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Fitch Puts Ocwen on Negative Watch

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Ocwen Financial Corp.’s long-term Issuer Default Rating (IDR) has been placed on Rating Watch Negative by Fitch Ratings for a probable downgrade. The primary reason for putting the rating under a negative watch is the recent announcement by the company to acquire Homeward Residential Holdings Inc. – an integrated mortgage firm with prime lending and mortgage servicing operations – from WL Ross & Co. LLC.

Fitch expects that the possible downgrade will not be more than two notches from the present long term IDR of “B+” rating. Nevertheless, the rating agency reiterated Ocwen’s short term IDR at “B”.

Homeward currently services approximately 422,000 mortgage loans with the total unpaid principal balance (UPB) of more than $77 billion. Following the closure of this deal, Ocwen’s total mortgage portfolio would be 1.2 million mortgage loans with the UPB of roughly $209 billion (based on the company’s June 30, 2012 data).

Ocwen stated that the deal, still subject to customary regulatory approvals, is expected to close by the end of this year. The company will be paying about $588 million in cash and $162 million in Ocwen convertible preferred stock.

Ocwen further stated that it will not have to raise any additional capital to wrap up the acquisition. Nevertheless, Fitch anticipates that the transaction would lead to an escalation in Ocwen’s overall leverage (on a pro forma basis) as it assumes about $2.3 billion of Homeward's existing servicing advances.

According to Fitch, despite the acquisition being a strategic fit for Ocwen’s present operations, the near term execution and integration risk could lead to disruption in servicing the loan portfolios, which in turn would adversely impact the financials. Further, the regulatory scrutiny of the mortgage servicing sector will weigh on the company’s risk profile.

Unlike Fitch, last week, Standard & Poor's (S&P) Ratings Services affirmed its counterparty credit and senior secured debt ratings at “B” on Ocwen. Also, the outlook for the company remains “Stable”.

Our Take

At a time when major mortgage servicers are shying away from mortgage servicing business as a result of stringent regulations and balance sheet risk, Ocwen has been filling up this void by a series of acquisitions. Though the company will have to comply with the regulations related to mortgage servicing, it is better positioned than the other servicers as it focuses only on servicing operations unlike the others.

Over the last one year, Ocwen has acquired Saxon Mortgage Services Inc. – mortgage subsidiary of Morgan Stanley (MS - Free Report) and Litton Loan Servicing from The Goldman Sachs Group, Inc. (GS - Free Report) , Also, the company bought certain mortgage-servicing rights (MSRs) related to non-prime loans from JPMorgan Chase Bank, N.A. – the banking division of JPMorgan Chase & Co. (JPM - Free Report) as well as residential MSRs from Bank of America, National Association – a unit of Bank of America Corporation (BAC - Free Report) .

Ocwen currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term ‘Neutral’ recommendation on the stock.

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