Nonbanks Like Ocwen Embrace Subprime Market as Banks Flee

Ocwen Financial (OCN) is one of several servicers bulking up in subprime in hopes of a day when it is no longer a dirty word.

Its $2.5 billion deal for the mortgage servicing rights portfolio of OneWest Bank on Thursday underscored how banks are pulling back from the business in favor of nonbanks with a higher tolerance for risk. Walter Investment Management and Nationstar Mortgage have been buying similar assets in the past year.

Banks want out for a few reasons, observers say. There is the heightened regulation and threat of Basel III rules that could make mortgage servicing difficult for banks. There is also the reputational risk associated with servicing delinquent loans.

"Someone like Ocwen is not ashamed to foreclose like some bank managements might be," says David C. Stephens, the chief financial officer at United Capital Markets, an advisory firm in Greenwood Village, Colo.

Ocwen's deal for $78 billion in unpaid principal balances from OneWest is the latest in a string of acquisitions the West Palm Beach, Fla., company has made recently. It would increase Ocwen's servicing portfolio by 17% to $547 billion.

While Ocwen and OneWest didn't give the breakdown of types and performance of loans, analysts say that the advance servicing rate of 2.67% implies that delinquencies are in double digits. Advanced servicing loans are extended by servicers to investors to cover missed payments.

Ocwen officials did not comment for this story, but Chief Financial Officer John Britti discussed the opportunity the company has to buy legacy portfolios during a presentation last month.

"Most of our growth has come from acquiring competitors," Britti said at Barclays High Yield and Syndicated Loan Conference on May 21. "At some point everybody views that this is going to end."

But it may last for awhile.

"We look at the overall opportunity that exists looking out for the next two to three years as about $1 trillion worth of potential servicing still left to move," Britti said in describing the market.

Ocwen had identified "$375 billion worth of potential transactions," he said.

Meanwhile, OneWest — the Pasadena, Calif., bank created to buy IndyMac from the Federal Deposit Insurance Corp. in 2008 — is positioning itself to become a public company in the next few years.

It decided to sell the MSRs "in order to sharpen our focus on developing a leading regional banking franchise," Chief Executive Joseph Otting said in an email.

Ocwen might have the ability to make money on the problem loans where others cannot because it has a leaner operations offshore.

"We believe we have the lowest cost in the industry," Britti said at the Barclays conference. "The typical servicer spends over $800 a year to service of nonperforming loan. Ocwen services a loan for closer to $250 a year."

One analyst agreed.

"OneWest has had some operational issues with the servicing, and quite frankly, they've been running it off," says Kevin Barker, an analyst at Compass Point. "It is not a core piece of the business and they'd rather remove themselves from having deal with the regulatory issues. Ocwen has the capability to use its operating leverage to make on a profit on it."

There could be 10 to 20 more entities looking to sell mortgage servicing rights in the next year or so, Barker says. Ocwen would have to compete with Nationstar and Walter Investment for them. The OneWest deal is a blockbuster size; Barker says the others are expected to be smaller.

"Expect singles or doubles — between $10 billion and $20 billion," he says, referring to MSR portfolio sizes.

Analysts applauded the deal as it positions the company for record earnings in 2015 from its string of acquisitions. Barker upgraded his price target by $5 to $49 per share. Ocwen's shares rose 3.5% on Thursday, to $45.74 on Thursday. They fell 15 cents Friday afternoon on above-average volume.

Ocwen could face potential long-term headaches once the portfolio runs dry. The run-off rate for Ocwen's portfolio is between $70 billion and $80 billion a year, analysts say.

The company says it thrives when there is a healthy subprime market. If that market doesn't revive itself, the company could be left scrambling.

"They don't have the operations in place to offset the run-off," Barker says. "Maybe they'll buy an originator."

Britti, however, seems convinced that the climate for subprime mortgages will improve — though he used an alternative industry term for them.

"I don't believe the nonprime space is coming back in the next year or two years but will come back in the next three to five years," Britti said. "If people truly believe that we weren't going to have a nonprime market reemerge and we only used the qualification standards we currently have, everybody ought to leave this room and short every builder in the country."