By buying Litton Loan Servicing LP from Goldman Sachs Group Inc., Ocwen Financial Corp. is betting scale will remain the driver of mortgage servicing profits after regulators overhaul servicer compensation.
Ocwen, a subprime special servicer in West Palm Beach, Fla., will nearly double in size when it acquires Litton, which services $41.2 billion of home loans, mostly subprime or distressed debt. Several industry experts said it is doubtful that Ocwen will keep Litton's servicing platform or maintain a major presence in Houston, where Litton has 1,500 employees.
Rather, Ocwen is likely to move Litton's loans to its own platform, observers said.
"It's all about economies of scale and utilizing the economies of the platform," said Tom Piercy, a managing member at Interactive Mortgage Advisors LLC, a Denver firm that brokers servicing portfolios. "I would be surprised if Ocwen keeps the platform in place."
Ocwen would not discuss its specific plans for Litton. The deal, rumored for more than a week and announced Monday, is expected to close Nov. 1. Ocwen would pay $263.7 million for Litton — far below the $428 million that Goldman paid in 2007, which included $916 million in debt payments that Litton had outstanding at the time.
Mark Garland, president of the servicing group at MountainView Capital Holdings LLC in Denver, said high-touch servicing does not lend itself to economies of scale.
"Ocwen is notorious for wanting the assets and not necessarily the bodies," Garland said. "It's not so much person-based as technology-based."
The sale of Litton also would allow Goldman to quit the management of disressed mortgage assets, a business that never achieved its intended goal, which was to buy delinquent residential loans at a discount from banks.
Litton is just the most recent high-profile example of what is expected to be many such roll-ups of mortgage servicing operations in anticipation of regulatory changes to servicer compensation and an overall crackdown on servicers.
On Monday, Fannie Mae announced new mortgage servicing standards for the management of delinquent loans including new incentives and compensatory fees that are expected to dramatically increase servicing costs.
One unknown is whether the Federal Reserve Bank of New York will continue its investigation of Litton after the sale. The New York Fed recently launched the inquiry into Litton following an anonymous employee tip that the company had systematically failed to approve government modifications for borrowers who were eligible to receive them.
Given that the Fed's authority to review mortgage servicing operations stems from its oversight of their bank parents, the status of the investigation now that Litton is being sold to a nonbank entity is unclear.
Asked whether the sale would affect its jurisdiction, a spokesman for the New York Fed declined to comment.
Industry experts said Goldman was spending an inordinate amount of time dealing with regulators and because of the investment bank's high profile, the company preferred to get out of mortgage servicing rather than continue to have yet another target on its back.
The investment bank has plenty of other public-relations and legal headaches.
In a more than 600-page report released in April, Sens. Carl Levin, D-Mich., and Tom Coburn, R-Okla., described serious conflicts of interest that existed at Goldman Sachs before the housing crisis and it has been reported that the investment bank has been subpoenaed by the Manhattan district attorney.
Litton is among the major servicers involved in ongoing settlement talks with state attorneys general over sloppy foreclosure practices.
Goldman has said that such regulatory scrutiny "may result in the imposition of fines or other regulatory action."
As part of the deal with Ocwen, Goldman agreed to retain some liabilities for any potential fines or penalties leveled against Litton before the sale closes. Ocwen and Goldman also agreed to share some losses from third-party claims related to Litton's performance before the purchase is completed.
After the sale closes, Goldman has agreed to retain certain contingent liabilities for fines and penalties that could be imposed by government authorities relating to Litton's foreclosure and servicing practices before the sale.
If anything, the deal to buy Litton underscores the growing role Ocwen has come to play in the servicing industry.
Last year, Ocwen bought HomEq Servicing Corp., a unit of Barclays PLC, for about $1.3 billion, which included $1 billion in secured financing from the London banking company.
"Ocwen has shown they can free up cash quickly and incorporate new portfolios," said Bose George, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc.
"Their role is consolidator in the industry."
In the Litton deal, Ocwen will assume $337.4 million in debt and plans a new debt line to fund a substantial $2.5 billion of servicing advances, according to a filing with the Securities and Exchange Commission.
Ocwen has long been Litton's main competitor though the two companies have very different approaches to servicing distressed loans.
Litton, founded in 1988, built a reputation for curing problem loans and preventing foreclosures primarily by giving delinquent borrowers work-out options. Ocwen is better known for its technology and systems, which can pinpoint which borrowers to solicit first.
Ocwen has among the highest rates of conversion of trial plans to permanent modifications in the government's Home Affordable Modification Program.
"For Ocwen it comes down to figuring out which consumers you can help and which you can't," said Garland.
"One advantage Ocwen has is they don't worry about headline risk. They're not trying to be nice guys. They can be more shrewd and abrasive to the consumer than commercial banks that have headline risk."
Many commercial banks have decided that dealing with distressed borrowers is not in their long-term best interests, Garland said, since they are unlikely to be able to cross-sell additional products to borrowers with low FICO scores.
Another major issue is servicing advances. When regulators extend foreclosure timelines, servicers are stuck advancing principal and interest payments, taxes to municipalities and insurance premiums when borrowers fall behind. While those payments eventually get reimbursed, they can go on for a lengthy period.
George, however, said that he thought Ocwen's advantage stemmed from its greater dexterity in handling problem loans. "There's no efficient way to foreclose," he said. "Ocwen is good at modifying people, and they've got their own principal reduction modifcations" through a proprietary program.
Ultimately, the deal seems likely to give both companies what they wanted.
"Goldman was motivated to separate themselves from distressed mortgages and Ocwen wants the units," Piercy said.