S-1 1 d398062ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on August 17, 2012

Registration No. 333-            

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

Home Loan Servicing Solutions, Ltd.

(Exact Name of Registrant As Specified in Its Charter)

 

Cayman Islands   6162   98-0683664

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Home Loan Servicing Solutions, Ltd.

c/o Walkers Corporate Services Limited

Walker House, 87 Mary Street

George Town, Grand Cayman KY1-9005

Cayman Islands

Telephone: +(345) 945-3727

(Address, Including Zip Code, and Telephone Number,

Including Area Code, of Registrant’s Principal Executive Offices)

C T Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 894-8940

(Name, address, including zip code, and telephone number,

including area code, of agent for service)

Copies to:

William C. Erbey

Home Loan Servicing Solutions, Ltd.

2002 Summit Boulevard, Sixth Floor

Atlanta, Georgia 30319

Telephone: (561) 682-7721

 

Christopher S. Auguste, Esq.

Kramer Levin Naftalis & Frankel LLP

1177 Avenue of the Americas

New York, New York 10036

Telephone: (212) 715-9265

 

Danielle Carbone, Esq.

Shearman & Sterling LLP

599 Lexington Avenue

New York, New York 10022

Telephone: (212) 848-4000

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  ¨   Accelerated Filer  ¨    Non-Accelerated Filer  x   Smaller reporting company  ¨
(Do not check if a smaller reporting company)                                        

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of
Securities to be Registered
    

Proposed

Maximum

Aggregate

  Offering Price(1)  

     Amount of
Registration  Fee(2)

Ordinary shares, par value $0.01 per share

     $150,000,000      $17,190

 

 

(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended. Includes the offering price of additional shares that the underwriters have the option to purchase.
(2) Calculated pursuant to Rule 457(o) under the Securities Act of 1933, as amended

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED AUGUST 17, 2012

PROSPECTUS

 

             Ordinary Shares

 

LOGO

 

 

 

We are offering ordinary shares. The public offering price of our ordinary shares is $         per share.

Our ordinary shares are listed for trading on The NASDAQ Global Select Market under the symbol “HLSS.” The last reported sale price of our ordinary shares on August 16, 2012 was $15.76 per share.

 

 

Investing in our ordinary shares involves risks that are described under “Risk Factors” beginning on page 19.

 

       Per Share        Total  

Price to public

       $                       $               

Underwriting discounts and commissions

       $                       $               

Proceeds, before expenses, to us

       $                       $               

We have granted the underwriters an option for a period of 30 days from the date of this prospectus to purchase up to an additional              ordinary shares from us, at the public offering price, less the underwriting discounts and commissions, to cover over-allotments, if any. If the underwriters exercise the option in full, the total underwriting discounts and commissions payable by us will be $         and the total proceeds to us, before expenses, will be $        . See “Underwriting.”

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the ordinary shares to purchasers on or about                     , 2012.

 

 

 

Wells Fargo Securities   Barclays   Citigroup

Prospectus dated                     , 2012.


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TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     19   

FORWARD-LOOKING STATEMENTS

     47   

INDUSTRY DATA

     49   

USE OF PROCEEDS

     50   

DIVIDEND POLICY

     51   

CAPITALIZATION

     53   

THE MORTGAGE SERVICING INDUSTRY

     54   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     59   

THE BUSINESS

     95   

MANAGEMENT

     121   

COMPENSATION DISCUSSION AND ANALYSIS

     128   

PRINCIPAL SHAREHOLDERS

     133   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     134   

DESCRIPTION OF SHARE CAPITAL

     138   

MARKET FOR OUR ORDINARY SHARES

     138   

SHARES ELIGIBLE FOR FUTURE SALE

     145   

MATERIAL CAYMAN ISLANDS AND UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

     146   

ENFORCEABILITY OF CIVIL LIABILITIES

     151   

UNDERWRITING (CONFLICTS OF INTEREST)

     152   

LEGAL MATTERS

     160   

EXPERTS

     160   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     160   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

We are responsible for the information contained in this prospectus and in any related free writing prospectus we prepare or authorize. Neither we nor the underwriters and their affiliates have authorized anyone to give you any other information. We do not, and the underwriters and their affiliates do not, take any responsibility for, and can provide no assurance as to the reliability of, any information that others may give you. We are offering to sell, and seeking offers to buy, our ordinary shares only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date on the front cover of this prospectus, or other earlier date stated in this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ordinary shares.

For investors outside of the United States: neither we nor any of the underwriters has done anything that would permit this offering outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of our ordinary shares and the distribution of this prospectus outside of the United States.


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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our ordinary shares, you should carefully read this entire prospectus, including our consolidated financial statements and the related notes included elsewhere in this prospectus. You should also consider, among other things, the matters described under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “The Business” appearing elsewhere in this prospectus. Unless otherwise stated, all references to “us,” “our,” “we,” the “Company” and similar designations refer to Home Loan Servicing Solutions, Ltd. and its consolidated subsidiaries.

Our Company

We are a Cayman Islands exempted company that acquires mortgage servicing assets consisting of mortgage servicing rights, rights to mortgage servicing rights, associated servicing advances and other related assets. We launched our operations on March 5, 2012 using the proceeds from our initial public offering and a concurrent private placement with our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion unpaid principal balance from Ocwen Loan Servicing, LLC, or “Ocwen Loan Servicing.” We do not originate or purchase mortgage loans, and as a result we are not subject to the risk of loss related to the origination or ownership of mortgage loans. We have engaged Ocwen Loan Servicing, a high quality residential mortgage loan servicer, to service the mortgage loans underlying our mortgage servicing assets and therefore have not and do not intend to develop our own mortgage servicing platform. While we have only completed one full quarter of operations, we believe that our revenue and expense structure is predictable and will generate a stable income stream and that the quality of our assets is and will continue to be strong. We believe this combination will accomplish our primary objective of delivering attractive and consistent risk-adjusted returns to our shareholders. We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly cash dividend. In addition, unlike many income-oriented investment alternatives, we believe that our income stream and the valuation of our assets are not substantially correlated to movements in interest rates.

Our results of operations for the quarter ended June 30, 2012, our first full quarter of operations, reflect consistent earnings that were in line with our expectations and exceeded the dividends declared for the period by approximately $400,000. The valuation of our assets for the period was stable. Ocwen Loan Servicing’s performance was strong, with delinquencies continuing to decrease and the advance ratio declining slightly faster than targeted in the Purchase Agreement (defined below). From an operational perspective, the transactions between Ocwen Loan Servicing and HLSS Holdings, LLC, or “HLSS Holdings,” our wholly-owned subsidiary that holds our mortgage servicing assets, were completed as planned and we believe that all servicing requirements under the pooling and servicing agreements were met in all material respects. Having achieved our business and financial objectives in the first quarter, we purchased additional assets from Ocwen Loan Servicing that are substantially similar to our initial portfolio under substantially similar terms, as described below under “Acquisitions of Mortgage Servicing Assets.”

Our executive management team has extensive experience in the mortgage servicing industry and each of our executive managers was formerly in a senior management role at Ocwen Financial Corporation or “Ocwen.” We believe our executive management team’s extensive experience provides us with the ability to assess the vital characteristics of the mortgage loans underlying the mortgage servicing assets we have acquired and may seek to acquire and evaluate the quality of our current and potential mortgage servicers. We believe this experience further enables us to accurately value mortgage servicing assets and better forecast future asset performance and servicing cash flows. In addition, our management team has demonstrated historical success in arranging cost-effective servicing advance financing through a variety of economic cycles.

 

 

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Our business strategy is focused on acquiring mortgage servicing rights. In many cases, however, the transfer of legal ownership of mortgage servicing rights requires the prior approval or consent of various third parties, including rating agencies. If the seller from whom we have agreed to purchase mortgage servicing rights has not obtained the necessary approvals and consents to transfer legal ownership of the mortgage servicing rights to us, we will instead seek to acquire the rights to receive the servicing fees that the current servicer is entitled to receive, and the current servicer will continue to service the mortgage loans and receive compensation from us for its servicing activities. We refer to these rights, along with the right to acquire legal ownership of the related mortgage servicing rights automatically upon obtaining the necessary approvals and consents to transfer the mortgage servicing rights, as “Rights to MSRs.” Upon receipt of the necessary third party approvals and consents, the seller is obligated to transfer legal ownership of the mortgage servicing rights to us without any additional payment. Whether we acquire mortgage servicing rights or Rights to MSRs, we also acquire servicing advances and other associated assets. We do not believe that our business strategy or economic performance has been or will be materially affected by whether we directly own mortgage servicing rights or the related Rights to MSRs. All of our acquisitions of mortgage servicing assets to date have been structured as acquisitions of Rights to MSRs and we expect that any additional acquisitions of mortgage servicing assets will be structured in the same manner, at least in the near term.

Throughout this prospectus, when we refer to our “Mortgage Servicing Assets,” we are referring to the Rights to MSRs that we own and the mortgage servicing rights that we may acquire in the future, and when we refer to “Purchased Assets,” we are referring to the Mortgage Servicing Assets, together with the associated servicing advances and any other assets related to such Mortgage Servicing Assets that we have acquired. We refer to the mortgage servicing rights related to the Rights to MSRs that we have acquired and any mortgage servicing rights we may acquire in the future and which are or will be serviced by Ocwen Loan Servicing as the “Ocwen Mortgage Servicing Rights.” As of the date of this prospectus, all of the Rights to MSRs that we have acquired have been acquired from, and are serviced by, Ocwen Loan Servicing.

We have not and do not intend to develop our own mortgage servicing platform but instead will rely on high quality third-party residential mortgage loan servicers. Ocwen Loan Servicing is a leader in the residential subprime and Alt-A mortgage servicing industry based on its historical servicing performance through a variety of real estate and economic cycles. Prior to the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will remain obligated to service the underlying mortgage loans and will remit to us the servicing and other related fees (excluding any ancillary income that Ocwen Loan Servicing will retain) it collects in each month related to the Rights to MSRs. Following the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will service the underlying mortgage loans on our behalf as subservicer, and we will receive the servicing and other related fees (excluding any ancillary income). As compensation for its servicing and subservicing activities, Ocwen Loan Servicing receives from us a monthly base fee initially equal to 12% of such recognized servicing fees collected each month. Ocwen Loan Servicing also earns a monthly performance-based incentive fee that fluctuates based on collections and servicing advance reduction criteria with respect to the underlying mortgage loans. We believe this arrangement aligns the interests of both companies. We will compensate Ocwen Loan Servicing for the services it performs for us prior to the transfer of legal ownership of the Ocwen Mortgage Servicing Rights to us. The method used to calculate the fees that we pay to Ocwen Loan Servicing under the Purchase Agreement with respect to the Rights to MSRs is the same as the method used to calculate the fees that we will pay to Ocwen Loan Servicing under the Subservicing Agreement with respect to any Ocwen Mortgage Servicing Rights that we subsequently acquire. As a result, the compensation to be paid to Ocwen Loan Servicing will not vary based on whether Ocwen Loan Servicing or we hold legal title to the underlying Ocwen Mortgage Servicing Rights.

 

 

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We anticipate future growth through subsequent acquisitions of Mortgage Servicing Assets. As part of our strategy to acquire additional Mortgage Servicing Assets, we intend to purchase substantially all of the remaining mortgage servicing rights currently owned by Ocwen Loan Servicing or, to the extent that Ocwen Loan Servicing has not received the necessary third party approvals and consents to transfer such mortgage servicing rights to us prior to the closing of any subsequent acquisitions of mortgage servicing rights, the related Rights to MSRs. As of June 30, 2012, this related to Ocwen’s approximately $91.2 billion of unpaid principal balance of subprime and Alt-A mortgage loans. We believe that Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us in connection with our previous acquisition transactions. Although we cannot guarantee that future acquisition transactions will occur, we also believe that Ocwen will benefit from such transactions and therefore will continue to sell mortgage servicing assets to us in this manner which will allow us to maintain or grow the unpaid principal balance of our servicing portfolio.

We intend to continue to acquire additional similar mortgage servicing assets from Owen in the near term in two ways:

 

   

In order to remain fully invested and to offset the impact of prepayments in our serving portfolio, we expect to continue to utilize cash flow from operations in excess of our dividend to purchase mortgage servicing assets that are similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as “flow transactions.” We expect flow transactions to take place at regular intervals. Certain terms of such flow transactions, including the servicing incentive fee and advance ratio targets, will vary over time through these transactions.

 

   

In order to increase the scale of our business we will look for opportunities to issue additional equity in the form of ordinary shares to allow us to execute larger purchases of mortgage serving assets similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as “bulk purchases.” Bulk purchases will be subject to equity market conditions and will likely require that additional advance financing capacity be arranged in advance or concurrently with each transaction in order to maintain leverage similar to our current level.

As of August 1, 2012, we have made purchases of Rights to MSRs from Ocwen Loan Servicing related to approximately $20.2 billion of unpaid principal balance of mortgage loans.

Although we believe that competitive and regulatory dynamics in the mortgage servicing industry will present us with opportunities to acquire Mortgage Servicing Assets from banks, other financial institutions and independent mortgage servicers and we remain open to purchasing mortgage servicing assets from third parties other than Ocwen Loan Servicing, given the large amount of mortgage servicing assets remaining at Ocwen Loan Servicing, we do not view initiating purchases from other third parties as a near-term priority. The provisions of our Amended and Restated Memorandum and Articles of Association (“Articles of Association”) restrict our ability to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. Future sales of ordinary shares by us will dilute the ownership percentage of our then-existing shareholders, including shareholders that purchase in this offering.

We were incorporated as an exempted company in the Cayman Islands, which currently does not levy income taxes on individuals or companies. We expect to be treated as a passive foreign investment company (“PFIC”) under U.S. federal income tax laws. We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly dividend that will primarily be based on projected annual earnings, although we are not required by law to do so. Payment of a monthly dividend is not a condition of our tax status, and our decision to pay this dividend is not expected to be impacted by any changes in our status for U.S. tax purposes. Except for our subsidiary that is taxed as a corporation for U.S. federal income tax purposes, we do not expect to be treated as engaged in a trade or business in the

 

 

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United States and thus do not expect to be subject to more than a nominal amount of U.S. federal income taxation.

Since the closing of our initial public offering, we have paid monthly dividends of $0.10 per ordinary share (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share). The following table sets forth the record and payment dates of the dividends declared by our Board of Directors, but are unpaid, for the months of August and September:

 

Record Date

  

Payment Date

  

Amount per

Ordinary Share

August 31, 2012    September 10, 2012    $0.10
September 28, 2012    October 10, 2012    $0.10

Our Board of Directors has the right to rescind declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy,” “Description of Share Capital” and “Material Cayman Islands and United States Federal Income Tax Considerations.”

Acquisitions of Mortgage Servicing Assets

The Initial Ocwen Purchase

On March 5, 2012, we consummated our initial acquisition of Mortgage Servicing Assets from Ocwen Loan Servicing (the “Initial Ocwen Purchase”). The Mortgage Servicing Assets that we purchased in connection with the Initial Ocwen Purchase are a portion of the assets acquired by Ocwen Loan Servicing when it acquired the U.S. subprime mortgage servicing business known as “HomEq Servicing” on September 1, 2010. The business acquired by Ocwen Loan Servicing included the mortgage servicing rights and associated servicing advances of HomEq Servicing, as well as the servicing platform based in Sacramento, California and Raleigh, North Carolina. The sellers were Barclays Bank PLC and Barclays Capital Real Estate Inc. (collectively, “Barclays”). The unpaid principal balance of the subprime and Alt-A mortgage loans underlying the mortgage servicing rights acquired in the Initial Ocwen Purchase was approximately $15.2 billion and the amount of associated servicing advances outstanding was approximately $413.4 million, in each case as of March 5, 2012. We funded the Initial Ocwen Purchase with a portion of the net proceeds from our initial public offering.

Pursuant to a master servicing rights purchase agreement between Ocwen Loan Servicing and HLSS Holdings, which we refer to as the “Purchase Agreement” throughout this prospectus, we purchased the following:

 

   

the contractual right to receive the servicing fees (excluding any ancillary income) related to the initial Ocwen Mortgage Servicing Rights;

 

   

the contractual right to receive any investment earnings on the custodial accounts related to the initial Ocwen Mortgage Servicing Rights that Ocwen Loan Servicing receives pursuant to the related pooling and servicing agreements, which are the agreements that govern the packaging of mortgage loans into a pool, the servicing of such mortgage loans and the terms of the mortgage-backed securities issued by the securitization trust;

 

   

the right to automatically obtain legal ownership, without any additional payment to Ocwen Loan Servicing, of each Ocwen Mortgage Servicing Right upon the receipt of the necessary third party approvals and consents (this right, together with rights described in the bullet points above, constitute the “Rights to MSRs” with respect to the initial Ocwen Mortgage Servicing Rights);

 

   

the outstanding servicing advances associated with the related pooling and servicing agreements; and

 

 

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other assets related to the foregoing (collectively, the foregoing represent the “Initial Purchased Assets”).

Pursuant to amended and restated servicing advance facility agreements that we refer to as the “Servicing Advance Facility Agreements” throughout this prospectus, we also assumed a related match funded servicing advance financing facility from Ocwen Loan Servicing effective upon the closing of the Initial Ocwen Purchase.

At closing on March 5, 2012, we paid cash of $149.8 million to Ocwen for the estimated purchase price of the Initial Purchased Assets (net of assumed liabilities of $359.2 million), subject to certain closing adjustments. The purchase price for the Rights to MSRs was based on the value of such assets at the time we entered into the Purchase Agreement and the estimated outstanding unpaid principal balance of the underlying mortgage loans at closing. The purchase price for the associated servicing advances and other assets was equal to the net consolidated book value, which approximated fair value, as of the purchase date of all assets and liabilities of the special purpose entity (“SPE”) established in connection with the advance financing facility that owns these servicing advances. We acquired servicing advances in connection with the Initial Ocwen Purchase that are held in the SPE pursuant to the Servicing Advance Facility Agreements.

On March 31, 2012, the Company and Ocwen, pursuant to the terms of the Purchase Agreement, agreed to a final purchase price of $138.8 million for the Initial Purchased Assets (net of assumed liabilities of $359.2 million), reflecting post-closing adjustments of $11.0 million that principally resulted from declines in match funded advances. See “The Business–Description of the Purchase Agreement” and “—Description of the Subservicing Agreement” for more information on the Master Servicing Rights Purchase Agreement and the related Master Subservicing Agreement, respectively.

The Flow Transactions

On May 1, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “Flow One Purchase”, of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “Flow One Purchased Assets”. The Flow One Purchase resulted in the acquisition by us of Rights to MSRs with approximately $2.9 billion in unpaid principal balance as of April 30, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the Flow One Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase. The Flow One Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The purchase price for the Flow One Purchase was $103.8 million. To finance the purchase price, we used $25.9 million in cash generated from our operations and borrowed $77.9 million under the Servicing Advance Facility against the $92.6 million in servicing advances associated with the Rights to MSRs. The final adjusted purchase price was $103.5 million.

On August 1, 2012, we completed an acquisition from Ocwen Loan Servicing, which we refer to as the “Flow Two Purchase,” and together with the Flow One Purchase, the “Flow Purchases” of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans, which we refer to as the “Flow Two Purchased Assets” and together with the Flow One Purchased Assets, the “Flow Purchased Assets,” and together with the Initial Purchased Assets, the “Aggregate Purchased Assets”. The Flow Two Purchase resulted in the acquisition by us of Rights to MSRs with approximately $2.1 billion in unpaid principal balance as of July 31, 2012. The characteristics of the Rights to MSRs and associated servicing advances acquired in the Flow Two Purchase are substantially similar to those rights we acquired in the Initial Ocwen Purchase and the Flow One Purchase. The Flow Two Purchased Assets were acquired pursuant to a supplement to the Purchase Agreement. The purchase price for the Flow Two Purchase was $74.7 million. To finance that amount, we used $18.6 million in cash generated from our operations and borrowed $56.1 million under the Servicing Advance Facility against the $66.7 million in servicing advances associated with the Rights to MSRs.

 

 

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Throughout this prospectus, we refer to the Initial Ocwen Purchase, the Flow One Purchase and the Flow Two Purchase together as the “Ocwen Transactions.” We refer to the mortgage servicing rights associated with the Ocwen Transactions as the “Initial Mortgage Servicing Rights.”

The Planned Acquisition

Consistent with our growth strategy, we intend to use the net proceeds of this offering to purchase additional Mortgage Servicing Assets from Ocwen Loan Servicing in a bulk purchase, which we refer to as the “Planned Acquisition.” We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets (as defined below), but have not yet identified the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. We also expect to amend our existing Servicing Advance Facility Agreements to allow for additional borrowing from Barclays Bank Plc to finance the acquisition of the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired, or, alternatively, we may amend our existing Servicing Advance Facility Agreements to issue new debt securities backed by the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired. We are currently in discussions with Barclays Bank Plc regarding the amendments to the Servicing Advance Facility Agreement, but we do not have a firm commitment for additional servicing advance financing for the Planned Acquisition.

The Planned Acquisition will be made pursuant to a supplement to the Purchase Agreement under similar terms to those supplements governing the Aggregate Purchased Assets, which provides for, among other things:

 

   

the contractual right to receive the servicing fees (excluding any ancillary income) related to any acquired mortgage servicing rights;

 

   

the contractual right to receive any investment earnings on the custodial accounts related to any acquired mortgage servicing rights that Ocwen Loan Servicing receives pursuant to the related pooling and servicing agreements;

 

   

the right to automatically obtain legal ownership, without any additional payment to Ocwen Loan Servicing, of each acquired mortgage servicing right upon the receipt of the necessary third party approvals and consents (this right, together with rights described in the bullet points above, constitute the “Rights to MSRs” with respect to any acquired mortgage servicing rights);

 

   

the outstanding servicing advances associated with the related pooling and servicing agreements; and

 

   

other assets related to the foregoing (collectively, the foregoing represent the “Planned Acquisition Assets”).

The mortgage loans underlying the Planned Acquisition Assets will be serviced by Ocwen Loan Servicing and, if and when we acquire the related Third Party Consent related to the Planned Acquisition Assets, will be subserviced by Ocwen Loan Servicing pursuant the Subservicing Agreement under similar terms to those subservicing supplements governing the Aggregate Purchased Assets. We currently expect that the Planned Acquisition will close shortly after this offering, although we cannot assure you that the closing of the Planned Acquisition will not be delayed. The closing of this offering is not conditioned upon the closing of the Planned Acquisition.

 

 

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Third Party Consents

Ocwen Loan Servicing will remain the named servicer of the Initial Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition until such time as the approvals and consents necessary to transfer legal ownership of such acquired mortgage servicing rights to us are obtained. We expect that the approvals, consents and other documentation from third parties necessary to transfer such legal ownership will include:

 

   

statements from the rating agencies that rated the related securitization transactions (which will likely include Moody’s Investors Service, Standard & Poor’s Ratings Service and Fitch Ratings Service) that the transfer of legal ownership of the acquired mortgage servicing rights to us will not cause a downgrade of the related mortgage-backed securities;

 

   

the consent of parties to the related pooling and servicing agreements, which may include the trustees of the related securitization trusts, the sponsors of the securitization transactions, any master servicer for the securitization transactions or any bond insurers or other credit enhancers insuring the mortgage-backed securities issued by the securitization trusts; and

 

   

any amendments to the related pooling and servicing agreements required to effectuate the transfer and sale of the related acquired mortgage servicing rights to us.

We refer to these requirements collectively as they relate to the Initial Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition or any acquired mortgage servicing rights as the “Required Third Party Consents.”

With respect to the Initial Purchased Assets, one of the rating agencies from whom a rating confirmation is required prior to the transfer of legal ownership of the mortgage servicing rights to us in the Initial Ocwen Purchase stated that it would not provide such confirmation primarily because we were a newly formed entity with no demonstrated operating history as a mortgage servicer. Although no specific time frame was provided by the rating agency, we believe that it will be at least six months to one year from the closing of our initial public offering before the rating agency will consider issuing a rating confirmation. As a result, the Flow Purchases were structured as purchases of Rights to MSRs and the Planned Acquisition is expected to be structured as a purchase of Rights to MSRs. A continued strategic priority for us is to obtain the Required Third Party Consents necessary for us to become the named servicers for the securitizations where we currently own Rights to MSRs and the associated advances. Based on our current dialogue with consent parties, our near term goal in pursuit of such consents is to establish an operating history that demonstrates a continued capability to perform the servicing requirements, specifically our obligation to fund servicing advances and to make principal and interest remittances in conformity with all requirements of the pooling and servicing agreements. As of the date of this prospectus, we have not received an update from rating agencies with respect to the timing of a rating confirmation or whether that confirmation will be forthcoming. We will automatically obtain legal ownership of any such mortgage servicing rights without any additional payment to Ocwen Loan Servicing if and when we obtain the Required Third Party Consents.

So long as any Required Third Party Consents have not been obtained:

 

   

Ocwen Loan Servicing will remain obligated to perform its obligations as servicer under the related pooling and servicing agreement;

 

   

we will be contractually required to purchase any servicing advances that Ocwen Loan Servicing is required to make pursuant to such pooling and servicing agreement as long as such servicing advances made by Ocwen Loan Servicing are made in accordance with its advance and stop advance policies;

 

 

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Ocwen Loan Servicing will be prohibited from taking actions inconsistent with our right to acquire legal ownership of the related mortgage servicing right upon receipt of the Required Third Party Consents; and

 

   

we will account for the acquired Rights to MSRs as a financing. Accordingly, we will record the purchase price paid to Ocwen Loan Servicing as a “Notes Receivable—Rights to MSRs.” We will record the servicing fees that we receive with respect to the Rights to MSRs, net of servicing costs related to such Rights to MSRs, as payments on the note and apportion these payments between interest income and principal repayment.

If and when we obtain the Required Third Party Consents and become the legal owner of any acquired mortgage servicing right:

 

   

we will be contractually obligated to service the mortgage loans underlying such acquired mortgage servicing rights in accordance with the related pooling and servicing agreement;

 

   

Ocwen Loan Servicing will be contractually obligated to us pursuant to a subservicing agreement to perform substantially all of the servicing functions it previously performed relating to such acquired mortgage servicing right on our behalf, other than maintaining custodial accounts, remitting amounts from the custodial accounts and funding servicing advances pursuant to the terms of the related pooling and servicing agreement, which will be functions for which we would be responsible; and

 

   

we will account for the remaining balance of the Notes Receivable—Rights to MSRs related to such acquired mortgage servicing right as mortgage servicing rights to the extent we receive any Required Third Party Consents to transfer legal ownership of such mortgage servicing rights to us.

We cannot be certain of how long it would take to obtain any Required Third Party Consents or if we would be able to obtain them at all. We do not believe, however, that our business strategy or economic performance has been or will be materially affected by whether we own any acquired mortgage servicing rights or the related Rights to MSRs.

The Market Opportunity

We believe that the current dynamics of the subprime and Alt-A mortgage servicing market have created a unique opportunity where the supply of mortgage servicing rights potentially for sale outweighs the number of potential buyers. These dynamics include:

 

   

higher borrower delinquencies and defaults experienced over the last few years and increased regulatory oversight has led to substantially higher costs for mortgage servicers and negatively impacted their profitability;

 

   

regulatory changes resulting from the implementation of the new international bank capital adequacy framework (“Basel III”), which will impose increased regulatory capital costs on depository institutions for owning mortgage servicing rights; and

 

   

our belief that subprime and Alt-A mortgage servicing has become less attractive to many mortgage servicers due to increasingly negative publicity and heightened government and regulatory scrutiny.

We believe that our business model allows us to be highly competitive in the acquisition of Mortgage Servicing Assets due to our cost structure, ability to access advance financing and our relationship with Ocwen Loan Servicing and although we remain open to purchasing assets from third parties other than Ocwen Loan Servicing, given the large amount of servicing assets remaining at Ocwen Loan Servicing, we do not view initiating purchases from other third parties as a near-term priority. We anticipate that our acquisitions of Mortgage Servicing Assets from sellers other than Ocwen Loan Servicing may involve

 

 

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engaging a party other than such seller to service the underlying mortgage loans. In addition, we may also pursue opportunities to purchase mortgage servicing rights relating to loans guaranteed or securitized by the U.S. government or government sponsored entities such as Fannie Mae and Freddie Mac (collectively, the “GSEs”).

Competitive Strengths

We believe we are well positioned to execute our business strategy based on the following competitive strengths:

Experienced Management Team with Extensive Knowledge of the Mortgage Servicing Industry.    We have an executive management team with extensive experience in the mortgage servicing industry. This experience includes evaluating and acquiring mortgage servicing rights, performing asset valuation analysis and financing mortgage servicing businesses through a variety of economic cycles. Key members of our executive management team also have experience in managing a public company in the mortgage servicing industry.

Asset Acquisition and Evaluation Expertise.    We believe that our asset acquisition evaluation process, which includes using proprietary historical data to project the performance of mortgage loans, and our executive management team’s experience and judgment in identifying, assessing, valuing and acquiring new Mortgage Servicing Assets enables us to accurately price assets.

Access to Mortgage Servicing Assets.    Members of our executive management team have extensive relationships in the mortgage servicing industry, including relationships with mortgage loan originators and potential sellers of mortgage servicing rights. We intend to acquire substantially all of Ocwen Loan Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A mortgage loans which had an unpaid principal balance of approximately $91.2 billion as of June 30, 2012. To date, we have acquired Rights to MSRs with an unpaid principal balance of $20.2 billion from Ocwen Loan Servicing. Future acquisitions of Ocwen Loan Servicing’s remaining mortgage servicing rights will depend on various factors, including our ability to access financing and to obtain the required third party approvals and consents, and may not take place.

Relationship with Ocwen.    We intend to continue to capitalize on the servicing capabilities of Ocwen Loan Servicing, which we view as superior relative to other servicers in terms of cost, management experience, technology infrastructure and platform scalability. Ocwen Loan Servicing will continue to service the mortgage loans underlying the Aggregate Purchased Assets, as well as service the mortgage loans underlying the Planned Acquisition Assets, during the period of time prior to the transfer of legal ownership to us of the Initial Mortgage Servicing Rights and the mortgage servicing rights associated with the Planned Acquisition. Thereafter, we will engage Ocwen Loan Servicing to service on our behalf the mortgage loans underlying our Mortgage Servicing Assets and any additional mortgage servicing assets that we may acquire from them in the future, provided that the performance criteria specified in the Subservicing Agreement are met. We may also engage Ocwen Loan Servicing to service mortgage loans underlying any mortgage servicing assets that we acquire from other third parties in the future.

 

 

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Ownership, Organizational and Operating Structure

On December 1, 2010, we were incorporated as a Cayman Islands exempted company. The following diagram illustrates our corporate structure, the jurisdiction of formation and the ownership interests of our subsidiaries.

 

LOGO

Risk Factors

We have a very limited operating history and our business model is new and relatively untested. An investment in our ordinary shares involves significant risks. Below is a summary of some of the key risk factors that you should consider in evaluating an investment in our ordinary shares. This list is not exhaustive and you should carefully read the full discussion of these risks and other risks described under “Risk Factors” beginning on page 19.

 

   

We may be unable to continue to implement our business strategy or operate our business as currently expected, including being able to obtain the Required Third Party Consents.

 

   

The assumptions underlying our business model may prove incorrect.

 

   

We will have increased risk related to our relationship with Ocwen Loan Servicing so long as it retains legal ownership of any mortgage servicing rights we may acquire from Ocwen Loan Servicing.

 

   

We may not be able to pay dividends on our ordinary shares, and our Board of Directors has the right to rescind any dividends declared, but unpaid at any time prior to the applicable dividend payment date.

 

   

We rely on Ocwen Loan Servicing to service our entire portfolio of Purchased Assets both before legal ownership is transferred to us and after.

 

   

We will need to acquire additional Mortgage Servicing Assets to maintain and grow our business as planned.

 

 

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We may not be able to obtain financing to fund our servicing advances and future acquisitions of Mortgage Servicing Assets, including the Planned Acquisition.

 

   

Government regulation may adversely affect our business.

 

   

We may become subject to taxation in the United States.

 

   

Many pooling and servicing agreements for subprime and Alt-A mortgage loans contain servicer termination events or events of default based upon the percentage of delinquent loans in the related mortgage loan pool, the loss performance of the related mortgage loans or servicer ratings downgrades. Servicer termination events or events of default based on the number of delinquent mortgage loans, loss performance of the related mortgage loans or servicer ratings downgrades have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Ocwen Mortgage Servicing Rights as of June 30, 2012, although the parties to the related securitization transactions have not exercised their right to terminate Ocwen Loan Servicing as servicer.

Corporate Information

Our principal executive offices are located in the Cayman Islands c/o Walkers Corporate Services Limited, Walker House, 87 Mary Street, George Town, Grand Cayman KYI-9005, Cayman Islands. We also maintain offices in the United States located at 2002 Summit Boulevard, Sixth Floor, Atlanta, Georgia 30319 and at 1661 Worthington Road, Suite 100, West Palm Beach, Florida 33409. We can be reached by telephone at (561) 682-7561, and our website is www.hlss.com. We do not incorporate information on, or accessible through, our corporate website into this prospectus, and you should not consider it a part of this prospectus.

 

 

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The Offering

 

Issuer

Home Loan Servicing Solutions, Ltd.

 

Ordinary shares offered in this offering

            ordinary shares.

 

Underwriters’ option to purchase additional ordinary shares

We have granted the underwriters an option to purchase up to an additional             ordinary shares from us at the public offering price, less the underwriting discounts, for a period of 30 days from the date of this prospectus to cover over-allotments, if any.

 

Number of ordinary shares to be outstanding after the offering

            ordinary shares (             ordinary shares if the underwriters’ option to purchase additional ordinary shares is exercised in full).

 

Use of proceeds

The net proceeds to us from this offering, after deducting underwriting discounts and commissions and our estimated offering expenses, will be approximately $         million (or $          million if the underwriters exercise their option to purchase up to an additional             ordinary shares). We intend to use the net proceeds of this offering to acquire the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets, but have not yet identified the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. We have not entered into any agreement to acquire the Planned Acquisition Assets. The closing of the Planned Acquisition is not a condition to the closing of this offering. We intend to use the remaining net proceeds, if any, for working capital and general corporate purposes. See “Use of Proceeds.”

 

Dividend policy

We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly cash dividend, although we are not required by law to do so.

 

  Since the closing of our initial public offering, we have paid monthly dividends of $0.10 per ordinary share (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share).

 

 

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  The following table sets forth the record and payment dates of the dividends declared by our Board of Directors for the months of August and September:

 

       

Record Date

  

Payment Date

  

Amount per

Ordinary Share

   

August 31, 2012

   September 10, 2012    $0.10
   

September 28, 2012

   October 10, 2012    $0.10

 

  Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy,” “Description of Share Capital” and “Material Cayman Islands and United States Federal Income Tax Considerations.”

 

NASDAQ Global Select Market symbol

“HLSS.”

 

Tax Considerations

We expect to be treated as a PFIC for U.S. federal income tax purposes. In order to avoid possible adverse tax consequences, including deferred tax and interest charges under the U.S. Internal Revenue Code and Treasury regulations thereunder, “U.S. Holders” (as defined below under “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation”) may make a “qualified electing fund,” or QEF, election or a mark-to-market election with respect to their investments in our ordinary shares. U.S. Holders should consult with their tax advisors as to whether or not to make such elections and the related consequences and should carefully review the information set forth under “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation—Consequences to U.S. Holders—Passive Foreign Investment Company Status and Related Tax Consequences” for additional information.

 

Conflicts of Interest

As described under “Underwriting,” a portion of the net proceeds of this offering may be paid to Ocwen Loan Servicing in connection with the Planned Acquisition. Ocwen Loan Servicing or its affiliates may use such proceeds to repay certain outstanding indebtedness under Ocwen’s senior secured term loan or one or more of Ocwen’s servicing advance facilities, the lenders under which include affiliates of certain of the underwriters. Because certain of the underwriters have provided a financing commitment to that term loan facility or are lenders under Ocwen’s servicing advance facilities, 5% or more of the net proceeds of this offering, not including underwriting compensation, may be paid to affiliates of certain of the underwriters. Accordingly, this offering is being conducted in compliance with Rule 5121 of the Financial Industry Regulatory Authority, Inc. (“FINRA”), which requires that a qualified

 

 

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independent underwriter (a “QIU”) participate in the preparation of this prospectus and perform the usual standards of due diligence with respect thereto.              is assuming the responsibilities of acting as the QIU in connection with this offering. We have agreed to indemnify              against certain liabilities incurred in connection with it acting as a QIU for this offering, including liabilities under the Securities Act.

 

Risk Factors

Please read “Risk Factors” beginning on page 19 of this prospectus for a discussion of the factors that you should carefully consider before deciding to invest in our ordinary shares.

Except as otherwise indicated, all information in this prospectus reflects or assumes no exercise by the underwriters of their option to purchase up to an additional             ordinary shares in this offering at the public offering price of $          per share.

 

 

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Summary Consolidated Financial Data

We were incorporated as a Cayman Islands exempted company on December 1, 2010. Prior to our initial public offering, our operations were limited to negotiating and entering into the Purchase Agreement and the Subservicing Agreement with Ocwen Loan Servicing, negotiating and entering into arrangements with lenders and other third parties to effect the transfer of our initial Mortgage Servicing Assets, associated servicing advances and the related match funded liabilities to us, negotiating and entering into professional and administrative services agreements with Ocwen Loan Servicing and Altisource Portfolio Solutions S.A., or “Altisource” and general corporate functions. We also entered into a stock purchase agreement pursuant to which William C. Erbey, the founder of our company and the Chairman of our Board of Directors, acquired $10.0 million of our ordinary shares at a purchase price of $14.00 per share concurrently with the closing of our initial public offering. Therefore, we have no historical financial statements reflecting our operations prior to our inception, and our audited balance sheet as of December 31, 2011 and the results of our operations for 2011 reflect only the activities described above. We completed our first full fiscal quarter of operations on June 30, 2012.

The following table sets forth certain of our financial information. The consolidated financial information for the year ended December 31, 2011 has been derived from our audited consolidated financial statements included in this prospectus. The summary financial information for the three and six month periods ended June 30, 2012 and 2011 has been derived from our unaudited consolidated financial statements included in this prospectus, which, in the opinion of management, include all adjustments (consisting of normal recurring adjustments) that are necessary for a fair presentation of our financial position and results of operations for such periods. The operating results for the six months ended June 30, 2012 may not be indicative of the results that may be expected for the entire year.

The unaudited as adjusted balance sheet data below gives effect to the completion of the offering as if it had been completed at June 30, 2012.

The following information should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements, including the notes thereto, appearing elsewhere in this prospectus.

Servicing Advances

We value servicing advances that we make on mortgage loans at their carrying amounts because they have no scheduled maturity, generally are realized within a relatively short period of time and do not bear interest.

Notes Receivable—Rights to MSRs

We record the Notes Receivable—Rights to MSRs at the purchase price of the related Rights to MSRs (as described in the Purchase Agreement). We amortize Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we calculate the present value of the net cash flows related to the underlying mortgage servicing rights and adjust the carrying value of the applicable Notes Receivable—Rights to MSRs to this amount. The change in the carrying value of the Notes Receivable—Rights to MSRs reduces the interest income associated with our Notes Receivable—Rights to MSRs.

 

 

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We estimate the fair value of our Notes Receivable—Rights to MSRs by calculating the present value of expected future cash flows of the related mortgage servicing rights utilizing assumptions that we believe are reasonable and consistent with the assumptions that are used by other market participants. The most significant assumptions used are estimates of the speed at which mortgages will prepay and the aggregate principal amount of mortgage loans that will become delinquent, both of which are based on our historical experience and available market data. Other assumptions used in our valuation are:

 

•    Cost of servicing

 

•    Compensating interest expense

•    Discount rate reflecting the risk of earning future income streams from the mortgage servicing rights

 

•    Interest rate used for computing float earnings

•    Interest rate used for computing the cost of servicing advances

 

•    Collection rate of other ancillary fees

The significant components of the estimated future cash inflows for the mortgage servicing rights held by us include servicing fees, late fees, prepayment penalties and float earnings. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments. We consider external market-based assumptions in determining the discount rate and interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing. The more significant assumptions used in the June 30, 2012 and December 31, 2011 valuation include mortgage loan prepayment projections ranging from 12% to 25% of the related mortgage loans’ unpaid principal balance per year (depending on loan type) averaging to a long-term projected mortgage loan prepayment rate of approximately 18% of the related mortgage loans’ unpaid principal balance per year, and delinquency rates ranging from 15% to 35% of the aggregate unpaid principal balance of mortgage loans related to the mortgage servicing rights held by us (depending on loan type). The long-term prepayment projections include voluntary and involuntary mortgage loan prepayment projections. Other assumptions include an interest rate of 1-month LIBOR plus 4% for computing the cost of financing servicing advances, an interest rate of 1-month LIBOR for computing float earnings and a discount rate of 20%, which reflects the risks associated with our relationship with Ocwen Loan Servicing (which currently services all of the Purchased Assets), including the risk that Ocwen Loan Servicing could become bankrupt, insolvent or otherwise be terminated as servicer.

Match Funded Liabilities

Because our match funded liabilities will bear interest at a rate that is adjusted regularly based on a market index, their carrying value approximates fair value.

 

 

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Consolidated Statement of Operations(1)

(dollars in thousands, except ordinary share data)

(unaudited)

 

      Three Months Ended
June 30,
    Six Months Ended
June 30,
    Twelve Months
Ended
 
     2012      2011     2012      2011     2011  

Revenue

            

Interest income–notes receivable–Rights to MSRs

   $ 10,580       $      $ 13,525       $      $   

Interest income–other

     103                136                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total interest income

     10,683                13,661                  

Other revenue

     744                995                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total revenue

     11,427                14,656                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Operating expenses

            

Organization costs

                                   273   
  

 

 

    

 

 

   

 

 

    

 

 

   

Compensation and benefits

     1,029                1,425                  

General and administrative expenses

     715         17        946         44          
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total operating expenses

     1,744         17        2,371         44        273   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from operations

     9,683         (17     12,285         (44     (273
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other expense

            
            

Interest expense

     4,964                6,255                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total other expense

     4,964                6,255                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     4,719         (17     6,030         (44       

Income tax expense

     60                77                  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 4,659       $ (17   $ 5,953       $ (44   $ (273
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Earnings (loss) per share

            
            

Basic

   $ 0.33       $ (0.83   $ 0.65       $ (2.19   $ (13.66
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Diluted

   $ 0.33       $ (0.83   $ 0.65       $ (2.19   $ (13.66
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Weighted average ordinary shares outstanding

            

Basic

     14,194,370         20,000        9,191,172         20,000        20,000   

Diluted

     14,194,370         20,000        9,191,172         20,000        20,000   

 

(1) Does not include the Flow Two Purchase, which was completed on August 1, 2012.

 

 

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Consolidated Balance Sheet(1)

(dollars in thousands, except ordinary share data)

 

     June 30,  2012
(unaudited)
    As adjusted
for the
offering
 

Assets

    

Cash

   $ 36,458      $                    

Match funded advances

     430,040     

Notes receivable—Rights to MSRs

     70,175     

Other assets

     23,986     
  

 

 

   

 

 

 

Total assets

   $ 560,659      $     
  

 

 

   

 

 

 

Liabilities and Equity

    

Liabilities

    

Match funded liabilities

   $ 368,467      $     

Dividends payable

     1,420     

Other liabilities

     8.696     
  

 

 

   

 

 

 

Total liabilities

   $ 378,583      $     
  

 

 

   

 

 

 

Equity

    

Equity — ordinary shares, $0.01 par value; 200,000,000 shares authorized; 14,197,218 shares issued and outstanding at June 30, 2012

   $ 142      $     

Additional paid-in-capital

     179,285     

Retained earnings

     3,214     

(Loss)

     (565  
  

 

 

   

 

 

 

Total equity

   $ 182,076      $     
  

 

 

   

 

 

 

Total liabilities and equity

   $ 560,659      $     
  

 

 

   

 

 

 

 

(1) Does not include the Flow Two Purchase, which was completed on August 1, 2012.

 

 

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RISK FACTORS

An investment in our ordinary shares involves significant risks. We describe below the principal risks and uncertainties that we believe affect us or could affect us in the future. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are not aware of or focused on or that we currently deem immaterial may also negatively affect our business operations. You should carefully read and consider the risks and uncertainties described below, together with all of the other information included in this prospectus, before you decide to invest in our ordinary shares. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, our ability to pay dividends in the future may be adversely affected, the value of our ordinary shares could significantly decline and you could lose all or part of your investment.

Risks Related to Our Business and Industry

We are a new company. If we are unable to implement our business strategy or operate our business as we currently expect, our operating results may be adversely affected and we may not be able to pay dividends in the future.

We commenced operations on March 5, 2012 using proceeds from our initial public offering and a concurrent private placement to our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion of unpaid principal balance from Ocwen Loan Servicing. Our business model is still new and relatively untested and we may not be able to execute our business strategy as planned, which may negatively impact our financial performance and our ability to pay dividends in the future. Businesses such as ours, which are starting up or in their initial stages of development, present substantial business and financial risks and may suffer significant losses. While we have an executive management team whose members are experienced in the mortgage servicing industry, their prior experience and relationships in the industry may not be successfully transferred to our company. In addition, primarily because we do not have a demonstrated operating history as a mortgage servicer, we have been unable to obtain all of the Required Third Party Consents necessary to transfer legal ownership of the Aggregate Purchased Assets to us at this time and may be unable to obtain all of the Required Third Party Consents necessary to transfer legal ownership of Planned Acquisition Assets to us. Our untested business model and limited operating history may also make it more difficult for us to acquire additional mortgage servicing rights from Ocwen Loan Servicing or other third parties in the future.

We have not entered into any agreement to acquire the Planned Acquisition Assets and our ability to do so will depend on a number of factors, including access to adequate financing and the completion of this offering. In connection with the Planned Acquisition, we expect to amend our existing Servicing Advance Facility Agreements to allow for additional borrowing from Barclays Bank Plc to finance the acquisition of the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired, or, alternatively, we may amend our existing Servicing Advance Facility Agreements to issue new debt securities backed by the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired. We are currently in discussions with Barclays Bank Plc regarding the amendments to the Servicing Advance Facility Agreement, but we do not have a firm commitment for additional servicing advance financing in connection with the Planned Acquisition. If we are not able to amend our Servicing Advance Facility Agreement on favorable terms or at all, we may not be able to complete the Planned Acquisition without delay or at all. The success of our business strategy depends, in large part, on our ability to acquire additional mortgage servicing assets. The completion of the offering is not conditioned upon completion of the Planned Acquisition. If the offering is completed and we are not able to complete the Planned Acquisition without delay or at all, our operating results could be adversely affected. As a new company we also must establish operating procedures, implement new systems and complete other tasks necessary to conduct our intended business activities.

 

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Because we are a newly formed company, the historical financial and operating data presented in this prospectus may not be representative of our future results.

We are a new company and have limited historical operating results. The quarter ended June 30, 2012 was our first full quarter of operations. In preparing our business and economic model, we made a number of assumptions about future revenues, expenses, assets and liabilities relating to the Aggregate Purchased Assets. We based these assumptions, in part, on the historical financial and operating data relating to the Initial Purchased Assets while they were owned by Ocwen Loan Servicing and the prior owners of the Aggregate Purchased Assets, which may not be indicative of the results we will be able to achieve in the future. Historical financial performance should not be considered a reliable indicator of future performance, and historical trends may not be reliable indicators of anticipated financial performance or trends in future periods. If our assumptions prove incorrect, we may be unable to pay dividends in the future.

We may not be able to obtain the Required Third Party Consents necessary to transfer legal ownership of any acquired mortgage servicing rights to us.

Generally, most pooling and servicing agreements require the consent of various parties, including the rating agencies, the trustees of the related securitization trusts, the sponsors of the securitization transactions, any master servicer or any bond insurers or other credit enhancers insuring the mortgage-backed securities issued by the securitization trusts, prior to the transfer of legal ownership of the related mortgage servicing rights. In connection with the Initial Ocwen Purchase, some but not all of the rating agencies indicated that they would issue a statement that the transfer to us of legal ownership of the mortgage servicing rights purchased would not result in a downgrade to the rating of the related mortgage-backed securities. Additionally, we have not received all of the other Required Third Party Consents in connection with mortgage servicing rights purchased by us. Although no specific time frame was provided by the rating agency that has not indicated that it would provide consent, we believe it will be at least six months to one year from the date or our initial public offering before the rating agency will consider issuing a rating confirmation. The rating agency may not issue the rating confirmation during this time frame or at all. Until we obtain the Required Third Party Consents necessary to transfer legal ownership of a mortgage servicing right to us, Ocwen Loan Servicing will retain legal ownership of such mortgage servicing right. Although are pursuing, and will continue to pursue, the Required Third Party Consents together with Ocwen Loan Servicing, we may not be able to obtain all the Required Third Party Consents in a timely manner or at all. Our understanding of one of the primary issues related to obtaining the Required Third Party Consents is that one of the rating agencies would not provide confirmation of its rating of the related mortgage-backed securities, at least until such time as we have developed an operating history as a mortgage servicer. We have not received an update from rating agencies with respect to the timing of a rating confirmation or whether that confirmation will be forthcoming. Until we receive the Required Third Party Consents and legal ownership of the mortgage servicing rights is transferred to us, we are subject to increased risks as a result of Ocwen Loan Servicing continuing to own the mortgage servicing rights, including the risks relating to the potential of Ocwen Loan Servicing filing for bankruptcy or being terminated as servicer. See below under “—A bankruptcy of Ocwen Loan Servicing could adversely affect our business, expected dividends on our ordinary shares and the value of your investment in us.”

A bankruptcy of Ocwen Loan Servicing could adversely affect our business, expected dividends on our ordinary shares and the value of your investment in us.

If Ocwen Loan Servicing becomes subject to a bankruptcy proceeding, our business could be materially adversely affected, and you could suffer losses.

The validity or priority of our security interest in the Initial Mortgage Servicing Rights could be challenged in a bankruptcy proceeding of Ocwen Loan Servicing, and the Purchase Agreement could be rejected in such proceeding.    Ocwen Loan Servicing’s obligations under the Purchase Agreement with respect to the Rights to MSRs is secured by a security interest in the related Initial Mortgage Servicing Rights and the proceeds of the related Initial Mortgage Servicing Rights. We have undertaken all

 

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requirements under applicable law to properly create and perfect such a security interest with respect to the Rights to MSRs that we have purchased to date, including pledging the collateral in the Purchase Agreement and filing financing statements in appropriate jurisdictions, and will undertake to properly create and perfect security interests in any additional Rights to MSRs that we may purchase from Ocwen Loan Servicing in the future, including in the Planned Acquisition. Nonetheless, our security interest may be ruled unenforceable or ineffective by a bankruptcy court. If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws, during the period of time prior to the transfer of the Initial Mortgage Servicing Rights to us, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could reject the Purchase Agreement and attempt to stop payments to us of the servicing or other related fees with respect to the Rights to MSRs and terminate our right to acquire those Initial Mortgage Servicing Rights that we have not already acquired. In the event the security interest is declared unenforceable or ineffective, we would be subject to the risk that our claim for any damages from the rejection of the Purchase Agreement or the failure to pay us the servicing or other related fees with respect to the Rights to MSRs would be treated as a general unsecured claim for purposes of distributions from Ocwen Loan Servicing’s bankruptcy estate. In addition, even if the security interest is found to be valid and enforceable, if a bankruptcy court determines that the value of the collateral exceeds the underlying obligation to us, then Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee would have the power (with the approval of the bankruptcy court) to modify the terms of the payment obligations to us, to substitute collateral securing the security interest or to reduce the collateral securing the security interest to a lesser amount deemed “adequate” to secure payment of our claim.

Payments made by Ocwen Loan Servicing to us could be avoided by a court under federal or state preference laws.    If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws and our security interest is declared unenforceable or ineffective, payments previously made by Ocwen Loan Servicing to us pursuant to the Purchase Agreement may be recoverable on behalf of the bankruptcy estate as preferential transfers. A payment could constitute a preferential transfer if a court were to find that the payment was a transfer of an interest of property of Ocwen Loan Servicing that:

 

   

was made to or for the benefit of a creditor;

 

   

was for or on account of an antecedent debt owed by Ocwen Loan Servicing before that transfer was made;

 

   

was made while Ocwen Loan Servicing was insolvent (a company is presumed to have been insolvent on and during the 90 days preceding the date the company’s bankruptcy petition was filed);

 

   

was made on or within 90 days (or if we are determined to be a statutory insider, on or within one year) before Ocwen Loan Servicing’s bankruptcy filing; and

 

   

permitted us to receive more than we would have received in a Chapter 7 liquidation case under applicable bankruptcy laws.

If the court were to determine that any payments were avoidable as preferential transfers, we would be required to return such payments to Ocwen Loan Servicing’s bankruptcy estate.

A sale of Mortgage Servicing Assets or other assets could be re-characterized as a pledge of such assets in a bankruptcy proceeding.    If Ocwen Loan Servicing’s transfer to us of Mortgage Servicing Assets or any other asset transferred pursuant to the Purchase Agreement were considered to be a sale of such assets, then such assets would not be part of Ocwen Loan Servicing’s bankruptcy estate. Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee might assert in a bankruptcy proceeding, however, that mortgage servicing rights or any other asset transferred to us pursuant to the Purchase Agreement were not sold to us but were merely pledged to us as security for

 

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Ocwen Loan Servicing’s obligation to repay amounts paid by us to Ocwen Loan Servicing pursuant to the Purchase Agreement. If such assertion were successful, all or part of the Mortgage Servicing Assets or any other asset transferred to us pursuant to the Purchase Agreement would constitute property of the bankruptcy estate of Ocwen Loan Servicing, and our rights against Ocwen Loan Servicing would be those of a secured creditor, and not those of an owner, of such assets. Although we will take steps to properly create and perfect a security interest in the assets we have purchased or may purchase in the future pursuant to the Purchase Agreement in case such purchase is re-characterized as a secured financing, the validity or priority of the security interest could be challenged. See above under “—The validity or priority of our security interest in the Initial Mortgage Servicing Rights could be challenged in a bankruptcy proceeding of Ocwen Loan Servicing, and the Purchase Agreement could be rejected in such proceeding” for a description of the risks associated with such security interest.

Payments made to us by Ocwen Loan Servicing, or obligations incurred by it, could be avoided by a court under federal or state fraudulent conveyance laws.    Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could also attempt to claim that a sale of Rights to MSRs or sale of mortgage servicing rights or other assets by Ocwen Loan Servicing to us was a fraudulent conveyance. Under the United States Bankruptcy Code and similar state insolvency laws, payments made, or obligations incurred, could be voided if Ocwen Loan Servicing, at the time it made such payment or incurred such obligation: (a) received less than reasonably equivalent value or fair consideration for such transfer or incurrence; and (b) either (i) was insolvent at the time of, or was rendered insolvent by reason of, such transfer or incurrence; (ii) was engaged in, or was about to engage in, a business or transaction for which the assets remaining with Ocwen Loan Servicing were an unreasonably small capital; or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature. If any transfer or incurrence is determined to be a fraudulent conveyance, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee would be entitled to recover such transfer or to avoid the obligation previously incurred.

The Subservicing Agreement could be rejected in a bankruptcy proceeding.    If Ocwen Loan Servicing were to file, or to become the subject of, a bankruptcy proceeding under the United States Bankruptcy Code or similar state insolvency laws, Ocwen Loan Servicing (as debtor-in-possession in the bankruptcy proceeding) or the bankruptcy trustee could reject the Subservicing Agreement and terminate Ocwen Loan Servicing’s obligation to service the mortgage loans underlying one or more of the mortgage servicing rights that we have acquired and that Ocwen Loan Servicing has agreed to service for us pursuant to the Subservicing Agreement. As we will not have and in the future do not expect to have the employees, servicing platforms or technical resources necessary to service mortgage loans, if the Subservicing Agreement is rejected we will need to either engage an alternate subservicer, which may not be readily available on acceptable terms or at all, or negotiate a new servicing arrangement with Ocwen Loan Servicing, which would presumably be on less favorable terms to us. Any claim we have for damages arising from the rejection of the Subservicing Agreement would be treated as a general unsecured claim for purposes of distributions from Ocwen Loan Servicing’s bankruptcy estate.

Any of the foregoing events might have a material adverse effect on our financial condition or operating results and our ability to pay dividends, which could cause delays or reductions in payments on our ordinary shares or a reduction in the value of our ordinary shares.

 

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We may not be able to pay dividends on our ordinary shares.

We intend to declare and pay regular cash dividends on our ordinary shares. We intend to distribute at least 90% of our net income over time to our shareholders on a monthly basis, although we are not required by law to do so. Since the closing of our initial public offering, we have paid monthly dividends of $0.10 per ordinary share (except during the month of March in which we paid a pro-rated amount of $0.08 per ordinary share). The following table sets forth the record and payment dates of dividends that have been declared by our Board of Directors, but are unpaid:

 

Record Date

   Payment Date    Amount per Ordinary Share

August 31, 2012

   September 10, 2012    $0.10

September 28, 2012

   October 10, 2012    $0.10

Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date. See “Dividend Policy,” “Description of Share Capital” and “Material Cayman Islands and United States Federal Income Tax Considerations.”

While we intend to continue to pay monthly dividends at this rate, we may not be able to do so in the future. Our dividend policy is subject to the discretion of our Board of Directors and will depend, among other things, on cash available for distributions, general economic and business conditions, our strategic plans and prospects, our financial results and condition, contractual, legal and regulatory restrictions on the declaration and payment of dividends by us and such other factors as our Board of Directors considers to be relevant.

Our ability to declare and pay dividends is dependent on cash flow generated by our subsidiaries because we are a holding company.

We are a holding company with no operations. Our subsidiaries own all of the assets that generate income and are expected to own any additional assets we purchase in the future. Therefore, our ability to declare and pay dividends is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, distribution or otherwise. Our subsidiaries may not be able or permitted to make distributions to enable us to make dividend payments in respect of our ordinary shares. Each of our subsidiaries is a distinct legal entity formed and governed under the laws of the State of Delaware, and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from them. The subsidiary that holds the Mortgage Servicing Assets and that will hold any additional Mortgage Servicing Assets we may acquire in the future, is a Delaware limited liability company. Delaware law provides that a limited liability company is prohibited from making a distribution of cash or other property to a member to the extent that, at the time of and after giving effect to the distribution, the limited liability company’s liabilities exceed the fair value of its assets, subject to certain exceptions. In addition, while our subsidiaries currently are not subject to any contractual restrictions with respect to the payment of dividends, any future financing or other arrangements that our subsidiaries enter into could limit their ability to make distributions to us. In the event that we do not receive distributions from our subsidiaries, we may be unable to make dividend payments on our ordinary shares.

We are highly dependent upon our senior management team.

Our business model and the execution of our business strategy is highly dependent upon the members of our senior management team. The loss of the services of any of our senior executives or key employees could delay or prevent us from executing our business strategy and could significantly and negatively affect our business.

Our senior management team will also devote a portion of its time to performing certain functions for Ocwen pursuant to the professional services agreement, which we refer to as the “Ocwen Professional Services Agreement” throughout this prospectus, that we entered into with Ocwen. This will detract from the amount of time these executives have available to focus on our business.

 

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In the future, we may need to hire additional personnel to meet the demands of our business, including any changes to our business strategy or operations due to a failure to obtain consents needed to transfer mortgage security rights on a timely basis or at all. The number of available, qualified personnel in the mortgage servicing industry may be limited, and the lack of qualified personnel may delay our ability to execute our business model as planned.

The continued economic slowdown and/or continued deterioration of the housing market could increase delinquencies and defaults on the mortgage loans underlying the mortgage servicing rights we acquire, which would negatively affect our operating results.

The residential mortgage market in the United States has experienced and may continue to experience a variety of difficulties and challenging economic conditions. Housing prices in many parts of the United States have declined or stopped appreciating after extended periods of significant appreciation. Any further deterioration of the U.S. housing market and declines in home prices could result in increased delinquencies or defaults on the mortgage loans underlying the mortgage servicing rights we acquire.

During any period in which the borrower is not making payments on a mortgage loan, the servicer under substantially all pooling and servicing agreements is required to advance its funds to meet contractual principal and interest remittance requirements for the securitization trust that owns the mortgage loans, pay property taxes and insurance premiums, process foreclosures and maintain, repair and market foreclosed real estate properties.

If the economy slows and/or the housing market continues to deteriorate, our operating results would be adversely affected in the following ways:

Interest Income and Servicing Fee Revenue.    Because we will recognize interest income and, if and when legal title to any mortgage servicing right is transferred to us, servicing fee revenue as principal and interest payments are collected from the borrowers on the mortgage loans underlying our Mortgage Servicing Assets and as delinquent loans are resolved, an increase in delinquencies would reduce the interest income and servicing fee revenue that we recognize.

Expenses.    An increase in servicing advances outstanding relative to the amount of the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets could result in substantial strain on our financial resources because growth of outstanding servicing advances relative to the unpaid principal balance of mortgage loans would increase financing costs with no offsetting increase in interest income or servicing fee revenue, thus reducing profitability. If servicing advances increase to a level where we are unable to fund additional servicing advances, we may not be able to fulfill our obligations under the Purchase Agreement to purchase the servicing advances that Ocwen Loan Servicing is required to make pursuant to the pooling and servicing agreements related to the Initial Mortgage Servicing Rights, or our obligations to fund servicing advances under those pooling and servicing agreements for which we are the servicer. As a result, the Purchase Agreement could be terminated, and we could lose the interest income or servicing fee revenue associated with our Rights to MSRs or be terminated as servicer under any affected pooling and servicing agreements and lose the interest income or servicing fee revenue associated with the mortgage servicing rights, as applicable.

Valuation of Mortgage Servicing Assets.    Defaults on mortgage loans will decrease the value of the associated notes receivable and Mortgage Servicing Assets. In addition, future default rates that exceed current estimates may result in higher amortization and a reduction in the value of our Mortgage Servicing Assets such that interest income or servicing fee revenue may decline and amortization and interest expense may increase.

 

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A significant increase in prepayment speeds would reduce the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets and could adversely affect our operating results.

Prepayment speeds significantly affect our business. Prepayment speed is the measurement of how quickly borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. Prepayment speeds, which are presently driven primarily by involuntary liquidations of subprime and Alt-A mortgage loans, have a significant impact on our servicing fees, our expenses and the valuation of our Mortgage Servicing Assets as follows:

Servicing Fees.    If prepayment speeds increase, our servicing fees will decline more rapidly than estimated because of the greater than expected decrease in the unpaid principal balance of the mortgage loans on which servicing fees are based.

Expenses.    Amortization of Mortgage Servicing Assets will be our largest operating expense. Since we amortize Mortgage Servicing Assets in proportion to total expected income over the life of the Mortgage Servicing Assets, an increase in prepayment speeds will lead to increased amortization expense as we revise downward our estimate of total expected income.

Valuation of Mortgage Servicing Assets.    We base the price we pay for Mortgage Servicing Assets and the rate of amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If prepayment speeds are significantly greater than expected, the carrying value of our Mortgage Servicing Assets could exceed their estimated fair value. If the carrying value of our Mortgage Servicing Assets exceeds their fair value, we will be required to record a non-cash charge for impairment or unrealized loss, which would have a negative impact on our operating results.

If we are unable to maintain the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets at an adequate level through the acquisition of additional Mortgage Servicing Assets or otherwise, we would likely reevaluate our long-term business strategy if such conditions persist for a period of approximately five years after the date of our initial public offering. One possible outcome of this evaluation would be to sell our remaining Mortgage Servicing Assets some time thereafter and use the proceeds to pay a liquidating distribution to our shareholders. In any such event, our shareholders may not be able to recover the full value of their investment in our ordinary shares.

We may not be able to successfully compete for the acquisition of mortgage servicing rights, which could adversely affect our business.

Our success depends, in large part, on our ability to acquire additional mortgage servicing rights on terms consistent with our business and economic model. We expect to compete with independent mortgage loan servicers, private equity firms, hedge funds and other large financial services companies in acquiring additional mortgage servicing rights. Many of our anticipated competitors are significantly larger than we are, have access to greater capital and other resources, are capable of financing servicing advances at a lower interest rate and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could lead them to offer higher prices than we would be willing to pay for these assets.

Under most pooling and servicing agreements the approval or consent of third parties will be required to transfer mortgage servicing rights to us. We have not yet been able to obtain all the Required Third Party Consents necessary to transfer legal ownership of the Initial Mortgage Servicing Rights to us, primarily because we do not have a demonstrated operating history as a mortgage servicer. No specific time frame was provided by the rating agency that has not provided consent. We believe it will be at least six months to one year before the rating agency will consider issuing a rating confirmation, although the rating agency may not issue the rating confirmation during this time frame or at all. Until such time as we establish an operating history as a mortgage servicer, we may need to continue to structure purchases of mortgage

 

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servicing assets as purchases of Rights to MSRs to the extent that the related pooling and servicing agreements require approvals or consents that we are unable to obtain. As a result, other potential purchasers of mortgage servicing rights may be more attractive to sellers if the sellers believe that they can obtain any necessary third party approvals and consents to transfer the mortgage servicing rights to these potential purchasers more easily than if they were transferring them to us. Even if other potential purchasers are not viewed by sellers to be a more attractive alternative, sellers may request a higher purchase price from us if we are not able to obtain the necessary approvals and consents prior to the completion of the sale of mortgage servicing rights. This may negatively affect our ability to acquire additional mortgage servicing rights or limit the available mortgage servicing rights or types of mortgage servicing rights that we are able to offer to acquire.

We also do not intend to build a mortgage servicing platform. Therefore, we may not be an attractive buyer for those sellers of mortgage servicing rights that prefer to sell mortgage servicing rights and their mortgage servicing platform in a single transaction. Since our business model does not currently include acquiring and running servicing platforms, to engage in a bid for such a business we would need to find a partner to acquire and run the platform or we would need to incur additional costs to shut down the acquired servicing platform. The need to work with a partner in these situations increases the complexity of such potential acquisitions, and Ocwen Loan Servicing may be unwilling to act as servicer or subservicer on any mortgage servicing rights acquisition we want to execute. The complexity of these transactions and the additional costs incurred by us if we were to execute future acquisitions of this type could adversely affect our future operating results.

We may be unable to maintain the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets at an adequate level, which may cause administrative expenses to increase relative to our equity base.

The unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline naturally over time. In addition, the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets could be reduced in connection with any loan put-backs. A loan put-back is a request by the securitization trustee for the originator of the loan or the party that transferred the loan to the securitization to repurchase the loan at par. These requests generally arise because the originator or transferor is found to have breached representations or warranties made at the time of origination or securitization. We have acquired additional Mortgage Servicing Assets in flow purchases in order to maintain a sufficient level of unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets relative to the size of our operations, and intend to continue to acquire additional Mortgage Servicing Assets in the future either through flow purchases or bulk purchases such as the Planned Acquisition. Given competition in our industry for the acquisition of mortgage servicing rights and the continued decrease in new securitizations, primarily as a result of the lack of new originations of subprime and Alt-A mortgage loans, a sufficient number of subprime and Alt-A mortgage servicing rights may not be available at attractive prices or at all. If we are unable to acquire new Mortgage Servicing Assets, the amount of servicing fees we receive, which is based on the unpaid principal balance of the loans underlying our Mortgage Servicing Assets, may decline as mortgage loans are repaid or liquidated. As a result, our future expenses may increase disproportionately to the size of our equity base, which will negatively affect our profitability and may limit our ability to pay dividends in the future. If we are unable to make additional acquisitions of mortgage servicing rights within a period of approximately five years, we would likely reevaluate our long-term business strategy at such time. One possible outcome of this evaluation would be to sell our remaining Mortgage Servicing Assets some time thereafter and use the proceeds to pay a liquidating distribution to our shareholders. In any such event, our shareholders may not be able to recover the full value of their investment in our ordinary shares.

 

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Our assumptions in determining the purchase price for Mortgage Servicing Assets may be inaccurate or the basis for such assumptions may change, which could adversely affect our results of operations.

To the extent that we purchase Mortgage Servicing Assets in the future, our success will be highly dependent upon accurate pricing of such Mortgage Servicing Assets. In determining the purchase price for Mortgage Servicing Assets, we will make assumptions regarding the following:

 

   

the rates of prepayment and repayment of the underlying mortgage loans;

 

   

amount of future servicing advances;

 

   

projected rates of delinquencies and defaults;

 

   

future interest rates; and

 

   

the costs associated with engaging subservicers to service the loans.

If any of our assumptions regarding the Mortgage Servicing Assets that we acquire are inaccurate or the basis for such assumptions change, the price we pay to acquire Mortgage Servicing Assets may prove to be too high. This could result in lower than expected profitability or a loss. We do not intend to obtain an opinion from an independent valuation firm of the fairness from a financial point of view of the price of any future acquisitions, including the Planned Acquisition.

We do not intend to operate a mortgage servicing platform and will need to engage subservicers to service the mortgage loans underlying any mortgage servicing rights we ultimately acquire. We may not be able to engage subservicers on terms that are favorable to us or at all.

We do not intend to operate a mortgage servicing platform. Our success will depend on our ability to enter into subservicing agreements with high-quality mortgage servicers, like Ocwen Loan Servicing, to service the mortgage loans underlying any mortgage servicing rights we ultimately acquire.

The terms of any subservicing agreement will be negotiated with the subservicer prior to the acquisition of the related mortgage servicing rights. It is unlikely that the term of any subservicing agreement we enter into will match the life of any mortgage servicing rights that we ultimately acquire and therefore will need to be renewed. As a result, the terms of any new subservicing agreement or renewal will depend on the economic environment and the costs of providing subservicing at that time. For example, the initial term of the Subservicing Agreement will expire on March 5, 2018. Therefore, we will need to renegotiate the terms of this agreement before these assets wind down. In addition, the terms of any future subservicing agreements, including those we enter into with Ocwen Loan Servicing, may not be similar to the terms of the Subservicing Agreement.

We may be unable to obtain sufficient capital or obtain or maintain the servicer advance financing necessary to meet the financing requirements of our business, which could adversely affect our operating results and our ability to pay dividends in the future.

We will need access to capital to finance servicing advances relating to our Mortgage Servicing Assets we may acquire and to fund future acquisitions of additional Mortgage Servicing Assets and associated servicing advances, including the Planned Acquisition.

Servicing Advances.    If delinquencies increase with respect to the mortgage loans underlying our Mortgage Servicing Assets, we will require more funding than we currently expect, which may not be available to us on favorable terms or at all. We currently meet our servicing advance financing requirements through the Servicing Advance Facility, which expires in August 2013. In order to meet our servicing advance financing requirements with respect to the Planned Acquisition Assets, we need to obtain additional advance financing. We expect to amend our existing Servicing Advance Facility Agreements to allow for additional borrowing from Barclays Bank Plc to finance the acquisition of the servicing advances related to the Planned Acquisition Assets and the servicing advances we have

 

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previously acquired, or, alternatively, we may amend our existing Servicing Advance Facility Agreements to issue new debt securities backed by the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired. We are currently in discussions with Barclays Bank Plc regarding the amendments to the Servicing Advance Facility Agreement, but we do not have a firm commitment for the additional servicing advance financing in connection with the Planned Acquisition. Under normal market conditions, mortgage servicers typically have been able to renew or refinance liquidity facilities for mortgage servicing rights. However, during the economic crisis that began in 2007, there were periods of time when mortgage servicers were unable to renew these facilities. Borrowing conditions have improved since that time; however, market conditions at the time of any renewal or refinancing may not enable us to renew or refinance our advance financing facilities or obtain additional facilities on favorable terms or at all. Ocwen Loan Servicing will not have any obligation to us to fund any servicing advances that we are required to purchase or fund. Our inability to obtain adequate financing to fund servicing advances would result in the termination of our mortgage servicing rights under the applicable pooling and servicing agreements or the loss of our Rights to MSRs pursuant to the Purchase Agreement, as applicable. If, for this reason, our mortgage servicing rights or Rights to MSRs are terminated or lost, as applicable, we will bear the full economic impact of this termination or loss without the right to seek indemnification from Ocwen Loan Servicing.

Mortgage Servicing Assets.    The unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline naturally over time, and we intend to acquire new Mortgage Servicing Assets to maintain the scale of our operations. To maintain our goal of distributing at least 90% of our net income over time to our shareholders on a monthly basis, we will limit the amount of unused cash and borrowing capacity. This means that we may need access to the capital markets to fund acquisitions of additional Mortgage Servicing Assets and associated servicing advances. The global capital markets are currently experiencing a period of disruption and instability that began in 2007 and that has most recently resulted in the downgrading of government debt in several European States. Our ability to fund future acquisitions may depend on our ability to access the capital markets and on the strength and performance of these markets. In addition, the provisions of our Articles of Association restrict our ability to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. This restriction may make it more difficult for us to raise capital through the issuance of additional ordinary shares.

Ocwen Loan Servicing or we may be terminated as servicer under a pooling and servicing agreement. Servicer termination events or events of default have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Initial Mortgage Servicing Rights as of June 30, 2012, and the parties to the related securitization transactions could enforce their rights against Ocwen Loan Servicing or us at any time as a result.

Ocwen Loan Servicing will remain obligated to service the mortgage loans underlying the Rights to MSRs that we acquire in accordance with the terms of the related pooling and servicing agreements during the period of time prior to the transfer of the Initial Mortgage Servicing Rights to us. If and when we acquire legal ownership of the Initial Mortgage Servicing Rights, we will be obligated to service these mortgage loans in accordance with the terms of the related pooling and servicing agreements. We will also be obligated to service the mortgage loans relating to any other mortgage servicing rights that we may acquire in the future. Pursuant to the Subservicing Agreement, we have engaged Ocwen Loan Servicing to service the mortgage loans underlying the Initial Mortgage Servicing Rights upon our receipt of the Required Third Party Consents, and may engage Ocwen Loan Servicing or other subservicers to service the mortgage loans underlying any other mortgage servicing rights that we acquire in the future. We intend to engage Ocwen Loan Servicing to service the mortgage loans underlying the Planned Acquisition Assets. Any default by Ocwen Loan Servicing relating to its obligations as servicer under any pooling and servicing agreement related to the Initial Mortgage Servicing Rights during the period of time prior to the transfer of the Initial

 

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Mortgage Servicing Rights to us, or as subservicer pursuant to the Subservicing Agreement following any such transfer, or the failure of any other servicer to perform its obligations or to satisfy the other requirements under the terms of the pooling and servicing agreement related to any of our mortgage servicing rights, could result in a servicer termination event or servicer event of default under such agreement. In addition, if we fail to perform any of our obligations as servicer with respect to our mortgage servicing rights that we did not delegate to a subservicer, such as making servicing advances or remitting funds to the securitization trust in accordance with the terms of the applicable pooling and servicing agreement, it will result in a servicer termination event or servicer event of default. If we fail to purchase the servicing advances that Ocwen Loan Servicing is required to make pursuant to the related pooling and servicing agreements prior to the transfer of such Initial Mortgage Servicing Rights to us, Ocwen Loan Servicing may be in breach of its obligations to make such servicing advances, which will also result in a servicer termination event or servicer event of default. If such servicer termination event or servicer event of default is a result of our breach of a representation under the Purchase Agreement, or our actions or our failure to act, we could owe an indemnification payment to Ocwen Loan Servicing for the amount of its losses resulting from such servicer termination event or servicer event of default.

Many pooling and servicing agreements for subprime and Alt-A mortgage loans also contain servicer termination events or events of default based upon the number of delinquent loans or the loss performance of the related mortgage loans. We believe that these servicer termination events or events of default have been triggered in most pooling and servicing agreements for subprime and Alt-A mortgage loans that were entered into prior to 2008. A significant number of the pooling and servicing agreements related to the Initial Mortgage Servicing Rights (representing approximately 81% of the unpaid principal balance of the mortgage loans underlying such Initial Mortgage Servicing Rights as of June 30, 2012) contain servicer termination events or events of default of this type, all of which have been triggered. We expect that a significant number of the pooling and servicing agreements related to the mortgage servicing assets that we intend to acquire in the Planned Acquisition will also contain servicer termination events or events of default that have been triggered. We believe that one possible reason that the parties to pooling and servicing agreements that have the right to terminate a servicer upon the occurrence of such servicer termination events or events of default have not exercised such rights may be because the transfer of servicing could lead to a disruption of servicing activities which could lead to increased delinquencies and decreased recovery on the underlying mortgage loans, which could result in a loss on the related mortgage-backed securities. While the parties to the securitization transactions have not exercised their right to terminate Ocwen Loan Servicing as servicer under the pooling and servicing agreements related to the Initial Mortgage Servicing Rights, they could enforce their rights against Ocwen Loan Servicing prior to the transfer of such Initial Mortgage Servicing Rights to us, or against us if and when we acquire the Initial Mortgage Servicing Rights at a later date. In addition, most of the pooling and servicing agreements related to the Initial Mortgage Servicing Rights also contain servicer termination events or events of default that require the servicer to maintain a tangible net worth of between $15 million and $50 million, and we expect the pooling and servicing agreements related to the mortgage servicing assets acquired in the Planned Acquisition to have similar terms.

If a servicer termination event or event of default has occurred under a pooling and servicing agreement, the servicer may be terminated without any right to compensation for its loss from the trustee for the securitization trust, other than the right to be reimbursed for any outstanding servicing advances as the related loans are brought current, modified, liquidated or charged off. So long as we are in compliance with our obligations under the Subservicing Agreement and the Purchase Agreement, if Ocwen Loan Servicing is terminated as servicer, or if we are terminated as servicer when Ocwen Loan Servicing is acting as subservicer, we will have the right to receive an indemnification payment from Ocwen Loan Servicing as servicer or subservicer, even if such termination related to servicer termination events or events of default existing at the time of the Initial Ocwen Purchase, including with respect to those servicer termination events or events of default that have been triggered in pooling and servicing agreements representing approximately 81% of the unpaid principal balance of the mortgage loans underlying the Initial Mortgage Servicing Rights as of June 30, 2012. See “—A downgrade in Ocwen Loan Servicing’s servicer rating and

 

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that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations.” If Ocwen Loan Servicing or we are terminated as servicer with respect to a pooling and servicing agreement and Ocwen Loan Servicing is unable to make any resulting indemnification payments to us, if any, it may have a material adverse effect on our operating results and our ability to pay dividends and may make it more difficult for us to acquire additional mortgage servicing rights in the future.

If our assumptions regarding subprime and Alt-A borrower refinancing options in a declining interest rate environment prove incorrect, the unpaid principal balance of the mortgage loans underlying Mortgage Servicing Assets could decline, which would adversely affect our operating results.

In preparing our business and economic model, we made a number of assumptions about future servicing fees, expenses, assets and liabilities relating to our Mortgage Servicing Assets. In connection with this process, we made certain assumptions about likely prepayment speeds on the mortgage loans underlying our Mortgage Servicing Assets in a declining interest rate environment. These assumptions were based on our view that subprime and Alt-A borrowers would have limited refinancing options even in such an environment. Refinancings, also known as voluntary prepayments, are a small component of total prepayments, with involuntary prepayments and liquidations being the larger component. If subprime and Alt-A borrowers were able to refinance their mortgage loans in a declining interest rate environment, prepayment speeds would increase, leading to lower unpaid principal balance on the mortgage loans underlying our Mortgage Servicing Assets, which would adversely affect our operating results.

If our assumptions regarding the rates at which delinquent mortgages loans will become performing or be resolved through loan modifications are higher than the actual rates, then the unpaid principal balance of the mortgage loans underlying our Mortgage Servicing Assets will decline more quickly than we have anticipated, and the amount and duration of outstanding servicing advances would increase, which would adversely affect our operating results.

In preparing our business plan and economic model, we made assumptions about the likely delinquency rates for the mortgage loans underlying our Mortgage Servicing Assets, and the rates at which those delinquent mortgage loans would reperform, either through a payment of past due amounts or through permitted modifications of the terms of these mortgage loans. Delinquent mortgage loans that become performing either because of a payment of past due amounts or a permitted loan modification remain outstanding as part of the aggregated unpaid principal balance of the underlying mortgage loans and therefore will continue to produce revenue for us over their remaining term. The servicer is also able to reimburse itself for outstanding servicing advances when delinquent mortgage loans reperform. On the other hand, when delinquent mortgage loans are resolved through foreclosure, the unpaid balance of such loans ceases to be a part of the aggregate unpaid principal balance when the related mortgage properties are foreclosed on and liquidated. Also, delinquent mortgage loans resolved through foreclosure generally require more servicing advances over a longer time horizon prior to reimbursement as compared with servicing advances made with respect to delinquent mortgage loans that are resolved through repayment or permitted loan modifications. A faster amortization of the aggregate unpaid principal balance of the underlying mortgage loans and an increase in the amount and duration of outstanding servicing advances would adversely affect our operating results.

Our hedging strategies may not be successful in mitigating the risks associated with changes in interest rates.

We are exposed to interest rate risk to the extent that the interest rates on our financing facilities are tied to a variable rate index and when we refinance those obligations or enter into new facilities. We use and plan to continue to use various derivative and other financial instruments to provide a level of protection against interest rate risks. Although we have executed a hedging strategy aimed to neutralize our net exposure to interest rate increases on our floating rate match funded liabilities and intend to

 

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continue to do so, no hedging strategy can completely protect us. Our hedging activities may include entering into interest rate swaps, caps and floors, options to purchase these items and futures and forward contracts. Our hedging decisions are determined in light of the facts and circumstances existing at the time and may differ from our current hedging strategy. Any significant change in interest rates could result in a significant margin call, which would require us to provide the counterparty with additional cash collateral. Any such margin call, or any decline in interest rates that results in the diminution in value of our hedges, could harm our liquidity, profitability, financial condition and business prospects.

If we are named in legal proceedings involving mortgage servicers, the costs of litigation could adversely affect our financial results.

The residential mortgage loan servicing industry is extremely litigious, and we could be subject to allegations of illegality in connection with our own operations or the business practices of subservicers acting on our behalf, including lawsuits related to their billing and collections practices, modification protocols or foreclosure practices and other loss mitigation efforts associated with the mortgage loans they service on our behalf. Ocwen Loan Servicing has informed us that it is currently a defendant in several lawsuits regarding its servicing activities, including putative class actions, and we face the risk that we could be added as a defendant in any of these actions that relate to servicing the Aggregate Purchased Assets.

Ocwen has informed us that it has received a Civil Investigative Demand (“CID”) from the Federal Trade Commission (the “FTC”), requesting documents and information concerning various loan servicing activities. Recently Ocwen was informed that this CID had been referred to the Bureau of Consumer Financial Protection (“BCFP”), a new federal entity responsible for administering and enforcing the laws and regulations for consumer financial products and services, such as residential mortgage loans. In addition, a coalition of state attorneys general is conducting an industry-wide investigation into certain acts and practices concerning the mortgage foreclosure process. The FTC, the BCFP and such attorneys general have not taken any action against Ocwen, but it is possible that Ocwen could receive notifications of alleged wrongdoing or be named as a defendant with respect to these matters or other litigation and regulatory matters.

We could be added as a defendant or investigated in any of these matters. We also may be added as a defendant in future lawsuits brought against Ocwen, Ocwen Loan Servicing or other servicers regarding their servicing practices relating to our mortgage servicing rights. Defending ourselves against lawsuits or adverse legal judgments against us may require that we pay significant legal fees, settlement costs, damages, penalties or other charges, or undertake remedial actions pursuant to administrative orders or court-issued injunctions, any of which could adversely affect our financial results.

Risks Related to Our Relationship with Ocwen, Other Subservicers and Related Parties

We are dependent on Ocwen Loan Servicing to act as a servicer with respect to the mortgage loans underlying the Initial Mortgage Servicing Rights.

We are dependent on Ocwen Loan Servicing to service the mortgage loans underlying the Initial Mortgage Servicing Rights until such time, if at all, as legal ownership of the Initial Mortgage Servicing Rights are transferred to us. A failure of Ocwen Loan Servicing to perform its servicing obligations under a related pooling and servicing agreement could result in the termination of Ocwen Loan Servicing as servicer. If Ocwen Loan Servicing is terminated, it will no longer receive the servicing fees or any other proceeds with respect to such Initial Mortgage Servicing Right that it owes to us. If this occurs, we will only have recourse against Ocwen Loan Servicing and will not have any recourse against the related trustee or securitization trust because we will not have legal title to the mortgage servicing rights at that time. If Ocwen Loan Servicing is unable to make any applicable indemnification payments owed to us, we could lose the entire value of the related Rights to MSRs, which would adversely affect our operating results and our ability to pay dividends. We will be exposed to this risk with respect to future purchases of Rights to MSRs from Ocwen Loan Servicing.

 

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We will be dependent on Ocwen Loan Servicing and any other third parties who we engage as subservicer, to perform substantially all of our servicing obligations relating to any mortgage servicing rights we own.

For those mortgage servicing rights that we may ultimately acquire, including the Initial Mortgage Servicing Rights if and when they are transferred to us and those we may acquire in the Planned Acquisition, we will be contractually obligated to service the loans underlying those mortgage servicing rights. We will not have and in the future do not expect to have the employees, servicing platforms or technical resources necessary to service the loans. We have engaged Ocwen Loan Servicing to service the mortgage loans underlying the Initial Mortgage Servicing Rights. In addition, we expect to engage Ocwen Loan Servicing or other subservicers to service the mortgage loans underlying any mortgage servicing rights we acquire in the future, including in the Planned Acquisition. If we are unable to engage a subservicer, we will be unable to perform our obligations under the related pooling and servicing agreements, which would lead to our termination as servicer without payment. If for any reason Ocwen Loan Servicing is no longer able to act as subservicer or any other subservicer is no longer able to act as subservicer with respect to any other mortgage servicing rights we may acquire, an alternate subservicer may not be readily available on acceptable terms or at all, which would adversely affect our operating results.

Under the Subservicing Agreement and the initial subservicing supplement, we will be required to pay Ocwen Loan Servicing fees for servicing the mortgage loans underlying the Initial Mortgage Servicing Rights. If we fail to pay Ocwen Loan Servicing any monthly base fee or monthly performance based incentive fee that is past due, subject to certain grace periods and other conditions specified in the Subservicing Agreement and the initial subservicing supplement, Ocwen Loan Servicing may cease to service the related mortgage loans until such fees have been paid to Ocwen Loan Servicing. Any failure of Ocwen Loan Servicing to service such mortgage loans could result in a servicer termination event or event of default, which could cause us to be terminated as servicer without any right to compensation for the loss of any affected mortgage servicing right.

Failure by Ocwen Loan Servicing and future subservicers to comply with applicable laws and regulations may adversely affect our business.

Mortgage servicing is subject to extensive and evolving federal, state and local laws and regulations. Mortgage servicers are contractually obligated to service the mortgage loans underlying mortgage servicing rights in compliance with such laws and regulations. Failure by Ocwen Loan Servicing or any subservicer we engage in the future to comply with such laws and regulations may result in a servicer termination event or an event of default of the servicer under the related pooling and servicing agreements. If a servicer termination event or event of default has occurred under a pooling and servicing agreement, we may be terminated as servicer (or Ocwen may be terminated as servicer under a pooling and servicing agreement related to an Ocwen Mortgage Servicing Right prior to its transfer to us). As a result, we may not receive any compensation for the loss of the related Mortgage Servicing Assets, other than the right to be reimbursed for any outstanding servicing advances as the related loans are brought current, modified, liquidated or charged off. In addition, the failure of Ocwen Loan Servicing or our other subservicers to comply with these laws and regulations in connection with servicing mortgage loans underlying our mortgage servicing rights, could possibly lead to civil and criminal liability, loss of licensing, damage to our reputation in the industry, fines and penalties and litigation, including class action lawsuits or administrative enforcement actions. Any of these outcomes would have a material adverse effect on our operating results and may make it more difficult for us to acquire additional mortgage servicing rights in the future.

 

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Failure by Ocwen Loan Servicing and future subservicers to ensure that servicing advances comply with the terms of the pooling and servicing agreements may have a material adverse effect on our operating results and our ability to pay dividends in the future.

Although we are responsible for purchasing or funding servicing advances, Ocwen Loan Servicing is responsible for ensuring that servicing advances associated with Ocwen Mortgage Servicing Rights are made in compliance with the terms of the related pooling and servicing agreements and its advance and stop advance policies so that the servicing advances with respect to a mortgage loan do not exceed the amount expected to be collected with respect to such mortgage loan. Future subservicers will have similar responsibilities with respect to future mortgage servicing rights we may acquire. Servicing advances that are improperly made may not be eligible for financing under an advance financing facility and may not be reimbursable by the related securitization trust or other owner of the mortgage loan, which would reduce our liquidity and may cause us to suffer a loss.

If we have to replace Ocwen Loan Servicing, we may not be able to find a suitable replacement, which could adversely affect our financial results.

We intend to continue to capitalize on the servicing capabilities of Ocwen Loan Servicing for the Aggregate Purchased Assets and future acquisitions of Mortgage Servicing Assets. We view Ocwen Loan Servicing as superior relative to many other servicers in terms of cost, management experience, technology infrastructure and platform scalability. If for any reason Ocwen Loan Servicing is no longer able to act as subservicer for us with respect to mortgage servicing rights that we have acquired, or if we decide to require Ocwen Loan Servicing to transfer their mortgage servicing rights to a successor servicer after the occurrence of an event of default under the Purchase Agreement, with respect to the Initial Mortgage Servicing Rights prior to the transfer of legal ownership to us, or under the Subservicing Agreement, we will need to find a replacement subservicer.

Although there are other entities that may be willing to act as subservicer (or as a successor servicer to Ocwen Loan Servicing with respect to the Ocwen Mortgage Servicing Rights) for us, they may not be of the same quality as Ocwen Loan Servicing, or they may not be willing to act on the same economic terms as Ocwen Loan Servicing. Even if we hire an entity of equal quality and on the same economic terms, there is typically a temporary degradation in the quality of servicing when the servicing of a mortgage loan is transitioned from one subservicer to another. As a result, if we have to replace Ocwen Loan Servicing, our operating results would be adversely affected.

If Ocwen Loan Servicing or any future subservicer fails to adequately perform its loss mitigation obligations, we could be required to make additional servicing advances and the time period for collecting servicing advances may extend.

Ocwen Loan Servicing and any future subservicers that we engage will be required to service the mortgage loans in accordance with specified standards and employ loss mitigation techniques to reduce the probability that borrowers will default on their loans and to minimize losses when defaults occur. These loss mitigation techniques may include the modification of mortgage loan rates and maturities. If Ocwen Loan Servicing or future subservicers fail to adequately perform their loss mitigation obligations under these agreements, we could be required to purchase or fund servicing advances in excess of those that we might otherwise have had to purchase or fund, and the time period for collecting servicing advances may extend. Any increase in servicing advances or material increase in the time to resolution of a defaulted loan could result in increased financing costs to us and adversely affect our liquidity and net income.

Ocwen Loan Servicing may not be able to satisfy its indemnification obligations under the Purchase Agreement and the Subservicing Agreement.

Under the Purchase Agreement, Ocwen Loan Servicing is obligated to indemnify us for losses suffered by us resulting from a breach of Ocwen Loan Servicing’s representations, warranties or covenants relating

 

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to any Mortgage Servicing Assets we purchase from it for any of its acts or omissions relating to such Mortgage Servicing Assets occurring prior to the transfer of legal ownership of the related mortgage servicing rights to us.

Under the Subservicing Agreement, Ocwen Loan Servicing is obligated to indemnify us for losses suffered by us resulting from Ocwen Loan Servicing’s failure to observe or perform any of its duties, obligations or covenants, any acts or omissions of Ocwen Loan Servicing or its agents, any breach of its representations and warranties, or any willful malfeasance, bad faith, fraud or negligence in the performance of its duties under the Subservicing Agreement. If we incur a loss for which indemnification may be available against Ocwen Loan Servicing under the Purchase Agreement or the Subservicing Agreement, as the case may be, and if Ocwen Loan Servicing does not have sufficient financial resources available to satisfy its obligation to indemnify us or if it is determined that Ocwen Loan Servicing is not required to provide indemnification, we may experience a loss which could have a material adverse effect on our operations and financial condition.

A downgrade in Ocwen Loan Servicing’s servicer rating and that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations.

Moody’s, Standard & Poor’s and Fitch rate many mortgage servicers, including Ocwen Loan Servicing. These ratings are subject to change in the future without notice. Servicer ratings are important to our ability to finance servicing advances. For example, the amount of debt that is permitted to be outstanding under the advance financing facility that we have assumed in connection with the Initial Ocwen Purchase will decrease with downgrades in the servicer ratings of Ocwen Loan Servicing. Downgrades in the servicer ratings of any future subservicers we engage could also affect the terms of advance financing facilities that we may enter into in the future, as lenders may require higher interest rates or may limit the amount of money that we can borrow to finance servicing advances if our subservicers’ ratings are deemed by the lenders to be too low. In addition, some pooling and servicing agreements may also require that the servicer or subservicer maintain specified servicer ratings. The failure to maintain the specified rating may cause the termination of the servicer under such pooling and servicing agreements. Any such downgrade could have an adverse effect on our business, financing activities, financial condition or results of operations. In December 2011, Fitch downgraded Ocwen Loan Servicing’s servicer ratings from RPS2 to RPS3 and RSS2 to RSS3 and maintained “rating watch negative.” On February 21, 2012, Ocwen Loan Servicing received a notice that servicer termination events or events of default had been triggered for certain pooling and servicing agreements underlying the Initial Mortgage Servicing Rights. This downgrade caused the cumulative percentage of the pooling and servicing agreements with triggered servicer termination events or events of default based on the number of delinquent mortgage loans, loss performance of the related mortgage loans or servicer ratings downgrades to increase from 83% to 89% on June 30, 2012. The Servicing Advance Facility Agreements provide that any pooling and servicing agreement that has triggered servicer termination events or events of default due to the downgrade of Ocwen Loan Servicing’s servicer rating by a rating agency do not lose eligibility for advance financing under the existing advance financing facility, unless and until Ocwen Loan Servicing or we receive a notice of termination of servicing.

Our ability to continue borrowing under our liquidity facilities could be adversely affected by events relating to Ocwen, Ocwen Loan Servicing and future subservicers with whom we enter into subservicing agreements.

Under the existing advance financing facility that we have assumed from Ocwen Loan Servicing, our ability to continue borrowing may be limited by the occurrence of certain events relating to Ocwen and Ocwen Loan Servicing. For example, if Ocwen undergoes a change of control or if Ocwen Loan Servicing fails to satisfy certain liquidity tests, this would constitute an early amortization event and the lenders under that facility may cease funding our servicing advances. If Ocwen defaults under a full-recourse term loan, including Ocwen’s senior secured term loan, that would constitute an event of default under our existing

 

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advance financing facility. If one of these events occurs prior to the facility’s expiration date in August 2013 and our lenders cease funding our servicing advances, we may not be able to arrange for a replacement facility to finance the servicing advances that we are obligated to continue purchasing from Ocwen Loan Servicing. Our inability to obtain adequate financing to fund servicing advances would result in the termination of our mortgage servicing rights under the applicable pooling and servicing agreement or our Rights to MSRs pursuant to the Purchase Agreement, as applicable. See “Description of Servicing Advance Facility Agreements and Advance Financing Facility.”

If we are required to register under the Investment Company Act, our ability to conduct our business could be materially adversely affected, and you could suffer losses.

We are not registered, and do not intend to register, as an investment company under the Investment Company Act of 1940 (the “Investment Company Act”). Under Section 3(a)(1)(A) of the Investment Company Act, a company is not deemed to be an “investment company” if it neither is, nor holds itself out as being, engaged primarily, nor proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of the Investment Company Act, a company is not deemed to be an “investment company” if it (1) neither is engaged, nor proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and (2) does not own or propose to acquire “investment securities” having a value exceeding 40% of the value of its total assets (exclusive of government securities and cash items) on an unconsolidated basis (the “40% test”). “Investment securities” excludes (A) government securities, (B) securities issued by employees’ securities companies and (C) securities issued by majority-owned subsidiaries which are not investment companies, and which are not relying on the exception from the definition of investment company under Section 3(c)(1) or 3(c)(7) of the Investment Company Act.

We intend to conduct our operations directly and through wholly or majority-owned operating subsidiaries, so that we and each of our subsidiaries is not an investment company under the Investment Company Act. We believe that neither we nor our operating subsidiaries will be considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because neither we nor our operating subsidiaries will engage primarily, or hold ourselves or our operating subsidiaries out as being engaged primarily, in the business of investing, reinvesting or trading in securities. Rather, we, through our operating subsidiaries, will be primarily engaged in the non-investment company business of these subsidiaries, namely the business of purchasing or otherwise acquiring mortgage servicing rights, Rights to MSRs, and associated servicing advances and engaging and managing one or more high-quality residential mortgage loan servicers to service the pools of mortgage loans underlying the mortgage servicing rights. We intend to structure the special purpose entities that we establish in connection with match funded advance financing facilities to rely on the investment company exemption provided to certain structured financing vehicles by Rule 3a-7 promulgated pursuant to the Investment Company Act.

We monitor our business strategy and assets to ensure continuing and ongoing compliance with the Investment Company Act. A change in our business strategy or in the value or classification of any of our assets could cause us or one or more of our wholly owned or majority owned operating subsidiaries to fall within the definition of “investment company” and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. For example, if we are unable to obtain legal ownership of mortgage servicing rights either due to the unwillingness of necessary consent parties or demands that do not fit within our business strategy (such as building or purchasing a servicing platform), we may be required to make changes to our business strategy and operations to avoid us or any of our operating subsidiaries being required to register as an investment company under the Investment Company Act. Changes to our business plan and operations could include amendment or modification of the Purchase Agreement or Subservicing Agreement, providing for increased control by us over Ocwen Loan Servicing’s servicing activities with respect to mortgage loans underlying our Rights to MSRs, or acquiring mortgage servicing rights which do not require the confirmation of a rating agency or consent of another party that has indicated that it would not provide a ratings confirmation or consent to the transfer of the mortgage servicing rights to us, such as private-label mortgage servicing rights that are not rated by

 

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particular rating agencies or mortgage servicing rights that are related to loans that are guaranteed or securitized by the U.S. government or the GSEs. We may also be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire Rights to MSRs that we would otherwise want to acquire and would be important to our business strategy.

If, however, we or any of our subsidiaries are deemed to be an investment company under the Investment Company Act, we may be required to institute burdensome compliance requirements and our activities may be restricted, among other things, which would materially adversely affect our business, financial condition and results of operations and our ability to pay dividends. For example, because affiliate transactions are generally prohibited under the Investment Company Act, we would not be able to enter into transactions with any of our affiliates if we are required to register as an investment company, and we may be required to terminate the Purchase Agreement, the Subservicing Agreement, the Ocwen Professional Servicing Agreement, the Altisource Administrative Services Agreement and any other agreements with affiliates and forgo opportunities to purchase additional Rights to MSRs from Ocwen Loan Servicing as currently contemplated. If we or one of our subsidiaries were deemed to be an investment company, we may also seek exemptive relief from the Securities and Exchange Commission (“SEC”), which could impose significant costs on our business. If we or any of our subsidiaries were required to register as an investment company but failed to do so, the unregistered entity would be prohibited from engaging in business, and criminal and civil actions could be brought against such unregistered entity. In addition, the contracts of such unregistered entity would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of such unregistered entity and liquidate the unregistered entity, which could lead to losses to our shareholders.

We may require the cooperation of Ocwen Loan Servicing to maintain our exemption from registration as an investment company under the Investment Company Act.

We may be required to make changes to our business strategy and operations to avoid the registration of us or any of our operating subsidiaries as an investment company under the Investment Company Act. Such changes could include amendment or modification of the Purchase Agreement or Subservicing Agreement or changes to the structure of future arrangements with Ocwen Loan Servicing. For example, we may be required to change the structure of future acquisitions of Mortgage Servicing Assets or the degree of control exercised by us over Ocwen Loan Servicing’s servicing activities with respect to mortgage loans underlying our Rights to MSRs. Although Ocwen Loan Servicing is contractually obligated in the Purchase Agreement to use all commercially reasonable efforts to make any changes necessary to our relationship and agreements so that we and our operating subsidiaries will not be required to register as an investment company, the necessary changes may not be acceptable to us, or Ocwen Loan Servicing may disagree that it is required to make the particular changes under the terms of the Purchase Agreement. In addition, the changes that we implement to our business strategy or operations may not be sufficient to avoid registration as an investment company or may have a negative effect on our results of operations and financial condition. If we are required to register under the Investment Company Act, our ability to conduct our business could be materially adversely affected, and you could suffer losses.

We could have conflicts of interest with Ocwen, and our officers and directors also could have conflicts of interest due to their relationships with us and Ocwen, that could be resolved in a manner adverse to us.

We have entered into various agreements with subsidiaries of Ocwen and we intend to enter into further agreements with Ocwen or its subsidiaries in the future. Certain of our executive officers and directors may have conflicts of interest with respect to such agreements and other matters due to their past and/or current relationships with Ocwen.

 

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William C. Erbey, the Chairman of our Board of Directors, is, and for the foreseeable future is expected to be, the Chairman of the Board of Directors of Ocwen. As a result, he has obligations to us as well as to Ocwen and may have conflicts of interest with respect to matters potentially or actually involving or affecting us and Ocwen. Mr. Erbey is the beneficial owner of approximately 13% of Ocwen’s common stock as of June 30, 2012. Richard Delgado, who is our Treasurer, owns 12,291 shares of Ocwen common stock. In addition, in connection with their resignation from their positions at Ocwen at the time of the closing of our initial public offering, the Ocwen Board of Directors extended the post-termination exercise period of options to purchase 625,000 shares of Ocwen common stock held by Mr. Van Vlack, of which 605,000 shares are unexercised, 90,197 shares of Ocwen common stock held by Mr. Delgado and 20,000 shares of Ocwen common stock held by Michael J. McElroy, who is our General Counsel, so that the options may be exercised during the original term of the option, subject to any existing vesting schedules of those options. The options would otherwise have expired following the date of such officers’ resignation from Ocwen. This ownership of Ocwen common stock and options to purchase Ocwen common stock could create or appear to create potential conflicts of interest when our Board of Directors or our executive officers are faced with decisions that involve Ocwen.

Matters that could give rise to conflicts between us and Ocwen include, among other things:

 

   

our ongoing and future relationships with Ocwen, including agreements, amendments to agreements and other arrangements with respect to servicing the mortgage loans underlying our Mortgage Servicing Assets and potential future acquisitions of Mortgage Servicing Assets from Ocwen;

 

   

the quality and pricing of services that Ocwen has agreed to provide to us;

 

   

the quality, valuation and pricing of Mortgage Servicing Assets that Ocwen has agreed to sell to us or may sell to us in the future; and

 

   

any competitive actions by Ocwen.

We will seek to manage these potential conflicts through oversight by the independent members of our Board of Directors. Such measures may not be effective, and we may not be able to resolve all conflicts with Ocwen. In addition, the resolution of any such conflicts may be less favorable to us than if we were dealing with an unaffiliated third party.

We could have conflicts with Altisource that could be resolved in a manner adverse to us.

We have entered into an administrative services agreement with Altisource, which we refer to as the “Altisource Administrative Services Agreement” throughout this prospectus. We also lease office space in the United States from Altisource. Certain of our executive officers and directors may be subject to conflicts of interest with respect to such agreements and other matters due to their past and/or current relationships with Altisource.

William C. Erbey, the Chairman of our Board of Directors, is the Chairman of the Board of Directors of Altisource. As a result, he has obligations to us as well as to Altisource and may have conflicts of interest with respect to matters potentially or actually involving or affecting us and Altisource. Mr. Erbey is the beneficial owner of approximately 25% of Altisource’s common stock as of June 30, 2012. This ownership could create or appear to create potential conflicts of interest when our Board of Directors is faced with decisions that involve Altisource.

We manage these potential conflicts through oversight by the independent members of our Board of Directors. Such measures may not be effective, and we may not be able to resolve all conflicts with Altisource. In addition, the resolution of any such conflicts may be less favorable to us than if we were dealing with an unaffiliated third party.

 

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The Purchase Agreement, Subservicing Agreement, Ocwen Professional Services Agreement and Altisource Administrative Services Agreement were not negotiated on an arm’s-length basis and the terms may not be as favorable to us as if such agreements were negotiated with unaffiliated third parties.

Because William C. Erbey, our founder and Chairman of our Board of Directors, is also the Chairman of the Board of Directors and largest shareholder of Ocwen and the Chairman of the Board of Directors and largest shareholder of Altisource, the terms of our agreements with them have not been negotiated on an arm’s-length basis, and any agreements we enter into with them in the future may not be negotiated on an arm’s-length basis. As a result, certain terms of these agreements may not be as favorable to us as agreements negotiated with unaffiliated third parties. Furthermore, we may choose not to enforce, or to enforce less vigorously, our rights under such agreements because of our desire to maintain our ongoing relationships with Ocwen and Altisource.

We rely on an exception to the rules of The NASDAQ Stock Market which require that all members of the Nominating and Corporate Governance Committee of our Board of Directors be independent, and, as a result, our shareholders will not have the protections afforded by this corporate governance requirement.

The rules of The NASDAQ Stock Market provide that, under limited and exceptional circumstances, a director who is not a current officer or employee (or a family member of an officer or employee) of our company, but who does not otherwise meet the independence criteria established by The NASDAQ Stock Market, may serve as a member of the Nominating and Corporate Governance Committee if such membership is in the best interests of our company and our shareholders. Our Board of Directors has elected to rely on this limited exception in appointing Mr. Erbey as the Chairman of the Nominating and Corporate Governance Committee. As a result, our shareholders will not have the same protections afforded to shareholders of companies that do not rely on this exception.

Ocwen Loan Servicing’s failure to perform adequately in external audits could have an adverse effect on our business, financial condition or results of operations.

We do not intend to build a mortgage servicing platform and will depend on Ocwen Loan Servicing to maintain the controls and processes needed to perform adequately on external audits, including in connection with reporting obligations under the pooling and servicing agreements and SEC reporting obligations, and other agreed-upon procedures for the advance financing facility that we assumed in connection with the Initial Ocwen Purchase and will depend on Ocwen Loan Servicing and possibly other subservicers to perform these functions for mortgage servicing rights we acquire in the future. The failure to pass such audits and to remediate issues identified could lead to a downgrade in Ocwen Loan Servicing’s servicer rating, which could have the consequences described above under “—A downgrade in Ocwen Loan Servicing’s servicer rating and that of any future subservicer with whom we enter into subservicing agreements could have an adverse effect on our business, financial condition or results of operations” or could lead to interruptions in, or the loss of, our advance financing.

A failure in Ocwen Loan Servicing or any of our future subservicers’ operational systems or information technology and security infrastructure, or those of third parties, could disrupt our business, result in the disclosure of confidential information, damage our reputation and cause losses.

Our business is substantially dependent on Ocwen Loan Servicing’s and any future subservicers’ ability to process and monitor a large number of transactions, many of which are complex, across numerous and diverse real estate markets. These transactions often must adhere to the terms of the underlying pooling and servicing agreements, as well as legal and regulatory standards governing the use and disclosure of sensitive consumer information. Ocwen Loan Servicing and any future subservicers are responsible for developing and maintaining operational systems and information technology and security infrastructure, which is challenging and depends, in part, on the ability of our subservicers, including

 

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Ocwen Loan Servicing, to monitor third-party service providers to whom our subservicers outsource information technology and data processing functions. Ocwen Loan Servicing and any future subservicers’ financial, accounting, data processing, security or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond their control, such as a spike in transaction volume, cyber attacks or unforeseen catastrophic events, adversely affecting their ability to process these transactions.

In addition, Ocwen Loan Servicing’s and any future subservicers’ operations rely on the secure processing, storage and transmission of confidential and other information in their computer systems and networks and those of outsourced third-party service providers. Although Ocwen Loan Servicing’s and any future subservicers are expected to take protective measures and endeavor to modify them as circumstances warrant, their computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. Given the volume of transactions Ocwen Loan Servicing and any future subservicers will process and monitor, certain errors may be repeated or compounded before they are discovered and rectified. If one or more of such events occurs, this could potentially jeopardize confidential and other information processed and stored in, and transmitted through, the computer systems and networks of Ocwen Loan Servicing and any future subservicers, which could result in significant compliance and remediation losses, reputational damage and legal liabilities to us.

Risks Related to Government Regulation

The expanding body of federal, state and local regulation and/or the licensing of mortgage servicers or other aspects of our business may increase our costs.

The servicing of residential mortgage loans is subject to extensive federal, state and local laws, regulations and administrative decisions. The volume of new or modified laws and regulations has increased in recent years and is likely to continue to increase. For example, on August 10, 2012, the BCFP proposed new regulations that would require mortgage servicers in part to provide enhanced statements to borrowers, provide notice of interest rate changes, correct errors and obtain information for borrowers, apply payments promptly, apply “force-placed” insurance only when they reasonably believed borrower’s policies had lapsed, provide greater access to servicer personnel and records, engage in outreach to delinquent borrowers with foreclosure alternatives, and allow borrowers to appeal denials of loan modifications and delay foreclosure proceedings while those applications or appeals are pending. If implemented, these rules or other new laws and regulations affecting the mortgage servicing industry could increase the cost of servicing loans. This may force us to have to pay increased fees to Ocwen Loan Servicing or other servicers when we renew our agreements with them at the end of their terms or enter into new subservicing agreements. In addition, our ability to purchase Mortgage Servicing Assets may be limited if we cannot engage mortgage servicers at fee rates that allow us to achieve the objectives of our business model. We will also become subject to licensing in some states if and when we become an owner of mortgage servicing rights. If the number of states that require the licensing of owners of mortgage servicing rights increases, or the states that require licensing impose additional obligations on the owners of mortgage servicing rights, our costs could increase. Any of these outcomes may adversely affect our results of operations or financial condition.

Regulatory scrutiny regarding foreclosure processes could lengthen foreclosure timelines or increase prepayment speeds which would negatively impact our liquidity and profitability.

Various state banking regulators and attorneys general have publicly announced that they have initiated inquiries into banks and servicers regarding compliance with legal procedures in connection with mortgage foreclosures, including the preparation, execution, notarization and submission of documents, principally affidavits, filed in connection with foreclosures. The process to foreclose on properties securing residential mortgage loans is governed by state law and varies by state. For the most part, these inquiries

 

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have arisen from the 23 so-called “judicial states”; namely, those jurisdictions that require lenders or their servicers to go through a judicial proceeding to obtain a foreclosure order. In these judicial states, lenders or their servicers are generally required to provide to the court the mortgage loan documents and a sworn and notarized affidavit of an officer of the lender or its servicer with respect to the facts regarding the delinquency of the mortgage loan and the foreclosure. These affidavits are generally required to be based on the personal knowledge of the officer that executes the affidavit after a review of the mortgage loan documents. Regulators from “quasi-judicial states” and “non-judicial states,” however, have made similar inquiries as well. In these states, lenders or their servicers may foreclose on a defaulted mortgage loan by delivering to the borrower a notice of the foreclosure sale without the requirement of going through a judicial proceeding, unless the borrower contests the foreclosure or files for bankruptcy. If the borrower contests the foreclosure or files for bankruptcy in a non-judicial state, court proceedings, including affidavits similar to those provided in the judicial states, will generally be required.

In connection with the recent governmental scrutiny of foreclosure processes and practices in the industry, the attorneys general of certain states and certain members of the U.S. Congress and state legislatures have called for a temporary moratorium on mortgage foreclosures, although no state has implemented a general foreclosure moratorium on mortgage loan servicers to date. In addition, some individual municipalities have begun to enact laws that may increase the time that it currently takes to complete a foreclosure or prevent foreclosures in such jurisdictions. Such moratoria or other action by federal, state or municipal government bodies, regulators or courts could increase the length of time needed to complete the foreclosure process. For example, the average number of days for Ocwen Loan Servicing to complete a foreclosure action during 2011 increased by 133 days in judicial foreclosure states and 32 days in traditional non-judicial foreclosure states as compared to 2010 averages. In the first six months of 2012, foreclosure timelines increased by an additional 102 days in judicial foreclosure states and 34 days in traditional non-judicial foreclosure states as compared to 2011 averages.

When a mortgage loan is in foreclosure, we are generally required to continue to advance delinquent principal and interest to the securitization trust and to also make advances for delinquent taxes and insurance and foreclosure costs and the upkeep of vacant property in foreclosure to the extent we determine that such amounts are recoverable. These servicing advances are generally recovered when the delinquency is resolved. Foreclosure moratoria or other actions that lengthen the foreclosure process will increase the amount of servicing advances we are required to make, lengthen the time it takes for us to be reimbursed for such advances and increase the costs incurred during the foreclosure process. In addition, advance financing facilities generally contain provisions that limit the eligibility of servicing advances to be financed based on the length of time that servicing advances are outstanding, and, as a result, an increase in foreclosure timelines could further increase the amount of servicing advances that we need to fund with our own capital. Such increases in foreclosure timelines could increase our need for capital to fund servicing advances which would increase our interest expense, delay the collection of interest income or servicing fee revenue until the foreclosure has been resolved and, therefore, reduce the cash that we have available to pay our operating expenses or to pay dividends.

Governmental bodies may also impose regulatory fines or penalties as a result of our subservicers’ foreclosure processes or impose additional requirements or restrictions on such activities which could increase their operating expenses. For instance, in April 2011 the Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System (“FRB”) and the Federal Deposit Insurance Corporation (“FDIC”) entered into consent orders with the fourteen largest mortgage servicers to address alleged deficient practices in residential mortgage loan servicing and foreclosure processing. Under the consent orders, these mortgage servicers are required to submit written remediation plans addressing enterprise-wide risk management, internal audit and compliance programs for their residential mortgage loan servicing, loss mitigation and foreclosure activities. Remedial measures required under these consent orders and written plans may include, among other measures, revisions to servicing operations and remediation of all financial injury to borrowers caused by any errors, misrepresentations or other deficiencies identified in the parties’ recent foreclosures. Ocwen Loan Servicing is not subject to OCC, FRB

 

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or FDIC regulation, and therefore it has not been subject to any consent decree initiated by these federal regulatory agencies. Nonetheless, Congress or federal or state regulatory agencies could subject it and other independent servicers to similar consent decrees, enforcement actions or investigations. In general, these regulatory developments with respect to foreclosure practices could result in increases in the amount of servicing advances and the length of time to recover servicing advances, fines or increases in operating expenses, and decreases in the advance rate and availability of financing for servicing advances. This would lead to increased borrowings, reduced cash and higher interest expense which could negatively impact our liquidity and profitability, and although the Subservicing Agreement and the Purchase Agreement relating to the Purchased Assets and the subservicing supplement relating to the Aggregate Purchased Assets contain adjustment mechanisms that would reduce the amount of incentive fees payable to Ocwen Loan Servicing if servicing advances exceed pre-determined amounts, those fee reductions may not be sufficient to cover the expenses resulting from longer foreclosure timelines.

On February 9, 2012, the Department of Housing and Urban Development and attorneys general representing 49 states and the District of Columbia announced a $25 billion settlement (the “Joint Federal-State Servicing Settlement”) with the five largest mortgage servicers—Bank of America Corporation, JP Morgan Chase & Co., Wells Fargo & Company, Citigroup Inc. and Ally Financial Inc. (formerly GMAC)—regarding servicing and foreclosure issues. In addition to assessing monetary penalties which are required to be used to provide financial relief to borrowers (including refinancing and principal write-downs), the Joint Federal-State Servicing Settlement requires these servicers to implement changes in how they service mortgage loans, handle foreclosures and provide information to bankruptcy courts. The federal-state regulators may seek to expand the participation in the Joint Federal-State Servicing Settlement or similar settlements to other servicers and could seek to include Ocwen Loan Servicing. Implementation of the servicing practices associated with the Joint Federal-State Servicing Settlement could result in increased costs for servicing mortgage loans generally, which could lead to higher subservicing fees being charged to us for subsequent mortgage servicing assets we acquire. In addition, the implementation of a refinancing or principal write-down program like that contemplated by the Joint Federal-State Servicing Settlement could result in an increase in prepayment speeds and negatively affect our earnings and operating results.

GSE initiatives and other actions may affect mortgage servicing generally and future servicing fees in particular.

On January 17, 2011, the Federal Housing Finance Agency announced that it has instructed Fannie Mae and Freddie Mac to study possible alternatives to the current residential mortgage servicing and compensation system used for single-family mortgage loans. A discussion paper containing alternative mortgage servicing compensation proposals was released at the direction of the Federal Housing Finance Agency on September 27, 2011. It requested comment on a number of proposals, including a proposal implementing a “fee for services” model of servicer compensation, in which Fannie Mae or Freddie Mac would pay the servicer a fee for servicing mortgage loans based on the delinquency status of each mortgage loan. Although the mortgage loans underlying the Initial Mortgage Servicing Rights or other pooling and servicing agreements that have already been executed are not subject to any changes implemented by Fannie Mae or Freddie Mac, because of the significant role of Fannie Mae and Freddie Mac in the secondary mortgage market, it is possible that any changes they implement could become prevalent in the mortgage servicing industry generally going forward. Other industry stakeholders or regulators may also implement or require changes in response to the perception that the current mortgage servicing practices and compensation do not serve broader housing policy objectives well. These proposals are still evolving. To the extent the GSEs implement reforms that materially affect the market for conforming loans, there may be secondary effects on the subprime and Alt-A markets, which may have a material adverse effect on the creation of new mortgage servicing rights or the economics or performance of any mortgage servicing rights or Rights to MSRs that we acquire.

 

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Risks Related to Taxation

We expect to be treated as a PFIC for U.S. federal income tax purposes, which could subject U.S. Holders to adverse U.S. federal income tax consequences.

We expect to be treated as a PFIC for U.S. federal income tax purposes. A PFIC generally is a foreign corporation if either at least (i) 75% of its gross income is “passive income,” or (ii) 50% of the gross value of its assets is attributable to assets that produce, or are held for the production of, passive income. If you are a U.S. Holder and do not make a QEF election with respect to us or a mark-to-market election with respect to our ordinary shares, you will be subject to adverse tax consequences, including deferred tax and interest charges with respect to certain distributions on our ordinary shares, any gain realized on a disposition of our ordinary shares and certain other events. The effect of these adverse tax consequences could be materially adverse to you. If you are a U.S. Holder and make a valid, timely QEF election for us, you will not be subject to those adverse tax consequences, but could recognize taxable income in a taxable year with respect to our ordinary shares in excess of any distributions that we make to you in that year, thus giving rise to so-called “phantom income” and to a potential out-of-pocket tax liability. We will provide information to all electing shareholders needed to comply with the QEF election. If you are a U.S. Holder and make a valid, timely mark-to-market election with respect to our ordinary shares, you will recognize as ordinary income or loss in each year that we are a PFIC an amount equal to the difference between your basis in our ordinary shares and the fair market value of the ordinary shares, thus also possibly giving rise to phantom income and a potential out-of-pocket tax liability. Ordinary loss generally is recognized only to the extent of net mark-to-market gains previously included in income. U.S. Holders should be aware that although we currently do not have any subsidiaries that are PFICs, we may form or acquire a subsidiary that is a PFIC in the future. In such event, U.S. Holders will also need to make the QEF election with respect to each such subsidiary in order to avoid the adverse tax consequences described above. We intend to provide all information necessary for U.S. Holders to make the QEF election with respect to any of our subsidiaries that may be classified as a PFIC. U.S. Holders should also be aware that the mark-to-market election generally will not be available with respect to any our subsidiaries that is a PFIC, rendering such election less beneficial to U.S. Holders than the QEF election. See “Material Cayman Islands and United States Federal Income Tax Considerations—United States Federal Income Taxation—Consequences to U.S. Holders—Passive Foreign Investment Company Status and Related Tax Consequences.”

If the IRS determines that we are not a PFIC, and you previously paid taxes pursuant to a QEF election or a mark-to-market election, you may pay more taxes than you legally owe.

While we expect to be treated as a PFIC for U.S. federal income tax purposes, our tax counsel has indicated that there is a risk that we will not be treated as such. If the U.S. Internal Revenue Service (“IRS”) makes a determination that we are not a PFIC in the future, then you may have paid more taxes than you legally owed due to a QEF or mark-to-market election. If you do not, or are not able to, file a refund claim before the expiration of the applicable statute of limitations, you will not be able to claim a refund for those taxes.

Distributions that we pay to individual U.S. Holders will not be eligible for taxation at reduced rates.

Distributions made to a U.S. Holder that is an individual will not be eligible for taxation at reduced tax rates generally applicable (for tax years beginning before January 1, 2013) to dividends paid by certain U.S. corporations and “qualified foreign corporations.” The more favorable rates applicable to regular corporate dividends could cause individuals to perceive investment in our ordinary shares to be relatively less attractive than investment in the shares of other corporations, which could adversely affect the value of our ordinary shares.

 

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If we are treated as engaged in a trade or business in the United States, we would become subject to U.S. federal income taxation, which could adversely affect our business and result in decreased cash available for distribution to our shareholders.

The IRS could assert that we are engaged in a U.S. trade or business because we own mortgage servicing rights and are participating in the servicing of U.S. mortgage loans, either directly or through agents such as Ocwen Loan Servicing. If, contrary to our expectations, we are treated as engaged in a trade or business in the United States, we would be subject to U.S. federal income taxation on a net income basis, which would adversely affect our business and result in decreased cash available for distribution to our shareholders. More specifically, if we are treated as engaged in a trade or business in the United States, the portion of our net income, if any, that was “effectively connected” with such trade or business would be subject to U.S. federal income taxation at a maximum rate of 35%, as opposed to our expectation that only income of our subsidiary that is taxed as a corporation for U.S. federal income tax purposes will be subject to U.S. federal income tax at such rate. In addition, we would be subject to the U.S. federal branch profits tax on our effectively connected earnings and profits at a rate of 30%.

We may become subject to taxation in the Cayman Islands.

The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. Dividend payments are not subject to withholding tax in the Cayman Islands. There are no other taxes likely to be material to our company levied by the government of the Cayman Islands, except for stamp duties that may be applicable on instruments executed in, or after execution brought within the jurisdiction of, the Cayman Islands. The tax treatment of our business in the Cayman Islands is subject to change. Thus, we may become subject to Cayman Islands taxation in the future.

Risks Related to Our Ordinary Shares and this Offering

An active trading market for our ordinary shares may not be sustained.

Our shares are listed on The NASDAQ Global Select Market under the symbol “HLSS.” However, an active trading market for our ordinary shares may not be sustained. Accordingly, your ability to sell ordinary shares when desired, or the prices that may be obtained for such shares, will depend on the existence and liquidity of an active trading market for our ordinary shares.

The market price and trading volume of our ordinary shares may be volatile, which could result in losses for our shareholders.

The market price of our ordinary shares may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume of our ordinary shares may fluctuate and cause significant price variations to occur. If the market price of our ordinary shares declines significantly, you may be unable to resell your shares at or above your purchase price, if at all. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our ordinary shares include:

 

   

changes in our dividend policy;

 

   

continued deterioration of the housing market or general market or economic conditions;

 

   

increases in market interest rates;

 

   

variations in our quarterly or annual operating results;

 

   

changes in our earnings estimates or differences between our actual financial and operating results and those expected by investors and analysts;

 

   

the contents of published research reports about us, Ocwen, other mortgage loan servicers or the mortgage servicing industry or the failure of securities analysts to cover our ordinary shares;

 

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changes to our business strategy or the way we conduct our operations, including our inability to obtain any third party approvals or consents required to transfer legal ownership of mortgage servicing rights to us;

 

   

our inability to fund the purchase of additional mortgage servicing rights;

 

   

additions or departures of key management personnel;

 

   

any indebtedness we may incur in the future;

 

   

actions by institutional shareholders;

 

   

litigation and governmental investigations;

 

   

tax changes that may subject our net income to corporate level taxation;

 

   

announcements by us, Ocwen or others and developments affecting us or Ocwen or speculation or reports by the press or investment community with respect to us, Ocwen or the mortgage servicing industry in general;

 

   

changes or proposed changes in laws or regulations affecting the mortgage servicing industry or enforcement of these laws and regulations, or announcements relating to these matters; and

 

   

realization of any of the risks described elsewhere under “Risk Factors.”

In addition, equity markets have experienced significant price and volume fluctuations that have affected the market prices for the securities of newly public companies for a number of reasons, including reasons that may be unrelated to our business or operating performance. These broad market fluctuations may result in a material decline in the market price of our ordinary shares, and you may not be able to sell your ordinary shares at prices you deem acceptable. In the past, following periods of volatility in the equity markets, securities class action lawsuits have been instituted against public companies. Such litigation, if instituted against us, could result in substantial cost and the diversion of management attention.

Sales of ordinary shares by us in the future could adversely affect the market price of our ordinary shares.

We expect that we will sell additional ordinary shares from time to time in the future primarily in connection with the acquisition of additional Rights to MSRs or mortgage servicing rights. Sales of additional ordinary shares by us for whatever reason may adversely affect the trading price of our ordinary shares and will dilute the percentage ownership of us by our then-existing shareholders, including shareholders that purchase in this offering.

Future sales of ordinary shares by our principal shareholder could cause our ordinary share price to decline.

In connection with our initial public offering, William C. Erbey entered into a written “lock-up” agreement providing, among other things, that he will not sell the ordinary shares he owns for a period of 18 months following the date of the pricing of our initial public offering without the prior written consent of Wells Fargo Securities, LLC. However, the lock-up agreement is subject to a number of specified exceptions. See “Underwriting.” Pursuant to a Registration Rights Agreement that we have entered into with Mr. Erbey, we have granted to Mr. Erbey demand registration rights, which he may exercise one time, and unlimited piggyback registration rights, which, subject to the applicable lock-up restrictions, may require us to register his ordinary shares beginning 18 months from the date of the pricing of our initial public offering. Upon expiration of the lock-up agreement, Mr. Erbey will be able to freely sell his ordinary shares.

 

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If equity research analysts issue unfavorable commentary or downgrade our ordinary shares, the price of our ordinary shares could decline.

The trading price of our ordinary shares is affected by research and reports that equity research analysts publish about us, Ocwen or the mortgage servicing industry. We do not control these analysts. The price of our ordinary shares could decline if one or more equity analysts downgrade our ordinary shares or if analysts issue other unfavorable commentary or cease publishing reports about us, Ocwen or the mortgage servicing industry.

As a public company we incur significant costs and face demands on our management to comply with the SEC and stock exchange requirements.

As a public company with shares listed on a U.S. securities exchange, we need to comply with an extensive body of regulations, including provisions of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), regulations of the SEC and requirements of The NASDAQ Stock Market. These rules and regulations could result in substantial legal and financial compliance costs and make some activities more time-consuming and costly. In addition, we incur costs associated with our public company reporting requirements and maintaining directors’ and officers’ liability insurance. Furthermore, our management has increased demands on its time in order to ensure we comply with public company reporting requirements and the compliance requirements of the Sarbanes-Oxley Act, as well as any rules subsequently implemented by the SEC and the applicable stock exchange requirements of The NASDAQ Stock Market.

We are required by Section 404 of the Sarbanes-Oxley Act to evaluate the effectiveness of our internal controls by the end of fiscal 2013, and we may identify control deficiencies, which may be expensive to remediate, and could affect the ability of our auditor to issue an unqualified audit report, which could affect our share price.

As a U.S.-listed public company, we are required to comply with Section 404 of the Sarbanes-Oxley Act by December 31, 2013. Section 404 requires that a public company evaluate its internal control over financial reporting to enable management to report on, and the company’s independent auditors to audit as of the end of the next fiscal year, the effectiveness of those controls. During the course of our review, we may identify control deficiencies of varying degrees of severity, and we may incur significant costs to remediate those deficiencies or otherwise improve our internal controls. As a public company, we are required to report control deficiencies that constitute a “material weakness” in our internal control over financial reporting. Public companies are also required to obtain an audit report from their independent auditors regarding the effectiveness of their internal controls over financial reporting. If we fail to implement the requirements of Section 404 in a timely manner, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or FINRA. Furthermore, if we discover a material weakness or our auditor does not provide an unqualified audit report when required, our share price could decline, our reputation could be significantly harmed and our ability to raise capital could be impaired. Management is not currently aware of any factors that could result in the determination that there is a material weakness in our internal controls.

We are a Cayman Islands exempted company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by Cayman Islands law and our Articles of Association. The rights of shareholders to take action against our directors, the rights of minority shareholders to institute actions and the fiduciary responsibilities of our directors to us are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, the latter of which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as

 

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they would be under statutes or judicial precedent in the United States. In particular, the Cayman Islands has a less developed body of securities law than the United States. In addition, a Cayman Islands company may not have standing to initiate a shareholder derivative action before the federal courts of the United States. As a result, our shareholders may encounter more difficulty in protecting their interests against actions taken by our management or Board of Directors than they would as shareholders of a public company incorporated in the United States. See “Description of Share Capital—Differences in Corporate Law.”

You may have difficulty enforcing judgments obtained against us.

We are a Cayman Islands exempted company, and it may be difficult for you to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors. In addition, the courts of the Cayman Islands may not recognize or enforce judgments of U.S. courts against us or our directors and officers predicated upon the civil liability provisions of the securities laws of the United States or any state. Furthermore, Cayman Islands courts may not be competent to hear original actions brought in the Cayman Islands against us or our directors and officers predicated upon the securities laws of the United States or any state. See “Enforceability of Civil Liabilities.”

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this prospectus, including, without limitation, statements regarding the assumptions we make about our business and economic model, our dividend policy, business strategy and other plans and objectives for our future operations, are forward-looking statements.

These statements include declarations regarding our management’s beliefs and current expectations. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “would,” “could,” “expects,” “plans,” “contemplate,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “intend” or “continue” or the negative of such terms or other comparable terminology, although not all forward-looking statements contain these identifying words. These forward-looking statements are subject to inherent risks and uncertainties in predicting future results and conditions that could cause the actual results to differ materially from those projected in these forward-looking statements. Some, but not all, of the forward-looking statements contained in this prospectus include, among other things, statements about the following:

 

   

estimates regarding prepayment speeds, delinquency rates, servicing advances, amortization of mortgage servicing assets, custodial account balances, interest income and other drivers of our results;

 

   

assumptions related to sources of liquidity, our ability to fund servicing advances and the adequacy of our financial resources;

 

   

our ability to obtain the Required Third Party Consents on a timely basis, or at all;

 

   

our ability to pay monthly dividends;

 

   

assumptions about the availability of additional portfolios of subprime and Alt-A mortgage servicing rights and our ability to acquire additional mortgage servicing assets from Ocwen Loan Servicing and others;

 

   

the performance of Ocwen on a timely basis, or at all, as mortgage servicer and our ability to add new mortgage servicing assets on terms consistent with our business and economic model;

 

   

assumptions about the effectiveness of our hedging strategy;

 

   

assumptions about the correlation between interest rates and the income we expect to generate and the valuation of our Mortgage Servicing Assets;

 

   

expectations regarding incentive fees in our Servicing Agreement and the stability of our gross servicing margin;

 

   

the susceptibility of our mortgage servicing assets to impairment charges;

 

   

our competitive position;

 

   

uncertainty related to future government regulation;

 

   

assumptions regarding the availability of refinancing options for subprime and Alt-A borrowers;

 

   

general economic and market conditions;

 

   

assumptions regarding amount and timing of additional equity offerings; and

 

   

assumptions regarding amount and timing of additional purchases of servicing assets from Ocwen Loan Servicing.

We have based these forward-looking statements largely on our current plans, intentions, expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. We may not actually achieve the plans, intentions or expectations

 

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disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations described in the forward-looking statements that we make. We have included important factors in the cautionary statements included in this prospectus, particularly in the “Risk Factors” section, that we believe could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements that we make. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. Our forward-looking statements do not reflect the potential impact of any future acquisitions of Mortgage Servicing Assets that we may make.

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement of which this prospectus is a part completely and with the understanding that our actual future results may be materially different from what we expect. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our ordinary shares. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise.

 

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INDUSTRY DATA

Unless otherwise indicated, information contained in this prospectus concerning the mortgage servicing industry, including our general expectations and market position and market opportunity is based on information from various sources (including government and industry publications, surveys, analyses, valuations and forecasts and our internal research), assumptions that we have made (which we believe are reasonable based on those data from such sources and other similar sources) and our knowledge of the markets for our services. The projections, assumptions and estimates of our future performance and the future performance of the mortgage servicing industry are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described under “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates included in this prospectus.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from this offering will be approximately $         million after deducting underwriting discounts and commissions and estimated offering expenses that we must pay.

We intend to use the proceeds of this offering to acquire the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing regarding the composition of the Planned Acquisition Assets, but have not yet identified the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. We have not entered into any agreement to acquire the Planned Acquisition Assets, but we expect the Planned Acquisition will be subject to the terms and conditions of the Purchase Agreement and a supplement thereto containing terms specific to the Planned Acquisition. See “Prospectus Summary–The Planned Acquisition.” We intend to use the remaining proceeds, if any, for working capital and general corporate purposes.

We expect to amend our existing Servicing Advance Facility Agreements to allow for additional borrowing from Barclays Bank Plc to finance the acquisition of the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired, or, alternatively, we may amend our existing Servicing Advance Facility Agreements to issue new debt securities backed by the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired. We are currently in discussions with Barclays Bank Plc regarding the amendments to the Servicing Advance Facility Agreement, but we do not have a firm commitment for additional servicing advance financing in connection with the Planned Acquisition. This offering is not conditioned upon the closing of the Planned Acquisition.

Upon the consummation of the Planned Acquisition, we expect that Ocwen Loan Servicing will remain the named servicer of each mortgage servicing right until such time as the Required Third Party Consents are obtained. We are continuing to pursue the Required Third Party Consents, and we will automatically obtain legal ownership of the acquired mortgage servicing rights without any additional payment to Ocwen Loan Servicing if and when we obtain the Required Third Party Consents.

 

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DIVIDEND POLICY

We intend to declare and pay monthly cash dividends over time on our ordinary shares with the income generated from net operating cash flows. We intend to distribute at least 90% of our net income over time to our shareholders, although we are not required by law to do so. Dividends are payable to holders of record of our ordinary shares on the last business day of each such month, subject to all applicable laws, and will be paid on the tenth day of the immediately following month, or the first business day thereafter if such payment date falls on a weekend or holiday.

Since our initial public offering, we paid the following dividends, on a per share basis:

 

Record Date

  

Payment Date

  

Amount per Ordinary Share

March 30, 2012

   April 10, 2012    $0.08

April 30, 2012

   May 10, 2012    $0.10

May 31, 2012

   June 11, 2012    $0.10

June 30, 2012

   July 10, 2012    $0.10

July 31, 2012

   August 10, 2012    $0.10

The following table sets forth the record and payment dates of dividends that have been declared by our Board of Directors, but are unpaid:

 

Record Date

  

Payment Date

  

Amount per Ordinary Share

August 31, 2012

   September 10, 2012    $0.10

September 28, 2012

   October 10, 2012    $0.10

Our Board of Directors has the right to rescind any declared, but unpaid dividends at any time prior to the applicable dividend payment date.

Our dividend policy is subject to certain risks and limitations. Our ability to continue to declare and pay dividends, if any, will depend on, among other things, our cash flows, our cash requirements (including requirements to service or repay our indebtedness), general economic and business conditions, our strategic plans and prospects, our financial results and condition, contractual restrictions binding on us, legal restrictions on the declaration and payment of dividends, including statutory liquidity requirements and other limitations under Cayman Islands law, and other factors that our Board of Directors considers to be relevant.

Under Cayman Islands law, we may declare cash dividends or make other distributions only out of profits lawfully available for that purpose, or out of our share premium account, which is a reserve account that holds the subscription monies over and above the nominal value of our ordinary shares paid by our shareholders (i.e., the premium for the shares issued by us), so long as we continue to have the ability to pay our debts in the ordinary course as they become due.

There can be no assurance that we will generate sufficient income from continuing operations or external sources of financing in the future, or have sufficient surplus, net profits or reserves, as the case may be, under the laws of the Cayman Islands or other jurisdictions where our subsidiaries are located, to continue to declare and pay dividends on our ordinary shares.

We are a holding company with no operations. Our subsidiaries own all of the assets that will generate income and acquisitions of additional Mortgage Servicing Assets that we may acquire in the future, including any purchased in the Planned Acquisition, will be held by our subsidiaries. Therefore, our ability to declare and pay dividends is dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us, by dividend, distribution or otherwise. Each of our subsidiaries is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from them.

 

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In deciding whether to make a dividend payment to our shareholders, our directors must have regard to the Company’s best interests and must have due regard for our future cash requirements, as well as our present and future solvency. Our dividend policy is based upon our directors’ current assessment of our business and the environment in which we operate, and that assessment could change based on a number of factors, including competitive developments, market conditions or new growth opportunities. Our Board of Directors may, in its discretion, change our dividend policy at any time to decrease the level of dividends or entirely discontinue the payment of dividends.

 

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CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2012 (in thousands of dollars, except ordinary share data):

 

   

on an actual basis; and

 

   

on an as-adjusted basis to give effect to the sale of              ordinary shares in this offering at an assumed public offering price of $         per share (the last reported sale price of our ordinary shares on the NASDAQ Global Select Market on the date of this prospectus) after deducting underwriting discounts and commissions and estimated offering expenses of approximately $         payable by us, resulting in net proceeds to us of $         .

The following table should be read in conjunction with “Summary Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus.

As of June 30, 2012 (in thousands of dollars, except ordinary share data)

 

     Actual      As adjusted for
this offering
 
Equity—ordinary shares, $0.01 par value; 200,000,000 (actual) and shares (as adjusted) authorized; 14,197,218 shares (actual) and shares (as adjusted) issued and outstanding at June 30, 2012      142      

Additional paid-in-capital

     179,285      

Retained Earnings

     3,214      

Accumulated other comprehensive loss

     (565   
  

 

 

    

 

 

 

Total equity

   $ 182,076       $                
  

 

 

    

 

 

 

Total capitalization

   $ 560,659       $     
  

 

 

    

 

 

 

 

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THE MORTGAGE SERVICING INDUSTRY

Overview

Over the last few decades the complexity of the market for residential mortgage loans in the United States has dramatically increased. A borrower seeking credit for a home purchase will typically obtain financing from a financial institution, such as a bank, savings association or credit union. In the past, these institutions would generally have held a majority of their originated mortgage loans as interest-earning assets on their balance sheets and would have performed all activities associated with servicing the loans, including accepting principal and interest payments, making advances for real estate taxes and property and casualty insurance premiums, initiating collection actions for delinquent payments and conducting foreclosures.

Now, institutions that originate mortgage loans generally hold a smaller portion of such loans as assets on their balance sheets and instead sell a significant portion of the loans they originate to third parties. Fannie Mae and Freddie Mac are currently the largest purchasers of home mortgage loans. Under a process known as securitization, the GSEs and financial institutions typically package residential mortgage loans into pools that are sold to securitization trusts. These securitization trusts fund the acquisition of mortgage loans by issuing securities, known as mortgage-backed securities, that entitle the owner of such securities to receive a portion of the interest and principal collected on the mortgage loans in the pool. The purchasers of the mortgage-backed securities are typically large institutions, such as pension funds, mutual funds and insurance companies. The agreement that governs the packaging of mortgage loans into a pool, the servicing of such mortgage loans and the terms of the mortgage-backed securities issued by the securitization trust is often referred to as a pooling and servicing agreement.

The following chart shows the growth in residential mortgage loans that have been securitized over the past ten years. This drove an increase in the number of residential mortgage loans outstanding until the credit dislocation in 2007 reduced origination and securitization activities, particularly for subprime and Alt-A mortgage loans.

 

LOGO

Sources: CPR CDR Technologies, Inc., LoanPerformance, Inc. and Inside Mortgage Finance.

In connection with a securitization, a number of entities perform specific roles with respect to the mortgage loans in a pool, including the trustee and the mortgage servicer. The trustee holds legal title to the mortgage loans on behalf of the owner of the mortgage-backed securities and either maintains the mortgage note and related documents itself or with a custodian. The trustee or a separate securities administrator for the trust receives the payments collected by the servicer on the mortgage loans and distributes them to the investors in the mortgage-backed securities pursuant to the terms of the pooling and servicing agreement. One or more other entities are appointed pursuant to the pooling and servicing agreement to service the mortgage loans. In some cases, the servicer is the same institution that originated the loan, and, in other cases, it may be a different institution. The duties of servicers for mortgage loans

 

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that have been securitized are generally discussed below under “Mortgage Servicing,” and are generally required to be performed in accordance with industry-accepted servicing practices and the terms of the mortgage note and applicable law. A servicer generally takes actions, such as foreclosure, in the name and on behalf of the trustee.

Segments of the Residential Mortgage Loan Market

The residential mortgage market is commonly divided into a number of categories based on certain mortgage loan characteristics, including the credit quality of borrowers and the types of institutions that originate or finance such loans. While there are no universally accepted definitions, the residential mortgage loan market is commonly divided by market participants into the following categories.

GSE and Government Guaranteed Loans

This category of mortgage loans includes “conforming loans,” which are first lien mortgage loans issued to prime borrowers and are secured by single-family residences that meet or “conform” to the underwriting standards established by Fannie Mae or Freddie Mac. Prime borrowers are borrowers that have strong credit histories and who generally purchase their properties with at least a 10% down payment. The conforming loan limit is established by statute and currently is $417,000 with certain exceptions for high-priced real estate markets. This category also includes mortgage loans issued to borrowers that do not meet conforming loan standards, but who qualify for a loan that is insured or guaranteed by the government through Ginnie Mae, primarily through federal programs operated by the Federal Housing Administration and the Department of Veterans Affairs.

Non-GSE or Government Guaranteed Loans

Residential mortgage loans that are not guaranteed by the GSEs or the government are generally referred to as “non-conforming loans” and fall into one of the following categories: jumbo, subprime, Alt-A or second lien loans.

Jumbo.    Jumbo mortgage loans have original principal amounts that exceed the statutory conforming limit for GSE loans. Jumbo borrowers generally have strong credit histories and provide full loan documentation, including verification of income and assets.

Subprime.    Subprime mortgage loans are generally issued to borrowers with blemished credit histories, who make low or no down payments on the properties they purchase or have limited documentation of their income or assets. Subprime borrowers generally pay higher interest rates and fees than prime borrowers.

Alt-A.    Alt-A mortgage loans are generally issued to borrowers with risk profiles that fall between prime and subprime. These loans have one or more high-risk features, such as the borrower having a high debt-to-income ratio, limited documentation verifying the borrower’s income or assets, or the option of making monthly payments that are lower than required for a fully amortizing loan. Alt-A mortgage loans generally have interest rates that fall between the interest rates on conforming loans and subprime loans.

Second Lien.    Second mortgages and home equity lines are often referred to as second liens and fall into a separate category of the residential mortgage market. These loans typically have higher interest rates than loans secured by first liens because the lender generally will only receive proceeds from a foreclosure of a property after the first lien holder is paid in full. In addition, these loans often feature higher loan-to-value ratios and are less secure than first lien mortgages.

 

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Since the economic crisis began in 2007, the origination of jumbo, subprime, Alt-A and second lien mortgage loans has dramatically declined, and the primary market for securitizations of such loans has largely closed. The refinancing of subprime and Alt-A mortgage loans has declined in tandem with loan originations. Decreased refinancing activity for subprime and Alt-A borrowers has resulted in lower prepayment speeds and an increase in the life of the related mortgage servicing rights.

 

LOGO

Source: Inside Mortgage Finance.

Mortgage Servicing

The largest mortgage loan servicers are large banks and other financial institutions that are active in mortgage loan originations and which typically have access to deposit-based funding. Other mortgage servicers include entities that focus primarily on servicing and typically do not have access to deposit-based funding. These mortgage servicers primarily service loans held by securitization trusts that do not have the infrastructure to service loans themselves. Recent legislative and regulatory developments may have an effect on the mortgage servicing industry in various jurisdictions. Reforms in the area generally add new prohibitions or requirements. In addition, Basel III, which is scheduled to be implemented into law in several countries on January 1, 2013, includes rules that could effectively raise a bank’s regulatory capital costs of owning mortgage servicing rights. Developments such as these could potentially cause institutions to decrease the amount of mortgage servicing rights that they own. The following table shows the top residential mortgage loan servicers ranked by the unpaid principal balance of the loans serviced as of June 30, 2012:

 

Top Residential Mortgage Servicers by Unpaid Principal Balance

 
(dollars in billions)  

Servicer

   June 30, 2012     

Servicer

   June 30, 2012  

Wells Fargo

   $ 1,863      

PNC

   $ 132   

Bank of America

     1,598      

Ocwen Financial Corp.

     123   

Chase

     1,078      

BB&T

     98   

Citi

     494      

HSBC

     94   

US Bank

     254      

Walter

     86   

ResCap

     190      

MetLife

     84   

Nationstar Mortgage

     188      

Flagstar Bank

     82   

PHH

     185      

OneWest

     77   

SunTrust

     152      

Fifth Third

     75   

Ally

     139      

Capital One

     69   

 

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Servicing Activities

Residential mortgage loan servicers manage the billing, collections and loss mitigation activities associated with mortgage loans that are originated by banks or other lenders. Servicers send borrowers monthly account statements, collect monthly mortgage payments, remit such payments to the owner of the mortgage loan, answer customer service inquiries and maintain custodial accounts to hold borrower payments of principal and interest and amounts received from borrowers to pay real estate taxes and insurance with respect to the properties securing the mortgage loans and pay such real estate taxes and insurance premiums from the custodial accounts. A servicer will also remit collections on the mortgage loans from the custodial accounts to the trustee of the applicable securitization trust to make payments on the related mortgage-backed securities and prepare and deliver monthly and annual reports to the trustee. A servicer may also be required to advance its own funds to cover shortfalls in collections of principal and interest from borrowers, to pay property and casualty insurance premiums and real estate taxes on a property and to cover the costs associated with protecting or foreclosing on a property. If borrowers become delinquent on loans, the servicer generally may conduct loss mitigation activities to reduce loan delinquencies and losses by working with borrowers to collect payments and modify loans or enforce the lenders’ remedies, which may include initiating foreclose procedures and selling the properties.

Servicing Fees

Mortgage servicers receive a monthly servicing fee, which is usually based on a percentage of the mortgage loan’s unpaid principal balance per annum and typically ranges from 25 to 50 basis points depending on the categories of mortgage loans comprising the loan portfolio. Subprime servicers typically receive a servicing fee at the higher end of this range to compensate for the additional costs incurred in connection with higher delinquencies experienced with respect to subprime borrowers. Mortgage servicers usually also have the right to receive ancillary fees relating to the servicing of the mortgage loans, such as late fees from borrowers and interest earned on custodial accounts. All costs incurred by the servicer in connection with performing its servicing functions, including its obligations to make servicing advances, are generally borne by the servicer.

Servicing Advances

Servicing advances generally fall into one of three categories:

 

   

“Principal and Interest Advances” are cash payments made by the servicer to the owner of the mortgage loan to cover scheduled payments of principal and interest on a mortgage loan that have not been paid on a timely basis by the borrower.

 

   

“Taxes and Insurance Advances” are cash payments made by the servicer to third parties on behalf of the borrower for real estate taxes and insurance premiums on the property that have not been paid on a timely basis by the borrower.

 

   

“Corporate Advances” are cash payments made by the servicer to third parties for the costs and expenses incurred in connection with the foreclosure, preservation and sale of the mortgaged property, including attorneys’ and other professional fees.

Servicing advances are structured to provide liquidity to the mortgage loan securitizations but are not intended to provide credit support to the owner of the mortgage loan or the underlying borrowers. Servicing advances are usually reimbursed from amounts received with respect to the related mortgage loan, including payments from the borrower or amounts received from the liquidation of the property securing the loan, which is referred to as “loan level recovery.” Servicers generally have the right to cease making servicing advances on a loan if they determine that advances cannot be recovered at the loan level. These determinations are made by each servicer in accordance with its stop advance policy and may vary among servicers. In the event that loan level recovery is not sufficient to reimburse the servicer in full for servicing advances made with respect to a mortgage loan, most pooling and servicing agreements provide that the

 

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servicer is entitled to be reimbursed from collections received with respect to other loans in the same securitized mortgage pool, which is referred to as “pool level recovery.” The servicer generally does not receive interest on servicing advances.

The Foreclosure Process

If a borrower defaults on a mortgage loan, the owner of the mortgage loan, or the servicer on its behalf, is entitled to foreclose the property in order to sell it to repay the loan. The foreclosure process is generally initiated when the loan becomes 90 days or more delinquent.

State foreclosure laws establish certain procedures that servicers must follow in conducting foreclosures and establish minimum time periods for various aspects of the foreclosure process. These laws and their associated timelines vary widely by state. States generally follow one of two methods for their foreclosure process: judicial, with a judge presiding over the process in a court proceeding; or statutory, with the process being conducted outside the courtroom in accordance with state law. Foreclosure proceedings generally take longer and are more costly to complete in states that follow the judicial foreclosure process, primarily because of the additional legal work involved. As of June 30, 2012, 20 states used a statutory process, 23 states used a judicial process and seven states provide the servicer with the option of selecting either approach.

Foreclosure timelines increase as the number of delinquent mortgage loans increase. In addition, various state banking regulators and attorneys general have publicly announced that they have initiated inquiries into banks and servicers regarding compliance with legal procedures in connection with mortgage foreclosures and, in the case of the Joint Federal-State Servicing Settlement, have entered into a settlement in connection with mortgage foreclosure issues. These activities raise the possibility that governmental authorities, including regulators and judicial bodies, could implement further measures, including foreclosure moratoria, that could further increase foreclosure timelines. All else being equal, an increase in foreclosure timelines would adversely affect servicers by lengthening the amount of time that servicing advances are outstanding and, consequentially, increasing the financing costs related to those servicing advances. See “Risk Factors—Risks Related to Government Regulation—Regulatory scrutiny regarding foreclosure processes could lengthen foreclosure timelines which would negatively impact our liquidity and profitability.”

Foreclosure Alternatives

The owner of a mortgage loan, or the servicer acting on its behalf, may elect to remediate borrower delinquencies through loss mitigation and home retention strategies that fall short of foreclosure. Under the terms of many pooling and servicing agreements, mortgage servicers are permitted, on behalf of the owner of the mortgage loan, to negotiate with a borrower to modify the terms of the loan. These modifications can include principal forgiveness, maturity extensions, delinquent interest capitalization and changes to contractual interest rates. In addition, a servicer can agree to modifications upon the liquidation of a loan, commonly known as a short sale, where a portion of the outstanding principal of the loan is forgiven as part of a sale of the underlying property to a third party, or the owner of the mortgage loan can take possession of the underlying property and suspend the foreclosure with the consent of the borrower, a process commonly known as a deed-in-lieu of foreclosure. Certain governmental and agency-sponsored programs, including the Home Affordable Modification Program (“HAMP”), also provide economic incentives for servicers to implement strategies to avoid or delay foreclosures.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve assumptions, risks and uncertainties. See “Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. You should read the following discussion together with our consolidated financial statements and the notes thereto appearing elsewhere in this prospectus as well as the rest of the information in this prospectus, including “Summary Consolidated Financial Data” and “Capitalization.”

We were incorporated as a Cayman Islands exempted company on December 1, 2010, and our operations prior to our initial public offering were limited to negotiating and entering into the Purchase Agreement and the Subservicing Agreement with Ocwen Loan Servicing on February 10, 2012, negotiating and entering into arrangements with lenders and other third parties to effect the transfer of Mortgage Servicing Assets, associated servicing advances and the related match funded liabilities to us, negotiating and entering into professional and administrative services agreements with Ocwen Loan Servicing and Altisource, and general corporate functions. We have no historical financial statements reflecting our operations prior to our inception, and our balance sheet as of December 31, 2011 and the results of our operations for the period from December 1, 2010 through December 31, 2011 reflect only the activities described above.

On March 5, 2012, we launched operations using proceeds from our initial public offering and a concurrent private placement with our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion of unpaid principal balance of underlying mortgage loans from Ocwen. Specifically, we purchased:

 

   

the contractual right to receive the servicing fees and investment earnings on the custodial accounts related to the Mortgage Servicing Rights and the right to automatically obtain legal ownership, without any additional payment to Ocwen, of each Initial Mortgage Servicing Right upon the receipt of the Required Third Party Consents;

 

   

the outstanding servicing advances associated with the related pooling and servicing agreements; and

 

   

other assets related to the foregoing.

We also assumed a related match funded servicing advance financing facility from Ocwen effective upon the closing of the Initial Ocwen Purchase. At closing on March 5, 2012, we paid cash of $149.8 million to Ocwen for the estimated purchase price of the Initial Purchased Assets (net of assumed liabilities), subject to certain closing adjustments. The purchase price for the Rights to MSRs was based on the value of such assets at the time we entered into the Purchase Agreement and the estimated outstanding unpaid principal balance of the underlying mortgage loans at closing. The purchase price for the associated servicing advances and other assets was equal to the net consolidated book value, which approximated fair value, as of the purchase date of all assets and liabilities of the subsidiary and special purpose entity established in connection with the advance financing facility that owns these servicing advances. On March 31, 2012, we and Ocwen, pursuant to the terms of the Purchase Agreement, agreed to a final purchase price of $138.8 million for the Initial Purchased Assets (net of assumed liabilities of $359.2 million), reflecting post-closing adjustments of $11.0 million that principally resulted from declines in match funded advances.

Having achieved our business and financial objectives in the first quarter, on May 1, 2012 we purchased additional assets from Ocwen Loan Servicing that are substantially similar to our initial portfolio under substantially similar terms. This purchase was funded primarily from excess proceeds from our initial public offering and a concurrent private placement of our ordinary shares and cash generated in excess of our dividend and allowed us to grow the size of our mortgage servicing portfolio to $17.3 billion of unpaid principal balance of underlying mortgage loans as of June 30, 2012. The final purchase price for the transaction was $103.4 million (initially $103.8 million; but was subsequently adjusted). To finance that

 

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amount, we used $25.9 million in cash and borrowed $77.9 million under the Servicing Advance Facility against the $92.6 million in servicing advances associated with the Rights to MSRs.

On August 1, 2012, we completed an acquisition from Ocwen Loan Servicing of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans. The Flow Two Purchase resulted in the acquisition by us of Rights to MSRs with approximately $2.1 billion in unpaid principal balance as of July 31, 2012. The purchase price for the Flow Two Purchase was $74.7 million. To finance that amount, we used $18.6 million in cash generated from our operations and borrowed $56.1 million under the Servicing Advance Facility against the $66.7 million in servicing advances associated with the Rights to MSRs.

The results for our first full quarter of operations ended on June 30, 2012 reflect consistent earnings that were in line with our expectations and exceeded the dividends declared for the period by approximately $400,000. The valuation of our assets was stable. Ocwen Loan Servicing’s performance on behalf of HLSS Holdings was strong with delinquencies continuing to decrease and the advance ratio declining slightly faster than targeted in our contract with Ocwen Loan Servicing. From an operational perspective, the transactions between HLSS Holdings and Ocwen Loan Servicing were completed as planned, and we believe that all servicing requirements under the pooling and servicing agreements were met in all material respects.

We intend to continue to acquire additional substantially similar mortgage servicing assets from Ocwen in the near term in two ways:

 

   

In order to remain fully invested and to offset the impact of prepayments in our servicing portfolio, we expect to continue to utilize cash flow from operations in excess of our dividend to purchase mortgage servicing assets that are substantially similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We will refer to such transactions as flow transactions, which we expect to take place at regular intervals. Certain terms of such flow transactions, including the servicing incentive fee and advance ratio targets, will vary from transaction to transaction. We expect to be able to maintain or moderately grow the size of our servicing portfolio over time through these transactions.

 

   

In order to increase the scale of our business we will look for opportunities to issue additional equity in the form of ordinary shares to allow us to execute larger purchases of mortgage servicing assets substantially similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We will refer to such transactions as bulk purchases. Bulk purchases will be subject to equity market conditions and will likely require that additional advance financing capacity be arranged in advance or concurrent with each transaction in order to maintain leverage similar to our current level.

Ocwen stated that as of June 30, 2012, it has servicing assets with over $100 billion of unpaid principal balance of underlying mortgage loans that are substantially similar to the assets that we purchased in the transactions described above. We believe that Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us in connection with our previous acquisition transactions. Although we cannot guarantee that future acquisition transactions will occur, we also believe that Ocwen will benefit from such transactions and therefore will continue to sell mortgage servicing assets to us in this manner which will allow us to maintain or grow the unpaid principal balance of our servicing portfolio.

We remain open to purchasing assets from third parties other than Ocwen, but given the large amount of servicing assets remaining at Ocwen, we do not view initiating purchases from other third parties as a near-term priority. Should Ocwen be unwilling or unable to sell mortgage servicing assets to us in the near future, we expect that there will continue to be opportunities to purchase mortgage servicing assets from other parties.

We intend to use the proceeds from this offering to purchase the Planned Acquisition Assets from Ocwen Loan Servicing in the Planned Acquisition. We are in discussions with Ocwen Loan Servicing

 

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regarding the composition of the Planned Acquisition Assets, but have not yet identified the specific assets we will acquire. We expect the Planned Acquisition Assets will have similar characteristics to those Mortgage Servicing Assets acquired in the Ocwen Transactions, and that the related servicing advances, both current and future, will be eligible for funding under the Servicing Advance Facility Agreements. The closing of this offering is not conditioned upon the completion of the Planned Acquisition.

We also expect to amend our existing Servicing Advance Facility Agreements to allow for additional borrowing from Barclays Bank Plc to finance the acquisition of the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired, or, alternatively, we may amend our existing Servicing Advance Facility Agreements to issue new debt securities backed by the servicing advances related to the Planned Acquisition Assets and the servicing advances we have previously acquired. We are currently in discussions with Barclays Bank Plc regarding the amendments to the Servicing Advance Facility Agreement, but we do not have a firm commitment to provide additional servicing advance financing in connection with the Planned Acquisition.

A continued strategic priority for us is to receive the consents necessary for us to become the named servicer for the securitizations where we currently own Rights to MSRs and the associated servicing advances. Based on our current dialogue with consent parties, our near term goal in pursuit of such consents is to establish an operating history that demonstrates a continued capability to perform the servicing requirements, specifically our obligation to fund servicing advances and to make principal and interest remittances in conformity with all requirements of the pooling and servicing agreements.

Primary Components of Income

Our operations involve the acquisition and ownership of Purchased Assets. We account for the Rights to MSRs related to the Initial Mortgage Servicing Rights as financial assets. Ocwen Loan Servicing remains obligated to service the mortgage loans underlying the Initial Mortgage Servicing Rights pursuant to the related pooling and servicing agreements until all Required Third Party Consents are obtained and legal ownership of the Initial Mortgage Servicing Rights is transferred to us. At that time, we will become contractually obligated to service those mortgage loans and generally to perform the functions described under “The Mortgage Servicing Industry—Mortgage Servicing—Servicing Activities.” Upon receiving the Required Third Party Consents related to an Initial Mortgage Servicing Right, we will account for the related Right to MSRs as a servicing asset. We do not intend to develop a mortgage servicing platform if and when we acquire legal ownership of any mortgage servicing rights, nor do we intend to acquire or maintain mortgage servicing platforms, personnel or processes in connection with the acquisition of the Aggregate Purchased Assets and any Mortgage Servicing Assets we may purchase in the future. As a result, we have engaged Ocwen Loan Servicing to perform substantially all of the servicing functions relating to the Aggregate Purchased Assets on our behalf if and when we acquire legal ownership of the Initial Mortgage Servicing Rights; however, we will not delegate to Ocwen Loan Servicing the responsibility for maintaining custodial accounts, remitting amounts from the custodial accounts and funding servicing advances pursuant to the terms of the pooling and servicing agreements, which are functions we will perform. We will employ the number of personnel necessary to manage our retained obligations with respect to those Mortgage Servicing Assets that we own.

The primary components of our net income, as determined under U.S. Generally Accepted Accounting Principles, are:

 

   

interest income (prior to receiving the Required Third Party Consents);

 

   

servicing fee revenue (subsequent to receiving the Required Third Party Consents);

 

   

fees payable to Ocwen Loan Servicing (subsequent to receiving the Required Third Party Consents);

 

   

expenses related to the amortization of our Mortgage Servicing Rights (subsequent to receiving the Required Third Party Consents);

 

   

interest expense incurred on the match funded liabilities used to finance servicing advances;

 

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other income, including fees we receive for services that we provide to Ocwen under the Ocwen Professional Services Agreement and interest income on collected but unremitted borrower payments and loan payoff receipts and amounts held for the payment of real estate taxes and insurance premiums in custodial accounts; and

 

   

general and administrative expenses.

Interest Income—Notes Receivable (prior to receiving the Required Third Party Consents)

Our primary source of income prior to receiving the Required Third Party Consents is interest income on the Notes Receivable—Rights to MSRs. This interest income represents the amount of the servicing and other related fees collected by Ocwen Loan Servicing on the underlying Initial Mortgage Servicing Rights (see “—Servicing Fees”) less any amounts due to Ocwen Loan Servicing for its services under the Purchase Agreement (see “—Fees to Ocwen Loan Servicing and Gross Servicing Margin”) and the amount of amortization of the Notes Receivable—Rights to MSRs (see “—Amortization of Mortgage Servicing Rights”). Upon receipt of each Required Third Party Consent related to an Initial Mortgage Servicing Right, we will account for the Notes Receivable—Rights to MSRs balance related to such Initial Mortgage Servicing Right as a mortgage servicing right and will begin recording servicing fee revenue related to the mortgage servicing right rather than interest income on the notes receivable.

Servicing Fees

Our primary source of revenue is the fees we are entitled to receive in connection with the servicing of mortgage loans. Prior to receiving the Required Third Party Consents, the servicing fees we earn will be accounted for as a component of interest income. The pooling and servicing agreements relating to the Initial Mortgage Servicing Rights entitle the servicer to an annual fee of 50 basis points of the unpaid principal balance of the mortgage loans serviced. In connection with the sale of Mortgage Servicing Assets to us, Ocwen Loan Servicing will remit to us the servicing fees related to the Initial Mortgage Servicing Rights it recognizes in each month. If and when we acquire legal ownership of the Initial Mortgage Servicing Rights, we will be contractually entitled to receive and retain these servicing fees directly.

The pooling and servicing agreements relating to the Initial Mortgage Servicing Rights entitle the servicer to certain revenue streams, including late fees, prepayment fees, government incentive payments and other ancillary revenue. Ocwen Loan Servicing will not transfer the right to receive this ancillary revenue to us as part of the Rights to MSRs, but instead will retain these ancillary revenue streams. If and when the Initial Mortgage Servicing Rights are transferred to us, we will be entitled to all ancillary servicing fees under the pooling and servicing agreements related to the Initial Mortgage Servicing Rights; however, under the terms of the Subservicing Agreement, Ocwen Loan Servicing will retain such ancillary fees.

We recognize servicing fees as revenue as mortgage principal and interest payments are received from borrowers and as delinquent loans are brought current, modified, liquidated or charged off. Servicing fees are considered a senior obligation of the securitization trusts to which they relate which means such fees are senior to the payment of principal and interest to holders of mortgage-backed securities and represent a very small proportion of the total cash flows of the pool of mortgage loans; therefore, the risk of non-collection by the servicer is remote.

Fees to Ocwen Loan Servicing and Gross Servicing Margin

We define our gross servicing margin as the servicing fee revenue that we recognize less the fees that we pay to Ocwen Loan Servicing and any subservicers that we may engage. The manner in which we calculate the fees we pay to Ocwen Loan Servicing is the same under both the Purchase Agreement, with respect to the Rights to MSRs, and under the Subservicing Agreement, with respect to any Initial Mortgage Servicing Right for which legal ownership has been transferred to us upon receipt of the Required Third Party Consents. However, prior to obtaining the Required Third Party Consents, these amounts will be accounted for as a component of interest income.

 

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We pay Ocwen Loan Servicing a monthly base fee equal in the aggregate to 12% of the servicing fee revenue recognized for that month with respect to the Initial Mortgage Servicing Rights or the related Rights to MSRs, as applicable. The monthly base fee payable to Ocwen Loan Servicing is expressed as a percentage of the servicing fee revenue actually collected in any given month, which varies from month to month based on the level of collections of principal and interest for the mortgage loans serviced. This monthly base fee structure is intended to correlate the revenue we earn with the fees we pay.

In addition to the monthly base fee, Ocwen Loan Servicing may also receive a monthly performance based incentive fee. Ocwen Loan Servicing receives this incentive fee to the extent the servicing fee revenue recognized for a given month exceeds the sum of the base fee and the amount initially retained by us (the “retained fee”), which is equal to a weighted average of 31.1 basis points of the average unpaid principal balance of the related mortgage loans, for the month of June 2012, and which will vary over the term of the related Sale Supplement or Subservicing Supplement, as applicable. The percentage used to calculate the retained fee will change over the term of each related supplement in accordance with a predetermined schedule. If we do not receive an amount equal to the retained fee in any given month, as expressed in terms of basis points of the average unpaid principal balance of the mortgage loans serviced, a shortfall in our targeted gross servicing margin percentage will occur. Ocwen Loan Servicing will not earn any performance based incentive fees for any month that there is such a shortfall, or in any subsequent month, until we have recovered such shortfall from amounts that would otherwise be available to pay future performance based incentive fees to Ocwen Loan Servicing.

The performance based incentive fee payable in any month is reduced if the ratio of outstanding servicing advances to the unpaid principal balance of the mortgage loans serviced (the “advance ratio”) exceeds a predetermined level for that month. If the advance ratio is exceeded in any month, any performance based incentive fee payable for such month will be reduced by an amount equal to 6.5% per annum of such excess servicing advances.

The fees are calculated monthly and paid by us to Ocwen Loan Servicing within three business days of the final day of each month. The base fees and the performance based incentive fees are subject to change upon any renewal of the subservicing supplement relating to the Initial Purchased Assets. The fees with respect to future pools of mortgage loans will be as agreed by us and Ocwen Loan Servicing in the agreements entered into in connection with the future acquisition of the related Mortgage Servicing Assets.

The gross servicing margin is expected (i) to cover our operating costs, which are principally comprised of amortization of mortgage servicing rights, interest expense incurred to finance servicing advances and administrative and other expenses, and (ii) to be sufficient to allow us to pay our targeted dividends. We believe that the structure of these fees as described above will align the interests of both companies and help us meet our performance targets.

Amortization of Mortgage Servicing Rights

We will record our mortgage servicing rights at their acquisition cost which is the same as their fair value. Prior to receiving the Required Third Party Consents related to the Initial Mortgage Servicing Rights, we will amortize the Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we will calculate the present value of the net cash flows related to the underlying Initial Mortgage Servicing Rights and adjust the carrying value of the Notes Receivable—Rights to MSRs to this amount. The change in the value of the Notes Receivable—Rights to MSRs will be deducted from the net of the servicing fees received from the Initial Mortgage Servicing Rights and the servicing fees paid to Ocwen Loan Servicing, and the resulting amount will be recorded as interest income.

Prepayment speeds are a significant driver of changes in estimated net servicing income, mortgage servicing rights amortization expense and the balance of the Notes Receivable—Rights to MSRs. Prepayment speeds relating to subprime and Alt-A mortgage loans have not historically shown a high degree of volatility from one period to the next. Therefore, we expect amortization rates to remain relatively stable over time.

 

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Interest Expense

Servicing advances are primarily financed through the use of match funded liabilities that accrue interest. We assumed the advance financing facility associated with the Initial Mortgage Servicing Rights from Ocwen Loan Servicing subject to and simultaneously with the closing of our initial public offering. The Class A-1 Term Note, Class A-2 Variable Funding Note, Class B Term Note and Class C Term Note issued under this facility bear interest at short-term rates equal to the commercial paper rate plus 225 to 625 basis points. The weighted average effective interest rate on the advance financing facility that we assumed from Ocwen Loan Servicing in connection with the Initial Ocwen Purchase was approximately 5.44% at June 30, 2012. Interest expense also includes amortization of deferred financing costs, non-use fees and any hedge related costs.

When a borrower is delinquent, the amount of cash that is required to be advanced to the trustee or other owner of the mortgage loan on behalf of the borrower increases. We incur significant interest costs to finance such advances. As a result, increased delinquencies result in increased interest expense without respect to any change in interest rates. The speed at which delinquent loans are resolved affect our interest expense. For example, slower resolution of delinquencies result in higher servicing advance balances and interest expense.

We have executed a hedging strategy designed to largely neutralize the impact of increases in interest rates over specified time periods. Our objective is to utilize hedges in an amount equal to our net exposure to interest rate increases on our match funded liabilities, which bear interest at floating interest rates, after taking into account our expected float balances which partially offset the impact of rising interest rates. If interest rates decline, the value of our hedges will decline. Should our hedging strategy prove ineffective or if we were not able to hedge all of our interest rate risk, rising interest rates would lead to higher interest expense. See “Risk Factors—Risks Related to Our Business and Industry—Our hedging strategies may not be successful in mitigating the risks associated with changes in interest rates” and “—Liquidity and Capital Resources.”

Other Income

Other income consists of amounts due to us from Ocwen under the terms of the Ocwen Professional Services Agreement and float earnings. Under the Ocwen Professional Services Agreement, we receive revenue for providing certain services to Ocwen, which includes pricing and valuation analysis of potential mortgage servicing rights acquisitions, treasury management and other similar services.

Float earnings consist of interest earned on mortgage loan payments and payoff collections that have been collected but which have not yet been remitted to the securitization trust that owns the mortgage loan or which are owed to pay real estate taxes and insurance premiums with respect to the related mortgaged properties. Mortgage loan payments are usually due from the borrower between the first and fifteenth days of the month and are usually remitted to the securitization trust between the eighteenth and twenty-fourth days of each month. Until these funds are remitted to the securitization trust, they reside in interest bearing custodial accounts controlled by the servicer and are invested in accordance with the pooling and servicing agreements and our investment policy. In some cases, this interest income may be reduced by fees for account maintenance or transaction processing or interest due to borrowers on amounts held in custodial accounts. Pursuant to the Purchase Agreement, we are entitled to receive from Ocwen Loan Servicing any float earnings related to the Rights to MSRs even though we will not have custody of the custodial accounts until such time as legal ownership of the related Initial Mortgage Servicing Rights is transferred to us.

Administrative and Other Expense

Administrative and other expenses consist largely of salaries, bonuses and related payroll taxes and employee benefit costs for our employees. In addition, we incur expenses for facilities, technology, communication and other expenses typical of public companies, including audit, legal and other professional fees. Some of our administrative services are provided pursuant to the Altisource

 

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Administrative Services Agreement as discussed in “—Related Party Transactions.” In addition, to the extent that we evaluate and/or complete acquisitions of Mortgage Servicing Assets in the future, we will incur additional expenses, most of which we do not expect to capitalize. Administrative and other expenses include expenses related to the services we provide to Ocwen, and the services provided by Ocwen to us, under the Ocwen Professional Services Agreement. See “—Related Party Transactions.”

Income Taxes

We are a Cayman Islands exempted company, and the Cayman Islands currently levies no taxes on individuals or corporations based on profits, income, gains or appreciation. HLSS Management, LLC, our management company that is taxed as a corporation for U.S. federal income tax purposes, will generate nominal income and will be subject to taxation in the United States. Accordingly, our consolidated effective income tax rate is and will likely continue to be substantially lower than the maximum U.S. federal income tax rate. See “Material Cayman Islands and United States Federal Income Tax Considerations.”

Results of Operations

The following table summarizes key components of our consolidated operating results for the periods indicated, which includes the periods prior to March 5, 2012 when we were a development stage enterprise.

 

     Three Months Ended     Six Months Ended  
     June 30,
2012
     June 30,
2011
    June 30,
2012
     June 30,
2011
 

Consolidated:

          

Revenue

   $ 11,427       $      $ 14,656       $   

Operating expenses

     1,744         17        2,371         44   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     9,683         (17     12,285         (44

Interest expense

     4,964                6,255           
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     4,719         (17     6,030         (44

Income tax expense

     60                77           
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 4,659       $ (17 )   $ 5,953       $ (44 )
  

 

 

    

 

 

   

 

 

    

 

 

 

Three Months and Six Months Ended June 2012 versus June 2011.    Revenue in 2012 primarily includes interest income recorded on Notes receivable–Rights to MSRs using the prospective interest method. Because we currently do not satisfy all of the requirements necessary to record the Rights to MSRs as mortgage servicing rights, this transaction was accounted for as a financing. Also included in revenue for the three and six months ended June 30, 2012 are the amounts billed to Ocwen Loan Servicing for services we provide under the Ocwen Professional Services Agreement and interest earned on custodial accounts and corporate account balances.

Operating expenses for the three and six months ended June 30, 2012 increased primarily due to compensation and benefits and professional services associated with our first months of full operations. Additionally, interest expense increased significantly in both periods due to the assumption of match funded liabilities on March 5, 2012 in connection with the Initial Ocwen Purchase and Flow One purchase.

Income tax expense was $60 and $77 for the three and six months ended June 30, 2012. There was no income tax expense for the three or six months ended June 30, 2011.

Our effective tax rate was 1.3% for the three and six months ended June 30, 2011. We base income tax provisions for interim periods on estimated annual income taxes calculated separately from the effect of significant, infrequent or unusual items. We are a Cayman Islands exempted company, and the Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation. Our subsidiary, HLSS Management, LLC, is the employer of all of our U.S. based employees and is a corporation for U.S. federal income tax purposes. We computed income tax expense by applying

 

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the Federal and state combined rate of 38% to the earnings of HLSS Management, LLC that are subject to U.S. federal and state income taxes.

Summary Operating Information

We operate the business as a single reportable segment. For purposes of our internal management reporting, we separately report the components of Interest income–notes receivable–Rights to MSRs, which include Servicing fee revenue, Servicing Expense and Amortization Expense for MSRs. We provide a reconciliation of our reported results to our internal management reporting for the three and six months ended June 30, 2012 in the following table. We did not provide reconciliations for the three and six months ended June 30, 2011 because we were a development stage enterprise during that period, and our operations were limited to raising capital to complete the Initial Ocwen Purchase. Operating items during that period consisted primarily of start-up costs and are not comparable to the three and six months ended June 30, 2012.

We executed our agreements with Ocwen Loan Servicing with the intent that we would receive the total amount of the servicing fees collected and that we would pay Ocwen Loan Servicing a subservicing fee that is determined based on its collections and advance ratio performance. We evaluate our operating performance and manage our business considering servicing fees collected and subservicing fees paid and maintain our internal management reporting on this basis. The following table presents our condensed consolidated results of operations in accordance with U.S. GAAP reconciled to our internally reported financial results.

Our total revenue, total operating expenses and income from operations as presented in our internal management reporting shown below should be considered in addition to, and not as a substitute for: total revenue, total operating expenses and income from operations determined in accordance with GAAP.

 

For the three months ended June 30, 2012:

   Condensed
Consolidated
Results (GAAP)
     Adjustments     Management
Reporting
(Non-GAAP)
 

Servicing fee revenue(1)

   $       $ 23,040      $ 23,040   

Interest income-notes receivable—Rights to MSRs(2)

     10,580         (10,580       

Professional services

     744                744   

Interest income–other

     103                103   
  

 

 

    

 

 

   

 

 

 

Total revenue

     11,427         12,460        23,887   
  

 

 

    

 

 

   

 

 

 

Operating expenses

       

Compensation and benefits

     1,029                1,029   

Servicing expense(3)

             9,728        9,728   

Amortization of MSRs(4)

             2,732        2,732   

General and administrative expenses

     715                715   
  

 

 

    

 

 

   

 

 

 

Total operating expenses

     1,744         12,460        14,204   
  

 

 

    

 

 

   

 

 

 

Income from operations

   $ 9,683       $      $ 9,683   
  

 

 

    

 

 

   

 

 

 

 

(1) Servicing fee revenue reflects $23,040 of servicing fees received under the agreements with Ocwen Loan Servicing.
(2) Interest income–notes receivable–Rights to MSRs represents the net amount of servicing fees received less servicing fees paid and amortization of the Notes receivable—Rights to MSRs. We exclude this interest income from our management reporting and instead report the contractual components including Servicing fee revenue, Servicing expense and Amortization of MSRs.
(3) Servicing expense reflects the fee we paid under the agreements with Ocwen Loan Servicing.
(4) Amortization of MSRs reflects $2,732 reduction in the value of the Notes receivable—Rights to MSRs.

 

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For the six months ended June 30, 2012:

   Condensed
Consolidated
Results (GAAP)
     Adjustments     Management
Reporting
(Non-GAAP)
 

Servicing fee revenue(1)

   $       $ 29,501      $ 29,501   

Interest income—notes receivable–Rights to MSRs(2)

     13,525         (13,525       

Professional services

     995                995   

Interest income–other

     136                136   
  

 

 

    

 

 

   

 

 

 

Total revenue

     14,656         15,976        30,632   
  

 

 

    

 

 

   

 

 

 

Operating expenses

       

Compensation and benefits

     1,425                1,425   

Servicing expense(3)

             12,460        12,460   

Amortization of MSRs(4)

             3,516        3,516   

General and administrative expenses

     946                946   
  

 

 

    

 

 

   

 

 

 

Total operating expenses

     2,371         15,976        18,347   
  

 

 

    

 

 

   

 

 

 

Income from operations

   $ 12,285       $      $ 12,285   
  

 

 

    

 

 

   

 

 

 

 

(1) Servicing fee revenue reflects $29,501 of servicing fees received under the agreements with Ocwen Loan Servicing.
(2) Interest income–notes receivable–Rights to MSRs represents the net amount of servicing fees received less servicing fees paid and amortization of the Notes receivable–Rights to MSRs. We exclude this interest income from our management reporting and instead report the contractual components including Servicing fee revenue, Servicing expense and Amortization of MSRs.
(3) Servicing Expense reflects the fee we paid under the agreements with Ocwen.
(4) Amortization of MSRs reflects $3,516 reduction in the value of the Notes receivable–Rights to MSRs.

Three months and six months ended June 2012 versus 2011.    Servicing fee revenue increased due to the Initial Ocwen Purchase on March 5, 2012 and Flow One Mortgage Servicing Asset purchase on May 1, 2012. Servicing fee revenue is a function of principal and interest collected during the period and the contractual servicing fee rate. In accordance with the rates set forth in the sale supplements for the Initial Ocwen Purchase and the Flow One purchases, our gross servicing margin (Servicing fee revenue less Servicing Expense) was 31.9 and 31.4 basis points of average unpaid principal balance for the three and six months ended June 30, 2012, respectively. We also earned income from professional services provided to Ocwen under the Ocwen Professional Services Agreement. We did not earn revenue in 2011 associated with these arrangements given we were a development stage organization.

Operating expenses increased for both periods because we began operations at the completion of our initial public offering and Initial Ocwen Purchase on March 5, 2012. Operating expenses in 2012 are primarily comprised of servicing fees paid to Ocwen for servicing the Rights to MSRs, salaries and wages and professional services. The servicing fees paid to Ocwen include $2,765 and $3,540 for the base fee and $6,963 and $8,920 in incentive fees for the three and six months ended periods, respectively. Amortization Expense relates to reductions in the unpaid principal balance for the Initial Purchased Assets. Our average headcount for the quarter and year to date periods was eleven. Most of our employees transferred to HLSS from Ocwen at the time of closing of our initial public offering and the Initial Ocwen Purchase on March 5, 2012. Expenses during the three and six months ended June 2011 were primarily related to organization costs associated with starting our business.

 

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The following table provides selected portfolio statistics as of June 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Residential Assets Serviced

      

Unpaid principal balance:

      

Performing loans(2)

   $ 13,675,159      $ 13,041,451        5

Non-performing loans

     3,142,209        3,018,840        4   

Non-performing real estate

     477,017        889,932        (46
  

 

 

   

 

 

   

Total residential assets serviced

   $ 17,294,385      $ 16,950,223        2   
  

 

 

   

 

 

   

Percent of total unpaid principal balance:

      

Servicing portfolio

     100.0     100.0     0   

Non-performing residential assets serviced

     20.9     23.1     (10

Number of:

      

Performing loans(2)

     92,275        84,802        9   

Non-performing loans

     15,307        14,312        7   

Non-performing real estate

     2,308        4,380        (47
  

 

 

   

 

 

   

Total number of residential assets serviced

     109,890        103,494        6   
  

 

 

   

 

 

   

Percent of total number:

      

Non-performing residential assets serviced

     16.0     18.1     (12

The following table provides selected portfolio statistics for the three months ended June 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Average residential assets serviced

   $ 16,552,992      $ 17,166,107        (4 %) 

Prepayment speed (average CPR)

     15.2     14.1     8   

Average number of residential assets serviced

     105,133        104,394        1   

The following table provides selected portfolio statistics for the six months ended June 30:

 

(in thousands, except for loan count data)

   2012     2011(1)     % Change  

Average residential assets serviced

   $ 15,898,609      $ 17,516,709        (9 %) 

Prepayment speed (average CPR)

     14.7     14.8     (1

Average number of residential assets serviced

     100,695        105,927        (5

 

(1) The data related to the Initial Mortgage Servicing Rights as of (and for the periods ended) June 30, 2011 is shown for comparative purposes only. HLSS acquired the Initial Mortgage Servicing Rights during 2012 and had no Mortgage Servicing Rights during 2011. 2011 data does not include amounts related to the Flow One assets acquired on May 1, 2012.
(2) Performing loans include those loans that are current or have been delinquent for less than 90 days in accordance with their original terms and those loans for which borrowers are making scheduled payments under loan modification, forbearance or bankruptcy plans. We consider all other loans to be non-performing.

The following table provides information regarding changes in our portfolio of residential assets serviced during the quarter:

 

(in thousands, except for loan count data)

   Unpaid
principal
balance
    Loan Count  

Servicing portfolio at March 31, 2012

   $ 15,031,688        95,486   
  

 

 

   

 

 

 

Additions

     2,947,289        16,914   

Runoff

     (684,592     (2,510
  

 

 

   

 

 

 

Servicing portfolio at June 30, 2012

   $ 17,294,385        109,890   

 

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Significant Assets and Liabilities

Because our future business will generally relate to the acquisition and financing of Mortgage Servicing Assets, the description of these assets and liabilities and of our accounting policies related to them is important to the understanding of our business. The principal assets that we acquired and liabilities that we assumed on the closing date of the Initial Ocwen Acquisition include the Notes Receivable—Rights to MSRs related to the Initial Mortgage Servicing Rights and the associated servicing advances and the match funded liabilities relating to the existing servicing advance facility pursuant to which such servicing advances are financed. We will acquire legal ownership of the Initial Mortgage Servicing Rights if and when the Required Third Party Consents are obtained.

Notes Receivable—Rights to MSRs

During the period before we receive the Required Third Party Consents related to the Initial Mortgage Servicing Rights, we account for the purchase of the Rights to MSRs as a financing. Accordingly, we account for the amount paid to Ocwen Loan Servicing for the purchase of the Rights to MSRs as a Notes Receivable—Rights to MSRs. The fair value of the Initial Mortgage Servicing Rights was $70.2 million as of June 30, 2012.

We will amortize the Notes Receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we calculate the present value of the net cash flows related to the underlying Initial Mortgage Servicing Rights and adjust the carrying value of the Notes Receivable—Rights to MSRs to this amount. The change in the value of the Notes Receivable—Rights to MSRs will be deducted from the net of the servicing fees received from the Initial Mortgage Servicing Rights and the servicing fees paid to Ocwen Loan Servicing, and the resulting amount will be recorded as interest income.

Mortgage Servicing Rights

If and when we obtain legal ownership of a mortgage servicing right, we will record the mortgage servicing right at the then current carrying value of the related Notes Receivable—Rights to MSRs. A mortgage servicing right is an intangible asset representing the right by the owner to service a pool of mortgage loans for a predetermined fee. The following sections discuss the accounting treatment for and valuation of mortgage servicing rights.

Mortgage Servicing Rights Valuation.    At the end of each fiscal quarter, an independent third party valuation firm will assist us in determining the fair value of our mortgage servicing rights using a valuation method that is based on the present value of their expected future cash flows utilizing assumptions that are believed to be reasonable and that are consistent with the assumptions that are used by other market participants. The most significant assumptions that will be used are estimates of the speed at which mortgages will prepay and the aggregate principal amount of mortgage loans that will become delinquent, both of which will be based on available market data. Other assumptions used in this valuation will be:

 

   

the cost of servicing;

 

   

compensating interest expense;

 

   

the discount rate reflecting the risk of earning the future income streams from our mortgage servicing rights;

 

   

the interest rate used for computing float earnings;

 

   

the interest rate used for computing the cost of servicing advances; and

 

   

the collection rate of other ancillary fees.

The primary component of the estimated future cash inflows for our mortgage servicing rights is contractual servicing fees. Significant cash outflows include the cost of servicing mortgage loans and the cost of financing servicing advances. The most significant assumptions used in the valuation analysis is the

 

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mortgage prepayment and delinquency rates, both of which are derived from available market data. Other assumptions used in this valuation of mortgage servicing rights are the discount rate (which reflects the risks associated with our relationship with Ocwen Loan Servicing, including that Ocwen Loan Servicing could become bankrupt, insolvent or otherwise be terminated as servicer), the interest rate used for computing the cost of the servicing advances and the cost of servicing representing industry averages. This valuation is made without regard to the owner of the mortgage servicing rights.

Changes in these assumptions would be generally expected to affect our results of operations as summarized below:

 

   

Increases in prepayment speeds generally reduce the value of our mortgage servicing rights as a result of decreased future cash flows, accelerated mortgage servicing rights amortization expense and lower overall servicing fees. These results would be partially offset by a lower cost of servicing and lower interest expense on decreased servicing advance balances.

 

   

Increases in delinquencies or foreclosures generally reduce the value of our mortgage servicing rights as the amount of servicing advances, match funded liabilities and related interest expense increase. Factors which could contribute to increases in delinquencies or foreclosures include increases in interest rates, which could increase the payments owed by borrowers on adjustable-rate mortgages, or further declines in home values generally, which could reduce the incentive for a borrower to continue to make timely payments on his or her mortgage.

 

   

Increases in the discount rate would reduce the value of our mortgage servicing rights due to the lower overall net present value of our future net cash flows.

 

   

Increases in interest rate assumptions relating to the cost of financing servicing advances would increase interest expense and reduce the value of our mortgage servicing rights.

Fair Value of Mortgage Servicing Rights.    The rate of decline in unpaid principal balance of mortgage loans is known as prepayment speed and is affected by factors such as employment rates, interest rates, housing prices, loan type and loan status. The unpaid principal balance of the related mortgage loans is the primary driver of servicing fees, subservicing expense, mortgage servicing rights amortization expense, mortgage servicing rights and servicing advance balances.

 

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The fair value of the Initial Mortgage Servicing Rights is presented in the table below in terms of both basis points and absolute dollar amounts. For the Initial Ocwen Purchase, management has estimated the fair value of such mortgage servicing rights associated with each pooling and servicing agreement for the period of time that such mortgage servicing rights were owned by Barclays. These estimates were based on our assumptions regarding the future cash flows of such Initial Mortgage Servicing Rights at the time the valuations were performed. The fair values presented for the quarters ended September 30, 2010 through December 31, 2011 or, in the case of the mortgage servicing rights acquired in the Flow One Purchase, through June 30, 2012, are based on management’s beliefs regarding such values for the period of time that the Initial Mortgage Servicing Rights were owned by Ocwen Loan Servicing. In arriving at these estimates, management also utilized industry assumptions regarding the future cash flows of the Initial Mortgage Servicing Rights. The risks associated with our relationship with Ocwen Loan Servicing, including the risk that Ocwen Loan Servicing could become insolvent or bankrupt or otherwise be terminated as servicer, have been considered by management in determining the discount rate used to value our Mortgage Servicing Assets. Management will continue to assess these risks when determining the discount rate to be used in the valuation of our Mortgage Servicing Assets in future periods. Since unpaid principal balance, and subsequently fair value, decline as loans are repaid, refinanced or otherwise resolved, the disclosure of valuation in terms of basis points provides a comparable view of the change in economic fair value over time.

 

     Fair Value of Initial Mortgage Servicing Rights  

Quarter Ended

   Unpaid Principal Balance      Basis Points      Amount  
     (dollars in millions)  

September 30, 2009

   $ 28,368         34.50         98   

December 31, 2009

   $ 26,659         32.46         87   

March 31, 2010

   $ 25,366         34.11         87   

June 30, 2010

   $ 24,170         38.09         92   

September 30, 2010

   $ 22,962         37.42         86   

December 31, 2010

   $ 22,147         40.35         89   

March 31, 2011

   $ 21,237         41.79         89   

June 30, 2011

   $ 20,406         40.19         82   

September 30, 2011

   $ 19,528         38.47         75   

December 31, 2011

   $ 18,743         40.45         76   

March 31, 2012

   $ 18,026         40.37         73   

June 30, 2012

   $ 17,295         40.58         70   

With respect to the Planned Acquired Assets, we expect the value of the related mortgage servicing rights to be similar–both in terms of basis points and the proportion of dollar value to unpaid principal balance–to the current values of the Initial Mortgage Servicing Rights.

Declines in unpaid principal balance and changes in the fair value of mortgage servicing rights may not necessarily give rise to future impairment of such mortgage servicing rights. We believe that the use of the amortization method of accounting will stabilize the value of mortgage servicing rights as reflected on our balance sheet for the following reasons:

 

   

Mortgage servicing rights amortization expense is expected to exceed our internal prepayment rate in most periods.

 

   

We purchased the Mortgage Servicing Assets related to the Initial Mortgage Servicing Rights at their current fair value, which reflects a significant portion of the impact of the general downward repricing of mortgage servicing rights that began in 2007.

 

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Servicing Advances

Servicing advances are our largest asset class. We acquired servicing advances of approximately $506 million from Ocwen Loan Servicing in connection with the Initial Ocwen Purchase and the Flow One Purchase. The reimbursement of servicing advances is a senior obligation of the related securitization trust, which means that such reimbursement is senior to the ultimate payment of principal and interest to holders of mortgage-backed securities. All of the pooling and servicing agreements relating to the Initial Mortgage Servicing Rights provide for loan level and pool level recoveries.

Pooling and servicing agreements generally require the servicer to advance funds to the securitization trusts that own the mortgage loans during any period in which borrowers are delinquent. The servicer is also required to fund servicing advances relating to the maintenance, repair and marketing of foreclosed properties on behalf of the securitization trust. These servicing advances are made pursuant to the terms of the pooling and servicing agreement governing the related pool of mortgage loans underlying the mortgage servicing rights.

Ocwen Loan Servicing remains contractually obligated to the trustees of the securitization trusts to make any servicing advances pursuant to the pooling and servicing agreements related to the Initial Mortgage Servicing Rights until legal ownership of such Initial Mortgage Servicing Rights is transferred to us. We are obligated to purchase the servicing advances made by Ocwen Loan Servicing during the period of time prior to the transfer of legal ownership of the Initial Mortgage Servicing Rights to us, and although we are not obligated directly to the trustees of the securitization trusts to make servicing advances pursuant to the related pooling and servicing agreements, we are obligated to Ocwen Loan Servicing pursuant to the Purchase Agreement to purchase such servicing advances. When an Initial Mortgage Servicing Right is transferred to us, we will become directly obligated to the related trustee to make any servicing advances required pursuant to the related pooling and servicing agreements.

Servicing advances are currently and will continue to be pledged as collateral under the terms of the existing advance financing facility relating to the Initial Mortgage Servicing Rights that we have assumed.

We value servicing advances at their face value, which is the same as their estimated fair value, because servicing advances are a senior obligation of the securitization trust that owns the mortgage loan, have no stated maturity, generally are realized within a relatively short period of time and do not bear interest.

The servicer is generally obligated to advance funds only to the extent that it believes servicing advances will be recoverable from the expected proceeds from the related mortgage loan. Pursuant to the terms of the Purchase Agreement, we are only obligated to purchase servicing advances relating to the Rights to MSRs from Ocwen Loan Servicing if and to the extent such servicing advances are made in accordance with the terms of the related pooling and servicing agreement and Ocwen Loan Servicing’s advance and stop advance policies. We believe that the likelihood of the servicer not collecting servicing advances relating to the Initial Mortgage Servicing Rights is remote primarily due to the availability of pool level recoveries for servicing advances ultimately not recoverable at the loan level in the related pooling and servicing agreements. We record a charge to earnings to the extent that we believe any servicing advances become uncollectible under the provisions of the related pooling and servicing agreement. Ocwen Loan Servicing is required to assess the collectability of servicing advances on our behalf using its stop advance policy. In addition, Ocwen Loan Servicing must notify us of any servicing advances that we are required to purchase prior to the transfer of the Initial Mortgage Servicing Rights to us, or that we are contractually required to make following any such transfer, pursuant to the terms of the pooling and servicing agreements and the stop advance policy. The projection models driving the stop advance policy incorporate a number of different factors depending on the characteristics of the mortgage loan or pool of loans, including time to a foreclosure sale, estimated costs of foreclosure action, future property tax payments and the estimated proceeds upon the sale of the underlying property net of carrying costs, commissions and closing costs. We periodically review and monitor Ocwen Loan Servicing’s compliance with the stop advance policy. We are entitled to recover from Ocwen Loan Servicing any servicing advance

 

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that was made in violation of the stop advance policy or that was not recoverable from the securitization trust because it violated the terms of the related pooling and servicing agreement.

The unpaid principal balance of a pool of mortgage loans and the amount of outstanding servicing advances typically decline as loan payments are received or loans are otherwise brought current, modified, liquidated or charged off. Servicing advances are typically financed, in part, by match funded liabilities and, therefore, are a principal driver of match funded liability balances and interest expense. The advance ratio is a ratio of the outstanding servicing advances to the unpaid principal balance of the related mortgage loans. The advance ratio influences match funded liabilities, interest expense and liquidity. Many factors can influence the level of servicing advances, including the following:

 

   

servicing requirements and advancing obligations under each pooling and servicing agreement;

 

   

characteristics of the underlying mortgage loans and economic conditions which drive delinquency status and prepayment speed;

 

   

foreclosure timelines;

 

   

the time required to dispose of real estate owned properties;

 

   

the servicer’s servicing efficiency; and

 

   

the servicer’s advance and stop advance policies.

Historical Servicing Advances Data

The table below sets forth the outstanding servicing advances relating to the Initial Mortgage Servicing Rights, excluding the Flow Two Purchase. For $14.4 billion of the related unpaid principal balance as of June 30, 2012, HomEq Servicing was the servicer of the mortgage loans underlying the related mortgage servicing rights for the quarters ended September 30, 2009 through June 30, 2010. Accordingly, the related amounts of outstanding servicing advances and advance ratios are reflective of HomEq Servicing’s servicing practices and policies and general economic conditions impacting the mortgage loans during that period. The amounts shown for the quarters ended September 30, 2010 and after represent the amount of outstanding servicing advances during the period in which Ocwen Loan Servicing serviced the mortgage loans underlying the Initial Mortgage Servicing Rights. The decrease in the advance ratio after September 30, 2010 reflects the impact of Ocwen Loan Servicing’s servicing practices and policies and general economic conditions impacting the mortgage loans during that period. The amount of outstanding servicing advances shown below, therefore, may have been affected by factors that will not apply to the Initial Mortgage Servicing Rights after we purchase the Rights to MSRs, or after we acquire legal ownership of any related Initial Mortgage Servicing Rights and may not be indicative of the results that we will achieve in the future.

 

Quarter Ended

   Unpaid Principal Balance      Amount of Outstanding
Servicing Advances
     Advance Ratio  
     (dollars in millions)  

September 30, 2009

     28,368         1,358         4.8

December 31, 2009

     26,659         1,348         5.1

March 31, 2010

     25,366         1,379         5.4

June 30, 2010

     24,170         1,304         5.4

September 30, 2010

     22,962         1,253         5.5

December 31, 2010

     22,147         1,099         5.0

March 31, 2011

     21,237         897         4.2

June 30, 2011

     20,406         753         3.7

September 30, 2011

     19,528         642         3.3

December 31, 2011

     18,743         572         3.1

March 31, 2012

     18,026         505         2.8

June 30, 2012

     17,295         430         2.5

 

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Servicing advances related to the Initial Mortgage Servicing Rights were comprised of the following advance types at June 30, 2012 (dollars in millions):

 

Principal and Interest

   $ 106   

Escrow Advances

     231   

Corporate Advances

     93   
  

 

 

 

Total

   $ 430   
  

 

 

 

With respect the Planned Acquired Assets, we expect the related servicing advances to have an advance ratio and composition similar to those currently exhibited by the servicing advances related to the Initial Purchased Assets.

The amount of each type of servicing advance outstanding can vary within each month and between months based on the timing of borrower payments, the receipt of loan payoff proceeds, the due dates of tax and insurance payments and other factors. Therefore, these amounts may not be indicative of the amount or the relative proportions of servicing advances that may be outstanding at any time in the future.

Match Funded Liabilities

All of the outstanding advances associated with the Initial Mortgage Servicing Rights are currently financed by the Servicing Advance Facility. Match funded liabilities are a form of non-recourse debt that are collateralized by, and are intended to approximate the duration of, the servicing advances. Our current match funded liabilities with respect to the Initial Mortgage Servicing Rights are financed pursuant to this facility. The investor in the notes issued under this facility is Sheffield Receivables Corporation, an asset-backed commercial paper conduit administered by Barclays Bank PLC. We record the facility at its book value, which is the same as its fair value as of the date of acquisition. Our match funded liability balance is driven primarily by the level of servicing advances and the advance borrowing rate, which is defined as the collateral value of servicing advances divided by total servicing advances. For the advance financing facility associated with the Initial Mortgage Servicing Rights, the advance borrowing rates, which are different for each type of advance: judicial and non-judicial; principal and interest; taxes and insurance; and corporate advances, were set at levels that enabled each class of notes issued pursuant to the advance financing facility to meet ratings criteria as determined by Standard & Poor’s.

The following table shows the match funded liabilities related to the Initial Mortgage Servicing Rights as of June 30, 2012.

Match Funded Liabilities

As of June 30, 2012

 

(Dollars in millions)

Borrowing Type

  Interest Rate(1)   Maturity     Amortization
Date(2)
    Unused
Borrowing
Capacity(3)
    Balance Outstanding  
          June 30,
2012
    December 31,
2011
 

Class A-1 Term Note

  1-Month LIBOR + 225 bps(4)5     Aug. 2043        Aug. 2013      $      $ 288      $   

Class A-2 Variable Funding Note

  1-Month LIBOR + 250 bps(4)5     Aug. 2043        Aug. 2013        146        54          

Class B Term Note(4)

  1-Month LIBOR + 525 bps     Aug. 2043        Aug. 2013               13          

Class C Term Note(4)

  1-Month LIBOR + 625 bps     Aug. 2043        Aug. 2013               13          
       

 

 

   

 

 

   

 

 

 

Total

        $ 146      $ 368      $     
       

 

 

   

 

 

   

 

 

 

 

1. The weighted average interest rate at June 30, 2012 was 2.78%. Interest is paid monthly.
2. The amortization date is the date on which the revolving period ends under each Advance Facility note and repayment of the outstanding balance must begin if the note is not renewed or extended. The maturity date is the date on which all outstanding balances must be repaid. After the amortization date, all collections that represent the repayment of advances pledged to the facility must be applied to reduce the balance of the note outstanding, and any new advances are ineligible to be financed.
3. Our unused borrowing capacity is available to us if we have additional eligible collateral to pledge and other conditions to borrowing are met. As of June 30, 2012, there were insufficient eligible servicing advances available to support any additional borrowings under this facility.

 

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4. If either the Class B Notes or the Class C Notes are not paid in full by November 2012, the margins over the 1-Month LIBOR rate on the Class A-1 Term Notes and Class A-2 Variable Funding Notes will increase by 1.00% per annum, and additional increases of 1.00% per annum will apply beginning in February 2013 and in May 2013 for the Class A-1 Term Notes and Class A-2 Variable Funding Notes if either the Class B Notes or the Class C Notes have not been paid in full on or before such times.

Interest rates on match funded liabilities vary based on the priority of such match funded liability to receive payments from the servicing advances securing the advance financing facility. For example, the Class A-1 Term Note and Class A-2 Variable Funding Note are generally required to be repaid prior to the other classes of notes, and thus the interest paid on such notes is less than on the subordinated notes. Although we do not know the securities that will be issued pursuant to the servicing advance facility in connection with the Planned Acquisition and their related interest rates, we anticipate that it will feature similar, if not more advantageous, interest rates than those we currently pay under our Servicing Advance Facility.

The following table sets forth the actual amount of match funded liabilities outstanding on the existing match funded advance financing facility during the period that Ocwen Loan Servicing owned the Initial Mortgage Servicing Rights, which includes the quarters ended September 30, 2010 through June 30, 2012, and a pro forma estimate of the amount of match funded liabilities that would have been outstanding for the quarters ended June 30, 2009 through June 30, 2010 when the Initial Mortgage Servicing Rights were owned by Barclays. The period ended June 30, 2012 also reflects the match funded liabilities added as a result of the Flow One Purchase.

The match funded advance financing facilities and other financing sources that HomEq Servicing used to finance servicing advances related to the Initial Ocwen Purchase during the period of Barclays’ ownership were different than the match funded advance financing facility that we assumed from Ocwen Loan Servicing upon completion of the Initial Ocwen Purchase. Therefore, the match funded liabilities shown in the table below for the quarters ended March 31, 2009 through June 30, 2010 are a pro forma calculation of the amount of match funded liabilities that could have been outstanding on such dates based on the servicing advances actually outstanding on such dates and the terms of the current Ocwen Loan Servicing match funded advance financing facility, but without regard to the limit on the actual amount that can be borrowed under such match funded advance financing facility. These pro forma match funded liabilities were calculated using the advance borrowing rates by servicing advance type as of June 30, 2012, and the servicing advances outstanding as of each date. See “—Advance Borrowing Rate.” These calculations were made without regard to either the outstanding balance or the unused borrowing capacity that existed as of June 30, 2012. Thus, the pro forma match funded liabilities do not necessarily represent the amount that we would have actually had outstanding under the existing facility on the dates shown had we owned the Initial Mortgage Servicing Rights and engaged Ocwen Loan Servicing to service the underlying mortgage loans on those dates, assuming the existing facility had been available to us on such dates.

 

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The pro forma match funded liabilities data presented below is a hypothetical illustration provided for informational purposes only, is subject to a number of uncertainties and assumptions and does not intend to represent what our actual match funded liabilities would have been if we had owned the Initial Mortgage Servicing Rights and servicing advances as of the dates shown in the table. In preparing this information, we used currently available information and made assumptions that our management believes are reasonable in order to reflect match funded liabilities information for the periods presented. The estimates and assumptions used in the calculation of this information may be materially different from what we would have experienced and what we will actually experience in the future. Accordingly, the pro forma match funded liabilities information included below does not intend to represent what our match funded liabilities would have been had we operated as an independent public company during the periods presented. The pro forma match funded liabilities information also does not intend to represent what our match funded liabilities, results of operations or financial condition will be in the future, nor does it give effect to any events other than those discussed above. Actual match funded liabilities shown below are amounts under the match funded advance financing facility that we assumed from Ocwen Loan Servicing in connection with the Ocwen Transactions.

 

Quarter Ended

   Match Funded Liabilities              
     (dollars in millions)              
                    

June 30, 2009

   $ 986      

)

)

)

)

)

     Pro forma   

September 30, 2009

     920         

December 31, 2009

     916         

March 31, 2010

     938         

June 30, 2010

     890         
        

September 30, 2010

   $ 799      

)

)

)

)

)

     Actual   

December 31, 2010

     786         

March 31, 2011

     606         

June 30, 2011

     493         

September 30, 2011

     452         

December 31, 2011

     371         

March 31, 2012

     357         

June 30, 2012

     368         

Historical match funded liabilities may not be indicative of future amounts as servicing advance balances are subject to prepayment speeds, delinquency rates, foreclosure timelines, the time required to dispose of real estate owned properties and other factors that can affect the amount of servicing advances on mortgage loans. In addition, we may choose to manage our liquidity and interest expense by foregoing permitted borrowing on our match funded advance financing facility.

Advance Borrowing Rate

The advance borrowing rate is the percentage of the amount of our outstanding servicing advances against which we can borrow. The rates shown in the table below apply to the servicing advances associated with the Initial Mortgage Servicing Rights that are financed under the Servicing Advance Facility. These advance borrowing rates are key factors that influence the amount of our match funded liabilities and associated interest expense. A higher advance borrowing rate enables us to borrow more on our outstanding servicing advances and improves our return on equity and liquidity but also increases our interest expense. Advance borrowing rates vary based on the type of servicing advance and the occurrence of certain specified events.

 

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The table below shows the advance borrowing rate that applies to each type of servicing advance when calculating the maximum amount of each class of notes that may be outstanding pursuant to the Servicing Advance Facility.

 

     As of June 30, 2012
Advance Borrowing Rate
 

Servicing Advance Type

   Class A-1 & A-2     Class B     Class C  

Judicial States:

      

Principal and Interest

     85.10     86.60     89.50

Escrow Advances

     77.00     82.70     85.70

Corporate Advances

     70.10     78.50     82.90

Non-Judicial States:

      

Principal Advances

     86.30     87.00     89.40

Escrow Advances

     79.50     83.90     85.70

Corporate Advances

     76.10     82.10     84.80

Series Weighted Average Advance Borrowing Rate as of June 30, 20121

     78.49     83.27     86.21

 

(1) The Series Weighted Average Advance Borrowing Rate is the weighted average of the advance borrowing rates applicable to the servicing advances of each servicing advance type outstanding as of the specified date.

Description of the Initial Purchased Assets

The mortgage loan pools underlying the Initial Mortgage Servicing Rights are characterized in terms of the loan category, geographic location of the mortgaged properties, delinquency status, year of origination, mortgage type, average borrower FICO score, average loan-to-value ratio and historical loan prepayment speeds. Each of these factors may impact one or more components of our financial condition or results of operations.

The following tables present a number of important metrics that drive our financial performance and the results of our operations. All loan counts shown in the following tables are expressed in units.

Servicing Portfolio by Loan Category

Each loan category has different characteristics with respect to delinquency rates and prepayment rates. These differences drive Mortgage Servicing Asset valuations, servicing fees received, float revenue, subservicing expense, amortization expense and interest expense relating to the Initial Mortgage Servicing Rights.

 

     As of June 30, 2012  

Category

   Number
of
Loans
     Average Unpaid
Principal Balance
per Loan
    Total Unpaid
Principal
Balance
     Fair Value
Mortgage Servicing
Rights Balance
 
            (dollars in
thousands)
    (dollars in millions)  

Subprime Loans

     108,551       $ 158      $ 17,125       $ 69   

Alt-A Loans

     1,339         127        170         1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     109,890       $ 157 1    $ 17,295       $ 70   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Represents the weighted-average unpaid principal balance of subprime and Alt-A mortgage loans.

We anticipate that the categories of mortgage loans underlying the Planned Acquisition Assets will be similar to those currently underlying the Initial Mortgage Servicing Rights.

 

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Mortgage Loans by State or Territory

The Initial Mortgage Servicing Rights relate to mortgage loans on properties throughout the United States and its territories. Historical and current economic and market conditions are different in each region, and the geographic distribution of the mortgaged properties can have a direct impact on the overall performance of the mortgage loans underlying the Initial Mortgage Servicing Rights.

 

     As of June 30, 2012  

(Dollars in millions)

State/Territory

   Number of
Loans
     Total Unpaid Principal
Balance
     Percent of Total
Loans
    Percent of Total Unpaid
Principal Balance
 

Alabama

     876       $ 81         0.8     0.5

Alaska

     103         17         0.1     0.1

Arizona

     2,557         343         2.3     2.0

Arkansas

     599         52         0.5     0.3

California

     14,666         3,785         13.3     21.9

Colorado

     1,572         228         1.4     1.3

Connecticut

     1,640         298         1.5     1.7

Delaware

     389         60         0.4     0.4

Florida

     12,157         1,783         11.1     10.3

Georgia

     2,975         341         2.7     2.0

Hawaii

     813         242         0.8     1.4

Idaho

     307         34         0.3     0.2

Illinois

     5,217         744         4.7     4.3

Indiana

     2,124         185         1.9     1.1

Iowa

     531         45         0.5     0.3

Kansas

     471         41         0.4     0.3

Kentucky

     750         70         0.7     0.4

Louisiana

     1,628         148         1.5     0.9

Maine

     422         59         0.4     0.4

Maryland

     2,926         607         2.7     3.5

Massachusetts

     2,224         489         2.0     2.8

Michigan

     2,908         291         2.6     1.7

Minnesota

     1,302         187         1.2     1.1

Mississippi

     876         74         0.8     0.4

Missouri

     1,525         140         1.4     0.8

Montana

     113         13         0.1     0.1

Nebraska

     410         37         0.4     0.2

Nevada

     1,214         211         1.1     1.2

New Hampshire

     399         70         0.4     0.4

New Jersey

     3,176         743         2.9     4.3

New Mexico

     437         54         0.4     0.3

New York

     7,134         1,939         6.5     11.2

North Carolina

     1,881         195         1.7     1.1

North Dakota

     44         4         0.1     0.0

Ohio

     4,029         376         3.7     2.2

Oklahoma

     888         77         0.8     0.4

Oregon

     934         152         0.8     0.9

Pennsylvania

     4,441         506         4.0     2.9

Rhode Island

     484         89         0.4     0.5

South Carolina

     1,114         111         1.0     0.6

South Dakota

     52         5         0.0     0.0

Tennessee

     2,298         208         2.1     1.2

Texas

     13,119         1,178         11.9     6.8

Utah

     546         76         0.5     0.4

Vermont

     71         12         0.1     0.1

Virginia

     1,833         316         1.7     1.8

Washington

     2,158         382         2.0     2.2

Washington, D.C.

     162         40         0.1     0.2

West Virginia

     179         17         0.2     0.1

Wisconsin

     1,137         130         1.0     0.7

Wyoming

     79         10         0.1     0.1
  

 

 

    

 

 

    

 

 

   

 

 

 
     109,890       $ 17,295         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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We anticipate that the geographic distribution of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

Delinquency Status

The servicer is contractually obligated to advance funds to the securitization trust or other third parties during any period in which a borrower is delinquent. As a result, the delinquency status of a loan directly influences the level of servicing advances, match funded liabilities and interest expense with respect to the Initial Mortgage Servicing Rights. In addition to external trends, such as unemployment rates and general economic conditions, delinquency status is highly dependent on the underwriting standards relating to loan origination and the processes, procedures and performance of the servicer or subservicer of a pool of mortgage loans.

 

     As of June 30, 2012  

Status

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of
Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

Current

     80,408       $ 11,718         73.2     67.8

Delinquent(1)

          

30-59 days

     5,223         816         4.8     4.7

60-89 days

     1,231         191         1.1     1.1

90 days or more

     2,711         452         2.5     2.6

Borrower has filed for bankruptcy

     5,322         861         4.8     5.0

Forbearance

     2,122         454         1.9     2.6

Foreclosure

     10,575         2,326         9.6     13.4

Real Estate Owned (property has been foreclosed)

     2,308         477         2.1     2.8
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     109,890       $ 17,295         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Does not include foreclosures and bankruptcies.

We anticipate that the delinquency status of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

Definitions used in this table are as follows:

 

   

“Current” means that the borrower has made all payments and the loan is current.

 

   

“30-59 days” means that the borrower has missed one monthly mortgage payment.

 

   

“60-89 days” means that the borrower has missed two monthly mortgage payments.

 

   

“90 days or more” means that the borrower has missed three or more monthly mortgage payments.

 

   

“Borrower has filed for bankruptcy” means that the servicer has been notified that the borrower has filed for bankruptcy and may be continuing to make payments or may be delinquent.

 

   

“Forbearance” means a temporary postponement of mortgage payments to give the borrower time to make up for overdue payments. Borrowers who are in the process of completing a loan modification are also classified in the forbearance category.

 

   

“Foreclosure” means that the servicer has started foreclosure proceedings. The time to complete a foreclosure proceeding varies by jurisdiction. Foreclosure proceedings usually begin when a borrower has missed three monthly mortgage payments.

 

   

“Real Estate Owned” means the foreclosure process has been completed and the securitization trust owns the property.

 

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Loans that are less than 90 days delinquent and loans that are in bankruptcy or forbearance for which payments are being received are generally referred to as “performing loans,” while loans 90 days or more delinquent and loans in forbearance or bankruptcy for which payments are not being received or are in foreclosure or real estate owned are considered “non-performing loans.”

An important part of Ocwen Loan Servicing’s activities is foreclosure prevention and home retention procedures, which are designed to help reduce delinquencies and assist borrowers in staying in their homes. Ocwen Loan Servicing may engage in early intervention activities with individual borrowers who are delinquent or whom risk models indicate may become delinquent.

The pooling and servicing agreements relating to the Initial Mortgage Servicing Rights and those anticipated to be included in the Planned Acquisition Assets generally permit the servicer to engage in loan modifications. Loan modifications can include principal forgiveness, maturity extension, delinquent interest capitalization and changes to contractual interest rates. The servicer can agree to modifications upon liquidation of a loan, commonly known as a short sale, where a portion of the outstanding principal of the loan is forgiven as part of a sale of the underlying property to a third party. Ocwen Loan Servicing participates in a variety of governmental and agency-sponsored programs, as well as internally designed proprietary programs, aimed at borrowers who are at risk of foreclosure. Each program has varying qualification criteria for the borrower to meet as well as associated modification options, which will be analyzed to determine the best solution for the borrower. Each of these actions serves to reduce delinquencies, recover servicing advances and lower interest expense given that such actions yield more rapid servicing advance recoveries than the foreclosure and subsequent sale of mortgaged properties.

Year of Origination

The year of origination and resulting age of a mortgage loan are key drivers of prepayments. Prepayment speeds tend to be more volatile with newly originated mortgage loans compared to more seasoned loans, such as the loans underlying the Initial Mortgage Servicing Rights. Prepayments result from the ordinary amortization of loans through monthly payments, proceeds of sales, short sales and refinancing, loan reductions through principal reduction modifications or resolution through foreclosure and sale.

 

     As of June 30, 2012  

Origination Year

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

Prior to 2005

     28,623       $ 4,408         26.0     25.5

2005

     47,208         8,142         43.0     47.1

2006

     7,317         1,300         6.7     7.5

2007

     26,742         3,445         24.3     19.9
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     109,890       $ 17,295         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

We anticipate that the seasoning of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

 

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Mortgage Type

There are a variety of fixed and variable rate mortgage loans underlying the Initial Mortgage Servicing Rights. The type of mortgage loan influences the prepayment speed and, to some extent, the delinquency rate of the loan. Mortgage type can change as loans are modified, and the mix can also change over time based on varying prepayment speeds across individual mortgage types.

 

     As of June 30, 2012  

Mortgage Type

   Number of
Loans
     Total Unpaid
Principal Balance
     Percent of Total
Number of Loans
    Percent of Total
Unpaid Principal
Balance
 
     (dollars in millions)  

1/29

     54       $ 10         0.0     0.1

2/28

     25,075         4,326         22.8     25.0

3/27

     5,182         893         4.7     5.2

5/25

     798         187         0.7     1.1

ARM6

     9         1         0.0     0.0

Other ARM

     1,210         294         1.1     1.7

Fixed Rate

     77,562         11,584         70.6     67.0
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     109,890       $ 17,295         100.0     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

We anticipate that the mix of the types of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

A description of the terms used in the above table are as follows:

 

   

Variable rate loans include 1/29, 2/28, 3/27, 5/25, ARM6 and Other ARM. For example, a 3/27 adjustable rate mortgage has a three-year fixed interest rate period after which the interest rate begins to float based on an index plus a margin (known as the fully indexed interest rate). Other ARM represents loans with terms that do not fall into the definition of any other standard products.

 

   

Fixed rate loans have a stated fixed rate determined at loan origination for the full term of the loan.

Variable rate loans are generally based on the six-month LIBOR rate published in The Wall Street Journal. Fixed rate loans range from a minimum rate of 0.125% to a maximum rate of 15.00% with a weighted-average rate of 5.14%. Fixed rate loans include loans that were originated as variable rate loans but that have been subsequently modified and converted into fixed rate loans.

FICO Score

FICO score is a type of credit score prepared by Fair Isaac Corporation. A credit score is a numerical expression of a person’s creditworthiness based upon a statistical analysis of the information about them available to a credit bureau as of a particular date. A FICO score is usually obtained by a lender when it is underwriting a mortgage loan and is one of the factors that the lender will assess when deciding whether to extend a mortgage loan. High FICO scores generally indicate a higher degree of creditworthiness than low scores. A servicer may obtain updated FICO scores at various times over the life of the loan.

 

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The table below sets forth the weighted average FICO score, based on unpaid principal balance, for the borrowers with respect to the mortgage loans underlying the Initial Mortgage Servicing Rights. The scores represent the average FICO scores that have been received between January 1, 2010 and June 30, 2012. The borrower’s most current score is most reflective of their current credit standing and would be used by a lender to assess any new borrowing or refinancing of an existing loan. Approximately 0.2% of the unpaid principal balance relating to the mortgage loans underlying the Initial Mortgage Servicing Rights have no FICO scores.

 

Mortgage Type

   Average FICO
Score Updated
as of June, 30, 2012
 

1/29

     620   

2/28

     610   

3/27

     619   

5/25

     651   

ARM6

     597   

Other ARM

     640   

Fixed Rate

     608   

We anticipate that the FICO scores of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

Loan-to-Value Ratio

Loan-to-value ratio is the ratio of the outstanding balance of a mortgage loan to the estimated fair market value of the property securing the related mortgage loan as of the time of the most recent valuation of such property. A servicer will generally not obtain an updated estimated fair market property value for a mortgaged property unless the mortgage loan is delinquent. Thus, for loans that have never been seriously delinquent, the estimated fair market property value is generally the appraised value of the property at the time of origination. A servicer will obtain an updated estimated fair market property value for a property securing a mortgage loan when the loan becomes seriously delinquent and will generally receive a further updated estimate every 180 days thereafter. For properties that the servicer has foreclosed, the property value represents the current listing price for the property, where available, or the latest estimated fair market value of the property.

 

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The table below sets forth the weighted average loan-to-value ratios, based on unpaid principal balance, for the mortgage loans underlying the Initial Mortgage Servicing Rights. The loan-to-value ratios in the left-hand column of the following table represent the average loan-to-value ratios for those mortgage loans for which the most recent estimated property value was received prior to January 1, 2010 (and which may have been at the time of loan origination). We have received updated estimated property values since January 1, 2010 for the properties securing approximately 67% of the unpaid principal balance relating to the mortgage loans underlying the Initial Mortgage Servicing Rights. Because a number of areas in the United States have been experiencing a decrease in the values of residential properties over the last several years, property value estimates that have not been recently updated may no longer accurately reflect the current value of a property. The loan-to-value ratios in the right-hand column represent the average loan-to-value ratios for those mortgage loans for which the most recent estimated property value was received between January 1, 2010 and June 30, 2012. Thus, we believe that the loan-to-value ratios shown in the right-hand column of the table are a better indication of the loan-to-value ratios for the mortgage loans underlying the Initial Mortgage Servicing Rights using current estimates of property values and would be similar to the values a lender would use to assess any new borrowing or refinancing of an existing loan.

Initial Mortgage Servicing Rights by Loan-to-Value Ratio

 

     As of June 30, 2012  

Mortgage Type

   Average Loan-to-
Value Ratio
Market Value Not
Updated Since
January 1, 2010
    Average Loan-to-
Value Ratio Market
Value Updated
Between January 1,
2010

and June 30, 2012
 

1/29

     77     142

2/28

     80     127

3/27

     77     122

5/25

     72     123

ARM6

     77     114

Other ARM

     82     137

Fixed Rate

     60     100

We anticipate that the loan-to-value rations of the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

 

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Aggregate Annualized Prepayment Speed

Prepayment speed refers to the annualized percentage by which the unpaid principal balance of a pool of mortgage loans declines due to ordinary amortization and monthly principal payments, early loan payoff due to refinancing or sale of the property, principal reduction loan modification or foreclosure and subsequent sale. Prepayment speed is a fundamental driver of the unpaid principal balance upon which servicing fees, subservicing expense, Mortgage Servicing Assets amortization expense, interest expense, servicing advances, match funded liabilities and the valuation of Mortgage Servicing Assets are based. Prepayment speed is driven by many external factors, including prevailing market mortgage interest rates, unemployment rates, real estate valuation trends and the ability of borrowers to qualify for new loans. In general, prepayment speeds for subprime and Alt-A mortgage loans tend to be more stable than for prime mortgage loans because subprime and Alt-A borrowers are less sensitive to interest rate fluctuations given that they have fewer refinancing opportunities and are less likely to qualify for new loans. The quality of the servicer or subservicer is also a significant determinant of prepayment speed as successful loss mitigation techniques tend to reduce prepayment speeds, as shown in the table below.

 

Quarter Ended

   Aggregate Annualized Prepayment Speed  

September 30, 2009

     26.1

December 31, 2009

     22.0

March 31, 2010

     18.0

June 30, 2010

     17.6

September 30, 2010

     18.5

December 31, 2010

     13.5

March 31, 2011

     15.4

June 30, 2011

     14.8

September 30, 2011

     16.1

December 31, 2011

     15.1

March 31, 2012

     14.5

June 30, 2012

     15.3

In general, prepayment speeds tend to decline as a pool of mortgage loans ages. The current industry prepayment speed assumption used by management to value the Initial Mortgage Servicing Rights is approximately 18% per annum. We anticipate that the prepayment speeds for the mortgage loans underlying the Planned Acquisition Assets will be similar to those loans currently underlying the Initial Mortgage Servicing Rights.

Change in Financial Condition

The overall increase in total assets of $557,516 and total liabilities of $375,449 during the six months ended June 30, 2012 primarily resulted from:

 

   

The completion of our initial public offering and a concurrent private placement of our ordinary shares: we raised cash of $184,300;

 

   

The completion of two acquisitions: we acquired assets of $601,794 and had associated increases in liabilities of $437,062 and

 

   

Advance facility activity: we received $75,559 in match funded advance remittances and paid down $67,755 of outstanding match funded liability balances.

 

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The assets acquired in the Initial Ocwen Purchase and Flow One Purchase included Notes receivable—Rights to MSRs which had a balance of $70,175 representing 12.5% of total assets at June 30, 2012. Notes receivable—Rights to MSRs are carried at fair value, which is determined based on an appraisal prepared with the assistance of an independent valuation firm and requires the use of significant unobservable inputs. The most significant assumptions used in the appraisal are:

 

   

Discount rates reflecting the risk of earning the future income streams ranging from 14% to 22%.

 

   

Interest rate used for calculating the cost of servicing advances of 1-Month LIBOR + 4%.

 

   

Mortgage loan prepayment projections ranging from 12% to 25% of the related mortgage lifetime projected prepayment rate.

 

   

Delinquency rate projections ranging from 15% to over 35% of the aggregate unpaid balance of the underlying mortgage loans.

The independent valuation firm reviewed the collateral attributes and the historical payment performance of the underlying mortgage servicing portfolio and compared them with similar mortgage servicing portfolios and with standard industry mortgage performance benchmarks to arrive at the assumptions set forth above. The selected collateral attributes and performance comparisons utilized were the voluntary prepayment performance, delinquency and foreclosure performance, operational cost comparison, average loan balance, weighted average coupon and note rate distribution, loan product type classification, geographic distribution and servicing advance behavior.

The unobservable inputs that have the most significant effect on the fair value of Notes receivable – Rights to MSRs are the mortgage loan prepayment rate projections and the interest rate projections; however, any significant increase (decrease) in discount rates, interest rates, mortgage loan prepayment projections or delinquency rate projections, each in isolation, would result in a substantially lower (higher) valuation.

Total equity amounted to $182,076 at June 30, 2012 as compared to $9 at December 31, 2011. This increase of $182,067 is primarily due to the proceeds of equity offerings of $185,994 less share issuance costs of $3,931, net income of $5,953 and dividends declared of $5,384. In addition, we recorded $565 of unrealized losses in other comprehensive loss on interest rate swaps that we designated as cash flow hedges.

Liquidity and Capital Resources

We define liquidity as unencumbered cash balances plus unused collateralized advance financing capacity. Since our servicing advances and Mortgage Servicing Assets balances are self-liquidating over time, which means that we will generate cash flow as these assets amortize, we anticipate that in most periods operating cash flow will exceed our targeted dividend payout ratio of 90% of net income. We plan to accumulate excess cash to purchase additional Mortgage Servicing Assets that meet our acquisition criteria. Excess cash could also be used to reduce borrowing on advance financing facilities to reduce interest expense. If no such Mortgage Servicing Assets acquisition opportunities are identified, we may engage in repurchases of outstanding ordinary shares.

Over time, we expect to acquire substantially all of Ocwen Loan Servicing’s remaining mortgage servicing rights relating to subprime and Alt-A mortgage loans. As of June 30, 2012, these remaining mortgage servicing rights had approximately $91.2 billion of unpaid principal balance, a fair market value of $341.8 million and match funded servicing advances of approximately $4.4 billion.

Our ability to acquire Ocwen Loan Servicing’s remaining mortgage servicing rights will largely depend on our ability to enter into new match funded financing facilities and to raise additional capital through the sale of additional ordinary shares. While we do not currently have commitments for new match funded advance financing, we believe we are well positioned to obtain future financing facilities. Our ability to raise future equity capital is dependent on our ability to access the capital markets on attractive terms. In

 

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addition, the provisions of our Articles of Association restrict our ability to issue and sell additional ordinary shares at a price below our then current net asset value per share without first obtaining the prior approval of holders of at least a majority of the outstanding ordinary shares voted with respect to such approval. Any issuance of additional ordinary shares would be dilutive to our existing shareholders, including shareholders that purchase in this offering.

Investment Policy, Funding Strategy and Interest Income

Our primary sources of funds for near-term liquidity will be match funded liabilities and servicing fees. Our primary uses of funds will be funding servicing advances, payment of fees, interest and other operating expenses, purchases of additional Mortgage Servicing Assets and associated servicing advances and repayment of borrowings.

Our investment policies will emphasize principal preservation by limiting investments to include:

 

   

securities issued by the U.S. government, a U.S. agency or a U.S. government-sponsored enterprise;

 

   

money market mutual funds; and

 

   

money market demand deposits.

Our investment policies will seek to minimize credit and counterparty risk by establishing risk limits based on each counterparty’s long-term credit ratings. In assessing our liquidity outlook, our primary focus will be on two measures:

 

   

the relationship of cash generated from maturing assets compared to cash required for the payment of maturing liabilities, assuming no renewal of existing facilities and no new financings; and

 

   

unused borrowing capacity.

At June 30, 2012 the unused borrowing capacity on the existing match-funded advance financing facility that we assumed from Ocwen Loan Servicing was $145.8 million. However, our ability to draw on the unused borrowing capacity related to this existing match-funded advance financing facility is limited by the amount of eligible servicing advances related to the Initial Mortgage Servicing Rights securing such facility at any given time and is subject to all other conditions to borrowing being met. As of June 30, 2012 there were not sufficient eligible servicing advances related to the Initial Mortgage Servicing Rights securing such existing match-funded advance financing to support any additional borrowings under such facility. We plan to establish additional unused borrowing capacity under existing and new advance financing facilities in the future at a level that we consider prudent. We plan to maintain unused borrowing capacity in the event that:

 

   

servicing advances increase due to increased delinquencies;

 

   

we are unable to either renew existing advance financing facilities or obtain new advance financing facilities; or

 

   

we acquire additional mortgage servicing rights.

Our ability to finance servicing advances will be a significant factor that affects our liquidity. The Advance Financing Facility is subject to decreases in the advance borrowing rate if deemed necessary by the rating agencies in order to maintain the minimum credit rating required for the facility. This advance financing facility is scheduled to expire in August 2013. Our ability to pledge collateral under the advance financing facility depends on the performance of the collateral.

As discussed in “Risk Factors” and elsewhere in this prospectus, ongoing inquiries into servicer foreclosure processes could result in actions by state or federal governmental bodies, regulators or courts that could result in an extension of foreclosure timelines. While the effect on our future servicing advance balances and liquidity is not expected to be material, a material extension in foreclosure timelines could result in an increase in future servicing advance balances, and advance rates under our advance financing

 

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facilities may have to be reduced to maintain the required note ratings which could adversely affect liquidity. The negative impact of such an increase in servicing advances and a decrease in advance rates may be mitigated if we maintain adequate excess capacity on our advance financing facilities. Conversely, if foreclosure moratoria are imposed and we believe that servicing advances on foreclosed properties cannot be recovered in a timely manner, the servicer would potentially no longer be obligated to make servicing advances and may be able to recover existing servicing advances at the pool level, which could cause servicing advances to decrease. We will be indemnified by Ocwen Loan Servicing against any fines assessed for improper foreclosure practices.

Our advance financing facilities will require that we maintain minimum levels of liquid assets and earnings. Failure to comply with these covenants would result in restrictions on new borrowings or the early termination of our advance financing facilities.

Outlook.

We believe that our cash balance and unused advance financing capacity are sufficient to meet foreseeable requirements.

Debt Financing Summary

During the first half of 2012, we assumed an existing advance financing facility from Ocwen in connection with the Initial Ocwen Purchase. As of June 30, 2012, we had $145,842 of unused borrowing capacity. Our ability to continue to pledge collateral under our advance facility depends on the performance of the collateral. Currently, the large majority of our collateral qualifies for financing. The debt covenants for our Advance Facility require that we maintain minimum levels of liquid assets. Failure to comply with these covenants could result in restrictions on new borrowings or the early termination of our Advance Facility. We believe we are in compliance with these covenants and do not expect them to restrict our activities.

Liquidity Risk

We are exposed to liquidity risk should the cash required to make new advances pursuant to servicing contracts and our agreements with Ocwen exceed the amount of advance repayments. In general, we finance our operations through operating cash flow and have an advance financing facility in place with sufficient capacity to cover the majority of cash required to make new advances. However, our advance financing facility contains borrowing conditions, which, if not met, could affect our ability to borrow on new advances and affect our liquidity.

Interest Rate Risk

Interest rate risk arises primarily from differences in cash balances that earn floating interest rates and incurred liabilities, such as match funded liabilities, that are subject to floating interest rates. Floating interest rate income and expenses are both expected to closely correlate with the one-month LIBOR rate. All of our borrowings as of the date of this prospectus are subject to floating interest rates.

We are party to interest rate swap agreements that we recognize at fair value. On the dates we entered into the interest rate swap agreements, we designated and documented them as hedges of the variable cash flows to be paid for floating rate interest expense on our borrowings (cash flow hedge). We assess and document quarterly the extent to which a derivative has been and is expected to continue to be effective in offsetting the changes in the fair value or the cash flows of the hedged item. To assess effectiveness, we use statistical methods, such as regression analysis, as well as nonstatistical methods including dollar-offset analysis. For a cash flow hedge, to the extent that it is effective, we record changes in the estimated fair value of the derivative in other comprehensive income. We subsequently reclassify these changes in estimated fair value to net income in the same period, or periods, that the hedged transaction affects earnings and in the same financial statement category as the hedged item.

 

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If a derivative instrument in a cash flow hedge is terminated or the hedge designation is removed, we reclassify related amounts in accumulated other comprehensive income into earnings in the same period or periods during which the cash flows that were hedged affect earnings. In a period where we determine that it is probable that a hedged forecasted transaction will not occur, any related amounts in accumulated other comprehensive income are reclassified into earnings in that period.

If interest rates were to increase by 1% on our variable rate advance financing and interest earning cash balances, we estimate a net positive impact of approximately $0.4 million on our net income resulting from an increase of $1.4 million in annual interest income compared to an increase of $1.0 million in annual interest expense, net of the impact of our interest rate hedges.

Cash Flows for the Periods ended June 30

The following table presents a summary of our cash flows for the periods ended June 30:

 

     Six Months  
     2012         2011      

Net income (loss)

   $ 5,953      $ (44

Adjustments for non-cash items

     2,271          

Change in working capital accounts

     82,812        41   

Cash flow from operating activities

     91,036        (3

Cash flow from investing activities

     (239,102       

Cash flow from financing activities

     184,241          

Net increase (decrease) in cash

     36,175        (3

Cash at beginning of period

     283        300   

Cash at end of period

   $ 36,458      $ 297   

Six months ended June 30, 2012.    Our operating activities provided $91,036 of cash. Components of operating cash flow included amounts provided by reductions in servicing advances of $75,559 and by our net income of $5,953, adjusted for amortization of debt issuance costs of $2,271. Additional cash flows were generated by decreases in other assets of $343 and increases in other liabilities of $6,910.

Our investing activities used $239,102 of cash during the six months ended June 30, 2012 to acquire Rights to MSRs, advances and other related assets net of liabilities assumed in connection with the Initial Ocwen Purchase. We based the purchase price that we paid to close the Initial Ocwen Purchase using estimated closing date values. On March 31, 2012, we determined that the final purchase price should be $138,792 and recorded $11,006 due from Ocwen, which was received on May 1, 2012, in connection with the Flow One Purchase. Additionally, we paid $25,940 to Ocwen for the Flow One Purchased Assets net of the $77,886 of new borrowings on the advance facility with Barclays Bank PLC which is reflected in the financing section of the cash flow. Lastly, we had a reduction in Notes receivable—Rights to MSRs of $3,516.

Our financing activities provided $184,241 of cash from the proceeds of our initial public offering and a concurrent private placement of our ordinary shares and over-allotment exercise offset by payments of offering costs, debt issue costs for the transfer of the advance financing facility, repayments of match funded liabilities and dividends paid to shareholders.

Six months ended June 30, 2011.    We were a development stage enterprise until the date of the completion of our initial public offering and a concurrent private placement of our ordinary shares and Initial Ocwen Purchase on March 5, 2012. We used $3 of cash for operating activities during the six months ended June 30, 2011 which consisted of a net loss of $44; the net loss was offset by an increase in other liabilities of $30 and decrease in other assets of $11.

 

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Contractual Obligations

We believe that we have adequate resources to fund all unfunded commitments to the extent required and meet all contractual obligations as they come due. Such contractual obligations include our interest payments and operating leases. The following table sets forth certain information regarding amounts we owe to others under contractual obligations as of June 30, 2012:

 

     Remainder
of 2012
     2013
through
2014
     2015
through
2016
     After
2016
     Total  

Operating leases

   $ 40       $ 148       $       $       $ 188   

Total contractual cash obligations

   $ 40       $ 148       $       $       $ 188   

We sublease office space from Altisource in Atlanta, Georgia and West Palm Beach, Florida in the aggregate of $7 per month. The leases terminate on October 31, 2014.

We exclude match funded liabilities from the contractual obligation table above because it represents non-recourse debt that has been collateralized by match funded advances which are not available to satisfy general claims against us. Holders of the notes issued by the SPE have no recourse against any assets other than the match funded advances that serve as collateral for the securitized debt. Actual interest on match funded liabilities was $2,913 and $3,703 during the three and six months ended June 30, 2012, respectively. Future interest expense may vary depending on utilization, changes in LIBOR and spreads and the execution of hedging strategies.

Off-Balance Sheet Arrangements

In the normal course of business, we may engage in transactions with a variety of financial institutions and other companies that we do not reflect on our Interim Condensed Consolidated Balance Sheet. We are subject to potential financial loss if the counterparties to our off-balance sheet transactions are unable to complete an agreed upon transaction. We seek to limit counterparty risk through financial analysis, dollar limits and other monitoring procedures. We have also entered into non-cancelable operating leases principally for our office facilities.

Derivatives.    We record all derivative transactions at fair value on our Interim Condensed Consolidated Balance Sheet. We use these derivatives primarily to manage our interest rate risk. The notional amounts of our derivative contracts do not reflect our exposure to credit loss.

Principles of Consolidation

Our financial statements include the accounts of Home Loan Servicing Solutions, Ltd. and its direct and indirect wholly owned subsidiaries, HLSS Holdings and HLSS Management, LLC. We eliminate intercompany accounts and transactions in consolidation.

We evaluate each special purpose entity (“SPE”) acquired in connection with the Ocwen Transactions for classification as a Variable Interest Entity (“VIE”). If an SPE meets the definition of a VIE and we determine that we are the primary beneficiary, we include the SPE in our consolidated financial statements. See “The Business—Description of Purchase Agreement” for additional information relating to the SPEs that were acquired in connection with the Ocwen Transactions.

Involvement with an SPE.    We use an SPE in the financing of our servicing advances. We use a match funded securitization facility to finance our servicing advances. The SPE to which the advances are transferred in the securitization transaction is included in our Interim Condensed Consolidated Financial Statements because we are the primary beneficiary of the SPE which is also a VIE. The holders of the debt of this SPE can look only to the assets of the SPE for satisfaction of the debt and have no recourse against HLSS.

VIEs.    If we determine that we are the primary beneficiary of a VIE, we report the VIE in our Interim Condensed Consolidated Financial Statements. As of June 30, 2012, we have no VIEs other than our advance financing SPE.

 

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Critical Accounting Policies

The need to estimate the impact or outcome of future events influences our ability to measure and report our operating results and financial position. Our critical accounting policies relate to the estimation and measurement of these risks. Because they inherently involve significant judgments and uncertainties, an understanding of these policies is fundamental to understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. The following is a summary of our more subjective and complex accounting policies as they relate to our overall business strategy.

Valuation of Notes Receivable—Rights to MSRs and Recognition of Interest Income

Accounting Standards Codification (“ASC”) 860, Transfers and Servicing, specifically prohibits accounting for a transfer of servicing rights as a sale if legal title to such servicing rights has not passed to the purchaser. As a result, during the period before we receive the Required Third Party Consents related to the Initial Mortgage Servicing Rights, we are required to account for the purchase of the Rights to MSRs as a financing. We initially recorded the Notes receivable—Rights to MSRs at the purchase price of the Rights to MSRs. We amortize the Notes receivable—Rights to MSRs using the prospective interest method of accounting. At each reporting date, we calculate the present value of the net cash flows related to the then outstanding UPB of the underlying Initial Mortgage Servicing Rights and adjust the carrying value of the Notes receivable—Rights to MSRs to this amount. We deduct the change in the carrying value of the Notes receivable—Rights to MSRs from the net servicing fees received by us with respect to the Initial Mortgage Servicing Rights and the servicing fees paid to Ocwen with respect to the Initial Mortgage Servicing Rights, and record the resulting amount as interest income. Interest income is our primary source of income prior to receiving the Required Third Party Consents.

Other than transfer of legal title, we believe we meet all the other criteria under ASC 860 for the transfer of the Initial Mortgage Servicing Rights for sales treatment.

We establish the value of the Notes receivable—Rights to MSRs based on an appraisal prepared with the assistance of an independent valuation firm. We summarize the most significant assumptions used in the appraisal below:

 

   

Discount rates reflecting the risk of earning the future income streams from the Notes receivable—Rights to MSRs ranging from 14% to 22%.

 

   

Interest rate used for calculating the cost of servicing advances of 1-Month LIBOR + 4%.

 

   

Mortgage loan prepayment projections ranging from 12% to 25% of the related mortgage lifetime projected prepayment rate.

 

   

Delinquency rate projections ranging from 15% to over 35% of the aggregate unpaid balance of the underlying mortgage loans.

The independent valuation firm reviews the collateral attributes and the historical payment performance of the underlying mortgage servicing portfolio and compares them with similar mortgage servicing portfolios and with standard industry mortgage performance benchmarks to arrive at the assumptions set forth above. The selected collateral attributes and performance comparisons utilized were the voluntary prepayment performance, delinquency and foreclosure performance, operational cost comparison, average loan balance, weighted average coupon and note rate distribution, loan product type classification, geographic distribution and servicing advance behavior.

Recent Accounting Pronouncements

Accounting Standards Update (“ASU”) 2011-04 (ASC 820, Fair Value Measurement): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.    The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of

 

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financial reporting. The amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and prescribe certain additional disclosures about fair value measurements, including (i) for fair value measurements within Level 3 of the fair value hierarchy, disclosing the valuation process used and the sensitivity of fair value measurement to changes in unobservable inputs and (ii) for items not carried at fair value but for which fair value must be disclosed, categorization by level of the fair value hierarchy. Our adoption of this standard effective January 1, 2012 did not have a material impact on our Interim Condensed Consolidated Financial Statements.

ASU 2011-05 (ASC 220, Comprehensive Income): Presentation of Comprehensive Income.    Current U.S. GAAP allows reporting entities three alternatives for presenting other comprehensive income and its components in financial statements. One of those presentation options is to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU eliminates that option. This ASU also requires consecutive presentation of the statement of net income and other comprehensive income and requires that an entity present reclassification adjustments from other comprehensive income to net income by component on the face of both the statement of net income and the statement of other comprehensive income. ASU 2011-12, issued on December 23, 2011, defers indefinitely the provision regarding the presentation of reclassification adjustments. Our adoption of this standard effective January 1, 2012 did not have a material impact on our Interim Condensed Consolidated Financial Statements.

Contingencies

Foreclosure Timelines

Inquiries into servicer foreclosure practices are continuing and may result in action by state or federal government bodies, regulators or courts that could have an adverse effect on the average foreclosure timelines and increase the amount of servicing advances. The average number of days for Ocwen Loan Servicing to complete a foreclosure action during 2011 increased by 133 days in judicial foreclosure states and 32 days in traditional non-judicial foreclosure states as compared to 2010 averages. In the first six months of 2012, foreclosure timelines increased by an additional 102 days in judicial foreclosure states and 34 days in traditional non-judicial foreclosure states as compared to 2011 averages. Despite this timeline extension, the 90 plus day non-performing delinquency rate on all of the mortgage loans serviced by Ocwen Loan Servicing as a percentage of the unpaid principal balance of the underlying mortgage loans that it services has decreased from 27.9% at December 31, 2011 to 24.5% at June 30, 2012. Ocwen has informed us that it believes this improvement occurred because modifications, especially related to the portfolio of mortgage loan servicing it acquired in connection with the acquisition of Litton Loan Servicing LP, drove down delinquency rates and obviated foreclosure and because fewer loans entered delinquency as early intervention loss mitigation improved. It is not possible to predict the full financial impact of changes in foreclosure practices, but if the extension of timelines causes delinquency rates to rise, this could lead to a delay in the amount of servicing fees collected, an increase in operating expenses and an increase in the advance ratio. An increase in the advance ratio could lead to a need for us to increase our borrowings which would lead to higher interest expense, and could also lead to a decrease in the amount we are able to borrow under the existing advance financing facility.

Servicing Transfers

Recent activities by certain residential mortgage-backed security investor groups bring the prospect of greater investor involvement in mortgage loan servicing and the possibility that investors may seek to transfer servicing on some seasoned non-agency securitized loan pools to servicers they deem to be of higher quality in order to improve returns. Many of the pooling and servicing agreements for subprime and Alt-A mortgage loans contain servicer termination events or events of default for the servicer based upon the number of delinquent loans, the loss performance of the related mortgage loans or servicer ratings downgrades. A significant number of the pooling and servicing agreements relating to the Initial Mortgage Servicing Rights contain servicer termination events or events of default of this type, all of which have been

 

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triggered. If Ocwen Loan Servicing is terminated as servicer prior to the transfer of an Initial Mortgage Servicing Right to us as a result of exceeding the maximum delinquency rates or loss limits or we are terminated as servicer for the same reason following such transfer, neither we nor Ocwen Loan Servicing, as applicable, may have any right to compensation from the trustee of the securitization trust for the loss of such mortgage servicing right, which could cause an impairment of our related Mortgage Servicing Assets. Notwithstanding the foregoing, we expect to be reimbursed from collections on the related mortgage loans for any outstanding servicing advances as the related loans are brought current, modified, liquidated or charged off, and we expect to collect any outstanding servicing advances in full. If servicing is deemed to have been lost because of Ocwen Loan Servicing’s servicing practices prior to the transfer of legal ownership of the Initial Mortgage Servicing Rights to us, Ocwen Loan Servicing will be responsible for reimbursing us in accordance with a predetermined schedule intended to reflect the expected amortized value of the Initial Mortgage Servicing Rights at the time the servicing was lost. If the servicing is deemed to be lost because of Ocwen Loan Servicing’s servicing practices while performing servicing functions for us pursuant to the Subservicing Agreement, Ocwen Loan Servicing will be responsible for reimbursing us for the amortized book value of the applicable Mortgage Servicing Assets at the time the servicing was lost.

Improper Loan Assignment

Certain borrowers have recently challenged the foreclosure of their properties by claiming that the foreclosure was improper because the servicer was unable to provide a chain of continuous ownership of the mortgage loan from the originator of the mortgage loan to the securitization trustee. Borrowers have had some success with such defenses. For example, the Massachusetts Supreme Court recently ruled that a foreclosure was improper because the plaintiff was unable to provide a chain of continuous ownership of the mortgage loan from the originator of the mortgage loan to the securitization trustee. This ruling only pertains to foreclosures in Massachusetts. Best servicing practices would have the servicer complete the assignment of the loan prior to initiating foreclosure. Ocwen Loan Servicing has informed us that it is not aware of any assignment issues with respect to the mortgage loans underlying the Initial Mortgage Servicing Rights, and any losses relating to improper assignments by Ocwen Loan Servicing would be recoverable by us from Ocwen Loan Servicing pursuant to our agreements with it. Deficiencies in documentation of loan ownership could nonetheless result in delayed recovery of servicing advances, which could have an adverse impact on our financial results.

Put-Back Risk

In addition to the possibility that servicing could be transferred between servicers, there is also the possibility that the servicing of certain mortgage loans may be transferred as a result of loan put-backs. A loan put-back is a request by the securitization trustee for the originator of the loan or the party that transferred the loan to the securitization to repurchase the loan at par. These requests generally arise because the originator or transferor is found to have breached representations or warranties made at the time of origination or securitization. Ocwen Loan Servicing has informed us that it has not experienced any third-party loan put-back requests with respect to mortgage loans that it originated. Generally, delinquent loans or loans which have already been resolved at a loss to the investor are the most likely loans to be put back to the originator. Although put-backs could reduce the amount of servicing fees collected, the effect on profitability could be positive because delinquent loans require higher advances than performing loans. While put-backs have the potential to reduce unpaid principal balance and affect mortgage servicing rights valuations, it is not clear whether the change in value would be adverse or that the change in the notes receivable or mortgage servicing rights value, even if adverse, would result in any impairment.

Related Party Transactions

We have entered into certain agreements with Ocwen, Ocwen Loan Servicing and Altisource that govern the ongoing relationships among these parties. We have also entered into agreements with Ocwen and its affiliates in connection with the existing advance financing facility. See “The Business” for a more detailed description of the following related party agreements.

 

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Purchase Agreement.    This agreement, in conjunction with the initial sale supplement, sets forth the terms of our purchase of the Aggregate Purchased Assets from Ocwen Loan Servicing. We pay Ocwen Loan Servicing a monthly base fee equal in the aggregate to 12% of the servicing fees collected for that month with respect to the Initial Mortgage Servicing Rights. So long as the Required Third Party Consents have not been obtained with respect to the transfer of legal ownership of any Initial Mortgage Servicing Right, Ocwen Loan Servicing remains obligated to perform its obligations as servicer under the related pooling and servicing agreement, we are required to purchase any servicing advances that Ocwen Loan Servicing is required to make pursuant to such pooling and servicing agreement and Ocwen Loan Servicing is prohibited from taking actions inconsistent with our right to acquire legal ownership of the related mortgage servicing right upon receipt of the Required Third Party Consents. The agreement includes customary representations and warranties made by Ocwen Loan Servicing with respect to the Aggregate Purchased Assets, and provides for indemnification to us for any losses we suffer as a result of the breach of such representations and warranties.

This agreement also provides a framework for us to purchase additional Mortgage Servicing Assets and associated servicing advances from Ocwen Loan Servicing in the future, although no such future acquisitions have been agreed upon, and there is no assurance that future acquisitions will take place or that we will be able to obtain the third party approvals and consents necessary to transfer any related mortgage servicing rights to us.

Subservicing Agreement.    This agreement, in conjunction with the initial subservicing supplement, provides for the appointment of Ocwen Loan Servicing to act as the subservicer of the mortgage loans underlying the Initial Mortgage Servicing Rights upon the transfer of legal ownership of the Initial Mortgage Servicing Rights to us. With respect to the Initial Purchased Assets, the Subservicing Agreement has an initial term ending six years from the closing of the Initial Ocwen Purchase. With respect to the Flow One Purchased Assets, the Subservicing Agreement has an initial term ending six years from the closing of the Flow One Purchase. This agreement also provides a framework for us to engage Ocwen Loan Servicing as subservicer for any mortgage servicing rights we acquire legal ownership of in the future.

Pursuant to the Subservicing Agreement, we pay Ocwen Loan Servicing a base subservicing fee equal in the aggregate to 12% of the servicing fees collected for that month with respect to any Initial Mortgage Serving Rights that we acquire legal ownership of following receipt of the applicable Required Third Party Consents. The monthly base fee payable to Ocwen Loan Servicing is expressed as a percentage of the servicing fees actually collected in any given month because servicing fees collected vary from month to month based on the level of collections of principal and interest for the mortgage loans serviced.

Ocwen Loan Servicing also receives a monthly performance based incentive fee to the extent the servicing fees collected for a given month exceed the retained fee. The percentage used to calculate the retained fee changes in the fourth and seventh months following the closing of the Initial Ocwen Purchase and every six months thereafter in accordance with a predetermined schedule. If we do not receive an amount equal to the retained fee in any given month, as expressed in terms of basis points of the average unpaid principal balance of the mortgage loans serviced, a shortfall in our targeted gross servicing margin percentage will occur. Ocwen Loan Servicing will not earn any performance based incentive fees for any month that there is such a shortfall, or in any subsequent month, until we have recovered such shortfall from amounts that would otherwise be available to pay future performance based incentive fees to Ocwen Loan Servicing.

The performance based incentive fee payable in any month will be reduced if the advance ratio exceeds a predetermined level for that month that is intended to target our return threshold. If the advance ratio is exceeded in any month, any performance based incentive fee payable for such month will be reduced by an amount equal to 6.5% per annum of such excess servicing advances.

Servicing Advance Facility Agreements.    Simultaneously with the closing of our initial public offering and the Initial Ocwen Purchase, we entered into the Servicing Advance Facility Agreements pursuant to which we assumed all of Ocwen Loan Servicing’s rights and obligations under its advance financing facility

 

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under which the servicing advances associated with the Initial Mortgage Servicing Rights were funded. The Servicing Advance Facility Agreements provide for our assumption of the rights and obligations of Ocwen, as administrator, and Ocwen Loan Servicing, as seller and servicer under the documents related to the advance financing facility, and the release of Ocwen and Ocwen Loan Servicing from their respective obligations, in and under the existing advance financing facility, and for certain amendments to the facility to accommodate the assumption of such facility. We will not replace Ocwen Loan Servicing as servicer under the Servicing Advance Facility Agreements with respect to any pooling and servicing agreement, and Ocwen Loan Servicing will remain a party to the Servicing Advance Facility Agreements as servicer with respect to each pooling and servicing agreement, until the related mortgage servicing right is transferred to us, and we become the servicer under such pooling and servicing agreement.

Ocwen Professional Services Agreement.    This agreement requires us to provide certain services to Ocwen, and for Ocwen to provide certain services to us, for an initial term of six years, subject to renewal, with pricing terms intended to reflect market rates. Services provided by us under this agreement include pricing and valuation analysis of potential mortgage servicing rights acquisitions, treasury management and other similar services. Services provided by Ocwen under this agreement include legal, licensing and regulatory support services, risk management services and other similar services. The fees we charge Ocwen and the fees that Ocwen charges us are based on the actual costs incurred by the party performing the service plus an additional markup of 15%.

Altisource Administrative Services Agreement.    This agreement requires Altisource to provide certain administrative services to us for an initial term of six years, subject to renewal with pricing terms intended to reflect market rates. Services provided to us under this agreement include human resources administration (benefit plan design, recruiting, hiring and training and compliance support), legal and regulatory compliance support services, general business consulting, corporate services (facilities management, security and travel services), finance and accounting support services (financial analysis, financial reporting and tax services), risk management services, vendor management and other related services. The fees we pay Altisource are based on the actual costs incurred by them plus an additional markup of 15%.

Private Placement.    On March 5, 2012, simultaneously with our initial public offering, William C. Erbey, the founder of our company and the Chairman of the Board of Directors, purchased 714,285 of our ordinary shares at a price per share equal to the IPO price in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”) pursuant to Section 4(2). The total proceeds from the private placement to us were $10.0 million. No underwriting discounts or commissions were paid in respect of these shares.

Over Allotment Exercise.    On April 2, 2012, we issued 129,600 additional ordinary shares to the underwriters in connection with the exercise of their over-allotment option under the IPO. The total gross proceeds from the issuance of these additional shares to HLSS were $1.8 million. After deducting underwriting discounts, commissions and expenses payable by HLSS, the aggregate net proceeds we received was $1.6 million.

Quantitative and Qualitative Disclosures About Market Risk

Market risk includes liquidity risk and interest rate risk. Market risk also reflects the risk of decline in the valuation of financial instruments and the collateral underlying loans. Our Investment Committee reviews significant transactions that may impact market risk and is authorized to utilize a wide variety of techniques and strategies to manage market risk including, in particular, interest rate risk. See the Liquidity and Capital Resources sections for additional discussion of liquidity and interest rate risks.

 

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THE BUSINESS

Overview

We are a Cayman Islands exempted company that acquires mortgage servicing assets consisting of mortgage servicing rights, rights to mortgage servicing rights, associated servicing advances and other related assets. We launched our operations on March 5, 2012, using the proceeds from our initial public offering and a concurrent private placement with our founder and Chairman of our Board of Directors to acquire mortgage servicing assets related to a portfolio with $15.2 billion unpaid principal balance from Ocwen Loan Servicing, LLC, or Ocwen Loan Servicing. We do not originate or purchase mortgage loans, and as a result we are not subject to the risk of loss related to the origination or ownership of mortgage loans. We have engaged Ocwen Loan Servicing, a high quality residential mortgage loan servicer, to service the mortgage loans underlying our mortgage servicing assets and therefore have not and do not intend to develop our own mortgage servicing platform. While we have only completed one full quarter of operations, we believe that our revenue and expense structure is predictable and will generate a stable income stream and that the quality of our assets is and will continue to be strong. We believe this combination will accomplish our primary objective of delivering attractive and consistent risk-adjusted returns to our shareholders. We intend to distribute at least 90% of our net income over time to our shareholders in the form of a monthly cash dividend. In addition, unlike many income-oriented investment alternatives, we believe that our income stream and the valuation of our assets are not substantially correlated to movements in interest rates.

The results for our first full quarter of operations ended on June 30, 2012, reflect consistent earnings that were in line with our expectations and exceeded the dividends declared for the period by approximately $400,000. The valuation of our assets for the period was stable. Ocwen Loan Servicing’s performance was strong, with delinquencies continuing to decrease and the advance ratio declining slightly faster than targeted in the Purchase Agreement. From an operational perspective, the transactions between Ocwen Loan Servicing and HLSS Holdings, our wholly owned subsidiary that holds our mortgage servicing assets, were completed as planned, and we believe that all servicing requirements under the pooling and servicing agreements were met in all material respects. Having achieved our business and financial objectives in the first quarter, we purchased additional assets from Ocwen Loan Servicing that are substantially similar to our initial portfolio under substantially similar terms.

Our executive management team has extensive experience in the mortgage servicing industry and each of our executive managers was formerly in a senior management role at Ocwen. We believe our executive management team’s extensive experience provides us with the ability to assess the vital characteristics of the mortgage loans underlying the mortgage servicing assets we have acquired and may seek to acquire and evaluate the quality of our current and potential mortgage servicers. We believe this experience further enables us to accurately value mortgage servicing assets and better forecast future asset performance and servicing cash flows. In addition, our management team has demonstrated historical success in arranging cost-effective servicing advance financing through a variety of economic cycles.

Our business strategy is focused on acquiring mortgage servicing rights. In many cases, however, the transfer of legal ownership of mortgage servicing rights requires the prior approval or consent of various third parties, including rating agencies. If the seller from whom we have agreed to purchase mortgage servicing rights has not obtained the necessary approvals and consents to transfer legal ownership of the mortgage servicing rights to us, we will instead seek to acquire the rights to receive the servicing fees that the current servicer is entitled to receive, and the current servicer will continue to service the mortgage loans and receive compensation from us for its servicing activities. Upon receipt of the necessary third party approvals and consents, the seller is obligated to transfer legal ownership of the mortgage servicing rights to us without any additional payment. Whether we acquire mortgage servicing rights or Rights to MSRs, we also acquire servicing advances and other associated assets. We do not believe that our business strategy or economic performance has been or will be materially affected by whether we directly own mortgage servicing rights or the related Rights to MSRs. All of our acquisitions of mortgage servicing

 

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assets to date have been structured as acquisitions of Rights to MSRs and we expect that any additional acquisitions of mortgage servicing assets will be structured in the same manner at least in the near term.

As of the date of this prospectus, all of the Rights to MSRs that we have acquired are serviced by Ocwen Loan Servicing. We have not and do not intend to develop our own mortgage servicing platform but instead will rely on high quality third-party residential mortgage loan servicers. Ocwen Loan Servicing is a leader in the residential subprime and Alt-A mortgage servicing industry based on its historical servicing performance through a variety of real estate and economic cycles. Prior to the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will remain obligated to service the underlying mortgage loans and will remit to us the servicing and other related fees (excluding any ancillary income that Ocwen Loan Servicing will retain) it collects in each month related to the Rights to MSRs. Following the transfer of legal ownership of any Ocwen Mortgage Servicing Rights to us, Ocwen Loan Servicing will service the underlying mortgage loans on our behalf as subservicer, and we will receive the servicing and other related fees (excluding any ancillary income). As compensation for its servicing and subservicing activities, Ocwen Loan Servicing receives from us a monthly base fee initially equal to 12% of such recognized servicing fees collected each month. Ocwen Loan Servicing also earns a monthly performance-based incentive fee that fluctuates based on collections and servicing advance reduction criteria with respect to the underlying mortgage loans. We believe this arrangement aligns the interests of both companies. We will compensate Ocwen Loan Servicing for the services it performs for us prior to the transfer of legal ownership of the Ocwen Mortgage Servicing Rights to us. The method used to calculate the fees that we pay to Ocwen Loan Servicing under the Purchase Agreement with respect to the Rights to MSRs is the same as the method used to calculate the fees that we will pay to Ocwen Loan Servicing under the Subservicing Agreement with respect to any Ocwen Mortgage Servicing Rights that we subsequently acquire. As a result, the compensation to be paid to Ocwen Loan Servicing will not vary based on whether Ocwen Loan Servicing or we hold legal title to the underlying Ocwen Mortgage Servicing Rights.

We anticipate future growth through subsequent acquisitions of Mortgage Servicing Assets. As part of our strategy to acquire additional Mortgage Servicing Assets, we intend to purchase substantially all of the remaining mortgage servicing rights currently owned by Ocwen Loan Servicing or, to the extent that Ocwen Loan Servicing has not received the necessary third party approvals and consents to transfer such mortgage servicing rights to us prior to the closing of any subsequent acquisitions of mortgage servicing rights, the related Rights to MSRs. As of June 30, 2012, this related to Ocwen’s approximately $91.2 billion of unpaid principal balance of subprime and Alt-A mortgage loans. We believe that Ocwen perceives that it has benefited from the transfer of Rights to MSRs to us in connection with our previous acquisition transactions. Although we cannot guarantee that future acquisition transactions will occur, we also believe that Ocwen will benefit from such transactions and therefore will continue to sell mortgage servicing assets to us in this manner which will allow us to maintain or grow the unpaid principal balance of our servicing portfolio.

We intend to continue to acquire additional similar mortgage servicing assets from Ocwen in the near term in two ways:

 

   

In order to remain fully invested and to offset the impact of prepayments in our serving portfolio, we expect to continue to utilize cash flow from operations in excess of our dividend to purchase mortgage servicing assets that are similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as “flow transactions.” We expect flow transactions to take place at regular intervals. Certain terms of such flow transactions, including the servicing incentive fee and advance ratio targets, will vary over time through these transactions.

 

   

In order to increase the scale of our business we will look for opportunities to issue additional equity in the form of ordinary shares to allow us to execute larger purchases of mortgage serving assets similar to our initial portfolio from Ocwen Loan Servicing under substantially similar terms. We refer to such transactions as “bulk purchases.” Bulk purchases will be subject to equity market conditions and will likely require that additional advance financing capacity be arranged in advance or concurrently with each transaction in order to maintain leverage similar to our current level.

 

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As of August 1, 2012, we have made purchases of Rights to MSRs from Ocwen Loan Servicing related to approximately $20.2 billion of unpaid principal balance of mortgage loans.

We intend to use the proceeds from this offering to purchase additional mortgage servicing rights and other related fees, associated servicing advances to date and other related assets from Ocwen Loan Servicing. The specific mortgage servicing assets that we expect to purchase from Ocwen Loan Servicing with the proceeds from this offering have not been identified, however we expect that the mortgage servicing assets will be similar to those that we have acquired from Ocwen Loan Servicing to date. The closing of this offering is not conditioned upon the completion of the purchase of additional mortgage servicing assets from Ocwen Loan Servicing.

Although we believe that competitive and regulatory dynamics in the mortgage se