PHH Corp. Q4 2008 Earnings Call Transcript

Mar. 2.09 | About: PHH Corporation (PHH)

PHH Corp. (NYSE:PHH)

Q4 2008 Earnings Call

March 02, 2009; 12:00 pm ET

Executives

Terence Edwards - President & Chief Executive Officer, PHH Mortgage

George Kilroy - Chief Executive Officer, PHH Arval

Sandra Bell - Executive Vice President & Chief Financial Officer

Mark Danahy - Senior Vice President & Chief Financial Officer, PHH Mortgage

Nancy Kyle - Vice President, Investor Relations

Analysts

Jade Rahmani - KBW

Paul Miller - Friedman, Billings, Ramsey & Co

Louis Syke - Tennant Capital

Patrick Donnelly - Blackrock

Barry Groveman - Deutsche Bank

Operator

Good morning ladies and gentlemen. Welcome to the PHH Corporation 2008 Fourth Quarter and Year-End Earnings Conference 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 key queue to ask your questions.

Today’s call is being webcast and recorded for replay purposes. The audio replay be accessed either on the company’s web site at www.PHH.com or by telephone at 1-888-203-1112 or 719-457-0820 pass code 4079569 approximately two hours after the conclusion of this call. It will be available until March 17th, 2009.

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 introductions.

Nancy Kyle

Thank you, Rachel. Good morning and welcome to the PHH fourth quarter and year-end 2008 earnings conference call. On the call today are Terry Edward, President and Chief Executive Officer of PHH Corporation; Mark Danahy, President and Chief Executive Officer of PHH Mortgage, George Kilroy, President and Chief Executive Officer of PHH Arval and Sandra Bell, Executive Vice President and Chief Financial Officer, PHH Corporation.

After the prepared remarks, we will begin a question-and-answer session when other members of our management team will be available. Today’s call will be supplemented by a presentation that is posted on our website at www.phh.com. You are invited to follow along as we go through each slide. If you did not receive a copy of the earnings release we issued on Friday, you may access this from our website at www.phh.com or you may call our investor hot line 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 that we will make include, our expectations regarding a profitable first quarter, our assumption about a $27 billion mortgage production break-even level assuming 80 basis points of margin.

Our expectations that 2009 market conditions could result in the mortgage servicing segment underperforming, our assumption about 2009 being the low point for our fleet management services segment, our expectations about the slowing trend on vehicle counts not turning upward in this economy, our discussions about more permanent sources of funding for the fleet business, our funding capacity being sufficient to handle expected needs for the mortgage business, the recent rating agencies downgrades resulting in a cost increase, but having no other impact on our funding facility, and our overall comments surrounding health and our efforts to add a deposit to our institution.

Our actual results may differ materially from those discussed on this call. Please see the Risk Factors in our 2008 Form 10-K when it becomes available. For a description of issues that may lead to different results. Please call our hotline if you would like paper copies of any of our filings or you may access them on our website. And now I would like to turn the call over to Terry.

Terence Edwards

Thank, Nancy. Good afternoon, everyone. I will begin our call with a brief or view of some of the key information that we provided in the press release on Friday, and then Mark, George and Sandra will provide detailed information about 2008 and our plans for 2009. After that, we will take questions.

So if everyone could turn to page six. As those that have followed us closely know, the key to PHH has been getting mortgage production segment to become a consistent profit generator. The good news as Nancy just said and as we said in the press release is we were profitable in December 2008 and we were profitable in January 2009.

Margins and volume versus have also been good in February, so we expect a profitable first quarter for production. December was driven by three factors, one, cost take-out that Mark will cover, which we believe lowered the volume required to break-even. Two, lower rates, which is meant increased (Inaudible) volume, Government action taken by November 25 probably brought rates down.

Three, better industry-wide pricing that Mark will also touch on. The positive for production is offset by having to write down our MSR value to 99 basis points from 129 basis points. This adjustment was all accounting driven and not economic or cash driven.

As previously discussed, we removed the servicing hedge back in the third quarter because about half of our portfolio was unable to refinance, because of lack of product or lack of equity in the property. In addition, the cost of hedging was $8 million to $10 million a month and we wanted to save that cost. Therefore, our hedge became 100% based on the natural business hedge from the production segment.

If Government action is to keep rates down are successful, we believe the natural business hedge provided by the production segment will recapture any economic value lost, because our origination share is about two times our servicing mark share, meaning for every loan that pays off, we believe we would add two new loans to the portfolio. If rates move up, we believe this lost accounting value could be added back to the degree rates increased.

Back to production, our market share is increasing for two reasons. One, because we are signing new relationships and two, our existing relationships are capturing more share because competitors have disappeared and also because mortgage brokers are no longer the factor they once were in the marketplace. Traditionally, brokerage share was about 30% and it is down to 20% for 2008. In addition, we think the run rate is even lower than that. So that means good things for our clients.

Turning to page seven, in the fourth quarter, if you adjusted the cost of debt in the vehicle business plus reorganization costs, the quarterly run rate looks more like the information George will cover on page 24 of the presentation, which provides adjusted 2008 results.

As you can see on this page, the actions listed on the slide are what must be done to get us back to a more normal run rate. However, because the lease book has an average three-year life this will take some time. It is our expectation that 2009 will be the low point for this business. As I said in the press release, we expect to be down $30 million to $40 million from 2008 to 2009. We expect leasing margins to improve late in 2009 and continue into 2010.

Turning to page eight, we provide the segment GAAP results and as Mark will talk about, the segment loss was $93 million for production for the year, but again to repeat, the fourth quarter was break-even and there are some adjustments that need to be made to understand what the volume, what the production segment run rate really looks like as we enter 2009.

The mortgage servicing segment was all driven by, was largely driven by the fourth quarter negatives associated with writing down the MSR, and the Fleet Management services segment came in at $62 million. George will also, as we said on page 24, show what the adjusted results look like. And then, we had the $42 million was from the payment from the break-up from the transaction that didn’t close last year.

Shifting to the 2008 balance sheet, you can see the mortgage loans held for sale is down pretty significantly. It is driven by lower volume, but more importantly, faster turn times. As Mark will talk about our business is almost all Fannie, Freddie, Jennie Mae and we are turning those loans pretty quickly through the pipeline.

As you can see, we wrote down the MSR, we also wrote down some goodwill during the third quarter and other assets are largely down, because of decline in accounts receivable related to servicing sales a year ago. Other liabilities are down, because last year we had derivatives and this year we don’t have any derivatives in place to hedge the servicing portfolio.

Debt-to-equity is just under 5, so tangible debt-to-equity is just under 5:1 and tangible book value is $22.13 per share. So, now that I have told you what was in the press release, the rest of the team will provide more details about each business and Sandra will the plan to fund our businesses during 2009. So Mark, why don’t you get us started with the mortgage slides?

Mark Danahy

Thank you, Terry. I’m happy to have this opportunity to share with you the 2008 results and our outlook for the mortgage business this year starting on Slide 11. As you know, 2008 was an extraordinarily difficult year for anyone in the mortgage business. And we believe, we are now well positioned to take advantage of the opportunities that 2009 will present.

First, we reduced costs to the point that we believe we will break-even in the production segment assuming $27 billion in origination volume at 80 basis points of margin, that 80 basis point margin assumption is conservative relative to current pricing. This level is down from a year ago when we said break-even was $39 billion with margins at roughly 70 basis points.

In our production segment, we were profitable in December 2008 and break-even for the fourth quarter, which is traditionally a difficult quarter. Given the current market environment, we expect our production segment to be profitable in the first quarter of 2009.

The secondary market is limited to conforming Fannie, Freddie products or Jennie Mae eligible loans and as a result we are turning that inventory in less than 20 days on average. From a competitive standpoint, all loans are well documented, well underwritten and pricing is rational.

Moving to Slide 12, you will see a chart of our volumes and margins over the last several quarters. When we talk about margin in this context, we are measuring what we can sell the note for relative to par and we include an expectation of the cost of hedging and any expected interest carry well in warehouse. We also include any discount points paid by a borrower to lower their rate. The value of servicing, origination cost and any other borrower-paid fees are all separate from margin. So margin to us really reflects the market pricing of the note.

On this chart, the thing to focus on is that the average quarterly margin increased throughout 2008 even as our origination volumes were declining. Historically, as volumes declined, the competitors would price more aggressively to maintain their production capacity.

In 2008, we saw the competition be more rational about pricing even growing margins in the face of declining volumes. This may well be attributable to the consolidation and failure of a number of our competitors. Take this a step further, we saw evidence that the industry has limited capacity and that margins can increase as demand picks up. We experienced this in January of this year.

The decline in the par mortgage security rate was far greater than the decline in rates available to borrowers. As a final note, on this slide, you can see the average quarterly margin in 2008 was above the 80 basis point benchmark, we have said for break-even at $27 billion.

On Slide 13, we show you our segment results for the production segment, we presented this format before where we adjust the results to present the production segment on what we believe is a normalized basis. As you can see, the segment lost $93 million for the year.

In the first two bars, we adjusted for the goodwill write down and the benefit from transition to fair value, which are both basically one-time accounting results. We then add back $69 million of mark to market adjustments on loans held for sale for products that were not saleable to the agencies including of course nonconforming, second lean products, scratch and dent loans among others. These adjustments reflect the ill illiquidity of all non-agency mortgage products.

We next adjusted for some of the extreme hedge losses during 2008, which relate primarily to the times when the market uncertainty of the fate of Bear Stearns and Lehman Brothers generated significant market volatility. And finally, we have added add back severance costs. The adjustment brings us to a result, which is reflective of a more stable market environment and result in $21 million of segment profit on $34 billion of originations, still in a challenging year.

Moving on to Slide 14, let’s discuss the production outlook for 2009. We already said, we expect to break-even at $27 billion with 80 basis points of margin. We are committed to scaling our business efficiency and quickly to meet market conditions. We expect our volume to be roughly 2/3 originated for sale and 1/3 originated for a fee; the loans originated for sale will enjoy the benefit of increased margins.

We also said as origination volumes increased for every additional $1 billion in volume, we expect $8 million to $12 million improvement to the segment profitability. I wanted to make sure you had these key assumptions as we move to the next page, because they are the lynch pins of the matrix we are providing.

This matrix on Slide 15 provides a summary of projected production segment results under a variety of margin assumption. The results presented in this matrix will generally follow the simple assumptions I just mentioned regarding changes in volumes and margins.

This business is far more complex, but I think these simple assumptions will help you understand the potential for production segment results under a variety of potential scenarios. At the risk of sounding like a voice over in a commercial, please note these are projections that normalize results for this segment and that other market factors can materially change these outcomes.

Also know that as projections they may vary from this matrix as noted at the bottom of this slide. On Slide 16, before moving to the servicing segment, I wanted to leave you with a summary of our tremendous success in signing new PLS clients during 2008 and highlight that we have a strong list of perspective clients going into 2009.

Now, onto the servicing segment beginning with Slide 17. The servicing results for the year were dominated by valuation adjustments on the MSR asset including a $390 million negative adjustment in the fourth quarter as primary mortgage rates; again the rate of borrowing we got on a new loan declined approximately 90 to 100 basis points from the beginning of the quarter landing right around 5%.

Borrowers may have seen lower rates if they were being to pay points. The servicing results for 2008 were also dampened by increased charges for foreclosures and loss reserves and increased loss reserves for our HM Reinsurance Business. Total delinquency rates on our servicing increased to 3.67%, which we believe compares favorably to industry averages.

In a normal stable market, we believe the servicing could generate a segment profit between 9 and 11 basis points of the capitalized portfolio excluding valuation adjustments to the asset and hedging results if any. We have $130 billion in capitalized servicing. From a cash flow perspective, we believe the servicing segment could be expected to generate between 24 and 28 basis points of cash flow, on the capitalized asset again excluding hedge results. The difference between these is affected the amortization of the MSR asset as we collect our fees each month and prepayments are realized.

Looking into 2009, we expect the market conditions will result in the segment underperforming. As you can see, low earnings rate on our float balances, high foreclosure charges, additional loss provisions for the reinsurance business and higher costs due to higher level of delinquency on the portfolio will be a drag on the servicing results for 2009.

Moving to the next slide, 18, we present the results of the servicing segment adjusted to what we believe is a normalized result. In the first bar, we back out the valuation adjustment on the MSR asset due to changes in market assumptions net of the hedge results from earlier in the year, which total $466 million, again at which $390 million occurred in the fourth quarter.

We also adjust for $36 million of increased foreclosure costs and $17 million loss from Atrium, which represents the increase in loss reserves over and above the premiums collected last year. The adjusted servicing segment shows a normalized profit that approximates 10 basis points of the capitalized servicing UPB.

Moving to Slide 19, let me talk a little about the mortgage book, the MSR asset is valued at 99 basis points at year-end. Simplistically, this gives it a three year life on our 33 basis points of service fees. We provide on the slide, a high level cut at segments of our portfolio that we would expect to have an impediment to refinancing under the current market conditions even in lower rate environments.

Year-to-date prepayment fees are tracking well below the model’s fees, which seem to support this expectation. While the specific details of the latest Government initiatives to help the housing sector are not yet available, we believe they will be directed at helping borrowers that have little or no equity in their homes. This may be accomplished by either removing low equity of an impediment to refinancing for some borrowers or offering a program where we may earn fees for the modification of a loan and we may also retain servicing rights on what is now a performing loan.

As Terry noted, we believe the revenue opportunity on the production side could more than offset the economic value loss due to loans prepaying. On the following page, Slide 20, we took the opportunity to summarize the recourse and reserves for mortgage on one page; we took the opportunity to summarize the recourse and reserves for mortgage on one page. All of this information will be contained in the 10-K.

The take away from this page is that we continued to build reserves in 2008 with additions to the reserve of $69 million versus realized losses of $37 million. Some level of success from the Government programs could reduce the need to build reserves, which may become evident later this year.

On Slide 21, we wanted to provide some additional insights into Atrium, our reinsurance business. We increased our projections of ultimate paid losses for Atrium, based on assumptions regarding economic trends, including delinquency in the portfolio, home price declines, unemployment levels et cetera.

There are no explicit assumptions regarding the impact of Government stimulus or programs directed at housing. We are expecting to ultimately have to pay claims for the 2004 through 2008 book years and do not currently expect to pay claims for book years 2003 and prior. At this point, we project losses at the contractual maximums for book years 2006 and 2007 and almost there for 2005.

So the risk of projecting higher losses is limited to the 2004 and 2008 book years as well as potentially the 2003 and prior books. The upshot is that while future premium income will be used to build reserves, we believe we may not see the increase in the projected ultimate losses that we saw last year.

Moving on to Slide 22, let me bring the mortgage portion to a close with risks and opportunities. Right now, the mortgage markets are driven by fed policy. It is unpredictable and it can change quickly. The fed has stated its commitment to keeping mortgage rates slow to stimulate and revive the housing market.

More specific details of the homeowner affordability and stability plan will be out later this week. We expect this will create opportunities for certain borrowers to lower their mortgage payments either by refinancing or through a loan modification. As I indicated earlier, we believe this may be favorable for our business.

The (inaudible) program may create liquidity for jumbo products and open a mark for our mortgage business. The need for scale to compete helps our PLS business. That concludes my part. Thank you for your time and attention. Now George will discuss the Fleet Business.

George Kilroy

Thank you, Mark. Good afternoon. If you go right to Slide 24, this is the slide that Terry talked about and what we are going to show is the two major impacts that we had on earnings in 2008 to try to show you what a normalized 2008 would be. And the $7 million termination positive fee was a positive for us offset by about a $40 million negative impact due to the mismatch and billing rates to funding costs. Of that, approximately $40 million, $12 million was a result of index mismatch and $28 million was a result of increased bank fees. And we will share with you the actions we are taking to correct that in a moment.

Go to Slide 25, this represents our year-over-year change in the number of vehicles in our leased portfolio and those units enrolled in our three major service programs. Reduced counts are a result of the overall economic slow down, less vehicles per client and clients with whom we no longer provide the service. We expect this trend to slow in 2009, but probably not turn upward in this current economy.

If you go to Slide 26, we spent quite a bit of time in resources throughout most of 2008 and continuing into 2009 in a client-by-client effort to change pricing to more closely match our anticipated funding costs. In 2008, we changed the index on the majority of our floating rate leased clients current portfolios to an index that better reflects the asset-backed market.

We have changed virtually all of our pricing for leases initiated in 2009 to also reflect our costs. In some cases, we were not able to come to an agreement with clients on the new pricing and have had to suspend accepting orders until we can. In addition, we have closely evaluated those clients who only use PHH for leasing for realistic additional fleet management services opportunities and have in some cases elected to suspend our leased line with them if those opportunities will not legitimately exist.

As new units work their way into the fleet portfolio, we believe our margins will improve. As Terry said, particularly in late 2009 and 2010, and beyond we will discuss funding for fleet leases in a moment.

If we go to Slide 27, some issues that we need to talk about for 2009. We are having frequent dialogue with our key partners in the fleet business, particularly the U.S. vehicle manufacturers. They remain committed to commercial fleet and continue to be very active in this market. We are also having discussions with the non-US based manufacturers to determine their appetite for the commercial fleet market in the U.S. and in Canada.

PHH has a history of managing our costs very closely and that will continue in 2009. We believe our severance program in late 2008 should save us approximately $9 million in 2009 and beyond. Many of our costs are tied directly to volumes and we are adapt at moving quickly, if volume drop-offs are anticipated and then realized.

PHH customers are major corporations in North America and are being challenged by the current economy just like everyone else. Although we don’t have any client concentration greater than 5% of our portfolio or any significant industry concentration, we constantly evaluate the credit worthiness of our customers.

As a result, we have averaged less than 7 basis points of write-offs over the last ten years, this diligence will continue. Now is not the time for PHH to turn inward. Our clients need us now more than ever. Our ability to analyze their fleet productivity and costs and make recommendations to improve will become even more important in this economy and our plan is to make sure that we continue to be outstanding in this area.

If we go straight to Slide 29, we will spend a couple of minutes on the status of funding for Fleet Business. You are probably aware that last week we were not able to come to an agreement with our banks on the renewal of Chesapeake and we chose to let both series begin to amortize.

Remember, not renewing is not an event where we have to come up with $3.3 billion to immediately pay it off. It is paid down with the lease payments associated with it. On Friday, we were able to successfully negotiate a 30-day extension of a reduced Chesapeake 2006-1 on basically the same terms as before.

The extension will provide us funding for one of the highest volume loans for new vehicle deliveries and provide additional time to negotiate a longer-term renewal. Because we had anticipated that Chesapeake may not be renewed, we have been in a number of discussions with a number of other sources for more permanent funds for the Fleet Business including individual banks and a subset of our current lenders.

In addition, we continue to pursue a depository bank, Sandra will talk more about that and we have been very active in insuring commercial fleet leases that are listed in any Government support programs in the U.S. and Canada. (Inaudible) and CSCF in Canada. We are also taking steps to prioritize and manage our commitments for new vehicles in order to maximize the funds we have made available and we are going to use to fund vehicles in this period. Now I will turn it over to Sandra. Thank you.

Sandra Bell

Thank you, George. Good afternoon, everyone. Following up on George’s update of the funding situation for fleet, we have provided a discussion of our funding capacity for our mortgage production business on page 30. We believe our funding capacity for the mortgage business is sufficient to handle our expected needs for the business.

The RVS repurchase facility () renews at our option in June of this year for another 364 days until June of 2010. The only condition to renewal is maintaining a total of $3 billion in capacity for PHH mortgage including the RBS facility for which our Fannie on committed line qualifies.

In combination with the RBS facility, we more than meet this requirement. The covenants in the RBS facility tracks are in our revolver, which I will review in a moment. Given our comfort level with the amount of available capacity on the RBS and Fannie facilities, we elected to allow the Citi facility to lapse without renewal.

Our PHH home loan facility will mature in May of this year. Commitments are currently amortizing, the end of the year we were at $225 million, the current availability is $165 million and it will reduce to $125 million at the end of March. As capacity on PHH home loans has declined, we have been able to utilize the RBS line to fund production sold to PHH mortgage.

We are continuing to evaluate a number of options to replace this facility from process changes internally to new lending arrangement for the remainder of the home loans production. As such, we believe that we will have alternatives to fund home loans production prior to the expiration of this facility.

On page 31, we summarized the remainder of our funding capacity and our continuing efforts to increase our flexibility. Committed unsecured revolving credit capacity of $260 million was up from $211 million at the end of the third quarter. The recent downgrades resulted in a relatively small increase to our cost of these funds of approximately $3.1 million for the remainder of 2009, but had no other impact on the facility.

As a reminder, we have two financial covenants in the facility, which we monitor very closely, a leverage test, which limits our debt to tangible net worth to 10 times. As Terry mentioned earlier, at the end of December, we were comfortably inside that covenant at 4.98 times. The second test is a minimum net worth maintenance covenant, primarily driven by the valuation adjustment on the MSR during the fourth quarter, our pretax cushion declined to $380 million at the end of the year.

Since year-end gives us positive trends and profitability for the quarter, we continue to have a significant cushion relative to that covenant. The FED alone long with the U.S. Treasuries proposed this () asset backed securities loan facility, which is anticipated to help unfreeze the U.S asset backed markets. First part targets towards consumer asset classes.

The Government is indicated and is considering up-sizing the program and in the second phase adding other asset classes including commercial assets and non-conforming residential mortgage collateral. We have had discussions with both treasury and the FED and provided them with detailed information regarding our asset classes and the structure of our financing arrangements, both conduit and term.

In the meanwhile, the existence of the program, which is scheduled to be implemented later this month, is expected to begin () the asset backed markets during the year, potentially even for asset classes not included in first phase. As George also mentioned, we are working in Canada with their Government equivalent to () and secure credit facility.

Quick update on our efforts to add a depository institution in our mix; in mid-December, we filed our application with the OTS. It is currently under review with both the OTS and the FDIC. We have met with both agencies and are continuing dialogue on both fronts. At this point, we do not have any specific timeframe for comments or next steps in connection with this application.

The OTC has established a new committee to review non-traditional charter applications such as ours. We filed an application with that agency as well and have begun the dialogue with them around the availability of (). Finally, we have engaged advisors to begin to help us with evaluate potential acquisitions as an alternative to a charter application.

We continue to view the addition of a depository as an important strategic focus to leverage our business model at both fleet and mortgage. I will now turn it back to Terry for questions.

Terence Edwards

Thank, Sandra, thanks Mark; thanks George. Rachael, we will be happy to take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Jade Rahmani - KBW.

Jade Rahmani - KBW

I wanted to ask if the $30 million to $40 million revenue decline you expect in the Fleet Management business in 2009 is based on the 4Q run rate of $5 million in pretax profit as the starting point.

Terence Edwards

If you take the $5 million on a run rate basis and you multiply it by 4 you get to 20. So, going from 60 down to 20 would be the high end, the 40. But included in the fourth quarter was some reorganization costs. So, the run rate when you adjusted the re-organization cost was better than 20 if you will, however, we will be impacted by some of the economic effects of the year as well as the negative lease spread issue we have been dealing with.

Jade Rahmani - KBW

Are there any further restructuring costs expected to be incurred this quarter.

Terence Edwards

They are not.

Jade Rahmani - KBW

On the mortgage side, can you give us your rate lock volume for the fourth quarter, we assumed a spike in the rates at quarter-end was a big driver of the increase in () income and the related question is the kind of pull through rates you are seeing from current loan to applications.

Terence Edwards

I will take the second question first. Pull through is about 60%. Normally would be 68% or 70% in the Refi market. The difference is fall out related to properties that do not appraise. We are looking up the other question and we will provide that answer later in the call.

Jade Rahmani – KBW

On the MSR mark, can you discuss the main inputs that were used to drive the mark? And secondly, how you would use the new housing plan that allows high LPV Refi’s into your calculation?

George Kilroy

We will start with the second part of the question and then hand it off to Mark. When we evaluated our portfolio at year-end, those loans that were unable to refinance were not a part of our calculation. In other words, we assume that they could refinance when we arrived at the 99 basis points.

So, that value has already been taken out and as both Mark and I indicated, with margins where they bend, particularly when volume picks up, the economic value lost in the pay by the economic value created with a new origination, both in terms of the amount created per origination and then we are benefited by the fact that we have twice the origination share as we have the servicing share. So we would be adding two loans for every one loan that pays off. Mark you want to take the first part of the question.

Mark Danahy

Let me go back to that first quarter, we took about $8.1 billion in first morgue applications. And then the first part of your, of the second question?

Jade Rahmani – KBW

The rates lock volume.

Mark Danahy

That was $8.1 billion.

Jade Rahmani – KBW

Okay. The main inputs that you have assumed that drive the MSR market?

Mark Danahy

The rate assumption, it would have been based on the interesting environment as of December 31. Using forward rate curves off of the spot yield curve.

Jade Rahmani – KBW

Is there any reason to expect further marks on the MSR despite the fact that rates quarter to-date haven’t changed much?

Mark Danahy

If rates have not changed much, we will go through a detailed analysis of the aggregate available data in the marketplace but if rates are not changing much, the refinance side shouldn’t change much and therefore you would expect it to be similar.

Jade Rahmani – KBW

Okay. And then, just the last question would be how scaleable is your current origination platform is, how much volume could you run through it without having to add additional head count?

Mark Danahy

We would add additional annual costs to accomplish closing more loans, but we have plenty of scale without adding a fixed cost component.

Terence Edwards

One other point of clarification, the fact is interest rates are up a little bit from where they were at year-end. As Mark indicated, all things being equal, if rates lined up at the end of 2009 where they closed 2008, we would expect little to no adjustment to the MSR value. To the extent that rates drift, up we would add back some value to the degree that interest rates rise, how far this quarter rates are up a little bit.

Operator

Your next question comes from Paul Miller - Friedman, Billings, Ramsey & Co.

Paul Miller - Friedman, Billings, Ramsey & Co

Can we go to Slide 30 again and can you explain to me, you said your break-even is at $27 billion my guess is you hope to do greater than $27 billion. Do you have, given this funding, your mortgage funding overview, can you walk me through a little bit how you enough funding for that, because I just don’t understand it.

Terence Edwards

Because the loans are plain vanilla, Paul, turning them in-between depending on month 17 to 19 days, we have got $1.5 billion in capacity from RBS and then we have got the equivalent of $1.5 billion or more in uncommitted capacity from Fannie Mae.

So for all of the numbers that are provided on the matrix up until the $40 billion, we are quite comfortable with our ability to finance and close loans.

Paul Miller - Friedman, Billings, Ramsey & Co

You don’t need, Citigroup you said you are going to let run off, you really don’t need to replace that at this point, given your current outlook for production.

Terence Edwards

Correct. In addition, the loans with our PLS clients are funded by our clients for the first ten days, before we buy them and then sell them into the secondary market. Then the other thing to keep in mind, we made the assumption is about 1/3 of our production will be fee based, where the loan doesn’t even enter into our warehouse. So for example, some of our clients are still making a market in the jumbo business and those loans are closed on a fee base and never touch our balance sheet.

Paul Miller - Friedman, Billings, Ramsey & Co

Where do you make most your money though, do you make most of your money by putting it in your warehouse; right rather than the fee base. What’s more profitable I guess Terry.

Terence Edwards

It depends on margins, but generally speaking running it through the warehouse and selling into the secondary market particularly in the environment that we are in now with the higher margins, with the better pricing that exists in the marketplace, that’s where we make more money.

Paul Miller - Friedman, Billings, Ramsey & Co

And moving onto the servicing side, have your CPR rates changed drastically? You made a statement I believe that you said your model, the actual prepayment rates are way below the model or above. I forget the comment you made.

Terence Edwards

Yeah, so far this year, we would have modeled prepay speeds at about 19% for the life of the asset at year-end. And so far, January and part of February, speeds look like 13%.

Paul Miller - Friedman, Billings, Ramsey & Co

That’s what is kind of confusing to me. This is just not, if the overall market, because we saw the index really spike. We know pull through is not as big as it used to be in the past, but we haven’t seen any movement in CPR rates. When should we start to see that you think?

Terence Edwards

As Mark indicated, the industry as a whole is cut back on capacity. It takes a little longer to process loans than it would traditionally, especially when you get hit with the surge that the industry was hit with in December and January. So processing time is a little longer. So, we expect the speeds to pick up a little in March as loans close from the surge in January.

Paul Miller - Friedman, Billings, Ramsey & Co

Okay. And then the Obama plan, I mean you guys don’t really service a lot, I mean you guy versus been very plain vanilla over the last couple of years, probably one of the few shops that didn’t get involved in all of the risky stuff, but does, are you having trouble with I guess the your interest flow and your servicing portfolio. And are you prepared for these type of loan modifications structurally that Obama is highlighting.

Nobody has really gotten the details of everything yet, but just wanted to know what type. I know you do mention that is a risk to the servicing side, but if you can give a little more detail into that?

Terence Edwards

Yeah. I mean as you say, there aren’t any details yet. So, the industry as a whole is going to work through this. The world is telling, the administration is telegraphed to the world that these rules will be out on March 4. So it is going to be interesting, an interesting day for everyone in mortgage industry on March 5 as just about everybody in America calls us and every other mortgage lender on the planet in the planet to see if they are qualified for either a refinance or a loan modification. So, as you say, the devil is in the details.

Generally speaking as Mark indicated, because loans that can now Refi that couldn’t because of the economics, we think will make up for the loan that pays off with the better economics associated with that loan, and then loans that do modify, that means the loan stays on our book longer than it was going to because in theory it might have been headed for bankruptcy or foreclosure.

In addition, as we understand it, we get a $1000 to modify that loan and we get another $1000 for the two following years to the extent that loan remains in good standing. So, we think that that should be a positive, but as you indicated, we are waiting for the details just as everyone else is.

Paul Miller - Friedman, Billings, Ramsey & Co

And on the production spreads right, you are finally getting I guess you are making the assumption, are the spreads above 80 basis points now, I don’t know if you can make that statement, because we are right in the middle of a quarter, but you said that you are expecting it to be profitable in the first quarter. Are you getting spreads greater than 80 or can you make that comment?

Mark Danahy

Our margins are above 80 right now. Pricing margins have been above 80 all quarter.

Terence Edwards

As Mark indicated, on the slide that he provided that showed the margins rising, it wound up the year at the 120. And that’s kind of where we are seeing things as with we speak.

Operator

Your next question comes from Louis Syke - Tennant Capital.

Louis Syke - Tennant Capital

I have a couple of questions also on Page 15 and digesting that. So, did you say that the margins in the first quarter, to-date were around 120 basis points? I thought it was even better?

Terence Edwards

They’re, we are currently pricing about 120, and during the month of January, when interest rafts were at all-time lows, we would have been at the high end of the chart. Ordinarily, Louis, we wouldn’t have 200 on this page, but since we experienced 200 during January, and it was brief, but it was touched. So we put it on the slide.

Louis Syke - Tennant Capital

So year-to-date it would be, I don’t know 150 or something like that?

Terence Edwards

Yeah, now you still have hedge results that you have to deal with and pull through and things like that that can cause these numbers to move a little bit, but generally speaking, margins are as good as we have ever seen them and hopefully that will remain the case, since the industry is way smaller than it once was in terms of the number of players.

It is consolidated at the top with Bank of America, Wells-Fargo and J.P. Morgan Chase, and to the extent that those institutions are raising margins on just about everything that they do, one would hope those margins would remain high in the mortgage business and we are fast followers there.

Louis Syke - Tennant Capital

Yep. And on the volume side, when, I mean, what kind of annual volume level are you tracking to year-to-date?

Terence Edwards

We are right now, Louis we are tracking well above the 27.

Louis Syke - Tennant Capital

That much is clear.

Mark Danahy

I would tell you to look at the next. Right now, realize that number changes dramatically with changes in Government programs, and we may see the results when we get the details from Obama’s latest plan, we may see volumes pick up from there.

Louis Syke - Tennant Capital

So $32 billion, so that is the current run rate or is that also including the stronger volume generated?

Terence Edwards

As Mark indicated, it is kind of lumpy, he may not have used that word, but I will use that word and it comes in fits and starts. So, when, in January, when rates hit all-time lows you couldn’t pick up a newspaper or turn on the television without having someone saying interest rates are at all-time lows.

So at that point in time, you are looking at a run rate in the 40s. Eventually that burns out. When Mark indicates the 32, we are pretty comfortable with that level just based on what we are seeing since things have slowed down a little bit. Things did slow down from the hectic pace we saw in January and February. But, that gives us comfort with saying you know, 32 should be achievable and to the extent that $79 million more people across the country now have become eligible for refinance because their property is not under water anymore that could mean significant run rate in terms of volume.

The other way to look at it is our overall market share businesses is about 2% and the latest Fannie Mae forecast is $2 trillion. So 2% on 2 trillion would mean more like $40 billion.

Louis Syke - Tennant Capital

And then if we think about the MSR valuation in your comment that actual prepayment fees have been about 2/3 of the model prepayment, can you give us a sense for how much higher you would mark the MSR, if you marked it to be more consistent with actual prepayment fees. I realize that the accounting doesn’t allow you to do that, I just wanted to get a sense for the magnitudes involved?

Terence Edwards

We’d actually have to run that through the models Louis, you might pick up another handful of basis points. I’m being a little vague there, because I prefer to run the model and actually calculate that result.

Louis Syke - Tennant Capital

But I mean at the very least, if you are saying roughly 50% of your servicing portfolio is not really eligible to Refi, but the accounting basically assumes 100% and I guess you could say in the lat quarter alone, if you mark the MSRs down by $400 million roughly there would be $200 million left.

Terence Edwards

Potentially, I mean this really becomes a timing question. The way we are thinking about this now Loius is our production business is well balanced against servicing to replace any loan that prepays; we should be able to replace it and replace it at a profit level in the current market that would offset the value of lost and the refinancing of the loan or the prepayment of the loan. So we think of it in terms of that economics and less though based on the valuation of the asset, which we think is somewhat arbitrary accounting rule as you had suggested.

Louis Syke - Tennant Capital

And if you think about it differently, when you talk about the 9 to 11 basis point sort of normalized level of servicing profit and hedge losses. Is that reflective of the model prep-paid fees or actual prepaid fees?

Terence Edwards

That would be reflective of what you see in actuality, not necessarily in terms of what a model would show.

Louis Syke - Tennant Capital

In other words, the 9 to 11 basis points would assume that the prepayment fees are lower than what you modeled?

Terence Edwards

That’s right.

Louis Syke - Tennant Capital

Then a couple of questions on the feat side; I just want to understand this $30 million to $40 million incremental hit in ’09 related to the funding mismatch and the weaker volume. How much of that is each of these factors roughly. How is volumes and how much is funding?

Terence Edwards

It is about 50-50 Louis.

Louis Syke - Tennant Capital

For the vast majority of ‘08, the higher funding cost were in place with the existing facilities, so why would there be such a sizable incremental hit. Are you assuming that you are renewing it at worse terms or what are you assuming?

Terence Edwards

There were step-ups in the cost of funding during the year that hit later in the year.

Louis Syke - Tennant Capital

This is on the index mismatch basically on the ADCT?

Terence Edwards

Just the basic cost of the funding; there were step-ups in the program.

Louis Syke - Tennant Capital

But the conduit had fixed fees, right though, it didn’t change?

Sandra Bell

No, the conduit fees had step-up, it started lower in the early part of the year and stepped up during the course of the year.

Louis Syke - Tennant Capital

It wasn’t a fixed fee over the course of the year, the life of the conduit?

Sandra Bell

There were specific step-ups.

Louis Syke - Tennant Capital

Can you just, I think you mentioned something in that respect, but I didn’t completely catch it. So, of the new leases that you are putting, you were putting in the fourth quarter, but also that you are putting in now. How many or what percentage of those have economics that has essentially equivalent to the historical levels when ‘07 and prior?

George Kilroy

Louis, there is a few different scenarios that new leases start, somewhere on fixed rate and all of those have had their rates changed for new deliveries to match what our cost of funds is going to be. A pretty good portion of our portfolio agreed to make a perfect match, we call it a cost of funds.

So, we pass on the exact cost of funds to our clients and some others that have wanted to continue to use a Wall-Street Journal track able index. We have priced those with sufficient mark up that we believe they are going to be pretty close to what our anticipated cost of funds is and what we have done is actually for those who have not agreed to one of the other of those changes.

We are no longer accepting new vehicle orders from them until they make the change. So, we should be for new leases going into this year fairly well matched with our cost and what our bill rate is.

Louis Syke - Tennant Capital

And George, the change was effectively implemented at the end of the year.

George Kilrov

It wasn’t any hard drawn line and we actually some of it back in the late ball. For example our fixed rate leases we could no longer accept deliveries under fixed rate leases that were based on treasuries back as early as November. So, it’s been a little bit staggered, but right now pretty much everything that is coming on. We have had to come to an agreement on what the new rates are going to be.

Louis Syke - Tennant Capital

But wouldn’t margins start improving right away basically with every quarter as the older leases exit and the newer leases go in?

George Kilrov

That’s the plan. A little bit of what we’ve seen is a pretty significant drop-off in new vehicle orders, as some of our customers business has slowed down a little bit, their natural tendency is want to extend their current leases longer. In January we saw that pretty significantly and in February it was not as telling, but it’s still a pretty significant drop off in what we would have expect it to replace. So I think it’s going to be a little slower throughout the year.

Operator

Your next question comes from Patrick Donnelly – Blackrock

Patrick Donnelly – Blackrock

Most of my questions were answered, but let me throw this at you. In regards to the TALF it seems as though that’s a pretty important item coming down the road here for a number of fronts. Number one, it helps you on your asset backside in terms of funding for your fleet business, but also I would assume that it opens up potentially the pallet of mortgages that are perhaps acceptable on the secondary market.

Right now it’s only GSE, but perhaps Jumbo has actually climbed a bid in the secondary market. If TALF is at all successful, could you please comment further on TALF and what it means to you guys.

Sandra Bell

I think you hit on both key points. The non-performing mortgage market, residential MBS is clearly a target of the second round TALF and as we said we’ve had ongoing dialog with both the treasury and FED around the specifics regarding our fleet program and we also are seeing some signs of simply the existence of that program, even stage one starting to loosen up the market generally for ABS product. So, we would agree with you that it is going to be a very important component as we go through the year in freeing up those markets for us to look at.

Patrick Donnelly – Blackrock

Does that mean that you go back to your existing Chesapeake people and try to re-up, because the market has now firmed and they are more comfortable; I mean is that one route you’ve moved on.

Sandra Bell

Well, we’ve always turned out a component of this program when we had access to the market and we have no prepayment costs to prepay Chesapeake. So as we go through this marketplace, as we get funding available, we would certainly look to reduce Chesapeake and add TALF to the extent it made economic sense.

Patrick Donnelly – Blackrock

I mean essentially what does TALF do. It’s like a giant balance sheet out there for all you guys correct, that you can lever. Is that what it amounts to?

Sandra Bell

Yes.

Patrick Donnelly – Blackrock

And then on the non-agency stuff, what are your thoughts there. I mean it’s all hypothetical, but what are your thoughts.

Sandra Bell

Again, it’s targeted to start to work on non-agency parts of the mortgage backed security market and we would expect to see those markets open up as well, as they begin to implement it.

Patrick Donnelly – Blackrock

And the pricing on that, it would be better than what you’re doing now in terms of the 100 to 150 basis points.

Terence Edwards

One would expect that it would be inline, perhaps slightly lower because the loan size is bigger and it would be a function of what the competition does, but so far the competition has been doing the right thing. So the benefit that comes from it is obviously just some REFI activity that can be done, but it also might get that into the housing market moving; we’d benefit from that.

Patrick Donnelly – Blackrock

Right, any sense as to the urgency of this; I heard that they TALF is targeting more consumer oriented stuff and not so much on the mortgage side. What is your sense, they can go right after the mortgage side immediately.

Terence Edwards

Our sense in our discussions is that they get the importance of a top pro ramp, our AAA assets like our vehicle program generates, they get the importance of getting the jumbo market going again. Their original timeline was to have a natural transaction in February and that has slipped to March.

Our understanding is that to try to get something done early in this month and then just my sense is that once they get something done and transactions start to move, then they’ll start layering on other assets that become eligible for the program.

Patrick Donnelly – Blackrock

Okay, what is the studio projections. You mentioned $32 billion potentially in terms of production, is that correct?

Terence Edwards

Yes, that’s the number that mark mentioned yes, but all of the number on the grid are a possibility and to the extent that the government programs work. I mean the bottom line is the government is committed to fixing this economy and it starts with fixing housing, which has to be good for us. We get to ride along with that benefit and hopefully housing leads this economy out of this bell drums, but that coupled with fewer players in the mortgage industry means better margins and it’s a much better business than it’s been in many, many years.

Patrick Donnelly – Blackrock

And then just to go down the road, where is your market share right now in terms of a service and as a mortgage producer; it’s gone up there.

Terence Edwards

I mean round numbers where 1% in the servicing and a little over 2% in the originations, but in the retail market as we showed on the slide, we went from a 3% retail market share, to a 4% retail share at the end of the fourth quarter. So we would expect that to continue to build because of the factors that I mentioned. We continue to sign new clients and our clients continue to gain more market share, because we are the trusted brand the consumers are looking from as they turn away from what used to be 30% of the market mortgage brokers.

Patrick Donnelly – Blackrock

Right, and I have to ask this question; it’s a little impolite perhaps; you’ve got some aggressive acquisitions going on, but at least some major ones. With IndyMac, players took out InyMac for the platform and then you’ve got [Roberos] taking out Citigroups mortgage servicing. Any thoughts in terms of selling the bulk on the mortgage side to a player that has the funding services you are looking for?

Terence Edwards

Right now, we feel really good about the mortgage business, in terms of the direction that it had and I would tell you that those other transactions that you mentioned were both far sales in effect; so we wouldn’t be able to achieve what we think the value of our business is with those particular buyers.

Patrick Donnelly – Blackrock

Now, in getting a bank, how far along are you guys? What kind of time frame should we look at; I know I’m pinning here, but..?

Sandra Bell

When you deal with federal agencies, particularly ones that are obviously very over whelmed with by a lot of things, it’s a time consuming process. So the charter applications are certainly taking quite a bit of time. We are evaluating with the advisors opportunities in the market place along the acquisition front, but even in that context, you obviously have to get regulatory approval, so we’re expecting it to take into the second half of this year before we would have anything in place, assuming everything goes well.

Terence Edwards

And obviously based on transactions that have been done in the market place very recently, you want to be very careful.

Operator

Your next question comes from Barry Groveman - Deutsche Bank.

Barry Groveman - Deutsche Bank

I just have two questions; you mentioned that sometime this month, first transaction is expected to occur. Maybe I misunderstood, but in terms of the eligibility for the commercial assets, I mean your lease program, what type of timing would you anticipate hearing from the treasury on that?

Terence Edwards

We are not in control of that timeline. My hypothesis is the FED wants to get the first security done sometime this month. Their original time table was February; they missed February, they want to get it done this month and then my hypotheses is that other asset classes that might be included in the expanded test, which was expanded from $200 billion to $1 trillion, would hopefully be announced after they get a transaction done, but again that’s just my thesis.

Barry Groveman - Deutsche Bank

Its sounds like you’re questioned of $380 million under your committed revolver, is that the same for other mortgage facilities, the same $380 million and the minimum net worth?

Terence Edwards

Yes, I mean that covenant apples basically to all of our borrowings. It applies to our revolver which is the key.

Barry Groveman - Deutsche Bank

How comfortable are you with the cushion given the right down in the MSR’s attached to your quarters going forward?

Sandra Bell

Just as an example that hit a [nator] at the end of the year. Since the end of the year that cushion has increased fairly substantially, because of the change in mortgage rates. The number that we hit at the end of the year was very low relative to the mortgage rate, while I would never say that there would never be a chance for rates to go lower, particularly with where the government is. I think we feel pretty comfortable with the rates that we used at the end of the year, around the MSR values, that there is more limited downside that our side.

Operator

There are no further questions.

Terence Edwards

Okay, with that we’ll wrap up the call for 2008. We look forward to speaking with everyone on the first quarter call for 2009. Thank you for your interest. Have a great day.

Operator

This concludes the PHH 2009 forth quarter and year end earnings conference call. Once again ladies and gentleman, the replay will be available in approximately two hours at the company’s website at www.phh.com or by dialing 1888-203-1112 or 719-457-0820 using passcode 4079569. It will be archived until March 17, 2009. You may now disconnect.

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