Cash Flowing with Ocwen Financial
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The mortgage servicing business has become a very profitable business since the financial crisis as large banks have sold the rights to smaller, focused firms such as Ocwen Financial (NYSE: OCN). The ongoing trend of banks selling off non-core servicing assets is expected to continue as many large and some regional banks see the servicing of delinquent loans as harmful to the banks consumer franchise--not to mention the fact that capital requirements make the rights attractive to sell.
The company engages in the servicing and origination of mortgage loans. Ocwen claims to be able to use proprietary technology to provide solutions to help homeowners and make the client’s loans worth more.
The stock has surged the last couple of years along with the sector as earnings soared from a growing asset base and a recovering real estate market. Unfortunately, most investors get confused with the terms such as match funded borrowing, servicing advances, and subservicing agreements to name a few that the stock trades considerably below earnings potential regardless of the stock gains.
2012 Cash Flow Machine
Ocwen generated a substantial operating cash flow of $719 million in 2012 on a current market cap of only $5.1 billion. While it is worth noting that conservative accounting standards and timing differences will lead to these cash flows falling into earnings over the next couple of years, the substantial current cash flow provides the cash now for re-investing. The below slide from the last quarterly presentation provides a quarter by quarter summary:
Incredibly increasing portfolio
Ocwen recently completed two agreements that substantially increased the servicing portfolio. The Homeward and ResCap deals increased the portfolio of unpaid principal balances ((UPBs)) by an amazing 270% to almost $470 billion. Incredibly, the CEO made the following statement in the earnings release:
"The fifty-percent plus growth rate in revenue and earnings we have produced over the past two years should accelerate in the coming years as a result of these transactions. Moreover, we continue to build a robust pipeline of new opportunities that should result in additional growth in cash flow and earnings."
During Q4, the company completed the Homeward merger adding $76.7 billion to UPB in the servicing portfolio while the ResCap deal finalized in February. It added $107.3 billion of mortgage servicing rights, $42.1 billion of master servicing agreements, and $25.9 billion of subservicing contracts. The company also assumed the subservicing on behalf of ResCap for approximately $91.4 billion of Freddie Mae loans and $31.5 billion of Freddie Mac loans.
Did you catch all of that? If not, go back to what the CEO stated about adding 270% to the portfolio. Not to add more confusion, but the company signed a deal a few weeks back with Ally Financial for MSRs of $90 billion. These numbers weren’t even included in the CEO stats.
Nationstar Mortgage went public at the beginning of 2012 and early investors have made huge returns. The IPO closed the first day below $15 and traded as high as $42 a few months back. The company saw the servicing portfolio nearly double during 2012 and expects another doubling by the end of Q2 as a huge Bank of America transaction closes. The UPB will surpass $400 billion and the company has a pipeline of around $300 billion in potential deals. The Q4 annualized earnings were $2.84 and will continue soaring along with the acquired MSRs.
Walter Investment has been aggressive in acquiring MSRs with the expected UPB to increase 185% from the end of 2011. While not as high as Ocwen, the company has captured business from Bank of America and ResCap providing for solid earnings growth in the next few years. The company earned $2.73 in 2012 that should grow appreciably as these sizable deals are added to the books.
While the substantial revenue growth that will occur in 2013 won’t be duplicated at that level in 2014 and beyond, the companies should continue growing earnings into the out years. The stocks trade at significant discounts to the cash flows being generated. The group has traded relatively flat the last six months providing an opportunity for investors to buy these stocks at 6-7x 2013 earnings and in the case of Ocwen at only 7x last year’s cash flow.
Mark Holder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!