Musing on Ocwen’s Liquidity Situation

Background

Last Friday (12/12/2014) Ocwen (OCN) announced the purchase of $253mm Ginnie Mae early buyout (EBO) loans. On the surface this looks like good news as it appears that OCN is back on their feet doing business again.

Reading between the lines, I see this as a confession that they lack liquidity.

1) The company was obligated to buy those loans. Barclays’ MBS analysts noted that Ginnie Mae requires servicers to maintain delinquency levels below a 5% threshold, and delinquencies on OCN serviced pools have ran above that threshold for months.

2) In November the scuttlebutt was that Ocwen tried to sell those Ginnie Mae loans but were unsuccessful.

3) Last Friday OCN finally bought what they had to buy all along. But they turned around and sold it to an “unaffiliated third party”. Since Ocwen was already the servicer on these loans, this is not adding to their mortgage servicing rights portfolio.

So here’s the more complete narrative. OCN faced obligations to put up cash for loans. They were delinquent in doing so and tried unsuccessfully to offload that obligation. When they finally bought the loans, they had to bring in a 3rd party to finance it.

Is OCN having cash issues?

Latest Liquidity Situation Uncertain From Filings

At 9/30/2014, Ocwen had almost $300mm of cash on balance sheet but planned to use that for upcoming debt obligations and share repurchases.

Ocwen has to “advance” payments on behalf of delinquent borrowers and raise the money for that through securitization of advance receivables. The advance securitization notes each have their own “amortization date”, which is when OCN has to start paying down those notes and new advances are no longer financed. October 2014 was when the majority of these notes were supposed to start amortizing. In the latest 10Q, Ocwen said they subsequently paid off some of these notes, pushed back the amortization dates of some notes, and issued new notes. The disclosures are vague in terms of dollar sources and uses, so I’m unable judge their current liquidity situation regarding the advance receivables notes. Given the show of weakness on these Ginnie Mae EBO loans, I have to wonder.

Implications

The conventional view is that Ocwen services such a large portion of the subprime market that they’re “too big to fail”. But “too big to fail” does not mean shareholders won’t be wiped out, so investors can’t ignore the tail risk. Still, Ginnie Mae loans are a small subset of OCN’s overall servicing portfolio, so how might this sink Ocwen?

Liquidity issues, like runs on banks, are a bit of circular logic. Confidence (or lack thereof) feeds on itself. It doesn't help that Ocwen may have a large legal settlement coming anytime and capital requirements for servicers are still being discussed. Should Ocwen somehow lose Ginnie Mae’s business or show further signs of liquidity/capital strains, rating agencies may feel intense pressure to downgrade them further (rating agency analysts are people and they have to protect their career risk!) Further rating downgrades could effectively make banks pull their credit facilities - lower advanced rates, higher interest cost, covenant triggers...etc. At that point the issue is no longer confined to advance receivable facilities, but spills over to MSR financing, warehouse lending, corporate debt issues, capital requirements. In short - everything. In fact banks are probably already worried about OCN. No credit access = even less liquidity -> securities price spiral downward -> less confidence -> even less cash access.

Ocwen can try to ease its cash outflows by stop advancing earlier, and quicken the pace of modifications/principal reductions. Keep in mind though, investors have already threated to sue Ocwen due to opaque servicing practices. Any further changes in operations could lead to revolt in the MBS investor base.

In theory, servicing advances and EBO loans are high quality assets with virtually no credit risk, so there should be plenty of hedge funds, insurers…etc willing to provide funding and take these assets off Ocwen’s hands. On the other hand, the corporate high yield market is currently in shambles and liquidity is also scarce there. If I were a hedge fund and OCN desperately seeks my help, I wouldn’t do so without extracting my pound of flesh (perhaps some sort of convertible preferred?)

What If Liquidity Deteriorates

3 Scenarios: 

· Most likely. OCN gets its liquidity at higher funding cost or equity dilution. Ocwen and PennyMac (PFSI) appears to have some sort of alliance going on.

· Possible. Without funding, OCN couldn’t originate loans or acquire MSR. It goes into runoff mode.

· Low probability. Liquidity and confidence evaporates suddenly. Government or a consortium of investors take over OCN on emergency basis and stock goes to 0.


OCN is near the cusp of a tipping point in confidence. It’s possible that capital market goes into raging bull mode, liquidity splashes everywhere, in which case all these issues go away and stock goes back to the 50’s. For now I’m still on the sidelines, viewing Ocwen with a negative bias. If a trend emerges, I’m ready to act either way.