10-Q 1 a2014q1-10q.htm 10-Q 2014 Q1 - 10Q

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
____________________
FORM 10-Q  
____________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended March 31, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-36116
____________________
Stonegate Mortgage Corporation
(Exact name of registrant as specified in its charter)
____________________
 
Ohio
34-1194858
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
9190 Priority Way West Drive, Suite 300
Indianapolis, Indiana
46240
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (317) 663-5100
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
____________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.    Yes  ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
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
ý
  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨   No   ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Title of Each Class
Outstanding at May 9, 2014
Common Stock, $0.01 par value
25,769,236 shares



Stonegate Mortgage Corporation
Quarterly Report on Form 10-Q
For the Period Ended March 31, 2014
Table of Contents
 
 
 
Page
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets (Unaudited) as of March 31, 2014 and December 31, 2013
 
 
 
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


 PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
Stonegate Mortgage Corporation
Consolidated Balance Sheets
(Unaudited)

(In thousands, except share and per share data)
March 31, 2014
 
December 31, 2013
 
 
 
 
Assets
 
 
 
Cash and cash equivalents
$
17,874

 
$
43,104

Restricted cash
1,159

 
730

Mortgage loans held for sale, at fair value
834,915

 
683,080

Servicing advances
3,290

 
4,177

Derivative assets
14,895

 
19,673

Mortgage servicing rights, at fair value
192,470

 
170,294

Property and equipment, net
13,461

 
12,640

Goodwill
4,265

 
3,638

Intangible assets, net
5,179

 
5,434

Investment in closely held entity, at cost
240

 
440

Loans eligible for repurchase from GNMA
38,443

 
26,268

Warehouse lending receivables
24,203

 
12,089

Other assets
9,304

 
8,322

Total assets
$
1,159,698

 
$
989,889

 
 
 
 
Liabilities and stockholders’ equity
 
 
 
Liabilities
 
 
 
Secured borrowings
456,975

 
342,393

Mortgage repurchase borrowings
288,470

 
223,113

Warehouse lines of credit
464

 
7,056

Operating lines of credit
10,716

 
6,499

Accounts payable and accrued expenses
29,489

 
37,052

Derivative liabilities
2,618

 
3,520

Reserve for mortgage repurchases and indemnifications
4,231

 
3,709

Due to related parties

 
608

Contingent earn-out liabilities
4,411

 
3,791

Liability for loans eligible for repurchase from GNMA
38,443

 
26,268

Deferred income tax liabilities, net
23,365

 
28,379

Total liabilities
$
859,182

 
$
682,388

 
 
 
 
Commitments and contingencies - Note 14


 


 
 
 
 
Stockholders’ equity
 
 
 
Common stock, par value $0.01, shares authorized – 100,000,000; shares issued and outstanding: 25,769,236 and 25,769,236
264

 
264

Additional paid-in capital
264,729

 
263,830
Retained earnings
35,523

 
43,407
Total stockholders’ equity
300,516

 
307,501
 
 
 
 
Total liabilities and stockholders’ equity
$
1,159,698

 
$
989,889



See accompanying notes to the unaudited consolidated financial statements.

3


Stonegate Mortgage Corporation
Consolidated Statements of Operations
(Unaudited)
 
(In thousands, except per share data)
Three Months Ended March 31,
 
2014
 
2013
Revenues 
 
 
 
Gains on mortgage loans held for sale
$
28,631

 
$
24,204

Changes in mortgage servicing rights valuation
(10,658
)
 
4,090

Loan origination and other loan fees
5,077

 
4,648

Loan servicing fees
9,174

 
3,119

Interest income
6,077

 
2,821

Total revenues 
38,301

 
38,882

 
 
 
 
Expenses 
 
 
 
Salaries, commissions and benefits
33,420

 
14,493

General and administrative expense
8,209

 
3,602

Interest expense
3,813

 
3,073

Occupancy, equipment and communication
4,141

 
1,485

Provision for mortgage repurchases and indemnifications - change in estimate
395

 

Depreciation and amortization expense
1,083

 
384

Loss on disposal of property and equipment
91

 

Total expenses 
51,152

 
23,037

 
 
 
 
(Loss) income before income tax expense 
(12,851
)
 
15,845

Income tax (benefit) expense
(4,967
)
 
6,130

Net (loss) income
(7,884
)
 
9,715

Less: preferred stock dividends

 
(19
)
Net (loss) income attributable to common stockholders
$
(7,884
)
 
$
9,696

 
 
 
 
(Loss) earnings per share
 
 
 
Basic
$
(0.31
)
 
$
3.42

Diluted
$
(0.31
)
 
$
0.86



See accompanying notes to the unaudited consolidated financial statements.
 

4


Stonegate Mortgage Corporation
Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited)
 
(In thousands)
Preferred Stock
Common Stock
Treasury Stock
Additional Paid-in Capital
Retained Earnings
Total Stockholders' Equity
 
Shares
Amount
Shares
Amount
Balance at December 31, 2013

$

25,769

$
264

$

$
263,830

$
43,407

$
307,501

Net loss






(7,884
)
(7,884
)
Stock-based compensation expense





899


899

Balance at March 31, 2014

$

25,769

$
264

$

$
264,729

$
35,523

$
300,516

 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
8,342

$
33,000

2,834

$
35

$
(1,820
)
$
3,198

$
20,836

$
55,249

Net income






9,715

9,715

Stock-based compensation expense





7


7

Issuance of stock warrants





1,522


1,522

Preferred stock dividends






(19
)
(19
)
Balance at March 31, 2013
8,342

$
33,000

2,834

$
35

$
(1,820
)
$
4,727

$
30,532

$
66,474


See accompanying notes to the unaudited consolidated financial statements.

5


Stonegate Mortgage Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
Three Months Ended March 31,
 
2014
 
2013
Operating activities
 
 
 
Net (loss) income
$
(7,884
)
 
$
9,715

Adjustments to reconcile net (loss) income to net cash used in operating activities:
 
 
 
Depreciation and amortization expense
1,083

 
384

Loss on disposal of property and equipment
91

 

Gains on mortgage loans held for sale
(28,631
)
 
(24,204
)
Changes in mortgage servicing rights valuation
10,658

 
(4,090
)
Provision for reserve for mortgage repurchases and indemnifications - change in estimate
395

 

Stock-based compensation expense
899

 
7

Deferred income tax (benefit) expense
(4,967
)
 
6,130

Change in contingent earn-out liabilities
42

 

Proceeds from sales and principal payments of mortgage loans held for sale
2,272,924

 
1,828,574

Originations and purchases of mortgage loans held for sale
(2,421,868
)
 
(1,899,805
)
Repurchases and indemnifications of previously sold loans
(1,469
)
 
(45
)
Changes in operating assets and liabilities:
 
 
 
Restricted cash
(429
)
 
(2,870
)
Servicing advances
887

 
(18
)
Warehouse lending receivables
(12,114
)
 

Other assets
(888
)
 
(1,683
)
Accounts payable and accrued expenses
(7,660
)
 
5,920

Due to related parties
(608
)
 
(39
)
Net cash used in operating activities
(199,539
)
 
(82,024
)
Investing activities
 
 
 
Purchases of property and equipment
(1,550
)
 
(1,652
)
Purchase of assets in a business combination
(258
)
 

Purchase of mortgage servicing rights
(1,622
)
 

Net cash used in investing activities
(3,430
)
 
(1,652
)
Financing activities
 
 
 
Proceeds from borrowings under mortgage funding arrangements and operating lines of credit
5,061,958

 
124,814

Repayments of borrowings under mortgage funding arrangements and operating lines of credit
(4,884,194
)
 
(48,439
)
Payments of contingent earnout liabilities
(25
)
 

Proceeds from borrowing from stockholder

 
10,000

Preferred stock dividends

 
(19
)
Net cash provided by financing activities
177,739

 
86,356

 
 
 
 
Change in cash and cash equivalents
(25,230
)
 
2,680

Cash and cash equivalents at beginning of period
43,104

 
15,056

Cash and cash equivalents at end of period
$
17,874

 
$
17,736



See accompanying notes to the unaudited consolidated financial statements.

6


Stonegate Mortgage Corporation
Notes to Unaudited Consolidated Financial Statements
March 31, 2014
(In Thousands, Except Share and Per Share Data or As Otherwise Stated Herein)

1. Organization and Operations
References to the terms “we”, “our”, “us”, “Stonegate” or the “Company” used throughout these Notes to Unaudited Consolidated Financial Statements refer to Stonegate Mortgage Corporation and, unless the context otherwise requires, its wholly-owned subsidiaries. The Company was initially incorporated in the State of Indiana in January 2005. As a result of an acquisition and subsequent merger with Swain Mortgage Company in 2009, the Company is now an Ohio corporation. The Company’s headquarters is in Indianapolis, Indiana.
The Company is a non-bank integrated mortgage company focused on the U.S. residential mortgage market. The Company originates, acquires, sells, finances and services residential mortgage loans. The Company predominantly sells mortgage loans to the Federal National Mortgage Association (“Fannie Mae” or “FNMA”), to the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “FHLMC”), to financial institution secondary market investors and in Government National Mortgage Association (“Ginnie Mae” or “GNMA”) pools of mortgage backed securities (“MBS”). Both FNMA and FHLMC are considered government-sponsored enterprises ("GSEs"). The Company’s integrated and scalable residential mortgage banking platform enables us to efficiently and effectively originate, acquire, sell, finance and service residential mortgage loans. The Company’s platform and operating model provides its constituents visibility and access to essential data, documents and analytics related to the loan and originator performance over time. The Company also provides warehouse financing through its NattyMac, LLC subsidiary to third party correspondent customers. The Company’s principal sources of revenue include (i) gain on sale of mortgage loans from loan securitizations and whole loan sales, and fee income from originations, (ii) fee income from loan servicing, and (iii) fee and net interest income from its financing facilities.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Stonegate and its subsidiaries and have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The Company has omitted certain financial disclosures that would substantially duplicate the disclosures in its audited consolidated financial statements as of and for the year ended December 31, 2013, unless the information contained in those disclosures materially changed or is required by GAAP. In the opinion of management, all adjustments, including normal recurring adjustments, necessary for a fair statement of the consolidated financial statements as of and for the three months ended March 31, 2014 and 2013 have been recorded. All intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014. These unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2013 included in its 2013 Annual Report on Form 10-K.

In the normal course of business, companies in the mortgage banking industry encounter certain economic and regulatory risks. Economic risks include interest rate risk and credit risk. The Company is subject to interest rate risk to the extent that in a rising interest rate environment, the Company may experience a decrease in loan production, as well as decreases in the value of mortgage loans held for sale and in commitments to originate loans, which may negatively impact the Company’s operations. Conversely, in a decreasing interest rate environment, the value of the Company’s mortgage servicing rights ("MSRs") may decrease, which could negatively impact the Company’s operations. Credit risk is the risk of default that may result from the borrowers’ inability or unwillingness to make contractually required payments during the period in which loans are being held for sale.

On May 14, 2013, the Company granted a stock dividend of 12.861519 shares of common stock for each share of common stock held as of that date, which was determined to be in substance a stock split for accounting and financial reporting purposes. All actual share, weighted-average share and per share amounts and all references to stock compensation data and prices of the Company’s common stock have been adjusted to reflect this stock split for all periods presented.





7


3. (Loss) Earnings Per Share

The following is a reconciliation of net (loss) income attributable to common stockholders and a table summarizing the basic and diluted (loss) earnings per share calculations for the three months ended March 31, 2014 and 2013:

 
Three Months Ended March 31,
 
2014
 
2013
Net (loss) income:
 
 
 
Net (loss) income
$
(7,884
)
 
$
9,715

Less: Preferred stock dividends

 
(19
)
Net (loss) income attributable to common stockholders
$
(7,884
)
 
$
9,696

 
 
 
 
Weighted average shares outstanding (in thousands):
 
 
 
Denominator for basic (loss) earnings per share – weighted average common shares outstanding
25,769

 
2,834

Effect of dilutive shares—employee and director stock options, restricted stock units, warrants and convertible preferred stock

 
8,389

Denominator for diluted (loss) earnings per share
25,769

 
11,223

 
 
 
 
(Loss) earnings per share:
 
 
 
Basic
$
(0.31
)
 
$
3.42

Diluted
$
(0.31
)
 
$
0.86


During the three months ended March 31, 2014, weighted average shares of 1,867,291, were excluded from the denominator for diluted loss per share because the shares (which related to stock options, restricted stock units and stock warrants) were anti-dilutive. During the three months ended March 31, 2013, weighted average shares of 66,745, were excluded from the denominator for diluted earnings per share because the shares (which related to stock options and stock warrants) were anti-dilutive.

4. Business Combinations

Acquisition of Medallion Mortgage Company

On February 4, 2014, in the continuing effort to expand retail originations, the Company completed its acquisition of Medallion Mortgage Company ("Medallion"), a residential mortgage originator based in southern California. Medallion services customers with an extensive portfolio of residential real estate loan programs and has 10 offices along the southern and central coast of California, Utah and a new operations center in Ventura, California. In the acquisition of Medallion, the Company agreed to purchase certain assets, assume certain liabilities and offer employment to certain employees.

The acquisition of Medallion was accounted for as a business combination. The following table summarizes the total consideration transferred to acquire Medallion and the fair values of the assets acquired and liabilities assumed on the acquisition date:
Consideration:
 
Cash consideration
$
258

Fair value of contingent consideration
603

Total consideration
861

Fair value of net assets acquired:
 
Property and equipment
190

Other assets
94

Accounts payable and accrued expenses
(50
)
Total fair value of net assets acquired
234

Goodwill
$
627

Acquisition-related expenses 1
$
49


1 Legal and miscellaneous expenses classified as general and administrative expenses

8


The excess of the aggregate consideration transferred over the fair value of the identified net assets acquired resulted in tax-deductible goodwill of $627 as of March 31, 2014. Goodwill recognized from the acquisition of Medallion primarily relates to the expected future growth of Medallion's business.
As part of the acquisition of Medallion, the Company agreed to pay Medallion's seller a deferred purchase price, which payment is contingent upon Medallion achieving certain predetermined minimum mortgage loan origination goals during the two year period following the acquisition date (the "earnout"). If such goals are met by Medallion, the Company will pay the seller annual payments equal to a multiple of the actual total mortgage loan volume of Medallion. The earnout is uncapped in amount. The fair value of the earnout was estimated to be approximately $603 as of the acquisition date and was estimated using a calibrated Monte-Carlo simulation. The fair value was primarily based on (i) the Company’s estimate of the mortgage loan origination volume of Medallion over the two year earnout period, an asset volatility factor of 16.90% and (iii) a discount rate of 6.05%. The Company estimated the fair value of the earnout as of March 31, 2014 to approximate its acquisition date fair value as there were no significant changes in the Company's estimate of future mortgage loan origination volume, volatility factor or the discount rate used to determine the fair value of the earnout.

5. Derivative Financial Instruments

The Company does not designate any of its derivative instruments as hedges. The following summarizes the Company’s outstanding derivative instruments as of March 31, 2014 and December 31, 2013:
March 31, 2014:
 
 
 
 
Fair Value
 
Notional
 
Balance Sheet Location
 
Asset
 
(Liability)
Interest rate lock commitments
$
1,489,053

 
Derivative assets/liabilities
 
$
11,453

 
$
(351
)
MBS forward trades
2,526,697

 
Derivative assets/liabilities
 
3,442

 
(2,267
)
Total derivative financial instruments
$
4,015,750

 
 
 
$
14,895

 
$
(2,618
)
December 31, 2013:
 
 
 
 
Fair Value
 
Notional
 
Balance Sheet Location
 
Asset
 
(Liability)
Interest rate lock commitments
$
1,190,119

 
Derivative assets/liabilities
 
$
4,553

 
$
(3,293
)
MBS forward trades
2,074,560

 
Derivative assets/liabilities
 
15,120

 
(227
)
Total derivative financial instruments
$
3,264,679

 
 
 
$
19,673

 
$
(3,520
)
        
The following summarizes the effect of the Company’s derivative financial instruments on its consolidated statements of operations for the three months ended March 31, 2014 and 2013:
 
Derivative (Losses) Gains Recognized
 
Three Months Ended March 31,
 
2014
 
2013
Interest rate lock commitments
$
9,842

 
$
13,506

MBS forward trades
(13,718
)
 
(4,957
)
Net derivative (losses) gains1
$
(3,876
)
 
$
8,549


1 All derivative (losses) gains are included within “Gains on mortgage loans held for sale” on the Company’s consolidated statements of operations.

The Company has exposure to credit loss in the event of contractual non-performance by its trading counterparties and counterparties to the over-the-counter derivative financial instruments that the Company uses in its rate risk management activities. The Company manages this credit risk by selecting only counterparties that the Company believes to be financially strong, spreading the credit risk among many such counterparties, by placing contractual limits on the amount of unsecured credit extended to any single counterparty and by entering into netting agreements with the counterparties, as appropriate.

The Company has entered into agreements with derivative counterparties which include netting arrangements whereby the counterparties are entitled to settle their positions on a net basis. In certain circumstances, the Company is required to provide certain derivative counterparties collateral against derivative financial instruments. As of March 31, 2014 and December 31, 2013, counterparties held $1,159 and $730, respectively, of the Company’s cash and cash equivalents in margin accounts as collateral (which is classified as "Restricted cash" on the Company's consolidated balance sheets), after which the Company was in a net credit loss position of $2,618 and $3,520 at March 31, 2014 and December 31, 2013, respectively, to

9


those counterparties. For the three months ended March 31, 2014 and 2013, the Company incurred no credit losses due to non-performance of any of its counterparties.

6. Mortgage Loans Held for Sale

The following summarizes mortgage loans held for sale at fair value as of March 31, 2014 and December 31, 2013:
 
March 31, 2014
 
December 31, 2013
Conventional 1
$
522,131

 
$
409,863

Government insured 2
303,990

 
267,497

Non-agency jumbo
8,794

 
5,720

Total mortgage loans held for sale, at fair value
$
834,915

 
$
683,080


1 Conventional includes FNMA and FHLMC mortgage loans.
2 Government insured includes GNMA mortgage loans (including Federal Housing Administration, Department of Veterans Affairs and United States Department of Agricultural mortgage loans).
        
Under certain of the Company’s mortgage funding arrangements (including secured borrowings and warehouse lines of credit), the Company is required to pledge mortgage loans as collateral to secure borrowings. The mortgage loans pledged as collateral must equal at least 100% of the related outstanding borrowings under the mortgage funding arrangements. The outstanding borrowings are monitored and the Company is required to deliver additional collateral if the amount of the outstanding borrowings exceeds the fair value of the pledged mortgage loans. As of March 31, 2014, the Company had pledged $800,056 in fair value of mortgage loans held for sale as collateral to secure debt under its mortgage funding arrangements, with the remaining $34,859 of mortgage loans held for sale funded with the Company’s excess cash. As of December 31, 2013, the Company had pledged $598,980 in fair value of mortgage loans held for sale as collateral to secure debt under its mortgage funding arrangements, with the remaining $84,100 of mortgage loans held for sale funded with the Company's excess cash. The mortgage loans held as collateral by the respective lenders are restricted solely to satisfy the Company’s borrowings under those mortgage funding arrangements. Refer to Note 10 “Debt” for additional information related to the Company’s outstanding borrowings as of March 31, 2014 and December 31, 2013.


7. Mortgage Servicing Rights

The Company sells residential mortgage loans in the secondary market and typically retains the right to service the loans sold. Upon sale, an MSR asset is capitalized, which represents the current fair value of the future net cash flows expected to be realized for performing servicing activities. The Company also purchases MSRs directly from third parties.
        
The Company’s total mortgage servicing portfolio as of March 31, 2014 and December 31, 2013 is summarized as follows (based on the UPB of the underlying mortgage loans):
 
March 31, 2014
 
December 31, 2013
FNMA
$
7,852,707

 
$
7,254,178

GNMA
5,378,027

 
4,507,443

FHLMC
872,060

 
161,889

Total mortgage servicing portfolio
$
14,102,794

 
$
11,923,510

 
 
 
 
MSRs balance
$
192,470

 
$
170,294

 
 
 
 
MSRs balance as a percentage of total mortgage servicing portfolio
1.36
%
 
1.43
%
    
A summary of the changes in the balance of MSRs for the three months ended March 31, 2014 and 2013 is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Balance at beginning of period
$
170,294

 
$
42,202

MSRs received as proceeds from loan sales
31,212

 
21,161

Purchased MSRs
1,622

 

Changes in valuation inputs and assumptions
(7,931
)
 
5,890

Actual portfolio runoff (payoffs and principal amortization)
(2,727
)
 
(1,800
)
Balance at end of period
$
192,470

 
$
67,453


10



The following is a summary of the components of loan servicing fees as reported in the Company’s consolidated statements of operations for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
 
2014
 
2013
Contractual servicing fees
$
8,765

 
$
3,009

Late fees
409

 
110

Loan servicing fees
$
9,174

 
$
3,119


8. Fair Value Measurements

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, derivatives and loans held for sale, or on a nonrecurring basis, such as when measuring intangible assets and long-lived assets. The Company has elected fair value accounting for loans held for sale to more closely align the Company’s accounting with its interest rate risk strategies without having to apply the operational complexities of hedge accounting.

The Company groups its assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level Input:
Input Definition:
Level 1
Unadjusted, quoted prices in active markets for identical assets or liabilities.
Level 2
Prices determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing an asset or liability and are developed based on market data obtained from sources independent of the Company. These may include quoted prices for similar assets and liabilities, interest rates, prepayment speeds, credit risk and others.
Level 3
Prices determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity), unobservable inputs may be used. Unobservable inputs reflect the Company's own assumptions about the factors that market participants would use in pricing the asset or liability, and are based on the best information available in the circumstances.

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

While the Company believes its valuation methods are appropriate and consistent with those used by other market participants, the use of different methods or assumptions to estimate the fair value of certain financial statement items could result in a different estimate of fair value at the reporting date. Those estimated values may differ significantly from the values that would have been used had a readily available market for such items existed, or had such items been liquidated, and those differences could be material to the consolidated financial statements.

Management incorporates lack of liquidity into its fair value estimates based on the type of asset or liability measured and the valuation method used. The Company uses discounted cash flow techniques to estimate fair value. These techniques incorporate forecasting of expected cash flows discounted at appropriate market discount rates that are intended to reflect the lack of liquidity in the market.

The following describes the methods used in estimating the fair values of certain financial statement items:

Mortgage Loans Held for Sale: The Company's mortgage loans held for sale at fair value are saleable into the secondary mortgage markets and their fair values are estimated using quoted market or contracted prices or market price equivalents.

Derivative Financial Instruments: The Company estimates the fair value of interest rate lock commitments based on the value of the underlying mortgage loan, quoted MBS prices and estimates of the fair value of the MSRs and the probability that the mortgage loan will fund within the terms of the interest rate lock commitment. The Company estimates the fair value of forward sales commitments based on quoted MBS prices.


11


Mortgage Servicing Rights: The Company uses a discounted cash flow approach to estimate the fair value of MSRs. This approach consists of projecting servicing cash flows discounted at a rate that management believes market participants would use in their determinations of value. The key assumptions used in the estimation of the fair value of MSRs include prepayment speeds, discount rates, default rates, cost to service, contractual servicing fees and escrow earnings.

The following are the major categories of assets and liabilities measured at fair value on a recurring basis as of March 31, 2014:
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
3

 
$

 
$

 
$
3

Mortgage loans held for sale

 
834,915

 

 
834,915

Derivative assets (IRLCs)

 
11,453

 

 
11,453

Derivative assets (MBS forward trades)

 
3,442

 

 
3,442

MSRs

 

 
192,470

 
192,470

Total assets
$
3

 
$
849,810

 
$
192,470

 
$
1,042,283

 
 
 
 
 
 
 
 

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (IRLCs)

 
351

 

 
351

Derivative liabilities (MBS forward trades)

 
2,267

 

 
2,267

Contingent earn-out liability

 

 
4,411

 
4,411

Total liabilities
$

 
$
2,618

 
$
4,411

 
$
7,029


The following are the major categories of assets and liabilities measured at fair value on a recurring basis as of December 31, 2013:
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
18,541

 
$

 
$

 
$
18,541

Mortgage loans held for sale

 
683,080

 

 
683,080

Derivative assets (IRLCs)

 
4,553

 

 
4,553

Derivative assets (MBS forward trades)

 
15,120

 

 
15,120

MSRs

 

 
170,294

 
170,294

Total assets
$
18,541

 
$
702,753

 
$
170,294

 
$
891,588

 
 
 
 
 
 
 
 

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (IRLCs)
$

 
$
3,293

 
$

 
$
3,293

Derivative liabilities (MBS forward trades)

 
227

 

 
227

Contingent earn-out liability

 

 
3,791

 
3,791

Total liabilities
$

 
$
3,520

 
$
3,791

 
$
7,311


Mortgage loans held for sale are carried at estimated fair value pursuant to the fair value option. Gains from changes in estimated fair values and are included in “Gains on mortgage loans held for sale” on the Company’s consolidated statements of operations and amounted to $10,877 and $599 for the three months ended March 31, 2014 and 2013.
        
The following are the fair values and related UPB due upon maturity for loans held for sale accounted under the fair value option as of March 31, 2014 and December 31, 2013:
 
March 31, 2014
 
December 31, 2013
 
Fair Value
 
UPB
 
Fair Value
 
UPB
Current through 89 days delinquent
$
826,723

 
$
788,854

 
$
676,906

 
$
653,938

90 or more days delinquent
8,192

 
9,153

 
6,174

 
7,630

Total
$
834,915

 
$
798,007

 
$
683,080

 
$
661,568

    


12


A reconciliation of the beginning and ending balances of the Company’s MSRs measured at fair value on a recurring basis using Level 3 inputs during the three months ended March 31, 2014 and 2013 is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Balance at beginning of period
$
170,294

 
$
42,202

Changes in fair value recognized in earnings1
(10,658
)
 
4,090

Purchases
1,622

 

Sales

 

Issuances
31,212

 
21,161

Settlements

 

Transfers into Level 3

 

Transfers out of Level 3

 

Balance at end of period
$
192,470

 
$
67,453

 
 
 
 
Changes in fair value recognized in net income during the
    period related to assets still held
$
(10,658
)
 
$
4,090


1 Recognized in the consolidated statements of operations within “Changes in mortgage servicing rights valuation”.

A reconciliation of the beginning and ending balances of the Company’s contingent earnout liabilities measured at fair value on a recurring basis using Level 3 inputs for the three months ended March 31, 2014 and 2013 is as follows:
 
Three Months Ended March 31,
 
2014
 
2013
 
 
 
 
Balance at beginning of period
$
3,791

 
$
2,095

Changes in fair value recognized in earnings1
42

 

Purchases2
603

 

Sales

 

Issuances

 

Settlements
(25
)
 

Transfers into Level 3

 

Transfers out of Level 3

 

Balance at end of period
$
4,411

 
$
2,095


1 Recognized in the consolidated statements of operations within “General and administrative expense”.

2 Contingent earnout liabilities resulted from the Company’s acquisitions of NattyMac during August 2012, Crossline during December 2013 and Medallion during February 2014. See Note 4, “Business Combinations,” within this Quarterly Report on Form 10-Q and Note 4, “Business Combinations,” to our audited consolidated financial statements as of and for the year ended December 31, 2013 included in our 2013 Annual Report on Form 10-K for additional information related to these contingent earnout liabilities.

Transfers between levels, if any, are recorded as of the beginning of the reporting period. During the three months ended March 31, 2014 and 2013, there were no transfers between levels.
    
Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. As disclosed in Note 4, "Business Combinations," we completed our acquisition of Medallion on February 4, 2014. The values of the net assets acquired in the acquisition of Medallion and resulting goodwill were recorded at fair value using Level 3 inputs. Refer to Note 4, "Business Combinations," for further information regarding the methodology and key assumptions used in the acquisition date fair value estimates.

Fair Value of Other Financial Instruments

As of March 31, 2014 and December 31, 2013, all financial instruments were either recorded at fair value or the carrying value approximated fair value. For financial instruments that were not recorded at fair value, such as cash, restricted

13


cash, servicing advances, secured borrowings, warehouse and operating lines of credit, accounts payable and accrued expenses, their carrying values approximated fair value due to the short-term nature of such instruments.

9. Transfers and Servicing of Financial Assets

Residential mortgage loans are primarily sold to FNMA or FHLMC or transferred into pools of GNMA MBS. The Company has continuing involvement in mortgage loans sold through servicing arrangements and the liability for loan indemnifications and repurchases under the representation and warranties it makes to the investors and insurers of the loans it sells. The Company is exposed to interest rate risk through its continuing involvement with mortgage loans sold, including the MSRs, as the value of the asset fluctuates as changes in interest rates impact borrower prepayment.

All loans are sold on a non-recourse basis; however, representations and warranties have been made that are customary for loan sale transactions, including eligibility characteristics of the mortgage loans and underwriting responsibilities, in connection with the sales of these assets.

In order to facilitate the origination and sale of mortgage loans held for sale, the Company entered into various agreements with warehouse lenders. Such 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 the Company surrenders control over the financial assets and such financial assets are legally isolated from the Company in the event of bankruptcy. For loan participations and repurchase agreements 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. As of March 31, 2014 and 2013, all repurchase agreements are accounted for by the Company as secured borrowings.

From time to time, the Company may sell loans whereby the underlying risks and cash flows of the mortgage loan have been transferred to a third party through the issuance of participating interests. The terms and conditions of these interests are governed by the participation agreements. In the instances where the loan participation has qualified for sale treatment, the Company will act as an agent on behalf of the participating entity when negotiating the terms of the ultimate sale of the underlying mortgage loans to FNMA, FHLMC or into pools of GNMA MBS. The Company will receive a marketing fee paid by the participating entity upon completion of the sale. In addition, the Company will also service the underlying mortgage loans to the participation agreement for the period that the participating interests are outstanding. As of March 31, 2014 and 2013, all participation arrangements were accounted for by the Company as secured borrowings.

The following table sets forth information regarding cash flows for the three months ended March 31, 2014 and 2013 relating to loan sales in which the Company has continuing involvement:
 
Three Months Ended March 31,
 
2014
 
2013
Proceeds from new loan sales 1
$
(654
)
 
$
(1,805
)
Proceeds from loan servicing fees
$
9,174

 
$
3,023

Proceeds from servicing advances
$
(887
)
 
$
18

Repurchases and indemnifications of previously sold loans
$
1,469

 
$


1 Represents the proceeds from mortgage loans or pools of mortgage loans sold to FNMA, FHLMC, and GNMA and is presented net of the related repayments of borrowings under the Company's mortgage funding arrangements used to fund the related mortgage loans prior to sale as well as the cost to retain the servicing rights.


The following table sets forth information related to outstanding loans sold as of March 31, 2014 and December 31, 2013 for which the Company has continuing involvement:
 
March 31, 2014
 
December 31, 2013
Total unpaid principal balance
$
14,102,794

 
$
11,923,510

Loans 30-89 days delinquent
$
158,801

 
$
167,293

Loans delinquent 90 or more days or in foreclosure 1
$
46,495

 
$
32,269

          
1 Includes GNMA mortgage loans, which are government-insured, of $38,443 and $26,268, respectively, as of March 31, 2014 and December 31, 2013.

14



    The key assumptions (or range of assumptions) used in determining the fair value of the Company’s MSRs as of March 31, 2014 and December 31, 2013 are as follows:
 
March 31, 2014
 
December 31, 2013
Discount rates
9.25% - 11.00%

 
9.25% - 11.00%

Annual prepayment speeds (by investor type):
 
 
 
Purchased FNMA 1
10.0
%
 
10.1
%
FNMA
8.4
%
 
7.8
%
GNMA I
8.4
%
 
8.1
%
GNMA II
7.9
%
 
7.6
%
FHLMC
8.6
%
 
7.7
%
Cost of servicing (per loan)
$
75

 
$
74


1 Represents older, higher interest rate loans acquired from the Company's merger with Swain in 2009.

The key assumptions (or range of assumptions) used in determining the fair value of the Company’s MSRs at initial recognition during the three months ended March 31, 2014 and 2013 are as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Discount rates
9.25% - 11.00%
 
9.25% - 11.00%
Annual prepayment speeds (by investor type):
 
 
 
FNMA
8.21% - 8.38%
 
9.27% - 9.67%
GNMA I
8.37% - 8.55%
 
12.09% - 12.89%
GNMA II
7.81% - 7.99%
 
8.89% - 9.27%
FHLMC
8.28% - 8.58%
 
N/A
Cost of servicing (per loan)
$74 - $75
 
$73 - $74


MSRs are generally subject to loss in value when mortgage rates decrease. Decreasing mortgage rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the life of the loans underlying the MSRs, thereby reducing MSR value. Reductions in the value of MSRs affect income through changes in fair value. These factors have been considered in the estimated prepayment speed assumptions used to determine the fair value of the Company’s MSRs.

In addition to the assumptions provided above, the Company uses assumptions for default rates in determining the fair value of MSRs. These assumptions are based primarily on internal estimates, and the Company also obtains third-party data, where applicable, to assess the reasonableness of its internal assumptions.  In the MSRs valuation as of March 31, 2014, the Company’s assumptions for default rates for FNMA, GNMA and FHLMC mortgage loans were 3.99%, 6.46% and 3.81%, respectively. In the MSRs valuation as of December 31, 2013, the Company's assumptions for default rates for FNMA, GNMA and FHLMC were 3.97%, 6.44%, and 3.82% respectively. The default rates represent the Company’s estimate of the loans that will eventually enter foreclosure proceedings over the entire term of the portfolio’s life.  These assumptions affect the future cost to service loans, future revenue earned from the portfolio, and future assumed foreclosure losses.  Because the Company’s portfolio is generally comprised of recent vintages, actual future defaults may differ from the Company’s assumptions.

15


The hypothetical effect of an adverse change in these key assumptions would result in a decrease in the fair values of MSRs as follows as of March 31, 2014 and December 31, 2013:
 
March 31, 2014
 
December 31, 2013
Discount rates:
 
 
 
Impact of discount rate + 1%
$
(9,483
)
 
$
(8,706
)
Impact of discount rate + 2%
$
(18,144
)
 
$
(16,638
)
Impact of discount rate + 3%
$
(26,079
)
 
$
(23,889
)
 
 
 
 
Prepayment speeds:
 
 
 
Impact of prepayment speed * 105%
$
(4,183
)
 
$
(3,558
)
Impact of prepayment speed * 110%
$
(8,228
)
 
$
(7,003
)
Impact of prepayment speed * 120%
$
(15,927
)
 
$
(13,570
)
 
 
 
 
Cost of servicing:
 
 
 
Impact of cost of servicing * 105%
$
(1,321
)
 
$
(1,157
)
Impact of cost of servicing * 110%
$
(2,641
)
 
$
(2,314
)
Impact of cost of servicing * 120%
$
(5,283
)
 
$
(4,629
)

As the table demonstrates, the Company’s methodology for estimating the fair value of MSRs is highly sensitive to changes in assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may indicate higher prepayments; however, this may be partially offset by lower prepayments due to other factors such as a borrower’s diminished opportunity to refinance), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

10. Debt

Short-term borrowings outstanding as of March 31, 2014 and December 31, 2013 are as follows:
 
March 31, 2014
 
December 31, 2013
 
Amount Outstanding
 
Weighted Average Interest Rate




Amount
Outstanding
 
Weighted Average Interest Rate
Secured borrowings
$
456,975

 
4.37
%
 
$
342,393

 
4.27
%
Mortgage repurchase borrowings
288,470

 
2.56
%
 
223,113

 
2.51
%
Warehouse lines of credit
464

 
4.00
%
 
7,056

 
4.98
%
Operating lines of credit
10,716

 
4.03
%
 
6,499

 
4.07
%
Total short-term borrowings
$
756,625

 
 
 
$
579,061

 
 
    
The Company maintains mortgage participation, repurchase and warehouse lines of credit arrangements (collectively referred to as “mortgage funding arrangements”) with various financial institutions, primarily to fund the origination of mortgage loans which are subject to participation. As of March 31, 2014 the Company held mortgage funding arrangements with 3 separate financial institutions and a total maximum borrowing capacity of $1,151,000. Each mortgage funding arrangement is collateralized by the underlying mortgage loans.










16


The following table summarizes the amounts outstanding, interest rates and maturity dates under the Company’s various mortgage funding arrangements as of March 31, 2014:
Mortgage Funding Arrangements
 
Amount Outstanding
 
Interest Rate



Maturity Date
 
Merchants Bank of Indiana - Participation Agreement
 
$
456,975

 
Same as the underlying mortgage rates, less contractual service fee
 
June 2014
 
Merchants Bank of Indiana - Warehouse Line of Credit
 
464

 
Prime plus 1.00%
 
June 2014
 
Barclays Bank PLC
 
188,697

 
LIBOR plus applicable margin
 
December 2014
 
Bank of America, N.A.
 
99,773

 
LIBOR plus applicable margin
 
April 2014
1 
Total
 
$
745,909

 
 
 
 
 

1 Extended on May 12, 2014 to a maturity date of May 2015.

The Company intends to renew the mortgage funding arrangements when they mature and has no reason to believe the Company will be unable to do so.

On March 31, 2014, the Company amended its master participation agreement with Merchants Bank of Indiana ("Merchants") to increase the aggregate maximum borrowing capacity from $400,000 to $600,000 through May 31, 2014, with the aggregate maximum borrowing capacity reverting back to $400,000 on June 1, 2014 until the agreement matures on June 30, 2014.

On March 31, 2014, the Company entered into two changes to its facilities with Merchants: a) it amended its mortgage warehouse and security agreement with Merchants to decrease the maximum borrowing capacity under the line of credit with Merchants from $2,000 to $1,000 and b) it amended its operating line of credit agreement with Merchants to increase the maximum borrowing capacity from $7,200 to $11,000 through May 31, 2014. The maximum borrowing capacity reverts back to $7,200 on June 1, 2014 until the operating line of credit agreement matures on June 30, 2014.

On March 25, 2014, the Company amended its master repurchase agreement with Bank of America, N.A. ("Bank of America") to increase the aggregate outstanding purchase price under the agreement from $200,000 to $250,000 and extend the termination date to April 30, 2014. On April 30, 2014, the master repurchase agreement with Bank of America was amended further to extend the maturity date to May 31, 2014. On May 12, 2014, the master repurchase agreement with Bank of America was increased to $400,000 and renewed until its maturity date of May 11, 2015.

11. Reserve for Mortgage Repurchases and Indemnifications

The following is a summary of changes in the reserve for mortgage repurchases and indemnifications for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
 
2014
 
2013
 
 
 
 
Balance at beginning of period
$
3,709

 
$
1,917

Provision for mortgage repurchases and indemnifications - new loan sales
478

 
999

Provision for mortgage repurchases and indemnifications - change in estimate
395

 

Losses on repurchases and indemnifications
(351
)
 
(45
)
Balance at end of period
$
4,231

 
$
2,871


Because of the uncertainty in the various estimates underlying the mortgage repurchase and indemnifications liability, there is a range of losses in excess of the recorded reserve for mortgage repurchase and indemnifications that is reasonably possible. The estimate of the range of possible loss for representations and warranties does not represent a probable loss and is based on current available information, significant judgment and a number of assumptions that are subject to change. The high end of this range of reasonably possible losses in excess of the Company’s recorded reserve was approximately $2,315 at March 31, 2014, and was determined based upon modifying the assumptions (particularly to assume significant changes in investor repurchase demand practices) utilized in the Company’s best estimate of probable loss to reflect what it believes to be the high end of reasonably possible adverse assumptions.


17


12. Related Party Transactions

Through May 15, 2013, the Company had an agreement with a stockholder to pay an annual management fee for consulting and advisory services and strategic planning. The agreement was terminated on May 15, 2013 in conjunction with the Company’s private offering of common stock. The total management fees amounted to $0 and $80, respectively, for the three months ended March 31, 2014 and 2013, and are included in "General and administrative expense" on the Company's consolidated statements of operations.

Through June 30, 2013, the Company had an agreement with a stockholder to manage and grow the Company’s Home Improvement Program division, which primarily focuses on the origination of FHA 203k loans and Fannie Mae Home Style renovation loans. In accordance with the terms of the agreement the stockholder was to receive an annual management fee of $108 payable quarterly through January 15, 2014, 10% of all revenue generated by the division payable quarterly through January 15, 2014, and 33.33% of the annual net income of the division for the calendar year ended December 31, 2013. This agreement was terminated on June 30, 2013. The total related fees amounted to $0 and $79, respectively, for the three months ended March 31, 2014 and 2013, and are included in "General and administrative expense" on the Company's consolidated statements of operations.

13. Income Taxes

During the three months ended March 31, 2014 and 2013, the Company recognized income tax (benefit) expense of $(4,967) and $6,130, respectively, which represented effective tax rates of 38.7% and 38.7%, respectively.

As of March 31, 2014, the Company had federal and state net operating loss carryforwards of $94,973 and $64,241, respectively. The Company's federal and state net operating loss carryforwards are available to offset future taxable income and expire from 2027 through 2033. Management has determined that it is more likely than not that these net operating loss carryforwards will be utilized prior to their expiration.  Accordingly, no valuation allowance has been established at March 31, 2014.

14. Commitments and Contingencies

Commitments to Extend Credit

The Company enters into interest rate lock commitments ("IRLCs") with customers who have applied for residential mortgage loans and meet certain credit and underwriting criteria. These commitments expose the Company to market risk if interest rates change and the loan is not economically hedged or committed to an investor. The Company is also exposed to credit loss if the loan is originated and not sold to an investor and the customer does not perform. The collateral upon extension of credit typically consists of a first deed of trust in the mortgagor’s residential property. Commitments to originate loans do not necessarily reflect future cash requirements as some commitments are expected to expire without being drawn upon. Total commitments to originate loans as of March 31, 2014 and December 31, 2013 approximated $1,489,053 and $1,190,119, respectively.

Litigation

The Company is subject to various legal proceedings arising out of the ordinary course of business. As of March 31, 2014, there were no current or pending claims against the Company, which could have a material impact on the Company's statement of financial position, net income or cash flows.

Other Contingencies

During 2013, the Company became aware that it had purchased certain refinancing loans, with a total principal amount of $5,163, from a correspondent lender where the prior mortgage loan on the property securing the mortgage loan that was 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 the Company’s process in purchasing a mortgage loan from a correspondent, it generally requires 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 purchased loans. As a result, the Company believes the borrower is insured against any liens prior to ours that were not identified in connection with the issuance of that closing protection letter. The Company believes that its 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 the Company’s practice of obtaining closing protection letters is appropriate to protect it in these situations. The Company has notified the affected borrowers and the relevant insurance carriers, and it expects that the title insurance obtained in connection with the refinancings will result in the loan

18


having a first priority status. However, there can be no assurances that the prior mortgages will be fully satisfied from the title insurance claims.


15. Capital Stock

Issuance of Warrants

On March 29, 2013, in conjunction with a $10,000 term loan the Company entered into with a stockholder, the Company issued warrants to the stockholder for the right to purchase 277,777 shares of its common stock at a price of $18.00 per share. The warrants are exercisable at any time through May 15, 2018. Because the warrants met the criteria of a derivative financial instrument that is indexed to the Company's own stock, the warrants' allocable fair value of $1,522 was recorded as a component of "Additional paid in capital" and resulted in a debt discount in the same amount.

Use of Capital and Common Stock Repurchases

The Company paid total cash dividends of $0 and $19 to its convertible preferred stockholders during the three months ended March 31, 2014 and 2013, respectively (the Company had no preferred stockholders during the three months ended March 31, 2014). The Company does not expect to pay dividends on its common stock for the foreseeable future. The declaration of future dividends and the establishment of the per share amount, record dates and payment dates for any such future dividends are subject to the final determination of the Company’s Board of Directors and will be dependent upon future earnings, cash flows, financial requirements and other factors.     

Common stock repurchases are discretionary as the Company is under no obligation to repurchases shares. The Company may repurchase shares when it believes it is a prudent use of capital. There were no repurchases of common stock during the three months ended March 31, 2014 or 2013.

16. Stock-Based Compensation

Stock Options

A summary of stock option activity for the three months ended March 31, 2014 is as follows:
 




Number of Shares
 


Weighted Average
Exercise Price Per Share
 

Weighted Average
Remaining Contractual Life (Years)
 



Aggregate Intrinsic Value
Outstanding at December 31, 2013
1,539,880

 
$
17.08

 

 


Granted

 
N/A

 

 


Exercised

 
N/A

 

 


Forfeited or expired

 
N/A

 

 


Outstanding at March 31, 2014
1,539,880

 
$
17.08

 
9
 
$
1,105

Exercisable at March 31, 2014
283,509

 
$
15.07

 
9
 
$
645


The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options granted. For a more detailed discussion of the Company's stock based compensation plan's fair value methodology, refer to Note 18, “Stock-Based Compensation,” to its audited consolidated financial statements as of and for the year ended December 31, 2013 included in its 2013 Annual Report on Form 10-K.

Restricted Stock Units

A summary of the nonvested restricted stock unit activity for the three months ended March 31, 2014 is as follows:


19


 
Restricted Stock Units
 
Weighted Average Grant Date Fair Value Per Share
Nonvested at December 31, 2013
49,634

 
17.04

Granted

 
N/A

Vested

 
N/A

Forfeited

 
N/A

Nonvested at March 31, 2014
49,634

 
17.04


17. Segment Information

The Company’s organizational structure is currently comprised of one operating segment: Mortgage Banking. This determination is based on the Company’s current organizational structure, which reflects how the chief operating decision maker evaluates the performance of the business.

The Mortgage Banking segment includes the Mortgage Originations, Mortgage Servicing and Mortgage Financing lines of business. The Mortgage Originations business primarily originates and sells residential mortgage loans, which conform to the underwriting guidelines of the GSEs and government agencies. The Mortgage Servicing business includes loan administration, collection and default activities, including the collection and remittance of loan payments, responding to customer inquiries, collection of principal and interest payments, holding custodial funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures on the Company’s property dispositions. The Mortgage Financing business includes warehouse lending activities to correspondent customers by the Company’s NattyMac subsidiary, which commenced operations in July 2013.

The principal sources of revenue from the Mortgage Banking segment include:

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;
Fee income from loan servicing; and
Fee and net interest income from the Company’s financing facility.

The Company’s chief operating decision maker evaluates the performance of the Mortgage Banking segment based on the measurement basis of income before income taxes. Refer to the Company’s consolidated statements of operations for three months ended March 31, 2014 and 2013 included in this Form 10-Q for details related to operating revenues, income before income taxes and depreciation and amortization for the Mortgage Banking segment. Refer to the Company’s consolidated balance sheets as of March 31, 2014 and December 31, 2013 included in this Form 10-Q for details of the assets and equity components of the Mortgage Banking segment.

The major components of revenues by product/service for the Mortgage Banking segment for the three months ended March 31, 2014 and 2013 are as follows:

20


 
Three Months Ended March 31,
 
2014
 
2013
Mortgage originations
 
 
 
Gains on mortgage loans held for sale
$
28,631

 
$
24,204

Loan origination and other loan fees
5,036

 
4,648

Interest income
5,925

 
2,821

Total mortgage originations
39,592

 
31,673

 
 
 
 
Mortgage servicing
 
 
 
Changes in mortgage servicing rights valuation
(10,658
)
 
4,090

Loan servicing fees
9,174

 
3,119

Total mortgage servicing
(1,484
)
 
7,209

 
 
 
 
Mortgage financing
 
 
 
Financing fees
41

 

Interest income
152

 

Total mortgage financing
193

 

 
 
 
 
Total revenues
$
38,301

 
$
38,882









18. Supplemental Cash Flow Information

Supplemental cash flow information for the three months ended March 31, 2014 and 2013 are as follows:
 
Three Months Ended March 31,
 
2014
 
2013
Cash paid for interest
$
3,631

 
$
3,073

Cash paid for taxes
$

 
$


In addition to the activities presented above, during the three months ended March 31, 2014, the Company sold a portion of its investment in shares of preferred stock of a closely held entity for $200, of which all of the proceeds from such sale were applied against the Company's outstanding balance on its operating line of credit with the same entity.

19. Subsequent Events

On April 15, 2014, the Company entered into an agreement with Merchants Bancorp (an Indiana-based bank holding company and the parent company of Merchants Bank of Indiana), whereby the Company agreed to invest up to $25,000 in the subordinate debt of Merchants Bancorp. Merchants Bancorp in turn, agreed to form and fund a wholly-owned subsidiary named NattyMac Funding Inc. (“NMF”) that will invest in participation interests in warehouse lines of credit ("WLOCs")originated by the Company's wholly-owned subsidiary, NattyMac, and in participation interests in residential mortgage loans originated by Stonegate. The amount of the subordinate debt funded by the Company will be sized to be greater than or equal to 10% of the assets of NMF. The subordinate debt provided to Merchants Bancorp will earn a return equal to one-month LIBOR, plus 350 basis points, plus additional interest that will be equal to 49% of the earnings of NMF.

    


21



 ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(In Thousands, Except Share and Per Share Data or As Otherwise Stated Herein)
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2013 and the MD&A included in our 2013 Annual Report on Form 10-K. This MD&A contains forward-looking statements that involve risk, uncertainties and assumptions. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of many factors, including those discussed in “Risk Factors” in our 2013 Annual Report on Form 10-K. As used in this discussion and analysis, unless the context otherwise requires or indicates, references to “the Company,” “our company,” “we,” “our” and “us” refer to Stonegate Mortgage Corporation.

Overview
We are a non-bank integrated mortgage company focused on the U.S. residential mortgage market. We originate, acquire, sell, finance and service residential mortgage loans. We predominantly sell mortgage loans to the Federal National Mortgage Association (“Fannie Mae” or “FNMA”), to the Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC") and in Government National Mortgage Association (“Ginnie Mae” or “GNMA”) pools of mortgage backed securities (“MBS”). Both FNMA and FHLMC are considered government-sponsored enterprises ("GSEs"). We also sell mortgage loans to other third-party investors in the secondary market and provide short-term financing to other residential mortgage loan originators. Our principal sources of revenue include (i) gain on sale of mortgage loans from loan securitizations and whole loan sales, and fee income from originations, (ii) fee income from loan servicing, and (iii) fee and net interest income from its financing facilities. We operate 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.
For additional information about our company and business operations, see the “Overview” section of the MD&A included in our 2013 Annual Report on Form 10-K.

Recent Industry Trends

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

a reduction in origination and loan lock volumes;
a shift from loan refinancing volume to purchase loan volume;
short-term contraction of the gain on sale margin of mortgage loans including negative fair market value adjustments on locked loans and loans held for sale;
an increase in net interest income from financing (assuming a steeper forward yield curve);
an increase in the value of mortgage servicing rights due to a decline in prepayment expectations; and
a reduction of gains from mortgage loan sales.

Performance Summary

Revenues of $38,301 for three months ended March 31, 2014, compared to revenues of $38,882 for the three months ended March 31, 2013.
Net loss of $7,884 for the three months ended March 31, 2014, compared to net income $9,696 for the three months ended March 31, 2013.
Diluted loss per share (“LPS”) of $0.31 for the three months ended March 31, 2014, compared to the diluted earnings per share ("EPS") of $0.86 for the three months ended March 31, 2013.
Mortgage loan originations of $2,421,868 for the three months ended March 31, 2014, an increase of 27% compared to the three months ended March 31, 2013.
Mortgage servicing portfolio of $14,102,794 as of March 31, 2014, an increase of 18% compared to the December 31, 2013 mortgage servicing portfolio of $11,923,510.


22


Non-GAAP Financial Measures
Our results of operations discussed throughout this MD&A are determined in accordance with U.S. generally accepted accounting principles (“GAAP”). We also calculate adjusted net income and adjusted diluted EPS as performance measures, which are considered non-GAAP financial measures under Regulation G and Item 10(e) of Regulation S-K, to further aid our investors in understanding and analyzing our core operating results and comparing them among periods. Adjusted net income and adjusted diluted EPS exclude certain items that we do not consider part of our core operating results, including changes in valuation inputs and assumptions on our MSRs, stock-based compensation expenses, ramp-up costs associated with our acquired Nationstar business and acquisition related costs. Ramp-up costs include the advance hiring of servicing and originations staff, recruiting expenses, travel, licensing and legal expenses. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for (loss) income before income taxes, net (loss) income or diluted (LPS) EPS prepared in accordance with GAAP.
In addition, adjusted net income has limitations as an analytical tool, including but not limited to the following:

adjusted net income does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;
adjusted net income does not reflect changes in, or cash requirements for, our working capital needs;
adjusted net income does not reflect the cash requirements necessary to service principal payments related to the financing of the business;
other companies in our industry may calculate adjusted net income differently, thereby limiting its usefulness as a comparative measure.
Because of these and other limitations, adjusted net income should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. Adjusted net income is a performance measure and is presented to provide additional information about our core operations.
The table below reconciles net (loss) income to adjusted net income and diluted (LPS) EPS to adjusted diluted EPS (which are the most directly comparable GAAP measures) for the three months ended March 31, 2014 and 2013:
 
 
Three Months
Ended
March 31, 
 
Change
 
2014
 
2013
 
$
 
%
Net (loss) income
$
(7,884
)
 
$
9,715

 
$
(17,599
)
 
(181
)%
Adjustments:
 
 
 
 
 
 
 
Changes in valuation inputs and assumptions on MSRs
7,931

 
(5,890
)
 
13,821

 
235
 %
Stock-based compensation expense
899

 
7

 
892

 
12,743
 %
Ramp-up and other non-routine expenses 1
9,593

 
36

 
9,557

 
26,547
 %
Acquisition related expenses
49

 

 
49

 
N/A

Tax effect of adjustments
(7,149
)
 
2,210

 
(9,359
)
 
(423
)%
Adjusted net income
$
3,439

 
$
6,078

 
$
(2,639
)
 
(43
)%
 
 
 
 
 
 
 
 
Diluted (LPS) EPS
$
(0.31
)
 
$
0.86

 
$
(1.17
)
 
(136
)%
Adjustments:
 
 
 
 
 
 
 
Changes in valuation inputs and assumptions on MSRs
0.31

 
(0.52
)
 
0.83

 
(160
)%
Stock-based compensation expense
0.04

 

 
0.04

 
N/A

Ramp-up expenses
0.37

 

 
0.37

 
N/A

Acquisition related expenses

 

 

 
N/A

Tax effect of adjustments
(0.28
)
 
0.20

 
(0.48
)
 
(240
)%
Adjusted diluted EPS
$
0.13

 
$
0.54

 
$
(0.41
)
 
(76
)%
1 Consists primarily of guarantees and other compensation expense prior to the period of meaningful origination production.
    
Adjusted net income decreased $2,639, or 43%, during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The decrease was primarily attributable to lower gain on sale margins and higher operating expenses associated with increased volume. Adjusted diluted EPS decreased $0.41, or 76%, during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 due primarily to the previously discussed decrease in adjusted net income as well as the dilution associated with higher weighted average shares outstanding as result of our equity offerings that occurred during the second and fourth quarters of 2013.

23





Significant Transactions

Acquisition of Medallion Mortgage Company

On February 4, 2014, we completed our acquisition of Medallion Mortgage Company ("Medallion"), a residential mortgage originator based in southern California. Medallion services customers with an extensive portfolio of residential real estate loan programs and has 10 offices along the southern and central coast of California, Utah and a new operations center in Ventura, California. In the acquisition of Medallion, we agreed to purchase certain assets, assume certain liabilities and offer employment to certain employees. Total consideration for Medallion, which, along with working capital for the business, has or will be funded out of our existing cash resources, was $861, which includes cash consideration of $258 and contingent consideration based primarily on future origination volume estimated to be $603 at the acquisition date. For additional information regarding this transaction, refer to Note 4 "Business Combinations," to our unaudited consolidated financial statements included in Part I, Item I of this Quarterly Report on Form 10-Q.

Recent Developments

On April 15, 2014, the Company entered into an agreement with Merchants Bancorp (an Indiana-based bank holding company and the parent company of Merchants Bank of Indiana), whereby the Company agreed to invest up to $25,000 in the subordinate debt of Merchants Bancorp. Merchants Bancorp in turn, agreed to form and fund a wholly-owned subsidiary named NattyMac Funding Inc. (“NMF”) that will invest in participation interests in warehouse lines of credit originated by the Company's wholly-owned subsidiary, NattyMac, and in participation interests in residential mortgage loans originated by Stonegate. The amount of the subordinate debt funded by the Company will be sized to be greater than or equal to 10% of the assets of NMF. The subordinate debt provided to Merchants Bancorp will earn a return equal to one-month LIBOR, plus 350 basis points, plus additional interest that will be equal to 49% of the earnings of NMF.


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 on mortgage loans is reduced by borrower payments and payoffs. Prepayment speeds, as reflected by the constant prepayment rate, vary according to interest rates, the type of loan, conditions in the housing and financial markets, competition and other factors, none of which can be predicted with any certainty. Prepayment spread impacts future servicing fees, value of MSRs, 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. An increase in prevailing interest rates could adversely affect our loan originations and potentially have an indirect impact on gain on sale. 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

24


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” included in this MD&A 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 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” for additional information.
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 service the mortgage loans where the borrower has defaulted influences the level of expenses that we incur in the mortgage loan servicing process.


Results of Operations

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

Our consolidated results of operations for the three months ended March 31, 2014 and 2013 are as follows:
 
Three Months Ended March 31,
 
2014
 
2013
 
$ Change
 
% Change
Gains on mortgage loans held for sale
$
28,631

 
$
24,204

 
$
4,427

 
18%
Changes in mortgage servicing rights valuation
(10,658
)
 
4,090

 
(14,748
)
 
(361)%
Loan origination and other loan fees
5,077

 
4,648

 
429

 
9%
Loan servicing fees
9,174

 
3,119

 
6,055

 
194%
Interest income
6,077

 
2,821

 
3,256

 
115%
Total revenues
38,301

 
38,882

 
(581
)
 
(1)%
 
 
 
 
 
 
 
 
Salaries, commissions and benefits
33,420

 
14,493

 
18,927

 
131%
General and administrative
8,209

 
3,602

 
4,607

 
128%
Interest expense
3,813

 
3,073

 
740

 
24%
Occupancy, equipment and communications
4,141

 
1,485

 
2,656

 
179%
Provision for mortgage repurchases and indemnifications - change in estimate
395

 

 
395

 
100%
Depreciation and amortization expense
1,083

 
384

 
699

 
182%
Loss on disposal of property and equipment
91

 

 
91

 
100%
Total expenses
51,152

 
23,037

 
28,115

 
122%
 
 
 
 
 
 
 
 
(Loss) income before income taxes
(12,851
)
 
15,845

 
(28,696
)
 
(181)%
Income tax (benefit) expense
(4,967
)
 
6,130

 
(11,097
)
 
(181)%
Net (loss) income
$
(7,884
)
 
$
9,715

 
$
(17,599
)
 
(181)%
 
 
 
 
 
 
 
 
Weighted average diluted shares outstanding (in thousands)
25,769

 
11,223

 
14,546

 
130%
 
 
 
 
 
 
 
 
Diluted (LPS) EPS
$
(0.31
)
 
$
0.86

 
$
(1.17
)
 
(136)%


Revenues
During the three months ended March 31, 2014, total revenues decreased $(581), or (1)%, as compared to the three months ended March 31, 2013. The decrease in revenues resulted from a decrease in the fair value of our MSRs, partially offset

25


by increases in our loan servicing fees, gains on mortgage loans held for sale, interest income and loan origination and other loan fees. The decrease in the fair value of our MSRs was driven primarily by the decrease in market interest rates at the end of the first quarter of 2014. Decreasing interest rates generally result in decreased MSRs values as the assumption for prepayment speeds of the underlying mortgage loans tend to increase (mortgage loans prepay faster). The increase in our gains on mortgage loans held for sale during the three months ended March 31, 2014 was due primarily to increases in origination volume. The increase in our loan servicing fees was primarily the result of our higher average servicing portfolio of $13,493,346 during the three months ended March 31, 2014, compared to an average servicing portfolio of $5,161,302 during the three months ended March 31, 2013. The increase in interest income was primarily a result of an increase in mortgage loan originations during the three months ended March 31, 2014 as compared to March 31, 2013. Loan origination and other loan fees increased primarily as a result of the increase in the amount of loans originated during the three months ended March 31, 2014 compared to the three months ended March 31, 2013.

Originations
The following table illustrates mortgage loan originations by type for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
 
2014
 
2013
 
$
 
% Total
 
$
 
% Total
Conventional
$
1,401,040

 
58
%
 
$
1,168,869

 
62
%
Government insured
989,506

 
41
%
 
729,265

 
38
%
Non-agency jumbo
31,322

 
1
%
 
1,471

 
%
Total mortgage loan originations
$
2,421,868

 
100
%
 
$
1,899,605

 
100
%
The following is a summary of mortgage loan origination volume by channel for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
 
2014
 
2013
 
# of Loans
 
$
 
% Total
 
# of Loans
 
$
 
% Total
Retail
1,181

 
$
260,908

 
11
%
 
897

 
$
150,286

 
8
%
Wholesale
1,954

 
422,161

 
17
%
 
2,007

 
396,414

 
21
%
Correspondent
8,790

 
1,738,799

 
72
%
 
7,062

 
1,352,905

 
71
%
Total mortgage loan originations
11,925

 
$
2,421,868

 
100
%
 
9,966

 
$
1,899,605

 
100
%
The increased volume in the retail channel during the three months ended March 31, 2014 is reflective of strategy of acquiring retail business and includes three months of originations from our Crossline subsidiary, which we acquired at the end of 2013, and for which there were no comparable amounts during the three months ended March 31, 2013. We intend to continue to build our retail operations through acquisitions of small retail mortgage operators during the remainder of 2014.
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.
 A summary of the mortgage loan origination volume by FICO score and LTV for the three months ended March 31, 2014 and 2013 is as follows:

26


 
Three Months Ended March 31, 2014
 
LTV Range
 
<70%
 
70%-80%
 
81%-90%
 
91%-100%
 
>100%
 
Total
 
% Total
FICO Score
 
 
 
 
 
 
 
 
 
 
 
 
 
<620
$
275

 
$
214

 
$
105

 
$
3,198

 
$
351

 
$
4,143

 
%
620-680
47,178

 
85,292

 
61,950

 
363,853

 
9,196

 
567,469

 
23
%
681-719
69,894

 
125,152

 
66,339

 
284,311

 
5,471

 
551,167

 
23
%
>719
230,605

 
439,963

 
163,894

 
456,622

 
8,005

 
1,299,089

 
54
%
Total mortgage loan originations
$
347,952

 
$
650,621

 
$
292,288

 
$
1,107,984

 
$
23,023

 
$
2,421,868

 
100
%
% Total
14
%
 
27
%
 
12
%
 
46
%
 
1
%
 
100
%
 
 
 
 
Three Months Ended March 31, 2013
 
LTV Range 
 
<70% 
 
70%-80%
 
81%-90%
 
91%-100%
 
>100% 
 
Total
 
% Total
FICO Score
 
 
 
 
 
 
 
 
 
 
 
 
 
<620
$

 
$

 
$
99

 
$
1,186

 
$

 
$
1,285

 
%
620-680
18,437

 
38,441

 
63,566

 
261,362

 
9,391

 
391,197

 
21
%
681-719
41,397

 
74,184

 
60,663

 
169,726

 
15,411

 
361,381

 
19
%
>719
281,843

 
385,571

 
160,854

 
287,836

 
29,638

 
1,145,742

 
60
%
Total mortgage loan originations
$
341,677

 
$
498,196

 
$
285,182

 
$
720,110

 
$
54,440

 
$
1,899,605

 
100
%
% Total
18
%
 
26
%
 
15
%
 
38
%
 
3
%
 
100
%
 
 
Our mortgage loan originations during the three months ended March 31, 2014 have shifted toward lower FICO scores and higher LTV percentages primarily as a result of the increase toward government insured mortgage originations, which increased from 38% of total mortgage loan originations during the three months ended March 31, 2013 to 41% of total mortgage loan originations during the three months ended March 31, 2014. Government insured mortgage loans generally allow for lower minimum FICO scores and higher maximum LTV percentages.

Servicing
The following is a summary of loan servicing fee income by component for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31, 
 
2014
 
2013
Contractual servicing fees
$
8,765

 
$
3,009

Late fees
409

 
110

Loan servicing fees
$
9,174

 
$
3,119

Our loan servicing fees increased to $9,174 during the three months ended March 31, 2014 from $3,119 during the three months ended March 31, 2013. The 194% increase in loan servicing fees was primarily the result of an increase in the average UPB of mortgage loans serviced during the three months ended March 31, 2014 compared to the three months ended March 31, 2013.
The following table illustrates our mortgage servicing portfolio by type as of March 31, 2014 and December 31, 2013:
 
March 31, 2014
 
December 31, 2013
 
$ UPB
 
% Total
 
$ UPB
 
% Total
FNMA
$
7,852,707

 
56
%
 
$
7,254,178

 
61
%
GNMA
5,378,027

 
38
%
 
4,507,443

 
38
%
FHLMC
872,060

 
6
%
 
161,889

 
1
%
Total servicing portfolio
$
14,102,794

 
100
%
 
$
11,923,510

 
100
%

27


The following is a summary of mortgage loan servicing portfolio characteristics by loan type as of March 31, 2014 and December 31, 2013:
 
March 31, 2014
 
Weighted Average Coupon
 
Average Age
(in months)
 
Average Loan
Amount
 
Weighted Average Servicing Fee
FNMA
3.90
%
 
12.5

 
$
195,672

 
25 bps
GNMA
3.86
%
 
10.8

 
$
161,687

 
31 bps
FHLMC
4.42
%
 
1.6

 
$
236,459

 
25 bps
Total
3.92
%
 
11.2

 
$
182,958

 
27 bps
 
 
 
 
 
December 31, 2013
 
Weighted Average
Coupon
 
Average Age (in months) 
 
Average Loan
Amount
 
Weighted Average Servicing Fee
FNMA
3.85
%
 
10.4

 
$
195,959

 
25 bps
GNMA
3.79
%
 
9.8

 
$
159,403

 
31 bps
FHLMC
4.35
%
 
0.3

 
$
249,829

 
25 bps
Total
3.84
%
 
10.0

 
$
180,809

 
27 bps
The weighted average coupon, average age and average loan amount of the portfolio increased slightly during the three months ended March 31, 2014. The increase in the weighted average coupon and average age was due primarily to the general increase in interest rates and the age of the existing portfolio. The increased average loan amounts represent expansion into certain higher-priced residential geographic areas as we continue to expand our footprint.
Expenses
Salaries, commissions and benefits expense increased $18,927, or 131%, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily as a result of the increase in our headcount from 532 employees at March 31, 2013 to 1,239 employees at March 31, 2014. We have and will continue to increase our sales force and support staff to facilitate the growth in our loan originations, mortgage servicing and mortgage financing operations. Since origination volumes have increased during the three months ended March 31, 2014, we have seen a corresponding increase in the variable commissions paid to employees.
General and administrative expenses increased $4,607, or 128%, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily as a result of increased consulting and outside service expenses related to our growth and continuing expansion and transition from a private company to a public company. We have also experienced an increase in travel related expenses as we continue to work through the acquisition and integration of retail originators.
Interest expense increased $740, or 24%, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to increased borrowings as a result of the increase in the volume of mortgage loans originated and funded in the current period.
Occupancy, equipment and communication expenses increased $2,656, or 179%, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013, primarily as a result of increased facility, system and computer equipment requirements to accommodate increased staffing levels, new operation centers and new retail branches.
Provision for mortgage repurchases and indemnification increased $395 or 100% due to the establishment of loss reserves related to specific HUD indemnification activity. This reserve is based on the estimated loss to be incurred upon the completion of the sale of the properties by HUD.
Depreciation and amortization expense increased $699, or 182%, during the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to increased property and equipment balances resulting from our overall growth and expansion, including acquisitions, as well as increased amortization expense related to the Crossline intangible assets acquired in December 2013.
Income tax (benefit) expenses were $(4,967) and $6,130, a decrease of 181%, for the three months ended March 31, 2014 and 2013, with effective tax rate of 38.65% and 38.66%. The decrease in income tax expense was due to pre-tax loss for the three months ended March 31, 2014 compared to a pre-tax gain for the three months ended March 31, 2013.


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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. We consider some of our most important accounting policies that require estimates and management judgment to be those policies with respect to reserves for loan repurchases and indemnifications, fair value of financial instruments, MSRs, derivative financial instruments, mortgage loans held for sale, business combinations (including accounting for intangible assets) and income taxes. For additional information regarding these significant accounting policies, refer to Note 2, “Basis of Presentation and Significant Accounting Policies,” to our audited consolidated financial statements as of and for the year ended December 31, 2013.
Recent Accounting Developments
ASU No. 2014-04, "Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure," was issued in January 2014. This update clarifies when a creditor is considered to have received physical possession of residential real estate property collateralized by a consumer mortgage loan in order to reduce diversity in practice for when a creditor derecognizes the loan receivable and recognizes the real estate property. The guidance in ASU No. 2014-04 also requires interim and annual disclosure of the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The new guidance will be effective for us beginning on January 1, 2015. We are currently evaluating the guidance under ASU 2014-04 and have not yet determined the impact, if any, on our consolidated financial statements.
Liquidity and Capital Resources
Overview
Liquidity measures our ability to meet potential cash requirements, including the funding of servicing advances, the payment of operating expenses, the originations of loans and the repayment of borrowings. Our unrestricted cash balance decreased from $43,104 as of December 31, 2013 to $17,874 as of March 31, 2014, primarily due to cash outflows from operating and financing activities, partially offset by cash inflows from financing activities. We continue to experience negative operating cash flows due to the cash investment in the creation of the MSR asset, the timing of originations versus loan sales, the related increases in our loan inventory and locked loan pipeline. The negative operating cash flows will continue in the future as we grow originations to increase the loan servicing portfolio. As the servicing fees collected from borrowers increases as the portfolio size increases, the operating cash flows are expected to increase. Cash outflows from investing activities were due primarily to the purchase of MSR assets, purchases of property and equipment and the acquisition of Medallion. The operating and financing cash outflows were partially offset by cash inflows from our financing activities, including primarily net proceeds from borrowings under our mortgage participations, repurchase agreements, warehouse and operating lines of credit.
Our primary sources of funds for liquidity include: (i) secured borrowings in the form of repurchase facilities and participation agreements with major financial institutions, as well as our warehouse lines of credit and operating lines of credit, (ii) equity offerings, (iii) servicing fees and ancillary fees, (iv) payments received from sales or securitizations of loans, and (v) payments received from mortgage loans held for sale. Our primary uses of funds for liquidity include: (i) originations of loans, (ii) originations of warehouse lines of credit, (iii) funding of servicing advances, (iv) payment of interest expenses, (v) payment of operating expenses, (vi) repayment of borrowings, and (vii) payments for acquisitions of MSRs.
Our financing strategy primarily consists of using repurchase facilities and participation agreements with major financial institutions, as well as regional and community banks. We believe this provides us with a stable, low-cost, diversified source of funds to finance our business.
In order to support the continued growth of our servicing portfolio, we are examining various financing alternatives that would involve the encumbrance of some or all of our mortgage servicing rights. Although there can be no assurances, based on discussions with our financial partners, we believe that financing for our MSRs will be available on acceptable terms in the marketplace.
We acquired our financing platform from NattyMac in the third quarter of 2012, fully integrated the platform into our mortgage banking operations in December of 2012 and launched NattyMac’s warehouse financing operations during July 2013. The financing platform features a centralized custodian and disbursement agent located in our Clearwater, Florida facilities.

29


Through March 31, 2014, we financed our NattyMac operations through the use of cash on hand. On April 15, 2014, we entered into an agreement with Merchants Bancorp (an Indiana-based bank holding company and the parent company of Merchants Bank of Indiana), whereby we agreed to invest up to $25,000 in the subordinate debt of Merchants Bancorp. Merchants Bancorp in turn, agreed to form and fund a wholly-owned subsidiary named NattyMac Funding Inc. (“NMF”) that will invest in participation interests in warehouse lines of credit originated by NattyMac and in participation interests in residential mortgage loans originated by us. The amount of the subordinate debt funded by us will be sized to be greater than or equal to 10% of the assets of NMF. The subordinate debt provided to Merchants Bancorp will earn a return equal to one-month LIBOR, plus 350 basis points, plus additional interest that will be equal to 49% of the earnings of NMF. The subordinate debt investment in Merchants Bancorp, subsequent funding of NMF by Merchants Bank, and resulting purchase of WLOCs and residential mortgage participations by NMF is designed to provide liquidity to the Company for its WLOCs originated by NattyMac and additional liquidity for its residential mortgage originations.
At this time, we see no material negative trends that we believe would affect our access to long-term or short-term borrowings to maintain our current operations, or would likely cause us to cease to be in compliance with any applicable covenants in our indebtedness or that would inhibit our ability to fund operations and capital commitments for the next 12 months.
Our servicing agreements impose on us various rights and obligations that affect our liquidity. Among the most significant of these obligations is the requirement that we advance our own funds to meet contractual principal and interest payments for certain investors and to pay taxes, insurance, foreclosure costs and various other items that are required to preserve the assets being serviced. Delinquency rates and prepayment speed affect the size of servicing advance balances. These advances are typically recovered upon weekly or monthly reimbursements or from sale in the market.
Because our servicing portfolio is generally of recent vintages and also because the servicing portfolio is primarily comprised of FNMA and GNMA servicing (which are generally of higher quality), the amount of delinquency and therefore advances for our current portfolio, are expected to be low. As of March 31, 2014, our servicing advances were $3,290, or less than 0.1%, of the unpaid principal balance of the servicing portfolio. We finance these advances using cash on hand. We are not currently anticipating that the servicing advance asset will grow in the near future beyond our capacity of financing the asset using available cash. If the servicing advances become a sizable asset on our balance sheet, we will negotiate a servicing advance facility with one or more of our financial partners, which we believe to be readily available in the market.
We intend to continue to seek opportunities to acquire loan servicing portfolios and/or businesses that engage in loan servicing and/or loan originations. Future acquisitions could require substantial additional capital in excess of cash from operations. We would expect to finance the capital required for acquisitions through a combination of additional issuances of equity, corporate indebtedness, asset-backed acquisition financing and/or cash from operations.

Off-Balance Sheet Arrangements

As of March 31, 2014, we did not have any off-balance sheet arrangements.

Quantitative and Qualitative Disclosures about Market Risk
Market risk is defined as the sensitivity of income, fair value measurements and capital to changes in interest rates, foreign currency exchange rates, commodity prices and other relevant market rates or prices. The primary market risks that we are exposed to are interest rate risks and the price risk associated with changes in interest rates. Interest rate risk is defined as risk to current or anticipated earnings or capital arising from movements in interest rates. Price risk is defined as the risk to current or anticipated earnings or capital arising from changes in the value of either assets or liabilities that are entered into as part of distributing or managing risk.
Our interest rate risk and price risk arise from the financial instruments and positions we hold. This includes mortgage loans held for sale, mortgage servicing rights, and derivative financial instruments. Due to the nature of our operations, we are not subject to foreign currency exchange or commodity price risk.
Our interest rate risk and the price risk associated with changes in interest rates are managed by a group of executive managers which identifies and manages the sensitivity of earnings or capital to changing interest rates to achieve our overall financial objectives. The members of this group include the Chief Financial Officer, acting as the chair, the Chief Executive Officer and other members of management. The group meets monthly and is responsible for:

understanding the nature and level of the Company’s interest rate risk and interest rate sensitivity;
assessing how that risk fits within our overall business strategies; and

30


ensuring an appropriate level of rigor and sophistication in the risk management process for the overall level of risk.
Credit Risk
We have exposure to credit loss in the event of contractual non-performance by our trading counterparties and counterparties to the over-the-counter derivative financial instruments that we use in our rate risk management activities. We manage this credit risk by selecting only counterparties that we believe to be financially strong, spreading the credit risk among many such counterparties, by placing contractual limits on the amount of unsecured credit extended to any single counterparty and by entering into netting agreements with the counterparties, as appropriate. For additional information, refer to Note 5 “Derivative Financial Instruments” to the unaudited consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
We also have exposure to credit loss in the event of non-repayment of amounts funded to correspondent customers through our NattyMac financing facility. We manage this credit risk by performing due diligence and underwriting analysis on the correspondent customers prior to lending. Each counterparty is evaluated according to the underwriting guidelines as documented in the NattyMac Warehouse Underwriting Guidelines as required by the NattyMac Warehouse Credit Policy. In addition, the correspondent customers pledge, as security to the Company, the underlying mortgage loans. We periodically review the warehouse lending receivables for collectability based on historical collection trends and management judgment regarding the ability to collect specific accounts.
Interest Rate Risk
Our principal market exposure is to interest rate risk, specifically long-term Treasury, LIBOR, and mortgage interest rates due to their impact on mortgage-related assets and commitments. Additionally, our escrow earnings on our mortgage servicing rights are sensitive to changes in short-term interest rates such as LIBOR. We also are exposed to changes in short-term interest rates on certain variable rate borrowings, primarily our mortgage warehouse lines of credit. We anticipate that such interest rates will remain our primary benchmark for market risk for the foreseeable future.
Our business is subject to variability in results of operations in both the mortgage origination and mortgage servicing activities due to fluctuations in interest rates. In a declining interest rate environment, we would expect our mortgage production activities’ results of operations to be positively impacted by higher loan origination volumes and loan margins. In contrast, we would expect the results of operations of our mortgage servicing activities to decline due to higher actual and projected loan prepayments related to our loan servicing portfolio. In a rising interest rate environment, we would expect a negative impact on the results of operations of our mortgage production activities and our mortgage servicing activities’ results of operations to be positively impacted. The interaction between the results of operations of our mortgage activities is a core component of our overall interest rate risk strategy.
Although our mortgage funding arrangements (mortgage participation agreements and warehouse lines of credit) carry variable rates, the majority of those funding arrangements carry interest rates that are equal to the interest rates on the underlying mortgage loans. As of March 31, 2014, approximately $456,975, or 61%, of our total $745,909 in outstanding adjustable rate mortgage funding arrangements had interest rates that were equal to the underlying mortgage loans. The remaining 39% of the adjustable rate mortgage funding arrangements carried a weighted average interest rate of 2.57%, which was well below the weighted average interest rate on the related mortgage loans held for sale of 4.36% as of March 31, 2014. In addition, mortgage loans held for sale are carried on our balance sheet on average for only 20 to 25 days after closing and prior to transfer to FNMA, FHLMC or into pools of GNMA MBS. As a result, we believe that any negative impact related to our variable rate mortgage funding arrangements resulting from a shift in market interest rates would not be material to our consolidated financial statements as of or for the three months ended March 31, 2014.
Interest rate lock commitments represent an agreement to extend credit to a mortgage loan applicant, or an agreement to purchase a loan from a third-party originator, whereby the interest rate on the loan is set prior to funding. Our mortgage loans held for sale, which are held in inventory awaiting sale into the secondary market, and our interest rate lock commitments, are subject to changes in mortgage interest rates from the date of the commitment through the sale of the loan into the secondary market. As such, we are exposed to interest rate risk and related price risk during the period from the date of the lock commitment through (i) the lock commitment cancellation or expiration date; or (ii) the date of sale into the secondary mortgage market. Loan commitments generally range between 30 and 90 days; and our holding period of the mortgage loan from funding to sale is typically within 30 days.
The Company manages the interest rate risk associated with its outstanding interest rate lock commitments and loans held for sale by entering into derivative loan instruments such as forward loan sales commitments and mandatory delivery commitments. Management expects these derivatives will experience changes in fair value opposite to changes in fair value of the derivative loan commitments and loans held for sale, thereby reducing earnings volatility. The Company takes into account

31


various factors and strategies in determining the portion of the mortgage pipeline (derivative loan commitments) and mortgage loans held for sale it wants to economically hedge. Our expectation of how many of our interest rate lock commitments will ultimately close is a key factor in determining the notional amount of derivatives used in hedging the position.
Sensitivity Analysis
We have exposure to economic losses due to interest rate risk arising from changes in the level or volatility of market interest rates. We assess this risk based on changes in interest rates using a sensitivity analysis. The sensitivity analysis measures the potential impact on fair values based on hypothetical changes in interest rates.
We use financial models in determining the impact of interest rate shifts on our mortgage loan portfolio, MSR portfolio and pipeline derivatives (IRLC and forward MBS trades). A primary assumption used in these models is that an increase or decrease in the benchmark interest rate produces a parallel shift in the yield curve across all maturities.
We utilize a discounted cash flow analysis to determine the fair value of MSRs and the impact of parallel interest rate shifts on MSRs. The primary assumptions in this model are prepayment speeds, discount rates, costs of servicing and default rates. However, this analysis ignores the impact of interest rate changes on certain material variables, such as the benefit or detriment on the value of future loan originations, non-parallel shifts in the spread relationships between MBS, swaps and U.S. Treasury rates and changes in primary and secondary mortgage market spreads. For mortgage loans held for sale, IRLCs and forward delivery commitments on MBS, we rely on a model in determining the impact of interest rate shifts. In addition, for IRLCs, the borrowers’ likelihood to close their mortgage loans under the commitment is used as a primary assumption.
Our total market risk is influenced by a wide variety of factors including market volatility and the liquidity of the markets. There are certain limitations inherent in the sensitivity analysis presented, including the necessity to conduct the analysis based on a single point in time and the inability to include the complex market reactions that normally would arise from the market shifts modeled.
We used March 31, 2014 market rates on our instruments to perform the sensitivity analysis. The estimates are based on the market risk sensitivity portfolios described in the preceding paragraphs and assume instantaneous, parallel shifts in interest rate yield curves. Management uses sensitivity analysis, such as those summarized below, based on a hypothetical 25 basis point increase or decrease in interest rates, on a daily basis to monitor the risks associated with changes in interest rates to our mortgage loans pipeline (the combination of mortgage loans held for sale, IRLCs and forward MBS trades). We believe the use of a 25 basis point shift (50 basis point range) is appropriate given the relatively short time period that the mortgage loans pipeline is held on our balance sheet and exposed to interest rate risk (during the processing, underwriting and closing stages of the mortgage loans which generally last approximately 60 days). We also actively manage our risk management strategy for our mortgage loans pipeline (through the use of economic hedges such as forward loan sale commitments and mandatory delivery commitments) and generally adjust our hedging position daily. In analyzing the interest rate risks associated with our MSRs, management also uses multiple sensitivity analyses (hypothetical 25, 50 and 100 basis point increases and decreases) to review the interest rate risk associated with its MSRs, as the MSRs asset is generally more sensitive to interest rate movements over a longer period of time.
These sensitivities are hypothetical and presented for illustrative purposes only. Changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in fair value may not be linear.
 
The following table summarizes the unfavorable estimated change in our mortgage loans pipeline as of March 31, 2014, given hypothetical instantaneous parallel shifts in the yield curve:
 
 
Down 25 bps
 
Up 25 bps
Mortgage loans pipeline1   
$
(2,812
)
 
$
(798
)
1 Represents unallocated mortgage loans held for sale, IRLCs and forward MBS trades that are considered “at risk” for purposes of illustrating interest rate sensitivity. Mortgage loans held for sale, IRLCs and forward MBS trades are considered to be unallocated when we have not committed the underlying mortgage loans for sale to the applicable GSEs.
Mortgage Servicing Rights
We use a discounted cash flow approach to estimate the fair value of MSRs. This approach consists of projecting
servicing cash flows discounted at a rate that management believes market participants would use in the determination of value.
The key assumptions used in the estimation of the fair value of MSRs include prepayment speeds, discount rates, default rates,
cost to service, contractual servicing fees, escrow earnings and ancillary income. Our MSRs are subject to substantial interest
rate risk as the mortgage loans underlying the MSRs permit the borrowers to prepay the loans. Therefore, the value of MSRs

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generally tends to vary with interest rate movements and the resulting changes in prepayment speeds. Although the level of
interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices,
underwriting standards and product characteristics. Since our mortgage origination activities’ results of operations are also impacted by interest rate changes, our mortgage origination activities’ results of operations may fully or partially offset the
change in fair value of MSRs over time. For additional information about the assumptions used in determining the fair value of
our MSRs and a quantitative sensitivity analysis on our MSRs as of March 31, 2014, refer to Note 9, "Transfers and
Servicing of Financial Assets," to our consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
The following table summarizes the (unfavorable) favorable estimated change in our MSRs as of March 31, 2014, given hypothetical instantaneous parallel shifts in the yield curve:
 
 
Down 100 bps
 
Down 50 bps
 
Down 25 bps
 
Up 25 bps
 
Up 50 bps
 
Up 100 bps
MSRs
$
(51,100
)
 
$
(22,407
)
 
$
(10,318
)
 
$
9,050

 
$
17,005

 
$
30,376

Prepayment Risk
To the extent that the actual prepayment rate on the mortgage loans underlying our MSRs differs from what we projected when we initially recognized the MSRs and when we measured fair value as of the end of each reporting period, the carrying value of our investment in MSRs will be affected. In general, an increase in prepayment expectations will accelerate the amortization of our MSRs accounted for using the amortization method and decrease our estimates of the fair value of both the MSRs accounted for using the amortization method and those accounted for using the fair value method, thereby reducing net servicing income.
Inflation Risk
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors will influence our performance more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Furthermore, our consolidated financial statements are prepared in accordance with GAAP and our activities and balance sheet are measured with reference to historical cost and/or fair value without considering inflation.
Market Value Risk
Our mortgage loans held for sale and MSRs are reported at their estimated fair values. The fair value of these assets fluctuates primarily due to changes in interest rates.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For a detailed discussion of our market risks, see the “Quantitative and Qualitative Disclosures about Market Risk” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part I, Item 2 of this Form 10-Q.
ITEM  4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of March 31, 2014. The Company's Disclosure Review Committee is charged with reviewing the adequacy of the disclosure controls and procedures to ensure the accuracy, completeness and timeliness of the Company's financial and other information in its periodic reports. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, as of March 31, 2014, to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. No matter how well a control system is designed and operated, it can provide only reasonable, not absolute, assurance that it will detect or uncover control issues and instances of fraud, if any, within the Company to disclose material information otherwise required to be set forth in our periodic reports. There have not been any changes in our internal control (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
ITEM  1. LEGAL PROCEEDINGS
For information regarding legal proceedings at March 31, 2014, see the “Litigation” section of Note 14, “Commitments and Contingencies” to our unaudited consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors included in our 2013 Annual Report on Form 10-K.
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM  3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM  4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM  5. OTHER INFORMATION
    None.
ITEM  6. EXHIBITS
Exhibits: A list of exhibits required to be filed as part of this Form 10-Q is set forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated herein by reference.

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Stonegate Mortgage Corporation
 
Registrant
 
 
 
Date: May 15, 2014
By:
/S/  Robert B. Eastep
 
 
Robert B. Eastep
 
 
Chief Financial Officer
 
 
 
(Duly Authorized Officer, Principal Financial Officer and Principal Accounting Officer)
    


35


INDEX TO EXHIBITS
 
Exhibit
Number
Description
 
 
3.1
Third Amended and Restated Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to Stonegate Mortgage Corporation Amendment No. 1 to S-1 filed September 30, 2013 (File No. 333-191047))
 
 
3.2
Third Amended and Restated Code of Regulations of the Registrant (incorporated by reference to Exhibit 3.2 to Stonegate Mortgage Corporation S-1 filed September 6, 2013 (File No. 333-191047)
 
 
4.1
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Stonegate Mortgage Corporation Amendment No. 1 to S-1 filed September 30, 2013 (File No. 333-191047))
 
 
31.1*
Certification of the Company’s Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2*
Certification of the Company’s Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
32.1*
Certification of the Company’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
32.2*
Certification of the Company’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101.INS*
XBRL Instance Document
 
 
101.SCH*
XBRL Taxonomy Extension Schema Document
 
 
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
* Filed herewith
† Indicates management contract or compensation plan


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