Given the current sustainability factor, on Friday we downgraded Ocwen Financial Cor. (OCN) to Neutral from Outperform. Although the company’s first quarter earnings were a penny ahead of the Zacks Consensus Estimate, the results reflected a lackluster performance by Ocwen’s financials. Declining top-line growth across all the segments and absence of any revenues associated with Ocwen Solutions dampened the earnings expansion.
Ocwen’s operations have been facing continuous headwinds from deterioration in the housing and mortgage markets. Declining prepayments and rising delinquencies lead to lower float balances and float income, while also resulting in increased interest expense related to funding of servicing advances. We do not expect any positive improvement in delinquency rates in 2010, which will lead to further reductions in advances as Ocwen’s seasoned portfolio matures.
Further, continued disruptions in the credit and capital markets will put added pressure on the bottom line in the near to medium term, due to a rising interest expense on early funding requirements. Ocwen’s asset valuations were also impacted as it recorded lower cost or market adjustments on loans held for resale and unrealized losses on trading security. This had led to severe net losses on loans held for resale and liquidation of discount certificates of deposits that were otherwise intended to be held through maturity. Until the markets rebound and stability is regained, these factors will continue to impact Ocwen’s operations in the coming quarters.
Moreover, Ocwen’s large scale offshore business poses considerable operational risk. A significant portion of Ocwen’s operations are concentrated in India. With more than half of its employees positioned in India, Ocwen remains exposed to the risk of any significant change in India’s economic liberalization and deregulation policies. Going forward, this excessive and extensive dependence on India could also increase the cost of operations while posing investment and operational risk to the company.
However, there is light at the end of the tunnel that raises optimism for future growth outlook. Despite the challenging economic environment and the company’s dealings with the worst hit real estate sector, Ocwen continues to solve loan problems with full efficiency. With its active participation in the Home Affordable Modification Program (HAMP), which seeks to prevent foreclosures and make housing more affordable, Ocwen has positively converted these efforts into profitable financials. During the first quarter 2010, Ocwen completed 19,612 modifications, of which 6,312 qualified under the HAMP, increasing 25% over the prior quarter. Going ahead, resolving more loans faster will not only help Ocwen in improving customer retention and reducing the level of advances but also in reducing costs.
Additionally, Ocwen continues to grow through acquisitions, mergers, alliances and spin-offs. From time to time, the company has restructured its business and operations in order to tap the healthy opportunities in a changing economic scenario throughout its history of operations. As a result, the company disposes of its redundant operations and keenly focuses on key investments in the most profitable prospects available. This growth strategy will help in enhancing the operating leverage even in the future.
Moreover, Ocwen continues to hold a favorable market position in the financial services industry. In September 2009, the Fitch rating agency affirmed a long-term Issuer Default Rating of ‘B+’; thereby, removing a Rating Watch Negative status and assigning a Stable Rating Outlook. This rating action reflects Ocwen’s seasoned management team, focused operational and default management capabilities as well as its proficient use of technology.
Overall, Ocwen continues to operate on a reliable servicing platform with the qualified staff, internal control environment and robust technology to manage its servicing operations and ongoing initiatives. The company also aims to generate sustainable revenue growth in its servicing operations, improve process efficiencies to continuously reduce costs, deliver best quality services and reduce asset intensity throughout 2010. Although near-term outlook remains cautious on market volatility and weak housing loan payment and demand, Ocwen remains committed to acquire new business, increase loan modifications and continue TALF financing, which are expected to convert into increased profitability in the future.
On Friday, the shares of Ocwen closed at $11.86, down 2.6%, on the New York Stock Exchange.
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