Hill Bridge Advisors discusses the ongoing activist situation in Home Loan Servicing Solutions and Ocwen Financial.
Hill Bridge Advisors: Mangrove Partners’ Flawed Strategy for HLSS – Summary
Hill Bridge Advisors, LLC (HBA) is offering an alternate opinion on how to view Home Loan Servicing Solutions, Ltd. (HLSS) based on our analysis of HLSS, Ocwen Financial Corp. (OCN), the mortgage servicing marketplace, and understanding of structured finance.
We believe that the proposal outlined in Mangrove Partners (Mangrove) proxy filed on February 10, 2015, would be detrimental to the interests of:
- Shareholders of HLSS and OCN;
- Investors in Mortgage Backed Securities (MBS) serviced by OCN; and
- Homeowners whose mortgages are being serviced by OCN.
Furthermore, we believe that it would be very difficult for HLSS, at the behest of Mangrove, to obtain timely approvals from the following multiple stakeholders with differing motivations. Please note that approvals would, in all likelihood, be required, if and when Mangrove and HLSS were to prevail in court and force OCN to sell and transfer over $165 billion of servicing (affecting 1.1 million homeowners) to a qualified successor servicer(s) from a very limited pool of interested servicers:
1. State and Federal Regulators
2. Credit Rating Agencies
3. MBS Trustees
4. Majority of investors in MBS bonds
5. Mortgage and Bond Insurers
6. “Soft approvals” from community organizations
If Mangrove is successful in its proxy effort and in remaking HLSS’s Board of Directors, and ultimately succeeds in terminating and transferring PLS Servicing, this will more than likely result in the liquidation of OCN as a going concern. Thus, OCN, would not concede to HLSS’s termination of services claim (the merits of which we question) and transfer of (PLS) servicing, after having announced an exit from the GSE servicing business, without a protracted legal fight.
So if you believe that Mangrove, through HLSS, could be successful, then go long HLSS and short OCN at your own peril.
On February 9, 2015, Mangrove Partners, a New York-based hedge fund and a shareholder of HLSS, sent the company a letter in which it urged HLSS’s Board to terminate its relationship with Ocwen, based on its belief that it may unlock significant value for HLSS shareholders.
To sum up our understanding of Mangrove’s argument:
Mangrove alleges that Multiple Termination Events under the documents governing HLSS’s purchase of Rights to MSRs (RMSRs) from Ocwen have occurred and therefore HLSS should immediately begin the process of exercising its rights to direct Ocwen to transfer the servicing rights to one or more different servicers.
This action, according to Mangrove, will “isolate HLSS from the risks of an ongoing relationship with Ocwen” and “would give HLSS the opportunity to engage with servicers that have greater servicing stability, better management oversight, stronger relationships with regulators, and higher ratings”.
We question whether HLSS has the legal authority to dictate termination and transfer of servicing. After all, the current parties to the servicing agreement are OCN (the title holder and servicer of record) and the MBS Trust (Trustee and investor). Furthermore, would HLSS even be able to obtain rating agency consent (RAC) for a transfer of servicing from Ocwen to other successor servicers?
Mangrove contends that a transfer of the servicing rights away from Ocwen will create $8-$13 per share of incremental value to HLSS, an increase in book value of between 44% and 72%. Furthermore, Mangrove asserts that by severing ties with Ocwen, HLSS stock could trade at its historic multiple of between 120% and 130% of book value. “In a reasonable scenario, this would give shareholders a value of between $31 and $40 per share.” Lastly, Mangrove includes an appendix to its letter which contains the Fund’s valuation analysis. (See the full text of Mangrove’s Letter here).
We See No Reason Why HLSS Would Trade Above Book
We may address how unlikely, in our view, this valuation framework is in a subsequent report. But let us, for now, leave you with the following thoughts:
Why would a company like HLSS, with limited growth prospects, no mortgage origination and servicing capability or infrastructure, approximately 18 employees, and Level 3 financials assets (valued by an independent valuation firm and auditors) have an intrinsic value close to 2x tangible book value?
Total assets for HLSS, as of Q3-2014 were approximately $7.95 billion.
Of this total, $6.1 billion (77%) was in Match Funded Advances, essentially in non-earning receivables, and given processing delays across the mortgage industry, we would be concerned with recoverability at 100% of book value.
Another $832 million is in Loans Held for Investment (GNMA Early Buyouts and distressed loans) whose values are based on company assumptions, limited price discovery and limited growth prospects.
See full PDF below.