Onity Group Inc (ONIT) 2006 Q1 法說會逐字稿

Good morning and welcome to the Ocwen Financial First Quarter Results 2006 Conference Call. All participants will be able to listen only until the question-and-answer session of the call. [Operator Instructions]

Today’s conference is being recorded. If anyone has any objections, you may disconnect at this time. Now, I’ll turn the call over to Mr. Robert Leist, Senior Vice President and Financial Officer. Sir, please begin.

Thank you. Good morning everyone, 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, first quarter 2006 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 grey 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 can 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 2005 10-K.

If you would like to receive our news releases, SEC filings and other materials via email, please contact Linda Ludwig at Linda.Ludwid@ocwen.com.

As indicated on slide 3, joining me for today’s presentation are Bill Erbey, Chairman & CEO of Ocwen; and Ron Faris, President.

This 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’ll turn the call over to Bill Erbey. Bill?

Thank you, Bob. And thanks all of you for attending Ocwen’s first quarter conference call. I would like to cover two topics in my remarks today; first, an overview of our first-quarter earnings and second, our investments and loans and related securitization activity over the past two quarters.

As shown on slide 4, pre-tax income for the first quarter of 2006 was $21.5 million. These results reflect both a strong performance by our residential servicing business, and several transaction gains aggregating approximately $4.4 million related to loan sales and securitization activity in our residential origination services segment.

Our first quarter 2006 pre-tax income increased by $16 million, or 313% over our quarterly average in 2005, and $15 million or 236% over the 2004 average.

As shown on slide 5, our non-interest revenue for the first quarter was $102 million, as compared to an average of $94 million per quarter in 2005, and $90 million in 2004; or increases of 9.5% and 14% respectively.

Operating expenses, as depicted on slide 6, remain essentially flat at $88 million, as compared to the 2005 quarterly average. This flattening of expenses is the net result of two trends; an increase in operating expenses in our new mortgage, due diligence, and loan processing businesses which began operation in the course of 2005; and decreases in overall operating expenses in the remainder of the organization. More specifically, loan processing and due diligence expenses in residential origination services, increased by $4 million, or 59% as compared to the 2005 average.

Apart from these activities, our operating expenses across all business and support departments decreased by $4.5 million or 5.5% as compared to the quarterly average last year. This decrease reflects, among other factors, decreased operating costs, particularly in loan servicing, created through process improvements and customer-satisfaction initiatives begun in 2005.

Given that our servicing volumes rose in the fourth quarter of 2005, and remained relatively stable during the first quarter this year, these reductions mean that we achieved a lower unit cost for servicing operations, which should continue to benefit operations for the remainder of 2006.

Ron and Bob will provide further information on our first quarter earnings later in this call.

As noted last quarter, during 2005 we began to implement a strategy in our residential origination services segment to better address three risks we continue to face in the mortgage industry; prepayment, default and interest rates.

Our efforts in this regard have been focused on developing our loan origination and due diligence processing capabilities and our targeted acquisition of loans with a view towards securitizing them and retaining the resulting residual security.

The past several years have clearly demonstrated the impact on the servicing business of high prepayment speed. Our new initiatives 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 operation.

Our loan purchase and securitization activities address interest-rate risk. Declining interest rates reduce earnings in our servicing business. As our earnings from a residual security will generally increase in this environment, and as much as the loan portfolio collateralizing the floating rate securities issued by the securitization trust, it generally includes a portion of fixed-rate collateral. The residual security is thus the beneficiary of excess cash flow resulting from declining interest rates. Residuals therefore provide a hedge against our interest-rate exposure.

Further, there is a significant economic benefit to a residual holder from quality servicing. Given our track record of achieving a high rate of pre-foreclosure resolution, we believe that holding residual securities will enable us to profit directly from the quality performance of our servicing operation.

As I said before, our strategy is to achieve measured growth with respect to residual holding. Our residual and subordinate securities portfolio grew to $46 million as of March 31st, 2006; including $19 million of securities we retained from the first-quarter securitization of approximately $470 million of loans. We expect this portfolio will increase further as we identify additional transactions during the remainder of the year.

In summary, we are pleased that our residential servicing operations have achieved a strong first-quarter performance. However, we need to remain focused on improving performance in our other business segments. 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 7, the pre-tax earnings of our core businesses was $22.8 million in the first quarter of 2006, a 338% increase over the 2005 quarterly average result of $5.2 million. These results reflect significant improvement made by the Residential Servicing and Residential Origination Services segment, offset by reduction in the Commercial Servicing, Business Process Outsourcing and Ocwen Recovery Group segments. I will provide the details behind these changes throughout the call.

Turning to slide 8, the Residential Servicing segment recorded $17.9 million in pre-tax income in Q1 2006, as compared to the 2005 quarterly average of $5.4 million, and the 2004 quarterly average of $4.2 million. The Q1 2006 results represent a 230% improvement over the 2005 quarterly average result and a 324% improvement over the 2004 quarterly average result.

Net revenues in the Residential Servicing segment were $79.9 million in the first quarter of 2006, a 14% improvement when compared to our 2005 quarterly average revenue of $69.9 million.

Slide 9 illustrates the continuing improvement in the residential home servicing portion of our Residential Servicing segment. Loan servicing achieved $18.6 million in contribution margin in Q1 2006, a 119% improvement over the 2005 quarterly average contribution margin of $8.5 million. This improvement is the result of both an increase in revenues and a decrease in expenses.

Our servicing fee revenue increased due to growth in the portfolio, coupled with reduced run off of the existing portfolio due to slower prepayment speeds. Float income also increased, primarily due to increases in short-term interest rates, partially offset by lower float balances.

On the expense side, our amortization expense also benefited from the slower prepayment speeds. Our first quarter 2006 amortization expense of $26.3 million is an increase of only 5% over the first quarter of 2005 amortization expense, while our MSR balance increased by 10% over the same period.

We are also seeing the expense reduction benefit of the efficiency improvements that we implemented in the second half of 2005. While our servicing portfolio grew from first quarter 2005 to first quarter 2006, our compensation expense declined by approximately $1 million over the same period, which results in a lower unit cost.

As shown on slide 10, our servicing portfolio’s unpaid principal balance at quarter end was $42.9 billion. While this balance is basically flat with our year-end balance of $42.8 billion, it represents a 24% increase from our December 31st, 2004 balance of $34.5 billion. As of March 31st, 2006, we were the servicer for 378,000 loans, as compared to 369,000 loans at year end 2005, and 320,000 at year end 2004.

Our balance of mortgage servicing rights at March 31st, 2006 was $147 million, a 1% decrease from our December 31st, 2005 balance of $148.7 million, and a 13% increase from our December 31st, 2004 balance of $131.4 million.

Slide 11 shows the trend in prepayment speeds over the past two years. As you can see, prepayment speeds at 30% in the first quarter, are well-below the 2005 average of 38% and the 2004 average of 41%. The first quarter CPR of 30% is the lowest quarterly average since Q1 2003.

Advancing to slide 12, our Commercial Servicing Business reported 300,000 in pre-tax income verses the 2005 quarterly average pre-tax income of $700,000 and the 2004 quarterly average pre-tax loss of $100,000. The decline in 2006 results reflects the absence of the asset resolution fees earned by GSS in Canada and in the domestic servicing operation in the third quarter of 2005.

As shown on slide 13, Ocwen Recovery Group, our unsecured collection segment, posted a pre-tax loss of $400,000 in the first quarter, as compared to the 2005 quarterly average pre-tax loss of $200,000 and the 2004 quarterly average pre-tax income of $1 million. This decline in results is primarily due to a reduction in revenue as the balances of older, high-margin portfolios decline.

On a more positive note, the first quarter 2006 revenue of $2.2 million represents a 16% increase over the fourth quarter 2005 revenue of $1.9 million. This increase is primarily the result of additional work received from existing clients.

Operating expenses are declining as a result of process improvement, technology enhancements, and a greater concentration of offshore resources. These initiatives have yet to reach completion, however.

Slide 14 shows the Residential Origination Services segment’s first quarter 2006 pre-tax income of $5 million, verses the 2005 quarterly average pre-tax loss of $1.1 million. As Bill stated earlier in the call, we had $4.4 million of transaction gains in our Residential Originations Services segment in the first quarter. The majority of these gains relate to the net realized gain on the securitization that occurred in the first quarter, along with hedge gains relating to loans held for sale, a portion of which were securitized in April.

In addition to these transaction gains, we also realized improvement in our securities portfolio, refinance, and Ocwen Realty Advisors businesses, offset by reductions in our mortgage due diligence business and losses in 2006 from an [entity] that we began to consolidate as of year end 2005.

Turning to slide 15, the Residential Origination Services segment’s process management fees continued to increase to $14.5 million in the first quarter of 2006. This represents a 7% increase over the 2005 quarterly average result of $13.6 million and a 41% increase over the 2004 quarterly average result of $10.3 million.

Our mortgage due diligence business continues to contribute to this growth, as well as improvement from other areas of the segment, such as Ocwen Realty Advisors, our property valuation business.

As reflected on slide 16, our Business Process Outsourcing segment reported a pre-tax loss of $12,000 for the first quarter 2006, as compared to the 2005 quarterly average pre-tax income of $300,000 and the 2004 quarterly average pre-tax income of $600,000.

Unfortunately, we lost a significant BPO client early in 2006 due a merger and the resulting consolidation of activities. We continue to refine the focus of our sales and marketing efforts, and we expect to continue to add new clients throughout 2006.

In summary, I am pleased with the results of the Residential Servicing business and Residential Origination Services segment, particularly the residential loan servicing business. We will continue to grow top-line revenue while maintaining our focus on our cost structure.

Thank you, everyone; I’d now like to turn the call over to Bob Leist.

Thank you, Ron. I’d like to focus on two areas this morning; the operating results of our corporate segment and the changes in our balance sheet during the first quarter.

As I noted before, 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 remaining activity of our former non-core affordable housing and commercial businesses.

As shown on slide 17, in the first quarter of 2006, the corporate segment reported a pre-tax loss of $1.3 million as compared to a loss of $3.5 million in the first quarter of 2005; a reduction of approximately $2 million.

This favorable variance was the result of several factors. In 2006 we recorded a net gain of $900,000, reflecting a cash payment from our only commercial mortgage-backed security which is now reaching the end of its economic life.

During the first quarter of 2005, corporate results included operating expenses related to real estate investments that were subsequently sold during 2005, and also included interest expense that we retained in corporate, reflecting the fact that we were holding large cash balances during that period in anticipation of de-banking. We had no comparable expenses of this nature in 2006.

Our balance sheet remains strong. Although our cash and investment-grade securities holdings declined by $54 million to $217 million as of March 31st, verses $271 million at the end of last year, we were able to reduce our liabilities by $316 million or 21%, thus improving our leverage overall as our equity to assets ratio rose from 18.7% at year end to 23.5% as of March 31st.

Our developing strategy with respect to origination services, which Bill covered earlier in this call, has also resulted in a number of changes in our balance sheet. Our loans held for resale decreased to $365 million as of March 31st, as compared to $625 million at the end of 2005. This reduction reflects the net impact of several factors. First, we securitized approximately $470 million of loans during the first quarter. Second, we purchased $158 million of loans in preparation for a securitization that closed in April. Finally, we reported a net increase of $52 million related to our other refinancing and loan sale programs.

Our lines of credit decreased by $220 million, primarily reflecting the reduction in our net funding requirements for our loans as of quarter end.

Before closing, I also want to note another change in our reporting which was a direct result of de-banking. As first disclosed in our 10-K filing for 2005, now that we are no longer a bank holding company, we’ve made a number of changes to our income statement presentation. Perhaps most notably, we have reclassified certain servicing costs formerly netted against revenues as expenses. These items include the amortization of servicing rates, which is now a separate caption on the income statement; as well as other costs which are now reflected as components of servicing and origination expenses, another new caption in our revised presentation.

We’ve also created a third section in the income statement, titled other income expense; in order to more clearly identify non-operating balances including interest income and expense, gains on loan sales, and trading gains and losses. Our objective in making these changes was to increase the transparency of our results.

In summary, we achieved strong earnings in the first quarter and ended with a strong balance sheet. We have cash and equivalence of $217 million, equity of $366 million, and unused borrowing capacity on our credit facilities of $366 million.

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

Thank you. [Operator Instructions]

Richard Shane, Jefferies and Company, you may ask your question.

Good morning guys, thank you for taking for my question. A couple things; to this point you saw a fairly significant decline in CPRs but it doesn’t seem to me like you changed the amortization rate on the servicing rights. Can you talk about that decision? Can you talk about what potentially would cause you to slow the amortization rate?

This is Ron. We currently—a big driver of your amortization rate depends on the forecast that you use for prepayment speeds. And the model that we used to forecast prepayment speeds is very much based on recent historical performance. And so we continue to show prepayment speeds out in the future that are probably more reflective of prepayment speeds that have occurred over the last 18 to 24 months verses those that have occurred over the last 3 to 6 months. Over time, as we bring back more current history into the model, you would see us probably slow down our projections somewhat.

With that being said, [though] as we mentioned in our talk here; the amount of amortization did not increase as much as the increase in our servicing rights or the servicing portfolio. So you are starting to see sort of just a natural reduction in the amount of amortization, kind of as a percentage of the portfolio as we move forward.

Got it. And the next question is – there was an implication in Bill’s comments that it sounds like selectively you will be purchasing additional pools of loans and securitizing them. Can you talk a little bit about how you’ll approach that market and also what your assumptions are for gain on sale and what the actual gain on sale in the transaction was on a percentage basis?

Well, I guess what we can say is that we do feel, as Bill mentioned in his part of the talk, that making select investments in mortgage products either through whole loans and then securitizing or directly investing in residuals, is a good somewhat hedge to our servicing portfolio; and that we do expect from time to time to make additional investments in that business. But I don’t want to kind of oversell that. It’s not something that we’re actively out there trying to grow significantly, but we will do on a select basis.

We are utilizing gain-on-sale accounting. I’m not sure that I have the details to the question that you asked though.

I think that one thing to keep in mind Rick is that the way it works is like in the fourth quarter of last year you noticed we took a rather substantial write down on those loans when we marked them to market. And then the market recovered to some extent, so when it’s net-net to gain is probably within—I’m doing this off my head—it’s very close to the loss we had in the fourth quarter verses the gain we had in the first quarter. So in that transaction, net-net there not a substantial amount of gains recognized.

Okay, great. Thank you guys, very much.

[Stephen Tannenbaum] with Greenwood Investments.

Howdy, guys. My question has to do with the mortgage servicing rights. Maybe I missed this. Could you tell me how many you have at quarter end—what the value is on the balance sheet? And what kind of a delta—did you add anything to the pool [inaudible]-?

Okay, the servicing right balance – the actual amount on mortgage servicing rights on the books at March 31st was 147 million verses 148.7 million at the end of the year. So it declined just a tad. And that’s similar to the overall servicing book of 42.8 billion I think, which was basically flat from the end of the year.

So what you’re saying, I guess, given the amortization, is that you bought about 26 million in servicing rights or generated or created 26 million in servicing rights; and added it to the balance sheet over the quarter?

Right, that is correct. And in addition you can say that we also acquired enough new servicing to kind of replace the run off that occurred in the first quarter.

That run off being the amortization, based upon the 18 to 24 months history you were talking about?

What I mean is that the 30% CPR, so that’s an annualized number of course, but the loans that ran off during the first quarter; we were able to bring in new loans to replace that. And as it turns out, about the same amount of mortgage servicing rights on the balance sheet that amortized off, the new loans that we brought on had about the same amount of new servicing rights. So, both the balance sheets stayed relatively consistent as well as the overall serving portfolio.

Super. I guess my final question is – you seem not to put into any of the financial statements on Edgar and the SEC filings, any indication of the sensitivity of amortization of servicing rights, different prepayment speeds. Is that a correct statement that there is nowhere where we can actually see the results of your modeling, like if you took into account present prepayment speeds as opposed to those over the last 18 to 24 months? Is there any way for us to find that data?

You’re right. It is not data we’re putting out there at this point in time. I’m sure we can take it under consideration doing that going forward.

We did provide, in the last quarterly conference call, we did provide a slide on that showing sensitivity if prepayment speeds had gone back as far as like in 2003-2004, what impact that would have on our amortization.

Super. And is there any chance we can get an updated slide perhaps in the next few days on that?

[Inaudible] we’ll try to get that out there for you.

I’d appreciate that tremendously. Thanks a lot for your time, guys.

[David Whittle], Avera, you may ask your question.

Hi, my question is about the Business Process Outsourcing – actually I beg your pardon, the Residential Origination Services. Could you give a little more detail about the change in operating expenses between the two periods and also the other income? Thank you.

Hold on, one second—

We’ll talk about other income first for a second. I apologize I know you had a couple parts to your question. Other income, as it pertains to Origination Services; the biggest piece of what’s in there – we have – I’ll call it the gross gain on the securitization transaction of about $3 million rolled into other income. There are also expenses that are in the expense section. So as Bill said, our net gain on that [inaudible] was far less significant as at just north of million dollars. But in other income---

About 3.1 million in other income and expense there which is the gross gain on that. And –

But there’s a swing of about $10 million and it looks like 4.4 is due to transaction gains. Another 3.1 you just mentioned due to the gain on the securitization.

Right, the other biggest piece I would think, and I apologize, I’ll have to do a little digging; it’s got to be interest cost, just based on all of the loan financing that we did because that’s where that would be captured, in that other income and expense caption.

I’d like to clarify—the gain on sale is really included in that 4.4 transaction gain. So those aren’t additive. That’s included in there.

Okay, so there’s another 6 million swing between Q1 ’05 and Q1 ’06.

Right and I’m trying to – bear with me a minute, I’m digging for a little more detail here for you. I’m going to tell you I believe it’s mostly interest, but let me take another look.

And again, if you look at the transactions that we’ve done, the actual net-net gains when you look at them from – since they go over multiple periods, are really rather nominal.

We’re talking about the other income and expense line now?

In ROS I think, right?

And that’s really going to be the next positive carry of carrying the whole loan, which going back last year we didn’t have those investments in the first quarter of last year. So if you recall, we started out the beginning of the year with loans of $624 million which we were earning a net positive spread on for a period of the quarter up until the time they were securitized and then we mentioned we bought some additional loans that are going to be securitized in April. And so that net positive spread is driving that additional big increase in that line item, compared to last year when we didn’t have any of those activities.

Okay, could you talk a little bit as well about the operating expenses line? Could you just give us a little detail about the changes there--- in ROS the other $10 million swing?

Right, let’s see. It’s spread across a couple of categories. As we indicated somewhere in our remarks, recall that this is a start-up business in the course of last year; so as you would expect, overall the expenses in this area are up. The biggest single piece of it is in compensation expense which is up in the segment, a little over $4.5 million. Also in professional services, and that relates largely to expenses we incurred in doing the securitization, due diligence on loan purchases and what not. Those are the two biggest components that brought that up period over period.

And the reason the compensation is going to be up so much is that was – the first quarter of last year was the first quarter that we had just started what we call our mortgage due diligence operation. And we ramped that up during the year, so the run rate of cost is much larger than it was back in the first quarter of last year. So there are a number of things that went on, but that business segment has ramped up a lot since the first quarter of last year.

Okay, so 4.5 million is from the compensation increase, another 5.5 to 6 from professional services? Is that about right?

I’m sorry – say that again?

It’s roughly 4.5 on comp benefits, about 2 million in professional services and then there are increases in servicing and origination expenses as well, the third piece. And again, that simply reflects increased activity over a start up, especially in the early part of last year.

And there are certain costs related to the securitization activities that are also in there as an expense which offset some of the gain that you see in that other income line.

Okay, thank you.

Thank you. [Operator Instructions]

At this time we have no further questions.

Everybody, thank you very much. Have a great afternoon; good-bye.