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Impac Mortgage Holdings, Inc. (NYSEMKT:IMH)

Q3 2013 Results Earnings Call

November 07, 2013, 12:00 PM ET

Executives

Justin Moisio - Investor Relations

William S. Ashmore - President and Director

Todd R. Taylor - Executive Vice President and Chief Financial Officer

Analysts

Michael Salzhauer - Benjamin Partners

Operator

[Call Starts Abruptly].

I would now like to turn the conference over to Justin Moisio, Director of Investor Relations. Please go ahead sir.

Justin Moisio

Good morning everyone, and thank you for joining Impac Mortgage Holdings earnings call.

During this call we will make projections or other forward-looking statements in regards to, but not limited to, GAAP and taxable earnings, cash flows, interest rate and market risk exposure, mortgage production and general market conditions. I would like to refer you to the business risk factors in our most recently filed Form 10-K, under the Securities and Exchange Act of 1934. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

This presentation, including any outlook, any guidance, is effective as of the date given and we expressly disclaim any duty to update the information herein.

I would like to get started by introducing Bill Ashmore, President of Impac Mortgage Holdings.

William S. Ashmore

Thanks Justin. Good morning. Welcome and thank you for joining Impac's third quarter 2013 earnings call.

I have on the line with me, Todd Taylor, our Chief Financial Officer, and Ron Morrison, our General Counsel.

I will begin with a brief review of the results for the third quarter 2013. Yesterday the company announced results for the third quarter of 2013 reporting a net loss of $4.9 million or $0.56 per diluted common share for the third quarter of 2013 as compared to a net loss of $2.3 million or $0.29 per diluted common share in the third quarter of 2012.

For the nine months ended September 30, 2013, the company reported a net loss of $4.5 million or $0.52 per diluted common share, as compared to a net loss of $2.9 million or $0.36 per diluted common share for the nine months ended September 30, 2012.

The company continuing operations, which include mortgage lending, real estate services and long-term portfolio segments, had a net loss of $4.7 million for the third quarter as compared to net earnings of $2.2 million in the second quarter of 2013 and $6.8 million in the third quarter of 2012, primarily due to a loss in mortgage lending.

Now let's go in to specific results of the business segments. First we'll begin with mortgage lending. With the unexpected rise in mortgage rates starting in May 2013, origination volumes declined across the mortgage lending industry during the third quarter . In addition, during the third quarter, gain on sale margins continued to compress creating challenges for many lenders in the market, including Impac Mortgage.

As a result, mortgage lending net revenues or net earnings decreased by $7.5 million in the third quarter of 2013 to a loss of $4.1 million as compared to the second quarter of 2013. and decreased by $12.3 million from the third quarter of the prior year, with both declines primarily due to a decrease in origination volumes and margins. We believe these trends are fairly consistent with the overall market.

Originations decreased to $576 million, a 26% decrease over the second quarter of 2013, and a 19% decrease over the third quarter of 2012. As the home refinance markets contracted due to the recent rise in interest rates, our percentage of purchase money transactions increased almost 55% of overall originations, as compared to 40% in the second quarter of 2013 and just 27% in the third quarter of 2012.

We did see a more balanced mix of originations across our origination channels with our correspondent channel producing 37% of the originations, the retail channel contributing 29% of originations and the remaining 34% coming from the wholesale channel. All of our channels continue to focus on purchase money transactions and less interest rate sensitive loan programs including Home Renovation 203(k) products, Reverse Mortgages, Home Affordable Refinance Programs and HUD 1023 loan programs in an effort to not only expand production and where applicable gain on sale margins.

During the second quarter we have maintained excess lending operating capacity for anticipated increase in volumes, but with the unexpected sudden decline in volume as well as increased compliance costs due to more new mortgage lending requirements, we had higher operating costs. In response to the reduced production volumes, we reduced lending operating expenses by 16% from $19.2 million in second quarter to $16.1 million in the third quarter of this year.

Further we anticipate continued expense reduction during the fourth quarter as we increase operational efficiencies, both in operations and sales which will improve our overall net operating results in mortgage lending. However, even though we have continued to reduce expenses, we will focus on opportunistically taking advantage of the industry-wide consolidation to capture greater market share as many other companies have found it difficult to compete in this challenging operating environment, with significant regulatory change occurring beginning in 2014.

In the third quarter of 2013 we increased remortgage servicing portfolio to $2.7 billion as of September 30, 2013. That was a 27% increase from June 30, 2013 and a 120% increase over the third quarter of 2012.

Net servicing fees in the third quarter of 2013 increased by 9% and 242% to a $1 million in the third quarter of 2013 over the second quarter of 2013 and the third quarter of 2012 respectively. The estimated fair value of mortgage servicing rise in the balance sheet has increase to $27.9 million at the September 30, 2013 as compared to $22.1 at June 30, 2013 and $10.7 million at December 31, 2012. The servicing portfolio was comprised of high credit quality agency loans and has a weighted average coupon of approximately 4%.

Currently the portfolio has a 60-day delinquency in terms of unpaid principal balance of less than 1% of the portfolio. These servicing portfolio characteristics along with the added growth from our mortgage lending production is expected to further increase the net servicing fee revenue in the future.

Further with the portfolio currently having a weighted average coupon well below today's mortgage rates it is expected to have minimal prepayments, increase in the longevity of this asset overtime. We do expect this trend to continue in the future as mortgage lending segment build its mortgage origination volumes throughout 2014.

As everyone is aware in the mortgage lending business, a huge advantage goes to those companies, that not only have GSE agency approvals but can build a mortgage servicing portfolio that supplies more stable long term returns.

As mentioned earlier, during the third and fourth quarters we have taken steps to reduce operational staffing levels and other operating costs as we streamline operational processes. Additionally, we expect to see increased efficiencies upon the complete implementation of our new loan origination system or tracking system in our retail operations.

Over the past 60 days, there have been numerous announced layouts in the mortgage industry in response to reduced lending volumes. Impac was not only into this and has also reduced certain staffing levels. However we have also try the capitalize on hiring additional seasoned sales professionals with books of business in all our origination channels. The upgrading and building out of retail, wholesale and correspondent sales staffs will continue to be top priority especially in light of the substantial industry consolidation going on during the fourth quarter.

The quality and depth of sales candidates we are seeing today is the best I've seen in several years and we hope to capitalize on that throughout the fourth quarter and into 2014. A key element to get lending back to profitability is increased market share with a larger more productive sales force. Our goal is to have additional or individual sales personnel generating better conversion metrics along with increased volume. We believe this will result in reduced time and effort for our lending operations to process and fund loans improving our turn times and our overall customer service and increasing volume levels.

By the beginning of 2014, we expect to have sales and operational capabilities to originate between $650 million and $700 million in quarterly volume which will allow us to continue to grow our mortgage servicing portfolio. That ultimately gives the company an ongoing earning assets that act as counterbalance for the volatility of mortgage lending volumes.

Now I'd like to move on to discussion of the real estate services business segment. The real estate services segment continues to earn consistent quarterly profits, increasing net earnings from real estate services segment to $4 million in the third quarter of 2013 as compared to $3.4 million in the second quarter of 2013, a 17.6% increase and $3.1 million in third quarter of 2012, a 29% increase. While we are focusing on building the mortgage lending segment and mortgage servicing portfolio, we continue to benefit from strong and consistent profits in this segment.

In a continuing effort to leverage our platform beyond mortgage lending, our real estate services segment has expanded by offering its loss mitigation services beyond its own legacy portfolio. The company recently established relationships with third parties to perform mortgage insurance recovery services. In addition we are in the final stages of solidifying arrangement to provide title remediation for a third party. Further we believe our real estate service segment will continue to augment the overall net revenue of the company into 2014.

Now to go on to some recent developments. In the third quarter of 2013, our warehouse lending business began operating, offering funding facilities to all lenders, but focusing on smaller mortgage bankers and credit unions, including some of our own current correspondent customers. We believe offering warehouse lending provides added value for our correspondent customers and increases the capture rate from our approved customers which will increase the volumes in our correspondent channel overall. We have received many application requests from the perspective warehouse lending customers and we are currently in process of finalizing agreements with our first clients.

In closing, I want to add that, even though the quarterly results were a disappointment, we believe we have taken the necessary steps to address the changes in lending environment and improve our net operating results in mortgage lending during the fourth quarter. In addition, we will continue to produce solid results in real estate service segment along with continued growth of our mortgage servicing portfolio.

As stated on the last conference call, we knew this quarter would be challenging and result in a transitional period, recognizing more historical margins with the volumes realigning to lower refinance activity. The management team has been through similar cycles in mortgage lending and we believe the adjustments we have made along with the numerous opportunities arising from consolidation will ultimately benefit the company's financial performance in the future.

This now concludes my prepared remarks and I'd like to open up the call to any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And your first question comes from [Daniel Baldini] with [Albarino].

Unidentified Analyst

Hi, thanks for taking my call. Could you tell me how much cash did you receive from the trust in the third quarter?

William S. Ashmore

Let me turn that over to Todd. Go ahead, Todd.

Todd R. Taylor

Yeah. The residuals held cash was about $1.7 million in the quarter.

Unidentified Analyst

Okay, great. Thank you.

Operator

Thank you. Your next question comes from Michael Salzhauer with Benjamin Partners.

Michael Salzhauer - Benjamin Partners

Hi, thank you for taking my call. So the real estate services business, should we think of that as a permanent ongoing part of the company or is that something that still has, will have some transition down as the mortgage business hopefully transitions from the crisis time?

William S. Ashmore

Well, the predominance overtime of real estate services were specific services we were supplying to our legacy portfolio. However, because of our abilities we have expanded that outside. So you are right from the standpoint of certain part of the real estate services will be winding down over the next year to two years. However, we hope that we will supplement that and maybe more than they got for any of the reduction in additional third party services that we're offering which we have mentioned on the conference call.

Michael Salzhauer - Benjamin Partners

So do you think this is a sustainable level of income from that business?

William S. Ashmore

I don't think we're modeling it that we are sustaining it at the growth rate, because you can see when you have a 17% to 29% increase. I don't think we're modeling it at a 17% to 29% increase over the next year. I think that in terms of current levels that put is actually sustainable within a certain margin. But not on that current growth trajectory.

Michael Salzhauer - Benjamin Partners

Okay. But with respect to bottom line probably sustainable.

William S. Ashmore

We will be profitable throughout 2014 and I really can't comment on whether it's going to be in that $4 million range, but it's probably going to be close to that.

Michael Salzhauer - Benjamin Partners

Okay. Thank you. And now the tough one that you probably won't answer is if this is a transition for the origination business how long does the transition continue?

Todd R. Taylor

I can answer that.

Ultimately being a mortgage lender and approved with Fannie Mae, Freddie Mac and Ginnie Mae and as we have seen with other mortgage companies, public companies that have reported having a larger portfolio, a servicing portfolio is really helpful during the volatile times of up and down of mortgage lending volumes and potential margin compression. So our goal is to continue to grow that portfolio. So, it instead of kicking out several hundred thousands, and it's kicking out millions of dollars on a quarterly basis. So that when you see some of these ups and downs which is happens throughout the calendar year in mortgage lending, that helps to smooth out and create more stable cash flows and returns.

So in terms of transition we are attempting to use the third quarter and into the fourth quarter the transitional stage going into 2014 to achieve net profitability in mortgage lending during the first part of 2014.

Michael Salzhauer - Benjamin Partners

Okay. Thank you. And then the last question is that which you may have already talked about it what kind of margins are you getting on your origination?

William S. Ashmore

So when you say volume you mean, secondary margins, depending upon the business channel, the one with the least expenses in the tighter margins this correspondent all the way up to retail.

Michael Salzhauer - Benjamin Partners

Right. And then I suppose you are retaining your servicing.

William S. Ashmore

Yes. We're almost a 100% of the servicing except for some of the jumbo loans that we're originating are sold on servicing lease and we have sold some of our UFDA on the servicing lease. However, I think going forward all of our Fannie Mae, Freddie Mac and FHA loans, along USCA loans will be on a retained basis, which that's why you have seen such rapid growth and at $2.7 billion, we should be adding on to that fairly significantly over the next quarter to the next year relative to the volume levels that we talked about in the earnings call.

Michael Salzhauer - Benjamin Partners

Okay. And is that market such, I mean I have seen mortgage markets, where you can't originate loans profitably. Is that the case or no? Or just volume of loans at this point.

William S. Ashmore

No, I don't think that's true, I think that is more, the cost, especially regulatory cost and the efficiencies in the business are can be attained and we can't keep those regulatory cost down and as I said we're moving to a new loan operating system that will be hopefully fully implemented in retail by the end of the year and then we are expanding out of your wholesale first part of next year. That's going to be adding certain amount of manual functions to be automated, both in compliance and in the underwriting and the docking of the loans.

So we're looking to try and achieve significant operational efficiencies throughout the fourth quarter and going into the first part of that year. It is absolutely vital that you have your operational efficiencies absolutely at the best levels that you can while also providing good customer service and sometimes those two things conflict, but you can't I believe at the end of the day in any of these channels be profitable.

Michael Salzhauer - Benjamin Partners

Okay. You didn't have the Obama people writing your procedures for this did you?

William S. Ashmore

No, we actually did beta testing.

Michael Salzhauer - Benjamin Partners

Good for you.

William S. Ashmore

Some important things that our IT department absolutely requires in the rolling out of any of our technologies.

Michael Salzhauer - Benjamin Partners

Thank you very much.

William S. Ashmore

Thank you.

Operator

Thank you. (Operator Instructions). You have a follow up question from Daniel Baldini.

Unidentified Analyst

Hi, thanks again. So I notice that the loss from discontinued operations has fallen a lot in the third quarter versus the second quarter and quarters before. Could you talk a little bit about what's behind that and when these losses might finally come to an end?

Todd R. Taylor

Yeah. This is Todd Taylor, I can talk to that. The expectation in general is that would dwindle down of our time, meaning it is discontinued. So the big piece in there has to do with some provisions that we are recording relative to the legacy lending operations that had some repurchase liability. So as that time continues and goes on that starts to go down, less requests, et cetera, less exposure, eventually that is going to turn to zero. I can't say exactly when, but I would expect that trend to continue. So that we would expect this to be small and continue to say like that or drop in the future quarters.

Unidentified Analyst

Todd, would it fair to say that, throughout 2014, once it becomes a insignificant or non material number that would actually not be part of the our financials, because it becomes a significant.

Todd R. Taylor

Yeah. At some point of time, when it becomes so insignificant like Phil mentioned, it really just gets rolled and to continuing until then you see a sort of a clean set of continuing operations instead of financials. It's a lot of confusion, I know what GAAP mix is due relative to discontinue. But I would imagine and I can't say for sure, but I'm guessing in 2014, we probably will be able to roll it in.

Unidentified Analyst

Okay, great. Thank you.

Operator

Thank you. (Operator Instructions). And thank you, there are no further questions in queue. You may continue with your closing remarks.

William S. Ashmore

There are no additional closing remarks. I appreciate everybody participating in the phone call. Thank you very much and have a good day.

Operator

Thank you. This concludes today's conference call. You may now disconnect your lines.

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