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

October 7, 2016 6:42 AM EDT

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S&P Global Ratings said today it lowered its issuer credit ratings on PHH Corp. (NYSE: PHH) to 'B-' from 'B'. The outlook remains 'negative'.

At the same time, we are affirming the rating on the senior unsecured notes at 'B' reflecting increased recovery expectations of '2' indicating our expectation for 'substantial' recovery (70%-90% lower end of the range) in a default scenario, from '3'. The short-term issuer rating was affirmed at 'B' and withdrawn at the issuer's request.

"The downgrade reflects the loss of business volumes and earnings prospects following the announcement that Bank of America will terminate their Private Label origination relationship with PHH," said S&P Global Ratings credit analyst Diogenes Mejia. This follows the announcement during August 2016 that HSBC had sold a significant portion of their owned mortgage servicing rights to a purchaser who did not intend to retain PHH as sub-servicer. Moreover, in April 2016, Merrill Lynch, a subsidiary of Bank of America, announced their intention to not renew its subservicing contract with PHH upon its expiration on December 31, 2016.

We believe these announcements further compound problems for PHH which is already facing a rather difficult transition due to its suboptimal scale in a high fixed cost fundamental business model. 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 expect the combined impact to subservicing from the HSBC and Bank of America actions will be a decline of approximately 47% of total subservicing units compared to June 30, 2016. We expect the losses in origination volume and sub-servicing units to be sufficient to increase leverage due to lower cash flow generation.

We acknowledge that the company continues to have a strong liquidity position anchored by their cash balance of approximately $1 billion. PHH should also be able to cover short-term obligations, including interest payments, with operating cash flows. PHH also has enough cash on hand to cover contingencies related to mortgage loan repurchases, legal and regulatory matters, and working capital. We expect that PHH's liquidity sources will exceed uses by more than 1.5x during the next 24 months, and we expect no significant capital expenditures, debt maturities, or acquisitions. Additionally, our projections indicate that, even if EBITDA were to decline by 30%, sources of cash would exceed uses while still allowing PHH to remain operational and cover its short-term obligations.

The negative outlook on PHH reflects Standard & Poor's view of the uncertainty surrounding the company's fundamental business model.

We could lower the rating in the next 12 months if capital actions or operating losses result in substantially reduced liquidity or lower capital without a reduction in debt.

If PHH is able to right-size its business model, we could revise the outlook to stable in the next 12 months. We could also revise the outlook to stable if the company demonstrates that it will preserve the firm's current liquidity and capital position.

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