PHH CORP (PHH)

other fee-based services for our clients’ vehicle fleets, which include vehicle maintenance service cards, fuel cards and accident management services.

 

On March 15, 2007, we entered into a definitive agreement (the “Merger Agreement”) with General Electric Capital Corporation (“GE”) and its wholly owned subsidiary, Jade Merger Sub, Inc. to be acquired (the “Merger”). In conjunction with the Merger Agreement, GE entered into an agreement (the “Mortgage Sale Agreement”) to sell our mortgage operations (the “Mortgage Sale”) to Pearl Mortgage Acquisition 2 L.L.C. (“Pearl Acquisition”), an affiliate of The Blackstone Group, a global investment and advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE pursuant to the Merger Agreement because the Merger was not completed by December 31, 2007. On January 2, 2008, we received a notice of termination from Pearl Acquisition pursuant to the Mortgage Sale Agreement and on January 4, 2008, a settlement agreement (the “Settlement Agreement”) between us, Pearl Acquisition and Blackstone Capital Partners V L.P. (“BCP V”) was executed. Pursuant to the Settlement Agreement, BCP V paid us a reverse termination fee of $50 million, which is included in Other income in the accompanying Consolidated Statement of Operations for 2008, and we paid BCP V $4.5 million for the reimbursement of certain fees for third-party consulting services incurred by BCP V and Pearl Acquisition in connection with the transactions contemplated by the Merger Agreement and the Mortgage Sale Agreement upon our receipt of invoices reflecting such fees from BCP V. As part of the Settlement Agreement, we received the work product that those consultants provided to BCP V and Pearl Acquisition.

 

 

We are a leading outsource provider of mortgage and fleet
management services. We conduct our business through three
operating segments: a Mortgage Production segment, a Mortgage
Servicing segment and a Fleet Management Services segment.

 

Our Mortgage Production segment originates, purchases and sells
mortgage loans through PHH Mortgage Corporation and its
subsidiaries (collectively, “PHH Mortgage”), which
includes PHH Home Loans and STARS. PHH Home Loans is a mortgage
venture that we maintain with Realogy that began operations in
October 2005. We own 50.1% of PHH Home Loans through our wholly
owned subsidiary, PHH Broker Partner Corporation (“PHH
Broker Partner”), and Realogy owns the remaining 49.9%
through its wholly owned subsidiary, Realogy Services Venture
Partner, Inc. (“Realogy Venture Partner”). PHH
Mortgage, STARS and PHH Home Loans conduct business throughout
the U.S. Our Mortgage Production segment focuses on
providing private-label mortgage services to financial
institutions and real estate brokers.

 

Our Mortgage Servicing segment services mortgage loans that
either PHH Mortgage or PHH Home Loans originated. Our Mortgage
Servicing segment also purchases MSRs and acts as a subservicer
for certain clients that own the underlying MSRs. Mortgage loan
servicing consists of collecting loan payments, remitting
principal and interest payments to investors, managing escrow
funds for the payment of mortgage-related expenses, such as
taxes and insurance, and otherwise administering our mortgage
loan servicing portfolio. Our Mortgage Servicing segment also
includes our mortgage reinsurance business, Atrium Insurance
Corporation (“Atrium”), a wholly owned subsidiary and
New York domiciled monoline mortgage guaranty insurance company.

 

Our Fleet Management Services segment provides commercial fleet
management services to corporate clients and government agencies
throughout the U.S. and Canada through our wholly owned
subsidiary, PHH Vehicle Management Services Group LLC (“PHH
Arval”). PHH Arval is a fully integrated provider of fleet
management services with a broad range of product offerings.
These services include management and leasing of vehicles and

other fee-based services for our clients’ vehicle fleets,
which include vehicle maintenance service cards, fuel cards and
accident management services.

 

On March 15, 2007, we entered into a definitive agreement
(the “Merger Agreement”) with General Electric Capital
Corporation (“GE”) and its wholly owned subsidiary,
Jade Merger Sub, Inc. to be acquired (the “Merger”).
In conjunction with the Merger Agreement, GE entered into an
agreement (the “Mortgage Sale Agreement”) to sell our
mortgage operations (the “Mortgage Sale”) to Pearl
Mortgage Acquisition 2 L.L.C. (“Pearl Acquisition”),
an affiliate of The Blackstone Group, a global investment and
advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE
pursuant to the Merger Agreement because the Merger was not
completed by December 31, 2007. On January 2, 2008, we
received a notice of termination from Pearl Acquisition pursuant
to the Mortgage Sale Agreement and on January 4, 2008, a
settlement agreement (the “Settlement Agreement”)
between us, Pearl Acquisition and Blackstone Capital Partners V
L.P. (“BCP V”) was executed. Pursuant to the
Settlement Agreement, BCP V paid us a reverse termination fee of
$50 million, which is included in Other income in the
accompanying Consolidated Statement of Operations for 2008, and
we paid BCP V $4.5 million for the reimbursement of certain
fees for third-party consulting services incurred by BCP V and
Pearl Acquisition in connection with the transactions
contemplated by the Merger Agreement and the Mortgage Sale
Agreement upon our receipt of invoices reflecting such fees from
BCP V. As part of the Settlement Agreement, we received the work
product that those consultants provided to BCP V and Pearl
Acquisition.

 

 

We are a leading outsource provider of mortgage and fleet management services. We conduct our business through three operating segments: a Mortgage Production segment, a Mortgage Servicing segment and a Fleet Management Services segment. Our Mortgage Production segment originates, purchases and sells mortgage loans through PHH Mortgage which includes PHH Home Loans. PHH Home Loans is a mortgage venture that we maintain with Realogy that began operations in October 2005. We, through our subsidiary, PHH Broker Partner, own 50.1% of PHH Home Loans and Realogy owns the remaining 49.9% through its subsidiary, Realogy Venture Partner. PHH Home Loans is consolidated within our Consolidated Financial Statements, and Realogy’s ownership interest is presented as a minority interest. Our Mortgage Production segment generated 22%, 9% and 14% of our Net revenues for the years ended December 31, 2008, 2007 and 2006, respectively. Our Mortgage Servicing segment services mortgage loans that either PHH Mortgage or PHH Home Loans originated. Our Mortgage Servicing segment also purchases MSRs and acts as a subservicer for certain clients that own the underlying MSRs. As a result of our net loss on MSRs risk management activities our Mortgage Servicing segment generated negative Net revenues for the year ended December 31, 2008. Our Mortgage Servicing segment generated 8% and 6% of our Net revenues for the years ended December 31, 2007 and 2006, respectively. Our Fleet Management Services segment provides commercial fleet management services to corporate clients and government agencies throughout the U.S. and Canada through PHH Arval. Our Fleet Management Services segment generated 89%, 83% and 80% of our Net revenues for the years ended December 31, 2008, 2007 and 2006, respectively. During the year ended December 31, 2008, 2% of our Net revenues were generated from the terminated Merger Agreement (as defined and further discussed below) which were not allocated to our reportable segments.

 

On March 15, 2007, we entered into the Merger Agreement with GE and its wholly owned subsidiary, Jade Merger Sub, Inc. to be acquired (as previously defined, the “Merger”). In conjunction with the Merger Agreement, GE entered into the Mortgage Sale Agreement to sell our mortgage operations to Pearl Acquisition, an affiliate of Blackstone, a global investment and advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE pursuant to the Merger Agreement because the Merger was not completed by December 31, 2007. On January 2, 2008, we received a notice of termination from Pearl Acquisition pursuant to the Mortgage Sale Agreement and on January 4, 2008, the Settlement Agreement between us, Pearl Acquisition and BCP V was executed. Pursuant to the Settlement Agreement, BCP V paid us a reverse termination fee of $50 million, which is included in Other income in the accompanying Consolidated Statement of Operations for 2008, and we paid BCP V $4.5 million for the reimbursement of certain fees for third-party consulting services incurred by BCP V and Pearl Acquisition in connection with the transactions contemplated by the Merger Agreement and the Mortgage Sale Agreement upon our receipt of invoices reflecting such fees from BCP V. As part of the Settlement Agreement, we received the work product that those consultants provided to BCP V and Pearl Acquisition.

 

Mortgage Production and Mortgage Servicing Segments

 

 

We are a leading outsource provider of mortgage and fleet
management services. We conduct our business through three
operating segments: a Mortgage Production segment, a Mortgage
Servicing segment and a Fleet Management Services segment. Our
Mortgage Production segment originates, purchases and sells
mortgage loans through PHH Mortgage which includes PHH Home
Loans. PHH Home Loans is a mortgage venture that we maintain
with Realogy that began operations in October 2005. We, through
our subsidiary, PHH Broker Partner, own 50.1% of PHH Home Loans
and Realogy owns the remaining 49.9% through its subsidiary,
Realogy Venture Partner. PHH Home Loans is consolidated within
our Consolidated Financial Statements, and Realogy’s
ownership interest is presented as a minority interest. Our
Mortgage Production segment generated 22%, 9% and 14% of our Net
revenues for the years ended December 31, 2008, 2007 and
2006, respectively. Our Mortgage Servicing segment services
mortgage loans that either PHH Mortgage or PHH Home Loans
originated. Our Mortgage Servicing segment also purchases MSRs
and acts as a subservicer for certain clients that own the
underlying MSRs. As a result of our net loss on MSRs risk
management activities our Mortgage Servicing segment generated
negative Net revenues for the year ended December 31, 2008.
Our Mortgage Servicing segment generated 8% and 6% of our Net
revenues for the years ended December 31, 2007 and 2006,
respectively. Our Fleet Management Services segment provides
commercial fleet management services to corporate clients and
government agencies throughout the U.S. and Canada through
PHH Arval. Our Fleet Management Services segment generated 89%,
83% and 80% of our Net revenues for the years ended
December 31, 2008, 2007 and 2006, respectively. During the
year ended December 31, 2008, 2% of our Net revenues were
generated from the terminated Merger Agreement (as defined and
further discussed below) which were not allocated to our
reportable segments.

 

On March 15, 2007, we entered into the Merger Agreement
with GE and its wholly owned subsidiary, Jade Merger Sub, Inc.
to be acquired (as previously defined, the “Merger”).
In conjunction with the Merger Agreement, GE entered into the
Mortgage Sale Agreement to sell our mortgage operations to Pearl
Acquisition, an affiliate of Blackstone, a global investment and
advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE
pursuant to the Merger Agreement because the Merger was not
completed by December 31, 2007. On January 2, 2008, we
received a notice of termination from Pearl Acquisition pursuant
to the Mortgage Sale Agreement and on January 4, 2008, the
Settlement Agreement between us, Pearl Acquisition and BCP V was
executed. Pursuant to the Settlement Agreement, BCP V paid us a
reverse termination fee of $50 million, which is included
in Other income in the accompanying Consolidated Statement of
Operations for 2008, and we paid BCP V $4.5 million for the
reimbursement of certain fees for third-party consulting
services incurred by BCP V and Pearl Acquisition in connection
with the transactions contemplated by the Merger Agreement and
the Mortgage Sale Agreement upon our receipt of invoices
reflecting such fees from BCP V. As part of the Settlement
Agreement, we received the work product that those consultants
provided to BCP V and Pearl Acquisition.

 

Mortgage
Production and Mortgage Servicing Segments

 

independent sales associates of any Realogy Franchisee acting in such capacity), (ii) all customers of the Realogy Entities (excluding Realogy Franchisees or any employee or independent sales associate thereof acting in such capacity) and (iii) all U.S.-based employees of Cendant. See “Item 1. Business—Arrangements with Realogy—Mortgage Venture Between Realogy and PHH” and “— Strategic Relationship Agreement” for a description of the terms of the Mortgage Venture Operating Agreement and the Strategic Relationship Agreement.

 

The Mortgage Venture is consolidated within our financial statements, and Realogy’s ownership interest is presented in our financial statements as a minority interest. (See Note 1, “Summary of Significant Accounting Policies—Basis of Presentation” and Note 3, “Spin-Off from Cendant” in the Notes to Consolidated Financial Statements included in this Form 10-K.) Subject to certain regulatory and financial covenant requirements, net income generated by the Mortgage Venture is distributed quarterly to its members pro rata based upon their respective ownership interests. The Mortgage Venture may also require additional capital contributions from us and Realogy under the terms of the Mortgage Venture Operating Agreement if it is required to meet minimum regulatory capital and reserve requirements imposed by any governmental authority or any creditor of the Mortgage Venture or its subsidiaries.

 

During 2005, prior to and as part of the Spin-Off, Cendant made a cash contribution to us of $100 million and we distributed assets net of liabilities of $593 million to Cendant. Such amount included the historical cost of the net assets of our former relocation and fuel card businesses, certain other assets and liabilities per the Spin-Off Agreements and the net amount of forgiveness of certain payables and receivables, including income taxes, between us, our former relocation and fuel card businesses and Cendant.

 

Because our business has changed substantially due to the internal reorganization in connection with the Spin-Off, and we now conduct our business as an independent, publicly traded company, our historical financial information does not reflect what our results of operations, financial position or cash flows would have been had we been an independent, publicly traded company during all of the periods presented. For this reason, as well as the inherent uncertainties of our business, the historical financial information for such periods is not indicative of what our results of operations, financial position or cash flows will be in the future.

 

During 2006, we devoted substantial internal and external resources to the completion of our Annual Report on Form 10-K for the year ended December 31, 2005 (the “2005 Form 10-K”) and related matters. As a result of these efforts, along with efforts to complete our assessment of internal control over financial reporting as of December 31, 2005, as required by Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”), we incurred incremental fees and expenses for additional auditor services, financial and other consulting services, legal services and liquidity waivers of approximately $44 million through December 31, 2006. Of this $44 million, we recorded $32 million and $12 million in Other operating expenses in the Consolidated Statements of Operations for the years ended December 31, 2006 and 2005, respectively. During 2007, we continued to incur fees and expenses for auditor services and financial and other consulting services that were significantly higher than historical fees and expenses to complete our Annual Report on Form 10-K for the year ended December 31, 2006, along with efforts to complete our assessment of internal control over financial reporting as of December 31, 2006, as required by SOX. Additionally, we devoted substantial internal and external resources to become a current filer with the SEC and to remediate the material weaknesses previously identified through our assessment of internal control over financial reporting as of December 31, 2006 and 2005.

 

On March 15, 2007, we entered into the Merger Agreement with GE and its wholly owned subsidiary, Jade Merger Sub, Inc. to be acquired (as previously defined, the “Merger”). In conjunction with the Merger, GE entered into the Mortgage Sale Agreement to sell our mortgage operations to Pearl Acquisition, an affiliate of Blackstone, a global investment and advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE pursuant to the Merger Agreement because the Merger was not completed by December 31, 2007. On January 2, 2008, we received a notice of termination from Pearl Acquisition pursuant to the Mortgage Sale Agreement and on January 4, 2008, the Settlement Agreement between us, Pearl Acquisition and BCP V was executed. Pursuant to the Settlement Agreement, BCP V paid us a reverse termination fee of $50 million and we agreed to pay BCP V up to $4.5 million for the reimbursement of certain fees for third-party consulting services incurred by BCP V and Pearl Acquisition in connection with the transactions contemplated by the Merger Agreement and the Mortgage Sale Agreement upon our receipt of invoices

reflecting such fees from BCP V. As part of the Settlement Agreement, we are entitled to receive the work product that those consultants provided to BCP V and Pearl Acquisition. As of the filing date of this Form 10-K, we paid BCP V $4.5 million and received the work product. See Note 2, “Terminated Merger” in the Notes to Consolidated Financial Statements included in this Form 10-K for more information.

 

Mortgage Production and Mortgage Servicing Segments

 

 

We are a leading outsource provider of mortgage and fleet
management services. We conduct our business through three
operating segments: a Mortgage Production segment, a Mortgage
Servicing segment and a Fleet Management Services segment. Our
Mortgage Production segment originates, purchases and sells
mortgage loans through PHH Mortgage which includes PHH Home
Loans. PHH Home Loans is a mortgage venture that we maintain
with Realogy that began operations in October 2005. Our Mortgage
Production segment generated 9%, 14% and 21% of our Net revenues
for the years ended December 31, 2007, 2006 and 2005,
respectively. Our Mortgage Servicing segment services mortgage
loans that either PHH Mortgage or PHH Home Loans originated. Our
Mortgage Servicing segment also purchases MSRs and acts as a
subservicer for certain clients that own the underlying MSRs.
Our Mortgage Servicing segment generated 8%, 6% and 10% of our
Net revenues for the years ended December 31, 2007, 2006
and 2005, respectively. Our Fleet Management Services segment
provides commercial fleet management services to corporate
clients and government agencies throughout the U.S. and
Canada through PHH Arval. Our Fleet Management Services segment
generated 83%, 80% and 69% of our Net revenues for the years
ended December 31, 2007, 2006 and 2005, respectively.

 

For all periods presented in this
Form 10-K
prior to February 1, 2005, we were a wholly owned
subsidiary of Cendant that provided homeowners with mortgages,
serviced mortgage loans, facilitated employee relocations and
provided vehicle fleet management and fuel card services to
commercial clients. During 2006, Cendant changed its name to
Avis Budget Group, Inc.; however, within this
Form 10-K,
our former parent company, now known as Avis Budget Group, Inc.
(NYSE: CAR) is referred to as “Cendant.” On
February 1, 2005, we began operating as an independent,
publicly traded company pursuant to the Spin-Off from Cendant.
See “Item 1. Business” for a discussion of the
Spin-Off.

 

In connection with the Spin-Off, we entered into several
agreements and arrangements with Cendant and its real estate
services division, Realogy, that we expect to continue to be
material to our business going forward. Cendant completed the
Realogy Spin-Off effective July 31, 2006. On April 10,
2007, Realogy became a wholly owned subsidiary of Domus Holdings
Corp., an affiliate of Apollo Management VI, L.P., following the
completion of a merger and related transactions. For a
discussion of these agreements and arrangements, see
“Item 1. Business—Arrangements with Cendant”
and “— Arrangements with Realogy.”

 

We, through our subsidiary, PHH Broker Partner, and Realogy,
through its subsidiary, Realogy Venture Partner, formed the
Mortgage Venture. We own 50.1% of the Mortgage Venture through
PHH Broker Partner and Realogy owns the remaining 49.9% through
Realogy Venture Partner. The Mortgage Venture originates and
sells mortgage loans primarily sourced through Realogy’s
owned real estate brokerage business, NRT and its owned
relocation business, Cartus. All mortgage loans originated by
the Mortgage Venture are sold to PHH Mortgage or unaffiliated
third-party investors on a servicing-released basis. The
Mortgage Venture does not hold any mortgage loans for investment
purposes or retain MSRs for any loans it originates.

 

The Mortgage Venture commenced operations, and we contributed
assets and transferred employees that have historically
supported originations from NRT and Cartus to the Mortgage
Venture in October 2005. The Mortgage Venture is principally
governed by the terms of the Mortgage Venture Operating
Agreement and the Strategic Relationship Agreement. The Mortgage
Venture Operating Agreement has a
50-year
term, subject to earlier termination, under certain
circumstances, including after the twelfth year, following a
two-year notice, or non-renewal by us after 25 years
subject to delivery of notice between January 31, 2027 and
January 31, 2028. In the event that we do not deliver a
non-renewal notice after the 25th year, the Mortgage
Venture Operating Agreement will be renewed for an additional
25-year
term. The provisions of the Strategic Relationship Agreement
govern the manner in which the Mortgage Venture is recommended
by NRT, Cartus and TRG as the exclusive recommended provider of
mortgage loans to (i) the independent sales associates
affiliated with the Realogy Entities (excluding the

independent sales associates of any Realogy Franchisee acting in
such capacity), (ii) all customers of the Realogy Entities
(excluding Realogy Franchisees or any employee or independent
sales associate thereof acting in such capacity) and
(iii) all
U.S.-based
employees of Cendant. See “Item 1.
Business—Arrangements with Realogy—Mortgage Venture
Between Realogy and PHH” and “— Strategic
Relationship Agreement” for a description of the terms of
the Mortgage Venture Operating Agreement and the Strategic
Relationship Agreement.

 

The Mortgage Venture is consolidated within our financial
statements, and Realogy’s ownership interest is presented
in our financial statements as a minority interest. (See
Note 1, “Summary of Significant Accounting
Policies—Basis of Presentation” and Note 3,
“Spin-Off from Cendant” in the Notes to Consolidated
Financial Statements included in this
Form 10-K.)
Subject to certain regulatory and financial covenant
requirements, net income generated by the Mortgage Venture is
distributed quarterly to its members pro rata based upon their
respective ownership interests. The Mortgage Venture may also
require additional capital contributions from us and Realogy
under the terms of the Mortgage Venture Operating Agreement if
it is required to meet minimum regulatory capital and reserve
requirements imposed by any governmental authority or any
creditor of the Mortgage Venture or its subsidiaries.

 

During 2005, prior to and as part of the Spin-Off, Cendant made
a cash contribution to us of $100 million and we
distributed assets net of liabilities of $593 million to
Cendant. Such amount included the historical cost of the net
assets of our former relocation and fuel card businesses,
certain other assets and liabilities per the Spin-Off Agreements
and the net amount of forgiveness of certain payables and
receivables, including income taxes, between us, our former
relocation and fuel card businesses and Cendant.

 

Because our business has changed substantially due to the
internal reorganization in connection with the Spin-Off, and we
now conduct our business as an independent, publicly traded
company, our historical financial information does not reflect
what our results of operations, financial position or cash flows
would have been had we been an independent, publicly traded
company during all of the periods presented. For this reason, as
well as the inherent uncertainties of our business, the
historical financial information for such periods is not
indicative of what our results of operations, financial position
or cash flows will be in the future.

 

During 2006, we devoted substantial internal and external
resources to the completion of our Annual Report on
Form 10-K
for the year ended December 31, 2005 (the “2005
Form 10-K”)
and related matters. As a result of these efforts, along with
efforts to complete our assessment of internal control over
financial reporting as of December 31, 2005, as required by
Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”),
we incurred incremental fees and expenses for additional auditor
services, financial and other consulting services, legal
services and liquidity waivers of approximately $44 million
through December 31, 2006. Of this $44 million, we
recorded $32 million and $12 million in Other
operating expenses in the Consolidated Statements of Operations
for the years ended December 31, 2006 and 2005,
respectively. During 2007, we continued to incur fees and
expenses for auditor services and financial and other consulting
services that were significantly higher than historical fees and
expenses to complete our Annual Report on
Form 10-K
for the year ended December 31, 2006, along with efforts to
complete our assessment of internal control over financial
reporting as of December 31, 2006, as required by SOX.
Additionally, we devoted substantial internal and external
resources to become a current filer with the SEC and to
remediate the material weaknesses previously identified through
our assessment of internal control over financial reporting as
of December 31, 2006 and 2005.

 

On March 15, 2007, we entered into the Merger Agreement
with GE and its wholly owned subsidiary, Jade Merger Sub, Inc.
to be acquired (as previously defined, the “Merger”).
In conjunction with the Merger, GE entered into the Mortgage
Sale Agreement to sell our mortgage operations to Pearl
Acquisition, an affiliate of Blackstone, a global investment and
advisory firm.

 

On January 1, 2008, we gave a notice of termination to GE
pursuant to the Merger Agreement because the Merger was not
completed by December 31, 2007. On January 2, 2008, we
received a notice of termination from Pearl Acquisition pursuant
to the Mortgage Sale Agreement and on January 4, 2008, the
Settlement Agreement between us, Pearl Acquisition and BCP V was
executed. Pursuant to the Settlement Agreement, BCP V paid us a
reverse termination fee of $50 million and we agreed to pay
BCP V up to $4.5 million for the reimbursement of certain
fees for third-party consulting services incurred by BCP V and
Pearl Acquisition in connection with the transactions
contemplated by the Merger Agreement and the Mortgage Sale
Agreement upon our receipt of invoices

reflecting such fees from BCP V. As part of the Settlement
Agreement, we are entitled to receive the work product that
those consultants provided to BCP V and Pearl Acquisition. As of
the filing date of this
Form 10-K,
we paid BCP V $4.5 million and received the work
product. See Note 2, “Terminated Merger” in the
Notes to Consolidated Financial Statements included in this
Form 10-K
for more information.

 

Mortgage
Production and Mortgage Servicing Segments

 

during 2006 were $2.8 trillion and forecasted a decline in industry originations during 2007 of approximately 9% from estimated 2006 levels, due to a 12% expected decline in purchase originations and a 5% expected decline in refinance originations.

 

Volatility in interest rates may have a significant impact on our Mortgage Production and Mortgage Servicing segments, including a negative impact on origination volumes and the value of our MSRs and related hedges. Volatility in interest rates may also result in changes in the shape or slope of the yield curve, which is a key factor in our MSR valuation model and the effectiveness of our hedging strategy. Furthermore, recent developments in the industry have resulted in more restrictive credit standards that may negatively impact home affordability and the demand for housing and related origination volumes for the mortgage industry. Many subprime origination companies have entered bankruptcy proceedings, shut down or severely curtailed their lending activities. Industry-wide mortgage loan delinquency rates have increased and may continue to increase over last year’s levels. With more restrictive credit standards, borrowers, particularly subprime borrowers, are less able to purchase a home. We expect that refinance activity over the next several quarters will be bolstered by the volume of adjustable-rate mortgages originated over the last five years nearing their interest-rate-reset dates creating an incentive for borrowers to refinance. However, based on home sale trends during the first six months of 2007, we expect that home sale volumes and purchase originations will decrease or remain flat during the remainder of 2007 and perhaps longer. (See “Item 1A. Risk Factors—Risks Related to our Business—Downward trends in the real estate market could adversely impact our business, profitability or results of operations.” in our 2006 Form 10-K for more information.)

 

The secondary mortgage market has been adversely impacted during the second quarter of 2007 and through the filing date of this Form 10-Q by deteriorating investor demand for mortgage loan products, particularly with regard to subprime, Alt-A and non-conforming products, as investors are tightening credit standards and offering less favorable pricing. The continued deterioration of the secondary mortgage market in such products and the expansion of this impact to more traditional prime loan products could have a negative impact on profit margins for the mortgage industry in the second half of 2007. While we adjust interest rates for new mortgage loan originations to reflect the current secondary market conditions and provide appropriate profit margins, we expect that the recent market developments will negatively impact Gain on sale of mortgage loans, net in the third quarter of 2007 and may continue to have a negative impact during the fourth quarter of 2007 and perhaps longer. In addition, increases in interest rates for new mortgage loan originations required as a result of these secondary mortgage market conditions may reduce the demand for mortgage loan originations, which could further impact profitability in our Mortgage Production segment. (See “Item 1A. Risk Factors—Risks Related to our Business—Recent developments in the subprime mortgage market may negatively affect the mortgage loan origination volumes and profitability of mortgage loan products that we offer in our Mortgage Production segment.” in our 2006 Form 10-K for more information.)

 

As a result of these factors, we expect that the mortgage industry will remain increasingly competitive throughout the remainder of 2007 as excess origination capacity and lower origination volumes put pressure on production margins and ultimately result in further industry consolidation. We intend to take advantage of this environment by leveraging our existing mortgage origination services platform to enter into new outsourcing relationships as more companies determine that it is no longer economically feasible to compete in the industry, however, there can be no assurance that we will be successful in this effort whether as a result of uncertainties regarding the proposed Merger or otherwise. During the year ended December 31, 2006 and the six months ended June 30, 2007, we sought to reduce costs in our Mortgage Production and Mortgage Servicing segments to better align our resources and expenses with anticipated mortgage origination volumes. These cost-reduction initiatives favorably impacted our pre-tax results for the second quarter of 2007 and the six months ended June 30, 2007 by $11 million and $19 million, respectively, and we expect that they will favorably impact our pre-tax results for the remainder of 2007 by approximately $21 million.

 

Fleet Market Trends

 

The market size for the U.S. commercial fleet management services market has displayed little or no growth over the last several years as reported by the Automotive Fleet 2007, 2006 and 2005 Fact Books. Growth in our Fleet Management Services segment is driven principally by increased market share in the large fleet (greater than 500 units) and national fleet (75 to 500 units) markets and increased fee-based services, which growth we anticipate will be negatively impacted during the remainder of 2007 by the proposed Merger.

segments, including a negative impact on origination volumes and the value of our MSRs and related hedges. Volatility in interest rates may also result in changes in the shape or slope of the yield curve, which is a key factor in our MSR valuation model and the effectiveness of our hedging strategy. Furthermore, recent developments in the industry have resulted in more restrictive credit standards that may negatively impact home affordability and the demand for housing and related origination volumes for the mortgage industry. Many subprime origination companies have entered bankruptcy proceedings, shut down or severely curtailed their lending activities. Industry-wide mortgage loan delinquency rates have increased and may continue to increase over last year’s levels. With more restrictive credit standards, borrowers, particularly subprime borrowers, are less able to purchase a home. We expect that refinance activity over the next several quarters will be bolstered by the volume of adjustable-rate mortgages originated over the last five years nearing their interest-rate-reset dates creating an incentive for borrowers to refinance. However, based on home sale trends in early 2007, we expect that home sale volumes and purchase originations will decrease or remain flat during the remainder of 2007 and perhaps longer. (See “Item 1A. Risk Factors — Risks Related to our Business — Recent developments in the subprime mortgage market may negatively affect the mortgage loan origination volumes and profitability of mortgage loan products that we offer in our Mortgage Production segment.” in our 2006 Form 10-K for more information.)

 

As a result of these factors, we expect that the mortgage industry will remain increasingly competitive throughout the remainder of 2007 as excess origination capacity and lower origination volumes put pressure on production margins and ultimately result in further industry consolidation. We intend to take advantage of this environment by leveraging our existing mortgage origination services platform to enter into new outsourcing relationships as more companies determine that it is no longer economically feasible to compete in the industry, however, there can be no assurance that we will be successful in this effort whether as a result of uncertainties regarding the proposed Merger or otherwise. During the year ended December 31, 2006 and the first quarter of 2007, we sought to reduce costs in our Mortgage Production and Mortgage Servicing segments to better align our resources and expenses with anticipated mortgage origination volumes. These cost-reduction initiatives favorably impacted our pre-tax results for the first quarter of 2007 by $8 million, and we expect that they will favorably impact our pre-tax results for the remainder of 2007 by approximately $32 million. (See “Item 1A. Risk Factors — Risks Related to our Business — Downward trends in the real estate market could adversely impact our business, profitability or results of operations.” in our 2006 Form 10-K for more information.)

 

Fleet Market Trends

 

The market size for the U.S. commercial fleet management services market has displayed little or no growth over the last several years as reported by the Automotive Fleet 2006, 2005 and 2004 Fact Books. Growth in our Fleet Management Services segment is driven principally by increased market share in the large fleet (greater than 500 units) and national fleet (75 to 500 units) markets and increased fee-based services, which growth we anticipate will be negatively impacted during the remainder of 2007 by the proposed Merger.

 

 

We, through our subsidiary, PHH Broker Partner, and Realogy, through its subsidiary, Realogy Venture Partner, formed the Mortgage Venture. We own 50.1% of the Mortgage Venture through PHH Broker Partner and Realogy owns the remaining 49.9% through Realogy Venture Partner. The Mortgage Venture originates and sells mortgage loans primarily sourced through Realogy’s owned real estate brokerage business, NRT and its owned relocation business, Cartus. All mortgage loans originated by the Mortgage Venture are sold to PHH Mortgage or unaffiliated third-party investors on a servicing-released basis. The Mortgage Venture does not hold any mortgage loans for investment purposes or retain MSRs for any loans it originates.

 

The Mortgage Venture commenced operations, and we contributed assets and transferred employees that have historically supported originations from NRT and Cartus to the Mortgage Venture in October 2005. The Mortgage Venture is principally governed by the terms of the Mortgage Venture Operating Agreement and the Strategic Relationship Agreement. The Mortgage Venture Operating Agreement has a 50-year term, subject to earlier termination, under certain circumstances, including after the twelfth year, following a two-year notice, or non-renewal by us after 25 years subject to delivery of notice between January 31, 2027 and January 31, 2028. In the event that we do not deliver a non-renewal notice after the 25^th year, the Mortgage Venture Operating Agreement will be renewed for an additional 25-year term. The provisions of the Strategic Relationship Agreement govern the manner in which the Mortgage Venture is recommended by NRT, Cartus and TRG as the exclusive recommended provider of mortgage loans to (i) the independent sales associates affiliated with the Realogy Entities (excluding the independent sales associates of any Realogy Franchisee acting in such capacity), (ii) all customers of the Realogy Entities (excluding Realogy Franchisees or any employee or independent sales associate thereof acting in such capacity) and (iii) all U.S.-based employees of Cendant. See “Item 1. Business—Arrangements with Realogy—Mortgage Venture Between Realogy and PHH” and “—Strategic Relationship Agreement” for a description of the terms of the Mortgage Venture Operating Agreement and the Strategic Relationship Agreement.

 

The Mortgage Venture is consolidated within our financial statements, and Realogy’s ownership interest is presented in our financial statements as a minority interest. (See Note 1, “Summary of Significant Accounting Policies—Basis of Presentation” and Note 2, “Spin-Off from Cendant” in the Notes to Consolidated Financial Statements included in this Form 10-K.) Subject to certain regulatory and financial covenant requirements, net income generated by the Mortgage Venture is distributed quarterly to its members pro rata based upon their respective ownership interests. The Mortgage Venture may also require additional capital contributions from us and Realogy under the terms of the Mortgage Venture Operating Agreement if it is required to meet minimum regulatory capital and reserve requirements imposed by any governmental authority or any creditor of the Mortgage Venture or its subsidiaries.

 

Prior to the Spin-Off and in the ordinary course of business, we were allocated certain expenses from Cendant for corporate functions including executive management, accounting, tax, finance, human resources, information technology, legal and facility-related expenses. Cendant allocated these corporate expenses to subsidiaries conducting ongoing operations based on a percentage of the subsidiaries’ forecasted revenues. Such expenses amounted to $3 million and $32 million during the years ended December 31, 2005 and 2004, respectively.

 

Although we had the ability to access the public debt market or available credit facilities for required funding, prior to the Spin-Off, Cendant provided intercompany funding to us in order to lower the total cost of funding for the consolidated entity through the use of its available cash. During the years ended December 31, 2005 and 2004, interest expense related to such intercompany funding was not significant. These intercompany funding arrangements with Cendant terminated at the time of the Spin-Off.

 

In addition, during 2005, prior to and as part of the Spin-Off, Cendant made a cash contribution to us of $100 million and we distributed assets net of liabilities of $593 million to Cendant. Such amount included the historical cost of the net assets of our former relocation and fuel card businesses, certain other assets and liabilities per the Spin-Off Agreements and the net amount of forgiveness of certain payables and receivables, including income taxes, between us, our former relocation and fuel card businesses and Cendant.

 

During the year ended December 31, 2004, we paid Cendant $140 million (or $2.66 per share after giving effect to the 52,684-for-one stock split effective January 28, 2005) of cash dividends. We did not pay cash dividends to Cendant during the year ended December 31, 2005.

 

Because our business has changed substantially due to the internal reorganization in connection with the Spin-Off, and we now conduct our business as an independent, publicly traded company, our historical financial information does not reflect what our results of operations, financial position or cash flows would have been had we been an independent, publicly traded company during all of the periods presented. For this reason, as well as the inherent uncertainties of our business, the historical financial information for such periods is not indicative of what our results of operations, financial position or cash flows will be in the future.

 

During 2006, we devoted substantial internal and external resources to the completion of our 2005 Form 10-K and related matters. As a result of these efforts, along with efforts to complete our assessment of internal control over financial reporting as of December 31, 2005, as required by Section 404 of the Sarbanes-Oxley Act of 2002, we incurred incremental fees and expenses for additional auditor services, financial and other consulting services, legal services and liquidity waivers of approximately $44 million through December 31, 2006. Of this $44 million, we recorded $32 million and $12 million in Other operating expenses in the Consolidated Statements of Operations for the years ended December 31, 2006 and 2005, respectively. While we do not expect fees and expenses relating to the preparation of our financial results for future periods to remain at this level, in 2007, we expect them to remain significantly higher than historical fees and expenses.

 

On March 15, 2007, we entered into the Merger Agreement with GE and its wholly owned subsidiary, Jade Merger Sub, Inc. to be acquired (as previously defined, the “Merger”). In conjunction with the Merger, GE entered into an agreement to sell our mortgage operations to Blackstone. The Merger is subject to approval by our stockholders and state licensing and other regulatory approvals, as well as various other closing conditions. Under the terms of the Merger Agreement, at closing, our stockholders will receive $31.50 per share in cash and shares of our Common stock will no longer be listed on the NYSE.

 

Mortgage Production and Mortgage Servicing Segments