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On Thursday, Benjamin Lawsky, superintendent of New York's Department of Financial Services (DFS) restricted the proceedings of the cash-deal worth $2.7 billion entered into by Wells Fargo & Co. (WFC - Analyst Report) and Ocwen Financial Corp. (OCN - Analyst Report) last month. As per the terms of agreement, Ocwen was to buy residential mortgage-servicing rights (MSRs) on 1,84,000 loans with total principal balance of about $39 billion from Wells Fargo. Notably, the portfolio represents 2% of the bank's total residential-servicing portfolio as of Dec 31, 2013.

Mortgage servicers’ role is to accumulate payments from homeowners and allocate those to investors who own the loans through mortgage securities. Collectively, over the past two years, servicing rights over $1 trillion in mortgages have changed hands. Therefore, some specialty mortgage servicers have been thriving, which has raised doubt by regulators in the servicers’ capabilities to service such loans.

Of late, Ocwen has been growing inorganically. The company has acquired MSRs from several large banks including Morgan Stanley (MS - Analyst Report), The Goldman Sachs Group, Inc. (GS - Analyst Report) and JPMorgan Chase & Co. Once the company closes all its announced deals, the total servicing portfolio will likely be approximately worth $500 billion. At present, the company is the fourth largest mortgage servicer in the country with a market share of roughly 5%.

Driven by concerns over the mortgage servicer's ability to handle the increase in servicing volume, Lawsky has halted the recent deal of Ocwen indefinitely. Therefore, Ocwen has put the deal on hold at regulator’s request and is cooperating to resolve his concerns regarding its ability to service portfolios.

After the U.S. housing market collapsed in 2008, home foreclosures increased, which led to a rise in legal costs related to the servicing of mortgage loans. Moreover, some banks had to pay penalties for malpractices related to such loans. Additionally, given the new capital regulations, servicing of loans has become a costly affair for the banks.

Therefore, banks started selling their rights to shrink their mortgage business, thereby reducing risks. Moreover, revenues from mortgage fees have lessened as the boom in mortgage refinancing is gradually fizzling out, which led banks to resort to reducing exposure to the mortgage market.

In Dec 2013, Ocwen announced a settlement with the Consumer Financial Protection Bureau (CFPB) and other regulators, along with 49 states and the District of Columbia. The settlement pertained to the resolution of the alleged charges against the company’s handling of mortgages. However, Oklahoma was not part of the settlement. Ocwen was bound to pay nearly $2.1 billion in relief to distressed homeowners.

Going by the allegations, Ocwen used deceptive and unfair means while working with borrowers who were delinquent and underwater. The company was accused of misrepresenting facts while filing foreclosure documents, charging unjustified fees for default-related services and forcing borrowers to buy unnecessary insurance policies, among others.

Continuation of such settlements will dent Ocwen’s financials in the near term. Moreover, the holding back of the deal by regulators will affect the company’s strategy of increasing revenue through the acquisition of servicing rights from big banks in the coming period.

Currently, both Ocwen and Wells Fargo carry a Zacks Rank #3 (Hold).

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