--Ocwen Financial Corp. succeeds at servicing, but cuts costs with tax moves, offshore workers
--Company bought chairman's house for 50% more than he paid six years earlier amid Virgin Islands relocation
--Offshore workers raise housing agency concerns, appear to influence recent deal
By Christian Berthelsen and Andrew R. Johnson
Ocwen Financial Corp. (OCN) is far from a household name, but it is about to become a lot better-known to millions of Americans.
With a $3 billion deal in October, it is now poised to become the fifth largest servicer of mortgages in the U.S., many of them to borrowers with shaky credit histories. Ocwen--the name is N-E-W-C-O spelled backwards--is buying up the business from banks that are more familiar to U.S. borrowers, including Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS).
The expansion has been paying off: Net income more than doubled in the third quarter, jumping to $51.4 million from $20.2 million a year earlier, while revenue nearly doubled to $232 million, as the balance of loans serviced by the company rose 20%. And the rapid growth has made the company a stock market darling, sending its shares up 259% in the last two years.
What emerges through extensive interviews and a review of securities filings is a complex portrait of a company that has seemingly found a way to succeed at a costly business where other banks have struggled--but has done so at least in part through practices that raise regulatory, housing agency and corporate governance concerns.
Ocwen has been scrutinized by regulators and plaintiff lawyers over its practices, even as it has won praise from consumer advocates for its willingness to re-work mortgages and help struggling borrowers stay in their homes. It does business with related companies that share the same chairman. It also keeps expenses down through an offshore labor force, and uses foreign incorporations to minimize taxes--including the creation of a new subsidiary in St. Croix, the U.S. Virgin Islands, that will hold most of the company's operations.
And in August, it bought an Atlanta-area home from its chairman, William C. Erbey-- for nearly 50% more than he paid six years earlier--so he could relocate to the Virgin Islands to oversee the new subsidiary.
While the moves are legal and disclosed in regulatory filings, "There are certainly some fairly serious red flags in terms of behavior that are raised there," said Paul Hodgson, chief research analyst for GMI Ratings, a corporate governance and risk management research firm. Whether the dealings raise shareholder concerns depends on their size relative to overall company operations, but "we would recommend they flag it anyway," Hodgson said.
In a series of prepared statements, Ocwen said it has saved 300,000 homeowners from foreclosure while helping mortgage investors earn better returns on their investments. The company further stated that its corporate governance practices were sound; that its tax moves were cost-effective and its offshore labor force best serves shareholders, customers and mortgage investors; and that the purchase of the chairman's home was consistent with company practice.
"We have a superior ability to resolve delinquent loans and keep people in their homes, while returning present value-positive results for investors," Paul Koches, Ocwen's general counsel, said in an interview.
Rapid Expansion, Offshore Employees
Ocwen, working with partner Walter Investment Management Corp., outbid rival Nationstar with a $3 billion offer in an Oct. 24 bankruptcy auction for the mortgage servicing assets of Residential Capital LLC, the onetime mortgage division of auto lender Ally Financial. The deal, combined with other recent transactions, will nearly triple the principle value of mortgages managed by Ocwen to more than $360 billion, and a total of 2.3 million loans. A bankruptcy judge approved the deal last month, and it is expected to close in the first quarter of 2013.
Ocwen's rapid expansion has helped it grow into the dominant player in an evolving industry: a nonbank that manages hundreds of billions of dollars in home loans on behalf of investors who own the loans through mortgage securities.
The work has historically been done by banks, but they are now eager to shed the business in the face of new capital requirements, risk measurements and regulatory scrutiny. Ocwen's fast growth has made it a favorite among investors.
Another shareholder appeal: low costs, achieved through a largely foreign labor force, and taking advantage of offshore tax incorporations.
Ocwen has long emphasized its cost advantages and low operating expenses as a competitive advantage, with at least three-quarters of its 5,000 employees based in India and Uruguay, where it says its per-employee costs are one-eighth of those of a U.S. worker.
Ocwen's use of offshore employees to service mortgages has raised concerns among government agencies. Fannie Mae (FNMA), in particular, feared whether proper controls could be enforced with call centers in foreign jurisdictions, borrower's private financial information would be safeguarded and loans and workouts would be effectively managed, according to a person familiar with the agency's thinking.
The agency has approval oversight whenever control over mortgage servicing portfolios are transferred; as the recent ResCap deal ultimately took shape, Ocwen's bidding partner in the deal, Walter Investment Management Corp., took over the Fannie Mae mortgages in the portfolio.
In a statement, Ocwen said it is "committed to retaining a substantial portion of the existing ResCap employees in their various facilities around the country," adding: "We do have an obligation to operate in ways that best serve our shareholders and customers, as well as the investors who own the mortgages we service. And those obligations affect where we have our operations."
Mr. Koches, the company's general counsel, declined comment on the company's communications with Fannie Mae or the ultimate shape of the deal with Walter and ResCap.
Like other mortgage servicers, Ocwen has faced regulatory and legal scrutiny. Last year, it paid $5.1 million to settle a class-action lawsuit alleging it overcharged delinquent borrowers, though the company denied wrongdoing or liability as part of the settlement agreement. On Wednesday, the company agreed to install an outside observer to monitor its servicing practices at the request of the New York Department of Financial Services.
In securities filings, it has disclosed information requests and subpoenas from agencies including the Federal Trade Commission and Massachusetts attorney general over servicing activities and foreclosures. Ocwen warned that the regulatory actions could result in fines, penalties and higher servicing costs. An FTC spokeswoman declined comment on the status of the inquiry. A spokeswoman for the Massachusetts attorney general declined comment.
Still, the company has shown its willingness to work with struggling borrowers, with strong results: It modifies loans well above the industry average rate, and its share of loans "seriously delinquent" 12 months after a workout is below the average of other subprime lenders, a Citigroup analysis found.
And consumer advocates say Ocwen has done a better job of working with struggling borrowers than banks have historically, and that new regulatory oversight by the newly created Consumer Financial Protection Bureau has given borrowers added protections.
"In the current crisis, servicers who are not conflicted for a variety of reasons that the big bank servicers are have been more aggressive and more creative in their loan modifications," said Julia Gordon, director of housing finance and policy at the Center for American Progress, a Washington, D.C., left-leaning policy advocacy group. "What differentiates these mono-line servicers is they're not servicing the loans they made, and they're not holding a portfolio of second mortgages, so they're not conflicted in that respect. That does give them more of an incentive to focus on what works for a sustainable loan modification."
Chairman Home Purchase, Related Company Transactions
In August, Ocwen purchased Mr. Erbey's home for $6.5 million so he could relocate to the new St. Croix headquarters of the company's servicing subsidiary, company securities filings show.
The securities filing by Ocwen said the company bought Mr. Erbey's house at his "cost basis." Mr. Erbey and his wife E. Elaine Erbey bought the home, a 14,400-square-foot European-style estate on two acres in Sandy Springs, for $4.4 million in 2006, Fulton County, Ga., property records show.
The Fulton County assessor's office valued the property at $3.1 million in 2005. Real estate website Zillow estimates the value of the home at $4.6 million, and lists nearby and comparable homes in the low $3 million to mid-$5 million range. According to Zillow's home value index, the median value of top-tier homes in the Sandy Springs area is down 11.2% since July 2006, just after the Erbeys bought the house.
In a prepared statement, Ocwen said the transaction "is consistent with our senior executive relocation policy and practice. The purchase price reflected Mr. Erbey's documented cost basis in the property and was within the market value range provided by an independent third-party appraiser." Mr. Koches, the company's general counsel, said Mr. Erbey documented improvements to the property that justified the higher price. Mr. Koches said Mr. Erbey was not available to discuss the matter.
Ocwen is now selling the house and has listed it at $6.7 million. It has been on the market for more than 10 weeks.
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As of the beginning of October, Ocwen placed its servicing operations--which account for the vast majority of its revenue--into a subsidiary domiciled in St. Croix. Analysts expect the move to drive down Ocwen's effective tax rate, which averaged nearly 37% in the last several quarters, into the single digits, saving the company tens of millions of dollars each quarter. The company officially has its headquarters in Atlanta.
It is the third such Ocwen-related entity to be domiciled in a foreign tax haven, joining others in Luxembourg and the Cayman Islands.
The Luxembourg company, Altisource Portfolio Solutions SA (ASPS), was spun off from Ocwen in 2009, and the shares have more than quintupled since. The company uses a team of psychologists to develop computer-generated scripts that Ocwen employees use to talk borrowers through loan workouts. In a securities filing, Altisource said: "Our services are primarily centered on our relationship with Ocwen." Its effective tax rate over the last six quarters has been 9.3%.
Michelle Esterman, Altisource's chief financial officer, said the company based itself in Luxembourg to be in a time zone closer to its employees in India, where a majority of its workforce is located, as well as the tax benefits afforded to technology companies by the western European nation.
She said that while Ocwen accounts for 60% of Altisource's revenue, it could be a viable stand-alone company in its own right without Ocwen's business. She said the company maintains an arms-length relationship with Ocwen and that Mr. Erbey abstains from any board vote involving both companies.
The Cayman Islands company, Home Loan Servicing Solutions Ltd. (HLSS), purchases mortgage rights to be serviced by Ocwen. It was founded by Mr. Erbey as a separate entity in 2010 and went public earlier this year, raising $200 million in an offering to finance acquisitions of mortgage assets and servicing rights. Its effective tax rate over its three quarters as a public company has been 1.2%, and it has paid out more than 80% of its profits to shareholders.
Since the IPO, the shares have gained nearly 40%.
John Van Vlack, the president of HLSS, said in an interview that the dividend payout was intended to be similar to those of real estate investment trusts or business development companies, to attract similar kinds of income-seeking investors, which help keep capital costs low if the company goes back to the market for additional fundraisings. He said the company is domiciled in the Caymans so it would receive similar tax treatment to a REIT, and that all transactions between HLSS and Ocwen are done at a fair market-value price.
Mr. Erbey is chairman of all three companies. He owns 25.5% of Altisource and 2.8% of HLSS, in addition to his 13.2% ownership of Ocwen's common stock, according to company stock ownership filings. Mr. Erbey drew $1.87 million in compensation from Ocwen in 2011, $135,000 as a board member of HLSS and $163,000 as a board member of Altisource, the companies' most recent proxy and incorporation filings show.
HLSS's prospectus, meanwhile, said it could have conflicts of interest with both Ocwen and Altisource because of Mr. Erbey's role as chairman of all three companies and executives who have moved between them, and that certain agreements between the companies were "not negotiated on an arm's length basis."
In a prepared statement, the company said the formation of the St. Croix subsidiary "is part of our initiative to cost-effectively expand our U.S.-based servicing activities." The statement said Altisource and HLSS handle discrete functions different from Ocwen's mission and allow Ocwen to focus more on its core loan servicing business. The statement said strong corporate governance is a priority for Mr. Erbey and that the companies maintain "arm's length business relationships" with separate boards of directors.
"Tight governance is what makes the relationship between the companies work," the statement said.
Write to Christian Berthelsen at firstname.lastname@example.org and Andrew R. Johnson at email@example.com
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