Onity Group Inc (ONIT) 2006 Q3 法說會逐字稿

Good morning and welcome to the Ocwen Third Quarter 2006 Earnings 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 slides, log onto our web site at www.ocwen.com, select Shareholder Relations, then Calendar of Events, then under Conference Calls, Third Quarter 2006 Results, select 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 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 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 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 telephone.

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 third quarter conference call. I would like to cover three topics in my remarks today. First, an overview of our third quarter earnings; second, our efforts and plans to enhance the effective utilization of our equity; and third, an update on our equity investment in BMS.

We are pleased with our third quarter results. As shown on Slide 4, pre tax income from the third quarter of 2006 was $26.4 million as compared to $17.4 million in the second quarter and $21.5 million in the first quarter and well ahead of the quarterly averages in the past three years.

These results reflect a continued strong performance by our Residential Servicing segment, a strong quarter for our Residential Origination Services segment, and modest losses for our Commercial Servicing and ORG segments.

As we noted in the earnings release this morning, during the third quarter we merged our BPO segment into Residential Origination Services. We did this to reflect the management changes that have taken place in the recent months which have enabled us to better align our resources, reduce costs and sharpen our focus on delivering mortgage-loan related outsourced services.

As shown on Slide 5, our revenue for the third quarter was $110.1 million as compared to $105.1 million in the second quarter and $102.4 million in the first quarter and averages of $93.8 million per 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 reflected a modest increase of 1% as compared to the second quarter this year, but we're 2.5% below the first quarter and the average for 2005.

These results reflect our continued emphasis on increased productivity as these reductions were achieved despite the cost increases associated with increased MSR amortization due to our growing portfolio, increased expenses associated with our growing loan origination services and training activities and the $3.9 million of settlement reserves we have provided during the year.

Another view as to our increased productivity is that even as revenues have been growing at an annual rate of 13.3%, we have reduced our global workforce by 6.5% since the beginning of the year.

As shown on Slide 7, other income and expense reflected net income of $1.4 million in the third quarter as compared to net expense of $3.3 million in the second quarter, and net income of $6.3 million in the first quarter of this year. This section of our income statement is heavily impacted by the results of our loan purchasing and securitization activity. During the third quarter, we recognized gains of $3.8 million related to this activity compared to losses of $3.2 million in the second quarter and gains of $4.4 million in the first quarter, bringing our year-to-date results from this activity to a gain of $5 million.

Because transactions often require several months to be fully executed, they can span quarters and have the potential to create earnings volatility. Under the applicable accounting rules, we recognize the impact of each phase of the transaction within the quarter in which it occurs. As we have noted before, 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 mentioned last quarter, one of our long-term strategic objectives is to free up equity for growth opportunities. One important measure of progress in this area is the reduction of the equity required to support our servicing business. We continue to make progress towards this objective, having achieved a reduction of 51% of the equity required to support each dollar of UPB since the beginning of the year. Furthermore, it is our belief that we can make further enhancements in this area.

Overall, we have three broad goals in this regard. First, to improve cash management; second, to increase the funding of our high-quality assets such as advances; and third, to convert our less-productive assets to cash.

Our cash management initiatives during 2006 included the implementation of new cash management technology, including the remote capture of checks. We also negotiated revised terms on our existing advance financing facility, which has decreased 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 provides further opportunities. In addition to our non financed advances, which represents our largest opportunity, we also had $60 million of receivables as of September 30, including amounts due from the Veterans Administration in connection with our REO servicing business as well as receivables from our Wall Street clients, whose credit is outstanding but whose payment cycles are sometimes elongated.

During the third quarter, we made substantial progress in renewing and modifying our financing arrangements, including the syndication of an expanded and amended line of credit which includes the above asset classes and the establishment of new warehouse lines of credit to increase the funding available for our loan trading and origination activities. Dave will provide further information on these initiatives later in this call.

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 equity optimization efforts thus far have met with success and we will continue to focus attention on these initiatives for the remainder of 2006 and beyond.

As we've previously announced, effective July 31 we closed on our investment in Bankruptcy Management Solutions, or BMS, which we acquired through a joint venture with Charlesbank Capital Partners. BMS is the largest single provider of software and asset management services to Chapter 7 bankruptcy trustees. BMS principally derives its revenue from fees received from the depository institution which holds the custodial balances collected by the trustees during the bankruptcy process.

As anticipated, we have accounted for this transaction as an equity investment. Other assets on Ocwen's balance sheet includes $45.8 million representing our cash investment in BMS, and included in other income for the third quarter is $374,000 representing our share of the after-tax net income of BMS for the months of August and September. Cash flow at BMS is meeting expectations and is substantially in excess of net income given the $5 million per quarter of non cash amortization associated with the purchase. Further information on this acquisition is contained in our 8K/A filed with the SEC on October 16.

We concluded that this investment is a strategic fit for us because the keys to earnings enhancements are the cash management expertise and the banking relationships that we have developed through the operation of our servicing business. We are excited about this opportunity because we believe that BMS represents a growth opportunity in a period of economic distress.

Before turning the call over to my colleagues, I also want to announce that we are considering capital efficient strategies to finance the growth of our core loan servicing business. One potential strategy being explored includes the creation of a special purpose investment vehicle funded by primary equity or debt, or in conjunction with third-party investors. The vehicle would acquire mortgage servicing rights and related mortgage-backed security assets which we would manage and service for fees commensurate with market rates. It is anticipated that we would invest up to $40 million in this initiative should it go forward. As the initiative is still in its preliminary stages, we cannot predict with any certainty whether or when it may be implemented or the form it may take.

In summary, we are pleased that the Residential Servicing segment has continued its strong performance through 2006 and that Residential Origination Services has significantly improved its profitability in the third quarter. BMS is performing according to plan, generating substantial cash flow. 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 four core business segments --Residential Servicing, Commercial Servicing, Ocwen Recovery Group and Residential Origination Services.

As shown on Slide 8, the pre tax earnings of our core businesses were $28.9 million in the third quarter of 2006, a 456% increase over the 2005 quarterly average results of $5.2 million. These results reflect the continued strong performance of our Residential Servicing segment and a strong quarter from our Residential Origination segment, offset by small losses in the Ocwen Recovery Group and Commercial Servicing segments.

Turning to Slide 9, the Residential Servicing segment recorded $23.9 million in pre tax income in the third quarter of 2006 as compared to the 2005 quarterly average of $5.4 million and the 2004 quarterly average of $4.2 million.

Net revenues in the Residential Servicing segment were $87.5 million in the third quarter of 2006, a 25% improvement over our 2005 quarterly average revenue of $69.9 million.

Slide 10 illustrates the continuing improvement in the loan servicing portion of our Residential Servicing segment. Loan Servicing achieved $25.3 million in contribution margin in the third quarter of 2006. This represents a 198% improvement over the 2005 quarterly average contribution margin of $8.5 million. This improvement is the result of an increase in revenues while maintaining control of our expenses.

Our servicing fee revenue increased due to growth in the portfolio coupled with reduced runoff of the existing portfolio due to slower prepayment speed.

Float income also increased due to a combination of increases in short-term interest rates and growth of the float balances which results from the growth in the servicing portfolio.

Some of this increase in revenue is 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 rights.

On the expense side, our amortization expense and compensating interest expense also benefited from the slower prepayment speed. Our $172 million mortgage servicing rights balance as of September 30, 2006 represents a 49% increase from the September 30, 2005 balance of $115.1 million. Despite this significant increase in our MSR balance, our third quarter 2006 amortization expense of $27 million is an increase of only 18% over the third quarter 2005 amortization expense.

Our third quarter 2006 compensating interest expense at $3.4 million compares very favorably 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 in the third quarter, our year-to-date compensation expense is $2.2 million or 10% lower than the same time last year. 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 $50.8 billion. This balance represents a 19% increase from our 2005 year-end balance of $42.8 billion.

As of September 30, 2006, we were the servicer for 453,000 loans as compared to 369,000 loans at year-end 2005.

Our balance of mortgage servicing rights at September 30, 2006 was $172 million, a 16% increase from our December 31, 2005 balance of $148.7 million.

During the third quarter, we paid $49.5 million for mortgage servicing rights and amortized $27 million of our mortgage servicing rights.

Slide 12 shows the trend in prepayment speeds over the past several years. As you can see, prepayment speeds at 31% in the third quarter are still well below the 2005 average of 38% and the 2004 average of 41%.

Advancing to Slide 13, our Commercial Servicing business reported a $300,000 pre tax loss for the third quarter of 2006 versus the 2005 quarterly average pre tax income of $700,000. The decline primarily reflects the sale of GSS Japan and reduced revenue and expenses in GSS Taiwan reflecting reduced activity in that location.

As shown on Slide 14, Ocwen Recovery Group, our unsecured collection segment, posted a pre tax loss of $400,000 in the third quarter of 2006 as compared to the 2005 quarterly average pre tax loss of $200,000. The decline in revenue in the 2006 period primarily reflects a shift in revenue from higher-margin accounts to lower-yielding third-party contracts.

Our year-to-date operating expenses continue to benefit from process improvement, technology enhancement and a greater concentration of India resources.

We are currently pursuing various opportunities to rapidly grow revenue.

Slide 15 shows the Residential Origination Services segment third quarter 2006 pre tax income of $5.6 million versus the 2005 quarterly average pre tax loss of $800,000. There are three main components to this segment -- trading or investing activities, originations activities and process management solutions activities.

As we discussed in our last call, the results of our trading and investment activities are significantly influenced by the timing of the transaction. In the third quarter of 2006, we exercised our right to collapse the securitization on certain residuals that we acquired earlier in the year and took ownership of the underlying loans. Primarily through the release of the overcollateralization supporting these residuals, our trading and investment activities record a pre tax income of $4.2 million during the quarter.

Our originations business had a pre tax loss of $1.9 million for the quarter. This loss can be attributed to the start-up operations of the small originator that we began consolidating for accounting purposes starting in December 2005 after we increased our investment in the company, partially offset by our refinance initiatives. We have been working with management of this originator to improve results by focusing on reducing fixed costs, increasing volumes and maintaining profit margins.

For the quarter, our process management solutions have recorded pre tax income of $3.3 million versus the 2005 quarterly average pre tax loss of $537,000. This positive trend represents improvement in all components of process management solutions, including business process outsourcing, property valuation services and mortgage due diligence and processing.

Turning to Slide 16, the Residential Origination Services segment's process management solution fees grew to $19.3 million in the third quarter of 2006. This represents an 18% increase over the 2005 quarterly average result of $16.4 million and a 52% increase over the 2004 quarterly average result of $12.7 million.

On a year-to-date basis, the Residential Origination Services segment has generated pre tax income of $9.3 million compared to pre tax income of $5.2 million for the first nine months of last year. This increase is primarily the result of improved earnings from process management solutions in our trading and investing activity, partially offset by losses in originations activities.

In summary, I am very pleased with the results of the Residential Servicing and Residential Origination segments. We continue to look for opportunities to improve the results of Ocwen Recovery Group and Commercial Servicing.

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 -- new financing initiatives completed in the third quarter, the operating results of our Corporate segment and changes in our effective tax rate since last quarter.

As Bill mentioned earlier, we made progress during the third quarter in renewing and expanding our credit facilities. Perhaps our most significant change was the expansion of our senior secured credit agreement which now expires in 2007 from a capacity of $140 million to $285 million through the inclusion of additional lenders in a new syndication.

Not only did we achieve this increase in borrowing capacity, we also expanded the assets eligible for financing on this line to include additional MSR coverage and various components of our receivable balances.

In addition, we closed in the third quarter an additional repurchase financing agreement with a capacity of $135 million to support our loan and trading activities.

We also negotiated changes in terms to the Barclay's advance facility which will increase the dates on which we can place advances on this line and will decrease the time between when we can make the advance and when we can receive funding on the line.

All of these changes represent progress in our cash management and equity objectives that Bill mentioned earlier in this call.

Slide 17 shows the trend in our Corporate results, which 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.

For the first three quarters of this year, the net pre tax loss from generally recurring activity in Corporate has ranged from $1 million to $1.5 million a quarter but has varied each quarter, reflecting a one time charge of $1 million in the third quarter of 2006 related to a legal settlement negotiation and a gain of $1.3 million in the second quarter of this year from the sale of a real estate asset.

I also wanted to touch briefly on our effective tax rate. As you recall, last quarter we reported a tax benefit of $141.7 million primarily due to the reversal of $145.2 million of a valuation allowance on our deferred tax assets that we had established in prior years. We also noted that our financial statement effective tax rate would increase in 2007 to closely approximate the statutory rate.

As required by accounting standards, we determine our tax expenses each quarter through the development of an estimated effective annual tax rate, with the required adjustment to that rate floating through the current quarter. This is a complex computation, made more so by the reversal of the valuation allowance during the year.

As a result of this method, our financial statement effective tax rate for the third quarter was 30.3%. We currently estimate that our effective annual tax rate for the full year 2006 will be 27.5% as compared to our estimate of 22% as of June 30. While a number of variables are entailed in making these determinations, this change is primarily due to the strong earnings we achieved in the third quarter. I also note that this rate is still subject to change in the fourth quarter based upon the amount, nature and location of our actual earnings for the remainder of the year.

Before closing, I wanted to clarify a point regarding the exposure that declining interest rates pose to our float earnings. While declining rates would, of course, reduce float earnings, I think it is important to note that this exposure is limited to the net difference between the level of custodial balances on which we earn float and the amount of advances that we have financed during the period as declining rates will alter or reduce our interest expense for that financing.

In summary, we achieved strong earnings in the third quarter and ended with a strong balance sheet as our equity-to-assets ratio increased from 18.7% as of December 31 to 28.1% at September 30.

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

Thank you. We will now begin the question-and-answer session. [OPERATOR INSTRUCTIONS]

Our first question comes from Rick Shane with Jefferies & Company. Your line is open.

Good morning, guys. Thank you for taking my question. I apologize. One of the key metrics that we track on the servicing side is fees as a percentage of average unpaid principal balances. Now admittedly we're calculating an average UPB on our own and so there's some timing things that could affect that number, but what we saw during the third quarter was about a 2 basis point decline there; and again I think that that's probably driven by the way that we're calculating average balances.

What I'd like to know is sort of directionally how you think fees are going and where they will trend given potentially an environment for rising delinquencies?

Ron, would you like to cover that?

Sure. I don't think at this point we really think that fees should deteriorate or increase in any meaningful way from where they currently are, so I'm not really sure that we expect any change on a go forward basis.

Okay and again, I'm not suggesting -- I think with our numbers, 2 basis points is way, way within the margin of error but I'm just wondering what the overall trend would be?

The thing that could impact it more than anything would be to the extent we did more sub-servicing versus purchasing the servicing rights because I'm assuming you have the amortization not in that fee number, correct?

We don't. You're correct.

So to the extent we did sub servicing we'd be receiving a much lower fee but wouldn't have the amortization below, but that mix of business hasn't changed a lot and I don't expect it to necessarily change. So that's one item that could change it, but beyond that I would expect it to stay pretty constant.

Great. Then one follow-up question related to what you just said. During the introductory comments, Bill had talked about reducing the equity related to MSRs. Is that because of the new facility and your ability to lever that up a little bit more or is that because you're talking about doing a greater percentage of third-party servicing?

It's a variety of different actions that we're taking and we spoke a little bit about, for example, how long it takes us to get an advance on the line. So it's really cash management as well as increasing the amount of financing that we have on the assets and in focusing on every asset class that we have to make sure that if we have lines available for them, to the extent that they're collateralizable assets. So it's both cash management as well as utilizing more effective financing techniques.

It's not intended to take into account the fact that we may have a mix change between servicing and sub servicing.

So it's basically just efficiency of financing of the servicing business?

Financing it as well as managing the cash. I mean, we are a fairly -- a lot of cash flows through a servicing shop and you need to make sure that you are very extremely focused with respect to applying that cash as quickly as you possibly can as well as when you fund an advance getting those advances financed.

Great. Okay, guys. Thank you very much for taking my questions this morning.

Thank you. [Derek] Wenger with Jefferies & Company, your line is open.

Yes, thank you. Could you give me the total amount of depreciation and amortization? And then on the capital expenditures side, the capital expenditures and the purchases of mortgage servicing rights in the quarter?

Let me take that in two pieces. This is Dave. Some of our depreciation and amortization we will reveal to you in the 10-Q because those numbers are buried inside other components.

Tell me the second part of the question that you had.

Capital expenditures and the purchasing of the mortgage servicing rights for the quarter.

The purchase of mortgage servicing rights, and you may have heard this as we talked through it earlier, was $49 million and just a very small number, again, we'll lay that one out in the 10-Q, but just a small number on capital expenditures.

And what is depreciation for the quarter?

We don't have the full number here, again because the depreciation as we report it isn't broken out as a separate line item for you. It's buried inside some of the other components. So we will break that out for you in the 10-Q.

But we did discuss the fact that we amortized $27 million of mortgage servicing rights for the quarter.

Yeah. I was just looking for the other piece versus the $49 million that you spent.

Well, that is the match. The roll forward that you're thinking of for the purchased mortgaged servicing rights?

Yes, but I'm just looking at depreciation versus capital expenditures as well.

Very good. We'll lay that out in detail in the Q.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS]

I'm showing no further questions at this time.

Well, thank you everyone for attending. Have a great day. Good-bye.