CHICAGO--(BUSINESS WIRE)--Fitch Ratings has placed the 'B' ratings of Ocwen Financial Corporation (OCN) and its wholly-owned, primary operating subsidiary, Ocwen Loan Servicing, LLC (OLS) on Rating Watch Negative. Rated secured and unsecured debt is similarly affected by these actions. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS - OCN and OLS
The Negative Watch follows a third letter sent to OCN by the New York Department of Financial Services (NY-DFS) alleging material weaknesses in the company's servicing practices. Fitch views regulatory and legislative risk as the key rating risk for OCN, followed by organizational complexity associated with its affiliate companies and an aggressive historical growth strategy.
The ongoing review by the NY-DFS has continued to raise material issues related to the servicing of OCN's loans, which call into question the corporate governance and operational control framework of the firm while increasing the potential of a materially adverse outcome that could affect the ratings. Furthermore, NY-DFS' findings may cause other states and/or regulatory bodies to launch additional investigations into OCN's business practices.
Responding to these regulatory reviews is likely to consume significant management time and resources that could otherwise be directed towards managing the day-to-day activities of the company and the integration of recent acquisitions. The one positive side-effect of the reviews is that it has slowed the pace of acquisitions, which Fitch had previously cited as introducing the potential for integration risk and elevated leverage.
In the course of its review of OCN's servicing practices, the NY-DFS has uncovered material problems with OCN's systems and processes, including the backdating of letters to borrowers in connection with their mortgage loan modifications, among other issues. In its letter dated Oct. 21, 2014, the NY-DFS alleged that the existence and pervasiveness of these issues raised critical questions as to the company's ability to perform its core function of servicing loans given that OCN had not resolved the issues nearly a year after its initial discovery.
The most recent letter follows the NY-DFS request in February 2014 that OCN suspend its previously announced purchase of mortgage servicing rights (MSRs) from Wells Fargo Bank, N.A. indefinitely due to its concerns regarding the company's portfolio growth and capacity to service additional loan volume while maintaining appropriate servicing standards. It also follows the NY-DFS announcement in August 2014 that it was looking into OCN's use of a related company, Altisource Portfolio Solutions (Altisource), in its force-placed insurance process.
Fitch believes there is a high level of interconnectedness between OCN and its affiliated companies - Home Loan Servicing Solutions (HLSS), which funds MSR acquisitions, and Altisource, which provides technology, valuation, title and insurance services. In addition to the stand-alone analysis of OCN's operating performance and overall credit metrics, Fitch considers the consolidated ratios, notably balance sheet leverage, that include HLSS and Altisource given the close operating and strategic relationships and shared management of these companies.
Leverage, as measured by total debt-to-tangible equity, was 3.03x on a stand-alone basis and 4.51x on a consolidated-affiliate basis, as of June 30, 2014, both of which were modestly higher than their five-year averages of 2.82x and 3.12x, respectively. On a stand-alone basis, Fitch expects OCN's leverage will remain consistent with historical levels, barring any outsized regulatory fine or settlement.
On a consolidated-affiliate basis, Fitch expects leverage will fluctuate based on growth either at OCN or HLSS. However, any positive impact from deleveraging of OCN's balance sheet through sales to HLSS would be offset by HLSS' requirement to raise debt and/or equity financing to fund the purchase. Fitch believes that increased leverage at the consolidated level could pressure OCN's financial condition under such stress. The subservicing arrangement between OCN and HLSS could be jeopardized in a bankruptcy proceeding, and the validity or priority of the security interest in MSRs acquired by HLSS could also be challenged. Still, Fitch believes that consolidated leverage currently remains appropriate relative to OCN's ratings.
RATING SENSITIVITIES - OCN
Resolution of the Negative Watch is unlikely until there is more clarity on the NY-DFS investigations and their impact on OCN's operational, governance and financial profiles. Adverse outcomes that would negatively affect the ratings include findings that indicate more pervasive operational or governance shortcomings, outsized fines and penalties, restrictions on business activities, or termination of servicing duties. Depending on the outcome of these investigations, ratings could be downgraded by more than one notch.
Fitch does not envision positive rating momentum for OCN at this time. The ratings could be removed from the Negative Watch if the NY-DFS investigations prove not to materially impact OCN's operational, governance or financial positions. That said, if and when the Negative Watch were to be resolved, it could potentially be replaced with a Negative Rating Outlook reflecting longer-term regulatory headwinds and uncertainty surrounding OCN's business model.
Material deterioration in financial performance resulting from a reduction in operating cash flow generation and/or available liquidity, sustained increase in balance sheet leverage, and/or aggressive capital management could result in further downgrade of OCN's ratings.
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 placed the following ratings on Rating Watch Negative:
Ocwen Financial Corporation
--Long-term IDR at 'B';
--Short-term IDR at 'B';
--Senior unsecured notes at 'CCC/RR6'.
Ocwen Loan Servicing, LLC
--Long-term IDR at 'B';
--Senior secured term loan at 'B/RR4'.
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:
Rating FI Subsidiaries and Holding Companies
Finance and Leasing Companies Criteria
Global Financial Institutions Rating Criteria