S&P Downgrades PHH Corp. (PHH) to 'B'; Outlook Negative

Standard & Poor's Ratings Services said it lowered its long-term issuer credit rating on PHH Corp. (NYSE: PHH) to 'B' from 'B+'. The outlook is negative. We also lowered our rating on the firm's senior unsecured notes to 'B' from 'B+'. Our recovery rating on the company's senior unsecured notes is unchanged at '3', reflecting our expectation for meaningful (50% to 70%; at the lower end of the range) recovery in the event of payment default.

"The rating change reflects the deterioration in the firm's competitive position following the announcement that Merrill Lynch will take a portion of its loan production and all of its subservicing in-house," said Standard & Poor's credit analyst Richard Zell. PHH estimates this change would have represented 5% of the company's 2015 loan volume. Merrill Lynch's total loan volume accounted for approximately 26% of PHH's overall volume in 2015. Consequently, if Merrill Lynch decides to move its remaining production activities to its internal operations, PHH's earnings would deteriorate much
further.

Additionally, Merrill Lynch plans to insource its $40 billion of mortgage unpaid principal balance (UPB) that is currently subserviced by PHH for a fee. Merrill Lynch's UPB represents 32% of PHH's subservicing portfolio and 18% of PHH's total servicing portfolio as of Dec. 31, 2015.

Separately, the company also announced that Morgan Stanley, which represented 20% of PHH's 2015 origination volume, informed PHH that is was assessing its arrangement for its mortgage origination services when their contract expires in October 2017.

We believe these announcements further compound problems for PHH, which is already facing a rather difficult transition of its fundamental business model. PHH has struggled to be profitable since the sale of its fleet business and implementation of its re-engineering strategy that included negotiating private-label contracts, reducing expenses, and searching for acquisitions to improve scale.

In 2015, three of PHH's private-label clients generated 57% of the company's origination activity: Merrill Lynch (26%), Morgan Stanley (20%), and HSBC (11%). We believe that given current market dynamics, other clients could follow suit. Because of this loss in origination volume and servicing UPB from Merrill Lynch, we now assess the business risk of the firm as "vulnerable."

The negative outlook on PHH reflects Standard & Poor's view that strategic options the company is considering could weaken its credit profile. In addition, the uncertainty surrounding the company's fundamental business model supports the negative outlook.

We could lower the rating on PHH if the company loses further business relationships. We could also lower the rating if capital actions or operating losses result in substantially reduced liquidity or lower capital. Additionally, if debt to tangible equity increases to more than 3.0x, we may lower the rating.

Although less likely, we could raise our rating if the firm's capital actions result in a reduction in leverage, such that we project debt to EBITDA to be less than 4x on a sustained basis.

If PHH is able to right-size its business model and extend and amend its private-label services contracts to ensure greater volume certainty, we could revise the outlook to stable. We could also revise the outlook to stable if the company demonstrates that its financial policy will preserve the firm's current liquidity and capital position.

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