S&P Lowers Outlook on Ocwen Financial (OCN) to Negative Following Recent Disclosure of SEC Subpoena

Standard & Poor's Ratings Services said today that it affirmed its 'B+' long-term issuer credit rating on Ocwen Financial (NYSE: OCN) and revised the outlook to negative from stable.

The revision of our outlook to negative reflects Ocwen’s disclosure in its recently filed second-quarter financial statements that it received a subpoena from the SEC in June requesting documents relating to its dealings with certain related parties. "We believe this disclosure, in conjunction with ongoing examinations by the New York Department of Financial Services (DFS) and identified weaknesses in the company’s internal controls that led to a restatement of certain financial statements, weighs sufficiently on our rating," said Standard & Poor's credit analyst Stephen Lynch.

In February, Ocwen, at the request of the New York DFS, placed an indefinite hold on its planned purchase of the rights to service mortgages with an unpaid principal balance (UPB) of $39 billion from Wells Fargo. Since that time, the New York DFS has sent a series of letters to Ocwen asking questions and raising concerns over the company’s related-party dealings, management and governance, and servicing practices. Most recently, the DFS sent Ocwen a letter on Aug. 4 regarding what it called a “troubling transaction” between Ocwen and Altisource Portfolio Solutions, a company that was spun out from Ocwen in 2009. The DFS said the transaction “appears designed to funnel” fees to Altisource for “minimal work” related to force-place insurance on loans serviced by Ocwen. We don’t know if the transaction was improper in any way--it is possible that it was completely innocuous--but believe the letter underscores Ocwen’s high level of regulatory risk and our concerns about its governance.

We are not taking any action on our issuer credit rating or outlook on Altisource (B+/Stable/--) at this time, as we believe Altisource’s business and financial performance would support the rating, even if the company was forced to forgo the fees in question. Still, we will continue to assess whether the scrutiny on Ocwen could materially affect its relationship with Altisource and if any changes in that relationship could result in lower earnings and cash flows at Altisource.

Earlier this month, Ocwen restated its fourth-quarter 2013 and first-quarter 2014 financial statements due to weaknesses in internal controls related to how the company values its mortgage servicing right (MSR) financing liability.The MSR liability relates to rights to servicing assets the company sold to related party Home Loan Servicing Solutions (HLSS). Although the restatement had no net impact on the company’s long-term financial position, it raises concerns about whether the cited weaknesses are emblematic of further deficiencies in internal controls.

Lastly, in its recently filed second-quarter financial statements, Ocwen disclosed that, in June, the SEC issued a subpoena requesting documents relating to the company's dealings with Altisource Portfolio Solutions, HLSS, Altisource Residential Corp., and Altisource Asset Management Corp. William Erbey serves as chairman of the board for all of the companies covered under the subpoena and is a large shareholder in Ocwen and Altisource. Earlier this year, Ocwen also received a letter from the SEC informing the company that they were conducting an investigation into Mr. Erbey’s surrender of options to purchase common stock. According to company filings, Mr. Erbey surrendered 1 million options after the company received a letter from a shareholder who claimed the award of options was inconsistent with the terms of the company’s 2007 Equity Incentive Plan.

We believe the confluence of these events raises serious management and governance concerns, which could hurt Ocwen’s market position and financial performance. Ocwen’s servicing assets, measured by UPB, underwent two consecutive quarters of decline due to what we believe is the company’s inability to execute bulk servicing acquisitions under the backdrop of regulatory inquiries. We believe debt to adjusted EBITDA, which ended the second quarter at about 3x on a trailing-12-month basis, could come under pressure if the company is unable to acquire future servicing assets. Leverage rose during the second quarter, largely due to the company’s issuance of $350 million of senior unsecured debt.

At the same time, we believe the company’s low level of debt relative to its equity provides support for the rating. If its ratio of debt to equity were to rise materially, we could lower the rating.

Our negative outlook reflects increasing regulatory pressure on the company’s business and servicing practices. We believe the ongoing examinations could hurt the company’s ability to acquire future servicing assets and heightens the risk of additional regulatory actions or fines and penalties.

We could lower our rating if the regulatory probes into Ocwen result in a reduction in earnings and cash flows--perhaps due to an inability to purchase new MSRS--causing leverage to continue to steadily rise and we believe that a heightened level of leverage is likely to be sustained. We could also lower the rating if regulatory actions cause a significant rise in legal and regulatory expenses or an alteration in Ocwen’s business model.

We also plan to continue to assess Ocwen’s governance over the coming months. We could lower the rating if that ongoing assessment results in an even more heightened concern about governance--especially if any of the regulatory investigations reveal evidence of improper business dealings.

We believe an upgrade is unlikely over the foreseeable future.

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