Ocwen Financial Corp (NYSE: OCN) is one of the few companies that Laughing Water Capital discussed in its Q4 investor letter – you can download a copy of the letter here. We have already covered the fund’s thoughts on EZCORP. In this article, we’re looking at the comments made by the fund’s manager Matthew Sweeney about Ocwen Financial. Here is his commentary:
Ocwen was first detailed in our Q1’18 letter. What had looked like a great entry-point and was a big winner did a complete 180 in the last 2 months of the year and turned into a mark to market loser. Ocwen is in the mortgage servicing business, and the headline problem here is that higher interest rates mean higher mortgage rates, and higher mortgage rates means lower mortgage applications, which is bad for mortgage servicers because they must consistently add mortgages to their portfolio to replace those that roll off as people pay off their mortgages.
Historically and generally the correlation has been valid, but a trip into the world of common sense shows that it does not fit for Ocwen today. For regulatory reasons Ocwen has been prohibited from participating in the purchase of bulk mortgage servicing rights (MSRs) for the last several years. However, that changed just a few months ago, and when Ocwen completes a transfer of their MSRs to a new servicing platform (expected in the next 2 or 3 quarters) Ocwen will once again be able to purchase bulk MSRs.
The question is thus, “is it better to not participate in a strong mortgage market, or to participate in a weaker mortgage market?” The answer should be obvious to those capable of patiently making this distinction, but patience is in short supply on Wall Street, and with a shareholder base that leans heavily toward quantitative investing, this qualitative distinction cannot be made at all.
The problem was made worse by the fact that Leon Cooperman, OCN’s largest shareholder, announced that he would be shuttering his Omega Advisors hedge fund and returning capital at year end. For those that took the time to read past the headline, it was clear that the vast majority of Cooperman’s OCN holding would survive in other entities, but when a filing announcing that Omega’s international fund had sold shares hit, OCN shares fell off a cliff, perhaps anticipating that the entire ownership stake would be hitting the market.
To be clear, Ocwen’s return to growth is taking longer than I had originally estimated, which does reduce my estimate of intrinsic value by a touch. Additionally, in retrospect, I should have been more attuned to the above-mentioned trading factors that caused OCN shares to fall by ~66% in the quarter, and reduced our position as its size grew through rapid appreciation following our initial purchases.
In general, I believe that ignoring trading noise is a better strategy for long term compounding of wealth than trying to anticipate the short-term movements of the market, but in this instance, it had been obvious for several months that the combination of the quant focused shareholder base and Cooperman’s pending sales had the potential to drive a large move down in the stock, yet I did nothing.
My inactivity was because even at the highs OCN traded well below its tangible book value, and when the technology transfer is complete in a few months, OCN will be able to flex its operating structure, which should lead to shares trading at tangible book if not higher.
Ordinarily focusing on balance sheet strength provides downside protection, but in the case of Ocwen, a fair amount of this tangible book value is non-GAAP, meaning that the quant investors focused on mortgage rates are not aware of this additional balance sheet strength. Longer term I think we will be proven right, and shares have already rallied by 50% from their lows.
West Palm Beach, Fla.-based Ocwen Financial Corp (NYSE: OCN) provides residential and commercial mortgage loan servicing, special servicing, and asset management services. Shares of the company have been performing in the green this year so far. Since the start of the year, the stock’s value has jumped more than 46%. However, over the past 12 months, the share price has fallen over 54%. Currently trading at $1.99, OCN has the consensus average target price of $3 and the consensus average recommendation of ‘HOLD’ from analysts polled by FactSet.
Meanwhile, Ocwen Financial Corp (NYSE: OCN) isn’t a popular stock among the hedge funds tracked by Insider Monkey. Our database shows that 17 funds held bullish positions in Ocwen Financial at the end of the third quarter of 2018, including Omega Advisors and Akanthos Capital.