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NOTE 19 DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES | 9 Months Ended
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Sep. 30, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract] |
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES |
| Note 19 | Derivative Financial Instruments and Hedging Activities
Because many of our current derivative agreements are not exchange-traded, we are exposed to credit loss in the event of nonperformance by the counterparty to the agreements. We control this risk through credit monitoring procedures including financial analysis, dollar limits and other monitoring procedures. The notional amount of our contracts does not represent our exposure to credit loss. The following table summarizes the changes in the notional balance of our holdings of derivatives during the nine months ended September 30, 2013:
|  | IRLCs |  |  | U.S. Treasury Futures |  |  | Forward MBS Trades |  |  | Interest Rate Caps |  |  | Interest Rate Swaps |
Balance at December 31, 2012 |  | $ | 1,112,519 |  |  | $ | 109,000 |  |  | $ | 1,638,979 |  |  | $ | 1,025,000 |  |  | $ | 1,495,955 |
Additions |  |  | 4,062,236 |  |  |  | 85,000 |  |  |  | 9,316,350 |  |  |  | — |  |  |  | 1,280,000 |
Amortization |  |  | (228,806 | ) |  |  | — |  |  |  | (33,372 | ) |  |  | (24,000 | ) |  |  | — |
Maturities |  |  | (3,709,513 | ) |  |  | — |  |  |  | (4,558,971 | ) |  |  | — |  |  |  | (295,604 | )
Terminations |  |  | (549,877 | ) |  |  | (194,000 | ) |  |  | (5,627,670 | ) |  |  | (1,001,000 | ) |  |  | (2,480,351 | )
Balance at September 30, 2013 |  | $ | 686,559 |  |  | $ | — |  |  | $ | 735,316 |  |  | $ | — |  |  | $ | — |
Fair value of net derivative assets (liabilities) at: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
September 30, 2013 |  | $ | 13,491 |  |  | $ | — |  |  | $ | (12,185 | ) |  | $ | — |  |  | $ | — |
December 31, 2012 |  | $ | 5,781 |  |  | $ | (1,258 | ) |  | $ | (1,719 | ) |  | $ | 168 |  |  | $ | (10,836 | )
Maturity |  |  | Oct. 2013 – Jan. 2014 |  |  |  | — |  |  |  | Oct. 2013 – Nov. 2013 |  |  |  | — |  |  |  | — |
Interest Rate Management Match Funded Liabilities We have previously entered into interest rate swaps in order to hedge against the effects of changes in interest rates on our borrowings under our advance funding facilities. These interest rate swap agreements required us to pay a fixed rate and receive a variable interest rate based on one-month LIBOR. At the time that we entered into the agreements, these swaps were designated as hedges for accounting purposes. As disclosed in Note 5 – Fair Value of Financial Instruments, we terminated these interest rate swaps on May 31, 2013 primarily because the custodial account float balances, which earn a variable rate of interest, are well in excess of variable rate borrowings under advance facilities. The earnings on these deposits reduce our exposure to changes in interest rates. We also purchased interest rate caps to minimize future interest rate exposure from increases in one-month LIBOR interest rates, as required by the certain of our advance financing arrangements. These caps were terminated with the payoff and termination of the related financing facilities. Loans Held for Sale, at Fair Value The mortgage loans held for sale that we carry at fair value are subject to interest rate and price risk from the loan funding date until the date the loan is sold into the secondary market. Generally, the fair value of a loan will decline in value when interest rates increase and will rise in value when interest rates decrease. To mitigate this risk, we enter into forward trades to provide an economic hedge against those changes in fair value on mortgage loans held for sale. Forward trades are primarily used to fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Interest Rate Lock Commitments IRLCs represent an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage applicant, whereby the interest rate is set prior to funding. The loan commitment binds us (subject to the loan approval process) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. The borrower is not obligated to obtain the loan, thus we are subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. Our interest rate exposure on these derivative loan commitments is hedged with derivatives, including forward contracts. We enter into forward contracts with respect to fixed rate loan commitments. MSRs at Fair Value The MSRs which we measure at fair value are subject to interest rate risk as the mortgage loans underlying the MSRs permit the borrowers to prepay the loans. Therefore, the fair value of these MSRs generally tends to diminish in periods of declining interest rates (as prepayments increase) and increase in periods of rising interest rates (as prepayments decrease). Although the level of interest rates is a key driver of prepayment activity, there are other factors that influence prepayments, including home prices, underwriting standards and product characteristics. Effective April 1, 2013, we terminated our hedging program for fair value MSRs. Prior to their termination, we used economic hedges including interest rate swaps, U.S. Treasury futures and forward contracts to minimize the effects of loss in value of these MSRs associated with increased prepayment activity that generally results from declining interest rates. Asset Acquisitions In March 2013, we entered into an interest rate swap to hedge the impact on cash flows of changes in the purchase price to be paid for MSRs acquired in the Ally MSR Transaction. This purchase was forecasted to occur in stages with the purchase price subject to adjustment based on changes in the 10-year swap rate between the date of the MSR purchase agreement and the date of each closing. We entered into an interest rate swap with a notional amount sufficient to yield changes in the fair value of the interest rate swap in response to changes in the swap rate that were essentially equal to and offsetting to changes in the purchase price of the MSRs. We designated the swap as a hedge for accounting purposes. We completed the transaction in April 2013 and terminated the swap agreement at the same time. See Note 9 – Mortgage Servicing for additional information regarding the Ally MSR Transaction. The following summarizes our use of derivatives at September 30, 2013 and the gains (losses) on those derivatives for the nine months then ended. None of these derivatives was designated as a hedge for accounting purposes at September 30, 2013:
Purpose |  | Expiration Date |  |  | Notional Amount |  |  | Fair Value (1) |  |  | Gains / (Losses) |  |  | Consolidated Statement of Operations Caption
Interest rate risk of mortgage loans held for sale and IRLCs |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Forward MBS trades |  |  | 2014 |  |  | $ | 735,316 |  |  | $ | (12,185 | ) |  | $ | 30,989 |  |  | Gain on loans held for sale, net and Other, net
IRLCs |  |  | 2013 |  |  |  | 686,559 |  |  |  | 13,491 |  |  |  | 5,918 |  |  | Gain on loans held for sale, net
Total derivatives |  |  |  |  |  |  |  |  |  | $ | 1,306 |  |  | $ | 36,907 |  |  |
| (1) | Derivatives are reported at fair value in Receivables, Other assets or in Other liabilities on our unaudited Consolidated Balance Sheets.
Included in AOCL at September 30, 2013 and December 31, 2012, respectively, were $12.1 million and $9.9 million of deferred unrealized losses, before taxes of $4.5 million and $3.6 million, respectively, on interest rate swaps that we designated as cash flow hedges. Changes in the losses on cash flow hedges included in AOCL during the nine months ended September 30, 2013 were as follows:
Accumulated losses on cash flow hedges at December 31, 2012 |  | $ | 9,878 |
Additional net losses on cash flow hedges |  |  | 12,363 |
Ineffectiveness of cash flow hedges reclassified to earnings |  |  | (657 | )
Losses on terminated hedging relationships amortized to earnings (1) |  |  | (9,434 | )
Accumulated losses on cash flow hedges at September 30, 2013 |  | $ | 12,150 |
| (1) | Where the hedging relationship has been terminated but the hedged transaction is still forecast to occur, losses on the hedging relationship that are included in AOCL are amortized to earnings in the periods in which earnings are affected by the hedged transaction. Amortization in the third quarter included $4.1 million of accelerated amortization as a result of the early repayment and termination of four advance financing facilities as a result of the July 1, 2013 HLSS Transaction.
The statements of operations include the following related to derivative financial instruments for the periods ended September 30:
|  | Three Months |  |  | Nine Months |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |
Servicing and origination expense |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Gains on economic hedges |  | $ | — |  |  | $ | — |  |  | $ | 1,017 |  |  | $ | — |
Gain on loans held for sale, net |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Gains on economic hedges |  |  | 9,608 |  |  |  | — |  |  |  | 36,907 |  |  |  | — |
Other, net |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Gains (losses) on economic hedges (1) |  |  | (103 | ) |  |  | 1,397 |  |  |  | (3,822 | ) |  |  | 6,645 |
Ineffectiveness of cash flow hedges |  |  | — |  |  |  | 47 |  |  |  | (657 | ) |  |  | 46 |
Write-off of losses in AOCL for a discontinued hedge relationship |  |  | (7,780 | ) |  |  | (3,089 | ) |  |  | (9,434 | ) |  |  | (4,633 | )
Write-off of losses in AOCL for hedge of a financing facility assumed by HLSS (See Note 3 –Transfers of Financial Assets) |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (5,958 | )
|  | $ | 1,725 |  |  | $ | (1,645 | ) |  | $ | 24,011 |  |  | $ | (3,900 | )
| (1) | Includes a gain of $3.4 million recognized during the three months ended March 31, 2012 from the termination of foreign exchange forward contracts.

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