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PHH Corp. (NYSE:PHH)

Q1 2008 Earnings Call

May 9, 2008 10:00 am ET

Executives

Nancy R. Kyle - VP of Investor Relations

Terence. W. Edwards - President and CEO, PHH Corporation and PHH Mortgage

George J. Kilroy - President and CEO, PHH Arval

Analysts

Frank - FBR

Louis Syke - Tennant Capital

Bose George - KBW

Craig DeCesare - Wall Street Consulting

Bin Lowrance - Southern Brook Capital

Operator

Good morning ladies and gentlemen and welcome to the PHH Corporation 2008 first quarter earnings conference call. Your lines will be in a listen-only mode, during remarks by PHH management. At the conclusion of the Company’s remarks, we will begin a question-and-answer session at which time I will give you instructions on entering the queue to ask your questions.

Today's call is also being webcast and recorded for replay purposes. The audio replay can be accessed either on the Company's website at www.phh.com or by telephone at 1-888-203-1112 again 888-203-1112 or internationally 1-719-457-0820, again 1-719-457-0820 the pass code -- your access code would be 6492105, and the recording should be available approximately two hours after the conclusion of the call. It will be available until June 9, 2008. This access information is also described in the company's earnings release, and I will repeat it again at the end of our session. This call is scheduled to conclude in one hour.

At this time, I would like to turn the call over to Nancy Kyle, Vice President of Investor Relations. Please go ahead maam.

Nancy Kyle

Thank you Ed. Good morning and welcome to the PHH first quarter 2008 earnings conference call. On the call today are Terry Edwards, President and Chief Executive Officer of PHH Corporation and PHH Mortgage and George Kilroy, President and Chief Executive Officer of PHH Arval. After the prepared remarks by Terry and George, we will begin a question-and-answer session when other members of the senior management will be available. If you did not receive a copy of the earnings release we issued last night, you may access it from our website at www.phh.com. or you may call our investor hotline at 1856-917-7405 and request a faxed or mailed copy.

Please note that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of such forward-looking statements include our belief as to the achievability of our mortgage closings target without new account signings, our break-even assumptions for the mortgage originations business in 2008, our expectations regarding MSR performance, our expectations regarding increased funding cost and reduced unit counts affecting our fleet segment, our expectations regarding changes to our funding arrangements when the credit markets allow, our expectations regarding potential new clients signings in our fleet and mortgage businesses and our belief regarding our position for the future.

Our actual results may differ materially from those discussed on this call. Please see the risk factor section in our 2007 Form 10-K and our first quarter 2008 Form10-Q for description of issues that may lead to different results. Please call our hotline if you would like paper copies of these filings or you may access them electronically on our website and now I will turn the call over to Terry.

Terence Edwards

Thanks Nanc. Okay, let me first give you an outline of what we are going to cover. We are going to follow the same outline that we used during our year end earnings call on February 29th and that outline is as follows. We are going to -- I will touch on the results for each of the operating segments, then I will dive into the origination segment and the servicing segment; after that of I turn it over to George who will take you through PHH Arval and the results there.

George and then turn it back to me and we will talk about there various aspects of the mortgage company that are at risk on the balance sheet like we did last time. As our story continues to be our mortgage company book is book so, I will again go through that exercise. We will then touch on the liquidity and then we will open it up for questions. As Nancy said there’s George and myself and we’ve got other members of senior management here ready to bail us out if we go into territory that neither one of us should be in.

So summary wise, the originations business for the first quarter lost $8 million. The Servicing business lost $16 million and the vehicle business made $24 million. So for continuing operations the company was break-even. For the originations business as you’ve seen in the press release we had $10 billion in originations and given the fact that we’ve talked about $39 billion for a year being break-even one would conclude that in a $10 million quarter the company should be able to get the break-even.

As you know it was not and it wasn’t because of reduce liquidity during March. We were impacted by a total of $42 million related to agency ARMs, prime jumbo and scratch and dent revised marks versus year-end marks as spreads widened for all these products because of the lack of liquidity within the marketplace. You can see this effect on Page 12 of the press release.

This was partially offset by a $30 million benefit at the adoption of fair value accounting. In addition we were also negatively impacted as you see on page 12, relative to the first quarter of last year by increased cost associated with the hedge and this hedge we are talking about here related to the pipeline.

During the quarter there was incredible volatility in the marketplace as a whole, options cost were close to record high, but rates themselves moved around pretty dramatically. The prime mortgage coupon ended the year at 552, went to as low as 460, then back to as high as 595 and closed the year to 527. In my lifetime there has never been that kind of volatility and as a result you windup churning through some expense, putting hedges on, taking hedges off etc., so that’s what drove this other part of ineffectiveness related to the hedge.

Volume for the quarter was up 6% versus the previous year because the lower rates that we did experience did drive refi activity, which was a good thing. Pricing margins within the industry as we discussed on February 29th, remained favorable during the quarter relative to the past two years. As we talked in about February our prospect list continues to be strong.

As we look forward we think we can breakeven excluding the $30 million benefit from fair value accounting. So, what that means we would expect to get to $30 million of profit within the production segment over the course of the year, because we don’t account that benefit as real in any respect. This assumes the pricing holds that we achieved $39 billion in closings and we do not have anymore extraordinary events as experienced during March.

Shifting to servicing, servicing was not profitable during the quarter as we reduced the amount of the hedge in order rely on the natural business hedge. As just discussed refi activity does increase when rates declined to the levels we saw during the first quarter. During my comments on 229, I said a rate drop of 50 basis points would hurt us by $50 million to $70 million, but that would be a timing event that would be offset by higher origination volume.

For the quarter, rates dropped 25 basis points and were coupled when other factors including market liquidity for MSRs and wider mortgage spread we were hurt by $50 million. Today, our hedge is structured in such a way that a 50 basis point drop will hurt us by a $160 million and a 50 basis point rise will help us by a $120 million. While this is larger than usual we are comfortable for the following reasons:

Any write-down due to lower rates is more accounting driven versus economic. I mean we do not expect to see actual runoff at the accounting model levels. For example the accounting model levels in the first quarter and at quarter end assumed the 21% prepayment rate. The experience during the first quarter was 13%, so actual prepayments are not running at the levels that we are using the model to the asset.

In addition, things that contribute to this are 20% of our portfolio with jumbo and there is really no refi incentive for people who have jumbo loans today and 20% of our portfolio is over 80 LTV and in that case because of our price values etc, refi runoff is unlikely. Although as you may read Sandy Mayes is trying to do something in that space were people can refi at LTVs above 100%, but we will see how that place are.

We expect any real runoff in a different rate would be more than offset by benefit to the natural hedge and lastly any dip in rate we would expect to be temporary as experienced overtime when rates at historical lows they typical balance off those lows. As rates rose we would get back the accounting write-down. All this is subject to many variables plus third party market evaluation, which we receive each month it’s one of the variables that we put into our overall evaluation.

Servicing segment was also adversely impacted by approximately $13 million of additional foreclosure related and increases in our insurance reserves of $7 million. We expect to be continually impacted by these types costs throughout the remainder of 2008 assuming home prices continuing decline. What’s happening there is we do have loans that we are working through in a foreclosure and REO space and as loss to vary increases we have to increase the reserves associated with that.

So that takes care of mortgage business as it relates to the origination and servicing segments and now I’ll turn it over to George, to talk about PHH Arval.

George Kilroy

Thanks Terry; good morning. As we indicated in the press release the fleet segment had a good quarter, but the results are not necessarily indicative of what to expect on go-forward basis. Primarily due to our increase in funding costs and reduce unit drivers. As we reported in the 8-K in March, we will be experiencing increasing fees throughout 2008 associated with the Chesapeake Funding, our asset back funding facility.

On February 28, we renewed $2.9 billion of debt and therefore experienced only one months impact of these increased fees in the first quarter. Additionally the program allows when increase in fees of certain capacity levels are not reduced throughout the year. I can assure you that we will remain committed to reducing our funding cost and we will make the necessary changes as the markets allow.

That being said it is very important to know that we have more than sufficient funding for all of our leases and plan investments to include anticipated growth in the fleet business. Our unit drivers for our fee based product decreased versus the prior quarter, due to the impact of lost clients during the uncertainty since March 2007 surrounding our future ownership. Although that’s now behind us, we expect to pull impact that we’ll realize over the next few quarters.

In our industry when a client elects to move to another fleet management company, services such in fuel and maintenance are quickly dropped while the lease inventory runs off over the normal life of the lease to 3 or 4 years. This slower roll off allows the opportunity to continue to demonstrate to these clients the value we can provide and helps us to resign them in a later date.

The sales as we discussed previously during 2007, sales and new clients were very difficult given the uncertainty of ownership. However, our sales team continued to engage potential new clients and as a result of that activity our new signing activity has picked up significantly. That in conjunction with a strong pipeline of that activity is a promising sign that we are returning to a more normal environment in sales.

And lastly expense management has always been core to our business. To a combination of activity based costing and our own version of sixth segment we monitor our expenses in the head count to assure that we are sizing the organization appropriately, for the unit drivers that we manage.

Now I will turn it back to Terry.

Terence Edwards

Thanks George. So back to the mortgage company, where we said book is book because all of our loans are mark-to-market and we did not have a held for investment portfolio and as I said on 229 as a company we have been running in place for three years of book equity of $1.5 billion. Poor mortgage performance once again this quarter offset by great vehicle performance.

As we did in the last call, let’s review where we are for the key items of risk on the balance sheet at quarter end. We believe our MSR continues to be fairly valued at 1.15%. We know this because our peer survey tells us that; we continue to be in the middle of the path.

We also tend to know this because our prepay story relative to others continues to hold even to the different rates that we saw during this quarter. Based on public data you should know that we wrote our MSR down less aggressively than the industry in the first quarter versus more aggressively in both the third quarter and the fourth quarter. On a net basis we believe we are still conservative with this asset relative to the industry. Again we believe the value of the slower prepay speeds that we have although not reflected in the mark will be realized overtime.

Sifting to captive insurance as I said earlier we increased the reserves by $7 million during the quarter. That brings our reserves to $39 million for the captive. As discussed on 229 we still expect the present value or future premiums from the existing book will at least equal the present value or future paid losses. With regard to recourse at the end of the year we had $485 million of recourse that’s down to 459 million at the end of the first quarter.

Delinquencies are 5.36 per 90 day delinquency period -- for 90 days, versus 5.54 a year end, so slight improvement. 69% of what’s in the book was originated 2003 and before, 17% in 2004 and the remaining 14% in the more risky years of ’05, ’06 and ‘07. The other portion of recourse that we have is for the loans we sell where we keep risk for the first 18 months of the loan.

Any loan -- because the 120 days delinquency we must buyback during this first 18 months. That exposure was $2.4 billion at year end; its down to $1.9 billion at the end of the first quarter, and based on when we halted that this program as discussed last time this should wind down to zero by June of 2009. We are carrying a $151 million of foreclosure REO related assets with $23 million in reserves for this risk. All in credit reserves including our captive insurance reserves are $93 million versus $81 million at the year-end. As I said earlier, we may have to continue to add these reserves if housing prices continue to decline. Again, such a scenario puts pressure on loss of various assumptions and to repeat one more time, we do not have a hell of a portfolio position, all assets are marked.

Shifting to liquidity for 331 and these numbers are prior to the convertible issue although we did that fourth quarter end, it didn’t settle until early April. We had $117 million in cash available, we had $221 million in unsecured capacity via our bank lines and we had $912 million warehouse capacity and $430 million in vehicle capacity as shown on page 15 of the press release. As

I said in last quarter we are back to the 90s; GSE and prime jumbo are the only products where there is activity. However, we’re even less in active jumbo space as a result of what occurred during March as we wait for that market to get past the affects of the lack of liquidity which was driven by March.

As everyone knows we have now successfully accepted the convertible debt market and then add an additional $213 million to our liquidity position, which was not reflected in the totals that I just went through. As a company we’re moving to -- move our maturities out on our debt and we will continue to try to expand liquidity went practical. In summary, we feel good about both our businesses and believe that they are in good position for the future.

With that’s said there will be bumps in the road as we work through the credit crisis. This is far from over but hopefully the recent actions as I said will minimize volatility and we will not see another period like we’ve experienced in the past two quarters and especially March and lastly, on the behalf of our Board, our shareholders and all of our employees I want to thank Clair for the great work that he is done. We brought him out of retirement because of his expertise in public accounting and as you know we’re now current, it took us a while to get there. We have been incurrent since June and is the work effort -- is the work as I said has been boundless, his work ethic is boundless. So, on behalf of all we say thank you, thank you, thank you for that work.

At this point we will open up to questions. Myself and George are ready for whatever you’ve got. In addition we’re backed up by the management team as Nancy said.

Question and Answer Session

Operator

(Operator Instructions) And our first question of the morning, we’ll go to Frank at FBR (Friedman, Billings, Ramsey).

Frank – FBR

Hi, good morning. Question on the funding side for the fleet business; you mentioned the increasing fee related to the Chesapeake Funding. Could explain this in more detail; is this just something you are seeing related to the specific vehicle or is that something that’s across the industry and potentially how could that be passed on to the consumer or to the institution?

George Kilroy

The first part of your question is, it is -- my assumption is and I don’t have inside information to where the other of the industry fund, but my assumption is that all of those costs have gone up across the industry and contractually we are committed to an index and a markup for the leased vehicles. So, it will take sometime to pass that cost onto customers. In the event that a customer should elect this year to go out for and bid and we bid their fleet I’m fairly confident that they will see the realities of the marketplace in bids that are returned to them for funding. Did that answer your question?

Frank – FBR

Yes, it does. Thank you.

Terence Edwards

Thanks and at the end of the day as we said at the end of February, we have got a $30 million number that we have to figure out how to offset either by passing it on or by making other efforts to take out cost etc..

Frank – FBR

Okay and can I have a second question; on the fair value, the adoption of the fair value accounting, you have this $30 million positive mark. The -- on the loans held for sale there is a negative mark in there, so where do you get the positive impact here as the positive fair value coming from?

Terence Edwards

Mark Danahy is going to take that question. He is the CFO of the Mortgage Company.

Mark Danahy

On this fair value accounting, when we adopted this, the $30 million really is the value of servicing on interest rate lot commitments that were existing as of 12/31/07. That were not allowed to be fair valued at that time.

Operator

And next question, we will go with Louis Syke of Tennant Capital.

Louis Syke - Tennant Capital

I have a few questions actually and without trying to downplay the effects of widening spreads I just want to be crystal clear about what the underlying results are since they are spread kind of widen forever. So, if you look at the production business first, I see as you said a pretax loss of $8 million, so then excluding the fair value adjustment of $30 million, the warehouse losses of $42 million and the risk management in effectiveness of $26 million we get to a profit of $30 million, so that would be a margin of 30 basis points, is that how you look at it?

Terence Edwards

We wouldn’t look at it that way. I wouldn’t jump all the way to $30 million profit because some of that $26 million is real cost of hedging that’s going to be there year-in, year-out. Now, it’s $20 million higher than it was in previous years, so I would be more comfortable with saying a little bit better than breakeven $3 million or $4 million breakeven at this point, but to the extent that volatility would last we would grab some of that $20 million hedge effectiveness back.

Louis Syke - Tennant Capital

If the hedging cost is up $20 million, I mean why wouldn’t we add back the 20 and so we’ve go to today $24 million in profits or 24 basis points in margin?

Terence Edwards

Just because we don’t want to set the bar too high for the future Louie.

Louis Syke - Tennant Capital

Okay and then also quickly on the production business, the salary and related expenses went up quite a bit; I mean $8 million versus $45 million last quarter; why is that up so much despite that you have calculated --?

Terence Edwards

It gets lost in the saws around the change in the accounting, the fair value accounting FAS 91 is gone away, we adopted FAS…

George Kilroy

When it’s under the fair value we no longer will utilize FAS 91 accounting so there is deferring of expenses and recognizing against the sale. When you see our Q, you will see good comparative information in the descriptions there.

Terence Edwards

At the end of day as it will be laid out in the Q; when we look at cost on an apples-to-apples basis for the Mortgage Company, they were down $15 million for the first quarter over the first quarter of last year.

Louis Syke - Tennant Capital

Right so, this is not an apples-to-apples comparison?

Terence Edwards

That’s right; it gets clouded because of the accounting.

Louis Syke - Tennant Capital

Okay and then moving onto the servicing side so a pretax loss is $16 million with $50 million loss from the hedging ineffectiveness and again the vast majority of that shouldn’t be sustainable so, I would be looking at an underlying profit of $30 million or so?

Terence Edwards

No, we would say that that’s -- we wouldn’t get to it that way, because you just can’t instantly assume there is -- within the hedge itself there is ongoing cost related to the hedge for options etc, so you just can’t wipe that slate clean.

Louis Syke - Tennant Capital

Right. That’s -- I’d didn’t back all -- I mean how much of that is sort of the same cost of just having the hedge on versus the ineffectiveness and what was driven by the rate moves in the quarter.

Terence Edwards

I mean at the end of the day Louie, the servicing results are going to be dramatically impacted on a go-forward basis, based on how rates move and as we said we have backed off on the hedge as a whole so to the extent of rates stay steady, which they won’t, you’d expect some level of profitability for servicing, but it's going to be impacted by the continuing factors related to the housing market as a whole. So, we might have to put up more and more reserves as we go, which will ease into that servicing profit. If rates rise, the originations business is going to slowdown and we'll have some servicing pickup, because we get the right to servicing up. If rates decline and they said the numbers are much bigger now. Down 50 is a $150 million, up 50 is a $120 million. So, there’s going to be a lot of noise in servicing has we progress through the year, but as the Company we feel like this is the prudent way to approach this servicing because as I said pre-paid is not as fast as have been modeled and all this will play out over time.

Louis Syke - Tennant Capital

Okay and I understand that there should be a hedge -- I’m just struggling with the fact that the rate can’t move in one direction forever and with the results presented the way you present them, it’s difficult for people to understand the earnings power of the underlying business. I mean the way I look at it is even if you assume some cost for the hedging both on the warehouse side as well as the servicing side and for the warehouse, so the holding period loss is associated with widening spread and even taking out this fair value adjustment the EPS for the quarter would have approached $1 per share and you don’t really get that impression reading the release.

Terence Edwards

Yeah, understood and hopefully everyone is fabie as you in terms of how you look at it. Recognize that we've put the date out there -- with regard to earnings power you can see the historical power associated with the servicing business. The biggest thing that’s held us back as a mortgage institution has been the lack of earnings power on the origination side and we've been working hard to make progress there. We made progress and to your point with -- if you take out some of this volatility, we’re starting to get that thing back to plus territory if you will. So, I would hope that investors look at the historical power associated with servicing, but at the end of the day you have to put the two businesses together. We have got the natural business hedge working, we think appropriately and together the goal is to get the mortgage business to total profitability this year, which it has not achieved for the last couple of years.

Louis Syke - Tennant Capital

And then just quickly on the -- congrats on the new outsourcing partnerships; can you give us a sense for the volumes associated with that if you looked at it on a annualized production volume basis.

Terence Edwards

We got to just let that play out. On that’s -- every time we put a number out there, we run the risk that that’s not the number, so obviously they are good names and we will see how the volume plays out as we go. They’re all factored into our goal of getting to the $39 billion, so they’re a part of puzzle.

Louis Syke - Tennant Capital

And I mean I understand that no one can forecast volumes, but can you tell us what they did in ’07?

Terence Edwards

’07 is different than ’06. I just don’t want to go there client-by-client Larry.

Operator

Our next question will go to Bose George at KBW.

Bose George – KBW

Hi, good morning. I had a couple of questions; one was just on the volume. It was up pretty nicely, but it looks like a big part of it was a spike in refi activity and I assume some of that was earlier in the quarter, so I was just wondering what the run rate on closings is right now?

Terence Edwards

Thanks Bose. Part of my comment had a section that has done that talked about rates had risen recently and I wrote that in the last couple of days; in last two days rates are back down to were we ended the quarter. As rates flows through April and in the first week of May we saw volumes slowdown. So, your point we did get a pickup from a refi activity during the first quarter. It also should be noted, the first quarter was above of our expectations, so that offsets any slowdown we might see in the back half of the year to get to the $39 billion. So -- but the point I was going to make is as we saw rates rise, we did see a slow down in volume which would have put our $39 billion, somewhat at risk. We think with new signings and those that we’ve already mentioned that we could still achieve the $39 billion, but we were seeing a slow down in business. Now in the last few days since rate have drifted back down and this is the natural business hedging action. We’re seeing a little bit of a pick up and we expect that pick up to start to come back again. So you’ve got -- we think the perfect balance between the originations business and the servicing business and the way we’ve structured the overall hedge, to the extend that our $39 billion was in jeopardy from an origination standpoint that would mean rates would be higher than they're all now and because of the structure of the hedge, all things being equal and recognizing, the danger I would say and assuming rates go up or don’t change the servicing business it just should be fine and should help offset any shortfall from the $39 billion in originations, but we also feel good about the pipeline to get additional clients, so at the end of the day, we still feel good about the $39 billion, but to your point, were sort of at a pivot point, with rates as a whole sitting around 5.30 on the par mortgage coupon on right now. As they sip there is an increase in refi activity that picks up significantly as you approach 5% and then there is a slowdown as you move above 5.30 up closer to the 5.50 level.

Bose George – KBW

Great, thanks; just a clarification on the $42 million hit on from this scratch and dent does that flow through the gain on sale income line and also given the change in FAS 91 is the gain on sale number not comparable enough to the rate within the past with that change as well?

George Kilroy

Yes, the scratch and dent inflations is a gain on sale and the gain on sale number will not be directly comparable in what’s your looking at right now, but again when you see the 10-Q later today you will see the good comparison data there.

Bose George – KBW

Okay and then just one last question on the $250 million, the convertible notes you issued. Did you give the conversion price for that and the 4% cost. I assume that’s lower than the cost of the revolving credit line you’re paying down so to net benefit your interest expense?

Terence Edwards

Revolving credit line right now given where LIBOR is plus the spread is right around the same cost.

Bose George – KBW

Okay.

Terence Edwards

So, the two are similar and then the conversion cost, the conversion number is….

George Kilroy

Is $20.50 with the bonds…

Terence Edwards

And then we bought the hedge to move that up to $27.20.

Operator

And our next question goes to Craig DeCesare of Wall Street Consulting. Please go ahead.

Craig DeCesare - Wall Street Consulting

Hi, guys. Most of my questions have been answered I just have a quick one. In the fleet segment -- what’s in the other expense line and why did it drop so much?

George Kilroy

The other operating expenses…

Craig DeCesare - Wall Street Consulting

Yes.

George Kilroy

Most of that is cost of good sold, that where the cost of the structure in our transnational business went through as well as the -- we had two dealerships and our dealership business runs through there as well. So, most of that is cost of good sold, some of that is also corporate overhead that we talked about being reduced from last year.

Craig DeCesare - Wall Street Consulting

So, is that an unusual drop this quarter or is that something going forward that would be in the range of any annual number?

George Kilroy

Well, you got to remember if cost of goods sold was down that means we sold less goods so we would hope that at the end of the year we get back to where we -- to a more normalized price and the dealerships I mentioned there, they are not a real big part of our business, but I’m not sure that business is in great shape so.

Craig DeCesare - Wall Street Consulting

Okay. Just a couple of other quick ones, did you sell any MSR’s in the quarter?

Terence Edwards

We did not.

Craig DeCesare - Wall Street Consulting

No, okay. Is that pretty much behind you?

Terence Edwards

Yes.

Craig DeCesare - Wall Street Consulting

Is the termination fee that you recorded, is there a tax on that, is that net of tax the $42 million?

Terence Edwards

The $42 million is pretax…

Craig DeCesare - Wall Street Consulting

Okay. So that, is that taxable -- fully taxable?

George Kilroy

Yes.

Terence Edwards

Yes.

Craig DeCesare - Wall Street Consulting

Okay and then just the sort of a theoretical question. Why are you sticking so, strictly to the $39 billion target. Why not reduce that a bit and just adjust the cost structure down?

Terence Edwards

Because we still feel good about the $39 billion...

Craig DeCesare - Wall Street Consulting

Okay. Can’t you make just as much money at $35 billion, if you reduce, instead of….

Terence Edwards

No, as we look at our company, any pickup beyond the $39 billion is leverage because of the fixed cost associated with our platform. Our platform is much more retail oriented and therefore it’s got more fixed cost associated with it. So, there is a leverage point. So as we get beyond $39 billion, the way we look at life as each additional billion should generated $10 million to the bottom line.

Craig DeCesare - Wall Street Consulting

I understand that. What is -- so you're saying so there a scenario where you can reduce that fixed cost structure again? So, so --

Terence Edwards

We continue to look at cost, but we feel really good about how we're positioned in the prospects that we have in the pipeline and it's our job to deliver a high-level service for our clients, and to reduce our cost structure any further would put the service that we deliver add risk for our clients today. Now we continue to work the cost structure and try to determine additional ways to take out cost, but for right now as I said we feel good about to 39 billion, we feel good about the prospects for our pipeline and we are thinking beyond 39 billion. Our internal goals are obviously bigger than that.

Craig DeCesare - Wall Street Consulting

And just one last quick one, I’m sorry -- can you just again touch on the scratch and dent, losses and what’s driving that and is there a risk every quarter going forward on those or is that being continually reduced?

Terence Edwards

Giving what we just went through I would say yes, there is a risk every quarter. In some way I kind of feel like a puppy dog in a room and everybody walking into the room has got news papers and that’s just -- you just become careless because you think you've seen everything as of 229 and then you March and you haven’t seen everything. So, with regard to the scratch and dent, the write downs were related to scratch and dent, prime jumbo and ARM - agency ARMs that we had in the pipeline and the three of those totaled to 42 million. The agency ARMs, the issued there as we priced when spreads were tighter in January and February and by the time those loans close we redelivered spreads has widen dramatically. For example, it's called the bean spread. We are pricing when the beam spreads were 180 to 190 and it went to it highest 350 in March when the loans were closing. So, we had to take our lump and sell those loans at those highest spreads not known where it was going to go from there. One would say “Of course they have going to come back down”, but who knew and who knew what else would happen during the months of March. So, it wasn’t all scratch and dent it was these arms spreads were 19 million, 7 million related to prime jumbo loans because of liquidity completing dried up for prime jumbo loans. We as a company have been completely focused for at least the last nine or ten months, when the scratch and dent market really started to come apply. Scratch and dent loans use be sold from 92, they are now sold for something more like 50. So, our goal in our entire managing team is focused on do not ever create scratch and dent loan. So, we think we’ve choke that off, we think we've seen the worst of it in March, but one never know as giving what everyone has seen recently.

Craig DeCesare - Wall Street Consulting

At some point, could you actually get a benefit from that even on a temporary basis, if you raise the loan the right way in it?

Terence Edwards

It would be to minimums as you just roll backup up the loans that did happen to sit there, but I would expect that to be the minimums and not anybody - and not anyone should be a one time affect just as I don’t expect you to count one time negative I don’t want you to count, onetime positives.

Craig DeCesare - Wall Street Consulting

If you could pick any – theoretically looking our, you talk about all the moves from where the rates go and on the servicing and production, if you could have your perfect environment over the next year what would you want to see that the rates there?

Terence Edwards

Just sit here, don’t move let us continue to sign-up our prospects, take market share to that way.

Operator

And our next question goes to Charles Jack at Wall Street Access. Please go ahead.

Charles Jack - Wall Street Access

I just wonder, if you could talk a little bit about how the secondary market looks now versus the first quarter. I mean, are you seeing any kind of sequential improvement from March, into April, and then into May at all?

Terence Edwards

Limited improvement, well we are seeing spreads on agency products comeback in closer to more historical levels. Traditionally, the spreads on 30 year fixed products would have in a high 70s, 80s would be a more traditional level and also now setting at 95, so some liquidity regarding there as Fenny and Freddy get more active in the marketplace. We’ve -- the jumbo market loss, some securities have traded when you reverse engineer the rates to that would be for the consumer. The securities market is really not a viable market for new originations right now, because it would produce like an 8% interest rate for 30 year fixed jumbo rates, which is clearly not a rate that somebody buying a house in the jumbo segment would be – would be looking to utilize. So, that aspect to the market hasn't comeback yet it got ways to go to bring that back to, a more realistic rate would be more like six in three quarters close to 7%. So when you're in the eight, we’ve got a way to go to bring those spreads back into something that would be in a more traditional.

Charles Jack - Wall Street Access

Okay great, and then just one, quick one on the fleet side, I mean I saw a presentation you guys put out early in the first quarter, they talked about may 48 - 48% of fleet market is un-served by staying on the top 10 fleet guys, I know it’s been a pretty stable business historically, but do you guys have kind of initiatives to capture some of that market or is that any kind of opportunity going forward?

Terence Edwards

Net 48% typically represent very small fleets or extremely large fleets. We keep taking a look at how far down can we go in fleet size to be effective so, we will continue to look in that segment to you see if there is some opportunity force. I'd suspect that it's not the tremendous opportunity what we will continue to look at it.

Operator

(Operator Instructions) And we do have another question in the queue. This is Bin Lowrance, I believe it is at [Southern Brook Capital]. Please go ahead.

Bin Lowrance - Southern Brook Capital

Yes. Hi, good morning. Just want to follow-up quickly on the SG&A for the production segment is all of the increase due to the fact 90s - 91, or is there any other element that sort of increased the expense.

Terence Edwards

No, there weren’t any other elements that increase the expense. We'll provide a better comparison in the queue and you'll be able to see that, expense management is being managed debt at the corporate level, because our - as George talked about the corporate allocations are down a little bit and then the expense management, as George said is a focal point out his business, and it's also a focal point of them of the own mortgage business. So, no surprise increase in expenses and we continue to work them in all angles.

Bin Lowrance - Southern Brook Capital

Okay, and then cost of hedging in that segments where -- which lines doest that affect in the P&L?

Terence Edwards

That’s in the gain on sale.

Bin Lowrance - Southern Brook Capital

Okay. So I’ll also include it in the P&L, Okay thanks.

Operator

And Mr. Edwards, we have no other questions in the queue at this time. So, I'd like to turn the call back to you for any closing sir.

Terence Edwards

Okay. Thanks Dave. As always we thank everyone for listening on the call. At the end of day as we say, look our companies -- our both businesses are well positioned over the long haul, were both going to be successful. There will be bumps in the road, but all of us at PHH feel good about life as we're going forward. Thanks again, we look forward to speaking to you in next quarter.

Operator

Thank you. That does conclude the PHH 2008 first quarter earnings conference call. Once again, ladies and gentlemen, the replay will be available in approximately two hours at the company’s website at www.phh.com or by dialing 1-888-203-1112 again 888-203-1112, or 1-719-457-0820 again 1-719-457-0820, using pass code or access code 6492105, 6492105. It will be activated until June the 8th, 2008. You may now disconnect. Thank you.

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