term, the imposition of higher regulatory standards can increase operating costs and extend process time. For example, the new CFPB rule that went into effect earlier this year extends foreclosure processes by generally not allowing foreclosures to be filed until a loan is 120 days delinquent versus the prior industry standard of 90 days. Also, the emerging compliance structures are driving towards near zero tolerance for error, which we embrace wholeheartedly, although it raises costs because of the additional activities and documentation now required under the regulation. There is no doubt that meeting the new regulatory standards has, at least in the short term, raised everyone's costs, including Ocwen's. We spoke in the first quarter about how we believe it is increasing the variable cost to service nonperforming loans for everyone in the industry. In addition, all servicers are adding substantially to their overhead cost, particularly for oversight and reporting. For example, in 2014 alone, we've made major investments in our compliance infrastructure, adding over 325 employees in legal, risk, audit and compliance. We are especially pleased to report that we have recently hired some additional highly skilled executives into our risk management, audit and compliance operation. We are moving as fast as we can towards a world-class enterprise risk management system. Not only will a CRM system strengthen our control environment, but in long term, it will allow us to improve operations, reduce risk and eliminate various operational expenses and losses. I'm sure that many of you are interested in the status of the Wells Fargo transaction we announced in January. Similar to last quarter, the deal remains on indefinite hold and we continue to cooperate with the New York Department of Financial Services. We have nothing new to report, and we will not be addressing questions related to New York or any other regulatory inquiries. We refer you to our 10-K and 10-Qs for more detail. Moving on, whereas many other servicers continue to focus their efforts on foreclosures and short sales, which displace families from their homes and communities, we continue to strive to reduce delinquencies and loan losses by keeping more families in their homes through sensible repayment and loan modification plans. As reported in the most recent Making Home Affordable Program performance report through May 2014, Ocwen has completed 279,834 HAMP first lien modifications, more than any other servicer. We have completed 63,422 HAMP principal reduction modifications, more than the next 3 highest servicers combined. Even more impressive is the fact that for homeowners who were not accepted for HAMP or who are disqualified from HAMP, Ocwen has the lowest foreclosure rate and the highest alternative modification and repayment plan rate. In other words, a family who has its home loan serviced by Ocwen has a significantly better chance of remaining in their home than if their loan is serviced by other large servicers. As third-party studies have confirmed, Ocwen's superior results in helping consumers avoid foreclosure through sustainable loan modifications also result in improved cash flow, lower delinquency rates and lower expected losses for loan investors. We have always been a strong supporter of the Making Home Affordable Program, and we're extremely proud that 20% of all active first lien HAMP modifications are serviced by Ocwen, a rate 33% greater than the next highest servicer. I would also like to address the recent report by the Special Inspector General for TARP. Ocwen is and has been compliant with laws, regulations and HAMP guidelines for handling modification requests. We do not have nor did we have a backlog of unprocessed modification applications. New rules that went into effect this year have changed if and when you can deny a modification application by a consumer. Historically, after a period of time, if a consumer was unable to provide a complete application, the application was denied. Regulators now require servicers to keep these partial applications open. Whether or not this is the reason for the discrepancy in the data used by say, TARP, we are not sure. However, we will continue to work with Treasury to clarify and/or correct any reporting discrepancy. The good news is, we continue to help more struggling families than any other servicer, and our customers are receiving the assistance they need from us to avoid foreclosure whenever possible. Moving on, I want to share with you some positive developments that underscore our long-standing commitment to building support and collaborating with nonprofit organizations and housing counseling agencies. First, on June 19, Ocwen hosted its fifth annual Housing Advocacy and Policy Forum in Washington, D.C. Participants included approximately 16 nonprofit and consumer counseling agencies, as well as key government officials from Treasury, HUD and the OCC. This forum provides an opportunity to exchange perspectives on important issues related to home ownership and allows our nonprofit partners to network with government officials responsible for developing policies and programs that they care about. The group discussed policy developments under the Making Home Affordable Program, and panelists discussed important topics, including access to mortgage credit and strategies to rehabilitate blighted communities. Importantly, the event also provides an opportunity for Ocwen to spend time with Washington policymakers in a positive environment, reinforcing our commitment to helping HAMP [ph] borrowers maintain their homes through the critical assistance of housing counselors. Second, as a leader in the mortgage servicing business, we have a responsibility to constantly evolve our company and serve as a thought leader. To that end, on July 16, Ocwen announced the creation of a Community Advisory Council, comprised of leading national, regional and local nonprofit community groups. The council, which I will chair, provides a forum for Ocwen executives and community advocates to share ideas and discuss policy issues. Our objective is to collaboratively identify opportunities to work together to preserve homeownership and improve servicer efficiencies, while at the same time, providing positive investor outcomes. We view these groups as valued partners in establishing and maintaining open and effective lines of communication with our customers. The work they do is critical to our business success and critical to communities nationwide. The council will serve to build and facilitate effective relationships with key stakeholders and will enhance the company's good standing and reputation overall. Finally, Ocwen continues to cosponsor with nonprofit organizations' community outreach programs across the country. These programs are designed to bring servicers, counselors and struggling homeowners together to find sustainable resolution. Just last week, we worked with We Help Community in Belle Glade, Florida, to hold a very successful outreach event in South Florida. We are cosponsoring another event with HOPE NOW in Central Florida in early August. These are just a few of the many events and programs we are proud to support and participate in. With that, I will turn the call over to our CFO, Michael Bourque.

Thank you, Ron. Today on the call, I will review our financial results and then update you on our balance sheet and recent capital repurchase activity. Beginning with a review of our financial results for the second quarter 2014. Ocwen generated a total revenue of $553 million, which was flat from the first quarter 2014. Servicing revenue was $520 million and was also flat sequentially. Higher REO commissions and residential servicing fees offset the impact of a 3% decline in the unpaid principal balance. Lending revenue of $31 million increased 8% from the first quarter of 2014. During the quarter, Ocwen originated $1.2 billion of forward loans and $145 million of reverse loans. Total operating expenses for the company were $345 million, of which -- sorry, which was down 1% versus the first quarter and down 8% year-over-year. On a normalized basis, operating expenses would have been up $6.1 million or 2% versus the first quarter. As I will discuss later, total operating expenses included about $20.3 million of costs that we will eliminate in our normalization. Total other expense in the second quarter 2014 was $130 million, which was 100 -- which was 15% higher than the first quarter. The big driver was a $12.7 million increase in interest expense payable to HLSS, which I will explain further on our normalization page. The second impact was the increased interest expense from having a full quarter of the OASIS notes, as well as our new high-yield bond offering. Collectively, they added $5 million in interest expense in the quarter. As a result of these factors, we reported second quarter 2014 net income of $67 million, which was down 12% sequentially. From an EPS standpoint, our reported diluted net income per share was $0.48 in the quarter, a decrease of 11% versus the first quarter of 2014. Cash from operating activities was $14 million. Additionally, a normalized view of adjusted cash from operating activities, a non-GAAP measure we typically provide, was also $14 million in the quarter. The only normalization adjustment here is the impact of the $67 million payment we made as part of our National Mortgage Settlement. This cash generation level is lower than our historical levels, largely as a result of $118 million increase in loans held for sale in our lending business, which is largely driven -- which is largely timing driven and the result of increased volume late in the quarter as mortgage rates fell. Ocwen's total effective tax rate for the quarter was 13.2%. Our projected annual effective tax rate was largely unchanged between the first and second quarter. As we have said in the past, our rate varies depending on where our earnings are generated and the relative mix of operations in the mainland U.S. Consistent with comments made last quarter, we would expect our tax run rate to be in the low to mid-teens through the rest of the year. Touching on a few key results for the second quarter. Both our servicing and lending businesses performed well operationally, with our combined operating income up 8% versus the first quarter of 2014. Our operating expenses were down 1% in the quarter. We are pleased to see reductions in our transition-related expenses, as well as in our uncollectible receivable costs, which were $9 million lower than the $24 million charge we took in the first quarter of 2014. However, these favorable items were offset by a significant increase in compliance and regulatory-related costs, which were up significantly over last quarter. The biggest item was roughly $12 million of expenses for the New York state and national monitors. These costs are a significant element of our cost base. It is difficult to anticipate their future magnitude. I can tell you that we expect to incur roughly $9 million in the third quarter in ongoing monitoring costs, about $3 million lower than we saw in the second quarter. We believe costs will remain significant through the duration of the monitoring periods. Ocwen delivered $77 million in pretax earnings and $110 million in normalized pretax earnings. Normalized pretax earnings were down 7% versus the first quarter of 2014, driven by the cost elements I mentioned earlier. Additionally, interest expense was higher as a result of the recent high-yield bond and OASIS transaction. $33 million of normalized items were led by $19.3 million of MSR fair value related charges, $8.3 million of integration, technology and other costs, and finally a $5.4 million onetime increase in compensation expense for the surrender of options back in April. I will address these items in more detail later in the presentation. Finally, we returned cash to shareholders. In the quarter, we repurchased 2.6 million shares of stock for $92.3 million at an average price of $35.45. In July, we repurchased an additional 1.2 million shares for $43.9 million under our share repurchase program. We also repurchased over 1.9 million shares from funds managed by WL Ross & Co. after they converted their remaining 62,000 preferred shares into common shares. These repurchase activities returned over $200 million to shareholders since April 1 of the year. We are also pleased that Wilbur Ross will remain on our Board of Directors. I will now discuss our Servicing segment, which performed well in the quarter. In the second quarter, total revenue of $520 million was flat versus the first quarter 2014 and up 2% from $510 million in the second quarter last year. This included $357 million of servicing revenue and $31 million subservicing revenue. Servicing revenue was flat versus the first quarter of 2014. Higher REO sales and the recognition of the deferred servicing fees were offset by the impact of a 3% smaller unpaid principal balance. We collected $109 million of HAMP fees, late fees and other fees, which was flat compared to the first quarter of 2014. From the standpoint of servicing operating expense, we saw costs decline 3% from the first quarter of 2014. Turning to our portfolio at midyear. In total, Ocwen provided servicing or subservicing services for a total of approximately 2.7 million loans, with a total of UPB or unpaid principal balance of $435 billion. Total UPB is down 3% from March 31, 2014, due to loan runoff. As of June 30, 2014, approximately 80% -- 87% of the loans were performing and the remaining 13% were nonperforming. Compared with the first quarter of 2014, the nonperforming percent of the population has declined by 90 basis points. Largely consistent with last quarter, approximately 48% of the loans are conventional loans, 42% are non-agency and 10% is government insured. The total prepayment rate, or CPR, was approximately 12.9%, which was up 170 basis points from first quarter. CPR related to prime loans was 14.4%, compared to 12.6% in the first quarter, and CPR related to non-prime loans was 11.3%, compared to 9.2% in the first quarter. These higher prepayment speeds are driven by an increase in total debt payoffs and higher REO sales, which we expected given the weather-related delays we witnessed in the first quarter. We had another successful quarter of modification activity with around 27,500 modifications completed. The pace of our modifications remains healthy, with modification offers up through the second quarter after a significant decline in March. Also encouraging is that modification offers in July were at their highest levels so far this year. This should bode well for modification volumes in the second half. In the quarter, we continued our efforts to transfer the remaining loans off of the legacy ResCap system to real servicing, transferring a total of over 300,000 loans. We're currently working on the final system enhancements necessary to transfer the remaining 340,000 loans, of which 250,000 are Ginnie Mae related. We expect this to be completed before the end of the year, after which the ResCap portfolio would have been fully boarded and we can complete our integration and restructuring efforts. This may mean some previously communicated shutdown costs may fall in 2015 rather than 2014. We are working through the schedule and will provide an update with more certainty at the third quarter earnings release. While this is modestly behind the schedule we discussed earlier this year, it is important to note the our focus is always on quality and compliance, and we are willing to accept some delays in order to execute the transition effectively and efficiently. We will not sacrifice quality to accelerate the transfer. Next, we will move to discuss our lending segment, which improved from the first quarter of 2014. In the second quarter, total lending revenue of $31 million was up 8% from the first quarter and down 8% from the second quarter last year. The second quarter revenue included $22 million from gains on sales of loans and $9 million of other revenues. The 8% lending revenue growth over the first quarter was driven by our reverse lending business, where stronger margins more than offset the decline in unit volumes. The forward business originated $1.2 billion and 6,378 units. Unit volumes in our directed [ph] broker segments led to 2% year-over-year increase. The portion of our volume related to the HARP program is 39%, a decline of 17 points versus the first quarter of 2014, but still significantly above where we were in 2013. Lending operating expenses declined by 14% compared to the prior quarter and by 6% versus the second quarter of last year. This was driven by significant headcount reductions and cost efficiencies in both our forward and reverse platforms. The lending segment posted pretax income of $7 million in the second quarter compared to $600,000 in the first quarter, driven by higher margins and lower costs. At the end of the second quarter, we estimate that our reverse business had $37 million of pretax, unrecognized, future embedded value in its Ginnie Mae servicing portfolio discounted at 12%, primarily comprised of the value of anticipated future borrowings draws. From a strategic perspective, we're focusing our forward origination segment on improving service, speed and accuracy in all of the channels. We are also deepening the Lenders One partnership by improving service and executing on building a strong product development franchise focused on products that Bill spoke about in his portion of the presentation. Next, let me review our normalizing adjustments for the second quarter of 2014. As in the past, we provide a normalized pretax income, which adjusts for the impact of certain items in the quarter. The normalization is designed to give a clearer view of the ongoing operating performance of the business. During the second quarter of 2014, we incurred $33 million in normalized -- normalization expenses and delivered $110 million of pretax normalized income. These costs are best understood broken down into 3 areas: Fair value related changes, integration and transition costs and compensation expense. The first is $19.3 million of charges related to MSR fair value changes. We believe it is helpful to begin normalizing for MSR fair value related changes to offer more clarity into the underlying performance of the business, to present our results more consistently with some of the other non-bank servicers, and to more closely reflect how many stock analysts and investors evaluate our results. The $19.3 million charge is broken into 2 items. The first item is related to our sale of rights to MSRs to HLSS. In the second quarter, there was a $12.7 million increase in the fair value of the rights to MSRs sold to HLSS. This raised the value of the liability we recorded on our balance sheet, lowering principal amortization and increasing interest expense. It is worth noting that if our non-agency MSRs had been recorded at fair value instead of lower of cost to market, there would have been a similar valuation increase in our MSRs, which would have offset the income statement impacts on the increase in interest expense. I would note that this did not result in any change in the cash paid to HLSS. Mechanically, it meant the split of the cash payment made to HLSS would result in $12.7 million less of note payable principal amortization than expected and more interest expense. We've normalized for this item as it is a direct result of an MSR fair value change. On January 1, 2015, we have the opportunity to change our MSR accounting election from lower than cost or market to fair value in whole or from a part of the portfolio. Ocwen is the only large servicer that does not carry the majority of its MSRs at fair value. We are currently evaluating our position on fair value accounting. Second item in the quarter is the $6.6 million adjustment related to the fair value change on a small part of our portfolio that is carried at fair value. This is consistent with remarks you've seen in the past. The next area of normalizing expenses is also consistent with what you've seen Ocwen report under normalization in the past. In the quarter, there was $8.3 million of integration, technology-related and severance cost primarily associated with the ResCap acquisition integration. The final area of normalization relates to compensation expense, specifically, costs in connection with Mr. Erbey's voluntary surrender of stock options in April. Compensation expense in connection with option grants is based on the value of the option on the grant date, which is then recognized ratably as compensation expense for the term of the option grant. In event of a voluntary surrender where there isn't a concurrent grant or re-issue of options, the appropriate treatment is to expense immediately any remaining unrecognized stock option value. Apparently, this was designed to prevent companies from canceling out of the money option grants to avoid compensation costs. This clearly is not that type of situation, but nonetheless, we expensed the remaining $5.4 million unrecognized balance in the quarter. Now that we've covered the various elements impacting our income statement, we thought it will be helpful to reground [ph] everybody on the drivers of our 7% decline in normalized earnings versus the prior quarter. Operationally, we saw a solid business performance. The servicing business delivered flat revenue on a smaller UPB base, and our lending business was up significantly after a tough first quarter. Normalized operating expenses were up 2% in the quarter. We booked $15 million of additional reserves from collectible advances. This was $9 million below the $24 million we recorded in the first quarter of 2014. While this is favorable versus our first quarter performance, the reduction, frankly, is not as significant as we expected, and we have more work to do here to bring the ongoing costs back down to a more historical run rate. That is followed by the approximately $12 million increase in monitor cost we discussed earlier. Finally, you have the increase in interest expense, which is higher than the first quarter as a result of OASIS and high-yield bond transactions completed in the first half of the year. This leaves us with $110 million of normalized pretax income. Next, we will discuss the strength of the Ocwen balance sheet. At June 30, 2014, Ocwen had total assets of $8.4 billion. A unique element of the balance sheet is the fact that we have many transactions that count as financing versus true sales for accounting reasons. The impact of these transactions effectively grossed up the balance sheet. Additionally, we have advances that are financed and have offsets in liabilities. We believe it is instructive to consider our balance sheet without these factors, and by so doing, highlight our position as the best capitalized nonbank mortgage servicer in the industry. You can see a simplified reported balance sheet on the left side of the page. We have our advances, MSRs and other assets. In the liabilities section, we split it between match-funded liabilities, financing liabilities and other liabilities, then we have our equity. As we walk from left to right, we are adjusting both our assets and liabilities for financing transactions. For instance, we have about $2 billion of advances and also $2 billion of match-funded liabilities against those advances, so we removed them. We have roughly $1.1 billion of reverse mortgages that have effectively been sold. But the accounting rules say that we need to treat them as a financing, so we also have $1.1 billion of liabilities against that. Finally, we have the rights to MSRs that Ocwen has economically sold to HLSS with servicing retained. These are also treated as financing, and our assets largely match our liabilities here. The impact of all of these is to leave us with $4.7 billion of assets, $2.8 billion of liabilities and $1.9 billion of equity, representing a debt-to-equity ratio of 1.1:1. This is a high-quality balance sheet with a significant portion, roughly 30% investment-grade assets. Note that this value is lower than the 50% mentioned before, as some of the assets were sold in the previously mentioned transactions. It is still, however, a significant percentage. As we also discussed earlier, our MSRs are carried at lower of cost or market. We estimate this to be roughly $400 million below their current fair value, indicating a relatively conservative presentation of the asset. You will also note our MSR to tangible net worth ratio is now roughly 1:1. Finally, you can see that at these low levels, Ocwen has significant capital flexibility to support our growth initiatives, should we need it. Moving on to capital allocation. Our capital allocation strategy is unchanged from what we discussed back in 2013. Our priority is to first deploy capital to support the growth of our core servicing business. Our next priority is to deploy capital to expand into similar or complementary businesses with sustainable competitive advantages that enable us to meet our return hurdles. Absent opportunities in this area, we will then look to return cash to shareholders by repurchasing shares when we consider them to be attractively priced. In the fourth quarter of 2013, we announced our board approved a $500 million share repurchase program. And in February of this year, we communicated a general goal, but not obligation, to repurchase shares at least equal to the prior period earnings in the 3 months following our earnings announcements. During the second quarter, the company repurchased 2.6 million shares at an average price of $35.47 per share, representing an aggregate value of $92.3 million. In July, we repurchased an additional $43.9 million of stock at an average price per share of $36.15. This brings the amount of repurchases dating back to the time when we announced our share repurchase program to $198.5 million. This is above our combined fourth quarter '13 and first quarter '14 earnings. Additionally, we purchased 1.9 million shares upon the conversion of our convertible preferred stock in July, bringing the amount of cash returned to shareholders since we announced our share repurchase program to $271 million. Our repurchase goals remain unchanged, and as of today, we intend to continue to repurchase stock in the third quarter 2014. Thank you for joining us today. We would now be happy to take your questions. Jamie, if you can...

[Operator Instructions] The first question comes from Henry Coffey from Sterne Agee. Henry J. Coffey - Sterne Agee & Leach Inc., Research Division: I don't -- when we look at the servicing market right now, it sounds like a logjam. There seems to be ample willingness on the servicers to buy troubled assets, ample -- particularly when you listen to comments coming out of the likes of JPMorgan, ample interest in moving past these problems. And so I would describe it as a logjam. But when you look at the output, it looks more like a drought. And I was wondering if you could give us a sense of how you see the market.

Henry, this is Bill. I think we're really cautious on commenting on how we see the market or what's coming into the market at present time. I think there are a variety of different factors that can affect that, and I think it's just -- it's not appropriate for us to comment on that. Henry J. Coffey - Sterne Agee & Leach Inc., Research Division: And then a second question, talking about the securitization buyouts. Can you give us a sense of what the economic cycle looks like that, given that you'll end up owning a bunch of whole loans? Do those goes to the likes of RESI, or do they stay with Ocwen? Or what would the life cycle look like on that investment?

We would -- we think there is an arbitrage by creating those loans in REO, and we would auction them off into the market. There's very -- exceptionally strong bids today for both performing, re-performing and nonperforming loans in REO. And it was an attractive transaction even before the run-up in price, and now it's become even more attractive. So our call rights enable us basically to truncate the time until one gets control of that value. And so we've -- once we do that, then we would look to sell the majority of those assets. Henry J. Coffey - Sterne Agee & Leach Inc., Research Division: And do you own these call rights now or they something that's going to require investment?

No. When you -- all -- servicing comes with call rights. Generally, 10% the right -- when the unpaid principal balance declines to 10%, it was -- it's embedded in there basically to achieve cost savings. When the security gets very small, it becomes less economical to service it. And that's why these were originally built into all the -- servicing agreements there in the business. So today, we own call rights somewhere between $150 billion and $200 billion of call rights.

The next question comes from Bose George from KBW. Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division: Just a follow-up on Henry's question, did you guys give the expected IRR on these kinds of investments?

They -- we're -- they differ by the way in which you execute it. It depends on whether or not they are longer-term positions that you hold before you execute the call, or whether you are able to do it almost simultaneously. So we prefer not to spend a whole -- for competitive reasons, not detail a lot of the reasons of why we would do that. But we certainly expect the business to meet our hurdle, expected hurdle of 25% return on equity. Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, great. And then just switching to operating costs, is there room to take costs down from current levels, especially if the portfolio continues to shrink?

Yes. As we talked, there are some offsetting factors as we've been building up our compliance infrastructure and absorbing some of the monitoring costs. That is still going to be a significant cost on a go-forward basis. But as the portfolio -- if it does run-off and as the compliance environment stabilizes, I think there's going to be meaningful opportunity to become more efficient. The value of moving towards 0 errors is, it eliminates a lot of the other costs that you end up incurring to address things that sort of are -- that don't go through the process perfectly the first time. So it's going to be an ongoing process. But I'm very excited and optimistic that we're going to have some good opportunity down the road to become even more efficient than we are today. Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division: Great. And actually one last one, just on the point you guys made about potentially fair valuing the MSR. I mean, if you did that, I guess amortization would go up. I'm just curious how you weigh sort of that factor? What are the factors you guys weigh in if you would make that decision?

That's a process that we go through typically every year starting about this time, and we look at various factors including the performance. One of the, I think, bigger advantages or disadvantages, depending on how you look at it is, we don't get the full equity credit of having those MSRs at fair value as you look at our capital base. And so that as the industry is talking about increased capital standards and the like, it's an important determination. But there's a whole host of factors including the accounting elements, the volatility in the quarterly earnings, the split of amortization versus the marks that we -- that we're making sure that we understand that and get our heads around as we make that evaluation. But as we do and have anything to announce or nothing to announce, we can talk more about that when it's appropriate.

Yes. So, we'll continue to evaluate that. And clearly, normally you'd think of the way we do it as resulting in less volatility. But here we are in a situation where there's a value increase on a portion of portfolio, requiring us to basically increase the liability, increase interest expense and not be able to show the corresponding increase in value of the assets. So even though our accounting policy today normally would be considered less volatile, there's a lot of factors coming into play, in this particular quarter, that's actually creating volatility.

The next question comes from Michael Grondahl from Piper.

Your approximate $300 million of operating expenses in your lending segment. Can you help us think about what percent of those are fixed and what percent are variable? And then secondly, on that sort of run rate level, do you have a lot of capacity to put on more volume without adding expenses?

So Mike, we don't generally disclose the split of variable cost within our business, first, but also within the lending segment. We've seen a relatively consistent level of volume here over the recent period of time and are evaluating our opportunities to grow the business. I think against obviously, increased cost investments and maybe just other things that we can do around enhancing -- the effectiveness of partnerships we have that could grow our business effectively without adding costs. So I think -- I guess, the short answer, I'd say there is opportunity probably to grow with adding costs and also opportunity to grow without.

And I would think the same way like the servicing business, Mike. I mean, we're much further along, but there are still significant opportunities to improve -- reducing -- improve quality, at the same time, reduce costs. There are even greater opportunities in the lending side of the business where we're nowhere near where the same level we are in the servicing business. So I think you saw some of the effects of that this quarter, which is just more efficient operations.

Okay. And did you guys break out legal cost in the quarter?

No, we didn't. I think you'll see more cost detail when we release our Q. I'd say the only, I guess, comments we've made around that effective impact of increased regulatory and compliance costs, which is a significant component of that, as Bear [ph] was always legal-related. But that's the -- I believe that's the extent of it.

Okay. And then any update on OASIS and any thoughts about another transaction there?

Well, we continue to kind of evaluate all of our alternatives around effectively hedging our prime portfolio and recognizing some of the embedded value that is not there today. So OASIS is a very innovative structure that serves us well, and it's -- we are not going to comment on timing, but it is definitely still part of our longer-term strategy.

I think too, one of the reasons we've been slow is because you can see the impact of carrying excess cash on your balance sheet in terms of excess interest expense, because you're really avoiding very low cost of advance financing charges. And also I think there's been some additional development work to be done in terms of another method for hedging the portfolio that may be more efficient, shall we say, than even OASIS transaction.

Okay. And then maybe just one last question. Your strategy for the RMBS kind of cleanup calls, if you will, what type of capital does that require?

Again it's -- it relates to the duration of how long you're holding the securities that you purchase in terms of, to get to a position that you need to put on the balance sheet. We really -- we prefer not to disclose exactly how much that is at the present time, because it is tells a little bit -- it gives more information than we would like about our strategy.

[Operator Instructions] The next question comes from Kevin Barker from Compass Point. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: Regarding the investment in cleanup calls relating to MBS, some of these whole loans are left over. Do you plan to sell them to potentially Altisource Residential? Or would you expect it to be bid out to several parties?

We would have to bid those out. We just can't assign them to one company. But I think you'll see a large -- it will create a meaningful amount of product that will be coming to market as a result of that. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: Can RESI participate in these auctions? Or is that off limits?

That would be something you'd have to ask RESI. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: Okay. And then regarding the potential change to fair value on the MSR, can you explain the strategy behind why you would change the fair value versus keep low comp? And how that would affect your balance sheet over a longer period of time?

As Michael said, I mean, we're just -- at this point, we're just in the evaluations phase. We have until the end of the year really to make that determination. As Michael pointed out, I think the biggest impact is our equity base, as we pointed out in prior calls is really understated relative to our competitors because we're not reflecting that significant increase or difference in fair value versus our carrying value. But there are a whole host of other things to consider. If you do make that adjustment, basically it's -- as I understand it, will be adjustment directly to your equity and you would not see the earnings come through the income statement, we just see it as a direct increase to equity. So there's a whole bunch of factors that we need to consider. I think we're still very early on in that evaluation phase. But I think, as I pointed out just a few minutes ago, it kind of becomes top of mind when we look at a quarter like this and see volatility driven largely because the fact that we're not at fair value. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: So would that allow you to increase leverage or look better in regards to the capital requirements that may come out in the future?

That's one of the things we're considering because we are not sure that lenders and others are able to distinguish between those companies that are on fair value, which is basically almost everybody, and Ocwen, who is not. And so we do think that we probably are not getting, in all cases, fair treatment. So that's one of the factors that's going into this consideration. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: Then one more, you -- in the last presentation, you mentioned that the internal valuation of the MSR was upwards of $3.7 billion and incrementally could be up as high as $4 billion. Now in your presentation in this quarter, you mentioned that the fair value is roughly, I believe, $390 million above low comp. It looks like it's about -- it was $850 million last quarter. What was the change in the fair value of the MSR between this quarter and last quarter, and maybe some of the details?

It wasn't a change, Kevin. It's like if we're going to mark it to market on our balance sheet, we're going to have rely -- it's going to be have to be marked based upon other people's cost, not ours.

Yes, that's right. The other difference is, when we talk about the -- there's a range of values typically these brokers give you. There's a midpoint value and then a high-end value. So the midpoint value is what's reflected here as that's what would ultimately be used for a test of impairment. But as Bill alluded to, there's other factors like costs and things like that, that help kind of the Ocwen story as well as the fact that there's other range of assumptions in the actual model themselves that could lead a higher value closer to the $800 million that you've seen in the past. What I'd tell you, Kevin, is there really wasn't a material change in the underlying value of our MSRs kind of in that broader context, from the first to second quarter. It's more of a presentation on midpoint of the range versus the high end, and if you're looking at the broker assumptions versus what Ocwen may represent. Kevin Barker - Compass Point Research & Trading, LLC, Research Division: Okay. So there was internal and external valuations, is that the way you'd look at it?

Yes.

The next question comes from Ken Bruce from Bank of America.

I've got a number of questions. So maybe to get started, I guess I'd like to understand the cost structure that you're looking at right now. And so I think if I heard you right, some of the cost savings that were anticipated later in 2014 are likely more in 2015. Could you maybe detail how we should be thinking about that? And -- yes, so that's question number one.

Sure, Ken. I mean, one of the, I would say, larger cost that's, I think, been out there on the horizon was when we actually would kind of flipped the switch and exit the legacy ResCap servicing platform and switched over entirely to real service, the Real servicing platform. And so as the delay has -- or, I'd say, as we've seen a delay in the actual transition, the timing of that payment is pushing out as well. And so that is what we are alluding to in the comments that some costs may fall into '15. And so that's going to depend largely on the timing of when they are complete. I also mentioned that we would give folks a more detailed update around the third quarter's -- third quarter earnings call. And I think it's probably more appropriate when we have moved closer to that timing and have more detail there. So that would be the most significant item that we think would fall into next year.

Okay. So the termination fee, which was I think $20 million, is really what you were referring to in that case?

That declines basically on a monthly basis. So that's been -- that will be lower in the future than it would have been if we had to pay it in July, let's say.

Okay. And so you're really not prepared to talk about what the cost savings will be when you are able to move on to real servicing versus the ResCap? Because there were some significant cost savings, if I understood the way that you've talked about the operating margins returning back to something that would be discussed as more normal.

I think the best way to look at it is to take a look at the normalization that we do on the expense side. That's why we normalize, to try to give investors a better sense as to what we think our cost structure will look like once we're -- we've completed the integration. So I think, yes, we're not ready to go beyond that, but I think that's the best thing for you to look at.

Okay. And in the quarter, there was roughly $12 million of monitoring costs. How sticky are these monitoring costs? Can you give us some better detail as to what they are? I mean, that's a run rate of close to $50 million a year.

Yes. So keep in mind that with our new National Mortgage Settlement, we now have a second monitor. We previously had just a monitor for the state of New York, now we have the national monitor. And so one of the big reasons for the increase in the quarter was related to the fact that we now have a second monitor that is in there, that wasn't in there before. And those costs will run for the next 3 years. The New York monitor was a 2-year period, and we're about a year into it, maybe a little bit more. So there is some volatility month to month, quarter to quarter, simply because largely you're paying for direct costs and time that professional firms hired by the monitor to do the work. How much time they spend in a quarter can vary from month to month, quarter to quarter. So as Michael said, our best estimate of the coming quarter would be it would be down some, down to $9 million, but I think he also said in his prepared remarks, but we -- at this point, it's difficult for us to give you a pinpoint amount for every quarter going on into the future because it varies depending on how much time the professional firms spend in any particular period.

I understand. Is there any way to think about that on an annualized basis in terms of what you think the cost burden on the company will be?

Yes, not really. And not to kind of make a projection, but I think you can think about it that we think $9 million is going to be -- our best estimate for this coming quarter. So that might be something that you want to think about on a run rate, but again, it can vary. So I need to put that caveat there, but I think that might be a good way to think about it.

Okay. And the additional 325 individuals in terms of headcount, are those largely domestic employees or are those overseas?

Yes, we're not going to get into the exact mix of that, but it is -- they are in both domestic and offshore. I would say generally not quite at the same mix that we have for the broader, say, servicing operation. It's probably more heavily weighted towards onshore, but it is a mix between onshore and offshore. So again, I think for us, our ability to build out a world-class compliance and risk management structure, we have the opportunity to be world class and still be more cost efficient than other servicers who are not set up to do some of that work offshore. So I think it just, in some ways, enhances our advantage long-term over the competition.

And I think it's been described, this -- the additional increase in costs associated with compliance was viewed as possibly a temporary inflated cost structure. Do you feel that that's still the case?

Well, I mean, certain things like the monitoring costs, at least as best we know, should be temporary in that it monitors are for set periods of time and then those costs will drop off. I think on the infrastructure that we put in place, we'll, of course, always try to look to make it more efficient, and to the extent work can be done in a lower cost labor environment, we'll always look at that. What I think is going to be the real benefit down the road is our ability by having a stronger, more robust compliance and risk structure, will be the ability to actually take costs out of the actual servicing and origination businesses, because we're going -- it's going to basically drive us to higher quality, lower error rates, faster identification of things that may not be working as intended, and long term, will allow us to bring costs down in the actual core operations, maybe more so than bringing it down into compliance fixed cost structure that we'll be putting in place.

Yes. And I appreciate that, and obviously, would like to see that sooner than later. I guess really where I'm going with this is, if we look at just the cost structure that's been put together around compliance and monitoring, you're really talking about something that is borderline between $0.40 and $0.50 of earnings per share. That costs us, from a market -- just from a valuation standpoint, something close to $5 per share. I think the market is really struggling with understanding what the overall operating costs in this business are going to look like, which has a tremendous impact in terms of the longer-term earnings outlook and the way that the Street's going to value the stock. Now -- I know you know that, but we need to get some very good understanding as to how these costs are going to play out over the next several years.

We appreciate the feedback. That is something we're looking at very hard internally as well, and at the appropriate time, hopefully, we can provide more clarity for you all on what that cost is going to look like long term.

There are no further questions. Ladies and gentlemen, thank you for attending the Ocwen Financial second quarter 2014 earnings conference call. This concludes the conference. You may now disconnect. Have a good day.