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UPDATE: Ocwen Financial (OCN) Outlook Revised to Stable by Fitch; Ratings Affirmed

June 24, 2015 2:24 PM EDT
(Updated - June 24, 2015 5:49 PM EDT)

(Update corrects headline to say outlook revised to Stable)

Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) for Ocwen Financial Corporation (NYSE: OCN) and its wholly-owned primary operating subsidiary, Ocwen Loan Servicing, LLC (OLS), at 'B-'. OLS's senior secured term loan and OCN's senior unsecured notes have also been affirmed at 'B-/RR4' and 'CC/RR6', respectively. The Rating Outlook has been revised to Stable from Negative. A full list of rating actions is at the end of this release.

KEY RATING DRIVERS

IDRS, SECURED AND UNSECURED DEBT

The rating affirmations reflect OCN's scale and market position in the sub-prime mortgage servicing space, sufficient liquidity, appropriate capitalization and leverage for its current ratings. Rating constraints reflect longer-term challenges with respect to 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 its origination strategy and potential earnings pressure associated with increased compliance costs.

While meaningful long-term strategic uncertainty remains, the revision of the Outlook to Stable from Negative reflects actual and expected improvements in Ocwen's financial profile over the outlook horizon, particularly with respect to cash flow generation, leverage and near-term funding obligations. While certain securitizations serviced by OCN remain subject to potential servicer replacement at the election of the investors due to Event of Default triggers, the financial impact of this potential outcome is viewed as manageable relative to the current ratings. According to OCN, servicing rights currently exposed to potential transfer represented approximately 10% in unpaid principal balance (UPB) of OCN's total servicing portfolio as of March 31, 2015. An additional 2% of UPB has termination triggers, although these triggers have not yet been tripped and Fitch currently expects the likelihood to be remote. The company's receipt of an unqualified opinion from its auditor and the presence of onsite regulatory oversight for the next two years are also viewed as supporting the revision of the Rating Outlook to Stable.

OCN has recently initiated a strategy with the objective of improving its liquidity position, reducing leverage and simplifying its operating structure through planned sales of its Agency servicing portfolios. To date, the company has closed or has entered into agreements to sell approximately $90 billion in UPB of performing Agency loans, which are expected to generate approximately $852 million in sale proceeds. In addition, OCN has entered into agreements to sell portfolios of nonperforming Agency servicing. It is expected these sales will largely be completed by year-end 2015.

The company expects to utilize the majority of the approximately $840 million of the $852 million in proceeds to deleverage its balance sheet via prepayments under its senior secured term loan. Given OCN's operating cash flow generation, in conjunction with the proceeds from the sale of servicing assets, Fitch believes the company has sufficient cash proceeds to fully repay outstanding amounts under its senior secured term loan and unsecured notes.

Fitch believes there remain longer-term challenges facing OCN in terms of building a core private label lending business (PLS) to reposition the company for sustainable growth while maintaining financial performance under a heightened operational and governance framework. Fitch expects that costs to meet elevated compliance and governance standards will create a drag on operating margins in the near-term to medium-term. In addition, without the ability to continue to utilize related parties for certain activities, additional operating costs may fall to OCN.

However, Fitch believes OCN's capitalization and leverage are appropriate relative to its current ratings. Fitch-calculated balance sheet leverage, defined as debt to tangible equity on a consolidated basis inclusive of debt obligations of HLSS and related parties, was 5.7x as of March 31, 2015, which is modestly higher than the long-run average of 4.2x, but down from 6.4x as of Dec. 31, 2014. On the basis of Fitch-calculated cash flow leverage, defined as consolidated debt to annualized EBITDA, leverage was 9.2x, as of the same period and consistent with the long-run average of 9.3x and 8.9x at Dec. 31, 2014. Fitch expects OCN's leverage metrics to improve materially by year-end following the repayment of the senior secured term loan, which would reduce balance sheet and cash flow leverage to 5.1x and 8.2x, respectively, on a proforma basis based on tangible equity and EBITDA levels as of March 31, 2015.

OLS's senior secured term loan has been affirmed at 'B-/RR4', which reflects the equalization of the senior secured term loan rating with the IDRs assigned to OCN and OLS and the average recovery prospects in a stressed scenario based upon collateral coverage for the term loan. The term loan 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 notes and the IDR assigned to OCN, and reflects the company's predominately secured funding profile and the modest level of unencumbered balance sheet assets available to support the unsecured noteholders 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.

RATING SENSITIVITIES

IDRS, SECURED AND UNSECURED DEBT

Fitch does not envision positive rating momentum for OCN at this time. The Rating Outlook could be revised to Positive if OCN can continue to demonstrate progress in complying with its independent monitors and consent orders, further strengthen 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 as a result of:

--Additional fines and penalties or further restrictions on business activities. However, this risk is likely reduced by ongoing oversight by regulators.
--A material transfer of servicing due to termination of servicing duties beyond the currently contractual maximum of $25 billion, or 12% of UPB
--A modified strategic focus for the firm, including an inability to build a sustainable core PLS business or decreased commitment by management to reduce balance sheet leverage
--Insufficient cash coverage of near term debt maturities
--A sustained increase in balance sheet leverage beyond 6.5x on a consolidated basis
--Aggressive capital management

The ratings of the senior secured term loan are sensitive to changes in OCN and OLS's IDRs as well as changes in collateral values and advances rates under the secured borrowing facilities, which ultimately impact the level of available asset coverage.

The ratings of the 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 versus 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 COMPANIES

The ratings for 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 Outlook has been revised to Stable from Negative.



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