LL Funds, LLC

In Defense of Ocwen Servicing July 2016 Update

INTRODUCTION
In Defense of Ocwen Servicing, published in the spring of 2015, argued that, The servicers job, is to
service (mortgage) loans in order to maximize the cashflow to the entire dealand not to pay down senior
classes in the fastest manner possible to the detriment of both subordinate bondholders and
homeowners. We reviewed the servicing practices at Ocwen Financial Corporation (Ocwen), finding
support for its aggressive loan modification practices.
In this update, we compare Ocwen performance to Select Portfolio Servicing, Inc. (SPS), a highly
regarded mortgage servicer. We chose SPS because they are viewed favorably by the mortgage
investment community, and hold above average servicer ratings from the rating agencies. Currently,
Ocwen is rated below average at Standard & Poors. These ratings matter to investors not only as a signal
of overall servicing quality, but also because servicing could be transferred away from Ocwen, if it does
not maintain a minimum average servicer rating by 2017. LL Funds owns over $1.8 Billion current face of
bonds where the underlying mortgage loans are serviced by Ocwen. Because the investment performance
of our opportunistic funds relies critically on how the underlying mortgage loans are serviced, we want
Ocwen to continue to service these loans, and are sharing our research to raise awareness of the benefits
of Ocwen servicing. While LL Funds does not own Ocwen equity in any of its funds, partners and
employees of LL Funds do own the stock in their personal accounts.
Our research convinced us early on that Ocwen was the best servicer for troubled borrowers, because
Ocwen is willing to modify borrowersmultiple times, if necessaryboth by lowering interest rates
and/or forgiving principal. We have enough data now to measure performance differences across
servicers. When we look at a pool of borrowers that went seriously delinquent between 2008 and 2014,
and track their performance through May 2016, we find that loans serviced by Ocwen resulted in 6% lower
lossesliquidation and modification combinedcompared to SPS. The reason for this difference is SPS
liquidated 71% of these delinquent loans, while Ocwen liquidated 57%, choosing to modify and re-modify
more often. Of this pool of initially delinquent borrowers, 18% of SPS serviced loans are performing as of
May 2016, compared to 28% for Ocwen. This 10% difference is significant for both investors and for
homeowners, who have been able to stay in their homes.
While it is clear from the data that Ocwens servicing practices have been good for investors overalland
also for homeownersthere are additional criteria used to arrive at servicer ratings. Because LL Funds
is not in a position to evaluate these other criteria, we conclude this update with a brief summary of the
Duff and Phelps report commissioned by Wells Fargo, acting as Master Servicer to some Ocwen serviced
trusts, to investigate allegations made by investors and regulators. The report investigated the most
important allegations against Ocwen and has found no evidence of malfeasance.
Collateral Summary
For the purpose of this study we will restrict our analysis to the performance of first-lien subprime
mortgages in the Loan Performance dataset (available upon request).

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In Table 1 below we summarize the characteristics of active loans serviced by Ocwen.
Table 1
Servicer
OCN
OCN
OCN
OCN
OCN
OCN
OCN

CLTV
Loan Group
Count
% UPB
No-Mod:Performing
180,446
24%
First-Mod:Performing
132,224
24%
Re-Mod:Performing
151,562
31%
No-Mod:Non-Performing
35,328
8%
First-Mod:Non-Performing
25,466
6%
Re-Mod:Non-Performing
33,102
7%
ALL
558,128
100%

64
68
70
80
83
81
70

Interest Rate Loan Size

Months Behind Judicial %
7.29
176,351
0
69%
3.88
227,547
0
67%
3.09
243,302
0
65%
7.67
290,712
64
87%
4.99
290,216
40
82%
3.17
285,673
21
75%
4.72
231,080
9
69%

As of May 2016, the Loan Performance database lists 558,128 active first-lien subprime loans as being
serviced by Ocwen. About 79% of these loans are performing, while 21% are delinquent by at least 60
days. Roughly, 68% of the loans have been modified at least once and consequently the whole portfolio
has a combined CLTV of 70 and an interest rate of 4.72%. The lengthy foreclosure timelines in judicial
states also is clear: of the delinquent loans, 8% have been non-performing for 5 years or more.
In Table 2 below we tabulate the corresponding results for subprime first-lien loans serviced by SPS.
Table 2
Servicer
SPS
SPS
SPS
SPS
SPS
SPS
SPS

Count
% UPB
CLTV
Loan Group
No-Mod:Performing
62,991
47%
First-Mod:Performing
24,010
20%
Re-Mod:Performing
17,831
16%
No-Mod:Non-Performing
8,054
7%
First-Mod:Non-Performing
5,372
5%
Re-Mod:Non-Performing
5,176
5%
ALL
123,434
100%

69
73
76
82
83
84
75

Interest Rate Loan Size

Months Behind Judicial %
5.69
294,313
0
63%
4.58
249,123
0
63%
3.87
246,854
0
60%
7.57
293,163
60
82%
5.47
277,084
35
75%
4.21
266,075
20
69%
4.84
263,457
8
64%

About 47% of SPSs loans are performing without modification compared to 24% for Ocwen. For a
mortgage investor evaluating a bond today that difference is notable, but this difference, itself, does not
imply SPS is a better servicer than Ocwen. Indeed, SPS could have liquidated many more delinquent
borrowers over time to achieve this difference today; alternatively, Ocwen may be servicing a set of loans
with a weaker credit profile. A better way to evaluate servicer performance, in our judgment, is to look
at overall losses for loans that ended up delinquent, a task to which we turn our attention in the next
section.
Historical Servicer Liquidation and Loss Mitigation Strategies
To better understand the two portfolios, it is helpful to track loan performance through the Great
Recession. From the following four graphs (Charts-1-4) we are able to observe the following facts:
a.
b.
c.
d.

SPS liquidated a higher % of loans than Ocwen.

Ocwen and SPS both have high but comparable severities (% UPB lost in liquidation).
Ocwen chose to aggressively modify and re-modify loans.
Ocwen modifications were often deeper with significantly more principal forgiveness.
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Chart 1

SPS has consistently chosen to liquidate more aggressively than Ocwen. When a loan is liquidated, senior
bondholders receive principal payments generated from the net home sales proceeds. At the same time,
junior bondholders suffer significant losses. As we can see from Chart 2 the losses from Subprime
liquidations are quite elevated. Though perhaps not immediately obvious, the higher the expected loss
in liquidation, the more room there is to make a NPV-positive modification, even allowing for substantial
principal forgiveness.
Chart 2

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During the peak of the Great Recession subprime severities were close to 80% for both SPS and Ocwen
serviced loans. Rising loss severities prompted various loss mitigation strategies from the servicers.
Chart 3

In Chart 3 above we plot the likelihood that a non-performing loan starts performing after a loan
modification. Juxtaposed with Chart 1, we can see that Ocwens liquidation rates came down as it
pursued a more aggressive modification strategy.
Chart 4

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LL Funds, LLC
As covered in our first paper, Ocwen has pursued a modification strategy involving significant principal
forgiveness and lower interest rates for the borrowerthereby making payments more affordableto
minimize losses. Ocwens proprietary modifications often followed failed HAMP modifications and
commenced when early capitalization modifications failed miserably (so far, roughly 90% of all
modifications made in the year 2008 have failed). From Chart 4, we can see that SPS also started with a
strategy to modify loans with principal forgiveness but quickly changed course to offering little principal
forgiveness. While beyond the scope of this paper, it would be interesting to understand why SPS changed
their modification practices post-2010.
Loss Estimates
As observed in the previous section, the servicing style of Ocwen is very different to that of SPS, given the
latter has a lower modification rate, an aversion to principal forgiveness since 2010, and a more aggressive
approach to liquidation. The question, from a bondholders perspective, is which approach minimizes
losses to the mortgage trusts?
In the following charts we capture the cumulative effect of first modifications, re-modifications and
liquidations. From Chart 5, we see that Ocwen started re-modifying failed modifications much earlier
than SPS. From Charts 6 and 7, we can see Ocwens cumulative recidivisms (accounting for modifications
with at least 18 months of history, i.e. modifications prior to 2015) are lower than SPS, once Ocwen began
pursuing aggressive principal forgiveness (post 2011).

Chart 5

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Chart 6

Chart 7

The collateral trends displayed in the above charts resulted in very different outcomes for both investors
and homeowners. During the Great Recession distressed borrowers needed foreclosure alternatives that
made their monthly payments affordable. From the bondholders perspective the servicer should act in
a manner that maximizes the cashflow to the trust and consequently minimize overall loan losses. How
did Ocwen and SPS respond when a distressed homeowner stopped making payments?
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To answer this question, we run the following experiment: for each servicer we consider all loans that
were in or entered a state of distress (defined as a loan being delinquent for 6 or more months) between
January 2008 and December 2014 (the start date of the period coincides with the onset of the Great
Recession and the end date is chosen to make sure there is enough time to evaluate the servicers
response). In Table 3, we track the non-performing loans (as defined above) from January 2008 to May
2016 (latest available data). All % quoted in Table 3 are based off the loan balance when the loan first
enters a state of distress on/after January 2008 (If the loans were already in a state of distress as of January
2008, then we use the loan balance as of January 2008).
Table 3
Loan Bucket
1
2
3
4
5
6
7
8
9
10
11
12
ALL

Final Mod
Status
No-Mod
No-Mod
No-Mod
No-Mod
First-Mod
First-Mod
First-Mod
First-Mod
Re-Mod
Re-Mod
Re-Mod
Re-Mod
Total

Final Performance
Status
Liquidated
Prepaid
Performing
Non-Performing
Liquidated
Prepaid
Performing
Non-Performing
Liquidated
Prepaid
Performing
Non-Performing

OCN
%UPB
42.6%
1.4%
1.1%
3.7%
11.1%
0.9%
9.5%
3.1%
3.4%
0.7%
17.9%
4.8%
100%

SPS
%UPB
59.3%
1.1%
0.9%
2.5%
9.3%
0.7%
8.8%
3.1%
2.4%
0.3%
8.2%
3.3%
100%

OCN
%Loss
65%
0%
3%
0%
67%
10%
25%
10%
67%
25%
30%
24%
47%

SPS
%Loss
67%
2%
8%
1%
69%
20%
25%
19%
70%
22%
19%
18%
53%

Once delinquent, some portion of the non-performing loans were modified and re-modified (Table 3).
Over the next 8.5 years some loans left the pool because of a liquidation or a prepayment, others
remained active. The remaining active loans are currently either performing or non-performing. In Table
4 we summarize the data in Table 3 by the final status of the loans.
Table 4
Loan Bucket

ALL

Final Performance Status

1

Liquidated

Prepaid

3
4

OCN
%UPB

SPS
%UPB

OCN
%Loss

SPS
%Loss

Wtd
Loss Diff

57.1%

71.0%

65.5%

67.2%

-10.4%

3.0%

2.1%

9.0%

10.7%

0.0%

Performing

28.4%

18.0%

27.3%

21.3%

3.9%

Non-Performing

11.5%

8.8%

12.6%

13.6%

0.2%

100.0%

100.0%

46.8%

53.0%

-6.2%

Total

From Table 4, we can see that Ocwen liquidated 57% of these loans compared to 71% for SPS. The
associated severities on those liquidated loans were 66% and 67% respectively. For Ocwen, 28% of the
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loans started performing through a combination of loan modifications and natural curing. This proportion
of newly performing loans is much higher than the corresponding SPS figure of 18%. In effect, an
additional 10% of seriously delinquent Ocwen loans transitioned to performing; when we examine the
cause for these transitions, we find that almost all of the difference can be explained due to remodification after a failed first-modification.
In the last column of Table 4, we tabulate the weighted difference in the losses (For e.g. -10.4% =
57.1%*65.5% - 71.0%*67.2%) to highlight the difference between the two servicers. As is evident from
Table 4, SPSs trusts incurred 10.4% additional loss because of its decision to liquidate more than Ocwen,
while Ocwen serviced loans incurred close to 4.2% (= 3.9% + .2%) of additional loss due to the decision to
modify and re-modify rather than liquidate. In total, Ocwens strategy resulted in 6% lower losses for its
delinquent loans compared to SPS.
Like SPS, Ocwen could have chosen to liquidate these failed first-modifications rather than re-modify the
loans. Such a course of action would have resulted in a higher severity (67% compared to modification
losses of 25%). By choosing to incur additional short term modification losses as opposed to higher
liquidation losses, Ocwen has given these homeowners a second (and in some cases third or more) chance
to save their homes and bondholders suffered a smaller loss overall. There will be additional losses on
these loans, but the rationale for modification is sound. There is no reason to believe that a similar strategy
by SPS would not have resulted in lower overall losses for SPS serviced trusts. At the very least, Ocwen
deserves credit for its best-in-class servicing: lower overall losses to trusts and more homeowners still in
their homes.
It is clear from the data that Ocwens servicing practices have been good for investors overalland also
for homeowners. However, there are other criteria used to arrive at servicer ratings. While not the focus
of this paper, we would note that the company has taken on a systematic deleveraging of its balance
sheet, reconstituted its Board of Directors, and adopted best practices for its internal audit, risk, and
compliance functions. Indeed, in less than two years, the number of resources dedicated to risk and
compliance has more than doubled to 450 FTE. These investments are bearing fruit: since July 2015, the
Consumer Financial Protection Bureau (CFPB) has consistently reported that Ocwen has experienced the
greatest percentage decrease in average monthly complaint volume, year-over-year, when compared
against all other major companies outlined in the Bureaus Monthly Complaint Report.
While LL Funds is not in a position to evaluate these other servicing criteria, Duff and Phelps (D&P)
undertook an exhaustive review of allegations made by investors and regulators. The review covered four
broad areas: accounting, borrower compliance, loan modifications, and operations and government
practices. As we will summarize in the next section, Ocwen largely was exonerated from allegations both
made by investors, and identified by the CFPB and New York Department of Financial Services (NYDFS)
consent orders. Even so, Ocwen continues to be under intense regulatory scrutiny today, having paid $30
Million in monitor costs just in the last reported quarter.

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Duff and Phelps Report on Ocwen
In March 2015 Alston and Bird LLP, a law firm retained by Wells Fargo in its capacity as Master Servicer
on certain RMBS trusts, hired D&P to review Ocwens servicing operations. This independent review was
in response to allegations made in 1) a letter sent by Gibbs and Bruns LLP (G&B) on behalf of a group of
institutional investors, and 2) CFPB and NYDFS Consent Orders. LL Funds has reviewed a redacted
versionto protect confidential information related to Ocwens loan modification and stop advance
policiesof the D&P report, and we discuss our impressions of the report below.
D&P carried out a thorough review of Ocwens servicing operations, using sophisticated statistical
sampling techniques and the ACES audit technology software platform. To the best of our knowledge,
none of Ocwens major competitors has been subjected to this level of scrutiny.
D&P split up the 16 allegations into 4 broad groups and reviewed 11 of the 16 allegations. In order to test
each allegation, D&P sampled loans randomly from a distinct loan populatione.g. the liquidated loan
pool or the modified loan poolthat was the specific focus of the allegation. The random selection
process ensured that a minimum number of loans were selected from each of the trusts under
consideration. In addition, D&P also carefully examined the problem loans identified by G&Bs servicing
expert.
Several allegations in the G&B letter were related to accounting allegations (the first broad group) such
as missing funds and mysterious expenses. D&P found that the servicing expert retained by G&B
relied on Ocwens investor website REALPortal to draw his conclusions regarding missing funds and
expenses. The nub of the issue is that REALPortal is not the system of record for Ocwen. D&P found that
data in REALPortal often appeared to be incorrect. Once data from the system of record were used, D&P
found no evidence to substantiate the charges of missing funds and strange expenses. In addition to
testing a random sample of loans, D&P focused specifically on the problem loans identified by G&Bs
servicing expert, and found no evidence of wrongdoing. Specifically, D&P found no evidence that Ocwen
failed to account for P&I payments to the Master Serviced Trusts or that Ocwen charged the trusts for
undisclosed or mysterious expenses incurred in connection with liquidation.
In our view Ocwen tried to be investor-friendly by making data available on a self-serve investor portal.
Given that the portal was not the system of record for loan-level informationand was never advertised
as suchone cannot draw precise accounting conclusions from data extracted from it. Having said that,
Ocwen created substantial confusion by releasing an investor portal without checking the data carefully,
and subsequently shut down the portal once they became aware of the problem.
A second broad group of allegations concerned improper modification practices and policies, such as
negative NPV modifications. Ocwen did not provide D&P with access to its HAMP NPV model (prohibited
by MHA regulations) or the Non-HAMP NPV Model (proprietary and confidential). D&P could not audit
either model or view the specific inputs and outputs. However, D&P noted that the MHA audits Ocwens
HAMP NPV model for compliance and other agencies perform regulatory audits on the non-HAMP NPV
model. Ocwen and ASPS provided a limited high-level comparison of the two models to D&P. D&P then
used the working assumption that the non-HAMP NPV model was similar enough to the HAMP NPV model
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to conclude that there was no evidence that it was unreasonable. D&P also agreed, within limitations,
with Ocwens approach of keeping the modification process and the Stop Advance process separate. D&P
conducted a high-level review of the Stop Advance model and concluded that Ocwens Stop Advance
model was a reasonable method to determine when to stop advancing on a loan.
In addition, after testing a sample of modified loans, D&P did not find sufficient evidence to conclude that
Ocwen carried out imprudent and extreme modifications, including excessive principal forgiveness or
principal forbearance. In its examination of modified loans, D&P did find cases in which Ocwen had
modified loans which had been delinquent for more than four years. However, D&P noted that in their
experience it is reasonable for servicers to modify such deeply delinquent loans as long as the result of
the modification is NPV positive under the applicable model. D&P also showed two specific examples
for which Ocwens modifications of deeply delinquent loans had resulted in performing loans. D&P
reached the same conclusion for loans that Ocwen had modified more than four times. To wit, as long as
the modification is NPV-positive under the model that is being used, it is reasonable for Ocwen to carry
out the modification. D&P also did not find any pattern of modifying loans with large advances more
frequently than loans with smaller advances. In general, D&P did not find evidence that Ocwen engaged
in modifications solely to recoup advances at the time of modification. D&P did find a small number of
loans (less than 1% of their sample) where borrowers did not make a single payment after modification,
though D&P concluded that this occurrence is not unusual in the servicing industry, and is not indicative
of unreasonable modifications. Finally, D&P examined cases in which principal and interest payments had
increased after modification and concluded that this was also reasonable and that it did not constitute a
violation of servicing practice.
Importantly, D&P also examined Ocwens practices with regard to servicing transfers, lender-placed
insurance (LPI) and the Servicemembers Civil Relief Act (SCRA). Allegations in this regard constituted the
third broad group of allegations. The basis for some of the allegations in this group was provided by the
CFPB Consent Order and the two NYDFS Consent Orders. D&P detected small error rates with regard to
recording of information on newly boarded loans (e.g. Ocwen recorded an incorrect property address on
1.7% of newly boarded loans). Similarly, D&P also detected small issues with LPI and SCRA procedures,
but did not find any evidence of wrongdoing as opposed to small levels of operating error. It would be
very interesting to compare Ocwens error rates with those of its top competitors.
The fourth, and last, broad group of allegations concerned operations and governance. D&P tested
allegations that Ocwens use of ASPS as a services provider was harmful to the Trusts. Specifically, it was
alleged that ASPS charged Ocwen higher fees for its services than it charged other customers. ASPS had
been a subsidiary of Ocwen until its spinout in 2009. D&P did not have access to ASPSs proprietary sales
data. Nevertheless, D&P designed tests using data from Ocwens systems to detect harm from excessive
fees. D&P did not find evidence that the Trusts were charged higher fees from Ocwens use of Hubzu, the
ASPS auction site. Further, D&P did not find evidence that the Trusts were charged higher fees from
Ocwens use of RealHome, an ASPS subsidiary that is a real-estate brokerage.

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CONCLUSION
In this update we compared the servicing strategies of SPS & Ocwen. When compared to SPS, Ocwens
modification and liquidation strategy resulted in more homeowners retaining their homes and at the same
time also resulted in lower overall losses to the associated mortgage trusts.
Additionally, we conclude that the Duff & Phelps exonerates Ocwen of most of the G&B allegations.
Ocwen fulfilled many, though not all, of D&Ps data requests. Had Ocwen granted D&P unfettered access
to its proprietary systems and models, some of D&Ps conclusions regarding the non-HAMP NPV model
might have been stronger. D&P also did not gain access to ASPSs proprietary data with regard to its
servicing contract with Ocwen. On balance, however, we believe D&P has investigated the most
important allegations against Ocwen and has found no evidence of malfeasance. There is evidence of
errors, but the rate of detected errors is small. Taken together, Ocwens servicing success and exoneration
after an exhaustive review of its practices argues for an upgrade to Above-Average servicer rating. We
cant find another servicer that does as good of a job at servicing troubled borrowers as Ocwen.

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