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).

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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.

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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.

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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.
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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.

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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.

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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
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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
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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.

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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.
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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)
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   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.

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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.

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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.

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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.

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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 
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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.

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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.

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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.

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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)  (5)  (5)       10,403     
Mortgage warehouse agreement  LHFS  1 ML + 275 bps;
floor of 3.50%
  Jun. 2014   56,755    3,245     
Secured borrowings - owed to securitization investors (12)  Loans held
for
investment
  1ML + 220 bps  (12)       284,276     
             635,600    588,667    388,075 
                         
Corporate Items and Other                        
Securities sold under an agreement to repurchase (13)  Ocwen Real
Estate Asset
Liquidating
Trust 2007-1
Notes
  Class A-2 notes:
1ML + 200 bps;
Class A-3 notes:
1ML + 300 bps
  Monthly       3,223    2,833 
             683,478    2,598,270    1,104,911 
                         
Discount (1)(2)                (5,679)   (8,232)
            $683,478   $2,592,591   $1,096,679 
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(1)In February 2013, we repaid this loan in full and wrote off the remaining discount as part of the loss on extinguishment.
(2)On February 15, 2013, we entered into a new SSTL facility agreement and borrowed $1.3 billion that was used principally to fund the ResCap Acquisition and repay the balance of the previous SSTL. The loan was issued with an original issue discount of $6.5 million that we are amortizing over the term of the loan. We are required to repay the principal amount of the borrowings in consecutive quarterly installments of $3.3 million. In addition, we are generally required to use the net cash proceeds (as defined) from any asset sale (as defined) to repay loan principal. Generally, this provision applies to non-operating sales of assets, and net cash proceeds represent the proceeds from the sale of the assets, net of the repayment of any debt secured by a lien on the assets sold. However, for assets sales that are part of an HLSS Transaction, we have the option, within 180 days, either to invest the net cash proceeds in MSRs or related assets, such as advances, or to repay loan principal. The borrowings are secured by a first priority security interest in substantially all of the assets of Ocwen. Borrowings bear interest, at the election of Ocwen, at a rate per annum equal to either (a) the base rate [the greatest of (i) the prime rate in effect on such day, (ii) the federal funds rate in effect on such day plus 0.50% and (iii) the one-month Eurodollar rate (1-Month LIBOR)], plus a margin of 2.75% and a base rate floor of 2.25% or (b) the one month Eurodollar rate, plus a margin of 3.75% with a 1-Month LIBOR floor of 1.25%. To date we have elected option (b) to determine the interest rate.
  
 On September 23, 2013, we entered into Amendment No. 1 to the Senior Secured Term Loan Facility Agreement and Amendment No. 1 to the related Pledge and Security Agreement. These amendments:
permit repurchases of all of the Preferred Stock, which may be converted to common stock prior to repurchase, and up to $1.5 billion of common stock, subject, in each case, to pro forma financial covenant compliance;
eliminate the dollar cap on Junior Indebtedness (as defined in the SSTL) but retain the requirement for any such issuance to be subject to pro forma covenant compliance;
include a value for whole loans (i.e., loans held for sale) in collateral value for purposes of calculating the loan-to-value ratio and include specified deferred servicing fees and the fair value of specified mortgage servicing rights in net worth for purposes of calculating the ratio of consolidated total debt to consolidated tangible net worth; and
modify the applicable quarterly covenant levels for the corporate leverage ratio, ratio of consolidated total debt to consolidated tangible net worth and loan-to-value ratio.
(3)We repaid this loan in full in February 2013.
(4)As part of the HLSS Transactions, we transfer certain Rights to MSRs to HLSS. Because we have not yet transferred legal title to the MSRs, we account for these transfers as financings with the proceeds from the sale of the Rights to MSRs recorded as a financing liability. The financing liability is amortized using the interest method with the servicing income that is remitted to HLSS representing payments of principal and interest. The liability has no contractual maturity but is amortized over the estimated life of the transferred Rights to MSRs. See Note 3 –Transfers of Financial Assets for additional information.
(5)We sold MSRs for certain loans to an unrelated third party in December 2012 and June 2013; however, we are required to repurchase the MSRs for any loans that cannot be refinanced by the purchaser under the federal government’s Home Affordable Refinance Program (HARP). As a result, the sale is being accounted for as a financing. The financing liability is being amortized using the interest method with the servicing income that is remitted to the purchaser representing payments of principal and interest. In June 2013 and September 2013, we derecognized the liability from the December 2012 sale related to loans that had been refinanced under HARP and recognized a total gain of $4.5 million gain on the retirement of the financing liability.
32
 
(6)Prepayments of the balance on this note may be required if the borrowing base, as defined, falls below the amount of the note outstanding.
(7)On March 19, 2013, the maturity date of the Master Repurchase Agreement was extended to March 18, 2014 and the maximum borrowing capacity was increased from $120.0 million to $300.0 million.
(8)Under this participation agreement, the lender provides financing on an uncommitted basis for up to $100.0 million at the discretion of the lender. The participation agreement allows the lender to acquire a 100% beneficial interest in the underlying mortgage loans. However, the transaction does not qualify for sales accounting treatment and is, therefore, accounted for as a financing. The lender earns the stated interest rate of the underlying mortgage loans while the loans are financed under the participation agreement. In April 2013, we extended the participation agreement maturity date to May 31, 2014.
(9)On August 3, 2013, we extended the maturity date of this facility to August 2, 2014.
(10)On September 27, 2013, we extended the maturity date of this facility to September 26, 2014,
(11)On October 28, 2013, we extended the maturity date of this facility to November 12, 2013.
(12)This represents amounts due to the holders of beneficial interests in Ginnie Mae guaranteed securitization that we include in our consolidated financial statements because the transfers of reverse mortgage loans to the trusts did not qualify for sales accounting treatment. There are no maturity dates; the borrowings mature as the related loans are repaid.
(13)This agreement has no stated credit limit and lending is determined for each transaction based on the acceptability of the securities presented as collateral.
Note 16Other Liabilities

Other liabilities are comprised of the following at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Liability for indemnification obligations (1)   $206,074   $38,140 
Accrued expenses    97,497    68,068 
Liability for certain foreclosure matters (2)    66,431    13,602 
Payable to servicing and subservicing investors (3)    27,063    9,973 
Checks held for escheat    24,965    33,259 
Liability for selected tax items    22,338    22,702 
Due to related parties (4)    16,535    45,034 
Derivatives, at fair value (6)    11,660    18,658 
Servicing liabilities (5)    11,568    9,830 
Accrued interest payable    9,455    5,410 
Other    61,122    23,861 
   $554,708   $288,537 
(1)The balance includes origination representation and warranty obligations and compensatory fees for foreclosures that may ultimately exceed investor timelines. These obligations were primarily assumed in connection with the Ally MSR Transaction, the ResCap Acquisition and the Homeward Acquisition. See Note 4 – Business Acquisitions, Note 9 – Mortgage Servicing and Note 25 – Commitments and Contingencies for additional information.
(2)We recognized $52.8 million of expense in Professional services in the second quarter of 2013 to establish the liability. We recognized the remaining $13.6 million of the liability as an adjustment to the initial purchase price allocation related to the Homeward Acquisition. We applied this measurement period adjustment retrospectively to our Consolidated Balance Sheet at December 31, 2012 with an offsetting increase in goodwill. See Note 25 – Commitments and Contingencies for additional information.
(3)The balance represents amounts due to investors in connection with loans we service under servicing and subservicing agreements.
(4)See Note 23 – Related Party Transactions for additional information.
(5)During the nine months ended September 30, 2013 and 2012, amortization of servicing liabilities exceeded the amount of charges we recognized to increase our servicing liability obligations by $0.5 million and $1.1 million, respectively. Amortization of mortgage servicing rights is reported net of this amount in the unaudited Consolidated Statement of Operations.
(6)See Note 19 – Derivative Financial Instruments and Hedging Activities for additional information.
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Note 17Mezzanine Equity

Preferred Stock

On December 27, 2012, we issued 162,000 shares of Series A Perpetual Convertible Preferred Stock (the Preferred Shares) having a par value of $0.01 per share and paying dividends at a rate of 3.75% on the liquidation preference of $1,000 per share as part of the consideration for the Homeward Acquisition. The dividends are payable quarterly at the end of each calendar quarter.

The Preferred Shares are accounted for as equity and are classified as “mezzanine” equity in the unaudited Consolidated Balance Sheets. The conversion option of the Preferred Shares represents a Beneficial Conversion Feature (BCF) with an intrinsic value of $8.7 million which we accounted for as a discount on the Preferred Shares with an offsetting increase in additional paid in capital upon issuance. The BCF will be amortizing through the second anniversary of the issue date, the first date at which we can redeem the Preferred Shares.

We amortize the BCF discount on the Preferred Shares as a deemed dividend with an offsetting reduction in retained earnings.

The carrying value of our Preferred Shares reflects the following:

Initial issuance price on December 27, 2012   $162,000 
Discount for beneficial conversion feature    (8,688)
Accretion of BCF discount (Deemed dividend)    60 
Carrying value at December 31, 2012    153,372 
Conversion of 100,000 Preferred Shares (1)    (100,000)
Accretion of BCF discount (Deemed dividend) (2)    6,573 
Carrying value at September 30, 2013   $59,945 
(1)On September 23, 2013, holders elected to convert 100,000 of the Preferred Shares into 3,145,640 shares of common stock. See Note 23 – Related Party Transactions for additional information.
(2)Accretion includes a $3.5 million accelerated write-off of the unamortized discount related to the 100,000 Preferred Shares converted on September 23, 2013.
Note 18Equity

Common Stock

On September 23, 2013, Ocwen paid $157.9 million to repurchase from the holders of our Preferred Shares all 3,145,640 shares of common stock that were issued upon their election to convert 100,000 of the Preferred Shares into shares of common stock. See Note 23 – Related Party Transactions for additional information.

On October 31, 2013, we announced that our Board of Directors had authorized a share repurchase program for up to an aggregate of $500.0 million of our issued and outstanding shares of common stock. Repurchases may be made in open market transactions at prevailing market prices or in privately negotiated transactions. Unless we amend the share repurchase program or repurchase the full $500.0 million amount by an earlier date, the share repurchase program will continue through July 2016. No assurances can be given as to the amount of shares, if any, that we may repurchase in any given period. The repurchase of shares issued in connection with the conversion of Preferred Shares is not considered to be part of this repurchase program and, therefore, does not count against the $500.0 million aggregate value limit.

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss (AOCL), net of income taxes, were as follows at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Unrealized losses on cash flow hedges   $7,649   $6,310 
Other    (580)   131 
   $7,069   $6,441 
34
 
Note 19Derivative Financial Instruments and Hedging Activities

Because many of our current derivative agreements are not exchange-traded, we are exposed to credit loss in the event of nonperformance by the counterparty to the agreements. We control this risk through credit monitoring procedures including financial analysis, dollar limits and other monitoring procedures. The notional amount of our contracts does not represent our exposure to credit loss.

The following table summarizes the changes in the notional balance of our holdings of derivatives during the nine months ended September 30, 2013:

   IRLCs   U.S.
Treasury
Futures
   Forward
MBS
Trades
   Interest
Rate Caps
   Interest
Rate Swaps
 
                     
Balance at December 31, 2012  $1,112,519   $109,000   $1,638,979   $1,025,000   $1,495,955 
Additions   4,062,236    85,000    9,316,350        1,280,000 
Amortization   (228,806)       (33,372)   (24,000)    
Maturities   (3,709,513)       (4,558,971)       (295,604)
Terminations   (549,877)   (194,000)   (5,627,670)   (1,001,000)   (2,480,351)
Balance at September 30, 2013  $686,559   $   $735,316   $   $ 
                          
Fair value of net derivative assets (liabilities) at:                         
September 30, 2013  $13,491   $   $(12,185)  $   $ 
December 31, 2012  $5,781   $(1,258)  $(1,719)  $168   $(10,836)
                          
Maturity   Oct. 2013 – Jan. 2014        Oct. 2013 – Nov. 2013         

Interest Rate Management

Match Funded Liabilities

We have previously entered into interest rate swaps in order to hedge against the effects of changes in interest rates on our borrowings under our advance funding facilities. These interest rate swap agreements required us to pay a fixed rate and receive a variable interest rate based on one-month LIBOR. At the time that we entered into the agreements, these swaps were designated as hedges for accounting purposes. As disclosed in Note 5 – Fair Value of Financial Instruments, we terminated these interest rate swaps on May 31, 2013 primarily because the custodial account float balances, which earn a variable rate of interest, are well in excess of variable rate borrowings under advance facilities. The earnings on these deposits reduce our exposure to changes in interest rates. We also purchased interest rate caps to minimize future interest rate exposure from increases in one-month LIBOR interest rates, as required by the certain of our advance financing arrangements. These caps were terminated with the payoff and termination of the related financing facilities.

Loans Held for Sale, at Fair Value

The mortgage loans held for sale that we carry at fair value are subject to interest rate and price risk from the loan funding date until the date the loan is sold into the secondary market. Generally, the fair value of a loan will decline in value when interest rates increase and will rise in value when interest rates decrease. To mitigate this risk, we enter into forward trades to provide an economic hedge against those changes in fair value on mortgage loans held for sale. 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.

Interest Rate Lock Commitments

IRLCs represent an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage applicant, whereby the interest rate is set prior to funding. The loan commitment binds us (subject to the loan approval process) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. The borrower is not obligated to obtain the loan, thus we are subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. Our interest rate exposure on these derivative loan commitments is hedged with derivatives, including forward contracts. We enter into forward contracts with respect to fixed rate loan commitments.

35
 

MSRs at Fair Value

The MSRs which we measure at fair value are subject to interest rate risk as the mortgage loans underlying the MSRs permit the borrowers to prepay the loans. Therefore, the fair value of these 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). Although the level of interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices, underwriting standards and product characteristics. Effective April 1, 2013, we terminated our hedging program for fair value MSRs. Prior to their termination, we used economic hedges including interest rate swaps, U.S. Treasury futures and forward contracts to minimize the effects of loss in value of these MSRs associated with increased prepayment activity that generally results from declining interest rates.

Asset Acquisitions

In March 2013, we entered into an interest rate swap to hedge the impact on cash flows of changes in the purchase price to be paid for MSRs acquired in the Ally MSR Transaction. This purchase was forecasted to occur in stages with the purchase price subject to adjustment based on changes in the 10-year swap rate between the date of the MSR purchase agreement and the date of each closing. We entered into an interest rate swap with a notional amount sufficient to yield changes in the fair value of the interest rate swap in response to changes in the swap rate that were essentially equal to and offsetting to changes in the purchase price of the MSRs. We designated the swap as a hedge for accounting purposes. We completed the transaction in April 2013 and terminated the swap agreement at the same time. See Note 9 – Mortgage Servicing for additional information regarding the Ally MSR Transaction.

The following summarizes our use of derivatives at September 30, 2013 and the gains (losses) on those derivatives for the nine months then ended. None of these derivatives was designated as a hedge for accounting purposes at September 30, 2013:

Purpose  Expiration
Date
   Notional
Amount
   Fair Value
(1)
   Gains /
(Losses)
   Consolidated
Statement of
Operations
Caption
Interest rate risk of mortgage loans held for sale and IRLCs                       
Forward MBS trades    2014   $735,316   $(12,185)  $30,989   Gain on loans held for sale, net and Other, net
                        
IRLCs    2013    686,559    13,491    5,918   Gain on loans held for sale, net
Total derivatives             $1,306   $36,907    
(1)Derivatives are reported at fair value in Receivables, Other assets or in Other liabilities on our unaudited Consolidated Balance Sheets.

Included in AOCL at September 30, 2013 and December 31, 2012, respectively, were $12.1 million and $9.9 million of deferred unrealized losses, before taxes of $4.5 million and $3.6 million, respectively, on interest rate swaps that we designated as cash flow hedges. Changes in the losses on cash flow hedges included in AOCL during the nine months ended September 30, 2013 were as follows:

Accumulated losses on cash flow hedges at December 31, 2012   $9,878 
Additional net losses on cash flow hedges    12,363 
Ineffectiveness of cash flow hedges reclassified to earnings    (657)
Losses on terminated hedging relationships amortized to earnings (1)    (9,434)
Accumulated losses on cash flow hedges at September 30, 2013   $12,150 
(1)Where the hedging relationship has been terminated but the hedged transaction is still forecast to occur, losses on the hedging relationship that are included in AOCL are amortized to earnings in the periods in which earnings are affected by the hedged transaction. Amortization in the third quarter included $4.1 million of accelerated amortization as a result of the early repayment and termination of four advance financing facilities as a result of the July 1, 2013 HLSS Transaction.
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The statements of operations include the following related to derivative financial instruments for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Servicing and origination expense                    
Gains on economic hedges   $   $   $1,017   $ 
Gain on loans held for sale, net                    
Gains on economic hedges    9,608        36,907     
Other, net                    
Gains (losses) on economic hedges (1)    (103)   1,397    (3,822)   6,645 
Ineffectiveness of cash flow hedges        47    (657)   46 
Write-off of losses in AOCL for a discontinued hedge relationship    (7,780)   (3,089)   (9,434)   (4,633)
Write-off of losses in AOCL for hedge of a financing facility assumed by HLSS (See Note 3 –Transfers of Financial Assets)                (5,958)
   $1,725   $(1,645)  $24,011   $(3,900)
(1)Includes a gain of $3.4 million recognized during the three months ended March 31, 2012 from the termination of foreign exchange forward contracts.
Note 20Interest Expense

The following table presents the components of interest expense for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Match funded liabilities   $11,249   $32,359   $66,678   $99,394 
Other borrowings (1)    95,496    24,877    228,198    60,160 
Debt securities:                    
3.25% Convertible Notes                153 
10.875% Capital Trust Securities        473        1,894 
Other    3,310    708    8,463    2,059 
   $110,055   $58,417   $303,339   $163,660 
(1)Includes interest expense of $74.2 million and $14.0 million for the three months ended September 30, 2013 and 2012, respectively, and $168.6 million and $27.6 million for the nine months ended September 30, 2013 and 2012, respectively, related to financing liabilities recorded in connection with the HLSS Transactions. See Note 3 –Transfers of Financial Assets and Note 15 – Other Borrowings for additional information.
37
 
Note 21Basic and Diluted Earnings Per Share (EPS)

Basic EPS excludes common stock equivalents and is calculated by dividing net income attributable to Ocwen common stockholders by the weighted average number of common shares outstanding during the year. We calculate diluted EPS by dividing net income attributable to Ocwen, as adjusted to add back preferred stock dividends and interest expense net of income tax on the Convertible Notes, by the weighted average number of common shares outstanding including the potential dilutive common shares related to outstanding stock options, restricted stock awards, the Preferred Shares and the Convertible Notes. The following is a reconciliation of the calculation of basic EPS to diluted EPS for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Basic EPS:                    
Net income attributable to Ocwen common stockholders   $61,155   $51,400   $177,847   $115,582 
                     
Weighted average shares of common stock    135,787,834    134,928,486    135,705,892    133,483,354 
                     
Basic EPS   $0.45   $0.38   $1.31   $0.87 
                     
Diluted EPS:                    
Net income attributable to Ocwen common stockholders   $61,155   $51,400   $177,847   $115,582 
Preferred stock dividends (1)                 
Interest expense on Convertible Notes, net of income tax (2)                98 
Adjusted net income attributable to Ocwen   $61,155   $51,400   $177,847   $115,680 
                     
Weighted average shares of common stock    135,787,834    134,928,486    135,705,892    133,483,354 
Effect of dilutive elements:                    
Preferred Shares (1)                 
Convertible Notes (2)                1,347,642 
Stock options    4,263,965    3,769,099    4,030,297    3,468,156 
Common stock awards    5,396    5,296    11,301    2,713 
Dilutive weighted average shares of common stock    140,057,195    138,702,881    139,747,490    138,301,865 
                     
Diluted EPS   $0.44   $0.37   $1.27   $0.84 
                     
Stock options excluded from the computation of diluted EPS:                    
Anti-dilutive (3)       255,000        190,833 
Market-based (4)   547,500    1,726,250    547,500    1,726,250 
(1)The effect of our Preferred Shares on diluted EPS is computed using the if-converted method. For the three and nine months ended September 30, 2013, we assumed no conversion to common shares because the effect was anti-dilutive.
(2)Prior to the redemption of the 3.25% Convertible Notes in March 2012, we also computed their effect on diluted EPS using the if-converted method. Interest expense and related amortization costs applicable to the Convertible Notes, net of income tax, were added back to net income. We assumed the conversion of the Convertible Notes into shares of common stock for purposes of computing diluted EPS unless the effect was anti-dilutive. We issued 4,635,159 shares of common stock upon conversion of $56.4 million of the Convertible Notes.
(3)These stock options were anti-dilutive because their exercise price was greater than the average market price of our stock.
(4)Shares that are issuable upon the achievement of certain performance criteria related to OCN’s stock price and an annualized rate of return to investors.
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Note 22Business Segment Reporting

Our business segments reflect the internal reporting that we use to evaluate operating performance of services and to assess the allocation of our resources. A brief description of our current business segments is as follows:

 

Servicing. This segment is primarily comprised of our core residential servicing business. We provide residential and commercial mortgage loan servicing, special servicing and asset management services. We earn fees for providing these services to owners of the mortgage loans and foreclosed real estate. In most cases, we provide these services either because we purchased the MSRs from the owner of the mortgage, retained the MSRs on the sale of residential mortgage loans or because we entered into a subservicing or special servicing agreement with the entity that owns the MSR. Our residential servicing portfolio includes both Agency and Non-Agency loans. Non-Agency loans include prime and subprime loans which represent residential loans that generally did not qualify under GSE guidelines or have subsequently become delinquent.

Lending. The Lending segment is focused on originating and purchasing Agency-conforming residential forward and reverse mortgage loans mainly through correspondent lending arrangements. We also commenced a direct lending business to pursue refinancing opportunities from our existing portfolio, where permitted. The loans are typically sold shortly after origination into a liquid market on a servicing retained basis.

Corporate Items and Other. Corporate Items and Other includes items of revenue and expense that are not directly related to a business, business activities that are individually insignificant, interest income on short-term investments of cash, corporate debt and certain corporate expenses. Business activities that are not considered to be of continuing significance include subprime loans held for sale (at lower of cost or fair value), investments in unconsolidated entities and affordable housing investment activities. Corporate Items and Other also included the diversified fee-based businesses that we acquired as part of the Homeward and ResCap Acquisitions and subsequently sold to Altisource.

We allocate interest income and expense to each business segment for funds raised or for funding of investments made, including interest earned on cash balances and short-term investments and interest incurred on corporate debt. We also allocate expenses generated by corporate support services to each business segment.

Financial information for our segments is as follows:

   Servicing   Lending   Corporate
Items and
Other
   Corporate
Eliminations
   Business
Segments
Consolidated
 
Results of Operations                         
                          
Three Months Ended September 30, 2013:                         
                          
Revenue  $496,302   $33,539   $1,801   $(402)  $531,240 
Operating expenses (1)   305,654    29,504    11,143    (41)   346,260 
Income (loss) from operations   190,648    4,035    (9,342)   (361)   184,980 
Other income (expense), net:                         
Interest income   859    3,066    1,454        5,379 
Interest expense (1)   (106,848)   (3,279)   72        (110,055)
Other   (6,631)   1,843    398    361    (4,029)
Other income (expense), net   (112,620)   1,630    1,924    361    (108,705)
Income (loss) before income taxes  $78,028   $5,665   $(7,418)  $   $76,275 
                          
Three Months Ended September 30, 2012:                         
                          
Revenue  $232,104   $   $873   $(277)  $232,700 
Operating expenses (1)   88,743        4,162    (112)   92,793 
Income (loss) from operations   143,361        (3,289)   (165)   139,907 
Other income (expense), net:                         
Interest income           2,084        2,084 
Interest expense (1)   (58,144)       (273)       (58,417)
Other   (963)       (2,030)   165    (2,828)
Other income (expense), net   (59,107)       (219)   165    (59,161)
Income (loss) before income taxes  $84,254   $   $(3,508)  $   $80,746 
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   Servicing   Lending   Corporate
Items and
Other
   Corporate
Eliminations
   Business
Segments
Consolidated
 
Nine Months Ended September 30, 2013:                         
                          
Revenue   $1,381,872   $81,180   $19,758   $(492)  $1,482,318 
Operating expenses (1)    795,645    69,543    95,361    (131)   960,418 
Income (loss) from operations    586,227    11,637    (75,603)   (361)   521,900 
Other income (expense), net:                         
Interest income    1,382    12,432    3,516        17,330 
Interest expense (1)    (293,381)   (10,108)   150        (303,339)
Other    (30,961)   6,852    2,977    361    (20,771)
Other income (expense), net    (322,960)   9,176    6,643    361    (306,780)
Income (loss) before income taxes   $263,267   $20,813   $(68,960)  $   $215,120 
                          
Nine Months Ended September 30, 2012:                         
                          
Revenue   $606,689   $   $2,736   $(812)  $608,613 
Operating expenses (1)    252,542        12,659    (391)   264,810 
Income (loss) from operations    354,147        (9,923)   (421)   343,803 
Other income (expense), net:                         
Interest income            6,434        6,434 
Interest expense (1)    (162,810)       (850)       (163,660)
Other    (204)       (5,765)   421    (5,548)
Other income (expense), net    (163,014)       (181)   421    (162,774)
Income (loss) before income taxes   $191,133   $    $(10,104)  $   $181,029 
                          
Total Assets                         
September 30, 2013   $3,925,510   $778,777   $607,393   $   $5,311,680 
                          
December 31, 2012   $4,498,043   $550,569   $634,143   $   $5,682,755 
                          
September 30, 2012   $3,611,768   $   $544,248   $   $4,156,016 

(1)Depreciation and amortization expense are as follows:

 

   Servicing   Lending   Corporate
Items and
Other
   Business
Segments
Consolidated
 
Three Months Ended September 30, 2013:                    
Depreciation expense  $3,589   $135   $2,973   $6,697 
Amortization of MSRs   79,035    148        79,183 
Amortization of debt discount   330            330 
Amortization of debt issuance costs – SSTL   1,178            1,178 
                     
Three Months Ended September 30, 2012:                    
Depreciation expense  $395   $   $1,564   $1,959 
Amortization of MSRs   20,150            20,150 
Amortization of debt discount   1,199            1,199 
Amortization of debt issuance costs – SSTL   1,207            1,207 
                     

Nine Months Ended September 30, 2013:

                    
Depreciation expense  $9,968   $209   $6,976   $17,153 
Amortization of MSRs   197,287    148        197,435 
Amortization of debt discount   1,082            1,082 
Amortization of debt issuance costs – SSTL   3,264            3,264 
                     
Nine Months Ended September 30, 2012:                    
Depreciation expense  $1,069   $   $2,827   $3,896 
Amortization of MSRs   53,561            53,561 
Amortization of debt discount   2,679            2,679 
Amortization of debt issuance costs – SSTL   3,050            3,050 
40
 
Note 23Related Party Transactions

Relationship with Executive Chairman of the Board of Directors

Ocwen’s Executive Chairman of the Board of Directors, William C. Erbey, also serves as Chairman of the Board of Altisource, HLSS, Altisource Residential Corporation (Residential) and Altisource Asset Management Corporation (AAMC). As a result, he has obligations to Ocwen as well as to Altisource, HLSS, Residential and AAMC. As of September 30, 2013, Mr. Erbey owned or controlled approximately 13% of the common stock of Ocwen, approximately 23% of the common stock of Altisource, approximately 1% of the common stock of HLSS and approximately 9% of the common stock of AAMC. Mr. Erbey’s percentage interest in Residential declined to 4% as a result of an additional public offering by Residential that closed on October 1, 2013.

Relationship with Altisource

Under the Services Agreement, Altisource provides various business process outsourcing services, such as valuation services and property preservation and inspection services, among other things. Altisource also provides certain technology products and support services to Ocwen under the Technology Products Services Agreement and the Data Center and Disaster Recovery Services Agreement. In addition, under the Data Access and Services Agreement, Ocwen has agreed to make available to Altisource certain data from Ocwen’s servicing portfolio in exchange for a per asset fee. Under the Support Services Agreement, Ocwen and Altisource provide to each other services in such areas as human resources, vendor management, corporate services, accounting, tax matters, risk management, law and consumer psychology.

In connection with the March 29, 2013 sale to Altisource of the diversified fee-based business acquired in connection with the Homeward Acquisition, Ocwen agreed to extend to August 31, 2025 the terms of the Services Agreement, the Technology Products Services Agreement, the Data Center and Disaster Recovery Services Agreement and the Intellectual Property Agreement with Altisource. In addition, Ocwen agreed to expand the terms of the Services Agreement to apply to the services as they relate to the Homeward servicing platform and further to establish Altisource as the exclusive provider of such services as they relate to the Homeward servicing platform. In addition, Ocwen agreed not to establish similar fee-based businesses (or establish relationships with other companies engaged in the line of similar fee-based businesses) that would directly or indirectly compete with diversified fee-based businesses as they relate to the Homeward servicing platform acquired by Altisource.

Certain services provided by Altisource under these contracts are charged to the borrower and/or loan investor. Accordingly, such services, while derived from our loan servicing portfolio, are not reported as expenses by Ocwen. These services include residential property valuation, residential property preservation and inspection services, title services and real estate sales.

Our business is currently dependent on many of the services and products provided under these long-term contracts which include renewal provisions. We believe the rates charged under these agreements are market rates as they are materially consistent with one or more of the following: the fees charged by Altisource to other customers for comparable services and the rates Ocwen pays to or observes from other service providers.

As disclosed in Note 4 – Business Acquisitions, on April 12, 2013 in connection with the sale to Altisource of the diversified fee-based business acquired in connection with the ResCap Acquisition, we agreed to establish additional terms related to existing servicing arrangements between Altisource and Ocwen for mortgage servicing assets acquired from ResCap.

The agreement provides that during the term of the existing servicing arrangements between Altisource and Ocwen (i) Altisource will be the exclusive provider, except as prohibited by applicable law, to Ocwen and all of its subsidiaries and affiliates, of certain services related to the ResCap business; (ii) Ocwen will not establish similar fee-based businesses that would directly or indirectly compete with Altisource services as they relate to the ResCap business; and (iii) Ocwen and all of its subsidiaries and affiliates will market and promote the utilization of Altisource’s services to their various third-party relationships. Additionally, the parties agreed to use commercially reasonable best efforts to ensure that the loans associated with the ResCap business are boarded onto Altisource’s mortgage servicing platform. The cash consideration paid by Altisource to Ocwen under the Agreement totaled $128.8 million.

Also as disclosed in Note 4 – Business Acquisitions, on March 31, 2013 we acquired from Altisource its 49% equity interest in Correspondent One.

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On December 27, 2012, we entered into a senior unsecured term loan facility agreement with Altisource and borrowed $75.0 million. The proceeds of this loan were used to fund a portion of the Homeward Acquisition. Borrowings under the Unsecured Loan Agreement bear interest at a rate equal to the one-month Eurodollar Rate (1-Month LIBOR) plus 675 basis points with a Eurodollar Rate floor of 150 basis points. In February 2013, we repaid this loan in full.

Relationship with HLSS

Ocwen and HLSS Management entered into an agreement to provide to each other certain professional services including valuation analysis of potential MSR acquisitions, treasury management services and other similar services, legal, licensing and regulatory compliance support services, risk management services and other similar services.

As disclosed in Note 3 – Transfers of Financial Assets, Ocwen has sold to HLSS certain Rights to MSRs and related servicing advances. OLS also entered into a subservicing agreement with HLSS on February 10, 2012, which was amended on October 1, 2012 and again on September 30, 2013, under which it will subservice the MSRs after legal ownership of the MSRs has been transferred to HLSS.

Relationship with Residential

On December 21, 2012, OMS entered into a 15-year servicing agreement with Altisource Residential, L.P., the operating partnership of Residential, pursuant to which Ocwen will service residential mortgage loans acquired by Residential and provide loan modification, assisted deed-in-lieu, assisted deed-for-lease and other loss mitigation programs.

On February 14, 2013, OLS sold a pool of non-performing residential mortgage loans to Altisource Residential, L.P. pursuant to a Master Mortgage Loan Sale Agreement. The aggregate purchase price for the pool of loans was $64.4 million and the gain recognized by Ocwen on the sale was not significant.

Relationship with AAMC

On December 11, 2012, Mr. Erbey received 52,589 shares of AAMC restricted stock pursuant to the Altisource Asset Management Corporation 2012 Special Equity Incentive Plan and a Special Restricted Stock Award Agreement in his capacity as Chairman of the Board of AAMC and Altisource.

On December 11, 2012, Ronald M. Faris, our President and Chief Executive Officer and a director of Ocwen, received 29,216 shares of AAMC restricted stock pursuant to the Altisource Asset Management Corporation 2012 Special Equity Incentive Plan and a Special Restricted Stock Award Agreement, in connection with the services he provides AAMC through his employment with Ocwen.

Relationship with Former Owner of Homeward

As consideration for the Homeward Acquisition, Ocwen paid an aggregate purchase price of $766.0 million, of which $604.0 million was paid in cash and $162.0 million was paid in 162,000 Preferred Shares issued to certain private equity firms ultimately controlled by WL Ross & Co. LLC (the Funds), that pay a dividend of 3.75% per annum on a quarterly basis. Each Preferred Share, together with any accrued and unpaid dividends, may be converted at the option of the holder into shares of Ocwen common stock at a conversion price equal to $31.79. Mr. Ross is the Chairman and Chief Executive Officer of WL Ross & Co. LLC and Invesco Private Capital, Inc. and the managing member of El Vedado, LLC, each of which directly or indirectly controls the Funds. Mr. Ross became a director of Ocwen in March 2013. On September 23, 2013, the Funds exercised their right to convert 100,000 of the Preferred Shares into 3,145,640 of common stock. On the same date, Ocwen repurchased the shares of common stock from the Funds for $157.9 million.

The following table summarizes our revenues and expenses related to the various service agreements with Altisource and its subsidiaries and HLSS for the periods September 30, and amounts receivable from or payable to at the dates indicated:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Revenues and Expenses:                    
Altisource:                    
Revenues  $5,185   $4,156   $15,390   $12,229 
Expenses   13,153    6,826    36,650    20,537 
HLSS:                    
Revenues  $20   $125   $172   $165 
Expenses   386    780    1,615    1,773 
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   September 30,
2013
   December 31,
2012
 
Net Receivable (payable)          
Altisource  $(3,489)  $(5,971)
HLSS   22,337    (25,524)
   $18,848   $(31,495)

 

Note 24Regulatory Requirements

Our business is subject to extensive regulation by federal, state and local governmental authorities, including the CFPB, the Federal Trade Commission (FTC), the SEC and various state agencies that license, audit and conduct examinations of our mortgage originations, servicing and collection activities in a number of states. The CFPB asserts supervisory authority (including the authority to conduct examinations) over Ocwen and its affiliates, including Homeward. From time to time, we also receive requests from federal, state and local agencies for records, documents and information relating to our policies, procedures and practices regarding our loan origination, loan servicing and debt collection business activities. We incur significant ongoing costs to comply with new and existing laws and governmental regulation of our business.

We must comply with a number of federal, state and local consumer protection laws including, among others, the Gramm-Leach-Bliley Act, the Fair Debt Collection Practices Act, the Real Estate Settlement Procedures Act (RESPA), the Truth in Lending Act (TILA), the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, Homeowners Protection Act, the Federal Trade Commission Act and, more recently, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and state mortgage origination, mortgage servicing and foreclosure laws. These laws apply to loan origination, loan servicing, debt collection, use of credit reports, safeguarding of non-public personally identifiable information about our customers, foreclosure and claims handling, investment of and interest payments on escrow balances and escrow payment features, and mandate certain disclosures and notices to borrowers. These requirements can and do change as statutes and regulations are enacted, promulgated or amended.

There are a number of foreign laws and regulations that are applicable to our operations in India, the Philippines and Uruguay, including acts that govern licensing, employment, safety, taxes, insurance, and the laws and regulations that govern the creation, continuation and the winding up of companies as well as the relationships between the shareholders, the company, the public and the government in both countries.

 

Note 25Commitments and Contingencies

We are subject to various pending legal proceedings, including those subject to loss sharing and indemnification provisions of our various acquisitions. In our opinion, the resolution of those proceedings will not have a material effect on our financial condition, results of operations or cash flows.

Regulatory Contingencies

We are subject to a number of pending federal and state regulatory investigations, examinations, inquiries, requests for information and/or other actions. In July 2010, OLS received two subpoenas from the Federal Housing Finance Agency as conservator for Freddie Mac and Fannie Mae in connection with ten private label mortgage securitization transactions where Freddie Mac and Fannie Mae have invested. The transactions include mortgage loans serviced but not originated by OLS or its affiliates. On November 24, 2010, OLS received a Civil Investigative Demand (CID) from the FTC requesting documents and information regarding various servicing activities. On June 6, 2012, the FTC notified OLS that it had referred this CID to the CFPB. On November 7, 2011, OLS received a CID from the Attorney General’s Office of the Commonwealth of Massachusetts requesting documents and information regarding certain foreclosures executed in Massachusetts. On January 18, 2012, OLS received a subpoena from the New York Department of Financial Services (NY DFS) requesting documents regarding OLS’ policies, procedures and practices regarding lender-placed or “force-placed” insurance which is required to be provided for borrowers who allow their hazard insurance policies to lapse. Separately, on December 5, 2012, we entered into a Consent Order with the NY DFS in which we agreed to the appointment of an independent Monitor to oversee our compliance with the Agreement on Servicing Practices. NY DFS selected the firms that will act as the Monitor, and their formal engagement commenced effective July 1, 2013. The engagement will last until July 1, 2015, and we intend to continue to cooperate with the NY DFS and the Monitor.

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As previously reported, on August 13, 2012, OLS received a request from the MMC to provide information and data relating to our loan servicing portfolio, including loan count and volume data, loan modifications, fees assessed, delinquencies, short sales, loan-to-value data and rating agency reports. The MMC, along with the CFPB, certain state Attorneys General and other agencies who were involved in the National Mortgage Settlement executed on February 9, 2012 by the five large banks (collectively, the Regulators), also requested that we indicate our position on behalf of OLS and Litton on the servicing standards and consumer relief provisions contained in that Settlement. In response, we indicated our willingness to adopt the servicing standards set out in the National Mortgage Settlement with certain caveats and to undertake various consumer assistance commitments in the form of loan modifications and other foreclosure avoidance alternatives. On February 26, 2013, the Regulators requested that, in addition to committing to the servicing standards and loan modifications, we also consider a proposal to contribute to a consumer relief fund that would provide cash payments to certain borrowers foreclosed upon by OLS and various entities we have acquired. In subsequent discussions, it was clarified that the Regulators sought our agreement on servicing standards, loan modifications and the proposed consumer relief fund to settle and release various potential legal claims against Ocwen, Litton and Homeward arising out of MMC examinations and potential follow on federal and/or state enforcement actions (the Proposed Regulators’ Settlement). In light of the substantial progress the parties have made toward an agreement in principle regarding the Proposed Regulators’ Settlement, we believe such a settlement is probable. Consummation of a final settlement would be subject to completion of definitive settlement documents acceptable to all parties, the participation of all relevant regulatory agencies, and execution of certain contractual undertakings by the sellers of Litton and Homeward. In the event a final settlement is not concluded, we will defend any ensuing legal proceedings vigorously. As disclosed in Note 16 – Other Liabilities, we have established a liability of $66.4 million for the Proposed Regulators’ Settlement.

As part of the ResCap Acquisition, OLS is required to service the ResCap loans in accordance with the requirements of the National Mortgage Settlement, although OLS is not responsible for any payment, penalty or financial obligation, including but not limited to providing Ally’s share of financial relief to borrowers under that settlement. The Office of Mortgage Settlement Oversight (OMSO) which is responsible for monitoring compliance with obligations under the National Mortgage Settlement, issued a report on February 14, 2013 confirming that Ally/ResCap have completed its minimum consumer relief obligations.

One or more of the foregoing regulatory actions or similar actions in the future against Ocwen, OLS, Litton or Homeward could cause us to incur fines, penalties, settlement costs, damages, legal fees or other charges in material amounts, or undertake remedial actions pursuant to administrative orders or court-issued injunctions, any of which could adversely affect our financial results or incur additional significant costs related to our loan servicing operations.

In addition to these matters, Ocwen receives periodic inquires, both formal and informal in nature, from various state and federal agencies as part of those agencies’ oversight of the mortgage servicing sector. Such ongoing inquiries, including those into servicer foreclosure processes, could result in additional actions by state or federal governmental bodies, regulators or the courts that could result in an extension of foreclosure timelines, which may be applicable generally to the servicing industry or to us in particular. In addition, a number of our match funded advance facilities contain provisions that limit the eligibility of advances to be financed based on the length of time that advances are outstanding, and two of our match funded advance facilities have provisions that limit new borrowings if average foreclosure timelines extend beyond a certain time period, either of which, if such provisions applied, could adversely affect liquidity by reducing our average effective advance rate. Increases in the amount of advances and the length of time to recover advances, fines or increases in operating expenses, and decreases in the advance rate and availability of financing for advances could result in increased borrowings, reduced cash and higher interest expense which could negatively impact our liquidity and profitability.

Loan Put-Back and Related Contingencies

In several recent court actions, mortgage loan sellers against whom repurchase claims have been asserted based on alleged breaches of representations and warranties are defending themselves on various grounds including the expiration of statutes of limitation, lack of notice and opportunity to cure and vitiation of the obligation to repurchase as a result of foreclosure or charge off of the loan. Ocwen is not a party to any of the actions, but we are the servicer for certain securitizations involved in such actions. In connection with these actions, Ocwen has entered into tolling agreements with respect to its role as servicer for a very small number of securitizations and may enter into additional tolling agreements in the future. Should Ocwen be made a party to these or similar actions, we may need to defend allegations that we failed to service loans in accordance with applicable agreements and that such failures prejudiced the rights of repurchase claimants against loan sellers. We believe that any such allegations would be without merit and, if necessary, would vigorously defend against them. If, however, we were required to compensate claimants for losses related to seller breaches of representations and warranties in respect of loans we service, then our business, financial condition and results of operations could be adversely affected.

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We have exposure to representation, warranty and indemnification obligations because of our lending, sales and securitization activities, our acquisitions to the extent we assume one or more of these obligations and in connection with our servicing practices. We recognize the fair value of representation and warranty obligations in connection with originations upon sale or securitization of the loan or upon completion of an acquisition, to the extent we assume these obligations.  Obligations recognized in connection with our loan sales and securitization activities are recognized in Gain on loans held for sale, net on our Consolidated Statements of Operations.  The fair value of liabilities assumed as part of an MSR or servicing business acquisition are recognized on the closing date.  Thereafter, the estimation of the liability considers probable future obligations based on industry data of loans of similar type segregated by year of origination and estimated loss severity based on current loss rates for similar loans, our historical rescission rates and the current pipeline of unresolved demands. Our historical loss severity considers the historical loss experience that we incur upon sale or liquidation of a repurchased loan as well as current market conditions. At September 30, 2013, we had provided or assumed representation and warranty obligations in connection with $89.4 billion of UPB covering both forward and reverse mortgage loans. At September 30, 2013, we had outstanding representation and warranty repurchase demands of $113.0 million UPB (534  loans).  We review each demand and monitor through resolution, primarily through rescission, loan repurchase or make-whole payment.

The following table presents the changes in our liability for indemnification obligations for the nine months ended September 30, 2013, including representation and warranty obligations and compensatory fees for foreclosures that may ultimately exceed investor timelines:

Balance at December 31, 2012  $38,140 
Provision for representation and warranty obligations   18,116 
New production reserves   1,055 
Obligations assumed in connection with MSR and servicing business acquisitions   189,742 
Charge-offs (1)   (40,979)
Balance at September 30, 2013  $206,074 
(1)Includes principal and interest losses realized in connection with repurchased loans, make-whole, indemnification and fee payments and settlements net of recoveries, if any.

 

We believe it is reasonably possible that losses beyond amounts currently recorded for potential representation and warranty obligations and related claims described above could occur, and such losses could have an adverse impact on our results of operations, financial condition or cash flows. However, based on currently available information, we are unable to estimate a range of reasonably possible losses above amounts that have been recorded at September 30, 2013.

 

Note 26Subsequent Events

On October 25, 2013, OLS completed a sale to HLSS Holdings, LLC and Home Loan Servicing Solutions, Ltd. of Rights to MSRs and related servicing advances for a servicing portfolio of subprime and Alt-A residential mortgage loans.

This transaction resulted in our sale of Rights to MSRs with approximately $10.0 billion in UPB of mortgage loans as of October 24, 2013. The purchase price for the transaction was approximately $388 million, including $360 million for servicing advances and $28 million for the associated Rights to MSRs. Within 90 days of the closing, the purchase price or other terms may be adjusted to reflect any adjustments in the calculation of the UPB of the underlying mortgage loans or servicing advance balances sold in the transaction.

We sold these mortgage servicing assets to HLSS pursuant to an amended Sale Supplement to the Master Servicing Rights Purchase Agreement between OLS, HLSS Holdings, LLC and Home Loan Servicing Solutions, Ltd. In addition to our sale of the right, title and interest to the Rights to MSRs and the associated servicing advances, HLSS Holdings, LLC also committed to purchase servicing advances that arise under the related pooling and servicing agreements after the closing date. In return, OLS continues to subservice the related mortgage loans, receives a monthly base fee equal to 12% of the servicing fees collected in any given month and retains any ancillary income payable to the servicer (excluding investment income earned on any custodial accounts) pursuant to the related pooling and servicing agreements. OLS also earns a monthly performance based incentive fee based on the servicing fees collected. If the targeted advance ratio in any month exceeds the predetermined level for that month set forth in the Sale Supplement and the Subservicing Supplement for the transaction, any performance based incentive fee payable for such month will be reduced by an amount equal to 3% per annum of the amount of any such excess servicing advances.

As disclosed in Note 1, we entered into a Purchase Agreement with OneWest Bank, FSB that is closing in stages. As part of the OneWest MSR Transaction, in October 2013, we closed the purchase of approximately $1.1 billion in UPB of MSRs and related servicing advances, including approximately $6.6 million of MSRs and approximately $37.1 million of servicing advances. On November 1, 2013, we closed the purchase of approximately $32.9 billion in UPB of MSRs and related servicing advances. The purchase included approximately $235.6 million of MSRs and approximately $1.3 billion of servicing advances. The November purchase was funded from the proceeds of a newly executed $1.6 billion match funded advance financing facility and available cash. The new facility consists of three notes, the largest of which bears interest at 1-Month LIBOR plus an initial margin of 1.75% with the two smaller notes bearing interest at the lender's commercial paper rate plus initial margins of 1.67% and 4.25%. The notes mature in October 2044 with an amortization date beginning in October 2014.

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in Thousands, Except Share Data or If Otherwise Indicated)

INTRODUCTION

The following discussion of our results of operations, change in financial condition and liquidity should be read in conjunction with our unaudited Consolidated Financial Statements and the related notes, all included elsewhere in this report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2012.

OVERVIEW

Strategic Priorities Update

We continue to execute our strategy to grow and sustain our loan servicing business through acquisitions and through our loan origination business whereby we retain the MSRs associated with sold loans. During the first nine months of 2013, we retained MSRs of $63.2 million on sales of residential mortgage loans with a UPB of $5.7 billion.

Consistent with this strategy, we executed the following acquisitions during the nine months ended September 30, 2013:

Transaction  Type  Completion Date    Purchase Price     Acquired MSR UPB 
ResCap Acquisition  Business (2)  Various    $2.3 billion(3)    $170.8 billion(4)
                     
Ally Bank  Contract Assumption  February 2013     N/A     $130.0 billion(5)
                     
Ally MSR Transaction  Asset  Various    $620.7 million(6)    $87.5 billion(7)
                     
Liberty Acquisition  Business  April 2013    $22.0 million     $652.6 million 
                     
OneWest MSR Transaction (1)  Asset  Various    $498.7 million(8)    $30.5 billion(9)
(1)Purchase price and MSR UPB are preliminary. Final purchase amounts could be different.
(2)Acquired ResCap servicing platform, related assets and assumed liabilities and added approximately 2,450 of primarily U.S. based employees.
(3)Aggregate purchase price consisting primarily of $391.9 million of MSRs and $1.7 billion of servicing advances, net of assumed liabilities of $74.6 million consisting primarily of accruals for compensatory fees for foreclosures that may ultimately exceed investor timelines. We recognized goodwill of $201.8 million in connection with the acquisition.
(4)UPB consists of $55.6 billion Agency, $48.2 billion Non-Agency, $40.7 billion master servicing and $26.3 billion subservicing. Included in subservicing UPB is $9.0 billion of Non-Agency UPB subserviced on behalf of ResCap until such time as ResCap obtains the necessary consents and court approvals to sell or transfer the related MSRs. We acquire newly originated MSRs from ResCap at contractually agreed multiples of the applicable servicing fee which approximates market value.
(5)We acquired the MSRs related to $87.5 billion in UPB from Ally Bank in the Ally MSR Transaction and terminated the subservicing contract with respect to the acquired MSRs.
(6)Aggregate purchase price consisting of $683.8 million of MSRs and $73.6 million of servicing advances and other receivables, net of assumed origination representation and warranty obligations in connection with the majority of the acquired MSRs. The estimated fair value of this obligation on the closing date was $136.7 million.
(7)UPB consists of Agency MSRs. Prior to the acquisition, we subserviced these loans on behalf of Ally Bank under a contract assumption in connection with the ResCap Acquisition. We acquired newly originated Agency MSRs from Ally Bank through August 31, 2013, at a contractually agreed multiple of the applicable servicing fee which approximates market value.
(8)Aggregate purchase price consists of $127.0 million of MSRs and $371.6 million of servicing advances. The OneWest MSR Transaction is expected to close in stages through the end of 2013. At September 30, 2013, estimated aggregate purchase price in connection with future settlements consisted of $305.1 million of MSRs and $1.6 billion of servicing advances. 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 to the unaudited Consolidated Financial Statements for additional information.
(9)UPB consists of $30.5 billion Agency MSRs. Additional UPB to be acquired is estimated at $41.9 billion Non-Agency MSRs.

In addition to the transactions above, on July 1, 2013 and September 1, 2013, we completed the boarding of $3.0 billion and $2.0 billion of UPB, respectively, for a total of approximately 32,800 loans, of non-prime subservicing from a large financial institution.

We are also continuing to execute on our strategy to reduce the amount of capital that we require through our relationship with HLSS. Until such time as we receive the third party consents required in connection with these sales, we account for the transactions as financings. As a result, the MSRs remain on our consolidated balance sheet and continue to be amortized. The excess of the proceeds received over our carrying value for the MSRs is deferred and amortized over the estimated life of the underlying MSRs. We recognize a financing liability and corresponding interest expense. See Note 3Transfers of Financial Assets and Note 26 – Subsequent Events to the unaudited Consolidated Financial Statements for additional information regarding the HLSS Transactions.

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The following table includes HLSS Transactions completed during the nine months ended September 30, 2013:

                                 
Completion Date   Aggregate
Proceeds
  Unpaid Principal
Balance MSRs (1)
  Match Funded
Advances
  Deferred Gain   Match Funded
Liabilities Repaid
 
                       
March 2013   $ 803.9 million   $ 15.9 billion   $ 703.2 million   $ 3.7 million   $ 625.8 million  
                                 
May 2013   $ 424.5 million   $ 10.6 billion   $ 376.6 million   $ 18.9 million   $ 311.5 million  
                                 
July 2013   $ 2.6 billion   $ 83.3 billion   $ 2.4 billion   $ 16.0 million   $ 1.8 billion  

(1)Consists of Non-Agency non-prime MSRs, including all such MSRs acquired in the Homeward and ResCap Acquisitions.

Market Outlook

We expect that other non-prime and prime servicing platforms and servicing portfolios will come to market in the next several months. We are currently aware of potential MSR acquisition opportunities with an aggregate UPB of approximately $400 billion over the next 12 to 18 months, with at least $100 billion in the next few months. We believe that servicing and subservicing opportunities with an aggregate UPB of over $1.0 trillion could come to market in the next 2 to 3 years. To the extent that we find these opportunities to be attractive, we believe that we are positioned to effectively compete for such opportunities in light of our low cost, high-quality servicing platform. Our technology also provides us the ability to quickly scale our servicing operations to handle acquired loan portfolios.

In September 2013, we completed the sale of newly originated GSE MSRs to a market participant and retained the subservicing related to loans underlying the sold MSRs. We expect to execute additional GSE MSR sales with retained subservicing to reduce exposure to prepayments of owned MSRs.

We would generally expect lower prepayment rates due to lower refinancing activity in a rising rate environment, primarily in our performing Agency servicing portfolio. The balance of our non-prime portfolio has not historically experienced significant voluntary prepayments. As such, rising and higher interest rates are expected to positively impact our servicing portfolio. Combined with an improving economy and housing market, which should reduce delinquencies, we anticipate a favorable environment for our servicing portfolio.

Operations Summary

Our recent business acquisitions (Homeward Acquisition in December 2012 and ResCap Acquisition in February 2013) and MSR asset acquisitions (Ally MSR Transaction in April 2013 and OneWest MSR Transaction partially closed in August and September 2013) have significantly affected our consolidated operating results. The operating results of the acquired businesses are included in our operating results from their respective acquisition dates.

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The following table summarizes our consolidated operating results for the three and nine months ended September 30, 2013 and 2012. We have provided a more complete discussion of operating results by line of business in the Segment Results and Financial Condition section.

   Three Months   Nine Months 
   2013   2012   $
Change
   %
Change
   2013   2012   $
Change
   %
Change
 
Consolidated:                                        
Revenue:                                        
Servicing and subservicing fees  $483,267   $ 223,011   $ 260,256    117%  $ 1,333,392   $578,435   $754,957    131%
Gain on loans held for sale, net   28,262        28,262        72,912        72,912     
Other   19,711    9,689    10,022    103    76,014    30,178    45,836    152 
Total revenue   531,240    232,700    298,540    128    1,482,318    608,613    873,705    144 
Operating expenses   346,260    92,793    253,467    273    960,418    264,810    695,608    263 
Income from operations   184,980    139,907    45,073    32    521,900    343,803    178,097    52 
Other income (expense):                                        
Interest expense   (110,055)   (58,417)   (51,638)   88    (303,339)   (163,660)   (139,679)   85 
Other   1,350    (744)   2,094    281    (3,441)   886    (4,327)   (488)
Other expense, net   (108,705)   (59,161)   (49,544)   84    (306,780)   (162,774)   (144,006)   88 
Income before income taxes   76,275    80,746    (4,471)   (6)   215,120    181,029    34,091    19 
Income tax expense   9,273    29,346    (20,073)   (68)   26,250    65,447    (39,197)   (60)
Net income   67,002    51,400    15,602    30    188,870    115,582    73,288    63 
Preferred stock dividends   (1,446)       (1,446)       (4,450)       (4,450)    
Deemed dividend related to beneficial conversion feature of preferred stock   (4,401)       (4,401)       (6,573)       (6,573)    
Net income attributable to Ocwen common stockholders  $61,155   $51,400   $9,755    19   $177,847   $115,582   $62,265    54 
                                         
Segment income (loss) before income taxes:                                        
Servicing  $78,028   $84,254   $(6,226)   (7)%  $263,267   $191,133   $72,134    38%
Lending   5,665        5,665        20,813        20,813     
Corporate Items and Other   (7,418)   (3,508)   (3,910)   111    (68,960)   (10,104)   (58,856)   583 
   $76,275   $80,746   $(4,471)   (6)  $215,120   $181,029   $34,091    19 

Three Months Ended September 30, 2013 versus September 30, 2012. Servicing and subservicing fee revenues for the three months ended September 30, 2013 were higher than the three months ended September 30, 2012 primarily as a result of a 234% increase in the average UPB of our total residential servicing portfolio. The Homeward and ResCap Acquisitions and the Ally and OneWest MSR Transactions drove the 234% increase in the average size of the total residential portfolio as compared to the third quarter of 2012. The increase in servicing revenue resulting from the increase in the average UPB of the residential portfolio was offset in part by the effects of changes in the portfolio mix, with a larger proportion attributed to Agency loans and to subservicing. Agency servicing fees are typically lower than Non-Agency servicing fees, and we generally earn lower fees in connection with subservicing contracts versus servicing contracts. Lower fees earned under subservicing contracts are offset by lower interest expense on advance financing. The combined servicing and subservicing fee revenues generated by the Homeward, ResCap, Ally and OneWest portfolios during the third quarter of 2013 were $239.0 million.

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Gain on sale of residential mortgage loans from our originations platforms, acquired as part of the Homeward and Liberty Acquisitions, reflected a strong pipeline coming into the quarter and higher conversion rates as borrowers reacted to rising mortgage rates. Margins on new originations were strong for most of the quarter. Gain on sale generated by the Homeward and Liberty platforms during the third quarter of 2013 were $17.0 million and $7.6 million, respectively. Liberty issued $206.7 million of Ginnie Mae reverse mortgage backed securities during the third quarter of 2013. As servicer, we are obligated to repurchase loans from Ginnie Mae guaranteed securitizations in order to complete a modification. Once the modification is completed, we pool the loans into new Ginnie Mae guaranteed securitizations at the then prevailing market value. We recorded $4.1 million in gains on the sale of the repurchased loans of $294.2 million of UPB during the quarter ended September 30, 2013.

Other revenues for the three months ended September 30, 2013 were higher than the three months ended September 30, 2012 primarily as a result of $8.7 million in loan origination revenues from our lending platforms.

Operating expenses for the three months ended September 30, 2013 increased as compared to the three months ended September 30, 2012 in part as a result of the Homeward, ResCap and Liberty Acquisitions which added $202.6 million of total operating expenses in the third quarter of 2013. In addition, operating expenses for the three months ended September 30, 2013 include transition costs related to moving loans from the ResCap platform onto Ocwen’s platform and ramp-up expenses for the OneWest transfer.

Other expense, net for the three months ended September 30, 2013 increased as compared to the three months ended September 30, 2012 primarily as a result of an increase in interest expense. The increase in interest expense was driven principally by the increase in interest on the financing liabilities that we have recognized in connection with the HLSS Transactions. This financing liability has increased from an average of $92.3 million in the third quarter of 2012 to an average of $661.2 million in the third quarter of 2013. The proceeds from the HLSS Transactions have allowed us to repay a substantial part of the borrowing incurred to finance the Homeward and ResCap Acquisitions and the Ally MSR Transaction and have provided a significant part of the financing to date for the OneWest MSR Transaction.

Consistent with our capital strategy, we expect to continue to sell rights to acquired and originated MSRs and the related servicing advances to HLSS. In the third quarter of 2013, we used the proceeds received in connection with the HLSS Transaction completed July 1 to reduce related match funded liabilities by $1.8 billion. Interest expense in connection with borrowings to fund servicing advances declined in the third quarter of 2013 as compared to the third quarter of 2012 as a result of sales of servicing advances to HLSS during the past year and the resulting payoff of advance financing facilities. However, the early repayment of our advance financing facilities resulted in our writing off to Interest expense $6.0 million of deferred financing costs associated with those facilities. We also wrote off to Other, net, $4.1 million of deferred loss on cash flow hedges relating to our advance financing facilities.

Nine Months Ended September 30, 2013 versus September 30, 2012. Servicing and subservicing fee revenues for the nine months ended September 30, 2013 were higher than for the nine months ended September 30, 2012 primarily as a result of a 256% increase in the average UPB of our residential servicing portfolio. Gains on sales of residential mortgage loans and origination revenues from our lending operations were $49.7 million and $30.9 million, respectively, for the nine months ended September 30, 2013. Gains on sales of modified FHA and VA insured loans into Ginnie Mae guaranteed securitizations were $20.3 million for the nine months ended September 30, 2013. The increase in revenues was offset in part by a decrease in the portfolio mix of servicing versus subservicing. Interest expense increased by 85% principally because of the increase in the HLSS financing liabilities and the increase in SSTL borrowings offset by a decline in match funded liabilities and a decline in the interest rate on the SSTL. Operating expenses and Other expense, net increased similarly, primarily as a result of the Homeward, ResCap, Liberty and OneWest transactions. In addition, we recorded a charge of $52.8 million during the second quarter of 2013 in connection with our ongoing discussions with the MMC, CFPB and state Attorneys General in connection with certain foreclosure related matters. See the Regulatory Contingencies section of Note 25 – Commitments and Contingencies for additional information regarding this matter.

 

Although income before income taxes for the nine months ended September 30, 2013 increased by $34.1 million as compared to the nine months ended September 30, 2012, income tax expense declined by $39.2 million as our estimated effective tax rate for 2013 declined to 12.2% as compared to 36.2% for the comparable 2012 period. Income tax provisions for interim periods are based on estimated annual income taxes calculated separately from the effect of significant, infrequent or unusual items. Income tax expense on income before income taxes differs from amounts that would be computed by applying the U.S. Federal corporate income tax rate of 35% primarily because of the effect of foreign taxes and foreign tax rates, foreign income with an indefinite deferral from U.S. taxation, losses from consolidated VIEs, state taxes and changes in the liability for selected tax items. Our effective tax rate for 2013 is lower than the U.S. Federal corporate income tax rate of 35% primarily because of lower tax rates on our operations in the USVI. As part of an initiative to consolidate the ownership and management of all of our global servicing assets and operations under a single entity, Ocwen formed OMS in 2012 under the laws of the USVI where OMS has its principal place of business. OMS is located in a federally recognized economic development zone and effective October 1, 2012 became eligible for certain benefits which have a favorable impact on our effective tax rate. Our actual effective tax rate in the future will vary depending on the mix of U.S. and foreign assets and operations.

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Change in Financial Condition Summary

Our balance sheet has grown as a result of the ResCap Acquisition and the Ally and OneWest MSR Transactions, partially offset by the HLSS Transactions completed during the period. The following table summarizes our consolidated balance sheet at the dates indicated. We provide a more complete discussion of our consolidated balance sheet in the Segments section.

   September 30,
2013
   December 31,
2012
   $ Change   %
Change
 
Cash  $357,486   $220,130   $137,356    62%
Loans held for sale, at fair value   335,102    426,480    (91,378)   (21)
Advances and match funded advances   1,480,012    3,233,707    (1,753,695)   (54)
Mortgage servicing rights, at amortized cost   1,736,943    678,937    1,058,006    156 
Mortgage servicing rights, at fair value   96,938    85,213    11,725    14 
Deferred tax assets, net   93,343    92,136    1,207    1 
Goodwill   407,620    412,866    (5,246)   (1)
Debt service accounts   45,462    88,748    (43,286)   (49)
Other   758,774    444,538    314,236    71 
Total assets  $5,311,680   $5,682,755   $(371,075)   (7)
                     
Match funded liabilities  $363,012   $2,532,745   $(2,169,733)   (86)%
Other borrowings   2,592,591    1,096,679    1,495,912    136 
Other   554,708    288,537    266,171    92 
Total liabilities   3,510,311    3,917,961    (407,650)   (10)
Mezzanine equity   59,945    153,372    (93,427)   (61)
Total stockholders’ equity   1,741,424    1,611,422    130,002    8 
Total liabilities, mezzanine equity and stockholders’ equity  $5,311,680   $5,682,755   $(371,075)   (7)

Loans held for sale, at fair value declined as sales and transfers to the loans held for investment portfolio more than offset new origination volume for the period and the loans acquired in the Liberty Acquisition. Collections and the sale of advances and match funded advances to HLSS more than offset advances and match funded advances acquired in connection with the ResCap Acquisition and the Ally and OneWest MSR Transactions. MSRs increased as a result of the ResCap Acquisition, the Ally and OneWest MSR Transactions and the MSRs generated from our lending activities during the period, net of MSR sales. The decrease in goodwill is attributable to the derecognition of goodwill assigned to the Homeward diversified fee-based business that we sold to Altisource during the period offset in part by the ResCap Acquisition.

Match funded liabilities decreased as repayments from advance collections and from reductions as a result of sales of advances to HLSS more than offset new borrowings to finance the advances acquired in the ResCap Acquisition and the Ally MSR Transaction. Other borrowings increased as a result of:

the new SSTL facility used to finance the ResCap Acquisition, partially offset by the repayment of the previous SSTL facility,
the increase in the financing liability that we recognize in connection with the sale of Rights to MSRs to HLSS,
the paydown of warehouse lines used to fund our lending business and
the repayment of the $75.0 million unsecured loan from Altisource.

Other liabilities increased largely as a result of origination representation and warranty and timeline and other penalties in connection with servicing performance against investor standards and liabilities recorded in connection with potential legal and regulatory settlements, including the potential settlement in connection with certain foreclosure related matters.

Mezzanine equity declined primarily in connection with the conversion of 100,000 of the 162,000 outstanding shares of Series A Perpetual Convertible Preferred stock in September. We repurchased the 3,145,640 shares of common stock issued upon conversion.

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Liquidity Summary

We meet our financing requirements using a combination of cash generated from operations and asset sales, debt and equity capital. Our short-term financing needs arise primarily from our holding of mortgage loans pending sale and our obligations to advance certain payments on behalf of delinquent mortgage borrowers. Our long-term financing needs arise primarily from our investments in MSRs and the financial instruments that we may acquire to manage the interest rate risk associated with those investments, and from investments that we make in technology and other capital expenditures. The structure and mix of our debt and equity capital are primarily driven by our strategic objectives but are also influenced by our credit ratings and market conditions. Such ratings and market conditions affect the type of financing we are able to obtain and the rate at which we are able to grow.

We rely primarily on secured borrowings as the key component of our financing strategy. Our financing arrangements allow us to fund a portion of our servicing advances until they are recovered and to fund our loan originations on a short-term basis until the loans are sold to secondary market investors. See Note 14 – Match Funded Liabilities and Note 15 – Other Borrowings to the unaudited Consolidated Financial Statements for additional information regarding the components of our debt.

We define liquidity as unencumbered cash balances plus unused collateralized advance financing capacity. At September 30, 2013, our cash position was $357.5 million compared to $220.1 million at December 31, 2012. We had only $0.1 million of unused collateralized advance financing capacity at September 30, 2013 and none at December 31, 2012. Additional borrowing under these facilities is limited by the amount of collateral pledged to the facility.

Unused collateralized advance financing capacity was nearly zero at September 30, 2013 primarily because we paid off and terminated three advance financing facilities as part of the July 1, 2013 HLSS Transaction. We also were able to pay off and terminate a fourth facility. As a result, total borrowing capacity under our advance financing facilities was reduced to $400.0 million at September 30, 2013 of which only $37.0 million was available at September 30, 2013. The portion of the OneWest MSR Transaction completed to date was financed using available cash, generated largely from the July 1, 2013 HLSS Transaction.

In order to reduce fees charged by lenders (which we recognize as interest expense), we limit available borrowing capacity to a level that we consider prudent relative to the current levels of advances and match funded advances and to our anticipated funding needs for reasonably foreseeable changes in advances. We regularly monitor and project cash flow to minimize liquidity risk. In assessing our liquidity outlook, our primary focus is on maintaining cash and available borrowing capacity that is sufficient to meet the needs of the business.

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

Securities issued by the U.S. government, a U.S. agency or a GSE
   
Money market mutual funds
   
Money market demand deposits
   
Demand deposit accounts

Interest Rate Risk Summary

Interest rate risk is a function of (i) the timing of re-pricing and (ii) the dollar amount of assets and liabilities that re-price at various times. We are exposed to interest rate risk to the extent that our interest rate sensitive liabilities mature or re-price at different speeds, or on different bases, than interest-earning assets.

In executing our hedging strategy for the servicing business, we attempt to mitigate the effect of increases in interest rates on the interest paid on our variable rate advance financing debt. We determine our hedging needs based on the projected excess of variable rate debt over cash and float balances since the earnings on cash and float balances are a partial offset to our exposure to changes in interest expense. Due to the recent growth of our residential servicing business, float balances have increased significantly to levels in excess of our variable rate debt. In response, we terminated our remaining interest rate swaps effective May 31, 2013. We also purchased interest rate caps as economic hedges (not designated as a hedge for accounting purposes) to minimize future interest rate exposure from increases in one-month LIBOR interest rates, as required by certain of our advance financing facilities. We terminated our remaining interest rate caps during the third quarter of 2013.

Our MSRs that are measured at fair value are subject to interest rate risk as the mortgage loans underlying the servicing rights permit the borrowers to prepay the loans. Therefore, the value of these 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). Effective April 1, 2013, we modified our strategy for managing the risks of the underlying loan portfolio and terminated all economic hedges related to our fair value MSRs. We terminated the MSR hedges because we determined that they were ineffective for large movements in interest rates and only assured losses in substantial increasing-rate environments.

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We are subject to interest rate and price risk on mortgage loans held for sale from the loan funding date until the date the loan is sold into the secondary market. To mitigate this risk, we enter into forward trades to provide an economic hedge against changes in fair value on mortgage loans held for sale. IRLCs, or loan commitments, bind us (subject to the loan approval process) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. Our interest rate exposure on these derivative loan commitments is hedged with freestanding derivatives such as forward contracts. We enter into forward contracts with respect to fixed rate loan commitments.

See Note 19 – Derivative Financial Instruments and Hedging Activities to the unaudited Consolidated Financial Statements for additional information regarding our use of derivatives.

CRITICAL ACCOUNTING POLICIES

Our ability to measure and report our operating results and financial position is heavily influenced by the need to estimate the impact or outcome of future events. Our critical accounting policies relate to the estimation and measurement of these risks. Because they inherently involve significant judgments and uncertainties, an understanding of these policies is fundamental to understanding Management’s Discussion and Analysis of Results of Operations and Financial Condition. Our significant accounting policies are discussed in detail on pages 44 through 47 of Management’s Discussion and Analysis of Results of Operations and Financial Condition and in Note 1 to our Consolidated Financial Statements for the year ended December 31, 2012 included in our Annual Report on Form 10-K filed March 1, 2013. Such policies have not changed during the first nine months of 2013.

SEGMENT RESULTS AND FINANCIAL CONDITION

For each of our segments, the following section provides a discussion of the changes in financial condition during the nine months ended September 30, 2013 and a discussion of pre-tax results of operations for the three and nine months ended September 30, 2013 and 2012.

Servicing

Servicing involves the collection and remittance of principal and interest payments received from borrowers, the administration of mortgage escrow accounts, the collection of insurance claims, the management of loans that are delinquent or in foreclosure or bankruptcy, including making servicing advances, evaluating loans for modification and other loss mitigation activities and, if necessary, foreclosure referrals and REO sales on behalf of investors or other servicers. Master servicing involves the collection of payments from servicers and the distribution of funds to investors in mortgage and asset-backed securities and whole loan packages. We typically earn contractual monthly servicing fees pursuant to servicing agreements (which are typically payable as a percentage of UPB) as well as other ancillary fees on mortgage loans for which we own the MSRs. We also earn fees under both sub-servicing and special servicing arrangements with banks and other institutions that own the MSRs. We typically earn these fees either as a percentage of UPB or on a per loan basis.

We recognize servicing fees as revenue when the fees are earned, which is generally when the borrower makes a payment or when a delinquent loan is resolved through modification (HAMP or non-HAMP), payoff or through the sale of the underlying mortgaged property following foreclosure. Our revenue recognition is, therefore, a function of unpaid principal balance (UPB), the number of payments received and delinquent loans that resolve. When a loan becomes current via our non-HAMP modification process, deferred servicing fees and late fees are considered earned and are recognized as revenue. However, if any debt is forgiven as part of a non-HAMP modification, no late fees are collected or earned. When a loan becomes current via the HAMP modification process, deferred servicing fees are earned and recognized as revenue. However, late fees are forfeited. Initial HAMP fees are also recognized as revenue at that time. In addition, under HAMP, if a modified loan remains less than 90 days delinquent, we earn HAMP success fees at the first, second and third anniversaries of the start of the trial modification.

Aggregate UPB is a key revenue driver for the Servicing business. Because servicing fees are generally expressed as a percentage of UPB, growth in the portfolio generally means growth in servicing fees. Additionally, a larger servicing portfolio generates increased ancillary fees and leads to larger custodial account balances (float balances) generating greater float earnings. In general, a larger servicing portfolio also increases operating expenses but at a less rapid pace than the growth in UPB. To the extent that we grow UPB, our amortization of MSRs will typically increase with the growth in the carrying value of our MSRs. We will also incur additional interest expense to finance servicing advances made in connection with those MSRs.

Changes in the mix of owned servicing versus subservicing impacts our fee revenue as we generally earn lower fees in connection with subservicing arrangements.  Owned servicing fees generally range from 25 to 65 basis points and entitle the servicer to certain ancillary fee income.  Subservicing fees earned typically range from 10 to 39 basis points on average.  Lower fees earned under subservicing contracts are offset by lower interest expense on advance financing.  Our product mix has changed significantly as a result of acquisitions.  Servicing fees earned on Non-Agency assets are generally higher than those earned on Agency assets.  The average servicing fee earned on our Non-Agency assets is approximately 45 basis points as compared to the Agency average servicing fee of 30 basis points.  

Delinquencies have a significant impact on the results of operations and cash flows of the Servicing business. Delinquencies affect the timing of revenue recognition because we recognize servicing fees as earned which is generally upon collection of payments from the borrower. Delinquencies also reduce float balances and float earnings. Non-performing loans are more expensive to service than performing loans because the cost of servicing is higher and, although collectibility is generally not a concern, advances to the investors increase resulting in higher financing costs.

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Prepayment speed, the rate at which the UPB for a pool or pools of loans declines, has a significant impact on the Servicing business. Items reducing UPB include normal principal payments, refinancing, loan modifications involving forgiveness of principal, voluntary property sales and involuntary property sales such as foreclosures. Prepayment speed impacts future servicing fees, amortization and valuation of MSRs, float earnings on float balances, interest expense on advances and compensating interest expense. If we expect prepayment speed to increase, amortization expense will increase because MSRs are amortized in proportion to total expected servicing income over the life of a portfolio. The converse is true when expectations for prepayment speed decrease.

The following table presents the results of operations of our Servicing segment for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Revenue                    
Servicing and subservicing fees:                    
Residential  $478,381   $219,251   $1,316,981   $570,849 
Commercial   4,123    3,907    12,086    8,198 
    482,504    223,158    1,329,067    579,047 
Gain on loans held for sale, net (1)   3,660        23,227     
Process management fees and other   10,138    8,946    29,578    27,642 
Total revenue   496,302    232,104    1,381,872    606,689 
                     
Operating expenses                    
Compensation and benefits   82,791    22,248    243,946    70,174 
Amortization of servicing rights   79,035    20,150    197,287    53,561 
Servicing and origination   30,748    9,808    76,864    18,887 
Technology and communications   30,330    9,809    84,411    25,958 
Professional services   6,621    2,947    21,989    13,166 
Occupancy and equipment   26,441    10,199    62,708    32,840 
Other operating expenses (1)   49,688    13,582    108,440    37,956 
Total operating expenses   305,654    88,743    795,645    252,542 
                     
Income from operations   190,648    143,361    586,227    354,147 
                     
Other income (expense)                    
Interest income (1)   859        1,382     
Interest expense   (106,848)   (58,144)   (293,381)   (162,810)
Loss on debt redemption           (17,030)    
Other, net   (6,631)   (963)   (13,931)   (204)
Total other expense, net   (112,620)   (59,107)   (322,960)   (163,014)
                     
Income before income taxes  $78,028   $84,254   $263,267   $191,133 
(1)Within the statement of operations for the nine months ended September 30, 2013, we reclassified certain amounts related to servicing FHA and VA loans in GNMA securitizations. We reclassified $9.9 million to Servicing and originations expense within Operating expenses. Previously, this amount was reported as Other operating expenses ($14.2 million) and Interest income ($4.3 million). We also reclassified $16.2 million of gains on sales of modified FHA and VA loans from Other, net within the Other income (expense) section to Gain on sale of loans held for sale within the Revenue section.
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The following table provides selected Servicing operating statistics at September 30:

   2013   2012   % Change 
Residential Assets Serviced               
UPB:               
Performing loans (1)  $ 371,279,813   $94,726,687    292%
Non-performing loans   56,846,036    26,639,871    113 
Non-performing real estate   6,693,577    5,700,122    17 
Total residential assets serviced (2)  $434,819,426   $ 127,066,680    242 
                
Agency loans (3)  $246,364,091   $19,759,506    1,147 
Non Agency loans   188,455,335    107,307,174    76 
Total residential loans serviced  $434,819,426   $127,066,680    242 
                
Percent of total UPB:               
Servicing portfolio   83.4%   85.4%   (2)%
Subservicing portfolio   16.6    14.6    14 
Non-performing residential assets serviced   14.6%   23.6%   (38)
                
Number of:               
Performing loans (1)   2,431,084    640,690    279%
Non-performing loans   328,546    134,445    144 
Non-performing real estate   36,521    30,292    21 
Total number of residential assets serviced (2)   2,796,151    805,427    247 
                
Agency loans (3)   1,390,272    103,453    1,244 
Non Agency loans   1,405,879    701,974    100 
Total residential loans serviced   2,796,151    805,427    247 
                
Percent of total number:               
Servicing portfolio   80.9%   86.5%   (6)%
Subservicing portfolio   19.1    13.5    41 
Non-performing residential assets serviced   13.1%   18.6%   (30)
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The following table provides selected Servicing operating statistics for the three and nine months ended September 30:

   Three Months   Nine Months 
   2013   2012   % Change   2013   2012   % Change 
Residential Assets Serviced                              
Average UPB of residential assets serviced:                              
Servicing  $ 345,662,822   $ 110,464,536    213%  $ 301,982,054   $99,644,259    203%
Subservicing   77,494,904    16,106,037    381    103,395,969    14,379,429    619 
   $423,157,726   $126,570,573    234   $405,378,023   $ 114,023,688    256 
                               
Prepayment speed (average Constant Prepayment Rate or CPR)   15.8%   14.3%   10    18.2%   14.7%   24 
                               
Average number of residential assets serviced:                              
Servicing   2,165,082    704,436    207%   1,884,850    644,776    192%
Subservicing   564,233    100,581    461    670,400    94,587    609 
    2,729,315    805,017    239    2,555,250    739,363    246 
                               
Residential Servicing and Subservicing Fees                              
Loan servicing and subservicing fees:                              
Servicing  $333,363   $143,085    133%  $903,253   $389,917    132%
Subservicing   35,189    14,297    146    91,508    27,774    229 
    368,552    157,382    134    994,761    417,691    138 
HAMP fees   40,213    21,610    86    117,681    55,684    111 
Late charges   30,155    16,171    86    85,211    52,454    62 
Loan collection fees   8,375    4,085    105    22,476    11,234    100 
Custodial accounts (float earnings)   576    927    (38)   4,184    2,378    76 
Other   30,510    19,076    60    92,668    31,408    195 
   $478,381   $219,251    118   $1,316,981   $570,849    131 
                               
Number of Completed Modifications                              
HAMP   15,273    5,317    187%   34,443    13,270    160%
Non-HAMP   16,778    12,818    31    49,928    50,288    (1)
Total   32,051    18,135    77    84,371    63,558    33 
                               
Financing Costs                              
Average balance of advances and match funded advances  $1,741,506   $4,122,294    (58)%  $2,944,769   $3,829,231    (23)%
Average borrowings (4)   1,603,023    3,147,677    (49)   2,892,292    3,203,530    (10)
Interest expense on borrowings (4)   23,134    43,191    (46)   116,026    131,868    (12)
Facility costs included in interest expense (4)   8,077    6,110    32    15,757    15,515    2 
Discount amortization included in interest expense   330    1,200    (73)   1,082    2,680    (60)
Effective average interest rate (4)   5.77%   5.49%   5    5.35%   5.49%   (3)
Average 1-month LIBOR   0.19%   0.24%   (21)   0.19%   0.24%   (21)
                               
Average Employment                              
India and other   5,120    3,792    35%   4,860    4,236    15%
United States (5)   3,275    725    352    3,386    714    374 
Total   8,395    4,517    86    8,246    4,950    67 
                               
Collections on Loans Serviced for Others  $  22,346,482   $     3,314,692    574%  $  66,846,411   $   8,563,886    681%
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(1)Performing loans include those loans that are current (less than 90 days past due) and those loans for which borrowers are making scheduled payments under loan modification, forbearance or bankruptcy plans. We consider all other loans to be non-performing.
(2)At September 30, 2013, we serviced 951,384 subprime loans with a UPB of $147.7 billion. This compares to 747,908 subprime loans with a UPB of $113.4 billion at December 31, 2012 and 609,304 subprime loans with a UPB of $93.2 billion at September 30, 2012.
(3)Agency loans at September 30, 2013 include 114,201 prime loans with a UPB of $33.7 billion that we subservice and which consist primarily of jumbo loans which exceed conforming loan size limits set by Fannie Mae and Freddie Mac.
(4)Excludes interest expense related to financing liabilities that we recognized in connection with the HLSS Transactions. Interest on the HLSS financing liabilities amounted to $74.2 million and $14.0 million for the three months ended September 30, 2013 and 2012, respectively, and $168.6 million and $27.6 million for the nine months ended September 30, 2013 and 2012, respectively. Also excludes the average balance of the HLSS financing liabilities of $661.2 million and $92.3 million, respectively, and $464.37 million and $60.2 million, respectively, during the same periods. See Note 3 – Transfers of Financial Assets to the unaudited Consolidated Financial Statements for additional information regarding the HLSS Transactions.
(5)The ResCap and Homeward Acquisitions added an average of 2,088 and 368 employees, respectively, during the three months ended September 30, 2013 and an average of 1,977 and 635 employees, respectively, during the nine months ended September 30, 2013. Excluding ResCap and Homeward employees, U.S average staffing was 819 and 725 for the three months ended September 30, 2013 and 2012, respectively, as compared to 773 and 714 for the nine months ended September 30, 2013 and 2012, respectively.
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The following table provides information regarding the changes in our portfolio of residential assets serviced:

   Amount of UPB (1)   Count 
   2013   2012   2013   2012 
Servicing and subservicing portfolio at beginning of the year  $ 203,665,716   $ 102,199,222    1,219,956    671,623 
Additions   276,366,219    47,480    1,773,522    206 
Runoff   (12,960,274)   (3,806,236)   (61,872)   (16,319)
Servicing and subservicing portfolio at March 31 (2)   467,071,661    98,440,466    2,931,606    655,510 
Additions   5,314,631    34,182,040    23,735    176,050 
        Servicing transfers   (10,933,630)       (49,356)    
Runoff   (25,197,279)   (4,749,282)   (120,060)   (20,666)
Servicing and subservicing portfolio at June 30   436,255,383    127,873,224    2,785,925    810,894 
Additions   38,739,521    4,136,704    196,251    15,741 
Servicing transfers   (22,259,926)       (94,301)    
Runoff   (17,915,552)   (4,943,248)   (91,724)   (21,208)
Servicing and subservicing portfolio at September 30  $434,819,426   $127,066,680    2,796,151    805,427 
(1)Principal modifications may include the legal separation and deferral of principal to the end of the loan (commonly referred to as principal forbearance). Principal forbearance does not accrue interest and may be collected upon final liquidation of the loan. We do not earn servicing fees on principal forbearance and, therefore, exclude it from our servicing portfolio UPB.
(2)In order to conform to the current presentation, we revised the previously reported servicing portfolio UPB at March 31, 2013 to exclude $2.4 billion related to principal forbearance.

Three months ended September 30, 2013 versus September 30, 2012. Total residential servicing and subservicing fees for the third quarter of 2013 were $259.1 million, or 118%, higher than the third quarter of 2012 primarily due to:

A 234% increase in the average UPB of assets serviced driven primarily by the Homeward and ResCap Acquisitions, the Ally and OneWest MSR Transactions and new MSR capitalization in connection with our lending activities. During the third quarter of 2013, the Homeward, ResCap, Ally and OneWest portfolios added total servicing fees and subservicing fees of $239.0 million. These increases were offset in part by runoff of the portfolio as a result of principal repayments, modifications, real estate sales and servicing transfers;
Approximately $7.1 billion in loans temporarily subserviced pending receipt of third party consents and court approvals in connection with the acquisition of ResCap in February 2013, became serviced loans upon completion of the MSR purchase in September 2013;
A 77% increase in total completed modifications across all portfolios;
Offset in part by:
oA change in the portfolio product mix, with a larger proportion of the portfolio attributable to Agency loans for which we earn a lower fees on average;
oA change in the portfolio profile, with a larger proportion of the portfolio growth attributable to performing loans, which leads to lower revenue potential for ancillary and default servicing; and,
oA change in the portfolio mix, with a larger proportion of the portfolio attributable to subservicing for which we earn lower fees.

An increase in modifications typically results in higher revenue for the period because when we return a loan to performing status, we generally recognize any deferred servicing fees and late fees on the loan. For loans modified under HAMP, which is set to expire on December 31, 2015, we earn HAMP fees in place of late fees. As noted above, total completed modifications were up 77% with HAMP accounting for 48% of the total versus 29% in the third quarter of 2012. Of the total modifications completed during the third quarter of 2013, 59% included principal modifications. This compares to 75% in the third quarter of 2012. Our “Shared Appreciation Modification” (SAM) program accounted for 15% of the total modifications completed during the third quarter of 2013 as compared to 24% for the third quarter of 2012. We recognized servicing fee, late charge and HAMP fee revenue of $80.8 million and $45.9 million during the third quarter of 2013 and 2012, respectively, in connection with modifications.

The serviced portfolio product mix has changed significantly as a result of the Homeward and ResCap Acquisitions and the Ally and OneWest MSR Transactions.  The proportion of Agency loans to total serviced assets grew from 16% at September 30, 2012 to 57% at September 30, 2013.  Agency loans represented 74% of the overall growth in the UPB of serviced assets.  Agency servicing fees earned are typically lower than Non-Agency servicing fees.  Continuing growth in our Agency serviced assets will result in revenue growth that will lag the growth in UPB.  Similarly, the change in mix of serviced loans versus subserviced loans results in residential servicing and subservicing revenues growing more slowly than the UPB of serviced assets.  Combined, these changes in portfolio mix resulted in a decrease in annualized revenues to 0.45% of average UPB in the third quarter of 2013 as compared to 0.69% for the third quarter of 2012.   

Overall, the non-performing delinquency rate based on UPB dropped from 23.6% at September 30, 2012 to 14.6% at September 30, 2013 largely due to the ResCap and Ally portfolios which had a combined non-performing rate of 7.1% at September 30, 2013. Excluding the effects of the ResCap Acquisition and Ally MSR Transaction, the non-performing rate was 19.7% at September 30, 2013. Improvements in our overall delinquency rates also continue to be driven by modifications and improvements in our early loss mitigation efforts.

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We estimate that the balance of deferred servicing fees related to delinquent borrower payments was $500.5 million at September 30, 2013 compared to $452.0 million at December 31, 2012. The net increase is primarily due to the ResCap Acquisition and the Ally and OneWest MSR Transactions offset by collections and resolutions of delinquent loans through modification, payoff or through the sale of the underlying mortgaged property following foreclosure.

Average prepayment speed increased to 15.8% for the third quarter of 2013 compared to 14.3% for the same period of 2012. For the third quarter of 2013, principal reduction modifications, regular principal payments and other voluntary payoffs accounted for approximately 83% of average CPR with real estate sales and other involuntary liquidations accounting for the remaining 17%. For the third quarter of 2012, total voluntary and involuntary reductions accounted for 51% and 49%, respectively, of average CPR. Principal reduction modifications accounted for 15% and 16% of our average prepayment speed for the 2013 and 2012 periods, respectively. Primarily as a result of the Homeward and ResCap Acquisitions and the Ally MSR Transaction, Agency, prime loans comprise 57% of the total UPB of our servicing portfolio at September 30, 2013 as compared to 16% at September 30, 2012. These Agency loans have higher voluntary prepayments as compared with our non-prime portfolios. Historically low interest rates and improving home values create the ideal environment for voluntary prepayments. The shift in the product mix of our portfolio is resulting in increased CPR. Loss mitigation activities in connection with newly acquired portfolios also increase CPR.

Gain on loans held for sale, net of $3.7 million for the three months ended September 30, 2013 represents gains on the sale of modified FHA and VA loans. As servicer, we are obligated to repurchase loans from Ginnie Mae guaranteed securitizations in order to complete a modification. Once the modification is completed we pool the loans into new Ginnie Mae guaranteed securitizations at the then prevailing market value.

Operating expenses increased by $216.9 million in the third quarter of 2013, or 244%, as compared to the third quarter of 2012 primarily as a result of the effects of the Homeward and ResCap Acquisitions and the Ally and OneWest MSR Transactions.

Compensation and benefits increased by $60.5 million, or 272%, largely as a result of an increase in headcount resulting from the ResCap and Homeward Acquisitions. At September 30, 2013, ResCap and Homeward employees totaled 2,015 and 1,428, respectively.
Amortization of MSRs increased by $58.9 million in the third quarter of 2013 due principally to $57.0 million of additional amortization attributed to the Homeward, ResCap, Ally and OneWest transactions offset in part by a decline in amortization on pre-existing MSRs because of portfolio runoff.
Servicing and origination expenses increased by $20.9 million primarily due to $17.8 million of losses recognized in connection with our Ginnie Mae servicing. As servicer, we are obligated to purchase delinquent loans immediately prior to foreclosure at a price equal to the UPB of the loans plus accrued and unpaid interest. Upon resolution of the loan, we file claims for reimbursement from the FHA or the VA in accordance with the contractual reimbursement levels. We may not be reimbursed fully for interest and principal losses and expenses to the extent that they exceed reimbursable rates. These costs are contemplated in the cash flow in connection with our Ginnie Mae MSRs.
Technology and communications and Occupancy and equipment costs increased by a combined $36.7 million as we added facilities and infrastructure, largely through the Homeward and ResCap Acquisitions, to support the residential servicing portfolio growth.
Other operating expenses increased by $36.1 million due in large part to $19.5 million of additional overhead cost allocations for support services including law, human resources, accounting and finance. We also incurred $13.6 million outsourcing expenses incurred primarily in connection with the acquired ResCap servicing platform. The ResCap servicing platform leverages third-party outsourcing for a variety of functions.  We anticipate these costs will be absorbed and/or diminish as the ResCap assets transition to the REALServicing™ platform.

Interest expense related to the financing liabilities that we recognized in connection with the HLSS Transactions increased to $74.2 million for the third quarter of 2013 from $14.0 million in the third quarter of 2012. The average balance of the HLSS financing liabilities increased to $661.2 million in the third quarter of 2013 from $92.3 million in the third quarter of 2012. As discussed in the following paragraphs, interest expense on the portion of the sales proceeds accounted for as a financing is greater than the interest on the match funded liabilities that were assumed by HLSS or repaid.

Under the agreements associated with the HLSS Transactions, we agree to remit to HLSS the servicing fees generated by the MSRs, except for the ancillary fees. HLSS, in turn, pays us a subservicing fee on the related mortgage loans. The servicing fees that we remit to HLSS, net of the subservicing fees that we receive from HLSS, are accounted for in part as a reduction of the HLSS financing liability with the remainder accounted for as interest expense.

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Typically, we fund 100% of the cost of MSRs with our own capital on which we recognize no interest expense. In the HLSS Transactions, we effectively finance 100% of the MSRs, and we are also relieved of both the obligation to fund future servicing advances and the need to bear the cost of financing the advances. A portion of the fees remitted to HLSS compensates HLSS for relieving us of this obligation. By comparison, in a traditional secured financing arrangement for financings related to private label securities, we would generally expect to obtain financing of between 70% and 90% of the value of the pledged assets. For these reasons, the interest expense paid to HLSS is substantially higher than it would be if we were to retain the MSRs and fund the MSRs and the advances on our balance sheet. The benefit of the HLSS Transactions is that they give us the ability to redeploy our capital toward additional acquisitions and to avoid the need to raise additional capital, which would dilute our shareholders.

Average borrowings of the Servicing segment, excluding the HLSS financing liabilities, decreased by 49% during the third quarter of 2013 as compared to 2012. The decline in these borrowings was driven largely by the 58% decline in the average balance of advances and match funded advances during the same period. During the fourth quarter of 2012 and through the first half of 2013, we increased borrowings substantially in order to fund the Homeward, ResCap and Ally transactions. While the decrease in average borrowings in the third quarter of 2013 is, in part, the result of repayments of match funded debt from advance collections, the largest contributor to the decline was the HLSS Transaction that closed on July 1, 2013. As a part of this transaction, we sold $2.4 billion of advances to HLSS and fully repaid $1.8 billion of borrowings under three match funded advance financing facilities. We were able the use the remaining proceeds from the July transaction to fund the initial purchases of MSRs and advances related to the OneWest MSR Transaction as well as other smaller asset acquisitions.

Interest expense, excluding interest on the HLSS financing liabilities, decreased by 46% as compared to the 49% decrease in average borrowings as the result of several factors. The average effective rate on our match funded debt increased from 4.43% during the third quarter of 2012 to 16.70% during the third quarter of 2013. This increase was principally the result of the accelerated write-off of $6.0 million of deferred financing costs associated with the three advance financing facilities that were repaid as part of the July 1, 2013 HLSS Transaction and a fourth facility that was also repaid in July. The effect of the write off of these deferred fees was largely offset by a decline in the effective rate on our SSTL debt from 9.45% to 5.54% as a result of decreases both in the margin applied to the interest rate index and in the floor placed on the interest rate index. However, because we chose to redeploy the net proceeds from the July 1, 2013 HLSS Transaction principally to fund the OneWest MSR Transaction rather than pay down the SSTL, we incurred additional interest expense during the three months ended September 30, 2013.

Other, net, for the three months ended September 30, 2013 includes the amortization of $7.8 million of deferred derivative losses on cash flow hedges from Accumulated other comprehensive loss. This loss is primarily the result of the accelerated write off of $4.1 million of deferrals associated with the four advance financing facilities that we repaid and terminated in July. The loss also includes the amortization of cash flow hedge losses related to the Ally MSR Transaction.

Nine months ended September 30, 2013 versus September 30, 2012. Similar to the three months ended September 30, 2013, revenues and operating expenses of the Servicing segment for the nine months ended September 30, 2013 were significantly impacted by the Homeward, ResCap, Liberty, Ally and OneWest transactions and the liability established during the second quarter of 2013 in connection with certain foreclosure related matters. Residential servicing and subservicing fee revenues for the nine months ended September 30, 2013 were $746.1 million, or 131%, higher than for the nine months ended September 30, 2012 primarily as a result of a 256% increase in the average UPB of our residential servicing portfolio and a 33% increase in completed modifications. This increase was offset in part by changes in the portfolio mix, with Agency loans and subservicing contracts comprising a larger proportion of the total portfolio. The Homeward, ResCap, Ally and OneWest portfolios added $587.2 million of total servicing fees and subservicing fees during the nine months ended September 30, 2013. Revenue for the nine months ended September 30, 2013 also includes $23.2 million of gains on the sale of modified FHA and VA loans. Operating expenses increased by $543.1 million, or 215%, with the Homeward, ResCap and Liberty Acquisitions accounting for approximately $516.7 million of the increase.

Interest expense on the HLSS financing liabilities increased from $27.6 million during nine months ended September 30, 2012 to $168.6 million during the nine months ended September 30, 2013 as the average balance of the HLSS financing liabilities increase from $60.2 to $464.7 million during the same periods, respectively.

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Excluding the HLSS financing liabilities, average borrowings of the Servicing segment decreased by 10% during the nine months ended September 30, 2013 as compared to the same period of 2012 while average advances and match funded advances decreased by 23%. Average borrowings declined less than average advances principally because we had significantly increased the percentage of assets financed during the first half of 2013 in order to fund the Homeward and ResCap Acquisitions. Interest expense, excluding interest on the HLSS financing liabilities, decreased by 12% as declines in the effective rate on the SSTL debt were offset by the write off of $ 6.0 million of deferred financing costs due to the early payoff of advance financing facilities. As a result, the average effective rate on our match funded debt increased from 4.47% during the nine months ended September 30, 2012 to 4.69% during the same period of 2013. The effective rate on our SSTL debt declined from 8.82% to 5.98% due to decreases both in the margin applied to the interest rate index and in the floor placed on the interest rate index.

The following table presents assets and liabilities of the Servicing segment at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Advances  $937,681   $176,360 
Match funded advances   533,725    3,049,244 
Mortgage servicing rights, at amortized cost   1,734,480    678,937 
Mortgage servicing rights, at fair value   96,938    85,213 
Receivables, net   135,663    83,223 
Goodwill   284,025    210,965 
Premises and equipment   28,349    13,932 
Debt service accounts   42,685    87,249 
Asset purchase price deposit – ResCap Acquisition       57,000 
Prepaid lender fees and debt issuance costs, net   24,846    14,313 
Due from related parties   33,541    8,111 
Loans held for sale, at lower of cost or fair value   67,798    147 
Other   5,779    33,349 
Total assets  $3,925,510   $4,498,043 
           
Match funded liabilities  $363,012   $2,532,745 
Other borrowings   2,000,701    705,771 
Liability for indemnification obligations   198,635    38,140 
Accrued expenses   38,138    47,682 
Due to related parties   12,553    37,260 
Checks held for escheat   24,155    29,593 
Payable to servicing and subservicing investors   27,063    9,973 
Servicing liabilities   11,568    9,830 
Accrued interest payable   9,371    5,412 
Other   50,472    21,101 
Total liabilities  $2,735,668   $3,437,507 

The ResCap Acquisition, the Ally and OneWest MSR Transactions and the HLSS Transactions, collectively, had a significant effect on the Servicing balance sheet during the nine months ended September 30, 2013. Largely as a result of these transactions:

Advances and Match funded advances decreased by $1.8 billion primarily due to the sale of $3.5 billion of advances to HLSS and collections offset by the ResCap Acquisition and Ally and OneWest MSR Transactions which added $1.7 billion, $73.6 million and $371.6 million of advances, respectively.
MSRs, at amortized cost, increased by $1.1 billion as a result of the ResCap Acquisition ($391.9 million), Ally MSR Transaction ($683.8 million), OneWest MSR Transaction ($127.0 million) and new capitalization of MSRs from our lending operations ($63.2 million) offset by amortization ($197.9 million) and sales ($17.5 million).
We recorded goodwill of $73.1 million in the Servicing segment in connection with the ResCap Acquisition.
As a Ginnie Mae servicer, we have an obligation to repurchase certain loans from Ginnie Mae guaranteed securitizations under certain circumstances including, but not limited to, in connection with loan modifications, immediately prior to foreclosure and in connection with loan resolutions. These loans are held for sale and are carried at the lower of cost or fair value. The carrying amount at September 30, 2013 was $67.8 million.
Match funded liabilities decreased by $2.2 billion. We used $2.7 billion of proceeds from the HLSS Transactions to repay match funded liabilities. This decrease was offset by new borrowings to finance the advances acquired in the ResCap Acquisition and the Ally MSR Transaction.
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Other borrowings increased by $1.3 billion primarily due to borrowings of $1.3 billion under a new SSTL facility principally to fund the ResCap acquisition. We repaid the previous SSTL which had an outstanding balance of $306.0 million net of discount at December 31, 2012 and recognized a loss on early redemption of $15.0 million representing the write-off of unamortized deferred costs and discount. We also repaid the senior unsecured loan agreement with Altisource under which we borrowed $75.0 million to finance a portion of the Homeward Acquisition. Financing liabilities that we recognized in connection with the HLSS Transactions increased by $341.4 million primarily as a result of a sale of Rights to MSRs that we accounted for as a financing.
The ResCap Acquisition added $74.6 million of accrued expenses, primarily related to a liability for compensatory fees for foreclosures that may ultimately exceed investor timelines. The Ally MSR Transaction included the assumption of origination representation and warranty obligations of approximately $136.7 million in connection with a majority of the acquired MSRs.

Lending

We significantly expanded our origination capabilities with the completion of the Homeward (December 2012) and Liberty (April 2013) Acquisitions. Liberty is the leading reverse mortgage originator based on industry data for June 2013 with strong positions in both retail and wholesale originations. There is sizable untapped potential in the reverse mortgage market that could sustain future growth. Based on Consumer Finance Protection Bureau (CFPB) data, we estimate the total potential size of the reverse mortgage market at $1.9 trillion, of which only about 10% has been penetrated to date. The Lending segment is focused on originating and purchasing Agency-conforming residential first-lien forward and reverse mortgage loans mainly through direct lending and correspondent channels.  The direct lending business has initially focused on pursuing refinancing opportunities from our existing servicing portfolio, where permitted. Originated loans are typically sold shortly after origination into a liquid market on a servicing retained basis.

Lending provides a low cost means of acquiring MSRs with good return profiles.  Loans are acquired through correspondent lender relationships, broker relationships and by directly originating loans for customers in our servicing portfolio. We continued to grow our direct lending business in the third quarter, increasing our number of loan officers by 50% to 75. Our business is well positioned to shift with the market as our Lending business operates with a highly variable cost structure enabling us to adapt to changing market demand.

The Lending segment contributed $5.7 million of pre-tax income on $33.5 million of revenue in the third quarter. The Homeward lending operation generated $8.9 million of pre-tax income and funded $1.4 billion with another $142 million recaptured via partnerships. While the residential lending market overall contracted almost 30% over the same period, pull-through adjusted lock volume of $1.5 billion increased 6% above the prior quarter.  Margin increased in the third quarter due to a change in the funded volume mix toward the recapture of loans from our portfolio. Loans originated through our own direct-to-consumer operations grew over 60% from $60.6 million in the second quarter of 2013 to over $98 million in the third quarter of 2013. Ocwen’s direct channel had locks increase by approximately four times the second quarter’s level while volume sourced from the correspondent channel dropped from 99% of total volume in the third quarter of 2012 to 61% in the third quarter of 2013. From a product perspective, FHA/VA products were introduced in the quarter and grew to 13% of fundings.  HARP comprised 16% of fundings compared to 1% in the third quarter of 2012.  The proportion of purchase as compared to refinance originations increased in line with overall market trends.

Liberty reverse mortgage operation had a negative overall contribution to segment pre-tax income with a $3.2 million loss as funded volume of $278 million declined from $370 million in the second quarter. Industry changes to product availability have resulted in current period volume and margin contraction. The reverse mortgage market shifted from a fixed rate product (70% share), to a LIBOR product (90% share) resulting in lower day one loan size and gain on sale impacting current period income. Over time, the loan balances on these newly originated loans are expected to grow generating estimated future value of $6.4 million relating to third quarter production.

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The following table presents the results of operations of the Lending segment for the periods ended September 30, 2013:

   Three Months   Nine Months 
Revenue          
Gain on loans held for sale, net  $24,602   $49,687 
Other   8,937    31,493 
Total revenue   33,539    81,180 
           
Operating expenses   29,504    69,543 
           
Income from operations   4,035    11,637 
           
Other income (expense)          
Interest income   3,066    12,432 
Interest expense   (3,279)   (10,108)
Gain on debt redemption   1,282    4,474 
Other, net   561    2,378 
Other income, net   1,630    9,176 
           
Income before income taxes  $5,665   $20,813 

Our funded originations in 2013 were as follows:

   Three Months
Ended
March 31
   Three Months
Ended
June 30
   Three Months
Ended
September 30
   Nine Months
Ended
September 30
 
Loans Funded (UPB):                    
Correspondent and other  $2,357,967   $1,532,425   $1,307,261   $5,197,653 
Direct   33,644    60,646    98,458    192,748 
   $2,391,611   $1,593,071   $1,405,719   $5,390,401 

Total revenue for the Lending segment declined slightly to $33.5 million, or 0.6%, in the third quarter of 2013 as compared to the second quarter of 2013. Revenue for the Homeward lending operation grew over 40% in the third quarter of 2013 as compared to the second quarter of 2013 as a result of higher gains on sales of mortgages, following a shift towards the recapture of loans from our portfolio. The market shift to variable rate product negatively impacted Liberty’s revenue which declined by 37% in the third quarter of 2013 as compared to the second quarter of 2013.  Overall operating expenses for the segment increased slightly to $29.5 million, or 2%, in the third quarter of 2013 as compared to the second quarter of 2013. 

The servicing values utilized in our gain on sale calculation are evaluated closely and measured against market levels to foster a strong balance sheet and generate required returns over the estimated life of the originated MSR.  To date, the excellent credit quality of the loans generated by our Lending segment has been reflected by our having no credit losses from repurchases and by our experiencing a 60+ day delinquency rate of only 1% on the loans.

As disclosed in Note 15 – Other Borrowings to the unaudited Consolidated Financial Statements, we have sold MSRs for certain loans to an unrelated third party in transactions accounted for as financings. In June 2013 and September 2013, we repurchased MSRs from the December 2012 sale related to loans that had been refinanced under HARP and recognized a gain on the retirement of the financing liability of $1.3 million and $4.5 million for the three and nine months ended September 30, 2013, respectively.

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The following table presents assets and liabilities of the Lending segment at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Loans held for sale, at fair value  $335,102   $426,480 
Mortgage servicing rights, at amortized cost   2,463     
Receivables   11,527    850 
Goodwill   123,494    120,294 
Loans – restricted for securitization investors, at fair value   290,853     
Derivatives, at fair value   12,965     
Other   2,373    2,945 
Total assets  $778,777   $550,569 
           
Other borrowings  $588,667   $388,075 
Derivatives, at fair value   11,659     
Other   22,077    19 
Total liabilities  $622,403   $388,094 

The Liberty Acquisition, offset by a decline in forward mortgage origination volume, drove the most significant changes to the Lending balance sheet during the nine months ended September 30, 2013:

Loans held for sale, at fair value declined as sales more than offset new origination volume for the period and the $60.0 million loans acquired in the Liberty Acquisition. See Note 6 – Loans Held for Sale, at Fair Value for additional information.
Loans – restricted for securitization investors, at fair value represent reverse mortgage loans sold into Ginnie Mae-guaranteed securitizations that we include in our consolidated financial statements because the transfers of the loans to the trusts did not qualify for sales accounting treatment.

Borrowings increased as a result of warehouse facilities assumed in connection with the Liberty Acquisition and the recognition of $284.2 million of amounts due to the holders of participating interests in 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 sales accounting treatment. These increases were offset in part by declines in borrowings under existing warehouse facilities as a result of a decline in origination volume. See Note 15 – Other Borrowings for additional information regarding warehouse facilities used to fund originations of loans.

Corporate Items and Other

The following table presents the results of operations of Corporate Items and Other for the periods ended September 30:

   Three Months   Nine Months 
   2013   2012   2013   2012 
Revenue  $1,801   $873   $19,758   $2,736 
Operating expenses   11,143    4,162    95,361    12,659 
Loss from operations   (9,342)   (3,289)   (75,603)   (9,923)
Other income (expense)                    
Net interest income   1,526    1,811    3,666    5,584 
Other, net   398    (2,030)   2,977    (5,765)
Other income (expense), net   1,924    (219)   6,643    (181)
                     
Loss before income taxes  $(7,418)  $(3,508)  $(68,960)  $(10,104)

Three months ended September 30, 2013 versus September 30, 2012. Operating expenses for the three months ended September 30, 2013 are higher than the three months ended September 30, 2012 primarily due to costs incurred in connection with certain legal matters and other professional services, Homeward Acquisition integration costs, costs associated with facilities in India and the Philippines that are not yet operational and other unallocated expenses due to timing.  Accumulated costs associated with India and Philippines facilities will be allocated to the appropriate segments once they are operational. 

Nine months ended September 30, 2013 versus September 30, 2012. Revenues and operating expenses for the first nine months of 2013 include $15.2 million and $15.0 million, respectively, related to the diversified fee-based business we acquired as part of the Homeward Acquisition, the majority of which was subsequently sold on March 29, 2013. Operating expenses for the nine months ended September 30, 2013 also include the $52.8 million charge recorded during the second quarter of 2013 in connection with our estimated liability related to our ongoing discussions with the MMC, CFPB and state Attorneys General in connection with certain foreclosure related matters.

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Other, net in the first nine months of 2013 includes $2.1 million of equity in earnings in Powerlink Settlement Services, LP (Powerlink), an entity in which we hold a 69.79% interest that we acquired as part of the Homeward Acquisition. Powerlink provides title, closing and valuation services. Other, net for the first nine months of 2012 includes $3.5 million of losses on subprime loans held for sale that we account for at the lower of cost or fair value.

The following table presents the assets and liabilities of Corporate Items and Other at the dates indicated:

   September 30,
2013
   December 31,
2012
 
Cash  $357,473   $220,130 
Loans held for sale, at lower of cost or fair value (1)   18,152    82,720 
Advances   8,620    8,144 
Income taxes receivable   23,955    25,546 
Other receivables, net   16,876    15,733 
Goodwill (2)   101    81,607 
Deferred tax assets, net   93,343    92,136 
Premises and equipment, net   27,517    19,289 
Investment in unconsolidated entities (3)   11,766    25,187 
Interest-earning collateral deposits (4)   5,533    23,193 
Prepaid income taxes   23,112    23,112 
Real estate   8,083    6,205 
Due from related parties   1,842    4,250 
Other   11,020    6,891 
Total assets  $607,393   $634,143 
           
Other borrowings  $3,223   $2,833 
Liability for certain foreclosure matters (5)   66,431    13,602 
Accrued expenses (6)   49,574    22,192 
Liability for selected tax items   22,338    22,702 
Derivatives, at fair value (4)       15,614 
Checks held for escheat   810    3,667 
Due to related parties   3,982    7,775 
Other   5,882    3,975 
Total liabilities  $152,240   $92,360 
(1)Loans held for sale are net of valuation allowances of $12.7 million and $13.8 million at September 30, 2013 and December 31, 2012, respectively. In December 2012, we acquired non-performing mortgage loans with an aggregate UPB of $124.3 million for a purchase price of $65.4 million. We sold these loans to Altisource Residential, LP in February 2013 for an insignificant gain. See Note 23 – Related Party Transactions.
(2)Goodwill assigned to the diversified fee-based business acquired from Homeward in 2012 was derecognized upon the sale of this business to Altisource on March 29 2013. See Note 4 – Business Acquisitions to the unaudited Consolidated Financial Statements.
(3)On March 31, 2013, we increased our ownership in Correspondent One to 100% by acquiring the 51% of shares held by others (including 49% held by Altisource). As a result, we began including the accounts of Correspondent One in our unaudited Consolidated Financial Statements as of the acquisition date and have eliminated our investment. See Note 4 – Business Acquisitions to the unaudited Consolidated Financial Statements.
(4)On May 31, 2013, we terminated our interest rate swap agreements that we purchased to hedge against our exposure to an increase in variable interest rates on match funded advance borrowings. Interest-earning collateral deposits at December 31, 2012 included $19.3 million of cash collateral on deposit with the counterparties to our derivatives, the majority of which related to the swap agreements. See Note 19 – Derivative Financial Instruments and Hedging Activities to the unaudited Consolidated Financial Statements.
(5)This balance represents a liability established in connection with our ongoing discussions with the MMC, CFPB and state Attorneys General in connection with certain foreclosure related matters. See the Regulatory Contingencies section of Note 25 – Commitments and Contingencies to the unaudited Consolidated Financial Statements for additional information.
(6)The increase in accrued expenses occurred largely because of compensation related accruals associated with increased headcount resulting primarily from the ResCap and Homeward Acquisitions.
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LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2013, our cash position was $357.5 million compared to $220.1 million at December 31, 2012. We invest cash that is in excess of our immediate operating needs primarily in money market deposit accounts.

Investment policy and funding strategy. Our primary sources of funds for near-term liquidity are:

     
  Collections of servicing fees and ancillary revenues
     
  Collections of prior servicer advances in excess of new advances
     
  Proceeds from match funded liabilities
     
  Proceeds from other borrowings, including warehouse facilities
     
  Proceeds from sales of Rights to MSRs and servicing advances
     
  Proceeds from sales of originated loans.

Advances and Match funded advances comprised 28% of total assets at September 30, 2013. Most of our advances have the highest reimbursement priority (i.e., “top of the waterfall”) whereby we are entitled to repayment from respective loan or REO liquidation proceeds before any interest or principal is paid to investors. At September 30, 2013, $37.0 million of the total maximum borrowing capacity under our servicing advance facilities of $400.0 million remained available; however, only $0.1 million could be used based on the amount of available collateral.

We use mortgage loan warehouse facilities to fund newly-originated loans on a short-term basis until they are sold to secondary market investors, including GSEs or other third party investors. The majority of these warehouse facilities are structured as repurchase agreements under which ownership of the loans is temporarily transferred to a lender. The loans are transferred at a discount or “haircut” which serves as the primary credit enhancement for the lender. The funds are repaid using the proceeds from the sale of the loans to the secondary market investors, usually within 30-45 days. In the first quarter of 2013, we extended the maturity date of a number of our warehouse facilities and increased the maximum borrowing capacity. At September 30, 2013, $635.6 million of borrowing capacity was available under our lending warehouse facilities including our warehouse facilities for reverse mortgages. See Note 15 – Other Borrowings to our unaudited Consolidated Financial Statements for additional details.

In addition to these near-term sources, potential additional long-term sources of liquidity include proceeds from long-term secured borrowings such as the SSTL facility and proceeds from the issuance of debt securities and equity capital; although we cannot assure that they will be available on terms that we find acceptable. In connection with the ResCap Acquisition in February 2013, we repaid the borrowings under our previous SSTL with a portion of the proceeds of a new $1.3 billion SSTL facility. In September 2013, the terms of our new SSTL facility were amended to allow for changes in our capital structure, including issuing additional debt and repurchasing common stock.

We also rely on the secondary mortgage market as a source of long-term capital to support our lending operations. Substantially all of the mortgage loans that we produce are sold in the secondary mortgage market in the form of residential mortgage backed securities guaranteed by Fannie Mae or Freddie Mac or, in the case of mortgage backed securities guaranteed by Ginnie Mae, are mortgage loans insured or guaranteed by the FHA or VA.

Our primary uses of funds are:

Payments for advances in excess of collections on existing servicing portfolios,
   
Payment of interest and operating costs,
   
Purchase of MSRs and related advances,
   
Funding of originated loans and
   
Repayments of borrowings, including match funded liabilities and warehouse facilities.

We closely monitor our liquidity position and ongoing funding requirements, and we regularly monitor and project cash flow by period to minimize liquidity risk. In assessing our liquidity outlook, our primary focus is on four measures:

Requirements for maturing liabilities compared to dollars generated from maturing assets and operating cash flow,
Future sales of Rights to MSRs and servicing advances
The change in advances and match funded advances compared to the change in match funded liabilities and
Available borrowing capacity.
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Outlook. In order to reduce fees charged by lenders (which we recognize as interest expense), we limit available borrowing capacity to a level that we consider prudent relative to the current levels of advances and to our funding needs for reasonably foreseeable changes in advances. We also monitor the duration of our funding sources. Increases in the term of our funding sources allows us to better match the duration of our advances and corresponding borrowings and to further reduce the relative cost of up-front facility fees and expenses.

Although we substantially reduced both the maximum and available borrowing capacities under our advance financing facilities during the third quarter of 2013, we believe that we have sufficient sources of debt financing to fund all but the largest servicing acquisitions without issuing common equity capital. Additional senior secured debt, borrowings under servicing advance facilities and net proceeds from sales of MSRs and Rights to MSRs and related advances were sufficient to fund the ResCap Acquisition and the Ally and OneWest MSR Transactions. We believe that the expected proceeds from a planned HLSS Transaction in the fourth quarter will be sufficient to fund additional asset acquisitions in the short term. In addition, we are negotiating a new advance financing facility that we expect to close in the fourth quarter that will add substantially to our borrowing capacity.

As disclosed in Note 18 – Equity, we announced on October 31, 2013 that our Board of Directors had authorized a share repurchase program for up to an aggregate of $500.0 million of our issued and outstanding shares of common stock. Repurchases may be made in open market transactions at prevailing market prices or in privately negotiated transactions. Unless we amend the share repurchase program or repurchase the full $500.0 million amount by an earlier date, the share repurchase program will continue through July 2016. We may use SEC Rule 10b5-1 plans in connection with our share repurchase program. No assurances can be given as to the amount of shares, if any, that we may repurchase in any given period. To date, we have not repurchased any shares under this program. The repurchase of shares issued in connection with the conversion of Preferred Shares is not considered to be part of this repurchase program and, therefore, does not count against the $500.0 million aggregate value limit.

Debt financing summary. During the nine months ended September 30, 2013:

We borrowed $1.3 billion under a new SSTL facility in connection with the ResCap Acquisition and repaid the remaining balance of the previous SSTL.
We borrowed $1.2 billion under two new facilities and one existing facility in connection with the financing of advances that we acquired in connection with the ResCap Acquisition. These facilities were repaid and terminated in conjunction with the July 1, 2013 HLSS Transaction;
We borrowed $1.2 billion under a new $1.4 billion bridge facility. The proceeds from this bridge facility were used to repay certain advance facilities that were assumed in the Homeward Acquisition. This facility was repaid and terminated in connection with the July 1, 2013 HLSS Transaction;
We amended the maximum borrowing capacity of certain warehouse facilities and added two new warehouse facilities, increasing the available borrowing capacity available to our Lending business activities by $286.5 million.

Maximum borrowing capacity for match funded advances decreased by $3.3 billion from $3.7 billion at December 31, 2012 to $400.0 million at September 30, 2013. During the first nine months of 2013, we fully repaid and terminated match funded advance financing facilities that had total aggregate maximum borrowing capacity of $3.7 billion at December 31, 2012. We also fully repaid two facilities with a maximum borrowing capacity of $1.4 billion that we had entered into in connection with the ResCap acquisition, and we reduced the borrowing capacity under another facility from $450.0 million to $100.0 million.

Our available advance borrowing capacity decreased from $1.2 billion at December 31, 2012 to $37.0 million at September 30, 2013, although only $0.1 million could be used given the amount of available collateral. Match funded advance financing facilities that we repaid and terminated during the first nine months of 2013 had total aggregate available borrowing capacity of $1.1 billion at December 31, 2012.

Our ability to finance servicing advances is a significant factor that affects our liquidity. Our ability to continue to pledge collateral under each advance facility depends on the performance of the collateral. In addition, a number of our match funded advance facilities contain provisions that limit the eligibility of advances to be financed based on the length of time that advances are outstanding, and certain of our match funded advance facilities have provisions that limit new borrowings if average foreclosure timelines extend beyond a certain time period, either of which, if such provisions applied, could adversely affect liquidity by reducing our average effective advance rate. Currently, the large majority of our collateral qualifies for financing under the advance facility to which it is pledged.

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Ongoing inquiries into servicer foreclosure processes could result in actions by state or federal governmental bodies, regulators or the courts that could result in a further extension of foreclosure timelines. The effect of such extensions could be an increase in advances, but if foreclosure moratoria are issued in a manner that brings into question the timely recovery of advances on foreclosed properties Ocwen may no longer be obligated to make further advances and may be able to recover existing advances in certain securitizations from pool-level collections which could mitigate any advance increase. The effects of the extension of foreclosure timelines have, thus far, been more than offset by the effects of lower UPB delinquencies through loss mitigation efforts and increases in modifications and other forms of resolution, and advances have continued to decline. Absent significant changes in the foreclosure process, we expect advances with respect to our existing portfolios to continue to decline.

Certain of our existing debt covenants limit our ability to incur additional debt in relation to our equity, require that we do not exceed maximum levels of delinquent loans and require that we maintain minimum levels of liquid assets and earnings. Failure to comply with these covenants could result in restrictions on new borrowings or the early termination of our borrowing facilities. We believe that we are currently in compliance with these covenants and do not expect them to restrict our activities.

Cash flows for the nine months ended September 30, 2013. Our operating activities provided $1.0 billion of cash largely due to $424.0 million of collections of servicing advances, and net income of $188.9 million, adjusted for MSR amortization of $197.4 million and other non-cash items. Operating cash flows were used principally to repay related match funded liabilities and to fund the portions of the ResCap Acquisition and the Ally and OneWest MSR Transactions not funded through borrowings.

Our investing activities provided $50.0 million of cash. We paid $2.3 billion to acquire ResCap, including advances of $1.7 billion and MSRs of $391.9 million. We paid $620.7 million to acquire MSRs and advances in the Ally MSR Transaction, net of assumed liabilities for origination and representation warranty obligations of $136.7 million. For the OneWest MSR Transaction, we paid $498.7 million to acquire MSRs and advances. Cash inflows from investing activities include $3.5 billion of proceeds from HLSS from the sale of advances and $215.7 million from the sales to Altisource of the diversified fee-based businesses acquired in the Homeward and ResCap Acquisitions. As disclosed below in the discussion of financing activities, we used a portion of the proceeds from the sales to HLSS to repay match funded liabilities and for required prepayments of the SSTL.

Our financing activities used $933.1 million of cash. To finance the ResCap acquisition, we deployed approximately $840.0 million of net additional capital from the proceeds of a new $1.3 billion SSTL facility and borrowed $1.2 billion pursuant to three servicing advance facilities, offset by our repayment of the old SSTL which had an outstanding principal balance of $314.2 million at December 31, 2012. We received $387.3 million from the sale of Rights to MSRs to HLSS in transactions accounted for as financings. We used collections of servicing advances and $2.7 billion of the proceeds received from the HLSS Transactions to repay match funded liabilities. Debt issuance costs paid on the new SSTL were $25.5 million. Borrowings under mortgage loan warehouse facilities used to fund newly-originated forward loans until they are sold declined by $175.5 million as sales exceeded originations during the period. We paid $157.9 million to repurchase the 3,145,640 shares of common stock we issued upon conversion of 100,000 of the outstanding shares of Series A Perpetual Convertible Preferred stock.

Cash flows for the nine months ended September 30, 2012. Our operating activities provided $1.4 billion of cash largely due to collections of servicing advances (primarily on the Litton portfolio) and net income adjusted for amortization and other non-cash items. Excluding the proceeds from the sale of match funded advances to HLSS in connection with the HLSS Transactions which is reported as investing activity, net collections of servicing advances were $1.2 billion. Operating cash flows were used principally to repay related match funded liabilities and to fund the portions of the Saxon and JPMCB MSR transactions not funded through borrowings.

Our investing activities used $944.8 million of cash. We paid $2.1 billion to purchase MSRs and advances in connection with the acquisition of several MSR portfolios during the second and third quarters. We used cash balances accumulated through the acquisition date as well as borrowings under both new and existing facilities to fund the acquisitions. Cash used for additions to premises and equipment of $16.6 million primarily relates to the build-out of two new leased facilities in India and the disaster recovery facility located in the U.S. Cash inflows from investing activities include $1.1 billion of proceeds from HLSS on the sale of advances and $2.8 million of distributions from our asset management entities. We used $731.8 million of the proceeds from the sales to HLSS to repay match funded liabilities and $143.4 million for required prepayments of the senior secured term loan.

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Our financing activities used $363.1 million of cash primarily due to net repayments of $352.9 million on match funded liabilities. Net repayments on match funded liabilities exclude $358.3 million of match funded liabilities assumed by HLSS in connection with the sale of Advance SPEs (reported as investing activity). We used collections of servicing advances and proceeds received from the HLSS Transactions to repay match funded liabilities. In the second quarter we had significantly increased borrowings under new and existing facilities to finance advances acquired in connection with MSR acquisitions, primarily the Saxon MSR Transaction and the JPMCB MSR Transaction. In addition to the net repayments on match funded liabilities, we also repaid $186.6 million of the $575.0 million senior secured term loan and paid $26.8 million to redeem the remaining balance of our 10.875% Capital Securities at a price of 102.719%. These cash outflows were partly offset by $184.2 million of proceeds from the sale of Rights to MSRs to HLSS in transactions accounted for as financings.

CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS

Contractual Obligations

We believe that we have adequate resources to satisfy all unfunded commitments to the extent required and meet all contractual obligations as they come due. At September 30, 2013, such contractual obligations were comprised of secured borrowings, interest payments and operating leases. Other than changes to our secured borrowings, including the effects of the ResCap and Liberty Acquisitions, there were no significant changes to our contractual obligations during the nine months ended September 30, 2013. See “Liquidity and Capital Resources – Debt financing summary” above for a discussion of changes to our secured borrowings related to our Servicing and Lending businesses. See Note 14 – Match Funded Liabilities, Note 15 – Other Borrowings and Note 25 – Commitments and Contingencies to the unaudited Consolidated Financial Statements for additional information.

Off-Balance Sheet Arrangements

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

Derivatives. We record all derivative transactions at fair value on our consolidated balance sheets. We use these derivatives primarily to manage our interest rate risk as well as our exposure to changes in the value of the India Rupee. The notional amounts of our derivative contracts do not reflect our exposure to credit loss. See Note 19 – Derivative Financial Instruments and Hedging Activities to the unaudited Consolidated Financial Statements for additional information regarding derivatives.

Involvement with SPEs. We use SPEs for a variety of purposes but principally in the financing of our servicing advances and in the securitization of mortgage loans.

We generally use match funded securitization facilities to finance our servicing advances. The SPEs to which the advances are transferred in the securitization transaction are included in our consolidated financial statements either because we have the majority equity interest in the SPE or because we are the primary beneficiary where the SPE is a VIE. The holders of the debt of these SPEs can look only to the assets of the SPEs for satisfaction of the debt and have no recourse against OCN.

VIEs. If we determine that we are the primary beneficiary of a VIE, we include the VIE in our consolidated financial statements. We have interests in VIEs that we do not consolidate because we have determined that we are not the primary beneficiary of the VIEs. In addition, we have transferred forward and reverse mortgage loans in transactions accounted for as sales or as secured borrowings for which we retain the obligation for servicing and for standard representations and warranties on the loans. See Note 2 – Securitizations and Variable Interest Entities and Note 3 – Transfers of Financial Assets to the unaudited Consolidated Financial Statements for additional information.

Mortgage Loan Repurchase and Indemnification Liability. We have exposure to representation, warranty and indemnification obligations. We recognize the fair value of representation and warranty obligations in connection with originations upon sale of the loan or upon completion of an acquisition. Thereafter, the estimation of the liability considers probable future obligations based on industry data of loans of similar type segregated by year of origination and estimated loss severity based on current loss rates for similar loans. Our historical loss severity considers the historical loss experience that we incur upon sale or liquidation of a repurchased loan as well as current market conditions.

The underlying trends for loan repurchases and indemnifications are volatile, and there is significant uncertainty regarding our expectations of future loan repurchases and indemnifications and related loss severities. Due to the significant uncertainties surrounding estimates related to future repurchase and indemnification requests by investors and insurers as well as uncertainties surrounding home prices, it is possible that our exposure could exceed our recorded mortgage loan repurchase and indemnification liability. Our estimate of the mortgage loan repurchase and indemnification liability considers the current macro-economic environment and recent repurchase trends; however, if we experience a prolonged period of higher repurchase and indemnification activity or a decline in home values, then our realized losses from loan repurchases and indemnifications may ultimately be in excess of our recorded liability. Given the levels of realized losses in recent periods, there is a reasonable possibility that future losses may be in excess of our recorded liability. See Note 2 – Securitizations and Variable Interest Entities, Note 16 – Other Liabilities and Note 25 – Commitments and Contingencies to the unaudited Consolidated Financial Statements for additional information.

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RECENT ACCOUNTING DEVELOPMENTS

Recent Accounting Pronouncements

Listed below are recent accounting pronouncements that we had not yet adopted as of September 30, 2013. We are currently evaluating the effect of adopting these standards effective January 1, 2014, but we do not anticipate that our adoption will have a material impact on our consolidated financial statements:

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.
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.
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).

In addition to the recently issued accounting pronouncements listed above, listed below are accounting pronouncements we adopted on January 1, 2013 that that require additional disclosures only and did not have a material effect on our unaudited Consolidated Financial Statements.

ASU 2011-11 (ASC 210, Balance Sheet): Disclosures about Offsetting Assets and Liabilities.
ASU 2013-01 (ASC 210, Balance Sheet): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.
ASU 2013-02 (ASC 220, Comprehensive Income): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.

The principal effect of ASU 2011-11 and ASU 2013-01 is to require additional disclosures that will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. Other than this additional disclosure, our adoption of these two pronouncements did not have a material effect on our unaudited Consolidated Financial Statements.

The amendments in ASU 2013-02 did not have a material impact on our unaudited Consolidated Financial Statements. However, we are required to disclose on the face of our statement of operations or in footnotes thereto the line items affected by any significant items reclassified from accumulated other comprehensive income to earnings and the before tax amount and the related effect on income tax expense of the reclassification.

We also adopted 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) effective July 17, 2013. The ASU permits the use of the Fed Funds Effective Swap Rate as a U.S. benchmark interest rate for hedge accounting purposes. The ASU also removes the restriction on using different benchmark rates for similar hedges. We terminated our remaining interest rate swaps on May 31, 2013 and therefore our adoption of this standard did not have a material impact on our unaudited Consolidated Financial Statements.

See Note 1 – Description of Business, Basis of Presentation and Significant Accounting Policies to our unaudited Consolidated Financial Statements for additional information.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollars in thousands except as otherwise indicated)

Our principal exposures to market risk include interest rate risk, liquidity risk, consumer credit risk, counterparty credit risk and foreign currency exchange rate risk. Market risk also reflects the risk of declines in the valuation of financial instruments and the collateral underlying loans. Our Investment Committee reviews significant transactions that may affect market risk and is authorized to utilize a wide variety of techniques and strategies to manage market risk.

Interest Rate Risk

Our principal market exposure is to interest rate risk due to the impact on our mortgage-related assets and commitments, including mortgage loans held for sale, IRLCs and MSRs. Changes in interest rates could materially and adversely affect our volume of mortgage loan originations or reduce the value of our MSRs.

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Loans Held for Sale and Interest Rate Lock Commitments

IRLCs represent an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage loan applicant, whereby the interest rate on the loan is set prior to funding. Our mortgage loans held for sale, which we hold in inventory while awaiting sale into the secondary market, and our IRLCs are subject to the effects of changes in mortgage interest rates from the date of the commitment through the sale of the loan into the secondary market. As a result, we are exposed to interest rate risk and related price risk during the period from the date of the lock commitment through (i) the lock commitment cancellation or expiration date or (ii) through the date of sale into the secondary mortgage market. Loan commitments generally range from 5 to 30 days; and our holding period of the mortgage loan from funding to sale is typically less than 20 days.

For our loans held for sale that we have elected to carry at fair value, we manage the associated interest rate risk through an active hedging program overseen by our Investment Committee. Our hedging policy determines the hedging instruments to be used in the mortgage loan hedging program, which include forward sales of agency “to be announced” securities (TBAs), whole loan forward sales, Eurodollar futures and interest rate options. Forward mortgage backed securities (MBS) trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Our hedging policy also stipulates the hedge ratio we must maintain in managing this interest rate risk, which is also monitored by our Investment Committee.

Fair Value MSRs

Our MSRs that we have elected to carry at fair value are subject to interest rate risk as the mortgage notes underlying the MSRs permit the borrowers to prepay the loans. Consequently, the value of these MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and tends to increase in periods of rising interest rates (as prepayments decrease). Although the level of interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices, underwriting standards and product characteristics.

For these MSRs, we may enter into economic hedges, including interest rate swaps, U.S. Treasury futures and forward MBS trades to minimize the effects of loss in value associated with increased prepayment activity that generally results from declining interest rates. Our Investment Committee establishes and maintains policies that govern our hedging program, including such factors as our target hedge ratio, the hedge instruments that we are permitted to use in our hedging activities and the counterparties with whom we are permitted to enter into hedging transactions. Our hedging policy permits us to use mortgage TBA instruments and options on mortgage TBAs, Treasury and Eurodollar futures and options on U.S. Treasury and Eurodollar futures as well as interest rate swaps, interest rate caps and interest rate forwards, floors and swaptions as hedge instruments in our MSR hedging program. Effective April 1, 2013, we terminated the hedging program for our fair value MSRs and closed out the remaining economic hedge positions.

Sensitivity Analysis

Fair Value MSRs, Loans Held for Sale and Related Derivatives

The following table summarizes the estimated change in the fair value of our fair value elected MSRs, fair value elected loans held for sale and related derivatives as of September 30, 2013 given hypothetical instantaneous parallel shifts in the yield curve (in thousands):

   Change in Fair Value 
   Down 25 bps   Up 25 bps 
         
Loans held for sale  $7,911   $(9,073)
Forward MBS trades   (7,965)   8,672 
Total loans held for sale and related derivatives   (54)   (401)
           
Fair value MSRs   (6,755)   6,307 
MSRs, embedded in pipeline        
Total fair value MSRs (1)   (6,755)   6,307 
           
Total, net  $(6,809)  $5,906 
(1)As disclosed above, effective April 1, 2013, we terminated the hedging program for our fair value MSRs and closed out the remaining economic hedge positions.
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We used September 30, 2013 market rates on our instruments to perform the sensitivity analysis. The estimates are based on the market risk sensitive portfolios described in the preceding paragraphs and assume instantaneous, parallel shifts in interest rate yield curves. These sensitivities are hypothetical and presented for illustrative purposes only. Changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in fair value may not be linear.

Borrowings

The debt used to finance much of our operations is exposed to interest rate fluctuations. We may purchase interest rate swaps and interest rate caps to minimize future interest rate exposure from increases in one-month LIBOR interest rates.

Based on September 30, 2013 balances, if interest rates were to increase by 1% on our variable rate debt (excluding our SSTL) and interest earning cash and float balances, we estimate a net positive impact of $31.1 million resulting from an increase of $38.5 million in annual interest income and an increase of $7.4 million in annual interest expense. See the tables below and Note 19 – Derivative Financial Instruments and Hedging Activities to the unaudited Consolidated Financial Statements for additional information regarding our use of derivatives.

   September 30,
2013
 
Fixed-rate borrowings  $ 
      
Variable-rate borrowings     
Match funded servicing advance facilities (3)   363,012 
Senior secured term loan (1)   1,293,500 
Lending warehouse facilities   293,988 
Other   72,508 
    2,023,008 
Total borrowings outstanding (2)  $2,023,008 
      
Float balances (held in custodial accounts, excluded from our consolidated balance sheet) (3)  $3,496,251 
(1)Balance excludes the unamortized discount of $5.7 million.
(2)Total borrowings exclude the financing liabilities recognized in connection with sales of MSRs. Total borrowings also exclude Secured borrowings – owed to securitization investors because the interest rate sensitive assets and liabilities of the consolidated trusts do not represent an interest rate risk for Ocwen. Ocwen has no obligation to provide financial support to the trusts. The creditors of the trusts can look only to the assets of the trusts themselves for satisfaction of the debt and have no recourse against the assets of Ocwen.  Similarly, the general creditors of Ocwen have no claim on the assets of the trusts. See Note 15 – Other Borrowings to the unaudited Consolidated Financial Statements for additional information.
(3)On May 31, 2013, we terminated our remaining interest rates swaps that we had purchased to hedge against the effects of changes in interest rates on our borrowings under advance funding facilities. Float balances, which earn a variable rate of interest, are well in excess of variable rate borrowings under advance facilities and therefore reduce our exposure to changes in interest rates.

Excluding Loans – restricted for securitization investors, our Consolidated Balance Sheet at September 30, 2013 and December 31, 2012 included interest-earning assets totaling $607.7 million and $738.6 million, respectively. Interest-earning assets at September 30, 2013 are comprised of $133.8 million of interest-earning cash accounts, $45.5 million of debt service accounts, $6.5 million of interest-earning collateral deposit and $421.9 million of loans held for sale (fair value and lower of cost or fair value combined).

Liquidity Risk

See “Overview - Liquidity Summary” and “Liquidity and Capital Resources” for additional discussions of liquidity.

Consumer Credit Risk

We sell our loans on a non-recourse basis. However, we also provide representations and warranties to purchasers and insurers of the loans sold that typically are in place for the life of the loan. In the event of a breach of these representations and warranties, we may be required to repurchase a mortgage loan or indemnify the purchaser, and any subsequent loss on the mortgage loan may be borne by us. If there is no breach of a representation and warranty provision, we have no obligation to repurchase the loan or indemnify the investor against loss. The outstanding UPB of loans sold by us represents the maximum potential exposure related to representation and warranty provisions.

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We maintain a reserve for losses on loans that may be repurchased or indemnified as a result of breaches of representations and warranties on our sold loans. We base our estimate on our most recent data regarding loan repurchases and indemnity payments, actual credit losses on repurchased loans and recovery history, among other factors. Internal factors that affect our estimate include, among other things, level of loan sales, to whom the loans are sold, the expectation of credit loss on repurchases and indemnifications, our success rate at appealing repurchase demands and our ability to recover any losses from third parties. External factors that may affect our estimate include, among other things, the overall economic condition in the housing market, the economic condition of borrowers, the political environment at GSEs and the overall U.S. and world economy. Many of the factors are beyond our control and may lead to judgments that are susceptible to change.

We are not subject to the majority of the credit-related risk inherent in maintaining a mortgage loan portfolio because we do not hold loans for investment purposes. We generally sell newly originated loans in the secondary market within 20 days of origination.

Counterparty Credit Risk & Concentration Risk

Credit risk represents the potential loss that may occur because a party to a transaction fails to perform according to the terms of the contract. The measure of credit exposure is the replacement cost of contracts with a positive fair value. We manage credit risk by entering into financial instrument transactions through national exchanges, primary dealers or approved counterparties and the use of mutual margining agreements whenever possible to limit potential exposure. We are exposed to counterparty credit risk in the event of non-performance by counterparties to various agreements. We manage such risk by monitoring the credit ratings of our counterparties and do not anticipate losses due to counterparty nonperformance.

Counterparty credit risk exists with our third party originators from whom we purchase originated mortgage loans. The third party originators incur a representation and warranty obligation when we acquire the mortgage loan from them, and they agree to reimburse us for any losses incurred due to an origination defect. We become exposed to losses for origination defects if the third party originator is not able to reimburse us for losses incurred for indemnification or repurchase. We mitigate this risk by monitoring purchase limits from our third party originators (to reduce any concentration exposure), quality control reviews of the third party originators, underwriting standards and monitoring the credit worthiness of third party originators on a periodic basis.

Foreign Currency Exchange Rate Risk

We are exposed to foreign currency exchange rate risk in connection with our investment in non-U.S. dollar functional currency operations to the extent that our foreign exchange positions remain unhedged. We periodically enter into foreign exchange forward contracts to hedge against the effect of changes in the value of the India Rupee (INR) on amounts payable to our India subsidiary, OFSPL. Our operations in Uruguay expose us to foreign currency exchange rate risk, but we consider this risk to be insignificant.

ITEM 4.CONTROLS AND PROCEDURES

Our management, under the supervision of and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of September 30, 2013. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2013, our disclosure controls and procedures (1) were designed and functioning effectively to ensure that material information relating to Ocwen, including its consolidated subsidiaries, is made known to our Chief Executive Officer and Chief Financial Officer by others within those entities, particularly during the period in which this report was being prepared and (2) were operating effectively in that they provided reasonable assurance that information required to be disclosed by Ocwen in the reports that it files or submits under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to management, including the Chief Executive Officer or Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

See Note 25Commitments and Contingencies to the Consolidated Financial Statements for information regarding legal proceedings.

 

ITEM 1A.RISK FACTORS

We include a discussion of the principal risks and uncertainties that affect or could affect our business operations under Item 1A on pages 19 through 32 of our Annual Report on Form 10-K for the year ended December 31, 2012 which should be read in conjunction with such disclosures.

 

ITEM 6.EXHIBITS
(3)Exhibits.
   2.1   Mortgage Servicing Rights Purchase and Sale Agreement between Ocwen Loan Servicing, LLC and One West Bank, FSB dated as of June 13, 2013 (1)
       
   3.1   Amended and Restated Articles of Incorporation (2)
       
   3.2   Articles of Amendment to Articles of Incorporation (3)
       
   3.3   Articles of Correction (3)
       
   3.4   Articles of Amendment to Articles of Incorporation (4)
       
   3.5   Amended and Restated Bylaws of Ocwen Financial Corporation (5)
       
  10.1   Agreement, dated as of April 12, 2013, by and among Altisource Solutions S.à r.l., Ocwen Financial Corporation and Ocwen Mortgage Servicing, Inc. (6)
       
  10.2   Guarantee between Ocwen Financial Corporation and OneWest Bank, FSB dated as of June 13, 2013 (1)
       
  10.3   Amendment No. 1 to Senior Secured Term Loan Facility Agreement and Amendment No. 1 to Pledge and Security Agreement dated as of September 23, 2013 by and among Ocwen Loan Servicing, LLC, as Borrower, Ocwen Financial Corporation, as Parent, Certain Subsidiaries of Ocwen Financial Corporation, as Subsidiary Guarantors, the Lender Parties thereto, and Barclays Bank PLC, as Administrative Agent and Collateral Agent (7)
       
  10.4   Amendment, dated as of September 30, 2013, to the Sale Supplement, dated as of July 1, 2013, to the Master Servicing Rights Purchase Agreement, dated as of October 1, 2012, between Ocwen Loan Servicing, LLC, HLSS Holdings, LLC and Home Loan Servicing Solutions, Ltd. (filed herewith)
       
  10.5   Amendment, dated as of September 30, 2013, to the Subservicing Supplement, dated as of July 1, 2013, to the Master Subservicing Agreement, dated as of October 1, 2012, between Ocwen Loan Servicing, LLC and HLSS Holdings (filed herewith)
       
  11.1   Computation of earnings per share (8)
       
  31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
       
  31.2   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
       
  32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
       
  32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
       
  101.INS   XBRL Instance Document (filed herewith)
       
  101.SCH   XBRL Taxonomy Extension Schema Document (filed herewith)
       
  101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith)
       
  101.DEF   XBRL Taxonomy Extension Definition Linkbase Document (filed herewith)
       
  101.LAB   XBRL Taxonomy Extension Label Linkbase Document (filed herewith)
       
  101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document (filed herewith)
 
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(1)Incorporated by reference from the similarly described exhibit included with the Registrant’s Form 8-K filed with the SEC on June 13, 2013.
(2)Incorporated by reference from the similarly described exhibit filed in connection with the Registrant’s Registration Statement on Form S-1 (File No. 333-5153) as amended, declared effective by the SEC on September 25, 1996.
(3)Incorporated by reference from the similarly described exhibit included with the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2010.
(4)Incorporated by reference to Exhibit 99.1 of the Registrant’s Form 8-K filed with the SEC on January 6, 2011.
(5)Incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed with the SEC on May 10, 2013.
(6)Incorporated by reference from the similarly described exhibit included with the Registrant’s Form 8-K filed with the SEC on April 18, 2013.
(7)Incorporated by reference from the similarly described exhibit included with the Registrant’s Form 8-K filed with the SEC on September 24, 2013.
(8)Incorporated by reference from Note 21 – Basic and Diluted Earnings per Share to the unaudited Consolidated Financial Statements.
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Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

       
    OCWEN FINANCIAL CORPORATION
       
Date: November 4, 2013 By: /s/ John V. Britti  
    John V. Britti  
    Executive Vice President and Chief Financial Officer
    (On behalf of the Registrant and as its principal financial officer)
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