CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the long-term Issuer Default Ratings (IDRs) of Ocwen Financial Corporation (OCN) and its wholly-owned, primary operating subsidiary, Ocwen Loan Servicing, LLC (OLS) at 'B', and affirmed OLS's senior secured term loan at 'B/RR4'. The Rating Outlook has been revised to Stable from Negative. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS - OCN and OLS
The affirmation of the ratings reflects OCN's operating cash flow generation and sufficient liquidity, positive asset/liability positioning relative to a rising rate environment and appropriate capitalization and leverage for its current ratings. The revision of the Outlook to Stable from Negative reflects the moderately slowing pace of acquisitions, which should allow for additional focus on integration, and a demonstrated ability to fund acquisitions with an appropriate balance of debt and equity.
Rating constraints include continued regulatory scrutiny of the mortgage servicing industry, organizational complexity and governance limitations associated with OCN and its affiliate companies, an aggressive historical growth strategy, which has increased integration and balance sheet risks, and low Fitch Core Capital levels.
The mortgage servicing industry is subject to significant regulatory scrutiny, which has increased the cost of servicing, but has also raised performance standards and served as a governor on growth and acquisitions. For example, in February 2014, the New York Department of Financial Services (NY DFS) requested that OCN indefinitely suspend its previously announced purchase of a mortgage servicing rights (MSR) portfolio from Wells Fargo Bank, N.A., with an unpaid principal balance (UPB) of $39 billion. The request stemmed from concerns regarding OCN's capacity to service additional loan volume, while maintaining appropriate servicing standards. Fitch believes the pause OCN's acquisition activity will help the company to advance the integration of its recent acquisitions while maintaining servicing standards, although a slowing of portfolio acquisitions may accelerate the company's growth into other adjacent businesses.
Fitch's analysis of OCN takes into account the operating performance and overall credit metrics of both OCN and Home Loan Servicing Solutions Ltd. (HLSS) given the close operating and strategic relationship between the two related parties. HLSS was launched in March 2012 as a publicly traded vehicle designed to acquire MSRs from OCN. As of year-end Dec. 31, 2013, OCN has completed sales of MSRs and rights to MSRs totaling $202.3 billion of UPB to HLSS.
OCN views HLSS as important to its overall 'asset-light', fee-for-servicing strategy, and is expected to remain the primary source of portfolio assets for HLSS in the near to medium term. To date, OCN has not sold any of its MSRs to other unaffiliated third-parties. Given this relationship, Fitch believes any positive impact on the deleveraging of OCN's balance sheet through the sale of its MSRs would be offset by HLSS' requirement to raise debt or equity financing to fund the purchase.
OCN reported revenue growth in 1Q'14 on continued growth in the average UPB of its servicing portfolio following servicing acquisitions in 2013. Recent revenue growth was also driven by improvements in overall portfolio delinquency rates and lower interest expenses on advance financing, offset by slower REO sales in 1Q'14. Normalized pre-tax earnings, adjusted for transition and transaction costs, as well as other one-time expenses, grew 12% year-over-year to $114 million in 1Q'14 from $101.4 million in 1Q12. Fitch anticipates operating performance in the near to medium term will continue to benefit from the incremental cash flow generated from additional servicing revenues from OCN's recent acquisitions. However, as MSR transfers slow, Fitch believes revenue growth may become more constrained.
Fitch believes OCN has sufficient liquidity from balance sheet cash and from operating cash flow to cover its financing needs. As of Dec. 31, 2013, the company had unrestricted cash of $178.5 million and the company generated $867.2 million of operating cash flow in 2013.
OCN is heavily reliant on wholesale funding markets to fund advances and its servicing operations. OCN also had available capacity of $85.2 million under its servicing advance facilities and available capacity of $536.2 million under its lending warehouse facilities to fund its servicing operations, although these may not be available in a stress scenario.
Fitch believes OCN's capitalization and leverage are appropriate relative to its current ratings. Balance sheet leverage, as defined as total debt to tangible equity, was 3.6x at March 31, 2014 compared to 4.7x at March 31, 2013. The 2014 metric is relatively in line with the five-year average. On the basis of cash flow leverage, as defined as total debt to annualized EBITDA, leverage declined to 4.4x in 1Q'14 compared to 6.5x in 1Q13. The improvement in leverage resulted from earnings generation from additional servicing and subservicing fee income due to acquisitions. While leverage is expected to improve due to excess cash generation used to repay outstanding debt, future large acquisitions could result in incremental leverage.
Including HLSS, consolidated balance sheet leverage, as measured by total debt to tangible equity, was approximately 4.4x at March 31, 2014 compared to 4.1x one year prior. Fitch-calculated core capital, which excludes the value of MSRs from tangible equity, was negative in 2013 given the amount of goodwill and additional MSRs recorded from OCN's recent acquisitions.
RATING SENSITIVITIES - OCN
Positive rating action could result from sustained and effective management of the regulatory environment, reduced organizational complexity, a continued moderation in the pace of growth, successful integration of recently acquired servicing rights, reduced overall leverage through consistent cash flow generation and deleveraging over time and improved Fitch Core Capital levels.
Conversely, negative rating action would be driven by a considerable reduction in revenue and cash flow generation caused by deterioration in portfolio performance, or a material change in OCN's cost structure resulting from integration, legal or regulatory risks. In addition, future large-scale portfolio or business acquisitions that materially increase leverage over a sustained period could also result in further negative rating actions.
Over a longer period of time, strategic uncertainty make become a negative rating driver as the declining size of the nonprime residential mortgage market and potential regulatory constraints on acquisitions may reduce the size and long-term viability of OCN's current business model. Should Ocwen pursue adjacent lending businesses that would result in a significant use of balance sheet leverage and/or a shift in strategy away from its core competencies, it could be viewed negatively by Fitch.
The Recovery Ratings and notching of the senior secured term loan are also sensitive to changes in collateral values and advance rates under secured borrowing facilities, which ultimately impact the level of available asset coverage.
RATING SENSITIVITIES - OLS
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. Therefore, the ratings for OLS are sensitive to the same factors that might drive a change in OCN's IDR.
Fitch has affirmed the following ratings:
Ocwen Financial Corporation
--Long-term IDR at 'B';
--Short-term IDR at 'B'.
Ocwen Loan Servicing, LLC
--Long-term IDR at 'B';
--Senior secured term loan at 'B/RR4'.
The Rating Outlook has been revised to Stable from Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
--'Recovery Ratings for Financial Institutions' (Sept. 24, 2013);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012);
--'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012).
Applicable Criteria and Related Research:
Finance and Leasing Companies Criteria
Rating FI Subsidiaries and Holding Companies
Global Financial Institutions Rating Criteria
Recovery Ratings for Financial Institutions