Lowering Whistleblower Odds; The Cost of Regulation

By rchrisman@robchrisman.com

This is the only day of the year that sounds like a military command: "March Forth"!  That is certainly not as interesting as the SAT eliminating "trick" questions, or as interesting as the question of, "Is Donald Trump actually helped in the eyes of some of the public when traditional politicians denounce him?"

Eric Hunsader, an opponent of high-frequency trading, says he will receive $750,000 for information that led to a New York Stock Exchange fine in 2012. The SEC declined to comment on the award but has previously said it would pay in excess of $700,000 to the whistleblower who provided the tip.

 There are plenty of penalties out there, and far fewer rewards. Remember that the CFPB does not have authority to bring lawsuits under the False Claims Act. At this point any industry watcher would be very hard pressed to remember a CFPB enforcement action that was the result of a whistleblower. Certainly they are not common. (Many would say that the term "whistleblower" is a politically correct term for someone that rats others out.) But Section 1057 of the Dodd Frank Act protects employees, including whistleblowers.

 The key for any institution to remember in avoiding many whistleblower situations is to not do anything wrong in the first place. But things can happen, and companies should provide a venue for complaints. Providing a forum for employees to say something is perhaps wrong, or to ask questions about a particular policy or procedure, is critical. Senior management must encourage employees to stay up to date on changes and to make training available for all staff.

 And staying trained is tough to do, especially in the world of regulation lenders find themselves in. In the post-crisis world, government regulation is brutally tight and bankers, especially community bankers, are swept up by all of this. Small banks must spend money to adhere to rules similar to those applied to big banks. This hardship erodes the ability to compete and prosper.

 Is the cure is worse than the disease? Regulation has been very good for non-banker consulting and legal firms, into which regulators tend to move when their jobs as regulators come to an end, but not so good for bankers themselves. A recent survey of community bankers demonstrates the toll. The Conference of State Bank Supervisors (CSBS) and state regulators' survey had results from commercial banks with assets less than $10B in 39 states. The survey asked bankers to quantify the cost of regulatory compliance to their operations in six areas.

 When the results were tallied, the bill came to a whopping $4.5B, which the report says represents 22% of all net income for those banks. Here's a breakdown of the percentage of expenses in each survey category that were attributed to regulatory compliance: consulting (38%); accounting and audit (30%); legal (20%); data processing (16%); and personnel (11%).

 Another survey of community bankers by KPMG found 45% said compliance costs are 5% to 10% of total operating costs and 33% said compliance costs are 11% to 20% of total operating costs. Bankers said the biggest drivers of compliance costs are Anti-Money Laundering (23%), consumer protection (17%) and lending practices (17%).

 Regulators rarely take into serious consideration the cost of regulations. But this pressure on community banks, particularly when rates are so low, is leading to heated discussions with regulators about easing the burden. Even Fed Chair Yellen is actively saying publically that bank regulation and supervision should not be "one-size-fits-all" and regulators need to reduce the "unnecessary regulatory burden" on community banks.

 "Rob, my HR and compliance folks are talking about 'Section 342'. Do you know what that is?" Yes, I have inkling and plenty of lenders are going to have to have a lot more than that going forward. The section was introduced by Maxine Waters into the Dodd-Frank legislation in July 2010. And most agree that the only reason you haven't heard much about it yet is because Dodd-Frank has so many laws, rules, and regulations it takes years to get through. But Congress is attempting to remedy historical practice. Section 342, an often overlooked provision of the act, was adopted to help correct racial and gender imbalances at financial institutions and their regulators by prescribing inclusion requirements at the specified U.S. government agencies that regulate the financial services sector, entities that contract with the agencies and the private businesses they regulate. A very good write up and summary from a couple years ago can be found here.

 What are the jungle drums saying about lenders out there?

 Originator and servicer Walter Investment, parent of Ditech, reported lower than expected earnings the other morning and the stock was down about 10%. For 2015, originations were up 36% and the servicing portfolio increased by 4%. In the fourth quarter, origination volume was up 8% YOY. Ditech, by the way, ended the year ranked as the 8th largest servicer in the nation by UPB (unpaid principal balance). Walter saw the removal of a $151 million goodwill impairment and a $20 million positive MSR mark. On the mortgage banking side of things income was less than many expected. Production volume declined to $5.6 billion vs. $6.9 billion last quarter and the gain-on-sale margin declined to 1.61% from 1.70%.

 This week Walter Investment appointed a new chairman of the board and COO. Yesterday WAC announced appointment of Daniel Beltzman as the new Chairman of the Board of Directors and David Schneider as Chief Operating Officer. Beltzman joined WAC's board in January; he is the co-founder of Birch Run Capital Advisors, at 21% of ownership is WAC's second-largest shareholder. Separately, David Schneider, EVP of WAC and President of Ditech Financial, will become WAC's COO effective immediately.

 Walter wasn't the only company to miss earnings estimates. Ocwen also was down in one day about 11% after missing its quarter. Delinquencies rose to 13.7% from 13.1%. 

 Remember a while back - Ocwen was in the news again. This time for its filing of an 8K. In addition to filing annual reports on Form 10-K and quarterly reports on Form 10-Q, public companies must report certain material corporate events on a more current basis. Form 8K is the "current report" companies must file with the SEC to announce major events that shareholders should know about. Keefe, Bruyette & Woods write, "OCN put out an 8K stating that a ratings action could come from S&P, Moody's, Fitch, or Morningstar in the near term. $45 billion of OCN's UPB has ratings triggers, of which $25 billion has already been tripped, although less than $1 billion has been transferred. There could also be some potential impact on the company' status with the GSEs." The filing announced that Ocwen will use payments connected with previous MSR sales to pay down $53.2 million of its senior secured term loan. As of now, Ocwen still has approximately $939.4 million left outstanding under this agreement.

 And Compass Point Research and Trading recently cuts it price target for Ocwen's stock. "Our price target represents a 0.8x multiple on our pro-forma FY16 TBV of $5.18. Our new FY16 and FY17 EPS estimates are -$1.05 and -$0.23 (vs. -$0.11 and $0.29 previously). OCN shares dropped -63% this week after the company reported disappointing 4Q15 results (4Q15 EPS - Quick Look), pulled FY16 profitability guidance and disclosed new incrementally negative risks in its 10-K. Permanent changes in OCN's servicing cost structure have impaired much of the hypothetical upside. The risk of default or other permanent capital impairment due to financial, regulatory and other factors remains high and difficult to handicap. Aside from these issues, the most important factor still needed to get comfortable with owning OCN is a clearer picture of the normalized cost structure with profitability in the low/mid double digits (bp/UPB)."

 Recent three public disclosures can be found here: Ocwen Financial Announces Operating Results for Fourth Quarter and Full Year 2015, Fourth Quarter 2015 Supplemental Management Comments and Investor Presentation, 2015 Form 10K.

 Bose George from KBW, "The difference between GAAP and operating reflected the exclusion of a $14 million loss on the sale of MSRs and $9.7 million of positive MSR marks, and a normalization of the tax rate to 12%...The earnings miss came on higher operating expenses and lower gain on sale revenue than we were forecasting."

 So Ocwen had higher operating expenses than expected and lower gain on sale revenue. Servicing was a mixed bag - servicing UPB totaled $251 billion at the end of 4Q15, down from $288.1 billion in 3Q. The decline reflected MSR sales and runoff.

 "The shares trade at about 90% of tangible book, which is a premium to peers such as NSM, which is profitable and trades closer to 75% of book value."

 While we're talking about big numbers and as a segue into capital markets, a few weeks ago I noted bank holdings of MBS up to the end of 3Q15. Data was recently released for Q4 and the notables are: the top 25 banks added $38B of agency MBS in Q4, of which $29.8B was GNMA passthroughs; bank MBS holdings grew $139B for the year, absorbing $161 of 2015's agency net issuance; banks added $61.2B of GNs vs $89.9B of net GNMA issuance; in conventionals, banks added $73.8B vs $71.3B in conventional net issuance; growth in MBS surpassed that in treasuries, with only $4.4B net growth in Q4 bringing the 2015 total to $6.6B.

 Turning to rates, we saw a bit of a rally Thursday in spite of a mixed bag of economic data.  February ISM Services beat expectations but January Factory Orders didn't, and jobless claims were worse. And really, should something dramatic happen overseas or to the price of oil we won't care what either number was, right?

 And this morning we've already had the trade balance and February employment numbers. Nonfarm Payroll came in +242k, much stronger than expected, and there were back-month revisions. The Unemployment Rate held at 4.9%. But Hourly Earnings fell .1%. And the trade figures showed a widening. We closed Thursday with the 10-year yield sitting at 1.83% and after this salvo of numbers it is at 1.88% with agency MBS prices worse .125.