Onity Group Inc (ONIT) 2010 Q2 法說會逐字稿

Welcome to the second quarter 2010 results conference call. All lines have been placed on listen-only until the question-and-answer session. (Operator instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Dave Gunter.

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 website at www.ocwen.com, select shareholder relations, then calendar of events, then click here to listen to conference call. Then under conference calls, second quarter 2010 earnings, select click here to listen and view slides. Each viewer will be able to control the progression of the slides during the presentation. To move the slides ahead, please click on the gray button pointing to the right.

As indicated on slide two, our presentation may contain certain forward-looking statements that are made pursuant to the Safe Harbor Provisions of the federal securities laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology. They may involve risks and uncertainties that could cause the Company's actual results to differ materially from the results discussed in the forward-looking statements.

For an elaboration of the factors that may cause such a difference, please refer to the risk disclosure statement in today's earnings release, as well as the Company's filing with the Securities and Exchange Commission including Ocwen's Form S-3, first quarter 2010 Form 10-Q and 2009 Form 10-K. If you would like to receive our news releases, SEC filings and other materials via email, please contact Linda Ludwig at linda.ludwig@ocwen.com.

As indicated on slide three, joining me for today's presentation are Bill Erbey, Chairman and CEO of Ocwen; and Ron Faris, President of Ocwen. And now we will turn the call over to Bill Erbey. Bill?

Thank you, Dave. As shown on slide 4, with the acquisition of HomeEq, we will become the third largest subprime servicer with more than $80 billion in unpaid principle balances. Since 2001, our servicing portfolio has grown at an annual rate of 17.8%. The primary value of growth is that it enables Ocwen to improve its operating margins. We believe there will be continued consolidation in the servicing industry and we are well positioned to benefit due to our significant and sustainable competitive advantages, including our strong financial position, highly scalable platform, lowest operating cost structure and our ability to resolve delinquent loans faster and for higher value than other servicers.

Additionally, servicing loans to credit impaired borrowers is a growth market. According to the Mortgage Bankers Association, 14.7% of all mortgage loans, both prime and subprime were 30-plus days delinquent as of March 31st, 2010. Even more important than our growth has been the resiliency of our business model. We have withstood three major economic downturns since our inception, because we have a recurring revenue stream and a self-hedging operating model, low leverage, self-liquidating assets with a duration shorter than our liabilities and well hedged interest rate risk. Dave will be covering these items later in the call.

With the Saxon and HomeEq transactions we doubled the equity and earning assets committed to the servicing business. Slide 6 details the $443 million that we invested in the combined portfolios. We committed the $443 million with the expectation of a 25% pretax return on equity, including the $60 million of transfer expenses which under accounting rules are required to be immediately expensed as opposed to amortized over the life of the investment. Additionally, revenue from a newly acquired portfolio is not level throughout the life of the investment. These dynamics will be explained by Ron later in the call.

Our ability to be competitive and earn these returns is directly related to first, our ability to resolve non-performing loans, reducing advances, which in turn reduces interest expense and lowers equity committed to the transaction, and second, operating costs 60% lower than the industry. Even after completing the Barclay's acquisition, Ocwen will have available liquidity of $200 million.

I will now turn the call over to Ron, who will review the results of our servicing business in the second quarter. Following that, Dave will review onetime and deal-related expenses and the health of our balance sheet. Ron?

Thank you, Bill. As reflected on slide 7, revenues of $75.8 million were up slightly over the first quarter. The addition of the $6.9 million Saxon portfolio midway through the quarter added revenue, however, this increase was mostly offset by lower modification and related HAMP fees. HAMP fees were down to $3.9 million in Q2 compared to $6.2 million in the first quarter. In the second quarter for the first time loans modified under HAMP reached their one-year life, entitling us to a success fee. We recorded $663,000 in HAMP success fees in the second quarter and expect this revenue stream to increase over the next few quarters as more loans reach this one year anniversary.

Turning to slide 8, operating expenses for the second quarter totaled $41.2 million, an increase of $10.4 million or 34% over the first quarter of this year. This is obviously not - we normally don't have our expenses go up like this in a quarter and they're due to onetime items. The increase was primarily due to a $5.1 million onetime accrual related to an agreement in principal to settle the MDL proceeding, along with $2.7 million in professional, facilities and other ramp-up expenses, in anticipation of the closing of the HomeEq transaction. In addition, amortization of mortgage servicing rates increased by $1.5 million over Q1, primarily as a result of the Saxon transaction.

As we have done in past quarters, slide 9 reflects the common size income statement in basis points per average quarterly UPB serviced for the past five quarters. Adjusting for the accrual for the potential legal settlement, we had pretax earnings of 5.1 basis points per average UPB in Q2. The $2.7 million of HomeEq related expense accounted for some of the decline from Q1, while other primary drivers were the Saxon transaction and the lower revenues from loan modifications. Overall, the Saxon portfolio had minimal impact on the quarter, despite the increase in UPB serviced. First, it was boarded midway through the quarter and second, the capture of deferred servicing fees and ancillary revenues generally don't ramp up until several quarters after an acquisition of this type. We expect to see a ramp-up in Saxon revenue and a reduction in outstanding advances on the Saxon portfolio over the next several quarters as our loss mitigation efforts take hold.

As shown on slide 10, our largest opportunity for both Saxon and HomeEq acquisitions is to reduce the percentage of non-performing loans to Ocwen's historical level and hence generate ancillary fees and reduce advances. By reducing advances we generate cash and reduce our capital consumed by the acquisitions. In terms of credit quality, LPV and product type, both the Saxon and HomeEq portfolios are similar in nature to the historical Ocwen portfolio, therefore, we believe that with time we can reduce delinquencies and advances on both portfolios.

As we have highlighted in the past, modifications are a significant driver of our profitability, representing between $500 and $1,500 per modification. As shown on slide 11, our total modifications for Q2 were 14,384 compared to 19,612 in Q1 of this year. This performance fell within our previous Q2 estimate of 12,500 to 15,500.

Slide 12 represents our completed HAMP modifications by quarter. We have very little history, but to date, approximately 81% of our HAMP modifications remain current and are eligible for the annual success fee of up to $1,000. For Q3 we expect total modifications in a range of 13,000 to 16,000.

Finally, we continue to make progress in reducing advances on our historical portfolio. As shown on slide 13, net advances decreased by 33.3 million for the quarter and are down 106.7 million since December 31, 2009 excluding the effects of the Saxon acquisition. We continue to refine our loss mitigation models and approach to keep more borrowers in their homes, reduce losses to investors and improve the quality of our servicing portfolio. We are particularly excited about the HAMP program's new emphasis on principle reductions, as we believe this will increase offer acceptance rates and decrease re-default rates. In addition to the HAMP changes, we are testing similar new home modifications for borrowers who do not qualify for HAMP.

Now, I would like to turn the call over to Dave Gunter. Dave?

Thank you Ron. I'd like to walk through a reconciliation of the items impacting our Q2 results. We accrued $5.1 million in connection with an agreement in principal to settle the MDL proceedings, thus reducing litigation exposure and expense respectively. We took a onetime non-cash write-off of a $3 million interest in a real estate partnership deemed uncollectable during the quarter. This represented the company's last commercial real estate asset.

We incurred professional services of $1.2 million as part of the announced acquisition of HomeEq. We incurred expenses for new facilities and other ramp-up expenses in anticipation of the closing of HomeEq of $1.5 million. We sold $46.8 million of auction rate securities on June 29, 2010 at a loss of $1.7 million. This transaction yielded cash of $4 million and allowed us to further reduce our exposure to non-servicing assets. We took a credit of $8.3 million in income tax expense as we released the valuation allowance related to a financing vehicle. The net effect of all of the above items is that Q2 results were essentially flat to Q1 with the decline in modification income offset by the initial impact of the Saxon portfolio.

Moving on to the health of the balance sheet. Since December 31, 2009 we have continued to decrease our exposure to non-servicing assets. As shown on slide 14, in the first six months of 2010, in total, our auction rate securities, subordinates and residuals, loans held for resale and investments in unconsolidated entities decreased by 59%. We have a low risk balance sheet as approximately 80% of our assets are investment grade quality. As shown on slide 15, even if our mortgage servicing rights, deferred tax assets, net receivables and other assets all feel to zero, we would still have more than sufficient equity to cover all debts and other liabilities.

Slide 16 shows that our maturing assets exceed maturing liabilities, even with no new financing or renewals. Our maturing assets are generating almost $1.6 billion of cumulative cash and exceed maturing liabilities in all periods for the next three years. Also as shown on slide 16, our interest rate exposure to floating LIBOR rates is well hedged.

We entered into swap agreements that allow us to pay fixed and receive floating rates of interest over a three-year period. These positions in conjunction with our medium term TALF notes and our float balances allow us to effectively eliminate our exposure to rising interest rates. We entered a $350 million senior secured term loan to provide acquisition financing for the HomeEq platform. We were pleased that the term loan was oversubscribed and that our original covenants and pricing levels held throughout the marketing period. Even with the $350 million of term loan financing, our recourse debt is still only $457 million and as Bill said, even after closing the HomeEq transaction we will still have $200 million of available liquidity. Although our leverage ratios will peak with the closing of the $350 million term loan at 1.7 times corporate debt to adjusted EBITDA and 2.7 times total debt to equity, we intend to lower these levels on a go-forward basis.

Thank you. We would now like to open the call up to questions. Operator?

(Operator instructions) Our first question is from Bob Napoli from Piper Jaffray.

I'd like to focus on the revenue yield or if you've got page 9. I missed a little bit of the beginning of the call there; you guys were moving through there pretty quick. I know you gave a little bit of color on it. The revenue yield is far below prior quarters and revenue was kind of flat quarter-over-quarter. I can understand some delay in receiving some of the ancillary revenues from Saxon, but you still should have had an increase in revenue unless there was something in the first quarter unusual or some revenue item in the second quarter that was unusual. What is the right revenue yield? The basis points you had were pretty consistent around the 15.5 to 16.5 basis point rate of revenue. Should we bring our expectations down long-term for that?

Bob, a couple of things were occurring in that and I'll rely on Ron and Dave to add more color. There are there components to those numbers. One is servicing contractual fees; two are sub serving contractual fees, which did not change throughout the quarter at all. We added some servicing in the form of Saxon partway through the quarter. And then third, there are ancillary fees with regard to it. The weighted average on the mix I think was more heavily sub serving weighted definitely before the Saxon transaction came in, so you had more subservicing fees which are lower, were a greater proportion in that quarter than they were in prior quarters. That's going to swing the other way obviously with both Saxon and HomeEq getting boarded which are full servicing. Because at one point I think we actually reached below 50% servicing; we were more than 50% subservicing during that quarter. So I think that's one of the elements.

The others are the items we spoke about with respect to modifications, etc. The first quarter was a very strong modification quarter. The second quarter was about on target on budget, so it was those third party ancillary fees with regard to the existing portfolio and then as Ron laid out, you pick up nominal amount of ancillary fees when you first board a new portfolio, primarily because of the time it takes to either modify a loan or to foreclose on the loan and sell it as REO. So that's a two or three quarter ramp-up once a portfolio is actually boarded and we actually price them that way, and that assumption. So there were a number of moving parts.

I guess maybe let me take it a step further and say you're target is a 25% pretax return on equity. How confident are you that you'll attain that pretax 25% ROE in 2011?

I think we're very comfortable we'll hit those numbers. Servicing has always been pretty much a very stable revenue and expense business for us. It will ramp-up throughout part of the year as we begin to pick up ancillary fees from those transactions we've just boarded.

Your next question is from Bose George from KBW.

I have a question; you decreased the HomeEq acquisition expense outlook for the back half of the year to 60 million and so even if you include the 2.7 million it took this quarter that suggests are you guiding to kind of a lower number for that versus the 60 you had originally expected?

You'll see the rest of that number come into say, 2011, so most of it, most of the 60 that you heard about comes in quarters three and four, but you'll have some flow into next year.

Okay, so it's still the 60 is what we should use?

Of course we'll try to beat that number, but you should think about that as your round number.

On the charge with the MDL proceeding; should we be concerned about other potential onetime things like that or is this a one-off that you're pretty comfortable is taken care of?

We lay out in our Q all the litigation that's outstanding. Obviously we feel in all cases that we've done the right thing with regard to those matters but the MDL has been out there for a long period of time and almost all of our motions have been upheld; this is really about cost efficiency as much as anything. We didn't feel we would lose the case. There's always a risk though whenever you go into a trial and we have been burning quite a bit of legal expenses and that ramp rate of legal expenses would continue to accelerate, so our law department calculates and basically net present and expected value and we felt this was well within the range of providing the legal expenses that we would incur.

Okay. Switching to the outlook for modifications; once the Barclay's portfolio is on, should we assume that we could see a pretty good ramp in the modification activity, I guess that would be early next year?

Yes. Our primary means of resolving non-performing loans is through the modification program and it will require a little bit of a ramp before you start seeing that flow through but certainly our expectations are within our pricing is that that would occur.

Your next question is from Mike Grondahl with Northland Capital Markets.

Bill, if you could just talk a little bit about the pricing environment for acquisitions out there? It would just seem to be going in your favor and secondly, maybe just your capacity to take on further acquisitions and maybe the execution ability that you have to do it, with all the activity you've done recently?

Why don't I take the first part and have Ron take the second part, if that would make sense to you?

The biggest challenge we have on getting product is really the decision on the part of the seller to sell. Certainly I think we have very significant competitive advantages going up against our peer group, in terms of most importantly our ability to reduce delinquencies, which is a huge driver of our economics; it reduces the amount of capital consumed in the business, both interest expense and equity and it also generates modification fees, etc. and reduces our operating expense because it's more expensive to service a non-performing loan than a performing loan. So it's not so much that it's the other bidder we have to compete against; we're competing against the marks that institutions have on their assets. So it's really a question of taking a loss as much as it is determining who the highest bidder is.

There has been some interesting changes that have occurred Basel and I've been fairly business on a number of things, not the least of which are two earnings calls that I'd like to spend more time thinking about that, because under Basel there's been a limitation that's been proposed for banks to hold MSRs, deferred tax assets which get generated by the servicing business, as well as any minority interests within entity. So that 15% could be rather interesting in terms of the capacity the players might have in the market for product.

We're even seeing a little bit of weakness quite frankly, in the secondary market, not on subprime but you're seeing weakness in the Ginnie market in terms of what servicing is really worth when it goes to trade, which I think long-term could be very helpful to us in that market. So I think there's weakness out there and some capacity problems with regard to people being able just to buy servicing.

From an operations standpoint, we're definitely on track to close the HomeEq transaction on September 1st. We've had 90-plus days to prepare for that and to ramp-up for that, so I think that we will be well positioned in the fourth quarter for example, to the extent there are larger opportunities out there to take those on. I don't think we have any concerns about our infrastructure or anything else that would restrict us from being able to take on additional portfolios, small or large, once we have this HomeEq deal boarded and closed on September 1st.

Okay then maybe just a follow-up for you, Ron. Prepayment speed during the June quarter stayed lower than I might have thought; it was at 13%, up a tick from 12% in the March quarter. Clearly that's speaking to the stickiness of the portfolio and some of the modification work you're doing, but where do you think that number is midterm to longer-term?

You know us; we don't really like to forecast things. But I don't really see any reason why we should expect any significant ramp-up in that; maybe a slight tick up if we see - there have been different things put in place by the state government and bankruptcy and foreclosure attorneys that may have made the process of getting through foreclosure slower than it had been historically, so to the extent that we're not able to modify loans, those loans may be taking a little longer to move through the process and then ultimately resolve out the backend. That might result in a small tick up as you start to flush through some of those, but I don't think that's a huge impact.

Even with interest rates where they are, I think there's still the ability of the kind of borrowers that we have to go out and get a conforming type loan is just very very restricted. The modifications that we're giving borrowers generally are such that they probably can't go out in the market and replace that with a better loan. So I think the voluntary aspect of prepayment speeds, in our portfolio at least should remain very low and not really change significantly going forward for quite a while.

Our voluntary rate is probably like 3%.

That's pretty low.

It's statistically almost the same as zero.

Well, you have a much bigger portfolio over the next couple of years than what we might have thought of three or four quarters ago when it was running 20-22%, so you make those basis points on a bigger asset for a longer period of time; it's good.

Your next question is from Ryan Zacharia from Jacobs Asset Management.

I guess the 25% pretax ROE that you guys state as kind of the overall return over the life of any given transaction; how can we think about how that translates in kind of the intermediate term 2011 and 2012 numbers, maybe translating that to a pretax income over average UPB figure, because I find that the timing is difficult to understand with the ramp and how you guys basically get the value that you expect to get out of it over the life of the portfolio. So maybe you guys can just speak to what 2011 is going to look like in light of the facts in HomeEq because based on the way you talk about Saxon requiring several quarters to ramp, then I would kind of think of HomeEq as a mid 2011 thing now, whereas I didn't think that was the case earlier?

The one thing that complicates HomeEq is the upfront expenses. We think of that from a cash flow perspective of looking as if they were PMSRs. In other words, it's an upfront cash flow, outflow, and it just means we have to expense them in the current period as opposed to expensing into an amortization over the life of the asset. So I'm going to try to differentiate between cash flow and actually reported earnings at least in the short-term if that's okay with you?

Sure.

It's a little bit easier to deal with; you just have to basically figure out when you think about it, the 60 million think about it as an investment that normally would be amortized and we can at least normalize all these transactions because it's the only one that has that upfront effect.

How you think about how it ramps is that when you take over a portfolio you have assets in various buckets; you have assets that are current, those that are non-performing/foreclosure bucket and those that are in REO. And as that flows through, let's suppose it takes on average about 180 days to sell REO and it takes an average of about 200 days to foreclose - I looked at those numbers yesterday, I think it's 202 days, so as you see the pig going through the pipeline, if you're able to start modifying those loans, in the second quarter after you have it you start seeing a ramp in modification fees as a result of that and then you start seeing as you go through the backend of the process you recapture some of the other fees that you had with respect to it. But the second quarter will get a pretty good size bump, if you will.

Keep in mind, Saxon hasn't even been on for a quarter; it's really on for half of a quarter. The day one you take over a portfolio you don't start immediately generating ancillary fees. You can't modify instantaneously. There's a process.

The ancillary fees are not the entirety of your return; there are fees that you're generating the day after you board the loans and those should be coming through, we should see them this quarter and next quarter and the quarter after that?

Absolutely. We had a basis point chart that listed ancillary fees. We took it out. Do you remember what it was? I think it was 2.7 basis points were ancillary fees. Does that sound right to you, Dave and Ron?

I want to take a look at the model but that's very very close.

So that's the number you're talking about; you've got virtually none of that on Saxon in the first half quarter that was in the portfolio. The 2.7 when it's compared to say, 15, isn't a whole lot but when you're comparing it to around 6, it's a meaningful number of the net down below; obviously anything becomes meaningful when you don't put expenses against it. So that was our only point with regard to that.

But on an absolute dollar basis, quarter-over-quarter sequentially servicing fees were down but UPB was up, so how do we reconcile that? I understand that there's a mix differential but it all kind of comes out in a wash or it should, so how do we reconcile the absolute dollars being down but UPB being up?

There's a couple of things that happened. As I was saying before, in the quarter your mix for most of the quarter had more subservicing than it had previously, which has a much lower fee. Our mods were down so modify 1,000 times every mod that we did less than we did in the prior quarter and that's about $4 million.

But shouldn't your amortization then be lower if this was predominantly subservicing? Your MSR amortization was up over 20% sequentially.

Right, because we added Saxon in, that's correct, when it first came in.

So you're only getting a negative from Saxon in the second quarter and none of the benefits?

No, I think Saxon helped make up for the lower mods that we had in the quarter compared to the first quarter.

We definitely did receive the contractual servicing fee revenue that you would get off of a portfolio but we did not receive the kind of ancillary fees including any sort of modification related fees that we would get. We also haven't had much opportunity to reduce advances and when we reduce advances, we will also recovery some of the deferred servicing fees, which would bring up even the contractual servicing fee line as we start to reduce advances on that portfolio. And that portfolio had I think in excess of $500 million of advances and I think we had a slide where it's 90-plus delinquency rate is over 40%.

So there's a lot of loans with deferred servicing fees that won't be recovered until we actually are able to modify the loan or push them through the foreclosure process. Our interest expense went up because we added in the $500 million of advances and had to finance those for a portion of the quarter and we did take amortization expense on our purchase price, which is what drove the increase in the MSR amortization. There was revenue, but there were probably over the long-term we'll see more revenue versus some of those expense items than we did in this initial couple of month period.

Okay, but I still don't understand how the MSR balance only increases 6% sequentially, PPR stays flat and MSR and amortization is up on the order of 20-plus percent.

Ryan, the biggest item really is the pullback in mods from what was it, 19,612 in the first quarter to 14,000-plus in the second quarter; that's significant because it's the timing of when you recognize your servicing fees and then your late fees. So what you have are two moving pieces; the decrease in the mods is significant and then bringing on Saxon you've got UPBs who aren't up to yet the full run-rate that you're accustomed to in the basis point model and therefore, the discussion about the ancillary fees and the ramp-up to get there.

If you look at overall net net, if you took out the onetime charges that were like the MDO and the commercial write-off, etc., essentially the quarter was flat with the first quarter, however--.

Except you added $7 billion of servicing generating at 25% pretax ROE.

Yes, for part of the quarter that's correct but you lost 4,000 mods.

So in order to kind of just tread water now because of a shortfall in HAMP, is it a safe assumption that we need to keep adding UPB?

No. First of all it wasn't just HAMP; it was any mod in terms of that number so our mod numbers in the first quarter were very high compared to historical and they were down more in the normal range, which we reflected to everyone in our guidance. So that number bounces around, as you can see on chart 11 and it depends on where you are in that, up or down a little bit makes a difference; 4,000 or 5,000 mods is $4 or $5 million.

So I guess again, trying to look at 2011, getting all of this stuff put together, what's an appropriate kind of way to think about what pretax income as expressed in basis points of UPB looks like? Just for modeling purposes we can say that things extend out and that recognition is tough to quantify?

There's two elements, again, I went through with respect to the revenue in UPB; one is the mix between subservicing and servicing and the other is basically the amount of ancillary fees that one earns. You had a downward slow when we were being conservative when there was illiquidity in the marketplace we were doing much more subservicing than servicing and subservicing has a lower basis points per UPB than servicing does. The new business we've added in such as the Saxon transaction and the HomeEq transaction are all servicing transactions which will in fact raise your revenue per dollar of UPB.

But I'm talking about pretax income, so the servicing versus subservicing, the mix should be a wash because whatever upside you're losing in your subservicing is basically the amortization of the servicing rights that you have with servicing.

No, not entirely at all because you have capital against the servicing business. You make more money in absolutely dollars on servicing than you do on subservicing, because you have capital up against it. The return on equity on subservicing is very high, but in terms of just raw dollars it doesn't generate the same amount of pretax net income.

So when we look at this pretax income over UPB, is 7 bps is that a reasonable assumption?

It's the highest number on the page, that was driven by one of our highest quarters in terms of modifications. You will see though, as you begin to go through this process, as more comes in as servicing, a natural upward trend in pretax income per UPB and basis points increasing with the addition of much more servicing as a proportion of the portfolio.

Your next question is from DeForest Hinman from Walthausen & Company.

Can we get some clarity on the charges we're expecting in the third quarter, the $15 million; how much of that is lease charges, software write-offs, severance? Can you help us understand what those are?

We don't really want to comment on that because it would be indicative of what our intentions are with respect to the operation.

I guess since we did the acquisition we paid cash for it, but in regards to those charges, what component of those would be a cash component?

We treat that 50 million as if it were an addition to MSRs in the economics. It's a cash outflow on the front-end of the transaction that's recovered over the subsequent life of the asset.

And DeForest, we'll expect that the dollars we spoke of today will spread roughly evenly over Q3, Q4, it could bounce around a little bit, but you'll look for it in each of the two quarters.

So when third quarter rolls around we'll be able to get details on what those expenses are, is what you're saying then?

You'll see them as they flow through, yes. You'll see what buckets they're in. Correct me if I'm wrong; I don't recall any that are non-cash. It's the same as if we paid $60 million more for the MSRs than we did.

I understand that. But a software write-off if you're not going to use their servicing platform, that seems reasonable. I just wanted to know how much that would have been, but that's all right.

Your next question is from Rob Schwartzberg with Compass Point.

You might have already answered this but I'm trying to understand the expense side in the expenses as a percentage of UPB because as you've been increasing the portfolio there's been a pretty clear reduction in operating expense as a percentage of UPB up until this quarter and I understand there's some timing issues but I still don't understand how an increase of let's call it 12% or 14% -- you still are increasing the size of the portfolio. Was there some other event? I understand that you had some expenses prior to boarding HomeEq but was there anything else going on from an expense angle in the portfolio that would have accounted for the uptick?

Let me step you through that just at the highest level to recount.

Do you happen to have the earnings release as well to follow along? It goes through those.

I have everything, yes.

Okay, if you look at the earnings release as Dave goes through this, it might be helpful.

So all together the pieces were the 5.1 million litigation accrual for the MBL.

Is that in these operations expenses? Underneath the footnote says it's normalized for that, so that shouldn't have impacted it, right?

If you're looking at page 9, that's right, that one item is normalized for those basis points.

That's the only one in the presentation that's been normalized; all the other ones will deal with actual expenses. So half that change was the MDL.

I guess I'm confused because the footnote makes it look like that. Is 5.1 million in the 6.9 of UPB?

It is normalized out of slide 9. You don't have the MDL represented in slide 9 and it would be worth roughly a full basis point if it were there.

And it's the only presentation in the slide where that is taken out. When you're looking at the $10 million increase in expenses; $5 million of that is the MDL settlement.

Is the 3 million non-cash write-off of the real estate partnership in the 6.9?

No, that will be at the corporate level, not in the servicing business.

Okay. And I assume then the 1.7 million of option rate securities is also not in there?

Corporate, that's true.

Right, so the only thing that's really in there is 1.5 million, I would think of the ramp-up expenses related to the HomeEq, right?

And you've got another 1.3 million in the HomeEq professional fees, another over 1 million which was the increase in the amortization, and then you've got the swing effect, a change in one of the strata inside our MSR that is about a $1.3 million impact if you compare sequentially Q1 to Q2 and yet for the full year a very slightly positive on that. So you've got that swing of about 1.3 as well.

Essentially you've had no increases in operating expenses associated with the ongoing platform.

That's what I was trying to get at was the core expenses and I would have thought actually since you're increasing the amount of UPB you might have even actually gone down slightly from the 6.2.

Again, it doesn't have the 5.1 in it but it has the 2.7 million for HomeEq and the Saxon increased amortization of MSRs. If you look at the gross number, we did not increase operating expenses on the portfolio during the quarter even though we added about 6.9 billion. So as Ron alluded to, we focus very much on being very efficient and effective; we have not suddenly had a breakdown in expense control, as a matter of fact, the expense control, even though it's a little cluttered up with these onetime things, expense control is very strong in the quarter.

I didn't think you had an expense breakdown. It's counterintuitive that your portfolio would be getting larger and your operating expenses as a percentage of the portfolio would still also be getting larger. I understand there's some onetime charges but it still seems unusual to me.

Let's go to the absolute dollars. Forget the basis points for a minute, let's go to actual dollars if we can and Dave you walk through what it was in the prior quarter, what it is this quarter and then the delta, so it's clear.

The pieces are - and Bill, I've got that at a consolidated level here. I don't have the servicing in front of me. But it's the pieces that we just walked through and you and I have done it at a pretax level. So Rob, you've talked through all the components that we talked about. If you were to go back and model that out and start with your operating expense and you can pick either the servicing business or the consolidated business, but if you start with OpEx at Q1 and then reconcile for all the items that we wrote about in the press release and that we discussed here with you, you would get back to stable operating expenses with Q1. That's true both for the servicing business and for the consolidated business.

So there's nothing related to the decline in modifications that has then sort of implications for expense control; there's no connection there either, right?

No, none whatsoever.

You're not trying to work harder to maintain a level of modifications or spending more money?

No. Ron went through these. There's 41.2 million of operating expenses in the quarter and that's an increase of 10.4 million; 5.1 of that or half was the onetime charge related to the MDL, so we're down to like 5.3; there was 2.7 million associated with the ramp-up of HomeEq, which is not boarded yet; so I'm down to 2.6 million at that particular point; there's 1.5 million of amortization associated just with the Saxon acquisition so I'm down to 900,000; and the strata on amortization we accelerated some of the amortization and that was in over 1 million so actually the expenses with boarding -- the operating expenses of servicing having boarded Saxon, went down for the quarter.

It's sometimes easier too if you look at the operating expenses and take out the amortization number and get the true operating expense. That true operating expense when you take out the onetime charges, decreased in the quarter yet we added 6.9 billion of servicing for part of the quarter.

Your next question is from Jake Blair.

My question was about the Fannie Mae trial program that you guys have got going on right now, is there any update on that and any potential new business that might be coming on as that program develops over time and matures?

First off, we have a pilot program with Freddie Mac and then we have additional business that we boarded last year and some of it continues to board, even into this year from Freddie Mac. We can't really project when and how much more is going to come from Freddie Mac. We do know, they've indicated to us that we're designated as one of their go-to special servicers and it's a very small list, only a couple of names on the list, but to date they have not -- we have not seen them proactively move troubled servicing except maybe what they've done with us already to any special servicer. Although we believe that that is in the cards and coming, we just don't know how much and we don't know when.

And in terms of taking on additional business that might be borne from FHA loans, can you guys tell us what you're working on there and how that might play out over the course of the next year or two?

We're investigating, obviously, being a larger scale servicer in that venue. Altisource, which is another company, owns a cooperative that represents about 6% -- their members originate about 6% of all mortgages originated in the United States. There is an opportunity we think to help those members realize greater value in their loans that they originate and at the same time for us to basically capture a stream of servicing related to FHA/Ginnie Mae servicing, so we're investigating doing that. Because the economics for FHA servicing more closely approximate subprime than they do prime with regard to the business.

And in terms of timing, you probably can't go into it that much, but when do you think that might play out or know whether or not it's something you want to spend some money trying to make happen?

We will start very very tentatively towards the end of the year. It will be sort of like Orville and Wilber Wright taking off; it won't be a big slash or anything but I think we've been spending well over a year making sure we understand exactly the economics of what the different events that can occur on the business. So we would see a very nominal amount towards the end of this year, beginning of next year with regard to that. Obviously we'll go over that as we become more comfortable that we understand everything that can go wrong.

Your next question is from Bob Napoli.

On mods, what percentage did you say of your mods are current and what percentage of the completed mods have made it a full year, what kind of metrics do you expect on that front?

On the HAMP side what we said in the presentation was that it's early and we don't have a lot of data but we're seeing about 81% of them making it through that one-year period. We've historically seen on modifications including non-HAMP on our portfolio a re-default rate of 25 to 30%; the industry is seeing closer to 50%.

Okay. And the 81% sounds like a really high number. It's still very early in getting to that point but what are you hearing from others in the industry?

There hasn't been a lot of information that I've seen out there. We were one of the first servicers to actually get loans modified, truly modified under HAMP so we're one of if not the first servicer to actually have loans that have reached that one-year anniversary and actually receive some of the success payment, so I'm not sure a lot of the other servicers have a lot of that data yet. For many of them it took them many many many months just to complete the modification, so they're still a number of months away from hitting that point.

We're hopeful that our numbers will be better than the industry, although it is a program that is the same for all parties involved and so to some degree we shouldn't see drastically different results from the rest of the industry but we still believe ours will likely be better. But I don't have any real good information on where the rest of the industry is tracking right now.

Ron, do you think that 80% number is somewhere in that range from what you're seeing on payments at various stages, the number that you think is reasonable and reasonably sustainable and does it surprise you that it's that high?

Keep in mind, Bob, that's our number at the 12-month mark, that's not our average.

For loans hitting the 12-month mark, I think that's reasonably good. Again, it's a small data set right now but I have no reason to believe that we're going to see anything wildly different than that for hitting the one-year mark. Obviously as you hit the two-year mark, which is another success fee at two years, you're going to see an additional fall off just from the passage of time and some borrowers will run into trouble. But I think for HAMP, at least for now, we accept the best information we have.

What date did you debt deal close?

It was July 29th.

Bob, I think you'll see one of the things that they did enhance, we're big believers in using our psychology department to look at the offers that are made. I think HAMP by making an offer where people get a reward for staying current has a pretty strong positive reinforcement to them, so you would expect the HAMP mods with the $1,000 payment to be meaningfully better in terms of the re-default rate than without.

The other thing that they've just recently come out with, which I think will have a very significant impact on the industry is the new HAMP program permits principal reductions because the largest reason I believe and our numbers show that people re-default is because they're woefully under water. So I think that's a change that hasn't been talked about very much but actually will change modification rates I think pretty significantly. It takes a little while to operationalize that change, but I think it adds legitimacy to that as a resolution strategy and the numbers we've run in terms of the tests we've done, show that it meaningfully improves net present value to the investor. So how you modify those cash flows and how the borrower perceives it has a significant impact on re-default rates. And again, I think the new program the administration has rolled out will be very beneficial to re-defaults.

Have you used that new program much at this point?

We're only in the test phase right now and we'll roll the HAMP modification program out in October.

(Operator instructions) Your final question is from Mr. George.

Did you give the cost of the debt that you just issued?

Yes, think about it with a 2% LIBOR floor and then 700 basis points; 2 OID.

And 700 basis point spread?

Yes.

Thank you very much everyone. Have a great day.

That does conclude today's conference call. We thank you for participating. You may now disconnect and have a great rest of the day.