| OCWEN FINANCIAL CORP Item 1A Risk Factors |
| 8 ITEM 1A RISK FACTORS An investment in OCNapstas common stock involves significant risks inherent to OCNapstas business |
| The principal risks and uncertainties that management believes affect or could affect OCN are described below |
| The risks and uncertainties described below are not the only ones facing OCN Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair OCNapstas business operations |
| This report is qualified in its entirety by these risk factors |
| You should carefully read and consider these risks and uncertainties described below together with all of the other information included or incorporated by reference in this report before you decide to invest in our common stock |
| If any of the following risks actually occur, OCNapstas financial condition and results of operations could be materially and adversely affected |
| If this were to happen, the value of OCNapstas common stock could decline significantly, and you could lose all or part of your investment |
| Our success is dependent upon our ability to acquire and accurately price mortgage servicing right, as well as general economic conditions in the geographic areas in which we service loans |
| The primary risk associated with mortgage servicing rights is that they will lose a portion of their value as a result of higher than anticipated prepayments occasioned by declining interest rates or because of higher than anticipated delinquency rates occasioned by deteriorating credit conditions |
| Interest rates, prepayment speeds and the payment performance of the underlying loans significantly affect both our initial and ongoing valuations and the rate of amortization of mortgage servicing rights |
| In general, the value of mortgage servicing assets is affected by increased mortgage refinance activity that is influenced by changes in borrowers &apos credit ratings, shifts in value in the housing market and interest rates |
| While mortgage servicing rights tend to decrease in value as interest rates decrease, they tend to increase in value as interest rates increase |
| During 2003 and 2004 and most of 2005, high prepayment speeds resulted in significant rates of amortization expense of our mortgage servicing rights |
| We acquire servicing rights principally from mortgage origination companies and investment banks |
| Servicing rights are typically acquired based upon a competitive bidding process |
| A number of our competitors have access to greater capital resources which may provide them with a competitive advantage if they seek to increase their market share |
| Although the market for the acquisition of servicing rights to subprime mortgage loans has grown in recent years, we may be unable to acquire the desired amount and type of servicing rights in future periods |
| In addition, the volume of servicing rights acquired by us may vary over time resulting in significant inter-period variations in our results of operations |
| In determining the purchase price for servicing rights, management makes assumptions regarding the following, among other things: o the rates of prepayment and repayment within the pools; o projected rates of delinquencies and defaults; o our cost to service the loans; o amounts of future servicing advances; o ancillary fee income; o our ability to service and resolve loans successfully and o future interest rates |
| If these assumptions are inaccurate or the bases for the assumptions change, the price we pay for servicing rights may be too high |
| This could result in reduced revenue or a loss to us |
| Therefore, our success is highly dependent upon accurate pricing of servicing rights as well as general economic conditions in the geographic areas in which we service loans |
| 8 Our strategy to grow our business is subject to uncertainty |
| Our strategy focuses on providing asset servicing and origination processing solutions to the loan industry |
| Many factors could adversely affect our ability to realize this strategy including general economic factors, the general interest rate environment, our ability to maintain the servicing ratings assigned to us by rating agencies, government regulation, competition, our ability to obtain mortgage servicing rights, the effectiveness of our marketing initiatives, our ability to recruit or replace experienced management and operations personnel and the availability of funding |
| In addition, there can be no assurance that we will be able to accomplish our strategic objectives as a result of changes in the nature of our operations over time or that such changes will not have a material adverse effect from time to time or generally on our business, financial condition or results of operations |
| A downgrade in our servicer ratings could have an adverse effect on our business, financial condition or results of operations |
| Standard & Poorapstas, Moodyapstas and Fitch rate us as a mortgage servicer |
| Our favorable servicer ratings from these entities are important to the conduct of our loan servicing business |
| We can provide no assurance that these ratings will not be downgraded in the future |
| Any such downgrade could have an adverse effect on our business, financing activities, financial condition or results of operations |
| Our earnings may be inconsistent |
| Our exit from certain businesses and entry into others has resulted in variations in our results of operations and earnings |
| Our past financial performance should not be considered a reliable indicator of future performance, and historical trends may not be reliable indicators of anticipated results or trends in future periods |
| In addition to inconsistency in results caused by our entry into or exit from businesses, the consistency of our operating results may be significantly affected by inter-period variations in our current operations, including the amount of servicing rights acquired and the changes in realizable value of those assets due to, among other factors, increases or decreases in prepayment speeds |
| In addition, certain non-recurring items have significantly affected our operating results |
| Items reported by us in prior periods may not be repeated in future periods, and we may experience substantial inter-period variations in our operating results |
| Governmental and legal proceedings and related costs could adversely affect our financial results |
| We face the risk of governmental proceedings and litigation, including class action lawsuits, challenging our residential loan servicing and other business practices |
| On April 19, 2004, the Bank entered into a Supervisory Agreement with the OTS Although the Supervisory Agreement terminated upon the completion of debanking, for a period of six years following the completion of debanking, the OTS retains the right to bring enforcement actions in respect of any breach or noncompliance by the Bank with the Supervisory Agreement during the period prior to the completion of our debanking |
| Accordingly, there can be no assurance that any such eventualities were they to occur, would not have a material adverse effect on our financial condition, results of operations or cash flows |
| In addition, in connection with debanking, we entered into various agreements to meet the conditions to the OTS &apos approval including a Guaranty in favor of the OTS and any holders of claims with respect to liabilities assumed by OLS from the Bank |
| While we do not expect that compliance with the Guaranty will have a material adverse impact on our financial condition, results of operations or cash flows, if an event of default were to occur we would be obligated to increase the dlra5cmam000 cash collateral amount established under the terms of the Guaranty |
| Furthermore, the OTS and other beneficiaries of the Guaranty are entitled to initiate enforcement proceedings against us, which, in the case of the OTS, could result in civil money penalties |
| Accordingly, there can be no assurance that any such eventualities, were they to occur, would not have a material adverse effect on our financial condition, results of operations or cash flows |
| In addition, we and certain of our affiliates, including the Bank, have been named as defendants in a number of purported class action lawsuits challenging the Bankapstas residential loan servicing practices |
| At least one of our competitors has paid significant sums to settle lawsuits brought against it that raised claims similar to those raised in the lawsuits brought against our affiliates and us |
| Although we believe that we have meritorious legal and factual defenses to the lawsuits, we can provide no assurance that we will ultimately prevail |
| Litigation and other proceedings may result in the adoption of business practices different from those of our competitors, as well as settlement costs, damages, penalties or other charges, which would adversely affect our financial results |
| We incur significant costs related to governmental regulation |
| As noted in "e Regulation "e , our business is subject to extensive regulation and supervision by federal, state and local governmental authorities and is subject to various laws and judicial and administrative decisions imposing requirements and restrictions on a substantial portion of our 9 operations |
| We incur significant costs on an on-going basis to comply with governmental regulations which adversely affects our net income |
| If our regulators impose new or more restrictive requirements, we may incur additional significant costs to comply with such requirements which could adversely affect our net income |
| Effective June 30, 2005, we completed the debanking process |
| We no longer control a federal savings bank and are no longer subject to federal banking regulations, but we remain subject to certain federal, state and local consumer protection provisions |
| As a result of the debanking, we also became subject to regulation as a mortgage service provider, mortgage loan originator and/or a debt collector in a number of states in which we previously had enjoyed exemptions |
| We have not previously operated our mortgage servicing and debt collection businesses under such regulatory regimes, and there can be no assurance that this transition will not result in additional costs or uncertainties that would have a material adverse effect on the profitability of our mortgage servicing and debt collection businesses |
| We may be unable to obtain the necessary additional capital to finance the growth of our business |
| Our financing strategy includes the use of leverage |
| Accordingly, our ability to finance our operations rests in part on our ability to borrow money |
| Our ability to borrow money depends on a variety of factors including: o our ability to meet our current debt service obligations on our existing debt; o our corporate credit rating as evaluated from time to time by rating agencies and the occasion of any changes to their published ratings; o our financial performance and the perception that existing and potential lenders have of our financial strength; o limitations imposed on us by regulatory agencies and/or existing lending agreements that limit our ability to raise additional debt; and o general economic conditions and the impact they have on the availability of credit |
| An event of default, a negative ratings action by a rating agency, the perception of financial weakness, an action by a regulatory authority or a restriction imposed on us as a function of a debt covenant that serves to limit our ability to borrow money, or a general deterioration in the economy that constricts the availability of credit may increase our cost of funds and make it difficult for us to renew existing credit facilities and obtain new lines of credit |
| As a result of the completion of our previously disclosed debanking process, we are no longer able to obtain deposits in the US Although we believe we will be able to replace those deposits with other financing arrangements, we can provide no assurance that such alternative funding sources will be adequate to meet our needs or will not increase our cost of funds |
| Our international operations are subject to political and economic uncertainties and other risks beyond our control |
| In addition to our US operations, we have established operations in Canada, China, Germany, India and Taiwan |
| Although currently not significant to our operations, we also operate a bank in Germany that we acquired in 2004 |
| Our foreign operations are subject to risks beyond those associated with our US operations, including: o unexpected changes in local regulatory requirements; o unfavorable changes in trade protection laws; o difficulties in managing and staffing international operations; o potentially adverse tax consequences; o adaptability problems; o increased accounting and control expenses; o the burden of complying with foreign laws; o adverse social, political, labor or economic conditions; and o changes in foreign currency exchange rates |
| Although we evaluate hedging strategies to limit the effects of currency exchange rate fluctuations on our results of operations, there can be no assurance that our strategies will achieve their intended purpose |
| Further, we may be unable to effectively manage the risks listed above in order to realize the benefits of international operations |
| We face strong competition in our primary business segment |
| We face strong competition from a variety of competitors in our residential loan servicing business |
| These competitors include several smaller companies focused on servicing as well as a number of large financial institutions |
| These financial institutions generally have significantly greater resources and access to capital than we do, resulting in a lower cost of funds and a greater ability to purchase mortgage servicing rights |
| Because a part of our strategy depends on our ability to obtain mortgage servicing rights, we can provide no assurance that such competition will not have an adverse impact on our ability to implement our strategy |
| 10 In general, our competition has intensified in recent years as the low-interest rate environment has created favorable conditions for other companies and banks to enter the residential subprime loan business or expand their existing activities within the industry |
| While some of these entities only originate and do not currently service loans, there is no assurance that they will not develop internal servicing capability or outsource the servicing function to one of our competitors |
| Some originators from whom we have purchased servicing rights in the past have developed their own servicing capabilities |
| We may not be able to adequately protect our proprietary rights or information |
| Our success is in part dependent upon our proprietary information and technology |
| We rely on a combination of copyright, trade secret and contract protection to establish and protect our proprietary rights in our products and technology |
| In general, we enter into intellectual property agreements with all employees (including our management and technical staff) and consultants as well as limit access to and distribution of our proprietary information |
| We cannot be sure that we have taken adequate steps to deter misappropriation of our proprietary rights or information |
| Independent third parties may develop products and technology substantially similar to ours |
| Although we believe that our products and technology do not infringe any proprietary rights of others, we could be subject to claims of infringement in the future |
| The loss of the services of our senior managers could have an adverse effect on us |
| The experience of our senior managers is a valuable asset to us |
| Our chairman and chief executive officer, William C Erbey, has been with us since our founding in 1987, and our president, Ronald M Faris, joined us in 1991 |
| Other senior managers of ours have been with us for 10 years or more |
| We do not have employment agreements with, or maintain key man life insurance relating to, Mr |
| Faris or any of our other executive officers |
| The loss of the services of our senior managers could have an adverse effect on us |
| Other industry risks could affect our financial performance |
| We face many industry risks that could negatively affect our financial performance |
| For example, we face the risk that increased criticism from consumer advocates or the media could hurt consumer acceptance of our services and could lead to the adoption of different business practices |
| In addition, the financial services industry as a whole is characterized by rapidly changing technologies, and system disruptions and failures may interrupt or delay our ability to provide services to our customers |
| The secure transmission of confidential information over the Internet is essential to maintain consumer confidence in certain of our services |
| Security breaches, acts of vandalism and developments in computer capabilities could result in a compromise or breach of the technology that we use to protect our customers &apos personal information and transaction data |
| Consumers generally are concerned with security breaches and privacy on the Internet, and Congress or individual states could enact new laws regulating the electronic commerce market that could adversely affect us |
| In addition, we rely on our foreign employees for a number of our business processes in our call processing and data centers overseas |
| The issue of outsourcing to lower-cost foreign workers and the impact on the US labor market continues to attract significant negative media and Congressional attention, and Congress or individual states could enact new laws regulating outsourcing that could adversely affect us |
| We may be required to repurchase loans or indemnify investors if we breach representations and warranties that we made in connection with the sale of those loans |
| We have purchased and originated loans that were subsequently pooled and securitized or sold outright |
| On substantially all loans sold, we made representations or warranties at the time the loans were sold |
| We may be required to repurchase loans at a price equal to the then outstanding principal balance of the loan and any accrued and unpaid interest thereon if there were a breach of those representations or warranties |
| Additionally, we may be required to advance funds to the securitization trusts or to indemnify the trustee or the underwriters of a securitization under specific circumstances |
| The representations made in connection with our loan sale agreements typically include, among others, representations regarding the nature and condition of the related properties, including environmental issues, the absence of liens, the lack of undocumented mortgage modifications, and validity and enforceability of the mortgages, and the existence of appropriate insurance coverage |
| The expense we have recognized to date in fulfilling of guarantees is not significant, and our exposure to future obligations in this regard is not estimated to be significant |
| We are subject to investment risks |
| We have, in some cases retained subordinate and residual interests in connection with the securitization of our loans and have acquired other residual interests outright or in connection with our acquisition of subsidiaries |
| The performance of these securities has at times been negatively impacted by higher than expected prepayment speeds and credit losses experienced on the mortgage loans collateralizing the securities |
| We remain subject to the risk of loss on our remaining securities primarily to the extent that future credit losses exceed expected credit losses |
| 11 In the securitization process the first tier of loss protection afforded to the holders of more senior classes of mortgage-related securities (debt securities) is over collateralization |
| Within the context of residual interests in these debt securities, over collateralization is the amount by which the collateral balance exceeds the sum of the debt securities principal amounts and is achieved by applying monthly a portion of the interest payments of the underlying mortgages toward the reduction of the senior class certificate principal amounts, causing them to amortize more rapidly than the aggregate loan balance |
| To the extent not consumed by losses, the excess over collateralization is remitted to the residual holders |
| Principal from the underlying mortgage loans generally is allocated first to the senior classes with the most senior class having a priority right to the cash flow from the mortgage loans until its payment requirements are satisfied |
| To the extent that there are defaults and unrecoverable losses on the underlying mortgage loans, resulting in reduced cash flows, the most subordinate security will be the first to bear this loss |
| Because subordinate and residual interests generally have no credit support, to the extent there are realized losses on the mortgage loans comprising the mortgage collateral for such debt securities, we may not recover the full amount or, indeed, any of our remaining investment in such subordinate and residual interests |
| Subordinate and residual interests are affected by the rate and timing of payments of principal (including prepayments, repurchase, defaults and liquidations) on the mortgage loans underlying a series of mortgage-related securities |
| The rate of principal payments may vary significantly over time depending on a variety of factors such as the level of prevailing mortgage loan interest rates and economic, demographic, tax, legal and other factors, although in the absence of defaults or interest shortfalls all subordinates receive interest |
| In periods of declining interest rates, rates of prepayments on mortgage loans generally increase, and if the rate of prepayments is faster than anticipated, then the yield on subordinates will generally be positively affected and the yield on residuals will be negatively affected |
| We periodically assess the carrying value of our subordinate securities and residual securities retained |
| There can be no assurance that our estimates used to determine the value of subordinate securities and residual securities retained will be accurate for the life of each securitization |
| If actual loan prepayments or defaults exceed our estimates, the carrying value of our subordinate securities and residual securities retained may be decreased during the period in which we recognized the disparity |
| We also have invested in loans that we hold for resale related to our Residential Origination Services business |
| We believe that we have established adequate reserves for declines in fair values below cost in accordance with generally accepted accounting principles |
| Future increases to these reserves may be necessary, however, due to changes in economic conditions and the performance of these loans prior to their sale or securitization |
| Increases in our reserves for declines in fair value below cost would adversely affect our results of operations |
| The carrying value of our loans held for resale at December 31, 2005 was dlra624cmam671, net of market valuation reserves of dlra7cmam659 |
| Our directors and executive officers collectively own a large percentage of our common shares and could influence or control matters requiring shareholder approval |
| Our directors and executive officers and their affiliates collectively own or control approximately 45prca of our outstanding common shares |
| This includes approximately 31prca owned or controlled by our chairman and chief executive officer, William C Erbey, and approximately 13prca owned or controlled by our director and former chairman, Barry N Wish |
| As a result, these shareholders could influence or control virtually all matters requiring shareholder approval, including amendment of our articles of incorporation, the approval of mergers or similar transactions and the election of all directors |