|
|
▪
|
Liquidity and Capital Resources
|
|
|
▪
|
Contractual Obligations
|
|
|
▪
|
Off-Balance Sheet Arrangements and Guarantees
|
|
|
▪
|
Critical Accounting Policies and Estimates
|
|
|
▪
|
Recently Issued Accounting Pronouncements
|
Proposed Merger with Ocwen Financial Corporation
On February 27, 2018, we entered into a definitive Agreement and Plan of Merger with Ocwen Financial Corporation (“Ocwen”), and POMS Corp (“MergerSub”) pursuant to which all of PHH’s outstanding common stock will be acquired by Ocwen in a merger of PHH with and into MergerSub with PHH surviving (the “Merger”) in an all cash transaction valued at approximately $360 million, or $11.00 per share on a fully-diluted basis. Our Board of Directors has unanimously approved the Merger. The Merger is subject to, in addition to various other customary closing conditions; approval by our stockholders; antitrust, state licensing, and other governmental and regulatory approvals; and PHH maintaining cash and adjusted net worth above certain thresholds.
See “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—"
We may fail to consummate the proposed Merger, and uncertainties related to the consummation of the Merger may have a material adverse effect on our business, financial position, results of operations and cash flows, and negatively impact the price of our Common stock.
" in this Form 10-K.
Business Overview
In February 2017, we announced certain strategic actions, including exiting our Private Label services business platform, selling our capitalized MSR portfolio and monetizing our interests in our PHH Home Loans joint venture. At that time, we announced that after completing these strategic actions, we will fully transition to a capital-light business model comprised of subservicing and portfolio retention services. Throughout 2017, we have focused on executing the necessary actions to achieve our strategic objectives as we transition and restructure the business. These actions included closing our asset sale transactions, re-engineering the cost structure of the business and transitioning to the new business model while maintaining strategic flexibility. We expect to incur operating losses during 2018 as we complete the exits of our PLS business and restructuring activities. Achieving profitability is highly dependent upon growing our subservicing portfolio to achieve appropriate scale.
We continue to believe there will be growing demand for subservicing and that the quality of our subservicing platform, established compliance management system and portfolio retention services offering can differentiate us from our competition. However, our long-term plans are dependent on growth, and adding new subservicing units is critical for us to eventually achieve the desired scale and a profitable business model. Establishing subservicing relationships involves a long sell cycle and new business growth is materializing slower than expected. Further, we are facing headwinds in portfolio retention from the interest rate environment driving a shift to a purchase-driven market.
Other headwinds to achieving scale in our business include the expected transfer of approximately
115,000
subservicing units off of our platform between May 2018 and April 2019, based upon receipt in February 2018 of formal notices and verbal indications from two of our largest subservicing clients. Approximately 65,000 of these units are subject to a portfolio defense agreement and will no longer be solicitable units upon transfer to a new servicer. There can be no assurances that our subservicing agreements or relationships will not be subject to further change, or that we will be successful in our business development efforts to grow our subservicing portfolio units and portfolio retention volumes.
For a discussion of risks related to our business, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—
Our operations have not been profitable in recent years, and we have changed the focus of our business to subservicing and portfolio retention activities to improve our financial results. The industry in which we operate in is highly competitive, and our success depends on our ability to attract and retain clients to achieve scale and meet competitive challenges, which may be negatively impacted by client perceptions of a lack of history operating as a focused player in this market, as well as from our actions, including any past or future efforts towards executing our strategic actions. We may not be able to fully or successfully execute or implement our business strategies or achieve our objectives, and our actions taken may not have the intended result.
"
For a discussion of risks related to our client concentrations, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—
Our remaining business will be focused on subservicing and portfolio retention activities, and we have significant client concentration risk related to the percentage of subservicing and portfolio retention activities from agreements with New Residential Mortgage, LLC and Pingora Loan Servicing, LLC. Further, the terms of a significant portion of our subservicing agreements allow the owners of the servicing to terminate the subservicing agreement without cause which would also terminate any related portfolio defense agreements.
" in this Form 10-K.
2017 Strategic Actions
During
2017
, we made significant progress on executing our strategic transactions as outlined in more detail below:
|
|
•
|
MSR Sales
.
During
2017
, we completed the delivery of $661 million of MSRs and advances under our sale agreements with New Residential Mortgage, LLC ("New Residential") and Lakeview Loan Servicing LLC ("Lakeview"), and pursuant to ordinary course sales to other third parties. The net cash received during
2017
from our sales of MSRs plus sale or collection of advances was
$727 million
, which is adjusted for purchase price and indemnification holdbacks and other costs. As of
December 31, 2017
, we have recognized a gross receivable for holdbacks from the 2017 MSR transfers of $42 million, and we are entitled to receipt of the MSR sale holdback either upon the complete delivery of the underlying mortgage loan documents, or to the extent not used to satisfy any indemnification claims of New Residential, as applicable.
|
The remaining $144 million of MSRs and advances committed under the New Residential agreement consist of private investor MSRs and related advances. While all parties continue to work diligently to close on the sale, the extended time frame for executing the remaining transactions is due to the complexity of the consent process, the number of parties involved, and the depth of investor and trustee due diligence.
|
|
•
|
Home Loans Asset Sales.
During 2017, we completed the asset sales to Guaranteed Rate Affinity, LLC ("GRA") in a series of five closings, which occurred between August 2017 and December 2017. In total, we received $70 million of cash for the asset sales during 2017, and we recognized a pre-tax gain on sale of $35 million in our financial statements for our 50.1% share. The cash received from these asset sales is shared pro-rata with the minority interest holder. We expect to liquidate the residual assets of the entity, and we have agreed to purchase Realogy Corporation's ("Realogy") membership interests at book value on or before March 19, 2018.
|
|
|
•
|
PLS & Exit Activities.
We continue to make progress in executing the exit of our PLS business and re-engineering our shared services platform. During 2017, we have incurred
$64 million
of cash exit costs associated with our exit programs. We currently expect
$207 million
in total PLS exit-related costs comprised of
$128 million
of operating losses and
$79 million
of cash exit expenses, of which a total of $150 million has been recognized as of
December 31, 2017
. Further, we expect
$35 million
in total Reorganization program cash costs, of which $33 million has been recognized as of
December 31, 2017
. We have committed exit dates, or an agreement as to the last date new applications will be accepted, with all of our clients that comprise our PLS channel. At this time, we continue to believe we will be in a position to substantially exit the PLS business by the first quarter of 2018, subject to certain transition support requirements.
|
See further details of executed and pending transactions below under "—Asset Sales and Exit Programs".
Capital Actions
During
2017
, our capital actions included the following:
|
|
•
|
Reduction in Debt.
In June 2017, we launched a tender offer for any and all of our unsecured senior notes. Through the completion of the tender, in July 2017, we extinguished $496 million of outstanding principal for total cash consideration of $524 million, plus accrued interest. We recognized a pre-tax loss during 2017 of $34 million in connection with the debt repayment. After the tender, $119 million of note principal remains outstanding. We continue to assess what amount, if any, of the remaining unsecured debt would be appropriate as part of our permanent capital structure.
|
|
|
•
|
Share Repurchases.
In September 2017, we completed $267 million in repurchases through our modified “Dutch auction” tender offer and retired
18,762,962
shares. In addition, prior to the Dutch auction tender offer, we executed $34 million in open market repurchases, retiring
2,450,466
shares.
|
In November 2017, our Board of Directors has provided a new authorization for up to $100 million of share repurchases and we did not repurchase any shares under this authorization in the fourth quarter of 2017. We have no obligation to repurchase shares under this authorization, and any share repurchase program may be extended, modified, suspended or discontinued at any time. Pursuant to the Agreement and Plan of Merger dated as of February 27, 2018 among Ocwen, POMS Corp and PHH, any share repurchases require the prior consent of Ocwen.
See further discussion of risks specific to the repurchase program at “Part I—Item 1A. Risk Factors—Risk Related to our Common Stock—
Our decision to return cash to shareholders through stock repurchases has reduced our market capitalization and may not prove to be the best use of our capital.
" in this Form 10-K.
Legal and Regulatory Matters
During 2017, we entered into settlement agreements related to several legacy matters, and we recorded
$22 million
of total provisions for legal and regulatory matters. As of December 31, 2017, our remaining legacy legal and regulatory matter is the Consumer Financial Protection Bureau’s ("CFPB") enforcement action with respect to our legacy reinsurance activities. In January 2018, the en banc court of the United States Court of Appeals for the District of Columbia Circuit reinstated the October 2016 panel decision as it related to the RESPA issues, which included vacating the CFPB’s order imposing $109 million in disgorgement penalties. In February 2018, the en banc court remanded the matter back to the CFPB for further proceedings in compliance with the reinstated panel opinion. We continue to believe that we complied with RESPA and other laws applicable to our former mortgage reinsurance activities in all respects, and with respect to the remand, we will continue to present, if necessary, the facts and evidence to support our position that mortgage insurers did not pay more than reasonable market value to PHH affiliated reinsurers.
During the fourth quarter of 2017, we entered into a settlement agreement with a multistate coalition of certain mortgage banking regulators (the “MMC”) and consent orders with certain state attorneys general to resolve and close out findings from the MMC examination, without any admission of liability. The settlements cover mortgage loan servicing practices, including foreclosure activities, occurring between January 1, 2009 and December 31, 2012. In addition, under the terms of the settlements, we agreed to comply with certain servicing standards, to conduct testing of compliance with such servicing standards for a period of three years, and to report to the MMC regarding the same. Under the terms of the settlement, we will pay approximately
$45 million
in aggregate, of which $38 million was paid during the fourth quarter of 2017. The remaining settlement amount not yet paid is included in our recorded liability as of December 31, 2017.
During the third quarter of 2017, we entered into settlement agreements, without any admission of liability, with the U.S. Department of Justice ("DOJ") on behalf of the Department of Housing and Urban Development and separately with the DOJ on behalf of the U.S. Department of Veteran Affairs (“VA”) and the Federal Housing Finance Agency to resolve certain matters regarding legacy mortgage origination and underwriting activities. The settlement agreements cover certain mortgage loans insured by the Federal Housing Administration during the period between January 1, 2006 and December 31, 2011, certain mortgage loans insured by the VA, and certain mortgage loans sold to Fannie Mae and Freddie Mac. Under the terms of the agreements, we agreed to pay approximately $75 million in aggregate to the U.S. Department of Justice, which was paid during 2017.
See
Note 13, 'Commitments and Contingencies' in the accompanying Notes to Consolidated Financial Statements
for further discussion of the settlements and our other outstanding matters.
|
|
ASSET SALES AND EXIT PROGRAMS
|
Sale of MSRs
During
2017
, we completed the delivery of $661 million of MSRs and advances under our sale agreements with New Residential, Lakeview, and other third parties.
The following table summarizes our MSRs committed under sale agreements and estimated committed Servicing advance receivables:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
December 31, 2016
|
|
MSR Fair Value
|
|
UPB
|
|
Servicing Advances
|
|
MSR Fair Value
|
|
UPB
|
|
Servicing Advances
|
|
(In millions)
|
MSR Commitments:
|
|
|
|
|
|
|
|
|
|
|
|
New Residential
|
$
|
34
|
|
|
$
|
5,940
|
|
|
$
|
110
|
|
|
$
|
579
|
|
|
$
|
69,937
|
|
|
$
|
286
|
|
Lakeview
|
—
|
|
|
—
|
|
|
—
|
|
|
97
|
|
|
13,369
|
|
|
14
|
|
Other counterparties
|
5
|
|
|
565
|
|
|
—
|
|
|
2
|
|
|
158
|
|
|
—
|
|
Total
|
$
|
39
|
|
|
$
|
6,505
|
|
|
$
|
110
|
|
|
$
|
678
|
|
|
$
|
83,464
|
|
|
$
|
300
|
|
See
Note 4, 'Servicing Activities' in the accompanying Notes to Consolidated Financial Statements
for further information about our MSR sales executed in 2017 and "Executive Summary" above for discussion of the remaining MSR sale commitments with New Residential and related risks.
Further information about our agreements with New Residential, and our continuing involvement with the portfolio transferred, follows:
|
|
•
|
Subservicing Agreement.
We entered into a subservicing agreement with New Residential in connection with our MSR Sale Agreement, which covers all units sold for an initial period of three years, subject to certain early transfer and termination provisions. This subservicing relationship became effective upon the initial delivery of MSRs to New Residential on June 16, 2017. As of December 31, 2017, our total units subserviced is approximately
629,000
, and New Residential represents 58% of our subserviced units, which is a significant client concentration in our portfolio.
|
|
|
•
|
Portfolio Defense Agreement.
In connection with the initial delivery of MSRs to New Residential on June 16, 2017, we entered into the MSR Portfolio Defense Agreement with New Residential, pursuant to which we will be entitled, subject to compliance with the terms of the agreement, to seek to refinance loans subserviced on behalf of New Residential as part of our Portfolio Retention services. Under this agreement, we have agreed to sell the MSR with respect to loans originated under this program to New Residential.
|
|
|
•
|
Secured Borrowing Accounting.
Our accounting evaluation of the New Residential MSR Sale agreement and related agreements concluded that New Residential has not acquired all ownership rewards since the terms of the subservicing contract limit New Residential's ability to terminate the contract within the first three years. Therefore, our transfer of MSRs to New Residential did not qualify for sale accounting under GAAP, and we record the transactions as a secured borrowing. Upon the receipt of cash for MSRs transferred to New Residential, we recognized a Mortgage servicing rights secured liability on our balance sheet, and we continued to recognize the MSR asset. Future changes in the Mortgage servicing rights secured liability are expected to fully offset future changes in the related MSR asset, including changes in fair value. See further information about the presentation in the 'Selected Income Statement Data' tables within "Results of Operations
—
Mortgage Servicing Segment".
|
PHH Home Loans Asset Sales
We announced in February 2017 that we entered into agreements to sell certain assets of PHH Home Loans and its subsidiaries, including its mortgage origination and processing centers and the majority of its employees, to GRA. The asset sales with GRA were completed in a series of five closings, which occurred between August 2017 and December 2017 ("Asset Sale Transactions"). In total, we received $70 million of cash for the asset sales during 2017, and we recognized a pre-tax gain on sale of $35 million in our financial statements for our 50.1% share. Under the terms of the agreement, the cash received from these asset sales is shared pro-rata with the minority interest holder. As a result of these transactions, we also transferred approximately 860 employees to GRA, which represented 25% of our total employees at December 31, 2016.
In connection with the asset purchase agreement with GRA, we entered into an agreement to purchase Realogy's 49.9% ownership interests in the PHH Home Loans joint venture ("JV Interests Purchase"), for an amount equal to its interest in the residual equity of PHH Home Loans after the final closing of the Asset Sale Transactions. As of the date of this filing, we have not completed the purchase of Realogy's ownership interest in PHH Home Loans, but are contractually obligated to do so on or before March 19, 2018, subject to certain closing conditions. We do not expect to recognize any gain or loss specific to the JV Interests Purchase in our financial statements. After and assuming the completion of the JV Interests Purchase, PHH Home Loans will be our wholly-owned subsidiary and its residual net assets will be included in our Consolidated Financial Statements. We will continue to monetize the remaining residual assets and resolve the residual liabilities of the entity and once completed, we will no longer operate through our Real Estate channel. During 2017, we have received $35 million of cash related to our net proceeds from the sale agreement and $34 million from monetizing the residual assets of PHH Home Loans. Once the remaining actions are completed, we estimate that we will receive additional proceeds of $27 million. See
Note 17, 'Variable Interest Entities' in the accompanying Notes to Consolidated Financial Statements
for more information.
Exit Programs
We are currently executing our programs to exit our PLS business and to reorganize to a smaller business that is focused on subservicing and portfolio retention services. As a result of these exit programs and the transfer of employees as part of our transactions with LenderLive Network, LLC and GRA, we have reduced our employee headcount from 3,500 at the end of 2016, to approximately 1,365 at the end of 2017.
The table below summarizes the total costs of these exit programs, the amount recognized to date and the expected cash flows related to the programs (all amounts are pre-tax):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exit Program Costs
|
|
Cash Outflows
|
|
PLS Exit
|
|
Reorganization
|
|
Total
|
|
Payments To Date
(1)
|
|
Future Outflows
|
|
(In millions)
|
Cash Exit Costs by Segment - 2017:
|
|
|
|
|
|
|
|
|
|
Mortgage Production segment
|
$
|
24
|
|
|
$
|
16
|
|
|
$
|
40
|
|
|
|
|
|
Mortgage Servicing segment
|
—
|
|
|
2
|
|
|
2
|
|
|
|
|
|
Other
|
7
|
|
|
15
|
|
|
22
|
|
|
|
|
|
Total Recognized in 2017
|
$
|
31
|
|
|
$
|
33
|
|
|
$
|
64
|
|
|
|
|
|
Recognized in prior periods
|
26
|
|
|
—
|
|
|
26
|
|
|
|
|
|
Estimate of remaining costs
|
22
|
|
|
2
|
|
|
24
|
|
|
|
|
|
Cash exit program expenditures
|
$
|
79
|
|
|
$
|
35
|
|
|
$
|
114
|
|
|
$
|
(38
|
)
|
|
$
|
76
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash charges and impairments
|
11
|
|
|
2
|
|
|
|
|
|
|
|
Exit costs attributed to Noncontrolling interest
|
—
|
|
|
(7
|
)
|
|
|
|
|
|
|
Total
|
$
|
90
|
|
|
$
|
30
|
|
|
|
|
|
|
|
______________
|
|
(1)
|
Cash outflows as presented above exclude the transfer of
$5 million
to Restricted cash related to a letter of credit posted in connection with the March 31, 2017 transaction with LenderLive.
|
We expect to incur substantially all of the remaining exit costs for PLS during the first half of 2018, a significant portion of which relate to facility costs that are dependent upon the timing of when we vacate certain facilities. Substantially all of the remaining exit costs for Reorganization are expected to be incurred during the first quarter of 2018. We expect the timing of cash outflows related to our exit costs to extend through the end of 2018, as certain payments related to our severance arrangements are paid in bi-weekly installments, not lump sum payments.
See further details in
Note 2, 'Exit Costs' in the accompanying Notes to Consolidated Financial Statements
, including the total program cost estimate by segment.
Exit from Private Label Services Business.
In addition to the exit costs outlined above, during 2017, we incurred
$93 million
of pre-tax operating losses for PLS. As we complete the exit from this channel, we expect to incur further pre-tax operating losses of
$35 million
for PLS, including maintaining the support and compliance infrastructure needed to comply with both regulatory and contractual requirements.
Reorganization.
To execute our Reorganization to change the focus of our operations to subservicing and portfolio retention services, we are restructuring our remaining business and shared services platform. We intend to re-engineer and reduce operating
and overhead costs, which may take into the third quarter of 2018 to complete. During
2017
, Reorganization-related exit costs were primarily related to employee retention agreements and employee-related costs as part of the PHH Home Loans asset sales.
The following table presents our consolidated results of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions, except per share data)
|
Net revenues
|
$
|
456
|
|
|
$
|
622
|
|
|
$
|
790
|
|
Total expenses
|
729
|
|
|
926
|
|
|
1,003
|
|
Loss before income taxes
|
(273
|
)
|
|
(304
|
)
|
|
(213
|
)
|
Income tax benefit
|
(79
|
)
|
|
(111
|
)
|
|
(82
|
)
|
Net loss
|
(194
|
)
|
|
(193
|
)
|
|
(131
|
)
|
Less: net income attributable to noncontrolling interest
|
23
|
|
|
9
|
|
|
14
|
|
Net loss attributable to PHH Corporation
|
$
|
(217
|
)
|
|
$
|
(202
|
)
|
|
$
|
(145
|
)
|
|
|
|
|
|
|
Basic and Diluted loss per share attributable to PHH Corporation
|
$
|
(4.62
|
)
|
|
$
|
(3.77
|
)
|
|
$
|
(2.62
|
)
|
Our financial results for
2017
reflect our continued progress to move to a smaller capital-light business comprised of subservicing and portfolio retention services. Our results before income taxes for
2017
include:
|
|
•
|
$93 million
in operating losses related to the exit of our PLS channel;
|
|
|
•
|
$62 million
in Exit and disposal costs related to all of our exit and restructuring activities, including severance and retention, facility exit costs and contract termination costs;
|
|
|
•
|
$35 million
gain related to the asset sales of PHH Home Loans, exclusive of the noncontrolling interests portion;
|
|
|
•
|
$34 million
loss related to the extinguishment of a majority of our unsecured debt;
|
|
|
•
|
$30 million
in transaction and related expenses from the MSRs sold primarily to New Residential and Lakeview.
|
|
|
•
|
$30 million
in strategic review expenses; and
|
|
|
•
|
$22 million
of provisions for legal and regulatory matters.
|
Income Taxes
Tax Reform Act.
On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was signed into law, which made significant changes to U.S. federal income tax law by, among other things, reducing the corporate income tax rate from 35% to 21% and eliminating the ability to carryback Federal net operating losses generated in taxable years beginning after December 31, 2017. We determined that the Tax Act required a revaluation of our net deferred tax asset that resulted in a one-time charge to income tax expense during the fourth quarter of 2017 of approximately $30 million.
Going into 2018, based on our current expectations for continued operating losses and our assessment of the impact of the Tax Act, we expect to reflect a full valuation allowance and loss of substantially all income tax benefits against such future operating losses.
Income Tax Benefit.
Our effective income tax rate for the years ended
December 31, 2017
,
2016
and
2015
was
(28.9)%
,
(36.7)%
and
(38.4)%
, respectively. Our effective tax rates differ from our federal statutory rate of
35%
, primarily due to: (i) the impact of Federal tax reform; (ii) different state and local income tax rates from various jurisdictions; (iii) changes in state apportionment factors; (iv) changes in valuation allowances; (v) nondeductible expenses; and (vi) amounts of net income attributable to noncontrolling interest (for which no taxes are recorded at PHH Corporation).
For 2017, we generated taxable income which was primarily driven by the recognition of
$214 million
of our deferred tax liabilities as a result of the completed MSR sales. For 2016, we generated a net operating loss, and our effective tax rate and resulting income tax benefit were impacted by nondeductible expenses for legal and regulatory matters and other adjustments. We elected to carry back our 2016 taxable loss to offset our 2014 taxable income, and received a refund of $23 million from the IRS during 2017.
See
Note 12, 'Income Taxes' in the accompanying Notes to Consolidated Financial Statements
for further information.
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Origination and other loan fees
|
$
|
136
|
|
|
$
|
280
|
|
|
$
|
284
|
|
Gain on loans held for sale, net
|
144
|
|
|
262
|
|
|
298
|
|
Loan servicing income, net
|
137
|
|
|
125
|
|
|
236
|
|
Net interest expense
|
(36
|
)
|
|
(32
|
)
|
|
(46
|
)
|
Other income (loss)
|
75
|
|
|
(13
|
)
|
|
18
|
|
Net revenues
|
$
|
456
|
|
|
$
|
622
|
|
|
$
|
790
|
|
Revenues from our Mortgage Production segment for
2017
, including Origination and other loan fees and Gain on Loans held for sale, net, reflect a
47%
decline in total closings. Origination and other loan fees decreased by
$144 million
, or
51%
, compared to the prior year resulting from a
46%
decrease in total retail closing units caused by reduced client volume from the exit of the PLS channel and the sale of certain assets of PHH Home Loans, including their mortgage origination and processing centers, that occurred during 2017.
Gain on loans held for sale, net decreased by
$118 million
, or
45%
compared to the prior year primarily related to a
38%
decrease in salable applications that was associated with the decline in retail applications as we exit the PLS business and Real Estate channel.
Loan servicing income, net increased by
$12 million
, or
10%
resulting from the change in mix of our total loan servicing portfolio to primarily subserviced loans which reduces the interest rate exposure and related revenue volatility from MSR fair value changes and lowers our contractual servicing fees since we receive a smaller fee per loan from our subservicing clients as compared to the servicing fee received for our capitalized servicing rights. As a result, the
$12 million
increase reflects a favorable change of
$157 million
associated fair value adjustments of our MSRs that was partially offset by a
$145 million
decline in loan servicing income.
The favorable change in Other income (loss) was primarily due to a $70 million gain from the proceeds of the PHH Home Loans asset sales in 2017. Our net proceeds from the asset sales is reduced by the $35 million noncontrolling interest holder's pro-rata share, which is recorded within Net income attributable to noncontrolling interest. In 2016, we also recognized a $23 million impairment on our equity investment in Speedy Title and Appraisal Review Services, LLC ("STARS"), as the exit of our PLS channel significantly reduced STARS appraisal volume and its projected cash flows.
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Salaries and related expenses
|
$
|
263
|
|
|
$
|
345
|
|
|
$
|
323
|
|
Commissions
|
44
|
|
|
64
|
|
|
79
|
|
Loan origination expenses
|
31
|
|
|
64
|
|
|
91
|
|
Foreclosure and repossession expenses
|
19
|
|
|
35
|
|
|
51
|
|
Professional and third-party service fees
|
120
|
|
|
156
|
|
|
171
|
|
Technology equipment and software expenses
|
35
|
|
|
42
|
|
|
37
|
|
Occupancy and other office expenses
|
33
|
|
|
47
|
|
|
50
|
|
Depreciation and amortization
|
14
|
|
|
16
|
|
|
18
|
|
Exit and disposal costs
|
62
|
|
|
41
|
|
|
—
|
|
Other operating expenses:
|
|
|
|
|
|
Loss on early debt retirement
|
34
|
|
|
—
|
|
|
30
|
|
Legal and regulatory reserves
|
22
|
|
|
38
|
|
|
78
|
|
Other
|
52
|
|
|
78
|
|
|
75
|
|
Total expenses
|
$
|
729
|
|
|
$
|
926
|
|
|
$
|
1,003
|
|
Salaries and related expenses for
2017
decreased by $82 million compared to the prior year, primarily due to a decline in our average employee headcount during 2017 resulting from our exit plans, as well as higher expenses in 2016 related to incentive compensation, severance costs and contract labor to assist with information technology needs and short-term customer service projects.
Commissions decreased by
$20 million
, or
31%
, compared to
2016
primarily driven by a
26%
decrease in closing volume from our real estate channel.
Loan origination expenses for
2017
declined by
$33 million
compared to
2016
primarily due to a
50%
decrease in the total number of retail application units.
Foreclosure and repossession expenses decreased by
$16 million
or
46%
from the prior year primarily driven by lower foreclosure activity and improved portfolio delinquencies that were partially the result of the Lakeview GNMA MSR sales and other recent MSR sales of delinquent government loans.
Professional and third-party service fees decreased by $36 million, or 23%, compared to the prior year primarily from increased costs in 2016 for information technology expenses that were associated with the modernization and security of our information technology systems, implementing new compliance requirements in our origination business and strategic actions.
Occupancy and other office expenses decreased to
$33 million
, down $14 million or 30% compared to
2016
primarily due to lower rent and related occupancy expenses as a result of vacating Jacksonville and other smaller facilities during 2017, driven by our exit and reorganization actions.
Exit and disposal costs were
$62 million
in
2017
, related to the announced exit of the PLS business and Reorganization of the business, compared to $41 million in the prior year primarily driven by the nature and timing of when the exit plans were announced. During 2017, these costs primarily consisted of
$42 million
in severance and retention expenses,
$8 million
in facility exit costs, and
$14 million
in contract termination costs that were partially offset by a $2 million benefit from other activity.
Within Other operating expenses, our results include: (i) a loss for early repayment of unsecured debt of
$34 million
in 2017 related to the extinguishment of a portion of the Term notes due in 2019 and 2021; (ii) a provision for legal and regulatory contingencies of
$22 million
in 2017 and
$38 million
in 2016, primarily driven by adjustments for negotiated settlements related to our legacy mortgage servicing practices and provisions for other matters; (iii)a decrease of $26 million or 33% in Other expenses primarily from a decrease in repurchase and foreclosure-related charges of
$16 million
due to lower expenses that will not be reimbursed pursuant to mortgage insurance programs and exposure for legacy repurchase claims from certain private investors that was incurred during 2016; and (iv) lower service level agreement penalties related to our PLS clients and declines in certain loan fees from less production during 2017.
|
|
Mortgage Production Segment
|
Segment Overview
Our Mortgage Production segment generates revenue through fee-based mortgage loan origination services and the origination and sale of mortgage loans into the secondary market. We generally sell all saleable mortgage loans that we originate to secondary market investors, which include a variety of institutional investors, and initially retain the servicing rights on mortgage loans sold. The composition of our Mortgage Production segment will change significantly as we complete our strategic actions. Once these exits are completed, our Mortgage Production segment will consist entirely of portfolio retention services.
Portfolio Retention.
Portfolio retention services are a product offered to our subservicing clients in an effort to mitigate potential MSR runoff with the replenishment of new MSRs for our clients, which allows us to subservice the new loan. Originations under our portfolio retention services are sold into the secondary market as saleable loans and include both purchase and refinance closings, and for the
year ended December 31, 2017
, represented
6%
of our total closing volume (based on dollars). We will principally generate revenue from the receipt of origination and application fees, earned on a per loan basis, as well as the gain on sale of loans sold into the secondary market, earned as a percentage of the unpaid principal balance of loans sold. Any MSRs that are originated under our portfolio defense agreements are transferred to the respective counterparty pursuant to the contractual terms. Depending on our agreements, the MSRs will be issued on a co-issue basis or sold through flow sale agreements. As of December 31, 2017, we have approximately 482,000 total subservicing units that are solicitable under portfolio defense agreements.
Future portfolio retention volumes are dependent on the size and breadth of our servicing portfolio, on the willingness of our subservicing clients to permit us to perform such services and on a declining or lower interest rate environment as compared to individual mortgagor's current rates. We provide portfolio retention services to two key clients associated with our significant subservicing client relationships, which represented a combined 77% concentration of our total subservicing portfolio as of December 31, 2017. Our portfolio defense agreements cease upon the termination of the related client subservicing relationship, or as units transfer out of our subservicing portfolio to a new servicer. In addition, for the majority of the solicitable portfolio, we are authorized to seek refinance of mortgage loans on a non-exclusive basis, which may further limit our future mortgage loan originations since we must compete with other originators. We expect the transfer of approximately
115,000
subservicing units off of our platform between May 2018 and April 2019, based upon receipt in February 2018 of formal notices and verbal indications from two of our largest subservicing clients. Approximately 65,000 of these units are subject to a portfolio defense agreement and will no longer be solicitable units upon transfer to a new servicer. There can be no assurances that our subservicing agreements, and related units covered by portfolio defense agreements, will not be subject to further change.
Private Label Services.
The PLS channel includes providing outsourced mortgage origination services for wealth management firms, regional banks and community banks throughout the U.S. For the
year ended December 31, 2017
, the PLS channel represented
66%
of our total closing volume (based on dollars).
In November 2016, we announced our intentions to exit our PLS business and we incurred operating losses related to PLS of
$93 million
during the
year ended December 31, 2017
. We estimate that we will incur additional operating losses in the Mortgage Production segment related to PLS of
$35 million
through the second quarter of 2018, including maintaining the support and compliance infrastructure needed to comply with both regulatory and contractual requirements.
Our costs to exit PLS include severance and retention programs, facility-related exit costs, contract termination and other expected payments and non-cash asset impairment charges. For the
year ended December 31, 2017
, we incurred PLS-related exit costs of
$27 million
, including
$20 million
in the Mortgage Production segment and
$7 million
in "—Other" related to shared services supporting PLS. We estimate that we will incur
$22 million
of additional exit costs (pre-tax), of which an estimated
$17 million
will be incurred in the Mortgage Production segment.
We accepted our last application from our PLS clients during the fourth quarter of 2017, and we expect to be substantially complete with the wind-down of the PLS business by the end of the first quarter of 2018, subject to certain transition support requirements. In addition, we expect to reflect the historical results of operations of our PLS channel as discontinued operations beginning on the date the operations of the channel cease and run-off activity is substantially complete, which is expected to occur in the first half of 2018.
Real Estate.
The Real Estate channel includes providing mortgage origination services for brokers associated with brokerages owned or franchised by Realogy Corporation and other third-party brokers, through PHH Home Loans, our joint venture with Realogy. For the
year ended December 31, 2017
, Real Estate represented
28%
of our total closing volume (based on dollars).
For the
year ended December 31, 2017
, we incurred exit costs of
$13 million
related to the joint venture exit which is reduced by the noncontrolling interest holder's pro-rata share.
We announced in February 2017 that we entered into agreements to sell certain assets of PHH Home Loans, including its mortgage origination and processing centers and the majority of its employees, to GRA. We have executed on this transaction through five asset sale closings, and received $70 million of cash during 2017. Under the terms of the agreement, the cash received from these asset sales is shared pro-rata with the minority interest holder. We intend to exit the existing joint venture relationship with Realogy through our purchase of their interests in the entity in the first quarter of 2018. Once the wind-down of the remaining mortgage pipeline at December 31, 2017 is complete, the Real Estate channel will not be part of our future operations. We expect to reflect the historical results of operations of the Real Estate channel, including the results of PHH Home Loans, as discontinued operations beginning on the date the operations of the channel cease and run-off activity is substantially complete, which is expected to occur in the first half of 2018. Refer to "—Asset Sales and Exit Programs" for more information about the agreements related to the PHH Home Loans asset sales.
Business Summary
The following table summarizes the closing statistics and the allocation of revenue of our exiting and remaining Mortgage Production businesses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2017
|
|
Exiting
|
|
Remaining
|
|
|
|
PLS
(1)
|
|
Real Estate
|
|
Portfolio Retention
|
|
Total
|
|
(In millions)
|
Origination and other loan fees
|
$
|
105
|
|
|
$
|
27
|
|
|
$
|
4
|
|
|
$
|
136
|
|
Gain on loans held for sale, net
|
(8
|
)
|
|
115
|
|
|
37
|
|
|
144
|
|
Net interest income
|
1
|
|
|
2
|
|
|
2
|
|
|
5
|
|
Other income
|
2
|
|
|
71
|
|
|
—
|
|
|
73
|
|
Net revenues
|
$
|
100
|
|
|
$
|
215
|
|
|
$
|
43
|
|
|
$
|
358
|
|
|
|
|
|
|
|
|
|
Total Closings
|
$
|
13,157
|
|
|
$
|
5,470
|
|
|
$
|
1,130
|
|
|
$
|
19,757
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2016
|
|
Exiting
|
|
Remaining
|
|
|
|
PLS & Wholesale
(1)
|
|
Real Estate
|
|
Portfolio Retention
|
|
Total
|
|
(In millions)
|
Origination and other loan fees
|
$
|
242
|
|
|
$
|
35
|
|
|
$
|
3
|
|
|
$
|
280
|
|
Gain on loans held for sale, net
|
11
|
|
|
187
|
|
|
64
|
|
|
262
|
|
Net interest income
|
4
|
|
|
4
|
|
|
2
|
|
|
10
|
|
Other (loss) income
|
(13
|
)
|
|
(1
|
)
|
|
1
|
|
|
(13
|
)
|
Net revenues
|
$
|
244
|
|
|
$
|
225
|
|
|
$
|
70
|
|
|
$
|
539
|
|
|
|
|
|
|
|
|
|
Total Closings
|
$
|
28,644
|
|
|
$
|
7,383
|
|
|
$
|
1,202
|
|
|
$
|
37,229
|
|
_______________
|
|
(1)
|
Portfolio Retention has historically been included in our disclosed PLS channel data; however, Portfolio Retention is displayed separately. Wholesale was also included in 2016; however, we completed the exit of the platform during the second quarter of 2016.
|
Segment Metrics:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
($ In millions)
|
Closings:
|
|
|
|
|
|
|
|
|
Saleable to investors
|
$
|
6,757
|
|
|
$
|
10,146
|
|
|
$
|
13,218
|
|
Fee-based
|
13,000
|
|
|
27,083
|
|
|
27,386
|
|
Total
|
$
|
19,757
|
|
|
$
|
37,229
|
|
|
$
|
40,604
|
|
|
|
|
|
|
|
Purchase
|
$
|
10,999
|
|
|
$
|
16,140
|
|
|
$
|
20,169
|
|
Refinance
|
8,758
|
|
|
21,089
|
|
|
20,435
|
|
Total
|
$
|
19,757
|
|
|
$
|
37,229
|
|
|
$
|
40,604
|
|
|
|
|
|
|
|
Retail - PLS and Portfolio Retention
|
$
|
14,287
|
|
|
$
|
29,261
|
|
|
$
|
30,436
|
|
Retail - Real Estate
|
5,470
|
|
|
7,383
|
|
|
8,752
|
|
Total retail
|
19,757
|
|
|
36,644
|
|
|
39,188
|
|
Wholesale/correspondent
|
—
|
|
|
585
|
|
|
1,416
|
|
Total
|
$
|
19,757
|
|
|
$
|
37,229
|
|
|
$
|
40,604
|
|
|
|
|
|
|
|
Retail - PLS and Portfolio Retention (units)
|
23,588
|
|
|
51,089
|
|
|
58,587
|
|
Retail - Real Estate (units)
|
18,239
|
|
|
26,075
|
|
|
32,428
|
|
Total retail (units)
|
41,827
|
|
|
77,164
|
|
|
91,015
|
|
Wholesale/correspondent (units)
|
—
|
|
|
2,298
|
|
|
6,199
|
|
Total (units)
|
41,827
|
|
|
79,462
|
|
|
97,214
|
|
|
|
|
|
|
|
Applications:
|
|
|
|
|
|
|
|
|
Saleable to investors
|
$
|
8,829
|
|
|
$
|
14,275
|
|
|
$
|
18,047
|
|
Fee-based
|
13,047
|
|
|
31,134
|
|
|
33,593
|
|
Total
|
$
|
21,876
|
|
|
$
|
45,409
|
|
|
$
|
51,640
|
|
|
|
|
|
|
|
Other:
|
|
|
|
|
|
|
|
|
IRLCs expected to close
|
$
|
2,473
|
|
|
$
|
4,373
|
|
|
$
|
7,199
|
|
Total loan margin on IRLCs (in basis points)
|
305
|
|
|
352
|
|
|
310
|
|
Loans sold
|
$
|
7,233
|
|
|
$
|
10,548
|
|
|
$
|
13,630
|
|
The following are descriptions of the business and certain metrics of the Mortgage Production segment:
Saleable closings.
Our saleable closings represent loans that are originated or purchased through the real estate and PLS channels of our retail platform which also includes the activities of the portfolio retention business. Saleable closings are originated or acquired with the intent that we will sell the loan after closing to secondary market investors, and we may retain the servicing rights upon sale of the loan. For all saleable closings, we recognize gain on sale revenue from investors and related origination fees from borrowers.
Fee-based closings.
Our fee-based closings represent loans that are originated through outsourcing relationships with our PLS clients, where we receive a stated fee per loan in exchange for performing loan origination services. These origination services are performed in the name of the PLS client and the ownership rights to the loans are retained by each respective client upon closing. While saleable closings are originated in all platforms, fee-based closings are only originated in our PLS channel. In our PLS channel, fee-based closings are retained by the client subsequent to closing; whereas, saleable closings are purchased by us for sale to secondary market investors subsequent to closing.
Segment Results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Origination and other loan fees
|
$
|
136
|
|
|
$
|
280
|
|
|
$
|
284
|
|
Gain on loans held for sale, net
|
144
|
|
|
262
|
|
|
298
|
|
Net interest income (expense)
|
5
|
|
|
10
|
|
|
(5
|
)
|
Other income (loss)
|
73
|
|
|
(13
|
)
|
|
9
|
|
Net revenues
|
358
|
|
|
539
|
|
|
586
|
|
|
|
|
|
|
|
Salaries and related expenses
|
150
|
|
|
216
|
|
|
213
|
|
Commissions
|
44
|
|
|
64
|
|
|
79
|
|
Loan origination expenses
|
31
|
|
|
64
|
|
|
91
|
|
Professional and third-party service fees
|
26
|
|
|
22
|
|
|
34
|
|
Technology equipment and software expenses
|
3
|
|
|
4
|
|
|
3
|
|
Occupancy and other office expenses
|
20
|
|
|
27
|
|
|
31
|
|
Depreciation and amortization
|
6
|
|
|
8
|
|
|
11
|
|
Exit and disposal costs
|
38
|
|
|
33
|
|
|
—
|
|
Other operating expenses
|
109
|
|
|
145
|
|
|
157
|
|
Total expenses
|
427
|
|
|
583
|
|
|
619
|
|
Loss before income taxes
|
(69
|
)
|
|
(44
|
)
|
|
(33
|
)
|
Less: net income attributable to noncontrolling interest
|
23
|
|
|
9
|
|
|
14
|
|
Segment loss
|
$
|
(92
|
)
|
|
$
|
(53
|
)
|
|
$
|
(47
|
)
|
2017
Compared With
2016
:
Mortgage Production segment loss was
$92 million
during
2017
, compared to a loss of
$53 million
during
2016
. Our results in the segment reflect the reduced volumes associated with our exit of the PLS business and reductions in our Real Estate channel from the asset sales of PHH Home Loans to GRA that began in August 2017. The 2017 segment loss includes
$93 million
of PLS operating losses and
$38 million
of Exit and disposal costs, which was partially offset by $35 million in net proceeds from the completion of the PHH Home Loans asset sales.
Net revenues.
Origination and other loan fees decreased to
$136 million
, down
$144 million
or
51%
, compared to the prior year. Origination assistance fees decreased by $109 million, which was primarily driven by a
57%
decrease in private label closing units compared to the prior year. The decrease in Origination and other loan fees also included a $33 million decline in appraisal income and application and other closing fees primarily driven by a
50%
decrease in total retail closing units.
Gain on loans held for sale, net decreased to
$144 million
, down
$118 million
or
45%
, compared to the prior year. This decrease related to a
38%
decrease in saleable applications that was primarily due to the decline in retail applications as we execute the exit of the PLS channel, and from the PHH Home Loans asset sales to GRA in our Real Estate channel.
Net interest income decreased to
$5 million
, down
$5 million
or
50%
, compared to the prior year, primarily due to a decline in average mortgage loans held for sale that was partially offset by a decline in the average mortgage warehouse debt from reduced borrowing needs, both of which were impacted by a decline in saleable volume.
The favorable change in Other income (loss) was primarily due to a $70 million gain from the proceeds of the PHH Home Loans asset sales to GRA. Our net proceeds from the asset sales is reduced by the $35 million noncontrolling interest holder's pro-rata share, which is recorded within Net income attributable to noncontrolling interest. In 2016, Other income included a $23 million impairment on our equity investment in STARS.
Total expenses
.
Salaries and related expenses were
$150 million
, down
$66 million
or
31%
, compared to the prior year, primarily due to a
$51 million
decline in Salaries, benefits and incentives as a result of declines in average employee headcount as we execute on our planned exit activities, and the transfer of a significant number of employees to LenderLive on March 31, 2017 as part of our transaction to outsource certain PLS mortgage origination fulfillment functions. Salaries and related expenses also included a
$15 million
decrease in Contract labor and overtime as a result of declining application volumes.
Commissions decreased by
$20 million
, or
31%
, compared to
2016
primarily driven by a
26%
decrease in closing volume from our Real Estate channel.
Loan origination expenses decreased by
$33 million
, or
52%
, compared to
2016
primarily due to a
50%
decrease in the total number of retail application units.
Professional and third-party service fees increased to
$26 million
, up
$4 million
or
18%
, primarily due to $7 million of fees paid in 2017 to LenderLive for outsourced PLS mortgage origination services that were partially offset by lower expenses for compliance activities.
Occupancy and other office expenses decreased to
$20 million
, down
$7 million
or
26%
, compared to
2016
primarily due to lower rent and related occupancy expenses as a result of assigning our Jacksonville lease to LenderLive, and other smaller facilities that were vacated during 2017.
Exit and disposal costs were
$38 million
, up
$5 million
during
2017
, as a result of our exit of the PLS business and Reorganization. These costs included
$21 million
of severance and retention expenses for impacted employees,
$8 million
for facility-related costs including our transfer of the Jacksonville facility to LenderLive and other smaller facility closures and
$10 million
in contract-related termination costs primarily related to PLS.
Within Other operating expenses, Corporate overhead allocation decreased to
$92 million
, down
$26 million
or
22%
, compared to the prior year primarily due to reduced professional fees for information technology shared services. See “—Other” for a more detailed discussion of the expenses included in the Corporate overhead allocation.
Within Other operating expenses, Other expenses decreased to
$17 million
, down
$10 million
or
37%
, compared to the prior year primarily due to lower service level agreement penalties related to our PLS clients and a decline in certain loan fees from less production during 2017.
2016
Compared With
2015
:
Mortgage Production segment loss was $53 million during 2016, compared to a loss of $47 million during 2015. Net revenues decreased to $539 million, down $47 million, or 8%, compared to the prior year driven by lower purchase closing volume and impairment on our equity investment in STARS, partially offset by the lack of allocated unsecured interest expense as compared with 2015. Total expenses decreased to $583 million, down $36 million, or 6%, compared to the prior year primarily driven by decreases in Commissions and Loan origination expenses from lower purchase closing volume and decreases in Professional and third-party service fees and Corporate overhead allocation, that were partially offset by Exit and disposal costs incurred in the fourth quarter of 2016 related to our exit from the PLS channel.
Net revenues.
Origination and other loan fees decreased to $280 million, down $4 million or 1%, as compared to the prior year. Appraisal income, application and other loan fees decreased by $17 million, primarily driven by a 15% decrease in total retail closing units. This was partially offset by a $13 million increase in Origination assistance fees, which was driven by operating benefits from amendments to our private label agreements, partially offset by a 13% decrease in total PLS closing units compared to the prior year.
Gain on loans held for sale, net decreased to $262 million, down $36 million or 12% as compared to the prior year. The $28 million decrease in gain on loans compared to the prior year was primarily related to a 39% decrease in IRLCs expected to close, reflecting the increased mix of fee-based closings (where we do not enter into an IRLC), that was partially offset by a 42 basis point increase in average total loan margins. Additionally, there was a $5 million unfavorable change in fair value of Scratch and Dent and certain non-conforming loans compared with the prior year, which was primarily driven by price adjustments.
Interest income decreased to $32 million, down $8 million or 20% as compared to the prior year, primarily due to the decline in average mortgage loans held for sale from the decline in saleable volume. Secured interest expense decreased to $22 million, down $2 million or 8%, compared to the prior year, primarily due to the decline in average mortgage warehouse debt from reduced borrowing needs as well as our funding strategy for mortgage loans held for sale.
Allocated unsecured interest expenses was zero for 2016, compared to $21 million for 2015, driven by updates to our interest allocation methodology. We evaluate the capital structure of each segment on an annual basis and have not allocated unsecured interest expense to Mortgage Production during 2016 as the segment's capital structure was fully supported by existing cash and the secured warehouse debt facilities for 2016.
The unfavorable change in Other (loss) income was primarily due to a $23 million impairment on our equity investment in STARS, as the exit of our PLS business will significantly reduce STARS appraisal volume and its projected cash flows.
Total expenses
.
Commissions decreased by $15 million, or 19%, compared to 2015 primarily driven by a 16% decrease in closing volume from our Real Estate channel.
Loan origination expenses decreased by $27 million, or 30%, compared to 2015 due to a 17% decrease in the total number of retail application units, as well as the termination of our trademark and licensing agreements with Realogy in 2015.
Professional and third-party service fees decreased to $22 million, down $12 million or 35%, primarily due to reduced consulting expenses on compliance activities and our efforts to re-engineer the business in 2016 as compared to 2015.
Occupancy and other office expenses decreased to $27 million, down $4 million or 13%, compared to 2015 due to one-time expenses and lower rent from consolidating Mt. Laurel facilities in 2015.
Exit and disposal costs were $33 million for 2016, as a result of our exit of the PLS business and Reorganization activities. These costs included $18 million of severance and retention expenses for impacted employees, $14 million of impairment of technology-related and other long-lived assets used in the PLS business and $1 million in contract-related costs.
Corporate overhead allocation decreased to $118 million, down $13 million or 10%, compared to the prior year primarily due to a reduced allocation of expenses to the Mortgage Production segment in 2016. See “—Other” for a more detailed discussion of the expenses included in the Corporate overhead allocation.
Selected Income Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Gain on loans held for sale, net:
|
|
|
|
|
|
|
|
|
Gain on loans
|
$
|
129
|
|
|
$
|
228
|
|
|
$
|
256
|
|
Change in fair value of Scratch and Dent and certain non-conforming mortgage loans
|
(7
|
)
|
|
(6
|
)
|
|
(1
|
)
|
Economic hedge results
|
22
|
|
|
40
|
|
|
43
|
|
Total change in fair value of mortgage loans and related derivatives
|
15
|
|
|
34
|
|
|
42
|
|
Total
|
$
|
144
|
|
|
$
|
262
|
|
|
$
|
298
|
|
|
|
|
|
|
|
Net interest income:
|
|
|
|
|
|
Interest income
|
$
|
22
|
|
|
$
|
32
|
|
|
$
|
40
|
|
Secured interest expense
|
(17
|
)
|
|
(22
|
)
|
|
(24
|
)
|
Unsecured interest expense
|
—
|
|
|
—
|
|
|
(21
|
)
|
Total
|
$
|
5
|
|
|
$
|
10
|
|
|
$
|
(5
|
)
|
|
|
|
|
|
|
Salaries and related expenses:
|
|
|
|
|
|
|
|
|
Salaries, benefits and incentives
|
$
|
145
|
|
|
$
|
196
|
|
|
$
|
196
|
|
Contract labor and overtime
|
5
|
|
|
20
|
|
|
17
|
|
Total
|
$
|
150
|
|
|
$
|
216
|
|
|
$
|
213
|
|
|
|
|
|
|
|
Other operating expenses:
|
|
|
|
|
|
|
|
|
Corporate overhead allocation
|
$
|
92
|
|
|
$
|
118
|
|
|
$
|
131
|
|
Other expenses
|
17
|
|
|
27
|
|
|
26
|
|
Total
|
$
|
109
|
|
|
$
|
145
|
|
|
$
|
157
|
|
The following are descriptions of the contents and drivers of the financial results of the Mortgage Production segment:
Origination and other loan fees
consist of fee income earned on all loan originations, including loans that are saleable to investors and fee-based closings in our PLS channel. Retail closings and fee-based closings are key drivers of Origination and other loan fees, and the fee income earned on those loans consists of application and underwriting fees, fees on canceled loans and amounts earned from financial institutions related to brokered loan fees and origination assistance fees resulting from our private label mortgage outsourcing activities.
Gain on loans held for sale, net
includes realized and unrealized gains and losses on our mortgage loans, as well as the changes in fair value of our interest rate lock commitments ("IRLCs") and loan-related derivatives. The fair value of our IRLCs is based upon the estimated fair value of the underlying mortgage loan, adjusted for: (i) the estimated costs to complete and originate the loan and (ii) the estimated percentage of IRLCs that will result in a closed mortgage loan.
Gain on loans is primarily driven by the volume of IRLCs expected to close, total loan margins and the mix of wholesale/correspondent closing volume. For certain retail closings from our private label clients and wholesale/correspondent closings, the cost to acquire the loan reduces the gain from selling the loan into the secondary market. Change in fair value of Scratch and Dent and certain non-conforming mortgage loans is primarily driven by additions, sales and changes in value of Scratch and Dent loans, which represent loans with origination flaws or performance issues. Economic hedge results represent the change in value of mortgage loans, IRLCs and related derivatives, including the impact of changes in actual pullthrough as compared to our initial assumptions.
Salaries and related expenses
consist of salaries, payroll taxes, benefits and incentives paid to employees in our mortgage production operations. These expenses are primarily driven by the average number of permanent employees.
Commissions
for employees involved in the loan origination process are primarily driven by the volume of retail closings. Closings from our real estate channel have higher commission rates than private label closings.
Loan origination expenses
represent variable costs directly related to the volume of loan originations and consist of appraisal, underwriting and other direct loan origination expenses. These expenses are primarily driven by the volume of applications.
Exit and disposal costs
consist of costs related to our announced exit of the PLS channel. These costs include employee severance and retention costs, facility-related exit costs, contract termination fees and asset impairment of technology-related and other long-lived assets.
Other operating expenses
consist of corporate overhead allocation and other production related expenses.
|
|
Mortgage Servicing Segment
|
Segment Overview
Our Mortgage Servicing segment services mortgage loans originated by us where we retain the Mortgage servicing rights ("MSRs"), or act as subservicer for certain clients that own the underlying servicing rights. The segment principally generates revenue through fees earned from our MSRs or from our subservicing agreements as described below. During 2017, we completed the sale of a significant portion of our capitalized MSRs and shifted our business focus to subservicing. We do not anticipate retaining a significant amount of capitalized MSRs on our Consolidated Balance Sheet in the future.
Beginning in the fourth quarter of 2016 and throughout 2017, we experienced significant changes in the mix of loans within our total loan servicing portfolio from the execution of our MSR sale agreements and client-driven actions. Specifically, between June 2017 and December 2017, we sold a significant portion of our owned MSRs to New Residential, and began functioning as subservicer for those approximately 392,000 units transferred. In addition, between February 2017 and August 2017, we sold approximately
87,000
units, representing our owned GNMA MSR portfolio, to Lakeview, and we did not retain any continuing involvement as servicer for that population. In the fourth quarter of 2016, our subservicing portfolio declined by approximately 211,000 units driven by Merrill Lynch's insourcing of their subservicing activities, and HSBC's sale of a population of MSRs related to loans that we subserviced.
At the end of 2017, our servicing platform consisted primarily of subserviced loans, and we expect our contractual servicing fees in future periods to decline since we receive a smaller fee per loan from our subservicing clients as compared to the servicing fee received for our capitalized servicing rights. However, subservicing relationships reduce the interest rate exposure and related revenue volatility from MSR fair value changes and eliminates curtailment interest expense and payoff-related costs, as well as eliminates the need for capital to fund servicing advance obligations. Additionally, our exposure to foreclosure-related costs and losses is generally limited in our subservicing relationships as those risks are retained by the owner of the MSR. Our servicing operations and expense base remain relatively consistent despite this shift in our business, other than as previously described. We are continuing to restructure our shared services and overhead cost scale for our future business, as discussed further in "—Asset Sales and Exit Programs—Exit Programs".
Business Summary
The following tables summarize our revenues between our owned and subservicing portfolios, and the portfolio statistics:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2017
|
|
Owned Servicing
|
|
Subservicing
|
|
Total
|
|
(In millions)
|
Servicing fees
|
$
|
116
|
|
|
$
|
56
|
|
|
$
|
172
|
|
MSR prepayments and receipts of recurring cash flows
|
(59
|
)
|
|
—
|
|
|
(59
|
)
|
MSR market-related adjustments, net
|
(12
|
)
|
|
—
|
|
|
(12
|
)
|
Other
|
(26
|
)
|
|
23
|
|
|
(3
|
)
|
Net revenues
|
$
|
19
|
|
|
$
|
79
|
|
|
$
|
98
|
|
|
|
|
|
|
|
Average number of loans serviced (units)
|
288,513
|
|
|
446,662
|
|
|
735,175
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2016
|
|
Owned Servicing
|
|
Subservicing
|
|
Total
|
|
(In millions)
|
Servicing fees
|
$
|
266
|
|
|
$
|
67
|
|
|
$
|
333
|
|
MSR prepayments and receipts of recurring cash flows
|
(138
|
)
|
|
—
|
|
|
(138
|
)
|
MSR market-related adjustments, net
|
(90
|
)
|
|
—
|
|
|
(90
|
)
|
Other
|
(34
|
)
|
|
12
|
|
|
(22
|
)
|
Net revenues
|
$
|
4
|
|
|
$
|
79
|
|
|
$
|
83
|
|
|
|
|
|
|
|
Average number of loans serviced (units)
|
608,085
|
|
|
435,094
|
|
|
1,043,179
|
|
Owned Servicing
Our owned servicing consists of revenues earned from our MSRs, which are capitalized on our Balance sheet. MSRs are the rights to receive a portion of the interest coupon and fees collected from the mortgagors for performing specified mortgage servicing activities, which consist of collecting loan payments, remitting principal and interest payments to investors, managing escrow funds for the payment of mortgage-related expenses such as taxes and insurance, performing loss mitigation activities on behalf of investors and otherwise administering our mortgage loan servicing portfolio. Our owned portfolio also requires capital and liquidity to fund servicing advance obligations, as we are required to fund scheduled principal, interest, tax and insurance payments when the mortgage loan borrower has failed to make the scheduled payments and to cover foreclosure costs and various other items that are required to preserve the assets being serviced.
As previously described, we completed the sale of a significant portion of our capitalized MSRs during 2017 and shifted our business focus to subservicing. During the fourth quarter of 2016, we entered into two separate agreements to sell substantially all of our MSRs, and during 2017, we completed sales of $54.0 billion in unpaid principal balance of MSRs to New Residential and sales of $13.2 billion in unpaid principal balance of GNMA MSRs to Lakeview. As of
December 31, 2017
, we have commitments to sell an additional
27,000
units (approximately) of our owned MSRs to New Residential, where we would continue functioning as subservicer. Substantially all of the remaining sale commitments of the MSRs and servicing advances currently require consents from third parties other than GSEs.
Our sales of MSRs to New Residential were accounted for as a secured borrowing, and accordingly, the MSRs remained on the balance sheet with the proceeds from sale recognized as MSRs secured liability. We elected to record the MSRs secured liability at fair value consistent with the related MSR asset. Future changes in the MSRs secured liability will fully offset future changes in the related MSR asset.
Owned servicing has historically experienced high degrees of earnings volatility due to significant exposure to changes in interest rates, and the related impact on our modeled MSR cash flows, high delinquent GNMA servicing costs and other market risks. These factors were impacted by, among other factors, conditions in the housing market, general economic factors, including higher unemployment rates, and policies of the Federal Reserve. Prior to the sale of substantially all of our owned MSRs, the results of servicing our owned portfolio have been negatively impacted by the persistent low interest rate environment and increasing costs to comply with regulations, while the compensation for servicers remained constant. Historically, we have used a combination of derivative instruments to protect against potential adverse changes in the fair value of our MSRs resulting from a decline in interest rates; however, in December 2016, we terminated substantially all of our MSR-related derivatives in connection with the MSR sale agreements, as our agreement with New Residential fixed the value we expect to realize on our MSRs as of the transaction date. The remaining MSR-related derivatives were primarily settled during the first quarter of 2017 with no significant impact to our results of operations.
Subservicing
Subservicing consists of revenues earned from performing servicing functions under subservicing agreements, whereby we service loans on behalf of the owner of the MSRs. The market for subservicing clients is comprised of independent mortgage bankers, community banks, credit unions and other mortgage investors. The size of the subservicing market is dependent on the following: (i) the rate of prepayment speeds and the size of the home purchase market; (ii) lack of operational scale for smaller MSR owners who may need a subservicing partner to keep pace with consumer, regulatory and investor requirements; and (iii) MSR ownership by financial investors who do not have in-house servicing capability.
We anticipate growth in the subservicing market as mid-size and smaller servicers may sell MSRs to financial investors who are likely to contract with subservicers. We also are monitoring the political environment for possible regulatory reform and changes to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which could potentially lower costs to subservicers. However, market factors such as higher interest rates, evolving regulations, and potentially volatile capital market conditions may adversely impact demand for MSRs by non-bank investors and create a more challenging environment for subservicing.
We are actively engaged in business development efforts in order to grow our subservicing units to achieve an adequate level of scale and a profitable business model. Our subservicing portfolio is subject to runoff and will continue to decline as our current additions through flow sales and portfolio retention are insufficient to offset runoff. There can be no assurances that we will be successful in growing our subservicing portfolio. We expect the transfer of approximately
115,000
subservicing units off of our platform between May 2018 and April 2019, based upon receipt in February 2018 of formal notices and verbal indications from two of our largest subservicing clients. Approximately 65,000 of these units are subject to a portfolio defense agreement and will no longer be solicitable units upon transfer to a new servicer. There can be no assurances that our subservicing agreements or relationships will not be subject to further change.
Although the underlying business activities are substantially similar, the key economic distinctions between owned MSRs and subservicing are outlined below, as well as some of the risks specific to our subservicing business:
|
|
•
|
Revenue/Expense Recognition.
Contractual subservicing fees are generally based on a stated amount per loan and vary depending on the delinquency status of each loan and the terms of each subservicing agreement. We receive a smaller fee per loan from our subservicing clients as compared to the servicing fee received for our capitalized servicing rights. However, we have less risks of elevated costs as a subservicer, as our exposure to foreclosure-related costs and losses is generally limited in our subservicing relationships as those risks are retained by the owner of the servicing rights.
|
|
|
•
|
Interest Rate Risk Management.
Our subservicing business has less exposure to interest rate volatility because we do not capitalize an MSR on our balance sheet, which eliminates earnings volatility from market-related changes in fair value, costs from executing MSR derivatives, as well as MSR amortization, curtailment interest expense and payoff-related costs. However, as a subservicer, we continue to be exposed to the risk of portfolio runoff driven by a low interest rate environment. We need to continually source new subservicing relationships or portfolio additions in order to maintain our portfolio size.
|
|
|
•
|
Capital Requirements.
Our subservicing business eliminates the need for capital to fund MSRs and execute related derivatives and limits our need to fund servicing advances. Our subservicing agreements generally contain provisions that require the subservicing client to pre-fund advances on the subserviced loans or to reimburse us for those advances on a periodic basis. Additionally, our exposure to foreclosure-related costs and losses is generally limited in our subservicing relationships as those risks are retained by the owner of the MSR.
|
|
|
•
|
Client Retention & Agreement Termination Rights.
The terms of a substantial portion of our subservicing agreements allow the owners of the servicing to terminate the subservicing agreement without cause with respect to some or all of the subserviced loans and, in some cases, without payment of any termination fee. This risk is further magnified by our client concentration exposure. As of December 31, 2017, 58% and 19% of our subservicing portfolio (by units) related to significant client relationships with New Residential and Pingora Loan Servicing, LLC, respectively. Our subservicing agreement with New Residential engages us to subservice the loans sold to New Residential for an initial period of three years, beginning in June 2017 upon the completion of the initial sale, subject to certain transfer and termination provisions (including New Residential's right to transfer, without cause, 25% of the subservicing units beginning in June 2018, and an additional 25% of the subservicing units beginning in June 2019).
|
For more information, see "—Risk Management—Counterparty and Concentration Risk" and “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—
Our remaining business will be focused on subservicing and portfolio retention activities, and we have significant client concentration risk related to the percentage of subservicing and portfolio retention activities from agreements with New Residential Mortgage, LLC and Pingora Loan Servicing, LLC. Further, the terms of a significant portion of our subservicing agreements allow the owners of the servicing to terminate the subservicing agreement without cause which would also terminate any related portfolio defense agreements.
"
Segment Metrics:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
($ In millions)
|
Total Loan Servicing Portfolio:
|
|
|
|
|
|
Conventional loans
|
$
|
137,029
|
|
|
$
|
151,004
|
|
|
$
|
197,971
|
|
Government loans
|
9,715
|
|
|
21,801
|
|
|
24,087
|
|
Home equity lines of credit
|
1,411
|
|
|
1,837
|
|
|
4,201
|
|
Total Unpaid Principal Balance
|
$
|
148,155
|
|
|
$
|
174,642
|
|
|
$
|
226,259
|
|
|
|
|
|
|
|
Number of loans in owned portfolio (units)
|
42,616
|
|
|
567,647
|
|
|
642,379
|
|
Number of subserviced loans (units)
(1)
|
629,174
|
|
|
264,718
|
|
|
450,295
|
|
Total number of loans serviced (units)
|
671,790
|
|
|
832,365
|
|
|
1,092,674
|
|
|
|
|
|
|
|
Weighted-average interest rate
|
3.9
|
%
|
|
3.8
|
%
|
|
3.8
|
%
|
|
|
|
|
|
|
Total Portfolio Delinquency:
|
|
|
|
|
|
% of UPB - 30 days or more past due
|
2.49
|
%
|
|
2.56
|
%
|
|
2.47
|
%
|
% of UPB - Foreclosure, REO and Bankruptcy
|
1.49
|
%
|
|
1.96
|
%
|
|
1.93
|
%
|
Units - 30 days or more past due
|
3.54
|
%
|
|
3.59
|
%
|
|
3.49
|
%
|
Units - Foreclosure, REO and Bankruptcy
|
2.02
|
%
|
|
2.37
|
%
|
|
2.32
|
%
|
|
|
|
|
|
|
Total Capitalized Servicing Portfolio:
|
|
|
|
|
|
UPB of capitalized MSRs owned
|
$
|
8,592
|
|
|
$
|
84,657
|
|
|
$
|
98,990
|
|
UPB of capitalized MSRs in secured borrowing arrangement
(2)
|
49,193
|
|
|
—
|
|
|
—
|
|
Total Unpaid Principal Balance of capitalized servicing portfolio
|
$
|
57,785
|
|
|
$
|
84,657
|
|
|
$
|
98,990
|
|
|
|
|
|
|
|
Capitalized servicing rate
|
0.82
|
%
|
|
0.82
|
%
|
|
0.89
|
%
|
Capitalized servicing multiple
|
3.0
|
|
|
2.9
|
|
|
3.1
|
|
Weighted-average servicing fee (in basis points)
|
27
|
|
|
28
|
|
|
29
|
|
______________
|
|
(1)
|
For
December 31, 2017
, includes
363,062
units of New Residential subserviced loans that are accounted for as a secured borrowing arrangement based on our evaluation of the New Residential MSR sale agreement. Refer to "Asset Sales and Exit Programs" for additional information.
|
|
|
(2)
|
Represents MSRs sold to New Residential during 2017 that are accounted for as a secured borrowing arrangement. Refer to "
—
Asset Sales and Exit Programs" for additional information.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Total Loan Servicing Portfolio:
|
|
|
|
|
|
Average Portfolio UPB
|
$
|
159,671
|
|
|
$
|
220,458
|
|
|
$
|
225,787
|
|
|
|
|
|
|
|
Owned Capitalized Servicing Portfolio
(1)
:
|
|
|
|
|
|
Average Portfolio UPB
|
43,547
|
|
|
92,303
|
|
|
105,343
|
|
Payoffs and principal curtailments
|
7,667
|
|
|
19,211
|
|
|
19,092
|
|
Sales
|
17,628
|
|
|
996
|
|
|
3,445
|
|
_____________
|
|
(1)
|
For 2017, balances exclude MSRs sold to New Residential that are accounted for as a secured borrowing arrangement. Refer to "
—
Asset Sales and Exit Programs" for additional information.
|
Segment Results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Loan servicing income, net
|
$
|
137
|
|
|
$
|
125
|
|
|
$
|
236
|
|
Net interest expense
|
(41
|
)
|
|
(42
|
)
|
|
(41
|
)
|
Other income
|
2
|
|
|
—
|
|
|
3
|
|
Net revenues
|
98
|
|
|
83
|
|
|
198
|
|
|
|
|
|
|
|
Salaries and related expenses
|
58
|
|
|
68
|
|
|
56
|
|
Foreclosure and repossession expenses
|
19
|
|
|
35
|
|
|
51
|
|
Professional and third-party service fees
|
32
|
|
|
35
|
|
|
28
|
|
Technology equipment and software expenses
|
14
|
|
|
17
|
|
|
16
|
|
Occupancy and other office expenses
|
11
|
|
|
17
|
|
|
16
|
|
Depreciation and amortization
|
2
|
|
|
3
|
|
|
2
|
|
Exit and disposal costs
|
2
|
|
|
—
|
|
|
—
|
|
Other operating expenses
|
81
|
|
|
131
|
|
|
160
|
|
Total expenses
|
219
|
|
|
306
|
|
|
329
|
|
Segment loss
|
$
|
(121
|
)
|
|
$
|
(223
|
)
|
|
$
|
(131
|
)
|
2017
Compared With
2016
:
Mortgage Servicing segment loss was
$121 million
during
2017
compared to a loss of
$223 million
during the prior year. Net revenues increased to $
98 million
, up
$15 million
or
18%
, compared to
2016
primarily driven by an increase in Loan servicing income, net resulting from the change in mix of our total loan servicing portfolio related to our MSR sales during 2017. This change in mix of our portfolio resulted in lower unfavorable fair value adjustments related to our MSRs that was partially offset by lower contractual servicing fees from our subservicing of those loans compared to the servicing fee we receive for capitalized servicing rights. Our servicing platform now consists primarily of subserviced loans, with the shift of our portfolio occurring beginning in the third quarter of
2017
. Total expenses decreased to
$219 million
, down
$87 million
or
28%
, compared to the prior year primarily driven by a lower Corporate overhead allocation, lower provisions for Legal and regulatory reserves and Repurchase and foreclosure-related charges and declines in Foreclosure and repossession expenses and Salaries and related expenses.
Net revenues.
Servicing fees from our capitalized portfolio decreased to
$116 million
, down
$150 million
or
56%
, compared to the prior year driven by a
53%
decrease in the average owned capitalized loan servicing portfolio. The decline in our owned capitalized loan servicing portfolio was primarily due to sales of substantially all of Freddie Mac and Fannie Mae owned servicing to New Residential, and sales of GNMA owned servicing to Lakeview, each of which occurred in multiple transactions during 2017.
Subservicing fees decreased to
$56 million
, down
$11 million
or
16%
, compared to the prior year primarily driven by declines in the average number of loans in our subserviced portfolio from the insourcing and MSR sale actions of certain clients during the fourth quarter of 2016 that was partially offset by new subservicing units from the sale of servicing rights to New Residential, the most significant of sales which occurred in June 2017 and July 2017. While our average total subservicing units increased during
2017
compared to the prior year, we have not realized the full benefit during
2017
from the 392,000 subservicing unit additions from the MSR sales to New Residential due to the timing of when those sales occurred.
During
2017
, the MSR yield on secured borrowing asset contributed
$29 million
to Loan servicing income, net, as a result of the sales of MSRs to New Residential, which were accounted for as a secured borrowing arrangement due to the long-term nature of the subservicing contract. This was entirely offset by
$29 million
in Net interest expense, which represents the implied interest cost recognized on the MSRs secured liability.
Late fees and other ancillary servicing revenue decreased to
$29 million
, down
$10 million
or
26%
, primarily due to declining late fees and other servicing fees from a lower overall average portfolio. Loss on sale of MSRs was
$16 million
during
2017
compared to
$3 million
in the prior year, primarily due to transaction-related expenses from the GNMA MSRs sold to Lakeview in 2017. Curtailment interest paid to investors decreased by
$10 million
due to the significant reduction of the owned capitalized portfolio from the New Residential sale, resulting in reduced payments to investors.
MSR valuation changes from actual prepayments of the underlying mortgage loans decreased by
$70 million
, or
63%
, primarily due to a 62% decrease in payoffs in our owned capitalized servicing portfolio compared to the prior year. MSR changes in value from actual receipts of recurring cash flows decreased by
$9 million
, or
35%
, primarily due to a smaller average owned capitalized portfolio size compared to the prior year.
We were not exposed to significant market exposure for the majority of our owned MSR asset during 2017 since our committed sale agreements established the pricing for a significant portion of our asset, and our valuation model included the calibration to those sales prices. In total, Market-related fair value adjustments decreased the value of our MSRs by
$12 million
during
2017
, and we did not recognize any significant gains or losses associated with MSR derivatives since we terminated substantially all of our MSR-related derivatives in the prior year.
Market-related fair value adjustments decreased the value of our MSRs by $100 million during 2016 which was partially offset by net gains on MSR derivatives of $10 million from changes in interest rates. The $100 million negative Market-related fair value adjustments during 2016 included: (i) $61 million of negative market adjustments related to changes in interest rates, a flattening of the yield curve and a calibration of our valuation model considering the pricing associated with the MSR sale agreements executed in the fourth quarter of 2016 and (ii) $39 million of negative model adjustments primarily related to $46 million of increased servicing costs and foreclosure losses that was partially offset by $5 million in favorable adjustments for updates to our prepayment model to align modeled and actual prepayments.
Net interest expense was
$41 million
during
2017
, down
$1 million
, compared to the prior year. This was primarily due to a
$22 million
decrease in Unsecured interest expense resulting from the July 2017 retirement of $496 million of Term notes, a
$4 million
increase in Interest income from cash management activities and an increase in interest rates related to our escrow accounts for our total servicing portfolio, and a
$4 million
decrease in Secured interest expense from lower utilization of our Servicing advance facility due to our MSR and servicing advance sales that occurred throughout
2017
. This was partially offset by
$29 million
of implied interest costs recognized on the MSRs secured liability within MSRs secured interest expense in 2017, which fully offsets the implied yield as previously discussed.
Other income was
$2 million
during
2017
, compared to zero in the prior year, as 2017 included fees earned from a client for assistance in complying with regulatory changes.
Total expenses.
Salaries and related expenses decreased to
$58 million
, down
$10 million
or
15%
, compared to the prior year primarily due to declines in average employee headcount and $2 million of severance costs incurred during 2016.
Foreclosure and repossession expense decreased by
$16 million
or
46%
compared to the prior year primarily driven by lower foreclosure activity and improved portfolio delinquencies that were partially the result of the Lakeview GNMA MSR sales and other recent MSR sales of delinquent government loans.
Professional and third-party service fees decreased to
$32 million
, down
$3 million
or
9%
, compared to the prior year primarily driven by expenses incurred during 2016 related to compliance enhancements.
Occupancy and other office expenses decreased by
$6 million
from the prior year primarily due to reductions in printing and mailing expenses from declines in our total loan servicing portfolio, as well as reductions in our rent and related occupancy expenses with respect to certain facilities that were vacated in 2016.
Exit and disposal costs were
$2 million
during
2017
for severance and retention expenses related to our reorganization activities.
Within Other operating expenses, Corporate overhead allocation decreased by
$17 million
compared to the prior year primarily due to reduced professional fees for information technology shared services. See “—Other” for a more detailed discussion of the expenses included in the Corporate overhead allocation.
Within Other operating expenses, we recorded a
$22 million
provision for legal and regulatory matters during
2017
, compared to a
$38 million
provision during the prior year, driven by adjustments for negotiated settlements related to our legacy mortgage servicing practices and provisions for other matters. During 2017, we finalized the settlement of a number of our legacy legal and regulatory matters as discussed in
Note 13, 'Commitments and Contingencies'
in the accompanying Notes to Consolidated Financial Statements.
Within Other operating expenses, Repurchase and foreclosure-related charges decreased to
$3 million
, down
$16 million
or
84%
, compared to the prior year primarily due to lower expenses that will not be reimbursed pursuant to mortgage insurance programs and exposure for legacy repurchase claims from certain private investors that was incurred during 2016.
2016
Compared With
2015
:
Mortgage Servicing segment loss was $223 million during 2016 compared to a loss of $131 million in 2015. Net revenues decreased to $83 million, down $115 million or 58%, compared with 2015 primarily driven by a decline in Loan servicing income and unfavorable results from our MSR market-related fair value adjustments. Total expenses decreased to $306 million, down $23 million or 7%, compared to the prior year primarily driven by lower Foreclosure and repossession expenses, lower provisions for Legal and regulatory reserves and a decrease in Other expenses. These decreases were partially offset by an increase in Repurchase and foreclosure-related charges, higher Corporate overhead allocation, an increase in Salaries and related expenses and an increase in Professional and third-party service fees.
Net revenues.
Servicing fees from our capitalized portfolio decreased by $38 million, or 13%, compared to the prior year driven by a 12% decrease in the average capitalized loan servicing portfolio. Subservicing fees decreased by $3 million, or 4%, compared to the prior year, primarily driven by declines in the average number of loans in our subserviced portfolio from the insourcing and MSR sale actions of Merrill Lynch and HSBC, respectively, during the fourth quarter of 2016. Late fees and other ancillary servicing revenue increased by $1 million, or 3%, due to deboarding fees received from these client terminations that was partially offset by a loss on the sale of delinquent FNMA servicing in 2016 and higher repurchase activity related to Ginnie Mae buyout eligible loans as compared to the prior year.
MSR valuation changes from actual prepayments of the underlying mortgage loans decreased by $17 million, or 13%, due to a 14 basis point decrease in the value of actual prepayments compared to the prior year. MSR changes in value from actual receipts of recurring cash flows decreased by $14 million, or 35%, due to a lower average capitalized servicing rate in 2016 compared to the prior year, as well as a favorable impact from the MSR value changes of Ginnie Mae buyout eligible loan transactions.
Market-related fair value adjustments decreased the value of our MSRs by $100 million during 2016 which was partially offset by net gains on MSR derivatives of $10 million from changes in interest rates. The $100 million negative Market-related fair value adjustments during 2016 included: (i) $61 million of negative market adjustments related to changes in interest rates, a flattening of the yield curve and a calibration of our valuation model considering the pricing associated with the MSR sale agreements executed in the fourth quarter of 2016 and (ii) $39 million of negative model adjustments primarily related to $46 million of increased servicing costs and foreclosure losses that was partially offset by $5 million in favorable adjustments for updates to our prepayment model to align modeled and actual prepayments.
During 2015, Market-related fair value adjustments decreased the value of our MSRs by $18 million and net gains on MSR derivatives were $29 million from changes in interest rates. The $18 million negative Market-related fair value adjustments during 2015 include a $30 million decrease primarily from model updates to reflect increased servicing costs and foreclosure losses that was partially offset by an $8 million increase from an 18 basis point increase in the modeled primary mortgage rate and $4 million in favorable adjustments associated with updates to our prepayment model to align modeled and actual prepayments.
Total expenses.
Salaries and related expenses increased to $68 million, up $12 million or 21%, compared to the prior year and included $2 million of severance costs incurred during 2016. The remaining increase was attributable to $5 million associated with an increased allocation of mortgage shared service employees to the Mortgage Servicing segment, $3 million from higher incentive compensation, and $2 million from higher contract labor to assist with short-term customer service projects.
Foreclosure and repossession expense decreased by $16 million or 31% compared to the prior year primarily driven by lower foreclosure activity and improved portfolio delinquencies that were partially the result of sales of MSRs with respect to delinquent government loans.
Professional and third-party service fees increased to $35 million, up $7 million or 25%, compared to the prior year primarily driven by expenses incurred during 2016 related to compliance activities.
Repurchase and foreclosure-related charges increased to $19 million, up $13 million which was primarily driven by increased expenses that will not be reimbursed pursuant to mortgage insurance programs and exposure for legacy repurchase claims from certain private investors.
We were subject to various regulatory investigations, examinations and inquiries related to our legacy mortgage servicing practices, and in both 2015 and 2016, we received further clarity about our expected cost of settling these matters. As a result, we recorded $38 million of provisions for Legal and regulatory reserves during 2016, as compared to $78 million in the prior year.
Other expenses decreased by $9 million compared to prior year primarily due to a $9 million provision incurred during 2015 for certain non-recoverable fees associated with foreclosure activities in which the reimbursement of fees to borrowers was completed in 2016.
Corporate overhead allocation increased by $7 million compared to the prior year primarily due to an increased allocation of expenses to the Mortgage Servicing segment in 2016. See “—Other” for a more detailed discussion of the expenses included in the Corporate overhead allocation.
Selected Income Statement Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Loan servicing income, net:
|
|
|
|
|
|
|
|
|
Loan servicing income:
|
|
|
|
|
|
Servicing fees from capitalized portfolio
|
$
|
116
|
|
|
$
|
266
|
|
|
$
|
304
|
|
Subservicing fees
|
56
|
|
|
67
|
|
|
70
|
|
MSR yield on secured asset
(1)
|
29
|
|
|
—
|
|
|
—
|
|
Late fees and other ancillary servicing revenue
|
29
|
|
|
39
|
|
|
40
|
|
Loss on sale of MSRs and related costs
|
(16
|
)
|
|
(3
|
)
|
|
(5
|
)
|
Curtailment interest paid to investors
|
(6
|
)
|
|
(16
|
)
|
|
(15
|
)
|
Total
|
$
|
208
|
|
|
$
|
353
|
|
|
$
|
394
|
|
Changes in fair value of mortgage servicing rights:
|
|
|
|
|
|
|
|
Actual prepayments of the underlying mortgage loans
|
$
|
(42
|
)
|
|
$
|
(112
|
)
|
|
$
|
(129
|
)
|
Actual receipts of recurring cash flows
|
(17
|
)
|
|
(26
|
)
|
|
(40
|
)
|
Market-related fair value adjustments
|
(12
|
)
|
|
(100
|
)
|
|
(18
|
)
|
Changes in fair value of owned MSR asset
|
$
|
(71
|
)
|
|
$
|
(238
|
)
|
|
$
|
(187
|
)
|
Change in fair value of MSRs secured asset
(2)
|
(48
|
)
|
|
—
|
|
|
—
|
|
Change in fair value of MSRs secured liability
(2)
|
48
|
|
|
—
|
|
|
—
|
|
Net derivative gain related to MSRs
|
—
|
|
|
10
|
|
|
29
|
|
Total
|
$
|
137
|
|
|
$
|
125
|
|
|
$
|
236
|
|
|
|
|
|
|
|
Other operating expenses:
|
|
|
|
|
|
|
|
Corporate overhead allocation
|
$
|
34
|
|
|
$
|
51
|
|
|
$
|
44
|
|
Legal and regulatory reserves
|
22
|
|
|
38
|
|
|
78
|
|
Repurchase and foreclosure-related charges
|
3
|
|
|
19
|
|
|
6
|
|
Other expenses
|
22
|
|
|
23
|
|
|
32
|
|
Total
|
$
|
81
|
|
|
$
|
131
|
|
|
$
|
160
|
|
____________________
|
|
(1)
|
Amount is related to the secured borrowing treatment of the
2017
sales of MSRs to New Residential. The income from the MSR yield on secured asset is fully offset by the implied interest cost recognized on the MSRs secured liability within Net interest expense.
|
|
|
(2)
|
Amounts are related to the secured borrowing treatment of the
2017
sales of MSRs to New Residential. The decrease to Change in fair value for MSRs secured asset is fully offset by an increase to Change in fair value of MSRs secured liability. For
2017
, the Changes in fair value of the secured asset and liability include offsetting amounts of
$29 million
in Actual prepayments of the underlying mortgage loans,
$12 million
in Actual receipts of recurring cash flows and
$7 million
in Market-related fair value adjustments.
|
The following are descriptions of the contents and drivers of the financial results of the Mortgage Servicing segment:
Loan servicing income
is primarily driven by the average capitalized loan servicing portfolio, the number of loans in our subservicing portfolio and the average servicing and subservicing fee. Servicing fees from the owned capitalized portfolio is driven by recurring servicing fees that are recognized upon receipt of the coupon payment from the borrower and recorded net of guarantee fees due to the investor. For loans that are subserviced, we receive a stated amount per loan which is less than our average servicing fee related to the capitalized portfolio. The MSR yield on secured asset is driven by the average yield on the capitalized MSRs associated with the secured borrowing arrangement, which is fully offset by the implied interest cost recognized on the MSRs secured liability within Net interest expense.
Curtailment interest paid to investors represents uncollected interest from the borrower that is required to be passed onto investors and is primarily driven by the number of loan payoffs. In addition to late fees received from borrowers, Late fees and other ancillary servicing revenue includes tax service fees, the net gain or loss from the sale of MSRs and other servicing revenue, including loss mitigation revenue.
Changes in fair value of mortgage servicing rights
include actual prepayments of the underlying mortgage loans, actual receipts of recurring cash flows and market-related fair value adjustments associated with our owned capitalized MSRs, as well as the capitalized MSRs and the related secured liability that have been accounted for as a secured borrowing arrangement. The fair value of our MSRs is estimated based upon projections of expected future cash flows considering prepayment estimates, our historical prepayment rates, portfolio characteristics, interest rates based on interest rate yield curves, implied volatility, servicing costs and other economic factors. In addition, our owned capitalized MSRs include consideration of pricing associated with committed MSR sale agreements.
Market-related fair value adjustments represent the change in fair value of MSRs due to changes in market inputs and assumptions used in the valuation model. Actual prepayments are driven by two factors: (i) the number of loans that prepaid during the period and (ii) the current value of the mortgage servicing right asset at the time of prepayment.
Foreclosure and repossession expenses
are associated with servicing loans in foreclosure and real estate owned and are primarily driven by the size, composition and delinquency status of our loan servicing portfolio. These expenses also include unreimbursed servicing and interest costs of government insured loans.
Other operating expenses
consist of Repurchase and foreclosure-related charges, Corporate overhead allocation, Legal and regulatory reserves and other servicing related expenses.
Repurchase and foreclosure-related charges are primarily driven by the actual and projected volumes of repurchase and indemnification requests, our success rate in appealing repurchase requests, expected loss severities and expenses that may not be reimbursed pursuant to government mortgage insurance programs or in the event we do not file insurance claims. Expected loss severities are impacted by various economic factors including delinquency rates and home price values while our success rate in appealing repurchase requests can fluctuate based on the validity and composition of repurchase demands and the underlying quality of the loan files.
Legal and regulatory reserves are estimated losses from litigation and various regulatory investigations, examinations and inquiries related to our legacy mortgage servicing practices.
We leverage a centralized corporate platform to provide shared services for general and administrative functions to our reportable segments. These shared services include support associated with, among other functions, information technology, enterprise risk management, internal audit, human resources, accounting and finance and communications. The costs associated with these shared general and administrative functions, in addition to the cost of managing the overall corporate function, are recorded within Other and allocated to our reportable segments through a corporate overhead allocation. The Corporate overhead allocation to each segment is determined based upon the actual and estimated usage by function or expense category. Any net results of Other represents amounts that are not allocated back to our reportable segments, which may include Loss on early debt retirement, certain Exit and disposal costs and Professional and third-party service fees incurred related to our strategic actions.
Results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
(In millions)
|
Net revenues
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6
|
|
Salaries and related expenses
|
55
|
|
|
61
|
|
|
54
|
|
Professional and third-party service fees
|
62
|
|
|
99
|
|
|
109
|
|
Technology equipment and software expenses
|
18
|
|
|
21
|
|
|
18
|
|
Occupancy and other office expenses
|
2
|
|
|
3
|
|
|
3
|
|
Depreciation and amortization
|
6
|
|
|
5
|
|
|
5
|
|
Exit and disposal costs
|
22
|
|
|
8
|
|
|
—
|
|
Other operating expenses:
|
|
|
|
|
|
Loss on early debt retirement
|
34
|
|
|
—
|
|
|
30
|
|
Other
|
10
|
|
|
9
|
|
|
11
|
|
Total expenses before allocation
|
209
|
|
|
206
|
|
|
230
|
|
Corporate overhead allocation:
|
|
|
|
|
|
Mortgage Production segment
|
(92
|
)
|
|
(118
|
)
|
|
(131
|
)
|
Mortgage Servicing segment
|
(34
|
)
|
|
(51
|
)
|
|
(44
|
)
|
Total expenses
|
83
|
|
|
37
|
|
|
55
|
|
Net loss before income taxes
|
$
|
(83
|
)
|
|
$
|
(37
|
)
|
|
$
|
(49
|
)
|
2017
Compared With
2016
:
Net loss before income taxes was
$83 million
, compared to a loss of
$37 million
in
2016
and primarily represents amounts that are not allocated back to our reportable segments. For
2017
, the net loss primarily represents costs associated with our early debt retirement, strategic actions and reorganization of our operations to subservicing and portfolio retention services, while for 2016, the net loss primarily represents costs associated with our strategic review and exit of the PLS business. Total allocated overhead expenses declined from $169 million to $126 million, driven primarily by our efforts to lower our cost structure through our reorganization project.
Total expenses
.
Salaries and related expenses decreased by
$6 million
or
10%
, compared to the prior year primarily from a decline in our average employee headcount as a result of our reorganization activities.
Professional and third-party service fees declined by
$37 million
in
2017
, a decrease of
37%
compared to the prior year. This decrease was primarily due to a $29 million decrease in information technology expenses that were associated with the modernization and security of our information technology systems and implementing new compliance requirements in our origination business in 2016. During 2017, there were also lower expenses associated with our strategic actions.
Exit and disposal costs were
$22 million
in
2017
, compared to
$8 million
in the prior year. The increased costs include
$18 million
of severance and retention expenses for impacted Other shared services employees primarily related to the reorganization which was announced in February 2017, and
$4 million
in contract termination costs for system decommissioning projects used in the PLS channel.
Loss on early debt retirement was $34 million in
2017
as a result of the July 2017 extinguishment of $496 million of Term notes due in 2019 and 2021.
2016 Compared With 2015:
Net loss before income taxes was $37 million, compared to a loss of $49 million in 2015 and primarily represents expenses that are not allocated back to our reportable segments. For 2016, the net loss primarily represents costs associated with our strategic review and Exit and disposal costs related to our exit of the PLS business, while for 2015, the net loss primarily represents losses related to the early retirement of unsecured debt and costs associated with re-engineering our business. Net revenues for 2015 were $6 million and related to the sale of the Fleet business through income from a transition services agreement. Total expenses before allocation decreased to $206 million, down $24 million, or 10%, primarily resulting from the absence of a loss on early debt retirement in 2016. The decrease in expenses was also driven from lower Professional and third-party service fees, that was partially offset with higher Salaries and related expenses.
Total expenses
.
Salaries and related expenses increased by $7 million in 2016, or 13%, compared to the prior year primarily from increased incentive compensation of $5 million. The remaining $2 million of expenses related to an increase in the use of contract labor for information technology resources and modest employee salary increases during 2016.
Professional and third-party service fees declined by $10 million in 2016, a decrease of 9% compared to the prior year. This decrease was primarily from the higher costs in 2015 associated with the modernization and security of our information technology systems including costs to separate our information technology systems from the Fleet business, implementing new compliance requirements in our origination business, providing services under the transition services agreement and other investments from our re-engineering efforts. This was partially offset by $32 million of expenses associated with our strategic review in 2016.
Exit and disposal costs were $8 million in 2016, as a result of our exit of the PLS channel within our Mortgage Production segment. These costs included $4 million of severance and retention expenses for impacted Other shared services employees, $3 million in contract termination costs for information technology support used in the PLS channel, and $1 million in impairment of technology-related assets.
Other operating expenses decreased by $32 million, or 78%, compared to the prior year primarily due to the 2015 Loss on early debt retirement for the exchange of the Convertible notes due in 2017.
The following are descriptions of the contents and drivers of our financial results:
Net revenues
for 2015 includes income associated with a transition services agreement in which we provided to Element Financial Corporation certain transition services after the closing of the 2014 sale of the Fleet business related to, among others, information technology, human resources and financial services. A majority of the costs incurred by us to provide such transition services are included in Professional and third-party service fees. The transition services agreement were complete in 2015.
Salaries and related expenses
represent costs associated with operating corporate functions and our centralized management platform and consist of salaries, payroll taxes, benefits and incentives paid to shared service support employees. These expenses are primarily driven by the average number of permanent employees.
Professional and third-party service fees
represent costs associated with outsourcing specific functions of our shared services to deliver additional support. These expenses are primarily driven by information technology related expenses.
Exit and disposal costs
consist of costs related to our announced exit of the PLS channel and reorganization of the business. These costs include employee severance and retention costs of impacted shared service support employees, contract termination costs of information technology support, facility exit costs and asset impairment and other non-cash related charges.
Other operating expenses
includes losses associated with the early retirement or conversion of debt, and other costs associated with our corporate shared services platform.
Net loss before income taxes
includes expenses that are not allocated to our reportable segments that include losses related to the early retirement of debt, costs associated with our strategic actions and re-engineering our business, and Exit and disposal costs.
We are exposed to various business risks which may significantly impact our financial results including, but not limited to: (i) strategic risk (ii) interest rate risk; (iii) consumer credit risk; (iv) counterparty and concentration risk; (v) liquidity risk; and (vi) operational risk. Our risk management framework and governance structure is intended to provide oversight and ongoing management of the risks inherent in our business activities and create a culture of risk awareness. Our Chief Executive Officer and Chief Risk and Compliance Officer are responsible for the design, implementation and maintenance of our enterprise risk management program. The Audit Committee of the Board of Directors provides oversight with respect to our risk management function and the policies, procedures and practices used in identifying and managing our material risks.
Our Compliance and Risk Management organization oversees governance processes and monitoring of these risks including the establishment of risk strategy and documentation of risk policies and controls. The Compliance and Risk Management organization operates independently of the business, but works in partnership to provide oversight of enterprise risk management and controls. This includes establishing enterprise-level risk management policies, appropriate governance activities and creating risk transparency through risk reporting.
Risks unique to our business are governed through various committees including, but not limited to: (i) interest rate risk, including development of hedge strategy and policies, monitoring hedge positions and counterparty risk; (ii) quality control, including audits related to the processing, underwriting and closing of loans, findings of any fraud-related reviews and reviews of post-closing functions, such as FHA insurance and monitoring of overall portfolio delinquency trends and recourse activity; (iii) credit risk, including establishing credit policy, product development and changes to underwriting guidelines; and (iv) operational risk, including the development of policies and governance activities, monitoring risks related to cyber security and business continuity plans and ensuring compliance with applicable laws and regulations.
We are exposed to risk with respect to our strategic actions, including completing the proposed Merger with Ocwen Financial Corporation, and the transition of our operations to a business model focused solely on subservicing and portfolio retention services. Strategic risk represents the risk to shareholder or enterprise value, current or future earnings, capital and liquidity from adverse business decisions and/or improper implementation of business strategies. Management is responsible for developing and implementing business strategies that leverage our core competencies and are appropriately structured, resourced and executed. Oversight for our strategic actions is provided by the Board of Directors. Our performance, relative to our annual business plan and our longer term strategic plan, is reviewed by management and the Board of Directors.
To achieve our financial objectives for our new business model, we need to realize our cost re-engineering reductions, subservicing growth, and portfolio retention recapture rate assumptions. Our ability to complete the transition to our new business model is highly dependent on the success of our business relationships with our significant clients and our ability to attract new clients, both of which are impacted by our capability to adequately address the competitive challenges we may face. The achievement of our goals is subject to both the risks affecting our business generally (including market, reputation, credit, operational, and legal and compliance risks) and the inherent difficulty associated with implementing these business objectives. Furthermore, our success is dependent on the skills, experience and efforts of our management team and our ability to negotiate with third parties.
For a discussion of risks related to the proposed Merger, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—"
We may fail to consummate the proposed Merger, and uncertainties related to the consummation of the Merger may have a material adverse effect on our business, financial position, results of operations and cash flows, and negatively impact the price of our Common stock.
" in this Form 10-K.
For a discussion of risks related to our business, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—
Our operations have not been profitable in recent years, and we have changed the focus of our business to subservicing and portfolio retention activities to improve our financial results. The industry in which we operate in is highly competitive, and our success depends on our ability to attract and retain clients to achieve scale and meet competitive challenges, which may be negatively impacted by client perceptions of a lack of history operating as a focused player in this market, as well as from our actions, including any past or future efforts towards executing our strategic actions. We may not be able to fully or successfully execute or implement our business strategies or achieve our objectives, and our actions taken may not have the intended result.
" in this Form 10-K.
Our principal market exposure is to interest rate risk, specifically long-term Treasury and mortgage interest rates due to their impact on mortgage-related assets and commitments. We are also exposed to changes in short-term interest rates on certain variable rate borrowings related to mortgage warehouse debt. We anticipate that such interest rates will remain our primary benchmark for market risk for the foreseeable future.
We are subject to variability in our results of operations due to fluctuations in interest rates. In a declining interest rate environment, we would expect the results of our origination business within the Mortgage Production segment to be positively impacted by higher loan origination volumes and improved loan margins. However, in a rising interest rate environment, we would expect a negative impact to the results of our origination business. With respect to a declining interest rate environment, we expect the results of our servicing business to decline due to higher actual and projected loan prepayments related to our capitalized loan servicing portfolio; while in a rising interest rate environment, we expect a positive effect.
Refer to “—Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for an analysis of the impact of changes in interest rates on the valuation of assets and liabilities that are sensitive to interest rates.
Mortgage Loans and Interest Rate Lock Commitments
Interest rate lock commitments represent an agreement to extend credit to a mortgage loan applicant, or an agreement to purchase a loan from a third-party originator, whereby the interest rate on the loan is set prior to funding. The fair values of our Mortgage loans held for sale, which are held in inventory awaiting sale into the secondary market, and our Interest rate lock commitments, are subject to changes in mortgage interest rates from the date of the commitment through the sale of the loan into the secondary market. As a result, we are exposed to interest rate risk and related price risk during the period from the date of the lock commitment through (i) the lock commitment cancellation or expiration date; or (ii) the date of sale into the secondary mortgage market. Loan commitments generally range between 30 and 90 days, and we typically sell mortgage loans within 30 days of origination.
A combination of options and forward delivery commitments on mortgage-backed securities or whole loans are used to hedge our commitments to fund mortgages and our loans held for sale. These forward delivery commitments fix the forward sales price that will be realized in the secondary market and thereby reduce the interest rate and price risk to us. Our expectation of the amount of our interest rate lock commitments that will ultimately close is a key factor in determining the notional amount of derivatives used in hedging the position.
For more information, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Business
—
Our hedging strategies may not be successful in mitigating our exposure to interest rate risk.
" in this Form 10-K.
Mortgage Servicing Rights
Mortgage servicing rights (“MSRs”) are inherently subject to substantial interest rate risk as the mortgage notes underlying the MSRs permit the borrowers to prepay the loans. Therefore, the value of MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and increase in periods of rising interest rates (as prepayments decrease). During 2017, we completed the sale of a significant portion of our MSRs, which shifted the composition of our servicing portfolio to primarily subserviced loans. We do not anticipate retaining a significant amount of capitalized MSRs in the future. As of December 31, 2017,
$34 million
of our owned capitalized MSRs are committed for sale to New Residential. These committed MSRs are not subject to significant interest rate risk since our determination of fair value considers the pricing associated with the sale agreement; however, these MSRs are subject to credit risk of New Residential.
We are not subject to the majority of the credit-related risks inherent in maintaining a mortgage loan portfolio because loans are not held for investment purposes. We sell nearly all of the mortgage loans that we originate in the secondary mortgage market on a non-recourse basis within 30 days of origination. Conforming loan sales are primarily in the form of mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (collectively, the "Agencies").
Our exposure to consumer credit risk primarily relates to loan repurchase and indemnification obligations from breaches of representation and warranty provisions of our loan sale or servicing agreements, which result in indemnification payments or exposure to loan defaults and foreclosures. The representation and warranties made by us are set forth in our loan sale agreements
and relate to, among other things, the ownership of the loan, the validity of the lien securing the loan, the underwriting standards required by the investor, the loan’s compliance with applicable local, state and federal laws and, for loans with a loan-to-value ratios greater than 80%, the existence of primary mortgage insurance. Investors routinely request loan files to review for potential breaches of representation and warranties. In the event a breach of these representation and warranties is identified by an investor, the investor will issue a repurchase demand, and we may be required to repurchase the mortgage loan or indemnify the investor against loss. We subject the population of repurchase and indemnification requests to a comprehensive review and appeals process to establish the validity of the claim and determine our corresponding obligation.
We have established a loan repurchase and indemnification liability for our estimate of exposure to losses related to our obligation to repurchase or indemnify investors for loans sold. This liability represents management’s estimate of probable losses based on the best information available and requires the application of a significant level of judgment and the use of a number of assumptions. As loans are repurchased, we reduce our estimated losses related to repurchase and indemnification obligations and record reserves for on-balance sheet loans in foreclosure and real estate owned which will likely not be recoverable from guarantors, insurers or investors.
The table below presents our repurchase and foreclosure-related reserves activity and the number of repurchase and indemnification requests received:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2017
|
|
2016
|
|
2015
|
|
($ In millions)
|
Balance, beginning of period
|
$
|
73
|
|
|
$
|
89
|
|
|
$
|
93
|
|
Realized losses
|
(34
|
)
|
|
(42
|
)
|
|
(19
|
)
|
Transfer of reserves
(1)
|
(5
|
)
|
|
—
|
|
|
—
|
|
Increase in reserves due to:
|
|
|
|
|
|
|
Change in assumptions
|
3
|
|
|
19
|
|
|
6
|
|
New loan sales
|
3
|
|
|
7
|
|
|
9
|
|
Balance, end of period
|
$
|
40
|
|
|
$
|
73
|
|
|
$
|
89
|
|
|
|
|
|
|
|
Repurchase and indemnification requests received (number of loans)
|
271
|
|
|
384
|
|
|
460
|
|
______________
|
|
(1)
|
Represents reserves associated with certain Mortgage loans in foreclosure that were transferred to Mortgage loans held for sale and subsequently sold during the
year ended December 31, 2017
in connection with our marketing those assets for sale.
|
In December 2016, we entered into resolution agreements with Fannie Mae and Freddie Mac to resolve substantially all representation and warranty exposure related to the sale of mortgage loans that were originated and delivered prior to September 30, 2016 and November 30, 2016, respectively. As of
December 31, 2017
, our Loan repurchase and indemnification liability primarily consisted of (i) losses for private loans and newly originated mortgage loans, where a repurchase or indemnification obligation could exist from breaches of representation and warranties, (ii) losses for specific non-performing loans where we believe we will be required to indemnify the investor and (iii) losses for government loans that may not be reimbursed pursuant to mortgage insurance programs. Our liability from loan repurchases and indemnification requests does not reflect losses from litigation or governmental examinations, investigations or inquiries. As of
December 31, 2017
, the estimated amount of reasonably possible losses in excess of the recorded liability was not significant.
See
Note 13, 'Commitments and Contingencies'
, in the accompanying Notes to Consolidated Financial Statements and “—Critical Accounting Policies and Estimates” for additional information regarding our repurchase and foreclosure-related reserves.
|
|
Counterparty and Concentration Risk
|
We are exposed to risk in the event of non-performance by counterparties to various agreements, derivative contracts, and sales transactions. In general, we manage such risk by evaluating the financial position and creditworthiness of counterparties, monitoring the amount for which we are at risk, requiring collateral, typically cash, in instances in which financing is provided and/or dispersing the risk among multiple counterparties. We also manage our exposure to risk from derivative counterparties through entering into bilateral collateral agreements and legally enforceable master netting agreements with many counterparties. As of
December 31, 2017
, there were no significant concentrations of credit risk related to our net exposure with any individual counterparty with respect to our derivative transactions.
During 2017, we entered into assignments with LenderLive and GRA related to certain facility leases that were transferred in connection with transactions associated with our PLS business and Real Estate channel exits. Under the terms of the original facility leases, we remain jointly and severally obligated with LenderLive and GRA for performance under the lease agreements. As of
December 31, 2017
, the total amount of potential future lease payments under these guarantees was approximately
$15 million
; however, we do not believe any amount of losses under these guarantees is probable.
See “Part I—Item 1A. Risk Factors—
Risks Related to Our Strategies
—
Our remaining business will be focused on subservicing and portfolio retention activities, and we have significant client concentration risk related to the percentage of subservicing and portfolio retention activities from agreements with New Residential Mortgage, LLC and Pingora Loan Servicing, LLC. Further, the terms of a significant portion of our subservicing agreements allow the owners of the servicing to terminate the subservicing agreement without cause which would also terminate any related portfolio defense agreements.
”
in this Form 10-K.
Production
After the completion of our exit activities, our future mortgage loan originations will be sourced solely through portfolio retention services, which we provide to two key clients associated with our significant subservicing client relationships that represented a combined
77%
concentration of our total subservicing portfolio as of December 31, 2017. Our portfolio defense agreements cease upon the termination of the related client subservicing relationship, or as units transfer out of our subservicing portfolio to a new servicer. In addition, for the majority of the solicitable portfolio, we are authorized to seek refinance of mortgage loans on a non-exclusive basis, which may further limit our future mortgage loan originations since we must compete with other originators. During the year ended December 31, 2017, total originations from portfolio retention represented
6%
of our total origination volume.
In November 2016, we announced our intentions to exit the PLS business, and during February 2017, we announced that we entered into agreements to sell certain assets of PHH Home Loans and its subsidiaries, including its mortgage origination and processing centers. During the year ended December 31, 2017, the PLS business and Real Estate channel represented
66%
and
28%
of our mortgage loan originations, respectively.
Servicing
Our Mortgage Servicing segment has exposure to concentration risk and client retention risk with respect to our subservicing agreements. As of
December 31, 2017
, our subservicing portfolio (by units) included significant client relationships with New Residential and Pingora Loan Servicing, LLC, which represented
58%
and
19%
of our subservicing portfolio, respectively. The terms of a substantial portion of our subservicing agreements allow the owners of the servicing to terminate the subservicing agreement without cause with respect to some or all of the subserviced loans and, in some cases, without payment of any termination fee. The term of our subservicing agreement with New Residential extends through June 2020; however, New Residential has the right to transfer, without cause, 25% of the subservicing units beginning in June 2018, and an additional 25% of the subservicing units beginning in June 2019. The termination of subservicing agreements, or other significant reductions to our subservicing units, could adversely affect our business, financial condition and results of operations. We expect the transfer of approximately
115,000
subservicing units off of our platform between May 2018 and April 2019, based upon receipt in February 2018 of formal notices and verbal indications from two of our largest subservicing clients. Approximately 65,000 of these units are subject to a portfolio defense agreement and will no longer be solicitable units upon transfer to a new servicer. There can be no assurances that our subservicing agreements or relationships will not be subject to further change.
Market conditions, including interest rates and future economic projections, could impact investor demand to hold MSRs, which may result in our loss of additional subservicing relationships, or significantly decrease the number of loans under such relationships.
Our Mortgage Servicing segment also has exposure to concentration risk associated with the amount of our servicing portfolio for which we must maintain compliance with the requirements of the GSE servicing guides. As of
December 31, 2017
,
57%
of our servicing portfolio requires compliance with these servicing guides.
We utilize several risk mitigation strategies in an effort to minimize losses from delinquencies, foreclosures and real estate owned including: collections, loan modifications, and foreclosure and property disposition. Since the majority of the risk resides with the investor and not with us, these techniques may vary based on individual investor and insurer requirements.
The greatest concentrations of properties securing the mortgage loans in our total servicing portfolio are located in the following states:
|
|
|
|
|
|
|
|
December 31,
|
|
2017
|
|
2016
|
Major Geographical Concentrations:
|
|
|
|
|
|
California
|
22.6
|
%
|
|
20.2
|
%
|
New York
|
11.8
|
%
|
|
11.4
|
%
|
Florida
|
6.5
|
%
|
|
6.3
|
%
|
New Jersey
|
5.8
|
%
|
|
5.7
|
%
|
Other
|
53.3
|
%
|
|
56.4
|
%
|
The following table summarizes the percentage of loans that are greater than 90 days delinquent, in foreclosure and real estate owned based on the unpaid principal balance for significant geographical concentrations:
|
|
|
|
|
December 31, 2017
|
New York
|
26.0
|
%
|
New Jersey
|
12.5
|
%
|
Florida
|
10.2
|
%
|
California
|
6.1
|
%
|
We are exposed to liquidity risk through our ongoing needs to originate and finance mortgage loans, sell mortgage loans into secondary markets, retain mortgage servicing rights, repay maturing debt, meet our contractual obligations and otherwise fund our operations. Liquidity is an essential component of our ability to operate and grow our business; therefore, it is crucial that we maintain adequate levels of excess liquidity to fund our businesses during normal economic cycles and events of market stress. We rely on internal cash flow generation and external financing sources to fund a portion of our operations. To achieve our liquidity objectives, we consider current cash position, business conditions, expected cash flow generation, upcoming debt maturities, potential risks, potential refinancing strategies and capital market conditions that dictate the availability of liquidity.
As we execute on our strategic actions, we are currently expecting significant changes to our business profile, liquidity and capital structure and funding requirements, including expected changes in our mortgage origination volumes driven by the sales or exit of certain businesses. As such, our ability to renew our mortgage warehouse facilities may be more limited than our historical experience. For further discussion of our risks related to our warehouse agreements, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Business
—
Our mortgage asset-backed debt arrangements, a significant portion of which are short-term agreements, are an important source of our liquidity. If any of our funding arrangements are terminated, not renewed or otherwise become unavailable to us, we may be unable to find replacement financing on economically viable terms, if at all. If a substantial portion of such arrangements are terminated, not renewed, and cannot be replaced, it would adversely affect our ability to fund our operations.
”
in this Form 10-K.
We periodically evaluate our liquidity sources and uses. Senior management regularly reviews our current liquidity position and projected liquidity needs including any potential and/or pending events that could impact liquidity positively or negatively. Additionally, management has established internal processes to monitor the availability under our existing debt arrangements. We address liquidity risk by maintaining committed borrowing capacity under mortgage funding facilities and cash on hand in excess of our expected operating needs. The Audit Committee reviews the liquidity and financing plan to assess whether management has appropriately planned and provided for liquidity risks and subsequently recommends the plan for approval by the Board of Directors on an annual basis.
Operational risk is inherent in our business practices and related support functions. Operational risk is the risk of loss resulting from inadequate or failed internal processes or systems, human factors or external events. Operational risk may occur in any of our business activities and can manifest itself in various ways including, but not limited to, errors resulting from business process failures, material disruption in business activities, system breaches and misuse of sensitive information and failures of outsourced
business processes. These events could result in non-compliance with laws or regulations, regulatory fines and penalties, litigation or other financial losses, including potential losses resulting from lost client relationships.
Our business is subject to extensive regulation by federal, state and local government authorities, which require us to operate in accordance with various laws, regulations, and judicial and administrative decisions. While we are not a bank, our business subjects us to both direct and indirect banking supervision (including examinations by our clients' regulators), and each client may require a unique compliance model. In recent years, there have been a number of developments in laws and regulations that have required, and will likely continue to require, widespread changes to our business. The frequent introduction of new rules, changes to the interpretation or application of existing rules, increased focus of regulators, and near-zero defect performance expectations have increased our operational risk related to compliance with laws and regulations.
To monitor and control this risk, we have established policies, procedures and a controls framework that are designed to provide sound and consistent risk management processes and transparent operational risk reporting. The Compliance and Risk Management organization receives reports and information regarding risk issues directly from our business process owners. We have established risk management tools that include:
|
|
•
|
Risk and control self-assessments to evaluate key control design and operating effectiveness, and determine if control enhancements are necessary;
|
|
|
•
|
Operational event reporting and tracking which provides information about operational breakdowns and the root cause, as well as the status of efforts to remediate;
|
|
|
•
|
Third party risk oversight which provides a framework to assess and monitor the level of risk and complexity of third party relationships; and
|
|
|
•
|
An independent assessment by Internal Audit of the design and effectiveness of our key controls, regulatory compliance and reporting.
|
Our operational risk includes managing risks relating to information systems and information security. As a service provider, we actively utilize technology and information systems to operate our business and support business development. We also must safeguard the confidential personal information of our customers, as well as the confidential personal information of the employees and customers of our clients. We consider industry best practices to manage our technology risk, and we continually develop and enhance the controls, processes and systems to protect our information systems and data from unauthorized access.
See “Part I—Item 1A. Risk Factors—
Other Risks
—
A failure in or breach of our technology infrastructure or information protection programs, or those of our outsource providers, could result in the inadvertent disclosure of the confidential personal information of our customers, as well as the confidential personal information of the customers of our clients. Any such failure or breach, including as a result of cyber-attacks against us or our outsource partners, could have a material and adverse effect on our business, reputation, financial position, results of operations or cash flows.
" for more information.
|
|
LIQUIDITY AND CAPITAL RESOURCES
|
Our sources of liquidity include: unrestricted Cash and cash equivalents; proceeds from the sale or securitization of mortgage loans; secured borrowings, including mortgage warehouse and servicing advance facilities; cash flows from operations; the unsecured debt markets; asset sales; and equity markets. Our primary operating funding needs arise from the origination and financing of mortgage loans and the retention of mortgage servicing rights. Our liquidity needs can also be significantly influenced by changes in interest rates due to collateral posting requirements from derivative agreements as well as the levels of repurchase and indemnification requests. Given our expectation for business volumes, we believe that our sources of liquidity are adequate to fund our operations for at least the next 12 months. We expect aggregate capital expenditures to not be significant for 2018, in comparison to
$1 million
for 2017.
We manage our liquidity and capital structure to achieve our strategic objectives, to fund business operations and to meet contractual obligations, including maturities of our indebtedness. In developing our liquidity plan, we consider how our needs may be impacted by various factors, including operating requirements during the period, risks and contingencies, upcoming debt maturities and working capital needs. We also assess market conditions and capacity for debt issuance in various markets that may provide funding alternatives for our business needs.
Throughout 2017, we were focused on completing asset sales, exiting certain business platforms, reducing our unsecured debt and completing returns of capital to our shareholders in order to transition to a capital-light business model. We have been continually assessing our available excess cash based on the total proceeds realized from our MSR sales, the value realized from our PHH Home Loans joint venture, the progress towards executing our PLS exit, transaction, restructuring and PLS exit costs, and the working capital and contingency needs for the remaining business. Based on such assessments, throughout 2017, we have made significant distributions to our shareholders and repaid unsecured debt to evolve our capital structure towards our targeted levels for our future business.
We started the year with
$906 million
of cash as of
December 31, 2016
, which included
$67 million
of cash in variable interest entities. During 2017, our significant cash activities included:
|
|
•
|
$810 million
of cash inflows realized from our asset sales, which includes
$727 million
from our sales of MSRs plus sale or collection of advances,
$35 million
of net inflows from our PHH Home Loans asset sales and
$48 million
from monetizing residual assets, including, among others, the sales of certain loans in foreclosure, second liens and real estate owned.
|
|
|
•
|
$303 million
of cash outflows incurred related to our business exits, transactions and legacy legal matters, including
$133 million
related to our PLS operating losses, re-engineering and exit programs,
$53 million
of costs associated with MSR transactions and our strategic actions, and
$117 million
in payments for legal and regulatory settlements;
|
|
|
•
|
$301 million
returned to our shareholders through share repurchases (see detail below); and
|
|
|
•
|
$524 million
paid to complete a debt tender offer for
$496 million
principal of our term notes. After the tender, note principal of
$119 million
remains outstanding.
|
Through those actions, and the net changes in funding our operations, our total unrestricted cash position as of
December 31, 2017
was
$542 million
, which includes
$33 million
of cash in variable interest entities.
We have started to monetize our residual assets; however, the time frame for executing the remaining MSR sale transactions has been extended due to the complexity of the consent process for private MSRs, the number of parties involved, and the depth of investor and trustee due diligence, as discussed further in "—Executive Summary".
We have identified further estimated potential uses of our cash over the next 12 months which, include $102 million related to PLS operating losses, re-engineering and exit programs, and $5 million for payment of MSR transaction costs and advisory, legal and professional fees associated with our strategic actions. We intend to maintain excess cash to cover contingencies, which include
$20 million
related to our legal and regulatory reserves, and $20 million related to other contingencies for mortgage loan repurchases, MSR sale agreement indemnifications, and other contingencies. In addition, our excess cash requirements include payment of our unsecured debt obligations which may limit our ability to use our cash to fund our operations and future business opportunities. If we are able to complete our sales of private MSRs and related advances, we would utilize a portion of the proceeds to repay borrowings under our servicing advance facility.
In November 2017, our Board of Directors provided an authorization for up to $100 million of share repurchases. We have no obligation to repurchase shares under this authorization, and any share repurchase program may be extended, modified, suspended or discontinued at any time. Pursuant to the Agreement and Plan of Merger dated as of February 27, 2018 among Ocwen, POMS Corp and PHH, any share repurchases require the prior consent of Ocwen.
For more information, see “Part II—Item 1A. Risk Factors—Risks Related to our Common Stock—
Our decision to return cash to shareholders through stock repurchases has reduced our market capitalization and may not prove to be the best use of our capital.
" and “Part I—Item 1A. Risk Factors—Risks Related to Our Strategies—
The amount of additional capital returned to shareholders, if any, as a result of our strategic actions may be less than our expectations. Furthermore, there can be no assurances about the method, timing or amounts of any such distributions.
" in this Form 10-K.
Completed Share Repurchases:
Between May 2017 and July 2017, our Board of Directors authorized share repurchases up to an aggregate $300 million. From May through early August 2017, we completed the repurchase of 2,450,466 shares for $34 million under an open market program. In August 2017, we announced the commencement of a modified “Dutch auction” tender offer to purchase shares of our common stock for an aggregate amount of up to $266 million in cash, with the right to increase the offer for an additional 2% of its outstanding shares. In September 2017, we completed the tender offer and repurchased 18,762,962 shares for $267 million.
Unencumbered Assets:
As of
December 31, 2017
, a significant portion of our assets are under financing arrangements or are subject to sale commitments. The following table identifies the Total assets on our Consolidated Balance Sheet that are unencumbered:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
Collateral for Asset-backed Borrowing Arrangements
|
|
Sale
Commitments
|
|
Other
|
|
Unencumbered Assets
|
|
(In millions)
|
Cash and cash equivalents
|
$
|
542
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
542
|
|
Restricted cash
|
41
|
|
|
13
|
|
|
—
|
|
|
28
|
|
|
—
|
|
Mortgage loans held for sale
|
270
|
|
|
233
|
|
|
—
|
|
|
—
|
|
|
37
|
|
Accounts receivable, net
|
78
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
78
|
|
Servicing advances, net
|
356
|
|
|
56
|
|
|
54
|
|
|
232
|
|
|
14
|
|
Mortgage servicing rights
|
476
|
|
|
—
|
|
|
39
|
|
|
419
|
|
|
18
|
|
Property and equipment, net
|
22
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
22
|
|
Other assets
|
26
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
25
|
|
Total assets
|
$
|
1,811
|
|
|
$
|
302
|
|
|
$
|
93
|
|
|
$
|
680
|
|
|
$
|
736
|
|
Total Servicing advances committed to be transferred under our MSR sale agreements of
$110 million
as of
December 31, 2017
includes both advances that are presently collateral for asset-backed borrowing arrangements and amounts that are self-funded. Therefore, the Servicing advances committed under MSR sale agreements appears in both columns of the table above.
Other restrictions and encumbrances include the following:
|
|
•
|
Restricted cash represents letters of credit, funds received for pending mortgage closings, and other contractual arrangements.
|
|
|
•
|
Servicing advances represent the balance of Servicing advance liabilities for advances funded by our subservicing clients, as discussed below under "—Debt—Servicing Advance Funding Arrangements".
|
|
|
•
|
MSRs represent amounts under secured borrowing arrangements where we have recognized a liability for MSRs transferred to a third party that does not meet the criteria for sale accounting. See further discussion in
Note 1, 'Summary of Significant Accounting Policies' in the accompanying Notes to Consolidated Financial Statements
.
|
The following table summarizes the changes in Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
December 31,
|
|
|
|
2017
|
|
2016
|
|
Change
|
|
(In millions)
|
Cash provided by (used in):
|
|
|
|
|
|
|
|
|
Operating activities
|
$
|
303
|
|
|
$
|
74
|
|
|
$
|
229
|
|
Investing activities
|
197
|
|
|
50
|
|
|
147
|
|
Financing activities
|
(864
|
)
|
|
(124
|
)
|
|
(740
|
)
|
Net decrease in Cash and cash equivalents
|
$
|
(364
|
)
|
|
$
|
—
|
|
|
$
|
(364
|
)
|
Operating Activities
Our cash flows from operating activities reflect the net cash generated or used in our business operations and can be significantly impacted by the timing of mortgage loan originations and sales. The operating results of our businesses are impacted by significant non-cash activities which include: (i) the capitalization of mortgage servicing rights in our Mortgage Production segment and (ii) the change in fair value of mortgage servicing rights in our Mortgage Servicing segment.
During the year ended
December 31, 2017
, cash provided by our operating activities was
$303 million
, primarily driven by a
$413 million
decrease in Mortgage loans held for sale between December 31,
2017
and
2016
, which was primarily the result of our declining
loan origination pipeline at the end of 2017 driven by our exits of the PLS business and Real Estate channel,
and also impacted by net collections of Servicing advances of $272 million driven by advances collected through our MSR sales and improved management of those receivable cash flows. This was partially offset by operating losses primarily in our PLS business of
$93 million
, cash used for our strategic actions, payments for exit and disposal costs and payments associated with settlements of legal and regulatory matters.
During the year ended
December 31, 2016
, cash provided by our operating activities was
$74 million
, primarily driven by a $60 million decrease in Mortgage loans held for sale between December 31, 2016 and 2015, which was the result of timing differences between origination and sale as of the end of each period. The increase in cash was also driven by operating benefits from amendments to our private label and subservicing agreements. This was partially offset by cash used for re-engineering efforts, our strategic actions and legal settlements.
Investing Activities
Our cash flows from investing activities include cash flows related to collateral postings or settlements of our MSR derivatives which were settled in the first half of 2017, proceeds on the sale of mortgage servicing rights, purchases of property and equipment and changes in the funding requirements of restricted cash.
During the year ended
December 31, 2017
, cash provided by our investing activities was
$197 million
, which was primarily driven by
$158 million
of net cash received from MSR and related servicing advances and
$70 million
of cash received from the PHH Home Loans asset sales, that was partially offset by
$45 million
of net cash paid to settle MSR-related derivatives which were terminated in December 2016 in connection with the MSR sale agreements.
During the year ended
December 31, 2016
, cash provided by our investing activities was
$50 million
. The balance was mainly driven by
$60 million
of net cash received from MSR derivatives for settlements and driven by relative changes in interest rates. During 2016, we announced the sale of substantially all of our MSR portfolio, which resulted in the settlement of the majority of our MSR derivatives. In addition, there was
$12 million
of cash received from the proceeds on the sale of MSRs under our MSR flow sale arrangements. These balances were partially offset with
$17 million
in purchases of property and equipment and an increase in our restricted cash balance.
Financing Activities
Our cash flows from financing activities include proceeds from and payments on borrowings under our mortgage warehouse facilities, our servicing advance facility and MSRs secured borrowing arrangement. The fluctuations in the amount of borrowings within each period are due to working capital needs and the funding requirements for assets, including Mortgage loans held for sale and Mortgage servicing rights. The outstanding balances under our warehouse and servicing advance debt facilities vary daily based on our current funding needs for eligible collateral and our decisions regarding the use of excess available cash to fund assets. As of the end of each quarter, our financing activities and Consolidated Balance Sheets reflect our efforts to maximize secured borrowings against the available asset base, increasing the ending cash balance. Within each quarter, excess available cash is utilized to fund assets rather than using the asset-backed borrowing arrangements, given the relative borrowing costs and returns on invested cash.
During the year ended
December 31, 2017
, cash used in our financing activities was
$864 million
which primarily related to
$524 million
of cash paid to complete the tender offer of our Term Notes due in 2019 and 2021 including the early tender premium,
$301 million
used to retire shares in our open market share repurchase program,
$402 million
of net payments on our secured borrowings primarily resulting from the decreased funding requirements for Mortgage loans held for sale and Servicing advances that were partially offset by
$426 million
of proceeds from the sales of our MSRs to New Residential that were treated as a secured borrowing arrangement. We also distributed $60 million of cash to the noncontrolling interest holder of PHH Home Loans, which reflects their pro-rata share of the proceeds from the asset sales to GRA, and other distributions pursuant to the Operating Agreement.
During the year ended
December 31, 2016
, cash used in our financing activities was
$124 million
which primarily related to $88 million of net payments on our secured borrowings resulting from decreased funding requirements for Mortgage loans held for sale and Servicing advances. Additionally, $23 million was used to retire shares in our open market share repurchase program.
The following table summarizes our Debt as of
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
Balance
|
|
Collateral
(1)
|
|
(In millions)
|
Warehouse facilities
|
$
|
220
|
|
|
$
|
236
|
|
Servicing advance facility
|
32
|
|
|
66
|
|
Unsecured debt, net
|
118
|
|
|
—
|
|
Total
|
$
|
370
|
|
|
$
|
302
|
|
______________
|
|
(1)
|
Assets held as collateral are not available to pay our general obligations.
|
See
Note 10, 'Debt and Borrowing Arrangements'
in the accompanying Notes to Consolidated Financial Statements for additional information regarding the components of our debt and for additional discussion of risks related to our asset-backed debt, see “Part I—Item 1A. Risk Factors—
Risks Related to Our Business
—
Our mortgage asset-backed debt arrangements, a significant portion of which are short-term agreements, are an important source of our liquidity. If any of our funding arrangements are terminated, not renewed or otherwise become unavailable to us, we may be unable to find replacement financing on economically viable terms, if at all. If a substantial portion of such arrangements are terminated, not renewed, and cannot be replaced, it would adversely affect our ability to fund our operations.
”
Warehouse facilities
Warehouse facilities primarily represent variable-rate mortgage repurchase facilities to support the origination of mortgage loans. Mortgage repurchase facilities, also called warehouse lines of credit, are one component of our funding strategy, and they provide creditors a collateralized interest in specific mortgage loans that meet the eligibility requirements under the terms of the facility during the warehouse period. The source of repayment of the facilities is typically from the sale or securitization of the underlying loans into the secondary mortgage market.
We utilize both committed and uncommitted warehouse facilities, and we evaluate our capacity needs under these facilities based on forecasted volume of mortgage loan closings and sales. Throughout the year ended
December 31, 2017
, at our election, we reduced the capacity for certain facilities as well as entered into shorter terms for certain facilities to allow both us and our lenders to evaluate facility needs and agreement terms that would be appropriate for our new business model after the completion of our strategic actions. There can be no assurances that our lenders will agree to continued facility extensions on terms acceptable to us.
Our ability to maintain liquidity through mortgage warehouse facilities is dependent on:
|
|
•
|
lenders' satisfactory assessment of us as a borrower and/or guarantor, including how these assessments are affected by our ongoing strategic actions;
|
|
|
•
|
the quality and eligibility of assets underlying the arrangements;
|
|
|
•
|
our ability to negotiate terms acceptable to us;
|
|
|
•
|
our ability to access the secondary market for mortgage loans; and
|
|
|
•
|
our ability to comply with certain financial covenants.
|
Mortgage warehouse facilities consisted of the following as of
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capacity
|
|
Outstanding Balance
|
|
Available
Capacity
(1)
|
|
Maturity
Date
|
|
(In millions)
|
|
|
Debt:
|
|
|
|
|
|
|
|
|
|
|
Committed facilities:
|
|
|
|
|
|
|
|
|
|
|
Wells Fargo Bank, N.A.
(2)
|
$
|
200
|
|
|
$
|
40
|
|
|
$
|
160
|
|
|
4/2/2018
|
Bank of America, N.A.
|
75
|
|
|
59
|
|
|
16
|
|
|
3/31/2018
|
Barclays Bank PLC
(3)
|
100
|
|
|
70
|
|
|
30
|
|
|
1/31/2018
|
Committed warehouse facilities
|
375
|
|
|
169
|
|
|
206
|
|
|
|
Uncommitted facilities:
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae
|
200
|
|
|
51
|
|
|
149
|
|
|
n/a
|
Barclays Bank PLC
(3)
|
100
|
|
|
—
|
|
|
100
|
|
|
n/a
|
Total
|
$
|
675
|
|
|
$
|
220
|
|
|
$
|
455
|
|
|
|
|
|
|
|
|
|
|
|
Off-Balance Sheet Gestation Facilities:
|
|
|
|
|
|
|
|
|
|
|
Uncommitted facilities:
|
|
|
|
|
|
|
|
|
|
|
JP Morgan Chase Bank, N.A.
|
$
|
100
|
|
|
$
|
—
|
|
|
$
|
100
|
|
|
n/a
|
______________
|
|
(1)
|
Capacity is dependent upon maintaining compliance with the terms, conditions, and covenants of the respective agreements and may be further limited by asset eligibility requirements.
|
|
|
(2)
|
On February 20, 2018, the committed capacity was reduced to
$100 million
at our request.
|
|
|
(3)
|
On January 30, 2018, we extended the committed Barclay's warehouse facility through April 30, 2018, with committed capacity of
$100 million
and uncommitted capacity of
$25 million
.
|
Our funding strategies for mortgage originations may also include the use of committed and uncommitted mortgage gestation facilities. Gestation facilities effectively finance mortgage loans that are eligible for sale to an agency prior to the issuance of the related mortgage-backed security.
Servicing Advance Funding Arrangements
Under most of our mortgage servicing agreements where we own the MSRs, we are required to advance our own funds for scheduled principal, interest, tax and insurance payments when the mortgage loan borrower has failed to make the scheduled payments; and to cover foreclosure costs and various other items that are required to preserve the assets being serviced. Generally, we collect on these servicing advance receivables through future payments from the respective borrower, from liquidation proceeds, or from investor or insurance claims following foreclosure or liquidation. We are generally exposed to losses from these receivables only to the extent that the respective servicing guidelines are not followed or if we have a breach of the representations and warranty provisions of our loan sale agreements. Also, in many cases, we can cease making advances when the advances are no longer deemed to be recoverable from liquidation proceeds. As discussed below, our strategies to fund these servicing advance receivables include the issuance of asset-backed notes.
In addition, under certain of our subservicing agreements, we are required to advance our own funds to preserve the assets being serviced. Our subservicing agreements generally contain provisions that require the subservicing client to pre-fund advances on the subserviced loans or to reimburse us for those advances on a monthly or other periodic basis. We are exposed to risk with respect to this process, because if the client fails to make such reimbursement, we may be required to fund unreimbursed advances for an extended period.
As of
December 31, 2017
, there are
$356 million
of Servicing advance receivables on our Consolidated Balance Sheet, including
$92 million
from our own funds, and the remainder funded as outlined below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capacity
(1)
|
|
Outstanding Balance
|
|
Available
Capacity
(2)
|
|
Maturity
Date
|
|
(In millions)
|
|
|
Debt:
|
|
|
|
|
|
|
|
|
|
|
PSART Servicing Advance facility
|
$
|
65
|
|
|
$
|
32
|
|
|
$
|
33
|
|
|
3/15/2018
|
Subservicing advance liabilities:
|
|
|
|
|
|
|
|
|
|
|
Client-funded amounts
|
n/a
|
|
|
232
|
|
|
n/a
|
|
|
n/a
|
Total
|
|
|
|
$
|
264
|
|
|
|
|
|
|
______________
|
|
(1)
|
On January 1, 2018 the total capacity for the PSART Servicing Advance facility was reduced to $50 million.
|
|
|
(2)
|
Capacity is dependent upon maintaining compliance with the terms, conditions, and covenants of the respective agreements and may be further limited by asset eligibility requirements.
|
PSART Servicing Advance Facility.
PHH Servicer Advance Receivables Trust (“PSART”), a special purpose bankruptcy remote trust, was formed for the purpose of issuing non-recourse asset-backed notes, up to a maximum principal amount of
$65 million
, secured by servicing advance receivables. PSART was consolidated as a result of the determination that we are the primary beneficiary of the variable interest entity, as discussed in
Note 17, 'Variable Interest Entities'
in the accompanying Notes to Consolidated Financial Statements.
PSART issues variable funding notes that have a revolving period, during which time the monthly collection of advances are applied to pay down the notes and create additional availability to fund advances. The expiration of the revolving funding period and the final maturity date of the notes is
March 15, 2018
, and we are required to repay the outstanding balance through advance collections or additional payments on or before final maturity. In all cases, including upon an increased pace of amortization or an event of default as described below, all amortization and repayment of the notes is serviced from the ongoing recovery on the servicing advances that secure the notes. On or before the final maturity date in March 2018, we expect to negotiate a short-term extension of the servicing advance facility to meet future capacity needs as we work towards executing our private MSR sales to New Residential; however, there can be no assurances that the noteholder will agree to such an extension. We are required to use the cash generated from the sale of Servicing advances financed through PSART to repay the related outstanding debt.
Our ability to maintain liquidity through PSART is dependent upon:
|
|
•
|
the eligibility of servicing advance receivables underlying the arrangement and our ability to recover advances in a timely and efficient manner;
|
|
|
•
|
maintaining our role as servicer of the underlying mortgage assets; and
|
|
|
•
|
our ability to comply with certain financial and other covenants, the breach of which could result in the ability of the noteholder to terminate their commitment to fund new advances through the purchase of additional notes, an increased pace of amortization for the notes and/or an event of default.
|
Subservicing Advance Liabilities.
When our subservicing client pre-funds advances or reimburses us for such advances, as described above, a subservicing advance liability is recorded for cash received from the subservicing client, and is repaid to the client upon the collection of the mortgage servicing advance receivables. As we transition to a subservicing focused, capital-light business model, we plan to increase our use of client-funded arrangements and minimize our funding needs for servicing advance receivables.
Our ability to maintain liquidity through such client-funded arrangements is dependent on the creditworthiness of our subservicing clients and their ability to fund and/or reimburse the servicing advances and our adherence to the applicable servicing guidelines when making the advances.
Unsecured Debt
On June 19, 2017, we commenced tender offers to purchase for cash any and all of the Term Notes due in 2019 and 2021. On July 3, 2017, we repaid $178 million of the 2019 Notes and $318 million of the 2021 Notes for an aggregate $524 million in cash, plus accrued interest. On July 17, 2017, upon expiration of the tender offer, the amount of notes repaid was not significant. We recognized a loss of $34 million in Other operating expenses in the Consolidated Statements of Operations related to this debt retirement during the year ended December 31, 2017.
Beginning on August 15, 2017, we have the option to redeem the Term notes due in 2021, in whole or in part, at certain defined redemption prices, plus any accrued and unpaid interest. If we exercise our option during the year ended December 31, 2018, the redemption price is 101.594% (expressed as a percentage of the principal amount), and if we exercise our option on or after January 1, 2019, the redemption price is 100.000%.
Unsecured borrowing arrangements consisted of the following as of
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Balance
|
|
Balance
at Maturity
|
|
Maturity
Date
|
|
(In millions)
|
|
|
7.375% Term notes due in 2019
|
$
|
97
|
|
|
$
|
97
|
|
|
9/1/2019
|
6.375% Term notes due in 2021
|
21
|
|
|
22
|
|
|
8/15/2021
|
Total
|
$
|
118
|
|
|
$
|
119
|
|
|
|
The following table summarizes our future contractual obligations as of
December 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than
1 year
|
|
1-3 years
|
|
3-5 years
|
|
More than
5 years
|
|
Total
|
|
(In millions)
|
Warehouse facilities
(1)
|
$
|
220
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
220
|
|
Servicing advance facility
(1) (2)
|
32
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
32
|
|
Unsecured debt
|
—
|
|
|
97
|
|
|
22
|
|
|
—
|
|
|
119
|
|
Interest expense on Unsecured debt
|
9
|
|
|
10
|
|
|
1
|
|
|
—
|
|
|
20
|
|
Operating leases
(3)
|
13
|
|
|
19
|
|
|
16
|
|
|
—
|
|
|
48
|
|
Purchase commitments
|
6
|
|
|
5
|
|
|
—
|
|
|
—
|
|
|
11
|
|
Mandatorily redeemable noncontrolling interest
|
20
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
20
|
|
Loan repurchase obligations
|
3
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3
|
|
|
$
|
303
|
|
|
$
|
131
|
|
|
$
|
39
|
|
|
$
|
—
|
|
|
$
|
473
|
|
________________
|
|
(1)
|
The table above excludes future cash payments related to interest expense on our warehouse facilities and servicing advance facility which totaled
$19 million
for 2017. Interest is calculated on most of our debt obligations based on variable rates referenced to LIBOR.
|
|
|
(2)
|
Maturities of the Servicing advance facility represent the contractual final repayment date which is March 15, 2018.
|
|
|
(3)
|
Excludes
$6 million
of minimum sublease income due in the future under noncancelable subleases.
|
For further information about our Mortgage warehouse and advance facilities and Unsecured debt, see “—Liquidity and Capital Resources—Debt” and
Note 10, 'Debt and Borrowing Arrangements'
in the accompanying Notes to Consolidated Financial Statements.
Purchase commitments include various commitments to purchase services from specific suppliers made by us in the ordinary course of our business, and the majority of our commitments relate to tax service expenses associated with managing our servicing portfolio and software expenses. For further information about our Operating lease and Purchase commitments, see
Note 13, 'Commitments and Contingencies'
in the accompanying Notes to Consolidated Financial Statements. We had no capital lease obligations as of
December 31, 2017
.
Mandatorily redeemable noncontrolling interest represents our unconditional obligation to purchase Realogy's membership interest in PHH Home Loans on or before March 19, 2018, subject to certain closing conditions. See "—Asset Sales and Exit Programs" for further information.
Loan repurchase obligations represent the unpaid principal amount of loans that have completed the repurchase request review process and the claims are pending final execution or payment. See
Note 13, 'Commitments and Contingencies'
in the accompanying Notes to Consolidated Financial Statements and “—Risk Management” for further information regarding our loan repurchase exposure and related reserves.
Other Obligations
Loan Origination Pipeline.
As of
December 31, 2017
, we had commitments with agreed-upon rates or rate protection that we expect to result in closed mortgage loans of
$192 million
.
Commitments to sell loans generally have fixed expiration dates or other termination clauses and may require the payment of a fee. We may settle the forward delivery commitments on MBS or whole loans on a net basis including the posting of collateral; therefore, the commitments outstanding do not necessarily represent future cash obligations. Our
$614 million
(gross notional) of forward delivery commitments on MBS or whole loans as of
December 31, 2017
generally will be settled within 90 days of the individual commitment date.
For further information about our commitments to fund or sell mortgage loans, see
Note 5, 'Derivatives'
in the accompanying Notes to Consolidated Financial Statements.
MSR Sales.
As of
December 31, 2017
, we had commitments to sell capitalized MSRs with
$6.5 billion
of unpaid principal balance and fair value of
$39 million
, and there are
$110 million
servicing advance receivables that will be delivered under those commitments. These commitments are primarily related to the MSR sale agreement with New Residential.
In addition, as of
December 31, 2017
, we had commitments to sell MSRs through third-party flow sales related to
$28 million
of the unpaid principal balance of Mortgage loans held for sale and Interest rate lock commitments that are expected to result in closed loans. We also are contractually obligated to transfer
$2 million
of servicing value associated with certain originations, pursuant to the terms of our portfolio defense agreements.
For further information about our commitments to sell Mortgage servicing rights, see
Note 4, 'Servicing Activities'
and
Note 16, 'Fair Value Measurements'
in the accompanying Notes to Consolidated Financial Statements.
Unrecognized Income Tax Benefits.
The future contractual obligations outlined above exclude an
$11 million
liability for income tax contingencies as of
December 31, 2017
since we cannot predict with reasonable certainty the timing of the resolution of such contingencies and potential cash settlements to the respective taxing authorities, if any. For more information regarding our liability for income tax contingencies, see
Note 12, 'Income Taxes'
in the accompanying Notes to Consolidated Financial Statements.
Compensation Agreements
. We have granted retention and other awards that obligate us to make future cash payments to the related employees, if they remain employed through specified vesting dates. If any employees are involuntarily terminated without cause prior to those dates, we owe the lump sum as soon as practicable.
The total amount of our compensation-related obligations not associated with our Exit cost liability is
$6 million
to be earned through the related service period, of which
$4 million
is accrued within Accounts payable and accrued expenses as of
December 31, 2017
.
Exit Liability Obligations.
Total compensation-related obligations associated with our exit activities is
$44 million
which relate to severance, retention and cash-based incentive awards. As of
December 31, 2017
,
$43 million
is accrued in Exit cost liability in Accounts payable and accrued expenses for these obligations. In addition, we have
$8 million
of contract termination and other costs related to the PLS and Reorganization exit programs which is included in the Exit cost liability as of
December 31, 2017
.
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OFF-BALANCE SHEET ARRANGEMENTS AND GUARANTEES
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In the ordinary course of business, we enter into numerous agreements that contain guarantees and indemnities whereby we indemnify another party for breaches of representations and warranties. Such guarantees or indemnifications are granted under various agreements, including those governing leases of real estate, access to credit facilities, use of derivatives and issuances of debt or equity securities. In addition, we utilize an uncommitted off-balance sheet mortgage gestation facility as a component of our financing strategy.
During 2017, we entered into assignments with LenderLive Network, LLC and Guaranteed Rate Affinity, LLC related to certain facility leases that were transferred in connection with transactions associated with our PLS business and Real Estate channel exits. Under the terms of the original facility leases, we remain jointly and severally obligated with LenderLive and GRA for performance under the lease agreements. As of
December 31, 2017
, the total amount of potential future lease payments under these guarantees was approximately
$15 million
; however, we do not believe any amount of losses under these guarantees is probable.
See “—Liquidity and Capital Resources—Debt—Warehouse facilities” above, and
Note 13, 'Commitments and Contingencies'
in the accompanying Notes to the Consolidated Financial Statements for additional information.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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Our significant accounting policies are described in
Note 1, 'Summary of Significant Accounting Policies'
and
Note 13, 'Commitments and Contingencies'
in the accompanying Notes to Consolidated Financial Statements. These accounting policies are integral in understanding our financial position and results of operations because we are required to make estimates and assumptions that may affect the value of our assets and liabilities and financial results. The accounting policies that we believe are critical due to the highly difficult, subjective and complex judgments and estimates relating to matters that are inherently uncertain include: (i) Fair value measurements; (ii) Mortgage servicing rights and related secured liability; (iii) Income taxes; (iv) Loan repurchase and indemnification liability; and (v) Litigation and regulatory accruals.
Additionally, events that are outside of our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. If actual results differ from our judgments and estimates, it could have a material adverse effect on our business, financial position, results of operations and cash flows. We believe that the estimates and assumptions we used when preparing our financial statements were the most appropriate at that time, and we discuss our critical accounting policies and estimates with our Audit Committee of our Board of Directors on an ongoing basis.
Fair Value Measurements
We record certain assets and liabilities at fair value, and we have an established and documented a process for determining fair value measurements. In addition, we utilize fair value measurements in our review of the carrying value of long-lived assets and equity method investments for impairment, whenever events or changes in circumstances indicate that such carrying value may not be recoverable. We determine fair value based on quoted market prices, if available. If quoted prices are not available, fair value is estimated based upon other observable inputs and may include valuation techniques such as present value cash flow models, option-pricing models or other conventional valuation methods.
We use unobservable inputs when observable inputs are not available. These inputs are based upon our judgments and assumptions, which represent our assessment of the assumptions market participants would use in pricing the asset or liability, which may include: (i) information about current pricing for similar products; (ii) modeled assumptions based on internally-sourced data and characteristics of the specific instrument; and (iii) counterparty risk, credit quality and liquidity.
The use of different assumptions may have a material effect on the estimated fair value amounts recorded in our financial statements, and the actual amounts realized in the sale or settlement of these instruments may vary materially from the recorded amounts. See
Note 16, 'Fair Value Measurements'
in the accompanying Notes to Consolidated Financial Statements for further discussions of our measurements at fair value.
Assets.
As of
December 31, 2017
,
41%
of our Total assets were measured at fair value on a recurring basis and
35%
of those assets were valued using primarily observable inputs and are comprised of the majority of our Mortgage loans held for sale. As of
December 31, 2017
,
65%
of our assets measured at fair value on a recurring basis were valued using significant unobservable inputs and include:
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Mortgage servicing rights.
See "—Mortgage Servicing Rights" below.
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Certain non-conforming Mortgage loans held for sale, including Scratch and Dent (loans with origination flaws or performance issues) and second lien loans.
We value these loans based upon a collateral-based valuation model, with consideration of market bid pricing. As the market for these loans is not liquid, we utilize assumptions in the valuation that reflect our best estimate of the current market, which may include spreads from collateral values in recent transactions.
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Interest rate lock commitments ("IRLCs").
As there is a lack of an observable market for trading IRLCs, fair value is based upon the estimated fair value of the underlying mortgage loan, adjusted for: (i) estimated costs to complete and originate the loan and (ii) an adjustment to reflect the estimated percentage of commitments that will result in a closed mortgage loan, which can vary based on the age of the underlying commitment and changes in mortgage interest rates.
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Liabilities.
As of
December 31, 2017
, 33% of our Total liabilities were measured at fair value on a recurring basis, all of which were valued using significant unobservable inputs and primarily related to the Mortgage servicing rights secured liability.
The fair value of MSRs secured liability is estimated based upon projections of expected future cash flows of the underlying MSR asset. The cash flow assumptions and prepayment assumptions used in the model are based on various factors, including portfolio characteristics, interest rates based on interest rate yield curves, implied volatility and other economic factors. See "—Mortgage Servicing Rights" below.
Mortgage Servicing Rights
The fair value of our mortgage servicing rights ("MSRs") is estimated based upon projections of expected future cash flows, including service fee income and costs to service the loans, actual and expected prepayment rates, portfolio characteristics, interest rates based on interest rate yield curves, implied volatility, servicing costs and other economic factors which are determined based on current market conditions. As of
December 31, 2017
, the fair value of the portion of MSRs that remain committed under bulk sale agreements includes calibration of the valuation model, considering the pricing associated with those agreements.
We use a third-party model as a basis to forecast prepayment rates at each monthly point for each interest rate path based around the implied forward interest rate, calculated using a probability weighted option adjusted spread ("OAS") model. The OAS model is used to generate and discount the expected future cash flows to value the MSR. Prepayment rates are based on historical observations of prepayment behavior in similar periods, comparing current mortgage rates to the mortgage interest rate in our servicing portfolio and incorporates loan characteristics (e.g., loan type and note rate) and factors such as recent prepayment experience, the relative sensitivity of our capitalized servicing portfolio to refinance if interest rates decline and estimated levels of home equity.
The evaluation of our MSRs is governed by a committee, which consists of key members of management, to approve our MSR valuation policies and ensure that the fair value of our MSRs is appropriate considering all available internal and external data. We validate assumptions used in estimating the fair value of our MSRs against a number of third-party sources, which may include peer surveys, MSR broker surveys, third-party valuations and other market-based sources. While our current valuation reflects our best estimate of servicing costs, future regulatory changes in servicing standards, as well as changes in individual state foreclosure legislation, may have an impact on our servicing cost assumption and our MSR valuation in future periods.
The key assumptions used in the valuations of MSRs include prepayment rates, discount rate and delinquency rates. If we experience a 10% adverse change in prepayment speeds, OAS and delinquency rates, the fair value of our owned MSRs would be reduced by
$3 million
,
$2 million
and
$4 million
, respectively. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in fair value may not be linear. Also, the effect of a variation in a particular assumption is calculated without changing any other assumption; in reality, changes in one assumption may result in changes in another, which may magnify or counteract the sensitivities. Further, this analysis does not assume any impact resulting from our intervention to mitigate these variations. These sensitivities are hypothetical and for illustrative purposes only and do not include the MSRs accounted for as a secured borrowing arrangement, in which any changes in fair value would be fully offset by the change in fair value of the MSR secured liability.
Income Taxes
We are subject to the income tax laws of the various jurisdictions in which we operate, including U.S. federal, state and local jurisdictions. These tax laws are complex and are subject to different interpretations by the taxpayer and the relevant government taxing authorities. When determining our current income tax expense, we must make judgments about the application of these inherently complex tax laws.
Deferred income taxes are determined using the balance sheet method. Recognition of deferred taxes is based upon estimates of future results and management's judgment; however, deferred tax assets are reduced by valuation allowances if it is more likely than not that some portion of the deferred tax asset will not be realized. We evaluate our deferred tax assets quarterly to determine if adjustments to our valuation allowance are required based on the consideration of all available evidence, using a "more likely than not" standard with respect to whether deferred tax assets will be realized. This evaluation considers, among other factors, our historical operating results, our expectations of future profitability, the duration of the applicable statutory carryforward periods and available tax planning strategies. The ultimate realization of our deferred tax assets depends primarily on our ability to generate future taxable income during the periods in which the related temporary differences in the financial basis and the tax basis of the assets become deductible. As of December 31, 2017, we recognized a full valuation allowance against our net deferred tax assets, driven by the impact of Federal tax reform, including the provisions that eliminate the net operating loss carryback.
Should a change in circumstances, including differences between our future operating results and estimates, lead to a change in our judgments about the realization of deferred tax assets in future years, we would adjust the valuation allowances in the period that the change in circumstances occurs, along with a charge or credit to income tax expense. Significant changes to our estimates and assumptions may result in an increase or decrease to our tax expense in a subsequent period.
Our interpretations of the complex tax laws in the jurisdictions in which we operate are subject to review and examination by the various governmental taxing authorities and disputes may arise over the respective tax positions. We record liabilities for income tax contingencies using a two-step process. We must first presume the tax position will be examined by the relevant taxing authority and determine whether it is "more likely than not" that the position will be sustained upon examination, based on its technical merits. Once an income tax position meets the "more likely than not" recognition threshold, it is then measured to determine the amount of the benefit to recognize in the financial statements.
Liabilities for income tax contingencies are reviewed periodically and are adjusted as events occur that affect our estimates, such as the availability of new information, subsequent transactions or events, the lapsing of applicable statutes of limitations, the conclusion of tax audits, the measurement of additional estimated liabilities based on current calculations (including interest and/or penalties), the identification of new income tax contingencies, the release of administrative tax guidance affecting our estimates of income tax liabilities or the rendering of relevant court decisions. The ultimate resolution of income tax contingency liabilities could have a significant impact on our effective income tax rate in a given financial statement period. Liabilities for income tax contingencies, including accrued interest and penalties, was
$11 million
as
December 31, 2017
.
Loan Repurchase and Indemnification Liability
Representations and warranties are provided to investors and insurers on a significant portion of loans sold and are also assumed on purchased mortgage servicing rights for loans that are owned by the Agencies or included in Agency-guaranteed securities. As a result, we may be required to repurchase the mortgage loan or indemnify the investor against loss in the event of a breach of representations and warranties. We have established a loan repurchase and indemnification liability for our estimate of exposure to losses related to our obligation to repurchase or indemnify investors for loans sold. The liability for probable losses includes estimates associated with: (i) losses for loans where a repurchase or indemnification obligation could exist from breaches of representation and warranties, (ii) losses for specific non-performing loans where we believe we will be required to indemnify the investor and (iii) losses for government loans that may not be reimbursed pursuant to mortgage insurance programs.
The key assumptions used in our estimate are impacted by a variety of factors, including actual defaults, estimated future defaults, the estimated probability we will receive a repurchase request, historical loss experience, our success rates in appealing repurchase requests and other economic conditions, including the political environment and oversight of the Agencies and related changes in Agency programs and guidelines, and the overall economic condition of borrowers and the U.S. economy. Changes to any one of these factors could significantly impact the estimate of our liability. We continue to evaluate our reserve based on the level and type of repurchase requests received, the defects identified and other relevant facts and circumstances. In order to monitor repurchase demand practices, we also maintain regular contact with the Agencies and with the private label clients for which we originate fee-based loans, and incorporate any new information into our reserve estimates as it becomes available.
Legal and Regulatory Contingencies
We are currently subject to various regulatory investigations, examinations and inquiries related to our mortgage origination and servicing practices. In addition, we are defendants in various legal proceedings, which include private and civil litigation. The measurement of our accruals for legal and regulatory contingencies is a critical accounting estimate because of the significant judgment involved in estimating the likelihood and range of potential liability involved, uncertainty related to the potential outcome of certain matters, coupled with the material impact on our results of operations, cash flows and financial position that could result from changes in our estimates or the ultimate resolution of these matters.
An accrual is established for pending or threatened litigation, claims or assessments when it is probable that a loss has been incurred, and the amount of such loss can be reasonably estimated. We recognize legal costs associated with loss contingencies as they are incurred. 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 we may estimate a range of possible loss for consideration in these estimates. The estimates are based upon currently available information and involve significant judgment taking into account the varying stages and inherent uncertainties of such matters. Accordingly, our estimates may change from time to time, and such changes may be material to our consolidated results of operations. There can be no assurance that the ultimate resolution of such matters will not result in losses in excess of our recorded accruals, or in excess of our estimate of reasonably possible losses, and the ultimate resolution of any particular matter, or matters, may have a material adverse effect on our consolidated financial position, results of operations or cash flows.
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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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For information regarding recently issued accounting pronouncements and the expected impact on our financial statements, see
Note 1, 'Summary of Significant Accounting Policies'
in the accompanying Notes to Consolidated Financial Statements.