Attached files
file | filename |
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EX-32 - EX-32 - DITECH HOLDING Corp | b83305exv32.htm |
EX-31.2 - EX-31.2 - DITECH HOLDING Corp | b83305exv31w2.htm |
EX-31.1 - EX-31.1 - DITECH HOLDING Corp | b83305exv31w1.htm |
EX-10.3 - EX-10.3 - DITECH HOLDING Corp | b83305exv10w3.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2010
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
Tampa, FL 33607
(Address of principal executive offices) (Zip Code)
(813) 421-7600
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o |
Accelerated filer þ |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
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 25,765,693 shares of common stock outstanding as of November 1, 2010.
WALTER INVESTMENT MANAGEMENT CORP.
FORM 10-Q
INDEX
Table of Contents
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(in thousands, except share and per share data)
September 30, | December 31, | |||||||
2010 | 2009 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 40,199 | $ | 99,286 | ||||
Restricted cash and cash equivalents |
10,875 | 8,963 | ||||||
Restricted cash of securitization trusts |
38,192 | 42,691 | ||||||
Receivables, net |
3,524 | 3,052 | ||||||
Residential loans, net of allowance for loan losses of $5,388 and $3,460, respectively |
355,212 | 333,636 | ||||||
Residential loans of securitization trusts, net of allowance for loan losses of
$10,893 and $14,201, respectively |
1,256,404 | 1,310,710 | ||||||
Subordinate security |
1,820 | 1,801 | ||||||
Real estate owned |
28,259 | 21,981 | ||||||
Real estate owned of securitization trusts |
35,949 | 41,143 | ||||||
Deferred debt issuance costs of securitization trusts |
17,360 | 18,450 | ||||||
Other assets |
4,979 | 5,961 | ||||||
Total assets |
$ | 1,792,773 | $ | 1,887,674 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Accounts payable |
$ | 590 | $ | 13,489 | ||||
Accounts payable of securitization trusts |
539 | 556 | ||||||
Accrued expenses |
28,386 | 28,296 | ||||||
Deferred income taxes, net |
118 | 173 | ||||||
Mortgage-backed debt of securitization trusts |
1,183,636 | 1,267,454 | ||||||
Accrued interest of securitization trusts |
8,129 | 8,755 | ||||||
Other liabilities |
801 | 767 | ||||||
Total liabilities |
1,222,199 | 1,319,490 | ||||||
Commitments and contingencies (Note 16) |
| | ||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value per share: |
||||||||
Authorized 10,000,000 shares |
||||||||
Issued and outstanding 0 shares at September 30, 2010 and December 31, 2009 |
| | ||||||
Common stock, $0.01 par value per share: |
||||||||
Authorized 90,000,000 shares |
||||||||
Issued and outstanding 25,758,716 and 25,642,889 shares at September 30,
2010 and December 31, 2009, respectively |
258 | 256 | ||||||
Additional paid-in capital |
125,955 | 122,552 | ||||||
Retained earnings |
442,981 | 443,433 | ||||||
Accumulated other comprehensive income |
1,380 | 1,943 | ||||||
Total stockholders equity |
570,574 | 568,184 | ||||||
Total liabilities and stockholders equity |
$ | 1,792,773 | $ | 1,887,674 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
3
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except share and per share data)
(Unaudited)
(in thousands, except share and per share data)
For the Three Months | For the Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net interest income: |
||||||||||||||||
Interest income |
$ | 41,307 | $ | 43,019 | $ | 124,817 | $ | 133,525 | ||||||||
Less: Interest expense |
20,316 | 22,229 | 62,612 | 67,972 | ||||||||||||
Total net interest income |
20,991 | 20,790 | 62,205 | 65,553 | ||||||||||||
Less: Provision for loan losses |
3,234 | 2,701 | 11,224 | 10,663 | ||||||||||||
Total net interest income after provision for loan losses |
17,757 | 18,089 | 50,981 | 54,890 | ||||||||||||
Non-interest income: |
||||||||||||||||
Premium revenue |
1,778 | 2,025 | 6,636 | 8,086 | ||||||||||||
Other income, net |
437 | 1,263 | 2,213 | 2,066 | ||||||||||||
Total non-interest income |
2,215 | 3,288 | 8,849 | 10,152 | ||||||||||||
Non-interest expenses: |
||||||||||||||||
Claims expense |
914 | 1,098 | 2,739 | 3,760 | ||||||||||||
Salaries and benefits |
5,708 | 5,441 | 18,547 | 15,254 | ||||||||||||
Legal and professional |
1,014 | 615 | 2,849 | 3,215 | ||||||||||||
Occupancy |
350 | 223 | 1,023 | 1,023 | ||||||||||||
Technology and communication |
681 | 687 | 2,082 | 2,236 | ||||||||||||
Depreciation and amortization |
59 | 105 | 243 | 336 | ||||||||||||
General and administrative |
2,868 | 3,219 | 8,131 | 8,286 | ||||||||||||
Gain on mortgage-backed debt extinguishment |
(1,680 | ) | | (1,680 | ) | | ||||||||||
(Gains) losses on real estate owned, net |
60 | 401 | (1,293 | ) | 548 | |||||||||||
Related party allocated corporate charges |
| | | 853 | ||||||||||||
Total non-interest expenses |
9,974 | 11,789 | 32,641 | 35,511 | ||||||||||||
Income before income taxes |
9,998 | 9,588 | 27,189 | 29,531 | ||||||||||||
Income tax expense (benefit) |
312 | 1,345 | 828 | (75,725 | ) | |||||||||||
Net income |
$ | 9,686 | $ | 8,243 | $ | 26,361 | $ | 105,256 | ||||||||
Basic earnings per common and common equivalent share |
$ | 0.36 | $ | 0.40 | $ | 0.98 | $ | 5.16 | ||||||||
Diluted earnings per common and common equivalent share |
$ | 0.36 | $ | 0.40 | $ | 0.98 | $ | 5.15 | ||||||||
Total dividends declared per common and common equivalent share |
$ | 0.50 | $ | 0.50 | $ | 1.00 | $ | 0.50 | ||||||||
Weighted average common and common equivalent shares outstanding
basic |
26,474,001 | 20,586,199 | 26,411,018 | 20,299,435 | ||||||||||||
Weighted average common and common equivalent shares outstanding
diluted |
26,569,897 | 20,687,965 | 26,492,850 | 20,357,139 |
The accompanying notes are an integral part of the consolidated financial statements.
4
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED
STATEMENT OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except share data)
STATEMENT OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except share data)
Accumulated | ||||||||||||||||||||||||||||||||||||
Additional | Other | |||||||||||||||||||||||||||||||||||
Common Stock | Paid-In | Comprehensive | Retained | Comprehensive | ||||||||||||||||||||||||||||||||
Total | Shares | Amount | Capital | Income | Earnings | Income | ||||||||||||||||||||||||||||||
Balance at December 31, 2009 |
$ | 568,184 | 25,642,889 | $ | 256 | $ | 122,552 | $ | 443,433 | $ | 1,943 | |||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||
Net income |
26,361 | $ | 26,361 | 26,361 | ||||||||||||||||||||||||||||||||
Other comprehensive income (loss), net
of tax: |
||||||||||||||||||||||||||||||||||||
Change in postretirement benefit
plans, net of $20 tax effect |
(377 | ) | (377 | ) | (377 | ) | ||||||||||||||||||||||||||||||
Net unrealized gain on subordinate
security, net of $0 tax effect |
19 | 19 | 19 | |||||||||||||||||||||||||||||||||
Net amortization of realized gain
on closed hedges, net of $0 tax
effect |
(205 | ) | (205 | ) | (205 | ) | ||||||||||||||||||||||||||||||
Comprehensive income |
$ | 25,798 | ||||||||||||||||||||||||||||||||||
Dividends and dividend equivalents declared |
(26,813 | ) | (26,813 | ) | ||||||||||||||||||||||||||||||||
Share-based compensation |
2,936 | 2,936 | ||||||||||||||||||||||||||||||||||
Shares issued upon exercise of stock
options and vesting of RSUs |
733 | 134,823 | 2 | 731 | ||||||||||||||||||||||||||||||||
Repurchase and cancellation of common stock |
(264 | ) | (18,996 | ) | (264 | ) | ||||||||||||||||||||||||||||||
Balance at September 30, 2010 |
$ | 570,574 | 25,758,716 | $ | 258 | $ | 125,955 | $ | 442,981 | $ | 1,380 | |||||||||||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
5
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
(Unaudited)
(in thousands)
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2010 | 2009 | |||||||
Operating activities: |
||||||||
Net income |
$ | 26,361 | $ | 105,256 | ||||
Adjustments to reconcile net income to net cash provided by operating
activities: |
||||||||
Provision for loan losses |
11,224 | 10,663 | ||||||
Amortization of residential loan discount to interest income |
(10,209 | ) | (11,637 | ) | ||||
Depreciation and amortization |
243 | 336 | ||||||
Gain on mortgage-backed debt extinguishment |
(1,680 | ) | | |||||
(Gains) losses on real estate owned, net |
(1,293 | ) | 548 | |||||
Proceeds from sale of mortgage securities classified as trading |
| 2,387 | ||||||
Benefit from deferred income taxes |
(35 | ) | (64,344 | ) | ||||
Amortization of deferred debt issuance costs to interest expense |
796 | 892 | ||||||
Share-based compensation |
2,936 | 886 | ||||||
Other |
(363 | ) | (329 | ) | ||||
(Increase) decrease in assets, net of effect of reverse acquisition: |
||||||||
Receivables |
373 | (4,826 | ) | |||||
Other |
379 | (1,828 | ) | |||||
Increase (decrease) in liabilities, net of effect of reverse acquisition: |
||||||||
Accounts payable |
332 | (1,076 | ) | |||||
Accrued expenses |
90 | (926 | ) | |||||
Accrued interest |
(626 | ) | (731 | ) | ||||
Cash flows provided by operating activities |
28,528 | 35,271 | ||||||
Investing activities: |
||||||||
Purchases of residential loans from third parties |
(40,740 | ) | | |||||
Principal payments received on residential loans |
77,072 | 91,533 | ||||||
Additions to real estate owned |
(11,382 | ) | (7,345 | ) | ||||
Cash proceeds from sales of real estate owned |
6,129 | 8,782 | ||||||
Additions to property and equipment, net |
360 | (2,167 | ) | |||||
(Increase) decrease in restricted cash and cash equivalents |
2,587 | (4,197 | ) | |||||
Cash acquired in Hanover reverse acquisition |
| 774 | ||||||
Cash flows provided by investing activities |
34,026 | 87,380 | ||||||
Financing activities: |
||||||||
Payments on mortgage-backed debt |
(62,179 | ) | (83,373 | ) | ||||
Mortgage-backed debt extinguishment |
(19,870 | ) | | |||||
Net activity with Walter Energy |
| 9,216 | ||||||
Dividends to WIM interest-holders |
| (16,000 | ) | |||||
Dividends and dividend equivalents paid |
(40,061 | ) | (10,373 | ) | ||||
Shares issued upon exercise of stock options and vesting of RSUs |
733 | 54 | ||||||
Repurchase and cancellation of common stock |
(264 | ) | | |||||
Cash flows used in financing activities |
(121,641 | ) | (100,476 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
(59,087 | ) | 22,175 | |||||
Cash and cash equivalents at the beginning of the period |
99,286 | 1,319 | ||||||
Cash and cash equivalents at the end of the period |
$ | 40,199 | $ | 23,494 | ||||
Supplemental Disclosure of Non-Cash Investing and Financing Activities: |
||||||||
Real estate owned acquired through foreclosure |
$ | 63,689 | $ | 64,305 | ||||
Residential loans originated to finance the sale of real estate owned |
$ | 57,061 | $ | 42,715 | ||||
Residential loans acquired with advances from Walter Energy |
$ | | $ | 2,504 | ||||
Dividends to Walter Energy |
$ | | $ | 306,458 | ||||
Consummation of reverse acquisition with Hanover |
$ | | $ | 2,186 |
The accompanying notes are an integral part of the consolidated financial statements.
6
Table of Contents
WALTER INVESTMENT MANAGEMENT CORP. AND SUBSIDARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Unaudited)
1. Business
The Company is a mortgage servicer and mortgage portfolio owner specializing in
credit-challenged, non-conforming residential loans primarily in the southeastern United States, or
U.S. The Company also operates ancillary mortgage advisory and insurance businesses. At September
30, 2010, the Company had four wholly owned, primary subsidiaries: Hanover Capital Partners 2,
Ltd., doing business as Hanover Capital, Walter Mortgage Company, LLC, or WMC, Best Insurors, Inc.,
or Best, and Walter Investment Reinsurance Company, Ltd., or WIRC.
The Companys business, headquartered in Tampa, Florida, was established in 1958 as the
financing segment of Walter Energy, Inc., formerly known as Walter Industries, Inc., or Walter
Energy. Throughout the Companys history, it purchased residential loans originated by Walter
Energys homebuilding affiliate, Jim Walter Homes, Inc., or JWH, originated and purchased
residential loans on its own behalf, and serviced these residential loans to maturity. Over the
past 50 years, the Company has developed significant expertise in servicing credit-challenged
accounts through its differentiated high-touch approach which involves significant face-to-face
borrower contact by trained servicing personnel strategically located in the markets where its
borrowers reside. As of September 30, 2010, the Company serviced approximately 33,500 individual
residential loans.
Throughout this Quarterly Report on Form 10-Q, references to residential loans refer to
residential mortgage loans and residential retail instalment agreements and references to
borrowers refer to borrowers under our residential mortgage loans and instalment obligors under
our residential retail instalment agreements.
The Spin-off
On September 30, 2008, Walter Energy outlined its plans to separate its Financing business
from its core Natural Resources business through a spin-off to stockholders. 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 Walter Investment Management LLC, or WIM, in
return for all of WIMs membership units. See Note 3 for further information.
The combined financial statements of WMC, Best and WIRC (collectively representing
substantially all of Walter Energys Financing business prior to the spin-off) are considered the
predecessor to WIM 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 WIM.
The Merger
On September 30, 2008, Walter Energy and WIM entered into a definitive agreement to merge WIM
with Hanover Capital Mortgage Holdings, Inc., or Hanover, which agreement was amended and restated
on February 17, 2009. On April 17, 2009, Hanover completed the transactions, or the Merger,
contemplated by the Second Amended and Restated Agreement and Plan of Merger (as amended on April
17, 2009, or the Merger Agreement) by and among Hanover, Walter Energy, WIM, and JWH Holding
Company, LLC, or JWHHC. The merged business, together with its consolidated subsidiaries, was
renamed Walter Investment Management Corp. on April 17, 2009 and is referred to herein as Walter
Investment or the Company. See Note 3 for further information.
2. Basis of Presentation
Interim Financial Reporting
The accompanying unaudited consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States, or GAAP, for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments, consisting of normal recurring accruals,
considered necessary for a fair presentation have been included. Operating results for the three
and nine month periods ended September 30, 2010 are not necessarily indicative of the results that
may be expected for the year ended December 31, 2010. These unaudited interim financial statements
should be read in conjunction with our audited consolidated financial statements and related notes
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009.
Although Hanover was the surviving legal and tax entity in the Merger, for accounting purposes
the Merger was treated as a reverse acquisition of the operations of Hanover and has been accounted
for pursuant to the guidance concerning business combinations, with WIM as the accounting acquirer.
As such, the pre-acquisition financial statements of WIM are treated as 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
7
Table of Contents
the Merger.
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 did not operate as an independent, stand-alone entity prior to April 17,
2009, management believes the assumptions underlying the consolidated financial statements for the
period through April 17, 2009 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; however, the consolidated financial statements do include
certain costs and expenses that had been allocated to the Company from Walter Energy for the nine
months ended September 30, 2009. As such, the financial information does not necessarily reflect
what would have been reflected had the Company been a separate, stand-alone entity during the
period through April 17, 2009.
Recently Adopted Accounting Guidance
Transfers and Servicing
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
guidance 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 guidance was effective for financial
asset transfers occurring after the beginning of an entitys first fiscal year that begins after
November 15, 2009. The adoption of this guidance on January 1, 2010 did not have a significant
impact on the Companys consolidated financial statements.
Fair Value Measurements and Disclosures
In January 2010, the FASB updated the accounting standards to require new disclosures for fair
value measurements and to provide clarification for existing disclosure requirements. More
specifically, this update requires (a) an entity to disclose separately the amounts of significant
transfers in and out of levels 1 and 2 fair value measurements and to describe the reasons for the
transfers and (b) information about purchases, sales, issuances, and settlements to be presented
separately (i.e., present the activity on a gross basis rather than net) in the roll forward of
fair value measurements using significant unobservable inputs (Level 3 inputs). This update
clarifies existing disclosure requirements for the level of disaggregation used for classes of
assets and liabilities measured at fair value and requires disclosures about the valuation
techniques and inputs used to measure for fair value for both recurring and nonrecurring fair value
measurements using Level 2 and Level 3 inputs. The standard was effective for interim and annual
reporting periods beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years beginning after December 12, 2010,
and for interim periods within those fiscal years. The adoption of this guidance on January 1, 2010
did not have a significant impact on the Companys disclosures. See Note 5 for the additional
required disclosures. The portion of the accounting update that the Company has not yet adopted is
not expected to have a material impact on the Companys disclosures.
Subsequent Events
In May 2009, the 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. This guidance was subsequently amended in February 2010 to
no longer require disclosure of the date through which an entity has evaluated subsequent events.
Other than the elimination of the requirement to disclose the date through which management has
performed its evaluation of subsequent events (Note 17), the adoption of these guidelines had no
impact on the Companys consolidated financial statements.
Receivables
In April 2010, the FASB updated the accounting standards to clarify that modifications of
acquired loans that are accounted for within a pool would not result in the removal of those loans
from the pool even if the modification would otherwise be considered a troubled debt restructuring.
The guidance will be effective for modifications of acquired loans exhibiting characteristics of
credit impairment at the time of acquisition that are accounted for within pools occurring in the
first interim or annual period ending on or after July 15, 2010. The adoption of this guidance on
September 30, 2010 did not have a significant impact on the Companys consolidated financial
statements.
Recently Issued Accounting Guidance
Receivables
In July 2010, the FASB updated the accounting standards to enhance disclosures about the
credit quality of financing receivables and the allowance for credit losses, including disclosures
regarding credit quality indicators, past due information, and modification of financing
receivables. The guidance related to disclosures as of the end of a reporting period will be
effective for interim and annual reporting periods ending on or after December 15, 2010. The
guidance related to disclosures about activity that occurs during a reporting period will be
effective for interim and annual reporting periods beginning on or after December 15, 2010. The
Company is continuing to evaluate the impact that the guidance will have on the Companys
disclosures.
8
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Insurance Contracts
In October 2010, the FASB updated the accounting standards to clarify which costs relating to
the acquisition of new or renewal insurance contracts qualify for deferral. The guidance will be
effective for fiscal years, and interim periods within those fiscal years, beginning after December
15, 2011 and will be applied prospectively upon adoption. The Company is evaluating the impact that
the guidance will have on the Companys consolidated financial statements.
Reclassifications
In order to provide comparability between periods presented, certain amounts have been
reclassified from the previously reported consolidated financial statements to conform to the
consolidated financial statement presentation of the current period.
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 WIM entered
into a definitive agreement to merge WIM with Hanover, which agreement was amended and restated on
February 17, 2009. To effect the separation, WIM 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 WIM in return for WIMs membership unit.
On April 17, 2009, the Company completed its separation from Walter Energy. In connection with
the separation, WIM and Walter Energy executed the following transactions or agreements which
involved no cash:
| Walter Energy distributed 100% of its interest in WIM to holders of Walter Energys common stock; | |
| All intercompany balances between WIM 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 WIM for periods prior to the separation. WIM will be responsible for any and all taxes reported on any WIM separate tax return and on any consolidated returns for Walter Investment subsequent to the separation; | |
| Walter Energys share-based awards held by WIM 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 WIM from Walter Energy also included $26.6 million
in cash, which was contributed to WIM by Walter Energy on April 17, 2009. Following the spin-off,
WIM 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 real estate
investment trust, or REIT, subsequent to the Merger. After the spin-off and Merger, Walter Energys
stockholders that became members of WIM as a result of the spin-off, and certain holders of options
to acquire limited liability company interests of WIM, 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 WIM 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.
The purchase price for the acquisition was $2.2 million based on the fair value of Hanover
(308,302 Hanover shares, which represented 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.
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The purchase price was allocated as of April 17, 2009 as follows (in thousands):
Cash |
$ | 774 | ||
Receivables |
330 | |||
Subordinate security |
1,600 | |||
Residential loans in securitization trusts, net |
4,532 | |||
Other assets |
388 | |||
Accounts payable and accrued expenses |
(2,093 | ) | ||
Mortgage-backed debt |
(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:
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,
2009. 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, 2009,
nor of future results of income.
The unaudited pro forma results for the nine months ended September 30, 2009 are as follows:
For the Nine Months | ||||
Ended September | ||||
30, 2009 | ||||
Total revenue |
$ | 144,071 | ||
Net income |
$ | 28,460 |
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.
4. Restricted Cash and Cash Equivalents
Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents totaled $10.9 million and $9.0 million at September 30,
2010 and December 31, 2009, respectively. Restricted cash and cash equivalents includes
approximately $5.9 million at September 30, 2010 and December 31, 2009 held in an insurance trust
account which secures payments under the Companys reinsurance agreements. The funds in the
insurance trust account include investments in money market funds. The remaining restricted cash
and cash equivalents at September 30, 2010 and December 31, 2009 consists primarily of compensating
balances.
Restricted Cash of Securitization Trusts
Restricted cash of securitization trusts ($38.2 million and $42.7 million, at September 30,
2010 and December 31, 2009, respectively) relates primarily to funds collected on residential loans
owned by the Companys various securitization trusts (see Note 9), which are available only to pay
expenses of the securitization trusts and principal and interest on indebtedness of the
securitization trusts. This restricted cash also provides overcollateralization within the
Companys mortgage-backed debt arrangements. Restricted cash at September 30, 2010 and December 31,
2009 include short-term deposits in FDIC-insured accounts.
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:
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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, 2010.
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.
Items Measured at Fair Value on a Recurring Basis
The subordinate security is measured in the consolidated financial statements at fair value on
a recurring basis in accordance with the accounting guidance concerning debt and equity securities
and is categorized in the table below based upon the lowest level of significant input to the
valuation (in thousands):
September 30, 2010 | ||||||||||||||||
Quoted Prices in | ||||||||||||||||
Active Markets | Significant | |||||||||||||||
for Identical | Significant Other | Unobservable | ||||||||||||||
Assets | Observable Inputs | Inputs | ||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | |||||||||||||
Subordinate security |
$ | | $ | | $ | 1,820 | $ | 1,820 | ||||||||
Total |
$ | | $ | | $ | 1,820 | $ | 1,820 | ||||||||
The subordinate security, acquired as part of the Merger, consists of a single,
fixed-rate security backed by notes that are collateralized by manufactured housing. Approximately
one-third of the notes include attached real estate on which the manufactured housing is located as
additional collateral. The subordinate security has a coupon of 8.0% and a contractual maturity of
2038. The underlying notes were originated primarily in 2004 and 2005, have a weighted average
coupon rate of 9.5% and a weighted average maturity of 18.9 years. The subordinate security has an
overcollateralization level of 9.4% with a 1.2% annual loss rate.
To estimate the fair value, the Company used a discounted cash flow approach. The significant
inputs for the valuation model include the following:
| Yield: 18.5% | |
| Probability of default: 2.4% | |
| Loss severity: 63.4% | |
| Prepayment: 3.1% |
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Table of Contents
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, 2010
(in thousands):
As of and for | ||||||||
Three Months Ended | Nine Months Ended |
|||||||
September 30, | September 30, | |||||||
2010 | 2010 | |||||||
Beginning balance |
$ | 1,823 | $ | 1,801 | ||||
Principal reductions |
| | ||||||
Total gains (losses): |
||||||||
Included in net income |
| | ||||||
Included in other comprehensive income |
(3 | ) | 19 | |||||
Purchases, sales, issuances and settlements, net |
| | ||||||
Transfer into or out of Level 3 category |
| | ||||||
$ | 1,820 | $ | 1,820 | |||||
Total gains (losses) for the period
included in earnings attributable to the change
in unrealized gains or losses relating to
assets still held at the reporting date |
$ | | $ | | ||||
Items Measured at Fair Value on a Non-Recurring Basis
At the time a residential loan becomes real estate owned, or REO, the Company records the
property at the lower of its carrying amount or estimated fair value less estimated costs to sell.
Upon foreclosure and through liquidation, the Company evaluates the propertys fair value as
compared to its carrying amount and records a valuation adjustment when the carrying amount exceeds
fair value. Any valuation adjustment at the time the loan becomes real estate owned is charged to
the allowance for loan losses. Subsequent declines in value, as well as gains and losses on the
sale of REO, are reported in (gains) losses on real estate owned, net in the consolidated
statements of income.
Carrying values, and the corresponding fair value adjustments for the nine and twelve months
ended September 30, 2010 and December 31, 2009, respectively, for Level 3 assets and liabilities
measured in the consolidated financial statements at fair value on a non-recurring basis are as
follows (in thousands):
Fair Value Measurements at Reporting Date Using | ||||||||||||||||||||
Quoted Prices in | ||||||||||||||||||||
Real | Active Markets for | Significant Other | Significant | |||||||||||||||||
Estate | Identical Assets | Observable Inputs | Unobservable Inputs | Fair Value | ||||||||||||||||
Fair Value at | Owned | (Level 1) | (Level 2) | (Level 3) | Adjustment | |||||||||||||||
Real estate owned: |
||||||||||||||||||||
September 30, 2010 |
$ | 28,259 | $ | | $ | | $ | 28,259 | $ | (407 | ) | |||||||||
December 31, 2009 |
$ | 21,981 | $ | | $ | | $ | 21,981 | $ | (372 | ) | |||||||||
Real estate owned of
securitization trusts: |
||||||||||||||||||||
September 30, 2010 |
$ | 35,949 | $ | | $ | | $ | 35,949 | $ | (1,152 | ) | |||||||||
December 31, 2009 |
$ | 41,143 | $ | | $ | | $ | 41,143 | $ | (1,310 | ) |
As of September 30, 2010, the fair value of the Companys Level 3 REO was $28.3
million and $35.9 million for the unencumbered and securitized residential loan portfolios,
respectively. These REO properties are generally located in rural areas and are primarily
concentrated in Texas, Mississippi, Alabama, Florida, South Carolina and Georgia. The REO
properties have a weighted average holding period of 11 months. To estimate the fair value, the
Company utilized historical loss severity rates experienced on similar REO properties previously
sold by the Company. The blended loss severity utilized at September 30, 2010 was 18.2%.
12
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Fair Value of Financial Instruments
The following table presents the carrying values and estimated fair values of financial assets
and liabilities that are required to be recorded or disclosed at fair value as of September 30,
2010 and December 31, 2009, respectively (in thousands):
September 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 40,199 | $ | 40,199 | $ | 99,286 | $ | 99,286 | ||||||||
Restricted cash and cash equivalents |
10,875 | 10,875 | 8,963 | 8,963 | ||||||||||||
Restricted cash of securitization trusts |
38,192 | 38,192 | 42,691 | 42,691 | ||||||||||||
Receivables, net |
3,524 | 3,524 | 3,052 | 3,052 | ||||||||||||
Residential loans, net |
355,212 | 317,000 | 333,636 | 295,000 | ||||||||||||
Residential loans of securitization trusts, net |
1,256,404 | 1,168,000 | 1,310,710 | 1,238,000 | ||||||||||||
Subordinate security |
1,820 | 1,820 | 1,801 | 1,801 | ||||||||||||
Financial liabilities: |
||||||||||||||||
Accounts payable |
590 | 590 | 13,489 | 13,489 | ||||||||||||
Accounts payable of securitization trusts |
539 | 539 | 556 | 556 | ||||||||||||
Accrued expenses |
28,386 | 28,386 | 28,296 | 28,296 | ||||||||||||
Mortgage-backed debt, net of deferred debt
issuance costs, of securitization trusts |
1,166,276 | 1,082,000 | 1,249,004 | 1,147,000 | ||||||||||||
Accrued interest of securitization trusts |
8,129 | 8,129 | 8,755 | 8,755 |
For assets and liabilities measured in the consolidated financial statements on a historical
cost basis, the estimated fair value shown in the above table is for disclosure purposes only. The
following methods and assumptions were used to estimate fair value:
Cash
and cash equivalents, restricted cash and cash equivalents, receivables, accounts payable, accrued expenses, and accrued interest
The estimated fair value of these financial instruments approximates their carrying value due to
their high liquidity or short-term nature.
Residential loans The fair value of residential loans is estimated by discounting the net
cash flows estimated to be generated from the asset. The discounted cash flows were determined
using assumptions such as, but not limited to, interest rates, prepayment speeds, default rates,
loss severities, and a risk-adjusted market discount rate. 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.
Mortgage-backed debt, net of deferred debt issuance costs, of securitization trusts The
fair value of mortgage-backed debt of securitization trusts 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 mortgage
loans and residential retail instalment agreements, summarized in the table below (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Residential loans,
principal balance |
$ | 401,311 | $ | 365,797 | ||||
Less: Yield adjustment, net (1) |
(40,711 | ) | (28,701 | ) | ||||
Less: Allowance for loan losses |
(5,388 | ) | (3,460 | ) | ||||
Residential loans, net (2) |
$ | 355,212 | $ | 333,636 | ||||
(1) | Yield adjustment, net consists of deferred origination costs, premiums and discounts and other costs which are generally amortized over the life of the residential loan portfolio. Deferred origination costs at September 30, 2010 and December 31, 2009 were $2.6 million and $2.8 million, respectively. Premiums and discounts, net at September 30, 2010 and December 31, 2009 were $46.6 million and $35.9 million, respectively. Other costs, including accrued interest receivable, net of deferred gains and other costs, at September 30, 2010 and December 31, 2009 were $3.3 million and $4.4 million, respectively. | |
(2) | The weighted average life of the portfolio approximates 11 years based on assumptions for prepayment speeds, default rates and losses. |
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The following table summarizes the activity in the allowance for loan losses on residential
loans, net (in thousands):
Nine Months Ended | ||||||||
September 30, | ||||||||
2010 | 2009 | |||||||
Balance, December 31 |
$ | 3,460 | $ | 3,418 | ||||
Provision charged to income |
1,291 | 1,174 | ||||||
Less: Transfers to REO |
(1,367 | ) | (1,211 | ) | ||||
Less: Charge-offs, net of
recoveries |
| (8 | ) | |||||
Balance, March 31 |
3,384 | 3,373 | ||||||
Provision charged to income |
1,330 | 968 | ||||||
Less: Transfers to REO |
(1,390 | ) | (874 | ) | ||||
Less: Charge-offs, net of
recoveries |
(4 | ) | (29 | ) | ||||
Balance, June 30 |
3,320 | 3,438 | ||||||
Provision charged to income |
3,036 | 1,520 | ||||||
Less: Transfers to REO |
(882 | ) | (1,370 | ) | ||||
Less: Charge-offs, net of
recoveries |
(86 | ) | (81 | ) | ||||
Balance, September 30 |
$ | 5,388 | $ | 3,507 | ||||
The amount of residential loans, net that had been put on nonaccrual status due to
delinquent payments of 90 days past due or greater was $18.0 million and $21.4 million at September
30, 2010 and December 31, 2009, respectively. 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.
The following table presents delinquencies as a percent of amounts outstanding on the
principal balance of residential loans, net:
September 30, 2010 | December 31, 2009 | |||||||
31-60 days |
1.98 | % | 1.98 | % | ||||
61-90 days |
1.18 | % | 1.53 | % | ||||
91 days or more |
4.61 | % | 5.84 | % | ||||
7.77 | % | 9.35 | % | |||||
Residential Loan Pool Acquisitions
The Company acquired residential loans to be held for investment in the amount of $21.0
million and $40.7 million during the three and nine months ended September 30, 2010. These
acquisitions were financed with proceeds from its secondary offering that closed on October 21,
2009, or 2009 Offering, and added $30.4 million and $54.6 million of unpaid principal to the
residential loan portfolio for each period, respectively. The residential loans acquired included
performing and non-performing, fixed and adjustable rate loans, on single-family, owner occupied
and investor residences located within the Companys existing southeastern United States geographic
footprint. The Company evaluated the individual loans acquired for evidence of credit quality
deterioration since origination and for which it is probable at the purchase date that the Company
will be unable to collect all contractually required payments. There was no significant evidence of
credit quality deterioration noted.
7. Residential Loans of Securitization Trusts
Residential loans of securitization trusts consist of residential mortgage loans and
residential retail instalment agreements 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 concerning 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 of securitization trusts and are non-recourse to the Company. The
Company records interest income on residential loans of 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.
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Table of Contents
Residential loans of securitization trusts, net are summarized as follows (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Residential loans of securitization trusts,
principal balance |
$ | 1,385,365 | $ | 1,454,062 | ||||
Less: Yield adjustment, net (1) |
(118,068 | ) | (129,151 | ) | ||||
Less: Allowance for loan losses |
(10,893 | ) | (14,201 | ) | ||||
Residential loans of securitization trusts, net (2) |
$ | 1,256,404 | $ | 1,310,710 | ||||
(1) | Yield adjustment, net consists of deferred origination costs, premiums and discounts and other costs which are generally amortized over the life of the residential loan portfolio. Deferred origination costs at September 30, 2010 and December 31, 2009 were $8.2 million and $8.8 million, respectively. Premiums and discounts, net at September 30, 2010 and December 31, 2009 were $134.8 million and $145.8 million, respectively. Other costs, including accrued interest receivable, net of deferred gains and other costs, at September 30, 2010 and December 31, 2009 were $8.5 million and $7.8 million, respectively. | |
(2) | The weighted average life of the portfolio approximates 9 years based on assumptions for prepayment speeds, default rates and losses. |
The following table summarizes the activity in the allowance for loan losses on residential
loans of securitization trusts, net (in thousands):
Nine Months Ended | ||||||||
September 30, | ||||||||
2010 | 2009 | |||||||
Balance, December 31 |
$ | 14,201 | $ | 15,551 | ||||
Provision charged to income |
2,651 | 2,938 | ||||||
Less: Transfers to REO |
(2,609 | ) | (3,127 | ) | ||||
Less: Charge-offs, net of
recoveries |
(303 | ) | (253 | ) | ||||
Balance, March 31 |
13,940 | 15,109 | ||||||
Provision charged to income |
2,718 | 2,882 | ||||||
Less: Transfers to REO |
(3,205 | ) | (3,016 | ) | ||||
Less: Charge-offs, net of
recoveries |
(40 | ) | (106 | ) | ||||
Balance, June 30 |
13,413 | 14,869 | ||||||
Provision charged to income |
198 | 1,181 | ||||||
Less: Transfers to REO |
(2,436 | ) | (1,327 | ) | ||||
Less: Charge-offs, net of
recoveries |
(282 | ) | (441 | ) | ||||
Balance, September 30 |
$ | 10,893 | $ | 14,282 | ||||
The amount of residential loans of securitization trusts, net that had been put on
nonaccrual status due to delinquent payments of 90 days past due or greater was $27.5 million and
$39.8 million at September 30, 2010 and December 31, 2009, respectively. 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.
All of the Companys residential loans of securitization trusts, net are pledged as collateral
for the mortgage-backed debt (see Note 9). The Companys only continued involvement with the
residential loans of securitization trusts, net is retaining all of the residual interests in the
securitization trusts and servicing the residential loans collateralizing the mortgage-backed debt.
The Company is not contractually required to provide any financial support to the securitization
trusts. The Company may, from time to time at its sole discretion, purchase certain assets from
the securitization trusts to cure delinquency or loss triggers for the sole purpose of releasing
excess overcollateralization to the Company. The Company does not expect to provide financial
support to the securitization trusts based on current performance trends.
The following table presents delinquencies as a percent of amounts outstanding on the
principal balance of residential loans of securitization trusts:
September 30, 2010 | December 31, 2009 | |||||||
31-60 days |
1.07 | % | 1.17 | % | ||||
61-90 days |
0.59 | % | 0.54 | % | ||||
91 days or more |
1.99 | % | 2.74 | % | ||||
3.65 | % | 4.45 | % | |||||
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8. Subordinate Security
The Companys subordinate security totaled $1.8 million at September 30, 2010 and December 31,
2009. The subordinate security was acquired as part of the Merger with Hanover. The subordinate
security is summarized as follows (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Principal balance |
$ | 3,812 | $ | 3,812 | ||||
Purchase price and other
adjustments |
(2,200 | ) | (2,200 | ) | ||||
Amortized cost |
$ | 1,612 | $ | 1,612 | ||||
Unrealized gain |
208 | 189 | ||||||
Carrying value (fair value) |
$ | 1,820 | $ | 1,801 | ||||
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.
9. Mortgage-Backed Debt and Related Collateral of Securitization Trusts
Mortgage-Backed Debt
Mortgage-backed debt consists of mortgage-backed and asset-backed notes and collateralized
mortgage obligations issued by the Company to fund its residential loans via the securitization
market. The securitization trusts beneficially owned by Walter Investment or its wholly owned
subsidiary, Mid-State Capital, LLC, or Mid-State Capital, are the depositors under the Companys
outstanding mortgage-backed and asset-backed notes, or the Trust Notes, which consist of eight
separate series of public debt offerings, and one private offering. Hanover Capital Grantor Trust,
acquired from Hanover as part of the Merger, is a public debt offering. These borrowings provide
financing for residential loans purchased by the Company.
These ten trusts have an aggregate of $1.2 billion of outstanding debt, collateralized by $1.5
billion of assets, including residential loans, REO and restricted cash at September 30, 2010. All
of the Companys mortgage-backed debt is non-recourse and not cross-collateralized and, therefore,
must be satisfied exclusively from the proceeds of the residential loans and REO held in each
securitization trust. The Company services the collateral underlying the nine securitization trusts
owned by Walter Investment and Mid-State Capital.
During the three months ended September 30, 2010, the Company invested approximately $19.9
million to purchase a portion of the Companys outstanding mortgage-backed debt through brokerage
transactions. The purchases, which were accounted for as a retirement of debt, resulted in a gain
on mortgage-backed debt extinguishment of approximately $1.7 million.
The securitization trusts contain provisions that require the cash payments received from the
underlying residential loans be applied to reduce the principal balance of the Trust Notes unless
certain overcollateralization or other similar targets are satisfied. The securitization trusts
also contain delinquency and loss triggers, that, if exceeded, require that any excess
overcollateralization be paid to reduce the outstanding principal balance of the Trust Notes for
that particular securitization at an accelerated pace. Assuming no servicer trigger events have
occurred and the overcollateralization targets have been met, any excess cash is released to the
Company either monthly or quarterly, in accordance with the terms of the respective underlying
trust agreements. As of September 30, 2010, Mid-State Trust 2006-1, or Trust 2006-1, exceeded
certain triggers and did not provide any significant levels of excess cash flow to the Company. The
delinquency trigger for Mid-State Trust 2005-1, or Trust 2005-1, was cured during the three months
ended June 30, 2010. The loss trigger for Trust X was cured during the three months ended March 31,
2010. With the exception of Trust 2006-1 which exceeded its delinquency trigger and the recently
cured Trust 2005-1 and Trust X, none of the Companys other securitization trusts have reached the
levels of underperformance that would trigger a delay in cash releases.
Borrower remittances received on the residential loan collateral are used to make payments on
the mortgage-backed debt. The maturity of the mortgage-backed debt is directly affected by
principal prepayments on the related residential loan collateral. As a result, the actual maturity
of the mortgage-backed debt is likely to occur earlier than the stated maturity. Certain of the
Companys mortgage-backed debt is also subject to redemption at the option of the Company according
to specific terms of the respective indenture agreements.
16
Table of Contents
Collateral for Mortgage-Backed Debt
The following table summarizes the carrying value of the collateral for the mortgage-backed
debt as of September 30, 2010 and December 31, 2009, respectively (in thousands):
September 30, 2010 | December 31, 2009 | |||||||
Residential loans of securitization trusts, principal balance |
$ | 1,385,365 | $ | 1,454,062 | ||||
Restricted cash of securitization trusts |
38,192 | 42,691 | ||||||
Real estate owned of securitization trusts |
35,949 | 41,143 | ||||||
Total mortgage-backed debt collateral of securitization
trusts |
$ | 1,459,506 | $ | 1,537,896 | ||||
10. Share-Based Compensation Plans
The Companys share-based compensation expense has been reflected in the consolidated
statements of income in salaries and benefits expense.
Option Activity
On January 4, 2010, certain executive officers of the Company were awarded a total of 118,651
nonqualified options, or the Executive Options, to acquire common stock of the Company pursuant to
the 2009 Long Term Incentive Plan, or LTIP. The Executive Options granted to each executive officer
of the Company will vest and become exercisable in equal installments on the first, second and
third anniversary of the date of grant. The exercise price of $14.39 for each of the Executive
Options was determined based on the mean of the high and low sales prices for a share of common
stock of the Company as reported by the NYSE Amex on the date of grant.
On January 22, 2010, an executive, in connection with his employment with the Company, was
awarded a total of 90,000 nonqualified options to acquire common stock of the Company pursuant to
the 2009 LTIP. The options granted will vest and become exercisable on the fourth anniversary of
the award. The exercise price of $14.29 for each option was determined based on the mean of the
high and low sales prices for a share of common stock of the Company as reported by the NYSE Amex
on the date of grant.
On March 3, 2010, the Company granted stock options to its new non-employee director who was
awarded a total of 5,195 nonqualified options to acquire common stock of the Company pursuant to
the 2009 LTIP. The options granted will vest and become exercisable in equal installments on the
first, second and third anniversary of the date of grant. The exercise price of $14.79 for each
option was determined based on the mean of the high and low sales prices for a share of common
stock of the Company as reported by the NYSE Amex on the date of grant.
On April 30, 2010, members of the Board of Directors of the Company were awarded a total of
20,672 nonqualified options to acquire common stock of the Company pursuant to the 2009 LTIP. The
options granted to the members of the Board of Directors will vest and become exercisable in equal
installments on the first, second and third anniversary of the date of grant. The exercise price of
$18.36 for each of the options was determined based on the mean of the high and low sales prices
for a share of common stock of the Company as reported by the NYSE Amex on the date of grant.
The grant date fair value of the stock options granted during the nine months ended September
30, 2010 approximated $0.7 million.
Non-Vested Share Activity
The Companys non-vested share-based awards consist of restricted stock and restricted stock
units.
On January 4, 2010, certain executive officers of the Company were awarded a total of 100,548
restricted stock units, or the Executive RSUs, of the Company pursuant to the 2009 LTIP. The
Executive RSUs granted to each executive officer of the Company will vest in equal installments on
the first, second and third anniversary of the date of grant. The settlement date for these RSUs is
January 22, 2013. Each executive receiving Executive RSUs will be entitled to receive cash payments
equivalent to any dividend paid to the holders of common stock of the Company, but they will not be
entitled to any voting rights otherwise associated with the common stock.
On January 22, 2010, an executive, in connection with his employment with the Company, was
awarded a total of 135,556 restricted stock units, or RSUs, of the Company under the 2009 LTIP. Of
the RSUs granted, 110,000 will vest in equal installments on the first, second and third
anniversary of the date of grant. The settlement date for these RSUs is January 22, 2013, and each
such RSU vested on such date will be paid out with a single share of common stock of the Company.
The remaining 25,556 RSUs granted will vest on the first anniversary of the date of grant. The
settlement date for these RSUs is March 14, 2011, and each such RSU vested on such date will be
paid out with a single share of common stock of the Company. The executive receiving the RSUs will
be entitled to receive cash payments equivalent to any dividend paid to the holders of common stock
of the Company, but they will not be entitled to any voting rights otherwise associated with the
common stock.
The grant date fair value of RSUs granted during the nine months ended September 30, 2010
approximated $3.4 million.
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11. Credit Agreements
The Companys syndicated credit agreement, revolving credit agreement and security agreement,
and support letter of credit agreement mature on April 20, 2011. As of September 30, 2010, no funds
have been drawn under any of the credit agreements and the Company is in compliance with all
covenants.
12. Transactions with 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. See Note 3 for further information regarding the spin-off transaction.
13. Comprehensive Income and Accumulated Other Comprehensive Income
The components of comprehensive income are as follows (in thousands):
Three Months Ended | ||||||||
September 30, | ||||||||
2010 | 2009 | |||||||
Net income |
$ | 9,686 | $ | 8,243 | ||||
Other comprehensive income (loss): |
||||||||
Change in postretirement benefit plans, net of $6 and $556 tax effect, respectively |
(125 | ) | 206 | |||||
Net unrealized (loss) gain on subordinate security, net of $0 and $0 tax effect, respectively |
(3 | ) | 157 | |||||
Net amortization of realized gain on closed hedges, net of $0 and $289 tax effect,
respectively |
(81 | ) | 217 | |||||
Comprehensive income |
$ | 9,477 | $ | 8,823 | ||||
Nine Months Ended | ||||||||
September 30, | ||||||||
2010 | 2009 | |||||||
Net income |
$ | 26,361 | $ | 105,256 | ||||
Other comprehensive income (loss): |
||||||||
Change in postretirement benefit plans, net of $20 and $556 tax effect, respectively |
(377 | ) | 206 | |||||
Net unrealized gain on subordinate security, net of $0 and $0 tax effect, respectively |
19 | 157 | ||||||
Net amortization of realized gain on closed hedges, net of $0 and $347 tax effect,
respectively |
(205 | ) | 117 | |||||
Comprehensive income |
$ | 25,798 | $ | 105,736 | ||||
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The components of accumulated other comprehensive income are as follows (in thousands):
Excess of | ||||||||||||||||
Additional | Net Unrealized | |||||||||||||||
Postretirement | (Loss) | Net Amortization of | ||||||||||||||
Employee Benefits | Gain on Subordinate | Realized Gain on | ||||||||||||||
Liability | Security | Closed Hedges | Total | |||||||||||||
Balance at December 31,
2009 |
$ | 1,117 | $ | 189 | $ | 637 | $ | 1,943 | ||||||||
Pre-tax amount |
(133 | ) | 36 | (64 | ) | (161 | ) | |||||||||
Tax benefit |
7 | | | 7 | ||||||||||||
Balance at March 31, 2010 |
991 | 225 | 573 | 1,789 | ||||||||||||
Pre-tax amount |
(133 | ) | (14 | ) | (60 | ) | (207 | ) | ||||||||
Tax benefit |
7 | | | 7 | ||||||||||||
Balance at June 30, 2010 |
865 | 211 | 513 | 1,589 | ||||||||||||
Pre-tax amount |
(131 | ) | (3 | ) | (81 | ) | (215 | ) | ||||||||
Tax benefit |
6 | | | 6 | ||||||||||||
Balance at September 30,
2010 |
$ | 740 | $ | 208 | $ | 432 | $ | 1,380 | ||||||||
14. Common Stock and Earnings Per Share
In accordance with the accounting guidance concerning earnings per share, or EPS, unvested
share-based payment awards that include non-forfeitable rights to dividends or dividend
equivalents, whether paid or unpaid, are considered participating securities. As a result, the
awards are required to be included in the calculation of basic earnings per common share pursuant
to the two-class method. For the Company, participating securities are comprised of certain
unvested restricted stock and restricted stock units.
Under the two-class method, net income is reduced by the amount of dividends declared in the
period for common stock and participating securities. The remaining undistributed earnings are then
allocated to common stock and participating securities as if all of the net income for the period
had been distributed. Basic earnings per share excludes dilution and is calculated by dividing net
income allocable to common shares by the weighted average number of common shares outstanding for
the period. Diluted earnings per share is calculated by dividing net income allocable to common
shares by the weighted average number of common shares for the period, as adjusted for the
potential dilutive effect of non-participating share-based awards.
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The following is a reconciliation of the numerators and denominators of the basic and diluted
EPS computations shown on the face of the accompanying consolidated statements of income (in
thousands, except per share data):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Basic earnings per share: |
||||||||||||||||
Net income |
$ | 9,686 | $ | 8,243 | $ | 26,361 | $ | 105,256 | ||||||||
Less: net income allocated to unvested restricted stock units |
(127 | ) | (66 | ) | (363 | ) | (427 | ) | ||||||||
Net income available to common stockholders (numerator) |
$ | 9,559 | $ | 8,177 | $ | 25,998 | $ | 104,829 | ||||||||
Weighted average common shares |
25,734 | 19,890 | 25,699 | 19,881 | ||||||||||||
Add: vested restricted stock units |
740 | 696 | 712 | 418 | ||||||||||||
Total weighted average common shares outstanding (denominator) |
26,474 | 20,586 | 26,411 | 20,299 | ||||||||||||
Basic earnings per share |
$ | 0.36 | $ | 0.40 | $ | 0.98 | $ | 5.16 | ||||||||
Diluted earnings per share: |
||||||||||||||||
Net income |
$ | 9,686 | $ | 8,243 | $ | 26,361 | $ | 105,256 | ||||||||
Less: net income allocated to unvested restricted stock units |
(127 | ) | (66 | ) | (362 | ) | (426 | ) | ||||||||
Net income available to common stockholders (numerator) |
$ | 9,559 | $ | 8,177 | $ | 25,999 | $ | 104,830 | ||||||||
Weighted average common shares |
25,734 | 19,890 | 25,699 | 19,881 | ||||||||||||
Add: Potentially dilutive stock options and restricted stock units |
836 | 798 | 794 | 476 | ||||||||||||
Diluted weighted average common shares outstanding
(denominator) |
26,570 | 20,688 | 26,493 | 20,357 | ||||||||||||
Diluted earnings per share |
$ | 0.36 | $ | 0.40 | $ | 0.98 | $ | 5.15 | ||||||||
The calculation of diluted earnings per share for the three and nine months ended
September 30, 2010, does not include 0.1 million and 0.2 million shares, respectively, and does not
include 0.3 million and 0.3 million shares for the same periods in 2009, respectively, because
their effect would have been anti-dilutive.
15. Income Taxes
During the three months ended September 30, 2010 and 2009, an estimated tax rate of 3.1% and
14.0%, respectively, was used to derive income tax expense of $0.3 million and $1.3 million,
respectively, calculated on our income from operations, before taxes, of $10.0 million and $9.6
million, respectively.
During the nine months ended September 30, 2010 and 2009, an estimated tax rate of 3.0% and
(256.4)%, respectively, was used to derive income tax expense (benefit) of $0.8 million and $(75.7)
million, respectively, calculated on our income from operations, before taxes, of $27.2 million and
$29.5 million, respectively. The income tax rate for the nine months ended was due to the impact of
the Company becoming qualified as a REIT in conjunction with the spin-off from Walter Energy and
Merger with Hanover which resulted in only the Companys TRSs being taxable entities.
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, 2010 and December 31, 2009, the total liability for unrecognized tax benefits was
$7.7 million.
REIT Qualification
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as
amended. The Companys continuing qualification as a REIT depends on its ability to meet the
various requirements imposed by the Code, which relate to organizational structure, distribution
levels, diversity of stock ownership and certain restrictions with regard to owned assets and
categories of income. As a REIT, the Company will generally not be subject to United States, or
U.S., federal corporate income tax on its taxable income that is currently distributed to
stockholders. Even as a REIT, the Company may be subject to U.S. federal income and excise taxes in
various situations, such as on the Companys undistributed income.
Certain of the Companys operations or portions thereof, including mortgage advisory and
insurance ancillary businesses, are conducted
through taxable REIT subsidiaries, or TRSs. A TRS is a C-corporation that has not elected REIT
status and, as such, is subject to U.S. federal corporate income tax. The Companys TRSs facilitate
its ability to offer certain services and conduct activities that generally cannot be offered
directly by the REIT. The Company also will be required to pay a 100% tax on any net income on
non-arms length transactions between the REIT and any of its TRSs.
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16. 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, 2010,
the unpaid principal balance of the 14 remaining mortgage securities was approximately $1.5
million.
Income Tax Exposure
A dispute exists with regard to federal income taxes owed by the Walter Energy consolidated
group. The Company was part of the Walter Energy consolidated group prior to the spin-off and
Merger. As such, the Company is jointly and severally liable with Walter Energy for any final
taxes, interest and/or penalties owed by the Walter Energy consolidated group during the time that
the Company was a part of the Walter Energy consolidated group. According to Walter Energys most
recent public filing on Form 10-Q, they state that the IRS has filed a proof of claim for a
substantial amount of taxes, interest and penalties with respect to fiscal years ended August 31,
1983 through May 31, 1994. The public filing goes on to disclose that the issues have been
litigated in bankruptcy court and that an opinion was issued by the court in June 2010 as to the
remaining disputed issues. The filing further states that the amounts initially asserted by the
IRS do not reflect the subsequent resolution of various issues through settlements or concessions
by the parties. Walter Energy believes that those portions of the claim which remain in dispute or
are subject to appeal substantially overstate the amount of taxes allegedly owing. However,
because of the complexity of the issues presented and the uncertainties associated with litigation,
Walter Energy is unable to predict the outcome of the adversary proceeding. Finally, Walter Energy
believes that all of its current and prior tax filing positions have substantial merit and intends
to defend vigorously any tax claims asserted and that they believe that they have sufficient
accruals to address any claims, including interest and penalties. Under the terms of the Tax
Separation Agreement between the Company and Walter Energy dated April 17, 2009, Walter Energy is
responsible for the payment of all federal income taxes (including any interest or penalties
applicable thereto) of the consolidated group, which includes the aforementioned claims of the IRS.
However, to the extent that Walter Energy is unable to pay any amounts owed, the Company could be
responsible for any unpaid amounts.
The Tax Separation Agreement also provides that Walter Energy is responsible for the
preparation and filing of any tax returns for the consolidated group for the periods when the
Company was part of the Walter Energy consolidated group. This arrangement may result in conflicts
between Walter Energy and the Company. In addition, the spin-off of WIM from Walter Energy was
intended to qualify as a tax-free spin-off under Section 355 of the Code. The Tax Separation
Agreement provides generally that if the spin-off is determined not to be tax-free pursuant to
Section 355 of the Code, any taxes imposed on Walter Energy or a Walter Energy shareholder as a
result of such determination (Distribution Taxes) which are the result of the acts or omissions
of Walter Energy or its affiliates, will be the responsibility of Walter Energy. However, should
Distribution Taxes result from the acts or omissions of the Company or its affiliates, such
Distribution Taxes will be the responsibility of the Company. The Tax Separation Agreement goes on
to provide that Walter Energy and the Company shall be jointly liable, pursuant to a designated
allocation formula, for any Distribution Taxes that are not specifically allocated to Walter Energy
or the Company. To the extent that Walter Energy is unable or unwilling to pay any Distribution
Taxes for which it is responsible under the Tax Separation Agreement, the Company could be liable
for those taxes as a result of being a member of the Walter Energy consolidated group for the year
in which the spin-off occurred. The Tax Separation Agreement also provides for payments from Walter
Energy in the event that an additional taxable dividend is required to cure a REIT disqualification
from the determination of a shortfall in the distribution of non-REIT earnings and profits made
immediately following the spin-off. As with Distribution Taxes, the Company will be responsible for
this dividend if Walter Energy is unable or unwilling to pay.
Other Tax Exposure
On June 28, 2010, the Alabama Department of Revenue, or ADOR, preliminarily assessed financial
institution excise tax of approximately $4.2 million, which includes interest and penalties, on a
predecessor entity for the years 2004 through 2008. This tax is imposed on financial institutions
doing business in the State of Alabama. The Company has contested the assessment and believes that
the Company did not meet the definition of a financial institution doing business in the State of
Alabama as defined by the Alabama Tax Code. As of September 30, 2010, ADOR has yet to respond to
the Companys appeal of the preliminary assessment.
Miscellaneous Litigation
The Company is a party to a number of lawsuits arising in the ordinary course of its business.
While the results of such litigation cannot be predicted with certainty, the Company believes that
the final outcome of such litigation will not have a materially adverse effect on the Companys
financial condition, results of operations or cash flows.
17. Subsequent Events
Acquisition of Marix Servicing, LLC
On August 25, 2010,
the Company entered into a securities purchase agreement with Marathon Asset
Management, L.P., or Marathon, and an individual seller to purchase 100% of the outstanding
ownership interests of Marix Servicing, LLC, or Marix. The acquisition closed on November 2, 2010.
Marix is a high-touch specialty mortgage servicer, based in Phoenix, Arizona, focused on default
management, borrower outreach, loss mitigation, liquidation strategies, component servicing and
specialty servicing.
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The acquisition of Marix will be accounted for pursuant to the guidance concerning business
combinations. The Marix assets acquired and liabilities assumed will be recorded at the date of
acquisition (November 2, 2010) at their respective fair values. The results of operations of Marix
will be included in the consolidated statements of income for periods subsequent to the
acquisition.
The purchase price for the acquisition consisted of a $50,000 cash payment at closing, and is
subject to customary post-closing adjustments based upon changes in the working capital of Marix
through the closing date. The terms of the agreement also allow for an earn-out if certain revenue
targets are met, as well as the repayment of certain servicing advances to Marathon.
Mortgage-Backed Debt Extinguishment
On November 1, 2010, the Company invested approximately $14.4 million to purchase a portion of
the Companys outstanding mortgage-backed debt through a brokerage transaction. The purchase,
which was accounted for as a retirement of debt, resulted in a gain on mortgage-backed debt
extinguishment of approximately $2.3 million.
Letters of Intent to Purchase Pools of Loans
During
October 2010, the Company entered into two separate letters of intent to purchase additional pools of performing and non-performing residential
loans which, when settled, are expected to utilize up to $10.6 million of the proceeds from the
Companys 2009 Offering. These letters of intent are not binding on the seller or the Company and
the proposed purchases may or may not close.
Dividend Declaration
On November 2, 2010, the Company declared a dividend of $0.50 per share on its common stock to
stockholders of record on November 12, 2010 which will be paid on November 24, 2010.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere in this Form 10-Q and in our results for the year
ended December 31, 2009, filed in our Annual Report on Form 10-K on March 2, 2010. Historical
results and trends which might appear should not be taken as indicative of future operations. Our
results of operations and financial condition, as reflected in the accompanying statements and
related footnotes, are subject to managements evaluation and interpretation of business
conditions, changing capital market conditions, and other factors.
Our website can be found at www.walterinvestment.com. We make available, free of charge
through the investor relations section of our website, access to our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, current reports on Form 8-K, other documents and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as amended, as well as proxy statements, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC. We also make available, free of
charge, access to our Corporate Governance Standards, charters for our Audit Committee,
Compensation and Human Resources Committee, and Nominating and Corporate Governance Committee, and
our Code of Conduct governing our directors, officers, and employees. Within the time period
required by the SEC and the New York Stock Exchange, we will post on our website any amendment to
the Code of Conduct and any waiver applicable to any executive officer, director, or senior officer
(as defined in the Code of Conduct). In addition, our website includes information concerning
purchases and sales of our equity securities by our executive officers and directors, as well as
disclosure relating to certain non-GAAP and financial measures (as defined by SEC Regulation G)
that we may make public orally, telephonically, by webcast, by broadcast, or by similar means from
time to time. The information on our website is not part of this Quarterly Report on Form 10-Q.
Our Investor Relations Department can be contacted at 3000 Bayport Drive, Suite 1100, Tampa,
FL 33607, Attn: Investor Relations, telephone (813) 421-7694.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Certain statements in this report, including, without limitation, matters discussed under Item
2, Managements Discussion and Analysis of Financial Condition and Results of Operations, should
be read in conjunction with the financial statements, related notes, and other detailed information
included elsewhere in this Quarterly Report on Form 10-Q. We are including this cautionary
statement to make applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Statements that are not historical fact are
forward-looking statements. Certain of these forward-looking statements can be identified by the
use of words such as believes, anticipates, expects, intends, plans, projects,
estimates, assumes, may, should, will, or other similar expressions. Such forward-looking
statements involve known and unknown risks, uncertainties and other important factors, which could
cause actual results, performance or achievements to differ materially from future results,
performance or achievements. These forward-looking statements are based on our current beliefs,
intentions and expectations. These statements are not guarantees or indicative of future
performance. Important assumptions and other important factors that could cause actual results to
differ materially from those forward-looking statements include, but are not limited to, those
factors, risks and uncertainties described in our Annual Report on Form 10-K filed on March 2, 2010
under the caption Risk Factors and in our other securities filings with the SEC.
In particular (but not by way of limitation), the following important factors and assumptions
could affect our future results and could cause actual results to differ materially from those
expressed in the forward-looking statements: local, regional, national and global economic trends
and developments in general, and local, regional and national real estate and residential mortgage
market trends and developments in particular; the availability of suitable qualifying investments
for the proceeds of our October 2009 secondary offering and risks associated with any such
investments we may pursue; the availability of additional investment capital and suitable
qualifying investments, and risks associated with the expansion of our business activities,
including risks associated with expanding our business outside of our current geographic footprint
and/or expanding the scope of our business to include activities not currently undertaken by our
business; limitations imposed on our business due to our real estate investment trust, or REIT,
status and our continued qualification as a REIT for federal income tax purposes; financing sources
and availability, and future interest expense; fluctuations in interest rates and levels of
mortgage prepayments; increases in costs and other general competitive factors; natural disasters
and adverse weather conditions, especially to the extent they result in material payouts under
insurance policies placed with our captive insurance subsidiary; changes in federal, state and
local policies, laws and regulations affecting our business, including, without limitation,
mortgage financing or servicing, changes to licensing requirements, and/or the rights and
obligations of property owners, mortgagees and tenants; the effectiveness of risk management
strategies; unexpected losses resulting from pending, threatened or unforeseen litigation or other
third party claims against us; the ability or willingness of Walter Energy, Inc. and other
counterparties to satisfy material obligations under agreements with us; our continued listing on
the NYSE Amex; uninsured losses or losses in excess of insurance limits and the availability of
adequate insurance coverage at reasonable costs; the integration of the former Hanover Capital
Mortgage Holdings, Inc., or Hanover, business into that of Walter Investment Management, LLC and
its affiliates as a result of the merger of the two companies, and the realization of anticipated
synergies, cost savings and growth opportunities from the Merger; future performance generally; and
other presently unidentified factors.
In addition, on November 2, 2010, the Company closed on a securities purchase agreement to
acquire 100% of the ownership interests of Marix Servicing, LLC, or Marix, a mortgage servicing
business. Risks include, without limitation, losses incurred in the Marix business, our inability
to reduce or eliminate such losses as quickly as anticipated, our ability to retain existing
licenses in jurisdictions in which Marix does business, our inability to integrate the Marix
business and/or to achieve anticipated synergies, and our inability to grow the Marix business as
quickly as anticipated.
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All forward looking statements set forth herein are qualified by these cautionary statements
and are made only as of the date hereof. We undertake no obligation to update or revise the
information contained herein, including without limitation any forward-looking statements whether
as a result of new information, subsequent events or circumstances, or otherwise, unless otherwise
required by law.
The Company
We are a mortgage servicer and mortgage portfolio owner specializing in credit-challenged,
non-conforming residential loans primarily in the southeastern United States, or U.S. We also
operate ancillary mortgage advisory and insurance businesses. At September 30, 2010, we had four
wholly owned, primary subsidiaries: Hanover Capital Partners 2, Ltd., doing business as Hanover
Capital, Walter Mortgage Company, LLC, or WMC, Best Insurors, Inc., or Best, and Walter Investment
Reinsurance Co., Ltd., or WIRC. We operate as an internally managed, publicly traded real estate
investment trust, or REIT.
Throughout this Quarterly Report on Form 10-Q, references to residential loans refer to
residential mortgage loans and residential retail instalment agreements and references to
borrowers refer to borrowers under our residential mortgage loans and instalment obligors under
our residential retail instalment agreements.
Recent Developments
Residential Loan Pool Acquisitions
We acquired residential loans to be held for investment in the amount of $21.0 million and
$40.7 million during the three and nine months ended September 30, 2010. These acquisitions were
financed with the proceeds from our secondary offering that closed on October 21, 2009, or 2009
Offering, and added $30.4 million and $54.6 million of unpaid principal to the residential loan
portfolio for the periods, respectively. The residential loans acquired included performing and
non-performing, fixed and adjustable rate loans, on single-family, owner occupied and investor
residences located within the Companys existing southeastern United States geographic footprint.
Acquisition of Marix Servicing, LLC
On August 25, 2010,
we announced that the Company had entered into a securities purchase agreement with
Marathon Asset Management, L.P., or Marathon, and an individual seller to purchase Marix Servicing
LLC, or Marix, a high-touch specialty mortgage servicer. The acquisition closed on November 2,
2010. Marix, based in Phoenix, Arizona, is focused on default management, borrower outreach, loss
mitigation, liquidation strategies, component servicing and specialty servicing. Marix is a
Standard &Poors Select Servicer and brings relationships with each of the government sponsored
entities, as well as a management team which averages over 22 years of industry experience. The
acquisition of Marix will enable the Company to expand the geographic footprint it is able to
consider for acquisitions of pools of loans and servicing capabilities. It will also assist the
Company with the extension of field servicing into key nationwide markets by providing existing
infrastructure and revenue for leverage, while offering the Company a well developed information
technology platform.
Mortgage-Backed Debt Extinguishment
During the three months ended September 30, 2010, we invested approximately $19.9 million to
purchase a portion of our outstanding mortgage-backed debt through brokerage transactions.
Management currently intends the purchases to be temporary investments of excess cash. The
purchases, which were accounted for as a retirement of debt, resulted in a gain on mortgage-backed
debt extinguishment of approximately $1.7 million. In a similar transaction on November 1, 2010,
we invested approximately $14.4 million as an additional purchase of our outstanding
mortgage-backed debt. This purchase, which was also accounted for as a retirement of debt,
resulted in a gain on mortgage-backed debt extinguishment of approximately $2.3 million.
Regulatory Trends
Focus on Foreclosure Practices
As a result of some highly publicized deficiencies in the mortgage foreclosure processes of several
large banks and loan servicers, a number of States Attorneys General have begun inquiries into
mortgage foreclosure processes in their states and several of our competitors announced the
suspension of foreclosure proceedings in certain states pending review of their procedures. We have
reviewed our processes and procedures and will continue to do so with both internal personnel and
third party consultants. To date, we have not received any inquiries from States Attorneys
General and we have not identified any non-compliance with existing mortgage processing laws and
regulations. We cannot be certain that lawyers and other service providers retained by the Company
to process mortgage foreclosures have complied in all respects with required processes in their
respective jurisdiction; however, we intend to monitor their activities going forward. It is not
known at this time whether any new laws or regulations affecting the mortgage foreclosure process
will be put into place by federal, state or local governmental authorities, nor is it currently
possible to determine what, if any effects they may have on our business; but should such laws or
regulations be enacted, they could adversely affect the Companys results of operations. For
example, changes in required processes or laws that increase the time required to foreclose may
reduce the Companys net income and could adversely affect liquidity.
Financial Reform
Certain provisions of the Dodd-Frank Act, and other proposed reforms related thereto, may impact
our ability to enter into future asset-backed securities transactions, however, the effect of any
such actions on the asset-backed securities market is currently uncertain. While we are continuing
to evaluate all aspects of the Dodd-Frank Act, such legislation and regulations promulgated
pursuant to such legislation could materially and adversely affect the manner in which we conduct
our businesses, result in heightened federal regulation and oversight of our business activities,
and result in increased costs and potential litigation associated with our business activities.
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 Walter Investment
Management LLC, or WIM. The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States, or GAAP, which requires management
to make estimates and assumptions that affect the amounts reported in the consolidated financial
statements. Actual results could differ from those estimates. All significant intercompany balances
have been eliminated in the consolidated financial statements.
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
September 30, 2009 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 period presented prior to the Merger.
Results of operations for the three and nine months ended September 30, 2010 and 2009 include
the results of operations of legacy WIM.
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The results of operations of legacy Hanover are included for the three and nine months ended
September 30, 2010 as well as for the period from April 17, 2009 through September 30, 2009. Since
the Merger constituted a reverse acquisition for accounting purposes, the pre-acquisition
consolidated financial statements of WIM 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 WIM for accounting purposes. The combined financial statements of
WMC, Best and WIRC have become WIMs historical financial statements for periods prior to the
Merger.
Business Separation and Merger
On September 30, 2008, Walter Energy outlined its plans to separate its Financing business
from its core Natural Resources business through a spin-off to stockholders and subsequent Merger
with Hanover. In furtherance of these plans, on September 30, 2008, Walter Energy and WIM entered
into a definitive agreement to merge with Hanover, which agreement was amended and restated on
February 17, 2009. 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 WIM in return for all of WIMs membership units. On April 17, 2009, immediately following the
spin-off from Walter Energy, WIM was merged with and into Hanover with Hanover continuing as the
surviving corporation in the Merger. Following the Merger, Hanover was renamed Walter Investment
Management Corp. After the spin-off and Merger, Walter Energys stockholders that became members of
WIM as a result of the spin-off, and certain holders of options to acquire limited liability
company interests of WIM, collectively owned 98.5% of the shares of common stock of the surviving
corporation in the Merger, while stockholders of Hanover owned 1.5% of the shares of common stock
of such corporation. As a result, the business combination has been accounted for as a reverse
acquisition, with WIM considered the accounting acquirer. On April 20, 2009, our common stock began
trading on the NYSE Amex under the symbol WAC.
Although Hanover was the legal and tax surviving entity in the Merger, for accounting purposes
the Merger was treated as a reverse acquisition of the operations of Hanover and has been accounted
for pursuant to the guidance concerning business combinations, with WIM as the accounting acquirer.
As such, the pre-acquisition financial statements of WIM are treated as 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.
On April 17, 2009, we completed our separation from Walter Energy. In connection with the
separation, WIM and Walter Energy executed the following transactions or agreements which involved
no cash:
| Walter Energy distributed 100% of its interest in WIM to holders of Walter Energys common stock; | |
| All intercompany balances between WIM 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 WIM for periods prior to the separation. WIM will be responsible for any and all taxes reported on any WIM separate tax return and on any consolidated returns for Walter Investment subsequent to the separation; | |
| Walter Energys share-based awards held by WIM 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 WIM from Walter Energy also included $26.6 million
in cash, which was contributed to WIM by Walter Energy on April 17, 2009. Following the spin-off,
WIM 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 continues to operate as a publicly traded REIT 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, 2009 included in our Annual Report on Form 10-K filed with the SEC on March 2,
2010. There have been no material changes to our critical accounting policies or the methodologies
or assumptions we apply under them.
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Results of Operations
Revenue by Portfolio Type
For the three and nine months ended September 30, 2010, we reported net income of $9.7 million
and $26.4 million, respectively, as compared to $8.2 million and $105.3 million for the same
periods, respectively, in the prior year. The main components of the change in net income for the
three and nine months ended September 30, 2010 and 2009 are detailed in the following table (in
thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | Increase/ | September 30, | Increase/ | |||||||||||||||||||||
2010 | 2009 | (Decrease) | 2010 | 2009 | (Decrease) | |||||||||||||||||||
Residential loans |
||||||||||||||||||||||||
Interest income |
$ | 8,469 | $ | 8,076 | $ | 393 | $ | 24,247 | $ | 25,576 | $ | (1,329 | ) | |||||||||||
Less: Interest expense |
| | | | | | ||||||||||||||||||
Net interest income |
8,469 | 8,076 | 393 | 24,247 | 25,576 | (1,329 | ) | |||||||||||||||||
Less: Provision for loan losses (1) |
3,036 | 1,520 | 1,516 | 5,657 | 3,662 | 1,995 | ||||||||||||||||||
Net interest income after
provision for loan losses |
5,433 | 6,556 | (1,123 | ) | 18,590 | 21,914 | (3,324 | ) | ||||||||||||||||
Residential loans of securitization trusts |
||||||||||||||||||||||||
Interest income |
32,838 | 34,943 | (2,105 | ) | 100,570 | 107,949 | (7,379 | ) | ||||||||||||||||
Interest expense |
20,316 | 22,229 | (1,913 | ) | 62,612 | 67,972 | (5,360 | ) | ||||||||||||||||
Net interest income |
12,522 | 12,714 | (192 | ) | 37,958 | 39,977 | (2,019 | ) | ||||||||||||||||
Less: Provision for loan losses (1) |
198 | 1,181 | (983 | ) | 5,567 | 7,001 | (1,434 | ) | ||||||||||||||||
Net interest income after
provision for loan losses |
12,324 | 11,533 | 791 | 32,391 | 32,976 | (585 | ) | |||||||||||||||||
Non-interest income |
||||||||||||||||||||||||
Premium revenue |
1,778 | 2,025 | (247 | ) | 6,636 | 8,086 | (1,450 | ) | ||||||||||||||||
Other income, net |
437 | 1,263 | (826 | ) | 2,213 | 2,066 | 147 | |||||||||||||||||
Total |
2,215 | 3,288 | (1,073 | ) | 8,849 | 10,152 | (1,303 | ) | ||||||||||||||||
Total revenues, net |
19,972 | 21,377 | (1,405 | ) | 59,830 | 65,042 | (5,212 | ) | ||||||||||||||||
Total non-interest expenses |
9,974 | 11,789 | (1,815 | ) | 32,641 | 35,511 | (2,870 | ) | ||||||||||||||||
Income before income taxes |
9,998 | 9,588 | 410 | 27,189 | 29,531 | (2,342 | ) | |||||||||||||||||
Income tax expense (benefit) |
312 | 1,345 | (1,033 | ) | 828 | (75,725 | ) | 76,553 | ||||||||||||||||
Net income |
$ | 9,686 | $ | 8,243 | $ | 1,443 | $ | 26,361 | $ | 105,256 | $ | (78,895 | ) | |||||||||||
(1) | Excludes the impact of the REO sale from the securitized residential loan portfolio to the unencumbered residential loan portfolio that occurred in the three months ended March 31, 2010. |
Net Interest Income
Our results of operations for our portfolio during a given period typically reflect the net
interest spread earned on our residential loan portfolio. The net interest spread is impacted by
factors such as the interest rate our residential loans are earning and our cost of funds.
Furthermore, the amount of discount on the residential loans will impact the net interest spread as
such amounts will be amortized over the expected term of the residential loans and the amortization
will be accelerated due to voluntary prepayments.
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The following table summarizes the average balance, interest and weighted average
yield on residential loan assets and mortgage-backed debt for the periods indicated.
For the Three Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average | (3) | Average | (3) | |||||||||||||||||||||
Balance | Interest | Yield | Balance | Interest | Yield | |||||||||||||||||||
Assets |
||||||||||||||||||||||||
Residential loans |
$ | 353,500 | $ | 8,469 | 9.58 | % | $ | 346,778 | $ | 8,076 | 9.32 | % | ||||||||||||
Residential loans of securitization trusts |
1,276,693 | 32,838 | 10.29 | % | 1,362,263 | 34,943 | 10.26 | % | ||||||||||||||||
Total interest-earning assets |
$ | 1,630,193 | $ | 41,307 | 10.14 | % | $ | 1,709,041 | $ | 43,019 | 10.07 | % | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Mortgage-backed debt |
$ | 1,204,022 | $ | 20,316 | 6.75 | % | $ | 1,305,969 | $ | 22,229 | 6.81 | % | ||||||||||||
Total interest-bearing liabilities |
$ | 1,204,022 | $ | 20,316 | 6.75 | % | $ | 1,305,969 | $ | 22,229 | 6.81 | % | ||||||||||||
Net interest spread (1)(3) |
$ | 20,991 | 3.39 | % | $ | 20,790 | 3.26 | % | ||||||||||||||||
Net interest margin (2)(3) |
5.15 | % | 4.87 | % |
For the Nine Months Ended September 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average | (3) | Average | (3) | |||||||||||||||||||||
Balance | Interest | Yield | Balance | Interest | Yield | |||||||||||||||||||
Assets |
||||||||||||||||||||||||
Residential loans |
$ | 348,848 | $ | 24,247 | 9.27 | % | $ | 355,157 | $ | 25,576 | 9.60 | % | ||||||||||||
Residential loans of securitization trusts |
1,296,104 | 100,570 | 10.35 | % | 1,387,442 | 107,949 | 10.37 | % | ||||||||||||||||
Total interest-earning assets |
$ | 1,644,952 | $ | 124,817 | 10.12 | % | $ | 1,742,599 | $ | 133,525 | 10.22 | % | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Mortgage-backed debt |
$ | 1,225,545 | $ | 62,612 | 6.81 | % | $ | 1,332,428 | $ | 67,972 | 6.80 | % | ||||||||||||
Total interest-bearing liabilities |
$ | 1,225,545 | $ | 62,612 | 6.81 | % | $ | 1,332,428 | $ | 67,972 | 6.80 | % | ||||||||||||
Net interest spread (1)(3) |
$ | 62,205 | 3.31 | % | $ | 65,553 | 3.42 | % | ||||||||||||||||
Net interest margin (2)(3) |
5.04 | % | 5.02 | % |
(1) | Net interest spread is calculated by subtracting the weighted average yield on interest-bearing liabilities from the weighted average yield on interest-earning assets. | |
(2) | Net interest margin is calculated by dividing the net interest spread by total average interest-earning assets. | |
(3) | Annualized. |
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Net Interest Spread
Net interest spread increased for the three months ended September 30, 2010 as compared to the
same period in 2009, due primarily to a decrease in interest expense, lower levels of
non-performing assets, and higher yields on the recently acquired residential loans, partially
offset by a decrease in voluntary prepayments. The decrease in interest expense is due to lower
average outstanding borrowings as a result of principal payments on the mortgage-backed debt, a
$19.9 million mortgage-backed debt extinguishment combined with no new mortgage-backed debt
issuances during the year. The average prepayment rate for the unencumbered portfolio was 3.5% for
the three months ended September 30, 2010, as compared to 4.1% in the same period of 2009. The
average prepayment rate for the securitized portfolio was 2.4% for the three months ended September
30, 2010, as compared to 3.2% in the same period of 2009.
Net interest spread decreased for the nine months ended September 30, 2010 as compared to the
same period in 2009, due primarily to declining portfolio balances as a result of principal
repayments and foreclosures, a decrease in voluntary prepayments offset by decreased interest
expense due to lower average outstanding borrowings as a result of principal payments on the
mortgage-backed debt, a $19.9 million mortgage-backed debt extinguishment combined with no new
mortgage-backed debt issuances during the year. The average prepayment rate for the unencumbered
portfolio was 3.5% for the nine months ended September 30, 2010, as compared to 4.7% in the same
period of 2009. The average prepayment rate for the securitized portfolio was 2.6% for the nine
months ended September 30, 2010, as compared to 3.4% in the same period of 2009, respectively.
Net Interest Margin
Net interest margin increased for the three and nine months ended September 30, 2010 as
compared to the same periods in 2009 due to lower levels of non-performing assets and lower
outstanding mortgage-backed debt balances, partially offset by a decrease in prepayment speeds.
Provision for Loan Losses
The increase in the unencumbered residential loan provision for loan losses for the three and
nine months ended September 30, 2010, as compared to the same periods in 2009 was primarily due to
increased frequency of default and loss severities.
The decrease in the securitized residential loan provision for loan losses for the three and
nine months ended September 30, 2010, as compared to the same periods in 2009 was primarily due to
reduced frequency of default and improved loss severities.
Non-Interest Income
The decrease in non-interest income for the three months ended September 30, 2010, as compared
to the same period in 2009 was primarily due to a $0.8 million gain in September 2009 resulting
from the sale of our third-party insurance agency portfolio and lower mortgage advisory services
revenue.
The decrease in non-interest income for the nine months ended September 30, 2010, as compared
to the same period in 2009 was primarily due to lower earned premiums from our insurance business
and a $0.8 million gain in September 2009 resulting from the sale of our third-party insurance
agency portfolio, partially offset by an improvement in taxes, insurance and other advances as a
result of lower insurance advances and an increase in collections.
Non-Interest Expenses
The decrease in non-interest expenses for the three months ended September 30, 2010, as
compared to the same period in 2009 was primarily due to a $1.7 million gain on debt
extinguishment, lower losses on REO due to improved loss severities, and a decrease in general and
administrative expenses due to lower expenses related to securitization trusts, partially offset by
an increase in salaries and benefits and legal and professional expenses due to growth initiatives.
The decrease in non-interest expenses for the nine months ended September 30, 2010, as
compared to the same period in 2009 was primarily due to a $1.7 million gain on debt
extinguishment, gains on REO due to improved loss severities, a decrease in claims expense as a
result of fewer active policies and prior year claims in our insurance business, a decrease in
legal and professional expenses that related primarily to the spin-off and Merger as well as no
longer incurring related party corporate charges from our former parent, partially offset by
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an increase in salaries and benefits. Salaries and benefits increased due to additional employees to
support the stand-alone company, additional stock compensation expense, as well as severance costs
incurred in 2010.
Income Taxes
The change in income taxes for the nine months ended September 30, 2010, as compared to the
same period in 2009 was due to the impact of our becoming qualified as a REIT in conjunction with
the spin-off from Walter Energy and Merger with Hanover. Our continued qualification as a REIT may
limit our income tax expense to the activities of our TRSs.
Additional Analysis of Residential Loan Portfolio
Allowance for Loan Losses
The allowance for loan losses represents managements estimate of probable incurred credit
losses inherent in our residential loan portfolio as of the balance sheet date. The determination
of the level of the allowance for loan losses and, correspondingly, the provision for loan losses,
is based on delinquency levels and trends, prior loan loss severity experience, and managements
judgment and assumptions regarding various matters, including the composition of the residential
loan portfolio, the estimated value of the underlying real estate collateral, the level of the
allowance in relation to total loans and to historical loss levels, national and local economic
conditions, changes in unemployment levels and the impact that changes in interest rates have on a
borrowers ability to refinance their loan and to meet their repayment obligations. Management
continuously evaluates these assumptions and various other relevant factors impacting credit
quality and inherent losses when quantifying our exposure to credit losses and assessing the
adequacy of our allowance for such losses as of each reporting date. The level of the allowance is
adjusted based on the results of managements analysis.
Given continuing pressure on residential property values, especially in our southeastern U.S.
market, continued high unemployment and a generally uncertain economic backdrop, we expect the
allowance for loan losses to continue to remain elevated until such time as we experience a
sustained improvement in the credit quality of the residential loan portfolio. The future growth of
the allowance is highly correlated to unemployment levels and changes in home prices within our
markets.
While we consider the allowance for loan losses to be adequate based on information currently
available, future adjustments to the allowance may be necessary due to changes in economic
conditions, delinquency levels, foreclosure rates, loss severity rates, and further declines in
real estate values.
The following table shows information about the allowance for losses by portfolio 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 Loan Losses | Residential Loans (1) | Allowance | Residential Loans (2) | |||||||||||||
(in thousands) | ||||||||||||||||
Residential loans: |
||||||||||||||||
September 30, 2010 |
$ | 5,388 | 1.49 | % | $ | 4,972 | (3) | 1.43 | %(3)4) | |||||||
December 31, 2009 |
$ | 3,460 | 1.03 | % | $ | 4,317 | 1.23 | % | ||||||||
Residential loans of
securitization trusts: |
||||||||||||||||
September 30, 2010 |
$ | 10,893 | 0.86 | % | $ | 11,833 | (3) | 0.91 | %(3)(4) | |||||||
December 31, 2009 |
$ | 14,201 | 1.07 | % | $ | 12,173 | 0.89 | % |
(1) | The allowance for loan loss ratio is calculated as period end allowance for loan losses divided by period end residential loans, by portfolio type, before the allowance for loan losses. | |
(2) | The charge-off ratio is calculated as annualized charge-offs, net of recoveries divided by average residential loans, by portfolio type, before the allowance for loan losses. | |
(3) | Annualized. | |
(4) | Excludes the impact of the REO sale from the securitized residential loan portfolio to the unencumbered residential loan portfolio in February 2010. |
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The following table summarizes activity in the allowance for loan losses in our residential
loan portfolios, net for the nine months ended September 30, 2010 and 2009 (in thousands):
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
Nine Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Balance, December 31 |
$ | 3,460 | $ | 3,418 | $ | 14,201 | $ | 15,551 | ||||||||
Provision charged to income |
1,291 | 1,174 | 2,651 | 2,938 | ||||||||||||
Less: Transfers to REO |
(1,367 | ) | (1,211 | ) | (2,609 | ) | (3,127 | ) | ||||||||
Less: Charge-offs, net of
recoveries |
| (8 | ) | (303 | ) | (253 | ) | |||||||||
Balance, March 31 |
3,384 | 3,373 | 13,940 | 15,109 | ||||||||||||
Provision charged to income |
1,330 | 968 | 2,718 | 2,882 | ||||||||||||
Less: Transfers to REO |
(1,390 | ) | (874 | ) | (3,205 | ) | (3,016 | ) | ||||||||
Less: Charge-offs, net of
recoveries |
(4 | ) | (29 | ) | (40 | ) | (106 | ) | ||||||||
Balance, June 30 |
3,320 | 3,438 | 13,413 | 14,869 | ||||||||||||
Provision charged to income |
3,036 | 1,520 | 198 | 1,181 | ||||||||||||
Less: Transfers to REO |
(882 | ) | (1,370 | ) | (2,436 | ) | (1,327 | ) | ||||||||
Less: Charge-offs, net of
recoveries |
(86 | ) | (81 | ) | (282 | ) | (441 | ) | ||||||||
Balance, September 30 |
$ | 5,388 | $ | 3,507 | $ | 10,893 | $ | 14,282 | ||||||||
Delinquency Information
The following table presents information about delinquencies as a percent of amounts
outstanding in our residential loan portfolios:
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Principal balance outstanding (in thousands) |
$ | 401,311 | $ | 365,797 | $ | 1,385,365 | $ | 1,454,062 | ||||||||
31-60 days |
1.98 | % | 1.98 | % | 1.07 | % | 1.17 | % | ||||||||
61-90 days |
1.18 | % | 1.53 | % | 0.59 | % | 0.54 | % | ||||||||
91 days or more |
4.61 | % | 5.84 | % | 1.99 | % | 2.74 | % | ||||||||
7.77 | % | 9.35 | % | 3.65 | % | 4.45 | % | |||||||||
The following table presents information about delinquencies as a percent of the
total number of loans outstanding in our residential loan portfolios:
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Total number of residential loans |
4,379 | 3,703 | 29,146 | 30,502 | ||||||||||||
31-60 days |
1.85 | % | 1.84 | % | 0.88 | % | 1.07 | % | ||||||||
61-90 days |
1.03 | % | 1.51 | % | 0.47 | % | 0.47 | % | ||||||||
91 days or more |
4.16 | % | 5.51 | % | 1.59 | % | 2.15 | % | ||||||||
7.04 | % | 8.86 | % | 2.94 | % | 3.69 | % | |||||||||
The past due or delinquency status is generally determined based on the contractual
payment terms. The calculation of delinquencies excludes from delinquent amounts those accounts
that are in bankruptcy proceedings that are paying their mortgage payments in contractual
compliance with the bankruptcy court approved mortgage payment obligations.
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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, | |||||||
2010 | 2009 | |||||||
Residential loans |
||||||||
Number of loans |
182 | 204 | ||||||
Balance (in millions) |
$ | 18.0 | $ | 21.4 | ||||
Residential loans of securitization
trusts |
||||||||
Number of loans |
464 | 656 | ||||||
Balance (in millions) |
$ | 27.5 | $ | 39.8 | ||||
Total |
||||||||
Number of loans |
646 | 860 | ||||||
Balance (in millions) |
$ | 45.5 | $ | 61.2 |
Portfolio Characteristics
The weighted average original loan-to-value, or LTV, dispersion of our portfolios is as
follows:
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Weighted average LTV |
87.00 | % | 88.00 | % | 89.00 | % | 89.00 | % | ||||||||
0.00 - 70.00 |
3.37 | % | 3.91 | % | 0.92 | % | 0.95 | % | ||||||||
70.01 - 80.00 |
5.74 | % | 6.88 | % | 1.93 | % | 1.93 | % | ||||||||
80.01 - 90.00(1) |
50.88 | % | 43.56 | % | 76.92 | % | 76.90 | % | ||||||||
90.01 - 100.00 |
40.01 | % | 45.65 | % | 20.23 | % | 20.22 | % | ||||||||
Total |
100.00 | % | 100.00 | % | 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
for any loans originated by Jim Walter Homes, Inc. or WMC. This additional value typically was
created by the installation and completion of wall and floor coverings, landscaping, driveways and
utility connections in more recent periods.
Current LTVs are not readily determinable given the rural geographic distribution of our
portfolio which precludes us from obtaining reliable comparable sales information to utilize in
valuing the collateral.
The weighted average FICO score dispersion of the loans in our residential loan portfolios,
refreshed as of December 31, 2009, is as follows:
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Weighted average FICO |
573 | 566 | 587 | 583 | ||||||||||||
<=600 |
60.81 | % | 62.77 | % | 53.30 | % | 54.90 | % | ||||||||
601 - 640 |
12.86 | % | 11.07 | % | 14.17 | % | 13.97 | % | ||||||||
641 - 680 |
8.50 | % | 6.84 | % | 9.46 | % | 8.85 | % | ||||||||
681 - 720 |
4.92 | % | 4.55 | % | 4.76 | % | 4.99 | % | ||||||||
721 - 760 |
2.24 | % | 2.42 | % | 2.84 | % | 2.94 | % | ||||||||
761-800 |
1.91 | % | 2.01 | % | 2.58 | % | 2.46 | % | ||||||||
>=801 |
0.59 | % | 0.84 | % | 1.05 | % | 0.99 | % | ||||||||
Unknown or unavailable |
8.17 | % | 9.50 | % | 11.84 | % | 10.90 | % | ||||||||
Total |
100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % | ||||||||
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Our residential loans are concentrated in the following states:
Residential Loans | ||||||||||||||||
Residential Loans | of Securitization Trusts | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Texas |
37.12 | % | 33.85 | % | 34.33 | % | 33.92 | % | ||||||||
Mississippi |
11.55 | % | 12.86 | % | 16.16 | % | 16.11 | % | ||||||||
Alabama |
8.79 | % | 10.25 | % | 8.33 | % | 8.31 | % | ||||||||
Louisiana |
7.17 | % | 8.00 | % | 6.12 | % | 6.15 | % | ||||||||
Florida |
10.30 | % | 9.38 | % | 5.19 | % | 5.25 | % | ||||||||
South Carolina |
5.92 | % | 6.73 | % | 5.65 | % | 5.63 | % | ||||||||
Other (1) |
19.15 | % | 18.93 | % | 24.22 | % | 24.63 | % | ||||||||
Total |
100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % | ||||||||
(1) | Other consists of loans in 25 states, individually representing a concentration of less than 5%. |
Our residential loans outstanding as of September 30, 2010 were originated in the following
periods:
Residential Loans of Securitization |
||||||||
Residential Loans | Trusts | |||||||
Year 2010 Origination |
4.33 | % | 3.00 | % | ||||
Year 2009 Origination |
5.76 | % | 2.99 | % | ||||
Year 2008 Origination |
32.84 | % | 1.91 | % | ||||
Year 2007 Origination |
52.94 | % | 1.60 | % | ||||
Year 2006 Origination |
2.11 | % | 13.24 | % | ||||
Year 2005 Origination |
0.19 | % | 9.97 | % | ||||
Year 2004 Origination and
earlier |
1.83 | % | 67.29 | % | ||||
Total |
100.00 | % | 100.00 | % | ||||
Real Estate Owned
The following table presents information about foreclosed property (dollars in thousands):
Real Estate Owned Related to the | ||||||||||||||||
Real Estate Owned Related to the | Residential Loans of | |||||||||||||||
Residential Loan Portfolio | Securitization Trusts | |||||||||||||||
Units | Balance | Units | Balance | |||||||||||||
Balance, December 31, 2009 |
271 | $ | 21,981 | 760 | $ | 41,143 | ||||||||||
Foreclosures and other additions, at fair value |
256 | 22,285 | 754 | 40,071 | ||||||||||||
Purchases from the securitized residential
loan portfolio |
72 | 3,882 | | | ||||||||||||
Sales to the residential loan portfolio |
| | (72 | ) | (3,882 | ) | ||||||||||
Sales to third parties and other dispositions |
(251 | ) | (19,482 | ) | (795 | ) | (40,231 | ) | ||||||||
Fair value adjustment |
| (407 | ) | | (1,152 | ) | ||||||||||
Balance, September 30, 2010 |
348 | $ | 28,259 | 647 | $ | 35,949 | ||||||||||
During February 2010, we purchased, at our discretion, 72 Mid-State Trust X, or
Trust X, REO accounts in order to cure the loss trigger. We purchased these accounts for
approximately $3.9 million which was the economic value of the accounts as defined by the Trust
agreement. As a result of this transaction, on February 16, 2010 we received a $4.2 million release
of excess overcollateralization and we continue to receive monthly cash releases from Trust X. Of
the 72 REO properties, 37 have subsequently been sold with the Company providing the financing.
The purchased REO accounts are now included in either the unencumbered residential loan or REO
balances.
Liquidity and Capital Resources
Overview
Our principal sources of funds are our existing cash balances, monthly principal and interest
payments we receive from our unencumbered residential loan portfolio, cash releases from our
securitized residential loan portfolio, proceeds from our 2009 Offering and other financing
activities. An additional source of liquidity is the mortgage-backed debt that we recently
purchased in the open market. We currently intend the purchases to be a temporary investment of
excess cash. As needed, we may recover this liquidity by either selling the bonds or using the
bonds as collateral for a repurchase facility. We generally use our liquidity for our operating
costs, to make additional investments, and to make dividend payments.
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Our securitization trusts are consolidated for financial reporting purposes under GAAP. Our
results of operations and cash flows include the activity of these Trusts. The cash proceeds from
the repayment of the collateral held in securitization trusts are owned by the Trusts and serve to
only repay the obligations of the Trusts unless certain overcollateralization or other similar
targets are satisfied. Principal and interest on the mortgage-backed debt of the Trusts can only be
paid if there are sufficient cash flows from the underlying collateral. As of September 30, 2010,
total debt decreased $83.8 million as compared to December 31, 2009.
The securitization trusts contain delinquency and loss triggers, that, if exceeded, result in
any excess overcollateralization going to pay down our outstanding mortgage-backed and asset-backed
notes for that particular securitization at an accelerated pace. Assuming no servicer trigger
events have occurred and the overcollateralization targets have been met, any excess cash flow is
released to the Company either monthly or quarterly, in accordance with the terms of the respective
underlying trust agreements. As of September 30, 2010, Mid-State Trust 2006-1, or Trust
2006-1,exceeded its delinquency trigger and did not provide any excess cash flow to us. The
delinquency trigger for Mid-State Trust 2005-1, or Trust 2005-1, was cured during the three months
ended June 30, 2010. The loss trigger for Trust X was cured during the three months ended March 31,
2010. With the exception of Trust 2006-1 which exceeded its trigger and the recently cured Trust
2005-1 and Trust X, none of our other securitization trusts have reached the levels of
underperformance that would trigger a delay in cash releases.
We believe that, based on current forecasts and anticipated market conditions, funding
generated from the residential loans and the proceeds from our 2009 Offering will be sufficient to
meet operating needs, to invest in residential loans, to make planned capital expenditures 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 Debt
We have historically funded our residential loans through the securitization market. As of
September 30, 2010, we had nine separate non-recourse securitization trusts where we service the
underlying collateral and one non-recourse securitization trust for which we do not service the
underlying collateral. These ten trusts have an aggregate of $1.2 billion of outstanding debt,
collateralized by residential loans (principal balance), REO and restricted cash of $1.5 billion.
All of our mortgage-backed debt is non-recourse and not cross-collateralized and, therefore, must
be satisfied exclusively from the proceeds of the residential loans and REO held in each
securitization trust. As we retained the residual interests in the securitizations and
significantly direct the activities of the securitization trusts, we have consolidated the
securitization entities and treat the residential loans as our assets and the related
mortgage-backed debt as our debt.
Borrower remittances received on the residential loan collateral held in securitization trusts
are used to make payments on the mortgage-backed debt. The maturity of the mortgage-backed debt is
directly affected by principal prepayments on the related residential loan collateral. As a result,
the actual maturity of the mortgage-backed debt is likely to occur earlier than the stated
maturity. Certain of our mortgage-backed debt are also subject to redemption according to specific
terms of the respective indenture agreements.
Credit Agreements
In April 2009, we entered into a syndicated credit agreement, a revolving credit agreement and
security agreement, and a support letter of credit agreement. All three of these agreements mature
on April 20, 2011. As of September 30, 2010, no funds have been drawn under any of the credit
agreements and we are in compliance with all covenants.
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Sources and Uses of Cash
One of the financial metrics on which we focus is our sources and uses of cash. As a
supplement to the Consolidated Statements of Cash Flows included in this Quarterly Report on Form
10-Q, we provide the table below which sets forth, for the periods indicated, our sources and uses
of cash (in millions). The cash balance at the beginning and ending of each period of 2010 and 2009
are GAAP amounts and the sources and uses of cash are organized in a manner consistent with how
management monitors the cash flows of our business. The presentation of our sources and uses of
cash for the table below is derived by aggregating and netting all items within our GAAP
Consolidated Statements of Cash Flows for the respective periods. The table excludes the gross cash
flows generated by our securitization trusts as those amounts are generally not available to us.
The table does include the cash releases distributed to us as a result of our investment in the
residual interests of the securitization trusts.
Nine Months Ended | ||||||||
September 30, | ||||||||
2010 | 2009 | |||||||
Beginning cash and cash equivalents balance |
$ | 99.3 | $ | 1.3 | ||||
Principal sources of cash: |
||||||||
Cash collections from the unencumbered portfolio |
37.3 | 43.3 | ||||||
Cash releases from the securitized portfolio |
38.7 | 24.6 | ||||||
Net cash flow from ancillary businesses |
7.7 | 9.1 | ||||||
83.7 | 77.0 | |||||||
Other sources of cash: |
||||||||
Cash received from Walter Energy |
| 16.4 | ||||||
Other |
0.1 | 2.8 | ||||||
Total sources of cash |
83.8 | 96.2 | ||||||
Principal uses of cash: |
||||||||
Acquisition of REO from the securitized portfolio |
(3.9 | ) | | |||||
Operating expenses paid |
(30.4 | ) | (37.3 | ) | ||||
(34.3 | ) | (37.3 | ) | |||||
Other uses of cash: |
||||||||
Dividends paid |
(40.1 | ) | (10.4 | ) | ||||
Loan pool acquisitions |
(40.7 | ) | | |||||
Mortgage-backed debt extinguishment |
(19.9 | ) | | |||||
Cash paid to Walter Energy |
| (15.3 | ) | |||||
Capital expenditures, net |
0.3 | (2.2 | ) | |||||
Other |
(8.2 | ) | (8.8 | ) | ||||
Total uses of cash |
(142.9 | ) | (74.0 | ) | ||||
Net (uses) sources of cash |
(59.1 | ) | 22.2 | |||||
Ending cash and cash equivalents balance |
$ | 40.2 | $ | 23.5 | ||||
Our principal business cash flows are those associated with managing our portfolio
and totaled $49.4 million for the nine months ended September 30, 2010, up $9.7 million from the
nine months ended September 30, 2009, due to an increase of cash releases from our
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securitized portfolio of $14.1 million and a decrease of $6.9 million of cash operating expenses primarily due
to lower insurance premiums and non-recurring expenses incurred in 2009 as well as $1.9 million of
one-time spin-off costs incurred in the nine months ended September 30, 2009. This was partially
offset by a decrease of cash collections from our unencumbered residential loan portfolio of $6.0
million primarily due to the declining balance nature of our portfolio partially offset by our
recent acquisitions, a decline in the level of voluntary prepayments, and a $1.4 million
decrease in cash provided by our ancillary businesses.
Cash of $3.9 million was used to acquire REO from Trust X within the securitized residential
loan portfolio. The cash utilized to acquire REO from Trust X resulted in subsequent monthly cash
releases totaling $14.1 million through September 30, 2010, from Trust X with the remaining
overcollateralization expected to be released in early 2011. The release of overcollateralization
was a direct result of the loss trigger being cured. Once the overcollateralization from Trust X
has been released and assuming that the loss trigger remains cured, Trust X cash releases will
consist of servicing fees and residual cash flows, similar to our other securitization trusts.
Cash releases from the securitized portfolio consist of servicing fees and residual cash flows
from residential loans held as securitized collateral within the securitization trusts after
distributions are made to bondholders of the securitized mortgage-backed debt to the extent
required credit enhancements are maintained and the delinquency and loss triggers are not exceeded.
These cash flows represent the difference between principal and interest payments received on the
underlying residential loans reduced by principal payments, including accelerated payments, if any,
on the securitized mortgage-backed debt; interest paid on the securitized mortgage-backed debt;
actual losses, net of any gains incurred upon disposition of REO; and the maintenance of
overcollateralization requirements.
Our net other cash use totaled $108.5 million for the nine months ended September 30, 2010, up
$91.0 million from the nine months ended September 30, 2009, primarily due to a $29.7 million
increase in dividends paid to stockholders, the $40.7 million acquisition of loan pools, and $19.9
million used to purchase our outstanding mortgage-backed debt, partially offset by the termination
of transactions with Walter Energy as a result of our spin-off.
During the nine months ended September 30, 2010, we deployed $40.7 million of the proceeds
from our 2009 Offering to purchase four pools of residential loans. We intend to invest the
remainder of the proceeds from our 2009 Offering in our targeted asset classes. We expect our
future sources of cash will continue to be generated from our existing residential loan portfolios,
as well as from future acquisitions of residential loans and servicing revenues from Marix
subsequent to the acquisition. If conditions in the securitization market improve, we may
securitize in the future. Additionally, we expect that our future cash operating expenses will be
relatively consistent with annualized fourth quarter 2009 actual results excluding Marix operating
costs.
The following table sets forth, for the periods indicated, selected consolidated cash flow
information (in thousands):
For the Nine Months | ||||||||
Ended September 30, | ||||||||
2010 | 2009 | |||||||
Cash flows provided by operating activities |
$ | 28,528 | $ | 35,271 | ||||
Cash flows provided by investing activities |
34,026 | 87,380 | ||||||
Cash flows used in financing activities |
(121,641 | ) | (100,476 | ) | ||||
Net increase (decrease) in cash and cash
equivalents |
$ | (59,087 | ) | $ | 22,175 | |||
Operating activities. Net cash provided by operating activities was $28.5 million
for the nine months ended September 30, 2010 as compared to $35.3 million for the same period in
2009. During the nine months ended September 30, 2010 and 2009, the primary sources of cash in
operating activities were the income generated from our portfolio and our ancillary businesses.
Investing activities. Net cash provided by investing activities was $34.0 million for the nine
months ended September 30, 2010 as compared to $87.4 million for the same period in 2009. For the
nine months ended September 30, 2010 and 2009, the primary source of cash from investing activities
was provided by principal payments received on our residential loans, which was partially offset by
the acquisition of pools of residential loans in the 2010 period.
Financing activities. Net cash used in financing activities was $121.6 million for the nine
months ended September 30, 2010 as compared to $100.5 million for the same period in 2009. For the
nine months ended September 30, 2010 and 2009, the primary uses of cash in financing activities
were principal payments on our mortgage-backed debt as well as the payment of dividends to our
stockholders. Additionally, we utilized $19.9 million of cash to purchase our outstanding
mortgage-backed debt.
Off-Balance Sheet Arrangements
As of September 30, 2010, we retained credit risk on 14 remaining mortgage securities totaling
$1.5 million that were sold with recourse
by Hanover in a prior year. Accordingly, we are responsible for credit losses, if any, with respect
to these securities.
We do not have any relationships with unconsolidated entities or financial partnerships, such
as entities often referred to as structured finance, special purpose or variable interest entities,
which would have been established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. In addition, we do not have any undisclosed
borrowings or debt, and have not
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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, 2010, we expect to pay dividends to our stockholders of all or
substantially all of our earnings 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 operating results, estimates of taxable earnings, cash flows and liquidity,
maintenance of REIT qualification and such other factors as the Board of Directors deems relevant.
On November 2, 2010, we declared a dividend of $0.50 per share on our common stock to
stockholders of record on November 14, 2010 which will be paid on November 24, 2010.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Qualitative Information on Market Risk
We seek to manage the risks inherent in our business including but not limited to credit
risk, interest rate risk, prepayment risk, liquidity risk, real estate risk and inflation risk
in a prudent manner designed to enhance our earnings and dividends and preserve our capital. In
general, we seek to assume risks that can be quantified from historical experience, to actively
manage such risks, and to maintain capital levels consistent with these risks.
Credit Risk
Credit risk is the risk that we will not fully collect the principal we have invested in
residential loans due to borrower defaults. Our portfolio as of September 30, 2010 consisted of
securitized residential loans with a principal balance of $1.4 billion and approximately $0.4
billion of unencumbered residential loans.
The residential loans are predominantly credit-challenged, non-conforming loans with a
weighted average LTV ratio at origination or acquisition of approximately 89% and a weighted
average borrower credit score of 584. While we feel that our underwriting and due diligence of
these loans will help to mitigate the risk of significant borrower default on these loans, we
cannot assure you that all borrowers will continue to satisfy their payment obligations under these
loans, thereby avoiding default.
The $1.5 billion of residential loans and other collateral of securitization trusts are
permanently financed with $1.2 billion of mortgage-backed debt leaving us with a net credit
exposure of $275.9 million, which approximates our residual interest in the securitization trusts.
When we purchase residential loans, the credit underwriting process will vary depending on the
pool characteristics, including loan seasoning or age, LTV ratios, payment histories and
counterparty representations and warranties. We will perform a due diligence review of potential
acquisitions which may include a review of the residential loan documentation, appraisal reports
and credit underwriting. Generally, an updated property valuation is obtained.
Interest Rate Risk
Interest rate risk is the risk of changing interest rates in the market place. Our primary
interest rate risk exposures relate to the interest rates on mortgage-backed debt of the Trusts and
the yields on our residential loan portfolios and prepayments thereof.
Our fixed-rate residential loan portfolio had $1.8 billion of unpaid principal as of September
30, 2010 and December 31, 2009, and fixed-rate mortgage-backed debt was $1.2 billion and $1.3
billion as of September 30, 2010 and December 31, 2009, respectively. The fixed rate nature of
these instruments and their offsetting positions effectively mitigate significant interest rate
risk exposure from these instruments. If interest rates decrease, we may be exposed to higher
prepayment speeds. This could result in a modest increase in short-term profitability. However, it
could adversely impact long-term profitability as a result of a shrinking portfolio. Changes in
interest rates may impact the fair value of these financial instruments.
Prepayment Risk
Prepayment risk is the risk that borrowers will pay more than their required monthly mortgage
payment including payoffs of residential loans. When borrowers repay the principal on their
residential loans before maturity, or faster than their scheduled amortization, the effect is to
shorten the period over which interest is earned, and therefore, increases the yield for
residential loans purchased at a discount to their then current balance, as with the majority of
our portfolio. Conversely, residential loans purchased at a premium to their then current balance
exhibit lower yields due to faster prepayments. Historically, when market interest rates declined,
borrowers had a tendency to refinance their residential loans, thereby increasing prepayments.
However, with tightening credit standards, the current low interest rate environment has not yet
resulted in higher prepayments. Increases in residential loan prepayment rates could result in GAAP
earnings volatility including substantial variation from quarter to quarter.
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We monitor prepayment risk through periodic reviews of the impact of a variety of prepayment
scenarios on revenues, net earnings, dividends, and cash flow.
Liquidity Risk
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing
commitments to repay mortgage-backed debt of the Trusts, fund and maintain the portfolio, pay
dividends to our stockholders and other general business needs. We recognize the need to have funds
available to operate our business. It is our policy to have adequate liquidity at all times.
Our principal sources of liquidity are the mortgage-backed debt of the Trusts we have issued
to finance our residential loans held in securitization trusts, the principal and interest payments
received from unencumbered residential loans, cash releases from our securitized loan portfolio,
cash proceeds from our 2009 Offering and other financing activities. We expect these sources of
funds will be sufficient to meet our liquidity requirements.
Our unencumbered and securitized mortgage loans are accounted for as held-for-investment and
reported at amortized cost. Thus, changes in the fair value of the residential loans do not have an
impact on our liquidity. However, the delinquency and loss triggers discussed previously may impact
our liquidity. Our obligations consist solely of mortgage-backed debt issued by our securitization
trusts. Changes in fair value of mortgage-backed debt generally have no impact on our liquidity.
Mortgage-backed debt issued by the securitization trusts are reported at amortized cost as are the
residential loans collateralizing the debt.
Real Estate Risk
We own assets secured by real property and own property directly as a result of foreclosures.
Residential property values are subject to volatility and may be affected adversely by a number of
factors, including, but not limited to, national, regional and local economic conditions (which may
be adversely affected by industry slowdowns and other factors); local real estate conditions (such
as an oversupply of housing); changes or continued weakness in specific industry segments;
construction quality, age and design; demographic factors; and retroactive changes to building or
similar codes. In addition, decreases in property values reduce the value of the collateral and the
potential proceeds available to a borrower to repay our loans, which could also cause us to suffer
losses.
Inflation Risk
Virtually all of our assets and liabilities are financial in nature. As a result, changes in
interest rates and other factors influence our performance far more so than inflation. Changes in
interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our
consolidated financial statements are prepared in accordance with GAAP. Our activities and balance
sheets are measured with reference to historical cost or fair value without considering inflation.
Effect of Government Initiatives on Market Risk
As a result of ongoing challenges facing the United States economy, new laws and regulations
have been and may continue to be proposed that impact the financial services industry. On July 21,
2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Act, was enacted and
signed into law. The Act includes, among other things, provisions establishing a Bureau of Consumer
Financial Protection, which will have broad authority to develop and implement rules regarding most
consumer financial products, including provisions addressing mortgage reform as well as provisions
affecting corporate governance and executive compensation at all publicly-traded companies. The Act
also requires securitizers of asset-backed securities to retain an economic interest (generally 5%)
in the credit risk of the securitized asset. Many aspects of the law are subject to further
rulemaking and will take effect over several years, making it difficult to anticipate the overall
financial impact to our Company or the financial services industry.
Quantitative Information on Market Risk
Our future earnings are sensitive to a number of market risk factors; changes in these factors
may have a variety of secondary effects that, in turn, will also impact our earnings. To supplement
this discussion on the market risk we face, the following table incorporates information that may
be useful in analyzing certain market risks.
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The table presents principal cash flows by year of repayment. The timing of principal cash
flows includes assumptions on the prepayment speeds of assets based on their recent performance and
future prepayment expectations. Our future results depend greatly on the credit performance of the
underlying loans (this table assumes no credit losses).
Principal Amounts Maturing and Effective Rates During Period | At September 30, 2010 | |||||||||||||||||||||||||||||||||||
Principal | ||||||||||||||||||||||||||||||||||||
(dollars in thousands) | Q4 2010 | 2011 | 2012 | 2013 | 2014 | Thereafter | Value | Book Value | Fair Value | |||||||||||||||||||||||||||
Residential loans |
||||||||||||||||||||||||||||||||||||
Principal |
$ | 4,373 | $ | 19,590 | $ | 20,473 | $ | 19,431 | $ | 18,476 | $ | 318,968 | $ | 401,311 | $ | 355,212 | $ | 317,000 | ||||||||||||||||||
Residential loans of
securitization trusts |
||||||||||||||||||||||||||||||||||||
Principal |
22,970 | 92,923 | 91,383 | 87,549 | 82,970 | 1,007,570 | 1,385,365 | 1,256,404 | 1,168,000 | |||||||||||||||||||||||||||
Mortgage-backed debt |
||||||||||||||||||||||||||||||||||||
Principal |
25,092 | 96,957 | 95,608 | 91,721 | 88,182 | 786,655 | 1,184,215 | 1,183,636 | 1,082,000 |
Approximately 99% of residential loans have fixed interest rates. Residential loans with
adjustable interest rates comprise only $7.0 million of the unencumbered loans and $18.4 million of
the securitized loans. Similarly, all of our mortgage-backed debt of securitization trusts is fixed
rate. The weighted average coupon is 9.1% for residential loans, 9.1% for residential loans of
securitization trusts and 6.6% for mortgage-backed debt.
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, 2010, that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Part II, Item 1, Legal Proceedings, of our Quarterly Report on Form 10-Q for the three
months ended March 31, 2010 filed on May 5, 2010.
See also the item under Note 16 entitled Other Tax Exposure.
Item 1A. Risk Factors
For risk factors, see Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year
ended December 31, 2009 filed on March 2, 2010. Our risk factors have not changed materially since
December 31, 2009 except for the addition of the risk factors below.
Risks Associated With Recent Adverse Developments in the Mortgage Finance and Credit Markets and
the Enactment of the Dodd-Frank Act
Recent scrutiny has been placed on mortgage foreclosure processes due to some highly publicized
deficiencies in such processes by others and we cannot be certain that new regulations will not be
put in place which could adversely affect our performance.
As a result of some highly publicized deficiencies in the mortgage foreclosure processes of several
large banks and loan servicers, a number of States Attorneys General have begun inquiries into
mortgage foreclosure processes in their states and several of our competitors announced the
suspension of foreclosure proceedings in certain states pending review of their procedures. We have
reviewed our processes and procedures and will continue to do so with both internal personnel and
third party consultants. To date, we have not received any inquiries from States Attorneys
General and we have not identified any non-compliance with existing mortgage processing laws and
regulations. We cannot be certain that lawyers and other service providers retained by the Company
to process mortgage foreclosures have complied in all respects with required processes in their
respective jurisdiction; however, we intend to monitor their activities going forward. It is not
known at this time whether any new laws or regulations affecting the mortgage foreclosure process
will be put into place by federal, state or local governmental authorities, nor is it currently
possible to determine what, if any effects they may have on our business; but should such laws or
regulations be enacted, they could adversely affect the Companys results of operations. For
example, changes in required processes or laws that increase the time required to foreclose may
reduce the Companys net income and could adversely affect liquidity.
The Dodd-Frank Act contains provisions related to asset-backed securities that may adversely impact
our business
Certain provisions of the Dodd-Frank Act, and other proposed reforms related thereto, may
impact our ability to enter into future asset-backed securities transactions, however, the effect
of any such actions on the asset-backed securities market is currently uncertain. While we are
continuing to evaluate all aspects of the Dodd-Frank Act, such legislation and regulations
promulgated pursuant to such legislation could materially and adversely affect the manner in which
we conduct our businesses, result in heightened federal regulation and oversight of our business
activities, and result in increased costs and potential litigation associated with our business
activities.
Risks Related to Our Business
We may not realize the growth opportunities expected from our acquisition and the integration of
Marix Servicing, LLCs business with our business could prove difficult
On November 2, 2010, the Company closed on its acquisition of 100% of the ownership interests
of Marix Servicing, LLC, or Marix. At the time of the purchase, Marix was operating at a loss.
While the Company plans to take actions to reduce costs and increase revenues in the business, as
well as to take advantage of synergies between the Companys operations and those of Marix, and we
believe that such actions will be successful in mitigating or eliminating such losses, there can be
no assurance that such measures will succeed in whole or in part or be achieved in the anticipated
time frame.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Removed and Reserved
Item 5. Other Information
None.
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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Table of Contents
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. O'Brien | |||
Mark J. O'Brien | ||||
Chief Executive Officer (Principal Executive Officer) | ||||
Dated: November 3, 2010
By: | /s/ Kimberly A. Perez | |||
Kimberly A. Perez | ||||
Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | ||||
Dated: November 3, 2010
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Table of Contents
INDEX TO EXHIBITS
Exhibit No | Notes | Description | ||||
2.1
|
(1 | ) | Second Amended and Restated Agreement and Plan of Merger dated as of February 6, 2009, among Registrant, Walter Industries, Inc., JWH Holding Company, LLC, and Walter Investment Management LLC. | |||
2.2
|
(1 | ) | Amendment to the Second Amended and Restated Agreement and Plan of Merger, entered into as of February 17, 2009 between Registrant, Walter Industries, Inc., JWH Holding Company, LLC and Walter Investment Management LLC | |||
3.1
|
(2 | ) | Articles of Amendment and Restatement of Registrant effective April 17, 2009. | |||
3.2
|
(2 | ) | By-Laws of Registrant, effective April 17, 2009. | |||
10.1
|
(3 | ) | Securities Purchase Agreement dated August 25, 2010 by and between the Registrant, Marathon Asset Management, L.P., Michael OHanlon and Marix Servicing, L.L.C. | |||
10.2
|
(4 | ) | Amendments to (a) Revolving Credit and Security Agreement and (b) L/C Support Agreement each dated September 23, 2010 by and between the Registrant and Walter Energy, Inc. | |||
10.3
|
(5 | ) | Supplement No. 1 dated October 28, 2010 to the Indenture dated November 2, 2006 relating to certain asset back notes by and between Mid-State Capital Corporation 2006-1 Trust as Issuer and The Bank of New York Mellon (formerly known as The Bank of New York) as Indenture Trustee | |||
31.1
|
(5 | ) | Certification by Mark J. OBrien pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
31.2
|
(5 | ) | Certification by Kimberly A. Perez pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
32
|
(5 | ) | Certification by Mark J. OBrien and Kimberly A. Perez pursuant to 18 U.S.C. Section 1352, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
Note | Notes to Exhibit Index | |
(1)
|
Incorporated herein by reference to the Annexes to the proxy statement/ prospectus forming a part of Amendment No. 4 to the Registrants Registration Statement on Form S-4, Registration No. 333-155091, as filed with the Securities and Exchange Commission on February 17, 2009. | |
(2)
|
Incorporated herein by reference to Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on April 21, 2009. | |
(3)
|
Incorporated herein by reference to Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on August 25, 2010. | |
(4)
|
Incorporated herein by reference to Registrants Current Report on Form 8-K filed with the Securities and Exchange Commission on September 27, 2010. | |
(5)
|
Filed herewith |
41