Ultimately, Ocwen Financial Corp.'s pending purchase of Litton Loan Servicing is likely to benefit the investors in the $45 billion of mortgages that Litton manages and some of the homeowners. That's because Ocwen has a record of moving faster than Litton to resolve troubled loans, either through modification or foreclosure.

In the short term, though, expect chaos.

Fitch Inc. and Moody's Investors Service Inc. have both warned investors that their cash flows are likely to get disrupted once Ocwen acquires Litton from Goldman Sachs Group Inc. One reason for this is the snafus that occur when servicers are combined.

"With servicing platform transfers, there can be a hiccup in performance," says Moody's Gene Berman. "That can manifest itself in actual collections, more calls being abandoned as borrowers experience longer wait times" and give up on trying to reach someone who could work out their loan.

The risk is particularly acute in this case. About 90% of Ocwen's collection staff and two-thirds of its loss mitigation staff is offshore. Most of Litton's staff works in the United States. In a recent report, Moody's said borrowers who may feel confused during a transfer may feel more so when interacting with offshore agents.

Another factor that may make things bumpy for the investors is Ocwen's habit of moving quickly to get itself reimbursed for servicing advances. When a borrower falls behind, a servicer typically fronts principal and interest payments to investors, along with property taxes and insurance premiums, for a time. Servicers are generally entitled to reimbursement for those advances when the property goes into foreclosure or the loan gets modified.

Litton, which has benefitted from Goldman Sachs' deep pockets, has advanced about $2 billion to owners of delinquent mortages in its servicing portfolio. According to Moody's, Ocwen may decide advances that Litton made on delinquent loans were nonrecoverable and seek reimbursements. That means less money for investors, because such reimbursements typically get paid out before loan payments are passed through to bondholders.

The problem could be exacerbated by the interest rate swaps that securitization trusts use to hedge the mismatch between the fixed rates on the mortgages and the floating rates on the mortgages. If the payments to the swap counterparties (typically banks) fall short because Ocwen has been using the money to reimburse itself for advances inherited from Litton, the counterparties could declare the trusts to be in default. That would trigger a termination payment — diverting even more of the cash flow that's available to investors.

Calls to Ocwen were not returned by deadline.

Ocwen's purchase of Litton, expected to close by Nov. 1, would make it the largest subprime servicer in the nation by dollar amount. According to Fitch, as of December 31, 2010 Ocwen's portfolio consisted of about 468,000 loans with an upaid balance of over $71.4 billion. Ninety-eight percent of Ocwen's loans are subprime. Litton's portfolio consisted of about 287,000 mortgages of which about 89% were subprime loans.

Both distresed loan servicing companies have recently drawn attention from regulators. In response to a recent whistleblower letter, Litton is the subject of an inquiry by the Federal Reserve Bank of New York for allegedly having a policy of denying modifications for borrowers eligible for government loan-mod programs. A Goldman Sachs spokesman, Michael DuVally, had no comment on the investigation.

Ocwen, on the other hand, is one of four servicers on a Treasury Department list, which includes Bank of America Corp, JPMorgan Chase & Co., and Wells Fargo & Co., that require substantial improvement on loan modification efforts. According to the Treasury, Ocwen has failed to meet benchmarks for correctly calculating homeowner eligibility for the Home Affordable Modification Program, and the regulator has also found substantial problems with the accuracy of reports that Ocwen is required to submit to the government under the program.

However, unlike the other servicers on the watch list, Ocwen is not having its servicer incentive payments docked by the Treasury Department. That is because Treasury Department acknowledged that Ocwen's compliance results are being affected by its integration of a large servicing portfolio during the government's servicer compliance testing period.

The Treasury didn't say which portfolio was causing problems, but the largest acquisition Ocwen has made recently is its September 2010 acquisition of HomeEq from Barclays PLC. That purchase certainly caused ripples. Ocwen rapidly moved to modify many HomeEq loans and it also deemed nonrecoverable a substantial number of advances the acquired servicer had made on delinquent loans. As a result, in eight of 133 HomeEq-serviced transactions, the swap counterparties had to be paid off. According to Moody's, this diverted all payments to the bondholders in those trusts, for periods lasting up to six months.

The other side of the coin, though, is that Ocwen's status as an independent servicer, and its resulting aversion to making advances, mean that it doesn't like to let delinquent loans fester.

Ocwen referred delinquent loans to foreclosure in an average of 197 days versus Litton's average of 402 days. It also took the company an average of 222 days to dispose of repossessed real estate, versus Litton's average of 236 days.

Ocwen's rapid disposition of property not only stands out in comparison to Litton, but also in comparison to banks.

"Specialty servicers are more nimble and banks are more bureaucratic," says Alan White, a law professor from Valapraiso University who has studied the mortgage servicing industry. In addition, according to White, banks are often reluctant to foreclose because that could translate into losses on their own loan portfolios.

Although redefault rates are slightly higher on Ocwen loan modifications than is the case with Litton, Ocwen has an overall better record of saving money for securities because it is doing significantly more modifications. During 2009 and the first half of 2010, for example, Ocwen performed 7,575 modifications versus Litton's 6,061 modifications.

Homeowners with loans being serviced by Litton could benefit from the transfer to an Ocwen platform, says Diane Thompson, of counsel to the National Consumer Law Center.

"Ocwen has done a better job of performing loan modifcations than many other servicers," says Thompson. "In terms of creating an infrastructure to modify loans, they have the staff, they have the protocol, and they have the experience."

Housing counselors working with Ocwen say the servicer has performed better than bank-owned ones.

"Ocwen's record with us has been very helpful," says Jennifer Murphy, director of lender services for the Center for New York City Neighborhoods, a nonprofit established to deal with the foreclosure crisis. "They gave us a designated point of contact for everyone in our network to use," Murphy says. "It didn't seem like working with nonprofits was foreign to them whereas with the regular servicers, they never had much contact with the non-profit world."

Although there are plenty of borrower complaints about Ocwen, ultimately it is doing a better job than bank owned servicers, says White.

"I have previously advocated that the Treasury ought to move loans from banks to specialty servicers," he says, "not because they are some gold standard, but they are clearly doing a better job of workouts than the banks."

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