Fitch Affirms Ocwen Financial Corp at 'B-'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Ocwen Financial Corporation (OCN) and its wholly-owned subsidiary, Ocwen Loan Servicing, LLC (OLS) at 'B-'. Fitch has also affirmed OCN's senior unsecured notes and OLS's senior secured term loan at 'CC/RR6' and 'B-/RR4', respectively. The Rating Outlook is Stable. A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS
IDRs AND SENIOR DEBT
The affirmations reflect OCN's scale and market position within the subprime mortgage servicing industry, sufficient liquidity and cash flow generation capacity, and appropriate capitalization and leverage for its current ratings. Rating constraints include longer-term challenges regarding OCN's strategic direction and financial performance under heightened operational and governance frameworks resulting from elevated regulatory scrutiny and compliance standards. In particular, OCN faces execution risk associated with building a lending platform positioned for sustainable growth, and earnings pressure associated with increased compliance costs. Potential risks associated with OCN's relationship with New Residential Investment Corp. (NRZ), namely NRZ's right to seek to transfer non-agency servicing rights away from OCN in the absence of a servicer rating upgrade, are also rating constraints.
The Stable Rating Outlook reflects Fitch's expectation that OCN's financial profile will remain fairly stable over the outlook horizon, particularly concerning its operating cash flow generation, leverage, and near-term funding obligations. In addition, OCN's ratings are already at a highly speculative rating level, which incorporates the potential business-, financial-, and compliance-related challenges associated with the company's current operations.
NRZ is a publicly traded REIT externally-managed by an affiliate of Fortress Investment Group LLC, which currently owns approximately $523.5 million in rights to mortgage servicing rights (MSRs) and related servicing advances for non-Agency loans totaling $132.7 billion in unpaid principal balances (UPB) for which OCN currently acts as servicer. These MSRs were previously held by OCN-affiliate, Home Loan Servicing Solutions, Ltd. (HLSS). Fitch believes the NRZ relationship poses potential risks to OCN. For example, NRZ has the right to direct a transfer of servicing after receipt of third-party consents on affected servicing agreements, should OCN's servicer ratings remain below a specified threshold after April 7, 2017. Following such a transfer of servicing, OCN may no longer be entitled to receive servicing fees on a meaningful notional amount of OCN's total non-Agency servicing portfolio. Fitch views the probability of a servicing transfer as limited given the required third-party consents and licenses, as well as OCN's low cost to service high-touch subprime mortgages and scale.
Facing earnings pressure and a declining revenue base, OCN announced a cost improvement initiative in September 2015 in an effort to adjust the business for a reduced portfolio size and overhead structure. The cost improvement initiative is expected by OCN to generate a $300 million reduction in operational costs in 2016. Adjusted operating expenses declined $55 million, or 17% in 1Q16. Excluding MSR fair value changes, monitoring, lending, and new initiatives spending (rental and dealer floorplan finance), OCN reduced expenses by $80 million in 1Q16. Given the progress made to date, Fitch believes OCN can execute on the planned savings in the remainder of 2016. However; Fitch believes that uncontrollable costs, such as elevated compliance costs and MSR valuation changes will continue to pressure operating margins and create a drag on OCN's profitability in the near - to medium-term.
Fitch believes OCN has sufficient liquidity from balance sheet cash and operating cash flow generation to cover its current financing needs. As of March 31, 2016, the company had unrestricted cash of $280.5 million and generated cash flow from operations of between $500 million and $600 million over the last two-years.
OCN is heavily reliant on the wholesale debt markets to fund its operations. The company had $1.5 billion in advance funding facilities, $718.8 million in secured borrowings and $345.8 million in unsecured notes outstanding, as of March 31, 2016. In March 2016, OCN negotiated an amendment under its senior secured term loan (SSTL). Among other things, the amendment permanently removed certain financial covenants in exchange for a $19 million prepayment of principal under the SSTL and limits on the future repurchase of OCN's common stock and the redemption of senior unsecured notes. Fitch views the improved covenant flexibility associated with the amendment positively.
Fitch views OCN's capitalization and leverage to be appropriate relative to its current ratings. Fitch primarily assesses OCN's leverage on the basis of consolidated debt to tangible equity, which amounted to 6.27x as of March 31, 2016. The current metric is higher than the long-run average of 4.79x since 2011, as recent net losses have eroded retained earnings, which has more than offset the significant paydowns of principal made under the SSTL. Fitch calculates the consolidated leverage metric including the debt from Altisource Portfolio Solutions S. A. which provides technology, servicing software, and short sale and REO management to OCN, and the servicing advance financing facilities related to the rights to MSRs held by NRZ. Given that OCN's sales of its Agency servicing portfolios is substantially complete, Fitch believes the pace of repayments under the SSTL will likely abate and leverage is expected to remain relatively stable or worsen given the potential for future net losses, which will continue to erode retained earnings over the near - to medium-term. OCN's meaningful cost reduction efforts are expected to mitigate some of the earnings pressures in the near-term.
OCN currently has a $500 million share repurchase program, approved by the board until July 31, 2016. In 1Q16, the company completed the repurchase of 991,985 shares under the program for a total purchase price of $5.9 million. As of March 31, 2016, the approximate remaining authorization under the repurchase program was $119.7 million. Given OCN's current strategic priorities regarding new businesses and liquidity, Fitch does not envision significant repurchases under the current program.
OLS's SSTL has been affirmed at 'B-/RR4', which reflects equalization of the SSTL rating with the IDRs assigned to OCN and OLS, as well as the average recovery prospects in a stressed scenario based upon available collateral coverage for the term loan. The SSTL is secured by a first-priority interest in all unencumbered assets of the company and a pledge of capital stock of all subsidiaries.
OCN's senior unsecured notes have been affirmed at 'CC/RR6', which maintains the two-notch differential between the senior unsecured note ratings and the IDR assigned to OCN, and reflects the company's predominately secured funding profile, the modest level of unencumbered assets available to support the unsecured noteholders and the expectation of poor recovery prospects in a stressed scenario.
SUBSIDIARY AND AFFILIATED COMPANY
OLS is a primary operating company and wholly-owned subsidiary of OCN. The ratings of OLS are aligned with those of OCN because of the unconditional guaranty provided by OCN and its guarantor subsidiaries.
IDRs AND SENIOR DEBT
Fitch does not envision upward rating momentum for OCN at this time given the on-going long-term strategic uncertainty and execution risks noted above, combined with recent profitability challenges. However, the Rating Outlook could be revised to Positive if OCN can continue to demonstrate progress in complying with its consent orders and independent monitors, further improve its overall corporate governance framework, strengthen its financial position, and establish a sustainable and competitive business model as a mortgage lender without incurring outsized credit risk.
The ratings could be downgraded or the Outlook could be revised to Negative as a result of:
--Material fines or penalties or further restrictions on business activities resulting from additional lawsuits or regulatory actions.
--A material transfer of servicing duties due to termination of the servicing contract from NRZ.
--Sustained strategic uncertainty, including inability to build a sustainable mortgage origination platform or material expansion into businesses outside of OCN's core business.
--Insufficient cash coverage of near-term debt maturities.
--A sustained increase in balance sheet leverage on a consolidated basis and/or a reduced commitment by management to reduce balance sheet leverage.
--Aggressive capital management.
The ratings of the SSTL are sensitive to changes in OLS and OCN's Long-term IDRs, as well as changes in collateral values and advance rates under the secured borrowing facilities, which ultimately impact the level of available asset coverage.
The ratings of the senior unsecured notes are sensitive to any changes in OCN's Long-term IDR as well as to changes in OCN's funding profile, the mix of secured to unsecured funding, and unencumbered asset coverage. A material increase in unsecured funding combined with a material improvement in unencumbered asset coverage could reduce the notching between the IDR and the unsecured notes and/or improve the RR.
SUBSIDIARY AND AFFILIATED COMPANY
The ratings of OLS are sensitive to the same factors that might drive a change in OCN's IDR due to the unconditional guaranty provided by OCN and its guarantor subsidiaries.
Fitch has affirmed the ratings as follows:
Ocwen Financial Corporation
--Long-Term IDR at 'B-';
--Short-Term IDR at 'B';
--Senior unsecured notes at 'CC/RR6'.
Ocwen Loan Servicing, LLC
--Long-Term IDR at 'B-';
--Senior secured term loan at 'B-/RR4'.
The Rating Outlook is Stable.
Date of Relevant Committee: June 20, 2016
Summary of Financial Statement Adjustments: Fitch has made no adjustments that are not disclosed within the company's public filings.