Ultimately, Ocwen Financial Corp.'s pending purchase of Litton Loan Servicing is likely to benefit the investors in the $45 billion of mortgages that Litton manages and some of the homeowners. That's because Ocwen has a record of moving faster than Litton to resolve troubled loans, either through modification or foreclosure.
In the short term, though, expect chaos.
Fitch Inc. and Moody's Investors Service Inc. have both warned investors that their cash flows are likely to get disrupted once Ocwen acquires Litton from Goldman Sachs Group Inc. One reason for this is the snafus that occur when servicers are combined.
"With servicing platform transfers, there can be a hiccup in performance," says Moody's Gene Berman. "That can manifest itself in actual collections, more calls being abandoned as borrowers experience longer wait times" and give up on trying to reach someone who could work out their loan.
The risk is particularly acute in this case. About 90% of Ocwen's collection staff and two-thirds of its loss mitigation staff is offshore. Most of Litton's staff works in the United States. In a recent report, Moody's said borrowers who may feel confused during a transfer may feel more so when interacting with offshore agents.
Another factor that may make things bumpy for the investors is Ocwen's habit of moving quickly to get itself reimbursed for servicing advances. When a borrower falls behind, a servicer typically fronts principal and interest payments to investors, along with property taxes and insurance premiums, for a time. Servicers are generally entitled to reimbursement for those advances when the property goes into foreclosure or the loan gets modified.
Litton, which has benefited from Goldman Sachs' deep pockets, has advanced about $2 billion to owners of delinquent mortgages in its servicing portfolio. According to Moody's, Ocwen may decide advances that Litton made on delinquent loans were nonrecoverable and seek reimbursements. That means less money for investors, because such reimbursements typically get paid out before loan payments are passed through to bondholders.
The problem could be exacerbated by the interest rate swaps that securitization trusts use to hedge the mismatch between the fixed rates on the mortgages and the floating rates on the mortgages. If the payments to the swap counterparties (typically banks) fall short because Ocwen has been using the money to reimburse itself for advances inherited from Litton, the counterparties could declare the trusts to be in default. That would trigger a termination payment — diverting even more of the cash flow that's available to investors.
Calls to Ocwen were not returned by deadline.
Ocwen's purchase of Litton, expected to close by Nov. 1, would make it the largest subprime servicer in the nation by dollar amount. According to Fitch, as of December 31, 2010 Ocwen's portfolio consisted of about 468,000 loans with an upaid balance of over $71.4 billion. Ninety-eight percent of Ocwen's loans are subprime. Litton's portfolio consisted of about 287,000 mortgages of which about 89% were subprime loans.
Both distressed loan servicing companies have recently drawn attention from regulators. In response to a recent whistleblower letter, Litton is the subject of an inquiry by the Federal Reserve Bank of New York for allegedly having a policy of denying modifications for borrowers eligible for government loan-mod programs. A Goldman Sachs spokesman, Michael DuVally, had no comment on the investigation.
Ocwen, on the other hand, is one of four servicers on a Treasury Department list, which includes Bank of America Corp, JPMorgan Chase & Co., and Wells Fargo & Co., that require substantial improvement on loan modification efforts. According to the Treasury, Ocwen has failed to meet benchmarks for correctly calculating homeowner eligibility for the Home Affordable Modification Program, and the regulator has also found substantial problems with the accuracy of reports that Ocwen is required to submit to the government under the program.
However, unlike the other servicers on the watch list, Ocwen is not having its servicer incentive payments docked by the Treasury Department. That is because Treasury Department acknowledged that Ocwen's compliance results are being affected by its integration of a large servicing portfolio during the government's servicer compliance testing period.
