The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto appearing elsewhere in this Form 10-Q and
in our results for the year ended December 31, 2011, filed in our annual Report
on Form 10-K on March 9, 2012. Historical results and trends which might appear
should not be taken as indicative of future operations, particularly in light of
our acquisition of GTCS Holdings LLC, or Green Tree, discussed below. Our
results of operations and financial condition, as reflected in the accompanying
statements and related footnotes, are subject to management's evaluation and
interpretation of business conditions, changing capital market conditions, and
other factors.
Our website can be found at www.walterinvestment.com. We make available, free of
charge through the investor relations section of our website, access to our
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K, other documents and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
amended, as well as proxy statements, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC. We also make
available, free of charge, access to our Corporate Governance Standards,
charters for our Audit Committee, Compensation and Human Resources Committee,
and Nominating and Corporate Governance Committee, and our Code of Conduct and
Ethics governing our directors, officers, and employees. Within the time period
required by the SEC and the NYSE Amex, we will post on our website any amendment
to the Code of Conduct and Ethics and any waiver applicable to any executive
officer, director, or senior officer (as defined in the Code of Conduct and
Ethics). In addition, our website includes information concerning purchases and
sales of our equity securities by our executive officers and directors, as well
as disclosure relating to certain non-GAAP and financial measures (as defined by
SEC Regulation G) that we may make public orally, telephonically, by webcast, by
broadcast, or by similar means from time to time. The information on our website
is not part of this Quarterly Report on Form 10-Q.
Our Investor Relations Department can be contacted at 3000 Bayport Drive, Suite
1100, Tampa, Florida 33607, Attn: Investor Relations, telephone (813) 421-7694.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Certain statements in this report, including matters discussed under Item 2,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," should be read in conjunction with the financial statements,
related notes, and other detailed information included elsewhere in this
Quarterly Report on Form 10-Q. We are including this cautionary statement to
make applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Form 10-Q may contain certain
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which reflect our current views with respect to certain events that
may affect our future performance. Statements that are not historical fact are
forward-looking statements. Certain of these forward-looking statements can be
identified by the use of words such as "believes," "anticipates," "expects,"
"intends," "plans," "projects," "estimates," "assumes," "may," "should," "will,"
or other similar expressions. Such forward-looking statements involve known and
unknown risks, uncertainties and other important factors, which could cause
actual results, performance or achievements to differ materially from future
results, performance or achievements. These forward-looking statements are based
on our current beliefs, intentions and expectations. These statements are not
guarantees or indicative of future performance. Important assumptions and other
important factors that could cause actual results to differ materially from
those forward-looking statements include, but are not limited to, those factors,
risks and uncertainties described in our Annual Report on Form 10-K filed on
March 9, 2012 under the caption "Risk Factors" and in our other securities
filings with the Securities and Exchange Commission.
In particular (but not by way of limitation), the following important factors
and assumptions could affect our future results and could cause actual results
to differ materially from those expressed in the forward-looking statements:
• local, regional, national and global economic trends and developments in
general, and local, regional and national real estate and residential
mortgage market trends in particular;
• continued uncertainty in the U.S. home sale market, including both the volume and pricing of sales, due to adverse economic conditions or
otherwise;
• fluctuations in interest rates and levels of mortgage prepayments;
• risks related to the financing incurred in connection with the acquisition
of Green Tree, including our ability to achieve cash flows sufficient to
carry our debt and otherwise to meet the covenants of our debt;
• the occurrence of anticipated growth of the specialty servicing sector;
• the effects of competition on our existing and potential future business, including the impact of competitors with greater financial resources and
broader scopes of operation;
29
--------------------------------------------------------------------------------
Table of Contents
• our ability to raise capital to make suitable investments to offset
run-off in a number of the portfolios we service and to grow our business;
• our ability to implement strategic initiatives, particularly as they
relate to our ability to develop new business, including the
implementation of delinquency flow programs and the receipt of new
business, which are both subject to customer demand and approval;
• our ability to earn anticipated levels of performance and incentive fees
on serviced business;
• the availability of suitable investments for any capital that we are able to raise and risks associated with any such investments we may pursue;
• changes in federal, state and local policies, laws and regulations
affecting our business, including mortgage financing or servicing, and
changes to our licensing requirements;
• changes caused by the Dodd-Frank Wall Street Reform and Consumer
Protection Act ("Dodd-Frank"), including regulations required by
Dodd-Frank that have yet to be finalized;
• uncertainties related to regulatory pressures on large banks related to
their mortgage servicing, as well as regulatory pressure on the rest of
the mortgage servicing sector, including increased performance standards
and reporting obligations;
• changes in regards to the rights and obligations of property owners,
mortgagors and tenants;
• our ability to remain qualified as a government-sponsored entity approved servicer or component servicer, including the ability to continue to
comply with the government-sponsored entities' respective servicing
guides;
• uncertainty relating to the status of government-sponsored entities;
• uncertainty related to inquiries from government agencies into past servicing, foreclosure, loss mitigation, and lender-placed insurance
practices;
• uncertainties related to the processes for judicial and non-judicial
foreclosure proceedings, including potential additional costs, delays or
moratoria in the future or claims pertaining to past practices;
• unexpected losses resulting from pending, threatened or unforeseen
litigation or other third-party claims against the Company;
• the effects of any changes to the servicing compensation structure for
mortgage servicers pursuant to programs of government-sponsored entities
or various regulatory authorities;
• changes to our insurance agency business, including increased scrutiny by
government regulators and government-sponsored entities on lender-placed
insurance practices;
• the effect of Company risk management strategies, including the management
and protection of the personal and private information of our customers
and mortgage holders and the protection of our information systems from
third-party interference (cyber security);
• changes in accounting standards;
• our continued listing on the NYSE Amex or other public exchange;
• the ability or willingness of Walter Energy, Inc. and other counterparties
to satisfy material obligations under agreements with us; and
• other presently unidentified factors.
The forward-looking statements included herein are only made as of the date of
the quarterly report on Form 10-Q. We undertake no obligation to update or
revise the information contained herein, including any forward-looking
statements whether as a result of new information, subsequent events or
circumstances, or otherwise, unless otherwise required by law.
The Company
We are a fee-based business services provider to the residential mortgage
industry. We are a specialty servicer providing residential loan servicing that
focuses on credit-sensitive residential mortgage assets located in the United
States, or U.S. We are also a mortgage portfolio owner and operate an insurance
agency serving residential loan customers.
Acquisitions and Other Business Combinations
Acquisition of Green Tree
On July 1, 2011, we acquired 100% of the outstanding membership interests of
Green Tree, or the Acquisition. Green Tree, based in St. Paul, Minnesota, is a
fee-based, business services company providing high-touch, third-party servicing
of credit-sensitive loans. The purchase price of the Acquisition consisted of
cash of approximately $1.0 billion and the issuance of common stock with a fair
value of $40.2 million. The cash portion of the purchase price was funded by
monetizing certain existing assets and by the issuance of corporate debt
totaling $765 million. The Acquisition was accounted for under the acquisition
method and accordingly, the assets acquired and liabilities assumed were
recorded at their estimated fair values. Net assets with an estimated fair value
of $1.1 billion were acquired by us, which included the recognition of estimates
of goodwill of $471.3 million and identifiable intangible assets of $150.1
million.
Pursuant to the accounting guidance for Variable Interest Entities, or VIEs, we
consolidated ten securitization trusts for which Green Tree performs the
servicing. We do not currently own any residual interests in these trusts, and
thus, we refer to these trusts as the Non-Residual Trusts. We have elected to
account for certain of the assets acquired and liabilities assumed of the
Non-Residual Trusts, which consist of residential loans, certain receivables and
the mortgage-backed debt, at fair value. We own the residual interests in all of
our other consolidated VIEs, which we refer to as the Residual Trusts.
30
--------------------------------------------------------------------------------
Table of Contents
Executive Summary
For the three and six months ended June 30, 2012, we reported net income of $0.4
million and $5.6 million, or $0.01 and $0.19 per diluted share, respectively,
which compared to a net loss of $3.4 million and net income of $0.1 million, or
$(0.13) and $0.00 per diluted share for the three and six months ended June 30,
2011, respectively.
We recognized before tax core earnings of $29.1 million and $62.2 million for
the three and six months ended June 30, 2012, respectively. Core earnings when
compared to our net income reflect the following key adjustments:
(1) depreciation and amortization expense related to the increase in basis
recognized on assets acquired with Green Tree, (2) share-based compensation,
(3) transaction and integration-related costs and (4) the net impact of the
Non-Residual Trusts, which are accounted for at fair value. For a reconciliation
of our consolidated income before income taxes under accounting principles
generally accepted in the U.S., or GAAP, to our core earnings, refer to the
Business Segment Results section.
Pro Forma Adjusted Earnings Before Interest, Taxes, Depreciation and
Amortization, or Pro Forma Adjusted EBITDA, was $58.2 million and $117.3 million
for the three months and six months ended June 30, 2012, respectively, which
when compared to our consolidated income before income taxes reflects the
adjustments noted above for core earnings as well as the following key
adjustments: (1) total depreciation and amortization expense, which includes
amortization noted as a core earnings adjustment, (2) interest expense on our
corporate debt, and (3) pro forma synergies. For a reconciliation of our
consolidated income before income taxes under GAAP to our Pro Forma Adjusted
EBIDTA, refer to the Business Segment Results section.
We generated $53.6 million in cash flow from operating activities during the six
months ended June 30, 2012 and finished the quarter with $38.3 million in cash
and cash equivalents. We also had $44.7 million in funds available under our
senior secured revolving credit facility at June 30, 2012.
We manage our Company in four primary business segments: Servicing; Asset
Receivables Management, or ARM; Insurance; and Loans and Residuals. Refer to the
Business Segment Results section for a presentation and discussion of our
financial results by business segment. A description of the business conducted
by each of these segments and related key financial highlights are provided
below:
Servicing - Our Servicing business segment consists of operations that perform
servicing for third-party investors in residential mortgages, manufactured
housing and consumer installment loans and contracts, as well as for the Loans
and Residuals segment and for the Non-Residual Trusts, which is reported in the
Other segment. For the three and six months ended June 30, 2012, our Servicing
segment recognized $74.2 million and $150.0 million, respectively, in
contractual servicing fees reflecting two full quarters of contractual fees on
our November and December 2011 boards of 159,000 loans. In addition, our
servicing segment recognized $14.4 million and $29.2 million in incentive and
performance fees during the three and six months ended June 30, 2012,
respectively, which includes amounts already earned from the 2011 boards, as
well as ancillary and other fees of $9.1 million and $18.2 million,
respectively.
ARM - Our ARM business segment performs collections of post charge-off
deficiency balances on behalf of securitization trusts and third-party asset
owners. Asset recovery revenue was $9.5 million and $17.8 million for the three
and six months ended June 30, 2012, respectively.
Insurance - Our Insurance business segment provides voluntary and lender-placed
hazard insurance for residential loans, as well as other ancillary products,
through our insurance agencies for a commission. Net written premiums were $39.0
million and $88.6 million for the three and six months ended June 30, 2012,
respectively. Net written premiums included lender-placed activity of $15.3
million and $44.1 million for the three and six months ended June 30, 2012,
respectively, and voluntary activity of $23.7 million and $44.5 million for the
same periods, respectively. Total insurance revenue was $16.8 million and $36.8
million for the three and six months ended June 30, 2012, respectively.
Loans and Residuals - Our Loans and Residuals business segment consists of the
assets and liabilities of the Residual Trusts, as well as our unencumbered
residential loan portfolio and real estate owned. Our net interest margin was
4.08% for the six months ended June 30, 2012, down 95 basis points from the same
period in 2011 due primarily to the monetization of assets completed during the
second quarter in 2011 in order to fund the acquisition of Green Tree. Total
delinquent loans have increased to 5.92% at June 30, 2012 from 5.73% at
December 31, 2011. The number of real estate owned properties has declined to
782 units at June 30, 2012, down 85 units from December 31, 2011.
31
--------------------------------------------------------------------------------
Table of Contents
Results of Operations - Comparison of Consolidated Results of Operations for the
Three and Six Months Ended June 30, 2012 and 2011
The acquisition of Green Tree had a significant impact on our consolidated
results of operations. Unless otherwise stated, significant variances are the
result of the acquisition of Green Tree.
We recognized net income of $0.4 million and $5.6 million for the three and six
months ended June 30, 2012, respectively, as compared to a net loss of $3.4
million and net income of $0.1 million for the same periods in the prior year,
respectively. A summary of our consolidated results of operations is provided
below (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011
Variance 2012 2011 Variance
Revenues
Servicing revenue and fees
$ 101,881 $ 3,310 $ 98,571 $ 204,529 $ 6,247 $ 198,282
Interest income on loans 40,453 42,029 (1,576 ) 79,733 83,384 (3,651 )
Insurance revenue 16,803 2,137 14,666 36,765 4,169 32,596
Other revenues 4,963 584 4,379 8,829 850 7,979
Total revenues 164,100 48,060 116,040 329,856 94,650 235,206
Expenses
Salaries and benefits 55,541 8,585 46,956 112,944 17,724 95,220
Interest expense 44,523 21,661 22,862 90,361 42,053 48,308
General and administrative 33,887 15,236 18,651 62,916 24,334 38,582
Depreciation and amortization 25,025 180 24,845 49,959 360 49,599
Provision for loan losses 1,957 875 1,082 3,526 1,500 2,026
Other expenses, net 3,180 4,993 (1,813 ) 6,666 8,949 (2,283 )
Total expenses 164,113 51,530 112,583 326,372 94,920 231,452
Other gains
Net fair value gains 788 - 788 5,551 - 5,551
Other - - - - 433 (433 )
Total other gains 788 - 788 5,551 433 5,118
Income (loss) before income taxes 775 (3,470 ) 4,245 9,035 163 8,872
Income tax expense (benefit) 347 (75 ) 422 3,472 68 3,404
Net income (loss) $ 428 $ (3,395 ) $ 3,823 $ 5,563 $ 95 $ 5,468
Servicing Revenue and Fees
We recognize servicing revenue and fees on servicing performed for third
parties. This revenue includes contractual fees earned on the serviced loans,
incentive and performance fees earned based on the performance of certain loans
or loan portfolios serviced by us and loan modification fees. Servicing revenue
and fees also includes asset recovery income, which is included in incentive and
performance fees, and ancillary fees such as late fees and prepayment fees.
Servicing revenue earned on loans in the consolidated VIEs, which consists of
both the Residual and Non-Residual Trusts, is eliminated in consolidation.
Servicing revenue and fees increased $98.6 million and $198.3 million for the
three and six months ended June 30, 2012, respectively, as compared to the same
periods in the prior year due to the acquisition of Green Tree.
A summary of servicing revenue and fees is provided below (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Servicing fees $ 69,068 $ 927 $ 68,141 $ 139,603 $ 1,953 $ 137,650
Incentive and performance fees 23,705 1,984 21,721 46,721 3,462 43,259
Ancillary and other fees 9,108 399 8,709 18,205 832 17,373
Servicing revenue and fees $ 101,881 $ 3,310 $
98,571 $ 204,529$ 6,247$ 198,282
Included in incentive and performance fees for the three and six months ended
June 30, 2012 are incentive fees of $7.0 million and $16.6 million,
respectively, Green Tree received for exceeding pre-defined performance hurdles
in servicing various loan portfolios. These fees may not recur on a regular
basis, as they are earned based on the performance of underlying loan pools as
compared to comparable pools serviced by others, as well as achievement of
certain performance hurdles over time, which may not be achieved on a regular
schedule.
32
--------------------------------------------------------------------------------
Table of Contents
Third-Party Servicing Portfolio
Provided below is a summary of the activity in our third-party servicing
portfolio, which includes accounts serviced for third parties for which we earn
servicing revenue and, thus, excludes residential loans and real estate owned
that have been recognized on our consolidated balance sheets (dollars in
thousands):
For the Six Months Ended June 30, 2012
Sub-Servicing
Number of Servicing Sub-Servicing Contracts
Accounts Rights Capitalized Contracts Capitalized Not Capitalized Total
Unpaid principal balance of
accounts serviced for third
parties
Balance at January 1, 2012 979,530 $ 18,717,559 $ 16,302,306 $ 48,264,295 $
83,284,160
New business added 25,634 615,904 - 1,570,883
2,186,787
Payoffs, sales and curtailments (30,334 ) (675,608 ) (805,910 ) (1,004,609 )
(2,486,127 )
Balance at March 31, 2012 974,830 18,657,855 15,496,396 48,830,569
82,984,820
New business added 3,300 - - 656,978
656,978
Payoffs, sales and curtailments (37,483 ) (757,107 ) (730,034 ) (2,995,090 )
(4,482,231 )
Balance at June 30, 2012 940,647 $ 17,900,748 $ 14,766,362 $ 46,492,457 $ 79,159,567
June 30, 2012
Ending number of accounts
serviced for third parties 387,862 292,733 260,052 940,647
For the Six Months Ended June 30, 2011
Sub-Servicing
Number of Servicing Sub-Servicing Contracts
Accounts Rights Capitalized Contracts Capitalized Not Capitalized (1) Total
Unpaid principal balance of
accounts serviced for third
parties
Balance at January 1, 2011 5,539 $ - $ - $ 1,348,329 $ 1,348,329
New business added 1,637 - - 382,771 382,771
Payoffs, sales and curtailments (1,086 ) - - (225,370 ) (225,370 )
Balance at March 31, 2011 6,090 - - 1,505,730 1,505,730
New business added 737 - - 105,849 105,849
Payoffs, sales and curtailments (1,315 ) - - (263,886 ) (263,886 )
Balance at June 30, 2011 5,512 $ - $ - $ 1,347,693 $ 1,347,693
June 30, 2011
Ending number of accounts
serviced for third parties - - 5,512 5,512
(1) The beginning balance of sub-servicing rights not capitalized of $1.3
billion consists of accounts acquired through the acquisition of Marix
Servicing, LLC, or Marix, in November 2010.
Interest Income on Loans
We earn interest income on the residential loans held in the Residual Trusts and
on our unencumbered residential loans, both of which are accounted for at
amortized cost. For the three and six months ended June 30, 2012, interest
income decreased $1.6 million and $3.7 million, respectively, as compared to the
same periods in 2011 primarily due to a decline in the residential loan balance.
The annualized portfolio disappearance rate, consisting of contractual payments,
voluntary prepayments and defaults, was 6.67% for the six months ended June 30,
2012. Provided below is a summary of the average balances of residential loans
at amortized cost and the related interest income and average yields (dollars in
thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Residential loans at
amortized cost
Interest income $ 40,453 $ 42,029 $
(1,576 ) $ 79,733$ 83,384 $ (3,651 )
Average balance
1,573,177 1,656,701 (83,524 ) 1,584,014 1,641,757 (57,743 )
Average yield 10.29 % 10.15 % 0.14 % 10.07 % 10.16 % -0.09 %
Insurance Revenue
Insurance revenue consists of commission income and fees earned on voluntary and
lender-placed insurance policies and other products sold to customers, net of
estimated future policy cancellations, as well as premium revenue from captive
reinsurers. Commission income is based on a percentage of the price of the
insurance policy sold, which varies based on the type of product. Insurance
revenue increased $14.7 million and $32.6 million for the three and six months
ended June 30, 2012, respectively, as compared to the same periods in the prior
year due to the acquisition of Green Tree.
33
--------------------------------------------------------------------------------
Table of Contents
Other Revenues
Other revenues increased $4.4 million and $8.0 million for the three and six
months ended June 30, 2012, respectively, as compared to the same periods in the
prior year due to management fee income, origination fee income and accretion of
certain acquisition-related fair value adjustments recognized by the Company.
Salaries and Benefits
The number of full-time-equivalent employees increased by approximately 2,200
employees as a result of the acquisition of Green Tree, causing the increase in
salaries and benefits expense of $47.0 million and $95.2 million for the three
and six months ended June 30, 2012, respectively, as compared to the same
periods in the prior year.
Interest Expense
We incur interest expense on our corporate debt, on the mortgage-backed debt
issued by the Residual Trusts, and on our servicing advance liabilities, all of
which are accounted for at amortized cost. For the three and six months ended
June 30, 2012, interest expense increased $22.9 million and $48.3 million,
respectively, as compared to the same periods in the prior year due largely to
the issuance in 2011 of $765.0 million in corporate debt and $223.1 million in
mortgage-backed debt used to fund the acquisition of Green Tree. Provided below
is a summary of the average balances of our corporate debt, the mortgage-backed
debt of the Residual Trusts, and the servicing advance liabilities, as well as
the related interest expense and average rates (dollars in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Debt
Interest expense $ 19,915 $ - $ 19,915 $ 40,343 $ - $ 40,343
Average balance 720,397 - 720,397 730,664 - 730,664
Average rate 11.06 % - 11.06 % 11.04 % - 11.04 %
Mortgage-backed debt at
amortized cost
Interest expense $ 23,425 $ 21,661 $ 1,764 $ 47,403 $ 42,053 $ 5,350
Average balance 1,376,229 1,361,929 14,300 1,388,656 1,372,456 16,200
Average rate 6.81 % 6.36 % 0.45 % 6.83 % 6.13 % 0.70 %
Servicing advance liabilities
Interest expense $ 1,183 $ - $ 1,183 $ 2,615 $ - $ 2,615
Average balance 105,341 - 105,341 106,434 - 106,434
Average rate 4.49 % - 4.49 % 4.91 % - 4.91 %
General and Administrative
General and administrative expenses increased $18.7 million and $38.6 million
during the three and six months ended June 30, 2012, respectively, as compared
to the same periods in the prior year. The increase was primarily due to $29.9
million and $54.1 million in general and administrative expenses incurred by
Green Tree in the three and six months ended June 30, 2012, respectively,
partially offset by transaction costs of $9.2 million and $12.3 million incurred
in the same periods of the prior year, respectively, relating to the acquisition
of Green Tree.
Depreciation and Amortization
Depreciation and amortization expense consists of amortization of capitalized
servicing rights and intangible assets other than goodwill, as well as
depreciation and amortization recognized on premises and equipment, which
includes amortization of internally-developed software acquired as part of the
acquisition of Green Tree. A summary of depreciation and amortization expense is
provided below (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Depreciation and amortization of:
Servicing rights $ 13,211 $ - $ 13,211 $ 26,126 $ - $ 26,126
Intangible assets 5,921 - 5,921 12,073 - 12,073
Premises and equipment 5,893 180 5,713 11,760 360 11,400
Total depreciation and amortization $ 25,025 $ 180$ 24,845$ 49,959$ 360$ 49,599
34
--------------------------------------------------------------------------------
Table of Contents
Provision for Loan Losses
We recognize a provision for loan losses for our residential loan portfolio
accounted for at amortized cost. The provision for loan losses increased $1.1
million and $2.0 million for the three and six months ended June 30, 2012,
respectively, due to favorable trends experienced early in 2011 that did not
continue in 2012.
Other Expenses, Net
Other expenses, net consist primarily of real estate owned expenses, net and
claims expenses. Other expenses, net decreased $1.8 million and $2.3 million for
the three and six months ended June 30, 2012, respectively, as compared to the
same periods in the prior year due primarily to lower claims expense of $1.5
million and $1.9 million. The decline in claims expense is due primarily to
severe wind storm damage claims during the three and six months ended June 30,
2011. In conjunction with the acquisition of Green Tree, we decided to wind down
our property reinsurance business. Existing property reinsurance policies were
terminated and no new property reinsurance policies have been entered into
beginning January 1, 2012 thereby eliminating claims costs and exposure
subsequent to this date.
Other Gains
We recognized net fair value gains on assets and liabilities accounted for at
fair value of $0.8 million and $5.6 million during the three and six months
ended June 30, 2012, respectively, which included a net gain of $1.4 million and
$7.2 million, respectively, on the assets and liabilities of the Non-Residual
Trusts as well as a loss of $0.5 million and $0.9 million, respectively, on
derivatives associated with the 2011 Term Loans. Lower discount rates resulting
from changes in market rates impacted the net fair values of the assets and
liabilities of the Non-Residual Trusts during the six months ended June 30,
2012. We recognized other gains of $0.4 million for the six months ended
June 30, 2011, which consisted of a $0.3 million gain from the reversal of the
estimated contingent earn-out liability for Marix and a $0.1 million gain on the
extinguishment of mortgage-backed debt.
Income Tax Expense
Income tax expense increased $0.4 million and $3.4 million for the three and six
months ended June 30, 2012, respectively, as compared to the same periods in the
prior year. As a result of the acquisition of Green Tree, we no longer qualify
as a REIT and are now a full tax-paying entity.
Business Segment Results
We manage our Company in four primary business segments: Servicing, ARM,
Insurance and Loans and Residuals. We measure the performance of our business
segments through the following measures: income before income taxes, core
earnings before income taxes and Pro Forma Adjusted EBITDA. Management considers
core earnings before income taxes and Pro Forma Adjusted EBITDA, both non-GAAP
financial measures, to be important in the evaluation of the Company as a whole
and of our business segments and for allocating capital resources to our
segments. Core earnings before income taxes and Pro Forma Adjusted EBITDA are
utilized to assess the underlying operational performance of the continuing
operations of the business. In addition, analysts, investors, and creditors may
use these measures when analyzing our operating performance.
In calculating income before income taxes, we allocate indirect expenses to our
business segments and include these expenses in other expenses, net. During the
first quarter of 2012, the Company revised its method of allocating costs to
business segments and has recast the segment measures of the prior periods to
reflect the new cost allocation method on a consistent basis for all periods
presented. In segment reporting prior to the first quarter of 2012, the
allocation of indirect expenses was based on segment profit or loss. The new
method allocates indirect expenses to our Insurance segment based on the ratio
of the number of policies to the number of accounts serviced and to our ARM and
other non-reportable segments based on headcount. All remaining indirect
expenses are allocated to our Servicing segment.
We reconcile our income before income taxes for our business segments to our
GAAP consolidated income before taxes and report the financial results of our
Non-Residual Trusts, other non-reportable operating segments and certain
corporate expenses and amounts to eliminate intercompany transactions between
segments as other activity. For a reconciliation of our income before income
taxes for our business segments to our GAAP consolidated income before income
taxes, refer to Note 16 in the Notes to Consolidated Financial Statements.
Core earnings before income taxes consists of income before income taxes
adjusted primarily for depreciation and amortization of the increased basis in
assets acquired with Green Tree, non-cash expenses including share-based
compensation, certain transaction charges and/or integration expenses to acquire
Green Tree and combine our businesses and overhead functions, and the net impact
of the consolidated Non-Residual Trusts. For a description of Pro Forma Adjusted
EBITDA, refer to the Liquidity and Capital Resources section. For a
reconciliation of core earnings before income taxes and Pro Forma Adjusted
EBITDA to our GAAP consolidated income before taxes, refer to the Reconciliation
of GAAP Consolidated Income Before Taxes to Core Earnings and Pro Forma Adjusted
EBITDA in this section.
Provided below is a discussion of our financial results for our four primary
business segments.
35
--------------------------------------------------------------------------------
Table of Contents
Servicing
As the size of our servicing portfolio has grown significantly during the past
year, the financial results may not be comparable across periods. Provided below
is a summary statement of operations for our Servicing segment, which also
includes core earnings (loss) before income taxes and Pro Forma Adjusted EBITDA
(in thousands):
For the Three
Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Servicing revenue and fees
Third parties $ 92,654 $ 3,310 $ 89,344 $ 186,974 $ 6,247 $ 180,727
Intercompany 5,011 5,025 (14 ) 10,421 10,080 341
Total servicing revenue and fees 97,665 8,335 89,330
197,395 16,327 181,068
Other income 1,033 158 875 1,819 361 1,458
Total revenues 98,698 8,493 90,205 199,214 16,688 182,526
Interest expense 1,228 - 1,228 2,723 - 2,723
Depreciation and amortization 21,799 165 21,634 43,365 329 43,036
Other expenses, net 70,585 10,752 59,833 137,246 22,085 115,161
Total expenses 93,612 10,917 82,695 183,334 22,414 160,920
Net fair value losses (246 ) - (246 ) (532 ) - (532 )
Income (loss) before income taxes 4,840 (2,424 ) 7,264
15,348 (5,726 ) 21,074
Core Earnings
Step-up depreciation and
amortization 17,192 - 17,192 34,032 - 34,032
Share-based compensation expense 2,600 555 2,045 6,067 904 5,163
Transaction and integration costs 1,464 - 1,464 1,464 - 1,464
Non-cash interest expense 151 - 151 437 - 437
Total adjustments 21,407 555 20,852 42,000 904 41,096
Core earnings (loss) before income
taxes 26,247 (1,869 ) 28,116
57,348 (4,822 ) 62,170
Pro Forma Adjusted EBITDA
Depreciation and amortization 4,607 165 4,442 9,333 329 9,004
Pro forma synergies 1,225 2,246 (1,021 ) 2,651 4,492 (1,841 )
Interest expense on debt 44 - 44 107 - 107
Non-cash interest income (1,030 ) - (1,030 ) (1,776 ) - (1,776 )
Other 316 (3 ) 319 577 (7 ) 584
Total adjustments 5,162 2,408 2,754 10,892 4,814 6,078
Pro Forma Adjusted EBITDA $ 31,409 $ 539 $ 30,870
$ 68,240 $ (8 ) $ 68,248
Provided below is a summary of the unpaid principal balance of our servicing
portfolio for third parties and for on-balance sheet residential loans and real
estate owned for which the Servicing segment receives intercompany servicing
fees (in thousands):
June 30,
2012 2011 Variance
Servicing portfolio composition
Third parties
First lien mortgages $ 57,600,104 $ 1,342,948 $ 56,257,156
Second lien mortgages 11,082,469 4,745 11,077,724
Manufactured housing 10,454,600 - 10,454,600
Other 22,394 - 22,394
Total third parties 79,159,567 1,347,693 77,811,874
On-balance sheet residential loans and
real estate owned 2,646,390 1,883,053 763,337
Total servicing portfolio $ 81,805,957 $ 3,230,746 $ 78,575,211
36
--------------------------------------------------------------------------------
Table of Contents
Provided below is a summary of the number of accounts, unpaid principal balance,
contractual servicing fee rate and past due status of our servicing portfolio
for third parties and for on-balance sheet residential loans and real estate
owned for which the Servicing segment receives intercompany servicing fees (in
thousands):
June 30, 2012
Number Unpaid Principal Contractual 30 Days or
of Accounts Balance Servicing Fee More Past Due (1)
Portfolio composition of
accounts serviced for third
parties
First lien mortgages 337,505 $ 57,600,104 0.20 % 11.70 %
Second lien mortgages 259,825 11,082,469 0.44 % 3.87 %
Manufactured housing 341,391 10,454,600 1.08 % 3.71 %
Other 1,926 22,394 0.94 % 2.56 %
Total accounts serviced for
third parties 940,647 79,159,567 0.35 % 9.55 %
On-balance sheet residential
loans and real estate owned 60,373 2,646,390 7.21 %
Total servicing portfolio 1,001,020 $ 81,805,957 9.47 %
December 31, 2011
Number Unpaid Principal Contractual 30 Days or
of Accounts Balance Servicing Fee More Past Due (1)
Portfolio composition of
accounts serviced for third
parties
First lien mortgages 341,514 $ 60,267,669 0.21 % 11.63 %
Second lien mortgages 274,912 11,857,226 0.44 % 4.63 %
Manufactured housing 360,528 11,130,515 1.08 % 4.36 %
Other 2,576 28,750 1.00 % 2.89 %
Total accounts serviced for
third parties 979,530 83,284,160 0.36 % 9.66 %
On-balance sheet residential
loans and real estate owned 62,027 2,749,894 7.36 %
Total servicing portfolio 1,041,557 $ 86,034,054 9.40 %
(1) Past due status is measured based on the applicable method specified in the
servicing agreement, which consists of the MBA method or the OTS method.
Under the MBA method, a loan is considered past due if its monthly payment
is not received by the end of the day immediately preceding the loan's next
due date. Under the OTS method, a loan is considered past due if its monthly
payment is not received by the loan's due date in the following month.
For the three and six months ended June 30, 2012, our Servicing segment
recognized core earnings of $26.2 million and $57.3 million, respectively. The
primary components of these earnings are described below:
• Servicing revenue and fees includes $74.2 million and $150.0 million of
contractual servicing fees, $14.4 million and $29.2 million of incentive
and performance fees and $9.1 million and $18.2 million of ancillary and
other fees, during the three and six months ended June 30, 2012,
respectively. Included in incentive and performance fees are fees that we
received during the three and six months ended June 30, 2012 for exceeding
pre-defined performance hurdles of $7.0 million and $16.6 million,
respectively. These fees may not recur on a regular basis, as they are
earned based on the performance of the underlying loan pools as compared
to comparable pools serviced by others, as well as achievement of certain
performance hurdles over time, which may not be achieved on a regular
schedule.
• For the three and six months ended June 30, 2012, depreciation and
amortization expense includes (1) $13.2 million and $26.1 million,
respectively, of amortization of servicing rights capitalized for Green
Tree's servicing and sub-servicing agreements that existed at the date of
acquisition, (2) $3.4 million and $6.9 million, respectively, of
amortization for the intangible assets recognized at the acquisition of
Green Tree for customer and institutional relationship intangibles of the
Servicing business, which are being amortized over a weighted-average life
of 7.0 years and 1.3 years, respectively, and (3) $4.2 million and $8.5
million, respectively, of depreciation of internally-developed software
capitalized with the acquisition of Green Tree, which is being depreciated
over an estimated useful life of 7.0 years.
• Other expense, net consists primarily of costs related to salaries and
benefits, technology and communications, occupancy and general and
administrative expenses as well as allocated indirect expenses. Other
expenses, net increased $59.8 million and $115.2 million during the three
and six months ended June 30, 2012, respectively, as compared to the same
periods in the prior year due primarily to direct costs of Green Tree,
which includes expenses for additional staffing and technology to support
the new business added during the second half of 2011.
37
--------------------------------------------------------------------------------
Table of Contents
Assets Receivables Management
Our ARM business, which was acquired as part of the Green Tree acquisition,
performs collections of delinquent balances on loans serviced by us for third
parties after they have been charged off. For the three and six months ended
June 30, 2012, the ARM business recognized revenue of $9.5 million and $17.8
million, operating expenses of $7.4 million and $14.6 million, income before
taxes of $2.1 million and $3.2 million, and core earnings of $4.2 million and
$7.6 million, respectively. During the three and six months ended June 30, 2012,
adjustments to core earnings included an adjustment for step-up depreciation and
amortization of $1.9 million and $3.9 million, respectively, related to the
amortization of the customer-relationship intangible asset recognized at the
acquisition of Green Tree for the ARM business.
Insurance
Our Insurance segment consists of our agency business and our reinsurance
business. The agency business recognizes commission income net of estimated
future policy cancellations at the time policies are effective. The reinsurance
business earns premium revenue over the life of an insurance contract and incurs
actual costs of property damage claims. With the acquisition of Green Tree, we
significantly increased the size of our agency business and we decided to wind
down our property reinsurance business. Existing property reinsurance policies
were terminated and no new property reinsurance policies have been entered into
beginning January 1, 2012.
Provided below is a summary statement of operations for our Insurance segment,
which also includes core earnings (loss) before income taxes and Pro Forma
Adjusted EBITDA (dollars in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Insurance revenue
Third parties $ 16,803 $ 2,137 $ 14,666 $ 36,765 $ 4,169 $ 32,596
Intercompany - 402 (402 ) - 947 (947 )
Total insurance revenue 16,803 2,539 14,264 36,765 5,116 31,649
Other income 187 2 185 489 4 485
Total revenues 16,990 2,541 14,449 37,254 5,120 32,134
Depreciation and amortization
1,310 15 1,295 2,657 31 2,626
Other expenses, net 8,703 4,828 3,875 18,123 8,569 9,554
Total expenses 10,013 4,843 5,170 20,780 8,600 12,180
Income (loss) before income taxes 6,977 (2,302 ) 9,279 16,474 (3,480 ) 19,954
Core Earnings
Step-up depreciation and
amortization 1,310 - 1,310 2,657 - 2,657
Share-based compensation expense 507 300 207 1,300 494 806
Non-cash interest expense 55 - 55 148 - 148
Total adjustments 1,872 300 1,572 4,105 494 3,611
Core earnings (loss) before income
taxes 8,849 (2,002 )
10,851 20,579 (2,986 ) 23,565
Pro Forma Adjusted EBITDA
Depreciation and amortization - 15 (15 ) - 31 (31 )
Pro forma synergies - 149 (149 ) - 298 (298 )
Non-cash interest income (187 ) - (187 ) (486 ) - (486 )
Other 14 51 (37 ) 14 102 (88 )
Total adjustments (173 ) 215 (388 ) (472 ) 431 (903 )
Pro Forma Adjusted EBITDA $ 8,676 $ (1,787 ) $ 10,463 $ 20,107 $ (2,555 ) $ 22,662
Net written premiums
Lender placed $ 15,272 $ 1,154 $ 14,118 $ 44,132 $ 2,779 $ 41,353
Voluntary 23,768 1,156 22,612 44,429 2,703 41,726
Total net written premiums $ 39,040 $ 2,310 $ 36,730 $ 88,561 $ 5,482 $ 83,079
38
--------------------------------------------------------------------------------
Table of Contents
Provided below is a summary of outstanding insurance policies written:
June 30,
2012 2011 Variance Number of outstanding policies written
Lender placed 110,221 6,150 104,071
Voluntary 91,172 7,542 83,630
Total outstanding policies written 201,393 13,692 187,701
For the three and six months ended June 30, 2012, total insurance revenue
increased $14.3 million and $31.6 million, respectively, due to the recognition
of commission revenue by Green Tree, reflecting an increase in the amount of net
written premiums of $36.7 million and $83.1 million, respectively, or over 15
times the amount written in the three and six months ended June 30, 2011, as a
result of the acquisition of Green Tree. The increase in revenue was offset by a
higher level of other expenses, net attributed to Green Tree.
Loans and Residuals
The Loans and Residuals segment primarily consists of the residential loans,
real estate owned and mortgage-backed debt of the Residual Trusts, as well as
unencumbered residential loans and real estate owned. Through this business, we
seek to earn a spread from the interest income we earn on the residential loans
less the credit losses we incur on these loans and the interest expense we pay
on the mortgage-backed debt issued to finance the loans.
Provided below is a summary statement of operations for our Loans and Residuals
segment, which also includes core earnings before income taxes and Pro Forma
Adjusted EBITDA (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Interest income $ 40,453 $ 42,029 $ (1,576 ) $ 79,733 $ 83,384 $ (3,651 )
Interest expense (23,425 ) (21,661 ) (1,764 ) (47,403 ) (42,053 ) (5,350 )
Net interest income 17,028 20,368 (3,340 ) 32,330 41,331 (9,001 )
Provision for loan losses
(1,957 ) (875 )
(1,082 ) (3,526 ) (1,500 ) (2,026 )
Net interest income after
provision for loan losses 15,071 19,493 (4,422 ) 28,804 39,831 (11,027 )
Other gains (losses) 118 - 118 (177 ) 95 (272 )
Intercompany expense (2,946 ) (5,427 ) 2,481 (5,970 ) (11,027 ) 5,057
Other expenses, net (4,376 ) (3,758 ) (618 ) (8,818 ) (7,551 ) (1,267 )
Total other expenses, net (7,204 ) (9,185 )
1,981 (14,965 ) (18,483 ) 3,518
Income before income taxes 7,867 10,308
(2,441 ) 13,839 21,348 (7,509 )
Core Earnings
Non-cash interest expense 345 282 63 1,052 593 459
Total adjustments 345 282 63 1,052 593 459
Core earnings before income taxes 8,212 10,590 (2,378 ) 14,891 21,941 (7,050 )
Pro Forma Adjusted EBITDA
Non-cash interest income (4,637 ) (3,599 ) (1,038 ) (8,122 ) (6,961 ) (1,161 )
Residual Trusts cash flows 5,363 5,662
(299 ) 5,625 10,178 (4,553 )
Provision for loan losses
1,957 875
1,082 3,526 1,500 2,026
Pro forma monetized assets
- (4,206 ) 4,206 - (13,305 ) 13,305
Other 1,405 (90 ) 1,495 2,202 539 1,663
Total adjustments 4,088 (1,358 ) 5,446 3,231 (8,049 ) 11,280
Pro Forma Adjusted EBITDA $ 12,300 $ 9,232 $ 3,068 $ 18,122 $ 13,892 $ 4,230
39
--------------------------------------------------------------------------------
Table of Contents
Provided below is a summary of the residential loan portfolio, the
mortgage-backed debt and real estate owned of the Loans and Residuals segment as
well as certain ratios (dollars in thousands):
June 30, 2012 December 31, 2011 Variance
Residential loans, net of cost basis
adjustments $ 1,563,476 $ 1,605,688 $ (42,212 )
Allowance for loan losses (14,330 ) (13,824 ) (506 )
Residential loans, net 1,549,146 1,591,864 (42,718 )
Mortgage-backed debt, net of
discounts 1,364,470 1,413,509 (49,039 )
Real estate owned
Carrying value $ 45,123 $ 53,651 $ (8,528 )
Number of units 782 867 (85 )
Delinquencies
30 days or more past due 5.92 % 5.73 % 0.19 %
90 days or more past due 4.11 % 3.99 % 0.12 %
Allowance as % of residential loans 0.92 % 0.86 % 0.06 %
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Net charge-offs(1) $ 5,644 $ 10,244 $ (4,600 ) $ 6,040$ 8,346 $ (2,306 )
Charge-off ratio(1)(2)
0.36 % 0.62 %
-0.26 % 0.38 % 0.51 % -0.13 %
Coverage ratio(1)(3)
254 % 129 % 125 % 237 % 159 % 78 %
(1) Annualized.
(2) The charge-off ratio is calculated as charge-offs, net of recoveries,
divided by average residential loans before the allowance for loan losses.
Net charge-offs includes charge-offs recognized upon acquisition of real
estate in satisfaction of residential loans.
(3) The coverage ratio is calculated as period end allowance for loan losses
divided by charge-offs, net of recoveries.
We recognized core earnings before income taxes of $8.2 million and $10.6
million for the three months ended June 30, 2012 and 2011, respectively, and
$14.9 million and $21.9 million for the six months ended June 30, 2012 and 2011,
respectively, in our Loans and Residuals segment. These earnings primarily
reflect the positive spread we earn on the residuals we hold in the Residual
Trusts. Provided below is a summary of the key components of earnings for this
segment for the three and six months ended June 30, 2012 and 2011.
Net Interest Income
Net interest income was $17.0 million and $32.3 million for the three and six
months ended June 30, 2012, respectively, a decrease of $3.3 million and $9.0
million as compared to the same periods in the prior year, respectively. Our net
interest margin decreased 59 and 95 basis points for the three and six months
ended June 30, 2012 as compared to the same periods in the prior year,
respectively. This decrease was due primarily to our issuance of mortgage-backed
debt in order to partly fund the acquisition of Green Tree. In June 2011, we
securitized unencumbered residential loans which resulted in the issuance of
$102.0 million in mortgage-backed debt by a consolidated securitization trust.
In addition, in May and June of 2011, we also issued $85.1 million in
mortgage-backed debt that had been held by us and reissued $36.0 million in
mortgage-backed debt that had previously been extinguished. During the three and
six months ended June 30, 2012, our net interest spread declined 31 and 79 basis
points as compared to the same periods in the prior year, respectively, due
primarily to the higher average rate on our mortgage-backed debt of 45 and 70
basis points, respectively.
40
--------------------------------------------------------------------------------
Table of Contents
Provided below is a summary of our average yields and rates and the net interest
spread and margin on our portfolio (dollars in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2012 2011 Variance 2012 2011 Variance
Residential loans at
amortized cost
Interest income $ 40,453 $ 42,029 $ (1,576 ) $ 79,733 $ 83,384 $ (3,651 )
Average balance 1,573,177 1,656,701 (83,524 ) 1,584,014 1,641,757 (57,743 )
Average yield (1) 10.29 % 10.15 % 0.14 % 10.07 % 10.16 % -0.09 %
Mortgage-backed debt at
amortized cost
Interest expense $ 23,425 $ 21,661 $ 1,764 $ 47,403 $ 42,053 $ 5,350
Average balance 1,376,229 1,361,929 14,300 1,388,656 1,372,456 16,200
Average rate (1) 6.81 % 6.36 % 0.45 % 6.83 % 6.13 % 0.70 %
Net interest income $ 17,028 $ 20,368 $ (3,340 ) $ 32,330 $ 41,331 $ (9,001 )
Net interest spread (2) 3.48 % 3.79 % -0.31 % 3.24 % 4.03 % -0.79 %
Net interest margin (3) 4.33 % 4.92 % -0.59 % 4.08 % 5.03 % -0.95 %
(1) Annualized
(2) Net interest spread is calculated by subtracting the average rate on
mortgage-backed debt at amortized cost from the average yield on residential
loans at amortized cost.
(3) Net interest margin is calculated by dividing net interest income by the
average balance of the residential loans at amortized cost.
Provision for Loan Losses
Our provision for loan losses reflects the recognition of incurred credit losses
on the residential loans held by the Residual Trusts and our unencumbered
residential loan portfolio. Our provision for loan losses increased by $1.1
million and $2.0 million during the three and six months ended June 30, 2012,
respectively, as compared to the same periods in the prior year. The increase in
our provision for loan losses reflects favorable trends experienced in early
2011 that did not continue on in 2012 thus resulting in a lower allowance for
loan loss requirement at June 30, 2011. For further information regarding the
credit quality of our residential loan portfolio and related trends, refer to
the Credit Risk Management section.
Other Gains
During the six months ended June 30, 2011, we extinguished $1.4 million in
mortgage-backed debt and recognized a gain of $0.1 million.
Intercompany Expenses
Our Loans and Residuals segment is charged a fee from the Servicing segment for
performing servicing activities for the residential loans and real estate owned
of the Residual Trusts as well as for our unencumbered residential loans and
real estate owned. In addition, during 2011 this segment was charged a premium
from the Insurance segment for insurance policies written on real estate owned
held by the Loans and Residuals segment.
Other Expenses, Net
Other expenses, net consists primarily of real estate owned expenses, net and
expenses incurred to protect the collateral underlying the residential loans
held by the Loans and Residuals segment.
41--------------------------------------------------------------------------------
Table of Contents
Reconciliation of GAAP Consolidated Income (Loss) Before Taxes to Core Earnings
and Pro Forma Adjusted EBITDA
Provided below is a reconciliation of our consolidated income (loss) before
income taxes under GAAP to our core earnings and Pro Forma Adjusted EBITDA (in
thousands):
