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Stonegate Mortgage Corporation (NYSE:SGM)

Q4 2013 Results Earnings Conference Call

February 24, 2014; 04:15 p.m. ET

Executives

Jim Cutillo - Founder & Chief Executive Officer

John Macke - Chief Financial Officer

Michael McFadden - Investor Relations

Analysts

Bose George - KBW

Paul Miller - FBR

Douglas Harter - Credit Suisse

Ken Bruce - Bank of America

Henry Coffey - Sterne Agee

Christopher Testa - Sidoti & Co.

Operator

Good day ladies and gentlemen and welcome to Stonegate Mortgage Corporation’s Q4 2013 earnings conference call. My name is Susan and I will be your operator today.

At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this call.

I would now like to turn the call over to Michael McFadden.

Michael McFadden

Thank you Susan and good afternoon everyone. Please note that a recording of this call and accompanying presentation material can be found on Stonegate Mortgage’s, Investor Relations website at www.investors.stontegatemtg.com. Please refer to that website for important materials, including the Q4 earnings press release.

A replay of this call will also be made available on that website. An additional investor presentation will also be posted tomorrow which highlights our strategic direction in 2014. We would encourage you to review that as well.

Financial results that will be discussed on today’s call and located in the press release are unaudited. Additionally, today’s discussion and accompanying materials include forward-looking statements and as such are subject to risks and uncertainty that we have discussed in detail in our documents filed with the SEC. Specifically our final prospectus which was filed with the SEC on October 9 of last year, which identifies important risk factors that can cause actual results to differ from the forward-looking statements.

Finally, the financial results and matters that we will be discussing today contain non-GAAP measures that Stonegate’s management uses in evaluating company performance. GAAP to non-GAAP reconciliations are located in the press release and appended to the slide presentation.

At this time I would like to turn the call over to Jim Cutillo, Founder and Chief Executive Officer of Stonegate Mortgage.

Jim Cutillo

Thank you, Mike and welcome everyone to our Q4, 2013 earnings call. Before we review our fourth quarter results, I wanted to take a few minutes and provide everyone with a quick overview of the company.

Stonegate was founded in 2005 and since then has made decisions and investments to position the company to take advantage of the emerging mortgage market. When we use the term emerging mortgage market we are referring to the return of private capital to the housing finance market.

With the return of private capital will be our stronger need for transparency and auditabilty through technology, as investors will not rely solely on reps and warrant and small to mid-sized originators will need solutions that create capital and operating efficiency for their businesses. We view our investments and technology, NattyMac and other non-agency conduit as required for the emerging mortgage market.

We manage our business like an asset manager. What we mean by this is, we deploy capital into assets like Mortgage Servicing Rights that we believe have a higher net present value and the net cost to originate the assets through our origination and financing businesses.

Our origination business is diversified. We operate retail, wholesale, prior approved and delegated correspondent channels. This diversification allows us to be more resilient to changing market conditions, resulting in a net-cost to originate a bit lower than the alternative of buying Mortgage Servicing Rights.

Our financing platform provides an efficient financing solution to our correspondents, which we expect to increase wallet share and result in lower net cost to originate or MSR's. The combination of the financing and origination businesses allow us to create a mortgage servicing right, which can be retained in our servicing portfolio to produce recurring fee based income.

What differentiates Stonegate from other mortgage servicers is that we are not at the mercy of the market to go out and buy MSR’s, since we have established origination in financing business. In fact, if we feel that we could get a high enough multiple for our existing servicing, we will consider selling and monetizing that investment through a structured finance transaction and redeploying the capital back into the origination side of our business to create new MSR’s and non-agency assets at more attractive multiples in return.

Going to slide four, when I think back to the year 2013, one word comes to mind, transitional. It was transitional for the industry as the refinance boom came to an end during the second half of the year. It was also transitional for Stonegate as we began the year as a privately held company with a $55 million balance sheet and successful raised approximately four times that amount of additional equity during the year, underscoring the tremendous confidence in our business from the investment community and positioning us as a well capitalized, non-bank originator, financer and servicer.

Operationally we grew origination volume by 152%. Our ending servicing UPB was $11.9 billion, a 188% increase from 2012. We made strategic acquisitions that we believe position us for growth for quarters and years to come. I will discuss those in greater detail later in my remarks.

We continue to invest in technology and our non-agency platform and brining it all together even with significant equity raise, we delivered approximately 20% return on weighted average equity. We believe this highlights the strength of our business and our differentiated business model.

Turning to slide five, the industry headwinds continued in Q4. Even through these headwinds our business is performing well both financially and operationally and is more noteworthy that per-inside mortgage finance, we were the only top 30 bank or non-bank originator to grow in the fourth quarter.

Once again we continued our origination growth by turning in company records for both origination and locked volume. It is important to note that this growth is not coming from reduced margins. In fact our margins improved in Q4 in our interest rate lock commitment and that trend has continued into the first quarter.

Purchase transactions represented 72% of our total origination volume in Q4, compared to 50% for the industry. Our constant focus on the purchase transaction has allowed us to achieve these results.

Our servicing fee income grew 32% from last quarter, as our servicing portfolio grew to $11.9 billion. Our average warehouse outstandings were $555 million for the fourth quarter. As we continue to roll out the NattyMac platform, we expect this number to grow noticeably.

At this point I’d like to turn the call over to John Macke, Stonegate’s, Chief Financial Officer, to discuss our fourth quarter financial results.

John Macke

Thanks Jim. Turning to slide six, total revenues in the fourth quarter were $43.8 million, an increase of 38% from the third quarter of 2013 and 35% from the fourth quarter of 2012, driven primarily by higher gain on sale margins as compared to the third quarter. We also saw increases in revenues from servicing fees, as well as interest income from both the prior quarter and year ago levels.

On slide seven, on the lower left, we show a revenue bridge graph from third quarter to fourth quarter, which shows the increased revenues and nearly all-financial statement line items. On the lower right graph we show the 37 basis point improvement in gain on sales margins from Q3 to Q4, which is reflected primary in the more valuable pipeline at the end of the quarter.

Turning to slide eight, fourth quarter net income was $2.1 million or $0.08 per diluted share and adjusted net income was $2.7 million, compared to third quarter net income of $1.7 million or $0.10 per diluted share and adjusted net income of $0.1 million.

Again the favorable change we experienced during the fourth quarter was due primarily to increased gain on sale margins and fair market value adjustments, as well as higher servicing fees and interest income. The decline in diluted EPS during the fourth quarter was due to the increase in weighted average shares outstanding resulting from our IPO during the quarter.

As a footnote to our adjusted net income numbers, after conversing with the analyst, we modified our non-GAAP net income calculation to better reflect industry standards. A non-GAAP reconciliation is located in the appendix of the presentation, with a footnote explaining these modifications.

I would now like to turn the call back over to Jim to discuss the results of our operating lines of business, as well as our strategic initiatives, before we open the call up for questions.

Jim Cutillo

Thanks John. Please turn to slide nine. As I previously stated, we are once again able to increase our origination volume in the fourth quarter due to our diversified origination business, geographic expansion and other strategic initiatives. Origination volume grew 2% over the third quarter and 70% over the fourth quarter of last year.

Importantly, we continue to focus on purchases as they are more stable and tend to have lower prepayment fees in early years, making the mortgage servicing assets more attractive.

Purchases represented 72% of our origination volume in the fourth quarter compared to 50% in the industry. It is important to note that purchases on an industry-wide basis are expected to increase 16% in 2014, outpacing refinances for the first time since the financial crises. This should translate into great market opportunity for Stonegate in 2014.

We also see an opportunity to continue to generate the refinance business since the industry began to shed excess capacity. Our acquisition of Crossline gives us a call center platform to capture this part of the market.

On slide 10, you can tell that the focus on purchase allowed Stonegate to outperform the rest of the market as we were the only top 30 mortgage bank or non-bank to grow origination volume in the fourth quarter, according to Inside Mortgage Finance. You can also see the shift in volumes from banks to non-banks, as large banks experienced more contraction than non-banks. Once again this was accomplished without reducing margins and in fact you can see in the Q4 gain on sale, a higher value in our interest rate lock commitment and pipeline.

Turning to slide 11, from a geographic standpoint, we are currently licensed in 41 states representing 87% of the total U.S. market. To put this growth into perspective, just six months ago we were licensed in 33 states representing 54% of the market. This means the seven states we’ve added represent 33% of the entire market and are only beginning to product meaningful volume. The most noteworthy of the remaining states where licenses as pending are Nevada, Arizona and New York.

As we have previously stated, we believe the recent addition of the Nationstar wholesale lending channel will accelerate our entrance into wholesale, mini-correspondent and warehouse lending in key States such as California.

We continue to add third party originators and capture a larger percentage of their wallet share. We have been focused and will continue to focus on building relationships with our small to mid-sized correspondent, to capture a larger share of the wallets through offering complementary services as such as NattyMac and technology.

In 2013 we had 1011 active accounts, meaning 1011 different third party originators sold us at lease one loan during the year. In the fourth quarter alone we had 837 active accounts compared to 715 in the third quarter. This again shows that we have recently added a number of new relationships that we expect to provide significant amount of growth in the coming year.

On slide 12 you can see that our servicing side of our business continued to deliver very strong results. Our ending servicing UPB was $11.9 billion, a 23% increase from the previous period and a 188% increase from Q4 of 2012. Our direct cost per service was $106, which while compared to $100 per loan in the same period last year was expected due to the build out of the Dallas Servicing Center.

The Dallas Servicing Center will offer us the ability to increase scale in our servicing operations in 2014. As a result of our operational improvement we expect to reduce our direct cost to loan, which is serviced in 2014. Our high quality-servicing portfolio has an average 90-day delinquency of 0.35% and an average CPR under 5% highlighting the quality of our young portfolio.

Turning to financing business on slide 13. Our financing platform is growing nicely as the number of customers and commitments are accelerating. Current commitments totaled $254 million to 60 customers and financing activity produced $2.2 million in net interest income in Q4.

We currently have 30 pending account applications for approval. Importantly, this business is allowing us to compete with bank-owned mortgage originators, who have historically offered warehouse financing as a means of building wallet share and generating fee and net interest income. This is a competitive advantage over other non-bank originators and servicers who do not have warehouse lending operations.

Turing to slide 14, now that we have a few months of data related to NattyMac customers, our strategy is playing out. On average, three months following signing up with NattyMac warehouse line, our correspondence are locking 52% more volume to Stonegate, compared to the three months prior to receiving the warehouse line. Our ability to provide liquidity and efficiency to our corresponding customers is resulting in a stronger relationship and higher wallet share.

Looking at the chart on the bottom right of slide 14, you can see that three months after receiving NattyMac warehouse lines, correspondence locked $38.7 million annualized. This compares to total locks per account in 2013 of $16.4 million. We expect this to allow us to maintain and improve our margins on the origination side of our business, which will reduce our net cost origination and our cost basis in our MSR’s.

Now on slide 15, lets discuss the recent acquisitions that we have completed, that we believe help us grow in the quarters and years to come. Starting with Nationstar; as you know in November, we announced that we were acquiring their wholesale lending channel and certain distributed retail asset. This acquisition enables us to further driver retail originations and serve an even larger group of mortgage brokers through our wholesale channel.

The wholesale acquisition resulted in 30 additional account executives, which will expedite our channel shift towards wholesale and mini-correspondent and as well as our geographic expansion in the space such as California.

Those 30 account executives have signed up over 300 new mortgage brokers to begin delivering loans to Stonegate. We closed the Crossline acquisition in December and quickly integrated their platform. We are committed to partnering with retail lenders who are dedicated to growing their business.

In January Crossline locked over $50 million in new retail loans. Since the closing of the deal, Crossline purchased the assets of the Medallion Mortgage, a Southern California based retail originator. Medallion funded more than $400 million in residential mortgages in 2013.

In terms of our pipeline, we continue to pursue additional retail tuck-in acquisitions with attractive multiples. We are focused on pursuing transactions with efficient operations, looking to have the support of a larger organization to grow their business. There are a good number of the targets out there, but we will be thoughtful and deliver it with our approach and will keep you abreast of our progress.

Turning to slide 16, we provide an update on our operations in Q1. Our growth in lock volume has continued into the first quarter as our locks per day in January increased 6% from Q4. The cash gain on sale in each channel has continued to increase in Q1 to-date over Q4.

The channel shift towards retail and wholesale in underway as retail locks represented 9% in January, compared to 6% in Q4 and wholesale locks represented 19 compared to 17 in Q4. We continue to add to our sales force as our retail loan officers have increased by 158 since the end of Q3 and the number of account executives has increased by 32 during the same period. California is beginning to represent a larger portion of our lock volume and we believe the remaining states will also produce meaningful growth over the next few periods.

NattyMac is off to a great start after its re-launch. The number of commitments in customers is continuing to grow, with the current level of 60 customers with commitments totaling $254 million. This should translate into higher average outstanding from the warehouse line, which financial translates into higher fee and net interest income and less margin sensitivity from our clients.

Stonegate will also be ready to take advantage of the reemergence of private capital when the time comes. Our non-agency work done today is in preparation of that time. As we expanded in the higher balance states, our non-agency lock volume has also increased. In January we locked $28 million compared to $5 million for the entire fourth quarter. We have also increased our takeout investors and non-bank hires of these assets and their associated IO.

In conclusion, our business is doing very well in what continues to be a difficult market. Originations are solid in growing. We’re pleased with the mix of our retail and wholesale; we continue to make good progress on a geographic expansion; our financing business is growing and resulting in higher wallet share and believe we have accelerated our efforts there with some strategic acquisitions.

We have a pipeline of additional acquisitions we will continue to pursue. Cash gain on sales trended up-to-date in the first quarter, with the shift in business and channel specific strategy we implemented and managed our net cost to originate in late Q4.

We continue to invest in technology that will help us lower our net cost origination and position us as a leading non-agency aggregate as the market returns. We are excited about where our business stands and our differentiated business model and our growth prospects.

We’ll now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Bose George with KBW.

Bose George – KBW

You noted that the cash gain on sales number is up in January. I was just curious, how are the other components of the gain on sale, roughly stable or line. So can we think of the total gain on sale margin essentially being up quarter-to-date versus last quarter?

Jim Cutillo

Yes, Bose, this is Jim. The way I would answer that question is, most of the other components parts of gain on sale are somewhat interest rate sensitive, for example the pull through. So we look at the cash very closely everyday and so the cash right now is roughly 15 to 20 basis points better quarter-to-date in Q4 or in Q1.

Bose George – KBW

Okay great, thanks. And then actually on the expenses, you guys characterized I guess around $5 million embedded in non-routine. So when we think of that going forward, do the revenues basically just come in next quarter or do the expenses decline or how should we think about that?

Jim Cutillo

Well, I think you’re going to see on a percentage basis the expenses decline as the originations increase. I think most of that’s tied to the Nationstar acquisition, which was a unique acquisition and that it didn’t run through the balance sheet. Its running through the P&L and that it was – we didn’t necessarily buy the business, we just in essence hired the employees, so without pipeline.

So going forward, that’s probably not the norm. Like when you look at how we did Crossline, that transaction was a little different. So I think going forwarded if we were to do another deal like that, we’d obviously be in front of it and communicating it with you guys.

Bose George – KBW

Okay, great, it makes sense. Thanks a lot guys.

Jim Cutillo

Sure.

Operator

Your next question comes from the line of Paul Miller with FBR.

Paul Miller - FBR

Thank you very much. On slide five you talk about and the third bullet down, adjusted EPS of $0.11 on adjusted net income was $2.7 million. In your footnote, adjustments included $6.2 million of non-routine expenses. If I just take that tax effect and divide it by the share count of $24 million, I get something closer to $0.16 to $0.17 adjustment. Am I missing something?

Jim Cutillo

We’ll do a double check for you Paul. I think we’ll have to follow up with you afterwards and then we’ll get you the number and maybe get it out to...

Paul Miller - FBR

I just wanted to know if there’s some other stuff in there that is just not being, that’s non-routine or that you are not considering non-routine, that’s all.

Jim Cutillo

The MSR write-ups backed out, which you know we would argue shouldn’t be, but you guys always kind of ding us on that. So, I think if you take the MSR out, you’ll probably get the same number.

Paul Miller - FBR

Okay and then on the MSR right, looking through the – I mean this just came out, so we’re still going through as fast we can. You talk about in your news release a $5 million decline and I’m positive that the natural authorization. So did you write-up the MSR by about $7 million, because that would give you a net of $2 million. Am I looking at that correctly?

John Macke

Yes, the amortization would have been about 2.7 or 2.4 and the write-up for the fourth quarter was 5.169 and that’s in the release too on the last page.

Paul Miller - FBR

Got you, yes that helps. Yeah okay, sorry about that. And then on the NattyMac right, which slide was that, you signed up 30 – I guess you said you had 39 and your cash balance is close to $25 million, which slide was that Jim?

Jim Cutillo

Probably about 13 and 14, we have two slides, right and we have an average outstanding of $25 million.

Paul Miller - FBR

Yes, how do I model? I mean -- you recommend we model something like that, I mean because that equated to what, like $3 million of net income revenues.

Jim Cutillo

Yes, I mean its both fee and net interest income and look I think its growing right and its going to continue to grow. If you look at the growth in lock volume from the customers that are using it, it actually has exceed our expectations and the lock volumes is up about 54% from those customers, with improving margins even right.

So I think again as we go forward, we assume that we were going to fund about 30% of our overall correspondent volume through the NattyMac facility and it may in fact be a little bigger than that on a go-forward basis, but you know its too early to tell right now. We’re just going to keep feeding you guys the information as we go forward.

Paul Miller - FBR

So when you get to fees, because I think its one of the most interesting part about your company, but when you get to fees, so I mean NattyMac average outstanding of $25 million and you make a spread of at that, am I correct, and then you get fees, which is per unit or on a dollar basis?

Jim Cutillo

No, it’s per unit. So we charge probably I would say on average between $75 and $100 per funded loan. So if you think about it, these guys are turning that facility by 3 to 3.5 times. So we probably funded $100 million or a little over a $100 million in loans and at a 200 basis point or a 200 average loan amount, you can kind of do the back of the math again and say if you get $80 a loan to funded, that’s going to continue to generate fee income for the company, in addition to the outstandings.

Paul Miller - FBR

Got you. And then on the spread, what are you making on the spread? You might have told me this before, but just can you remind me. Is it about 1%?

Jim Cutillo

No, no. It’s I’d say about 200 basis points, so between our cost of funds and the average note rate.

Paul Miller - FBR

Okay. Thank you very much guys.

Jim Cutillo

Sure.

Operator

Your next question comes from the line of Douglas Harter with Credit Suisse.

Douglas Harter - Credit Suisse

Thanks. I was hoping you could update, in the increase in the lock volume in January? How much are the acquisitions already contributing or is there still upside as, you know in particular when Nationstar comes online?

Jim Cutillo

Yes, well what we highlighted for you on ’15 is that Crossline, which is really the first. I think the most relevant thing here right now, is that we locked an additional $50 million in retail loans, $50.8 million from that platform in January, so that’s the retail. So that in effect has created obviously immediately accretive to Stonegate.

And then on the Nationstar side, we locked additional retail production from the retail team and we’re just starting to lock wholesale and correspondent loans, because we just – we did that deal in November, signed them up in December, about 300 new accounts in December and now in January they just started locking loans.

So I mean your not really even seeing the effects of that yet in our lock volume and then in January our lock volume is up already. So it maybe incrementally, but not to the level that we think -- we haven’t even got a lock from all the accounts yet.

Douglas Harter - Credit Suisse

Got it. So that’s room for additional growth as we kind of go through the first quarter and into the second quarter?

Jim Cutillo

Yes, I mean yes, and then we added – just so you know, I mean with the Nationstar deal we added 100 retail loan officers. So you can do the math on that and say, okay, well what’s the average retail loan officer produced and you can see how very quickly between the Nationstar retail acquisition and the Crossline acquisition and then Crossline’s acquisition of Medallion where we’ve added a couple of 100 retail loan officers here just within the last 45 days.

Douglas Harter - Credit Suisse

And then I thought you highlighted the growth your seeing in California. Can you help break that down as to how much of that’s kind of the acquisitions you’ve done and how you’re sort of trending on an organic basis in terms of picking up share?

Jim Cutillo

Well California right now represented in January about 16% of our overall locks and then in Q4 it was about 8%. So in Q4 we wouldn’t have had any of the acquisitions in it, so that was kind of our organic platform and then its doubled just in January. But I think a lot of that you are going to look at Crossline and the Nationstar retail people, because honestly, we’re just starting to see the wholesale production now in our February locks. But across all the channels, we are seeing an increase in our cash gain on sale, which is really translated into better margins from what I would say was the industry low at the end of Q3.

Douglas Harter - Credit Suisse

Great, thank you.

Operator

Your next question comes from the line of Ken Bruce with Bank of America.

Ken Bruce - Bank of America

Thank you. Good evening gentlemen. Some more questions on gain on sale. I guess I just want to make sure I understand which line items include which components. In terms of the cash gain on sale, does that also reflect any hedges that would be incorporated against the pipeline?

Jim Cutillo

Yes. The cash gain on sale is a result of delivering loans into the market and settling them, so that you deliver into the same hedge that you use to head the portfolio, so that would include that.

Ken Bruce - Bank of America

Okay, and then in terms of the pipeline, the valuation adjustment, is that mostly just a function of a higher pull-through that led to the valuation adjustment.

Jim Cutillo

Well, higher pull- through as well as increased margin, gain on sale margins relative to this end a shift to more retail and wholesale and less delegated correspondent. Just so you know, we’re cautiously managing our delegated volume against the increase in our retail and wholesale; meaning we’re driving down our net cost to originate versus chasing volume.

Ken Bruce - Bank of America

Understood. And then I know thought our earlier conversations, the composition of this, of the origination profile is going to have an impact on overall profitability levels. I’m hoping you might be willing to provide some segment level gain on sale numbers. I know that you said they are up 15, 20-basis points, quarter-over-quarter that’s up, but can you decompose that within the correspondent versus wholesale and retail.

Jim Cutillo

I think what we’re going to do Ken is you remember from the Q3 presentation, I think it was slide 12, we provided everybody a net cost to originate number that was channel specific. So I think what you’ll finally see from us there is something like that going forward here, once you get a little further into Q1.

Ken Bruce - Bank of America

Okay, thank you. I’ll look forward to that and then as we think about the growth in accounts, and please if you can give me the number again, but on slide 11 you show a little over 1000 active accounts at the end of 2013 and you gave a little bit more detail on Q4, I think with 807 either active accounts in the quarter or remind me about that number. But also I guess as we think about the growth going forward, is that across both wholesale and the correspondent, those active accounts?

Jim Cutillo

I think the 300 that we added were all wholesale and predominantly in California through the Nationstar gain, so we were very – I mean we were very excited about that, because obviously our net cost originating wholesale is much better than delegating correspondent.

The reason why we don’t have a 1011 active is you know we just added 300 and not all those 300 have yet to cement or close a loan with Stonegate. So there’s some catch-up there, where we’re just training and bringing on new accounts here in January and February, and as we go into obviously March and April.

So by the time the end of April rolls around, I would say we’ll have for our Q1, well a really good sense for what those accounts are actually producing and then for the accounts that we had that were active, that we went back, that we gave NattyMac warehouse lines to, you can see that their lock volume has increased about 50% plus quarter-over-quarter or within 90 days of activating the line and I think its important to note that that’s going to market the decline by about 40%. So that’s not adjusted for the market size. So that increase is actually significantly more than the percentage if that makes sense.

Ken Bruce - Bank of America

Yes, could you repeat that? So basically within, you would expect that an account will activate, call it 90 days or within a quarter after you signed them up and then what was the percentage of pull-through on those acquisitions?

Jim Cutillo

Right. So it takes about 90 days to get an account where its active, which active is defined by the loan is actually funded, right. So they may lock something in 60 days, but by the time we close it and fund it, its 90 to 120 days. So your still seeing the 300 new accounts we added in the fourth quarter, which were predominantly wholesale. We have yet to really start to see the effect of that in our closed loan or our origination volume and we’re just starting to see it in our lot volume, but not any significance yet, okay.

Ken Bruce - Bank of America

Okay, so that’s all still to come.

Jim Cutillo

Right. And then the next point is – and you asked this question I remember very specifically. We said, hey, we think we’re going to see an increase of maybe 25% to 30% in these accounts when we give them warehouse lines. We’re actually seeing a 50% plus increase in lock volume 90 days after we activate the warehouse line and my comment was that’s pretty significant when you think about the market being down 40% during this period of time that we kind of snapshoted that measurement. Does that make sense?

Ken Bruce - Bank of America

Yes it does, and I think your earlier comment just in terms of the pull-through that you are seeing into the NattyMac, side of the equation speaks very nicely to the overall benefits that you’ve always [spelled] that your model has to start with. So that sounds like it’s coming through, so it’s very encouraging.

Jim Cutillo

Okay, and then the other thing that we didn’t highlight, I think is relevant is from a technology perspective we’re pushing the technology further out into the supply chain where we have clients now, they are able to access and use it and its helping with our turn times and its helping with our pre-closed, due diligence and our compliance and regulatory controls which we feel really good about.

And so we continue to monitor very closely and our clients are seeing both capital efficiency, because they are able to turn their warehouse lines faster with us and they are seeing operational efficiency, because they are not having to run the same checks and the same diligence that we’re doing and that’s really been our push for the small to mid-sized originator, which is look, we can make you more efficient and more effective with the same balance sheet.

Ken Bruce - Bank of America

Excellent, well that’s all my questions for the moment. But thank you very much for the additional information.

Operator

(Operator Instructions) Your next question comes from the line of Henry Coffey with Sterne Agee.

Henry Coffey - Sterne Agee

Hello everyone. Just so I understand you correctly, you sort of restated your core format; so it just includes the fair value write up, not the amortization, correct?

Jim Cutillo

Correct.

Henry Coffey - Sterne Agee

Thank you. The next item, you gave unit cost on servicing. I know there has been some questions sort of along this team anyway, is that obviously we’d like to get a better sense of what it actually cost you to service a loan, either in UPB or total dollar terms. Could you break that up for me now or…?

Jim Cutillo

We do – well the slide 12 is not…

Henry Coffey - Sterne Agee

Oh yes, unit cost…

Jim Cutillo

Its $100 per year.

Henry Coffey - Sterne Agee

Right. So how does that – I was wondering, what would that look like in total dollar terms for FY ’12 or as a percentage of average servicing. I’m just trying to – unfortunately that’s how we all tend to look at it.

Jim Cutillo

You mean the total dollars, if you multiply that $106 of revenue …

Henry Coffey - Sterne Agee

Ultimately at some point we’d like to build more of a line of business model, where we can look at the origination business, the servicing business and the finance business as sort of separate entities.

Jim Cutillo

Yes, let us circle back with you on that and then like I said, we’ll put out some more guidance on that or more data on that if we can figure out exactly how to position us the way you guys want to use it.

Henry Coffey - Sterne Agee

And then finally you mentioned early on the potential use of a structured finance vehicle, but you also said there might have to be a sale. Would that mean that you’d have to give the servicing over to a third party or could you settle for the [line] of the bulk of the economics.

Jim Cutillo

No, we’re not looking to do that. I mean you know look, I mean if we can – I guess it goes back to more along the lines of as an asset manager you got to be willing to buy and sell the asset right, and so at some point when you look at the market right now for servicing, below servicing, you look at the IO deal that Ocwen just did and your like wow! If we can get a five multiple on a 445 WAC, you know we have 374 WAC in our servicing portfolio, you know what could we monetize that at?

And so we’re not looking to sell the servicing, we’re maybe looking to garner some of the benefits of that cash flow if you will.

Henry Coffey - Sterne Agee

So that would be a financing vehicle for you in lieu of say adding term debt or something like that?

Jim Cutillo

Yes, right, because we don’t believe that we – we’ve been very conservative. We have no debt on our balance sheet today and we feel like that’s a good position to be in. We have a lot of – we have liquidity, we have investable capital from the IPO and so just kind of looking forward, if we’re able to do a financing vehicle that makes sense, we’re going to do that.

So we think it’s prudent to continue to look at that, because you would argue that at some point a fixed multiple, maybe that’s – the certainty of financing out of a six is better than trying to get a seven or eight out of it and hold on to it for 10 years.

Henry Coffey - Sterne Agee

Well, if you look at your December 31 balance sheet, how much more in terms of MSR acquisitions do you have the capacity to finance?

Jim Cutillo

Quite a bit if we do it. I mean it just depends on the mix right. So I mean we’re looking at 2014 and you know the numbers we have out there for origination volume, we can get there with our current balance sheet.

Now we’ve talked to you guys and others about maybe doing some interim debt, but we believe the financing markets, you know there’s opportunity out there that could be more accretive for us at a lower cost of capital than doing, say high yield debt right now.

Henry Coffey - Sterne Agee

All right, thank you.

Jim Cutillo

Yes, just to answer another follow-up question. Out of the 300 accounts that we signed up in the fourth quarter that were almost all wholesale or we’re all wholesale, only 19 have funded a loan as of today. So obviously there’s a lot upside.

Operator

(Operator Instructions) You have a question that came in from the line of Christopher Testa with Sidoti & Co.

Christopher Testa - Sidoti & Co.

Thanks for taking my questions guys. In terms of your cost per loan, are you still targeting to get this down to about $74 or $75 by the end of 2014 or is this kind of pushed up due to the increase that we saw this quarter.

Jim Cutillo

No, our targets still $75 and if you look at the models the analysts put out, I think you’d see that we had this kind of increase planned actually in our model.

Christopher Testa - Sidoti & Co.

Okay, and in terms of expanding into the non-agency loans, where are you seeing the most opportunities for that geographically and do you have like a target or a guidance that you could provide as a percentage of your mortgage loans that are held for sale.

Jim Cutillo

Well, I don’t have any guidance on that yet, but what I will tell you is that we’re obviously with the entrance into a higher balance phase like California. You can see that our lock volume just in January has exceeded what we locked in all of the fourth quarter.

The thing that we’re most bullish on is the whole loan execution market for us right now, it seems to be very strong given our technology and our controls and the fact that we’re a public company, it gives the investors I think a little bit more certainty that in fact they are buying not only wholesale or not only retail loans from us, but wholesale and correspondent loans from us, which has really been our goal, because a lot of the buyers out there only buy retail.

So the work that Eric Scholtz and his team have done on the controls and the technology that we’re using seems to have really resonated with the whole loan buyers and given us an opportunity to expand that into all of our channels.

Christopher Testa - Sidoti & Co.

Okay, and I guess my last question will be, what percentage of loans do you think that you guys could purchase from NattyMac by year-end? I think you said it was about 52% this most recent quarter. So do you have like an idea of what that could be by the end of the year?

Jim Cutillo

Well, the 52% just represents the increase in lot volume from Stonegate approved third party originators that have a NattyMac line. The customers that have a NattyMac line, on average sell us the majority of those loans. We do allow them to sell away for the rest of the purposes than it is truly a stand-alone company, but for the most part, we’re purchasing the vast majority of all those loans that they are funding through the NattyMac platform.

Christopher Testa - Sidoti & Co.

Okay, got it. Thanks for answering my questions guys.

Jim Cutillo

Sure.

Operator

We have reached our allotted time for questions. I would now like to turn the conference back over to Michael McFadden for any closing remarks.

Michael McFadden

Thanks Susan. A replay of today’s call will be available on the Investor Relations website at www.investors.stonegatemtg.com. Members of the media with additional questions can contact Whit Clay at 212-446-1864 and analysts can contact myself at 317-663-5904.

Thank you again to everyone for joining us today.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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Source: Stonegate Mortgage's CEO Discusses Q4 2013 Results - Earnings Call Transcript

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