Onity Group Inc (ONIT) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Ocwen Financial, second quarter 2014 earnings conference call. (Operator Instructions). I would now like to turn the call over to Michael Bourque, Executive Vice President and CFO.

Thank you, Jamie. Good morning, everybody , and thank you for joining us today for Ocwen's second quarter 2014 earnings conference Call. Before we begin, please note that a slide presentation is available to accompany today's call. To access the presentation please go to shareholder relations section on our website at www.ocwen.com, and click on the Events and Presentations tab. As a reminder the presentation in our conference this morning may contain forward-looking statements made pursuit to the Safe Harbor Provisions of the Federal Securities Laws. These forward-looking statements may be identified by reference to a future period, or buy use of forward-looking terminology. Forward-looking statements, by their nature, address matters that are, to different degrees, uncertain.

Forward-looking statements involve risk and uncertainties that could cause the Company's actual results to differ materially from the results discussed in these forward-looking statements. In addition, the presentation in our comments contain references to non-GAAP financial measure such as normalized pre-tax earnings and adjusted cash flow from operations. We believe these non-GAAP financial measures may provide additional meaningful comparisons between current results and results in prior periods.

Non-GAAP financial measures should be viewed in addiction to, and not as an alternative for, the Company's reported results under accounting principles generally accepted in the United States. For an elaboration of the factors I just discussed, please refer to today's earnings release, as well as the Company's filings with the Securities and Exchange Commission including Ocwen's 2013 Form 10-K and quarterly 10-Qs. Note that we expect to file our second quarter 2014 Form 10-Q in the coming days. Joining me on the call today are Bill Erbey, our Chairman and Ron Faris, President and Chief Executive Officer. Now, I will turn the call over to Bill.

Thank you, Michael. Good morning, and thank you for joining us for today's call. As on our recent calls I want to focus my comments specifically on why Ocwen enjoys the unique market position which should support continued portfolio growth going forward, and more importantly, how we believe the macro trends are truly aligned with Ocwen's strengths. I will then close with a discussion on how we think about new business opportunities, and share one idea we're in the process of launching.

Ron will then provide an overview on the regulatory and compliance environment before discussing some highlights from the recent US department of housing and urban development report on making home affordable program. Finally, he will partnership with various constituencies on bar outreach programs, and our efforts to encourage dialogue around positive changes in housing policy. Michael will then summarize our financial results for the second quarter and review our balance sheet and recent capital activity.

First, let me address the macro environment which we believe aligns extremely well with Ocwen's strength. There are four key points. First, and improving US economy increases the value of our business. Second, the increased regulatory scrutiny presents both challenges and opportunities to Ocwen. Third, large banks have a strong preference for outsourcing delinquent servicing. And, fourth, there was a significant population of non-prime consumers whose financing needs are not being met. US economy continues to improve, albeit it slowly.

An improving economy serves to increase the value of our portfolio of MSRs by reducing the reasons for delinquency, and lowering and prepayments. Second, the heightened regulatory environment, of which we are all keenly aware, is both a challenge and an opportunity. Obviously, it's a challenge in the near-term because it increases operating costs and can result in longer timelines for servicing transfers. It also adds uncertainty for those wishing to execute transactions including special lease servicers and banks.

Over the long run, however, we believe the regulatory changes have created opportunity for Ocwen. Most large banks don't like loans that are likely to default. Banks that already viewed servicing pools with higher levels of non-performing loans as unprofitable, before the recent changes in regulatory compliance increased their already high cost of service. So, the increase in regulatory burden amplifies an already strong desire to shift away from credit challenged products and transfer those activities to other participants.

And for non-bank servicers, it levels the playing field ensuring they are held to the same high standards as banks. We firmly believe that Ocwen has size and scale advantages and we are very well capitalized in comparison to our peers. Ocwen is deeply committed to adhering to the highest standards of compliance and regulatory oversight. We have made significant investments in this area over many years and will continue to do so. Later in the presentation Ron will review some of our recent investments with you.

Based on comments from several regulators, the other potential change that could come out of the current environment are more stringent capital requirements. As we've said before, we believe that any mandated capital requirements would be a relative benefit to Ocwen because our capital position is stronger than other non-bank servicers. Later in the presentation we'll discuss what we call our economic balance sheet, which is our balance sheet after removing assets and liabilities where we have sold our economic interest. The impact is significant and illustrates a robust balance sheet highlighted by a one-to-one relationship between our MSR value and intangible net worth, and a low 1.1:1 debt to equity ratio.

Third, the forces that are expected to shift delinquent loan servicing away from the banks remain intact. Most importantly of these forces is that many banks have shifted their focus to activities that support their core banking franchise. These banks have a wide variety of consumer products they want to sell, and delinquent non-performing bars are generally not their target customers.

Moreover, these customers can be more of a distraction, and increase the risk of adverse publicity. And, as I discussed, most banks are not structured to properly service non-performing loans. As a result, we believe there's been a long-term shift in how mortgage servicing will work. At a minimum, we would expect two things. First, higher risk mortgage products more likely be serviced by specialists, and second, lower risk loans that do default will more than likely also be serviced by specialists. We believe this emerging servicing market will be one where Ocwen will compete very effectively. Finally, several factors suggest that there is significant unmet demand for alternative credit products to support home ownership. Core logic estimated tempted last year that only 25% of all American households could qualify for a mortgage to buy a home.

This compares to a pre crisis estimate that approximately 60% of households could get mortgage loan financing in either the prime or non-prime lending market. Thus far, mortgage standards have been maintained on origination and there has been no return of a non-prime lending market. We've recently received reverse inquiries from major sources of capital to create mortgages that serve borrowers slightly below the prime lending standard. Expanding a credit matrix has also been solidly supported by community groups with whom we are in close contact. Let me state that we have no interest in originating non-QM loans, given the penalties that originator could incur. We do believe, however, that there are innovative products that could safely serve this under-served market and would not violate the QM rules.

In most cases, these products will require a flexible servicing platform that can manage the risks associated with non-prime or credit impaired servicing which is where Ocwen has its greatest competitive advantage. Clearly, there's lots of work to do. We anticipate that it will be next year before this could become a meaningful opportunity.

Next, let me discuss Ocwen's strength and track record. We continue to believe that Ocwen is uniquely positioned as the most efficient and effective provider of non-prime mortgage servicing in an environment where the demand for our services should continue to rise, despite the current uncertainty on portfolio transfers. As we have shown in prior presentations, we have been ranked number one in numerous third-party studies of aspects of service and quality. We have a scalable platform designed from the beginning to handle non-performing loans. For example, by using in depth dialogue engines and automated decision making, we're extremely effective at returning loans to re-performing status and keeping them performing.

As a result, we've been able to drive superior results for the loans we service. We have demonstrated consistent cost advantages in our platform. For example, based on comparisons against an independent third-party study, we estimate that our cost of servicing non-performing, non-agency loans on the real servicing platform is 67% lower than the industry averages. Certainly, the heightened regulatory environment is raising compliance costs and extending processing times.

However, longer-term, we believe this strengthens Ocwen's competitive advantage because the changes increase the importance of scale and efficiency, and believe that it places a greater premium on operational skills where Ocwen excels relative to our competitors. Ocwen's platform is designed in such a way that we can more easily automate requirements than others even if initially almost everyone's processes, including ours, are more manual than we might like.

As a result, we expect that over time our margins should improve, and our competitive advantage will be maintained, if not increased. Further, Ocwen is subject to its own national mortgage settlement which we agreed to abide by in 2013. Ocwen is the only non-bank, and one of only six institutions, which is specifically subject to its own national mortgage settlement. We believe we are uniquely positioned as a partner to banks as they look to shed non-performing assets from their books.

No one can accurately claim the bank selling service into Ocwen, are in any way end running regulatory supervision. As a result, we believe we're better positioned than other potential acquirer's as a low risk solution to banks looking at possible buyers of their non-prime MSRs. Ocwen has strong track record of integrating large portfolios and platform acquisitions. Since 2009 we have acquired and boarded over 3 million loans representing unpaid principal balance of over $510 billion.

At the same time, we've continued to produce superior results in servicing these loans and resolving delinquencies more quickly and more effective than the industry in general. Since 2008 we have helped more than 510,000 families keep their homes with sensible modifications, which is more than any other non-bank mortgage loan servicer in the country. Ocwen has been a leader in (inaudible) modifications as shown by treasury data. We are a leader as well in private label modifications.

We have also led the industry with innovative programs such as the share depreciation modification. Third-party studies by a variety of analysts point to Ocwen as a Best-in-Class loss mitigation servicer. In short, we helped more homeowners become current on their mortgages, and by doing so, provide better results for mortgage investors. Our management team is fully aligned with shareholders. Our leadership team and board own approximately 17% of our stock, in addition, the Board has put in place a share repurchase program under which we have purchased and retired more than 5.8 million shares so far in 2014, returning over $210 million to shareholders.

Ocwen is financially sound in keeping with a strategic goals we followed for our entire history. Almost 50% of our asset base is investment grade. We also enjoy significantly lower leverage than our peers. As of the first quarter of 2014, our reported corporate debt to net worth ratio is roughly one-third our closest competitor. If you adjust the balance sheet for differences in fair value accounting to make a light comparison, we estimate our ratio is roughly one fifth that competitor.

Further, we have create and utilized innovative capital structures and relationships such as with HLSS, and with our recent OASIS bonds transaction through which we reduce the capital required and significantly lowered Ocwen's exposure to shifting pre-payment rates and interest rate volatility. As a result of all these factors, we are the true leader in the industry as a Best-in-Class loss mitigation servicer with our track record of efficiently boarding large acquisitions and our cost advantages and regulatory alignment, we believe we are the most attractive partner for banks looking to reduce their servicing of delinquent and non-prime loans.

We generate the strongest operating margins and highest operating cash flow among our closest competitors in the non-bank servicing sector which we expect to sustain in the future. Looking forward, we continue to look to use our capital to grow and capture attractive returns for shareholders. In addition to growing our core servicing business, we're also interested in expanding into adjacent or complementary businesses in which we can utilize our competitive advantages to achieve our return hurdles.

A lot of you have asked us what opportunities we are considering, so I would like to give you a construct of how we consider opportunities. First, any new opportunity we pursue has to align with long-term macro trends. We're not looking for short-term value creation, but opportunities that can and meaningfully to our long-term growth rate and return on equity. Second, we'll only a enter a business if we feel we can capture and maintain a long-term competitive advantage. Our advantage may be related to our operational efficiencies, or cost of capital, or even tax structure, but we must view it as meaningful and sustainable versus our other competitors in the market.

Third, any business we enter must have a demonstrated ability to generate positive cash flows with manageable risks particularly liquidity and interest rate risks. Fourth, we prefer businesses that can be structured efficiently around repetitive processes where we can bring our operational expertise, innovation to bear to create Best-in-Class practices. Fifth, any business we add on to our platform must not jeopardize our franchise or dilute our core servicing business.

Sixth, once an opportunity is identified, we are not wedded to a single path of entry. Depending on the opportunity and the competitive environment, we would consider a combination of acquisitions or internal start-ups as a path to build the right platform with the right competitive advantages. And lastly, we must ultimately be able to capture a target of pre-tax return on equity of 25% or more. While we have had several new opportunities in various stages of development, I wanted to discuss one that builds directly off of our core mortgage servicing business.

I will also talk in broad terms at the end about an opportunity for examining in the non-mortgage lending space. I believe that Ocwen has substantial opportunities to leverage our strong servicing capabilities by exercising cleanup call rights, or investing in existing private label RNBS traunches that we service. Most RNBS securities we service have cleanup call provisions that allow the servicer to calling the deal at par.

Typically, when it's been paid down to 10% of the original unpaid principal balance. Notwithstanding slower prepayments, we see a steady stream of deals maturing in the next several years. The opportunity results from the arbitrage of the underlying loans and REO being worth more in than the securities. In other words, the whole is worth less than the sum of the parts. A condition for (inaudible) to our investment is our belief that Ocwen servicing creates strong cash flows for the securities overall. We're building out this program and expect to be in the market purchasing securities in the next few months.

Ocwen is also close to executing on it's diversification effort in an adjacent lending space as well. It's a bit premature to describe this initiative in detail, but we believe we can build a new franchise for Ocwen, largely organically, that will leverage our world-class collections ability, tax and operating efficiency, funding innovations, technology expertise and knowledge of managing a distributed vendor network to add a significant value for our shareholders. We're excited about this opportunity and expect to speak to you more about it in the very near future. And, with that, I will turn the call over to our President and CEO, Ron Faris.

Thank you, Bill. This morning I will cover three main topics in my prepared remarks. First, I will provide an update on the regulatory environment and the impact it is having on Ocwen and the industry. And, second, I would like to share with you some recently released results from the US treasury that highlighted Ocwen's performance in the Making Home Affordable program. And, third, I will review our recent housing policy day in Washington DC, and discuss our recent announcement about our Community Advisory Council.

Let me begin by stating that the notion that non-bank servicers are subject to less stringent regulation is simply untrue. We are subject to federal regulatory oversight by the Consumer Financial Protection Bureau, or CFPB. In addition, we are subject to oversight from a host of others including state regulators, Freddie Mac, Fannie Mae, FHFA, Ginnie Mae, FHA, private trustees, and a broad range of clients for whom we service or sub service loans, including some large national banks. Overall, we welcome regulatory oversight because it is good for the industry as it increases confidence in the markets, raises the standards for all servicers, and removes marginal players from the market.

Moreover, we believe that stricter regulation is ultimately a competitive advantage for Ocwen as we are the only large non-bank fully subject to its own national mortgage settlement and monitoring. Certainly, in the near-term, the imposition of higher regulatory standards can increase operating costs and extend process time. For example, the new CFPB rules that went into effect earlier this year extend foreclosure processes by generally not allowing to be filed until a loan is 120 days delinquent, versus the prior industry standards of 90 days. Also, the emerging compliance structures are driving towards near zero tolerance for error, which we embrace wholeheartedly, although it raises costs because of the additional activities and documentation now required under the regulation. There is no doubt that meeting the new regulatory standards has, at least in the short-term, raised everyone's costs, including Ocwen's.

We spoke in the first quarter about how we believe it is increasing the variable costs to service non-performing loans for everyone in the industry. In addition, all servicers are adding substantially to their overhead costs particularly for oversight and reporting. For example, in 2014 alone, we have made major investments in our compliance infrastructure, adding over 325 employees in Legal, Risk, Audit and Compliance. We are especially pleased to report that we have recently hired some additional highly skilled executives into our Risk Management, Audit and Compliance operations. We are moving as fast as we can towards a world-class enterprise risk management system. Not only will this ERM system strengthen our control environment, but long-term, it will allow us to improve operations, reduce risks and eliminate various operational expenses and losses. I am sure that many of you are interested in the status of the Wells Fargo transaction we announced in January.

Similar to last quarter, the deal remains on indefinite hold and we continue to cooperate with the New York Department of Financial Services. We have nothing new to report, and we will not be addressing questions related to New York, or any other regulatory inquiries. We refer you to our 10-K and 10-Qs for more detail. Moving on, whereas many other servicers continue to focus their efforts on foreclosures and short sales, which displace families from their homes and communities, we continue to strive to reduce delinquencies and loan losses by keeping more families in their homes through sensible repayment and loan modification plans. As reported in the most recent making home affordable program performance report through May 2014, Ocwen has completed 279,834 HAMP first lien modification. More than any other servicer. We have completed 63,422 HAMP principal reduction modifications, more than the next three highest servicers combined.

Even more impressive is the fact that for homeowners who were not accepted for HAMP, or who were disqualified from HAMP, Ocwen has the lowest foreclosure rate and the highest alternative modification and repayment plan rate. In other words, a family who has its home loan serviced by Ocwen has a significantly better chance of remaining in their home than if their loan is serviced by other large servicers. As third party studies have confirmed, Ocwen's superior results in helping consumers avoid foreclosure through sustainable loan modifications, also results in improved cash flow, lower delinquency rates, and lower expected losses for loan investors. We have always been a strong supporter of the making home affordable program and we are extremely proud that 20% of all active first lien HAMP modifications are serviced by Ocwen. A rate 33% greater than the next highest servicer.

I would also like to address the recent reports by the special inspector general for TARP. Ocwen is, and has been, complaint with laws, regulations and HAMP guidelines for handling modification requests. We do not have, nor did we have, a backlog of unprocessed modification applications. New rules that went into effect this year have changed if and when you can deny a modification application by a consumer.

Historically, after a period of time, if a consumer was unable to provide a complete application, the application was denied. Regulators now require servicers to keep these partial applications open. Whether or not this is the reason for the discrepancy in the data used by sig-TARP, we are not sure. However, we will continue to work with treasury to clarify and/or correct any reporting discrepancies. The good news is, we continue to help more struggling families than any other servicer and our customers are receiving the assistance they need from us to avoid foreclosure whenever possible.

Moving on, I want to share with you some positive developments that underscore our longstanding commitment to building support and collaborating with nonprofit organizations and housing counselling agencies. First, on June 19th, Ocwen hosted it's fifth annual housing advocacy and policy forum in Washington DC. Participants included approximately 60 non-profit and consumer counselling agencies, as well as key government officials from treasury, HUD and the OCC. This forum provides an opportunity to exchange perspectives on important issues related to homeownership, and allows our non-profit partners to network with government officials responsible for developing policies and programs that they care about. The group discussed policy developments under the making home affordable program, and panelists discussed important topics including access to mortgage credits, and strategies to rehabilitate blighted communities.

Importantly, the event also provides an opportunity for Ocwen to spend time with Washington policy makers in a positive environment reinforcing our commitment to helping borrowers maintain their homes through the critical assistance of housing counselors. Second, as a leader in the mortgage servicing business we have a responsibility to constantly evolve our Company, and serve as a thought leader. To that end, on July 16th, Ocwen announced the creation of a community advisory council comprised of leading national, regional and local non-profit communities groups.

The council, which I will share, provides a forum for Ocwen executives and community advocates to share ideas and discuss policy issues. Our objective is to collaboratively identify opportunities to work together to preserve homeownership and improve servicer efficiencies, while at the same time providing positive investor outcomes. We view these groups as valued partners in establishing and maintaining open and effective lines of communication with our customers. The work they do is critical to our business success and critical to communities nationwide. The council will serve to build and facilitate effective relationships with key stakeholders, and will enhance the Company's good standing and reputation overall.

Finally, Ocwen continues to co-sponsor, with nonprofit organizations, community outreach programs across the country. These programs are designed to bring servicers, counselors and struggling homeowners together to find sustainable resolution. Just last week we worked we helped communities in Bell Grade, Florida to hold a very successful outreach event in south Florida. We are co-sponsoring another even with Hope Now, in central Florida, in early August. These are just a few of the many events and programs we are proud to support and participate in. With that, I will turn the call over to our CFO, Michael Bourque.

Thank you, Ron. Today on the call I will review our financial results and then update you on our balance sheet and recent capital and repurchase activity. Beginning with a review of our financial results for the second quarter of 2014, Ocwen generated a total revenue of $553 million, which was flat from the first quarter of 2014. Serviceable revenues over $520 million, and was also flat sequentially. Higher REO commissions, and residential servicing fees offset the impact of a 3% decline in the unpaid principal balance. The lending revenue of $31 million increased 8% from the first quarter of 2014. During the quarter, Ocwen originated and $1.2 billion of forward loans, and $145 million of reverse loans. Total operating expenses for the Company were $345 million, which was down 1% versus the first quarter, and down 8% year-over-year. On a normalized basis, operating expenses would have been up $6.1 million, or 2% versus the first quarter.

As I will discuss later, total operating expenses included about $20.3 million of costs that we'll eliminate in our normalization. Total other expense in the second quarter 2014 was $130 million, which was 15% higher than the first quarter. The big driver was a $12.7 million increase in interest expense payable to HLSS, which I will explain further on our normalization page. The second impact was the increased interest expense from having a full quarter of the OASIS notes, as well as our new high yield bond offering. Collectively, they added $5 million in interest expense in the quarter. As a result of these factors, we reported second quarter 2014 net income of $67 million, which was down 12% sequentially.

From an EPS standpoint, our reported diluted net income per share was $0.48 in the quarter, a decrease of 11% versus the first quarter of 2014. Cash from operating activities was $14 million. Additionally, a normalized view of adjusted cash from operating activities, a non-GAAP measure we typically provide, was also $14 million in the quarter. The only normalization adjustment here is the impact of the $67 million payment we made as part of our national mortgage settlement. This cash generation level is lower than our historical levels, largely as a results of $118 million increase in loans held for sale in our lending business. Which is largely timing driven and the result of increased volume late in the quarter as mortgage rates fell. Ocwen's total effective tax rate for the quarter was 13.2%. Our projected annual effective tax rate was largely unchanged between the first and second quarter.

As we have said in the past, our rate varies depending on where our earnings are generated, and the relative mix of operations in the main land US. Consistent with comments made last quarter, we would expect our tax run rates to be in the low to mid-teens through the rest of the year. Touching on a few key results of the second quarter. Both our servicing and lending businesses performed well operationally with their combined operating income up 8% versus the first quarter of 2014. Our operating expenses were down 1% in the quarter.

We are pleased to see reductions in our transition related expenses, as well as in our uncollectible receivable costs, which were $9 million lower than the $24 million charge we took in the first quarter of 2014. However, these favorable items were offset by a significant increase in compliance and regulatory related costs which were up significantly over last quarter. The biggest item was roughly $12 million of expenses for the New York states and national monitors. These cost are a significant element of our cost base. It is difficult to anticipate their future magnitude.

I can tell you that we expect to incur roughly $9 million dollars in the third quarter, and ongoing monitoring costs, about $3 million lower than we saw in the second quarter. We believe costs will remain significant through the duration of the monitoring periods. Ocwen delivered $77 million in pre-tax earnings, and $110 million in normalized pre-tax earnings. Normalized pre-tax earnings were down 7% versus the first quarter of 2014, driven by the cost elements I mentioned earlier. Additionally, interest expense was higher as a result of the recent high yield bond and OASIS transaction. $33 million of normalized items were led by $19.3 million of MSR fair value related charges, $8.3 million of integration technology and other cost, and finally a $5.4 million one time increase in compensation expense for the surrender of options back in April.

I will address these items in more detail later in the presentation. Finally, we returned cash to shareholders. In the quarter we repurchased 2.6 million shares of stock for $92.3 million at average price of $35.45. In July, we repurchased and additional 1.2 million shares for $43.9 million, under our share repurchase program. We also repurchased over 1.9 million shares from funds managed by WL Roth and Company after they converted their remaining 62,000 preferred shares into common shares. These repurchase activities returned over $200 million to shareholders since April 1st of the year. We are also pleased that Wilbur Ross will remain on our Board of Directors. I will now discuss our servicing segment which performed well in the quarter.

In the second quarter total revenue of $520 million was flat versus the first quarter of 2014, and up 2% from $510 million in the second quarter last year. This included $357 million of servicing revenue, and $31 million of sub servicing revenue. Servicing revenue was flat versus the first quarter of 2014. Higher REO sales in recognition of deferred servicing fees were offset by the impact of a 3% smaller unpaid principal balance. We collected $109 million of HAMP fees, late fees and other fees which was flat compared to the first quarter of 2014.

From the standpoint of servicing operating expense, we saw cost decline 3% from the first quarter of 2014. Turning to our portfolio at mid-year and total Ocwen provided servicing and/or sub servicing services for a total of approximately 2.7 million loans with a total of UPB, or unpaid principal balance, of $435 billion. Total UPB is down 3% from March 31, 2014 due to loan run off.

As of June 30th, 2014 approximately 87% of the loans were performing, and the remaining 13% were non-performing. Compared with the first quarter of 2014, the non-performing percent of the population has declined by 90 basis points. Largely consistent with last quarter, approximately 48% of the loans are conventional loans, 42% are non-agency, and 10% is government insured. The total pre-payment rate for CPR was approximately 12.9% which was up 170 basis points from the first quarter.

CPR related to prime loans was 14.4% compared to 12.6% in the first quarter, and CPR related to non-prime loans was 11.3% compared to 9.2% in the first quarter. These higher prepayments speeds are driven by an increase in total debt payoffs, and higher OREO sales which we expected given the weather related delays we witnessed in the first quarter.

We had another successful quarters of modification activity with around 27,500 modifications completed. The pace of our modifications remains healthy, with modification offers up through the second quarter after a significant decline in March. Also encouraging, is that modification offers in July are at their highest level so far of this year. This should bode well for modification volumes in the second half. In the quarter, we have continued our efforts to transfer the remaining loans off of the legacy ResCap system to real servicing. Transferring a total of over 300,000 loans. We're currently working on the final system enhancements necessary to transfer the remaining 340,000 loans, of which 250,000 are Ginnie Mae related.

We expect this to be completed before the end of the year after which the ResCap portfolio will have been fully boarded and we can complete our integration and restructuring efforts. This may mean some previously communicated shut down costs may fall into 2015 rather than 2014. We're working through the schedule and will provide an update with more certainty at the third quarter earnings release.

While this is modestly behind the schedule we discussed earlier this year, it is important to note that our focus is always on quality and compliance and we are willing to accept some delays in order to execute the transition effectively and efficiently. We will not sacrifice quality to accelerate the transfer. Next, we will move to discuss our lending segment which improved from the first quarter of 2014. The second quarter total lending revenue of $31 million was up 8% from the first quarter, and down 8% from the second quarter last year. The second quarter revenue included $22 million from gains on sales of loans, and $9 million of other revenues.

The 8% lending revenue growth over the first quarter was driven by our Reverse Lending business with stronger margins more than offset a decline in unit volumes. The forward business originate $1.2 billion, and 6,378 units. Unit volumes in our direct and broker segments led to 2% year-over-year increase. The portion of our volume related to the HARP program of 39%, a decline of 17 points versus the first quarter of 2014, but still significantly above where we were in 2013. Lending operating expenses declined by 14% compared to the prior quarter, and by 6% versus the second quarter of last year. This was driven by significant headcount reductions and cost efficiencies in both our forward and reverse platforms. The lending segment posted pre-tax income of $7 million in the second quarter, compared to $600,000 in the first quarter, driven by higher margins and lower costs.

At the end of the second quarter we estimate that our reverse business had $37 million of pre taxed unrecognized future embedded value in its Ginnie Mae servicing portfolio discounted at 12% primarily comprised of the value of anticipated future borrowing draws. From a strategic perspective, we're focusing our forward origination segment on improving service, speed, and accuracy in all its channels. We're also deepening the lenders (inaudible) partnership by improving service and by executing on building a strong product development franchise focused on products that Bill spoke about in his portion of the presentation. Next, let me review our normalizing adjustments for the second quarter of 2014.

As in the past we provide a normalized pre-tax income which adjusts for the impact of certain items in the quarter. The normalization is designed to give a clearer view of the ongoing operating performance of the business. During the second quarter of 2014, we incurred $33 million in normalization expenses, and delivered $110 million of pre-tax normalized income. These costs are best understood broken down into three areas. Fair value related changes, integration and transitions costs, and compensation expense. The first is $19.3 million with charges related to MSR fair value changes. We believe it is helpful to begin normalizing for MSR fair value related changes, to offer more clarity into the underlying performance of the business, to present our results more consistently with some of the other non-bank servicers, and to more closely reflect how many stock analyst and investors evaluate our results.

The $19.3 million charge is broken into two items. The first item is related to our sale of rights to MSRs to HLSS. In the second quarter there was a $12.7 million increase in the fair value of the rights to MSRs sold to HLSS. This raised the value of the liability we recorded on our balance sheet, lowering principal amortization, and increasing interest expense. It is worth noting that if our non-agency MSRs had been recorded at fair value instead of lower of cost to market, there would have been a similar valuation increase in our MSRs which would have offset the income statement impact on the increase in interest expense. I would note that this did not result in any change in the cash paid to HLSS.

Mechanically, it meant the split of the cash payment made to HLSS would result in $12.7 million less of note payable principal amortization than expected, and more interest expense. We have normalized for this item as it is a direct result of an MSR fair value change. On January 1, 2015 we have the opportunity to change our MSR accounting election from lower of cost or market, to fair value. In whole, or for only part of the portfolio. Ocwen is the only large servicer that does not carry the majority of it's MSRs at fair value. We are currently evaluating our position on fair value accounting. Second item in the quarter is a $6.6 million adjustment related to the fair value change on the small part of our portfolio that is carried at fair value.

This is consistent with marks you have seen in the past. The next area of normalizing expenses is also consistent with what you have seen Ocwen report under normalization in the past. In the quarter, there was $8.3 million of integration, technology related, and severance costs, primarily associated with the ResCap acquisition integration. The final area of normalization relates to compensation expense. Specifically, costs in connection with Mr. Erbey's voluntary surrender of stock options in April. Compensation expense, in connection with option grants, is based on the value of the option on the grant date, which is then recognized (inaudible), as compensation expense over the term of the option grants.

In the event of a voluntary surrender where there isn't a concurrent grant or reissue of options, the appropriate treatment is to expense immediately any remaining unrecognized stock option value. Apparently, this was designed to prevent companies from cancelling out of the money option grants to avoid compensation costs. This, clearly, is not that type of situation, but nonetheless we expensed the remaining $5.4 million unrecognized balance in the quarter.

Now that we have covered the various elements impacting our income statement, we thought it would be helpful to reground everybody on the drivers of our 7% decline in normalized earnings versus the prior quarter. Operationally we saw a solid performance. The servicing business delivered flat revenue on a smaller UPB base, and our lending business was up significantly after a tough first quarter. Normalized operating expenses were up 2% in the quarter.

We booked $15 million of additional reserves for uncollectible advances. This was $9 million below the $24 million we recorded in the first quarter of 2014. While this is favorable versus our first quarter performance, the reduction, frankly, is not as significant as we expected and we have more work to do here to bring the ongoing costs back down to a more historical run-rate. That is followed by the approximately $12 million increase in monitor costs we discussed earlier. Finally, you have the increase of interest expense which is higher than the first quarter as a result of our OASIS and high yield bonds transactions completed in the first half of the year. This leaves us with $110 million of normalized pre-tax income. Next, we will discuss the strength of the Ocwen balance sheet.

At June 30, 2014 Ocwen had total assets of $8.4 billion. A unique element of the balance sheet if the fact that we have many transactions that counts as financings versus true sales for accounting reasons. The impact of these transactions effectively gross up the balance sheet. Additionally, we have advances that are financed, and that have offsets and liabilities. We believe it is constructive to consider our balance sheet without these factors and, by so doing, highlight our position as the best capitalized, non-bank mortgage servicer in the industry. You can see a simplified reported balance sheet on the left side of the page. We have our advances, MSRs and other assets.

And in the liability section we have split it between matched funded liabilities, financing liabilities, and other liabilities. Then we have our equity. As we walk from left to right, we are adjusting both our assets at liabilities for financing transactions. For instance, we have about $2 billion of advances and also $2 billion of match-funded liabilities against those advances, so we removed them.

We had roughly $1.1 billion of reverse mortgages that have effectively been sold but the accounting rules say that we need to treat them as a financing. We also have $1.1 billion of liabilities against that. Finally, we have the rights to MSRs that Ocwen has economically sold to HLSS with servicing retained. These are also treated as a financing and our assets largely match our liabilities here.

The impact of all of this is to leave us with $4.7 billion of assets, $2.8 billion of liabilities and $1.9 billion of equity representing a debt to equity ratio of 1.1:1. This is a high-quality balance sheet with a significant portion roughly 30% investment grade assets. Note that this value is lower than the 50% mentioned before as some of the assets were sold in the previously mentioned transactions. It is still, however, a significant percentage.

As we also discussed earlier, our MSRs are carried at lower cost to market. We estimate this to be roughly $400 million below their current fair value, indicating a relative conservative presentation of the assets. You will also note our MSR to tangible net worth ratio is now roughly 1:1. Finally, you can see at that at these low levels, Ocwen has significant capital flexibility to support our growth initiatives should we need it. Moving on to capital allocation. Our capital allocation strategy is unchanged from what we discussed back in 2013. Our priority is to first deploy capital to support the growth of our core servicing business. Our next priority is to deploy capital to expand into similar or complementary businesses with sustainable competitive advantages that enable us to meet our return hurdles.

As an opportunities in this area we will then look to return cash to shareholders by repurchasing shares when we consider them to be attractively priced. In the fourth quarter of 2013 we announced our board approved a $500 million share repurchase program and in February of this year we communicated a general goal but not obligation to repurchase shares at least equal to the prior period earnings in the three months following our earnings announcements.

During the second quarter, the Company repurchased 2.6 million shares at an average price of $35.47 per share representing and aggregate value of $92.3 million. In July, we repurchased an additional $43.9 million of stock at an average price of per share of $36.15. This brings the amount of repurchases dating back to the time when we announced our share repurchase program to $198.5 million. This is above our combined fourth quarter 2013 and first quarter 2014 earnings.

Additionally, we purchased 1.9 million shares upon the conversion of our convertible preferred stock in July, bringing the amount of cash returned to shareholders since we announced our share repurchase program to $271 million. Our repurchase goals remain unchanged, and as of today we intend to continue to repurchase stock in the third quarter 2014. Thank you for joining us today. We would now be happy to take your questions.

(Operator Instructions). The first question comes from Henry Coffey, from Sterne Agee.

Yes. Good morning everyone. Thank you for taking my question. When we look at the servicing market right now, it sounds like a log jam that there seems to be ample willingness on the servicers to buy troubled assets. Particularly when you listen to comments coming of the likes of JPMorgan. Ample interest in moving past these problems, and so I would describe it as a log jam, but when you look at the output, it looks more like a drought and I was wondering if you could give us a sense of how you see the market?

Henry, this is Bill. I think we're going to be cautious on commenting on how we see the market, or what's coming into the market at the present time. I think there are a variety of different factors that can affect that and I think it's not appropriate for us to comment on that.

And then a second question talking about the securitization buyouts. Could you give us a sense of what the economic cycle looks like given that you will end up owning a bunch of whole loans. Do those go to the likes of Resi, or do they stay with Ocwen, or what would the life cycle look like on that investment?

We think there's an arbitrage by creating those loans in REO and we would auction them off into the market. There's exceptionally strong bids today for both performing, re-performing, and non-performing loans in REO, and it was and attractive transaction even before the runoff of pricing, and now it's become even more attractive. So, our call rights enable us basically to truncate the time until one gets control of that value. And so, once we do that, though, we would look to sell the majority of those assets.

And do you own these call rights now, or is there a required investment?

No. Servicing comes with call rights, generally.

Right.

10% the right when the unpaid principal balance declines the 10%, its embedded in there, basically, to achieve a cost savings. When a security gets very small it becomes less economical to service it, and that's why these were originally built into all of the, the pull-in servicing agreements that are in the business. So, today we own call rights somewhere between $150 billion and $200 billion of call rights.

Thank you, very much.

Thank you.

The next question comes from Bose George, from KBW.

Hi, guys. Good morning. I would like to just follow up on Henry's question. Did you guys give the expected IRR on those kind of investments?

They differ by the way in which you execute it. It depends on whether or not they're longer-term positions that you hold before you execute the call, or whether you are able to do it almost simultaneously. So we would prefer not to, for competitive reasons, not detail the reasons why we would do that, but we certainly expect the business to meet our expected hurdle of 25% return on equity.

Okay, great. And then switching to operating costs. Is there room to take costs down from current levels especially if the portfolio continues to shrink ?

Yes. As we talked there's some offsetting factors as we have been building up our compliance infrastructure and absorbing some of the monitoring costs. That is still going to be a significant cost on a go-forward basis. But as the portfolio, if it does run off, and as the compliance environment stabilizes, I think there's going to be meaningful opportunities to become more efficient. The value of moving towards zero errors is it eliminates a lot of other costs that you end up incurring to address things that don't go through the process perfectly the first time. So, it's going to be an ongoing process, but I'm very excited and optimistic that we're going to have some good opportunities down the road to become even more efficient than we are today.

Alright. Thanks. Actually one last one just on the point you guys made about potentially fair valuing the MSR. I mean if you did that, I guess, amortization would go up. I'm just curious how you weigh that factor. So, what are the factors as you guys weigh as you make that decision?

Yes. I mean that's a process that we go through typically every year starting about this time and we look at various factors including the performance. One of the bigger advantages, or disadvantages depending on how you look at it, is we don't get the full equity credit of having those MSRs at fair value as you look at our capital base. And so that has the industry is talking about increased capital standards and the like is an important determination. But there's a whole host of factors including the accounting elements, the volatility and the quarterly earnings, the split of amortization versus the marks, that we are making sure that we understand and get our heads around as we make that evaluation. But as we do, and have anything to announce, or nothing to announce, we can talk more about that when it's appropriate.

Yes. So we will continue it evaluate that. And normally you would think of, the way we do it, as resulting in less volatility but here we are in a situation where there's a value increase on a portion of portfolio requiring us to basically increase the liability, increase interest expense and not be able to show the corresponding increase in value of the asset. So even though our accounting policy today normally would be considered less volatile, there's a lot of factors coming into play and in this particular quarter it's actually creating volatility.

The next question comes from Mike Grondahl, from Piper.

Yes. Guys. Your approximate $300 million of operating expenses in your lending segment, can you help us think about what percent of those are fixed and what percent are variable? And then, secondly, on that sort of run-rate level, do you have a lot of capacity to put on more volume without adding expenses?

Mike, we don't generally disclose the split of fixed and variable costs within our business first, but also within the lending segment. We have seen a relatively consistent level of volume here over the recent period of time and are evaluating our opportunities to grow the business. I think against obviously increased cost investments and maybe just other things that we can do around enhancing the effectiveness of partnerships we have that could grow our business effectively without adding costs. I guess in short answer I would say there is opportunity probably to grow with adding cost, and also opportunity to grow without.

I would think the same with the servicing business Mike, we're much further along but there's still significant opportunities to improve. Improve quality, and the same time reduce costs. There are even greater opportunities on the Lending side of the business. We're nowhere near the same level we are in the servicing business. So, I think you saw some of the effects of that this quarter, which is more efficient operations.

Okay. And did you guys break out legal costs in the quarter?

No, we didn't. I think you will see more cost detail when we release our Q. I would say the only comments we have made around it are the effective impact of increased regulatory and compliance costs of which a significant component of that is (inaudible) legal-related. But I believe that's the extent of it.

Okay. And then, any update on OASIS and thoughts about another transaction there?

Well, we continue to kind of evaluate all of our alternative around effectively hedging our prime portfolio and recognizing some of the embedded value that is not there today. So, OASIS is a very innovative structure that served us well and we're not going to comment on timing, but it is definitely still part of our longer-term strategy.

I think, too, one of reasons we have been slow is because you can see the impact of carrying excess cash on your balance sheet in terms of excess interest expense, because you're really avoiding very low cost advance financing charges. And also, I think there's been some additional development work we've done in terms of another method for hedging the portfolio that may be more efficient, shall we say, than even an OASIS transaction.

Okay. And then maybe just one last question. Your strategy for the RMBS kind of cleanup calls, if you will, what type of capital does that require?

Again, it relates to the duration of how long you're holding the securities that you purchased in terms of to get the position that you need to put on the balance sheet. We really would prefer not to disclose exactly how much that is at the present time because it gives more information than we would like about our strategy.

Okay. Well, hey we look forward to hearing more about it, guys. Thank you.

(Operator Instructions). The next question comes from Kevin Barker, from Compass Point.

Regarding the investment in cleanup calls related to MBS. Some of the small loans are left over. Do you plan to sell them to potentially (inaudible) source residential, or would it expect to be bids out to several parties?

We would have to bid those out. We just can't assign them to one company. It will create a meaningful amount of product that will about coming to market as a result of that.

Can Resi participate in those auctions, or is that off limits?

That would be something you would have to ask Resi.

Okay. And then, regarding the potential change to fair value on the MSR, can you explain the strategy behind why you would change the fair value versus keep low com, and how that would affect your balance sleet over a longer period of time?

As Michael said, at this point we're just in the evaluation phase. We have in the end of the year, really, to make that determination. As Michael pointed out, I think the biggest impact is our equity base. And as we pointed out on prior calls, is really understated relative to our competitors because we're not reflecting that significant difference in fair value versus our carrying value. But there are a whole host of other things to consider if you do make that adjustment. Basically, as I understand it, it would be an adjustment directly to your equity and you would not see the earnings come through. The income statement we just did a direct increase to equity. So, there's a whole bunch of factors that I think we need to consider, I think we're still very early on in that evaluation phase but, as I pointed out just a few minutes ago, it kind of becomes top of mind when we look at a quarter like this and see volatility driven largely because of the fact that we're not at fair value.

Okay. So, would that allow you to increase leverage, or look better in regards to capital requirements that may come out in the future?

That's one of the things we're considering because we're not sure that lenders and others are able to distinguish between those companies that are on fair value, which is basically almost everybody, and Ocwen who is not. And so we do think that we probably are not getting, in all cases, fair treatment. So that's one of the factors that is going into this consideration.

Okay. Then one more. In the last presentation you mentioned that the internal valuation of the MSR was upwards of $3.7 billion and incrementally could be up as high as $4 billion. Now, in your presentation this quarter you mentioned that the fair value is roughly, I believe, $390 million above low com, and it looks like it was 850 last quarter. What was the change in fair value of the MSR between this quarter and last quarter, and maybe some of the details?

It wasn't a change, Kevin. It's like if we were going to market-to-market on our balance sheet, it's going to have to be marked based upon other people's costs, not ours.

Yes. That's right, Bill. The other difference is there's a range of values typically these brokers give you. There as mid-point value, and then a high-end value. So the mid-point value is what's reflected here, as that's what would ultimately be used for a test of impairment. But, as Bill allude to, there's other factors like costs and things like that that help the Ocwen story as well as the fact there's a range of assumptions in the actual models themselves that could lead to a higher value, closer to the 800 that you have seen in the past. What I would tell you, Kevin, is there really wasn't a material change in the underlying value of our MSRs, in that broader context, from the first to second quarter. It's more of a presentation and mid-point of the range versus the high end, and if you're looking at the broker assumptions versus what Ocwen may represent.

Okay. So the difference between internal and external valuations, is that the way you would put it?

Yes.

Okay. Thank you for taking my questions.

The next question comes from Ken Bruce, from Bank of America.

Thanks. Good afternoon, gentlemen. I've got a number of questions so maybe to get started I would like to understand the cost structure that you're looking at right now. And so, I think if I heard you right, some of the cost savings that were anticipated later in 2014, or likely more in 2015, could you maybe detail how we should be thinking about that. So that's question number one.

One of the, I would say, larger costs that I think has been out there on the horizon was when we actually would flip the switch and exit the legacy ResCap servicing platform, and switch over entirely to the real servicing platform. And so, as we have seen a delay in the actual transition, the timing of that payment is pushing out as well. That is what we are alluding to in the comments that some costs may fall into 2015. And so that's going to depend largely on the timing of when we're complete. I also mentioned that we would give folks a more detailed update around the third quarter earnings call, and I think that's probably more appropriate when we're close to that timing and have more detail there. But that would be the most significant item that we think would fall into next year.

Okay, so the termination fee, which was I think $20 million, is really what you're referring to in that case?

Yes. And that decline is basically on a monthly basis. So that will be lower in the future than it would have been if we had to pay it in July, let's say.

Okay. And so you're really not prepared to talk about what the cost savings will be when you are able to move on to real servicing versus the ResCap? Because those were some significant cost savings if I understood the way that you talked about the operating margins returning back to something that would be discussed as more normal?

I think the best way to look at it is take a look at the normalization that we do on the expense side. That's why we normalize to try to give investors a better sense as to what we think our cost structure will look like once we have completed the integration. So, I don't think we're going to go beyond that, but I think that's the best thing for you to look at.

Okay. And in the quarter there was roughly $12 million of monitoring costs. How sticky are these monitoring costs? Can you give us some better detail as to what they are? I mean that's a run-rate of close to $50 million a year.

Yes. Keep in mind that with our new national mortgage settlement, we now have a second monitor. We previously had just a monitor for the state of New York. Now, we have the national monitor. And so, one of big reasons for the increase in the quarter was related to the fact that we now have a second monitor. That is in there, that wasn't in there before. And those costs will run for the next three years. The New York monitor was a two-year period and we're about a year into it, maybe a little bit more. So, there is some volatility month to month, quarter to quarter, simply because largely you're paying for direct costs and time that professional firms hired by the monitor to do the work, how much time they spend in a quarter can vary from month to month, quarter to quarter. So, as Michael said, our best estimate of the coming quarter would be it would be down some, down to $9 million. But I think he also said in his prepared remarks, at this point it's difficult for us to give you a pinpoint amount for every quarter going out in the future because it varies depending on how much time the professional firms spend in any particular period.

I understand. Is there any way to think about that on and annualized basis in terms of what you think the cost burden on the Company will be?

Not really, and not to kind of make a projection, but I think you can think about the fact that we think $9 million is going to be our best estimate for this coming quarter. So, that might be something that you want to think about on a run-rate. But, again, it can vary so I need to put that caveat there, but I think that might be a good way to think about it.

Okay. And the additional 325 individuals in terms of headcount, are those largely domestic employees, or are those overseas?

Yes. We're not going to get into the exact mix of that, but they are in both domestic and offshore. I would say, generally not quite at the same mix that we have for the broader, say, servicing operation. It's probably more heavily weighted towards onshore, but it is a mix between onshore and offshore. So, again, I think for us, our ability to build out a world-class compliance and risk management structure, we have the opportunity to be world-class and still be more cost efficient than other servicers who are not set up to do some of that work offshore. So I think it just in some ways enhance our advantage long-term over the competition.

And, I think it's been described, the additional increase in costs associated with compliance was viewed as possibly a temporary inflated cost structure. Do you feel that's still the case?

Well, I mean certain things like the monitoring costs, at least as best we know, should be temporary in that the monitors are for set periods of time and then those costs will drop off. I think on the infrastructure that we put in place we'll, of course, always try to look to make it more efficient and to the extent where it can be done in a lower cost labor environment, we will always look at that. What I think is going to be the real benefit down the road is our ability by having a stronger, more robust compliance and risk structure, will be the ability to actually take costs out of the actual servicing and origination businesses because it's going to basically drive us to higher quality, lower error rate, faster identification of things that may not be working, as intended. And long-term will allow us to bring costs down in the actual core operations maybe more so than brining it down in the compliance fixed cost structure that we'll be putting in place.

Yes. And I appreciate that and, obviously, would like to see that sooner than later. I guess really where I'm going with this is if you look at just the cost structure that's been put together around compliance and monitoring, you're really talking about something that is borderline between $0.40 and $0.50 of earning per share. That costs us from a valuation standpoint something close to $5 per share. I think the market is really struggling with understanding what the overall operating costs in this business are going to look like, which has a tremendous impact in terms of the longer-term earnings outlook and the way that the street is going to value the stock. Now, I know you know that, but we need to get some very good understanding as to how these costs are going to play out over the next several years. I guess that's a comment. There no question. Thanks for your time.

Thank you. And we appreciate the feedback and that is something that we are looking at very hard internally as well and at the appropriate time hopefully we can provide more clarity for you all on what that cost is going to look like long-term.

Thank you.

There are no further questions. Ladies and gentlemen, thank you four attending the Ocwen Financial second quarter 2014 Earnings Conference Call. This concludes the conference. You may now disconnect. Have a good day.