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PHH Corp. (NYSE:PHH)

Q2 2009 Earnings Call

August 4, 2009 10:00 pm ET

Executives

George Kilroy - Acting CEO and President

Sandra Bell - EVP and CFO of PHH Corporation

Mark Danahy - President and CEO of PHH Mortgage

Tom Keilty - COO and SVP of PHH Arval

Nancy Kyle - Vice President, Investor Relations

Analysts

Bose George - KBW

Steve DeLaney - JMP Securities

Paul Miller - FBR Capital Markets

Debra Fine - Fine Capital Markets

Howard Shanker - Third Point

Wayne Archambo - BlackRock

Operator

Welcome to the PHH Corporation 2009 second quarter 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 queue to ask your questions.

Today’s call is also being webcast and recorded for replay purposes. The audio replay can be accessed either on the company’s web site at www.phh.com or by telephone at 1-888-203-1112 or 1-719-457-0820 pass code 1944221 beginning shortly after the conclusion of this call. It will be available until August 19, 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

Good morning and welcome to the PHH second quarter 2009 earnings conference call. On the call today are; George Kilroy, Acting Chief Executive Officer and President; and Sandra Bell, Executive Vice President and Chief Financial Officer of PHH Corporation; Mark Danahy, President and Chief Executive Officer of PHH Mortgage and Tom Keilty, Chief Operating Officer of PHH Arval, who will be available during the question and answer session following the prepared remarks.

Remarks by our management team 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 that we issued last night, 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 also that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as further described in Slide 2 of our presentation. Our actual results may differ materially from those forward-looking statements discussed on this call.

Please see the cautionary note in our second quarter 2009 Form 10-Q that we expect to file later today and the risk factors in our 2008 Form 10-K and our first quarter 2009 Form 10-Q for descriptions of issues that may lead 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.

During today's presentation we will be referring to certain non-GAAP financial measures. Please refer to slide three in the presentation for a description of these non-GAAP financial measures and the appendix in the presentation for a reconciliation of those non-GAAP financial measures to the most directly comparable GAAP financial measures.

And now, I will turn the call over to George.

George Kilroy

Thanks Nancy and good morning everyone. Thank you for joining us today. We are pleased to report very strong results for the second quarter of 2009. We believe we have outstanding businesses and that these results demonstrate not only the enduring strength and earnings potential of the company, but also the impact of initiatives we are taking to fully realize that earnings potential.

For today's call, I'll be giving an overview of PHH's results and outlook. And then we'll turn it over to our Chief Financial Officer, Sandra Bell, who will provide a more detailed look at our numbers as well as our funding updates.

Please note that I will follow the slides that we posted on PHH's corporate website. In addition to the slides I will touch on today, we posted a number of other supplemental slides that you might find useful in understanding the performance of the company.

As you'll see on slide 4 for the second quarter 2009, last night we reported consolidated net income of $106 million and earnings per share of $1.93. This is a substantial improvement from our first quarter results of net income of $2 million and earnings per share of $0.04.

The key factors that drove these positive results and allowed us to capitalize on a very active mortgage refinancing market, including our ongoing efforts to gain benefits from our efficiency and cost reduction initiatives, deliver high quality customer service at best-in-class cost, successfully execute our funding plans to support our business development efforts, generate additional origination volumes from new private label solutions clients added in the last 12 months and bring our fleet pricing inline with market rates.

On slide 5, you will see some of the key market trends impacting our businesses during the first half of the year. We've seen attractive consumer mortgage rates for borrowers and margins remain favorable. Servicing profits continue to be affected by the negative impact of recessionary trends and the positive impact of rates on the mark-to-market of the MSR.

Fortunately, our default rates continue to be favorable, compared to the rest of the industry. New vehicle purchases have slowed as a result of the recession, but we are seeing a marked improvement in the pipeline of new orders for the second half.

Our results were obviously impacted by these market trends, but they were also substantially impacted by actions the company has taken to ensure that it can deliver profitability across cycles.

On slide 6, we have listed some of those actions. We continue to execute on our initiatives to shift to a more flexible cost structure, allowing us to react to rapid changes while maintaining our higher customer service levels.

In fleet management, we have made significant progress reducing the interest rate, basis risk on the underlying portfolio and we are adding new leased vehicles at market rates. We have also solidified our funding availability for our fleet clients that is expected to ensure sufficient liquidity to support the business.

This successful funding execution, combined with our average to move the lease portfolio to market rates has led us to raise our fleet management segment profit guidance for the current year from $20 million to $30 million to $30 million to $40 million.

Turning to the Fleet Management Service segment, we have driven improved performance there in large part by fixing the lease interest rate mismatch ahead of the schedule.

Tom Keilty and his team have made great efforts to renegotiate lease pricing and combined with better than expected financing cost and execution, the fleet segment posted a profit of $18 million.

On slide 8, you can see trends in this market during the second quarter, and while our clients continue to right-size fleet as a result of the economy, pent-up demand is expected to positively impact new vehicles purchases in the second half. We also expect maintenance spend to increase as vehicles remain in service longer.

Recently, we have seen an increase in spreads associated with lease rates throughout our market. We expect that trend to continue although overall lease rates to our customers remain at historic lows.

It's also important to note that our issuance of TALF-eligible securities has been positively received by our fleet clients. As a result of the restructuring of two of the North American motor companies, we are seeing order to delivery times continuing to grow longer and supplier impact on motor companies continues to be a concern. However, motor companies have emerged from bankruptcy much faster than anticipated and plants are beginning to come back online for the 2010 model year. As such we expect our clients demand for new vehicles to be met.

Slide 9, provides a summary of our second quarter results and fleet services. First, fleet lease assets were deemed TALF eligible in March and we were able to attract a tremendous amount of interest from investors during the June TALF offer. Remember, PHH does not receive funds directly from the Federal government, investors do. The program has encouraged investing in AAA asset-backed securities by TALF supported and non-TALF supported investors. We saw interest from both in this transaction.

Second, since we have succeeded in ensuring that lease prices are matched much more closely to funding cost, our margins are improving as current leases run off and are replaced with re-priced units.

Third, cost reduction initiatives that were implemented during the fourth quarter of 2008 in anticipation of expected volume declines that favorably impacted segment profit for the second quarter by $3 million.

We have also had continued success in sales discussions with large perspective clients. Our prospect list represents companies that have over 50,000 vehicles that could be enrolled in PHH programs.

As I mentioned, all of these favorable trends improve the fleet services segment profit outlook from $20 million to $30 million, to $30 million to $40 million for the full year 2009.

Now let me turn it over to Chief Financial Officer, Sandra Bell for an update on the results from mortgage production and serving and on our funding.

Sandra Bell

Thank you George. Good morning everyone. As you know, we've been working hard to keep the mortgage production segment consistently profitable

As slide 11 indicates we're very pleased with the second quarter segment profit of $82 million. We saw a solid production volumes, healthy pricing margins, which continue to be favorable compared to prior year's level, and lower fixed G&A cost. The product of our effort to reduce expenses.

Second quarter application volumes were up 22% over the prior year, which we would expect to lead to a favorable year-over-year comparison in closing volumes in the third quarter.

Purchase closing volumes are 35% of our total volumes, which compare favorably to the overall market of roughly 30%. We have seen signs of improvement in home purchase activity. And if this trend continues as expected we believe we are well prepared to capture market share.

Moving to slide 12, despite contraction from the first half we expect these favorable margins to continue into the third quarter. The current run rate of volume is lower than the first half of this year as interest rates have risen over the last several weeks.

However, based on our application volume trend we would expect second half '09 closing volumes to exceed '08 level. With the attractive margin environment taken together with anticipated volumes and management focus on cost, we expect to drive profitability through the mortgage production segment through the second half of the year. We intend to maintain our cost discipline as we manage production capacity.

Our focus on a more flexible cost structure is precisely aimed at maintaining profitability in lower volume scenarios, while still being able to maximize earnings in higher volume scenario.

We have reduced fixed G&A cost by $9 million in the second quarter and $14 million in the first half. Although the absolute level of expenses went up in the first half on a year-over-year basis, the increased scale combined with driving fixed cost out of the business resulted in significantly lower cost for loan. We will continue to seek these cost reductions in the second half.

Continuing the market trend we discussed in the last two quarters, slide 13 shows that margins remain above historic level. The pricing margin is a key measure that we monitor, because it represents the market pricing as of now, and is the most highly variable component of the gain on sale.

We expect margins to continue at favorable level for the rest of the year inline with our current margins of approximately 120 basis points.

On slide 14, you will see a familiar slide from last quarter, showing the sensitivities around Mortgage Production segment annualized potential profitability. This slide remains unchanged from last quarter. We believe it remains an appropriate way to measure rolling 12 months results under various volume and margins scenario.

While this metric is intended to be approximation of annualized profitability, we suspect many of you will want to compare our first half results to the metric. If you take our volumes year-to-date of approximately 20 billion, annualize that number to 40 billion, then move across the metrics to our year-to-date pricing margin of a 176 basis points.

You can interpolate to roughly 400 million in annualized segment profit, which would imply 200 million for the first half of the year. Our reported production segment profit of $195 million is reasonably inline with the level suggested by the metrics.

On slide 15, we provide our non-GAAP operating profit for the production segment. In order to better understand the drivers of quarterly and first half results, we have isolated the mark-to-market on the less liquid portion of our loans held for sale.

This adjustment is significantly less material than last year as the management team has reduced the book value of this population of loans to approximately $100 million through corrective actions, working with the borrowers or through sales of the loans.

We believe it is helpful to understand the impact of these factors and how management is addressing the impact they may have on results, separately from the results from normal production activity.

As slide 16 indicates, given the nearly $20 billion year-to-date closing and the favorable margin environment expected in the third quarter, we would expect strong 2009 mortgage production earnings.

Margins remain rational and production continues to favor a more profitable mix of business as we move into the second half of the year. Our new client pipeline remains strong and includes advanced discussions with the potential top-10 clients.

Fannie Mae and the MBA are predicting more than $2 trillion in industry volumes for 2009, which translates to $35 billion to $40 billion in originations for PHH assuming our current market share. We are extremely enthusiastic about this business.

Turning to the mortgage servicing segment, slide 17; our second quarter segment profit of $86 million was positively impacted by a $175 million mark-to-market valuation adjustment, which more than offset the first quarter 2009 negative valuation adjustment of $71 million pretax. While our actual prepayments remained below modest level, realized prepayments resulted in an $85 million reduction in servicing segment profitability aligned with prior production volumes.

Interest on our escrows and the float benefit declined by approximately $17 million from the second quarter of 2008 as short-term LIBOR rates declined by over 200 basis points since this time last year. While we added to foreclosure and credit reserves in the second quarter with credit related charges of $25 million, our relatively low delinquencies have limited the impact on our results from broader recessionary trends.

Moving on to slide 18, we show our mortgage servicing segment non-GAAP operating profit. This slide looks familiar and is a visual representation of what we just discussed.

Slide 19 demonstrates our superior servicing portfolio performance. Our servicing portfolio continues to significantly outperform the industry despite an increase in delinquencies. You can see that PHH portfolio delinquencies are less than half the industry average for prime first mortgage loans and we believe our credit exposure is limited accordingly.

Ultimately, our lower delinquencies translate into higher expected future cash flows from our servicing asset relative to our competitors.

Moving on to slide 20, we walk through some of the considerations related to the valuation of the MSR assets. Our servicing portfolio in its entirety is valued at 114 basis points up 17 basis points since the first quarter.

Newly created servicing is valued at 5.7 multiple versus 4.5 in the past, as new servicing rights are more valuable than those running off. In addition, our valuation does not include any potential revenue opportunities from government sponsored loan modification program.

The second quarter increase in valuation adjustments was driven primarily by the increase in primary mortgage rates during the quarter. As mentioned earlier, our actual prepayment speeds continue to run at rate of only about 55% of our speed.

We present our outlook for the mortgage servicing segment on slide 21. We expect servicing segment results to benefit in the second half from slowing prepayments, consistent with the anticipated slower refinance activity in our production segment. This balance reflects the natural business hedge we have been highlighting.

The full benefit of this natural business hedge on servicing will be partially offset during the remainder of 2009 by the lower earnings on our escrow balances due to low short-term interest rate and the limited impact of continuing recessionary trends on provisions for credit losses and on delinquencies, which could also temporarily increase segment operating costs.

Again, we expect to continue to create high value low note rate MSR. Before I turn it back to George, I would like to give you a quick overview of our funding position.

On slide 23, as George mentioned earlier, we successfully issued a $1 million TALF-eligible securities in June. Under the TALF program, our funding entity Chesapeake can issue up to an additional $2.5 million in securities.

As we consider alternatives under this program, our goal is to ensure consistent availability of funding for our fleet client. We are also making significant progress in our plan to refinance our Canadian fleet operation.

As you may remember, we have been funding our Canadian clients' needs under our revolver. The Canadian government has established a program aimed at improving liquidity for ABS backed by vehicle and equipment leases and loans.

We would expect to use the proceeds from the execution of any Canadian transaction to reduce outstanding under our revolving credit facility. Both the TALF program and the Canadian government program have been successful in opening up the ABS market and we are seeing, both Canadian conduit funding and private investors begin to return to the market. We are confident that we have sufficient liquidity to meet our fleet customers projected leasing needs.

Moving onto slide 24, we present an overview of our mortgage funding availability. We have renewed the terms of the RBS repurchase facility in June for another 364 days.

In combination with our $2.9 billion in uncommitted funding from Fannie Mae, we are comfortable that our warehouse funding capacity is sufficient to handle our expected needs for the mortgage business for at least the next 12 months.

As a reminder, mortgage loans generally remain on our balance sheet for an average of approximately 20 days. As in the case with all of our funding needs, we will be reviewing all available options throughout the course of this year to ensure we maintain our funding flexibility to meet the needs of our mortgage client.

On slide 25, we highlight our current debt rating, the remainder of our funding capacity and our continuing efforts to increase our flexibility in that area. Our committed unsecured revolving credit availability stood at $252 million at June 30th.

Our senior unsecured ratings remain unchanged, and as a reminder, we have two primary financial covenants, a leverage test that limits our debt-to-tangible net worth to 10 times. At the end of the quarter, we were comfortably inside that covenant at 4.8 times.

The second test is a minimum tangible net worth maintenance covenant. Our pre-tax cushion was $449 million at the end of the quarter. We continue to review available funding alternatives in the marketplace as we remain focused on our goal of delivering on our multi-pronged, multi-source and multi-duration funding plan.

I will now turn it back to George to review our outlook for the company and our action plan for the remainder of 2009.

George Kilroy

Thanks Sandra. We've had great work from Sandra and her team in executing our funding plan to diversify our funding sources and reduce our funding costs.

Slide 27 touches briefly on the government's loan modification program HAMP. PHH is participating in this program for Fannie and Freddie loans and has actively begun contacting borrowers and modifying loans.

If the modified loan stays current for three months, PHH will receive a $1,000 fee and assuming the loan remains the current, PHH will receive up to a total of $3,000 over the next three years for each successful loan modification.

We began modifying loans in May with the first modified payments from borrowers due in July. We expect to begin to see revenues from this program ramp up in the fourth quarter and while this program is expected to have a limited impact on revenues for 2009, we are optimistic about the potential in this program.

Slide 28, list the priorities of the mortgage company for 2009. We will continue our progress in moving toward a more flexible cost structure. We will maximize the value of our current client relationships and sign new PLS clients.

We look for additional opportunities in the government loan modification programs and expand our sub servicing business, which is generating fees without owning the MSR.

Our outlook for mortgage for the remainder of 2009 is showed on slide 29. MSR valuation adjustments will continue to track interest rate changes. A strong mortgage production profits are expected to offset actual pre-payments and credit charges in the servicing segment.

Credit cost should slow with the stabilization of home prices and modification alternatives and we'll continue to take advantage of opportunities to sign new PLS clients.

On slide 30, you can see our priorities for the remainder of the year in the fleet services segment. We're going to continue to be aggressive on cost management. Our process efficiency culture called R2R continues to provide internal cost savings, while improving service to our fleet customers.

Our flexible staffing model has had positive impact on controlling our head count. We will also continue to closely manage cash flow and the credit quality of our portfolio. As you may know PHH fleet client credit profile is outstanding. We averaged two basis points of write-off over the last 10 years. And as a reminder we do not, take residual risk on 94% of our lease portfolio. Rather we manage this risk for our clients.

We also increased our level of clients consulting to assist them through their business challenges and look for more opportunities for our clients to outsource to us while also continuing to invest in our own technology.

All of this will ensure we continue to maintain our outstanding service to our clients. As I mentioned earlier, our fleet segment profit outlook has been revised upward to 30 to 40 million for 2009.

Now before we take questions, I would like to reiterate some key points about our performance and talk about our priorities going forward, both of which we highlight on slide 31 and 32.

PHH has great businesses with room for improvement and plenty of opportunity. We have a talented and experienced management team and engaged Board and we are supported by great employees that are dedicated to the highest level of customer service.

We have solid, longstanding client relationships and we’re constantly striving to improve our service to them. There have been strong headwinds in the broader economy, which has had an impact on our business.

The industries in which we operate have gone through a period of dramatic change, but we have been successful, not only navigating through market challenges but also taking actions that we believe will create opportunities and drive earnings growth in all environments.

We’re beginning to see some of our efforts paying off and we’re very optimistic about our future. I want to be clear that PHH's Board and Senior Management are intensely focused on creating shareholder value and achieving sustainable earnings growth across cycles and in all market environments. That commitment will guide everything we do.

While we reported strong second quarter results, solidified our funding needs and assuming a stable interest rate environment expect to be profitable for the second half of this year. One of the key priorities for management and the Board is to take a fresh look at every aspect of our business with an eye toward driving improved profitability, growth and shareholder value.

PHH is in a position to look at ways to evolve our business and we believe that right now we have unique opportunity to drive the positive changes that can take our company to the next level. We will carefully evaluate the market dynamics, future trends and real customer needs of each of our businesses and aggressively pursue those opportunities that we believe can deliver the greatest value.

In the meantime, I along with my management team in active oversight from the Board will remain intensely focused on continuing to, one; capitalize on market trends. Two; create efficiencies and reduce cost across the organization. Three; deliver high-quality customer service at best-in-class cost. Four; execute on our funding plans to support our business development efforts. Five; add new clients in, both fleet and mortgage. Six; bring fleet pricing inline with market rates and seven; deliver consistent returns across business cycles.

As we move forward, we are also committed to continuing to improve our dialog in our communication with you. And ensuring that you understand our plans for the business and our progress in executing against them.

So along with Tom Keilty, the COO of PHH's fleet business, Mark Danahy, CEO of PHH's mortgage business and Sandra, I will now open the phone to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will take our first question from Bose George with KBW.

Bose George - KBW

I have a couple of questions. First, just wanted a little more clarity on the fleet business improvement. You’ve given that the revenue run rate was $18 million in the second quarter, I was just curious about the guidance of 30 to 40, since you've already done $25 million in the first two quarters?

George Kilroy

Yes. Let me take that one. The actual the, there was profit of $18 million for the second quarter and profit of $25 million for the first half. We would love to be able to tell you of double that and get to the year but we think we have some cost in the second half that would have normally, we would have anticipated in the first half, for example, fees that are associated with some of the funding structures that we're going to put in place in the second half.

We also are seeing a trend towards slightly lower volumes, although as we said we're seeing the order volume, kind of a pent-up demand building up in the second half. So, right now we are comfortable moving to the $30 million to $40 million.

Bose George - KBW

Then just, switching to the mortgage segment, can you talk about the potential value to your MSR if we see a lot of loan modifications, just given the longer duration of the new assets and just leaving aside the potential benefit of the fees that you're going to get from the government or you might get from the government. What is the loan models that do just suit you the best way you value your MSR?

George Kilroy

Let me, let Mark answer that one.

Mark Danahy

The modification will move the loan from a delinquent loan to a current loan. So, you will end up collecting service fees. From a value perspective, you'd expect to see that. It would most likely have a lower rate associated with it, which will improve its value somewhat from a prepayment propensity perspective.

Bose George - KBW

So it's not unreasonable to think that, I mean it helps the value of the MSR if there is, if a lot of these loans, delinquent loans end up modifying?

George Kilroy

Absolutely. I mean it helps the MSR, it helps the underlying cash flow because we'll collect fees again.

Bose George - KBW

And then just a related question about Atrium: I mean, has there been a change in the way you think about potential losses there but also could these government programs reduce the amount of payments that you have to pay out at Atrium and help them that way as well?

Mark Danahy

It’s a little early to tell how effective some of the government programs will be for Atrium. The high LTV refinance program hedge you had to really take home. So, it’s a little early to tell. Most of the reinsurance trust are through their corridor. So for example I think we talked about this last quarter, 2005, 6 and 7, the losses are through the risk corridor for Atrium. So the first benefit would be realized by the [EMI] company. You would have to get back inside that loss corridor for Atrium to have a benefit from the programs.

Operator

And we'll take our next question from Steve DeLaney with JMP Securities.

Steve DeLaney - JMP Securities

I appreciate you taking my questions. Two questions, both on the mortgage side, one about your production outlook and secondly servicing related about the foreclosure related charges. You did $20 billion in the first half and if I heard Sandra correctly, I believe and kind of the words you mouthed Sandra but I believe you indicated you guys thought you could hold up your production volumes.

I am looking at the MBA data, in the survey for July and of course they don't have a perfect crystal ball either, but it looks like they are projecting a decline of 13% and Q half of '09 over the first half of '09, Mark could you clarify, do you think you can hold your production at that $20 billion first half level and if so, if the national trend is down, what is it that you're going to be doing to be able to maintain your level of volume?

Mark Danahy

Sure Steve, that 13% decline you referenced if you apply that $20 billion would be what $2.5 billionish.

Steve DeLaney - JMP Securities

Right.

Mark Danahy

So you are looking at $37.5 million, which is right in the middle of the range that we talked about between $35 billion and $40 billion in the second half. So we expect some decline associated with the overall market decline.

Steve DeLaney - JMP Securities

Got it. Okay, so basically you are not looking at $40 billion, you are looking at being in that range at $35 million to $40 million. That helps to clarify.

Mark Danahy

Yes on a full year basis.

Steve DeLaney - JMP Securities

Right on a full year basis. And I was just curious, we have started to see a little bit of fixed rate mortgages, I guess were up in the 530 range as far as national average from most of the surveys etcetera. Starting to see some pickup in hybrid ARM, new hybrid ARM production and I guess I want to know if you guys are emphasizing those products as maybe more attractive from a payment standpoint and have you seen any shift in borrower appetite now that if we don’t have a 75% third year rate.

Mark Danahy

Yes we absolutely have the borrower rate for a 51 ARM for example would be roughly three quarters of a percent lower than it would be a third year fixed rate today. That’s quite a bit different in the first half of the year when those two rates would have been, pretty much the same. So, hybrid ARMs are now probably in the neighborhood of a 10% of our total application level right now.

Steve DeLaney - JMP Securities

Right and are those – are you quoting those, are they amortizing or IO?

Mark Danahy

We have historically have both. I would have to actually double-check if it’s (NYSE:IO) or amortizing. I am assuming it would be more likely to be amortizing.

Steve DeLaney - JMP Securities

Okay, you have to think so, but that would obviously besides you could even more – obviously even more payment than if it’s just the 75 basis points that you were mentioning.

Mark Danahy

Right.

Steve DeLaney - JMP Securities

Okay, and is your profit margin, have you done enough hybrid business or ARM business over the years versus the fixed? Is there any distinction between your profit margin on the ARMs versus the fixed?

Mark Danahy

It really is a balancing of the investor appetite and market demand.

Steve DeLaney - JMP Securities

Okay.

Mark Danahy

So I don’t know that there is a significant difference there.

Steve DeLaney - JMP Securities

Okay, very good. And then on the servicing related charges, the actual method for mark-to-market, we get that, but the $13 million of foreclosure related charges, help me to understand that you're primarily servicing these pools for third party. So a lot of it is GSE guaranteed.

So, just maybe talk a bit about the nature of those charges and why they would be non- reimbursable, something that you wouldn’t be able to recover from cash flow from the loan pools. I understand you might have to advance something or reserve something but when you charge $13 million, is that money you don’t expect to get back?

Mark Danahy

The vast majority of that 13 million that we're taking in terms of foreclosure charges would be on loans that we have the underlying recourse risk on.

Steve DeLaney - JMP Securities

I see.

Mark Danahy

So that would be, maybe there is a violation of a REPO warranty at the origination date and we end up being on the hook for that loan.

Steve DeLaney - JMP Securities

Got it, okay. So it's directly related to the purchases, the sale contract and what exposure you agreed to take on the front end.

Mark Danahy

A vast majority of it is, yes.

Operator

And we'll take our next question from Paul Miller with FBR Capital Markets.

Paul Miller - FBR Capital Markets

Yeah, thank you very much. And can we go back to the fleet a little bit and the issue is that you made $80 million, it was really good, but you said that that probably comes down in the second half of the year. Can you talk a little bit about the fee that’s going to be associated with some of the funding programs and can you also talk about what type of pricing did you get for TALF and what exactly were the benefits from the TALF securitization.

George Kilroy

Paul, I’m not sure we want to discuss the price of TALF. I’m not sure we want to put that information out there right now. But TALF was going through the process. We had a lot of interest, a lot of potential buyers for TALF and it ended up being actually a little bit better priced than we thought it is. So, that was very encouraging.

But some of the other transactions that we are looking at of course require upfront fees. And those are the fees that we had client to pay in the first half because we originally anticipated doing those transactions in the first half. But they are now going to be done in the second half, so those fees will be in the second half.

Paul Miller - FBR Capital Markets

That means these all will be related to the funding of the leases which is the funding of the business?

George Kilroy

This is pretty much of funding of the leases.

Paul Miller - FBR Capital Markets

Funding of the leases. Okay, and I think one of the big issues with you guys is when can we get the fleet management back to normalized earnings. Did anything happen over the last couple of months or you think that this can happen sooner rather than later. Are you still thinking to 18 months?

George Kilroy

Well, I guess it's all relative. You know, I think we feel better about that the fleet business now that we did at the beginning of the year or certainly at the end of last year. We do see some volume fall off from customers who are appearing back in their businesses. We're pretty comfortable with where we are in the funding and that's still going to be another 18 months or so, maybe 18 to 24 before that entire portfolio turns over.

But we feel pretty good about the direction that is headed in and along with some of the potential for new customers in that business and our continued cost initiatives, we'll get that business back on track pretty soon.

Paul Miller - FBR Capital Markets

Okay, and moving over to the mortgage bank I mean I apologize you guys tremendously for cutting out the cost and especially in the second quarter. Can you talk a little bit about what exactly you did to get the G&A cost out and any guidance whatsoever, can you replicate this type of cost and types in the second half of the year?

George Kilroy

Well, let me give you kind of the higher level and Mark can may be give you little more detail. But as you know and you’re very familiar with the swings of that business, we try to match up the amount of customer service that you need for the swings and the volume in that business has always been very pretty tough, and Mark and his team have done a pretty good job using temporaries and contract employees and part-time employees to fill in for those needs and I think it was probably as successful as we have ever seen in the over the last first six months of this year. So we’re going to continue down that path.

I think the other thing that we’re going to look at Paul is, we have a pretty disciplined culture in the fleet business of monitoring every process, not just necessarily people, but the processes themselves and we have been pretty good at squeezing out unneeded cost in almost every transaction that we do. So Mark is starting that process, using the same sort of six sigma culture in the mortgage business that we’ve been using in the fleet business and hopefully it would be successful. You’ll find the cost. Then there is lot of different places as you look and they are not big huge cost in any one place but a culture of that will certainly continue to drive out some cost. Mark, do you have any more to add to that?

Mark Danahy

Paul, the only thing I would tell you is we believe that cost reductions are sustainable and then we want to go after some more, and the cost reductions really apply across the board in virtually have a category of cost.

Operator

And we’ll take our next question from Debra Fine with [Fine Capital Markets]

Debra Fine - Fine Capital Markets

Thank you for the detail and the clarity from all three of you. I have a couple of questions. The strategic plan process that you are undertaking, did you mention how long that’s going to be and how broad that task is going to be and who is going to be heading that up? Is there a timetable or so?

George Kilroy

Deborah we didn’t call it our strategic plan review. It’s kind of a business opportunity review is what we are calling it and what we want to do is look at every part of the business for opportunities for growth. See if each part of the business is profitable, how do we make it more profitable? Is there something else that fits in with this business? Those types of things. We don’t expect this whole process to take more than another 90 days or so.

Debra Fine - Fine Capital Markets

And then will you be reporting back on that?

George Kilroy

Yes. If we find that there are going to be some things that we do or we change, we will certainly let you know. That’s the point of it.

Debra Fine - Fine Capital Markets

And will you be considering splitting up the two businesses in that review or does this sounds like that you mentioned adding but not subtracting?

George Kilroy

What we have committed ourselves to do is not come up with the answer first. Its to go to the process and hopefully the process will drive you to some alternative. So, what we don’t want to do is limit the outcomes at the beginning. Let's go to the process and see where we come out. In that way everything is considered.

Debra Fine - Fine Capital Markets

Okay. So everything will be on the table.

George Kilroy

Everything will be on the table and the end result is to maximize the shareholder value.

Debra Fine - Fine Capital Markets

Okay. And Sandra I apologize if you mentioned this, I wasn’t focusing for a little bit. But the prior discussions to potentially buy a bank, are those off the table?

Sandra Bell

As George said everything is on the table in this review and so we will consider the applicability of a bank in our overall process. So one thing I will say is that any acquisition of the bank will have to meet all of our objectives. The first is to generate positive earnings from mobilizing our escrows. The second would be to improve operating efficiencies and increase our flexibility to manage our costs.

We are not going to acquire a problem bank and then we would expect any acquisition to be small and additive and most importantly as I have told you in the past Debra we are not going to do it if it's going to constrain our business flexibility or dilute shareholder value.

Debra Fine - Fine Capital Markets

Okay. It would just seem that, it makes sense to have everything on the table. It's just you mentioned that and we all are aware that the credit markets are opening up a little bit and funds are flowing little more easily and it seems like there are lots of alternatives to financing that probably were not on the table when the bank idea came up, which was in a much more stressed credit environment.

Sandra Bell

Absolutely.

Operator

(Operator Instructions) We will take our next question from [Howard Shanker with Third Point]

Howard Shanker - Third Point

Good. Can we just talk a little bit about the profitability of the MSR and whether we should still think about this, I think we'll see some of that when the Q comes out that the MSR on the sort of an economic profitability basis should earn about 10 bps or are delinquencies and other thing sort of ruining the economics of the business irrespective of how it's reported on GAAP?

George Kilroy

I think Howard, that range of earnings potential from the MSR would still be appropriate. The delinquencies will drive marginally higher operating cost as you have additional collection efforts but it's not a significant driver of the value, of the servicing. The credit cost is the issue that we need to wrestle through at this point given the overall economy. So, I think the ten basis points -- I think we said 9 to 10 is sort of what a normalized level would be. The other thing that's really impacting servicing at this point is…

Howard Shanker - Third Point

Sorry, and when you have -- just on the credit cost basis, are you talking about incremental cost of servicing because its more expensive to service link with loans or are you talking about sort of curtailment of the IO strip because loans are going delinquent more quickly.

George Kilroy

You got both of those, the IO strip will be more impactful than the cost, the incremental or marginal costs of servicing the delinquent loan. But there's no value associated with the -- very little value will be associated with a delinquent loan or it might be a negative value. The credit costs that I am thinking of is the charges that were in the provisions that we've been putting up because of the recourse on the portfolio and then…

Howard Shanker - Third Point

Can you just give us an update as to where that stands? Do you have a table? I didn’t see a table. You usually have – there's a table on this presentation perhaps?

George Kilroy

Yes, let me just hit one more item for you. The other thing that's impacting servicing profitability at least correctly is the low interest rates and the low benefit that we would receive on the earnings for the Escrows and float balances. So that's good but its sort of a dampening effect on the valuations or dampening effect on the cash flow on the business.

Howard Shanker - Third Point

Okay.

George Kilroy

There is an appendix that we gave you that table on the credit side of the business, its back on the appendix pages, page 40.

Howard Shanker - Third Point

On recourse. Yes I see it now. Okay. And so we're now at a point where the loans -- the recourse portfolio is how big? 300-500 million bucks I believe that?

George Kilroy

Yes 314 in the recourse population and then we have a $120 million gross value of the loans in foreclosure and $46 million in REO on balance sheet. So foreclosure in REO is on balance sheet and the 314 is off balance sheet.

Howard Shanker - Third Point

And is the 314 continuing to run down?

George Kilroy

Most of that -- the landscape or that special program that we had has virtually run off. There is this small tail to that at this point and then the rest of the off balance sheet recourse would be less likely to run off as fast. It has a longer life especially with the recourse provision.

Howard Shanker - Third Point

Okay and so -- but the way to think about it, putting the off balance sheet recourse side for a second. Is that the business is on $129 billion or $130 billion should earn about 10%, on a free tax basis.

George Kilroy

That’s right

Operator

And we will take our next question from Wayne Archambo with BlackRock

Wayne Archambo - BlackRock

Yes, good morning. You talked about, someone asked earlier about everything being on the table and you mentioned that you lack a number of objectives, in current terms of earnings accretion and smaller bank and what not. I am just curious to know have the objectives changed at all since the change in management?

George Kilroy

I wouldn't say that the objectives have changed; I think we've gotten maybe a more intense focus on some of the things that we had been doing but kind of stepping up that effort today. In addition with this overall business review, we think we'll come out of that with a better handle on m what are those things and either confirm the focus that we have or tell us that there are some other things that we should be focusing on, but I’m -- does that answer you question. If you are not sure get that surely.

Wayne Archambo - BlackRock

So you're saying nothing has really changed?

George Kilroy

No that’s not what I said. What I said was we have had a number of initiatives in place for I will say the last 12 months and they have been cost efficiency objectives, they have been customer service objectives. They have been ideas to look at other opportunities, to grow revenue in this business, but I would say that now we've kind of linked all of those together with how do they impact shareholder value and as we said in the presentation, that’s going to drive our decisions going forward.

Operator

And we have no further questions at this time. I would like to turn the call back over to Mr. George Kilroy for any additional and closing remarks.

George Kilroy

Thank you very much again for joining us on the call and as we said before, one of our objectives is to keep you all very much informed as to what we're doing and we look forward to talking to you again. Thank you.

Operator

This concludes the PHH 2009 second quarter earnings conference call. Once again, ladies and gentlemen the replay will be available beginning later today at the company's website at www.phh.com or by dialing 1-888-203-1112 or 1-719-457-0820 using pass code 1944221. It will be archived until August 19th 2009. You may now disconnect.

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