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PHH Corporation (NYSE:PHH)

Q4 2010 Earnings Conference Call

March 1, 2011, 10:00 am ET

Executives

Jonathan McGrain – SVP, Corporate Communications

Jerry Selitto – President and CEO

Luke Hayden – EVP, Mortgage

George Kilroy – EVP, Fleet

John Erdmann – VP and Controller

Bill Brown – General Counsel

Analysts

Bose George – Keefe, Bruyette & Woods

Paul Miller – FBR Capital Markets

Operator

Good morning, ladies and gentlemen. Welcome to the PHH Corporation Fourth Quarter 2010 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 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 website at www.phh.com or by telephone at 719-457-0820 or 1-888-203-1112 using conference ID 599-5097, beginning shortly after the conclusion of this call. It will be available until March 15, 2011. This access information is also described in the company earnings release and I will repeat it again at the end of our session.

At this time, Jonathan McGrain, Senior Vice President of Corporate Communications will proceed with the introduction.

Jonathan McGrain

Good morning and welcome to the PHH Corporation fourth quarter 2010 earnings conference call. On the call today are Jerry Selitto, President and Chief Executive Officer; Luke Hayden, Executive Vice President of Mortgage; George Kilroy, Executive Vice President of Fleet and John Erdmann, Vice President and Controller. Remarks by our management team will be supplemented by our presentation that is posted on our website at www.phh.com.

The earnings release we issued yesterday may be accessed from our website or you may request a fax or mailed copy by calling our investor hotline at 856-917-7405. Please note that statements made during this conference call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as further described in slide two of the presentation. We will also be discussing various non-GAAP financial measures, including core earnings pre-tax, core earnings after-tax and core earnings per share. Please refer to our earnings release and accompanying investor presentation for a description of these non-GAAP financial measures as well as a reconciliation of such measures to the respected most directly comparable GAAP financial measures.

I will now turn the call over to Jerry Selitto.

Jerry Selitto

Thank you, Jon and good morning. My report today begins with a review of 2010, including our fourth quarter results with commentary on the mortgage and fleet businesses from Luke Hayden and George Kilroy. I'll then focus on the outlook for 2011.

We released our 10-K yesterday and hopefully, you’ve had a chance to review the information. Our objective, today, is to provide perspective to give you a sense of the capabilities we’re developing to drive superior performance. 2010 was a transformation year for PHH. We began a journey to reengineer the major processes in our mortgage and fleet businesses to enable us to operate a more flexible business model, increasing efficiency and enhancing customer service.

PHH has a unique outsourcing business model with tremendous potential, which can withstand adverse market conditions. We've stated several specific objectives for 2010, stabilizing our funding to enable business growth, driving earnings through the cycle by increasing market share and improving penetration across our mortgage channels, focusing on growth opportunities, and fee-based services in fleet, and increasing efficiency and reducing expenses through our transformation initiative.

I'm pleased to report that we made significant progress across all of these initiatives. As summarized in slide three, in 2010, we drove a 20% increase in year-over-year pre-tax core earnings, $289 million in 2010 compared to $240 million in 2009. We did this by increasing market share from 2% to 3% and mortgage originations from $38 billion to $49 billion in 2010. This represents a 30% increase in an originations market that declined by 20%.

We strengthened liquidity, diversified lenders and extended maturities with $6.5 billion in financings during the year, and we earned $63 million in fleet, up 17% from 2009 and added more than 50,000 fee for service vehicles and completed transformation initiatives to deliver approximately $88 million in run-rate savings.

I'm going to skip slide four as you can review on your own. 2010 marked an important first step in a transformation of PHH. Deepening our market penetration and mortgage, improving net margins in fleet, creating greater operational efficiencies and reducing operating expenses across the corporation, which will benefit us over the long-term. I'll say more about this in a moment, when we discuss 2011, but first, I would like to ask Luke Hayden to provide perspective on the mortgage results. Luke.

Luke Hayden

Thanks, Jerry. As you can see on slide six, PHH was one of the few major originators to increase volume in 2010 over 2009 and of the top 20, we recorded the greatest year-over-year percentage increase.

On slide seven, the unpaid principal balance of our servicing portfolio increased by $15 billion during the year and stood at $166 billion by year end 2010.

On slide eight, our delinquency performance continues to be one of the lowest in the industry at 3.88% as of December 31, down from 4.68% at year end 2009. Foreclosure costs for the year were $72 million, compared to $70 million in 2009. Provisions increased to $21 million in the fourth quarter, compared to $11 million in the fourth quarter of 2009 due to the continuing decline in home values and an increase in our repurchase requests from the GSEs. Based on our historical results, we expect to continue to have a high degree of success in defending these repurchase requests.

And now, I'll turn it over to George.

George Kilroy

Thanks Luke. If you turn to slide nine, our fleet business finished the year on a strong note with segment profit of $25 million in the fourth quarter, up 67% from the fourth quarter of 2009. All of our service metrics were up in the fourth quarter compared to the prior quarter, reflective of our effort to grow fee-based services. Over 60% of the new units signed in 2010 were for services only and almost all potential new lease units will be implemented with services. 2010 was a good year for both new client signings and client retention.

In 2010, we acquired a safety training company, CTS, that will be an additional fee-based service for both light-duty vehicle fleets and truck fleets. We have hired an experienced leader for our truck lease business, PHH first lease, which is positioned to take advantage of the significant projected growth of the large and medium truck deliveries in 2011.

Keep in mind, in this business plan – in this business, we plan to fully syndicate all lease transactions, thereby making this more like a fee for service business. We also plan additional investment in our people who serve our clients as well as in our technology, both client facing and for continuous process improvements. Although the overall business environment remains challenging, we anticipate continued growth in both the clients we serve and in profitability in 2011.

Now, I'll turn it back to Jerry.

Jerry Selitto

Thank you, Luke and George. On slide 10, our transformation initiatives successfully delivered approximately $88 million in run rate savings. Accomplished in a year in which we are able to respond to volume spikes and increased regulations while growing market share and increasing revenues. The best way to understand these savings is to consider that, had we not pursued transformation last year, our expenses in 2011 and beyond would be $88 million higher. Transformation – excuse me – transformation allowed us to grow volume and cover increased regulatory costs, while maintaining flat to slightly lower total expenses on a volume adjusted basis.

On slide 11, the challenges of 2011 are similar to those we confronted in 2010. The mortgage industry faces uncertainty regarding the role of the GSEs, increasing regulation as well as the interest rate risk inherent in the mortgage business. Mortgage industry forecasts call for originations to contract once again this year by one-third from approximately $1.5 trillion in 2010 to around $1 trillion in 2011.

The first quarter is shaping up as a period of transition and adjustment as we close out 2010 mortgage application volume and jump start sales efforts in advance of the spring home – home buying season. With the rate increase in December, we've seen a sharp reduction in application volume and compressed margins, which is continued into the first quarter. But through our unique mortgage business model, PHH is well positioned to tackle these challenges.

If you turn to slide 12, it summarizes our outlook for 2011. I believe that we have barely tapped the enormous potential of our distribution channels, which provide mortgage outsourcing services to high quality financial institutions, real estate brands and correspondence and enable us to achieve greater economies of scale, by touching hundreds of thousands of borrowers nationwide as we leverage the infrastructure of our partners.

For example, our private label channel provides PHH with a nationwide footprint comparable to that of our largest competitors that drives originations through more than 30,000 financial advisors, 4,300 bank branches, 750 loan officers. Through our realty partnership, we have access to one of the largest networks of real estate agents and offices in the nation.

In addition, as we stated, one of our goals in 2010 was to expand our presence in the correspondent channel, where we increased penetration significantly last year while maintaining prudent underwriting discipline. In fleet, nearly one-third of our top 200 customers are Fortune 500 companies and over 100 clients have been with us for 20 years or more.

Our focus in 2011 is a step-up our efforts to drive revenue and higher ROE business. Growth will come from gaining market share, providing more fee based services to current customers, expanding our truck business and providing services to fleets that do not lease from PHH. We continue to differentiate ourselves as an innovation leader in technology for the fleet industry.

Our transformation focus in 2011 is shifting from reducing costs to further increasing efficiencies and investing some of our 2010 savings into technology that will drive scalability and operating flexibility. In 2011, we will continue our momentum of increasing market share and delivering solid results in a down market as we have demonstrated in the past. Our unique franchise, our rock solid outsourcing model, the cost savings we have already achieved, our efficiencies, the teams we have assembled, our market penetration success, our position of the company to be one of the most dominant mortgage players this year and a solid earnings contributor.

In summary, as one of the country’s largest companies in the mortgage and fleet management business, we have emerged from the last few years of unprecedented turmoil as a more efficient company. Our 2010 achievements in solidifying our funding and liquidity, increasing mortgage market share, developing fee-based opportunities in fleet and transforming our businesses, position us well to compete in a challenging 2011.

Before we take questions, I want to speak about the CFO transition that we announced this morning. Sandra Bell is leaving PHH to pursue other opportunities. She has played a critical role in our company's recent success. Under her leadership, we have significantly strengthened our liquidity position and improved core operating results. I want to thank her for our contributions and wish her the very best going forward.

We also announced the David Coles of Alvarez & Marsal has joined us effective immediately as interim CFO, while we conduct a search for Sandra's successor. David brings excellent financial experience and we are fortunate to be able to call upon his knowledge and expertise during the transition period. You will be hearing from him in the days and weeks ahead.

Now, I'll turn it over and we'll take your questions.

Question-and-Answer Session

Operator

Okay. Thank you. (Operator Instructions) Our first question comes from Bose George.

Bose George – Keefe, Bruyette & Woods

Hey, good morning and congratulations on a solid year. I had a couple of questions. First on the gain on sale margin, I was curious what the gain on sale margin impact was from the increased volume you’re getting from the correspondent channel and also just curious what the correspondent channel percentage was at the beginning of the year versus the end of the year?

Jerry Selitto

Yeah. Bose, good morning and thank you. I'll take the latter part of that question and I will turn the first part of your question over to Luke. One of the goals that we had stated in 2010 at the beginning of the year was that we were going to increase our penetration of the correspondent channel, and we were going to increase that from 15% to about 25%. We were able to take advantage of attractive margins in that channel in 2010, and we actually increased our concentration or our participation in that channel from 15% to over 30%.

With that, I'll turn it over to Luke to answer the first part of your question.

Luke Hayden

Yeah. With respect to the margins, Bose, we enjoyed good margins in the – good margins in the correspondent business in the third and the first portion of the fourth quarter and then margins contracted towards the end of the fourth quarter on that business. Margins in the correspondent business are not as robust typically as the margins in the retail business.

Bose George – Keefe, Bruyette & Woods

Okay. Great. Thanks and then switching to the – to volumes on the outsourcing side as volumes have slowed sharply, as you guys noted, have you seen any pickup in discussions as originators on outsourcing agreements or is that do you think that there will be a bit of a lag and then people will look more at outsourcing contracts as volumes fall?

Jerry Selitto

Yes, one of the things, Bose, we really have a very, very strong pipeline in POS prospects. We, you know, this year is going to be about investing in technology and also in increasing our outsourcing services. So Milton Prime, our PMO, has been really working diligently to expand that. We have got a large footprint through our channels and our partners and we just are going to continue the momentum from last year in increasing penetration in a down market.

Bose George – Keefe, Bruyette & Woods

Okay. Great. And then just switching to a broader question, just on the GSE, you know, the whole discussion about the GSE service or compensation structure and I was curious what your thoughts are about that and what happens if the servicing fee, the minimum servicing fee goes down, how it impacts the industry and you in particular?

Jerry Selitto

Bose, I love that question. We agree with your analysis. We think it’s going to be neutral to positive for us, in terms of the servicing fees, if that was the question.

Bose George – Keefe, Bruyette & Woods

Yeah. That definitely was. Thank you. And my last question is just on the guidance you guys have given earlier for 2011, I just wanted to see if you guys wanted to discuss sort of ROE outlooks for next year?

Jerry Selitto

No, I think I learned my lesson in 2010, about guidance. There is just so much uncertainty in the market that it’ really difficult for us to give guidance in 2011. I think the key for us right now is that we are going to continue – we are just going to strengthen our penetration with our key clients. We are going to continue to build market share and we are going to be focused on those things that you know over which we have control.

So, it’s a down market, but we really expect, again, in a down market to be able to increase market share and deeper penetration of our key clients.

Bose George – Keefe, Bruyette & Woods

Okay. Definitely appreciate that. Thanks.

Jerry Selitto

Thank you.

Operator

Next we have Paul Miller with FBR Capital Markets.

Paul Miller – FBR Capital Markets

Yes, just going back to the market share discussion, you guys, I think, had surprised everybody with a 3.7% market share in the fourth quarter. Was that mostly – if you said this in the presentation, I missed it, was that mostly due to increased penetration to correspondent or did you get an increased market share across-the-board?

Jerry Selitto

Yes, it was really – Paul, thank you and good morning. It was really across-the-board. I mean, we did increase our penetration in the correspondent channel. I think as I mentioned, we took advantage of a high margins in that channel and that was really during the second to third quarter. And then, we saw a 68% spike in volume in the third quarter and it really was, we were able to increase across all channels.

Paul Miller – FBR Capital Markets

So, it wasn’t just that the correspondent channel driving that 3.7% market share?

Jerry Selitto

It was not.

Paul Miller – FBR Capital Markets

And then the gain on sale margins, which is, I know for any mortgage bank is the most difficult thing to predict. But, we know the gain on sale margins have got, you know, came in when rates really spiked in the latter half of the fourth quarter. Are you continuing to see that pressure or has it stabilized from that point?

Jerry Selitto

Yes. No, we are still seeing pressure on margins.

Paul Miller – FBR Capital Markets

Okay. So, you are still seeing pressure? And I guess in most times, when mortgage relations drop like this, I guess – we would expect to see pressure throughout the year, if rates stay where they are right now?

Jerry Selitto

I think as we have said in the past, that as you see rates increasing in the marketplace, that we do see margin compression.

Jerry Selitto

And then the positive on all that, is that we are actually seeing much slower pre-pays on our servicing portfolio.

Paul Miller – FBR Capital Markets

And then jumping tracks here a little bit to credit, because I get a lot of questions about this. A lot of people know that GSE reps and warrants, I guess a lot of companies would say we are through more than two thirds of the GSE reps and warrants. But the question is nobody can quantify the private label. You do not have a lot of private label exposure, am I correct? And you have not been named in any of these lawsuits that hits the press a lot, did you – how do you?

Jerry Selitto

No, we don’t have – we really don't have a lot of participation in the private label side.

Paul Miller – FBR Capital Markets

And that’s the (inaudible) because you guys did do some jumbos, but even on that side, the jumbo market – there is not a lot of issues?

Jerry Selitto

There is not.

Paul Miller – FBR Capital Markets

Okay. And thanks a lot, gentlemen.

Jerry Selitto

Thank you.

Operator

(Operator instructions) And since we have no further questions, I would like – sorry, Bose George with KBW.

Bose George – Keefe, Bruyette & Woods

Hi, thanks. I just had a follow-up. The first was just on the regulators are obviously doing this investigation of the large servicers – the regulated servicers and you guys aren’t on the list. A bit curious, like have you guys had this sort of parallel discussions with anyone in the government on the same issue?

Jerry Selitto

I am going to have Bill answer that, our general counsel, Bill Brown.

Bill Brown

As you indicated, we are not a bank, we are state regulated. We do have regulators and as we indicated in our disclosure documents, we have received inquiries from regulators and we respond to them in the ordinary course. And I think we have disclosed recently that obviously, the Attorney’s general, the regulators. And I guess recently, Congress have sort of jumped into the discussion. But again, we respond to these requests for information as warranted.

Jerry Selitto

Yes, Bose, as I think we mentioned in the past, when all of this hit, the whole crisis dealing with foreclosures, we did it and we had an independent review of our processes, we are really very comfortable and very confident in what we do in handling our foreclosures. The reality is, we are a top 10 servicer.

Bose George – Keefe, Bruyette & Woods

Right, right. That would make sense. Thanks. And then a couple of little questions. On the gain on sale margin on page five, that 167 basis points, I just wanted to make sure how that was being calculated?

Jerry Selitto

Let us look. Turn to page five. John, you want to take that?

John Erdmann

Sure. This is the margin on the security pass through price on the date of lock and obviously, a lot of things can change from there, but that’s the initial margin on the date that we locked the loan.

Bose George – Keefe, Bruyette & Woods

Okay. And so, the number to use there is the rate lock commitments. And so, it’s the margin on the lock divided by the number of loans over rate locked?

John Erdmann

Correct. Yes, the lock is the driver we want to focus on there.

Bose George – Keefe, Bruyette & Woods

Okay. And then one last question on the truck lease business comment that you guys made, how large is that business at the moment? And just in terms of that market, like who are the other competitors, the main competitors in that area?

Jerry Selitto

George, you want to take that?

George Kilroy

Sure. How large that business is, I am not sure we disclosed that, but I kind of tell you who we are competing with – maybe then I will give you a size of it. If you think of the large truck lease business, on one side you have the banks, very large banks that do just the leasing and on the other side you have the full service lessors like Ryder and Penske. And we position ourselves in the middle, where we provide a lot of technical assistance, engineering help for our customers, and then we lease the vehicles to them, and then syndicate – fully syndicate those leases off.

So, the comment that we made was, that market is looking at maybe 40%, 50% growth in the number of heavy trucks that will be delivered this year.

Bose George – Keefe, Bruyette & Woods

Okay. Great. Thank you.

Jerry Selitto

Thank you.

Operator

And that does conclude our question and answer session. At this time I would turn the call back over to Mr. Selitto for any closing remarks.

Jerry Selitto

To conclude, let me reiterate that while 2011 brings new challenges, we believe that our success in 2010 have positioned us well to meet them. We look forward to continuing to drive earnings through improved efficiency and enhanced customer satisfaction, which will position us to deliver sustainable, attractive returns to our shareholders throughout the business cycle.

Thank you for your confidence and support.

Operator

This concludes the PHH Corporation fourth quarter 2010 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 or by dialing 719-457-0820 or 1-888-203-1112 using conference ID 5995097, once again, by dialing 719-457-0820 or 888-203-1112 using conference ID 5995097. It will be archived until March 15, 2011. You may now disconnect.

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