UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_______________________________________________________________________________________
Form 10-Q/A
_______________________________________________________________________________________
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2016
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission file number: 001-13417
_______________________________________________________________________________________
Walter Investment Management Corp.
(Exact name of registrant as specified in its charter)
_______________________________________________________________________________________
Maryland | 13-3950486 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1100 Virginia Drive, Suite 100 Fort Washington, PA | 19034 | |
(Address of principal executive offices) | (Zip Code) |
(844) 714-8603
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | o | Accelerated filer | x | |||
Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | o | |||
Emerging growth company | o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The registrant had 36,143,487 shares of common stock outstanding as of August 3, 2016.
_______________________________________________________________________________________
EXPLANATORY NOTE
Certain acronyms and terms used throughout this Form 10-Q/A are defined in the Glossary of Terms located at the end of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Walter Investment Management Corp. is amending its Quarterly Report on Form 10-Q for the six months ended June 30, 2016 (hereinafter referred to as the Original Filing and, as amended, the Amended Filing), and separately amending its Annual Report on Form 10-K for the year ended December 31, 2016 as well as its Quarterly Reports on Form 10-Q for the quarterly periods ended September 30, 2016 and March 31, 2017, in each case, to reflect a correction to the net deferred tax assets balance as described in further detail below as well as in Note 2 to the Consolidated Financial Statements. The Company reported that these previously issued financial statements contained in the Original Filings could no longer be relied upon in its Current Report on Form 8-K filed with the SEC on May 26, 2017. Further, as discussed in Note 2 to the Consolidated Financial Statements, the Company has also revised the amended quarterly reports for 2016 to include immaterial corrections of errors in its consolidated balance sheets related to insurance related receivables and payables.
The Company records a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates in each jurisdiction that applies to taxable income in effect for the years in which those tax assets are expected to be realized or settled.
The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on the evaluation of the realizability of the Company's deferred tax assets for the six months ended June 30, 2016 performed in connection with the Original Filing, management concluded that a partial valuation allowance was necessary, and included such allowance in the Original Filing. Subsequent to the Original Filing, management discovered an error in the calculation of the valuation allowance on the deferred tax assets, which is discussed in further detail in Note 2 to the Consolidated Financial Statements. As a result of this error, it was determined that the valuation allowance should have been $257.6 million higher than what was originally recorded and reduced the deferred tax assets, net to $16.3 million from $273.8 million at June 30, 2016.
As explained in Note 2 to the Consolidated Financial Statements included within this Amended Filing, the Company is amending its Original Filing and restating the Consolidated Financial Statements contained in the Original Filing to correct the error noted above regarding the calculation of the valuation allowance on the deferred tax assets. This Amended Filing and the restated Consolidated Financial Statements contained herein reflect the corrected estimated net amount of deferred tax assets that are considered by Company management to be recoverable.
The cumulative impact of the non-cash adjustment to correct the aforementioned error was a reduction in the net deferred tax assets balance and a corresponding increase in accumulated deficit of approximately $257.6 million as of June 30, 2016. Net loss increased for the six months ended June 30, 2016 by $257.6 million, which increased the loss per share by $7.22.
As a result of the identification of the error that led to this Amended Filing, Company management determined that the Company did not maintain effective internal controls with respect to the operating effectiveness of the review of the tax calculations associated with the valuation allowance on the deferred tax asset balances and further determined that this control deficiency constitutes a material weakness in internal controls over financial reporting as of June 30, 2016. Refer to Item 9A in this Amended Filing for management's revised conclusions related to internal controls over financial reporting as of June 30, 2016.
The adjustment being made in this Amended Filing does not impact revenues, cash position or total cash flows from operating, investing or financing activities, or any metric considered by the Compensation and Human Resources Committee with respect to the determination of executive compensation for the year ended December 31, 2016.
As disclosed in Note 2 to the Consolidated Financial Statements, in light of the Company’s need to restate the aforementioned financial statements, the Company received waivers from each of its warehouse and advance facility lenders, and from the requisite holders of its term loans and senior unsecured notes to the extent necessary to waive any default, event of default, amortization event, termination event or similar event resulting or arising from the restatement.
Management is required to evaluate its ability to continue as a going concern as of the date of issuance of financial statements. Accordingly, based on recent developments as described in Note 3, the Company has concluded that there is substantial doubt as to its ability to continue as a going concern. Refer to Note 3 for a more detailed description of the factors that resulted in this conclusion.
Pursuant to the rules of the SEC, Item 15 of Part IV of the Original Filing has been amended to contain the currently-dated certifications from the Company's Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the Company's Chief Executive Officer and Chief Financial Officer are attached to this Form 10-Q/A as Exhibits 31.1, 31.2, and 32, respectively.
This Amended Filing reflects the restatement of (i) the Company’s consolidated balance sheet at June 30, 2016, (ii) the consolidated statements of comprehensive loss; stockholders’ equity and cash flows for the year then ended, and (iii) the notes related thereto. For a more detailed description of these matters, see Note 2 to the Consolidated Financial Statements. Except for certain of the information appearing in this Explanatory Note and Note 3 to the Consolidated Financial Statements, this Amended Filing sets forth the Original Filing in its entirety, only amends Items 1, 2 and 4 of Part I, and Items 1A and 6 of Part II of the Original Filing to the extent necessary to reflect the adjustments described above and described in Note 2 to the Consolidated Financial Statements and to reflect recent developments specifically described in Note 3 to the Consolidated Financial Statements, does not reflect any events occurring after the filing date of the Original Filing and has not been updated or otherwise amended. Accordingly, the forward-looking statements included in this Amended Filing represent management’s views as of the date of the Original Filing and should not be assumed to be accurate as of any date thereafter.
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
FORM 10-Q/A
INDEX
Page No. | ||
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (As Restated, See Note 2)
(in thousands, except share and per share data)
June 30, 2016 | December 31, 2015 | |||||||
(Restated) | (Restated) | |||||||
(unaudited) | ||||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 312,893 | $ | 202,828 | ||||
Restricted cash and cash equivalents | 209,898 | 708,099 | ||||||
Residential loans at amortized cost, net (includes $4,329 and $4,457 in allowance for loan losses at June 30, 2016 and December 31, 2015, respectively) | 565,061 | 541,406 | ||||||
Residential loans at fair value | 12,723,753 | 12,673,439 | ||||||
Receivables, net (includes $12,681 and $16,542 at fair value at June 30, 2016 and December 31, 2015, respectively) | 192,103 | 137,190 | ||||||
Servicer and protective advances, net (includes $124,387 and $120,338 in allowance for uncollectible advances at June 30, 2016 and December 31, 2015, respectively) | 1,334,202 | 1,631,065 | ||||||
Servicing rights, net (includes $1,255,351 and $1,682,016 at fair value at June 30, 2016 and December 31, 2015, respectively) | 1,350,276 | 1,788,576 | ||||||
Goodwill | 156,283 | 367,911 | ||||||
Intangible assets, net | 77,910 | 84,038 | ||||||
Premises and equipment, net | 103,642 | 106,481 | ||||||
Deferred tax assets, net | 16,254 | 108,050 | ||||||
Other assets (includes $79,597 and $58,512 at fair value at June 30, 2016 and December 31, 2015, respectively) | 256,031 | 200,364 | ||||||
Total assets | $ | 17,298,306 | $ | 18,549,447 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Payables and accrued liabilities (includes $36,408 and $6,475 at fair value at June 30, 2016 and December 31, 2015, respectively) | $ | 597,864 | $ | 597,926 | ||||
Servicer payables | 158,654 | 603,692 | ||||||
Servicing advance liabilities | 1,002,451 | 1,229,280 | ||||||
Warehouse borrowings | 1,396,102 | 1,340,388 | ||||||
Servicing rights related liabilities at fair value | 120,825 | 117,000 | ||||||
Corporate debt | 2,159,947 | 2,157,424 | ||||||
Mortgage-backed debt (includes $548,067 and $582,340 at fair value at June 30, 2016 and December 31, 2015, respectively) | 999,499 | 1,051,679 | ||||||
HMBS related obligations at fair value | 10,717,148 | 10,647,382 | ||||||
Total liabilities | 17,152,490 | 17,744,771 | ||||||
Commitments and contingencies (Note 15) | ||||||||
Stockholders' equity: | ||||||||
Preferred stock, $0.01 par value per share: | ||||||||
Authorized - 10,000,000 shares | ||||||||
Issued and outstanding - 0 shares at June 30, 2016 and December 31, 2015 | — | — | ||||||
Common stock, $0.01 par value per share: | ||||||||
Authorized - 90,000,000 shares | ||||||||
Issued and outstanding - 36,137,082 and 35,573,405 shares at June 30, 2016 and December 31, 2015, respectively | 361 | 355 | ||||||
Additional paid-in capital | 595,212 | 591,454 | ||||||
Retained earnings (accumulated deficit) | (450,611 | ) | 212,054 | |||||
Accumulated other comprehensive income | 854 | 813 | ||||||
Total stockholders' equity | 145,816 | 804,676 | ||||||
Total liabilities and stockholders' equity | $ | 17,298,306 | $ | 18,549,447 |
5
The following table presents the assets and liabilities of the Company’s consolidated variable interest entities, which are included on the consolidated balance sheets above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated variable interest entities. The liabilities in the table below include third-party liabilities of the consolidated variable interest entities only, and for which creditors or beneficial interest holders do not have recourse to the Company, and exclude intercompany balances that eliminate in consolidation.
June 30, 2016 | December 31, 2015 | |||||||
ASSETS OF CONSOLIDATED VARIABLE INTEREST ENTITIES THAT CAN ONLY BE USED TO SETTLE THE OBLIGATIONS OF CONSOLIDATED VARIABLE INTEREST ENTITIES: | (unaudited) | |||||||
Restricted cash and cash equivalents | $ | 47,686 | $ | 59,705 | ||||
Residential loans at amortized cost, net | 484,517 | 500,563 | ||||||
Residential loans at fair value | 558,972 | 526,016 | ||||||
Receivables | 13,180 | 16,542 | ||||||
Servicer and protective advances, net | 935,367 | 1,136,246 | ||||||
Other assets | 23,818 | 12,170 | ||||||
Total assets | $ | 2,063,540 | $ | 2,251,242 | ||||
LIABILITIES OF THE CONSOLIDATED VARIABLE INTEREST ENTITIES FOR WHICH CREDITORS OR BENEFICIAL INTEREST HOLDERS DO NOT HAVE RECOURSE TO THE COMPANY: | ||||||||
Payables and accrued liabilities | $ | 3,173 | $ | 3,435 | ||||
Servicing advance liabilities | 820,047 | 992,769 | ||||||
Mortgage-backed debt (includes $548,067 and $582,340 at fair value at June 30, 2016 and December 31, 2015, respectively) | 999,499 | 1,051,679 | ||||||
Total liabilities | $ | 1,822,719 | $ | 2,047,883 |
The accompanying notes are an integral part of the consolidated financial statements.
6
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (As Restated, See Note 2)
(Unaudited)
(in thousands, except per share data)
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
REVENUES | ||||||||||||||||
Net servicing revenue and fees | $ | 31,936 | $ | 223,915 | $ | (73,826 | ) | $ | 314,802 | |||||||
Net gains on sales of loans | 100,176 | 119,399 | 184,653 | 244,626 | ||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | 7,650 | 6,815 | 42,858 | 37,589 | ||||||||||||
Interest income on loans | 11,849 | 18,186 | 24,020 | 50,127 | ||||||||||||
Insurance revenue | 11,277 | 11,429 | 21,644 | 25,560 | ||||||||||||
Other revenues | 24,585 | 32,689 | 54,895 | 50,586 | ||||||||||||
Total revenues | 187,473 | 412,433 | 254,244 | 723,290 | ||||||||||||
EXPENSES | ||||||||||||||||
Salaries and benefits | 133,681 | 143,157 | 266,320 | 290,385 | ||||||||||||
General and administrative | 135,776 | 142,100 | 265,382 | 270,747 | ||||||||||||
Goodwill impairment | 215,412 | 56,539 | 215,412 | 56,539 | ||||||||||||
Interest expense | 64,400 | 68,665 | 128,648 | 143,536 | ||||||||||||
Depreciation and amortization | 14,540 | 16,093 | 28,963 | 32,725 | ||||||||||||
Other expenses, net | 1,897 | 1,401 | 4,403 | 5,448 | ||||||||||||
Total expenses | 565,706 | 427,955 | 909,128 | 799,380 | ||||||||||||
OTHER GAINS (LOSSES) | ||||||||||||||||
Gain on extinguishment | — | — | 928 | — | ||||||||||||
Other net fair value gains (losses) | (819 | ) | 3,326 | (2,963 | ) | 2,454 | ||||||||||
Other | (532 | ) | (2,803 | ) | (1,556 | ) | 8,959 | |||||||||
Total other gains (losses) | (1,351 | ) | 523 | (3,591 | ) | 11,413 | ||||||||||
Loss before income taxes | (379,584 | ) | (14,999 | ) | (658,475 | ) | (64,677 | ) | ||||||||
Income tax expense | 110,379 | 23,120 | 4,190 | 4,450 | ||||||||||||
Net loss | $ | (489,963 | ) | $ | (38,119 | ) | $ | (662,665 | ) | $ | (69,127 | ) | ||||
Comprehensive loss | $ | (489,947 | ) | $ | (38,030 | ) | $ | (662,624 | ) | $ | (69,011 | ) | ||||
Net loss | $ | (489,963 | ) | $ | (38,119 | ) | $ | (662,665 | ) | $ | (69,127 | ) | ||||
Basic and diluted loss per common and common equivalent share | $ | (13.68 | ) | $ | (1.01 | ) | $ | (18.57 | ) | $ | (1.83 | ) | ||||
Weighted-average common and common equivalent shares outstanding — basic and diluted | 35,811 | 37,759 | 35,679 | 37,739 |
The accompanying notes are an integral part of the consolidated financial statements.
7
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (As Restated, See Note 2)
(Unaudited)
(in thousands, except share data)
Common Stock | Additional Paid- In Capital | Retained Earnings (Accumulated Deficit) | Accumulated Other Comprehensive Income | ||||||||||||||||||||
Shares | Amount | Total | |||||||||||||||||||||
(Restated) | (Restated) | ||||||||||||||||||||||
Balance at January 1, 2016 | 35,573,405 | $ | 355 | $ | 591,454 | $ | 212,054 | $ | 813 | $ | 804,676 | ||||||||||||
Net loss (As Restated) | — | — | — | (662,665 | ) | — | (662,665 | ) | |||||||||||||||
Other comprehensive income, net of tax | — | — | — | — | 41 | 41 | |||||||||||||||||
Share-based compensation | — | — | 5,705 | — | — | 5,705 | |||||||||||||||||
Tax shortfall on share-based compensation | — | — | (1,237 | ) | — | — | (1,237 | ) | |||||||||||||||
Share-based compensation issuances, net | 563,677 | 6 | (710 | ) | — | — | (704 | ) | |||||||||||||||
Balance at June 30, 2016 | 36,137,082 | $ | 361 | $ | 595,212 | $ | (450,611 | ) | $ | 854 | $ | 145,816 |
The accompanying notes are an integral part of the consolidated financial statements.
8
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (As Restated, See Note 2)
(Unaudited)
(in thousands)
For the Six Months Ended June 30, | ||||||||
2016 | 2015 | |||||||
(Restated) | (Restated) | |||||||
Operating activities | ||||||||
Net loss | $ | (662,665 | ) | $ | (69,127 | ) | ||
Adjustments to reconcile net loss to net cash provided by (used in) operating activities | ||||||||
Net fair value gains on reverse loans and related HMBS obligations | (42,858 | ) | (37,589 | ) | ||||
Amortization of servicing rights | 7,236 | 13,978 | ||||||
Change in fair value of servicing rights | 514,073 | 128,094 | ||||||
Change in fair value of servicing rights related liabilities | (12,724 | ) | 2,821 | |||||
Change in fair value of charged-off loans | (14,296 | ) | (8,656 | ) | ||||
Other net fair value losses | 6,815 | 2,455 | ||||||
Accretion of discounts on residential loans and advances | (1,845 | ) | (5,221 | ) | ||||
Accretion of discounts on debt and amortization of deferred debt issuance costs | 16,195 | 15,495 | ||||||
Provision for uncollectible advances | 22,356 | 28,185 | ||||||
Depreciation and amortization of premises and equipment and intangible assets | 28,963 | 32,725 | ||||||
Provision for deferred income taxes | 90,552 | 21,423 | ||||||
Share-based compensation | 5,705 | 8,429 | ||||||
Purchases and originations of residential loans held for sale | (10,078,201 | ) | (13,072,613 | ) | ||||
Proceeds from sales of and payments on residential loans held for sale | 10,239,448 | 12,698,437 | ||||||
Net gains on sales of loans | (184,653 | ) | (244,626 | ) | ||||
Gain on sale of investments | — | (8,959 | ) | |||||
Goodwill impairment | 215,412 | 56,539 | ||||||
Other | 6,090 | 310 | ||||||
Changes in assets and liabilities | ||||||||
Increase in receivables | (62,619 | ) | (46,448 | ) | ||||
Decrease in servicer and protective advances | 282,018 | 202,384 | ||||||
Decrease (increase) in other assets | (11,150 | ) | 17,186 | |||||
Decrease in payables and accrued liabilities | (84,929 | ) | (2,680 | ) | ||||
Increase (decrease) in servicer payables, net of change in restricted cash | 31,122 | (1,298 | ) | |||||
Cash flows provided by (used in) operating activities | 310,045 | (268,756 | ) | |||||
9
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES | ||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS (As Restated, See Note 2) (Continued) | ||||||||
(Unaudited) | ||||||||
(in thousands) | ||||||||
For the Six Months Ended June 30, | ||||||||
2016 | 2015 | |||||||
(Restated) | ||||||||
Investing activities | ||||||||
Purchases and originations of reverse loans held for investment | (384,816 | ) | (922,422 | ) | ||||
Principal payments received on reverse loans held for investment | 473,617 | 385,073 | ||||||
Principal payments received on mortgage loans held for investment | 45,238 | 69,666 | ||||||
Payments received on charged-off loans held for investment | 12,542 | 12,249 | ||||||
Payments received on receivables related to Non-Residual Trusts | 4,011 | 3,853 | ||||||
Proceeds from sales of real estate owned, net | 51,924 | 37,544 | ||||||
Purchases of premises and equipment | (22,638 | ) | (9,748 | ) | ||||
Decrease in restricted cash and cash equivalents | 10,328 | 3,114 | ||||||
Payments for acquisitions of businesses, net of cash acquired | (1,947 | ) | (2,810 | ) | ||||
Acquisitions of servicing rights, net | (8,410 | ) | (189,276 | ) | ||||
Proceeds from sale of servicing rights | 19,920 | 778 | ||||||
Proceeds from sale of residual interests in Residual Trusts | — | 189,513 | ||||||
Proceeds from sale of investment | — | 14,376 | ||||||
Other | (2,174 | ) | 12,242 | |||||
Cash flows provided by (used in) investing activities | 197,595 | (395,848 | ) | |||||
Financing activities | ||||||||
Payments on corporate debt | (345 | ) | (8,414 | ) | ||||
Extinguishments and settlement of debt | (6,327 | ) | — | |||||
Proceeds from securitizations of reverse loans | 410,107 | 951,234 | ||||||
Payments on HMBS related obligations | (590,678 | ) | (466,188 | ) | ||||
Issuances of servicing advance liabilities | 815,800 | 425,896 | ||||||
Payments on servicing advance liabilities | (1,043,972 | ) | (546,463 | ) | ||||
Net change in warehouse borrowings related to mortgage loans | (59,801 | ) | 454,012 | |||||
Net change in warehouse borrowings related to reverse loans | 115,515 | (10,708 | ) | |||||
Proceeds from sales of servicing rights | 29,738 | — | ||||||
Payments on servicing rights related liabilities | (9,639 | ) | (4,576 | ) | ||||
Payments on mortgage-backed debt | (52,017 | ) | (81,795 | ) | ||||
Other debt issuance costs paid | (5,912 | ) | (5,594 | ) | ||||
Other | (44 | ) | (19,195 | ) | ||||
Cash flows provided by (used in) financing activities | (397,575 | ) | 688,209 | |||||
Net increase in cash and cash equivalents | 110,065 | 23,605 | ||||||
Cash and cash equivalents at beginning of the period | 202,828 | 320,175 | ||||||
Cash and cash equivalents at end of the period | $ | 312,893 | $ | 343,780 | ||||
Supplemental Disclosures of Cash Flow Information | ||||||||
Cash paid for interest | $ | 134,703 | $ | 153,066 | ||||
Cash paid (received) for taxes | 58 | (18 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
10
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AS RESTATED)
(Unaudited)
1. Business and Basis of Presentation
Walter Investment Management Corp. and its subsidiaries, or the Company, is a mortgage banking firm focused primarily on servicing and originating residential loans, including reverse loans. The Company services loans for its own portfolio and for GSEs, government agencies, third-party securitization trusts and other credit owners. In addition, the Company operates several other businesses that include managing a portfolio of credit-challenged, non-conforming residential mortgage loans; an insurance agency serving borrowers and credit owners of its servicing portfolio; a post charge-off collection agency; and an asset management business. The Company operates throughout the U.S.
The Company operates through three reportable segments, Servicing, Originations, and Reverse Mortgage. Refer to Note 14 for additional information.
Certain acronyms and terms throughout these notes are defined in the Glossary of Terms in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
RCS Asset Purchase Agreement
On December 8, 2015, the Company entered into an asset purchase agreement with RCS, which closed on January 28, 2016. Pursuant to the terms of the agreement, on or about the closing date, among other things: (i) the Company became obligated to purchase certain assets from, and assume certain liabilities of, RCS; (ii) the Company entered into a residential mortgage loan sub-servicing agreement with RCS pursuant to which the Company will sub-service residential mortgage loans for RCS; and (iii) RCS became obligated to transfer to the Company certain of its existing residential mortgage loan sub-servicing agreements (collectively, the sub-servicing assets). The Company gained control over the purchased assets on March 1, 2016, which is the date that the Company purchased and RCS transferred to the Company certain assets, including servicer and protective advances, and certain liabilities, including employee-related liabilities. In connection with the acquisition, the Company recorded $3.8 million in goodwill, which is included in the Servicing segment.
Interim Financial Reporting
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and related notes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Although management is not currently aware of any factors that would significantly change its estimates and assumptions, actual results may differ from these estimates.
11
Recent Accounting Guidance
In May 2014, the FASB issued new revenue recognition guidance that supersedes most industry-specific guidance but does exclude insurance contracts and financial instruments. Under the new revenue recognition guidance, entities are required to identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when the entity satisfies a performance obligation. In April 2015, the FASB voted for a one-year deferral of the effective date, resulting in this new guidance being effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017. Subsequent to the initial issuance, the FASB has continued to issue updates to this guidance to provide additional clarification and implementation instructions to issuers regarding (i) principal versus agent considerations, (ii) identifying performance obligations, (iii) licensing, and (iv) narrow-scope improvements and practical expedients relating to assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In August 2014, the FASB issued an accounting standards update intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. This update is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. The adoption of this guidance may result in additional disclosures; however, this guidance will not have a material impact on the consolidated results of operations or financial condition.
In April 2015, the FASB issued an accounting standards update that provides guidance regarding whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the entity should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the entity should account for the arrangement as a service contract. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption permitted. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements.
In September 2015, the FASB issued an accounting standards update that provides updated guidance regarding simplifying the accounting for recognizing adjustments to provisional amounts identified during the measurement period in a business combination. To simplify the accounting for these adjustments, the amendments in this update eliminate the requirement to retrospectively account for the adjustments and to recognize them in the period that they are identified. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption permitted. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements.
In January 2016, the FASB issued an accounting standards update that amends the guidance on the classification and measurement of financial instruments. The new standard revises an entity's accounting related to (i) the classification and measurement of investments in equity securities and (ii) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In February 2016, the FASB issued an accounting standards update that requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset to not recognize lease assets and lease liabilities. In transition, lessees are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, which includes a number of optional practical expedients that entities may elect to apply. This guidance is effective for fiscal years beginning after December 15, 2018, with early application permitted. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In March 2016, the FASB issued an accounting standards update that provides updated guidance for improvements to employee share-based payment accounting. The new standard revises an entity's accounting for income taxes on share-based-compensation, such that all excess tax benefits and tax deficiencies should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
12
In March 2016, the FASB issued an accounting standards update that provides guidance to simplify the transition to the equity method of accounting for investments. It requires that the equity method investor add the cost of acquiring additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. It also requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
In June 2016, the FASB issued an accounting standards update that amends the guidance for recognizing credit losses on financial instruments measured at amortized cost. This update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2019. The Company does not expect that the adoption of this guidance will have a material impact on its consolidated financial statements.
2. Restatement of Previously Issued Consolidated Financial Statements
The restatement of the Company's audited consolidated financial statements results from an error in the calculation of the valuation allowance on the net deferred tax assets balance. In determining the amount of the valuation allowance in the Original Filing, an error was made that resulted in the double-counting of expected future taxable income associated with the projected reversals of taxable temporary differences (i.e., deferred tax liabilities). Accordingly, the Company has revised its calculation to reflect the removal of the duplicative amounts, and reevaluated all sources of estimated future taxable income used to assess the recoverability of deferred tax assets under GAAP after taking into account both positive and negative evidence through the issuance date of the restated financial statements to consider the effect of the error.
The determination of the need for a valuation allowance in deferred tax assets under GAAP is highly judgmental and requires the subjective weighting of both positive and negative evidence relating to expectations about the recoverability of those assets. Management has reevaluated both positive and negative evidence through the issuance date of the restated financial statements regarding the use of all sources of future taxable income on the recoverability of its deferred tax assets after correcting for the duplication error. While judgments and estimates made at the time of the Original Filing, using then-available facts and circumstances, are considered to be reasonable and appropriate, the revised analysis has resulted in management's conclusion as of the restatement issuance date that only reversals of deferred tax liabilities and/or net operating loss carrybacks when available should be used as a source of income to recover its deferred tax assets.
Based on the revised calculation and analysis, the Company concluded that the valuation allowance on the deferred tax assets should be increased by $257.6 million which reduces the net deferred tax assets that are expected to be realized in the future. The impact of the adjustment was to reduce the overall net deferred tax assets balance by increasing the valuation allowance, and reducing the tax benefit recorded in the Company's previously issued consolidated statement of comprehensive loss.
The consolidated financial statements included in this Form 10-Q/A have been restated as of and for the three and six months ended June 30, 2016 to reflect the adjustment described above. The following statements present the effect of the restatement on (i) the consolidated balance sheet as of June 30, 2016, (ii) the consolidated statements of comprehensive loss; stockholders’ equity and cash flows for the six months ended June 30, 2016, and (iii) the notes related thereto. The impact to stockholders' equity is reflected below in the restated consolidated balance sheet.
Revision of Previously Issued Financial Statements
During the year ended December 31, 2016, the Company made immaterial corrections of errors in its consolidated balance sheet to insurance related receivables and payables. The insurance business was acquired in 2011. The accounting related to insurance premium receivables and carrier payables was maintained consistently with practices prior to the acquisition. As part of the potential sale transaction, certain agreements related to the insurance business were further reviewed and it was determined that the gross up of premiums and related carrier payables was not consistent with the terms of such agreements. Thus, the Company assessed the effect of the overstatement in the aggregate on prior periods’ financial statements in accordance with the SEC’s Staff Accounting Bulletins No. 99 and 108 and, based on an analysis of quantitative and qualitative factors, determined that the overstatement was not material to the Company’s prior interim and annual financial statements. The Company corrected the overstatement in the year ended December 31, 2016 and revised its previously-issued financial statements for the year ended December 31, 2015. All financial information contained in the accompanying notes to these financial statements has been revised to reflect the correction of the overstatement. Total assets and total liabilities at December 31, 2015 decreased by $42.1 million, which included a decrease in receivables, net of $77.2 million, an increase in servicer and protective advances, net of $35.2 million, and a decrease in payables and accrued liabilities of $42.1 million.
13
The Company revised the Consolidated Statements of Cash Flows for the six months ended June 30, 2015. All of the revisions were made to the changes in assets and liabilities included in cash flows provided by operating activities. For the six months ended June 30, 2015, cash flows from the change in receivables decreased by $4.0 million, while cash flows from the change in servicer and protective advances and change in payables and accrued liabilities increased by $0.3 million and $3.7 million, respectively. Adjustments to the Company's balance sheet as of June 30, 2016 and cash flows for the six months ended June 30, 2016 are included in the other adjustments column in the tables below.
The Company evaluated its internal controls over financial reporting as it related to this overstatement. The error in application of accounting guidance occurred at the time of acquisition of the insurance business. Subsequent controls over contract review were implemented in 2013 and deemed to be operating effectively as of December 31, 2016.
14
The following table presents the consolidated balance sheet as previously reported, restatement adjustments, other adjustments, and the consolidated balance sheet as restated as of June 30, 2016 (in thousands):
June 30. 2016 (unaudited) | ||||||||||||||||
As Previously Reported | Restatement Adjustments | Other Adjustments | As Restated | |||||||||||||
ASSETS | ||||||||||||||||
Cash and cash equivalents | $ | 312,893 | $ | — | $ | — | $ | 312,893 | ||||||||
Restricted cash and cash equivalents | 209,898 | — | — | 209,898 | ||||||||||||
Residential loans at amortized cost, net | 565,061 | — | — | 565,061 | ||||||||||||
Residential loans at fair value | 12,723,753 | — | — | 12,723,753 | ||||||||||||
Receivables, net | 251,116 | — | (59,013 | ) | 192,103 | |||||||||||
Servicer and protective advances, net | 1,309,096 | — | 25,106 | 1,334,202 | ||||||||||||
Servicing rights, net | 1,350,276 | — | — | 1,350,276 | ||||||||||||
Goodwill | 156,283 | — | — | 156,283 | ||||||||||||
Intangible assets, net | 77,910 | — | — | 77,910 | ||||||||||||
Premises and equipment, net | 103,642 | — | — | 103,642 | ||||||||||||
Deferred tax assets, net | 273,816 | (257,562 | ) | — | 16,254 | |||||||||||
Other assets | 256,031 | — | — | 256,031 | ||||||||||||
Total assets | $ | 17,589,775 | $ | (257,562 | ) | $ | (33,907 | ) | $ | 17,298,306 | ||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||
Payables and accrued liabilities | $ | 631,771 | $ | — | $ | (33,907 | ) | $ | 597,864 | |||||||
Servicer payables | 158,654 | — | — | 158,654 | ||||||||||||
Servicing advance liabilities | 1,002,451 | — | — | 1,002,451 | ||||||||||||
Warehouse borrowings | 1,396,102 | — | — | 1,396,102 | ||||||||||||
Servicing rights related liabilities at fair value | 120,825 | — | — | 120,825 | ||||||||||||
Corporate debt | 2,159,947 | — | — | 2,159,947 | ||||||||||||
Mortgage-backed debt | 999,499 | — | — | 999,499 | ||||||||||||
HMBS related obligations at fair value | 10,717,148 | — | — | 10,717,148 | ||||||||||||
Total liabilities | 17,186,397 | — | (33,907 | ) | 17,152,490 | |||||||||||
Stockholders' equity: | ||||||||||||||||
Preferred stock | — | — | — | — | ||||||||||||
Common stock | 361 | — | — | 361 | ||||||||||||
Additional paid-in capital | 595,212 | — | — | 595,212 | ||||||||||||
Accumulated deficit | (193,049 | ) | (257,562 | ) | — | (450,611 | ) | |||||||||
Accumulated other comprehensive income | 854 | — | — | 854 | ||||||||||||
Total stockholders' equity | 403,378 | (257,562 | ) | — | 145,816 | |||||||||||
Total liabilities and stockholders' equity | $ | 17,589,775 | $ | (257,562 | ) | $ | (33,907 | ) | $ | 17,298,306 |
15
The following table presents the consolidated statement of comprehensive loss as previously reported, restatement adjustments, and the consolidated statement of comprehensive loss as restated for the three months ended June 30, 2016 (in thousands, except share and per share data):
For the Three Months Ended June 30, 2016 (unaudited) | ||||||||||||
As Previously Reported | Restatement Adjustments | As Restated | ||||||||||
REVENUES | ||||||||||||
Net servicing revenue and fees | $ | 31,936 | $ | — | $ | 31,936 | ||||||
Net gains on sales of loans | 100,176 | — | 100,176 | |||||||||
Net fair value gains on reverse loans and related HMBS obligations | 7,650 | — | 7,650 | |||||||||
Interest income on loans | 11,849 | — | 11,849 | |||||||||
Insurance revenue | 11,277 | — | 11,277 | |||||||||
Other revenues | 24,585 | — | 24,585 | |||||||||
Total revenues | 187,473 | — | 187,473 | |||||||||
EXPENSES | ||||||||||||
Salaries and benefits | 133,681 | — | 133,681 | |||||||||
General and administrative | 135,776 | — | 135,776 | |||||||||
Goodwill impairment | 215,412 | — | 215,412 | |||||||||
Interest expense | 64,400 | — | 64,400 | |||||||||
Depreciation and amortization | 14,540 | — | 14,540 | |||||||||
Other expenses, net | 1,897 | — | 1,897 | |||||||||
Total expenses | 565,706 | — | 565,706 | |||||||||
OTHER LOSSES | ||||||||||||
Other net fair value losses | (819 | ) | — | (819 | ) | |||||||
Other | (532 | ) | — | (532 | ) | |||||||
Total other losses | (1,351 | ) | — | (1,351 | ) | |||||||
Loss before income taxes | (379,584 | ) | — | (379,584 | ) | |||||||
Income tax expense (benefit) | (147,183 | ) | 257,562 | 110,379 | ||||||||
Net loss | $ | (232,401 | ) | $ | (257,562 | ) | $ | (489,963 | ) | |||
Comprehensive loss | $ | (232,385 | ) | $ | (257,562 | ) | $ | (489,947 | ) | |||
Basic and diluted loss per common and common equivalent share | $ | (6.49 | ) | $ | (7.19 | ) | $ | (13.68 | ) | |||
Weighted-average common and common equivalent shares outstanding — basic and diluted | 35,811 | — | 35,811 |
16
The following table presents the consolidated statement of comprehensive loss as previously reported, restatement adjustments, and the consolidated statement of comprehensive loss as restated for the six months ended June 30, 2016 (in thousands, except share and per share data):
For the Six Months Ended June 30, 2016 (unaudited) | ||||||||||||
As Previously Reported | Restatement Adjustments | As Restated | ||||||||||
REVENUES | ||||||||||||
Net servicing revenue and fees | $ | (73,826 | ) | $ | — | $ | (73,826 | ) | ||||
Net gains on sales of loans | 184,653 | — | 184,653 | |||||||||
Net fair value gains on reverse loans and related HMBS obligations | 42,858 | — | 42,858 | |||||||||
Interest income on loans | 24,020 | — | 24,020 | |||||||||
Insurance revenue | 21,644 | — | 21,644 | |||||||||
Other revenues | 54,895 | — | 54,895 | |||||||||
Total revenues | 254,244 | — | 254,244 | |||||||||
EXPENSES | ||||||||||||
Salaries and benefits | 266,320 | — | 266,320 | |||||||||
General and administrative | 265,382 | — | 265,382 | |||||||||
Goodwill and intangible assets impairment | 215,412 | — | 215,412 | |||||||||
Interest expense | 128,648 | — | 128,648 | |||||||||
Depreciation and amortization | 28,963 | — | 28,963 | |||||||||
Other expenses, net | 4,403 | — | 4,403 | |||||||||
Total expenses | 909,128 | — | 909,128 | |||||||||
OTHER GAINS (LOSSES) | ||||||||||||
Gain on extinguishment | 928 | — | 928 | |||||||||
Other net fair value losses | (2,963 | ) | — | (2,963 | ) | |||||||
Other | (1,556 | ) | — | (1,556 | ) | |||||||
Total other losses | (3,591 | ) | — | (3,591 | ) | |||||||
Loss before income taxes | (658,475 | ) | — | (658,475 | ) | |||||||
Income tax expense (benefit) | (253,372 | ) | 257,562 | 4,190 | ||||||||
Net loss | $ | (405,103 | ) | $ | (257,562 | ) | $ | (662,665 | ) | |||
Comprehensive loss | $ | (405,062 | ) | $ | (257,562 | ) | $ | (662,624 | ) | |||
Basic and diluted loss per common and common equivalent share | $ | (11.35 | ) | $ | (7.22 | ) | $ | (18.57 | ) | |||
Weighted-average common and common equivalent shares outstanding — basic and diluted | 35,679 | — | 35,679 |
17
The following table presents the consolidated statement of cash flows as previously reported, restatement adjustments, other adjustments, and the consolidated statement of cash flows as restated for the six months ended June 30, 2016 (in thousands):
For the Six Months Ended June 30, 2016 (unaudited) | ||||||||||||||||
As Previously Reported | Restatement Adjustments | Other Adjustments | As Restated | |||||||||||||
Operating activities | ||||||||||||||||
Net loss | $ | (405,103 | ) | $ | (257,562 | ) | $ | — | $ | (662,665 | ) | |||||
Adjustments to reconcile net loss to net cash provided by operating activities | ||||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | (42,858 | ) | — | — | (42,858 | ) | ||||||||||
Amortization of servicing rights | 7,236 | — | — | 7,236 | ||||||||||||
Change in fair value of servicing rights | 514,073 | — | — | 514,073 | ||||||||||||
Change in fair value of servicing rights related liabilities | (12,724 | ) | — | — | (12,724 | ) | ||||||||||
Change in fair value of charged-off loans | (14,296 | ) | — | — | (14,296 | ) | ||||||||||
Other net fair value losses | 6,815 | — | — | 6,815 | ||||||||||||
Accretion of discounts on residential loans and advances | (1,845 | ) | — | — | (1,845 | ) | ||||||||||
Accretion of discounts on debt and amortization of deferred debt issuance costs | 16,195 | — | — | 16,195 | ||||||||||||
Provision for uncollectible advances | 22,356 | — | — | 22,356 | ||||||||||||
Depreciation and amortization of premises and equipment and intangible assets | 28,963 | — | — | 28,963 | ||||||||||||
Provision (benefit) for deferred income taxes | (167,010 | ) | 257,562 | — | 90,552 | |||||||||||
Share-based compensation | 5,705 | — | — | 5,705 | ||||||||||||
Purchases and originations of residential loans held for sale | (10,078,201 | ) | — | — | (10,078,201 | ) | ||||||||||
Proceeds from sales of and payments on residential loans held for sale | 10,239,448 | — | — | 10,239,448 | ||||||||||||
Net gains on sales of loans | (184,653 | ) | — | — | (184,653 | ) | ||||||||||
Goodwill impairment | 215,412 | — | — | 215,412 | ||||||||||||
Other | 6,090 | — | — | 6,090 | ||||||||||||
Changes in assets and liabilities | ||||||||||||||||
Increase in receivables | (44,424 | ) | — | (18,195 | ) | (62,619 | ) | |||||||||
Decrease in servicer and protective advances | 271,970 | — | 10,048 | 282,018 | ||||||||||||
Increase in other assets | (11,150 | ) | — | — | (11,150 | ) | ||||||||||
Decrease in payables and accrued liabilities | (93,076 | ) | — | 8,147 | (84,929 | ) | ||||||||||
Increase in servicer payables, net of change in restricted cash | 31,122 | — | — | 31,122 | ||||||||||||
Cash flows provided by operating activities | 310,045 | — | — | 310,045 | ||||||||||||
18
For the Six Months Ended June 30, 2016 (unaudited) | ||||||||||||||||
As Previously Reported | Restatement Adjustments | Other Adjustments | As Restated | |||||||||||||
Investing activities | ||||||||||||||||
Purchases and originations of reverse loans held for investment | (384,816 | ) | — | — | (384,816 | ) | ||||||||||
Principal payments received on reverse loans held for investment | 473,617 | — | — | 473,617 | ||||||||||||
Principal payments received on mortgage loans held for investment | 45,238 | — | — | 45,238 | ||||||||||||
Payments received on charged-off loans held for investment | 12,542 | — | — | 12,542 | ||||||||||||
Payments received on receivables related to Non-Residual Trusts | 4,011 | — | — | 4,011 | ||||||||||||
Proceeds from sales of real estate owned, net | 51,924 | — | — | 51,924 | ||||||||||||
Purchases of premises and equipment | (22,638 | ) | — | — | (22,638 | ) | ||||||||||
Decrease in restricted cash and cash equivalents | 10,328 | — | — | 10,328 | ||||||||||||
Payments for acquisitions of businesses, net of cash acquired | (1,947 | ) | — | — | (1,947 | ) | ||||||||||
Acquisitions of servicing rights, net | (8,410 | ) | — | — | (8,410 | ) | ||||||||||
Proceeds from sale of servicing rights | 19,920 | — | — | 19,920 | ||||||||||||
Other | (2,174 | ) | — | — | (2,174 | ) | ||||||||||
Cash flows provided by investing activities | 197,595 | — | — | 197,595 | ||||||||||||
Financing activities | ||||||||||||||||
Payments on corporate debt | (345 | ) | — | — | (345 | ) | ||||||||||
Extinguishments and settlement of debt | (6,327 | ) | — | — | (6,327 | ) | ||||||||||
Proceeds from securitizations of reverse loans | 410,107 | — | — | 410,107 | ||||||||||||
Payments on HMBS related obligations | (590,678 | ) | — | — | (590,678 | ) | ||||||||||
Issuances of servicing advance liabilities | 815,800 | — | — | 815,800 | ||||||||||||
Payments on servicing advance liabilities | (1,043,972 | ) | — | — | (1,043,972 | ) | ||||||||||
Net change in warehouse borrowings related to mortgage loans | (59,801 | ) | — | — | (59,801 | ) | ||||||||||
Net change in warehouse borrowings related to reverse loans | 115,515 | — | — | 115,515 | ||||||||||||
Proceeds from sales of servicing rights | 29,738 | — | — | 29,738 | ||||||||||||
Payments on servicing rights related liabilities | (9,639 | ) | — | — | (9,639 | ) | ||||||||||
Payments on mortgage-backed debt | (52,017 | ) | — | — | (52,017 | ) | ||||||||||
Other debt issuance costs paid | (5,912 | ) | — | — | (5,912 | ) | ||||||||||
Other | (44 | ) | — | — | (44 | ) | ||||||||||
Cash flows used in financing activities | (397,575 | ) | — | — | (397,575 | ) | ||||||||||
Net increase in cash and cash equivalents | 110,065 | — | — | 110,065 | ||||||||||||
Cash and cash equivalents at the beginning of the year | 202,828 | — | — | 202,828 | ||||||||||||
Cash and cash equivalents at the end of the year | $ | 312,893 | $ | — | $ | — | $ | 312,893 |
3. Going Concern
The Company is facing certain challenges and uncertainties that could have significant adverse effects on its business, liquidity and financing activities. The Company may be adversely impacted by the following factors, among others: failure to maintain sufficient liquidity to operate its servicing and lending businesses due to the inability to renew, replace or extend its advance financing or warehouse facilities on favorable terms, or at all; failure to comply with covenants contained in its debt agreements or obtain any necessary waivers or amendments; failure to resolve its obligation with respect to the remaining mandatory clean-up calls; and failure to successfully restructure its corporate debt.
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As disclosed in Note 11, the Company uses and relies upon short-term borrowing facilities to fund its servicing, originations and reverse mortgage operating businesses. As a result of continued losses, the need for additional waivers and/or amendments, including those required as a result of or in connection with the restatement discussed in Note 2, and the passage of time since the Company first announced its debt restructuring initiative, certain of the Company’s lenders have effected reductions in its advance rates and/or have required other changes to the terms of such facilities, which has negatively impacted the Company’s available liquidity and capital resources. Each of these facilities is typically subject to renewal each year. Borrowing capacity on the various facilities is dependent upon maintaining compliance with the representations, terms, conditions and covenants of the respective agreements. The Company intends to renew, replace, or expand its facilities consistent with its past practices and may seek waivers or amendments in the future, if necessary. The Company is in negotiations with current and prospective lenders regarding expanded financing capacity for its reverse loan repurchases and/or replacement financing capacity for its originations business in the event the Company experiences a material reduction in the financing capacity available to it under its existing borrowing facilities or otherwise requires additional financing capacity to support its businesses and obligations. No assurance can be given that the Company will be successful in maintaining adequate financing capacity with its current or prospective lenders.
The Company continues to focus on its debt restructuring initiative to seek to improve its capital structure through the restructuring of its corporate debt and continues to incur significant expense in connection therewith.
On July 31, 2017, the Company entered into a Restructuring Support Agreement with lenders holding, as of July 31, 2017, more than 50% of the loans and/or commitments outstanding under the 2013 Credit Agreement. As set forth in the Restructuring Support Agreement, the parties thereto have agreed to, among other things, the principal terms of a proposed financial restructuring of the Company, which will be implemented through an out-of-court restructuring and, in the absence of sufficient stakeholder support for an out-of-court restructuring, a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code. The Restructuring Support Agreement contains a number of conditions and milestones, including reaching an agreement with the holders of at least 66⅔% aggregate principal amount of Senior Notes to a restructuring support agreement consistent with the terms specified in the Restructuring Support Agreement. The Company and its debt restructuring advisors intend to continue to negotiate with the financial and legal advisors to ad hoc groups of holders of the Senior Notes and the lenders under the 2013 Credit Agreement as the Company seeks to obtain sufficient stakeholder support for a comprehensive de-leveraging transaction.
Pursuant to the terms of the Restructuring Support Agreement, on the dates specified in the Restructuring Support Agreement, the Company is obligated to purchase at par (or in certain limited circumstances, voluntarily prepay) the term loans of the lenders who become party to the Restructuring Support Agreement in an aggregate principal amount of $100 million. On July 31, 2017, the Company entered into a third amendment to the 2013 Credit Agreement pursuant to which the 2013 Credit Agreement was amended to, among other things, require that upon receipt by the Company or certain of its subsidiaries of the gross proceeds of any disposition of certain Bulk MSR by the Company or such subsidiaries, the Company shall make a prepayment of the term loans in an amount equal to 80% of such gross proceeds; provided that, to the extent as of the earlier of 120 days following the effective date (as defined in the Restructuring Support Agreement) and February 15, 2018 the aggregate principal amount of term loans prepaid as a result of such prepayments is less than $100 million, the Company shall be required to prepay as of such date the term loans in an amount equal to $100 million minus the amount of proceeds of such dispositions of Bulk MSR previously applied to prepay the term loans after the date of the third amendment to the 2013 Credit Agreement pursuant to such mandatory prepayment. The Third Amendment also requires mandatory prepayments of the term loans in an amount equal to (i) 80% of the net sale proceeds of non-ordinary course asset sales and dispositions of certain Bulk MSR and (ii) 100% of the net sale proceeds of certain non-core assets, in each case, received by the Company and certain of its subsidiaries.
As discussed previously, the Company is subject to various financial and other covenants under its existing debt agreements, many of which contain cross default provisions such that if a default occurs under any one agreement, the lenders under certain of the Company’s other debt agreements could declare a default. The lenders can waive their contractual rights in the event of a default. In connection with the financial statement restatement discussed in Note 2 and the circumstances impacting the Company's ability to continue as a going concern included in this disclosure, the Company received waivers and/or amendments under its warehouse and advance financing facilities, the 2013 Credit Agreement and the Senior Notes Indenture to the extent necessary to waive any default, event of default, amortization event, termination event or similar event resulting or arising from the restatement discussed in Note 2 and the going concern matters discussed herein.
20
The Company is not currently in compliance with, and may be unable to regain and/or maintain compliance with, certain continued listing standards of the NYSE. If the Company is unable to cure any event of noncompliance with any continued listing standard of the NYSE within the applicable timeframe and other parameters set forth by the NYSE, or if the Company fails to maintain compliance with certain continued listing standards that do not provide for a cure period, it will result in the delisting of the Company’s common stock from the NYSE, which could negatively impact the trading price, trading volume and liquidity of, and have other material adverse effects on, the Company’s common stock. If the Company’s common stock is delisted from the NYSE, this could also have negative implications on the Company’s business relationships under the Company’s material agreements with lenders and other counterparties. If the Company’s common stock is delisted from the NYSE, it would constitute a fundamental change as that term is defined under the terms of the Convertible Notes, and require, among other things, that the Company take steps to make an offer to repay the Convertible Notes at 100% of the principal amount thereof. The Company currently is not permitted to repurchase the Convertible Notes pursuant to the terms of certain of its debt facilities and agreements. If the Company is de-listed and is not able to satisfy this obligation, it would constitute an event of default under the indenture governing the Convertible Notes. In such event, the trustee or the holders of 25% in aggregate principal amount outstanding of the Convertible Notes will have the right to accelerate such indebtedness.
The Company’s subsidiaries are parties to seller/servicer agreements with, and/or subject to the guidelines and regulations of (collectively, the seller/servicer obligations), the GSEs and various government agencies, including HUD, FHA, VA and Ginnie Mae. These seller/servicer obligations include financial covenants and other requirements as defined by the applicable agency. To the extent that these seller/servicer obligations are not met, the applicable GSE or government agency may, at its option, take action to implement one or more of a variety of remedies including, without limitation, requiring certain Company subsidiaries to deposit funds as security for one or more of such subsidiaries’ obligations to the GSEs or government agencies, imposing sanctions on one or more of such subsidiaries, which could include monetary fines or penalties, forcing one or more subsidiaries to transfer servicing on all or a portion of the mortgage loans such subsidiary services for the applicable GSE or government agency, and/or suspending or terminating the approved seller/servicer status of one or more subsidiaries, which could prohibit or severely limit the ability of one or more subsidiaries to originate, service and/or securitize mortgage loans for the applicable GSE or agency. To date, none of the GSEs or government agencies with which the Company and its subsidiaries do business has communicated any material sanction, suspension or prohibition that would materially adversely affect the Company’s business; however, the GSEs and certain of such government agencies have required frequent reporting regarding the financial status of the Company, including preliminary financial results and the availability to the Company of financing capacity under its existing borrowing facilities. The GSEs and certain of such government agencies have also requested frequent telephonic updates with senior Company management regarding the status of the Company’s debt restructuring initiative and other matters. The Company’s subservicing agreements also contain requirements regarding servicing practices and other matters, and a failure to comply with these requirements could have an adverse impact on the Company’s business and liquidity.
As disclosed in Note 15, the Company is obligated to exercise the mandatory clean-up call obligations assumed as part of an agreement to acquire the rights to service the loans in the Non-Residual Trusts. Additionally, as part of its Reverse Mortgage segment, the Company is obligated to purchase loans out of Ginnie Mae securitization pools under certain circumstances.
To address the challenges and uncertainties set forth above, the Company is proactively engaged with its lenders and other counterparties as follows:
• | Prior to the issuance of the restated consolidated financial statements discussed in Note 2, the Company entered into amendments and/or obtained waivers from each lender, to the extent necessary, to waive any default, event of default, amortization event, termination event or similar event resulting or arising from the restatement discussed in Note 2 or the substantial doubt as to the Company’s ability to continue as a going concern described in this Note 3, and/or to allow for compliance with profitability covenants at the Ditech level; |
• | As a result of the above waivers and/or amendments, no known events of default exist, and amounts due under the Company's outstanding material debt and financing agreements have not been accelerated; |
• | While the Company believes that the debt facilities it relies on to support ongoing operations remain renewable in the ordinary course of business, the Company is seeking additional, or expansion of existing facilities to provide adequate financing capacity for new loan originations should existing facilities not be renewed at their maturity date. The Company may also consider temporary volume reductions within the business lending channel of the originations business, if necessary; |
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• | The Company is seeking additional, or expansion of existing, master repurchase or similar agreements for continued growth of the required reverse loan repurchases. As part of this effort, in August 2017, RMS has entered into an amendment that increases the size of an existing credit facility by $100 million on a committed basis. The facility expires in May 2018. Additionally, in the future, the Company may seek to access the securitization market, if such market is available to the Company, to provide adequate financing capacity for continued growth in the number and amount of required reverse loan repurchases; |
• | The Company is in the process of negotiating a term sheet with a counterparty to resolve its obligations with respect to the remaining mandatory clean-up calls. The negotiated resolution is expected to cover all mandatory calls starting in the fourth quarter of 2017; |
• | The Company has been in contact with the NYSE and is working to regain compliance with NYSE continued listing requirements, including, among other things, by restructuring its corporate debt. The Company continues to monitor other listing standards. No assurance can be given that the Company’s common stock will not be delisted from the NYSE; and |
• | The Company continues to engage in communications with key stakeholders, including the GSEs, Ginnie Mae, HUD, regulators and government agencies in connection with the restatement discussed in Note 2, the status of the Company’s debt restructuring initiative, and the uncertainties regarding the Company’s ability to continue as a going concern as identified above. To date, none of these key stakeholders have communicated any material sanctions, suspensions or prohibitions. |
The above factors have been taken into account in assessing the Company’s liquidity and ability to meet its obligations for the next twelve months from the date of issuance of these financial statements. Based on this assessment, management has concluded that while there can be no assurance that the Company’s recent and future actions will be successful in mitigating the above risks and uncertainties, the Company’s current plans provide enough liquidity to meets its obligations over the next twelve months from the date of issuance of these financial statements. However, as set forth in the Restructuring Support Agreement, the parties thereto have agreed to, among other things, the principal terms of a proposed financial restructuring of the Company, which will be implemented through an out-of-court restructuring and, in the absence of sufficient stakeholder support for an out-of-court restructuring, a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code. The potential for a prepackaged Chapter 11 filing raises substantial doubt about the Company’s ability to continue as a going concern that has not been alleviated. The Company’s consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company will continue to monitor progress on its initiatives and the impact on its ongoing assessment of going concern in future periods.
4. Variable Interest Entities
Consolidated Variable Interest Entities
Included in Note 4 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 are descriptions of the Company’s Consolidated VIEs.
Revolving Credit Facilities-Related VIEs
Certain revolving credit facilities utilize subsidiaries and/or trusts, collectively referred to as the entities, which are considered VIEs. The Company transfers certain assets into the entities created as a mechanism for holding assets as collateral for the revolving credit facilities in order to facilitate the pledging of assets to the revolving credit facilities. The entities have no equity investment at risk, making them variable interest entities. The Company’s continuing involvement with the entities is in the form of servicing the assets and through holding the ownership interests of the entities. Accordingly, the Company concluded that it is the primary beneficiary of the entities and, therefore, the Company consolidated the entities. All of the subsidiaries and/or trusts are separate legal entities and the collateral held by the entities are owned by them and are not available to other creditors.
During the six months ended June 30, 2016, the Reverse Mortgage VIEs were funded with HECMs and real estate owned that were repurchased from Ginnie Mae securitization pools utilizing warehouse facilities. These assets collateralize certain master repurchase agreements, which are not included in the Reverse Mortgage VIEs. Refer to Note 11 for additional information.
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Included in the tables below are summaries of the carrying amounts of the assets and liabilities of consolidated VIEs (in thousands):
June 30, 2016 | ||||||||||||||||||||
Residual Trusts | Non-Residual Trusts | Servicer and Protective Advance Financing VIEs | Reverse Mortgage VIEs | Total | ||||||||||||||||
Assets | ||||||||||||||||||||
Restricted cash and cash equivalents | $ | 13,313 | $ | 11,382 | $ | 22,991 | $ | — | $ | 47,686 | ||||||||||
Residential loans at amortized cost, net | 484,517 | — | — | — | 484,517 | |||||||||||||||
Residential loans at fair value | — | 488,179 | — | 70,793 | 558,972 | |||||||||||||||
Receivables | — | 12,681 | — | 499 | 13,180 | |||||||||||||||
Servicer and protective advances, net | — | — | 935,367 | — | 935,367 | |||||||||||||||
Other assets | 9,145 | 1,712 | 1,152 | 11,809 | 23,818 | |||||||||||||||
Total assets | $ | 506,975 | $ | 513,954 | $ | 959,510 | $ | 83,101 | $ | 2,063,540 | ||||||||||
Liabilities | ||||||||||||||||||||
Payables and accrued liabilities | $ | 2,035 | $ | — | $ | 1,138 | $ | — | $ | 3,173 | ||||||||||
Servicing advance liabilities | — | — | 820,047 | — | 820,047 | |||||||||||||||
Mortgage-backed debt | 451,432 | 548,067 | — | — | 999,499 | |||||||||||||||
Total liabilities | $ | 453,467 | $ | 548,067 | $ | 821,185 | $ | — | $ | 1,822,719 |
December 31, 2015 | ||||||||||||||||
Residual Trusts | Non-Residual Trusts | Servicer and Protective Advance Financing VIEs | Total | |||||||||||||
Assets | ||||||||||||||||
Restricted cash and cash equivalents | $ | 13,369 | $ | 11,388 | $ | 34,948 | $ | 59,705 | ||||||||
Residential loans at amortized cost, net | 500,563 | — | — | 500,563 | ||||||||||||
Residential loans at fair value | — | 526,016 | — | 526,016 | ||||||||||||
Receivables | — | 16,542 | — | 16,542 | ||||||||||||
Servicer and protective advances, net | — | — | 1,136,246 | 1,136,246 | ||||||||||||
Other assets | 9,357 | 558 | 2,255 | 12,170 | ||||||||||||
Total assets | $ | 523,289 | $ | 554,504 | $ | 1,173,449 | $ | 2,251,242 | ||||||||
Liabilities | ||||||||||||||||
Payables and accrued liabilities | $ | 2,084 | $ | — | $ | 1,351 | $ | 3,435 | ||||||||
Servicing advance liabilities | — | — | 992,769 | 992,769 | ||||||||||||
Mortgage-backed debt | 469,339 | 582,340 | — | 1,051,679 | ||||||||||||
Total liabilities | $ | 471,423 | $ | 582,340 | $ | 994,120 | $ | 2,047,883 |
Unconsolidated Variable Interest Entities
Included in Note 4 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 are descriptions of the Company’s variable interests in VIEs relating to servicing arrangements with an LOC reimbursement obligation and other servicing arrangements that it does not consolidate as it has determined that it is not the primary beneficiary of such VIEs. Additionally, refer to Note 17 for information on the Company's transactions with WCO.
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5. Transfers of Residential Loans
Sales of Mortgage Loans
As part of its originations activities, the Company sells substantially all of its originated or purchased mortgage loans into the secondary market for securitization or to private investors as whole loans. The Company sells conventional-conforming and government-backed mortgage loans through GSE and agency-sponsored securitizations in which mortgage-backed securities are created and sold to third-party investors. The Company also sells non-conforming mortgage loans to private investors. The Company accounts for these transfers as sales, and in most, but not all, cases, retains the servicing rights associated with the sold loans. If the servicing rights are retained, the Company receives a servicing fee for servicing the sold loans, which represents continuing involvement.
Certain guarantees arise from agreements associated with the sale of the Company's residential loans. Under these agreements, the Company may be obligated to repurchase loans, or otherwise indemnify or reimburse the credit owner or insurer for losses incurred, due to a breach of contractual representations and warranties. Refer to Note 15 for additional information.
The following table presents the carrying amounts of the Company’s assets that relate to its continuing involvement with mortgage loans that have been sold with servicing rights retained and the unpaid principal balance of these loans (in thousands):
Carrying Value of Assets Recorded on the Consolidated Balance Sheets | Unpaid Principal Balance of Sold Loans | |||||||||||||||
Servicing Rights, Net | Servicer and Protective Advances, Net | Total | ||||||||||||||
June 30, 2016 | $ | 387,255 | $ | 18,775 | $ | 406,030 | $ | 50,418,217 | ||||||||
December 31, 2015 | 509,785 | 25,078 | 534,863 | 46,983,388 |
At June 30, 2016 and December 31, 2015, 0.7% and 0.5%, respectively, of mortgage loans sold and serviced by the Company were 60 days or more past due.
The Company has elected to measure mortgage loans held for sale at fair value. The gains and losses on the sale of mortgage loans held for sale are included in net gains on sales of loans on the consolidated statements of comprehensive loss. Also included in net gains on sales of loans is interest income earned during the period the loans were held, the change in fair value of loans, and the gain or loss on the related freestanding derivatives. All activity related to mortgage loans held for sale and the related freestanding derivatives are included in operating activities on the consolidated statements of cash flows.
The following table presents a summary of cash flows related to sales of mortgage loans (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Cash proceeds received from sales, net of fees | $ | 4,825,191 | $ | 7,009,854 | $ | 10,290,056 | $ | 12,668,998 | ||||||||
Servicing fees collected (1) | 36,407 | 26,542 | 71,179 | 48,764 | ||||||||||||
Repurchases of previously sold loans | 10,386 | 5,249 | 16,318 | 8,379 |
__________
(1) | Represents servicing fees collected on all loans sold whereby the Company has continuing involvement. |
In connection with these sales, the Company recorded servicing rights using a fair value model that utilizes Level 3 unobservable inputs. Refer to Note 8 for information relating to servicing of residential loans.
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Transfers of Reverse Loans
The Company, through RMS, is an approved issuer of Ginnie Mae HMBS. The HMBS are guaranteed by Ginnie Mae and collateralized by participation interests in HECMs insured by the FHA. The Company both originates and purchases HECMs that are pooled and securitized into HMBS that the Company sells into the secondary market with servicing rights retained. Based upon the structure of the Ginnie Mae securitization program, the Company has determined that it has not met all of the requirements for sale accounting and accounts for these transfers as secured borrowings. Under this accounting treatment, the reverse loans remain on the consolidated balance sheets as residential loans. The proceeds from the transfer of reverse loans are recorded as HMBS related obligations with no gain or loss recognized on the transfer. Ginnie Mae, as guarantor of the HMBS, is obligated to the holders of the HMBS in an instance of RMS default on its servicing obligations, or when the proceeds realized on HECMs are insufficient to repay all outstanding HMBS related obligations. Ginnie Mae has recourse to RMS to the extent of the participation interests in HECMs serving as collateral to the HMBS, but does not have recourse to the general assets of the Company, except that Ginnie Mae has recourse to RMS in connection with certain claims relating to the performance and obligations of RMS as both an issuer of HMBS and a servicer of HECMs underlying HMBS.
At June 30, 2016, the unpaid principal balance and the carrying value associated with both the reverse loans and the real estate owned pledged as collateral to the securitization pools were $10.0 billion and $10.6 billion, respectively.
6. Fair Value (As Restated)
Basis for Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A three-tier fair value hierarchy is used to prioritize the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The three levels of the fair value hierarchy are as follows:
Level 1 — Valuation is based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2 — Valuation is based on quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 — Valuation is based on inputs that are both significant to the fair value measurement and unobservable.
The accounting guidance concerning fair value allows the Company to elect to measure financial instruments at fair value and report the changes in fair value through net income or loss. This election can only be made at certain specified dates and is irrevocable once made. Other than mortgage loans held for sale, which the Company has elected to measure at fair value, the Company does not have a fair value election policy, but rather makes the election on an instrument-by-instrument basis as assets and liabilities are acquired or incurred, other than for those assets and liabilities that are required to be recorded and subsequently measured at fair value.
Transfers into and out of the fair value hierarchy levels are assumed to be as of the end of the quarter in which the transfer occurred. There were no transfers between levels during the three and six months ended June 30, 2016 and 2015.
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Items Measured at Fair Value on a Recurring Basis
The following table summarizes the assets and liabilities in each level of the fair value hierarchy (in thousands). There were no assets or liabilities measured at fair value on a recurring basis utilizing Level 1 assumptions.
June 30, 2016 | December 31, 2015 | |||||||
Level 2 | ||||||||
Assets | ||||||||
Mortgage loans held for sale | $ | 1,274,275 | $ | 1,334,300 | ||||
Freestanding derivative instruments | 4,120 | 6,993 | ||||||
Level 2 assets | $ | 1,278,395 | $ | 1,341,293 | ||||
Liabilities | ||||||||
Freestanding derivative instruments | $ | 36,245 | $ | 5,405 | ||||
Level 2 liabilities | $ | 36,245 | $ | 5,405 | ||||
Level 3 | ||||||||
Assets | ||||||||
Reverse loans | $ | 10,910,237 | $ | 10,763,816 | ||||
Mortgage loans related to Non-Residual Trusts | 488,179 | 526,016 | ||||||
Charged-off loans | 51,062 | 49,307 | ||||||
Receivables related to Non-Residual Trusts | 12,681 | 16,542 | ||||||
Servicing rights carried at fair value | 1,255,351 | 1,682,016 | ||||||
Freestanding derivative instruments (IRLCs) | 75,477 | 51,519 | ||||||
Level 3 assets | $ | 12,792,987 | $ | 13,089,216 | ||||
Liabilities | ||||||||
Freestanding derivative instruments (IRLCs) | $ | 163 | $ | 1,070 | ||||
Servicing rights related liabilities | 120,825 | 117,000 | ||||||
Mortgage-backed debt related to Non-Residual Trusts | 548,067 | 582,340 | ||||||
HMBS related obligations | 10,717,148 | 10,647,382 | ||||||
Level 3 liabilities | $ | 11,386,203 | $ | 11,347,792 |
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The following assets and liabilities are measured on the consolidated balance sheets at fair value on a recurring basis utilizing significant unobservable inputs or Level 3 assumptions in their valuation. The following tables provide a reconciliation of the beginning and ending balances of these assets and liabilities (in thousands):
For the Three Months Ended June 30, 2016 | ||||||||||||||||||||||||||||
Fair Value April 1, 2016 | Total Gains (Losses) Included in Comprehensive Loss | Purchases and Other | Originations / Issuances | Sales | Settlements | Fair Value June 30, 2016 | ||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Reverse loans | $ | 10,872,891 | $ | 141,375 | $ | 84,935 | $ | 118,807 | $ | — | $ | (307,771 | ) | $ | 10,910,237 | |||||||||||||
Mortgage loans related to Non-Residual Trusts | 506,337 | 6,418 | — | — | — | (24,576 | ) | 488,179 | ||||||||||||||||||||
Charged-off loans (1) | 53,246 | 9,668 | — | — | — | (11,852 | ) | 51,062 | ||||||||||||||||||||
Receivables related to Non-Residual Trusts | 14,118 | 618 | — | — | — | (2,055 | ) | 12,681 | ||||||||||||||||||||
Servicing rights carried at fair value (2) | 1,427,331 | (187,493 | ) | (2,531 | ) | 46,279 | (28,235 | ) | — | 1,255,351 | ||||||||||||||||||
Freestanding derivative instruments (IRLCs) | 64,407 | 11,304 | — | — | — | (234 | ) | 75,477 | ||||||||||||||||||||
Total assets | $ | 12,938,330 | $ | (18,110 | ) | $ | 82,404 | $ | 165,086 | $ | (28,235 | ) | $ | (346,488 | ) | $ | 12,792,987 | |||||||||||
Liabilities | ||||||||||||||||||||||||||||
Freestanding derivative instruments (IRLCs) | $ | (255 | ) | $ | 92 | $ | — | $ | — | $ | — | $ | — | $ | (163 | ) | ||||||||||||
Servicing rights related liabilities | (105,559 | ) | 1,903 | — | (27,886 | ) | — | 10,717 | (120,825 | ) | ||||||||||||||||||
Mortgage-backed debt related to Non-Residual Trusts | (564,832 | ) | (7,987 | ) | — | — | — | 24,752 | (548,067 | ) | ||||||||||||||||||
HMBS related obligations | (10,697,435 | ) | (133,725 | ) | — | (207,160 | ) | — | 321,172 | (10,717,148 | ) | |||||||||||||||||
Total liabilities | $ | (11,368,081 | ) | $ | (139,717 | ) | $ | — | $ | (235,046 | ) | $ | — | $ | 356,641 | $ | (11,386,203 | ) |
__________
(1) | Included in gains on charged-off loans are gains from instrument-specific credit risk, which primarily result from changes in assumptions related to collection rates and discount rates, of $3.4 million during the three months ended June 30, 2016. |
(2) | During the three months ended June 30, 2016, the Company sold mortgage servicing rights with a fair value of $28.2 million and recognized a total net loss on sale of $0.5 million. |
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For the Six Months Ended June 30, 2016 | ||||||||||||||||||||||||||||
Fair Value January 1, 2016 | Total Gains (Losses) Included in Comprehensive Loss | Purchases and Other | Originations / Issuances | Sales | Settlements | Fair Value June 30, 2016 | ||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Reverse loans | $ | 10,763,816 | $ | 296,209 | $ | 138,955 | $ | 245,958 | $ | — | $ | (534,701 | ) | $ | 10,910,237 | |||||||||||||
Mortgage loans related to Non-Residual Trusts | 526,016 | 11,581 | — | — | — | (49,418 | ) | 488,179 | ||||||||||||||||||||
Charged-off loans (1) | 49,307 | 24,044 | — | — | — | (22,289 | ) | 51,062 | ||||||||||||||||||||
Receivables related to Non-Residual Trusts | 16,542 | 151 | — | — | — | (4,012 | ) | 12,681 | ||||||||||||||||||||
Servicing rights carried at fair value (2) | 1,682,016 | (514,073 | ) | 17,106 | 98,537 | (28,235 | ) | — | 1,255,351 | |||||||||||||||||||
Freestanding derivative instruments (IRLCs) | 51,519 | 24,406 | — | — | — | (448 | ) | 75,477 | ||||||||||||||||||||
Total assets | $ | 13,089,216 | $ | (157,682 | ) | $ | 156,061 | $ | 344,495 | $ | (28,235 | ) | $ | (610,868 | ) | $ | 12,792,987 | |||||||||||
Liabilities | ||||||||||||||||||||||||||||
Freestanding derivative instruments (IRLCs) | $ | (1,070 | ) | $ | 907 | $ | — | $ | — | $ | — | $ | — | $ | (163 | ) | ||||||||||||
Servicing rights related liabilities | (117,000 | ) | 5,197 | — | (27,886 | ) | — | 18,864 | (120,825 | ) | ||||||||||||||||||
Mortgage-backed debt related to Non-Residual Trusts | (582,340 | ) | (14,919 | ) | — | — | — | 49,192 | (548,067 | ) | ||||||||||||||||||
HMBS related obligations | (10,647,382 | ) | (253,351 | ) | — | (410,107 | ) | — | 593,692 | (10,717,148 | ) | |||||||||||||||||
Total liabilities | $ | (11,347,792 | ) | $ | (262,166 | ) | $ | — | $ | (437,993 | ) | $ | — | $ | 661,748 | $ | (11,386,203 | ) |
__________
(1) | Included in gains on charged-off loans are gains from instrument-specific credit risk, which primarily result from changes in assumptions related to collection rates and discount rates, of $14.3 million during the six months ended June 30, 2016. |
(2) | During the six months ended June 30, 2016, the Company sold mortgage servicing rights with a fair value of $28.2 million and recognized a total net loss on sale of $0.5 million. |
For the Three Months Ended June 30, 2015 | ||||||||||||||||||||||||
Fair Value April 1, 2015 | Total Gains (Losses) Included in Comprehensive Loss | Purchases and Other | Originations / Issuances | Settlements | Fair Value June 30, 2015 | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Reverse loans | $ | 10,429,893 | $ | 69,178 | $ | 270,484 | $ | 223,825 | $ | (257,282 | ) | $ | 10,736,098 | |||||||||||
Mortgage loans related to Non-Residual Trusts | 567,912 | 12,000 | — | — | (26,502 | ) | 553,410 | |||||||||||||||||
Charged-off loans (1) | 50,845 | 15,707 | — | — | (12,928 | ) | 53,624 | |||||||||||||||||
Receivables related to Non-Residual Trusts | 22,935 | (302 | ) | — | — | (1,833 | ) | 20,800 | ||||||||||||||||
Servicing rights carried at fair value | 1,570,320 | 1,141 | 139,449 | 86,811 | — | 1,797,721 | ||||||||||||||||||
Freestanding derivative instruments (IRLCs) | 84,925 | (34,053 | ) | — | — | (122 | ) | 50,750 | ||||||||||||||||
Total assets | $ | 12,726,830 | $ | 63,671 | $ | 409,933 | $ | 310,636 | $ | (298,667 | ) | $ | 13,212,403 | |||||||||||
Liabilities | ||||||||||||||||||||||||
Freestanding derivative instruments (IRLCs) | $ | (204 | ) | $ | (4,587 | ) | $ | — | $ | — | $ | — | $ | (4,791 | ) | |||||||||
Servicing rights related liabilities | (63,349 | ) | (5,694 | ) | — | — | 4,487 | (64,556 | ) | |||||||||||||||
Mortgage-backed debt related to Non-Residual Trusts | (635,239 | ) | (8,274 | ) | — | — | 26,719 | (616,794 | ) | |||||||||||||||
HMBS related obligations | (10,304,384 | ) | (62,363 | ) | — | (493,785 | ) | 271,861 | (10,588,671 | ) | ||||||||||||||
Total liabilities | $ | (11,003,176 | ) | $ | (80,918 | ) | $ | — | $ | (493,785 | ) | $ | 303,067 | $ | (11,274,812 | ) |
__________
(1) | Included in gains on charged-off loans are gains from instrument-specific credit risk, which primarily result from changes in assumptions related to collection rates and discount rates, of $8.7 million during the three months ended June 30, 2015. |
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For the Six Months Ended June 30, 2015 | ||||||||||||||||||||||||||||
Fair Value January 1, 2015 | Total Gains (Losses) Included in Comprehensive Loss | Purchases and Other | Originations / Issuances | Sales | Settlements | Fair Value June 30, 2015 | ||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||
Reverse loans (1) | $ | 10,064,365 | $ | 192,087 | $ | 509,859 | $ | 413,335 | $ | (16,592 | ) | $ | (426,956 | ) | $ | 10,736,098 | ||||||||||||
Mortgage loans related to Non-Residual Trusts | 586,433 | 20,164 | — | — | — | (53,187 | ) | 553,410 | ||||||||||||||||||||
Charged-off loans (2) | 57,217 | 21,691 | — | — | — | (25,284 | ) | 53,624 | ||||||||||||||||||||
Receivables related to Non-Residual Trusts | 25,201 | (548 | ) | — | — | — | (3,853 | ) | 20,800 | |||||||||||||||||||
Servicing rights carried at fair value | 1,599,541 | (128,094 | ) | 167,162 | 159,112 | — | — | 1,797,721 | ||||||||||||||||||||
Freestanding derivative instruments (IRLCs) | 60,400 | (9,330 | ) | — | — | — | (320 | ) | 50,750 | |||||||||||||||||||
Total assets | $ | 12,393,157 | $ | 95,970 | $ | 677,021 | $ | 572,447 | $ | (16,592 | ) | $ | (509,600 | ) | $ | 13,212,403 | ||||||||||||
Liabilities | ||||||||||||||||||||||||||||
Freestanding derivative instruments (IRLCs) | $ | (263 | ) | $ | (4,528 | ) | $ | — | $ | — | $ | — | $ | — | $ | (4,791 | ) | |||||||||||
Servicing rights related liabilities | (66,311 | ) | (7,512 | ) | — | — | — | 9,267 | (64,556 | ) | ||||||||||||||||||
Mortgage-backed debt related to Non-Residual Trusts | (653,167 | ) | (16,830 | ) | — | — | — | 53,203 | (616,794 | ) | ||||||||||||||||||
HMBS related obligations | (9,951,895 | ) | (154,596 | ) | — | (951,233 | ) | — | 469,053 | (10,588,671 | ) | |||||||||||||||||
Total liabilities | $ | (10,671,636 | ) | $ | (183,466 | ) | $ | — | $ | (951,233 | ) | $ | — | $ | 531,523 | $ | (11,274,812 | ) |
__________
(1) | During the six months ended June 30, 2015, the Company sold $16.6 million in reverse loans and recognized $0.1 million in net losses on sales of loans. |
(2) | Included in gains on charged-off loans are gains from instrument-specific credit risk, which primarily result from changes in assumptions related to collection rate and discount rates, of $8.7 million during the six months ended June 30, 2015. |
All gains and losses on assets and liabilities measured at fair value on a recurring basis and classified as Level 3 within the fair value hierarchy, with the exception of gains and losses on charged-off loans, IRLCs, servicing rights carried at fair value, and servicing rights related liabilities, are recognized in either other net fair value gains (losses) or net fair value gains on reverse loans and related HMBS obligations on the consolidated statements of comprehensive loss. Gains and losses related to charged-off loans are recorded in other revenues, while gains and losses relating to IRLCs are recorded in net gains on sales of loans on the consolidated statements of comprehensive loss. The change in fair value of servicing rights carried at fair value and servicing rights related liabilities are recorded in net servicing revenue and fees on the consolidated statements of comprehensive loss. Total gains and losses included in the financial statement line items disclosed above include interest income and interest expense at the stated rate for interest-bearing assets and liabilities, respectively, accretion and amortization, and the impact of the changes in valuation inputs and assumptions.
The Company’s Valuation Committee determines and approves valuation policies and unobservable inputs used to estimate the fair value of items measured at fair value on a recurring basis. The Valuation Committee, consisting of certain members of the senior executive management team, meets on a quarterly basis to review the assets and liabilities that require fair value measurement, including how each asset and liability has actually performed in comparison to the unobservable inputs and the projected performance. The Valuation Committee also reviews related available market data.
The following is a description of the methods used to estimate the fair values of the Company’s assets and liabilities measured at fair value on a recurring basis, as well as the basis for classifying these assets and liabilities as Level 2 or 3 within the fair value hierarchy. The Company’s valuations consider assumptions that it believes a market participant would consider in valuing the assets and liabilities, the most significant of which are disclosed below. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the valuations for recent historical experience, as well as for current and expected relevant market conditions.
29
Residential loans
• | Reverse loans, mortgage loans related to Non-Residual Trusts and charged-off loans — These loans are not traded in an active, open market with readily observable prices. Accordingly, the Company estimates fair value using Level 3 unobservable market inputs. The estimated fair value is based on the net present value of projected cash flows over the estimated life of the loans. The discount rate assumption for these assets considers, as applicable, collateral and credit risk characteristics of the loans, collection rates, current market interest rates, expected duration, and current market yields. |
• | Mortgage loans held for sale — These loans are valued using a market approach by utilizing observable quoted market prices, where available, or prices for other whole loans with similar characteristics. The Company classifies these loans as Level 2 within the fair value hierarchy. |
Receivables related to Non-Residual Trusts — The Company estimates the fair value of these receivables using the net present value of expected cash flows from the LOCs to be used to pay bondholders over the remaining life of the securitization trusts and applies Level 3 unobservable market inputs in its valuation. Receivables related to Non-Residual Trusts are recorded in receivables, net on the consolidated balance sheets.
Servicing rights carried at fair value — The Company accounts for servicing rights associated with the risk-managed loan class at fair value. The Company uses a discounted cash flow model to estimate the fair value of these assets. The assumptions vary based on collateral stratifications including product type, remittance type, geography, delinquency, and coupon dispersion of the underlying loan portfolio. The Company classifies servicing rights within Level 3 of the fair value hierarchy.
Freestanding derivative instruments — Fair values of IRLCs are derived using valuation models incorporating market pricing for instruments with similar characteristics and by estimating the fair value of the servicing rights expected to be recorded at sale of the loan. The fair values are then adjusted for anticipated loan funding probability. Both the fair value of servicing rights expected to be recorded at the date of sale of the loan and anticipated loan funding probability are significant unobservable inputs and, as a result, IRLCs are classified as Level 3 within the fair value hierarchy. The loan funding probability ratio represents the aggregate likelihood that loans currently in a lock position will ultimately close, which is largely dependent on the loan processing stage that a loan is currently in and changes in interest rates from the time of the rate lock through the time a loan is closed. IRLCs have positive fair value at inception and change in value as interest rates and loan funding probability change. Rising interest rates have a positive effect on the fair value of the servicing rights component of the IRLC fair value and increase the loan funding probability. An increase in loan funding probability (i.e., higher aggregate likelihood of loans estimated to close) will result in the fair value of the IRLC increasing if in a gain position, or decreasing, to a lower loss, if in a loss position. A significant increase (decrease) to the fair value of servicing rights component in isolation could result in a significantly higher (lower) fair value measurement.
The fair value of forward sales commitments and MBS purchase commitments is determined based on observed market pricing for similar instruments; therefore, these contracts are classified as Level 2 within the fair value hierarchy. Counterparty credit risk is taken into account when determining fair value, although the impact is diminished by daily margin posting on all forward sales and purchase commitments. Refer to Note 7 for additional information on freestanding derivative financial instruments.
Servicing rights related liabilities — The Company uses a discounted cash flow model to estimate the fair value of both its excess servicing spread liabilities and its servicing rights financing. The assumptions utilized are based on collateral stratifications including product type, remittance type, geography, delinquency, and coupon dispersion of the underlying loan portfolio. The Company classifies its servicing rights related liabilities as Level 3 within the fair value hierarchy.
Mortgage-backed debt related to Non-Residual Trusts — This debt is not traded in an active, open market with readily observable prices. Accordingly, the Company estimates fair value using Level 3 unobservable market inputs. The estimated fair value of the debt is based on the net present value of the projected principal and interest payments owed for the estimated remaining life of the securitization trusts. An analysis of the credit assumptions for the underlying collateral in each of the securitization trusts is performed to determine the required payments to bondholders.
HMBS related obligations — These obligations are not traded in an active, open market with readily observable prices. Accordingly, the Company estimates fair value using Level 3 unobservable market inputs. The estimated fair value is based on the net present value of projected cash flows over the estimated life of the liabilities. The discount rate assumption for these liabilities is based on an assessment of current market yields for HMBS, expected duration, and current market interest rates. The yield on seasoned HMBS is adjusted based on the duration of each HMBS and assuming a constant spread to LIBOR.
30
The following tables present the significant unobservable inputs used in the fair value measurement of the assets and liabilities described above. The Company utilizes a discounted cash flow model to estimate the fair value of all Level 3 assets and liabilities included on the consolidated financial statements at fair value on a recurring basis, with the exception of IRLCs for which the Company utilizes a market approach. Significant increases or decreases in any of the inputs disclosed below could result in a significantly lower or higher fair value measurement.
June 30, 2016 | December 31, 2015 | |||||||||||
Significant Unobservable Input (1) (2) | Range of Input (3) | Weighted Average of Input (3) | Range of Input (3) | Weighted Average of Input (3) | ||||||||
Assets | ||||||||||||
Reverse loans | Weighted-average remaining life in years (4) | 0.8 - 11.8 | 4.1 | 1.1 - 10.0 | 4.1 | |||||||
Conditional repayment rate | 10.82% - 61.96% | 26.54 | % | 13.53% - 52.94% | 25.59 | % | ||||||
Discount rate | 1.64% - 2.95% | 2.29 | % | 2.08% - 3.56% | 2.84 | % | ||||||
Mortgage loans related to Non-Residual Trusts | Conditional prepayment rate | 2.97% - 4.03% | 3.36 | % | 2.67% - 4.66% | 3.52 | % | |||||
Conditional default rate | 1.69% - 2.60% | 2.13 | % | 1.47% - 2.74% | 2.05 | % | ||||||
Loss severity | 76.78% - 100.00% | 91.68 | % | 73.07% - 95.88% | 88.72 | % | ||||||
Discount rate | 8.00% | 8.00 | % | 8.00% | 8.00 | % | ||||||
Charged-off loans | Collection rate | 2.60% - 3.42% | 2.64 | % | 2.15% - 3.54% | 2.23 | % | |||||
Discount rate | 28.00% | 28.00 | % | 28.00% | 28.00 | % | ||||||
Receivables related to Non-Residual Trusts | Conditional prepayment rate | 2.33% - 3.06% | 2.76 | % | 1.93% - 3.62% | 2.90 | % | |||||
Conditional default rate | 1.68% - 2.80% | 2.20 | % | 1.66% - 2.98% | 2.30 | % | ||||||
Loss severity | 72.26% - 100.00% | 89.06 | % | 70.33% - 93.46% | 85.63 | % | ||||||
Discount rate | 0.50% | 0.50 | % | 0.50% | 0.50 | % | ||||||
Servicing rights carried at fair value | Weighted-average remaining life in years (4) | 2.4 - 7.1 | 5.2 | 5.2 - 9.0 | 6.3 | |||||||
Discount rate | 10.14% - 14.23% | 10.58 | % | 10.00% - 14.34% | 10.88 | % | ||||||
Conditional prepayment rate | 7.02% - 26.30% | 13.39 | % | 6.07% - 13.15% | 9.94 | % | ||||||
Conditional default rate | 0.02% - 3.35% | 0.99 | % | 0.05% - 2.49% | 1.06 | % | ||||||
Interest rate lock commitments | Loan funding probability | 16.00% - 100.00% | 75.81 | % | 2.34% - 100.00% | 79.42 | % | |||||
Fair value of initial servicing rights multiple (5) | 0.10 - 6.48 | 3.20 | 0.05 - 7.06 | 3.71 |
31
June 30, 2016 | December 31, 2015 | |||||||||||
Significant Unobservable Input (1) (2) | Range of Input (3) | Weighted Average of Input (3) | Range of Input (3) | Weighted Average of Input (3) | ||||||||
Liabilities | ||||||||||||
Interest rate lock commitments | Loan funding probability | 16.00% - 100.00% | 77.45 | % | 38.00% - 100.00% | 83.28 | % | |||||
Fair value of initial servicing rights multiple (5) | 1.66 - 5.28 | 3.49 | 0.11 - 5.88 | 4.00 | ||||||||
Servicing rights related liabilities | Weighted-average remaining life in years (4) | 2.1 - 7.0 | 5.4 | 6.3 - 7.4 | 6.6 | |||||||
Discount rate | 10.17% - 12.85% | 11.48 | % | 11.67% - 13.85% | 13.24 | % | ||||||
Conditional prepayment rate | 8.77% - 18.13% | 12.56 | % | 8.32% - 11.28% | 9.98 | % | ||||||
Conditional default rate | 0.01% - 3.01% | 0.48 | % | 0.11% - 1.06% | 0.58 | % | ||||||
Mortgage-backed debt related to Non-Residual Trusts | Conditional prepayment rate | 2.33% - 3.06% | 2.76 | % | 1.93% - 3.62% | 2.90 | % | |||||
Conditional default rate | 1.68% - 2.80% | 2.20 | % | 1.66% - 2.98% | 2.30 | % | ||||||
Loss severity | 72.26% - 100.00% | 89.06 | % | 70.33% - 93.46% | 85.63 | % | ||||||
Discount rate | 6.00% | 6.00 | % | 6.00% | 6.00 | % | ||||||
HMBS related obligations | Weighted-average remaining life in years (4) | 0.6 - 7.3 | 3.5 | 0.9 - 6.6 | 3.5 | |||||||
Conditional repayment rate | 11.38% - 66.94% | 25.96 | % | 12.06% - 55.49% | 24.70 | % | ||||||
Discount rate | 1.39% - 2.63% | 1.94 | % | 1.73% - 3.08% | 2.39 | % |
(1) | Conditional repayment rate includes assumptions for both voluntary and involuntary rates as well as assumptions for the assignment of HECMs to HUD, in accordance with obligations as servicer. |
(2) | Voluntary and involuntary prepayment rates have been presented as conditional prepayment rate and conditional default rate, respectively. |
(3) | With the exception of loss severity, fair value of initial servicing rights embedded in IRLCs and discount rate on charged-off loans, all significant unobservable inputs above are based on the related unpaid principal balance of the underlying collateral, or in the case of HMBS related obligations, the balance outstanding. Loss severity is based on projected liquidations. Fair value of servicing rights embedded in IRLCs represents a multiple of the annual servicing fee. The discount rate on charged-off loans is based on the loan balance at fair value. |
(4) | Represents the remaining weighted-average life of the related unpaid principal balance or balance outstanding of the underlying collateral adjusted for assumptions for conditional repayment rate, conditional prepayment rate and conditional default rate, as applicable. |
(5) | Fair value of servicing rights embedded in IRLCs, which represents a multiple of the annual servicing fee, excludes the impact of IRLCs identified as servicing released. |
Fair Value Option
With the exception of freestanding derivative instruments, the Company has elected the fair value option for the assets and liabilities described above as measured at fair value on a recurring basis. The fair value option was elected for these assets and liabilities as the Company believes fair value best reflects their expected future economic performance.
32
Presented in the table below is the estimated fair value and unpaid principal balance of loans and debt instruments that have contractual principal amounts and for which the Company has elected the fair value option (in thousands):
June 30, 2016 | December 31, 2015 | |||||||||||||||
Estimated Fair Value | Unpaid Principal Balance | Estimated Fair Value | Unpaid Principal Balance | |||||||||||||
Loans at fair value under the fair value option | ||||||||||||||||
Reverse loans (1) | $ | 10,910,237 | $ | 10,244,435 | $ | 10,763,816 | $ | 10,187,521 | ||||||||
Mortgage loans held for sale (1) | 1,274,275 | 1,210,315 | 1,334,300 | 1,285,582 | ||||||||||||
Mortgage loans related to Non-Residual Trusts | 488,179 | 544,808 | 526,016 | 580,695 | ||||||||||||
Charged-off loans | 51,062 | 2,792,844 | 49,307 | 2,887,367 | ||||||||||||
Total | $ | 12,723,753 | $ | 14,792,402 | $ | 12,673,439 | $ | 14,941,165 | ||||||||
Debt instruments at fair value under the fair value option | ||||||||||||||||
Mortgage-backed debt related to Non-Residual Trusts | $ | 548,067 | $ | 552,070 | $ | 582,340 | $ | 585,839 | ||||||||
HMBS related obligations (2) | 10,717,148 | 10,002,171 | 10,647,382 | 10,012,283 | ||||||||||||
Total | $ | 11,265,215 | $ | 10,554,241 | $ | 11,229,722 | $ | 10,598,122 |
__________
(1) | Includes loans that collateralize master repurchase agreements. Refer to Note 11 for additional information. |
(2) | For HMBS related obligations, the unpaid principal balance represents the balance outstanding. |
Included in mortgage loans related to Non-Residual Trusts are loans that are 90 days or more past due that had a fair value of $1.7 million and $2.6 million at June 30, 2016 and December 31, 2015, respectively, and an unpaid principal balance of $16.3 million and $16.2 million at June 30, 2016 and December 31, 2015, respectively. Mortgage loans held for sale that are 90 days or more past due are insignificant at June 30, 2016 and December 31, 2015. Charged-off loans are predominantly 90 days or more past due.
Items Measured at Fair Value on a Non-Recurring Basis
The Company held real estate owned, net of $91.1 million and $77.4 million at June 30, 2016 and December 31, 2015, respectively. In addition, the Company had loans that were in the process of foreclosure of $456.1 million and $244.9 million at June 30, 2016 and December 31, 2015, respectively, which are included in residential loans at amortized cost, net and residential loans at fair value on the consolidated balance sheets. Real estate owned, net is included on the consolidated balance sheets within other assets and is measured at net realizable value on a non-recurring basis utilizing significant unobservable inputs or Level 3 assumptions in their valuation.
The following table presents the significant unobservable input used in the fair value measurement of real estate owned, net:
June 30, 2016 | December 31, 2015 | |||||||||||
Significant Unobservable Input | Range of Input | Weighted Average of Input | Range of Input | Weighted Average of Input | ||||||||
Real estate owned, net | Loss severity (1) | 0.00% - 69.48% | 6.72 | % | 0.00% - 72.58% | 8.25 | % |
__________
(1) | Loss severity is based on the unpaid principal balance of the related loan at time of foreclosure. |
The Company held real estate owned, net in the Reverse Mortgage and Servicing segments and Other non-reportable segment of $77.6 million, $11.8 million and $1.7 million at June 30, 2016, respectively and $66.4 million, $10.4 million and $0.6 million at December 31, 2015, respectively. In determining fair value, the Company either obtains appraisals or performs a review of historical severity rates of real estate owned previously sold by the Company. When utilizing historical severity rates, the properties are stratified by collateral type and/or geographical concentration and length of time held by the Company. The severity rates are reviewed for reasonableness by comparison to third-party market trends and fair value is determined by applying severity rates to the stratified population. In the determination of fair value of real estate owned associated with reverse mortgages, the Company considers amounts typically covered by FHA insurance. Management approves valuations that have been determined using the historical severity rate method.
33
Fair Value of Other Financial Instruments
The following table presents the carrying amounts and estimated fair values of financial assets and liabilities that are not recorded at fair value on a recurring or non-recurring basis and their respective levels within the fair value hierarchy (in thousands). This table excludes cash and cash equivalents, restricted cash and cash equivalents, servicer payables and warehouse borrowings as these financial instruments are highly liquid or short-term in nature and as a result, their carrying amounts approximate fair value.
June 30, 2016 | December 31, 2015 | |||||||||||||||||
Fair Value Hierarchy | Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | ||||||||||||||
Financial assets | ||||||||||||||||||
Residential loans at amortized cost, net | Level 3 | $ | 565,061 | $ | 580,595 | $ | 541,406 | $ | 554,664 | |||||||||
Insurance premium receivables (1) | Level 3 | 12,409 | 12,016 | 12,845 | 12,463 | |||||||||||||
Servicer and protective advances, net (2) | Level 3 | 1,334,202 | 1,273,267 | 1,631,065 | 1,546,958 | |||||||||||||
Financial liabilities | ||||||||||||||||||
Payables to insurance carriers (3) | Level 3 | 3,667 | 3,638 | 21,356 | 21,128 | |||||||||||||
Servicing advance liabilities (4) | Level 3 | 1,001,074 | 1,004,351 | 1,226,898 | 1,232,147 | |||||||||||||
Corporate debt (5) | Level 2 | 2,155,095 | 1,528,443 | 2,152,031 | 1,904,467 | |||||||||||||
Mortgage-backed debt carried at amortized cost | Level 3 | 451,432 | 457,643 | 469,339 | 475,347 |
__________
(1) | The carrying amounts of insurance premium receivables were reduced by $59.0 million and $77.2 million at June 30, 2016 and December 31, 2015, respectively, and the estimated fair values were reduced by $57.0 million and $74.7 million at June 30, 2016 and December 31, 2015, respectively, to correct an immaterial error as discussed in further detail in Note 2. |
(2) | The carrying amounts of servicer and protective advances, net were increased by $25.1 million and $35.2 million at June 30, 2016 and December 31, 2015, respectively, and the estimated fair values were increased by $23.7 million and $33.9 million at June 30, 2016 and December 31, 2015, respectively, to correct an immaterial error as discussed in further detail in Note 2. |
(3) | The carrying amounts of payables to insurance carriers were reduced by $33.9 million and $42.1 million at June 30, 2016 and December 31, 2015, respectively, and the estimated fair values were reduced by $33.5 million and $41.6 million at June 30, 2016 and December 31, 2015, respectively, to correct an immaterial error as discussed in further detail in Note 2. |
(4) | The carrying amounts of servicing advance liabilities are net of deferred issuance costs, including those relating to line-of-credit arrangements, which are recorded in other assets. |
(5) | The carrying amounts of corporate debt in the table above are net of the 2013 Revolver deferred issuance costs, which are recorded in other assets on the consolidated balance sheets. |
The following is a description of the methods and significant assumptions used in estimating the fair value of the Company’s financial instruments that are not measured at fair value on a recurring or non-recurring basis.
Residential loans at amortized cost, net — The methods and assumptions used to estimate the fair value of residential loans carried at amortized cost are the same as those described above for mortgage loans related to Non-Residual Trusts.
Insurance premium receivables — The estimated fair value of these receivables is based on the net present value of the expected cash flows. The determination of fair value includes assumptions related to the underlying collateral serviced by the Company, such as delinquency and default rates, as the insurance premiums are collected as part of the borrowers’ loan payments or from the related trusts.
Servicer and protective advances, net — The estimated fair value of these advances is based on the net present value of expected cash flows. The determination of expected cash flows includes consideration of recoverability clauses in the Company’s servicing agreements, as well as assumptions related to the underlying collateral and when proceeds may be used to recover these receivables.
Payables to insurance carriers — The estimated fair value of these liabilities is based on the net present value of the expected carrier payments over the life of the payables.
Servicing advance liabilities — The estimated fair value of the majority of these liabilities approximates carrying value as these liabilities bear interest at a rate that is adjusted regularly based on a market index.
Corporate debt — The Company’s 2013 Term Loan, Convertible Notes, and Senior Notes are not traded in an active, open market with readily observable prices. The estimated fair value of corporate debt is primarily based on an average of broker quotes.
34
Mortgage-backed debt carried at amortized cost — The methods and assumptions used to estimate the fair value of mortgage-backed debt carried at amortized cost are the same as those described above for mortgage-backed debt related to Non-Residual Trusts.
Net Gains on Sales of Loans
Provided in the table below is a summary of the components of net gains on sales of loans (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Realized gains on sales of loans | $ | 79,999 | $ | 18,696 | $ | 160,079 | $ | 80,075 | ||||||||
Change in unrealized gains on loans held for sale | 2,548 | (15,649 | ) | 12,839 | (14,260 | ) | ||||||||||
Gains (losses) on interest rate lock commitments | 11,395 | (38,640 | ) | 25,312 | (13,858 | ) | ||||||||||
Gains (losses) on forward sales commitments | (43,384 | ) | 71,935 | (110,337 | ) | 33,287 | ||||||||||
Losses on MBS purchase commitments | (2,477 | ) | (13,107 | ) | (13,273 | ) | (18,786 | ) | ||||||||
Capitalized servicing rights | 46,279 | 86,811 | 98,537 | 159,112 | ||||||||||||
Provision for repurchases | (3,724 | ) | (4,532 | ) | (8,437 | ) | (6,557 | ) | ||||||||
Interest income | 9,540 | 13,885 | 19,933 | 25,613 | ||||||||||||
Net gains on sales of loans | $ | 100,176 | $ | 119,399 | $ | 184,653 | $ | 244,626 |
Net Fair Value Gains on Reverse Loans and Related HMBS Obligations
Provided in the table below is a summary of the components of net fair value gains on reverse loans and related HMBS obligations (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Interest income on reverse loans | $ | 113,631 | $ | 109,406 | $ | 224,225 | $ | 215,686 | ||||||||
Change in fair value of reverse loans | 27,744 | (40,228 | ) | 71,984 | (23,501 | ) | ||||||||||
Net fair value gains on reverse loans | 141,375 | 69,178 | 296,209 | 192,185 | ||||||||||||
Interest expense on HMBS related obligations | (103,368 | ) | (100,564 | ) | (206,622 | ) | (199,100 | ) | ||||||||
Change in fair value of HMBS related obligations | (30,357 | ) | 38,201 | (46,729 | ) | 44,504 | ||||||||||
Net fair value losses on HMBS related obligations | (133,725 | ) | (62,363 | ) | (253,351 | ) | (154,596 | ) | ||||||||
Net fair value gains on reverse loans and related HMBS obligations | $ | 7,650 | $ | 6,815 | $ | 42,858 | $ | 37,589 |
7. Freestanding Derivative Financial Instruments
The following table provides the total notional or contractual amounts and related fair values of derivative assets and liabilities as well as cash margin (in thousands):
June 30, 2016 | December 31, 2015 | |||||||||||||||||||||||
Notional/ Contractual Amount | Fair Value | Notional/ Contractual Amount | Fair Value | |||||||||||||||||||||
Derivative Assets | Derivative Liabilities | Derivative Assets | Derivative Liabilities | |||||||||||||||||||||
Interest rate lock commitments | $ | 3,351,210 | $ | 75,477 | $ | 163 | $ | 3,398,892 | $ | 51,519 | $ | 1,070 | ||||||||||||
Forward sales commitments | 4,413,700 | 17 | 36,245 | 4,650,000 | 6,427 | 4,871 | ||||||||||||||||||
MBS purchase commitments | 655,500 | 4,103 | — | 703,000 | 566 | 534 | ||||||||||||||||||
Total derivative instruments | $ | 79,597 | $ | 36,408 | $ | 58,512 | $ | 6,475 | ||||||||||||||||
Cash margin | $ | 25,436 | $ | — | $ | 209 | $ | 10,101 |
35
Derivative positions subject to netting arrangements include all forward sale commitments, MBS purchase commitments, and cash margin, as reflected in the table above, and allow the Company to net settle asset and liability positions, as well as cash margin, with the same counterparty. After consideration of these netting arrangements and offsetting positions by counterparty, the total net settlement amount as it relates to these positions were asset positions of $0.5 million and $0.3 million, and liability positions of $7.2 million and $8.6 million, at June 30, 2016 and December 31, 2015, respectively. A master netting arrangement with one of the Company’s counterparties also allows for offsetting derivative positions and margin against amounts associated with the master repurchase agreement with that same counterparty. At June 30, 2016, the Company’s net derivative asset position with that counterparty of $0.1 million was comprised of $3.1 million of over-collateralized positions associated with the master repurchase agreement and cash margin paid of $0.9 million, partially offset by a net derivative liability position of $3.9 million.
During the first quarter of 2016, the Company entered into a master netting arrangement with another of the Company’s counterparties, which also allows for offsetting derivative positions and margin against amounts associated with the master repurchase agreement with the same counterparty. At June 30, 2016, the Company’s net derivative liability position with that counterparty was $1.8 million. Under the master netting arrangement, the Company is able to utilize certain over-collateralized positions and excess cash deposited with the counterparty associated with the master repurchase agreement to reduce potential cash margin posting requirements on derivative transactions. At June 30, 2016, there were $21.1 million of over-collateralized positions and $69.9 million in excess cash deposited with the counterparty related to the master repurchase agreement. The master netting agreement does not obligate the counterparty to transfer cash margin to the Company related to the master repurchase agreement over-collateralization and excess cash positions.
Over collateralized positions on master repurchase agreements are not reflected as margin in the table above. Refer to Note 6 for a summary of the gains and losses on freestanding derivatives.
8. Servicing of Residential Loans
The Company provides servicing of residential loans and real estate owned for itself and third-party credit owners. The Company’s total servicing portfolio consists of accounts serviced for others for which servicing rights have been capitalized, accounts sub-serviced for others, as well as residential loans and real estate owned recognized on the consolidated balance sheets.
Provided below is a summary of the Company’s total servicing portfolio (dollars in thousands):
June 30, 2016 | December 31, 2015 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Number of Accounts | Unpaid Principal Balance | |||||||||||
Third-party credit owners (1) | ||||||||||||||
Capitalized servicing rights (2) | 1,572,863 | $ | 187,617,542 | 1,637,541 | $ | 197,154,579 | ||||||||
Capitalized sub-servicing (3) | 143,475 | 8,161,267 | 159,368 | 9,053,755 | ||||||||||
Sub-servicing (4) | 407,417 | 60,672,148 | 346,755 | 47,734,378 | ||||||||||
Total third-party servicing portfolio | 2,123,755 | 256,450,957 | 2,143,664 | 253,942,712 | ||||||||||
On-balance sheet residential loans and real estate owned | 99,089 | 12,682,938 | 102,044 | 12,705,532 | ||||||||||
Total servicing portfolio (5) | 2,222,844 | $ | 269,133,895 | 2,245,708 | $ | 266,648,244 |
__________
(1) | Includes real estate owned serviced for third parties. |
(2) | Includes $5.5 billion and $1.7 billion in unpaid principal balance associated with servicing rights sold legally to WCO at June 30, 2016 and December 31, 2015, respectively. |
(3) | Consists of sub-servicing contracts acquired through business combinations whereby the benefits from the contract are greater than adequate compensation for performing the servicing. |
(4) | Includes $6.2 billion and $6.6 billion in unpaid principal balance of sub-servicing performed for WCO at June 30, 2016 and December 31, 2015, respectively. |
(5) | Excludes charged-off loans managed by the Servicing segment. |
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Net Servicing Revenue and Fees
The Company services loans for itself, as well as for third parties, and earns servicing income from its third-party servicing portfolio. The following table presents the components of net servicing revenue and fees, which includes revenues earned by the Servicing and Reverse Mortgage segments (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
2016 | 2015 | 2016 | 2015 | ||||||||||||
Servicing fees (1) (2) | $ | 177,082 | $ | 176,316 | $ | 354,836 | $ | 348,048 | |||||||
Incentive and performance fees (1) | 18,011 | 33,681 | 37,783 | 65,419 | |||||||||||
Ancillary and other fees (1) (3) | 25,058 | 25,436 | 49,667 | 50,919 | |||||||||||
Servicing revenue and fees | 220,151 | 235,433 | 442,286 | 464,386 | |||||||||||
Amortization of servicing rights (4) | (2,625 | ) | (6,965 | ) | (7,236 | ) | (13,978 | ) | |||||||
Change in fair value of servicing rights | (187,493 | ) | 1,141 | (514,073 | ) | (128,094 | ) | ||||||||
Change in fair value of servicing rights related liabilities (2) (5) | 1,903 | (5,694 | ) | 5,197 | (7,512 | ) | |||||||||
Net servicing revenue and fees | $ | 31,936 | $ | 223,915 | $ | (73,826 | ) | $ | 314,802 |
__________
(1) | Includes sub-servicing fees and incentive, performance, ancillary and other fees related to servicing assets held by WCO of $1.2 million and $0.1 million, respectively, for the three months ended June 30, 2016 and $2.1 million and $0.3 million, respectively, for the six months ended June 30, 2016. |
(2) | Includes a pass-through of $1.8 million and $3.0 million relating to servicing rights sold to WCO during the three and six months ended June 30, 2016, respectively. |
(3) | Includes late fees of $17.9 million and $15.2 million for the three months ended June 30, 2016 and 2015, respectively, and $33.7 million and $29.6 million for the six months ended June 30, 2016 and 2015, respectively. |
(4) | Includes amortization of a servicing liability of $3.1 million and $4.3 million for the three and six months ended June 30, 2016, respectively. |
(5) | Includes interest expense on servicing rights related liabilities, which represents the accretion of fair value, of $3.1 million and $2.1 million for the three months ended June 30, 2016 and 2015, respectively, and $7.0 million and $4.7 million for the six months ended June 30, 2016 and 2015, respectively. |
Servicing Rights
Servicing Rights Carried at Amortized Cost
The following table summarizes the activity in the carrying value of servicing rights carried at amortized cost by class (in thousands):
For the Six Months Ended June 30, 2016 | For the Six Months Ended June 30, 2015 | |||||||||||||||
Mortgage Loan | Reverse Loan | Mortgage Loan | Reverse Loan | |||||||||||||
Balance at beginning of the period | $ | 99,302 | $ | 7,258 | $ | 121,364 | $ | 9,311 | ||||||||
Servicing rights capitalized upon deconsolidation of Residual Trusts | — | — | 3,133 | — | ||||||||||||
Sales | (103 | ) | — | — | — | |||||||||||
Amortization of servicing rights (1) | (10,626 | ) | (906 | ) | (12,901 | ) | (1,077 | ) | ||||||||
Balance at end of the period | $ | 88,573 | $ | 6,352 | $ | 111,596 | $ | 8,234 |
__________
(1) | Includes amortization of servicing rights for the mortgage loan class and the reverse loan class of $5.2 million and $0.4 million, respectively, for the three months ended June 30, 2016 and $6.4 million and $0.5 million, respectively, for the three months ended June 30, 2015. |
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Servicing rights accounted for at amortized cost are evaluated for impairment by strata based on their estimated fair values. The risk characteristics used to stratify servicing rights for purposes of measuring impairment are the type of loan products, which consist of manufactured housing loans, first lien residential mortgages and second lien residential mortgages for the mortgage loan class, and reverse mortgages for the reverse loan class. At June 30, 2016, the fair value of servicing rights for the mortgage loan class and the reverse loan class was $107.0 million and $8.8 million, respectively. At December 31, 2015, the fair value of servicing rights for the mortgage loan class and the reverse loan class was $117.3 million and $11.1 million, respectively. Fair value was estimated using the present value of projected cash flows over the estimated period of net servicing income.
The estimation of fair value requires significant judgment and uses key economic inputs and assumptions, which are provided in the table below:
June 30, 2016 | ||||||
Mortgage Loan | Reverse Loan | |||||
Weighted-average remaining life in years (1) | 5.6 | 2.9 | ||||
Weighted-average discount rate | 12.05 | % | 15.00 | % | ||
Conditional prepayment rate (2) | 6.79 | % | N/A | |||
Conditional default rate (2) | 2.18 | % | N/A | |||
Conditional repayment rate (3) | N/A | 29.13 | % |
__________
(1) | Represents the remaining weighted-average life of the related unpaid principal balance of the underlying collateral adjusted for assumptions for conditional repayment rate, conditional prepayment rate and conditional default rate, as applicable. |
(2) | Voluntary and involuntary prepayment rates have been presented as conditional prepayment rate and conditional default rate, respectively. |
(3) | Conditional repayment rate includes assumptions for both voluntary and involuntary rates as well as assumptions for the assignment of HECMs to HUD, in accordance with obligations as servicer. |
The valuation of servicing rights is affected by the underlying assumptions above. Should the actual performance and timing differ materially from the Company’s projected assumptions, the estimate of fair value of the servicing rights could be materially different.
Servicing Rights Carried at Fair Value
The following table summarizes the activity in servicing rights carried at fair value (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Balance at beginning of the period (1) | $ | 1,427,331 | $ | 1,570,320 | $ | 1,682,016 | $ | 1,599,541 | ||||||||
Purchases | 2,202 | 139,449 | 21,839 | 167,162 | ||||||||||||
Servicing rights capitalized upon sales of loans | 46,279 | 86,811 | 98,537 | 159,112 | ||||||||||||
Sales | (28,235 | ) | — | (28,235 | ) | — | ||||||||||
Other | (4,733 | ) | — | (4,733 | ) | — | ||||||||||
Change in fair value due to: | ||||||||||||||||
Changes in valuation inputs or other assumptions (2) | (127,713 | ) | 59,286 | (386,173 | ) | (15,248 | ) | |||||||||
Other changes in fair value (3) | (59,780 | ) | (58,145 | ) | (127,900 | ) | (112,846 | ) | ||||||||
Total change in fair value | (187,493 | ) | 1,141 | (514,073 | ) | (128,094 | ) | |||||||||
Balance at end of the period (1) | $ | 1,255,351 | $ | 1,797,721 | $ | 1,255,351 | $ | 1,797,721 |
__________
(1) | Includes servicing rights that were sold to WCO and accounted for as a financing of $35.6 million and $16.9 million at June 30, 2016 and December 31, 2015, respectively. |
(2) | Represents the change in fair value resulting primarily from market-driven changes in interest rates and prepayment speeds. |
(3) | Represents the realization of expected cash flows over time. |
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The fair value of servicing rights accounted for at fair value was estimated using the present value of projected cash flows over the estimated period of net servicing income. The estimation of fair value requires significant judgment and uses key economic inputs and assumptions which are described at Note 6. Should the actual performance and timing differ materially from the Company's projected assumptions, the estimate of fair value of the servicing rights could be materially different.
The following table summarizes the hypothetical effect on the fair value of servicing rights carried at fair value using adverse changes of 10% and 20% to the weighted average of the significant assumptions used in valuing these assets (dollars in thousands):
June 30, 2016 | December 31, 2015 | |||||||||||||||||||||
Decline in fair value due to | Decline in fair value due to | |||||||||||||||||||||
Assumption | 10% adverse change | 20% adverse change | Assumption | 10% adverse change | 20% adverse change | |||||||||||||||||
Weighted-average discount rate | 10.58 | % | $ | (45,191 | ) | $ | (87,250 | ) | 10.88 | % | $ | (68,874 | ) | $ | (132,645 | ) | ||||||
Weighted-average conditional prepayment rate | 13.39 | % | (67,232 | ) | (128,344 | ) | 9.94 | % | (63,884 | ) | (123,173 | ) | ||||||||||
Weighted-average conditional default rate | 0.99 | % | (23,396 | ) | (47,716 | ) | 1.06 | % | (21,208 | ) | (43,576 | ) |
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation in a particular assumption on the fair value of the servicing rights is calculated without changing any other assumptions, while in reality changes in one factor may result in changes in another, which may either magnify or counteract the effect of the change.
Fair Value of Originated Servicing Rights
For mortgage loans sold with servicing retained, the Company used the following inputs and assumptions to determine the fair value of servicing rights at the dates of sale. These servicing rights are included in servicing rights capitalized upon sales of loans in the table presented above that summarizes the activity in servicing rights accounted for at fair value.
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||
2016 | 2015 | 2016 | 2015 | |||||
Weighted-average life in years | 6.2 | 6.5 | 6.2 | 6.6 | ||||
Weighted-average discount rate | 12.20% | 12.02% | 12.72% | 10.90% | ||||
Weighted-average conditional prepayment rate | 9.11% | 7.68% | 9.41% | 7.80% | ||||
Weighted-average conditional default rate | 0.46% | 0.24% | 0.38% | 0.46% |
9. Goodwill
The table below sets forth the activity in goodwill by reportable segment (in thousands):
Reportable Segment | ||||||||||||
Servicing (2) | Originations | Total | ||||||||||
Balance at January 1, 2016 (1) | $ | 320,164 | $ | 47,747 | $ | 367,911 | ||||||
Acquisition of RCS net assets | 3,784 | — | 3,784 | |||||||||
Impairment | (215,412 | ) | — | (215,412 | ) | |||||||
Balance at June 30, 2016 (1) | $ | 108,536 | $ | 47,747 | $ | 156,283 |
__________
(1) | The goodwill included in the Reverse Mortgage segment became fully impaired as of the second quarter of 2015. There were accumulated impairment losses of $138.8 million relating to the Reverse Mortgage segment at both June 30, 2016 and December 31, 2015. In addition, there were accumulated impairment losses included in goodwill relating to the Servicing segment of $366.4 million and $151.0 million at June 30, 2016 and December 31, 2015, respectively. |
(2) | The Servicing, Insurance and ARM reporting units are components of the Servicing segment. |
39
During the first six months of 2016, operating results for the Servicing reporting unit were below expectations, primarily driven by delays in transitioning the business model as described further below, as well as external pressures that the sector continues to experience, including regulatory scrutiny and market volatility due to the declining interest rate environment. During this same period, the ARM reporting unit has been unsuccessful in developing new business opportunities. Additionally, the Company's share price has continued to experience downward pressures during 2016. As a result, the Company's market capitalization was reassessed, including the potential impact that the decline in market capitalization could have on the carrying value of goodwill. Management concluded that the aforementioned circumstances indicated that it is more likely than not that the fair value of these reporting units may be below their respective carrying amounts, and accordingly, that Step 1 testing should be completed for both the Servicing and ARM reporting units. The Step 1 test indicated that both the Servicing and ARM reporting units had carrying values that exceeded the respective estimated fair values and therefore, the second step of the impairment evaluation was required to be completed to measure the amount of impairment to be recorded, if any. Based on the Step 2 analysis, the carrying amount of the Servicing reporting unit’s goodwill exceeded its implied fair value by $194.1 million, for which a goodwill impairment charge was recorded in the second quarter of 2016. This impairment was primarily the result of an increased company-specific risk premium added to the discount rate that was applied to lower re-forecasted cash flows. The decline in cash flows was driven by continued challenges associated with certain company-specific matters, including delays in transitioning the Servicing business to a more fee-for-service and capital-light business model, and other market developments that have also contributed to the decline in the Company's stock price. Additionally, based on the Step 2 analysis, the carrying amount of the ARM reporting unit’s goodwill exceeded its implied fair value by $21.3 million, for which a goodwill impairment charge was recorded in the second quarter of 2016. This impairment was primarily the result of lower cash flows due to the inability of this reporting unit to develop new business opportunities. At June 30, 2016, the Servicing, Originations, ARM and Insurance reporting units had goodwill of $91.0 million, $47.7 million, $13.1 million and $4.4 million, respectively.
The Company is likely to continue to be impacted in the near term by certain company-specific matters, overall market performance within the sector, and a continued level of regulatory scrutiny. As a result, market capitalization, overall economic and sector conditions and other events or circumstances, including the ability to execute on strategic objectives, amongst other factors, will continue to be regularly monitored by management. Unanticipated outcomes in these areas may result in an impairment of goodwill in the future.
10. Payables and Accrued Liabilities (As Restated)
Payables and accrued liabilities consist of the following (in thousands):
June 30, 2016 | December 31, 2015 | |||||||
Accounts payable and accrued liabilities | $ | 153,972 | $ | 113,325 | ||||
Curtailment liability | 116,890 | 115,453 | ||||||
Employee-related liabilities | 67,124 | 95,926 | ||||||
Loans subject to repurchase from Ginnie Mae | 62,849 | 22,507 | ||||||
Originations liability | 46,003 | 48,930 | ||||||
Payables to insurance carriers (1) | 3,667 | 21,356 | ||||||
Derivative instruments | 36,408 | 6,475 | ||||||
Servicing rights and related advance purchases payable | 31,995 | 21,649 | ||||||
Uncertain tax positions (2) | 11,253 | 64,554 | ||||||
Accrued interest payable | 9,952 | 9,819 | ||||||
Acquisition related escrow funds payable to sellers | 1,236 | 10,236 | ||||||
Margin payable on derivative instruments | — | 10,101 | ||||||
Other | 56,515 | 57,595 | ||||||
Total payables and accrued liabilities | $ | 597,864 | $ | 597,926 |
__________
(1) | The balances were reduced by $33.9 million and $42.1 million at June 30, 2016 and December 31, 2015, respectively, to correct an immaterial error as discussed in further detail in Note 2. |
(2) | During the year ended December 31, 2015, the Company determined that a tax accounting method as employed was not more likely than not to be realized, and therefore derecognized the tax position with an offsetting deferred tax asset recorded related to servicing rights. The Company filed for an accounting method change with the IRS during the first quarter of 2016 and, as a result, this uncertain tax position was reversed. |
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Costs Associated with Exit Activities
During 2015, the Company took distinct actions to improve efficiencies within the organization, which included re-branding its mortgage business by consolidating Ditech Mortgage Corp and Green Tree Servicing into one legal entity with one brand, Ditech, a Walter Company. Additionally, the Company took measures to restructure its mortgage loan servicing operations and improve the profitability of the reverse mortgage business by streamlining its geographic footprint and strengthening its retail originations channel. These actions resulted in costs relating to the closing of offices and the termination of certain employees as well as other expenses to institute efficiencies. The Company completed these activities in the fourth quarter of 2015.
In the fourth quarter of 2015, the Company made a decision to exit the consumer retail channel of the Originations segment beginning in January 2016. As a result of this decision, the Company incurred $1.2 million in costs during the fourth quarter of 2015 and $2.0 million in costs during the six months ended June 30, 2016. The Company completed these activities in the second quarter of 2016. The actions to improve efficiencies, re-brand the originations business, restructure the servicing operations and exit from the consumer retail channel are collectively referred to as the 2015 Actions herein.
In addition, during the first and second quarters of 2016, the Company initiated actions in connection with its continued efforts to enhance efficiencies and streamline processes which included various organizational changes to scale the Company's leadership team and support functions to further align with the Company's business needs. These actions resulted in costs relating to the termination of certain employees. As of June 30, 2016, the Company expects to incur additional costs relating to these actions of approximately $1.9 million during the second half of 2016. However, the Company will continue to evaluate other opportunities for further cost reductions which may result in future costs associated with exit activities being incurred. These actions are collectively referred to as the 2016 Actions herein.
The costs resulting from the 2015 Actions and the 2016 Actions are recorded in salaries and benefits and general and administrative expenses on the Company's consolidated statements of comprehensive loss.
The following table presents the current period activity in the accrued restructuring liability resulting from each of the 2015 Actions and 2016 Actions described above, which is included in payables and accrued liabilities on the consolidated balance sheets, and the related charges and cash payments and other settlements associated with these actions (in thousands):
For the Six Months Ended June 30, 2016 | ||||||||||||
2015 Actions | 2016 Actions | Total | ||||||||||
Balance at January 1, 2016 | $ | 4,183 | $ | — | $ | 4,183 | ||||||
Charges | ||||||||||||
Severance and related costs | 1,311 | 6,615 | 7,926 | |||||||||
Office closures and other costs | 814 | — | 814 | |||||||||
Total charges | 2,125 | 6,615 | 8,740 | |||||||||
Cash payments or other settlements | ||||||||||||
Severance and related costs | (3,205 | ) | (2,217 | ) | (5,422 | ) | ||||||
Office closures and other costs | (1,522 | ) | — | (1,522 | ) | |||||||
Total cash payments or other settlements | (4,727 | ) | (2,217 | ) | (6,944 | ) | ||||||
Balance at June 30, 2016 | $ | 1,581 | $ | 4,398 | $ | 5,979 | ||||||
Cumulative charges incurred | ||||||||||||
Severance and related costs | $ | 7,317 | $ | 6,615 | $ | 13,932 | ||||||
Office closures and other costs | 6,369 | — | 6,369 | |||||||||
Total cumulative charges incurred | $ | 13,686 | $ | 6,615 | $ | 20,301 | ||||||
Total expected costs to be incurred | $ | 13,686 | $ | 8,481 | $ | 22,167 |
41
The following table presents the current period activity for each of the 2015 Actions and 2016 Actions described above by reportable segment (in thousands):
For the Six Months Ended June 30, 2016 | ||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Total Consolidated | ||||||||||||||||
Balance at January 1, 2016 | ||||||||||||||||||||
2015 Actions | $ | 1,174 | $ | 1,663 | $ | 1,346 | $ | — | $ | 4,183 | ||||||||||
2016 Actions | — | — | — | — | — | |||||||||||||||
Total balance at January 1, 2016 | 1,174 | 1,663 | 1,346 | — | 4,183 | |||||||||||||||
Charges | ||||||||||||||||||||
2015 Actions | 23 | 2,065 | 37 | — | 2,125 | |||||||||||||||
2016 Actions | 5,984 | 34 | 370 | 227 | 6,615 | |||||||||||||||
Total charges | 6,007 | 2,099 | 407 | 227 | 8,740 | |||||||||||||||
Cash payments or other settlements | ||||||||||||||||||||
2015 Actions | (567 | ) | (2,970 | ) | (1,190 | ) | — | (4,727 | ) | |||||||||||
2016 Actions | (1,710 | ) | — | (280 | ) | (227 | ) | (2,217 | ) | |||||||||||
Total cash payments or other settlements | (2,277 | ) | (2,970 | ) | (1,470 | ) | (227 | ) | (6,944 | ) | ||||||||||
Balance at June 30, 2016 | ||||||||||||||||||||
2015 Actions | 630 | 758 | 193 | — | 1,581 | |||||||||||||||
2016 Actions | 4,274 | 34 | 90 | — | 4,398 | |||||||||||||||
Total balance at June 30, 2016 | $ | 4,904 | $ | 792 | $ | 283 | $ | — | $ | 5,979 | ||||||||||
Total cumulative charges incurred | ||||||||||||||||||||
2015 Actions | $ | 6,485 | $ | 4,673 | $ | 1,677 | $ | 851 | $ | 13,686 | ||||||||||
2016 Actions | 5,984 | 34 | 370 | 227 | 6,615 | |||||||||||||||
Total cumulative charges incurred | $ | 12,469 | $ | 4,707 | $ | 2,047 | $ | 1,078 | $ | 20,301 | ||||||||||
Total expected costs to be incurred | ||||||||||||||||||||
2015 Actions | $ | 6,485 | $ | 4,673 | $ | 1,677 | $ | 851 | $ | 13,686 | ||||||||||
2016 Actions | 7,850 | 34 | 370 | 227 | 8,481 | |||||||||||||||
Total expected costs to be incurred | $ | 14,335 | $ | 4,707 | $ | 2,047 | $ | 1,078 | $ | 22,167 |
11. Warehouse Borrowings (As Restated)
The Company's subsidiaries enter into master repurchase agreements with lenders providing warehouse facilities. The warehouse facilities are used to fund the origination and purchase of residential loans, as well as the repurchase of certain HECMs and real estate owned from Ginnie Mae securitization pools. The facilities had an aggregate funding capacity of $2.5 billion at June 30, 2016 and are secured by certain residential loans and real estate owned. At June 30, 2016, the interest rates on the facilities are primarily based on LIBOR plus between 2.10% and 3.13%, and have various expiration dates through June 2017. At June 30, 2016, $1.2 billion of the outstanding borrowings were secured by $1.3 billion in originated and purchased residential loans and $188.8 million of outstanding borrowings were secured by $220.0 million in repurchased HECMs and real estate owned.
42
Borrowings utilized to fund the origination and purchase of residential loans are due upon the earlier of sale or securitization of the loan or within 60 to 90 days of borrowing. On average, the Company sells or securitizes these loans within 20 days of borrowing. Borrowings utilized to repurchase HECMs and real estate owned are due upon the earlier of receipt of claim proceeds from HUD or receipt of proceeds from liquidation of the related real estate owned. In any event, borrowings associated with repurchased HECMs are due within 364 days of borrowing while borrowings relating to repurchased real estate owned are due, depending on the agreement, within 180 days or 364 days. In accordance with the terms of the agreements, the Company may be required to post cash collateral should the fair value of the pledged assets decrease below certain contractual thresholds. The Company is exposed to counterparty credit risk associated with the repurchase agreements in the event of non-performance by the counterparties. The amount at risk during the term of the repurchase agreement is equal to the difference between the amount borrowed by the Company and the fair value of the pledged assets. The Company mitigates this risk through counterparty monitoring procedures, including monitoring of the counterparties' credit ratings and review of their financial statements.
All of the Company’s master repurchase agreements contain customary events of default and covenants, the most significant of which are financial covenants. Financial covenants most sensitive to the Company’s operating results and financial position are minimum tangible net worth requirements, indebtedness to tangible net worth ratio requirements, and minimum liquidity and profitability requirements. Ditech Financial was in compliance with all financial covenants relating to master repurchase agreements at June 30, 2016.
Subsequent to the Original Filing, Ditech Financial received waivers and/or amendments required as a result of the restatement and conclusions reached regarding the Company's ability to continue as a going concern, as described in Notes 2 and 3. The Ditech Financial master repurchase agreements that contain profitability covenants were also amended to allow for a net loss under such covenants for the quarters ending September 30, 2017 and December 31, 2017 as applicable to the terms of each respective agreement.
For the quarter ended March 31, 2016, one of RMS’s master repurchase agreements was amended to allow for a lower adjusted EBITDA (as determined pursuant to this agreement) for each of the first quarter and second quarter of 2016 under such agreement’s profitability covenant. Without this amendment, RMS would have been required to have a higher adjusted EBITDA as defined in the agreement for the quarter ended June 30, 2016 under this covenant and, therefore, would not have been in compliance with such covenant for the current quarter. In August 2016, an additional amendment was executed to allow for a lower adjusted EBITDA for each of the third quarter and fourth quarter of 2016 under such agreement's profitability covenant.
Subsequent to the Original Filing, RMS received waivers and/or amendments on its master repurchase agreements required as a result of the restatement and conclusions reached regarding the Company's ability to continue as a going concern, as described in Notes 2 and 3.
12. Share-Based Compensation
On June 9, 2016, the 2011 Plan was amended and restated to increase the authorized shares thereunder by 2,000,000 shares, resulting in a total of 10,815,000 shares of common stock authorized for issuance under the amended and restated 2011 Plan.
During the three and six months ended June 30, 2016, the Company granted 953,084 RSUs and 208,074 options.
The RSUs granted include immediately vesting RSUs granted to the Company's non-employee directors and former Chief Executive Officer, detailed further below, and 500,000 RSUs granted to the Company's Interim Chief Executive Officer, George M. Awad, that vest ratably in annual installments over three years based upon a service condition. The weighted-average grant date fair value of $3.26 for these awards was based on the average of the high and low market prices of the Company's stock on their respective dates of grant.
The options granted cliff vest in three years based upon a service condition and have a five year contractual term. The fair value of the stock options of $1.59 was based on the estimate of fair value on the date of the grant using the Black-Scholes option pricing model and related assumptions.
The Company's share-based compensation expense has been reflected in salaries and benefits expense in the consolidated statements of comprehensive loss.
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On June 8, 2016, the Company and Denmar J. Dixon, the Company’s former Chief Executive Officer, President and former director and Vice Chairman of the Board of Directors, entered into a separation agreement effective June 30, 2016, pursuant to which all RSUs, performance shares and stock options previously awarded to Mr. Dixon will remain outstanding and continue to vest as though Mr. Dixon remained employed by the Company through each applicable vesting date. In addition, Mr. Dixon received 125,000 RSUs that immediately vested on June 30, 2016. The weighted-average grant date fair value of $2.85 for these RSUs was based upon the average of the high and low market prices of the Company's stock on their date of grant. The retention of the performance shares was considered a Type III modification for share-based compensation, and, as a result, the Company reversed all expense previously recorded for these retained awards and recorded the new compensation expense over the new requisite service period. The total incremental compensation benefit resulting from these modifications was $1.0 million.
13. Common Stock and Loss Per Share (As Restated)
Rights Agreement
On June 29, 2015, the Company and Computershare, as Rights Agent, entered into a Rights Agreement. Also on June 29, 2015, the Board of Directors of the Company authorized and the Company declared a dividend of one preferred stock purchase right for each outstanding share of common stock of the Company. The dividend was payable on July 9, 2015 to stockholders of record as of the close of business on July 9, 2015 and entitles the registered holder to purchase from the Company one one-thousandth of a fully paid non-assessable share of Junior Participating Preferred Stock, par value $0.01 per share, of the Company at a price of $74.16 subject to adjustment as provided in the Rights Agreement. The terms of the preferred stock purchase rights are set forth in the Rights Agreement, which is summarized in the Company's Current Report on Form 8-K dated June 29, 2015. Subject to certain limited exceptions specified in the Rights Agreement (including the amendments described below), the rights are not exercisable until a person or group of persons acting in concert acquires beneficial ownership, as defined in the Rights Agreement, of more than 20% of the Company's outstanding shares of common stock. One such exception is that a person or group that already owned 20% or more of the Company's outstanding shares of common stock before the first public announcement of the rights plan may continue to own those shares without causing the rights to become exercisable.
Amendment No. 1 to the Rights Agreement
On November 16, 2015, the Company and Computershare entered into Amendment No. 1 to the Rights Agreement. Upon the terms and subject to the conditions set forth in the Rights Agreement and this Amendment, (i) Birch Run and its affiliates and associates may acquire up to 25% of the total voting power of all shares of the Company’s common stock without triggering the exercisability of the preferred share purchase rights attached to shares of the Company’s common stock pursuant to the Rights Agreement, and (ii) shares of the Company’s common stock received by directors as compensation for their services, pursuant to any director compensation program of the Company, will also not trigger the exercisability of such rights.
Amendment No. 2 to the Rights Agreement
On November 22, 2015, the Company and Computershare entered into Amendment No. 2 to the Rights Agreement. Upon the terms and subject to the conditions set forth in the Rights Agreement and this Amendment, Baker Street may acquire up to 25% of the total voting power of all shares of the Company’s common stock without triggering the exercisability of the preferred share purchase rights attached to shares of the Company’s common stock pursuant to the Rights Agreement.
Amendment No. 3 to the Rights Agreement
On June 28, 2016, the Company and Computershare entered into Amendment No. 3 to the Rights Agreement to extend the expiration date of the Rights Agreement by one year, from June 29, 2016 to June 29, 2017.
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Loss Per Share
The following is a reconciliation of the numerators and denominators of the basic and diluted loss per share computation shown on the consolidated statements of comprehensive loss (in thousands, except per share data):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
Basic and diluted loss per share | ||||||||||||||||
Net loss available to common stockholders (numerator) | $ | (489,963 | ) | $ | (38,119 | ) | $ | (662,665 | ) | $ | (69,127 | ) | ||||
Weighted-average common shares outstanding (denominator) | 35,811 | 37,759 | 35,679 | 37,739 | ||||||||||||
Basic and diluted loss per common and common equivalent share | $ | (13.68 | ) | $ | (1.01 | ) | $ | (18.57 | ) | $ | (1.83 | ) |
A portion of the Company’s unvested RSUs during the six months ended June 30, 2015 were participating securities. During periods of net income, the calculation of earnings per share for common stock is adjusted to exclude the income attributable to the participating securities from the numerator and exclude the dilutive impact of those shares from the denominator. During periods of net loss, as was the case for the period above, no effect is given to the participating securities because they do not share in the losses of the Company.
The following table summarizes anti-dilutive securities excluded from the computation of dilutive loss per share (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||
Outstanding share-based compensation awards | ||||||||||||
Stock options | 3,018 | 3,061 | 2,942 | 3,061 | ||||||||
Performance shares (1) | — | 688 | — | 688 | ||||||||
Restricted stock units | 461 | 769 | 461 | 769 | ||||||||
Assumed conversion of Convertible Notes | 4,932 | 4,932 | 4,932 | 4,932 |
__________
(1) | Performance shares represent the number of shares expected to be issued based on the performance percentage as of the end of the reporting periods above. |
The Convertible Notes are antidilutive when calculating earnings (loss) per share when the Company's average stock price is less than $58.80. Upon conversion of the Convertible Notes, the Company may pay or deliver, at its option, cash, shares of the Company’s common stock, or a combination of cash and shares of common stock. It is the Company’s intent to settle all conversions through combination settlement, which involves repayment of an amount of cash equal to the principal amount and any excess of conversion value over the principal amount in shares of common stock.
14. Segment Reporting (As Restated)
Management has organized the Company into three reportable segments based primarily on its services as follows:
• | Servicing — consists of operations that perform servicing for third-party credit owners of mortgage loans for a fee and the Company’s own mortgage loan portfolio. The Servicing segment also operates complementary businesses consisting of an insurance agency serving residential loan borrowers and credit owners and a collections agency which performs collections of post charge-off deficiency balances for third parties and the Company. In addition, the Servicing segment holds the assets and mortgage-backed debt of the Residual Trusts. |
• | Originations — consists of operations that originate and purchase mortgage loans that are intended for sale to third parties. |
• | Reverse Mortgage — consists of operations that purchase and originate HECMs that are securitized, but remain on the consolidated balance sheet as collateral for secured borrowings. This segment performs servicing for third-party credit owners and the Company and provides other complementary services for the reverse mortgage market, such as real estate owned property management and disposition. |
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The following tables present select financial information of reportable segments (in thousands). The Company has presented the revenue and expenses of the Non-Residual Trusts and other non-reportable operating segments, as well as certain corporate expenses that have not been allocated to the business segments, in Other. Intersegment servicing revenues and expenses have been eliminated. Intersegment revenues are recognized on the same basis of accounting as such revenue is recognized on the consolidated statements of comprehensive loss.
For the Three Months Ended June 30, 2016 | ||||||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Eliminations | Total Consolidated | |||||||||||||||||||
Total revenues (1) (2) (3) | $ | 72,813 | $ | 110,209 | $ | 16,137 | $ | 45 | $ | (11,731 | ) | $ | 187,473 | |||||||||||
Income (loss) before income taxes | (356,026 | ) | 45,615 | (26,944 | ) | (42,229 | ) | — | (379,584 | ) |
For the Three Months Ended June 30, 2015 | ||||||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Eliminations | Total Consolidated | |||||||||||||||||||
Total revenues (1) (2) | $ | 274,196 | $ | 128,702 | $ | 20,172 | $ | 854 | $ | (11,491 | ) | $ | 412,433 | |||||||||||
Income (loss) before income taxes | 82,296 | 32,965 | (90,960 | ) | (39,300 | ) | — | (14,999 | ) |
__________
(1) | With the exception of $3.1 million and $2.4 million for the three months ended June 30, 2016 and 2015, respectively, associated with intercompany activity with the Originations segment and the Other non-reportable segment, all net servicing revenue and fees of the Servicing segment were derived from external customers, including WCO. Included in these revenues for the three months ended June 30, 2016, are late fees of $1.0 million recorded by the Servicing segment which were waived as an incentive for borrowers refinancing their loans. These fees reduced the gain on sale of loans recognized by the Originations segment. All net servicing revenue and fees of the Company's Reverse Mortgage segment were derived from external customers. |
(2) | The Company's Servicing segment includes other revenues of $9.5 million and $8.5 million for the three months ended June 30, 2016 and 2015, respectively, associated with fees earned for certain loan originations completed by the Originations segment from leads generated through the Servicing segment's servicing portfolio. Beginning in the first quarter of 2016, the Servicing segment increased the fee per origination charged to the Originations segment to reflect current market pricing. As a result of the change in fee, these intersegment revenues increased by $2.8 million. |
(3) | The Company’s Originations segment includes other revenues of $0.2 million for the three months ended June 30, 2016 associated with fees earned for supporting the Servicing segment in administrative functions relating to the acquisition of certain servicing rights. |
For the Six Months Ended June 30, 2016 | ||||||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Eliminations | Total Consolidated | |||||||||||||||||||
Total revenues (1) (2) (3) | $ | 9,558 | $ | 210,486 | $ | 60,232 | $ | 75 | $ | (26,107 | ) | $ | 254,244 | |||||||||||
Income (loss) before income taxes | (612,347 | ) | 62,016 | (21,917 | ) | (86,227 | ) | — | (658,475 | ) |
For the Six Months Ended June 30, 2015 | ||||||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Eliminations | Total Consolidated | |||||||||||||||||||
Total revenues (1) (2) | $ | 417,959 | $ | 259,002 | $ | 64,099 | $ | 4,147 | $ | (21,917 | ) | $ | 723,290 | |||||||||||
Income (loss) before income taxes | 31,624 | 74,763 | (104,417 | ) | (66,647 | ) | — | (64,677 | ) |
__________
(1) | With the exception of $6.2 million and $4.8 million for the six months ended June 30, 2016 and 2015, respectively, associated with intercompany activity with the Originations segment and the Other non-reportable segment, all net servicing revenue and fees of the Servicing segment were derived from external customers, including WCO. Included in these revenues for the six months ended June 30, 2016, are late fees of $2.0 million recorded by the Servicing segment which were waived as an incentive for borrowers refinancing their loans. These fees reduced the gain on sale of loans recognized by the Originations segment. All net servicing revenue and fees of the Company's Reverse Mortgage segment were derived from external customers. |
(2) | The Company's Servicing segment includes other revenues of $21.0 million and $16.5 million for the six months ended June 30, 2016 and 2015, respectively, associated with fees earned for certain loan originations completed by the Originations segment from leads generated through the Servicing segment's servicing portfolio. Beginning in the first quarter of 2016, the Servicing segment increased the fee per origination charged to the Originations segment to reflect current market pricing. As a result of the change in fee, these intersegment revenues increased by $6.3 million. |
(3) | The Company’s Originations segment includes other revenues of $0.9 million for the six months ended June 30, 2016 associated with fees earned for supporting the Servicing segment in administrative functions relating to the acquisition of certain servicing rights. |
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Total Assets Per Segment (As Restated) | ||||||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Eliminations | Total Consolidated | |||||||||||||||||||
June 30, 2016 | $ | 3,925,075 | $ | 1,555,120 | $ | 11,216,386 | $ | 1,241,550 | $ | (639,825 | ) | $ | 17,298,306 | |||||||||||
December 31, 2015 | 5,244,070 | 1,570,258 | 11,127,641 | 1,318,840 | (711,362 | ) | 18,549,447 |
15. Commitments and Contingencies
Letter of Credit Reimbursement Obligation
As part of an agreement to service the loans in seven securitization trusts, the Company has an obligation to reimburse a third party for the final $165.0 million drawn under LOCs issued by such third party as credit enhancements to such trusts. The total amount available on these LOCs for these trusts was $257.3 million at June 30, 2016. The securitization trusts will draw on these LOCs if there are insufficient cash flows from the underlying collateral to pay the bondholders of the securitization trusts. Based on the Company’s estimates of the underlying performance of the collateral in the securitization trusts, the Company does not expect that the final $165.0 million of capacity under the LOCs will be drawn and, therefore, no liability for the fair value of this obligation has been recorded on the Company’s consolidated balance sheets, although actual performance may differ from this estimate in the future.
Mandatory Clean-Up Call Obligation
The Company is obligated to exercise the mandatory clean-up call obligations assumed as part of an agreement to acquire the rights to service the loans in the Non-Residual Trusts. The Company determined that it is the primary beneficiary of these securitization trusts and as a result, has consolidated these trusts. The Company is required to call these securitizations when each loan pool falls to 10% of the original principal amount and expects to begin to make such calls in 2017 and continuing through 2019. The total outstanding balance of the residential loans expected to be called at the respective call dates is $417.9 million. The Company estimates call obligations of $100.9 million, $254.0 million and $63.0 million during the years ending December 31, 2017, 2018 and 2019, respectively.
Unfunded Commitments
Reverse Mortgage Loans
At June 30, 2016, the Company had floating-rate reverse loans in which the borrowers have additional borrowing capacity of $1.3 billion and similar commitments on fixed-rate reverse loans of $0.7 million primarily in the form of undrawn lines-of-credit. The borrowing capacity includes $1.1 billion in capacity that was available to be drawn by borrowers at June 30, 2016 and $190.2 million in capacity that will become eligible to be drawn by borrowers through the period ending July 1, 2017 assuming the loans remain performing. In addition, the Company has other commitments of $14.0 million to fund taxes and insurance on borrowers’ properties to the extent of amounts that were set aside for such purpose upon the origination of the related reverse loan. There is no termination date for these drawings so long as the loan remains performing. The Company also had short-term commitments to lend $20.9 million and commitments to purchase and sell loans totaling $12.5 million and $50.9 million, respectively, at June 30, 2016, as well as other commitments to lend of $13.9 million.
Mortgage Loans
The Company had short-term commitments to lend $3.2 billion and commitments to purchase loans totaling $164.9 million at June 30, 2016. In addition, the Company had commitments to sell $4.4 billion and purchase $655.5 million in mortgage-backed securities at June 30, 2016.
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HMBS Issuer Obligations
As an HMBS issuer, the Company assumes certain obligations related to each security issued. The most significant obligation is the requirement to purchase loans out of the Ginnie Mae securitization pools once the outstanding principal balance of the related HECM is equal to or greater than 98% of the maximum claim amount. Performing repurchased loans are conveyed to HUD and payment is received from HUD typically within 30 days of repurchase. Non-performing repurchased loans are generally liquidated through foreclosure and subsequent sale of real estate owned. The Company relies upon certain master repurchase agreements and operating cash flows, to the extent necessary, to repurchase loans. The timing and amount of the Company's obligation to repurchase HECMs is uncertain as repurchase is predicated on certain factors such as whether or not a borrower event of default occurs prior to the HECM reaching the mandatory repurchase threshold under which the Company is obligated to repurchase the loan. During the six months ended June 30, 2016 and 2015, the Company repurchased $270.3 million and $127.9 million, respectively, in reverse loans and real estate owned from securitization pools. At June 30, 2016, the Company had $316.6 million in repurchased reverse loans and real estate owned. Repurchases of reverse loans and real estate owned have increased significantly as compared to prior periods and are expected to continue to increase due to the increased flow of defaulted HECMs and real estate owned that have moved through the buyout process.
Mortgage Origination Contingencies
The Company sells substantially all of its originated or purchased mortgage loans into the secondary market for securitization or to private investors as whole loans. The Company sells conventional-conforming and government-backed mortgage loans through GSE and agency-sponsored securitizations in which mortgage-backed securities are created and sold to third-party investors. The Company also sells non-conforming mortgage loans to private investors. In doing so, representations and warranties regarding certain attributes of the loans are made to the third-party investor. Subsequent to the sale, if it is determined that a loan sold is in breach of these representations or warranties, the Company generally has an obligation to cure the breach. In general, if the Company is unable to cure such breach, the purchaser of the loan may require the Company to repurchase such loan for the unpaid principal balance, accrued interest, and related advances, and in any event, the Company must indemnify such purchaser for certain losses and expenses incurred by such purchaser in connection with such breach. The Company’s credit loss may be reduced by any recourse it has to correspondent lenders that, in turn, have sold such residential loans to the Company and breached similar or other representations and warranties.
The Company's representations and warranties are generally not subject to stated limits of exposure with the exception of certain loans originated under HARP, which limits exposure based on payment history of the loan. At June 30, 2016, the Company’s maximum exposure to repurchases due to potential breaches of representations and warranties was $57.6 billion, and was based on the original unpaid principal balance of loans sold from the beginning of 2013 through June 30, 2016 adjusted for voluntary payments made by the borrower on loans for which the Company performs servicing. A majority of the Company's loan sales were servicing retained.
The Company’s obligations vary based upon the nature of the repurchase demand and the current status of the mortgage loan. During the three months ended June 30, 2016, the Company decreased the liability associated with representations and warranties exposure by $8.9 million, due to adjustments to certain assumptions based on recently observed trends as compared to historical expectations, primarily relating to loan defect rates and counterparty review probabilities, partially offset by certain qualitative considerations regarding long-term assumptions related to resales and recoveries. This adjustment is considered a change in estimate and has been applied prospectively. The Company’s estimate of the liability associated with representations and warranties exposure was $20.3 million at June 30, 2016 and is included in originations liability as part of payables and accrued liabilities on the consolidated balance sheets.
Servicing Contingencies
The Company’s servicing obligations are set forth in industry regulations established by HUD, the FHA, the VA, and other government agencies and in servicing and sub-servicing agreements with the applicable counterparties, such as Fannie Mae, Freddie Mac and other credit owners. Both the regulations and the servicing agreements provide that the servicer may be liable for failure to perform its servicing obligations and further provide remedies for certain servicer breaches.
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Reverse Mortgage Loans
FHA regulations provide that servicers meet a series of event-specific timeframes during the default, foreclosure, conveyance, and mortgage insurance claim cycles. Failure to timely meet any processing deadline may stop the accrual of debenture interest otherwise payable in satisfaction of a claim under the FHA mortgage insurance contract and the servicer may be responsible to HUD for debenture interest that is not self-curtailed by the servicer, or for making the credit owner whole for any interest curtailed by FHA due to not meeting the required event-specific timeframes. The Company had a curtailment obligation liability of $106.7 million at June 30, 2016 related to the foregoing which reflects management’s best estimate of the probable incurred claim. The curtailment liability is recorded in payables and accrued liabilities on the consolidated balance sheets. During the six months ended June 30, 2016, the Company recorded a provision, net of expected third party recoveries, related to the curtailment liability of $5.1 million. The Company has potential estimated maximum financial statement exposure for an additional $142.9 million related to similar claims, which are reasonably possible, but which the Company believes are the responsibility of third parties (e.g., prior servicers and/or credit owners).
Mortgage Loans
The Company had a curtailment obligation liability of $10.2 million at June 30, 2016 related to mortgage loan servicing that it primarily assumed through an acquisition of servicing rights. The Company is obligated to service the related mortgage loans in accordance with Ginnie Mae requirements, including repayment to credit owners for corporate advances and interest curtailment. The curtailment liability is recorded in payables and accrued liabilities on the consolidated balance sheets.
Litigation and Regulatory Matters
In the ordinary course of business, the Parent Company and its subsidiaries are defendants in, or parties to, pending and threatened legal actions and proceedings, including actions brought on behalf of various classes of claimants. Many of these actions and proceedings are based on alleged violations of consumer protection laws governing the Company's servicing and origination activities. In some of these actions and proceedings, claims for substantial monetary damages are asserted against the Company.
The Company, in the ordinary course of business, is also subject to regulatory and governmental examinations, information requests and subpoenas, inquiries, investigations and threatened legal actions and proceedings. In connection with formal and informal inquiries, the Company receives numerous requests, subpoenas and orders for documents, testimony and information in connection with various aspects of the Company’s activities.
In view of the inherent difficulty of predicting outcomes of such litigation, regulatory and governmental matters, particularly where the claimants seek very large or indeterminate restitution, penalties or damages, or where the matters present novel legal theories or involve a large number of parties, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each pending matter may be.
Reserves are established for pending or threatened litigation, regulatory and governmental matters when it is probable that a loss has been incurred and the amount of such loss can be reasonably estimated. In light of the inherent uncertainties involved in litigation and other legal proceedings, it is not always possible to determine a reasonable estimate of the amount of a probable loss, and the Company may estimate a range of possible loss for consideration in its estimated accruals. The estimates are based upon currently available information, including advice of counsel, and involve significant judgment taking into account the varying stages and inherent uncertainties of such matters. Accordingly, the Company’s estimates may change from time to time and such changes may be material to the consolidated financial results.
At June 30, 2016, the Company’s recorded reserves associated with legal and regulatory contingencies for which a loss is probable and can be reasonably estimated were approximately $52 million. In addition, the Company has recorded a receivable for a loss recovery where a recovery is deemed probable of $24 million due from insurers relating to the shareholder class action complaint detailed further below. There can be no assurance that the ultimate resolution of the Company’s pending or threatened litigation, claims or assessments will not result in losses in excess of the Company’s recorded reserves. As a result, the ultimate resolution of any particular legal matter, or matters, could be material to the Company’s results of operations or cash flows for the period in which such matter is resolved.
For matters involving a probable loss where the Company can estimate the range but not a specific loss amount, the aggregate estimated amount of reasonably possible losses in excess of the recorded liability was $0 to approximately $10 million at June 30, 2016. Given the inherent uncertainties and status of the Company’s outstanding legal and regulatory matters, the range of reasonably possible losses cannot be estimated for all matters; therefore, this estimated range does not represent the Company’s maximum loss exposure. As new information becomes available, the matters for which the Company is able to estimate, as well as the estimates themselves, will be adjusted accordingly.
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The following is a description of certain litigation and regulatory matters:
The Company has received various subpoenas for testimony and documents, motions for examinations pursuant to Federal Rule of Bankruptcy Procedure 2004, and other information requests from certain Offices of the United States Trustees, acting through trial counsel in various federal judicial districts, seeking information regarding an array of the Company’s policies, procedures and practices in servicing loans to borrowers who are in bankruptcy and the Company's compliance with bankruptcy laws and rules. The information has been provided in response to these subpoenas and requests and the Company's management have met with representatives of certain Offices of the United States Trustees to discuss various issues that have arisen in the course of these inquiries, including compliance with bankruptcy laws and rules. The outcome of the aforementioned proceedings and investigations cannot be predicted, which could result in requests for damages, fines, sanctions, or other remediation. The Company could face further legal proceedings in connection with these matters, and may seek to enter into one or more agreements to resolve these matters. Any such agreement may require the Company to pay fines or other amounts for alleged breaches of law and to change or otherwise remediate the Company's business practices.
On March 7, 2014, a putative shareholder class action complaint was filed in the United States District Court for the Southern District of Florida against the Company, Mark O’Brien, Charles Cauthen, Denmar Dixon, Marc Helm and Robert Yeary captioned Beck v. Walter Investment Management Corp., et al., No. 1:14-cv-20880 (S.D. Fla.). On July 7, 2014, an amended class action complaint was filed. The amended complaint named as defendants the Company, Mark O’Brien, Charles Cauthen, Denmar Dixon, Keith Anderson, Brian Corey and Mark Helm, and is captioned Thorpe, et al. v. Walter Investment Management Corp., et al. No. 1:14-cv-20880-UU. The amended complaint asserted federal securities law claims against the Company and the individual defendants under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. Additional claims are asserted against the individual defendants under Section 20(a) of the Exchange Act. On December 23, 2014, the court granted the defendants’ motions to dismiss and dismissed the amended complaint without prejudice. On January 6, 2015, plaintiffs filed a second amended complaint. The second amended complaint asserted the same legal claims and alleged that between May 9, 2012 and August 11, 2014 the Company and the individual defendants made material misstatements or omissions relating to the Company’s internal controls over financial reporting, the processes and procedures for compliance with applicable regulatory and legal requirements by Ditech Financial, the liabilities associated with the Company’s acquisition of RMS, and RMS's internal controls. The complaint sought class certification and an unspecified amount of damages on behalf of all persons who purchased the Company’s securities between May 9, 2012 and August 11, 2014. On January 23, 2015, all defendants moved to dismiss the second amended complaint. On June 30, 2015, the court issued a decision that granted the motions to dismiss in part and denied the motions in part. Among other things, the court dismissed the claims against Messrs. O’Brien, Cauthen, Dixon and Helm and the claims relating to statements about the Company’s acquisition of RMS. On July 10, 2015, plaintiffs filed a third amended complaint that, among other things, added certain allegations concerning the Company’s settlement with the FTC and CFPB. On July 24, 2015, the Company and Messrs. Anderson and Corey filed an answer to the third amended complaint, which denied the substantive allegations and asserted various defenses. On August 30, 2015, Plaintiffs filed a motion for class certification, which the court granted in substantial part on March 16, 2016. On April 15, 2016, the parties entered into an agreement to fully resolve all claims that were asserted or could have been asserted in the action for a total payment of $24 million, which is inclusive of plaintiffs’ attorneys’ fees and all other costs associated with the proposed settlement. The proposed settlement, which is subject to court approval, provides that defendants, including the Company, are not making any admission of liability or wrongdoing. On June 13, 2016, the court entered an order preliminarily approving the proposed settlement and directing that potential members of the class be notified of the proposed settlement. The court also scheduled a hearing for October 14, 2016 to decide whether to enter an order finally approving the proposed settlement. In accordance with the settlement agreement, certain insurers of the Company have paid the full amount of the proposed settlement into an escrow account. The Company cannot provide any assurance as to the outcome of the action or that such an outcome will not have a material adverse effect on its reputation, business, prospects, results of operations, liquidity or financial condition.
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Ditech Financial is subject to several putative class action lawsuits related to lender-placed insurance. These actions allege that Ditech Financial and its affiliates improperly received benefits from lender-placed insurance providers in the form of commissions for work not performed, services provided at a reduced cost, and expense reimbursements that did not reflect the actual cost of the services rendered. Plaintiffs in these suits assert various theories of recovery and seek remedies including compensatory, actual, punitive, statutory and treble damages, return of unjust benefits, and injunctive relief. One such matter is Circeo-Loudon v. Green Tree Servicing, LLC et al. filed in the United States District Court for the Southern District of Florida on April 17, 2014 and amended on October 16, 2014. A settlement agreement was reached between the parties in the Circeo-Loudon matter on September 11, 2015. This settlement received preliminary approval by the court on December 8, 2015 and a hearing for final approval originally scheduled for May 12, 2016 has been rescheduled for August 30, 2016. Pursuant to the settlement agreement, all of the defendants collectively, including Ditech Financial, are required to pay damages to class members who timely file a claim, administrative costs to effectuate the settlement and attorneys' fees and costs. The Company believes it has accrued the full amount expected to be paid under the settlement agreement in its consolidated financial statements as of June 30, 2016. The settlement agreement also provides that Ditech Financial and its subsidiary, Green Tree Insurance Agency, Inc., and their affiliates will be released from certain claims and may no longer receive commissions on the placement of certain lender-placed insurance for a period of five years commencing 120 days from the effective date of the settlement. The Company expects that this settlement, if approved by the court, will lead to the ultimate resolution of the other putative class action lawsuits related to lender-placed insurance to which Ditech Financial is currently subject, although the proposed settlement does not apply to potential claims by class members who opt out of the proposed settlement.
From time to time, federal and state authorities investigate or examine aspects of the Company's business activities, such as its mortgage origination, servicing, collection and bankruptcy practices, among other things. It is the Company's general policy to cooperate with such investigations, and the Company has been responding to information requests and otherwise cooperating with various ongoing investigations and examinations by such authorities. The Company cannot predict the outcome of any of the ongoing proceedings and cannot provide assurances that investigations and examinations will not have a material adverse effect on the Company.
Walter Energy Matters
The Company may become liable for U.S. federal income taxes allegedly owed by the Walter Energy consolidated group for the 2009 and prior tax years. Under federal law, each member of a consolidated group for U.S. federal income tax purposes is severally liable for the federal income tax liability of each other member of the consolidated group for any year in which it was a member of the consolidated group at any time during such year. Certain former subsidiaries of the Company (which were subsequently merged or otherwise consolidated with certain current subsidiaries of the Company) were part of the Walter Energy consolidated tax group prior to the Company's spin-off from Walter Energy on April 17, 2009. As a result, if the Walter Energy consolidated group’s federal income taxes (including penalties and interest) for such tax years are not discharged by Walter Energy or otherwise, the Company could be liable for such amounts.
Walter Energy Tax Matters. According to Walter Energy’s Form 10-Q, or the Walter Energy Form 10-Q, for the quarter ended September 30, 2015 (filed with the SEC on November 5, 2015) and certain other public filings made by Walter Energy in its bankruptcy proceedings currently pending in Alabama, described below, certain tax matters with respect to certain tax years prior to and including the year of the Company's spin-off from Walter Energy remain unresolved, including certain tax matters relating to: (i) a “proof of claim” for a substantial amount of taxes, interest and penalties with respect to Walter Energy’s fiscal years ended August 31, 1983 through May 31, 1994, which was filed by the IRS in connection with Walter Energy’s bankruptcy filing on December 27, 1989 in the United States Bankruptcy Court for the Middle District of Florida, Tampa Division; (ii) an IRS audit of Walter Energy’s federal income tax returns for the years ended May 31, 2000 through December 31, 2008; and (iii) an IRS audit of Walter Energy’s federal income tax returns for the 2009 through 2013 tax years. It is unclear how these tax matters will be impacted, if at all, by Walter Energy’s recent Chapter 11 bankruptcy filing in Alabama, which is discussed below.
Walter Energy 2015 Bankruptcy Filing. On July 15, 2015, Walter Energy filed for Chapter 11 bankruptcy in the United States Bankruptcy Court for the Northern District of Alabama and, in connection therewith, filed a motion to assume a pre-petition RSA between Walter Energy and certain holders of its funded indebtedness. Under the RSA, the parties thereto agreed to pursue confirmation of a plan of reorganization unless certain events occur, in which case Walter Energy will abandon the plan process and pursue a sale of its assets in accordance with Section 363 of the Bankruptcy Code. There was no indication in the RSA of the amount of anticipated tax claims. According to the Walter Energy Form 10-Q, Walter Energy intended to seek a comprehensive resolution of all outstanding federal tax issues including, to the extent possible, issues relating to the “proof of claim” described above, in connection with its recent Chapter 11 bankruptcy filing in Alabama.
51
On August 18, 2015, Walter Energy filed a motion with the Florida bankruptcy court requesting that the court transfer venue of its disputes with the IRS to the Alabama bankruptcy court. In that motion, Walter Energy asserted that it believed the liability for the years at issue "will be materially, if not completely, offset by the [r]efunds" asserted by Walter Energy against the IRS. The Florida bankruptcy court transferred venue of the matter to the Alabama bankruptcy court, where it remains pending.
In accordance with the RSA, on August 26, 2015, Walter Energy filed with the Alabama bankruptcy court a proposed plan of reorganization and accompanying disclosure statement. There was no indication in the plan or disclosure statement of the amount of anticipated tax claims. No such information was contained in Walter Energy's schedules of assets and liabilities and statement of financial affairs, filed with the Alabama bankruptcy court on August 28, 2015. As a result of certain disputes in the Alabama bankruptcy court, on September 28, 2015, the Alabama bankruptcy court entered an order confirming that the RSA had been terminated.
On November 5, 2015, Walter Energy together with certain of its subsidiaries, entered into the Walter Energy Asset Purchase Agreement with Coal Acquisition, a Delaware limited liability company formed by members of Walter Energy’s senior lender group, pursuant to which, among other things, Coal Acquisition agreed to acquire substantially all of Walter Energy’s assets and assume certain liabilities, subject to, among other things, a number of closing conditions set forth therein. On January 8, 2016, after conducting a hearing, the Bankruptcy Court entered an order approving the sale of Walter Energy's assets to Coal Acquisition free and clear of all liens, claims, interests and encumbrances of the Debtors. The sale of such assets pursuant to the Walter Energy Asset Purchase Agreement was completed on March 31, 2016 and was conducted under the provisions of Sections 105, 363 and 365 of the Bankruptcy Code.
The Company cannot predict whether or to what extent it may become liable for federal income taxes of the Walter Energy consolidated group, in part because it believes, based on publicly available information, that: (i) the amount of taxes owed by the Walter Energy consolidated group for the periods from 1983 through 2009 remains unresolved; (ii) in light of Walter Energy’s 2015 Chapter 11 bankruptcy filing, it is unclear (a) whether Walter Energy will be obligated or able to pay any or all of such amounts owed and (b) what portion of the IRS claims against the Walter Energy consolidated group for 2009 and prior tax years are attributable to tax, interest and/or penalties and what priority, if any, the IRS will receive in the Alabama bankruptcy proceedings with respect to its claims against Walter Energy; and (iii) it cannot predict whether, in the event Walter Energy does not discharge all tax obligations for the consolidated group, the IRS will seek to enforce tax claims against former members of the Walter Energy consolidated group. Further, because the Company cannot currently estimate its liability, if any, relating to the federal income tax liability of Walter Energy’s consolidated tax group during the tax years in which it was a part of such group, it cannot determine whether such liabilities, if any, could have a material adverse effect on its business, financial condition, liquidity and/or results of operations.
Tax Separation Agreement. In connection with the Company's spin-off from Walter Energy, the Company and Walter Energy entered into a Tax Separation Agreement, dated April 17, 2009. Notwithstanding any several liability the Company may have under federal tax law described above, under the Tax Separation Agreement, Walter Energy agreed to retain full liability for all U.S. federal income or state combined income taxes of the Walter Energy consolidated group for 2009 and prior tax years (including any interest, additional taxes or penalties applicable thereto), subject to limited exceptions. Accordingly, the Company filed "proofs of claim" in the Alabama bankruptcy proceedings asserting claims for any such amounts to the extent the Company is ultimately held liable for the same.
It is unclear whether claims made by the Company under the Tax Separation Agreement would be enforceable against Walter Energy in connection with, or following the conclusion of, the various Walter Energy bankruptcy proceedings described above or if such claims would be rejected or disallowed under bankruptcy law, and whether Walter Energy will have the ability to satisfy in part or in full the amount of any claims made by the Company under the Tax Separation Agreement or otherwise.
Furthermore, the Tax Separation Agreement provides that Walter Energy has, in its sole discretion, the exclusive right to represent the interests of the consolidated group in any audit, court proceeding or settlement of a claim with the IRS for the tax years in which certain of the Company’s former subsidiaries were a member of the Walter Energy consolidated group for U.S. federal income tax purposes. Moreover, the Tax Separation Agreement obligates the Company to take certain tax positions that are consistent with those taken historically by Walter Energy. In the event the Company does not take such positions, it could be liable to Walter Energy to the extent our failure to do so results in an increased tax liability or the reduction of any tax asset of Walter Energy. These arrangements may result in conflicts of interests between the Company and Walter Energy, particularly with regard to the Walter Energy bankruptcy proceedings described above.
Lastly, according to its public filings, Walter Energy’s 2009 tax year is currently under audit. Accordingly, if it is determined that certain distribution taxes and other amounts are owed related to the Company's spin-off from Walter Energy in 2009, the Company may be liable under the Tax Separation Agreement for all or a portion of such amounts.
The Company is unable to estimate reasonably possible losses for the matter described above.
52
16. Separate Financial Information of Subsidiary Guarantors of Indebtedness (As Restated)
In accordance with the Senior Notes Indenture, certain existing and future 100% owned domestic subsidiaries of the Parent Company have fully and unconditionally guaranteed the Senior Notes on a joint and several basis. These guarantor subsidiaries also guarantee the Parent Company's obligations under the 2013 Secured Credit Facilities. The indenture governing the Senior Notes contains customary exceptions under which a guarantor subsidiary may be released from its guarantee without the consent of the holders of the Senior Notes, including (i) the permitted sale, transfer or other disposition of all or substantially all of a guarantor subsidiary's assets or common stock; (ii) the designation of a restricted guarantor subsidiary as an unrestricted subsidiary; (iii) the release of a guarantor subsidiary from its obligation under the 2013 Secured Credit Facilities and its guarantee of all other indebtedness of the Parent Company and other guarantor subsidiaries; and (iv) the defeasance of the obligations of the guarantor subsidiary by payment of the Senior Notes.
Presented below are the condensed consolidating financial information of the Parent Company, the guarantor subsidiaries on a combined basis, and the non-guarantor subsidiaries on a combined basis.
53
Condensed Consolidating Balance Sheet (As Restated, See Note 2) | ||||||||||||||||||||
June 30, 2016 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
ASSETS | ||||||||||||||||||||
Cash and cash equivalents | $ | 320 | $ | 310,573 | $ | 2,000 | $ | — | $ | 312,893 | ||||||||||
Restricted cash and cash equivalents | 1,501 | 161,832 | 46,565 | — | 209,898 | |||||||||||||||
Residential loans at amortized cost, net | 13,496 | 67,048 | 484,517 | — | 565,061 | |||||||||||||||
Residential loans at fair value | — | 12,164,781 | 558,972 | — | 12,723,753 | |||||||||||||||
Receivables, net | 69,381 | 108,502 | 14,220 | — | 192,103 | |||||||||||||||
Servicer and protective advances, net | — | 417,265 | 885,281 | 31,656 | 1,334,202 | |||||||||||||||
Servicing rights, net | — | 1,350,276 | — | — | 1,350,276 | |||||||||||||||
Goodwill | — | 156,283 | — | — | 156,283 | |||||||||||||||
Intangible assets, net | — | 72,749 | 5,161 | — | 77,910 | |||||||||||||||
Premises and equipment, net | 1,562 | 102,080 | — | — | 103,642 | |||||||||||||||
Deferred tax assets, net | — | 26,687 | — | (10,433 | ) | 16,254 | ||||||||||||||
Other assets | 32,517 | 199,696 | 23,818 | — | 256,031 | |||||||||||||||
Due from affiliates, net | 600,878 | — | — | (600,878 | ) | — | ||||||||||||||
Investments in consolidated subsidiaries and VIEs | 1,653,293 | 149,994 | — | (1,803,287 | ) | — | ||||||||||||||
Total assets | $ | 2,372,948 | $ | 15,287,766 | $ | 2,020,534 | $ | (2,382,942 | ) | $ | 17,298,306 | |||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||||||
Payables and accrued liabilities | $ | 60,228 | $ | 538,172 | $ | 6,265 | $ | (6,801 | ) | $ | 597,864 | |||||||||
Servicer payables | — | 158,654 | — | — | 158,654 | |||||||||||||||
Servicing advance liabilities | — | 182,404 | 820,047 | — | 1,002,451 | |||||||||||||||
Warehouse borrowings | — | 1,396,102 | — | — | 1,396,102 | |||||||||||||||
Servicing rights related liabilities at fair value | — | 120,825 | — | — | 120,825 | |||||||||||||||
Corporate debt | 2,159,135 | 812 | — | — | 2,159,947 | |||||||||||||||
Mortgage-backed debt | — | — | 999,499 | — | 999,499 | |||||||||||||||
HMBS related obligations at fair value | — | 10,717,148 | — | — | 10,717,148 | |||||||||||||||
Deferred tax liabilities, net | 7,769 | — | 2,664 | (10,433 | ) | — | ||||||||||||||
Obligation to fund Non-Guarantor VIEs | — | 42,493 | — | (42,493 | ) | — | ||||||||||||||
Due to affiliates, net | — | 558,388 | 42,489 | (600,877 | ) | — | ||||||||||||||
Total liabilities | 2,227,132 | 13,714,998 | 1,870,964 | (660,604 | ) | 17,152,490 | ||||||||||||||
Stockholders' equity: | ||||||||||||||||||||
Total stockholders' equity | 145,816 | 1,572,768 | 149,570 | (1,722,338 | ) | 145,816 | ||||||||||||||
Total liabilities and stockholders' equity | $ | 2,372,948 | $ | 15,287,766 | $ | 2,020,534 | $ | (2,382,942 | ) | $ | 17,298,306 |
54
Condensed Consolidating Balance Sheet (As Restated, See Note 2) | ||||||||||||||||||||
December 31, 2015 | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
ASSETS | ||||||||||||||||||||
Cash and cash equivalents | $ | 4,016 | $ | 196,812 | $ | 2,000 | $ | — | $ | 202,828 | ||||||||||
Restricted cash and cash equivalents | 10,512 | 639,151 | 58,436 | — | 708,099 | |||||||||||||||
Residential loans at amortized cost, net | 14,130 | 26,713 | 500,563 | — | 541,406 | |||||||||||||||
Residential loans at fair value | — | 12,147,423 | 526,016 | — | 12,673,439 | |||||||||||||||
Receivables, net | 11,465 | 108,227 | 17,498 | — | 137,190 | |||||||||||||||
Servicer and protective advances, net | — | 514,213 | 1,082,405 | 34,447 | 1,631,065 | |||||||||||||||
Servicing rights, net | — | 1,788,576 | — | — | 1,788,576 | |||||||||||||||
Goodwill | — | 367,911 | — | — | 367,911 | |||||||||||||||
Intangible assets, net | — | 78,523 | 5,515 | — | 84,038 | |||||||||||||||
Premises and equipment, net | 1,559 | 104,922 | — | — | 106,481 | |||||||||||||||
Deferred tax assets, net | — | 132,687 | — | (24,637 | ) | 108,050 | ||||||||||||||
Other assets | 37,724 | 150,470 | 12,170 | — | 200,364 | |||||||||||||||
Due from affiliates, net | 674,139 | — | — | (674,139 | ) | — | ||||||||||||||
Investments in consolidated subsidiaries and VIEs | 2,278,009 | 54,810 | — | (2,332,819 | ) | — | ||||||||||||||
Total assets | $ | 3,031,554 | $ | 16,310,438 | $ | 2,204,603 | $ | (2,997,148 | ) | $ | 18,549,447 | |||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||||||
Payables and accrued liabilities | $ | 43,778 | $ | 554,710 | $ | 5,206 | $ | (5,768 | ) | $ | 597,926 | |||||||||
Servicer payables | — | 603,692 | — | — | 603,692 | |||||||||||||||
Servicing advance liabilities | — | 236,511 | 992,769 | — | 1,229,280 | |||||||||||||||
Warehouse borrowings | — | 1,340,388 | — | — | 1,340,388 | |||||||||||||||
Servicing rights related liabilities at fair value | — | 117,000 | — | — | 117,000 | |||||||||||||||
Corporate debt | 2,156,944 | 480 | — | — | 2,157,424 | |||||||||||||||
Mortgage-backed debt | — | — | 1,051,679 | — | 1,051,679 | |||||||||||||||
HMBS related obligations at fair value | — | 10,647,382 | — | — | 10,647,382 | |||||||||||||||
Deferred tax liabilities, net | 26,156 | — | 1,746 | (27,902 | ) | — | ||||||||||||||
Obligation to fund Non-Guarantor VIEs | — | 36,048 | — | (36,048 | ) | — | ||||||||||||||
Due to affiliates, net | — | 579,715 | 94,423 | (674,138 | ) | — | ||||||||||||||
Total liabilities | 2,226,878 | 14,115,926 | 2,145,823 | (743,856 | ) | 17,744,771 | ||||||||||||||
Stockholders' equity: | ||||||||||||||||||||
Total stockholders' equity | 804,676 | 2,194,512 | 58,780 | (2,253,292 | ) | 804,676 | ||||||||||||||
Total liabilities and stockholders' equity | $ | 3,031,554 | $ | 16,310,438 | $ | 2,204,603 | $ | (2,997,148 | ) | $ | 18,549,447 |
55
Condensed Consolidating Statement of Comprehensive Loss (As Restated, See Note 2) | ||||||||||||||||||||
For the Three Months Ended June 30, 2016 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
REVENUES | ||||||||||||||||||||
Net servicing revenue and fees | $ | — | $ | 34,179 | $ | — | $ | (2,243 | ) | $ | 31,936 | |||||||||
Net gains on sales of loans | — | 100,176 | — | — | 100,176 | |||||||||||||||
Net fair value gains (losses) on reverse loans and related HMBS obligations | — | 7,876 | (226 | ) | — | 7,650 | ||||||||||||||
Interest income on loans | 295 | 98 | 11,456 | — | 11,849 | |||||||||||||||
Insurance revenue | — | 10,433 | 1,032 | (188 | ) | 11,277 | ||||||||||||||
Other revenues, net | (402 | ) | 25,728 | 16,469 | (17,210 | ) | 24,585 | |||||||||||||
Total revenues | (107 | ) | 178,490 | 28,731 | (19,641 | ) | 187,473 | |||||||||||||
EXPENSES | ||||||||||||||||||||
Salaries and benefits | 18,583 | 115,098 | — | — | 133,681 | |||||||||||||||
General and administrative | 11,348 | 137,748 | 3,261 | (16,581 | ) | 135,776 | ||||||||||||||
Goodwill impairment | — | 215,412 | — | — | 215,412 | |||||||||||||||
Interest expense | 35,920 | 12,136 | 17,119 | (775 | ) | 64,400 | ||||||||||||||
Depreciation and amortization | 175 | 14,191 | 174 | — | 14,540 | |||||||||||||||
Corporate allocations | (29,255 | ) | 29,255 | — | — | — | ||||||||||||||
Other expenses, net | 146 | 725 | 1,026 | — | 1,897 | |||||||||||||||
Total expenses | 36,917 | 524,565 | 21,580 | (17,356 | ) | 565,706 | ||||||||||||||
OTHER GAINS (LOSSES) | ||||||||||||||||||||
Other net fair value gains (losses) | — | 154 | (973 | ) | — | (819 | ) | |||||||||||||
Other | — | (532 | ) | — | — | (532 | ) | |||||||||||||
Total other losses | — | (378 | ) | (973 | ) | — | (1,351 | ) | ||||||||||||
Income (loss) before income taxes | (37,024 | ) | (346,453 | ) | 6,178 | (2,285 | ) | (379,584 | ) | |||||||||||
Income tax expense (benefit) | (15,276 | ) | 122,851 | 3,149 | (345 | ) | 110,379 | |||||||||||||
Income (loss) before equity in earnings (losses) of consolidated subsidiaries and VIEs | (21,748 | ) | (469,304 | ) | 3,029 | (1,940 | ) | (489,963 | ) | |||||||||||
Equity in earnings (losses) of consolidated subsidiaries and VIEs | (468,215 | ) | 305 | — | 467,910 | — | ||||||||||||||
Net income (loss) | $ | (489,963 | ) | $ | (468,999 | ) | $ | 3,029 | $ | 465,970 | $ | (489,963 | ) | |||||||
Comprehensive income (loss) | $ | (489,947 | ) | $ | (468,999 | ) | $ | 3,029 | $ | 465,970 | $ | (489,947 | ) |
56
Condensed Consolidating Statement of Comprehensive Loss | ||||||||||||||||||||
For the Three Months Ended June 30, 2015 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
REVENUES | ||||||||||||||||||||
Net servicing revenue and fees | $ | — | $ | 226,953 | $ | 10 | $ | (3,048 | ) | $ | 223,915 | |||||||||
Net gains on sales of loans | — | 119,399 | — | — | 119,399 | |||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | — | 6,815 | — | — | 6,815 | |||||||||||||||
Interest income on loans | 289 | 38 | 17,859 | — | 18,186 | |||||||||||||||
Insurance revenue | — | 10,469 | 1,170 | (210 | ) | 11,429 | ||||||||||||||
Other revenues | 310 | 33,014 | 12,273 | (12,908 | ) | 32,689 | ||||||||||||||
Total revenues | 599 | 396,688 | 31,312 | (16,166 | ) | 412,433 | ||||||||||||||
EXPENSES | ||||||||||||||||||||
Salaries and benefits | 7,258 | 135,875 | 24 | — | 143,157 | |||||||||||||||
General and administrative | 10,436 | 140,947 | 5,207 | (14,490 | ) | 142,100 | ||||||||||||||
Goodwill impairment | — | 56,539 | — | — | 56,539 | |||||||||||||||
Interest expense | 37,065 | 12,484 | 19,797 | (681 | ) | 68,665 | ||||||||||||||
Depreciation and amortization | 29 | 15,877 | 187 | — | 16,093 | |||||||||||||||
Corporate allocations | (13,709 | ) | 13,709 | — | — | — | ||||||||||||||
Other expenses, net | (1,086 | ) | 2,113 | 374 | — | 1,401 | ||||||||||||||
Total expenses | 39,993 | 377,544 | 25,589 | (15,171 | ) | 427,955 | ||||||||||||||
OTHER GAINS (LOSSES) | ||||||||||||||||||||
Other net fair value gains (losses) | — | (98 | ) | 3,424 | — | 3,326 | ||||||||||||||
Other | (2,803 | ) | — | — | — | (2,803 | ) | |||||||||||||
Total other gains (losses) | (2,803 | ) | (98 | ) | 3,424 | — | 523 | |||||||||||||
Income (loss) before income taxes | (42,197 | ) | 19,046 | 9,147 | (995 | ) | (14,999 | ) | ||||||||||||
Income tax expense (benefit) | (13,602 | ) | 36,150 | 970 | (398 | ) | 23,120 | |||||||||||||
Income (loss) before equity in earnings (losses) of consolidated subsidiaries and VIEs | (28,595 | ) | (17,104 | ) | 8,177 | (597 | ) | (38,119 | ) | |||||||||||
Equity in earnings (losses) of consolidated subsidiaries and VIEs | (9,524 | ) | 3,565 | — | 5,959 | — | ||||||||||||||
Net income (loss) | $ | (38,119 | ) | $ | (13,539 | ) | $ | 8,177 | $ | 5,362 | $ | (38,119 | ) | |||||||
Comprehensive income (loss) | $ | (38,030 | ) | $ | (13,539 | ) | $ | 8,177 | $ | 5,362 | $ | (38,030 | ) |
57
Condensed Consolidating Statement of Comprehensive Loss (As Restated, See Note 2) | ||||||||||||||||||||
For the Six Months Ended June 30, 2016 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
REVENUES | ||||||||||||||||||||
Net servicing revenue and fees | $ | — | $ | (69,296 | ) | $ | — | $ | (4,530 | ) | $ | (73,826 | ) | |||||||
Net gains on sales of loans | — | 184,653 | — | — | 184,653 | |||||||||||||||
Net fair value gains (losses) on reverse loans and related HMBS obligations | — | 43,084 | (226 | ) | — | 42,858 | ||||||||||||||
Interest income on loans | 612 | 202 | 23,206 | — | 24,020 | |||||||||||||||
Insurance revenue | — | 19,928 | 2,100 | (384 | ) | 21,644 | ||||||||||||||
Other revenues, net | (808 | ) | 57,242 | 32,085 | (33,624 | ) | 54,895 | |||||||||||||
Total revenues | (196 | ) | 235,813 | 57,165 | (38,538 | ) | 254,244 | |||||||||||||
EXPENSES | ||||||||||||||||||||
Salaries and benefits | 31,093 | 235,227 | — | — | 266,320 | |||||||||||||||
General and administrative | 22,589 | 271,565 | 6,396 | (35,168 | ) | 265,382 | ||||||||||||||
Goodwill impairment | — | 215,412 | — | — | 215,412 | |||||||||||||||
Interest expense | 71,816 | 23,709 | 34,735 | (1,612 | ) | 128,648 | ||||||||||||||
Depreciation and amortization | 364 | 28,246 | 353 | — | 28,963 | |||||||||||||||
Corporate allocations | (51,123 | ) | 51,123 | — | — | — | ||||||||||||||
Other expenses, net | 417 | 1,964 | 2,022 | — | 4,403 | |||||||||||||||
Total expenses | 75,156 | 827,246 | 43,506 | (36,780 | ) | 909,128 | ||||||||||||||
OTHER GAINS (LOSSES) | ||||||||||||||||||||
Gain on extinguishment | 928 | — | — | — | 928 | |||||||||||||||
Other net fair value gains (losses) | — | 370 | (3,333 | ) | — | (2,963 | ) | |||||||||||||
Other | — | (1,556 | ) | — | — | (1,556 | ) | |||||||||||||
Total other gains (losses) | 928 | (1,186 | ) | (3,333 | ) | — | (3,591 | ) | ||||||||||||
Income (loss) before income taxes | (74,424 | ) | (592,619 | ) | 10,326 | (1,758 | ) | (658,475 | ) | |||||||||||
Income tax expense (benefit) | (12,742 | ) | 12,979 | 4,097 | (144 | ) | 4,190 | |||||||||||||
Income (loss) before equity in earnings (loss) of consolidated subsidiaries and VIEs | (61,682 | ) | (605,598 | ) | 6,229 | (1,614 | ) | (662,665 | ) | |||||||||||
Equity in earnings (loss) of consolidated subsidiaries and VIEs | (600,983 | ) | 678 | — | 600,305 | — | ||||||||||||||
Net income (loss) | $ | (662,665 | ) | $ | (604,920 | ) | $ | 6,229 | $ | 598,691 | $ | (662,665 | ) | |||||||
Comprehensive income (loss) | $ | (662,624 | ) | $ | (604,920 | ) | $ | 6,229 | $ | 598,691 | $ | (662,624 | ) |
58
Condensed Consolidating Statement of Comprehensive Loss | ||||||||||||||||||||
For the Six Months Ended June 30, 2015 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
REVENUES | ||||||||||||||||||||
Net servicing revenue and fees | $ | — | $ | 322,006 | $ | 66 | $ | (7,270 | ) | $ | 314,802 | |||||||||
Net gains on sales of loans | — | 244,626 | — | — | 244,626 | |||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | — | 37,589 | — | — | 37,589 | |||||||||||||||
Interest income on loans | 549 | 100 | 49,478 | — | 50,127 | |||||||||||||||
Insurance revenue | — | 23,391 | 2,592 | (423 | ) | 25,560 | ||||||||||||||
Other revenues | 3,288 | 48,639 | 31,150 | (32,491 | ) | 50,586 | ||||||||||||||
Total revenues | 3,837 | 676,351 | 83,286 | (40,184 | ) | 723,290 | ||||||||||||||
EXPENSES | ||||||||||||||||||||
Salaries and benefits | 12,371 | 277,936 | 78 | — | 290,385 | |||||||||||||||
General and administrative | 19,088 | 270,058 | 10,922 | (29,321 | ) | 270,747 | ||||||||||||||
Goodwill impairment | — | 56,539 | — | — | 56,539 | |||||||||||||||
Interest expense | 73,799 | 23,428 | 47,748 | (1,439 | ) | 143,536 | ||||||||||||||
Depreciation and amortization | 59 | 32,290 | 376 | — | 32,725 | |||||||||||||||
Corporate allocations | (26,453 | ) | 26,453 | — | — | — | ||||||||||||||
Other expenses, net | (813 | ) | 3,043 | 3,218 | — | 5,448 | ||||||||||||||
Total expenses | 78,051 | 689,747 | 62,342 | (30,760 | ) | 799,380 | ||||||||||||||
OTHER GAINS (LOSSES) | ||||||||||||||||||||
Other net fair value gains (losses) | — | (332 | ) | 2,786 | — | 2,454 | ||||||||||||||
Other | 8,959 | — | — | — | 8,959 | |||||||||||||||
Total other gains (losses) | 8,959 | (332 | ) | 2,786 | — | 11,413 | ||||||||||||||
Income (loss) before income taxes | (65,255 | ) | (13,728 | ) | 23,730 | (9,424 | ) | (64,677 | ) | |||||||||||
Income tax expense (benefit) | (18,494 | ) | 24,672 | 2,038 | (3,766 | ) | 4,450 | |||||||||||||
Income (loss) before equity in earnings (loss) of consolidated subsidiaries and VIEs | (46,761 | ) | (38,400 | ) | 21,692 | (5,658 | ) | (69,127 | ) | |||||||||||
Equity in earnings (loss) of consolidated subsidiaries and VIEs | (22,366 | ) | 9,388 | — | 12,978 | — | ||||||||||||||
Net income (loss) | $ | (69,127 | ) | $ | (29,012 | ) | $ | 21,692 | $ | 7,320 | $ | (69,127 | ) | |||||||
Comprehensive income (loss) | $ | (69,011 | ) | $ | (29,012 | ) | $ | 21,692 | $ | 7,320 | $ | (69,011 | ) |
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Condensed Consolidating Statement of Cash Flows | ||||||||||||||||||||
For the Six Months Ended June 30, 2016 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
Cash flows provided by (used in) operating activities | $ | (88,861 | ) | $ | 166,164 | $ | 232,742 | $ | — | $ | 310,045 | |||||||||
Investing activities | ||||||||||||||||||||
Purchases and originations of reverse loans held for investment | — | (384,816 | ) | — | — | (384,816 | ) | |||||||||||||
Principal payments received on reverse loans held for investment | — | 473,617 | — | — | 473,617 | |||||||||||||||
Principal payments received on mortgage loans held for investment | 654 | — | 44,584 | — | 45,238 | |||||||||||||||
Payments received on charged-off loans held for investment | — | 12,542 | — | — | 12,542 | |||||||||||||||
Payments received on receivables related to Non-Residual Trusts | — | — | 4,011 | — | 4,011 | |||||||||||||||
Proceeds from sales of real estate owned, net | 4 | 50,091 | 1,829 | — | 51,924 | |||||||||||||||
Purchases of premises and equipment | (411 | ) | (22,227 | ) | — | — | (22,638 | ) | ||||||||||||
Decrease in restricted cash and cash equivalents | 9,011 | 1,260 | 57 | — | 10,328 | |||||||||||||||
Payment for acquisition of business | — | (1,947 | ) | — | — | (1,947 | ) | |||||||||||||
Acquisitions of servicing rights, net | — | (8,410 | ) | — | — | (8,410 | ) | |||||||||||||
Proceeds from sale of servicing rights | — | 19,920 | — | — | 19,920 | |||||||||||||||
Capital contributions to subsidiaries and VIEs | — | (4,122 | ) | — | 4,122 | — | ||||||||||||||
Returns of capital from subsidiaries and VIEs | 9,410 | 6,693 | — | (16,103 | ) | — | ||||||||||||||
Change in due from affiliates | 71,923 | 43,029 | (6,960 | ) | (107,992 | ) | — | |||||||||||||
Other | 162 | (2,336 | ) | — | — | (2,174 | ) | |||||||||||||
Cash flows provided by investing activities | 90,753 | 183,294 | 43,521 | (119,973 | ) | 197,595 | ||||||||||||||
Financing activities | ||||||||||||||||||||
Payments on corporate debt | — | (345 | ) | — | — | (345 | ) | |||||||||||||
Extinguishments and settlement of debt | (6,327 | ) | — | — | — | (6,327 | ) | |||||||||||||
Proceeds from securitizations of reverse loans | — | 410,107 | — | — | 410,107 | |||||||||||||||
Payments on HMBS related obligations | — | (590,678 | ) | — | — | (590,678 | ) | |||||||||||||
Issuances of servicing advance liabilities | — | 128,450 | 687,350 | — | 815,800 | |||||||||||||||
Payments on servicing advance liabilities | — | (182,557 | ) | (861,415 | ) | — | (1,043,972 | ) | ||||||||||||
Net change in warehouse borrowings related to mortgage loans | — | (59,801 | ) | — | — | (59,801 | ) | |||||||||||||
Net change in warehouse borrowings related to reverse loans | — | 115,515 | — | — | 115,515 | |||||||||||||||
Proceeds from sales of servicing rights | — | 29,738 | — | — | 29,738 | |||||||||||||||
Payments on servicing rights related liabilities | — | (9,639 | ) | — | — | (9,639 | ) | |||||||||||||
Payments on mortgage-backed debt | — | — | (52,017 | ) | — | (52,017 | ) | |||||||||||||
Other debt issuance costs paid | — | (5,870 | ) | (42 | ) | — | (5,912 | ) | ||||||||||||
Capital contributions | — | — | 4,122 | (4,122 | ) | — | ||||||||||||||
Capital distributions | — | (5,840 | ) | (10,263 | ) | 16,103 | — | |||||||||||||
Change in due to affiliates | 1,442 | (64,531 | ) | (44,903 | ) | 107,992 | — | |||||||||||||
Other | (703 | ) | (246 | ) | 905 | — | (44 | ) | ||||||||||||
Cash flows used in financing activities | (5,588 | ) | (235,697 | ) | (276,263 | ) | 119,973 | (397,575 | ) | |||||||||||
Net increase (decrease) in cash and cash equivalents | (3,696 | ) | 113,761 | — | — | 110,065 | ||||||||||||||
Cash and cash equivalents at the beginning of the period | 4,016 | 196,812 | 2,000 | — | 202,828 | |||||||||||||||
Cash and cash equivalents at the end of the period | $ | 320 | $ | 310,573 | $ | 2,000 | $ | — | $ | 312,893 |
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Condensed Consolidating Statement of Cash Flows | ||||||||||||||||||||
For the Six Months Ended June 30, 2015 | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||
Parent Company | Guarantor Subsidiaries | Non-Guarantor Subsidiaries and VIEs | Eliminations and Reclassifications | Consolidated | ||||||||||||||||
Cash flows provided by (used in) operating activities | $ | (86,981 | ) | $ | (340,671 | ) | $ | 158,896 | $ | — | $ | (268,756 | ) | |||||||
Investing activities | ||||||||||||||||||||
Purchases and originations of reverse loans held for investment | — | (922,422 | ) | — | — | (922,422 | ) | |||||||||||||
Principal payments received on reverse loans held for investment | — | 385,073 | — | — | 385,073 | |||||||||||||||
Principal payments received on mortgage loans held for investment | 386 | — | 69,280 | — | 69,666 | |||||||||||||||
Payments received on charged-off loans held for investment | — | 12,249 | — | — | 12,249 | |||||||||||||||
Payments received on receivables related to Non-Residual Trusts | — | — | 3,853 | — | 3,853 | |||||||||||||||
Proceeds from sales of real estate owned, net | 2 | 32,689 | 4,853 | — | 37,544 | |||||||||||||||
Purchases of premises and equipment | (143 | ) | (9,605 | ) | — | — | (9,748 | ) | ||||||||||||
Decrease (increase) in restricted cash and cash equivalents | (3 | ) | (4,007 | ) | 7,124 | — | 3,114 | |||||||||||||
Payments for acquisitions of businesses, net of cash acquired | — | (2,810 | ) | — | — | (2,810 | ) | |||||||||||||
Acquisitions of servicing rights, net | — | (189,276 | ) | — | — | (189,276 | ) | |||||||||||||
Proceeds from sale of servicing rights | — | 778 | — | — | 778 | |||||||||||||||
Proceeds from sale of residual interests in Residual Trusts | 189,513 | — | — | — | 189,513 | |||||||||||||||
Proceeds from sale of investment | 14,376 | — | — | — | 14,376 | |||||||||||||||
Capital contributions to subsidiaries and VIEs | (4,505 | ) | (4,296 | ) | — | 8,801 | — | |||||||||||||
Returns of capital from subsidiaries and VIEs | 20,094 | 12,370 | — | (32,464 | ) | — | ||||||||||||||
Change in due from affiliates | (132,284 | ) | 24,983 | (21 | ) | 107,322 | — | |||||||||||||
Other | 11,754 | 488 | — | — | 12,242 | |||||||||||||||
Cash flows provided by (used in) investing activities | 99,190 | (663,786 | ) | 85,089 | 83,659 | (395,848 | ) | |||||||||||||
Financing activities | ||||||||||||||||||||
Payments on corporate debt | (7,500 | ) | (914 | ) | — | — | (8,414 | ) | ||||||||||||
Proceeds from securitizations of reverse loans | — | 951,234 | — | — | 951,234 | |||||||||||||||
Payments on HMBS related obligations | — | (466,188 | ) | — | — | (466,188 | ) | |||||||||||||
Issuances of servicing advance liabilities | — | 141,555 | 284,341 | — | 425,896 | |||||||||||||||
Payments on servicing advance liabilities | — | (138,273 | ) | (408,190 | ) | — | (546,463 | ) | ||||||||||||
Net change in warehouse borrowings related to mortgage loans | — | 454,012 | — | — | 454,012 | |||||||||||||||
Net change in warehouse borrowings related to reverse loans | — | (10,708 | ) | — | — | (10,708 | ) | |||||||||||||
Payments on servicing rights related liabilities | — | (4,576 | ) | — | — | (4,576 | ) | |||||||||||||
Payments on mortgage-backed debt | — | — | (81,795 | ) | — | (81,795 | ) | |||||||||||||
Other debt issuance costs paid | — | (5,397 | ) | (197 | ) | — | (5,594 | ) | ||||||||||||
Capital contributions | — | 4,235 | 4,566 | (8,801 | ) | — | ||||||||||||||
Capital distributions | — | (9,581 | ) | (22,883 | ) | 32,464 | — | |||||||||||||
Change in due to affiliates | (961 | ) | 132,184 | (23,901 | ) | (107,322 | ) | — | ||||||||||||
Other | 250 | (20,316 | ) | 871 | — | (19,195 | ) | |||||||||||||
Cash flows provided by (used in) financing activities | (8,211 | ) | 1,027,267 | (247,188 | ) | (83,659 | ) | 688,209 | ||||||||||||
Net increase (decrease) in cash and cash equivalents | 3,998 | 22,810 | (3,203 | ) | — | 23,605 | ||||||||||||||
Cash and cash equivalents at the beginning of the period | 3,162 | 311,810 | 5,203 | — | 320,175 | |||||||||||||||
Cash and cash equivalents at the end of the period | $ | 7,160 | $ | 334,620 | $ | 2,000 | $ | — | $ | 343,780 |
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17. Related-Party Transactions
WCO was established to invest in mortgage-related assets. The Company's investment in WCO was $20.7 million and $22.6 million at June 30, 2016 and December 31, 2015, respectively. The Company recorded income (loss) relating to its investment in WCO of $(0.5) million and $0.2 million for the three months ended June 30, 2016 and 2015, respectively, and $(1.0) million and $0.5 million for the six months ended June 30, 2016 and 2015, respectively. Additionally, the Company received a dividend of $1.0 million from WCO during the six months ended June 30, 2016.
The Company’s subsidiary, GTIM, earns fees for providing investment advisory and management services to WCO and administering its business activities and day-to-day operations. The Company earned fees associated with these activities of $0.4 million and $0.2 million for the three months ended June 30, 2016 and 2015, respectively, and $0.8 million and $0.4 million for the six months ended June 30, 2016 and 2015, respectively, which are recorded in other revenues on the consolidated statements of comprehensive loss. The Company had $1.2 million included in receivables, net on the consolidated balance sheets at June 30, 2016 and December 31, 2015, respectively, relating to fees earned for the aforementioned investment advisory and management services provided to WCO, as well as pass-throughs to WCO related to general and administrative and payroll-related expenses.
The Company, in exchange for a servicing fee, services certain assets held by WCO. The Company also has servicing rights related liabilities for the sales to WCO of beneficial interests in certain portions of contractual servicing fees associated with mortgage loans serviced by the Company as well as for the sale of servicing rights. The Company is engaged by WCO to offer refinancing options to borrowers with mortgage loans underlying the excess servicing spread and servicing rights transactions that occurred prior to June 30, 2016. In addition, the Company has a similar arrangement with WCO with respect to certain other servicing rights held by WCO. These arrangements were made for purposes of reducing portfolio runoff. Further, the Company entered into various other ancillary agreements with WCO pursuant to which, among other things, WCO has the right to make the first offer to purchase servicing rights relating to certain mortgage loans originated by the Company and certain excess servicing spread that the Company may create from time to time.
Sub-servicing fees from WCO were $1.2 million and $2.1 million during the three and six months ended June 30, 2016, respectively, and are included in net servicing revenue and fees on the consolidated statement of comprehensive loss. In addition, the Company earned incentive and performance fees and ancillary and other fees related to servicing assets held by WCO of $0.1 million and $0.3 million for the three and six months ended June 30, 2016, respectively, which are included in net servicing revenue and fees on the consolidated statement of comprehensive loss.
WCO lacks sufficient equity at risk to finance its activities without subordinated financial support and as such is a VIE. WCO’s board of directors have decision making authority as it relates to the activities that most significantly impact the economic performance of WCO, including making decisions related to significant investments, servicing, capital and debt financing. As a result, the Company is not deemed to be the primary beneficiary of WCO as it does not have the power to direct the activities that most significantly impact WCO’s economic performance.
The following table presents the carrying amounts of the Company’s assets and liabilities that relate to WCO, as well as the size of the unconsolidated VIE (in thousands):
Carrying Value of Assets and Liabilities Recorded on the Consolidated Balance Sheets | ||||||||||||||||||||||||||||||||
Servicing Rights, Net (1) | Servicer and Protective Advances, Net | Receivables, Net | Other Assets (2) | Payables and Accrued Liabilities | Servicing Rights Related Liabilities | Net Liabilities (3) | Size of VIE (4) | |||||||||||||||||||||||||
June 30, 2016 | $ | 35,567 | $ | 7,378 | $ | 6,442 | $ | 21,634 | $ | (6,495 | ) | $ | (120,825 | ) | $ | (56,299 | ) | $ | 214,099 | |||||||||||||
December 31, 2015 | 16,889 | 7,015 | 9,814 | 23,578 | (4,500 | ) | (117,000 | ) | (64,204 | ) | 228,361 |
__________
(1) | During May 2016, the Company sold additional mortgage servicing rights to WCO for $27.9 million. |
(2) | Other assets at June 30, 2016 and December 31, 2015 are primarily comprised of the Company's investment in WCO. |
(3) | At June 30, 2016 and December 31, 2015, the Company had no net exposure to loss as it relates to transactions with WCO as a result of its net liabilities due to WCO. |
(4) | The size of the VIE is deemed to be WCO's net assets. |
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18. Subsequent Events
On August 5, 2016, the Company entered into an amendment to the 2013 Credit Agreement that, among other things, permanently reduced the aggregate commitments under the 2013 Revolver from $125.0 million to $100.0 million, increased the interest rate on any drawn amounts under the 2013 Revolver to LIBOR plus 4.50% through January 1, 2017, and increased the required Total Leverage Ratio for the second and third quarters of 2016. After giving effect to the amendment, the Company was in compliance with the increased Total Leverage Ratio and with all other covenants contained in the 2013 Credit Agreement at June 30, 2016.
On August 8, 2016, the Company entered into an employment agreement with Anthony Renzi to serve as the President and Chief Executive Officer of the Company, commencing no later than November 15, 2016. Pursuant to the terms of the agreement, the executive will receive a salary, annual incentive bonus and annual long-term incentive, and will also receive a signing bonus of $2.5 million. Additionally, on or near the commencement date, the Company shall grant the executive a number of restricted stock units with an economic value equal to $0.6 million and a long-term restricted cash award with an aggregate value equal to $0.6 million, both of which will vest ratably on the first, second, and third anniversaries of the commencement date.
On August 8, 2016 the Company entered into agreements with NRM to sell mortgage servicing rights for a purchase price of approximately $231 million, subject to adjustment. The agreements also provide that, subject to agreement on price and other matters, NRM will from time to time purchase mortgage servicing rights relating to mortgage loans that the Company originates in the future. Pursuant to those arrangements, the Company expects to be retained by NRM to subservice the mortgage servicing rights that are sold to NRM. The closing of these transactions is subject to the receipt of GSE and other approvals, various other conditions precedent and certain termination provisions.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (AS RESTATED)
The terms "Walter Investment," the "Company," "we," "us," and "our" as used throughout this report refer to Walter Investment Management Corp. and its consolidated subsidiaries. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q/A and in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC on February 29, 2016 and with the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in that Annual Report on Form 10-K. Historical results and trends discussed herein and therein may not be indicative of future operations, particularly in light of regulatory developments. Our results of operations and financial condition, as reflected in the accompanying consolidated financial statements and related footnotes, reflect management’s evaluation and interpretation of business conditions, changing capital market conditions, and other factors.
As discussed in the Explanatory Note to this Amended Filing and in Note 2 to the Consolidated Financial Statements, we have restated our Consolidated Financial Statements and related disclosures as of and for the six months ended June 30, 2016 to correct the estimated valuation allowance recorded on our deferred tax assets. The impact of the restatement is reflected in Management’s Discussion and Analysis of Financial Condition and Results of Operations below. Other than as disclosed in the Explanatory Note, no other information in this Item 2 has been amended and this Item 2 does not reflect any events occurring after the Original Filing. The Company is filing its Form 10-Q for the quarterly period ended June 30, 2017 on our about the date of the filing of this amended report.
We use certain acronyms and terms throughout this Quarterly Report on Form 10-Q/A that are defined in the Glossary of Terms of this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Our website can be found at www.walterinvestment.com. We make available free of charge on our website or provide a link on our website to our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after those reports are electronically filed with, or furnished to, the SEC. To access these filings, go to our website, click on “Investor Relations” and then click on "SEC Filings." We also make available through our website other reports filed with or furnished to the SEC under the Exchange Act, including our proxy statements and reports filed by officers and directors under Section 16(a) of the Exchange Act, as well as our Code of Conduct and Ethics, our Corporate Governance Guidelines, and charters for our Audit Committee, Compensation and Human Resources Committee, Nominating and Corporate Governance Committee, Finance Committee, and Compliance Committee. In addition, our website may include disclosure relating to certain non-GAAP financial measures that we may make public orally, telephonically, by webcast, by broadcast, or by similar means from time to time.
From time to time, we may use our website as a channel of distribution of material company information. Financial and other material information regarding the Company is routinely posted on and accessible at http://investor.walterinvestment.com.
Any information on our website or obtained through our website is not part of this Quarterly Report on Form 10-Q/A.
Our Investor Relations Department can be contacted at 3000 Bayport Drive, Suite 1100, Tampa, Florida 33607, Attn: Investor Relations, telephone (813) 421-7694.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Certain statements in this report, including matters discussed under this Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Part II, Item 1. Legal Proceedings, and elsewhere in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,” “may,” “should,” “will,” “targets,” or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, and our actual results, performance or achievements could differ materially from future results, performance or achievements expressed in these forward-looking statements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties described below and in more detail under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2015, our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2016, this Quarterly Report on Form 10-Q/A for the quarterly period ended June 30, 2016, and in our other filings with the SEC.
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In particular (but not by way of limitation), the following important factors, risks and uncertainties could affect our future results, performance and achievements and could cause actual results, performance and achievements to differ materially from those expressed in the forward-looking statements:
• | risks and uncertainties relating to, or arising in connection with, the restatement of financial statements included in the amendments to our Annual Report on Form 10-K for the year ended December 31, 2016 and our Quarterly Reports on Form 10-Q for the quarterly periods ended June 30, 2016, September 30, 2016 and March 31, 2017, including: reactions from the Company’s creditors, stockholders, or business partners; and the impact and result of any litigation or regulatory inquiries or investigations related to the findings of the Company’s assessment or the restatement; |
• | risks and uncertainties relating to the Company's proposed financial restructuring, including: the ability of the Company to comply with the terms of the Restructuring Support Agreement described in Note 3 to the Consolidated Financial Statements, including completing various stages of the restructuring within the dates specified by the Restructuring Support Agreement; the ability of the Company to obtain requisite support of the restructuring from various stakeholders; and the effects of disruption from the proposed restructuring making it more difficult to maintain business, financing and operational relationships; |
• | our ability to operate our business in compliance with existing and future laws, rules, regulations and contractual commitments affecting our business, including those relating to the origination and servicing of residential loans, default servicing and foreclosure practices, the management of third-party assets and the insurance industry, and changes to, and/or more stringent enforcement of, such laws, rules, regulations and contracts; |
• | scrutiny of our industry by, and potential enforcement actions by, federal and state authorities; |
• | the substantial resources (including senior management time and attention) we devote to, and the significant compliance costs we incur in connection with, regulatory compliance and regulatory examinations and inquiries, and any consumer redress, fines, penalties or similar payments we make in connection with resolving such matters; |
• | uncertainties relating to interest curtailment obligations and any related financial and litigation exposure (including exposure relating to false claims); |
• | potential costs and uncertainties, including the effect on future revenues, associated with and arising from litigation, regulatory investigations and other legal proceedings, and uncertainties relating to the reaction of our key counterparties to the announcement of any such matters; |
• | our dependence on U.S. GSEs and agencies (especially Fannie Mae, Freddie Mac and Ginnie Mae) and their residential loan programs and our ability to maintain relationships with, and remain qualified to participate in programs sponsored by, such entities, our ability to satisfy various existing or future GSE, agency and other capital, net worth, liquidity and other financial requirements applicable to our business, and our ability to remain qualified as a GSE and agency approved seller, servicer or component servicer, including the ability to continue to comply with the GSEs’ and agencies' respective residential loan selling and servicing guides; |
• | uncertainties relating to the status and future role of GSEs and agencies, and the effects of any changes to the origination and/or servicing requirements of the GSEs, agencies or various regulatory authorities or the servicing compensation structure for mortgage servicers pursuant to programs of GSEs, agencies or various regulatory authorities; |
• | our ability to maintain our loan servicing, loan origination or collection agency licenses, or any other licenses necessary to operate our businesses, or changes to, or our ability to comply with, our licensing requirements; |
• | our ability to comply with the terms of the stipulated order resolving allegations arising from an FTC and CFPB investigation of Ditech Financial and a CFPB investigation of RMS; |
• | operational risks inherent in the mortgage servicing and mortgage originations businesses, including our ability to comply with the various contracts to which we are a party, and reputational risks; |
• | risks related to the significant amount of senior management turnover and employee reductions recently experienced by the Company; |
• | risks related to our substantial levels of indebtedness, including our ability to comply with covenants contained in our debt agreements or obtain any necessary waivers or amendments, generate sufficient cash to service such indebtedness and refinance such indebtedness on favorable terms, or at all, as well as our ability to incur substantially more debt; |
• | our ability to renew advance financing facilities or warehouse facilities on favorable terms, or at all, and maintain adequate borrowing capacity under such facilities; |
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• | our ability to maintain or grow our residential loan servicing or subservicing business and our mortgage loan originations business; |
• | our ability to achieve our strategic initiatives, particularly our ability to: increase the mix of our fee-for-service business, including by entering into new subservicing arrangements; improve servicing performance; successfully develop our originations capabilities in the consumer and wholesale lending channels; reduce our debt; and execute and realize planned operational improvements and efficiencies, including those relating to our core and non-core framework; |
• | the success of our business strategy in returning us to sustained profitability; |
• | changes in prepayment rates and delinquency rates on the loans we service or subservice; |
• | the ability of Fannie Mae, Freddie Mac and Ginnie Mae, as well as our other clients and credit owners, to transfer or otherwise terminate our servicing or subservicing rights, with or without cause; |
• | a downgrade of, other adverse change relating to, or our ability to improve our servicer ratings or credit ratings; |
• | our ability to collect reimbursements for servicing advances and earn and timely receive incentive payments and ancillary fees on our servicing portfolio; |
• | our ability to collect indemnification payments and enforce repurchase obligations relating to mortgage loans we purchase from our correspondent clients and our ability to collect in a timely manner indemnification payments relating to servicing rights we purchase from prior servicers; |
• | local, regional, national and global economic trends and developments in general, and local, regional and national real estate and residential mortgage market trends in particular, including the volume and pricing of home sales and uncertainty regarding the levels of mortgage originations and prepayments; |
• | uncertainty as to the volume of originations activity we can achieve and the effects of the expiration of HARP, which is scheduled to occur on September 30, 2017, including uncertainty as to the number of "in-the-money" accounts we may be able to refinance and uncertainty as to what type of product or government program will be introduced, if any, to replace HARP; |
• | risks associated with the reverse mortgage business, including changes to reverse mortgage programs operated by FHA, HUD or Ginnie Mae, our ability to accurately estimate interest curtailment liabilities, our ability to fund HECM repurchase obligations, our ability to fund principal additions on our HECM loans, and our ability to securitize our HECM loans and tails; |
• | our ability to realize all anticipated benefits of past, pending or potential future acquisitions or joint venture investments; |
• | the effects of competition on our existing and potential future business, including the impact of competitors with greater financial resources and broader scopes of operation; |
• | changes in interest rates and the effectiveness of any hedge we may employ against such changes; |
• | risks and potential costs associated with technology and cybersecurity, including: the risks of technology failures and of cyber-attacks against us or our vendors; our ability to adequately respond to actual or alleged cyber-attacks; and our ability to implement adequate internal security measures and protect confidential borrower information; |
• | risks and potential costs associated with the implementation of new or more current technology, such as MSP, the use of vendors (including offshore vendors) or the transfer of our servers or other infrastructure to new data center facilities; |
• | our ability to comply with evolving and complex accounting rules, many of which involve significant judgment and assumptions; |
• | risks related to our deferred tax assets, including the risk of an "ownership change" under Section 382 of the Code; |
• | our ability to regain and maintain compliance with the continued listing requirements of the NYSE, and risks arising from the potential suspension of trading of our common stock on, and delisting of our common stock from, the NYSE; |
• | our ability to continue as a going concern; |
• | uncertainties regarding impairment charges relating to our goodwill or other intangible assets; |
• | risks associated with one or more material weaknesses identified in our internal controls over financial reporting, including the timing, expense and effectiveness of our remediation plans; |
• | our ability to implement and maintain effective internal controls over financial reporting and disclosure controls and procedures; |
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• | our ability to manage potential conflicts of interest relating to our relationship with WCO; and |
• | risks related to our relationship with Walter Energy and uncertainties arising from or relating to its bankruptcy filings and liquidation proceedings, including potential liability for any taxes, interest and/or penalties owed by the Walter Energy consolidated group for the full or partial tax years during which certain of the Company's former subsidiaries were a part of such consolidated group and certain other tax risks allocated to us in connection with our spin-off from Walter Energy. |
All of the above factors, risks and uncertainties are difficult to predict, contain uncertainties that may materially affect actual results and may be beyond our control. New factors, risks and uncertainties emerge from time to time, and it is not possible for our management to predict all such factors, risks and uncertainties.
Although we believe that the assumptions underlying the forward-looking statements (including those relating to our outlook) contained herein are reasonable, any of the assumptions could be inaccurate, and therefore any of these statements included herein may prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made, except as otherwise required under the federal securities laws. If we were in any particular instance to update or correct a forward-looking statement, investors and others should not conclude that we would make additional updates or corrections thereafter except as otherwise required under the federal securities laws.
In addition, this report may contain statements of opinion or belief concerning market conditions and similar matters. In certain instances, those opinions and beliefs could be based upon general observations by members of our management, anecdotal evidence and/or our experience in the conduct of our business, without specific investigation or statistical analyses. Therefore, while such statements reflect our view of the industries and markets in which we are involved, they should not be viewed as reflecting verifiable views and such views may not be shared by all who are involved in those industries or markets.
Executive Summary
The Company
We are a diversified mortgage banking firm focused primarily on servicing and originating residential loans, including reverse loans. We service a wide array of loans across the credit spectrum for our own portfolio and for GSEs, government agencies, third-party securitization trusts and other credit owners. Through our consumer and correspondent lending channels, we originate and purchase residential loans that we predominantly sell to GSEs and government entities. In addition, we operate several other complementary businesses that include managing a portfolio of credit-challenged, non-conforming residential mortgage loans; an insurance agency serving borrowers and credit owners of our servicing portfolio; a post charge-off collection agency; and an asset management business through our SEC registered investment advisor. These supplemental businesses allow us to leverage our core servicing capabilities and consumer base to generate complementary revenue streams.
At June 30, 2016, we serviced 2.2 million residential loans with a total unpaid principal balance of $269.1 billion. We have been one of the 10 largest residential loan servicers in the U.S. by unpaid principal balance for the past three years according to Inside Mortgage Finance. Our originations business originated $9.7 billion in mortgage loan volume during the first six months of 2016, ranking it in the top 20 originators nationally by unpaid principal balance according to Inside Mortgage Finance. Our reverse mortgage business is a leading integrated franchise in the reverse mortgage sector and, according to an industry source, was the sixth leading issuer of HMBS during the first six months of 2016.
During the six months ended June 30, 2016, we added to the unpaid principal balance of our third-party mortgage loan servicing portfolio: $4.9 billion relating to acquired servicing rights, $10.7 billion relating to sub-servicing contracts and $6.5 billion relating to servicing rights capitalized upon sales of mortgage loans, while also adding $1.3 billion to our third-party reverse loan servicing portfolio. Our third-party mortgage loan and reverse mortgage servicing portfolio was reduced by $21.0 billion of unpaid principal balance in payoffs and sales, net of recapture activities, during the six months ended June 30, 2016. In the same period, we originated and purchased $385.0 million in reverse mortgage volume and issued $376.4 million in HMBS.
Our mortgage loan originations business diversifies our revenue base and offers various sources for replenishing and growing the Company's servicing portfolio. During the six months ended June 30, 2016, we originated $3.4 billion of mortgage loans, the majority of which resulted from retention activities associated with our existing servicing portfolio. Through our retention activities, we assist consumers in refinancing their loans, which reduces the runoff on our existing servicing portfolio. In addition, we purchased $6.3 billion of mortgage loans through our correspondent channel during the six months ended June 30, 2016. Substantially all of these purchased and originated mortgage loans were added to our servicing portfolio upon loan sale.
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We manage our Company in three reportable segments: Servicing, Originations, and Reverse Mortgage. A description of the business conducted by each of these segments is provided below:
Servicing — Our Servicing segment consists of operations that perform servicing for third-party credit owners of mortgage loans for a fee and the Company’s own mortgage loan portfolio. The Servicing segment also operates complementary businesses consisting of an insurance agency serving residential loan borrowers and credit owners and a collections agency which performs collections of post charge-off deficiency balances for third parties and the Company. In addition, the Servicing segment holds the assets and mortgage-backed debt of the Residual Trusts.
Originations — Our Originations segment consists of operations that originate and purchase mortgage loans that are intended for sale to third parties. During the six months ended June 30, 2016, the mix of mortgage loans sold by our Originations segment, based on unpaid principal balance, consisted of (i) 47% Fannie Mae conventional conforming loans, (ii) 40% Ginnie Mae loans, and (iii) 13% Freddie Mac conventional conforming loans.
Reverse Mortgage — Our Reverse Mortgage segment consists of operations that purchase and originate HECMs that are securitized, but remain on the consolidated balance sheet as collateral for secured borrowings. This segment performs servicing for third-party credit owners and the Company and provides other complementary services for the reverse mortgage market, such as real estate owned property management and disposition.
Other — Our Other non-reportable segment primarily consists of the assets and liabilities of the Non-Residual Trusts, corporate debt and our asset management business, which we operate through GTIM.
Overview
Our profitability is dependent on our ability to generate revenue, primarily from our servicing and originations businesses. Our Servicing segment revenue is primarily impacted by the size and mix of our capitalized servicing and sub-servicing portfolios and is generated through servicing of mortgage loans for clients and/or credit owners. Net servicing revenue and fees includes the change in fair value of servicing rights carried at fair value and the amortization of all other servicing rights. Our servicing fee income generation is influenced by the level and timing of entrance into sub-servicing contracts and purchases and sales of servicing rights. The fair value of our servicing rights is largely dependent on the size of the related portfolio, discount rates, and prepayment and default speeds, which are influenced by interest rates. Our Originations segment revenue, which is primarily net gains on sales of loans, is impacted by interest rates and the volume of loans locked as well as the margins earned in our origination channels. Net gains on sales of loans include the cost of additions to the representations and warranties reserve. Our Reverse Mortgage segment is impacted by new origination reverse loan volume, draws on existing reverse loans and the fair value of reverse loans and HMBS.
Our results of operations are also affected by expenses such as salaries and benefits, information technology, occupancy, legal and professional fees, the provision for uncollectible advances, curtailment, interest expense and other operating expenses. Refer to the Financial Highlights, Results of Operations and Business Segment Results sections below for further information.
Currently, our profitability in the Reverse segment is being negatively impacted by the legacy HECM product and the acceleration of default status driven by new HUD regulations. Regulatory changes to the HECM program in late 2013 reduced the principal available to be drawn initially by borrowers, and further changes effective in April of 2015 introduced certain financial assessment requirements of borrowers and in certain instances, required that a portion of the borrowing capacity be set-aside to pay for insurance and taxes on the related property. We believe that over time, the improved credit risk profile of these products may have a favorable impact on our costs to service reverse mortgages as the legacy HECM product seasons and the newer IDL product becomes a larger portion of our portfolio.
Our principal sources of liquidity are the cash flows generated from our business segments and funds available from our 2013 Revolver, master repurchase agreements, mortgage loan servicing advance facilities, issuance of HMBS and excess servicing spread financing arrangements. We may generate additional liquidity through sales of MSRs, any portion thereof, or other assets.
Financial Highlights
Total revenues for the three months ended June 30, 2016 were $187.5 million, which represented a decline of $225.0 million, or 55%, as compared to the same period of 2015. The decrease in revenue reflects a decrease of $192.0 million in net servicing revenue and fees, primarily driven by $188.6 million in higher fair value losses on servicing rights; $19.2 million in lower net gains on sales of loans; and $6.3 million in lower interest income on loans.
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Total revenues for the six months ended June 30, 2016 were $254.2 million, which represented a decline of $469.0 million, or 65%, as compared to the same period of 2015. The decrease in revenue reflects a decrease of $388.6 million in net servicing revenue and fees, primarily driven by $386.0 million in higher fair value losses on servicing rights; $60.0 million in lower net gains on sales of loans; and $26.1 million in lower interest income on loans.
We recorded fair value losses on our servicing rights carried at fair value primarily as a result of a higher assumed conditional prepayment rate used to value our servicing rights and accelerated realization of expected cash flows driven by declining interest rates, offset in part by a decline in discount rates. We had lower net gains on sales of loans due primarily to a lower volume of locked loans, offset partially by a shift in mix from the lower margin correspondent channel to the higher margin consumer channel. We had lower interest income on loans primarily due to the sale of our residual interest in seven of the Residual Trusts in the second quarter of 2015.
Total expenses for the three and six months ended June 30, 2016 were $565.7 million and $909.1 million, respectively, which represented increases as compared to the same periods of 2015. The increases in expenses reflect higher goodwill impairment, offset in part by $9.5 million and $24.1 million, respectively, in lower salaries and benefits, $4.3 million and $14.9 million, respectively, in lower interest expense, and $6.3 million and $5.4 million, respectively, in lower general and administrative expenses for the three and six months ended June 30, 2016 as compared to the same periods of 2015. Income tax expense was impacted by the recording of a valuation allowance on the deferred tax assets balance in the amount of $257.6 million in connection with the restatement as discussed in Note 2 to the Consolidated Financial Statements.
As a result of goodwill evaluations performed during the second quarters of 2016 and 2015, we recorded $215.4 million and $56.5 million in non-cash goodwill impairment charges during the three and six months ended June 30, 2016 and 2015, respectively. The evaluation performed in the current year resulted in impairment charges to the Servicing and ARM reporting units' goodwill, and evaluation performed in the prior year resulted in impairment charges to the Reverse Mortgage reporting unit's goodwill. Refer to Note 9 to the Consolidated Financial Statements for further information.
We had lower salaries and benefits primarily due to a decrease in benefits and incentives resulting from a lower average headcount and a decrease in commissions due to lower originations volume, partially offset by an increase in severance. The lower expenses for the six months ended June 30, 2016 were also impacted by a decrease in share-based compensation due to higher forfeitures. We had lower interest expense driven by a decrease in interest expense related to mortgage-backed debt, primarily as a result of the sale of our residual interest in seven of the Residual Trusts in April 2015. We had lower general and administrative expenses resulting from lower curtailment expense, lower advertising costs, and a reduction in our representations and warranties reserve related to a change in estimate, partially offset by higher costs to support efficiency and technology-related initiatives including our servicing platform conversion and higher legal accruals for loss contingencies and legal expenses, primarily for defense litigation.
During the second quarter ended June 30, 2016, Ditech Financial transitioned approximately 1.4 million loans, or greater than 60% of our mortgage loan servicing portfolio, to MSP, the industry-standard loan servicing platform. The conversion resulted in a reduction to servicer payables and related restricted cash balances as a result of changes in the structure and timing of the flow of funds to certain custodial accounts that are not reflected in the Company's consolidated balance sheets. The conversion also had an indirect impact on other balances included in the Servicing segment, which is discussed in further detail under the Business Segment Results section below.
Our cash flows provided by operating activities were $310.0 million during the six months ended June 30, 2016. We finished the six months ended June 30, 2016 with $312.9 million in cash and cash equivalents. Cash flows provided by operating activities increased by $578.8 million during the six months ended June 30, 2016 as compared to the same period of 2015. The increase in cash provided by operating activities was primarily a result of an increase in cash provided by originations activities, resulting from a higher volume of loans sold in relation to originated loans as compared to the same period of 2015.
Refer to the Results of Operations and Business Segment Results sections below for further information on the changes addressed above. Also included in our Business Segment Results is a discussion of changes in our non-GAAP financial measures. A description of our non-GAAP financial measures is included in the Non-GAAP Financial Measures section below.
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Strategy
Capital Efficiency
We are focused on using our capital efficiently. We continue to pursue opportunities to bolster our servicing portfolio. First, we use our originations platform to refinance and retain loans in our current servicing portfolio as well as to generate new loans to add to our servicing portfolio. Second, we are seeking to increase over time the portion of our servicing portfolio that is associated with sub-servicing contracts, which generate fee income for us with lower capital outlay, as compared to purchasing servicing rights. Third, we believe there will continue to be a trend towards consolidation in the mortgage servicing industry and, accordingly, from time to time if opportunities arise, we may seek to acquire mortgage servicing rights or other businesses or assets that are complementary to our core servicing portfolio and mortgage banking platform.
With a view to using our capital efficiently, we expect to limit or reduce our investment in mortgage servicing rights. We plan to seek opportunities to sell mortgage servicing rights owned by us to third parties, generally on the basis that we are retained by the buyer to sub-service such rights; however, from time to time we may sell the servicing rights with servicing released. We may also seek to sell excess servicing spread or other similar assets. Our ability to execute such transactions will depend on various factors such as the capital available to potential counterparties, their ability to purchase servicing rights at a price attractive to them, and agreement between us and them on the price and terms for our sub-servicing engagement. In May 2016, we sold Fannie Mae mortgage servicing rights to a third party for $40.2 million, for which we did not retain sub-servicing on the related mortgage loans. In May 2016, we sold Fannie Mae mortgage servicing rights to WCO for $27.9 million; we continue to service the mortgage loans relating to these mortgage servicing rights under our sub-servicing arrangement with WCO. Further, in June 2016, we sold servicing rights for which the underlying loans included non-performing loans. We paid $10.7 million to relinquish our servicing rights associated with this transaction, and did not retain sub-servicing on this portfolio.
On August 8, 2016 we entered into agreements with NRM to sell mortgage servicing rights for a purchase price of approximately $231 million, subject to adjustment. The agreements also provide that, subject to agreement on price and other matters, NRM will from time to time purchase mortgage servicing rights relating to mortgage loans we originate in the future. Pursuant to those arrangements, we expect to be retained by NRM to subservice these mortgage servicing rights. The closing of these transactions is subject to the receipt of GSE and other approvals, various other conditions precedent and certain termination provisions.
In part to simplify our business and also to generate cash in connection with our focus on efficient use of capital, we have been selling certain non-core assets since 2015, including our first quarter 2015 sale of an equity method investment and our April 2015 sale of the residual interests in seven of the Residual Trusts. During the second quarter of 2016, we began to evaluate strategic options for our reverse mortgage business, including the possibility of transitioning this business to a fee-for-service model, entering into flow arrangements for future production, selling some or all of the business and other potential alternatives. Total assets within the reverse business were $11.3 billion as of June 30, 2016. Further, we continue to work on a potential sale of substantially all of our insurance business. Based on recently obtained regulatory guidance, we are seeking to determine whether we can restructure the proposed transaction to meet the expectations of the parties and the regulatory authorities. We are not certain whether these discussions will be successful or that we will be able to consummate the proposed transaction, and are considering other options for our insurance business, which may include, among other things, alternative transactions. We may consider other asset sale opportunities if they arise.
During the six months ended June 30, 2016, we repurchased $7.2 million in principal balance of the 2013 Term Loan for $6.3 million as part of our efforts to strengthen the capital structure of the Company. We intend to pursue opportunities designed to further strengthen the Company’s capital structure through the efficient deployment of capital we generate from operations and other future actions. Among other things, we may deploy funds to reduce our leverage by repurchasing debt securities in open market transactions, repaying corporate or other debt, and we may engage in other transactions designed to reduce, extend, exchange or otherwise modify the terms or amount of our corporate debt. We may also from time to time seek to repurchase our equity securities. Our ability to deploy such funds or engage in such transactions may be limited by covenants in our debt facilities and securities and by our other contractual and regulatory obligations, including covenants restricting our ability to sell assets, covenants imposing requirements on the use of the proceeds from such sales and covenants and other obligations requiring us to meet certain financial tests.
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Operational Efficiency
We have been accelerating our efforts to improve the efficiency of our operations.
Process efficiencies have been a key focus for us, as we announced a company-wide process re-engineering initiative earlier this year that includes a comprehensive review of our cost structure and operations. We have already taken actions in conjunction with this transformation effort that we expect will result in over $75 million of annual savings, including $17 million of cost savings from actions taken during the first quarter of 2016, and includes further site consolidation, operational realignment, a focused collections strategy and the redesign of certain operational procedures. Approximately $46 million of these annual savings as well as the elimination of losses from closure of retail originations were a direct result of the exit activities discussed in Note 10 to the Consolidated Financial Statements. One-time costs associated with exit activities were $8.7 million during the six months ended June 30, 2016.
While we have been successful in implementing certain cost saving initiatives and we plan to continue to take actions across our businesses to improve efficiency, identify revenue opportunities, and reduce expense, certain other costs have arisen or are expected to arise. For example, we have been making investments and taking other measures to enhance the structure and effectiveness of our compliance and risk processes and associated programs across the Company, with a view to improving our customers’ experience and our compliance results. The mortgage industry generally, including our Company, is subject to extensive and evolving regulation and continues to be under scrutiny from federal and state regulators, enforcement agencies and other government entities. This oversight has led, in our case, to ongoing investigations and examinations of several of our business areas, and we have been and will be required to dedicate internal and external resources to providing information to and otherwise cooperating with such government entities. In addition, we have incurred, and expect that in the future we will incur, expenses (i) associated with the remediation or other resolution of findings or concerns raised by regulators, enforcement agencies, other government entities and customers, (ii) to enhance the effectiveness of our risk and compliance program and (iii) to otherwise rectify instances of operational issues and other events of noncompliance discovered through our compliance program or otherwise. These investments to enhance our compliance and risk processes are also intended to result in an improved customer experience and competitive advantage for our business.
Walter Capital Opportunity Corp.
In 2014, we established WCO, a company formed to invest in mortgage-related assets, including MSRs, excess servicing spread related to MSRs, residential whole loans, agency mortgage-backed securities and other real estate-related securities and related derivatives, (i) to facilitate our transition toward a business model in which, where appropriate and feasible, we sub-service and manage mortgage-related assets owned by third parties rather than by us, and (ii) to grow our investment management business. We have been in discussions with WCO and its other investors regarding strategic options for WCO, which may include WCO selling some or all of its assets to other parties or to us. There can be no assurance WCO will successfully execute any of these strategic options, and the impact, if any, of any such transactions on our business, financial condition and liquidity is uncertain.
As of June 30, 2016, WCO had aggregate total capital commitments of $245 million, of which approximately $220 million had been funded, including the entirety of our $20.0 million capital commitment. We also own warrants to purchase additional equity in WCO.
Concurrently with the first funding of WCO capital commitments in July 2014:
(i) | we entered into a management agreement with WCO pursuant to which GTIM was appointed the manager of WCO. Under the management agreement, GTIM provides investment advisory and management services to WCO and administers its business activities and day-to-day operations, including providing the management team of WCO (which is comprised of persons that are also officers and/or employees of the Company) and counseling WCO regarding its qualification as a REIT. GTIM provides its services under the management agreement subject to the supervision of WCO’s board of directors, which was comprised of four members as of June 30, 2016. Effective June 30, 2016, our former Chief Executive Officer and Vice Chairman resigned from the WCO board, and effective July 1, 2016, we appointed two of our officers to the WCO board, which resulted in the WCO board being comprised of five members as of July 1, 2016. Pursuant to the management agreement, GTIM is entitled to earn a base management fee and certain performance-based incentive fees. The management agreement has an initial four-year term, with automatic one-year renewal periods; |
(ii) | we entered into a contribution agreement with WCO, which was subsequently amended, and pursuant thereto, in May 2015, contributed 100% of the equity of Marix to WCO (Marix holds certain state licenses to own MSRs and is an approved Freddie Mac and Fannie Mae servicer; however, any transfer to Marix of an MSR relating to a GSE mortgage loan would require the consent of the applicable GSE, and potentially other approvals); |
(iii) | we sold to WCO a portion of the excess servicing spread associated with certain mortgage loans serviced by us for $75.4 million; and |
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(iv) | we entered into various other ancillary agreements with WCO pursuant to which, among other things, WCO has the right to make the first offer to purchase servicing rights relating to certain mortgage loans we originate and certain excess servicing spread that we may create from time to time. |
In November 2015, we entered into additional arrangements with WCO:
(i) | we sold to WCO excess servicing spread associated with certain mortgage loans serviced by us for $46.8 million; |
(ii) | we sold mortgage servicing rights originated by Ditech Financial to WCO for $17.8 million; |
(iii) | we entered into a sub-servicing arrangement with WCO pursuant to which we sub-service the mortgage loans underlying the mortgage servicing rights sold by Ditech Financial to WCO in exchange for a sub-servicing fee; and |
(iv) | Ditech Financial was engaged by WCO to offer refinancing options to borrowers with mortgage loans underlying the aforementioned excess spread sale transaction and mortgage servicing rights transaction for purposes of minimizing portfolio runoff. |
Further, in May 2016, pursuant to the aforementioned November 2015 arrangement, we sold additional mortgage servicing rights originated by Ditech Financial to WCO for $27.9 million, and in accordance with the aforementioned sub-servicing arrangement with WCO are now sub-servicing the mortgage loans underlying the mortgage servicing rights sold in exchange for a sub-servicing fee.
In addition, we have entered into servicing and sub-servicing arrangements with WCO pursuant to which we service residential whole loans acquired by WCO from a third party in exchange for a servicing fee and sub-service GSE mortgage loans underlying mortgage servicing rights acquired by WCO from a third party in exchange for a sub-servicing fee. Ditech Financial was also engaged by WCO to offer refinancing options to borrowers with mortgage loans underlying the aforementioned sub-servicing arrangement for purposes of minimizing portfolio runoff.
We have sold excess servicing spread and servicing rights to WCO and have been engaged by WCO to service whole loans and sub-service mortgage loans underlying mortgage servicing rights owned by WCO.
Regulatory Developments
Our business is subject to extensive regulation by federal, state and local authorities, including the CFPB, HUD, VA, the SEC and various state agencies that license, audit and conduct examinations of our mortgage servicing and mortgage originations businesses. We are also subject to a variety of regulatory and contractual obligations imposed by credit owners, investors, insurers and guarantors of the mortgages we originate and service, including, but not limited to, Fannie Mae, Freddie Mac, Ginnie Mae, FHFA and the VA/FHA. Furthermore, our industry has been under increased scrutiny by federal and state regulators over the past several years. We expect this scrutiny to continue. Laws, rules, regulations and practices that have been in place for many years may be changed, and new laws, rules, regulations and administrative guidance have been, and may continue to be, introduced in order to address real and perceived problems in our industry. We expect to incur ongoing operational, legal and system costs in order to comply with these rules and regulations.
Refer to our Annual Report on Form 10-K for the year ended December 31, 2015 for additional information about the regulatory framework under which we operate.
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Results of Operations — Comparison of Consolidated Results of Operations (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | ||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | ||||||||||||||||||||||
(Restated) | (Restated) | ||||||||||||||||||||||||||||
REVENUES | |||||||||||||||||||||||||||||
Net servicing revenue and fees | $ | 31,936 | $ | 223,915 | $ | (191,979 | ) | (86 | )% | $ | (73,826 | ) | $ | 314,802 | $ | (388,628 | ) | (123 | )% | ||||||||||
Net gains on sales of loans | 100,176 | 119,399 | (19,223 | ) | (16 | )% | 184,653 | 244,626 | (59,973 | ) | (25 | )% | |||||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | 7,650 | 6,815 | 835 | 12 | % | 42,858 | 37,589 | 5,269 | 14 | % | |||||||||||||||||||
Interest income on loans | 11,849 | 18,186 | (6,337 | ) | (35 | )% | 24,020 | 50,127 | (26,107 | ) | (52 | )% | |||||||||||||||||
Insurance revenue | 11,277 | 11,429 | (152 | ) | (1 | )% | 21,644 | 25,560 | (3,916 | ) | (15 | )% | |||||||||||||||||
Other revenues | 24,585 | 32,689 | (8,104 | ) | (25 | )% | 54,895 | 50,586 | 4,309 | 9 | % | ||||||||||||||||||
Total revenues | 187,473 | 412,433 | (224,960 | ) | (55 | )% | 254,244 | 723,290 | (469,046 | ) | (65 | )% | |||||||||||||||||
EXPENSES | |||||||||||||||||||||||||||||
Salaries and benefits | 133,681 | 143,157 | (9,476 | ) | (7 | )% | 266,320 | 290,385 | (24,065 | ) | (8 | )% | |||||||||||||||||
General and administrative | 135,776 | 142,100 | (6,324 | ) | (4 | )% | 265,382 | 270,747 | (5,365 | ) | (2 | )% | |||||||||||||||||
Goodwill impairment | 215,412 | 56,539 | 158,873 | 281 | % | 215,412 | 56,539 | 158,873 | 281 | % | |||||||||||||||||||
Interest expense | 64,400 | 68,665 | (4,265 | ) | (6 | )% | 128,648 | 143,536 | (14,888 | ) | (10 | )% | |||||||||||||||||
Depreciation and amortization | 14,540 | 16,093 | (1,553 | ) | (10 | )% | 28,963 | 32,725 | (3,762 | ) | (11 | )% | |||||||||||||||||
Other expenses, net | 1,897 | 1,401 | 496 | 35 | % | 4,403 | 5,448 | (1,045 | ) | (19 | )% | ||||||||||||||||||
Total expenses | 565,706 | 427,955 | 137,751 | 32 | % | 909,128 | 799,380 | 109,748 | 14 | % | |||||||||||||||||||
OTHER GAINS (LOSSES) | |||||||||||||||||||||||||||||
Other net fair value gains (losses) | (819 | ) | 3,326 | (4,145 | ) | (125 | )% | (2,963 | ) | 2,454 | (5,417 | ) | (221 | )% | |||||||||||||||
Gain on extinguishment | — | — | — | — | % | 928 | — | 928 | n/m | ||||||||||||||||||||
Other | (532 | ) | (2,803 | ) | 2,271 | (81 | )% | (1,556 | ) | 8,959 | (10,515 | ) | (117 | )% | |||||||||||||||
Total other gains (losses) | (1,351 | ) | 523 | (1,874 | ) | n/m | (3,591 | ) | 11,413 | (15,004 | ) | (131 | )% | ||||||||||||||||
Loss before income taxes | (379,584 | ) | (14,999 | ) | (364,585 | ) | n/m | (658,475 | ) | (64,677 | ) | (593,798 | ) | n/m | |||||||||||||||
Income tax expense | 110,379 | 23,120 | 87,259 | 377 | % | 4,190 | 4,450 | (260 | ) | n/m | |||||||||||||||||||
Net loss | $ | (489,963 | ) | $ | (38,119 | ) | $ | (451,844 | ) | n/m | $ | (662,665 | ) | $ | (69,127 | ) | $ | (593,538 | ) | n/m |
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Net Servicing Revenue and Fees
A summary of net servicing revenue and fees is provided below (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | ||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | ||||||||||||||||||||||
Servicing fees | $ | 177,082 | $ | 176,316 | $ | 766 | — | % | $ | 354,836 | $ | 348,048 | $ | 6,788 | 2 | % | |||||||||||||
Incentive and performance fees | 18,011 | 33,681 | (15,670 | ) | (47 | )% | 37,783 | 65,419 | (27,636 | ) | (42 | )% | |||||||||||||||||
Ancillary and other fees | 25,058 | 25,436 | (378 | ) | (1 | )% | 49,667 | 50,919 | (1,252 | ) | (2 | )% | |||||||||||||||||
Servicing revenue and fees | 220,151 | 235,433 | (15,282 | ) | (6 | )% | 442,286 | 464,386 | (22,100 | ) | (5 | )% | |||||||||||||||||
Changes in valuation inputs or other assumptions (1) | (127,713 | ) | 59,286 | (186,999 | ) | n/m | (386,173 | ) | (15,248 | ) | (370,925 | ) | n/m | ||||||||||||||||
Other changes in fair value (2) | (59,780 | ) | (58,145 | ) | (1,635 | ) | 3 | % | (127,900 | ) | (112,846 | ) | (15,054 | ) | 13 | % | |||||||||||||
Change in fair value of servicing rights | (187,493 | ) | 1,141 | (188,634 | ) | n/m | (514,073 | ) | (128,094 | ) | (385,979 | ) | n/m | ||||||||||||||||
Amortization of servicing rights | (2,625 | ) | (6,965 | ) | 4,340 | (62 | )% | (7,236 | ) | (13,978 | ) | 6,742 | (48 | )% | |||||||||||||||
Change in fair value of servicing rights related liabilities | 1,903 | (5,694 | ) | 7,597 | (133 | )% | 5,197 | (7,512 | ) | 12,709 | (169 | )% | |||||||||||||||||
Net servicing revenue and fees | $ | 31,936 | $ | 223,915 | $ | (191,979 | ) | (86 | )% | $ | (73,826 | ) | $ | 314,802 | $ | (388,628 | ) | (123 | )% |
__________
(1) | Represents the net change in servicing rights carried at fair value resulting primarily from market-driven changes in interest rates and prepayment speeds. |
(2) | Represents the realization of expected cash flows over time. |
We recognize servicing revenue and fees on servicing performed for third parties in which we either own the servicing right or act as sub-servicer. This revenue includes contractual fees earned on the serviced loans, incentive and performance fees earned based on the performance of certain loans or loan portfolios serviced by us, and loan modification fees. Servicing revenue and fees also includes asset recovery income, which is included in incentive and performance fees, and ancillary fees such as late fees and expedited payment fees. Servicing revenue and fees are adjusted for the amortization and change in fair value of servicing rights and the change in fair value of the servicing rights related liabilities.
Servicing fees increased $6.8 million in the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to growth in the third-party servicing portfolio resulting from portfolio acquisitions and servicing rights capitalized as a result of our loan origination activities, partially offset by runoff of the servicing portfolio. Incentive and performance fees decreased $15.7 million and $27.6 million in the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to lower real estate owned management fees resulting from the phase out of one of our larger arrangements for the management of real estate owned, and lower fees earned under HAMP resulting from lower fees for maintenance of performing modified loans no longer eligible for HAMP incentive fees. Ancillary and other fees remained relatively flat for the three and six months ended June 30, 2016 as compared to the same periods of 2015. Refer to the Servicing segment section under our Business Segment Results section below for additional information on the changes in fair value relating to servicing rights and our servicing rights related liabilities.
Net Gains on Sales of Loans
Net gains on sales of loans include realized and unrealized gains and losses on loans held for sale, fair value adjustments on IRLCs and other related freestanding derivatives, values of the initial capitalized servicing rights, and a provision for the repurchase of loans. Net gains on sales of loans decreased $19.2 million and $60.0 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to a lower volume of locked loans, offset partially by a shift in mix from the lower margin correspondent channel to the higher margin consumer channel. Additionally, we had lower capitalized servicing rights due primarily to a lower volume of loans sold with servicing retained, coupled with a reduction in the fair value of servicing rights.
Net Fair Value Gains on Reverse Loans and Related HMBS Obligations
Net fair value gains on reverse loans and related HMBS obligations include the contractual interest income earned on reverse loans, including those not yet securitized or bought out of securitization pools, net of interest expense on HMBS related obligations, and the change in fair value of these assets and liabilities. Refer to the Reverse Mortgage segment discussion under our Business Segment Results section below for additional information including a detailed breakout of the components of net fair value gains on reverse loans and related HMBS obligations.
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Net fair value gains on reverse loans and related HMBS obligations increased $5.3 million during the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to a lower fair value reduction due to a larger decrease in the interest rate curve in 2016 as compared to 2015, offset in part by lower origination volumes. Reverse loans and related HMBS obligations are generally subject to net fair value gains when interest rates decline primarily as a result of a longer duration of reverse loans as compared to HMBS related obligations. Our reverse loans have longer durations primarily as a result of our obligations as issuer of HMBS, which includes the requirement to purchase loans out of the Ginnie Mae securitization pools once the outstanding principal balance of the related HECM is equal to or greater than 98% of the maximum claim amount.
Interest Income on Loans
We earn interest income on the residential loans held in the Residual Trusts and on our unencumbered mortgage loans, both of which are accounted for at amortized cost. During April 2015, we sold our residual interest in seven of the Residual Trusts, or sale of residual interests, and deconsolidated the assets and liabilities of these trusts. Interest income decreased $6.3 million and $26.1 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to the aforementioned sale of our residual interests in 2015, runoff of the overall mortgage loan portfolio and a lower average yield on loans due to an increase in delinquencies that are 90 days or more past due.
Provided below is a summary of the average balances of residential loans carried at amortized cost and the related interest income and average yields (dollars in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||
2016 | 2015 | Variance | 2016 | 2015 | Variance | |||||||||||||||||||
Residential loans at amortized cost | ||||||||||||||||||||||||
Interest income | $ | 11,849 | $ | 18,186 | $ | (6,337 | ) | $ | 24,020 | $ | 50,127 | $ | (26,107 | ) | ||||||||||
Average balance (1) | 556,861 | 798,376 | (241,515 | ) | 553,369 | 1,057,393 | (504,024 | ) | ||||||||||||||||
Annualized average yield | 8.51 | % | 9.11 | % | (0.60 | )% | 8.68 | % | 9.48 | % | (0.80 | )% |
__________
(1) | Average balance is calculated as the average recorded investment in the loans at the beginning of each month during the period. |
Insurance Revenue
Insurance revenue consists of commission income and fees earned on voluntary and lender-placed insurance policies issued and other products sold to borrowers, net of estimated future policy cancellations. Commission income is based on a percentage of the premium of the insurance policy issued, which varies based on the type of policy. Insurance revenue decreased $3.9 million for the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to the runoff of existing policies. In addition, in September 2015 we entered into an agreement to settle a litigation matter (which agreement remains subject to final court approval) pursuant to which we have agreed not to receive commissions as a result of the placement of certain lender-placed insurance policies for five years commencing 120 days from the effective date of the settlement.
Other Revenues
Other revenues consist primarily of the change in fair value of charged-off loans, origination fee income and other interest income. Other revenues decreased $8.1 million for the three months ended June 30, 2016 as compared to the same period of 2015 due primarily to $6.0 million in lower fair value gains relating to charged-off loans resulting from lower variances between actual and expected collections over time and a $1.7 million decrease in origination fee income resulting from a decline in originations volume. Origination fee income was $9.8 million and $11.5 million for the three months ended June 30, 2016 and 2015, respectively.
Other revenues increased $4.3 million for the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to a $5.3 million increase in origination fee income resulting from our having waived certain fees charged to borrowers refinancing mortgage loans during the first half of 2015, and $2.4 million in higher fair value gains relating to charged-off loans resulting from better collections performance in the portfolio than previously expected, partially offset by a $2.4 million decrease in other interest income. Origination fee income was $21.4 million and $16.1 million for the six months ended June 30, 2016 and 2015, respectively.
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Salaries and Benefits
Salaries and benefits decreased $9.5 million and $24.1 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to a decrease in benefits and incentives resulting from a lower average headcount and a decrease in commissions due to lower originations volume, partially offset by an increase in severance. The lower expenses for the six months ended June 30, 2016 were also impacted by a decrease in share-based compensation due to higher forfeitures. Headcount decreased by approximately 400 full-time employees from approximately 6,000 at June 30, 2015 to approximately 5,600 at June 30, 2016.
General and Administrative
General and administrative decreased $6.3 million for the three months ended June 30, 2016 as compared to the same period of 2015 resulting primarily from an $8.9 million reduction in our representations and warranties reserve related to a change in estimate as described in further detail in the Originations segment results, and $5.5 million in lower advertising costs, partially offset by $8.7 million in additional costs to support efficiency and technology-related initiatives, including the MSP conversion.
General and administrative decreased $5.4 million for the six months ended June 30, 2016 as compared to the same period of 2015 resulting primarily from $17.6 million in lower curtailment expense, $10.8 million in lower advertising costs, and an $8.9 million reduction in our representations and warranties reserve related to a change in estimate, partially offset by $13.2 million in additional costs to support efficiency and technology-related initiatives, including the MSP conversion, $9.9 million in higher legal accruals for loss contingencies and legal expenses primarily for defense litigation, $4.8 million in higher operating costs, and $3.7 million in higher information technology maintenance costs.
Goodwill Impairment
We incurred $215.4 million in impairment charges in our Servicing segment during the three and six months ended June 30, 2016 as a result of a goodwill evaluation performed in the second quarter of 2016. Refer to Note 9 to the Consolidated Financial Statements for further information.
We incurred $56.5 million in impairment charges in our Reverse Mortgage segment during the three and six months ended June 30, 2015 as a result of a goodwill evaluation performed in the second quarter of 2015. As a result of these goodwill charges, the Reverse Mortgage reporting unit no longer has goodwill.
Interest Expense
We incur interest expense on our corporate debt, mortgage-backed debt issued by the Residual Trusts, master repurchase agreements and servicing advance liabilities, all of which are accounted for at amortized cost. Interest expense decreased $4.3 million and $14.9 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, driven by a decrease in interest expense related to mortgage-backed debt primarily as a result of the sale of our residual interests in April 2015, which required the deconsolidation of the related mortgage-backed debt, and the runoff of the overall related mortgage loan portfolio. Refer to the Liquidity and Capital Resources section below for additional information on our debt.
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Provided below is a summary of the average balances of our corporate debt, servicing advance liabilities, master repurchase agreements, and mortgage-backed debt of the Residual Trusts, as well as the related interest expense and average rates (dollars in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||
2016 | 2015 | Variance | 2016 | 2015 | Variance | |||||||||||||||||||
Corporate debt (1) | ||||||||||||||||||||||||
Interest expense | $ | 35,920 | $ | 37,076 | $ | (1,156 | ) | $ | 71,817 | $ | 73,826 | $ | (2,009 | ) | ||||||||||
Average balance (4) | 2,181,624 | 2,268,298 | (86,674 | ) | 2,182,970 | 2,268,725 | (85,755 | ) | ||||||||||||||||
Annualized average rate | 6.59 | % | 6.54 | % | 0.05 | % | 6.58 | % | 6.51 | % | 0.07 | % | ||||||||||||
Servicing advance liabilities (2) | ||||||||||||||||||||||||
Interest expense | $ | 11,109 | $ | 9,798 | $ | 1,311 | $ | 22,291 | $ | 20,671 | $ | 1,620 | ||||||||||||
Average balance (4) | 1,213,136 | 1,245,838 | (32,702 | ) | 1,223,965 | 1,294,373 | (70,408 | ) | ||||||||||||||||
Annualized average rate | 3.66 | % | 3.15 | % | 0.51 | % | 3.64 | % | 3.19 | % | 0.45 | % | ||||||||||||
Master repurchase agreements (3) | ||||||||||||||||||||||||
Interest expense | $ | 10,207 | $ | 11,066 | $ | (859 | ) | $ | 20,067 | $ | 19,977 | $ | 90 | |||||||||||
Average balance (4) | 1,184,447 | 1,538,349 | (353,902 | ) | 1,174,321 | 1,461,234 | (286,913 | ) | ||||||||||||||||
Annualized average rate | 3.45 | % | 2.88 | % | 0.57 | % | 3.42 | % | 2.73 | % | 0.69 | % | ||||||||||||
Mortgage-backed debt of the Residual Trusts (2) | ||||||||||||||||||||||||
Interest expense | $ | 7,164 | $ | 10,725 | $ | (3,561 | ) | $ | 14,473 | $ | 29,062 | $ | (14,589 | ) | ||||||||||
Average balance (5) | 460,025 | 687,236 | (227,211 | ) | 464,443 | 887,558 | (423,115 | ) | ||||||||||||||||
Annualized average rate | 6.23 | % | 6.24 | % | (0.01 | )% | 6.23 | % | 6.55 | % | (0.32 | )% |
__________
(1) | Corporate debt includes our 2013 Term Loan, Senior Notes, and Convertible Notes. Corporate debt activities are included in the Other non-reportable segment. |
(2) | Mortgage-backed debt of the Residual Trusts and servicing advance liabilities are held by our Servicing segment. |
(3) | Master repurchase agreements are held by the Originations and Reverse Mortgage segments. |
(4) | Average balance for corporate debt, servicing advance liabilities and master repurchase agreements is calculated as the average daily carrying value. |
(5) | Average balance for mortgage-backed debt of the Residual Trusts is calculated as the average carrying value at the beginning of each month during the period. |
Other Gains (Losses)
Other gains of $9.0 million for the six months ended June 30, 2015 include an $11.8 million gain recognized on the sale of an investment accounted for using the equity method in the first quarter of 2015 and a $2.8 million loss recognized on the sale of our residual interests in the second quarter of 2015.
Income Tax Expense
We calculate income tax expense based on our estimated annual effective tax rate, which takes into account all expected ordinary activity for the calendar year. Our effective tax rate normally differs from the U.S. statutory tax rate of 35% due to state and local taxes and non-deductible expenses.
Income tax expense was $110.4 million during the three months ended June 30, 2016 as compared to $23.1 million in the same period of 2015. Tax expense was impacted by the impairment of non-deductible goodwill, which was more than offset by the additional valuation allowance recorded on the net deferred tax assets balance in connection with this Amended Filing of $257.6 million.
Income tax expense was $4.2 million during the six months ended June 30, 2016 as compared to $4.5 million in the same period of 2015. This change was primarily driven by the additional valuation allowance recorded on the net deferred tax assets balance in connection with this Amended Filing of $257.6 million, offset in part by the impairment of non-deductible goodwill.
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We are required to establish a valuation allowance for deferred tax assets and record a charge to income if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets, net decreased $257.6 million primarily as a result of the valuation allowance recorded against our deferred tax assets, including the restatement adjustment as described in Note 2 to the Consolidated Financial Statements, which increased the valuation allowance by $257.6 million at June 30, 2016.
Non-GAAP Financial Measures
We manage our Company in three reportable segments: Servicing, Originations and Reverse Mortgage. We measure the performance of our business segments through the following measures: income (loss) before income taxes, Adjusted Earnings (Loss), and Adjusted EBITDA. Management considers Adjusted Earnings (Loss) and Adjusted EBITDA, both non-GAAP financial measures, to be important in the evaluation of our business segments and of the Company as a whole, as well as for allocating capital resources to our segments. Adjusted Earnings (Loss) and Adjusted EBITDA are supplemental metrics utilized by management to assess the underlying key drivers and operational performance of the continuing operations of the business. In addition, analysts, investors, and creditors may use these measures when analyzing our operating performance. Adjusted Earnings (Loss) and Adjusted EBITDA are not presentations made in accordance with GAAP and our use of these measures and terms may vary from other companies in our industry.
Adjusted Earnings (Loss) is defined as income (loss) before income taxes plus changes in fair value due to changes in valuation inputs and other assumptions; certain depreciation and amortization costs related to the increased basis in assets (including servicing rights and sub-servicing contracts) acquired within business combination transactions (or step-up depreciation and amortization); goodwill impairment, if any; a portion of the provision for curtailment expense, net of expected third-party recoveries; share-based compensation expense; non-cash interest expense; restructuring costs; estimated settlements and costs for certain legal and regulatory matters; fair value to cash adjustments for reverse loans; and select other cash and non-cash adjustments primarily including severance; gain or loss on extinguishment of debt; the net impact of the Non-Residual Trusts; transaction and integration costs; and certain non-recurring costs. Adjusted Earnings (Loss) excludes unrealized changes in fair value of MSRs that are based on projections of expected future cash flows and prepayments. Adjusted Earnings (Loss) includes both cash and non-cash gains from mortgage loan origination activities. Non-cash gains are net of non-cash charges or reserves provided. Adjusted Earnings (Loss) includes cash generated from reverse mortgage origination activities. Adjusted Earnings (Loss) may from time to time also include other adjustments, as applicable based upon facts and circumstances, consistent with the intent of providing investors with a supplemental means of evaluating our operating performance.
Adjusted EBITDA eliminates the effects of financing, income taxes and depreciation and amortization. Adjusted EBITDA is defined as income (loss) before income taxes; amortization of servicing rights and other fair value adjustments; interest expense on corporate debt; depreciation and amortization; goodwill impairment, if any; a portion of the provision for curtailment expense, net of expected third-party recoveries; share-based compensation expense; restructuring costs; estimated settlements and costs for certain legal and regulatory matters; fair value to cash adjustments for reverse loans; and select other cash and non-cash adjustments primarily the net provision for the repurchase of loans sold; non-cash interest income; severance; gain or loss on extinguishment of debt; interest income on unrestricted cash and cash equivalents; the net impact of the Non-Residual Trusts; the provision for loan losses; Residual Trust cash flows; transaction and integration costs; servicing fee economics; and certain non-recurring costs. Adjusted EBITDA includes both cash and non-cash gains from mortgage loan origination activities. Adjusted EBITDA excludes the impact of fair value option accounting on certain assets and liabilities and includes cash generated from reverse mortgage origination activities. Adjusted EBITDA may also include other adjustments, as applicable based upon facts and circumstances, consistent with the intent of providing investors a supplemental means of evaluating our operating performance.
Adjusted Earnings (Loss) and Adjusted EBITDA should not be considered as alternatives to (i) net income (loss) or any other performance measures determined in accordance with GAAP or (ii) operating cash flows determined in accordance with GAAP. Adjusted Earnings (Loss) and Adjusted EBITDA have important limitations as analytical tools, and should not be considered in isolation or as substitutes for analysis of our results as reported under GAAP. Some of the limitations of these metrics are:
• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect cash expenditures for long-term assets and other items that have been and will be incurred, future requirements for capital expenditures or contractual commitments; |
• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs; |
• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect certain tax payments that represent reductions in cash available to us; |
• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect any cash requirements for the assets being depreciated and amortized that may have to be replaced in the future; |
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• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect non-cash compensation which is and will remain a key element of our overall long-term incentive compensation package; |
• | Adjusted Earnings (Loss) and Adjusted EBITDA do not reflect the change in fair value due to changes in valuation inputs and other assumptions; |
• | Adjusted EBITDA does not reflect the change in fair value resulting from the realization of expected cash flows; and |
• | Adjusted EBITDA does not reflect the significant interest expense or the cash requirements necessary to service interest or principal payments on our servicing rights related liabilities and corporate debt, although it does reflect interest expense associated with our servicing advance liabilities, master repurchase agreements, mortgage-backed debt, and HMBS related obligations. |
Because of these limitations, Adjusted Earnings (Loss) and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using Adjusted Earnings (Loss) and Adjusted EBITDA only as supplements. Users of our financial statements are cautioned not to place undue reliance on Adjusted Earnings (Loss) and Adjusted EBITDA.
The following tables reconcile Adjusted Earnings (Loss) and Adjusted EBITDA to net loss, which we consider to be the most directly comparable GAAP financial measure to Adjusted Earnings (Loss) and Adjusted EBITDA (in thousands):
Adjusted Loss
For the Six Months Ended June 30, 2016 | ||||
(Restated) | ||||
Net loss | $ | (662,665 | ) | |
Adjust for income tax expense | 4,190 | |||
Loss before income taxes | (658,475 | ) | ||
Adjustments to loss before income taxes | ||||
Changes in fair value due to changes in valuation inputs and other assumptions (1) | 359,154 | |||
Goodwill impairment | 215,412 | |||
Step-up depreciation and amortization (2) | 19,554 | |||
Restructuring costs (3) | 8,740 | |||
Non-cash interest expense | 5,796 | |||
Share-based compensation expense | 5,705 | |||
Fair value to cash adjustment for reverse loans (4) | (3,197 | ) | ||
Legal and regulatory matters | 2,196 | |||
Other (5) | 20,330 | |||
Sub-total | 633,690 | |||
Adjusted Loss | $ | (24,785 | ) |
__________
(1) | Consists of the change in fair value due to changes in valuation inputs and other assumptions relating to servicing rights, servicing rights related liabilities and charged-off loans. |
(2) | Represents depreciation and amortization costs related to the increased basis in assets, including servicing and sub-servicing rights, acquired within business combination transactions. |
(3) | Restructuring costs include expenses related to the closing of offices and the termination of certain employees as well as other expenses to institute efficiencies. Restructuring costs incurred in the six months ended June 30, 2016 include those relating to our exit from the consumer retail channel of the Originations segment and actions initiated in 2015 and 2016 in connection with our continued efforts to enhance efficiencies and streamline processes of the organization. Refer to Note 10 in the Notes to Consolidated Financial Statements. |
(4) | Represents the non-cash fair value adjustment to arrive at cash generated from reverse mortgage origination activities. |
(5) | Includes severance, gain on extinguishment of debt, the net impact of the Non-Residual Trusts, transaction and integration costs, and certain non-recurring costs. |
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Adjusted EBITDA
For the Six Months Ended June 30, 2016 | ||||
(Restated) | ||||
Net loss | $ | (662,665 | ) | |
Adjust for income tax expense | 4,190 | |||
Loss before income taxes | (658,475 | ) | ||
EBITDA Adjustments | ||||
Amortization of servicing rights and other fair value adjustments (1) | 494,290 | |||
Goodwill impairment | 215,412 | |||
Interest expense | 75,791 | |||
Depreciation and amortization | 28,963 | |||
Restructuring costs (2) | 8,740 | |||
Share-based compensation expense | 5,705 | |||
Fair value to cash adjustment for reverse loans (3) | (3,197 | ) | ||
Legal and regulatory matters | 2,196 | |||
Other (4) | 16,417 | |||
Sub-total | 844,317 | |||
Adjusted EBITDA | $ | 185,842 |
__________
(1) | Consists of the change in fair value due to changes in valuation inputs and other assumptions relating to servicing rights, servicing rights related liabilities and charged-off loans as well as the amortization of servicing rights and the realization of expected cash flows relating to servicing rights carried at fair value. |
(2) | Restructuring costs include expenses related to the closing of offices and the termination of certain employees as well as other expenses to institute efficiencies. Restructuring costs incurred in the six months ended June 30, 2016 include those relating to our exit from the consumer retail channel of the Originations segment and actions initiated in 2015 and 2016 in connection with our continued efforts to enhance efficiencies and streamline processes of the organization. Refer to Note 10 in the Notes to Consolidated Financial Statements. |
(3) | Represents the non-cash fair value adjustment to arrive at cash generated from reverse mortgage origination activities. |
(4) | Includes the net provision for the repurchase of loans sold, non-cash interest income, severance, gain on extinguishment of debt, interest income on unrestricted cash and cash equivalents, the net impact of the Non-Residual Trusts, the provision for loan losses, Residual Trust cash flows, transaction and integration costs, servicing fee economics, and certain non-recurring costs. |
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Business Segment Results
In calculating income (loss) before income taxes for our segments, we allocate indirect expenses to our business segments. Indirect expenses are allocated to our Servicing, Originations, Reverse Mortgage and certain non-reportable segments based on headcount.
We reconcile our income (loss) before income taxes for our business segments to our GAAP consolidated income (loss) before taxes and report the financial results of our Non-Residual Trusts, other non-reportable operating segments and certain corporate expenses as other activity. Refer below for further information on the results of operations for our Servicing, Originations and Reverse Mortgage segments. For a reconciliation of our income (loss) before income taxes for our business segments to our GAAP consolidated loss before income taxes, refer to Note 14 in the Notes to Consolidated Financial Statements.
Reconciliation of GAAP Income (Loss) Before Income Taxes to Adjusted Earnings (Loss) and Adjusted EBITDA (in thousands):
For the Three Months Ended June 30, 2016 | ||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Total Consolidated | ||||||||||||||||
Income (loss) before income taxes | $ | (356,026 | ) | $ | 45,615 | $ | (26,944 | ) | $ | (42,229 | ) | $ | (379,584 | ) | ||||||
Adjustments to income (loss) | ||||||||||||||||||||
Changes in fair value due to changes in valuation inputs and other assumptions | 118,825 | — | — | — | 118,825 | |||||||||||||||
Goodwill impairment | 215,412 | — | — | — | 215,412 | |||||||||||||||
Step-up depreciation and amortization | 6,601 | 157 | 894 | — | 7,652 | |||||||||||||||
Restructuring costs | 4,126 | 303 | 407 | — | 4,836 | |||||||||||||||
Non-cash interest expense | 18 | — | — | 2,940 | 2,958 | |||||||||||||||
Share-based compensation expense | 3,160 | 820 | 610 | 256 | 4,846 | |||||||||||||||
Step-up amortization of sub-servicing rights | 1,049 | — | — | — | 1,049 | |||||||||||||||
Fair value to cash adjustment for reverse loans | — | — | 14,512 | — | 14,512 | |||||||||||||||
Other | 6,065 | 1,515 | 1,398 | 4,393 | 13,371 | |||||||||||||||
Total adjustments | 355,256 | 2,795 | 17,821 | 7,589 | 383,461 | |||||||||||||||
Adjusted Earnings (Loss) | (770 | ) | 48,410 | (9,123 | ) | (34,640 | ) | 3,877 | ||||||||||||
EBITDA adjustments | ||||||||||||||||||||
Amortization of servicing rights and other fair value adjustments | 60,911 | — | 446 | — | 61,357 | |||||||||||||||
Interest expense on debt | 1,251 | — | — | 32,979 | 34,230 | |||||||||||||||
Depreciation and amortization | 4,103 | 2,091 | 693 | 1 | 6,888 | |||||||||||||||
Other | (767 | ) | (7,013 | ) | 21 | 169 | (7,590 | ) | ||||||||||||
Total adjustments | 65,498 | (4,922 | ) | 1,160 | 33,149 | 94,885 | ||||||||||||||
Adjusted EBITDA | $ | 64,728 | $ | 43,488 | $ | (7,963 | ) | $ | (1,491 | ) | $ | 98,762 |
81
For the Six Months Ended June 30, 2016 | ||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Total Consolidated | ||||||||||||||||
Income (loss) before income taxes | $ | (612,347 | ) | $ | 62,016 | $ | (21,917 | ) | $ | (86,227 | ) | $ | (658,475 | ) | ||||||
Adjustments to income (loss) | ||||||||||||||||||||
Changes in fair value due to changes in valuation inputs and other assumptions | 359,154 | — | — | — | 359,154 | |||||||||||||||
Goodwill impairment | 215,412 | — | — | — | 215,412 | |||||||||||||||
Step-up depreciation and amortization | 13,335 | 452 | 1,789 | — | 15,576 | |||||||||||||||
Restructuring costs | 6,007 | 2,099 | 407 | 227 | 8,740 | |||||||||||||||
Non-cash interest expense | (11 | ) | — | — | 5,807 | 5,796 | ||||||||||||||
Share-based compensation expense | 3,941 | 233 | 923 | 608 | 5,705 | |||||||||||||||
Step-up amortization of sub-servicing rights | 3,978 | — | — | — | 3,978 | |||||||||||||||
Legal and regulatory matters | 2,196 | — | — | — | 2,196 | |||||||||||||||
Fair value to cash adjustment for reverse loans | — | — | (3,197 | ) | — | (3,197 | ) | |||||||||||||
Other | 6,373 | 1,515 | 2,446 | 9,996 | 20,330 | |||||||||||||||
Total adjustments | 610,385 | 4,299 | 2,368 | 16,638 | 633,690 | |||||||||||||||
Adjusted Earnings (Loss) | (1,962 | ) | 66,315 | (19,549 | ) | (69,589 | ) | (24,785 | ) | |||||||||||
EBITDA adjustments | ||||||||||||||||||||
Amortization of servicing rights and other fair value adjustments | 130,252 | — | 906 | — | 131,158 | |||||||||||||||
Interest expense on debt | 3,986 | — | — | 66,009 | 69,995 | |||||||||||||||
Depreciation and amortization | 8,150 | 4,141 | 1,086 | 10 | 13,387 | |||||||||||||||
Other | (1,102 | ) | (3,212 | ) | 54 | 347 | (3,913 | ) | ||||||||||||
Total adjustments | 141,286 | 929 | 2,046 | 66,366 | 210,627 | |||||||||||||||
Adjusted EBITDA | $ | 139,324 | $ | 67,244 | $ | (17,503 | ) | $ | (3,223 | ) | $ | 185,842 |
82
For the Three Months Ended June 30, 2015 | ||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Total Consolidated | ||||||||||||||||
Income (loss) before income taxes | $ | 82,296 | $ | 32,965 | $ | (90,960 | ) | $ | (39,300 | ) | $ | (14,999 | ) | |||||||
Adjustments to income (loss) | ||||||||||||||||||||
Changes in fair value due to changes in valuation inputs and other assumptions | (64,359 | ) | — | — | — | (64,359 | ) | |||||||||||||
Goodwill impairment | — | — | 56,539 | — | 56,539 | |||||||||||||||
Step-up depreciation and amortization | 6,923 | 618 | 1,328 | — | 8,869 | |||||||||||||||
Restructuring costs | 1,578 | 130 | — | 184 | 1,892 | |||||||||||||||
Non-cash interest expense | 363 | — | — | 2,660 | 3,023 | |||||||||||||||
Share-based compensation expense | 3,123 | 1,453 | 284 | 146 | 5,006 | |||||||||||||||
Step-up amortization of sub-servicing rights | 4,940 | — | — | — | 4,940 | |||||||||||||||
Legal and regulatory matters | 544 | — | 4,628 | — | 5,172 | |||||||||||||||
Fair value to cash adjustment for reverse loans | — | — | 24,149 | — | 24,149 | |||||||||||||||
Curtailment expense | — | — | 6,488 | — | 6,488 | |||||||||||||||
Other | 976 | 85 | 63 | 1,493 | 2,617 | |||||||||||||||
Total adjustments | (45,912 | ) | 2,286 | 93,479 | 4,483 | 54,336 | ||||||||||||||
Adjusted Earnings (Loss) | 36,384 | 35,251 | 2,519 | (34,817 | ) | 39,337 | ||||||||||||||
EBITDA adjustments | ||||||||||||||||||||
Amortization of servicing rights and other fair value adjustments | 59,649 | — | 522 | — | 60,171 | |||||||||||||||
Interest expense on debt | 2,121 | — | — | 34,405 | 36,526 | |||||||||||||||
Depreciation and amortization | 4,489 | 2,074 | 658 | 3 | 7,224 | |||||||||||||||
Other | (5,090 | ) | 2,140 | 25 | 26 | (2,899 | ) | |||||||||||||
Total adjustments | 61,169 | 4,214 | 1,205 | 34,434 | 101,022 | |||||||||||||||
Adjusted EBITDA | $ | 97,553 | $ | 39,465 | $ | 3,724 | $ | (383 | ) | $ | 140,359 |
83
For the Six Months Ended June 30, 2015 | ||||||||||||||||||||
Servicing | Originations | Reverse Mortgage | Other | Total Consolidated | ||||||||||||||||
Income (loss) before income taxes | $ | 31,624 | $ | 74,763 | $ | (104,417 | ) | $ | (66,647 | ) | $ | (64,677 | ) | |||||||
Adjustments to income (loss) | ||||||||||||||||||||
Changes in fair value due to changes in valuation inputs and other assumptions | 9,412 | — | — | — | 9,412 | |||||||||||||||
Goodwill impairment | — | — | 56,539 | — | 56,539 | |||||||||||||||
Step-up depreciation and amortization | 13,967 | 1,788 | 2,656 | — | 18,411 | |||||||||||||||
Restructuring costs | 1,983 | 321 | — | 724 | 3,028 | |||||||||||||||
Non-cash interest expense | 1,118 | — | — | 5,224 | 6,342 | |||||||||||||||
Share-based compensation expense | 5,128 | 2,250 | 820 | 231 | 8,429 | |||||||||||||||
Step-up amortization of sub-servicing rights | 9,827 | — | — | — | 9,827 | |||||||||||||||
Legal and regulatory matters | 2,218 | — | 2,862 | — | 5,080 | |||||||||||||||
Fair value to cash adjustment for reverse loans | — | — | 19,794 | — | 19,794 | |||||||||||||||
Curtailment expense | — | — | 22,562 | — | 22,562 | |||||||||||||||
Other | 1,248 | 422 | 430 | 4,282 | 6,382 | |||||||||||||||
Total adjustments | 44,901 | 4,781 | 105,663 | 10,461 | 165,806 | |||||||||||||||
Adjusted Earnings (Loss) | 76,525 | 79,544 | 1,246 | (56,186 | ) | 101,129 | ||||||||||||||
EBITDA adjustments | ||||||||||||||||||||
Amortization of servicing rights and other fair value adjustments | 115,921 | — | 1,077 | — | 116,998 | |||||||||||||||
Interest expense on debt | 4,717 | — | 1 | 68,575 | 73,293 | |||||||||||||||
Depreciation and amortization | 8,918 | 4,091 | 1,298 | 7 | 14,314 | |||||||||||||||
Other | (5,408 | ) | 2,543 | 99 | 87 | (2,679 | ) | |||||||||||||
Total adjustments | 124,148 | 6,634 | 2,475 | 68,669 | 201,926 | |||||||||||||||
Adjusted EBITDA | $ | 200,673 | $ | 86,178 | $ | 3,721 | $ | 12,483 | $ | 303,055 |
84
Servicing
Provided below is a summary of results of operations, Adjusted Earnings (Loss) and Adjusted EBITDA for our Servicing segment (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Net servicing revenue and fees | �� | |||||||||||||||||||||||||||||
Third parties | $ | 24,935 | $ | 212,000 | $ | (187,065 | ) | (88 | )% | $ | (87,736 | ) | $ | 291,481 | $ | (379,217 | ) | (130 | )% | |||||||||||
Intercompany | 3,066 | 2,437 | 629 | 26 | % | 6,217 | 4,783 | 1,434 | 30 | % | ||||||||||||||||||||
Total net servicing revenue and fees | 28,001 | 214,437 | (186,436 | ) | (87 | )% | (81,519 | ) | 296,264 | (377,783 | ) | (128 | )% | |||||||||||||||||
Interest income on loans | 11,837 | 18,174 | (6,337 | ) | (35 | )% | 23,995 | 50,090 | (26,095 | ) | (52 | )% | ||||||||||||||||||
Insurance revenue | 11,277 | 11,429 | (152 | ) | (1 | )% | 21,644 | 25,560 | (3,916 | ) | (15 | )% | ||||||||||||||||||
Intersegment retention revenue | 9,461 | 8,458 | 1,003 | 12 | % | 20,994 | 16,539 | 4,455 | 27 | % | ||||||||||||||||||||
Net gains (losses) on sales of loans | (1,191 | ) | 3,795 | (4,986 | ) | (131 | )% | (5,727 | ) | 3,704 | (9,431 | ) | (255 | )% | ||||||||||||||||
Other revenues | 13,428 | 17,903 | (4,475 | ) | (25 | )% | 30,171 | 25,802 | 4,369 | 17 | % | |||||||||||||||||||
Total revenues | 72,813 | 274,196 | (201,383 | ) | (73 | )% | 9,558 | 417,959 | (408,401 | ) | (98 | )% | ||||||||||||||||||
Goodwill impairment | 215,412 | — | 215,412 | n/m | 215,412 | — | 215,412 | n/m | ||||||||||||||||||||||
General and administrative and allocated indirect expenses | 112,446 | 92,476 | 19,970 | 22 | % | 207,426 | 173,066 | 34,360 | 20 | % | ||||||||||||||||||||
Salaries and benefits | 70,475 | 64,533 | 5,942 | 9 | % | 138,095 | 134,356 | 3,739 | 3 | % | ||||||||||||||||||||
Interest expense | 18,330 | 20,534 | (2,204 | ) | (11 | )% | 36,892 | 49,759 | (12,867 | ) | (26 | )% | ||||||||||||||||||
Depreciation and amortization | 10,704 | 11,412 | (708 | ) | (6 | )% | 21,485 | 22,885 | (1,400 | ) | (6 | )% | ||||||||||||||||||
Other expenses, net | 1,075 | 44 | 1,031 | n/m | 2,289 | 3,134 | (845 | ) | (27 | )% | ||||||||||||||||||||
Total expenses | 428,442 | 188,999 | 239,443 | 127 | % | 621,599 | 383,200 | 238,399 | 62 | % | ||||||||||||||||||||
Other net fair value gains (losses) | 135 | (98 | ) | 233 | (238 | )% | 226 | (332 | ) | 558 | (168 | )% | ||||||||||||||||||
Other | (532 | ) | (2,803 | ) | 2,271 | (81 | )% | (532 | ) | (2,803 | ) | 2,271 | (81 | )% | ||||||||||||||||
Total other losses | (397 | ) | (2,901 | ) | 2,504 | (86 | )% | (306 | ) | (3,135 | ) | 2,829 | (90 | )% | ||||||||||||||||
Income (loss) before income taxes | (356,026 | ) | 82,296 | (438,322 | ) | n/m | (612,347 | ) | 31,624 | (643,971 | ) | n/m | ||||||||||||||||||
Adjustments to income (loss) | ||||||||||||||||||||||||||||||
Changes in fair value due to changes in valuation inputs and other assumptions | 118,825 | (64,359 | ) | 183,184 | (285 | )% | 359,154 | 9,412 | 349,742 | n/m | ||||||||||||||||||||
Goodwill impairment | 215,412 | — | 215,412 | n/m | 215,412 | — | 215,412 | n/m | ||||||||||||||||||||||
Step-up depreciation and amortization | 6,601 | 6,923 | (322 | ) | (5 | )% | 13,335 | 13,967 | (632 | ) | (5 | )% | ||||||||||||||||||
Restructuring costs | 4,126 | 1,578 | 2,548 | 161 | % | 6,007 | 1,983 | 4,024 | 203 | % | ||||||||||||||||||||
Legal and regulatory matters | — | 544 | (544 | ) | (100 | )% | 2,196 | 2,218 | (22 | ) | (1 | )% | ||||||||||||||||||
Step-up amortization of sub-servicing rights | 1,049 | 4,940 | (3,891 | ) | (79 | )% | 3,978 | 9,827 | (5,849 | ) | (60 | )% | ||||||||||||||||||
Share-based compensation expense | 3,160 | 3,123 | 37 | 1 | % | 3,941 | 5,128 | (1,187 | ) | (23 | )% | |||||||||||||||||||
Non-cash interest expense | 18 | 363 | (345 | ) | (95 | )% | (11 | ) | 1,118 | (1,129 | ) | (101 | )% | |||||||||||||||||
Other | 6,065 | 976 | 5,089 | n/m | 6,373 | 1,248 | 5,125 | n/m | ||||||||||||||||||||||
Total adjustments | 355,256 | (45,912 | ) | 401,168 | n/m | 610,385 | 44,901 | 565,484 | n/m | |||||||||||||||||||||
Adjusted Earnings (Loss) | (770 | ) | 36,384 | (37,154 | ) | (102 | )% | (1,962 | ) | 76,525 | (78,487 | ) | (103 | )% | ||||||||||||||||
EBITDA adjustments | ||||||||||||||||||||||||||||||
Amortization of servicing rights and other fair value adjustments | 60,911 | 59,649 | 1,262 | 2 | % | 130,252 | 115,921 | 14,331 | 12 | % | ||||||||||||||||||||
Depreciation and amortization | 4,103 | 4,489 | (386 | ) | (9 | )% | 8,150 | 8,918 | (768 | ) | (9 | )% | ||||||||||||||||||
Interest expense on debt | 1,251 | 2,121 | (870 | ) | (41 | )% | 3,986 | 4,717 | (731 | ) | (15 | )% | ||||||||||||||||||
Other | (767 | ) | (5,090 | ) | 4,323 | (85 | )% | (1,102 | ) | (5,408 | ) | 4,306 | (80 | )% | ||||||||||||||||
Total adjustments | 65,498 | 61,169 | 4,329 | 7 | % | 141,286 | 124,148 | 17,138 | 14 | % | ||||||||||||||||||||
Adjusted EBITDA | $ | 64,728 | $ | 97,553 | $ | (32,825 | ) | (34 | )% | $ | 139,324 | $ | 200,673 | $ | (61,349 | ) | (31 | )% |
85
Mortgage Loan Servicing Portfolio
Our Servicing segment services loans for which we own the servicing right and on behalf of other servicing right or mortgage loan owners, which we refer to as “sub-servicing.” A sub-servicing asset (or liability) is recognized on our consolidated balance sheets when the sub-servicing fee is deemed to be greater (or lower) than adequate compensation for the servicing activities performed by the Company. No sub-servicing asset or liability is recorded if the amounts earned represent adequate compensation. Generally, no servicing asset or liability is recognized when we enter into new sub-servicing contracts; however, previously existing contracts acquired in a business combination may be deemed to provide greater (or lower) than adequate compensation as compared to market conditions at the time of the transaction.
Provided below are summaries of the activity in our mortgage loan servicing portfolio (dollars in thousands):
For the Six Months Ended June 30, 2016 | For the Six Months Ended June 30, 2015 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Number of Accounts | Unpaid Principal Balance | |||||||||||
Third-party servicing portfolio (1) | ||||||||||||||
Balance at beginning of the period | 2,087,618 | $ | 244,124,312 | 2,142,689 | $ | 234,905,729 | ||||||||
Loan sales with servicing retained | 30,929 | 6,517,586 | 39,366 | 8,904,897 | ||||||||||
Other new business added (2) | 90,369 | 15,609,071 | 98,030 | 15,965,350 | ||||||||||
Payoffs and sales, net (2) (3) | (142,376 | ) | (19,990,443 | ) | (147,812 | ) | (19,283,651 | ) | ||||||
Balance at end of the period (4) | 2,066,540 | 246,260,526 | 2,132,273 | 240,492,325 | ||||||||||
On-balance sheet residential loans and real estate owned (5) | 35,328 | 2,350,565 | 38,296 | 2,711,797 | ||||||||||
Total mortgage loan servicing portfolio | 2,101,868 | $ | 248,611,091 | 2,170,569 | $ | 243,204,122 |
__________
(1) | Third-party servicing includes servicing rights capitalized, sub-servicing rights capitalized and sub-servicing rights not capitalized. Sub-servicing rights capitalized consist of contracts acquired through business combinations whereby the benefits from the contract are greater than adequate compensation for performing the servicing. |
(2) | Consists of activities associated with servicing and sub-servicing contracts. |
(3) | Amounts presented are net of loan sales associated with servicing retained multi-channel recapture activities of $3.1 billion and $3.3 billion for the six months ended June 30, 2016 and 2015, respectively. |
(4) | Excludes the impact of the sale of servicing rights during the six months ended June 30, 2016 associated with 25,246 accounts and $5.6 billion in unpaid principal balance as we continue to service these loans as sub-servicer until the expected release of servicing in the third quarter of 2016. |
(5) | On-balance sheet residential loans and real estate owned primarily includes mortgage loans held for sale as well as assets of the Non-Residual Trusts and Residual Trusts. |
The annualized portfolio disappearance rate, consisting of contractual payments, voluntary prepayments, and defaults, net of recapture, of the total mortgage loan portfolio was 14.29% and 14.65% for the six months ended June 30, 2016 and 2015, respectively.
The Servicing segment receives intercompany servicing fees related to on-balance sheet assets of the Originations segment and the Other non-reportable segment. Provided below are summaries of the composition of our mortgage loan servicing portfolio (dollars in thousands):
At June 30, 2016 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Weighted Average Contractual Servicing Fee | 30 Days or More Past Due (1) | ||||||||||
Third-party servicing portfolio | |||||||||||||
First lien mortgages | 1,689,164 | $ | 234,798,950 | 0.25 | % | 10.31 | % | ||||||
Second lien mortgages | 161,299 | 5,234,936 | 0.45 | % | 3.79 | % | |||||||
Manufactured housing and other | 216,077 | 6,226,640 | 1.09 | % | 7.04 | % | |||||||
Total accounts serviced for third parties (2) (3) | 2,066,540 | 246,260,526 | 0.28 | % | 10.09 | % | |||||||
On-balance sheet residential loans and real estate owned (4) | 35,328 | 2,350,565 | 7.36 | % | |||||||||
Total mortgage loan servicing portfolio | 2,101,868 | $ | 248,611,091 | 10.06 | % |
86
At December 31, 2015 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Weighted Average Contractual Servicing Fee | 30 Days or More Past Due (1) | ||||||||||
Third-party servicing portfolio | |||||||||||||
First lien mortgages | 1,676,307 | $ | 231,637,730 | 0.27 | % | 9.09 | % | ||||||
Second lien mortgages | 179,594 | 5,823,302 | 0.46 | % | 3.41 | % | |||||||
Manufactured housing and other | 231,717 | 6,663,280 | 1.09 | % | 6.42 | % | |||||||
Total accounts serviced for third parties (2) (3) | 2,087,618 | 244,124,312 | 0.30 | % | 8.88 | % | |||||||
On-balance sheet residential loans and real estate owned (4) | 36,857 | 2,439,806 | 5.07 | % | |||||||||
Total mortgage loan servicing portfolio | 2,124,475 | $ | 246,564,118 | 8.85 | % |
__________
(1) | Past due status is measured based on either the MBA method or the OTS method as specified in the servicing agreement. Under the MBA method, a loan is considered past due if its monthly payment is not received by the end of the day immediately preceding the loan's next due date. Under the OTS method, a loan is considered past due if its monthly payment is not received by the loan's due date in the following month. Past due status is based on the current contractual due date of the loan, except in the case of an approved repayment plan, including a plan approved by the bankruptcy court, or a completed loan modification, in which case past due status is based on the modified due date or status of the loan. |
(2) | Consists of $185.5 billion and $60.8 billion in unpaid principal balance associated with servicing and sub-servicing contracts, respectively, at June 30, 2016 and $194.8 billion and $49.3 billion, respectively, at December 31, 2015. |
(3) | Includes $6.2 billion and $6.6 billion in unpaid principal balance of sub-servicing performed for WCO at June 30, 2016 and December 31, 2015, respectively, and $5.5 billion and $1.7 billion associated with servicing rights sold to WCO at June 30, 2016 and December 31, 2015, respectively. Refer to Note 17 for further information. |
(4) | Includes residential loans and real estate owned held by the Servicing segment for which it does not recognize servicing fees. |
The unpaid principal balance of our third-party servicing portfolio increased $2.1 billion at June 30, 2016 as compared to December 31, 2015 primarily due to our originations sales with servicing retained and servicing and sub-servicing portfolio acquisitions, partially offset by runoff of the portfolio. Sub-servicing portfolio acquisitions include servicing acquired through the RCS asset acquisition and new sub-servicing performed for WCO. The decrease in the unpaid principal balance of our on-balance sheet residential loans and real estate owned of $89.2 million can be attributed to a decrease in mortgage loans held for sale of $75.3 million and portfolio runoff of the assets held by the Residual and Non-Residual Trusts, offset in part by an increase in delinquent mortgage loans that we are required to record on our consolidated balance sheets as a result of our unilateral right to repurchase such loans from Ginnie Mae.
The delinquencies associated with our third-party servicing portfolio increased at June 30, 2016 as compared to December 31, 2015 as a result of the addition of delinquent loans to our servicing portfolio, combined with reduced collection efforts as employees assisted with a temporary increase in servicing calls associated with the MSP conversion, offset in part by the favorable impact of seasonality as delinquencies tend to decrease in the first quarter and then increase throughout the remainder of the year. The delinquencies associated with our on-balance sheet residential loans and real estate owned have increased as a result of an increase in delinquent mortgage loans that we are required to record on our consolidated balance sheets as a result of our unilateral right to repurchase such loans from Ginnie Mae, and the impact from the MSP conversion as described above, partially offset by the favorable impact of seasonality.
87
Net Servicing Revenue and Fees
A summary of net servicing revenue and fees for our Servicing segment is provided below (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | ||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | ||||||||||||||||||||||
Servicing fees | $ | 175,611 | $ | 175,324 | $ | 287 | — | % | $ | 351,966 | $ | 346,030 | $ | 5,936 | 2 | % | |||||||||||||
Incentive and performance fees | 15,671 | 26,506 | (10,835 | ) | (41 | )% | 33,089 | 51,615 | (18,526 | ) | (36 | )% | |||||||||||||||||
Ancillary and other fees | 24,488 | 23,603 | 885 | 4 | % | 48,632 | 47,126 | 1,506 | 3 | % | |||||||||||||||||||
Servicing revenue and fees | 215,770 | 225,433 | (9,663 | ) | (4 | )% | 433,687 | 444,771 | (11,084 | ) | (2 | )% | |||||||||||||||||
Changes in valuation inputs or other assumptions (1) | (127,713 | ) | 59,286 | (186,999 | ) | n/m | (386,173 | ) | (15,248 | ) | (370,925 | ) | n/m | ||||||||||||||||
Other changes in fair value (2) | (59,780 | ) | (58,145 | ) | (1,635 | ) | 3 | % | (127,900 | ) | (112,846 | ) | (15,054 | ) | 13 | % | |||||||||||||
Change in fair value of servicing rights | (187,493 | ) | 1,141 | (188,634 | ) | n/m | (514,073 | ) | (128,094 | ) | (385,979 | ) | n/m | ||||||||||||||||
Amortization of servicing rights | (2,179 | ) | (6,443 | ) | 4,264 | (66 | )% | (6,330 | ) | (12,901 | ) | 6,571 | (51 | )% | |||||||||||||||
Change in fair value of servicing rights related liabilities (3) | 1,903 | (5,694 | ) | 7,597 | (133 | )% | 5,197 | (7,512 | ) | 12,709 | (169 | )% | |||||||||||||||||
Net servicing revenue and fees | $ | 28,001 | $ | 214,437 | $ | (186,436 | ) | (87 | )% | $ | (81,519 | ) | $ | 296,264 | $ | (377,783 | ) | (128 | )% |
__________
(1) | Represents the net change in servicing rights carried at fair value resulting primarily from market-driven changes in interest rates and prepayment speeds. |
(2) | Represents the realization of expected cash flows over time. |
(3) | Includes interest expense on servicing rights related liabilities, which represents the accretion of fair value, of $3.1 million and $2.1 million for the three months ended June 30, 2016 and 2015, respectively, and $7.0 million and $4.7 million for the six months ended June 30, 2016 and 2015, respectively. |
Servicing fees remained relatively flat and increased $5.9 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to growth in the third-party servicing portfolio resulting from portfolio acquisitions and servicing rights capitalized as a result of our loan origination activities, partially offset by runoff of the servicing portfolio and a decline in the average servicing fee. Average loans serviced increased by $7.2 billion, or 3%, and $10.0 billion, or 4%, for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively.
Incentive and performance fees include modification fees, fees earned under HAMP, asset recovery income, and other incentives. Fees earned under HAMP decreased $4.4 million and $8.0 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to lower fees for maintenance of performing modified loans no longer eligible for HAMP incentive fees and a lower volume of completed modifications. Fees earned under HAMP will continue to decrease as a result of the scheduled termination of HAMP in December 2016. Modification fees decreased $3.5 million and $5.7 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to a lower volume of defaults leading to fewer modifications. In addition, asset recovery income decreased $1.5 million and $4.2 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, as a result of lower gross collections due primarily to runoff of the related loans managed for third parties by the Servicing segment and reaching the statute of limitations. Incentives relating to the performance of certain loan pools serviced by us decreased $1.5 million and $0.6 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively. We expect incentives relating to the performance of loan pools serviced by us to decline as a result of market and other factors, including changes in incentive programs, runoff of the related loan portfolio and improving economic conditions, which may reduce the opportunity to earn these incentives.
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Provided below is a summary of the average unpaid principal balance of loans serviced and the related average servicing fee for our Servicing segment (dollars in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||
2016 | 2015 | Variance | 2016 | 2015 | Variance | |||||||||||||||||||
Average unpaid principal balance of loans serviced (1) | $ | 252,656,638 | $ | 245,470,422 | $ | 7,186,216 | $ | 252,145,125 | $ | 242,173,786 | $ | 9,971,339 | ||||||||||||
Annualized average servicing fee (2) | 0.28 | % | 0.29 | % | (0.01 | )% | 0.28 | % | 0.29 | % | (0.01 | )% |
__________
(1) | Average unpaid principal balance of loans serviced is calculated as the average of the average monthly unpaid principal balances. The average unpaid principal balance presented above includes on-balance sheet loans owned by the Servicing segment for which it does not earn a servicing fee. |
(2) | Average servicing fee is calculated by dividing gross servicing fees by the average unpaid principal balance of loans serviced. |
The decrease in average servicing fee of one basis point for the three and six months ended June 30, 2016 as compared to the same periods of 2015 related primarily to a shift in our third-party servicing portfolio from servicing to sub-servicing and an increase in delinquencies.
Servicing Rights Carried at Fair Value
Changes in the fair value of servicing rights, which reflect our quarterly valuation process, have a significant effect on net servicing revenue and fees. A summary of key economic inputs and assumptions used in estimating the fair value of servicing rights carried at fair value is presented below (dollars in thousands):
June 30, 2016 | December 31, 2015 | Variance | ||||||||||
Servicing rights at fair value | $ | 1,255,351 | $ | 1,682,016 | $ | (426,665 | ) | |||||
Unpaid principal balance of accounts serviced | 174,978,533 | 183,506,006 | (8,527,473 | ) | ||||||||
Inputs and assumptions | ||||||||||||
Weighted-average remaining life in years | 5.2 | 6.3 | (1.1 | ) | ||||||||
Weighted-average stated borrower interest rate on underlying collateral | 4.14 | % | 4.31 | % | (0.17 | )% | ||||||
Weighted-average discount rate | 10.58 | % | 10.88 | % | (0.30 | )% | ||||||
Weighted-average conditional prepayment rate | 13.39 | % | 9.94 | % | 3.45 | % | ||||||
Weighted-average conditional default rate | 0.99 | % | 1.06 | % | (0.07 | )% |
We recognized a reduction in the fair value of servicing rights during the six months ended June 30, 2016 comprised of a loss of $386.2 million in changes in valuation inputs or other assumptions and a loss of $127.9 million in other changes in fair value which reflect the impact of the realization of expected cash flows resulting from both regularly scheduled and unscheduled payments and payoffs of loan principal.
The loss resulting from changes in valuation inputs or other assumptions during the six months ended June 30, 2016 was due primarily to a higher assumed conditional prepayment rate at June 30, 2016 as compared to December 31, 2015 resulting from declining interest rates and forward projections of interest rate curves, offset in part by a decline in discount rates.
The change in fair value of servicing rights resulting from the realization of expected cash flows increased $15.1 million for the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to faster prepayment speeds resulting from declining interest rates, offset in part by a decline in discount rates.
Servicing Rights Related Liabilities
The favorable change in fair value relating to servicing rights related liabilities of $7.6 million and $12.7 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, was due primarily to a higher assumed conditional prepayment rate resulting from the low interest rate environment, partially offset by higher interest expense.
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Interest Income on Loans
Interest income decreased $6.3 million and $26.1 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to the sale of our residual interests in April 2015, runoff of the overall mortgage loan portfolio and a lower average yield on loans due to an increase in delinquencies that are 90 days or more past due.
Insurance Revenue
Insurance revenue decreased $3.9 million for the six months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of the runoff of existing policies. In addition, in September 2015 we entered into an agreement to settle a litigation matter (which agreement remains subject to final court approval) pursuant to which we have agreed not to receive commissions as a result of the placement of certain lender-placed insurance policies for five years commencing 120 days from the effective date of the settlement.
Intersegment Retention Revenue
Intersegment retention revenue relates to fees the Servicing segment charges to our Originations segment for loan originations completed that resulted from access to the Servicing segment’s servicing portfolio for which there was a related capitalized servicing right. The increase in intersegment retention revenue of $1.0 million and $4.5 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, was due primarily to a higher fee per origination charged by the Servicing segment beginning in 2016 to reflect current market pricing.
Net Gains (Losses) on Sales of Loans
Net gains or losses on sales of loans for the Company include realized and unrealized gains and losses on loans as well as the changes in fair value of our IRLCs and other freestanding derivatives. A substantial portion of the gain or loss on sales of loans is recognized at the time we commit to originate or purchase a loan at specified terms as we recognize the value of the IRLC at the time of commitment. The fair value of the IRLC includes an estimate of the fair value of the servicing right we expect to receive upon sale of the loan.
The Originations segment recognizes the initial fair value of the entire commitment, including the servicing rights component, on the date of the commitment, while the Servicing segment recognizes the change in fair value of the servicing rights component of our IRLCs and loans held for sale that occurs subsequent to the date of our commitment through the sale of the loan. Net gains (losses) on sale of loans for the Servicing segment consist of this change in fair value as well as net gains or losses on sales of loans to third parties.
Other Revenues
Other revenues decreased $4.5 million for the three months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of $6.0 million in lower fair value gains relating to charged-off loans resulting from lower variances between actual and expected collections over time, partially offset by a $1.6 million increase in other interest income.
Other revenues increased $4.4 million for the six months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of $2.4 million in higher fair value gains relating to charged-off loans resulting from better collections performance in the portfolio than previously expected, and a $2.1 million increase in other interest income.
Goodwill Impairment
We incurred $215.4 million in impairment charges to the Servicing and ARM reporting units during the three and six months ended June 30, 2016 as a result of a goodwill evaluation performed in the second quarter of 2016. Refer to Note 9 to the Consolidated Financial Statements for further information.
General and Administrative and Allocated Indirect Expenses
General and administrative and allocated indirect expenses increased $20.0 million and $34.4 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, resulting primarily from additional costs to support efficiency and technology-related initiatives including the MSP conversion as well as higher accruals for loss contingencies and legal expenses primarily related to defense litigation.
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Salaries and Benefits
Salaries and benefits increased $5.9 million for the three months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of an increase in severance costs and timing differences associated with certain health benefit costs. Average headcount remained relatively flat as compared to the prior year period as it has not yet been impacted by announced workforce reductions.
Interest Expense
Interest expense decreased $2.2 million and $12.9 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily as a result of the sale of our residual interests in April 2015, offset in part by an increase in expense related to servicing advance liabilities due to a higher average interest rate.
Adjusted Earnings (Loss) and Adjusted EBITDA
Provided below is a summary of our Servicing segment's margin (in basis points):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||
2016 | 2015 | Variance | 2016 | 2015 | Variance | |||||||||||||
Annualized Adjusted Earnings margin (1) | — | 6 | (6 | ) | — | 6 | (6 | ) | ||||||||||
Annualized Adjusted EBITDA margin (1) | 10 | 16 | (6 | ) | 11 | 17 | (6 | ) |
__________
(1) | Margins are calculated by dividing the applicable non-GAAP measure by the average unpaid principal balance of loans serviced during the period as set forth in the table above under Net Servicing Revenue and Fees. |
Adjusted Earnings margin and Adjusted EBITDA margin both decreased by six basis points for each of the three and six months ended June 30, 2016 as compared to the same periods of 2015 primarily due to lower revenues (adjusted for the impact of the change in fair value) per loan serviced and higher expenses per loan serviced. The decline in revenues per loan serviced is primarily due to the decline in incentive and performance fees and interest income. The increase in expenses per loan serviced is primarily due to higher general and administrative and allocated indirect expenses offset in part by lower interest expense.
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Originations
Provided below is a summary of results of operations, Adjusted Earnings and Adjusted EBITDA for our Originations segment (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Net gains on sales of loans | $ | 100,358 | $ | 115,604 | $ | (15,246 | ) | (13 | )% | $ | 188,340 | $ | 241,020 | $ | (52,680 | ) | (22 | )% | ||||||||||||
Other revenues | 9,851 | 13,098 | (3,247 | ) | (25 | )% | 22,146 | 17,982 | 4,164 | 23 | % | |||||||||||||||||||
Total revenues | 110,209 | 128,702 | (18,493 | ) | (14 | )% | 210,486 | 259,002 | (48,516 | ) | (19 | )% | ||||||||||||||||||
Salaries and benefits | 27,168 | 42,105 | (14,937 | ) | (35 | )% | 60,245 | 82,700 | (22,455 | ) | (27 | )% | ||||||||||||||||||
General and administrative and allocated indirect expenses | 17,981 | 32,548 | (14,567 | ) | (45 | )% | 46,627 | 61,374 | (14,747 | ) | (24 | )% | ||||||||||||||||||
Intersegment retention expense | 9,461 | 8,458 | 1,003 | 12 | % | 20,994 | 16,539 | 4,455 | 27 | % | ||||||||||||||||||||
Interest expense | 7,736 | 9,934 | (2,198 | ) | (22 | )% | 16,011 | 17,747 | (1,736 | ) | (10 | )% | ||||||||||||||||||
Depreciation and amortization | 2,248 | 2,692 | (444 | ) | (16 | )% | 4,593 | 5,879 | (1,286 | ) | (22 | )% | ||||||||||||||||||
Total expenses | 64,594 | 95,737 | (31,143 | ) | (33 | )% | 148,470 | 184,239 | (35,769 | ) | (19 | )% | ||||||||||||||||||
Income before income taxes | 45,615 | 32,965 | 12,650 | 38 | % | 62,016 | 74,763 | (12,747 | ) | (17 | )% | |||||||||||||||||||
Adjustments to income | ||||||||||||||||||||||||||||||
Restructuring costs | 303 | 130 | 173 | 133 | % | 2,099 | 321 | 1,778 | n/m | |||||||||||||||||||||
Step-up depreciation and amortization | 157 | 618 | (461 | ) | (75 | )% | 452 | 1,788 | (1,336 | ) | (75 | )% | ||||||||||||||||||
Share-based compensation expense | 820 | 1,453 | (633 | ) | (44 | )% | 233 | 2,250 | (2,017 | ) | (90 | )% | ||||||||||||||||||
Other | 1,515 | 85 | 1,430 | n/m | 1,515 | 422 | 1,093 | 259 | % | |||||||||||||||||||||
Total adjustments | 2,795 | 2,286 | 509 | 22 | % | 4,299 | 4,781 | (482 | ) | (10 | )% | |||||||||||||||||||
Adjusted Earnings | 48,410 | 35,251 | 13,159 | 37 | % | 66,315 | 79,544 | (13,229 | ) | (17 | )% | |||||||||||||||||||
EBITDA adjustments | ||||||||||||||||||||||||||||||
Depreciation and amortization | 2,091 | 2,074 | 17 | 1 | % | 4,141 | 4,091 | 50 | 1 | % | ||||||||||||||||||||
Other | (7,013 | ) | 2,140 | (9,153 | ) | n/m | (3,212 | ) | 2,543 | (5,755 | ) | (226 | )% | |||||||||||||||||
Total adjustments | (4,922 | ) | 4,214 | (9,136 | ) | (217 | )% | 929 | 6,634 | (5,705 | ) | (86 | )% | |||||||||||||||||
Adjusted EBITDA | $ | 43,488 | $ | 39,465 | $ | 4,023 | 10 | % | $ | 67,244 | $ | 86,178 | $ | (18,934 | ) | (22 | )% |
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The volume of our originations activity and changes in market rates primarily govern the fluctuations in revenues and expenses of our Originations segment. Provided below are summaries of our originations volume by channel (in thousands):
For the Three Months Ended June 30, 2016 | For the Three Months Ended June 30, 2015 | |||||||||||||||||||||||
Locked Volume (1) | Funded Volume | Sold Volume | Locked Volume (1) | Funded Volume | Sold Volume | |||||||||||||||||||
Correspondent | $ | 3,640,496 | $ | 3,189,020 | $ | 2,978,806 | $ | 4,604,686 | $ | 5,195,849 | $ | 4,814,669 | ||||||||||||
Consumer | 1,666,615 | 1,561,071 | 1,607,284 | 1,554,909 | 1,870,414 | 1,835,551 | ||||||||||||||||||
Retail (2) | — | — | 523 | 158,452 | 163,391 | 140,588 | ||||||||||||||||||
Total | $ | 5,307,111 | $ | 4,750,091 | $ | 4,586,613 | $ | 6,318,047 | $ | 7,229,654 | $ | 6,790,808 |
For the Six Months Ended June 30, 2016 | For the Six Months Ended June 30, 2015 | |||||||||||||||||||||||
Locked Volume (1) | Funded Volume | Sold Volume | Locked Volume (1) | Funded Volume | Sold Volume | |||||||||||||||||||
Correspondent | $ | 6,662,249 | $ | 6,348,762 | $ | 6,275,934 | $ | 9,477,734 | $ | 8,846,591 | $ | 8,490,211 | ||||||||||||
Consumer | 3,214,772 | 3,354,328 | 3,440,374 | 3,490,402 | 3,601,352 | 3,530,922 | ||||||||||||||||||
Retail (2) | 10,923 | 14,883 | 64,667 | 280,592 | 249,253 | 217,514 | ||||||||||||||||||
Total | $ | 9,887,944 | $ | 9,717,973 | $ | 9,780,975 | $ | 13,248,728 | $ | 12,697,196 | $ | 12,238,647 |
__________
(1) | Volume has been adjusted by the percentage of mortgage loans not expected to close based on previous historical experience and change in interest rates. |
(2) | We exited the consumer retail channel in January 2016. |
Net Gains on Sales of Loans
Net gains on sales of loans include realized and unrealized gains and losses on loans, the initial fair value of the capitalized servicing rights upon loan sales, as well as the changes in fair value of our IRLCs and other freestanding derivatives. The amount of net gains on sales of loans is a function of the volume and margin of our originations activity and is impacted by fluctuations in interest rates. A substantial portion of our gains on sales of loans is recognized at the time we commit to originate or purchase a loan at specified terms, as we recognize the value of the IRLC at the time of commitment. The fair value of the IRLC includes our estimate of the fair value of the servicing right we expect to receive upon sale of the loan. We recognize loan origination costs as incurred, which typically align with the date of loan funding for consumer originations and the date of loan purchase for correspondent lending. These expenses are primarily included in general and administrative expenses and salaries and benefits on the consolidated statements of comprehensive loss. In addition, we record a provision for losses relating to representations and warranties made as part of the loan sale transaction at the time the loan is sold.
The volatility in the gain on sale spread is attributable to market pricing, which changes with demand, channel mix, and the general level of interest rates. While many factors may affect consumer demand for mortgages, generally, pricing competition on mortgage loans is lower in periods of low or declining interest rates, as consumer demand is greater. This provides opportunities for originators to increase volume and earn wider margins. Conversely, pricing competition increases when interest rates rise as consumer demand lessens. This reduces overall origination volume and may lead originators to reduce margins. The level and direction of interest rates are not the sole determinant of consumer demand for mortgages. Other factors such as secondary market conditions, home prices, credit spreads or legislative activity may impact consumer demand more significantly than interest rates in any given period.
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Net gains on sales of loans for our Originations segment consist of the following (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Realized gains on sales of loans | $ | 77,601 | $ | 18,624 | $ | 58,977 | n/m | $ | 154,867 | $ | 80,061 | $ | 74,806 | 93 | % | |||||||||||||||
Change in unrealized gains on loans held for sale | 3,123 | (15,649 | ) | 18,772 | (120 | )% | 14,416 | (14,260 | ) | 28,676 | (201 | )% | ||||||||||||||||||
Gains (losses) on interest rate lock commitments (1) | 11,855 | (40,259 | ) | 52,114 | (129 | )% | 27,014 | (15,776 | ) | 42,790 | (271 | )% | ||||||||||||||||||
Gains (losses) on forward sales commitments (1) | (43,384 | ) | 71,935 | (115,319 | ) | (160 | )% | (110,337 | ) | 33,287 | (143,624 | ) | n/m | |||||||||||||||||
Losses on MBS purchase commitments (1) | (2,477 | ) | (13,107 | ) | 10,630 | (81 | )% | (13,273 | ) | (18,786 | ) | 5,513 | (29 | )% | ||||||||||||||||
Capitalized servicing rights | 47,832 | 84,707 | (36,875 | ) | (44 | )% | 104,202 | 157,438 | (53,236 | ) | (34 | )% | ||||||||||||||||||
Provision for repurchases | (3,724 | ) | (4,532 | ) | 808 | (18 | )% | (8,437 | ) | (6,557 | ) | (1,880 | ) | 29 | % | |||||||||||||||
Interest income | 9,532 | 13,885 | (4,353 | ) | (31 | )% | 19,888 | 25,613 | (5,725 | ) | (22 | )% | ||||||||||||||||||
Net gains on sales of loans | $ | 100,358 | $ | 115,604 | $ | (15,246 | ) | (13 | )% | $ | 188,340 | $ | 241,020 | $ | (52,680 | ) | (22 | )% |
__________
(1) | Realized gains (losses) on freestanding derivatives were $(30.1) million and $17.5 million for the three months ended June 30, 2016 and 2015, respectively, and $(89.4) million and $(26.7) million for the six months ended June 30, 2016 and 2015, respectively. |
The decrease in net gains on sales of loans for the three and six months ended June 30, 2016 as compared to the same periods of 2015 was primarily due to a lower volume of locked loans, partially offset by a slight shift in mix from the lower margin correspondent channel to the higher margin consumer channel during the 2016 period. The decline in volume is largely due to an increase in market competition, lower HARP volume, and a slight market shift towards more home purchase volume as opposed to refinancing volume. We had lower capitalized servicing rights during the three and six months ended June 30, 2016 as compared to the same periods of 2015 due primarily to a lower volume of loans sold with servicing retained, coupled with a reduction in the fair value of servicing rights. Additionally, we had a higher provision for repurchases for the six months ended June 30, 2016 due to higher defect rates on correspondent loan sales, partially offset by lower sold loan volume.
The three and six months ended June 30, 2016 and 2015 included the benefit of higher margins from HARP, which is scheduled to expire on December 31, 2016. HARP is a federal program of the U.S. that helps homeowners refinance their mortgage. Our strategy includes significant efforts to maintain retention volumes through traditional refinancing opportunities and HARP, although we believe peak HARP refinancing occurred in prior periods.
Provided below is a summary of origination economics for all channels (in basis points):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | Amount | % | 2016 | 2015 | Amount | % | |||||||||||||||||||||||
Gain on sale of loans (1) | $ | 189 | $ | 183 | $ | 6 | 3 | % | $ | 190 | $ | 182 | $ | 8 | 4 | % | ||||||||||||||
Fee income (2) | 21 | 18 | 3 | 17 | % | 23 | 14 | 9 | 64 | % | ||||||||||||||||||||
Direct expenses (2) | (123 | ) | (101 | ) | (22 | ) | 22 | % | (130 | ) | (110 | ) | (20 | ) | 18 | % | ||||||||||||||
Direct margin | $ | 87 | $ | 100 | $ | (13 | ) | (13 | )% | $ | 83 | $ | 86 | $ | (3 | ) | (3 | )% |
__________
(1) | Calculated on pull-through adjusted lock volume. |
(2) | Calculated on funded volume. |
The decrease in direct margin for the three and six months ended June 30, 2016 as compared to the same periods of 2015 was primarily due to a slight shift in mix from the lower expense driven correspondent channel to the higher expense based consumer channel as well as higher intersegment retention charges. During the six months ended June 30, 2016, the decrease was partially offset by higher origination fees. Our correspondent volume represented 67% of total pull-through adjusted locked volume as compared to 72% during the six months ended June 30, 2015.
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Other Revenues
Other revenues, which consist primarily of origination fee income and interest on cash equivalents, decreased $3.2 million for the three months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of decline in volumes.
Other revenues increased $4.2 million for the six months ended June 30, 2016 as compared to the same period of 2015 primarily as a result of higher origination fees due to having waived certain fees charged to borrowers refinancing mortgage loans during the six months ended June 30, 2015.
Salaries and Benefits
Salaries and benefits decreased $14.9 million and $22.5 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to a lower average headcount as well as lower commissions due to a decrease in funded volume.
General and Administrative and Allocated Indirect Expenses
General and administrative and allocated indirect expenses decreased $14.6 million and $14.7 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to a reserve reduction recorded in the second quarter of 2016 related to the change in estimate of the liability associated with our selling representations and warranties. The reduction is primarily due to adjustments to certain assumptions based on recently observed trends as compared to historical expectations, primarily relating to loan defect rates and counterparty review probabilities. The remainder of the decrease is primarily a result of lower loan origination expenses due to a decreased volume of loan fundings and decreased advertising resulting from a decrease in mail solicitations and internet lead generation.
Intersegment Retention Expense
Intersegment retention expense relates to fees charged by the Servicing segment to the Originations segment in relation to loan originations completed that resulted from access to the Servicing segment’s servicing portfolio for which there was a related capitalized servicing right. The increase in intersegment retention expense of $1.0 million and $4.5 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, was due primarily to a higher fee per origination charged by the Servicing segment beginning in 2016 to reflect current market pricing.
Interest Expense
Interest expense decreased $2.2 million and $1.7 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily due to lower average borrowings on master repurchase agreements due to a lower volume of loan fundings, offset partially by higher average cost of debt.
Adjusted Earnings
Adjusted Earnings increased $13.2 million for the three months ended June 30, 2016 as compared to the same period in 2015 due primarily to lower expenses as it relates to headcount, volume related expenses, and the benefit recorded as a result of the adjustment to the selling representations and warranties reserve, offset by lower net gains on sales of loans.
Adjusted Earnings decreased $13.2 million for the six months ended June 30, 2016 as compared to the same period of 2015 due primarily to lower net gains on sales of loans, offset partially by higher origination fee income and lower expenses as described above.
Adjusted EBITDA
Adjusted EBITDA increased $4.0 million for the three months ended June 30, 2016 as compared to the same period in 2015 due primarily to lower expenses, partially offset by lower net gains on sales of loans.
Adjusted EBITDA decreased $18.9 million for the six months ended June 30, 2016 as compared to the same period of 2015, due primarily to lower net gains on sales of loans, partially offset by lower expenses and higher origination fee income.
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Reverse Mortgage
Provided below is a summary of results of operations, Adjusted Earnings (Loss) and Adjusted EBITDA for our Reverse Mortgage segment (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | $ | 7,650 | $ | 6,815 | $ | 835 | 12 | % | $ | 42,858 | $ | 37,589 | $ | 5,269 | 14 | % | ||||||||||||||
Net servicing revenue and fees | 7,001 | 11,915 | (4,914 | ) | (41 | )% | 13,910 | 23,321 | (9,411 | ) | (40 | )% | ||||||||||||||||||
Net losses on sales of loans | — | — | — | — | % | — | (98 | ) | 98 | (100 | )% | |||||||||||||||||||
Other revenues | 1,486 | 1,442 | 44 | 3 | % | 3,464 | 3,287 | 177 | 5 | % | ||||||||||||||||||||
Total revenues | 16,137 | 20,172 | (4,035 | ) | (20 | )% | 60,232 | 64,099 | (3,867 | ) | (6 | )% | ||||||||||||||||||
General and administrative and allocated indirect expenses | 21,967 | 27,298 | (5,331 | ) | (20 | )% | 37,962 | 56,191 | (18,229 | ) | (32 | )% | ||||||||||||||||||
Salaries and benefits | 16,350 | 22,963 | (6,613 | ) | (29 | )% | 34,398 | 47,503 | (13,105 | ) | (28 | )% | ||||||||||||||||||
Interest expense | 2,414 | 1,132 | 1,282 | 113 | % | 3,929 | 2,231 | 1,698 | 76 | % | ||||||||||||||||||||
Depreciation and amortization | 1,587 | 1,986 | (399 | ) | (20 | )% | 2,875 | 3,954 | (1,079 | ) | (27 | )% | ||||||||||||||||||
Goodwill impairment | — | 56,539 | (56,539 | ) | (100 | )% | — | 56,539 | (56,539 | ) | (100 | )% | ||||||||||||||||||
Other expenses, net | 763 | 1,214 | (451 | ) | (37 | )% | 1,961 | 2,098 | (137 | ) | (7 | )% | ||||||||||||||||||
Total expenses | 43,081 | 111,132 | (68,051 | ) | (61 | )% | 81,125 | 168,516 | (87,391 | ) | (52 | )% | ||||||||||||||||||
Other losses | — | — | — | — | % | (1,024 | ) | — | (1,024 | ) | n/m | |||||||||||||||||||
Loss before income taxes | (26,944 | ) | (90,960 | ) | 64,016 | (70 | )% | (21,917 | ) | (104,417 | ) | 82,500 | (79 | )% | ||||||||||||||||
Adjustments to loss | ||||||||||||||||||||||||||||||
Fair value to cash adjustment for reverse loans | 14,512 | 24,149 | (9,637 | ) | (40 | )% | (3,197 | ) | 19,794 | (22,991 | ) | (116 | )% | |||||||||||||||||
Step-up depreciation and amortization | 894 | 1,328 | (434 | ) | (33 | )% | 1,789 | 2,656 | (867 | ) | (33 | )% | ||||||||||||||||||
Share-based compensation expense | 610 | 284 | 326 | 115 | % | 923 | 820 | 103 | 13 | % | ||||||||||||||||||||
Restructuring costs | 407 | — | 407 | n/m | 407 | — | 407 | n/m | ||||||||||||||||||||||
Goodwill impairment | — | 56,539 | (56,539 | ) | (100 | )% | — | 56,539 | (56,539 | ) | (100 | )% | ||||||||||||||||||
Curtailment expense | — | 6,488 | (6,488 | ) | (100 | )% | — | 22,562 | (22,562 | ) | (100 | )% | ||||||||||||||||||
Legal and regulatory matters | — | 4,628 | (4,628 | ) | (100 | )% | — | 2,862 | (2,862 | ) | (100 | )% | ||||||||||||||||||
Other | 1,398 | 63 | 1,335 | n/m | 2,446 | 430 | 2,016 | n/m | ||||||||||||||||||||||
Total adjustments | 17,821 | 93,479 | (75,658 | ) | (81 | )% | 2,368 | 105,663 | (103,295 | ) | (98 | )% | ||||||||||||||||||
Adjusted Earnings (Loss) | (9,123 | ) | 2,519 | (11,642 | ) | (462 | )% | (19,549 | ) | 1,246 | (20,795 | ) | n/m | |||||||||||||||||
EBITDA adjustments | ||||||||||||||||||||||||||||||
Depreciation and amortization | 693 | 658 | 35 | 5 | % | 1,086 | 1,298 | (212 | ) | (16 | )% | |||||||||||||||||||
Amortization of servicing rights | 446 | 522 | (76 | ) | (15 | )% | 906 | 1,077 | (171 | ) | (16 | )% | ||||||||||||||||||
Interest expense on debt | — | — | — | — | % | — | 1 | (1 | ) | (100 | )% | |||||||||||||||||||
Other | 21 | 25 | (4 | ) | (16 | )% | 54 | 99 | (45 | ) | (45 | )% | ||||||||||||||||||
Total adjustments | 1,160 | 1,205 | (45 | ) | (4 | )% | 2,046 | 2,475 | (429 | ) | (17 | )% | ||||||||||||||||||
Adjusted EBITDA | $ | (7,963 | ) | $ | 3,724 | $ | (11,687 | ) | n/m | $ | (17,503 | ) | $ | 3,721 | $ | (21,224 | ) | n/m |
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Reverse Mortgage Servicing Portfolio
Provided below are summaries of the activity in our third-party servicing portfolio for our reverse mortgage business, which includes accounts serviced for third parties for which we earn servicing revenue and, thus, excludes servicing performed related to reverse loans and real estate owned that have been recognized on our consolidated balance sheets, as the reverse loan transfer was accounted for as a secured borrowing (dollars in thousands):
For the Six Months Ended June 30, 2016 | For the Six Months Ended June 30, 2015 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Number of Accounts | Unpaid Principal Balance | |||||||||||
Third-party servicing portfolio | ||||||||||||||
Balance at beginning of the period | 56,046 | $ | 9,818,400 | 50,196 | $ | 8,626,946 | ||||||||
New business added | 5,801 | 951,265 | 6,824 | 1,014,462 | ||||||||||
Other additions (1) | — | 387,373 | — | 297,924 | ||||||||||
Payoffs and sales | (4,632 | ) | (966,607 | ) | (3,195 | ) | (655,376 | ) | ||||||
Balance at end of the period | 57,215 | $ | 10,190,431 | 53,825 | $ | 9,283,956 |
__________
(1) | Other additions include additions to the principal balance serviced related to draws on lines-of-credit, interest, servicing fees, mortgage insurance and advances owed by the existing borrower. |
Provided below are summaries of our reverse loan servicing portfolio (dollars in thousands):
At June 30, 2016 | At December 31, 2015 | |||||||||||||
Number of Accounts | Unpaid Principal Balance | Number of Accounts | Unpaid Principal Balance | |||||||||||
Third-party servicing portfolio (1) | 57,215 | $ | 10,190,431 | 56,046 | $ | 9,818,400 | ||||||||
On-balance sheet residential loans and real estate owned | 63,761 | 10,332,373 | 65,187 | 10,265,726 | ||||||||||
Total reverse loan servicing portfolio | 120,976 | $ | 20,522,804 | 121,233 | $ | 20,084,126 |
__________
(1) | We earn a fixed dollar amount per loan on a majority of our third-party reverse loan servicing portfolio. The weighted-average contractual servicing fee for our third-party servicing portfolio was 0.14% at June 30, 2016 and December 31, 2015. |
Net Fair Value Gains on Reverse Loans and Related HMBS Obligations
Provided in the table below is a summary of the components of net fair value gains on reverse loans and related HMBS obligations (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||
Interest income on reverse loans | $ | 113,631 | $ | 109,406 | $ | 4,225 | 4% | $ | 224,225 | $ | 215,686 | $ | 8,539 | 4% | ||||||||||||||
Interest expense on HMBS related obligations | (103,368 | ) | (100,564 | ) | (2,804 | ) | 3% | (206,622 | ) | (199,100 | ) | (7,522 | ) | 4% | ||||||||||||||
Net interest income on reverse loans and HMBS related obligations | 10,263 | 8,842 | 1,421 | 16% | 17,603 | 16,586 | 1,017 | 6% | ||||||||||||||||||||
Change in fair value of reverse loans | 27,744 | (40,228 | ) | 67,972 | (169)% | 71,984 | (23,501 | ) | 95,485 | n/m | ||||||||||||||||||
Change in fair value of HMBS related obligations | (30,357 | ) | 38,201 | (68,558 | ) | (179)% | (46,729 | ) | 44,504 | (91,233 | ) | (205)% | ||||||||||||||||
Net change in fair value on reverse loans and HMBS related obligations | (2,613 | ) | (2,027 | ) | (586 | ) | 29% | 25,255 | 21,003 | 4,252 | 20% | |||||||||||||||||
Net fair value gains on reverse loans and related HMBS obligations | $ | 7,650 | $ | 6,815 | $ | 835 | 12% | $ | 42,858 | $ | 37,589 | $ | 5,269 | 14% |
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Net fair value gains on reverse loans and related HMBS obligations include the contractual interest income earned on reverse loans, including those not yet securitized or no longer in securitization pools, net of interest expense on HMBS related obligations, and the change in fair value of these assets and liabilities. Included in the change in fair value are gains due to loan originations that include "tails." Tails are participations in previously securitized HECMs and are created by additions to principal for borrower draws on lines-of-credit, interest, servicing fees, and mortgage insurance premiums. Economic gains and losses result from the pricing of an aggregated pool of loans exceeding the cost of the origination or acquisition of the loan as well as the change in fair value resulting from changes to market pricing on HECMs and HMBS. No gain or loss is recognized as a result of the securitization of reverse loans as these transactions are accounted for as secured borrowings. However, HECMs and HMBS related obligations are marked to fair value, which can result in a net gain or loss related to changes in market pricing.
Net interest income on reverse loans and HMBS related obligations increased $1.4 million and $1.0 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily as a result of an overall increase in reverse loans compounded by a decrease in HMBS related obligations as a result of an increase in buyouts, partially offset by an increase in nonperforming reverse loans, which have lower interest rates than performing loans. The net change in fair value on reverse loans and HMBS related obligations is comprised of cash generated by origination, purchase, and securitization of HECMs as well as non-cash fair value gains or losses. Cash generated by origination, purchase and securitization of HECMs decreased $10.2 million and $18.7 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, primarily as a result of overall lower origination volumes, partially offset by a shift in mix from lower margin new originations to higher margin tails. Net non-cash fair value gains increased by $9.6 million and $23.0 million during the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to a larger decrease in the interest rate curve in 2016 as compared to 2015. Reverse loans and related HMBS obligations are generally subject to net fair value gains when interest rates decline primarily as a result of a longer duration of reverse loans as compared to HMBS related obligations. Our reverse loans have longer durations primarily as a result of our obligations as issuer of HMBS, which includes the requirement to purchase loans out of the Ginnie Mae securitization pools once the outstanding principal balance of the related HECM is equal to or greater than 98% of the maximum claim amount. The conditional repayment rate utilized in the valuation of reverse loans and HMBS related obligations has increased from 25.59% and 24.70%, respectively, at December 31, 2015 to 26.54% and 25.96%, respectively, at June 30, 2016 primarily due to the aging of the portfolio.
Provided below are summaries of our funded volume, which represent purchases and originations of reverse loans, and volume of securitizations into HMBS (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Funded volume | $ | 200,634 | $ | 469,821 | $ | (269,187 | ) | (57 | )% | $ | 385,024 | $ | 880,695 | $ | (495,671 | ) | (56 | )% | ||||||||||||
Securitized volume (1) | 188,506 | 442,145 | (253,639 | ) | (57 | )% | 376,385 | 855,192 | (478,807 | ) | (56 | )% |
__________
(1) | Securitized volume includes $113.6 million and $94.7 million of tails securitized for the three months ended June 30, 2016 and 2015, respectively, and $228.9 million and $190.4 million for the six months ended June 30, 2016 and 2015, respectively. Tail draws associated with the HECM IDL product were $69.5 million and $41.6 million during the three months ended June 30, 2016 and 2015, respectively, and $138.5 million and $82.9 million for the six months ended June 30, 2016 and 2015, respectively. |
Funded and securitized volumes decreased during the three and six months ended June 30, 2016 as compared to the same periods of 2015 primarily due to the negative impact of new financial assessment rules and other regulatory changes, and the Company's decision to reduce participation in the correspondent market based on management's assessment of pricing levels in the marketplace.
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Net Servicing Revenue and Fees
A summary of net servicing revenue and fees for our Reverse Mortgage segment is provided below (dollars in thousands):
For the Three Months Ended June 30, | Variance | For the Six Months Ended June 30, | Variance | |||||||||||||||||||||||||||
2016 | 2015 | $ | % | 2016 | 2015 | $ | % | |||||||||||||||||||||||
Servicing fees | $ | 3,529 | $ | 3,429 | $ | 100 | 3 | % | $ | 7,047 | $ | 6,801 | $ | 246 | 4 | % | ||||||||||||||
Incentive and performance fees | 2,340 | 7,175 | (4,835 | ) | (67 | )% | 4,694 | 13,804 | (9,110 | ) | (66 | )% | ||||||||||||||||||
Ancillary and other fees | 1,578 | 1,833 | (255 | ) | (14 | )% | 3,075 | 3,793 | (718 | ) | (19 | )% | ||||||||||||||||||
Servicing revenue and fees | 7,447 | 12,437 | (4,990 | ) | (40 | )% | 14,816 | 24,398 | (9,582 | ) | (39 | )% | ||||||||||||||||||
Amortization of servicing rights | (446 | ) | (522 | ) | 76 | (15 | )% | (906 | ) | (1,077 | ) | 171 | (16 | )% | ||||||||||||||||
Net servicing revenue and fees | $ | 7,001 | $ | 11,915 | $ | (4,914 | ) | (41 | )% | $ | 13,910 | $ | 23,321 | $ | (9,411 | ) | (40 | )% |
The decline in net servicing revenue and fees of $4.9 million and $9.4 million for the three and six months ended June 30, 2016 as compared to the same periods in 2015, respectively, was due primarily to a decrease in incentive and performance fees for the management of real estate owned. In March 2015, we entered into an agreement with a counterparty to phase out one of our larger arrangements for the management of real estate owned through October 1, 2015.
General and Administrative and Allocated Indirect Expenses
General and administrative and allocated indirect expenses decreased by $5.3 million and $18.2 million, respectively for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to certain regulatory developments during 2015, which led to additional charges around curtailable events and to accrual adjustments associated with legal and regulatory matters outside of the normal course of business. This reduction was offset in part by the impact of changes in the provisions on uncollectible receivables and advances.
Salaries and Benefits
Salaries and benefits expense decreased $6.6 million and $13.1 million for the three and six months ended June 30, 2016 as compared to the same periods of 2015, respectively, due primarily to lower commissions and bonuses as a result of lower origination volume combined with a lower average headcount.
Goodwill Impairment
We incurred $56.5 million in impairment charges during the three and six months ended June 30, 2015 as a result of a goodwill evaluation performed in the second quarter of 2015. As a result of these goodwill charges, the Reverse Mortgage reporting unit no longer has goodwill.
Adjusted Earnings (Loss) and Adjusted EBITDA
Adjusted Loss changed by $11.6 million and $20.8 million for the three and six months ended June 30, 2016 from Adjusted Earnings for the same periods of 2015, respectively, and Adjusted EBITDA decreased by $11.7 million and $21.2 million for the same periods, respectively. The change in these non-GAAP financial measures was due primarily to the decline in cash generated from origination, purchase and securitization of HECMs combined with lower net servicing revenue and fees, partially offset by a decrease in salaries and benefits.
Other Non-Reportable
Other revenues for our Other non-reportable segment consist primarily of asset management advisory fees and other interest income. Other revenues for the three months ended June 30, 2016 remained relatively flat as compared to the same period of 2015. Other revenues decreased $4.1 million for the six months ended June 30, 2016 as compared to the same period of 2015 as a result of the settlement of a receivable that was repaid in conjunction with the sale of an investment accounted for using the equity method during 2015. Expenses for the same periods remained relatively flat.
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Liquidity and Capital Resources
Overview
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay debt and meet the financial obligations of our operations including funding acquisitions; mortgage loan and reverse loan servicing advances; obligations associated with the repurchase of reverse loans from securitization pools; funding additional borrowing capacity on reverse loans; origination of mortgage loans; and other general business needs, including the cost of compliance with changing legislation and related rules. Our liquidity is measured as our consolidated cash and cash equivalents excluding subsidiary minimum cash requirement balances, which are typically associated with our servicer licensing or financing agreements with third parties. This measure also includes our borrowing capacity available under the 2013 Revolver, as described under the Corporate Debt section below. Our ability to draw upon the 2013 Revolver is contingent upon our satisfaction of certain financial and other covenants, and the permitted use of the 2013 Revolver is limited to our and our subsidiaries' liquidity needs (but excluding voluntary prepayments, redemptions or repurchases of other indebtedness). On August 5, 2016, we entered into an amendment to the 2013 Credit Agreement, which among other things, permanently reduced the aggregate commitments under the 2013 Revolver from $125.0 million to $100.0 million, increased the interest rate on any drawn amounts under the 2013 Revolver to LIBOR plus 4.50% through January 1, 2017, and increased the required Total Leverage Ratio for the second and third quarters of 2016. After giving effect to the amendment, we were in compliance with the increased Total Leverage Ratio and we were in compliance with all other covenants contained in our 2013 Credit Agreement as of June 30, 2016. At June 30, 2016, we had cash liquidity of $246.0 million and after giving effect to the aforementioned amendment, our availability under the 2013 Revolver is $99.7 million. At June 30, 2016, we had contractual obligations, subject to certain conditions and adjustments, to utilize approximately $9.4 million of our liquidity to fund acquisitions of servicing rights, including related servicer and protective advances.
We endeavor to maintain our liquidity at a level sufficient to fund certain known or expected payments and to fund our working capital needs. Our principal sources of liquidity are the cash flows generated from our business segments and funds available from our 2013 Revolver, master repurchase agreements, mortgage loan servicing advance facilities, issuance of HMBS and excess servicing spread financing arrangements. We may generate additional liquidity through sales of MSRs, any portion thereof, or other assets.
We believe that, based on current forecasts and anticipated market conditions, our current liquidity, along with the funds generated from our principal sources of liquidity discussed above, will allow for financial flexibility to meet anticipated cash requirements to fund operating needs and expenses, servicing advances, loan originations and repurchases of mortgage loans and HECMs, planned capital expenditures, current committed business and asset acquisitions, cash taxes and cash requirements associated with mandatory clean-up call obligations on the Non-Residual trusts and all required debt service obligations for the next 12 months. We expect that significant acquisitions of servicing rights and other opportunities to grow by acquisition would need to be funded primarily through, or in collaboration with, external capital sources. Our operating cash flows and liquidity are significantly influenced by numerous factors, including interest rates and continued availability of financing. Our liquidity outlook assumes the renewal of existing mortgage loan servicing advance facilities, mortgage loan and reverse loan master repurchase agreements and reverse loan master repurchase agreements to fund repurchases of HECMs. In addition, management from time to time pursues other financing facilities. We may access the capital markets from time to time, in public or in private transactions, to augment our liquidity position, fund growth opportunities or for other reasons. We continually monitor our cash flows and liquidity in order to be responsive to changing conditions.
We have an effective universal shelf registration statement on file with the SEC. Under this universal shelf registration statement, we have the capacity to offer and sell from time to time an indeterminate number of our securities, including common stock, debt securities, preferred stock, warrants and units, having an aggregate initial offering price not to exceed $1.5 billion. This universal shelf registration statement expires on or about January 13, 2018.
Share Repurchase Program
On May 6, 2015, the Board of Directors of the Company authorized us to repurchase up to $50.0 million of shares of our common stock during the period beginning on May 11, 2015 and ending on May 31, 2016. Repurchases were made from time to time based upon our discretion through one or more open market or privately negotiated transactions, and pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act. The timing and amounts of any such repurchases depended on a variety of factors, including the market price of our shares and general market and economic conditions. Our share repurchase program expired on May 31, 2016.
We repurchased a total of 2,382,733 shares of common stock pursuant to our share repurchase program, all of which were repurchased during the year ended December 31, 2015, at an aggregate cost of $28.1 million, or an average cost of $11.78 per share. Shares of common stock that we repurchased were canceled and returned to the status of authorized but unissued shares.
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Mortgage Loan Servicing Business
Our servicing agreements impose on us various rights and obligations that affect our liquidity. Among the most significant of these obligations is the requirement that we advance our own funds to pay taxes, insurance and foreclosure costs and various other items, referred to as protective advances. Protective advances are required to preserve the collateral underlying the residential loans being serviced. In addition, we advance our own funds to meet contractual payment requirements for credit owners. As a result of bulk servicing right acquisitions in 2013 and 2014, we experienced and continue to incur an elevated level of advance requirements. Sub-servicers are generally reimbursed for advances in the month following the advance, so our advance funding requirements may be reduced if we succeed in increasing the fee-for-service mix in our servicing portfolio. In the normal course of business, we borrow money from various counterparties who provide us with financing to fund a portion of our mortgage loan related servicing advances on a short-term basis or provide for reimbursement within an agreed-upon period. Our ability to fund servicing advances is a significant factor that affects our liquidity, and to operate and grow our servicing portfolio we depend upon our ability to secure these types of arrangements on acceptable terms and to renew or replace existing financing facilities as they expire. However, there can be no assurance that these facilities will be available to us in the future. The servicing advance financing agreements that support our servicing operations are discussed below.
Servicing Advance Liabilities
Ditech Financial has four servicing advance facilities through several lenders and an Early Advance Reimbursement Agreement with Fannie Mae which, in each case, are used to fund servicer and protective advances that are our responsibility under certain servicing agreements. The servicing advance facilities and the Early Advance Reimbursement Agreement had an aggregate capacity amount of $1.5 billion at June 30, 2016. The interest rates are either fixed or are primarily based on LIBOR plus between 2.30% and 4.40% and have various expiration dates from August 2016 to October 2018. Payments on the amounts due under these agreements are paid from proceeds received (i) in connection with the liquidation of mortgaged properties, (ii) from repayments received from mortgagors, or (iii) from reimbursements received from the owners of the mortgage loans, such as Fannie Mae, Freddie Mac and private label securitization trusts. Accordingly, repayment of the servicing advance liabilities is dependent on the proceeds that are received on the underlying advances associated with the agreements. Two of the servicing advance facilities, with total borrowing capacity of $1.2 billion, are non-recourse to the Company.
The servicing advance facilities contain customary events of default and covenants, including financial covenants. Financial covenants most sensitive to our operating results and financial position are the requirements that Ditech Financial maintain minimum tangible net worth, indebtedness to tangible net worth and minimum liquidity. Ditech Financial was in compliance with these financial covenants at June 30, 2016.
Subsequent to the Original Filing, Ditech Financial received waivers from each of its lenders to the extent necessary to waive any default, event of default, amortization event, termination event or similar event resulting from or arising from the restatement, as described in the Explanatory Note and Note 2 to the Consolidated Financial Statements.
Green Tree Agency Advance Funding Trust
Ditech Financial has a non-recourse servicer advance facility that provides funding for servicer and protective advances made in connection with its servicing of certain Fannie Mae and Freddie Mac mortgage loans. On October 21, 2015, this facility was amended and restated to provide for the issuance of $500.0 million aggregate principal amount of term notes consisting of Series 2015-T1 one-year term notes with an initial aggregate principal balance of $360.0 million and Series 2015-T2 three-year term notes with an initial aggregate principal balance of $140.0 million; to extend the commitment for up to $600.0 million of previously issued Series 2014-VF2 variable funding notes until October 2016; and to reduce total borrowing capacity under this facility by $100.0 million to $1.1 billion in the aggregate. The proceeds from the issuance of the Series 2015-T1 term notes and the Series 2015-T2 term notes were used to reduce the outstanding principal balance of the Series 2014-VF2 variable funding notes and to pay certain transaction fees, costs and expenses. We had $754.1 million outstanding under this facility at June 30, 2016, which included $500.0 million outstanding on the term notes and $254.1 million outstanding on the variable funding notes.
The collateral securing the term notes and the variable funding notes consists primarily of rights to reimbursement for servicer and protective advances in respect of certain mortgage loans serviced by Ditech Financial on behalf of Freddie Mac and Fannie Mae.
Each series of term notes were issued in four classes. Interest on the term notes is based on a fixed rate per annum ranging from approximately 2.30% to 3.93% for the Series 2015-T1 term notes and 3.09% to 4.67% for the Series 2015-T2 term notes. If the Series 2015-T1 term notes are not redeemed or refinanced on or prior to October 17, 2016, and the Series 2015-T2 term notes are not redeemed or refinanced on or prior to October 15, 2018, one-twelfth of the related note balances will be required to be repaid on each monthly payment date thereafter. Failure to make any such one-twelfth payment will result in an event of default.
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The interest on the variable funding notes is based on one-month LIBOR, (or, in certain circumstances, the higher of (i) the prime rate and (ii) the federal funds rate plus 0.50%) plus a per annum margin ranging from approximately 2.34% to 4.36%. The maximum permitted principal balance of the variable funding notes that can be drawn at any given time is dependent upon the amount of eligible collateral owned by the issuer of the notes and, after giving effect to the issuance of the Series 2015-T1 term notes and the Series 2015-T2 term notes, may not exceed $600.0 million in the aggregate. We may repay and redraw the variable funding notes issued for 364-days from and including October 21, 2015, subject to the satisfaction of various funding conditions. If such 364-day period is not extended, the variable funding notes will become due and payable on October 19, 2016.
Under this facility, creditors of the issuer and depositor entities (including the holders of the term notes and variable funding notes) have no recourse to any assets or revenues of Ditech Financial or the Parent Company other than to the limited extent of Ditech Financial’s or the Parent Company’s obligations with respect to various representations and warranties, covenants and indemnities under this facility and the Parent Company’s obligations as a guarantor of certain of Ditech Financial's representations, warranties, covenants and indemnities under the facility. Creditors of the Parent Company and Ditech Financial do not have recourse to any assets or revenues of either the issuer or depositor entities under the facility.
The facility's base indenture and indenture supplements include facility events of default and target amortization events customary for financings of this type, including but not limited to target amortization events related to breaches of covenants, defaults under certain other material indebtedness, material judgments, certain tests related to the collection and performance of the receivables securing the notes issued pursuant to the base indenture and the applicable indenture supplement, and with respect to the variable funding notes, certain financial tests and change of control. Upon the occurrence of an event of default, specified percentages of noteholders have the right to terminate all commitments and accelerate the notes under the base indenture, enforce their rights with respect to the collateral and take certain other actions. The events of default include, among other events, the occurrence of any failure to make payments (subject to certain cure periods and including balances due after the occurrence of a target amortization event), failure of Ditech Financial to satisfy various deposit and remittance obligations as servicer of certain mortgage loans, the requirement of a subsidiary, Green Tree Agency Advance Funding Trust I, to be registered as an “investment company” under the Investment Company Act of 1940, as amended, certain tests related to the collection and performance of the receivables securing the notes issued pursuant to the base indenture and applicable indenture supplement, removal of Ditech Financial’s status as an approved seller or servicer by either Fannie Mae or Freddie Mac and bankruptcy events.
In connection with this facility, we entered into an acknowledgment with Fannie Mae, dated as of December 19, 2014, and an amended and restated consent agreement with Freddie Mac, dated as of October 21, 2015, which (i) in the case of Fannie Mae, waived or (ii) in the case of Freddie Mac, subordinated, their respective rights of set-off against rights to reimbursement for certain servicer advances and delinquency advances subject to this facility. The Fannie Mae acknowledgment agreement remains in effect unless Fannie Mae withdraws its consent (i) at each yearly anniversary of the agreement by providing thirty days' advance written notice or (ii) upon certain other specified events. The Freddie Mac consent agreement automatically renews for successive annual terms; however, Freddie Mac may terminate its consent on 30 days' written notice. If either Fannie Mae or Freddie Mac were to withdraw such waiver or subordination, as applicable, of its respective rights of set-off, our ability to increase the draws on the variable funding notes or maintain the drawn balances thereunder could be materially limited or eliminated.
Early Advance Reimbursement Agreement
Ditech Financial's Early Advance Reimbursement Agreement with Fannie Mae is used exclusively to fund certain principal and interest, servicer and protective advances that are the responsibility of Ditech Financial under its Fannie Mae servicing agreements. This agreement was renewed in March 2016 and now expires in March 2017. If not renewed in 2017, there will be no additional funding by Fannie Mae of new advances under the agreement. In addition, collections recovered during the 18 months following the expiration of the agreement are to be remitted to Fannie Mae to settle any remaining outstanding balance due under such agreement. Upon expiration of the 18 month period, any remaining balance would become due and payable. At June 30, 2016, we had borrowings of $118.0 million under the Early Advance Reimbursement Agreement, which has a capacity of $200.0 million.
Other Servicing Advance Facilities
Ditech Financial has three additional servicing advance facilities through several lenders which are used to fund servicer and protective advances that are our responsibility under certain servicing agreements. These servicing advance facilities had an aggregate capacity amount of $170.0 million at June 30, 2016. The interest rates are primarily based on LIBOR plus between 2.50% and 3.00% and have various expiration dates from August 2016 to July 2018. One of these servicing advance facilities, with total borrowing capacity of $75.0 million, is non-recourse to the Company. At June 30, 2016 we had borrowings of $131.9 million under these facilities.
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Mortgage Loan Originations Business
Master Repurchase Agreements
We utilize master repurchase agreements to support our origination or purchase of mortgage loans. These agreements were entered into by Ditech Financial and various warehouse lenders. The five facilities under the repurchase agreements had an aggregate capacity of $2.1 billion at June 30, 2016. At June 30, 2016, the interest rates on the facilities were primarily based on LIBOR plus between 2.10% and 3.00% and have various expiration dates from August 2016 to June 2017. These facilities provide creditors a security interest in the mortgage loans that meet the eligibility requirements under the terms of the particular facility in exchange for cash proceeds used to originate or purchase mortgage loans. We agree to repay borrowings under these facilities within a specified timeframe, and the source of repayment is typically from the sale or securitization of the underlying loans into the secondary mortgage market. We evaluate our needs under these facilities based on forecasted mortgage loan origination volume; however, there can be no assurance that these facilities will be available to us in the future. The aggregate capacity includes $0.9 billion of committed funds and $1.2 billion of uncommitted funds. To the extent uncommitted funds are requested to purchase or originate mortgage loans, the counterparties have no obligation to fulfill such request. All obligations of Ditech Financial under the master repurchase agreements are guaranteed by the Parent Company. We had $1.2 billion of short-term borrowings under these master repurchase agreements at June 30, 2016, which included $258.3 million of borrowings utilizing uncommitted funds.
All of our master repurchase agreements contain customary events of default and covenants, the most significant of which are financial covenants. Financial covenants that are most sensitive to the operating results and resulting financial position are minimum tangible net worth requirements, indebtedness to tangible net worth ratio requirements, and minimum liquidity and profitability requirements.
Subsequent to the Original Filing, Ditech Financial received waivers and/or amendments required as a result of the restatement and conclusions reached regarding the Company's ability to continue as a going concern, as described in the Explanatory Note and Notes 2 and 3 to the Consolidated Financial Statements. The Ditech Financial master repurchase agreements that contain profitability covenants were also amended to allow for a net loss under such covenants for the quarters ending September 30, 2017 and December 31, 2017 as applicable to the terms of each respective agreement.
Representations and Warranties
In conjunction with our originations business, we provide representations and warranties on loan sales. We sell substantially all of our originated or purchased mortgage loans into the secondary market for securitization or to private investors as whole loans. We sell conventional conforming and government-backed mortgage loans through GSE and agency-sponsored securitizations in which mortgage-backed securities are created and sold to third-party investors. We also sell non-conforming mortgage loans to private investors. In doing so, representations and warranties regarding certain attributes of the loans are made to the third-party investor. Subsequent to the sale, if it is determined that a loan sold is in breach of these representations or warranties, we generally have an obligation to cure such breach. In general, if we are unable to cure such breach, the purchaser of the loan may require us to repurchase such loan for the unpaid principal balance, accrued interest, and related advances, and in any event, we must indemnify such purchaser for certain losses and expenses incurred by such purchaser in connection with such breach. Our credit loss may be reduced by any recourse we have to correspondent lenders that, in turn, have sold such residential loans to us and breached similar or other representations and warranties.
Our representations and warranties are generally not subject to stated limits of exposure with the exception of certain loans originated under HARP, which limits exposure based on payment history of the loan. At June 30, 2016, our maximum exposure to repurchases due to potential breaches of representations and warranties was $57.6 billion, and was based on the original unpaid principal balance of loans sold from the beginning of 2013 through June 30, 2016 adjusted for voluntary payments made by the borrower on loans for which we perform the servicing. A majority of our loan sales were servicing retained.
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Rollforwards of the liability associated with representations and warranties are included below (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Balance at beginning of the period | $ | 27,106 | $ | 12,132 | $ | 23,145 | $ | 10,959 | ||||||||
Provision for new sales | 3,724 | 4,532 | 8,437 | 6,557 | ||||||||||||
Change in estimate of existing reserves (1) | (10,086 | ) | (392 | ) | (10,759 | ) | (1,027 | ) | ||||||||
Net realized losses on repurchases | (481 | ) | (897 | ) | (560 | ) | (1,114 | ) | ||||||||
Balance at end of the period | $ | 20,263 | $ | 15,375 | $ | 20,263 | $ | 15,375 |
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(1) | The change in estimate during the three and six months ended June 30, 2016 is primarily due to adjustments to certain assumptions based on recently observed trends as compared to historical expectations, primarily relating to loan defect rates and counterparty review probabilities. |
Rollforwards of loan repurchase requests based on the original unpaid principal balance are included below (dollars in thousands):
For the Three Months Ended June 30, 2016 | For the Three Months Ended June 30, 2015 | |||||||||||||
No. of Loans | Unpaid Principal Balance | No. of Loans | Unpaid Principal Balance | |||||||||||
Balance at beginning of the period | 40 | $ | 10,466 | 93 | $ | 20,703 | ||||||||
Repurchases and indemnifications | (9 | ) | (2,570 | ) | (14 | ) | (2,090 | ) | ||||||
Claims initiated | 61 | 12,891 | 74 | 14,735 | ||||||||||
Rescinded | (62 | ) | (13,791 | ) | (59 | ) | (13,356 | ) | ||||||
Balance at end of the period | 30 | $ | 6,996 | 94 | $ | 19,992 |
For the Six Months Ended June 30, 2016 | For the Six Months Ended June 30, 2015 | |||||||||||||
No. of Loans | Unpaid Principal Balance | No. of Loans | Unpaid Principal Balance | |||||||||||
Balance at beginning of the period | 30 | $ | 6,225 | 48 | $ | 11,509 | ||||||||
Repurchases and indemnifications | (19 | ) | (4,416 | ) | (33 | ) | (6,070 | ) | ||||||
Claims initiated | 110 | 24,725 | 175 | 36,064 | ||||||||||
Rescinded | (91 | ) | (19,538 | ) | (96 | ) | (21,511 | ) | ||||||
Balance at end of the period | 30 | $ | 6,996 | 94 | $ | 19,992 |
The following table presents our maximum exposure to repurchases due to potential breaches of representations and warranties at June 30, 2016 based on the original unpaid principal balance of loans sold adjusted for voluntary payments made by the borrower on loans for which we perform the servicing by vintage year (in thousands):
Unpaid Principal Balance | ||||
2013 | $ | 10,827,901 | ||
2014 | 14,252,991 | |||
2015 | 22,832,534 | |||
2016 | 9,687,673 | |||
Total | $ | 57,601,099 |
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Reverse Mortgage Business
Master Repurchase Agreements
Through RMS's warehouse facilities under master repurchase agreements we finance the origination or purchase of reverse loans and repurchases of certain HECMs and real estate owned from Ginnie Mae securitization pools. At June 30, 2016, the three facilities had an aggregate capacity of $425.0 million, which includes $300.0 million of capacity that could be used to repurchase HECMs and real estate owned from Ginnie Mae securitization pools. The interest rates on the facilities are primarily based on LIBOR plus between 2.50% and 3.13%, and have expiration dates from September 2016 to May 2017. These facilities are secured by the underlying asset and provide creditors a security interest in the assets that meet the eligibility requirements under the terms of the particular facility. We agree to repay the borrowings under these facilities within a specified timeframe, and the source of repayment is typically from proceeds received on the securitization of the underlying reverse loans, claim proceeds received from HUD or liquidation proceeds from the sale of real estate owned. We evaluate our needs under these facilities based on forecasted reverse loan origination volume and repurchases; however, there can be no assurance that these facilities will be available to us in the future. At June 30, 2016, $250.0 million of the aggregate capacity has been provided on an uncommitted basis, and as such, to the extent these funds are requested to purchase or originate reverse loans or repurchase HECMs and real estate owned from Ginnie Mae securitization pools, the counterparties have no obligation to fulfill such request. At June 30, 2016, we had $69.0 million of borrowings utilizing uncommitted funds. All obligations of RMS under the master repurchase agreements are guaranteed by the Parent Company. We had $237.8 million of aggregated borrowings under these master repurchase agreements at June 30, 2016, which included borrowings of $188.8 million related to repurchases of HECMs and real estate owned.
All of our master repurchase agreements contain customary events of default and covenants, the most significant of which are financial covenants. Financial covenants that are most sensitive to the operating results and resulting financial position are minimum tangible net worth requirements, indebtedness to tangible net worth ratio requirements, and minimum liquidity and profitability requirements.
For the quarter ended March 31, 2016, one of RMS’s master repurchase agreements was amended to allow for a lower adjusted EBITDA (as determined pursuant to this agreement) for each of the first quarter and second quarter of 2016 under such agreement’s profitability covenant. Without this amendment, RMS would have been required to have a higher adjusted EBITDA as defined in the agreement for the quarter ended June 30, 2016 under this covenant and, therefore, would not have been in compliance with such covenant for the current quarter. In August 2016, an additional amendment was executed to allow for a lower adjusted EBITDA for each of the third quarter and fourth quarter of 2016 under such agreement's profitability covenant.
Subsequent to the Original Filing, RMS received waivers and/or amendments on its master repurchase agreements required as a result of the restatement and conclusions reached regarding the Company's ability to continue as a going concern, as described in the Explanatory Note and Notes 2 and 3 to the Consolidated Financial Statements.
Reverse Loan Securitizations
We transfer reverse loans that we have originated or purchased through the Ginnie Mae HMBS issuance process. The proceeds from the transfer of the HMBS are accounted for as a secured borrowing and are classified on the consolidated balance sheets as HMBS related obligations. The proceeds from the transfer are used to repay borrowings under our master repurchase agreements. At June 30, 2016, we had $10.0 billion in unpaid principal balance outstanding on the HMBS related obligations. At June 30, 2016, $10.0 billion in unpaid principal balance of reverse loans and real estate owned was pledged as collateral to the HMBS beneficial interest holders, and are not available to satisfy the claims of our creditors. Ginnie Mae, as guarantor of the HMBS, is obligated to the holders of the HMBS in an instance of RMS default on its servicing obligations, or when the proceeds realized on HECMs are insufficient to repay all outstanding HMBS related obligations. Ginnie Mae has recourse to RMS in connection with certain claims relating to the performance and obligations of RMS as both an issuer of HMBS and a servicer of HECMs underlying HMBS.
Borrower remittances received on the reverse loans, if any, proceeds received from the sale of real estate owned and our funds used to repurchase reverse loans are used to reduce the HMBS related obligations by making payments to Ginnie Mae, who will then remit the payments to the holders of the HMBS. The maturity of the HMBS related obligations is directly affected by the liquidation of the reverse loans or liquidation of real estate owned and events of default as stipulated in the reverse loan agreements with borrowers. Refer to the below for additional information on repurchases of reverse loans.
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HMBS Issuer Obligations
As an HMBS issuer, we assume certain obligations related to each security issued. The most significant obligation is the requirement to purchase loans out of the Ginnie Mae securitization pools once the outstanding principal balance of the related HECM is equal to or greater than 98% of the maximum claim amount. Performing repurchased loans are conveyed to HUD and payment is received from HUD typically within 30 days of repurchase. Non-performing repurchased loans are generally liquidated through foreclosure and subsequent sale of real estate owned. Loans are considered non-performing upon events such as, but not limited to, the death of the mortgagor, the mortgagor no longer occupying the property as their principal residence, or the property taxes or insurance not being paid. We rely upon certain master repurchase agreements and operating cash flows, to the extent necessary, to repurchase loans. The timing and amount of our obligation to repurchase HECMs is uncertain as repurchase is predicated on certain factors such as whether or not a borrower event of default occurs prior to the HECM reaching the mandatory repurchase threshold under which we are obligated to repurchase the loan.
Rollforwards of reverse loan and real estate owned repurchase activity (by unpaid principal balance) are included below (in thousands):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Balance at beginning of the period | $ | 289,980 | $ | 149,659 | $ | 233,594 | $ | 114,727 | ||||||||
Repurchases and other additions (1) | 143,359 | 71,264 | 270,339 | 127,862 | ||||||||||||
Liquidations | (116,784 | ) | (47,041 | ) | (187,378 | ) | (68,707 | ) | ||||||||
Balance at end of the period | $ | 316,555 | $ | 173,882 | $ | 316,555 | $ | 173,882 |
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(1) | Other additions include additions to the principal balance related to interest, servicing fees, mortgage insurance and advances. |
Our repurchases of reverse loans and real estate owned have increased significantly during the three and six months ended June 30, 2016 as compared to the same periods of 2015. We expect a continued increase to repurchase requirements due to the increased flow of HECMs and real estate owned that have moved through the buyout process as a result of these assets reaching 98% of their maximum claim amount.
Reverse Loan Servicer Obligations
Similar to our mortgage loan servicing business, our reverse mortgage servicing agreements impose on us obligations to advance our own funds to meet contractual payment requirements for customers and credit owners and to pay protective advances, which are required to preserve the collateral underlying the residential loans being serviced. We rely upon operating cash flows to fund these obligations.
As servicer of reverse loans, we are also obligated to fund additional borrowing capacity in the form of undrawn lines of credit on floating rate and fixed rate reverse loans. We rely upon our operating cash flows to fund these additional borrowings on a short-term basis prior to securitization (when performing services of both the issuer and servicer) or reimbursement by the issuer (when providing third-party servicing). The additional fundings made by us, as issuer and servicer, are generally securitized within 30 days after funding. Similarly, the additional fundings made by us, as third-party servicer, are typically reimbursed by the issuer within 30 days after funding. Our commitment to fund additional borrowing capacity was $1.3 billion at June 30, 2016, which includes $1.1 billion in capacity that was available to be drawn by borrowers at June 30, 2016 and $190.2 million in capacity that will become eligible to be drawn by borrowers throughout the period ending July 1, 2017 assuming the loans remain performing. There is no termination date for these drawings so long as the loan remains performing. The obligation to fund these additional borrowings could have a significant impact on our liquidity.
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Servicing Rights Related Liabilities
Excess Servicing Spread Liabilities
In July 2014, we completed an excess servicing spread transaction with WCO whereby we sold 70% of the excess servicing spread from a pool of servicing rights, with an unpaid principal balance of $25.2 billion, to WCO for a sales price of $75.4 million. In November 2015, we completed an additional excess servicing spread transaction with WCO whereby we sold 100% of excess servicing spread from a pool of servicing rights, with an unpaid principal balance of $7.5 billion, to WCO for a sales price of $46.8 million. We recognized the proceeds from the sales of the excess servicing spreads as financing arrangements. We elected to record the excess servicing spread liabilities at fair value similar to the related servicing rights. At June 30, 2016, the carrying value of our excess servicing spread liabilities was $84.6 million, the repayment of which is based on future servicing fees received from the residential loans underlying the servicing rights.
Servicing Rights Financing
In November 2015, we completed the sale of servicing rights, with an unpaid principal balance of $1.8 billion, to WCO for a sales price of $17.8 million. Further, in May 2016, we sold additional servicing rights with an unpaid principal balance of $4.1 billion to WCO for a sales price of $27.9 million. We recognized the proceeds from the sale of the servicing rights as a financing arrangement. We elected to record the servicing rights financing at fair value similar to the related servicing rights. The repayment of such financing is based on future servicing fees received from the residential loans underlying the servicing rights. At June 30, 2016, the carrying value of our servicing rights financing was $36.2 million. We have a receivable due from WCO for these sales of $4.6 million at June 30, 2016.
Corporate Debt
Term Loans and Revolver
We have a $1.5 billion 2013 Term Loan and a $100.0 million 2013 Revolver. Our obligations under the 2013 Secured Credit Facilities are guaranteed by substantially all of our subsidiaries and secured by substantially all of our assets subject to certain exceptions, such as the assets of the consolidated Residual and Non-Residual Trusts and consolidated financing entities, as well as the residential loans and real estate owned of the Ginnie Mae securitization pools that have been recorded on our consolidated balance sheets.
The material terms of our 2013 Secured Credit Facilities are summarized in the table below:
Debt Agreement | Interest Rate | Amortization | Maturity/Expiration | |||
$1.5 billion 2013 Term Loan | LIBOR plus 3.75% LIBOR floor of 1.00% | 1.00% per annum beginning 1st quarter of 2014; remainder at final maturity | December 18, 2020 | |||
$100.0 million 2013 Revolver | LIBOR plus 4.50% (1) | Bullet payment at maturity | December 19, 2018 |
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(1) | As a result of an amendment to the 2013 Credit Agreement discussed below, the interest rate on any drawn amounts under the 2013 Revolver increased from LIBOR plus 3.75% to LIBOR plus 4.50% through January 1, 2017. |
An amount of up to $25.0 million under the 2013 Revolver is available to be used for the issuance of LOCs. Any amounts outstanding in issued LOCs reduce availability for cash borrowings under the 2013 Revolver. There have been no borrowings under the 2013 Revolver. At June 30, 2016, we had $0.3 million outstanding in an issued LOC with remaining availability under the 2013 Revolver of $99.7 million. The commitment fee on the unused portion of the 2013 Revolver is 0.50% per year. During the six months ended June 30, 2016, we repurchased $7.2 million in principal balance of the 2013 Term Loan for $6.3 million resulting in a gain on extinguishment of $0.9 million. The balance outstanding on the 2013 Term Loan was $1.4 billion at June 30, 2016.
The 2013 Secured Credit Facilities contain restrictive covenants that, among other things, limit our ability and the ability of our restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends on or redeem or repurchase our capital stock, make certain types of investments, create restrictions on the payment of dividends or other amounts to us from our restricted subsidiaries, incur certain liens, sell or otherwise dispose of certain assets, enter into transactions with affiliates, enter into sale and leaseback transactions, and consolidate or merge with or into, or sell all or substantially all of our assets to, another person. These covenants are subject to a number of important limitations and exceptions. The 2013 Secured Credit Facilities also contain customary events of default, including the failure to make timely payments on the 2013 Term Loan and 2013 Revolver or other material indebtedness, the failure to satisfy certain covenants and specified events of bankruptcy and insolvency.
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Our ability to draw upon the 2013 Revolver is contingent upon our satisfaction of certain financial and other covenants, and the permitted use of the 2013 Revolver is limited to our and our subsidiaries' liquidity needs (but excluding voluntary prepayments, redemptions or repurchases of other indebtedness). On August 5, 2016, we entered into an amendment to the 2013 Credit Agreement, which among other things, permanently reduced the aggregate commitments under the 2013 Revolver from $125.0 million to $100.0 million, increased the interest rate on any drawn amounts under the 2013 Revolver to LIBOR plus 4.50% through January 1, 2017, and increased the required Total Leverage Ratio for the second and third quarters of 2016. After giving effect to the amendment, we were in compliance with the increased Total Leverage Ratio and we were in compliance with all other covenants contained in our 2013 Credit Agreement as of June 30, 2016. At any time at which the aggregate amount of revolving loans and outstanding letters of credit issued under the 2013 Revolver exceeds $20.0 million, we are required to comply with certain interest coverage ratios and total leverage ratios specified in the 2013 Credit Agreement. A failure to comply with these financial ratios would give the lenders under the 2013 Revolver the right to terminate their revolving commitments, accelerate any outstanding revolving loans and exercise other remedies, and any such acceleration by the lenders under the 2013 Revolver could result in an event of default under the 2013 Term Loan.
Subsequent to the Original Filing, we received waivers from each of the requisite holders of our term loans to the extent necessary to waive any default, event of default, amortization event, termination event or similar event resulting from or arising from the restatement and conclusions reached regarding the Company's ability to continue as a going concern, as described in the Explanatory Note and Notes 2 and 3 to the Consolidated Financial Statements.
Senior Notes
In December 2013, we completed the sale of $575.0 million aggregate principal amount of Senior Notes, which pay interest semi-annually at an interest rate of 7.875% and mature on December 15, 2021. The balance outstanding on the Senior Notes was $538.7 million at June 30, 2016.
The Senior Notes were offered and sold in a transaction exempt from the registration requirements under the Securities Act, and resold to qualified institutional buyers in reliance on Rule 144A and Regulation S under the Securities Act. The Senior Notes were issued pursuant to an indenture, dated as of December 17, 2013, among the Company, the guarantor parties thereto and Wells Fargo Bank, National Association, as trustee. The Senior Notes are guaranteed on an unsecured senior basis by each of our current and future wholly-owned domestic subsidiaries that guarantee our obligations under our 2013 Term Loan. On October 14, 2014, we filed with the SEC a registration statement under the Securities Act so as to allow holders of the Senior Notes to exchange their Senior Notes for the same principal amount of a new issue of notes with identical terms, except that the exchange notes are not subject to certain restrictions on transfer. The registration statement was declared effective by the SEC on October 27, 2014, the exchange offer expired on November 25, 2014, and settlement occurred on December 2, 2014.
On or prior to December 15, 2016, we may on any one or more occasions redeem up to 35% of the aggregate principal amount of the Senior Notes with the net cash proceeds of certain equity offerings at 107.875% of their aggregate principal amount plus accrued and unpaid interest as of the redemption date. Prior to December 15, 2016, we may redeem some or all of the Senior Notes at a make-whole premium plus accrued and unpaid interest, if any, as of the redemption date.
On or after December 15, 2016, we may on any one or more occasions redeem some or all of the Senior Notes at a purchase price equal to 105.906% of the principal amount of the Senior Notes, plus accrued and unpaid interest, if any, as of the redemption date, such optional redemption prices decreasing to 103.938% on or after December 15, 2017, 101.969% on or after December 15, 2018 and 100.000% on or after December 15, 2019.
If a change of control, as defined under the Senior Notes Indenture, occurs, the holders of our Senior Notes may require that we purchase with cash all or a portion of these Senior Notes at a purchase price equal to 101% of the principal amount of the Senior Notes, plus accrued and unpaid interest to the redemption date.
The Senior Notes Indenture contains restrictive covenants that, among other things, limits our ability and the ability of our restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends on or redeem or repurchase our capital stock, make certain types of investments, create restrictions on the payment of dividends or other amounts to us from our restricted subsidiaries, incur certain liens, sell or otherwise dispose of certain assets, enter into transactions with affiliates, enter into sale and leaseback transactions, and consolidate or merge with or into, or sell all or substantially all of our assets to, another person. These covenants are subject to a number of important limitations and exceptions. The Senior Notes Indenture also contains customary events of default, including the failure to make timely payments on the Senior Notes or other material indebtedness, the failure to satisfy certain covenants and specified events of bankruptcy and insolvency. We were in compliance with all covenants contained in the Senior Notes Indenture at June 30, 2016.
Subsequent to the Original Filing, the beneficial owners of the requisite principal amount of our Senior Notes agreed to waive any default or event of default arising from the restatement, as described in the Explanatory Note and Note 2 to the Consolidated Financial Statements.
Convertible Notes
In October 2012, we closed on a registered underwritten public offering of $290.0 million aggregate principal amount of Convertible Notes. The Convertible Notes pay interest semi-annually on May 1 and November 1, commencing on May 1, 2013, at a rate of 4.50% per annum, and mature on November 1, 2019.
Prior to May 1, 2019, the Convertible Notes will be convertible only upon specified events and during specified periods, and, on or after May 1, 2019, at any time. The Convertible Notes will initially be convertible at a conversion rate of 17.0068 shares of our common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of approximately $58.80 per share. Upon conversion, we may pay or deliver, at our option, cash, shares of our common stock, or a combination of cash and shares of common stock. It is our intent to settle all conversions through combination settlement, which involves payment of an amount of cash equal to the principal amount and any excess of conversion value over the principal amount in shares of common stock.
As market conditions warrant, we may from time to time, subject to limitations as stated in our 2013 Secured Credit Facilities, repurchase debt securities issued by us, in the open market, in privately negotiated transactions, by tender offer or otherwise.
Mortgage-Backed Debt
We funded the residential loan portfolio in the consolidated Residual Trusts through the securitization market. We record on our consolidated balance sheets the assets and liabilities, including mortgage-backed debt, of the Non-Residual Trusts as a result of certain obligations to exercise mandatory clean-up calls for each of these trusts at their earliest exercisable dates. The total unpaid principal balance of mortgage-backed debt was $1.0 billion at June 30, 2016.
At June 30, 2016, mortgage-backed debt was collateralized by $1.0 billion of assets including residential loans, receivables related to the Non-Residual Trusts, real estate owned and restricted cash and cash equivalents. All of the mortgage-backed debt is non-recourse and not cross-collateralized and, therefore, must be satisfied exclusively with the proceeds from the residential loans and real estate owned held in each securitization trust and also from draws on the LOCs of certain Non-Residual Trusts.
Borrower remittances received on the residential loans of the Residual and Non-Residual Trusts collateralizing this debt and draws under LOCs issued by a third-party and serving as credit enhancements to certain of the Non-Residual Trusts are used to make payments on the mortgage-backed debt. The maturity of the mortgage-backed debt is directly affected by the rate of principal prepayments on the collateral. As a result, the actual maturity of the mortgage-backed debt is likely to occur earlier than the stated maturity. Certain of our mortgage-backed debt issued by the Residual Trusts is also subject to voluntary redemption according to the specific terms of the respective indenture agreements, including an option by us to exercise a clean-up call. The mortgage-backed debt issued by the Non-Residual Trusts is subject to mandatory clean-up call provisions pursuant to which we are required to purchase the related mortgage loans from the trusts at the earliest of their exercisable call dates, which is the date each loan pool falls to 10% of the original principal amount. We anticipate the mandatory call obligations to settle beginning in 2017 and continuing through 2019 based upon our current cash flow projections for the Non-Residual Trusts. At June 30, 2016, the total estimated outstanding balance of the residential loans expected to be called at the respective call dates is $417.9 million. We estimate call obligations of $100.9 million, $254.0 million and $63.0 million during the years ending December 31, 2017, 2018 and 2019, respectively. We expect to finance the capital required to exercise the mandatory clean-up call primarily through cash on hand, asset-backed financing or in partnership with a capital provider, or through any combination of the foregoing. However, there can be no assurance that we will be able to sell the loans or obtain financing when needed. Our obligation for the mandatory clean-up call could have a significant impact on our liquidity.
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Certain Capital Requirements and Guarantees
We, including our subsidiaries, are required to comply with requirements under federal and state laws and regulations, including requirements imposed in connection with certain licenses and approvals, as well as requirements of federal, state, GSE, Ginnie Mae and other business partner loan programs, some of which are financial covenants related to minimum levels of net worth and other financial requirements. If these mandatory imposed capital requirements are not met, our selling and servicing agreements could be terminated and lending and servicing licenses could be suspended or revoked. As a result of the restatement as described in Note 2 to the Consolidated Financial Statements, RMS was not in compliance with certain financial covenants required by Ginnie Mae and Fannie Mae as of June 30, 2016. As of June 30, 2017, RMS was in compliance with such financial covenants.
Noncompliance with those requirements for which we have not received a waiver could have a negative impact on our company, which could include suspension or termination of the selling and servicing agreements, which would prohibit future origination or securitization of mortgage loans or being an approved seller or servicer for the applicable GSE.
We also have financial covenant requirements relating to our servicing advance facilities and master repurchase agreements. Refer to additional information at the Mortgage Loan Servicing Business, Mortgage Loan Originations Business and Reverse Mortgage Business sections above for further information.
Dividends
We have no current plans to pay any cash dividends on our common stock. Any decision to declare and pay dividends in the future will be made at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our Board of Directors may deem relevant. In addition, our ability to pay dividends is limited by covenants in our 2013 Credit Agreement and the Senior Notes Indenture. Refer to the Corporate Debt section above.
Sources and Uses of Cash
The following table sets forth selected consolidated cash flow information (in thousands):
For the Six Months Ended June 30, | ||||||||||||
2016 | 2015 | Variance | ||||||||||
Cash flows provided by (used in) operating activities: | ||||||||||||
Net loss adjusted for non-cash operating activities | $ | (5,644 | ) | $ | (63,724 | ) | $ | 58,080 | ||||
Changes in assets and liabilities | 154,442 | 169,144 | (14,702 | ) | ||||||||
Net cash provided by (used in) originations activities (1) | 161,247 | (374,176 | ) | 535,423 | ||||||||
Cash flows provided by (used in) operating activities | 310,045 | (268,756 | ) | 578,801 | ||||||||
Cash flows provided by (used in) investing activities | 197,595 | (395,848 | ) | 593,443 | ||||||||
Cash flows provided by (used in) financing activities | (397,575 | ) | 688,209 | (1,085,784 | ) | |||||||
Net increase in cash and cash equivalents | $ | 110,065 | $ | 23,605 | $ | 86,460 |
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(1) | Represents purchases and originations of residential loans held for sale, net of proceeds from sale and payments. |
Operating Activities
The primary sources and uses of cash for operating activities are purchases, originations and sales activity of residential loans held for sale, changes in assets and liabilities, or operating working capital, and net loss adjusted for non-cash items. Cash provided by operating activities increased $578.8 million during the six months ended June 30, 2016 as compared to net cash used in operating activities for the same period of 2015. The increase in cash provided by operating activities was primarily a result of an increase in cash provided by originations activities, resulting from a higher volume of loans sold in relation to originated loans as compared to the same period of 2015.
Investing Activities
The primary sources and uses of cash for investing activities relate to purchases, originations and payment activity on reverse loans, payments received on mortgage loans held for investment, and payments made for business and servicing rights acquisitions. Net cash provided by investing activities increased $593.4 million during the six months ended June 30, 2016 as compared to net cash used in investing activities for the same period of 2015. Cash used for purchases and originations of reverse loans held for investment, net of payments received, decreased $626.2 million primarily as a result of a lower funded volume and higher principal repayments and payments received for loans conveyed to HUD. Cash paid for business acquisitions and purchases of servicing rights decreased $181.7 million. These increases described above were partially offset by the cash received in 2015 of $189.5 million in proceeds from the sale of our residual interests.
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Financing Activities
The primary sources and uses of cash for financing activities relate to securing cash for our originations, reverse mortgage and servicing businesses, as well as for our corporate investing activities. Net cash used in financing activities changed by $1.1 billion during the six months ended June 30, 2016 as compared to net cash provided by financing activities for the same period of 2015. Cash generated from the securitization of reverse loans, net of payments on HMBS related obligations, decreased $665.6 million primarily as a result of a lower volume of loan securitizations and an increase in the repurchase of certain HECMs and real estate owned from securitization pools. Net cash borrowings from warehouse borrowings used to fund purchases and originations of mortgage loans and reverse loans decreased $387.6 million primarily as a result of a lower funded volume, partially offset by an increase in Ginnie Mae buyouts. Payments on servicing advance liabilities, net of related issuances, increased $107.6 million during the six months ended June 30, 2016 as compared to the same period of 2015, due to a net increase in collections on servicing advances from bulk filing process with certain investors.
Credit Risk
Consumer Credit Risk
In conjunction with our originations business, we provide representations and warranties on loan sales. Subsequent to the sale, if it is determined that a loan sold is in breach of these representations or warranties, we generally have an obligation to cure such breach. In general, if we are unable to cure such breach, the purchaser of the loan may require us to repurchase such loan for the unpaid principal balance, accrued interest, and related advances, and in any event, we must indemnify such purchaser for certain losses and expenses incurred by such purchaser in connection with such breach. In the case we repurchase the loan, the Company bears any subsequent credit loss on the loan. Our credit loss may be reduced by any recourse we have to correspondent lenders that, in turn, have sold such residential loans to us and breached similar or other representations and warranties. We maintain a reserve for losses on our representations and warranties obligations. Refer to Notes 5 and 15 in the Notes to Consolidated Financial Statements and to the Liquidity and Capital Resources section for additional information. At June 30, 2016, we held $8.2 million in repurchased loans.
We are also subject to credit risk associated with mortgage loans that we purchase and originate during the period of time prior to the sale of these loans. We consider the credit risk associated with these loans to be insignificant as we hold the loans for a short period of time, typically less than 20 days, and the market for these loans continues to be highly liquid.
Counterparty Credit Risk
We are exposed to counterparty credit risk in the event of non-performance by counterparties to various agreements, including our mortgage loan sales and MBS purchase commitments. We attempt to minimize this risk through monitoring procedures, including monitoring of our counterparties’ credit ratings, review of our counterparties' financial statements, and establishment of collateral requirements. Counterparty credit risk, as well as our own credit risk, is taken into account when determining fair value, although its impact is diminished by daily cash margin posting on the majority of our mortgage loan sales and MBS purchase commitments and other collateral requirements.
Counterparty credit risk also exists with our third-party originators from whom we purchase originated mortgage loans and certain third-party originators from whom we acquire servicing rights. The third-party originators incur a representation and warranty obligation when they sell the mortgage loan to us or another third party, and they agree to reimburse us for any losses incurred due to an origination defect. We become exposed to losses for origination defects if the third-party originator is not able to reimburse us for losses incurred for indemnification or repurchase. We attempt to mitigate this risk by conducting quality control reviews of the third-party originators, reviewing compliance by third-party originators with applicable underwriting standards and our client guide, and evaluating the credit worthiness of third-party originators on a periodic basis.
Real Estate Market Risk
We include on our consolidated balance sheets assets secured by real property and property obtained directly as a result of foreclosures. Residential property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
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We held real estate owned, net of $77.6 million, $11.8 million and $1.7 million in the Reverse Mortgage and Servicing segments and the Other non-reportable segment, respectively, at June 30, 2016. We held real estate owned, net of $66.4 million, $10.4 million and $0.6 million in the Reverse Mortgage and Servicing segments and the Other non-reportable segment, respectively, at December 31, 2015.
A non-performing reverse loan for which the maximum claim amount has not been met is generally foreclosed upon on behalf of Ginnie Mae with the real estate owned remaining in the securitization pool until liquidation. Although performing and non-performing loans are covered by FHA insurance, we may incur expenses and losses in the process of repurchasing and liquidating these loans that are not reimbursable by FHA in accordance with program guidelines. In addition, in certain circumstances, we may be subject to real estate price risk to the extent we are unable to liquidate real estate owned within the FHA program guidelines. We attempt to mitigate this risk by monitoring the aging of real estate owned and managing our marketing and sales program based on this aging. The growth in the real estate owned portfolio held by the Reverse Mortgage segment was due to the increased flow of HECMs that move through the foreclosure process.
Ratings
We receive various credit and servicer ratings as set forth below. Our ratings may be subject to a revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Rating agency ratings are not a recommendation to buy, sell or hold any security.
Credit Ratings
Credit ratings are intended to be an indicator of the creditworthiness of a particular company, security or obligation and are considered by lenders in connection with the setting of interest rates and terms for a company's borrowings. Our ability to obtain adequate and cost effective financing depends, in part, on our credit ratings. A downgrade in our credit ratings could negatively affect our cost of, and ability to access, capital. The following table summarizes our credit ratings and outlook as of the date of this report.
Moody's | S&P | |||
Corporate / CCR | B3 | B | ||
Senior Secured Debt | B3 | B+ | ||
Senior Unsecured Debt | Caa1 | CCC+ | ||
Outlook | Stable | Negative | ||
Date of Last Action | March 2016 | July 2016 |
Servicer Ratings
Residential loan and manufactured housing servicer ratings reflect the applicable rating agency's assessment of a servicer’s operational risk and how the quality and experience of the servicer affect loan performance. The following table summarizes the servicer ratings and outlook assigned to certain of our servicer subsidiaries as of the date of this report. Unless otherwise specified, these servicer ratings relate to Ditech Financial as a servicer of mortgage loans.
Moody's | S&P | |||
Residential Prime Servicer | — | — | ||
Residential Subprime Servicer | SQ3+ | Above Average | ||
Residential Special Servicer | — | Above Average | ||
Residential Second/Subordinated Lien Servicer | SQ2- | Above Average | ||
Manufactured Housing Servicer | SQ2- | Above Average | ||
Residential HLTV Servicer | — | — | ||
Residential HELOC Servicer | — | — | ||
Residential Reverse Mortgage Servicer | — | Strong (1) | ||
Outlook | Not on review | Stable | ||
Date of Last Action | December 2015 | October 2015 |
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(1) | S&P last affirmed its rating for RMS as a residential reverse mortgage servicer in November 2015 with a stable outlook. |
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Following an internal review of our servicer ratings in 2015, including the servicer rating requirements contained in our contracts, we decided to no longer solicit servicer ratings from Fitch. On April 29, 2016, Fitch issued a press release stating it has withdrawn all, and will no longer provide, servicer ratings and outlooks for Ditech Financial.
Cybersecurity
We devote significant resources to maintain and regularly update our systems and processes that are designed to protect the security of our computer systems, software, networks and other technology assets against attempts by unauthorized parties to obtain access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage. From time to time we, our vendors and other companies that store or process confidential borrower personal and transactional data are targeted by unauthorized parties using malicious code and viruses or otherwise attempting to breach the security of our or our vendors’ systems and data. We employ extensive layered security at all levels within our organization to help us detect malicious activity, both from within the organization and from external sources. It is company protocol to investigate the cause and extent of all instances of cyber-attack, potential or confirmed, and take any additional necessary actions including: conducting additional internal investigation; engaging third-party forensic experts; updating our defenses; and involving senior management. We have established, and continue to establish on an ongoing basis, defenses to identify and mitigate these cyber-attacks, and although these cyber-attacks have on occasion penetrated certain defenses, they have not, to date, resulted in any material disruption to our operations and have not had a material adverse effect on our results of operations. However, loss, unauthorized access to, or misuse of confidential or personal information could disrupt our operations, damage our reputation, and expose us to claims from customers, financial institutions, regulators, employees and other persons, any of which could have an adverse effect on our business, financial condition and results of operations.
In addition to our vendors, other third parties with whom we do business or that facilitate our business activities (e.g., GSEs, transaction counterparties and financial intermediaries) could also be sources of cybersecurity risk to us, including with respect to breakdowns or failures of their systems, misconduct by the employees of such parties, or cyber-attacks which could affect their ability to deliver a product or service to us or result in lost or compromised information of us or our consumers. We work with our vendors and other third parties with whom we do business, to enhance our defenses and improve resiliency to cybersecurity threats. Systems failures could result in reputational damage to our business and cause us to incur significant costs and third-party liability, and this could adversely affect our business, financial condition and results of operations.
Off-Balance Sheet Arrangements
We have certain off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, revenues and expenses, results of operations, liquidity, capital expenditures or capital resources.
We have exposure to representations and warranties obligations as a result of our loan sales activities. If it is determined that loans sold are in breach of these representations or warranties and we are unable to cure such breach, we generally have an obligation to either repurchase the loan for the unpaid principal balance, accrued interest, and related advances, and in any event, we must indemnify the purchaser of the loans for certain losses and expenses incurred by such purchaser in connection with such breach. Our credit loss may be reduced by any recourse we have to correspondent lenders that, in turn, have sold such residential loans to us and breached similar or other representations and warranties. We record an estimate of the liability associated with our representations and warranties exposure on our consolidated balance sheet. Refer to Notes 5 and 15 in the Notes to Consolidated Financial Statements for the financial effect of these arrangements and to the Liquidity and Capital Resources section for additional information.
We have a variable interest in WCO which has provided financing to us since 2014 through the sale of excess servicing spreads and servicing rights. The repayment of the excess servicing spread liabilities and servicing rights financing is based on future servicing fees received from the residential loans underlying the servicing rights. In addition, we perform sub-servicing for WCO. Refer to Notes 8 and 17 in the Notes to Consolidated Financial Statements for additional information on servicing activities and transactions with WCO. We also have other variable interests in other entities that we do not consolidate as we have determined we are not the primary beneficiary. Included in Note 4 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 are descriptions of our variable interests in VIEs that we do not consolidate, as we have determined that we are not the primary beneficiary of such VIEs.
Critical Accounting Estimates
The critical accounting estimates used in preparation of our consolidated financial statements are described in the Critical Accounting Estimates section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC on February 29, 2016. Provided below is a summary of goodwill as described in such Annual Report on Form 10-K and significant updates. Except as provided below, there have been no material changes to our critical accounting policies or estimates and the methodologies or assumptions we apply under them.
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Goodwill
As a result of our various acquisitions, we have recorded goodwill, which represents the excess of the consideration paid for a business combination over the fair value of the identifiable net assets acquired. Goodwill is initially recorded at fair value and is subsequently evaluated at least annually for impairment. We perform this annual test at the reporting unit level as of October 1 of each year, or whenever events or circumstances indicate potential impairment. Impairment exists when a reporting unit’s carrying amount of goodwill exceeds its implied fair value. A reporting unit is a business segment or one level below. We have identified five reporting units, which constitute businesses: (i) Servicing; (ii) ARM; (iii) Insurance; (iv) Originations; and (v) Reverse Mortgage. Segment management regularly reviews discrete financial information for these reporting units.
We have the option of performing a qualitative assessment to determine whether any further quantitative testing for a potential impairment is necessary. Our qualitative assessment will use judgments including, but not limited to, changes in the general economic environment, industry and regulatory considerations, current economic performance compared to historical economic performance, entity-specific events, events affecting our reporting units, and sustained changes in our stock price, where applicable. If we elect to bypass the qualitative assessment or if we determine, based upon our assessment of those qualitative factors that it is more likely than not that the fair value of the reporting unit is less than its net carrying value, a quantitative assessment is required. The quantitative test is a two-step test. The first step identifies whether there is potential impairment by comparing the fair value of a reporting unit to the carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying amount, the second step of the impairment test is required to measure the amount of impairment loss, if any. As part of the second step, we allocate the reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value allocated to goodwill (implied fair value of goodwill). If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of such goodwill, we recognize an impairment loss in an amount equal to that excess up to the carrying value of goodwill.
During the first six months of 2016, operating results for our Servicing reporting unit were below expectations, primarily driven by delays in transitioning the business model as described below, as well as external pressures that the sector continues to experience, including regulatory scrutiny and market volatility due to the declining interest rate environment. During this same period, our ARM reporting unit has been unsuccessful in developing new business opportunities. Additionally, our share price has continued to experience downward pressures during 2016. As a result, we reassessed our market capitalization and the potential impact that the decline in market capitalization could have on the carrying value of goodwill. Management concluded that the aforementioned circumstances indicated that it was more likely than not that the fair value of these reporting units may be below their respective carrying amounts and accordingly, that Step 1 testing should be completed for both the Servicing and ARM reporting units. The Step 1 test indicated that both the Servicing and ARM reporting units had carrying values that exceeded the respective estimated fair values and therefore, the second step of the impairment evaluation for these reporting units was required to be completed to measure the amount of impairment to be recorded, if any. Based on the Step 2 analysis, the carrying amount of the Servicing reporting unit’s goodwill exceeded its implied fair value by $194.1 million, for which a goodwill impairment charge was recorded in the second quarter of 2016. This impairment was primarily the result of an increased company-specific risk premium added to the discount rate that was applied to lower re-forecasted cash flows. The decline in cash flows was driven by continued challenges associated with certain company-specific matters, including delays in transitioning the Servicing business to a more fee-for-service and capital-light business model, and other market developments that have also contributed to the decline in the Company's stock price. Additionally, based on the Step 2 analysis, the carrying amount of the ARM reporting unit’s goodwill exceeded its implied fair value by $21.3 million, for which a goodwill impairment charge was recorded in the second quarter of 2016. This impairment was primarily the result of the inability of this reporting unit to develop new business opportunities. At June 30, 2016, the Servicing, Originations, ARM and Insurance reporting units had goodwill of $91.0 million, $47.7 million, $13.1 million and $4.4 million, respectively.
We are likely to continue to be impacted in the near term by overall market performance within the sector, a continued level of regulatory scrutiny and other company-specific matters. As a result, we have and will continue to regularly monitor, among other things, our market capitalization, overall economic and sector conditions and other events or circumstances, including the ability to execute on our strategic objectives. Unanticipated outcomes in these areas may result in an impairment of goodwill in the future.
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Glossary of Terms
This Glossary of Terms includes acronyms and defined terms that are used throughout this Quarterly Report on Form 10-Q/A.
2011 Plan | 2011 Omnibus Incentive Plan established by the Company on May 10, 2011, as amended and restated |
2013 Credit Agreement | Credit Agreement entered into on December 19, 2013 among the Company, Credit Suisse AG, as administrative agent and collateral agent, the lenders from time to time party thereto and other parties thereto, as amended |
2013 Revolver | Senior secured revolving credit facility entered into on December 19, 2013, as amended |
2013 Term Loan | $1.5 billion senior secured first lien term loan entered into on December 19, 2013, as amended |
2013 Secured Credit Facilities | 2013 Term Loan and 2013 Revolver, collectively |
Adjusted EBITDA | Adjusted earnings before interest, taxes, depreciation and amortization, a non-GAAP financial measure; refer to Non-GAAP Financial Measures section under Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for a description of this metric |
Adjusted Earnings (Loss) | Adjusted earnings or loss before taxes, a non-GAAP financial measure; refer to Non-GAAP Financial Measures section under Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for a description of this metric |
Amended Filing | The Company's Amended Quarterly Report on Form 10-Q/A for the quarterly period ended June 30, 2016 |
ARM | Asset Receivables Management, a reporting unit of the Company |
Bankruptcy Code | Title 11 of the United States Code |
Borrowers | Borrowers under residential mortgage loans and installment obligors under residential retail installment agreements |
Bps | Basis points |
Bulk MSR | Bulk MSR as defined under the 2013 Credit Agreement |
CCR | Corporate credit rating |
CFPA | Consumer Financial Protection Act of 2010 |
CFPB | Consumer Financial Protection Bureau |
Charged-off loans | Defaulted consumer and residential loans acquired by the Company at substantial discounts to face value acquired during 2014, which are also referred to as post charge-off deficiency balances |
CID | Civil investigative demand |
Coal Acquisition | Warrior Met Coal, LLC (f/k/a Coal Acquisition LLC) |
Consenting Term Lenders | Lenders holding, as of July 31, 2017, more than 50% of the loans and/or commitments outstanding under the 2013 Credit Agreement |
Consolidated Financial Statements | The consolidated financial statements of Walter Investment Management Corp. and its subsidiaries and the notes thereto included in Item 1 of this Form 10-Q/A |
Convertible Notes | $290 million aggregate principal amount of 4.50% convertible senior subordinated notes sold in a registered underwritten public offering on October 23, 2012 |
Distribution taxes | Taxes imposed on Walter Energy or a Walter Energy shareholder as a result of the potential determination that the Company's spin-off from Walter Energy was not tax-free pursuant to Section 355 of the Code |
Ditech Financial | Ditech Financial LLC, formerly Green Tree Servicing LLC, an indirect wholly-owned subsidiary of the Company |
Ditech Mortgage Corp | Formerly an indirect wholly-owned subsidiary of the Company; Ditech Mortgage Corp and DT Holdings LLC were merged with and into Green Tree Servicing LLC, with Green Tree Servicing LLC continuing as the surviving entity, which was renamed Ditech Financial LLC |
EBITDA | Earnings before interest, taxes, depreciation, and amortization |
Early Advance Reimbursement | $200 million financing facility with Fannie Mae |
Agreement
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ECOA | Equal Credit Opportunity Act |
EFTA | Electronic Fund Transfer Act |
Exchange Act | Securities Exchange Act of 1934, as amended |
Fannie Mae | Federal National Mortgage Association |
FASB | Financial Accounting Standards Board |
FHA | Federal Housing Administration |
FHFA | Federal Housing Finance Agency |
Fitch | Fitch Ratings Inc., a nationally recognized statistical rating organization designated by the SEC |
Forward sales commitments | Forward sales of agency to-be-announced securities, a freestanding derivative financial instrument |
Freddie Mac | Federal Home Loan Mortgage Corporation |
FTC | Federal Trade Commission |
GAAP | United States Generally Accepted Accounting Principles |
Ginnie Mae | Government National Mortgage Association |
Green Tree Servicing | Green Tree Servicing LLC; former name of Ditech Financial. Ditech Mortgage Corp and DT Holdings LLC were merged with and into Green Tree Servicing LLC, with Green Tree Servicing LLC continuing as the surviving entity, which was renamed Ditech Financial LLC |
GSE | Government-sponsored entity |
GTIM | Green Tree Investment Management, LLC, an indirect wholly-owned subsidiary of the Company |
HAMP | Home Affordable Modification Program |
HARP | Home Affordable Refinance Program |
HECM | Home Equity Conversion Mortgage |
HECM IDL | Home Equity Conversion Mortgage Initial Disbursement Limit |
HELOC | Home equity line of credit |
HLTV | High loan to value |
HMBS | Home Equity Conversion Mortgage-Backed Securities |
HUD | U.S. Department of Housing and Urban Development |
IRLC | Interest rate lock commitment, a freestanding derivative financial instrument |
IRS | Internal Revenue Service |
Lender-placed | Also referred to as "force-placed" |
LIBOR | London Interbank Offered Rate |
LOC | Letter of Credit |
MAP Rule | Mortgage Acts and Practices Advertising Rule |
Marix | Marix Servicing LLC |
MBA | Mortgage Bankers Association |
MBS | Mortgage-backed securities |
MBS purchase commitments | Commitments to purchase mortgage-backed securities, a freestanding derivative financial instrument |
Moody's | Moody's Investors Service Limited, a nationally recognized statistical rating organization designated by the SEC |
Mortgage loans | Traditional mortgage loans and residential retail installment agreements, which include manufactured housing loans as well as consumer loans |
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MSP | A mortgage and consumer loan servicing platform licensed from Black Knight Financial Services, LLC |
MSR | Mortgage servicing rights |
Net realizable value | Fair value less cost to sell |
n/m | Not meaningful |
Non-Residual Trusts | Securitization trusts that the Company consolidates and in which the Company does not hold residual interests |
NRM | New Residential Mortgage LLC, a wholly owned subsidiary of New Residential Investment Corp., a Delaware Corporation |
Original Filing | The Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016, initially filed with the SEC on August 9, 2016 |
OTS | Office of Thrift Supervision |
Parent Company | Walter Investment Management Corp. |
RCS | Residential Credit Solutions, Inc., a Delaware corporation |
REIT | Real estate investment trust |
Residential loans | Residential mortgage loans, including traditional mortgage loans, reverse mortgage loans and residential retail installment agreements, which include manufactured housing loans as well as consumer loans |
Residual Trusts | Securitization trusts that the Company consolidates and in which it holds a residual interest |
RESPA | Real Estate Settlement Procedures Act |
Restructuring Support Agreement | Restructuring Support Agreement, dated as of July 31, 2017, by and among Walter Investment Management Corp. and the Consenting Term Lenders |
Reverse loans | Reverse mortgage loans, including HECMs |
RMS | Reverse Mortgage Solutions, Inc., an indirect wholly-owned subsidiary of the Company |
RSA | Restructuring support agreement, dated as of July 15, 2015, by and between Walter Energy and its affiliated debtors and debtors-in-possession and the holders of its first lien claims party thereto, relating to Walter Energy’s Chapter 11 bankruptcy filed on July 15, 2015 in the United States Bankruptcy Court for the Northern District of Alabama |
RSU | Restricted stock unit |
SEC | U.S. Securities and Exchange Commission |
Securities Act | Securities Act of 1933, as amended |
Senior Notes | $575 million aggregate principal amount of 7.875% senior notes due 2021 issued on December 17, 2013 |
Senior Notes Indenture | Indenture for the 7.875% Senior Notes due 2021 dated as of December 17, 2013 among the Company, the guarantors and Wells Fargo Bank, National Association, as trustee |
S&P | Standard and Poor's Ratings Services, a nationally recognized statistical rating organization designated by the SEC |
TBAs | To-be-announced securities |
TCPA | Telephone Consumer Protection Act |
TILA | Truth in Lending Act |
Total Leverage Ratio | Total Leverage Ratio as defined under the 2013 Credit Agreement |
U.S. | United States of America |
VA | United States Department of Veteran Affairs |
VIE | Variable interest entity |
Walter Energy | Walter Energy, Inc. |
Walter Energy Asset Purchase
Agreement | Stalking horse asset purchase agreement entered into by Walter Energy, together with certain of its subsidiaries, and Coal Acquisition on November 5, 2015 and amended and restated on March 31, 2016 |
Warehouse borrowings | Borrowings under master repurchase agreements |
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WCO | Walter Capital Opportunity Corp. and its consolidated subsidiaries |
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We seek to manage the risks inherent in our business — including, but not limited to, credit risk, liquidity risk, real estate market risk, and interest rate risk — in a prudent manner designed to enhance our earnings and preserve our capital. In general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital levels consistent with these risks. For information regarding our credit risk, real estate market risk and liquidity risk, refer to the Credit Risk, Real Estate Market Risk and Liquidity and Capital Resources sections above in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Interest Rate Risk
Interest rate risk is the risk of loss of future earnings or fair value due to changes in interest rates. Our principal market exposure associated with interest rate risk relates to changes in long-term Treasury and mortgage interest rates and LIBOR.
We provide sensitivity analysis surrounding changes in interest rates in the Servicing, Originations and Reverse Mortgage Segments and Other Financial Instruments sections below. However, there are certain limitations inherent in any sensitivity analysis, including the necessity to conduct the analysis based on a single point in time and the inability to include the complex market reactions that normally would arise from the market shifts modeled.
Servicing, Originations and Reverse Mortgage Segments
Sensitivity Analysis
The following tables summarize the estimated change in the fair value of certain assets and liabilities given hypothetical instantaneous parallel shifts in the interest rate yield curve (in thousands):
June 30, 2016 | |||||||||||||||
Down 50 bps | Down 25 bps | Up 25 bps | Up 50 bps | ||||||||||||
Servicing segment | |||||||||||||||
Servicing rights carried at fair value | $ | (235,475 | ) | $ | (130,484 | ) | $ | 143,351 | $ | 269,675 | |||||
Servicing rights related liabilities | 13,904 | 7,927 | (9,168 | ) | (17,200 | ) | |||||||||
Net change in fair value - Servicing segment | $ | (221,571 | ) | $ | (122,557 | ) | $ | 134,183 | $ | 252,475 | |||||
Originations segment | |||||||||||||||
Residential loans held for sale | $ | 12,362 | $ | 7,561 | $ | (11,063 | ) | $ | (24,868 | ) | |||||
Freestanding derivatives (1) | (21,358 | ) | (11,187 | ) | 12,870 | 26,765 | |||||||||
Net change in fair value - Originations segment | $ | (8,996 | ) | $ | (3,626 | ) | $ | 1,807 | $ | 1,897 | |||||
Reverse Mortgage segment | |||||||||||||||
Reverse loans | $ | 126,073 | $ | 62,964 | $ | (61,941 | ) | $ | (122,867 | ) | |||||
HMBS related obligations | (102,936 | ) | (51,612 | ) | 51,010 | 101,414 | |||||||||
Net change in fair value - Reverse Mortgage segment | $ | 23,137 | $ | 11,352 | $ | (10,931 | ) | $ | (21,453 | ) |
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December 31, 2015 | |||||||||||||||
Down 50 bps | Down 25 bps | Up 25 bps | Up 50 bps | ||||||||||||
Servicing segment | |||||||||||||||
Servicing rights carried at fair value | $ | (227,315 | ) | $ | (99,025 | ) | $ | 78,064 | $ | 145,147 | |||||
Servicing rights related liabilities | 8,408 | 4,005 | (3,662 | ) | (7,011 | ) | |||||||||
Net change in fair value - Servicing segment | $ | (218,907 | ) | $ | (95,020 | ) | $ | 74,402 | $ | 138,136 | |||||
Originations segment | |||||||||||||||
Residential loans held for sale | $ | 29,695 | $ | 15,759 | $ | (17,443 | ) | $ | (36,162 | ) | |||||
Freestanding derivatives (1) | (35,817 | ) | (18,457 | ) | 18,404 | 37,024 | |||||||||
Net change in fair value - Originations segment | $ | (6,122 | ) | $ | (2,698 | ) | $ | 961 | $ | 862 | |||||
Reverse Mortgage segment | |||||||||||||||
Reverse loans | $ | 128,204 | $ | 64,074 | $ | (63,184 | ) | $ | (125,508 | ) | |||||
HMBS related obligations | (108,500 | ) | (54,385 | ) | 53,808 | 107,053 | |||||||||
Net change in fair value - Reverse Mortgage segment | $ | 19,704 | $ | 9,689 | $ | (9,376 | ) | $ | (18,455 | ) |
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(1) | Consists of IRLCs, forward sales commitments and MBS purchase commitments. |
We used June 30, 2016 and December 31, 2015 market rates on our instruments to perform the sensitivity analysis. These sensitivities measure the potential impact on fair value, are hypothetical, and presented for illustrative purposes only. There are certain limitations inherent in the sensitivity analysis presented, including the necessity to conduct the analysis based on a single point in time and the inability to include complex market reactions that normally would arise from the market shifts modeled. Changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in fair value may not be linear. Additionally, the impact of a variation in a particular assumption on the fair value is calculated while holding other assumptions constant. In reality, changes in one factor can have an effect on other factors (i.e., a decrease in total prepayment speeds may result in an increase in credit losses), which could impact the above hypothetical effects.
Servicing Rights
Servicing rights are subject to prepayment risk as the mortgage loans underlying the servicing rights permit the borrowers to prepay the loans. Consequently, the value of these servicing rights generally tend to diminish in periods of declining interest rates (as prepayments increase) and tend to increase in periods of rising interest rates (as prepayments decrease). This analysis ignores the impact of changes on certain material variables, such as non-parallel shifts in interest rates, or changing consumer behavior to incremental changes in interest rates.
Although the level of interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices, underwriting standards, availability of government-sponsored refinance programs and other product characteristics. Since our Originations segment’s results of operations are positively impacted when interest rates decline, our Originations segment’s results of operations may partially offset the change in fair value of servicing rights over time. The interaction between the results of operations of these activities is a core component of our overall interest rate risk assessment. We take into account the estimated benefit of originations on our Originations segment’s results of operations to determine the impact on net economic value from a decline in interest rates, and we continuously assess our ability to replenish lost value of servicing rights and cash flow due to increased prepayments. The Company does not currently use derivative instruments to hedge the interest rate risk inherent in the value of servicing rights. The Company may choose to use such instruments in the future. The amount and composition of derivatives used to hedge the value of servicing rights, if any, will depend on the exposure to loss of value on the servicing rights, the expected cost of the derivatives, expected liquidity needs, and the expected increase to earnings generated by the origination of new loans resulting from the decline in interest rates. The servicing rights sensitivity to interest rate changes increased at June 30, 2016 from December 31, 2015 due primarily to a lower interest rate environment.
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Servicing Rights Related Liabilities
Servicing rights related liabilities consist of excess servicing spread liabilities and servicing rights financing. Servicing rights related liabilities are generally subject to fair value losses when interest rates rise. Increasing interest rates typically slow down refinancing activity. Decreased refinancing activity increases the life of the loans underlying the servicing rights related liabilities, thereby increasing the fair value of the servicing rights related liabilities. As the fair value of the servicing rights related liabilities are related to the future economic performance of certain servicing rights, any adverse changes in those servicing rights would inherently benefit the fair value of the servicing rights related liabilities by decreasing our obligation, while any beneficial changes in the assumptions used to value servicing rights would negatively impact the fair value of the servicing rights related liabilities by increasing our obligation.
Residential Loans Held for Sale and Related Freestanding Derivatives
We are subject to interest rate and price risk on mortgage loans held for sale during the short time from the loan funding date until the date the loan is sold into the secondary market. Interest rate lock commitments represent an agreement to extend credit to a mortgage loan applicant or to purchase loans from a third-party originator, collectively referred to as IRLC, whereby the interest rate of the loan is set prior to funding or purchase. IRLCs, which are considered freestanding derivatives, are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. Loan commitments generally range from 35 to 50 days from lock to funding of the mortgage loan and our holding period from funding to sale is typically less than 20 days.
An integral component of our interest rate risk management strategy is our use of freestanding derivative instruments to minimize significant fluctuations in earnings caused by changes in interest rates that affect the value of our IRLCs and mortgage loans held for sale. The derivatives utilized to hedge the interest rate risk are forward sales commitments, which are forward sales of agency TBAs. These TBAs are primarily used to fix the forward sales price that will be realized upon the sale of the mortgage loans into the secondary market. We also enter into commitments to purchase MBS as part of our overall hedging strategy.
Reverse Loans and HMBS Related Obligations
We are subject to interest rate risk on our reverse loans and HMBS related obligations as a result of different expected cash flows and longer expected durations for loans as compared to HMBS related obligations. Our reverse loans have longer durations primarily as a result of our obligations as issuer of HMBS which includes the requirement to purchase loans out of the Ginnie Mae securitization pools once the outstanding principal balance of the related HECM is equal to or greater than 98% of the maximum claim amount.
Other Financial Instruments
For quantitative and qualitative disclosures about interest rate risk on other financial instruments, refer to Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk of our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC on February 29, 2016. These risks have not changed materially since December 31, 2015.
ITEM 4. CONTROLS AND PROCEDURES (AS RESTATED)
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2016.
In connection with the Original Filing, the Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2016. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2016, the design and operation of the Company's disclosure controls and procedures were effective at the reasonable assurance level.
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Subsequent to the Original Filing, the Chief Executive Officer and Chief Financial Officer determined that the Company's design and operation of the Company's disclosure controls and procedures were not effective because of a material weakness in its internal control over financial reporting as management determined that the Company did not maintain effective internal controls over operational processes within the transaction level processing of Ditech Financial default servicing activities. Specifically, the Company did not design and maintain effective controls related to our ability to identify foreclosure tax liens and resolve such liens timely, foreclosure related advances, and the processing and oversight of loans in bankruptcy status. Additionally, subsequent to the Original Filing, the Company also determined it did not have adequate controls operating effectively to ensure that it correctly calculated its deferred tax asset valuation allowance, including having adequate technical review of the deferred tax asset valuation allowance for the six months ended June 30, 2016. The Company determined that there was an error in the calculation of the valuation allowance for deferred tax assets related to an ineffective review of the tax calculations associated with the valuation allowance on the deferred tax asset balance. This resulted in an error requiring the Company to restate its financial statements as of and for the six months ended June 30, 2016.
As a result of these material weaknesses in the Company’s internal control over financial reporting the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of June 30, 2016.
(b) Changes in Internal Control Over Financial Reporting
Other than with respect to the remediation efforts outlined below, there were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended June 30, 2016 covered by this Quarterly Report on Form 10-Q/A that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Remediation of the Material Weaknesses in Internal Control Over Financial Reporting
During the fourth quarter of 2016, the Company began placing new leadership throughout Ditech Financial to strengthen operations and improve oversight of controls and processes throughout the business. During 2017, Management’s emphasis will be to design and implement certain remediation measures to address the material weaknesses and enhance the Company’s internal control over financial reporting. Management, with the oversight of our Audit Committee, expects to take the following actions to improve the design and operating effectiveness of our internal control over financial reporting in order to remediate the material weaknesses, for Ditech Financial operational processes and over the deferred tax asset valuation allowance, respectively:
Ditech Financial operational processes:
• | Management will design, document, and implement control procedures related to the review of foreclosure liens, foreclosure related advance coding, and bankruptcy plans. |
• | Management will test and evaluate the design and operating effectiveness of control procedures throughout the default servicing function. |
• | Management will assess the effectiveness of the remediation plan. |
Deferred tax asset valuation allowance:
• | Management will enhance the key control over the review of the calculation of the deferred tax asset valuation allowances in accordance with GAAP. |
• | Management will supplement our current tax professionals with personnel who have expertise in accounting for deferred tax asset valuation allowances and/or will augment the internal review procedures to include consultation and external review procedures over the quarterly and annual income tax calculations that are used to determine the deferred tax asset valuation, as applicable. |
Management intends to implement the remediation measures outlined above, relating to default servicing and deferred tax asset valuation allowance, respectively, with an expected completion date of no later than December 31, 2017. Management believes the remediation measures will strengthen Walter Investment's internal control over financial reporting and remediate the material weaknesses identified. In connection with the restatement effort, management engaged and utilized additional third party tax advisors to review and provide necessary feedback with respect to the calculation of the deferred tax asset valuation allowance. Management expects to continue to utilize these third-party tax advisors in subsequent filing periods as needed. If management is unsuccessful in fully implementing the new controls to address the material weaknesses and to strengthen the overall internal control environment, our financial condition and results of operations may result in inaccurate and untimely reporting. Management will continue to monitor the effectiveness of these remediation measures and will make any changes and take such other actions that management deems appropriate given the circumstance.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is, and expects that, from time to time, it will continue to become, involved in litigation, arbitration, examinations, inquiries, investigations and claims. These include pending examinations, inquiries and investigations by governmental and regulatory agencies, including but not limited to the SEC, state attorneys general and other state regulators, Offices of the United States Trustees and the CFPB, into whether certain of the Company's residential loan servicing and originations practices, bankruptcy practices and other aspects of its business comply with applicable laws and regulatory requirements.
From time to time, the Company has received and may in the future receive subpoenas and other information requests from federal and state governmental and regulatory agencies that are examining or investigating the Company. The Company, Mark O’Brien, Denmar Dixon and certain current and former Company officers have received subpoenas from the SEC requesting documents, testimony and/or other information in connection with an investigation concerning trading in the Company’s securities. The Company and the aforementioned individuals are cooperating with the investigation. The Company cannot provide any assurance as to the outcome of the aforementioned investigations or that such outcomes will not have a material adverse effect on its reputation, business, prospects, results of operations, liquidity or financial condition.
On August 28, 2015, RMS received a CID from the CFPB to produce certain documents and answer questions relating to RMS’s marketing and provision of reverse mortgage products and services. RMS has been cooperating with the CFPB by responding to the CID. The CFPB investigation staff have advised RMS that they are considering seeking authority from the Director of the CFPB to institute an enforcement action against RMS in relation to potential violations by RMS of the MAP Rule and the CFPA. RMS has provided a response to the CFPB denying these allegations. The Company is unable to predict whether an enforcement action will be instituted by the CFPB, the ultimate outcome of this investigation or the amount of loss, if any, that would result from an adverse resolution of this matter.
RMS has received a subpoena from the Office of Inspector General of the U.S. Department of Housing and Urban Development requiring RMS to produce documents and other materials relating to, among other things, the origination, underwriting and appraisal of reverse mortgages for the time period since January 1, 2005. RMS has also received a letter from the New York Department of Financial Services requesting information on the company's reverse mortgage servicing business in New York. We are cooperating with these inquiries.
The Company has received various subpoenas for testimony and documents, motions for examinations pursuant to Federal Rule of Bankruptcy Procedure 2004, and other information requests from certain Offices of the United States Trustees, acting through trial counsel in various federal judicial districts, seeking information regarding an array of the Company’s policies, procedures and practices in servicing loans to borrowers who are in bankruptcy and the Company's compliance with bankruptcy laws and rules. We have provided information in response to these subpoenas and requests and have met with representatives of certain Offices of the United States Trustees to discuss various issues that have arisen in the course of these inquiries, including our compliance with bankruptcy laws and rules. We cannot predict the outcome of the aforementioned proceedings and investigations, which could result in requests for damages, fines, sanctions, or other remediation. We could face further legal proceedings in connection with these matters. We may seek to enter into one or more agreements to resolve these matters. Any such agreement may require us to pay fines or other amounts for alleged breaches of law and to change or otherwise remediate our business practices. Legal proceedings relating to these matters and the terms of any settlement agreement could have a material adverse effect on the Company’s reputation, business, prospects, results of operations, liquidity and financial condition.
Since mid-2014, we have received subpoenas for documents and other information requests from the offices of various state attorneys general who have, as a group and individually, been investigating our mortgage servicing practices. We have provided information in response to these subpoenas and requests and have had discussions with representatives of the states involved in the investigations to explain our practices. We may seek to reach an agreement to resolve these matters with one or more states. Any such agreement may include, among other things, enhanced servicing standards, monitoring and testing obligations, injunctive relief and payments for remediation, consumer relief, penalties and other amounts. We cannot predict whether litigation or other legal proceedings will be commenced by one or more states in relation to these investigations. Any legal proceedings and any agreement resolving these matters could have a material adverse effect on the Company’s reputation, business, prospects, results of operation, liquidity and financial condition.
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The Company is involved in litigation, including putative class actions, and other legal proceedings concerning, among other things, lender-placed insurance, private mortgage insurance, bankruptcy practices, employment practices, the Consumer Financial Protection Act, the Fair Debt Collection Practices Act, the TCPA, the Fair Credit Reporting Act, TILA, RESPA, EFTA, the ECOA, and other federal and state laws and statutes. For example, in Sanford Buckles v. Green Tree Servicing LLC and Walter Investment Management Corporation, filed on August 18, 2015 in the U.S. District Court for the District of Nevada, the Parent Company and Ditech Financial are subject to a putative class action suit alleging that the Parent Company and Ditech Financial improperly recorded phone calls received from, and/or made to, Nevada residents without their prior consent in violation of Nevada state law. The plaintiff in this suit, on behalf of himself and others similarly situated, seeks punitive and statutory damages, and attorneys’ fees. Ditech Financial is also subject to several purported class action suits alleging violations of the TCPA for placing phone calls to plaintiffs’ cell phones using an automatic telephone dialing system without their prior consent. The plaintiffs in these suits, on behalf of themselves and others similarly situated, seek statutory damages for both negligent and knowing or willful violations of the TCPA.
On June 17, 2016, the Board of Directors of the Company received a letter from a stockholder demanding that the Board of Directors of the Company assert legal claims against certain current and former directors and officers of the Company. The stockholder alleged that these directors and officers breached their fiduciary duties by failing to oversee the Company's operations and internal controls regarding its loan servicing, loan origination, reverse mortgage and financial reporting practices. The Board of Directors of the Company has appointed an evaluation committee to consider the demand letter and the matters raised therein. The Company cannot provide any assurance as to the outcome or the effect on the Company of the matter.
The outcome of all of the Company's regulatory matters and other legal proceedings is uncertain, and it is possible that adverse results in such proceedings (which could include restitution, penalties, punitive damages and injunctive relief affecting the Company's business practices) and the terms of any settlements of such proceedings could have a material adverse effect on the Company's reputation, business, prospects, results of operations, liquidity or financial condition. In addition, governmental and regulatory agency examinations, inquiries and investigations may result in the commencement of lawsuits or other proceedings against us or our personnel. Although the Company has historically been able to resolve the preponderance of its ordinary course litigations on terms it considered favorable and without a material effect, this pattern may not continue and, in any event, individual cases could have unexpected materially adverse outcomes, requiring payments or other expenses in excess of amounts already accrued. The Company cannot predict whether or how any legal proceeding will affect the Company's business relationship with actual or potential customers, the Company's creditors, rating agencies and others. In addition, cooperating in, defending and resolving these legal proceedings consume significant amounts of management time and attention and could cause the Company to incur substantial legal, consulting and other expenses and to change the Company's business practices, even in cases where there is no determination that the Company's conduct failed to meet applicable legal or regulatory requirements.
For a description of certain legal proceedings, please see Note 15 to the Notes to Consolidated Financial Statements.
ITEM 1A. RISK FACTORS (AS RESTATED)
In addition to the other information set forth in this report, you should carefully review and consider the risks and uncertainties described under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, which are the risks and uncertainties that could materially adversely affect our business, prospects, financial condition, cash flows, liquidity, results of operations, our ability to pay dividends to our stockholders and/or our stock price. In addition, to the extent that any of the information contained in this report or in the aforementioned periodic reports constitute forward-looking information, the risk factors set forth in such periodic reports are cautionary statements identifying important factors that could cause our actual results for various financial reporting periods to differ materially from those expressed in any forward-looking statements made by or on our behalf.
Subsequent to our Original Filing, we identified two material weaknesses in the original filing of the Form 10-K for the year ended December 31, 2016. If we do not adequately address these material weaknesses, if we have other material weaknesses or significant deficiencies in our internal controls over financial reporting in the future, or if we otherwise do not maintain effective internal controls over financial reporting, we could fail to accurately report our financial results, which may materially adversely affect our business and financial condition.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting and have our independent auditors issue their own opinion on our internal controls over financial reporting. Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. A material weakness is defined by the standards issued by the Public Company Accounting Oversight Board as a deficiency or a combination of deficiencies in internal controls over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
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In the original filing of the Form 10-K for the year ended December, 31, 2016, we concluded at December 31, 2016 that there was a material weakness in internal controls over financial reporting related to operational processes associated with Ditech Financial default servicing activities. Further, in connection with the identification of the error in the calculation of the valuation allowance on our deferred tax assets that resulted in preparing this Amended Filing, we have identified an additional material weakness in internal controls over financial reporting related to the technical review of such calculation. We have initiated steps to remediate both of these material weaknesses. While we believe these steps will improve the effectiveness of our internal controls over financial reporting and remediate the material weaknesses, if our remediation efforts are insufficient to address the material weaknesses, or if additional material weaknesses in our internal controls are discovered in the future, they may adversely affect our ability to record, process, summarize and report financial information timely and accurately and, as a result, our financial statements may contain material misstatements or omissions. Refer to Part I, Item 4. Controls and Procedures for further information regarding these material weaknesses and our related remediation plans.
It is possible that additional material weaknesses and/or significant deficiencies could be identified by our management or by our independent auditing firm in the future, or may occur without being identified. The existence of any additional material weakness or significant deficiency could require management to devote significant additional time and incur significant additional expense to remediate such weakness or deficiency and management may not be able to remediate the same in a timely manner. Any additional weakness or deficiency, even if remediated quickly, could result in regulatory scrutiny or lead to a default under our indebtedness. Furthermore, any additional material weakness requiring disclosure could cause investors to further lose confidence in our reported financial condition, materially affect the market price and trading liquidity of our debt instruments, reduce the market value of our common stock and otherwise materially adversely affect our business and financial condition.
The restatement of our financial statements may lead to additional risks and uncertainties, including loss of investor and counterparty confidence and negative impacts on our stock price.
We have restated our Consolidated Financial Statements as of and for the periods ended June 30, 2016, September 30, 2016, December 31, 2016 and March 31, 2017 to correct an error in our calculation of the valuation allowance on our deferred tax assets. For a discussion of this error and the related adjustment, see Note 2 to the Consolidated Financial Statements included in this report and the Explanatory Note immediately preceding the Index. In connection with this restatement of our prior financial statements, we have identified a material weakness in our internal controls over financial reporting in addition to the material weakness that was identified in connection with the preparation of our Annual Report on Form 10-K for the year ended December 31, 2016, originally filed with the SEC on March 14, 2017. Management has concluded that our internal control over financial reporting and disclosure controls and procedures were ineffective as of June 30, 2016. For a description of these material weaknesses, refer to Part I, Item 4. Controls and Procedures.
In connection with the restatement, including the evaluation of the valuation allowance on our deferred tax asset balance, preparation of the Amended Filings, obtaining necessary waivers and/or amendments from our warehouse and advance facility lenders and remediation of our ineffective disclosure controls and procedures and material weakness in internal control over financial reporting, we have incurred significant additional costs consisting of additional accounting and legal fees, diversion of management’s time and attention and reductions in our advance rates and/or other changes to the terms of our warehouse and advance facilities. We may also become subject to regulatory investigations, stockholder demands or other legal actions in connection with the restatement, which would, regardless of the outcome, consume substantial resources (including management’s time and attention) and result in additional legal, accounting, insurance and other costs. The restatement and related matters could also impair our reputation and cause our lenders and other counterparties to lose confidence in us. Our ability to comply with certain continued listing standards of the NYSE may be impacted following this Amended Filing. Each of these occurrences, individually or in the aggregate, could have a material adverse effect on our business, results of operations, financial condition, liquidity and stock price.
If we fail to regain and maintain compliance with the continued listing standards of the NYSE, it may result in the delisting of our common stock from the NYSE and have other negative implications under our material agreements with lenders and counterparties.
Our common shares are currently and have been listed for trading on the NYSE, and the continued listing of our common shares on the NYSE is subject to our compliance with a number of listing standards. To maintain compliance with these continued listing standards, the Company is required, among other things, to maintain an average closing price per share of $1.00 or more over a consecutive 30 trading-day period. On July 13, 2017, we received written notification from the NYSE that the average closing price of our common stock had fallen below $1.00 per share over a consecutive 30 trading-day period as of July 10, 2017, and, as a result, the average closing price per share of our common stock was below the minimum average closing price required to maintain listing on the NYSE. We have notified the NYSE of our intent to cure this noncompliance and are considering various options we may take in an effort to cure this deficiency and regain compliance. Additionally, as of the date we file this report, we will be considered to be below compliance with another NYSE continued listing standard because the Company's average global market capitalization over a consecutive 30 trading-day period has fallen below $50.0 million at the same time our stockholders' equity is less than $50.0 million.
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In addition, our common stock could be delisted if the trading price of our common stock on the NYSE is abnormally low, which has generally been interpreted to mean at levels below $0.16 per share, or if our average market capitalization over a consecutive 30 day-trading period is less than $15 million. In these events, we would not have an opportunity to cure the deficiency, and our shares would be delisted immediately and suspended from trading on the NYSE.
If we are unable to cure any event of noncompliance with any continued listing standard of the NYSE within the applicable timeframe and other parameters set forth by the NYSE, or if we fail to maintain compliance with certain continued listing standards that do not provide for a cure period, it will result in the delisting of our common stock from the NYSE, which could negatively impact the trading price, trading volume and liquidity of, and have other material adverse effects on, our common stock. If our common stock is delisted from the NYSE, this could also have negative implications on our business relationships under our material agreements with lenders and other counterparties. If our common stock is delisted from the NYSE, it would constitute a fundamental change as that term is defined under the terms of the Convertible Notes, and require, among other things, that we take steps to make an offer to repay the Convertible Notes at 100% of the principal amount thereof. We currently are not permitted to make such an offer pursuant to the terms of certain of our debt facilities and agreements. If our common stock is delisted from the NYSE and we are not able to satisfy this repurchase obligation, it would constitute an event of default under the indenture governing the Convertible Notes and result in a cross default under certain of our other debt agreements. In such event, the holders of 25% in aggregate principal amount outstanding of the Convertible Notes will have the right to accelerate such indebtedness. Lenders under the 2013 Credit Agreement and under the warehouse facilities would similarly be able to accelerate the indebtedness thereunder if we are unable to fulfill such obligations and if indebtedness in excess of $75.0 million in the aggregate were so accelerated, holders of the Senior Notes could similarly accelerate the Senior Notes indebtedness. Each of these occurrences, individually or in the aggregate, could have a material adverse effect on our business, results of operations, financial condition, liquidity and stock price.
Risks Related to our Proposed Restructuring
The Restructuring Support Agreement is subject to significant conditions and milestones that may be beyond our control and may be difficult for us to satisfy. If the Restructuring Support Agreement is terminated, our ability to consummate a restructuring of our debt could be materially and adversely affected.
The Restructuring Support Agreement sets forth certain conditions we must satisfy, including seeking to negotiate a restructuring support agreement with at least 66 2/3% of the Senior Noteholders and the timely satisfaction of conditions and milestones to consummate the restructuring. Our ability to timely satisfy such conditions and milestones is subject to risks and uncertainties that, in certain instances, are beyond our control, including whether we receive the requisite level of participation from each of the holders of the 2013 Term Loan, Senior Notes and Convertible Notes to consummate the transactions contemplated by the Restructuring Support Agreement. The Restructuring Support Agreement gives the Consenting Term Lenders the ability to terminate the Restructuring Support Agreement under certain circumstances, including the failure of certain conditions or milestones to be satisfied. Should the Restructuring Support Agreement be terminated, all obligations of the parties to the Restructuring Support Agreement will terminate (except as expressly provided in the Restructuring Support Agreement). A termination of the Restructuring Support Agreement may result in the loss of support for a restructuring and our ability to effect a restructuring in the future could be materially and adversely affected.
In the event we pursue the in-court restructuring and file for relief under the Bankruptcy Code, we may be subject to the risks and uncertainties associated with Chapter 11 proceedings.
The terms of the Restructuring Support Agreement provide that in the absence of sufficient stakeholder support for the out-of-court restructuring and subject to certain other conditions, the parties thereto will implement the proposed financial restructuring through a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code. In the event we pursue the in-court restructuring and file for relief under the Bankruptcy Code, our operations, our ability to develop and execute our business plan and our continuation as a going concern will be subject to the risks and uncertainties associated with bankruptcy proceedings, including, among others: the high costs of bankruptcy proceedings and related fees; our ability to obtain sufficient financing to allow us to emerge from bankruptcy and execute our business plan post-emergence, and our ability to comply with terms and conditions of that financing; our ability to maintain our relationships with our lenders, counterparties, employees and other third parties; our ability to maintain contracts that are critical to our operations on reasonably acceptable terms and conditions; the ability of third parties to use certain limited safe harbor provisions of the Bankruptcy Code to terminate contracts without first seeking bankruptcy court approval; and the actions and decisions of our creditors and other third parties who have interests in our Chapter 11 proceedings that may be inconsistent with our operational and strategic plans.
The Consolidated Financial Statements included herein contain disclosures that express substantial doubt about our ability to continue as a going concern due to the possibility that we may implement a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code.
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As set forth in the Restructuring Support Agreement, the parties thereto have agreed to, among other things, the principal terms of a proposed financial restructuring of the Company, which will be implemented through an out-of-court restructuring and, in the absence of sufficient stakeholder support for an out-of-court restructuring, a prepackaged plan of reorganization under Chapter 11 of the Bankruptcy Code. The potential for a prepackaged Chapter 11 filing raises substantial doubt about the Company’s ability to continue as a going concern. The Company’s consolidated financial statements have been prepared assuming the Company will continue as a going concern, and management has concluded that while there can be no assurance that the Company’s recent and future actions will be successful in mitigating the various risks and uncertainties to which the Company is currently subject, the Company’s current plans provide enough liquidity to meet its obligations over the next twelve months from the date of issuance of the Consolidated Financial Statements. The Company will continue to monitor progress on its debt restructuring initiatives and the impact on its ongoing assessment of going concern in future periods.
We may not be able to obtain sufficient stakeholder support for the transactions contemplated by the Restructuring Support Agreement.
There can be no assurance that the proposed financial restructuring of the Company as contemplated in the Restructuring Support Agreement will receive the necessary level of support to be implemented either through an out-of-court restructuring or an in-court-restructuring. The success of any restructuring will depend on the willingness of existing creditors to agree to the exchange or modification of their claims, and if applicable, approval by the bankruptcy court, and there can be no guarantee of success with respect to those matters. We may receive objections to the terms of the transactions contemplated by the Restructuring Support Agreement, including objection to the confirmation of any plan of reorganization from various stakeholders in any Chapter 11 proceedings. We cannot predict the impact that any objection or third party motion may have on a bankruptcy court’s decision to confirm a plan of reorganization or our ability to complete an in-court restructuring as contemplated by the Restructuring Support Agreement or otherwise. Any objection may cause us to devote significant resources in response which could materially and adversely affect our business, financial condition and results of operations.
The pursuit of the Restructuring Support Agreement has consumed, and compliance with the terms thereof will consume, a substantial portion of the time and attention of our management, which may have an adverse effect on our business and results of operations.
It is impossible to predict with certainty the amount of time and resources necessary to successfully implement the restructuring contemplated by the Restructuring Support Agreement, particularly if we must proceed with an in-court restructuring. Compliance with the terms of the Restructuring Support Agreement will involve additional expense and our management will be required to spend a significant amount of time and effort focusing on the proposed transactions. This diversion of attention may materially adversely affect the conduct of our business, and, as a result, our financial condition and results of operations.
Furthermore, loss of key personnel, significant employee attrition or material erosion of employee morale has negatively impacted and could have a material adverse effect on our ability to effectively conduct our business, and could impair our ability to execute our strategy and implement operational initiatives, thereby having a material adverse effect on our business and on our financial condition and results of operations.
If we are unable to effectuate a satisfactory debt restructuring transaction this could have a material adverse effect on the Company.
If the Company is unable to effectuate a satisfactory debt restructuring transaction, the adverse pressures the Company has recently experienced with respect to its:
• | relationships with counterparties and key stakeholders who are critical to its business; |
• | ability to access the capital markets; |
• | ability to execute on its operational and strategic goals; |
• | ability to recruit and/or retain key personnel; and |
• | business, prospects, results of operations and liquidity generally, |
are expected to continue and potentially intensify, and could have a material adverse effect on the Company’s business, prospects, results of operations, liquidity and financial condition.
Even if the restructuring is consummated, we may not be able to achieve our stated goals and continue as a going concern.
Even if the debt restructuring is consummated, whether by means of the out-of-court restructuring or in-court restructuring, we will continue to face a number of risks, including our ability to reduce expenses, return our servicing and originations businesses to sustained profitability, implement our strategic initiatives, including those related to our “core” and “non-core” framework and generally maintain favorable relationships with and secure the confidence of our counterparties. Accordingly, we cannot guarantee that
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the proposed financial restructuring will achieve our stated goals nor can we give any assurance of our ability to continue as a going concern.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
a) | Not applicable. |
b) | Not applicable. |
c) | Not applicable. |
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Entry into a Material Definitive Agreement.
On August 5, 2016, the Company entered into an amendment to its 2013 Credit Agreement in order to (i) amend the springing financial leverage ratio covenant under the 2013 Revolver to increase the Total Leverage Ratio levels applicable to the second and third quarter of 2016, (ii) for the period during which the increased Total Leverage Ratio levels apply, (x) limit the permitted use of the 2013 Revolver to liquidity needs of the Company and its subsidiaries (but excluding voluntary prepayments, redemptions or repurchases of other indebtedness), (y) include a requirement to repay any amounts outstanding under the 2013 Revolver from excess cash amounts and (z) increase the interest rate for any drawn amounts under the 2013 Revolver by 0.75% per annum, (iii) reduce the amount of the aggregate commitments under the 2013 Revolver from $125.0 million to $100.0 million and (iv) make certain other amendments. After giving effect to the amendment, we were in compliance with the increased Total Leverage Ratio, and the borrowing capacity under the 2013 Revolver was $99.7 million.
Credit Suisse AG, certain of its affiliates and other lenders under the 2013 Credit Agreement and their affiliates have, from time to time, provided investment banking and advisory services to the Company and/or its affiliates for which they have received customary fees and commissions and such affiliates may provide these services from time to time in the future.
The foregoing description of the amendment does not purport to be complete and is qualified in its entirety by reference to the full text of the amendment, which is filed as Exhibit 10.8 to this report and is incorporated herein by reference.
ITEM 6. EXHIBITS
The Index to Exhibits, which appears immediately following the signature page below, is incorporated by reference herein.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WALTER INVESTMENT MANAGEMENT CORP. | ||||
Dated: August 9, 2017 | By: | /s/ Anthony N. Renzi | ||
Anthony N. Renzi | ||||
Chief Executive Officer and President (Principal Executive Officer) | ||||
Dated: August 9, 2017 | By: | /s/ Gary L. Tillett | ||
Gary L. Tillett | ||||
Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
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INDEX TO EXHIBITS
Exhibit No. | Note | Description | ||
3.1 | Walter Investment Management Corp. Articles of Amendment, effective June 9, 2016 (Incorporated herein by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 13, 2016). | |||
3.2 | Walter Investment Management Corp. First Amendment to Bylaws, effective June 9, 2016 (Incorporated herein by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 13, 2016). | |||
4.1 | Amendment No. 3, dated as of June 28, 2016, to the Rights Agreement, dated as of June 29, 2015, and previously amended by Amendment No. 1, dated as of November 16, 2015, and Amendment No. 2, dated as of November 22, 2015, each between Walter Investment Management Corp. and Computershare Trust Company, N.A., as Rights Agent (Incorporated herein by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 28, 2016). | |||
10.1 | Employment Agreement, by and between Walter Investment Management Corp. and Denmar J. Dixon, entered into as of April 4, 2016 (Incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K/A as filed with the Securities and Exchange Commission on April 6, 2016). | |||
10.2 | Amendment No. 9 to Receivables Loan Agreement, dated as of April 22, 2016, by and among Green Tree Advance Receivables II LLC, as borrower, Ditech Financial LLC, as administrator, the financial institutions identified on the signature pages thereto, as lenders, Wells Fargo Bank, National Association, as calculation agent, account bank, verification agent and securities intermediary, and Wells Fargo Capital Finance, LLC, as agent for the lenders (Incorporated herein by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on May 3, 2016). | |||
10.3 | (1) | Amendment No. 1 to Master Repurchase Agreement, dated as of May 23, 2016, among Barclays Bank PLC, as agent, Sutton Funding LLC, as purchaser, Reverse Mortgage Solutions, Inc., as a seller, and RMS REO BRC, LLC, as a seller. | ||
10.4 | Separation Agreement and General Release of Claims, dated as of June 8, 2016, by and between Walter Investment Management Corp. and Denmar J. Dixon (Incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 9, 2016). | |||
10.5 | Letter Agreement, dated as of June 8, 2016, by and between Walter Investment Management Corp. and George M. Awad (Incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 9, 2016). | |||
10.6 | Walter Investment Management Corp. 2011 Omnibus Incentive Plan, Amended and Restated effective June 9, 2016 (Incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 13, 2016). | |||
10.7 | (1) | Side Letter, dated as of July 22, 2016, among Credit Suisse First Boston Mortgage Capital LLC, as administrative agent, Reverse Mortgage Solutions, Inc., as seller, RMS REO CS, LLC, as REO subsidiary, RMS CS Repo Trust 2016, as transaction subsidiary, and Credit Suisse AG, as buyer. | ||
10.8 | (1) | Amendment No. 2 to Amended and Restated Credit Agreement, dated as of August 5, 2016, among Walter Investment Management Corp., as borrower, the lender from time to time and parties thereto, and Credit Suisse AG, as administrative agent. | ||
31.1 | (1) | Certification by Anthony N. Renzi pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | (1) | Certification by Gary L. Tillett pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32 | (1) | Certification by Anthony N. Renzi and Gary L. Tillett pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
101 | (1) | XBRL (Extensible Business Reporting Language) — The following materials from Walter Investment Management Corp.’s Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2016, formatted in XBRL (Extensible Business Reporting Language); (i) Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015; (ii) Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2016 and 2015; (iii) Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2016; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015; and (v) Notes to Consolidated Financial Statements. |
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Note | Notes to Exhibit Index | |
(1) | Filed or furnished herewith. |
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