PHH's CEO Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: PHH Corporation (PHH)
by: SA Transcripts

PHH Corporation (NYSE:PHH)

Q4 2013 Results Earnings Conference Call

February 12, 2014 10:00 AM ET

Executives

Jim Ballan - Vice President, Investor Relations

Glen Messina - President and CEO

Rob Crowl - Chief Financial Officer

Analysts

Paul Miller - FBR

Henry Coffey - Sterne Agee

Kevin Barker - Compass Point

Daniel Furtado - Jefferies

Cheryl Pate - Morgan Stanley

Chris Gamaitoni - Autonomous Research

Brad Ball - Evercore

Jeffrey Schachter - Morgan Stanley

Operator

Please standby, we are about to begin. Good morning, ladies and gentlemen. And welcome to the PHH Corporation Fourth Quarter 2013 Earnings Conference Call. Your lines will be in a listen-only during remarks by PHH management. At the conclusion of the company’s remarks, we will begin a question-and-answer session. At which time I will give 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 access either on the company’s website at www.phh.com/invest or by telephone at [(888) 203-1119-457-0820] (sic) (888) 203-1112, (719) 457-0820 (888) and using the conference ID 6379559 beginning shortly after the conclusion of the call. It will be available until February 27, 2014. This access information is also described in the company’s earnings release and I’ll repeat it again at the end of our session.

At this time, Jim Ballan, Vice President of Investor Relations will proceed with the introduction.

Jim Ballan

Thanks, Tim. Good morning. And welcome to PHH Corporation's fourth quarter 2013 earnings conference call. Please note that statements made during this conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as further described in slide three of our fourth quarter 2013 Investor Presentation of Supplemental Schedules, which is posted in the Investors section of our website at www.phh.com under Webcasts and Presentations.

Such forward-looking statements represent only our current beliefs regarding future events and are not guarantees of performance or results. Actual results, performance or achievements may differ materially from those expressed or implied in such forward looking statements, due to a variety of factors including, but not limited to the factors under the headings Cautionary Note Regarding Forward-Looking Statements and Risk Factors in our periodic reports filed with the U.S. Securities and Exchange Commission, including our most recent annual report on Form 10-K and quarterly reports on Form 10-Q, which are also available in the Investors section of our website. Investors are cautioned not to place undue reliance on such forward-looking statements.

The earnings release we issued yesterday also maybe accessed from the Investors section of our website or you may request a faxed or mailed copy by calling our investor hotline.

During this call, we may discuss various non-GAAP financial measures, including core earnings or loss pre-tax, core earnings or loss after-tax, core earnings or loss per share, adjusted cash flow and tangible book value per share.

Please refer to our earnings release and accompanying Investor Presentation of Supplemental Schedules for a description of these and other non-GAAP financial measures, as well as a reconciliation of such measures to their respective most directly comparable GAAP financial measures.

Speaking on the call today will be Glen Messina, President and Chief Executive Officer; and Rob Crowl, Chief Financial Officer. Other members of PHH's senior management team are also with us and will be available.

And now, I will turn the call over to Glen Messina.

Glen Messina

Thanks, Jim. Good morning, everyone, and thank you for your continued interest in PHH. This morning I want to briefly discuss our fourth quarter and full year 2013 results after which Rob will discuss our results in greater detail. Then I will provide updates on some of the items we discussed on our last earnings call and discuss the outlook for 2014 including the Board and management’s decision to explore ways to maximize shareholder value through the separation of sale of our fleet business, our mortgage business or both.

In the fourth quarter, our Mortgage Servicing business generated positive results on the both the GAAP and core earnings basis as prepayment rates dropped significantly and reduced reserves for mortgage loan repurchases. A positive mark on our MSR also contributed to servicing results in the quarter.

Our mortgage production segment generated a loss for the fourth quarter due to a continued decline in application and lot volume, a higher mix of client invested originations and severance charges. This was partially offset by meeting the cost improvement objectives we laid out last quarter. Meanwhile, our fleet business continued to provide solid segment profit.

For the full year 2013, we delivered meaningful improvements in our business in the pace of a rapidly changing mortgage industry environment and rising interest rates. In 2013 as compared to 2012 retail closings were up 4% and retail home purchase applications were up 19%.

The number of subservice loans increased by 194% as we focused on less capital-intensive servicing opportunities. Total mortgage quality related cost decline 76%. We implemented the necessary systems and process changes to ensure we operate in compliance with numerous regulatory changes, including the ability to repay regulations. Mortgage customer satisfaction scores improved reflecting our commitment to operation and process improvements.

Fleet continued to grow average total service units in all three key ancillary services. We extended the maturity profile, lower the cost of our unsecured debt. We improved our ratio of unencumbered assets unsecured debt and we initiated alternative funding source for MSRs. We believe our operating execution and the improvements in our liquidity and capital structure position our business for the challenges and opportunities that lie ahead.

Now I’ll turn it over to Rob to discuss our financial results.

Rob Crowl

Thanks, Glen. On a GAAP basis we reported net income attributable to PHH Corporation for the fourth quarter of 2013 of $45 million or $0.78 per basic share, which included a $48 million pre-tax favorable mark-to-market adjustment on our MSR asset net of $2 million in hedge losses, as mortgage interest rates continue their upward trend in the fourth quarter.

Core earnings after-tax and core earnings per share both of which exclude the net MSR mark equaled $16 million and $0.28 per share respectively in the fourth quarter. The GAAP and core earnings results included $12 million pre-tax charge or $0.13 per basic share after-tax for severance cost-related capacity reductions implemented in our mortgage production segment.

For the full year 2013 on a GAAP basis, net income attributable to PHH Corporation was $135 million or $2.36 per basic share, which included a $257 million pre-tax favorable mark-to-market adjustment on our MSR asset, primarily from rising mortgage interest rates throughout the year, net of $19 million in MSR hedge losses. Core loss after-tax and core loss per share for the full year of 2013 were $19 million and $0.32 per share, respectively.

Full year 2013 results included $54 million pre-tax loss on the early retirement of debt, $22 million in pre-tax severance charges, primarily related to capacity reductions and $21 million in pre-tax on active mortgage reinsurance agreement, together totaling a loss of $1.04 per basic share after-tax. GAAP segment profit for the combined mortgage segments was $41 million in the fourth quarter compared to a loss of $50 million in the third quarter.

Core earnings pre-tax for the combined mortgage segments was a loss of $7 million during the fourth quarter as compared to a loss of $39 million in the third quarter Sequential quarter improvement in GAAP and core earnings pretax results was driven by improved profitability in our mortgage servicing segment partially offset by decline in mortgage production segment results.

For the full year 2013, GAAP results for the combined mortgage segments totaled profit of $179 million and $157 million in profit in the mortgage servicing segment and $22 million in the mortgage production segment. Core earnings pretax for the full year of 2013 for the combined mortgage segments totaled a loss of $78 million on $22 million of core earnings in the production segment offset by $100 million core loss in the servicing segment.

Mortgage production segment profit in the fourth quarter equaled a loss of $45 million compared to a loss of $23 million in the third quarter. Results in the third and fourth quarters of 2013 include $9 million and $12 million in severance-related charges respectively. As compared to the third quarter of 2013, mortgage production earnings were down $23 million primarily due to a decline in both applications and Interest Rate Lock Commitments expected to close.

Interest Rate Lock Commitments expected to close sequentially declined 27% to $2.1 billion in the fourth quarter while total loan margin narrowed by only 2 basis points to 313 basis points for the fourth quarter. The IRLC decline was driven by a decline in purchase and refinance activity, which were down 29% and 24% respectively quarter-over-quarter.

In addition, fee-based closings rose to 61% of total closings from 58% last quarter and 41% in the fourth quarter of 2012. Fee-based loans represent production that is retained by our clients for their own balance sheet so we do not recognize the gain on sale. Also, our fee-based revenues are recognized in mortgage fees at closing.

Applications for the fourth quarter totaled $10.4 billion, down 18% from the third quarter and consistent with an 18% decline in the MBA application index for the same periods. For the full year, the mortgage production segment earned $22 million and these results include $22 million of severance-related cost taken in third and fourth quarters.

Mortgage servicing segment profit was $86 million in the fourth quarter compared to a segment loss of $28 million in the previous quarter. Mortgage servicing core earnings pretax was $38 million in the fourth quarter compared to a core loss of $17 million in the previous quarter.

The $55 million improvement in sequential quarter core earnings was driven by a $19 million improvement in MSR runoff due to slower prepayments, a $19 million reserve release primarily from lower than expected repurchase requests from the GSEs, $8 million of additional loan servicing income and $8 million in lower servicing expense primarily from lower provisions for compensatory fees and uncollectible servicing advances. We continue to see opportunities for improvement in the core earnings result of our mortgage servicing segment as prepayment speed slow and quality-related costs improved.

For the full year of 2013, segment profit and mortgage servicing was $157 million and core earnings pretax in the mortgage servicing segment equaled a loss of $100 million both included $21 million loss on the termination of an inactive mortgage reinsurance agreement.

Our total loan servicing portfolio of $227 billion at year end 2013 was up 23% from the beginning of the year, principally due to the assumption of $47 billion in subservicing during the second quarter. The capitalized portion of our loan servicing portfolio, which totaled $129 billion in UPB at year end was down slightly from the third quarter and down 8% from the beginning of year.

The decline in the capitalized servicing portfolio during 2013 was driven primarily by high prepayment rates, a greater portion of mortgage production on a fee-for-service basis and our narrowed focus in correspondent -- in our correspondent channel.

We experienced a significant slowdown in prepayments during the fourth quarter as CPRs fell to an annualized rate of approximately 11.5% as compared to 17.6% on average for the third quarter. At year end 2013, we valued our MSR at 99 basis points of our capitalized loan servicing portfolio, representing a 3.4 times capitalized servicing multiple.

These valuations are up from 94 basis points and 3.2 times at the end of the third quarter and 73 basis points and 2.4 times at the end of 2012. The valuation increases were primarily driven by the increase in mortgage interest rates and represents the present value of higher expected servicing cash flows in the future.

We believe both Fannie Mae and Freddie Mac have substantially completed the issuance of repurchase demands of pre-2009 origination vintages. As a result of the agencies pushing to meet their year end deadlines, the total number of newly purchase request in fourth quarter rose to 1017 from 735 in the third quarter and the total dollar amount outstanding repurchase request equaled $191 million as compared to $150 million at the end of the third quarter.

During the fourth quarter, our repurchase and foreclosure reserves fell to $142 million from $180 million at end of the third quarter as the total amount of request from agencies was less than previously anticipated. While we believe that GSEs are substantially complete with their pre-2009 vintage repurchase demand process, we remain obligated to repurchase loans of these vintages for items such as lien or title issues or charter violations.

We currently do not expect the remaining repurchase obligations for these loan vintages to have a material impact on our future results of operations. Our estimate for reasonably possible future losses related to repurchase and indemnification request declined to $30 million at the end of 2013 from $35 million at the end of the third quarter.

As a reminder, the estimate for reasonably possible losses is above and beyond, our recorded repurchase and foreclosure related reserve. Our year-end estimate on reasonably possible future losses is entirely related to FHA claims and represents the potential for reduction in the number of claims we may file in the future as compared to historical experience.

With regard to the recently announced CFPB action regarding our legacy reinsurance business, we are extremely disappointed that that CFPB has filed a notice of charges related to those subsidiaries’ former activities. We believe the CFPB’s allegations grossly mischaracterized legitimate former business activities of mortgage reinsurance subsidiaries.

We firmly believe our mortgage reinsurance subsidiaries comply with applicable statutory and regulatory requirements in existence during the period that such subsidiaries were engaged in the mortgage reinsurance business. And that we complied with the Real Estate Settlement Procedures Act, HUD guidance for the structuring of captive mortgage reinsurance arrangements and other laws applicable to our mortgage reinsurance activities.

Consumer protection has always been and remains core to our customer service philosophy. We have been very supportive of the CFPB’s efforts to improve customer, consumer protection across the mortgage industry and have maintain a positive working relationship with the bureau since they assumed supervisory responsibilities for PHH in 2012.

From time-to-time, these agreements may arise in the interpretation of laws and regulations that were seen by the CFPB, and we seek to resolve such conflicting interpretations as fairly and efficiently as possible. Nevertheless, as we have said, we intend to vigorously defend against the CFPB’s allegations. However, there could be no assurance that we would be successful in such efforts given the inherent uncertainties involved in litigation.

Our fleet business had another solid quarter, continuing to provide consistent segment profit. Fourth quarter segment profit for fleet was $22 million, down from $24 million in the third quarter of 2013 and up from $20 million in the fourth quarter of 2012. On a sequential quarter basis, leased vehicle average unit accounts and net investment and leases were both down 1%, while maintenance and fuel card average units were up 2% and 1% respectively.

For the full year of 2013, fleet were $88 million, up from $87 million in 2012. Maintenance fuel and accident services, the average units, all experienced year-over-year growth. The net investment in leases was up one half of 1% from 12/31/12 to 12/31/13 and leased vehicle average unit accounts for 2013 compared to 2012 were down 3%.

With regards to liquidity, we closed the quarter with approximately $1.2 billion in unrestricted cash, an increase of $90 million compared to the end of the third quarter. Drivers of this increase include $47 million in reduced collateral posting requirements and the balance from improvements in working capital.

Approximately, $750 million to $825 million of our unrestricted cash at year-end was earmarked for specific purposes, compared to a range of $820 million end of the third quarter. These cash earmarks are outlined in our investor supplement.

In addition, the cash balance at year-end included $110 million of cash held for our Canadian fleet business, which we do not intend to use in the U.S. and $99 million of cash held in consolidated variable interest entities.

And now, I will turn it back over to Glen.

Glen Messina

Thanks, Rob. We continue to pursue making our loan bank retail focus prime mortgage lender with greater scale and increased capital and operating efficiencies. We've made progress with regards to the milestones we identified as important to the mortgage business on our last earnings call.

The first milestone is a resolution of our repurchase backlog with the GSEs for our pre-2009 originations. As Rob mentioned, we believe both Fannie Mae and Freddie Mac have substantially completed the issuance of repurchase demands for pre-2009 originations. Accordingly, this milestone has been met.

The second milestone is the sustained execution of our alternative MSR funding strategy. Under our recently announced MSR purchase and sale agreement with an affiliate of Two Harbors Investment Corporation, we started committing MSRs on lock loans in the fourth quarter and we expect sizable settlements to occur in the second quarter.

We expect this funding relationship to contribute positively to our adjusted cash flow this year, while diversifying our funding sources and allowing us to maintain scale for our servicing operations. While, we are pleased with the execution of this agreement so far, we believe more time is required to demonstrate the program’s sustainability. We continue to believe we can achieve this milestone in the first half of 2014.

The third milestone is the renegotiation and amendment of our PLS contracts. In our discussions with PLS clients, they have acknowledge the significant increases in costs to produce and service mortgages today and we believe they recognize the value that PHH brings to their franchises.

We have completed the process of modifying our contracts for the qualified mortgage regulations and remain in active discussions regarding revised economics, our rights to directly source a refinancing from PLS client borrowers, our flexibility with regard to capacity management and our ability to sell and encumber MSRs created from PLS source loans.

We have achieved a targeted economic adjustment with clients representing 22% of our 2013 total PLS closing volume. Discussions with our largest PLS clients are ongoing and are expected to continue into the second quarter. If we do not achieve our target economic on our largest PLS contracts based on current market conditions and expected volumes, margins and mix, these contract will likely be unprofitable on a fully allocated basis and unless and until we can renegotiate the economics upon renewal, which occurs from December of 2015 through 2018.

We expect a highly challenging mortgage industry environment in 2014. The MBA’s anticipating industry origination volumes will be down by approximately one third as compared to 2013 to a level the industry has not seen since the year 2000. Additionally, we are continuing to see total loan margin compression, and an increasing mix of fee-based closings related to our PLS originations.

As these market conditions materialize and interest rates remain at the current level, our Mortgage Production segment will likely be unprofitable in cash consumption this year, while our Mortgage Servicing segment profitability will likely improve from meaningfully lower MSR amortization, curtailments expense and payoff related costs in 2014 as compared to 2013.

Should this increase, we would expect the value of our MSR would increase and we could have the opportunity to generate increased interest income on our approximately $3.3 billion in escrow balances. However, we would expect PHH on a consolidated basis to produce negative adjusted cash flow in 2014.

Management is taking decisive actions to reengineer PHH mortgage to offset the challenging market conditions we expect for 2014. We met our goal of at least $60 million in annualized expense savings by the fourth quarter of 2013 relative to the second quarter 2013 levels. In total, based on expected 2014 volume levels, the expense reduction actions taken to-date, plus our planned expense reduction actions in 2014, we expect to achieve at least a $110 million in annualized expense savings in 2014 relative to the second quarter of 2013. We will continue to monitor application activity and adjust our origination capacity levels to match market demand.

Given the higher fixed cost in mortgage resulting from the more complex regulatory environment, more stringent loan originations quality requirements, and the unique nature of our PLS contracts we believe mortgage will be set as scale of projected volume levels for 2014. As we said last quarter, the company is committed to evaluating all alternatives to address the scale challenges in mortgage, including but not limited to, new products, new channels, organic and inorganic growth.

We believe our focus on operational excellence has allowed us to build a leading origination and servicing platform that is capable of meeting today's stringent standards. This will be a critical success factor in our pursuit of organic growth opportunities to provide mortgage origination services and subservicing to regional community banks. We also believe our real estate platform has opportunities for enhanced profitability and growth as we improve mortgage loan officer effectiveness, fulfillment performance and expand regional coverage in products to improve our capture rate and the real estate offices we currently serve and to selectively expand our presence in offices we are not.

In our Mortgage Servicing segment, as a result of our belief that the GSEs are substantially complete regarding repurchase request related to pre-2009 loan originations and our effort to reduce new loan origination defects, we expect lower mortgage quality related cost in 2014 as compared to 2013. As we work through the ultimate disposition of loan repurchases relating to pre-2009 originations and our delinquent FHA and VA insured loans, we would expect our delinquent loan servicing foreclosure and REO expenses, which were $61 million in 2013 to decline.

To further improve the profitability of our servicing segment, we’ve engaged an advisor to assist us in evaluating the economic benefits of loan sales and outsourcing opportunities relating to our high delinquent servicing. The costs of servicing highly delinquent loans are multiple of the cost of service, high credit quality performing loans. While our delinquent loan portfolio was smaller than some of the larger loan servicers and we are meeting investor requirements for servicing delinquent loans, it is not our core competency and we may not be as efficient as servicers who specialize in delinquent loan servicing.

Regarding our evaluation of a separate MSR financing vehicle to further diversify our funding sources, we have concluded that the economics of an MSR secured funding arrangement are more favorable than that of our REIT at this time. As a result, we are actively pursuing the development of secured funding structure that would provide financing for MSRs related to originations from approximately 2009 or later vintages.

The implementation of a separate MSR financing vehicle remains a high priority for us and our goal is to implement our first secured funding transaction in 2014, subject to attaining GSE approvals, amendments to our PLS agreements and the achievement of the targeted economics. Additionally, in September of 2014 $250 million of convertible debt will mature. Once this debt is retired, this will result in annualized interest expense reduction of $32 million.

On our third quarter earnings call we talked about some of the complications that could arise as a result of the separation of the fleet and mortgage businesses. Over the last several months the board, management and its advisors have continued to analyze the debt and tax complexities of such a scenario and I'm pleased to say that we have made substantial progress in possibly reducing what could be material frictional cost. As a result PHH has retained JPMorgan, Centerview Partners and Kirkland & Ellis to explore a separation or sale of our fleet business, our mortgage business or both. This action reflects our determination and commitment to maximize shareholder value.

We expect to come to some conclusions with regard to this process as we approach the end of the second quarter. We appreciate the constructive input we have received from Orange Capital and our other shareholders in this regard. As part of the process, the company will evaluate the use of any excess cash, which may include the prepayment of unsecured debt, strategic business investments and/or the return of capital to shareholders.

In conclusion, PHH has consistently shown the resilience to manage through credit crisis and numerous interest rate cycles. We have accomplished this by staying focused on our customers’ needs, enhancing our processes and taking decisive actions and pursuing new growth opportunities. I have confidence in our employees and leadership team to navigate us through these challenging times and I want to recognize and thank my colleagues at PHH for their continued hard work and enduring commitment to our success.

And with that, we are ready to take questions. Tim?

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Paul Miller with FBR.

Paul Miller - FBR

Yes, thank you very much. Hey, on the capital front, I know -- I don’t think you mentioned on what you’re going to be planning buyback any more of your debt. What is your ticket initiatives when hiring an outside consulting people to look at your -- to maximize shareholder value. Are you holding off from buying back debt or where you stand there?

Glen Messina

Paul, given the complexities involved in separating the fleet and mortgage business, certainly we are going to -- as we move through this process, we will give consideration to what we do with any excess capital to include as we said returning capital to shareholders or strategic business investments or retiring some of our debt.

Paul Miller - FBR

So are you just going to wait I guess until there is an analysis done by your advisors?

Glen Messina

We have to consider the proceeds of the process to see what the best decision is as it relates to the separation of the fleet and mortgage business.

Paul Miller - FBR

Okay. And then when you talk about a -- just to clarify when you talk about an MSR secured funding vehicle, are you referring to Two Harbors, are you referring to some other type of strategy with the MSR funding?

Glen Messina

This is in addition to Two Harbors, Paul. So Two Harbors MSR funding is actually considered a sale. And the MSR is actually come of our balance sheet. In addition to that we are exploring secured funding for MSRs which actually would be recorded on balance sheet.

Paul Miller - FBR

Is that issuing like securitizations and things like that?

Glen Messina

Yeah, similar structure.

Paul Miller - FBR

Okay. And then one other thing, I notice is that your MSR portfolio including your -- I can’t think of it -- your sub-servicing loans went down over the quarter. That doesn’t usually happen, is that -- was that by design or is that just you weren’t able to recapture a lot of the refis this quarter? It wasn’t a lot of refis but your recapture ratio went down.

Glen Messina

Its just timing of additions and run-off, Paul.

Paul Miller - FBR

Okay, thank you very much.

Glen Messina

You’re welcome.

Operator

And we’ll take our next question from Henry Coffey with Sterne Agee.

Henry Coffey - Sterne Agee

Yeah, good morning everyone.

Glen Messina

Good morning Henry.

Henry Coffey - Sterne Agee

Going back to this, I mean, obviously we’ve been reading the press. Its sounds like your bankers had been pretty engaged for a while. Can you give us a sense of what sort of timeline they’ve presented you with, in terms of delivering proposals?

Glen Messina

Henry, as we said earlier, as we progress to this process, we expect to reach some conclusions by the end of the second quarter.

Henry Coffey - Sterne Agee

Okay. So -- and obviously if they concluded that you should -- you could sell the mortgage business to someone, would there be anything that would stop you from doing that?

Glen Messina

The board management are evaluating all opportunities to maximize value for our shareholders.

Henry Coffey - Sterne Agee

No, I know, I may have missed this. We had a bad connection here. But you talked about the PLS contracts, did you talk about a specific contract or does the general contract concept?

Glen Messina

The contracts in general.

Henry Coffey - Sterne Agee

Have you had -- have you renewed anything say in the last six months that would give us an indication of how receptive clients are to new terms and conditions?

Glen Messina

Yeah, as I mentioned, Henry, we’ve successfully completed amending the contracts for revised economics on about 22% of the volume that were recorded in 2013.

Henry Coffey - Sterne Agee

Can you give us some insight into what that meant to PHH?

Glen Messina

Pardon now.

Henry Coffey - Sterne Agee

I mean, what was the net effect of those revised contracts. How does that business look vis-à-vis the other 88% of the business for the period or the other 78% of the business of the period?

Glen Messina

Yeah. On a go-forward basis, we believe those contracts would be profitable on a fully allocated basis based upon the expected outlook for 2014.

Henry Coffey - Sterne Agee

Can you put some numbers on it for us?

Glen Messina

Not at this time.

Henry Coffey - Sterne Agee

And then the mark on the MSR, was it 99 basis points approximately?

Glen Messina

That’s correct.

Henry Coffey - Sterne Agee

Great. Well, thank you. You’ve obviously done a lot and seen a lot. And I think this is a good step forward.

Glen Messina

Thank you Henry.

Operator

And we’ll take our next question from Kevin Barker with Compass Point.

Kevin Barker - Compass Point

Good morning. Could you follow up on your comments on the reps and warrants reserves. Did you officially settle with the agencies or did they indicate to you that they’ve concluded their reviews in any future claims that they expect to make?

Glen Messina

Yeah, based upon our ongoing dialogue with the GSEs, we believe they’ve substantially completed the presentment of repurchase request related to pre-2009 originations.

Kevin Barker - Compass Point

So would that be official settlement or they just indicated they have done during their reviews?

Glen Messina

It is not an official settlement.

Kevin Barker - Compass Point

Okay. And then how much of your $142 million of reserves are currently allocated to post 2009 originations?

Glen Messina

Yeah, that’s something that we don't disclose in any of our public financials or earning supplement.

Kevin Barker - Compass Point

Okay. And you mentioned the potential -- correct me if I’m wrong, the potential sale or expiration of liquidating post 2009 MSRs. Could you just give us a little more color around that and the details of the sale of MSRs or the possibility of may be selling pieces or strips of those MSRs?

Glen Messina

Yeah, the statement from our comments is really directed towards the application of MSR secured funding. And we believe that secured funding could be applied to post 2009 for MSRs relating to post 2009 loan origination.

Kevin Barker - Compass Point

Okay. So that essentially would be -- would you secure finding when you’re issuing debt that would essentially mimic an I/O strip or the servicing fees associated with that MSRs. Is that the right way to think about it?

Glen Messina

That’s correct.

Kevin Barker - Compass Point

Okay. And then -- okay, thank you. That was all my questions.

Glen Messina

Your welcome.

Operator

And we’ll take our next question from Daniel Furtado with Jefferies.

Daniel Furtado - Jefferies

Thanks for the opportunity. Just as point of clarity, you can’t currently sell the MSRs associated with the PLS business in the past, can you?

Glen Messina

That’s correct.

Daniel Furtado - Jefferies

And so, is your focus predominantly on the ability to free those MSRs in your renegotiations or is it predominantly on driving incremental profitability into the positive territory?

Glen Messina

It’s on the combination of things, Daniel .As we said it’s economic. It’s getting the right to solicit bars directly for recapture. It is about getting flexibility to secure and/or find alternative funding for the MSRs as well as the capacity management.

Daniel Furtado - Jefferies

Got you. And so when we duck-tailed that into the secured financing vehicle to be absolutely clear which you’re contemplating now is basically moving, bringing those MSRs up, funding them long term. And then on incremental production, what would the play be there, just sell 50% of that to Two Harbors?

Glen Messina

The play would be actually best execution. So if it made sense for us to selling the Two Harbors and sub-service, we would that. Obviously if the economics are more beneficial, we keep it on our books in new secured funding forth.

Daniel Furtado - Jefferies

Got you. And then my last question is just the clarity, earlier you said that -- am I correct, when you said assuming current outlook for the mortgage business, you expect negative operating cash flow for 2014 in that segment?

Glen Messina

Negative adjusted cash flow, that is correct.

Daniel Furtado - Jefferies

Okay, okay. Thank you for the time.

Glen Messina

You are welcome.

Operator

And we’ll take our next question from Cheryl Pate with Morgan Stanley.

Cheryl Pate - Morgan Stanley

Hi, good morning. Couple of questions from my side. I think, I just wonder if you could expand upon your earlier comments, did you say that you had done some transaction with Two Harbors and we should expect to see that hit -- is it first quarter or second quarter?

Glen Messina

Sure, we had started to actually commit MSRs for two harbors on loans locked. And we expect the bulk of our fundings there that will occur in the second quarter.

Cheryl Pate - Morgan Stanley

Okay. So loans locked now and then we’ll start to see that flow through in the second quarter?

Glen Messina

That’s right.

Cheryl Pate - Morgan Stanley

Okay. And then just on the planned expense reductions for 2014 in the production segment I think. Can you just expand a little bit upon what other sort of opportunities there are to take out costs over and above what you’ve been able to execute on already?

Rob Crowl

Yes. We will continue to manage our originations capacity to match volume. As we talk about at the end of the third quarter, we've done some of that already through the course of 2013 and we are continuing that trend to 2014. And the $110 million of cost reduction activities includes things like managing overtime, managing contractors, some of the fixed cost reduction activities we had talked about previously. So to make it easier for people, we bucket it all to one number.

Cheryl Pate - Morgan Stanley

Okay. Got it. And then just one last one from me on the numbers. Was there anything unusual in the tax rate this quarter?

Rob Crowl

Yes. So we did have some state tax adjustments that we made all in the fourth quarter related to some prior provisions. And they rolled up in the fourth quarter, made an unusual tax position for the forth quarter. But we better to look at it for the full year for the effective tax rate.

Cheryl Pate - Morgan Stanley

Okay. Great. Thanks very much.

Operator

(Operator Instructions) We'll take our next question from Chris Gamaitoni with Autonomous Research. Chris Gamaitoni, your line is open.

Chris Gamaitoni - Autonomous Research

Hi. I have three questions, two detailed, one higher level. Can you hear me?

Glen Messina

Yes. We can now, Chris. Thank you.

Chris Gamaitoni - Autonomous Research

All right. Thanks. Can you give us any detail around how we should think about the deferred tax liability from depreciation of the fleet asset and in concept? It's hard to put a valuation on the difference if we don't kind of understand that concept.

Glen Messina

Yeah, Chris, generally if there is a sale of assets, the deferred tax liabilities trigger and it gets paid. If you structure a transaction where somebody would purchase the stock of an entity or business, generally the deferred tax liability would not be triggered and it would be inherited by the new owner of the business, the various IRS rules which can create a different outcome in that scenario. Chris, I would recommend that to the extent you want to get detailed in that conversation then we would probably do that offline.

Chris Gamaitoni - Autonomous Research

Okay. Okay, no problem. On the issue of the mortgage business, can you give us any idea of the profitability targets, how we should think about the private-label contract margin, return on equity? I'm not asking for any detail. But when you roll it up five years from now, what do you want to see the business produce?

Glen Messina

Yeah. Five years from now, assuming we can get all of our contracts replaced and adjusted, our target for the business has been to be in that double-digit return -- low double-digit ROE average throughout the cycle. So that continues to be our target for that business.

Chris Gamaitoni - Autonomous Research

Okay. You spoke about a possible sale of either fleet or mortgage. Given the nature of the contracts relative and unique to PHH, are there any like change in control provisions if you were to sell the mortgage business, where some of your more valuable contracts become kind of rebid, or any -- were there specific servicing contracts that would allow for like a buyer to not take out costs that might fit on their platform, those types of operational considerations?

Glen Messina

Yeah. Chris, as you are maybe aware of some of our public fillings, our PLS arrangements are a joint venture agreement with Realogy and several of our financing arrangements maybe affected by a change in control. However, those changes in control provisions may or may not be triggered and that would be really dependent upon the structure of a transaction. And it's really too early to speculate on whether or not those would be triggered. Yeah, obviously, we would take into account. We have complexities of the separation including what would happen under any change in control provisions as we decide on the appropriate structure and path to move forward.

Chris Gamaitoni - Autonomous Research

Sure. And then finally the high level -- underneath the noise and the generally bad industry environment for originations, you accomplished a lot of your goals. You are starting to restructure PLS contracts. What’s the thought of even putting the mortgage business on the block at a level when you haven't really come close to what your targeted ROEs are for the business? It seems to me any buyer would probably not to be full baked-in value of your ultimate return profile, and that kind of leaves a lot of money on the plate for future value for the shareholders.

Glen Messina

Yeah, Chris, as I said earlier, the management and Board are considering all opportunities to maximize shareholder value. And as well all opportunities to position the mortgage business to be successful in the purchase market environment.

Chris Gamaitoni - Autonomous Research

Okay. Thank you so much. Appreciate it.

Glen Messina

You're welcome.

Operator

We'll take our next question from Brad Ball with Evercore.

Brad Ball - Evercore

Hi. Thanks. You mentioned that the amount of cash that is -- that has a call upon and it is $750 million to $825 million. Could you talk about what the different calls on the cash are, and what drove the reduction from the amount of cash that was encumbered last quarter?

Glen Messina

Rob, you want to take that one?

Rob Crowl

Yeah. Sure. Hey, Brad, it’s Rob Crowl. So in investor supplement, you will see it is on Page 10. We do detail out the $750 million to $825 million. $200 million to $250 million is just basically cash for working capital needs. There is another $250 million for the repayment of the 2014 convertibles. There is another $200 million, which is essentially cash held for contingencies related to either mortgage loan repurchases or legal regulatory matters.

And then there is a $100 million to $125 million that are related for interest rate risk management activities and the collateral posting related to that. That is down from the third quarter as I stated in the script. The two buckets that had changes are the minimum cash balances for operating capital, was $250 million to $300 million last quarter. It’s come down to $200 million to $250 million, it’s really just based on some of the reduction in the business that we are doing, just a slowdown in the mortgage business and the working capital, that’s required for funding loans. And then our contingent liquidity needs was 225 last quarter, we’ve reduced that to 200 based on both the settlement with the New Jersey AG along with our drop in reasonably possible rep and warrant, along with some of the progress that we’ve made with the GSCs on legacy rep and warrant reserves.

Brad Ball - Evercore

Okay. And did you say that the $110 million of cash related to the Canadian fleet and the $99 million related to consolidated variable interest entities, is that in addition to these 750, 825?

Glen Messina

So those are -- it would be in addition and so we’ve got a total cash balance of $1.245 billion, 110 out of that was in Canada, which we did not intend to repatriate to U.S. and 99 of that is held in variable interest entities, the bulk of that for our Realogy joint venture.

Brad Ball - Evercore

So again sort of adding this all up and netting it, you’ve got a couple hundred, $200 million, $250 million of excess cash that it doesn’t have a call on it at this time.

Glen Messina

Yes, if you want to take the subtraction there of the $1.36 billion less the range we’ve given you.

Brad Ball - Evercore

Okay. And then…

Glen Messina

(Inaudible)

Brad Ball - Evercore

Separately related to the POS renegotiations you said that you’ve renegotiated 22%, now would that include some that you attempted to renegotiate and failed the contracts that are not going to be updated. I guess the question is, did you talk to 50% of your customers and now we’ve resolved 22% of the total or you only addressed 22% so far?

Glen Messina

Obviously, we are in continued dialogue with all of our POS clients, the 22% resolves are those contracts that we have concluded negotiations on, it’s roughly about eight clients for about 22% of our volume.

Brad Ball - Evercore

Okay. So eight clients have come to final resolution and other negotiations are ongoing I guess?

Glen Messina

That is correct.

Brad Ball - Evercore

Okay. And then finally sort of bigger picture with respect to the strategic options that you are considering, would you envision potentially separating the mortgage servicing in origination businesses, is that something you are contemplating or would you likely separate that out as one entity?

Glen Messina

We are not at this time contemplating separating servicing from originations.

Brad Ball - Evercore

Okay. So any spend or separation would be a divide of the two businesses, mortgage and fleet overall?

Glen Messina

That is correct.

Brad Ball - Evercore

Okay. Thank you.

Operator

And we will take our next question from Jeffrey Schachter with Morgan Stanley.

Jeffrey Schachter - Morgan Stanley

Hi. How are you doing? A quick one for you is, can you give a sense for 2014 under the back expense structure and margin expectations, kind of a breakeven lock volume, either on monthly basis or quarterly or where you would like to be for the origination channel under that structure?

Glen Messina

Yes, I don’t think that’s a number we’ve previously talked about in the framework. Bob, I don’t think that’s guidance we’ve given before, is it?

Rob Crowl

It’s not.

Jeffrey Schachter - Morgan Stanley

.Okay. And then the last one, is there any contemplates for 2014 on the MSR front in terms of an actual acquisition strategy or is it just own servicing retained from your portfolio or and sub-servicing work? Is there any aggressive notion of going out and biding on portfolios or acquiring MSRs in that manner?

Glen Messina

Yes, Jeffery, as we have said earlier, management is considering all options to better position the mortgage business in this environment and to address some of the scale challenges. We think having access to alternative funding, as such with the arrangement we have with Two Harbors. And to the extent we are successful developing the MSR secured funding enable us to pursue a broader range of options, potentially including acquiring servicing.

Jeffrey Schachter - Morgan Stanley

Okay, great. Thank you.

Operator

And at this time, there are no other questions in queue. I will turn it back to our presenters for any closing remarks.

Glen Messina

Great. Thank you, Tim. Thanks everybody. Look forward to giving you updates on our next quarter call.

Operator

And this concludes the PHH Corporation fourth quarter 2013 earnings conference call. Once again ladies and gentlemen, the replay will be available beginning later today at the company’s website www.phh.com/invest or by dialing 888-203-1112 or 719-457-0820 and using the conference ID 6379559. It will be archived until February 27, 2014. You may now disconnect.

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