Attached files
file | filename |
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EX-32 - EX-32 - DITECH HOLDING Corp | b86128exv32.htm |
EX-31.2 - EX-31.2 - DITECH HOLDING Corp | b86128exv31w2.htm |
EX-31.1 - EX-31.1 - DITECH HOLDING Corp | b86128exv31w1.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-13417
Walter Investment Management Corp.
(Exact name of registrant as specified in its charter)
Maryland | 13-3950486 | |
(State or other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification No.) |
3000 Bayport Drive, Suite 1100
Tampa, FL 33607
(Address of principal executive offices) (Zip Code)
Tampa, FL 33607
(Address of principal executive offices) (Zip Code)
(813) 421-7600
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ
No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o
No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The registrant had 25,801,754 shares of common stock outstanding as of May 3, 2011.
WALTER INVESTMENT MANAGEMENT CORP.
FORM 10-Q
INDEX
2
Table of Contents
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(in thousands, except share and per share data)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 58,390 | $ | 114,352 | ||||
Restricted cash and cash equivalents |
53,658 | 52,289 | ||||||
Receivables, net |
2,018 | 2,643 | ||||||
Servicing advances and receivables, net |
9,779 | 11,223 | ||||||
Residential loans, net of allowance for loan losses of $14,920 and $15,907, respectively |
1,652,361 | 1,621,485 | ||||||
Subordinate security |
1,843 | 1,820 | ||||||
Real estate owned |
58,659 | 67,629 | ||||||
Deferred debt issuance costs |
19,132 | 19,424 | ||||||
Deferred income tax asset, net |
237 | 221 | ||||||
Other assets |
3,927 | 4,404 | ||||||
Total assets |
$ | 1,860,004 | $ | 1,895,490 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Accounts payable and other accrued liabilities |
$ | 32,112 | $ | 33,640 | ||||
Dividend payable |
| 13,431 | ||||||
Mortgage-backed debt |
1,260,500 | 1,281,555 | ||||||
Servicing advance facility |
| 3,254 | ||||||
Accrued interest |
7,910 | 8,122 | ||||||
Total liabilities |
1,300,522 | 1,340,002 | ||||||
Commitments
and contingencies |
||||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value per share: |
||||||||
Authorized - 10,000,000 shares |
||||||||
Issued and outstanding - 0 shares at March 31, 2011 and December 31, 2010, respectively |
| | ||||||
Common stock, $0.01 par value per share: |
||||||||
Authorized - 90,000,000 shares |
||||||||
Issued and outstanding - 25,801,754 and 25,785,693 shares at March 31, 2011 and December 31, 2010, respectively |
258 | 258 | ||||||
Additional paid-in capital |
127,777 | 127,143 | ||||||
Retained earnings |
430,326 | 426,836 | ||||||
Accumulated other comprehensive income |
1,121 | 1,251 | ||||||
Total stockholders equity |
559,482 | 555,488 | ||||||
Total liabilities and stockholders equity |
$ | 1,860,004 | $ | 1,895,490 | ||||
The following table presents the assets and liabilities of the Companys consolidated
variable interest entities, or securitization trusts, which are included in the Consolidated
Balance Sheets above. The assets in the table below include those assets that can only be
used to settle obligations of the consolidated securitization trusts. The liabilities in the
table below include third-party liabilities of the consolidated securitization trusts only,
and for which, creditors or beneficial interest holders do not have recourse to the Company,
and exclude intercompany balances that eliminate in consolidation.
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS OF THE CONSOLIDATED SECURITIZATION TRUSTS THAT CAN ONLY BE USED TO SETTLE THE OBLIGATIONS OF THE CONSOLIDATED SECURITIZATION TRUSTS: | ||||||||
Restricted cash and cash equivalents |
$ | 43,149 | $ | 42,859 | ||||
Residential loans, net |
1,503,247 | 1,527,830 | ||||||
Real estate owned |
33,569 | 38,234 | ||||||
Deferred debt issuance costs |
19,132 | 19,424 | ||||||
Total assets |
$ | 1,599,097 | $ | 1,628,347 | ||||
LIABILITIES OF THE CONSOLIDATED SECURITIZATION TRUSTS FOR WHICH CREDITORS OR BENEFICIAL INTEREST HOLDERS DO NOT HAVE RECOURSE TO THE COMPANY: | ||||||||
Accounts payable and other accrued liabilities |
$ | 458 | $ | 471 | ||||
Mortgage-backed debt |
1,260,500 | 1,281,555 | ||||||
Accrued interest |
7,910 | 8,122 | ||||||
Total liabilities and stockholders equity |
$ | 1,268,868 | $ | 1,290,148 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
3
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except share and per share data)
(in thousands, except share and per share data)
For the Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net interest income: |
||||||||
Interest income |
$ | 41,355 | $ | 41,628 | ||||
Less: Interest expense |
20,392 | 21,003 | ||||||
Total net interest income |
20,963 | 20,625 | ||||||
Less: Provision for loan losses |
625 | 1,455 | ||||||
Total net interest income after provision for loan losses |
20,338 | 19,170 | ||||||
Non-interest income: |
||||||||
Premium revenue |
2,032 | 2,691 | ||||||
Servicing revenue and fees |
2,937 | | ||||||
Other income, net |
699 | 760 | ||||||
Total non-interest income |
5,668 | 3,451 | ||||||
Non-interest expenses: |
||||||||
Claims expense |
877 | 912 | ||||||
Salaries and benefits |
9,139 | 6,981 | ||||||
Legal and professional |
4,031 | 968 | ||||||
Occupancy |
450 | 345 | ||||||
Technology and communication |
988 | 728 | ||||||
Depreciation and amortization |
180 | 91 | ||||||
General and administrative |
3,891 | 2,618 | ||||||
Real estate
owned expenses, net |
2,817 | 1,735 | ||||||
Total non-interest expenses |
22,373 | 14,378 | ||||||
Income before income taxes |
3,633 | 8,243 | ||||||
Income tax expense |
143 | 131 | ||||||
Net income |
$ | 3,490 | $ | 8,112 | ||||
Basic earnings per common and common equivalent share |
$ | 0.13 | $ | 0.30 | ||||
Diluted earnings per common and common equivalent share |
$ | 0.13 | $ | 0.30 | ||||
Total dividends declared per common and common equivalent share |
$ | | $ | | ||||
Weighted average common and common equivalent shares outstanding basic |
26,596,187 | 26,343,279 | ||||||
Weighted average common and common equivalent shares outstanding diluted |
26,730,792 | 26,403,281 |
The accompanying notes are an integral part of the consolidated financial statements.
4
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except share data)
(in thousands, except share data)
Accumulated | ||||||||||||||||||||||||||||
Member Unit/ Common | Additional | Other | ||||||||||||||||||||||||||
Stock | Paid-In | Comprehensive | Retained | Comprehensive | ||||||||||||||||||||||||
Total | Shares | Amount | Capital | Income | Earnings | Income | ||||||||||||||||||||||
Balance at December 31, 2010 |
$ | 555,488 | 25,785,693 | $ | 258 | $ | 127,143 | $ | 426,836 | $ | 1,251 | |||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||
Net income |
3,490 | $ | 3,490 | 3,490 | ||||||||||||||||||||||||
Other comprehensive income (loss), net of tax: |
||||||||||||||||||||||||||||
Change in postretirement (loss) plans, net of $14 tax effect |
(108 | ) | (108 | ) | (108 | ) | ||||||||||||||||||||||
Net unrealized gain on subordinate security, net of $0 tax effect |
23 | 23 | 23 | |||||||||||||||||||||||||
Net amortization of realized gain on closed hedges, net of $0 tax effect |
(45 | ) | (45 | ) | (45 | ) | ||||||||||||||||||||||
Comprehensive income |
$ | 3,360 | ||||||||||||||||||||||||||
Share-based compensation |
557 | 557 | ||||||||||||||||||||||||||
Shares issued upon exercise of stock options and vesting of RSUs |
77 | 16,061 | | 77 | ||||||||||||||||||||||||
Balance at March 31, 2011 |
$ | 559,482 | 25,801,754 | $ | 258 | $ | 127,777 | $ | 430,326 | $ | 1,121 | |||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
5
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
(in thousands)
For the Three Months | ||||||||
Ended March 31, | ||||||||
2011 | 2010 | |||||||
Operating activities: |
||||||||
Net income |
$ | 3,490 | $ | 8,112 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Provision for loan losses |
1 | 1,327 | ||||||
Amortization of residential loan discount to interest income |
(3,363 | ) | (3,235 | ) | ||||
Depreciation and amortization |
180 | 91 | ||||||
Change in
contingent earn-out payment liability |
(338 | ) | | |||||
(Gains) losses on real estate owned, net |
629 | (433 | ) | |||||
Benefit from deferred income taxes |
(3 | ) | (5 | ) | ||||
Amortization of deferred debt issuance costs to interest expense |
311 | 259 | ||||||
Share-based compensation |
557 | 1,172 | ||||||
Other |
(184 | ) | (124 | ) | ||||
Decrease in assets: |
||||||||
Receivables |
1,993 | 1,108 | ||||||
Servicing advances and receivables, net |
1,444 | | ||||||
Other |
299 | 805 | ||||||
Decrease in liabilities: |
||||||||
Accounts payable and other accrued liabilities |
(1,215 | ) | (2,623 | ) | ||||
Accrued interest |
(212 | ) | (200 | ) | ||||
Cash flows provided by operating activities |
3,589 | 6,254 | ||||||
Investing activities: |
||||||||
Purchases of residential loans |
(44,794 | ) | | |||||
Principal payments received on residential loans |
23,497 | 24,736 | ||||||
Cash proceeds from sales of real estate owned, net |
756 | 1,190 | ||||||
Additions to property and equipment, net |
(2 | ) | (8 | ) | ||||
(Increase) decrease in restricted cash and cash equivalents |
(1,369 | ) | 1,429 | |||||
Cash flows (used in) provided by investing activities |
(21,912 | ) | 27,347 | |||||
Financing activities: |
||||||||
Payments on mortgage-backed debt |
(19,693 | ) | (23,085 | ) | ||||
Mortgage-backed debt extinguishment |
(1,338 | ) | | |||||
Servicing advance facility, net |
(3,254 | ) | | |||||
Shares issued upon exercise of stock options and vesting of RSUs |
77 | 12 | ||||||
Dividends and dividend equivalents paid |
(13,431 | ) | (13,248 | ) | ||||
Repurchase and cancellation of common stock |
| (264 | ) | |||||
Cash flows used in financing activities |
(37,639 | ) | (36,585 | ) | ||||
Net decrease in cash and cash equivalents |
(55,962 | ) | (2,984 | ) | ||||
Cash and cash equivalents at the beginning of the period |
114,352 | 99,286 | ||||||
Cash and cash equivalents at the end of the period |
$ | 58,390 | $ | 96,302 | ||||
Supplemental Disclosure of Non-Cash Investing and Financing Activities: |
||||||||
Real estate owned acquired through foreclosure |
$ | 13,534 | $ | 20,009 | ||||
Residential loans originated to finance the sale of real estate owned |
$ | 21,068 | $ | 20,608 |
The accompanying notes are an integral part of the consolidated financial statements.
6
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Unaudited)
1. Business
The Company is a mortgage servicer and mortgage portfolio owner specializing in
credit-challenged, non-conforming residential loans primarily in the southeastern United States, or
U.S. The Company originates, purchases, and provides property insurance for residential loans. The
Company also provides ancillary mortgage advisory services. At March 31, 2011, the Company had five
wholly owned, primary subsidiaries: Hanover Capital Partners 2, Ltd., doing business as Hanover
Capital, Walter Mortgage Company, LLC, or WMC, Best Insurors, Inc., or Best, Walter Investment
Reinsurance Company, Ltd., or WIRC, and Marix Servicing LLC, or Marix.
The Companys business, headquartered in Tampa, Florida, was established in 1958 as the
financing segment of Walter Energy, Inc., formerly known as Walter Industries, Inc., or Walter
Energy. Throughout the Companys history, it purchased residential loans originated by Walter
Energys homebuilding affiliate, Jim Walter Homes, Inc., or JWH, originated and purchased
residential loans on its own behalf, and serviced these residential loans to maturity. The Company
has continued these servicing activities since spinning off from Walter Energy in 2009. In 2010,
the Company began acquiring pools of residential loans. Over the past 50 years, the Company has
developed significant expertise in servicing credit-challenged accounts through its differentiated
high-touch approach which involves significant face-to-face borrower contact by trained servicing
personnel strategically located in the markets where its borrowers reside. As of March 31, 2011,
the Company serviced approximately 34,000 individual residential loans for its owned portfolio and
approximately 6,100 for other investors.
Throughout this Quarterly Report on Form 10-Q, references to residential loans refer to
residential mortgage loans and residential retail installment agreements and references to
borrowers refer to borrowers under our residential mortgage loans and installment obligors under
our residential retail installment agreements.
The Acquisition of Marix Servicing, LLC
On August 25, 2010, the Company entered into a definitive agreement with Marathon Asset
Management, L.P., or Marathon, and an individual seller to purchase 100% of the outstanding
ownership interests of Marix. The acquisition was effective as of November 1, 2010. See Note 3 for
further information.
2. Basis of Presentation
Interim Financial Reporting
The accompanying unaudited consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States, or GAAP, for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments, consisting of normal recurring
accruals, considered necessary for a fair presentation have been included. Operating results for
the three month period ended March 31, 2011 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2011. These unaudited interim financial statements
should be read in conjunction with our audited consolidated financial statements and related notes
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010.
The consolidated financial statements have been prepared in accordance with GAAP, which
requires management to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements. Actual results could differ from those estimates. All
significant intercompany balances have been eliminated in the consolidated financial statements.
Recent Accounting Guidance
Recently Adopted Accounting Guidance
In January 2010, the FASB issued an accounting standards update to require new disclosures for
fair value measurements and to provide clarification for existing disclosure requirements of which
certain disclosure provisions were deferred to fiscal periods beginning after December 15, 2010,
and interim periods within those fiscal years. Specifically, the changes require a reporting entity
to disclose, in the reconciliation of fair value measurements using significant unobservable inputs
(Level 3), separate information
7
Table of Contents
about purchases, sales, issuances, and settlements (that is, on a
gross basis rather than as one net number). The adoption of this guidance on January 1, 2011, did
not have a significant impact on the Companys disclosures.
Recently Issued
In December 2010, the FASB issued an accounting standard update focused on the disclosure of
supplementary pro-forma information in business combinations. The purpose of the update was to
eliminate diversity in practice surrounding the interpretation of select revenue and expense
pro-forma disclosures. The update provides guidance as to the acquisition date that should be
selected when preparing the pro-forma disclosures; in the event that comparative financial
statements are presented, the acquisition date assumed for the pro-forma disclosure shall be the
first day of the preceding comparative year. The adoption of this standard was effective January
1, 2011, and will be applied in the quarter that the proposed acquisition of GTCS Holdings, LLC is
consummated.
In January 2011, the FASB issued an accounting standard that related to the disclosures of
troubled debt restructurings. The amendments in this standard deferred the effective date related
to these disclosures, enabling creditors to provide such disclosures after the FASB completes their
project clarifying the guidance for determining what constitutes a troubled debt restructuring. As
the provisions of this standard only defer the effective date of disclosure requirements related to
troubled debt restructurings, the adoption of this standard will have no impact on the Companys
disclosures.
In April 2011, the FASB issued an accounting standard to provide additional guidance related
to troubled debt restructuring. The standard provides guidance in determining whether a creditor
has granted a concession, include factors and examples for creditors to consider in evaluating
whether a restructuring results in a delay in payment that is insignificant, prohibits creditors
from using the borrowers effective rate test to evaluate whether a concession has been granted to
the borrower, and add factors for creditors to use in determining whether a borrower is
experiencing financial difficulties. A provision in this standard also ends the FASBs deferral of
the additional disclosures about troubled debt restructurings. The provisions of this guidance are
effective for the Companys reporting period ending September 30, 2011. The adoption of this
standard is not expected to have a material impact on the Companys consolidated financial
statements.
Reclassifications
In order to provide comparability between periods presented, certain amounts have been
reclassified from the previously reported consolidated financial statements to conform to the
consolidated financial statement presentation of the current period. The Company reclassified
certain trust expenses from interest expense to general and administrative expenses on the
consolidated statements of income. Additionally, the Company reclassified certain legal and
professional expenses out of general and administrative expenses.
3. Acquisitions
GTCS Holdings, LLC
On March 28, 2011, the Company executed a Membership Interest Purchase Agreement to acquire
GTCS Holdings LLC, or Green Tree, in a transaction valued at $1.065 billion. Green Tree, based in
St. Paul, Minnesota, is a leading independent, fee-based business services company which provides
high-touch, third-party servicing of credit-sensitive consumer loans. The Company will issue
approximately 1.8 million shares of common stock to the seller; assume approximately $18 million of
existing Green Tree debt, and issue approximately $765 million of new debt which, together with
cash, will be used to acquire the equity of Green Tree, repay certain existing Green Tree corporate
indebtedness, and pay fees and expenses of the transaction. In addition, the Company will have
access to a $45 million revolving line of credit. The transaction is subject to receipt of
government approvals, third-party consents and the satisfaction of other customary closing
conditions. The Company expects to complete the transaction in the third quarter of 2011.
Marix Servicing, LLC
On November 1, 2010, the Company completed its acquisition of a 100% interest in Marix. Marix
is a high-touch specialty mortgage servicer, based in Phoenix, Arizona, focused on default
management, borrower outreach, loss mitigation, liquidation strategies, component servicing and
specialty servicing.
The purchase price for the acquisition was a cash payment due at closing of less than $0.1
million plus estimated contingent earn-out payments of $2.1 million. The earn-out payments are
driven by net servicing revenue in Marixs existing business in excess of a base of $3.8 million
per quarter. The payments are due within 30 days after the end of each fiscal quarter through the
three year period ended December 31, 2013. The estimated liability for future earn-out payments is
recorded in accounts payable and other accrued liabilities. In accordance with the accounting
guidance on business combinations, any future adjustments to the estimated earn-out liability will
be recognized in the earnings of that period. Based upon the results of the first quarter earn-out
payment calculation, there was no amount paid as of March 31, 2011 and the accrual for the
contingent earn-out payment was adjusted to $1.8 million,
resulting in $338 thousand being recorded in
income during the first quarter of 2011.
8
Table of Contents
The fair value of the estimated earn-out liability is based on the present value of the
expected future payments to be made to the seller of Marix in accordance with the provisions
outlined in the purchase agreement. In determining fair value, Marixs future performance is
estimated using financial projections developed by management. The expected future payments are
estimated on the basis of the earn-out formula specified in the purchase agreement compared to the
associated financial projections. These payments are then discounted to present value using a
risk-adjusted rate that takes into consideration the likelihood that the forecasted earn-out
payments will be made.
4. Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents relate primarily to funds collected on residential loans
owned by the Companys various securitization trusts (see Note 8), which are available only to pay
expenses of and principal and interest on indebtedness of the securitization trusts. Restricted
cash equivalents at March 31, 2011 and December 31, 2010 include short-term deposits in
FDIC-insured accounts and compensating balances. Restricted cash equivalents also include $5.9
million at March 31, 2011 and December 31, 2010 held in an insurance trust account. As part of the
Marix acquisition, the Company is required to maintain cash investments in support of letters of
credit issued by third party banks in connection with certain Marix servicing and lease contracts
in the amount of $0.8 million at March 31, 2011 and December 31, 2010.
5. Custodial Accounts
In connection with its servicing activities, the Company has a fiduciary responsibility for
servicing accounts related to borrower escrow funds and custodial funds due to investors,
aggregating approximately $24.4 million and $24.0 million as of March 31, 2011 and December 31,
2010, respectively. These funds are maintained in segregated bank accounts, which do not represent assets and
liabilities of the Company, and accordingly, are not reflected in the accompanying consolidated
balance sheets.
6. Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants. A three-tier fair value
hierarchy is used to prioritize the inputs used in measuring fair value. The hierarchy gives the
highest priority to unadjusted quoted market prices in active markets for identical assets or
liabilities and the lowest priority to unobservable inputs. A financial instruments level within
the fair value hierarchy is based on the lowest level of any input that is significant to the fair
value measurement. The three levels of the fair value hierarchy are as follows:
Basis or Measurement
Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date
for identical, unrestricted assets or liabilities.
Level 2 Inputs other than quoted prices included in Level 1 that are observable for the asset
or liability, either directly or indirectly.
Level 3 Prices or valuations that require inputs that are both significant to the fair value
measurement and unobservable.
The accounting guidance concerning fair value allows the Company to elect to measure certain
items at fair value and report the changes in fair value through the statements of income. This
election can only be made at certain specified dates and is irrevocable once made. The Company does
not have a policy regarding specific assets or liabilities to elect to measure at fair value, but
rather makes the election on an instrument by instrument basis as they are acquired or incurred.
The Company has not made the fair value election for any financial assets or liabilities as of
March 31, 2011.
The Company determines fair value based upon quoted broker prices when available or through
the use of alternative approaches, such as discounting the expected cash flows using market rates
commensurate with the credit quality and duration of the investment.
9
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Items Measured at Fair Value on a Recurring Basis
The subordinate security is measured in the consolidated financial statements at fair value on
a recurring basis in accordance with the accounting guidance concerning debt and equity securities
and is categorized in the table below based upon the lowest level of significant input to the
valuation (in thousands):
Quoted Prices in | |||||||||||||||||||
Active Markets | Significant | ||||||||||||||||||
for Identical | Significant Other | Unobservable | |||||||||||||||||
Assets | Observable Inputs | Inputs | |||||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | ||||||||||||||||
March 31,
2011 |
$ | | $ | | $ | 1,843 | $ | 1,843 | |||||||||||
December 31,
2010 |
$ | | $ | | $ | 1,820 | $ | 1,820 | |||||||||||
The subordinate security consists of a single, fixed-rate security backed by notes that are
collateralized by manufactured housing. Approximately one-third of the notes include attached real
estate on which the manufactured housing is located as additional collateral. The subordinate
security has a coupon of 8.0% and a contractual maturity of 2038. The underlying notes were
originated primarily in 2004 and 2005, have a weighted-average coupon rate of 9.5% and a
weighted-average maturity of 18.7 years. The subordinate security has an overcollateralization
level of 10.6% with a 1.2% annual loss rate.
To estimate the fair value, the Company used a discounted cash flow approach. The significant
inputs for the valuation model at March 31, 2011 include the following:
| Yield: 18.5% | ||
| Probability of default: 2.3% | ||
| Loss severity: 68.3% | ||
| Prepayment: 3.5% |
10
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The following table provides a reconciliation of the beginning and ending balances of the
Companys subordinate security which is measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) for the three months ended
March 31, 2011 and December 31, 2010 (in thousands):
As of and for the | As of and for the | |||||||
Three Months Ended | Year Ended | |||||||
March 31, 2011 | December 31, 2010 | |||||||
Balance at beginning of period |
$ | 1,820 | $ | 1,801 | ||||
Total gains (losses): |
||||||||
Included in net income |
| | ||||||
Included in other comprehensive income |
23 | 19 | ||||||
Balance at end of period |
$ | 1,843 | $ | 1,820 | ||||
Total gains (losses) for the period
included in earnings attributable to
the change in unrealized gains or
losses relating to assets still held
at the reporting date |
$ | | $ | |
Items Measured at Fair Value on a Non-Recurring Basis
At the time a residential loan becomes real estate owned, or REO, the Company records the
property at the lower of its carrying amount or estimated fair value less estimated costs to sell.
Upon foreclosure and through liquidation, the Company evaluates the propertys fair value as
compared to its carrying amount and records a valuation adjustment when the carrying amount exceeds
fair value. Any valuation adjustment at the time the loan becomes REO is charged to the allowance
for loan losses. Subsequent declines in value, as well as gains and losses on the sale of REO, are
reported in real estate owned expenses, net in the consolidated statements of income.
Carrying values, and the corresponding fair value adjustments during the period, for assets
and liabilities measured in the consolidated financial statements at fair value on a non-recurring
basis are as follows (in thousands):
Fair Value Measurements at Reporting Date Using | ||||||||||||||||||||
Quoted Prices in | ||||||||||||||||||||
Real | Active Markets for | Significant Other | Significant | |||||||||||||||||
Estate | Identical Assets | Observable Inputs | Unobservable Inputs | Fair Value | ||||||||||||||||
Fair Value at | Owned | (Level 1) | (Level 2) | (Level 3) | Adjustment | |||||||||||||||
Real estate owned: |
||||||||||||||||||||
March 31, 2011 |
$ | 58,659 | $ | | $ | | $ | 58,659 | $ | (1,093 | ) | |||||||||
March 31, 2010 |
$ | 61,951 | $ | | $ | | $ | 61,951 | $ | (657 | ) |
These REO properties are generally located in rural areas and are primarily concentrated in
Texas, Mississippi, Alabama, Florida, South Carolina, Louisiana and Georgia. The REO properties
have a weighted-average holding period of 12 months. To estimate the fair value, the Company
utilized historical loss severity rates experienced on similar REO properties previously sold by
the Company. The blended loss severity utilized at March 31, 2011 and 2010 was 10.0% and 19.2%,
respectively.
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Fair Value of Financial Instruments
The following table presents the carrying values and estimated fair values of financial assets
and liabilities that are required to be recorded or disclosed at fair value as of March 31, 2011
and December 31, 2010, respectively (in thousands):
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 58,390 | $ | 58,390 | $ | 114,352 | $ | 114,352 | ||||||||
Restricted cash and cash equivalents |
53,658 | 53,658 | 52,289 | 52,289 | ||||||||||||
Receivables, net |
2,018 | 2,018 | 2,643 | 2,643 | ||||||||||||
Servicing advances and receivables, net |
9,779 | 9,779 | 11,223 | 11,223 | ||||||||||||
Residential loans, net |
1,652,361 | 1,584,000 | 1,621,485 | 1,566,000 | ||||||||||||
Subordinate security |
1,843 | 1,843 | 1,820 | 1,820 | ||||||||||||
Real estate owned |
58,659 | 58,659 | 67,629 | 67,629 | ||||||||||||
Financial liabilities: |
||||||||||||||||
Accounts payable and other accrued liabilities |
32,112 | 32,112 | 33,640 | 33,640 | ||||||||||||
Dividend payable |
| | 13,431 | 13,431 | ||||||||||||
Mortgage-backed debt, net of deferred debt issuance costs |
1,241,368 | 1,205,000 | 1,262,131 | 1,235,000 | ||||||||||||
Servicing advance facility |
| | 3,254 | 3,254 | ||||||||||||
Accrued interest |
7,910 | 7,910 | 8,122 | 8,122 |
For assets and liabilities measured in the consolidated financial statements on a historical
cost basis, the estimated fair value shown in the above table is for disclosure purposes only. The
following methods and assumptions were used to estimate fair value:
Cash and cash equivalents, restricted cash and cash equivalents, receivables, accounts payable
and other accrued liabilities, dividends payable, and accrued interest The estimated fair value
of these financial instruments approximates their carrying value due to their high liquidity or
short-term nature.
Servicing advances and receivables The estimated fair value of these advances approximate
the carrying value due to the advances having no stated maturity, are non-interest bearing and are
generally realized within a short period of time.
Residential loans The fair value of residential loans is estimated by discounting the net
cash flows estimated to be generated from the asset. The discounted cash flows were determined
using assumptions such as, but not limited to, interest rates, prepayment speeds, default rates,
loss severities, and a risk-adjusted market discount rate.
Subordinate security The fair value of the subordinate security is measured in the
consolidated financial statements at fair value on a recurring basis by discounting the net cash
flows estimated to be generated from the asset. Unrealized gains and losses are reported in
accumulated other comprehensive income. To the extent that the cost basis exceeds the fair value
and the unrealized loss is considered to be other-than-temporary, an impairment charge is
recognized and the amount recorded in accumulated other comprehensive income or loss is
reclassified to earnings as a realized loss.
Real estate owned Real estate owned is recorded at the lower of its carrying amount or
estimated fair value less estimated costs to sell. The estimates utilize managements assumptions,
which are based on historical resale recovery rates and current market conditions.
Mortgage-backed debt, net of deferred debt issuance costs The fair value of mortgage-backed
debt is determined by discounting the net cash outflows estimated to be used to repay the debt.
These obligations are to be satisfied using the proceeds from the residential loans that secure
these obligations and are non-recourse to the Company.
Servicing advance facility The fair value of the servicing advance facility approximates
the carrying value due to the short-term nature of the facility.
12
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7. Servicing Advances and Receivables, net
Servicing advances represent payments made on behalf of borrowers or on foreclosed properties in
the owned and serviced for others portfolios. The Company began servicing for other investors as a
result of the acquisition of Marix in November 2010. The following table presents servicing
advances and receivables, net (in thousands):
March 31, 2011 | December 31, 2010 | |||||||
Principal and interest |
$ | 3,372 | $ | 3,285 | ||||
Taxes and insurance |
14,832 | 17,128 | ||||||
Other servicing advances |
6,244 | 4,183 | ||||||
Subservicing fees receivable |
690 | 783 | ||||||
Servicing advances and receivables |
25,138 | 25,379 | ||||||
Less: Allowance for uncollectible servicing advances |
(15,359 | ) | (14,156 | ) | ||||
Servicing advances and receivables, net |
$ | 9,779 | $ | 11,223 | ||||
As of
December 31, 2010, there were advances of $4.5 million
pledged as collateral. The facility was terminated and repaid on
March 31, 2011.
8. Residential Loans, net
Residential loans are held for investment and consist of unencumbered residential loans and
residential loans held in securitization trusts. Residential loans held in securitization trusts
consist of residential loans that the Company has securitized in structures that are accounted for
as financings. These securitizations are structured legally as sales, but for accounting purposes
are treated as financings under the accounting guidance for transfers and servicing. The Company
has determined that it is the primary beneficiary of the securitization trusts
because (1) as the servicer the Company has the right to direct the activities that most
significantly impact the economic performance of the Trusts through the Companys ability to manage
the delinquent assets of the Trusts and (2) as holder of all or a portion of the residual
securities issued by the Trusts, the Company has the obligation to absorb losses of the Trusts, to
the extent of its investment, and the right to receive benefits from the Trusts both of which could
potentially be significant. Specifically, the Company, as servicer to the ten trusts owned by
Walter Investment or Mid-State Capital, LLC or Mid-State, a wholly-owned subsidiary of Walter
Investment, subject to applicable contractual provisions, has discretion, consistent with prudent
mortgage servicing practices, to determine whether to sell or work out any loans securitized
through the securitization trusts that become troubled. Accordingly, the loans in these
securitizations remain on the balance sheet as residential loans. Given this treatment, retained
interests are not created, and securitization mortgage-backed debt is reflected on the balance
sheet as a liability.
The Companys only continued involvement with the residential loans held in securitization
trusts is retaining all of the beneficial interests in the securitization trusts and servicing the
residential loans collateralizing the mortgage-backed debt. The Company is not contractually
required to provide any financial support to the securitization trusts. The Company may, from time
to time at its sole discretion, purchase certain assets from the securitization trusts to cure
delinquency or loss triggers for the sole purpose of releasing excess overcollateralization to the
Company. The Company does not expect to provide financial support to the securitization trusts
based on current performance trends.
The assets of the securitization trusts are pledged as collateral for the mortgage-backed
debt, and are not available to satisfy claims of general creditors of the Company. The
mortgage-backed debt issued by the securitization trusts is to be satisfied solely from the
proceeds of the residential loans and other collateral held in securitization trusts, are not
cross-collateralized and are non-recourse to the Company (see Note 11). The Company records
interest income on residential loans held in securitization trusts and interest expense on
mortgage-backed debt issued in the securitizations over the life of the securitizations.
13
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Residential loans, net are summarized in the table below (in thousands):
March 31, 2011 | December 31, 2010 | |||||||
Residential loans, principal balance |
$ | 1,849,274 | $ | 1,803,758 | ||||
Less: Yield adjustment, net(1) |
(181,993 | ) | (166,366 | ) | ||||
Less: Allowance for loan losses |
(14,920 | ) | (15,907 | ) | ||||
Residential loans, net(2) |
$ | 1,652,361 | $ | 1,621,485 | ||||
(1) | Yield adjustments net consists of deferred origination costs, premiums and discounts and other costs which are generally amortized over the life of the residential loan portfolio. Deferred origination costs at March 31, 2011 and December 31, 2010 were $10.4 million and $10.6 million, respectively. Premiums and discounts at March 31, 2011 and December 31, 2010 were $204.2 million and $189.5 million, respectively. Other costs, including accrued interest receivable, net of deferred gains and other costs, at March 31, 2011 and December 31, 2010 were $11.8 million and $12.5 million, respectively. | |
(2) | The weighted average life of the portfolio approximates 9.5 and 9 years, at March 31, 2011 and December 31, 2010, respectively, based on assumptions for prepayment speeds, default rates and losses. |
Residential Loan Pool Acquisitions
The
Company acquired residential loans to be held for investment in the amount of $44.8
million adding $62.8 million of unpaid principal to the residential loan portfolio in the first
quarter of 2011. There were no acquisitions during the first quarter of 2010. These acquisitions
were financed with proceeds from the Companys private placement securitization that closed on
December 1, 2010, or 2010 securitization. The residential loans acquired included performing and
non-performing, fixed and adjustable rate loans, on single-family, owner occupied and investor
residences located within the Companys existing southeastern United States geographic footprint.
Purchased Credit-Impaired Residential Loans At acquisition, the fair value of residential loans
acquired outside of a business combination is the purchase price of the residential loans, which is
generally based on the outstanding principal balance, probability of default and estimated loss
given default.
During the three months ended March 31, 2011, the Company acquired certain residential loans it
deemed to be credit-impaired as detailed in the table below (in thousands). There were no
credit-impaired residential loans acquired during the three months ended March 31, 2010.
Contractually required cash flows for acquired loans at acquisition |
$ | 46,779 | ||
Nonaccretable difference |
(22,707 | ) | ||
Expected cash flows for acquired loans at acquisition |
24,072 | |||
Accretable yield |
(7,431 | ) | ||
Purchase price |
$ | 16,641 | ||
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The table below sets forth the accretable yield activity for purchased credit-impaired residential
loans for the period ended March 31, 2011 (in thousands):
Accretable Yield | ||||
Balance at beginning of period |
$ | 4,174 | ||
Additions |
7,431 | |||
Accretion |
(87 | ) | ||
Balance at end of period |
$ | 11,518 | ||
The table
below provides additional information about purchased credit-impaired residential loans:
March 31, 2011 | December 31, 2010 | |||||||
Outstanding balance (a) |
$ | 72,823 | $ | 26,277 | ||||
Carrying amount |
25,679 | 9,348 |
(a) | Represents the sum of contractual principal and interest at the reporting date. |
Disclosures About the Credit Quality of Residential Loans and the Allowance for Loan Losses
The allowance for loan losses represents managements estimate of probable incurred credit
losses inherent in our residential loan portfolio as of the balance sheet date. The Company has one
portfolio segment and class that consist primarily of less-than prime, credit challenged
residential loans. The risk characteristics of the portfolio segment and class relate to credit
exposure. The method for monitoring and assessing the credit risk is the same throughout the
portfolio. The allowance for loan losses on residential loans includes two components: (1)
specifically identified residential loans that are evaluated individually for impairment and (2)
all other residential loans that are considered a homogenous pool that are collectively evaluated
for impairment.
The Company reviews all residential loans for impairment and determines a residential loan is
impaired when, based on current information and events, it is probable that the Company will be
unable to collect amounts due according to the original contractual terms of the loan agreement.
Factors considered in assessing collectability include, but are not limited to, a borrowers
extended delinquency and the initiation of foreclosure proceedings. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case
basis, taking into consideration all of the circumstances surrounding the loan and the borrower,
including the length of delay, the reasons for the delay, the borrowers prior payment record, and
the amount of the shortfall in relation to the principal and interest owed. The Company determines
a specific impairment allowance generally based on the difference between the carrying value of the
residential loan and the estimated fair value of the collateral.
The determination of the level of the allowance for loan losses and, correspondingly, the
provision for loan losses, for the residential loans evaluated collectively is based on, but not
limited to, delinquency levels and trends, default frequency, prior loan loss severity experience,
and managements judgment and assumptions regarding various matters, including the composition of
the residential loan portfolio, known and inherent risks in the portfolio, the estimated value of
the underlying real estate collateral, the level of the allowance in relation to total loans and to
historical loss levels, current economic and market conditions within the applicable geographic
areas surrounding the underlying real estate, changes in unemployment levels and the impact that
changes in interest rates have on a borrowers ability to refinance their loan and to meet their
repayment obligations. Management continuously evaluates these assumptions and various other
relevant factors impacting credit quality and inherent losses when quantifying our exposure to
credit losses and assessing the adequacy of our allowance for such losses as of each reporting
date. The level of the allowance is adjusted based on the results of managements analysis.
Generally, as residential loans age, the credit exposure is reduced, resulting in decreasing
provisions.
While we consider the allowance for loan losses to be adequate based on information currently
available, future adjustments to the allowance may be necessary if circumstances differ
substantially from the assumptions used by management in determining the allowance for loan losses.
The following table summarizes the activity in the allowance for loan losses on residential loans,
net (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Balance, December 31 |
$ | 15,907 | $ | 17,661 | ||||
Provision charged to income |
625 | 1,455 | ||||||
Less: Transfers to REO |
(922 | ) | (1,381 | ) | ||||
Less: Charge-offs, net of recoveries |
(690 | ) | (411 | ) | ||||
Balance, March 31 |
$ | 14,920 | $ | 17,324 | ||||
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The following table summarizes the ending balance of the allowance for loan losses and the
residential loan balance by basis of impairment method (in thousands):
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Allowance for loan losses: |
||||||||
Loans individually evaluated for loss potential |
$ | 4,096 | $ | 3,599 | ||||
Loans collectively evaluated for loss potential |
10,824 | 12,308 | ||||||
Loans acquired with deteriorated credit quality |
| | ||||||
Total |
$ | 14,920 | $ | 15,907 | ||||
Recorded investment in Residential Loans: |
||||||||
Loans individually evaluated for loss potential |
$ | 45,231 | $ | 44,737 | ||||
Loans collectively evaluated for loss potential |
1,596,371 | 1,583,315 | ||||||
Loans acquired with deteriorated credit quality |
25,679 | 9,340 | ||||||
Total |
$ | 1,667,281 | $ | 1,637,392 | ||||
Impaired Residential Loans
The following table presents loans individually evaluated for impairment which consist primarily of
residential loans in the process of foreclosure and purchased credit-impaired residential loans (in
thousands):
Unpaid | Average | Interest | |||||||||||||||||||
Recorded | Principal | Related | Recorded | Income | |||||||||||||||||
Investment | Balance | Allowance | Investment | Recognized | |||||||||||||||||
Amortized cost: |
|||||||||||||||||||||
With no related
allowance recorded: |
|||||||||||||||||||||
March 31, 2011 |
$ | 6,855 | $ | 8,177 | $ | | $ | 9,394 | $ | 3 | |||||||||||
December 31, 2010 |
$ | 11,932 | $ | 13,911 | $ | | $ | 10,164 | $ | 13 | |||||||||||
With an allowance
recorded: |
|||||||||||||||||||||
March 31, 2011 |
$ | 38,376 | $ | 41,131 | $ | 4,096 | $ | 35,591 | $ | 16 | |||||||||||
December 31, 2010 |
$ | 32,805 | $ | 35,799 | $ | 3599 | $ | 39,808 | $ | 106 | |||||||||||
Purchased credit-impaired: |
|||||||||||||||||||||
With no related
allowance recorded: |
|||||||||||||||||||||
March 31, 2011 |
$ | 25,679 | $ | 39,667 | $ | | $ | 15,457 | $ | 205 | |||||||||||
December 31, 2010 |
$ | 9,340 | $ | 14,329 | $ | | $ | 4,670 | $ | 40 | |||||||||||
With an allowance
recorded: |
|||||||||||||||||||||
March 31, 2011 |
$ | | $ | | $ | | $ | | $ | | |||||||||||
December 31, 2010 |
$ | | $ | | $ | | $ | | $ | |
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Aging of Past Due Residential Loans
Residential loans are placed on non-accrual status when any portion of the principal or
interest is 90 days past due. When placed on non-accrual status, the related interest receivable is
reversed against interest income of the current period. Interest income on non-accrual loans, if
received, is recorded using the cash method of accounting. Residential loans are removed from
non-accrual status when the amount financed and the associated interest are no longer over 90 days
past due. If a non-accrual loan is returned to accruing status the accrued interest, at the date
the residential loan is placed on non-accrual status, and forgone interest during the non-accrual
period, are recorded as interest income as of the date the loan no longer meets the non-accrual
criteria. The past due or delinquency status of residential loans is generally determined based on
the contractual payment terms. The calculation of delinquencies excludes from delinquent amounts
those accounts that are in bankruptcy proceedings that are paying their mortgage payments in
contractual compliance with the bankruptcy court approved mortgage payment obligations. Loan
balances are charged off when it becomes evident that balances are
not fully collectible. The following table presents the aging
of the residential loan portfolio (in thousands).
30-59 | 60-89 | Greater | Total | Non- | Recorded | |||||||||||||||||||||||||||
Days Past | Days Past | Than 90 | Total | Residential | Accrual | Investment > | ||||||||||||||||||||||||||
Due | Due | Days | Past Due | Current | Loans | Loans | 90 Days and Accruing | |||||||||||||||||||||||||
Amortized Cost: |
||||||||||||||||||||||||||||||||
March 31, 2011 |
$ | 19,825 | $ | 8,556 | $ | 51,456 | $ | 79,837 | $ | 1,587,444 | $ | 1,667,281 | $ | 51,456 | $ | | ||||||||||||||||
December 31, 2010 |
$ | 24,262 | $ | 8,274 | $ | 43,355 | $ | 75,891 | $ | 1,561,501 | $ | 1,637,392 | $ | 43,355 | $ | |
Credit Risk Profile Based on Delinquencies
Factors that are important to managing overall credit quality and minimizing loan losses are sound
loan underwriting, monitoring of existing loans, early identification of problem loans, timely
resolution of problems, an appropriate allowance for loan losses, and sound nonaccrual and
charge-off policies. The Company primarily utilizes delinquency status to monitor the credit
quality of the portfolio. Monitoring of the residential loan increases when the loan is delinquent.
The Company considers all loans 30 or more days past due to be non-performing. The classification of
delinquencies, and thus the non-performing calculation, excludes from delinquent amounts those
accounts that are in bankruptcy proceedings that are paying their mortgage payments in contractual
compliance with the bankruptcy court approved mortgage payment obligations.
The following table presents residential loans by credit quality indicator (in thousands):
March 31, 2011 | December 31, 2010 | |||||||
Performing |
$ | 1,587,444 | $ | 1,561,501 | ||||
Non-performing |
79,837 | 75,891 | ||||||
Total |
$ | 1,667,281 | $ | 1,637,392 | ||||
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Table of Contents
9. Loan Servicing Portfolio Third Party Servicing
The Company services mortgage loans
for itself and, with the acquisition of Marix, for third party
investors. The Company earns servicing income from its third party servicing portfolio. The
Companys geographic diversification of its serviced for others portfolio, based on outstanding
unpaid principal balance, or UPB, is as follows (in thousands, except for number of loans):
Number of | UPB | Percentage of | Number of | UPB | Percentage of | |||||||||||||||||||
Loans | March 31, | Total | Loans | December 31, | Total | |||||||||||||||||||
March 31, 2011 | 2011 | March 31, 2011 | December 31, 2010 | 2010 | December 31, 2010 | |||||||||||||||||||
California |
836 | $ | 349,906 | 23.2 | % | 700 | $ | 291,192 | 21.6 | % | ||||||||||||||
Florida |
852 | 210,813 | 14.0 | 882 | 216,300 | 16.0 | ||||||||||||||||||
New York |
458 | 180,461 | 12.0 | 422 | 163,466 | 12.1 | ||||||||||||||||||
New Jersey |
260 | 79,309 | 5.3 | 232 | 71,875 | 5.3 | ||||||||||||||||||
Other < 5% |
3,684 | 685,241 | 45.5 | 3,303 | 605,496 | 45.0 | ||||||||||||||||||
6,090 | $ | 1,505,730 | 100.0 | % | 5,539 | $ | 1,348,329 | 100.0 | % | |||||||||||||||
10. Subordinate Security
The Companys subordinate security totaled $1.8 million at March 31, 2011 and December 31,
2010. The subordinate security was acquired as part of the Merger with Hanover and is
summarized as follows (in thousands):
Actual maturities on mortgage-backed securities are generally shorter than the stated
contractual maturities because the actual maturities are affected by the contractual lives of the
underlying notes, periodic payments of principal, and prepayments of principal. The contractual
maturity of the subordinate security is 2038.
March 31, 2011 | December 31, 2010 | |||||||
Principal balance |
$ | 3,812 | $ | 3,812 | ||||
Purchase price and other adjustments |
(2,200 | ) | (2,200 | ) | ||||
Amortized cost |
$ | 1,612 | $ | 1,612 | ||||
Unrealized gain |
231 | 208 | ||||||
Carrying value (fair value) |
$ | 1,843 | $ | 1,820 | ||||
11. Mortgage-Backed Debt and Related Collateral
Mortgage-Backed Debt
The securitization trusts beneficially owned by Mid-State Capital, are the depositors under
the Companys outstanding mortgage-backed and asset-backed notes or the Trust Notes, which consist
of eight separate series of public debt offerings and two private offering. Hanover Capital Grantor
Trust, acquired from Hanover as part of the Merger, is a public debt offering.
These eleven trusts have an aggregate of $1.3 billion of outstanding debt, collateralized by
$1.7 billion of assets, including residential loans, REO and restricted cash and cash equivalents.
All of the Companys mortgage-backed debt is non-recourse and not cross-collateralized and,
therefore, must be satisfied exclusively from the proceeds of the residential loans and REO held in
each securitization trust. The Company services the collateral underlying the ten securitization
trusts owned by the Company and Mid-State Capital.
The securitization trusts contain provisions that require the cash payments received from the
underlying residential loans be applied to reduce the principal balance of the Trust Notes unless
certain overcollateralization or other similar targets are satisfied. The securitization trusts
also contain delinquency and loss triggers, that, if exceeded, allocate any excess
overcollateralization to paying down the outstanding principal balance of the Trust Notes for that
particular securitization at an accelerated pace. Assuming no servicer trigger events have occurred
and the overcollateralization targets have been met, any excess cash is released to the Company
either monthly or quarterly, in accordance with the terms of the respective underlying trust
agreements. Since January 2008, Mid-State Trust 2006-1 has exceeded
certain triggers and has not
provided any excess cash flow to the Company. The
delinquency rate for the trigger calculations, which includes REO, was at 11.35% compared to a
trigger level of
18
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8.00%. The delinquency trigger for Mid-State Trust 2005-1 and Trust X were
exceeded in November 2009 and October 2006, respectively, and cured in 2010. With the exception of
Trust 2006-1, which exceeded its trigger and the recently cured Trust 2005-1 and Trust X, none of
the Companys other securitization trusts have reached the levels of underperformance that would
result in a trigger breach causing a delay in cash releases.
Borrower remittances received on the residential loan collateral are used to make payments on
the mortgage-backed debt. The maturity of the mortgage-backed debt is directly affected by
principal prepayments on the related residential loan collateral. As a result, the actual maturity
of the mortgage-backed debt is likely to occur earlier than the stated maturity. Certain of the
Companys mortgage-backed debt is also subject to redemption according to specific terms of the
respective indenture agreements.
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Table of Contents
Collateral for Mortgage-Backed Debt
The following table summarizes the collateral for the mortgage-backed
debt as of March 31, 2011 and December 31, 2010, respectively (in thousands):
March 31, 2011 | December 31, 2010 | |||||||
Residential loans of securitization trusts, principal balance |
$ | 1,663,807 | $ | 1,682,138 | ||||
Real estate owned |
33,569 | 38,234 | ||||||
Restricted cash and cash equivalents |
43,149 | 42,859 | ||||||
Total mortgage-backed debt collateral |
$ | 1,740,525 | $ | 1,763,231 | ||||
12. Servicing Revenue and Fees
The Companys third party servicing operations began as a result of the acquisition of Marix in
November 2010. The following table presents servicing fees (in thousands):
March 31, 2011 | ||||
Servicing fees |
$ | 1,026 | ||
Incentive fees |
880 | |||
Other servicing fees |
598 | |||
Other ancillary fees |
433 | |||
Servicing revenues and fees |
$ | 2,937 | ||
13. Share Based Compensation
The Companys share-based compensation expense has been reflected in the consolidated
statements of income in salaries and benefits expense. There were no options or non-vested
share-based awards granted during the three months ended March 31, 2011.
14. Credit Agreements
On April 20, 2009, the Company entered into a syndicated credit agreement, a revolving credit
agreement and security agreement, and a support letter of credit agreement. As of March 31, 2011,
no funds have been drawn under any of the credit agreements and the Company is in compliance with
all covenants. The credit agreements were cancelled on or before April 6, 2011.
15. Servicing Advance Facility
As of November 11, 2008, Marix entered into a Servicing Advance Financing Facility Agreement,
or the Servicing Facility, between Marathon Distressed Subprime Fund L.P., as a lender, an
affiliate of Marathon, and Marix as a borrower. The note rate on the Servicing Facility is LIBOR
plus 6.0%. The facility was originally set to terminate on September 30, 2010, but was extended as
part of the purchase agreement for six months to March 31, 2011. The maximum borrowing capacity on
the Servicing Facility was $8.0 million.
On September 9, 2009, Marix entered into a Servicing Advance Financing Facility Agreement, or
Second Facility, between Marathon Structured Finance Fund L.P. as an agent and a lender, an
affiliate of Marathon, and Marix as a borrower. The rate on this agreement was converted from
one-month LIBOR plus 6.0% to one-month LIBOR plus 3.5% on March 31, 2010. The facility was set to
terminate on March 31, 2010, but was extended for twelve months to March 31, 2011. The maximum
borrowing capacity on the Second Facility was $2.5 million.
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The collateral for this servicing advance facility represents servicing advances on mortgage
loans serviced by Marix for investors managed by or otherwise affiliated with Marathon, and such
advances include principal and interest, taxes and insurance, and corporate advances. During the
first quarter of 2011, the Company paid off the servicing advance facilities.
16. Comprehensive Income and Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income are as follows (in thousands):
Excess of | Net | |||||||||||||||
Additional | Unrealized | Net | ||||||||||||||
Postretirement | Gain on | Amortization of | ||||||||||||||
Employee Benefits | Subordinate | Realized Gain on | ||||||||||||||
Liability | Security | Closed Hedges | Total | |||||||||||||
Balance at December 31, 2010 |
$ | 686 | $ | 208 | $ | 357 | $ | 1,251 | ||||||||
Pre-tax amount |
(122 | ) | 23 | (45 | ) | (144 | ) | |||||||||
Tax benefit |
14 | | | 14 | ||||||||||||
Balance at March 31, 2011 |
$ | 578 | $ | 231 | $ | 312 | $ | 1,121 | ||||||||
17. Common Stock and Earnings Per Share
In accordance with the accounting guidance concerning earnings per share, or EPS, unvested
share-based payment awards that include non-forfeitable rights to dividends or dividend
equivalents, whether paid or unpaid, are considered participating securities. As a result, the
awards are required to be included in the calculation of basic earnings per common share pursuant
to the two-class method. For the Company, participating securities are comprised of certain
unvested restricted stock and restricted stock units.
Under the two-class method, net income is reduced by the amount of dividends declared in the
period for common stock and participating securities. The remaining undistributed earnings are
then allocated to common stock and participating securities as if all of the net income for the
period had been distributed. Basic earnings per share excludes dilution and is calculated by
dividing net income allocable to common shares by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share is calculated by dividing net income
allocable to common shares by the weighted-average number of common shares for the period, as
adjusted for the potential dilutive effect of non-participating share-based awards.
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The following is a reconciliation of the numerators and denominators of the basic and diluted
EPS computations shown on the face of the accompanying consolidated statements of income (in
thousands, except per share data):
For the Quarter Ended March 31, |
||||||||
2011 | 2010 | |||||||
Basic earnings per share: |
||||||||
Net income |
$ | 3,490 | $ | 8,112 | ||||
Less: net income allocated to unvested participating securities |
(36 | ) | (113 | ) | ||||
Net income available to common stockholders (numerator) |
3,454 | 7,999 | ||||||
Weighted-average common shares |
25,779 | 25,657 | ||||||
Add: vested participating securities |
817 | 686 | ||||||
Total weighted-average common shares outstanding (denominator) |
26,596 | 26,343 | ||||||
Basic earnings per share |
$ | 0.13 | $ | 0.30 | ||||
Diluted earnings per share: |
||||||||
Net income |
$ | 3,490 | $ | 8,112 | ||||
Less: net income allocated to unvested participating securities |
(35 | ) | (113 | ) | ||||
Net income available to common stockholders (numerator) |
3,455 | 7,999 | ||||||
Weighted-average common shares |
25,779 | 25,657 | ||||||
Add: Potentially dilutive stock options and vested participating securities |
952 | 746 | ||||||
Diluted weighted-average common shares outstanding (denominator) |
26,731 | 26,403 | ||||||
Diluted earnings per share |
$ | 0.13 | $ | 0.30 | ||||
The
calculation of diluted earnings per share for the three months ended March 31, 2011 and
2010 does not include less than 0.1 million and 0.2 million shares, respectively, because their
effect would have been anti-dilutive.
18. REIT Qualification
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as
amended. The Companys continuing qualification as a REIT depends on (a) the Board of Directors
determination that it remains in the best interests of the Company to continue to be taxed as a
REIT, and (b) its ability to meet the various requirements imposed by the Code, which relate to
organizational structure, distribution levels, diversity of stock ownership and certain
restrictions with regard to owned assets and categories of income. As a REIT, the Company will
generally not be subject to United States, or U.S., federal corporate income tax on its taxable
income that is currently distributed to stockholders. Even as a REIT, the Company may be subject to
U.S. federal income and excise taxes in various situations, such as on the Companys undistributed
income. We expect that upon consummation of the Green Tree acquisition we will
no longer qualify as a REIT.
Certain of the Companys operations or portions thereof, including mortgage advisory and
insurance ancillary businesses, are conducted through taxable REIT subsidiaries, or TRSs. A TRS is
a C-corporation that has not elected REIT status and, as such, is subject to U.S. federal corporate
income tax. The Companys TRSs facilitate its ability to offer certain services and conduct
activities that generally cannot be offered directly by the REIT. The Company also will be required
to pay a 100% tax on any net income on non-arms length transactions between the REIT and any of
its TRSs.
If the Company elects or otherwise fails to qualify as a REIT in any taxable year and does not
qualify for certain statutory relief provisions, it will be subject to U.S. federal income and
applicable state and local tax at regular corporate rates and may be precluded from qualifying as a
REIT for the subsequent four taxable years following the year during which it fails to qualify as a
REIT. Even if the Company qualifies for taxation as a REIT, it may be subject to some U.S. federal,
state and local taxes on its income or property.
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19. Income Taxes
The Company recorded income tax expense of $0.1 million for each of the three months periods
ended March 31, 2011 and 2010, respectively. During the three months ended March 31, 2011 and 2010,
an estimated tax rate of 4.0% and 1.6%, respectively, was used to derive income tax expense of $0.1
million for each period, calculated on income from operations, before taxes, of $3.6 million and
$8.2 million, respectively. The increase in estimated tax rate was due to our taxable TRSs net
income representing a greater portion of the net income than in the prior year first quarter.
The Company recognizes tax benefits in accordance with the guidance concerning uncertainty in
income taxes. This guidance establishes a more-likely-than-not recognition threshold that must be
met before a tax benefit can be recognized in the financial statements. As of March 31, 2011 and
December 31, 2010, the total gross amount of unrecognized tax benefits was $7.7 million.
20. Transactions with Walter Energy
Following the spin-off, the Company and Walter Energy have operated independently, and neither
has any ownership interest in the other. In order to allocate responsibility for overlapping or
related aspects of their businesses, the Company and Walter Energy entered into certain agreements
pursuant to which the Company and Walter Energy assume responsibility for various aspects of their
businesses and agree to indemnify one another against certain liabilities that may arise from their
respective businesses, including liabilities relating to certain tax and litigation exposure.
21. Commitments and Contingencies
Securities Sold with Recourse
In October 1998, Hanover sold 15 adjustable-rate FNMA certificates and 19 fixed-rate FNMA
certificates that the Company received in a swap for certain adjustable-rate and fixed-rate
mortgage loans. These securities were sold with recourse. Accordingly, the Company retains credit
risk with respect to the principal amount of these mortgage securities. As of March 31, 2011, the
unpaid principal balance of the 13 remaining mortgage securities was approximately $1.4 million.
Employment Agreements
At March 31, 2011, the Company had employment agreements with its senior officers, with
varying terms that provide for, among other things, base salary, bonus, and change-in-control
provisions that are subject to the occurrence of certain triggering events.
Income Tax Exposure
A dispute exists with regard to federal income taxes owed by the Walter Energy consolidated
group. The Company was part of the Walter Energy consolidated group prior to the spin-off and
Merger. As such, the Company is jointly and severally liable with Walter Energy for any final
taxes, interest and/or penalties owed by the Walter Energy consolidated group during the time that
the Company was a part of the Walter Energy consolidated group. According to Walter Energys most
recent public filing on Form 10-K, they state that the IRS has filed a proof of claim for a
substantial amount of taxes, interest and penalties with respect to fiscal years ended August 31,
1983 through May 31, 1994. The public filing goes on to disclose that the issues have been
litigated in bankruptcy court and that an opinion was issued by the court in June 2010 as to the
remaining disputed issues. The filing further states that the amounts initially asserted by the IRS
do not reflect the subsequent resolution of various issues through settlements or concessions by
the parties. Walter Energy believes that those portions of the claim which remain in dispute or are
subject to appeal substantially overstate the amount of taxes allegedly owing. However, because of
the complexity of the issues presented and the uncertainties associated with litigation, Walter
Energy is unable to predict the outcome of the adversary proceeding. Finally, Walter Energy
believes that all of its current and prior tax filing positions have substantial merit and intends
to defend vigorously any tax claims asserted and that they believe that they have sufficient
accruals to address any claims, including interest and penalties. Under the terms of the Tax
Separation Agreement between the Company and Walter Energy dated April 17, 2009, Walter Energy is
responsible for the payment of all federal income taxes (including any interest or penalties
applicable thereto) of the consolidated group, which includes the aforementioned claims of the IRS.
However, to the extent that Walter Energy is unable to pay any amounts owed, the Company could be
responsible for any unpaid amounts.
In addition, Walter Energys most recent public filing disclosed that the IRS completed an
audit of Walter Energys federal income tax returns for the years ended May 31, 2000 through
December 31, 2005. WIM predecessor companies were included within Walter Energy during these years.
The IRS issued 30-Day Letters to Walter Energy proposing changes for these tax years which Walter
Energy has protested. Walter Energys filing states that the disputed issues in this audit period
are similar to the issues remaining in the above-referenced dispute and therefore Walter Energy
believes that its financial exposure for these years is limited to interest and possible penalties;
however, we have no knowledge as to the extent of the claim. In addition, Walter Energy reports
that the IRS has
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begun an audit of Walter Energys tax returns filed for 2006 through 2008,
however, because the examination is in its early stages Walter Energy cannot estimate the amount of
any resulting tax deficiency, if any.
The Tax Separation Agreement also provides that Walter Energy is responsible for the
preparation and filing of any tax returns for the consolidated group for the periods when the
Company was part of the Walter Energy consolidated group. This arrangement may result in conflicts
between Walter Energy and the Company. In addition, the spin-off of WIM from Walter Energy was
intended to qualify as a tax-free spin-off under Section 355 of the Code. The Tax Separation
Agreement provides generally that if the spin-off is determined not to be tax-free pursuant to
Section 355 of the Code, any taxes imposed on Walter Energy or a Walter Energy shareholder as a
result of such determination (Distribution Taxes) which are the result of the acts or omissions
of Walter Energy or its affiliates, will be the responsibility of Walter Energy. However, should
Distribution Taxes result from the acts or omissions of the Company or its affiliates, such
Distribution Taxes will be the responsibility of the Company. The Tax Separation Agreement goes on
to provide that Walter Energy and the Company shall be jointly liable, pursuant to a designated
allocation formula, for any Distribution Taxes that are not specifically allocated to Walter Energy
or the Company. To the extent that Walter Energy is unable or unwilling to pay any Distribution
Taxes for which it is responsible under the Tax Separation Agreement, the Company could be liable
for those taxes as a result of being a member of the Walter Energy consolidated group for the year
in which the spin-off occurred. The Tax Separation Agreement also provides for payments from Walter
Energy in the event that an additional taxable dividend is required to cure a REIT disqualification
from the determination of a shortfall in the distribution of non-REIT earnings and profits made
immediately following the spin-off. As with Distribution Taxes, the Company will be responsible for
this dividend if Walter Energy is unable or unwilling to pay.
Other Tax Exposure
On June 28, 2010, the Alabama Department of Revenue, or ADOR, preliminarily assessed financial
institution excise tax of approximately $4.2 million, which includes interest and penalties, on a
predecessor entity for the years 2004 through 2008. This tax is imposed on financial institutions
doing business in the State of Alabama. The Company has contested the assessment and believes that
the Company did not meet the definition of a financial institution doing business in the State of
Alabama as defined by the Alabama Tax Code. As of the time of filing, ADOR has yet to respond to
the Companys appeal of the preliminary assessment.
Miscellaneous Litigation
The Company is a party to a number of lawsuits arising in the ordinary course of its business.
While the results of such litigation cannot be predicted with certainty, the Company believes that
the final outcome of such litigation will not have a materially adverse effect on the Companys
financial condition, results of operations or cash flows.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
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, 2010, filed in our Annual Report on Form 10-K on March 8, 2011. Historical
results and trends which might appear should not be taken as indicative of future operations. Our
results of operations and financial condition, as reflected in the accompanying statements and
related footnotes, are subject to managements 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 governing our directors, officers, and employees. Within the time period
required by the SEC and the New York Stock Exchange, we will post on our website any amendment to
the Code of Conduct and any waiver applicable to any executive officer, director, or senior officer
(as defined in the Code of Conduct). 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,
FL 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, without limitation, matters discussed under Item
2, Managements 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. 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 under the caption Risk Factors in our Annual Report on
Form 10-K for the year ended December 31, 2010 filed with the SEC on March 8, 2011 and detailed
from time to time in our other securities filings with the SEC.
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 and developments in particular; the availability of suitable qualifying investments
for the proceeds of our November 2010 secondary offering and risks associated with any such
investments we may pursue; the availability of additional investment capital and suitable
qualifying investments, and risks associated with the expansion of our business activities,
including risks associated with expanding our business outside of our current geographic footprint
and/or expanding the scope of our business to include activities not currently undertaken by our
business; limitations imposed on our business due to our real estate investment trust, or REIT,
status and our continued qualification as a REIT for federal income tax purposes; financing sources
and availability, and future interest expense; fluctuations in interest rates and levels of
mortgage prepayments; increases in costs and other general competitive factors; natural disasters
and adverse weather conditions, especially to the extent they result in material payouts under
insurance policies placed with our captive insurance subsidiary; changes in federal, state and
local policies, laws and regulations affecting our business, including, without limitation,
mortgage financing or servicing, changes to licensing requirements, and/or the rights and
obligations of property owners, mortgagees and tenants; the effectiveness of risk management
strategies; unexpected losses resulting from pending, threatened or unforeseen litigation or other
third party claims against us; the ability or willingness of Walter Energy, Inc. and other
counterparties to satisfy material obligations under agreements with us; our continued listing on
the NYSE Amex; uninsured losses or losses in excess of insurance limits and the availability of
adequate insurance coverage at reasonable costs and the effects of competition from a variety of
local, regional, national and other mortgage servicers.
On November 2, 2010, the Company closed on a securities purchase agreement to acquire 100% of
the ownership interests of Marix, a mortgage servicing business. See Note 3 for further
information on this acquisition. Risks and uncertainties related to this acquisition include, but
are not limited to, losses incurred in the Marix business, our inability to reduce or eliminate
such losses as
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quickly as anticipated, our ability to retain existing licenses in jurisdictions in
which Marix does business, our inability to integrate the Marix business and/or to achieve
anticipated synergies, and our inability to grow the Marix business as quickly as anticipated.
On March 25, 2011, the Company entered into a Membership Interest Purchase Agreement to
acquire 100% of the ownership interests in GTCS Holdings, LLC. See Note 3 for further information
on this acquisition. The risks and uncertainties include, but are not limited to, the satisfactory
completion of all conditions precedent to the closing of the proposed transaction in accordance
with the terms and conditions of the purchase agreement, including the receipt of regulatory and
customer approvals; the negotiation, execution and delivery of definitive financing agreements and
the satisfaction of all conditions precedent that will be contained therein; the completion of
asset sales contemplated by the purchase agreement; the obligation to pay a termination fee under
the purchase agreement in certain circumstances if the closing does not occur; and anticipated
growth of the specialty servicing sector. See Part II, Item IA, Risk Factors, for additional
risks and uncertainties related to this acquisition.
All forward looking statements set forth herein are qualified by these cautionary statements
and are made only as of the date hereof. We undertake no obligation to update or revise the
information contained herein, including without limitation 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 mortgage servicer and mortgage portfolio owner specializing in credit-challenged,
non-conforming residential loans primarily in the southeastern United States, or U.S. The Company
originates, purchases, and provides property insurance for residential loans. The Company also
provides ancillary mortgage advisory services. At March 31, 2011, the Company had five wholly
owned, primary subsidiaries: Hanover Capital Partners 2, Ltd., doing business as Hanover Capital,
Walter Mortgage Company, LLC, or WMC, Best Insurors, Inc., or Best, Walter Investment Reinsurance
Company, Ltd., or WIRC, and Marix Servicing LLC, or Marix.
Basis of Presentation
The consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States, or GAAP, which requires management to make
estimates and assumptions that affect the amounts reported in the consolidated financial
statements. Actual results could differ from those estimates. All significant intercompany balances
have been eliminated in the consolidated financial statements.
Acquisitions
GTCS Holdings, LLC
On March 28, 2011, we executed a Membership Interest Purchase Agreement to purchase GTCS
Holdings LLC, or Green Tree, in a transaction valued at $1.065 billion. Green Tree, based in St.
Paul, Minnesota, is a leading independent, fee-based business services company which provides
high-touch, third-party servicing of credit-sensitive consumer loans. We will issue approximately
1.8 million shares of common stock to the seller; assume approximately $18 million of existing
Green Tree debt, and issue approximately $765 million of new debt which, together with cash, will
be used to acquire the equity of Green Tree, repay certain existing Green Tree corporate
indebtedness, and pay fees and expenses of the transaction. In addition, we will have access to a
$45 million revolving line of credit. The transaction is subject to receipt of government
approvals, third-party consents and the satisfaction of other customary closing conditions. We
expect to complete the transaction in the third quarter of 2011.
Marix Servicing, LLC
On August 25, 2010, we entered into a definitive agreement with Marathon Asset Management,
L.P., or Marathon, and an individual seller to purchase 100% of the outstanding ownership interests
of Marix. The acquisition was effective as of November 1, 2010. Marix is a high-touch specialty
mortgage servicer, based in Phoenix, Arizona, focused on default management, borrower outreach,
loss mitigation, liquidation strategies, component servicing and
specialty servicing.
The purchase price for the acquisition was a cash payment due at closing of less than $0.1
million plus contingent earn-out payments. The earn-out payments are driven by net servicing
revenue in Marixs existing business in excess of a base of $3.8 million per quarter. The payments
are due within 30 days after the end of each fiscal quarter through the three year period ended
December 31, 2013. The estimated liability for future earn-out payments is recorded in accounts
payable and other accrued liabilities. In accordance with the accounting guidance on business
combinations, any future adjustments to the estimated earn-out liability would be recognized in the
earnings of that period. Based upon the results of the first quarter earn-out payment calculation
there was no amount paid as of March 31, 2011 and the accrual for the contingent earn-out payment
was adjusted to $1.8 million, resulting in $338 thousand being
recorded in income during the first quarter of 2011.
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Critical Accounting Policies
The significant accounting policies used in preparation of our consolidated financial
statements are described in Note 2 of Notes to Consolidated Financial Statements for the year
ended December 31, 2010 included in our Annual Report on Form 10-K filed with the SEC on March 8,
2011. There have been no material changes to our critical accounting policies or the methodologies
or assumptions we apply under them.
Results of Operations
For the three months ended March 31, 2011 and 2010, we reported net income of $3.5 million and
$8.1 million, respectively. The main components of the change in net income for the three months
ended March 31, 2011 and 2010 are detailed in the following table (in thousands):
For the Three Months Ended | ||||||||||||
March 31, | Increase | |||||||||||
2011 | 2010 | (Decrease) | ||||||||||
Net interest income: |
||||||||||||
Interest income |
$ | 41,355 | $ | 41,628 | $ | (273 | ) | |||||
Less: Interest expense |
20,392 | 21,003 | (611 | ) | ||||||||
Total net interest income |
20,963 | 20,625 | 338 | |||||||||
Less: Provision for loan losses |
625 | 1,455 | (830 | ) | ||||||||
Total net interest income after provision for loan losses |
20,338 | 19,170 | 1,168 | |||||||||
Non-interest income: |
||||||||||||
Premium revenue |
2,032 | 2,691 | (659 | ) | ||||||||
Servicing revenue and fees |
2,937 | | 2,937 | |||||||||
Other income, net |
699 | 760 | (61 | ) | ||||||||
Total non-interest income |
5,668 | 3,451 | 2,217 | |||||||||
Total non-interest expenses: |
||||||||||||
Total non-interest expenses |
22,373 | 14,378 | 7,995 | |||||||||
Income before income taxes |
3,633 | 8,243 | (4,610 | ) | ||||||||
Income tax expense |
143 | 131 | 12 | |||||||||
Net income |
$ | 3,490 | $ | 8,112 | $ | (4,622 | ) | |||||
Net Interest Income
Our results of operations for our portfolio during a given period typically reflect the net
interest spread earned on our residential loan portfolio. The net interest spread is impacted by
factors such as the interest rate our residential loans are earning and our cost of funds.
Furthermore, the amount of discount on the residential loans will impact the net interest spread as
such amounts will be amortized over the expected term of the residential loans and the amortization
will be accelerated due to voluntary prepayments.
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The following table summarizes the average balance, interest and weighted average yield on
residential loan assets and mortgage-backed debt for the periods indicated (in thousands):
For the Three Months Ended March 31, | |||||||||||||||||||||||||
2011 | 2010 | ||||||||||||||||||||||||
Average | (3) | Average | (3) | ||||||||||||||||||||||
Balance | Interest | Yield | Balance | Interest | Yield | ||||||||||||||||||||
Assets |
|||||||||||||||||||||||||
Residential loans |
$ | 1,652,337 | $ | 41,355 | 10.01 | % | $ | 1,649,834 | $ | 41,628 | 10.09 | % | |||||||||||||
Liabilities |
|||||||||||||||||||||||||
Mortgage-backed debt |
$ | 1,271,028 | $ | 20,392 | 6.42 | % | $ | 1,255,917 | $ | 21,003 | 6.69 | % | |||||||||||||
Net interest spread (1)(3) |
$ | 20,963 | 3.59 | % | $ | 20,625 | 3.40 | % | |||||||||||||||||
Net interest margin (2)(3) |
5.07 | % | 5.00 | % |
(1) | Net interest spread is calculated by subtracting the weighted average yield on interest-bearing liabilities from the weighted average yield on interest-earning assets. | |
(2) | Net interest margin is calculated by dividing the net interest spread by total average interest-earning assets. | |
(3) | Annualized. |
Net Interest Spread
Net interest spread of 3.59% for the three months ended March 31, 2011 increased as compared
to 3.40% in the same period of 2010, due primarily to a decrease in interest expense and higher
yields on the recently acquired residential loans. The decrease in interest expense is due to the declining balances on older trusts with
higher interest rates. The average prepayment rate for the portfolio was 2.2% for the three months ended
March 31, 2011, as compared to 2.3% in the same period of 2010.
Net Interest Margin
Net interest margin increased for the three months ended March 31, 2011 as compared to the
same period in 2010 primarily due to decreased interest expense due to the declining debt balances
on older trusts with higher interest rates and the 2010
securitization at a weighted average interest cost of 4.56%.
Provision for Loan Losses
The provision for loan losses decreased for the three months ended March 31, 2011, as
compared to the same period in 2010. The decrease from the prior year period was primarily
driven by improving economic trends, including lower unemployment rates, which supports assumptions
for lower default rates.
Non-Interest Income
The increase in non-interest income for the three months ended March 31, 2011, as
compared to the same period in 2010, was primarily due to additional subservicing revenues and fees
related to the Marix acquisition offset by lower premium revenues in the insurance business, lower
collections on insurance advances and a decline in advisory revenues.
Non-Interest Expenses
The increase in non-interest expenses for the three months ended March 31, 2011, as
compared to the same period in 2010, was primarily a result of $4.0 million of higher servicing and
overhead costs related to the Marix acquisition and $3.0 million of transaction costs related
to the acquisition of Green Tree. These increases are offset by the
prior year quarter including a
severance charge of $0.7 million associated with certain senior management changes. Additionally,
we recorded a $1.1 million adjustment for a decline in value on REO properties and had an increase
of $0.5 million in tax and escrow advances.
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Income Taxes
The increase in income tax expense for the three months ended March 31, 2011, as compared to
the same period in 2010 was due to taxable activities of our TRSs.
Additional Analysis of Residential Loan Portfolio
Allowance for Loan Losses
The
following tables show information about the allowance for loan losses for the periods presented
(in thousands):
Allowance | ||||||||
as a % of | ||||||||
Allowance for | Residential | |||||||
Loan Losses | Loans (1) | |||||||
March 31, 2011
|
$ | 14,920 | 0.89 | % | ||||
December 31, 2010
|
$ | 15,907 | 0.97 | % |
Net Losses and | Net Losses and | |||||||
Charge-offs | Charge-offs as a % | |||||||
Deducted from the | of Average | |||||||
Allowance (3) | Residential Loans (2) | |||||||
March 31, 2011 |
$ | 17,716 | (4) | 1.07 | % (4) | |||
December 31, 2010 |
$ | 14,799 | 0.90 | % |
(1) | The allowance for loan loss ratio is calculated as period end allowance for loan losses divided by period end residential loans before the allowance for loan losses. | |
(2) | The charge off ratio is calculated as charge-offs, net of recoveries divided by average residential loans before the allowance for loan losses. | |
(3) | Managements calculation of the charge-off ratio incorporates an economic view which considers all costs through disposition of the REO property as a charge-off. | |
(4) | Annualized. |
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The following table summarizes activity in the allowance for loan losses in our residential
loan portfolios, net for the three months ended March 31, 2011 and 2010 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Balance, December 31 |
$ | 15,907 | $ | 17,661 | ||||
Provision charged to income |
625 | 1,455 | ||||||
Less: Transfers to REO |
(922 | ) | (1,381 | ) | ||||
Less: Charge-offs, net of recoveries |
(690 | ) | (411 | ) | ||||
Balance, March 31 |
$ | 14,920 | $ | 17,324 | ||||
Delinquency Information
The following table presents information about delinquencies in our residential loan
portfolios:
March 31, 2011 | December 31, 2010 | |||||||
Total number of residential loans outstanding |
33,971 | 33,801 | ||||||
Delinquencies as a percent of number of residential loans outstanding: |
||||||||
31-60 days |
0.88 | % | 1.12 | % | ||||
61-90 days |
0.36 | % | 0.39 | % | ||||
91 days or more |
2.11 | % | 1.99 | % | ||||
3.35 | % | 3.50 | % | |||||
Principal balance of residential loans outstanding (in thousands) |
$ | 1,849,274 | $ | 1,803,758 | ||||
Delinquencies as a percent of amounts outstanding: |
||||||||
31-60 days |
1.26 | % | 1.54 | % | ||||
61-90 days |
0.55 | % | 0.49 | % | ||||
91 days or more |
2.92 | % | 2.65 | % | ||||
4.73 | % | 4.68 | % |
The past due or delinquency status is generally determined based on the contractual payment
terms. The calculation of delinquencies excludes from delinquent amounts those accounts that are in
bankruptcy proceedings that are paying their mortgage payments in contractual compliance with the
bankruptcy court approved mortgage payment obligations.
The following table summarizes our residential loans placed in non-accrual status due to
delinquent payments of 90 days past due or greater:
March 31, 2011 | December 31, 2010 | |||||||
Residential loans |
||||||||
Number of loans |
720 | 672 | ||||||
Unpaid principal balance (in millions) |
$ | 53.8 | $ | 47.8 |
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Portfolio Characteristics
The weighted average original loan-to-value, or LTV, dispersion of our residential loan
portfolios is 89.00% as of both March 31, 2011 and December 31, 2010. The LTV dispersion of our
portfolio as follows:
March 31, 2011 | December 31, 2010 | |||||||
0.00 - 70.00 |
2.33 | % | 2.03 | % | ||||
70.01 - 80.00 |
5.14 | % | 4.14 | % | ||||
80.01 - 90.00 (1) |
63.60 | % | 65.82 | % | ||||
90.01 -100.00 |
28.93 | % | 28.01 | % | ||||
Total |
100.00 | % | 100.00 | % | ||||
(1) | For those residential loans in the portfolio prior to electronic tracking of original LTVs, the maximum LTV was 90%, or 10% equity. Thus, these residential loans have been included in the 80.01 to 90.00 LTV category. |
Original LTVs do not include additional value contributed by the borrower to complete the
home. This additional value typically was created by the installation and completion of wall and
floor coverings, landscaping, driveways and utility connections in more recent periods.
Current LTVs are not readily determinable given the rural geographic distribution of our
portfolio which precludes us from obtaining reliable comparable sales information to utilize in
valuing the collateral.
The refreshed weighted average FICO score of the loans in our residential loan portfolios,
refreshed as of December 31, 2010, was 585 and 584 as of March 31, 2011 and December 31, 2010,
respectively. The refreshed FICO dispersion of our portfolio is as follows:
March 31, 2011 | December 31, 2010 | |||||||
<=600 |
55.36 | % | 55.11 | % | ||||
601 - 640 |
14.04 | % | 13.71 | % | ||||
641 - 680 |
9.56 | % | 9.25 | % | ||||
681 - 720 |
4.93 | % | 4.86 | % | ||||
721 - 760 |
2.72 | % | 2.77 | % | ||||
761-800 |
2.26 | % | 2.37 | % | ||||
>=801 |
0.93 | % | 0.96 | % | ||||
Unknown or unavailable |
10.20 | % | 10.97 | % | ||||
Total |
100.00 | % | 100.00 | % | ||||
Our residential loans are concentrated in the following states:
March 31, 2011 | December 31, 2010 | |||||||
Texas |
34.53 | % | 34.62 | % | ||||
Mississippi |
14.26 | % | 14.67 | % | ||||
Alabama |
7.97 | % | 8.23 | % | ||||
Florida |
7.13 | % | 6.78 | % | ||||
Louisiana |
6.10 | % | 6.24 | % | ||||
South Carolina |
5.59 | % | 5.64 | % | ||||
Others (1) |
24.42 | % | 23.82 | % | ||||
Total |
100.00 | % | 100.00 | % | ||||
(1) | Other consists of loans in 40 states, individually representing a concentration of less than 5%. |
Our residential loans outstanding were originated in the following periods:
March 31, 2011 | December 31, 2010 | |||||||
Year 2011 Origination |
2.05 | % | ||||||
Year 2010 Origination |
3.71 | % | 4.07 | % | ||||
Year 2009 Origination |
3.18 | % | 3.39 | % | ||||
Year 2008 Origination |
8.96 | % | 8.42 | % | ||||
Year 2007 Origination |
15.89 | % | 14.25 | % | ||||
Year 2006 Origination |
10.43 | % | 10.93 | % | ||||
Year 2005 Origination |
7.41 | % | 7.69 | % | ||||
Year 2004 Origination and earlier |
48.37 | % | 51.25 | % | ||||
Total |
100.00 | % | 100.00 | % | ||||
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Real Estate Owned
The following table presents information about foreclosed property (dollars in thousands):
Units | Balance | |||||||
Balance as of December 31, 2010 |
1,041 | $ | 67,629 | |||||
Foreclosures and other additions, at fair value |
242 | 14,120 | ||||||
Financed sales |
(349 | ) | (20,609 | ) | ||||
Cash sales to third parties and other dispositions |
(25 | ) | (1,388 | ) | ||||
Fair value adjustment |
| (1,093 | ) | |||||
Balance as of March 31, 2011 |
909 | $ | 58,659 | |||||
Liquidity and Capital Resources
Overview
Our principal sources of funds are our existing cash balances, monthly principal and interest
payments we receive from our unencumbered residential loan portfolio, cash releases from our
securitized residential loan portfolio, and proceeds from other financing activities. An additional
source of liquidity is the mortgage-backed debt that we purchased during 2010 and 2011 in the open
market. We currently intend the purchases to be a temporary investment of excess cash. As needed,
we may recover this liquidity by either selling the bonds or using the bonds as collateral for a
repurchase facility. We generally use our liquidity for our operating costs, to make additional
investments and to make dividend payments.
Our securitization trusts are consolidated for financial reporting purposes under GAAP. Our
results of operations and cash flows include the activity of these Trusts. The cash proceeds from
the repayment of the collateral held in securitization trusts are owned by the Trusts and serve to
only repay the obligations of the Trusts unless certain overcollateralization or other similar
targets are satisfied. Principal and interest on the mortgage-backed debt of the Trusts can only be
paid if there are sufficient cash flows from the underlying collateral. As of March 31, 2011, total
debt decreased $21.1 million as compared to December 31, 2010 due to current year repayments and a
debt extinguishment of $1.4 million.
The securitization trusts contain delinquency and loss triggers, that, if exceeded, allocate
in any excess overcollateralization going to paying down the outstanding mortgage-backed notes for
that particular securitization at an accelerated pace. Assuming no servicer trigger events have
occurred and the overcollateralization targets have been met, any excess cash is released to us. Since January 2008,
Mid-State Trust 2006-1 has exceeded certain triggers and has not provide any excess
cash flow to us. The delinquency rate for trigger calculations, which includes REO, was at 11.35%
compared to a trigger level of 8.00%. However, this is an improvement from a level of 13.24% one
year prior. The delinquency trigger for Mid-State Trust 2005-1 and Trust X were
exceeded in November 2009 and October 2006, respectively, and cured in 2010. With the exception of Trust
2006-1 which exceeded its trigger and the recently cured Trust 2005-1 and Trust X, none of our
other securitization trusts have reached the levels of underperformance that would result in a
trigger breach causing a delay in cash releases.
We believe that, based on current forecasts and anticipated market conditions, funding
generated from the residential loans will be sufficient to meet operating needs. However, we
anticipate having to monetize our existing unencumbered residential loan portfolio, as well as the
mortgage-backed debt securities we are currently holding to have sufficient funds to close the
proposed Green Tree acquisition. Our operating cash flows and liquidity are significantly
influenced by numerous factors, including the general economy, interest rates and, in particular,
conditions in the mortgage markets.
Mortgage-Backed Debt
We have historically funded our residential loans through the securitization market. As of
March 31, 2011, we had ten separate non-recourse securitization trusts for which we service the
underlying collateral and one non-recourse securitization for which we do not service the
underlying collateral. These eleven trusts have an aggregate of $1.3 billion of outstanding debt,
collateralized by residential loans with a principal balance of $1.7 billion and REO with a fair
value of $33.6 million. All of our mortgage-backed debt is non-recourse and not
cross-collateralized and, therefore, must be satisfied exclusively from the proceeds of the
residential loans and REO held in each securitization trust. As we have the power to direct the
activities that most significantly impact the economic performance of the securitization trusts and
our investment in the subordinate debt, if any, and residual interests provide us with the
obligation to absorb losses or the right to receive benefits that are significant, we have
consolidated the securitization trusts and treat the residential loans as our assets and the
related mortgage-backed debt as our debt.
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Borrower remittances received on the residential loan collateral held in securitization trusts
are used to make payments on the mortgage-backed debt. The maturity of the mortgage-backed debt is
directly affected by principal prepayments on the related residential loan collateral. As a result,
the actual maturity of the mortgage-backed debt is likely to occur earlier than the stated
maturity. Certain of our mortgage-backed debt is also subject to redemption according to specific
terms of the respective indenture agreements.
Credit Agreements
In April 2009, we entered into a syndicated credit agreement, a revolving credit agreement and
security agreement, and a support letter of credit agreement. All
three of these agreements were due to mature
on April 20, 2011. As of March 31, 2011, no funds have been drawn under any of the credit
agreements and we are in compliance with all covenants. These agreements were terminated by the
Company on or before April 6, 2011.
Sources and Uses of Cash
The following table sets forth, for the periods indicated, selected consolidated cash flow
information (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Cash flows provided by operating activities |
$ | 3,589 | $ | 6,254 | ||||
Cash flows (used in) provided by investing activities |
(21,912 | ) | 27,347 | |||||
Cash flows used in financing activities |
(37,639 | ) | (36,585 | ) | ||||
$ | (55,962 | ) | $ | (2,984 | ) | |||
Operating activities. Net cash provided by operating activities was $3.6 million for the
three months ended March 31, 2011 as compared to $6.3 million for the same period in 2010. During
the three months ended March 31, 2011 and 2010, the primary sources of cash in operating activities
were the income generated from our portfolio and our ancillary businesses.
Investing activities. Net cash (used in) provided by investing activities was $(21.9)
million for the three months ended March 31, 2011 as compared to $27.3 million for the same period
in 2010. For the three months ended March 31, 2011 and 2010, the primary source of cash from
investing activities was provided by principal payments received on
our residential loans of $23.5
million and $24.7 million, respectively. During the three months ended March 31, 2011, cash of
$44.8 million was used to purchase of residential loans.
Financing activities. Net cash used in financing activities was $37.6 million for the three
months ended March 31, 2011 as compared to $36.6 million for the same period in 2010. For the three
months ended March 31, 2011 and 2010, net cash used in financing activities was primarily for
principal payments on our mortgage-backed debt as well as the payment of dividends to our
stockholders.
One of the financial metrics on which we focus is our sources and uses of cash. As a
supplement to the Consolidated Statements of Cash Flows included in this Quarterly Report on Form
10-Q, we provide the table below which sets forth, for the periods indicated, our sources and uses
of cash (in millions). The cash balance at the beginning and ending of each period of 2011 and 2010
are GAAP amounts and the sources and uses of cash are organized in a manner consistent with how
management monitors the cash flows of our business. The presentation of our sources and uses of
cash for the table below is derived by aggregating and netting all items within our GAAP
Consolidated Statements of Cash Flows for the respective periods. The table excludes the gross cash
flows generated by our securitization trusts as those amounts are generally not available to us.
The table does include the cash releases distributed to us as a result of our investment in the
residual interests of the securitization trusts.
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Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Beginning cash and cash equivalents balance |
$ | 114.4 | $ | 99.3 | ||||
Principal sources of cash: |
||||||||
Cash collections from the unencumbered portfolio |
4.3 | 11.9 | ||||||
Cash releases from the securitized portfolio |
16.7 | 10.0 | ||||||
Cash flow from ancillary business revenue |
5.3 | 2.9 | ||||||
26.3 | 24.8 | |||||||
Other sources of cash: |
||||||||
Other |
| 0.1 | ||||||
Total sources of cash |
26.3 | 24.9 | ||||||
Principal uses of cash: |
||||||||
Claims paid |
(1.0 | ) | (0.9 | ) | ||||
Operating expenses paid |
(17.6 | ) | (12.5 | ) | ||||
Servicing advances, net |
(0.4 | ) | | |||||
(19.0 | ) | (13.4 | ) | |||||
Other uses of cash: |
||||||||
Purchases of residential loans |
(44.8 | ) | | |||||
Dividends and dividend equivalents paid |
(13.4 | ) | (13.2 | ) | ||||
Mortgage-backed debt extinguishment |
(1.3 | ) | | |||||
Other |
(3.8 | ) | (1.3 | ) | ||||
Total uses of cash |
(82.3 | ) | (27.9 | ) | ||||
Net uses of cash |
(56.0 | ) | (3.0 | ) | ||||
Ending cash and cash equivalents balance |
$ | 58.4 | $ | 96.3 | ||||
Our principal business cash flows are those associated with managing our portfolio and totaled
$7.3 million for the three months ended March 31, 2011, down $4.1 million from the three months
ended March 31, 2010, as the combined cash collections and releases from our unencumbered and
securitized residential loan portfolios decreased by $0.9 million due primarily to the declining
balance nature of the existing portfolio and a decline in the level of voluntary prepayments offset
partially by the cash flows associated with newly acquired residential loans. Principal cash flows
also declined due to an increase in cash operating experiences as a result of the Marix
acquisition. Cash flows from ancillary business revenues also increased due to the Marix
acquisition.
Cash releases from the securitized portfolio consist of servicing fees and residual cash flows
on residential loans held as securitized collateral within the securitization trusts after
distributions are made to bondholders of the securitized mortgage-backed debt to the extent
required credit enhancements are maintained and the delinquency and loss triggers are not exceeded.
These cash flows represent the difference between principal and interest payments received on the
underlying residential loans reduced by principal payments, including accelerated payments, if any,
on the securitized mortgage-backed debt; interest paid on the securitized mortgage-backed debt;
actual losses, net of any gains incurred upon disposition of REO; and the maintenance of
overcollateralization requirements.
During the first quarter of 2011, we deployed $44.8 million of the proceeds from our 2010
securitization to purchase pools of
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residential loans. We expect our future sources of cash will
continue to be generated from our existing residential loan and
servicing revenues from Marix and Green Tree.
On March 28, 2011, we announced the definitive agreement to acquire Green Tree in a
transaction valued at $1.065 million. As a result of the proposed transaction, we plan to issue
approximately $1.8 million shares of common stock to the seller, assume approximately $18 million
of existing Green Tree corporate debt, and issue $765 million of new debt which has been fully
committed by Credit Suisse and The Royal Bank of Scotland plc and which, together with cash, will
be used to acquire the equity of Green Tree, repay certain existing Green Tree indebtedness and pay fees
and expenses of the transaction. In addition, we will have access to a $45 million revolving line
of credit. During the second quarter of 2011, we plan to monetize
certain of our unencumbered assets to generate cash for the proposed acquisition of Green Tree. All significant free cash flow will be committed to de-levering the Company.
Off-Balance Sheet Arrangements
As of March 31, 2011, we retained credit risk on 13 remaining mortgage securities totaling
$1.4 million that were sold with recourse by Hanover in a prior year. Accordingly, we are
responsible for credit losses, if any, with respect to these securities.
We do not have any relationships with unconsolidated entities or financial partnerships, such
as entities often referred to as structured finance, special purpose or variable interest entities,
which would have been established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. In addition, we do not have any undisclosed
borrowings or debt, and have not entered into any derivative contracts or synthetic leases. We are,
therefore, not materially exposed to any financing, liquidity, market or credit risk that could
arise if we had engaged in such relationships.
Dividends
As long as we elect to maintain REIT status, we are required to have declared dividends
amounting to at least 90% of our net taxable income (excluding net capital gain) for each year by
the time our U.S. federal tax return is filed. Therefore, a REIT generally passes through
substantially all of its earnings to stockholders without paying U.S. federal income tax at the
corporate level.
We expect that upon consummation of the Green Tree acquisition we will
no longer qualify as a REIT. The expected change to our REIT status
will be retroactive to January 1, 2011. All future distributions will be made
at the discretion of our Board of Directors and will depend on our earnings, financial condition and liquidity, and such other factors as the Board of Directors deems relevant.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Qualitative Information on Market Risk
We seek to manage the risks inherent in our business including but not limited to credit
risk, interest rate risk, prepayment risk, liquidity risk, real estate risk and inflation risk
in a prudent manner designed to enhance our earnings and preserve our capital. In general, we seek
to assume risks that can be quantified from historical experience, to actively manage such risks,
and to maintain capital levels consistent with these risks.
Credit Risk
Credit risk is the risk that we will not fully collect the principal we have invested in
residential loans due to borrower defaults. Our portfolio as of March 31, 2011 consisted of
securitized residential loans with a principal balance of $1.7 billion and approximately $0.1
million of unencumbered residential loans.
The residential loans were predominantly credit challenged, non-conforming loans with an
average LTV ratio at origination of approximately 89% and average borrower credit core of 585.
While we feel that our underwriting and due diligence of these loans will help to mitigate the risk
of significant borrower default on these loans, we cannot assure you that all borrowers will
continue to satisfy their payment obligations under these loans, thereby avoiding default.
The $1.6 billion carrying value of residential loans and other collateral of securitization
trusts are permanently financed with $1.3 billion of mortgage-backed debt leaving us with a net
credit exposure of $311 million, which approximates our residual interest in the securitization
trusts.
When we purchase residential loans, the credit underwriting process varies depending on the
pool characteristics, including loan seasoning or age, LTV ratios, payment histories and
counterparty representations and warranties. We perform a due diligence review of potential
acquisitions which may include a review of the residential loan documentation, appraisal reports
and credit underwriting. Generally, an updated property valuation is obtained.
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Interest Rate Risk
Interest rate risk is the risk of changing interest rates in the market place. Our primary
interest rate risk exposures relate to the interest rates on mortgage-backed debt of the Trusts and
the yields on our residential loan portfolios and prepayments thereof.
Our fixed-rate residential loan portfolio had $1.8 billion of unpaid principal as of March 31,
2011 and December 31, 2010, and fixed-rate mortgage-backed debt was $1.2 billion and $1.3 billion
as of March 31, 2011 and December 31, 2010, respectively. The fixed rate nature of these
instruments and their offsetting positions effectively mitigate significant interest rate risk
exposure from these instruments. If interest rates decrease, we may be exposed to higher prepayment
speeds. This could result in a modest increase in short-term profitability. However, it could
adversely impact long-term profitability as a result of a shrinking portfolio. Changes in interest
rates may impact the fair value of these financial instruments.
Prepayment Risk
Prepayment risk is the risk that borrowers will pay more than their required monthly mortgage
payment including payoffs of residential loans. When borrowers repay the principal on their
residential loans before maturity, or faster than their scheduled amortization, the effect is to
shorten the period over which interest is earned, and therefore, increases the yield for
residential loans purchased at a discount to their then current balance, as with the majority of
our portfolio. Conversely, residential loans purchased at a premium to their then current balance
exhibit lower yields due to faster prepayments. Historically, when market interest rates declined,
borrowers had a tendency to refinance their residential loans, thereby increasing prepayments.
However, with tightening credit standards, the current low interest rate environment has not yet
resulted in higher prepayments. Increases in residential loan prepayment rates could result in GAAP
earnings volatility including substantial variation from quarter to quarter.
We monitor prepayment risk through periodic reviews of the impact of a variety of prepayment
scenarios on revenues, net earnings, and cash flow.
Liquidity Risk
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing
commitments to repay mortgage-backed debt of the Trusts, fund and maintain the portfolio, and other
general business needs. We recognize the need to have funds available to operate our business. It
is our policy to have adequate liquidity at all times.
Our principal sources of liquidity are the mortgage-backed debt of the Trusts we have issued
to finance our residential loans held in securitization trusts, the principal and interest payments
received from unencumbered residential loans, cash releases from the securitized portfolio and cash
proceeds from the issuance of our equity and other financing activities. We believe these sources
of funds will be sufficient to meet our liquidity requirements prior to the proposed acquisition of
Green Tree.
Our unencumbered and securitized mortgage loans are accounted for as held-for-investment and
reported at amortized cost. Thus, changes in the fair value of the residential loans do not have
an impact on our liquidity. However, the delinquency and loss triggers discussed previously may
impact our liquidity. Our obligations consist solely of mortgage-backed debt issued by our
securitization trusts. Changes in fair value of mortgage-backed debt generally have no impact on
our liquidity. Mortgage-backed debt issued by the securitization trusts are reported at amortized
cost as are the residential loans collateralizing the debt.
Real Estate Risk
We own assets secured by real property and own property directly as a result of foreclosures.
Residential property values are subject to volatility and may be affected adversely by a number of
factors, including, but not limited to, national, regional and local economic conditions (which may
be adversely affected by industry slowdowns and other factors); local real estate conditions (such
as an oversupply of housing); changes or continued weakness in specific industry segments;
construction quality, age and design; demographic factors; and retroactive changes to building or
similar codes. In addition, decreases in property values reduce the value of the collateral and
the potential proceeds available to a borrower to repay our loans, which could also cause us to
suffer losses.
Inflation Risk
Virtually all of our assets and liabilities are financial in nature. As a result, changes in
interest rates and other factors influence our performance far more so than inflation. Changes in
interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our
consolidated financial statements are prepared in accordance with GAAP. Our activities and balance
sheets are measured with reference to historical cost or fair value without considering inflation.
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Effect of Governmental Initiatives on Market Risk
As a result of ongoing challenges facing the United States economy, new laws and regulations
have been and may continue to be proposed that impact the financial services industry. On July 21,
2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Act, was enacted and
signed into law. The Act includes, among other things, provisions establishing a Bureau of Consumer
Financial Protection, which will have broad authority to develop and implement rules regarding most
consumer financial products, including provisions addressing mortgage reform as well as provisions
affecting corporate governance and executive compensation at all publicly-traded companies. The Act
also requires securitizers of asset-backed securities to retain an economic interest (generally 5%)
in the credit risk of the securitized asset. Many aspects of the law are subject to further
rulemaking and will take effect over several years, making it difficult to anticipate the overall
financial impact to our Company.
In addition, state governments have become increasingly involved in regulating mortgage
servicing activities, particularly as it pertains to processes and procedures surrounding mortgage
modifications. It is difficult to determine at this time what effects these actions may have on
our business, but a minimum they would likely extend the foreclosure process in some cases.
Quantitative Information on Market Risk
Our future earnings are sensitive to a number of market risk factors; changes in these factors
may have a variety of secondary effects that, in turn, will also impact our earnings. There were
no material changes to our quantitative information as of March 31, 2011 as compared to December
31, 2010.
Item 4. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by
this report, we carried out an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under
the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our management,
including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure
controls and procedures are effective in timely alerting them to material information required to
be included in our periodic SEC filings.
(b) Changes in Internal Controls. There have been no changes in our internal control over
financial reporting during our first quarter ended March 31, 2011, that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. | Legal Proceedings |
We are not currently a party to any lawsuit or proceeding which, in the opinion of management,
is likely to have a material adverse effect on our business, financial condition, or results of
operation.
As
discussed in Note 21 of Notes to Consolidated Financial Statements, Walter Energy is in
dispute with the IRS on a number of federal income tax issues. Walter Energy has stated in its
public filings that it believes that all of its current and prior tax filing positions have
substantial merit and that Walter Energy intends to defend vigorously any tax claims asserted.
Under the terms of the tax separation agreement between us and Walter Energy dated April 17, 2009,
Walter Energy is responsible for the payment of all federal income taxes (including any interest or
penalties applicable thereto) of the consolidated group, which includes the aforementioned claims
of the IRS. However, to the extent that Walter Energy is unable to pay any amounts owed, we could
be responsible for any unpaid amounts.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider
the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the
year ended December 31, 2010, which could materially affect our business, financial condition or
future results. The risks described in our Annual Report on Form 10-K are not the only risks facing
our Company. Additional risks and uncertainties not currently known to us or that we currently deem
to be immaterial also may materially adversely affect our business, financial condition and/or
operating results. With the exception of the risk factors below, relating to the Green Tree
acquisition there have been no material changes to the risk factors set forth in our Annual Report
on Form 10-K for the year ended December 31, 2010.
Completion of the Green Tree acquisition is conditioned upon the receipt of various regulatory and
customer consents. If such consents are delayed, not obtained or are subject to conditions that
become applicable to the parties, the completion of the acquisition may be delayed or jeopardized
or the anticipated benefits of the acquisition could be reduced.
Completion of the acquisition of Green Tree is conditioned upon the receipt of various
regulatory and customer consents. Although the Company, Green Tree and Green Trees seller have
agreed in the acquisition agreement to use their reasonable best efforts to obtain the necessary
consents, there can be no assurance that they will be granted. In addition, the relevant
governmental authorities have broad discretion in administering the governing regulations. As a
condition to approval of the change in control of Green Tree, these governmental authorities may
require that the Company file new applications for licenses, or impose requirements, limitations or
costs, or place restrictions on the conduct of our business after the completion of the
acquisition. If either the Company or Green Tree becomes subject to any term, condition, obligation
or restriction the imposition of such term, condition, obligation or restriction could delay or
adversely affect the ability to operate the Green Tree business as currently operated or integrate
Green Trees operations into our operations, reduce the anticipated benefits of the acquisition or
otherwise adversely affect our business and results of operations after the completion of the
acquisition.
The Companys and Green Trees business relationships, including customer relationships, may be
subject to disruption due to uncertainty associated with the acquisition.
Parties with which the Company and Green Tree do business, including current and potential
customers, may experience uncertainty associated with the transaction, including with respect to
current or future business relationships with the Company, Green Tree, or the combined business.
The Companys or Green Trees business relationships may be subject to disruption as customers and
others may attempt to negotiate changes in existing business relationships or consider entering
into business relationships with parties other than the Company, Green Tree, or the combined
business. These disruptions could have an adverse effect on the businesses, financial condition,
results of operations or prospects of the combined business. The adverse effect of such disruptions
could be exacerbated by a delay in the completion of the acquisition or termination of the
acquisition agreement.
Failure to complete the acquisition could negatively impact our stock price and the future business
and financial results.
If the acquisition is not completed, our ongoing business may be adversely affected and,
without realizing any of the benefits of having completed the acquisition, we would be subject to a
number of risks, including the following:
| We may experience negative reactions from the financial markets and from our customers and employees; | ||
| We may be required to pay GTH LLC, the seller of Green Tree, a termination fee of $50 million if the acquisition is terminated under certain circumstances; | ||
| We will be required to pay certain costs relating to the acquisition, whether or not the acquisition is completed. |
There can be no assurance that the risks described above will not materialize, and if any of
them do, they may adversely affect our business, financial results and stock price. In addition,
we could be subject to litigation related to any failure to complete the acquisition
or related to
any enforcement proceeding commenced against us to perform our obligations under the
acquisition
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agreement. If the acquisition is not completed, these risks may materialize and may adversely
affect our business, financial results and stock price.
We could be obligated to pay significant termination fees to GTH LLC if the acquisition agreement
is terminated under certain circumstances.
Under the acquisition agreement, either the Company or GTH Holdings LLC may terminate the
acquisition agreement under certain circumstances if the acquisition is not completed by August 31,
2011 (subject to extension of thirty days by either party under certain circumstances). Under
certain circumstances, we may be required to pay GTH Holdings a termination fee of $50 million
depending on the basis for termination.
We are obligated to consummate the acquisition of Green Tree whether or not we are able to obtain
financing or raise sufficient capital to pay the purchase price.
Under the acquisition agreement we are obligated to consummate the acquisition of Green Tree
whether or not we are able to obtain financing or raise sufficient capital to pay the purchase
price. We could be subject to litigation related to any failure to complete the acquisition or
related to any enforcement proceeding commenced against us to perform our obligations under the
acquisition agreement. If the acquisition is not completed, these risks may materialize and may
adversely affect our business, financial results and stock price. While we have entered into a
commitment letter with Credit Suisse AG, Credit Suisse Securities (USA) LLC, The Royal Bank of
Scotland plc, RBS Securities Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Bank of
America N.A. and Morgan Stanley Senior Funding, Inc. pursuant to which they have committed to
provide financing under senior secured facilities aggregating up to $810 million, their commitment
is subject to the conditions contained therein. Accordingly, we cannot assure you that such
financing will be available upon acceptable terms or at all. In addition, in order to have
sufficient capital to pay the purchase price it will be necessary for us to sell certain assets of
the Company. We cannot assure you that we will receive fair value for the assets to be sold, nor
that we will receive sufficient capital from such sales to pay the difference between the purchase
price and the amount of the purchase price to be financed.
After completion of the acquisition, we may fail to realize the anticipated benefits and cost
savings of the acquisition, which could adversely affect the value of our common stock.
The success of the acquisition will depend, in part, on our ability to realize the anticipated
benefits and cost savings from combining the businesses of the Company and Green Tree. Our ability
to realize these anticipated benefits and cost savings is subject to certain risks including:
| our ability to successfully combine the businesses of the Company and Green Tree; | ||
| whether the combined businesses will perform as expected; | ||
| the possibility that we paid more than the value we will derive from the acquisition; | ||
| the reduction of our cash available for operations and other uses, and the incurrence of indebtedness to finance the acquisition; and | ||
| the assumption of certain known and unknown liabilities of Green Tree. |
If we are not able to successfully combine the businesses of the Company and Green Tree within
the anticipated time frame, or at all, the anticipated benefits and cost savings of the acquisition
may not be realized fully or at all or may take longer to realize than expected, the combined
businesses may not perform as expected, and the value of our common stock may be adversely
affected. The Company and Green Tree have operated and, until the completion of the acquisition,
will continue to operate, independently. It is possible that the integration process could result
in the loss of key Company and Green Tree employees, the disruption of each companys ongoing
businesses or in unexpected integration issues, higher than expected integration costs and an
overall post-closing integration process that takes longer than originally anticipated.
Specifically, issues that must be addressed in integrating the operations of Green Tree into our
operations in order to realize the anticipated benefits of the acquisition so the combined business
performs as expected, include, among other things:
| combining the companies business development and operations; | ||
| integrating the companies technologies and services; | ||
| harmonizing the companies operating practices, employee development and compensation programs, internal controls and other policies, procedures and processes; | ||
| consolidating the companies corporate, administrative and information technology infrastructure; | ||
| maintaining existing agreements with customers and avoiding delays in entering into new agreements with prospective customers and suppliers; and | ||
| coordinating geographically dispersed organizations; |
In addition, at times, the attention of certain members of the companies management and
resources may be focused on the completion of the acquisition and the integration of the businesses
of the two companies and diverted from day-to-day business operations, which may disrupt each of
the companies ongoing business and the business of the combined company.
The Green Tree business is significantly larger than the Companys business and therefore may
subject the combined business to greater scrutiny by state and federal regulators than preciously
experienced by our Company.
As a result of the high residential mortgage foreclosure rate in general and reports of
improper servicing practices by some
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mortgage servicers in particular, the mortgage servicing
industry has been under increased scrutiny from state and federal regulators and other authorities.
This scrutiny is more likely to target larger servicing organizations like Green Tree than smaller
organizations like the Company. As an example, the State Attorneys General of all fifty states
have targeted several of the largest banks in the US for review and reform of their servicing
practices. Similarly, in November of 2010 the Federal Trade Commission, or FTC, issued subpoenas
to an unknown number of mortgage servicers, including Green Tree, requesting information on a broad
range of subjects relating to the companies operations. While it is not believed that Green Tree
has operated its business other than in compliance with law, and Green Tree has represented in the
acquisition agreement that it has operated its business in compliance in all material respects with
material laws applicable to its business, we cannot guarantee that the FTCs investigation will not
reveal violations with law or regulation that may adversely affect Green Trees business.
Moreover, as a significantly larger company than, the combined business is more likely to be
investigated and we cannot assure you that such investigations would not reveal any improprieties
in Green Trees past or present operations.
The Company and Green Tree may have difficulty attracting, motivating and retaining executives and
other key employees in light of the acquisition.
Uncertainty about the effect of the acquisition on the companies employees may have an
adverse effect on the Company or Green Tree, and consequently the combined business. This
uncertainty may impair the companies respective ability to attract, retain and motivate key
personnel until the acquisition is completed. Employee retention may be particularly challenging
during the pendency of the acquisition, as employees of the Company or Green Tree may experience
uncertainty about their future roles with the combined business. Additionally, certain of Green
Trees officers and employees may own interests in the Green Trees parent and, if the acquisition
is completed, may therefore be entitled to a portion of the acquisition consideration, the payment
of which could provide sufficient financial incentive for certain officers and employees to no
longer pursue employment with the combined business. If key employees of either company depart
because of issues relating to the uncertainty and difficulty of integration, financial incentives
or a desire not to become employees of the combined business, we may have to incur significant
costs in identifying, hiring and retaining replacements for departing employees, which could reduce
our ability to realize the anticipated benefits of the acquisition.
Our level of indebtedness will increase substantially upon completion of the acquisition. This
increased level of indebtedness could adversely affect us, including by decreasing our business
flexibility and increasing our borrowing costs.
Upon completion of the
acquisition, we will have incurred acquisition debt financing of up to
$810 million, which will replace debt outstanding under Green
Trees existing senior secured
credit facilities. Covenants and terms
to which we have agreed or may agree in connection with the acquisition debt financing, and our
substantial increased indebtedness and higher debt-to-equity ratio following completion of the
acquisition in comparison to our and Green Trees recent historical basis, will have the effect,
among other things, of reducing our flexibility to respond to changing business and economic
conditions and will increase borrowing costs. In addition, the amount of cash required to service
our increased indebtedness levels and thus the demands on our cash resources will be significantly
greater than the percentages of cash flows required to service our or Green Trees indebtedness
prior to the transaction. The increased levels of indebtedness could also reduce funds available
for our capital expenditures and other activities, and may create competitive disadvantages for us
relative to other companies with lower debt levels.
We will incur significant transaction and acquisition-related costs in connection with the
acquisition.
We expect to incur a number of non-recurring costs associated with combining the operations of
the two companies. We will incur transaction fees and costs related to formulating and implementing
integration plans. We continue to assess the magnitude of these costs and additional unanticipated
costs may be incurred in the integration of the two companies businesses. Although we expect that
the elimination of duplicative costs, as well as the realization of other efficiencies related to
the integration of the businesses, should allow us to offset incremental transaction and
acquisition-related costs over time, this net benefit may not be achieved in the near term, or at
all.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Removed and Reserved |
Item 5. | Other Information |
None.
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Item 6. | Exhibits |
The exhibits listed on the Exhibit Index, which appears immediately following the signature
page below, are included or incorporated by reference herein.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
WALTER INVESTMENT MANAGEMENT CORP. |
||||
By: | /s/ Mark J. OBrien | |||
Mark J. OBrien | ||||
Chief Executive Officer (Principal Executive Officer) |
||||
Dated: May 6, 2011
By: | /s/ Kimberly A. Perez | |||
Kimberly A. Perez | ||||
Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
||||
Dated: May 6, 2011
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INDEX TO EXHIBITS
Exhibit No | Notes | Description | ||||
2.1
|
(1 | ) | Second Amended and Restated Agreement and Plan of Merger dated as of February 6, 2009, among Registrant, Walter Industries, Inc., JWH Holding Company, LLC, and Walter Investment Management LLC. | |||
2.2
|
(1 | ) | Amendment to the Second Amended and Restated Agreement and Plan of Merger, entered into as of February 17, 2009 between Registrant, Walter Industries, Inc., JWH Holding Company, LLC and Walter Investment Management LLC | |||
3.1
|
(2 | ) | Articles of Amendment and Restatement of Registrant effective April 17, 2009. | |||
3.2
|
(2 | ) | By-Laws of Registrant, effective April 17, 2009. | |||
10.1
|
(3 | ) | Membership Interest Purchase Agreement, dated as of March 25, 2011, by and among GTH LLC, GTCS Holdings LLC and the Company | |||
10.2
|
(3 | ) | Debt Commitment Letter with Credit Suisse Securities (USA) LLC, Credit Suisse AG, RBS Securities Inc. and Royal Bank of Scotland PLC | |||
10.3
|
(4 | ) | Amended and Restated Debt Commitment Letter, dated as of April 25, 2011, with Credit Suisse Securities (USA) LLC, Credit Suisse AG, RBS Securities Inc., Royal Bank of Scotland PLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Bank of America N.A. and Morgan Stanley Senior Funding, Inc. | |||
31.1
|
(5 | ) | Certification by Mark J. OBrien pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
31.2
|
(5 | ) | Certification by Kimberly A. Perez pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
32
|
(5 | ) | Certification by Mark J. OBrien and Kimberly A. Perez pursuant to 18 U.S.C. Section 1352, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
Note | Notes to Exhibit Index | |
(1)
|
Incorporated herein by reference to the Annexes to the proxy statement/ prospectus forming a part of Amendment No. 4 to the Registrants Registration Statement on Form S-4, Registration No. 333-155091, as filed with the Securities and Exchange Commission on February 17, 2009. | |
(2)
|
Incorporated herein by reference to Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on April 21, 2009. | |
(3)
|
Incorporated by reference to Registrants Quarterly Report on Form 8-K, as filed with the Securities and Exchange Commission on March 30, 2011. | |
(4)
|
Incorporated by reference to Registrants Report on Form 8-K, as filed with the Securities and Exchange Commission on May 5, 2011. | |
(5)
|
Filed herewith |
43