UPDATE: Home Loan Servicing Closes Down 3% Post-IPO

Shares of Home Loan Servicing Solutions Ltd. (HLSS), a company created by an Ocwen Financial Corp. (OCN) executive to buy up certain mortgage-related rights and liabilities from Ocwen, declined 3.1% on their first day of trading Wednesday.

The company's shares closed at $13.56 on the Nasdaq, down from their initial public offering price of $14. It sold 13.3 million shares at the low end of its expected price range of $14 to $16.

Headquartered in the Cayman Islands, Home Loan Servicing was created to acquire mortgage-servicing rights and other income from servicing mortgage loans. By just acquiring the rights, the company will not originate or purchase mortgage loans; in fact, it won't even actually service the loans. It plans to hire Ocwen to do that.

Prior to its IPO, Home Loan Servicing was owned entirely by William C. Erbey, the chairman of Ocwen Financial; the 13.3 million shares sold in the deal represented 95% of the float, so he owns about 5% post-IPO.

The money raised in the IPO will be used to purchase the right to receive servicing and other fees from Ocwen Loan Servicing LLC, a subsidiary of Ocwen Financial, on a portion of its pooling and servicing agreements. Its executives were in senior management roles at Ocwen Financial up until the IPO, when they -- with the exception of Erbey -- resigned from Ocwen to join Home Loan Servicing. The company plans to eventually purchase "substantially all" the remaining mortgage-servicing rights currently owned by Ocwen Loan Servicing.

That fits in with Erbey's strategy of making Ocwen into a more "equity-light" fee-for-service business. The chairman of the two companies laid out Home Loan Servicing's role in lightening Ocwen's load in an Ocwen earnings release last week.

"In the near-term, [Home Loan Servicing] should provide us additional capital for growth, without dilution to existing shareholders, and make Ocwen more competitive on transactions. Over time, we would hope to move most of Ocwen's mortgage servicing rights and advances to [Home Loan]. The impact of this should be higher returns on equity than we could achieve by keeping the assets on Ocwen's balance sheet," Erbey said in an earnings release last week.

However, in acquiring those mortgage servicing rights, Home Loan is also shouldering the cost of associated servicing cash advances to cover delinquent principal, taxes and interest on home loans. Such advances provide liquidity to mortgage-backed securitizations; they're not meant to provide credit to mortgage lenders or homeowners.

Servicing advances are usually reimbursed from payments that are eventually made by a homeowner or through the liquidation of the property. But anything that lengthens the foreclosure process increases the amount of servicing advances that must be made, and increases the time it takes to get reimbursed.

Foreclosures timelines have generally been increasing over the last two years due to an uptick in the number of delinquent loans, and regulators could further increase the timeline, based on inquiries into the whether banks have complied with foreclosure laws. Home Loan Servicing warns that any increase in foreclosure timelines would increase interest expense, and reduce the cash available to pay operating expenses or to pay dividends.

A downgrade in Ocwen Loan Servicing's servicer rating could also hurt business, Home Loan Servicing warns. In December, Fitch downgraded Ocwen Loan Servicing's servicer ratings from RPS2 to RPS3 and RSS2 to RSS3 and kept it on negative rating watch.

Ocwen's stock closed Wednesday at $16.11, down 2 cents.

Home Loan says its business plan will result in predictable revenue and expenses, generating a stable income stream. It plans to distribute at least 90% of its net income to its shareholders via dividends. On Jan. 30, Home Loan's board declared a contingent interim dividend of 10 cents a share per month for each of the three full months following the IPO. On an annualized basis of $1.20, that results in a yield of 8.6% at the IPO price.

The company's strategy is complicated by the transfer of legal ownership of mortgage-servicing rights from the seller, which requires the prior approval or consent of various third parties, including rating agencies. That's the case with its initial deal with Ocwen Loan Servicing, which doesn't have the necessary approvals and consents as of the IPO closing. Home Loan Servicing says that shouldn't affect its business strategy or performance. If a seller hasn't obtained the necessary approvals and consents, the company instead plans to acquire the rights to receive the servicing fees that the current servicer receives, as it has done with Ocwen's first batch.

As compensation for its servicing work after Home Loan buys the rights, Ocwen Loan Servicing will receive a monthly base fee initially equal to 12% of servicing fees collected each month, with the opportunity to earn a monthly performance-based incentive fee.

The mortgage-servicing assets that the new company will purchase are a portion of the assets acquired by Ocwen Loan Servicing when it purchased the U.S. subprime mortgage-servicing business of HomEq Servicing in September 2010. The estimated price for the initial purchase is $181 million. The company says it obtained an opinion from the Mortgage Industry Advisory Corporation, an independent valuation firm, of the fairness of the purchase price.

One of the risks Home Loan cites in its prospectus is its status as a new company. It has no track record of performance to show investors. It warns that its business model is untested and its operations don't begin until after the IPO and the initial acquisition from Ocwen. The closing date of that initial acquisition isn't specified in the company's prospectus.

Wells Fargo & Co. (WFC), Barclays PLC's (BCS) Barclays Capital, Citigroup Inc. (C) and Deutsche Bank AG (DB) managed Home Loan Servicing's offering.

-By Lynn Cowan, Dow Jones Newswires; 301-270-0323; lynn.cowan@dowjones.com

(Al Yoon contributed to this article.)

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