Fitch Ratings has affirmed PHH Corporation's (PHH) long-term Issuer Default Rating (IDR) and senior unsecured debt ratings at 'BB-' and the short-term IDR and commercial paper (CP) ratings at 'B'. The Rating Outlook remains Negative. Fitch has simultaneously withdrawn PHH's ratings for commercial reasons. A detailed list of rating actions follows at the end of this press release.
KEY RATING DRIVERS - IDRs and SENIOR DEBT
The affirmation of PHH's ratings follows the closing of the fleet leasing business during the third-quarter of 2014 (3Q'14), which generated net proceeds of $821 million, taking into account tax payments of approximately $500 million related to the sale. A portion of the proceeds from the sale were used to repay $420 million of PHH's outstanding senior unsecured notes while the remaining proceeds, along with a portion of cash on the balance sheet, are expected to be used to re-invest and re-engineer PHH's mortgage origination and servicing business, and return capital to shareholders, as part of PHH's previously announced strategic plan.
PHH's IDRs reflect its established position in the prime mortgage servicing industry and improved capitalization, leverage and liquidity levels following the sale of the fleet leasing business. The IDRs are constrained by the monoline nature of the business model and the focus on the mortgage servicing and origination industries, which are cyclical, low-margin businesses subject to increased regulatory scrutiny. The ratings of senior unsecured debt and CP are equalized with PHH's long-term and short-term IDRs, reflecting solid coverage of unencumbered balance sheet assets for all classes of debt.
The maintenance of the Negative Rating Outlook continues to reflect the uncertainty and execution risk associated with PHH's ambitious strategic plan, particularly in light of the inherently cyclical nature of the mortgage origination business and the capital-intensive nature and highly volatile GAAP earnings profile of the mortgage servicing business. Furthermore, the overall mortgage business remains subject to intense regulatory and legislative scrutiny, which could potentially be a drain on cash resources. Given the time it could take PHH to implement its business plans and observe meaningful results, Fitch expected that resolution of the Negative Outlook could be toward the outer end of the 12-24 month Outlook horizon. As such, Fitch is unable to resolve the Negative Outlook prior to the rating withdrawal.
GAAP earnings from continuing operations, which include fair market changes to mortgage servicing rights (MSRs) but exclude PHH's divested fleet operations, remain challenged due to current levels of gain-on-sale margins, subpar economics of PLS contracts and fair market changes in the MSR portfolio. PHH reported pretax losses of $129 million in 3Q'14 compared to losses of $101 million one-year prior. Fitch focuses on core earnings, which eliminate the impact of unrealized (noncash) fair value adjustments to MSRs, which better reflect PHH's ability to generate earnings. On this basis, PHH generated core pretax losses of $92 million in 3Q'14 compared to losses of $96 million, one-year prior.
Leverage, as measured by total debt to tangible equity, was 0.98x as of Sept. 30, 2014, compared to 3.66x one-year prior, reflecting the reduction in debt through the sale of the fleet leasing business as well as the accelerated debt reduction by PHH through the repayment of unsecured debt in 3Q'14. Fitch expects leverage will increase modestly over time due to higher origination volumes and announced share repurchases, but the funding needs of the standalone mortgage business are expected to remain consistent with the current ratings.
As of Sept. 30, 2014, PHH had $1.45 billion of unrestricted cash on hand, and $250 million of investment securities, for a total of $1.7 billion of unrestricted cash and cash equivalents. Fitch views PHH's liquidity as temporarily elevated, as the company has identified the following uses for its excess liquidity: up to $200 million for re-engineering the mortgage business; up to $150 million for growth initiatives; and $250 million for additional share buybacks. Taking into account these cash uses, PHH estimates that it will have $140 million of excess liquidity remaining above its estimated $875 million in key cash requirements. Overall, Fitch views PHH's liquidity profile as adequate.
RATING SENSITIVITIES - IDRS AND SENIOR DEBT
Inability to renegotiate existing private label contracts at more favorable economic terms, loss of clients, weakening in PHH's competitive position, and/or sustained operating losses would be viewed negatively. In addition, a sustained increase in leverage, reduction in liquidity due to higher than expected operational and contingency needs, or higher than planned share repurchases would also be viewed negatively.
Successful execution of management's strategic objectives as measured by strengthened competitive position, successful client contract negotiations, and sustained increased in earnings and cash flows, while maintaining appropriate capital and liquidity levels would be viewed positively.
Fitch affirms and withdraws the following ratings:
PHH Corporation
--Long-term IDR at 'BB-';
--Short-term IDR at 'B';
--Senior unsecured debt at 'BB-';
--Commercial paper at 'B'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=963375
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