Toll Brothers' CEO Discusses F3Q 2011 Results - Earnings Call Transcript

Aug.24.11 | About: Toll Brothers (TOL)

Toll Brothers, Inc. (NYSE:TOL)

F3Q 2011 Earnings Call

August 24, 2011 2:00 PM ET

Executives

Douglas Yearley – CEO

Martin Connor – CFO and Treasurer

Robert Toll – Executive Chairman

Don Salmon – President, TBI Mortgage Co.

Analysts

Joshua Levin – Citigroup

Ivy Zelman – Zelman & Associates

David Goldberg – UBS

Robert Wetenhall, Jr. – RBC Capital Markets

Joel Locker – FBN Securities

Joshua Pollard – Goldman Sachs

Stephen East – Ticonderoga Securities

Jade Rahmani – Keefe, Bruyette & Woods

Megan Mcgrass – MKM Partners

Jason Marcus – JPMorgan

Ken Zener – KeyBanc

Rob Henson – Deutsche Bank

Adam Rigger – Wells Fargo Securities

Daniel Oppenheim – Credit Suisse

Michael Smith – JMP Securities

Alex Barron – Housing Research Center

Jay McCanless – Guggenheim

Operator

Good afternoon. My name is Tamika and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2011 Earnings Conference Call hosted by Doug Yearley. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) Thank you.

I will now turn the conference over to Mr. Doug Yearley, CEO. Sir, you may begin.

Douglas Yearley

Thank you, Tamika. Welcome and thank you for joining us. I am Doug Yearley, CEO and with me today are Bob Toll, Executive Chairman, Marty Connor, CFO; Fred Cooper, Senior VP of Finance, International Development and Investor Relations; Joe Sicree, Chief Accounting Officer; Kira Sterling, Chief Marketing Officer; Mike Synder, Chief Planning Officer; Don Salmon, President of TBI Mortgage Co.; and Greg Ziegler, Senior VP Treasury.

Before I begin I’ll ask you to read the statement on forward-looking information in today’s release and on our website. I caution you that many statements on this call are based on assumptions about the economy, world events, housing and financial markets, and many other factors beyond our control that could significantly affect future results. Those listening on the web can email questions to rtoll@tollbrothersinc.com.

As has become our regular practice you will limit our prepared remarks to provide more time for Q&A. Since our detailed release has been out since early this morning and is posted on our website, I’m sure you have all read it. So I won’t re-read it to you.

The past’s result indicate some continued stabilization in the upscale housing market albeit at the label dramatically below historical levels for the fifth consecutive quarter on a pre-impairment basis. In fact this quarter we also achieved modest pre-tax profit after impairments as well. We reported fiscal year 2011 third-quarter net income of $42.1 million or $0.25 per share. Fiscal year 2011 third-quarter included a net tax benefit of $38.2 million due to the reversal of previously accrued state and federal taxes.

Fiscal year 2011 third-quarter pre-tax income was $3.9 million; excluding write-downs and debt retirement charges of $20.2 million fiscal year 2011’s third-quarter pre-tax income was $24.1 million. These were all improvements over our results of one year ago.

Fiscal year 2011 third-quarter revenues and homebuilding deliveries decreased 13% in dollars and 14% in units compared to fiscal year 2010 third-quarter results. Fiscal year 2011 third quarter net signed contracts rose 2% in dollars and units compared to 2010’s third-quarter. However, they were still well below our historical third-quarter paces. The average price of net signed contracts was $570,000, approximately the same as 2010’s third quarter.

Fiscal year 2011 third quarter end backlog increased 8% in dollars and 9% in units compared to fiscal year 2010’s third quarter end backlog. We end the quarter with nearly $2 billion of liquidity including $1.18 billion of cash and marketable securities and $778 million available under our $885 million 12 bank credit facility which matures in October of 2014.

Our net debt to capital at third quarter end was 13.9%. Our strong financial position and the value of our brand distinguish us in the luxury market as nervous buyers are exhibiting the flight quality and dependability. Our large presence in the Metro DC to Boston corridor and our high rise business in Metro New York City region give us a strong position in some of the most promising U.S. markets. Our buyers generally have very strong financial profiles which have enabled them to secure mortgage financing.

We closed on about $75 million of land this quarter, nearly half of which was for a great site at 22nd Street in the Gramercy Park area of Manhattan, which we bought at the bankruptcy auction. We are seeing some attractive land, loan and portfolio buying opportunities, however, the flow of deals is not occurring at the pace we would have expected this long into a down cycle.

On the portfolio side, Gibraltar Capital and Asset Management, our subsidiary focused on acquiring the managing portfolios of the stressed real estate loans and properties produced $4 million of profits this quarter. It is really too soon to access the ramifications of the financial volatility of the past few weeks on the housing market. While late summer is generally not the best time to sell homes, in the short run, the stock markets’ gyrations, the budget impasse and the U.S. government bond rating downgrade are certainly not helping consumer confidence. Surprisingly, gross agreements for the first three weeks of August were basically flat to last year, while trust traffic was actually up about 5%.

Gross deposits have been down about 18% for the most recent three weeks, but these were likely reduced in part by the very successful summer sales event we held over the last week in July which pulled some activity forward. There is no question our buyers’ confidence at the moment has been shaken and they maybe waiting to see what’s the next weeks or months hold. Maybe that family with the now 80 pound yellow lab, remember that dog was a puppy in 2006, will continue to delay their move to a bigger Toll Brothers home. But they like many others are becoming more and more anxious to buy when the market settles down.

Looking forward, historic low interest rates and the growing imbalance between housing production and demographics driven demand bode well for the industry sooner or later. The key question of course is when?

Now let me turn it over to Marty.

Martin Connor

Thanks, Doug. Third quarter home building cost of sales as a percentage of home building revenues before interest and write-downs was 76.6% compared to 77% in the second quarter, and 77.9% in last year’s third quarter. The year-over-year improvement was principally a result of cost savings driven by our trade purchasing initiatives and by our reduced incentives.

The third quarter interest expense included in cost of sales was 5.3% of revenues about 10 basis points lower than the last quarter, principally a result of mix. We had no directly expensed interest. Of the third quarter write-downs of $16.8 million, $14 million was attributable to land owned for a future community in South Carolina.

The third quarter SG&A was 16.4% of revenues compared to 21% in the second quarter. This reduction was a result of higher revenues in the quarter compared to the previous quarter, ongoing benefits of cost reduction initiatives and insurance reversals and recoveries. The increase in joint venture and other income was principally a result of our joint ventures in the New York Metropolitan area and as Doug mentioned, approximately $4 million in income from our Gibraltar operations.

In the third quarter, we recognized the tax benefit of $38.2 million related primarily to the release of reserves associated with completed tax audits or statute expirations; we do not expect the benefit of this size or nature in our fourth quarter. Subject to our normal caveats regarding forward-looking statements in today’s release and in our SEC filings, we offer the following limited guidance.

We expect that deliveries in the fourth quarter will be between 620 and 820 homes bringing total deliveries in 2011 to between 2,475 and 2,675 homes. We also estimate the average delivered price per home for the fourth quarter will be between $555,000 and $570,000.

At this point, I’ll turn it back to Bob.

Robert Toll

Thanks, Marty. Research shows that homeownership remains the goal of most Americans, with historically low mortgage rates, home affordability remains tremendous. And studies are showing that it is now cheaper in most cities to buy a home than to rent. Rents have been climbing quickly in the past year.

New home prices according to ISI are trending positive. Per report they just issued today new home prices through July are up 8% since the recent lows in March 2009. The data on the S&P/Case-Shiller Index website goes back to January 3, 2000. The person who invested 500,000 in Dow Jones on that day would have made a profit of $125,000 including dividends in the nearly 11 years since. If they have invested that amount in the S&P 500, they would have lost $22,000 even including dividends. According to the Case-Shiller 20-City Composite if on that same day in 2000, that person has instead bought a home for 500,000 that house will be worth 700,000 today, that’s a gain of 200,000 despite the worse housing market since the great depression. And that is without the advantage of using leverage, also known as a mortgage in our business.

Consumer confidence is still weak and the housing sector remains in a fragile state. The nation’s economy continues to suffer from the lack of jobs in housing construction and the related manufacturing and service sectors that a decent new home market would typically generate. Housing construction is a primary job creator for those Americans who are now suffering among the highest levels of unemployment in the current recession. We all know that housing got us into the mess and most of us recognize that only new construction will get us out of the mess.

Many people that work in new construction unfortunately are not fungible with the rest of the economy. They do not fit easily into other parts of the job market. Our sales have gained some traction, but are terribly inhibited by the negative feeling coming out of the budget crisis, and now the stock market gyrations. Most of all, however, confidence in new housing takes a hit from the uncertainty of loan limits, mortgage deductions, Fannie, Freddie, et cetera.

We hope that our elected representatives will proceed cautiously with housing as they review options to address the deficit by ensuring that liquidity remains available to the sector and that the foundations of our system that support homeownership are not dismantled. Doug?

Douglas Yearley

Thank you, Bob. Tamika, we are ready for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Josh Levin with Citigroup.

Joshua Levin – Citigroup

Hi. Good afternoon, everybody.

Robert Toll

Hi, Josh.

Joshua Levin – Citigroup

Doug, you talked about, you gave us good color on the first three weeks of August about gross agreements, traffic and deposit. When we think about net agreements, I guess, have you seen an uptick in cancellations at all in the first three weeks of August?

Douglas Yearley

We have not.

Joshua Levin – Citigroup

Okay. And second, given the volatility and the negative consumer sentiment, how are you thinking about your pricing and incentive strategy as you head into the fall?

Douglas Yearley

There is no change, we still believe that the pricing is very inelastic, the few times we’ve tested it, as we’ve talked about on prior calls. By adding incentives we have not seen more sales. I think buyers understand that our pricing is fabulous, our locations are great. They just have lost confidence right now. So they’re not in haggling the way they were a few years ago. I think they recognize the great prices. We do have incentives in most places, but they are flat or going down and we intend to continue that through the fall.

Joshua Levin – Citigroup

Thank you very much.

Robert Toll

You’re welcome.

Douglas Yearley

You’re very welcome.

Operator

Your next question comes from the line of Ivy Zelman with Zelman & Associates.

Ivy Zelman – Zelman & Associates

Hi, good afternoon, guys. I hope you can hear me okay, I’m on a cell. Just tracking a little bit about the weakness specifically in D.C., orders were down about 14% year-over-year in the Mid-Atlantic and looking at 20% quarter-over-quarter, if you look at that weakness, do you think it’s just more of the close the beltway and the law makers and a little more jitters, they are coming off of what have been a stronger market?

And then just secondly, if you can comment on mortgage funding, what’s happening in the jumbo market? Have you seen rates moving higher, have you seen a reluctance here of banks to fund?

And lastly, stock buy-back with the weakness in your shares, would you strategically consider using your significant liquidity to be a buyer of your stock right now? Thank you.

Robert Toll

That’s it? No more?

Ivy Zelman – Zelman & Associates

I got it all in (inaudible).

Robert Toll

Yes, you did. Yes, you did.

Douglas Yearley

Okay. Virginia, the Mid-Atlantic it’s primarily, the slowdown is primarily coming out of Maryland, Virginia and I think it’s indicative of what happened through our third quarter in Washington D.C.

Robert Toll

If there’s anybody that should be nervous, it should be the guys in Washington.

Douglas Yearley

Right. Don. Don Salmon is here of TVR Mortgage, let’s talk about jumbos.

Don Salmon

In terms of jumbo actually quite the opposite, we’re seeing more opportunities for jumbo, rates are very competitive. We have more banks than ever willing to lend jumbo, in fact we have increased liquidity now for some of our self-employed buyers that we didn’t have six months ago. We had a phone call today and a meeting going on right now with another bank that we think is going to be a terrific source for us. We’re very optimistic about the jumbo coming back pretty strongly actually.

Douglas Yearley

Thank you, Don. Ivy, your question was stock buyback. Like many other companies, we’re watching our stock price very closely and have been over the last few weeks even more closely. And we plan to evaluate our options as soon as our trading window opens in a couple of days.

Ivy Zelman – Zelman & Associates

Great, guys. Thanks a lot.

Robert Toll

You’re welcome.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of David Goldberg with UBS.

David Goldberg – UBS

Thanks. Good afternoon, everybody.

Douglas Yearley

Hi, David.

David Goldberg – UBS

My first question, actually I want to follow-up on Josh’s question on cancellation rates, and what I want to get an idea about is how you kind of feel about the strength of the backlog and given everything that’s kind of happened in the last month in the broader economy, how solid do you think the backlog is and how much work to do to kind of solidify and make sure the backlog is not going to – we’re not going see a wave of cancellations in the next month or two?

Douglas Yearley

We feel good. There’s no question, it’s taking a little bit longer to get a client from deposit to binding agreement and we have to work a little harder and we have to be a little more patient and put quite the pressure on them that we have in the past. But they’ve put a lot of money down and I think they’re going into this right now with eyes wide open and we’ve had very stabilized cancellation rates now for a couple of years. And what’s going on in the stock market in the last couple of weeks, we don’t think will affect that. So we’re quite confident with the amount of money that’s been put down and the time we’re giving our clients to make that final decision. We feel pretty good and as I mentioned before, we really haven’t seen anything fall out for the last few weeks.

David Goldberg – UBS

Got it. And then my follow-up question, you were talking a last couple quarters about buying some units for the development in New York and more of the high rise business. I’m wondering if you could tell us, who do you compete against when you are bidding on this land. And maybe if you can talk about just the competitive bidding process and who else is in the business and how competitive that process is for you guys, and what you think is Toll has an edge versus some of your competitors?

Douglas Yearley

Well, the simple answer is cash. For example, we mentioned that this last quarter we are successful at a bankruptcy auction in the court house for a great property down by Gramercy Park and that was the ability to write a pretty big check. You can figure it out since we said it’s about half of what we spent for the quarter within 10 days. So that’s gives us a huge advantage and we are hungry. We’ve been very – we’ve seen great success in New York and Hoboken and we are aggressively looking for opportunities. Most of what we look for is under the radar screen. We tend to focus on the more boutique buildings that you can get in and out of a little quicker in fabulous locations.

And we have sold out seven buildings in City Living New York. We have five right now that are open for sale. We have two that will be opening in this coming fall and we have seven more that we own, properties that we own that are still going through stages of approvals. So we love the land we have tied up and the buildings we are going to be opening, not to mention those that are already open.

The competition, it’s all over the place. Occasionally, you’ll run into the real big guys, but it tends to be smaller New York investors and right now they just don’t have the capital, so we are taking advantage of that.

David Goldberg – UBS

Right. Thank you.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of Bob Wetenhall with RBC.

Robert Wetenhall, Jr. – RBC Capital Markets

Hey, good afternoon. Can I just get your view on impairments going forward and if we should expect any more write-downs associated with that South Carolina community that you referenced?

Douglas Yearley

Bob, we evaluate impairment each quarter, and we take the impairments that are appropriate and that are known in that quarter and it’s looking forward, if we thought there were impairments to be taken, we would have already taken them in this quarter. In terms of the South Carolina community, we have very limited basis left in that particular community after this impairment.

Robert Wetenhall, Jr. – RBC Capital Markets

Got it. And can you give a little bit more color, you had some nice gross margin expansion this quarter, and can you kind of give us a little idea of what’s driving that?

Douglas Yearley

Well, our margin improvement this quarter over last quarter was predominantly the result of some of our centralized trade purchasing initiatives running through the deliveries. Year-over-year it was a combination of reduced incentives running through the deliveries and the start, if you will, of those trade purchasing initiatives.

Robert Wetenhall, Jr. – RBC Capital Markets

Understood. Thanks very much, good luck.

Douglas Yearley

You’re welcome.

Robert Toll

Thank you.

Douglas Yearley

Tamika?

Operator

Yes, sir. Your next question comes from the line of Joel Locker with FBN Securities.

Joel Locker – FBN Securities

(Inaudible) what your spec count was at the end the third quarter?

Martin Connor

Our spec count is flat versus last quarter. Last quarter we have 357 traditional home building specs and this quarter 355.

Joel Locker – FBN Securities

355. And just a question on your West orders were down 23% year-over-year, was that just weakness or was it a matter of community account being down?

Douglas Yearley

Primarily, community account in California.

Joel Locker – FBN Securities

Community account and what was community account on a percentage basis down there just trying to get a comparison.

Martin Connor

It’s 17 out of 207.

Joel Locker – FBN Securities

17 out of 207?

Unidentified Company Representative

Yes.

Joel Locker – FBN Securities

All right. Thanks a lot, guys.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of Joshua Pollard with Goldman Sachs.

Joshua Pollard – Goldman Sachs

Hey, good afternoon. You are closer to the rental business than your competitors, first, because you have the sort of multi-family condo business but also there is some of the things you guys do on your JVs. Could you talk about any ideas that you guys are looking at as far as getting deeper into the rental business? Do you guys still like that outside of your warehouse or is that something you guys are looking at intimately at this point?

Robert Toll

When we do the rental business, we do it off balance JV and it’s done under the REIT. So we do our best to move it away from Toll Brothers which is an earnings company as opposed to building equity cash flow from the rental business. You’re right, we do compete with the rental business through condos and multi-family product for sale and our experience has been good as we said in the trial log, it’s now a log. Rent has been going up so rapidly that they pay us what it cost to own one of these units on a few simple basis.

Joshua Pollard – Goldman Sachs

I guess the question then Bob would really be what would it take for you guys to go deeper into that business or is that just not, it’s a rental business, it’s not something that you guys are interested on for the – for I guess what I’d call the balance sheet portion of Toll Brothers?

Robert Toll

Well, we’re interested in it, but we’re interested in it off balance sheet.

Joshua Pollard – Goldman Sachs

Okay. I guess my second question is on the margin expansion, centralized trade purchasing initiatives, are you guys done with that, should we see any further benefit. And then my last question is around Gibraltar, the gain you guys saw there, should we expect – should we expect Gibraltar to be earning that much income each quarter for the foreseeable future or were there one-time items there?

Douglas Yearley

There were not one-time items and we expect Gibraltar to continue to grow based on the deal flow we’re now seeing. With respect to centralized purchasing, we have launched this initiative in most of our markets, certainly in all of our core markets. There are still some saving to come through but I think most of it has already hit.

Robert Toll

Yes, the low hanging fruits been picked. Definitely, we’ll get more of the closer skies and we’re working at it and if they don’t get more, well for them. So, we’ll definitely see some but the main benefits are probably already achieved.

Joshua Pollard – Goldman Sachs

Are there any other besides the purchasing initiatives, are there anything else – is there anything else out there that you guys are doing to drive further margin expansion or is it all of our pricing from here?

Robert Toll

Josh, I think it’s predominantly all about pricing from here. There may be some small items that comes to bear, but nothing that we could point to. We’re looking at it every day and we may find a nugget here and nugget there. But for the most part, as we said on the last call, true margin expansion is going to come from volume and pricing power, which go hand in hand.

Joshua Pollard – Goldman Sachs

Okay. Thanks, guys.

Robert Toll

You’re welcome.

Operator

Your next question comes from the line of Stephen East with Ticonderoga Securities.

Stephen East – Ticonderoga Securities

Thank you, good afternoon, guys. Doug, when you talked about the trends in August, could you give us some color about the trends as we move through the quarter, the monthly sequential trends and then also geographically whether you’re seeing anything unique yourself was much stronger than the rest of it, was that just community growth or was that or where you’re seeing better demand there?

Douglas Yearley

As we worked through the quarter, we actually saw a great improvement in July, but that was driven by a big national sales event that we launched the last 2.5 weeks of July. Now, some of those contracts came through in early August which is why I mentioned earlier that our agreements were flat for the first two weeks of August. But some of that hit in late July and that was a – that was in partnership with our vendors who were offering upgrades to our clients, so they added incentives we’re not out of Toll Brothers’ pocket, but they were out of our partner vendor’s pocket. We’ve been doing this now for a year and a half, two years very successfully. So it’s hard, Stephen to, because of that event, it’s hard for me to tell you what normalized demand would have been through the quarter. But for us, July was significantly better.

Stephen East – Ticonderoga Securities

Okay. And geographically on that with the south?

Douglas Yearley

Texas has done very well through the quarter. It’s a bright spot in our company along with of course we talked about City Living. Florida East grew primarily because of a new community that we brought online, which had good sales through the spring. But again, the best action still tends to be Washington, D.C. up through Boston with the exception for us of what we call New York Metro, which is not City Living and sadly it’s not Westchester County, but it’s up in Fishkill. So it’s a little bit of a tougher market and that has not performed as well as the other markets from Virginia up to Boston. And as we mentioned before, Maryland and Virginia have softened a bit primarily because of what’s going on in Washington, D.C.

And then when you get out of the Mid-Atlantic and Northeast, I mentioned Texas as being the other bright spot. And we’ve also been pretty happy with Charlotte although it’s very small and Raleigh at times through the quarter has done well. So that’s pretty much it for the roundup.

Robert Toll

The New York ex-urban Fishkill, Peekskill, Poughkeepsie, et cetera was very strong for us. It’s just recently gone more quiet.

Douglas Yearley

That’s right.

Stephen East – Ticonderoga Securities

Okay. Great roundup. I appreciate that. And then, on your cash flow or your cash spend, you talked about several different things, Gibraltar, where do you think you allocate your cash when you talk about how fast you may want to grow Gibraltar or whether you want to do some debt repurchase like you did in the quarter or share repurchase? And then also, you talked about South Carolina project. Are you getting more into development? Are you still when you’re doing your land spend; it is primarily for new properties versus development?

Douglas Yearley

Well, in terms of allocation of capital at the start, we are very opportunistic. We do not plan our allocation; we think that’s a big mistake. As we’ve been mentioning now for a year, we’re frustrated with the deal flow we’re seeing for this deep into a cycle. It doesn’t mean we’re not seeing opportunities, it doesn’t mean we’re not doing deals. But we’ve certainly had hoped that we will be spending more of our 1.2 billion of cash and bank line on great opportunities and the banks are not just motivated right now to be out in the market moving products.

So Gibraltar on the other hand have seen very good deal flow, we have about $75 million invested through Gibraltar. There is nothing new to report but they’ve got balls up in the air, they’ve got offers out. And again, it’s just opportunistic use of our capital and if there is good deals through Gibraltar, we will not be shy. I wouldn’t be surprised if that $75 million investment doubled. We’ll just have to see how it plays out.

With respect to stock repurchase I’ve already talked about it with Ivy. With respect to debt, we’ve spent 45 million in the third quarter on some debt buyback, so we will continue to be opportunistic in all fronts, Stephen. I think it’s the best way I can answer it.

Stephen East – Ticonderoga Securities

All right, I appreciate it. Thank you.

Douglas Yearley

And your final point was whether we’re spending our money on new land deals or developing old, it’s a blend. There’s a number of great properties that we’re just now closing on because the entitlements have been completed and we will be starting land development to bring communities online and those I would call very old but we bought them at a time when the pricing was right and we’re not closing until we have all approvals, which in most of our markets takes many, many years, so I think you’ll see the capital spend on both new and old.

Stephen East – Ticonderoga Securities

All right. Thank you.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of Jade Rahmani with KBW.

Jade Rahmani – Keefe, Bruyette & Woods

Thanks for taking the question. Going back to the jumbo mortgage market, I wanted to ask if the decline in conforming loan limits in September is what you think is driving the increased interest from originators or is it the stickiness of jumbo mortgage rates which appear to have held in there despite the historic decline in treasuries?

Martin Connor

I think that the banks have a lot of liquidity and they are looking for places to put it with the credit quality, especially the credit quality that comes out of the Toll Brothers communities, it’s a terrific asset to put on the books. A lot of the jumbos these days are arms and that’s a great asset for the banks to have and I think that’s what’s driving it. If and when the rates drop, we’ll see what happens. My guess is that the same jumbo product will be available to those folks, but I don’t think the banks are saying the maximum loan limit is going to drop, therefore we’ll commit with jumbo. I don’t think that’s what drives it. I think what drives it is their appetite for their balance sheet.

Jade Rahmani – Keefe, Bruyette & Woods

Okay. And can you just give an indication what rates are currently quoting?

Martin Connor

Sure. Conforming rates today are about 4%, which is just about an all-time low. We actually hit 3 7/8 for a nano second.

Unidentified Company Representative

No points.

Martin Connor

These are zero point loans and for highly qualified buyers in good markets. Agency jumbo, which what we just talked about is about 4 1/8. You talked about the stickiness of jumbo that’s about 4.75, so that spread has widened a little bit and I think that’s because it is still going into portfolio there is still no active secondary market for jumbo although there are rumors that they are really trying to kick start one. You’d probably know that Raineri (ph) invested a bunch of money in a company as it drove for us so hopefully those guys are smart enough to get it going for us.

Robert Toll

Washington has not determined to lower the limits of Fannie/Freddie, FHA and don’t be surprised to see them extended is the word that I get from many of my contacts in D.C.

Jade Rahmani – Keefe, Bruyette & Woods

Okay.

Martin Connor

Okay. To be clear about that, the reduction in the high balance conforming really is going to affect those folks who need loan to values over 80% more than anyone else. It will be a price issue for those folks who are 80% and below but it won’t be an availability issue because the availability is there today and just to put that in perspective in the third quarter, we had eight houses settle that had agency jumbo loans over 80% LTV. So we think we can overcome the price objection one way or another and I think the availability will be there.

And again, of those eight folks that closed, four of them were conventional, one was an FHA. That probably wouldn’t get financing and of the four conventional, three of them could have gone to 80% LTV. They had the assets to put more money down. They just chose to get the higher leverage for whatever their own personal investment in cash allocation reasons were.

Robert Toll

Probably the intelligence these rates are. Okay, thanks.

Jade Rahmani – Keefe, Bruyette & Woods

Thanks for the color. And then a follow-up on city living if I may. I just wanted to ask if you could give the percentage of revenues that came from that business and also if you’re comfortable with the investment pay plan being able to hold that same ratio for say the next couple of years. Thanks.

Douglas Yearley

City living accounted for 15% of sales in the third quarter and 23% of revenue, and yes, we think we can easily sustain that.

Jade Rahmani – Keefe, Bruyette & Woods

Thanks a lot.

Douglas Yearley

You’re welcome, Jay.

Operator

Your next question comes from the line of Megan Mcgrass with MKM Partners.

Megan Mcgrass – MKM Partners

Good afternoon. Just a quick follow-up on your comments around the landmark and it’s being slower than you had hoped at this point in the cycle. Any thoughts given the recent volatility in the market and the pressure the banks are facing, if based on past experience if that’s going to perhaps help you or hurt you in the sense the banks are going to be more willing to do deals or are they too distracted now to concentrate on that part of their business?

Robert Toll

Well far from being distracted, if you’re going to take one of your better lines like credit cards in Canada and off it, then maybe you’re going to start to direct some attention to shedding some of the real estate troubled loans that you have. But so far, we don’t see any indication of pick up in volume from the banks for this forged troubled real estate loans, which seems to us to be an anomaly because when we compare it to all of the past recessions that we’ve been through, we had much better deal flow.

So I can’t give you an answer as to why we would expect to see more in the near-term because nothing has changed basically from this quarter, to this quarter from the last and the quarters before.

Megan Mcgrass – MKM Partners

Okay. And then you talked a lot about the New York metro market and city living and how happy you are with that business. Does it get you interested any other urban markets given your success in New York, anything that you’re thinking about entering or expanding into?

Robert Toll

Well certainly.

Douglas Yearley

Yeah, we’re studying Washington D.C. and Boston at the moment.

Megan Mcgrass – MKM Partners

Okay, great. Thanks so much.

Douglas Yearley

And one small more expansion in Philadelphia.

Unidentified Company Representative

Yes. That’s right. Thank you.

Operator

Your next question comes from the line of Michael Rehaut with JP Morgan.

Jason Marcus – JPMorgan

Hi, this is actually Jason Marcus in for Mike. Just a couple housekeeping items. The first was what was the value of your deferred tax asset at the end of the quarter?

Martin Connor

$403.8 million.

Jason Marcus – JPMorgan

And then the next is just regarding the mortgage mix during quarter can you give the break out of conforming jumbo and cash?

Martin Connor

Sure. Conforming and FHAVA was 66%, jumbo was 11%, true cash was 23. That represents the mix for Toll Brothers through TBI mortgage in which we had a 73% capture rate, so I think that’s a representative sample of the unit.

Jason Marcus – JPMorgan

Well, that gives the….

Robert Toll

That is no profits.

Jason Marcus – JPMorgan

Not the TBI.

Unidentified Company Representative

No.

Jason Marcus – JPMorgan

Thanks, sorry.

Unidentified Company Representative

No problem.

Jason Marcus – JPMorgan

Okay, great. That’s all I have.

Douglas Yearley

We’re clear of 99%, 1,180 of the loans were prime. There were 13 Alt A loans, high quality Alt A which is reflective of the liquidity starting to open up for the self-employed people that wasn’t there before. So that’s a good thing.

Jason Marcus – JPMorgan

Okay, great. Thanks.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of Ken Zener with KeyBanc.

Ken Zener – KeyBanc

Good afternoon.

Douglas Yearley

Hi, Ken.

Ken Zener – KeyBanc

Could you comment, obviously I think you’re talking about pricing being somewhat elastic. Your gross margins are obviously showing sequential improvement for a variety of reasons. Could you comment on your thoughts of what would have to happen for your current impairment levels to increase if we kind of saw flat demand in 2012 related to both your mothballed units and your active inventory, please?

Robert Toll

If you see flat demand, you shouldn’t see impairments. If you see negative demand, demand flattening then you have perhaps some communities that will have to be impaired.

Douglas Yearley

We may give you a CPA soon, Bob.

Robert Toll

Thank you. Not sure I’d accept it.

Ken Zener – KeyBanc

Okay and I guess you’ve commented a couple times on Gibraltar in terms of the deal flow not being perhaps what you’d expected as well as the fact having cash is clearly an advantage. Perhaps at a level down, can you kind of talk about your bidding process? I know in the past when you started your activity in Gibraltar, you might have been on a bit of a learning curve which might have given you a bit more conservative posture or forecast than others. Have the deals that while there is fewer deals, have the deals you’ve been losing, can you kind of talk about the dynamics and did you increase your kind of risk profile or does it appear that the competitors are getting more aggressive?

Robert Toll

No. We haven’t changed our profile. We didn’t pay a dump tax on this one. We have great guys that came over from the homebuilding business that really know how to organize, manage, and evaluate the properties that are in these pools and the notes that are in these pools and our comment is we pity the fools that are paying all that money when we lose.

Ken Zener – KeyBanc

Thank you.

Robert Toll

You’re welcome.

Operator

Your next question comes from the line of Nishu Sood with Deutsche Bank.

Rob Henson – Deutsche Bank

Hi, this is Rob Henson on for Nishu. Earlier this year seems like some of the other public builders were starting to get into the move up market and potentially more development type opportunities. So throughout the year, have you seen kind of an increased competition from some of the other publics in the land market?

Douglas Yearley

Not really. We haven’t seen any change.

Rob Henson – Deutsche Bank

And then you guys decreased your community count guidance by a very small amount, so I just wanted to see if you could talk about what’s impacting that. Is it faster close outs or expecting slower growth or something else?

Douglas Yearley

No, it’s primarily due to land entitlements taking longer than we had hoped.

Rob Henson – Deutsche Bank

All right. Thank you very much.

Douglas Yearley

You’re welcome.

Operator

Your next question comes from the line of Adam Rigger with Wells Fargo Securities.

Adam Rigger – Wells Fargo Securities

Hi. Thanks for taking my call. My first question, Doug was you mentioned earlier on there was inelasticity towards pricing and you kind of addressed and I was going to ask you then what the elasticity was for your July promotion. You kind of commented on that, but could you elaborate on that a little bit more and if there is some elasticity towards your partnerships with your suppliers and stuff, does it only work because of the temporary thing or is there a way you could permanently try to do that and I think we know that those companies aren’t making money hand over fist these days either so it could be a win all situation. So why can’t you do that on a more sustainable basis now if there is elasticity towards that?

Douglas Yearley

Well it’s absolutely urgency. We will not be selling homes like Joseph Banks sells suits with a deal every week, that’s repackaged. What happens is the client understands that it’s good for a couple of weeks, they also understand that it’s not the local project manager making it up, but it’s Kohler and Anderson Windows and our flooring company and whirlpool appliances and everybody else and it’s out of our control, that goes away and that helps us greatly in terms of creating that urgency and we’ve been successful now for a couple of years in doing that.

Adam Rigger – Wells Fargo Securities

I wanted to just the gross margin question has been asked a few times but can you quantify the change in incentives year-over-year and then can you quantify what the impact of the insurance reversal was in the SG&A this quarter too?

Martin Connor

The change in incentives year-over-year was very nominal, 3 to $5,000. The change in the insurance recoveries really goes through SG&A. The SG&A move year-over-year was about a third due to the volume, a third due to the recoveries and then the third due to the ongoing benefits of the cost reduction initiatives.

Adam Rigger – Wells Fargo Securities

Is that like about 1 million bucks then would be the insurance?

Martin Connor

It could go slightly higher than that.

Adam Rigger – Wells Fargo Securities

Okay. Thanks.

Douglas Yearley

1 to $2 million.

Adam Rigger – Wells Fargo Securities

Okay. Thanks.

Douglas Yearley

And the incentive we’re offering today is $35,000 per house which is 6% that’s on average of course and the incentives in the third quarter contracts is at $39,000 on average which is 6.75%.

Operator

Your next question comes from the line of Dan Oppenheim with Credit Suisse.

Daniel Oppenheim – Credit Suisse

Thanks. Wondering about the comments earlier in terms of the trends and traffic and deposit, I guess traffic up, deposits down which indicated it’s getting tougher to get people to convert and to make that deposit to commit to it. I guess last comment there seems to indicate that you’re reducing the incentives you’re currently offering and in some ways don’t you offer a dog a bone and try to get them to sign a contract and put a deposit down there?

Douglas Yearley

Just can’t get off it, can you, Dan? Well the agreements are generally late July deposits, okay. There is a lag there between deposit and agreement so the deposits of course are more indicative of where we’re headed in terms of agreements for the next few weeks. And we just don’t think added incentives are going to get those people to buy. We have tried it and tried it and tried it and that’s now what the market is about right now. Our pricing is great. They know it, it’s just they’re scared, they have their own issues and they need to get some confidence back to step up and buy, so we’re not going to throw more money at it. We think that’s wasting money. It’s not the smart way to run the business and we’ll leave it with that.

Daniel Oppenheim – Credit Suisse

Okay. And then just follow-up, you’re talking about being hungry in terms of landing specifically in New York, but how is that overall when you think about this; do you – when you look at your land inventory, how much would sales activity influence the appetite there?

Douglas Yearley

In New York City?

Daniel Oppenheim – Credit Suisse

No, overall.

Douglas Yearley

I’m sorry; I’m not following the question.

Daniel Oppenheim – Credit Suisse

Just how much your land buying, the hunger for the land would be influenced in terms of just looking at the sales activity over there.

Douglas Yearley

Well, this is –

Robert Toll

100%.

Douglas Yearley

Right. We under write land in today’s market. That’s always been the way the company has been run. And so if we’re in a better market, then the comps support a higher selling price of a home, which supports the higher land price. If we’re in a worst market, it’s going to go the other way, so we are constantly adjusting our land buying to the market.

Robert Toll

In fact, we ask for columns of current price and current pace on our project profitability and analysis sheets and because it frustrates the land buyers that have to deal with the reality of current price and current pace, we invite them also to put in another column that shows an inflation of 2% in price and 2% in pace, and now we don’t go by those columns, but we have them there so the guys feel as though there’s a greater possibility on being reviewed that their project will be chosen but the reality around here is heaven is now.

We don’t buy on the basis of things are going to get better and we don’t stay away on the basis of things are going to get worse. We analyze on the basis of what is.

Daniel Oppenheim – Credit Suisse

Okay, thanks.

Robert Toll

You’re welcome.

Operator

Your next question comes from the line of Michael Smith with JMP Securities.

Michael Smith – JMP Securities

Good morning, guys. So most of my questions by now have been asked and answered, but just real quick. You did mention earlier that stuff coming to market, land wise slower and I know you mentioned this before more slowly than in previous cycles and more slowly than you would have expected at this point. Does that give you any thoughts of seriously entertaining some M&A ideas? Is there anything out there and would you guys be willing to deploy your capital if land remains sparse into buying operators or is that something that you this early in the recovery cycle want to stay away from?

Douglas Yearley

Well, we would always consider it, but right now we are focused on distressed land, so if there’s a distressed builder that has great land and we can pick the land up at a distressed price then there is a play. But unless we’re talking about expansion into a new market which historically is the reason done M&A, we would not be out there looking to buy a builder because again it’s a deal at a time from the banks at distressed prices, seasonally rather be selective in terms of what we’re buying than pick up a portfolio ground from a builder some of which we like, some of which we don’t so I think that’s why you aren’t seeing real M&A in today’s market because those builders with capital are focused on the individual assets that they can buy inexpensively.

Michael Smith – JMP Securities

I think that’s a good answer. Any thoughts on geographic expansion since you brought it up?

Douglas Yearley

I’m sorry? My apologies.

Michael Smith – JMP Securities

Did you not hear me?

Douglas Yearley

You spoke fine We were talking amongst ourselves. I apologize. I’m sorry; your question was geographic expansion? We continue to consider the Pacific Northwest. We continue to explore a couple of international opportunities. Right now there is nothing to report.

Operator

Your next question comes from the line of Alex Barron with Housing Research Center.

Alex Barron – Housing Research Center

Thank you. My first question was I imagine it’s probably hard to think the market could slowdown anymore than it already has but in case it does, I’m wondering what you guys are prepared to do in terms of SG&A or buying down debt?

Douglas Yearley

Well we’ll continue to be opportunistic in our buying down of debt and evaluating stock repurchases. In terms of SG&A, I think Bob has said it in the past. We’re in this for the long term not to make a couple nickels next year and that is our current mentality and probably would be our mentality in any kind of modest reduction in demand.

Alex Barron – Housing Research Center

Got it. And my other question was can you help me understand a little bit more the Gibraltar income that you reported? Is that based on the sale of a property or is that more that you’re earning interest on loans that we’re not performing that are now performing or what’s the nature of those earnings and are they cash earnings or they just kind of accounting earnings?

Douglas Yearley

We don’t believe in the cash throughout year. Well I think there is some interest income and accretable yield income that Gibraltar recognizes and that was maybe about a quarter of the earnings this quarter and then as we settle loans in excess of what our expected settlement amount was when we purchased them, we recognize almost capital gain types income and that was about three quarters of the revenue and net profits we recognized from Gibraltar.

Now, the first portfolio we executed was with the FDIC and so in that situation, there is a defeasance of the 50% financing we got from the FDIC that has to happen before there is a return of our investment or cash earnings if you will, but this is all cash. We’ve defeased about half of that debt in the structure. On our second transaction, we don’t have to wait to defease any debt that’s unlevered. We are excited about Gibraltar, and if we could put an advertisement out there at the moment for any distressed debt and the ability to work with banks and investors as they have A, D, & C situations, we’re going to take advantage of it right here.

So if you know anybody who’s got some troubled loans, we have the capital and the skills to work them out.

Robert Toll

Bring this you’re tired and you’re poor.

Operator (Operator Instructions). Your next question comes from the line of Jay McCanless with Guggenheim.

Jay McCanless – Guggenheim

Hey, good afternoon, everyone. First question just wanted to get an idea if I could on what you’re thinking on fiscal 12 community growth given the comments you made about being more difficult to find deals that meet your hurdles.

Douglas Yearley

I think we’re going to punt on that until our next call.

Jay McCanless – Guggenheim

Okay. My second question is for Don and talking about more people coming into the jumbo space, sounds like more people are wanting to lend. Can you give us a sense of what down payment trends are doing right now and also if you’re expecting the rates to the spread between conforming and jumbo to narrow any further than us? I think you said it widened out recently. Do you expect that to come back in?

Don Salmon

First question about LTVs. Typically, we’re still at 80% LTVs, although we have a conversation right now, we hope to announce in the near future, 85% LTVs, up to a 1 million and perhaps to a 1.5 million and that’s without private mortgage insurance, so that will be a terrific loan if we could. We do have a source for 90% combined loan to value being an 80% first and a 10% second on a jumbo up to over a $1 million so that’s terrific and we’re having more and more conversations with people every day, so it is starting to loosen up.

PMI companies, some of the liquidity issues notwithstanding some of the companies that we all publicized recently, PMI companies are loosening guidelines as well. Most of them are reducing or eliminating their challenged markets and opening up more and more opportunities for us there. In terms of spreads, there is one thing I know about spreads I know they are going to go up, they’re going to go down, or going to stay the same. I just can’t tell you which one it’s going to be and I can’t tell you when or by how much but if you think about it, if the banks really are putting them in portfolio, they are going to have a return hurdle if they want and right now it appears to be probably a floor in that 4.5-4.3% range on the fixed rate and interestingly on the 5.1 arms on a jumbo right now, zero points, good buyers, good markets worth 3%, which is just about free.

So to the extent that conforming fixed rates continue to drop, my expectation would be that the spread between conforming and jumbo would widen. If conforming rates start to go up a little bit my expectation would be that spread starts to narrow a little bit, so but don’t take that to the bank because I really am clueless as to what’s going to happen in the future.

Robert Toll

Otherwise call your broker.

Don Salmon

Otherwise we would be talking ship to shore.

Douglas Yearley

Jay, I think our average down payment still is at the 29% or 30% as its been for the past so many quarters and our borrowers is still in the mid 750s in terms of FICO score.

Don Salmon

Yes, sir average LTV including FHA which is at 96%, average LTV across the board is 72 and average FICO score is 754 so there is still very strong buyers.

Jay McCanless – Guggenheim

Okay, great. Thanks everyone.

Douglas Yearley

You’re welcome. Tamika, one second. I have an e-mail question and since Don has the floor, it will be for him. This is from Steve Sullivan at Horizon Financial. What if anything can home builders do to mitigate the negative effect appraisals are having on the housing market?

Don Salmon

We do not have a material appraisal issue. I would say that there is some spotty appraisal issues but nothing that comes across our desk as a –

Robert Toll

We used to –

Douglas Yearley

At one-time we did, yes.

Unidentified Company Representative

But the problem seems to have abated substantially.

Don Salmon

Yeah, and I think part of it is we’ve gotten a little smarter and a little better and we just don’t see appraisals being a major impairment to closing houses.

Steve Sullivan – Horizon Financial Okay. Second part which you’ve answered in part. Also, are you seeing signs of lenders loosening up credit standards for mortgage apps?

Don Salmon

Yeah. Absolutely. On jumbo and conforming. In fact today, and the reason I keep say we just had a managers meeting we evaluated a lender who will go down to 560 credit scores and we’re looking at that. We will not deploy TBI capital for that. If we do we’ll refer it out and let them close the loan because it’s not what we want to deploy our capital, but the question of availability, there is absolutely companies out there that will do those loans that that opportunity was not there a few months ago and we’re seeing multiple companies now with those kind of criteria.

Douglas Yearley

Okay. Tamika, back to you.

Operator

And there are no further questions at this time. I’ll turn the conference back over to Mr. Doug Yearly for any closing remarks.

Douglas Yearley

Thank you, Tamika. Thank you, everybody and have a great day. Have a great Labor Day, and let’s keep our fingers crossed. Thanks.

Operator

Thank you all for participating in today’s Conference Call. You may now disconnect.

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Toll Brothers (TOL): FQ3 EPS of $0.25 beats by $0.22. Revenue of -$394M (-13% Y/Y) misses by $10M. Says "consumer confidence is still weak and the housing sector remains in a fragile state." (PR)