Onity Group Inc (ONIT) 2005 Q4 法說會逐字稿

At this time, all participants are in a listen-only mode. After the presentation today, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS]. Today's conference is being recorded. If you have any objections, please disconnect at this time. I will turn the meeting over to your host today, Mr. Robert Leist, Senior Vice President, Principal Financial Officer. Sir, you may begin.

Thank you. Good morning, everyone, and 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,` `fourth quarter 2005 results` and then view 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 OCN's 2004 10-K. If you would like to receive our news releases, SEC filings, and other materials via email, please contact 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 a 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 fourth quarter conference call. I would like to cover three topics in my remarks today. First, an overview of our fourth quarter and 2005 earnings; second, our recent litigation experience; and third, our investments and loans in the latter months of 2005.

As shown on slide 4, pretax income for the fourth quarter of 2005 was $9.8 million, virtually equal to the results achieved in the third quarter and well ahead of the pace in the first half of the year. We are particularly pleased that we achieved these results despite having increased our litigation reserves by more than $3 million in the fourth quarter in response to a recent jury verdict and our analysis of other pending cases. Fourth quarter results also included a net charge of $3.4 million to reduce our loans held for resale portfolio -- pardon me, our loans held for resale portfolio to market value as of the end of the year. I will cover both of these topics further later in this call.

As shown on slide 5, our 2005 pretax income increased by 2.7 million or 11% over 2004. This increase was largely the result of a significant improvement in our Residential Servicing earnings during the latter half of 2005. We are particularly pleased with these results, given that for most of the year, prepayment speeds remained exceptionally high and therefore we continued to experience high amortization expense on our mortgage servicing rights. Our progress in the servicing area was reduced by a decline in earnings from our VA contract as transaction volumes declined throughout 2005. Our Commercial Servicing business also had a strong performance in 2005, particularly during the third quarter when we earned significant resolution fees. As expected these fees did not reoccur in the fourth quarter.

Finally, I want to note that we experienced a year-over-year decline in our Residential Origination of Services segment. This decline reflects two primary factors. First, we have experienced a decline in earnings from our UK-based residual securities. These assets are maturing and has declined from a balance of 32 million as of December 31, 2004 to 24 million as of year-end 2005. While we continue to earn a strong return on these assets, we will continue to experience declines in future earnings as the underlying collateral matures.

Second, as I mentioned earlier, we recorded a net $3.4 million charge to reduce our loans held for resale portfolio towards market value as of December 31, 2005. This adjustment reflected in part an overall decline in the sub-prime market in the fourth quarter of 2005. We believe, however, that pricing for sub-prime loans has experienced a modest recovery in the past month.

One of our major objectives for 2005 was to improve our performance in achieving topline revenue growth. As shown on slide 6, our non-interest revenue in 2005 rose to $251.7 million as compared to $223 million in 2004, an increase of 28.6 million or 13%. We achieved increases across four of our five segments with 21.5 million of the increase coming from Residential Servicing and Residential Originations Services. The only segment experiencing a revenue decline in 2005 was Ocwen Recovery Group, where revenues declined by 1.8 million as we experienced a shift in the source of our revenue from our maturing proprietary asset portfolio to an increase in volume of lower yielding third party contracts. Our Residential Servicing segment accounted for $11 million of the increase reflecting increased float earnings while our new loan processing securitization and mortgage [inaudible] initiatives in Residential Origination Services resulted in a net increase of $10.5 million in that segment. We are pleased that our new initiatives have demonstrated their revenue potential in the first year of operations, although as expected the start of operations incurred costs that resulted in losses during the first year of operations. It's also worth noting that Residential Origination Services achieved net revenue growth despite the $4.1 million decline in revenue from our residual portfolio.

As depicted on slide 7, non-interest expense grew to $211.6 million in 2005 as compared to 192.8 million in 2004, an increase of $18.7 million or 10%. The most significant factor of this increase were expenses of 14.9 million associated with our new mortgage due diligence and loan processing activities in Residential Origination Services, which as I noted were startup operations in 2005. Apart from these activities, our operating expenses across all business and support departments increased by only 3.9 million or 2% as compared to 2004. This small net increase reflects increased expenses related to the litigation and the high cost of our first year of Sarbanes-Oxley compliance, offset almost entirely by decreased operating costs particularly in loan servicing, where we reduced our compensation expenses by 3.6 million in 2005 as compared to 2004. Given that our servicing volumes were up in 2005, these reductions mean that we achieved a lower unit cost for servicing operations, which should benefit operations as we enter 2006. Ron and Bob will provide further information on our 2005 earnings later in this call.

As I mentioned earlier and as noted in our earnings release, in the fourth quarter of 2005, we provided 3.2 million of additional reserves related to current and pending litigation. As of year-end, our litigation reserves included 1.8 million for a judgment we expect to be entered shortly in a loan servicing case in a Texas State court in Galveston. While this amount is substantially less than initially cited at the jury verdict, we believe that even this award is not justified on the facts or the law, and we will continue to defend this case as well as the multi-district litigation currently pending in Federal court in Chicago. Last year, the MDL judge granted partial summary judgment in favor of Ocwen, finding the default related fees challenged by plaintiffs are legally authorized to be charged under the controlling mortgage contracts. Overall, we believe that the publicity that invariably accompanies cases such as that at Galveston has overshadowed the realities of our litigation experience.

It's worth noting that no class action has been certified by the MDL court or by any other court in any other loan servicing case. Only 59 loans are involved in the MDL out of close to 1 million loans that we have serviced during the relevant time period. Notwithstanding these relatively small number of incidents, we expend significant amounts each year defending these and lesser claims and expect that we will continue to do so while the current litigation environment continues to focus its attention across all aspects of the sub-prime lending business including servicing operations. In addition to mounting the vigorous defense when we believe we have been wrongfully accused, we work to continuously improve our servicing practices and evolve our policies in accordance with industry standards and best practices. To that end, we employ Six Sigma based analysis to make improvements to our servicing practices and we have also been partnering with community activist groups in order to understand their perspectives on best practices in the industry.

As I noted earlier, we are holding approximately 552 million of loans available for sale as of the end of 2005. Of this amount, approximately 470 million are planning to be sold into a securitization in the first quarter. Although pricing and execution of this transaction has not yet been completed, we estimate that the residual security we will hold after the securitization is completed will have an initial value of between $25 to $30 million. These loans as well as the residual transaction executed in the third quarter of this year represent an additional aspect of our strategy to establish natural hedges in our business. As we have discussed in earlier calls, our efforts in the loan processing space will provide us with fee revenue that will increase in periods of high-origination activity, thus providing a hedge against the impact of prepayments on our servicing operations.

We continue to believe that our best strategy in the origination segment lies in providing services as we do not believe managing our own sales force plays to our core competencies. In the latter half of 2005, we have expanded this strategy to include target acquisitions of residual securities. While residuals are subject to the same risks from prepayment as our mortgage servicing rights, they do represent a hedge with respect to the interest rate risk inherent in our collection accounts. As we have seen over the past several years, in periods of declining interest rates, our servicing operations are impacted by a decline in earnings that we realized from our collection account balances. However, earnings from a residual security will generally increase in this environment. It is much as a portfolio typically includes fixed-rate collateral that generates interest income to meet the variable rates payable by the securitization trust. The residual security is thus the beneficiary of excess cash flow resulting from a declining interest rate scenario.

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 8, the pre-tax earnings of our core businesses were $28 million in 2005, a 22% decrease over the 2004 results of 36 million. These results reflect improvements made by the Residential Servicing and Commercial Servicing segments, offset by reductions in Residential Origination Services, Business Process Outsourcing, and Ocwen Recovery Group. I'll provide the details behind these changes throughout the call.

Turning to slide 9, the Residential Servicing segment recorded $21.7 million in pre-tax income in 2005 as compared to $16.6 million in 2004. The 2005 results represent a 31% improvement over the 2004 pre-tax income. Net revenues in the Residential Servicing segment were $126.7 million in 2005, an 8% improvement when compared to our 2004 revenue of $117.5 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, the 2005 results in this segment reflect the absence of the one-time fees of $2.9 million recognized in the second quarter of 2004 from a real servicing contract. Slide 10 illustrates the continuing improvement over 2004 results in the Residential Loan Servicing portion of our Residential Servicing segment.

Loan Servicing achieved $34.1 million in contribution margin in 2005, a 120% improvement over the 2004 contribution margin of $15.5 million. This improvement is the result of revenue growth primarily reflecting the improvement in float income. In addition to the revenue growth, we are also seeing the positive impact of the cost reduction initiatives that we put in place earlier in the year. As shown on slide 11, our servicing portfolio's unpaid principal balance at year-end was $42.8 billion, a 24% increase from the December 31, 2004 balance of 34.5 billion. As of December 31, 2005, we were the servicer for 369,000 loans as compared to 320,000 loans at year-end 2004. Our balance of mortgage servicing rights at December 31, 2005 was $148.7 million, a 13% increase from our December 31, 2004 balance of $131.4 million. This increase primarily reflects our mortgage servicing rights acquisitions in the fourth quarter. We believe that market conditions improved during the second half of 2005 and our increased acquisitions reflect this belief. We anticipate the market for servicing rights to be very competitive in the first half of 2006 as volumes flatten out or declines and other servicers take a more optimistic view of prepayment speeds. Slide 12 shows the trends in prepayment speeds over the past three years. As you can see, prepayment speeds at 35% in the fourth quarter are below their 2004 average of 41%. The fourth quarter CPR of 35% is the lowest quarterly average since the first quarter of 2003. 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.

Slide 13 illustrates the effect of the high CPR rates that we have been experiencing over the last few years. Our average PMSR balance has declined from $137.3 million in 2002 to $131.3 million in 2005. Over the same period, our actual amortization expense increased from $58.2 million in 2002 to 96.7 million in 2005. If amortization expense had remained at the historical 2002 levels, our 2005 amortization expense would have been $55.7 million, a $41 million reduction from the 2005 actual amortization expense. Needless to say, this would have dramatically improved our pretax income results for 2005.

Advancing to slide 14, our Commercial Servicing business had a strong year reporting 2.9 million in pretax income versus a $200,000 loss in 2004 and a $5.7 million loss in 2003. In 2005, Commercial Servicing reported $20.2 million in revenue, a 19% increase over the 2004 revenue of 17 million. These improvements and results are primarily due to one-time asset resolution fees earned by GSS in Asia and in the domestic servicing operations that occurred in the third quarter of 2005.

As shown on slide 15, Ocwen Recovery Group, our unsecured collections segment, posted a pretax loss of $700,000 in 2005 as compared to pretax income of $3.9 million in 2004. This decline in results is primarily the result of a combination of a reduction in revenue and one-time expenses relating to the settlement of contractual disputes. The reduction in revenue was primarily the result of declining balances in older, high-margin portfolios.

Slide 16 shows the Residential Origination Services segment's 2005 pretax income of $2.8 million versus the 2004 results of 13.5 million. The 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 Services group, primarily due to the need to increase our processing capabilities in advance of increased transaction volumes.

On a more positive note, turning to slide 17, the Residential Origination Services segment's servicing and vendor management fees continued to increase to $53.3 million in 2005. This represents a 29% increase over the 2004 results of 41.2 million and a 132% increase over the 2003 results of $23 million. One of the primary drivers behind this positive trend is our new Mortgage Due Diligence Services group. We are pleased with the progress that this group has made in its first year of operations, recording 9.1 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 $1.2 million for 2005, a 45% decline from the 2004 results of $2.2 million. We believe that we are beginning to see the results of the investments that we've made in this business line. BPO's 2005 revenue of $11.2 million represents an 18% increase over our 2004 revenue of $9.5 million. We added seven new clients to this segment in 2005 and expect to continue this positive trend in 2006.

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 am 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 in Ocwen Recovery Group segments. We believe our 2005 results reflect the steps to improve our cost structure that we reported to you earlier in the year. We will continue to benefit from these cost cutting measures in 2006. Thank you everyone.

I would now like to turn the call over to Bob Leist.

Thank you, Ron. I would like to focus on two areas this morning. First, the operating results of our corporate segment, including the status of our remaining non-core assets and the changes in our balance sheet during the course of 2005. Let me begin the discussion with 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 business activities that are not individually significant, and certain general corporate expense and income items. In addition, the corporate segment also includes the results of our former non-core Affordable Housing and Commercial businesses.

As shown on slide 19, in 2005, the corporate segment reported pretax income of $0.2 million as compared to losses of 10.6 million in 2004 and 27.1 million in 2003. In 2005, Corporate results included the net gain of $4.3 million on the repurchases of our debt securities in the third and fourth quarters of this year, largely offset by interest expense that we have retained in Corporate in the first half of the year as we were holding substantial amounts of cash in preparation for debanking at the end of June. The losses in Corporate in 2004 and 2003 primarily reflect the results of our non-core businesses.

Our debanking initiatives and our developing strategy with respect to origination services, which Bill covered earlier in this call, have resulted in a number of changes in our balance sheet, which I want to cover briefly. First, our cash and investment grade securities holdings declined from $629 million as of December 31, 2004 to $271 million as of the end of 2005. This expected decline reflects the fact that as of the end of 2004, we were actively preparing for debanking and had accumulated a substantial amount of cash in order to fund the transfer of our deposits, which amounted to $377 million as of the end of 2004. As Bill noted earlier, our loans held for resale increased to $552 million as of the end of 2005 as compared to 8.4 million at the end of the prior year. 2005 ending balance includes the $470 million of loans we are about to securitize, as well as $72 million of loans that we originated under our refinancing and resale programs. These wider loans are presold to other parties and are generally held for periods of less than 30 days. We funded the purchase of the loans we were about to securitize through an increase in our lines of credit of approximately $459 million. As Bill noted earlier, when the securitization is completed, we will be left with a residual security with an estimated value of 25 to $30 million and the loans on the related financing will be removed from our balance sheet.

The growth in our residential servicing portfolio during the year was reflected in increases in our servicing related assets, advances in mortgage servicing rates, both of which increased during 2005. We increased advances that we had sold into securitization type structures, which we refer to as net funded advances, by approximately 34% and reflected a corresponding increase in our net funded liabilities. Unfunded advances declined by approximately 8.6% while mortgage servicing rates rose by 13%. All other asset categories in the aggregate declined by approximately $67 million or 27%. The single largest factor in this net decline is our receipt of $67 million of tax receivables and related interest in the third quarter of 2005.

Our liquidity position and increased use of collateralized borrowings also enabled us to retire $76.9 million or 33% of our outstanding debt securities during the third and fourth quarters of this year. Before closing, I want to note that as graphed on slide 20, as of December 31, our remaining non-core assets amounted to $4.4 million consisting primarily of two remaining commercial assets as compared to $28.2 million as of the end of 2004. At this time, we believe that our cash and equivalents of $271 million, together with our unused borrowing capacity of $294.5 million provide us with adequate liquidity and credit capacity to continue to meet our daily operating cash requirements and achieve our investment objectives.

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

Thank you. [OPERATOR INSTRUCTIONS]. Bob Napoli, Piper Jaffray.

Good morning. Question on prepayment speeds, I guess, I mean, they did slow down in the fourth quarter. I was wondering -- and seasonally I know you are generally slow in the first quarter, but are you seeing -- do you think this is the real thing? Are you seeing a real -- do you think this is a real slowdown in prepayments in the sub-prime mortgage industry?

I agree with your comment that historically the first quarter has been the slowest quarter. I guess all we really can comment on is that what we are seeing is, we are seeing originators in this upfront space moving up their coupon rate rather significantly, which you would have to believe will impact their ability for certain individuals to refi. So, it's definitely the thing that we had been looking for a while was were the originators really going to start increasing rates, and I think finally towards the end of the fourth quarter and here so far in the first month of the year, those rates are starting to increase.

What is your CPR so far in January? What kind of an outlook do you have for first quarter?

Yes, Bob, at this point I don't have really a good idea of exactly what it is in January. We don't really project out what we think it's going to be.

Has it further slowed from what you saw in the fourth quarter?

I would think, Bob, that -- generally it's been a fairly standard pattern year-over-year, the first quarter is the lowest quarter for a variety of structural reasons that tends to occur. And we don't expect it to be different than that this year.

Okay. The converts, you guys have been making what looks like some pretty attractive repurchases of some of your debt, and how much of that convert that you put on in '04 is left?

Approximately $100 million.

About $100 million? That was as of the end of the year or have you bought any more subsequent to year-end?

That was as of the end of the year.

Okay. And that was 175 million, right?

Yes, we purchased 75 -- approximately $75 million last year.

Okay. So that's a pretty good move given the conversion price that's attached to those as well, I guess. Do you intend to buy back more of that security?

Obviously, we have a great deal of cash and unused borrowing capacity and we continue to evaluate where we are going to deploy those spots. So, that is simply one of the areas where we could in fact deploy funds out there, it certainly depends on the price for the bond -- at what price the bond is trading and what other investment alternatives do we have.

Thanks. And last question, I mean, you ramped up your purchases of servicing pretty significantly in the fourth quarter. Have you seen an improvement in pricing and is that continuing -- do you expect that trend of increased purchases of servicing rights to continue?

This is Ron. As I commented in the speech part, we did feel that market conditions were improving in the second half of the year, and I think that led us, for lack of a better word, stepping up our pricing a little bit to be more competitive in the market and resulted in a nice growth there in the latter half of the year. Keep in mind too that up until the middle of the year, we feel that some of the regulatory constraints on purchasing servicing rights. So, there were some additional factors that allowed us to grow the portfolio in the second half of the year, but as I commented with potentially lower sub-prime volumes out there and other servicers started to take a more optimistic view as to where prepayments fees are going -- optimistic meaning they may be going much lower -- we expect the environment to be pretty competitive in the first half of the year and so, for us we -- it will depend on where we think pricing should be and how competitive we are in the market. So, it's hard to really say where volumes are going to go in the first half.

Thank you.

John Hecht, JMP Securities.

Morning guys. Thanks for taking questions. Can you guys tell me where you stand on third-party servicing as a portion of the overall servicing right now?

When you say third-party servicing John, what do you mean?

The servicing that you don't -- that you just get -- getting you’re providing for other people?

Sub-servicing?

Sub-servicing.

You mean sub-servicing John as opposed to when we buy the PMSR?

Yes.

It's approximately -- it still remains -- it's approximately 30% of the overall.

And in the fourth quarter, going further into the success and building up the [UPV] base, were you seeing the flows from the typical parties that you have seen the flows from -- or was there a change you know, as the Wall Street conduits or was it the other lendors out there or was it pretty typical in terms of where you had the originations from?

Well, our bread and butter continues to be the Wall Street firms, that buy product and then sell the servicing rights or whatever you want to call it, sub-service it over to us. There was one transaction -- there were a couple of transactions direct from originators in the fourth quarter which we do do from time to time, but there were a couple larger ones in the fourth quarter that we hadn't seen a whole lot of before. They were people we have done business with in the past, a fair amount of business, but we hadn't seen much from them on a direct basis. Just happened to be issues where they were -- they were doing the securitization on their own, but chose to sell the servicing rights to us as opposed to selling the loans to Wall Street and going that route.

And then finally, can you give us the loans held for resale category you are going to securitize. Can you give us some sense of what the characteristics of those loans are as well as maybe where the source of those was?

The third quarter transaction -- all of it represents sub-prime loans, but the third quarter transaction represented aged collateral, basically old collateral that was in [key] amount of securitizations that were collapsed. The bigger amount, the 470 million or whatever that is on the balance sheet at the end of the year, really represents first lien sub-prime product, typical product that you would see with a reasonable concentration in California, very similar to what makes up most of our servicing book.

Okay. Thank you.

Derrick Wenger, Jefferies & Co.

Yes, three just financial questions. The depreciation and amortization for the quarter, I know it's relatively small. The capital expenditures for the quarter and the outlook for accounting in '06 and then the amount paid for the convertible bonds?

The first part of your question, can you repeat that please?

The depreciation and amortization for the fourth quarter.

Are you talking about MSR amortization; I am sorry or –-

Yes.

MSR amortization for the quarter was about 23.7 million.

Okay. Any other depreciation or amortization?

I would have to get back –- I would have to check that number. We have certainly depreciation on all of our technology equipment and so forth as well. That's a big portion, I apologize, I don't have the precise number here. But our technology and communications expense on our P&L was 7.5, a significant portion of that expense is amortization and depreciation.

A rough cut would be that we have about $30 million of technology equipment. We then depreciate it over three years and so would be 4 and 10, so $2.5 million. But, that's a rough -- and that doesn't vary -- varies very little quarter-to-quarter.

Okay, and then the capital expenditures for the quarter, the outlook for the calendar year '06 and then how much was paid for the converts, what's the average prices you paid for the convertible?

We can get back to you. We made 3.4 million net of offering expenses (multiple speakers) and then refurnished 75 million. So the operating expenses would begin what percentage that was. I have to (multiple speakers) --

The date was on two different security types. It was also on the straights.

Those were the loss. Those we repurchased probably around 105, 106 on average. I think it's generally between 105 point something. So, those were losses. But they were nominal repurchases. So, it doesn’t really affect the overall numbers.

Were the converts at like 94 and change --?

They were ranged all the way through the 80s (multiple speakers) to the 90s.

The fair range that’s why I am [indiscernible].

They started at 80 -- probably as low as 82, 83, but they went up probably to the low 90s.

And capital expenditures both for the fourth quarter and for the outlook for calendar year '06?

We don’t have any other than in the [inaudible]. That’s our significant capital expenditure –- was our MSRs.

And how much was that?

57 million –-

57 and change, 57 million in the fourth quarter.

Okay, and do you have an outlook for what that would be this calendar year?

That's a pretty much forward-looking statement that we don't make.

Richard Shane, Jefferies & Co.

Hi guys. Just a couple follow-ups and then sort of a broader market question. Bob had been asking about CPR's potentially in January, and you weren't able to answer that. One thing you might be able to answer that would be helpful is in the fourth quarter what was the trend? What was the December CPR like versus, for example, the October?

We can give you that, but I wouldn't -- there is significant seasonality within the quarter. So, that won't tell you a whole lot unless you know what it is at every prior year.

I mean, I guess presumably, there is a little bit of a rush at the end of the year, but did you see the -- ?

December was the lowest. It was the lowest of the three months.

Keep in mind our CPR numbers are not seasonably adjusted. So using macroeconomic numbers that are seasonally adjusted, you know, a lot of people do not take trade homes or refinance loans over the holidays.

Got it. Next question, and I guess this is actually a sort of follow-up on John's question, which is that headed into the first quarter -- it sounds like you are a little bit more cautious on pricing on MSRs than you were at the end of the year. But in the past, we've seen transactions that you were bidding on slip from one quarter to the next. Things that you worked on, for example in the fourth quarter, might actually show up on the balance sheet in the first quarter. Should we consider that that could be a possibility, just so even though you are a little bit more cautious on pricing headed into the year, we may see continued acceleration at least for the first quarter?

I think you are correct when you say that a lot of what we would bid on now would probably be more reflective of what we'll add to the balance sheet in the second quarter. But I don't think right now we believe that there will be the kind of growth that you saw in the fourth quarter in the first quarter. We don't expect that to occur.

If you look back at us historically, not in every year -- but generally we are much stronger in the latter parts of the year than the early part of the year. There is a lot more competition in the early part of the year as people try to fill their volume. So, we have tended to be more towards the latter part of the year when we pick up volume.

Okay. That's actually helpful also. And then the last thing. This is just sort of a broader question, but I think you are in a unique position to comment on this. As a servicer, what are you seeing generally in the sub-prime mortgage sector for credit performance, what are you seeing in terms of delinquencies, in terms of charge-offs, in terms of severity of losses? And are you seeing pockets -- regional pockets where you are particularly concerned? What insight can you give all of us who are sort of looking at this from the outside?

This is Ron and this is my opinion. I think we are seeing a very small increase in delinquency levels, but pretty minimal at this point in time. [I have know] that our REO timelines and proceeds are taking a little bit longer to sell the REO and the proceeds you are getting is a little bit off, but that is a little hard to judge too, because some of that could be seasonality. As you go into the winter season, things get a little slower, a little weaker in the real estate market, but there are small, small signs of things moving in that negative direction, but nothing significant at this point in time.

And to follow-up on that, are you seeing differences in performance by vintage. For example, are loans that were made in '03 or '04 performing differently giving underlying housing appreciation versus '05 vintage, are you starting to see any sort of stratification by vintage at this point?

At this point, I don't really have any information on that, I can't really comment.

Okay. Thank you guys.

I think one of the things though if you are looking at prepayment speeds to look at is what Ron had spoken about before, not speaking about our experience, but with the change in subordination levels that occurred in the fourth quarter, that generated increase in yields on what originators have to generate in order to be able to sell their loans above their cost; that obviously helps. We think that is a positive effect from a servicer’s perspective. And that is the first real example that we have seen that in a long time.

Bill, I am not sure I understood that. Could you explain that just a little bit greater detail, I am sorry.

Sub-prime mortgages have gone up in yield, primarily because Moody's REIT increased their subordination levels on the securitization. So, i.e., you need to keep more high cost capital against that position and your cost of capital went up to finance the mortgage loan. The mortgage loans didn't go up, because interest rates exploded I mean even if the rates did go up, but you haven't had -- they weren't -- the increase in mortgage rates were not directly proportionate to the sub-prime market. The increases in interest rates, they were really more affected by the subordination level, levels that one of the rating agencies thought were necessary to support the credit losses inherent in that collateral. So, by raising those rates, that actually makes it a little bit, even though we don't think sub-prime is directly related to the rates you pay, it does have some minor retarding effect on the amount of prepayments that will occur or the refinancing that will occur. (multiple speakers) I think it is the impact we think is really the value of the home, to the extent that when Ron was talking about, that it takes longer to sell a home or mortgage appreciation has been -- or rather home price appreciation isn’t as great. We think that will have a much greater impact in terms of prepayment speed.

And do you think, just curious out a little bit, do you think that due to more challenging economics for the originators, that's causing a shift in behavior and that they are trying to regain some of the additional economics by selling full servicing release?

There is some pressure on cash that we see in the origination community. It is possible that you would see originators who may have their own servicing capabilities, but would prefer to get the cash today to sell portfolios. I mean that is definitely a possibility, I mean clearly where loans were capped in trading, it’s got to be making it difficult on the origination side from a cash flow standpoint. There is some possibility that there could be more servicing because of that. At the same time, volumes may just start to shrink because of what is going on. So, net-net, it is hard to tell whether there will be an increase, decrease or remain flat in the amount of third party servicing available in the market. And at least several of the REITs are pretty full up. In other words, they have spent all their cash and it's going to be pretty hard to go back to the market until they get their stock prices up. So, one of your big buyers that retain servicing tended to be some of the REITs and a lot of them do not have as much power as they had, shall we say, even two or three months ago.

Okay. Great, you have taken a lot of questions from us. Thank you very much.

Welcome.

[David Rudolph, Eric Global Partners]

Hello, gentlemen.

[Letlo].

I have two questions. The first question has to do with the reserves for litigation that you mentioned at the beginning of the call. I would just like to confirm, you have put aside 1.8 million for the judgment in Galveston and a total of 3.2 million or rather an increase, a total increase of 3.2 million. So, is the 1.4 million additional increase earmarked for the MDL or is it just a general increase in the reserve?

No, it's not brought through the MDL. We do look across all the outstanding cases in -- as best we can estimate where exposures might be and adjust our reserves accordingly. But there is no specific reserve for the MDL.

Right.

Keep in mind, just to help you with your math a little bit is that the 1.8 was -- we have reserves up, some reserves were already against the 1.8. So, there were 3.4 less; 1.8 was not the increase. The increase was greater than that. It may not have been fully reserved, but it was well reserved before we ever had the jury trial.

Right. What is the total litigation reserve?

I have to double check, give me just a minute and I will come back to you, I have to check a couple of numbers here before I give you that.

Thank you. I can jump ahead to a second question while you are doing that. In the expense item, the professional services line recorded 10.2 million, can you tell us what is in the professional services, sort of a breakout of the two or three or four main categories within that?

It's a euphemism for –

I am sorry I shouldn't be --

For attorney fees and –-

Attorney fees, settlement costs, etc., are significant components. Up until the last six months we also had significant regulatory fees including FDIC Insurance fees affecting regulated and so forth. So, historically and through the first half of '05, that will be the second largest component. Accounting and auditing fees would be another significant element of that as well as consulting arrangements and so forth that we would do.

The litigious element, when you look at the litigation environment in the sub-prime area at least with respect to Ocwen so far is not the actual judgments you get, which have been very nominal. It's actually the level of attorney fees that you expend to defend yourself against contingency law firms.

Are the FDIC and accounting and auditing expenses seasonal, do you tend to encounter those more in the fourth quarter?

The FDIC fees are gone as of the middle of last year because we are not at risk anymore.

Right of course, okay.

And we estimate, obviously the attorney fees are as incurred and our CPAs, we had an estimate the end of the year and we accrue it. Now, we may be off at year-end one way or the other, but we haven't [inaudible]. We set up an accrual at the beginning of the calendar year for the audit.

The reason I asked is it looked like the fourth quarter of '04, you had a 10 million expense there; in the fourth quarter of '05, you had a 10 million expense. But most of the other quarters, it was more like 4 to 5 million. So, I wondered if there was a fourth quarter seasonal expense or if it’s just a coincidence that the two fourth quarters were larger.

I would say no, there’s not particularly anything seasonal other than to say that in general particularly in the area of legal fees, you tend to get a lot more intelligence and information from law firms as it gets towards the end of the calendar year. So, I would say across a lot of improving categories, you tend to see a bit of a fourth quarter lift. It is a fairly expected phenomena.

But probably more of a coincidence than anything those two quarters.

Okay. That's it, if you have the litigation reserve number. I have no further questions.

The litigation rate number and [ground res] numbers were probably be somewhat in the neighborhood of $6 million. Without getting back to check this probably in detail, but we are somewhere in that range.

Okay. And so, the 3.2 million is an addition that brings the total to 6 million?

Ultimately, yes.

Okay. Thank you very much. I'm done.

Bob Napoli, Piper Jaffray.

I apologize if you answered this -- I had to miss a fair amount of your prepared remarks, if you've answered this question already, but the $470 million of loans, then your press release says you purchased during the fourth quarter and plan to securitize, is this a change in strategy? Are you doing correspondent originations? Why did you purchase that and what type of a securitization? You are going to securitize the loans, retain the servicing rights, I assume, and take a gain on sale?

We are not intending to take a gain on sale. Bob, it is part of our strategy to look at our capital structure of Ocwen. When you stand back and look at us, you can see that we have a very large amount of cash and a lot of unused borrowing capacity. The primary reason for that is on a net basis, third-party lenders would say that our assets are very low risk and we use very little equity to support our existing lines of business. One would say why don't you return it by shares back. There is the -- one of the constraints we have is that in order to keep your servicer ratings, you have to keep a certain amount of -- we believe we have to keep a certain amount of equity in the business. So, historically, what we've done is either not borrow -- not deploy the funds or we've kept a $0.25 billion of cash on the balance sheet, basically in fed funds. So, our objective is to say, from a corporate finance perspective, if you look at that on a net basis to deploy most of the equity base of your company in overnight fed funds, it's difficult to generate an attractive return on equity, once the small amount you invest is at just simply ballistic returns, which they are good returns but they are not enough to overcome three-quarters of your balance sheet, three-quarters of your equity base being deployed in cash. So, what would we do with that cash? Well, you have seen some things that we have done. One opportunity is we could buy back debt or convertible debt. That is certainly one way to deploy those funds.

The other way would be to say, are there other investments that we can make that would in fact be somewhat of a hedge against our operating businesses? And at the same time, under most stress scenarios, provide you a rate of return that is equal or better than fed funds. We happen to believe that, you know, we've attempted over the past six months or so to -- or past year to develop things that have become natural hedges to our servicing business and to support that business. One is our Residential Origination Services. That provides us with a hedge against one of the three risks that you have within servicing. Those risks being prepayment, default and interest rate risk. Certainly, Residential Origination Service needs, as prepayments accelerate to generate more fee income, which had helped us set the impact on earnings of the servicing business of more rapid prepayments. The residual, in fact, has prepayment risk and has default risk, but it is inversely related to interest rate exposure on our servicing business. In other words, just putting servicing and decoupling it from prepayments, the servicing business has a $1 billion collection account. We like high rates on the servicing business as you can see this year. On the other hand, at residual high rates are a bad thing. Conversely, when rates go down, residuals become incredibly valuable in terms of their cash flows, because again the underlying collateral tends to be fixed and the obligation tends to be floating, it creates an enormous value creation on a residual when rates go down. So, that's one of the two -- that's the second of the three risks. So, to a limited extent, having residuals in our portfolio, if you will, will provide us with a hedge against the interest rate exposure we have on our collection accounts. Something of interest to us right now, because I'm not sure that anybody knows what's going to happen to short-term rates as we go out a year or two in the environment. So, that would provide us with somewhat of a natural hedge.

The other thing that I think is very important to think about is that a residual booked at a net present value of 18% is a very high-risk asset. Residuals provide you over the first 36 months, a low level of cash return, then you get the huge release hopefully if you haven't triggered the default triggers of the loss triggers and that huge flush of cash gets discounted back to today and you come up with a very high yield of 18%. We are trying to basically be more -- we are working with our auditors to try to even be more conservative than that, because if you look at a residual at say, 4% or 4.5%, if you were to discount at that rate, the odds that you would make less than that are very, very low. So, in fact what we would like to see over time is if we could structure it such that we have a low rate of return, high profitability of occurrence with effectively what would be an option on the backend, if in fact the release of over-collateralization would occur at 137.

Now, how did you originate that product and so this is something you want to consistently build as part of your strategy, it sounds like? So, how are you originating? Are you buying -- ?

To a limited amount. We are not running out and just saying, let's buy a ton of products to this regard, it would have to fit this part of our portfolio. That product there was actually purchased to create that.

So, it was purchased directly from an originator?

Correct. We do not believe that our distinctive competency is running a mortgage sales force, and so we are really effectively -- when you look at the business' Residential Origination Servicing and Residential Servicing, it effectively looks somewhat like a mortgage company without the balance sheet or without basically the sales force. It's all the processing involved with the mortgage company but not -- the two elements of a large balance sheet and a large sales force do not exist.

Right, I understand. But should we expect then to see, I mean, do you want to buy $500 million a quarter and securitize it? Is that kind of -- ?

I mean, I am not going to go forward with what projections are. We have a very modest budget for proceeding with this business through 2006. We think that it will provide us with a hedge against the collection accounts and to the extent -- one of the other reasons we like it is that if you look at the LPS study, it shows that on securities we service, those securities recognize losses of approximately one-half the industry average, which obviously creates value in the residual and feeds right into our servicing shop as well. So, we are not intending to go out and basically become a REIT or build a big balance sheet in that area, but it does have its place within the overall deployment, if you will, of our liquidity.

Last question on taxes, your tax net operating loss carry-forward, you guys are making a lot more money, now that rates are up in that servicing business, and that you should continue to make more money, I think, buying something unforeseen. When would you need to make a decision on the NOL and when it should be brought into earnings and into book value?

We actually take a look at that every single quarter. You are right, as we continue to have quarters of earnings, that becomes a higher probability. I would say some of the factors now, if you get into the GAAP (indiscernible) of what we have to look at, there are also predictability standards. So, my eye right now is on looking at coming to realization of some of our newer strategies that Bill has been talking about and I think that is high on my agenda in 2006, as we are going to be looking very carefully throughout 2006 as to when we have achieved enough probability there to meet the accounting standards. I don't want to put a date on it, that would be premature, but it's something very high on the watch list every quarter during the coming year.

Right, it's a judgment issue and I think we've been reasonably conservative at evaluating that position.

Post that move what would be your GAAP tax rate?

Well, I am not sure I have all the factors correct. But it will come closer to the statutory rate all of the things being equal. There's a lot of moving parts. I’d have to (technical difficulty) give you a more precise answer than that.

Thank you very much.

You’re welcome.

[OPERATOR INSTRUCTIONS]. Shawn Paydar, Friedman, Billings, Ramsey.

I just have one question if you can take me back to slide 8, I am sorry that I missed this. Can you just bridge me from the 2004, $36 million figure to the 2005, $28 million?

Hang on one second here. We are back to slide 8. I apologize, what was the question again?

Just if you can bridge me from the 2004 number to the 2005 number, what kind of composed the earnings difference -- I am sorry the pre-tax income difference?

The results reflected an improvement in our residential servicing and commercial segments that were offset by reductions in Residential Origination Services, Business Process Outsourcing, and Ocwen Recovery Group.

If you can find, if you have got the full section of the earnings release, we actually have that on the last page of the earnings release we announced this morning as well.

Okay.

So, if you go to the last page of the earnings release, you can see of the five business segments, how much the growth was or decline in each one.

In each one, okay.

Okay.

Thank you.

And now there are no other questions at this time.

Thank you very much everybody. Have a great day.

Today's call is concluded. You may disconnect at this time. Thank you.