The following discussion should be read in conjunction with the "Cautionary Note
Regarding Forward-Looking Statements", "Item 1A. Risk Factors" and our Condensed
Consolidated Financial Statements included in this Quarterly Report on Form 10-Q
and "Part I-Item 1. Business" and "Part I-Item 1A. Risk Factors", "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Consolidated Financial Statements and the notes thereto
included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Our Management's Discussion and Analysis of Financial Condition and Results of
Operations is presented in sections as follows:
† Overview
† Results of Operations
† Risk Management
† Liquidity and Capital Resources
† Critical Accounting Policies and Estimates
† Recently Issued Accounting Pronouncements
OVERVIEW
We are a leading outsource provider of mortgage and fleet management services.
We conduct our business through three operating segments: a Mortgage Production
segment, a Mortgage Servicing segment and a Fleet Management Services segment.
Our Mortgage Production segment originates, purchases and sells mortgage loans
through PHH Mortgage. Our Mortgage Servicing segment services mortgage loans
originated by PHH Mortgage, and also purchases mortgage servicing rights and
acts as a subservicer for certain clients that own the underlying servicing
rights. Our Fleet Management Services segment provides commercial fleet
management services to corporate clients and government agencies throughout the
United States and Canada.
Although our Fleet Management Services segment has historically generated a
larger portion of our Net revenues, our Mortgage Production and Mortgage
Servicing segments have historically contributed a significantly larger portion
of our Net income. Our Mortgage Production and Mortgage Servicing segments have
experienced, and may continue to experience, high degrees of earnings volatility
due to significant exposure to interest rates and the real estate markets, which
impacts our loan origination volumes, valuation of our mortgage servicing rights
and foreclosure-related charges.
See "-Risk Management" in this Form 10-Q for additional information regarding
our interest rate and market risks.
Executive Summary
For 2012, we are focusing on four key strategies to increase shareholder value:
† pursue disciplined growth in our three franchise platforms which are
mortgage private label services, our mortgage relationship with Realogy and our
fleet management business;
† drive industry-leading operational excellence;
† continue our unwavering commitment to customer service; and
† in the near-term, prioritize liquidity and cash flow generation from our
mortgage and fleet businesses and deleverage the balance sheet.
These strategies represent a shift in focus for 2012 away from an emphasis on
growing origination market share and mortgage servicing rights. Some of the
actions we are taking to reposition the business, including prioritizing
liquidity and cash flow generation in the near-term, may have a negative impact
on our 2012 earnings.
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In May 2012, our debt rating was downgraded by Fitch to BB from BB+. In recent
months, S&P downgraded our debt rating from BB+ to BB- and placed us on negative
outlook, and Moody's placed us on negative outlook. The downgrades in our
credit rating reflect the rating agencies' assessments of a variety of factors
including but not limited to: (i) an increase in potential mortgage loan
repurchases; (ii) our hedge practices related to our mortgage servicing rights;
and (iii) uncertainties regarding our liquidity profile. See "-Liquidity and
Capital Resources" for further discussion of our 2012 goals and liquidity and
capital plan.
Our unrestricted cash balance was $700 million as of June 30, 2012 compared to
$875 million as of March 31, 2012 which reflects the repayment of $201 million
of unsecured term debt and a $52 million increase in the cash collateral posted
under derivative agreements. Excluding those changes, we generated $78 million
of positive cash flow for the second quarter of 2012, which resulted from our
operations and the following actions:
† generated $31 million of unrestricted cash from our reinsurance
subsidiary, including $24 million from the termination of a reinsurance
agreement and $7 million from the release of restricted cash in excess of the
trust requirements;
† generated $28 million of cash from the sale of non-conforming
mortgage loans and the repayment of retained subordinated notes from prior fleet
lease asset-backed borrowing arrangements;
† selectively originated loans in our wholesale/correspondent platform
to control cash utilization; and
† aligned our business operations with established cash flow targets to
support the repayment of our near-term unsecured debt maturities.
The termination of the reinsurance agreement generated a $16 million pre-tax
loss in the Mortgage Servicing segment during the second quarter and six months
ended June 30, 2012. See "-Risk Management" for additional information
regarding the termination agreement. The remaining actions outlined above did
not have an overall impact on our net income.
We are continuing to execute on our plans to improve our liquidity and cash flow
generation and believe that the initiatives started during the first half of
2012 provide a solid foundation to meet our near-term unsecured debt maturities.
See "-Liquidity and Capital Resources" for additional information regarding our
outstanding indebtedness, upcoming debt maturities and our liquidity and capital
plan.
In our Mortgage Production segment we continue to experience elevated margins
and volume. Total loan margins during the second quarter of 2012 were 381 basis
points, representing a 140 basis points increase over the same period in 2011.
Wholesale/correspondent closings declined to 14% of our total closings during
the second quarter of 2012 compared to 28% in 2011, reflecting the emphasis on
our retail platform and our efforts to manage cash consumption.
Our Mortgage Servicing segment continued to be negatively impacted by an
increase in foreclosure-related charges. During the first half of 2012, we
experienced increased levels of loan repurchase and indemnification requests,
primarily from the GSEs, that exceeded our historical experience. This increase
in repurchase and indemnification requests caused a significant increase in our
unresolved requests, and we recorded $39 million of provisions during the second
quarter of 2012, compared to $65 million during the first quarter of 2012 and
$24 million during the second quarter of 2011.
During the second quarter of 2012, we received 1,171 repurchase and
indemnification requests, compared to 1,407 in the first quarter of 2012 as
further compared to 807 and 698 in the second and fourth quarters of 2011,
respectively. The increase in repurchase requests in 2012 is primarily due to an
increase in the number of loan file reviews by the GSEs as they focused more
resources on clearing the backlog of previously requested loan files primarily
related to the 2005 through 2008 origination years. The majority of repurchase
requests continue to be related to the 2005 through 2008 origination years.
We
continue to monitor these trends and may need to further increase our loan
repurchase and indemnification liability if the elevated levels of repurchase
requests continue. Additionally, an increased level of repurchase requests
could result in an increased use of cash, as compared to prior periods, to fund
loan repurchases or make payments under loan indemnification agreements. We
expect foreclosure losses to remain elevated throughout 2012, and potentially
into 2013, as investors continue to review both performing and non-performing
loans for potential underwriting defects and representation and warranty
violations. See "-Risk Management" for additional information regarding our
repurchase obligations and potential exposure.
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Our Fleet Management Services segment continued to grow earnings in the second
quarter of 2012, driven by growth in our Net investment in leases as well as
increases in maintenance service, fuel, and accident management average units.
Industry Trends
Regulatory Trends
We are subject to numerous federal, state and local laws and regulations and may
be subject to various judicial and administrative decisions imposing various
requirements and restrictions on our business. By agreement with our private
label clients in our mortgage business, we are required to comply with
additional requirements that our clients may be subject to through their
regulators. These laws, regulations and judicial and administrative decisions
include those pertaining to the following areas:
† Real estate settlement procedures;
† Consumer credit provisions; fair lending, fair credit reporting and
truth in lending;
† The establishment of maximum interest rates, finance charges and
other charges;
† Secured transactions; collections, foreclosure, repossession and
claims-handling procedures;
† Privacy regulations providing for the use and safeguarding of
non-public personal financial information of borrowers and guidance on
non-traditional mortgage loans issued by the federal financial regulatory
agencies;
† Taxing and licensing of vehicles and environmental protection;
† Insurance regulations and licensing requirements pertaining to
standards of solvency that must be met and maintained; reserves and provisions
for unearned premiums, losses and other obligations and deposits of securities
for the benefit of policyholders.
In January 2012, we were notified that the Bureau of Consumer Financial
Protection (the "CFPB") had opened an investigation to determine whether our
mortgage insurance premium ceding practices to captive reinsurers comply with
the Real Estate Settlement Procedures Act and other laws enforced by the CFPB.
The CFPB requested certain related documents and information for review. During
the second quarter of 2012, the CFPB requested further production of documents
and answers to written questions. We have provided reinsurance services in
exchange for premiums ceded and believe that we have complied with the Real
Estate Settlement Procedures Act and other laws applicable to the Company's
mortgage reinsurance activities. We did not provide reinsurance on loans
originated after 2009. There can be no assurance that this investigation will
not result in the imposition of any penalties or fines against us or our
subsidiaries.
We have received inquiries and requests for information from regulators and
attorneys general of certain states as well as from the Committee on Oversight
and Government Reform of the U.S. House of Representatives and the U.S. Senate
Judiciary Committee requesting information as to our mortgage origination and
servicing practices, including our foreclosure processes and procedures. There
also has been a continued focus on foreclosure practices by Fannie Mae and
Freddie Mac. While we have not been assessed any material fines or penalties
from regulatory agencies resulting from our mortgage origination or servicing
practices to date, Fannie Mae and Freddie Mac have assessed compensatory fees
against us for failing to meet certain foreclosure timelines specified in their
respective servicing guides. We expect that the higher level of legislative and
regulatory focus on mortgage origination and servicing practices will result in
higher legal, compliance and servicing related costs as well as potential
regulatory fines and penalties. It is also reasonably possible that we could
experience an increase in mortgage origination or servicing related litigation
in the future.
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Mortgage Production Trends
As of July 2012, Fannie Mae's Economics and Mortgage Market Analysis forecasts
an increase in industry loan originations to $1.5 trillion during 2012 compared
to $1.4 trillion during 2011, consisting of a 9% increase in both projected
refinance and purchase originations. Refinance originations are sensitive to
interest rates which have remained historically low, and Fannie Mae is
projecting interest rates will remain at these levels for the remainder of 2012,
positively impacting consumer demand. The increase in purchase originations is
reflective of an increase in new and existing home sales expected during 2012.
During the first half of 2012, we experienced elevated levels of initial pricing
margins compared to historical periods as mortgage interest rates remained low
and high consumer demand persisted, which has continued into the third quarter
of 2012. Although we expect margins to eventually decline from current levels,
we believe that pricing margins could remain elevated throughout 2012 reflecting
a longer term industry view of the returns required to manage the underlying
risk of a mortgage production and servicing business. The Federal HousingFinance Agency increased guarantee fees on mortgage backed securities issued by
Fannie Mae and Freddie Mac which became effective on April 1, 2012. We expect
this increase, and potential future increases, will have the impact of
increasing mortgage interest rates charged to borrowers, which could negatively
impact conforming loan origination volumes.
The increased consumer demand for mortgage loans, coupled with more stringent
underwriting guidelines and the increasingly complex regulatory compliance
environment have led to longer processing cycle times across the mortgage
industry. Consistent with these industry trends, we have experienced loan
processing delays and other service issues that have negatively impacted
customer service delivery in our Mortgage Production segment. As a result, we
have failed to satisfy certain service level agreements and other performance
provisions under some of our mortgage origination assistance agreements. During
the six months ended June 30, 2012, we incurred an immaterial amount of
contractual penalties related to these issues; however, a continuation of our
failure to fully satisfy the terms of service-level and other performance
provisions of these contracts could result in material penalties or the loss of
client relationships. We are currently implementing measures to improve our
loan processing and customer service delivery in an effort to more fully satisfy
the terms of our mortgage origination assistance agreements.
Mortgage Servicing Trends
Repurchase requests have been volatile in recent periods, and we have seen a
significant increase in repurchase requests, primarily from the Agencies. These
requests have especially been concentrated in loans originated during 2005
through 2008. This trend has accelerated during 2012, as repurchase requests
increased by 89% in the first half of 2012 compared to the second half of 2011,
and the amount of outstanding repurchase requests as of June 30, 2012 increased
to $297 million from $222 million as of December 31, 2011. The Federal HousingFinance Agency has committed to reducing taxpayer losses from the support of
Fannie Mae and Freddie Mac, and the strict enforcement of representation and
warranty provisions provides the Agencies with an effective means of loss
mitigation. We believe repurchase requests and foreclosure costs will continue
to remain high during 2012 and potentially into 2013. We expect that the
Agencies will continue to focus on losses from origination years prior to 2009,
since losses from those years have been intensified by the poor economic
environment and challenging conditions in the housing market. Although
repurchase requests have been primarily concentrated in loans originated during
2005 through 2008, the Agencies have also increased their reviews of more
current loan production, which could further increase future repurchase
activity.
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In addition to the increased focus on loan repurchases and indemnifications, we
have experienced higher reinsurance losses as a result of the continued weakness
in the housing market coupled with an elevated level of delinquency and
foreclosure experience. We paid $30 million in reinsurance claims during the
six months ended June 30, 2012, which included $8 million paid in connection
with the reinsurance agreement that was terminated in the second quarter of
2012. The claim payments for our one remaining inactive reinsurance contract
are expected to remain high throughout 2012 as foreclosures are completed and
insurance claims are processed; however, we do not expect paid claims to remain
at current levels since we have reached the maximum loss thresholds for certain
origination years. We hold cash and securities in trust related to our potential
obligation to pay such claims, which were $130 million and were included in
Restricted cash, cash equivalents and investments in the accompanying Condensed
Consolidated Balance Sheets as of June 30, 2012. We expect that the amount
currently held in trust will be significantly higher than future claims for
reinsurance losses.
See "- Risk Management" for additional information regarding mortgage
reinsurance and loan repurchases.
Fleet Management Services Trends
The fleet management industry continues to be influenced by the relative
strength of the U.S. economy and we would expect to see improvement in the
industry if the U.S. economy improves. Although we have experienced a decline
in our leased units in recent years, our net investment in leases has increased
as our mix has changed to include more expensive truck and service-type
vehicles. We have seen positive trends in our service units and we expect to
balance the growth in our service unit counts with our leased units during 2012.
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RESULTS OF OPERATIONS
Consolidated Results
The following table presents our consolidated results of operations:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions, except per share data)
Net fee income $ 128 $ 100 $ 255 $ 228
Fleet lease income 338 343 674 680
Gain on mortgage loans, net 208 119 438 178
Mortgage net finance expense (32 ) (25 ) (62 ) (44 )
Loan servicing income 100 117 221 225
Valuation adjustments relating to mortgage
servicing rights, net (203 ) (159 ) (229 ) (191 )
Other income 20 21 39 105
Net revenues 559 516 1,336 1,181
Depreciation on operating leases 303 309 604 615
Fleet interest expense 17 21 34 41
Total other expenses 319 252 654 506
Total expenses 639 582 1,292 1,162
(Loss) income before income taxes (80 ) (66 ) 44 19
Income tax (benefit) expense (38 ) (29 ) 1 4
Net (loss) income (42 ) (37 ) 43 15
Less: net income attributable to
noncontrolling interest 15 4 25 7
Net (loss) income attributable to PHH
Corporation $ (57 ) $ (41 ) $ 18 $ 8
Basic (loss) earnings per share
attributable to PHH Corporation $ (1.00 ) $ (0.73 ) $ 0.32 $ 0.14
Diluted (loss) earnings per share
attributable to PHH Corporation $ (1.00 ) $ (0.73 ) $ 0.31 $ 0.14
The following table summarizes the key highlights that drove our operating
performance and segment profit (loss) for our reportable segments:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Reportable Segments Profit (Loss):(1)
Mortgage Production segment $ 78 $ 25 $ 195 $ 77
Mortgage Servicing segment (196 ) (113 ) (222 ) (99 )
Fleet Management Services segment 22 19 46 35
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(1) Segment Profit (Loss) is described in Note 14, "Segment Information", in
the accompanying Notes to Condensed Consolidated Financial Statements.
Mortgage Production Segment
Quarterly Comparison:
† Segment profit was $53 million higher compared to 2011 primarily due
to 140 basis points of higher total margins and a 64% increase in fee-based loan
closings, partially offset by a 10% decline in interest rate lock commitments
expected to close.
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† Interest rate lock commitments expected to close decreased to $6.8
billion from $7.5 billion in 2011; however, applications increased by 21% over
the same period reflecting the shift in mix to fee-based production. Total
closings reflect the significant increase in refinance activity as refinance
closings increased by 94% compared to 2011 due to the historically low interest
rate environment.
† The mix of wholesale/correspondent originations declined to 14% in 2012
from 28% in 2011, reflecting our strategy to selectively manage originations in
this platform.
Year-to-Date Comparison:
† Segment profit was $118 million higher compared to 2011 primarily due
to 129 basis points of higher total margins and a 9% increase in the volume of
interest rate lock commitments expected to close. In addition, the prior year
profit includes a $68 million gain on the sale of 50.1% of the equity interests
in STARS.
† Total mortgage applications increased by 39% compared to 2011 and interest
rate lock commitments expected to close increased to $13.6 billion from $12.5
billion in 2011 due to lower market interest rates and higher consumer demand.
Mortgage Servicing Segment
Quarterly Comparison:
† Segment loss was unfavorably impacted by a $15 million increase in
foreclosure-related charges compared to 2011 related to a significant increase
in loan repurchase and indemnification requests in 2012 as discussed above under
"-Executive Summary".
† Loan servicing income for the second quarter of 2012 includes a loss
of $16 million on the termination of one of our inactive reinsurance contracts
as discussed below under "-Risk Management".
† Segment loss was unfavorably impacted by a 104% increase in loan
payoffs in our capitalized servicing portfolio compared to 2011, resulting in a
$21 million impact on the fair value of our mortgage servicing rights and an
additional $5 million of curtailment interest payments.
Year-to-Date Comparison:
† Segment loss was unfavorably impacted by a $65 million increase in
foreclosure-related charges compared to 2011 related to a significant increase
in loan repurchase and indemnification requests in the first half of 2012, as
discussed above under "-Executive Summary".
† Loan servicing income for the six months ended 2012 includes a loss
of $16 million on the termination of one of our inactive reinsurance contracts
as discussed below under "-Risk Management".
† Segment loss was unfavorably impacted by a 68% increase in loan
payoffs in our capitalized servicing portfolio as compared to 2011, resulting in
a $30 million impact on the fair value of our mortgage servicing rights and an
additional $7 million of curtailment interest payments.
Fleet Management Services Segment
Quarterly Comparison:
† Segment profit increased by $3 million to $22 million in 2012, driven
by growth in net investment in leases, lower funding costs and higher units and
usage of fee-based and asset-based management services.
† Maintenance service, fuel, and accident management average units all
increased in 2012 compared to 2011.
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Year-to-Date Comparison:
† Segment profit increased by $11 million to $46 million in 2012,
driven by growth in net investment in leases, lower funding costs and higher
units and usage of fee-based and asset-based management services.
† Maintenance service, fuel, and accident management average units all
increased in 2012 compared to 2011.
† The average number of leased vehicles declined by 3% compared to
2011; however, our net investment in leases increased by $175 million compared
to June 30, 2011.
The results of each of our reportable segments are discussed in detail below.
Income tax expense
We record our interim tax provisions or benefits by applying a projected
full-year effective income tax rate to our quarterly pre-tax income or loss for
results that we deem to be reliably estimable. Certain results dependent on
fair value adjustments of our Mortgage Production and Mortgage Servicing
segments are considered to not be reliably estimable and therefore we record
discrete year-to-date income tax provisions on those results.
Our effective income tax rates for the six months ended June 30, 2012 and 2011
were 1.3% and 19.5%, respectively.
For the six months ended June 30, 2012, the rate was primarily impacted by:
(i) the noncontrolling interest holder's portion of taxes on the income of PHH
Home Loans; and (ii) the impact of applying statutory changes to apportionment
weight, apportionment sourcing and corporate income tax rates that were enacted
by various states, primarily New Jersey, in the first quarter of 2012.
For the six months ended June 30, 2011, the rate was primarily impacted by:
(i) a decrease in our liability for tax contingencies resulting from the
resolution and settlement with various taxing authorities including the
conclusion of the IRS examination and review of our taxable years 2006 through
2009; and (ii) the noncontrolling interest holder's portion of taxes on the
income of PHH Home Loans; partially offset by (iii) changes in the valuation
allowance driven by state tax losses generated by our mortgage business.
See Note 8, "Income Taxes" in the accompanying Notes to Condensed Consolidated
Financial Statements for further detail.
Appraisal Services Business Joint Venture
On March 31, 2011, we sold 50.1% of the equity interests in our appraisal
services business, Speedy Title and Appraisal Review Services, ("STARS") to
CoreLogic, Inc. for a total purchase price of $35 million. We retained a 49.9%
equity interest in STARS, which is accounted for under the equity method.
For the six months ended June 30, 2012, earnings from the equity method
investment in STARS of $3 million are recorded as a component of Other income in
the Mortgage Production segment. During the six months ended June 30, 2011, a
$68 million gain on the sale of STARS was recorded within Other income of the
Mortgage Production segment, which consisted of the net present value of the
purchase price from CoreLogic plus the $34 million from the initial valuation of
our equity method investment.
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Other
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, marketing and communications. The costs associated with
these shared general and administrative functions, in addition to the cost of
managing the overall corporate function, are incurred and recorded within Other
and allocated back to our reportable segments through a corporate overhead
allocation. Other also includes intersegment eliminations and certain income
and expenses that are not allocated back to our reportable segments.
The following table presents the revenues and expenses recorded in Other:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Net revenues $ - $ (1 ) $ (1 ) $ (2 )
Salaries and related expenses 18 17 35 36
Occupancy and other office expenses 1 1 2 2
Fleet interest expense (1 ) - (2 ) (2 )
Other depreciation and amortization 3 2 4 2
Other operating expenses 12 9 28 20
Corporate overhead allocation (34 ) (29 ) (68 ) (59 )
Total expenses (1 ) - (1 ) (1 )
Net income (loss) before income taxes $ 1 $ (1 ) $ - $ (1 )
Net revenues
Net revenues represent income that is not allocated to the reportable segments
and intersegment eliminations.
Salaries and Related Expenses
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.
Quarterly Comparison: Salaries and related expenses increased by $1 million
compared to 2011 primarily due to an increase in management incentive
compensation.
Year-to-Date Comparison: Salaries and related expenses decreased by $1 million
compared to 2011 primarily due to $2 million in lower actual payments related to
2011 incentive compensation plans that was partially offset by an increase in
management incentives related to 2012 compensation plans.
Other Operating Expenses
The components of Other operating expenses were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Professional fees $ 8 $ 6 $ 18 $ 14
Other expenses 4 3 10 6
Total $ 12 $ 9 $ 28 $ 20
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Quarterly Comparison: Professional fees increased by $2 million compared to
2011, which was primarily attributable to an increase in information
technology-related expenses associated with private label client implementations
in our Mortgage Production segment.
Year-to-Date Comparison: Professional fees increased by $4 million compared to
2011, which was primarily attributable to an increase in information
technology-related expenses associated with private label client implementations
in our Mortgage Production segment. Other expenses increased by $4 million
compared to 2011, which was primarily driven by computer software and hardware
expenses associated with the continued development of our information technology
infrastructure.
Corporate Overhead Allocation
The table below provides a summary of our corporate overhead allocation by
segment:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Mortgage Production segment $ 19 $ 14 $ 38 $ 30
Mortgage Servicing segment 4 4 8 7
Fleet Management Services segment 11 11 22 22
Other (34 ) (29 ) (68 ) (59 )
Total $ - $ - $ - $ -
The amount of expense allocated to each segment is based upon the actual and
estimated usage by function or expense category or based on the relative size of
the operating segment.
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Mortgage Production Segment
The following tables present a summary of our financial results and key related
drivers for the Mortgage Production segment and are followed by a discussion of
each of the key components of Net revenues and Total expenses:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
($ in millions, except average loan amount)
Loans closed to be sold $ 8,059 $ 6,834 $ 18,736 $ 16,530
Fee-based closings 4,771 2,913 8,047 7,047
Total closings $ 12,830 $ 9,747 $ 26,783 $ 23,577
Purchase closings $ 5,010 $ 5,716 $ 8,860 $ 9,867
Refinance closings 7,820 4,031 17,923 13,710
Total closings $ 12,830 $ 9,747 $ 26,783 $ 23,577
Fixed rate $ 8,717 $ 6,727 $ 19,401 $ 16,665
Adjustable rate 4,113 3,020 7,382 6,912
Total closings $ 12,830 $ 9,747 $ 26,783 $ 23,577
Retail closings $ 11,056 $ 7,029 $ 20,546 $ 16,776
Wholesale/correspondent closings 1,774 2,718 6,237 6,801
Total closings $ 12,830 $ 9,747 $ 26,783 $ 23,577
Average loan amount $ 286,531 $ 252,126 $ 267,668 $ 256,495
Loans sold $ 7,868 $ 6,831 $ 19,477 $ 19,728
Applications $ 18,653 $ 15,365 $ 36,509 $ 26,302
IRLCs expected to close $ 6,763 $ 7,501 $ 13,625 $ 12,545
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Mortgage fees $ 83 $ 56 $ 163 $ 142
Gain on mortgage loans, net 208 119 438 178
Mortgage interest income 19 20 42 51
Mortgage interest expense (36 ) (28 ) (75 ) (61 )
Mortgage net finance expense (17 ) (8 ) (33 ) (10 )
Other income 2 2 4 73
Net revenues 276 169 572 383
Salaries and related expenses 100 76 193 167
Occupancy and other office expenses 8 8 15 15
Other depreciation and amortization 1 2 3 5
Other operating expenses 74 54 141 112
Total expenses 183 140 352 299
Income before income taxes 93 29 220 84
Less: net income attributable to
noncontrolling interest 15 4 25 7
Segment profit $ 78 $ 25 $ 195 $ 77
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Mortgage Production Statistics
Mortgage loan originations are driven by the demand to fund home purchases and
the demand to refinance existing loans. Purchase closings are influenced by the
number of home sales and the overall condition of the housing market whereas
refinance closings are sensitive to interest rate changes relative to borrowers'
current interest rates. Refinance closings typically increase when interest
rates fall and decrease when interest rates rise. Although the level of interest
rates is a key driver of refinancing activity, there are other factors which
influence the level of refinance closings including home prices, levels of home
equity, underwriting standards and product characteristics.
As of July 2012, Fannie Mae's Economics and Mortgage Market Analysis shows an
increase in mortgage industry origination volumes of approximately 62% and 37%
during the second quarter and six months ended June 30, 2012, respectively, as
compared to the same period of 2011. Refinance closings continued to be
positively impacted by a sustained low interest rate environment despite the
many borrowers who took advantage of refinance incentives during prior periods
of low interest rates. Based on the July industry origination volumes reported
by Fannie Mae, refinance closings represented 68% and 72% of total origination
volumes during the second quarter and six months ended June 30, 2012,
respectively.
The level of wholesale/correspondent closings can be influenced by a variety of
factors, including overall industry capacity, pricing margins and the
competitive landscape. Our decline in wholesale/correspondent volume reflects
our efforts to manage cash consumption and our strategy to generate mortgage
servicing rights with minimal use of cash. As of June 30, 2012, 24% of our
outstanding Interest rate lock commitments ("IRLCs") expected to close were
wholesale/correspondent compared to 44% as of December 31, 2011.
Wholesale/correspondent loans are generally less profitable than retail loans
and have lower loan margins and expenses.
IRLCs 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. IRLCs expected to close are
adjusted for the amount of loans expected to close in accordance with the terms
of the commitment. IRLCs expected to close result in loans closed to be sold as
we do not enter into interest rate lock commitments on fee-based closings.
Quarterly Comparison: Our total closings increased by $3.1 billion (32%)
compared to 2011 and were comprised of a $3.8 billion increase in refinance
closings offset by a $706 million decrease in purchase closings. Refinance
closings were positively impacted by the low interest rate environment and
represented 61% of our total closing volumes during the second quarter of 2012
compared to 41% in 2011.
Wholesale/correspondent closings represented 14% and 28% of our total closing
volumes in the second quarters of 2012 and 2011, respectively which reflects our
shift in focus to ensure that our operations are cash flow positive and to
manage our wholesale/correspondent originations to control cash consumption.
Applications increased by 21% compared to 2011 resulting from a historically low
interest rate environment and higher consumer demand; however our IRLCs expected
to close declined by 10% primarily due to the change in mix to a greater
composition of fee-based production where we do not enter into an interest rate
lock commitment.
Year-to-Date Comparison: Our total closings increased by $3.2 billion (14%)
compared to 2011 and were comprised of a $4.2 billion increase in refinance
closings offset by a $1.0 billion decrease in purchase closings. Refinance
closings were positively impacted by the low interest rate environment and
represented 67% of our total closing volumes during the six months ended
June 30, 2012 compared to 58% in 2011.
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Wholesale/correspondent closings represented 23% and 29% of our total closing
volumes in the six months ended June 30, 2012 and 2011, respectively which
reflects our shift in focus to ensure that our operations are cash flow positive
and to manage our wholesale/correspondent originations to control cash
consumption.
A historically low interest rate environment and higher consumer demand compared
to 2011 resulted in a 39% increase in application volume and a 9% increase in
IRLCs expected to close.
Mortgage Fees
Retail closings and fee-based closings are key drivers of Mortgage fees.
Mortgage fees consist of fee income earned on all loan originations, including
loans closed to be sold and fee-based closings. Fee income consists of amounts
earned related to application and underwriting fees and fees on cancelled
loans. Appraisal and other income generated by our appraisal services business
is included through the quarter ended March 31, 2011. Fee income also consists
of amounts earned from financial institutions related to brokered loan fees and
origination assistance fees resulting from our private-label mortgage
outsourcing activities. Fees associated with the origination and acquisition of
mortgage loans are recognized as earned.
Quarterly Comparison: Mortgage fees increased by $27 million (48%) compared to
2011 primarily due to an $18 million increase in origination assistance fees
from private label clients resulting from a 53% increase in private label
closing units, a $5 million increase in appraisal income and a $4 million
increase in application revenue. The increases in appraisal income and
application revenue were both primarily driven by a 42% increase in the number
of retail closing units compared to 2011.
Year-to-Date Comparison: Mortgage fees increased by $21 million (15%) compared
to 2011 primarily due to a $15 million increase in origination assistance fees
from private label clients resulting from a 19% increase in private label
closing units, a $3 million increase in appraisal income and a $3 million
increase in application revenue. Both increases in appraisal income and
application revenue were primarily driven by a 23% increase in the number of
retail closing units compared to 2011.
Gain on Mortgage Loans, Net
IRLCs expected to close are the primary driver of Gain on mortgage loans, net.
Gain on mortgage loans, net includes realized and unrealized gains and losses on
our mortgage loans, as well as the changes in fair value of our interest rate
locks 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. The valuation of
our interest rate lock commitments and mortgage loans approximates a whole-loan
price, which includes the value of the related mortgage servicing rights.
Mortgage servicing rights are recognized and capitalized at the date the loans
are sold and subsequent changes in the fair value are recorded in Change in fair
value of mortgage servicing rights in the Mortgage Servicing segment.
The components of Gain on mortgage loans, net were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Gain on loans $ 199 $ 102 $ 362 $ 141
Change in fair value of Scratch
and Dent and certain
non-conforming mortgage loans (11 ) 5 (16 ) -
Economic hedge results 20 12 92 37
Total change in fair value of
mortgage loans and related
derivatives 9 17 76 37
Total $ 208 $ 119 $ 438 $ 178
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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.
Margins generally widen when mortgage interest rates decline and tighten when
mortgage interest rates increase, as loan originators balance origination volume
with operational capacity. For wholesale/correspondent closings and certain
retail closings from our private label clients, 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, interest
rate lock commitments and related derivatives, including the impact of changes
in actual pullthrough as compared to our initial assumptions. We use derivative
instruments to economically hedge changes in value of mortgage loans and
interest rate lock commitments from the date of interest rate lock commitment
through the date the loan is sold into the secondary market. These derivatives
are intended to mitigate the changes in value attributable to changes in
interest rates. Economic hedge results also includes changes in value of
mortgage loans held for sale due to changes in expected execution upon sale
which may not be interest rate related and would not be offset by changes in
value of derivative instruments.
Quarterly Comparison: Gain on loans increased by $97 million compared to 2011
primarily due to higher total loan margins that was partially offset by a 10%
decrease in IRLCs expected to close. Average initial loan margins increased by
140 basis points primarily due to a reduction in mortgage interest rates and
higher consumer demand.
For the second quarter of 2012, the $11 million unfavorable change in fair value
of Scratch and Dent and certain non-conforming loans was primarily attributable
to additions to the population of Scratch and Dent loans resulting from an
increase in repurchases. For the second quarter of 2011, the $5 million
favorable change in fair value of Scratch and Dent and certain non-conforming
loans was primarily due to the sale of Scratch and Dent loans at a gain and an
increase in the estimated fair value of the remaining population.
The $8 million increase in economic hedge results compared to 2011 was driven by
favorable execution gains on mortgage loans sold coupled with lower interest
rate volatility that was partially offset by a lower impact of actual
pullthrough of mortgage loans as compared to initial assumptions.
Year-to-Date Comparison: Gain on loans increased by $221 million compared to
2011 primarily due to a 9% increase in IRLCs expected to close and higher total
loan margins. Average initial loan margins increased by 129 basis points
primarily due to a reduction in mortgage interest rates and higher consumer
demand.
For the six months ended June 30, 2012, the $16 million unfavorable change in
fair value of Scratch and Dent and certain non-conforming loans was primarily
attributable to additions to the population of Scratch and Dent loans resulting
from an increase in repurchases that was partially offset by the sale of Scratch
and Dent loans at a gain. For the six months ended June 30, 2011, the change in
fair value of Scratch and Dent and certain non-conforming loans was impacted by
the sale of Scratch and Dent loans at a gain and an increase in the estimated
fair value of the remaining population which was offset by additions to Scratch
and Dent loans resulting from repurchases.
The $55 million increase in economic hedge results compared to 2011 was driven
by favorable execution gains on mortgage loans sold coupled with lower interest
rate volatility and a higher impact of actual pullthrough of mortgage loans as
compared to initial assumptions.
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Mortgage Net Finance Expense
Mortgage net finance expense allocable to the Mortgage Production segment
consists of interest income on mortgage loans, interest expense allocated on
debt used to fund mortgage loans and an allocation of interest expense for
working capital. Mortgage net finance expense is primarily driven by the
average balance of loans held for sale, the average volume of outstanding
borrowings, the note rate on loans held for sale and the cost of funds rate of
our outstanding borrowings. A significant portion of our loan originations are
funded with variable-rate short-term debt.
Quarterly Comparison: Mortgage net finance expense increased by $9 million
compared to 2011 and was comprised of an $8 million (29%) increase in Mortgage
interest expense and a $1 million (5%) decrease in Mortgage interest income.
The increase in Mortgage interest expense was related to higher allocated
financing costs related to an increase in the average balance and cost of funds
rate of corporate unsecured borrowings coupled with the higher average balance
of loans held for sale. The decrease in Mortgage interest income was primarily
due to a lower average note rate of loans held for sale.
Year-to-Date Comparison: Mortgage net finance expense increased by $23 million
compared to 2011 and was comprised of a $14 million (23%) increase in Mortgage
interest expense and a $9 million (18%) decrease in Mortgage interest income.
The increase in Mortgage interest expense was related to higher allocated
financing costs related to an increase in the average balance of corporate
unsecured borrowings, partially offset by the lower average balance of loans
held for sale. The decrease in Mortgage interest income was primarily due to a
lower average balance of loans held for sale and a lower note rate of loans held
for sale.
Other Income
Year-to-Date Comparison: Other income decreased by $69 million compared to 2011
primarily due to a $68 million gain related to the March 31, 2011 sale of 50.1%
of our equity interests in Speedy Title and Appraisal Review Services.
Salaries and Related Expenses
Salaries and related expenses allocable to the Mortgage Production segment
consist of salaries, payroll taxes, benefits and incentives paid to employees in
our mortgage production operations and commissions paid to employees involved in
the loan origination process.
The components of Salaries and related expenses were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)Salaries, benefits and incentives $ 60 $ 50$ 119 $
109
Commissions 30 22 56 42
Contract labor and overtime 10 4 18 16
Total $ 100 $ 76 $ 193 $ 167
Salaries, benefits and incentives are primarily driven by the average number of
permanent employees. Commissions are primarily driven by the volume of retail
closings. Contract labor and overtime are primarily driven by origination
volumes and consists of overtime paid to permanent employees and amounts paid to
temporary and contract personnel. We continue to balance the number of
full-time employees and the use of temporary and contract personnel with
anticipated loan origination volumes.
Quarterly Comparison: Salaries, benefits and incentives increased by $10
million compared to 2011 primarily due to an increase in the average number of
permanent employees in the mortgage production operations and an increase in
management incentive compensation. The $8 million increase in commissions was
primarily attributable to a 36% increase in closings from our real estate
channel which has higher commission rates than
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private label closings. Contract labor and overtime increased by $6 million
compared to 2011 and was driven by higher overall closing volumes.
Year-to-Date Comparison: Salaries, benefits and incentives increased by $10
million compared to 2011 primarily due to an increase in the average number of
permanent employees in the mortgage production operations and an increase in
management incentive compensation. The $14 million increase in commissions was
primarily attributable to a 32% increase in closings from our real estate
channel which has higher commission rates than private label closings. Contract
labor and overtime increased by $2 million compared to 2011 and was driven by
higher overall closing volumes.
Other Operating Expenses
Other operating expenses allocable to the Mortgage Production segment consist of
production-related direct expenses, allocations for corporate overhead and other
production related expenses.
The components of Other operating expenses were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)Production-related direct expenses $ 32 $ 23 $ 61
$ 43
Corporate overhead allocation 19 14 38 30
Other expenses 23 17 42 39
Total $ 74 $ 54 $ 141 $ 112
Production-related direct 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 incurred during the loan
origination process and are primarily driven by applications. Corporate
overhead allocations relate to segment allocations of shared general and
administrative costs and costs associated with operating and managing corporate
functions and are discussed above under "-Results of Operations-Other." Other
expenses consist of other production-related expenses that include, but are not
limited to professional fees, information technology costs, outsourcing fees and
customer service expenses.
Quarterly Comparison: Production-related direct expenses increased by $9
million compared to 2011 primarily due to increases in the number of retail
applications. The $6 million increase in other expenses compared to 2011 was
primarily attributable to higher costs associated with legal and regulatory
compliance activities.
Year-to-Date Comparison: Production-related direct expenses increased by $18
million compared to 2011 primarily due to increases in the number of retail
applications. The $3 million increase in other expenses compared to 2011 was
primarily attributable to higher costs associated with legal and regulatory
compliance activities.
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Mortgage Servicing Segment
The following tables present a summary of our financial results and key related
drivers for the Mortgage Servicing segment, and are followed by a discussion of
each of the key components of Net revenues and Total expenses:
As of June 30,
2012 2011
($ In millions)
Ending total loan servicing portfolio $ 192,775 $ 173,651
Number of loans serviced 1,100,857
1,033,360
Ending capitalized loan servicing portfolio $ 147,894$ 142,436
Capitalized servicing rate
0.78 % 1.06 %
Capitalized servicing multiple 2.6
3.5
Weighted-average servicing fee (in basis points) 30 30
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Average total loan servicing portfolio $ 186,984 $ 172,053 $ 185,551 $ 170,365
Average capitalized loan servicing
portfolio 148,864 141,499 148,622 139,707
Payoffs and principal curtailments of
capitalized portfolio 8,412 4,943 16,639 10,966
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Mortgage interest income $ 2 $ 4 $ 5 $ 8
Mortgage interest expense (17 ) (20 ) (33 ) (40 )
Mortgage net finance expense (15 ) (16 ) (28 ) (32 )
Loan servicing income 100 117 221 225
Change in fair value of mortgage
servicing rights (205 ) (159 ) (226 ) (191 )
Net derivative gain (loss) related to
mortgage servicing rights 2 - (3 ) -
Valuation adjustments related to
mortgage servicing rights, net (203 ) (159 ) (229 ) (191 )
Net loan servicing (loss) income (103 ) (42 ) (8 ) 34
Other (expense) income - - (1 ) (3 )
Net revenues (118 ) (58 ) (37 ) (1 )
Salaries and related expenses 9 8 19 17
Occupancy and other office expenses 2 2 4 5
Other operating expenses 67 45 162 76
Total expenses 78 55 185 98
Segment loss $ (196 ) $ (113 ) $ (222 ) $ (99 )
Mortgage Net Finance Expense
Mortgage net finance expense allocable to the Mortgage Servicing segment
consists of interest income from escrow balances, income from investment
balances (including investments held in reinsurance trusts) and interest expense
allocated on debt used to fund our Mortgage servicing rights ("MSRs"), which is
driven by the average volume of outstanding borrowings and the cost of funds
rate of our outstanding borrowings.
Quarterly Comparison: Mortgage net finance expense decreased by $1 million
compared to 2011 and was comprised of a $3 million (15%) decrease in Mortgage
interest expense that was partially offset by a $2 million (50%) decrease in
Mortgage interest income. The decrease in Mortgage interest expense was
primarily
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attributable to a $2 million decrease in the interest expense allocated to fund
our MSRs resulting from a lower average MSR balance. Mortgage interest expense
and Mortgage interest income both decreased by $1 million compared to 2011 due
to the first quarter 2012 deconsolidation of a mortgage securitization trust
where we sold the residual interest.
Year-to-Date Comparison: Mortgage net finance expense decreased by $4 million
compared to 2011 and was comprised of a $7 million (18%) decrease in Mortgage
interest expense that was partially offset by a $3 million (38%) decrease in
Mortgage interest income. The decrease in Mortgage interest expense was
primarily attributable to a $5 million decrease in the interest expense
allocated to fund our MSRs resulting from a lower average MSR balance. Mortgage
interest expense and Mortgage interest income both decreased by $2 million
compared to 2011 due to the first quarter 2012 deconsolidation of a mortgage
securitization trust where we sold the residual interest.
Loan Servicing Income
The components of Loan servicing income were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Servicing fees from capitalized
portfolio $ 111 $ 106 $ 223 $ 209
Subservicing fees 3 4 7 7
Late fees and other ancillary
servicing revenue 13 12 30 29
Curtailment interest paid to
investors (10 ) (5 ) (20 ) (13 )
Net reinsurance loss (17 ) - (19 ) (7 )
Total $ 100 $ 117 $ 221 $ 225
The primary drivers for Loan servicing income are the average capitalized loan
servicing portfolio and average servicing fee. Service fee revenue is driven by
recurring servicing fees that are recognized upon receipt of the coupon payment
from the borrower and recorded net of guaranty fees. For loans that are
subserviced for others, we receive a nominal stated amount per loan which is
less than our average servicing fee related to the capitalized portfolio.
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. Net reinsurance loss represents premiums earned on
reinsurance contracts, net of ceding commission and provisions for reinsurance
reserves. Net reinsurance loss for the second quarter and six months ended June
30, 2012 also includes a loss related to the termination of one of our inactive
reinsurance contracts. Refer to "-Risk Management-Consumer Credit Risk-Mortgage
Reinsurance" for a description.
Quarterly Comparison: The $5 million increase in servicing fees from the
capitalized portfolio was primarily related to a 5% increase in the average
capitalized loan servicing portfolio compared to 2011. Curtailment interest
paid to investors increased by $5 million (100%) compared to 2011 primarily due
to a 117% increase in loan payoffs in our total loan servicing portfolio. The
$17 million increase in net reinsurance loss compared to 2011 was driven by a
$16 million loss related to the termination of an inactive reinsurance contract
and a $1 million decrease in premiums earned under reinsurance agreements in
runoff.
Year-to-Date Comparison: The $14 million increase in servicing fees from the
capitalized portfolio was primarily related to a 6% increase in the average
capitalized loan servicing portfolio compared to 2011. Curtailment interest
paid to investors increased by $7 million (54%) compared to 2011 primarily due
to a 72% increase in loan payoffs in our total loan servicing portfolio. The
$12 million increase in net reinsurance loss compared to 2011 was driven by a
$16 million loss related to the termination of an inactive reinsurance contract
and a $3 million decrease in premiums earned under reinsurance agreements in
runoff that was partially offset by a $7 million decrease in the provision for
reinsurance reserves resulting from slowing loss progressions as the maximum
loss rates for certain origination years have been reached.
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Valuation Adjustments Related to Mortgage Servicing Rights
Valuation adjustments related to mortgage servicing rights include Change in
fair value of mortgage servicing rights and Net derivative loss related to
mortgage servicing rights. The components of Valuation adjustments related to
mortgage servicing rights are discussed separately below.
Change in Fair Value of Mortgage Servicing Rights: 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 and other economic factors. Generally, the value of our MSRs is
expected to increase when interest rates rise and decrease when interest rates
decline due to the effect those changes in interest rates have on prepayment
estimates. Other factors noted above as well as the overall market demand for
MSRs may also affect the valuation.
The components of Changes in fair value of mortgage servicing rights were as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Actual prepayments of the
underlying mortgage loans $ (50 ) $ (29 ) $ (103 ) $ (73 )
Actual receipts of recurring cash
flows (10 ) (13 ) (21 ) (26 )
Market-related fair value
adjustments (145 ) (117 ) (102 ) (92 )
Total $ (205 ) $ (159 ) $ (226 ) $ (191 )
The change in fair value of MSRs due to actual prepayments is 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.
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.
Refer to "-Critical Accounting Policies and Estimates" for a description of the
updates made to the model used in the valuation of our mortgage servicing
rights.
Quarterly Comparison: The $21 million increase in actual prepayments of the
underlying mortgage loans compared to 2011 was primarily due to a 104% increase
in loan payoffs in the capitalized loan servicing portfolio which was partially
offset by a 13 basis point decrease in the average MSR value of prepayments.
Market-related fair value adjustments decreased the value of our MSRs by $145
million during the second quarter of 2012 and was primarily attributable to a
decrease in mortgage interest rates, including a 36 basis point decrease in the
primary mortgage rate used to value our MSR. The $117 million market-related
fair value decrease during the second quarter of 2011 was primarily attributable
to a decrease in mortgage interest rates and a $20 million decrease in fair
value related to higher projected foreclosure costs to service.
Year-to-Date Comparison: The $30 million increase in actual prepayments of the
underlying mortgage loans compared to 2011 was primarily due to a 68% increase
in loan payoffs in the capitalized loan servicing portfolio which was partially
offset by a 15 basis point decrease in the average MSR value of prepayments.
Market-related fair value adjustments decreased the value of our MSRs by $102
million during the six months ended June 30, 2012 and was primarily attributable
to a decrease in mortgage interest rates, including a 32 basis point decrease in
the primary mortgage rate used to value our MSR. The $92 million market-related
fair value decrease during the six months ended June 30, 2011 was primarily
attributable to a decrease in mortgage interest rates.
Net Derivative Gain (Loss) Related to Mortgage Servicing Rights: From
time-to-time, we may use 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. The change in fair value of derivatives is intended
to react in the opposite direction of the market-related change in the fair
value of MSRs, and generally increase in value as interest rates decline and
decrease in value as interest rates rise. The amount and composition of
derivatives used depends on
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the exposure to loss of value on our MSRs, the expected cost of the derivatives,
our expected liquidity needs and the increased earnings generated by origination
of new loans resulting from the decline in interest rates.
During the second quarter of 2012, we closed out of our derivative contracts
that were hedging a minor portion of our mortgage servicing rights based on the
current profile of MSR valuation sensitivities relative to the leverage and net
worth compliance requirements in our debt agreements. The value of derivatives
related to our MSRs increased by $2 million during the second quarter of 2012
and decreased by $3 million during the six months ended June 30, 2012. There
were no open derivatives related to MSRs during either period of 2011.
Other Income
Other income allocable to the Mortgage Servicing segment primarily consists of
the change in the net fair value of a mortgage securitization trust where we
hold a residual interest. These residual interests were sold during the first
quarter of 2012.
Year-to-Date Comparison: The $1 million reduction in Other income during the
six months ended June 30, 2012 was the resulting loss on sale of our residual
interests in the mortgage securitization trust which was partially offset by
realized gains from the sale of available-for-sale securities associated with
restricted investments held in our reinsurance trust accounts.
The $3 million reduction in Other income during the six months ended June 30,
2011 was primarily attributable to an increase in projected credit losses of the
underlying securitized mortgage loans which comprised the securitization trust.
Other Operating Expenses
The following table presents a summary of Other operating expenses:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)Foreclosure-related charges $ 39 $ 24 $ 104 $
39
Corporate overhead allocation 4 4 8 7
Other expenses 24 17 50 30
Total $ 67 $ 45 $ 162 $ 76
Foreclosure-related charges are driven by the volume of repurchase and
indemnification requests, claims appeal success rates and expected loss
severities. Repurchase requests from all investors and insurers have been
volatile and the persistency of these recent trends remains extremely
uncertain. Expected loss severities are impacted by various economic factors
including delinquency rates and home price values while our claims appeal
success rate can fluctuate based on the validity and composition of repurchase
demands and the underlying quality of the loan files. See "-Risk
Management-Consumer Credit Risk-Loan Repurchases and Indemnifications" for a
further discussion of the sensitivity of our loan repurchase and indemnification
liability.
Corporate overhead allocations relate to segment allocations of shared general
and administrative costs and costs associated with operating and managing
corporate functions and are discussed above under "-Results of
Operations-Other."
Other expenses include operating expenses of the Mortgage Servicing segment,
including costs directly associated with servicing loans in foreclosure and real
estate owned, professional fees and outsourcing fees.
Quarterly Comparison: Foreclosure-related charges increased by $15 million
compared to 2011 and were primarily attributable to a significant increase in
our actual and future expected number of repurchase and indemnification requests
from the GSEs and a decline in our claims appeal success rate that was partially
offset by a decrease in our estimated future loss severities. The amount of
unresolved repurchase and indemnification
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requests was 36% higher compared to June 30, 2011 and the total number of
repurchase requests we received increased by 45% compared to the second quarter
of 2011.
The $7 million increase in other expenses compared to 2011 was primarily due to
an increase in expenses associated with servicing delinquent and foreclosed
loans and real estate owned that was partially offset by a reduction in
liabilities for compensatory fees related to foreclosure processing which was
driven by changes to the servicing guidelines that were announced during the
second quarter of 2012.
Year-to-Date Comparison: Foreclosure-related charges were $104 million during
the six months ended June 30, 2012, compared to $39 million during 2011. The
increase is reflective of the significant increase in the actual and future
expected number of repurchase and indemnification requests from the GSEs and a
decline in our claims appeal success rate that was partially offset by a
decrease in our estimated future loss severities. The total number of
repurchase requests we received increased by 57% compared to the six months
ended June 30, 2011.
The $20 million increase in other expenses compared to 2011 was primarily due to
an increase in expenses associated with servicing delinquent and foreclosed
loans and real estate owned.
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Fleet Management Services Segment
The following tables present a summary of our financial results and related
drivers for the Fleet Management Services segment, and are followed by a
discussion of each of the key components of our Net revenues and Total expenses:
Average for the Average for the
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In thousands of units)
Leased vehicles 267 274 268 276
Maintenance service cards 347 318 343 318
Fuel cards 301 293 299 291
Accident management vehicles 314 293 314 294
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Fleet management fees $ 45 $ 44 $ 92 $ 86
Fleet lease income 338 343 674 680
Other income 18 19 36 35
Net revenues 401 406 802 801
Salaries and related expenses 16 16 32 31
Occupancy and other office expenses 3 4 7
8
Depreciation on operating leases 303 309 604
615
Fleet interest expense 18 21 36
43
Other depreciation and amortization 2 2 5 5
Other operating expenses 37 35 72 64
Total expenses 379 387 756 766
Segment profit $ 22 $ 19 $ 46 $ 35
Fleet Management Fees
The drivers of Fleet management fees are leased vehicles and service unit counts
as well as the usage of fee-based services. Fleet management fees consist
primarily of the revenues of our principal fee-based products: fuel cards,
maintenance services, accident management services and monthly management fees
for leased vehicles. Fleet management fees also include driver safety training
services fees.
Quarterly Comparison: Fleet management fees increased by $1 million (2%)
compared to 2011 primarily due to higher usage of asset-based fleet management
services related to asset dispositions.
Year-to-Date Comparison: Fleet management fees increased by $6 million (7%)
compared to 2011 primarily due to a $4 million increase in fees associated with
fee-based products resulting from higher client participation in driver safety
training services and an increase in maintenance service card units. The
remaining $2 million increase in Fleet management fees compared to 2011 was due
to higher usage of asset-based fleet management services related to asset
dispositions.
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Fleet Lease Income
The following table presents a summary of the components of Fleet lease income:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Leasing revenue $ 334 $ 340 $ 667 $ 677
Operating lease syndication revenue 4 3 7 3
Total $ 338 $ 343 $ 674 $ 680
Fleet lease income consists of leasing revenue related to operating and direct
financing leases as well as the gross sales proceeds associated with our
operating lease syndications. We originate certain leases with the intention of
syndicating to banks and other financial institutions, which includes the sale
of the underlying assets and assignment of any rights to the leases. Upon the
transfer and assignment of operating leases that qualify for sales treatment we
record the proceeds from the sale within Fleet lease income and recognize the
cost of goods sold within Other operating expenses for the undepreciated cost of
the asset sold.
Leasing revenue related to operating leases consists of an interest component
for the funding cost inherent in the lease as well as a depreciation component
for the cost of the vehicles under lease. Leasing revenue related to direct
financing leases consists of an interest component for the funding cost inherent
in the lease.
Quarterly Comparison: Leasing revenue decreased by $6 million (2%) compared to
2011 primarily due to a 3% decline in the average number of leased vehicles,
which was partially offset by an increase in net investment in leases reflecting
the growth in average lease balances. The $6 million decrease in leasing
revenue was partially offset by a $6 million decrease in Depreciation on
operating leases as described below. The amount of gross sales proceeds related
to operating lease syndications resulted in a $1 million increase in Fleet lease
income compared to 2011.
Year-to-Date Comparison: Leasing revenue decreased by $10 million (1%) compared
to 2011 primarily due to a 3% decline in the average number of leased vehicles,
which was partially offset by an increase in net investment in leases reflecting
the growth in average lease balances. The $10 million decrease in leasing
revenue was partially offset by an $11 million decrease in Depreciation on
operating leases as described below. The amount of gross sales proceeds related
to operating lease syndications resulted in a $4 million increase in Fleet lease
income compared to 2011.
Other Income
Other income primarily consists of gross sales proceeds from our owned vehicle
dealerships, the gain or loss from the sale of used vehicles and other ancillary
revenues.
Depreciation on Operating Leases
Depreciation on operating leases is the depreciation expense associated with our
vehicles under operating leases included in Net investment in fleet leases.
Quarterly Comparison: Depreciation on operating leases decreased by $6 million
(2%) compared to 2011 primarily due to a 3% decline in the average number of
leased vehicles which was partially offset by an increase in net investment in
leases.
Year-to-Date Comparison: Depreciation on operating leases decreased by
$11 million (2%) compared to 2011 primarily due to a 3% decline in the average
number of leased vehicles which was partially offset by an increase in net
investment in leases.
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Fleet Interest Expense
Fleet interest expense is primarily driven by the average volume and cost of
funds rate of outstanding borrowings and consists of interest expense associated
with borrowings related to leased vehicles, changes in market values of interest
rate cap agreements related to vehicle asset-backed debt and amortization of
deferred financing fees.
Quarterly Comparison: Fleet interest expense decreased by $3 million (14%)
compared to 2011 primarily due to a favorable change in the cost of funds rates
resulting from debt renewals and a decrease in the amortization of deferred
financing fees.
Year-to-Date Comparison: Fleet interest expense decreased by $7 million (16%)
compared to 2011 primarily due to a favorable change in the cost of funds rates
resulting from debt renewals and a decrease in the amortization of deferred
financing fees.
Other Operating Expenses
The following table presents a summary of the components of Other operating
expenses:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Cost of goods sold $ 17 $ 15 $ 32 $ 27
Corporate overhead allocation 11 11 22 22
Other expenses 9 9 18 15
Total $ 37 $ 35 $ 72 $ 64
Cost of goods sold represents the acquisition cost of vehicles at our
dealerships and the carrying value of certain operating leases syndicated to
banks and other financial institutions. The gross sales proceeds from our owned
dealerships are included in Other income and the proceeds from syndications are
recorded within Fleet lease income. Corporate overhead allocations relate to
segment allocations of shared general and administrative costs and costs
associated with operating and managing corporate functions and are discussed
above under "-Results of Operations-Other."
Quarterly Comparison: The $2 million increase in cost of goods sold compared to
2011 was primarily attributable to an increase in the amount of operating lease
syndications.
Year-to-Date Comparison: The $5 million increase in cost of goods sold compared
to 2011 was primarily attributable to an increase in the amount of operating
lease syndications. Other expenses increased by $3 million compared to 2011
primarily due to expenses associated with higher client participation in driver
safety training services.
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RISK MANAGEMENT
In the normal course of business we are exposed to various risks including, but
not limited to, interest rate risk, consumer credit risk, commercial credit
risk, counterparty credit risk, liquidity risk and foreign exchange risk. The
Finance and Risk Management Committee of the Board of Directors provides
oversight with respect to the assessment of our overall capital structure and
its impact on the generation of appropriate risk adjusted returns, as well as
the existence, operation and effectiveness of our risk management programs,
policies and practices. Our Chief Risk Officer, working with each of our
businesses, oversees governance processes and monitoring of these risks
including the establishment of risk strategy and documentation of risk policies
and controls.
Interest Rate Risk
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. Additionally, our escrow earnings on our mortgage
servicing rights and our net investment in variable-rate lease assets are
sensitive to changes in short-term interest rates such as LIBOR. We also are
exposed to changes in short-term interest rates on certain variable rate
borrowings including our mortgage warehouse asset-backed debt, vehicle
management asset-backed debt and our unsecured revolving credit facility. We
anticipate that such interest rates will remain our primary benchmark for market
risk for the foreseeable future.
Refer to "-Item 3. Quantitative and Qualitative Disclosures About Market Risk"
for an analysis of the impact of 25 bps, 50 bps and 100 bps changes in interest
rates on the valuation of assets and liabilities sensitive to interest rates.
Consumer Credit Risk
Our exposures to consumer credit risk include:
† Loan repurchase and indemnification obligations from breaches of
representation and warranty provisions of our loan sales or servicing
agreements, which result in indemnification payments or exposure to loan
defaults and foreclosures;
† Mortgage reinsurance losses; and
† A decline in the fair value of mortgage servicing rights as a result
of increases in involuntary prepayments from increasing portfolio delinquencies.
Loan Repurchases and Indemnifications
Foreclosure-related reserves are maintained for probable losses related to
repurchase and indemnification obligations and on-balance sheet loans in
foreclosure and real estate owned. The liability for loan repurchases and
indemnifications 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. These assumptions
include the estimated amount and timing of repurchase and indemnification
requests, the expected success rate of defending against requests and estimated
loss severities on repurchases and indemnifications. While the best information
available is used in estimating our liability, our actual experience can vary
significantly from our assumptions as the estimation process is inherently
uncertain. Given the increased levels of repurchase requests and realized
losses in recent periods, there is a reasonable possibility that future losses
may be in excess of the recorded liability.
As of June 30, 2012, the estimated amount of reasonably possible losses in
excess of the recorded liability was $105 million. This estimate assumes that
repurchases and indemnifications remain at an elevated level through the year
ended December 31, 2013, our success rate in defending against requests declines
and loss severities remain at current levels. Our estimate of reasonably
possible losses does not represent probable losses and is based upon significant
judgments and assumptions which can be influenced by many factors, including:
(i) home prices and the levels of home equity; (ii) the criteria used by
investors in selecting loans to request; (iii) borrower delinquency patterns;
and (iv) general economic conditions.
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Actual losses incurred in connection with loan repurchases and indemnifications
could vary significantly from and exceed the recorded liability. We may also be
required to increase our loan repurchase and indemnification liability in the
future. Accordingly, there can be no assurance that actual losses or estimates
of reasonably possible losses associated with loan repurchases and
indemnifications will not be in excess of the recorded liability or that we will
not be required to increase the recorded liability in the future.
Foreclosure-related reserves consist of the following:
June 30, December 31,
2012 2011
(In millions)
Loan repurchase and indemnification liability $ 140 $ 95
Allowance for probable foreclosure losses
21 19
Adjustment to value for real estate owned 14 13
Total $ 175 $ 127
A summary of the activity in foreclosure-related reserves is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)
Balance, beginning of period $ 165 $ 115 $ 127 $ 111
Realized foreclosure losses (33 ) (19 ) (66 ) (35 )
Increase in reserves due to:
Change in assumptions 39 24 104 39
New loan sales 4 2 10 7
Balance, end of period $ 175 $ 122 $ 175 $ 122
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Loan Repurchase & Indemnification Liability
We subject the population of repurchase and indemnification requests received to
a review and appeal process to establish the validity of the claim and
corresponding obligation. The following table presents the unpaid principal
balance of our unresolved requests by status:
As of June 30, 2012 As of December 31, 2011
Investor Insurer Investor Insurer
Requests Requests Total Requests Requests Total
(In millions)
Agency Invested:
Claim pending (1) $ 59 $ - $ 59 $ 33 $ 1 $ 34
Appealed (2) 29 12 41 24 10 34
Open to review (3) 94 20 114 101 14 115
Agency requests 182 32 214 158 25 183
Private Invested:
Claim pending (1) 16 - 16 3 - 3
Appealed (2) 26 9 35 17 3 20
Open to review (3) 23 9 32 12 4 16
Private requests 65 18 83 32 7 39
Total $ 247 $ 50 $ 297 $ 190 $ 32 $ 222
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(1) Claim pending status represents loans that have completed the review
process where we have agreed with the representation and warranty breach and are
pending final execution.
(2) Appealed status represents loans that have completed the review process
where we have disagreed with the representation and warranty breach and are
pending response from the claimant. Based on claims received and appealed
during the twelve months ended June 30, 2012 that have been resolved, we were
successful in refuting approximately 90% of claims appealed.
(3) Open to review status represents loans where we have not completed our
review process. We appealed approximately 70% of claims received and reviewed
during the twelve months ended June 30, 2012.
Approximately 80% and 70% of the unpaid principal balance of our unresolved
repurchase requests relates to loans originated between 2005 and 2008 as of
June 30, 2012 and December 31, 2011, respectively.
See Note 9, "Credit Risk", in the accompanying Notes to Condensed Consolidated
Financial Statements for additional information regarding our
foreclosure-related reserves.
Mortgage Reinsurance
In the second quarter of 2012, we terminated one of our inactive reinsurance
contracts that resulted in a pre-tax loss of $16 million for the second quarter
and six months ended June 30, 2012 which was recorded in Loan servicing income
in the Condensed Consolidated Statements of Operations. See Note 9, "Credit
Risk", in the accompanying Notes to Condensed Consolidated Financial Statements
for additional information regarding the termination agreement.
We have remaining exposure to consumer credit risk through losses from one
contract with a primary mortgage insurance company that is inactive and in
runoff. We are required to hold securities in trust related to this potential
obligation, which were $130 million as of June 30, 2012 and were included in
Restricted cash, cash equivalents and investments in the accompanying Condensed
Consolidated Balance Sheets. As of June 30, 2012, a liability of $43 million was
included in Other liabilities in the accompanying Condensed Consolidated Balance
Sheets for incurred and incurred but not reported losses associated with our
mortgage reinsurance activities, which was determined on an undiscounted basis.
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A summary of the activity in reinsurance-related reserves is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In millions)Balance, beginning of period $ 72 $ 110 $
84 $ 113
Realized reinsurance losses(1) (33 ) (17 ) (51 ) (33 )
Increase in liability for
reinsurance losses(2) 4 4 10 17
Balance, end of period $ 43 $ 97 $ 43 $ 97
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(1) Realized reinsurance losses for the three and six months ended
June 30, 2012 includes $21 million related to the release of reserves associated
with the termination of an inactive reinsurance agreement.
(2) The increase in reinsurance reserves is recorded as an expense within
Loan servicing income in the accompanying Condensed Consolidated Statements of
Operations.
The following table summarizes certain information regarding mortgage loans that
are subject to reinsurance by year of origination as of June 30, 2012:
Maximum Foreclosures/
Unpaid Potential Average Real estate
Principal Exposure to Credit owned/
Balance (UPB) Reinsurance Loss Score(3) Delinquencies(1)(3) Bankruptcies(2)(3)
($ In millions)
Year of Origination:
2003 $ 208 $ 50 690 5.20% 8.12%
2004 582 71 690 4.17% 7.99%
2005 534 16 693 4.65% 10.86%
2006 300 - 692 7.08% 11.52%
2007 770 2 699 4.58% 11.36%
2008 539 18 723 3.73% 5.95%
2009 321 7 758 0.57% 0.37%
Total $ 3,254 $ 164 706 4.32% 8.61%
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(1) Represents delinquent mortgage loans for which payments are 60 days
or more outstanding as a percentage of the total unpaid principal balance.
(2) Calculated as a percentage of the total unpaid principal balance.
(3) Based on March 31, 2012 data.
Commercial Credit Risk
We are exposed to commercial credit risk for our clients under the lease and
service agreements of our Fleet Management Services segment. We manage such risk
through an evaluation of the financial position and creditworthiness of the
client, which is performed on at least an annual basis. The lease agreements
generally allow us to refuse any additional orders; however, the obligation
remains for all leased vehicle units under contract at that time. The fleet
management service agreements can generally be terminated upon 30 days written
notice.
Counterparty & 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.
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As of June 30, 2012, there were no significant concentrations of credit risk
with any individual counterparty or group of counterparties with respect to our
derivative transactions. Concentrations of credit risk associated with
receivables are considered minimal due to our diverse client base. With the
exception of the financing provided to customers of our mortgage business, we do
not normally require collateral or other security to support credit sales.
LIQUIDITY AND CAPITAL RESOURCES
We manage our liquidity and capital structure to fund growth in assets, 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 maximum liquidity needs during the
period, fluctuations in assets and liability levels due to changes in business
operations, levels of interest rates, and working capital needs. We also assess
market conditions and capacity for debt issuance in various markets we access to
fund our business needs. Our primary operating funding needs arise from the
origination and financing of mortgage loans, the purchase and funding of
vehicles under management 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 from investors and
insurers of loans that have been previously sold.
Sources of liquidity include: equity capital (including retained earnings); the
unsecured debt markets; committed and uncommitted credit facilities; secured
borrowings, including the asset-backed debt markets; cash flows from operations
(including service fee and lease revenues); cash flows from assets under
management; and proceeds from the sale or securitization of mortgage loans and
lease assets.
We are continuing to monitor developments in regulations that may impact our
businesses including the Dodd-Frank Act and ongoing GSE reforms that could have
a material impact on our liquidity. For more information, see "Part I-Item 1A.
Risk Factors-Risk Related to our Company-The businesses in which we engage are
complex and heavily regulated, and changes in the regulatory environment
affecting our businesses could have a material adverse effect on our business,
financial position, results of operations or cash flows." in our Form 10-K and
"Item 1A. Risk Factors-Risk Related to our Company-Changes in existing U.S.
government-sponsored mortgage programs or servicing eligibility standards could
materially and adversely affect our business, financial position, results of
operations or cash flows." in this Form 10-Q.
As of June 30, 2012, our near-term unsecured debt maturities include $418
million of Term notes due March 1, 2013. Additionally, we may need greater
liquidity in the short term to fund increases in loan repurchases and
indemnifications as well as potential increased collateral posting requirements
related to derivative and debt agreements.
On August 2, 2012, our existing Amended Credit Facility agreement was amended
and restated, extending $300 million of available commitments. Under the terms
of the new facility (the "Revolving Credit Facility"), $50 million of
commitments expire on July 1, 2014 and $250 million of commitments expire on
August 2, 2015. Borrowings under the Revolving Credit Facility are subject to
satisfaction of certain conditions, including compliance with a borrowing base
coverage ratio test of unencumbered assets to unsecured debt of at least 1.2:1.
See Note 15, "Subsequent Events" for further discussion of the facility.
We have historically been reliant on accessing the capital markets for unsecured
debt in order to refinance or extend the maturities of our unsecured debt at the
parent company level and we may do so in the future. There has been a prolonged
period of uncertainty and volatility in the economy, which may impair or limit
our access to unsecured funding. Additionally, our senior unsecured long-term
debt credit ratings are below investment grade, and as a result, our access to
the public debt markets may be severely limited in comparison to the ability of
investment grade issuers to access such markets.
Liquidity and Capital Plan
Our goals for 2012 include a focus on increasing liquidity and cash flow
generation, addressing our near-term debt maturities and negotiating an
extension of our unsecured revolving credit facility. Consistent with those
goals, we
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have developed a liquidity and capital plan consisting of various steps to
improve our liquidity and capital position, which may involve one or more of the
following:
(i) focusing our efforts to ensure that our operations are cash flow
positive, which may include reductions in our correspondent mortgage
originations;
(ii) disposing of assets that are not necessary to support our business
strategies, which may include the assets of our reinsurance business; and
(iii) generating mortgage servicing rights with minimal use of cash.
We have taken the following actions in the six months ended June 30, 2012 to
improve our liquidity and capital position:
† completed an offering of 6.0% Convertible notes due 2017 with $243
million of net cash proceeds;
† repaid $252 million of unsecured term debt, including the Convertible
notes due 2012;
† generated $78 million of cash from the sale of non-conforming mortgage
loans and residual investments and the securitization of fleet leases;
† generated $40 million of unrestricted cash from our reinsurance
subsidiary, including $24 million from the termination of a reinsurance
agreement and $16 million from the release of restricted cash in excess of the
trust requirements;
† selectively originated loans in our wholesale/correspondent platform
with minimal cash consumption; and
† aligned our business operations with established cash flow targets to
support the repayment of our near-term unsecured debt maturities.
These actions generated $109 million of unrestricted cash during the six months
ended June 30, 2012, and combined with our cash flows from other operating,
financing and investing activities, as discussed below, our Cash and cash
equivalents increased by $286 million from December 31, 2011.
In addition, in August 2012, we amended and restated our Amended Credit
Facility. See Note 15, "Subsequent Events" for details.
We will continue to actively refine our liquidity plan and take all appropriate
actions in an effort to ensure we have more than adequate liquidity to meet our
debt maturities and other liabilities. There can be no assurances that we will
be successful implementing this plan, or if we are successful, there can be no
assurances that our plan will be sufficient to meet our liquidity needs. We
believe that the execution of our liquidity and capital plan will provide
sufficient liquidity to meet our debt service obligations, fund potential
increases in repurchase and indemnification requests and operate our business.
However, the execution of our plan may have a negative impact on our future
results of operations, including revenue and net income.
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
and to repay our upcoming maturities. We expect aggregate capital expenditures
to be between $40 million and $45 million for 2012, in comparison to $25 million
for 2011.
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Cash Flows
At June 30, 2012, we had $700 million of Cash and cash equivalents, an increase
of $286 million from $414 million at December 31, 2011. The following table
summarizes the changes in Cash and cash equivalents:
Six Months Ended
June 30,
2012 2011 Change
(In millions)
Cash provided by (used in):
Operating activities $ 1,511 $ 3,099 $ (1,588 )
Investing activities (732 ) (638 ) (94 )
Financing activities (494 ) (2,440 ) 1,946
Effect of changes in exchange rates on Cash
and cash equivalents 1 (4 ) 5
Net increase in Cash and cash equivalents $ 286 $ 17 $ 269
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. In addition to depreciation and
amortization, the operating results of our reportable segments are impacted by
the following significant non-cash activities:
† Mortgage Production -Capitalization of mortgage servicing rights
† Mortgage Servicing -Change in fair value of mortgage servicing rights
† Fleet Management Services -Depreciation on operating leases
During the six months ended June 30, 2012, cash provided by operating activities
was $1.5 billion. This is primarily reflective of $1.2 billion of net cash
provided by the volume of mortgage loan sales in our Mortgage Production segment
and $21 million received from counterparties related to cash collateral posted
on derivative agreements. Cash provided by operating activities was further
driven by positive cash flows from our Mortgage Servicing and Fleet Management
Services segments.
The net cash provided by the operating activities of our Mortgage Production
segment resulted from a $682 million decrease in the Mortgage loans held for
sale balance in our Condensed Consolidated Balance Sheets between June 30, 2012
and December 31, 2011, which is the result of timing differences between
origination and sale as of the end of each period. The decrease in Mortgage
loans held for sale also resulted in a decrease in Mortgage Asset-Backed Debt as
further described in Financing Activities below.
During the six months ended June 30, 2011, cash provided by our operating
activities was $3.1 billion. This was reflective of $2.9 billion of net cash
provided by the volume of mortgage loan sales in our Mortgage Production segment
and in the operating activities of our Fleet Management Services segment. Other
adjustments and changes in other assets and liabilities, net primarily includes
the $68 million gain on the sale of an interest in our appraisal services
business and a net cash outflow of $200 million for cash collateral on
derivative agreements.
Investing Activities
Our cash flows from investing activities include cash outflows for purchases of
vehicle inventory, net of cash inflows for sales of vehicles within the Fleet
Management Services segment as well as changes in the funding requirements of
Restricted cash, cash equivalents and investments for all of our business
segments. Cash flows related to the acquisition and sale of vehicles fluctuate
significantly from period to period due to the timing of the underlying
transactions.
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During the six months ended June 30, 2012, cash used in our investing activities
was $732 million, which primarily consisted of $814 million in net cash outflows
from the purchase and sale of vehicles, partially offset by a $76 million net
decrease in Restricted cash, cash equivalents and investments primarily due to
the release of restricted cash and investments held in trust to the primary
mortgage insurer which resulted from the termination of one of our reinsurance
agreements.
During the six months ended June 30, 2011, cash used in our investing activities
was $638 million, which primarily consisted of $650 million in net cash outflows
from the purchase and sale of vehicles, partially offset by $20 million in net
cash inflows from the sale of an interest in our appraisal services business.
Financing Activities
Our cash flows from financing activities include proceeds from and payments on
borrowings under our vehicle management asset-backed debt, mortgage asset-backed
debt and unsecured debt facilities. The fluctuations in the amount of
borrowings within each period are due to working capital needs and the funding
requirements for assets supported by our secured and unsecured debt, including
Net investment in fleet leases, Mortgage loans held for sale and Mortgage
servicing rights.
During the six months ended June 30, 2012, cash used in our financing activities
was $494 million and related to $446 million of net payments on secured
borrowings resulting from the decreased funding requirements for Mortgage loans
held for sale described in Operating Activities and $9 million of net payments
on unsecured borrowings resulting from the repayment of the Convertible notes
due 2012 which was offset by the issuance of the Convertible Senior Notes due
2017. Our financing activities also reflect our efforts to maximize secured
borrowings against the available asset base.
During the six months ended June 30, 2011, cash used in our financing activities
was $2.4 billion and related to net payments on borrowings resulting from the
decreased funding requirements for Mortgage loans held for sale described in
Operating Activities and Investing Activities above.
Debt
We utilize both secured and unsecured debt as key components of our financing
strategy. Our primary financing needs arise from our assets under management
programs which are summarized in the table below:
June 30, December 31,
2012 2011
(In millions)
Restricted cash, cash equivalents and investments $ 497 $ 574
Mortgage loans held for sale
1,976
2,658
Net investment in fleet leases 3,701 3,515
Mortgage servicing rights 1,157 1,209
Total $ 7,331 $ 7,956
Asset-backed debt is used primarily to support our investments in vehicle
management and mortgage assets, and is secured by collateral which include
certain Mortgage loans held for sale and Net investment in fleet leases, among
other assets. The outstanding balance under the asset-backed debt facilities
varies daily based on our current funding needs for eligible collateral. In
addition, amounts undrawn and available under our revolving credit facility can
also be utilized to supplement asset-backed facilities and provide for the
funding of vehicles in the U.S. and Canada as well as the funding of mortgage
originations.
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The following table summarizes our Debt as of June 30, 2012:
Total Assets
Held as
Balance Collateral(1)
(In millions)
Vehicle Management Asset-Backed Debt $ 3,324 $ 3,953
Mortgage Asset-Backed Debt 1,789 1,866
Unsecured Debt 1,287 -
Total $ 6,400 $ 5,819
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(1) Assets held as collateral are not available to pay our general
obligations.
Vehicle Management Asset-Backed Debt
Vehicle management asset-backed debt primarily represents variable-rate debt
issued by our wholly owned subsidiary, Chesapeake Funding LLC, to support the
acquisition of vehicles used by our Fleet Management Services segment's U.S.
leasing operations and debt issued by Fleet Leasing Receivables Trust ("FLRT"),
a special purpose trust, used to finance leases originated by our Canadian fleet
operation.
Vehicle management asset-backed funding arrangements consisted of the following
facilities as of June 30, 2012:
End of Estimated
Total Available Revolving Maturity
Balance Capacity Capacity(1) Period(2) Date(3)
(In millions)
Chesapeake 2009-1 $ 136 n/a n/a n/a 12/15/12
Chesapeake 2009-2 498 n/a n/a n/a 02/15/14
Chesapeake 2009-3 43 n/a n/a n/a 08/07/14
Chesapeake 2009-4 28 n/a n/a n/a 11/07/12
FLRT 2010-1 67 n/a n/a n/a 12/15/13
Term notes, in amortization 772
Chesapeake 2011-2 350 $ 350 $ - 09/19/13 06/07/16
Chesapeake 2012-1 643 643 - 04/18/13 01/07/16
Term notes, in revolving period 993 993 -
Chesapeake 2010-1 574 875 301 06/26/13 03/07/16
FLRT 2010-2 547 741 194 08/30/12 04/15/22
Chesapeake 2011-1 410 625 215 06/26/14 10/07/16
Variable funding-notes 1,531 2,241 710
Other 28 28 -
Total $ 3,324 $ 3,262 $ 710
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(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) During the revolving period, the monthly collection of lease payments
allocable to each outstanding series creates availability to fund the
acquisition of vehicles and/or equipment to be leased to customers. Upon
expiration, the revolving period of the related series of notes ends and the
repayment of principal commences, amortizing monthly with the allocation of
lease payments until the notes are paid in full.
(3) Represents the estimated final repayment date of the amortizing
notes.
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Mortgage Asset-Backed Debt
Mortgage asset-backed debt primarily represents 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 needs under these facilities based on
forecasted volume of mortgage loan closings and sales.
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 MBS.
Mortgage asset-backed funding arrangements consisted of the following as of
June 30, 2012:
Total Available Maturity
Balance Capacity Capacity(1) Date
(In millions)
Debt:
Committed facilities of PHH
Mortgage:
Fannie Mae $ 652 $ 1,000 $ 348 12/15/12
Royal Bank of Scotland plc 187 500 313 06/21/13
Bank of America 50 415 365 10/11/12(2)
Barclays Bank PLC 69 350 281 12/11/12
Wells Fargo Bank 26 300 274 08/10/12(4)
Credit Suisse First Boston
Mortgage Capital LLC 103 250 (3) 147 05/22/13
Committed facilities of PHH Home
Loans:
Credit Suisse First Boston
Mortgage Capital LLC 352 425 (3) 73 05/22/13
Wells Fargo Bank 142 150 8 08/10/12(4)
Barclays Bank PLC 140 150 10 12/11/12
Committed repurchase facilities 1,721 3,540 1,819
Uncommitted facilities of PHH
Mortgage:
Fannie Mae - 2,000 2,000 n/a
Uncommitted repurchase
facilities - 2,000 2,000
Servicing advance facility 68 120 52 06/30/13
Total $ 1,789 $ 5,660 $ 3,871
Off-Balance Sheet Gestation
Facilities:
JP Morgan Chase $ 156 $ 500 $ 344 09/30/12
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(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) Provided certain conditions are met, the Bank of America facility may
be renewed for an additional year at our request.
(3) We may allocate a limited amount of capacity from the committed
facilities with Credit Suisse First Boston Mortgage Capital LLC between PHH
Mortgage and PHH Home Loans; however, the aggregate combined borrowing capacity
cannot exceed $675 million. The borrowing capacities in the table above
reflects the maximum available to PHH Home Loans.
(4) In July 2012, the Wells Fargo Bank facilities were amended and the
respective maturity dates were extended to October 9, 2012.
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Unsecured Debt
Unsecured credit facilities are utilized to fund our short-term working capital
needs to fund our MSRs and to supplement asset-backed facilities and provide for
a portion of the operating needs of our mortgage and fleet management
businesses. As of and during the six months ended June 30, 2012, there were no
amounts outstanding under the Amended Credit Facility.
Unsecured borrowing arrangements consisted of the following as of June 30, 2012:
Balance Total Available Maturity
Balance at Maturity Capacity Capacity Date
(In millions)
4% notes due in 2014 $ 218 $ 250 n/a n/a 09/01/14
6% notes due in 2017 192 250 n/a n/a 06/15/17
Convertible notes 410 500
9.25% notes due in 2016 449 450 n/a n/a 03/01/16
7.125% notes due in 2013 420 418 n/a n/a 03/01/13
Other 8 8 n/a n/a 04/15/18
Term notes 877 876
Amended Credit Facility - - $ 525 $ 507 (1) 02/28/13(2)
Other - - 5 5 09/30/12
Credit Facilities - - $ 530 $ 512
Total $ 1,287 $ 1,376
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(1) Utilized capacity reflects $18 million of letters of credit issued
under the Amended Credit Facility, which are not included in Debt in the
Condensed Consolidated Balance Sheet.
(2) In August 2012, the Amended Credit Facility was amended and restated as
discussed in Note 15, "Subsequent Events".
As of July 24, 2012, our credit ratings, and ratings outlook on our senior
unsecured debt were as follows:
Senior Short-Term Ratings
Debt Debt Outlook/Watch
Moody's Investors Service Ba2 NP Negative
Standard & Poors BB- B Negative
Fitch BB B Negative
In the three months ended June 30, 2012, Fitch Ratings downgraded our long-term
Issuer Default Ratings and senior unsecured debt rating to 'BB' from 'BB+',
removed us from Ratings Watch Negative and maintained our Rating Outlook as
Negative. The downgrade reflects Fitch's assessment of a variety of factors,
including but not limited to: an increase in potential mortgage loan
repurchases, our hedge practices related to our mortgage servicing rights, and
uncertainties regarding our liquidity profile.
Our senior unsecured long-term debt credit ratings are below investment grade,
and as a result, our access to the public debt markets may be severely limited
in comparison to the ability of investment grade issuers to access such markets.
A security rating is not a recommendation to buy, sell or hold securities, may
not reflect all of the risks associated with an investment in our debt
securities and is subject to revision or withdrawal by the assigning rating
organization. Each rating should be evaluated independently of any other rating.
See "Item 1A. Risk Factors-Risk Related to Our Company-Our senior unsecured
long-term debt ratings are below investment grade (and were subject to recent
downgrades) and, as a result, we may be limited in our ability to obtain or
renew financing on economically viable terms or at all." in this Form 10-Q for
more information.
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Debt Covenants
Certain of our debt arrangements require the maintenance of certain financial
ratios and contain other affirmative and negative covenants, termination events,
and other restrictions, including, but not limited to, covenants relating to
material adverse changes, liquidity maintenance, restrictions on our
indebtedness and the indebtedness of our material subsidiaries, mergers, liens,
liquidations, sale and leaseback transactions, and restrictions on certain types
of payments, including dividends and stock repurchases. Certain other debt
arrangements, including the Fannie Mae committed facility, contain provisions
that permit us or our counterparty to terminate the arrangement upon the
occurrence of certain events, including those described below.
There were no significant amendments to the terms of debt covenants during the
six months ended June 30, 2012. The covenants of the Amended Credit Facility
were amended in August 2012. See Note 15, "Subsequent Events" for additional
information.
As of June 30, 2012, we were in compliance with all financial covenants related
to our debt arrangements.
During the six months ended June 30, 2012, the termination events for the Fannie
Mae committed facility were amended to require that we maintain (i) on the last
day of each fiscal quarter, consolidated net worth of at least $1.0 billion;
(ii) on the last day of each fiscal quarter, a ratio of indebtedness to tangible
net worth no greater than 6.5 to 1; (iii) a minimum of $1.0 billion in committed
mortgage warehouse or gestation facilities, with no more than $500 million of
gestation facilities included towards the minimum, but excluding committed or
uncommitted loan purchase arrangements or other funding arrangements from Fannie
Mae and any mortgage warehouse capacity provided by government sponsored
enterprises; and (iv) compliance with certain loan repurchase trigger event
criteria related to the aging of outstanding loan repurchase demands by Fannie
Mae.
Under certain of our financing, servicing, hedging and related agreements and
instruments, the lenders or trustees have the right to notify us if they believe
we have breached a covenant under the operative documents and may declare an
event of default. If one or more notices of default were to be given, we believe
we would have various periods in which to cure certain of such events of
default. If we do not cure the events of default or obtain necessary waivers
within the required time periods, the maturity of some of our debt could be
accelerated and our ability to incur additional indebtedness could be
restricted. In addition, an event of default or acceleration under certain of
our agreements and instruments would trigger cross-default provisions under
certain of our other agreements and instruments.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Mortgage Servicing Rights. In the first quarter of 2012, we integrated an
updated prepayment model used in the valuation of our mortgage servicing rights,
which we believe is more closely aligned with the actual prepayment speeds of
our capitalized servicing portfolio. Additionally, the new model utilizes a
combination of standard default curves and current delinquency levels to project
future delinquencies and foreclosures, whereas the previous model assumed
current delinquency and foreclosure rates would remain constant over the life of
the asset. Based upon the results of our analysis of the modeled value and
validation of our value and current assumptions against third-party sources,
there was no change to the overall value of MSRs as a result of the prepayment
model update.
See "Part II - Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Policies and
Estimates" of our 2011 Form 10-K for further discussion of our critical
accounting policies and estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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 Condensed Consolidated
Financial Statements.
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