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PHH Corporation (NYSE:PHH)

Q1 2012 Earnings Call

May 2, 2012 10:00 am ET

Executives

Glenn Messina – President and Chief Executive Officer

David Coles – Interim Executive Vice President and Chief Financial Officer

Robert Crowl – Executive Vice President

George Kilroy – Executive Vice President of Fleet

Smriti Popenoe – Chief Risk Officer and Interim President of Mortgage

Jim Ballan – Vice President of Investor Relations

John Erdmann – Vice President and Controller

Analysts

Richard Eckert – B. Riley & Co.

Paul Miller – FBR

Bose George – KBW

Henry Coffey – Sterne Agee

Jim Fowler – Harvest Capital

Joe Galzerano – Muzinich

Jordan Hymowitz – Philadelphia Financial

Michael Kim – CRT

Operator

Good morning ladies and gentlemen. Welcome to the PHH Corporation first quarter 2012 earnings conference call. (Operator instructions)

Today’s call is also being webcast and recorded for replay purposes. The audio replay can be accessed either on the company’s Web site at www.phh.com/invest or by telephone at 719-457-0820 or 888-203-1112 using conference ID 4407247 beginning shortly after the conclusion of the call. It will be available until May 16, 2012. This access information is also described in the company’s earnings release and I will repeat it again at the end of our session.

At this time, Jim Ballan, Vice President of Investor Relations will proceed with the introductions.

Jim Ballan

Good morning and welcome to the PHH Corporation’s first quarter 2012 earnings conference call. Please note that statements made during this conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as further described in slide three of our first quarter 2012 investor presentation of supplemental schedules. Such forward-looking statements represent only our current beliefs regarding future events and are not guarantees of performance or results.

Actual results, performance or achievements may differ materially from those expressed or implied in such forward-looking statements due to a variety of factors including, but not limited to, the factors under the headings Cautionary Note regarding forward-looking statements and Risk Factors in our periodic reports filed with the US Securities and Exchange Commission, including our most recent annual report on Form 10-K and quarterly reports on Form 10-Q, which are available in the Investor section of our Web site at www.phh.com and are also available at www.sec.gov. Investors are cautioned not to place undue reliance on such forward-looking statements.

We will also be discussing various non-GAAP financial measures, including core earnings pre-tax, core earnings after-tax, core earnings per share, adjusted cash flow, tangible book value, and tangible book value per share.

Please refer to our earnings release and accompanying investor presentation of supplemental schedules for a description of these non-GAAP financial measures, as well as a reconciliation of such measures to their respective most directly comparable GAAP financial measures.

The earnings release we issued yesterday may be accessed from our Web site or you may request a faxed or a mailed copy by calling our investor hotline at 856-917-7405. In addition, the investor presentation of supplemental schedules is posted in the Investors section of our Web site under Webcasts and Presentations.

Speaking on the call today will be Glenn Messina, President and Chief Executive Officer, David Coles, Interim Chief Financial Officer, and Rob Crowell, Executive Vice President.

George Kilroy, President of Fleet, and Smriti Popenoe, Chief Risk Officer and Interim President of Mortgage, are also are also with us today and will be available to take your questions.

First, Glenn will discuss the company’s performance in the first quarter and strategic objectives. Then, David will review our financial results and provide an update on our liquidity position, after which we will take questions.

With that, I will turn the call over to Glenn Messina.

Glenn Messina

Thank you, Jim. Good morning, everyone, and thank you for your interest in PHH. Before I get into the quarter, I’d like to introduce Rob Crowl, who will be assuming the duties of Chief Financial Officer of PHH Corporation.

As we announced on April 20th, Rob joins us with more than 25 years of management and senior level mortgage and banking experience and will be responsible for leading PHH’s financial and reporting functions.

Welcome, Rob.

Robert Crowl

Thanks, Glenn. I’m very pleased to join PHH. I look forward to working with Glenn, the board, our finance team and our shareholders.

Glenn Messina

Thanks, Rob. Rob will succeed David Coles, who’s been serving as our Interim CFO. We are grateful that David has agreed to stay on for a brief transition and we thank him for the great job that he has done for our company.

Overall in the quarter, we had solid operating performance in both our Mortgage and Fleet businesses and we made good progress on executing the four key strategies I laid out for our company earlier this year.

First, we demonstrated solid growth in our three franchise platforms. Retail mortgage applications were up 87% and Fleet delivered 50% growth in segment profit, both as compared to the first quarter of 2011.

Second, on operational excellence, we are making progress around quantifying defects. On Slide 19 of our supplemental schedules, we have disclosed our mortgage quality related costs. This schedule reveals that our potential earnings and returns are far greater than what we achieved this quarter. Reducing defect costs for operational excellence is where I believe we have a meaningful opportunity to drive value creation for our shareholders.

Third, we are committed to customer service. We have increased our level of engagement with our clients and customers and we’ve identified a number of opportunities to enhance the service experience we deliver. We are focusing our teams on the key operating and relationship elements to serve our clients and customers better and capture market opportunities.

And fourth, our prioritization of liquidity and cash with generation has produced meaningful results. We closed the first quarter with an unrestricted cash balance of $875 million, up $461 million from the fourth quarter of 2011.

Subsequent to the end of the first quarter, we retired our 2012 debt maturities and we reached agreement with Fannie Mae to maintain our $1 billion committed early funding facility along with our $2 billion uncommitted facility. After retiring our 2012 debt maturities, we currently have sufficient cash to pay down our 2013 debt maturities.

Turning to Mortgage, the combined segment profit for production and servicing was up 38% over the same quarter last year. Retail application volume in the first quarter benefitted from continued refinancing activity due to low mortgage rates and the ramping up of our PLS clients.

Thanks to wide margins in the first quarter, we were able to originate MSRs with minimal use of cash while continuing to grow our capitalized servicing portfolio, which was up 6% compared to the end of the first quarter 2011. The credit quality of our servicing portfolio continues to be strong as our delinquency rates remain less than half the level reported for large residential mortgage servicers.

Our total delinquency rate, excluding foreclosure and real estate-owned, was down 41 basis points from the first quarter 2011. Also, the percentage of loans in foreclosure and real estate-owned was down 40 basis points from the first quarter of 2011.

During the first quarter, mortgage repurchase demands more than doubled as compared to the fourth quarter of 2011. The increase in repurchase requests was primarily due to a high number of loan file reviews by the GSEs.

We believe they focus more resources on clearing their backlog of previously requested loan files and are being more stringent in applying their criteria for accepting our defense of their claims. As a result, we recorded a $65 million provision during the first quarter of 2012, compared to $15 million in the same quarter last year. With the addition of the first quarter provision, our total foreclosure-related reserves were $165 million at quarter end, which represents the losses we believe are probable.

Based on our ongoing discussions with the GSEs, we believe that by the end of 2012, they may be substantially complete with their review of our seriously delinquent and defaulted related to origination years 2005 and prior, and by the end of 2013, they may be substantially complete with their review of our seriously delinquent and defaulted loans related to origination years 2008 and prior.

Almost 78% of our standing repurchase requests at quarter end are related to the 2005 through 2008 origination years. Given the results of the first quarter, our ongoing discussions with the GSEs, we believe it’s reasonably possible that future losses related to repurchase and indemnification requests may be in excess of our recorded foreclosure-related reserves.

Assuming that the elevated level of repurchase demands that we have recently experienced continues through the end of 2013, and the company’s success rate in defending against such requests declines, and that loss severities on repurchases remain at current levels, the estimated amount of possible losses in excess of our foreclosure-related reserves is $140 million.

If these losses materialize, we believe the maturity would be realized over the next 24 months. Because this is an estimate of reasonably possible losses, not probable losses, the amount is not included in our reserves.

We believe that our cash on hand and the execution of our liquidity plan will provide sufficient liquidity to operate our business, meet our 2013 debt service obligations, and fund potential increases in repurchase and indemnification requests.

Moving to Fleet, segment profit was up 50% in the first quarter as compared to the same period last year. Fleet management fee revenue increased 12% compared to the same period last year, primarily reflecting growth in maintenance and other real asset-related services and driver safety training.

Segment operating expenses were effectively unchanged. Although leased vehicle average unit count decreased 3% in the quarter, our net investment of Fleet leases grew 3% from year-end 2011. This is due to a shift in mix of our lease units to more service-type vehicles that have a higher value per unit. These types of vehicles tend to be leased over longer time periods and typically use more services than passenger cars.

Our Fleet business provides a mission critical component of many of our clients’ operations, takes on minimal lease, residual risk and credit risk, and has high barriers to entry. We are continuously innovating and introducing time-saving productivity tools for our clients, such as mobile connections and applications. We believe these innovations make our offerings more competitive and facilitate customer retention.

Our focus on customer service and technology innovation makes our Fleet business a leader in its industry. During the first quarter, we won the Fraser Group’s Outstanding Customer Support Performance Award for the third year in a row.

Also in the quarter, we signed 14 new clients representing more than 8,500 potential additional new vehicles. We anticipate continuing to grow service units at a faster rate than leased units, which should continue to drive ROE improvement as evidenced in our first quarter results.

And now, I’ll turn it over to David.

David Coles

Thank you, Glenn. Before going into the results for the quarter, I wanted to say that it has been a pleasure to work with you and the entire PHH management team, and I want to add my word of welcome to Rob.

On a GAAP basis, net income attributable to PHH Corporation for the first quarter 2012 was $75 million, or $1.32 per share. Core earnings after tax for the first quarter was $53 million, and core earnings per share for the quarter was $0.93. The difference between our pretax GAAP and core earnings in the first quarter is due to a $43 million positive mark on the MSR, offset by a $5 million loss on the related derivative position.

Interest rate lock commitment, or IRLC, is expected to close, which are the primary driver of revenues in our mortgage production segment, was $6.9 billion for the quarter. This is down sequentially from $9.7 billion in the fourth quarter 2011. This decline was primarily due to our intended reduction in originations in our correspondent channel.

In the Mortgage Servicing segment, we continue to build our capitalized servicing portfolio, which increased to $150 billion in UPB at the end of the first quarter, up from $141 billion at the end of the first quarter 2011, and $147 billion at the end of 2011.

Our replenishment rate in the first quarter declined to 144% from 162% in the fourth quarter 2011. Because of the expected decline in origination volume related to our correspondent business, our replenishment rate could continue to decline, although we anticipate that we will be likely to replenish most, if not all, of our prepayments in the foreseeable future. A greater than 100% replenishment rate generally should coincide with growth in our capitalized servicing portfolio.

Our Fleet management segment remains a key contributor to our consolidated results. First quarter profit in the segment was $24 million, up from $16 million in the first quarter of 2011, primarily due to high units and usage of fee-based and asset-based management services and lower funding costs.

On a consolidated basis, other operating expenses in the first quarter 2011 increased by approximately $80 million over the first quarter 2011. This was primarily driven by the increase in our provision for rep and warranty expense, up $50 million to the $65 discussed by Glenn, higher production-related direct expenses from higher volumes, and higher servicing costs from compensatory fees and costs related to servicing foreclosed loans.

Now I’d like to provide an update on our liquidity position. At the end of the first quarter, our liquidity included $875 million in unrestricted cash, plus an additional $509 million of availability under our revolving credit facility, totaling approximately $1.38 billion. This represents a $461 million increase from year-end 2011 and includes net proceeds from January’s issuance of convertible notes of $243 million, less $51 million paid down against the 2012 convertible notes.

The balance of $269 million comprises the recovery of $73 million of collateral postings, $50 million of proceeds from the sale of nonstrategic assets, primarily scratch and dent loans and Fleet leases, and the remaining balance of $146 million is fairly evenly split between working capital initiatives and operating cash performance in the businesses.

In addition, in the first quarter, as expected, we extended the maturity of our $525 million unsecured revolving credit facility through to February 2013. Subsequent to the end of the quarter, we retired the remaining balance of our convertible debt due 2012. Our unrestricted cash balance as of March 31 pro forma for that debt repayment would be $676 million, more than sufficient to prefund our 2013 debt maturities of $421 million.

In order to provide investors greater clarity regarding our cash flow generation capabilities, we have introduced a new non-GAAP financial metric called adjusted cash flow, the calculation of which is outlined in Slide 6 of our investor presentation of supplemental schedules.

Although this figure can be somewhat volatile quarter to quarter, it is intended to illustrate the cash generated from business activities that is available for our unsecured debt and equity holders. Adjusted cash flow is a key metric by which management performance will be measured internally in 2012. Our execution against our cash generation initiatives has been strong through the first quarter and we continue to manage the business to be cash flow positive for the full year 2012.

And now I will turn it back over to Glenn.

Glenn Messina

Thanks, David. We had a good quarter and we are making progress. Fleet continues to execute well on a number of fronts and is delivering strong growth in segment profit. The mortgage origination environment remains favorable, cash costs of originations is low, and we delivered solid core earnings performance despite the increased provision for foreclosure-related reserves.

Realizing the underlying strength of our business will require focused execution of our four key strategies. We are delivering growth in our franchise platforms and we are continuing to execute on our liquidity objectives.

I believe outstanding customer service and operational excellence are prerequisites to thrive in our business today and in the future. I believe that our Fleet and Mortgage businesses have the potential to produce auto lease in the mid-teens and there is significant opportunity before us to create value for our shareholders.

We are working hard across the company to continually improve our performance. I want to recognize and thank my colleagues at PHH for their hard work and commitment.

And with that, we’re ready to take questions. Lindy?

Question-and-Answer Session

Operator

(Operator instructions) We’ll take our first question from Paul Miller with FBR. Please go ahead. Your line is open.

Paul Miller – FBR

Thank you very much, gentlemen. Can we real quick go back to the reps and warrants? In the past, and you said this in the press release, you were guiding to roughly $20 million per quarter of expenses related to that.

Reading between the lines, I’m going to guess that number’s going up, but by how much is the question. I know there’s a lot of inputs into that, but is there any more -- can you really add some more color to what you think the impact to the income statement would be on a quarterly basis, at least throughout the end of -- the rest of this year?

Glenn Messina

Hi, Paul. It’s Glenn. How are you doing?

Paul Miller – FBR

How are you doing, Glenn?

Glenn Messina

Good, good. Paul, we’ve quantified based on a number of assumptions. The probable future losses, rep and warranty losses in excess of the existing reserves, and we’ve quantified that to be $140 million.

We do expect, if those losses materialize, we believe they’d materialize within the coming 24 months, but from a timing perspective, Paul, it is going to be lumpy and we really can’t predict or forecast what’s going to come in each month.

But we’ve laid out there that we think it’s reasonably possible that we have an additional $140 million of loss, again, based on a couple of assumptions, and we would expect to see those, if they materialize, within the next 24 months.

Paul Miller – FBR

So you have the $165 million in reserves and you think above that, over the next two years, you’re probably going to have to have losses close to $140 million, give or take what the economic conditions give us?

Glenn Messina

Based on our assumptions, it’s reasonably possible that we could see an additional $140 million in losses.

Paul Miller – FBR

And then the other question is, I kind of missed it. You said at the end of 2012, Fannie and Freddy will complete their review, and then you said at the end of 2013, you talk about another completion.

Can you tell the difference between the two completions?

Glenn Messina

Sure, Paul. We believe that by the end of 2012, the GSEs will be complete with their review of seriously delinquent and defaulted loans related to origination years 2005 and prior, and then we believe by the end of 2013, they’ll be complete with their review of seriously delinquent and defaulted loans related to origination years 2008 and prior.

Paul Miller – FBR

Okay. What about -- because we saw some uptick in some other banks of the ’09, ’10, ’11 vintages. Have you seen any of that?

Glenn Messina

Yes, the majority, Paul, continues to be ’05 through ’08 books of business, 78% of our backlog in purchase demands is sitting in that bucket.

Paul Miller – FBR

Okay, so really, it’s really going to be 2013 is the -- which is the end of next year, is when you think everything is done, and up until that point you think that, given that knowledge that you have, it would be at $140 million losses over the next seven quarters above the $165 reserves.

Glenn Messina

We believe the 140 is reasonably possible.

Paul Miller – FBR

Okay, and then going back to cash, I missed the -- I think you gave the three sources of cash and one was $70 million. I missed exactly, where did that come from?

Glenn Messina

David, could you repeat that for Paul, please?

David Coles

Absolutely. So, Paul, I was attempting to attribute the $269 million, which caused the adjusted cash flow number that you’ll see in the investor supplement, and that comprised recovery of $73 million previously posted collateral.

Paul Miller – FBR

And can you -- What exactly was that? Can you go through what that is?

David Coles

That is essentially the collateral we post against our pipeline.

Paul Miller – FBR

So as your pipeline goes up and down, this number will go up and down, also. Is that -- am I correct?

David Coles

It’s related to scale, but it’s also related to interest rates.

Glenn Messina

Yes, Paul, so as interest rates to up or down, the amount of collateral we would post against the hedges against that portfolio, that pipeline, would change.

Now, when the loans ultimately get sold into a security, the hedges unwind, the cash comes back, or the loans sell for a higher value and you get the cash back that way. So it’s -- that cash will cycle back through the business.

Paul Miller – FBR

Okay, so because -- So is it mainly because rates rose throughout the quarter, that’s why this cash is freed up? And now that it’s coming back down, did this cash get used up?

David Coles

Well, it didn’t get used up.

Paul Miller – FBR

Well, it doesn’t get used up. I don’t mean it that way, but --

David Coles

-- balance sheet, but that’s right. The rising environment gave us bad collateral back and we have that in our cash balance today, less anything else we’ve had to post if rates have dropped.

Paul Miller – FBR

Okay, and then the sale scratch and dent, is that also a lumpy number? That’s going to go up and down? Or you talked about being more efficient with that. Have you become more efficient or it’s still going to take time?

David Coles

We have become more efficient. That was one of the initiatives that we earmarked on the full year call back in January/February, and we would expect they are to maintain more like that level of scratch and dent on our balance sheet going forward.

Paul Miller – FBR

Okay.

David Coles

There was one time, in so far as it was balance sheet cleanup, but we should be able to hold on to that over performance.

Paul Miller – FBR

Okay, and then the $146 million, can you break that out relative to what you -- what the operating cash earnings was this quarter versus the working capital free up? I guess that’s the difference.

David Coles

What we’re prepared to disclose, Paul, is that that’s fairly evenly split between operating cash performance and in scoping operating cash performance. We have included the fact that the rep and warranty reserve has not been realized in cash yet, so after making that adjustment, it’s fairly evenly split between other working capital initiatives and operating cash performance.

Paul Miller – FBR

You made a comment that the operating reps and warranty reserve is not out of cash, so should we back out that $65 million out of 676?

David Coles

Well, I think in the investor supplement, you can see that we’ve realized -- our realized losses are something like $33 million in the quarter, so we’ve really built up the reserve and we haven’t yet seen that go out in cash.

Paul Miller – FBR

So is that considered unrestricted? Are you considering that reserve unrestricted cash?

David Coles

Absolutely.

Paul Miller – FBR

Okay. Thanks a lot, gentlemen.

David Coles

You’re welcome.

Glenn Messina

Thank you, Paul.

Operator

And we’ll take our next question from Bose George with KBW. Please go ahead. Your line is open.

Bose George – KBW

Good morning. I actually had one follow up on the rep and warranty issue. Your agreement with Fannie Mae notes that you can’t have any outstanding unsatisfied repurchase obligations that are more than 270 days. I’m just curious how contested loans will be resolved as they approach that date.

Glenn Messina

Hi, Bose. It’s Glenn. How are you?

Bose George – KBW

I’m good. How are you doing?

Glenn Messina

Good, good. Bose, we are -- well, number one, just given the increase in repurchase demands that we have seen, we are staffing up our repurchased demand unit to make sure that we’ve got adequate staffing to deal with this in the appropriate cycle time.

There is a prescribed process we go through with Fannie Mae where we have x number of days to either pay the claim or assert a defense against the claim. Fannie Mae will then evaluate our response to the claim. They come back to us, and then based upon their determination, we either have to buy it back or we reassert another claim. The bottom line is we’ve got to get through that process within 270 days because we can’t have any loans outstanding over 270 days.

For the most part, historically, we’ve been able to do that, get them all resolved within 270 days. We do have a small quantity of loans right now that sits over 270 days. It’s about 50 loans right now – I’m sorry, 54 loans – at the end of the quarter, and quite frankly, that’s just because I don’t think we did our best job in executing against that pile.

So with increased management rigor and increased staffing against it, Bose, I feel comfortable that we could manage that timeframe -- manage within those timeframes.

Bose George – KBW

Okay, great. Thanks, and then switching to the origination side, you’re -- you have correspondent volume was 32% of closing this quarter, and as you deemphasize that channel, do you have a target for a correspondent as a percent of the total?

Glenn Messina

Yes, Bose, right now we think by year end we’ll probably ramp it down to about 20% of the total, but yes, I do want to caution everyone. Last quarter I talked about managing the correspondent operations to a cash budget, and given where margins are today, cash cost origination tends to be very low.

So within the right quality parameters, and we’ve established defined quality parameters around who sells loans to us and the quality of their originations, we may flex up or down depending upon what the cash cost originations is.

Bose George – KBW

Okay, that makes sense. And just switching to HARP, just curious what the HARP percentage of your loans were this quarter, and also, are you refinancing HARP loans from others, or is it just your own portfolio?

Glenn Messina

Right now, Bose, we’re focused on our own portfolio. About 15% of our total portfolio qualifies to be HARP eligible and IMF reported as of the fourth quarter, or was it first quarter, that we were ranked number -- tenth in the nation for HARP originations. That was the first quarter, Bose.

Bose George – KBW

Okay, great. Thanks a lot. Nice quarter.

Glenn Messina

Thank you.

Operator

And we will take our next question from Henry Coffey with Sterne Agee. Please go ahead. Your line is open.

Henry Coffey – Sterne Agee

Good morning, everyone, and congrats on a great quarter. Just to focus in on this cash issue, when we look at your unrestricted cash, we obviously have the reserve balance that we can take out. You’re still well over $420 million when we do that.

Is the expectation that that balance kind of grows quarter to quarter as you get closer to refinancing the 2013s, or how should we kind of benchmark you on that number?

Glenn Messina

Hi, Henry. It’s Glenn. How are you?

Henry Coffey – Sterne Agee

Good.

Glenn Messina

Good. Henry, we really are not going to give forecasts of what we expect our cash balance to be.

I do want to reemphasize what I said before, and that is we do believe that with our cash on hand and the execution of our liquidity plan, we have -- we believe we have ample liquidity to deal with the repurchases, our 2013 debt maturities, and to fund our existing operations.

Henry Coffey – Sterne Agee

And then getting back to the mortgage business for a minute, I guess I’ll state the obvious. Those are pretty big margins. Can you give us some sense of where they’re likely to go over the next three or four quarters?

I know it’s hard to get your arm around it, but something we could hold our hat to, because obviously, if we just assume that you kept growth gain on sale at over 3% on IRLCs, we’d probably have some pretty outsized numbers here.

Glenn Messina

Sure. Henry, we really can’t forecast where margins are going to go. We can tell you that we did see -- in the first quarter, we did see a typical amount of margin volatility, so we did see in the course of a week, margins drop by 40 basis points and then spring back up by 40 basis points, and that level of volatility is fairly consistent with historical practice.

The refinancing, there’s been a lot of capacity that’s been taken out of the industry. Refinancing activity continues to remain high as interest rates are low. You’ve got the HARP programs, HARP 1, HARP 2. It’s all contributing to add stress to the system from a capacity perspective, which I believe is helping to keep margins elevated to the point where they are today.

I would like to believe that those people who remain in the business are recognizing the fact that being in mortgage origination and servicing is going to be more costly on prospective basis and they’re pricing those costs in.

But, Henry, I’ve got to tell you, this industry has been very volatile at the margin side. You know it. You’ve tracked it for years. We can’t really predict with any degree of certainty where margins are going to be two, three quarters out.

Henry Coffey – Sterne Agee

In terms of looking at your future volumes, is it fair to assume that the private client channels produce the same amount of volumes every quarter, or even grow slightly, and that most of the shrink is in correspondent, or how should we start to judge those numbers?

Glenn Messina

As we talked about before, we are going to run correspondent to a cash budget. Our expectation would be correspondent is about 20% of our total volume mix at the end of the year.

We do believe that we can -- we’re seeing good strength in the PLS accounts. The new PLS clients that we’ve added are beginning to grow and add new volume that’s offsetting Schwab running off out of the portfolio, so we do feel optimistic about what we see out of the PLS channel.

Henry Coffey – Sterne Agee

And then as volumes go down -- You obviously have a lot of staff resources and a lot of staff needs, but as volumes go down, will you be able to re-staff for a lower number without much disruption, or how should we gauge cost numbers?

Glenn Messina

Henry, we do have the capacity or do have the ability to take capacity out of our business. We did that in the first half or first half of 2010, 2011, where we took almost 500, 600 people out of the business, but as our practice is to continue to adjust our staffing as business needs demand.

We do have a flexible and variable staffing framework that we use in the business, so within reason, we can flex up and flex down with changes in market environment.

Henry Coffey – Sterne Agee

Well, Glenn, you’re off to a great start, so thank you very much.

Glenn Messina

Thank you, Henry. Appreciate the kind words.

Operator

We’ll take our next question from Richard Eckert with B. Riley & Co. Please go ahead. Your line is open.

Richard Eckert – B. Riley & Co.

Actually, these are probably directed at David. Can you -- I missed it and I know you’ve already repeated this once or twice, but can you go over those changes in cash flows again?

David Coles

Absolutely. Good morning, Richard. Yes, so at the end of the first quarter, our liquidity included $875 million in unrestricted cash. That represented a $461 million increase from the year end 2011. A part of that increase was because we issued convertible notes in January. That was 250 gross, less 7 or so of costs, for net proceeds of 243.

We also, during that quarter, prefunded some of the 2012 convertible notes that we fully paid off in April, so there was $51 million paid against that issuance during the quarter.

So when you take 243 less the 51, you’re left with a residual balance of 269. Of that 269, I said that about 73 of it was related to the return to us of collateral that had been previously posted.

It was about $50 million of proceeds from the sale of nonstrategic assets, and that was primarily scratch and dent loans and Fleet leases, and the residual balance of $146 million was fairly evenly split between working capital initiatives and the operating cash performance of the businesses.

Richard Eckert – B. Riley & Co.

Okay, good, and then the second question is that your effective tax rate was about 10 percentage points below my expectation. Is there anything unusual like a recovery from the valuation reserve on the deferred tax asset or something like that?

David Coles

I’m going to ask John Erdmann to address that one. John is our corporate controller.

John Erdmann

How are you doing? There was a favorable event in the effective tax rate related to state taxes, about $5 million, which you’ll see when the 10-Q comes out in the income tax footnote, but nothing related to the valuation allowance.

Richard Eckert – B. Riley & Co.

Okay. Thank you very much.

John Erdmann

You’re welcome.

Glenn Messina

Thanks, Richard.

Operator

We’ll take our next question from Jim Fowler with Harvest Capital. Your line is open.

Jim Fowler – Harvest Capital

Hello, gentlemen. One detail question and one general one. The detail, do you have any balance of loans where you have indemnified their performance rather than repurchased them?

Glenn Messina

Hi, Jim. It’s Glenn. The answer to that question is yes, we do. We do have a mixture of indemnifications and repurchases.

Jim Fowler – Harvest Capital

What’s the balance of outstanding loans where you’ve indemnified?

Glenn Messina

We believe it’s approximately $220 million. David or John, can you help me with that one? It is disclosed in our Q, which we expect to be filing at the end of the quarter -- or at the end of today, I’m sorry.

Jim Fowler – Harvest Capital

Is it disclosed by vintage or is it just a balance that’s disclosed?

Glenn Messina

Yes, John, go ahead. Can you --

John Erdmann

There’s a couple pieces of information. In the investor summary, you can see the pipeline of outstanding requests and we disclose that both by in total by agency and by private and by vintage. You can see that in the investor supplement. The -- I’m trying to --

Jim Fowler – Harvest Capital

Let me ask, does that include indemnification? I’m looking -- I’m just thinking specifically of outstanding indemnification balances, and then does your current reserves incorporate any losses you might expect from those indemnified loans versus repurchased loans, the prospects for repurchases?

Glenn Messina

Yes, it includes both.

Jim Erdmann

We consider them together, so yes, it includes both indemnifications and repurchases.

Jim Fowler – Harvest Capital

Okay, great. Okay, so then whatever you’ve reserved and your guidance for the perspective, the potential for the 140, I think you said, includes indemnifications that you have already in place?

John Erdmann

That’s correct.

Glenn Messina

Yes.

Jim Fowler – Harvest Capital

Okay, excellent. Thank you. Looking on page 17 of the investor package, prior conversations with lenders leads me to believe that the EOCs [ph] kind of go through these reviews chronologically.

Given, if that’s true, and I’m interested to know if that is true, actually, and then looking at your February and March upticks, have they gone into a new vintage or new period. I mean, it was just such a big increase. I’m just wondering if -- what could explain that if it’s not chronological.

Glenn Messina

Jim, they have not gone into -- this is Glenn, by the way. They have not gone into a new vintage year. Again, roughly 78% of our total outstanding repurchase requests are related to 2005 to 2008 vintage years.

The spike, we believe, is as a result of two things. One, they -- we believe they’ve allocated more resources to deal with their backlog of previously requested loan files from us, so they’ve allocated more resources to go through our defense claims, and the second is we believe they’re being more stringent in applying their criteria against our defense of their claims.

So I think it’s just one of they’re getting through the backlog.

Jim Fowler – Harvest Capital

And you mentioned additional staffing on your part. Is that going to be noticeable in your expense line or do you think it won’t be?

Glenn Messina

Oh, no. No, we’ve got roughly 5,500 employees here at PHH and we’re talking maybe 12.

Jim Fowler – Harvest Capital

Oh, okay. Fantastic. Great, Glenn. Thank you very much for your time.

Glenn Messina

Thanks, Jim.

Operator

We’ll take our next question from Joe Galzerano with Muzinich. Please go ahead. Your line is open.

Joe Galzerano – Muzinich

Yes, thank you. I’m sorry to do this, but I want to go back to Paul’s first question about the 140. I know it’s getting to the point where we’re beating a dead horse, but when you originally discussed it during your comments, I thought you said that we went and we made all these assumptions, and you went really fast so I didn’t write them all down, but you went through all these assumptions.

So one, if you could just go through those assumptions again, and two, I took it as these were the kind of -- our assumptions of a worst case scenario which got to the 140.

So maybe you could just give us some color on that, whether those were assumptions based on what you’re seeing of the industry or those were your, “Let’s just really go and say this is the worst case scenario and this is what we have,” so I’m just trying to figure out what that --

I know you said it’s reasonably possible. I get that, but I’m just -- I just want to go through the assumptions and give us color how conservative they are.

Glenn Messina

Okay. So, there’s a number of assumptions. There’s three main assumptions that I talked to earlier, and the first was assuming that the elevated level of repurchased demands that we’ve recently experienced continues through the end of 2013. Second is the company’s success rate in defending against those requests to climb, and third, the loss severities remain at the current levels.

Now, those are at a very high level. Underneath that, I just want to make sure you understand that there’s a number of other factors that go into this modeling. It is an estimate of what we believe is reasonably possible, and the factors of what we consider are home prices, the levels of home equity, criteria used by investors in selecting loans, borrowed delinquency patterns, general economic conditions, so there are a number of inputs into this, so it is just an estimate of what we believe is reasonably possible.

Joe Galzerano – Muzinich

Okay. Thank you. That was helpful.

Glenn Messina

You’re welcome.

Operator

And we’ll take our next question from Jordan Hymowitz with Philadelphia Financial. Please go ahead. Your line is open.

Jordan Hymowitz – Philadelphia Financial

Thank you. I have two questions and two topics.

The first topic is on the extra $165 million in a worst case environment. That’s only $1.50 a share. I mean, that still leaves your stock substantially below book value, even if your worst case scenario happens, so I just want to hear you guys say that this is what I think the worst case scenario is, not that it could be four or five times worse than this.

Glenn Messina

So, Jordan, let me clarify. The $165 million is what we have on the books, which is our estimate of probable loss. In addition, we’ve estimated it’s reasonably possible for us to incur an additional $140 million in losses that’s not in the $165 million reserve.

Jordan Hymowitz – Philadelphia Financial

I’m sorry. It’s my meticulous -- Is the 140 additional the worst case scenario plus the 165? It’s not going to be five times the 140 or something?

Glenn Messina

Jordan, it’s our estimate of what is reasonably possible.

Jordan Hymowitz – Philadelphia Financial

Is that a worst case reasonably possible or just reasonably possible?

Glenn Messina

It’s our estimate of what is reasonably possible.

Jordan Hymowitz – Philadelphia Financial

Okay, different topic, then.

The gains around share [ph] you guys are seeing are phenomenal at this point and no one seems to be focused on that side of the business, which is your core business, and you imply that it’s likely to stay that way in the near future?

Glenn Messina

Jordan, I didn’t -- my statement with respect to margins is they’ve been unusually wide in the first quarter. We really can’t predict where they’re going to go in the future. Historically, margins have been volatile in the origination side of the business.

Jordan Hymowitz – Philadelphia Financial

But from what you’re seeing this quarter to date, have they been stable at that level?

Glenn Messina

Margins have been, so far this quarter, have been consistent with what we’ve seen in the first quarter.

Jordan Hymowitz – Philadelphia Financial

Thank you.

Operator

And we’ll take our next question from Michael Kim with CRT. Please go ahead. Your line is open.

Michael Kim – CRT

Hi. Good morning and thank you for taking my question. Just wanted to talk about the foreclosure-related reserve. The increase this quarter, was there -- was this more influenced by an increase in the pace of repurchase requests or severities or just an extension of duration in resolving these requests?

Glenn Messina

Michael, it was influenced by pay -- by pace. I’m sorry.

Michael Kim – CRT

By pace? Okay.

Glenn Messina

By pace, yes.

Michael Kim – CRT

Okay. And I guess of the repurchase requests so far, I guess at least the trend that we’ve seen pick up in February and March, what percent of those are actually previously refuted, or things that you’ve kicked back but they’re coming back to you again?

Glenn Messina

Michael, unfortunately, we don’t -- we have not disclosed that historically, and I’m looking at John or Smriti. We believe it’s a reasonably small piece. We typically get through these things in the course of a series of discussions on it.

Michael Kim – CRT

I see, and just given we’re in May right now, how are the volume trends for repurchase requests into April? Was this pretty consistent in terms of vintage and composition relative to what we saw at the end of the first quarter?

Glenn Messina

Yes, they continue to be focused on ’05 through ’08 vintage years. That continues to be at least three-quarters of what we see.

Michael Kim – CRT

I see, okay. And one, I guess you just put in some new slides on the unencumbered asset coverage, just really appreciate that slide. I was just wondering, do you have expectations or goals for this coverage ratio over the course of this year?

I know we don’t have historicals in terms of the quarterly coverage ratios and not sure how much fluctuation we may see.

Glenn Messina

Michael, my goal -- again, we don’t have any covenants around this unencumbered ratio, unencumbered assets to unsecured debt ratio. My goal is to try to get the business to at least 3 to 1.

Michael Kim – CRT

3 to 1? And is that a goal -- over what duration of time?

Glenn Messina

I’d like to get there by year end and that can actually -- that gives consideration to effectively retiring the 2013 debt maturities, so I just want to make that clear.

Michael Kim – CRT

Okay, great, and my last question, is there any update to provide on the CFPB investigation, timing of resolution or perhaps the topics they’re focused on right now?

Glenn Messina

Michael, right now we have no material updates to report with respect to any regulatory matters.

Michael Kim – CRT

Okay, great. Thank you. Nice quarter.

Glenn Messina

Appreciate it.

Operator

And next we have a follow up from Paul Miller with FBR. Please go ahead. Your line is open.

Paul Miller – FBR

Hi, Glenn. Can you talk about -- I think a lot of investors are waiting for that revolver to get it out to a multiyear revolver rather than just a 12-month revolver, and is there any possibility of, if this cash continues to build up at this pace, to prefund the debt due in 2013 and then try to get that revolver negotiated out to a multiyear?

Glenn Messina

Hi, Paul. Part of our liquidity plan is to -- we want to get there -- negotiate a multiyear extension of our revolver within the 2012 calendar year, so that is something we’ve -- we’ve closed the quarter and we’re beginning to have some discussions internally with our lenders around the path to get that done.

Paul Miller – FBR

But is there a possibility that you could prefund that April ’13 debt this year or would you -- or you just wouldn’t do that?

Glenn Messina

We’re evaluating what the options are to, quote, “apply the cash,” so a number of different things we could do. We could set it aside, we could -- you could try to buy it in the open market, you can try to do a tender and exchange offer.

There’s a number of different mechanisms out there where we can do that, but Paul, we haven’t committed to any one mechanism just yet.

Paul Miller – FBR

Okay, thank you very much, guys.

Glenn Messina

Thank you.

Operator

(Operator instructions) And it appears we have no further questions at this time.

Glenn Messina

Okay. Thank you, everyone, again for joining the call and I look forward to speaking to you again next quarter.

Operator

This concludes the PHH Corporation first quarter 2012 earnings conference call.

Once again, ladies and gentlemen, the replay will be available beginning later today at the company’s Web site, www.phh.com/invest, or by dialing 719-457-0820 or 888-203-1112 using conference ID 4407247. It will be archived until May 16th, 2012.

You may now disconnect.

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