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TheStreet Open House

Ocwen Shares Look Ripe After Brutal Pullback

NEW YORK (TheStreet) -- Shareholders of Ocwen Financial (OCN) have had a pretty rough ride this year, especially over the past week, but it appears the negative market reaction has been overdone, setting up quite an opportunity for long-term investors looking to jump in, or for current investors considering adding to their holdings.

Ocwen's shares closed at $38.07 Tuesday, down 9% for the day and giving up 31% so far this year, following a 60% return during 2013.

The company specializes in servicing mortgage loans for lenders. This includes collecting payments from borrowers and remitting payments to Fannie Mae (FNMA), Freddie Mac (FMCC) and other investors, including lenders for loans held in portfolio, as well as handling all other aspects of servicing. That includes paying taxes and insurance for escrowed loans, as well as handling the entire servicing process for nonperforming loans, including foreclosure and even the repossession, maintenance and disposal of real estate.

The aftermath of the credit crisis has been a golden period for Ocwen, because so many banks ran into trouble servicing loan and handling the foreclosure process, which ultimately cost them billions of dollars in regulatory fines and relief payments to borrowers. Please see Dan Freed's in-depth profile of Ocwen founder William Erbey for a discussion of the company's competitive advantage, its somewhat complex structure and history.

Ocwen on Jan. 22 announced a deal with Wells Fargo Bank, NA -- the main subsidiary of Wells Fargo (WFC) -- to purchase the rights to service 184,000 mortgage loans with a balance of about $39 billion. This would have been a beautiful deal for Ocwen, which has greatly expanded over the past several years, through the purchase of servicing rights for large mortgage loan portfolios from many companies, including subsidiaries of Barclays (BCS), Goldman Sachs (GS), as well as Residential Capital and O&H Acquisition Corp. Ocwen's servicing portfolio, on a pro forma basis, including "substantially completed" previous acquisitions grew to roughly $473 billion in November from $204 billion at the end of 2012, according to the company's Jan. 28 presentation to lenders.

But that $473 billion pro forma figure has here been adjusted down from $512 billion, because Ocwen on Feb. 6 said it had it had agreed "to put an indefinite hold" on the Wells Fargo deal at the request of the New York Department of Financial Services Superintendent. Reuters report the same day reported that NY DFS Superintendent Benjamin Lawsky is "concerned that Ocwen lacks the ability to handle the additional servicing load," according to an unnamed source. Ocwen said it would "continue to work closely with the NY DFS to resolve its concerns about Ocwen's servicing portfolio growth."

That sent Ocwen's shares down 4% last Thursday to $41.38. Then on Friday the shares rose 4% to close at $43.09, after Compass Point analyst Kevin Barker upgraded the shares to a "buy" rating, with a $57 price target.

"Although we certainly see this as a setback, even if the [Wells Fargo] portfolio ultimately does not get transferred, we believe the cash flows the company will generate from the current portfolio to be worth roughly $40 per share. Hence, the stock is essentially trading below discounted cash flows from operations and getting no credit for servicing acquisitions, acquisitions outside of the servicing space, increasing earnings from share buybacks, or the potential to lower earnings volatility by setting up a prime MSR financing vehicle (or some other of prime servicing vehicle)," Barker wrote in note to clients.

Barker also pointed out that previous deals by Ocwen to purchase mortgage servicing rights had been delayed by the New York Department of Financial Services, only to be approved soon after by the regulator, after Ocwen met "largely symbolic" mandates laid down by Lawsky.

On Monday, Ocwen's shares pulled back 3% to $41.85. Then on Tuesday, the shares were down another 9% to close at $38.08, which is just 6.5 times the consensus 2015 earnings estimate of $5.90, among analysts polled by Thomson Reuters. That's a very low forward price-to-earnings ratio for a company that has grown so significantly. The consensus 2014 EPS estimate is $4.96.

The latest blow on Tuesday was another report from Reuters, saying institutional investors including BlackRock (BLK) were considering taking "legal action against Ocwen Financial Corp over its mortgage servicing practices," according to an unnamed source. According to the report, the investors are seeking "greater transparency on how Ocwen, the country's largest nonbank mortgage servicer, manages its mortgages, particularly loan modifications."

The Financial Times reported that Pimco was also among the investors considering suing Ocwen, since the servicer's loan modifications may have "hurt" the performance of mortgage-backed securities held by the investors.

Ocwen prides itself on having a better track record than most servicers for making appropriate deals with borrowers past due on their mortgage loan payments, to keep them in their homes.

Oppenheimer analyst Ben Chittenden rates Ocwen "oupterfrom," with a $57 price target, implying 50% upside from Tuesday's close over the next 12 to 18 months.

"We think that while there may be continued headline risk associated with this potential case, ultimately the financial risk is minimal, and we would be using this pullback as a buying opportunity," Chittenden wrote in a note to clients. The investors if they sue Ocwen will have "a high bar to meet," according to the analyst, since they will need to prove that the net present value of the mortgage-backed securities "(both in dollar and community terms) would have been higher than the NPV of the modification and thus the servicer hurt the MBS performance with the modification.

Chittenden's price target is based on a multiple of 9.5 times his 2015 EPS estimate of $5.98. "We choose 9.5x because since the crisis, the stock has generally traded between 8x and 11x NTM earnings, and thus we think 9.5x is a reasonable multiple," he wrote.

Ocwen's shares were up 1.3% in midday trading Wednesday, to $38.56.

This chart shows the performance of Ocwen's stock against the S&P 500 over the past five years:
< OCN Chart data by YCharts

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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