UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 1-13219
Ocwen Financial Corporation
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(Exact name of registrant as specified in its charter)
Florida 65-0039856
--------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1661 Worthington Road, Suite 100, West Palm Beach, Florida 33409
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(Address of principal executive offices) (Zip Code)
(561) 682-8000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act:
Large Accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
Number of shares of Common Stock, $0.01 par value, outstanding as of May 5,
2006: 63,396,645 shares.
OCWEN FINANCIAL CORPORATION
FORM 10-Q
INDEX
================================================================================
PART I - FINANCIAL INFORMATION Page
----
Item 1. Interim Consolidated Financial Statements (Unaudited)................3
Consolidated Balance Sheet at March 31, 2006 and December 31, 2005...3
Consolidated Statements of Operations for the Three Months Ended
March 31, 2006 and 2005..............................................4
Consolidated Statements of Comprehensive Income (Loss) for the
Three Months Ended March 31, 2006 and 2005...........................5
Consolidated Statement of Changes in Stockholders' Equity for
the Three Months Ended March 31, 2006................................6
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2006 and 2005........................................7
Notes to Consolidated Financial Statements...........................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................15
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........31
Item 4. Controls and Procedures.............................................32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...................................................32
Item 1A. Risk Factors........................................................32
Item 6. Exhibits............................................................32
Signature....................................................................34
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS (Unaudited)
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
March 31, December 31,
2006 2005
------------ ------------
Assets
Cash ................................................................ $ 183,813 $ 269,611
Trading securities, at fair value
Investment grade ................................................ 33,215 1,685
Subordinates and residuals ...................................... 45,992 30,277
Loans held for resale, at lower of cost or market value ............. 364,924 624,671
Advances ............................................................ 238,920 219,716
Match funded advances ............................................... 357,828 377,105
Mortgage servicing rights ........................................... 146,993 148,663
Receivables ......................................................... 62,025 68,266
Premises and equipment, net ......................................... 39,947 40,108
Other assets ........................................................ 80,903 74,031
------------ ------------
Total assets .................................................... $ 1,554,560 $ 1,854,133
============ ============
Liabilities and Stockholders' Equity
Liabilities
Match funded liabilities ........................................ $ 322,757 $ 339,292
Servicer liabilities ............................................ 218,088 298,892
Lines of credit and other secured borrowings .................... 405,385 626,448
Debt securities ................................................. 150,329 154,329
Other liabilities ............................................... 89,918 85,912
------------ ------------
Total liabilities ............................................ 1,186,477 1,504,873
------------ ------------
Minority interest in subsidiaries ................................... 1,943 1,853
Commitments and Contingencies (Note 7)
Stockholders' Equity
Common stock, $.01 par value; 200,000,000 shares authorized;
63,358,780 and 63,133,471 shares issued and outstanding at
March 31, 2006 and December 31, 2005, respectively ........... 634 631
Additional paid-in capital ...................................... 186,095 184,262
Retained earnings ............................................... 179,731 163,198
Accumulated other comprehensive loss, net of taxes .............. (320) (684)
------------ ------------
Total stockholders' equity ...................................... 366,140 347,407
------------ ------------
Total liabilities and stockholders' equity ................... $ 1,554,560 $ 1,854,133
============ ============
The accompanying notes are an integral part of these
consolidated financial statements
3
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
For the three months
ended March 31,
-----------------------------
2006 2005
------------ ------------
Revenue
Servicing and subservicing fees .......... $ 80,084 $ 72,380
Process management fees .................. 19,312 16,952
Other revenues ........................... 3,053 2,156
------------ ------------
Total revenue ........................ 102,449 91,488
------------ ------------
Operating expenses
Compensation and benefits ................ 25,701 24,371
Amortization of servicing rights ......... 26,288 25,115
Servicing and origination ................ 13,197 14,033
Technology and communications ............ 6,639 7,399
Professional services .................... 7,779 5,018
Occupancy and equipment .................. 4,976 4,242
Other operating expenses ................. 2,522 4,511
------------ ------------
Total operating expenses ............. 87,102 84,689
------------ ------------
Other income (expense)
Interest income .......................... 18,113 6,332
Interest expense ......................... (17,254) (8,440)
Loss on trading securities ............... (374) (1,398)
Gain (loss) on loans held for resale, net. 2,216 --
Other, net ............................... 3,410 (356)
------------ ------------
Other income (expense), net .......... 6,111 (3,862)
------------ ------------
Income before income taxes ................... 21,458 2,937
Income tax expense ........................... 4,925 550
------------ ------------
Net income ............................... $ 16,533 $ 2,387
============ ============
Earnings per share
Basic ..................................... $ 0.26 $ 0.04
Diluted ................................... $ 0.24 $ 0.04
Weighted average common shares outstanding
Basic ...................................... 63,247,835 62,743,287
Diluted .................................... 72,041,171 64,018,882
The accompanying notes are an integral part of these
consolidated financial statements
4
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
Net income ............................................................................... $ 16,533 $ 2,387
Other comprehensive income, net of taxes:
Change in unrealized foreign currency translation income
arising during the period (net of tax benefit (expense) of $(214) and $(574)) ... 364 977
Less: Reclassification adjustment for foreign currency translation gains
included in net income (net of tax benefit of $396) ............................. -- (675)
------------ ------------
Net change in unrealized foreign currency translation adjustment arising
during the period ................................................................ 364 302
------------ ------------
Comprehensive income ..................................................................... $ 16,897 $ 2,689
============ ============
The accompanying notes are an integral part of these
consolidated financial statements
5
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2006
(Dollars in thousands)
Accumulated
Other
Common Stock Additional Comprehensive
--------------------------- Paid-in Retained Income (Loss),
Shares Amount Capital Earnings Net of Taxes Total
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2005 ......... 63,133,471 $ 631 $ 184,262 $ 163,198 $ (684) $ 347,407
Net income ........................... -- -- -- 16,533 -- 16,533
Issuance of common stock awards to
employees .......................... 46,326 1 403 -- -- 404
Exercise of common stock options ..... 178,983 2 843 -- -- 845
Excess tax benefits from the exercise
of stock options.................... -- -- 331 -- -- 331
Employee compensation -
common stock options ............... -- -- 246 -- -- 246
Director's compensation -
common stock ....................... -- -- 10 -- -- 10
Other comprehensive income (loss),
net of taxes ....................... -- -- -- -- 364 364
------------ ------------ ------------ ------------ ------------ ------------
Balance at March 31, 2006 ............ 63,358,780 $ 634 $ 186,095 $ 179,731 $ (320) $ 366,140
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements
6
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
Cash flows from operating activities
Net income ...................................................................................... $ 16,533 $ 2,387
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities
Net cash provided (used) by trading activities .............................................. (26,211) 12,010
Purchases of loans held for resale .......................................................... (187,793) --
Originations of loans held for resale ....................................................... (203,897) (14,546)
Principal payments received on loans held for resale ........................................ 5,613 --
Proceeds from sales of loans held for resale ................................................ 653,256 16,096
Premium amortization (discount accretion) on securities, net ................................ (2,320) 167
Amortization of servicing rights ............................................................ 26,288 25,115
Depreciation and other amortization ......................................................... 3,477 3,269
Provision for bad debts ..................................................................... 41 2,204
Loss (gain) on trading securities ........................................................... 374 1,398
Gain on loans held for resale, net........................................................... (2,216) --
Loss (gain) on investment in affordable housing properties .................................. -- 642
Excess tax benefits from the exercise of stock options....................................... (331) --
Decrease (increase) in advances and match funded advances ................................... 72 18,514
Decrease (increase) in receivables and other assets, net .................................... 820 (7,621)
Increase (decrease) in servicer liabilities ................................................. (80,804) (34,184)
Increase (decrease) in other liabilities, net ............................................... (257) (6,267)
Other ....................................................................................... 682 (1,131)
------------ ------------
Net cash provided (used) by operating activities ................................................ 203,327 18,053
------------ ------------
Cash flows from investing activities
Principal payments received on match funded loans ........................................... -- 289
Purchase of mortgage servicing rights ....................................................... (21,879) (28,980)
Principal payments received on loans ........................................................ 2 296
Purchases, originations and funded commitments on loans ..................................... -- (146)
Additions to premises and equipment ......................................................... (1,358) (3,457)
Proceeds from the sale of a subsidiary ...................................................... -- 1,905
Net cash from consolidated VIE .............................................................. 247 --
------------ ------------
Net cash provided (used) by investing activities ................................................ (22,988) (30,093)
------------ ------------
Cash flows from financing activities
Increase (decrease) in deposits and escrow deposits ......................................... -- (78,495)
Proceeds from (repayments of) lines of credit and other secured borrowings, net ............. (246,733) 40,477
Proceeds from (repayments of) match funded liabilities, net ................................. (16,535) (21,891)
Issuance (repurchase) of debt securities .................................................... (3,865) --
Excess tax benefits from the exercise of stock options....................................... 331 --
Exercise of common stock options ............................................................ 665 42
------------ ------------
Net cash provided (used) by financing activities ................................................ (266,137) (59,867)
------------ ------------
Net increase (decrease) in cash ................................................................. (85,798) (71,907)
Cash at beginning of period ..................................................................... 269,611 542,891
------------ ------------
Cash at end of period ........................................................................... $ 183,813 $ 470,984
============ ============
The accompanying notes are an integral part of these
consolidated financial statements
7
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
(Dollars in thousands)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Ocwen Financial Corporation ("OCN"), through its subsidiaries, is
engaged in business activities related to residential and commercial servicing,
consumer unsecured debt collections, loan origination services and business
process outsourcing. At March 31, 2006, OCN owned all of the outstanding stock
of its primary subsidiaries, Ocwen Loan Servicing, LLC ("OLS"), Investors
Mortgage Insurance Holding Company and Ocwen Financial Solutions, Private
Limited ("India"). OCN also owns 70% of Global Servicing Solutions, LLC ("GSS")
with the remaining 30% minority interest held by ML IBK Positions, Inc.
("Merrill Lynch"). Effective June 30, 2005, Ocwen Federal Bank FSB (the "Bank"),
a wholly owned subsidiary, voluntarily terminated its status as a federal
savings bank and dissolved, a process we referred to as "debanking".
Basis of presentation
The accompanying unaudited interim consolidated financial statements
have been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In our opinion, the accompanying unaudited financial
statements contain all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation. The results of operations and other
data for the three months ended March 31, 2006 are not necessarily indicative of
the results that may be expected for any other interim period or for the entire
year ending December 31, 2006. The unaudited consolidated financial statements
presented herein should be read in conjunction with the audited consolidated
financial statements and related notes thereto included in our Annual Report on
Form 10-K for the year ended December 31, 2005.
In preparing the consolidated financial statements, we are required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the dates of the balance sheet and revenues and expenses for the
periods covered. Material estimates that are particularly significant in the
near or medium term relate to our valuation of securities, servicing rights,
intangibles and deferred tax assets, as well as to our determination of
valuation allowances for other asset categories. Actual results could differ
from those estimates and assumptions.
Prior to debanking, our consolidated financial statements followed the
presentation requirements of Securities and Exchange Commission ("SEC")
Regulation S-X, Article 9, Bank Holding Companies. As a result of debanking,
effective December 31, 2005, we revised the presentation of our consolidated
financial statements to better align our presentation with the growth and
significance of loan servicing and loan origination and outsourcing services,
our principal businesses. The principal change in our consolidated financial
statements for the periods presented as compared to the presentation in prior
periods are in the format of our consolidated statement of operations. In
adopting the new format for our consolidated statement of operations, we have
made a number of reclassifications of expenses. The most significant of these
reclassifications has been to report as operating expenses amounts that were
netted against the revenues that were previously reported as servicing and
related fees. These expenses are directly related to the generation of revenues
and are reported in our consolidated statement of operations as amortization of
servicing rights and as components of servicing and origination. Servicing and
origination includes expenses of approximately $8,600 for the quarter ended
March 31, 2005 that had previously been netted against revenues reported in
servicing and other fees. Similarly, expenses previously included in loan
expenses on the consolidated statement of operations are also principally
reported as components of servicing and origination expense.
Revenues that are associated with our Residential Origination Services
and Business Processing Outsourcing business segments are reported in a separate
revenue category, process management fees. These revenues were previously
reported as a component of servicing and related fees. Other categories of
income, including interest income and interest expense, which were previously
reported as revenues but which were not related to the operations of our
principal business segments, are reported in other income (expense).
In addition, we created a new liability caption, servicer liabilities,
in our consolidated balance sheet. This caption represents amounts that we have
collected from borrowers that will be remitted to off-balance sheet custodial
accounts, paid directly to investment trusts or refunded to borrowers.
Previously, the amounts included in servicer liabilities had been reported
either as escrow deposits or as reductions of our cash balances.
8
Amounts included in our 2005 consolidated financial statements have
been reclassified to conform to these changes in presentation in our
consolidated statement of operations as well as to conform to certain other,
less significant, reclassifications that have been made in our consolidated
financial statements in 2006.
Principles of Consolidation
We evaluate special purpose entities first for classification as a
"qualifying special purpose entity" ("QSPE") as specified by Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140"). Where
we determine that a special purpose entity is classified as a QSPE, it is
excluded from our consolidated financial statements. Where we determine that a
special purpose entity is not classified as a QSPE, it is further evaluated for
classification as a variable interest entity ("VIE") as specified by Financial
Accounting Standard Board ("FASB") Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised. When a special purpose entity meets the
definition of a VIE, and OCN is identified as the primary beneficiary of the
entity, it is included in our consolidated financial statements.
Our consolidated balance sheets at March 31, 2006 and December 31, 2005
include the assets and liabilities of VIEs. We have determined that we hold a
variable interest in these VIEs and have also determined that we are the primary
beneficiary. The VIEs are engaged in the origination, acquisition and subsequent
securitization or sale of subprime single family residential loans. As a result
of consolidation, total assets include $126,642 of loans held for sale that are
pledged to secure collateralized borrowings of $123,243. OCN is a party to two
agreements whereby it has guaranteed repayment of certain obligations of the
VIEs up to 100% under one agreement and up to a maximum of 5% under the second
agreement. Other than with respect to these guaranties, the creditors of the
VIEs have no recourse against OCN.
All material intercompany accounts and transactions have been
eliminated in consolidation. We report minority interests in our majority-owned
subsidiaries as a separate item on our consolidated balance sheets. Minority
interest in our earnings is included in other income (expense), net, on our
consolidated statements of operations.
NOTE 2 CURRENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 123(R), "Share-Based Payment" and Staff Accounting Bulletin
No. 107 (SAB 107),"Share-Based Payment". SFAS No. 123(R) requires a public
entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award.
That cost is recognized over the period during which an employee is required to
provide service in exchange for the award - the requisite service period. The
determination of compensation expense under SFAS 123(R) also includes the
estimation of expected forfeitures, which we previously recognized as incurred.
Prior to January 1, 2006, we followed the guidance of Accounting Principles
Board ("APB") Opinion No. 25, which provided for accounting for share-based
compensation using the intrinsic value method and recognizing compensation costs
for such stock options to the extent that the exercise price was less than the
price of the stock at the grant date.
Effective January 1, 2006, we adopted the provisions of SFAS No.
123(R), using the modified prospective method. Accordingly, results for prior
periods have not been restated. Compensation and benefits expense for the three
months ended March 31, 2006 includes $246 ($160 after tax) related to stock
options. As a result of adopting FAS 123(R), incremental compensation expense
related to stock options for the three months ended March 31, 2006 was $98 ($64
after tax).
There were no new grants during the three months ended March 31, 2006,
however, 178,983 stock options were exercised and 13,911 were forfeited during
that period. At March 31, 2006, a total of 4,037,581 stock options were
outstanding, of which 3,190,600 were exercisable. Cash received from the
exercise of stock options during the three months ended March 31, 2006 was $665.
Financing cash inflows include $331 of tax benefits arising from related tax
deductions that reduce the amount of income taxes that would otherwise be
payable. The total intrinsic value of stock options exercised, which is defined
as the amount by which the market value of the stock on the date of exercise
exceeds the exercise price, was $1,124 for the three months ended March 31,
2006. As of March 31, 2006, unrecognized compensation costs related to
non-vested stock options amounted to $2,522, which will be recognized over a
weighted-average remaining requisite service period of approximately 2.9 years.
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments." In
February 2006, the FASB issued SFAS No. 155 as an amendment to SFAS No. 133 and
SFAS No. 140. SFAS No. 155 allows financial instruments that have embedded
derivatives to be accounted for as a whole (eliminating the need to bifurcate
the derivative from its host) if the holder elects to account for the whole
instrument on a fair value basis. The standard also: a) Clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of Statement 133; b) Establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation; c) Clarifies that concentrations
of credit risk in the form of subordination are not embedded derivatives; and d)
Amends Statement 140 to eliminate the prohibition on a qualifying
special-purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. SFAS No. 155 is effective for all financial instruments acquired or
issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006.
SFAS No. 156, "Accounting for Servicing of Financial Assets-an
amendment of FASB Statement No. 140." FASB issued SFAS No. 156 in March 2006 as
an amendment to SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", with respect to the
accounting for separately recognized servicing assets and liabilities.
Recognition of a servicing asset or liability would be required each time an
entity commits to service a financial asset through a servicing contract that:
a) represents a transfer of the servicer's financial assets that meets the
requirements for sale accounting, b) represents a transfer of the servicer's
financial assets to a qualifying special-purpose entity in a guaranteed mortgage
9
securitization in which the transferor retains all of the resulting securities
and classifies them as either available-for-sale securities or trading
securities in accordance with SFAS 115. "Accounting for Certain Investments in
Debt and Equity Securities", or c) represents an acquisition or assumption of an
obligation to service a financial asset that does not relate to financial assets
of the servicer or its consolidated affiliates.
SFAS 156 also requires all separately recognized servicing assets and
liabilities to be initially measured at fair value, if practicable, and allows
an entity to chose from two subsequent measurement methods for each class of
separately recognized servicing assets and liabilities. The two methods are: a)
the amortization method which amortizes servicing assets or liabilities in
proportion to and over the period of estimated net servicing income or net
servicing loss and assesses servicing assets or liabilities for impairment or
increased obligation based on fair value at each reporting date, and b) the fair
value measurement method which measures servicing assets or liabilities at fair
value each reporting date and reports changes in fair value in earnings in the
period in which the changes occur.
A prospective application of SFAS 156 is required as of the beginning
of an entity's first fiscal year that begins after September 15, 2006. As of
March 31, 2006, the estimated fair value of our mortgage servicing rights was
$197,731 as compared to a carrying value of $146,993.
NOTE 3 BASIC AND DILUTED EARNINGS PER SHARE
We are required to present both basic and diluted earnings per share
("EPS") on the face of our statement of operations. Basic EPS excludes common
stock equivalents and is calculated by dividing net income by the weighted
average number of common shares outstanding during the year. We calculate
diluted EPS by dividing net income, as adjusted to add back interest expense on
the 3.25% Contingent Convertible Senior Unsecured Notes due 2024 ("Convertible
Notes"), by the weighted average number of common shares outstanding including
the potential dilutive common shares related to outstanding stock options,
restricted stock awards and the Convertible Notes.
The following is a reconciliation of the calculation of basic EPS to
diluted EPS for the three months ended March 31:
2006 2005
------------ ------------
Basic EPS:
----------
Net income ...................................................... $ 16,533 $ 2,387
============ ============
Weighted average shares of common stock ......................... 63,247,835 62,743,287
============ ============
Basic EPS ....................................................... $ 0.26 $ 0.04
============ ============
Diluted EPS:
------------
Net income ...................................................... $ 16,533 $ 2,387
Interest expense on Convertible Notes, net of income tax (1) .... 792 --
------------ ------------
Adjusted net income ............................................. $ 17,325 $ 2,387
============ ============
Weighted average shares of common stock ......................... 63,247,835 62,743,287
Effect of dilutive elements:
Convertible Notes (1) ......................................... 7,962,205 --
Stock options (2) ............................................. 775,358 915,196
Common stock awards ........................................... 55,773 360,399
------------ ------------
Dilutive weighted average of common stock ....................... 72,041,171 64,018,882
============ ============
Diluted EPS ..................................................... $ 0.24 $ 0.04
============ ============
(1) The effect of our Convertible Notes on diluted EPS is computed using the
if-converted method. Interest expense and related amortization costs
applicable to the Convertible Notes, net of income tax, is added back to
net income. Conversion of the Convertible Notes into shares of common
stock has not been assumed for purposes of computing diluted EPS for the
first quarter of 2005 because the effect would be anti-dilutive. The
effect is anti-dilutive whenever interest expense on the Convertible
Notes, net of income tax, per common share obtainable on conversion
exceeds basic EPS.
(2) Excludes an average of 1,085,903 and 1,632,039 of options that were
anti-dilutive for the first quarter of 2006 and 2005, respectively,
because their exercise price was greater than the average market price of
our stock.
At OCN's Annual Meeting on May 5, 2006, the shareholders approved a
proposal to amend OCN's Articles of Incorporation to effect a 1-for-10 reverse
stock split, followed immediately by a 10-for-1 forward stock split (the
"Reverse/Forward Split"). We currently expect to complete the Reverse/Forward
Split on May 12, 2006 (the "Effective Date").
As a result of the Reverse/Forward Split, accounts with less than ten
shares of common stock will be converted on the Effective Date into the right to
receive a cash payment for each share held equal in value to the average
official closing price of the common stock on The New York Stock Exchange over
the ten trading days immediately preceding the Effective Date. All shareholder
accounts holding ten shares or more will be unaffected, and the total number of
shares held by such accounts will not change.
The Reverse/Forward Split is intended to reduce our administrative cost
associated with the maintenance of nominal shareholder accounts while at the
same time providing shareholders holding fewer than ten shares with a
cost-effective way to liquidate their investment without incurring fees.
While we cannot currently determine the effect that the Reverse/Forward
Split will have on EPS, we do not anticipate that the effect will be material.
10
NOTE 4 FOREIGN CURRENCY EXCHANGE RATE RISK MANAGEMENT
Foreign Currency Exchange Rate Risk Management
Our derivative contracts are exchange-traded; therefore, holders of
these instruments look to the exchange for performance under these contracts and
not to the holders of the offsetting futures contracts. Using exchange-traded
instruments minimizes our exposure to risk from nonperformance under these
contracts. The notional amount of our contracts does not represent our exposure
to credit loss.
We entered into foreign currency derivatives to hedge our net
investment in a foreign subsidiary that owns residual securities backed by
subprime residential loans originated in the United Kingdom ("UK"). Our
remaining principal exposure to foreign currency exchange rates exists primarily
with the British Pound versus the U.S. Dollar. Our policy is to periodically
adjust the amount of foreign currency derivative contracts we have entered into
in response to changes in our recorded investment as well as to changes in our
assets denominated in a foreign currency. Our net exposure is subject to gain or
loss if the foreign currency exchange rate fluctuates. Currency futures are
commitments to either purchase or sell foreign currency at a future date for a
specified price. We have determined that the local currency of our investment in
UK residuals is the functional currency. The foreign currency derivative
financial instrument related to our foreign subsidiary that owns the residual
securities was designated as a hedge. Accordingly, for this instrument we
include the gains or losses in the net unrealized foreign currency translation
in accumulated other comprehensive income in stockholders' equity.
The following table sets forth the terms and values of the British
Pound foreign currency futures at the dates indicated:
Position Maturity Notional Amount Strike Rate Fair Value
-------- -------- --------------- ----------- ----------
March 31, 2006:
---------------
British Pound currency futures (1) ...... Short June 2006 (pound) 13,438 $ 1.7387 $ 10
==========
December 31, 2005:
------------------
British Pound currency futures (1) ...... Short March 2006 (pound) 13,438 $ 1.7692 $ 726
==========
(1) The U.S. Dollar equivalent notional amount of the British Pound currency
futures was $23,343 and $23,148 at March 31, 2006 and December 31, 2005,
respectively.
Beginning in the second quarter of 2005, Bankhaus Oswald Kruber GmbH &
Co. KG ("BOK"), entered into Euro foreign exchange forward ("FX Forward")
contracts in order to hedge its investment in U.S. dollar-denominated servicing
advances that it acquired from OLS. The remaining advances were repurchased by
OLS in the second quarter of 2006. The following table sets forth the terms and
value of the foreign exchange forward contracts as at the dates indicated:
Notional Amount
---------------------------- Contract
Maturity Sell Buy Rate Fair Value
---------------------------- ---------- ------------ ---------------- -----------
March 31, 2006:
---------------
April to August 2006 $ 7,464 (euro) 6,111 1.1854 to 1.2590 $ (36)
December 31, 2005:
------------------
April to August 2006 $ 7,464 (euro) 6,111 1.1854 to 1.2590 $ (189)
The fair value of our FX Forward contracts represents the estimated
amount that we would receive or pay to terminate these agreements taking into
account current interest rates. Since the FX Forward contracts were not
designated as hedges, changes in the fair value of the contracts and gains and
losses from these instruments are included in earnings in the period in which
they occur, and we report them as a component of other income (expense), net.
The net realized and unrealized gains (losses) included in earnings to record
these contracts at fair value were $153 during the first quarter of 2006.
Interest Rate Risk Management
In connection with our Residential Origination Services business, we
acquire certain mortgage loan portfolios with the intention of securitizing them
within a short period of time. Since the value of the mortgage loans are subject
to interest rate risk prior to being securitized, we have sold short a series of
three-month Eurodollar interest rate futures contracts to hedge the exposure to
interest rate risk represented by our loans held for resale. Our policy is to
adjust the amount of Eurodollar futures contracts that we sell short to
accommodate changes in the amount of our mortgage loans held for resale. Since
the Eurodollar interest rate futures contracts were not designated as hedges,
changes in the fair value of the contracts and gains and losses from these
instruments are included in earnings in the period in which they occur, and we
report them as a component of other income (expense), net.
11
The following table sets forth the terms and values of our Eurodollar
interest rate futures contracts as at the dates indicated:
Position Maturity Notional Amount Contract Price Fair Value
--------------------- ---------------------------- --------------- -------------- ----------
March 31, 2006:
---------------
Short June 2006 to December 2010 $ 2,206,000 94.75 to 95.40 $ 1,529
December 31, 2005:
------------------
Short March 2006 to September 2010 $ 3,261,000 94.92 to 95.46 $ 731
The fair value of our Eurodollar interest rate futures contracts
represents the estimated amount that we would receive or pay to terminate these
agreements taking into account current interest rates. The net realized and
unrealized gains (losses) included in earnings to record these contracts at fair
value were $1,647 during the first quarter of 2006. The following table
summarizes our use of interest rate risk management instruments:
Notional Amount
Short Euro Dollar
Interest Rate Futures
---------------------
Balance at December 31, 2005..................... $ 3,261,000
Sales....................................... 1,229,000
Maturities.................................. (340,000)
Terminations................................ (1,944,000)
-----------------
Balance at March 31, 2006 ....................... $ 2,206,000
=================
NOTE 5 REGULATORY MATTERS
Effective June 30, 2005, the Bank terminated its status as a federal
savings bank. Prior to returning its original thrift charter to the Office of
Thrift Supervision ("OTS"), the Bank operated as a federal savings bank, and OCN
was a registered savings and loan holding company. Our primary regulatory
authority was the OTS.
Pursuant to the conditions set forth in the OTS Approval, OCN entered
into an agreement (the "Guaranty") in favor of the OTS and any holders of claims
with respect to liabilities assumed by OLS from the Bank (the "Assumed
Liabilities"). Assumed Liabilities include all legal actions against the Bank.
The Guaranty contains affirmative covenants relating to the maintenance of a
$5,000 cash collateral account, reporting requirements, transactions with
affiliates, preservation of the existence of our subsidiaries and maintenance of
not less than $35,000 of unencumbered financial assets. Pursuant to the
Guaranty, we have also agreed to certain limits on the incurrence of debt,
merger or sale transactions, disposition of assets and payment of dividends. As
of March 31, 2006, we were in compliance with all of the covenants specified in
the Guaranty.
The Guaranty will remain in effect until the later of (a) the sixth
anniversary of the date on which the Bank's federal bank charter was cancelled
or (b) the date on which we have paid in full (i) any obligations that arise out
of the Assumed Liabilities with respect to which a claim has been asserted on or
prior to the sixth anniversary of the date on which the Bank's federal bank
charter was cancelled and (ii) all other amounts payable by us under the
Guaranty.
Effective June 30, 2005, the Supervisory Agreement that the Bank and
OTS had entered into on April 19, 2004 terminated because we were no longer a
FDIC - insured institution. The OTS retains, for a period of six years after
termination of the Supervisory Agreement, the right to bring enforcement actions
in respect of any breach or noncompliance by the Bank with the Supervisory
Agreement, or other applicable regulations, that may have occurred prior to
debanking.
We have continued the Bank's residential mortgage servicing business
under OLS, which is a licensed servicer in all fifty states, the District of
Columbia and Puerto Rico. As a result of debanking, we are no longer able to
accept deposits in the U.S or benefit from federal preemption with regard to
post-debanking activities. OLS is subject to the rules and regulations of
various Federal agencies, Fannie Mae, Freddie Mac, Ginnie Mae and state
regulatory authorities
BOK is licensed as a credit institution (Kreditinstitut) under the laws
of the Federal Republic of Germany and is supervised and regulated in Germany by
the German Federal Financial Supervisory Authority (Bundesanstalt fur
Finanzdienstleistungsaufsicht, or BaFin), the German Central Bank (Deutsche
Bundesbank) and, in respect of minimum reserves on deposits, the European
Central Bank. BOK, under its license, may engage not only in a number of
traditional banking activities such as deposit and lending business, but also in
investment banking, underwriting and securities trading transactions, both for
its own account and for customers. BOK is currently not material to our
operations.
12
NOTE 6 BUSINESS SEGMENT REPORTING
A brief description of our business segments, aligned within our two
areas of focus, is as follows:
Servicing
---------
o Residential Servicing. Through this business we provide loan servicing
including asset management and resolution services to third party
owners of subprime residential mortgage and high loan-to-value loans
for a fee. We acquire the rights to service loans by purchasing them
or by entering into subservicing contracts. This segment also includes
our residential loan servicing system product (REALServicing).
o Commercial Servicing. This segment includes the results of both our
domestic and international servicing of commercial assets (loans and
real estate), as well as our commercial loan servicing product
(REALSynergy). International servicing is conducted through GSS.
o Ocwen Recovery Group. This business primarily conducts collection
activities for third party owners of unsecured receivables and for a
portfolio of unsecured credit card receivables that we acquired in
1999 and 2000.
Loan Processing and Origination Services
----------------------------------------
o Residential Origination Services. This business provides various loan
origination services, including residential property valuation
services, mortgage due diligence, title services and loan refinancing
for Residential Servicing customers. This segment also includes our
internet-based vendor management system product (REALTrans) and our
subprime residual trading securities.
o Business Process Outsourcing. This business segment began operations
in December 2002. Business Process Outsourcing provides outsourcing
services to third parties including mortgage underwriting, data entry,
call center services and mortgage research.
Corporate Items and Other. This segment includes items of revenue and
expense that are not directly related to a business, including business
activities that are individually insignificant, interest income on short-term
investments of cash and the related costs of financing these investments and
certain other corporate expenses.
We allocate interest income and expense to each business segment for
the investment of funds raised or funding of investments made. We also make
allocations of non-interest expense generated by corporate support services to
each business segment.
Financial information for our segments is as follows for the dates indicated:
Total Assets
---------------------------
March 31, December 31,
2006 2005
------------ ------------
Residential Servicing ............................ $ 784,218 $ 783,560
Commercial Servicing ............................. 7,360 6,433
Ocwen Recovery Group ............................. 1,541 1,002
Residential Origination Services ................. 431,779 679,432
Business Process Outsourcing ..................... 1,114 1,193
------------ ------------
1,226,012 1,471,620
Corporate Items and Other (1) .................... 328,548 382,513
------------ ------------
$ 1,554,560 $ 1,854,133
============ ============
(1) Includes cash of $178,901 and $264,373 at March 31, 2006 and December 31,
2005, respectively.
13
Operating Other Income Pre-Tax
Revenue Expenses (Expense) Income (Loss)
------------ ------------ ------------ ------------
For the Three Months Ended March 31, 2006
----------------------------------------------
Residential Servicing .................... $ 79,941 $ 55,630 $ (6,443) $ 17,868
Commercial Servicing ..................... 3,115 2,849 (1) 265
Ocwen Recovery Group ..................... 2,201 2,633 82 (350)
Residential Origination Services ......... 14,574 20,548 10,997 5,023
Business Process Outsourcing ............. 2,723 2,725 (10) (12)
------------ ------------ ------------ ------------
102,554 84,385 4,625 22,794
Corporate Items and Other ................ (105) 2,717 1,486 (1,336)
------------ ------------ ------------ ------------
$ 102,449 $ 87,102 $ 6,111 $ 21,458
============ ============ ============ ============
For the Three Months Ended March 31, 2005
----------------------------------------------
Residential Servicing .................... $ 68,446 $ 61,396 $ (4,103) $ 2,947
Commercial Servicing ..................... 4,441 4,373 (46) 22
Ocwen Recovery Group ..................... 3,812 3,398 89 503
Residential Origination Services ......... 12,267 11,081 1,648 2,834
Business Process Outsourcing ............. 2,586 2,455 (33) 98
------------ ------------ ------------ ------------
91,552 82,703 (2,445) 6,404
Corporate Items and Other ................ (64) 1,986 (1,417) (3,467)
------------ ------------ ------------ ------------
$ 91,488 $ 84,689 $ (3,862) $ 2,937
============ ============ ============ ============
NOTE 7 COMMITMENTS AND CONTINGENCIES
At March 31, 2006, we had commitments of $44,381 to fund loans secured
by mortgages on single family residential properties. We also have commitments
to sell $17,195 of loans held for resale generally within 30 days of funding.
Through our investment in subordinated residual securities, which had a
fair value of $45,992 at March 31, 2006, we support senior classes of
securities. Principal from the underlying mortgage loans generally is allocated
first to the senior classes, with the most senior class having a priority right
to the cash flow from the mortgage loans until its payment requirements are
satisfied. To the extent that there are defaults and unrecoverable losses on the
underlying mortgage loans, resulting in reduced cash flows, the most subordinate
security will be the first to bear this loss. Because subordinate and residual
interests generally have no credit support, to the extent there are realized
losses on the mortgage loans comprising the mortgage collateral for such debt
securities, we may not recover our remaining investment.
Under the terms of the sales agreements entered into in connection with
the sale of certain of our affordable housing properties, we have a commitment
to fund cash deficits that may arise from the operations of those properties.
The remaining term of these commitments ranges from two to five years. The
obligation under these commitments was $4,373 as of March 31, 2006. Any
operating deficits we fund are supported by a promissory note to be repaid to us
from future cash flows of the property. In addition, we have provided to the
purchasers of certain affordable housing properties guaranties against the
possible recapture of future tax credits. We have never experienced a recapture
of tax credits on any of the affordable housing properties in which we invested
or sold. We have not recognized these guaranties as a liability because the
probability of recapture is considered remote.
Under the terms of the Assignment and Assumption agreement, OLS has
become the successor to the Bank with respect to all legal actions. Therefore,
any references to the Bank in connection with the following legal matters
pertain to OLS as successor.
On April 13, 2004, the United States Judicial Panel on Multi-District
Litigation granted our petition to transfer and consolidate a number of lawsuits
against the Bank, OCN and various third parties arising out of the servicing of
plaintiffs' mortgage loans into a single case to proceed in the United States
District Court for the Northern District of Illinois under caption styled: In re
Ocwen Federal Bank FSB Mortgage Servicing Litigation, MDL Docket No. 1604 (the
"MDL Proceeding"). The consolidated lawsuits in which we are defendants involve
60 mortgage loans currently or previously serviced. Additional similar lawsuits
have been brought in other courts, some of which may be transferred to and
consolidated in the MDL Proceeding. The borrowers in these lawsuits seek class
action certification. No class has been certified in the MDL Proceeding or any
related lawsuits. On August 23, 2004, plaintiffs filed a Consolidated Complaint
containing various claims under federal statutes, including the Real Estate
Settlement Procedures Act and Fair Debt Collection Practices Act, state
deceptive trade practices statutes and common law. The claims are generally
based on allegations of improper loan servicing practices, including (i)
charging borrowers allegedly improper or unnecessary fees such as breach letter
fees, hazard insurance premiums, foreclosure-related fees, late fees and
property inspection fees; (ii) untimely posting and misapplication of borrower
payments; and (iii) improperly treating borrowers as in default on their loans.
While the Consolidated Complaint does not set forth any specific amounts of
claimed damages, plaintiffs are not precluded from requesting leave from the
court to amend the Consolidated Complaint or otherwise seeking damages should
the matter proceed to trial. On April 25, 2005, the court entered an Opinion and
14
Order granting us partial summary judgment finding that, as a matter of law, the
mortgage loan contracts signed by plaintiffs authorize the imposition of breach
letter fees and other legitimate default or foreclosure related expenses. The
court explained that its ruling was in favor of defendants to the specific and
limited extent that plaintiffs' claims challenge the propriety of the
above-mentioned fees. On March 22, 2006, the court denied defendants' motions to
dismiss various portions of the Consolidated Complaint on federal preemption and
procedural grounds, as well as our motion to dismiss OCN from the case for lack
of personal jurisdiction. The court has not ruled on class certification. We
cannot currently determine the ultimate outcome of the MDL Proceeding or the
other matters described above and have not established a reserve in respect
thereof. We believe the allegations in the MDL Proceeding are without merit and
will continue to vigorously defend against them.
On November 3, 2004, the trial judge in litigation brought by Cartel
Asset Management, Inc. ("Cartel") against OCN, the Bank and Ocwen Technology
Xchange, Inc. ("OTX"), a subsidiary that has been dissolved, in federal court in
Denver, Colorado entered final judgment in the amount of $520 against OTX and
nominal damages of two dollars against the Bank. In the November 3, 2004 order,
the judge reduced a prior jury verdict in the amount of $9,320 after trial on
this matter involving allegations of misappropriation of trade secrets and
contract-related claims brought by a former vendor. The litigation does not
relate to our Residential Servicing business. Notwithstanding the nominal damage
award against the Bank, it was assessed a statutory award to Cartel of
attorneys' fees in an additional amount of $170, and the Bank and OTX were
further assessed costs in the amount of $9. Cartel and defendants are pursuing
cross-appeals in the United States Court of Appeals for the Tenth Circuit. We
intend to continue to vigorously defend this matter.
On February 8, 2005, a jury in Circuit Court for Palm Beach County,
Florida returned verdicts of $1,000 and $1,056 in compensatory damages in favor
of two former employees of the Bank in a lawsuit against OCN and the Bank. The
jury rejected plaintiffs' request for punitive damages. The plaintiffs brought
claims under the Florida Civil Rights Act, the Florida Whistleblower Act and
state tort law, arising out of an alleged invasion of privacy and related
incidents allegedly committed by other former employees of the Bank in 1998 for
which plaintiffs sought to hold the Ocwen defendants vicariously liable. We
believe the verdicts, which were reduced to final judgments on May 20, 2005, as
well as an additional award of $900 in plaintiffs' attorneys' fees, are against
the weight of evidence and contrary to law. Our appeals therefrom have been
taken to the Florida Court of Appeals for the Fourth District. We intend to
continue to vigorously defend this matter.
On November 29, 2005, a jury in County Court for Galveston County,
Texas, returned a verdict of $11,500 in compensatory and punitive damages and
attorneys' fees against Ocwen in favor of a plaintiff borrower who defaulted on
a mortgage loan we serviced. The plaintiff claimed that Ocwen's foreclosure on
the loan violated the Texas Deceptive Trade Practices Act and other state
statutes and common law. On February 9, 2006, the trial court reduced the jury
verdict and entered judgment in the amount of $1,830 which was comprised of $5
in actual damages, approximately $675 in emotional distress, statutory and other
damages and interest, and $1,150 for attorneys' fees. We believe the judgment
was against the weight of evidence and contrary to law and have asked the trial
court to set it aside. We intend to continue to vigorously defend this matter
and have taken an appeal to the Texas Court of Appeals.
OCN is subject to various other pending legal proceedings. In our
opinion, the resolution of these proceedings will not have a material effect on
our financial condition, results of operations or cash flows. We continuously
monitor the status of our litigation, including advice from external legal
counsel, and perform periodic assessments of our litigation for potential loss
accrual and disclosure. We accrue for judgments and maintain litigation reserves
when it is probable that a liability has been incurred and the amount of loss
can be reasonably estimated.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Dollars in thousand, except share data)
The following discussion of our results of operations, consolidated
financial condition and capital resources and liquidity should be read in
conjunction with our Selected Consolidated Financial Information, Consolidated
Financial Statements and the related notes, all included elsewhere herein.
RISK FACTORS AND CRITICAL ACCOUNTING POLICIES
Risk Factors
We include a discussion of the principal risks and uncertainties that
affect or could affect our business operations under Item 1A on pages 8 through
12 of our Annual Report on Form 10-K for the year ended December 31, 2005. There
have been no material changes to this information during the first quarter of
2006.
15
Critical Accounting Policies
Our ability to measure and report our operating results and financial
position is heavily influenced by the need to estimate the impact or outcome of
risks in the marketplace or other future events. Our critical accounting
policies are those that relate to the estimation and measurement of these risks.
Because they inherently involve significant judgments and uncertainties, an
understanding of these policies is fundamental to understanding Management's
Discussion and Analysis of Results of Operations and Financial Condition. Our
significant accounting policies are discussed in detail on pages 17 through 19
of Management's Discussion and Analysis of Results of Operations and Financial
Condition and in Note 1 of our Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended December 31, 2005. There have been
no material changes to this information during the first quarter of 2006.
Forward Looking Statements
This Quarterly Report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including, but not
limited to the following:
o projections for growth of the residential loan servicing business and
business opportunities in other core businesses;
o assumptions related to the sources of liquidity and the adequacy of
financial resources;
o estimates regarding interest rates and foreign currency transactions; and
o expectations related to pending litigation.
Forward-looking statements are not guarantees of future performance,
and involve a number of assumptions, risks and uncertainties that could cause
actual results to differ materially. Important factors that could cause actual
results to differ materially from those suggested by the forward-looking
statements include, but are not limited to, the following:
o general economic and market conditions,
o prevailing interest or currency exchange rates,
o availability of servicing rights for purchase,
o governmental regulations and policies,
o international political and economic uncertainty,
o availability of adequate and timely sources of liquidity,
o uncertainty related to dispute resolution and litigation, and
o real estate market conditions and trends.
Further information on the risks specific to our business are detailed
within this report and our other reports and filings with the Securities and
Exchange Commission, including our periodic report on Form 10-K for the year
ended December 31, 2005 and our Forms 8-K filed during 2006. The forward-looking
statements speak only as of the date they are made and should not be relied
upon. OCN undertakes no obligation to update or revise the forward-looking
statements.
OVERVIEW
Changes in Financial Condition
Total assets declined to $1,554,560 during the first three months of
2006, as compared to $1,854,133 as of December 31, 2005. This $299,573 decrease
is primarily due to a $259,747 decrease in loans held for resale. The net
decline in loans held for resale is largely due to a securitization transaction
that closed in the first quarter, offset in part by the acquisition of
additional loans in the first quarter. Also, cash and investment grade
securities declined by $54,268. Partially offsetting these declines was a
$15,715 increase in subordinate and residual securities that primarily resulted
from securities we retained in connection with the first quarter loan
securitization transaction.
Total liabilities decreased to $1,186,477 at March 31, 2006 as compared
to $1,504,873 at December 31, 2005. This $318,396 decrease is largely the result
of a $221,063 decline in amounts due under lines of credit and other secured
borrowings, primarily reflecting reduced funding requirements on a lower balance
of loans held for resale. Also, servicer liabilities, which primarily represent
borrower payments held by us prior to their transfer to custodial accounts,
declined by $80,804 during the first three months of 2006.
At March 31, 2006, we had $183,813 of cash, $486,445 of unused
borrowing capacity on our existing lines and $366,140 of equity.
16
Results of Operations
We recorded net income of $16,533 for the first quarter of 2006 as
compared to $2,387 for the first quarter of 2005. Our basic earnings per share
were $0.26 and $0.04 for the first quarter of 2006 and 2005, respectively.
Pre-tax income was $21,458 and $2,937 for the first quarter of 2006 and 2005,
respectively.
Our first quarter 2006 results reflect a strong performance in our
Residential Servicing segment whose pre-tax income of $17,868 represents a
$14,921, or 506% increase as compared to the first quarter of 2005. This
increase primarily reflects increased servicing fees on a larger servicing
portfolio, the positive impact of rising short-term interest rates on our
revenue from custodial accounts ("float earnings") and a reduction in total
operating expenses, including a reduction in interest paid to investors related
to loan pay-offs. Pre-tax income for Residential Origination Services improved
to $5,023 in the first quarter of 2006, a $2,189 or 77% improvement over the
first quarter of 2005. This improvement primarily reflects a gain from the
securitization of loans and an increase in net interest earnings on loans as a
result of higher volumes, partially offset by losses of a VIE that we began to
consolidate as of the end of 2005. Ocwen Recovery Group incurred a pre-tax loss
of $(350) as compared to pre-tax income of $503 during the first quarter in
2005, primarily reflecting a continuing shift in revenue from maturing
proprietary assets to lower yielding third-party contracts.
We provide additional financial information and discuss our segment
results in the following section.
SEGMENTS
The following section provides a discussion of the changes in financial
condition of our business segments during the three months ended March 31, 2006
and a discussion of pre-tax results of operations of our business segments for
the three-month periods ended March 31, 2006 and 2005.
The following table presents the assets and liabilities of each of our
business segments at March 31, 2006:
Ocwen Residential Business Corporate Business
Residential Commercial Recovery Origination Process Items and Segments
Servicing Servicing Group Services Outsourcing Other Consolidated
------------ ------------ ------------ ------------ ------------ ------------ ------------
Assets
Cash ....................... $ -- $ 4,248 $ -- $ 664 $ -- $ 178,901 $ 183,813
Trading securities:
Investment grade ......... -- -- -- -- -- 33,215 33,215
Subordinates and residuals -- -- -- 45,111 -- 881 45,992
Loans held for resale ...... -- -- -- 364,924 -- -- 364,924
Advances ................... 234,618 267 -- 3,018 -- 1,017 238,920
Match funded advances ...... 357,828 -- -- -- -- -- 357,828
Mortgage servicing rights .. 146,993 -- -- -- -- -- 146,993
Receivables ................ 19,014 2,450 819 13,525 1,107 25,110 62,025
Premises and equipment ..... 1,807 237 685 757 7 36,454 39,947
Other assets ............... 23,958 158 37 3,780 -- 52,970 80,903
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total assets ............. $ 784,218 $ 7,360 $ 1,541 $ 431,779 $ 1,114 $ 328,548 $ 1,554,560
============ ============ ============ ============ ============ ============ ============
Liabilities
Match funded liabilities ... $ 322,757 $ -- $ -- $ -- $ -- $ -- $ 322,757
Servicer liabilities ....... 218,088 -- -- -- -- -- 218,088
Lines of credit and other
secured borrowings ...... 104,954 -- -- 285,844 -- 14,587 405,385
Debt securities ............ -- -- -- -- -- 150,329 150,329
Other liabilities .......... 33,032 3,540 3,275 7,250 -- 42,821 89,918
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total liabilities ........ $ 678,831 $ 3,540 $ 3,275 $ 293,094 $ -- $ 207,737 $ 1,186,477
============ ============ ============ ============ ============ ============ ============
17
The following table presents the pre-tax statement of operations for each of our
business segments for the quarter ended March 31, 2006:
Ocwen Residential Business Corporate Business
Residential Commercial Recovery Origination Process Items and Segments
Servicing Servicing Group Services Outsourcing Other Consolidated
------------ ------------ ------------ ------------ ------------ ------------ ------------
Revenue
Servicing and subservicing
fees .......................... $ 76,013 $ 2,008 $ 2,201 $ -- $ -- $ (138) $ 80,084
Process management fees ........ 2,068 -- -- 14,488 2,723 33 19,312
Other revenues ................. 1,860 1,107 -- 86 -- -- 3,053
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total revenue ............... 79,941 3,115 2,201 14,574 2,723 (105) 102,449
------------ ------------ ------------ ------------ ------------ ------------ ------------
Operating expenses
Compensation and benefits ..... 7,845 1,702 1,128 7,265 1,222 6,539 25,701
Amortization of servicing
rights ....................... 26,288 -- -- -- -- -- 26,288
Servicing and origination ..... 6,110 7 126 6,954 -- -- 13,197
Technology and communications . 4,976 391 479 1,734 731 (1,672) 6,639
Professional services ......... 3,049 98 70 2,333 -- 2,229 7,779
Occupancy and equipment ....... 2,691 171 257 606 142 1,109 4,976
Other operating expenses ...... 4,671 480 573 1,656 630 (5,488) 2,522
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total operating expenses .... 55,630 2,849 2,633 20,548 2,725 2,717 87,102
------------ ------------ ------------ ------------ ------------ ------------ ------------
Other income (expense)
Interest income ............... 117 7 -- 15,698 -- 2,291 18,113
Interest expense .............. (6,562) (4) (13) (10,082) (10) (583) (17,254)
Gain (loss) on trading
securities.................... -- -- -- 135 -- (509) (374)
Gain (loss) on loans held for
for resale, net............... -- -- -- 2,216 -- -- 2,216
Other, net .................... 2 (4) 95 3,030 -- 287 3,410
------------ ------------ ------------ ------------ ------------ ------------ ------------
Other income (expense), net . (6,443) (1) 82 10,997 (10) 1,486 6,111
------------ ------------ ------------ ------------ ------------ ------------ ------------
Pre tax income (loss) ............ $ 17,868 $ 265 $ (350) $ 5,023 $ (12) $ (1,336) $ 21,458
============ ============ ============ ============ ============ ============ ============
Residential Servicing
Comparative selected balance sheet data is as follows:
March 31, December 31,
2006 2005
------------ ------------
Total assets .......................................... $ 784,218 $ 783,560
Advances .......................................... 234,618 215,207
Match funded advances ............................. 357,828 377,105
Mortgage servicing rights ......................... 146,993 148,663
Receivables ....................................... 19,014 23,323
Total liabilities ..................................... $ 678,831 $ 745,760
Match funded liabilities .......................... 322,757 339,292
Servicer liabilities .............................. 218,088 298,892
Lines of credit and other secured borrowings ...... 104,954 81,218
Advances. During any period in which the borrower is not making
payments, we are required under certain servicing agreements to advance our own
funds to meet contractual principal and interest remittance requirements for
investors, pay property taxes and insurance premiums and process foreclosures.
Advances on loans serviced for others consist of the following:
March 31, December 31,
2006 2005
------------ ------------
Principal and interest ......................... $ 58,548 $ 40,201
Taxes and insurance ............................ 89,562 98,331
Other .......................................... 86,508 76,675
------------ ------------
$ 234,618 $ 215,207
============ ============
18
We are entitled to recover advances from borrowers for reinstated and
performing loans and from investors for foreclosed loans. We record a charge to
earnings to the extent that advances are uncollectible under provisions of the
servicing contracts, taking into consideration historical loss and delinquency
experience, length of delinquency and the amount of the advance. Advances on
loans serviced for others are net of reserves of $583 and $570 as of March 31,
2006 and December 31, 2005, respectively.
Match Funded Advances. Match funded advances consist of the following:
March 31, December 31,
2006 2005
------------ ------------
Principal and interest ......................... $ 151,278 $ 174,252
Taxes and insurance ............................ 131,641 129,700
Other .......................................... 74,909 73,153
------------ ------------
$ 357,828 $ 377,105
============ ============
Match funded advances on loans serviced for others resulted from our
transfers of residential loan servicing related advances to third parties in
exchange for cash. We retain control of the advances, and therefore the
transfers do not qualify as sales for accounting purposes. As a result, we
report the amount of proceeds received from the transfers as secured borrowings
with a pledge of collateral (match funded liabilities). Match funded advances
are owned by special purpose entities and are, therefore, not available to
satisfy general claims of creditors.
Mortgage Servicing Rights. The unamortized balance of mortgage
servicing rights is primarily related to subprime residential loans. Mortgage
servicing rights declined during the first three months of 2006 as amortization
exceeded purchases.
Balance at December 31, 2005 .................................. $ 148,663
Purchases ..................................................... 24,618
Amortization .................................................. (26,288)
------------
Balance at March 31, 2006 ..................................... $ 146,993
============
Purchases during the first quarter of 2006 include $2,739 of servicing
rights retained in connection with the securitization of loans held for resale.
At March 31, 2006, we serviced loans under 455 servicing agreements for 30
investors. This compares to 466 servicing agreements for 22 investors at
December 31, 2005.
Receivables. Receivables related to the Residential Servicing business
include $9,016 and $15,674 at March 31, 2006 and December 31, 2005,
respectively, representing fees earned from the servicing of loans and real
estate. The remaining balance consists principally of reimbursable expenses due
from loan servicing investors. The total balance of receivables for this segment
is net of reserves of $6,198 and $6,509 at March 31, 2006 and December 31, 2005,
respectively.
Match Funded Liabilities. Match funded liabilities are obligations
secured by the collateral underlying the related match funded assets, and are
repaid through the cash proceeds arising from those assets. We account for and
report match funded liabilities as secured borrowings with pledges of
collateral.
Balance Outstanding
Unused ----------------------------
Borrowing March 31, December 31,
Collateral Interest Rate Capacity 2006 2005
------------------- -------------------------------- ------------ ------------ ------------
Advances (1) See (1) below $ 52,341 $ 222,659 $ 238,943
Advances (2) 1-Month LIBOR + 175 basis points 24,902 100,098 100,349
------------ ------------ ------------
$ 77,243 $ 322,757 $ 339,292
============ ============ ============
(1) In November 2004, we executed a servicing advance securitization. This
transaction involved the issuance of a term note for $100,000 and a
one-year variable funding note for a maximum of $75,000. On March 31,
2005, we executed an indenture supplement to the November 2004
securitization with a closing date of April 6, 2005. This supplement
included the issuance of a second term note for $75,000. In addition,
the maximum amount of the variable funding note was increased to
$100,000. The original term note bears interest at LIBOR plus 50 basis
points, and the second term note bears interest at LIBOR plus 40 basis
points. The variable funding note bears interest at a commercial paper
19
rate plus a margin that approximates LIBOR plus 50 basis points. The
original term note under this facility has a stated maturity of October
2013, and the second term note has a stated maturity of March 2014. The
variable funding note has a stated maturity of November 2011.The
variable funding note has a stated maturity of November 2010. The
1-Month LIBOR was 5.00% and 4.39% at March 31, 2006 and December 31,
2005, respectively.
(2) Under the terms of the agreement, we are eligible to finance additional
advances on loans serviced for others up to a maximum balance of
$125,000. This facility will mature in January 2007.
Servicer Liabilities. Servicer liabilities represent amounts we have
collected, primarily from Residential Servicing borrowers, that will be
deposited in custodial accounts and excluded from our balance sheet, paid
directly to an investment trust or refunded to borrowers. The principal
components of servicer liabilities are as follows:
March 31, December 31,
2006 2005
------------ ------------
Borrower payments due to custodial accounts .......... $ 170,921 $ 225,862
Escrow payments due to custodial accounts ............ 8,065 22,573
Partial payments and other unapplied balances ........ 39,102 50,457
------------ ------------
$ 218,088 $ 298,892
============ ============
The decline in the amount of borrower payments held by us prior to
their transfer to collection accounts is primarily due to slower mortgage
prepayment speeds, partially offset by the increase in the average balance of
loans serviced.
Lines of Credit and Other Secured Borrowings. Secured line of credit
arrangements are as follows:
Balance Outstanding
Unused Borrowing --------------------------------------
Borrowing Type Interest Rate Maturity Capacity March 31, 2006 December 31, 2005
---------------------- --------------------- ----------- ---------------- -------------- -----------------
Senior secured credit 1-Month LIBOR + June 2006 $ 35,046 $ 104,954 $ 81,218
agreement (1) 162.5 or 225 basis
points
(1) Secured by mortgage servicing rights and advances on loans serviced for
others. Borrowing secured by mortgage servicing rights is at LIBOR plus
225 basis points. Borrowing secured by other acceptable collateral is at
LIBOR plus 162.5 basis points. The interest rate may be reduced to 1.625%
or 2.25% to the extent that we have available balances on deposit with
the lender.
Comparative selected operations data is as follows:
At or For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
Unpaid principal balance of loans serviced at March 31 ................... $ 42,855,463 $ 37,380,682
Number of loans serviced at March 31 ..................................... 377,540 330,567
Average unpaid principal balance of loans serviced during the quarter .... $ 43,038,004 $ 36,797,725
Pre-tax income ........................................................... $ 17,868 $ 2,947
Revenue:
Servicing and subservicing fees ....................................... $ 76,013 $ 65,518
Process management fees ............................................... 2,068 2,088
Other ................................................................. 1,860 840
------------ ------------
Total revenue ....................................................... $ 79,941 $ 68,446
============ ============
Operating expenses:
Compensation and benefits ............................................. $ 7,845 $ 9,910
Amortization of servicing rights ...................................... 26,288 25,115
Servicing and origination ............................................. 6,110 8,861
Technology and communications ......................................... 4,976 6,069
Professional services ................................................. 3,049 2,684
Occupancy and equipment ............................................... 2,691 2,206
Other ................................................................. 4,671 6,551
------------ ------------
Total operating expenses ............................................ $ 55,630 $ 61,396
============ ============
Other income (expense):
Interest income ....................................................... $ 117 $ 66
Interest expense ...................................................... (6,562) (4,170)
Other ................................................................. 2 1
------------ ------------
Total other income (expense) ....................................... $ (6,443) $ (4,103)
============ ============
20
Servicing and Subservicing Fees. The principal components of servicing
and subservicing fees are provided in the table below:
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
Servicing and subservicing fees ....................... $ 50,264 $ 43,508
Late charges .......................................... 9,191 9,126
Revenue from custodial accounts (float earnings) ...... 8,821 6,507
Prepayment and collection related fees ................ 2,467 2,225
Other fees ............................................ 5,270 4,152
------------ ------------
$ 76,013 $ 65,518
============ ============
The increase in servicing and subservicing fees in the first quarter of
2006 as compared to the first quarter of 2005 is primarily due to the increase
in the average balance of loans serviced. The increase in the average balance is
due to growth in the loan servicing portfolio and reduced run-off of the
existing portfolio due to slower prepayment speeds. First quarter 2006
prepayment speeds fell to 30% as compared to 36% in the first quarter of 2005,
largely due to rising mortgage interest rates. The increase in loan servicing
fees was partially offset by a decline in real estate property management fees
associated with our contract with the VA due to lower transaction volumes. The
VA fees amounted to $2,955 and $3,952 during the first quarter of 2006 and 2005,
respectively.
Increases in short-term interest rates have had a positive impact on
float earnings. Although the average balance of funds that we have received from
borrowers that are held in custodial accounts until remitted to investors has
declined in the first quarter of 2006, the average yield we earned on these
funds increased to 3.79% during the first quarter of 2006 as compared to 2.58%
during the first quarter of 2005. Custodial accounts are excluded from our
balance sheet. The average balances held in these custodial accounts were
approximately $930,100 and $1,008,700 for the first three months of 2006 and
2005, respectively. The decline in the average balance in the first quarter of
2006 is primarily due to a decline in mortgage prepayment speeds offset by the
increase in the average balance of loans serviced. The underlying servicing
agreements restrict the investment of float balances to certain types of
instruments. We are responsible for any losses incurred on the investment of
these funds; although to date, we have not incurred any such losses.
The following table sets forth information regarding
residential loans and real estate serviced for others:
Loans (1)(2)(3) Real Estate (4) Total
--------------------------- --------------------------- ---------------------------
Amount Count Amount Count Amount Count
------------ ------------ ------------ ------------ ------------ ------------
March 31, 2006
Performing ....... $ 36,394,277 306,623 $ -- -- $ 36,394,277 306,623
Non-Performing ... 5,293,625 57,087 1,167,561 13,830 6,461,186 70,917
------------ ------------ ------------ ------------ ------------ ------------
$ 41,687,902 363,710 $ 1,167,561 13,830 $ 42,855,463 377,540
============ ============ ============ ============ ============ ============
December 31, 2005:
Performing ....... $ 36,532,664 297,649 $ -- -- $ 36,532,664 297,649
Non-performing ... 5,125,116 57,420 1,121,268 13,733 6,246,384 71,153
------------ ------------ ------------ ------------ ------------ ------------
$ 41,657,780 355,069 $ 1,121,268 13,733 $ 42,779,048 368,802
============ ============ ============ ============ ============ ============
(1) At March 31, 2006 we serviced 277,630 subprime loans with a total unpaid
principal balance of $33,849,536 as compared to 304,234 subprime loans
with an unpaid principal balance of $37,429,090 at December 31, 2005.
Subprime loans represent residential loans we service that were made by
others to borrowers who generally did not qualify under guidelines of
Fannie Mae and Freddie Mac ("nonconforming loans").
(2) Non-performing loans have been delinquent for 90 days or more. Performing
loans are current or have been delinquent for less than 90 days.
(3) We serviced under subservicing contracts 109,690 residential loans with
an unpaid principal balance of $10,541,890 as of March 31, 2006. This
compares to 105,873 residential loans with an unpaid principal balance of
$10,983,237 serviced under subservicing contracts at December 31, 2005.
(4) Real estate includes $701,426 and $683,193 of foreclosed residential
properties serviced for the VA at March 31, 2006 and December 31, 2005,
respectively.
Compensation and Benefits Expense. The decrease in compensation expense
and benefits in the first quarter of 2006 as compared to the first quarter of
2005 has occurred primarily due to a decline in the average number of employees
in the U.S. as a result of cost reduction initiatives put in place in 2005,
including a greater utilization of the lower cost workforce in India. Although
average employment in India increased in the first quarter of 2006, total
average employment declined, and the ratio of India employment to total
employment increased as compared to the first quarter of 2005.
21
Average employment in the Residential Servicing segment is as follows:
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
India .......................................... 913 881
United States .................................. 441 611
------------ ------------
1,354 1,492
============ ============
Amortization of Servicing Rights. First quarter 2006 amortization
increased $1,173 or 5% as compared to the first quarter of 2005. This increase
is due to an increase in our investment in mortgage servicing rights, offset by
a reduction in the rate of amortization as a result of slower prepayment speeds.
Servicing and Origination Expenses. The principal components of
servicing and origination expenses are as follows:
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
Compensating interest expense .................... $ 3,015 $ 5,656
Satisfaction expense ............................. 1,595 1,521
Other ............................................ 1,500 1,684
------------ ------------
$ 6,110 $ 8,861
============ ============
Mortgage prepayments generally create an obligation for us to pay
compensating interest to the securitization trusts for the full month of
interest on loans that were repaid before the end of a calendar month. The
primary reason for the decline in compensating interest expense in the first
quarter of 2006 as compared to the first quarter of 2005 is a shift towards a
higher percentage of loans serviced under a mid-month structure versus a
calendar month structure. Under a calendar month structure, compensating
interest is paid on all loans that prepay during the month, whereas under a
mid-month structure we are not obligated to pay compensating interest on
prepayments that occur during the first half of the month. The effect on
compensating interest expense of the lower prepayment speeds experienced in the
first quarter of 2006 was largely offset by the increase in the average size of
the loan servicing portfolio.
Other Operating Expenses. Other primarily consists of overhead
allocation charges and bad debt expense. The $1,880 decrease in other operating
expenses in the first quarter of 2006 is mostly due to a $1,864 decrease in bad
debt expense. The higher bad debt expense in 2005 was primarily the result of
providing for aged reimbursable expenses that may be uncollectible. Bad debt
expense amounted to $261 and $2,125 in the first quarter of 2006 and 2005,
respectively.
Commercial Servicing
Comparative selected balance sheet data is as follows:
March 31, December 31,
2006 2005
------------ ------------
Total assets ................................................. $ 7,360 $ 6,433
Cash ...................................................... 4,248 3,057
Receivables ............................................... 2,450 2,508
Total liabilities ............................................ $ 3,540 $ 3,220
Comparative selected operations data is as follows:
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
Pre-tax income (loss) ........................................ $ 265 $ 22
Revenue:
Servicing and subservicing fees .......................... $ 2,008 $ 3,086
Other .................................................... 1,107 1,355
------------ ------------
Total revenue ......................................... $ 3,115 $ 4,441
============ ============
Operating expenses .......................................... $ 2,849 $ 4,373
22
Servicing Fees. The principal components of servicing and subservicing
fees are as follows:
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
International servicing fees ..................... $ 1,398 $ 1,730
Domestic servicing fees .......................... 610 1,356
------------ ------------
$ 2,008 $ 3,086
============ ============
The decline in international servicing fees in the first quarter of
2006 reflects the sale of our Japan operations in December 2005. The decline in
domestic servicing fees in the first quarter of 2005 is primarily due to a
decline in asset resolution fees.
The following table sets forth information regarding commercial loans
and real estate serviced for others:
Loans Real Estate Total
--------------------------- --------------------------- ---------------------------
Amount Count Amount Count Amount Count
------------ ------------ ------------ ------------ ------------ ------------
March 31, 2006:
Performing ........ $ 2,054,530 297 $ -- -- $ 2,054,530 297
Non-performing .... 143,441 390 52,624 46 196,064 436
------------ ------------ ------------ ------------ ------------ ------------
$ 2,197,971 687 $ 52,624 46 $ 2,250,594 733
============ ============ ============ ============ ============ ============
December 31, 2005:
Performing ........ $ 1,389,787 300 $ -- -- $ 1,389,787 300
Non-performing .... 193,635 274 56,719 69 250,354 343
------------ ------------ ------------ ------------ ------------ ------------
$ 1,583,422 574 $ 56,719 69 $ 1,640,141 643
============ ============ ============ ============ ============ ============
At March 31, 2006, our international offices serviced a total of 440
loans with an unpaid principal balance of $1,917,251. This compares to 272 loans
with an unpaid principal balance of $1,269,796 serviced at December 31, 2005.
Operating Expenses. The decline in operating expenses in the first
quarter of 2006 is primarily due to the sale of our Japan operations in December
2005.
Ocwen Recovery Group
Comparative selected operations data is as follows:
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
Pre-tax income (loss) ........................... $ (350) $ 503
Revenue:
Servicing fees:
Third-party collections ................... $ 1,933 $ 3,463
Proprietary recoveries .................... 268 349
------------ ------------
Total revenue ........................... $ 2,201 $ 3,812
============ ============
Operating expenses .............................. $ 2,633 $ 3,398
The decline in revenue in the first quarter of 2006 reflects an ongoing
shift in revenue from a maturing portfolio of proprietary assets to lower
yielding third-party contracts. The decrease in operating expenses in the first
quarter of 2006 is largely the result of ongoing process improvements,
technology enhancements and a greater concentration of resources in India.
23
Residential Origination Services
Comparative selected balance sheet data is as follows:
March 31, December 31,
2006 2005
------------ ------------
Total assets ...................................... $ 431,779 $ 679,432
Trading securities ............................. 45,111 27,023
Loans held for resale .......................... 364,924 624,671
Receivables .................................... 13,525 18,497
Total liabilities ................................. $ 293,094 $ 538,226
Lines of credit and other secured borrowings ... 285,844 530,569
Trading Securities. During the first three months of 2006, trading
securities increased by $18,088 primarily due to residual securities with a fair
value of $18,732 at March 31, 2006 that were retained in connection with the
first quarter loan securitization. In addition to providing various mortgage due
diligence and loan origination services, our strategy in this business includes
the targeted acquisition of residual securities, either directly or indirectly,
through the purchase and subsequent securitization of loans.
Subordinate and residual securities do not have a contractual maturity
but are paid down over time as cash distributions are received. The weighted
average remaining life of these securities was 2.3 years at March 31, 2006.The
anticipated effective yield to maturity as of March 31, 2006 based on the
purchase price, actual cash flows received to date and the current estimate of
future cash flows under the pricing assumptions at March 31, 2006 was 17.14%.
The original anticipated effective yield to maturity based on the purchase price
and anticipated future cash flows under pricing assumptions at the time of
purchase was 18.09%. Differences in the March 31, 2006 anticipated yield to
maturity from that originally anticipated are due to differences between
estimated cash flows and actual cash flows. Each quarter, we update the
assumptions used to estimate future cash flows based on the actual results to
date. The primary assumptions include prepayment speeds, loss rates and the
discount rate. The mortgages that underlie our residential trading unrated
subprime subordinate and residual securities amounted to $782,577 at March 31,
2006 and are secured by properties located in 50 states, one U.S. territory and
the UK. The largest aggregate value of mortgages in any one state, territory or
foreign country is $132,748 in Florida.
Loans Held for Resale. Loans held for resale represent single-family
residential loans originated or acquired by our Residential Origination Services
segment that we intend to sell or securitize. The $259,747 decline in loans held
for resale during the first three months of 2006 is due to the securitization of
loans with a carrying value of $428,168 at December 31, 2005, offset by the
acquisition $158,455 of loans in preparation for a securitization transaction
that closed in April 2006 and a $51,705 net increase related to our other loan
refinancing, origination and sale programs. Loans held for resale are carried at
the lower of cost or market value and were comprised of the following at March
31, 2006:
o Loans with a carrying value of $158,455, net of a market valuation
reserve of $554, were acquired during the first quarter of 2006. These
loans were securitized in a transaction that closed in April 2006.
o Loans with a carrying value of $11,144, net of a market valuation reserve
of $3,206, were acquired as a part of a larger acquisition of loans in
September 2005. These loans included non-performing loans at the time of
acquisition. We completed a securitization in October 2005 involving the
majority of the acquired loans. The remaining carrying value at March 31,
2006 includes $9,464 of non-performing loans.
o Loans with a carrying value of $51,635 were originated in connection with
our origination services business.
o A balance of $17,195 represented loans that were originated in response
to requests from Residential Servicing customers to refinance their
mortgage. Only loans with sales commitments prior to closing are
originated under this program. Of the loans outstanding at March 31,
2006, nearly all were sold in April 2006.
o Loans with a carrying value of $126,495, net of a market valuation
reserve of $146, were held by consolidated VIEs. The majority of these
loans were sold or securitized in April 2006.
Receivables. The $4,972 decrease in receivables during the first
quarter of 2006 is primarily due to the collection of principal and interest
on loans held for resale, the balance of which has declined significantly since
the end of the year.
24
Lines of Credit and Other Secured Borrowings. The loans we acquired in
the fourth quarter of 2005 were funded through a transaction involving the sale
of loans under an agreement to repurchase, which we account for as a
collateralized financing. The loans were securitized in the first quarter of
2006, and the outstanding balance was repaid. Lines of credit and other secured
borrowings are as follows:
Balance Outstanding at
-------------------------------
Unused Borrowing March 31, December 31,
Borrowing Type Interest Rate Maturity Capacity 2006 2005
-------------------------- ------------------------- ---------------- ------------- ------------ --------------
Repurchase agreement 1-Month LIBOR + 75 March 2006 (1) $ -- $ -- $ 459,400
Repurchase agreement - Overnight LIBOR + 80 -
consolidated VIE 110 basis points (2) July 2006 58,350 91,650 --
Repurchase agreement 1-Month LIBOR + 50 bps February 2007 520 9,480 --
Master loan and security 1-Month LIBOR + 55 or
agreement (3) 355 basis points October 2006 91,886 8,114 --
Master loan and security
agreement - 1-Month LIBOR + 55 or
consolidated VIEs (4) 355 basis points October 2006 223,400 176,600 71,169
------------- ------------ --------------
$ 374,156 $ 285,844 $ 530,569
============= ============ ==============
(1) This agreement matured on March 31, 2006 and was not extended.
(2) The interest rate on this agreement varies based on the type of loan sold.
Overnight LIBOR was 4.90% at March 31, 2006.
(3) We entered into this agreement on October 11, 2005 and borrowings under
this agreement will be secured by mortgage loans. We can borrow up to 100%
of the principal balance of the mortgage loans or 98% of the market value
of the loans whichever is lower. Borrowing up to 90% of the unpaid
principal balance of the loans or 88.2% of the market value of the loans
bears interest at LIBOR plus 55 basis points. Borrowing above this level
bears interest at LIBOR plus 355 basis points.
(4) Two consolidated VIEs entered into this agreement on October 11, 2005.
Borrowings under this agreement are secured by mortgage loans. The
consolidated VIEs can borrow up to 100% of the principal balance of the
mortgage loans or 98% of the market value of the loans whichever is lower.
Borrowing up to 90% of the unpaid principal balance of the loans or 88.2%
of the market value of the loans bears interest at LIBOR plus 55 basis
points. Borrowing above this level bears interest at LIBOR plus 355 basis
points.
Comparative selected operations data is as follows:
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
Pre-tax income (loss) ................................. $ 5,023 $ 2,834
Revenue:
Process management fees ........................... $ 14,488 $ 12,269
Other ............................................. 86 (2)
------------ ------------
Total revenue ................................... $ 14,574 $ 12,267
============ ============
Operating expenses:
Compensation and benefits ......................... $ 7,265 $ 2,674
Servicing and origination ......................... 6,954 4,962
Technology and communications ..................... 1,734 1,342
Professional services ............................. 2,333 142
Occupancy and equipment ........................... 606 336
Other ............................................. 1,656 1,625
------------ ------------
Total operating expenses ........................ $ 20,548 $ 11,081
============ ============
Other income (expense):
Interest income:
Subordinate and residual trading securities ..... $ 2,789 $ 3,455
Loans held for resale ........................... 12,794 4
Other ........................................... 115 1
------------ ------------
Total interest income .......................... 15,698 3,460
Interest expense .................................. (10,082) (501)
Gain (loss) on trading securities ................. 135 (1,327)
Gain (loss) on loans held for resale, net.......... 2,216 --
Other, net ........................................ 3,030 16
------------ ------------
Total other income (expense) .................... $ 10,997 $ 1,648
============ ============
25
Process Management Fees. The principal components of process management
fees are:
For the three months
ended March 31,
---------------------------
2006 2005
------------ ------------
Property valuation fees .......................... $ 7,082 $ 6,805
Mortgage due diligence fees ...................... 2,770 1,813
Loan refinancing fees ............................ 2,236 1,263
Other ............................................ 2,400 2,388
------------ ------------
$ 14,488 $ 12,269
============ ============
Other process management fees primarily includes title service and
other fees earned from vendors in the REALTrans network.
Operating Expenses. The increase in operating expenses in the first
quarter of 2006 is in large part due to $3,683 of operating expenses of a VIE
that we began consolidating as of the end of 2005. In addition, operating
expenses associated with the mortgage fulfillment center and due diligence
operation we acquired in December 2004 increased significantly in the first
quarter of 2006 as compared to 2005 primarily as a result of increased staffing
as we continue to build capacity in this business. Servicing and origination
expenses for the first quarter of 2006 and 2005 include $4,325 and $4,054,
respectively, of fees incurred in connection with the residential property
valuation services that we provided. The $2,191 increase in professional
services in the first quarter of 2006 is primarily due to underwriting fees and
other direct costs incurred in connection with the securitization of loans.
Interest Income. The increase in interest income in the first quarter
of 2006 as compared to 2005 is largely due to an increase in the average balance
of loans held for resale, primarily as a result of acquisitions during the
fourth quarter of 2005 and the first quarter of 2006. The consolidation of a VIE
as of the end of 2005 also contributed to the increase.
Interest Expense. The increase in interest expense in the first quarter
of 2006 as compared to 2005 reflects the additional funding requirements as a
result of the increase in the average balance of loans held for resale. The
increase is also partially attributed to the consolidation of a VIE as of the
end of 2005.
Gain (Loss) on Trading Securities The $135 of net gains in the first
quarter of 2006 is primarily comprised of $964 of unrealized gains on the
residual securities that were retained in connection with the securitization of
loans in the first quarter of 2006 and $(847) of losses on unrated subprime
residual securities backed by loans originated in the UK. The net loss of
$(1,327) in the first quarter of 2005 represents unrealized losses on unrated
subprime residual securities, including $(1,021) on the UK residual securities.
A decline in cash flows from the UK securities has resulted in reduced interest
income and a decline in fair value.
Gain (Loss) on Loans Held for Resale, Net. The $2,216 gain includes a
$3,105 gain in the first quarter of 2006 that represents the gain, before
related expenses, on the securitization of loans with a carrying value of
$428,168 at the time of sale. We acquired these loans during the fourth quarter
of 2005. We determine the gain by allocating the carrying value of the loans
between loans sold and the interests retained, based on their relative estimated
fair values. The gain on sale that we report represents the difference between
the cash proceeds from the sale and the cost allocated to the loans sold. In
connection with this securitization, we retained the mortgage servicing rights
and the residual securities. This gain was partially offset by charges of $889
to reduce loans held for resale to market value.
Other, Net. Other income for the first quarter of 2006 includes $1,436
of net realized and unrealized gains (losses) related to Eurodollar interest
rate futures contracts.
Business Process Outsourcing
Comparative selected operations data is as follows:
For the three months
ended March 31,
-----------------------------
2006 2005
------------ ------------
Pre-tax income (loss) ......................... $ (12) $ 98
Process management fees ....................... 2,723 2,586
Operating expenses ............................ 2,725 2,455
The increase in operating expenses in the first quarter of 2006 is
primarily the result of increased compensation costs in preparation for new
sales initiatives. We lost a significant business process outsourcing client
early in 2006 due to a merger and the resulting consolidation of activities.
26
Corporate Items and Other
Comparative selected balance sheet data is as follows:
March 31, December 31,
2006 2005
------------ ------------
Total assets ....................................... $ 328,548 $ 382,513
Cash ............................................ 178,901 264,373
Trading securities .............................. 34,096 4,939
Receivables ..................................... 25,110 21,891
Premises and equipment, net ..................... 36,454 37,227
Other assets .................................... 52,970 52,985
Total liabilities .................................. $ 207,737 $ 214,894
Lines of credit and other secured borrowings .... 14,587 14,661
Debt securities ................................. 150,329 154,329
Other liabilities ............................... 42,821 45,904
Trading Securities. The fair value of our trading securities in the
Corporate Items and Other segment is as follows:
March 31, December 31,
2006 2005
------------ ------------
Investment grade securities:
Commercial paper ............................. $ 31,743 $ --
Bonds and debentures ......................... 1,472 1,685
------------ ------------
33,215 1,685
Subordinates (commercial unrated) ................ 881 3,254
------------ ------------
$ 34,096 $ 4,939
============ ============
Receivables. Receivables in this segment consist of the following:
March 31, December 31,
2006 2005
------------ ------------
Amounts due from sales of affordable housing properties .... $ 13,334 $ 13,160
Security deposits .......................................... 3,739 3,678
Other ...................................................... 8,037 5,053
------------ ------------
$ 25,110 $ 21,891
============ ============
Payments to be received in future years (through June 2014) from the
sale of investments in affordable housing properties are net of unaccreted
discounts of $1,356 and $1,530 and reserves for doubtful accounts of $6,243 and
$6,150 at March 31, 2006 and December 31, 2005, respectively. We sold our one
remaining affordable housing limited partnership investment during 2005.
Other Assets. Other assets held by this segment are comprised of the
following:
March 31, December 31,
2006 2005
------------ ------------
Deferred tax assets, net ......................... $ 20,057 $ 20,270
Interest earning collateral deposits ............. 15,263 15,164
Deferred debt related costs ...................... 4,034 4,349
Goodwill and intangibles ......................... 5,435 5,435
Real estate ...................................... 4,332 4,062
Prepaid expenses ................................. 2,580 2,796
Loans ............................................ 135 413
Other ............................................ 1,134 496
------------ ------------
$ 52,970 $ 52,985
============ ============
Deferred tax assets are net of a valuation allowance totaling $163,802
at both March 31, 2006 and December 31, 2005. Interest earning collateral
deposits at both March 31, 2006 and December 31, 2005 include $8,912 of deposits
that were required in order to obtain surety bonds for affordable housing
properties that we sold before the end of the fifteen-year tax credit
amortization period and on which we have previously claimed tax credits on our
27
income tax returns. Interest earning collateral balances also include a $5,000
cash collateral account required under the Guaranty we entered into in
connection with debanking.
Lines of Credit and Other Secured Borrowings. Lines of credit and other
secured borrowings in this segment represent a mortgage note collateralized by
our loan servicing call center located in Orlando, Florida. This note has a
fixed interest rate of 5.62% and matures in October 2014.
Debt Securities. Debt securities in this segment consist of the
following:
March 31, December 31,
2006 2005
------------ ------------
3.25% Contingent Convertible Senior Unsecured Notes due August 1, 2024 ... $ 96,900 $ 100,900
10.875% Capital Securities due August 1, 2027 ............................ 53,429 53,429
------------ ------------
$ 150,329 $ 154,329
============ ============
During the first quarter of 2006, we repurchased $4,000 of the
Convertible Notes generating total gains of $25, net of the write-off of
unamortized issuance costs.
Other Liabilities. Other liabilities in this segment consist primarily
of accruals for incentive compensation awards, audit fees, legal fees and
settlements, interest on debt securities and other operating expenses. Other
liabilities also include funds of third parties held on deposit by BOK.
Comparative selected operations data is as follows:
For the three months
ended March 31,
----------------------------
2006 2005
------------ ------------
Pre-tax income (loss) .......................... $ (1,336) $ (3,467)
Revenue ........................................ $ (105) $ (64)
Operating expenses ............................. $ 2,717 $ 1,986
Other income (expense), net:
Interest income ............................ $ 2,291 $ 2,800
Interest expense ........................... (583) (3,686)
Loss on trading securities ................. (509) (70)
Other, net ................................. 287 (461)
------------ ------------
Total other income (expense) ............. $ 1,486 $ (1,417)
============ ============
Revenue. Revenues primarily represent the elimination of inter-segment
servicing and subservicing revenues. The elimination of the related
inter-segment servicing expense is included in operating expenses.
Operating Expenses. Operating expenses for the three months ended March
31, 2006 and 2005 include $1,332 and $1,304, respectively, of expenses
associated with business activities that are individually insignificant,
primarily Affordable Housing, Commercial Assets and BOK.
Interest Income. The decline in interest income in the first quarter of
2006 as compared to 2005 reflects a decline in cash, investment grade securities
and other short-term investments after debanking, offset in part by an increase
in interest income on a commercial unrated subordinate security arising out of a
cash distribution in the first quarter of 2006.
Interest Expense. The decline in interest expense in the first quarter
of 2006 as compared to 2005 is partly due to a decline in interest expense on
debt securities as a result of repurchases during the third and fourth quarters
of 2005. Also, interest expense for the first quarter of 2005 included $1,720 on
customer deposits prior to debanking. We retained a greater amount of interest
expense in the Corporate Items and Other segment in the first quarter of 2005,
reflecting the high cash balances we were holding in preparation of debanking.
Loss on Trading Securities. The loss in the first quarter of 2006 is
primarily due to a $492 unrealized loss on a commercial unrated subordinate
security that reflects a decline in fair value as a result of a large cash
distribution.
MINORITY INTEREST IN SUBSIDIARY
Minority interest of $1,943 and $1,853 at March 31, 2006 and December
31, 2005, respectively, represents the investment by others in GSS. Merrill
Lynch owns 30% of GSS.
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STOCKHOLDER'S EQUITY
Stockholders' equity amounted to $366,140 at March 31, 2006 as compared
to $347,407 at December 31, 2005. The $18,733 increase in stockholders' equity
during first quarter of 2006 was primarily due to net income of $16,533 and the
issuance of 225,309 shares of common stock to employees as a result of the
exercise of stock options and the vesting of stock awards.
We did not purchase any shares of our own common stock during the three
months ended March 31, 2006. A total of 5,568,900 shares may be purchased under
a plan we announced on May 9, 2000 to repurchase up to 6,000,000 shares of our
issued and outstanding common stock. Our ability to repurchase shares of our
common stock is restricted under the terms of the Guaranty that we entered into
with the OTS in connection with debanking.
INCOME TAX EXPENSE (BENEFIT)
Income tax expense amounted to $4,925 and $550 for the three months
ended March 31, 2006 and 2005, respectively. Income tax expense on income before
income taxes differs from amounts that would be computed by applying the Federal
corporate income tax rate of 35% primarily because of the effect of foreign
taxes, losses from consolidated VIES, changes in the valuation allowance, state
taxes and low-income housing tax credits. Income tax expense reflects tax
credits earned of $15 and $367 for the first quarter of 2006 and 2005,
respectively. Although we have substantial unused tax credits available to
reduce the liability arising from income taxes on our current year income, tax
credits can be used to reduce federal income tax expense only to the corporate
alternative minimum tax rate of 20% of taxable income. Our effective tax rate in
the first quarter of 2006 was 23% as compared to 19% for the first quarter of
2005. The increase in the effective tax rate is due to: 1) the losses from
consolidated VIEs which reduce pre-tax income, but which are not included in our
consolidated income tax return; 2) a projected decrease in the proportion of
foreign income with an indefinite deferral from U.S. taxation; and 3) an
increase in state taxes because our net operating loss carry forward has been
fully utilized. These factors were partly offset by a decrease in taxes paid to
foreign countries. We estimate our effective tax rate based on projected
full-year results, and we revise the estimate quarterly during the year.
We maintain a valuation allowance in an amount sufficient to reduce our
deferred tax asset to the amount that is more likely than not to be realized.
The valuation allowance amounted to $163,802 at both March 31, 2006 and December
31, 2005. The amount of the valuation allowance was based on consideration of
all available evidence, both positive and negative, including our recent
earnings history, current tax position and estimates of future taxable income.
The tax character (ordinary versus capital) and the carry forward and carry back
periods of certain tax attributes (e.g., capital losses and tax credits) were
also considered. We assess the amount of our valuation allowance each quarter,
and in light of our recent positive earnings history changes to the valuation
allowance may be appropriate in 2006.
LIQUIDITY, COMMITMENTS AND OFF-BALANCE SHEET RISKS
Liquidity
Our primary sources of funds for liquidity are:
o Lines of credit and other secured borrowings o Servicing fees
o Match funded liabilities o Payments received on trading securities
o Debt securities
We closely monitor our liquidity position and ongoing funding
requirements. At March 31, 2006, we had $182,282 of unrestricted cash, which
represented 12% of total assets. We also had $33,215 of investment grade
securities at March 31, 2006. Under certain of our credit facilities, we are
required to maintain minimum liquidity levels. Among the risks and challenges
associated with our funding activities are the following:
o Cash requirements to fund our acquisition of additional servicing rights
and related advances and to fund existing operations and growth in other
core business lines.
o The maturity of existing lines of credit and other secured borrowings at
various dates through October 2006, subject to the renewals of these
agreements. We had an aggregate balance of $381,318 outstanding under
these agreements at March 31, 2006.
We grow our Residential Servicing business through the purchase of
servicing rights or by entering into subservicing agreements. Servicing rights
entitle us as the owner to earn servicing fees and other types of ancillary
income, but they also impose on us various obligations as the servicer. Among
these are the obligations to advance our own funds to meet contractual principal
and interest payments for certain investors and to pay taxes, insurance and
various other items that are required to preserve the assets being serviced.
Our ability to expand our Residential Servicing business depends in
part on our ability to obtain additional financing to purchase new servicing
rights and to fund servicing advances. We currently use a variety of sources of
debt to finance these assets, including match funded agreements, credit
29
facilities and seller financing. Our credit facilities provide funds to us in
amounts that are less than the full value of the related servicing assets that
serve as collateral for the credit facilities. If we cannot replace or renew
these sources as they mature or obtain additional sources of financing, we may
be unable to acquire new servicing rights or make the associated advances.
Credit facilities directly related to our Residential Servicing business are
summarized as follows:
o Under a match funding agreement that we entered into on December 20,
2001, we are eligible to sell advances on loans serviced for others up
to a maximum debt balance of $125,000 at any one time. At March 31,
2006, we had $100,098 of match funded liabilities outstanding under
this facility, which will mature in January 2007.
o We have a $140,000 secured credit agreement that may be used to fund
servicing advances and acquisitions of servicing rights. At March 31,
2006, we had a balance outstanding under this agreement of $104,954.
The agreement matures in June 2006.
o Under a match funding agreement we entered into on November 17, 2004,
we are eligible to sell advances on loans serviced for others up to a
maximum outstanding balance of $275,000. As of March 31, 2006, the
balance outstanding under this agreement was $222,659. The two term
notes of $100,000 and $75,000 under this facility have stated
maturities of October 2013 and March 2014, respectively. The variable
funding note has a maximum amount of $100,000 and a stated maturity of
November 2010.
In connection with our Residential Origination Services segment, we
have available a warehouse line of credit of $500,000, including $400,000
associated with two consolidated VIEs. We had $184,714 of borrowings outstanding
under this line, which expires in October 2006. We also had $250,000 available
through a loan repurchase agreement that expires July 2006 and under which we
had borrowed $91,650 at March 31, 2006. Under a securities repurchase agreement
that expires February 2007, we had borrowed $9,480 of the $10,000 that was
available.
We believe that our existing sources of liquidity, including internally
generated funds, will be adequate to fund planned activities, although there can
be no assurances in this regard. At March 31, 2006, we had $486,445 of unused
borrowing capacity under existing credit agreements, including $281,750 that is
available to consolidated VIEs. We continue to evaluate other sources of
liquidity, such as debt securities, lines of credit from unaffiliated parties,
match funded debt and other secured borrowings.
Our operating activities provided $203,327 and $18,053 of cash flows
during the three months ended March 31, 2006 and 2005, respectively. The
increase in net cash flows provided by operating activities primarily reflects a
significant decline in loans held for resale during the first quarter of 2006.
During the first quarter of 2006 and 2005, proceeds from sales of loans held for
resale exceeded purchases and originations during the quarter by $261,566 and
$1,550, respectively. The net cash flows from loans held for resale in the first
quarter of 2006 was partially offset by an $80,804 decline in the amount of
borrower payments held by us prior to their transfer to collection accounts.
Our investing activities used cash flows totaling $22,988, and $30,093
during the three months ended March 31, 2006 and 2005, respectively. The decline
in net cash flows used by investing activities in the first quarter of 2006 is
largely the result of a decline in purchases of mortgage servicing rights.
Our financing activities used cash flows of $266,137 and $59,867 during
the three months ended March 31, 2006 and 2005, respectively. Cash flows used by
financing activities were greater in the first quarter of 2006 principally
because of a net decrease in collateralized borrowing agreements used to finance
loans held for resale during the quarter. Net repayments of lines of credit and
other secured borrowings amounted to $246,733 during the first quarter of 2006.
Collateralized borrowings provided net cash flows of $40,477 during the first
quarter of 2005 primarily because of increased borrowing under a senior credit
agreement secured by servicing rights and advances. Cash flows used by financing
activities during the first quarter of 2005 included $78,495 used to repay
maturing customer deposits prior to debanking on June 30, 2005.
Commitments
We believe that we have adequate resources to fund all unfunded
commitments to the extent required and meet all contractual obligations as they
come due. Such contractual obligations include our Convertible Notes, Capital
Trust Securities, lines of credit and other secured borrowings and operating
leases. See Note 7 to the Interim Consolidated Financial Statements for
additional information regarding commitments and contingencies.
Off-Balance Sheet Risks
As of March 31, 2006 we had outstanding commitments to fund mortgage
loans of $44,381 and outstanding commitments to sell $17,195 of our loans held
for resale.
In addition to commitments to extend credit, we are party to various
off-balance sheet financial instruments in the normal course of our business to
manage our interest rate risk and foreign currency exchange rate risk. We have
also committed to fund operating cash deficits of certain affordable housing
properties that we have sold.
30
We conduct business with a variety of financial institutions and other
companies in the normal course of business, including counterparties to our
off-balance sheet financial instruments. We are subject to potential financial
loss if the counterparty is unable to complete an agreed upon transaction. We
seek to limit counterparty risk through financial analysis, dollar limits and
other monitoring procedures.
RECENT ACCOUNTING DEVELOPMENTS
During the first quarter of 2006, we adopted SFAS No. 123(R),
"Share-Based Payment", however it did not have a material effect on our
consolidated financial statements. For additional information regarding recent
accounting pronouncements, see Note 2 to the Interim Consolidated Financial
Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk includes interest rate risk, foreign currency exchange rate
risk and liquidity risk. We are exposed to interest rate risk to the degree that
our interest-bearing liabilities mature or reprice at different speeds, or
different bases, than our interest-earning assets. We are exposed to foreign
currency exchange rate risk in connection with our investment in non-U.S. dollar
functional currency operations and to the extent our foreign exchange positions
remain unhedged. Market risk also reflects the risk of declines in the valuation
of trading securities, mortgage servicing rights and in the value of the
collateral underlying loans.
We are also exposed to liquidity risk primarily because of the highly
variable daily cash requirements to support the Residential Servicing business
including acquisitions of mortgage servicing rights, the requirement to make
advances pursuant to servicing contracts and the process of remitting borrower
payments to the custodial accounts. In general, we finance our operations
through operating cash flows and various other sources including long-term debt
and financing facilities. See "Liquidity, Commitments and Off-Balance Sheet
Risks" for additional discussion regarding liquidity.
The primary risk associated with mortgage servicing rights is that they
will lose a portion of their value as a result of higher than anticipated
prepayments occasioned by declining interest rates or because of higher than
anticipated delinquency rates occasioned by deteriorating credit conditions.
Interest rates, prepayment speeds and the payment performance of the underlying
loans significantly affect both our initial and ongoing valuations and the rate
of amortization of mortgage servicing rights. As of March 31, 2006, the carrying
value and fair value of our mortgage servicing rights was $146,993 and $197,731,
respectively.
Our Residential Servicing business is characterized by non-interest
earning assets financed by interest-bearing liabilities. Among the more
significant non-interest earning assets are servicing advances and mortgage
servicing rights. At March 31, 2006, we had servicing advances of $592,446
consisting of advances on loans serviced for others of $234,618 and match funded
advances on loans serviced for others of $357,828.
We are also exposed to interest rate risk because earnings on float
balances are affected by short-term interest rates. These float balances, which
are not included in our financial statements, amounted to $863,025 at March 31,
2006. We report these earnings as a component of servicing and subservicing
fees.
At March 31, 2006, the combined balance of our match funded
liabilities, debt securities, lines of credit and other secured borrowings
totaled $878,471. Of this amount $713,555 was variable rate debt, for which debt
service costs are sensitive to changes in interest rates, and $164,916 was fixed
rate debt.
Our balance sheet at March 31, 2006 included interest-earning assets
totaling $494,574, including $364,924 of loans held for resale. During April
2006, the majority of the loans held for resale were securitized or sold.
Impact of Changes in Interest Rates on the Net Value of Interest Rate-Sensitive
Financial Instruments
We perform an interest rate sensitivity analysis of our mortgage
servicing rights portfolio every quarter. We currently estimate that the fair
value of the portfolio increases or decreases by approximately 3% for every 50
basis point (bp) increase or decrease in interest rates. This sensitivity
analysis is limited in that it was performed at a particular point in time; only
contemplates certain movements in interest rates; does not incorporate changes
in interest rate volatility; is subject to the accuracy of various assumptions
used, including prepayment forecasts and discount rates; and does not
incorporate other factors that would impact our overall financial performance in
such scenarios. Mortgage servicing rights are carried at the lower of amortized
cost or fair value by strata. To the extent that fair value were to decline
below amortized cost, we would record an impairment charge to earnings and
establish a valuation allowance. A subsequent increase in fair value could
result in the recovery of some or all of a previously established valuation
allowance. However, an increase in fair value of a particular stratum above its
amortized cost would not be reflected in current earnings. For these reasons,
this estimate should not be viewed as an earnings forecast.
31
Our Asset/Liability Management Committee is authorized to utilize a
wide variety of off-balance sheet financial techniques to assist it in the
management of interest rate risk and foreign currency exchange rate risk. These
techniques include interest rate exchange contracts or "swap" agreements,
interest rate caps and floors, U.S. Treasury interest rate futures contracts,
foreign currency futures contracts, foreign currency forwards and European
swaptions and put options.
We have entered into foreign currency futures to hedge our net
investment in the foreign subsidiary that owns our UK subprime residual
securities. The notional amount of these futures was (pound)13,438 ($23,343) at
March 31, 2006. Our principal exposure to foreign currency exchange rates exists
with the British Pound versus the U.S. dollar. Our operations in India and the
foreign operations of GSS also expose us to foreign currency exchange rate risk.
However, this risk is insignificant.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer
and principal financial officer, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) under the Securities
Exchange Act) as of March 31, 2006. Based on this evaluation, our chief
executive officer and principal financial officer concluded that, as of March
31, 2006 our disclosure controls and procedures (1) were designed to ensure that
material information relating to Ocwen Financial Corporation, including its
consolidated subsidiaries, is made known to our chief executive officer and
principal financial officer by others within those entities, particularly during
the period in which this report was being prepared and (2) were operating
effectively, in that they provide reasonable assurance that information required
to be disclosed by Ocwen Financial Corporation in the reports that it files or
submits under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms.
No change in our internal control over financial reporting (as defined
in Rules 13a - 15(f) and 15d - 15(f) under the Exchange Act) occurred during the
fiscal quarter ended March 31, 2006 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
See "Note 7 Commitments and Contingencies" of Ocwen Financial
Corporation's Interim Consolidated Financial Statements.
ITEM 1A. RISK FACTORS
See discussion of risk factors on page 15 of "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
ITEM 6. EXHIBITS.
(3) Exhibits. (Exhibits marked with a " * " denote management contracts or
compensatory plans or agreements)
2.1 Agreement of Merger dated as of July 25, 1999 among Ocwen
Financial Corporation, Ocwen Asset Investment Corp. and Ocwen
Acquisition Company (1)
3.1 Amended and Restated Articles of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.0 Form of Certificate of Common Stock (2)
4.1 Certificate of Trust of Ocwen Capital Trust I (4)
4.2 Amended and Restated Declaration of Trust of Ocwen Capital
Trust I (4)
4.3 Form of Capital Security of Ocwen Capital Trust I (included in
Exhibit 4.4) (4)
4.4 Form of Indenture relating to 10.875% Junior Subordinated
Debentures due 2027 of OCN (4)
4.5 Form of 10.875% Junior Subordinated Debentures due 2027 of OCN
(included in Exhibit 4.6) (4)
4.6 Form of Guarantee of OCN relating to the Capital Securities of
Ocwen Capital Trust I (4)
4.7 Registration Rights Agreement dated as of July 28, 2004,
between OCN and Jeffries & Company Inc. (5)
4.8 Indenture dated as of July 28, 2004, between OCN and the Bank
of New York Trust Company, N.A., as trustee (5)
10.1* Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (6)
10.2* Ocwen Financial Corporation 1998 Annual Incentive Plan (7)
10.3 Compensation and Indemnification Agreement, dated as of May 6,
1999, between OAC and the independent committee of the Board
of Directors (8)
10.4 Indemnity agreement, dated August 24, 1999, among OCN and
OAC's directors (9)
10.5* Amended Ocwen Financial Corporation 1991 Non-Qualified Stock
Option Plan, dated October 26, 1999 (9)
10.6 First Amendment to Agreement, dated March 30, 2000 between HCT
Investments, Inc. and OAIC Partnership I, LP (9)
10.7* Ocwen Financial Corporation Deferral Plan for Directors, dated
March 7, 2005 (10)
10.8 Collateral Trust Agreement, dated June 28, 2005, between OCN
and the Bank of New York Trust Company, N.A. (11)
10.9 Guaranty, dated June 28, 2005, from OCN to the Guaranteed
Parties (11)
32
10.10 Cash Collateral Agreement, dated June 28, 2005, among OCN,
Bank of New York Trust Company, N.A. as collateral Trustee
and Bank of New York Trust Company, N.A. as Account Bank (11)
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
(1) Incorporated by reference from a similarly described exhibit included
with the Registrant's Current Report on Form 8-K filed with the
Commission on July 26, 1999.
(2) Incorporated by reference from the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1
(File No. 333-5153) as amended, declared effective by the commission on
September 25, 1996.
(3) Incorporated by reference from the similarly described exhibit included
with the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998.
(4) Incorporated by reference from the similarly described exhibit filed in
connection with our Registration Statement on Form S-1 (File No.
333-28889), as amended, declared effective by the Commission on August
6, 1997.
(5) Incorporated by reference from the similarly described exhibit included
with Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2004.
(6) Incorporated by reference from the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-8
(File No. 333-44999), effective when filed with the Commission on
January 28, 1998.
(7) Incorporated by reference from the similarly described exhibit to our
definitive Proxy Statement with respect to our 1998 Annual Meeting of
Shareholders as filed with the Commission on March 31, 1998.
(8) Incorporated by reference from OAC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1999.
(9) Incorporated by reference from the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2000.
(10) Incorporated by reference from the similarly described exhibit included
with the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004.
(11) Incorporated by reference from the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2005.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
OCWEN FINANCIAL CORPORATION
By: /s/ ROBERT J. LEIST, JR.
-----------------------------------------
Robert J. Leist, Jr., Senior Vice President &
Principal Financial Officer
(On behalf of the Registrant and as its
principal financial officer)
Date: May 10, 2006
34