PHH's (PHH) CEO Glen Messina on Q1 2014 Results - Earnings Call Transcript

May. 8.14 | About: PHH Corporation (PHH)

PHH Corporation (NYSE:PHH)

Q1 2014 Earnings Conference Call

May 8, 2014 11:00 AM ET

Executives

Jim Ballan - VP, IR

Glen Messina - President and CEO

Rob Crowl - EVP and CFO

Analysts

Bose George - KBW

Paul Miller - FBR

Henry Coffey - Sterne Agee

Kevin Barker - Compass Point

Daniel Furtado - Jefferies

Chris Gamaitoni - Autonomous Research

Christopher Testa - Sidoti & Company

Jordan Hymowitz - Philadelphia Financial

Craig Gilbert - Linden Advisors

Operator

Good morning, ladies and gentlemen. Welcome to the PHH Corporation First Quarter 2014 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 the question-and-answer session. At which time I will give you instructions on entering the queue to ask your questions.

Today’s call is also being webcast and recorded for replay purposes. The audio replay can be accessed either on the Company’s Web site at www.phh.com/invest or by telephone at (888) 203-1112 or (719) 457-0820 and using conference ID 2161517 beginning shortly after the conclusion of the call. It will be available until May 23, 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, Angela. Good morning and welcome to PHH Corporation's first quarter 2014 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 first quarter 2014 Investor Presentation of Supplemental Schedules, which is posted in the Investors section of our Web site at www.phh.com under Webcasts & 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 Report on Form 10-Q, which are also available in the Investors section of our Web site. Investors are cautioned not to place undue reliance on such forward-looking statements.

The earnings release we issued yesterday also may be accessed from the Investors section of our Web site 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 to take your questions.

I now will turn the call over to Glen Messina.

Glen Messina

Thanks, Jim. Good morning, everyone and thank you for your interest in PHH. This morning I want to provide an update on our evaluation of strategic alternatives, briefly review our financial highlights for the first quarter and discuss our outlook for the rest of this year. Then Rob will discuss our results for this quarter.

In February, we announced the Board and management’s decision to explore ways to maximize shareholder value through the separation or sale of our fleet business, our mortgage business or both. Since our last earnings call, we have been actively engaged in detailed discussions with several interested parties. The Board, management and our advisors are following thorough and disciplined process, focused on optimizing both near-term and long-term value for our shareholders. We expect to reach conclusions in this process by the end of this quarter.

In the first quarter, our fleet business again delivered strong earnings while results in our Mortgage business were consistent with the mortgage industry environment and our expectations. Our Mortgage Servicing segment reported positive core earnings pre-tax for the second consecutive quarter and mortgage quality related costs were down 69% versus the first quarter of last year. Total application volume was down 36% versus the first quarter of last year. However , retail home purchase application volume is up 15%, both comparing favorably to comparable first quarter results to the overall industry as reported by the MBA.

In addition, total mortgage production expenses were down 26% versus the first quarter of last year. Nevertheless our mortgage production segment reported a loss primarily driven by the high mix of fee-based business in our PLS channel. We will talk more about our efforts to improve the economics of our PLS contracts in a few minutes.

We continue to anticipate a highly challenging mortgage industry environment this year. First quarter industry reported volume levels are tracking below the average of previous estimates published by the MBA and the GSEs at the end of 2013. We believe this may result in total mortgage industry volume for 2014 below the $1.2 trillion average previously estimated by the MBA and the GSE. If current market conditions and the straight levels persist our mortgage production segment will likely be unprofitable on cash consumption this year, based on how the industry environment has developed over the first four months of 2014. We continue to expect to report negative core earnings and adjusted cash flow on a consolidated basis for the full year 2014.

In response to these challenging market conditions, we remain focused on executing our forward strategic priorities to ensure our mortgage business and create long-term value for our shareholders. Our actions aligned to disciplined growth are focused on reengineering our PLS business model and pursuing options to increase scale in mortgage production and servicing. Our actions aligned to operational excellence are focused on reducing production and overhead costs, improving cycle time, and enhancing customer experience, and our actions aligned to liquidity are focused on diversifying our MSR funding alternatives.

Regarding reengineering our PLS business model, we’re taking a deliberate and methodical approach with our largest clients to improve these arrangements to meet our mutual operating and economic objectives. Through this process we have confirmed, we have a unique and highly valued mortgage outsourcing model, the importance of a turnkey end-to-end private-label service offering, the importance of key tenants of our operational excellence efforts, namely speed, quality, compliance, and customer experience and that our clients recognize that a change to our contractual arrangements are necessary, and they want to work with us to achieve our mutual objective.

As we have said, our largest PLS contracts did not come up for renewal until between December 2015 and 2018. Due to the size and complexities of these relationships, the need of our clients and our desire to maintain a differentiated model with improved flexibility for the future, negotiations with our largest PLS counterparties are continuing. Nonetheless, we are cautiously optimistic that these contracts can be restructured or renewed on mutually beneficial terms. We believe the changes we are making in our PLS arrangement will result in a stronger business model, with better economics and improved value proposition to our PLS clients.

Regarding increase in the scale of our production and servicing segments, as we have said before, we believe our mortgage business remain subscale at projected industry volume levels for this year due to the higher fixed cost from a complex regulatory environment and more stringent loan origination and servicing quality requirements. We believe we have a number of opportunities to adjust our scale challenges through new products, new channels, organic and inorganic growth.

First, after completing the restructuring of our PLS relationships, we believe we can achieve profitable PLS growth through increasing our focus on the mass affluent customer segment in addition to the high network segment of our PLS clients. We believe the mass affluent customer segment represents a significant mortgage loan origination opportunity for us. Second, we believe shrinking industry volume and ever-increasing regulatory standards are making the value proposition for our unique outsourcing model increasingly attractive to many retail community banks. We believe there is an approximately $300 billion mortgage outsourcing market opportunity in this market segment.

We are investing the time upfront and engaging in prospective client interviews and discussions to align our service offering to this market segment. This will increase our probability of success in capturing future opportunities. Third, we believe our real estate channel has opportunities for enhanced profitability and growth in certain real estate offices we currently serve and to expand the regional coverage to real estate offices we do not cover today. In addition, we are focused on simplifying and standardizing the loan origination process in our real estate channel to deliver a consistent high-quality experience to the borrowers we serve.

In particular, our recently launched express craft process has reduced our average approval time by 66% and allows some credit approvals to be completed in as little as 24 hours. This program helps to ensure borrowers can meet their desired close date, while allowing PHH to meet investor and regulatory requirements. This is an essential operational capability for real estate agents to recommend PHH to their home purchase clients. Finally, we will evaluate inorganic growth opportunities to expand participation and position in the overall home purchase market to the extent these opportunities will create long-term value for our shareholders. Our focus is on expanding both our local retail footprint in select markets and direct to consumer reach.

Regarding opportunities in our mortgage servicing segments, consistent with our capitalized strategy we continue to pursue sub-servicing opportunities with other residential mortgage originators and servicers. Since the beginning of this year, we have signed contracts with four new sub-servicing clients representing an expected initial transfer of approximately 8,000 loans or $1.7 billion in unpaid principal balance. We anticipate forwarding these loans during the second and third quarter. We also expect these contracts to provide a significant flow of sub-servicing loan growth going forward. We continue to build the pipeline of sub-servicing contracts opportunities and we are excited about this efforts potential contribution for the profitability of mortgage servicing segment.

We believe a rising interest rate environment can result in significant earnings upside opportunities for our mortgage servicing segment, should interest rates increase this year we would expect that the value of our MSR to increase, MSR fair value adjustments for prepayments to decrease, MSR cash flows to extend and curtailment interest expense to decline. Rising short-term rates should enable greater returns on the approximately $3.1 billion in escrow balances we manage and an improving economy should enable improvement in our already very low delinquency rate which should lower our average servicing cost per loan.

With regards to reducing production and overhead costs, we have made measurable progress toward achieving our goal of $110 million in annualized cost savings by the fourth quarter of 2014 compared to the second quarter of 2013. In the first quarter, we achieved about three quarters of our expense reduction target in the mortgage production segment. We'll continue to carefully monitor application volume levels and adjust our origination capacity accordingly.

Regarding diversifying our MSR funding alternatives during the first quarter, we completed initial sales of newly created mortgage servicing rights related to approximately $120 million in underlying principal balance. We are sub-servicing these loans and we expect the combined value of the sales price of these MSRs and the net present value of the sub-servicing of the underlying loans to at least equal, the value we would have ascribed to the MSR if it was retained by PHH.

At the end of the first quarter, we had commitments to sell servicing rights related to $1.1 billion of unpaid principal balance. We continue to pursue a separate MSR secured funding arrangement to further diversify funding sources. The implementation of a separate MSR secured funding arrangement remains a high priority for us although we are unlikely to make significant progress until we complete the evaluation of our strategic alternatives.

Moving to fleet, we have an extremely valuable franchise and our fleet business is focused on building its industry leadership position. We are pursuing opportunities to accelerate fleet’s growth rate through investments to enhance processes, information management and strategic consulting capabilities as well as investments in new products and expansion into new markets. We are expanding our remarketing capability and we have recently opened the Commercial Truck Vehicle Remarketing Centre in Virginia Beach that was already outperforming our initial expectation.

We also continue to enhance the breadth and quality of our service offering such as telematics which allows our clients to improve the efficiency of their drivers and fleet assets lowering their operating costs. Further, we are actively pursuing material handling equipment industry which leverages our fleet management capability. We have expanded our sales force to support all of these initiatives.

Regarding capital liquidity, the previously discussed mortgage industry environment may cause inherent uncertainty regarding the future levels of our excess capital above the key cash requirement. We believe it’s critical that we maintain an adequate liquidity position that is commensurate with the cash flow dynamics of the current mortgage industry cycle. Our cash position in excess of free cash requirements has declined due to the negative cash flow in our mortgage production business. This negative cash flow is primarily driven by declining origination margins and volume levels as well as our PLS contract pricing levels.

As I said earlier, we are making every effort to restructure those arrangements. Our priorities for deployment of excess capital remain de-risking our capital structure, strategic investments and the return of capital to shareholders. Once we complete our evaluation of strategic alternatives we will re-evaluate our capital position and any uses of excess capital.

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

Rob Crowl

Thanks, Glen. For the first quarter of 2014 we reported a net loss attributable to PHH Corporation of $42 million or $0.73 per basic share, as compared to a net income of $45 million or $0.78 per basic share in the fourth quarter of 2013. The MSR mark-to-market adjustment net of hedge gains was an unfavorable $39 million pre-tax in the first quarter of 2014 as opposed to a favorable pre-tax mark-to-market adjustment net of hedge losses of $48 million in the fourth quarter of 2013.

We also reported a first-quarter core loss after-tax and core loss per share both of which exclude the net MSR mark of $18 million and $0.32 per share respectively as compared to core earnings after-tax of $16 million and core earnings per share of $0.28 in the fourth quarter of 2013. As I'll explain in more detail, the majority of the sequential quarter decline in core earnings stems from lower mortgage production segment earnings in the first quarter coupled with the $19 million rep and warrant reserve release experienced in the fourth quarter 2013 in the servicing segment.

In mortgage production, we had a segment loss of $60 million in the first quarter compared to a $45 million segment loss inclusive of $12 million in severance charges in the fourth quarter of 2013. The sequential quarter decline in mortgage production segment results was primarily due to a 22% decrease in total loan closings and 18% decrease in interest rate lock commitments expected to close, and a 22 basis point narrowing of our total loan margin to 291 basis points. In April, total loan margin narrowed an additional 17 basis points to 274 basis points. Partially offsetting these declines were reductions in indirect variable expenses related to capacity reduction actions to align capacity with expected origination volumes.

Fee-based closings as a portion of total closings increased to 65% in the first quarter from 61% of total closings in the fourth quarter of 2013 and 41% in the first quarter of 2013. As a reminder fee-based closings represent production that’s retained by our client for their own balance sheet. We did not recognize a gain on sale and fee-based revenues are recognized at closing. The continued shift in the percentage of fee-based closings underscores the importance of our efforts to reengineer our PLS contracts.

Our Mortgage Servicing segment recorded a segment loss of $29 million in the first quarter compared to a segment profit of $86 million in the fourth quarter of 2013 including MSR mark-to-market adjustments, net of hedging gains and losses of negative 39 million and positive 48 million respectively. Excluding the net MSR mark-to-market of negative $39 million, the first quarter mortgage servicing core earnings pre-tax equaled $10 million as prepayments continue to slow in the first quarter to an annualized average CPR of approximately 8.9% as compared to 11.5% for the fourth quarter of 2013.

Slowing prepayment speeds and improvement in quality related costs continue to have a positive effect on the profitability of our mortgage servicing segment. We see opportunities for further improvement in our mortgage servicing segment if prepayments fees remain low and we work through our delinquent FHA, NVA insured loans which should enable us to further decrease our delinquent loan servicing, foreclosure and REO expenses which were $14 million in the first quarter.

Our total loan servicing portfolio of $225.7 billion in UPB at the end of the first quarter was up 24% from the first quarter of last year principally due to the assumption of $47 billion in subservicing during the second quarter of last year. The capitalized portion of our loan servicing portfolio which totaled 127.2 billion in UPB at the end of the first quarter was down 2% from the beginning of the year and 7% from the end of the first quarter of 2013. The decline in the capitalized servicing portfolio over last year was driven primarily by payoffs, declines in loan production, an increasing portion of our loan production on fee for service basis and our narrowed focus in our correspondent channels.

At the end of the first quarter, we valued our MSR at 96 basis points of our capitalized loan servicing portfolio or $1.224 billion representing a 3.3 times capitalized servicing multiple. This valuation is down from 99 basis points or $1.279 billion and a 3.4 times capitalized servicing multiple at the end of 2013. The 4.3% sequential quarter decrease in valuation was primarily driven by the decline in mortgage rates during the first quarter. During the first quarter our repurchase and foreclosure reserve declined to $120 million from $142 million at the end of 2013 and the total dollar amount of unresolved loan repurchase requests at the end of the first quarter declined to $116 million from $191 million at year end 2013 driven by a significant decline in the pipeline of agency repurchase request.

The only repurchase and foreclosure related provisions in the first quarter were reserves taken at the time of sale related to new loan production. We do not expect loan repurchase obligations for pre-2009 loan vintages that have a material impact on our future results of operations. Our estimate for reasonably possible future losses related to loan repurchase and indemnification requests declined 25 million at the end of the first quarter from 30 million at year-end 2013. This estimate 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.

Our fleet business segment profit was $21 million in the first quarter average service unit count grew on a sequential quarter and same quarter last year basis due to our success in cross-selling to existing client and the on-boarding of new clients. Average leased unit count and net investment and leases were down 1% sequentially and 2% versus the same quarter last year. While our sales pipeline remains healthy, the time to close an on-boarding client has lengthened. Our truck syndication group also had a strong first quarter. Our fleet business continues to attract solid investor demand for our asset backed securities. In the first quarter we executed an $800 million asset backed securitization. We also chose to downsize our U.S. fleet lease conduit financing capacity by $200 million to $1.1 billion and to reduce the size of our Canadian revolver from CAD125 million to CAD25 million due to our strong cash position in Canada.

With regards to liquidity we closed the first quarter with approximately 1.155 billion in unrestricted cash a $90 million decrease from year-end 2013. Adjusted cash flow for the first quarter totaled negative $92 million and which primarily a function of results of our mortgage segments and higher working capital requirement in our fleet business. Approximately 700 million to 775 million of our unrestricted cash at the end of the first quarter was earmarked for specific purposes down by $50 million from the prior quarter range due to a reduction in mortgage related interest rate risk management earmark. Included in our cash requirements is $250 million for the pay down of convertible debt that matures in September of ’14. The retirement of this convertible debt will result in an annualized interest expense reduction of $33 million on a GAAP basis. Our cash balance at the end of the first quarter included $107 million of cash held for our Canadian fleet business which we do not intend to use in the U.S. and $94 million of cash held in consolidated variable interest entity.

There are no material updates to report with respect to the pending CFPB matter. There has been an increased level of activity with respect to industry litigation and settlement involving lender placed hazard insurance. The Company is currently subject to pending litigation alleging that its servicing practices around lender placed hazard insurance were not in compliance with applicable laws. We do have certain outsourcing arrangements for the purchase of lender placed hazard insurance but did not have a captive reinsurance affiliate or lender placed hazard insurance similar to other large lenders. We believe we have mature defenses to these allegations however there can be no insurance that we will not incur losses in connection with these matters and we cannot presently estimate the amount of loss or range of possible losses if any associated with these matters.

And now I’ll turn it back over to Glen.

Glen Messina

Thanks Rob. We’ve made solid progress to strengthen PHH’s position to meet the challenges and opportunities that lie ahead in a home purchase driven market. The Company is better on a number of dimensions. Over the last 12 months through our disciplined growth actions we have delivered 15% year-over-year growth in retail home purchase related loan application volume. We've re-priced PLS client relationships comprising 22% of our 2013 volume. We’re in active negotiations with our largest clients to realize our mutual operating and financial objectives and we have closed $1.7 billion in new sub-servicing relationships.

Through our operational excellence actions, we reduced quality related cost by 69%, we have reduced credit approval cycle time by 66%, we've achieved about three quarters of our $110 million annualized cost reduction target, all while responding to a dynamic operating and regulatory environment. Through our customer service improvement actions, mortgage customer satisfaction is at its highest level and through our actions to improve liquidity. We have increased our cash balances by 228 million, we've lowered our cost and extended the maturity profile of our unsecured debt and we've diversified funding sources for MSR. And finally, while executing these actions we are continuing to evaluate our strategic alternatives and we remain committed to maximizing shareholder value in this process. I want to thank and recognize my colleagues at PHH for their continued hard work and enduring commitment to our success.

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

Question-and-Answer Session

Operator

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

Bose George - KBW

Actually the first question just wanted to see how far along you are into the discussions with your private-label partners, I think last quarter you guys gave kind of percentages to contracts that had been renegotiated, just curious where that stands now?

Glen Messina

Well, the percentage stands the same. We’re right about 22% last quarter we saw at the same place. We are still working with our large PLS clients. The discussions are continuing in the spirit of a long-term partnership of those relationships. As I said in the script, you know, the clients have confirmed the value of our service offering to them. But these are large, complex, complicated arrangements and the teams are actively working together to pursue both our mutual economic and operating objectives in those contracts.

Bose George - KBW

Okay so, I guess it’s fair to say that part of the slowdown is really the complexity of these relationships?

Glen Messina

Yes, I think that’s fair.

Bose George - KBW

Well, okay. And then just, in terms of gain on sales margin trends since the end of the quarter, just curious where that’s trending?

Glen Messina

Rob do you want to talk to that.

Rob Crowl

Yes, as we stated through April we have seen another 17 basis points of tightening, narrowing in the margin, so that would put us about 274 in April versus the 291 that we reported for the first quarter.

Bose George - KBW

Okay, great. And then just, one last one on the non-controlling interest, just I was curious, given the reasonable a large mortgage banking loss, just kind of surprises the non-controlling interest number, is that small. The gains historically seem to have corresponded with bigger sort of numbers for the non-controlling interest, so I was just curious what drives that?

Glen Messina

Rob or Mike, do you want to talk to that?

Rob Crowl

Sure. It's really the relative profitability of the PHH loans joint venture to the overall production segment, is really what’s driving that.

Bose George - KBW

So, it’s that really sort of -- because that's more purchase focused, is that the purchase piece is doing better than sort of the overall one which is more -- kind of tracing that?

Rob Crowl

That’s correct, Bose.

Bose George - KBW

Okay, great. Thanks.

Operator

And we will now go to Paul Miller with FBR

Paul Miller - FBR

Hi. Thank you very much. And Glen one of the things that we have seen that’s in the first quarter as the purchase market has failed to materialize and refi has done probably what people have expected. And I know, I used to be out there, pounding the table, saying the normalized market is doing 1 trillion and 1.5 trillion, but what happens if the normalized markets below a trillion. I mean, are you at the cost structure currently be able to generate a profit, if we are at some parts showing in the purchase market, it hovers around 600 billion, I don’t want to think about that. But it is sure looks like that’s where we are right now?

Glen Messina

Let's look at what we've been able to accomplish in the first quarter and given the strength of our foothold in the purchase market, both of our PLS clients as well as with realty, we’ve been able to grow purchase buying, purchase application buying, 15% year-over-year. That’s a lot better than what we have seen in the MBA. And as I said on the call, we’re on track with achieving our cost reduction target for the overall business. We keep a keen eye on costs and our volume levels and obviously we have got the fiduciary responsibility to respond to changes in market conditions if we see them, and if the market is going to be a smaller market, we’ve got to respond accordingly and adjust our cost accordingly.

Paul Miller - FBR

My guess what that would mean more, I mean a lot of people are talking about 6 to 9 months for the industry as a whole to adjust to the new reality. Do you think you are in that same boat or can you get there quicker?

Glen Messina

I think we have been, we have acted pretty quickly and getting cost down. And we are on-track, even if you look at year-over-year with that production expenses overall down 26%. Based upon where our volume is trending for the first quarter, we believe our operation decides the level needs to be. And again if the market forecasts or projections change will change and respond accordingly.

Paul Miller - FBR

And then relative to the fleet business I think it was a little bit light than it’s been the past is all the talk about you guys being for sale is that hurt fleet business growing or was that just some noise that flowed through the system this quarter?

Glen Messina

As you know Paul the fleet business has a number of elements of its business that are very they’re not smooth throughout the quarter they can time differently quarter-to-quarter so syndication volume in particular is very heavy in the fourth quarter and if you look sequentially there was a downtick there was a profit from the first quarter were lower than they were in the fourth quarter principally all related to syndication volume because it is fourth quarter driven price sensitive product from our clients perspective our customers perspective. Just generally we talked last year about the pace of decision slowing down in the fleet industry amongst our customers that has remained unchanged but I got to tell you I feel really good about what now the teams are driving the fleet business they’ve got a lot of new exciting things on the table.

Operator

And we will take Henry Coffey with Sterne Agee.

Henry Coffey - Sterne Agee

Good morning everyone and thanks for taking my follow up. I know continuing the false line of question is the issues in mortgage right now that’s profit included that’s the issue we need to renegotiate the existing contracts and make some more workable for advise [indiscernible]?

Glen Messina

I’m going Henry I’m sorry you really broke up there on the question so if I could ask you to get a little closer to the foundry ask your question.

Henry Coffey - Sterne Agee

Yeah hang on a second. Is the issue with the mortgage business the nature of the private label contract which need to be renegotiated so you have a more profitable business or is it the size of your volume right now in other words if you at the current volume level can this business be profitable? And what’s the cost of getting there?

Glen Messina

Henry great question the issue is the high mix of fee based business on our private label contracts. And as we talked about before just the increased investment we’ve had to make from a regulatory perspective given the changes there and from an investment compliance perspective given the changes there these contracts are they’re older contracts more mature the pricing interest does not reflect the current issue environment from a price perspective. On the other aspects I feel great about all other aspects of our originations franchise strong growth in the purchase market we’ve done what we need to do to take out cost we’re seeing profitability improvement in the servicing segment it really does come down for PLS story and in particular the fee-based business.

Henry Coffey - Sterne Agee

So it’s the processing fee on the POS business is not big enough to cover the existing cost?

Glen Messina

No, that’s correct.

Henry Coffey - Sterne Agee

And is it possible just to stop generating that business and the contracts that we set or do you have a certain obligation to process volumes?

Glen Messina

Yeah, contractually Henry we are obligated to continue to process volume and I will say that from that time of renewal for contracts that have come up we’ve been successful at achieving our desired operating and financial objectives. And as I said before clients are continuing to work with us this is our economic need but the contracts are big complex with a lot of filter sales in both places. I am sorry go ahead.

Henry Coffey - Sterne Agee

No I am sorry I am listening.

Glen Messina

So I mean again we feel cautiously optimistic that we’ll have productive discussion and have been having productive discussions. And we’ll have to carry it out for its conclusion.

Henry Coffey - Sterne Agee

Thank you.

Operator

And we will now go to Kevin Barker with Compass Point.

Kevin Barker - Compass Point

I know you can’t give a lot of details on strategic transactions but if you were to estimate how far along you are in your and you’re reviewing your strategic alternatives I mean what inning would you say you are in?

Glen Messina

Kevin that’s an interesting question obviously I am not going to speculate or talk about that on the public call I think that would be reckless of me as it relates to all constituents involved here as I said on the call look we’ve been actively engaged in details discussions with several interested parties we’re following a disciplined process both on optimizing value both near term and long term for our shareholders and we expect to reach conclusion this parts of study into the quarter.

Kevin Barker - Compass Point

Do you have confidence or do you feel that you’re not confident on where it’s going to end up right now or do you feel like it’s a very fluid process that right now?

Glen Messina

Yeah again Kevin I think I’ve said what I need to say about this process so far.

Kevin Barker - Compass Point

Okay, I appreciate it. And then the $14 million foreclosure expenses and I know you spoke about FHA losses earlier but is this primarily coming from the FHA do you expect it to continue to pop up or do you feel like you have negotiations with the FHA to pull out of these claims a bit?

Rob Crowl

Hey Kevin, I’d probably state that it’s primarily related to VA related VA no-bid losses where the insurance from the VA only covers a portion a limit of the loss. So it has been bouncing around if you look at the segment supplement by couple of million bucks a quarter up and down over the last three-four quarters this is something though however that if you look at further in time was a much slower number and so we do anticipate to the extent we’re able to continue to work our delinquencies down that this $14 million represents an earnings opportunity, improvement opportunity for us.

Kevin Barker - Compass Point

Okay. And then you feel that the VA is going loan by loan or is something where they are going through large pools of loans and they’re almost on the process?

Glen Messina

I think they I think it’s basically on a might be correct me if I’m wrong I think it’s on it’s a loan level review that they go through on as we work with them on it so it’s a loan level review.

Kevin Barker - Compass Point

Okay. And then you marked down the CPR because of lower interest rates I mean you marked down your MSR because of lower interest rate this quarter however you saw meaningful decline in your prepayment rate. If you were to adjust your prepayment rate for what you actually experienced this quarter how much of a mark up in MSR would you actually have?

Glen Messina

I am not sure if I can do the middle math for you or if I understand the question can you state is…

Kevin Barker - Compass Point

You lowered your CPR correct me if I am wrong 11.5% to 8.9%

Glen Messina

It is yes.

Kevin Barker - Compass Point

Right. And so that’s a pretty big decline. Now you changed your valuation assumptions for interest rate this quarter, once you call the decline in the fair value MSR but in reality your experience on the servicing fees are going to incur in the amortization that come through your income statement it’s going to be a lot different than what the fair value marks may reflect.

Glen Messina

So in the press release as an example the amortization related to the MSR drop to $34 million it was $43 million last quarter so we did see a slowdown in the amortization of the MSR and then I guess the other thing I’d just point out is the assumptions that we use for valuing the MSR are lifetime sort of prepayment rates as well. So look we saw a decline in this quarter for the quarter on an annualized basis it was 8.9% we think if rates hold there and the CPR holds there we’re going to see we would see meaningful improvements in servicing segment profitability it’s just takes a while and matriculate through the accounting statements.

Kevin Barker - Compass Point

If your CPR how what’s your CPR assumption right now on the MSR, roughly 11.5%, is that correct?

Glen Messina

I’d have to look that up for you Kevin.

Kevin Barker - Compass Point

Okay, thank you very much.

Operator

And we will now go to Daniel Furtado with Jefferies.

Daniel Furtado - Jefferies

Good morning. Thank you for taking the question I just had one and that’s what specifically has changed that makes the PLS unprofitable today whereas they were profitable in the past?

Glen Messina

Yeah Daniel really what’s changed over the last call it 12 to 14 months is the increased investments or the number of regulatory changes that have happened affecting the industry from the regulations promulgated by the CFPB as well as changes in investor guidelines requiring additional investments in the business to meet the regulatory demand as well as to meet the stringent loan quality standards that we need to achieve primarily related to GSE and client invested productions. So it’s really driven by change in regulation and industry environment.

Daniel Furtado - Jefferies

Got you, and this I mean to me it seems like something that while the first generation of originations would be unprofitable and that’s into fixed that can be spread over the production as it continues to ramp going forward I guess that just incorrect way to think about these costs?

Glen Messina

Yeah they’re not capitalized in deferred like we have for initial direct cost and certain leasing and lending businesses this is it’s a static operating cost and you incur it on a as it shows up in the P&L as a non-incurred basis.

Operator

And we will now go to Chris Gamaitoni with Autonomous Research.

Chris Gamaitoni - Autonomous Research

Good morning guys. Can you provide us any type of target that ultimately you’re looking to kind of recent abundant servicing portfolio or whether it’d be ROE or basis points to whatever kind of what the long-term goal you want to reach it?

Glen Messina

So on a blended basis between our servicing and sub servicing portfolios again we talk about our long-term profitability target for our mortgage business overall through the cycles is low to mid teen ROE. Now given the unique accounting that we have around the servicing asset, you know that’s going to vary from period to period as markets close through the P&L up or down, or as actual performance may or may not differ from the model performance. Just based on the model being a long-term average versus what happens in the stock market. So, for example, today because our MSR is tallied on a forward basis the model is assuming a certain level of escrow earning on our escrow balances that’s right now $ 3.1 billion. But because the short end of the curve today is still low, you don’t see that come through the P&L. Over time it will, so then it’s straight drive. But today, the profitability of that portfolio is going to look different than what’s being modeled assumed based on the forward curve.

Chris Gamaitoni - Autonomous Research

Would you be able to -- can you give us a sense of the difference and profitability. You may recommend that you’re happy with the rest of the origination business except for this explained issue of the near negative operating earnings in the PLS business. Do you know dollar number? Or like if you would do it on the PLS business, what the rest of this year, loans close to be sold in reality relationship because it would be producing?

Glen Messina

Yes, we have not publicly disclosed channel level profitability within origination segment and at this stage of the game I don't think we're prepared to have that discussion around that.

Chris Gamaitoni - Autonomous Research

And then just a housekeeping item. Within your components, again on sale, the net adjustments again on sale turn negative this quarter, and after two quarters of being positive. There was a relatively large heat from the change in scratch and dent. I mean, like I was just wondering what happened there in this quarter and whether we should take another going forward or transitioning back to where it had been.

Glen Messina

Mike, you want to answer for that?

Unidentified Company Representative

Sure, so the first quarter is reflective of a lower lock number, and the net adjustment begin until we would expect that to return to that normalized trend as the rare reductions in the locked pipeline have sort of stabilized throughout the third quarter and first quarters.

Glen Messina

So it’s more of a denominator issue rather than the numerator going into calculator.

Operator

And now we will go to Christopher Testa with Sidoti & Company.

Christopher Testa - Sidoti & Company

In terms of in organic growth initiative, what specific types of businesses would you be looking at to complement mortgage

Glen Messina

Chris, I don’t want to -- I think again this is an area where we kind of reckless to speculate on any imminent activity. You know as we have said earlier in the script, our focus here in driving growth in the businesses around sub-servicing and it’s around expanding our presence in the reader purchased market sector. So organic and inorganic efforts are going to be focused to that end.

Christopher Testa - Sidoti & Company

And if origination continues to slow as it has you know across the industry broadly, is this kind of change your use of capital from M&A in return of capital to investors as to maybe buying bulk MSR more to make sure the portfolio doesn’t run-off.

Glen Messina

I’ll tell you the primary objective that we have in our use of excess capital is maximizing value for shareholders. So our both continue to evaluate opportunities for return of capital, whether it’s reinvesting in the business, to afford our capital structure objectives for returning capital to shareholders.

Christopher Testa - Sidoti & Company

Okay, and then we’re looking at in terms of the MSR funding sources that you’re looking at, if you were to do some type of funding on prime MSR, should we expect something, maybe like in oasis type deal where you guys are able actually tell prepayment risk.

Glen Messina

So oasis, what we are looking at from a secured MSR funding perspective would look like the oasis transaction. But it would not be identical, just given the different nature of the MSRs that we have now portfolio versus some of the stuff that we have been the oasis to transaction, but that’s directionally correct.

Christopher Testa - Sidoti & Company

And I guess again going back to origination, if the volume drop-off continues to be significant, how much more can you guys scale back the overhead there to make sure that it doesn’t even fit the overall profitability as much.

Glen Messina

We’ve approached overhead before unless we have all options on the table, obviously we are going to not doing things irresponsible that would jeopardize our ability to maintain compliance with regulatory investor standards. We will, we are and we will take the actions necessary to probably size and scale the business to the mortgage origination environment.

Operator

And we will take Jordan Hymowitz with Philadelphia Financial

Jordan Hymowitz - Philadelphia Financial

Thanks for taking my question. I was just off another mortgage company’s conference call and they actually wrote up the MSR looks like I mean using a base servicing fee of a little over 4 and you guys are obviously essentially lower than that. And they also seem to have with the product the superior rate that’s going down or in other words prepayment fees are going down. I was just wondering the thought process on reducing the MSR for you guys while another companies right in the here is there some kind of standard that make one right up or right down so to speak?

Rob Crowl

Jordon its Rob. Well, we did have a decline in the mortgage rate from period end to period end that is what drove our MSR adjustment down. There is a relatively expensive process that all companies go through with that I mean the MSR since it’s generally considered a level three assets there is not obviously an observable robust trading market for it. So those companies will get third party opinions value range of value that they use to help guide their own marks once the models are run. So I am not sure what the other company did sometimes there is adjustments to other types of inputs you could lower your servicing cost or assume higher ancillary fee income those other types of inputs that could go adjust your prepayment model that could go into a rise but ours was clearly driven by the drop in mortgage rates from the end of the ’13 to the end of the first quarter.

Jordan Hymowitz - Philadelphia Financial

And what you think that two companies talk about one is writing up the MSR and the other is writing it down on much high multiples. The other question is that you back out the market related 45 million in the servicing segment and again it’s all on you to find or not to find it but is this a market related moving into argue that that’s all non-core or non-adjusted or whatever you may want to just for standardization purposes you may want to think about backing that up because all these companies seem to be doing that as well because especially because it’s a number that moves with the rates so to speak.

Rob Crowl

I appreciate that Jordon certainly we’ll take that input so we do try to emulate that in our disclosure of core earnings for the servicing segment which state that market adjustment out.

Operator

And we’ll take our next question from Craig Gilbert with Linden Advisors.

Craig Gilbert - Linden Advisors

Thanks for taking my question just a quick one here on the previous call you mentioned some tender and potential make whole payments and then other I guess frictional cost and then on a later call you said you made some progress on reducing those frictional costs. Is there any color you can give us on I mean was it more on the tax fronts that you have reduction the frictional cost or did you also find I guess way around some of the bond holder cost?

Glen Messina

Yeah, as I said on previous call I think our last earnings call which is the fourth quarter earnings call these are detailed complicated issues we’ve extended our team of advisers to dive into all areas of fictional cost whether it’d be tax or debt. And obviously depending on transaction structure which high affects what basket of frictional cost you have to work on that’s where we’d be putting our effort to putting our solutions. So we really are higher dependent on transaction structure and I really don’t want to speculate on structure and implication on this call.

Operator

And we will take a follow up question from Chris Gamaitoni with Autonomous Research.

Chris Gamaitoni - Autonomous Research

Hi. Thanks for taking the follow up early in the call you made a comment that you thought the MPB or the future servicing contract and the sale price of your MSR in the related fair party sales was at least as now the value of the MSR I am just trying to make sure I understand kind of the bottom line economical impact. Is it just you will receive the small subservicing fee and it will be thin margin but the ultimate results kind of being the same with more uploaded front cash because of the sale?

Glen Messina

Chris directionally correct so yes we are from accounting perspective it does recorded as a sale of the MSR but from an accounting perspective again we have recognized the cash proceeds as the proceeds on sale we have to write off the MSR and now the current U.S. GAAP standards we’re not allowed to report the present value of the subservicing contract. So we are selling the majority of the cash flow associated with MSR but we are entering into a profitable and an appropriate economic subservicing arrangement.

Chris Gamaitoni - Autonomous Research

Right. Do you have any type of guidance on types of return you’re targeting from that structure?

Glen Messina

Not specifically we don’t want to get too detailed on our pricing assumptions here from a competitive perspective but I can tell you that we certainly look to cover our fully loaded cost and the structure of subservicing arrangements typically is down on a fee per loan basis based upon the delinquency stage of these loans. So you don’t get caught in a pinch of delinquency rates by reduced your reimbursement flexes with your cost structure so you take less cost rift as a result of portfolio quality.

.

Operator

It appear there are no further questions at this time. Mr. Messina I’d like to turn the conference back to you for any additional or closing remarks.

Glen Messina

Great, Angela. Thank you very much and thanks everybody for joining the call. We look forward to speaking with you next quarter.

Operator

This concludes the PHH Corporation first quarter 2014 earnings conference call. Once again ladies and gentlemen, the replay will be available beginning later today at the Company's Web site at www.phh.com/invest or by dialing 888-203-1112 or 719-457-0820 and using conference ID 2161517. It will be archived until May 23, 2014. You may now disconnect.

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