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PHH Corporation. (NYSE:PHH)

Q3 2008 Earnings Call

November 10, 2008 11:00 am ET

Executives

Nancy Kyle - VP, IR

Terence Edwards - President and CEO, PHH Mortgage

George Kilroy - CEO, PHH Arval

Sandra Bell - EVP and CFO

Mark Danahy - SVP and CFO, PHH Mortgage

Analysts

Bose George - KBW

Paul miller - FBR Capital Markets

Wayne Archambo - BlackRock

Howard Shanker - Fairpoint

Peter Collery - SC Fundamentals

Loui Scites - Penny Capital

Operator

Welcome to the PHH Corporation 2008 third quarter Earnings Call. Your lines will be in a listen-only mode, during remarks by PHH management. At the conclusion of the company's remarks we will begin the question-and-answer session, at which time I will give you instructions on entering the queue to ask your questions.

Today's call is also being webcast and recorded for replay purposes. The audio replay can be accessed on the company's website at www.phh.com or by telephone at 1-888-203-1112 or 1-719-457-0820, with a pass code of 4935751, approximately 2 hours after the conclusion of this call. It will available until November 25th, 2008.

This access information is also described in the company's earnings release and I will repeat it again at the end of our session. This call is scheduled to conclude in one hour.

At this time, Nancy Kyle, Vice President of Investor Relations, will proceed with the introduction.

Nancy Kyle

Good morning and welcome to the PHH third quarter 2008 earnings conference call. On the call today are Terence Edwards, President and Chief Executive Officer of PHH Corporation and PHH Mortgage, George Kilroy, Chief Executive Officer of PHH Corporation and Sandra Bell, Executive Vice President and Chief Financial Officer, PHH Corporation.

After their prepared remarks, we will begin a question-and-answer session, when other members of our senior management team will be available. If you did not receive a copy of the earnings release we issued this morning, you may access this from our website at www.phh.com or you may call our investor hotline at 856-917-7405 and request a faxed or mailed copy.

Please note that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, our mortgage outsource model being part of the solution to the industry's problems, our market share in the mortgage origination segment has the potential to continue to increase, new fleet signings should begin to be reflected in our results over the next 6 to 12 months, our expectations for the trend for reduced fleet funding to continue, our belief that we have taken the necessary steps to enhance our financial performance in our fleet business and our belief that we have adequate liquidity.

Our actual results may differ materially from those discussed on this call. Please see the risk factors in our 2007 Form 10-K and our third quarter 2008 Form 10-Q for description of issues that may lead to different results. Please call our hotline, if you would like paper copies of these filings or you may access them on our website.

And now, I'll turn the call over to Terry.

Terence Edwards

Thank you for joining us on the call today. As usual George and I will review the quarter and we'll be assisted by our team which includes our new CFO, Sandra Bell.

As we all know the markets continue to do things no one ever imagined and no one would have imagined that our stock would be as down as much as it is today, as much as it is down since the middle of August. But I guess that's just sign of the times, hopefully, by the end of this call, we'll get the stock turned around.

Before getting into the details, I want to touch on the opportunities this unique market presents to PHH. As you know, we are an outsource solution for mortgages and fleet management. In the past during recessionary times we experienced increased new fleet activity for both businesses and today that remains true.

In the mortgage space the consolidation means having scale is more important than ever. We believe any one who is not a top five bank, should be seeking scale by partnering with PHH, which is now the 7th largest originator, according to Inside Mortgage Finance, after you adjust for recent acquisition activity. During 2006, we were the 27th largest player. So we've moved from 27 to 7 overtime as the industry is consolidated.

In the vehicle space, corporations with large fleets will continue to look to lower costs and we provide that fleet management solution. In addition, although there is no assurance that this will occur, the lawyers maybe put that in there. We've been analyzing the benefits of becoming or acquiring a bank depository where we can benefit from the servicing escrows that we control. In addition, this would add to funding all alternatives for other assets, should we want to temporarily place those on the balance sheet.

We are paying close attention to the possible expansion of TARP beyond banking. We have spoken with the regulators and we have said that our outsource mortgage model can be part of the solution to the banking crisis. We pointed out that many of our clients did not suffer any of the damages related to mortgages in large part because they work with us and we kept them away from those exotic products that got so many into trouble.

So, now shifting in to the results. In the origination business, it was a tough quarter, couple of things running through the quarter. One, the slow volume and two, the write-off of the Goodwill related to our PHH Home Loans joint venture. So pre-Goodwill, the segment loss $67 million pre-tax and adjusted for Goodwill, the segment loss $32 million and servicing million loss $66 million and I'll get in to what occurred there and the vehicle business made $17 million.

So diving into the originations business. Rising rates during the quarter as consumer interest rates approached 7% was withdraw of the $67 million loss for this segment, included $35 million of non-cash Goodwill impairment. This segment was hurt as new application volumes slowed significantly down $2.6 billion from the second quarter to $9.5 billion.

Recall what the accounting changes implemented this year that we've discussed on previous calls expenses are no longer deferred and much of the revenue is booked when we locked a loan with the customer. Slowdown in new application activity industry-wide has been significant as evidenced by MBA mortgage application data, which in certain weeks during the quarter has hit levels not seen since the year 2000.

In addition, the high volatility this quarter continued to negatively impact the cost of hedging the pipeline, which also cut in to margins. We also had a $11 million in write-downs of held for sale loans, as shown on page 19 of the press release.

We are once again rebalancing our operating platforms to slower volume and recently reduced headcounts by 120 people during the quarter. As I said at the top, typically in environments like this where the mortgage industry goes into a downturn, we signed many accounts and our prospect list continued strong. We continue to evaluate our cost structure and we'll be reducing headcount again in the near-term.

As we said in the beginning of the year, $10 billion run rate would be breakeven. To the extent that we would have done a couple more billion dollars of applications during the quarter we would have been closer to break even adjusted for Goodwill and adjusted for those one-time write-downs the $11 million that I mentioned.

Shifting to servicing. Servicing had a $66 million loss driven by $62 million in hedge losses. Continued charge-offs of $12 million and continued additions to reserve $20 million, plus the affects of reduced earnings on our escrows as LIBOR declined during the quarter were also negatives.

With regards to hedging during the quarter, we saw unprecedented levels of market activity, federal takeover of the GSEs, federal takeover of AIG, the disappearance of Washington Mutual and Wachovia as independent entities and the bankruptcy of Lehman Brothers. We also saw extraordinarily high-levels of market volatility driving hedge costs to new levels and the relationships between swaps mortgages no longer following historical relationships.

In addition, changes to underwriting guidelines, changes in secondary market conditions and declines in home values reduced the ability of the borrower to refinance a loan to reduce the monthly payment. As such prepayments and underlying cash flows of the servicing asset are less sensitive to changes in rates than the model based on the what -- the way history would suggest. In fact prepaid speeds were 9% for the quarter versus 16% modeled therefore there was significant hidden value within our MSR.

During the quarter the company reassessed its hedging strategy in light of market conditions. We exited virtually all derivative contracts for the hedge of the MSR asset between the middle of August and early September. In hindsight, we can see that we exited the majority of these positions when mortgage and swap rates were near the highs for quarter.

The par mortgage coupon started the quarter at about 5.84, peaked to 6.21, hit a low of 4.88, and then it decoded down 19 basis points from the 5.84 to 5.65, incredible volatility, level of volatility that we typically don't see in a period of year's, yet, we saw it in a period of months. It was the timing of these rate moves interactions that gave rise to the loss in the derivatives used to hedge the MSR.

On a positive note, given the timing of our decision, we didn't occur any losses due to non performance of any counter party, such as Lehman Brothers and we've avoided the demands on our liquidity position to fund margin accounts related to the derivative mark-to-market of the MSR, during this last half of the quarter. So now that we are not hedged there will be accounting volatility in the servicing segment.

As of September 30th, our MSR would lose approximately $97 million if rates declined 25 basis points. Now when I say lose, that's an accounting terminology, we don't expect the economic impact to be anything like that, because as I said earlier, consumers just can't refinance, because they don't have equity in their property or products that they used to rely on, aren't there any longer.

If rates rose 25 basis points, we'd make about $86 million. Keep in mind our accounting policies require that we mark our MSR at fair value, which assumes our sale of the MSR between the willing seller and buyer. It does not necessarily reflect the true economics of the underlying cash flows, as evidenced by the fact that actual prepayments continue to be significantly lower than modeled. The company will continue to monitor the market conditions, refinancability of the MSR portfolio and the appropriateness of hedging the MSR.

One of the other reasons not to hedge is the cost of carry associated with the hedge. If I breakdown the $62 million of hedge losses that I spoke about, $41 million was related to market moves, while $21 million was related to the cost of the hedge, meaning the cost of optionality and the time to carry associated with carrying the hedge or any negative carry associated with carrying the hedges. As a result on a go forward basis, we no longer have the negative of the cost of the hedge on a go forward basis.

Just spend another second on the hedge itself as it relates to servicing. To the extent that the world suddenly could refinance on MSR, prepay speeds picked up, that would mean our credit losses declined, our losses on our captive insurance would be declining and that would mean that the originations business would be coming back. So, on one breath I say we are not hedged, we're not hedged with derivatives, but we do have natural hedge in place and that if the originations business picks up, if the economy comes back and things get better, those negatives offset any pick up in prepay speeds associated with the MSR.

We'll now shift to the fleet segment and George will take you through that.

George Kilroy

Thanks, Terry. Fleet earnings during third quarter were $24 million less than the same period last year, primarily as a result of increased interest costs and the impact of the reduction in the number of our car services from 2007. We believe the causes for the reduction in our account over the past year are behind us and the new signings should begin to be reflected in these numbers over the next 6 to 12 months.

Year-to-date our new account signings, have been 21 accounts in the US and 20 accounts in Canada that represent 18,000 vehicles in North America that will be added to our leased inventory overtime and more quickly adding will add our services. In addition to continuing to be the premier service provider in the fleet management business, much of our focus over the past several months has been on addressing the impact, the significantly increased cost of funding has had on our lease portfolio.

If you will recall from our earlier calls, PHH is contractually committed to a specific interest index and basis point mark up with our clients. This makes up our billing rate decline and is historically been very close to our cost of funds. Both indexes and bank fees have increased dramatically, more than we had anticipated this year. We are developing communicated specific plans for each leasing client and will implement these pricing changes over the next few months.

This has been a difficult conversation with our clients, because many of them are experiencing similar challenges in their own business. However, our investment in these relationships often over a number of years has resulted thus far in a neutral agreeable outcome in most cases. In those cases where it hasn't, we will likely suggest that they consider alternative funding for their vehicles.

It's difficult to determine the impact the liquidity issues have had on our competitors, although we have seen evidence of price increase across the landscape. Our requirement for lease funding has been reduced over the past 12 months and we expect that trend to continue, therefore, we will continue to evaluate our expected need and size our asset-backed program accordingly.

Remember, we currently have over $500 million of available excess capacity, under our 2006-1 February facility. Terry, will talk a little more about this in the liquidity discussion. We do feel bank fees and funding costs will remain high throughout 2009, and our pricing initiatives will not get us all the way back to where we want to be.

As a result we have evaluated cost at PHH Avral to determine possible savings, which does include a reduction in force that will be fully implemented by year end. The remainder of 2008 and 2009 will be very challenging for both PHH and our clients. But, we feel that we have taken necessary steps to enhance our financial performance, while not compromising in any way the level of service or the value we provide to our customers.

I will turn it back to Terry.

Terence Edwards

Thanks, George. As we do during each call, let's review the key areas of risk related to the mortgage balance sheet at quarter end. MSR as we just talked about is solid at 1.29% our peer survey confirms this, in fact in that we are in the middle of the survey of the pact. Plus we believe the value of our slower prepay speeds, versus models will be realized overtime, as I said 16% is what's modeled, versus 9% we saw during the quarter.

Shifting to captive insurance. We increased reserves by $11 million during this quarter which is the same amount as last quarter. We now have $61 million in reserves. We currently project the present value of future premiums to be $30 million below the present value of future paid losses. This has changed from the last quarter when the net of this calculation was $14 million.

That said the $30 million is still significantly below the $61 million we carry in reserves. Again these caps are done on industry data, so we'd hope that our portfolio would outperform. Restricted cash for atrium is over $200 million, so losses there with related to captive insurance are not a liquidity issue.

With regard to recourse, loans we have sold by whole recourse totaled $284 million at September 30, of this portfolio, 10.2% are at least 90 days delinquent and I should add that 59% of these loans were originated in 2004 or before.

The other source of recourse we have is the retained credit risk we have related to a program we did with one of the GSE's. This number is $922 million, down from $1.4 billion at the end of June. Recall under this program we have exposure for the first 18 months of the loan. Any loan that goes 120 days delinquent in that timeframe we must buy back. Based on when we halted this program, we expect this to go to zero sometime during the second quarter of 2009.

We have said all along we would expect to add reserves and we did that during the quarter. Reserves including those related to our captive insurance are now $138 million versus $81 million at year end and $118 million at June 30. So the $138 million is made up of $61 million for atrium and $77 million for the rep course positions discussed, plus REO that we hold on the balance sheet.

With regard to mortgage loans held for sale are shown on page 18, 83% conforming and we do not have a held for investment portfolio.

Shifting to liquidity, as of September 30, we had $211 million in unsecured capacity via our bank lines. We have $2 billion in warehouse capacity for the mortgage business and $526 million in vehicle capacity. Our tangible debt to equity is 4:1 which we believe is conservative for a company like ours.

With regard to the upcoming renewal of the billion dollars for Chesapeake, 2006-2 facility because it is fully drawn and the fact that we have capacity on Series 2006-1 the $526 million I just mentioned relates to the February facility, we do not need to renew the November facility. This means, we can afford to allow the cash flows from the assets that are in the Chesapeake series to pay down the facility over the life of the loans.

As I said in my opening comments, we are strategically reviewing becoming or acquiring a depository which we believe overtime will enhance our liquidity position, as we leveraged the servicing escrows that currently live in other financial institutions. In ex-maturity we have to deal with $2.9 billion Chesapeake series in February.

Since we have $526 million of extra capacity in this facility we expect to reduce the renewal amount. However, we do have the same options that I just described with the November facility, with regard to the February facility. Bottom-line is both businesses are well positioned for the economy turns. With that liquidity and we look to a bright future, as I said when the economy eventually turns around and as we all know the government is doing everything they can to get the economy to swivel.

Before we open up lines for questions, let me address a question, I know will be asked. What are our expectations of the Merrill Lynch contract, given the BEA acquisition? We describe the arrangement in our Form 10-K and the contract is filed. The term runs until December 31, 2010. However, it automatically renews for five more years if certain conditions are met related to volume and service.

Since the volume conditions have been met and the service conditions will continue to be maintained, we expect this contract to renew for another five years. So at the end of the day we have 7 years to go. On a volume basis, Merrill is 23% of our business for the first nine months of the year.

Now, those are my prepared remarks as I watch what our stock done this morning, I couldn't help to make some further notes, what's changed since last time we spoke publicly. One is the loss on the hedge and $40 million of that was related to market moves. Now that we are not hedged, we'll save the cost of carry. Credit losses, we've talked about we said they would continue, so that's really no change.

Housing is slower, which is not a positive but it does means is a positive for signing new accounts. So in the long-term we'll benefit from this. This is also better for servicing because customers are not prepaying their loans, and as I've said and I'll say it for the third time. The MSR value is modeled at 16% and its prepaying is 9% and the pace is probably going to slow down more as we move in to this quarter.

As George just indicated, we've had dialogue with the fleet customers, we're out there adjusting our pricing and it appears that there aren't competitors out there with alternatives. So we appear to be competing in a level playing field as it relates to providing financing for our clients. Recall that this business, we are the last people on earth to call this a leasing business.

This a fleet management consulting business, it starts with buying cars, eventually selling the cars and providing knowledgeable information to help our clients minimize the cost of operating those vehicles over the cost of time, it includes fuel management, maintenance management, accident management, driver behavior, so a great business.

When all said and done, we're now the 7th largest player in the mortgage space and we would do expect to get to the other side of this when the economy turns. So as we look at the overall stock market since the middle of August when last we spoke to the public, it's down about 22%, PHH is down 60% and we're now trading at 23% of tangible book, that doesn't make any sense to me.

So now, we'll open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question today will come from Bose George with KBW.

Bose George - KBW

Hey, good morning. I had a question on the CP roll. Could you just go over how the discussions with the bank are going? Also, since the government is buying CP as long as it meets certain requirements, I just thought it would not be a problem for that the banks, for the conduits to sell the CP to the government.

Terence Edwards

Bose, we think all of that is right. Our discussions with the banks are going fine. Our relationships with the banks continue to be fine. The issue is where do assets as a whole trade in the marketplace. While LIBOR is coming down and you see some normalcy returning to the market, the primary markets themselves are not open. So the price discussions at this point in time are not at a level that it would make sense for us to renew the November facility.

That said, we are still in discussions with the banks, the facility has got more weeks to go before it matures. As I said, we have got a choice. We can put it into the stage where the leases self amortize the facility, but we will continue the discussions with the banks because the banks are critical to enable to provide the financing for our clients.

Bose George - KBW

So just to be clear, I mean the banks can sell the CP to the government at whatever the rate the government sets, but is that rate not being put out to the market to people like you who use the liquidity facility?

Terence Edwards

At the end of the day there is a step function in there between us and access to that facility. That is what the banks are willing to charge for providing the back up facility, and therefore, the use of their balance sheet. So, the world continues to try to de-leverage.

Unfortunately, the color we get is based on where the secondary market is, trading for commercial asset-backed paper. That bank balance sheet backed up, and that market is illiquid I would say for now. So pricing has not stabilized, the market has not stabilized like the LIBOR market is starting to stabilize.

Mark, you want to add anything to that?

Mark Danahy

Clarification, it is more of the term market for ABS securities that people want to comp. These are lease assets or any other ABS markets out there. For example, in October, our understanding is there were in no credit card deals done for the first time in 15 years.

So that is a mark up that the market faces and that is thanks to people's opinion of what is appropriate pricing for any ABS transaction. So as Terry said, what we are trying to do is figure out what the right price is and move forward.

Bose George - KBW

Great. Then actually switching to the statements you made about the potential of the bank acquisition, I mean, could you use the bank to fund the fleet business and if you put this in to runoff and then essentially use the bank to pick up the slack as you need it?

Terence Edwards

That is a possible outcome, Bose. That is clearly in our thoughts as we work on becoming a depository.

Bose George - KBW

Okay, great. Thanks very much.

Terence Edwards

It is not automatic, though. We are going to work on it. We had discussions with the regulators. We think we will well received by the regulators, but there is still a lot of wood to chop before we become a depository.

Operator

Our next question comes from Paul miller with FBR Capital Markets.

Paul miller - FBR Capital Markets

Can you back up a little bit and talk a little bit about, you said something about that you are in discussions with the Treasury about TARP? Have you applied for TARP? Are you trying to convince them that you would qualify for TARP?

Terence Edwards

Now, there is two things going on. We are in discussions with regulators about becoming a depository and then the other part of my comment was we are paying close attention to those that are being permitted to participate in TARP. So we all read the papers a week or so go and there were some talk of companies like GE and CIT participating in TARP. So, we are paying close attention to whether or not TARP opens up to companies like that.

That said, the better path to TARP would be becoming a depository. I want to add that becoming a depository has been part of our strategic plan for years, but we have been burdened by other things, contracts, delayed filings, things like that that kept us from getting to where we wanted to be.

Part of adding Sandra Bell to our team was to add banking expertise. If you saw her resume, she was former CFO at the Federal Home Bank of Cincinnati. It is been a number of years Deutsche Bank working on the bank side of the house. So now that we have got expertise on board, now that we have got other things behind us, the discussions have begun and we hope that we will eventually get there.

Paul miller - FBR Capital Markets

Okay. Then on the fleet side, if you chose not to rollover this $1 billion and you got the other $3 billion due in February of next year, how does that impacted the fleet business?

Because you are going to your customers and asking them to find other, maybe you want to bring them on your balance sheet, find other forms of financing for the assets. How would that impact your overall business going forward? I know that is the worst case scenario, but just trying to figure if that is something that might happen down the road.

George Kilroy

Paul, this is George. Just a correction on what you said, we are not telling clients that they cannot lease through us. That would not be an outcome of not renewing the $1 billion. We have over $500 million excess capacity in the February piece. So that is not something we are telling them right now.

I think what it does say is we do have some flexibility as to what to do with the $1 billion that is renewable this month and we are working pretty closely with the banks to figure out the best outcome for both of us. The bad news is the markets are in pretty bad shape and the good news is we have got plenty of flexibility on what to do there.

Paul miller - FBR Capital Markets

George, when you said you have plenty of flexibility. I am not trying to pinpoint you on this, by you have $500 million excess on the other ABS, but is that going to able to absorb the whole $1 billion that you have sitting out there now?

George Kilroy

Well, remember the $1 billion runs off slowly, it runoffs actually over the next 10 years.

Paul miller - FBR Capital Markets

Okay.

George Kilroy

So what is coming off every year, or every say every month, could easily be absorbed by the $500 million excess in February and then whatever we plan to do going forward from there.

Paul miller - FBR Capital Markets

Okay. Then, Terry, back to you, can you give us 10,000 foot view of the mortgage market right now? I know even if you can come up with one, but we all know that the way we did mortgages over the last five years is not going to be the way we are going to do mortgages going forward in the next five years. Not having the MSR hedge, which is probably the correct economic things to do is going to cause a lot of volatility on that.

How do you see the mortgage market playing getting out of this and playing out going forward, when 90% of all home sale that we are hearing in some of these states like of California and Florida are foreclosed properties. I mean how do we get out of this mess?

Terence Edwards

Well we are not worried about, we are worried about the industry as a whole. I am not so much worried about getting out of this mess with regard to the industry. I am worried about getting out of this mess with regard to our company. The road for us to get out of this mess is to sign more and more accounts. As I said, in the past, through the 90s, and through the early parts of this decade when the market did slowdown, we signed more accounts, there has been more consolidation.

Consolidation has happened more rapidly than anyone ever imagined. So now you have got the top five banks. If you are not one of the top five banks, you can not afford the run a platform. You need to be us. We can provide them a platform to be able to compete with those top five banks, because they are going to be difficult to compete with. So as the independent player out there, we view this as a great opportunity to sign accounts.

Now in the short-term, it is going to be painful as we balance our costs this quarter and in the first quarter of next year. As we all know, the government is doing everything they can to fix the overall marketplace, to eventually get the economy turned around and since is the economy does not turn around until there is some level of stability associated with housing.

We thought we worked with a close folks and Realty closely and we watch their surveys of the realtors et cetera. In a lot of respects, the markets seized up because all home buyers read about is the fact that home prices are going down and they are getting through the fact that the stock markets just come off. Recent data showed that consumers are starting to save more money versus spend more money.

So the consumer is hunkering down and at some point, we expect them to resurface because that is what the surveys and the realtors from Realty say, there are consumers out there waiting for the opportunity to buy. So eventually, this thing will turn. So as I said, we will get through this by signing more accounts and becoming a larger, larger, increasing our market share.

Paul miller - FBR Capital Markets

Thanks a lot, Larry.

Operator

Our next question will come from Wayne Archambo with BlackRock.

Wayne Archambo - BlackRock

As CFO, while joining I wonder if she had any general comments about being on board here?

Sandra Bell

Well, first of all, I feel pretty honored to be a part of this team. As you all get to know me and I expect to get to know you, I view this market as an opportunity for this company for many of the reasons that Terry has laid out. I think the marketplace will continue to consolidate. We have a platform on the mortgage side and on the fleet side, that through outsource providing is delivering exactly what client's need right now, which is helping managing their costs. So, I am happy to be here.

Wayne Archambo - BlackRock

The CEO at the end of his prepared remarks made comments regarding the fact that the stock price makes no sense to you. If this is the case, why are not we seeing a lot of insider buying from management if the price is so dislocated from reality?

Mark Danahy

The windows have been closed, the windows open up in the next couple of days.

Wayne Archambo - BlackRock

So we would expect to see insiders buying?

Mark Danahy

It is a possibility. I still have to consult with the lawyers on to make sure that everything that I possibly know has been discussed on this call.

Wayne Archambo - BlackRock

Now management is so aligning with shareholders, I think it is in your best interest to be in buying the stock at these ridiculous prices as you put it?

Mark Danahy

I personally agree I am not going to speak for the rest of my management team.

Wayne Archambo - BlackRock

I think as a shareholder would certainly show a sign of confidence that management believes in the company at these distressed prices.

Mark Danahy

The CEO has gotten the hint and given the lawyers allow him to do it he will do it.

Wayne Archambo - BlackRock

Thank you.

Mark Danahy

Thank you for the questions and the priority.

Operator

Our next question will come from Howard Shanker with Fairpoint.

Howard Shanker - Fairpoint

Hey. Terry, can you revisit your production estimates and where you think you need to be in terms of mortgage production volumes, so that you can be for materially profitable at that segment?

Terence Edwards

We continue to work through our plan to try to get a sense of what next year is going to be like. As I said, volume has slowed down dramatically, and I think when we were together in August I had said the same thing volume has slowed down dramatically as gas prices hit four bucks, gas prices are down to 240 now, hopefully that is a good thing for the economy as we all would expect it to be. So as we look at the volume forecast, the Fannie Mae forecast has volume dropping 42% going into next year.

If we take that straight decline, that would mean a number for us of about $27 billion next year. Now $27 billion would mean that we did not sign any new accounts and that we did not have any pickup from existing accounts that were signed in the back half of this year. So we are modeling, doing scenarios anywhere from $27 billion to $34 billion on the optimistic basis, with the idea of trying to get many of those scenarios that breakeven or better.

As you go lower it gets more and more challenging because we have got a significant component of fixed costs associated with providing the level of services our clients expect and deserve. So, it is in between there and we continue to work through scenarios to get the originations business to close to breakeven, so that, with any pick up in the economy it will be a contributor.

Howard Shanker - Fairpoint

Would it be breakeven, I realize that the budgeting is not done. Would it be breakeven at $27 billion run rate is that the plan? The other question is there any flexibility on the work force and maybe on some of the service levels given the precipitous volume decline?

Is there a way to go back to customers and say, look, we have not made money in this business because we have so staffed to levels which you and I see reasonable at the time we signed the contracts but just have not come anywhere near fruition. So as a result our service levels are probably way too high, and our profitability is too low?

Terence Edwards

Backing off on service it is not a success part of the equation for overall success. The way we sign new accounts is got some references from our existing accounts. So when we bring a new account on they want to talk to all of our existing accounts. So to the extent that we are providing great service that opens the door to additional services.

Getting to breakeven at $27 billion is almost impossible. That said, in an industry that does what Fannie Mae expects it to do next year, our servicing business should be all things being equal profitable and overall we should be able to get the overall business to profitability. That assumes credit losses do not worsen beyond what we are seeing today. So $27 billion challenge, at the $30 billion to the $34 billion, more achievable to be able to get to breakeven at the $30 billion.

Howard Shanker - Fairpoint

Then can you just run through the sensitivities again that you talked about before on being unhedged on the MSR? Then can you let us know, if you have not decided to take off the hedges when you did what would have been the impact from the P&L perspective and from liquidity perspective?

Terence Edwards

Round numbers, down a basis point is about a $4 million hit, up a basis point is about a $2.5 to $3 million positive. Now again these are accounting marks they are not economic.

Howard Shanker - Fairpoint

This is just on MSR valuation or this will be through the P&L?

Terence Edwards

This would be MSR valuation and it will go through the P&L.

Howard Shanker - Fairpoint

Got it, okay.

Terence Edwards

Then the second part of your question was?

Howard Shanker - Fairpoint

Had you not taken off the hedges halfway through the quarter or when ever you decided to take them off?

Terence Edwards

Yes.

Howard Shanker - Fairpoint

What would have been the ultimate hedge loss P&L impact to that liquidity impact?

Terence Edwards

The hedge losses would have been less and liquidity would have been better.

Howard Shanker - Fairpoint

Okay. Thanks.

Terence Edwards

You are welcome.

Operator

(Operator Instructions). We go next to Peter Collery with SC Fundamentals.

Peter Collery - SC Fundamentals

Hi, thank you for taking the call. I have a couple of questions. With respect to the servicing, the methodology by which you get to the servicing value is a DCF, but it is also I think characterized as a fair value. Is it fair to say that if you wanted to sell the servicing for its carrying value today in today's market that you would be able to do that?

Terence Edwards

Probably not fair to say because just as we talked about other markets locked up. The markets for secondary sales is a servicing market, are pretty seized up also.

Peter Collery - SC Fundamentals

So is there any way of approximating what a market value for the servicing is?

Terence Edwards

We think with our methodology where we look at where other participants mark, I mean at the end of the day the value is much closer, you are getting to something where you are looking where other participants are marking the asset and you are looking at the DCF and then you are taking some reasonable assessment of the value of our servicing model that at 16% versus the 9% and you are making the assessment that if you had to sell it you could get close to the value, if you had to sell it.

Peter Collery - SC Fundamentals

We see in the marketplace all over now, things would seem extraordinarily cheap, that is what happened in any liquid market. I am trying to draw a distinction or I am trying to get the sense of how large the distinction is, between the what we think the fair value of the servicing should be under normal circumstances, with people looking for normal rates of return and normal amount of liquidity being available and what you could actually honest to god realize for the servicing if you really needed to sell it, not withstanding the fact that you might not will not to because, you do not think it makes economic sense.

Terence Edwards

In the current market to try and do a servicing sale would essentially be a fire sale and it would be hard to guess what the execution level would look like. There really has not been any significant trade of servicing in the past 6 months.

Peter Collery - SC Fundamentals

Okay, fair enough.

Terence Edwards

In fact our execution of a trade back in December was the last probably large conforming servicing trade out there.

Mark Danahy

That said, interest-only securities continue to trade and one of the things that we are looking at is possible execution, where we sell some of our excess servicing in the marketplace, via the form of an interest-only transaction.

Peter Collery - SC Fundamentals

Okay. Do you have any sense based on the parameters you get from there or what the value of the servicing might be or at least the excess portion of value of the servicing might be as compared to the carrying value of that?

Terence Edwards

We will once we execute the transaction.

Peter Collery - SC Fundamentals

Okay. With respect to the auto leasing, if in the worst case, you were to put that business in essence into runoff because you were not able to reach satisfactory arrangements to sustain it. What would be implications overtime be for your balance sheet. In other words, could you run that thing off in an orderly way or would there will be material charges that you would have to take in the course of getting out of that business?

Terence Edwards

The answer is yes. We could.

Peter Collery - SC Fundamentals

You could run it off without taking material hits to book value, if it came to that?

Terence Edwards

Yes.

Peter Collery - SC Fundamentals

Okay. Then finally, with respect to originations, if you concluded, I know that again, this is not the way you are thinking, but if you concluded that the origination business was just not a business that was going to be profitable for the next ex-number of years and that on balance it was better business not to be in a business to be in, what would the implications for book value be of getting out of that business?

Terence Edwards

That is a place where we feel so good about our business model that we do not need to go there.

Peter Collery - SC Fundamentals

Well, the reason I ask the questions is that with your stock trading, as you pointed out at 23% of book value, you have an extraordinary opportunity to redirect capital from the least desirable of your businesses and by virtual buying stock to redeploy that capital into what you think is the best of your businesses at a $0.75 on the $1 discount.

It seems to me the market is giving you an extraordinarily strong message that it does not believe you are headed down the right road here. If you think the market is wrong, the greatest possible opportunity you could have would be to redeploy capital from some part of your business and buy another part of the business at a enormous, enormous discount.

I would just be interested in getting your reaction to that strategy. Because it does not make any sense to me at all if you really think all of the businesses are fundamental sound that you would not want to buy the best of them at a 75% discount.

Terence Edwards

The runoff mode gets you to book value.

Peter Collery - SC Fundamentals

Right.

Terence Edwards

Running the business successfully can get you to a multiple of book value.

Peter Collery - SC Fundamentals

If you can free up capital today by going in to runoff, you can take $1 worth of capital and buy $4 worth of book value. That is obviously got to be mathematically, that is got to be much better than hoping that eventually the stock; you do not do anything and hoping that eventually the stock goes from 23% of book value to 150% of book value.

Terence Edwards

We think the steps that I mentioned with regard to becoming a depository, broadening our funding strategy can enable us to get to something beyond book value and that is where our management team is trying to go.

Peter Collery - SC Fundamentals

All right. So I am going to get off. I just want to clarify, just so that I understand you do not see any appeal to the notion that freeing up capital from some parts of your business and using that capital to repurchase shares, at a greater than 75% discount to book value represents an attractive strategy?

Terence Edwards

I do not disagree that it is an attractive strategy, but I think we have got a better longer term strategy.

Peter Collery - SC Fundamentals

Fair enough. Thank you for your time.

Terence Edwards

You are welcome.

Operator

(Operator Instructions). Our next question will come from Loui Scites with Penny Capital [ph].

Loui Scites - Penny Capital

Hi, Terry and George and Sandra and everyone else.

Terence Edwards

Hello.

Loui Scites - Penny Capital

Just follow-up actually on the last discussion and also to what Paul has been saying, given where the stock is, when you talk about acquiring a bank is this a relatively small operation or would you be thinking about deploying a significant amount of capital here and diluting the opportunity available for shareholders at current prices?

Terence Edwards

We are looking at all opportunities, Loui.

Loui Scites - Penny Capital

All opportunities being including big bank acquisitions, I mean relative to how big you are?

Terence Edwards

Yes. I mean this strategy is to look at something that could support a $1 billion in escrows, size assets, we have looked at are in the small as a $1 billion in assets to as large as $10 billion in assets.

Loui Scites - Penny Capital

With the equity component according?

Terence Edwards

As you would look at players out there that have a $1 billion to $10 billion in assets, they do not necessarily have a significant equity component as things stand today. So combining with somebody like us can be capital accretive.

Loui Scites - Penny Capital

Okay. I mean if on the smaller end of that range, I see how that makes sense given the advantages you would have from having a bank license at the larger end, I mean I do not know if I just assume 20 times leverage putting $500 million in equity into a bank with your stock at $6 it is very difficult to understand.

Terence Edwards

You asked what we are looking at, Loui. We are looking at all options in between. Going back to the question I got earlier, if I do not disclose everything on this call when I get a question, then I have insider information and I can not buy the stock.

Loui Scites - Penny Capital

I mean can we agree conceptually with regards to the previous callers question, I mean, it bear minimum the shares are worth runoff value, which to your point is somewhere in the mid-high 20s, and you think the company is worth much more than that, if you continue to running at, I just want to make sure that if you deploy $500 million in capital towards the bank that you are looking at similar, I do not know 6 TARP in returns.

Sandra Bell

Can I say one thing, Loui?

Loui Scites - Penny Capital

Sure.

Sandra Bell

We have a 1.5 billion of equity on 10 billion of deposits or assets that represent particularly when you play around with the numbers, 16% tier-one capital ratio and a 15% tangible book ratio. There are many opportunities in the banking field that require virtually no actual capital investment, so it can be as Terry said very accretive to earnings particularly when you can look at the use of deposits to improve our funding position.

So I would not expect that some of these scenarios would be considered as they were significantly dilutive in the long run to our shareholders.

Loui Scites - Penny Capital

Okay. Thank you.

Terence Edwards

You are welcome.

Operator

Now at this time, I will turn the conference back over to Mr. Edwards for any additional or concluding remarks.

Terence Edwards

We thank everyone for joining us on this call and we look forward to updating several of you during the quarter. As Sandra said, she hopes to get to know many of you. Then, we will be back at the beginning of next year with an update on the fourth quarter. Thanks again for listening everyone.

Operator

This concludes the PHH Corporation 2008 third quarter earnings conference call. Once again, ladies and gentlemen, the replay will be available in approximately two hours at the company's website at www.phh.com, or by dialing 1-888-203-1112 or 1-719-457-0820, using pass code 4935751. It will be archived until November 25th, 2008. You may now disconnect.

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