Ocwen Financial Corp.'s $360 million acquisition of PHH Corp. presents an opportunity for the nonbank servicer to rebuild scale that's been diminished by years of regulatory restrictions and the decline in distressed mortgage volume brought about by improvements in the overall housing market.

Maintaining scale is critical for servicers and subservicers like Ocwen in the event of an uptick in mortgage delinquencies. Servicers are held to much higher and more complex regulatory standards for handling loss mitigation and foreclosure processes than they were when the housing crisis began. But with the worst of the downturn in servicers' rearview mirror, the industry's overall capacity to handle distressed loans has declined.

"If we see even a modest increase in delinquencies, servicing will struggle," Ocwen President and CEO Ron Faris said Feb. 28, during the company's fourth quarter earnings call.

Ocwen's ability to acquire mortgage servicing rights has been curtailed significantly after years of regulatory restrictions. Four years ago, New York regulators halted a deal for Ocwen to buy an MSR portfolio from Wells Fargo out of concern that the nonbank was growing too fast. More recently, state regulators have required Ocwen to limit or temporarily suspend its MSR acquisitions as a condition of settlement agreements.

Acquiring PHH will increase the number of loans in Ocwen's servicing portfolio by approximately 55%, while the unpaid principal balance will increase 83%. This indicates the average loan balance of PHH's servicing book is higher than Ocwen's, which could lead to higher per-loan servicing fee revenue.

Ocwen recorded a net loss of more than $45 million in the fourth quarter and more than $128 million for the full year. This marked an increase from the $10 million loss the company took in fourth-quarter 2016, but improved on a more than a $224 million loss it took for 2016 as a whole.

Like Ocwen, PHH was motivated to agree to the acquisition because of its own challenges with scale. PHH recorded net losses of $49 million for the fourth quarter and $217 million for the full year 2017. It took net losses of $133 million in the fourth quarter of 2016 and $202 million for the whole year.

Ocwen acquiring PHH

The lengthy legal battle over the Consumer Financial Protection Bureau's action against PHH has hurt its ability to attract new clients, PHH President and CEO Robert Crowl said during a Feb. 28 investor call about the Ocwen acquisition.

Also, two of PHH's current clients have notified the company they planned to move all or part of their business off of the servicing platform between the second quarter this year and the first quarter of 2019.

This is "placing further pressure on our growth plans," Crowl said.

The move will take 115,000 units off PHH's platform, according to Crowl. PHH is not disclosing the names of the companies or the unpaid principal balance, according to a spokesman.

Although PHH's cost reduction efforts were better than expected through year-end 2017, PHH's transition to a new business model has not been going as well as planned when it comes to attracting new subservicing clients, said Crowl.

"Over the past 12 months progress on PHH 2.0 as measured against our established goals of reducing our cost infrastructure and growth of business development efforts has been mixed," said Crowl.

"While we have developed a robust pipeline of prospects and believe market demand is evident, we have to date been unable to convert these efforts into meaningful new business and we are behind where we would have expected to be in terms of number of subservicing units."

Both companies have shifted their business models away from mortgage originations with some exceptions, and are refocusing on subservicing, a decision they could reconsider after combining. They both are continuing to originate for portfolio retention purposes, although higher rates have reduced this type of loan volume. Ocwen, after a strategic review of its reverse mortgage lending unit, also has decided to retain that business line as well as continue its commercial servicing activities.

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