S-1/A 1 d551855ds1a.htm AMENTMENT NO. 1 TO S-1 Amentment No. 1 to S-1
Table of Contents

As filed with the Securities and Exchange Commission on September 30, 2013

Registration No. 333-191047

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 1

to

FORM S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933

 

 

Stonegate Mortgage Corporation

(Exact name of Registrant as specified in its charter)

 

 

 

Ohio   6162   34-1194858

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(IRS Employer

Identification Number)

 

 

9190 Priority Way West Drive, Suite 300

Indianapolis, IN 46240

Phone: (317) 663-5100

(Address, including zip code, and telephone number, including

area code, of Registrant’s principal executive offices)

 

 

Barbara A. Cutillo, CPA

Chief Administrative Officer

9190 Priority Way West Drive, Suite 300

Indianapolis, IN 46240

Phone: (317) 663-5100

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Please send copies of all communications to:

 

Robert W. Downes
  Curt W. Hidde, Esq.   Daniel M. LeBey, Esq.
Sullivan & Cromwell LLP
  Barnes & Thornburg LLP   Hunton & Williams LLP
125 Broad Street
  11 South Meridian Street   Riverfront Plaza, East Tower
New York, NY 10004
  Indianapolis, IN 46204-3535   951 East Byrd Street
(212) 558-4000   (317) 231-7707   Richmond, VA 23219
(212) 558-3588 (Facsimile)   (317) 231-7433 (Facsimile)   (804) 788-7366
    (804) 788-8218 (Facsimile)

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x    Smaller reporting company  ¨
     

(Do not check if a

smaller reporting company)

  

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

  Amount to be
registered(1)
 

Proposed

maximum

offering price

per share(2)

 

Proposed

maximum

aggregate

offering

price(2)

 

Amount of

registration

fee(3)

Common stock, par value $0.01 per share

  9,890,000   $22.00   $217,580,000   $29,678

 

 

(1) Includes shares of common stock that the underwriters have the option to purchase.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) under the Securities Act of 1933.
(3) $13,640 of this amount has been paid previously.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated September 30, 2013

PROSPECTUS

8,600,000 Shares

 

LOGO

Stonegate Mortgage Corporation

Common Stock

 

 

This is Stonegate Mortgage Corporation’s initial public offering. We are selling 7,100,000 shares of our common stock and the selling shareholders are selling 1,500,000 shares of our common stock. We will not receive any proceeds from the sale of shares to be offered by the selling shareholders.

We expect the public offering price to be between $20.00 and $22.00 per share. Currently, no public market exists for the shares. After pricing of the offering, we expect that the shares will trade on the NYSE under the symbol ‘‘SGM ’’.

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, and therefore have elected to comply with certain reduced public company reporting requirements.

Investing in the common stock involves risks that are described in the ‘‘Risk Factors’’ section beginning on page 23 of this prospectus.

 

 

 

      

Per Share

      

Total

 

Public offering price

     $           $     

Underwriting discount(1)

     $           $     

Proceeds, before expenses, to us

     $           $     

Proceeds, before expenses, to the selling shareholders

     $           $     

 

  (1)

See “Underwriting” for additional disclosure regarding the underwriting discount and expenses payable to the underwriters by us.

The underwriters may also exercise their option to purchase up to an additional 1,290,000 shares from us and the selling shareholders at the public offering price, less the underwriting discount, for 30 days after the date of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The shares will be ready for delivery on or about October     , 2013.

 

 

 

BofA Merrill Lynch  

Credit Suisse

  Barclays   FBR

 

 

 

Keefe, Bruyette & Woods

                                A Stifel Company

  Sterne Agee

 

The date of this prospectus is October     , 2013.


Table of Contents

TABLE OF CONTENTS

 

    

Page

 

SUMMARY

     1   

THE OFFERING

     19   

RISK FACTORS

     23   

CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS

     50   

USE OF PROCEEDS

     53   

DIVIDEND POLICY

     54   

CAPITALIZATION

     55   

DILUTION

     56   

SELECTED HISTORICAL FINANCIAL DATA

     57   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     58   

GLOSSARY OF INDUSTRY TERMS

     99   

INDUSTRY

     104   

OUR BUSINESS

     111   

MANAGEMENT

     131   

EXECUTIVE AND DIRECTOR COMPENSATION

     138   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     155   

PRINCIPAL AND SELLING SHAREHOLDERS

     160   

DESCRIPTION OF CAPITAL STOCK

     162   

CERTAIN PROVISIONS OF OHIO LAW AND STONEGATE’S ARTICLES AND REGULATIONS

     166   

MATERIAL UNITED STATES TAX CONSEQUENCES TO NON-U.S. HOLDERS OF COMMON STOCK

     175   

ERISA CONSIDERATIONS

     179   

SHARES ELIGIBLE FOR FUTURE SALE

     181   

UNDERWRITING

     183   

VALIDITY OF COMMON STOCK

     191   

CHANGES IN THE COMPANY’S INDEPENDENT REGISTERED ACCOUNTING FIRM

     191   

EXPERTS

     191   

WHERE YOU CAN FIND MORE INFORMATION

     192   

INDEX TO FINANCIAL STATEMENTS

     F-1   

 

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Unless the context requires otherwise, references in this prospectus to “Stonegate,” the “Company,” “we,” “us” and “our” refer to Stonegate Mortgage Corporation and its consolidated subsidiaries.

In this prospectus, we refer to Long Ridge Equity Partners, LLC as “Long Ridge Equity Partners” and Stonegate Investors Holdings LLC, our largest shareholder, as “Stonegate Investors Holdings.”

You should rely only on the information contained in this prospectus or contained in any free writing prospectus filed with the Securities and Exchange Commission. Neither we nor the underwriters have authorized anyone to provide you with additional information or information different from that contained in this prospectus or in any free writing prospectus filed with the Securities and Exchange Commission. We are offering to sell, and seeking offers to buy, our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus, or of any sale of our common stock.

For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus outside of the United States.

Market data used in this prospectus has been obtained from independent industry sources and publications as well as from research reports prepared for other purposes. We have not independently verified the data obtained from these sources, and we cannot assure you of the accuracy or completeness of the data. Forward-looking information obtained from these sources is subject to the same qualifications and additional uncertainties regarding the other forward-looking statements in this prospectus.

 

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SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our common stock, you should read the entire prospectus carefully, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes. Unless indicated otherwise, the information in this prospectus assumes (1) the shares of our common stock to be sold in this offering will be sold at an initial public offering price of $21.00 per share, which is the mid-point of the price range set forth on the front cover page of this prospectus, and (2) no exercise by the underwriters of the option to purchase additional shares described on the front cover page of this prospectus. Unless the context otherwise requires, the information in this prospectus reflects our stock dividend of 12.861519 additional shares of our common stock for each share of our common stock that was outstanding on May 14, 2013.

Our Company

We are a leading, non-bank, integrated mortgage company focused on efficiently and effectively originating, acquiring, selling, financing and servicing U.S. residential mortgage loans. We are also one of the fastest growing non-bank mortgage originators, having grown origination volume by 298% during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. Our loan originations are primarily sourced through our network of retail branches and through our relationships with approximately 950 third party originators (“TPOs”). For the six months ended June 30, 2013, we originated $4.0 billion in loans and, as of June 30, 2013, we serviced a portfolio with an unpaid principal balance of $7.6 billion.

We attribute our growth to our vertically integrated and scalable mortgage banking platform, which we believe enables us to efficiently and effectively originate, acquire, sell, finance and service residential mortgage loans, and to our on-going geographic and product expansion. Since January 1, 2012, we have expanded our business into 18 additional states and Washington, D.C., added approximately 750 correspondent and wholesale customers, opened or acquired 19 retail branch offices and as a result increased our origination volume substantially. We also recently launched additional mortgage products, including our mortgage financing business, through a wholly-owned operating subsidiary, NattyMac, LLC (“NattyMac”), which will complement our growth. We focus on originating mortgage loans associated with the purchase of residential real estate, representing 45% of our originations for the twelve months ended June 30, 2013, as opposed to the refinancing of existing mortgage loans. We believe our focus on purchase mortgage loans will continue to drive our growth in a stabilizing real estate market, making our business sustainable. Our servicing business, which complements our origination and financing activities, has also expanded along with our serviced portfolio, increasing by 260% over the twelve months ended June 30, 2013. Our three businesses – mortgage origination, servicing and financing – complement each other and create a natural hedge against interest rate volatility and business cyclicality.

We were founded in 2005 by members of our executive team who held various senior level executive positions at large mortgage companies and financial institutions. The loans we originate, finance and service conform to the requirements of Government-Sponsored Enterprises (“GSEs”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), as well as government agencies, such as the Government National Mortgage Association (“Ginnie Mae”), the Federal Housing Administration (“FHA”), the Department of Veterans Affairs (“VA”), and private investors. We utilize proprietary technology to automate many of our core processes, which allows us to perform a high level of risk-based due diligence on each loan. We have also automated various aspects of quality control and regulatory compliance risk processes, which allows us to ensure adherence to credit, compliance and collateral standards of the GSEs and other investors. We believe that our expertise and the strength of our mortgage platform is best demonstrated by our exceptional track record as a mortgage originator and servicer, coupled with our ability to

 

 

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scale operations without compromising the quality of originated and serviced loans. As a result of our strong operating, technology and underwriting procedures that we apply consistently to each loan, we have not incurred any material losses related to repurchase or indemnification demands from the GSEs or other investors in our loans. We believe our lack of legacy issues and our focus on purchase versus refinance mortgages has positioned us as one of the leading non-bank integrated mortgage origination and servicing providers capable of taking advantage of growth opportunities in the mortgage sector.

Market Overview

The U.S. residential mortgage industry is the largest segment of the consumer finance industry with over $10.0 trillion of outstanding debt at December 31, 2012 and originations of $1.8 trillion, including $1.2 trillion of refinancing volume, for the year ending December 31, 2012. Of the 2012 total volume, over 87% of originations conformed to the requirements of the GSEs or government agencies, compared to approximately 38% and 36% in 2005 and 2006, respectively. We expect that with the proposed GSE reform, lower qualifying loan limits and higher GSE guarantee fees, origination volumes conforming to the requirements of the GSEs or government agencies (collectively referred to as “Agency mortgage loans”) will gradually decline while non-Agency mortgage loans will increase and comprise a larger portion of the mortgage loan market. The non-Agency mortgage loan market has also been stressed due to the limited ability of mortgage originators to securitize mortgage loans or sell loans to investors. According to Inside Mortgage Finance, non-Agency mortgage-backed securities (“MBS”) issuance, which accounted for 56% of all MBS in 2006, declined to less than 1% in 2012, though volumes are expected to increase with higher quality originations and increasing confidence in a housing recovery.

Participants in the mortgage industry consist of large depository institutions and non-bank originators that sell directly to the GSEs as well as other originators, referred to as TPOs, that originate loans from retail customers and sell them to a depository institution or non-bank originator (referred to as an “Aggregator”), such as ourselves. Loans are sourced through a variety of channels including retail branches, the internet and call centers, as well as acquired from TPOs such as banks, mortgage bankers and brokers. The mortgage industry is extremely fragmented and is principally comprised of a large number of regional participants. Of the over 15,000 mortgage companies that are currently licensed to originate mortgage loans in the U.S., 81% have a presence in only one state and 75% have five or fewer mortgage loan officers. These mortgage originators either sell directly to the GSEs or to Aggregators, though there is significant concentration amongst the loans sold to the GSEs. Of the $710 billion of loans sold to the GSEs during the six months ended June 30, 2013, as reported to Inside Mortgage Finance, the top 25 sellers accounted for 70%, or $495 billion, of loan originations with the remaining approximately 2,000 sellers accounting for the remaining 30%, or $215 billion, of loan originations.

The financial crisis led many of the largest depository institutions to reduce their participation in the mortgage market, including discontinuing the acquisition of mortgages from TPOs, and the industry remains in a period of significant transformation. Additionally, GSEs and other regulators have imposed substantial compliance requirements, increased capital requirements and proposed enhanced fees based on volume for smaller originators, thus potentially limiting participants in the sector and driving consolidation across the sector. We expect that these changes will drive more and more originators to become TPOs and sell originations to Aggregators such as ourselves, rather than the current practice of selling directly to the GSEs. During the six months ended June 30, 2013, over 1,700 sellers sold $50 million or less in loans to the GSEs, representing $21 billion or 3% of total volume. Further, we also believe that evolving market conditions, including the higher requirements to be able to sell directly to the GSEs, will also drive consolidation amongst industry participants with smaller originators lacking scale being acquired by larger participants in the sector. We believe that the fragmented mortgage industry, increasing regulation and stricter policies provide an attractive opportunity to an Aggregator such as ourselves.

 

 

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As a result of regulatory and market driven changes instituted in the mortgage market, including higher capital requirements for commercial banks on mortgage servicing rights (“MSR”) and increased quality control and compliance standards for mortgage underwriting, we believe that mortgage origination activity is gradually shifting from banks to non-banks. We believe that this trend is expected to continue at an accelerated rate in the future. Additionally, because the residential mortgage industry is characterized by high barriers to entry, including the necessity for approvals required to sell loans to, and service loans for, the GSEs or government organizations, state licensing requirements, and operating and technology platform requirements, we believe that we are well positioned to lead the rapidly evolving mortgage loan origination and servicing sector.

Our Business

We are an integrated mortgage company that derives revenue from three principal sources: mortgage origination, mortgage financing and mortgage servicing. 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 and others 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 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.

 

LOGO

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. We expect that as the non-Agency market continues to recover and GSE reform is approved and implemented, a larger proportion of the industry volume will be comprised of non-Agency mortgage loans. We believe we are well positioned to benefit from this shift in the market given our business model and management expertise in originating and securitizing non-Agency mortgage loans.

We are currently licensed in 39 states and Washington, D.C., including six states (California, Montana, Oregon, Rhode Island, Virginia and Washington) where we have become licensed since June 30, 2013. We intend to become licensed in 45 states by year end 2013 and to become licensed in the final three of the contiguous United States, New Hampshire, New York and Nevada, in the first half of 2014. The nine states in which we are not licensed, including five states where we have a pending license application, represented approximately 15% of the overall residential mortgage origination market in 2012 and the six states where we

 

 

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have become licensed since June 30, 2013, represented approximately 30% of the overall residential mortgage origination market in 2012. As we become licensed in these additional states and as we increase our origination activity in the states where we have only recently become licensed, we believe our origination volume will increase substantially. Economic and housing and mortgage market conditions can vary significantly from one geographic region to another; therefore, the geographic distribution of our mortgage originations can have a direct impact on the overall performance of our servicing portfolio. As of June 30, 2013, approximately 13%, 11% and 9% of the aggregate outstanding loan balances in our servicing portfolio were concentrated in Texas, Indiana and Ohio, respectively. Although we anticipate that our origination and servicing portfolios will become less geographically concentrated over time as we expand our operations into the additional nine states where we are not currently licensed and the states where we have only recently become licensed, the geographic distribution of the mortgage loans we originate and service in the near term will likely be similar to that of our current servicing portfolio. To the extent the states where we have a higher concentration of loans experience weaker economic conditions, greater rates of decline in single family residential real estate values or reduced demand within the residential mortgage sector relative to the United States generally, the risks inherent in our business would be magnified as compared to our competitors that have a broader and less concentrated geographic footprint.

Additionally, since inception, we have focused on originating mortgage loans associated with purchase transactions as opposed to refinancings to a greater degree than many industry participants. During 2012, approximately 45% of our loan originations were purchase loans and approximately 55% were refinance transactions, compared to 29% and 71%, respectively, for the industry as a whole. We believe purchase transactions are more sustainable than refinance transactions, and typically have slower prepayment speeds in early years, making the MSRs more valuable and less volatile. Additionally, we believe that the mortgage market will increasingly shift to purchase mortgages as the housing market continues to recover, first time home buyers re-enter the housing market and interest rates increase. Further, as the non-Agency market continues to recover, we believe that our platform and management expertise in originating and securitizing these mortgages will position us well to benefit from this transformation.

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.

Our three mortgage loan originations channels are discussed in more detail below.

Correspondent Channel

We acquire newly originated loans conforming to the underwriting standards of the GSEs or government agencies as well as non-Agency mortgage loans conforming to the standards of our investors from our network of correspondents across 39 states plus Washington, D.C. We identify our correspondent customers

 

 

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through a team of relationship managers who are responsible for signing-up customers and ensuring that we receive an adequate share of their origination volume. In addition to competitive pricing, we offer our correspondents access to a state-of-the-art technology platform, funding through our financing platform (NattyMac), including access to innovative financing programs such as early purchase facilities, as well as a timely and transparent process of acquiring their loans. In return, our correspondents provide us with high quality products that meet our underwriting standards. We track the performance of our correspondents on a score-card and terminate relationships where quality and other requirements are not met. We believe that our programs offer correspondents an attractive value proposition, including greater access to capital and liquidity, as they seek to maintain and grow their businesses. As a testament to our relationship management and product offering, our correspondent origination volume has increased from $521.5 million in the six months ended June 30, 2012 to $2.8 billion in the six months ended June 30, 2013, or by 445%.

Our growth has been driven by adding new correspondents as well as deepening relationships with existing correspondents. Our correspondent channel represented 71% of our mortgage originations for the six months ended June 30, 2013. We conduct financial, operational and risk reviews of each correspondent prior to initially approving them as a customer and on an annual basis to ensure compliance with our guidelines and those of the various regulators who govern our business. In addition we conduct background and financial reviews of the principals and their mortgage loan officers, and in some cases require personal guarantees. We believe that as we receive licenses in additional states and continue to increase our coverage of correspondents, we will continue to increase our market share.

Wholesale Channel

Through our wholesale channel, we originate loans through a network of approximately 460 non-exclusive relationships with various approved mortgage companies and mortgage brokers. Mortgage brokers identify applicants, help them complete a loan application, gather required information and documents, and act as our liaison with the borrower during the lending process. We review and underwrite an application submitted by a broker, accept or reject the application, determine the range of interest rates and other loan terms, and fund the loan upon acceptance by the borrower and satisfaction of all conditions to the loan in much the same manner as our retail channel. By relying on brokers to market our products and assist the borrower throughout the loan application process, we can increase loan volume through our wholesale channel with proportionately lower increases in overhead costs compared with the costs of increasing loan volume through loan originations in our retail channels.

We provide a variety of Agency, government insured and non-Agency mortgage loan products to our brokers to allow them to better service their borrowers. Before approving a mortgage broker for business, we focus on several attributes including origination volume, quality of originations and tangible net worth. We also conduct financial and background checks on the principals and their mortgage loan officers through various third-party sources and in some cases we require personal guarantees. Once we begin acquiring loans from our mortgage brokers, we track the performance of the loans on an on-going basis and terminate business relationships if the loans consistently do not perform or if there is evidence of misrepresentation. During the twelve months ended June 30, 2013, we did not terminate any significant relationships due to our continued focus on underwriting loans and ensuring compliance with policies.

Retail Channel

Our retail channel primarily operates through 27 retail offices across 12 states. In this channel, company representatives originate loans through their relationships with local real estate agents, builders, telemarketing and other local contacts. This channel accounted for 15% of our 2012 originations. We expect to continue to grow our retail channel by opening 3 new branches by the end of 2013, and by continuing to seek opportunities

 

 

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to open additional new branches for at least the next 24 months. In addition, we expect that with the continued transformation of the mortgage sector there will be opportunities to acquire small retail mortgage operators as several independent mortgage originators will lack the scale to profitably originate and sell mortgages. We believe that we could provide a solution to such operators by acquiring and integrating them into our branch network. We are currently actively evaluating opportunities to acquire several of these retail originators and believe that the continued development and growth of our retail channel is central to our business strategy.

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. Following our acquisition, in June 2013, we consolidated our NattyMac financing platform into a wholly-owned subsidiary which will focus on providing warehouse financing to us, our correspondent customers and others. We expect that NattyMac will be able to leverage our proprietary technology (OLIE) 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 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 to purchase.

Our financing platform features a centralized custodian and disbursement agent allowing us to enter into participation arrangements with financial institutions, such as regional banks for an interest in our newly originated loans during the time these loans would otherwise be funded by a warehouse line or traditional repurchase facility. Additionally, by offering regional banks an opportunity to invest in a liquid high-quality asset, we are able to earn fee and net interest income. We believe that regional banks continue to have significant appetite for such investment opportunities and we believe our financing platform allows us to compete with bank-owned mortgage lenders who have access to cheaper deposit funding. We believe this is a competitive advantage over other non-bank mortgage originators and servicers who are reliant on other forms of wholesale financing to fund their operations.

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.

Our servicing model is also very focused on “recapture,” which involves actively working with existing borrowers to refinance their mortgage loans. When a loan is paid off or refinanced with a different lender, we lose the servicing fees on the loan, so our ability to recapture loans successfully is important to the longevity of our servicing cash flows. Because the refinanced loans typically have lower interest rates or lower monthly payments, and, in general, subsequently refinance more slowly and default less frequently, these refinancings also typically improve the overall quality of our servicing portfolio. For the twelve months ended June 30, 2013, we recaptured 38% of our payoffs (based on the dollar amount of refinanced mortgage loans).

Our servicing business produces strong recurring, contractual fee-based revenue with minimal credit risk. Servicing fees are primarily based on the aggregate unpaid principal balance (“UPB”) of the loans serviced and the payment structure varies by loan source and type. These include differences in rate of servicing fees as a percentage of UPB and in the structure of advances. We believe our origination business gives us a distinct

 

 

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advantage in building a high-quality portfolio of MSRs over those who rely heavily on purchasing MSRs from others to build their portfolios as originated portfolios generally perform better given the extensive diligence and underwriting procedures that we apply to each loan.

We service loans using a model designed to improve loan performance and reduce loan defaults and foreclosures. Our servicing portfolio consists of MSRs we retain from loans that we originate and MSRs we acquire from third party originators, including in transactions facilitated by GSEs, such as Fannie Mae and Freddie Mac. The loans we service are typically securitized by us, i.e., the loans have been pooled together with multiple other loans and interests have been sold to third party investors that are secured by loans in the securitization pool. As of June 30, 2013, our servicing portfolio contained $7.6 billion of residential first mortgages, with a weighted average coupon of 3.64% and a weighted average age of 9 months. At June 30, 2013, the 90+ day delinquency rate in our servicing portfolio was 0.37%, the weighted average FICO score of our servicing portfolio was 733, and the adjusted constant prepayment rate (“CPR”) of our servicing portfolio as of June 30, 2013 was 5.98%.

Our Strengths

Leading, Non-Bank, Integrated Mortgage Company

We are a leading, non-bank, integrated mortgage company focused on efficiently and effectively originating, acquiring, selling, financing and servicing residential mortgage loans. We originate mortgages loans through our correspondent, wholesale and retail channels which provide diversity, increase scale and reduce dependency on any particular channel. During the six months ended June 30, 2013, the correspondent, wholesale and retail channels accounted for 71%, 20% and 9%, respectively, of our origination volume. Our origination and financing businesses enable us to offer a comprehensive product suite to our customers and build an attractive mortgage servicing portfolio.

Profitable, Sustainable Business with Significant Growth Potential

We have been profitable every year since 2008 and, for the six months ended June 30, 2013, our net income grew by 382% over the same period last year. The growth in net income has been driven by a significant increase in origination volume which increased by 298% during the six months ended June 30, 2013 over the same period last year. We were able to achieve this growth as we expanded geographically into additional states, deepened correspondent relationships and expanded product offerings. We believe that we have significant growth potential as we are currently licensed in only 39 states plus Washington, D. C., representing approximately 85% of the nation’s total origination volume in 2012. These 39 states include six states (California, Montana, Oregon, Rhode Island, Virginia and Washington) where we have become licensed since June 30, 2013 and have not yet commenced any material operations. As we launch our services nationally and expand in the remaining nine contiguous United States, which accounted for approximately $287 billion, or approximately 15%, of the nation’s origination volume in 2012 and the six states where we have become licensed since June 30, 2013, which accounted for approximately $590 billion, or approximately 30%, of the nation’s origination volume in 2012, we believe that we will be able to continue to see meaningful growth in our origination volume. We will also see meaningful growth as we expect to benefit from consolidation in the mortgage market with the potential acquisition of retail originators.

Additionally, we are focused on purchase money volume which accounted for 45% of our origination volume for the twelve months ended June 30, 2013 compared to the industry average of 28% for the twelve months ended June 30, 2013. We believe that as refinancing volumes potentially decline with an increase in interest rates, we will be better positioned than the rest of the industry as our origination volumes will be more sustainable. Further, we also benefit from our growing mortgage servicing business which produces recurring fee income and from our financing business which provides fee and interest income.

 

 

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We have made significant strategic investments in our business as we strive for growth. These investments include the opening of 19 retail branches in six states during 2012 and first half of 2013. We intend to expand further into three states by opening three additional retail branches during the remainder of 2013. In addition, in June 2013 we launched our non-Agency jumbo mortgage loan program and mortgage financing business to offer our customers a full suite of products. In order to achieve our growth targets, we have made significant investments and incurred significant operating expenses, which we believe will generate attractive returns over time.

Stable, Diversified and Complementary Funding Platform

Our NattyMac platform allows us to integrate a “syndicated” financing facility into our mortgage banking platform that consists of repurchase and participation agreements with major financial institutions, as well as regional and community banks. The financing facility provides a stable, low-cost diversified source of funding for our business and allows us to offer this as a service to our correspondent and other customers. We view this as a competitive advantage over other non-bank mortgage originators and servicers and a means of competing with banks that historically use deposit funding sources to finance their businesses. The platform also provides an ancillary source of fee and net interest income as we sell participations to depository institutions seeking an interest in liquid assets.

We view our NattyMac platform as being complementary to our origination business as correspondents are incentivized to sell the loans warehoused on our platform to us as it provides them with greater liquidity and minimizes the capital they require in their business. We believe our “pre-funding” due diligence process also reduces credit, compliance, collateral, interest rate and market risk by allowing us to assess the salability to potential funding sources and/or other loan investors prior to funding.

Consistent Ability to Produce High Quality Loans

We are focused on originating and servicing a portfolio of high quality residential mortgage loans. The table below contains information on the quality of our loans and delinquency rates for the dates indicated.

 

     As of or for the  
     Six Months
Ended June 30,
    Year Ended December 31,  
    

2013

   

2012

   

2011

 

Average FICO score of loans originated

     737        747        741   

LTV of loans originated

     84     83     84

Servicing portfolio weighted average FICO score

     733        744        735   

Servicing portfolio 90+ day delinquency rate

     0.37     0.44     0.37

We believe that our asset performance is superior to the industry due to our technologically advanced platform, consistent and conservative underwriting processes and focus on conducting a pre-funding review of each loan to ensure it meets the standards set by the GSEs or our loan investors. These practices differ from many of our competitors that apply different underwriting standards and review policies depending on the channel from which the loan is originated from. For example, some of our competitors conduct a pre-funding analysis on a sampling basis for loans acquired in the correspondent and wholesale channels but a full review on loans originated through the retail channel. We believe that our relentless focus on quality and consistency in applying underwriting policies and procedures has enabled us to have no significant repurchase demands, thus minimizing our risk profile and differentiating us from much of our competition.

 

 

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Our Complementary Origination, Servicing and Financing Businesses Create a Natural Hedge Against Interest Rate Volatility and Business Cyclicality

Our principal sources of revenue, mortgage servicing, mortgage origination and mortgage financing, contribute to our stable business profile by creating a natural hedge against changes in the interest rate environment. As interest rates rise and the likelihood of refinancing decreases, MSRs generally increase in value which helps to offset any decline in origination volumes. Additionally, as long-term interest rates increase we will earn greater fee and interest income as yields on mortgage loans will increase while the funding costs will remain proportionately lower. As interest rates decline and the likelihood of refinancing increases, origination volumes tend to increase which helps to offset the decline in the value of MSRs caused by the higher probability of loan prepayment. In addition, our origination platform helps us to recapture servicing rights on loan payoffs and thus replenish our MSRs during periods of high prepayments. For the twelve months ended June 30, 2013, our recapture rate was 38% of payoffs (based on the dollar amount of refinanced mortgage loans). We expect that our recapture rate will increase further as our retail call center operations continue to expand their focus on retention of our servicing portfolio.

Robust, Proprietary Operating Platform

We believe that the current processes and systems generally used by brokers and correspondents to originate loans are fragmented and result in inconsistent data, lack of controls, and limited transparency for market participants. In response to this weakness, we have built a proprietary diligence and underwriting decision platform, OLIE, that incorporates what we believe to be the best balance of data integrity, efficiency, ease of use, speed of decision, loan quality, consistency and control. We believe this service is valued by our brokers and correspondents and offers us a distinct advantage over our competitors.

OLIE provides a transparent view of all documents and loan level data throughout the entire life of a loan, from origination through securitization and final disposition, enabling us to measure and manage the performance of our loans, giving us the ability to proactively identify trends that may negatively impact our operational or financial performance. We believe that our current platform and our robust diligence procedures are the central reason we have not had any significant loan losses from indemnification or repurchase demands compared to other competitors who have realized significant losses. Additionally, we are able to offer greater transparency to the institutional investors that purchase our loans which is reflected in our sales execution.

Subsequent to June 30, 2013, we implemented version 1.0 and 2.0 of our “C3” automated risk-based diligence engine, which is integrated with OLIE. C3 allows us to perform an electronic quantitative risk assessment on each loan, enabling us to target our due diligence procedures on higher risk loans and thereby gain efficiencies in performing the diligence process.

Seasoned Management Team

Our senior management team is comprised of experienced mortgage industry executives with a track record of managing all aspects of the residential mortgage business through a variety of credit cycles and market conditions. Our founder and Chief Executive Officer, Jim Cutillo, has successfully led and managed the company through the recent transformation of the mortgage industry. Additionally, our president and other members of our senior management team have an average of 20 years of experience in the mortgage banking industry. We believe our executive management team has a clear vision and common set of core values and will be able to successfully execute our rapid growth strategy.

 

 

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Our Growth Drivers

We expect to drive future growth in the following ways:

Grow Origination Volume Across Channels

We intend to grow our origination volume across our channels by expanding nationally. We are currently licensed in 39 states plus Washington, D.C., which account for approximately 85% of U.S. residential mortgage originations. These 39 states include six states where we have become licensed since June 30, 2013, and have not yet commenced any material operations. We intend to become licensed in 45 states by year end 2013 and to become licensed in the final three contiguous United States, New Hampshire, New York and Nevada, in the first half of 2014. As we launch our services nationally and expand in the remaining nine contiguous United States, which accounted for approximately $287 billion, or approximately 15%, of the nation’s origination volume in 2012, and the six states where we have become licensed since June 30, 2013, which accounted for approximately $590 billion, or approximately 30%, of the nation’s origination market in 2012 we believe that we will be able to continue to see meaningful growth in our origination volume. This will also enable us to substantially grow our correspondent, wholesale and retail footprint and deepen existing correspondent and wholesale relationships. In executing this goal, we have recently accomplished the following since June 30, 2013:

 

   

Hired an additional 18 loan officers and 12 account executives;

 

   

Added 133 new TPOs;

 

   

Launched our warehouse financing through NattyMac and have generated approximately $41.0 million in funding commitments with 12 correspondent customers and have approximately $46.0 million in additional funding commitments pending approval; and

 

   

Were notified that we were awarded the winning bid to purchase a portfolio of existing mortgage servicing rights.

We also intend to grow our presence in the retail channel by increasing our origination volume through geographic expansion into new markets and “tuck-in” branch and/or company acquisitions. Our “tuck-in” acquisition strategy is capital efficient and, in 2012, resulted in six new branches being opened. As of September 20, 2013, we had one signed letter of intent to acquire an independent retail mortgage originator in the California market, which would add six new retail branches to our business. If we are successful in completing this proposed acquisition, we would expect to consummate it during the fourth quarter of 2013. This potential acquisition is subject to completion of our due diligence investigation, mutual agreement with respect to financial terms and negotiation of documentation. In addition, we have identified certain other tuck-in branches and/or companies with aggregate annual origination volumes of approximately $4.5 billion for potential acquisition and are currently in the early stages of discussions. However, there can be no assurances that any proposed acquisitions we pursue in the future will be consummated.

We intend to continue to focus on acquiring branches and/or companies as a growth strategy and expect that with GSE reform, higher guarantee fees (“GFees”) and benefits of scale, the mortgage market will undergo consolidation with the acquisition of smaller originators and we will be one of the key beneficiaries of this industry trend.

Expand into Non-Agency Mortgage Loans

Our extensive expertise in prime non-Agency jumbo securitization provides us the opportunity to substantially grow our non-Agency loan origination volume. We intend to focus on increasing production of loans that meet Agency criteria in nearly all respects other than loan size. These loans are generally referred to as

 

 

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“jumbo” loans and are originated through our existing channels. Over the last few years, this market has been hindered by the lack of an efficient capital market in which to sell such loans. We believe, as the market normalizes and non-Agency private securitization returns, we will be one of the few non-bank originators with this capability, giving us the ability to be an Aggregator for others and establishing ourselves as a market leader. The non-Agency MBS market was 56% of the total MBS market or $1.14 trillion in 2006 compared to 0.78% or $13.2 billion in 2012. In anticipation of the non-Agency market recovering and GSE reform, we intend to create a securitization shelf in 2014 and offer investors an opportunity to invest in securities backed by these loans. We may also retain the junior subordinated notes from the securitizations and create a recurring interest income stream for ourselves.

We believe that our integrated origination and servicing platform coupled with our expertise provides us with what we believe is a significant competitive advantage. We expect this investment strategy to create an attractive risk-adjusted return for our shareholders and to position us as one of the leading non-bank integrated mortgage origination and service providers.

Grow our Servicing Business

We anticipate being able to continue to retain the MSRs associated with loans we originate at attractive multiples through our integrated mortgage banking platform, whereas many of our competitors rely on purchasing MSRs. We feel our strategy is not only a more efficient utilization of capital but has less credit, collateral and compliance risk, since all loans are carefully reviewed by us prior to purchase.

We believe we can also leverage our correspondent channel to purchase MSRs from correspondent clients on a “co-issue” basis, meaning our clients originate and securitize Agency loans and concurrently transfer the servicing rights to us. This “co-issue” strategy will allow us to acquire the MSRs on an originated MSR (“OMSR”) basis versus a purchased MSR (“PMSR”) basis, since the servicing is treated as a whole loan origination. The “co-issue” strategy provides a competitive advantage over other purchasers of MSRs via bulk acquisitions as we have an existing relationship with the originator and understand their origination capabilities and techniques which drives the credit quality and performance of these loans. MSRs purchased in this way are expected to have substantially similar attributes to our originated loans with respect to note rate, credit quality and loan type. We anticipate completing our first such transaction in the fourth quarter of 2013 and growing this area of our business to augment the acquisition of servicing rights. We plan to perform the same level of pre-funding due diligence on these loans prior to purchasing the servicing rights from the seller. This strategy is similar in nature to our origination strategy of offering mandatory delivery and is another delivery type that is not dependent on our origination business, making it highly scalable and efficient from an operational and financial perspective.

Grow our Mortgage Financing Business

In the current market, many correspondents lack capital to grow their businesses and, therefore, are constrained by their balance sheets from a warehouse lending perspective. A typical warehouse lender will provide financing subject to a tangible net worth covenant and require that the correspondent contribute a percentage of the principal balance to fund the warehoused loans. Often, this creates a capital constraint for the correspondent if the “take-out” or permanent investor takes too long to review or purchase the loan. We have created an early purchase facility that allows approved correspondents to sell us loans on an accelerated basis, moving them off their balance sheets and freeing up their warehouse lines so they can fund more loans. We earn fee and net interest income on these loans, which are held on average 15 days prior to sale. This also complements our mortgage origination business as we will generally acquire these loans from the correspondents add the MSR to portfolio and service the loans for borrowers going forward. We launched our financing business in June 2013 by hiring two dedicated experienced account executives and we expect to make additional hires as we roll out this business nationwide.

 

 

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Summary Risk Factors

Our business is subject to numerous risks and uncertainties, including those highlighted in the section titled “Risk Factors” immediately following this prospectus summary. Some of these risks are:

 

   

our ability to compete successfully in the highly competitive mortgage loan servicing and mortgage loan origination industries;

 

   

experiencing financial difficulties like some originators and mortgage servicers have experienced;

 

   

adverse changes in the residential mortgage market;

 

   

our ability to obtain sufficient capital to meet our financing requirements;

 

   

our ability to grow our loan origination volume;

 

   

the geographic concentration of our servicing portfolio may result in a higher rate of delinquencies and/or defaults;

 

   

our mortgage financing business is subject to risks, including the risk of default and competitive risks;

 

   

our estimates may prove to be imprecise and result in significant changes in financial performance, including valuation;

 

   

the impact on our business of federal, state and local laws and regulations concerning loan servicing, loan origination, loan modification or the licensing of individuals and entities that engage in these activities;

 

   

substantial compliance costs arising from state licensing and operational requirements or loss of our licenses;

 

   

our ability to originate and/or acquire MSRs;

 

   

our ability to recover our significant investments in personnel and our technology platform;

 

   

the implementation of our proprietary loan due diligence, scoring and decision platform on schedule, which is still in the process of being refined and implemented;

 

   

the accuracy and completeness of information we receive about borrowers and counterparties;

 

   

a significant change in delinquencies and/or defaults for the mortgage loans we service;

 

   

our ability to recapture mortgage loans from borrowers who refinance;

 

   

changes in prevailing interest rates, such as the recent increases in interest rates experienced since June 2013, and any corresponding effects on origination volumes or the value of our assets;

 

   

our rapid growth may be difficult to sustain and manage and may place significant demands on our administrative, operational and financial resources;

 

 

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our ability to identify and complete acquisitions of retail mortgage originators and other businesses;

 

   

our ability to realize all of the anticipated benefits of our acquisitions;

 

   

the change of control rules under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), may limit our ability to use net operating loss carryforwards to reduce future taxable income;

 

   

failure to establish and maintain effective systems of internal controls;

 

   

errors in our financial models or changes in assumptions;

 

   

our ability to adapt to and implement technological changes;

 

   

the impact of the ongoing implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) on our business activities and practices, costs of operations and overall results of operations;

 

   

losses due to fraudulent and negligent acts on the part of loan applicants, brokers, other vendors, existing customers, our employees and other third parties;

 

   

the loss of the services of one or more of the members of our executive management team; and

 

   

an active trading market for our common stock may not develop or be sustained.

Our Ownership Structure

We are an Ohio corporation that was incorporated in 1976. Prior to March 2012, our shareholders were members of our executive management team and other investors. In March 2012, Long Ridge Equity Partners, a private investment firm focused on the financial services industry, invested in us through its affiliate. We completed a private offering in May 2013, which we refer to as our May 2013 private offering, in which we issued and sold 6,388,889 shares of our common stock to various institutional investors, accredited investors and offshore investors at an offering price of $18.00 per share, and we received approximately $115 million of proceeds, before expenses. Long Ridge Equity Partners remains our largest shareholder and has entered into various agreements with us and certain other parties which are described further in “Certain Relationships and Related Party Transactions—Arrangements with Long Ridge Equity Partners and its Affiliates.”

 

 

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The following chart illustrates our organizational structure, after giving effect to this offering. We have one wholly-owned subsidiary, NattyMac, LLC, an Indiana limited liability company.

 

LOGO

 

1 

Includes investors from our May 2013 private offering and our directors and other non-executive management shareholders (other than Stonegate Investors Holdings and its affiliates).

 

2 

Includes the shares of common stock owned by Stonegate Investors Holdings, Long Ridge Equity Partners I, LP and Long Ridge Offshore Subsidiary Holdings, LLC, each of which is an affiliate of Long Ridge Equity Partners, LLC. Stonegate Investors Holdings and its affiliate also own warrants to purchase 242,621 shares of our common stock with an exercise price of $18.00 per share. Excludes shares issuable upon any exercise of the warrants.

Recent Developments

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;

 

 

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

 

   

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

Recent Operating Statistics

In light of the recent industry trends discussed above, the following tables have been provided to illustrate our significant operating statistics in recent periods.

The following is a summary of mortgage loan origination volume by channel (measured by the sum of loan amounts) and associated average origination volume per business day for the periods indicated:

 

(in millions)

   September 1,
2013 to
September 20,
2013
     July 1, 2013
to
September 20,
2013
     Three
Months
Ended
June 30,
2013
     Three
Months
Ended
March 31,
2013
     Three
Months
Ended
December 31,
2012
     Three Months
Ended
September 30,
2012
 

Retail

   $ 24.6       $ 134.4       $ 194.2       $ 150.3       $ 163.6       $ 145.8   

Wholesale

     78.6         383.2         402.1         396.3         357.2         257.6   

Correspondent

     363.2         1,601.2         1,488.6         1,353.3         878.0         646.9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total origination volume

   $ 466.4       $ 2,118.8       $ 2,084.9       $ 1,899.9       $ 1,398.8       $ 1,050.3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average origination

volume per business

day

   $ 33.3       $ 36.5       $ 32.6       $ 30.6       $ 22.6       $ 16.7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of mortgage loans locked (measured by the sum of loan amounts) and associated average mortgage loans locked per business day for the periods indicated:

 

(in millions)

   September 1,
2013 to
September 20,
2013
     July 1, 2013
to
September 20,
2013
     Three
Months
Ended
June 30,
2013
     Three
Months
Ended
March 31,
2013
     Three
Months
Ended
December 31,
2012
     Three Months
Ended
September 30,
2012
 

Mortgage loans locked 1

   $ 753.7       $ 2,615.9       $ 2,800.0       $ 2,534.0       $ 2,057.8       $ 1,796.9   

Average mortgage loans

locked per business

day

   $ 53.8       $ 45.1       $ 43.8       $ 40.9       $ 33.2       $ 28.5   

 

1 

Represents mortgage loan commitments under which we have agreed to extend credit to a borrower and the associated interest rate and maximum principal amount are fixed prior to funding.

The following is a summary of purchases of residential real estate (vs. refinancings) as a percentage of the total origination volume for the periods indicated:

 

     September 1,
2013 to
September 20,
2013
    July 1,
2013 to
September 20,
2013
    Three
Months
Ended
June 30,
2013
    Three
Months
Ended
March 31,
2013
    Three
Months
Ended
December 31,
2012
    Three Months
Ended
September 30,
2012
 

Purchases of residential real estate as a percentage of total origination volume

     75     73     54     37     41     50

 

 

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The following is a summary of originations and accounts for the periods indicated:

 

     July 1,
2013 to
September 20,
2013
     Six Months
Ended
June 30,
2013
     Year Ended
December 31,
2012
     Year Ended
December 31,
2011
 

Originations 1

   $ 1,984.4       $ 3,640.3       $ 2,940.1       $ 733.3   

Accounts

     701         693         517         228   

 

1 

Represents correspondent and wholesale origination volume.

The following is a summary of our servicing portfolio (measured by the unpaid principal balance of the underlying mortgage loans) as of the dates indicated:

 

(in millions)

   September 20,
2013
     June 30,
2013
     March 31,
2013
     December 31,
2012
     September 30,
2012
 

Servicing portfolio

   $ 9,529.4       $ 7,588.3       $ 5,775.2       $ 4,145.3       $ 2,943.0   

Emerging Growth Company Status

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” These exemptions provide that, so long as a company qualifies as an “emerging growth company,” it will, among other things:

 

   

be exempt from the “say on pay” provisions (requiring a non-binding shareholder vote to approve compensation of certain executive officers) and the “say on golden parachute” provisions (requiring a non-binding shareholder vote to approve golden parachute arrangements for certain executive officers in connection with mergers and certain other business combinations) of the Dodd-Frank Act, and certain disclosure requirements of the Dodd-Frank Act relating to compensation of its named executive officers;

 

   

be permitted to omit the detailed compensation discussion and analysis from proxy statements and reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and instead provide a reduced level of disclosure concerning executive compensation; and

 

   

be exempt from any rules that may be adopted by the Public Company Accounting Oversight Board (the “PCAOB”), requiring mandatory audit firm rotation or a supplement to the auditor’s report on the financial statements.

Although we are still evaluating the JOBS Act, we may take advantage of some or all of the reduced regulatory and reporting requirements that will be available to us as long as we qualify as an “emerging growth company,” except that we have irrevocably elected not to take advantage of the extension of time to comply with new or revised financial accounting standards available under Section 102(b) of the JOBS Act.

We will, in general, qualify as an “emerging growth company” until the earliest of:

 

   

the last day of our fiscal year following the fifth anniversary of the date of this offering;

 

   

the last day of our fiscal year in which we have annual gross revenue of $1.0 billion or more;

 

 

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the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and

 

   

the date on which we are deemed to be a “large accelerated filer,” which will occur at such time as we (1) have an aggregate worldwide market value of common equity securities held by non-affiliates of $700 million or more as of the last business day of our most recently completed second fiscal quarter, (2) have been required to file annual and quarterly reports under the Exchange Act for a period of at least 12 months and (3) have filed at least one annual report pursuant to the Exchange Act.

Registration Rights and Lock-Up Agreements

Pursuant to a Registration Rights Agreement between us and the initial purchaser/placement agent for our May 2013 private offering, which we refer to as the Registration Rights Agreement, we are required, among other things, to:

 

   

file with the Securities and Exchange Commission, or the SEC, a resale shelf registration statement registering all of the shares of our common stock sold in our May 2013 private offering that are not sold by selling shareholders in this offering no later than September 12, 2013 (which is 120 days after the closing date of our May 2013 private offering); and

 

   

use our commercially reasonable efforts to cause the resale shelf registration statement to become effective under the Securities Act of 1933, as amended (the “Securities Act”), as soon as reasonably practicable after the filing, and in any event, no later than February 15, 2014, and to maintain the resale shelf registration statement continuously effective under the Securities Act for a specified period.

On September 9, 2013, we confidentially submitted the shelf registration statement for the resale of the shares sold in our May 2013 private offering and satisfied the first requirement described above. There would have been no monetary penalties to us for failing to file the shelf registration statement by September 12, 2013 or any other date.

In addition, if (i) prior to June 30, 2014, either a shelf registration statement for the resale of the shares sold in our May 2013 private offering has not been declared effective by the SEC or we have not completed an initial public offering of our common stock, or (ii) we have completed an initial public offering of our common stock prior to June 30, 2014, but we have not caused a shelf registration statement for the resale of the shares sold in our May 2013 private offering to be declared effective by the SEC by the 75th day after the closing date of the initial public offering, subject to extension under certain circumstances, then the Registration Rights Agreement will require that we hold a special meeting of our shareholders for the purpose of considering and voting on proposals to expand our board of directors by three and elect three new independent directors to our board of directors who are nominated by the holders of the shares sold in the May 2013 private offering, unless the holders of at least 75% of the outstanding shares of our common stock entitled to vote thereon, excluding shares beneficially owned by our directors and officers and by Stonegate Investors Holdings, consent to a waiver or deferral of the requirement that we hold the special meeting. There are no monetary penalties to us for failing to have the shelf registration statement declared effective by the SEC by June 30, 2014 or any other date.

We, and each of our officers, directors and Stonegate Investors Holdings will enter into a lock-up agreement with the lead managing underwriters of this offering with respect to shares of our common stock, restricting the direct or indirect sale of such securities, subject to certain exceptions, for 180 days after the date of this prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated.

 

 

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Additionally, our other shareholders who purchased common stock in our May 2013 private offering have agreed with us, subject to certain exceptions, not to directly or indirectly sell, offer to sell, grant any option or otherwise transfer or dispose of our common stock for 180 days, in the case of any shareholders who elect to sell stock in this offering, if any, and 60 days, in the case of holders who are not selling stock in this offering, in each case after the date of this prospectus.

Our Offices

Our principal executive offices are located at 9190 Priority Way West Drive, Suite 300, Indianapolis, Indiana, 46240. Our main telephone number is (317) 663-5100. Our Internet website is www.stonegatemtg.com.

 

 

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THE OFFERING

 

Common stock offered by us

7,100,000 shares

 

Common stock offered by selling shareholders

1,500,000 shares

 

Common stock outstanding immediately after this offering

24,704,236 shares1

 

Offering price

$             per share of common stock

 

Use of proceeds

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and other estimated offering expenses payable by us, will be approximately $136.0 million, based on the mid-point of the price range set forth on the front cover page of this prospectus ($156.9 million if the underwriters exercise their option to purchase additional shares in full).

 

  We intend to use the net proceeds of this offering to make investments relating 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. However, we have no commitments with respect to any such acquisitions or investments at this time.

 

Dividend policy

We do not expect to pay dividends on our common stock for the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used for the operation and growth of our business.

 

  Any future determination to pay dividends on our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, results of operations, liquidity, legal requirements, restrictions that may be imposed by the terms in current and future financing instruments and other factors deemed relevant by our Board of Directors.

 

Listing

We intend to apply to list our common stock on the NYSE under the symbol “SGM”.

 

1  Excludes (i) an aggregate of 1,539,883 shares of our common stock underlying currently outstanding stock options that have been granted to our executive officers, certain key employees and our independent directors pursuant to our 2011 Omnibus Incentive Plan, (ii) 524,062 shares of our common stock reserved for future issuance under our 2013 Omnibus Incentive Compensation Plan (419,250 shares) and our 2013 Non-Employee Director Plan (104,812 shares), (iii) shares of our common stock that we may issue and sell upon the exercise of the underwriters’ option to purchase up to 1,290,000 additional shares from us and the selling shareholders and (iv) 277,777 shares of our common stock issuable upon the exercise of warrants owned by Stonegate Investors Holdings and its affiliate and Glick Pluchenik 2011 Trust.

 

 

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Ownership and transfer restrictions

To assist us in complying with applicable Federal and state regulations that regulate our activities as an originator and servicer of mortgage loans, including regulations that restrict ownership of our common stock, our Second Amended and Restated Articles of Incorporation generally prohibit any person from beneficially owning more than 9.9% of the outstanding shares of our common stock. Effective upon the closing of this offering, this 9.9% ownership limitation will be removed.

 

 For further details about resale and transfer restrictions and procedures see “Description of Capital Stock—Restrictions on Ownership and Transfer of Common Stock.”

 

Risk factors

Investing in our common stock involves a high degree of risk. For a discussion of factors you should consider in making an investment, see “Risk Factors” beginning on page 23.

 

 

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SUMMARY HISTORICAL FINANCIAL DATA

The following tables present our summary historical financial data for the periods as of the dates indicated. The statement of operations data for the six months ended June 30, 2013 and for the years ended December 31, 2012 and 2011 and the balance sheet data at June 30, 2013, December 31, 2012 and December 31, 2011 have been derived from our audited financial statements included elsewhere in this prospectus. Historical results are not necessarily indicative of results we expect in future periods. The statement of operations data for the six months ended June 30, 2012, and the balance sheet data as of June 30, 2012 have been derived from unaudited financial statements of Stonegate Mortgage Corporation included elsewhere in this prospectus. The unaudited financial statements of Stonegate Mortgage Corporation have been prepared on substantially the same basis as the audited financial statements and include all adjustments that we consider necessary for a fair presentation of our financial position and results of operations for all periods presented. Amounts presented for basic and diluted earnings per share reflect the impact of our stock dividend of 12.861519 additional shares of our common stock for each share of our common stock that was outstanding on May 14, 2013.

The data presented below should be read in conjunction with, and is qualified in its entirety by reference to, “Capitalization,” “Selected Historical Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the notes thereto included elsewhere in this prospectus.

 

    

Six Months Ended June 30,

    

Year Ended December 31,

 
    

2013

    

2012

    

2012

    

2011

 
            (unaudited)                
    

(in thousands, except per share data)

 

Statement of Operations Data

           

Revenues:

           

Gains on mortgage loans held for sale

   $ 50,575       $ 23,486       $ 73,337       $ 16,735   

Fee income

     18,356         5,554         15,779         6,916   

Changes in MSR valuation

     9,550         —           —           —     

Other income

     5,747         1,584         6,429         2,371   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     84,228         30,624         95,545         26,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses:

           

Salaries, commissions and benefits

     32,127         12,042         32,737         13,085   

General and administrative

     8,895         2,516         7,705         3,163   

Interest expense

     7,675         1,936         6,239         2,728   

Amortization of MSRs

     —           1,413         3,680         960   

Impairment of MSRs

     —           4,827         11,698         2   

Other expenses

     5,001         1,626         5,677         2,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     53,698         24,360         67,736         21,988   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     30,530         6,264         27,809         4,034   

Income taxes

     11,680         2,385         10,724         1,699   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 18,850       $ 3,879       $ 17,085       $ 2,335   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 2.80       $ 1.19       $ 5.31       $ 0.70   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share

   $ 1.46       $ 0.70       $ 2.26       $ 0.59   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

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     June 30,      December 31,  
    

2013

    

2012

    

2012

    

2011

 
            (unaudited)                
    

(in thousands)

 

Balance Sheet Data

           

Cash and cash equivalents

   $ 31,556       $ 11,092       $ 15,056       $ 403   

Mortgage loans held for sale, at fair value

     418,000         126,161         218,624         61,729   

MSRs, at fair value

     99,209         —           ––           ––     

MSRs, at lower of amortized cost or fair value

     —           22,835         42,202         17,679   

Total assets

     628,882         178,250         309,606         89,108   

Secured borrowings

     246,516         118,470         102,675         57,894   

Warehouse lines of credit

     92,354         —           100,301         —     

Total liabilities

     447,426         144,654         254,357         78,692   

Total stockholders’ equity

     181,456         33,686         55,249         10,415   

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as other information contained in this prospectus, before deciding to invest in our common stock. The occurrence of any of the following risks could materially and adversely affect our business, prospects, financial condition, results of operations and cash flow, in which case, the trading price of our common stock could decline and you could lose all or part of your investment. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section entitled “Cautionary Note Concerning Forward-Looking Statements.”

Risks Related to Our Business and Industry

The industry in which we operate is highly competitive and our inability to compete successfully could adversely affect our business, financial condition and results of operations.

We operate in a highly competitive industry that could become even more competitive as a result of economic, technological and regulatory changes. Our mortgage loan origination business faces competition in mortgage loan offerings, rates, fees and levels of customer service. Competition to originate mortgage loans comes primarily from large commercial banks and savings institutions, but we also compete with a growing number of national and regional mortgage companies. Financial institutions generally have significantly greater resources and access to capital than we do, which gives them the benefit of a lower cost of funds and the ability to originate more mortgage loans. Our servicing business faces competition in areas such as fees and service. Competition to service mortgage loans comes from large commercial banks, large savings institutions and large independent servicers. Additionally, our servicing competitors may decide to modify their servicing model to compete more directly with our servicing model, or our servicing model may generate lower margins as a result of competition or as overall economic conditions improve.

In addition, technological advances and heightened e-commerce activities have increased consumers’ accessibility to products and services. This has intensified competition among banks and non-banks in offering mortgage loans and servicing them. We may be unable to compete successfully in our origination and servicing businesses, and this could materially and adversely affect our business, financial condition and results of operations.

We may experience financial difficulties like some originators and mortgage servicers have experienced, which could adversely affect our business, financial condition and results of operations.

Since 2006, a number of originators and servicers of residential mortgage loans experienced serious financial difficulties and, in some cases, ceased operations. These difficulties have resulted, in part, from declining markets for mortgage loans as well as from claims for repurchases of mortgage loans previously sold under provisions requiring repurchase in the event of early payment defaults or breaches of representations and warranties regarding loan quality, compliance and certain other loan characteristics. Overall, origination volumes are down significantly in the current economic environment. According to the Mortgage Bankers Association, total U.S. residential mortgage origination volume decreased from $2.8 trillion in 2006 to $1.75 trillion in 2012. Higher delinquencies and defaults may contribute to these difficulties by reducing the value of mortgage loans and requiring originators to sell their portfolios at greater discounts to par. In addition, servicing an increasingly delinquent mortgage loan portfolio increases servicing costs without a corresponding increase in servicing compensation. The value of many residual interests retained by sellers of mortgage loans in the securitization market has also been declining. Any of the foregoing adverse developments could materially and adversely affect our business, financial condition and results of operations.

 

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Adverse changes in the residential mortgage market would adversely affect our business, financial condition and results of operations.

Since 2007, adverse economic conditions, including high unemployment, stagnant or declining incomes and higher taxes, have impacted the residential mortgage market, resulting in unprecedented delinquency, default and foreclosure rates, all of which have led to increased losses on all types of residential mortgage loans due to sharp declines in residential real estate values. Falling home prices have resulted in higher LTVs, lower recoveries in foreclosure and an increase in losses above those that would have been realized had property values remained the same or continued to increase. As LTVs increase, borrowers sometimes have insufficient equity in their homes, which prohibits them from refinancing their existing loans. This may also provide borrowers an incentive to default on their mortgage loans even if they have the ability to make principal and interest payments, which we refer to as strategic defaults. Increased mortgage defaults negatively impact our servicing business because they increase the costs to service the underlying loans and may ultimately reduce the number of mortgages we service.

Adverse economic conditions also adversely impact our originations business. Declining home prices and increasing LTVs may preclude many potential borrowers, including borrowers whose existing loans we service, from refinancing their existing loans.

Adverse changes in the residential mortgage market may reduce the number of mortgages we service or new mortgages we originate, reduce the profitability of mortgages currently serviced by us, adversely affect our ability to sell mortgage loans originated by us or increase delinquency rates. Any of the foregoing adverse developments could materially and adversely affect our business, financial condition and results of operations.

We may be unable to obtain sufficient capital to meet the financing requirements of our business.

Our financing strategy consists primarily of using repurchase facilities and participation agreements with major financial institutions and regional and community banks. As we continue to grow, we will likely need to borrow additional money. Our ability to renew or replace our existing facilities as they expire and borrow the additional funds we will need to accomplish our growth strategy is affected by a variety of factors including:

 

   

the level of liquidity in the mortgage related credit markets;

 

   

prevailing interest rates;

 

   

the strength of the lenders that provide us financing;

 

   

limitations on borrowings on repurchase facilities and participation agreements imposed by the amount of eligible collateral pledged;

 

   

limitations imposed on us under financing agreements that contain restrictive covenants and borrowing conditions that may limit our ability to raise or borrow additional funds; and

 

   

accounting changes that may impact calculations of covenants in our financing agreements.

In the ordinary course of our business, we periodically borrow money or sell newly-originated loans to fund our mortgage loan origination and servicing operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” Our ability to fund current operations and make advances required under our mortgage loan servicing agreements depends on our ability to secure these types of financings on acceptable terms and to renew or replace existing financings as they expire. Such financings may not be available on acceptable terms or at all.

 

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An event of default, a negative ratings action by a rating agency, an adverse action by a regulatory authority or a general deterioration in the economy that constricts the availability of credit—similar to the market conditions that we have experienced during the last five years—may increase our cost of funds and make it difficult for us to renew existing facilities or obtain new financing facilities. We intend to seek opportunities to acquire mortgage loan servicing portfolios and/or businesses that engage in mortgage loan servicing and/or mortgage loan originations. Our liquidity and capital resources may be diminished by any such transactions. Additionally, we believe that a significant acquisition may require us to raise additional capital to facilitate such a transaction, which may not be available on acceptable terms or at all.

In June 2011, the Basel Committee on Banking Supervision of the Bank of International Settlements announced the final framework for strengthening capital requirements, known as Basel III, which, if implemented by U.S. bank regulatory agencies, will increase the cost of funding on financial institutions that we rely on for financing. Such Basel III requirements on financial institutions could reduce our sources of funding and increase the costs of originating and servicing mortgage loans. If we are unable to obtain sufficient capital on acceptable terms for any of the foregoing reasons, this could materially and adversely affect our business, financial condition and results of operations.

We may not be able to continue to grow our loan originations volume, which could adversely affect our business, financial condition and results of operations.

Our mortgage loan origination business consists of providing purchase money loans to homebuyers and refinancing existing loans. The origination of purchase money mortgage loans is greatly influenced by traditional business clients in the home buying process such as realtors and builders. As a result, our ability to secure relationships with such traditional business clients will influence our ability to grow our purchase money mortgage loan volume and, thus, our loan origination business.

Our loan origination business operates largely through third party mortgage brokers who do business with us on a best efforts basis, i.e., they are not obligated to do business with us. Further, our competitors also have relationships with these brokers and actively compete with us in our efforts to expand our broker networks. Accordingly, we may not be successful in maintaining our existing relationships or expanding our broker networks. If we are unable to continue to grow our loan origination business, this could adversely affect our business, financial condition and results of operations.

We are licensed in 39 states and Washington, D.C. and have a license pending in five states. We intend to become licensed in 45 states by year end 2013 and to become licensed in the final three contiguous United States, New Hampshire, New York and Nevada, in the first half of 2014. The nine states in which we are currently not licensed, including the states where we have a license pending, represented approximately 15% of the overall single-family residential mortgage origination market in 2012. As we become licensed in these additional states, we believe this geographic expansion will be a major driver of our growth. However, there are no assurances that we will obtain licenses in all 48 contiguous United States or that our licensing efforts will continue on the pace that we intend. If we are unable to obtain the licenses we plan to obtain, we will not be able to grow our business in accordance with our current plans, and our business, financial condition and results of operations would be materially and adversely affected.

 

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The geographic concentration of our servicing portfolio may result in a higher rate of delinquencies and/or defaults, which could adversely affect our business, financial condition and results of operations.

The following is a summary of the loans we serviced as of June 30, 2013 by geographic concentration as measured by the total unpaid principal balance as of June 30, 2013:

 

(in millions)    $UPB      % of
Total
$UPB
 

Texas

   $ 972.7         13

Indiana

     838.1         11

Ohio

     703.4         9

Missouri

     522.2         7

Georgia

     511.5         7

Illinois

     480.4         6

New Jersey

    
416.0
  
     5

Kansas

     399.6         5

Pennsylvania

    
385.7
  
    
5

All other states

     2,358.7         32
  

 

 

    

 

 

 

Total

   $ 7,588.3         100
  

 

 

    

 

 

 

To the extent the states where we have a higher concentration of loans experience weaker economic conditions, greater rates of decline in single family residential real estate values or reduced demand within the residential mortgage sector relative to the United States generally, the concentration of loans we service in those regions may increase the effect of the risks described in this “Risk Factors” section. Additionally, if states in which we have greater concentrations of mortgage loans were to change their licensing or other regulatory requirements to make our business cost-prohibitive, we may be required to stop doing business in those states or may be subject to higher costs of doing business in those states, which could adversely affect our business, financial condition and results of operations.

The nine states in which we are not currently licensed, including the states where we have a license pending, represented approximately 15% of the overall single-family residential mortgage origination market in 2012. Once our origination volume increases in the additional states in which are becoming licensed, we expect our geographic concentration to change and our origination and servicing of loans could be impacted by geographic concentrations in different states. To the extent those states experience weaker economic conditions or greater rates of decline in single family residential real estate values, the concentration of loans we originate and service in those regions may increase the effect of the risks to our business.

We use financial models and estimates in determining the fair value of certain assets, such as MSRs, commitments to originate loans, mortgage loans held for sale and related hedging instruments. If our estimates or assumptions prove to be incorrect, we may be required to record impairment charges, which would adversely affect our earnings.

We use internal financial models that utilize, wherever possible, market participant data to value certain of our assets, including our MSRs when they are initially acquired and newly originated loans held for sale for purposes of financial reporting. These models are complex and use asset-specific collateral data and market inputs for interest and discount rates. In addition, the modeling requirements of MSRs are complex because of the high number of variables that drive cash flows associated with MSRs. Even if the general accuracy of our valuation models is validated, valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of the models. In determining the value for MSRs, we make certain assumptions, many of which are beyond our control, including, among other things:

 

   

the rates of prepayment and repayment;

 

   

projected rates of delinquencies, defaults and liquidations;

 

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future interest rates;

 

   

our cost to service the loans;

 

   

ancillary fee income; and

 

   

amounts of future servicing advances.

Although we have processes and procedures in place governing internal valuation models and their testing and calibration, such assumptions are complex as we must make judgments about the effect of matters that are inherently uncertain. Different assumptions could result in significant changes in financial performance, including valuation, which in turn could affect earnings or result in significant changes in the dollar amount of assets reported on the balance sheet. Additionally, if loan loss levels are higher than anticipated due to an increase in delinquencies, prepayment speeds are higher than we predict, our recapture rate on loans that are refinanced is lower than we predict, or financial market illiquidity continues beyond our estimate, the value of certain of our assets may decrease and we may be required to record impairment charges, which could adversely affect our earnings. In addition, there can be no assurance that, even if our models are correct, these assets could be sold for our carrying value should we choose or be forced to sell them in the open market.

Federal, state and local laws and regulations could materially adversely affect our business, financial condition and results of operations.

Due to the highly regulated nature of the residential mortgage industry, we are required to comply with a wide array of federal, state and local laws and regulations that regulate, among other things, the manner in which we conduct our origination and servicing businesses, the fees we may charge, and the services we provide. These regulations directly impact our business and require constant compliance, monitoring and internal and external audits. A material failure to comply with any of these laws or regulations could result in the loss or suspension of our licenses to conduct our businesses or subject us to lawsuits or governmental actions, which could materially and adversely affect our business, financial condition and results of operations.

In addition, there continue to be changes in legislation and licensing requirements that are intended to improve the consumer mortgage loan experience, which require technological changes and additional implementation costs for mortgage loan originators and servicers. We expect legislative and licensing changes will continue in the foreseeable future, which will likely increase our operating expenses. Furthermore, there continue to be changes in state law that are adverse to mortgage servicers that increase costs and operational complexity of our business and impose significant penalties for violation. Any of these changes in the law could materially and adversely affect our business, financial condition and results of operations.

Federal, state and local governments have recently proposed or enacted numerous laws, regulations and rules related to mortgage loans generally and foreclosure actions in particular. These laws, regulations and rules may result in significant delays in the foreclosure process, reduced payments by borrowers, modification of the original terms of mortgage loans, permanent forgiveness of debt and increased servicing advances. In some cases, local governments have ordered moratoriums on foreclosure activity, which prevent a servicer or trustee, as applicable, from exercising any remedies they might have in respect of liquidating a severely delinquent mortgage loan. Several courts also have taken unprecedented steps to slow the foreclosure process or prevent foreclosure altogether.

Certain proposed federal legislation would permit borrowers in bankruptcy to restructure mortgage loans secured by primary residences. Bankruptcy courts could, if this legislation is enacted, reduce the principal balance of a mortgage loan that is secured by a lien on mortgaged property, reduce the mortgage interest rate, extend the term to maturity or otherwise modify the terms of a bankrupt borrower’s mortgage loan.

 

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We originate and sell FHA and VA loans. The origination of FHA and VA loans represented approximately 29% and 37% of the dollar value of loans originated in 2012 and 2011, respectively. The housing finance reform contemplated by the Obama administration may impact the lending qualification and limits of these programs, which may adversely impact our volume of FHA and VA loan originations in the future and may increase the price of our mortgage insurance premiums or otherwise adversely affect our business, financial conditions and results of operations.

We may be subject to liability for potential violations of predatory lending laws, which could adversely impact our results of operations, financial condition and business.

Various U.S. federal, state and local laws have been enacted that are designed to discourage predatory lending practices. The U.S. federal Home Ownership and Equity Protection Act of 1994, or HOEPA, prohibits inclusion of certain provisions in residential mortgage loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain disclosures prior to origination. Some states have enacted, or may enact, similar laws or regulations, which in some cases impose restrictions and requirements greater than those in HOEPA. In addition, under the anti-predatory lending laws of some states, the origination of certain residential mortgage loans, including loans that are not classified as “high-cost” loans under applicable law, must satisfy a net tangible benefits test with respect to the related borrower. This test may be highly subjective and open to interpretation. As a result, a court may determine that a residential mortgage loan, for example, does not meet the test even if the related originator reasonably believed that the test was satisfied. If any of our production loans are found to have been originated in violation of predatory or abusive lending laws, we could incur losses, which could adversely impact our results of operations, financial condition and business.

We are highly dependent upon programs administered by GSEs such as Fannie Mae and Freddie Mac to generate revenues through mortgage loan sales to institutional investors. Any changes in existing U.S. government-sponsored mortgage programs could materially and adversely affect our business, financial position and results of operations.

In February 2011, the Obama Administration delivered a report to Congress regarding a proposal to reform the housing finance markets in the United States. The report, among other things, outlined various potential proposals to wind down the GSEs and reduce or eliminate over time the role of the GSEs in guaranteeing mortgages and providing funding for mortgage loans, as well as proposals to implement reforms relating to borrowers, lenders and investors in the mortgage market, including reducing the maximum size of loans that the GSEs can guarantee, phasing in a minimum down payment requirement for borrowers, improving underwriting standards and increasing accountability and transparency in the securitization process.

Our ability to generate revenues through mortgage loan sales to institutional investors depends, to a significant degree, on programs administered by the GSEs, such as Fannie Mae and Freddie Mac, a government agency, Ginnie Mae, and others that facilitate the issuance of MBS in the secondary market. These GSEs play a critical role in the residential mortgage industry, and we have significant business relationships with many of them. Most of the conforming loans we originate qualify under existing standards for inclusion in guaranteed mortgage securities backed by GSEs. We also derive other material financial benefits from these relationships, including the assumption of credit risk by these GSEs on loans included in such mortgage securities in exchange for our payment of guarantee fees and the ability to avoid certain loan inventory finance costs through streamlined loan funding and sale procedures.

Any discontinuation of, or significant reduction in, the operation of these GSEs or any significant adverse change in the level of activity in the secondary mortgage market or the underwriting criteria of these GSEs could materially and adversely affect our business, financial position and results of operations.

 

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The conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. federal government, could adversely affect our business and prospects.

Due to increased market concerns about the ability of Fannie Mae and Freddie Mac to withstand future credit losses associated with securities held in their investment portfolios, in July 2008, the U.S. government passed the Housing and Economic Recovery Act of 2008. In September 2008, the Federal Housing Finance Agency (“FHFA”) placed Fannie Mae and Freddie Mac into conservatorship and, together with the U.S. Treasury, established a program designed to boost investor confidence in their respective debt and MBS. As the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the operations of Fannie Mae and Freddie Mac and may (i) take over the assets and operations of Fannie Mae and Freddie Mac with all the powers of the shareholders, the directors and the officers of Fannie Mae and Freddie Mac and conduct all business of Fannie Mae and Freddie Mac; (ii) collect all obligations and money due to Fannie Mae and Freddie Mac; (iii) perform all functions of Fannie Mae and Freddie Mac that are consistent with the conservator’s appointment; (iv) preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (v) contract for assistance in fulfilling any function, activity, action or duty of the conservator.

Although the U.S. Treasury has committed capital to Fannie Mae and Freddie Mac, these actions may not be adequate for their needs. If these actions are inadequate, Fannie Mae and Freddie Mac could continue to suffer losses and could fail to honor their guarantees and other obligations. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantees could be considerably limited relative to historical measurements. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac could redefine what constitute Agency and government conforming MBS and could have broad adverse market implications. Such market implications could materially and adversely affect our business, financial condition and results of operations.

Unlike banks and similar financial institutions with which we compete, we are subject to state licensing and operational requirements that result in substantial compliance costs.

Because we are not a depository institution, we do not benefit from a federal exemption to state mortgage banking, loan servicing or debt collection licensing and regulatory requirements. We must comply with state licensing requirements and varying compliance requirements in every state in which we do business. Future regulatory changes may increase our costs through stricter licensing laws, disclosure laws or increased fees, or may impose conditions to licensing that we are unable to meet. In addition, we are subject to periodic examinations by state regulators, which can result in refunds to borrowers of certain fees earned by us, and we may be required to pay substantial penalties imposed by state regulators due to compliance errors. Future state legislation and changes in existing regulation may significantly increase our compliance costs or reduce the amount of ancillary fees, including late fees, that we may charge to borrowers. This could make our business cost-prohibitive in the affected state or states and could materially and adversely affect our business, financial condition and results of operations.

Our business would be adversely affected if we lose our licenses or if we are unable to obtain licenses in new markets.

Our operations are subject to regulation, supervision and licensing under various federal, state and local statutes, ordinances and regulations. In most states in which we operate, a regulatory agency regulates and enforces laws relating to mortgage loan servicing companies and mortgage loan origination companies such as us. These rules and regulations generally provide for licensing as a mortgage servicing company, mortgage origination company or third party debt default specialist, requirements as to the form and content of contracts and other documentation, licensing of our employees and employee hiring background checks, licensing of independent contractors with which we contract, restrictions on collection practices, disclosure and record-keeping requirements and enforcement of borrowers’ rights. In certain states, we are subject to periodic examination by state regulatory authorities. Some states in which we operate require special licensing or provide extensive regulation of our business.

 

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We believe that we maintain all material licenses and permits required for our current operations and are in substantial compliance with all applicable federal, state and local laws. But we may not be able to maintain all requisite licenses and permits, and the failure to satisfy those and other regulatory requirements could result in a default under our servicing agreements and have a material adverse effect on our business, financial condition or results of operations. The states that currently do not provide extensive regulation of our business may later choose to do so, and if such states so act, we may not be able to obtain or maintain all requisite licenses and permits. The failure to satisfy those and other regulatory requirements could result in a default under our servicing agreements and have a material and adverse effect on our business, financial condition or results of operations. Furthermore, the adoption of additional, or the revision of existing, rules and regulations could materially and adversely affect our business, financial condition and results of operations.

Challenges to the MERS® System could materially and adversely affect our business, results of operations and financial condition.

MERSCORP, Inc. is a privately held company that maintains an electronic registry, referred to as the MERS System, that tracks servicing rights and ownership of loans in the United States. Mortgage Electronic Registration Systems, Inc., or MERS, a wholly-owned subsidiary of MERSCORP, Inc., can serve as a nominee for the owner of a mortgage loan and in that role initiate foreclosures or become the mortgagee of record for the loan in local land records. We may choose to use MERS as a nominee. The MERS System is widely used by participants in the mortgage finance industry.

Several legal challenges in the courts and by governmental authorities have been made disputing MERS’s legal standing to initiate foreclosures or act as nominee for lenders in mortgages and deeds of trust recorded in local land records. These challenges have focused public attention on MERS and on how loans are recorded in local land records. Although most legal decisions have accepted MERS as mortgagee, these challenges could result in delays and additional costs in commencing, prosecuting and completing foreclosure proceedings, conducting foreclosure sales of mortgaged properties and submitting proofs of claim in borrower bankruptcy cases.

We may not be able to maintain or grow our business if we cannot originate and/or acquire MSRs.

Our servicing portfolio is subject to “run off,” meaning that mortgage loans we service may be prepaid prior to maturity, refinanced with a mortgage not serviced by us or liquidated through foreclosure, deed-in-lieu of foreclosure or other liquidation process or repaid through standard amortization of principal. As a result, our ability to maintain and grow the size of our servicing portfolio depends on our ability to originate additional mortgages, to recapture the servicing rights on loans that are refinanced, and to acquire the right to service additional residential mortgage loans. We may not be able to originate a sufficient volume of mortgage loans, recapture a sufficient volume of refinanced loans or acquire MSRs on additional pools of mortgage loans with sufficient volume or on terms that are favorable to us or at all, which could materially and adversely affect our business, financial condition and results of operations.

We may not be able to recapture loans from borrowers who refinance.

One of the focuses of our origination efforts is “recapture,” which involves actively working with existing borrowers to refinance their mortgage loans with us instead of another originator of mortgage loans. Borrowers who refinance have no obligation to refinance their loans with us and may choose to refinance with a different originator. If borrowers refinance with a different originator, this decreases the profitability of our primary servicing portfolio because the original loan will be repaid, and we will not have an opportunity to earn further servicing fees after the original loan is repaid. Moreover, recapture allows us to generate additional loan servicing more cost-effectively than MSRs acquired on the open market. If we are not successful in recapturing our existing loans that are refinanced, our servicing portfolio will become increasingly subject to run-off, and we may need to purchase additional MSRs on the open market to add to our servicing portfolio, which would increase ours costs and risks and decrease the profitability of our servicing business.

 

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We may not be able to recover our significant investments in personnel and our technology platform if we cannot originate and acquire MSRs on favorable terms, which could adversely affect our business, financial condition and results of operations.

We have made, and expect to continue to make, significant investments in personnel and our technology platform to allow us to service additional loans. In particular, we invest significant resources in recruiting, training, technology and systems. We may not realize the expected benefits of these investments to the extent we are unable to increase the pool of residential mortgage loans we service, we are delayed in obtaining the right to service such loans or we do not appropriately value the MSRs that we do purchase. Any of the foregoing could adversely affect our business, financial condition and results of operations.

Our proprietary loan due diligence, scoring and decision platform is still in the process of being refined and implemented, and we may not be successful in completing its implementation as quickly as we intend, which could adversely affect our business and operations.

We believe our proprietary, automated loan due diligence, scoring and decision platform (known as OLIE) is a significant competitive advantage, but the technology in this platform is new and is still being refined and implemented. If we are unsuccessful in implementing this platform as quickly as we intend, or if we experience technical difficulties with the platform, our business and operations could be adversely affected.

We depend on the accuracy and completeness of information about borrowers and counterparties and any misrepresented information could adversely affect our business, financial condition and results of operations.

In deciding whether to extend credit or to enter into other transactions with borrowers and counterparties, we may rely on information furnished to us by or on behalf of borrowers and counterparties, including financial statements and other financial information. We also may rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. We additionally rely on representations from public officials concerning the licensing and good standing of the third party mortgage brokers through which we do business. While we have a practice of independently verifying the borrower information that we use in deciding whether to extend credit or to agree to a loan modification, including employment, assets, income and credit score, if any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected. Whether a misrepresentation is made by the loan applicant, the mortgage broker, another third party or one of our employees, we generally bear the risk of loss associated with the misrepresentation. We have controls and processes designed to help us identify misrepresented information in our loan originations operations; however, we may not have detected or may not detect all misrepresented information in our loan originations or from our business clients. Any such misrepresented information could materially and adversely affect our business, financial condition and results of operations.

In addition, when we originate loans, we rely heavily upon information supplied by third parties, including the information contained in the loan application, appraisal, title information and employment and income documentation. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to the loan funding, the value of the loan may be significantly lower than expected, and we may be subject to repurchase or indemnification obligations under loan sales agreements. Whether a misrepresentation is made by the loan applicant, the broker, another third party or one of our own employees, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a material misrepresentation is not typically saleable or is subject to repurchase if it is sold prior to detection of the misrepresentation. Even though we may have rights against persons and entities who made or knew about the misrepresentation, such persons and entities are often difficult to locate and it is often difficult to collect any monetary losses that we have suffered as a result of their actions.

 

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A significant change in delinquencies and/or defaults for the loans we service could materially and adversely affect our business, financial condition and results of operations.

Delinquency rates are expected to have a significant impact on our revenues, our expenses and on the valuation of our MSRs as follows:

 

   

Revenue. An increase in delinquencies will result in lower revenue for loans we service. We only collect servicing fees from GSEs for performing loans. Additionally, while increased delinquencies generate higher ancillary fees, including late fees, these fees are not likely to be recoverable in the event that the related loan is liquidated. In addition, an increase in delinquencies, by reducing the amount of cash held in collection and other accounts, reduces the interest income we earn on those accounts.

 

   

Expenses. An increase in delinquencies will result in a higher cost to service due to the increased time and effort required to collect payments from delinquent borrowers. It may also result in an increase in interest expense as a result of an increase in our advancing obligations.

 

   

Liquidity. An increase in delinquencies could also negatively impact our liquidity because of an increase in borrowings to make servicer advances.

 

   

Valuation of MSRs. We base the value of our MSRs on, among other things, our projections of the cash flows from the related mortgage loans. Our expectation of delinquencies is a significant assumption underlying those cash flow projections. If delinquencies were significantly greater than expected, the estimated fair value of our MSRs could be diminished. If the estimated fair value of MSRs is reduced, we could suffer a loss, which has a negative impact on our financial results.

An increase in delinquency rates could therefore materially and adversely affect our business, financial condition and results of operations.

Our earnings may decrease because of changes in prevailing interest rates, such as the recent increases in interest rates experienced since June 2013, and any corresponding effects on origination volumes or the value of our assets.

Our profitability is directly affected by changes in prevailing interest rates, such as the recent increases in interest rates experienced since June 2013. The following are the material risks we face related to changes in prevailing interest rates:

 

   

because many of the mortgage loans we service have adjustable rates, an increase in prevailing interest rates could generate an increase in delinquency, default and foreclosure rates resulting in an increase in both operating expenses and interest expense and could cause a reduction in the value of our assets;

 

   

an increase in prevailing interest rates could adversely affect our loan originations volume because refinancing an existing loan would be less attractive for homeowners and qualifying for a loan may be more difficult for prospective borrowers;

 

   

an increase in prevailing interest rates would increase the cost of financing servicing advances and loan originations;

 

   

a decrease in prevailing interest rates may require us to record a decrease in the value of our MSRs; and

 

   

a decrease in prevailing interest rates could reduce our earnings from our custodial deposit accounts.

 

   

We have experienced rapid growth, which may be difficult to sustain and which may place significant demands on our administrative, operational and financial resources.

 

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Our servicing portfolio, measured in unpaid principal balance, has grown from approximately $624 million at December 31, 2010 to approximately $7.6 billion at June 30, 2013. Our rapid growth has caused, and if it continues will continue to cause, significant demands on our legal, accounting and operational infrastructure, and increased expenses. In addition, we are required to continuously develop our systems and infrastructure in response to the increasing sophistication of the mortgage lending market and legal, accounting and regulatory developments relating to all of our business activities. Our future growth will depend, among other things, on our ability to maintain an operating platform and management system sufficient to address our growth and will require us to incur significant additional expenses and to commit additional senior management and operational resources. As a result, we face significant challenges in:

 

   

maintaining adequate financial and business controls,

 

   

implementing new or updated information and financial systems and procedures, and

 

   

training, managing and appropriately sizing our work force and other components of our business on a timely and cost-effective basis.

There can be no assurance that we will be able to manage our expanding operations effectively or that we will be able to continue to grow, and any failure to do so could materially and adversely affect our business, financial condition and results of operations.

As part of our growth strategy, we intend to acquire loan origination platforms or businesses, servicing assets and businesses and other businesses that we believe complement our existing business and will contribute to our growth, and the failure to do so on attractive terms or at all or to integrate acquisitions into our operations or otherwise manage our planned growth may adversely affect us.

We can provide no assurances that we will be successful in identifying origination platforms or businesses, servicing assets and businesses or other businesses that meet our acquisition criteria or that, once identified, we will be successful in completing an acquisition. We face significant competition for attractive acquisition opportunities from other well-capitalized investors, some of which have greater financial resources and a greater access to debt and equity capital to secure and complete acquisitions than we do. As a result of such competition, we may be unable to acquire certain assets or businesses that we deem attractive or the purchase price may be significantly elevated or other terms may be substantially more onerous. In addition, we may seek to finance future acquisitions through a combination of borrowings, the use of retained cash flows, and offerings of equity and debt securities, which may not be available on advantageous terms, or at all. Any delay or failure on our part to identify, negotiate, finance on favorable terms, consummate and integrate such acquisitions could impede our growth.

We may not realize all of the anticipated benefits of our acquisitions, which could adversely affect our business, financial condition and results of operations.

We have expanded our business through acquisitions. In 2009, we merged with Swain Mortgage Company (“Swain”) to accelerate our entrance into the servicing business. In the third quarter of 2012, we acquired our financing platform and fully integrated the platform into our mortgage banking operations in December of 2012. Our ability to realize the anticipated benefits of these acquisitions and future acquisitions of servicing portfolios, origination platforms or businesses will depend, in part, on our ability to integrate those portfolios, platforms and businesses with our business. The process of acquiring assets or companies may disrupt our business and may not result in the full benefits expected. The risks associated with acquisitions include, among others:

 

   

unanticipated issues in integrating information, communications and other systems;

 

   

unanticipated incompatibility of purchasing, logistics, marketing and administration methods;

 

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direct and indirect costs and liabilities;

 

   

not retaining key employees; and

 

   

the diversion of management’s attention from ongoing business concerns.

Moreover, the acquired portfolios, platforms or businesses may not contribute to our revenues or earnings to any material extent, and cost savings and synergies we expect at the time of an acquisition may not be realized once the acquisition has been completed. If we inappropriately value the assets or businesses we acquire or the value of the assets or businesses we acquire declines after we acquire them, the resulting charges may negatively affect the carrying value of the assets on our balance sheet and our earnings. See “—We use financial models and estimates in determining the fair value of certain assets, such as MSRs, commitments to originate loans, mortgage loans held for sale and related hedging instruments. If our estimates or assumptions prove to be incorrect, we may be required to record impairment charges, which could adversely affect our earnings.” Furthermore, if we incur additional indebtedness to finance an acquisition, the acquired business may not be able to generate sufficient cash flow to service that additional indebtedness. Unsuitable or unsuccessful acquisitions could materially and adversely affect our business, financial condition and results of operations.

Our mortgage financing business is subject to risks, including the risk of default and competitive risks, which could adversely affect our results of operations.

Through NattyMac, we provide financing to correspondents and other third party residential mortgage originators with respect to the loans they originate, and these customers may default on their obligations to us, including their obligations to pay the line of credit or transfer the relevant loan under such financing arrangements. If our financing customers default on their obligations to us, we could incur losses. In addition, competition in warehouse lending has increased on a national level as new lenders, including national, community and regional banks that use deposit funds to finance loans, have begun entering the mortgage warehouse business. If increased competition negatively affects our mortgage financing business, our earnings could decrease.

The change of control rules under Section 382 of the Code may limit our ability to use net operating loss carryforwards to reduce future taxable income.

We have net operating loss (“NOL”) carryforwards for federal and state income tax purposes. Generally, NOL carryforwards can be used to reduce future taxable income. Our use of our NOL carryforwards will be limited, however, under Section 382 of the Code, if we undergo a change in ownership of more than 50% of our capital stock over a three-year period as measured under Section 382 of the Code. These complex change of ownership rules generally focus on ownership changes involving shareholders owning directly or indirectly 5% or more of our stock, including certain public “groups” of shareholders as set forth under Section 382 of the Code, including those arising from new stock issuances and other equity transactions. We believe we experienced an ownership change for these purposes in March 2012. In connection with this offering or with another public or private offering in the future, it is likely that we will experience another ownership change within the meaning of Section 382 of the Code, measured for this purpose by including transfers and issuances of stock that took place after the ownership change that we believe occurred in March 2012. If we experience another ownership change, the resulting annual limit on the use of our NOL carryforwards (which would generally equal the product of the applicable federal long-term tax-exempt rate, multiplied by the value of our capital stock immediately before the ownership change, and potentially increased by certain existing gains, if any, recognized within five years after the ownership change if we have a net built-in gain in our assets at the time of the ownership change) could result in a meaningful increase in our federal and state income tax liability in future years. Whether an ownership change occurs by reason of trading in our stock is not within our control and the determination of whether an ownership change has occurred is complex. No assurance can be given that we will not in the future undergo another ownership change that would have a significant adverse effect on the use of our NOL carryforwards. In addition, the possibility of causing an ownership change may reduce our willingness to issue new common stock to raise capital.

 

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As a public reporting company, we will be subject to rules and regulations established from time to time by the SEC and the NYSE regarding our internal control over financial reporting. We may not complete needed improvements to our internal control over financial reporting in a timely manner, or these internal controls may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the market price of our common stock and your investment.

Upon completion of this offering, we will become a public reporting company subject to the rules and regulations established from time to time by the SEC and the NYSE. These rules and regulations will require, among other things, that we establish and periodically evaluate procedures with respect to our internal controls over financial reporting. Reporting obligations as a public company are likely to place a considerable strain on our financial and management systems, processes and controls, as well as on our personnel. In addition, as a public company we will be required to document and test our internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) so that our management can certify as to the effectiveness of our internal controls over financial reporting by the time our annual report for the year ending December 31, 2014 is due and thereafter, which will require us to document and make significant changes to our internal controls over financial reporting. Likewise, our independent registered public accounting firm will be required to provide an attestation report on the effectiveness of our internal control over financial reporting when we cease to be an “emerging growth company,” as defined in the JOBS Act, although, we could potentially qualify as an “emerging growth company” until December 31, 2018. As a result, we are in the process of improving our financial and managerial controls, reporting systems and procedures, incurring substantial expenses in making such improvements and testing our systems and hiring additional personnel. However, if we are unable to remediate material weaknesses that have been identified, if our management is unable to certify the effectiveness of our internal controls (at the time they are required to do so), if our independent registered public accounting firm cannot deliver (at such time as it is required to do so) a report attesting to the effectiveness of our internal control over financial reporting or if we remediate material weaknesses in our internal controls identified in the future, we could be subject to regulatory scrutiny and a loss of public confidence, which could harm our reputation and the market price of our common stock. In addition, if we do not maintain adequate financial and management personnel, processes and controls, we may not be able to manage our business effectively or accurately report our financial performance on a timely basis, which could cause a decline in our common stock price and adversely affect our results of operations and financial condition.

The success and growth of our business will depend upon our ability to adapt to and implement technological changes.

Our mortgage loan origination business is dependent upon our ability to effectively interface with our brokers, borrowers and other third parties and to efficiently process loan applications and closings. The origination process is becoming more dependent upon technological advancement. We are in the process of enhancing our proprietary, automated, risk-based due diligence platform (known as OLIE), which we expect to provide a highly scalable, transparent, and consistent diligence platform from loan origination to securitization.

Our due diligence platform and other technologies may not meet our expectations or maintain our needs for technological advancement. Further, the development of such technologies and maintaining and improving new technologies will require significant capital expenditures and maintaining the technological proficiency of our personnel will require significant expense.

As technological requirements increase in the future, we will have to fully develop these capabilities to remain competitive, and any failure to do so could adversely affect our business, financial condition and results of operations.

 

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The ongoing implementation of the Dodd-Frank Act will increase our regulatory compliance burden and associated costs and place restrictions on certain originations and servicing operations, all of which could adversely affect our business, financial condition and results of operations.

The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry in the United States. The Dodd-Frank Act includes, among other things: (i) the creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and to improve cooperation among federal agencies; (ii) the creation of a Bureau of Consumer Financial Protection (“CFPB”) authorized to promulgate and enforce consumer protection regulations relating to financial products; (iii) the establishment of strengthened capital and prudential standards for banks and bank holding companies; (iv) enhanced regulation of financial markets, including the derivatives and securitization markets; and (v) amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards and prepayment considerations.

On January 10, 2013, the CFPB announced a rule to implement certain provisions of the Dodd-Frank Act relating to mortgage originations. Under the new originations rule, before originating a mortgage loan, lenders must determine on the basis of certain information and according to specified criteria that the prospective borrower has the ability to repay the loan. Lenders that issue loans meeting certain requirements will be presumed to comply with the new rule with respect to these loans. On January 17, 2013, the CFPB announced rules to implement certain provisions of the Dodd-Frank Act relating to mortgage servicing. The new servicing rules require servicers to meet certain benchmarks for customer service. Servicers must provide periodic billing statements and certain required notices and acknowledgments, promptly credit borrowers’ accounts for payments received and promptly investigate complaints by borrowers and are required to take additional steps before purchasing insurance to protect the lender’s interest in the property. The new servicing rules also call for additional notice, review and timing requirements with respect to delinquent borrowers, including early intervention, ongoing access to servicer personnel and specific loss mitigation and foreclosure procedures. Both the origination and servicing rules will take effect on January 10, 2014. The CFPB also issued guidelines on October 13, 2011 and January 11, 2012 indicating that it would send examiners to banks and other institutions that service and/or originate mortgage loans to assess whether consumers’ interests are protected.

The ongoing implementation of the Dodd-Frank Act, including the implementation of the new origination and servicing rules by the CFPB and the CFPB’s continuing examination of our industry, will increase our regulatory compliance burden and associated costs and place restrictions on our servicing operations, which could in turn adversely affect our business, financial condition and results of operations.

State or federal governmental examinations, legal proceedings or enforcement actions and related costs could have a material adverse effect on our liquidity, financial position and results of operations.

We are routinely involved in regulatory reviews and legal proceedings concerning matters that arise in the ordinary course of our business. An adverse result in regulatory actions or examinations or private lawsuits may adversely affect our financial results. In addition, a number of participants in our industry have been the subject of purported class action lawsuits and regulatory actions by state regulators and other industry participants have been the subject of actions by state Attorneys General. Regulatory investigations, both state and federal, can be either formal or informal. The costs of responding to the investigations can be substantial. In addition, government-mandated changes to servicing practices could lead to higher costs and additional administrative burdens, in particular regarding record retention and informational obligations.

The enforcement consent orders by, agreements with, and settlements of, certain federal and state agencies against other mortgage servicers related to foreclosure practices could impose additional compliance costs on our servicing business, which could adversely affect our business, financial condition and results of operations.

The federal and state agencies overseeing certain aspects of the mortgage market have entered into settlements and enforcement consent orders with other mortgage servicers regarding foreclosure practices that

 

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primarily relate to mortgage loans originated during the credit crisis. The enforcement consent orders require the servicers, among other things, to: (i) make significant modifications in practices for residential mortgage loan servicing and foreclosure processing, including communications with borrowers and limitations on dual-tracking, which occurs when servicers continue to pursue foreclosure during the loan modification process; (ii) establish a single point of contact for borrowers throughout the loan modification and foreclosure processes; and (iii) establish robust oversight and controls pertaining to their third party vendors, including outside legal counsel, that provide default management or foreclosure services.

Although we are not a party to any of these settlements and enforcement consent orders and lack the legacy loans that gave rise to these settlements and enforcement consent orders, the practices set forth in those settlements and consent orders are being adopted by the industry as a whole, forcing us to comply with them in order to follow standard industry practices. We may also become required to comply with these practices by our servicing agreements. While we have made and continue to make changes to our operating policies and procedures in light of these settlements and consent orders, further changes could be required, and changes to our servicing practices will increase compliance costs for our servicing business, which could adversely affect our business, financial condition and results of operations.

Our foreclosure proceedings in certain states may be delayed due to inquiries by certain state Attorneys General, court administrators and state and federal government agencies, the outcome of which could have an adverse effect on business, financial condition and results of operations.

Allegations of irregularities in foreclosure processes, including so-called “robo-signing” by mortgage loan servicers, have gained the attention of the Department of Justice, regulatory agencies, state Attorneys General and the media, among other parties. Certain state Attorneys General, court administrators and government agencies, as well as representatives of the federal government, have issued letters of inquiry to mortgage servicers requesting written responses to questions regarding policies and procedures, especially with respect to notarization and affidavit procedures. Even though we have not received any letters of inquiry and we do not have the legacy loans that have been examined for irregularities in the foreclosure process, our operations may be affected by regulatory actions or court decisions that are taken in connection with these inquiries. In addition to these inquiries, several state Attorneys General have requested that certain mortgage servicers suspend foreclosure proceedings pending internal review to ensure compliance with applicable law.

The current legislative and regulatory climate could lead borrowers to contest foreclosures that they would not otherwise have contested under ordinary circumstances, and we may incur increased litigation costs if the validity of a foreclosure action is challenged by a borrower. Delays in foreclosure proceedings could also require us to make additional servicing advances by drawing on our financing facilities, or delay the recovery of advances, all or any of which could adversely affect our business, financial condition and results of operations.

We may incur increased costs and related losses if a borrower challenges the validity of a foreclosure action, if a court overturns a foreclosure or if a foreclosure subjects us to environmental liabilities, which could adversely affect our business, financial condition and results of operations.

We may incur costs if we are required to, or if we elect to, execute or re-file documents or take other action in our capacity as a servicer in connection with pending or completed foreclosures. We may incur litigation costs if the validity of a foreclosure action is challenged by a borrower. If a court overturns a foreclosure because of errors or deficiencies in the foreclosure process, we may have liability to a title insurer or the purchaser of the property sold in foreclosure. These costs and liabilities may not be legally or otherwise reimbursable to us, particularly to the extent they relate to securitized mortgage loans. In addition, if certain documents required for a foreclosure action are missing or defective, we could be obligated to cure the defect or repurchase the loan. A significant increase in litigation costs could adversely affect our liquidity, and our inability to be reimbursed for an advance could adversely affect our business, financial condition and results of operations.

 

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In addition, in the course of our business, it is necessary to foreclose and take title to real estate, which could subject us to environmental liabilities with respect to these properties. Hazardous substances or waste, contaminants, pollutants or sources thereof may be discovered on properties during our ownership or after a sale to a third party. We could be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances or chemical releases at such properties. The costs associated with investigation or remediation activities could be substantial and could substantially exceed the value of the real property. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. We may be unable to recover costs from any third party. These occurrences may materially reduce the value of the affected property, and we may find it difficult or impossible to use or sell the property prior to or following any environmental remediation. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.

Borrowers with adjustable rate mortgage loans are especially exposed to increases in monthly payments and they may not be able to refinance their loans, which could cause delinquency, default and foreclosure and therefore adversely affect our business.

At June 30, 2013, we serviced adjustable rate mortgage loans that represented less than 0.1% of our total servicing portfolio. Borrowers with adjustable rate mortgage loans are exposed to increased monthly payments when the related mortgage loan’s interest rate adjusts upward from an initial fixed rate or a low introductory rate, as applicable, to the rate computed in accordance with the applicable index and margin. Borrowers with adjustable rate mortgage loans seeking to refinance their mortgage loans to avoid increased monthly payments as a result of an upwards adjustment of the mortgage loan’s interest rate may no longer be able to find available replacement loans at comparably low interest rates. This increase in borrowers’ monthly payments, together with any increase in prevailing market interest rates, may result in significantly increased monthly payments for borrowers with adjustable rate mortgage loans, which may cause delinquency, default and foreclosure. Increased mortgage defaults and foreclosures may adversely affect our business as they increase the cost of servicing the mortgage loans we service and reduce the number of mortgage loans we service.

Our counterparties may terminate our servicing rights, which could materially and adversely affect our business, financial condition and results of operations.

The owners of the loans we service may, under certain circumstances, terminate our MSRs. As is standard in the industry, under the terms of our master servicing agreement with GSEs, GSEs have the right to terminate us as servicer of the loans we service on their behalf at any time and also have the right to cause us to sell the MSRs to a third party. In addition, failure to comply with servicing standards could result in termination of our agreements with GSEs. See “—Because we are required to follow the guidelines of the GSEs with which we do business and are not able to negotiate our fees with these entities for the purchase of our loans, our competitors may be able to sell their loans to GSEs on more favorable terms.” Some GSEs may also have the right to require us to assign the MSRs to a subsidiary and sell our equity interest in the subsidiary to a third party. If we were to have our servicing rights terminated on a material portion of our servicing portfolio, this could materially and adversely affect our business, financial condition and results of operations.

Federal and state legislative and Agency initiatives in mortgage-backed securities and securitization may adversely affect our financial condition and results of operations.

There are federal and state legislative and Agency initiatives that could, once fully implemented, adversely affect our business. For instance, the risk retention requirement under the Dodd-Frank Act requires securitizers to retain a minimum beneficial interest in MBS they sell through a securitization, absent certain qualified residential mortgage (“QRM”) exemptions. Once implemented, the risk retention requirement may result in higher costs of certain origination operations and impose on us additional compliance requirements to

 

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meet servicing and origination criteria for QRMs. Additionally, the amendments to Regulation AB relating to the registration statement required to be filed by asset-backed securities (“ABS”) issuers adopted in March 2011 by the SEC pursuant to the Dodd-Frank Act would increase compliance costs for ABS issuers, which could in turn increase our cost of funding and operations. Any of the foregoing could adversely affect our business, financial condition and results of operations.

We may be required to indemnify purchasers of the mortgage loans we originate or of the MBS backed by such loans or to repurchase the related loans if the loans fail to meet certain criteria or characteristics or under other circumstances.

The indentures governing our securitized pools of mortgage loans and our contracts with purchasers of our whole loans contain provisions that require us to indemnify purchasers of the loans we originate or of the MBS backed by such loans or to repurchase the related loans under certain circumstances. While our contracts vary, they contain provisions that require us to repurchase loans if:

 

   

our representations and warranties concerning loan quality and loan circumstances are inaccurate;

 

   

we fail to secure adequate mortgage insurance within a certain period after closing;

 

   

a mortgage insurance provider denies coverage; or

 

   

we fail to comply, at the individual loan level or otherwise, with regulatory requirements in the current dynamic regulatory environment.

We believe that, as a result of the current market environment, many purchasers of residential mortgage loans are particularly aware of the conditions under which originators must indemnify them or repurchase loans they have purchased and would benefit from enforcing any repurchase remedies they may have. We believe that our exposure to repurchases under our representations and warranties includes the current unpaid balance of all loans we have sold. If we are required to indemnify or repurchase loans that we originate and sell or securitize that result in losses that exceed our reserve, this could adversely affect our business, financial condition and results of operations.

Because we are required to follow the guidelines of the GSEs with which we do business and are not able to negotiate our fees with these entities for the purchase of our loans, our competitors may be able to sell their loans to GSEs on more favorable terms.

In our transactions with the GSEs, we are required to follow specific guidelines that impact the way we service and originate mortgage loans including:

 

   

our staffing levels and other servicing practices;

 

   

the servicing and ancillary fees that we may charge;

 

   

our modification standards and procedures; and

 

   

the amount of non-reimbursable advances.

In particular, the FHFA has directed GSEs to align their guidelines for servicing delinquent mortgages they own or guarantee, which can result in monetary incentives for servicers that perform well and penalties for those that do not. In addition, FHFA has directed Fannie Mae to assess compensatory fees against servicers in connection with delinquent loans, foreclosure delays, and other breaches of servicing obligations.

 

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We cannot negotiate these terms with the GSEs, and they are subject to change at any time. A significant change in these guidelines that has the effect of decreasing our fees or requires us to expend additional resources in providing mortgage services could decrease our revenues or increase our costs, which could adversely affect our business, financial condition and results of operations.

We are required to make servicing advances that can be subject to delays in recovery or may not be recoverable in certain circumstances, which could adversely affect our liquidity, business, financial condition and results of operations.

During any period in which a borrower is not making payments, we are required under most of our servicing agreements to advance our own funds to meet contractual principal and interest remittance requirements for investors, pay property taxes and insurance premiums, pay legal expenses and fund other protective advances. We also advance funds to maintain, repair and market real estate properties that we service. As home values change, we may have to reconsider certain of the assumptions underlying our decisions to make advances and, in certain situations, our contractual obligations may require us to make certain advances for which we may not be reimbursed. In addition, in the event a mortgage loan serviced by us defaults or becomes delinquent, the repayment to us of the advance may be delayed until the mortgage loan is repaid or refinanced or a liquidation occurs. They are typically recovered upon weekly or monthly reimbursement or from sale in the market. In the event we receive requests for advances in excess of amounts we are able to fund, we may not be able to fund these advance requests, which could materially and adversely affect our liquidity. A delay in our ability to collect an advance may adversely affect our liquidity, and our inability to be reimbursed for an advance could adversely affect our business, financial condition and results of operations.

Our hedging strategies may not be successful in mitigating our risks associated with interest rates.

From time to time, we have used various derivative financial instruments to provide a level of protection against interest rate risks, including the commitments we make to prospective borrowers, but no hedging strategy can protect us completely. The derivative financial instruments that we select may not have the effect of reducing our interest rate risks. In addition, the nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies, improperly executed and documented transactions or inaccurate assumptions could actually increase our risks and losses. In addition, hedging strategies involve transaction and other costs. Our hedging strategies and the derivatives that we use may not be able to adequately offset the risks of interest rate volatility, and our hedging transactions may result in or magnify losses. Furthermore, interest rate derivatives may not be available on favorable terms or at all, particularly during economic downturns. Any of the foregoing risks could adversely affect our business, financial condition and results of operations.

A delay in obtaining or failure to obtain servicer ratings could have an adverse effect on our business, financial condition and results of operations.

In connection with our business of servicing non-Agency mortgage loans, we are pursuing obtaining servicer ratings from Standard & Poor’s Ratings Services, Moody’s Investors Service and Fitch Ratings as a residential mortgage loan servicer. We expect to receive those ratings, but there can be no assurances that we will receive servicer ratings from each rating agency in a timely manner, or at all. A delay in obtaining or failure to obtain servicer ratings will delay our ability to increase our non-Agency mortgage loan servicing business, which could have an adverse effect on our business, financial condition and results of operations. In addition, any ratings that we receive may be downgraded in the future. Any such downgrade could adversely affect our business, financial condition and results of operations.

Technology failures or terrorist attacks could damage our business operations and increase our costs, which could adversely affect our business, financial condition and results of operations.

The financial services industry as a whole is characterized by rapidly changing technologies, and system disruptions and failures caused by fire, power loss, telecommunications failures, unauthorized intrusion,

 

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computer viruses and disabling devices, natural disasters and other similar events may interrupt or delay our ability to provide services to our borrowers and other business partners. Security breaches, acts of vandalism and developments in computer capabilities could result in a compromise or breach of the technology that we use to protect our borrowers’ personal information and transaction data. Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or implement effective preventive measures against all security breaches, especially because the techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including third parties such as persons involved with organized crime or associated with external service providers. Those parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients. These risks may increase in the future as we continue to increase our reliance on the internet and use of web-based product offerings and on the use of cybersecurity.

A successful penetration or circumvention of the security of our systems or a defect in the integrity of our systems or cybersecurity could cause serious negative consequences for our business, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to our computers or operating systems and to those of our customers and counterparties. Any of the foregoing events could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation exposure and harm to our reputation, all of which could adversely affect our business, financial condition and results of operations.

In addition, the terrorist attacks on September 11, 2001 disrupted the U.S. financial markets, including the real estate capital markets, and negatively impacted the U.S. economy in general. Any future terrorist attacks, the anticipation of any such attacks, the consequences of any military or other response by the United States and its allies, and other armed conflicts could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economy. The economic impact of these events could also adversely affect the credit quality of some of our loans and investments and the properties underlying our interests.

We may suffer losses as a result of the adverse impact of any future attacks and these losses may adversely impact our performance and may cause the market value of our shares of common stock to decline or be more volatile. A prolonged economic slowdown, recession or declining real estate values could impair the performance of our investments and harm our financial condition and results of operations, increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. We cannot predict the severity of the effect that potential future armed conflicts and terrorist attacks would have on us. Losses resulting from these types of events may not be fully insurable.

We have purchased certain refinancing loans where the correspondent originating the refinancing loan failed to obtain a satisfaction and release of the prior mortgage loan.

In early 2013, we became aware that we purchased certain refinancing loans with original principal amounts totaling approximately $5.2 million from a correspondent in cases where the prior mortgage loan on the property securing the mortgage loan that we purchased from the correspondent was not satisfied and released by the correspondent’s title company at the time the loan from the correspondent was made. As part of our process in purchasing a mortgage loan from a correspondent, we generally require that a closing protection letter be issued by the title insurer in favor of the borrower. A closing protection letter was obtained with respect to each of these loans. As a result, the borrower should be insured against any liens prior to ours that were not identified in connection with the issuance of that closing protection letter. We believe that our procedures, including conducting a post-purchase audit, were effective in identifying the failure by the correspondent to obtain a release of the prior mortgage loan and that our practice of obtaining closing protection letters is appropriate to protect us in these situations. We have notified the affected borrowers and the relevant insurance carriers, and we expect that the title insurance obtained in

 

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connection with the refinancings will result in our loan having a first priority status. However, there can be no assurances that the prior mortgages will be fully satisfied from the title insurance claims or that instances like this will not occur in the future.

Any failure of our internal security measures or breach of our privacy protections could cause harm to our reputation and subject us to liability, any of which could adversely affect our business, financial condition and results of operations.

In the ordinary course of our business, we receive and store certain confidential information concerning borrowers. Additionally, we enter into third party relationships to assist with various aspects of our business, some of which require the exchange of confidential borrower information. If a third party were to compromise or breach our security measures or those of the vendors, through electronic, physical or other means, and misappropriate such information, it could cause interruptions in our operations and expose us to significant liabilities, reporting obligations, remediation costs and damage to our reputation. Any of the foregoing risks could adversely affect our business, financial condition and results of operations. See also “—Technology failures or terrorist attacks could damage our business operations and increase our costs, which could adversely affect our business, financial condition and results of operations.”

Our vendor relationships subject us to a variety of risks.

We have significant vendors that, among other things, provide us with financial, technology and other services to support our mortgage loan servicing and origination businesses. With respect to vendors engaged to perform activities required by servicing criteria, we have elected to take responsibility for assessing compliance with the applicable servicing criteria for the applicable vendor and are required to have procedures in place to provide reasonable assurance that the vendor’s activities comply in all material respects with servicing criteria applicable to the vendor. In the event that a vendor’s activities do not comply with the servicing criteria, it could negatively impact our servicing agreements. In addition, if our current vendors were to stop providing services to us on acceptable terms, including as a result of one or more vendor bankruptcies due to poor economic conditions, we may be unable to procure alternatives from other vendors in a timely and efficient manner and on acceptable terms, or at all. Further, we may incur significant costs to resolve any such disruptions in service and this could adversely affect our business, financial condition and results of operations.

The loss of the services of our senior executives could adversely affect our business, financial condition and results of operations.

The experience of our senior executives is a valuable asset to us. Our management team has significant experience in the residential mortgage origination and servicing industry. We have obtained a key life insurance policy on Mr. Cutillo but do not maintain and do not currently plan to obtain key life insurance policies on any of our other senior managers.

Additionally, under certain financing agreements, the loss of the services of senior executives could have adverse consequences. Under the Master Purchase Agreement between us and Barclays Bank PLC (“Barclays”), dated as of December 24, 2012, if Mr. Cutillo resigns, is removed or experiences a substantial change in management responsibilities without the approval of Barclays, an event of default would occur. If an event of default occurs, Barclays may terminate the agreement and may exercise various other remedies.

Under the Master Repurchase Agreement between us and Bank of America, N.A. (“Bank of America”), dated as of February 28, 2013, event of default is defined to include a change in key personnel without the prior written consent of Bank of America. Key personnel is defined as Mr. Cutillo as chief executive officer, Mr. Bettenburg as president and Mr. Swain as executive vice president of loan servicing. If an event of default occurs, Bank of America may declare certain amounts immediately due and payable and may exercise various other remedies. Thus, the loss of services of our senior executives could thus adversely affect our business, financial condition and results of operations.

 

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Our business could suffer if we fail to attract and retain a highly skilled workforce.

Our future success will depend on our ability to identify, hire, develop, motivate and retain highly qualified personnel for all areas of our organization, in particular skilled managers, loan servicers, debt default specialists, loan officers and underwriters. Trained and experienced personnel are in high demand and may be in short supply in some areas. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment. In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them. We may not be able to attract, develop and maintain an adequate skilled workforce necessary to operate our businesses, and labor expenses may increase as a result of a shortage in the supply of qualified personnel. If we are unable to attract and retain such personnel, we may not be able to take advantage of acquisitions and other growth opportunities that may be presented to us, and this could materially affect our business, financial condition and results of operations.

Negative public opinion could damage our reputation and adversely affect our earnings.

Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending and debt collection practices, corporate governance, and actions taken by government regulators and community organizations in response to those activities. Negative public opinion can also result from media coverage, whether accurate or not. Negative public opinion can adversely affect our ability to attract and retain customers and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our customers, business partners and communities, this risk will always be present in our organization.

Risks Related to Our Organization and Structure

If the ownership of our common stock continues to be highly concentrated, it may prevent you and other minority shareholders from influencing significant corporate decisions and may result in conflicts of interest.

Following the completion of this offering, affiliates of Long Ridge Equity Partners, will own approximately 23.7% of our outstanding common stock (excluding shares issuable upon exercise of the warrants owned by Long Ridge Equity Partners and Stonegate Investors Holdings, an affiliate of Long Ridge Equity Partners, to purchase an additional 242,621 shares of our common stock). As a result, Long Ridge Equity Partners will have a significant impact on any shareholder vote, including: the election of directors; mergers, consolidations and acquisitions; the sale of all or substantially all of our assets and other decisions affecting our capital structure; the amendment of our Third Amended and Restated Articles of Incorporation (the “Articles”) and our Third Amended and Restated Code of Regulations, as amended (the “Regulations”); and our winding up and dissolution. This concentration of ownership may delay, deter or prevent acts that may be favored by our other shareholders. The interests of Long Ridge Equity Partners may not always coincide with our interests or the interests of our other shareholders. This concentration of ownership may also have the effect of delaying, preventing or deterring a sale of our business or other change in control of us that our other shareholders might favor. Also, Long Ridge Equity Partners may seek to cause us to take courses of action that, in its judgment, could enhance its investment in us, but which might involve risks to our other shareholders or adversely affect us or our other shareholders, including investors in this offering. As a result, the market price of our common stock could decline or shareholders might not receive a premium over the then-current market price of our common stock upon a sale or other change in control. In addition, this concentration of share ownership may adversely affect the trading price of our common stock because investors may perceive disadvantages in owning shares in a company with a significant shareholder. See “Principal and Selling Shareholders” and “Certain Provisions of Ohio Law and Stonegate’s Articles and Regulations—Anti-Takeover Effect of Certain Provisions of Ohio Law and Our Articles and Regulations.”

 

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We do not anticipate paying any dividends on our common stock in the foreseeable future.

We do not expect to declare or pay any cash or other dividends in the foreseeable future on our common stock because we intend to use cash flow generated by operations to grow our business. We may enter into credit agreements or other borrowing arrangements in the future that restrict or limit our ability to pay cash dividends on our common stock. See “Dividend Policy.”

Certain provisions of our Articles and Regulations and of the Second Amended and Restated Shareholders Agreement, as amended between us and Stonegate Investors Holdings could hinder, delay or prevent a change in control of us, which could adversely affect the price of our common stock.

Certain provisions of our Articles and Regulations and of the Second Amended and Restated Shareholders Agreement, as amended that we entered into with Stonegate Investors Holdings on May 15, 2013, or the Shareholders Agreement, contain provisions that could make it more difficult for a third party to acquire us without the consent of our Board of Directors or Stonegate Investors Holdings. These provisions provide for:

 

   

Our Articles do not grant cumulative voting rights to our shareholders, which, if granted, would enhance the ability of minority shareholders to elect directors;

 

   

A super-majority vote of the holders of at least two-thirds of our shares of common stock entitled to vote is required to amend certain provisions in our Articles which have anti-takeover effects, including the elimination of preemptive rights and the elimination of cumulative voting of shares;

 

   

Our Regulations create a staggered Board of Directors where the directors are divided into two classes (consisting of not fewer than three directors in each class), with only one class of directors standing for election in any given year beginning in 2014. Because all the members of our Board of Directors will not be elected at the same time, this may make it more difficult to gain control of our Board of Directors;

 

   

All of the directors or any individual director may be removed by the holders of no less than 75% of all shares of our common stock then entitled to vote at an election of directors, but then only for cause, which also makes it more difficult to gain control of our Board of Directors;

 

   

Our Board of Directors has the power to cause us to issue additional shares of stock of any class or series, including “blank check” preferred stock, and to fix the terms of one or more classes of series of stock without shareholder approval, which may have rights that adversely affect the rights of holders of our common stock and impede or deter any efforts to acquire control of us;

 

   

Shareholders must follow certain advance notice and information requirements to nominate individuals for election as directors or to propose matters that may be acted upon at a shareholders’ meeting, which may discourage a potential acquirer from conducting a proxy contest to elect directors or otherwise attempting to influence or gain control of us;

 

   

Our Regulations require that, among other methods, shareholders holding at least 25% of our outstanding shares of common stock must act together to require us to call a special meeting of shareholders, other than the special election meeting required under the Registration Rights Agreement if we fail to perform certain obligations under that agreement;

 

   

Our Regulations provide that vacancies on our Board of Directors (including vacancies created by an expansion of the Board of Directors) may be filled by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum, or by our shareholders;

 

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Stonegate Investors Holdings will be able to nominate for election (i) three directors for our Board of Directors until the earlier of the completion of this initial public offering and the date on which their beneficial ownership of our common stock falls below 30% of the outstanding shares of common stock, (ii) thereafter two directors until the date on which their beneficial ownership of our common stock falls below 15% of the outstanding shares of common stock; and (iii) thereafter one director until the date on which their beneficial ownership of our common stock falls below 10% of the outstanding shares of common stock;

 

   

At least one Stonegate Investors Holdings nominated director will be on each committee of our Board of Directors until the date on which their beneficial ownership of our common stock falls below 10% of the outstanding shares of common stock for so long as their representation on those committees is permitted by the corporate governance rules of the national securities exchange on which our shares of common stock are then listed; and

 

   

Stonegate Investors Holdings will have a preemptive right to purchase shares of common stock in any private offering of shares of our common stock, subject to certain exceptions, until the date on which their beneficial ownership of our common stock falls below 10% of the outstanding shares of common stock.

In addition, these provisions may make it difficult and expensive for a third party to pursue a tender offer, a change in control or a takeover attempt that is opposed by Long Ridge Equity Partners, our management or our Board of Directors. Other shareholders who might desire to participate in these types of transactions may not have an opportunity to do so, even if the transaction is favorable to shareholders. These anti-takeover provisions could substantially impede the ability of other shareholders to benefit from a change in control or a change in our management or Board of Directors and, as a result, may adversely affect the market price of our common stock and your ability to realize any potential change of control premium. See “Certain Provisions of Ohio Law and Stonegate’s Articles and Regulations—Anti-Takeover Effect of Certain Provisions of Ohio Law and Our Articles and Regulations.”

We will have broad discretion in the use of a significant part of the net proceeds from this offering and may not use them effectively.

Our management currently intends to use the net proceeds from this offering in the manner described in “Use of Proceeds” and will have broad discretion in the application of a significant part of the net proceeds from this offering. The failure by our management to apply these funds effectively could affect our ability to operate and grow our business.

Risks Related to this Offering

An active trading market for our common stock may never develop or be sustained.

Although we intend to apply to list our common stock on the NYSE, even if such application is approved, an active trading market for our common stock may not develop on that exchange or elsewhere, or, if developed, that market may not be sustained. Accordingly, if an active trading market for our common stock does not develop or is not maintained, the liquidity of our common stock, your ability to sell your shares of common stock when desired and the prices that you may obtain for your shares of common stock will be adversely affected.

We are an “emerging growth company” and as a result of the reduced disclosure and governance requirements applicable to emerging growth companies, our common stock may be less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not

 

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emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We may take advantage of these reporting exemptions until we are no longer an emerging growth company. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to take advantage of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

The market price and trading volume of our common stock may be volatile, which could result in rapid and substantial losses for our shareholders.

Even if an active trading market develops, the market price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. The initial public offering price of our common stock will be determined by negotiation between us and the representatives of the underwriters based on a number of factors and may not be indicative of prices that will prevail in the open market following completion of this offering. If the market price of our common stock declines significantly, you may be unable to resell your shares at or above your purchase price, if at all. The market price of our common stock may fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:

 

   

variations in our quarterly or annual operating results;

 

   

changes in our earnings estimates (if provided) or differences between our actual financial and operating results and those expected by investors and analysts;

 

   

the contents of published research reports about us or our industry or the failure of securities analysts to cover our common stock after this offering;

 

   

additions or departures of key management personnel;

 

   

any increased indebtedness we may incur in the future;

 

   

announcements by us or others and developments affecting us;

 

   

actions by institutional shareholders;

 

   

litigation and governmental investigations;

 

   

changes in market valuations of similar companies;

 

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speculation or reports by the press or investment community with respect to us or our industry in general;

 

   

increases in market interest rates that may lead purchasers of our shares to demand a higher yield;

 

   

announcements by us or our competitors of significant contracts, acquisitions, dispositions, strategic relationships, joint ventures or capital commitments; and

 

   

general market, political and economic conditions, including any such conditions and local conditions in the markets in which our customers are located.

These broad market and industry factors may decrease the market price of our common stock, regardless of our actual operating performance. The stock market in general has from time to time experienced extreme price and volume fluctuations, including in recent months. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

The initial public offering price per share of our common stock in this offering may not accurately reflect the value of your investment.

Immediately prior to this offering, there was no public market for our common stock. The initial public offering price was determined by negotiations between us and the representatives of the underwriters of this offering. Among the factors considered in determining the initial public offering price were our future prospects and those of our industry in general, our revenues, results of operations and certain other financial and operating information in recent periods, and the valuation measures, market prices of securities and certain financial and operating information of companies engaged in activities similar to ours.

Investors in this offering will suffer immediate and substantial dilution.

The initial public offering price of our common stock will be substantially higher than the as adjusted net tangible book value per share issued and outstanding immediately after this offering. Our net tangible book value as of June 30, 2013 was approximately $178.0, or approximately $10.11 per share based on the 17,604,236 shares of common stock issued and outstanding as of such date. After giving effect to our sale of common stock in this offering at the initial public offering price of $21.00 per share (the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus), and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted net tangible book value as of June 30, 2013 would have been $314.1 million, or $12.71 per share (assuming no exercise of the underwriters’ option to purchase additional shares of common stock). Therefore, if you purchase shares of our common stock in this offering, you will experience immediate and substantial dilution of $8.29 in the net tangible book value per share, based upon the initial public offering price of $21.00 per share. Investors that purchase common stock in this offering will have purchased 34.8% of the shares issued and outstanding immediately after the offering, but will have paid 55.7% of the total consideration for those shares.

Members of our senior management team, our Board of Directors, continuing investors and Stonegate Investors Holdings collectively own a significant amount of our common stock or options exercisable for shares of our common stock, and future sales by these holders of shares of our common stock, or the perception that such sales could occur in the future, could have a material adverse effect on the market price of our common stock.

Mr. Cutillo, Mr. Bettenburg and other members of our senior management team, our Board of Directors, continuing investors and affiliates of Long Ridge Equity Partners will beneficially own, upon completion of this offering, an aggregate of approximately 37.4% of our outstanding shares of common stock (excluding the

 

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warrants to purchase 277,777 shares of our common stock owned by Glick Pluchenik 2011 Trust, Stonegate Investors Holdings and its affiliate, Long Ridge Equity Partners, LLC, and other option awards made to members of our senior management team and Board of Directors). Future sales by these holders of shares of our common stock, or the perception that such sales could occur in the future, could have a material adverse effect on the market price of our common stock.

Holders of 6,388,889 shares of our common stock have registration rights that obligate us to register the offer and sale of their shares under the Securities Act. Once we register the offer and sale of shares for the holders of registration rights, the shares can be freely sold in the public market, subject to any applicable lock-up agreements or unless they are held by “affiliates,” as that term is defined in Rule 144 of the Securities Act.

Future offerings of debt or equity securities by us may adversely affect the market price of our common stock.

In the future, we may attempt to obtain financing or to further increase our capital resources by issuing additional shares of our common stock or offering debt or other equity securities, including commercial paper, medium-term notes, senior or subordinated notes, debt securities convertible into equity or shares of preferred stock. Future acquisitions could require substantial additional capital in excess of cash from operations. We would expect to obtain the capital required for acquisitions through a combination of additional issuances of equity, corporate indebtedness and/or cash from operations.

Issuing additional shares of our common stock or other equity securities or securities convertible into equity may dilute the economic and voting rights of our existing shareholders or reduce the market price of our common stock or both. Upon liquidation, holders of such debt securities and preferred shares, if issued, and lenders with respect to other borrowings would receive a distribution of our available assets prior to the holders of our common stock. Debt securities convertible into equity could be subject to adjustments in the conversion ratio pursuant to which certain events may increase the number of equity securities issuable upon conversion. Preferred shares, if issued, could have a preference with respect to liquidating distributions or a preference with respect to dividend payments that could limit our ability to pay dividends to the holders of our common stock. Our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, which may adversely affect the amount, timing or nature of our future offerings.

The market price of our common stock could be negatively affected by sales of substantial amounts of our common stock in the public markets.

After this offering, there will initially be 24,704,236 shares of common stock outstanding, or 25,769,236 shares outstanding if the underwriters exercise their option to purchase additional shares in full. Of our issued and outstanding shares, all the common stock sold in this offering will be freely transferable, except for any shares held by our “affiliates,” as that term is defined in Rule 144 under the Securities Act.

Each of our executive officers, directors and Stonegate Investors Holdings has entered into a lock-up agreement with respect to shares of our common stock and securities exchangeable or exercisable for shares of our common stock, restricting the direct or indirect sale of such securities, subject to certain exceptions, for 180 days after the date of this prospectus without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated. Additionally, our other shareholders who purchased common stock in our May 2013 private offering have agreed with us, subject to certain exceptions, not to directly or indirectly sell, offer to sell, grant any option or otherwise transfer or dispose of our common stock for 180 days, in the case of any shareholders who elect to sell stock in this initial public offering, if any, and 60 days, in the case of holders who are not selling stock in this offering, in each case after the date of this prospectus. We have agreed not to waive or otherwise modify this agreement without the prior written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated. Merrill Lynch, Pierce, Fenner & Smith Incorporated may, at any time, release, or authorize us to release, as the case may be, all or a portion of our common stock subject to the foregoing lock-up provisions. If the restrictions under the lock-up agreements are waived, shares of our common stock may become available for sale into the market, subject to applicable law, which could reduce the market price for our common stock.

 

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The future issuance of additional common stock in connection with our incentive plans, acquisitions or otherwise will dilute all other stockholdings.

After this offering, assuming the underwriters exercise their option to purchase additional shares in full, we will have an aggregate of 25,769,236 shares of common stock authorized but unissued and not reserved for issuance under our incentive plans. We may issue all of these shares of common stock without any action or approval by our shareholders, subject to certain exceptions. We also intend to continue to evaluate acquisition opportunities and may issue common stock in connection with these acquisitions. Any common stock issued in connection with our incentive plans, acquisitions, the exercise of outstanding stock options or otherwise, will dilute the percentage ownership held by the investors who purchase common stock in this offering and reduce the number of authorized shares available for future issuance. Additionally, our Articles permit our Board of Directors to issue up to 25,000,000 of preferred shares on terms which will be set by the Board of Directors at the time of issuance of such preferred shares.

As a public company, we will incur additional costs and face increased demands on our management.

As a public company with shares listed on a U.S. exchange, we will need to comply with an extensive body of regulations that did not apply to us previously, including provisions of the Sarbanes-Oxley Act, regulations of the SEC and requirements of the NYSE. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, particularly after we are no longer an emerging growth company. For example, as a result of becoming a public company, we intend to add independent directors, create additional board committees and adopt certain policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements and maintaining directors’ and officers’ liability insurance. We are currently evaluating and monitoring developments with respect to these rules, which may impose additional costs on us and materially affect our business, financial condition and results of operations.

 

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CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS

Various statements contained in this prospectus, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements. These forward-looking statements may include projections and estimates concerning the timing and success of specific projects and our future production, revenues, income and capital spending. Our forward- looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “intend,” “anticipate,” “potential,” “plan,” “goal” or other words that convey the uncertainty of future events or outcomes. The forward-looking statements in this prospectus speak only as of the date of this prospectus; we disclaim any obligation to update these statements unless required by law, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control. These and other important factors, including those discussed under “Risk Factors” may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. These risks, contingencies and uncertainties include, but are not limited to, the following:

 

   

our ability to compete successfully in the highly competitive mortgage loan servicing and mortgage loan origination industries;

 

   

experiencing financial difficulties like some originators and mortgage servicers have experienced;

 

   

adverse changes in the residential mortgage market;

 

   

our ability to obtain sufficient capital to meet our operating requirements;

 

   

our ability to grow our loan origination volume;

 

   

the geographic concentration of our servicing portfolio may result in a higher rate of delinquencies and/or defaults;

 

   

our mortgage financing business is subject to risks, including the risk of default and competitive risks;

 

   

our estimates may prove to be imprecise and result in significant changes in financial performance, including valuation;

 

   

the impact on our business of federal, state and local laws and regulations concerning loan servicing, loan origination, loan modification or the licensing of individuals and entities that engage in these activities;

 

   

changes in existing U.S. government-sponsored mortgage programs;

 

   

changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. federal government, along with the conservatorship of Fannie Mae and Freddie Mac and related efforts;

 

   

substantial compliance costs arising from state licensing and operational requirements;

 

   

loss of our licenses or failure to obtain licenses in new markets;

 

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our ability to originate and/or acquire mortgage servicing rights;

 

   

our ability to recover our significant investments in personnel and our technology platform;

 

   

the implementation of our proprietary loan due diligence, scoring and decision platform on schedule, which is still in the process of being refined and implemented;

 

   

the accuracy and completeness of information we receive about borrowers and counterparties;

 

   

a significant change in delinquencies and/or defaults for the mortgage loans we service;

 

   

our ability to recapture mortgage loans from borrowers who refinance;

 

   

changes in prevailing interest rates and any corresponding effects on origination volumes or the value of our assets;

 

   

our rapid growth may be difficult to sustain and manage and may place significant demands on our administrative, operational and financial resources;

 

   

our ability to identify and complete acquisitions of retail mortgage originators and other businesses;

 

   

our ability to realize all of the anticipated benefits of our acquisitions;

 

   

the change of control rules under Section 382 of the Code may limit our ability to use net operating loss carryforwards to reduce future taxable income;

 

   

failure to establish and maintain an effective system of internal controls;

 

   

errors in our financial models or changes in assumptions;

 

   

our ability to adapt to and implement technological changes;

 

   

the impact of the ongoing implementation of the Dodd-Frank Act on our business activities and practices, costs of operations and overall results of operations;

 

   

state or federal governmental examinations, legal proceedings or enforcement actions and related costs;

 

   

increased costs and related losses if a borrower challenges the validity of a foreclosure action, if a court overturns a foreclosure or if a foreclosure subjects us to environmental liabilities;

 

   

the impact of the termination of our servicing rights by counterparties;

 

   

federal and state legislative and Agency initiatives in mortgage-backed securities and securitization;

 

   

we may be required to indemnify purchasers of the loans we originate or of the MBS backed by such loans or repurchase the related loans, if the loans fail to meet certain criteria or characteristics or under other circumstances;

 

   

our inability to negotiate our fees with GSEs for the purchase of our loans;

 

   

delays in our ability to collect or be reimbursed for servicing advances;

 

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our ability to successfully mitigate our risks through hedging strategies;

 

   

our ability to obtain servicer ratings in a timely manner, or at all;

 

   

failure of our internal security measures or breach of our privacy protections;

 

   

losses due to fraudulent and negligent acts on the part of loan applicants, brokers, other vendors, existing customers, our employees and other third parties;

 

   

failure of our vendors to comply with servicing criteria;

 

   

the loss of the services of one or more of the members of our executive management team;

 

   

failure to attract and retain a highly skilled work force;

 

   

the offering price per share of common stock offered under this prospectus may not accurately reflect the value of your investment;

 

   

an active trading market for our stock may never develop or be sustained;

 

   

future sales of our common stock or other securities convertible into our common stock could cause the market value of our common stock to decline and could result in dilution; and

 

   

future offerings of debt securities or preferred stock and future offerings of equity securities that may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the shares of our common stock offered by us will be approximately $136.0 million, based on an assumed initial public offering price of $21.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and other estimated offering expenses payable by us. If the underwriters’ option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will be approximately $156.9 million, after deducting underwriting discounts and commissions and other estimated offering expenses payable by us.

A $1.00 increase (decrease) in the assumed initial public offering price of $21.00 per share would increase (decrease) the net proceeds to us from this offering by approximately $6.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions. Similarly, each increase (decrease) of one million shares in the number of shares of common stock offered by us would increase (decrease) the net proceeds to us from this offering by approximately $19.6 million, assuming the assumed initial public offering price remains the same and after deducting underwriting discounts and commissions. We intend to use the net proceeds of this 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. However, we have no commitments with respect to any such acquisitions or investments at this time.

 

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DIVIDEND POLICY

We do not expect to pay dividends on our common stock for the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used for the operation and growth of our business.

Any future determination to pay dividends on our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, results of operations, liquidity, legal requirements, restrictions that may be imposed by the terms in current and future financing instruments to which we are a party, and other factors deemed relevant by our Board of Directors.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2013 (1) on a historical basis and (2) as adjusted to give effect to the sale by us of 7,100,000 shares of our common stock in this offering at an initial public offering price of $21.00 per share, which is the mid-point of the price range set forth on the front cover page of this prospectus, less underwriting discounts and commissions and other estimated offering expenses payable by us. You should read this table together with “Selected Historical Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    

Actual

   

As Adjusted

 
     (in millions)  

Cash and cash equivalents

   $ 31.6      $ 167.6   
  

 

 

   

 

 

 

Secured borrowings

   $ 246.5      $ 246.5   

Warehouse lines of credit

     92.4        92.4   

Operating lines of credit

     1.5        1.5   
  

 

 

   

 

 

 

Total borrowings

     340.4        340.4   

Stockholders’ equity:

    

Preferred Stock 25,000,000 shares authorized

     —          —     

Common stock, $0.01 par value; 100,000,000 shares authorized, 17,604,236 shares issued and outstanding, actual; 100,000,000 shares authorized, 24,704,236 issued and outstanding, as adjusted for this initial public offering(1)

     0.2        0.3   

Treasury stock, 591,554 shares of common stock, actual; 0 shares of common stock, as adjusted for this initial public offering

     (1.7     —     

Additional paid-in-capital

     143.3        277.5   

Retained earnings

     39.7        39.7   
  

 

 

   

 

 

 

Total stockholders’ equity

     181.5        317.5   
  

 

 

   

 

 

 

Total capitalization

   $ 521.9      $ 657.9   
  

 

 

   

 

 

 

 

(1) The number of outstanding shares of common stock does not include (a) 1,817,660 shares issuable upon the exercise of outstanding warrants and options or (b) up to 1,065,000 shares of our common stock that we may issue and sell upon the exercise of the underwriters’ option to purchase 1,290,000 additional shares from us and the selling shareholders.

 

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DILUTION

If you invest in our common stock, your ownership interest will be diluted to the extent of the difference between the initial public offering price in this offering per share of our common stock and the as adjusted net tangible book value per share of our common stock upon consummation of this offering. Net tangible book value per share represents the book value of our total tangible assets less the book value of our total liabilities divided by the number of shares of common stock then issued and outstanding.

Our net tangible book value as of June 30, 2013 was approximately $178.0 million, or approximately $10.11 per share based on the 17,604,236 shares of common stock issued and outstanding as of such date. After giving effect to our sale of common stock in this offering at the initial public offering price of $21.00 per share (the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus), and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our as adjusted net tangible book value as of June 30, 2013 would have been $314.1 million, or $12.71 per share (assuming no exercise of the underwriters’ option to purchase additional shares of common stock). This represents an immediate and substantial dilution of $8.29 per share to new investors purchasing common stock in this offering. The following table illustrates this dilution per share assuming the underwriters do not exercise their option to purchase additional shares of common stock:

 

Assumed initial public offering price per share.

      $ 21.00   

Net tangible book value per share as of June 30, 2013, before giving effect to this offering

   $ 10.11      

Increase in net tangible book offering per share attributable to this offering

     2.60      
  

 

 

    

Net tangible book value per share, as adjusted to give effect to this offering

        12.71   
     

 

 

 

Dilution in net tangible book value per share to new investors in this offering

      $ 8.29   
     

 

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $21.00 per share (the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus) would increase (decrease) our net tangible book value by $6.6 million, the as adjusted net tangible book value per share after this offering by $0.27 per share and the dilution to new investors in this offering by $0.73 per share, assuming the number of shares of common stock offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The following table summarizes, on a pro forma basis as of June 30, 2013, the differences between the number of shares of common stock purchased from us, the total price and the average price per share paid by continuing shareholders, selling shareholders and by the new investors in this offering, before deducting the underwriting discounts and commissions and estimated offering expenses payable by us, at an assumed initial public offering price of $21.00 per share (the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus).

 

    

Common Stock

Purchased

   

Total Consideration

       
    

Number

    

Percent

   

Amount

    

Percent

   

Average Price Per Share of
Common Stock

 
     (in millions)      

Continuing shareholders

     16,104,236         65.2   $ 138.1         42.6   $ 8.57   

Selling shareholders(1)

     1,500,000         —          5.4         1.7        3.61   

Investors in this offering(1)

     8,600,000         34.8        180.6         55.7        21.00   
     

 

 

   

 

 

    

 

 

   

Total

        100.0   $ 324.1         100.0  
     

 

 

   

 

 

    

 

 

   

 

(1) Shares of common stock purchased by investors in this offering include the 1,500,000 shares to be sold by selling shareholders in the line above. Shares to be sold by selling shareholders are not included in the percent of common stock purchased.

If the underwriters’ option to purchase additional shares of common stock is fully exercised, the adjusted net tangible book value per share after this offering as of June 30, 2013 would be approximately $13.00 per share and the dilution to new investors per share after this offering would be $8.00 per share.

 

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SELECTED HISTORICAL FINANCIAL DATA

The following tables present selected financial information of Stonegate. The selected statement of operations data for the six months ended June 30, 2013 and the years ended December 31, 2012 and 2011 and the selected balance sheet data at June 30, 2013, December 31, 2012 and December 31, 2011 has been derived from our audited financial statements included elsewhere in this prospectus. The statement of operations data for the six months ended June 30, 2012 and the balance sheet data as of June 30, 2012 have been derived from unaudited financial statements of Stonegate Mortgage Corporation included elsewhere in this prospectus. The unaudited financial statements of Stonegate Mortgage Corporation have been prepared on substantially the same basis as the audited financial statements and include all adjustments that we consider necessary for a fair presentation of our financial position and results of operations for all periods presented. Amounts presented for basic and diluted earnings per share reflect the impact of our stock dividend of 12.861519 additional shares of our common stock for each share of our common stock that was outstanding on May 14, 2013.

You should read these tables along with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Our Business” and our financial statements and the related notes included elsewhere in this prospectus.

 

    

  Six Months Ended June 30,  

    

  Year Ended December 31,  

 
    

2013

    

2012

    

2012

    

2011

 
            (unaudited)                
    

(in thousands, except per share data)

 

Statement of Operations Data

           

Revenues:

           

Gains on mortgage loans held for sale

   $ 50,575       $ 23,486       $ 73,337       $ 16,735   

Fee income

     18,356         5,554         15,779         6,916   

Changes in MSR valuation

     9,550         —           —           —     

Other income

     5,747         1,584         6,429         2,371   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     84,228         30,624         95,545         26,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses:

           

Salaries, commissions and benefits

     32,127         12,042         32,737         13,085   

General and administrative

     8,895         2,516         7,705         3,163   

Interest expense

     7,675         1,936         6,239         2,728   

Amortization of MSRs

     —           1,413         3,680         960   

Impairment of MSRs

     —           4,827         11,698         2   

Other expenses

     5,001         1,626         5,677         2,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     53,698         24,360         67,736         21,988   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     30,530         6,264         27,809         4,034   

Income taxes

     11,680         2,385         10,724         1,699   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 18,850       $ 3,879       $ 17,085       $ 2,335   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per share

   $ 2.80       $ 1.19       $ 5.31       $ 0.70   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share

   $ 1.46       $ 0.70       $ 2.26       $ 0.59   
  

 

 

    

 

 

    

 

 

    

 

 

 
    

June 30,

    

December 31,

 
    

2013

    

2012

    

2012

    

2011

 
            (unaudited)                
    

(in thousands)

 

Balance Sheet Data

           

Cash and cash equivalents

   $ 31,556       $ 11,092       $ 15,056       $ 403   

Mortgage loans held for sale, at fair value

     418,000         126,161         218,624         61,729   

MSRs, at fair value

     99,209         —           ––           ––     

MSRs, at lower of amortized cost or fair value

     —           22,835         42,202         17,679   

Total assets

     628,882         178,250         309,606         89,108   

Secured borrowings

    
246,516
  
     118,470         102,675         57,894   

Warehouse lines of credit

     92,354         —           100,301         —     

Total liabilities

     447,426         144,654         254,357         78,692   

Total stockholders’ equity

     181,456         33,686         55,249         10,415   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read together with our financial statements and related notes and other financial information appearing elsewhere in this prospectus. This MD&A contains forward-looking statements that involve risk, uncertainties and assumptions. See “Cautionary Note Concerning Forward-Looking Statements.” 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” and elsewhere in this prospectus. 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.

Overview

We are a specialty financial services firm that operates in one segment: Mortgage Banking. This determination is based on our current organizational structure, which reflects how our chief operating decision maker evaluates the performance of our business.

Our Company

We are a leading, non-bank, integrated mortgage company focused on efficiently and effectively originating, acquiring, selling, financing and servicing U.S. residential mortgage loans. We are also one of the fastest growing non-bank mortgage originators, having grown origination volume by 298% during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. Our loan originations are primarily sourced through our network of retail branches and through our relationships with approximately 950 TPOs. For the six months ended June 30, 2013, we originated $4.0 billion in loans and, as of June 30, 2013, we serviced a portfolio with an unpaid principal balance of $7.6 billion.

We attribute our growth to our vertically integrated and scalable mortgage banking platform, which we believe enables us to efficiently and effectively originate, acquire, sell, finance and service residential mortgage loans, and to our on-going geographic and product expansion. Since January 1, 2012, we have expanded our business into 18 additional states and Washington, D.C., added approximately 750 correspondent and wholesale customers, opened or acquired 19 retail branch offices and as a result increased our origination volume substantially. We also recently launched additional mortgage products, including our mortgage financing business, through a wholly-owned operating subsidiary, NattyMac, which will complement our growth. We focus on originating mortgage loans associated with the purchase of residential real estate, representing 45% of our originations for the twelve months ended June 30, 2013, as opposed to the refinancing of existing mortgage loans. We believe our focus on purchase mortgage loans will continue to drive our growth in a stabilizing real estate market, making our business sustainable. Our servicing business, which complements our origination and financing activities, has also expanded along with our serviced portfolio, increasing by 260% over the twelve months ended June 30, 2013. Our three businesses—mortgage origination, servicing and financing—complement each other and create a natural hedge against interest rate volatility and business cyclicality.

We were founded in 2005 by members of our executive team who held various senior level executive positions at large mortgage companies and financial institutions. The loans we originate, finance and service conform to the requirements of GSEs, such as Fannie Mae and Freddie Mac, as well as government agencies, such as Ginnie Mae, the FHA, the VA, and private investors. We utilize proprietary technology to automate many of our core processes, which allows us to perform a high level of risk-based due diligence on each loan. We have also automated various aspects of quality control and regulatory compliance risk processes, which allows us to ensure adherence to credit, compliance and collateral standards of the GSEs and other investors. We believe that our expertise and the strength of our mortgage platform is best demonstrated by our exceptional track record as a mortgage originator and servicer, coupled with our ability to scale operations without compromising

 

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the quality of originated and serviced loans. As a result of our strong operating, technology and underwriting procedures that we apply consistently to each loan, we have not incurred any material losses related to repurchase or indemnification demands from the GSEs or other investors in our loans. We believe our lack of legacy issues and our focus on purchase versus refinance mortgages has positioned us as one of the leading non-bank integrated mortgage origination and servicing providers capable of taking advantage of growth opportunities in the mortgage sector.

Our Business

We are an integrated mortgage company that derives revenue from three principal sources: mortgage origination, mortgage financing and mortgage servicing. 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 and others 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 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. We expect that as the non-Agency market continues to recover and GSE reform is approved and implemented, a larger proportion of the industry volume will be comprised of non-Agency mortgage loans. We believe we are well positioned to benefit from this shift in the market given our business model and management expertise in originating and securitizing non-Agency mortgage loans.

We are currently licensed in 39 states and Washington, D.C. including six states (California, Montana, Oregon, Rhode Island, Virginia and Washington) where we have become licensed since June 30, 2013 and have not yet commenced any material operations. We intend to become licensed in 45 states by year end 2013 and to become licensed in the final three of the contiguous United States, New Hampshire, New York and Nevada, in the first half of 2014. The nine states in which we are not licensed, including five states where we have a pending license application, accounted for approximately $287 billion, or approximately 15% of the nation’s residential mortgage origination market in 2012 and the six states where we have become licensed since June 30, 2013, accounted for approximately $590 billion, or approximately 30%, of the nation’s origination volume in 2012. As we become licensed in these additional states and as we increase our origination activity in the states where we have only recently become licensed, we believe our origination volume will increase substantially. Economic and housing and mortgage market conditions can vary significantly from one geographic region to another; therefore, the geographic distribution of our mortgage originations can have a direct impact on the overall performance of our servicing portfolio. As of June 30, 2013, approximately 13%, 11% and 9% of the aggregate outstanding loan balances in our servicing portfolio were concentrated in Texas, Indiana and Ohio, respectively. Although we anticipate that our origination and servicing portfolios will become less geographically concentrated over time as we expand our operations into the additional nine states where we are not currently licensed, the geographic distribution of the mortgage loans we originate and service in the near term will likely be similar to that of our current servicing portfolio. To the extent the states where we have a higher concentration of loans experience weaker economic conditions, greater rates of decline in single family residential real estate values or reduced demand within the residential mortgage sector relative to the United States generally, the risks inherent in our business would be magnified as compared to our competitors that have a broader and less concentrated geographic footprint.

 

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Additionally, we have focused on originating mortgage loans associated with purchase transactions as opposed to refinancings to a greater degree than many industry participants. During 2012, approximately 45% of our loan originations were purchase loans and approximately 55% were refinance transactions, compared to 29% and 71%, respectively, for the industry as a whole. We believe purchase transactions are more sustainable than refinance transactions, and typically have slower prepayment speeds in early years, making the MSRs more valuable and less volatile. Additionally, we believe that the mortgage market will increasingly shift to purchase mortgages as the housing market continues to recover, first time home buyers re-enter the housing market and interest rates increase. Further, as the non-Agency market continues to recover, we believe that our platform and management expertise in originating and securitizing these mortgages will position us well to benefit from this transformation.

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, 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.

Our three mortgage loan originations channels are discussed in more detail below.

Correspondent Channel

We acquire newly originated loans conforming to the underwriting standards of the GSEs or government agencies as well as non-Agency mortgage loans conforming to the standards of our investors from our network of correspondents across 39 states plus Washington, D.C. We identify our correspondent customers through a team of relationship managers who are responsible for signing-up customers and ensuring that we receive an adequate share of their origination volume. In addition to competitive pricing, we offer our correspondents access to a state-of-the-art technology platform, funding through our financing platform (NattyMac), including access to innovative financing programs such as early purchase facilities, as well as a timely and transparent process of acquiring their loans. In return, our correspondents provide us with high quality products that meet our underwriting standards. We track the performance of our correspondents on a score-card and terminate relationships where quality and other requirements are not met. We believe that our programs offer correspondents an attractive value proposition, including greater access to capital and liquidity, as they seek to maintain and grow their businesses. As a testament to our relationship management and product offering, our correspondent origination volume has increased from $521.5 million during the six months ended June 30, 2012 to $2.8 billion during the six months ended June 30, 2013, or by 445%.

Our growth has been driven by adding new correspondents as well as deepening relationships with existing correspondents. Our correspondent channel represented 71% of our mortgage originations for the six months ended June 30, 2013. We conduct financial, operational and risk reviews of each correspondent prior to initially approving them as a customer and on an annual basis to ensure compliance with our guidelines and those of the various regulators who govern our business. In addition we conduct background and financial reviews of the principals and their mortgage loan officers, and in some cases require personal guarantees. We believe that as we receive licenses in additional states and continue to increase our coverage of correspondents, we will continue to increase our market share.

 

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Wholesale Channel

Through our wholesale channel, we originate loans through a network of approximately 460 non-exclusive relationships with various approved mortgage companies and mortgage brokers. Mortgage brokers identify applicants, help them complete a loan application, gather required information and documents, and act as our liaison with the borrower during the lending process. We review and underwrite an application submitted by a broker, accept or reject the application, determine the range of interest rates and other loan terms, and fund the loan upon acceptance by the borrower and satisfaction of all conditions to the loan in much the same manner as our retail channel. By relying on brokers to market our products and assist the borrower throughout the loan application process, we can increase loan volume through our wholesale channel with proportionately lower increases in overhead costs compared with the costs of increasing loan volume through loan originations in our retail channels.

We provide a variety of Agency, government insured and non-Agency mortgage loan products to our brokers to allow them to better service their borrowers. Before approving a mortgage broker for business, we focus on several attributes including origination volume, quality of originations and tangible net worth. We also conduct financial and background checks on the principals and their mortgage loan officers through various third-party sources and in some cases we require personal guarantees. Once we begin acquiring loans from our mortgage brokers, we track the performance of the loans on an on-going basis and terminate business relationships if the loans consistently do not perform or if there is evidence of misrepresentation. During the twelve months ended June 30, 2013, we did not terminate any significant relationships due to our continued focus on underwriting loans and ensuring compliance with policies.

Retail Channel

As of June 30, 2013, our retail channel primarily operated through 27 retail offices across 12 states. In this channel, company representatives originate loans through their relationships with local real estate agents, builders, telemarketing and other local contacts. This channel accounted for 15% of our 2012 originations. We expect to continue to grow our retail channel by opening 3 new branches by the end of 2013, and by continuing to seek opportunities to open additional new branches for at least the next 24 months. In addition, we expect that with the continued transformation of the mortgage sector there will be opportunities to acquire small retail mortgage operators as several independent mortgage originators will lack the scale to profitably originate and sell mortgages. We believe that we could provide a solution to such operators by acquiring and integrating them into our branch network. We are currently actively evaluating opportunities to acquire several of these retail originators and believe that the continued development and growth of our retail channel is central to our business strategy.

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. Following our acquisition, in June 2013, we consolidated our NattyMac financing platform into a wholly-owned subsidiary which will focus on providing warehouse financing to us, our correspondent customers and others. We expect that NattyMac will be able to leverage our proprietary technology (OLIE) 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 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 to purchase.

Our financing platform features a centralized custodian and disbursement agent allowing us to enter into participation arrangements with financial institutions, such as regional banks for an interest in our newly

 

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originated loans during the time these loans would otherwise be funded by a warehouse line or traditional repurchase facility. Additionally, by offering regional banks an opportunity to invest in a liquid high-quality asset, we are able to earn fee and net interest income. We believe that regional banks continue to have significant appetite for such investment opportunities and we believe our financing platform allows us to compete with bank-owned mortgage lenders who have access to cheaper deposit funding. We believe this is a competitive advantage over other non-bank mortgage originators and servicers who are reliant on other forms of wholesale financing to fund their operations.

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.

Our servicing model is also very focused on “recapture,” which involves actively working with existing borrowers to refinance their mortgage loans. When a loan is paid off or refinanced with a different lender, we lose the servicing fees on the loan, so our ability to recapture loans successfully is important to the longevity of our servicing cash flows. Because the refinanced loans typically have lower interest rates or lower monthly payments, and, in general, subsequently refinance more slowly and default less frequently, these refinancings also typically improve the overall quality of our servicing portfolio. For the twelve months ended June 30, 2013, we recaptured 38% of our payoffs (based on the dollar amount of refinanced mortgage loans).

Our servicing business produces strong recurring, contractual fee-based revenue with minimal credit risk. Servicing fees are primarily based on the aggregate UPB of the loans serviced and the payment structure varies by loan source and type. These include differences in rate of servicing fees as a percentage of UPB and in the structure of advances. We believe our origination business gives us a distinct advantage in building a high-quality portfolio of MSRs over those who rely heavily on purchasing MSRs from others to build their portfolios as originated portfolios generally perform better given the extensive diligence and underwriting procedures that we apply to each loan.

We service loans using a model designed to improve loan performance and reduce loan defaults and foreclosures. Our servicing portfolio consists of MSRs we retain from loans that we originate and MSRs we acquire from third party originators, including in transactions facilitated by GSEs, such as Fannie Mae and Freddie Mac. The loans we service are typically securitized by us, i.e., the loans have been pooled together with multiple other loans and interests have been sold to third party investors that are secured by loans in the securitization pool. As of June 30, 2013, our servicing portfolio contained $7.6 billion of residential first mortgages, with a weighted average coupon of 3.64% and a weighted average age of 9 months. At June 30, 2013, the 90+ day delinquency rate in our servicing portfolio was 0.37%, the weighted average FICO score of our servicing portfolio was 733, and the adjusted CPR of our servicing portfolio as of June 30, 2013 was 5.98%.

 

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Our Business Evolution

Since 2009, our mortgage banking platform has evolved in support of our business strategy. Prior to June 2009, all loans we originated were sold on a servicing-released basis into the secondary market, on either a best-efforts or assignment-of-trade basis. Our merger with Swain in 2009 allowed us to retain the servicing rights on a percentage of the mortgage loans we originated and/or acquired from our third party originators. The table below shows our origination volume during each period presented and servicing portfolio (by unpaid principal balance, or $UPB) at the end of each period presented:

 

(in millions)    Six Months June 30,      Year Ended December 31,  
    

2013

    

2012

    

2012

    

2011

    

2010

    

2009

 

Origination volume

   $ 3,985       $ 1,000       $ 3,449       $ 1,050       $ 741       $ 386   

Servicing ($UPB)

   $ 7,588       $ 2,108       $ 4,145       $ 1,316       $ 624       $ 245   

Our Integrated Business Model

Our integrated and scalable mortgage banking platform enables us to efficiently and effectively originate mortgage loans, generating gain on sale and fee income from the origination and servicing components of our business. We anticipate that our results of operations will be affected by various factors, some of which are beyond our control. Our principal sources of revenue include:

(i) gains on mortgage loans held for sale, including changes in the fair value of commitments to purchase or originate mortgage loans held for sale and the related hedging instruments;

(ii) fee and net interest income from our financing facility; and

(iii) fee income from loan servicing.

Origination. In evaluating revenue per mortgage loan originated, we focus on various revenue sources, including loan origination points and fees. We record gain on mortgage loans held for sale based on the terms of the originated mortgage loan or the price paid for purchased mortgage loans, the effect of any hedging activities that we undertake, the sales price of the mortgage loan and the value of any MSRs received in the transaction. Our gain on mortgage loans held for sale includes both cash and non-cash elements and realized gains (losses) associated with the mortgage loans held for sale and related derivative instruments. We recognize revenue on sale that include both cash and our estimate of the value of MSRs. These components are compared to established revenue targets and operating plans by channel.

In addition to the cost of financing our mortgage loan originations, operating costs associated with our originations component include staffing costs, sales commissions, technology, rent and other general and administrative costs.

Servicing. Servicing fee income is primarily based on the aggregate unpaid principal balance of mortgage loans serviced and varies by mortgage loan type. Other factors that impact servicing fee income include delinquency rates, prepayment speeds and loss mitigation activity. Delinquency rates on the mortgage loans we service impact the contractual servicing and ancillary fees we receive and the costs to service. Delinquent loans cost more to service than performing loans due to the additional resources and required servicing advances.

The largest cost in our servicing component is staffing cost, which is primarily impacted by delinquency levels and the size of our portfolio. Other operating costs in our servicing component include technology, occupancy, general and administrative costs and the cost of financing our servicing advances. We continually monitor these costs to improve efficiency by streamlining workflows and implementing technology-based solutions.

 

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Subsequent to the acquisition of Swain, we also expanded various servicing operations in both Indianapolis, Indiana and Dallas, Texas, as well as invested in additional management, technology, process refinement, key vendor relationships and internal reporting/controls. These ongoing servicing platform investments allow us to drive efficiency and scalability, while maintaining customer service levels and regulatory compliance.

Financing. We earn fee income and net interest income from our mortgage financing business. For a warehouse line of credit, net interest income is the difference between the rate at which we lend funds to our customers and our borrowing costs. This spread is determined by a variety of factors, including credit quality of loan, term of the loan, prevailing interest rates, regulatory environment, and general competition. The larger the spread the higher the net interest income derived per loan. Conversely, very competitive environments, when the spread is narrower, result in lower net interest income.

We intend for our financing business to provide an additional source of revenues through fee and interest income from warehouse funding to our correspondent customers. However, as of June 30, 2013, our financing business had not yet commenced operations and did not generate any revenues during the six months ended June 30, 2013 or during the years ended December 31, 2012 and 2011.

Market Considerations

Origination. Today’s U.S. residential mortgage loan originations 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. 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 decrease the originations 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. See “Our Business—Regulation.”

Servicing. Current trends in the mortgage servicing industry include elevated borrower delinquencies, a significant increase in loan modifications and the need for servicing expertise. In the aftermath of the 2008 U.S. financial crisis, the residential mortgage loan industry is undergoing major structural changes that affect the way residential mortgage loans are originated, owned and serviced. These changes have benefited and should continue to benefit non-bank mortgage servicers, such as us. Banks currently dominate the residential mortgage loan servicing industry, servicing over 90% of all residential mortgage loans as of December 31, 2012. Over 50% of all residential mortgage loan servicing was concentrated among just four banks as of December 31, 2012. However, banks are currently under tremendous pressure to exit or reduce their exposure to the mortgage loan servicing business as a result of increased regulatory scrutiny and capital requirements, as well as potentially significant earnings volatility.

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

 

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net income per share, which are non-GAAP financial measures, to further aid our investors in understanding and analyzing our core operating results and comparing them among periods. Adjusted net income and adjusted diluted net income per share exclude certain items that we do not consider part of our core operating results. These non-GAAP measures are not intended to be considered in isolation or as a substitute for income before income taxes, net income or diluted net income prepared in accordance with GAAP, and may not be comparable to similarly titled non-GAAP measures reported by other companies.

The table below reconciles net income to adjusted net income and diluted net income per share to adjusted diluted net income per share (which are the most directly comparable GAAP measures) for the six months ended June 30, 2013 and 2012 and for the years ended December 31, 2012 and 2011:

 

(in millions, except per share data)   

Six Months
Ended

June 30,

    

Year Ended

December 31,

 
    

2013

   

2012

    

2012

   

2011

 

Net income

   $ 18.8      $ 3.9       $ 17.1      $ 2.3   

Adjustments:

         

Non-deferrable expenses associated with equity offering

     0.9        —           —          —     

Interest expense associated with warrant

     1.5        —           —          —     

NattyMac bargain purchase

     —          —           (1.2     —     

Tax effect of adjustments

     (0.9     —           0.5        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Adjusted net income

   $ 20.3      $ 3.9       $ 16.4      $ 2.3   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted net income per share

   $ 1.46      $ 0.70       $ 2.26      $ 0.59   

Adjustments:

         

Non-deferrable expenses associated with equity offering

     0.07        —           —          —     

Interest expense associated with warrant

     0.12        —           —          —     

NattyMac bargain purchase

     —          —           (0.16     —     

Tax effect of adjustments

     (0.07     —           (0.06     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Adjusted diluted net income per share

   $ 1.58      $ 0.70       $ 2.16      $ 0.59   
  

 

 

   

 

 

    

 

 

   

 

 

 

Results of Operations

Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

Effective January 1, 2013, the Company irrevocably elected to account for the subsequent measurement of its existing 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 the six months ended June 30, 2013, the net changes in the fair value in our MSRs are reported in our statement of operations within “Changes in mortgage servicing rights valuation.”

 

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Our results of operations for the six months ended June 30, 2013 and 2012 are as follows:

 

(in millions, except per share data)   

Six Months Ended June 30,

 
    

2013

    

2012

    

% Change

 

Gains on mortgage loans held for sale

   $ 50.6       $ 23.5         115

Changes in MSRs valuation

     9.5         —           N/A   

Loan origination and other loan fees

     10.0         3.3         203

Loan servicing fees

     8.4         2.2         282

Interest income

     5.7         1.6         256
  

 

 

    

 

 

    

Total revenues

     84.2         30.6         175

Salaries, commissions and benefits

     32.1         12.0         168

General and administrative

     8.9         2.5         256

Interest expense

     7.7         1.9         305

Occupancy, equipment and communications

     3.1         1.1         182

Provision for mortgage repurchases and indemnifications

     1.0         0.3         233

Depreciation and amortization

     0.9         0.3         200

Amortization of MSRs

     —           1.4         (100 )% 

Impairment of MSRs

     —           4.8         (100 )% 
  

 

 

    

 

 

    

Total expenses

     53.7         24.3         121
  

 

 

    

 

 

    

Income before income taxes

     30.5         6.3         384

Income tax expense

     11.7         2.4         388
  

 

 

    

 

 

    

Net income

   $ 18.8       $ 3.9         382
  

 

 

    

 

 

    

Weighted average diluted shares outstanding

     12.9         5.4         139

Diluted net income per share

   $ 1.46       $ 0.70         109

Revenues

For the six months ended June 30, 2013, a 298% increase in mortgage loans originated drove a 175% increase in our revenues, in each case compared to the six months ended June 30, 2012. The revenue increase for the six months ended June 30, 2013 compared to the six months ended June 30, 2012 resulted from increases in our gain on loans held for sale, net change in MSRs valuation, loan origination fee income and loan servicing fee income. The increases in our gain on loans held for sale and loan origination fee income were a result of the increase in the amount of loans originated during the first half of 2013 compared to the first half of 2012 (which increased 298%). The increase in the net change in MSRs valuation resulted from our change in accounting for our MSRs during the six months ended June 30, 2013, as described above. The increase in total servicing fee income was primarily the result of our higher average servicing portfolio balance of $6.1 billion for the six months ended June 30, 2013, compared to $1.8 billion for the six months ended June 30, 2012.

 

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We classify our revenues by component as follows for the six months ended June 30, 2013 and 2012. The table also shows the loan volume originated and servicing portfolio by type: Agency (Fannie Mae, Freddie Mac) and Ginnie Mae government insured (FHA, VA and USDA):

 

(in millions)   

Six Months Ended

June 30,

 
    

2013

    

2012

 

Revenue by Component:

     

Origination

   $ 66.3       $ 28.4   

Servicing

     17.9         2.2   
  

 

 

    

 

 

 

Total

   $ 84.2       $ 30.6   
  

 

 

    

 

 

 

Loan Volume Originated, by Type:

     

Agency

   $ 2,408         675   

Government Insured

     1,577         325   
  

 

 

    

 

 

 

Total

   $ 3,985       $ 1,000   
  

 

 

    

 

 

 

Servicing Portfolio, by Type:

     

Agency

   $ 4,797       $ 1,331   

Government Insured

     2,791         777   
  

 

 

    

 

 

 

Total

   $ 7,588       $ 2,108   
  

 

 

    

 

 

 

Originations

The following is a summary of mortgage loan origination volume by channel (by number of loans and sum of loan amounts) for the six months ended June 30, 2013 and 2012:

 

(dollars in millions)   

Six Months Ended June 30,

 
    

2013

    

2012

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

Channel:

           

Retail

     2,065       $ 344.5         1,240       $ 199.5   

Wholesale

     4,080         798.4         1,507         279.0   

Correspondent

     15,114         2,841.9         2,707         521.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     21,259       $ 3,984.8         5,454       $ 1,000.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

The trend toward the correspondent channel is consistent with our strategic direction of building a diversified and scalable origination business and retaining MSRs on residential mortgage loans. We intend on building our retail operations through acquisitions of small retail mortgage operators during the remainder of 2013 and into 2014 and by increasing our retail operations as a percentage of our overall business.

 

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The following is a summary of mortgage loan origination volume by FICO score (by number of loans and sum of loan amounts) for the six months ended June 30, 2013 and 2012:

 

(dollars in millions)   

Six Months Ended June 30,

 
    

2013

    

2012

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

FICO Score:

           

< 620

     24       $ 3.1         12       $ 1.6   

620 – 680

     5,516         907.2         1,178         178.7   

681 – 719

     4,068         761.6         937         165.3   

> 719

     11,651         2,312.9         3,327         654.4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     21,259       $ 3,984.8         5,454       $ 1,000.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of mortgage loan origination volume by LTV at origination (by number of loans and sum of loan amounts) for the six months ended June 30, 2013 and 2012:

 

(dollars in millions)   

Six Months Ended June 30,

 
    

2013

    

2012

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

LTV Range:

           

< 70%

     3,210       $ 623.3         729       $ 142.9   

70% – 80%

     4,966         1,007.3         1,546         316.5   

81% – 90%

     3,111         587.4         687         128.0   

91% – 100%

     9,413         1,663.4         2,312         379.5   

> 100%

     559         103.4         180         33.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     21,259       $ 3,984.8         5,454       $ 1,000.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

While our total mortgage loan origination volume (in dollars) increased 298% between periods, mortgage loan originations by the FICO score and LTV categories remained relatively consistent as a percentage of total loans originated, considering the impact of increased government insured mortgage originations during the current period.

We seek to manage asset quality and control credit risk by diversifying our loan portfolio and by applying policies designed to promote sound underwriting and loan monitoring practices. We perform various levels of analysis in order to monitor the overall risk profile of our mortgage originations and servicing portfolio. This analysis includes review of the LTV, FICO scores, delinquencies, defaults and historical loan losses. Monthly risk meetings are conducted where portfolio risk analysis, such as FICO and LTV combination migration, is studied to ensure that the population distributions are in accordance with risk parameters. In addition, default activity is evaluated in the context of credit spectrum to identify any emerging credit quality trends so that they may be remedied.

 

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A summary of the mortgage loan origination volume by FICO score and LTV for the six months ended June 30, 2013 and 2012:

 

(in millions)   

Six Months Ended June 30, 2013

 
    

LTV Range

 
    

<70%

    

70%-80%

    

81%-90%

    

91%-100%

    

>100%

    

Total

 

FICO Score

                 

<620

   $ —         $ —         $ 0.2       $ 2.7       $ 0.2      $ 3.1   

620-680

     41.3         92.2         135.7         618.7         19.3         907.2   

681-719

     76.3         151.0         128.3         381.0         25.0         761.6   

>719

     505.7         764.1         323.2         661.0         58.9         2,312.9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 623.3       $ 1,007.3       $ 587.4       $ 1,663.4       $ 103.4       $ 3,984.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(in millions)   

Six Months Ended June 30, 2012

 
    

LTV Range

 
    

<70%

    

70%-80%

    

81%-90%

    

91%-100%

    

>100%

    

Total

 

FICO Score

                 

<620

   $ —         $ 0.2      $ 0.6       $ 0.8       $ —        $ 1.6   

620-680

     8.2         19.9         23.1         123.9         3.6         178.7   

681-719

     15.1         34.6         27.6         81.2         6.8         165.3   

>719

     119.6         261.8         76.7         173.6         22.7         654.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 142.9       $ 316.5       $ 128.0       $ 379.5       $ 33.1       $ 1,000.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of loan sales/securitizations volume by type, retained and released for the six months ended June 30, 2013 and 2012:

 

(dollars in millions)   

GNMA
Retained

   

FNMA
Retained

   

Released

   

Total Sold

 

Six Months Ended June 30, 2013

        

% of total

     40.4     59.4     0.2     100.0

Total volume

   $ 1,535.0      $ 2,259.5      $ 8.6      $ 3,803.1   

Six Months Ended June 30, 2012

        

% of total

     31.4     66.9     1.7     100.0

Total volume

   $ 295.0      $ 628.1      $ 15.9      $ 939.0   

Servicing Fees

The following is a summary of servicing fee income by component for the six months ended June 30, 2013 and 2012:

 

    

Six Months Ended June 30,

 
(in millions)   

2013

    

2012

 

Contractual servicing fees

   $ 8.2       $ 2.1   

Late fees

     0.2         0.1   
  

 

 

    

 

 

 

Total

   $ 8.4       $ 2.2   
  

 

 

    

 

 

 

Our loan servicing fees increased to $8.4 million during the six months ended June 30, 2013 from $2.2 million during the six months ended June 30, 2012. The 282% increase in loan servicing fees was primarily the result of a 260% increase in the unpaid principal balance of mortgage loans serviced at June 30, 2013 compared to June 30, 2012.

 

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The following is a summary of mortgage loan portfolio characteristics by loan type for the six months ended June 30, 2013 and 2012:

 

    

Six Months Ended June 30, 2013

 
    

Weighted
Average
Coupon
(WAC)

   

Average
Age

(in months)

    

Average
Loan
Amount

 
       

Type:

       

FNMA

     3.65     8.6       $ 193,776   

Government Insured

     3.62     8.6         155,109   

Total

     3.64     8.6       $ 177,499   
    

Six Months Ended June 30, 2012

 
    

Weighted
Average
Coupon
(WAC)

   

Average
Age

(in months)

    

Average
Loan
Amount

 

Type:

       

FNMA

     4.22     12.2       $ 170,700   

Government Insured

     4.35     11.7         140,750   

Total

     4.27     12.0       $ 158,293   

Our servicing portfolio characteristics reflect the influence of a significant amount of lower interest rates in the first half of 2013 loan production. The weighted average coupon (“WAC”) and average age of the portfolio dropped during the first half of 2013, while the average balance increased. Lower rates tend to prepay more slowly and newer loans generally have longer remaining lives. The larger loan balances represent expansion into some higher balance geographic areas as we continue to expand our footprint.

The following is a summary of delinquencies ($UPB) by loan type as of June 30, 2013 and 2012. We consider any loan that is overdue by more than 30 days to be delinquent.

 

(in millions)   

As of June 30,

 
    

2013

    

2012

 
    

Adjustable
Rate

    

Fixed
Rate

    

Adjustable
Rate

    

Fixed
Rate

 

FNMA

   $ 0.1       $ 27.5       $ —         $ 8.4   

Government Insured

     —           95.4         —           32.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 0.1       $ 122.9       $          $ 41.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Overall our delinquencies remain relatively low which is in line for the age of our portfolio. Delinquencies on government insured loans tend to be higher than FNMA because government insured loan programs are designed for first time home buyers and those borrowers generally have lower down payments. The low amount of delinquency on the Adjustable Rate loans is primarily due to the low percentage of these loans in our portfolio.

Expenses

Expenses increased by 121% during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. This increase was due primarily to increased loan production and a larger servicing portfolio, which drove a 175% increase in revenues. To accommodate the growth in our loan production and servicing portfolio, we incurred additional expenses related to employee compensation (due to increased staffing levels and incentive compensation costs), and other related general and administrative expenses such as technology costs and retail branch occupancy costs.

 

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Salaries, commissions and benefits expense increased $20.1 million (168%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of the increase in our headcount from 254 employees at June 30, 2012 to 652 employees at June 30, 2013. We increased our sales force and support staff to facilitate the growth in our loan originations and mortgage servicing operations. Since origination volumes had increased significantly, the variable commissions paid to employees were also much higher in 2013. The company also increased its contribution to and the quality of the employee benefit packages, including incentive compensation and employee stock options, to continue to attract and retain talent in the markets we serve, which contributed to the increase in 2013.

General and administrative expenses increased $6.4 million (256%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of the increase in loan origination and loan servicing activities as well as $0.9 million of non-deferrable expenses. We also saw an increase in travel and administrative expenses as we expanded our operations into additional states.

Interest expense increased $5.8 million (305%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of the increase in the volume of mortgage loans originated and funded throughout 2012 and the first half of 2013, as well as increased interest expense of $1.5 million associated with the warrants issued to a stockholder in March 2013 (for additional information related to the warrants, refer to “Financings” within the “Liquidity and Capital Resources” section of this MD&A).

Occupancy, equipment and communication expenses increased $2.0 million (182%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of increased facility, system and computer equipment requirements to accommodate increased staffing levels and new retail branches.

The provision for mortgage repurchases and indemnifications increased $0.7 million (233%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of the increase in the volume of mortgage loans originated during the six months ended June 30, 2013.

Depreciation and amortization expense increased $0.6 million (200%) during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily due to increased property and equipment balances as well as amortization expense related to the NattyMac intangible assets acquired during the third quarter of 2012.

Amortization of MSRs and impairment of MSRs decreased $1.4 million and $4.8 million, respectively, during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 as a result of the previously discussed change in our accounting treatment of MSRs.

Income tax expenses were $11.7 million and $2.4 million for the six months ended June 30, 2013 and 2012, respectively, which represented an increase of 388%, which was driven primarily by the growth in our income before income taxes as discussed above.

We anticipate our aggregate servicing operating costs will increase as our portfolio increases in size. Our servicing portfolio is generally of recent vintages and consists of Agency loans which tend to be of higher quality. These characteristics tend to allow our servicing platform to direct most of its efforts on creating processing efficiencies and a solid customer experience rather than addressing legacy delinquencies and resultant high servicing costs. We expect the average cost to service a loan to decrease due to economies of scale, future technology improvements and outsourcing opportunities where deemed appropriate. On a per-loan basis, we also expect that our servicing costs will improve as we spread our fixed capital investments over a larger loan servicing portfolio.

 

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Year ended December 31, 2012 Compared to Year Ended December 31, 2011

Our results of operations for the years ended December 31, 2012 and 2011 are as follows:

 

(in millions)   

Years Ended December 31,

 
    

2012

    

2011

    

% Change

 

Gains on mortgage loans held for sale

   $ 73.3       $ 16.7         339

Loan origination and other loan fees

     9.9         4.3         130

Loan servicing fees

     5.9         2.6         127

Interest income

     5.2         2.4         117

Other revenue

     1.2         —           N/A   
  

 

 

    

 

 

    

Total revenues

     95.5         26.0         267

Salaries, commissions and benefits

     32.7         13.1         150

Impairment of MSRs

     11.7         —           N/A   

General and administrative

     7.7         3.2         141

Interest expense

     6.2         2.7         130

Amortization of MSRs

     3.7         0.9         311

Occupancy, equipment and communication

     3.0         1.6         88

Provision for mortgage repurchases and indemnifications

     1.9         —           N/A   

Depreciation and amortization

     0.8         0.4         100

Loss on disposal of property and equipment

     —           0.1         (100 )% 
  

 

 

    

 

 

    

Total expenses

     67.7         22.0         208
  

 

 

    

 

 

    

Income before income taxes

     27.8         4.0         595

Income tax expense

     10.7         1.7         529
  

 

 

    

 

 

    

Net income

   $ 17.1       $ 2.3         643
  

 

 

    

 

 

    

Average diluted shares outstanding

     7.5         3.5         114

Diluted net income per share

   $ 2.26       $ 0.59         283

Revenues

For the year ended December 31, 2012, a 228% increase in mortgage loans originated drove a 267% increase in our revenues, in each case compared to the year ended December 31, 2011. The revenue increase in 2012 compared to 2011 resulted from increases in both our gain on loans held for sale and our loan servicing fee income, offset by mortgage servicing right temporary impairment adjustments amounting to $11.7 million. The increase in our gain on loans held for sale was a result of the increase in the amount of loans originated during 2012 compared to 2011 (which increased 228%), and higher margins earned on the sale of residential mortgage loans during the period. The increase in total servicing fee income was primarily the result of our higher average servicing portfolio balance of $4.1 billion for the year ended December 31, 2012, compared to $1.3 billion for the year ended December 31, 2011.

 

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We classify our non-financing revenue by component as follows for 2012 and 2011. The table also shows the loan volume originated and servicing portfolio by type: Agency (Fannie Mae, Freddie Mac) and Ginnie Mae government insured (FHA, VA and USDA):

 

(in millions)   

Year Ended December 31,

 
    

2012

    

2011

 

Revenue by Component:

     

Origination

   $ 88.4       $ 23.4   

Servicing

     5.9         2.6   

Other

     1.2         —    
  

 

 

    

 

 

 

Total

   $ 95.5       $ 26.0   
  

 

 

    

 

 

 

 

(in millions)     

Year Ended December 31,

 
      

2012

      

2011

 

Loan Volume Originated, by Type:

         

Agency

       2,382           620   

Government Insured

       1,067           430   
    

 

 

      

 

 

 

Total

     $ 3,449         $ 1,050   
    

 

 

      

 

 

 

Servicing Portfolio, by Type:

         

Agency

     $ 2,781         $ 802   

Government Insured

       1,364           514   
    

 

 

      

 

 

 

Total

     $ 4,145         $ 1,316   
    

 

 

      

 

 

 

Originations

The following is a summary of mortgage loan origination volume by channel (by number of loans and sum of loan amounts) for the years ended December 31, 2012 and 2011:

 

(dollars in millions)   

Year Ended December 31,

 
    

2012

    

2011

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

Channel:

           

Retail

     3,039       $ 509         2,029       $ 317   

Wholesale

     4,554         894         2,072         361   

Correspondent

     10,536         2,046         2,145         372   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     18,129       $ 3,449         6,246       $ 1,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

The trend toward the correspondent channel is consistent with our strategic direction of building a diversified and scalable origination business and retaining MSRs on residential mortgage loans. We intend on building our retail operations through acquisitions of small retail mortgage operators during 2013 and 2014 and by increasing our retail operations as a percentage of our overall business.

 

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The following is a summary of mortgage loan origination volume by FICO score (by number of loans and sum of loan amounts) for the years ended December 31, 2012 and 2011:

 

(dollars in millions)   

Year Ended December 31,

 
    

2012

    

2011

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

FICO Score:

           

< 620

     26       $ 3         23       $ 3   

620 – 680

     3,707         590         1,504         208   

681 – 719

     2,998         541         1,080         173   

> 719

     11,398         2,315         3,639         666   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     18,129       $ 3,449         6,246       $ 1,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of mortgage loan origination volume by LTV at origination (by number of loans and sum of loan amounts) for the years ended December 31, 2012 and 2011:

 

(dollars in millions)   

Year Ended December 31,

 
    

2012

    

2011

 
    

# of
Loans

    

Sum of
Loan
Amounts

    

# of
Loans

    

Sum of
Loan
Amounts

 

LTV Range:

           

< 70

     2,686       $ 557         862       $ 157   

70% – 80%

     5,039         1,052         1,733         322   

81% – 90%

     2,383         457         796         140   

91% – 100%

     7,410         1,265         2,805         425   

> 100

     611         118         50         6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     18,129       $ 3,449         6,246       $ 1,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of loan sales/securitizations volume by type, retained and released for the years ended December 31, 2012 and 2011:

 

(dollars in millions)    GNMA Retained     FNMA Retained     Released     Total Sold  

2012

        

% of total

     29.2     70.0     0.8     100.0

Total volume

   $ 955      $ 2,292      $ 25      $ 3,273   

2011

        

% of total

     31.3     43.2     25.5     100.0

Total volume

   $ 328      $ 453      $ 267      $ 1,048   

Financing

Our net interest loss on loans held for sale was $0.2 million for the year ended December 31, 2012 compared to $0.0 million for the year ended December 31, 2011. For each year ended December 31, 2012 and December 31, 2011, there was no net income (loss) on loans/securities held for investment.

Servicing Fees

Our loan servicing fees increased from $2.6 million in 2011 to $5.9 million in 2012. The 127% increase in loan servicing fees was the result of the 215% increase in unpaid principal balance ($UPB) of mortgage loans serviced on December 31, 2012 compared to December 31, 2011.

 

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The following is a summary of serving fee income by component for the years ended December 31, 2012 and 2011:

 

    

Year Ended December 31,

 
(in millions)   

2012

    

2011

 

Contractual servicing fees

   $ 5.7       $ 2.5   

Late fees

     0.2         0.1   
  

 

 

    

 

 

 

Total

   $ 5.9       $ 2.6   
  

 

 

    

 

 

 

The following is a summary of mortgage loan portfolio characteristics by loan type for the years ended December 31, 2012 and 2011:

 

    

Year Ended December 31, 2012

 
    

Weighted
Average
Coupon
(WAC)

   

Average
Age

    

Average
Loan
Amount

 

Type:

       

FNMA

     3.84     8.5       $ 188,942   

Government Insured

     3.92     10.3         145,877   

Total

     3.86     9.0       $ 172,213   
    

Year Ended December 31, 2011

 
    

Weighted
Average
Coupon
(WAC)

   

Average
Age

    

Average
Loan
Amount

 

Type:

       

FNMA

     4.51     16.0       $ 154,281   

Government Insured

     4.64     11.6         138,011   

Total

     4.56     14.3       $ 147,488   

Our servicing portfolio characteristics reflect the influence of a significant amount of lower interest rate 2012 loan production. The weighted average coupon (WAC) and average age of the portfolio dropped during 2012, while the average balance increased. Lower rates tend to prepay more slowly and newer loans generally have longer remaining lives. The larger loan balances represent expansion into some higher balance geographic areas as we continue to expand our footprint.

The following is a summary of delinquencies ($UPB) by loan type as of December 31, 2012 and 2011:

 

(in millions)   

As of December 31,

 
    

2012

    

2011

 
    

Adjustable
Rate

    

Adjustable
Rate

    

Adjustable
Rate

    

Adjustable
Rate

 

FNMA

   $ —         $ 14.7       $ 0.2       $ 6.6   

Government Insured

     —           52.9         —          25.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 67.6       $ 0.2       $ 31.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Overall our delinquencies remain relatively low which is in line for the age of our portfolio. Delinquencies on government insured loans tend to be higher than FNMA because government insured loan programs are designed for first time home buyers and those borrowers generally have lower down payments. The low amount of delinquency on the Adjustable Rate loans is primarily due to the low percentage of these loans in our portfolio.

 

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Expenses

The 267% increase in revenues from 2011 to 2012 was accompanied by a 208% increase in expenses. Expenses and impairments increased primarily due to the increase in compensation expenses related to increased staffing levels in order to accommodate our significant growth in origination volume and a larger servicing portfolio, as well as other related increases in expenses, such as administrative, travel and office operation expenses. In addition, we recorded $11.7 million in temporary impairment against the value of our MSRs in 2012.

Salaries, commissions and benefits increased $19.6 million (150%) in 2012 compared to 2011 primarily as a result of the increase in our headcount from 198 employees at December 31, 2011 to 443 employees at December 31, 2012. We increased our sales force to expand geographically and take advantage of the low interest rate environment in 2012. Our staffing levels were increased to accommodate this significant growth in origination volume and manage the larger servicing portfolio. Since origination volumes had increased significantly, the variable commissions paid to employees were also much higher in 2012. The company also increased its contribution and the quality of the employee benefit packages to continue to attract and retain the very best talent in the markets we serve.

Impairment of MSRs of $11.7 million was recognized in 2012 as a result of primarily the difference between the weighted average coupon (WAC) rates of the portfolio (3.86%) compared to the average 30-year fixed rate mortgage coupon rate (3.59%) at 12/31/12. This can lead to higher loan prepayments which negatively affects the fair market value of the MSRs.

General and administrative expenses increased $4.5 million (141%) in 2012 compared to 2011 primarily as a result of the increase in loan origination volume and loans serviced, as well as additional states in which we obtained licenses and staff travel to support growth.

Interest expense increased $3.5 million (130%) in 2012 compared to 2011 primarily as a result of the increase in the volume of mortgage loans originated and funded throughout 2012.

Amortization of MSRs increased $2.8 million (311%) in 2012 compared to 2011 primarily as a result of the increase in unpaid principal balance of mortgage loans serviced during 2012.

Occupancy, equipment and communication expenses increased $1.4 million (88%) in 2012 compared to 2011 primarily as a result of increased facility, system and computer equipment requirements to accommodate increased staffing levels.

A provision for mortgage repurchases and indemnifications in the amount of $1.9 million was recorded in 2012 as a result of the significant increases in origination volumes and increased level of credit, compliance and collateral reviews performed by the agencies since the recent mortgage crisis.

Depreciation and amortization expense increased $0.4 million (100%) in 2012 compared to 2011 primarily due to increased property and equipment balances as well as amortization expense related to the NattyMac intangible assets acquired during the third quarter of 2012.

Income tax expenses were $10.7 million and $1.7 million in 2012 and 2011, respectively, which represented an increase of almost 530%.

Other Factors Influencing Our Results

Prepayment Speeds. A significant driver of our business is prepayment speed, which is the measurement of how quickly unpaid principal balance is reduced. Prepayment speeds, as reflected by the constant prepayment rate, vary according to interest rates, the type of investment, conditions in the housing and

 

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financial markets, competition and other factors, none of which can be predicted with any certainty. Prepayment spread impacts future servicing fees, value of servicing rights, float income, interest expense on advances and interest expense. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their mortgage loans and, as a result, prepayment speeds tend to decrease. This can extend the period over which we earn servicing income but reduce the demand for new mortgage loans. When interest rates fall, prepayment speeds tend to increase, thereby decreasing the value of MSRs and shortening the period over which we earn servicing income but increasing the demand for new mortgage loans.

Changing Interest Rate Environment. Generally, when interest rates rise, the value of mortgage loans and interest rate lock commitments decrease while the value of hedging instruments related to such loans and commitments increases. When interest rates fall, the value of mortgage loans and interest rate lock commitments increases and the value of hedging instruments related to such loans and commitments decrease. Decreasing interest rates also precipitate increased loan refinancing activity by borrowers seeking to benefit from lower mortgage interest rates.

Risk Management Effectiveness—Credit Risk. We are subject to the risk of potential credit losses on all of the residential mortgage loans that we hold for sale or investment as well as for losses incurred by investors in mortgage loans that we sell to them as a result of breaches of representations and warranties we make as part of the loan sales. The representations and warranties require adherence to investor or guarantor origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law. The level of mortgage loan repurchase losses is dependent on economic factors, investor repurchase demand strategies, and other external conditions that may change over the lives of the underlying loans.

Risk Management Effectiveness—Interest Rate Risk. Because changes in interest rates may significantly affect our activities, our operating results will depend, in large part, upon our ability to effectively manage interest rate risks and prepayment risks, including risk arising from the change in value of our inventory of mortgage loans held for sale and commitments to fund mortgage loans and related hedging derivative instruments, as well the effects of changes in interest rates on the value of our investment in MSRs. See “—Quantitative and Qualitative Disclosures about Market Risk” for a discussion on the effects of changes in interest rates on the recorded value of our MSRs.

Liquidity. Our ability to operate profitably is dependent on both our access to capital to finance our assets and our ability to profitably sell and service mortgage loans. An important source of capital for the residential mortgage industry is warehouse financing facilities. These facilities provide funding to mortgage loan producers until the loans are sold to investors or securitized in the secondary mortgage loan market. Our ability to hold loans pending sale and/or securitization depends, in part, on the availability to us of adequate financing lines of credit at suitable interest rates. During any period in which a borrower is not making payments, if we own the MSR then we may be required to advance our own funds to meet contractual principal and interest remittance requirements for investors and advance costs of protecting the property securing the investors’ loan and the investors’ interest in the property. We finance a portion of these advances under bank lines of credit. The ability to obtain capital to finance our servicing advances at appropriate interest rates influences our ability to profitably service delinquent loans. See “—Liquidity and Capital Resources” and “—Contractual Obligations.”

Servicing Effectiveness. Our servicing fee rates for loans serviced for non-affiliates are generally at specified servicing rates that do not change with a loan’s performance status. As a mortgage loan becomes delinquent and moves through the delinquency process to settlement through acquisition of the property or partial payoff, the loan requires greater effort on our part to service. Increased mortgage delinquencies, defaults and foreclosures will therefore result in a higher cost to service those loans due to the increased time and effort required to collect payments from delinquent borrowers. Therefore, how efficiently we are able to maintain the credit quality of our portfolio of serviced mortgage loans and address the mortgage loans where the borrower has defaulted influences the level of expenses that we incur in the mortgage loan servicing process.

 

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Critical Accounting Policies

Our financial accounting and reporting policies are in accordance with GAAP. Some of these accounting policies require us to make estimates and judgments about matters that are uncertain. The application of assumptions could have a material impact on our financial condition or results of operations. Critical accounting policies and related assumptions, estimates and disclosures are determined by management and reviewed periodically with the Audit Committee of the Board of Directors. We believe that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time. A brief discussion of our most important policies and the nature of the related assumptions and estimates are presented below. For additional information regarding our other significant accounting policies, please refer to Note 2, “Basis of Presentation and Significant Accounting Policies,” to our audited financial statements as of and for the six months ended June 30, 2013.

Reserve for Loan Repurchases and Indemnifications

Loans sold to investors by the Company and which met investor and agency underwriting guidelines at the time of sale may be subject to repurchase or indemnification in the event of specific default by the borrower or subsequent discovery that underwriting standards were not met. In limited circumstances, the full risk of loss on loans sold is retained to the extent the liquidation of the underlying collateral is insufficient.

We establish a reserve for mortgage repurchases and indemnifications related to various representations and warranties that reflect management’s estimate of losses for loans for which we could have a repurchase obligation, whether or not we currently service those loans, based on a combination of factors. Such factors include the type of loan, the channel from which it came, loan to value (LTV) and other loan-related specifics. The process for determining the measurement of the liability involves certain unobservable inputs such as estimated repurchase demand and repurchases, and loss severity and is generally subjective and involves a high degree of management judgment and assumptions. These judgments and assumptions may have a significant effect on our measurements of the liability, and the use of different judgments and assumptions, as well as changes in market conditions, could have a material effect on our statements of operations as well as our balance sheets.

Fair Value of Financial Instruments

The Company uses fair value measurements in fair value disclosures and to record certain assets and liabilities at fair value on a recurring basis (such as MSRs, derivative assets and liabilities and loans held for sale) or on a non-recurring basis, such as measuring impairment on assets carried at amortized cost or the lower of amortized cost or fair value (for periods prior to January 1, 2013). The Company has elected fair value accounting for MSRs and loans held for sale, as permitted under current accounting guidance, to more closely align the Company’s accounting with its interest rate risk management strategies.

When observable market prices do not exist for our financial instruments, we estimate fair value primarily by using cash flow and other valuation models. Our valuation models may include adjustments, such as market liquidity and credit quality, where appropriate. Valuations of products using models or other techniques are sensitive to assumptions used for the significant inputs. The process for determining fair value using unobservable inputs, such as discount rates, prepayment speeds, default rates and cost of servicing, is generally more subjective and involves a higher degree of management judgment and assumptions than the measurement of fair value using observable inputs. These judgments and assumptions may have a significant effect on our measurements of fair value, and the use of different judgments and assumptions, as well as changes in market conditions, could have a material effect on our statements of operations as well as our balance sheets.

 

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Mortgage Servicing Rights

MSRs are non-financial assets that are created when a mortgage loan is sold and we retain the right to service the loan. The servicing of these loans includes payment processing, remittance of funds to investors, payment of taxes and insurance, collection of delinquent payments, and disposition of foreclosed properties. In return for these services, we receive servicing fee income and ancillary fee income. The MSRs are initially recorded at fair value, which is estimated by using a valuation model that calculates the present value of estimated future net servicing cash flows. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of the cost of servicing, the discount rate, the float value, the inflation rate, estimated prepayment speeds, and default rates. We use a dynamic model to estimate the fair value of our MSRs. The model is validated internally and senior management reviews all significant assumptions quarterly. In addition, we benchmark the performance of our internal model against the results obtained from a third party valuation specialist firm and other market participant information such as surveys, broker quotes, trades in the marketplace, and other observable data.

Effective January 1, 2013, the Company elected to irrevocably account for the subsequent measurement of its existing 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. The fair value of the MSRs is assessed at each reporting date using the methods described above. 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 MSRs as of January 1, 2013 equaled the fair value due to MSR impairment charges recorded during 2012.

Prior to January 1, 2013, the subsequent measurement of the Company’s MSRs was recorded using the amortization method. Under the amortization method, capitalized MSRs were initially recorded at fair value and amortized over the estimated economic life of the related loans in proportion to the estimated future net servicing revenue. The net capitalized cost of MSRs was periodically evaluated to determine whether capitalized amounts were in excess of their estimated fair value. For this fair value assessment, the Company stratified its MSRs based on interest rates: (1) those with note rates below 4.00%; (2) those with note rates between 4.00% and 4.99%; and (3) those with note rates above 5.00%. If the amortized book value of the MSRs exceeded its fair value, management recorded a valuation adjustment as a reduction to the mortgage servicing right asset. However, in the event that the fair value of the MSRs recovered, the valuation allowance was reversed.

Derivative Financial Instruments

The Company enters into derivative instruments to serve the financial needs of its customers and to reduce its risk exposure to fluctuations in interest rates. For example, the Company enters into interest rate lock commitments (“IRLCs”) with certain customers to originate residential mortgage loans at specified interest rates and within a specified period of time. IRLCs on mortgage loans that are intended to be sold are accounted for as derivatives, with changes in fair value recorded in the statement of operations as part of gain or loss on sale of mortgage loans. The fair value of an IRLC is based upon changes in the fair value of the underlying mortgages estimated to be realizable upon sale into the secondary market. In estimating the fair value of an IRLC, we also adjust the fair value of the underlying mortgage loan to reflect the estimated percentage of commitments that will result in a closed mortgage loan; our estimate of this percentage will vary based on the age of the underlying commitment and changes in mortgage interest rates.

The primary factor influencing the probability that a loan will fund within the terms of the IRLC is the change, if any, in mortgage rates subsequent to the commitment date. In general, the probability of funding

 

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increases if mortgage rates rise and decreases if mortgage rates fall. This is due primarily to the relative attractiveness of current mortgage rates compared to the applicant’s committed rate. The probability that a loan will fund within the terms of the IRLC also is influenced by the source of the application, age of the application, purpose of the loan (purchase or refinance) and the application approval rate.

The Company manages the interest rate risk associated with its outstanding IRLCs and loans held for sale by entering into derivative loan instruments, such as forward loan sales commitments and mandatory delivery commitments. For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models, and discounted cash flow methodologies. Fair value estimates also take into account counterparty credit risk and the Company’s own credit standing.

Mortgage Loans Held-for-Sale

Loans that are intended to be sold in the foreseeable future, including residential mortgages, are reported as loans held-for-sale. The Company accounts for loans held for sale under the fair value option. Fair value of loans held for sale is typically calculated using observable market information, including pricing from actual market transactions or observable market prices from other loans that have similar collateral, credit, and interest rate characteristics. Gains or losses from the sale of mortgages are recognized based upon the difference between the selling price and fair value of the related loans upon the sale of such loans. Direct mortgage loan origination costs are recognized as noninterest expense at origination.

In order to facilitate the origination and sale of mortgage loans held for sale, we have entered into various agreements with warehouse lenders. These agreements are in the form of loan participations and repurchase agreements with banks and other financial institutions. Mortgage loans held for sale are considered sold when we surrender control over the financial assets and those financial assets are legally isolated from us in the event of our bankruptcy. For loan participations that meet the sale criteria, the transferred financial assets are derecognized from the balance sheet and a gain or loss is recognized upon sale. If the sale criteria are not met, the transfer is recorded as a secured borrowing in which the assets remain on the balance sheet and the proceeds from the transaction are recognized as a liability. We account for all repurchase agreements as secured borrowings.

Business Combinations, including Intangible Assets

As part of the Company’s growth strategy, we acquired certain assets in 2012 related to a single-family residential mortgage loan warehousing platform of third parties that constituted a business combination. In connection with this acquisition, the Company recognized a bargain purchase gain, as well as certain intangible assets, including a trade name, customer relationships, and an active agent list. A significant component of the transaction’s total consideration was contingent and related to deferred purchase price for each mortgage loan subsequently funded, up to a specified maximum amount. The contingent consideration was a significant factor in the determination of the bargain purchase gain. The fair value of the contingent consideration arrangement was determined by Management, with assistance from a third party valuation provider, using the income approach; this method required Management’s estimation of the number of loans which would subsequently be funded, as well as the anticipated timing of the loans being funded. The fair value of the trade name and the customer relationship intangibles were determined using a discounted cash flow method. This method required Management to make estimates related to future revenue, expenses and income tax rates. The fair value of the agent list intangible asset was determined using a cost-to-recreate approach, which required Management to estimate the amount of time it would take to replace the active agent list, as well as future income tax rates.

Intangible assets determined to have a finite life, such as the customer relationships and active agent list, are amortized on a straight-line basis over their useful lives. If events or changes in circumstances indicate that the carrying amounts of finite-lived intangible assets may not be recoverable, Management compares the carrying value to the current fair value (determined in the same manner and with the same assumptions as

 

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discussed above) and records any required impairment. Intangible assets that are deemed to have an indefinite life, such as the trade name, are not subject to amortization but rather must be reviewed for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the assets are impaired. Management exercises judgment in its assessment of qualitative factors in determining whether events or circumstances suggest that it is more likely than not that an indefinite-lived intangible asset is impaired. If Management determines it is more likely than not that the asset is impaired, Management performs a quantitative assessment of current fair value (which incorporates the same assumptions listed above) compared to carrying value and subsequently records any required impairment.

Income Taxes

We determine deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on future tax consequences attributable to the differences between the book and tax bases of assets and liabilities, as well as operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period that includes the enactment date. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods.

Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. We determine whether a deferred tax asset is realizable based on currently available facts and circumstances, including the Company’s current and projected future tax position, the historical level of our taxable income, and estimates of our future taxable income. In most cases, the realization of deferred tax assets is based on our future profitability. On a quarterly basis, the Company evaluates its deferred tax assets to assess whether they are more likely than not to be realized in the future. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets may no longer be considered more likely than not to be realized. In such an instance, we could be required to record a valuation allowance on our deferred tax assets by charging earnings. Management has analyzed the impact of the private equity offering that occurred on May 15, 2013 and has determined that an ownership change under Section 382 did not occur. The IRS allows for the application of two approaches (the full value methodology and the hold constant principle) for valuing companies when identifying whether a Section 382 ownership change has occurred and requires that the taxpayers apply a consistent method from year to year. The Company applied the full value method in its valuation and analysis of the Section 382 ownership change and, as a result, determined that a Section 382 ownership change did not occur. The Company has determined that no valuation allowance as of June 30, 2013 is necessary for the Company’s deferred tax assets as it is more likely than not that the recorded amounts will be realized.

In 2012, we had a change in ownership as defined by Section 382 of the Code (“Section 382”). Section 382 generally requires a corporation to limit the amount of its income in future years that can be offset by historic taxable losses (i.e. net operating loss carryovers and certain built-in losses) after a corporation has undergone an ownership change of more than 50%. In the event of an ownership change of more than 50%, an annual limitation on the amount of net operating losses available to offset future taxable income is determined by multiplying a federally stated interest rate times the value of the company on the ownership change date. As a result, utilization of certain tax attributes including net operating loss and other carry-forwards are subject to annual limitations. Our deferred tax assets at December 31, 2012 consisted primarily of net operating loss carryforwards, and no valuation allowance was deemed necessary, as we concluded that it is more likely than not that recorded amounts will be realized.

Recent Accounting Developments

ASU No. 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” was issued in January 2013. This update clarifies the scope of transactions that are subject

 

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to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11. ASU No. 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement. ASU 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of ASU 2013-01 did not materially impact the Company’s financial statements.

ASU No. 2012-02 “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” was issued in July 2012. This update simplifies the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. The amendment allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. This amendment is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of ASU 2012-02 did not materially impact the Company’s financial statements.

Balance Sheet

The following table presents our balance sheets as of the periods indicated:

 

    

June 30,

    

December 31,

 
(in millions)   

2013

    

2012

    

2012

    

2011

 

Assets:

           

Cash and cash equivalents

   $ 31.6       $ 11.1      $ 15.1       $ 0.4   

Restricted cash

     2.5         0.8         3.5         —    

Mortgage loans held for sale, at fair value