3 conditions before Ocwen and PHH are clear to close

Ocwen Financial Corp.’s $360 million bid to buy PHH Corp. is intended to alleviate a multitude of regulatory and financial strains that have plagued both companies for years. But the deal also raises a number of questions for investors, borrowers and regulators.

Here’s a look at three obstacles that must be addressed before the deal’s projected closing in the second half of 2018:

Stakeholder sign-off

A host of stakeholders will have a say in whether the deal can proceed, including regulators, shareholders and secondary mortgage market participants.

Ocwen will pay PHH shareholders $360 million and assume $119 million in corporate debt. But PHH has $260 million in cash on its balance sheet that Ocwen will be able to use to fund the deal — making the actual cost for Ocwen to acquire PHH roughly $219 million.

The deal must be approved by PHH’s shareholders. Some PHH stockholders may not like Ocwen’s plan to pay $11 per share because it represents a 35% discount to PHH’s GAAP book equity. PHH’s stock price has increased about 25% since the deal was announced, and Ocwen’s has gone up about 5%.

Some law firms representing shareholders are already investigating whether PHH was adequately shopped before the deal was announced. But analysts are skeptical that there’s a better alternative for the struggling company.

"I don’t think that there’s a third party waiting in the wings to outbid everybody. It would surprise me," said Henry Coffey Jr., a managing director in equity research at Wedbush Securities who covers PHH.

Ocwen investors may not like that the deal adds short-term strain on the company’s finances at a time when it is spending a fair amount on legal and regulatory battles. But so far, its stock has reacted positively because the deal improves the company’s growth prospects and economies of scale.

Meanwhile, regulators, including those that have been critical of Ocwen and PHH in the past, will also have a say in whether the deal can move forward.

"The regulatory issues are the main [concerns], assuming shareholders on both sides see this as being a decent deal," said Bose George, a managing director in equity research at Keefe, Bruyette & Woods, a company that provides some investment banking services for Ocwen.

The Federal Trade Commission and the Department of Justice share oversight of mergers and acquisitions. In general, any deal valued at more than $84.4 million receives at least a preliminary review to ensure there are no antitrust or anticompetitive concerns. The FTC has also put particular emphasis on monitoring the changing conditions in the real estate industry to ensure fair competition among a growing number of digital service providers.

But given the relative size of Ocwen and PHH and the number of other mortgage servicing competitors in the industry, it is unlikely the deal will face significant antitrust scrutiny. The bigger challenge will be state and federal financial regulators.

"I think that’s where the highest risk is because with the states you’ve got 30 people that have to agree that this is in the interest of all the stakeholders," said Coffey. About 30 states that license servicers will need to sign off on the deal.

Mortgage-backed securities investors will also need to approve the deal because servicing rights on their loans will be transferred, and Ocwen may use its MSRs as collateral to raise capital. New Residential Investment Corp., the largest subservicing client of both Ocwen and PHH, has already given its blessing.

Other secondary mortgage market participants, including Fannie Mae, Freddie Mac, Ginnie Mae and private-label securitizers that work with the servicers will also have to approve the deal.

"We are working with Ocwen to fully understand the details of their transaction with PHH. In all transactions of this type, we work to ensure the acquiring entity has the resources and capacity, systems and technology, and process and controls in place to properly service the portfolio according to the Ginnie Mae MBS Guide requirements as well as those of the insuring/guaranteeing agency," Ginnie Mae said in a written statement to National Mortgage News. "In addition to quantitative operational capabilities, we also evaluate the qualitative operational fitness of the acquiring entity and how it would be impacted by the transaction."

Borrower protections

The key to appeasing regulators will be ensuring borrowers won’t be harmed during the transition when loans are transferred to a common servicing platform or after the transition when Ocwen is handling a much larger loan portfolio.

Ocwen and PHH are closer to detente with state regulators on this point than they have been in the past. And one aspect of the deal that’s likely to assuage regulators’ concerns is that Ocwen can more quickly migrate to Black Knight’s LoanSphere MSP servicing system of record.

That’s been a condition of many of Ocwen’s recent regulatory settlements, because its existing platform had "technology glitches that the states took issue with," said attorney Marx Sterbcow.

"It does make it an easier process for the regulators to bite into when it comes to approving the deal," he said.

But the idea of consolidating more loans in the hands of a distressed loan servicer like Ocwen, which has a long track record of borrower complaints, could give some regulators pause.

"You have 30 state regulators that have to sign off on this and they are going to be thinking about their consumers," Coffey said.

Consumer advocates are also wary of the deal.

"We have had concerns about Ocwen in the past and during the crisis they were certainly one of the more complained-of institutions," said Kevin Stein, deputy director of the California Reinvestment Coalition.

He added that while Ocwen’s reputation among some of his organization’s "allies" has improved over time, "We would look on with concerns to any merger and would hope the resulting institution will be responsible and deal well with consumers."

Industry implications

Like regulators, secondary mortgage market participants with servicing rights that will be transferred or financed as part of the deal will be concerned about how the transaction affects their borrowers.

The challenge is compounded by the fact that different investors have different preferences for how loans and borrowers are treated, particularly when it comes to loss mitigation strategies. Those priorities can differ even among investors with different stakes in the same securitization.

"Everybody’s just trying to get their piece of the pie," Coffey said.

Other parties like Fannie Mae, Freddie Mac and Ginnie Mae will likely be more concerned that the counterparties servicing their loans will be strong and will do their job well enough to protect the cash flows that the agencies guarantee.

Given ongoing concerns about market concentration in mortgage servicing, the question comes down to whether the agencies are better off with Ocwen and PHH as two small competitors or one large counterparty. But since both companies have faced myriad challenges, "there’s an argument to be made that the combined entity will be stronger," George said.

Ocwen has been reducing its origination footprint and "that was a question for us on where its material future business was coming from," said Fitch Managing Director Roelof Slump. The acquisition doesn’t ensure that the combined company will be able to re-enter home loan origination beyond portfolio retention, but it does make it more likely and also helps to stabilize its servicing operation, he said.

There is some concentration risk in putting more loans in the hands of a single counterparty, but the constraints on growth at both companies and the market reduction in Ocwen’s distressed portfolio mitigates that.

"It’s just not a significant piece of the pie," Coffey said. "I think as long as they can convince everyone that they are reducing risk, or at least not increasing risk; and improving servicing quality or at least keeping it the same, you’ll find a variety of parties will ultimately check this off. But it’s a complex gauntlet."

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Bonnie Sinnock

Bonnie Sinnock is the capital markets editor of National Mortgage News.

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