11. Servicing of Residential Loans

The Company provides servicing for credit-sensitive consumer loans including residential mortgages, manufactured housing and consumer installment loans, and reverse mortgage loans for third parties, as well as for loans recognized on the consolidated balance sheets. The Company also services loans originated and purchased by the Company and sold with servicing rights retained. The Company’s total servicing portfolio consists of accounts serviced for others for which servicing rights have been capitalized, accounts sub-serviced for others, as well as residential loans and real estate owned recognized on the consolidated balance sheets. In connection with recent acquisitions, the Company capitalized the servicing rights associated with servicing and sub-servicing agreements in existence at the dates of acquisition.

Provided below is a summary of the Company’s total servicing portfolio (dollars in thousands):


	September 30, 2013				December 31, 2012
	Number of Accounts		Unpaid Principal Balance		Number of Accounts		Unpaid Principal Balance
Third-party investors ⁽¹⁾
Capitalized servicing rights		1,292,070	$	139,480,153		415,617	$	23,469,620
Capitalized sub-servicing ⁽²⁾		256,514		14,188,764		289,417		16,333,529
Sub-servicing		264,535		44,452,321		240,226		42,310,373

Total third-party servicing portfolio		1,813,119		198,121,238		945,260		82,113,522
On-balance sheet residential loans and real estate owned		111,517		11,262,424		93,721		7,980,667


Total servicing portfolio		1,924,636	$	209,383,662		1,038,981	$	90,094,189

(1)	Includes real estate owned serviced for third parties.

(2)	Consists of sub-servicing contracts held by Green Tree and RMS at their respective dates of the acquisition.

The Company’s geographic diversification of its third-party servicing portfolio, based on outstanding unpaid principal balance, is as follows (dollars in thousands):


	September 30, 2013							December 31, 2012
	Number of Accounts		Unpaid Principal Balance		Percentage of Total			Number of Accounts		Unpaid Principal Balance		Percentage of Total
California		203,255	$	35,039,332		17.7	%		81,547	$	16,073,080		19.6	%
Florida		167,392		20,582,925		10.4	%		91,318		10,476,321		12.8	%
Texas		142,290		10,306,953		5.2	%		86,406		3,621,528		4.4	%
Other < 5%		1,300,182		132,192,028		66.7	%		685,989		51,942,593		63.2	%

Total		1,813,119	$	198,121,238		100.0	%		945,260	$	82,113,522		100.0	%

Net Servicing Revenue and Fees

The Company services residential mortgage loans, including reverse mortgage loans, manufactured housing and consumer installment loans, for itself and third parties. The Company earns servicing income from its third-party servicing portfolio. The following table presents the components of net servicing revenue and fees, which includes revenues earned by the Servicing, Asset Receivables Management and Reverse Mortgage segments (in thousands):


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2013			2012			2013			2012
Servicing fees	$	140,267		$	66,034		$	403,612		$	205,637
Incentive and performance fees		38,424			25,251			106,031			71,972
Ancillary and other fees ⁽¹⁾		25,522			9,742			67,416			27,947

Servicing revenue and fees		204,213			101,027			577,059			305,556
Amortization of servicing rights		(10,779	)		(11,683	)		(33,312	)		(37,809	)
Change in fair value of servicing rights		25,297			—			69,299			—

Net servicing revenue and fees	$	218,731		$	89,344		$	613,046		$	267,747

(1)	Includes late fees of $11.7 million and $4.3 million for the three months ended September 30, 2013 and 2012, respectively, and $28.7 million and $11.1 million for the nine months ended September 30, 2013 and 2012, respectively.

Servicing Rights

Servicing rights are represented by three classes, which consist of a risk-managed loan class, a forward loan class and a reverse loan class. These classes are based on the availability of market inputs used in determining the fair values of servicing rights and the Company’s planned risk management strategy associated with the servicing rights. At initial recognition, the fair value of the servicing right is established using assumptions consistent with those used to establish the fair value of existing servicing rights. Subsequent to initial capitalization, servicing rights are accounted for using either the fair value method or the amortization method based on the servicing class. Servicing rights accounted for at amortized cost consist of the forward loan class and the reverse loan class. Servicing rights accounted for at fair value consist of the risk-managed loan class.

Servicing Rights at Amortized Cost

The amortization of servicing rights is recorded in net servicing revenue and fees in the consolidated statements of comprehensive income. The following tables summarize the activity in the carrying value of servicing rights accounted for at amortized cost by class (in thousands):


	For the Three Months Ended September 30,
	2013									2012
	Forward Loans			Reverse Loans			Total			Forward Loans
Balance at beginning of period	$	180,002		$	13,831		$	193,833		$	224,203
Purchases		—			—			—			177
Amortization		(9,830	)		(949	)		(10,779	)		(11,683	)
Impairment		—			—			—			—
Other		(2	)		(5	)		(7	)		—

Balance at end of period	$	170,170		$	12,877		$	183,047		$	212,697


	For the Nine Months Ended September 30,
	2013									2012
	Forward Loans			Reverse Loans			Total			Forward Loans
Balance at beginning of period	$	200,742		$	15,588		$	216,330		$	250,329
Purchases		—			36			36			177
Amortization		(30,570	)		(2,742	)		(33,312	)		(37,809	)
Impairment		—			—			—			—
Other		(2	)		(5	)		(7	)		—

Balance at end of period	$	170,170		$	12,877		$	183,047		$	212,697

Servicing rights accounted for at amortized cost are evaluated for impairment by strata based on their estimated fair values. The risk characteristics used to stratify servicing rights for purposes of measuring impairment are the type of loan products, which consist of manufactured housing loans, first lien residential mortgages and second lien residential mortgages for the forward loan class and reverse mortgages for the reverse loan class. At September 30, 2013, the fair value of servicing rights for the forward loan class and the reverse loan class was $200.6 million and $16.8 million, respectively. At December 31, 2012 the fair value of servicing rights for the forward loan class and the reverse loan class was $229.9 million and $15.7 million, respectively. Fair value was estimated using the present value of projected cash flows over the estimated period of net servicing income. The estimation of fair value requires significant judgment and uses key economic inputs and assumptions, which are provided in the table below (dollars in thousands):


	September 30, 2013
	Forward Loans			Reverse Loans
Fair value of servicing rights carried at amortized cost	$	200,648		$	16,833
Inputs and assumptions:
Weighted-average remaining life in years		5.1			3.0
Weighted-average stated customer interest rate on underlying collateral		7.86	%		3.22	%
Weighted-average discount rate		11.67	%		18.00	%
Conditional prepayment rate		7.55	%			⁽¹⁾
Conditional default rate		4.28	%			⁽¹⁾
Conditional repayment rate			⁽¹⁾		25.47	%

(1)	Assumption is not significant to valuation.

The valuation of servicing rights is affected by the underlying assumptions including discount rate and prepayments of principal and defaults or repayment rates. Should the actual performance and timing differ materially from the Company’s projected assumptions, the estimate of fair value of the servicing rights could be materially different.

Servicing Rights at Fair Value

The change in fair value of servicing rights is recorded in net servicing revenue and fees in the consolidated statements of comprehensive income. The following table summarizes the activity in servicing rights accounted for at fair value (in thousands):


	For the Three Months			For the Nine Months
	Ended September 30, 2013			Ended September 30, 2013
Balance at beginning of period	$	880,950		$	26,382
Servicing rights capitalized in connection with the acquisition of the ResCap net assets		—			242,604
Purchase of servicing rights in connection with the BOA asset purchase		—			495,714
Other purchases		19,234			53,887
Servicing rights capitalized upon transfers of loans		80,550			118,145

Changes in fair value due to:
Realization of cash flows		(48,084	)		(96,870	)
Changes in valuation inputs or other assumptions		60,487			153,275
Other ⁽¹⁾		12,894			12,894

Balance at end of period	$	1,006,031		$	1,006,031

(1)	Other changes in fair value relate to servicing rights transferred to the Company for no consideration in accordance with the Payoffs, Assumptions, Modifications and Refinancing terms of the BOA asset purchase agreement. Refer to Note 3 for additional information related to the BOA asset purchase.

The fair value of servicing rights accounted for at fair value was estimated using the present value of projected cash flows over the estimated period of net servicing income. The estimation of fair value requires significant judgment and uses key economic inputs and assumptions, which are provided in the table below (dollars in thousands):


	September 30, 2013
Inputs and assumptions:
Weighted-average remaining life in years		6.2
Weighted-average stated customer interest rate on underlying collateral		5.24	%
Weighted-average discount rate		9.40	%
Conditional prepayment rate		8.16	%
Conditional default rate		3.21	%

The valuation of servicing rights is affected by the underlying assumptions including prepayments of principal, defaults and discount rate. Should the actual performance and timing differ materially from the Company’s projected assumptions, the estimate of fair value of the servicing rights could be materially different.

The following table summarizes the hypothetical effect on the fair value of servicing rights carried at fair value using adverse changes of 10% and 20% to the weighted-average of certain significant assumptions used in valuing these assets (dollars in thousands):


	September 30, 2013
				Decline in fair value due to
	Actual			10% adverse change			20% adverse change
Weighted-average discount rate		9.40	%	$	(42,042	)	$	(80,960	)
Conditional prepayment rate		8.16	%		(45,917	)		(85,783	)
Conditional default rate		3.21	%		(12,798	)		(25,072	)

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation in a particular assumption on the fair value of the servicing rights is calculated without changing any other assumption, while in reality changes in one factor may result in changes in another, which may either magnify or counteract the effect of the change.

Fair Value of Originated Servicing Rights

For forward loans transferred with servicing retained, the Company used the following inputs and assumptions to determine the fair value of servicing rights at the date of transfer. These servicing rights are included in servicing rights capitalized upon transfers of loans in the table presented above that summarizes the activity in servicing rights accounted for at fair value.


	For the Three Months	For the Nine Months
	Ended September 30, 2013	Ended September 30, 2013
Weighted-average life in years	8.8 - 9.5	6.1 - 9.6
Weighted-average stated customer interest rate on underlying collateral	3.73% - 4.32%	3.73% - 4.32%
Weighted-average discount rates	9.50% - 9.72%	9.50% - 12.30%
Conditional prepayment rates	4.78% - 6.09%	3.00% - 8.10%
Conditional default rates	0.69% - 0.96%	0.50% - 2.00%