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PHH Corporation (NYSE:PHH)

Q4 2009 Earnings Call

March 1, 2010 10:00 am ET

Executives

Nancy Kyle – Vice President Investor Relations

Jerry Selitto – President, Chief Executive Officer

Sandra Bell – Executive Vice President, Chief Financial Officer

Mark Danahy – Executive Vice President, Mortgage

Analysts

Paul Miller – FBR Capital Markets

Bose George – KBW

Steve DeLaney – JMP Securities

Meryl Whitmer – Eagle Capital

[Mark Aga – Lay & Partners]

Wayne Archambo – Monarch Partners

Operator

Welcome to the PHH Corporation 2009 fourth quarter and year end earnings conference call. (Operator Instructions) Today’s call is also being webcast and recorded for replay purposes. The audio replay can be accessed either on the company’s website at www.phh.com or by telephone at 1-888-203-1112 or 1-719-457-0820 using conference ID 2514715 and that’s beginning shortly after the conclusion of this call. It will be available until March 16, 2010. 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 and at this time, Nancy Kyle, Vice President of Investor Relations will proceed with the introduction.

Nancy Kyle

Good morning and welcome to the PHH fourth quarter and year end 2009 earnings conference call. On the call today are Jerry Selitto, President and Chief Executive Officer, Sandra Bell, Executive Vice President and Chief Financial Officer, Mark Danahy, Executive Vice President, Mortgage and George Kilroy, Executive Vice President, Fleet.

Remarks by our management team will be supplemented by an investor presentation that is posted on our website at www.phh.com. You are invited to follow along as we go through each slide. Additional information which will not be addressed specifically on today’s call is available in the investor supplement which has also been posted to our website.

If you did not receive a copy of the earnings release we issued earlier this morning, you may access it from our website at www.phh.com or you may call our investor hotline at 856-917-7405 and request a faxed or mailed copy.

Please note that statements made during this conference call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as further described in Slide 2 of the presentation. Our actual results may differ materially from any forward-looking statements made during this call.

For a description of certain factors that may lead to different results, please see the cautionary note regarding forward-looking statements and risk factors in our reports filed with the U.S. Securities and Exchange Commission including our most recent annual report on Form 10-K and quarterly reports on 10-Q. 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’ll turn the call over to Jerry.

Jerry Selitto

Good morning everyone. It’s a pleasure to be able to speak to you again. In framing today’s call, I’d like to start by looking back at some of the strategic priorities we discussed on our third quarter call in November and updating you on the progress to date. Then I’ll ask Sandra to review our fourth quarter results before I wrap up the presentation with a discussion of the challenges and opportunities ahead of us in 2010.

Beginning with Slide 3, 2009 was a year of very solid performance for PHH and one of our most significant accomplishments has been to strengthen and diversify our funding. We successfully tapped the securitization market which allowed us to strengthen spending for our Fleet Leasing needs while paying down our revolving line of credit.

We’re currently in discussions to further diversify our funding sources through initiatives to add warehouse lines for our Mortgage business and conduit capacity in Fleet and renew our revolving line. Our goal is to complete all of these by the end of second quarter.

Sandra will provide more detail around these accomplishments and initiatives, but I’m pleased to report that PHH has entered 2010 in a solid funding position. Our transformation effort which we discussed on the investor call two weeks ago is critical to our long term ability to create value for shareholders through process improvement and greater efficiency.

We’ve committed to generate annual run rate expense reduction of $100 million to $120 million and to achieve a sustainable prudent cycle after tax ROE of 13% by early 2011. We began executing against this initiative in the fourth quarter and we are on track to achieve the goals outlined in our previous call.

We’ve also addressed the lease interest rate mismatch in our Fleet segment. We’ve renegotiated client leases, and from 2009 forward, cars and trucks are being added on the basis of the renegotiated lease.

Finally, I want to emphasize that we are managing our business to create long term economic value which is a core underlying objective of all of our strategic priorities and ongoing management actions. Beginning this quarter we are supplementing our GAAP results with non-GAAP core earnings measure which we believe will provide greater transparency and understanding of our businesses and financial results.

Sandra will discuss this approach in additional detail so at this point, I’ll ask her to take you through the fourth quarter and full year 2009 results.

Sandra Bell

Thank you Jerry. Turn to Slide 4. We ended 2009 with strong results for the quarter and the year. Our after tax GAAP results are as follows; fourth quarter net income of $97 million and basic earnings per share of $1.76 with full year net income of $153 million and basic earnings per share of $2.80.

These results were driven to a significant extent by four consecutive quarters of profitability in Mortgage production. We also reported strong growth in Fleet as funding costs continued to improve during the quarter.

Moving to Slide 5, in previous calls, we’ve discussed the challenges that the MSR presents to our ability to measure the shareholder value that we create. We evaluate the results of our businesses by utilizing multiple metrics to ensure we adequately understand the drivers of our results and take appropriate actions to achieve alignment with our objective to create long term economic value.

Today, we are introducing the concept of core earnings, a non-GAAP measure as a supplement to our GAAP results. We believe this metric will be useful to help investors gain a more complete understanding of our business results and alignment with our plans and actions to create long term economic value.

Our core earnings supplemental disclosures start with GAAP but exclude certain MSR valuation adjustments primarily driven by interest rate volatility and other estimates. Based on this approach, our after tax core earnings for the fourth quarter were $55 million or $0.99 per share and $142 million for the year or $2.60 per share. The drivers of these results will be discussed in the following slide.

On Slide 6, our Mortgage production segment produced pre tax profits of $65 million for the quarter and $306 million for the year on both the GAAP and core earnings basis. Fourth quarter origination volume was $8.7 billion of which approximately 26% was fee based closings and the rest were loans closed to be sold.

The primary reason for the increased amount of fee based closings relates to the fact that our clients are adding more jumbo loans to their portfolios as the secondary market for prime jumbo loans remains effectively closed.

51% of our total originations were purchase closings, up slightly from the third quarter. In comparison, purchase loans represented 35% of total industry closings in the fourth quarter. This difference reflects our purchase originations through the Realegy channel. Our stronger mix of purchase closings should provide more stability to our volume in 2010 relative to the industry.

For the full year 2009, our volumes were $37.6 billion and we expect that purchase closings will remain a significant percentage of our total closings in 2010 as the home buyer tax credit program has been broadened and extended as we expect to increase our penetration in the Realegy channel.

Our weighted average pricing margins were up from the third quarter as 134 basis points but fell off slightly in December to 131 basis points as the primary rate increased towards the end of the quarter. This margin pressure has continued into the first quarter of 2010.

Moving to Slide 7, turning to our Mortgage Servicing segment, by focusing on core earnings and removing the MSR valuation estimates I mentioned earlier, we have eliminated some of the noise surrounding our Servicing segment performance.

Pre-tax core earnings in the segment were $15 million for the quarter and a negative $105 million for the year. The full year result was driven by $49 million in net finance expense due to low short term interest rates, and $105 million in combined additions to reserves for re-insurance and foreclosure.

Our total portfolio delinquencies rose slightly from 4.54% at the end of the third quarter to 4.68% at the end of the fourth quarter based on unpaid balances. We believe that our delinquencies remain at approximately half the industry average given our strong underwriting policies and procedures.

While we are comfortable with our current reserve levels, we are keeping a close eye on underlying unemployment and delinquency trends which continue to remain high.

As a reminder, we do not maintain loans in portfolio. Therefore, our credit risk is substantially limited to those circumstances in which the borrower has defaulted on the loan and the loan file is found to contain an underwriting defect causing the loan to be put back to us for example, by the GSE’s or one of the mortgage insurers.

Our Loan Servicing portfolio increased by $1.7 billion from 12/31/08 and we replenished payoffs in our capitalized portfolio with new originations as we experienced $24.3 billion on loan payoffs and were able to add $27.7 billion in new originations with an initial MSR value of $497 million.

The weighted average interest rate in our Servicing portfolio was 5.3% at the end of the 2009, down 50 basis points from the end of 2008. The prior value MSR should be less susceptible to prepayments as interest rates rise.

Turning to Slide 8, our Fleet business continues to benefit from the improving trends in the securitization markets as we posted pre-tax profits of $15 million for the quarter and $54 million for the year on both a GAAP and core earnings basis.

As we have strengthened our funding, we’ve also been successful in addressing the lease interest rate mismatch. Leased vehicles added in 2009 and forward reflect the renegotiated lease contracts at the revised rates. This in conjunction with favorable funding costs, produced better than anticipated results in 2009.

On Slide 9, as Jerry mentioned, we had a very successful quarter, executing against our financing plan. In November we sold excess servicing for approximately $83 million in net proceeds.

Chesapeake funding, our U.S. Fleet funding program, issued approximately $300 million in asset backed notes, and in January of this year our Canadian funding program issued another $343 million of asset backed notes. The proceeds of both of these issuances were primarily used to increase the availability under our revolver which was more than $1 billion in mid February.

Moving on to Slide 10, as we move through the first quarter of 2010, we are actively engaged in negotiations with our lenders to renew our revolver. Given the relatively low level of outstandings as well as our expected future business needs, we expect to renew the revolver at a lower commitment level. We are comfortable that our discussions will provide ample liquidity for the businesses.

We are also in discussions about Mortgage warehouse facilities with multiple lenders including the renewal of our existing facility with RBS. And, we’re negotiating with lenders to provide conduit capacity for Fleet in both the U.S. and Canada. We expect to finalize all of these facilities by the end of the second quarter.

In summary, all of these efforts are part of our overall goal to diversify our sources and extend our maturities. With that, I will turn the call back to Jerry.

Jerry Selitto

Thank you Sandra. While our fourth quarter results are positive in many respects, we operate under no illusions about the serious challenges facing our businesses. We must do more to increase shareholder value.

That’s why we’ve undertaken the transformation initiative that we discussed on our investor call two weeks ago. That call focused on process and efficiency improvements and our commitment to generate annual run rate expense reductions of $100 million to $120 million and a sustainable further cycle return on equity of 13% by early 2011.

Today, I want to give you a sense of the challenges that we see on the revenue side and the plans that we have to confront them. So turning to Slide 11, after a relatively strong recovery in 2009, we expect the Mortgage market to decline in 2010, rate to increase and unemployment to remain near present levels. This is expected to result in a fall off in overall industry origination volume of approximately 32%, down to $1.3 trillion.

Given these market conditions, and our typical mix of originations, if we do nothing, we would expect our mortgage volume to decrease by about 20%. But we don’t intend to stand still.

We have developed and are implementing plans to maintain our revenues at 2009 levels which will require us to increase our market share from approximately 2% to 3%. We are taking a very aggressive new direction in our mortgage sales and marketing strategy with the addition of Mike Dirrane as our new VP of Sales.

Mike is completing a review of all of our origination channels including a thorough review of the Realegy channel where we will work with our joint venture partner to increase penetration and build volume through increased efficiencies in sales and fulfillment operations.

In addition, we are looking to selectively expand our footprint in the wholesale correspondent channel which we believe is currently underserved and presents opportunities to lenders with the necessary tools and experience. We will be highly selective in terms of the companies with whom we do business to ensure the highest quality production consistent with our stringent underwriting philosophy and we’re evaluating a number of alternatives to capture new business both organically and through strategic partnerships.

There is also a focused marketing effort in our private label Solutions business designed to penetrate the regional bank and credit union markets which are seeking solutions to manage costs and increase efficiency.

We just completed implementation with Keybanc the new major client that we mentioned in the third quarter and we’re looking to further penetrate our existing clients, some of which are adding new financial advisors. We believe that building a more efficient operation through our transformation effort will give us a competitive advantage in an environment where margins are down.

On Slide 12, our Fleet business is also focused on regaining market share through cost competitive and differentiated products and services. We are an industry leader in terms of innovative solutions we deliver and with our funding issues well behind us, we are actively marketing to both new and existing accounts as well as some of those we have previously lost.

Specific new areas of focus will be small fleets and government where we’ve brought in dedicated resources to help us expand our presence.

So while we have our work cut out for us in 2010, if you will look at Slide 13, we’ve taken the proactive steps necessary to capitalize on opportunities we see ahead of us building our revenues sources and improving our internal processes to allow permanent cost reductions while maintaining our excellent customer services, solidifying our funding picture and converting all of those efforts into greater shareholder value.

Barring any unforeseen macro events, I am highly confident that we are well positioned to deliver a sustainable run rate after-tax ROE of 13% by early 2011.

I will now open the discussion for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Miller – FBR Capital Markets.

Paul Miller – FBR Capital Markets

Could you discuss a little bit about the release, the MSR pre-payments and returning cash flows? I mean this number was almost halved from two quarters ago and down from $97 million last quarter. Can you guide us to what the run rate on that number should be and why did it jump and why has it been so volatile lately?

Sandra Bell

Actually in response to the questions we had over the course of the quarter last year, we actually enhanced our disclosures and split out the credit related components to a separate line. So the easiest way to understand the comparison is go to page 24 in the press release and compare that to page 22 in the third quarter release, and it’s just the first two components are in that line in the fourth quarter release.

We separately highlighted the credit down further in our disclosures.

Paul Miller – FBR Capital Markets

So the numbers really haven’t been that volatile. It’s just where they’ve been disclosed upon in the release.

Sandra Bell

Correct.

Paul Miller – FBR Capital Markets

I’ll touch base with Nancy to find all those data points. One of the big ways that you beat our numbers was the credit costs were way down roughly from $25 million last quarter in the servicing side down to about $10 million. Is that $10 million a good run rate going forward because I know you did guide us for lower credit losses going forward, or would that jump around still?

Mark Danahy

I think the fourth quarter was probably seasonally low and we’d expect to see that trend increasing from the fourth quarter but below the third quarter levels, somewhere in between.

Paul Miller – FBR Capital Markets

So in that middle would be a good way to model that out for the time being until we get improvement in the overall housing market or the economy.

Mark Danahy

Yes.

Paul Miller – FBR Capital Markets

We talked I think it was two weeks ago, or last week, I forgot when your conference call was about a new break even point and you talked a little bit about that you might disclose it on this call. There’s something in here. I missed it, but are you ready to give a new break even point or is that something you want to work on a little bit longer?

Jerry Selitto

We’re ready. The new number is $22 billion.

Operator

Your next question comes from Bose George – KBW.

Bose George – KBW

I wanted to clarify, on the transformation call you had a couple of weeks ago, I thought you mentioned you would take a charge related to this. I was wondering if that didn’t happen. Is it going to happen or is that just something that’s not going to happen now?

Jerry Selitto

We did take a charge in the fourth quarter of $10 million for severance.

Bose George – KBW

So it’s just in the expense line item.

Sandra Bell

In the salary and related expenses.

Bose George – KBW

Just to follow up on the earlier question on credit, the re-insurance related line item also fell very sharply with $1 million this quarter. I was wondering what the run rate for that should be also, do something in between third quarter and fourth quarter?

Mark Danahy

The fourth quarter you can probably have a reasonable expectation going forward. We would anticipate most of the revenues being offset by reserve on a prospective basis.

Bose George – KBW

Switching to your mortgage production, there was obviously a strong gain on sale margin, one thing you highlighted was the benefit of the hedges on your interest rate locks. Can you talk about that? Should we think about that as an unusual gain or is it just offsetting the decline in the value of mortgages that you sold given higher rates?

Mark Danahy

The way gain on sale is recorded, at this point you recognize the value of interest rate lock commitments when you make the commitment to a borrower and then that is affected by hedging and then ultimately what you pull through. The pull through in this particular case was stronger than we initially modeled at the time of the rate lock commitment and so I would not consider this to be a necessarily an unusual item.

Bose George – KBW

On the funding you noted that by the end of the second quarter you should have most of your funding issues addressed. In terms of the need for any more term funding, is it reasonable to assume that you don’t need any more term funding now that this Canadian securitization is done?

Sandra Bell

I think we will always look at opportunities to extend maturities if the market allows us to do so, but we don’t need to.

Operator

Your next question comes from Steve DeLaney – JMP Securities.

Steve DeLaney – JMP Securities

I want to applaud the switch to a core earnings presentation. I think that’s going to serve PHH well going forward and it will really simplify things for investors. So thank you for that.

Looking at the fourth quarter and the change in the MSR valuation, it looked like you benefited a great deal from slower pre-payments, the actual run off amortization expense was $44 million and we look at on a full year basis it’s $244 million, about a $61 million average. Are you looking at that as being a direct reflection of a slower re-fi index in the fourth quarter?

Jerry Selitto

Yes.

Steve DeLaney – JMP Securities

The gain on sale of excess servicing, had that been discussed previously? I don’t recall on one of the previous calls.

Jerry Selitto

I’m not sure whether we did or not.

Steve DeLaney – JMP Securities

The question is, I want to make sure I’m thinking about this right. On your $151 billion your actual servicing fee income, I think you had $466 million for the year so it works out to be about a 31 basis points or something. When we think about pulling forward, when I think of excess servicing I think of just your excess spread that is coming through monthly, but if you do a transaction and sell that for present value figure, should we be thinking that going forward, servicing fee revenue as a percentage of UPB is going to be reduced by that one time transaction?

Jerry Selitto

Yes. I actually think when you look at the size of the excess servicing, it’s not going to be a major reduction.

Steve DeLaney – JMP Securities

Like maybe it might be a basis point or so.

Jerry Selitto

In the 10-K we went from 33 basis points at the end of 2008 to 31 at the end of 2009.

Steve DeLaney – JMP Securities

On other thing on servicing, the expectations going forward. I know you’ve definitely been benefiting from slower pre-pays. Is all the noise that we’ve got going on now with the GSC’s and the buyouts, and I know that doesn’t affect you directly because you don’t own agency, but are you concerned that as they buy these loans out at $200 billion or whatever, have you had any discussions with the GSC’s? I’m sure you have pools that will have buyouts. Do you think you’ll be able to retain that servicing for the agency even though the loans out of the pool or do you have any idea whether they’re thinking to centralize that servicing or move it away from the seller servicer?

Mark Danahy

We’ll be keeping the servicing and we’re also in active discussions with the GSC’s at this point in time. But we’ll be keeping the servicing.

Steve DeLaney – JMP Securities

So you’re expectation is that for you and your servicing platform that you’re not going to see servicing moved away from you.

Mark Danahy

That’s our expectation, that we will not see servicing moved away from us.

Steve DeLaney – JMP Securities

That’s good. I wasn’t sure how it was going to play that. One final thing Jerry, and please forgive me, in your thought process and I commend you on the action orientation you’ve taken here with the new hires and the transformation, so this is probably like the last thing you’re thinking about right now, but if we look down the road and you’re successful with reducing expenses, getting to this 13% stabilized ROE, is it your view that a year or two years from now you could see PHH as a company that is paying a quarterly cash dividend to its shareholders?

Jerry Selitto

Given all the things that you described, that might be in the cards.

Steve DeLaney – JMP Securities

So stay tuned. If the plan works, that’s something that we might be able to expect. Some companies obviously have just a philosophy on that, that either they do or they don’t pay dividends and I just wanted to get your sense. And what I’m hearing is that if the company is stable and returns are stable, you would be inclined to consider that.

Jerry Selitto

We would be inclined to consider that. That’s correct.

Operator

Your next question comes from Meryl Whitmer – Eagle Capital.

Meryl Whitmer – Eagle Capital

Was the $100 million severance expense in the fourth quarter? How does that hit the different segments? And is there a reason why you don’t add it back in your core earnings adjustments?

Mark Danahy

First of all, the breakdown is a 60/40 breakdown, approximately a 60/40 breakdown. The second part of your question?

Meryl Whitmer – Eagle Capital

It’s sort of a one time in nature item. I’m wondering why you don’t add it back in your core earnings.

Sandra Bell

As we think about core earnings, we think about operating performance and since the severance is related to improving the performance of the business, we have left it in. So the only time you will see adjustments other than the MSR estimates we talked about is when it’s a non business related charge.

Operator

Your next question comes from [Mark Aga – Lay & Partners]

[Mark Aga – Lay & Partners]

I don’t know if I missed this and I apologize if I did, but Jerry you said the ROE targets for early 2011 was 13%?

Jerry Selitto

It was a 13% ROE run rate beginning in 2011.

[Mark Aga – Lay & Partners]

I don’t know if you mentioned this or not, is that GAAP or core?

Jerry Selitto

It’s a core after tax run rate of 13%.

Operator

Your next question comes from Bose George – KBW.

Bose George – KBW

On the expense reduction guideline, the $100 million to $120 million, was any of that already implemented in the fourth quarter or should we just think of that as a 2010 number?

Jerry Selitto

Some of the initiatives were implemented in the fourth quarter, but you’ll see the results of that going forward in 2010. But a lot of the strategies were implemented during the fourth quarter, but we didn’t get any saves in the fourth quarter. Those saves will be in 2010.

Bose George – KBW

One question on MSR hedging, I was curious at what rate level you revisit the whole idea of hedging the MSR again.

Jerry Selitto

At this point in time we’re comfortable with our MSR strategy. It’s something that we review constantly but we’re very comfortable with our strategy at this point. Our production net cost has more than offset any of the run off that we’ve seen.

As you know, it looks like the prognostications are that we’re going to see a rate increase going forward, but it’s just something that we constantly monitor.

Operator

Your next question comes from Wayne Archambo – Monarch Partners.

Wayne Archambo – Monarch Partners

Going back to the ROE objective, the 13% number, can you explain to us how management’s compensation is directly tied to that number:

Jerry Selitto

We are currently reviewing all of our compensation metrics and our metrics going forward will be a management by objectives. And I can tell you that my compensation and the senior team’s compensation is going to be based on our obtaining that $100 million to $120 million target saves as well as achieving a 13% core after tax REO, so we are well aligned with the interest of our shareholders.

Operator

There are no further questions. I’d like briefly to remind everyone of the replay information for today’s call. If you’d like to listen to either an audio replay at the website you can do so by going to www.phh.com or you can dial in by telephone to listen to the replay and that number is either 1-888-203-1112 or 719-457-1820 and use the conference ID 2514715. That will be available shortly after the conclusion of the call and will also be available until March 16, 2010.

With that, I’d like to turn things back over to our speakers for any additional or closing remarks.

Jerry Selitto

I want to thank everyone for participating in the call today. I just want to mention that despite the challenges, after four months of PHH, I am more enthusiastic than ever about our prospects. We’re making considerable progress in re-engineering the company. We’re bringing a sense of strategy and financial discipline to our decision making and we’re building an experienced leadership team to navigate the challenges and the opportunities in front of us.

As I said on our call two weeks ago, I want to earn your trust by delivering on the opportunities identified. So please stay tuned for future developments. I want to thank you once again for your participation in the call today. Thank you.

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