Fair Value Measurements

6 Months Ended

Jun. 30, 2013

Fair Value Measurements

Fair Value Measurements

15.  Fair Value Measurements

For assets and liabilities measured at fair value, there has been no change in the valuation methodologies and classification pursuant to the valuation hierarchy during the three months ended June 30, 2013.  The incorporation of counterparty credit risk did not have a significant impact on the valuation of assets and liabilities recorded at fair value as of June 30, 2013 or December 31, 2012.  Significant inputs to the measurement of fair value and further information on the assets and liabilities measured at fair value are as follows:

Mortgage Loans Held for Sale.  The following table reflects the difference between the carrying amounts of Mortgage loans held for sale measured at fair value, and the aggregate unpaid principal amount that the Company is contractually entitled to receive at maturity:

	June 30, 2013				December 31, 2012
	Total		Loans 90 days or more past due and on non-accrual status		Total		Loans 90 days or more past due and on non-accrual status
	(In millions)
Mortgage loans held for sale:
Carrying amount	$	1,751	$	15	$	2,174	$	17
Aggregate unpaid principal balance	1,775		23		2,126		25
Difference	$	(24)	$	(8)	$	48	$	(8	)

The following table summarizes the components of Mortgage loans held for sale:

	June 30,		December 31,
	2013		2012
	(In millions)
First mortgages:
Conforming (1)	$	1,556	$	1,966
Non-conforming	140		143
Total first mortgages	1,696		2,109
Second lien	6		8
Scratch and Dent (2)	49		56
Other	—		1
Total	$	1,751	$	2,174

______________

(1)Represents mortgage loans that conform to the standards of the government-sponsored entities.

(2)Represents mortgage loans with origination flaws or performance issues.

Derivative Instruments. The average pullthrough percentage used in measuring the fair value of Interest Rate Lock Commitments (“IRLCs”) was 80% and 74% as of June 30, 2013 and December 31, 2012, respectively.  The pullthrough percentage is considered a significant unobservable input and is estimated based on changes in pricing and actual borrower behavior using a historical analysis of loan closing and fallout data.  Actual loan pullthrough is compared to the modeled estimates in order to evaluate this assumption each period based on current trends.  Generally, a change in interest rates is accompanied by a directionally opposite change in the assumption used for the pullthrough percentage, and the impact to fair value of a change in pullthrough would be partially offset by the related change in price.

Mortgage Servicing Rights.  The following tables summarize certain information regarding the initial and ending capitalization rate of Mortgage Servicing Rights (“MSRs”):

	Six Months Ended
	June 30,
	2013	2012
Initial capitalization rate of additions to MSRs	1.08 %	1.00	%

	June 30,	December 31,
	2013	2012
Capitalization servicing rate	0.94 %	0.73	%
Capitalization servicing multiple	3.2	2.4
Weighted-average servicing fee (in basis points)	29	30

The significant assumptions used in estimating the fair value of MSRs were as follows (in annual rates):

	June 30,	December 31,
	2013	2012
Weighted-average prepayment speed (CPR)	11 %	17	%
Option adjusted spread, in basis points	1,025	1,013
Weighted-average delinquency rate	5.6 %	6.8	%

The following table summarizes the estimated change in the fair value of MSRs from adverse changes in the significant assumptions:

	June 30, 2013
	Weighted-				Weighted-
	Average		Option		Average
	Prepayment		Adjusted		Delinquency
	Speed		Spread		Rate
	(In millions)
Impact on fair value of 10% adverse change	$	(55)	$	(58)	$	(23	)
Impact on fair value of 20% adverse change	(106)		(110)		(47		)

These sensitivities are hypothetical and presented for illustrative purposes only. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, this analysis does not assume any impact resulting from management’s intervention to mitigate these variations.

The effect of a variation in a particular assumption is calculated without changing any other assumption and the assumptions used in valuing the MSRs are independently aggregated. Although there are certain inter-relationships among the various key assumptions noted above, changes in one of the significant assumptions would not independently drive changes in the others.  The prepayment speed assumptions are highly dependent upon interest rates, which drive borrowers’ propensity to refinance; however, there are other factors that can influence borrower refinance activity.  These factors include housing prices, the levels of home equity, underwriting standards and loan product characteristics.  The option adjusted spread is a component of the discount rate used to present value the cash flows of the MSR asset and represents the spread over a base interest rate that equates the present value of cash flows of an asset to the market price of that asset.  The weighted average delinquency rate is based on the current and projected credit characteristics of the capitalized servicing portfolio and is dependent on economic conditions, home equity and delinquency and default patterns.

Assets and liabilities measured at fair value on a recurring basis were included in the Condensed Consolidated Balance Sheets as follows:

	June 30, 2013
							Cash
	Level		Level		Level		Collateral
	One		Two		Three		and Netting		Total
	(In millions)
ASSETS
Mortgage loans held for sale	$	—	$	1,696	$	55	$	—	$	1,751
Mortgage servicing rights	—		—		1,247		—		1,247
Other assets—Derivative assets:
Interest rate lock commitments	—		—		26		—		26
Forward delivery commitments	—		214		—		(164)		50
Option contracts	—		24		—		(2)		22
Interest rate contracts	—		2		—		—		2
Convertible note-related agreements	—		—		12		—		12
LIABILITIES
Other liabilities—Derivative liabilities:
Interest rate lock commitments	$	—	$	—	$	37	$	—	$	37
Forward delivery commitments	—		63		—		(43)		20
Option contracts	—		—		—		2		2
Convertible note-related agreements	—		—		12		—		12

	December 31, 2012
							Cash
	Level		Level		Level		Collateral
	One		Two		Three		and Netting		Total
	(In millions)
ASSETS
Restricted investments	$	—	$	121	$	—	$	—	$	121
Mortgage loans held for sale	—		2,110		64		—		2,174
Mortgage servicing rights	—		—		1,022		—		1,022
Other assets—Derivative assets:
Interest rate lock commitments	—		—		140		—		140
Forward delivery commitments	—		15		—		(7)		8
Option contracts	—		2		—		—		2
MSR-related agreements	—		5		—		(5)		—
Interest rate contracts	—		1		—		—		1
Convertible note-related agreements	—		—		27		—		27
LIABILITIES
Other liabilities—Derivative liabilities:
Interest rate lock commitments	$	—	$	—	$	1	$	—	$	1
Forward delivery commitments	—		19		—		(13)		6
MSR-related agreements	—		—		—		5		5
Convertible note-related agreements	—		—		27		—		27

Activity in assets and liabilities classified within Level Three of the valuation hierarchy consisted of:

	Three Months Ended June 30, 2013
					Interest
	Mortgage		Mortgage		rate lock
	loans held		servicing		commitments,
	for sale		rights		net
	(In millions)
Balance, beginning of period	$	56	$	1,101	$	113
Realized and unrealized gains (losses)	(6)		75		67
Purchases	31		—		—
Issuances	—		71		—
Settlements	(26)		—		(191)
Transfers into Level Three	11		—		—
Transfers out of Level Three	(11)		—		—
Balance, end of period	$	55	$	1,247	$	(11)

	Six Months Ended June 30, 2013
					Interest
	Mortgage		Mortgage		rate lock
	loans held		servicing		commitments,
	for sale		rights		net
	(In millions)
Balance, beginning of period	$	64	$	1,022	$	139
Realized and unrealized (losses) gains	(12)		80		269
Purchases	56		—		—
Issuances	—		145		—
Settlements	(56)		—		(419)
Transfers into Level Three	25		—		—
Transfers out of Level Three	(22)		—		—
Balance, end of period	$	55	$	1,247	$	(11)

	Three Months Ended June 30, 2012
	Interest
	Mortgage		Mortgage		rate lock
	loans held		servicing		commitments,
	for sale		rights		net
	(In millions)
Balance, beginning of period	$	13	$	1,296	$	128
Realized and unrealized gains (losses)	(1)		(205)		374
Purchases	1		—		—
Issuances	1		66		—
Settlements	(1)		—		(323)
Transfers into Level Three	—		—		—
Transfers out of Level Three	(1)		—		—
Balance, end of period	$	12	$	1,157	$	179

	Six Months Ended June 30, 2012
					Interest						Mortgage loan
	Mortgage		Mortgage		rate lock				Securitized		securitization
	loans held		servicing		commitments,		Investment		mortgage		debt
	for sale		rights		net		securities		loans		certificates
	(In millions)
Balance, beginning of period	$	17	$	1,209	$	184	$	—	$	28	$	21
Realized and unrealized gains (losses)	(1)		(226)		760		(2)		—		—
Purchases	2		—		—		—		—		—
Issuances	1		174		—		—		—		—
Settlements	(2)		—		(765)		(5)		—		—
Transfers into Level Three	—		—		—		—		—		—
Transfers out of Level Three	(5)		—		—		—		—		—
Deconsolidation of entity(1)	—		—		—		7		(28)		(21)
Balance, end of period	$	12	$	1,157	$	179	$	—	$	—	$	—

______________

(1) In  2012, the Company sold its investment in the subordinated debt and residual interests of a Mortgage loan securitization trust that had been consolidated as a variable interest entity.

Transfers into Level Three generally represent mortgage loans held for sale with performance issues, origination flaws, or other characteristics that impact their salability in active secondary market transactions.  Transfers out of Level Three generally represent Scratch and Dent loans that were foreclosed upon.  Mortgage loans in foreclosure are measured at fair value on a non-recurring basis.

Realized and unrealized gains (losses) related to assets and liabilities classified within Level Three of the valuation hierarchy were included in the Condensed Consolidated Statements of Operations as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2013		2012		2013		2012
	(In millions)
Gain on mortgage loans, net:
Mortgage loans held for sale	$	(7)	$	(2)	$	(15)	$	(2	)
Interest rate lock commitments	67		374		269		760
Change in fair value of mortgage servicing rights:
Mortgage servicing rights	75		(205)		80		(226		)
Mortgage interest income:
Mortgage loans held for sale	1		1		3		1
Other income:
Investment securities	—		—		—		(2		)

Unrealized gains (losses) included in the Condensed Consolidated Statements of Operations related to assets and liabilities classified within Level Three of the valuation hierarchy that are included in the Condensed Consolidated Balance Sheets were as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2013		2012		2013		2012
	(In millions)
Gain on mortgage loans, net	$	(23)	$	169	$	(22)	$	178
Change in fair value of mortgage servicing rights	155		(145)		237		(102		)

Fair Value of Other Financial Instruments

As of June 30, 2013 and December 31, 2012, all financial instruments were either recorded at fair value or the carrying value approximated fair value, with the exception of Debt and derivative instruments included in Total PHH Corporation stockholders’ equity. For financial instruments that were not recorded at fair value, such as Cash and cash equivalents and Restricted cash and cash equivalents and investments, the carrying value approximates fair value due to the short-term nature of such instruments.  These financial instruments are classified within Level One of the valuation hierarchy.

Debt.  As of June 30, 2013 and December 31, 2012, the total fair value of Debt was $6.7 billion and $7.0 billion, respectively, and substantially all of the debt is measured using Level Two inputs. For Level Two Debt as of June 30, 2013, fair value was estimated using the following valuation techniques: (i) $4.0 billion was measured using a market based approach, considering the current market pricing of recent trades for similar instruments or the current expected ask price for the Company’s debt instruments; (ii) $1.6 billion was measured using observable spreads and terms for recent pricing of similar instruments; and (iii) $1.1 billion was measured using a discounted cash flow model incorporating assumptions based on current market information available for similar debt instruments.