Onity Group Inc. (ONIT) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Ocwen Financial’s Fourth Quarter 2015 Earnings Call. At this time, all participants are in a listen-only mode. Later we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions] I’d now like to turn the call over to your host for today’s conference, Mr. Steve Swett. Sir, you may begin.

Good afternoon and thank you for joining us today for Ocwen’s fourth quarter and full-year 2015 earnings conference call. Before we begin, please note that our earnings release, supplemental management comments, slide presentation are available to accompany today’s call. To access the presentation, please go to the Shareholder Relations section on our Web site at www.ocwen.com and click on the Events and Presentations tab. As a reminder, the presentation and our comments today 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 a different degree uncertain. Our business has been undergoing substantial change which has magnified such uncertainties. You should bear these factors in mind when considering such statements and should not place undue reliance on such statements. 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. Our forward-looking statements speak only as of the date they are made and we disclaim any obligation to update or revise any forward-looking statement. In addition, the presentation and our comments contain references to non-GAAP financial measures, such as adjusted operating expense, normalized adjusted cash flow from operations, available liquidity and the economic value to Ocwen of our MSRs. We believe these non-GAAP financial measures provide a useful supplement to discussions and analysis of our financial condition. We also believe these non-GAAP financial measures provide an alternate way to view certain aspects of our business that is instructive. 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 SEC, including Ocwen’s 2015 Form 10-K, which was filed after 5:30 PM on February 26, 2016. Joining me on the call today is Ron Faris, President and Chief Executive Officer; and Michael Bourque, our Chief Financial Officer. Now, I’ll turn the call over to Ron.

Good afternoon everyone. As a result of being able to file our Form 10-K last Friday evening and slightly ahead of schedule, we decided it would be useful to investors to make available our prepared supplemental management comments and investor presentation in advance of the day’s trading. As a result, we’re not going to read the prepared comments on the call this afternoon, since they were available early this morning. However, I’d like to reiterate a few statements and then make five additional comments about the business before opening the call up to questions. I want to start by thanking the Ocwen Board and our management team for guiding the Company through its most challenging year in our 27 plus year history. I also want to thank the whole Ocwen team and our various business partners, without whom we could not have made the progress that we have. If you recall, last year at this time, we were unable to file our Form 10-K on time due to going concern questions and did not file until mid-May. I am pleased to report that we filed our 2015 Form 10-K on Friday evening and on time. In 2015, we reduced our corporate debt by over half, from $1.63 billion at the start of the year to under $750 million today. We refinanced all of our asset backed lending facilities and improved our overall liquidity position. The Blue Mountain issue is gone, we’ve defended ourselves against RMBS investors who have attacked our servicing practices, and we’ve resolved various significant legal and regulatory matters. Our mortgage origination business was profitable, and we’ve launched an important new commercial lending business. We believe all of these accomplishments in 2015 position us for a better future; but we still have a lot of work to do. While we’re very pleased that our servicer rating from Fitch was recently upgraded to average, we must work to get S&P to also upgrade our servicer ranking to average. We must continue to work with California and New York to both lift our restrictions on servicing rights acquisitions and to allow us to operate in a more normalized business environment which includes winding down the monitorships and associated costs. We must continuously improve our operations, service levels and our cost structure. We must also chart a new course, one that can lead us back to growth and profitability. We believe we’ve a strategy that can, over time, accomplish both. Our goal and strategy going forward is to transform Ocwen into a world class asset origination and servicing company that delivers service excellence to our customers and strong returns to our shareholders. Historically, we were considered a transaction Company. We purchased assets that others created. Going forward, we want to be the one that creates the assets. We believe that this strategy will provide us more control and higher operating margins over the long-term and we outlined this strategy in detail in the documents released this morning. Now I’d like to make five additional comments. First, you’ve seen the recent changes that we’ve made to our Board of Directors. Numerous investors have encouraged us to continue to improve our governance and we believe we accomplished that by adding five great new independent Board members over the past 13 months, with key areas of expertise including housing, mortgage, risk, compliance, audit and community outreach. Feedback from investors, regulators, and other industry participants on these editions has been very positive and I’m thrilled to be able to work with such a strong diverse group of leaders. Second, I want to highlight the quality of our balance sheet. We’ve no remaining intangible assets on the books and we’ve now fully reserved for our deferred tax assets. Still we’ve a corporate debt to equity ratio of below 0.9 to 1. Our assets are high quality, and they’re less sensitive to interest rates than most of our competitors. Our largest asset, Servicing Advances, is generally top of the waterfalls in terms of repayment priority. In addition, as reflected on Slide 4 of the investor presentation, at December 31, we also had approximately $391 million of off balance sheet estimated future value in the form of call rights, future reverse mortgage draws, unrecorded fair value adjustments in our agency MSRs and unrecorded deferred servicing fees. All of these had incremental value to the Company’s reported financial statements. Third, despite our GAAP losses, we continue to generate positive cash flow. We generated over $580 million of cash from operating activity in ’15. Even on a normalized basis, for which we can see details on Page 25 of the presentation, we generated over $250 million of positive cash flow from operations. Since we’re not acquiring new MSRs at this time, as advances decline and MSRs amortize, we generate cash in excess of earnings. Cash generation from the servicing business is a strength of our Company. Fourth, our cost improvement initiative is taking hold. We recognize that it is difficult to see the benefit in the Q4 numbers. But we reduced headcount by 300 in Q4 and we’re continuing to reduce our servicing headcount in 2015. We’ve brought certain functions in-house by procurement, facilities management, and certain technology functions to reduce costs. These types of changes raise compensation costs, but have savings in other expense line items, since we no longer have certain third-party costs in these areas. Other cost savings in areas like reduced facilities costs will be recognized more fully in 2016. We are examining every opportunity to utilize our global workforce to reduce costs further, especially in areas like lending, compliance, finance and risks. We are also ramping up our process reengineering and lean Six Sigma efforts to improve efficiency wherever we can. We also believe that we’ve taken meaningful steps to reduce future uncollectible servicing advances and FHA claims losses, which have been significant, but generally declining. Continuous cost improvement remains a top priority. Finally, let me say a few more words about our new Automotive Capital Services business. This is an opportunity our corporate development team identified over two years ago. We then met Tom Gilman, former CEO of Chrysler Financial, and discovered that he had also identified a similar opportunity in the area of floor plan inventory finance for independent used car dealers. Remember, this is a commercial business not a consumer business. We were very fortunate to get Tom and his small team of experienced auto finance executives to join Ocwen over one year ago. They’ve been building the business ever since and as we’ve said today, we’re now moving forward with scaling up the business. The return profile on this type of lending is very attractive, but only if you know how to attract dealers and then manage the risk. Tom and his team have the experience and expertise to do just that along with oversight from our risk management group. In closing, as indicated in our remarks posted this morning, 2016 will be a year of great transition for the Company. However, we believe the strategy we’re pursuing is the best path forward at this point of time. I hope this additional commentary is useful. We will now open the call up to questions. But please note that we’re not going to take any questions related to financial projections for 2016 or beyond. Operator?

Thank you. [Operator Instructions] Our first question is from Bose George with KBW. Your line is open.

Hey guys. Good afternoon. Actually just one on the expense projection, is the starting point that we should use would be the number for 2016 ex the amortization, so the $1.06 billion and then we use your estimates to sort of go forward from there?

Yes, just start with the reported results, Bose, we talked in September that amortization from the declining loan count was included in that bracket or I guess in those buckets.

Okay, great. And then, actually in terms of -- is there a way for us to kind of think about when you could potentially be able to get back in the market for purchasing MSRs? Is that something you think could happen in 2016?

So, Bose, I think it could happen, but as I mentioned, we need to work with our two state regulators that have restrictions on us to get us back in that position. We intend to continue doing that, but we can’t predict when those restrictions will be lifted at this time.

Okay, great. Thank you.

The next question is from Henry Coffey with Sterne, Agee. Your line is open.

Hi. Good afternoon, everyone and thanks for taking my questions. Obviously, Bose’s question is the question, as we try to get a handle around costs and the additional monitoring costs and stuff, I know you don’t want to get too deep into that, but what should we think about the servicing business over a multiyear cycle? What -- give us some steps to profitability and where you think that core business is going to end up when this whole process is finished?

So Henry, first off as far as segment reporting, and our servicing business had a profit in the year, I think we maybe the only one of the bigger non-banks to report that. But with the sale off of our agency MSRs which we get bookings on and is included as part of that profit, we do need to significantly reduce our costs in order to replace the revenue that we lost on a go-forward basis. So we’re not going to project out for you when that’s going to occur, except to say that we’re very focused on reducing the cost burden. Some of that is in our control; some like the monitor expenses are lessen our control. But as we indicated in our remarks that were issued this morning, we do hope to make progress each quarter. Obviously, the business is quite volatile and the market is quite volatile. So we don’t know exactly what will happen, but we do hope to show progress each quarter going forward. Part of that also involves us doing a better job of ramping up our origination business so that, with more -- we get more volume out of that business and that will help replace some of the runoff that’s going to naturally continue to occur.

And the other issue the press picked up on the, that SEC comments on your use of third party. I thought that was -- that issue surfaced over a year ago, and what relevance is it to the SEC who is obviously supposed to be looking at the integrity of your financial statements more than business practices?

Yes, I guess I -- I’m, you’d have to ask them and I can't really comment except to say that I -- we feel confident that the fees that are part of the servicing business that are either assessed to borrowers or passed on to RMBS investors are -- there is -- they are monitored closely by master servicers and trusties and others. We’ve had various third parties look at them. We have a good sense as to what others servicers have done since we’ve acquired a lot of servicing portfolios and have been able to see what industry practice has been, and we feel comfortable that our process is within industry practice. So we can't comment on what exactly a regulator maybe looking for, but we do believe that our processes are appropriate.

And then on the debt reduction front, Ron the plan is to continue to chip away all levels of debt or maybe you could give us a sense of where you’ll be reducing debt burden?

Yes, so -- look we made tremendous progress reducing corporate debt, in paying down the term loan this year. If you remember our October amendment included sort of a -- I think it’s a three point fee that we would need to pay if we don’t refinance or payoff that loan prior to the end of March of 2017. It’s been our intention that we take care of that well in advance of that. So I think, we’re going to be very focused now that we have the financials and last year behind us to look to find a better way to capitalize the business on a long-term basis and one that allows us to not -- operate without undue restriction, but also allows us to operate in a safe and sound manner. So we’re going to be very focused on finding the best possible capital structure for the company going forward over the coming months.

Great and thank you. An awful lot of work was done in the last year.

Thanks, Henry.

[Operator Instructions] Our next question is from Kevin Barker with Piper Jaffray. Your line is open.

Thank you for taking my questions. In particular on the expense side, one of the main drivers that have grown over the last two years is primarily professional service fees. And I know a lot of the monitor costs I believe are coming through there. Could you detail some of the other expenses that have been -- that go into professional services and what you can do to bring that line in particular down over time?

Michael, do you want to start with that one and then I can fill in?

Yes, that’s fine. I mean, so Kevin I mean, you’re correct. It’s generally grown. There’s been -- it’s generally a catch all for professional firms. And so under that bucket you can have everything from the monitoring companies, you can have third party consultants that we’ve hired to come in to that to do things like, help us formalize and finalize some of our risk and compliance built out over the last couple of years to supplement the efforts that had undertaken inside the company. We’ve also had folks, I mean Ron mentioned some of the pricing. We’ve had folks come in and help us look at that. You also have third party vendors. So to the extent you have technology providers for things like technology that’s non -- maybe real servicing related type stuff, you would have expenses there. You also have a big chunk of that bucket is legal costs and outside legal firms that are supporting the company. So its not one thing, but generally I would say monitors, consultants, outside council. Our audit fees last year were very significant just given the efforts at the beginning of the year, all the strategic advisors that certainly went into that bucket. So, as we look at the cost improvement initiatives, we’re certainly focused on the things that, in the near-term we can control. We’ve taken actions on a lot of -- ending consulting engagements when appropriate or early as appropriate. And hopefully as we continue to work through some of the open legal matters and other enquiries, we’ll continue to demonstrate progress there and -- but the biggest driver right now is the monitoring costs and we need to continue to work with those regulators to help bring them down.

Yes. And Kevin, I mean maybe just a slightly broader speaking and a lot of this, what I’m going to say here would probably be covered in the professional services, but just sort of more broadly. When you think about and I think these are numbers that are available. I mean, the monitor expense for the year was $50 million, strategic advisors was $25 million. I think we had restructuring costs in the year in the neighborhood of $50 million, and in the fourth quarter we had a settlement related to an old homeward item, $13 million or $14 million. We also have one litigation in case that has been very, very expensive for us. Just adding up those things that I just mentioned, I think will account for over $170 million of costs in 2015, and that doesn’t cover some of the other things that Michael mentioned there. So, there’s a lot of things that we incurred this year that hopefully we will start to see decline over time and many of those items are in the professional services line item.

Okay. And then, also your servicing and origination line has also been quite elevated in 2015 versus 2014. Now I know a bunch of that maybe due to the FHA servicing. You addressed part of that on your prepared comments. Is there anything else in particular that you would look as core expense versus non-core expense within that line item?

Yes, I mean in there Kevin, remember at the start of this year we made a change in how we accounted for the non-agency MSRs and in changing from low comp to fair value. So you’ve effectively moved year-over-year probably $80 million of expense from amortization into the servicing and origination line. So that’s by far the biggest increase year-over-year. The other two, I’d say big chunky items that we’ve seen in there, both in ’14 and in ’15 have been the uncollectible servicer advances. I think year-over-year we disclosed in the pitch probably a $50 million improvement, but still almost $80 million in 2015, and then we also noted in our remarks the activity on the FHA claim filings and that’s about $80 million as well and an increase from last year, but something we believe is important for us to do now, and in terms of standing future losses for the company. And I’d say the last big thing in that bucket Kevin is the impairment we’ve recorded year-to-date on the Ginnie Mae MSRs which are carried at lower of cost to market. But with some of the rate movements and the sensitivity of that portfolio we’ve booked $17 million through 2015 of impairment.

Okay. And then, I’ve noticed that you amortization of mortgage servicing rights have been fairly low at $11 million this quarter, but you had a fair value mark up of roughly $8 million. Is there anything else in particular that’s causing that line to be lower than expected given what your prepaid rates are running right now, and how far -- how much lower the MSR is in just raw value in the fourth quarter? In other words, is there any onetime items in there that are coming through?

No. No, it really just reflects the size of the portfolio and the fact that so much more of the portfolio now is the non-agency book that does effectively flow to fair value and is recorded in the servicing and origination bucket.

Okay. And then finally, regarding the California and New York monitors, they are supposed to provide reports and studies regarding their work. Is that going to be made public and is there anything you -- any detail you can provide on the timing when we could expect the reports from New York in particular and potentially California?

I mean at this point in time we don’t expect anything to be public. I think the monitors do report into the regulators themselves, but we’re not aware that anything is going to be made public.

And have they completed their -- I know New York was working on a biannual -- I mean a semiannual report every six months they were supposed to give. Have they completed their first cycle?

Yes.

Okay. And one last thing, you mentioned in the 10-K that the state licenses could be at risk to do a delay and financial statements. Now you’ve obviously hit your target -- the timely financials with the 10-K filing this year. Does that essentially satisfy the state regulators given that you’ve done it already for this year?

So, just stepping back, some states do have requirements to file audited financial statements within a certain time period. Last year due to the late filing, we did miss some of those. We were in communication all along the way with the regulators to keep them up to date and to the extent that there’s anything ongoing related to that we’re working with the various regulators. But as you pointed out, for this year we don’t expect there to be any issues with that since we’ve completed our audited financial statements.

Okay, all right. Thank you for taking my questions.

Thanks, Kevin.

Thank you. And our next question is from Fred Small with Compass Point. Your line is open.

Hi, thanks for taking my question. Just following up on the SEC investigation disclosed in the K on fees and expenses from earlier this month. Does any of that relate to the relationship with Altisource portfolio solutions, and are any of those expenses passed through to Altisource and would show up as revenues for them or is it separate?

So, again we’re not really commenting on the SEC investigation nor do I think we know exactly what it is that they’re looking into. But as I said, we’ve had lots of reviews of the fees that are part of our servicing operation including those that would come from LTI providers, come from valuations like from Altisource. So Altisource is one vendor that does have costs that get flow through. And like I said, we’ve had those looked at. We feel very comfortable with our practices.

Okay. Thanks.

Thank you.

That completes our Q&A for today. Thank you for attending the Ocwen financial corporation fourth quarter 2015 earnings call. You may now disconnect. Everyone have a great day.

Thank you.

Thanks.