Onity Group Inc (ONIT) 2005 Q3 法說會逐字稿

Welcome to Ocwen third-quarter earnings announcement call. All participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today's conference, Mr. Robert Leist, Senior Vice President and Principal Financial Officer. Sir, you may begin.

Thank you. Good morning, everyone, and welcome. Thank you for joining us today. Before we begin, I want to remind you that the slide presentation is available to accompany our remarks. To access the slides, log on to our website at www.Ocwen.com, select "Shareholder Relations," then "Conference Calls," "Third-quarter 2005 Results" and then "Views Slides." Each viewer will be able to control the progression of the slides during the presentation. To move the slides ahead, please click on the gray button pointing to the right.

As indicated on slide 2, our presentation may contain certain forward-looking statements that are 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. They may involve risks and uncertainties that could cause the Company's actual results to differ materially from the results discussed in the forward-looking statements. For an elaboration of the factors that may cause such a difference, please refer to the risk disclosure statement in today's earnings release as well as the Company's filings with the Securities and Exchange Commission, including our 2004 10-K.

We are happy to make Ocwen news releases, 10-Qs, 10-Ks and other materials available to you via email. If you're not already receiving our materials by email and would like to be added to our distribution list, please email Linda Ludwig at linda.ludwig@Ocwen.com.

As indicated on slide 3 joining me for today's presentation are Bill Erbey, Chairman and CEO of Ocwen, and Ron Faris, President. The presentation will be followed by question-and-answer period; during which, we will be taking questions from those of you attending the conference by telephone.

Without further delay, I will now turn the call over to Bill Erbey. Bill.

Thank you, Bob. And thanks to all of you for attending Ocwen's third-quarter conference call. I would like to cover two topics in my remarks today -- first, an overview of our third-quarter earnings and second, our growth plans for providing processing and origination services to the loan industry.

As shown on slide 4, pretax income for the third quarter of 2005 was $10.2, an increase of 96% and 251% as compared to the first two quarters of this year and 59% and 629% as compared to the quarterly averages of the past two years. These results reflect non-interest revenue growth for most of our core businesses as well as a declining rate of expense growth, as we have begun to benefit from cost reduction initiatives undertaken earlier this year.

The major objective for 2005 has been to improve our performance at achieving topline revenue growth. As shown on slide 5, our non-interest revenue in the third quarter rose to $68.2 million as compared to 59.5 million and 56.7 million in the first and second quarters and quarterly averages of 55.7 million and 44.4 million in 2004 and 2003 respectively.

Both our residential and commercial servicing segments had improved results in the third quarter. Within the residential servicing segment, the Loan Servicing business posted non-interest revenue growth in the third quarter of 29% as compared to the quarterly average in 2004 despite the continuing pressure on MSR amortization from high prepayment speeds. This improvement was partially offset by a decline in our revenue in our VA Servicing unit, which continues to be affected by sharply-reduced number of properties and by the absence in 2005 of the $2.9 million of fees we earned from our REALServicing platform in the second quarter of 2004.

Our Commercial Servicing segment had an exceptional quarter, reflecting asset resolution fees in both our domestic servicing operations and in GSS Asia. Further growth in the Commercial Servicing portfolio will be required to repeat these results in future periods.

As depicted on slide 6, non-interest expense grew to $53.5 million in the third quarter as compared to 52.1 and 51.7 million in the second and first quarters and quarterly averages of 48.2 and 39.2 million in 2004 and 2003 respectively. The most significant factor in our expense increase during the third quarter was our investment in our loan origination processing capabilities, which we hope will lead to increased revenue in the future as we work to grow this business.

As I reported last quarter, we experienced expense increases in both our BPO and our ORG segments during the first half of 2005. I'm pleased to note that apart from a one-time charge of $0.5 million to resolve certain contractual disputes in ORG, we achieved an aggregate net cost reduction before overhead charges of 7.4% as compared to the second quarter of this year. Ron and Bob will provide further information on our third-quarter earnings later in this call.

Before turning the call over to Ron, I would like to provide greater detail on our loan processing services. As shown on slide 7, we have narrowed our strategic focus to being a leader provider of process solutions to the loan industry. We enable our clients to achieve their goals by leveraging our superior processes, innovative technology and high-quality, cost-effective global human resources. We make our clients worth more, who are servicing and loan origination processing services. We are well-recognized for our ability to mitigate our clients' losses on the loans that we service.

Complementing our servicing capabilities are our loan origination solutions that allow our customers access to the low transaction processing costs in economies of scale usually attainable -- only attainable by the largest origination firms. We are able to achieve lower costs by leveraging our technology infrastructure and our access to high quality, low-cost global labor.

Furthermore, we're also able to offer even small originators the ability to securitize their mortgage loans, further enhancing the value of their production. Our revised segments, which we introduced in the first quarter of this year, are reflective of this approach. As shown on slide 8, our five core business segments can be aligned within our two areas of focus -- servicing and loan origination processing solutions.

In servicing, our residential and commercial segments as well as our Ocwen Recovery Group enable clients to maximize the performance of their assets, while Residential Origination Services and Business Process Outsourcing segments offer a wide range of origination solutions.

During the third quarter, we have obtained several new clients in this sector and have an active pipeline of future prospects. In the short-term, we have focused on adding capacity and enhancing capability. To that end, we've established a comprehensive training program we refer to as the Institute of Mortgage Originations. We believe that this 3-month training program will enable us to provide highly skilled, cost-effective global resources to our clients.

I would now like to turn the call over to our President, Ron Faris.

Thank you, Bill. My remarks today will cover our five core business segments -- Residential Servicing, Commercial Servicing, Ocwen Recovery Group, Residential Origination Services, and Business Process Outsourcing. As shown on slide 9, the pretax earnings of our core businesses were $9.4 million in the third quarter of this year, a 45% increase over the third-quarter 2004 results of 6.5 million and a 4% increase over the 2004 quarterly average of 9 million. These results reflect improvements made by the Residential Servicing and Commercial Servicing segments offset by reductions in Residential Origination Services and Ocwen Recovery Group. I will provide the details behind these changes throughout the call.

Turning to slide 10, the Residential Servicing segment recorded $7.7 million in pretax income in the third quarter of 2005 as compared to 3.4 million in the third quarter of 2004 and 2.6 million for the second quarter of 2005. The third quarter of 2005 results represent an 83% improvement over the 2004 quarterly average of 4.2 million. Net revenues of the Residential Servicing segment were $33.3 million in the third quarter of 2005, a 13% improvement when compared to our 2004 quarterly average revenue of 29.4 million. These improvements are the net result of gains in the Loan Servicing unit offset by a decline from the VA Servicing unit's results, which continue to be negatively impacted by reduced volumes. Also year-to-date 2005 results in this segment reflects the absence of the one-time fees of $2.9 million recognized in the second quarter of 2004 from a REALServicing contract.

Slide 11 illustrates the continuing improvement over 2004 results in the residential loan servicing portion of our Residential Servicing segment. Loan servicing achieved $11.1 million of contribution margin in the third quarter of 2005 versus 5.3 million in the second quarter of 2005 and the 2004 quarterly average of 3.9 million. This improvement is the result of revenue growth, primarily reflecting the improvement in float income. In addition to the revenue growth, we're also seeing the positive impact of the cost reduction initiatives that we put in place earlier in the year.

As shown on slide 12, our servicing portfolio's unpaid principal balance at quarter end was 36.5 billion, a 5.8% increase from the December 31, 2004 balance of 34.5 billion. As of September 30, 2005, we were the servicer for 332,000 loans as compared to 320,000 loans at year end 2004.

Our balance of mortgage servicing rights at September 30, 2005 was $115 million, a 13% decrease from our December 31, 2004 balance of 132 million. This decrease reflects our limited mortgage servicing rights acquisitions in the third quarter. However, we believe that market conditions have begun to improve, and we have already acquired a number of new pools that are scheduled to close in the fourth quarter of 2005.

Slide 13 shows the trend in prepayment speeds over the past 11 quarters. As you can see, prepayment speeds at 40% in the third quarter continue to remain relatively high but below the 2004 high of 44%. We continue to remain cautiously optimistic that prepayment speeds will decline as we see originators finally increasing coupon rates on sub-prime loans and as home prices begin to stabilize.

Advancing to slide 14, our Commercial Servicing business had a very strong third quarter, reporting $2.1 million in pretax income versus 300,000 in the second quarter of 2005 and the 2004 quarterly average pretax loss of $100,000.

In the third quarter of 2005, Commercial Servicing recorded $6.4 million in revenue, a 36% increase over their second-quarter 2005 revenue of 4.7 million. These improvements and results are primarily due to asset resolution fees earned by GSS in Asia and in the domestic servicing operations.

As shown on slide 15, Ocwen Recovery Group, our unsecured collections segment, posted a pretax loss of $600,000 in the third quarter of 2005 as compared to pretax income of 200,000 in the second quarter of 2005 and the 2004 quarterly average of $1 million. This decline in results is primarily the result of a combination of a reduction in revenue and one-time expenses related to the settlement of contractual disputes. Reduction in revenue was primarily a result of declining balances in an older, high-margin portfolio.

Slide 16 shows the residential origination services segment third-quarter 2005 pretax loss of $93,000 versus the 2004 quarterly average pretax income of $3.4 million and the second quarter of 2005 pretax income of $1.7 million.

Year to date, pretax income was 4.5 million in 2005 as compared to 10 million in the same period last year. The third-quarter 2005 results were significantly impacted by a decline in cash flows from our remaining UK-based residual securities, resulting in reduced interest income and a decline in the fair value of these trading securities.

We also incurred an operating loss in our new Mortgage Due Diligence and Origination Services Group, primarily due to the need to increase processing capabilities in advance of increased transaction volume. Earnings in our Ocwen Realty Advisors, REALTrans and refinancing operations largely offset these losses.

On a more positive note, turning to slide 17, the Residential Origination Services segment's servicing and vendor management fees continued to increase to $14.6 million in the third quarter of 2005. This represents a 13% increase over the second-quarter 2005 results of 12.9 million and a 42% increase over the 2004 quarterly average of 10.3 million.

One of the primary drivers behind this positive trend is our new Mortgage Due Diligence and Origination Services Group. We are very pleased with the progress that this group has made in its first 9 months of operations, recording 6.4 million in revenue. We are optimistic that this operation combined with our existing origination capabilities will provide meaningful growth opportunities in the future. As we continue to grow this business, we anticipate leveraging our global resources to improve our cost structure, which should result in a significant margin improvement.

As reflected on slide 18, our Business Process Outsourcing segment reported pretax income of $400,000 for the third quarter 2005, a 33% improvement over the second quarter of 2005 results of $300,000. While these results are still below the 2004 quarterly average of 600,000, we believe that we are beginning to see the results of the investments we've made in this business line. BPO's third-quarter 2005 revenue of 2.8 million represents a 17% increase over our 2004 quarterly average revenue of $2.4 million.

In summary, I am pleased with the results of the Residential and Commercial Servicing segments, particularly the residential loan servicing business. We will continue to grow topline revenue, while maintaining our focus on our cost structure. I'm excited about the growth potential in Residential Origination Services, as we continue to invest in this business and remain confident that we can also grow the Business Process Outsourcing and Ocwen Recovery Group segments.

We believe our third-quarter 2005 results reflect the steps to improve our cost structure that we reported to you last quarter. We will continue to benefit from these cost-cutting measures in the fourth quarter 2005.

Thank you, everyone. I would now like to turn the call over to Bob Leist.

Thank you, Ron. I would like to focus on three areas this afternoon -- be after this morning -- the operating results of our corporate segment, including the status of our remaining non-core assets; the growth in loans held for resale; and our liquidity position as of September 30. Let me begin the discussion of the operating results of our Corporate segment with a definition.

The Corporate segment consists of any unallocated net interest income or expense, the results of the business activities that are not individually significant, and certain general corporate expense and income items. As shown on slide 19 for the third quarter of 2005, the Corporate segment reported pretax income of 0.8 million as compared to breakeven results and the pretax loss of 3.5 million in the second and first quarters of this year respectively.

Corporate pretax income in the third quarter includes approximately $800,000 of net pretax losses from the former non-core businesses as well as other small initiatives. These were offset by corporate items with a net impact on pretax income of 1.6 million.

I also want to note that there were no valuation reserves for non-core assets required in the third quarter. As graphed on slide 20 as of September 30, our remaining non-core assets amounted to $5 million. During the third quarter, we sold a major portion of our investment in a real estate partnership, received full repayment on the facilitating loan we had made earlier this year to the purchaser of our Canadian shopping mall, and also sold our remaining affordable housing asset. Of the three commercial assets remaining, one was sold during October for a modest gain and another is under contract for sale, which we anticipate will close prior to end of the year.

Another aspect of our balance sheet worth noting is the increase in our loans held for resale, which rose to $163 million as of September 30. These loans, all of which have identified purchasers primarily consist of two components -- first, approximately $76 million of loans we held briefly as part of the residual security transaction and two, approximately $71 million of loans held for resale relating to clients utilizing our new origination services capabilities. Approximately $110 million of these loans were sold during the month of October.

With regard to our liquidity position at the end of our first quarter following de-banking, we had $189 million of cash as compared to $543 million at December 31st of last year. With the completion of de-banking, we removed from our balance sheet $409 million of deposit and escrow deposit liabilities that had been outstanding as of December 31 last year. That decrease was partially offset by an increase in our non-deposit liabilities of $123 million.

Ensuring that we maintain adequate borrowing capacity was another objective of the de-banking process. As of September 30 in addition to our long-term debt, our three principal credit facilities had an aggregate borrowing capacity of $615 million, of which 243 million was unutilized and available.

I also want to point out that as noted in our earnings release this morning, we repurchased some of our outstanding debt securities during the third quarter. In total, we repurchased $9.5 million of our 3.25% convertible notes and $2.3 million of our 10.875% notes for a net gain of $900,000. We will continue to evaluate further debt repurchases in the open market based on available pricing and alternative uses of our cash. At this time, we believe we have adequate liquidity and credit capacity to meet our daily operating cash requirements.

Before closing, I also want to note that during the third quarter, we received the full amount of the $65.3 million of income tax receivables that we have commented on in prior calls. This represents a reduction of approximately 50% in our outstanding receivable balances.

I would now like to open up the call to questions.

(OPERATOR INSTRUCTIONS). Don Hatch (ph).

Rob, can you comment a little bit more on maybe where you saw the direction of prepayments in October as well as maybe the pricing environment that we're -- with MSRs this quarter, you guys mentioned you're purchasing -- you have a lot of sort of in the back -- in the pipeline of purchasing. Where you're seeing things change to get more active?

I don't actually have the final figures for October's prepayment speed. But our projections were that they were going to be similar to the prior couple of months. Really, I think what happened is -- our third quarter was slow because of our acquisition -- bidding on deals in the second quarter really is what drove the third quarter. In the third quarter, we actually did bid on a number of portfolios. And we're able to win them; it's just that they're closing in the fourth quarter. I would not say that prices have really dropped at all. It is just simply that I think we believe that prices are more realistic based on where prepayment speeds now are and where we expect them to be in the future.

The market does remain competitive. Similar competitors that we have had before with Chase and Countrywide -- Wells Fargo continues to participate. We also have seen some reemergence of the old Fairbanks Company's select portfolio services now that they are in the process of being acquired by CS First Boston. So there is still competition out there. But we felt in the third quarter that the prices based on our expectations of prepayments, fees and delinquencies made sense, and we were able to win a number of portfolios which will close in the fourth quarter.

So if I am to summarize that, you have not seen much change in prepayment activity. And the sort of subdued environment on the balance sheet in Q3 was mostly because pipeline is expected to close in Q4, but the competitive environment still remains outstanding.

Right. And we do -- as I mentioned in the call, I think here especially in the last 2 to 3 weeks, we have seen sub-prime originators finally start to have meaningful increases in their coupon rates. And really, we have not seen much of that in quite a while. And so that does give us reason to believe that prepayment speeds -- I am not saying they're going to dramatically fall necessarily. But with that and housing prices stabilizing, we would at least expect them to stabilize somewhat. We're not expecting any big pick-up in prepayment speeds.

Second question on the Commercial Servicing revenues and as particularly related to the resolution fees in the quarter, I guess of the balance of Commercial Servicing remaining into Q4, how much of those types of resolution fees would we see in the quarter beyond this one?

We generally try not to forecast that per se. The growth -- let's put it this way -- the growth in 2006 will be principally dependent upon the acquisition by Merrill Lynch at least on the GSS side of portfolios in Germany. And they have seen some reasonable level of success in acquiring portfolios. Asia will probably not be a driver -- much significant driver of earnings going forward. And hopefully, we will continue to see some continued pick-up in volume with respect to the U.S. Commercial Servicing activities.

Can you just give a sense of where the balance of the portfolio -- Commercial Servicing portfolio was at the end of the quarter?

Well, let me try it this way because I'm not sure that the numbers would be illustrative because some of these numbers are so large, but they're not really relevant to the amount of earnings capability. Taiwan has principally utilized most of its portfolio, and that was generating a lot of the gains in the third quarter. Because they were the end -- these portfolios have an incentive compensation component to them that when you exceed a certain rate of return, we get paid extra money. So the third-quarter earnings coming out of Taiwan probably will not be significantly replicated going forward as Taiwan, from a Merrill Lynch perspective, is winding down.

The U.S. business is continuing to grow, and that should continue to generate reasonable earnings levels going forward. And we're hopeful that Germany -- the growth in Germany will replace the less activity in GSS that is being demonstrated within Asia.

Rick Shane.

A couple different things. What was the -- during the quarter -- the amortization expense on the MSRs please?

It will be in the Q, Rick. I don't have that sitting here now. But we will have that in the Q in just a few more days.

Okay, makes it a little bit harder to model. I assume the same goes for the interest on the custodial accounts?

Correct.

Okay. I guess just to sort of follow-up on John's question, Bill, you had made the comment that in order to sustain the level of profitability that you enjoyed in Commercial Servicing during the quarter, you're going to need to grow. You're going to need to see continued growth. The suggestion being that there was sort of some one-time stuff that was embedded in there. I think you fleshed that out a little bit with John.

How much do you need to grow? Is this a level of profitability that you don't see foreseeable for several quarters? Or is this something that you think, given for example you had a big announcement midmonth about Canada reaching $1 billion portfolio size. Do you think that this is a level of size and then ultimately profitability you can achieve over the next couple quarters?

I don't think we'll achieve the same level of profitability in Commercial Servicing in the next several quarters that we achieved in the third quarter this year.

Will the business continue to be -- will it continue to be positive on a quarterly basis?

Without going forward with a forward-looking statement, we think the business will continue to maintain positive profitability.

Doug Hammet (ph).

Since you're not answering questions about MSRP amortization, I just wanted to ask about the balance sheet, sale of loans, the 110 million or 163 million that were held for sale. The cash from that, what was that used for? I take it that was post -- that of course happened in October, you said?

Right. If you look at our cash position, the way in which I look at it, it is a combination of cash we have on the balance sheet plus unborrowed lines of credit -- in other words, excess collateral that we had. So whenever we paid off those loans basically, they may in fact come back as effectively unutilized lines of credit. Now some of those were actually levered in of themselves. So in fact it was not a -- it wasn't a net $110 million of cash that came back to us.

Okay, so should I assume that the cash position you've described of September 30 would be larger today in some manner or form?

If you look at the aggregate cash position that we have of the 189 plus the $200 and some million of unborrowed credit lines, that's really at month end what our cash position could be if we wanted it to be.

Now, subsequent to month end, you sold these $163 million worth of loans --

Right. But they were levered too. In some cases, we did not put out fully 100% cash on them.

Of course. And so the net cash position increased by how much since then due to this sale?

I didn't look today to be honest with you. Our biggest problem is really -- keep in mind, our cash position at month end is not our cash position throughout the month. So in fact, there is some reasonable degree of volatility within that that we are in fact focused on very intently. Because obviously, if your minimum cash position throughout the month were at $300 and some million, you would operate differently than if it had volatility to it.

So we have focused a great deal of people's time focusing on how we manage cash. That's a carryover from what we did to basically de-thrift in terms of understanding exactly how our cash works.

Probably more than most other companies, it probably shocks people to tell them that our cash flow last year was $52 billion. It is a critically important part of our business plan to effectively manage that cash and know basically how we can in fact optimize it. But the issue of what it is at month's end, if you are trying to use that for some form of analysis, it is not going to lead you anywhere. Because you have to know what it is on the minimum day of the month.

Fine. I understand where we're getting with the -- there. Could you just describe where it is on the minimum day of the month? Where does that end up? That is the number you say you look at.

That is correct. I guess I can go through that, right? In terms of --

The minimum day of the month is generally, okay, generally because there are some -- keep in mind if you divide $52 billion by 250 business days, it is quite a number. There can be some fluctuations. But generally, it is north of $100 million.

David Foster (ph).

Regarding the servicing business that you bid on in the fourth quarter. Could you quantify that in any way?

And I had a second question also. I will give you the second question also. The loans held for resale, the 76 million that relates to a residual securities transaction, can you explain what that is again?

I don't have the exact numbers for the acquisitions. But I think it's fair to say that like in the first couple of quarters of this year where you saw the portfolio grow and then we shrunk back down in the third quarter. You'll see us grow again by a couple billion or whatever. It all depends on how much runoff there is in everything. But you will see us grow again in the fourth quarter would be my expectation.

And then your question on the residual transaction, is that what it was?

It had to do with the $163 million loans held for resale. You said, I think 76 million relates to a residual of some sort; I did not follow that.

Yes, there was a portfolio of loans that we were servicing where we had the opportunity to actually acquire the residuals on those securities. We felt comfortable with that because we were servicing the loans. These were very old portfolios, which we were then able to -- they were getting very close to their call provisions and actually did reach their call provisions. So we called them. In effect what happens then is you actually acquire the loans that are left in the pool. And that's why you saw the loans go on our books. Subsequent to that here in the fourth quarter, we have securitized those loans. And so in effect, that's the sale of those -- we in fact sold those loans through a securitization.

Will there be a gain associated with that?

(multiple speakers) Yes. There was some gain already in the third quarter and a bit more I believe in the fourth.

How much in the third quarter question?

The raw gain on that was --

The raw gain is irrelevant -- I mean the net gains to that component was about $400,000. You had a gross gain but then taking the expenses away from it is about $400,000.

I would want to interject since we had several calls on amortization of servicing rights, since there seem to be a lot of interest in that number. For the third quarter, it was $23 million roughly in amortization. That compares to about 25 in the second quarter of this year.

And just as a parenthetical on that, we are still amortizing as rapidly as we were previously; we just had a smaller balance against which to amortize. So its relative effect on income -- if you noticed our fees dropped by almost the same amount that our amortization amount dropped. So there was no -- that was not reflective of a slower amortization because of a slower runoff of the portfolio.

(OPERATOR INSTRUCTIONS). There are no further questions at this time.

Everybody have a great day. Thank you very much. Goodbye.