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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, 2005
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ].
Number of shares of Common Stock, $0.01 par value, outstanding as of May 5,
2005: 62,750,904 shares.
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OCWEN FINANCIAL CORPORATION
FORM 10-Q
INDEX
Page
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PART I - FINANCIAL INFORMATION
Item 1. Interim Consolidated Financial Statements (Unaudited).............. 3
Consolidated Statements of Financial Condition at
March 31, 2005 and December 31, 2004............................... 3
Consolidated Statements of Operations for the Three Months Ended
March 31, 2005 and 2004............................................ 4
Consolidated Statements of Comprehensive Income (Loss) for the
Three Months Ended March 31, 2005 and 2004......................... 5
Consolidated Statement of Changes in Stockholders' Equity
for the Three Months Ended March 31, 2005.......................... 6
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2005 and 2004............................................ 7
Notes to Consolidated Financial Statements......................... 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 46
Item 4. Controls and Procedures............................................ 50
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 51
Item 6. Exhibits........................................................... 51
Signature.................................................................. 53
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS (Unaudited)
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
March 31, December 31,
2005 2004
------------ ------------
ASSETS
Cash and amounts due from depository institutions .................................... $ 107,227 $ 168,799
Interest earning deposits ............................................................ 113,306 119,052
Trading securities, at fair value
Investment grade ................................................................... 75,104 86,215
Subordinates and residuals ......................................................... 37,363 39,527
Match funded assets (including advances on loans serviced for others of $266,281
and $276,626) ....................................................................... 269,959 280,760
Advances on loans and loans serviced for others ...................................... 232,261 240,430
Mortgage servicing rights ............................................................ 135,274 131,409
Receivables .......................................................................... 135,468 126,719
Real estate .......................................................................... 9,450 18,732
Affordable housing properties ........................................................ 4,968 5,641
Loans (net of allowance for loan losses of $4,350 and $4,546) ........................ 8,575 3,792
Premises and equipment ............................................................... 39,066 37,440
Other assets ......................................................................... 66,568 68,977
------------ ------------
Total assets ....................................................................... $ 1,234,589 $ 1,327,493
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits ........................................................................... $ 199,530 $ 301,299
Escrow deposits .................................................................... 121,499 125,977
Match funded liabilities ........................................................... 222,437 244,327
Lines of credit and other secured borrowings ....................................... 91,089 50,612
Debt securities .................................................................... 231,249 231,249
Accrued liabilities ................................................................ 34,278 42,391
------------ ------------
Total liabilities ................................................................ 900,082 995,855
------------ ------------
Minority interest in subsidiaries .................................................... 1,581 1,530
COMMITMENTS AND CONTINGENCIES (NOTE 8)
STOCKHOLDERS' EQUITY
Common stock, $.01 per value; 200,000,000 shares authorized; 62,750,904 and
62,739,478 shares issued and outstanding .......................................... 628 627
Additional paid-in capital ......................................................... 181,464 181,336
Retained earnings .................................................................. 150,520 148,133
Accumulated other comprehensive income (loss), net of taxes ........................ 314 12
------------ ------------
Total stockholders' equity ......................................................... 332,926 330,108
------------ ------------
Total liabilities and stockholders' equity ....................................... $ 1,234,589 $ 1,327,493
============ ============
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, 2005 2004
- ------------------------------------------------------------------------------------------ ------------ ------------
REVENUE
Servicing and related fees ........................................................... $ 45,389 $ 42,291
Vendor management fees ............................................................... 10,881 13,003
Gain (loss) on trading securities, net ............................................... (1,397) (643)
Valuation gains (losses) on real estate .............................................. 89 (1,851)
Gain (loss) on sales of real estate .................................................. 34 (541)
Operating income (losses) from real estate ........................................... (174) 8
Other income ......................................................................... 1,884 6,621
------------ ------------
Non-interest revenue ............................................................. 56,706 58,888
------------ ------------
Interest income ...................................................................... 6,332 4,605
Interest expense ..................................................................... 8,440 7,802
------------ ------------
Net interest income (expense) before provision for loan losses ................... (2,108) (3,197)
Provision for loan losses ............................................................ 4 (531)
------------ ------------
Net interest income (expense) after provision for loan losses .................... (2,112) (2,666)
------------ ------------
Total revenue ................................................................. 54,594 56,222
------------ ------------
NON-INTEREST EXPENSE
Compensation and employee benefits ................................................... 24,371 22,033
Occupancy and equipment .............................................................. 4,242 3,997
Technology and communication costs ................................................... 7,399 6,669
Loan expenses ........................................................................ 5,712 7,927
Loss (gain) on investments in affordable housing properties .......................... 642 (38)
Professional services and regulatory fees ............................................ 4,721 5,825
Other operating expenses ............................................................. 4,570 3,036
------------ ------------
Non-interest expense ............................................................. 51,657 49,449
------------ ------------
Income (loss) before income taxes ........................................................ 2,937 6,773
Income tax expense (benefit) ............................................................. 550 11
------------ ------------
Net income (loss) .................................................................... $ 2,387 $ 6,762
============ ============
EARNINGS (LOSS) PER SHARE
Basic ................................................................................ $ 0.04 $ 0.10
Diluted .............................................................................. $ 0.04 $ 0.10
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic ................................................................................ 62,743,287 67,762,414
Diluted .............................................................................. 64,018,882 69,093,785
The accompanying notes are an integral part of these consolidated
financial statements.
4
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in Thousands)
For the three months ended March 31, 2005 2004
- ------------------------------------------------------------------------------------------ ------------ ------------
Net income (loss) ........................................................................ $ 2,387 $ 6,762
Other comprehensive income (loss), net of taxes:
Change in unrealized foreign currency translation adjustment arising during
the period (1) .......................................................................... 302 (46)
------------ ------------
Comprehensive income (loss) .............................................................. $ 2,689 $ 6,716
============ ============
(1) Net of tax benefit (expense) of $(178) and $1,329 for the three months
ended March 31, 2005 and 2004, respectively.
The accompanying notes are an integral part of these consolidated
financial statements.
5
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2005
(Dollars in thousands)
Accumulated
Other
Common Stock Additional Comprehensive
--------------------- Paid-in Retained Income (Loss),
Shares Amount Capital Earnings Net of Taxes Total
---------- -------- ---------- ---------- --------------- ----------
Balances at December 31, 2004 .................... 62,739,478 $ 627 $ 181,336 $ 148,133 $ 12 $ 330,108
Net income ....................................... -- -- -- 2,387 -- 2,387
Issuance of restricted common stock
awards to employees and directors ............... 2,195 -- 46 -- -- 46
Exercise of common stock options ................. 9,231 1 82 -- -- 83
Other comprehensive income (loss), net of taxes... -- -- -- -- 302 302
---------- -------- ---------- ---------- --------------- ----------
Balances at March 31, 2005 ....................... 62,750,904 $ 628 $ 181,464 $ 150,520 $ 314 $ 332,926
========== ======== ========== ========== =============== ==========
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, 2005 2004
- ------------------------------------------------------------------------------------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ........................................................................ $ 2,387 $ 6,762
Adjustments to reconcile net income (loss) to net cash provided (used) by operating
activities
Net cash provided by trading activities .............................................. 12,010 3,179
Premium amortization (discount accretion) on securities, net ......................... 167 (420)
Amortization of servicing rights ..................................................... 25,115 25,661
Depreciation and other amortization .................................................. 3,269 3,992
Provision for loan losses ............................................................ 4 (531)
Valuation (gains) losses on real estate .............................................. (89) 1,851
(Gain) loss on trading and match funded securities ................................... 1,397 643
Provision for losses on affordable housing properties ................................ 721 --
(Gain) loss on sale of real estate ................................................... (34) 541
(Increase) decrease in advances and match funded advances on loans and loans
serviced for other .................................................................. 18,514 43,448
(Increase) decrease in receivables and other assets, net ............................. (3,908) (9,298)
Increase (decrease) in accrued liabilities, net ...................................... (10,082) (8,943)
Other ................................................................................ 923 (2,259)
------------ ------------
Net cash provided (used) by operating activities ......................................... 50,394 64,626
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments received on match funded loans .................................... 289 1,676
Acquisitions of match funded loans ................................................... -- (7,119)
Purchase of mortgage servicing rights ................................................ (28,980) (11,242)
Principal payments received on loans ................................................. 296 11,253
Purchases, originations and funded commitments of loans, net ......................... (146) (15,898)
Capital improvements to real estate ..................................................
Proceeds from sale of real estate .................................................... -- 18,910
Additions to premises and equipment .................................................. (3,457) (4,487)
Proceeds from the sale of subsidiary ................................................. 1,905 --
------------ ------------
Net cash provided (used) by investing activities ......................................... (30,093) (6,907)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in deposits and escrow deposits .................................. (106,247) 66,087
Proceeds from (repayment of) lines of credit and other secured borrowings, net ....... 40,477 (50,857)
Proceeds from (repayment of) match funded liabilities, net ........................... (21,891) 12,772
Exercise of common stock options ..................................................... 42 1,988
------------ ------------
Net cash provided (used) by financing activities ......................................... (87,619) 29,990
------------ ------------
Net increase (decrease) in cash and cash equivalents ..................................... (67,318) 87,709
Cash and cash equivalents at beginning of period ......................................... 287,851 229,930
------------ ------------
Cash and cash equivalents at end of period ............................................... $ 220,533 $ 317,639
============ ============
CASH AND CASH EQUIVALENTS AT END OF PERIOD
Cash and amounts due from depository institutions ........................................ $ 107,227 $ 311,655
Interest-earning deposits ................................................................ 113,306 5,984
------------ ------------
$ 220,533 $ 317,639
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
7
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
For the three months ended March 31, 2005 2004
- ------------------------------------------------------------------------------------------ ------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for
Interest ............................................................................. $ 11,908 $ 9,917
Income tax refunds (payments) ........................................................ (24) (66)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Assumption of line of credit by purchaser of real estate ............................. $ -- $ 20,000
Equipment acquired through capital leases ............................................ 1,312 --
SALE OF SUBSIDIARY
Fair value of subsidiary sold ........................................................ $ 9,200 $ --
Financing to buyer ................................................................... (4,863) --
Due from buyer for hold back ......................................................... (2,432) --
------------ ------------
Net cash received for subsidiary sold ................................................ $ 1,905 $
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
8
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
(Dollars in thousands)
NOTE 1 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 U.S.
generally accepted accounting principles ("GAAP") for complete financial
statements. The interim consolidated financial statements of Ocwen Financial
Corporation ("OCN") include the accounts of OCN and its subsidiaries. OCN owns
directly and indirectly all of the outstanding common and preferred stock of its
primary subsidiaries, Ocwen Federal Bank FSB (the "Bank"), Investors Mortgage
Insurance Holding Company, Ocwen Technology Xchange, Inc. ("OTX"), Ocwen Asset
Investment Corp. ("OAC") 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"). We have eliminated all significant intercompany transactions and
balances in consolidation.
In our opinion, the accompanying unaudited financial statements contain
all adjustments, consisting only of normal recurring accruals, necessary for a
fair statement of our financial condition at March 31, 2005 and December 31,
2004, the results of our operations for the three months ended March 31, 2005
and 2004, our comprehensive income (loss) for the three months ended March 31,
2005 and 2004, our changes in stockholders' equity for the three months ended
March 31, 2005 and our cash flows for the three months ended March 31, 2005 and
2004. The results of operations and other data for the three months ended March
31, 2005 are not necessarily indicative of the results that may be expected for
any other interim period or the entire year ending December 31, 2005. 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, 2004. Certain reclassifications have been made to the prior periods' interim
consolidated financial statements to conform to the March 31, 2005 presentation.
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 statements of financial condition and revenues
and expenses for the periods covered. Material estimates that are particularly
significant in the near or medium term relate to our determination of allowances
for loans, servicing advances, and receivables, as well as our valuation of
securities, real estate, affordable housing properties, servicing rights,
intangibles and deferred tax assets. Actual results could differ from those
estimates and assumptions.
NOTE 2 CURRENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards ("SFAS") No. 123 (R),
"Share-Based Payment". This Statement was issued by the Financial Accounting
Standards Board ("FASB") on December 16, 2004 and is a revision of SFAS No. 123,
"Accounting for Stock-Based Compensation". This Statement also supersedes
Accounting Principles Board ("APB") Opinion No. 25 and its related
implementation guidance.
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 (with limited exceptions). That cost
will be recognized over the period during which an employee is required to
provide service in exchange for the award - the requisite service period
(usually the vesting period). No compensation cost is recognized for equity
instruments for which employees do not render the requisite service. The fair
value of an award is not re-measured after its initial estimation on the grant
date (except in the case of a liability award or if the award is subsequently
modified). The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless observable market prices for
the same or similar instruments are available). The notes to financial
statements will disclose information to assist users of financial information to
understand the nature of share-based payment transactions and the effects of
those transactions on the financial statements.
SFAS No. 123 (R) eliminates the alternative to use Opinion 25's
intrinsic value method of accounting that was provided in SFAS No. 123 as
originally issued. Under APB Opinion No. 25, issuing stock options to employees
generally resulted in recognition of no compensation cost, except with respect
to options that were granted with an exercise price that was less than fair
value of the stock at the date of grant.
On April 14, 2005, the Securities and Exchange Commission ("SEC")
approved a new rule that delays the effective date of SFAS 123 (R) for public
companies. Under the SEC's rule, SFAS 123 (R) is now effective for public
companies for annual, rather than interim, periods that begin after June 15,
2005. SFAS 123 (R) applies to all awards granted after the required effective
date and to awards modified, repurchased, or cancelled after that date. The
cumulative effect of initially applying this Statement, if any, is recognized as
of the required effective date.
9
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
As of the required effective date, all public entities will apply this
Statement using a modified version of prospective application. Under that
transition method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under Statement 123 for either recognition or pro forma
disclosures. For periods before the required effective date, public entities may
elect to apply a modified version of retrospective application under which
financial statements for prior periods are adjusted on a basis consistent with
the pro forma disclosures required for those periods by SFAS No. 123.
We have not yet determined which transition method we will apply or the
cumulative effect of initially adopting this Statement. We have determined that
awards we have granted to date will be classified as equity awards (versus
liability awards) because their terms contain service conditions. Therefore, the
fair value of these awards will not be re-measured after our initial estimation
on the grant date. We currently account for our stock option plans based on the
intrinsic value method set forth in APB Opinion No. 25. Therefore, we anticipate
that the amount of compensation expense we recognize in connection with our
stock option awards will increase under the fair value based method of SFAS No.
123 and 123(R).
Earnings Per Share - An Amendment of SFAS No. 128. The FASB has decided
to defer the issuance of a final standard on EPS until the third quarter of
2005. When issued, the provisions of the final standard will require
retrospective application for all prior periods presented. When computing
diluted EPS for year-to-date periods, companies will be required to use the
year-to-date average stock price to compute the number of treasury shares that
could theoretically be purchased with the proceeds from exercise of share
contracts such as options or warrants. The year-to-date computation would be
performed independently from the quarterly computations. The old method required
companies to calculate an average of the potential incremental common shares
computed for each quarter when computing year-to-date incremental shares. This
amendment will apply to Ocwen as we use the treasury stock method to determine
the number of incremental shares from the assumed exercise of stock options to
be included in the denominator of diluted EPS computations. Under the treasury
stock method, the proceeds from the assumed exercise of options are assumed to
be used to purchase common stock at the average market price during the period.
The incremental shares (the difference between the number of shares assumed
issued and the number of shares assumed purchased) are included in the
denominator of the diluted EPS computation.
Statement of Position 03-3, "Accounting for Certain Loans or Debt
Securities Acquired in a Transfer" ("SOP 03-3"), which was issued by the
Accounting Standards Executive Committee of the American Institute of Certified
Public Accountants in December 2003, requires acquired impaired loans for which
it is probable that the investor will be unable to collect all contractually
required payments receivable to be recorded at the present value of expected
cash flows. Under SOP 03-3, it is not appropriate to create or carry over a
valuation allowance at the time of acquisition. SOP 03-3 was issued in December
2003 and is effective for loans acquired on or after January 1, 2005. Our total
net investment in loans at March 31, 2005 amounted to $8,575 and other than to
repurchase single family residential loans previously sold, we have not acquired
any loans since 2000; therefore, the application of SOP 03-3 did not have a
significant impact on our consolidated financial statements.
NOTE 3 BASIC AND DILUTED EARNINGS PER SHARE
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% Convertible Notes (if dilutive), by the
weighted average number of common shares outstanding, including the dilutive
potential common shares related to outstanding stock options, restricted stock
awards and the Convertible Notes.
10
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
The following is a reconciliation of the calculation of basic EPS to
diluted EPS for the periods ended:
For the three months ended March 31, 2005 2004
- ---------------------------------------------------- ------------ ------------
Basic EPS:
Net income (loss) .................................. $ 2,387 $ 6,762
============ ============
Weighted average shares of common stock ............ 62,743,287 67,762,414
============ ============
Basic EPS .......................................... $ 0.04 $ 0.10
============ ============
Diluted EPS:
Net income (loss) .................................. $ 2,387 $ 6,762
============ ============
Weighted average shares of common stock ............ 62,743,287 67,762,414
Effect of dilutive elements:
Convertible Notes (1) ............................ -- --
Stock options (2) ................................ 915,196 1,054,433
Restricted stock awards .......................... 360,399 276,938
------------ ------------
Dilutive weighted average shares of common stock ... 64,018,882 69,093,785
============ ============
Diluted EPS ........................................ $ 0.04 $ 0.10
============ ============
(1) Conversion of the Convertible Notes into shares of common stock is not
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 the effect of an average of 1,632,039 and 1,006,205 of options
that were antidilutive for the first quarter of 2005 and 2004,
respectively, because their exercise price was greater than the average
market price of our stock.
NOTE 4 FOREIGN CURRENCY EXCHANGE RATE RISK MANAGEMENT
We entered into foreign currency derivatives to hedge our net
investments in foreign subsidiaries that own residual securities backed by
subprime residential loans originated in the U.K. and that owned a shopping
center located in Halifax, Nova Scotia. During the first quarter of 2005, we
sold our foreign subsidiary that owned the shopping center. However, in
connection with the sale, OCN extended a short-term Canadian Dollar loan in the
amount of C$6,000 ($4,957 U.S. Dollar equivalent at March 31, 2005) to the
buyer. We are managing our exposure to foreign currency exchange rate risk
related to this foreign currency-denominated transaction through the use of
currency futures. Our principal exposure to foreign currency exchange rates
exists with the British Pound versus the U.S. dollar and the Canadian Dollar
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 exposures are subject to gain or loss
if foreign currency exchange rates fluctuate. 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 U.K.
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 foreign currency
derivative financial instrument related to our Canadian Dollar-denominated loan
was not designated as a hedge. Gains and losses from this instrument are
included in earnings as an offset to the related foreign currency transaction
gain or loss arising from remeasurement of the loan.
11
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
The following table sets forth the terms and values of these foreign
currency financial instruments at the dates indicated:
Notional
Position Maturity Amount(1) Strike Rate Fair Value
-------- ---------- --------------- ------------ ----------
March 31, 2005:
Canadian Dollar currency futures ....... Short June 2005 C$ 6,000 0.8147 $ (73)
British Pound currency futures ......... Short June 2005 (pound) 15,750 1.9040 337
----------
$ 264
==========
December 31, 2004:
Canadian Dollar currency futures ....... Short March 2005 C$ 11,500 0.8416 $ 109
British Pound currency futures ......... Short March 2005 (pound) 17,000 1.9248 301
----------
$ 410
==========
(1) The U.S. Dollar equivalent notional amounts of the Canadian Dollar
currency futures and British Pound currency futures at March 31, 2005
were $4,957 and $29,774, respectively. At December 31, 2004, the U.S.
Dollar equivalent notional amounts were $9,570 and $32,609,
respectively.
Foreign currency futures contracts are exchange traded. Holders of
these instruments look to the exchange for performance under these contracts and
not the entity holding the offsetting futures contract, thereby minimizing the
risk of nonperformance. Accordingly, the notional principal amount does not
represent our exposure to credit loss.
NOTE 5 REGULATORY REQUIREMENTS
The Bank, as a federal savings bank organized under the Home Owners'
Loan Act (the "Act"), and OCN, as a registered savings and loan holding company
under the Act, are subject to extensive federal and state regulation under the
Act and other U.S. federal and state laws. Our primary regulatory authority is
the U.S. Office of Thrift Supervision ("OTS"). As such, the OTS periodically
conducts an examination of the Bank and its business practices.
On April 19, 2004, the Bank and the OTS entered into a Supervisory
Agreement (the "Agreement"). The Agreement memorializes various loan servicing
and customer service practices, some of which the Bank had previously adopted
and some of which it implemented on a going-forward basis. Under the Agreement,
the Bank will continue to maintain and further develop its Office of Consumer
Ombudsman, an initiative implemented effective January 1, 2004. The Agreement
acknowledges that the Bank no longer assesses attorneys' fees for issuing
notices of default (breach fees) to delinquent borrowers. Beginning with the
effective date of the Agreement, the Bank will no longer charge delinquent
borrowers a fee for providing forbearance plans in lieu of foreclosures
(forbearance fees). The Agreement also establishes the procedures to be followed
to determine whether appropriate hazard insurance is in place before placing
insurance on behalf of the borrower. Those procedures include some already
implemented by the Bank, as well as new requirements, including that the second
notice shall be sent to borrowers by certified mail. Consistent with practices
in place prior to the date of the Agreement, the Bank will not place the
borrower's loan in default, assess fees or initiate foreclosure proceedings
solely due to the borrower's nonpayment of insurance premiums. The Agreement
also provides that the Bank agrees "to utilize best efforts" to provide
borrowers or their agents pay-off quotes within five business days and sets
forth new guidelines regarding documentation of charges on such pay-off quotes.
The Bank also is required to meet a number of deadlines and submit
reports relating to its implementation of the Agreement. While we do not expect
that compliance with the Agreement will have a material adverse impact on our
financial condition, results of operations or cash flows, we do not know whether
the OTS or other regulatory agencies will seek to implement additional measures
relating to the Bank's servicing practices, including with respect to the
matters that are the subject of the Agreement. Accordingly, there can be no
assurance that any such measures, if implemented, would not have a material
adverse effect on our financial condition, results of operations or cash flows.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
and the regulations promulgated thereunder established certain minimum levels of
regulatory capital for savings institutions subject to regulation by the OTS. As
a federally chartered savings bank regulated by the OTS, the bank must follow
specific capital guidelines stipulated by the OTS. These guidelines involve
quantitative measures of the Bank's assets, liabilities and certain off-balance
sheet items. An institution that fails to comply with its regulatory capital
requirements must obtain OTS approval of a capital plan and can be subject to a
capital directive and certain restrictions on its operations.
12
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
At March 31, 2005, the Bank was "well capitalized" under the prompt
corrective action regulations adopted by the OTS pursuant to the Federal Deposit
Insurance Corporation Improvement Act of 1991. To be categorized as "well
capitalized", the Bank must maintain minimum core capital, Tier 1 risk-based
capital and risk-based capital ratios as set forth in the following table. The
Bank's capital amounts and classification are subject to review by federal
regulators regarding components, risk-weightings and other factors. There are no
conditions or events since March 31, 2005 that we believe have changed the
Bank's category.
Since 1997, the Bank has committed to the OTS to maintain a core
capital (leverage) ratio and a total risk-based capital ratio of at least 9.00%
and 13.00%, respectively. The Bank continues to be in compliance with this
commitment as well as with the regulatory capital requirements of general
applicability (as indicated in the table below). In addition during 2002, we
committed to limit our investment in mortgage servicing rights to an amount no
greater than 50% of stockholders' equity on a consolidated basis and no greater
than 60% of core capital (before any deduction thereto for mortgage servicing
rights) at the Bank. On a consolidated basis, our investment in mortgage
servicing rights is below the limit and represented 41% of stockholders' equity
at March 31, 2005. At the Bank, mortgage servicing rights are also below the
limit, amounting to 55% of core capital at March 31, 2005.
We are in the process of having the Bank terminate its status as a
federal savings bank under OTS and FDIC supervision, which would, among other
things, eliminate certain restrictions on our growth. If this process, which we
refer to as "debanking," is completed, we would dissolve the Bank and continue
its non-depository businesses, including its mortgage servicing business, under
another subsidiary of our Company, which is a licensed servicer in fifty states,
the District of Columbia and Puerto Rico. Should debanking be completed, Ocwen
Financial Corporation would no longer be a savings-and-loan holding company and
would no longer be able to take deposits in the United States or benefit from
federal preemption. Our ability to debank is subject to a number of
contingencies, many of which are beyond our control, including approvals by the
OTS with respect to the application for a voluntary dissolution (which we filed
with the OTS on November 24, 2004) and sales of the Bank's deposits to third
parties. There can be no assurance that we ultimately will be successful in
debanking.
In connection with our debanking process, on February 4, 2005, we
entered into a Branch Purchase and Deposit Assumption Agreement (the "Branch
Purchase Agreement") with Marathon National Bank of New York ("Marathon").
Pursuant to the Branch Purchase Agreement, Marathon agreed to assume the deposit
liabilities of the accounts associated with the Bank branch facility in Fort
Lee, New Jersey. In addition, Marathon will take over the lease and other
contracts and acquire assets related to the branch. In connection with that
closing, Ocwen will make a cash payment to Marathon, which payment is calculated
based upon, among other things, the amount of those deposit account liabilities
as of the closing. As of March 31, 2005, the amount of the deposit liabilities
of the accounts subject to the Branch Purchase Agreement was approximately
$181,000. The transaction is subject to regulatory and other customary approvals
and conditions.
13
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
The following table summarizes the Bank's actual and required
regulatory capital at March 31, 2005:
To Be Well Capitalized Committed
Minimum For Capital For Prompt Corrective Capital
Actual Adequacy Purposes Action Provisions Requirements
----------------- ------------------- ---------------------- ------------
Ratio Amount Ratio Amount Ratio Amount Ratio
----- --------- ----- ---------- ------ ------------ ------------
Shareholders' equity, and ratio to total
assets ...................................... 28.43% $ 216,156
Disallowed mortgage servicing rights ......... (10,256)
Disallowed deferred tax assets ............... (25,849)
Non-includable subsidiary .................... (811)
Intangible assets (1) ........................ (2,360)
---------
Tier 1 (core) capital and ratio to adjusted
total assets ................................ 24.53% 176,880 4.00% $ 28,839 5.00% $ 36,049 9.00%
Non-mortgage servicing rights ................ (811)
---------
Tangible capital and ratio to tangible
assets ...................................... 24.45% $ 176,069 1.50% $ 10,802
=========
Tier 1 capital and ratio to risk-weighted
assets ...................................... 32.08% $ 176,880 6.00% $ 33,087
Tier 2 capital - Allowance for loan losses ... 4,376
Real estate required to be deducted .......... (844)
---------
Total risk-based capital and ratio to risk-
weighted assets ............................. 32.72% $ 180,412 8.00% $ 44,116 10.00% $ 55,144 13.00%
=========
Total regulatory assets ...................... $ 760,267
=========
Adjusted total assets ........................ $ 720,976
=========
Tangible assets .............................. $ 720,165
=========
Risk-weighted assets ......................... $ 551,445
=========
(1) Unamortized balance of computer software.
Bankhaus Oswald Kruber GmbH & Co. KG ("BOK"), our German banking
subsidiary that we acquired on September 30, 2004, 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 - BaFin),
the German Central Bank (Deutsche Bundesbank) and, in respect of minimum
reserves on deposits, the European Central Bank.
Although currently not significant to our operations, 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.
German regulatory requirements applicable to BOK concern in particular
the maintenance of adequate regulatory capital and liquidity, the monitoring of,
and limitations on, large credit exposures, limitations on equity and
equity-like participations in other companies, the protection of depositors and
the adoption of certain accounting standards and business practices. The German
Federal Financial Supervisory Authority and the German Central Bank monitor
compliance with the applicable German banking laws, rules and regulations
largely upon the basis of extensive reporting requirements as well as through
general and specific audits. BOK is in compliance in all material respects with
the German regulatory requirements that are applicable to its business.
14
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
NOTE 6 NET INTEREST INCOME (EXPENSE) BEFORE PROVISION FOR LOAN LOSSES
For the three months ended March 31, 2005 2004
- ------------------------------------------------------------------------ ------------ ------------
Interest income:
Interest earning cash and other .................................... $ 615 $ 114
Federal funds sold and repurchase agreements ....................... 244 392
Trading securities ................................................. 5,460 3,238
Loans .............................................................. 13 460
Match funded loans and securities .................................. -- 401
------------ ------------
6,332 4,605
------------ ------------
Interest expense:
Deposits ........................................................... 1,824 4,038
Match funded liabilities ........................................... 2,647 1,027
Lines of credit and other secured borrowings ....................... 668 1,208
Debt securities .................................................... 3,301 1,529
------------ ------------
8,440 7,802
------------ ------------
Net interest income (expense) before provision for loan losses ..... $ (2,108) $ (3,197)
============ ============
NOTE 7 BUSINESS SEGMENT REPORTING
An operating segment is defined as a component of an enterprise that
(a) engages in business activities from which it may earn revenues and incur
expenses, (b) whose operating results are regularly reviewed by the enterprise's
chief operating decision maker to make decisions about resources to be allocated
to the segment and assess its performance and (c) for which discrete financial
information is available. In the first quarter of 2005, we redefined our segment
reporting. We have restated prior periods to conform to the new segment
structure. A brief description of our segments at March 31, 2005, follows.
. 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 and obtain such
rights by purchasing them outright or by entering into sub-servicing
contracts. This segment also includes our residential loan servicing
system product (REALServicing).
. Residential Origination Services. This business provides various loan
origination services, including residential property valuation services
(Ocwen Realty Advisors, or ORA), mortgage due diligence, title
services, loan refinancing for Residential Servicing customers and our
internet-based vendor management system (REALTrans). This segment also
includes the results of our subprime residual trading securities, which
was reported as a separate segment (Subprime Finance) prior to 2005.
. Ocwen Recovery Group. This business conducts collection activities for
third party owners of unsecured receivables and for a portfolio of
unsecured credit card receivables that we acquired at a discount in
1999 and 2000.
. Business Process Outsourcing. Business Process Outsourcing provides
outsourcing services to third parties including mortgage underwriting,
data entry, call center services and mortgage research.
. Commercial Servicing. This segment includes the results of both our
domestic and international servicing of commercial assets, as well as
our commercial loan servicing system product (REALSynergy).
International servicing is conducted through GSS.
. Corporate Items and Other. This segment includes certain 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, gains and losses from debt repurchases
and certain other corporate expenses.
Based on the relative insignificance of the assets remaining in the
following segments, the remaining assets of these businesses and any related
income or loss arising from their resolution have been included in the Corporate
Items and Other segment beginning January 1, 2005.
. Commercial Assets. This segment comprised operations to acquire
sub-performing commercial loans at a discount, as well as operations to
invest in and reposition under-performing real estate assets. No assets
have been acquired since 2000; since that time, this business has
consisted of the repositioning, management and resolution of the
remaining non-core assets.
15
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
. Affordable Housing. Includes our investments, primarily through limited
partnerships, in qualified low-income rental housing for the purpose of
obtaining Federal income tax credits pursuant to Section 42 of the
Internal Revenue Code of 1986, as amended. Except to complete those
projects in which an investment had already been made, we ceased making
investments in properties in 2000.
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,
2005 2004
------------ ------------
Core businesses:
Residential Servicing ........................ $ 674,001 $ 687,238
Residential Origination Services ............. 49,277 49,348
Ocwen Recovery Group ......................... 1,188 541
Business Process Outsourcing ................. 2,352 2,502
Commercial Servicing ......................... 12,141 13,659
------------ ------------
738,959 753,288
------------ ------------
Non-core businesses:
Commercial Assets ............................ -- 24,149
Affordable Housing ........................... -- 36,715
------------ ------------
-- 60,864
------------ ------------
Corporate Items and Other ........................ 495,630 513,341
------------ ------------
$ 1,234,589 $ 1,327,493
============ ============
16
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
Net Interest Provision Pre-Tax
Non-Interest Income for Loan Non-Interest Income
Revenue (Expense) Loses Expense (Loss)
------------ ------------ ------------ ------------ ------------
For the three months ended March 31, 2005
Core businesses:
Residential Servicing ................... $ 34,707 $ (4,104) $ -- $ 27,656 $ 2,947
Residential Origination Services ........ 10,934 2,959 -- 11,060 2,834
Ocwen Recovery Group .................... 3,893 -- -- 3,390 503
Business Process Outsourcing ............ 2,586 (32) -- 2,455 98
Commercial Servicing .................... 4,749 (45) -- 4,682 21
------------ ------------ ------------ ------------ ------------
56,869 (1,222) -- 49,243 6,403
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... (162) (886) 5 2,414 (3,466)
------------ ------------ ------------ ------------ ------------
$ 56,707 $ (2,108) $ 5 $ 51,657 $ 2,937
============ ============ ============ ============ ============
For the three months ended March 31, 2004
Core businesses:
Residential Servicing ................... $ 37,073 $ (5,272) $ -- $ 26,308 $ 5,493
Residential Origination Services ........ 11,165 2,735 -- 10,866 3,034
Ocwen Recovery Group .................... 3,479 -- -- 2,077 1,401
Business Process Outsourcing ............ 2,155 (3) -- 1,755 397
Commercial Servicing .................... 3,892 -- -- 3,933 (42)
------------ ------------ ------------ ------------ ------------
57,764 (2,540) -- 44,939 10,283
------------ ------------ ------------ ------------ ------------
Non-core businesses:
Commercial Assets ....................... (2,295) (293) (509) 1,162 (3,241)
Affordable Housing ...................... -- (411) (29) 592 (973)
------------ ------------ ------------ ------------ ------------
(2,295) (704) (538) 1,754 (4,214)
------------ ------------ ------------ ------------ ------------
Corporate Items and Other ................... 3,419 47 7 2,756 704
------------ ------------ ------------ ------------ ------------
$ 58,888 $ (3,197) $ (531) $ 49,449 $ 6,773
============ ============ ============ ============ ============
NOTE 8 COMMITMENTS AND CONTINGENCIES
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 $4,595 and $4,813 as of March 31, 2005
and December 31, 2004, respectively. 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.
OCN and certain of its affiliates, including the Bank, have been named
as defendants in purported class action lawsuits brought in various federal and
state courts challenging the Bank's mortgage servicing practices. On April 13,
2004 the United States Judicial Panel on Multi-District Litigation granted our
petition to transfer and consolidate a number of the lawsuits 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"). Additional similar
lawsuits have been brought in other courts, some of which have been or may be
transferred and consolidated in the MDL Proceeding.
17
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
The MDL Proceeding currently includes the following actions in which
OCN and/or the Bank are defendants:
(1) Patricia Antoine, et al. v. Ocwen Federal Bank FSB, et al., Case No. C-03-5503 (N.D.Cal.)
(2) Deborah Bush v. Ocwen Federal Bank FSB, et al., Case No. 7:04-cv-02827 (N.D.Ala.)
(3) Carolyn P. Calhoun v. Ocwen Federal Bank FSB, et al., Case No. 4:04-cv-00293 (N.D.Miss.)
(4) Ralph Carreon Jr., et al. v. Ocwen Federal Bank FSB, Case No. 5:03-5151 (W.D.Tex. Bankr.)
(5) Delilie Carruthers, et al. v. Ocwen Federal Bank FSB, et al., Case No. 2:04-901 (M.D. Ala.)
(6) Stevie Cooper, et al. v. Ocwen Federal Bank FSB, et al., Case No. 1:04-cv-00639 (S.D.Ala.)
(7) Mary Crosby v. Ocwen Federal Bank FSB, et al., Case No. 5:04-cv-02828 (N.D.Ala.)
(8) Billy M. Dockery, et al. v. Ocwen Federal Bank FSB, et al., Case No. 7:04-cv-02830 (N.D.Ala.)
(9) Thomas B. Doherty v. Ocwen Federal Bank FSB, et al., Case No. 04-cv-04880 (D.Minn.)
(10) Marvin Ellison, et al. v. Ocwen Federal Bank FSB, et al., Case No. 2:04-2909 (N.D. Ala.)
(11) Unnatiben Gandabhai, et al. v. Ocwen Federal Bank FSB, et al., Case No. 3:04-2582 (N.D.Cal.)
(12) Willowdean Glover v. Ocwen Federal Bank FSB, et al., Case No. 2:04-961 (M.D. Ala.)
(13) Lizzie Hannah, et al. v. Ocwen Federal Bank FSB, et al., Case No. 7:04-cv-02833 (N.D.Ala.)
(14) Kweku Hanson, et al v. Ocwen Federal Bank FSB, et al., Case No. 02-CV-860 (D.Conn.)
(15) William Hearn, et al v. Ocwen Federal Bank FSB, et al., Case No. C-04-0291 (E.D.Cal.)
(16) Daisy J. Howard v. Ocwen Federal Bank FSB, et al., Case No. 1:04-1156 (S.D. Ala. Bankr.)
(17) Stephanie Hunter, et al. v. Ocwen Federal Bank FSB, et al., Case No. 2:04-cv-02864 (N.D.Ala.)
(18) Lula M. Jackson, et al v. Ocwen Federal Bank FSB, et al., Case No. C-03-0743 (N.D.Cal.)
(19) Freddie Jones v. Ocwen Federal Bank FSB, et al., Case No. 4:04-cv-00294 (N.D.Miss.)
(20) Mikail Khashan v. Hacienda Escrow Corp., et al., Case No. 8:04-1291 (C.D. Cal.)
(21) Brad David Londre v. Ocwen Federal Bank FSB, et al., Case No. 4:04-4055 (W.D.N.C. Bankr.)
(22) Marion Long v. Ocwen Federal Bank FSB, et al., Case No. 7:04-cv-02852 (N.D.Ala.)
(23) Allie M. Maddox, et al v. Ocwen Federal Bank FSB, et al., Case No. CV-03-9515 (C.D.Cal.)
(24) Jeannette E. Martinez v. Ocwen Federal Savings Bank FSB, Case No. 1:04-296 (D.N.M.)
(25) Michele McAuliffe, et al. v. U.S. Bank, N.A. as Trustee, et al., Case No. 03-C-1103 (N.D. Ill.)
(26) George McDonald v. Ocwen Financial Corp., et al., Case No. 1:04-03673 (N.D.Cal.)
(27) Al McZeal v. Ocwen Federal Bank FSB, et al., Case No. 4:04-1576 (S.D.Tex.)
(28) Delores B. Moore v. Ocwen Federal Bank FSB, et al., Case No. 2:04-2612 (E.D. Pa.)
(29) Louise Morrow v. Ocwen Federal Bank FSB, et al., Case No. 7:04-2970 (N.D. Ala.)
(30) Timothy Napier, et al. v. Ocwen Federal Bank FSB, et al., Case No. 2:03-174 (E.D.Wash.)
(31) Arleatha Robinson v. Ocwen Federal Bank FSB, et al., Case No. 03-1302 (N.D. Cal.)
(32) Selby D. Schmidt-Elvin v. Ocwen Financial Corp., et al., Case No. 5:05-139 (C.D. Cal.)
(33) William A. Soto, et al v. Ocwen Federal Bank FSB, et al., Case No. 02-C-6818 (N.D.Ill.).
(34) Geneva Spires, et al v. Ocwen Financial Services, Inc., et al., Case No. C-03-5600 (N.D.Cal.)
(35) Angela Valdez v. Ocwen Federal Bank FSB, Case No. 4:04-10139 (S.D. Iowa)
(36) Maggie Williams, et al. v. Ocwen Federal Bank FSB, et al., Case No. 4:04-cv-02869 (N.D.Ala.)
(37) Thomas Wright, et al. v. Ocwen Federal Bank FSB, et al., Case No. 1:04-cv-00638 (S.D.Ala.)
On August 23, 2004, plaintiffs filed a Consolidated Complaint, setting
forth claims contained in lawsuits consolidated in the MDL Proceeding. Those
claims variously involve alleged violations of federal statutes, including the
Real Estate Settlement Procedures Act and Fair Debt Collection Practices Act,
and state deceptive trade practices statutes, and assert common law claims. The
claims are based on various allegations of improper 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 some of the individual lawsuits had set forth specific damage
allegations (e.g., the Gandabhai complaint (item 11 above) claimed actual
damages of $61; the Hanson complaint (item 14 above) claimed actual damages of
$150,000 and punitive and exemplary damages of $1,500,000), the Consolidated
Complaint in the MDL Proceeding does not set forth any specific amounts of
claimed damages. The absence of any specification of damages in the Consolidated
Complaint does not, however, preclude plaintiffs in the MDL Proceeding from
requesting leave from the court to amend the Consolidated Complaint or from
otherwise seeking damages should the matter proceed to trial.
18
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
On September 30, 2004, the Ocwen defendants filed various motions to
dismiss, for summary judgment, to strike class allegations and to stay
discovery. Discovery in the MDL Proceeding has been stayed pending resolution of
the motions. No motion for class certification has been submitted by plaintiffs,
and the court has not indicated when any such motion would be permitted to be
filed.
On April 25, 2005, the court entered an Opinion and Order granting
partial summary judgment to defendants 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. The court has not yet ruled on any other claims presented
in the MDL Proceeding.
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 and
the other matters described above 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 OTX 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. No damages were entered against
OCN. By 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 core Residential Loan
Servicing business practices. 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. A reserve of $1,000 had been
established for this matter. 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 have not yet been reduced to final judgments, are
against the weight of evidence and contrary to law. On May 6, 2005, the court
denied defendants' motions for a new trial and/or remittitur. If final judgments
are entered on these verdicts, we will take an appeal to the Florida Court of
Appeals for the Fourth District. We intend to continue to vigorously defend this
matter.
On February 28, 2005, a jury in County Court for Nueces County, Texas,
returned a verdict of $140 in compensatory and statutory damages in favor of two
borrowers whose mortgage loan was serviced by the Bank in a lawsuit arising out
of a disputed foreclosure. The jury rejected plaintiffs' request for punitive
damages. The verdict included $2,900 for plaintiffs' attorneys' fees, an amount,
which we believe is unsupported by the evidence and impermissibly excessive
under the controlling legal authorities. The verdict has not yet been reduced to
a final judgment. We are pursuing post-trial motions seeking to set aside or
substantially reduce the attorneys' fees award and, if necessary, will take an
appeal on that issue and perhaps other issues to the Texas Court of Appeals for
the Thirteenth Judicial District. We intend to continue to vigorously defend
this matter.
The verdicts in the Florida and Texas cases have not yet been reduced
to a final judgment, a process that requires the trial judge to, among other
things, review and rule upon post-trial motions before entering final judgment.
It is possible for jury verdicts to be reduced during this period, as we
recently experienced in the Cartel litigation. As previously reported, we
established a reserve of $3,000 in 2004 for the Florida and Texas matters.
On March 9, 2005, the Bank was served with a complaint filed in
Superior Court for Los Angeles County, California, by Banco Popular North
America, successor by merger to Quaker City Bank ("Banco Popular"), which claims
to be a holder of residual interest in two mortgage loan trusts for which the
Bank provides loan servicing. The case was subsequently removed upon the Bank's
motion to the United States District Court for the Central District of
California. In this lawsuit, Banco Popular challenges the Bank's fee charges for
recoveries on charged-off loans. The complaint variously alleges breach of
contract, conversion, breach of fiduciary duty and fraud, and seeks declaratory
and equitable relief, along with claimed compensatory damages in excess of
$3,000 and punitive damages in an unspecified amount. We believe the allegations
are without merit and will vigorously defend this matter.
19
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
MARCH 31, 2005
(Dollars in thousands)
OCN and the Bank are also 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 accrual of litigation reserves and disclosure. We accrue a
litigation reserve when it is probable that a liability had been incurred and
the amount of loss can be reasonably estimated.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollars in thousand, except share data)
GENERAL
OCN is a diversified financial services holding company with
headquarters in West Palm Beach, Florida, and operations in Canada, China,
Germany, India, Japan and Taiwan. We are engaged in a variety of businesses
related to residential and commercial mortgage servicing, real estate asset
management, asset recovery, business process outsourcing and the marketing and
sales of technology solutions to third parties.
For the past several years, we have been undergoing a fundamental
transition in the nature of our business. In late 1999 and early 2000, we began
to execute a strategic plan to shift our business activities away from
capital-intensive businesses involving the purchase of loans, real estate and
related assets toward less capital-intensive businesses that generate fee-based
revenues. As a result, we generally ceased to invest in such assets unless we
were contractually committed and continue to actively manage and resolve those
remaining assets. Our primary goal is to become the leading provider of third
party outsourcing solutions to the mortgage and real estate industries. Key
elements of our strategy are summarized as follows:
. grow our residential loan servicing business, including the
opportunistic acquisition of servicing and sub-servicing rights;
. continuing our globalization efforts through both the expansion of our
international facilities and the expansion of the potential client base
for our products and services;
. expanding our other core businesses, such as unsecured debt collection,
business process outsourcing and the sale or licensing of our
proprietary technology;
. diversifying our funding sources by eliminating our reliance on
deposits and utilizing alternative funding sources, such as
securitizing our rights to receive reimbursement for servicing
advances; and
. terminating the status of the Bank as a federal savings bank, which
would eliminate the restrictions imposed on the amount of mortgage
servicing rights that we may obtain and, therefore, provide us more
flexibility to grow our residential servicing business.
As disclosed in Note 7 to the Interim Consolidated Financial Statements, our
business segments at March 31, 2005, were as follows:
Residential Servicing
Residential Origination Services
Ocwen Recovery Group
Business Process Outsourcing
Commercial Servicing
Corporate Items and Other
Based on the relative insignificance of the assets remaining in the
Commercial Assets and Affordable Housing segments, the remaining assets of these
businesses and any related income or loss arising from their resolution have
been included in the Corporate Items and Other segment beginning January 1,
2005.
OVERVIEW OF RISKS AND RELATED CRITICAL ACCOUNTING POLICIES
Risks Relating to Our Business. We include a discussion of the
principal risk factors that relate to our businesses and that may affect future
results on pages 13 through 18 of Management's Discussion and Analysis of
Operations and Financial Conditions in our Annual Report on Form 10-K for the
year ended December 31, 2004.
Critical Accounting Policies. Our strategy to grow our core businesses
is affected by risks in the marketplace. Further, 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 these risks or other future events.
Our critical accounting policies are those that relate to the estimation and
measurement of these risks; an understanding of these policies is fundamental to
understanding Management's Discussion and Analysis of Results of Operations and
Financial Condition. We summarize our more subjective and complex accounting
policies as they relate to our overall business strategy on pages 18 through 21
of Management's Discussion and Analysis of Results of Operations and Financial
Condition in our Annual Report on Form 10-K for the year ended December 31,
2004. We discuss our significant accounting policies in detail in Note 1 to our
Consolidated Financial Statements included in our Annual Report on Form 10-K for
the year ended December 31, 2004.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
BANKING OPERATIONS
The Bank operates one bank branch in Fort Lee, New Jersey. This
location, which provides most of our retail banking services, is primarily
focused on the issuance of retail certificates of deposit that currently serve
as a source of financing for us. We do not conduct loan origination activities
in the Fort Lee branch. We currently also operate several of our core businesses
primarily in the Bank: Residential Servicing, portions of Residential
Origination Services and portions of Ocwen Recovery Group.
We have an active ongoing dialogue with the OTS regarding our various
businesses and business plans, and we continue to be subject to a number of
restrictions with respect to our future operations. Arising out of our ongoing
dialogue and communications with the OTS, which includes the Supervisory
Agreement we entered into on April 19, 2004, we are no longer collecting
forbearance and multiple breach fees directly from borrowers whose loans we
service. Forbearance fees represent a charge to compensate us for the costs we
incur in developing forbearance plans, i.e. alternative payment schedules that
enable borrowers to make affordable loan payments and retain their homes during
periods of personal economic difficulty. Breach fees represent attorneys' fees
we paid to a law firm to whom we had outsourced the process of sending
obligatory default notices to borrowers who were delinquent in making their
mortgage payments. We reassumed this process internally in September of 2003,
thus eliminating these fees prospectively. See Note 5 to the Interim
Consolidated Financial Statements for additional information regarding the
Supervisory Agreement.
We have also committed to the OTS to limit our investment in mortgage
servicing rights at no more then 60% of core capital (before any deduction
thereto for mortgage servicing rights) at the Bank and 50% of stockholders'
equity on a consolidated basis. As disclosed in Note 5 to the Interim
Consolidated Financial Statements, our investments in mortgage servicing rights
are below these limits at March 31, 2005. These commitments effectively limit
the size of our residential servicing business and, consistent with our strategy
of growing that business, we are in the process of having the Bank terminate its
status as a federal savings bank under OTS and FDIC supervision, which would,
among other things, eliminate these restrictions on our growth. If debanking is
completed, we would dissolve the Bank and continue its non-depository
businesses, including its mortgage servicing business, under another subsidiary
of our Company, which is a licensed servicer in fifty states, the District of
Columbia and Puerto Rico. Should debanking be successful we would no longer be
able to take deposits in the United States or benefit from federal preemption.
Our ability to debank is subject to a number of contingencies, many of which are
beyond our control, including approvals by the OTS with respect to the
application for a voluntary dissolution.
As discussed in Note 5 to the Interim Consolidated Financial
Statements, in connection with our debanking process we entered into the Branch
Purchase Agreement with Marathon. Pursuant to the Branch Purchase Agreement,
Marathon agreed to assume the deposit liabilities of the accounts associated
with the Bank branch facility in Fort Lee, New Jersey. In addition, Marathon
will take over the lease and other contracts and acquire assets related to the
branch. The transaction is subject to regulatory and other customary approvals
and conditions.
As disclosed in Note 5 to the Interim Consolidated Financial
Statements, we acquired BOK, a German bank, on September 30, 2004. Our primary
objectives in acquiring BOK were to diversify our funding sources and to
establish a platform to provide services to our multinational client base. The
results of operations of BOK are included in our consolidated results beginning
on October 1, 2004. BOK is not significant to our current banking operations.
The following discussion of our consolidated financial condition,
results of operations, capital resources and liquidity should be read in
conjunction with the Interim Consolidated Financial Statements and related
Notes.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following tables present selected consolidated financial
information at the dates and for the periods indicated.
Increase (Decrease)
March 31, December 31, ----------------------------
2005 2004 $ %
------------ ------------ ------------ ------------
Financial Condition Data
Total assets ............................................... $ 1,234,589 $ 1,327,493 $ (92,904) (7)%
Investment grade ..................................... $ 75,104 $ 86,215 $ (11,111) (13)%
Subordinate and residuals ............................ $ 37,363 $ 39,527 $ (2,164) (5)%
Match funded assets, net ............................... $ 269,959 $ 280,760 $ (10,801) (4)%
Advances on loans and loans serviced for others ........ $ 232,261 $ 240,430 $ (8,169) (3)%
Mortgage servicing rights .............................. $ 135,274 $ 131,409 $ 3,865 3%
Receivables ............................................ $ 137,348 $ 126,719 $ 10,629 8%
Total liabilities .......................................... $ 900,082 $ 995,855 $ (95,773) (10)%
Deposits ............................................... $ 199,530 $ 301,299 $ (101,769) (34)%
Escrow deposits ........................................ $ 121,499 $ 125,977 $ (4,478) (4)%
Match funded liabilities ............................... $ 222,437 $ 244,327 $ (21,890) (9)%
Lines of credit and other secured borrowings ........... $ 91,089 $ 50,612 $ 40,477 80%
Debt securities ........................................ $ 231,249 $ 231,249 $ -- --%
Stockholders' equity ....................................... $ 332,926 $ 330,108 $ 2,818 1%
For the Three Months Ended March 31,
----------------------------------------------------------
Favorable/(Unfavorable)
----------------------------
2005 2004 $ %
------------ ------------ ------------ ------------
Operations Data
Net income (loss) .......................................... $ 2,387 $ 6,762 $ (4,375) (65)%
Non-interest revenue ....................................... $ 56,706 $ 58,888 $ (2,182) (4)%
Net interest income (expense) .............................. $ (2,108) $ (3,197) $ 1,089 34%
Provision for loan losses .................................. $ 4 $ (531) $ (535) (101)%
Non-interest expense ....................................... $ 51,657 $ 49,449 $ 2,208 (4)%
Income tax expense (benefit) ............................... $ 550 $ 11 $ 539 (4,900)%
Net income (loss) per share:
Basic .................................................. $ 0.04 $ 0.10 $ (0.06) (60)%
Diluted ................................................ $ 0.04 $ 0.10 $ (0.06) (60)%
RESULTS OF OPERATIONS
General. We recorded net income of $2,387 for the first quarter of
2005, as compared to $6,762 for the first quarter of 2004. Our core businesses
recorded combined pre-tax income of $6,403 in the first quarter of 2005, a
decrease of $3,880 or 38% as compared to pre-tax income of $10,283 for the first
quarter of 2004. A $2,546 decline in Residential Servicing income and a $898
decline in Ocwen Recovery Group income account for most of this decrease.
Combined results of our non-core segments and the Corporate Items and Other
segment amounted to a loss of $3,466 and $3,510 for the first quarter of 2005
and 2004, respectively. We discuss these segment results in detail in our review
of segment profitability, which follows.
Segment Results. In general, we have ceased conducting any new business
activities related to our non-core businesses, although we are actively engaged
in the sale or other resolution of the remaining non-core assets. These assets
are comprised of loans, real estate and an affordable housing property.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
The following is a discussion of income (loss) before income taxes for
each of our business segments.
CORE BUSINESSES
Residential Servicing. Through this business we earn fees for providing
loan servicing, including asset management and resolution services, to third
party owners of subprime and "high loan to value" residential mortgage loans.
Subprime residential mortgages comprise the vast majority of loans we service.
We acquire the rights to service loans by purchasing them outright or by
entering into sub-servicing contracts. As shown in the tables below, results
reflect a decline in the number of mortgage loans serviced and continuing
earnings pressure from low interest rates and high prepayments in our servicing
portfolio. Not only do prepayments result in the loss of future servicing fees,
they also result in increases to the rate at which we amortize the balance of
our servicing rights. Prepayments also create an obligation for us to pay
compensating interest expense to investors for the full month of interest on
loans that are repaid before the end of a calendar month.
Selected information
2005 2004
------------ ------------
Number of loans at March 31 .................................................... 330,567 352,078
Unpaid principal balance at March 31 ........................................... $ 37,380,682 $ 36,577,269
Average unpaid principal balance for the three months ended March 31 ........... $ 36,797,725 $ 36,882,231
Average number of employees for the three months ended March 31:
United States .............................................................. 611 709
India ...................................................................... 881 729
For the three months ended March 31,
Pre-tax income (loss) .......................................................... $ 2,947 $ 5,493
Net interest expense ........................................................... $ 4,104 $ 5,272
Non-interest revenue:
Servicing and related fees:
Fees ..................................................................... $ 62,655 $ 67,979
Amortization of servicing rights ......................................... (25,115) (25,661)
Compensating interest expense ............................................ (5,656) (8,211)
------------ ------------
Total servicing and related fees ........................................... 31,884 34,107
Vendor management fees ..................................................... 2,088 2,110
Other ...................................................................... 735 856
------------ ------------
Total non-interest revenue ..................................................... $ 34,707 $ 37,073
============ ============
Non-interest expense ........................................................... $ 27,656 $ 26,308
. The decline in fees in the first quarter of 2005, as compared to the
first quarter of 2004, reflects a $2,610 decline in servicing fees, a
$2,318 decline in prepayment penalties, a $2,243 decline in late
charges and a $1,064 decline in forced placed insurance fees, offset in
part by a $3,493 increase in interest on float balances (see below).
. For the first quarter of 2005, earnings on funds that we have received
from borrowers that are held on deposit with an unaffiliated bank
(float balances) have increased by $3,493, as compared to the first
quarter of 2004, due to changes in the interest rate environment. The
yield we earned on float balances averaged 2.58% and 1.11% during the
first quarter of 2005 and 2004, respectively.
. Fees for the first quarter of 2005 and 2004 include $3,956 and $4,417,
respectively, of real estate property management fees associated with
our contract with the U.S. Department of Veteran's Affairs (the "VA").
See "Non-interest Revenue - Servicing and Related Fees" for a detail of
the principal components of servicing and related fees.
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Residential Origination Services. This business provides various loan
origination services, including residential property valuation services,
mortgage due diligence, title services, loan refinancing for Residential
Servicing customers and our internet-based vendor management system (REALTrans).
This segment also includes the results of our subprime residual trading
securities.
Selected information
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ 2,834 $ 3,034
Non-interest revenue:
Servicing and related fees (1) ............... $ 3,461 $ 96
Vendor management fees (2) ................... 8,785 10,899
Gain (loss) on trading securities ............ (1,327) (784)
Other ........................................ 15 954
---------- ----------
$ 10,934 $ 11,165
========== ==========
Net interest income .............................. $ 2,959 $ 2,735
Non-interest expense ............................. 11,060 10,866
(1) Primarily comprised of $1,813 of mortgage due diligence fees and $1,240
of loan refinancing fees related to loans held for resale. We acquired
a mortgage fulfillment center and due diligence operation in December
2004. Our loan refinancing program for Residential Servicing customers
began earning fees in the second quarter of 2004.
(2) Includes fees for residential property valuation services of $6,805 and
$9,196 for the first quarter of 2005 and 2004, respectively. Also
includes $1,980 and $1,703 of fees earned across the business groups in
this segment from vendors in our REALTrans network.
Ocwen Recovery Group. This core business conducts collection activities
for third party owners of unsecured receivables and for a portfolio of unsecured
credit card receivables that we acquired at a discount in 1999 and 2000. On
collections for third party owners, we generally earn a fee based upon a
percentage of the amount collected.
Selected information
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ 503 $ 1,401
Non-interest revenue:
Third-party collection fees .................. $ 3,455 $ 2,975
Recoveries of unsecured credit card
receivables owned ........................... 349 473
Other ........................................ 89 31
---------- ----------
$ 3,893 $ 3,479
========== ==========
Non-interest expense ............................. $ 3,390 $ 2,077
. Pre-tax income declined in the first quarter of 2005 in spite of an
increase in non-interest revenue, reflecting both a reduction in
collections on our aging portfolio of receivables, which yielded high
margins, and increased staffing costs.
. The increase in non-interest expense in 2005 reflects an increase in
staffing levels, primarily in India.
Business Process Outsourcing. Business Process Outsourcing provides
outsourcing services to third parties, including mortgage underwriting, data
entry, call center services, and mortgage research.
Selected information
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ 98 $ 397
Servicing and related fees ....................... $ 2,586 $ 2,155
Non-interest expense ............................. $ 2,455 $ 1,755
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Commercial Servicing. This segment includes the results of both our
domestic and international servicing of commercial assets, as well as our
commercial loan servicing system product (REAL Synergy). International servicing
is conducted through GSS, our joint servicing venture with Merrill Lynch. We
have established servicing offices in Tokyo, Japan, Taipei, Taiwan, and Toronto,
Canada. We have also established consulting operations in the United Kingdom,
Germany and China. At March 31, 2005, this segment serviced a total of 9,717
loans with an aggregate unpaid principal balance of $13,184,903, the majority of
which were serviced by our office in Japan.
Selected information
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ 21 $ (42)
Non-interest revenue:
Servicing and related fees ................... $ 4,076 $ 3,498
Other ........................................ 673 394
---------- ----------
$ 4,749 $ 3,892
========== ==========
Non-interest expense ............................. $ 4,682 $ 3,933
Corporate Items and Other. Pre-tax results for this segment include
certain 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, gains and losses from debt repurchases and certain
other corporate expenses. The table below presents the more significant amounts
included in each of the periods indicated.
Selected information
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ (3,466) $ 704
Net interest income (expense) .................... (886) 47
Non-interest revenue ............................. (162) 3,419
Non-interest expense ............................. 2,414 2,756
. Net interest expense for the first quarter of 2005 includes interest on
the $175,000 of 3.25% Convertible Notes that we issued in July 2004.
. Non-interest revenue includes $397 and $3,675 of interest income
recognized during the first quarter of 2005 and 2004, respectively, on
federal income tax refund claims. See "Changes in Financial Condition -
Receivables" for additional information regarding these claims.
NON-CORE BUSINESSES
See Note 7 to the Interim Consolidated Financial Statements for
additional information related to our segments.
Based on the relative insignificance of the assets remaining in the
following segments, the remaining assets of these businesses and any related
income or loss arising from their resolution have been included in the Corporate
Items and Other segment beginning January 1, 2005.
Commercial Assets. Results for this segment reflect our continuing exit
from the commercial loan and real estate businesses. We have not purchased any
commercial assets since 2000. Since then, this business has consisted of the
management, repositioning and resolution of the remaining non-core assets. At
December 31, 2004 the $21,560 of non-core assets remaining in this business
consisted of four real estate assets (a shopping center, parcel of land and two
partnership interests) and one unrated subordinate security.
Selected information
For the periods ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ -- $ (3,241)
Net interest income (expense) .................... -- (293)
Provision for loan losses ........................ -- (509)
Non-interest revenue ............................. -- (2,295)
Non-interest expense ............................. -- 1,162
Affordable Housing. Historically, we invested in affordable housing
properties primarily through a series of limited partnerships. Except to
complete those projects in which an investment had already been made, we ceased
making investments in properties in 2000 as part of our shift in strategy to
fee-based businesses and because the volume of tax credits being generated was
exceeding our ability to utilize them effectively. Since that time, we have been
marketing these properties for sale. Our investment in affordable housing
properties at December 31, 2004 consisted of one limited partnership property
with a carrying value of $5,641. In addition, this segment had $3,198 of loans
outstanding at December 31, 2004 to the one remaining limited partnership
property that we do not consolidate in our financial statements.
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Pre-tax income (loss) ............................ $ -- $ (973)
Net interest income (expense) .................... -- (411)
Provision for loan losses ........................ -- (29)
Non-interest expense ............................. -- 592
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Non-Interest Revenue. The following table sets forth the principal
components of non-interest income during the periods indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Servicing and related fees ....................... $ 45,389 $ 42,291
Vendor management fees ........................... 10,881 13,003
Gain (loss) on trading securities, net ........... (1,397) (643)
Valuation gains (losses) on real estate .......... 89 (1,851)
Gain (loss) on sales of real estate .............. 34 (541)
Operating income (losses) from real estate ....... (174) 8
Other income ..................................... 1,884 6,621
---------- ----------
$ 56,706 $ 58,888
========== ==========
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Servicing and Related Fees. Our servicing and related fees are
primarily comprised of fees we earned from investors for servicing residential
mortgage loans on their behalf. The following table sets forth the principal
components of servicing and related fees by segment for the periods indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Residential Servicing:
Servicing fees (1) ........................... $ 43,507 $ 46,117
Late charges ................................. 9,126 11,369
Interest on custodial accounts (2) ........... 6,507 3,013
Compensating interest expense (3) ............ (5,656) (8,211)
Amortization of servicing rights ............. (25,115) (25,661)
Default servicing fees ....................... 214 945
Retail banking fees .......................... 2,285 2,370
Other fees, net............................... 1,016 4,165
---------- ----------
31,884 34,107
Commercial Servicing.............................. 4,076 3,498
Residential Origination Services.................. 3,461 96
Ocwen Recovery Group.............................. 3,455 2,975
Business Process Outsourcing...................... 2,586 2,155
Corporate Items and Other......................... (73) (540)
---------- ----------
$ 45,389 $ 42,291
========== ==========
(1) The decline in residential loan servicing fees during the first quarter
of 2005 as compared to 2004 primarily reflects a decline in the number
of loans serviced. See "Segment Results - Residential Servicing".
(2) Interest we earned on float balances during the holding period between
collection of borrower payments and remittance to investors. These
custodial accounts are held by an unaffiliated bank and are excluded
from our statement of financial condition. The average balances held in
these custodial accounts were approximately $1,008,700 and $1,081,700
for the first quarter of 2005 and 2004, respectively. The increase in
interest earned during the first quarter of 2005 is due to an increase
in interest rates. See "Segment Results - Residential Servicing". The
investment of float balances is restricted to certain types of
interest-earning instruments, although we are responsible for any
losses incurred on the investment of these funds. To date, we have not
incurred any such losses on our investment of float balances.
(3) A servicer of securitized loans is typically obligated to pay the
securitization trust the difference between a full month of interest
and the interest collected on loans that are repaid before the end of a
calendar month.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
The following table sets forth information regarding loans and real
estate we serviced at the dates indicated.
Loans(1)(2)(3) Real Estate(4) Total
--------------------------- --------------------------- ---------------------------
Amount Count Amount Count Amount Count
------------ ------------ ------------ ------------ ------------ ------------
Residential Loan Servicing
March 31, 2005:
Performing ............... $ 32,140,521 266,487 $ -- -- $ 32,140,521 266,487
Non-performing ........... 4,081,801 48,840 1,158,360 15,240 5,240,161 64,080
------------ ------------ ------------ ------------ ------------ ------------
$ 36,222,322 315,327 $ 1,158,360 15,240 $ 37,380,682 330,567
============ ============ ============ ============ ============ ============
December 31, 2004:
Performing ............... $ 29,227,341 253,617 $ -- -- $ 29,227,341 253,617
Non-performing ........... 3,971,439 48,711 1,325,711 17,857 5,297,150 66,568
------------ ------------ ------------ ------------ ------------ ------------
$ 33,198,780 302,328 $ 1,325,711 17,857 $ 34,524,491 320,185
============ ============ ============ ============ ============ ============
Commercial Servicing
March 31, 2005:
Performing ............... $ 1,159,689 345 $ -- -- $ 1,159,689 345
Non-performing (5)........ 11,928,048 9,335 97,166 37 12,025,214 9,372
------------ ------------ ------------ ------------ ------------ ------------
$ 13,087,737 9,680 $ 97,166 37 $ 13,184,903 9,717
============ ============ ============ ============ ============ ============
December 31, 2004:
Performing ............... $ 834,032 367 $ -- -- $ 834,032 367
Non-performing (5)........ 12,530,324 9,393 120,367 34 12,650,691 9,427
------------ ------------ ------------ ------------ ------------ ------------
$ 13,364,356 9,760 $ 120,367 34 $ 13,484,723 9,794
============ ============ ============ ============ ============ ============
(1) At March 31, 2005 we serviced 260,670 subprime loans with a total
unpaid principal balance of $32,125,502, as compared to 238,105
subprime loans with an unpaid principal balance of $28,374,493 at
December 31, 2004. Subprime loans represent residential loans we
service which 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 serviced for others have been delinquent for 90
days or more. Performing loans serviced for others are current or have
been delinquent for less than 90 days.
(3) Under sub-servicing contracts we serviced approximately 64,463
residential loans with an unpaid principal balance of $7,768,421. This
compares to approximately 71,235 residential loans with an unpaid
principal balance of $7,902,887 serviced under sub-servicing contracts
at December 31, 2004.
(4) Includes $699,685 and $839,654 of foreclosed residential properties
serviced for the VA at March 31, 2005 and December 31, 2004,
respectively.
(5) Non-performing loans serviced by the Commercial Servicing Segment
include unsecured charged-off loans and deficiency loans.
Vendor Management Fees. Vendor management fees are primarily comprised
of property valuation fees earned by the Residential Origination Services
segment. The following table sets forth the principal components of vendor
management fees by segment for the periods indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Residential Servicing (1) ........................ $ 2,087 $ 2,110
Residential Origination Services (1) (2) ......... 8,785 10,899
Corporate Items and Other ........................ 9 (6)
---------- ----------
$ 10,881 $ 13,003
========== ==========
(1) Includes a total of $3,221 and $3,041 of fees earned across our
business segments from vendors in the REALTrans network during the
first quarter of 2005 and 2004, respectively.
(2) Includes residential property valuation fees of $6,805 and $9,196
earned during the first quarter of 2005 and 2004, respectively. The
higher fees in 2004 primarily relates to the initial boarding of the
VA portfolio of properties in 2004.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Gain (Loss) on Trading Securities, Net. Gain (loss) on trading
securities, net, includes both unrealized gains (losses) on securities and
realized gains (losses) resulting from sales thereof. The losses for the first
quarter of 2005 and 2004 are primarily comprised of net unrealized losses of
$(1,327) and $(792), respectively, on our unrated subprime residual securities.
Valuation Gains (Losses) on Real Estate. We regularly assess the value
of our remaining real estate assets and provide additional loss reserves or
impairment charges as appropriate. During the first quarter of 2004, we recorded
a $1,900 charge to reflect a loss in fair value on our retail shopping center
located in Halifax, Nova Scotia. During the first quarter of 2005 we sold the
wholly-owned subsidiary that held this shopping center. See "Changes in
Financial Condition - Real Estate."
Other Income. The following table sets forth the principal components
of other income by segment for the periods indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ---------- ----------
Interest on federal tax refund claims (1) ........ $ 397 $ 3,675
Technology and related revenue (2) ............... 799 644
Collections of credit card receivables (3) ....... 349 473
Other ............................................ 339 1,829
---------- ----------
$ 1,884 $ 6,621
========== ==========
(1) Interest income on federal tax refund claims due from the Internal
Revenue Service ("IRS"). Our policy is to recognize interest income on
income tax receivable balances upon receipt of a written finding from
the IRS agent that validates our claim. See "Changes in Financial
Condition - Receivables".
(2) Represents service contract fees, maintenance fees, consulting revenue
and other fees earned through our technology products - REALServicing,
REALSynergy and REALTrans.
(3) Comprised of collections of credit card receivables accounted for under
the cost recovery method. See "Segment Results - Ocwen Recovery Group".
Net Interest Income (Expense). Net interest income (expense) is the
difference between the interest income earned from our interest-earning assets
and the interest expense incurred on our interest-bearing liabilities. Net
interest income (expense) is determined by net interest spread (i.e., the
difference between the yield earned on our interest-earning assets and the rates
incurred on our interest-bearing liabilities), the relative amount of
interest-earning assets and interest-bearing liabilities and the degree of
mismatch in the maturity and repricing characteristics of our interest-earning
assets and interest-bearing liabilities.
In addition to interest income reported in this caption, we also earn
interest on the balance of custodial accounts we hold in connection with our
Residential Servicing business. These amounts are reported as a component of
servicing fees and are not included in the following information.
Our net interest income and net interest margin began declining in 2000
and have been negative since 2001. This trend reflects a decline in the ratio of
interest-earning assets to interest-bearing liabilities, which has fallen from
98% for 1999 to 55% for the first quarter of 2005. Our change in strategic
direction from capital-intensive businesses to fee-based sources of income has
contributed to an increase in the relative amount of non-interest-earning assets
(such as advances on loans serviced for others and mortgage servicing rights)
that are funded by interest-bearing liabilities. We expect the trend of net
interest expense and negative net interest margin to continue as we dispose of
our remaining non-core assets, a portion of which are interest-bearing, and
increase non-interest-earning assets of our core businesses. In more recent
periods, this trend has been partially offset by the continuing reduction in
higher rate brokered certificates of deposit and the issuance, in July 2004, of
$175,000 of Convertible Notes at 3.25%, which have had a positive impact on net
interest income, spread and margin.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
The following table sets forth, for the periods indicated, information
regarding the total amount of income from our interest-earning assets and the
resultant average yields, the interest expense associated with our
interest-bearing liabilities, expressed in dollars and rates, and the net
interest spread and net interest margin. Information is based on average daily
balances during the indicated periods:
2005 2004
----------------------------------- --------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
For the three months ended March 31, Balance Expense Rate Balance Expense Rate
- ------------------------------------------------------- ---------- ---------- ------- ---------- ---------- -------
Average Assets:
Interest-earning cash and other ....................... $ 87,241 $ 615 2.82% $ 38,028 $ 114 1.20%
Federal funds sold and repurchase agreements .......... 39,618 244 2.46% 156,119 392 1.00%
Trading securities (1):
Investment grade securities ....................... 244,418 1,545 2.53% 5,281 16 1.21%
Subordinates and residuals ........................ 38,801 3,915 40.36% 43,132 3,222 29.88%
Loans (2) ............................................. 8,271 13 0.63% 44,715 460 4.11%
Match funded loans (3) ................................ 4,064 -- --% 23,912 401 6.71%
---------- ---------- ---------- ----------
Total interest earning assets ..................... 422,413 6,332 6.00% 311,187 4,605 5.92%
---------- ----------
Advances on loans and loans serviced for others ....... 246,314 355,334
Mortgage servicing rights ............................. 137,522 162,229
Match funded advances on loans serviced for others .... 269,211 102,118
Other non-interest earning assets ..................... 192,077 308,427
---------- ----------
Total assets ...................................... $1,267,537 $1,239,295
========== ==========
Average Liabilities and Stockholders Equity:
Interest-bearing demand deposits ...................... $ 12,467 51 1.64% $ 24,160 58 0.96%
Savings deposits ...................................... 5,951 7 0.47% 1,719 3 0.70%
Certificates of deposit (4) ........................... 220,045 1,766 3.21% 457,104 3,977 3.48%
---------- ---------- ---------- ----------
Total interest-bearing deposits ................... 238,463 1,824 3.06% 482,983 4,038 3.34%
Match funded liabilities (5) .......................... 224,242 2,647 4.72% 114,217 1,027 3.60%
Lines of credit and other secured borrowings (6) ...... 69,950 668 3.82% 102,910 1,208 4.70%
Debt securities (7) ................................... 231,249 3,301 5.71% 56,249 1,529 10.87%
---------- ---------- ---------- ----------
Total interest-bearing liabilities ................ 763,904 8,440 4.42% 756,359 7,802 4.13%
---------- ----------
Escrow deposits ....................................... 126,876 120,889
Other non-interest bearing liabilities ................ 43,974 38,837
---------- ----------
Total liabilities ................................. 934,754 916,085
Minority interest ..................................... 1,511 1,340
Stockholders' equity .................................. 331,272 321,870
---------- ----------
Total liabilities and stockholders' equity ........ $1,267,537 $1,239,295
========== ==========
Net interest income (expense) ......................... $ (2,108) $ (3,197)
========== ==========
Net interest spread ................................... 1.58% 1.79%
Net interest margin ................................... (2.00)% (4.11)%
Ratio of interest-earning assets to interest-bearing
liabilities .......................................... 55% 41%
(1) The increase in the average yield on subordinates and residual
securities in the first quarter of 2005 is largely the result of
increased cash flows from our U.K. unrated single-family subprime
residual securities, which increased the interest earnings on these
securities. The decrease in our average investment in subordinates and
residuals is primarily due to principal repayments and a decline in
fair value of our subprime residuals.
(2) The decline in the average balance of loans is a result of sales,
resolutions and repayments (primarily commercial loans) coupled with a
decline in originations and repurchases. This reflects our strategic
decision to exit non-core businesses and dispose of the related assets.
The average balances include non-performing loans, interest on which is
recognized on a cash basis. The decrease in the yield for the first
quarter of 2005 reflects the fact that approximately 50% of the
portfolio consists of non-performing loans.
(3) The decline in the average balance of match funded loans was primarily
the result of principal repayments received on the loans and the sale
of the remaining single family loans at the end of the first quarter of
2004 in connection with the redemption of the related match funded
debt.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
(4) The decrease in the average balance of certificates of deposits
resulted primarily from maturing brokered and non-brokered certificates
of deposit. We have not issued any new brokered certificates of deposit
since 2000. The decline in the average rate earned on deposits reflects
the maturing of brokered certificates with higher rates.
(5) The increase in the average balance of match funded liabilities is due
primarily to a servicing advance securitization that we executed in
November 2004 offset in part by principal repayments on other match
funded liabilities and the redemption at the end of the first quarter
2004 of the match funded debt secured by single family loans (as noted
in (3) above).
(6) The decline in the average balance of lines of credit and other secured
borrowings is due to repayments and maturities.
(7) The increase in the average balance of debt securities outstanding
resulted primarily from the issuance in July 2004 of $175,000 of 3.25%
Contingent Convertible Senior Unsecured Notes due 2024. See "Changes in
Financial Condition - Debt Securities". The issuance of the Convertible
Notes has also resulted in a decline in the average rates for the first
quarter of 2005.
The following table describes the extent to which changes in interest
rates and changes in volume of interest-earning assets and interest-bearing
liabilities have affected our interest income and expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior rate), (ii) changes in rate (change
in rate multiplied by prior volume) and (iii) total change in rate and volume.
Changes attributable to both volume and rate have been allocated proportionately
to the change due to volume and the change due to rate.
2005 vs. 2004
--------------------------------------
Favorable (Unfavorable) Variance
--------------------------------------
For the three months ended March 31, Rate Volume Total
- ----------------------------------------------------------------- ---------- ---------- ----------
Interest Income from Interest-Earning Assets
Interest earning cash and other ................................. $ 256 $ 245 $ 501
Federal funds sold and repurchase agreements .................... 288 (436) (148)
Trading securities:
Investment grade securities ................................... 36 1,493 1,529
Subordinates and residuals .................................... 1,042 (349) 693
Loans ........................................................... (228) (219) (447)
Match funded loans .............................................. (219) (182) (401)
---------- ---------- ----------
Total interest income from interest-earning assets ............ 1,175 552 1,727
---------- ---------- ----------
Interest Expense on Interest-Bearing Liabilities
Interest-bearing demand deposits ................................ (29) 36 7
Savings deposits ................................................ 1 (5) (4)
Certificates of deposit ......................................... 288 1,923 2,211
---------- ---------- ----------
Total interest-bearing deposits ............................... 260 1,954 2,214
Match funded liabilities ........................................ (395) (1,225) (1,620)
Lines of credit and other secured borrowings .................... 199 341 540
Notes and debentures ............................................ 1,025 (2,797) (1,772)
---------- ---------- ----------
Total interest expense on interest-bearing liabilities ........ 1,089 (1,727) (638)
---------- ---------- ----------
Favorable (unfavorable) variance, net ........................... $ 2,264 $ (1,175) $ 1,089
========== ========== ==========
Non-Interest Expense. The following table sets forth the principal
components of our non-interest expense during the period indicated:
For the three months ended March 31, 2005 2004
- ----------------------------------------------------------------- ---------- ----------
Compensation and employee benefits .............................. $ 24,371 $ 22,033
Occupancy and equipment ......................................... 4,242 3,997
Technology and communication costs .............................. 7,399 6,669
Loan expenses ................................................... 5,712 7,927
Loss (gain) on investments in affordable housing properties ..... 642 (38)
Professional services and regulatory fees ....................... 4,721 5,825
Other operating expenses ........................................ 4,570 3,036
---------- ----------
$ 51,657 $ 49,449
========== ==========
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Compensation and Employee Benefits. The following table presents the
principal components of compensation and benefits we incurred for the period
indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ------------ ------------
Salaries (1) ..................................... $ 16,711 $ 14,104
Bonuses (2) ...................................... 2,610 2,694
Payroll taxes .................................... 1,792 1,734
Commissions ...................................... 1,317 1,240
Insurance ........................................ 802 525
Severance ........................................ -- 908
Other (3) ........................................ 1,139 828
------------ ------------
$ 24,371 $ 22,033
============ ============
(1) Salaries include fees paid for the services of temporary employees.
(2) Bonus expense includes compensation related to employee incentive
awards of restricted stock and stock options.
(3) Other consists primarily of recruiting expenses, matching contributions
to our 401(K) plan, other benefits and payments to independent
contractors.
The increase in compensation and benefits in the first quarter of 2005
as compared to the first quarter of 2004 is primarily due to increases in
salaries. The increase in salaries has occurred primarily because of an increase
in the average number of our full-time employees, both in the U.S. and our India
offices. Our total combined workforce (domestic and international) averaged
3,158 employees in the first quarter of 2005 as compared to 2,474 for the first
quarter of 2004. For the three months ended March 31, 2005 and 2004, our India
workforce averaged 2,060 and 1,481, respectively. Severance for the first
quarter of 2004 includes a one-time payment of $750 to the former president of
OTX in accordance with the terms of his employment agreement.
Occupancy and Equipment. The following table presents the principal
components of occupancy and equipment costs for the period indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ------------ ------------
Postage and mailing .............................. $ 1,181 $ 1,558
Rent ............................................. 900 709
Depreciation ..................................... 714 696
Other ............................................ 1,447 1,034
------------ ------------
$ 4,242 $ 3,997
============ ============
Technology and Communication Costs. The following table presents the
principal components of technology and communication costs for the years
indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ------------ ------------
Depreciation:
Hardware ..................................... $ 1,479 $ 1,574
Software ..................................... 845 706
Other ........................................ 187 141
------------ ------------
2,511 2,421
------------ ------------
Telecommunications ............................... 1,567 1,486
Document imaging.................................. 723 483
Maintenance and other............................. 2,598 2,279
------------ ------------
$ 7,399 $ 6,669
============ ============
Loan Expenses. Loan expenses for the first quarter of 2005 and 2004
included $4,054 and $7,095, respectively, of appraisal fees incurred in
connection with property valuation services we provided through the Residential
Origination Services segment. Loan expenses also include other miscellaneous
expenses incurred in connection with loans we own and those we service for
others.
Professional Services and Regulatory Fees. The following table presents
the principal components of professional services and regulatory fees for the
periods indicated:
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ------------ ------------
Legal fees and settlements (1) ................... $ 2,213 $ 3,333
Consulting fees (non-technology) ................. 531 602
Audit and accounting fees (2)..................... 901 554
Insurance ........................................ 547 437
Other ............................................ 529 899
------------ ------------
$ 4,721 $ 5,825
============ ============
(1) Includes $2,000 recorded during the first quarter of 2004 to establish
a reserve for multiple breach fees that were charged to borrowers but
may no longer be collectible.
(2) The increase in audit and accounting fees in the first quarter of 2005
is primarily due to additional fees incurred in connection with
compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
Other Operating Expenses. The following table presents the principal
components of other operating expenses for the periods indicated:
For the three months ended March 31, 2005 2004
- -------------------------------------------------- ------------ ------------
Bad debt expense (1) ............................. $ 2,204 $ 1,650
Travel, lodging, meals and entertainment ......... 1,074 662
Amortization of deferred costs ................... 287 264
Deposit related expense .......................... 225 197
Other ............................................ 780 263
------------ ------------
$ 4,570 $ 3,036
============ ============
(1) Bad debt expense includes a provision of $2,096 and $1,393 recorded
during the first quarter of 2005 and 2004, respectively, for estimated
uncollectible servicing advances and other receivables related to our
Residential Servicing segment. The provision recorded during the first
quarter of 2004 includes $1,000 to establish an allowance for
forbearance fees that we are no longer collecting directly from
borrowers.
Income Tax Expense (Benefit). The following table provides details of
our income tax expense for the periods indicated:
For the three months ended March 31, 2005 2004
- --------------------------------------------------------------------------- -------- --------
Income tax expense (benefit) on income (loss) before taxes ................ $ 550 $ 2,476
Provision for (reversal of) valuation allowance on deferred tax asset ..... -- (2,465)
-------- --------
Total income tax expense (benefit) ........................................ $ 550 $ 11
======== ========
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 $165,927 at both March 31, 2005 and December
31, 2004. Our assessment of 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) was also considered. Reversal of all or a portion of the
valuation allowance may be appropriate in the future based on the results of our
operations.
Income tax expense (benefit) on income (loss) before income taxes
differs from amounts that would be computed by applying the Federal corporate
income tax rate of 35% because of the effect of foreign taxes, non-economic tax
residual payments, changes in the valuation allowance and low-income housing tax
credits. Income tax expense for the first quarter of 2005 and 2004 reflects tax
credits of $352 and $598, 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 income tax expense only
to the corporate alternative minimum tax rate of 20% of taxable income.
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
CHANGES IN FINANCIAL CONDITION
Trading Securities. The following table sets forth the fair value of
our trading securities at the dates indicated:
March 31, December 31,
2005 2004
------------ ------------
Investment grade (1):
U.S. Treasury ................................ $ 591 $ 1,594
Collateralized mortgage obligations
(AAA-rated) ................................. 71,962 81,466
Bonds and debentures (2) ..................... 2,551 3,155
------------ ------------
$ 75,104 $ 86,215
============ ============
Subordinates and residuals (3):
Single family residential
BB-rated subordinates ...................... $ 254 $ 256
B-rated subordinates ....................... 420 435
Unrated subordinates ....................... 206 217
Unrated subprime residuals ................. 33,257 35,276
------------ ------------
34,137 36,184
Commercial unrated subordinates .............. 3,226 3,343
------------ ------------
$ 37,363 $ 39,527
============ ============
(1) Investment grade securities declined by $11,111 during the first
quarter 2005 primarily due to maturities and principal repayments on
CMOs. We invest in CMOs as needed to meet the Qualified Thrift Lender
requirements of the Bank.
(2) These securities were acquired in connection with our acquisition of
BOK on September 30, 2004.
(3) During the first quarter 2005, our subordinate and residual trading
securities declined by $2,164. This change was primarily due to a
decline in fair value of the subprime residual securities.
Subordinate and residual interests in mortgage-related securities
provide credit support to the more senior classes of the mortgage-related
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
securities, we may not recover the full amount or, indeed, any of our remaining
investment in such subordinate and residual interests.
Subordinate and residual interests are affected by the rate and timing
of payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until over
collateralization or the balance in the reserve account reaches a specified
level. For residual interests in residential mortgage-backed securities, over
collateralization is the amount by which the collateral balance exceeds the sum
of the bond principal amounts. Over collateralization is achieved by applying
monthly a portion of the interest payments of the underlying mortgages toward
the reduction of the senior class certificate principal amounts, causing them to
amortize more rapidly than the aggregate loan balance. Over collateralization
represents the first tier of loss protection afforded to the non-residual
holders. To the extent not consumed by losses on more highly rated bonds, over
collateralization is remitted to the residual holders. In periods of declining
interest rates, rates of prepayments on mortgage loans generally increase, and
if the rate of prepayments is faster than anticipated, then the yield on
subordinates will be positively affected and the yield on residuals will be
negatively affected.
We periodically assess the carrying value of our subordinate securities
and residual securities retained. There can be no assurance that our estimates
used to determine the value of subordinate securities and residual securities
retained will remain appropriate for the life of each securitization. If actual
loan prepayments or defaults exceed our estimates, the carrying value of our
subordinate securities and residual securities retained may be decreased during
the period in which we recognized the disparity.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
The following table presents information regarding our subordinate and
residual trading securities summarized by classification and rating at March 31,
2005:
ANTICIPATED ANTICIPATED ANTICIPATED
YIELD TO YIELD TO WEIGHTED
PERCENT MATURITY AT MATURITY AT AVERAGE
OWNED PURCHASE 3/31/2005 REMAINING
RATING/DESCRIPTION (1) BY OCWEN (2)(3) (2)(4) COUPON LIFE (2)(5)
- ---------------------------------------- ---------- ------------ ------------ ------ ------------
Single family residential:
BB-rated subordinates .............. 100.00% 19.23% 11.46% 6.75% 3.77
B-rated subordinates ............... 100.00% 17.09% 17.65% 5.92% 1.86
Unrated subordinates ............... 100.00% 13.92% 41.97% 6.50% 0.19
Unrated subprime residuals ......... 100.00% 17.27% 11.58% N/A 4.21
Commercial:
Unrated subordinates ............... 25.00% 22.15% 14.10% N/A 1.40
(1) Refers to the credit rating designated by the rating agency for each
securitization transaction. Classes designated "A" have a superior
claim on payment to those rated "B." Additionally, multiple letters
have a superior claim to designations with fewer letters. Thus, for
example, "BBB" is superior to "BB," which in turn is superior to "B."
The lower class designations in any securitization will receive
interest payments after senior classes and will experience losses
before any senior class. The lowest potential class designation is
"unrated" which, if included in a securitization, will always receive
interest last and experience losses first.
(2) Subordinate and residual securities do not have a contractual maturity
but are paid down over time as cash distributions are received. Because
they do not have a stated maturity, we disclose the weighted average
life of these securities.
(3) Represents the effective yield from inception to maturity based on the
purchase price and anticipated future cash flows under pricing
assumptions.
(4) Represents the effective yield based on the purchase price, actual cash
flows received from inception until the respective date, and the then
current estimate of future cash flows under the assumptions at the
respective date. Changes in the March 31, 2005 anticipated yield to
maturity from that originally anticipated are due to differences
between estimated 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.
(5) Represents the weighted average life in years based on the March 31,
2005 book value.
The mortgages that underlie our trading subordinate and residual
securities, which totaled $208,831 at March 31, 2005, are secured by properties
located in forty-nine states and the United Kingdom. The largest aggregate value
of mortgages in any one state or country is $46,095.
Real Estate. Our investment in real estate declined from $18,732 at
December 31, 2004 to $9,450 at March 31, 2005. This decline of $9,282 is
primarily due to the sale of our consolidated subsidiary that owned our retail
shopping center located in Halifax, Nova Scotia. This property had a net
carrying value of $8,827 at December 31, 2004. Our investment in real estate at
March 31, 2005 consists primarily of interests in two limited partnerships
operating as multi-family real estate ventures with a net carrying value of
$8,361.
Loans, Net. Our net investment in loans amounted to $8,575 and $3,792
at March 31, 2005 and December 31, 2004, respectively. The balance at March 31,
2005 consists primarily of two loans - a loan with a carrying value of $3,211 to
our one remaining affordable housing property, in which we have invested as a
limited partner but do not consolidate in our financial statements, and a loan
with a carrying value of $4,957 that we made during the first quarter of 2005 to
facilitate the sale of our investment in a consolidated subsidiary that owned
our shopping center located in Halifax, Nova Scotia. This new loan is the
primary reason for the $4,783 increase in loans during the first quarter of
2005. See "Real Estate" above.
See "Changes in Financial Condition - Allowance for Loan Losses" below
for information regarding the allowance for loan losses.
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Allowances for Loan Losses. As discussed in the "Results of Operations
- - Provision for Loan Losses" section, we maintain an allowance for loan losses
for each of our loans at a level that we consider adequate to provide for
probable losses based upon an evaluation of known and inherent risks.
The following table sets forth an analysis of activity in the allowance
for loan losses during the three months ended March 31, 2005:
Balance at December 31, 2004................................ $ 4,546
Provision for loan losses................................... 4
Charge-offs................................................. (200)
--------------
Balance at March 31, 2005................................... $ 4,350
==============
The allowance for loan losses at March 31, 2005 and December 31, 2004
included $4,268 and $4,468, respectively, related to a loan to our one remaining
affordable housing property.
Match Funded Assets. Match funded assets are comprised of the following
at the dates indicated:
March 31, December 31,
2005 2004
----------- ------------
Match funded advances on loans serviced for others:
Principal and interest ......................... $ 90,643 $ 107,102
Taxes and insurance ............................ 113,245 107,710
Other .......................................... 62,393 61,814
----------- ------------
266,281 276,626
Commercial loans ................................... 3,678 4,134
----------- ------------
$ 269,959 $ 280,760
=========== ============
Match funded advances on loans serviced for others resulted from the
transfers of certain residential loan servicing related advances to qualified
special purpose entities ("QSPE") in exchange for cash. These advances are owned
by the QSPEs and are, therefore, not available to satisfy the claims of our
general creditors. These transfers did not qualify as sales under generally
accepted accounting principles because we retained effective control of the
advances. Accordingly, we report the amount of proceeds we received from the
sales as secured borrowings with pledges of collateral (match funded
liabilities). See "Match Funded Liabilities".
Commercial match funded loans held by our GSS subsidiary in Japan
resulted from the transfer, on a non-recourse basis, of an undivided 100%
participation interest in certain real estate loans to a Japanese subsidiary of
Merrill Lynch on March 30, 2004 in exchange for cash. The transfer did not
qualify as a sale under generally accepted accounting principles as we did not
meet all of the conditions for surrender of control over the transferred loans.
Accordingly, we report the amount of proceeds we received from the transfer as a
secured borrowing with pledge of collateral (match funded liabilities). See
"Match Funded Liabilities".
Advances on Loans and Loans Serviced for Others. Advances related to
our loan portfolios and loans we serviced for others consisted of the following
at the dates indicated:
March 31, December 31,
2005 2004
------------ ------------
Loans serviced for others:
Principal and interest ....................... $ 50,237 $ 51,782
Taxes and insurance .......................... 90,257 94,926
Other ........................................ 91,423 93,375
------------ ------------
231,917 240,083
Loans ............................................ 344 347
------------ ------------
$ 232,261 $ 240,430
============ ============
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. We generally
recover such advances from borrowers for reinstated and performing loans and
from investors for foreclosed loans. We record a charge to the extent that we
estimate that advances are uncollectible, taking into consideration the age and
nature of the advance and our historical loss experience, among other factors.
Advances on loans serviced for others are net of reserves of $4,308 and $5,212
as of March 31, 2005 and December 31, 2004, respectively. The $4,308 of reserves
at March 31, 2005 includes $3,503 to provide for forbearance plan fees and
multiple breach fees that may no longer be collectible. See "Results of
Operations - Core Businesses - Residential Servicing".
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Advances on loans serviced for others do not include match funded
advances that were transferred to a third party in transactions that did not
qualify as sales for accounting purposes and that we account for as secured
borrowings. See "Match Funded Assets" for information regarding these advances.
Mortgage Servicing Rights. The unamortized balance of our mortgage
servicing rights is primarily related to residential assets. Our investment
increased by $3,865 during the three months ended March 31, 2005 as purchases
exceeded amortization. The rate of amortization reflects high rates of actual
and projected prepayments on subprime residential mortgage loans due to low
interest rates. Purchases for the three months ended March 31, 2005 reflects the
more cautious acquisition strategy that we adopted given the uncertainty of
prepayment speeds in the current environment. In addition, we have commitments
with the OTS to maintain our investment in mortgage servicing rights at certain
levels. See Note 5 to the Interim Consolidated Financial Statements and "General
- - Banking Operations" for additional information regarding these commitments.
See also "Results of Operations Non-Interest Revenue - Segment Results" and -
"Servicing and Related Fees". The following table sets forth the activity in our
mortgage servicing rights at the dates indicated:
Balance at December 31, 2004............................... $ 131,409
Purchases.................................................. 28,980
Amortization............................................... (25,115)
-------------
Balance at March 31, 2005.................................. $ 135,274
=============
At March 31, 2005, we serviced loans under approximately 363 servicing
agreements for 22 investors. Purchases during the three months ended March 31,
2005 were all for residential assets.
Receivables. Receivables consisted of the following at the dates
indicated:
March 31, December 31,
2005 2004
------------ ------------
Residential Loan Servicing (1) ................... $ 25,873 $ 24,012
Residential Origination Services ................. 6,120 3,455
Commercial Servicing ............................. 2,055 2,736
Business Process Outsourcing ..................... 1,370 1,532
Ocwen Recovery Group ............................. 999 341
Commercial Assets (2) ............................ -- 192
Affordable Housing (3) ........................... -- 18,308
Corporate Items and Other (4) .................... 99,051 76,143
------------ ------------
$ 135,468 $ 126,719
============ ============
(1) Includes $18,422 and $12,801 at March 31, 2005 and December 31, 2004,
respectively, of receivables representing fees earned from the
servicing of loans and real estate. The remaining balance consists
principally of reimbursable expenses earned from loan servicing
investors.
(2) Based on the relative insignificance of the non-core assets remaining
in this segment, the remaining assets of this business have been
included in the Corporate Items and Other segment beginning January 1,
2005.
(3) Based on the relative insignificance of the non-core assets remaining
in this segment, the remaining assets of this business have been
included in the Corporate Items and Other segment beginning January 1,
2005. The balance primarily represents payments to be received in
future years from the sale of investments in affordable housing
properties. On March 31, 2005 the balance included in the Corporate
Items and Other segment was $18,385, net of an unaccreted discount of
$2,108 and a reserve for doubtful accounts of $5,799. The December 31,
2004 balance of $18,308 is net of discount and reserves $2,346 and
$5,596, respectively.
(4) Includes $61,074 and $61,591 of income taxes receivable at March 31,
2005 and December 31, 2004, respectively. As of March 31, 2005, income
taxes receivable includes $56,526 of federal tax refund claims, the
payment of which is subject to final approval by the Joint Committee on
Taxation of the U.S. Congress. We have agreed with the IRS to extend
the statute of limitations with respect to these claims until December
31,2005, and we currently expect that this approval will be issued
prior to that date. The receivable balance a March 31, 2005 and
December 31, 2004 also included $7,269 and $6,872, respectively, of
accrued interest on the federal tax refund claims. The increase in the
balance of receivables in the Corporate Items and Other segment in the
first quarter of 2005 is primarily due to the transfer of Affordable
Housing assets to this segment effective January 1, 2005, as noted in
(3) above.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Other Assets. Other assets consisted of the following at the dates
indicated:
March 31, December 31,
2005 2004
----------- ------------
Deferred tax assets, net (1) ....................... $ 17,504 $ 17,683
Deferred debt related costs, net ................... 10,923 11,216
Interest earning insurance collateral deposits (2).. 8,832 8,905
Loans held for resale (3) .......................... 6,887 8,437
Interest earning reserve accounts (4) .............. 5,664 5,850
Goodwill, net ...................................... 5,312 5,312
Prepaid expenses ................................... 4,085 4,069
Mutual fund and stocks (5) ......................... 2,592 2,886
Capitalized software development costs, net ........ 782 1,147
Other .............................................. 3,987 3,472
----------- ------------
$ 66,568 $ 68,977
=========== ============
(1) Deferred tax assets are net of valuation allowances totaling $165,927
at both March 31, 2005 and December 31, 2004. See "Results of
Operations - Income Tax Expense (Benefit)".
(2) These deposits 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 income tax returns. The surety
bond is necessary in order to avoid the recapture of those tax credits
previously claimed.
(3) Loans 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. The
loans outstanding at March 31, 2005 were all sold during April 2005.
(4) Represents amounts set aside from the proceeds of our match funded
advance facilities to provide for possible shortfalls in the funds
available to pay certain expenses and interest.
(5) This balance primarily represents an investment by the Bank in a mutual
fund that invests in assets that meet the requirements of the Community
Reinvestment Act.
Deposits. Our customer deposits declined by $101,769 during the first
quarter of 2005 primarily as a result of maturing certificates of deposit. This
trend reflects our reduced reliance on deposits as a source of financing our
operations. See "Banking Operations" and "Liquidity, Commitments and Off-Balance
Sheet Risks". The following table sets forth information related to our deposits
at the dates indicated:
March 31, 2005 December 31, 2004
------------------------------------ -----------------------------------
Weighted Weighted
Average % of Total Average % of Total
Amount Rate Deposits Amount Rate Deposits
---------- ---------- ---------- ---------- ---------- ----------
Non-interest bearing checking accounts ........... $ 4,929 --% 2.5% $ 4,513 --% 1.5%
NOW and money market checking accounts ........... 10,302 2.00% 5.2% 12,541 0.75% 4.1%
Savings accounts ................................. 5,673 1.18% 2.8% 6,574 0.75% 2.2%
---------- ---------- ---------- ----------
20,904 10.5% 23,628 7.8%
---------- ----------
Total certificates of deposit (1)(2) ............. 178,626 2.93% 89.5% 277,671 3.12% 92.2%
---------- ---------- ---------- ----------
$ 199,530 100.0% $ 301,299 100.0%
========== ========== ========== ==========
(1) Included $5,808 and $26,418 at March 31, 2005 and December 31, 2004,
respectively, of brokered deposits originated through national,
regional and local investment banking firms that solicit deposits from
their customers, all of which are non-cancelable.
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
(2) At March 31, 2005 and December 31, 2004, certificates of deposit with
outstanding balances of $100 or more amounted to $47,724 and $76,002,
respectively. The basic insured amount of a depositor is $100. Deposits
maintained in different categories of legal ownership are separately
insured.
The following table sets forth the remaining maturities of our time
deposits with balances of $100 or more at March 31, 2005:
Matures within three months................................... $ 7,065
Matures after three months through six months................. 6,245
Matures after six months through twelve months................ 21,779
Matures after twelve months................................... 12,635
------------
$ 47,724
============
Escrow Deposits. Escrow deposits on our loans and loans we serviced for
others amounted to $121,499 and $125,977 at March 31, 2005 and December 31,
2004, respectively. The balance consisted principally of custodial deposit
balances representing collections that we made from borrowers for the payment of
taxes and insurance premiums on mortgage properties underlying loans that we
serviced for others. Such balances amounted to $116,713 and $105,924 at March
31, 2005 and December 31, 2004, respectively. See "Results of Operations -
Non-Interest Revenue - Servicing and Related Fees".
Match Funded Liabilities. Match funded liabilities represent proceeds
received from transfers of loans and advances on loans serviced for others.
Because we retained effective control over the assets transferred, these
transfers did not qualify as sales for accounting purposes and, therefore, we
report them as secured borrowings with pledges of collateral. See "Match Funded
Assets" for additional details regarding these transactions. Match funded
liabilities were comprised of the following at the dates indicated:
March 31, December 31,
Collateral (Interest Rate) Interest Rate 2005 2004
- --------------------------------------------- ------------------------------ ------------ ------------
Advances on loans serviced for others (2) See (1) below $ 132,186 $ 149,342
Advances on loans serviced for others (2) LIBOR plus 175 basis points 86,573 90,851
Commercial loans (3) 3,678 4,134
------------ ------------
$ 222,437 $ 244,327
============ ============
(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. The term note
bears interest at LIBOR plus 50 basis points. The variable funding note
bears interest at a commercial paper rate plus a margin that
approximates LIBOR plus 53 basis points. Under the terms of the
agreement, as of March 31, 2005, we are eligible to finance additional
advances on loans serviced for others of $42,814. The term note under
this facility has a stated maturity of October 2013. The variable
funding note has a stated maturity of November 2010.
(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
$200,000. This facility will mature in January 2006.
(3) Represents a 100% participation interest held by a third party.
The lending agreements for our match funded liabilities contain various
qualitative and quantitative covenants that, among other things,
establish requirements for the monitoring and reporting of specified
financial transactions and reporting on defined events affecting the
collateral underlying the agreements. We are currently in compliance
with these covenants. We are also in discussions with our lenders to
amend the lending agreements such that we will not be in default should
we succeed in terminating our status as a federal savings bank. We
anticipate successful completion of the discussions prior to debanking.
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
Lines of Credit and Other Secured Borrowings. We have obtained secured
borrowings from unaffiliated financial institutions as follows:
March 31, December 31,
Borrowing Type Collateral Maturity Interest Rate (1) 2005 2004
- ------------------------- ------------------------ --------------- -------------------- ------------ ------------
Senior secured credit Purchased mortgage April 2006 LIBOR + 162.5 or 225 $ 67,891 $ 24,218
agreement servicing rights and basis points
advances on loans
serviced for others (2)
Senior secured credit Purchased mortgage December 2005 LIBOR + 250 basis 8,333 11,458
agreement servicing rights points
Mortgage note Office building (3) October 2014 5.62% 14,865 14,936
------------ ------------
$ 91,089 $ 50,612
============ ============
(1) 1-month LIBOR was 2.87% and 2.40% at March 31, 2005 and December 31,
2004, respectively.
(2) The maximum amount of borrowing under this facility is $70,000.
(3) Collateral represents our loan servicing call center located in
Orlando, Florida. We entered into this mortgage in October 2004.
Each of our lines contains qualitative and quantitative covenants that
establish, among other things, the maintenance of specified net worth and
restrictions on future indebtedness, as well as the monitoring and reporting of
various specified transactions or events. We are currently in compliance with
these covenants. While we have not historically paid dividends, our covenants,
by establishing net worth requirements, in effect limit the amount of dividends
that could be paid. As of March 31, 2005, the most restrictive limitation of all
the covenants would limit dividends that could be paid to $55,726. We are in
discussions with our lenders to amend the lending agreements such that we will
not be in default should we succeed in terminating our status as a federal
savings bank. We anticipate successful completion of the discussions prior to
debanking.
Debt Securities. Debt securities consisted of the following at the
dates indicated:
March 31, December 31,
2005 2004
------------ ------------
3.25% Convertible Notes due August 1, 2024 ....... $ 175,000 $ 175,000
10.875% Capital Securities due August 1, 2027 .... 56,249 56,249
------------ ------------
$ 231,249 $ 231,249
============ ============
In addition to the specific requirements discussed below, each of our
debt securities contain qualitative and quantitative covenants that establish,
among other things, the maintenance of specified net worth and restrictions on
future indebtedness, as well as the monitoring and reporting of various
specified transactions or events. We are currently in compliance with these
covenants.
Convertible Notes. In July 2004, OCN issued $175,000 aggregate
principal amount of 3.25% Contingent Convertible Senior Unsecured Notes due 2024
("Convertible Notes") in a private placement as permitted by the Securities Act
of 1933, as amended. The Convertible Notes are senior unsecured obligations of
Ocwen Financial Corporation and bear interest at the rate of 3.25% per year.
Interest is payable on February 1 and August 1 of each year, beginning on
February 1, 2005. The Convertible Notes will mature on August 1, 2024.
Holders may convert all or a portion of their notes into shares of our
common stock under the following circumstances: (1) at any time during any
calendar quarter commencing after December 31, 2004, if the closing sale price
of our common stock for at least 20 trading days in a period of 30 consecutive
trading days ending on the last trading day of the calendar quarter prior to
such quarter is greater than 125% of the conversion price per share of common
stock on such last day; (2) subject to certain exceptions, during the five
business day period after any five-consecutive-trading-day period in which the
trading price per $1 principal amount of the notes for each day of the
five-consecutive-trading-day period was less than 98% of the product of the
closing sale price of our common stock and the number of shares issuable upon
conversion of $1 principal amount of the notes; (3) if the notes have been
called for redemption; (4) upon the occurrence of specified corporate
transactions; or (5) if we elect at our sole discretion to permit conversion
following the implementation of EITF Issue 04-8. We elected not to permit
conversion following the implementation of EITF 04-8 in the fourth quarter of
2004.
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
The conversion rate will be 82.1693 shares of our common stock per $1
principal amount of the notes, subject to adjustment. Events that may cause the
conversion rate to be adjusted, as more fully described in the related indenture
agreement, primarily relate to cash dividends or other distributions to holders
of our common stock. Upon conversion, we may at our option choose to deliver, in
lieu of our common stock, cash or a combination of cash and common stock as
described herein.
Beginning August 1, 2009, we may redeem all or a portion of the notes
for cash for a price equal to 100% of the principal amount of the notes to be
redeemed plus accrued and unpaid interest, if any.
Holders may require us to repurchase all or a portion of their notes
for cash on August 1, 2009, August 1, 2014, and August 1, 2019 or upon the
occurrence of a "fundamental change" at a repurchase price equal to 100% of the
principal amount of the notes to be repurchased plus accrued and unpaid
interest, if any. A "fundamental change", as further defined in the indenture
agreement, is deemed to have occurred upon a change of control or a termination
of trading in our common stock.
Capital Securities. In August 1997, Ocwen Capital Trust ("OCT") issued
$125,000 of 10.875% Capital Securities (the "Capital Securities"). OCT invested
the proceeds from issuance of the Capital Securities in 10.875% Junior
Subordinated Debentures issued by OCN. The Junior Subordinated Debentures, which
represent the sole assets of OCT, will mature on August 1, 2027.
Holders of the Capital Securities are entitled to receive cumulative
cash distributions accruing from the date of original issuance and payable
semiannually in arrears on February 1 and August 1 of each year, commencing on
February 1, 1998, at an annual rate of 10.875% of the liquidation amount of
$1,000 per Capital Security. OCN guarantees payment of distributions out of
moneys held by OCT, and payments on liquidation of OCT or the redemption of
Capital Securities, to the extent OCT has funds available. If Ocwen Financial
Corporation does not make principal or interest payments on the Junior
Subordinated Debentures, OCT will not have sufficient funds to make
distributions on the Capital Securities, in which event the guarantee shall not
apply to such distributions until OCT has sufficient funds available therefore.
We have the right to defer payment of interest on the Junior
Subordinated Debentures at any time or from time to time for a period not
exceeding 10 consecutive semiannual periods with respect to each deferral
period, provided that no extension period may extend beyond the stated maturity
of the Junior Subordinated Debentures. Upon the termination of any such
extension period and the payment of all amounts then due on any interest payment
date, we may elect to begin a new extension period. Accordingly, there could be
multiple extension periods of varying lengths throughout the term of the Junior
Subordinated Debentures. If we defer interest payments on the Junior
Subordinated Debentures, distributions on the Capital Securities will also be
deferred, and we may not, nor may any of our subsidiaries, (i) declare or pay
any dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, their capital stock or (ii) make any
payment of principal, interest or premium, if any, on or repay, repurchase or
redeem any debt securities that rank pari passu with or junior to the Junior
Subordinated Debentures. During an extension period, interest on the Junior
Subordinated Debentures will continue to accrue at the rate of 10.875% per
annum, compounded semiannually.
We may redeem the Junior Subordinated Debentures before maturity at our
option, subject to the receipt of any necessary prior regulatory approval, (i)
in whole or in part on or after August 1, 2007, at a redemption price equal to
105.438% of the principal amount thereof on August 1, 2007, declining ratably on
each August 1 thereafter to 100% on or after August 1, 2017, plus accrued
interest thereon, or (ii) at any time, in whole (but not in part), upon the
occurrence and continuation of a special event (defined as a tax event,
regulatory capital event or an investment company event) at a redemption price
equal to the greater of (a) 100% of the principal amount thereof or (b) the sum
of the present values of the principal amount and premium payable with respect
to an optional redemption of such Junior Subordinated Debentures on August 1,
2007, together with scheduled payments of interest from the prepayment date to
August 1, 2007, discounted to the prepayment date on a semiannual basis at the
adjusted Treasury rate plus accrued interest thereon to the date of prepayment.
The Capital Securities are subject to mandatory redemption, in whole or in part,
upon repayment of the Junior Subordinated Debentures at maturity or their
earlier redemption, in an amount equal to the amount of the related Junior
Subordinated Debentures maturing or being redeemed and at a redemption price
equal to the redemption price of the Junior Subordinated Debentures, plus
accumulated and unpaid distributions thereon to the date of redemption.
For financial reporting purposes, we treat OCT as a subsidiary and,
accordingly, the accounts of OCT are included in our consolidated financial
statements. We eliminate intercompany balances and transactions with OCT,
including the balance of Junior Subordinated Debentures outstanding, in our
consolidated financial statements.
Stockholders' Equity. Stockholders' equity amounted to $332,926 at
March 31, 2005 as compared to $330,108 at December 31, 2004. The $2,818 increase
in stockholders' equity during the first quarter of 2005 was primarily due to
net income of $2,387. See the Consolidated Statements of Changes in
Stockholders' Equity in the Interim Consolidated Financial Statements for
additional information regarding changes in stockholders' equity during the
first quarter of 2005.
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
We did not purchase any shares of our own common stock during the three
months ended March 31, 2005. 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.
LIQUIDITY, COMMITMENTS AND OFF-BALANCE SHEET RISKS
Our primary sources of funds for liquidity are:
. Lines of credit and other . Payments received on loans
secured borrowings and securities
. Match funded debt . Proceeds from sales of assets
. Debt securities . Deposits
. Servicing fees
We closely monitor our liquidity position and ongoing funding
requirements. At March 31, 2005, we had $205,574 of unrestricted cash and cash
equivalents and $73,312 of short-term investment grade securities. Unrestricted
cash and cash equivalents and short-term investment grade securities combined
represented 23% of total assets at March 31, 2005. 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:
. As noted in "Banking Operations", debanking, if successful, will
require that we make a cash payment to the purchaser of our branch that
will be based in part on the amount of deposits assumed. Scheduled
maturities of all certificates of deposit for the twelve months ending
March 31, 2006, the twelve months ending March 31, 2007 and thereafter
amount to $118,166, $46,683 and $13,777, respectively.
. Cash requirements to fund our acquisition of additional servicing
rights and related advances.
. The maturity of an existing senior secured credit with an outstanding
balance of $8,333 in December 2005.
. Ongoing cash requirements to fund operations of our holding company.
Our reliance on deposits has been reduced through sales of non-core
assets and by diversifying our funding sources, including obtaining credit
facilities for servicing rights and advances. If, as described under "Banking
Operations," we cease to control a federal savings bank, we would no longer be
able to rely on deposits obtained in the United States through the Bank as a
source of funding.
In the last several years, our Residential Servicing business has grown
through the purchase of servicing rights. 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 on 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, deposits,
credit facilities and seller financing. Our credit facilities provide financing
to us at 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:
. 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 $200,000 at any one time. At March 31,
2005, we had $86,573 of match funded liabilities outstanding under this
facility, which will mature in January 2006. The sales of advances do
not qualify as sales for accounting purposes; therefore, we report them
as secured borrowings with pledges of collateral.
. In April 2003, we also entered into a $60,000 secured credit agreement
that may be used to fund servicing advances and acquisitions of
servicing rights. The agreement matured in April 2005 and has been
renewed through April 2006. In April 2004, the size of the facility was
increased to $70,000. At March 31, 2005, we had a balance outstanding
under this agreement of $67,891. In April 2005, we concluded a
syndication of this credit line which will increase our borrowing
capacity under this agreement by $65,000 for a total of $135,000. The
syndication will formally close effective with debanking.
43
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
. In December 2003, we entered into a $12,500 secured credit agreement
under which any borrowings are collateralized by mortgage servicing
rights. In January 2004, we borrowed $12,500 under this facility, and
the balance outstanding as of March 31, 2005 was $8,333.
. On November 17, 2004, we entered into a match funded agreement under
which we transferred certain of our advances on loans serviced for
others. As of March 31, 2005, proceeds received in connection with
this transfer of advances were $132,186. As of December 31, 2004,
there was $42,814 of capacity available under this facility. The
transfers of advances under this agreement do not qualify as sales for
accounting purposes because we retain effective control of the
advances. Accordingly, we report the advances transferred as match
funded assets and the amount of proceeds we receive from the transfers
as a secured borrowing with pledge of collateral. The $100,000 term
note under this facility has a stated maturity of October 2013. The
variable funding note has a stated maturity of November 2010. In April
2005, we issued an incremental term note for $75,000 and an additional
one-year variable funding note for $25,000, thus providing an
additional $100,000 of financing under this advance securitization
structure.
We believe that our existing sources of liquidity, including internally
generated funds, will be adequate to fund our planned activities for the
foreseeable future, although there can be no assurances in this regard. As
discussed above, 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 (used) $50,394 and $64,626 of cash
flows during the three months ended March 31, 2005 and 2004, respectively.
Operating cash flow decreased principally because of lower net income and
because net collections on advances and match funded advances on loans and loans
serviced for others declined to $18,514 in the first quarter of 2005 as compared
to $43,448 in the first quarter of 2004. These declines were partially offset by
an increase in net cash provided by trading securities.
Our investing activities provided (used) cash flows totaling $(30,093)
and $(6,907) during the three months ended March 31, 2005 and 2004,
respectively. The increase in cash flows used by investing activities is largely
the result of increased purchases of mortgage servicing rights in the first
quarter of 2005 as compared to the first quarter of 2004, coupled with decreased
proceeds from the sale of real estate and lower principal payments on loans. The
increase in these cash outflows was partly offset by lower acquisitions of match
funded loans and lower originations of loans.
Our financing activities provided (used) cash flows of $(87,619) and
$29,990 during the three months ended March 31, 2005 and 2004, respectively.
Cash flows from financing activities decreased principally because deposits
declined in the first quarter of 2005 by $(106,247) as a result of maturing
brokered and non-brokered deposits. This compares to an increase of $66,087 in
the first quarter of 2004 when we were replacing maturing brokered deposits with
new non-brokered deposits. Offsetting this decrease in cash flows, lines of
credit and other secured borrowing provided cash of $40,477 in the first quarter
of 2005 because of increased borrowing under a senior secured credit agreement
that is secured by servicing rights and advances. During the first quarter of
2004, lines of credit and other secured borrowings used $(50,857) of cash
principally because of the maturity of a line of credit collateralized by
servicing advances.
See the Consolidated Statements of Cash Flows in the Interim
Consolidated Financial Statements for additional details regarding cash flows
during the three months ended March 31, 2005 and 2004.
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,
certificates of deposit and operating leases. See Note 8 to the Interim
Consolidated Financial Statements for additional information regarding
commitments and contingencies.
Off-Balance Sheet Risks. 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. See Note 45 to the Interim Consolidated Financial Statements
and "Asset and Liability Management" above.
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.
44
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - (Continued)
(Dollars in thousand, except share data)
REGULATORY CAPITAL AND OTHER REQUIREMENTS
See Note 5 to the Interim Consolidated Financial Statements.
RECENT ACCOUNTING DEVELOPMENTS
For information relating to the effects of our adoption of recent
accounting standards, see Note 2 to the Interim Consolidated Financial
Statements.
45
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Dollars in thousands)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and
magnitude of the repricing of assets and liabilities. Our objective is to
control risks associated with interest rate and foreign currency exchange rate
movements. Our Asset/Liability Management Committee (the "Committee"), which is
composed of certain of our officers, formulates and monitors our asset and
liability management strategy in accordance with policies approved by our Board
of Directors. The Committee meets to review, among other things, the sensitivity
of our assets and liabilities to interest rate changes and foreign currency
exchange rate changes, the book and market values of assets and liabilities,
unrealized gains and losses, including those attributable to hedging
transactions, purchase and sale activity, and maturities of investments and
borrowings. The Committee also approves and establishes pricing and funding
decisions with respect to overall asset and liability composition.
The Committee's method for evaluating interest rate risk includes an
analysis of the our interest rate sensitivity "gap," which is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
The following table sets forth the estimated maturity or repricing of
our interest-earning assets and interest-bearing liabilities at March 31, 2005.
The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except:
. Adjustable-rate loans, performing discount loans and securities are
included in the period in which they are first scheduled to adjust and
not in the period in which they mature,
. Fixed-rate mortgage-related securities reflect prepayments that were
estimated based on analyses of broker estimates, the results of a
prepayment model we use and empirical data,
. Non-performing discount loans reflect the estimated timing of
resolutions that result in repayment to us,
. NOW and money market checking deposits and savings deposits, which do
not have contractual maturities, reflect estimated levels of attrition,
which are based on our detailed studies of each such category of
deposit and,
. Escrow deposits and other non interest-bearing checking accounts, which
amounted to $126,428 at March 31, 2005, are excluded.
We believe that these assumptions approximate actual experience and
consider them reasonable; however, the interest rate sensitivity of our assets
and liabilities in the table could vary substantially if we were to use
different assumptions or actual experience differs from the historical
experience on which we based the assumptions.
46
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - (Continued)
(Dollars in thousands)
March 31, 2005
----------------------------------------------------------------------------
Four to More Than
Within Three Twelve One Year to Three Years
Months Months Three Years and Over Total
------------ ---------- ------------ ------------ ----------
Rate-Sensitive Assets (1):
Interest-earning deposits ...................... $ 113,306 $ -- $ -- $ -- $ 113,306
Trading securities ............................. 18,116 44,776 36,603 12,972 112,467
Investments .................................... 8,256 -- -- -- 8,256
Loans, net (1) ................................. 228 5,335 1,150 1,862 8,575
Match funded loans (1) ......................... 3,678 -- -- -- 3,678
------------ ---------- ------------ ------------ ----------
Total rate-sensitive assets .................. 143,584 50,111 37,753 14,834 246,282
------------ ---------- ------------ ------------ ----------
Rate-Sensitive Liabilities:
NOW and money market checking deposits ......... 8,488 208 445 1,161 10,302
Savings deposits ............................... 4,032 253 500 888 5,673
Certificates of deposit ........................ 21,858 96,351 55,717 4,700 178,626
------------ ---------- ------------ ------------ ----------
Total interest-bearing deposits .............. 34,378 96,812 56,662 6,749 194,601
Match funded liabilities ....................... 222,437 -- -- -- 222,437
Lines of credit and other secured borrowings ... 67,890 8,333 -- 14,866 91,089
Notes and debentures ........................... -- -- -- 231,249 231,249
------------ ---------- ------------ ------------ ----------
Total rate-sensitive liabilities ............. 324,705 105,145 56,662 252,864 739,376
------------ ---------- ------------ ------------ ----------
Interest rate sensitivity gap (2) ................ $ (181,121) $ (55,034) $ (18,909) $ (238,030) $ (493,094)
============ ========== ============ ============ ==========
Cumulative interest rate sensitivity gap ......... $ (181,121) $ (236,155) $ (255,064) $ (493,094)
============ ========== ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets ....... (73.48)% (95.89)% (103.57)% (200.22)%
As of December 31, 2004:
Cumulative interest rate sensitivity gap ......... $ (243,089) $ (296,306) $ (325,317) $ (564,364)
============ ========== ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets ....... (94.00)% (114.58)% (125.79)% (218.23)%
(1) We have not reduced balances for any non-performing loans.
(2) We had no rate-sensitive derivative financial instruments outstanding
at March 31, 2005.
We have experienced a large negative interest rate sensitivity gap in
recent years. The negative interest rate sensitivity gap reflects the economics
of our Residential Servicing business. At March 31, 2005, we had servicing
advances of $517,056 consisting of advances on loans and loans serviced for
others of $240,430 and match funded advances on loans serviced for others of
$276,626. Servicing advances do not bear interest but are generally funded with
interest bearing liabilities. As a result, these instruments result in a
negative interest rate sensitivity gap. In addition, we earn interest on float
balances. We earn a short term, 30 days or less, rate of interest on float
balances. These float balances, which are not included in our financial
statements, amounted to $1,028,785 and $867,884 at March 31, 2005 and December
31, 2004, respectively. When the float balances are considered by adding them to
the within three months rate-sensitive assets, the interest rate sensitivity gap
shifts from negative to positive.
The OTS has established specific minimum guidelines for thrift
institutions to observe in the area of interest rate risk as described in Thrift
Bulletin No. 13a, "Management of Interest Rate Risk, Investment Securities, and
Derivative Activities" ("TB 13a"). Under TB 13a, institutions are required to
establish and demonstrate quarterly compliance with board-approved limits on
interest rate risk that are defined in terms of net portfolio value ("NPV"). We
use NPV to measure our exposure to interest rate risk. NPV is calculated as the
net present value of expected cash flows from an institution's existing assets,
less the net present value of the expected cash flows from existing liabilities,
plus the net present value of expected cash inflows from existing financial
derivatives and off-balance sheet contracts. Cash flows for each asset and
liability are based on the contractual rates and terms at the individual asset
and liability level. These cash flows are discounted to the present period using
a discount rate that is relevant to the particular asset or liability, to arrive
at the base case scenario. Deposit instruments are discounted using their annual
percentage rate paid to the depositor, loans at their contractual interest rate.
Residual and subordinate securities are discounted at rates ranging from 18% to
21% depending on the composition of their underlying collateral and its
performance.
47
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - (Continued)
(Dollars in thousands)
The NPV model does not value new business activity or other projected
or possible changes in the company's balance sheet. Rather, it takes a snapshot
view of the portfolio at each quarter-end and estimates its economic value at
that time and the value of the portfolio under the different interest rate
scenarios. The model estimates the current, or base case, economic value of each
type of asset, liability and off-balance sheet contract at the end of each
quarter.
NPV is useful in assessing interest rate risk in that it measures how
changes in interest rates might affect the economic value of a portfolio of
assets, liabilities and off balance sheet contracts. By recalculating NPV under
various interest rate scenarios, we can see the consequences of our business
strategy under several possible alternative courses of interest rates, and
evaluate the extent to which we may want to alter our interest rate exposure
through hedging or other techniques.
The board-approved limits specify the minimum net portfolio value ratio
("NPV Ratio") allowable under current interest rates and hypothetical interest
rate scenarios. An institution's NPV Ratio for a given interest rate scenario is
calculated by dividing the NPV that would result in that scenario by the present
value of the institution's assets in that same scenario. The hypothetical
scenarios are represented by immediate, permanent, parallel movements (shocks)
in the term structure of interest rates of plus 100, 200 and 300 basis points
and minus 100 basis points from the actual term structure observed at quarter
end. The NPV Ratio may be interpreted as an indicator of capital strength in
each scenario: the higher the NPV Ratio, the greater is the institution's
ability to weather negative events. The change in an institution's NPV Ratio
across the various scenarios gives an indication of the capacity of the
institution to withstand interest rate stress. The current NPV Ratio for each of
the five rate scenarios and the corresponding limits approved by the Board of
Directors, as applied to Ocwen Financial Corporation and its subsidiaries, are
as follows at March 31, 2005:
Board Limits Current
Rate Shock in basis points (minimum NPV Ratios) NPV Ratios
- -------------------------- -------------------- ----------
+300 5.00% 35.58%
+200 6.00% 33.54%
+100 7.00% 31.24%
-- 8.00% 28.60%
-100 7.00% 25.54%
The Committee also regularly reviews interest rate risk by forecasting
the impact of alternative interest rate environments on net interest income or
expense and NPV and evaluating such impacts against the maximum potential
changes in net interest income and NPV that is authorized by the Board of
Directors, as applied to Ocwen Financial Corporation and its subsidiaries. We
calculate the cash flows associated with the loan portfolios and securities
based on prepayment and default rates that vary by asset. We generate projected
losses, as well as prepayments, based upon the actual experience with the
subject pool, as well as similar, more seasoned pools. To the extent available,
we use loan characteristics such as loan-to-value ratio, interest rate, credit
history, prepayment penalty terms and product types to produce the projected
loss and prepayment assumptions that are included in the cash flow projections
of the securities. When we shock interest rates we further adjust these
projected loss and prepayment assumptions. The base interest rate scenario
assumes interest rates at March 31, 2005. The base case net interest expense is
a projection of interest for the following 12 months based on the net interest
income or expense in our consolidated statement of operations for the last month
of the period. A weighted average rate of interest is calculated based on the
interest rate sensitivity gap of our rate sensitive assets and liabilities that
are scheduled to mature over the next twelve months following the end of the
period. The weighted average interest rate is then applied against the interest
rate sensitivity gap for this twelve-month period to determine the base case net
interest expense.
48
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - (Continued)
(Dollars in thousands)
An interest rate sensitivity gap is calculated for each interest rate
scenario, and a hypothetical net interest expense is calculated based upon the
weighted average interest rate. The result is then compared to the base case net
interest expense to determine the percentage increase or decrease in net
interest expense that each scenario produces relative to the base case. The
following table quantifies the potential changes in net interest expense and NPV
should interest rates go up or down (shocked) 300 or 100 basis points,
respectively, assuming the yield curves of the rate shocks will be parallel to
each other. Actual results of Ocwen Financial Corporation and its subsidiaries
could differ significantly from the results estimated in this table:
Estimated Changes in
--------------------------------------
Rate Shock in basis points Net Interest (1) NPV
- -------------------------- ---------------- ----------------
+300 68.10% 31.54%
+200 45.40% 21.99%
+100 22.70% 11.57%
-- --% --%
-100 (22.70)% (12.77)%
(1) The base case interest expense was based on net interest expense of
$714 for the month of March 2005.
The 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.
Foreign Currency Exchange Rate Risk Management. We have entered into foreign
currency futures to hedge our net investment in the foreign subsidiary that owns
our U.K. suprime residual securities and the short-term
Canadian-Dollar-denominated loan we made to facilitate the sale of our
investment in the foreign subsidiary that owned the shopping center in Halifax,
Nova Scotia. Our principal exposure to foreign currency exchange rates exists
with the British Pound versus the U.S. dollar and the Canadian Dollar versus the
U.S. Dollar. Our policy is to periodically adjust the amount of foreign currency
derivative contracts that we have entered into in response to changes in our
recorded investment in these foreign entities as well as to changes in our
assets denominated in a foreign currency. Our net exposures are subject to gain
or loss if foreign currency exchange rates fluctuate. See Note 4 to our Interim
Consolidated Financial Statements.
49
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our chief executive officer
and acting chief 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, 2005. Based on this evaluation, our
chief executive officer and acting chief financial officer concluded that, as of
March 31, 2005 our disclosure controls and procedures were (1) designed to
ensure that material information relating to the Company, including its
consolidated subsidiaries, is made known to our chief executive officer and
acting chief financial officer by others within those entities, particularly
during the period in which this report was being prepared and (2) effective, in
that they provide reasonable assurance that information required to be disclosed
by the Company 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, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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:
.. expectations related to the debanking process, related transactions and
subsequent plans;
.. projections for growth of the residential loan servicing business and
business opportunities in other core businesses;
.. predictions regarding sales of our commercial and affordable housing
assets;
.. assumptions related to the diversification of financing sources and the
adequacy of resources;
.. estimates regarding interest rates and foreign currency transactions; and
.. 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:
.. general economic and market conditions,
.. prevailing interest or currency exchange rates,
.. availability of servicing rights for purchase,
.. governmental regulations and policies,
.. international political and economic uncertainty,
.. availability of adequate and timely sources of liquidity,
.. uncertainty related to dispute resolution and litigation, and
.. 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, 2004 and periodic reports on Form 8-K. 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.
50
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
See "Note 10 Commitments and Contingencies" of Ocwen Financial
Corporation's Interim Consolidated Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a)3 EXHIBITS.
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 to Ocwen Capital Trust
I (4)
4.3 Form of Capital Security of Ocwen Capital Trust I (Included in
Exhibit 4.2) (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 4.4) (4)
4.6 Form of Guarantee of the 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. (10)
4.8 Indenture dated as of July 28, 2004, between OCN and the Bank of
New York Trust Company, N.A., as trustee (10)
10.1 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (5)
10.2 Ocwen Financial Corporation 1998 Annual Incentive Plan (6)
10.3 Compensation and Indemnification Agreement, dated as of May 6,
1999, between OAC and the independent committee of the Board of
Directors (7)
10.4 Indemnity agreement, dated August 24, 1999, among OCN and OAC's
Board of Directors (8)
10.5 Amended Ocwen Financial Corporation 1991 Non-Qualified Stock
Option Plan, dated October 26, 1999 (8)
10.6 First Amendment to Agreement, dated March 31, 2000, between HCT
Investments, Inc. and OAIC Partnership I, L.P. (8)
10.7 Ocwen Financial Corporation Deferral Plan for Directors, dated
March 7, 2005 (9)
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 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 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 the 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 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 Ocwen Financial Corporation's 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 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.
(6) Incorporated by reference from the similarly described exhibit to Ocwen
Financial Corporation's Definitive Proxy Statement with respect to
Ocwen Financial Corporation's 1998 Annual Meeting of Shareholders filed
with the Commission on March 31, 1998.
(7) Incorporated by reference from OAC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1999.
(8) Incorporated by reference from the similarly described exhibit included
with Registrant's Quarterly Report of Form 10-Q for the quarterly
period ended March 31, 2000.
51
(9) 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.
(10) Incorporated by reference from the similarly described exhibit included
with Registrant's Quarterly Report on Form10-Q for the quarterly period
ended June 30, 2004.
(b) Reports on Form 8-K Filed during the Quarter Ended March 31, 2005.
(1) A Form 8-K was filed by OCN on January 31, 2005, which contained
a news release announcing our 2004 fourth quarter and year
results and certain other information.
(2) A Form 8-K was filed by OCN on February 10, 2005, which disclosed
that we had entered into a Branch Purchase and Deposit Assumption
Agreement with Marathon National Bank of New York for the sale of
the Fort Lee, NJ branch of our subsidiary, Ocwen Federal Bank
FSB.
(3) A Form 8-K was filed by OCN on February 24, 2005, which disclosed
the resignation of Mark S. Zeidman as the principal financial
officer of Ocwen Financial Corporation and the appointment of
Robert J. Leist, Jr. as the interim principal financial officer.
(4) A Form 8-K was filed by OCN on March 10, 2005, which disclosed
that the Company's Board of Directors had approved a reserve of
$3 million for the two contingent liabilities and the consequent
revision of the previously announced fourth quarter and 2004
earnings and certain other information.
(5) A Form 8-K was filed by OCN on March 10, 2005, which disclosed
that the Board of Directors had adopted a Deferral Plan for
Directors effective May 17, 2005, that provides Directors with
the opportunity to defer the receipt of all or a portion of their
stock-based compensation.
52
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., Vice President &
Chief Accounting Officer and Acting
Chief Financial Officer
(On behalf of the Registrant and as its
principal financial officer)
Date: May 10, 2005
53