Beware of Big Mortgage Settlement Numbers

Corporate America has long known the public relations power of putting a big dollar number on a deal.

Regulators, it seems, like to play the same game.

Ocwen Financial is a little-known firm whose business is to gather mortgage payments from millions of borrowers and pass them on to the banks and investors that own the mortgages. But last week, Ocwen emerged from obscurity after a federal regulator, the Consumer Financial Protection Bureau, ordered it to enter into a $2 billion settlement over allegations that it had mistreated struggling borrowers.

“Ocwen took advantage of borrowers at every stage of the process,” Richard Cordray, the bureau’s director, said. “Today’s action sends a clear message that we will be vigilant about making sure that consumers are treated with the respect, dignity and fairness they deserve.”

The bureau detailed the financial terms of the settlement. First, it required Ocwen to provide $125 million in refunds to borrowers who entered foreclosure. Second, Ocwen was also required to write down the outstanding amount owed on mortgages by $2 billion, to make the loans more affordable for the borrowers.

Anyone reading the news release would be forgiven for thinking that Ocwen had to pay out $125 million in refunds and then take a bruising $2 billion hit on the mortgages it services.

But neither assumption would be correct.

Ocwen’s refund payment is actually only $66 million, according to a filing by the company. (The firms that serviced the mortgages before Ocwen are paying the remainder.)

The $2 billion number is easy to misunderstand. Ocwen isn’t going to have to bear any of that $2 billion write-down itself, though the bureau’s news release never makes that clear. Ocwen doesn’t own the mortgages that it collects payments on. Bondholders own most of them, since banks packaged the loans into securities and sold those bonds into the markets. Indeed, a $2 billion write-down would probably wipe out most of Ocwen’s $1.8 billion in capital.

“There is not a hit to Ocwen when the loans are written down,” said Roelof Slump, a managing director at Fitch Ratings. “The $2 billion is coming from the bondholders.”

There is nothing new about how the consumer bureau constructed this deal â€" or described it. The standard practice in big mortgage settlements has been to place a burden on bondholders in this way. That was the case in the consumer-relief portion of the Justice Department’s $13 billion settlement with JPMorgan Chase earlier this year. And though the $26 billion national mortgage settlement that was struck in early 2012 was aimed at a few big banks, it ultimately included many mortgages owned by bondholders.

When loan servicers like Ocwen modify mortgages, they are theoretically obliged to do it in a way that does not harm the economic interests of bondholders. While write downs reduce the value of the loans in a bond, they may actually be worth it to the bondholder if foreclosures are avoided. Foreclosures, with their extra expenses, like maintaining repossessed properties, often end up being more costly to bondholders than principal reductions.

Still, none of this changes the fact that the loans belong to the bondholders â€" not Ocwen.

On a conference call after the settlement was announced, Mr. Cordray was asked whether Ocwen was passing on the costs of the principal reductions to other parties. In response, he said that Ocwen would incur costs itself in processing the write-downs. He added that Ocwen would be subject to penalties if the reductions did not take place.

“They have every financial incentive to see to it the entire $2 billion is delivered to consumers,” Mr. Cordray said.

The important question, however, is whether Ocwen was always going to do $2 billion of write-downs â€" even before the settlement.

Ocwen regularly reduces the principal on thousands of mortgages as part of its business. When asked if Ocwen might have done these principal reductions anyway, Paul A. Koches, who oversees corporate affairs at Ocwen, said, “We’ve been doing these for a long time â€" that’s all I’ll say.”