Onity Group Inc (ONIT) 2006 Q2 法說會逐字稿

[event begins in session.] ...2006 conference call. At this time, all participants are in a listen-only mode. [OPERATOR INSTRUCTIONS]

Now I will turn the meeting over to Mr. David Gunter, Senior Vice President and CFO. 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 a slide presentation is available to accompany our remarks. To access the slide, log onto our website at www.ocwen.com. Select Shareholder Relations; then Calendar of Events. Then under Conference Calls Second Quarter 2006 Results, select View Slide. 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 a 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 statement.

For an elaboration of the factors that may 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 Ocwen's 2005 Form 10K. 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. This presentation will be followed by a question and answer period during which we will take questions from those of you attending the conference by telecomm.

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

Thank you, Dave, and thanks to all of you for attending Ocwen's second quarter conference call. I would like to cover three topics in my remarks today. First, an overview of our second quarter earnings; second, our efforts and plans to enhance the effective utilization of our equity; and third, our previously announced joint venture investment in BMS.

We are pleased with our second quarter results. Net income amounted to $159.1 million, which included a tax benefit of $141.7 million, primarily because we reversed $145.2 million of the valuation allowance under deferred tax assets that we have provided in previous years. Dave will provide further information on that event later in the call.

As shown on Slide 4, pretax income for the second quarter of 2006 was $17.4 million as compared to $21.5 million in the first quarter and well ahead of the quarter averages in the past three years. These results reflect a continued strong performance by our Residential Servicing segment and positive pretax income in all of our segments except for Residential Origination Services, which posted a pretax loss of $2.1 million for the quarter.

As shown on Slide 5, our revenue for the second quarter was $105.1 million as compared to $102.4 million in the first quarter and averages of $93.8 million for quarter in 2005 and $90 million in 2004. This growth is largely due to the Residential Servicing segment.

Operating expenses as depicted on Slide 6 declined to $84.8 million, a 3% decline as compared to expenses in the first quarter of 2006 and the 2005 quarterly average. The reduction of operating expenses in the second quarter as compared to the first quarter is the net result of several factors. In Residential Servicing, expenses increased due to higher MSR amortization, reflecting the growth in our servicing portfolio and increased legal costs; although, other operating expenses in this segment, including compensation, reflected small decreases. Operating costs decreased in all of our other segments, including Corporate. We are particularly pleased that operating expenses in the Residential Origination Services segment, where we have been investing an increased capacity over the past several quarters, declined by $3.2 million as compared to the first quarter, primarily due to decreases in compensation costs.

As shown on Slide 7, other income and expenses reflected a net expense of $3.3 million in the second quarter as compared to income of $6.3 million in the first quarter of this year. This is the section of our income statement where most of the results of our loan purchase and securitization activity is reflected. As you may recall, we noted in our last call that our first-quarter results included $4.4 million of transaction gains related to this activity. In the second quarter, we recognized losses of $3.2 million with respect to the securitization, bringing us to a $1.2 million gain on these transactions in the first half of this year. Because they often require several months to be fully executed, these activities can stay in quarters and have the potential to create earnings volatility, as under the applicable accounting rules we recognize the impact of each phase of the transaction within the quarters in which it occurs.

It is important to note that our objective with regard to this activity is not to achieve significant gains upon initial execution, but to achieve a modest gain while creating residuals and other securities that we project will earn a high rate of return over time. Ron and Dave will provide further information on our second-quarter earnings later in this call.

As I have mentioned in prior calls, one of our long-term strategic objectives is to free up equity for growth opportunities. We have three goals in this regard -- first, to improve cash management; second, to improve the funding of our high-quality assets; and third, to convert our less productive assets to cash. The past 12 months provide evidence of our success thus far in this regard, as we have been able to complete our de-banking initiative and replace all of our deposit financing without a significant decline in cash balances or increase in funding costs.

As Dave will address later in this call, our balance sheet has strengthened over this period. One important measure of progress in this area is the reduction of the equity required to support our servicing unpaid principal balance. While we are pleased that we have been able to reduce this measure by 34% since the beginning of the year, we believe that we can still achieve further enhancements in this area.

We remain focused on cash management. During this first half of this year, we've implemented new cash management technology, including the remote capture of checks. As a result, we have been able to reduce our clearing cycles for payments received by one to two days. Considering the size of our cash flow during the year, improved clearing times represents a substantial potential benefit.

We are also currently negotiating revised terms in our existing advance financing facility, which would decrease the delay between our expending funds for an advance and our receipt of financing on that asset.

On the asset funding front, we believe that the quality of our assets provide further opportunities. Approximately 59% of our assets are cash, cash equivalents and assets that are the equivalent of AAA rated credit, and we are currently examining all of our asset classes to identify increased funding opportunities. Among the most significant are our receivables, which amounted to [$60.7] million at June 30th, and which include amounts due from the Veterans Administration in connection with our REO servicing business as well as receivables from other Wall Street clients whose credit is outstanding, but its payments are cycles are sometimes elongated. We are currently negotiating revised lending agreements which would include these assets in their term.

Our second opportunity is to examine our refinance and loan origination program in order to identify opportunities to obtain additional funding during the period in which we hold these loans. Furthermore, we're also exploring increased financing opportunities with respect to our mortgage servicing rights and advances and believe there is some receptivity in the market to increase our coverage in those areas.

Finally, as I noted earlier, we will remain focused on careful asset management in order to minimize asset size overall and reduce or eliminate our less productive assets. Our efforts thus far have met with success, as on average we have been able to increase our liquidity position at the low point of the month by 24% in the second quarter as compared to the first. We will continue to focus attention on these initiatives for the remainder of 2006 and beyond.

As we announced earlier in the quarter, we are about to close on our investment in Bankruptcy Management Services or BMS, which we are acquiring through a joint venture with Charlesbank Capital Partners. Because we and our JV partner have not yet closed this transaction, my comments today are, of necessity, limited. I can tell you that BMS is the largest single provider of software and asset management services to Chapter 7 bankruptcy trustees, with over 50% of the market.

BMS provides technology and other support services to court-appointed Chapter 7 bankruptcy trustees. BMS principally derives its revenue from control over the funds which the trustees collect during the bankruptcy process, which it refers to a depository institution of its choice. BMS earns recurring fees from that institution based on the size of the custodial balances, which currently approximate $2.5 billion.

We concluded that this investment is a strategic fit for us because the keys to earning enhancement are the cash management expertise and banking relationships that we have developed through the operation of our servicing business. We and Charlesbank will each invest approximate $45 million and management will invest approximate $8 million towards the purchase price of $445 million, which includes both a payment to the current owners of BMS as well as other related fees and expenses of the transaction.

While we are still completing the accounting analysis, our expectation is that this will be accounted for as an equity investment and will not be consolidated in our financial statement. We are excited about this opportunity because we believe that BMS will be a strong cash-flow generator and represents an opportunity to create an asset of long-term value.

In summary, we are pleased that our Residential Servicing segment has continued its strong performance in 2006 and that we are realizing the operating cost reductions across the organization. We are also excited about the prospects for long-term benefit from our BMS investment. We remain focused on improving the asset and equity efficiency of our business to free up equity to support our growth opportunities.

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 pretax earnings of our core businesses were $17.2 million in the second quarter of 2006, a 231% increase over the 2005 quarterly average results of $5.2 million. These results reflect improvements made by the Residential Servicing, Ocwen Recovery Group and Business Process Outsourcing segments, offset by reductions in the Residential Origination Services and Commercial Servicing segments. I will provide the details behind these changes throughout the call.

Turning to Slide 9, the Residential Servicing segment recorded $18.1 million in pretax income in the second quarter of 2006 as compared to the 2005 quarterly average of $5.4 million and the 2004 quarterly average of $4.2 million. The second quarter of 2006 results represent a 235% improvement over the 2005 quarterly average results. Net revenues in the Residential Servicing segment were $83 million in the second quarter of 2006, a 19% improvement when compared to our 2005 quarterly average revenue of $69.9 million.

Slide 10 illustrates the continuing improvement in the Residential Loan Servicing portion of our Residential Servicing segment. Loan servicing achieved $19.6 million in contribution margin in the second quarter of 2006, a 131% 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 runoff of the existing portfolio due to slower prepayment fees. Float income also increased, primarily due to increases in short-term interest rates. Some of this increase in revenue was offset by an increase in interest expense, which is included in other income expense, due to the increase in financing costs associated with our servicing advances and mortgage servicing rates.

On the expense side, our Amortization expense and compensating interest expense also benefited from the slower prepayment speed. Our second quarter 2006 amortization expense of $27.6 million is an increase of 11% over the second quarter 2005 amortization expense. However, our MSR balance increased by only 13% over the same period. Our second quarter 2006 compensating interest expense was approximately $3.6 million as compared to the 2005 quarterly average of $5.6 million.

We are also seeing the expense reduction benefits of the efficiency improvements that we implemented in the second half of 2005. While our servicing portfolio continued to grow over the first six months of 2006, our compensation expense in the second quarter of 2006 declined by approximately $1 million when compared to the second quarter of 2005. This results in a lower unit cost of service.

As shown on Slide 11, our servicing portfolio's unpaid principal balance at quarter end was $47.1 billion. This balance represents a 10% increase from our 2005 year-end balance of $42.8 billion and a 37% increase from our December 31, 2004 balance of $34.5 billion. As of June 30, 2006, we were the servicer for 404,000 loans as compared to 369,000 loans at year-end 2005 and 320,000 at year-end 2004.

Our balance of mortgage servicing rates on June 30, 2006 was $149.5 million, a 1% increase from our December 31, 2005 balance of $148.7 million and a 14% increase from our December 31, 2004 balance of $131.4 million.

Slide 12 shows the trend in prepayment fees over the past several years. As you can see, prepayment fees remained at 30% in the second quarter and are well below the 2005 average of 38% and the 2004 average of 41%.

Although the price of subprime whole loans has declined from the prior year, the price for subprime servicing rights has increased by 10 to 20% or more as the servicing industry has adjusted its view of future prepayment fees. Although we continue to acquire servicing rights and grow our portfolio, we have not necessarily increased the price we have been willing to pay as much as some of our competitors.

Advancing to Slide 13, our Commercial Servicing business reported $300,000 in pretax income for the second quarter of 2006 versus the 2005 quarterly average pretax income of $700,000. The revenue and expense decline primarily reflect the sale of DFS Japan and reduced revenue and expenses in DFS Taiwan, reflecting reduced activity in that location.

As shown on Slide 14, Ocwen Recovery Group, our unsecured collections segment, posted pretax income of $100,000 in the second quarter of 2006 as compared to the 2005 quarterly average pretax loss of $200,000 and the 2004 quarterly average pretax income of $1 million. A decline in revenue in the 2006 period primarily reflects a shift in revenue from higher margin accounts to lower yielding third-party contracts. Operating expenses continued to decline in the second quarter of 2006 as a result of process improvement, technology enhancements and a greater concentration of India resources.

Slide 15 shows the Residential Origination Services segment's second quarter 2006 pretax loss of $2.1 million versus the 2005 quarterly average pretax loss of $1.1 million. The second quarter loss of $2.1 million compares to a second quarter 2005 gain of $1.7 million, while the contribution from the Process Management Solutions aspect of this segment, including mortgage due diligence services and Ocwen Realty Advisors, were about flat for the quarter when compared to the second quarter of last year. Losses in our investment activities during the quarter and lower earnings from our origination activities resulted in the decline for the quarter year over year.

The results of our investment activities are influenced by the timing of loan acquisitions and securitization. On a year-to-date basis, our investment activities have generated a positive contribution of $3.4 million. The decline in contribution from origination activities is due to the results of our investment in a small startup subprime originator, which commenced operations in July of 2005 and was consolidated by Ocwen for accounting purposes starting in December 2005 after we increased our investment in the Company. This was partially offset by improvements in our re-buy initiatives.

Turning to Slide 16, the Residential Origination Services segment Process Management Solutions [deed] declined slightly to $14 million in the second quarter of 2006. This represents a 3% increase over the 2005 quarterly average results of $13.6 million and a 36% increase over the 2004 quarterly average results of $10.3 million. On a year-to-date basis, the Residential Origination Services segment has generated pretax income of $2.9 million compared to a gain of $4.6 million for the first half of last year. This decline is the result of lower earnings from our origination activities and Process Management Solution activities, partially offset by small increased gains in our investment activities.

To date, we have had difficulty in growing our mortgage due-diligence and loan-processing revenue. However, as we continue to improve our technology, processing capabilities and cost structures, we believe that we will be successful in adding new clients, although there is no guarantee this will occur. We also continue to improve our home loan acquisition and securitization capabilities. And we have made significant process improvements in expense reduction in our origination activities.

As reflected on Slide 17, our Business Process Outsourcing segment reported pretax income of $700,000 for the second quarter of 2006 as compared to the 2005 quarterly pretax income of $300,000 and the 2004 quarterly pretax income of $600,000. Unfortunately, we lost a significant BPO client early in 2006 due to a merger and the resulting consolidation of activities.

In summary, I am pleased with the results of the Residential Servicing segment. I am also pleased that we made improvements in our earnings from Ocwen Recovery and BPO over the first quarter of this year. The results for Residential Origination Services were disappointing for the quarter. However, as I previously stated, I believe we are improving our capabilities in all aspects of this business segment.

Thank you, everyone. I'd now like to turn the call over to Dave Gunter.

Thank you, Ron. I would like to focus on three areas this morning -- the operating results of our corporate segment, our reversal of the majority of our valuation allowance on higher deferred tax assets and the changes in our balance sheet since year-end. Corporate results include 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, Corporate also includes the remaining activity of our former non-core affordable housing and commercial businesses.

As shown on Slide 18, in the second quarter of 2006, Corporate reported pretax income of $0.2 million as compared to a pretax loss of $1.3 million in the first quarter. The favorable trend in the second quarter is primarily the result of recognizing a gain of $1.2 million on the sale of a real estate asset.

As Bill noted earlier, our second quarter results included a tax benefit of $141.7 million, primarily due to the reversal of $145.2 million of the valuation allowance on our deferred tax assets that we had established in prior years. The determination of when such an allowance is established and when it might subsequently be reversed entails a significant amount of fairly complex calculations and estimations. Stated simply, accounting standards require that we evaluate whether we are more likely than not to be able to realize our deferred tax assets in the future. As we have returned to profitability, we have been actively working through that assessment each quarter. We concluded that after considering our recent earnings history and all of the other relevant factors, this quarter was the appropriate time to make this entry.

I also want to note the impact that this decision will have on our effective tax rate. In accordance with the accounting requirements, this change will not impact the determination of our effective rate for the remainder of this year, which is currently estimated at approximate 22%. While we currently expect that our financial statement effective rate will remain at that level for the balance of 2006, we also note that events in the second half of this year could result in changes in that estimate. However, we currently project that effective with the first quarter of 2007, our rates on the financial statement will more closely approximate the statutory tax rate.

Before closing, I want to focus on a few of the more significant changes in our balance sheet. Overall, total assets as of June 30 declined by $274.1 billion since the end of last year, primarily due to a reduction in loans held for resale of $510.2 million. This change is directly related to our developing strategies with respect to origination services, which Bill covered earlier in this call, as we completed 2 of our 3 securitization transactions during the first half of this year.

In a related change, our borrowings under lines of credit declined by $438.6 million, reflecting the repayment of the financings in place while we held the loan to be securitized. While loans declined, our subordinate and residual securities portfolio increased by $27.1 million, primarily due to the new securities we retained from our securitization transaction.

Our deferred tax asset increased by $151 million since the end of last year, reflecting both the reversal of the valuation allowance as well as changes in the composition of these assets over the first 6 months of the year, and is now reflected as a separate caption on our balance sheet.

Finally, we also increased our cash [and] investment grade securities portfolio, which represents short-term investments of cash by $44.6 million.

In summary, we achieved strong earnings in the second quarter and ended with a strong balance sheet as our equity-to-assets ratio increased from 18.7% as of December 31 to 32.7% at June 30.

I would now like to open the call to questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Robert Napoli with Piper Jaffray. Thank you. Your line is open. Robert Napoli, your line is open. Please check your mute feature.

Hello?

Bob.

Yes, sorry. A couple questions. First question -- I'm sorry; there's two calls going on at the same time, so trying to handle both, and I thought that, a very nice quarter. The -- I'd like a little more clarity, if I could, on a couple of things. The UPB growth you had in the quarter was very strong, and you've had lumpy growth in UPBs in the past. I mean is this -- should we expect to see kind of a stabilizing at the current level? Or do you see more growth opportunities? Why did you grow so much in the quarter? And is this a trend or are we going to end the year around where you ended the second quarter?

Bob, I think -- this is Ron. I think it's really difficult for us to say. I mean, like I said, we were pleased with what's occurred so far in the first half of this year. But from a pricing standpoint, things have become more competitive, and we haven't necessarily increased our pricing as much as some of our competitors. So I would hope that we would be able to grow a little bit more throughout the remainder of the year, but it's really very difficult to project at this point in time.

And the prepayment fees that you -- were stable quarter-over-quarter, so I think seasonally that would be, fundamentally be a little bit of a decline because first quarter's usually seasonally the slowest. Are you seeing a continuing slowdown in prepayment fees? Have prepayment fees stabilized at this level? I mean, it's still well above prepayment fees you had many years ago.

Well, I agree with you that you could potentially interpret the results of the second quarter as a continued slowing because historically you are correct that the first quarter has always been slower than other quarters. And so the fact that the second quarter was the same as the first quarter would indicate that trend had continued. At this point in time, I think we -- I would say we kind of think that they'll stay in this range. But again, it's very hard to tell. There are certain reasons to believe they could continue to slow further. But at the same time, you never know.

Okay. And the $3 million charge that you took or the addition to the legal fee provision, can you give us a little update on the legal, the lawsuits that you may be involved in? Is there -- should we have built into our model some base level of legal fees that -- is that $3 million -- do you view that as a non-recurring item or should we have modeled $1.5 million of additional legal fees in that segment each quarter? What's going on there?

This is Dave. Speaking to that litigation, I can tell you that we continuously monitor the status of our litigation. We take advice from external legal counsel. And we do a periodic assessment of our litigation so that we can develop an accrual and develop our disclosure. As a result of that process, we thought this was the right amount in light of pending litigation. We do not have for you a prospective view of what you can think of as far as litigation in the future. But we can tell you that we've taken a serious look, and we've got the right accrual here under accounting standards.

Can you remind me what -- how many lawsuits are you involved with today? And have there been more lawsuits? I mean what is the trend there? I mean is becoming a more litigious business for you or less? Or is this related to one large case, the Texas case? Or is it -- what is it related to?

I think I'll refer you back to our previously filed 10-K and recent 10-Q because we, again, according to regulation and accounting policy, we talk a lot about what our litigation reserves are for and the cases that are ongoing. And then of course no later than August the 9th, you can look forward to our release of the next 10-Q where we will, of course, say a little bit more. But for right now, again, we can't really give prospective guidance.

Well, can you tell me what the trend is on -- what is -- are you seeing more litigious activity or less in your business?

We can tell you that it's stabilized, and that's the view that we're looking at right now.

Okay. And my last question is -- the investment banks are getting a lot more aggressive, obviously, in this business. I think, Bill, you called that many years ago, and that really seems to be accelerating. Competitively, is this something that you are worried about? Do you feel like this is helpful to you? Or does this make you want to kind of join forces with them in one way or another, whether it's selling the business or through more direct joint ventures?

Well I think, as we've spoke for a number of years, we see the investment banks becoming a far more dominant force within the subprime industry. We happen to think in some cases that's actually a positive for us, since most of our production comes from Wall Street. On the other hand, you do have a number of Wall Street firms that, in fact, are looking to try to get into the servicing business because I think recognize as the economy turns more difficult here, servicing is going to be a key ingredient to maintaining returns on your invested assets. But, no, we think on balance that we would rather see Wall Street see the production, increase their production levels because of our strong ties, our strong ties to the Street.

Okay. Thank you.

Our next question comes from Richard Shane with Jeffries & Company. Your line is now open.

Hi, guys. Thank you for taking my question. First of all, on the quarter, what was the Residential Servicing fee number? And what I'm looking for is something comparable to the $76.01 million from last quarter, just because we need that for our model. Now, while you're looking that up, maybe I'll ask some more sort of conceptual questions. One of the things we saw this quarter was that there was a relatively wide negative spread between your interest income and interest expense and Bill talked right up front about sort of improving, pressuring management, et cetera. Can you give us some idea, first of all, what the yields on those assets were this quarter? And I'm assuming that you're not planning -- the expectation is that we're not going to see that level of negative spread going forward. Can you talk about how you think that's going to narrow and what the mix is going to look like as well?

Well this is Dave. Let me go back to your first question, and that is, you were looking at the Residential Servicing business.

Yes. The number I'm looking for is comparable to the $76.0 million you reported last quarter.

That number for the quarter, June 30, is $79.7.

Terrific. Thank you, Dave.

That's a direct comparable.

Perfect.

And now your other question was related to the spread on interest income against interest expense?

Exactly. And I'm assuming that that has a lot to do with timing and sort of the asset mix right now, which -- sort of interpreting --

Ron, Let me make a couple comments about that. Keep in mind that our interest expense is going to be associated with financing our assets, which you're going to have servicing advances; you're going to have servicing rights. And depending on whether we do any loan acquisition activity, you're going to have interest expense on the loans that we acquire. And then you'll have some ongoing interest expense potentially against the residuals that we hold, but that number -- those investments tend to be much smaller when we're holding the loan.

I think, when you look at the first quarter of this year, we had more loan balances on the books. And therefore the spread wasn't as wide because we were earning interest income on the loans that we held, whereas in the second quarter, because we had securitized most everything and carried much smaller balance of loans, the spread widens. Because keep in mind, in servicing, there is no interest income component. Income on float balances rolls up into servicing and sub-servicing fees. It's not in interest income column because it comes through in a different way. Does that help clarify anything for you?

Sure. So let me just see -- I mean, obviously you saw the interest income line decline significantly because you essentially moved the assets off balance sheet through the securitization. So that explains that decline. And what you're saying is that you also saw a coincident decline with the interest expense associated with that because the warehouse funding that you were using to pool that went away. And however, what you -- there is still some level of corporate debt that basically -- meant that interest expense didn't come down as far as the interest income because you still have that capacity in place.

Right. And rates, short-term rates have continued increase even during the quarter. I mean, there's various components that result in that interest expense number increasing somewhat. But I think what you -- everything you said there was accurate.

Right. And so what I'm saying is this. I mean, it strikes me that the negative spread that you have there this quarter, given how strong the balance sheet is, is going to decline over time. What I'm trying to get sense of is how that happens, what the drivers are there. Because if there's a $1 million or $2 million swing there, that's very significant to everybody's model.

Let's look at the components of that for a moment if we could. I mean, certainly there is -- there is a 10 and 7/8 in the convertible issue, in the convertible bond. But this side component of that is our financing for advances. And what you will, what effect that you are seeing is that prepayment's slow and the delinquent fees begin to rise, you're going to see that we are -- if you were to look at -- take the float income that's up above in revenue and compare it to your interest expense, you're going to see that we're going to become less sensitive to interest rates because the gap between your float balance and your advance balance has narrowed.

Okay. That's very helpful, guys. I appreciate it, and I probably will have some follow-up questions offline. But thank you very much for your time.

Our next question comes from [technical difficulty] Investments. [technical difficulty]

Thank you for taking my call. I'm just trying to put a couple of more numbers on the servicing rate. Can you tell me what the acquisitions were for the quarter?

You're looking at our mortgage servicing rights and asking what the acquisitions were for the quarter?

Yes.

I won't give you that detail on this call -- this is Dave -- but I will tell you, if you refer back to our balance sheet, you can see that that number's increased. It's now, at the end of June 30, $151.5 million for all of Ocwen compared to, back at the last audited balance sheet of 12/31, it was $148.7 --

Right.

-- and that that's more than increased from March 31 which, as we filed it, was really $147.0.

Well what I'm --

There are some increases there, but we're not going to provide an account analysis here of all the push and take.

No, I'm just looking for the equivalent number of the $24,618 for the first quarter, the acquisitions of rights.

I don't have a calculator here [inaudible].

Yes, but you add in -- if you take the, what's in the press release here. You had amortization and servicing rights of $27.7 million.

Okay.

And the balance grew from $148.7 to $151.5. So there was a -- you can do the math and figure out how much we acquired.

Right. I guess -- well, what I'm trying to do is get to a different place. Let me run this by you. And I realize you're using you're using for amortization a complicated formula based on more than this quarter's actual experience at this, I guess an 18- to 24-month formula. And so tell me if I'm on track this with type of analysis.

As of -- for last quarter, where I do have the Q and all the information, the 12/31 fair market value balance of your MSR drop was $183 million. And your acquisitions were $24 million 618. So just working with fair market value and acquisitions, I come up with a number of $208 million, $208, 373 And your fair market value at the end of March 31 was $197, 731. So if I work with fair market value on December 31, acquisitions in the quarter, and come up with -- and use your Q's March 31 fair market value, I come up with an amortization, so to speak, number of $10 million 642. I know that there's other stuff going on in there. Can you tell me what I'm, what else I need to be looking for?

Well, I think some of that was the change in the value of the servicing rights from quarter-to-quarter such as prepayment fees had started to slow; the market value of servicing rights has increased. So I think you are seeing amortization, but then an increase in market value was why the number was only $10 million or whatever that you're referring to.

Let me just make it real simple for you. What we should do is, in order to determine how much we purchase, you would take Q2 ending balance of PMS mortgage servicing rights on the balance sheet, right, $151?

Okay. Yep.

And you'd subtract, basically subtract from that what we had at -- if you want to know much we acquired, you subtract from that $146, 993. So it's $151, 501 less $146, 993. That gives you $4.5 million, plus our amortization was $27, 663.

Okay.

Going out on a limb here, it's $32 million 171.

But what we don't have for you is what the new market value of the servicing rights is at the end of the quarter, and that'll be provided in the Q. But we don't have that for you right now.

But so -- okay, that's fair enough. But for my analysis that I was doing before, what I'm potentially missing is, I think, what Ron was saying earlier in the call, that servicing rights have just increased in price 10% to 20% since the beginning of the year. So there is amortization and there's the prepayment speed slowing. But there's also the increase in the value of the amortization that you -- that is reflected in fair market value but not on your book value.

That's correct. Because that increase in fair market value will not effect what we've paid. If you're going back to you first question as to what do we pay for new servicing in the quarter, you would take Q2 ending balance for servicing minus Q1 ending balances for PMSRs and add to it the amortization of the income statement. That would come out to $32 -- we spent $32 million for servicing in the quarter.

Got it.

Amortized $27 million of that -- what is the rate today -- amortize $27.6 million of that away and ended up with a net gain of $5 million.

Right. So to the extent that your fair market value on June 30 exceeds more than that -- well, that differential will reflect changes in valuation and real amortization in all of these factors we've been talking about. The number that I came up with before for the first quarter showed a $17 million difference, which I viewed as excess profits, and I still think it is. But it's a combination of less amortization than you're taking plus some increase in valuation of the servicing rights. Is that a fair general statement?

Yes. The increase in value does not -- let me just start by -- the increase in value does not flow through our income statement.

Right. It's just in the fair market value calculation, through.

Correct, correct. And our amortization and what we purchase doesn't relate to fair value, either. The only thing fair value gives you is what do you think they would be worth if you were to sell them today.

Right. But by taking one quarter, the end of the year in each quarter I can kind of follow the -- maybe get a better sense of the actual amortization that you're experiencing rather than the number that you're taking, which is an 18- to 24- month formula. Is that --?

I see. You're trying to create, determine what economic, true economic value is.

Yeah. I think your $26 million amortization for last quarter was too high, and the $27 million for this quarter is too high. And I'm trying to nail it down a little bit.

Yes, but I wouldn't say, per se, it affects amortization. What it does affect is that you would increase the balance of what the asset would be worth under your, the way you're viewing it.

Right, because I have to take into account now rising prices for the assets that you already own.

Correct. And I, just by way of background -- and I'll probably get kicked under the table for saying this. The valuations that you see for fair market value, you could not actually buy. You wouldn't win any purchase mortgage servicing rights if you actually paid those prices.

They're too low.

Yes. I mean we would have purchased virtually nothing for the quarter if we actually made that price.

Let me restate that to make sure I understand. The fair market value number that you're disclosing in the Q is less than the actual prices that you'd have to pay to replace those assets [inaudible].

Yes, I'm going to really get kicked under the table. Let me just --

Because --

Let's just constrain it that the value, the fair market value is probably less today than what you would pay to buy, purchase mortgage servicing rights.

Okay. I think I'm glad to hear that also. A more general question -- you've gotten the $47 billion in balance. Is there a capacity constraint, either in your financially, that you could help me understand or your -- sorry, personnel or anything that I should be aware of?

I mean, as long as there's reasonable planning from a systems or facilities or people standpoint, we're nowhere close to a capacity level. From a financial standpoint, I mean, I think we have plenty of liquidity to grow. But I think it's a question of what's out there in the market and whether we want to put all our eggs in one basket, you know. So from a management standpoint, they'll be some constraint probably in what we would grow. But there are no real constraints at this point for reasonable flat growth.

Then we should see expenses as a percentage of [inaudible] growth decreasing dramatically because there's [inaudible] --

I mean, there's definitely a component to the operation, and growth will lower your overall kind of per unit clock if you're including your fixed costs. And we do service that to be true, yes.

Okay, great. Thank you very much. Congratulations. It sounds like a perfect storm of good things happening to you now.

Bill Erbey Thank you.

Our next question comes from Derek Wilder with Jeffries & Company. Thank you. Your line is open.

Yes, can you hear me?

Yes.

Okay. What was the more traditional depreciation for the second quarter and any capital expenditures other than amortization servicing rights? And what's the calendar year '06 expectations for CapEx other than servicing rights?

Well your first question was depreciation for the quarter?

Yes.

I don't think we're prepared to lay that out for you today, but we'll lay it out once we get to the 10-Q. The P&L that we've released today is the one that we intend to release for this Form 8-K.

Okay. And any capital expenditure comments?

I think that the majority of our capital expenditures really revolve around our technology equipment that we purchased. We've been -- we're very pleased with -- we've rolled all of our technology services under one individual. I think that he's brought a great deal of thought and planning to the process. And we have significantly -- we've been able to significantly curtail the amount of purchases we have by way of equipment. And we would consider that to be -- you'll start seeing effect of that because existing equipment gets depreciated generally over 36 months. And we hope to continue to be able to hold the line with regard to our capital expenditures.

Okay. What were they in the quarter? And what's the outlook for the year?

I don't have that in front of me. I actually look at some -- I would say they're less than a couple, less than $1 million or $2 for the quarter, but that's a guess. I mean I would -- it'd be $1 million, probably around $1 million is an estimate.

Okay. Thank you.

We have -- we should have that.

No, it's in that number.

Okay.

Our next question comes from comes from Robert Napoli with Piper Jaffray. Thank you, your line is open.

Thank you. A couple follow-up questions. First of all, credit trends within the subprime business. You guys are certainly on the front lines and we're expecting to see -- there's certainly, if you look at static pools of 2005, generated loans. The delinquencies there are a lot of higher. I don't think they're out of whack with years prior to 2003. But are -- what are you seeing and what do you expect to see as far as credit performance in the subprime mortgage market? And how does that affect your -- with your business, good or bad?

Well, I don't think that -- I guess we have, we do have a view that with housing prices not going up as much, or in some cases coming down, and with interest rates rising, that's -- especially if some of the ARM loans reset, that it's going to put borrowers under stress and that there is likely to be an increase in delinquencies. But we haven't seen any real significant trends up to this point. But our view is that we are going to see an increase in delinquencies. Is that good or bad for us? I mean, usually a sign of increased delinquencies is going to mean slower prepayment fees. And we believe [net/net], slower prepayment fees are a bigger benefit for us than the increased costs that's associated with higher delinquencies. You have an increased cost because you have higher advances as well as operationally it's more expensive to manage a delinquent loan. But net/net, we believe that it's a positive for us.

We also believe that we continue to be considered one of, if not the best, servicer as far as keeping losses low and loss mitigation. It's what we've always been known for. And, therefore, we believe that our services potentially will be -- start out more in this kind of environment versus the environment that we were going through a couple years ago where delinquencies and losses just didn't matter. Bill, anything to add to that?

Yeah. I mean I think, Bob, if you look at -- when you're amortizing $27 million a quarter on prepayments, if you look at the operating expenses for our business and assume that a reasonable proportion of them in fact are A6 and B not associated with loss mitigation or foreclosure, you can see that there is a -- it's much, much larger, the impact of prepayments, than the increased expenses of dealing with delinquencies. So, on balance, we think that will improve our bottom-line results.

I think -- I'll just reiterate, or iterate, rather, what Ron said, that we're hopeful that because we keep more people in their homes and that reduces losses, that we will begin to see more business when people are not so worried about the performance of their assets. And I think the third issue, though, that is -- Ron, you may want to comment because you're closer to the numbers than I am on this -- is that the thing that we do see that is negative is you have an enormous bubble of loans that are resetting in the latter half of this year, and that's -- some of those people will be significantly challenged if their home prices haven't gone up to refinance those assets.

Yeah, I mean these are rough numbers. But not only do we see a fairly large number of loans that have resets in the latter part of the year. But when you look at what their resets might have been a year ago, they may have been resetting up less than 100 basis points, maybe 75, 80 basis points. Whereas now we see loans resetting and their rate is going up by anywhere from 150, sometimes as high as 250 basis points.

So the stress on the increase of their payment is a lot more significant than it was in the prior environment. And there's no doubt that that's going to cause some higher delinquency levels. In some cases it will also cause people to -- even though this isn't a re-fi environment anymore, if they have equity in their home or whatever there might be, they're going to seek to try to figure out a way to get a lower-rate loan. So you will see loans that have those resets also try -- the quality borrowers will do what they can to try to re-fi out of that higher payment. If there credit's improved, they may be eligible for an [all-day] or prime loan. I mean they'll probably be forced to have to go out and try to see what they can do.

So again, I'm not taking a view necessarily, but you will see the good borrowers prepay. You will see the borrowers that don't have the financial means go delinquent and then they're -- but there likely will be a bunch of people in the middle that probably will be good for us because they'll stay around. There's nowhere for them to go.

Okay. On another track, though, you invested -- you guys invested what, $40 million into a bankruptcy processing company during the quarter? Is that -- I'm sure I got the numbers wrong and I'm sure I got the exact tight of the investment wrong. But I wonder if you could talk a little bit about that and what the strategy is there.

Yes, we're a little bit constrained because we're under a proxy agreement with respect to the transaction. But we anticipate we will invest approximate $45 million in the next several days into a CM called 'Bankruptcy Management Solutions, which is the largest provider of services to Chapter 7 bankruptcy trustees. They're paid for the services by basically being able to earn income off the cash deposits that the trustees generate as they begin to go through the bankrupt cases that they manage.

With a value-add that we brought to the table with respect to this transaction was really understanding how that whole process works in terms of basically dealing with those funds and figuring out how to negotiate with the financial institutions to get those returns as close as we possibly can to the risk-free rate, if you will. So it's keeping as much of that spread for us within the Company.

And your ownership percentage is what?

Approximately 46%.

So you will not consolidate. It'll be -- show up as an equity investment?

That is -- well, that is our intention at this time. And, obviously, it's never over until the transaction closes, and you agree, and you put your position forth with your external auditors. But that's our expectation as we sit here today.

And that's an accretive? Is that immediately accretive to --

Well, it's -- we're not giving an earnings forecast, but if we make a dollar, it's accretive because we didn't -- it's a dollar more than we would, relatively speaking. If the yield is higher than the short-term money market rate, we're running on a fund that's accretive.

Let's see. The Corporate -- the Residential Servicing business -- and you talked a little bit about that, and it's -- but is, and would you expect that -- what is kind of an average earnings number than, if you -- and you take the first quarter and the second quarter and, say, divide it by two, and -- or how much, I mean, are you losing per quarter on the origination business you took over late last year? I'd just like to think about that. It seems like that segment has a lot of potential, but it's -- I'm not sure if it's a drag, or on earnings right now, or not.

You almost have to break it as Ron went through, and maybe he can go through it again. You have to think about it as a couple different activities, if you will, in terms of thinking. You're talking about Residential Origination Services.

Yes.

I -- the --

I can follow up.

I mean, there's the investment -- I went through the numbers. I mean, there's an investment component which is a little bit lumpy, depending on if we bought whole loans and securitized them and how the earnings are recorded on those transactions. And we had some downs in the fourth quarter, ups in the first quarter, down in the second quarter. It's a little hard to kind of project that; it will be a little lumpy. But what we're really trying to do is generate higher earning assets for the long term, hoping that all that up-and-down stuff ends up being relatively flat.

We have kind of the Process Management Solutions component of that business, which I mentioned we were a little bit disappointed that we haven't added more clients there yet. Then we haven't grown it more. But we have done a lot of things to position it for growth, and we still are hopeful that we still be able to grow it, but there's no guarantees.

And then we have the origination aspect, which really primarily is our re-fi initiative which we've talked about in the past. And then this subprime originator, which is relatively small at this point in time, but that we now consolidate, and which has generated some losses definitely, both last year as well as this year. We are putting a lot of cost controls in place and have put them in place to reduce the loss in that business. And we are hopeful that we can turn it around, but again, there's no guarantees of that. But we should expect the losses that we've seen in the first half of the year to decrease on a go-forward basis because we've already implemented certain cost controls that we know are in place.

And on the expense side, is there more of a decline in expenses? I mean, it's a pretty amazing things it does to earnings when revenues go up and expenses go down. But you did certainly talk about more operating efficiencies. But have we seen the biggest chunks of efficiencies already come through?

Well, there's always incremental -- there's always things that we can continue to do with the servicing side. It's such a large business and we've had great success really every year for the last number of years and being able to reduce our costs. It does get a little bit harder as we've made some really big leaps. But we would hope that there's still something to be had there. I think the other business segments have shown really good trends this year in reducing their costs. I think in Residential Origination Services we have started to make progress in moving some of that work to our lower cost locations. But I would say there are definitely more opportunities there. So there are more opportunities, but it does get harder every year, and especially since servicing is so big and has been at it for a number of years, that one is -- it's a little harder to kind of say that we're going to continue to see the savings that we've had in prior years. But we still think there's some room.

Thanks. And last question -- and I think you may have already given this, and I apologize. But the cash payment tax rate on a go-forward basis. Is that the 23%, or what taxes will Ocwen -- at what rate will Ocwen be paying taxes until it actually finishes going through its NOLs?

What we've released today is GAAP accounting numbers and the effective rates that you heard for quarters three and four approximate 22%. That doesn't speak to the cash basis, but that's not a GAAP number that we would release here.

And what we also stated, because you might not have been on the call, was that starting next year our current anticipation is that it would move up to a statutory rate.

Right. But the tax payment rate -- is it 22%? Is that a -- somewhere around there, a reasonable rate that you would be paying taxes at? Obviously you're not going to be paying at the 40 -- the statutory rate.

It would be closer to the effective tax rate that we've talked about today, but just can't pinpoint it for you.

Okay. And that's the 22%. It's closer to the 22%

The 22% is our effective tax rate. That's a GAAP measurement.

Okay. Thank you very much.

The next question comes from [Seth Hammond] with [RRH]. Thank you, your line is open.

Hi guys. I had a question regarding accounting issues. Am I correct that at the end of this year, or is it beginning of next year, you have a choice that you can actually include fair market value of the mortgage servicing rights in the GAAP accounting?

Many companies have not yet declared what policy they're going to move to. We are studying this issue, and the time period will be in play for next year. And the consideration under FASB 156 is whether or not companies will use fair market accounting. We have not made that determination. And we are going through a deliberative process now to make that determination. Once we do, we'll disclose that. So we can't provide any prospective guidance yet because it's a fairly new issuance. And we're assessing the impact internally now.

Fantastic. And I understand you can't provide guidance. Just an understanding, the changes in fair market value, would they run through comprehensive income? Just anticipating this a little bit for myself. Should that run through comprehensive income?

No. I believe you would see that on the face of the P&L.

Super. Thanks a lot for your time.

Thank you.

[OPERATOR INSTRUCTIONS]

Moderator, could you speak up, please? We can barely hear you.

Yes. [OPERATOR INSTRUCTIONS] And our next question comes from [Richard Shane] with Jeffries & Company. Thank you. Your line is open.

Hi guys. Thanks again for taking my second question, but it was actually asked by Bob. Thank you.

Very good.

At this time there are no further questions.

Thank you very much, everybody. Have a great day. Goodbye.

Thank you. That does conclude today's conference. You may disconnect at this time.