PHH's (PHH) CEO Glen Messina on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: PHH Corporation (PHH)

PHH Corporation (NYSE:PHH)

Q2 2014 Earnings Conference Call

August 5, 2014 10:00 AM ET

Executives

Jim Ballan – Vice President, Investor Relations

Glen Messina – President and Chief Executive Officer

Robert Crowl – Executive Vice President and Chief Financial Officer

Analysts

Bose George – Keefe, Bruyette & Woods, Inc.

Paul Miller – FBR Capital Markets & Co.

Chris Gamaitoni – Autonomous Research

Cheryl Pate – Morgan Stanley & Co. LLC

Kevin Barker – Compass Point

Christopher Testa – Sidoti & Company

Ninad Sanghvi – Hudson Bay Capital

Operator

Good morning, ladies and gentlemen. Welcome to the PHH Corporation Second Quarter 2014 Earnings Conference Call. Your lines will be in a listen-only mode during remarks by PHH management. At the conclusion of the company’s remarks, we will begin a question-and-answer session. At which time I will give 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 website at www.phh.com/invest or by telephone at 888-203-1112 or 719-457-0820 and using conference ID 9283101 beginning shortly after the conclusion of the call. It will be available through August 20, 2014. This access information is also described in the company’s press release and I will 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, Cassandra. Good morning and welcome to PHH Corporation's Second 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 four of our Second Quarter 2014 Investor Presentation of Supplemental Schedules, which is posted in the Investors section of our website 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 Reports on Form 10-Q, which are also available in the Investors section of our website. Investors are cautioned not to place undue reliance on such forward-looking statements.

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

During this call, we may discuss various non-GAAP financial measures, including core earnings or loss pre-tax, core earnings or loss after-tax, core earnings or loss per share, adjusted cash flow and tangible book value per share. Please refer to our earnings release and accompanying Investor Presentation of Supplemental Schedules for a description of these and other non-GAAP financial measures, as well as a reconciliation of such measures to their respective most directly comparable GAAP financial measures.

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

I now will turn the call over to Glen Messina.

Glen Messina

Thank you, Jim. Good morning, everyone and thank you for your interest in PHH. This morning I want to briefly discuss our financial highlights for the second quarter and our outlook for the business. Then I'll provide some detail on the operating and capital initiatives we announced July 7, the execution of which we believe will position the company for success in the mortgage business going forward. Then Rob will discuss our results for the quarter.

While our second quarter results continue to reflect a highly challenging industry environment, we have reduced expenses and gained share in the retail home purchase mortgage market demonstrating our commitment to managing expense levels and the strength of our market access through our private label and real estate relationships.

Our Mortgage Servicing segment reported positive core earnings pre-tax for the third consecutive quarter and mortgage quality related costs were down 90% in the second quarter of 2014 versus same period last year.

Our mortgage production segment reported a loss reflecting the continued high mix of fee-based business in our PLS channel. Total loan application volume is down 35% versus the second quarter of last year. However, retail home purchase application volume was up 9%, both comparing favorably to comparable second quarter results for the overall industry as reported by the MBA.

Over the past four quarters that have been reported by inside mortgage finance we have achieved retail mortgage origination market share gains of approximately 1.7 percentage points and we believe the growth initiatives we are implementing if achieved should enable us to continue to gain retail market share. In addition, total Mortgage Production expenses were down 27% versus the second quarter of last year.

The industry experienced an unusual set of circumstances in the first-half of 2014, where interest rates, volumes, and margins all declined at the same time. Total mortgage industry volume estimates for 2014 are now below the $1.2 trillion average previously estimated by the MBA and the GSEs driven by reductions and the estimates for purchase and refinancing volumes.

Assuming current market conditions and interest rate levels persist, we expect to report negative core earnings on a consolidated basis through the first-half of 2015. However, with the expected implementation of our reengineering initiatives over the next six to 12 months, we would anticipate reporting positive core earnings for the second-half of 2015.

We remain focused on executing the operating and capital strategies that we laid out last month when we announced the closing of our sale of our Fleet Management business. These include returning capital to shareholders, reducing our unsecured debt to within our target range, reengineering our mortgage operations to accelerate expense reduction, productivity, and efficiency improvements and enhancing profitability and scale through selective organic and inorganic growth.

We believe execution of these strategies will help us achieve our vision of being the leading, most trusted provider of end-to-end mortgage service enabling our customer success. Further, we believe the successful execution of these strategies will allow us to achieve double-digit to mid-teen ROE levels on average across purchase and refinancing cycles.,

As you know on July 7, we closed the sale of our Fleet business for $1.4 billion subject to certain post-closing adjustments. We are providing certain transition services to Element Financial for up to 12 months after closing, related to information technology, human resources, and finance services among others.

As a result of the Fleet sale, utilizing our pro forma unrestricted cash and excluding cash held by our variable interest entities, we estimate that we have more than $1 billion in cash above our key cash requirements. We believe the completion of this transaction is an important step forward for PHH enabling us to return significant capital to shareholders, strengthen our balance sheet and cease opportunities in the market. We believe, our financial flexibility is a competitive advantage especially in the current market and that we have significant opportunities to create value for our stakeholders.

We intend to initiate $200 million accelerated stock repurchase program or ASR, shortly following the beginning of our open-market period, which we expect to commence on August 7. Over the 12 months following the completion of the ASR, we intend to repurchase up to an incremental $250 million in stock subject to market conditions and the other requirements of the repurchase program. This total of up to $450 million in share repurchase represents roughly one-third of our current market capitalization.

On August 7, we expect to complete the redemption of our outstanding 9.25% senior unsecured notes due 2016 at Mako [ph] and we have the cash ear-marked to repay our 4% senior convertible notes due 2014 after September maturity date. These two actions reduced our unsecured debt balance by $420 million putting us well within a range, we believe is required to maintain our target debt ratings.

This debt reduction will lower our annualized GAAP interest expense by approximately $48 million and our next unsecured debt maturity will not occur until almost three years from now.

In the second quarter, we substantially completed our goal of generating $110 million in annualized production and overhead costs savings ahead of schedule. As I noted a moment ago, we reduced total mortgage production expenses in the second quarter by 27% compared to the same period last year, and we will continue to focus on optimizing our direct operating expense levels to match projected industry and client specific volume levels, and program requirements.

These efforts will include managing staffing levels, utilizing outsourcing relationships for certain operating activities, as well as investing in process and technology enhancements to drive continuous improvement in the speed, cost, and quality of our operating activities.

As we stated, over the next six to 12 months, we intend to invest up to $200 million in reengineering to further reduce expenses, simplify business processes, and restructure our PLS business model. We believe we can realize up to $225 million in annual operating benefits from these investments, the level of which would be expected to be commensurate with the amount of investments.

The benefits should phase in during the first-half of 2015 and to be fully realized on an annualized basis by mid to late 2015. Our efforts in this regard will be focused in areas, we believe can provide high returns in the short timeframe with relatively low execution risk. We are consolidating our support infrastructure to eliminate redundant activities, processes, and organizational layers that exists between the PHH Corporation Holding Company and our mortgage operating subsidiary.

We have already taken the first step in this process by making changes in our leadership structure and each member of our newly aligned leadership team has been inside cost savings and productivity targets.

As a standalone mortgage company, we have consolidated key leadership roles, and I now serve as President and CEO of both PHH Mortgage and PHH Corporation. Rich Bradfield, a more than 20-year veteran of PHH Mortgage, now runs our Financial Institutions Group, which includes our private label and corresponding origination channels, and our Treasury and Capital Markets functions now reported to finance under Rob Crowl.

We've also consolidated our compliance and risk management functions, which are now run by Leith Kaplan. Dave Tucker, who has been leading our private label contract renegotiations will remain as Executive Vice President of PHH Mortgage through the end of January. Dave will focus exclusively on the contract renegotiations to ensure we maintain continuity and momentum on this key priority in our reengineering process. Both we and our private label clients have an interest in updating these contracts prior to their renewal date to ensure these programs support our respective business objectives.

We remain cautiously optimistic that these contracts can be restructured or renewed on mutually beneficial terms. The timing to complete this process, however, remains uncertain due to the complexity of these contracts and our desire to build a differentiated model that has the flexibility to adopt to future market changes. Our goal for these negotiations is better economics and improve value proposition for our PLS clients.

As we've discussed before, we believe we have a number of focused organic and inorganic growth opportunities in our Mortgage Production and our Mortgage Servicing Segments, where we can leverage our existing infrastructure and capabilities. Our goal is to diversify our revenue and earning streams and to enhance profitability and scale.

As a result, we intend to invest up to $150 million in selective growth opportunities, and we believe these growth opportunities could potentially generate up to $175 million in annualized operating benefits. We expect to fund these investments over the next 12 to 24 months. We believe we have multiple opportunities to achieve profitable, origination growth with our existing private label clients and to expand our target market. One growth opportunity is targeted [ph] to be our clients' mass affluent customer base, which we believe represents greater than $1 million just within our existing clients.

In addition, we believe the development of a range of more standardized service models should enable us to expand our private label client base, especially to regional community banks that are facing shrinking industry volumes at ever increasing regulatory standards.

We believe retail and community banks that either view residential mortgage as an accommodation product or as a core relationship product which we estimate represents $180 billion annual mortgage origination market opportunity of buying the value proposition of our unique outsourcing model increasingly attractive.

In our real estate channel, we are focused on continuous improvement in our people, processes, products and platforms to outperform our competition in terms of relationship management, operational execution, and customer experience for both the borrower and the realtor.

We are already seeing the benefits of simplifying and standardizing the loan origination process in this channel to deliver a consistent high quality experience and ensure borrowers can meet their desired closed dates, while generating loans that meet mortgage investor and regulatory requirements. We believe, these are essential differentiating capabilities that we must excel at for real estate agents to recommend PHH to their home purchase clients.

We intend to selectively invest in expanding coverage in the top 25 home purchase markets in 2015 and 2016 and in the third quarter of 2014, we are also opening new offices in both the Houston and Dallas markets.

We also are targeting expansion into lower density home purchase markets by leveraging our call center fulfillment capability focused directly on the real estate agent. We will seek to expand our participation and position in the overall home purchase market through selective inorganic growth opportunities that can leverage our existing support infrastructure to expand our local retail footprint in select markets and/or our direct-to-consumer reach.

We continue to focus on improving profitability and scale in our Mortgage Servicing segment, through growth in mortgage servicing rights and subservicing created from our own production as well as (inaudible) flow subservicing acquisitions.

Since the beginning of this year, we have signed contracts with five new subservicing clients, representing expected initial transfers of approximately $3.2 billion in unpaid principal balance. We also expect these contracts to provide a flow of subservicing loan growth going forward. We continue to build a pipeline of subservicing contract opportunities and we are excited about this efforts' potential contribution to the profitability of our Mortgage Servicing segment.

We may acquire or assume own servicing or subservicing through acquisitions of mortgage production businesses which often include a servicing asset. In the case of a servicing acquisition consistent with our current funding strategy for MSR, we may look to partner with financial intermediary to finance and own the servicing right that we would service. Such an arrangement would enable us to leverage our servicing capabilities while remaining in sync with our capital life strategy.

We believe executing the capital and operating strategies I just outlined have the potential to generate an incremental $448 million in annualized operating benefits and will be key to achieving double-digit to mid-teen ROE levels, on average across purchase and refinancing industry cycles. I will now turn it over to Rob, to discuss our financial results.

Robert Crowl

Thanks, Glen. For the second quarter of 2014, we recorded a net loss attributable to PHH Corporation of $59 million or $1.02 per basic share. The net loss from continuing operations attributable to PHH Corporation was $13 million or $0.23 per basic share, as compared to a net loss of $58 million or $1.01 per basic share on the first quarter of 2014. The pre-tax market related MSR mark-to-market adjustment net of hedge gains was a favorable $8 million in the second quarter of 2014, as opposed to an unfavorable adjustment of $39 million in the first quarter.

The reported net loss from continuing operations attributable to PHH Corporation in the second quarter of 2014 does not include our discontinued operations, which totaled a net loss after taxes of $46 million. Included in this number are the results of the Fleet business and certain transaction related costs net of tax. In addition, income tax expense related to discontinued operations for the second quarter also includes provisions for taxes related to the previously un-repatriated cumulative earnings of our Canadian Fleet subsidiaries. We reported a second quarter core loss after tax and core loss per share, both of which exclude the net MSR mark and the results of discontinued operations of $18 million or $0.31 per share respectively.

This compares to our core loss after tax of $34 million and a core loss per share of $0.60 in the first quarter of 2014. Overall, the sequential quarter improvement in core loss in the second quarter stems from an improvement in our Mortgage Production segment, partially offset by lower Mortgage Servicing segment profit and $8 million in overhead expenses not allocated to our operating segments, primarily related to severance charges.

In the second quarter, Mortgage Production had a segment loss of $27 million compared to a $60 million segment loss in the first quarter. The sequential quarter improvement in mortgage production segment results was primarily due to a 26% increase in total closings and an 18% increase in IRLCs expected to close, partially offset by an 18 basis point narrowing of our total loan margin to 273 basis points.

In July, total loan margins were similar to the second quarter levels.

Fee-based closings as a portion of total closing equaled 65% in the second quarter, consistent with the first quarter, but above the second quarter of 2013 level of 47%. As a reminder, fee-based closings represent production that is retained by our clients for their own balance sheet. We do not recognize a gain on sale and fee-based revenues are recognized at closing.

The continued elevated percentage of fee-based closings underscores the importance of our efforts to re-engineer our PLS contracts. Our Mortgage Servicing segment recorded a segment profit of $10 million in the second quarter of 2014, compared to our segment loss of $29 million in the first quarter of 2014. These results include market related MSR mark-to-market adjustments net of hedging gains and losses of a positive $8 million and a negative $39 million respectively, excluding the net market related MSR mark-to-market adjustment second quarter 2014, Mortgage Servicing core earnings pre-tax was $2 million as compared to $10 million in the first quarter. The majority of the decline was due to an increase in prepayment speed during the quarter.

Our total loan servicing portfolio of $225.9 billion in UPB at the end of the second quarter 2014 was up slightly from the first quarter of 2014, as increases in subservicing UPB were mostly offset by decreases in the capitalized portfolio. The decline in the capitalized serving portfolio is driven primarily by pay-offs, a continued high portion of our loan production on fee-for-service basis and our narrowed focus in our correspondent channel.

At the end of the second quarter we valued our MSR at 96 basis points of our capitalized loan servicing portfolio or $1.187 billion, representing a 3.3 times capitalized servicing multiple. The MSR valuation on our capitalized loan servicing portfolio and the capitalized servicing multiple are unchanged from the end of the first quarter. Prepayment speeds increased in the second quarter to an annualized average CPR of approximately 11% as compared to 9% for the first quarter of 2014, mostly due to a 29 basis point decrease in primary mortgage rates.

While CPRs rose this quarter the increase in prepayment speeds was considerably slower than modeled expectations, resulting in a smaller market related fair value adjustment. During the second quarter our repurchase and foreclosure reserve declined to $110 million from $120 million at the end of the first quarter and $142 million at the end of 2013. The total dollar amount of unresolved loan repurchase request at the end of the second quarter declined to $86 million from a $116 million at the end of the first quarter, driven by a continued significant decline in the pipeline of agency repurchase request.

The GSE has substantially completed those repurchase and indemnification requests for pre-2009 vintages last year and during the second quarter we observed a continued downward trend and new repurchase request for origination years, 2009 through 2012. As a result, we recorded a $1 million repurchase and foreclosure related reserve release in the second quarter. There was no change to our estimate of reasonably possible losses which totaled $25 million at the end of the second quarter.

With regards to liquidity we closed the second quarter with approximately $964 million in unrestricted cash which excludes $274 million in unrestricted cash in assets held for sale related to the Fleet transaction. Taking into account $821 million in estimated net proceeds from the Fleet sale transaction, the unrestricted cash in assets held for sale, $73 million of cash held in consolidated variable interest entities and approximately $525 million to $625 million in cash that's ear-marked for specific purposes.

We have more than $1 billion in excess cash available for operations on a pro-forma basis. In addition to the impact from our results of operations you should expect our unrestricted cash balance at the end of the third quarter to also reflect the redemption of our senior notes to 2016 which we anticipate will require approximately $200 million in cash, the repayment of our $250 million in senior convertible notes due September 2014 and our $200 million payment related to the accelerated share repurchase program.

Adjusted cash flow for the second quarter total of negative $68 million versus negative $96 million last quarter, this improvement was primarily a function of increased profitability in our Mortgage Production segment.

Our book value per share at the end of the second quarter was $26.49 taking into account the Fleet transaction, our pro-forma book value per basic share at quarter end is $31.34. Regarding diversifying our MSR funding alternatives during the second quarter we completed approximately $6 million in sales of newly created mortgage servicing rights, we are subservicing these loans and we expect the combined value of the sale price of these MSRs and the net present value of the subservicing of the underlying loan to at least equal the value we would have ascribed to the MSR if it was retained by PHH.

In addition, we continue to pursue a separate MSR secured funding arrangement to further diversify our funding sources. And now, I'll turn it back over to Glen.

Glen Messina

Thanks, Rob. We believe the execution of our capital and operating strategies will help us achieve our vision of being the leading and most trusted provider of end-to-end mortgage services in enabling our customer's success. These actions should enhance our operating efficiency and productivity, property count, capitalize our balance sheet, enable us to gain scale and market share and ultimately, if achieved, enable us to attain double-digit to mid-teen ROEs on average across purchase and refinancing market cycles.

We believe, there are continued growth opportunities in the current mortgage environment for companies with access to the purchase market, operational focus, and financial flexibility. We believe our status relationships with banks, wealth management firms, and real estate brokers provide outstanding access to borrowers. We believe, our focus on operational excellence and our upcoming investments in reengineering will enhance our already superior operating capabilities.

We believe, increased regulatory complexity makes our proven and unique end-to-end residential mortgage outsourcing service offering a competitive advantage. And we believe our focus on liquidity and the net proceeds of the Fleet transaction provide us with the financial flexibility to return capital to shareholders, reduce debt, invest in organic and inorganic growth, and take actions to gain market share in a competitive environment.

We intend to update the market on our progress on all our capital and operating initiatives on our third quarter earnings call. I want to recognize and thank the PHH Board of Directors and my colleagues and PHH for their continued hard work and enduring commitment to creating value for our shareholders and customers.

And with that, we're ready to take questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And we'll take our first question from Bose George of KBW.

Bose George – Keefe, Bruyette & Woods, Inc.

Hey, guys, good morning. Actually, the first question was just on the – what volume expectations are embedded in your – the expectation that you guys would be profitable in the back-half of 2015?

Glen Messina

Hey, Bose, this is Glen.

Bose George – Keefe, Bruyette & Woods, Inc.

Hi, Glen.

Glen Messina

So, Bose, we – as you know, we've talked historically that we typically referenced the average of the MBA and GSE volume estimates. And as we look forward, we would have no other basis for market forecast than the MBA and GSE estimate. So our forecasted, we are expecting a market to be the same size as what the MBA – average MBA and GSE forecast would be.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great, thanks. And then the – can you repeat what you said on the return on the $200 million of spending, did you say annualized return of $225 million, can you just go over that again?

Glen Messina

That’s correct, Bose. So in our reengineering initiative, we expect to invest approximately $200 million, and again, we are focused thereon continued work to make sure our organization infrastructure is sized appropriately for the mortgage market, delayering and simplifying the holding company and operating company restructure and reengineering our PLS contracts, and we expect the accurate of those to generate $225 million in annualized operating benefits.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. And then just, are there any updates on your negotiations with the private label counterparties?

Glen Messina

Discussions continue in this period of the partnership – the long-term partnership that we had with our clients. As I mentioned on the call, they – our partners are equally engaged and focused on making sure that these contracts reflect both our needs as well as their needs looking at very different mortgage market than what existed in years past when these contracts were negotiated.

So I'm cautiously optimistic we've got engaged clients who are sitting at the table with us, negotiating in good faith in the spirit of long-term partnership who are interested in having a mortgage product and a mortgage program that meets their needs.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. Actually let me just make in one more the – you guys showed a profit in the non-controlling interest, so is that mean that the Realogy part of your mortgage business is profitable?

Glen Messina

That is correct.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. Thanks.

Operator

And we'll take our next question from Paul Miller of FBR.

Paul Miller – FBR Capital Markets & Co.

Yes, thank you very much. Glen, on the buyback, right, I know you talked about that the – you have an ASR that starts on August 7, how are you approaching the – and there is another $250 million behind that, when would that be started?

Glen Messina

So, Paul, this is Glen. Our accelerated share repurchase program will start shortly following the opening of our open market window. And if I go back to our July 7, call, we expect the ASR could take up to seven months to nine months, and then in the 12 months following that, we would be engaging in open market purchases subject to the terms of that plan.

Paul Miller – FBR Capital Markets & Co.

Okay. So it’s ASR seven months to nine months, and then after that to 12 months would be the other $250 million?

Glen Messina

That is correct.

Paul Miller – FBR Capital Markets & Co.

And then can you update Two Harbors, I know that a while back, I can't – it was two quarters ago you signed an agreement for Flow business to Two Harbors. I think as of the last update, correct me if I'm wrong, Glen, the last update that there wasn’t a material amount of product – MSR is going to Two Harbors, did that change in the second quarter or is that still working up period?

Glen Messina

Rob?

Robert Crowl

Hey, Paul, this is Rob. We had as I stated in my script, we had $6 million of MSR that was sold in the second quarter. So it is continuing to ramp up, again, that’s the MSR amount, not the UPB. We're continuing to starting to – I would say, sort of hit a more normalized – getting closer to a more normalized stride here.

Paul Miller – FBR Capital Markets & Co.

And can you give me, because I know, correct me if I'm wrong the Flow agreement to 50% plus, right, but it’s all subject to pricing. So of the $6 million, what was that as a percentage of your creation of MSRs?

Glen Messina

I think we created, yes, probably about 25%.

Paul Miller – FBR Capital Markets & Co.

Okay, so it’s moving very long. And then can you add some more color in this MSR funding? You talked about, is that a securitization similar what Ocwen did about a year ago?

Glen Messina

Yes, Rob, do you want to add some color to that?

Robert Crowl

Yes, it’s exactly what we've been talking about over the last couple of quarters. It would be a secured type of transaction, so it would not be in MSR sale like the Two Harbors structure, it would be a secured financing. It would be somewhat similar I would think from the OASIS deal that you are referencing that Ocwen did, yes.

Paul Miller – FBR Capital Markets & Co.

And then my last question is, we're seeing MS issuance in July really spiked up from June. Can you talk a little bit about your pipeline, are you seeing, because we're not seeing anything in the – like the MBA application indexes and a big spike, but we definitely saw MBS issuance almost top $90 billion in July. Are you guys seeing an increase in your pipeline around the same degree and can you add some color behind that if you are?

Glen Messina

Paul, as we discussed in the call, we've – I think we've done – our access to the purchase market is strong as we access through the financial advisors wealth mangers and realtors. We reported strong 9% growth in applications for purchase mortgage originations. And we believe based on the MBA statistics that were released on, we've outpaced the application performance during the second quarter across the industry both in terms of total apps, as well as some purchase related – home purchase related apps.

Paul Miller – FBR Capital Markets & Co.

Okay. Thanks a lot, guys.

Operator

And we'll take our next question from Chris Gamaitoni of Autonomous.

Chris Gamaitoni – Autonomous Research

Yes, thanks for taking my call.

Glen Messina

Good morning, Chris.

Chris Gamaitoni – Autonomous Research

Could you walk me through the – on the $250 million or $200 million of target investment, to me the – can you give us some kind of guidance for the split between servicing risk [ph] origination where that will fall, from where there really the cost improvements by business unit will be?

Glen Messina

Yes, Chris, a lot of our reengineering initiatives here are really focused on what I would call optimizing and consolidating our support infrastructure. So delayering the holding company and operating company structured to operators, the standalone mortgage business, eliminating redundant activities, simplifying processes, and certainly IT investments to support productivity.

At this stage of the game, we've not provided specific guidance on attribution between origination and servicing as you may suspect with a lot of our reengineering activities here focused on our support infrastructure, those will transcend both the origination and production.

Chris Gamaitoni – Autonomous Research

Okay, that makes sense. And then on the kind of what on the IT invest side are you focused on to do that improvement? I'm trying to get a sense of like how much of this investment is capitalized, really what type of technology solution that will drive these results and try to get a sense of the feasibility with those types of investments?

Glen Messina

Yes, it's continued investments, Chris, in what I'll call operations automation. So, more efficiency through improving workflows, document flows, transition of data between modules within our originations and servicing systems to eliminate double entry of information, it's nuts and bolts, productivity drivers.

Chris Gamaitoni – Autonomous Research

Okay. On the mass affluent opportunities (inaudible), can you define what you mean by mass affluent?

Glen Messina

Yes, so most of our wealth management clients will look at their customers what they refer to as their clients in various segments, and as we've talked previously, that the marketing of our mortgage program has been focused on what they refer to historically as their high net worth segments.

Each of our clients defines that differently in terms of minimum liquid net worth, but in addition to that high net worth segment, most of our clients also have a body of customers which they refer to as the mass affluent segment which are those customers who do have balances under management, assets under management, but not up to the level that the high net worth segment would be.

Historically, that's not been a major focus for some of our clients in terms of marketing the mortgage program. But with obviously overall mortgage industry volumes coming down and refinancing volumes coming down as our clients are looking to continue to grow their mortgage programs, they are expanding the marketing coverage of their programs within their portfolio to include both high net worth and mass affluent.

Chris Gamaitoni – Autonomous Research

And do they bear the cost of that increased marketing initiative or do you?

Glen Messina

It really depends upon the program and some cases it's for the client and some cases we share the development expenses from materials.

Chris Gamaitoni – Autonomous Research

Okay. And then can you give us any sense of looking at the growth and originations into your guidance of $40 billion to $60 billion. I mean, there's a couple of questions, it's you made two comments of – you expect to reach that by the end of 2016, but then you also said it's a normalized market. And I think the general consensus is, at normalized market it will be $1.3 trillion to $1.5 trillion which is about the expectation of 2016. So that's kind of – trying to figure out what you really mean by that commentary and make sure that we set expectations right, relative to in a real market opportunity.

Glen Messina

Yes, Chris, as we are looking forward, our expectation is consistent with the MBA and the GSE future forecasts. So, I don't know that specifically there is a normalized – that much of a difference in a normalized market from our perspective versus what we see in the MBA and average GSE forecast.

We expect our growth in originations to come from both new opportunities and new penetration, so organic and inorganic growth is – and with that would as well help us to capture market share.

Chris Gamaitoni – Autonomous Research

And then, how much of that improvement is from skill versus cost initiatives versus assuming either contract restructuring or shifting back to again on sale. I mean this $40 billion to $60 billion makes all the sense in the (inaudible) gain on sale, but given the high mix of fee-based, it's more difficult if you assume the consistent high mix.

Glen Messina

Yes, so Chris, I think there's – there are couple of things that have to happen in our origination channel to get to that $40 billion to $60 billion. Clearly, make no mistake about it, re-pricing and renegotiating our PLS contracts is one of them. We have to make money on that fee-for-service business.

And I think there's – a balance of contribution between our re-engineering activities to reduce our overhead and direct operating expense levels as well as incremental growth to improve the profitability of the channel. But, reengineering our PLS contracts is clearly part of how we get to the $40 billion to $60 billion.

Chris Gamaitoni – Autonomous Research

Okay, that makes sense. Thank you so much.

Glen Messina

Operator

We'll take our next question from Cheryl Pate of Morgan Stanley.

Cheryl Pate – Morgan Stanley & Co. LLC

Hi, good morning. First is a question on the expansion into further top 25 markets. Just wondering if you could sort of give us a sense of following the Dallas and Houston roll-out in third quarter. What's sort of the next best set of opportunities within the top 25? And is the expansion into that market, is that primarily new, relationships with regional community banks or how do you get there?

Glen Messina

Good morning, Cheryl, it's Glen. So, Cheryl, we outlined the top 25 markets and where obviously those asserted by size of home purchase related activity that's happening in those markets.

For competitive reasons that I really don't think it's appropriate for me to be outlining the next five or ten markets that I'm going into. I'm happy to announce but we're getting into the Houston and Dallas markets, because that's actually happening during the third quarter as we speak, right, so our presence is already there.

In terms of our focus, and as I talk about it with respect to the real estate channel it is with real estate agents as opposed to regional community banks, so it is both inside and outside of the joint venture that we have with Realogy.

Cheryl Pate – Morgan Stanley & Co. LLC

Okay. And then just in terms of the opportunity on the top 25 markets versus the lower density markets, maybe, more of a call-center type approach, how do you weigh the relative attractiveness?

Glen Messina

Look, I think we've got a – in this type of a market you can leave no stone unturned, we do have the call-center for fulfillment capability, so there is no incremental or a limited incremental investment to go and market to those realtors either via outbound tele-sales or direct marketing materials to them, internet advertising and the likes. So, as we look at it, the incremental investment for potential volume to our call-centers is worth the trade-off for us. But as you might suspect, as with any outbound call-center related activity your pull-through rates do tend to be lower, so while it is a lower investment relative to putting a mortgage loan officer in the field, the pull-through of a mortgage loan officer in the field tends to be much higher.

We think it's a fair trade-off and certainly in this market environment we've got to do both.

Cheryl Pate – Morgan Stanley & Co. LLC

Okay. Got it. Maybe just one last one if I may. When I sort of looked at the cash available for operations versus requirements and some of the changes we've seen in the prices of bonds in the high yield market, recently any thoughts to you whether any of the other bonds outstanding become more attractive at these levels?

Glen Messina

Right now, Cheryl, I think we've outlined our capital strategy for the next, really for the next 12 months we are going to be focused on taking out the – paying down the 2014s that maturity where we've tendered for the 2016s and we're going to return $450 million in capital to shareholders.

As time – and certainly in the near term I do want to say that our primary focus really will be reengineering and restructuring our PLS contracts and we believe that those, the combination of those initiatives will provide the maximum benefit and value creation opportunity for our shareholders. Once we're through with that, I think we'll consider alternatives to further adjust our capital structure as opportunities permit and as we believe it can create value for our shareholders.

Cheryl Pate – Morgan Stanley & Co. LLC

Okay. Just one clarification question if I may, the five new subservicing contracts you highlighted, has that UPB already transferred or when do you expect that to move over?

Glen Messina

It will be – it will occur throughout the third and fourth quarters.

Cheryl Pate – Morgan Stanley & Co. LLC

Okay. Thanks very much.

Operator

(Operator Instructions) and we'll take our next question from Kevin Barker of Compass Point.

Kevin Barker – Compass Point

Thank you for taking my questions. I know this quarter you had an outsized derivative gain on the MSR of $20 million. Was there a shift in the hedging strategy that you put in place regarding MSR this quarter?

Glen Messina

Rob, would you like to address that?

Robert Crowl

Yes, hey, Kevin it's Rob. No, there was not.

Kevin Barker – Compass Point

Was that – that was just the economic hedge and the results of that due to lower interest rates?

Robert Crowl

It was just – it was the result of, yes, lower interest rates, and the hedge position that we had on – it probably looks more outsized relative to the mark-to-market adjustment that was taken on the MSR. But now, there was no change in our hedging strategy or any significant change in that hedge portfolio.

Kevin Barker – Compass Point

Thanks. And then on the MSR, I know, the fair value mark was lower in proportion to the decline in interest rates this quarter, given what we've seen in past quarters. Was there a significant change in your prepay assumptions this quarter, given prepay speeds have been slow, outside of the movement of interest rates?

Robert Crowl

Yeah, I mean, what we witnessed this quarter and what I referenced in my prepared remarks is – well, we did see a tick-up in CPRs, but from roughly 9 [ph] last quarter on average for the first quarter to 11, but it was much more muted than what the model would have predicted based on the interest rate movement of, close to 29 basis point. So we just did not experienced the level of prepayments that the model would have predicted and that resulted in a much lower mark-to-market change in the MSR.

Kevin Barker – Compass Point

Okay, rest of my questions have been answered. Thank you.

Operator

And we'll take our next question from Christopher Testa of Sidoti & Company.

Christopher Testa – Sidoti & Company

Hi, thanks for taking my questions. Just more on the secured MSR funding, could you just give us some color around maybe the timing in which you're attempting to do this, and possibly give us a dollar amount of what leverage you are comfortable using?

Glen Messina

As it relates to the secured MSR funding, we are – there is a number of different steps that need to be completed. So in terms of, recall, generic documentation and transaction structure we've – we believe we've gotten that substantially completed.

Quite frankly, with the long-haul and (inaudible) any transaction structure like this is generally getting approval from the GSEs, and we are essentially working through that process now. Both while Fannie, Freddie and to the extent you put Ginnie in there, it would be Ginnie Mae, have slightly differing requirements, preferences, approaches to a structure.

So just because you may get one level of approval, it doesn’t mean others are automatically guaranteed, and because quite frankly, the GSE approval processes outside of our control. Timing, right now we are not forecasting or predicting what we expect the ultimate launch date of a transaction could be until we actually get through the GSE approval process.

Christopher Testa – Sidoti & Company

Okay. And with regards to the PLS contracts and you're trying to get new clients with a smaller community banks, what do you think the addressable market is for the smaller community and regionals over the next, say, four quarters?

Glen Messina

Yes, we work with our consultants and advisors and believe that those regional community banks who view mortgage as either an accommodation product or a critical product, but don’t necessarily have their volume to achieve the right scale within their operations, constitute approximately $180 billion mortgage origination market segment.

Christopher Testa – Sidoti & Company

Okay. And do you think that’s over approximately the next year or so?

Glen Messina

That’s an annualized production volume estimate.

Christopher Testa – Sidoti & Company

Oh, I got it.

Glen Messina

Yes.

Christopher Testa – Sidoti & Company

Okay. And with regards to standardizing the PLS contracts further, I was wondering if you could provide some more color on that, and what's being done with that?

Glen Messina

We are looking at accomplishing four objectives in our PLS contract renegotiation. So first is, updating a modernizing economics based on the cost structures and the compliance and investor requirements that exist in the market today, vis-à-vis when those contracts are negotiated.

Second would be altering the capacity management, provisions within those contracts, so that there is a greater sharing of responsibility as we adjust capacity up and down for accurate forecast and things of that nature.

Third would be the ability to finance MSR is created underneath these PLS programs through something like an MSR secured funding are Two Harbors structure, so getting more flexibility around MSR funding.

And then finally would be more flexibility or increased responsibility on a part of the private label client to endorse permit recapture activities for MSR is previously originated under the program.

Christopher Testa – Sidoti & Company

Great. And what's the current progress with standardizing those and accomplishing those?

Glen Messina

Yes, I think as we mentioned on the call that, we – these contracts are highly complex and there are a fair amount of detail to work through on each one of these four provisions, because they do address multiple areas or impact multiple areas of our contracts.

Notwithstanding, we have got engaged clients. They're – I think they're showing a good spirit of – or negotiating a good faith in the spirit of the partnership. They are at the table, discussions are live and ongoing. And we remain cautiously optimistic that we will be able to restructure these contracts and relationships at or before their contract renewal date.

Christopher Testa – Sidoti & Company

Great. And just the last question, with regards to the Texas offices you are opening, what's your current retail market share there, and what you expect to gain in terms of market share by opening these offices?

Glen Messina

Yes, that’s the information right now, the competitive information that we've not disclosed and probably (inaudible) those until we get lost.

Christopher Testa – Sidoti & Company

Okay. Thank you. I appreciate taking my questions.

Glen Messina

Thank you.

Operator

And we'll take our next question from Ninad Sanghvi of Hudson Bay Capital.

Ninad Sanghvi – Hudson Bay Capital

Hi, good morning, guys. Thank you for taking my questions. I had a few quick questions, what is the overall size of the ASR?

Glen Messina

The ASR, the accelerated share repurchase program is expected to be $200 million.

Ninad Sanghvi – Hudson Bay Capital

And is there an expiration date on it?

Glen Messina

There typically is, well, let's put it this way, we have not stated an expiration date, but we do expect the accelerated share repurchase program to be completed within…

Robert Crowl

I believe was seven and nine months.

Glen Messina

Seven to nine months after program launch.

Ninad Sanghvi – Hudson Bay Capital

Got it. And then the $250 million following that, is that going to have to come through additional approvals?

Glen Messina

The Board has approved the additional $250 million open market purchase program. And obviously, you would be subject to market conditions, that are existing at the time.

Ninad Sanghvi – Hudson Bay Capital

Got it. And then the final question the $31.34 in book value pro forma for the Fleet sale, does that account for dilution from the 2017 converts?

Robert Crowl

No, that was basic charges.

Ninad Sanghvi – Hudson Bay Capital

And any, do you know what that number would be accounting for the dilution?

Robert Crowl

I don’t have the exact figure in front of me, but you can – you roughly take $250 million, let’s just say of equity, it’s around $28, but I don’t…

Ninad Sanghvi – Hudson Bay Capital

Got it.

Robert Crowl

I don’t have the exact number in front of me.

Ninad Sanghvi – Hudson Bay Capital

Okay, fair enough. Those are all my questions. Thank you, guys.

Operator

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

Glen Messina

Great. Thank you so much, and thank you all attending this call. We look forward to speaking with you next quarter.

Operator

This concludes the PHH Corporation second quarter 2014 earnings conference call. Once again ladies and gentlemen, the replay will be available beginning later today at the company's website at www.phh.com/invest or by dialing 888-203-1112 or 719-457-0820 and using the conference ID 9283101. It will be archived until August 20, 2014. You may now disconnect.

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PHH Corporation (NYSE:PHH): Q2 EPS of -$0.31. Revenue of $196M (-52.8% Y/Y)