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SGM > SEC Filings for SGM > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for STONEGATE MORTGAGE CORP

Form 10-K for STONEGATE MORTGAGE CORP


14-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data or As Otherwise Stated Herein)
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with our audited consolidated financial statements and related notes as of and for the years ended December 31, 2013, 2012 and 2011, included in Part II, Item 8 of this Annual Report on Form 10-K. This MD&A contains forward-looking statements that involve risk, uncertainties and assumptions. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of many factors, including those discussed in "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K. As used in this discussion and analysis, unless the context otherwise requires or indicates, references to "the Company," "our company," "we," "our" and "us" refer to Stonegate Mortgage Corporation and its consolidated subsidiaries.

Overview
We are a non-bank integrated mortgage company focused on the U.S. residential mortgage market. We were initially incorporated in the State of Indiana in January 2005. As a result of an acquisition and subsequent merger with Swain Mortgage Company in 2009, we are now an Ohio corporation. We originate, acquire, sell, finance and service residential mortgage loans. We predominantly sell mortgage loans to the Federal National Mortgage Association ("Fannie Mae" or "FNMA"), to the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC") and in Government National Mortgage Association ("Ginnie Mae" or "GNMA") pools of mortgage backed securities ("MBS"). We also sell mortgage loans to other third-party investors in the secondary market and provide short-term warehouse financing to other residential mortgage loan originators. As of December 31, 2013, we were licensed to originate and service residential mortgage loans in 45 states and Washington, D.C., and we are an approved Seller Servicer of FNMA, FHLMC and GNMA. We intend to become licensed in the final three of the contiguous United States, New York, Vermont and Nevada, in 2014. We derive our revenue from three principal sources: mortgage origination, mortgage servicing and mortgage financing. Our mortgage origination business generates income primarily through origination fees and gains upon the sale of mortgage loans sourced through our correspondent, wholesale and retail channels. We also provide financing to our correspondent customers while they are accumulating loans prior to selling them to aggregators, including ourselves, through our mortgage financing business and we earn interest and fee income for these services. We also have the ability to retain the mortgage servicing rights ("MSRs") on the loans we sell and to create a recurring servicing income stream in our mortgage servicing business. We believe our three business lines are complementary and provide us with the ability to effectively and efficiently source, finance, sell and service mortgage loans. Mortgage Originations
Our mortgage origination business primarily originates and sells residential mortgage loans, which conform to the underwriting guidelines of the GSEs and government agencies. We also originate and sell jumbo loans, i.e., loans that conform to the underwriting guidelines of the GSEs, except that they exceed the maximum loan size allowed for single unit properties. For additional information regarding the mortgage loan products we offer, refer to the "Mortgage Originations" section included in Part I, Item 1 of this Annual Report on Form 10-K.
We originate residential mortgage loans through three channels: correspondent, wholesale and retail. Although the majority of our originations are currently through our correspondent channel, our presence in the wholesale and retail channels makes our platform both diversified and scalable. While the channels are diverse, we constantly focus on quality control and maintaining high underwriting standards. We perform diligence on and underwrite loans through our proprietary technology platform, Online Loan Information Exchange ("OLIE"), an integrated, automated risk-based due diligence engine that automates the review process by applying business rules specific to the loan and the seller. We analyze credit, collateral and compliance risk on every loan on a pre-funding or a pre-purchase basis in order to ensure that each loan meets our investors' standards and any applicable regulatory rules. We also capture loan data and documents associated with the loan from application through sale/securitization and servicing, giving us the ability to run additional business rules that provide indication of loan performance. We believe that the ability to offer greater transparency and data to institutional investors that purchase our loans or securities backed by our loans will provide us with a substantial advantage over our competitors in our sales executions as the mortgage market continues to evolve and we begin to securitize our own non-Agency mortgage loans. For additional information regarding our mortgage loan origination channels, refer to the "Mortgage Originations" section included in Part I, Item 1 of this Annual Report on Form 10-K.


Mortgage Servicing
Our mortgage servicing business is organized to maintain a high quality servicing portfolio and keep delinquency rates far below the industry average. We perform loan administration, collection and default activities, including the collection and remittance of loan payments, responding to customer inquiries, accounting for principal and interest, holding custodial (impound) funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures and our property dispositions. For additional information regarding our mortgage servicing business, refer to the "Mortgage Servicing" section included in Part I, Item 1 of this Annual Report on Form 10-K.
Mortgage Financing
We acquired our financing platform, known as NattyMac, in August 2012, and fully integrated the platform into our mortgage banking operations in December of 2012. Founded in 1994, NattyMac earlier operated as an independent mortgage warehouse lender focused on financing prime mortgage collateral, such as Agency-eligible, government insured and government guaranteed loans that were committed for purchase by GSEs. In June 2013, we consolidated our NattyMac financing platform into a wholly-owned subsidiary which will focus on providing warehouse financing to our correspondent customers and others. We expect that NattyMac will be able to leverage our proprietary technology and our existing due diligence and underwriting processes to efficiently underwrite the warehouse lines of credit it provides for our correspondents who are its customers and others. We are currently financing NattyMac's warehouse lending operations through the use of cash on hand and our existing financing facilities and continue to explore alternative financing opportunities. We intend for this to create an additional source of funding for our correspondents to originate mortgage loans that meet our underwriting requirements and are eligible for us and other investors to purchase. For additional information regarding our mortgage loan products, refer to the "Mortgage Financing" section included in

Part I, Item 1 of this Annual Report on Form 10-K.
Market Considerations
Mortgage Originations
Today's U.S. residential mortgage loan origination sector primarily offers conventional Agency and government conforming mortgage loans. Non-prime and alternative lending programs and products represent only a small fraction of total mortgage loan originations. This dynamic, along with increased capital requirements, increased regulatory and compliance burdens and increased risks associated with repurchase requirements, has led to a consolidation among mortgage lenders in both the retail and wholesale channels and has resulted in less competition. In addition to such consolidation, many mortgage loan originators have exited the market entirely.
Origination volume is impacted by changes in interest rates and the housing market. Overall originations volumes are down significantly in the current economic environment. According to Inside Mortgage Finance, total U.S. residential mortgage originations volume decreased from $3.0 trillion in 2006 to $1.9 trillion in 2013 and is projected to decrease further to an estimated $1.2 trillion during 2014. Depressed home prices and increased loan-to-value ratios may preclude many potential borrowers, including borrowers whose existing mortgage loans we service, from refinancing their existing mortgage loans. An increase in prevailing interest rates could also decrease origination volume. In addition, there continue to be changes in legislation and licensing in an effort to simplify the consumer mortgage loan experience, which require technological changes and additional implementation costs for mortgage loan originators. We expect legislative changes will continue in the foreseeable future, which may increase our operating expenses. For additional information, see "Regulation" within Part I, Item 1 "Business" of this Annual Report on Form 10-K.
Mortgage Servicing
The mortgage servicing industry is impacted by borrower delinquencies and foreclosure practices, and servicers require a high level of expertise to comply with ongoing mortgage servicing reform and standardization of servicing and foreclosure practices through the industry. The modification of our processes to adopt any new servicing and foreclosure standards may cause an increase in our operating expenses. For additional information, see "Regulation" within Part I, Item 1 "Business" of this Annual Report on Form 10-K.


Recent Industry Trends

Since June 2013, the U.S. residential mortgage industry has experienced an increase in interest rates. Industry-wide mortgage loan originations have declined as the recent increase in interest rates has made the refinancing of mortgage loans less attractive for borrowers. Increasing interest rates can have a direct impact on the operating results of companies in the mortgage industry, including on our operating results. An increase in interest rates generally could lead to the following, which may in the aggregate have an adverse effect on our results:

a reduction in origination and loan lock volumes;

a shift from loan refinancing volume to purchase loan volume;

        short-term contraction of the gain on sale margin of mortgage loans
         including negative fair market value adjustments on locked loans and
         loans held for sale;


        an increase in net interest income from financing (assuming a steeper
         forward yield curve);


        an increase in the value of mortgage servicing rights due to a decline
         in prepayment expectations; and

a reduction of gains from mortgage loan sales.

Performance Highlights

        Revenues of $157,947 for the year ended December 31, 2013, an increase
         of 69% compared to the year ended December 31, 2012.


        Net income of $22,598 for the year ended December 31, 2013, an increase
         of 32% compared to the year ended December 31, 2012.


        Diluted earnings per share ("EPS") of $1.32 for the year ended December
         31, 2013 a decrease of 42% compared to the year ended December 31, 2012.


        Mortgage loan originations of $8,706,887 for the year ended December 31,
         2013, an increase of 152% compared to the year ended December 31, 2012.


        Mortgage servicing portfolio of $11,923,510 as of December 31, 2013, an
         increase of 188% from December 31, 2012.

Non-GAAP Financial Measures
Our results of operations discussed throughout this MD&A are determined in accordance with U.S. generally accepted accounting principles ("GAAP"). We also calculate adjusted net income and adjusted diluted EPS as performance measures, which are considered non-GAAP financial measures under Regulation G and Item 10(e) of Regulation S-K, to further aid our investors in understanding and analyzing our core operating results and comparing them among periods. Adjusted net income and adjusted diluted EPS exclude certain items that we do not consider part of our core operating results including changes in valuation inputs and assumptions on our MSRs, the bargain purchase gain from our 2012 acquisition of NattyMac, interest expense related to the financing of our term loan with an investor (including warrants issued), certain other non-cash expense items and ramp-up costs associated with the launch of our non-agency jumbo loan origination program and Nationstar business. These ramp-up costs include the advance hiring of servicing and origination staff, recruiting expenses, travel, licensing and legal expenses. In addition, adjusted net income excludes certain other non-routine income and expenses, primarily non-deferrable expenses associated with our private equity and initial public offerings and acquisition costs related to business combinations. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for income before income taxes, net income or diluted EPS prepared in accordance with GAAP.
In addition, adjusted net income has limitations as an analytical tool, including but not limited to the following:

          adjusted net income does not reflect our cash expenditures or future
           requirements for capital expenditures or contractual commitments;


          adjusted net income does not reflect changes in, or cash requirements
           for, our working capital needs;


          adjusted net income does not reflect the cash requirements necessary
           to service principal payments related to the financing of the
           business; and


          other companies in our industry may calculate adjusted net income
           differently, thereby limiting its usefulness as a comparative measure.

Because of these and other limitations, adjusted net income should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. Adjusted net income is a performance measure and is presented to provide additional information about our core operations.


The table below reconciles net income and diluted EPS to adjusted net income and adjusted diluted EPS (which are the most directly comparable GAAP measures) for the years ended December 31, 2013, 2012 and 2011:

                                   Years Ended December 31,             2013 vs. 2012            2012 vs. 2011
                                2013          2012        2011       $ Change    % Change     $ Change    % Change
Net income                    $ 22,598     $ 17,085     $ 2,335     $  5,513         32  %   $ 14,750         632 %
Adjustments:
Interest expense associated
with term loan                   1,587            -           -        1,587        N/A             -         N/A
Changes in valuation inputs
and assumptions on MSRs        (22,967 )          -           -      (22,967 )      N/A             -         N/A
Impairment of MSRs                   -       11,698           2      (11,698 )     (100 )%     11,696     584,800 %
Stock-based compensation
expense                          2,579           13           -        2,566     19,738  %         13         N/A
Ramp-up and other non-routine
expenses                         7,386            -           -        7,386        N/A             -         N/A
Bargain purchase gain                -       (1,172 )         -        1,172       (100 )%     (1,172 )       N/A
Acquisition costs                  146          406           -         (260 )      (64 )%        406         N/A
Tax effect of adjustments        4,238       (4,225 )        (1 )      8,463       (200 )%     (4,224 )   422,400 %
Adjusted net income           $ 15,567     $ 23,805     $ 2,336     $ (8,238 )      (35 )%   $ 21,469         919 %

Diluted EPS                   $   1.32     $   2.26     $  0.59     $  (0.94 )      (42 )%   $   1.67         283 %
Adjustments:
Interest expense associated
with term loan                    0.09            -           -         0.09        N/A             -         N/A
Changes in valuation inputs
and assumptions on MSRs          (1.34 )          -           -        (1.34 )      N/A             -         N/A
Impairment of MSRs                   -         1.56           -        (1.56 )     (100 )%       1.56         N/A
Stock-based compensation
expense                           0.15            -           -         0.15        N/A             -         N/A
Ramp-up and other non-routine
expenses                          0.43            -           -         0.43        N/A             -         N/A
Bargain purchase gain                -        (0.15 )         -         0.15       (100 )%      (0.15 )       N/A
Acquisition costs                 0.01         0.05           -        (0.04 )      (80 )%       0.05         N/A
Tax effect of adjustments         0.25        (0.56 )         -         0.81       (145 )%      (0.56 )       N/A
Adjusted diluted EPS          $   0.91     $   3.16     $  0.59     $  (2.25 )      (71 )%   $   2.57         436 %

Adjusted net income decreased $8,238, or 35%, for the year ended December 31, 2013 as compared to the year ended December 31, 2012. The decrease was primarily attributable to margin compression from an increase in originations from the correspondent channel, which typically has lower profit margins. In addition, higher operating expenses as a result of our rapid growth and expansion caused increases in compensation, facilities and professional services expenses. Adjusted diluted EPS decreased $2.25, or 71%, for the year ended December 31, 2013 as compared to the year ended year ended December 31, 2012. The decrease was primarily attributable to the previously discussed decrease in adjusted net income as well as the dilution associated with higher weighted average shares outstanding as a result of our equity offerings during 2013.

Significant Transactions

Acquisition of Crossline Capital, Inc.

On December 19, 2013, we acquired Crossline Capital, Inc. ("Crossline"), a California-based mortgage lender that originates and services residential mortgages. The acquisition of Crossline will allow the Company to increase its origination volume through geographic expansion. Crossline is licensed to originate mortgages in 20 states including Arizona, California, Colorado, Connecticut, Florida, Georgia, Idaho, Maryland, Massachusetts, New Hampshire, New Mexico, North Carolina, Ohio, Oregon, Pennsylvania, Rhode Island, Texas, Utah, Virginia and Washington, and is an approved FNMA Seller Servicer. In addition, Crossline operates two national mortgage origination call centers in Lake Forest, California and Scottsdale, Arizona and also operates retail mortgage origination branches in seven other locations in Southern California. Total consideration for Crossline, which, along with working capital for the business, has or will be funded out of our existing cash resources and line of credit facilities with our warehouse lenders, was $11,471, which includes cash consideration of $9,765 and contingent consideration based primarily on future origination volume estimated to be $1,706 at the acquisition date. Crossline contributed approximately $20,861 in mortgage loan originations during the year ended December 31, 2013 (during the period between the December 19, 2013 acquisition date and December 31, 2013). For additional information regarding this transaction, refer to Note 4, "Business Combinations," to our audited consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.


Acquisition of Wholesale Channel and Retail Assets from Nationstar Mortgage Holdings, Inc.

On November 29, 2013, we acquired the wholesale lending channel and certain distributed retail assets of Nationstar Mortgage Holdings Inc. ("Nationstar"). The acquisition of Nationstar's wholesale lending channel and retail assets complement our existing wholesale and retail channels and accelerates our geographic retail channel expansion. In the acquisition, we agreed to purchase the assets and offer employment to certain employees associated with these businesses. The cash purchase price for the assets acquired from Nationstar was $484, which, along with working capital for the business, was funded out of our existing cash resources and line of credit facilities with our warehouse lenders. For additional information regarding this transaction, refer to Note 4, "Business Combinations," to our audited consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Initial Public Offering
On October 16, 2013, we completed our initial public offering of 8,165,000 shares of common stock (including 1,065,000 shares exercised pursuant to an overallotment option granted to the underwriters) at a price to the public of $16.00 per share, resulting in initial net proceeds of $123,928 after deducting underwriting discounts and commissions of approximately $6,712. In addition, we incurred $3,259 of issuance costs associated with the initial public offering. We intend to use the net proceeds of our initial public offering to make investments related to our business and for other general corporate purposes. Additionally, we may choose to expand our business through acquisitions of or investments in other businesses using cash or shares of our common stock.

Launch of Non-Agency Jumbo Loans

During the third quarter of 2013, we launched our non-agency jumbo loan program, which includes mortgage loans exceeding the conforming loan limits of FNMA and FHLMC (the "GSEs"). Under current limits, a jumbo loan represents a mortgage loan of more than $417, or, in certain geographies where homes are considered high cost, a mortgage loan of more than $626. During the year ended December 31, 2013, our non-agency jumbo loan originations totaled $7,387. We expect our non-agency jumbo loan originations to grow in the future as we expand into new geographic markets and continue our marketing efforts related to this program. During the year ended December 31, 2013, we entered into loan sale agreements with two additional financial institutions, expanding our capability to sell non-agency jumbo loans direct to secondary market investors.

Private Offering

On May 15, 2013, we completed a private offering of 6,388,889 shares of common stock at a per-share price of $18.00, resulting in initial net proceeds of $107,300 after deducting the initial purchaser's discount and placement fee of approximately $7,700. In addition, we incurred $2,700 of issuance costs associated with the private offering. We used the net proceeds of our private offering to make investments related to our business and for other general corporate purposes.

Acquisition of Assets from NattyMac, LLC

On August 30, 2012, we acquired all rights, title and interest in the assets of the NattyMac, LLC ("NattyMac") single-family mortgage loan warehousing business for total consideration of $2,607, which included cash consideration of $512 and contingent consideration based on future funding volume estimated to be $2,095 at the acquisition date. Founded in 1994 in St. Petersburg, FL, NattyMac operated as an independent mortgage warehouse lender focused on financing prime mortgage loans that were committed for purchase by GSEs. NattyMac's strong reputation in the mortgage banking industry, along with its warehouse financing platform and experienced staff, has complemented the Company's existing business and allowed the Company to provide an additional source of funding to its correspondent customers beginning in the third quarter of 2013. We are currently financing NattyMac's warehouse lending operations through the use of cash on hand and our existing financing facilities and continue to explore alternative financing opportunities. For additional information related to this acquisition, refer to Note 4, "Business Combinations," to our audited consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Change in Accounting for Mortgage Servicing Rights Effective January 1, 2013, the Company irrevocably elected to account for the subsequent measurement of its existing mortgage servicing rights ("MSRs") using the fair value method, whereby the MSRs are initially recorded on our balance sheet at fair value with subsequent changes in fair value recorded in earnings during the period in which the changes in fair value occur. We believe that accounting for the MSRs at fair value best reflects the impact of current market conditions on our MSRs, and our investors and other users of our financial statements will have greater insight into management's views as to the value of our MSRs at each reporting date. Prior to January 1, 2013, the Company accounted for the subsequent


measurement of its MSRs at the lower of amortized cost or estimated fair value (the "amortization method"), whereby the MSRs were initially recorded on our balance sheet at fair value and subsequently amortized in proportion to and over the period of estimated net servicing income. In addition, under the amortization method, the carrying value of the MSRs was periodically assessed for impairment at each balance sheet date. In accordance with the applicable GAAP guidance, this change in accounting principle was accounted for on a prospective basis (financial statement periods prior to 2013 have not been restated). We did not record a cumulative-effect adjustment to retained earnings as of January 1, 2013, as the net amortized carrying value of the existing MSRs as of January 1, 2013 equaled the fair value at such date due to MSR impairment charges recorded during 2012. Beginning with January 1, 2013, the net changes in the fair value in our MSRs are reported in our consolidated statement of operations within "Changes in mortgage servicing rights valuation."

Recent Developments

Acquisition of Medallion Mortgage Company

On February 4, 2014, we completed our acquisition of Medallion Mortgage Company ("Medallion"), a residential mortgage originator based in southern California. Medallion originated more than $400,000 in mortgage loans during the year ended December 31, 2013 through its California and Utah locations, serving customers with an extensive portfolio of residential real estate loan programs. The acquisition of Medallion included 10 offices along the southern and central coast of California, Utah and a new operations center in Ventura, California. In the acquisition of Medallion, we agreed to purchase certain assets, assume certain liabilities and offer employment to certain employees. The cash consideration for this acquisition was $258. Consideration yet to be paid for this acquisition also includes contingent consideration based upon future origination volume, for which we have not yet determined the acquisition date fair value. The contingent consideration is conditional upon Medallion achieving certain predetermined minimum mortgage loan origination goals during the two year period following the acquisition date and is uncapped in amount. Total . . .

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