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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 September 30, 2009
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 (State or other Jurisdiction of Incorporation or Organization) |
13-3950486 (I.R.S. Employer 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 o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company þ |
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 25,642,887 shares of common stock outstanding as of November 10, 2009.
Explanatory Note
On April 17, 2009, Hanover Capital Mortgage Holdings, Inc. (Hanover) completed the
transactions (the Merger) contemplated by the Second Amended and Restated Agreement and Plan of
Merger (as amended on April 17, 2009, the Merger Agreement) by and among Hanover, Walter Energy,
Inc. (formerly known as Walter Industries, Inc. (Walter Energy)), Walter Investment Management,
LLC (Spinco) and JWH Holding Company, LLC (JWHHC). The merged business was renamed Walter
Investment Management Corp. on April 17, 2009 and is referred to herein as Walter Investment or
the Company. The Merger is described in greater detail in this Form 10-Q. As the Merger
constituted a reverse acquisition for accounting purposes, the pre-acquisition financial statements
of Spinco are treated as historical financial statements of Walter Investment, with the results of
Hanover being included from April 17, 2009 for the nine months ended September 30, 2009, but not
included in the nine months ended September 30, 2008.
WALTER INVESTMENT MANAGEMENT CORP.
FORM 10-Q
INDEX
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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)
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 23,896 | $ | 1,319 | ||||
Short-term investments, restricted |
53,186 | 49,196 | ||||||
Receivables, net |
4,369 | 5,447 | ||||||
Residential loans, net of allowance for loan losses
of $17,789 and $18,969, respectively |
1,673,103 | 1,767,838 | ||||||
Subordinate security |
1,769 | | ||||||
Real estate owned |
56,745 | 48,198 | ||||||
Unamortized debt expense |
18,822 | 19,745 | ||||||
Other assets |
10,859 | 7,098 | ||||||
Total assets |
$ | 1,842,749 | $ | 1,898,841 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Accounts payable |
$ | 1,507 | $ | 2,181 | ||||
Accrued expenses |
29,875 | 46,367 | ||||||
Deferred income taxes, net |
208 | 55,530 | ||||||
Mortgage-backed debt |
1,292,242 | 1,372,821 | ||||||
Accrued interest |
8,989 | 9,717 | ||||||
Other liabilities |
742 | 748 | ||||||
Total liabilities |
1,333,563 | 1,487,364 | ||||||
Commitments and contingencies (Note 17) |
||||||||
Stockholders equity: |
||||||||
Member unit |
||||||||
Issued 0 member units at September 30,
2009 and 1 member unit at December 31, 2008 |
| | ||||||
Preferred stock, $0.01 par value per share: |
||||||||
Authorized 10,000,000 shares |
||||||||
Issued and outstanding 0 shares at
September 30, 2009 and December 31, 2008 |
| | ||||||
Common stock, $0.01 par value per share: |
||||||||
Authorized 90,000,000 shares |
||||||||
Issued and outstanding 19,892,887
shares at September 30, 2009 and 0 at
December 31, 2008 |
199 | | ||||||
Additional paidin capital |
45,354 | 52,293 | ||||||
Retained earnings |
461,406 | 684,127 | ||||||
Accumulated other comprehensive income |
2,227 | 1,747 | ||||||
509,186 | 738,167 | |||||||
Less: Receivable from Walter Energy |
| (326,690 | ) | |||||
Total stockholders equity |
509,186 | 411,477 | ||||||
Total liabilities and stockholders equity |
$ | 1,842,749 | $ | 1,898,841 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Unaudited)
(in thousands, except share and per share data)
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Unaudited)
(in thousands, except share and per share data)
For the Three Months | For the Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net interest income: |
||||||||||||||||
Interest income |
$ | 43,191 | $ | 47,649 | $ | 133,701 | $ | 146,107 | ||||||||
Less: Interest expense |
22,229 | 24,278 | 67,972 | 78,432 | ||||||||||||
Less: Interest rate hedge ineffectiveness |
| | | 16,981 | ||||||||||||
Total net interest income |
20,962 | 23,371 | 65,729 | 50,694 | ||||||||||||
Less: Provision for loan losses |
3,102 | 5,289 | 11,211 | 12,646 | ||||||||||||
Total net interest income after
provision for loan losses |
17,860 | 18,082 | 54,518 | 38,048 | ||||||||||||
Non-interest income: |
||||||||||||||||
Premium revenue |
2,581 | 3,205 | 9,060 | 8,264 | ||||||||||||
Other income, net |
461 | (1,272 | ) | 838 | (1,627 | ) | ||||||||||
Total non-interest income |
3,042 | 1,933 | 9,898 | 6,637 | ||||||||||||
Non-interest expenses: |
||||||||||||||||
Claims expense |
1,098 | 1,400 | 3,760 | 3,870 | ||||||||||||
Salaries and benefits |
5,441 | 4,177 | 15,254 | 12,272 | ||||||||||||
Legal and professional |
615 | 273 | 3,215 | 855 | ||||||||||||
Occupancy |
223 | 389 | 1,023 | 1,168 | ||||||||||||
Technology and communication |
687 | 300 | 2,236 | 1,008 | ||||||||||||
Depreciation and amortization |
283 | 308 | 893 | 1,132 | ||||||||||||
General and administrative |
2,914 | 1,924 | 7,212 | 5,447 | ||||||||||||
Other expense |
53 | 361 | 439 | 1,119 | ||||||||||||
Related party allocated corporate charges |
| 869 | 853 | 2,603 | ||||||||||||
Goodwill impairment charges |
| 12,291 | | 12,291 | ||||||||||||
Provision for estimated hurricane losses |
| 3,853 | | 3,853 | ||||||||||||
Total non-interest expenses |
11,314 | 26,145 | 34,885 | 45,618 | ||||||||||||
Income (loss) before income taxes |
9,588 | (6,130 | ) | 29,531 | (933 | ) | ||||||||||
Income tax expense (benefit) |
1,345 | 1,767 | (75,725 | ) | 3,694 | |||||||||||
Net income (loss) |
$ | 8,243 | $ | (7,897 | ) | $ | 105,256 | $ | (4,627 | ) | ||||||
Basic earnings (loss) per common and common
equivalent share |
$ | 0.40 | $ | (0.40 | ) | $ | 5.16 | $ | (0.23 | ) | ||||||
Diluted earnings (loss) per common and common
equivalent share |
$ | 0.40 | $ | (0.40 | ) | $ | 5.15 | $ | (0.23 | ) | ||||||
Weighted average common and common equivalent
shares outstanding basic |
20,586,199 | 19,871,205 | 20,299,435 | 19,871,205 | ||||||||||||
Weighted average common and common equivalent
shares outstanding diluted |
20,687,965 | 19,871,205 | 20,357,139 | 19,871,205 |
The accompanying notes are an integral part of the consolidated financial statements.
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WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except share data)
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except share data)
Accumulated | Receivable | |||||||||||||||||||||||||||||||
Member Unit/ | Additional | Other | from | |||||||||||||||||||||||||||||
Common Stock | Paid-In | Comprehensive | Retained | Comprehensive | Walter | |||||||||||||||||||||||||||
Total | Shares | Amount | Capital | Income | Earnings | Income | Energy | |||||||||||||||||||||||||
Balance at December 31, 2008 |
$ | 411,477 | | $ | | $ | 52,293 | $ | 684,127 | $ | 1,747 | $ | (326,690 | ) | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net income |
105,256 | $ | 105,256 | 105,256 | ||||||||||||||||||||||||||||
Other comprehensive income,
net of tax: |
||||||||||||||||||||||||||||||||
Change in postretirement
benefit plans, net of $556
tax effect |
206 | 206 | 206 | |||||||||||||||||||||||||||||
Net unrealized gain on
subordinate security |
157 | 157 | 157 | |||||||||||||||||||||||||||||
Net amortization of
realized gain on closed
hedges, net of $347 tax
effect |
117 | 117 | 117 | |||||||||||||||||||||||||||||
Comprehensive income |
$ | 105,736 | ||||||||||||||||||||||||||||||
Net activity with Walter Energy |
24,124 | 24,124 | ||||||||||||||||||||||||||||||
Dividends to Walter Energy |
(4,210 | ) | (5,172 | ) | (301,604 | ) | 302,566 | |||||||||||||||||||||||||
Consummation of spin-off and
merger |
(2,508 | ) | 19,871,205 | 199 | (2,707 | ) | ||||||||||||||||||||||||||
Share-based compensation |
886 | 886 | ||||||||||||||||||||||||||||||
Dividends to Spinco
interest-holders |
(16,000 | ) | (16,000 | ) | ||||||||||||||||||||||||||||
Dividends to stockholders |
(10,373 | ) | (10,373 | ) | ||||||||||||||||||||||||||||
Issuance of restricted stock |
| 15,390 | | | ||||||||||||||||||||||||||||
Shares issued upon exercise of
stock options |
54 | 6,456 | | 54 | ||||||||||||||||||||||||||||
Cancellation of common stock |
| (164 | ) | | | |||||||||||||||||||||||||||
Balance at September 30, 2009 |
$ | 509,186 | 19,892,887 | $ | 199 | $ | 45,354 | $ | 461,406 | $ | 2,227 | $ | | |||||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Operating activities: |
||||||||
Net income (loss) |
$ | 105,256 | $ | (4,627 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
||||||||
Provision for loan losses |
11,211 | 12,646 | ||||||
Amortization of residential loan discount to interest income |
(11,814 | ) | (15,564 | ) | ||||
Depreciation and amortization |
893 | 1,132 | ||||||
Proceeds from sale of mortgage securities classified as trading |
2,387 | | ||||||
Benefit from deferred income taxes |
(64,344 | ) | (251 | ) | ||||
Amortization of debt expense to interest expense |
892 | 1,386 | ||||||
Share-based compensation |
886 | 1,863 | ||||||
Goodwill impairment charges |
| 12,291 | ||||||
Other |
(710 | ) | (240 | ) | ||||
Increase in assets: |
||||||||
Receivables |
(4,826 | ) | (3,237 | ) | ||||
Other |
(1,918 | ) | (599 | ) | ||||
Increase (decrease) in liabilities: |
||||||||
Accounts payable |
(672 | ) | (1,283 | ) | ||||
Accrued expenses |
(837 | ) | 21,701 | |||||
Accrued interest |
(731 | ) | (1,975 | ) | ||||
Cash flows provided by operating activities |
35,673 | 23,243 | ||||||
Investing activities: |
||||||||
Principal payments received on residential loans |
91,533 | 119,407 | ||||||
Additions to real estate owned |
(7,345 | ) | (6,170 | ) | ||||
Cash proceeds from sales of real estate owned |
8,782 | 8,399 | ||||||
Additions to property and equipment |
(2,167 | ) | (207 | ) | ||||
(Increase) decrease in short-term investments, restricted |
(4,197 | ) | 17,193 | |||||
Cash acquired in Hanover reverse acquisition |
774 | | ||||||
Cash flows provided by investing activities |
87,380 | 138,622 | ||||||
Financing activities: |
||||||||
Issuance of mortgage-backed debt |
| 25,000 | ||||||
Payments on mortgage-backed debt |
(83,373 | ) | (329,034 | ) | ||||
Net decrease in receivable from Walter Energy |
13,118 | 152,941 | ||||||
Dividends to Walter Energy |
(3,902 | ) | (12,593 | ) | ||||
Dividends to Spinco interest-holders |
(16,000 | ) | | |||||
Dividends to stockholders |
(10,373 | ) | | |||||
Stock options exercised |
54 | | ||||||
Cash flows used in financing activities |
(100,476 | ) | (163,686 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
22,577 | (1,821 | ) | |||||
Cash and cash equivalents at the beginning of the period |
1,319 | 3,122 | ||||||
Cash and cash equivalents at the end of the period |
$ | 23,896 | $ | 1,301 | ||||
Supplemental Disclosure of Non-Cash Investing and Financing Activities: |
||||||||
Real estate owned acquired through foreclosure |
$ | 64,305 | $ | 53,146 | ||||
Residential loans originated to finance the sale of real estate owned |
$ | 42,715 | $ | 34,452 | ||||
Residential loans acquired with warehouse proceeds and/or advances from Walter Energy |
$ | 2,504 | $ | 100,058 | ||||
Dividends to Walter Energy |
$ | 306,458 | $ | 12,593 | ||||
Consummation of reverse acquisition with Hanover |
$ | 2,186 | $ | |
The accompanying notes are an integral part of the consolidated financial statements.
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WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Business
On April 17, 2009, Hanover Capital Mortgage Holdings, Inc. (Hanover) completed the
transactions (the Merger) contemplated by the Second Amended and Restated Agreement and Plan of
Merger (as amended on April 17, 2009, the Merger Agreement) by and among Hanover, Walter Energy,
Inc. (formerly known as Walter Industries, Inc. (Walter Energy)), Walter Investment Management,
LLC (Spinco) and JWH Holding Company, LLC (JWHHC). The merged business was renamed Walter
Investment Management Corp. on April 17, 2009 and is referred herein as Walter Investment or the
Company. See Note 3 for further detail.
The Company operates as an internally managed, publicly traded real estate investment trust
(REIT). The Company is a mortgage servicer and mortgage portfolio owner specializing in subprime,
non-conforming and other credit-challenged residential loans, primarily in the southeastern United
States. The Company also operates mortgage advisory and insurance product lines of business. At
September 30, 2009, the Company had four wholly owned, primary subsidiaries: Hanover Capital
Partners 2, Ltd., doing business as Hanover Capital, Walter Mortgage Company, LLC (WMC), Walter
Investment Reinsurance Company, Ltd. (WIRC), and Best Insurors, Inc. (Best).
Prior to the Merger, Hanovers principal executive offices were located at 200 Metroplex
Drive, Suite 100, Edison, NJ 08817. From April 17, 2009 to July 20, 2009, the Companys principal
executive offices were located at 4211 West Boy Scout Boulevard, 4th Floor, Tampa, FL 33607. As of
July 20, 2009, the Companys principal executive offices are located 3000 Bayport Drive, Suite
1100, Tampa, FL 33607.
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 (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for complete financial
statements.
The consolidated financial statements reflect the historical operations of Spinco which have
been presented as the historical financial statements of Walter Investment. The combined financial
statements of WMC, Best and WIRC (collectively representing substantially all of Walter Energys
Financing business prior to the Merger) are considered the predecessor to Spinco for accounting
purposes. Under Walter Energys ownership, the Financing business operated through separate
subsidiaries. A direct ownership relationship did not exist among the legal entities prior to the
contribution to Spinco. 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.
Although the Company has operated as an independent, stand-alone entity only since April 17,
2009, management believes the assumptions underlying the consolidated financial statements as of
December 31, 2008 and the three and nine months ended September 30, 2008 are reasonable. However,
the consolidated financial statements included herein do not include all of the expenses that would
have been incurred had the Company been a separate, stand-alone entity, although, the consolidated
financial statements do include certain costs and expenses that have been allocated to the Company
from Walter Energy. As such, the financial information does not necessarily reflect or is not
necessarily indicative of our consolidated financial position, results of operations and cash flows
in the future, or what would have been reflected had the Company been a separate, stand-alone
entity during the periods presented.
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Results of operations for the three and nine months ended September 30, 2009 include the
results of operations of legacy Spinco. The results of operations of legacy Hanover are included
from the completion of the Merger with Hanover on April 17, 2009 through September 30, 2009.
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
and nine months ended September 30, 2009 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 2009. The accompanying financial statements
should be read in conjunction with the Companys audited consolidated financial statements and
footnotes for the year ended December 31, 2008, included in the Form 8-K/A filed on July 10, 2009.
Recent Accounting Guidance
In June 2009, the Financial Accounting Standards Board (FASB) issued new guidance concerning the organization of authoritative
guidance under U.S. GAAP. The new guidance created the FASB Accounting Standards Codification (the
Codification or ASC). The Codification is now the single source of authoritative
nongovernmental GAAP, superseding existing FASB, American Institute of Certified Public Accountants
(AICPA), Emerging Issues Task Force (EITF), and related accounting literature. The ASC
reorganizes the thousands of GAAP pronouncements into roughly 90 accounting topics and displays
them using a consistent structure. Also included is relevant Securities and Exchange Commission
(SEC) guidance organized using the same topical structure in separate sections. The ASC is
effective for financial statements issued for reporting periods that end after September 15, 2009.
The adoption of this pronouncement on September 30, 2009 did not have a significant impact on the
Companys consolidated financial statements.
Consolidation and Business Combinations
In December 2007, the FASB issued new guidance on
noncontrolling interests in consolidated financial statements to establish accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in
the consolidated entity that should be reported as equity in the consolidated financial statements.
The adoption of this ASC on January 1, 2009 did not have a significant impact on the Companys
consolidated financial statements.
Also in December 2007, the FASB issued new guidance on business combinations that changes or
clarifies the acquisition method of accounting for acquired contingencies, transaction costs, step
acquisitions, restructuring costs and other major areas affecting how the acquirer recognizes and
measures the assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. In addition, this guidance amends previous interpretations of intangible asset accounting
by requiring the capitalization of in-process research and development and proscribing impacts to
current income tax expense (rather than a reduction to goodwill) for changes in deferred tax
benefits related to a business combination. This guidance was applied prospectively for business
combinations occurring after December 31, 2008. The adoption of this guidance impacted our
operating results in 2009 with the completion of the business combination with Hanover. Acquisition
costs and fees were expensed, resulting in a decrease in our operating results.
Investments
In April 2009, the FASB issued new guidance related to investments in debt and equity
securities which clarifies the determination of an other-than-temporary impairment. The ASC (i)
changes existing guidance for determining whether an impairment is other than temporary to debt
securities and (ii) replaces the existing requirement that the entitys management assert it has
both the intent and ability to hold an impaired security until recovery with a requirement that
management assert: (a) it does not have the intent to sell the security; and (b) it is more likely
than not it will not have to sell the security before recovery of its cost basis. Under the
existing guidance, declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary are reflected in earnings as realized
losses to the extent the impairment is related to credit losses. The amount of impairment related
to other factors is recognized in other comprehensive income. The ASC is effective
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for interim and annual periods ending after June 15, 2009. The adoption of the ASC on June 30,
2009 did not have a significant impact on the Companys consolidated financial statements or
disclosures.
Transfers and Servicing
In February 2008, the FASB issued guidance related to transfers and servicing of financial
assets which requires an assessment as to whether assets purchased from a counterparty and financed
through a repurchase agreement with the same counterparty can be considered and accounted for as
separate transactions. If certain criteria are met, the transaction is considered a sale and a
subsequent financing. If certain criteria are not met, the transaction is not considered a sale
with a subsequent financing, but rather a linked transaction that is recorded based upon the
economics of the combined transaction, which is generally a forward contract. The new guidance was
effective for fiscal years beginning after November 15, 2008, and it is applied to all initial
transfers and repurchase financings entered into after the effective date. The adoption of this ASC
on January 1, 2009 did not have a significant impact on the Companys consolidated financial
statements.
In December 2008, the FASB issued new accounting guidance concerning the disclosures by public
entities of transfers of financial assets and interests in variable interest entities which
requires expanded disclosures for transfers of financial assets and involvement with variable
interest entities (VIEs). Under this guidance, the disclosure objectives related to transfers of
financial assets now include providing information on (i) the Companys continued involvement with
financial assets transferred in a securitization or asset backed financing arrangement, (ii) the
nature of restrictions on assets held by the Company that relate to transferred financial assets,
and (iii) the impact on financial results of continued involvement with assets sold and assets
transferred in secured borrowing arrangements. VIE disclosure objectives now include providing
information on (i) significant judgments and assumptions used by the Company to determine the
consolidation or disclosure of a VIE, (ii) the nature of restrictions related to the assets of a
consolidated VIE, (iii) the nature of risks related to the Companys involvement with the VIE and
(iv) the impact on financial results related to the Companys involvement with the VIE. Certain
disclosures are also required where the Company is a non-transferor sponsor or servicer of a QSPE.
The ASC was effective for the first reporting period ending after December 15, 2008. See Note 6 to
the consolidated financial statements for the additional disclosures required by the ASC.
In June 2009, the FASB issued new accounting guidance concerning the accounting for transfers
of financial assets which amends the existing derecognition accounting and disclosure guidance. The
ASC eliminates the exemption from consolidation for QSPEs, it also requires a transferor to
evaluate all existing QSPEs to determine whether it must be consolidated in accordance with the
accounting guidance concerning variable interest entities. The ASC is effective for financial
asset transfers occurring after the beginning of an entitys first fiscal year that begins after
November 15, 2009. The Company is continuing to evaluate the impact that ASC will have on its
financial condition and results of operations upon adoption.
Derivatives and Hedging
In March 2008, the FASB issued new guidance concerning disclosures of derivative instruments
and hedging activities. The ASC amends and expands the disclosure requirements of previous
guidance to provide greater transparency about how and why an entity uses derivative instruments,
how derivative instruments and related hedge items are accounted for, and how derivative
instruments and related hedged items affect an entitys financial position, results of operations,
and cash flows. The ASC requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in derivative
agreements. The ASC was effective January 1, 2009. The adoption of this ASC by the Company on
January 1, 2009, did not have a significant impact on the Companys consolidated financial
statements.
Fair Value Measurements and Disclosures
In October 2008, the FASB issued new accounting guidance concerning the determination of fair
value of a financial asset when the market for that asset is not active. The new guidance clarifies
the application of the existing fair value accounting guidance in a market that is not active. The
ASC applies to financial assets within the scope of accounting guidance that require or permit fair
value measurements in accordance with the existing ASC and
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provides an example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. The ASC was effective upon
issuance, including prior periods for which financial statements have not been issued. Revisions
resulting from a change in the valuation technique or its application are to be accounted for as a
change in accounting estimate. The adoption of this ASC did not have a significant impact on the
Companys consolidated financial statements or disclosures.
In April 2009, the FASB issued new accounting guidance concerning the determination of fair
value when the volume and level of activity for the asset or liability have significantly decreased
and the identification of transactions are not orderly. The ASC affirms the objective of fair value
when a market is not active, clarifies and includes additional factors for determining whether
there has been a significant decrease in market activity, eliminates the presumption that all
transactions are distressed unless proven otherwise, and requires an entity to disclose a change in
valuation technique. The ASC is effective for interim and annual periods ending after June 15,
2009. The adoption of the ASC on June 30, 2009 did not have a significant impact on the Companys
consolidated financial statements or disclosures.
In August 2009, the FASB updated the accounting standards to provide additional guidance on
estimating the fair value of a liability in a hypothetical transaction where the liability is
transferred to a market participant. The standard is effective for the first reporting period,
including interim periods, beginning after issuance. The Company does not expect the adoption of
this guidance to have a material effect on the Companys consolidated financial statements or
disclosures.
Financial Instruments
In January 2009, the FASB issued new impairment guidance concerning beneficial interests which
amends the existing impairment guidance to achieve a more consistent determination of whether an
other-than-temporary impairment has occurred for all beneficial interests. The ASC eliminates the
requirement that a holders best estimate of cash flows be based upon those that a market
participant would use and instead requires that an other-than-temporary impairment be recognized
as a realized loss through earnings when it its probable there has been an adverse change in the
holders estimated cash flows from cash flows previously projected. This change is consistent with
the impairment models contained in the accounting guidance concerning accounting for certain
investments in debt and equity securities. The ASC emphasizes that the holder must consider all
available information relevant to the collectibility of the security, including information about
past events, current conditions and reasonable and supportable forecasts, when developing the
estimate of future cash flows. Such information generally should include the remaining payment
terms of the security, prepayments speeds, financial condition of the issuer, expected defaults,
and the value of any underlying collateral. The holder should also consider industry analyst
reports and forecasts, sector credit ratings, and other market data that are relevant to the
collectibility of the consolidated security. The adoption of the ASC on December 31, 2008 did not
have a significant impact on the Companys consolidated financial statements.
In April 2009, the FASB issued new guidance related to financial instruments which amends
disclosures about fair value of financial instruments. The ASC requires a public entity to provide
disclosures about fair value of financial instruments in interim financial information. This ASC is
effective for interim and annual financial periods ending after June 15, 2009. The adoption of the
ASC as of June 30, 2009 did not have a significant impact on the Companys consolidated financial
statements. See Note 5 for our fair value disclosures.
Compensation
In June 2008, the FASB issued new accounting guidance concerning the determination of whether
instruments granted in share-based payment transactions are participating securities which provides
that unvested share-based payment awards that contain nonforfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class method. The ASC requires that all
previously reported earnings per share (EPS) data is retrospectively adjusted to conform with the
provisions of the new accounting guidance. Current period EPS amounts have been adjusted to reflect
the adoption of the ASC on January 1, 2009.
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Subsequent Events
In May 2009, FASB issued guidelines on subsequent event accounting to establish general
standards of accounting for and disclosure of events that occur after the balance sheet date but
before financial statements are issued. The Company evaluated all events or transactions that
occurred from September 30, 2009 to November 11, 2009, the date the Company issued these financial
statements. During this period the Company did not have any material recognizable or non
recognizable subsequent events, except as disclosed in Note 18.
Reclassifications
In order to provide comparability between periods presented, certain amounts have been
reclassified from the previously reported unaudited consolidated financial statements to conform to
the unaudited consolidated financial statement presentation of the current period.
3. Business Separation and Merger
On September 30, 2008, Walter Energy outlined its plans to separate its Financing business
from its core Natural
Resources businesses through a spin-off to stockholders and subsequent merger with Hanover. In
furtherance of these plans, on September 30, 2008, Walter Energy and Spinco entered into a
definitive agreement to merge with Hanover, which agreement was amended and restated on February
17, 2009. To effect the separation, Spinco was formed on February 3, 2009, as a wholly-owned
subsidiary of Walter Energy, having no independent assets or operations. Immediately prior to the
spin-off, substantially all of the assets and liabilities related to the Financing business were
contributed, through a series of transactions, to Spinco in return for Spincos membership unit.
On April 17, 2009, the Company completed its separation from Walter Energy. In connection
with the separation, Spinco and Walter Energy executed the following transactions or agreements
which involved no cash:
| Walter Energy distributed 100% of its interest in Spinco to holders of Walter Energys common stock; | ||
| All intercompany balances between Spinco and Walter Energy were settled with the net balance recorded as a dividend to Walter Energy; | ||
| In accordance with the Tax Separation Agreement, Walter Energy will, in general, be responsible for any and all taxes reported on any joint return through the date of the separation, which may also include Spinco for periods prior to the separation. Spinco will be responsible for any and all taxes reported on any Spinco separate tax return and on any consolidated returns for Walter Investment subsequent to the separation; | ||
| Walter Energys share-based awards held by Spinco employees were converted to equivalent share-based awards of Walter Investment, with the number of shares and the exercise price being equitably adjusted to preserve the intrinsic value. The conversion was accounted for as a modification pursuant to the guidance concerning stock compensation. |
The assets and liabilities transferred to Spinco from Walter Energy also included $26.6
million in cash, which was contributed to Spinco by Walter Energy on April 17, 2009. Following the
spin-off, Spinco paid a taxable dividend consisting of cash of $16.0 million and additional equity
interests to its members.
The Merger occurred immediately following the spin-off and taxable dividend on April 17, 2009.
The surviving company, Walter Investment, continues to operate as a publicly traded REIT subsequent
to the Merger. Walter Investment is headquartered in Tampa, Florida and has approximately 215
employees. After the spin-off and Merger, Walter Energys stockholders that became members of
Spinco as a result of the spin-off, and certain holders of options to acquire limited liability
company interests of Spinco, collectively owned 98.5% and stockholders of Hanover owned 1.5% of the
shares of common stock of Walter Investment outstanding or reserved for issuance in settlement of
restricted stock units of Walter Investment. As a result, the business combination has been
accounted for as a reverse acquisition, with Spinco considered the accounting acquirer. Walter
Investment applied for, and was granted approval, to list its shares on the NYSE Amex. On April 20,
2009, the Companys common stock began trading on the NYSE Amex under the symbol WAC.
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The reverse acquisition of the operations of Hanover has been accounted for pursuant to the
Business Combinations Topic, with Spinco as the accounting acquirer. As a result, the historical
financial statements of Spinco have become the historical financial statements of Walter
Investment. The Hanover assets acquired and the liabilities assumed were recorded at the date of
acquisition (April 17, 2009) at their respective fair values. The results of operations of Hanover
were included in the consolidated statements of income for periods subsequent to the Merger.
The purchase price for the acquisition was $2.2 million and was the fair value of Hanover
(308,302 Hanover shares, which represents 1.5% of the shares of common stock at the time of the
transaction, at $7.09, the closing stock price of Walter Investment) on April 17, 2009.
The above purchase price has been allocated to the tangible assets acquired and liabilities
assumed based on managements estimates of their current fair values. Acquisition-related
transaction costs, including legal and accounting fees and other external costs directly related to
the Merger, were expensed as incurred.
The purchase price has been allocated as of April 17, 2009 as follows (in thousands):
Cash |
$ | 774 | ||
Receivables |
330 | |||
Investment in mortgage securities |
1,600 | |||
Instalment notes receivable, net |
4,532 | |||
Other assets |
388 | |||
Accounts payable and accrued expenses |
(2,093 | ) | ||
Mortgage-backed notes |
(2,666 | ) | ||
Other liabilities |
(679 | ) | ||
$ | 2,186 | |||
The amounts of revenue and net income of Hanover included in the Companys consolidated income
statement from the acquisition date to the period ending September 30, 2009 are as follows (in
thousands):
For the Period | ||||
April 17, 2009 | ||||
to September 30, 2009 | ||||
Total revenue |
$ | 507 | ||
Net loss |
$ | (149 | ) |
The following unaudited pro forma information assumes that the Merger occurred on January 1,
2008. The unaudited pro forma supplemental results have been prepared based on estimates and
assumptions, which management believes are reasonable but are not necessarily indicative of the
consolidated financial position or results of income had the Merger occurred on January 1, 2008,
nor of future results of income.
The unaudited pro forma results for the nine months ended September 30, 2009 and 2008 are as
follows (in thousands):
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Total revenue |
$ | 144,071 | $ | 155,181 | ||||
Net income |
$ | 28,460 | $ | 32,688 |
These amounts have been calculated after applying the Companys accounting policies and
adjusting the results of Hanover for operations that will not continue post-Merger, together with
the consequential tax effects.
Prior to the acquisition, the Company loaned Hanover funds under a revolving line of credit,
as well as a loan and security agreement which were automatically terminated by operation of law
upon consummation of the Merger.
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4. Restricted Short-Term Investments
Restricted short-term investments 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 the securitization trusts and principal and interest on indebtedness of the
securitization trusts ($47.3 million and $49.0 million, at September 30, 2009 and December 31,
2008, respectively). Restricted short-term investments at September 30, 2009 include short-term
deposits in FDIC-insured accounts. Restricted short-term investments at December 31, 2008 include
temporary investments, primarily in commercial paper or money market accounts, with original
maturities of less than 90 days. Restricted short-term investments also include $5.9 million and $0
at September 30, 2009 and December 31, 2008, respectively, held in an insurance trust account. The
insurance trust account, which secures payments under the Companys reinsurance agreements,
replaced a $5.9 million letter of credit canceled by the Company in June 2009. The funds in the
insurance trust account include investments in money market funds. Additionally, restricted
marketable securities totaled $0 and $0.2 million at September 30, 2009 and December 31, 2008,
respectively.
5. 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
September 30, 2009.
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.
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 (dollars in thousands):
As of September 30, 2009 | ||||||||||||||||
Quoted Prices in | ||||||||||||||||
Active Markets | Significant | |||||||||||||||
for Identical | Significant Other | Unobservable | ||||||||||||||
Assets | Observable Inputs | Inputs | ||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | |||||||||||||
Subordinate security |
$ | | $ | | $ | 1,769 | $ | 1,769 | ||||||||
Total |
$ | | $ | | $ | 1,769 | $ | 1,769 | ||||||||
Total assets valued by Level 3 methods are less than 1% of the Companys total assets as of
September 30, 2009. The subordinate security was acquired as part of the Merger.
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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 and nine months ended September 30, 2009
(dollars in thousands):
As of and for | ||||||||
Three Months Ended | Nine Months Ended | |||||||
September 30, 2009 | September 30, 2009 | |||||||
Beginning balance |
$ | 1,607 | $ | | ||||
Principal Reductions |
| | ||||||
Total gains (losses): |
||||||||
Included in net income |
| | ||||||
Included in other comprehensive income |
157 | 157 | ||||||
Purchases, sales, other settlements and issuances, net |
5 | 1,612 | ||||||
Transfer into or out of Level 3 category |
| | ||||||
$ | 1,769 | $ | 1,769 | |||||
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 |
$ | | $ | | ||||
At the time a residential loan becomes real estate owned, 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 real estate owned is charged to
the allowance for loan losses.
Carrying values for Level 3 assets and liabilities measured in the consolidated financial
statements at fair value on a non-recurring basis are as follows (dollars in thousands):
Fair Value Measurements at Reporting Date Using | ||||||||||||||||
Quoted Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Real Estate | Identical Assets | Inputs | Inputs | |||||||||||||
Fair Value at | Owned | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
September 30, 2009 |
$ | 56,745 | $ | | $ | | $ | 56,745 | ||||||||
December 31, 2008 |
48,198 | | | 48,198 |
The following table presents the carrying values and estimated fair values of assets and
liabilities that are required to be recorded or disclosed at fair value as of September 30, 2009
and December 31, 2008 (dollars in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||||||
Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | |||||||||||||
Cash and cash equivalents |
$ | 23,896 | $ | 23,896 | $ | 1,319 | $ | 1,319 | ||||||||
Short-term investments, restricted |
53,186 | 53,186 | 49,196 | 49,196 | ||||||||||||
Receivables, net |
4,369 | 4,369 | 5,447 | 5,447 | ||||||||||||
Residential loans, net |
1,673,103 | 1,593,476 | 1,767,838 | 1,460,000 | ||||||||||||
Subordinate security |
1,769 | 1,769 | | | ||||||||||||
Real estate owned |
56,745 | 56,745 | 48,198 | 48,198 | ||||||||||||
Accounts payable |
$ | 1,507 | $ | 1,507 | $ | 2,181 | $ | 2,181 | ||||||||
Accrued expenses |
29,875 | 29,875 | 46,367 | 46,367 | ||||||||||||
Mortgage-backed debt, net of
unamortized debt expense |
1,273,420 | 1,177,236 | 1,353,076 | 1,075,000 | ||||||||||||
Accrued interest |
8,989 | 8,989 | 9,717 | 9,717 |
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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, restricted short-term investments, receivables, accounts payable, accrued expenses,
and accrued interest The estimated fair value of these financial
instruments is estimated to be their carrying value due to their high liquidity or short-term
nature.
Residential loansThe 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. The value of these assets is very
sensitive to changes in interest rates.
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 unamortized debt expense 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. The value of mortgage-backed debt is very
sensitive to changes in interest rates.
6. Residential Loans
Residential loans are held for investment and consist of unencumbered residential loans and
residential loans held in securitization trusts, summarized in the table below (in thousands).
Residential loans consist of residential mortgage loans and residential retail instalment
agreements.
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Unencumbered residential loans, net |
$ | 339,647 | $ | 363,741 | ||||
Residential loans held in securitization trusts, net |
1,333,456 | 1,404,097 | ||||||
Residential loans, net (1) |
$ | 1,673,103 | $ | 1,767,838 | ||||
(1) | The average life of the portfolio approximates 8 years based on assumptions for prepayment speeds, default rates and losses. |
The following table summarizes the activity in the residential loan allowance for loan losses
(in thousands):
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Balance, December 31 |
$ | 18,969 | $ | 13,992 | ||||
Provision charged to income |
4,376 | 4,241 | ||||||
Less: Charge-offs, net of recoveries |
(4,863 | ) | (4,224 | ) | ||||
Balance, March 31 |
18,482 | 14,009 | ||||||
Provision charged to income |
3,733 | 3,116 | ||||||
Less: Charge-offs, net of recoveries |
(3,908 | ) | (3,179 | ) | ||||
Balance, June 30 |
18,307 | 13,946 | ||||||
Provision charged to income |
3,102 | 5,289 | ||||||
Less: Charge-offs, net of recoveries |
(3,620 | ) | (4,299 | ) | ||||
Balance, September 30 |
$ | 17,789 | $ | 14,936 | ||||
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The following table presents delinquencies as a percent of amounts outstanding on the
principal balance of residential loans:
September 30, 2009 | December 31, 2008 | |||||||
31-60 days |
1.56 | % | 1.58 | % | ||||
61-90 days |
0.75 | % | 0.72 | % | ||||
91 days or more |
3.24 | % | 3.05 | % | ||||
5.55 | % | 5.35 | % |
Unencumbered Residential Loans, Net
Unencumbered residential loans, net consist of instalment notes receivable and mortgage loans
and are summarized as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||||
Unencumbered residential loans, principal balance |
$ | 373,873 | $ | 399,099 | ||||
Less: Yield adjustment, net (1) |
(30,719 | ) | (31,940 | ) | ||||
Less: Allowance for loan losses |
(3,507 | ) | (3,418 | ) | ||||
Unencumbered residential loans, net |
$ | 339,647 | $ | 363,741 | ||||
(1) | Origination costs are deferred and amortized over the life of the note portfolio. Deferred origination costs included in the yield adjustment, net for unencumbered residential loans, net at September 30, 2009 and December 31, 2008 were $2.8 million and $3.1 million, respectively. |
The following table summarizes the activity in the allowance for loan losses on unencumbered
residential loans, net (in thousands):
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Balance, December 31 |
$ | 3,418 | $ | 1,737 | ||||
Provision charged to income |
1,269 | 1,377 | ||||||
Less: Charge-offs, net of recoveries |
(1,314 | ) | (872 | ) | ||||
Balance, March 31 |
3,373 | 2,242 | ||||||
Provision charged to income |
1,090 | 940 | ||||||
Less: Charge-offs, net of recoveries |
(1,025 | ) | (856 | ) | ||||
Balance, June 30 |
3,438 | 2,326 | ||||||
Provision charged to income |
812 | 1,396 | ||||||
Less: Charge-offs, net of recoveries |
(743 | ) | (1,378 | ) | ||||
Balance, September 30 |
$ | 3,507 | $ | 2,344 | ||||
The amount of unencumbered residential loans, net that had been put on nonaccrual status due
to delinquent payments of ninety days past due or greater was $19.6 million and $16.0 million at
September 30, 2009 and December 31, 2008, respectively. Residential loans are placed on non-accrual
status when any portion of the principal or interest is ninety days past due. When placed on
non-accrual status, the related interest receivable is reversed against interest income of the
current period. Residential loans are removed from non-accrual status when the amount financed and
the associated interest are no longer over ninety days past due.
The following table presents delinquencies as a percent of amounts outstanding on the
principal balance of unencumbered residential loans:
September 30, 2009 | December 31, 2008 | |||||||
31-60 days |
2.46 | % | 2.29 | % | ||||
61-90 days |
1.41 | % | 0.92 | % | ||||
91 days or more |
5.24 | % | 4.03 | % | ||||
9.11 | % | 7.24 | % |
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.
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Residential Loans Held in Securitization Trusts, Net
Residential loans held in securitization trusts, net 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 of financial assets, as amended. 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 assets of the securitization trusts are not available to satisfy claims
of general creditors of the Company and the mortgage-backed debt issued by the securitization
trusts is to be satisfied solely from the proceeds of the residential loans held in securitization
trusts and are non-recourse to the Company. 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. Deferred debt issuance costs and discounts
related to the mortgage-backed debt are amortized on a level yield basis over the estimated life of
the mortgage-backed debt.
Residential loans held in securitization trusts, net consist of instalment notes receivable
and mortgage loans and are summarized as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||||
Residential loans held in securitization trusts, principal balance |
$ | 1,482,976 | $ | 1,565,879 | ||||
Less: Yield adjustment, net (1) |
(135,238 | ) | (146,231 | ) | ||||
Less: Allowance for loan losses |
(14,282 | ) | (15,551 | ) | ||||
Residential loans held in securitization trusts, net |
$ | 1,333,456 | $ | 1,404,097 | ||||
(1) | Origination costs are deferred and amortized over the life of the note portfolio. Deferred origination costs included in the yield adjustment, net for residential loans held in securitization trusts, net at September 30, 2009 and December 31, 2008 were $9.0 million and $9.6 million, respectively. |
The following table summarizes the activity in the allowance for loan losses on residential
loans held in securitization trusts, net (in thousands):
Nine Months Ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
Balance, December 31 |
$ | 15,551 | $ | 12,255 | ||||
Provision charged to income |
3,107 | 2,864 | ||||||
Less: Charge-offs, net of recoveries |
(3,549 | ) | (3,352 | ) | ||||
Balance, March 31 |
15,109 | 11,767 | ||||||
Provision charged to income |
2,643 | 2,176 | ||||||
Less: Charge-offs, net of recoveries |
(2,883 | ) | (2,323 | ) | ||||
Balance, June 30 |
14,869 | 11,620 | ||||||
Provision charged to income |
2,290 | 3,893 | ||||||
Less: Charge-offs, net of recoveries |
(2,877 | ) | (2,921 | ) | ||||
Balance, September 30 |
$ | 14,282 | $ | 12,592 | ||||
The amount of residential loans held in securitization trusts, net that had been put on
nonaccrual status due to delinquent payments of ninety days past due or greater was $40.4 million
and $42.3 million at September 30, 2009 and December 31, 2008, respectively. Residential loans are
placed on non-accrual status when any portion of the principal or interest is ninety days past due.
When placed on non-accrual status, the related interest receivable is reversed against interest
income of the current period. Residential loans are removed from non-accrual status when the amount
financed and the associated interest are no longer over ninety days past due.
All of the Companys residential loans held in securitization trusts, net are pledged as
collateral for the mortgage-backed debt (see Note 8). The Companys only continued involvement with
the residential loans held in securitization trusts, net is retaining all of the beneficial
interests in the securitization trusts and servicing the residential loans collateralizing the
mortgage-backed debt.
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The following table presents delinquencies as a percent of amounts outstanding on the
principal balance of residential loans held in securitization trusts:
September 30, 2009 | December 31, 2008 | |||||||
31-60 days |
1.33 | % | 1.39 | % | ||||
61-90 days |
0.59 | % | 0.67 | % | ||||
91 days or more |
2.72 | % | 2.78 | % | ||||
4.64 | % | 4.84 | % |
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.
7. Subordinate Security
The Companys fixed-rate subordinate security consists of a single 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.
Subordinate security totaled $1.8 million and $0 at September 30, 2009 and December 31, 2008,
respectively. The subordinate security was acquired as part of the Merger with Hanover.
September 30, 2009 | December 31, 2008 | |||||||
Principal balance |
$ | 3,812 | $ | | ||||
Purchase price and other adjustments |
(2,200 | ) | | |||||
Amortized cost |
$ | 1,612 | $ | | ||||
Unrealized gain |
157 | | ||||||
Carrying value (fair value) |
$ | 1,769 | $ | | ||||
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.
8. Mortgage-Backed Debt
Mortgage-backed debt consists of mortgage-backed/asset-backed notes and collateralized
mortgage obligations, summarized as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||||
Mortgage-backed/asset-backed notes |
$ | 1,289,858 | $ | 1,372,821 | ||||
Collateralized mortgage obligations |
2,384 | | ||||||
Mortgage-backed debt |
$ | 1,292,242 | $ | 1,372,821 | ||||
Mortgage-Backed/Asset-Backed Notes
The securitization trusts beneficially owned by WMC and its wholly owned subsidiary, Mid-State
Capital, LLC, are the depositors under the Companys outstanding mortgage-backed and asset-backed
notes (the Trust Notes), which consist of eight separate series of public debt offerings and one
private offering. Prior to April 30, 2008, the Company was a borrower under a $150.0 million and a
$200.0 million Variable Funding Loan Agreement (the Warehouse Facilities). The Trust Notes
provide long-term financing for instalment notes receivable and mortgage loans purchased by WMC,
while the Warehouse Facilities provided temporary financing. Mortgage-backed/asset-backed notes
totaled $1,289.9 million and $1,372.8 at September 30, 2009 and December 31, 2008, respectively.
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 over-collateralization or other similar targets are satisfied. The securitization trusts
also contain delinquency and loss triggers, that, if exceeded, result in any excess
over-collateralization going to pay down the Trust Notes for that particular securitization at an
accelerated pace. Assuming no servicer trigger events have occurred and the over-collateralization
targets have been met, any excess cash is released to the Company. As of September 30, 2009, two
of the securitization trusts have exceeded the servicer triggers and are currently not providing
any excess cash flows to the Company.
At the beginning of the second quarter 2008, the Warehouse Facilities provided temporary
financing to WMC for its originations of mortgage loans, purchases of instalment notes receivable
originated by Jim Walter Homes,
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Inc. (a wholly-owned subsidiary of Walter Energy) and purchases of third-party mortgage loans.
On April 30, 2008, Walter Energy provided $214.8 million of available funds to the Company to repay
and terminate the Warehouse Facilities. With the termination of the Warehouse Facilities, the
Company is no longer reliant on the availability of mortgage warehouse facilities or the
mortgage-backed securitization market.
Prior to the termination of the Warehouse Facilities, the Company held multiple interest rate
hedge agreements with various counterparties with an aggregate notional value of $215.0 million.
The objective of these hedges was to protect against changes in the benchmark interest rate on the
forecasted issuance of mortgage-backed notes in a securitization. At March 31, 2008, the hedges no
longer qualified for hedge accounting treatment because the Company no longer planned to access the
distressed securitization market. As a result, the Company recognized a loss on interest rate hedge
ineffectiveness of $17.0 million in the first quarter of 2008. On April 1, 2008, the Company
settled the hedges for a payment of $17.0 million. There are no hedges outstanding at September 30,
2009.
Collateralized Mortgage Obligations
The Company assumed long-term debt in the form of collateralized mortgage obligations (CMOs)
through the Merger with Hanover. All of the Companys CMOs are structured as financing
transactions, whereby the Company has pledged $4.1 million of residential loans to secure the CMOs.
As the Company retained the subordinated securities of this securitization and will absorb a
majority of any losses on the underlying collateral, the Company has consolidated the
securitization entity and treats these mortgage loans as assets of the Company and treats the
related CMOs as debt of the Company. CMO debt totaled $2.4 million and $0 at September 30, 2009 and
December 31, 2008, respectively.
Borrower remittances received on the CMO collateral are used to make payments on the CMOs. The
obligations of the CMOs are payable solely from the underlying residential loans that collateralize
the debt and otherwise are non-recourse to the Company. The maturity of each class of CMO is
directly affected by principal prepayments on the related CMO collateral. Each class of CMO is also
subject to redemption according to specific terms of the respective indenture agreements. As a
result, the actual maturity of any class of CMO is likely to occur earlier than its stated
maturity.
Collateral for Mortgage-Backed Debt
The following table summarizes the carrying value of the collateral for the mortgage-backed
debt as of September 30, 2009 and December 31, 2008 (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Mortgage-Backed/ | Mortgage-Backed/ | |||||||||||||||||||||||
Asset-Backed Notes | CMO | Total | Asset-Backed Notes | CMO | Total | |||||||||||||||||||
Residential
loans in
securitization
trusts, net |
$ | 1,329,399 | $ | 4,057 | $ | 1,333,456 | $ | 1,404,097 | $ | | $ | 1,404,097 | ||||||||||||
Real estate owned |
37,497 | | 37,497 | 35,763 | | 35,763 | ||||||||||||||||||
Restricted short-term
investments |
47,286 | | 47,286 | 48,985 | | 48,985 | ||||||||||||||||||
Total
mortgage-backed debt
collateral |
$ | 1,414,182 | $ | 4,057 | $ | 1,418,239 | $ | 1,488,845 | $ | | $ | 1,488,845 | ||||||||||||
9. Postretirement Employee Benefits
The components of net periodic benefit cost, included in salaries and benefits expenses, are
as follows (in thousands):
For the Three Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Components of net periodic benefit credit: |
||||||||
Service cost |
$ | | $ | 3 | ||||
Interest cost |
12 | 15 | ||||||
Amortization of prior service credit |
(107 | ) | (106 | ) | ||||
Amortization of net gain |
(24 | ) | (24 | ) | ||||
Net periodic benefit credit |
$ | (119 | ) | $ | (112 | ) | ||
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For the Nine Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Components of net periodic benefit credit: |
||||||||
Service cost |
$ | | $ | 9 | ||||
Interest cost |
36 | 45 | ||||||
Amortization of prior service credit |
(319 | ) | (318 | ) | ||||
Amortization of net gain |
(72 | ) | (73 | ) | ||||
Net periodic benefit credit |
$ | (355 | ) | $ | (337 | ) | ||
10. Share-Based Compensation Plans
For the period ended September 30, 2008, share-based compensation represents the costs related
to Walter Energys share-based awards granted to employees of Walter Investment recognized under
the accounting guidance concerning stock compensation. Prior to the spin-off from Walter Energy,
certain employees of the Company participated in Walter Energys 2002 Long-Term Incentive Award
Plan. Under this plan, employees were granted options and restricted stock units. The expense
incurred for these share-based awards related to Company employees has been reflected in the
Companys consolidated statements of income in salaries and benefits. In connection with the
spin-off, the Companys board of directors adopted Hanovers 1999 Equity Incentive Plan (the 1999
EIP) and 2009 Long Term Incentive Plan (the 2009 LTIP) providing for future awards to the
Companys employees and directors. The 1999 EIP and the 2009 LTIP were filed as exhibits to the
Registrants Quarterly Report on Form 10-Q, filed with the SEC on August 14, 2009.
In connection with the spin-off, Walter Energys share-based awards held by Company employees
were converted to and replaced with equivalent share-based awards of Walter Investment based on the
ratio of the Companys fair market value of stock when issued to the fair market value of Walter
Energy stock. The number of shares and, for options, the ratio of the exercise price to market
price were equitably adjusted to preserve the intrinsic value of the award as of immediately prior
to the spin-off. The conversion was accounted for as a modification under the accounting guidance
concerning stock compensation and resulted in no increase in the fair value of the awards to be
recognized immediately upon modification. As of September 30, 2009, the remaining fair value
associated with the unvested awards is $0.1 million and will be recorded through February 2011.
On April 20, 2009, the Company granted share-based awards to each of its non-employee
directors under the 1999 EIP to purchase 2,000 shares of the Companys common stock which were
fully vested as of the date of the grant. The exercise price for the stock option grants is $8.00,
which is equal to the close price of the Companys common stock on the NYSE Amex on the grant date
as provided under the 1999 EIP. Each of the non-employee directors was also issued options to
purchase 8,333 shares of the Companys common stock under the 2009 LTIP. The exercise price for the
stock option grants is $7.67, which is equal to the average high and low of the Companys common
stock on the NYSE Amex on the grant date as provided under the 2009 LTIP. These stock options vest
in equal installments over three years.
On April 29, 2009, the Company granted 3,078 shares of restricted stock to each of its
non-employee directors under the 1999 EIP. The restricted stock vests on a three year cliff vesting
schedule.
On May 19, 2009, the Company granted approximately 0.2 million restricted stock units under
the 2009 LTIP to certain employees. The restricted stock units vest in equal installments over
three years. Additionally, the Company also granted stock options under the 1999 EIP and 2009 LTIP
to purchase approximately 0.3 million shares of the Companys common stock to certain employees.
The exercise price of the stock option grants is $13.37, which is equal to the average high and low
of the Companys common stock on the NYSE Amex on the grant date. The stock options vest in equal
installments over three years.
The grant date fair value of these post-Merger share-based award grants approximated $2.8
million. No share-based awards were granted in the three months ended September 30, 2009.
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11. Credit Agreements
Syndicated Credit Agreement
On April 20, 2009, the Company entered into a syndicated credit agreement (the Syndicated
Credit Agreement) that establishes a secured $15.0 million bank revolving credit facility, with a
letter of credit sub-facility in an amount not to exceed $10.0 million outstanding at any time. The
Syndicated Credit Agreement is guaranteed by the subsidiaries of the Company other than Walter
Investment Reinsurance, Co., Ltd., Mid-State Capital, LLC, Hanover SPC-A, Inc. and the Companys
securitization trusts. In addition, Walter Energy posted a letter of credit (the Support Letter of
Credit) in an amount equal to $15.7 million to secure the Companys obligations under the
Syndicated Credit Agreement. The loans under the Syndicated Credit Agreement shall be used for
general corporate purposes of the Company and its subsidiaries. The Syndicated Credit Agreement
contains customary events of default and covenants, including covenants that restrict the ability
of the Company and certain of their subsidiaries to incur certain additional indebtedness, create
or permit liens on assets, engage in mergers or consolidations, and certain restrictive financial
covenants. The Syndicated Credit Agreement also requires the Company to maintain unencumbered
assets with an unpaid principal balance of at least $75.0 million at all times. If an event of
default shall occur and be continuing, the commitments under the related credit agreement may be
terminated and all obligations under the Syndicated Credit Agreement may be due and payable. All
loans under the Syndicated Credit Agreement shall be available until the termination date, which is
April 20, 2011, at which point all obligations under the Syndicated Credit Agreement shall be due
and payable. The commitment fee on the unused portion of the Syndicated Credit Agreement is 0.50%.
All loans made under the Syndicated Credit Agreement will bear interest at a rate equal to LIBOR
plus 4.00%.
As of September 30, 2009, no funds have been drawn under the Syndicated Credit Agreement and
the Company is in compliance with all covenants.
The foregoing description of the Syndicated Credit Agreement does not purport to be complete
and is qualified in its entirety by the terms and conditions of such agreement. The agreement was
filed as an exhibit to the Registrants Quarterly Report on Form 10-Q, filed with the SEC on August
14, 2009.
Revolving Credit Agreement and Security Agreement
On April 20, 2009, the Company entered into a revolving credit agreement and security
agreement (the Revolving Credit Agreement) among the Company, certain of its subsidiaries and
Walter Energy, as lender. The Revolving Credit Agreement establishes a guaranteed $10.0 million
revolving facility, secured by a pledge of unencumbered assets with an unpaid principal balance of
at least $10.0 million. The Revolving Credit Agreement also is guaranteed by the subsidiaries of
the Company that guarantee the Syndicated Credit Agreement. The Revolving Credit Agreement is
available only after a major hurricane has occurred with projected losses greater than the $2.5
million self-insured retention (the Revolving Credit Agreement Effective Date). The Revolving
Credit Agreement contains customary events of default and covenants, including covenants that
restrict the ability of the Company and certain of their subsidiaries to incur certain additional
indebtedness, create or permit liens on assets, engage in mergers or consolidations, and certain
restrictive financial covenants. The Revolving Credit Agreement also requires the Company to
maintain unencumbered assets with an unpaid principal balance of at least $75.0 million at all
times. If an event of default shall occur and be continuing, the commitments under the related
credit agreement may be terminated and all obligations under the Revolving Credit Agreement may be
due and payable. All loans under the Revolving Credit Agreement shall be available from the
Revolving Credit Agreement Effective Date until the termination date, which is April 20, 2011, at
which point all obligations under the Revolving Credit Agreement shall be due and payable. On the
Revolving Credit Agreement Effective Date, the Company will pay Walter Energy a funding fee in an
amount equal to $25,000. A commitment fee of 0.50% is payable on the daily amount of the unused
commitments after the Revolving Credit Agreement Effective Date. All loans made under the Revolving
Credit Agreement will bear interest at a rate equal to LIBOR plus 4.00%.
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As of September 30, 2009, no funds have been drawn under the Revolving Credit Agreement and
the Company is in compliance with all covenants.
The foregoing description of the Revolving Credit Agreement does not purport to be complete
and is qualified in its entirety by the terms and conditions of such agreement. The agreement was
filed as an exhibit to the Registrants Quarterly Report on Form 10-Q, filed with the SEC on August
14, 2009.
Support Letter of Credit Agreement
On April 20, 2009, the Company entered into a support letter of credit agreement (the Support
LC Agreement) between the Company and Walter Energy. The Support LC Agreement was entered into in
connection with the Support Letter of Credit of $15.7 million and the bonds similarly posted by
Walter Energy in support of the Companys obligations. The Support LC Agreement provides that the
Company will reimburse Walter Energy for all costs incurred by it in posting the Support Letter of
Credit as well as for any draws under bonds posted in support of the Company. In addition, upon any
draw under the Support Letter of Credit, the obligations of the Company to Walter Energy will be
secured by a perfected security interest in unencumbered assets with an unpaid principal balance of
at least $65.0 million. The Support LC Agreement contains customary events of default and
covenants, including covenants that restrict the ability of the Company and certain of their
subsidiaries to incur certain additional indebtedness, create or permit liens on assets, engage in
mergers or consolidations, and certain restrictive financial covenants. The Support LC Agreement
also requires the Company to maintain unencumbered assets with an unpaid principal balance of at
least $75.0 million at all times. If an event of default shall occur and be continuing, the
commitments under the related credit agreement may be terminated and all obligations under the
Support LC Agreement may be due and payable. All obligations under the LC Support Agreement shall
be due and payable on April 20, 2011. The Support LC Agreement provides that any draws under the
Support Letter of Credit will be deemed to constitute loans of Walter Energy to the Company and
will bear interest at a rate equal to LIBOR plus 6.00%.
As of September 30, 2009, a $15.7 million letter of credit remains outstanding and the Company
is in compliance with all covenants.
The foregoing description of the LC Support Agreement does not purport to be complete and is
qualified in its entirety by the terms and conditions of such agreement. The agreement was filed
as an exhibit to the Registrants Quarterly Report on Form 10-Q, filed with the SEC on August 14,
2009.
12. Transactions with Walter Energy
Transition Services and Other Agreements Related to the Spin-Off from Walter Energy
Following the spin-off, Walter Investment and Walter Energy have operated independently, and
neither has any ownership interest in the other. In order to govern certain of the ongoing
relationships between the Company and Walter Energy after the spin-off and to provide mechanisms
for an orderly transition, the Company and Walter Energy entered into certain agreements, pursuant
to which (a) the Company and Walter Energy provide certain services to each other, (b) the Company
and Walter Energy will abide by certain non-compete and non-solicitation arrangements, and (c) the
Company and Walter Energy will indemnify each other against certain liabilities arising from their
respective businesses. The specified services that the Company and Walter Energy may provide each
other, as requested, include tax and accounting services, certain human resources services,
communications systems and support, and insurance/risk management. Each party will be compensated
for services rendered, as set forth in the Transition Services Agreement. The Transition Services
Agreement provides for terms not to exceed 24 months for the various services, with some of the
terms capable of extension.
As discussed in the Form S-4 filed on February 17, 2009, Walter Energy and the Company have
also entered into certain other agreements including the Tax Separation Agreement, Joint Litigation
Agreement, and Trademark License Agreement. See Note 3 for further discussion of the spin-off
transaction. See also further discussion of these agreements in the Registrants Quarterly Report
on Form 10-Q, filed with the SEC on May 15, 2009 and the Trademark License Agreement, the
Transition Services Agreement, the Tax Separation Agreement and the Joint Litigation Agreement in
the Registrants Quarterly Report on Form 10-Q, filed with the SEC on August 14, 2009.
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13. Comprehensive Income and Accumulated Other Comprehensive Income
The components of comprehensive income are as follows (in thousands):
For the Three Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Net income (loss) |
$ | 8,243 | $ | (7,897 | ) | |||
Other comprehensive income (loss): |
||||||||
Change in postretirement benefit plans, net of $556 and $90 tax effect, respectively |
206 | 235 | ||||||
Net unrealized gain on subordinate security |
157 | | ||||||
Net amortization of realized gain on closed hedges, net of $289 and $25 tax effect,
respectively |
217 | (56 | ) | |||||
Comprehensive income (loss) |
$ | 8,823 | $ | (7,718 | ) | |||
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Net income (loss) |
$ | 105,256 | $ | (4,627 | ) | |||
Other comprehensive income (loss): |
||||||||
Change in postretirement benefit plans, net of $556 and $114 tax effect, respectively |
206 | (143 | ) | |||||
Net unrealized gain on subordinate security |
157 | | ||||||
Net amortization of realized gain on closed hedges, net of $347 and $112 tax effect,
respectively |
117 | (204 | ) | |||||
Net recognized loss on hedges, net of $0 and $3,329 tax effect, respectively |
| 6,130 | ||||||
Comprehensive income |
$ | 105,736 | $ | 1,156 | ||||
The components of accumulated other comprehensive income are as follows (in thousands):
Excess of | ||||||||||||||||
Additional | ||||||||||||||||
Postretirement | Net Amortization of | Net Unrealized Gain | ||||||||||||||
Employee Benefits | Realized Gain on | on Subordinate | ||||||||||||||
Liability | Closed Hedges | Security | Total | |||||||||||||
Balance at December 31, 2008 |
$ | 1,158 | $ | 589 | $ | | $ | 1,747 | ||||||||
Pre-tax amount |
(350 | ) | (230 | ) | 157 | (423 | ) | |||||||||
Tax benefit |
55 | 58 | | 113 | ||||||||||||
Change in tax due to REIT conversion |
501 | 289 | | 790 | ||||||||||||
Balance at September 30, 2009 |
$ | 1,364 | $ | 706 | $ | 157 | $ | 2,227 | ||||||||
14. Common Stock and Earnings Per Share
In June 2008, the FASB issued guidance on determining whether share-based awards are
participating securities. In accordance with the accounting guidance concerning EPS, unvested
share-based payment awards that include non-forfeitable rights to dividends, 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. In accordance with the accounting guidance concerning earnings per share,
the basic and diluted earnings per share amounts have been calculated for the three and nine months
ended September 30, 2009 using the two-class method. The basic and diluted loss per share amounts
for the three and nine months ended September 30, 2008 were not adjusted retrospectively as no
participating securities were outstanding during the period.
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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):
Three Months | Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Basic earnings (loss) per share: |
||||||||||||||||
Net income (loss) |
$ | 8,243 | $ | (7,897 | ) | $ | 105,256 | $ | (4,627 | ) | ||||||
Less: net income allocated to unvested restricted stock units |
(66 | ) | | (427 | ) | | ||||||||||
Net income (loss) available to common stockholders (numerator) |
$ | 8,177 | $ | (7,897 | ) | $ | 104,829 | $ | (4,627 | ) | ||||||
Weighted-average common shares |
19,890 | 19,871 | 19,881 | 19,871 | ||||||||||||
Add: vested restricted stock units |
696 | | 418 | | ||||||||||||
Total weighted-average common shares outstanding (denominator) |
20,586 | 19,871 | 20,299 | 19,871 | ||||||||||||
Basic earnings (loss) per share |
$ | 0.40 | $ | (0.40 | ) | $ | 5.16 | $ | (0.23 | ) | ||||||
Diluted earnings (loss) per share: |
||||||||||||||||
Net income (loss) |
$ | 8,243 | $ | (7,897 | ) | $ | 105,256 | $ | (4,627 | ) | ||||||
Less: net income allocated to unvested restricted stock units |
(66 | ) | | (426 | ) | | ||||||||||
Net income (loss) available to common stockholders (numerator) |
$ | 8,177 | $ | (7,897 | ) | $ | 104,830 | $ | (4,627 | ) | ||||||
Weighted-average common shares |
19,890 | 19,871 | 19,881 | 19,871 | ||||||||||||
Add: Potentially dilutive stock options and restricted stock units |
798 | | 476 | | ||||||||||||
Diluted weighted-average common shares outstanding (denominator) |
20,688 | 19,871 | 20,357 | 19,871 | ||||||||||||
Diluted earnings (loss) per share |
$ | 0.40 | $ | (0.40 | ) | $ | 5.15 | $ | (0.23 | ) | ||||||
The calculation of diluted earnings (loss) per share for the three and nine months ended
September 30, 2009 and 2008, does not include 320,349 and 0 shares, respectively, because their
effect would have been anti-dilutive.
15. REIT Qualification
Effective with the Merger, the Companys operations related to its residential loan portfolios
qualify for treatment as a REIT for federal income tax purposes. REITs are generally not required
to pay federal income taxes contingent upon the Company meeting applicable distribution, income,
asset and ownership criteria. The REIT-qualifying operations are conducted by the Company and its
wholly owned subsidiaries, other than those wholly owned subsidiaries for which taxable REIT
subsidiary (TRS) elections have been made. The Companys use of TRSs, which are taxed as C
corporations, enables the Company to engage in non-REIT qualifying businesses without violating the
REIT requirements. Effective with the Merger, the Companys insurance and consulting businesses
have been conducted through wholly owned TRSs.
If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory
relief provisions, we 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 we fail to qualify as a REIT. Even if we qualify for
taxation as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or
property.
As a consequence of the Companys qualification as a REIT, the Company was not permitted to
retain earnings and profits accumulated during years when the Company was taxed as a C corporation.
Therefore, in order to remain qualified as a REIT, the Company distributed these earnings and
profits by making a one-time special distribution to stockholders, which the Company refers to as
the special E&P distribution, on April 17, 2009. The special E&P distribution, with an aggregate
value of approximately $80.0 million, consisted of $16.0 million in cash and approximately 12.7
million shares of Spinco common stock valued at approximately $64.0 million.
16. Income Taxes
The Company recorded an income tax expense of $1.3 million and income tax benefit of $75.7
million for the three and nine months ended September 30, 2009, respectively. The income tax
expense for the three months ended
September 30, 2009 included $0.8 million related to the reversal of tax benefits previously
reflected in accumulated other comprehensive income. The income tax benefit for the nine months
ended September 30, 2009 was largely due to the reversal of $82.1 million in mortgage-related
deferred tax liabilities that were no longer necessary as a result of the Companys REIT
qualification. Excluding the tax benefit related to the reversal of deferred tax liabilities, the
Company recorded an income tax expense of $6.4 million for the nine months ended September 30,
2009, respectively, which was largely due to the Companys C corporation earnings before the Merger
and resulting REIT qualification.
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During the three months ended September 30, 2009 and 2008, an estimated tax rate of 14.0% and
(28.8)%, respectively, was used to derive income tax expense of $1.3 million and $1.8 million,
respectively, calculated on our income (loss) from operations, before taxes, of $9.6 million and
$(6.1) million, respectively. During the nine months ended September 30, 2009 and 2008, an
estimated tax rate of (256.4)% and (395.9)%, respectively, was used to derive an income tax expense
(benefit) of $(75.7) million and $3.7 million, respectively, calculated on our income (loss) from
operations, before taxes, of $29.5 million and $(0.9) million, respectively.
The Company recognizes tax benefits in accordance with the FASB 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 September 30, 2009 and December 31, 2008, the total gross amount of unrecognized tax benefits
was $15.2 million and $15.1 million, respectively.
17. 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 September 30, 2009,
the unpaid principal balance of the 15 remaining mortgage securities was approximately $1.9
million.
Employment Agreements
At September 30, 2009, 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.
Bayport Plaza Lease
On May 1, 2009, the Company entered into a sublease with Municipal Mortgage & Equity, LLC to
secure the Companys new corporate headquarters located at 3000 Bayport Drive, Suite 1100, Tampa,
Florida 33607. The lease commenced on May 15, 2009 and expires on April 29, 2016. The base rent
over the lease term is $4.0 million.
See the office sublease dated May 1, 2009, in the Registrants Quarterly Report on Form 10-Q,
filed with the SEC on August 14, 2009.
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
we were a part of the Walter Energy consolidated group. According to Walter Energys Quarterly
Report on Form 10-Q for the quarter ended September 30, 2009 as filed with the SEC on November 6,
2009 (Walter Energy September 30, 2009 10-Q): (a) the Internal Revenue Service (IRS) has
completed its audit of Walter Energys federal income tax returns for the years ended May 31, 2000
through December 31, 2005; (b) the unresolved issues relate primarily to Walter Energys method of
recognizing revenue on the sale of homes and related interest on the instalment notes receivable;
and (c) the items at issue relate primarily to
the timing of revenue recognition and consequently, should the IRS prevail on its positions,
Walter Energys financial exposure is limited to interest and penalties. The Walter Energy
September 30, 2009 10-Q also states that (a) a controversy exists with regard to federal income
taxes allegedly owed by Walter Energy for fiscal years 1980 through 1994; (b) after adjusting for
various issues that have been settled or conceded to by the parties, Walter Energy estimates that
the amount of tax presently claimed by the IRS is approximately $34.0 million for issues currently
in dispute; (c) of the $34.0 million in claimed tax, $21.0 million represents issues in which the
IRS is not challenging the deductibility of the particular expense but only whether such expense is
deductible in a particular year; and (d) consequently, Walter Energy believes that, should the IRS
prevail on any such issues, Walter Energys
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financial exposure is limited to interest and possible
penalties. Walter Energy discloses further that it believes that all of its current and prior tax
filing positions have substantial merit and it intends to defend vigorously any tax claims
asserted. Walter Energy also states that it believes it has 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.
The Tax Separation Agreement also provides that Walter Energy is responsible for the
preparation and filing of any tax returns, and the payment of any taxes related thereto, 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 us. In addition, the
spinoff of WIM LLC from Walter Energy was intended to qualify as a tax-free spin-off under Section
355 of the Internal Revenue Code of 1986, as amended. The Tax Separation Agreement provides
generally that if the spinoff is determined not to be tax-free pursuant to Section 355 of the
Internal Revenue Code of 1986, as amended, 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, we 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 spinoff occurred.
The foregoing descriptions of the Walter Energy September 30, 2009 10-Q and the Tax Separation
Agreement do not purport to be complete and are qualified in their entirety by, respectively,
Walter Energys Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 as filed
with the SEC on November 6, 2009, and the terms and conditions of the Tax Separation Agreement
filed as an exhibit to the Companys Report on Form 10-Q filed with the SEC on August 14, 2009.
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. See also Critical Accounting Polices
Litigation and Investigations in Managements Discussion and Analysis of Financial Condition and
Results of Operations.
18. Subsequent Events
Subsequent events were evaluated through November 11, 2009 which is the date that the Company
issued these financial statements. In its evaluation, the Company determined that there were no
other material recognized or unrecognized subsequent events other than the following:
Common Stock Offering
On September 22, 2009, the Company filed a registration statement on Form S-11 with the SEC
(Registration Number 333-162067), as amended on October 8, 2009 and October 16, 2009, to offer 5
million shares of common stock. In addition, the underwriters of the offering, Credit Suisse and
SunTrust Robinson Humphrey, exercised their over-allotment option to purchase an additional 750,000
shares of common stock. The offering closed on October 21, 2009 with all 5 million shares plus the
over-allotment of 750,000 shares sold.. This offering of the Companys common stock, including the
exercise of the over-allotment option, generated net proceeds to the Company of approximately $76.9
million, after deducting underwriting discounts and commissions and estimated offering expenses.
None of the Companys directors or officers received a direct or indirect benefit from the
offering. The proceeds generated from the offering are currently being held in an FDIC-insured
account.
Dividend Declaration
On November 5, 2009, the Company declared a dividend of $0.50 per share on its common stock to
stockholders of record on November 18, 2009 which will be paid on November 30, 2009.
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Explanatory Note
On April 17, 2009, Hanover Capital Mortgage Holdings, Inc. (Hanover) completed the
transactions (the Merger) contemplated by the Second Amended and Restated Agreement and Plan of
Merger (as amended on April 17, 2009, the Merger Agreement) by and among Hanover, Walter Energy,
Inc. (formerly known as Walter Industries, Inc. (Walter Energy)), Walter Investment Management,
LLC (Spinco) and JWH Holding Company, LLC (JWHHC). The merged business was renamed Walter
Investment Management Corp. on April 17, 2009 and is referred to herein as Walter Investment,
we, or us.
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, 2008, filed on Form 8-K/A on July 10, 2009. 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, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as
well as proxy statements, as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the U.S. Securities and Exchange Commission (SEC). We also make
available, free of charge, access to our Corporate Governance Standards, charters for our Audit
Committee, Compensation Committee, and Nominating and Corporate Governance Committee, and our Code
of Business 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 web site any amendment to
the Code of Ethics and any waiver applicable to any executive officer, director, or senior officer
(as defined in the Code). In addition, our web site includes information concerning purchases and
sales of our equity securities by our executive officers and directors, as well as disclosure
relating to certain non generally accepted accounting principles (GAAP) and financial measures (as
defined in the SECs 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 this
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 in our Registration Statement on Form S-11 dated
September 22, 2009 (Registration Number 333-162067), as amended on October 8, 2009 and October 16,
2009, and in our other securities filings with the Securities and Exchange Commission (SEC).
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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 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; limitations imposed on our business
due to our 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, 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 and other counterparties to satisfy our/their material obligations
under our/their 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; the integration of the former Hanover Capital Mortgage Holdings, Inc. business
into that of Walter Investment Management, LLC and its affiliates (the Merger), and the
realization of anticipated synergies, cost savings and growth opportunities from the Merger; future
performance generally; and other presently unidentified factors. In addition, the financial
information presented herein is unaudited. Should any of the financial information upon which a
forward looking statement is based be changed upon audit, the forward looking statement may also
change.
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 operate as an internally managed, publicly traded REIT. We are a mortgage servicer and
mortgage portfolio owner specializing in subprime, non-conforming and other credit-challenged
residential loans primarily in the southeastern United States. We also operate mortgage advisory
and insurance product lines of business. At September 30, 2009, we had four wholly owned, primary
subsidiaries: Hanover Capital Partners 2, Ltd., doing business as Hanover Capital, Walter Mortgage
Company, LLC (WMC), Walter Investment Reinsurance Company, Ltd. (WIRC), and Best Insurors, Inc.
(Best).
Basis of Presentation
The consolidated financial statements reflect the historical operations of the Financing
business which was operated as part of Walter Energy prior to the spin-off. Under Walter Energys
ownership, the Financing business operated through separate subsidiaries. A direct ownership
relationship did not exist among the legal entities prior to the contribution to Spinco. 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.
Although we have operated as an independent, stand-alone entity only since April 17, 2009,
management believes the assumptions underlying the consolidated financial statements as of
December 31, 2008 and the three and nine months ended September 30, 2008 are reasonable. However,
the consolidated financial statements included herein do not include all of the expenses that would
have been incurred had we been a separate, stand-alone entity, although, the consolidated financial
statements do include certain costs and expenses that have been allocated to us from Walter Energy.
As such, the financial information does not necessarily reflect or is not necessarily indicative of
our consolidated financial position, results of operations and cash flows in the future, or what
would have been reflected had we been a separate, stand-alone entity during the periods presented.
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Results of operations for the three and nine months ended September 30, 2009 include the
results of operations of legacy Spinco. The results of operations of legacy Hanover are included
from the completion of the Merger with Hanover on April 17, 2009 through September 30, 2009. Since
the Merger constitutes a reverse acquisition for accounting purposes, the pre-acquisition
consolidated financial statements of Spinco are treated as the historical financial statements of
Walter Investment.
The combined financial statements of WMC, Best and WIRC (collectively representing
substantially all of Walter Energys Financing business prior to the Merger) are considered the
predecessor to Spinco for accounting purposes. The combined financial statements of WMC, Best and
WIRC have become Spincos historical financial statements for periods prior to the Merger. Results
of operations for three and nine months ended September 30, 2008 are the results of Spinco only.
Business Separation and Merger
On September 30, 2008, Walter Energy outlined its plans to separate its Financing business
from its core Natural
Resources businesses through a spin-off to stockholders and subsequent merger with Hanover. In
furtherance of these plans, on September 30, 2008, Walter Energy and Spinco entered into a
definitive agreement to merge with Hanover, which agreement was amended and restated on February
17, 2009. To effect the separation, Spinco was formed on February 3, 2009, as a wholly-owned
subsidiary of Walter Energy, having no independent assets or operations. Immediately prior to the
spin-off, substantially all of the assets and liabilities related to the Financing business were
contributed, through a series of transactions, to Spinco in return for Spincos membership unit.
On April 17, 2009, we completed our separation from Walter Energy. In connection with the
separation, Spinco and Walter Energy executed the following transactions or agreements which
involved no cash:
| Walter Energy distributed 100% of its interest in Spinco to holders of Walter Energys common stock; | ||
| All intercompany balances between Spinco and Walter Energy were settled with the net balance recorded as a dividend to Walter Energy; | ||
| In accordance with the Tax Separation Agreement, Walter Energy will, in general, be responsible for any and all taxes reported on any joint return through the date of the separation, which may also include Spinco for periods prior to the separation. Spinco will be responsible for any and all taxes reported on any Spinco separate tax return and on any consolidated returns for Walter Investment subsequent to the separation; | ||
| Walter Energys share-based awards held by Spinco employees were converted to equivalent share-based awards of Walter Investment, with the number of shares and the exercise price being equitably adjusted to preserve the intrinsic value. The conversion was accounted for as a modification under the provisions of the guidance concerning stock compensation. |
The assets and liabilities transferred to Spinco from Walter Energy also included $26.6
million in cash, which was contributed to Spinco by Walter Energy on April 17, 2009. Following the
spin-off, Spinco paid a taxable dividend consisting of cash of $16.0 million and additional equity
interests to its members.
The Merger occurred immediately following the spin-off and taxable dividend on April 17, 2009.
The surviving company is named Walter Investment Management Corp. and continues to operate as a
publicly traded REIT subsequent to the Merger. We are headquartered in Tampa, Florida and have
approximately 215 employees. After the spin-off and Merger, Walter Energys stockholders that
became members of Spinco as a result of the spin-off, and certain holders of options to acquire
limited liability company interests of Spinco, collectively owned 98.5% and stockholders of Hanover
owned 1.5% of the shares of our common stock outstanding or reserved for issuance in settlement of
restricted stock units of Walter Investment. As a result, the business combination has been
accounted for as a reverse acquisition, with Spinco considered the accounting acquirer. We applied
for, and was granted approval, to list our shares on the NYSE Amex. On April 20, 2009, our common
stock began trading on the NYSE Amex under the symbol WAC.
The reverse acquisition of the operations of Hanover has been accounted for pursuant to the
Business Combinations Topic, with Spinco as the accounting acquirer. As a result, the historical
financial statements of
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Spinco have become the historical financial statements of Walter Investment. The Hanover
assets acquired and the liabilities assumed were recorded at the date of acquisition (April 17,
2009) at their respective fair values. The results of operations of Hanover were included in the
consolidated statements of income for periods subsequent to the Merger.
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, 2008 included in the Form 8-K/A filed with the SEC on July 10, 2009.
While all significant accounting policies are important to our consolidated financial
statements, some of these policies may be viewed as critical. Critical policies are those that are
most important to the portrayal of our financial condition and require our most difficult,
subjective and complex estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, expenses and related disclosures. These estimates are based upon our
historical experience and on various assumptions that we believe to be reasonable under the
circumstances. Our actual results may differ from these estimates under different assumptions or
conditions. We believe our most critical accounting policies are as follows:
Revenue Recognition
Residential loans consist of residential mortgage loans and residential retail instalment
agreements and are initially recorded at the discounted value of the future payments using an
imputed interest rate. The imputed interest rate used represents the estimated prevailing market
rate of interest for credit of similar terms issued to borrowers with similar credit. References to
borrowers refer to borrowers under our residential mortgage loans and instalment obligors in our
residential retail instalment agreements. We have had minimal purchase and origination activity
subsequent to May 1, 2008, when we ceased purchasing new originations from JWH or providing
financing to new customers of JWH. New originations relate to the financing of sales of REO
properties. The imputed interest rate on these financings is based on observable market mortgage
rates, adjusted for variations in expected credit losses where market data is unavailable.
Variations in the estimated market rate of interest used to initially record residential loans
could affect the timing of interest income recognition.
The interest income earned by us is recognized using the interest method. An instalment note
states the maximum amount to be charged to the borrowers, and ultimately recognized as revenue,
based on the contractual number of payments and dollar amount of monthly payments. Residential loan
pay-offs received in advance of scheduled maturity (voluntary prepayments) effect the amount of
interest income due to the recognition at that time of any remaining unamortized discounts or
premiums arising from the loans inception.
We have the ability to levy costs to protect our collateral position upon default, such as
attorney fees and late charges, as allowed by state law. The various legal instruments used allow
for different fee structures to be charged to the borrower, for example, late fees and prepayment
fees. These fees are ultimately recognized as revenue when collected. Recoveries of advanced taxes
and insurance related to residential loans are recognized as income when collected.
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. Residential loans are removed from
non-accrual status when the amount financed and the associated interest are no longer over 90 days
past due.
We sell REO which was repossessed or foreclosed from borrowers in default of their loans or
notes. Sales of REO involve the sale and, in most circumstances, the financing of both a home and
related real estate. Revenues from the sales of REO are recognized by the full accrual method where
appropriate. However, the requirement for a minimum 5% initial cash investment (for primary
residences), frequently is not met. When this is the case, losses are immediately recognized, and
gains are deferred and recognized by the installment method until the borrowers investment reaches
the minimum 5%. At that time, revenue is recognized by the full accrual method.
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Allowance for Loan Losses on Residential Loans
Managements periodic evaluation of the adequacy of the allowance for losses on residential
loans is based on our past loss experience, known and inherent risks in the portfolio,
delinquencies, the estimated value of the underlying real estate collateral and current economic
and market conditions within the applicable geographic areas surrounding the underlying real
estate. The allowance for losses on residential loans is increased by provisions for losses charged
to income and is reduced by charge-offs, net of recoveries. As the amount of residential loans
decreases and as they age, the credit exposure is reduced, resulting in decreasing provisions.
Real Estate Owned
REO is recorded at the lower of cost or estimated fair value less estimated costs to sell,
which is based on historical resale recovery rates and current market conditions.
Litigation and Investigations
We are involved in litigation, investigations and claims arising out of the normal
conduct of our business. We estimate and accrue liabilities resulting from such matters based on a
variety of factors, including outstanding legal claims and proposed settlements and assessments by
internal counsel of pending or threatened litigation. These accruals are recorded when the costs
are determined to be probable and are reasonably estimable. We believe we have adequately accrued
for these potential liabilities; however, facts and circumstances may change that could cause the
actual liabilities to exceed the estimates, or that may require adjustments to the recorded
liability balances in the future.
Notwithstanding the foregoing, WMC is a party to a lawsuit entitled Casa Linda Homes,
et al. v. Walter Mortgage Company, et al. , Cause No. C-2918-08-H, 389th
Judicial District Court of Hidalgo County, Texas, claiming breach of contract, fraud, negligent
misrepresentation, breach of fiduciary duty and bad faith, promissory estoppel and unjust
enrichment. The plaintiffs are seeking actual and exemplary damages, the amount of which have not
been specified, but if proven could be material. The allegations arise from a claim that we
breached a contract with the plaintiffs by failing to purchase a certain amount of loan pool
packages from the corporate plaintiff, a Texas real estate developer. We believe the case to be
without merit and are vigorously pursuing the defense of the claim.
As discussed in Note 17 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.
Results of Operations
Revenue, net
For the three and nine months ended September 30, 2009, we reported net income of $8.2 million
and $105.3 million, respectively, as compared to a net loss of $7.9 million and $4.6 million for
the same periods, respectively, in the prior year. The main components of the change in net income
(loss) for the three and nine months ended September 30, 2009 as compared to the same periods in
the prior year are detailed in the following table:
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Revenue by Portfolio Type
(dollars in thousands)
(dollars in thousands)
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | Increase/ | September 30, | Increase/ | |||||||||||||||||||||
2009 | 2008 | (Decrease) | 2009 | 2008 | (Decrease) | |||||||||||||||||||
Residential loans, unencumbered |
||||||||||||||||||||||||
Interest income |
$ | 8,118 | $ | 8,690 | $ | (572 | ) | $ | 25,601 | $ | 25,063 | $ | 538 | |||||||||||
Less: Interest expense |
| | | | 3,509 | (3,509 | ) | |||||||||||||||||
Less: Interest rate hedge
ineffectiveness |
| | | | 16,981 | (16,981 | ) | |||||||||||||||||
Net interest income |
8,118 | 8,690 | (572 | ) | 25,601 | 4,573 | 21,028 | |||||||||||||||||
Less: Provision for loan losses |
812 | 1,396 | (584 | ) | 3,171 | 3,713 | (542 | ) | ||||||||||||||||
Net interest income after
provision for loan losses |
7,306 | 7,294 | 12 | 22,430 | 860 | 21,570 | ||||||||||||||||||
Residential loans held in
securitization trusts |
||||||||||||||||||||||||
Interest income |
35,073 | 38,959 | (3,886 | ) | 108,100 | 121,044 | (12,944 | ) | ||||||||||||||||
Interest expense |
22,229 | 24,278 | (2,049 | ) | 67,972 | 74,923 | (6,951 | ) | ||||||||||||||||
Net interest income |
12,844 | 14,681 | (1,837 | ) | 40,128 | 46,121 | (5,993 | ) | ||||||||||||||||
Less: Provision for loan losses |
2,290 | 3,893 | (1,603 | ) | 8,040 | 8,933 | (893 | ) | ||||||||||||||||
Net interest income after
provision for loan losses |
10,554 | 10,788 | (234 | ) | 32,088 | 37,188 | (5,100 | ) | ||||||||||||||||
Non-interest income |
||||||||||||||||||||||||
Premium revenue |
2,581 | 3,205 | (624 | ) | 9,060 | 8,264 | 796 | |||||||||||||||||
Other income, net |
461 | (1,272 | ) | 1,733 | 838 | (1,627 | ) | 2,465 | ||||||||||||||||
Total |
3,042 | 1,933 | 1,109 | 9,898 | 6,637 | 3,261 | ||||||||||||||||||
Total revenues, net |
20,902 | 20,015 | 887 | 64,416 | 44,685 | 19,731 | ||||||||||||||||||
Total non-interest expenses |
11,314 | 26,145 | (14,831 | ) | 34,885 | 45,618 | (10,733 | ) | ||||||||||||||||
Income (loss) before income taxes |
9,588 | (6,130 | ) | 15,718 | 29,531 | (933 | ) | 30,464 | ||||||||||||||||
Income tax expense (benefit) |
1,345 | 1,767 | (422 | ) | (75,725 | ) | 3,694 | (79,419 | ) | |||||||||||||||
Net income (loss) |
$ | 8,243 | $ | (7,897 | ) | $ | 16,140 | $ | 105,256 | $ | (4,627 | ) | $ | 109,883 | ||||||||||
Net Interest Income
The decrease in unencumbered residential loan net interest income for the three months ended
September 30, 2009, as compared to the same period in the previous year was due primarily to
principal repayments of these loans, a decrease in the volume of voluntary prepayments and a lack
of new loan acquisition activity and higher delinquencies. The average prepayment rate for the
unencumbered portfolio was 4.05% during the third quarter of 2009, as compared to 4.46% in the
third quarter of 2008. The increase in unencumbered net interest income for the nine months ended
September 30, 2009, as compared to the same period in the previous year was due primarily to the
decrease in interest expense as a result of the repayment of the Warehouse Facilities in April
2008, as well as the $17.0 million interest rate hedge ineffectiveness charge recorded in 2008. The
average prepayment rate for the unencumbered portfolio was 4.69% during the nine months ended
September 30, 2009, as compared to 6.92% in the same period of 2008.
The decrease in the securitized residential loan net interest income for the three and nine
months ended September 30, 2009, as compared to the same periods in the previous year was due to a
decrease in the volume of voluntary prepayments and principal repayments of these loans, offset by
a decrease in interest expense due to lower average outstanding borrowings. The average prepayment
rate for the securitized portfolio was 3.18% and 3.38% during the three and nine months ended
September 30, 2009, respectively, as compared to 4.50% and 4.91% in the same periods of 2008,
respectively. The reduction in average borrowings was due to principal payments on the
mortgage-backed debt issued with no new issuances over the past year.
Provision for Loan Losses
The decrease in the residential loan provision for loan losses for the three and
nine months ended September 30, 2009, as compared to the same periods in the previous year was
primarily due to an increase in the
loss severity assumption for adjustable rate loans in the 2008 period.
Additionally, as the amount of residential loans decreases and as the loans season, the credit
exposure is reduced, resulting in decreasing provisions.
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Non-Interest Income
The increase in non-interest income for the three and nine months ended September 30, 2009, as
compared to the same periods in the previous year was primarily due to the sale of the third-party
insurance agency portfolio, as well as an increase in mortgage advisory revenue.
Non-Interest Expenses
The decrease in non-interest expenses for the three and nine months ended September 30, 2009,
as compared to the same periods in the previous year was primarily due to $16.1 million in
non-recurring charges recorded in 2008 related to a goodwill impairment charge and a provision for
estimated hurricane losses offset by additional expenses incurred during 2009 to support corporate
functions required as a result of the spin-off from Walter Energy and merger with Hanover.
Income Taxes
The change in income tax expense (benefit) for the three and nine months ended September 30,
2009, as compared to the same periods in the previous year was due to the reversal of
mortgage-related deferred tax liabilities that were no longer applicable upon our REIT
qualification. Income tax expense for the three months ended September 30, 2009 includes a
non-cash charge related to the reversal of tax benefits previously reflected in accumulated other
comprehensive income.
Residential Loan Portfolio and Related Liabilities
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. Loan losses due to defaults will also negatively
impact our earnings.
The following table reflects the average balances of our residential loan portfolio, net, as
well as associated liabilities, with corresponding rates of interest and effective yields (dollars
in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Average residential loan balance (1) |
$ | 1,705,294 | $ | 1,823,012 | $ | 1,738,850 | $ | 1,827,719 | ||||||||
Average mortgage-backed debt balance |
1,305,969 | 1,419,811 | 1,332,532 | 1,554,226 | ||||||||||||
Net investment |
399,325 | 403,201 | 406,318 | 273,493 | ||||||||||||
Interest income |
$ | 43,191 | $ | 47,649 | $ | 133,701 | $ | 146,107 | ||||||||
Less: Interest expense |
22,229 | 24,278 | 67,972 | 78,432 | ||||||||||||
Less: Interest rate hedge ineffectiveness |
| | | 16,981 | ||||||||||||
Net interest income |
$ | 20,962 | $ | 23,371 | $ | 65,729 | $ | 50,694 | ||||||||
Effective interest income yield on the
residential loan portfolio (2) |
10.13 | % | 10.46 | % | 10.25 | % | 10.66 | % | ||||||||
Effective interest expense rate (2) |
6.81 | % | 6.84 | % | 6.80 | % | 6.73 | % | ||||||||
Net interest spread (2) |
3.32 | % | 3.62 | % | 3.45 | % | 3.93 | % | ||||||||
Average equity balance |
509,862 | 382,121 | 460,332 | 258,234 | ||||||||||||
Average leverage ratio (3) |
2.56 | 3.72 | 2.89 | 6.02 | ||||||||||||
Yield on net portfolio assets (2)(4) |
4.92 | % | 5.13 | % | 5.04 | % | 4.94 | % | ||||||||
Return on net investment (2)(5) |
21.00 | % | 23.19 | % | 21.57 | % | 32.99 | % |
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(1) | Average residential loan balance is net of yield adjustments and gross of allowance for losses for the period. | |
(2) | Results have been annualized. | |
(3) | Average leverage ratio is calculated as average mortgage-backed debt balance divided by average equity. | |
(4) | The yield on net portfolio assets for the nine months ended September 30, 2008 does not include the interest rate hedge ineffectiveness charge of $17.0 million. There were no hedging costs for the three and nine months ended September 30, 2009 or the three months ended September 30, 2008. The yield on net portfolio assets is calculated by dividing net interest income by the average residential loan balance. | |
(5) | The return on net investment for the nine months ended September 30, 2008 does not include the interest rate hedge ineffectiveness charge of $17.0 million. There were no hedging costs for the three and nine months ended September 30, 2009 or the three months ended September 30, 2008. The return on net investment is calculated by dividing net interest income by the net investment. |
Net investment decreased for the three months ended September 30, 2009, as compared to the
same period in 2008 due to residential loan principal and mortgage-backed debt repayments. Net
investment increased for the nine months ended September 30, 2009, compared to the same period in
2008 primarily due to the repayment and termination of the Warehouse Facilities in April 2008
offset by loan principal and mortgage-backed debt repayments.
Net interest spread decreased for the three and nine months ended September 30, 2009, compared
to the same periods in 2008. These decreases are primarily due to a reduction in the effective rate
on the residential loans due to a decrease in the voluntary prepayment speeds which resulted in a
decrease in the recognition of purchase discounts into interest income, as well as an increase in
borrower delinquencies.
Average leverage ratio decreased for the three and nine months ended September 30, 2009,
compared to the same periods in 2008. The decreases are primarily related to a decrease in the
average mortgage-backed debt balance due to repayment and termination of the Warehouse Facilities
resulting in an increase in the average equity.
The return on net investment decreased for the three and nine months ended September 30, 2009,
as compared to the same period in 2008. The decreases are primarily the result of decreases in
interest income due to lower voluntary prepayments and higher delinquencies, as well as a decrease
in interest expense from a decrease in the average mortgage-backed debt balance due to repayments
and the termination of the Warehouse Facilities.
Additional Analysis of Residential Loan Portfolio
Allowance for Loan Losses
The allowance for loan losses on residential loans was $17.8 million at September 30,
2009 and $19.0 million at December 31, 2008. The following table shows information about the
allowance for losses for the periods presented.
Net Losses and | Net Losses and | |||||||||||||||
Charge-offs | Charge-offs as a % | |||||||||||||||
Allowance | Allowance as a % of | Deducted from the | of Average | |||||||||||||
for Losses | Residential Loans | Allowance | Residential Loans | |||||||||||||
(dollars in thousands) | ||||||||||||||||
September 30, 2009 |
$ | 17,789 | 1.05 | % | $ | 12,391 | 0.71 | % | ||||||||
December 31, 2008 |
$ | 18,969 | 1.06 | % | $ | 16,338 | 0.90 | % |
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The following table summarizes activity in the allowance for loan losses in our
residential portfolio, net for the three and nine months ended September 30, 2009 and 2008 (in
thousands):
Unencumbered Residential Loans | Residential Loans Held in Securitization Trusts | |||||||||||||||
Nine Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Balance, December 31 |
$ | 3,418 | $ | 1,737 | $ | 15,551 | $ | 12,255 | ||||||||
Provision charged to income |
1,269 | 1,377 | 3,107 | 2,864 | ||||||||||||
Less: Charge-offs, net of
recoveries |
(1,314 | ) | (872 | ) | (3,549 | ) | (3,352 | ) | ||||||||
Balance, March 31 |
3,373 | 2,242 | 15,109 | 11,767 | ||||||||||||
Provision charged to income |
1,090 | 940 | 2,643 | 2,176 | ||||||||||||
Less: Charge-offs, net of
recoveries |
(1,025 | ) | (856 | ) | (2,883 | ) | (2,323 | ) | ||||||||
Balance, June 30 |
3,438 | 2,326 | 14,869 | 11,620 | ||||||||||||
Provision charged to income |
812 | 1,396 | 2,290 | 3,893 | ||||||||||||
Less: Charge-offs, net of
recoveries |
(743 | ) | (1,378 | ) | (2,877 | ) | (2,921 | ) | ||||||||
Balance, September 30 |
$ | 3,507 | $ | 2,344 | $ | 14,282 | $ | 12,592 | ||||||||
Delinquency Information
The following table presents information about delinquencies in our residential loan
portfolio:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Total number of residential loans outstanding |
34,804 | 36,767 | ||||||
Delinquencies as a percent of number of
residential loans outstanding: |
||||||||
31-60 days |
1.32 | % | 1.32 | % | ||||
61-90 days |
0.61 | % | 0.60 | % | ||||
91 days or more |
2.40 | % | 2.23 | % | ||||
4.33 | % | 4.15 | % | |||||
Principal balance of residential loans
outstanding ($ in thousands) |
$ | 1,856,849 | $ | 1,964,978 | ||||
Delinquencies as a percent of amounts outstanding |
||||||||
31-60 days |
1.56 | % | 1.58 | % | ||||
61-90 days |
0.75 | % | 0.72 | % | ||||
91 days or more |
3.24 | % | 3.05 | % | ||||
5.55 | % | 5.35 | % |
The following table presents further information about delinquencies as a percent of
amounts outstanding in our residential loan portfolio:
Residential Loans Held in | ||||||||||||||||
Unencumbered Residential Loans | Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
31-60 days |
2.46 | % | 2.29 | % | 1.33 | % | 1.39 | % | ||||||||
61-90 days |
1.41 | % | 0.92 | % | 0.59 | % | 0.67 | % | ||||||||
91 days or more |
5.24 | % | 4.03 | % | 2.72 | % | 2.78 | % | ||||||||
9.11 | % | 7.24 | % | 4.64 | % | 4.84 | % |
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The calculation of delinquencies excludes from delinquent amounts those residential loans
that are in bankruptcy proceedings that are paying their mortgage payments in contractual
compliance with 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:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Unencumbered residential loans |
||||||||
Number of loans |
187 | 153 | ||||||
Balance (in millions) |
$ | 19.6 | $ | 16.0 | ||||
Residential loans held in securitization trusts |
||||||||
Number of loans |
647 | 666 | ||||||
Balance (in millions) |
$ | 40.4 | $ | 42.3 | ||||
Total |
||||||||
Number of loans |
834 | 819 | ||||||
Balance (in millions) |
$ | 60.0 | $ | 58.3 |
Portfolio Characteristics
The weighted average original LTV on the loans in our residential loan portfolio is
89.37% as of September 30, 2009 and 89.18% as of December 31, 2008. The LTV dispersion of our
portfolio is as follows:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
0.00 - 70.00 |
1.56 | % | 1.66 | % | ||||
70.01 - 80.00 |
2.95 | % | 3.04 | % | ||||
80.01 - 90.00(1) |
69.82 | % | 69.49 | % | ||||
90.01 - 100.00 |
25.67 | % | 25.81 | % | ||||
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.
The current weighted average FICO score of the loans in our residential loan portfolio,
updated as of March 31, 2009, was 581 as of September 30, 2009 and 579 as of December 31, 2008. The
FICO dispersion of our portfolio is as follows:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
<=600 |
50.61 | % | 51.07 | % | ||||
601 - 640 |
11.86 | % | 11.30 | % | ||||
641 - 680 |
8.05 | % | 7.68 | % | ||||
681 - 720 |
4.40 | % | 4.60 | % | ||||
721 - 760 |
2.64 | % | 2.45 | % | ||||
761 - 800 |
2.23 | % | 2.39 | % | ||||
>800 |
0.84 | % | 1.00 | % | ||||
Unknown or unavailable |
19.37 | % | 19.51 | % | ||||
100.00 | % | 100.00 | % |
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Our residential loans are concentrated in the following states:
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
Texas |
33.88 | % | 33.41 | % | ||||
Mississippi |
15.43 | % | 15.36 | % | ||||
Alabama |
8.72 | % | 8.86 | % | ||||
Louisiana |
6.50 | % | 6.49 | % | ||||
Florida |
6.12 | % | 6.24 | % | ||||
Others |
29.35 | % | 29.64 | % | ||||
Total |
100.00 | % | 100.00 | % |
Our residential loans were originated in the following periods:
Year 2009 Origination |
2.53 | % | ||
Year 2008 Origination |
7.57 | % | ||
Year 2007 Origination |
13.17 | % | ||
Year 2006 Origination |
12.06 | % | ||
Year 2005 Origination |
8.60 | % | ||
Year 2004 Origination and earlier |
56.07 | % | ||
Total |
100.00 | % |
Real Estate Owned
The following table presents information about repossessed property related to the
unencumbered residential loans (dollars in thousands):
Units | Balance | |||||||
Balance at December 31, 2008 |
151 | 12,435 | ||||||
Repossessions |
202 | 17,815 | ||||||
Sales |
(126 | ) | (11,002 | ) | ||||
Balance at September 30, 2009 |
227 | $ | 19,248 | |||||
The following table presents information about repossessed property related to the
residential loans held in securitization trusts (dollars in thousands):
Units | Balance | |||||||
Balance at December 31, 2008 |
673 | 35,763 | ||||||
Repossessions |
812 | 43,824 | ||||||
Sales |
(791 | ) | (42,090 | ) | ||||
Balance at September 30, 2009 |
694 | $ | 37,497 | |||||
Liquidity and Capital Resources
Overview
Our principal sources of funds are our existing cash balances, monthly principal and interest
payments we receives from our unencumbered residential loan portfolio, cash releases from the
securitized residential loan portfolio, and from the sale of our equity and other financing
activities. We generally use our liquidity for our operating costs, to make investments, to pay
down our mortgage-backed debt and to make dividend payments. As of September 30, 2009, total debt
decreased $80.6 million compared to December 31, 2008.
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Our securitization trusts are consolidated for financial reporting 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 over-collateralization or other similar
targets are satisfied. Principal and interest on the mortgage-backed debt of the trusts can only
be paid if there is sufficient cash flows from the underlying collateral. We own the residual
interests in the mortgage-backed debt securities issued by the trusts, which is a component of our
cash flow.
The securitization trusts contain delinquency and loss triggers, that, if exceeded, result in
any excess over-collateralization going to pay down the Trust Notes for that particular
securitization at an accelerated pace. Assuming no servicer trigger events have occurred and the
over-collateralization targets have been met, any excess cash is released to us. As of September
30, 2009, two of the securitization trusts have exceeded servicer triggers and are currently not
providing any excess cash flows to us.
We believe that, based on current forecasts and anticipated market conditions, funding
generated from the residential loans and the proceeds from our recent secondary equity offering
will be sufficient to meet operating needs, to invest in residential loans, to make planned capital
expenditures, to make all required principal and interest payments on indebtedness, for general
corporate purposes and to pay cash dividends as required for our qualification as a REIT. However,
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/Asset-Backed Notes and Warehouse Facilities
We have historically funded our residential loans through the securitization market. As of
September 30, 2009, our nine separate non-recourse securitization trusts have an aggregate of $1.3
billion of outstanding debt, collateralized by $1.4 billion of assets. The 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.
At the beginning of the second quarter of 2008, we were a borrower under a $200.0 million
Warehouse Facility and a $150.0 million Warehouse Facility providing temporary financing to us for
our purchases and/or originations of residential loans. On April 30, 2008, we repaid all
outstanding borrowings and terminated the Warehouse Facilities using funds provided by Walter
Energy. Since the termination of the Warehouse Facilities, we have no longer used or accessed the
mortgage-backed securitization market.
Collateralized Mortgage Obligations
We have long-term debt in the form of CMOs. CMO debt totaled $2.4 million and $0 at September
30, 2009 and December 31, 2008, respectively. The CMOs, and the related residential loan
collateral, were acquired as part of the Merger with Hanover. All of our CMOs are structured as
financing transactions, whereby we have pledged residential loans to secure CMOs. As we retained
the subordinated securities of this securitization and will absorb a majority of any losses on the
underlying collateral, we have consolidated the securitization entity and treat these residential
loans as our assets and treat the related CMOs as our debt.
Borrower remittances received on the CMO collateral are used to make payments on the CMOs. The
obligations of the CMOs are payable solely from the underlying residential loans that collateralize
the debt and otherwise are non-recourse to us. The maturity of each class of CMO is directly
affected by principal prepayments on the related CMO collateral. Each class of CMO is also subject
to redemption according to specific terms of the respective indenture agreements. As a result, the
actual maturity of any class of CMO is likely to occur earlier than its stated maturity.
Credit Agreements
In April 2009, we entered into a syndicated credit agreement that provides for a $15.0 million
secured revolving credit facility provided by a bank group (the Syndicated Credit Agreement). A
portion of the Syndicated Credit Agreement, up to $10.0 million, may be used to issue letters of
credit. We intend to use the proceeds of the
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Syndicated Credit Agreement, as necessary, for general corporate purposes. No borrowings have
been made under the Syndicated Credit Agreement since inception and we are in compliance with all
covenants
In April 2009, we entered into a revolving credit agreement and security agreement (the
Revolving Credit Agreement) among us, certain of our subsidiaries and Walter Energy, as lender.
The Revolving Credit Agreement establishes a guaranteed $10.0 million revolving facility, secured
by a pledge of unencumbered assets with an unpaid principal balance of at least $10.0 million. This
facility would be available only after a major hurricane has occurred with projected losses greater
than a $2.5 million self-insured retention. As of September 30, 2009, no funds have been drawn
under the Revolving Credit Agreement and we are in compliance with all covenants.
In April 2009, we entered into a support letter of credit agreement (the Support LC
Agreement) with Walter Energy. The Support LC Agreement was entered into in connection with a
letter of credit of $15.7 million and the bonds similarly posted by Walter Energy in support of our
obligations. The Support LC Agreement provides that we will reimburse Walter Energy for all costs
incurred by it in posting the Support Letter of Credit as well as for any draws under bonds posted
in support of us. As of September 30, 2009, a $15.7 million letter of credit remains outstanding
and we are in compliance with all covenants.
See Note 11 for further information regarding the Agreements.
Statement of Cash Flows
The following table sets forth, for the periods indicated, selected consolidated cash flow
information (in thousands):
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2009 | 2008 | |||||||
Cash flows provided by operating activities |
$ | 35,673 | $ | 23,243 | ||||
Cash flows provided by investing activities |
87,380 | 138,622 | ||||||
Cash flows used in financing activities |
(100,476 | ) | (163,686 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
$ | 22,577 | $ | (1,821 | ) | |||
Cash balances outstanding were $23.9 million and $1.3 million at September 30, 2009, and
December 31, 2008, respectively.
Net cash provided by operating activities increased $12.4 million for the nine months ended
September 30, 2009 as compared to the same period in 2008. The increase primarily reflected a
one-time cash charge of $17.0 million for interest rate hedge ineffectiveness that was paid in
2008.
Net cash provided by investing activities decreased $51.2 million for the nine months ended
September 30, 2009 as compared to the same period in 2008. The decrease was primarily due to a
$27.9 million decrease in principal payments received on residential loans due to a decline in the
overall portfolio balance, lower levels of voluntary prepayments and increased delinquencies, $2.0
million of capital expenditures, as well as $5.9 million of cash transferred to and held as
restricted cash in an insurance trust account. The remaining decrease in investing cash flows
primarily relate to increases in restricted cash due to the requirements of the securitization
trust agreements.
Net cash used in financing activities decreased $63.2 million for the nine months ended
September 30, 2009 as compared to the same period in 2008. The decrease was primarily due to an
$8.7 million decrease in dividends paid to Walter Energy and a $245.7 million decrease in payments
on mortgage-backed debt over the prior year. The prior year payments included $214.0 million used
to repay and terminate the Warehouse Facilities in 2008. This decrease was partially offset by a
$139.8 million decrease in the receivable from Walter Energy over the prior year due to the
dividend of the remaining balance to Walter Energy prior to the spin-off, a $25.0 million decrease
in the issuance of mortgage-backed debt, $16.0 million of dividends to Spinco interest-holders
immediately following the spin-off and $10.4 million of dividends to stockholders.
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Off-Balance Sheet Arrangements
As of September 30, 2009, we retained credit risk on 15 remaining mortgage securities totaling
$1.9 million that were sold with recourse 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 a REIT, 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.
As of September 30, 2009, we expect to pay dividends to our stockholders of all or
substantially all of our net income in each year to qualify for the tax benefits accorded to a REIT
under the Code. All distributions will be made at the discretion of our board of directors and will
depend on our earnings, both tax and GAAP, financial condition, maintenance of REIT qualification
and such other factors as the board of directors deems relevant.
On November 5, 2009, we declared a dividend of $0.50 per share on our common stock which will
be paid on November 30, 2009 to stockholders of record on November 18, 2009.
40
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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 third quarter ended September 30, 2009, that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
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Table of Contents
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.
Notwithstanding the above, we are involved in litigation, investigations and
claims arising out of the normal conduct of its business. We estimate and accrue
liabilities resulting from such matters based on a variety of factors, including outstanding legal
claims and proposed settlements and assessments by internal counsel of pending or threatened
litigation. These accruals are recorded when the costs are determined to be probable and are
reasonably estimable. We believe we have adequately accrued for these potential
liabilities; however, facts and circumstances may change that could cause the actual liabilities to
exceed the estimates, or that may require adjustments to the recorded liability balances in the
future.
Notwithstanding the foregoing, WMC is a party to a lawsuit entitled Casa Linda Homes,
et al. v. Walter Mortgage Company, et al. , Cause No. C-2918-08-H, 389th
Judicial District Court of Hidalgo County, Texas, claiming breach of contract, fraud, negligent
misrepresentation, breach of fiduciary duty and bad faith, promissory estoppel and unjust
enrichment. The plaintiffs are seeking actual and exemplary damages, the amount of which have not
been specified, but if proven could be material. The allegations arise from a claim that we
breached a contract with the plaintiffs by failing to purchase a certain amount of loan pool
packages from the corporate plaintiff, a Texas real estate developer. We believe the case
to be without merit and are vigorously pursuing the defense of the claim.
As discussed in Note 17 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
Not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) | Not applicable. | ||
(b) | The information required in this item is reported herein in Note 18 to the Notes to Consolidated Financial Statements. | ||
(c) | Not applicable. |
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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: November 11, 2009
By: | /s/ Kimberly Perez | |||
Kimberly Perez | ||||
Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |
||||
Dated: November 11, 2009
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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. | |||
31.1
|
(3 | ) | 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
|
(3 | ) | Certification by Kimberly Perez pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
32
|
(3 | ) | Certification by Mark J. OBrien and Kimberly Perez pursuant to 18 U.S.C. Section 1352, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
45
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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)
|
Filed herewith |
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