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Toll Brothers, Inc. (NYSE:TOL)

F3Q07 Earnings Call

August 22, 2007 2:00 pm ET

Executives

Robert Toll - Chairman, CEO

Don Salmon - President TBI Mortgage Company

Joel Rassman - CFO

Analysts

Michael Rehaut - JP Morgan

Kenneth Zener - Merrill Lynch

Robert Stevenson - Morgan Stanley

Susan Berliner - Bear Stearns

Myron Kaplan - - Private Investor

Alex Barron - Agency Trading Group

Timothy Jones - Wasserman Associates

Todd Voigt - Cliffwood Partners

Dan Oppenheim - Banc of America Securities

Nishu Sood - Deutsche Bank

Scott McCullough - Nationwide

Joel Locker - FBN Securities

Carl Reichardt - Wachovia

Rick Murray - Host Capital

Steve Burroughs - Conning Asset Management

Douglas Kass - Seabreeze Partners

Presentation

Operator

I would like to welcome everyone to the Toll Brothers 2007 third quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Robert Toll, Chairman and Chief Executive Officer. Please go ahead, sir.

Robert Toll

Thank you, Vonda. Hello, everybody, welcome. Thank you for joining us. With me today are Joel Rassman, Chief Financial Officer; Fred Cooper, Senior Vice President of Finance and Investor Relations; Joe Sicree, Chief Accounting Officer; Kira McCarron, Chief Marketing Officer -- and this certainly is marketing -- Greg Ziegler, EVP of Finance; and Don Salmon, President of our mortgage company.

Before I begin, I ask you to read the statement of 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, financial, mortgage markets, weather and other factors beyond our control that could significantly affect future results. Those listening on the web can email questions to rtoll@tollbrothersinc.com. We will try to answer as many as possible.

Today we reported third quarter and nine-month results for the period ended July 31 '07. Fiscal year '07 third quarter net income was $26.5 million or $0.16 a share diluted, compared to fiscal year '06 third quarter of $174.6 million or $1.07 per share diluted. In fiscal year '07 third quarter net income was reduced by after-tax writedowns of $88.5 million or $0.54 per share fully diluted. In fiscal year '06 third quarter after-tax writedowns totaled $14.6 million or $0.09 per share diluted. Excluding writedowns, fiscal year '07's third quarter earnings were $0.70 per share diluted, down 40% from the $1.16 per share diluted in fiscal year '06's third quarter. Fiscal year '07's third quarter total revenues were $1.21 billion compared to fiscal year '06's third quarter total revenues of $1.53 billion. Third quarter end backlog was $3.67 billion compared to fiscal year '06's third quarter end backlog of $5.59 billion.

Fiscal year '07's third quarter net signed contracts were $727 million compared to fiscal year '06's third quarter total of $1.05 billion. We signed 1,457 contracts before cancellations in fiscal year '07's third quarter, a 17% decline from the 1,760 signed in fiscal year '06's third quarter. Net of cancellations, third quarter contracts totaled 1,110 units, down 23% from 1,443 units in the third quarter of fiscal year '06. Third quarter fiscal year '07 cancellations totaled 347 units versus 384 units and 436 units in the second and first quarters of fiscal year '07, respectively; and 585 units in fourth quarter fiscal year '06. Fiscal year '07's third quarter cancellations were 23.8% as a percentage of current quarter contracts, and 6% as a percentage of beginning quarter backlog, compared to 18.9% and 6.5% respectively in the previous quarter; and the highs of 36.7% and 17.3% respectively in the fourth quarter of fiscal year '06.

We continue to focus on managing conservatively during this downturn. We ended the third quarter with over $770 million in cash and more than $1.17 billion available under our bank credit facility, which matures in 2011. Our net debt-to-capital ratio at July 31 stood at 28.6% compared to 36.8% one year ago. We continue to renegotiate, and in some cases reduce, our option lands positions. We ended this third quarter with approximately 63,000 lots owned and optioned compared to approximately 91,200 at its peak in the second quarter end of fiscal year '06. We ended the third quarter with 315 selling communities, down from 325 at second quarter end, and expect to be selling from approximately 305 communities by fiscal year-end '07.

We continue to wrestle with the interrelated challenges of softer demand and excess housing supply in most markets. So far, nearly two years into the current housing slowdown, we have continued to remain profitable and increased stockholders equity. We believe our build-to-order operating model has helped. In single-family communities we typically don't start a home until we have a contract in place and a significant nonrefundable downpayment. In our multi-family and high-rise communities, although we do presell, it generally is not feasible nor desirable to wait for 100% pre-sales before breaking ground. Even with these policies, during this downturn we have experienced a much higher rate of cancellations than at anytime in our 21 year history as a public company.

While our cancellation rates are at the very low end of the range compared to the other major public homebuilders, they are still, for us, quite elevated. As a luxury homebuilder we try to focus on great locations with excellent schools in established, affluent markets, where approvals are often very difficult to obtain. We believe that in the medium and long term our locations have value that we don't wish to sacrifice to generate short-term sales volumes and cash flow. With no major debt maturities before 2011, and the third quarter end leverage ratio quite low by historical standards, we believe we have flexibility to operate patiently in the current downturn.

We, along with many others, are concerned about the dislocation in the secondary mortgage market. We maintain relationships with a widely diversified variety of mortgage providers, most of which are among the largest, and we believe most reliable, in our industry. This morning the Wall Street Journal said industry watchers want to know how much the slump in home sales has been aggravated by lenders backing out of loan commitments or saying no to would-be buyers. I would like to turn it over to Don Salmon, President of TBI Mortgage Co., to discuss this and other issues further.

Don Salmon

Thanks, Bob. With few exceptions the investors who provide our customers with mortgages continue to issue new commitments. Through our third quarter end our buyers generally were able to obtain both conforming and jumbo loans. No lenders working with buyers who used TBI Mortgage have backed out of any commitments with our buyers. For those buyers who have used other mortgage companies, we know of no lenders, other than those who went bankrupt, who backed out of their commitments. We have already been able to find loans for most of the buyers whose lenders went bankrupt. Tightening credit standards will likely shrink the pool of potential home buyers. Mortgage market liquidity issues and higher borrowing rates may impede some customers from closing. Others may find it more difficult to sell their existing homes.

However, we believe that our buyers generally should be able to continue to secure mortgages due to their typically lower loan-to-value ratios and attractive credit profiles. The average FICO score year-to-date on our conforming loans exceed 745, and is 735 on jumbos. Not only is our customer credit profiles strong, but their mortgages are performing quite well. In a survey of our two top providers who are currently servicing approximately 6,150 of our buyers' loans, they reported combined delinquency rate on that current portfolio of just two-thirds of 1%. Delinquency is defined as loans 30 days or more delinquent. Most of our delinquencies are in the 30 day category. Only one loan is reported in foreclosure.

We have continued to work with our traditional relationships with major mortgage providers such as Chase, Bank of America, IndyMac, Countrywide, Wells Fargo and others. Although underwriting standards have tightened, none of these providers have defaulted on any of their obligations, and continue to issue new commitments to our buyers. In addition, we are pleased to announce that today we received a commitment for $0.5 billion from Citizens Bank, a large national mortgage lender, which is 100% owned by RBS, the Royal Bank of Scotland. Under this commitment we will be able to deliver jumbo loans as well.

We are continually reviewing our pipeline of sales to determine where there might be a problem because of mortgage issues, particularly with the changing underwriting standards. We believe that our efforts have been successful in minimizing the impact of these issues.

Robert Toll

Thanks, Don. Now let's hear from Joel Rassman, our CFO, to do the numbers.

Joel Rassman

Thank you, Bob. For the third quarter home-building revenues were approximately $1.2 billion, as we delivered 1,792 homes at an average price of $658,000 and we recognized $29 million of revenues from percentage of completion buildings. I would like to remind you that given the current accounting rules it is unlikely that any new buildings will use the percentage of completion method going forward.

Gross home-building margins, exclusive of interest expense and write-offs, at 25.67% were approximately 157 basis points better than the top of our guidance. The difference was a result of using less incentives than budgeted, particularly for spec homes, and a richer mix of settlements. Write-offs in this quarter were $147.3 million compared to last year's third quarter of $23.9 million. The write-offs reflect $7.7 million attributable to land options, and $139.6 million attributable to existing communities, the vast majority of which were in Florida with about $60 million, Nevada at $29 million, and California at $29 million.

Net income from the percentage of completion buildings was lower than our estimates as result of slower construction, which resulted in less closings and higher costs. Other income and joint venture income combined of $43 million, was $31 million higher than our previous guidance, the majority of which was attributable to the sale of a security business which produced $15 million of profits, higher interest income, and higher income from cancellations. We have consistently included cancellation income in other income rather than as additional home-building revenues or a reduction of cost of sales.

SG&A at 10.9% of revenues was approximately 116 basis points better than the midpoint of our previous guidance, as we had lower level of spending, principally related to lower payroll costs, while we were at the higher end of our revenue projections. Our effective tax rate for the quarter at 41.2% was higher than our guidance of 39%. When income levels are very low, small changes in state tax allocations significantly change the effective rate.

Given the numerous uncertainties surrounding sales pace, the mortgage markets, market direction, and the potential for and the size of future impairment under current market conditions, we are not comfortable providing fourth quarter guidance at this time, or confirming any previous guidance.

Robert Toll

We believe that reducing new home production until the current oversupply is absorbed is a key step in bringing housing markets back into equilibrium. Last week's very low housing starts data implied that this is beginning to occur. Once equilibrium is achieved, we believe home prices will firm, and customers who are waiting on the sidelines will have the confidence to enter the market.

Finally, I would like to thank our dedicated and loyal associates, as together we weather these difficult times and remain focused on providing our buyers with the highest standards of quality, value and service. I would like to thank our shareholders also for their patience and support.

Question-and-Answer Session

Operator

Your next question comes from Michael Rehaut - JP Morgan.

Michael Rehaut - JP Morgan

First question on the comments regarding the relationships with the mortgage lenders. I assume those comments all also include the more recent weeks in August where there was the majority of the turbulence?

Robert Toll

I am sorry for interrupting, but that is correct. The stats do not end July 31. We have taken you to the present.

Michael Rehaut - JP Morgan

Have you seen though, aside from perhaps your own customers still being able to essentially get mortgages, have you seen any increase in cancellations in the last few weeks due to their own homes not being able to be sold given the tighter conditions?

Robert Toll

Don, I don't think so. But do you have a more recent? I've got up to last week.

Don Salmon

I haven't seen an increase in cancellations for that. I will tell you we are working with some homebuyers to try to place some loans, but I don't believe at this point it is a significant number.

Michael Rehaut - JP Morgan

Second question more relates to overall conditions. If you were to talk about what you're seeing in terms of land sellers, has there been any material change in the last month or two in terms of as yourself and perhaps a couple of other builders are gaining a lot of cash on the balance sheet, and generating positive cash flow, and perhaps serving land sellers to the extent that when things stabilize you would like to take advantage of deals? Have you seen any material change in land sellers' approach to their own pricing and getting more in line with the market?

Robert Toll

Not really, not yet. We have seen a couple of deals, but not any number that would compare to what happened in '90, '91, '92 but we are only two years into this. Generally I think sellers are more patient, especially if they paid for the land and it is a true investment they will sit. I want to watch what I wish for, so I don't want to say that we're looking forward to another two years of this. But should it lengthen for two more years, it would be at a time like that that I would expect a bunch of deals to be disgorged.

The other way that we will see opportunity is if the credit lines and backing in general of small to medium builders or even large builders fail. Then you'll see property on the market. That will of course impact also those who are just holding on speculation. As of now, there may be no buyers, but there aren't many sellers either.

Michael Rehaut - JP Morgan

Last question. In that event over the next year, let's say, there are some assets that come up, do you have a specific market focus? In previous downturns you were able to get into D.C., for example, way back when. Are there any markets that you are particularly interested in to expand your presence, or is it just going to be more opportunistic, with just staying in the markets that you are and just opportunistically adding to one market presence versus another?

Robert Toll

It will be the latter. So far we haven't identified any market that we want to jump into if and when it becomes available. There are several markets that we're not in, but I don't think they are suffering as much as the rest of the country, such as Seattle. We're not there. We don't see any great opportunity for us to enter either.

Operator

Your next question comes from Kenneth Zener - Merrill Lynch.

Kenneth Zener - Merrill Lynch

How much of the impairments came from communities that you already selling, so they are active as opposed to the communities that you are delaying, the 35 that you mentioned a few weeks ago?

Robert Toll

Joel, do you know that?

Joel Rassman

The vast majority, there is only one large write-off I believe that was pretty large with a community that we have delayed.

Kenneth Zener - Merrill Lynch

You're saying for the delayed communities, which I think two weeks ago you said was 35, you actually didn't have impairments?

Joel Rassman

We had at least one that I can remember.

Kenneth Zener - Merrill Lynch

Because I thought you had a few weeks ago talked about impairments already on those communities in general, but that is not the case?

Joel Rassman

If we needed it in previous quarters, we may have taken it in previous quarters. But there was one new one in this quarter.

Kenneth Zener - Merrill Lynch

Have you guys had any impairments on any of your joint ventures, such as your large one in Surprise outside of Phoenix?

Joel Rassman

None.

Kenneth Zener - Merrill Lynch

I was just under the impression, Bob, you had given us the example two weeks ago where you thought you had land let's say in Florida, that was valuable. You already have took down your home price, took impairments, but you didn't think it was worth impairing any more because of its inherent value. It sounds like these delayed communities are actually in pretty good shape from your purchase prices.

Robert Toll

That was the whole point. Once you have taken the lots down and this is not an exact example of a specific, but it is a generalized example, so you understand how our thinking works. Once you have taken a lot down to $25,000 a unit, that is a price that you could build apartments at and make a living. So it doesn't pay to keep on impairing or to keep on offering discounts or incentives. You're better off to mothball.

Kenneth Zener - Merrill Lynch

Right. I just thought there had been greater impairments on those ones that were being delayed. It is interesting, I think that is really important, Bob, essentially that logic holds that there's an economic value there. And it is not just for your premium location or prices, but I mean that would be an industrywide comment in my opinion.

Robert Toll

It depends. It depends where you are, what your location is. It is not an industrywide comment, but it might be. It primarily is your location. Thank you. Vonda?

Operator

Your next question comes from Robert Stevenson - Morgan Stanley.

Robert Stevenson - Morgan Stanley

Bob, are you guys doing anything different on the mortgage side in the past couple of weeks?

Robert Toll

Have we done anything different? Yes. In order to test a thesis that jumbo loans, 80% LTV or better with good credit score don't deserve to not be underwritten along with the junk stuff. We set out looking for guys that would put it in writing and say to us, send us your stuff and we will provide shelter. We have only been on that a couple of days and we got a letter of commitment from Citizens. So that is different.

Also, whereas we would talk to our major -- I will call them suppliers of funds for the mortgages -- once a week or once every other week, now we talk to them every day. How are you doing? How do you feel? How are things? How does it look? Because we want to make sure that we're putting stuff into people that can cover it and handle it. Naturally we were as shaken as the market was until the discount window opened wide with invitations for banks to seek shelter from the storm. Naturally, we were as concerned as anybody else, and we want to make sure that we have a source for our mortgages.

Robert Stevenson - Morgan Stanley

Does this new line require you guys to sort of limit LTV in any way?

Robert Toll

No.

Robert Stevenson - Morgan Stanley

The rates that you will be able to offer here, is it going to be at a sort of normal spread for jumbos relative to conforming?

Robert Toll

Yes.

Robert Stevenson - Morgan Stanley

Does it allow you to do any Alt-A?

Robert Toll

I don't know. Don?

Don Salmon

The commitment that we're taking down with Citizens Bank is under their now current underwriting guidelines. So the extent that they are writing good Alt-A paper, we will be able to write it.

Robert Stevenson - Morgan Stanley

You guys had a pretty high percentage of Alt-A in the third quarter when you guys were talking on your preliminary results. It was like 43%, 44% of the buyers.

Robert Toll

Yes.

Robert Stevenson - Morgan Stanley

So that will be able to continue in some fashion. It may not be in the mid-40s, but it is not going to go to zero on you.

Robert Toll

That is probably right.

Robert Stevenson - Morgan Stanley

Last question, do you guys track the amount of the resale product in your current selling communities? What has been the trend there in the past 60, 90 days?

Robert Toll

No, we don't have that information.

Robert Stevenson - Morgan Stanley

Thank you guys.

Robert Toll

You're welcome. Vonda, I have a question from Briggs Philips. What is the percentage of unimproved home sites owned relative to owned total home sites for sale? What is the percentage of unimproved home sites to the ones that are improved? Joel.

Joel Rassman

We have about 17,000 improved or substantially improved home sites, including those under backlog. What is our total loans? About 40% are improved or substantially improved, of which 40% is probably under houses under construction, of that number.

Robert Toll

The second part of the question. Additionally, why is your backlog value per home site so much higher than your current average selling price per unit? Joel.

Joel Rassman

When a more expensive home is sold, generally it takes longer to build, therefore it stays in backlog longer, which affects the mathematics. In addition, we currently have two very expensive communities in high-rises, Ocean's Edge and 110 Third Avenue, which have just started to get closed. So they have no previous closings in them, but they all sit in backlog, those units.

Robert Toll

Thank you, Joel and thank you, Mr. Briggs.

Operator

Your next question comes from Myron Kaplan.

Myron Kaplan - Investor

My question was on those Alt-A mortgages. The 43%, or whatever that the recent report listed, does that mean that those were mortgages that were obtained they are low-doc or no-doc?

Robert Toll

One form or another. They were, as you have just suggested, no-doc, stated asset, no income; stated income, no asset. There is a wide variety of those. No ratios.

Myron Kaplan - Investor

Do you think the new program is going to be able to continue the practice?

Robert Toll

No, I think the practice of Alt-A will be shrunk considerably as the mortgage market looks for more verifiable income and assets. Don?

Don Salmon

Yes, I agree with Bob that the market for those loans will shrink, but I don't think it is going to be eliminated. I think frankly there were some loans done in the marketplace in the past, and I'm proud to say not by TBI Mortgage, that probably should not have been made. I think those loan programs are going away. I think that the good quality Alt-A business will eventually find a home. I think that will be a stable market over the long term.

Operator

Your next question comes from Alex Barron - Agency Trading Group.

Alex Barron - Agency Trading Group

Do you have a breakdown by geography of your impairments this quarter?

Joel Rassman

I think we just gave it. About $60 million were in Florida, $29 million in Nevada, and $29 million in California.

Alex Barron - Agency Trading Group

My second question is a little bit more theoretical. You guys you have talked about mothballing the land. I'm just trying to understand some of the economics of doing so, and some of your thought process. Like if the market doesn't start to recoup for another call it three, five years, and you're capitalizing all this interest and if home prices never come back, how does that make sense versus just going ahead and building it?

Robert Toll

What happened to the sky falling in? If the home market never comes back and we have mothballed a piece, I would say we're in deep trouble there, using your example. In my example, if you have mothballed at 35, and you ascribe 7% in interest, so next year you are at 38. And the next year you're at 40 to 41 or 42. And then the next year you're at 43, 44. And then the market comes back, you should be in pretty good shape, if it is a well located piece.

It depends upon whether you believe your land is fungible, or whether you believe your land is unique. If you think you are in a unique location, something special to it, then there's no reason in my opinion, and this is just my opinion, to liquefy in order to increase cash on balance sheet as opposed to keeping that good asset. If you believe your land is fungible, and you can buy other land the same as the land that you are thinking about selling, you should get rid of that land as soon as possible, go to cash. Then when and if you want to pick up other land, you do.

Joel Rassman

Can I correct something?

Robert Toll

Correct? Sure.

Joel Rassman

One is we haven't mothballed 35 communities. In certain cases we have delayed closings with the seller, so that we have never taken title and that is most of them. Then second of all, we do not capitalize interest in any communities not currently in production. So if we happen to buy a community and decide to delay it for six months, there is no interest capitalized for accounting purposes to that community. So from an accounting standpoint you don't get the anomaly that you're suggesting may be happening.

Alex Barron - Agency Trading Group

So basically the interest would get expensed then in that example?

Joel Rassman

It gets allocated to communities currently in production.

Alex Barron - Agency Trading Group

Now I guess I'm just trying to understand what are the general assumptions you guys are making about how low home prices will come back to, like '03 levels, '04. I'm just trying to figure out what you're assuming as far as when the market will, I guess, start to improve in terms of volume?

Robert Toll

In some cases we have said that prices stay as they are I think we said through '09, and then in '09 for analysis purposes using assumption of prices going up by I can't remember if it was 3% or 5%, and pace going up by 3% or 5%. I think we did that for a couple of years. But that is on analysis of new deals. I haven't got the old deals in my head as to what we have slowed down or decided not to open.

Alex Barron - Agency Trading Group

You mentioned like Vegas was an F minus minus in the last call.

Robert Toll

It still is. You might add another minus to that.

Alex Barron - Agency Trading Group

What does that mean exactly, and what are you doing to turn it back up?

Robert Toll

What does it mean? What does an F minus minus mean? You must have been a hell of a student. You never saw one of those? It means you flunked. What are we doing about it? We are out there with the rest of the builders in Vegas praying. There's not much you can do. You can't advertise your way out of that situation. You just have to wait for the market to come back.

Alex Barron - Agency Trading Group

Does that mean there's just zero sales, or it means there is negative sales, or does it mean you're not cutting prices?

Robert Toll

I hadn't thought to address that, but I don't think we have negative sales. I don't think we have positive either. I think we're pretty much flat over the last four weeks. I haven't got that stat immediately in front of me. I can get it though.

Alex Barron - Agency Trading Group

I was just trying to understand like is it just a situation where the volume has dried up for a while, and you just need to cut prices another 10%, 15%, 20% to get it going again?

Robert Toll

This week we took no deposits. We did take one agreement. Last week we took five deposits. The week before that we took none. The week before that we took six. The preceding four weeks to that we took 12. These are deposits, I would guess that about two-thirds go to agreement and then some of the agreements don't stick. Yes, in the last eight weeks we have taken seven agreements. So that is what we consider real bad.

Operator

Your next question comes from Timothy Jones - Wasserman Associates.

Timothy Jones - Wasserman Associates

I find the statement good quality Alt-A to be an oxymoron.

Robert Toll

Let me interrupt you. Go ahead, Don, do you want to do it instead of me?

Don Salmon

There are a lot of really good quality Alt-A loans out there. A lot of consumers have legitimate reasons for going Alt-A. For example, if somebody is self-employed and they have a complicated income scenario, it may be a matter of convenience for them to state their income or use some other Alt-A vehicle, as opposed to providing many tax returns. Some of the entrepreneurs have multiple corporations or partnerships set up and it just gets very complicated and onerous.

Robert Toll

Excuse me. For instance, in New York City, we have in this 110 Third Avenue, which we will be delivering pretty much the whole building in the next three or four months will be delivered, we have a handful of Alt-A type mortgages that have already shown up as no longer being good enough. The buyers simply say, all right, how much more income do I have to show, and we will show that income, but I don't want to show all my income.

Don Salmon

Yes, that's absolutely true. You also have some buyers, for example people who are on commission. They have fluctuating incomes. Most of our buyers, if you think about it, are high-income individuals and are not straight W-2 buyers. They have bonuses and commissions and that sort of thing. Sometimes it is hard to document all that. So those are legitimate Alt-A deals. Most of our buyers have good down payments, high credit scores. They have a history of making their payments. We don't believe they are an imprudent risk for a lender to take.

Timothy Jones - Wasserman Associates

I think statistics show that about 50% of Alt-A buyers take a piggyback loan. So I don't agree with that. I like Bob's answer on that previous call better, but I won't repeat it. I know you had 42% basically. I would think it would go down something at least down to under 20% of your business. I have talked to other builders and they said this Alt-A market has dried up tremendously.

Robert Toll

Don, do you have any opinion for Tim as to what percentage of our business you think will be Alt-A going forward?

Don Salmon

It is hard for me to predict the future, but I think it is going to be roughly the same. If you think about it, last time I looked roughly 38% of our buyers were self-employed. Many of those people get Alt-A product because of the nature of their income and the nature of their employment. In our view that is a very legitimate Alt-A deal. Many banks will step up to the plate to do that because they understand the self-employed buyer. In fact, they seek that business because of the multiple lines of business the banks can do with those buyers. So it is a great investment for the bank.

Robert Toll

On the other hand, as standards become more difficult, if these buyers cannot secure mortgages by going the Alt-A method then they will go more normal routes and state it all plainly and cleanly and secure their mortgage that way. I don't think they will drop from the market because they have to show their income.

Timothy Jones - Wasserman Associates

Can you just give me what the average down payment for an Alt-A loan is as compared to the 50% which are jumbos?

Joel Rassman

Our average LTV on a stated, stated loan throughout the entire book of our business is 70.8%. Let's call that 71%. As opposed to our total book of business, which is 75% average combined loan-to-value. That by the way includes any first or piggyback loan. So the average on the stated, stated is 71%, including piggybacks.

Timothy Jones - Wasserman Associates

And the 75%, I am sorry, is what?

Joel Rassman

Is on the entire book of business, including full-doc and no-ratio and all that good stuff.

Timothy Jones - Wasserman Associates

Lastly, congratulations, I might add, on getting this commitment from the Royal Bank of Canada.

Robert Toll

It is Scotland, not Canada.

Timothy Jones - Wasserman Associates

Excuse me. It is World Bank of Scotland, my mistake. Very good anyways. But a lot of builders are not taking jumbo loans, or not writing them, even some very big mortgage companies, just on the worry that they will not be able to sell them, not that they're going under anything, but they then may not be able to sell the mortgages in the open market. Are you running into that?

Robert Toll

No, Chase has taken. Wells Fargo has taken. Countrywide has taken.

Joel Rassman

Bank of America has taken. Thornburg is just reopening shortly. World Bank of Scotland just gave us a $500 million commitment. Of course that includes jumbo loans. So we believe that at least for our book of business we're highly liquid.

Operator

Your next question comes from Todd Voigt - Cliffwood Partners.

Todd Voigt - Cliffwood Partners

You mentioned that Seattle was an attractive market. Would that be an example of a place that you would like to look for future transactions?

Robert Toll

Yes, but right now we don't see an opening for us. We don't like to enter markets unless they are down. Of all the markets that are 90% of them are down, and Seattle is I don't think one of them. I think Seattle is still doing okay.

Todd Voigt - Cliffwood Partners

I guess that answers my next question. Would you consider moving north of the border into the Province of Alberta because housing markets there are doing very well?

Robert Toll

Yes, it is. We sort of looked at it. But we're not that interested yet. They have some weird tax laws.

Todd Voigt - Cliffwood Partners

Finally, of that $31 million when you sold the security business, how much did you make on the sale of the security business?

Joel Rassman

$15 million.

Robert Toll

I have a question from William Maloney. Do you see still see strength in the Hoboken Jersey City area? Yes, we do. Both those markets are B plus markets, and they're doing very well. Thank you, Bill.

A question from Robert Tracy. Could you please comment on what changes you have seen over the past few weeks in the availability of jumbo mortgages from Countrywide, IndyMac and Wells Fargo? I think we have answered that already. All three of those are offering us jumbo mortgages at we think very reasonable and decent spreads, although we expect the spreads to even tighten further.

Two, are there any particular lenders who have tightened standards more than average, and are there any lenders who are more accommodating than the average? You know what, guys, I think we're going to pass on that one. We are not a mortgage brokerage or a taker of reference, so I'm going to leave that one alone. Any other questions, Vonda?

Operator

Your next question comes from Dan Oppenheim - Banc of America Securities.

Dan Oppenheim - Banc of America Securities

You have talked a lot about the central cancellations or lack thereof recently with mortgage issues. Can you talk in terms of what is happening with new traffic activity as you monitor that, in terms of as the media has focused on the mortgage issue, what it has done to the traffic levels here in August?

Robert Toll

Very simply traffic is horrible. This past week was the lowest traffic for this particular week ever in our history. That condition has existed pretty much for the last nine weeks. Prior to that there was a hiatus where we did a little better than the worst in our history. Going back even further, once again, we're doing the worst in our history. Our history includes '87, '88, '89, '90, so traffic is pretty stinky out there. That is on a per community basis, which is the only way to measure it.

Operator

Your next question comes from Nishu Sood - Deutsche Bank.

Nishu Sood - Deutsche Bank

You were mentioning the need obviously for reduced construction by the builders to alleviate the oversupply situation. How has the behavior of your peers as compared to the rest of the builders perhaps have been? So the small luxury-oriented builders, are they pulling back their construction at the same rate as everyone else, more or less?

Robert Toll

I really don't know. I'm sorry. Indications are that of the small builders they're building to order, and therefore their construction has been pulled back as much as ours. Whether that gives them the ability to survive is questionable.

Joel Rassman

The banks have told us that they have tightened up on those that don't, that they pull fresh loans. And if they are not tightening up themselves, their banks are withdrawing credit.

Nishu Sood - Deutsche Bank

I also had a follow up question actually on this commitment you got from RBS and Citizens. Just to clarify, was that a commitment that you went out and sought to replace reduced commitments from other lenders or was that simply more?

Robert Toll

No, it actually was a commitment we went out and sought on to answer the market's concerns about our ability to place our jumbo loans. I don't know what our relationship is jumbo to conforming. I know we do a bunch of conforming also. Do you know, Don?

Don Salmon

Yes, we're about 46% jumbo and about 54% conforming.

Robert Toll

It is about 50-50, but the majority is conforming. Nevertheless, the market is very focused on whether Toll Brothers will be able to take care of its mortgage needs because of dislocations in the mortgage market. Specifically people believe jumbos are no longer being offered. We sought this commitment as much for the market as for ourselves to prove that you don't have a problem placing a jumbo. Nor logically should you. A $600,000 mortgage on a per dollar basis is more easily managed. You need the same kind of clerical assistance to track fire insurance, and whether you paid your taxes, whether your H08 fees have been paid up, if there are any, or your condo fees. It takes the same manpower to service a $300,000 mortgage as it does to service a $600,000 mortgage. So a jumbo actually, excepting for the quasi government backing that does not exist, it should be a better piece of paper, if it has got a lower LTV.

If you've got a conforming loans with an LTV of 80%, it is 80% of $400,000 the guy has got $80,000 into the house. Now you take an $800,000 home with a similar LTV, and you've got double the amount of equity into the home. So very often, if not most often, that jumbo loan is, in our mind, more valuable, more creditworthy than the conforming, except for the guarantee. We think what you're going to see in the future is a differentiation in the kind of jumbos as they are put to market in securities.

Right now securitization is still pretty much blocked. But I believe what you're going to see securitization come back for quality paper. That will have a difference score than of course than the sub-prime paper. But instead of it being divided tranches in one piece, I think you're going to see separate pieces. I think that is going to make a big difference to the market.

Joel Rassman

You can see the quality in the statistics that we gave you before, with a very low delinquency rate in our portfolio of our providers.

Nishu Sood - Deutsche Bank

Just one other clarification question on the mortgage issue. You mentioned that you haven't seen any of your customers lose their mortgages as a result of the banks pulling back their commitments. Does that translate then to you haven't seen an uptick in your cancellation rates due to any mortgage-related reason?

Robert Toll

It would logically, yes.

Don Salmon

No. I don't think so. I think what we said is of those commitments that have been issued, everybody has honored them. But we also expect underwriting guidelines to tighten, and we expect the pool of available buyers to shrink a little bit.

Robert Toll

That is not the question. The questions is have you had higher cancellations. You missed it. It was can rate. I don't see a higher can rate at all in the last three weeks. Anybody else around here?

Don Salmon

It is the same as it was last quarter for that reason.

Joel Rassman

The two quarters were the same.

Robert Toll

Okay. So the two quarters the same, so far mortgage travail has not shown its head.

Operator

Your next question comes from Scott McCullough - Nationwide.

Scott McCullough - Nationwide

I was just wondering have you considered raising the deposit requirement, or would that be cutting your nose off to spite your face?

Robert Toll

The answer is yes to both questions. We have considered raising deposit requirements and in fact we have. We have often discussed whether that is cutting our nose to spite our face, and have decided that in some cases it would be, and in some cases it wouldn't be. Where it is not, of course we have raised our deposit requirements. Where we think that we can't get away with that, it would be too great a problem to continue selling, we haven't.

Scott McCullough - Nationwide

In certain markets like down in Florida or any particular market in general?

Robert Toll

I haven't got that in my head. In Florida we had increased deposit requirements for to-be-built and for that is homes where we're stuck with specs. I mean those communities where we're stuck with specs we have not raised deposit requirements because, what the hay, we already have a spec. The delivery is very quick. So I'll take a very low down payment because the worst that happens is that I have wasted a month in trying to off the home.

Scott McCullough - Nationwide

I was just thinking in terms of an effort to bring down cancellations.

Robert Toll

That is exactly right. That is why in the cases where we have raised deposit we have done it. We want to bring down the cans.

Operator

Your next question comes from Joel Locker - FBN Securities.

Joel Locker - FBN Securities

I just wanted to get behind your breakdown of your COGS, and just wondering if that has changed in the last year? Just say of the $1.023 billion, maybe it is $876 million after impairments, what portion of that was labor, what portion was land, and what portion of that was materials?

Joel Rassman

I don't think our relationships have changed significantly between labor and materials. When we look for a write-down we write-down the entire community. It doesn't differentiate between whether it was caused by labor or materials. If you have a problem, it is problem. I'm not sure if I answered your question, but I hope I did.

Joel Locker - FBN Securities

I understand on the homes you closed, but the revenue.

Joel Rassman

The same relationships have generally been in effect for the last year or so that we had before.

Robert Toll

So COGS aren't going up?

Joel Rassman

Well the percentage of the components of the COGS is what I thought he asked me.

Joel Locker - FBN Securities

Yes.

Joel Rassman

The percentage of components of the COGS is basically the same. It changes by product type, but within that product type it is generally the same.

Joel Locker - FBN Securities

Generally the same.

Robert Toll

I apologize. COGS is cost of goods sold, in case there are some people out there that wonder what we're talking about.

Joel Locker - FBN Securities

I just wanted to get your comment on the 700 Grove Street. You had mentioned that Hoboken was B plus markets, but just wondering if that differentiated between the Grove Street and your other project there?

Robert Toll

Pretty much same. Let me see, 70% sold at 1500 Washington, which is Hudson Tea, 72% sold in Harborside Lofts. Commencing design, commencing design, future building completed, garage. Oh, I see. Wait a minute. Maxwell, 78%, 97%, and Jersey City, 84% sold out.

Joel Locker - FBN Securities

84%. Thanks a lot.

Robert Toll

So we are in pretty good shape there.

Operator

Your next question comes from Carl Reichardt - Wachovia.

Carl Reichardt - Wachovia

I think you guys mentioned some of the data from on the bank side, it was from your two largest banks in terms of mortgage purchase. What percentage do your two largest banks represent of the total mortgage purchase pool?

Don Salmon

Our two largest banks were roughly about 80% or so of our originations year-to-date.

Carl Reichardt - Wachovia

Second, an interesting point I think that Ken was getting to about looking at impairments. If you took the value on a piece of ground down low enough you could get to a point where maybe the highest and best use of the property would be not for for-sale housing but for something like apartments.

I think I want to follow-up on what Ken was getting at. Effectively the residual value of this land, if you take it down low enough to get to the point where you shouldn't be building houses on it, does that therefore, as you look at it in some projects, provide a floor for impairments that they effectively can't go below if your assumptions on the rental market are right?

Robert Toll

That is correct.

Don Salmon

That is correct.

Carl Reichardt - Wachovia

Have you done that on any particular community that you have impaired to this point?

Robert Toll

I can think of one.

Joel Rassman

There are at least two.

Robert Toll

Two, okay.

Joel Rassman

Not necessarily for rental property, but the value of the land today can be sold at.

Robert Toll

I remember one where I specifically had --.

Joel Rassman

You went to the buyer.

Robert Toll

Had the Toll REIT people look at it. As I recall, they asked for a few more million to keep written off and before we took it over, which we didn't do.

Carl Reichardt - Wachovia

That is interesting. Two more quick ones. Don, I think you said that 38% of your buyers, who I assume take out mortgages, are self-employed. Is that right?

Don Salmon

That is a rough number, but, yes.

Carl Reichardt - Wachovia

That is folks with just single incomes? That isn't self-employed and then also another household member has a job that is contributing to the mortgage payment?

Don Salmon

I don't know the answer to that.

Robert Toll

That is pretty high.

Carl Reichardt - Wachovia

It just seems really high.

Robert Toll

I don't see how you could have 38% self-employed, unless what you could be looking at is somebody such as Carl Reichardt who is working for a large institution, who says that I pretty much depend on my bonuses as opposed to my salary. Let me tell you that --.

Carl Reichardt - Wachovia

Not this year, Bob.

Robert Toll

I wouldn't think so. Mine neither. But over the years I have earned so much and this is what I am stating my income is. We may look at that as self-employed, but it is not really. I don't know how you are keeping your stats.

Carl Reichardt - Wachovia

The last question, more qualitative. I'm sorry to ask so many.

Robert Toll

No, go ahead.

Carl Reichardt - Wachovia

You mentioned that there is a distinction in how you look at land, your qualification, unique versus I guess we would call it commoditized. If you look at your own land pool now, putting Bob Toll's hat on, what percentage of that owned land pool would you call unique locations versus locations that have become commoditized as we sit here today?

Robert Toll

I think almost all of it is a desired location. I didn't use the commoditized.

Carl Reichardt - Wachovia

No, I used it. That is my term.

Robert Toll

Fungible is what I said. I don't think any of our land is really fungible. But what the hell, I am the guy that bought it. So I would have to go back through it and put your hat on and look at it again. I can't say.

Operator

Your next question comes from Rick Murray - Host Capital.

Rick Murray - Host Capital

In reference to your commitment from RBS, about $500 million, is that what you said?

Robert Toll

That was exactly it. Yes.

Rick Murray - Host Capital

By my math that is a little more than half a quarter's production for you guys. Do you have other commitments out there that you're looking to pursue or expand from other investors? Who might some of your bigger investors be at this point?

Robert Toll

Do you have commitments?

Joel Rassman

We don't have any signed commitments at this point. We have had a number of conversations with people that may or may not develop into commitments. But I will tell you there is an appetite in the market. In terms of this particular commitment, this was really to ensure our liquidity. We still have our standard investors in place and active. There is nothing wrong with Chase and Wells and Bank of America. And even the press about Countrywide notwithstanding, they have been active buyers of our loans.

Robert Toll

Countrywide has been terrific.

Joel Rassman

Countrywide has stepped up to the plate, and we have seen no interruption in our flow of fundings from Countrywide.

Operator

Your next question comes from Steve Burroughs - Conning Asset Management.

Steve Burroughs - Conning Asset Management

Going back to the topic a little while ago with respect to your cancellation rate, if inability to get mortgages hasn't been an issue, how much of it is from not being able to sell your other home, or just lost of confidence?

Robert Toll

Hold on, I've got that stat somewhere buried in this paper. Not being able to sell your home: existing home not sold, 19% of the cans, the cans were 347 for the third quarter. So almost 20% of 347. So you're talking about 70. As a matter of fact, you're talking exactly 66 of the deals, according to the answers to the question as to why is this deal going south, are because their existing home is not sold.

Steve Burroughs - Conning Asset Management

How about just lost of confidence in general?

Robert Toll

Loss of confidence. I don't think I have that category. The big categories are family reasons, job status changes, reduced financial positions and that is 16%. We had 15% who wouldn't give us a reason. They just said keep the deposit and we're walking. We identified those people as probably all investors. The only other big category is no mortgage commitment. Did I address that one already? That was 14% or 49 didn't get mortgage commitments. Some of them don't try. They have got cold feet.

Steve Burroughs - Conning Asset Management

With respect to the impairment pace, it has been steadily rising this year. Can you give us any general guidance of what you might see for the fourth quarter and going into '08?

Joel Rassman

If we knew it, we would have taken it. We do the best we can under the individual information that we can generate. Obviously if a market continues to worsen it may create a change in the assumptions, which will change the number. But in general we have been consistent in how we have applied our process. We have done the best we can in estimating what the losses would be.

Operator

Your next question comes from Douglas Kass - Seabreeze Partners.

Douglas Kass - Seabreeze Partners

This is a much broader question then has been asked in the conference call.

Robert Toll

That is great to be a short, by the way.

Douglas Kass - Seabreeze Partners

If the administration came to you to resolve the housing crisis, what remedies would you recommend, Bob, to bring supply and demand back into balance over a reasonable period of time?

Robert Toll

I think the most important thing is to immediately address the mortgage concerns. Giuliani was asked in an interview with Kudlow recently, would he bring in any regulation? He said, it was up to the market to straighten things out, and it will. In my opinion, that is probably what the guy said in '29 that were running the Fed.

I was castigated recently for suggesting a few weeks ago that some government regulation would not be a bad thing. The average reaction was the minute you let the government in you're begging for disaster. I can generally agree with that. Look what has happened with wetland regulation, for instance. You need a team of lawyers to fill a puddle in your backyard. On the other hand, where would we be without antitrust legislation? We probably have one oil company known in the United States as American Standard. I think a little regulation --

Douglas Kass - Seabreeze Partners

That is a toilet company, Bob.

Robert Toll

Thank you very much. American Standard is. But it was Standard Oil. So I think a little regulation wouldn't be a bad thing. I wouldn't rule out 100% or 95% LTV, but if you are seeking that kind of thing you've got to pledge additional assets, or at least prove additional assets, so that if the home price goes down and you want to walk, the mortgage lender has got a note that he can apply not only to the home, but he can apply to other assets that are obviously sufficient to take care of the costs.

Douglas Kass - Seabreeze Partners

You would approach it fiscally, not monetarily?

Robert Toll

I'm not sure I understand that.

Douglas Kass - Seabreeze Partners

You're talking almost like a Marshall plan for housing?

Robert Toll

No, I don't think so. I just think that there ought to be some minor regulation with the respect to standards of what you can do in the mortgage market. What happened was for 100 years we had S&Ls as the backbone of the mortgage system. Then they went bad, and we tossed the baby out with the bath water, and went to another system which I don't suggest we try and break away from, which is really the securitization. The problem is that everybody is working on commission today. Nobody is a portfolio lender. The guy that wants to get you the mortgage is a commission fellow. He's handling it over to guys that are working commission to package it. The brokers are working on commission in order to sell their goods. The guy that is buying the goods are not really paying attention to what they are buying.

I think it is reasonable to have standards imposed that you can't lend above these lines. That should, to some extent, protect us from ourselves. But I'm getting so many cut their throats around here. Guys are signaling to me to please stop this. Remember, it is a Toll Brothers call, not a Bob Toll call. So I'm off. I'm going back to Toll Brothers work.

Operator

Your final question comes from Dan Oppenheim - Banc of America Securities.

Dan Oppenheim - Banc of America Securities

A quick follow-up. I was wondering if you, for the mortgage set you were talking about before with over half of the buyers using the conforming mortgages and not jumbo, is that for only the mortgages that you are capturing or is that for all of the buyers?

Joel Rassman

That is the book of business at TBI Mortgage. 60% of our customers, but we think it is probably consistent.

Robert Toll

Any other fellows come in on the wire guys? It says here we have a question from Ramsey Siu. What percentage of your backlog is from buyers who have not yet sold their existing homes? I don't know. But I do know that our project managers and our sales managers, with only four months left in the process of delivering a home are all over the buyers to make sure that their homes are sold, or if not that they are dropping their price in order to make sure that they do sell their home by the time our home is ready to deliver. We do everything we can to make sure that we don't get stuck with a home or have to delay the settlement because it is just impossible to get the buyer to close. We don't want that, so we are all over that.

During the conference call a couple weeks ago you said about 9% of the closings utilized a bridge loan. Do you see that trend continuing? We didn't say a bridge loan. A bridge loan is specific. It applies to the fact that you are getting a loan on the existing home as well as a new home to carry you through, so that you can carry two homes at once. We didn't address that. What we said was we had 9% of our homes is no-ratio loans.

Do I see the trend continuing in bridge loans? Immediately, yes, and medium term, no, because I think it will be made clearer and clearer to the homebuyers in the commitments that it is stated subtly now in your commitment. We grant you a $400,000 loan, assuming that your ratios will be ABC. Of course, you can't get there without selling your home. But it is not specifically stated that clearly. I think it will be bolder and bolder in print that, please be advised when you press firmly and sign this mortgage commitment that you realize you're not going to be owning two homes.

Another question from Vito. Question one, why did you sell the security monitoring company? What was the number of reasons, 31?

Joel Rassman

$31 million of profit, and $16 million of cash.

Robert Toll

Are there any other non-core operations you may consider selling? Before I get to that, the way we sold is we still continue to set up security. Then every quarter or every year we off again for the same relationships, the same ratios what we brought in. In effect we are continuing now to sell. We are a supplier. I think that is a lovely business for us to be in, and a lovely place to be.

Are there any other non-core operations you may consider selling in the future? We sold our advanced broadband, which was our own cable company. We sold that to Comcast. We're very pleased with that deal.

Joel Rassman

That was a couple of quarters ago.

Robert Toll

Do we have any other core business we would consider selling that we would be willing to talk about?

Joel Rassman

No.

Robert Toll

No, I don't think so. So thank you, Vito. Vonda?

Operator

There are no further questions.

Robert Toll

Great. Thank you very much everybody. Thank you, Vonda. Bye.

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Source: Toll Brothers F3Q07 (Qtr End 7/31/07) Earnings Call Transcript
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