Ocwen's Loan Mods Rile RMBS Investors

Ocwen Financial has developed a reputation among mortgage bond investors for ripping off the band aid.

The Atlanta company’s rapid expansion into mortgage servicing by acquiring the rights to portfolios, mostly from banks, has recently generated some backlash, as stock investors and analysts question its ability to integrate the new business.

Mortgage bond investors are just as concerned about Ocwen’s practice of aggressively modifying troubled loans, often by writing down the principal balance, which not only reduces the value of the collateral in these deals, but also interrupts interest payments on the bonds.

In August and September, Ocwen assumed the rights to servicer approximately $30 billion of unpaid balances (UPB) related to Freddie Mac and Fannie Mae loans. Most of the bank’s $42 billion of UPB non-agency portfolio is scheduled for transfer and close on November.

On July 1 and September 1, Ocwen respectively completed the boarding of $3.0 billion and $2.0 billion in UPB representing the non-prime subservicing from a large financial institution.

Ocwen isn’t alone; rivals Nationstar and Walter Investment have also been snapping up mortgage servicing rights from banks eager to exit the business. But Nationstar and Walter haven’t been writing down the principal of troubled loans at the same pace.

“The big game in the market today is trying to figure out which of these loans might get transferred to Ocwen,” said the head of active taxable fixed-income at a major East Coast money manager. This person said that prices on residential mortgage backed securities (RMBS) can drop as much as 10 points when the news is first reported, so a bond already trading at a discount of 80 cents on the dollar could see its price drop as low as 70.

Paul Nikodem, executive director and head of RMBS research at Nomura Securities, said it’s difficult to isolate one factor among the many impacting RMBS prices when servicing rights on the underlying loans change hands. However, news about MSRs moving to Ocwen likely results in investors revising their cash flow assumptions to be more conservative, in anticipation of payments on their bonds taking longer to arrive or never arriving at all if the servicer writes down principal, he said, and that’s bound to exert downward pressure on prices.

Nikodem added that affected securities typically experience cash low disruptions when Ocwen reimburses itself from the payment “waterfall” for fees earns for modifying loans, as well as from the past advances it recoups as the result of modifications. In addition, the significant loan-principal reductions that Ocwen pursues lower payments to RMBS bondholders, at least in the short term, although payments could later improve because borrowers have greater incentive to pay. The impact of the servicing transfer varies depending on where bonds are in the capital structure. “Junior bondholders and current cashflowing senior bondholders are much more negatively affected by lower advances,” he said. 

Although Ocwen and Nationstar have experienced similar growth in MSRs, it is Ocwen that prompts investors to bite their fingernails when they first learn it will service the loans backing their bonds. Modifications of loans increase soon after they’re transferred to both Ocwen and Nationstar and advances of payments to bondholders decrease, but Ocwen has been far more aggressive on both fronts.

According to Nomura, the servicer writes down principal in 80% of its subprime loan modifications, compared with 67% for the overall subprime sector and 55% for Nationstar. A similar deviation from the norm holds true for advances, which mortgage servicers have traditionally provided to facilitate payments to investors when borrowers are delinquent, at least until it becomes clear those advances can no longer be recovered. Nomura said Ocwen’s advance rate is 20% to 30% of delinquent balance in subprime, compared with an average of 35% to 40% for most other servicers.

“On average for previous Ocwen transfers, certain bondholders could see up to six or eight months of cashflow cut offs,” Nikoderm said, adding, “We have not seen anything nearly to this magnitude for Nationstar-transferred deals.”

Ocwen’s strategy is undoubtedly aggressive. However, it claims that its business model serves the interests of investors as well as borrowers. A company spokesperson pointed to an Oct. 4 report by Moody’s Investors Service ranking the servicer among the best the rating agency has analyzed.

“We believe that report reflects our successful efforts to both reduce investor losses through NPV positive resolutions, including those involving principle reductions, and help thousands of families remain in their homes,” the spokesperson said. “In addition, our advance model is strong; we have outstanding advances of over $8.5 billion, which we believe is industry-leading.”