S&P Cuts PHH Corp. (PHH) to 'B+'; Cites Review Following Sale of PHH Arval

Standard & Poor's Ratings Services today said it lowered its counterparty and senior unsecured ratings on PHH Corp. (NYSE: PHH) to 'B+' from 'BB-'. We also removed the ratings from CreditWatch with negative implications where we had placed them on June 3, 2014. The outlook is stable.

"The downgrade of Mount Laurel, N.J.-based residential mortgage servicer and originator PHH Corp. follows the firm's July 7 sale of its fleet management services business, PHH Arval, to Element Financial Corp. (Element) for $1.4 billion in a cash-for-stock transaction," said Standard & Poor's credit analyst Jeffrey Zaun. This transaction will be treated as an asset sale for tax purposes. Net proceeds from the transaction were $821 million after payment of expected taxes and transaction expenses, and management will use these proceeds to pay down debt due in 2016, provide for ongoing liquidity needs, make investments (including possible acquisitions) in its mortgage business, and repurchase up to $450 million of its equity shares over the next 12 to 18 months.

Although we believe the proceeds from this sale will bolster PHH's financial position in the near term, we also believe that without the steady income from its fleet leasing business, the mortgage business will be more vulnerable to market volatility and will encounter greater difficulty funding its volatile mortgage servicing rights assets.

Over the past year, PHH suffered as housing markets deteriorated and origination volumes, especially refinancings, declined when interest rates rose. As a result, we expect earnings will be under pressure, and that the company may experience losses through the first half of 2015. At the same time, regulatory changes and new capital requirements could cause banks to pull back from mortgage lending and servicing, which would likely improve PHH's strategic position. Increased scrutiny over consumer protections should increase barriers to entry for new competitors and may drive more banks and nonbank financial institutions to consider outsourcing their mortgage origination and servicing.

As the largest provider of private label mortgage production and servicing, PHH has a strong strategic position. Over the past two years, however, management has been unable to pass along the increased compliance costs of originating and servicing mortgage loans, pressuring PHH's margins. Management has announced that they will re-engineer the company's private label services business. We will monitor the firm's progress on re-negotiating its contracts and retaining its longer-term customers. We will also monitor management's plans to invest in its retail servicing platform. The ratings on PHH will remain limited by uncertainty surrounding the longer-term (two to five year) structure of the mortgage origination and servicing industry and management's need to maintain a stable funding platform for its volatile mortgage servicing assets and interest-rate sensitive mortgage origination platform.

The stable outlook incorporates our expectation that PHH's earnings will remain negative through 2014 and into 2015 as the firm completes its re-engineering as a stand-alone mortgage company. We also consider management's commitment to deleveraging as a positive rating factor. Management's commitment includes maintaining the ratio of unencumbered assets to unsecured debt above 3.0x.

We could downgrade PHH if losses place pressure on the firm's ability to retire its 2017 debt obligation, or if we believe the firm's ratio of debt to EBITDA will remain above 4.0x through 2015. We could upgrade PHH if the firm is able to reduce its leverage, measured as debt to EBITDA, below 3x on a sustainable basis and if earnings improve and stabilize with a return on average assets above 2.0%.

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