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WAC > SEC Filings for WAC > Form 10-K on 14-Mar-2017All Recent SEC Filings




Annual Report

The following discussion should be read in conjunction with our Consolidated Financial Statements and notes thereto included in this report. This discussion contains a number of forward-looking statements, all of which are based on our current expectations and all of which could be affected by uncertainties and risks. Our actual results may differ materially from the results contemplated in these forward-looking statements as a result of many factors including, but not limited to, those described in Part I, Item 1A. Risk Factors. Historical results and trends that might appear should not be taken as indicative of future operations, particularly in light of our recent acquisitions and regulatory developments discussed throughout this report. Refer to the Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 section located in the forepart in this report for a discussion regarding forward-looking statements.

Defined terms used in this Annual Report on Form 10-K are defined in the Glossary of Terms.
Executive Summary
The Company
We are an independent servicer and originator of mortgage loans and servicer of reverse mortgage loans. We service a wide array of loans across the credit spectrum for our own portfolio and for GSEs, government agencies, third-party securitization trusts and other credit owners. Through our consumer, correspondent and wholesale lending channels, we originate and purchase residential mortgage loans that we predominantly sell to GSEs and government agencies. We also operate two supplementary businesses; asset receivables management and real estate owned property management and disposition. Our goal is to become a partner with our customers; assisting them with the originations process and through the life of their loan, with a highly regarded originations and servicing platform and quality customer service in an open, honest and straightforward manner.
At December 31, 2016, we serviced 2.1 million residential loans with a total unpaid principal balance of $246.4 billion. We originated $20.3 billion in mortgage loan volume in 2016.

Part of our strategy is to move towards more of a fee-for-service model in our servicing business by increasing the proportion of subservicing activity in our business mix. For example, in 2016, we entered into several transactions with NRM pursuant to which we sold MSR to NRM and were retained by NRM to subservice these and other MSR. Largely as a result of these transactions, and based on unpaid principal loan balance, the portion of our servicing portfolio represented by subservicing rose from 21% (or $56.8 billion in unpaid principal loan balance) at the end of 2015 to 49% (or $120.8 billion in unpaid principal loan balance) at the end of 2016. Our subservicing fees vary considerably from contract to contract, and in general subservicing fees are lower than the servicing fee associated with owning the MSR and servicing the related loans. Therefore, our servicing revenues have been and are expected to continue to be negatively affected by the sale of our MSR, even in situations where we are engaged to subservice the loans relating to such MSR following their sale. However, as the portion of our servicing portfolio represented by subservicing increases, we generally expect to benefit from lower advance funding costs and from the elimination of amortization charges associated with the MSR we have sold.

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During 2016, we added to the unpaid principal balance of our third-party mortgage loan servicing portfolio with $13.9 billion relating to servicing rights capitalized upon the sale of mortgage loans, $11.1 billion relating to subservicing contracts and $5.2 billion relating to acquired servicing rights, which was more than offset by $51.0 billion of payoffs and sales, net of recapture activities. In addition, we added to the unpaid principal balance to our third-party reverse loan servicing portfolio with $2.6 billion in new business and tails, which was partially offset by $2.1 billion in payoffs, sales and curtailments. Also in 2016, we originated and purchased $872.2 million in reverse mortgage volume and issued $868.0 million in HMBS.
Our mortgage loan originations business diversifies our revenue base and helps us replenish our servicing portfolio. During 2016, we originated $6.8 billion of mortgage loans, the majority of which resulted from retention activities associated with our existing servicing portfolio. In addition, we purchased $13.5 billion of mortgage loans through our correspondent channel during 2016. Substantially all of these purchased and originated mortgage loans were added to our servicing portfolio upon loan sale.
We manage our Company in three reportable segments: Servicing, Originations, and Reverse Mortgage. A description of the business conducted by each of these segments is provided below:
Servicing - Our Servicing segment performs servicing for our own mortgage loan portfolio and on behalf of third-party credit owners of mortgage loans for a fee and also performs subservicing for third-party owners of MSR. The Servicing segment also operates complementary businesses including a collections agency that performs collections of post charge-off deficiency balances for third parties and us. In addition, the Servicing segment holds the assets and mortgage-backed debt of the Residual Trusts.
Originations - Our Originations segment originates and purchases mortgage loans that are intended for sale to third parties. In 2016, the mix of mortgage loans sold by our Originations segment, based on unpaid principal balance, consisted of (i) 47% Fannie Mae conventional conforming loans, (ii) 39% Ginnie Mae loans and (iii) 14% Freddie Mac conventional conforming loans.
Reverse Mortgage - Our Reverse Mortgage segment primarily focuses on the servicing of reverse loans. In December 2016, management decided to exit the reverse mortgage originations business, which occurred in January 2017. We intend to fulfill reverse loans in our originations pipeline consistent with our underwriting practices and to fund undrawn amounts available to borrowers, and we will continue to service reverse loans. Reverse loan originations were historically conducted through our consumer direct, consumer retail, wholesale and correspondent lending origination channels.
Other - As of December 31, 2016, our Other non-reportable segment holds the assets and liabilities of the Non-Residual Trusts and corporate debt. This segment also includes our asset management business, which we are in the process of winding down.
Our Servicing segment revenue is primarily impacted by the size and mix of our capitalized servicing and subservicing portfolios and is generated through servicing of mortgage loans for clients and/or credit owners. Net servicing revenue and fees include the change in fair value of servicing rights carried at fair value and the amortization of all other servicing rights. Our servicing fee income generation is influenced by the volume and timing of entrance into subservicing contracts and purchases and sales of servicing rights. The fair value of our servicing rights is largely dependent on the size of the related portfolio, discount rates, and prepayment and default speeds. Our Originations segment revenue, which is primarily comprised of net gains on sales of loans, is impacted by interest rates and the volume of loans locked as well as the margins earned in our various origination channels. Net gains on sales of loans include the cost of additions to the representations and warranties reserve. Our Reverse Mortgage segment has historically been impacted by new origination reverse loan volume, draws on existing reverse loans, subservicing contracts and the fair value of reverse loans and HMBS.
Our results of operations are also affected by expenses such as salaries and benefits, information technology, occupancy, legal and professional fees, the provision for advances, curtailment, interest expense and other operating expenses. In addition, during 2016, 2015 and 2014, our expenses were impacted by non-cash goodwill and intangible assets impairment charges of $326.3 million, $207.6 million and $82.3 million, respectively. Refer to the Financial Highlights, Results of Operations and Business Segment Results sections below for further information.

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Our profitability for the Reverse segment has been and will continue to be negatively impacted by the level of defaults we are experiencing with HECM loans originated pre-2014, before the product was changed to introduce financial assessment requirements and to limit initial draws. When a HECM loan is in default, we earn interest at the debenture rate, which is generally lower than the note rate we must pay. Additionally, if we miss HUD prescribed milestones in the foreclosure and claims filing process, HUD curtails the debenture interest being earned on loans in default. During late 2015 and early 2016 we experienced an acceleration in the number of reverse loans in default, in part because of new HUD regulations that required servicers to foreclose more quickly on delinquent reverse loans. This increase in default levels was somewhat mitigated during the latter part of 2016 when HUD allowed for a de minimis amount for non-payment of taxes and insurance. As a result of this change, there were defaults that were cured. For loans in default, servicing costs generally increase as a result of foreclosure related activities such as legal costs, property preservation expense and other costs that arise on loans in default, which may also include bankruptcy related activities. In addition, after a foreclosure sale occurs and title to the property is obtained, we become responsible for the sale of the REO property. If we are unable to sell the property underlying a defaulted reverse loan for an acceptable price within the timeframe established by HUD, we are required to make an appraisal-based claims to HUD. In such case, HUD will reimburse us for the loan balance, eligible expenses and debenture interest, less the appraised value of the underlying property, and thereafter all the risk and cost associated with maintaining and liquidating the property remains with us. The Reverse segment has sold approximately 23.7% of its REO property through appraisal based claims, with a loss severity rate of approximately 13.5%. During 2016, the Reverse segment incurred approximately $5.7 million in losses resulting from REO sold through appraisal based claims filed during 2016 or in prior years. The Company may incur additional losses on these REO properties as they progress through the claims and liquidation processes. The significance of future losses associated with appraisal-based claims is dependent upon the volume of defaulted loans, condition of foreclosed properties and the general real estate market environment.
Our principal sources of liquidity are the cash flows generated from our business segments and funds available from our master repurchase agreements, mortgage loan servicing advance facilities, the 2013 Revolver and issuance of GMBS and HMBS to fund our tail commitments. We may generate additional liquidity through sales of MSR, any portion thereof, or other assets. Refer to the Liquidity and Capital Resources section below for additional information. Financial Highlights
2016 Compared to 2015
Total revenues for 2016 were $1.0 billion, which represented a decline of $278.5 million, or 22%, as compared to 2015. The decline in revenue reflects a $153.3 million decrease in net servicing revenue and fees driven by $78.5 million in higher fair value losses on servicing rights, $47.4 million in lower incentive and performance fees and $28.5 million in lower servicing fees; $44.4 million in lower net gains on sales of loans; and $28.7 million in lower interest income on loans.
During 2016, we recorded higher fair value losses on our servicing rights carried at fair value as a result of decreasing interest rates and forward projections of the interest rate curve during the first half of 2016. We recognized lower incentive and performance fees due primarily to lower real estate management fees resulting from the phase out of one of our larger arrangements for the management of real estate owned, and lower HAMP fees earned for continued performance of modified loans as fewer loans were eligible for these fees leading up to the expiration of HAMP. We recognized lower servicing fees due primarily to a combination of runoff of our third-party servicing portfolio, a shift in the portfolio from servicing to subservicing resulting from the sale of servicing rights to NRM, and an overall increase in delinquencies. We had lower net gains on sales of loans due primarily to a lower volume of locked loans, offset partially by a shift in mix from the lower margin correspondent channel to the higher margin consumer channel. We had lower interest income on loans primarily due to the sale of our residual interests in seven of the Residual Trusts in April 2015, or the sale of our residual interests.
Total expenses for 2016 were $1.8 billion, which represented an increase of $80.4 million, or 5%, as compared to 2015, which reflects $118.7 million in higher goodwill and intangible assets impairment and $45.7 million in higher general and administrative expenses, offset in part by $56.5 million in lower salaries and benefits and $17.8 million in lower interest expense. We recorded $326.3 million, $207.6 million and $82.3 million in goodwill and intangible assets impairment charges during 2016, 2015 and 2014, respectively. These impairment charges were the result of certain market, industry and company-specific matters as discussed in more detail in Note 14 to the Consolidated Financial Statements.

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During 2016, we had higher general and administrative expenses due in part to support efficiency and technology-related initiatives, higher severance and transformation costs, and elevated advance provisions and other costs resulting from operational challenges within default servicing, partially offset by savings from cost reduction efforts. We had lower salaries and benefits primarily due to a decrease in compensation, benefits and incentives resulting from a lower average headcount driven by site closures and reorganization, a decrease in commissions and incentives due to lower originations volume, and a decrease in share-based compensation due to higher forfeitures, partially offset by an increase in severance. We had lower interest expense related primarily to mortgage-backed debt as a result of the sale of our residual interests, which required the deconsolidation of the related mortgage-backed debt.
As of December 31, 2016, we identified a material weakness in internal controls over operational processes within the transaction level processing of Ditech Financial default servicing activities. Specifically, we did not design and maintain effective controls related to our ability to identify foreclosure tax liens and resolve such liens timely, foreclosure related advances, and the processing and oversight of loans in bankruptcy status. This resulted in several adjustments to reserves during the fourth quarter of 2016 totaling $16.3 million for exposures related to deficient processes within the operating control environment for default servicing.
Net gains on extinguishment of debt of $14.7 million during 2016 were primarily attributable to the repurchase of a portion of our Convertible Notes with a carrying value of $39.3 million, which resulted in a gain of $14.5 million. During the second quarter of 2016, Ditech Financial transitioned approximately 1.4 million loans, or greater than 60% of our mortgage loan servicing portfolio, to MSP, the industry-standard loan servicing platform. The conversion resulted in a reduction to servicer payables and related restricted cash balances as a result of changes in the structure and timing of the flow of funds. The conversion also had an indirect impact on other balances included in the Servicing segment, which is discussed in further detail under the Business Segment Results section below.
Our cash flows provided by operating activities were $452.0 million during 2016 and we ended the year with $224.6 million in cash and cash equivalents. Cash provided by operating activities increased by $500.0 million during 2016 as compared to net cash used in operating activities in 2015. The increase in cash provided by operating activities was primarily a result of an increase in cash provided by origination activities resulting from a higher volume of loans sold in relation to loans originated for 2016 as compared to 2015 and a decrease in servicer and protective advances resulting largely from advance reimbursements received in connection with Fannie Mae and Freddie Mac loan sales and NRM MSR sales as well as increased collections.
2015 Compared to 2014
Total revenues for 2015 were $1.3 billion, which represented a decline of $212.9 million, or 14%, as compared to 2014. The decrease in revenue reflects a $107.2 million decrease in net servicing revenue and fees, primarily driven by $128.5 million in higher fair value losses on servicing rights; $60.2 million in lower interest income on loans; $11.7 million in lower net fair value gains on reverse loans and related HMBS obligations; and $8.3 million in lower net gains on sales of loans.
We recorded fair value losses on our servicing rights carried at fair value primarily as a result of higher discount rates used to value our servicing rights and higher realization of expected cash flows. We had lower interest income on loans primarily due to the sale of our residual interests. We had lower net fair value gains on reverse loans and related HMBS obligations primarily due to the widening of spreads resulting from changes in market pricing for HECMs and HMBS and a lower reduction of LIBOR in 2015 as compared to 2014, offset partially by an increase in cash generated by origination, purchase and securitization of HECMs. We had lower net gains on sales of loans due primarily to a shift in volume from the higher margin retention channel to the lower margin correspondent channel, even though average interest rates were lower during 2015 as compared to 2014 and these lower rates gave rise to a higher total volume of locked loans.
Total expenses for 2015 were $1.7 billion, which represented an increase of $86.7 million, or 5%, as compared to 2014. We incurred $56.5 million and $82.3 million in impairment charges in the Reverse Mortgage reporting unit during the years ended December 31, 2015 and 2014, respectively, and $151.0 million in impairment charges in our Servicing reporting unit during the year ended December 31, 2015. As a result of the goodwill impairment charges in the Reverse Mortgage reporting unit, this reporting unit no longer has goodwill. In addition, we had $33.5 million in lower interest expense related to mortgage-backed debt primarily due to the aforementioned sale of our residual interests, which required the deconsolidation of the related mortgage-backed debt.
We recognized total other gains of $33.1 million in 2015, which were primarily attributable to an $11.8 million gain recognized on the sale of an equity-method investment, an $8.9 million gain realized on the sale of a trading security, and a $7.3 million net fair value gain relating to the Non-Residual Trusts.

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Our cash flows used in operating activities were $48.1 million during 2015 and we ended the year with $202.8 million in cash and cash equivalents. Cash used in operating activities decreased by $156.2 million during 2015 as compared to 2014. The decrease in cash used in operating activities was primarily a result of an increase in cash related to changes in assets and liabilities, including higher collections of servicer and protective advances and an increase in accrued expenses related to uncertain tax positions, partially offset by higher settlements of payables relating to servicer and protective advances acquired in conjunction with the acquisition of servicing rights and a decrease in accrued expenses related to legal and regulatory matters. In addition, cash increased due to proceeds received from the sale of a trading security received as consideration for the sale of the excess servicing spread associated with certain servicing rights. These increases were partially offset by a decrease in cash related to a lower volume of loans sold in relation to originated loans. Refer to the Results of Operations and Business Segment Results sections below for further information on the changes addressed above. Also included in the Business Segment Results section is a discussion of changes in our non-GAAP financial measures. A description of our non-GAAP financial measures is included in the Non-GAAP Financial Measures section below. Regulatory Developments
For a summary of the regulatory framework under which we operate and recent regulatory developments, refer to the Laws and Regulations section of Part I, Item 1. Business.
During the fourth quarter of 2016, after the appointment of Anthony Renzi as the Company's Chief Executive Officer, the Company made extensive changes to its leadership team, installing among other things new heads of compliance, default servicing, performing servicing, reverse mortgage, and human resources. In conjunction with the Board, this new leadership team has developed a strategy and business plan for 2017 that is focused on the company's core mortgage servicing and origination businesses, with a view to improving both financial and operating performance significantly during the year.
In servicing, we expect to execute numerous initiatives to improve the efficiency of our operations, through such measures as better processes, site consolidation and improved use of technology. We are also concentrating on improving the performance of our servicing business, customer service, and reversing the recent increase in delinquency rates and improving standards and compliance. We plan to prioritize these initiatives over the pursuit of significant new servicing or subservicing opportunities, though over time as we improve operations we aim to be able to compete effectively and profitably for opportunities to subservice for others.
In originations, our goal is to achieve significant revenue growth over time, primarily from increased wholesale lending, increased outbound contact efforts and improved retention. As we endeavor to expand our originations business, we expect that we will need to increase significantly the amount of purchase money loans we originate, particularly in our consumer direct and wholesale channels. This will require us to enhance our brand awareness among potential customers, and we are working on plans to develop a digital marketing presence. In addition, we believe that to achieve our originations goals we need to enable consumers to apply for mortgages through our website. We recently abandoned a software project we had been supporting to develop a website-based application system, and we are now considering vendors who could assist with re-initiating this project. Further, our strategy will require us to hire a considerable number of new loan officers and other employees.
In the reverse segment, having exited the originations business, we are working to improve the efficiency of our servicing activities in order to reduce expected future losses. We have also been evaluating options for our reverse mortgage business, including the possibility of selling some or all of its assets or pursuing alternative solutions for the business that include collaboration with other parties.
Improving the effectiveness and efficiency of our information technology group is an important element of our strategy across all of our operations. We use numerous systems and incur considerable expense to support our lending, servicing, reverse and other business activities. We have initiated measures to reduce the complexity and cost of our information technology operations and are continuing our review of this function to identify further areas of opportunity. Investments in MSR
From time to time over the past five years, to support our servicing business, we have bought or sold MSR. With a view to using our capital efficiently, in 2016 we began to limit our investment in MSR. We plan to continue that approach in the future and to move towards more of a fee-for-service model in the servicing business. Accordingly, we expect that from time to time we will sell MSR we now own or those we create in connection with our mortgage origination activities. See the Subservicing section under Part I, Item 1. Business. We expect that normally we will retain the right to subservice such MSR sold by us, but we may also sell MSR with servicing released. We may also engage in other transactions to limit or reduce our investment in MSR, including sales of excess servicing spread.

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In 2016, we executed a number of transactions that helped us reduce our investment in MSR. In particular, we entered into a several transactions with NRM pursuant to which we sold MSR to NRM and were retained by NRM to subservice these and other MSR. Refer to Note 4 to the Consolidated Financial Statements for additional information on transactions with NRM. We may seek to sell additional MSR to NRM in the future and may also seek to enter into arrangements to sell MSR to other buyers.
In November 2016, NRM also entered into a mortgage servicing right purchase and sale agreement with WCO. In connection with the completion of this transaction and the other transactions relating to the sale of substantially all of WCO's assets in December 2016, WCO commenced liquidation activities and we do not expect to sell further assets to WCO.
Non-Core Assets
Since early 2015, we have sold various assets we considered to be "non-core" or "legacy" assets. These transactions included the sale of an equity method investment in the first quarter of 2015 and the sale in April 2015 of the residual interests in seven of our Residual Trusts. Most recently, in December 2016 we executed a stock purchase agreement to sell our insurance business for a cash purchase price of $125.0 million, subject to adjustment, with potential earnout payments of up to $25.0 million in cash. This transaction was completed in February 2017. During the year ended December 31, 2016, the insurance business generated income before taxes of $24.6 million.
We are actively reviewing our assets and activities to determine those that should be considered "core" or "non-core" in relation to our strategic goals. Assets and activities that we identify as "non-core" will include non-strategic operations, locations and portfolios. These may in the future may be sold, wound down or otherwise managed in a manner designed to limit the investment, costs and attention we are required to devote to them. Debt Restructuring Initiative
We are a highly leveraged company, in relation to our ability to service our debt and on a relative basis in comparison to our peers. We depend upon ongoing access to the loan markets and the capital markets on commercially satisfactory terms to finance our business on a daily basis, and we would also need access to those markets to refinance our corporate debt. We have engaged legal and financial debt restructuring advisors and have been reviewing a number of potential actions we may take to reduce our leverage. There can be no assurance as to when or whether we will determine to implement any action as a result of this review, whether the implementation of one or more such actions will be successful, or the effects the failure to take action may have on our business, our ability to achieve our operational and strategic goals or our ability to finance our business or refinance our indebtedness. The failure to develop and . . .

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