10-Q 1 ocn_3q13.htm FORM 10-Q
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

or

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: _____________________ to _____________________

Commission File Number: 1-13219

Ocwen Financial Corporation

(Exact name of registrant as specified in its charter)

 

Florida 65-0039856
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

 

  2002 Summit Boulevard, 6th Floor, Atlanta, Georgia 30319  
  (Address of principal executive offices) (Zip Code)  

 

(561)  682-8000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

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.

Large accelerated filer  x  Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Number of shares of Common Stock, $0.01 par value, outstanding as of October 31, 2013: 135,822,932 shares.

 
 

OCWEN FINANCIAL CORPORATION

FORM 10-Q

 

INDEX

 

         
PART I – FINANCIAL INFORMATION   PAGE
         
Item 1.   Financial Statements (unaudited)   3
         
    Consolidated Balance Sheets (unaudited) at September 30, 2013 and December 31, 2012   3
         
    Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012   4
         
    Consolidated Statements of Comprehensive Income (unaudited) for the Three and Nine Months Ended September 30, 2013 and 2012   5
         
    Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the Nine Months Ended September 30, 2013 and 2012   6
         
    Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2013 and 2012   7
         
    Notes to unaudited Consolidated Financial Statements   9
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   46
         
Item 3.   Quantitative and Qualitative Disclosures About Market Risk   69
         
Item 4.   Controls and Procedures   72
         
PART II – OTHER INFORMATION    
         
Item 1.   Legal Proceedings   73
         
Item 1A.   Risk Factors   73
         
Item 6.   Exhibits   73
         
Signatures   75
1
 

Forward-Looking Statements

This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact included in this report, including, without limitation, statements regarding our financial position, 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,” “could”, “intend,” “consider,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict” or “continue” or the negative of such terms or other comparable terminology. Such statements are not guarantees of future performance and involve a number of assumptions, risks and uncertainties that could cause actual results to differ materially from expected results. Important factors that could cause actual results to differ include, but are not limited to, the risks discussed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 and the following:

the adequacy of our financial resources, including our sources of liquidity and ability to fund and recover advances, repay borrowings and comply with debt covenants;
the characteristics of our servicing portfolio, including prepayment speeds along with delinquency and advance rates;
our ability to grow and adapt our business, including the availability of new loan servicing and other accretive business opportunities;
our ability to contain and reduce our operating costs;
our ability to successfully modify delinquent loans, manage foreclosures and sell foreclosed properties;
our reserves, valuations, provisions and anticipated realization on assets;
our ability to effectively manage our exposure to interest rate changes and foreign exchange fluctuations;
our credit and servicer ratings and other actions from various rating agencies;
uncertainty related to general economic and market conditions, delinquency rates, home prices and disposition timelines on foreclosed properties;
uncertainty related to the actions of loan owners, including mortgage-backed securities investors and government sponsored entities (GSEs), regarding loan put-backs, penalties and legal actions;
uncertainty related to the processes for judicial and non-judicial foreclosure proceedings, including potential additional costs or delays or moratoria in the future or claims pertaining to past practices;
uncertainty related to claims, litigation and investigations brought by private parties and government agencies regarding our servicing, foreclosure, modification and other practices;
uncertainty related to legislation, regulations, regulatory agency actions, government programs and policies, industry initiatives and evolving best servicing practices;
uncertainty related to acquisitions, including our ability to integrate the systems, procedures and personnel of acquired companies;
our ability to maintain our technology systems and our ability to adapt such systems for future operating environments;
failure of our internal security measures or breach of our privacy protections;
uncertainty related to the political or economic stability of foreign countries in which we have operations;
conflicts of interest with our officers and directors; and
the loss of the services of our senior managers.

Further information on the risks specific to our business is detailed within this report and our other reports and filings with the Securities and Exchange Commission (SEC) including our Annual Report on Form 10-K for the year ended December 31, 2012, our quarterly reports on Form 10-Q and our current reports on Form 8-K. Forward-looking statements speak only as of the date they were made and except for our ongoing obligations under the U.S. federal securities laws, we undertake no obligation to update or revise forward-looking statements whether as a result of new information, future events or otherwise.

2
 

PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

(Dollars in thousands, except share data)

 

   September 30,
2013
   December 31,
2012
 
Assets          
Cash   $357,486   $220,130 
Loans held for sale, at fair value    335,102    426,480 
Advances    946,287    184,463 
Match funded advances    533,725    3,049,244 
Mortgage servicing rights, at amortized cost    1,736,943    678,937 
Mortgage servicing rights, at fair value    96,938    85,213 
Receivables, net    223,404    137,713 
Deferred tax assets, net    93,343    92,136 
Goodwill and intangibles    407,620    412,866 
Premises and equipment, net    56,837    33,247 
Debt service accounts    45,462    88,748 
Other assets    478,533    273,578 
Total assets   $5,311,680   $5,682,755 
           
Liabilities, Mezzanine Equity and Stockholders’ Equity Liabilities          
Match funded liabilities   $363,012   $2,532,745 
Other borrowings    2,592,591    1,096,679 
Other liabilities    554,708    288,537 
Total liabilities    3,510,311    3,917,961 
           
Commitments and Contingencies (Note 25)          
           
Mezzanine Equity          
Series A Perpetual Convertible Preferred stock, $.01 par value; 200,000 shares authorized; 62,000 and 162,000 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively; redemption value $62,000 plus accrued and unpaid dividends at September 30, 2013    59,945    153,372 
           
Stockholders’ Equity          
Common stock, $.01 par value; 200,000,000 shares authorized; 135,822,932 and 135,637,932 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively    1,358    1,356 
Additional paid-in capital    864,723    911,942 
Retained earnings    882,412    704,565 
Accumulated other comprehensive loss, net of income taxes    (7,069)   (6,441)
Total stockholders’ equity    1,741,424    1,611,422 
Total liabilities, mezzanine equity and stockholders’ equity   $5,311,680   $5,682,755 

 

The accompanying notes are an integral part of these consolidated financial statements.

3
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(Dollars in thousands, except per share data)

   Three Months   Nine Months 
For the Periods Ended September 30,  2013   2012   2013   2012 
Revenue                    
Servicing and subservicing fees   $483,267   $223,011   $1,333,392   $578,435 
Gain on loans held for sale, net    28,262        72,912     
Other revenues    19,711    9,689    76,014    30,178 
Total revenue    531,240    232,700    1,482,318    608,613 
                     
Operating expenses                    
Compensation and benefits    118,054    29,759    330,679    90,546 
Amortization of servicing rights    79,183    20,150    197,435    53,561 
Servicing and origination    34,236    9,838    89,740    18,988 
Technology and communications    38,809    11,608    102,698    31,999 
Professional services    19,090    5,241    99,228    19,743 
Occupancy and equipment    30,786    10,899    74,631    36,484 
Other operating expenses    26,102    5,298    66,007    13,489 
Total operating expenses    346,260    92,793    960,418    264,810 
                     
Income from operations    184,980    139,907    521,900    343,803 
                     
Other income (expense)                    
Interest income    5,379    2,084    17,330    6,434 
Interest expense    (110,055)   (58,417)   (303,339)   (163,660)
Gain (loss) on debt redemption    1,282    (653)   (12,556)   (653)
Other, net    (5,311)   (2,175)   (8,215)   (4,895)
Other expense, net    (108,705)   (59,161)   (306,780)   (162,774)
                     
Income before income taxes    76,275    80,746    215,120    181,029 
Income tax expense    9,273    29,346    26,250    65,447 
Net income    67,002    51,400    188,870    115,582 
Preferred stock dividends    (1,446)       (4,450)    
Deemed dividend related to beneficial conversion feature of preferred stock    (4,401)       (6,573)    
Net income attributable to Ocwen common stockholders   $61,155   $51,400   $177,847   $115,582 
                     
Earnings per share attributable to Ocwen common stockholders                    
Basic   $0.45   $0.38   $1.31   $0.87 
Diluted   $0.44   $0.37   $1.27   $0.84 
                     
                     
Weighted average common shares outstanding                    
Basic    135,787,834    134,928,486    135,705,892    133,483,354 
Diluted    140,057,195    138,702,881    139,747,490    138,301,865 

 

The accompanying notes are an integral part of these consolidated financial statements.

4
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)
(Dollars in thousands unless otherwise indicated)

 

   Three Months   Nine Months 
For the Periods Ended September 30,  2013   2012   2013   2012 
                 
Net income   $67,002   $51,400   $188,870   $115,582 
                     
Other comprehensive income (loss), net of income taxes:                    
                     
Unrealized foreign currency translation income (loss) arising during the period    30    (1)    707    (1) 
                     
Change in deferred loss on cash flow hedges arising during the period (1)        (1,743)   (7,537)   (5,476)
Reclassification adjustment for losses on cash flow hedges included in net income (2)    4,714    1,947    6,198    6,749 
Net change in deferred loss on cash flow hedges    4,714    204    (1,339)   1,273 
                     
Other    1    1    4    4 
                     
Total other comprehensive income, net of income taxes    4,745    204    (628)   1,276 
Comprehensive income   $71,747   $51,604   $188,242   $116,858 
                     
(1)Net of income tax benefit of $0.9 million for the three months ended September 30, 2012 and $4.8 million and $3.1 million for the nine months ended September 30, 2013 and 2012, respectively.
(2)Net of income tax expense of $3.1 million and $1.1 million for the three months ended September 30, 2013 and 2012, respectively, and $3.9 million and $3.8 million for the nine months ended September 30, 2013 and 2012, respectively.

 

The accompanying notes are an integral part of these consolidated financial statements.

5
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Dollars in thousands)

 

   Common Stock   Additional
Paid-in
   Retained   Accumulated
Other
Comprehensive
Loss,
     
   Shares   Amount   Capital   Earnings   Net of Taxes   Total 
                         
Balance at December 31, 2012    135,637,932   $1,356   $911,942   $704,565   $(6,441)  $1,611,422 
Net income                188,870        188,870 
Preferred stock dividends ($27.92 per share)                (4,450)       (4,450)
Deemed dividend related to beneficial conversion feature of preferred stock                (6,573)       (6,573)
Conversion of Series A preferred stock    3,145,640    31    99,969            100,000 
Repurchase of common stock    (3,145,640)   (31)   (157,849)           (157,880)
Exercise of common stock options    172,969    2    (188)           (186)
Equity-based compensation    12,031        10,849            10,849 
Other comprehensive loss, net of income taxes                    (628)   (628)
Balance at September 30, 2013    135,822,932   $1,358   $864,723   $882,412   $(7,069)  $1,741,424 
                               
                               
Balance at December 31, 2011    129,899,288   $1,299   $826,121   $523,787   $(7,896)  $1,343,311 
Net income                115,582        115,582 
Conversion of 3.25% Convertible Notes    4,635,159    46    56,364            56,410 
Exercise of common stock options    462,041    5    2,058            2,063 
Equity-based compensation    8,877        4,572            4,572 
Other comprehensive income, net of income taxes                    1,276    1,276 
Balance at September 30, 2012    135,005,365   $1,350   $889,115   $639,369   $(6,620)  $1,523,214 

 

The accompanying notes are an integral part of these consolidated financial statements.

6
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)

 

For the Nine Months Ended September 30,  2013   2012 
Cash flows from operating activities          
Net income   $188,870   $115,582 
Adjustments to reconcile net income to net cash provided by operating activities          
Amortization of mortgage servicing rights    197,435    53,561 
Amortization of debt discount    1,082    2,679 
Amortization of debt issuance costs – senior secured term loans    3,264    3,050 
Depreciation    17,153    3,896 
Gain on sales of loans    (72,912)    
Realized and unrealized losses on derivative financial instruments, net    12,896    3,900 
Loss on extinguishment of debt    12,556    653 
Origination and purchase of loans held for sale    (7,072,260)    
Proceeds from sale and collection of loans held for sale    7,006,883    1,136 
Changes in assets and liabilities:          
Decrease in advances and match funded advances    424,008    1,213,917 
Decrease in receivables and other assets, net    265,554    3,184 
Increase in servicer liabilities    13,046    14,474 
Increase in other liabilities    14,737    7,911 
Other, net    8,143    10,208 
Net cash provided by operating activities    1,020,455    1,434,151 
Cash flows from investing activities          
Cash paid to acquire ResCap Servicing Operations (a component of Residential Capital, LLC)    (2,260,830)    
Cash paid to acquire Liberty Home Equity Solutions, Inc.    (26,568)    
Purchase of mortgage servicing rights, net    (676,750)   (175,508)
Acquisition of advances in connection with the purchase of mortgage servicing rights    (445,478)   (1,914,687)
Origination of loans held for investment    (274,081)    
Principal payments received on loans held for investment    2,164     
Proceeds from sale of MSRs    21,511     
Proceeds from sale of advance financing subsidiary and special purpose entity        76,334 
Proceeds from sale of match funded advances    3,492,489    1,084,309 
Proceeds from sale of diversified fee businesses to Altisource Portfolio Solutions, S.A.    215,700     
Net cash acquired in acquisition of Correspondent One S.A.    22,108     
Distributions of capital from unconsolidated entities      1,300    2,839 
Additions to premises and equipment    (24,475)   (16,596)
Purchase of real estate        (6,501)
Other    2,947    5,009 
Net cash provided by (used in) investing activities    50,037    (944,801)
Cash flows from financing activities          
Net repayment of match funded liabilities    (2,169,732)   (352,963)
Proceeds from other borrowings    7,935,374    29,784 
Repayment of other borrowings    (7,182,275)   (191,238)
Payment of debt issuance costs – senior secured term loan    (25,547)    
Proceeds from sale of mortgage servicing rights accounted for as a financing    404,509    184,205 
Proceeds from sale of loans accounted for as a financing    272,652     
Redemption of 10.875% Capital Securities        (26,829)
Repurchase of common stock    (157,880)    
Proceeds from exercise of common stock options    947    1,969 
Payment of preferred stock dividends    (4,534)    
Other    (6,650)   (8,009)
Net cash used in financing activities    (933,136)   (363,081)
Net increase in cash    137,356    126,269 
Cash at beginning of period    220,130    144,234 
Cash at end of period   $357,486   $270,503 

 

The accompanying notes are an integral part of these consolidated financial statements.

7
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(Dollars in thousands)

 

For the Nine Months Ended September 30,  2013   2012 
Supplemental non-cash investing and financing activities          
Conversion of Series A preferred stock to common stock  $100,000   $ 
Conversion of 3.25% Convertible Notes to common stock       56,410 
           
Supplemental business acquisition information – ResCap Servicing Operations          
Fair value of assets acquired          
Advances  $(1,722,379)  $ 
Mortgage servicing rights   (391,853)    
Premises and equipment   (16,423)    
Goodwill   (201,810)    
Receivables and other assets   (2,989)    
    (2,335,454)    
Fair value of liabilities assumed          
Accrued expenses and other liabilities   74,624     
Total consideration   (2,260,830)    
Amount due to seller for purchase price adjustments        
Cash paid   (2,260,830)    
Less cash acquired        
Net cash paid  $(2,260,830)  $  

 

(1)See Note 4 – Business Acquisitions for additional information regarding the acquisitions of Liberty Home Equity Solutions, Inc. and Correspondent One S.A. and Note 9 – Mortgage Servicing for additional information regarding the acquisition of mortgage servicing rights from Ally Bank and OneWest Bank.

 

The accompanying notes are an integral part of these consolidated financial statements.

8
 

OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2013

(Dollars in thousands, except per share data or if otherwise indicated)

 

Note 1Description of Business, Basis of Presentation and Significant Accounting Policies

Organization

Ocwen Financial Corporation (NYSE: OCN) (Ocwen, OCN, “we”, or “us”) is a financial services holding company which, through its subsidiaries, is engaged in the servicing and origination of mortgage loans. Ocwen is headquartered in Atlanta, Georgia with offices throughout the United States and in the United States Virgin Islands (USVI) with support operations in India and Uruguay. Ocwen is a Florida corporation organized in February 1988. Ocwen owned all of the common stock of one of its primary operating subsidiaries, Ocwen Mortgage Servicing, Inc. (OMS), and directly or indirectly owned all of the outstanding stock of its other primary operating subsidiaries: Ocwen Loan Servicing, LLC (OLS), Ocwen Financial Solutions Private Limited, Homeward Residential, Inc. (Homeward) and Liberty Home Equity Solutions, Inc. (Liberty) (formerly known as Genworth Financial Home Equity Access, Inc.).

We are licensed to service mortgage loans and to originate mortgage loans in all jurisdictions in which we operate.

We purchase existing mortgage servicing rights (MSRs) from market participants and generate new servicing rights through our origination activities. We perform primary and master servicer activities on behalf of investors and other servicers, including the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Government National Mortgage Association (Ginnie Mae) (collectively, the GSEs). We service prime and non-prime mortgages including mortgages included in private label mortgage-backed securities. As primary servicer, we may make certain payments of property taxes and insurance premiums, default and property maintenance payments, as well as advances of principal and interest payments before collecting them from borrowers. As master servicer, we collect mortgage payments from primary servicers and distribute the funds to investors in the mortgage-backed securities. To the extent that the primary servicer does not advance the scheduled principal and interest, as master servicer we are responsible for advancing the shortfall subject to certain limitations.

We originate, purchase, sell and securitize prime forward and reverse mortgages. These loans are insured or guaranteed by the Federal Housing Authority (FHA) or the Department of Veterans Affairs (VA) or conform to the underwriting standards of Fannie Mae or Freddie Mac. The GSEs guarantee these securitizations.

We are actively engaged in identifying and completing asset and other acquisitions in connection with our growth strategy. This could involve the acquisition of domestic and international servicing and/or origination platforms or related assets. See Note 4 – Business Acquisitions for additional information.

On June 13, 2013, OLS entered into a mortgage servicing rights purchase and sale agreement (Purchase Agreement) with OneWest Bank, FSB, a federal savings bank (the Seller), pursuant to which OLS agreed to purchase MSRs and related servicing advance receivables (the OneWest MSR Transaction).  No operations, entities or other assets were acquired in the transaction. Contemporaneously with the execution of the Purchase Agreement, Ocwen executed a guarantee pursuant to which it agreed to guarantee the obligations and performance of OLS under the Purchase Agreement. As part of the OneWest MSR Transaction, each of the Seller and OLS have agreed to indemnification provisions for the benefit of the other party.

The OneWest MSR Transaction is closing in stages, and we expect that the majority of loans will be boarded onto our primary servicing platform by December 31, 2013. The GSE loans were boarded during August and September, and we expect to board the majority of the private label securities in November. Each closing is subject to, among other things, receipt of certain investor and third party consents and customary closing conditions. In the event that all of the closings have not been completed by January 31, 2014, the unsettled component of the transaction would be subject to termination in accordance with the terms of the Purchase Agreement.

On various dates beginning on April 1, 2013 and continuing through August 31, 2013, the date on which our purchase obligation terminated, we completed the acquisition of Fannie Mae and Freddie Mac MSRs and related advances from Ally Bank (Ally MSR Transaction), a wholly-owned subsidiary of Ally Financial Inc. (Ally), the indirect parent of Residential Capital, LLC (ResCap). Prior to the closing, we subserviced the related MSRs on behalf of Ally Bank. We assumed certain origination representation and warranty obligations in connection with the Ally MSR Transaction. No operations, entities or other assets were acquired in the transaction.

9
 

On April 1, 2013, we completed the acquisition of Liberty (the Liberty Acquisition) through a stock purchase agreement. Liberty is engaged in the origination, purchase, sale and securitization of reverse mortgage loans, both retail and wholesale.

On February 15, 2013, we completed the acquisition of certain assets and operations of ResCap in connection with the asset sale by ResCap and certain of its subsidiaries pursuant to a plan under Chapter 11 of the Bankruptcy Code (the ResCap Acquisition). We purchased MSRs related to private label, Freddie Mac and Ginnie Mae residential forward mortgage loans and certain master and subservicing agreements. The ResCap Acquisition included advances and elements of the servicing platform related to the acquired MSRs. Under the terms of the ResCap Acquisition, we are obligated to acquire certain servicing rights and subservicing agreements that were not settled as part of the initial closing on February 15, 2013 as a result of objections raised in connection with the sale. We completed subsequent settlements as objections were resolved on July 1 and September 1, 2013. We expect to have additional settlements through December 31, 2013 in connection with the ResCap Acquisition.

On December 27, 2012, we completed the merger by and among Ocwen, O&H Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of Ocwen, Homeward Residential Holdings, Inc. (Homeward Holding) and WL Ross & Co. LLC, a Delaware limited liability company as shareholder representative. Pursuant to the merger, O&H Acquisition Corp. merged with and into Homeward Holding with Homeward Holding continuing as the surviving corporation and becoming a wholly-owned subsidiary of Ocwen (the Homeward Acquisition). Homeward primarily engages in the origination, purchase, sale and securitization of prime loans and the servicing of residential forward mortgage loans.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with the instructions of the Securities and Exchange Commission (SEC) to Form 10-Q and SEC Regulation S-X, Article 10, Rule 10-01 for interim financial statements. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. In our opinion, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation. The results of operations and other data for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2013. The unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.

The preparation of financial statements in conformity with GAAP requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Material estimates that are particularly significant in the near or medium term relate to fair value measurements, the provision for potential losses that may arise from litigation proceedings, representation and warranty and other indemnification obligations, the amortization of MSRs and the valuation of goodwill and deferred tax assets.

Principles of Consolidation

Our financial statements include the accounts of Ocwen, its majority-owned subsidiaries and any variable interest entity (VIE) where we have determined that we are the primary beneficiary. We apply the equity method of accounting to investments when the entity is not a VIE, and we are able to exercise significant influence, but not control, over the policies and procedures of the entity but own 50% or less of the voting securities. We have eliminated intercompany accounts and transactions in consolidation.

Reclassification

Within the revenue section of the Consolidated Statement of Operations for the three and nine months ended September 30, 2012, we reclassified Process management fees of $8.9 million and $27.6 million to Other revenues. In addition, certain other insignificant amounts in the Consolidated Statements of Operations and Cash Flows for prior periods have been reclassified to conform to the current period presentation. These reclassifications had no impact on our consolidated financial position, cash flows or results of operations.

Significant Accounting Policies

Transfers of Financial Assets

We securitize, sell and service forward and reverse residential mortgage loans. Securitization transactions typically involve the use of VIEs and are accounted for either as sales or as secured financings. We typically retain economic interests in the securitized assets in the form of servicing rights and obligations. In order to efficiently finance our assets and operations and create liquidity, we may sell servicing advances, MSRs and the right to receive servicing fees, excluding ancillary income, relating to certain of our MSRs (Rights to MSRs).

10
 

In order to determine whether or not a VIE is required to be consolidated, we consider our ongoing involvement with the VIE. In circumstances where we have both the power to direct the activities that most significantly impact the VIEs performance and the obligation to absorb losses or the right to receive benefits that could be significant, we would conclude that we would consolidate the entity, which precludes us from recording an accounting sale in connection with the transfer of the financial assets. In the case of a consolidated VIE, we continue to record the underlying residential mortgage loans or servicing advances, and we record the securitized debt on our consolidated balance sheet.

In the case of transfers where either one or both of the power or economic criteria above are not met, we evaluate whether we achieve a sale for accounting purposes. In order to achieve a sale, the transferred assets must be legally isolated, not be constrained by restrictions from further transfer, and be deemed to be beyond our control. If we fail any of these three criteria, the accounting is consistent with a secured financing as described in the preceding paragraph. Subsequent to the determination that a transaction does not meet the accounting sale criteria, we may determine that we meet the criteria. In the event we subsequently meet the accounting sale criteria, we derecognize the transferred assets and related liabilities.

In the case of transfers of MSRs and Rights to MSRs where we retain the right to subservice, we defer the related gain or loss and amortize the balance over the life of the subservicing agreement.

Gains or losses on off-balance sheet securitizations take into consideration any retained interests, including servicing rights and representation and warranty obligations, both of which are initially recorded at fair value at the date of sale in Gain on loans held for sale, net, in our Consolidated Statements of Operations.

Recent Accounting Pronouncements

Accounting Standards Update (ASU) 2011-11, (Accounting Standards Codification (ASC) 210, Balance Sheet): Disclosures about Offsetting Assets and Liabilities and ASU 2013-01: Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This ASU contains new disclosure requirements regarding the nature of an entity’s rights of offset and related arrangements associated with financial and derivative instruments. ASU 2013-01 clarified the scope of transactions that are subject to ASU 2011-11. The new disclosures also provide information about gross and net exposures. Retrospective application is required for all comparative periods presented. Our adoption of these standards on January 1, 2013 did not have a material impact on our unaudited consolidated financial statements, as the requirements relate to disclosures only.

ASU 2013-02 (ASC 220, Comprehensive Income): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (which amends ASC 220, Comprehensive Income). ASC 2013-02 contains new requirements related to the presentation and disclosure of items that are reclassified out of accumulated other comprehensive income. The ASU is required to be applied prospectively. Adoption of this standard on January 1, 2013 did not have a material impact on our unaudited consolidated financial statements, as the requirements relate to disclosures only.

ASU 2013-04 (ASC 405, Liabilities): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, a consensus of the FASB Emerging Issues Task Force (EITF). On February 28, 2013, the FASB issued ASU 2013-04. The ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following:

a.The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and
b.Any additional amount the reporting entity expects to pay on behalf of its co-obligors.

Required disclosures include a description of the joint-and-several arrangement and the total outstanding amount of the obligation for all joint parties. The ASU permits entities to aggregate disclosures (as opposed to providing separate disclosures for each joint-and-several obligation). The ASU is effective for all prior periods in fiscal years beginning on or after December 15, 2013 (and interim reporting periods within those years). The ASU should be applied retrospectively to obligations with joint-and-several liabilities existing at the beginning of an entity’s fiscal year of adoption. Entities that elect to use hindsight in measuring their obligations during the comparative periods must disclose that fact. Early adoption is permitted. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

11
 

ASU 2013-05 (ASC 830, Foreign Currency Matters): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity, a consensus of the FASB Emerging Issues Task Force. On March 4, 2013, the FASB issued ASU 2013-05, which requires that the entire amount of a cumulative translation adjustment (CTA) related to an entity’s investment in a foreign entity should be released when there has been a:

sale of a subsidiary or group of net assets within a foreign entity and the sale represents the substantially complete liquidation of the investment in the foreign entity,
loss of a controlling financial interest in an investment in a foreign entity (i.e., the foreign entity is deconsolidated), or
step acquisition for a foreign entity (i.e., when an entity has changed from applying the equity method for an investment in a foreign entity to consolidating the foreign entity).

The ASU does not change the requirement to release a pro rata portion of the CTA of the foreign entity into earnings for a partial sale of an equity method investment in a foreign entity. The ASU is effective for fiscal years (and interim periods within those fiscal years) beginning on or after December 15, 2013. The ASU should be applied prospectively from the beginning of the fiscal year of adoption. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

ASU 2013-10 (ASC 815, Derivatives and Hedging): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force). On July 17, 2013, the FASB issued ASU 2013-10, which permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815, in addition to interest rates on direct Treasury obligations of the U.S. government (UST) and the London Interbank Offered Rate (LIBOR). The ASU also removes the restriction on using different benchmark rates for similar hedges. The ASU is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. Because we terminated our remaining interest rate swap agreements on May 31, 2013, our adoption of this standard did not have a material impact on our consolidated financial condition or results of operations.

ASU 2013-11 (ASC 740, Income Taxes): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). On July 18, 2013, the FASB issued ASU 2013-11, which clarifies that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date.

The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The ASU should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. We are currently evaluating the effect of adopting this standard effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial condition or results of operations.

 

Note 2Securitizations and Variable Interest Entities

We securitize, sell and service forward and reverse residential mortgage loans and regularly transfer financial assets in connection with asset-backed financing arrangements. We have aggregated these securitizations and asset-backed financing arrangements into two groups: (1) securitizations of residential mortgage loans and (2) financings of advances on loans serviced for others.

We have determined that the SPEs created in connection with our match funded financing facilities are VIEs of which we are the primary beneficiary. We also determined that we were the primary beneficiary for certain residential mortgage loan securitization trusts which were de-recognized at December 31, 2012, upon sale of our retained interest to a third party.

12
 

Securitizations of Residential Mortgage Loans

Currently, we securitize forward and reverse residential mortgage loans involving the GSEs. We retain the right to service these loans and receive servicing fees based upon the securitized loan balances and certain ancillary fees, all of which are reported in servicing and subservicing fees on the Consolidated Statements of Operations. In prior years, we securitized residential mortgage loans through “private label” securitization trusts. We continued to be involved with the securitization trusts, typically by acting as the servicer or sub-servicer for the loans held by the trust and by retaining a beneficial ownership interest in the securitization trust. The beneficial interests that we held consisted of both subordinate and residual securities that were either retained at the time of the securitization or subsequently acquired. We also acquired residual and subordinated interests in trusts where we were not the transferor but were the servicer.

In December 2012, we sold the beneficial interests that we held in the four consolidated securitization trusts and deconsolidated these securitization trusts. All assets and liabilities associated with the trusts were derecognized. We have no obligation to provide financial support to unconsolidated securitization trusts and have provided no such support. The beneficial owners of the trusts can look only to the assets of the securitization trusts for satisfaction of the debt issued by the securitization trusts and have no recourse against the assets of Ocwen. The general creditors of Ocwen have no claim on the assets of the trusts.

Transfers of Forward Loans

As part of our origination activities, we sell or securitize forward loans that we originate or that we purchase from third parties, generally in the form of mortgage-backed securities guaranteed by the GSEs. Securitization usually occurs within 30 days of loan closing or purchase. We retain servicing rights associated with the transferred loans and receive a servicing fee for services provided. We act only as a fiduciary and do not have a variable interest in the securitization trusts. As a result, we account for these transactions as sales upon transfer.

We elected to measure loans held for sale at fair value. We report interest income on loans held for sale in other income (expense). We report the gain or loss on the transfer of the loans held for sale in Gain on loans held for sale, net in the Consolidated Statements of Operations. We also include in Gain on loans held for sale, net changes in fair value of loans and the gain or loss on the related derivatives. See Note 19 – Derivative Financial Instruments and Hedging Activities for information on these derivative financial instruments. We include all changes in loans held for sale and related derivative balances in operating activities in the Consolidated Statements of Cash Flows.

The following table presents a summary of cash flows received from and paid to securitization trusts related to transfers accounted for as sales that were outstanding during the periods ended September 30, 2013:

   Three Months   Nine Months 
Proceeds received from securitizations   $1,776,309   $6,240,459 
Servicing fees collected    6,317    13,125 
Purchases of previously transferred assets, net of claims reimbursed    (358)   (358)
   $1,782,268   $6,253,226 

In connection with these transfers, we recorded MSRs of $16.3 million and $63.2 million for the three and nine months ended September 30, 2013. We initially record the MSRs at fair value and subsequently account for them at amortized cost. See Note 9 – Mortgage Servicing for information relating to MSRs.

Certain guarantees arise from agreements associated with the transfers of loans. Under these agreements, we may be obligated to repurchase the loans, or otherwise indemnify or reimburse the investor or insurer, for losses incurred due to material breach of contractual representations and warranties. See Note 16 – Other Liabilities for further information.

The following table presents the carrying amounts of our assets that relate to our continuing involvement with forward loans that we have transferred with servicing rights retained since the Homeward Acquisition as well as our maximum exposure to loss including the unpaid principal balance of the transferred loans:

   September 30,
2013
   December 31,
2012
 
Carrying value of assets:          
Mortgage servicing rights, at amortized cost   $53,562   $ 
Mortgage servicing rights, at fair value    2,751    2,908 
Advances and match funded advances    16,254     
Unpaid principal balance of loans transferred (1)    6,125,869    238,010 
Maximum exposure to loss   $6,198,436   $240,918 
(1)The UPB of the loans transferred is the maximum exposure to loss under our standard representations and warranties obligations.
13
 

At September 30, 2013, only 1.0% of the transferred residential loans that we serviced were 60 days or more past due. During the three and nine months ended September 30, 2013, there were no charge-offs, net of recoveries, associated with these transferred loans.

Transfers of Reverse Mortgages

We are an approved issuer of Ginnie Mae Home Equity Conversion Mortgage-Backed Securities (HMBS) that are guaranteed by Ginnie Mae. With the acquisition of Liberty, we have begun to originate Home Equity Conversion Mortgages (HECMs or reverse mortgages) that are insured by the FHA. We then pool the loans into HMBS that we sell into the secondary market with servicing rights retained. Based upon the structure of the Ginnie Mae securitization program, we have determined that loan transfers in the HMBS program do not meet the definition of a participating interest because of the servicing requirements in the product that require the Issuer/Servicer to absorb some level of interest rate risk, cash flow timing risk and incidental credit risk. As a result, HECMs do not qualify for sale accounting, and we, therefore, account for these transfers as secured borrowings. Under this accounting treatment, the HECMs remain on our Consolidated Balance Sheet as loans held for investment (Loans – Restricted for Securitization Investors) in Other assets. We record the proceeds from the transfer of assets as secured borrowings (Secured borrowing – owed to securitization investors) in Other borrowings and recognize no gain or loss on the transfer. Holders of participating interests in the HMBS have no recourse against Ocwen, except for standard representations and warranties and our contractual obligation to service the HECMs and the HMBS, and have no recourse against the assets of Ocwen.

We have elected to measure the HECMS and HMBS-related borrowings at fair value. The changes in fair value of the HECMs and HMBS-related borrowings are included in other revenues in our Consolidated Statement of Operations. Included in net fair value gains on the HECMs and related HMBS borrowings are the interest income that we expect to be collected on the HECMs and the interest expense that we expect to be paid on the HMBS-related borrowings. We report originations and payments of HECMs in investing activities in the Consolidated Statements of Cash Flows. We report net fair value gains on HECMs and the related HMBS borrowings as an adjustment to the net cash provided by or used in operating activities in the Consolidated Statements of Cash Flows. Proceeds from securitizations of HECMs and payments on HMBS-related borrowings are included in financing activities in the Consolidated Statements of Cash Flows.

We had HMBS-related borrowings of $284.3 million and $290.9 million of HECMs pledged as collateral to the pools at September 30, 2013.

Financings of Advances on Loans Serviced for Others

Match funded advances on loans serviced for others result from our transfers of residential loan servicing advances to SPEs in exchange for cash. We consolidate these SPEs because the transfers do not qualify for sales accounting treatment or because Ocwen is the primary beneficiary of the SPE.

These SPEs issue debt supported by collections on the transferred advances. We made these transfers under the terms of our advance facility agreements. We classify the transferred advances on our Consolidated Balance Sheet as Match funded advances and the related liabilities as Match funded liabilities. The SPEs use collections of the pledged advances to repay principal and interest and to pay the expenses of the SPE. Holders of the debt issued by these entities can look only to the assets of the SPE for satisfaction of the debt and have no recourse against Ocwen. However, Ocwen and OLS have guaranteed the payment of the obligations under the securitization documents of one of the entities. The maximum amount payable under the guarantee is limited to 10% of the notes outstanding at the end of the facility’s revolving period in December 2014. The entity to which this guarantee applies had $37.6 million of notes outstanding at September 30, 2013. Ocwen and OLS had previously guaranteed the payment of obligations under the securitization documents of one additional entity; however, in July 2013, the notes outstanding under this facility were repaid, and the facility was terminated. The assets and liabilities of the advance financing SPEs are comprised solely of Match funded advances, Debt service accounts, Match funded liabilities and amounts due to affiliates. Amounts due to affiliates are eliminated in consolidation.

See Note 8 – Match Funded Advances, Note 12 – Debt Service Accounts and Note 14 – Match Funded Liabilities for additional information.

 

Note 3Transfers of Financial Assets

In order to efficiently finance our assets and operations and create liquidity, we periodically sell MSRs, Rights to MSRs and servicing advances to market participants, including Home Loan Servicing Solutions, Ltd. and its wholly owned subsidiary, HLSS Holdings, LLC (collectively HLSS). We typically retain the right to subservice loans when we sell MSRs and rights to MSRs. To the extent applicable, HLSS may also acquire advance SPEs and the related match funded liabilities (together with the purchase of Rights to MSRs and servicing advances, the HLSS Transactions). During the nine months ended September 30, 2013 and 2012, we completed HLSS Transactions relating to the Rights to MSRs for $109.8 billion and $48.2 billion of UPB, respectively.

14
 

As part of the HLSS Transactions, we retain legal ownership of the MSRs and continue to service the related mortgage loans. We are obligated to transfer legal ownership of the MSRs to HLSS upon obtaining all required third party consents. At that time, we would subservice the MSRs pursuant to our subservicing agreement, as amended, with HLSS. See Note 23 – Related Party Transactions for additional information.

The following table provides a summary of the assets and liabilities sold to HLSS in connection with the HLSS Transactions during the nine months ended September 30:

   2013   2012 
Sale of MSRs accounted for as a financing   $388,472   $184,269 
           
Sale of match funded advances    3,489,907    1,088,505 
           
Sale of advance SPEs:          
Match funded advances        413,374 
Debt service account        14,786 
Prepaid lender fees and debt issuance costs        5,422 
Other prepaid expenses        1,928 
Match funded liabilities        (358,335)
Accrued interest payable and other accrued expenses        (841)
Net assets of advance SPEs        76,334 
Sales price, as adjusted    3,878,379    1,349,108 
Amount due to (from) HLSS for post-closing adjustments at September 30        (4,260)
    3,878,379    1,344,848 
Amount received from (paid to) HLSS as settlement of post-closing adjustments outstanding at the end of the previous year    1,410     
Total cash received   $3,879,789   $1,344,848 

Because we retained legal title to the MSRs, the sales of Rights to MSRs are accounted for as financings. To the extent that we obtain all third party consents, legal title will transfer to HLSS, at which point we will derecognize the related MSRs. Upon derecognition, any resulting gain or loss will be deferred and amortized over the expected life of the related subservicing agreement. Until such time, we continue to recognize the full amount of servicing revenue and amortization of the MSRs.

The related advance sales meet the requirements for sale accounting under GAAP. When HLSS acquired advance SPEs from Ocwen, we derecognized the consolidated assets and liabilities of the Advance SPEs at the time of the sale. In subsequent sales of advances, HLSS acquired the advances directly and the transferred financial assets were accounted for as a sale and were derecognized from our financial statements. We have also evaluated our relationship with the financing SPEs to which HLSS has transferred the servicing advances that it has acquired from us and have determined that we are not required to consolidate these SPEs. 

 

Note 4Business Acquisitions

We completed the Liberty, Correspondent One S.A. (Correspondent One), ResCap and Homeward acquisitions as part of our ongoing strategy to expand our residential origination and servicing businesses. We accounted for these transactions using the acquisition method which requires, among other things, that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. In a business combination, the initial allocation of the purchase price is considered preliminary and, therefore, subject to change until the end of the measurement period (up to one year from the acquisition date). Goodwill is calculated as the excess of the consideration transferred over the net assets recognized and represents the expected revenue and cost synergies of the combined business.

The pro forma consolidated results presented below for each business acquisition are not indicative of what our consolidated net earnings would have been had we completed the acquisitions on the dates indicated because of differences in servicing practices and cost structure between Ocwen and each acquiree. In addition, the pro forma consolidated results do not purport to project our combined future results nor do they reflect the expected realization of any cost savings associated with the acquisitions.

15
 

The ResCap acquisition was treated as an asset acquisition for U.S. tax purposes. We expect the opening tax basis for the acquired assets and liabilities to be the fair value as shown in the purchase price allocation table below. We expect MSRs and goodwill to be treated as intangible assets acquired in connection with the purchase of a trade or business and, as such, amortized over 15 years for U.S. tax purposes. The acquisitions of Liberty and Homeward were treated as stock purchases for U.S. tax purposes.

Purchase Price Allocation

The following table summarizes the fair values of assets acquired and liabilities assumed as part of the ResCap and Homeward Acquisitions:

                         
   ResCap   Homeward 
Purchase Price Allocation  March 31,
2013
   Adjustments   Revised   December 31,
2012
   Adjustments   Revised 
Cash  $   $   $   $79,511   $   $79,511 
Loans held for sale               558,721        558,721 
MSRs (2)   393,891    (2,038)   391,853(1)   358,119    2,225    360,344 
Advances and match funded advances (2)   1,622,348    100,031    1,722,379(1)   2,266,882        2,266,882(1)
Deferred tax assets               47,346        47,346(1)
Premises and equipment   22,398    (5,975)   16,423(1)   16,803    (4,288)   12,515(1)
Debt service accounts               69,287        69,287 
Investment in unconsolidated entities               5,485        5,485(1)
Receivables and other assets (3)   2,989        2,989    56,886    (29,746)   27,140 
Match funded liabilities               (1,997,459)       (1,997,459)
Other borrowings               (864,969)       (864,969)
Other liabilities                              
Liability for indemnification obligations   (49,500)       (49,500)   (32,498)       (32,498)(1)
Liability for certain foreclosure matters (4)                   (13,602)   (13,602)(1)
Accrued bonuses               (35,201)       (35,201)
Checks held for escheat               (16,418)   (35)   (16,453)(1) 
Other   (24,840)   (284)   (25,124)   (47,614)   2,763    (44,851)(1)
Total identifiable net assets   1,967,286    91,734    2,059,020    464,881    (42,683)   422,198 
Goodwill   204,743    (2,933)   201,810(1)   300,843    41,783    342,626(1)
Total consideration  $2,172,029   $88,801   $2,260,830   $765,724   $(900)  $764,824 
(1)Initial fair value estimate.
(2)As of the acquisition date, the purchase of MSRs with a UPB of $9.0 billion from ResCap was not complete pending the receipt of certain consents and court approvals. During the third quarter we obtained the required consents and approvals for a portion of these MSRs and paid an additional purchase price of $93.3 million to acquire the MSRs and related advances. The purchase price allocation has been revised to include the resulting adjustments to MSRs, advances and goodwill. We anticipate there will be additional settlements in connection with the ResCap Acquisition in the fourth quarter of 2013.
(3)The purchase price allocation has been revised to include a $29.7 million income tax liability, with an offsetting increase to goodwill.
(4)See Note 16 - Other Liabilities.

The estimated fair values of the assets acquired and liabilities assumed at the acquisition date, as set forth in the table above, includes some amounts based on preliminary fair value estimates. The following factors led to certain balances having preliminary fair value estimates:

The complex nature of certain acquired assets and assumed liabilities prevents us from completing our valuations and reconciliations;
We engaged a third party specialist to assist in valuing certain assets and liabilities and this work is not yet complete; and
16
 
Underlying information such as unpaid principal balance (UPB) and other loan level details have not yet been boarded and reconciled onto our servicing platform, and therefore, we have not been able to fully validate and reconcile certain asset and liability balances correlated with UPB data.

Because the measurement period is still open, we expect that certain fair value estimates will change once we receive all information necessary to make a final fair value assessment. Any measurement period adjustments that we identify and determine to be material will be applied retrospectively to the period of acquisition, and depending on the nature of the adjustments, other periods subsequent to the period of acquisition could also be affected. We have adjusted the initial purchase price and purchase price allocations related to the Homeward and ResCap Acquisitions as indicated in the table above. These measurement period adjustments were applied retrospectively to the period of acquisition. The December 31, 2012 Consolidated Balance Sheet has been revised to reflect the adjustments attributable to the Homeward Acquisition. None of the adjustments had a material effect on earnings.

ResCap Acquisition

We completed the ResCap Acquisition on February 15, 2013. We acquired MSRs to “private label,” Freddie Mac and Ginnie Mae loans with a UPB of $103.8 billion and master servicing agreements with a UPB of $40.7 billion. We also assumed subservicing contracts with a UPB of $26.3 billion, including $9.0 billion we agreed to subservice on behalf of ResCap until we obtain certain consents and court approvals. We purchase these MSRs and assume the subservicing contracts from ResCap when such consents and approvals are obtained. As disclosed above, we completed the purchase of certain of these MSRs during the third quarter. We also acquired certain diversified fee-based business operations that included recovery, title and closing services.

To finance the ResCap Acquisition, we deployed $840.0 million from the proceeds of a new $1.3 billion senior secured term loan (SSTL) facility and borrowed an additional $1.2 billion pursuant to two new servicing advance facilities and one existing facility. We settled the third quarter closings from operating cash. Ocwen assumed certain limited liabilities as part of the transaction, including certain employee liabilities and certain business payables outstanding at the closing date. Under the agreement with ResCap, Ocwen generally did not assume any contingent obligations, including pending or threatened litigation, financial obligations in connection with any settlements, orders or similar agreements entered into by ResCap or obligations in connection with any representations or warranties associated with loans previously sold by ResCap except for litigation that may arise in the ordinary course of servicing mortgage loans relating to servicing agreements assumed by Ocwen. Ocwen assumed all liabilities related to servicing loans that are guaranteed by Ginnie Mae, whether arising prior to or after the closing date.

On April 12, 2013 in connection with the sale to Altisource Portfolio Solutions, S.A. (Altisource) of the diversified fee-based business acquired in connection with the ResCap Acquisition, Ocwen agreed to establish additional terms related to existing servicing arrangements between Altisource and Ocwen for mortgage servicing assets acquired from ResCap. The cash consideration paid by Altisource to Ocwen under the Agreement totaled $128.8 million. At the time of the closing, we derecognized goodwill of $128.8 million associated with the diversified fee-based business sold to Altisource. There were no other significant assets or liabilities associated with this business. See Note 22 – Business Segment Reporting for a discussion of the additional terms of the servicing arrangements.

Post-Acquisition Results of Operations

The following table presents the revenue and earnings of the ResCap Business operations that are included in our unaudited Consolidated Statements of Operations from the acquisition date of February 15, 2013 through September 30, 2013:

For the Periods Ended September 30, 2013:    Three Months   Nine Months 
Revenues   $212,164   $508,589 
Net income  $8,230  $81,362 

Pro Forma Results of Operations

The following table presents supplemental pro forma information for Ocwen as if the ResCap Acquisition occurred on January 1, 2012. Pro forma adjustments include:

conforming servicing revenues to the revenue recognition policies followed by Ocwen;
conforming the accounting for MSRs to the valuation and amortization policies of Ocwen;
adjusting interest expense to eliminate the pre-acquisition interest expense of ResCap and to recognize interest expense as if the acquisition-related debt of Ocwen had been outstanding at January 1, 2012; and
17
 
reporting acquisition-related charges for professional services as if they had been incurred in 2012 rather than 2013.
For the Periods Ended September 30:  Three Months   Nine Months 
   2012   2013   2012 
Revenues   $374,751   $1,530,055   $1,027,102 
Net income  $2,696  $205,062   $21,921 

Homeward Acquisition

We completed the Homeward Acquisition on December 27, 2012. We acquired the MSRs and subservicing for approximately 421,000 residential mortgage loans with a UPB of $77.0 billion. We also acquired Homeward’s loan origination platform and its diversified fee-based businesses, including property valuation, REO management, title, closing and advisory services. On March 29, 2013, Ocwen sold the Homeward diversified fee-based businesses to Altisource Solutions S.à r.l. and Altisource Portfolio Solutions, Inc., wholly-owned subsidiaries of Altisource, for an aggregate purchase price of $87.0 million in cash. Ocwen sold its investment in two subsidiaries of Homeward, Beltline Road Insurance Agency, Inc. and Power Default Services, Inc. As part of this transaction, Ocwen also agreed to sell certain designated assets used or usable in the business conducted by another Homeward subsidiary, Power Valuation Services, Inc., as well as certain designated intellectual property and information technology assets that are used or usable in the business conducted by the acquired subsidiaries or by Powerline Valuation Services, Inc. Altisource also assumed certain liabilities of the diversified fee-based business. The carrying value of the net assets sold, including allocated goodwill, approximated the sales price. The assets sold consisted of receivables and other assets of $9.4 million. The liabilities assumed by Altisource of $4.0 million consisted principally of deferred revenue. At the time of the sale, we derecognized goodwill of $81.6 million associated with the sold business. In connection with this transaction, Ocwen entered into amendments to certain of its services and intellectual property agreements with Altisource. See Note 23 – Related Party Transactions for a discussion of these amendments.

Pro Forma Results of Operations

The following table presents supplemental pro forma information for Ocwen as if the acquisition of Homeward occurred on January 1, 2011. Pro forma adjustments include:

conforming servicing revenues to the revenue recognition policy followed by Ocwen;
conforming the accounting for MSRs to the valuation and amortization policies of Ocwen;
reversing depreciation recognized by Homeward and reporting depreciation based on the estimated fair values and remaining lives of the acquired premises and equipment at the date of acquisition;
adjusting interest expense to eliminate the pre-acquisition interest expense of Homeward and to recognize interest expense as if the acquisition-related debt of Ocwen had been outstanding at January 1, 2011; and
reporting acquisition-related charges for professional services as if they had been incurred in 2011 rather than 2012.
For the Periods Ended September 30, 2012: Three Months   Nine Months 
Revenues $346,037   $949,587 
Net income $57,013   $133,821 

Other Acquisitions

Correspondent One

On March 31, 2013, we increased our ownership in Correspondent One, an entity formed with Altisource in March 2011, from 49% to 100%. We acquired the shares of Correspondent One held by Altisource (49% interest) for $12.6 million and acquired the remaining shares held by an unrelated entity for $0.9 million. We accounted for this transaction as an acquisition and recognized the assets acquired and liabilities assumed at their fair values as of the acquisition date. The acquired net assets were $26.3 million and consisted primarily of cash ($23.0 million) and residential mortgage loans ($1.1 million). We remeasured our previously held investment, which we accounted for using the equity method, at fair value and recognized a loss of $0.4 million. We also recognized goodwill of $0.1 million. We began including the accounts of Correspondent One in our consolidated financial statements effective on the date of acquisition and have eliminated our investment in consolidation. Correspondent One facilitates the purchase of conforming and government-guaranteed residential mortgages from approved mortgage originators and resells the mortgages to secondary market investors. Correspondent One is not material to our financial condition, results of operations or cash flows.

18
 

Liberty

On April 1, 2013, we completed the Liberty Acquisition for $22.0 million in cash. In addition, and as part of the closing, Ocwen repaid Liberty’s $9.1 million existing outstanding debt to the sellers. We acquired approximately 420 reverse mortgage loans with a UPB of $55.2 million. We also acquired Liberty’s reverse mortgage origination platform. The acquired net assets were $31.1 million and consisted primarily of residential reverse mortgage loans ($60.0 million), receivables ($11.2 million), loans held for investment ($10.3 million), intangible assets ($3.2 million) and cash ($4.6 million) less amounts due under warehouse facilities ($46.3 million) and HMBS-related borrowings ($10.2 million). We did not recognize any goodwill in connection with this acquisition. The acquisition of Liberty did not have a material effect on our financial condition, results of operations or cash flows.

 

Note 5Fair Value of Financial Instruments

We estimate fair value based on a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are inputs that reflect the assumptions that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs to valuation techniques into three broad levels whereby the highest priority is given to Level 1 inputs and the lowest to Level 3 inputs.

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

 

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3: Unobservable inputs for the asset or liability.

We classify assets in their entirety based on the lowest level of input that is significant to the fair value measurement.

The carrying amounts and the estimated fair values of our financial instruments and our nonfinancial assets measured at fair value are as follows:

      September 30, 2013   December 31, 2012 
   Level  Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 
Financial assets:                       
Loans held for sale, at fair value (1)   2  $335,102   $335,102   $426,480   $426,480 
Loans held for sale, at lower of cost or fair value (2)   3   86,753    86,753    82,866    82,866 
Loans – restricted for securitization investors, at fair value (1)   3   290,853    290,853         
Advances and match funded advances (3)   3   1,480,012    1,480,012    3,233,707    3,233,707 
Receivables, net (3)   3   223,404    223,404    137,713    137,713 
                        
Financial liabilities:                       
Match funded liabilities (3)   3  $363,012   $363,012   $2,532,745   $2,533,278 
Other borrowings:                       
Senior secured term loan (3)   3   1,287,821    1,278,273    305,997    310,822 
Secured borrowings – owed to securitization investors, at fair value (1)   3   284,276    284,276         
Other (3)   3   1,020,494    1,020,494    790,682    790,682 
Total Other borrowings       2,592,591    2,583,043    1,096,679    1,101,504 
                        
Derivative financial instruments (1):                       
Interest rate lock commitments (IRLCs)   2  $13,491   $13,491   $5,781   $5,781 
Interest rate swaps   3           (10,836)   (10,836)
Forward MBS trades   1   (12,185)   (12,185)   (1,719)   (1,719)
U.S. Treasury futures   1           (1,258)   (1,258)
Interest rate caps   3           168    168 
                        
MSRs, at fair value (1)   3  $96,938   $96,938   $85,213   $85,213 
(1)Measured at fair value on a recurring basis.
(2)Measured at fair value on a non-recurring basis.
(3)Disclosed, but not carried, at fair value.
19
 

The following tables present a reconciliation of the changes in fair value of Level 3 assets that we measure at fair value on a recurring basis:

 

   Loans –
restricted for
securitization
investors
   Secured
borrowings –
owed to
securitization
investors
   Derivative
Financial
Instruments
   MSRs at
Fair
Value
   Total 
                     
Three Months Ended September 30, 2013:                         
Beginning balance  $76,649   $(73,641)  $176   $97,163   $100,347 
                          
Purchases, issuances, sales and settlements:                         
Purchases                    
Issuances   211,052    (206,714)           4,338 
Sales                    
Settlements   (1,293)   1,021    (176)       (448)
    209,759    (205,693)   (176)       3,890 
                          
Total realized and unrealized gains and (losses) (1):                         
Included in Other, net   4,445    (4,942)       (225)   (722)
Included in Other comprehensive income (loss)                    
    4,445    (4,942)       (225)   (722)
                          
Transfers in and / or out of Level 3                    
Ending balance  $290,853   $(284,276)  $   $96,938   $103,515 
                          
Three Months Ended September 30, 2012:                         
Beginning balance  $   $   $(14,905)  $   $(14,905)
                          
Purchases, issuances, sales and settlements:                         
Settlements           102        102 
            102        102 
                          
Total realized and unrealized gains and (losses) (1):                         
Included in Other, net           1,397        1,397 
Included in Other comprehensive income (loss)           (2,688)       (2,688)
            (1,291)       (1,291)
                          
Transfers in and / or out of Level 3                    
Ending balance  $   $   $(16,094)  $   $(16,094)
20
 
   Loans –
restricted for
securitization
investors
   Secured
borrowings –
owed to
securitization
investors
   Derivative
Financial
Instruments
   MSRs at
Fair
Value
   Total 
                     
Nine Months Ended September 30, 2013:                         
Beginning balance  $   $   $(10,668)  $85,213   $74,545 
                          
Purchases, issuances, sales and settlements:                         
Purchases   10,251    (10,179)           72 
Issuances   274,081    (272,652)           1,429 
Sales           24,156        24,156 
Settlements   (2,164)   1,888    (1,242)       (1,518)
    282,168    (280,943)   22,914        24,139 
                          
Total realized and unrealized gains and (losses) (1):                         
Included in Other, net   8,685    (3,333)   117    11,725    17,194 
Included in Other comprehensive income (loss)           (12,363)       (12,363)
    8,685    (3,333)   (12,246)   11,725    4,831 
                          
Transfers in and / or out of Level 3                    
Ending balance  $290,853   $(284,276)  $   $96,938   $103,515 
                          
Nine Months Ended September 30, 2012:                         
Beginning balance  $   $   $(16,676)  $   $(16,676)
                          
Purchases, issuances, sales and settlements:                         
Settlements           2,524        2,524 
            2,524        2,524 
                          
Total realized and unrealized gains and (losses) (1):                         
Included in Other, net           6,645        6,645 
Included in Other comprehensive income (loss)           (8,587)       (8,587)
            (1,942)       (1,942)
                          
Transfers in and / or out of Level 3                    
Ending balance  $   $   $(16,094)  $   $(16,094)
(1)For derivative financial instruments held at September 30, 2012, total net losses were $1.3 million and $7.7 million for the three and nine months ended September 30, 2012, respectively.

The methodologies that we use and key assumptions that we make to estimate the fair value of financial instruments and other assets and liabilities measured at fair value on a recurring or non-recurring basis are described below:

Loans Held for Sale

We originate and purchase residential forward and reverse mortgage loans that we intend to sell to the GSEs. We also own residential mortgage loans that are not eligible to be sold to the GSEs due to delinquency or other factors. Residential forward and reverse mortgage loans that we intend to sell to the GSEs are carried at fair value as a result of a fair value election. Such loans are subject to changes in fair value due to fluctuations in interest rates from the closing date through the date of the sale of the loan into the secondary market. These loans are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. We have the ability to access this market, and it is the market into which conforming mortgage loans are typically sold.

21
 

We report all other loans held for sale at the lower of cost or fair value. Current market illiquidity has reduced the availability of observable pricing data for certain of these loans. When we enter into an agreement to sell a loan or pool of loans to an investor at a set price, we value the loan or loans at the commitment price. We base the fair value of uncommitted loans on the expected future cash flows discounted at a rate commensurate with the risk of the estimated cash flows. Assumptions used in the valuation of performing loans include historical default rates, re-performance rates on defaulted loans, loss severity on defaulted loans, average resolution timeline, average coupon rate and a discount rate. Significant assumptions used in the valuation of nonperforming loans include the current market value of the underlying collateral based on third party sources such as appraisals or broker price opinions, resolution timeline, estimated foreclosure and disposition costs that are based on historical experience and a discount rate. The assumptions we used in the valuation of these performing and non-performing loans at September 30, 2013 have not changed significantly from those we used in the December 31, 2012 valuations.

We repurchase certain loans from Ginnie Mae guaranteed securitizations in connection with loan modifications and loan resolution activity as part of our servicing obligations. These are classified as loans held for sale at the lower of cost or fair value, in the case of modified loans, as we expect to redeliver (sell) the loans to new Ginnie Mae guaranteed securitizations.  The fair value of these loans is estimated using published forward Ginnie Mae prices.  Loans repurchased in connection with loan resolution activities are modified or otherwise remediated through loss mitigation activities or are reclassified to receivables.  Because these loans are insured or guaranteed by the FHA or VA, the fair value of these loans represents the net recovery value taking into consideration the insured or guaranteed claim.

Loans – Restricted for Securitization Investors

These loans are not traded in an active, open market with readily observable prices. We base the fair value of transferred reverse mortgage loans that do not qualify as sales for accounting purposes on the expected future cash flows discounted over the expected life of the loans at a rate commensurate with the risk of the estimated cash flows. Significant assumptions included expected prepayment and delinquency rates and cumulative loss curves. The discount rate assumption for these assets is primarily based on an assessment of current market yields on newly originated reverse mortgage loans, expected duration of the asset, and current market interest rates.

The more significant assumptions used in the September 30, 2013 valuation of our Loans – Restricted for Securitization Investors include:

Life in years ranging from 2.97 to 23.52 (weighted average of 6.79);
Conditional repayment rate ranging from 4.80% to 38.40% (weighted average of 8.44%); and
Discount rate of 1.84%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Mortgage Servicing Rights

Amortized Cost MSRs

We estimate the fair value of MSRs carried at amortized cost using a combination of internal models and data provided by third-party valuation experts. The most significant assumptions used in the valuation of MSRs are the speed at which mortgages prepay and delinquency experience. Other assumptions typically used in the valuation of MSRs are:

  Cost of servicing
     
  Discount rate
     
  Interest rate used for computing the cost of financing servicing advances
     
  Interest rate used for computing float earnings
     
  Compensating interest expense
     
  Collection rate of other ancillary fees

The significant components of the estimated future cash inflows for MSRs include servicing fees, late fees, float earnings and other ancillary fees. Significant cash outflows include the cost of servicing, the cost of financing servicing advances and compensating interest payments.

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

We estimate fair value using internal models and with the assistance of third-party valuation experts. Our internal models calculate the present value of expected future cash flows utilizing assumptions that we believe are used by market participants. We derived prepayment speeds and delinquency assumptions from historical experience adjusted for prevailing market conditions. We utilize a discount rate provided by third-party valuation experts, and we consider external market-based assumptions in determining the interest rate for the cost of financing advances, the interest rate for float earnings and the cost of servicing.

22
 

Third-party valuation experts generally utilize: (a) transactions involving instruments with similar collateral and risk profiles, adjusted as necessary based on specific characteristics of the asset or liability being valued; and/or (b) industry-standard modeling, such as a discounted cash flow model, in arriving at their estimate of fair value. The prices provided by the valuation experts reflect their observations and assumptions related to market activity, including risk premiums and liquidity adjustments. The models and related assumptions used by the valuation experts are owned and managed by them and, in many cases, the significant inputs used in the valuation techniques are not reasonably available to us. However, we have an understanding of the processes and assumptions used to develop the prices based on our ongoing due diligence, which includes regular discussions with the valuation experts. We believe that the procedures executed by the valuation experts, combined with our internal verification and analytical procedures, provide assurance that the prices used in our consolidated financial statements comply with the accounting guidance for fair value measurements and disclosures and reflect the assumptions that a market participant would use.

The more significant assumptions used in the September 30, 2013 valuation of our MSRs carried at amortized cost include:

Prepayment speeds ranging from 7.39% to 19.23% (weighted average of 14.87%) depending on loan type;
Delinquency rates ranging from 6.55% to 29.42% (weighted average of 17.04%) depending on loan type;
Interest rate of 1-month LIBOR plus 3.75% for computing the cost of financing advances;
Interest rate of 1-month LIBOR for computing float earnings; and
Discount rates ranging from 11.33% to 17.13% (weighted average of 12.80%).

We perform an impairment analysis based on the difference between the carrying amount and fair value after grouping our loans into the applicable strata based on one or more of the predominant risk characteristics of the underlying loans. As a result of the Homeward and ResCap Acquisitions, management has re-evaluated the portfolio and determined the appropriate strata are Agency and Non-Agency. The Agency stratum includes all GSE MSRs. The Non-Agency stratum includes all private label primary and master MSRs.

Fair Value MSRs

MSRs carried at fair value are classified within Level 3 of the valuation hierarchy due to the use of third party valuation expert pricing without adjustment. The fair value of these MSRs is within the range of prices provided by the valuation experts, however, a change in the valuation inputs utilized by the valuation expert or a change in the best point price in the range might result in a significantly higher or lower fair value measurement.

The key assumptions (generally unobservable inputs) used in the valuation of these MSRs include:

Mortgage prepayment speeds;
Delinquency rates, and
Discount rates.

The primary assumptions used in the September 30, 2013 valuation include an 8.95% weighted average constant prepayment rate and a discount rate equal to 1-Month LIBOR plus 10.50%.

Advances

We value advances that we make on loans that we service for others at their net realizable value which generally approximates fair value because advances have no stated maturity, generally are realized within a relatively short period of time and do not bear interest.

Receivables

The carrying value of receivables generally approximates fair value because of the relatively short period of time between their origination and realization.

Secured Borrowings – Owed to Securitization Investors

We recognize the proceeds from the transfer of reverse mortgages as a secured borrowing that we account for at fair value. These borrowings are not actively traded and therefore quoted market prices are not available. We determine fair value by discounting the future principal and interest repayments over the estimated life of the borrowing at a market rate commensurate with the risk of the estimated cash flows. Significant assumptions include prepayments, discount rate and borrower mortality rates for reverse mortgages. The discount rate assumption for these liabilities is based on an assessment of current market yields for newly issued HMBS, expected duration and current market interest rates.

23
 

The more significant assumptions used in the September 30, 2013 valuation of our Secured Borrowings – Owed to Securitization Investors include:

Life in years ranging from 2.94 to 22.85 (weighted average of 6.15),
Conditional repayment rate ranging from 4.80% to 37.97% (weighted average of 8.44%) and
Discount rate of 1.17%.

Significant increases or decreases in any of these assumptions in isolation would result in a significantly higher or lower fair value.

Match Funded Liabilities and Other Borrowings

The carrying value of match funded liabilities and secured borrowings that bear interest at a rate that is adjusted regularly based on a market index approximates fair value. For other match funded or secured borrowings that bear interest at a fixed rate, we determine fair value by discounting the future principal and interest repayments at a market rate commensurate with the risk of the estimated cash flows. We estimate principal repayments of match funded liabilities during the amortization period based on our historical advance collection rates and taking into consideration any plans to refinance the notes. At September 30, 2013, the interest on all borrowings under match funded facilities was based on a variable rate adjusted regularly using a market index and therefore the carrying value approximates fair value. For the SSTL, we used a discount rate of 5.50% and the repayment schedule specified in the loan agreement to determine fair value.

Derivative Financial Instruments

We may execute interest rate swaps to hedge against the effects of changes in interest rates on our borrowings under advance funding facilities. These derivatives are not exchange-traded and, therefore, quoted market prices or other observable inputs are not available. Fair value is based on information provided by third-party pricing sources. Third-party valuations are derived from proprietary models based on inputs that include yield curves and contractual terms such as fixed interest rates and payment dates. Although we have not adjusted the information obtained from the third-party pricing sources, we review this information to ensure that it provides a reasonable basis for estimating fair value. Our review is designed to identify information that appears stale, information that has changed significantly from the prior period and other indicators that the information may not be accurate. For interest rate contracts, significant increases or decreases in the unobservable portion of the yield curves in isolation will result in substantial changes in the fair value measurement. We terminated our outstanding interest rates swaps on May 31, 2013.

In addition, we may use interest rate caps to minimize future interest rate exposures on variable rate debt issued on servicing advance facilities from increases in one-month LIBOR interest rates. The fair value for interest rate caps is based on counterparty market prices and adjusted for counterparty credit risk.

We enter into forward trades to provide an economic hedge against changes in the value of residential forward and reverse mortgage loans held for sale that we carry at fair value. Forward trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Forward contracts are actively traded in the market and we obtained unadjusted market quotes for these derivatives, thus they are classified within Level 1 of the valuation hierarchy.

IRLCs represent an agreement to purchase loans from a third-party originator, or an agreement to extend credit to a mortgage applicant (locked pipeline), or an agreement to sell a loan to investors, whereby the interest rate is set prior to funding. IRLCs are classified within Level 2 of the valuation hierarchy as the primary component of the price is obtained from observable values of mortgage forwards for loans of similar terms and characteristics. Fair value amounts of IRLCs are adjusted for expected “fallout” (locked pipeline loans not expected to close), using models that consider cumulative historical fallout rates and other factors.

We previously entered into derivative contracts that included interest rate swaps, U.S. Treasury futures and forward contracts to hedge against the effects of changes in the value of the MSRs that we carry at fair value. Effective April 1, 2013, we modified our strategy for managing the risks of the underlying loan portfolios and no longer use derivative contracts to hedge against the effects of changes in the value of MSRs which we carry at fair value. The fair value of interest rate swaps were based upon projected short-term interest rates and volatility based on published market based sources, a Level 3 valuation. Because futures and forward contracts are actively traded in the market, they are classified within Level 1 of the valuation hierarchy.

See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information regarding derivative financial instruments.

24
 
Note 6Loans Held for Sale, at Fair Value

Loans held for sale, at fair value, represent residential forward and reverse mortgage loans originated or purchased and held until sold to secondary market investors, such as GSEs or other third party investors. The following table summarizes the activity in the balance of Loans held for sale during the nine months ended September 30, 2013:

Balance at December 31, 2012   $426,480 
Originations and purchases (1)    5,988,501 
Proceeds from sale    (6,033,785)
Loss on sale of loans (2)    (46,962)
Other    868 
Balance at September 30, 2013   $335,102 
(1)Purchases include $60.0 million of reverse mortgages acquired in the Liberty Acquisition.
(2)Includes gains of $14.5 million and $20.6 million recorded during the three and nine months ended September 30, 2013, respectively, to adjust Loans – Restricted for Securitization Investors to fair value.

The following table summarizes the activity in Gain on loans held for sale, net, during the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Gain on sales of loans (1)   $4,622   $   $36,156   $ 
Change in fair value of IRLCs    18,912        5,918     
Change in fair value of loans held for sale    14,362        1,452     
Gain (loss) on hedge instruments    (9,408)       30,989     
Other    (226)       (1,603)    
   $28,262   $   $72,912   $ 
(1)Includes gains of $16.3 million and $63.2 million for the three and nine months ended September 30, 2013, respectively, representing the value assigned to MSRs retained on sales of loans. Also includes gains of $4.1 million and $20.3 million recorded during the three and nine months ended September 30, 2013, respectively, on sales of repurchased loans into Ginnie Mae guaranteed securitizations. These loans are classified as held for sale at the lower of cost or fair value. See Note 13 – Other Assets.
Note 7Advances

Advances, representing payments made on behalf of borrowers or on foreclosed properties, consisted of the following at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Servicing:          
Principal and interest   $149,184   $83,617 
Taxes and insurance    604,636    51,447 
Foreclosures, bankruptcy and other    183,861    41,296 
    937,681    176,360 
Other    8,606    8,103 
   $946,287   $184,463 
25
 
Note 8Match Funded Advances

Match funded advances on residential mortgage loans that we service for others are comprised of the following at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Principal and interest   $235,766   $1,577,808 
Taxes and insurance    218,952    1,148,486 
Foreclosures, bankruptcy, real estate and other    79,007    322,950 
   $533,725   $3,049,244 
Note 9Mortgage Servicing

Mortgage Servicing Rights – Amortization Method

The following table summarizes our activity related to MSRs for the nine months ended September 30:

   2013   2012 
Balance at December 31   $678,937   $293,152 
Additions recognized in connection with business and asset acquisitions (1)    1,208,222    181,949 
Additions recognized on the sale of residential mortgage loans    63,154     
Sales (2)    (17,523)    
Servicing transfers, adjustments and other    2,052    (88)
Amortization (3)    (197,899)   (54,678)
Balance at September 30   $1,736,943   $420,335 
           
Estimated fair value at September 30   $2,532,239   $488,499 
(1)MSR recognized in connection with business and asset acquisitions during the first nine months of 2013 include:
MSRs of $391.9 million acquired in the ResCap Acquisition. See Note 4 – Business Acquisitions for additional information.
MSRs of $683.8 million acquired in the Ally MSR Transaction. The acquired MSRs relate to mortgage loans with a UPB of $87.5 billion owned by Freddie Mac and Fannie Mae. We also acquired servicing advances and other receivables of $73.6 million. We assumed the origination representation and warranty obligations of approximately $136.7 million in connection with a majority of the acquired MSRs. We had been subservicing these MSRs on behalf of Ally under a subservicing contract assumed by us in connection with the ResCap Acquisition.
MSRs of $127.0 million with a UPB of approximately $30.5 billion and related servicing advance receivables of $371.6 million acquired in the OneWest MSR Transaction.  We expect the remainder of the transaction to close during the fourth quarter. The total estimated purchase price is approximately $2.4 billion with $432.2 million attributed to MSRs and $2.0 billion attributed to servicing advances. The total UPB to be acquired is estimated at $72.4 billion. No operations or other assets were purchased in the transaction. In October 2013, we closed the purchase of approximately $6.6 million of MSRs with a UPB of approximately $1.1 billion and approximately $37.1 million of servicing advances. On November 1, 2013, we closed the purchase of approximately $235.6 million of MSRs with a UPB of approximately $32.9 billion and approximately $1.3 billion of servicing advances. See Note 26 - Subsequent Events for additional information.
(2)Cash proceeds from the sale were $21.5 million. These MSRs were sold with subservicing retained. The gain on the sale of $3.2 million has been deferred and will be recognized in earnings over the life of the subservicing contract.
(3)Amortization of mortgage servicing rights is reported net of the amortization of servicing liabilities and includes the amount of charges we recognized to increase servicing liability obligations.

As disclosed in Note 3 – Transfers of Financial Assets, we sold certain Rights to MSRs during 2012 and 2013 as part of the HLSS Transactions. The carrying value of the related MSRs which have not been derecognized at September 30, 2013 was $465.8 million.

Mortgage Servicing Rights—Fair Value Measurement Method

This portfolio comprises servicing rights for which we elected the fair value option and includes prime forward mortgage loans for which we hedged the related market risks. We acquired these MSRs as part of the Homeward Acquisition. See Note 4 – Business Acquisitions for additional information.

26
 

The following table summarizes the activity related to our fair value MSRs for the nine months ended September 30, 2013:

Balance at December 31, 2012   $85,213 
Changes in fair value:     
Due to changes in market valuation assumptions    19,800 
Realization of cash flows and other changes    (8,075)
Balance at September 30, 2013   $96,938 

Because the mortgages underlying these MSRs permit the borrowers to prepay the loans, the value of the MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and increase in periods of rising interest rates (as prepayments decrease). The following table summarizes the estimated change in the value of the MSRs that we carry at fair value as of September 30, 2013 given hypothetical instantaneous parallel shifts in the yield curve:

   Adverse change in fair value 
   10%   20% 
Weighted average prepayment speeds   $(3,695)  $(7,234)
Discount rate (Option-adjusted spread)   $(2,148)  $(4,128)

The sensitivity analysis measures the potential impact on fair values based on hypothetical changes (increases and decreases) in interest rates.

Servicing Revenue

The following table presents the components of servicing and subservicing fees for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Loan servicing and subservicing fees:                    
Servicing   $335,884   $145,861   $887,500   $394,454 
Subservicing    35,286    14,257    115,437    27,619 
    371,170    160,118    1,002,937    422,073 
Home Affordable Modification Program (HAMP) fees    40,213    21,687    118,412    55,761 
Late charges    30,445    16,370    85,930    52,891 
Loan collection fees    8,387    4,102    22,524    11,271 
Custodial accounts (float earnings)    743    942    4,533    2,393 
Other    32,309    19,792    99,056    34,046 
   $483,267   $223,011   $1,333,392   $578,435 

Portfolio of Assets Serviced

The following table presents the composition of our servicing and subservicing portfolios by type of asset serviced as measured by UPB. The servicing portfolio represents loans for which we own the MSRs while subservicing represents all other loans.

   Residential   Commercial   Total 
UPB at September 30, 2013               
Servicing (1)  $  362,792,312   $   $  362,792,312 
Subservicing    72,027,114    495,312    72,522,426 
   $434,819,426   $495,312   $435,314,738 
                
UPB at December 31, 2012               
Servicing (1)   $175,762,161   $   $175,762,161 
Subservicing    27,903,555    401,031    28,304,586 
   $203,665,716   $401,031   $204,066,747 
(1)Includes UPB of $177.1 billion and $79.4 billion at September 30, 2013 and December 31, 2012, respectively, for which the Rights to MSRs have been sold to HLSS.

Residential assets serviced consist principally of residential mortgage loans, but also include foreclosed real estate. Residential assets serviced also include small-balance commercial assets with a UPB of $2.5 billion and $2.1 billion at September 30, 2013 and December 31, 2012, respectively, that are managed using the REALServicing™ application. Commercial assets consist of large-balance foreclosed real estate. The UPB of assets serviced for others are not included on our unaudited Consolidated Balance Sheets.

27
 

Custodial accounts, which hold funds representing collections of principal and interest that we receive from borrowers, are held in escrow by an unaffiliated bank and are excluded from our unaudited Consolidated Balance Sheets. Custodial accounts amounted to $3.5 billion and $1.3 billion at September 30, 2013 and December 31, 2012, respectively.

Note 10Receivables

Receivables consisted of the following at the dates indicated:

   Receivables   Allowance for
Losses
   Net 
September 30, 2013               
Servicing (1)   $155,076   $(19,413)  $135,663 
Due from related parties (2)    35,383        35,383 
Income taxes receivable    23,955        23,955 
Other    30,372    (1,969)   28,403 
   $244,786   $(21,382)  $223,404 
                
December 31, 2012               
Servicing (1)   $84,870   $(1,647)  $83,223 
Income taxes receivable    25,546        25,546 
Due from related parties (2)    12,361        12,361 
Other    18,577    (1,994)   16,583 
   $141,354   $(3,641)  $137,713 
(1)The receivable balances arise from our Servicing business and include reimbursable expenditures due from investors and amounts to be recovered from the custodial accounts of the trustees. The balances at September 30, 2013 also include $67.4 million of receivables and $16.2 million of allowance for losses related to defaulted FHA or VA insured loans repurchased from Ginnie Mae guaranteed securitizations.
(2)See Note 23 – Related Party Transactions for additional information regarding transactions with Altisource and HLSS.
Note 11Goodwill AND INTANGIBLES

The following table provides a summary of activity in the carrying value of goodwill during the nine months ended September 30, 2013:

                     
   ResCap
Acquisition
   Homeward
Acquisition
   Litton
Acquisition
   HomEq
Acquisition
   Total 
Balance at December 31, 2012  $   $342,626   $57,430   $12,810   $412,866 
Derecognition of goodwill in connection with the sale of a business (1) (2)   (128,750)   (81,607)           (210,357)
ResCap Acquisition (2)   201,810                201,810 
Balance at September 30, 2013  $73,060   $261,019   $57,430   $12,810    404,319 
Liberty Acquisition (2) (3)                       3,200 
Correspondent One (2)                       101 
Balance at September 30, 2013                      $407,620 
(1)On March 29, 2013, we sold the diversified fee-based business acquired in the Homeward Acquisition to Altisource and derecognized the assigned goodwill. On April 12, 2013, we sold the diversified fee-based business acquired in the ResCap Acquisition to Altisource and derecognized the assigned goodwill.
(2)See Note 4 – Business Acquisitions for additional information regarding this transaction.
(3)Acquired intangible asset related to licenses. The useful life is considered indefinite and therefore the intangible asset is not amortized.

 

For the ResCap Acquisition, the $73.1 million of remaining goodwill is assigned to the Servicing segment. For the Homeward Acquisition, $140.7 million of the remaining goodwill is assigned to the Servicing segment and $120.3 million is assigned to the Lending segment. The assignment of goodwill in the ResCap, Homeward and Liberty Acquisitions is preliminary pending the final purchase price allocation. For the Litton and HomEq Acquisitions, the entire balance of goodwill pertains to the Servicing segment.

28
 

We perform an annual impairment test of goodwill as of August 31 of each year. Based on our 2013 annual assessment, we determined that goodwill was not impaired.

Note 12Debt Service Accounts

Under our advance funding facilities, we are contractually required to remit collections on pledged advances to the trustee within two days of receipt. The collected funds are not applied to reduce the related match funded debt until the payment dates specified in the indenture. The balances also include amounts that have been set aside from the proceeds of our match funded advance facilities and certain of our warehouse lines to provide for possible shortfalls in the funds available to pay certain expenses and interest. These funds are held in interest earning accounts in the name of the SPE created in connection with the match funded financing facility. The balance of such debt service accounts at September 30, 2013 and December 31, 2012 was $45.5 million and $88.7 million, respectively.

Note 13Other Assets

Other assets consisted of the following at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Loans – restricted for securitization investors, at fair value (1)   $290,853   $ 
Loans held for sale, at lower of cost or fair value (2)    86,753    82,866 
Prepaid lender fees and debt issuance costs, net (3)    25,197    14,389 
Prepaid income taxes    23,112    23,112 
Derivatives, at fair value (4)    12,849    10,795 
Investment in unconsolidated entities (5)    11,767    25,187 
Real estate, net    8,346    6,205 
Interest earning collateral deposits (6)    6,533    31,710 
Acquisition deposits (7)        57,000 
Prepaid expenses and other    13,123    22,314 
   $478,533   $273,578 
(1)Loans sold into Ginnie Mae guaranteed securitizations that we include in our Consolidated Financial Statements because the transfers of reverse mortgage loans to the trusts did not qualify for sale accounting treatment. See Note 2 – Securitizations and Variable Interest Entities for additional information.
(2)The carrying values at September 30, 2013 and December 31, 2012 are net of valuation allowances of $27.0 million and $14.7 million, respectively. The balances include non-performing subprime single-family residential loans that we do not intend to hold to maturity. The balance at September 30, 2013 includes $67.8 million of loans that we are required to repurchase from Ginnie Mae guaranteed securitizations in connection with loan modifications and loan resolutions. The balance at December 31, 2012 includes non-performing mortgage loans with a carrying value of $65.4 million that we acquired in December 2012 and sold to Altisource Residential, LP in February 2013 for an insignificant gain.
(3)These balances relate to match funded liabilities and other secured borrowings.
(4)See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information.
(5)The balance at December 31, 2012 includes an investment of $13.4 million that represented our 49% equity interest in Correspondent One. As disclosed in Note 4 – Business Acquisitions, we increased our ownership to 100% on March 31, 2013. Effective on that date, we began including the accounts of Correspondent One in our consolidated financial statements and eliminated our current investment in consolidation.
(6)These balances include $1.5 million and $25.8 million of cash collateral held by the counterparties to certain of our derivative agreements at September 30, 2013 and December 31, 2012, respectively.
(7)The balance at December 31, 2012 represents an earnest money cash deposit we made in connection with the ResCap Acquisition. This deposit was subsequently applied towards the purchase price upon closing of the transaction on February 15, 2013. See Note 4 – Business Acquisitions for additional information.
29
 
Note 14Match Funded Liabilities

Match funded liabilities are comprised of the following at the dates indicated:

                      
            Available   Balance Outstanding 
      Maturity  Amortization  Borrowing   September 30,   December 31, 
Borrowing Type  Interest Rate  (1)  Date (1)  Capacity (2)   2013   2012 
2011-Servicer Advance Revolving Trust 1 (3)  2.23%  May 2043  May 2013  $   $   $325,000 
2011-Servicer Advance Revolving Trust 1 (3)  3.37 – 5.92%  May 2043  May 2013           525,000 
2012-Servicing Advance Revolving Trust 2 (3)  3.27 – 6.90%  Sep. 2043  Sept. 2013           250,000 
2012-Servicing Advance Revolving Trust 3 (3)  2.98%  Mar. 2043  Mar. 2013           248,999 
2012-Servicing Advance Revolving Trust 3 (3)  3.72 – 7.04%  Mar. 2044  Mar. 2014           299,278 
Total fixed rate                    1,648,277 
Advance Receivable Backed Notes (4)  1-month
LIBOR (1ML)
+ 285 bps
  Apr. 2015  Apr. 2014           205,016 
Advance Receivable Backed Notes Series 2012-ADV1 (5)  Commercial
paper (CP)
rate + 225 or
335 bps
  Dec. 2043  Dec. 2013   18,959    81,041    232,712 
Advance Receivable Backed Notes Series 2012-ADV1  1ML + 250
bps
  June 2016  June 2014       225,000    94,095 
Advance Receivable Backed Note  1ML + 300
bps
  Dec. 2015  Dec. 2014   12,383    37,617    49,138 
2011-Servicing Advance Revolving Trust 1 (3)  1ML + 300
bps
  May 2043  May 2013           204,633 
2012-Servicing Advance Revolving Trust 2 (3)  1ML + 315
bps
  Sep. 2043  Sep. 2013           22,003 
2012-Servicing Advance Revolving Trust 3 (3)  1ML + 300
bps – 675 bps
  Mar. 2044  Mar. 2014           40,626 
2012-Homeward Agency Advance Funding Trust 2012-1 (6)  1ML + 300
bps
  Nov. 2013  Nov. 2013   5,646    19,354    16,094 
2012-Homeward DSF Advance Revolving Trust 2012-1 (3)  1ML + 450
bps
  Feb. 2013  Feb. 2013           20,151 
Total variable rate            36,988    363,012    884,468 
            $36,988   $363,012   $2,532,745 
(1)The amortization date of our facilities 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. In two advance facilities, there are multiple notes outstanding. For each note, 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.
(2)Borrowing capacity is available to us provided that we have additional eligible collateral to pledge. Collateral may only be pledged to one facility. At September 30, 2013, $0.1 million of the available borrowing capacity could be used based on the amount of eligible collateral.
(3)Facility was repaid in February 2013 from the proceeds of a new $1.4 billion bridge facility (Homeward Residential Bridge Loan Trust – 2013) with an amortization date of August 14, 2013. On July 1, 2013, we repaid the new bridge facility in full from proceeds received on the sale of servicing advances to HLSS.
(4)We repaid this facility in full in July 2013.
(5)On August 30, 2013, we amended this facility to reduce the maximum borrowing capacity to $100 million from $450 million.
(6)On October 21, 2013, we extended the maturity date of this facility to November 29, 2013 with two optional six-month extensions subject to lender approval.
30
 
Note 15      Other Borrowings

Lines of credit and other secured and unsecured borrowings are comprised of the following at the dates indicated:

                      
            Available   Balance Outstanding 
            Borrowing   September 30,   December 31, 
Borrowings  Collateral  Interest Rate  Maturity  Capacity   2013   2012 
Servicing:                        
SSTL (1)  (1)  1ML + 550 bps;
LIBOR floor of
150 bps (1)
  Sept. 2016  $   $   $314,229 
SSTL (2)  (2)  (2)  Feb. 2018       1,293,500     
                         
Senior unsecured term loan (3)     1-Month Euro-
dollar rate + 675
bps with a
Eurodollar floor
of 150 bps
  Mar. 2017           75,000 
Financing liability – MSRs pledged (4)  MSRs (4)  (4)  (4)       643,595    303,705 
Financing liability – MSRs pledged (5)  MSRs (5)  (5)  (5)           2,603 
Promissory note (6)  MSRs  1ML + 350 bps  May 2017       17,163    18,466 
Repurchase agreement  Loans held
for sale
(LHFS)
  1 ML + 250 – 345
bps
  Apr. 2014   47,878    52,122     
             47,878    2,006,380    714,003 
                         
Lending:                        
Master repurchase agreement (7)  LHFS  1ML + 175 bps  Mar. 2014   230,085    69,915    88,122 
Participation agreement (8)  LHFS  N/A  May 2014       19,588    58,938 
Master repurchase agreement (9)  LHFS  1ML + 175 to 275
bps
  Aug. 2014   60,989    89,011    133,995 
Master repurchase agreement (10)  LHFS  1ML + 175 to 200
bps
  Sep. 2014   265,898    34,102    107,020 
Master repurchase agreement (11)  LHFS  1ML + 275 bps  Nov. 2013   21,873    78,127     
Financing liability – MSRs pledged (5)  MSRs (5)